Changes in Accounting Standards for Environmental Liabilities

By Collin Ackerman of Encore Redevelopment, June 2009

Standards in accounting for contingencies such as environmental liabilities will likely become much more stringent in the near future.  In response to calls from investors seeking greater transparency, the Financial Accounting Standards Board released an exposure draft revising FASB Statement 5 (Accounting for Loss Contingencies) in June of 2008 stating:

• Companies must disclose contingencies that are “more likely than not”, or greater than 50% likely to result in loss. The original statement required disclosure of contingencies in which the possibility of loss was “probable” or greater than 75% likely.

• All loss contingencies must be noted unless the possibility of loss is remote. Even in the case where the chance of loss is remote, the issue must be noted if it is expected to be resolved in one year or less. The original text stated that contingencies of reasonable possibility must be noted only if the value could be reasonably estimated. It also allowed companies to use the lowest estimate. The revised statement requires companies to disclose the market value that a third party would pay for cleanup (in the case of an environmental contamination issue.)

• Quantitative and qualitative disclosures would be required in accounting notes however accrual of these values would not be required.

• Tax incentives are available to companies to cleanup contaminated land. All expenses for cleanup are fully deductable in the year incurred rather than capitalized over a period of many years.

• Owners of contaminated land also have the option of selling to a bona-fide prospective purchaser, eliminating the liability.

The original draft was open for comment from June 2008 until August 2008 and was met with significant opposition.  The major objection was the alleged damaging effect of the enhanced disclosure requirements on pending lawsuits.  The draft was repealed in the fall of 2008 and a revised edition is expected to be released during the second or third quarter of 2009.

Although we do not know exactly what the revised statement will require, it is certain that the new requirements will result in a greater number of environmental contingencies being reported and at greater cost.  Depending on the timing of the release, changes in reporting could be required as early as December 15, 2010.  As a result of the increased requirements for disclosure of environmental liabilities on corporate balance sheets, we anticipate seeing an increase in the number of liability transfer deals being transacted on environmentally contaminated property.

Details and updates on the FASB Statement 5 can be found at: http://www.fasb.org/project/accounting_for_contingencies.shtml#next_steps