Publicly held companies are beginning to report for the first time to the Securities & Exchange Commission (SEC) tens of millions of dollars in estimated liabilities that they face for retiring assets that contain hazardous materials, such as asbestos or other toxic compounds, to comply with a new accounting rule that took effect late last year.
Corporations are required to comply with the new accounting rule because it is considered a Generally Accepted Accounting Procedure under the Sarbanes-Oxley corporate reporting law.
Shareholder and environmental activists say the new liability disclosures will serve to warn investors about companies at risk of tort claims and government action that could severely weaken their bottom line. The disclosure requirement will also encourage management to be “forward-looking in terms of avoiding environmental liabilities,” says a source with the Interfaith Center on Corporate Responsibility (ICCR), which lobbies for increased corporate disclosure. ??In “8K” statements filed with the SEC over the past few weeks, a slew of major corporations have documented potential liabilities for the fist time under the new rule, according to the filings and sources tracking the issue.
Ford Motor Co. Jan. 23 reported a first-time $251 million charge to earnings to comply with the rule, United Technologies reported Jan. 24 that it faced a $95 million charge, while ConocoPhillips reported Jan. 25 that it faced an $88 million charge to its income statement. Other corporations facing charges in excess of $10 million include Marathon Oil ($18 million), Dow Chemical ($20 million), 3M ($35 million), Commonwealth Edison ($42 million), Citigroup ($49 million) and Eastman Kodak ($57 million).??The accounting rule, developed by the Financial Accounting Standards Board (FASB), also includes a first-time requirement to use a formula for determining the cost of liabilities that will likely raise a corporation’s estimated liabilities, according to an accounting industry expert familiar with the proposal.
The rule includes a requirement to use a weighted probability formula in determining the cost of such liabilities, regardless of how likely it is to occur, in reporting those liabilities on their income statements, according to sources familiar with the proposal.
FASB Interpretation No. 47, or FIN 47, specifically requires companies to examine the future liabilities they face when selling or retiring assets, including buildings that may have asbestos and sites such as electric utility poles containing polychlorinated biphenyls. Relevant documents are available on InsideEPA.com.
In addition to including the liabilities in their income statements, the companies are expected to detail actual cleanup costs when they unveil their balance sheets later this year, the accounting expert says.
The same requirement will soon go into effect for state and local governments in accounting for their pollution remediation liabilities, but is not yet required under the federal government’s accounting standards, the source says.
FIN 47 took effect over the objections of industry, including chemical makers and electric utilities, who had argued vigorously that the disclosure requirement was subjective and would make it more difficult for industry to attract investors. For example, American Electric Power argued in public comments that the FASB interpretation “provides examples that are contradictory and cannot be applied consistently. In addition, we believe the examples could lead an entity to record a liability when its legal counsel has determined it does not have a current legal obligation.”
The FASB said when it finalized the rule in March 2005 that it would result in “more consistent recognition of liabilities relating to asset retirement obligations, more information about expected future cash outflows associated with those obligations, and more information about investments in long-lived assets.”
Shareholder and environmental activists are heralding the rule change as “landmark” for getting environmental liability information to investors. But they also note that the requirement to report environmental liabilities is narrow. For example, it does not require — as some groups have urged — companies to account for potential risks that cannot be assigned a dollar value, such as the possible costs of future climate change rules.
The ICCR source says the rule change is important because it represents a key shift in accounting rules requiring disclosure of what were previously off-balance-sheet risks for investors.
Prior to the adoption of FIN 47, for example, a company did not have to report the potential cost of selling a building that was contaminated with asbestos or property that held leaking underground storage tanks. “These facilities are not just sitting there mothballed, they are a liability . . . and their liability accrues the longer they sit,” the source explains.
Environmental and shareholder activists are also welcoming the recent corporate reports. An environmental liability attorney familiar with the rule says, “Ford is taking a $251-million hit to earnings and that doesn’t even reflect the actual liability. The income statement is just the impact of the rule’s adoption on the balance sheet.” The source explains that the numbers will likely rise to include the estimate of retiring the asset when companies submit their 10K filings in March.
The attorney adds that many companies are being caught unaware by the new requirement. A second attorney notes, “The rule has not received the widespread attention that it deserves.”
The first attorney says it is unclear how stringently the SEC will enforce FIN 47. “It depends on what comes back in the first round of 10Ks. If there are widely varying numbers, the SEC will likely take a look. Conoco posted an $88-million charge and if all other major oil refiners report nothing” that would raise a red flag, the source says.
The second attorney source adds that the Sarbanes-Oxley Act of 2002 — adopted following widespread corporate accounting scandals — includes requirements on filings by auditors and CEOs that strengthen FIN 47 regardless of SEC enforcement.
Sarbanes-Oxley requires that financial statements “must comply with Generally Accepted Accounting Procedures [such as FIN47] and if companies do not report their financial statements properly, they have violated securities law and misled shareholders,” the source says.
In particular, Section 404 of the accounting law requires companies to review the soundness of their “internal controls,” which now include their asset retirement obligations. In the past, companies with potentially contaminated assets might not have assessed them. “Maybe you don’t test because you don’t want to know” about contamination, the source adds.
Meanwhile, the Government Accounting Standards Board (GASB), which dictates accounting procedures for state and local governments, is preparing to adopt the same weighted probability formula as contained in FIN47 as part of a proposed standard for governments to account for their pollution remediation liabilities, according to a GASB source.
The source says the old formula — which is still used by the federal government — only required a liability to be accounted for if its occurrence was considered “probable.” If a liability’s occurrence was considered “reasonably possible,” then it needed to be discussed in financial statements but not accounted. And if the occurrence was considered remote, it need not be mentioned at all.
The new approach adopted in FIN 47 and GASB is based on the ASTM International standard for estimating monetary costs and liabilities for environmental measures, the GASB source says.
Industry, states and local governments objected to this aspect of the new standards as well, but GASB “believes a number that represents all potential outcomes is better and more representative,” the source says.
A second shareholder activist adds that adoption of the ASTM standard is something like-minded groups have long been seeking, and have a petition pending with the SEC on the issue.
The GASB source adds that the pollution remediation accounting requirement outlines five circumstances where state and local governments would have to include cleanup costs in their financial statement, including when EPA names those governments as cost-sharing parties in a Superfund cleanup.
GASB is taking comment on the plan until May 1 and expects it to take effect June 15, 2007.