BACKGROUND

P&C, Inc (PC) operations occasionally result in contaminated soil at the company’s US based factories. PC company policy allows contamination cleanup when required by environmental legislation. The company also needs to install smoke filtering systems before the law is instituted early next year.

PC is concerned with the financial accounting treatment for two environmental issues: (a) environmental cleanup, and (b) smoke filter installation for year 20x2. Both issues, if not resolved, could lead to legal action against PC if not followed by a prescribed date.

The Company needs to determine if the contaminated soil and smoke filter requirement should be disclosed on the financial statements as an asset retirement obligation, loss contingency, or an environmental obligation.

APPLICABLE AUTHORITATIVE LITERATURE

FASB Accounting Standards Codification (ASC) 410 Asset Retirement and Environmental Obligations
FASB Accounting Standards Codification (ASC) 450 Contingencies

DISCUSSION OF ALTERNATIVES

The following section will address the alternative treatments accounting for both the remedial action and smoke filtration system under US GAAP. Recording both issues as a loss contingency will be discussed first, followed by soil contamination as environmental remediation, then applying the asset retirement obligation treatment for pollution from normal operations.

Alternative 1: Contaminated Soil and Smoke Filter
Disclose both environmental issues as a loss contingency using a footnote.

Soil contamination and smoke filters both meet the definition of contingent loss. ASC 450-20-20 states:

“An existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur…”

Cleanup costs, extent of the pollution, and legal fines are few of the uncertain variables inevitably resolved by the new laws and requirements. Until the laws go into effect, variable uncertainties continue to exist. The uncertainty resides with the amount of loss, not if a loss exists. Difficulty in estimation results in loss recognition in subsequent periods. Per ASC 450-20-25-7:

“If a loss cannot be accrued in the period when it is probable that an asset had been impaired or a liability had been incurred because the amount of loss cannot be reasonably estimated, the loss shall be charged to the income of the period in which the loss can be reasonably estimated and shall not be charged retroactively to an earlier period... “

Understanding the amount of pollution and contamination from the factory is difficult, especially in estimating the extent of the total loss. Pollution experts should evaluate factory pollution to estimate appropriate treatments, required time-frame, and associated costs.

The company should recognize the loss contingency in the period where it can reasonably estimate the total cleanup expense. However, a loss contingency footnote disclosure including an explanation the difficult estimation would be appropriate for US GAAP.

Alternative 2: Contaminated Soil
Record the liability at the minimum estimate

The company’s soil pollution did not originate from normal operating activities because company reports specify contamination would “sometimes” result in contamination. Costs associated with remedial treatment are difficult for PC to estimate, especially because the company has not done an environmental cleanup in the country before. ASC 410-30-15-3 provides the following guidance:

“Uncertainties are pervasive in the measurement of environmental remediation liabilities, and reporting entities are required to recognize their best estimate at the particular point in time (or, if no best estimate can be made, the minimum estimate) of their share of the liability and to refine their estimate as events in the remediation process occur.”

The minimum estimate is required to share on the financial statement. According to US GAAP, PC can make a conservative estimation based on minimum costs, such as a basic investigation, and record the liability in the current year. Over time, adjustments can be made to record accurate projections for the remediation obligation.

Alternative 3: Smoke Filters
Potential settlement methods and costs should be reported at estimated present value.

An oil refinery emits smoke and pollution into the air. Such pollution is environmental contamination resulting from normal business operations in the oil industry. ASC 410-20-55-7 illustrates:

“…Obligations that result from the normal operation of an asset should be predictable and likely of occurring. For example, consider an entity that owns and operates a nuclear power plant. That entity has a legal obligation to perform decontamination activities when the plant ceases operations. Contamination, which gives rise to the obligation, is predictable and likely of occurring and is unavoidable as a result of operating the plant. Therefore, the obligation to perform decontamination activities at that plant results from the normal operation of the plant.”

PC has an obligation to perform decontamination activities because of the company’s normal operative nature, falling under ASC 410-20-5-1.

“An obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel.”

Legislation requiring smoke filters creates an obligation for the company to purchase and install the filters before June 30, 20x2. This obligation creates a liability based on the normal operation of the asset. ASC 410-20-15-2 states:

“Legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, or development and (or) the normal operation of a long-lived asset, including any legal obligations that require disposal of a replaced part that is a component of a tangible long-lived asset.”

The legal obligation the company has to install smoke filters will effect the retirement of the building from its normal use. Since PC knows the deadline at hand, they should have potential methods of settlement with associated costs that should be reported on the financial statements estimated at present value.

RESOLUTIONS

Contaminated Soil
The company should record the remediation obligation at the minimum cost for cleanup. Disclosure of the environmental remediation, even at a minimal level, will impact the books slightly the first year with adjustments to the obligation as the extent of cleanup is determined. The amount should be adjusted to reflect current expenses related to the contamination.

Smoke Filters
On June 30, 20x2, legislation requires PC to have smoke filters installed. Since the deadline, the company should recognize the potential costs associated with mounting the filters at present value. As the process continues, the company should adjust the estimated present value to reflect expenses of the project.