Environmental Accounting

Business and Economic Review, Apr-Jun 2006 by Stanko, Brian B, Brogan, Erin, Alexander, Erin, Chay, Josephine Choy-Mee

Here's why projected cleanup costs from hazardous waste sites will be finding their way onto the balance sheets of Corporate America.

"...thirty years ago we began to fight environmental battles with a mainframe approach that included, and I am going to make up a word here, 'siloed' environmental laws and 'siloed' environmental approaches. We now know that we have picked the low-hanging fruit and what's left are more complex problems, more difficult problems ..."

-U.S. Environmental Protection Agency, 2004

Monitoring the production and disposal of hazardous waste has been a top priority of the United States government and the Environmental Protection Agency (EPA) since the mid-1970s, largely as a result of the Love Canal environmental disaster.1 Unfortunately, the remediation of hazardous waste sites is not finished, and cleanup cost estimates range anywhere between $500 billion and $1 trillion. American corporations will ultimately be held accountable for these costs. What remains to be seen, however, is exactly who, when, and how much.

In terms of corporate responsibilities, this article discusses requirements regarding the financial reporting of environmental liabilities and current initiatives that should improve the measurement and disclosure of these liabilities. Investors and business professionals alike must understand the significance of these obligations as they relate to current and future corporate financial statements.

Financial Reporting

Financial reporting requirements have evolved over time under several governing bodies. The securities Act of 1934 created the securities and Exchange Commission (sec) and gave it the authority to administer federal securities laws and prescribe accounting principles and reporting practices. Companies that are considered under the jurisdiction of the SEC include any company whose stock is publicly traded. As a result, these companies are required to follow SEC disclosure requirements in their filings.

The Financial Accounting Standards Board (FASB) is responsible for establishing the current standards of financial accounting and reporting. The standards or pronouncements that the FASB issues, "Statements of Financial Accounting Standards" (SFASs), are officially recognized as authoritative by the securities and Exchange Commission and the American Institute of Certified Public Accountants (AICPA), the national professional organization of CPAs.

Until recently, the AICPA played a prominent role in the accounting and reporting environment. But as a result of the Sarbanes-Oxley Act of 2002, the AlCPA's Auditing Standards Board (ASB) was limited in its role of establishing Generally Accepted Auditing Standards. Auditing and related professional practice standards as they pertain to public companies are now established by the Public Company Accounting Oversight Board (PCAOB), a private-sector, nonprofit corporation created to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports.

Evolution of Environmental Accounting Standards

The common definition of "environmental accounting" is "the identification, measurement, and allocation of environmental costs, the integration of these environmental costs into business decisions, and the subsequent communication of the information to a company's stakeholders" (AICPA).

Typical environmental costs include off-site waste disposal costs, cleanup costs, litigation costs, and other related costs. Shown below is a timeline that identifies the regulatory releases by many of the financial reporting governing bodies followed by a brief discussion of each rule or legislative initiative.

SFAS 5 and FIN 14

The first accounting standards or interpretation of standards that could be applied to environmental liabilities were enacted by the FASB in 1975 and 1976. These rules covered a generic grouping of contingent liabilities (including environmental liabilities). Initially the FASB stated that contingent liabilities arising from environmental cleanup costs should be accounted for and disclosed according to Statement of Financial Accounting Standards (SFAS) No. 5, "Accounting for Contingencies" (FASB 1975). One year later, the FASB issued Interpretation (FIN) No. 14, "Reasonable Estimation of the Amount of a Loss" (FASB 1976), offering additional guidance regarding loss contingencies. Essentially, the standard required losses to be accrued for when they became "probable and reasonably estimable." SFAS No. 5 is still followed today by accountants who are considering the measurement and disclosure of environmental liabilities.

Superfund

Prior to Congress passing legislation granting the EPA authority to identify and sanction Potentially Responsible Parties (PRPs), most reported environmental liabilities were minimal. That changed in 1980 when Congress passed the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), commonly know as the Superfund Act. CERCLA established strict regulatory requirements regarding the release of hazardous substances from existing or future waste sites.