On the Radar
Environmental obligations can arise from (1) the improper operation,
retirement, or closing of a facility and (2) the current or former ownership of a
facility at or near a contaminated site. Entities that have incurred a legal
obligation to remove or remediate pollution or contaminants from environmental media
such as soil, sediment, groundwater, and surface water are generally required to
recognize an environmental remediation liability in their financial statements when
certain conditions are met.
An asset retirement obligation (ARO) is a legal or contractual
obligation associated with the retirement of a tangible long-lived asset that
results from the acquisition, construction, development, and normal operation of
that long-lived asset.
The FASB has established specific guidance on accounting for
environmental obligations and AROs in ASC 410.
Environmental Remediation Liabilities
The FASB’s guidance on accounting for environmental remediation
liabilities is codified in ASC 410-30, and the recognition and disclosure
guidance is principally based on a framework outlined by the guidance on loss
contingencies in ASC 450-20. Environmental remediation liabilities are a
specific type of contingent liability that arises from federal, state, and local
environmental regulations — or, in some instances, international treaties —
related to contamination in soil, sediment, groundwater, and surface water.
In the United States, the U.S. Environmental Protection Agency (EPA) is the
primary, though not the only, environmental regulator. Other federal, tribal,
state, or local agencies may also have authority to regulate environmental
programs. The guidance on accounting for environmental liabilities classifies
laws into two categories: (1) environmental remediation liability laws and (2)
laws intended to control or prevent pollution. The following are some of the
main federal regulations that serve as drivers of environmental liabilities:
- The Clean Air Act of 1970 (CAA).
- The Clean Water Act of 1972 (CWA).
- The Toxic Substances Control Act of 1976 (TSCA).
- The Resource Conservation and Recovery Act of 1976 (RCRA).
- The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA or the “Superfund”).
As with other contingent
liabilities, an environmental remediation liability is recognized when it is
probable that such a liability has been incurred and the amount of the liability
can be reasonably estimated. There is often uncertainty about whether and, if
so, when a legal obligation for environmental remediation has been incurred. The
existence and amount of an environmental remediation liability often become
determinable over a continuum of events and activities. A typical environmental
remediation process consists of the following steps:
ASC 410-30 provides specific benchmarks for an entity
to consider when evaluating the probability of a
loss and the extent to which any loss is reasonably
estimable. One such benchmark requires recognition
of an environmental liability once a feasibility
study is substantially complete, which is no later
than when PRPs recommend a proposed course of action
to the EPA. Sometimes the EPA performs and completes
its own feasibility study in lieu of, or in addition
to, a PRP-conducted feasibility study. Thus, a
PRP-recommended course of action may not always take
place, or it may occur after the EPA’s completion of
a feasibility study and related recommended course
of action.
We believe that if the EPA completes a feasibility
study for a particular site before PRPs have
recommended their proposed course of action, the ASC
410-30 recognition benchmark is met and a liability
must therefore be recognized at the time the EPA
completes the feasibility study.
When the recognition criteria are met, entities initially
measure environmental remediation liabilities at the estimated cost of
remediating the site; generally, environmental remediation liabilities are not
discounted unless certain conditions are met. Estimated remediation costs are
continually updated, and the recorded liability is adjusted prospectively until
the obligation is settled.
In a manner consistent with the guidance in ASC 450-20 and ASC
275 on other loss contingencies and uncertainties, entities are required to
disclose the existence of environmental remediation loss contingencies when it
is at least reasonably possible that a loss has been incurred regardless of
whether the loss is reasonably estimable. Additional disclosure requirements
exist for recognized environmental remediation loss contingencies.
Asset Retirement Obligations
Unlike an environmental liability, which results from the
improper use of a long-lived asset, an ARO exists when an entity has an
unconditional obligation associated with the retirement of a tangible long-lived
asset used under normal operations. Like environmental obligations, AROs can
arise from an existing or enacted law. However, unlike many environmental
obligations, AROs can also arise (1) from statute, ordinance, or written or oral
contract or (2) by legal construction of a contract under the doctrine of
promissory estoppel.
Entities should
evaluate the existence of legal obligations on the
basis of current laws, regulations, contractual
obligations, and related interpretations and facts
and circumstances and should not forecast changes in
laws or interpretations of such laws and
regulations. The impacts of changes in laws or
regulations should be considered in the period in
which such laws or regulations are enacted.
An ARO is recognized at fair value when incurred or when a
reasonable estimate of its fair value can be made. An asset retirement cost
(ARC) is recorded by increasing the associated long-lived asset’s carrying
value. The ARC is depreciated over the useful life of the long-lived asset. An
ARO liability is discounted and recorded at present value, and accretion of an
ARO liability due to the passage of time is recognized as a component of
operating expense. Revisions to the estimated timing or amount of cash flows
associated with the retirement activities are recognized as an increase or
decrease in the carrying amount of the ARO and the related ARC.
Entities often
incorporate the use of internal resources into their
remediation plans. The guidance in ASC 410-20
requires the amounts included in the ARO cash flow
estimate to reflect costs that a third party would
incur to conduct retirement activities. Therefore,
in addition to internal resources, entities need to
consider incremental costs (e.g., overhead,
equipment charges, profit margin) to ensure that the
amounts included in the ARO cash flow estimate
reflect costs that a third party would incur.
Accordingly, if an entity settles the ARO by using
its own internal resources, the incorporation of
third-party and marketplace assumptions into the
estimate of ARO cash flows and the initial
measurement of the ARO will most likely result in
the recognition of gains upon the settlement of the
ARO.
Application of the guidance in ASC 410-20 can be complex and
requires significant management estimates and judgment. For example, determining
whether a legal obligation to retire a long-lived asset has been incurred may
not always be clear and unambiguous. If an entity makes a promise to a third
party, including the public at large, about its intentions to undertake asset
retirement activities, significant judgment may be required in the determination
of whether the entity has created a legal obligation under the legal doctrine of
promissory estoppel, which is defined in ASC 410-20-20 (citing Black’s Law
Dictionary, seventh edition) as the “principle that a promise made
without consideration may nonetheless be enforced to prevent injustice if the
promisor should have reasonably expected the promisee to rely on the promise and
if the promisee did actually rely on the promise to his or her detriment.”
Regulatory Landscape
Driven by investor demand, stakeholder pressures, and, more
recently, regulatory attention, companies are increasingly focused on
climate-related and environmental matters. In addition, climate change has been
a central topic of U.S. policy discussions in many government departments and
agencies. An example of the federal government’s heightened attention to this
matter is the SEC’s March 21, 2022, proposed
rule that would enhance and standardize climate-related
disclosures provided by public companies. Under the proposed rule, a registrant
would be required to provide disclosures about greenhouse gas emissions (with
attestation for Scope 1 and Scope 2 disclosures), certain financial statement
disclosures, and qualitative and governance disclosures in its registration
statements and annual reports (e.g., Form 10-K). For more information about the
proposed rule, see Deloitte’s March 21,
2022 (updated March 29, 2022); March
29, 2022; and May 26, 2022,
Heads Up newsletters. The SEC received over 15,000 comments on the
proposed rule and is taking that feedback into account as it works toward a
final rule.
Concurrently with the SEC’s ongoing rulemaking activities related to climate
disclosures, its Division of Corporation Finance (the “Division”) continues to
issue comment letters to registrants in various industries regarding
climate-change disclosures. The Division has publicly released such comment
letters and registrants’ responses to them.
In the forthcoming regulatory environment, it will be essential
for companies to closely monitor their environmental obligations under new or
changing laws and regulations.
Many companies are
also publicly committing to achieve environmental
goals related to climate change and sustainability.
Public commitments about intentions to undertake a
certain course of action with respect to asset
retirement activities can result in an entity’s
incurrence of an ARO that must be recognized in the
financial statements under the doctrine of
promissory estoppel. Companies should carefully
monitor and evaluate their public commitments and
work closely with legal counsel to evaluate their
own specific circumstances in determining whether
legal obligations have been incurred.
This Roadmap comprehensively discusses
the recognition, measurement, presentation, and
disclosure guidance in ASC 410-20 and ASC 410-30.