On the Radar
Environmental Obligations and
Asset Retirement Obligations
Environmental obligations can arise from the improper operation, retirement, or
closing, or from 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 required to recognize an environmental
remediation liability in their financial statements.
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, or 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, whose recognition and disclosure guidance is principally
based on the 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.
The U.S. Environmental Protection Agency (EPA) is the primary environmental
regulator in the United States, but it does not regulate all environmental
concerns. 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 the PRPs recommend a proposed course of
action to the EPA. It is possible that the EPA will
perform and complete 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 the 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, those 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
An ARO exists when an entity has an unconditional obligation associated with the
retirement of a tangible long-lived asset. Like environmental obligations, AROs
can arise from an existing or enacted law. However, unlike many environmental
obligations, AROs can also arise from statute, ordinance, or written or oral
contract or 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. Entities capitalize the asset retirement cost by
increasing the associated long-lived asset’s carrying value. The asset
retirement cost is later depreciated over the useful life of the long-lived
asset. Accretion of the ARO liability due to the passage of time is recognized
as a component of operating expense while 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
long-lived asset.
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 the costs
that a third party would incur to conduct the
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 the
costs that a third party would incur. Accordingly,
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 if the entity settles the
obligation by using its own resources.
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. Examples of
the federal government’s heightened attention to this matter include:
- President Biden’s day-one action to rejoin the Paris Climate Agreement.
- The directive of then SEC Acting Chair Allison Herren Lee instructing the SEC Division of Corporation Finance to enhance its focus on climate-related disclosures in public-company filings.
- SEC Chairman Gary Gensler’s recent statement that the SEC has the necessary authority to move forward with rulemaking on climate, human capital, and other environmental, social, and governance (ESG) disclosures.
- The SEC’s March 21, 2022, proposed rule that would enhance and standardize the climate-related disclosures provided by public companies.
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.
Deloitte's Roadmap Environmental Obligations and Asset Retirement
Obligations comprehensively
discusses the recognition, measurement, presentation,
and disclosure guidance in ASC 410-20 and ASC
410-30.
Contacts
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Ashley Carpenter
Partner
Deloitte & Touche LLP
+1 203 761 3197
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Jamie Davis
Partner
Deloitte &
Touche LLP
+1 312 486
0303
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