Environmental Obligations and Asset Retirement Obligations

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”).

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.

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.

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.”

In the forthcoming regulatory environment, it will be essential for companies to closely monitor their environmental obligations under new or changing laws and regulations.