Accounting for Environmental Liabilities

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Accounting for Environmental Liabilities
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Definition of liability

• Definition of liability
• A liability is defined as a probable future
  sacrifice of economic benefits arising from
  present obligations to transfer assets or provide
  services in the future as a result of past
  transactions or events.
• 3 common types of liabilities
• Debt repayment obligations
• Payment obligations to suppliers, customers and
  other stakeholders
• Deferred revenues

The term has important accounting and legal
dimensions
Accounting dimension A liability is a present
obligation to make an expenditure in the
future. Legal dimension A liability is a
legally enforceable obligation.
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Criteria for recording liabilities
First Criteria An obligation has been occurred.
Second Criteria The amount and timing of the
obligation is measurable with reasonable
certainty
Record a liability

• Therefore, the two most important issues
  regarding liability reporting are
• Uncertainty about whether an obligation has been
  occurred
• Difficulty in measuring the value of the
  obligation

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Definition of environmental liability
EPAs definition of environmental liability A
legal obligation to make a future expenditure due
to the past or ongoingmanufacture, use, release
or threatened release of a particular substance,
or other activities that adversely affect the
environment. Potential environmental
liability liability depends on future events or
the law or regulation creating the liability is
not yet in effect. The company has still the
opportunity to prevent the liability from
occurring.

• Types of environmental liabilities
• Compliance
• Remediation
• Fines and penalties
• Compensation
• Obligation to pay for punitive damages
• Obligation to pay for natural resource damages

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Types of environmental liabilities

• ComplianceCompanies are obliged to be in
  compliance with all current and future
  environmentallaws and regulations that apply to
  them. The costs of coming into compliance can
  range from modest (administrative requirements)
  to substantial (pollution control, waste
  treatment or decommission of industrial
  facilities).

• RemediationThe obligation to remediate
  environmental damage, e.g. the accidental release
  of toxic substances (Bophal). Includes the
  obligation to clean up contaminated sites under
  the Comprehensive Environmental Response,
  Compensation and Liability Act (CERCLA, 1980)
  and the Superfund Amendments and Reauthorization
  Act (SARA,1986). Costs involved are usually very
  high.

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Types of environmental liabilities

• Fines and penaltiesCompanies that are not in
  compliance are subject to civil or criminal fines
  or penalties.Fines and penalties can range from
  modest to high. Generally, a civic penalty is
  designed to be at least equal to the cost
  savings through non-compliance.

• CompensationCompanies may be obligated to pay
  for compensation of damages suffered- by
  individuals (personal injury)- their property
  (property damage)- their businesses (economic
  loss)due to the use or release of toxic
  substances or other pollutants.

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Types of environmental liabilities

• Obligation to pay for punitive
  damagesSupplements compensatory payments to
  those harmed by the actions of othersin order to
  punish current or deter future perpetrators.
  Unlike compensatory liability,these payments
  are not directly tied to the actual damages and
  are often many times larger than the cost of
  compensation. Example Exxon Valdez oil spill.

• Obligation to pay for natural resource
  damagesRelatively new category of environmental
  liability, which relates to injury,
  destruction,loss or loss of use of natural
  resources that do not constitute private
  property.Liability can arise from accidental as
  well as lawful releases to air, water and soil.
  To date, most natural resource damage payments
  have been relatively small.

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Accounting for Environmental Liabilities
Environmental liabilities in financial
accountingRules and practices for recognizing
and reporting environmental liabilities in
financial statements are still evolving. Focus
is on - timing and likelihood of the expenditure
and - the materiality of the expense. Since the
information is for external users it is typically
not disaggregated enoughto be used for
managerial decision-making.
Environmental liabilities in managerial
accountingValuing environmental liabilities is
important in the context of- evaluating
pollution prevention investments and - internal
recognition and proper allocation of
environmental cost.Even though it is difficult
to value potential environmental liabilities, it
may be better to assign an uncertain monetary
value instead of simply ignoring it (i.e.
setting monetary value equal to zero).
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Valuation of environmental liabilities

• Important issues in the context of valuing
  environmental liabilities are
• Timing
• Likelihood
• Uncertainty

TimingBy definition, all environmental
liabilities involve future costs.A common
approach for evaluating future payments is to
calculate their ???.
NPV.
This requires three parameters
Magnitude of the expense, timing of the expense,
discount rate.
Payments of compliance and remediation
obligations, for example, may be many years
away, and may also stretch out over a long period
of time. Compensation and natural resource damage
liabilities, on the other hand, can arise in the
near term but also have long time frames.
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Valuation of environmental liabilities
Likelihooddifferent environmental liabilities
may occur with different likelihoods.One way to
consider the likelihood of environmental
liabilities is to multiply the forecasted
magnitude of the expense with its probability.
This probability should account for factual and
legal questions, and thus require scientific and
legal analysis. A more complete way to account
for the likelihood of liability expenses is to
calculate its expected value based on a
probability distribution of expense magnitudes.

• UncertaintyEstimates of future costs have
  unavoidable uncertainties, which may be about-
  Magnitude of costs
• Probability of occurrence
• Timing of occurrenceIt is thus recommended to
  apply the standard uncertainty assessment methods
  of
• ???

sensitivity and scenario analysis.
Useful additional methods are- Monte Carlo
simulation - Event and decision trees
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Example Contaminated Land

• 1980 Comprehensive Environmental Response,
  Compensation and Liability Act (CERCLA)
• Comprehensive federal state mechanism for a
  rapid response to actual or threatened releases
  of hazardous substances
• Federal trust fund financed mainly by private
  industry to pay for the cost of response
• A federal cause of action for recovery of costs
  incurred for responses from 4 classes of
  potentially responsible parties (PRPs)
• - Current owners and operators
• - Owners and operators at time of
  disposal
• - Processors of the hazardous substances
• - Transporters who selected the facility
• Liability under CERCLA is strict, and joint and
  several
• 1986 Superfund Amendments and Reauthorisation Act
  (SARA)
• Importance of permanent remedies and innovative
  treatment technologies
• Increase size of trust fund to 8.5 billion

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National Priorities List Sites in California
Casmalia Resources Hazardous Waste Management
Facility Over 4.5 billion pounds of industrial
and commercial wastes,1973-1989 pesticides,
solvents, acids, metals, caustics, cyanide, and
non-liquid polychlorinated biphenyls (PCBs).
1990 Owner/operators close facility 1992-96
site stabilization activities by US EPA
(emergency response) 1996 settlement with a
group of major waste generators to promote a
long-term cleanup
Source http//www.epa.gov/superfund/sites/npl/ca.
htm