The Greening of GAAP

Are corporations being forthright about their environmental liabilities?

On July 21, when New York State Attorney General Eliot Spitzer announced that eight states were filing a law suit against five utilities, Joe Buonaiuto, the senior vice president and controller of American Electric Power Co., was working on his company’s 10-Q.

AEP was one of the five power companies named in the suit, which seeks to force the utilities to cut back on emissions of carbon dioxide, which many scientists believe contributes to global warming.

Two weeks later, when Buonaiuto and chief financial officer Susan Tomasky filed the company’s quarterly report with the Securities and Exchange Commission, the lawsuit was disclosed in the document’s “significant factors” section, and it will probably be included in the “management’s discussion and analysis” section of the company’s 10-K.

In general, says Buonaiuto, environmental factors are a key reporting focus for AEP, and the company strives for full and fair disclosure in that area. Indeed, AEP’s 10-K lists pages of environmental regulations, policies, and other factors that could affect the utility’s financial performance. The document also details past and current pollution-abatement costs, and it estimates future environmental liabilities — such as $1.2 billion in capital costs to comply with sulfur dioxide emissions regulations over the next two years, and $500 million to reduce nitrogen oxide emissions.

But not all companies are interpreting disclosure rules so conservatively. At least that’s the contention of many socially responsible investors (SRIs), the institutional investors and mutual fund groups that screen their portfolio companies for several social and environmental criteria. Some SRIs claim that while many companies comply with the letter of SEC and accounting rules, they fail to embrace the spirit of the law in not providing a full picture of their future environmental liabilities.

The attempt by SRIs to focus more attention on such breaches of the legal spirit was bolstered in July, when the Government Accountability Office (formerly the Government Accounting Office) published a 75-page report on the state of corporate environmental disclosures. The study, which sparked partisan reactions from SRIs and corporate executives, didn’t take sides. Rather, the GAO study crystallized the underlying debate, underscoring SEC deficiencies in collecting and monitoring corporate environmental disclosure data.

As a result, SRIs and other like-minded stakeholders are renewing their two-year-old call for changes in generally accepted accounting principles (GAAP). The changes would require companies to disclose detailed estimates of their contingent environmental liabilities, among other things.

Overwhelmed with Details

Indeed, the advocacy for that point of view has grown formidable. SRIs now represent $2.2 trillion worth of assets and account for one in every nine dollars under professional management in the United States, according to the Social Investment Forum, a Washington, D.C.-based nonprofit group that promotes socially responsible investing.

The targets of this investor ire are two venerable rules of the Financial Accounting Standards Board, FAS 5 (Accounting for Contingencies) and FIN 14 (Reasonable Estimation of Loss). SRIs see loopholes in the FASB standards that “allow companies to hide the financial significance of environmental problems,” says Tim Little, executive director of the Rose Foundation for Communities and the Environment.

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