The disclosure issue is a “classic” rules-based versus principles-based accounting argument, according to Jay Hanson, national director of accounting for accountancy McGladrey & Pullen. Hanson posits that on one side, investors want more-precise guidelines to tighten the perceived loopholes in GAAP. On the other side, corporate finance managers seek flexibility in reporting material information, arguing that to provide much more would overwhelm shareholders with useless data.
To be sure, FAS 5 currently provides for a relatively flexible approach. The rule requires companies to disclose environmental contingencies if the liabilities are material to the financial condition of the company; companies must then accrue the estimated cost of the liabilities with a charge to income. But there are caveats. For instance, FASB requires corporations to accrue for the future liabilities only if the cost can be reasonably estimated and the liability is probable. In cases in which the liability is probable but cannot be estimated, the company needs to disclose only the nature of the liability.
FIN 14, however, pushed for more disclosure. It states that even if a company has only enough information to work up a range of estimates, it’s required to disclose that range. Under FIN 14, corporate accountants must accrue either the best estimate in the range, or if that can’t be determined, the minimum amount.
With that much flexibility, say experts, some companies chose to accrue as little as possible on the grounds that the minimum amount under FIN 14 was zero. In 1992, 15 years after FAS 5 was released, the SEC decided more guidance was needed and issued Staff Accounting Bulletin 92. The rule warned companies that the cost of environmental remediation was “unlikely” to be zero and that a “known minimum” estimate was required, but SAB 92 didn’t make it illegal to report zero or a relatively low estimate.
Accordingly, says Little, companies continued to report lowball estimates. Among other studies, he points to a warning that the SEC’s Division of Corporate Finance aimed at Fortune 500 companies. In December 2001, in the wake of the Enron scandal, the commission cautioned a number of oil, gas, mining, and manufacturing companies to properly disclosing environmental and product liabilities. The SEC didn’t name the companies or provide a count, only stating that “many companies did not provide adequate disclosure” and that “companies could improve their disclosures required by SAB 92.”
In August 2002, the Rose Foundation — backed by SRI funds representing more than $1 trillion in assets — petitioned the SEC to adopt rules based on two voluntary best-practice standards proposed by the American Society of Testing and Materials (ASTM). The foundation hoped to tighten — if not altogether close — what it considered to be loopholes in FAS 5, FIN 14, and SAB 92 and to stop companies from wriggling out of detailed disclosure.
One of the two guidelines, ASTM standard E 2137-0 (Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters) is a blueprint for using an expected-value methodology to calculate cost estimates of environmental liabilities. Essentially, it’s a weighted-average calculation that takes into consideration both the likelihood of a remediation scenario and its cost.