However, Sarbanes-Oxley Section 404 (which requires an independent audit of a company’s internal financial controls) and the new FAS interpretation may, in combination, require companies to inventory their mothballed sites and book the related environmental-cleanup obligations. Failure to do so might be viewed as a control deficiency under Section 404, possibly requiring the company to disclose a material weakness for environmental financial reporting. Such a disclosure could expose the company to bad press, an SEC investigation, and shareholder lawsuits against the company and the board.
Those directors and officers may be surprised to learn that their D&O insurance policy contains a “pollution exclusion” as well as other provisions that could deny coverage. In February, a decision by the U.S. Fifth Circuit Court of Appeals involving a shareholder lawsuit against U.S. Liquids Inc. upheld the validity of such a pollution exclusion. That suit — in which shareholders alleged that the company did not fully disclose environmental matters in SEC filings — “should be sounding alarm bells for directors and officers of public corporations with significant environmental exposures,” warns Rogers.
Historically, the commission itself has not pursued enforcement actions against companies for underreporting their environmental liabilities — but the Section 404 requirements of Sarbanes-Oxley add a new twist. Accordingly, urges Rogers, companies with mothballed facilities should talk with their independent auditors now to avoid unpleasant surprises in 2005.
Marie Leone is senior editor of CFO.com.
We’re Booking as Best as We Can
In the two years since the effective date of FAS No. 143, Accounting for Asset Retirement Obligations, the staff of the Financial Accounting Standards Board have noticed that corporate accountants are not consistent in booking the effects of these legal obligations, especially when they are conditional on future events.
Asbestos-removal laws, for example, constitute a legal obligation triggered when a company renovates or demolishes a building containing the flame retardant. In such a case, says BDO Seidman partner Ben Neuhausen, some accountants have deferred recognizing an ARO when retirement of the building was not yet planned, on the grounds that the legal obligation to remove the asbestos did not yet exist.
Neuhausen explains that since the future conditional event — such as retirement, renovation, demolition, sale, or refinancing of the building — is usually controlled by the asset owner, one might maintain that in those cases, it would be the asset owner who would pull the trigger, so to speak. In other words, unless a company were required by law or court order to initiate one of those events, booking the ARO could be deferred.
Other accountants in similar situations, figuring that the asset would someday be retired, recorded the fair value of the liability immediately. Of course, booking the ARO triggered environmental cleanup laws immediately, too.
The accounting board’s proposed interpretation of FAS 143 would eliminate these different accounting treatments by directing companies to book the fair value of an ARO immediately, regardless of whether the legal obligation is conditional on a future event. “It’s FASB’s assumption that every asset has a finite life,” maintains Neuhausen.