Buried within the flurry of earnings releases issued during the past two weeks were reports by a handful of large companies of charges related to FIN 47, an accounting rule that went into effect in December. The immediate result of their applications of the new standard, which governs disclosures related to future environmental liabilities, were modest hits to net income and earnings per share.
For instance, Ford Motor Co. recorded a $251 million after-tax charge to net income for 2005 and an accompanying 11 cent reduction in earnings per share. United Technologies Corp. posted a $95 million charge, which shaved 9 cents off annual EPS. Similarly, USG Corp. and ConocoPhillips saw their annual net incomes cut by $11 million and $88 million respectively. USG’s per-share earnings dropped 25 cents, and ConocoPhillips’s fell by 7 cents.
The longer-term effect of FIN 47, however, will not be apparent until companies that are bound by the new rule issue their annual reports later this year. That’s when investors will get a look at the effect that estimated future cleanup costs will have on balance sheets.
The standard is a new interpretation of FAS 143, Accounting for Asset Retirement Obligations, which was issued in June 2001. Under the new reading, affected companies must recognize on current financial statements future environmental liabilities associated with permanently shutting down a facility.
In the past, companies interpreted FAS 143 differently. They reckoned that the liability only had to be booked when the cleanup cost and the timing of the facility closing were relatively certain. Independent auditors agreed, but the Financial Accounting Standards Board continued to mull the practical application of the rule.
Originally, FAS 143 pertained to the future cost of cleaning up nuclear power plant sites after the facilities were shuttered. The standard instructed plant owners to estimate future liabilities (including cleanup and remediation costs) using a discounted cash flow model. After that, they should recognize the charge every year until the plant entered retirement, according to FASB.
From an accounting perspective, as the plant ages and moves closer to retirement, the amortized asset is written down while the liability grows. By the time the plant is closed, the liability turns into a cash outlay.
Further, power plant owners are obligated by law to eventually clean up the site, which means that the liability is a sure thing. It was that widespread certainty that led FASB to suggest that nuclear power plants were not the only facilities that should fall under the auspices of FAS 143.
For five years, FASB, auditors, and companies had tangled over the question of whether the owners of factories, warehouses, coal-fired power plants, and other industrial facilities should also be made to recognize future environmental liabilities. Finally, on December 15, FIN 47 was released, clarifying FASB’s position: Any company required by contract or statue to perform an environmental cleanup after retiring a facility must book the future cleanup cost — whether or not it can be ascertained today.
In addition to recognizing the future environmental liability on its balance sheet, a company must also make appropriate disclosures about the cost and timing of obligations in shuttering the facility. Further, each affect companies must take a one-time “cumulative” accounting charge to net income as a way of truing up their books in light of the new rule.