By Khaled Abdel Ghany, CPA, PhD
The Governmental Accounting Standards Board’s (GASB’s) Standard No. 49 requires state and local governments to estimate the components of expected pollution remediation outlays and determine whether outlays for those components should be accrued as a liability or capitalized when goods and services are acquired.
This accounting treatment should be used if any of the following specified obligating events occurs:
-- The government is compelled to take pollution remediation action because of imminent endangerment.
-- The government violates pollution prevention.
-- The government is named, or evidence indicates that it will be named, by a regulator as a reasonable party for remediation or as a government responsible for sharing costs.
-- The government is named, or evidence indicates that it will be named, in a lawsuit to compel pollution remediation.
-- The government commences or legally obligates itself to commence pollution remediation.
The standard, Accounting and Financial Reporting for Pollution Remediation Obligation, however, is inconsistent with the Generally Accepted Accounting Principals (GAAP) presented in the accounting standards issued by the Financial Accounting Standards Advisory Board (FASAB), the Financial Accounting Standards Board (FASB), AICPA, and the International Accounting Standards Board (IASB).
Standard No. 49 develops new criteria to recognize the liability for pollution remediation outlays. These criteria state that the liability should be accrued when a range of outlays is "reasonably estimable." If a government cannot reasonably estimate the range of all components of the liability, it should recognize the liability as the range of each component - such as legal service, site investigation, and required post-remediation monitoring - becomes reasonably estimable.
For measuring the liability, GASB requires the use of the expected-cash-flow technique. This measures the liability as the sum of probability-weighted amounts in a range of possible estimated amounts, or the estimated mean or average. The standard also requires remeasurement of the liability, and its components, when new information indicates increases or decreases in estimated outlays.
Where FASAB Falls
According to FASAB Standard No. 5, Accounting for Liabilities of the Federal Government, a contingency liability should be recognized when all of the following three conditions are met:
-- A past event or exchange transaction has occurred (such as a federal entity has breached a contract with a nonfederal entity).
-- A future outflow or other sacrifice of resources is probable (such as the nonfederal entity has filed a legal claim against a federal entity for breach of contract, and the federal entity’s management believes the claim is more likely than not to be settled in favor of the claimant).
-- The future outflow or sacrifice is measurable.
The contingent liability will be disclosed if any of the conditions are not met and there is at least a reasonable possibility that a loss or additional loss may have occurred.
For measuring the contingent liability, this standard uses the better estimate amount in a range of amounts. If no amount within the range is a better estimate than any other amount, the minimum amount in the range is recognized, and the range and a description of the nature of the contingency should be disclosed.
What FASB Says
According to FASB Standard No. 5, Accounting for Contingencies, an estimated loss from a contingency shall be accrued by a charge to income. However, both of the following conditions must be met:
-- Information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements.
-- The amount of loss can be reasonably estimated.
If a range of loss can be reasonably estimated, and one amount in the range appears to be a better estimate than any other amount, that amount shall be accrued. When no amount within the range is a better estimate, the minimum amount in the range shall be accrued.
SEC Staff Accounting Bulletin No. 92 reviews the presentation of the contingency on the financial statements, and states that the charge on the income statement should be categorized as an operating expense, and should be included as a component of operating income or loss.
What AICPA Has Provided
AICPA Statement of Position (SOP) No. 96-1, Environmental Remediation Liabilities, requires environmental remediation liabilities to be accrued when the criteria in FASB Standard No. 5 are met. SOP 96-1 also requires that the accrual for environmental remediation liabilities should include the incremental direct costs of the remediation effort and the costs of compensation and benefits for employees who are expected to devote a significant amount of time to the remediation effort, to the extent of the time expected to be spent directly on the effort.
The International Position
IASB Standard No. 37, Provisions, Contingent Liabilities and Contingent Assets, addresses the liability of uncertain timing or amount. It states that these should be recognized when, and only when, an entity has a present obligation as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation.
The amount recognized is the best estimate of the expenditures required to settle the obligation at the balance sheet date. The best estimate is the amount that an entity would rationally pay to settle the obligation at the balance sheet date, or to transfer it to a third party at that time.
Conclusion
GASB justifies Standard No. 49 by stating that recognizing pollution remediation liabilities after they are judged to be probable would cause a number of expected liabilities not to be recognized in financial statements. In fact, GASB lowered the criteria for recognizing the contingency liabilities, which would result in recognizing more contingent liabilities in the balance sheet.
GASB introduced a scientific technique to estimate the value of the expected contingency liabilities, but it requires the recognition of liabilities that are unrecognizable according to GAAP standards. This will result in increasing the liabilities recognized in the financial statements for state and local governments, weakening their financial positions and affecting their financial market credit rating while having no affect on the attitudes of the people and local governments toward protecting the environment.
GASB needs to reconsider its position in Standard No. 49 and recognize the environmental remediation liability when the expected loss is probable, not when it is reasonably estimable.
Khaled Abdel Ghany, CPA, PhD, is an auditor in the Office of the Inspector General in Washington, D.C. He can be reached at drabdelghany@yahoo.com.
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