Environmental Disclosure Obligations for “Mothballed Sites”

C&G Review
Fall 2005

The Financial Accounting Standards Board (“FASB”) recently issued a significant interpretation of a standard set to take effect in 2006, clarifying that companies must recognize, estimate and account for as-yet-unaccrued liabilities related to the eventual retirement of tangible assets. In the environmental context, this means that public companies will be expected (and private companies may conclude that it is best practice) to disclose the value of future environmental liabilities at contaminated sites and facilities whenever the fair market value of those liabilities can be reasonably estimated.

Suppose, for example, that Acme Company is a manufacturer that has been in business for fifty years. Ten years ago, Acme needed to expand, so it purchased land, built a state-of-the-art facility on the new land and moved all of its operations over from a facility that it had owned and operated since the 1960s. Acme has no plans to sell the old property, partly because Acme knows that a sale will trigger environmental cleanup costs stemming from Acme’s early operations.

As a general principle, companies must annually account for their assets and liabilities. Under FASB standards first promulgated in 2002 and set to take effect in 2006, liabilities include “conditional asset retirement obligations” (i.e., future financial obligations associated with the sale or disposition of tangible, long-lived assets), even if it is not yet known when those assets will be retired. For a company like Acme that expects to incur cleanup liabilities if and when it eventually sells an unused, non-productive, contaminated facility (a/k/a a “mothballed site”), this disclosure requirement was ambiguous. As long as Acme did not sell the property, it could probably avoid the cleanup costs, but it knew that those costs would eventually be incurred. The question was whether this would be a reportable liability under the new FASB standard.

The FASB’s Financial Interpretation No. 47 clarifies that a company is required to recognize liability for as-yet-unaccrued financial obligations, provided that the fair market value of the obligations can be reasonably estimated at the time of reporting. It also attempts to clarify when a company has “sufficient information” to estimate the fair value of such obligations.

Interpretation No. 47 provides that if a company can reasonably estimate future liability in connection with its eventual disposition of tangible assets, the company must account for that future liability and carry it on the company’s books. For a company like Acme that owns a non-productive, contaminated site, this presents a choice between (a) selling the property now and getting it off of the company’s books, at which point the company would actually incur and disclose the costs of its cleanup liability, or (b) holding on to the property, estimating the fair market value of its eventual cleanup liability and recognizing that liability in its annual accounting. In either case, Interpretation No. 47 will prompt many companies to reconsider their long-term plans for “mothballed sites.”

For more information, please contact sthistle@cohenlaw.com or enewman@cohenlaw.com