The Codification and SEC requirements

What about the Codification and SEC requirements?

Public companies have separately authoritative requirements from the SEC (U.S. Securities and Exchange Commission) that pertain to environmental disclosure. Those requirements were not made part of FASB’s (Financial Accounting Standards Board) Codification instructions, per se.

Instead, relevant portions of authoritative content issued by the SEC and selected SEC staff interpretations and administrative guidance are shown in the Codification as a convenience to users, for reference purposes only, according to FASB. FASB attempts to make it clear that the Codification does not replace or affect requirements or guidance issued by the SEC or its staff for public companies in their filings with the SEC.

The Codification’s SEC content is held in separate Sections, with headings that begin with the letter S. For example, FASB ASC Subtopic 450-20 (for loss contingencies) has SEC content in:

• S00 Status
• S25 Recognition
• S30 Initial Measurement
• S50 Disclosure
• S75 XBRL Elements
• S99 SEC Materials

Meanwhile, there is no SEC content in FASB ASC Subtopic 410-20 (for asset retirement obligations) or in FASB ASC Subtopic 820-10 (for fair value measurement), as indicated by no Section headings beginning with the letter S.

FASB reminds users that SEC content being in the Codification does not affect the SEC’s normal update procedures for the information. Users may find delays between SEC changes and FASB’s incorporation of the modified text in the Codification.

The Codification does not contain all SEC guidance. It excludes content outside the scope of basic financial statements. Notably, and potentially pertaining to an entity’s environmental liabilities, it does not include SEC content from SEC Regulation S-K, Item 303, about Management’s Discussion and Analysis.

So, where are Codification instructions for environmental liabilities?

Effective now for public companies is a new source of instructions for recognizing, measuring, and disclosing liabilities under U.S. generally accepted accounting principles (US GAAP). Released by the Financial Accounting Standards Board (FASB) and called the Codification, it replaces and supersedes all other non-SEC (U.S. Securities and Exchange Commission) instructions, e.g., all preceding FASB standards and guidance.

Where are instructions in the Codification for recognition, measurement, and disclosure of environmental liabilities?

Locating those instructions requires users to adjust from the standards-based model for information that FASB formerly used to the Codification’s topics-based organization. Recall that information in the standards-based model had the topics loss contingencies and asset retirement obligations for environmental liabilities.

The Codification has roughly 90 formal Topics, subdivided further into Subtopics, Sections, paragraphs, and subparagraphs. Codification Topics are identified by 3-digit numbers, and Subtopics and Sections by 2-digit numbers.

Instructions for loss contingencies and asset retirement obligations in the Codification are found at the Subtopic level, in these five Subtopics:

• FASB ASC Subtopic 410-20, Asset Retirement and Environmental Obligations – Asset Retirement Obligations.
• FASB ASC Subtopic 410-30, Asset Retirement Obligations and Environmental Obligations – Environmental Obligations.
• FASB ASC Subtopic 450-20, Contingencies – Loss Contingencies
  FASB ASC Subtopic 805-20, Business Combinations – Identifiable Assets and Liabilities, and Any Noncontrolling Liabilities.
• FASB ASC Subtopic 820-10, Fair Value Measurements and Disclosures – Overall.

It will take some initial effort for users to adjust to new locations for information formerly associated with other sources. The Codification does provide users with assistance in that effort, however. With the Codification’s Cross Reference feature, users can select a former source name, e.g., FAS 5 or FAS 143, and be directed to its content in the Codification.

Still news--the Codification and environmental liabilities

In July this year, the Financial Accounting Standards Board (FASB) changed things by releasing a new source of instructions for recognizing, measuring, and disclosing liabilities, including environmental liabilities, for compliance with U.S. generally accepted accounting principles (US GAAP). That new source of instructions is the Accounting Standards Codification, or the Codification (FASB, 2009a). Its release capped a 5-year project effort by FASB.

The Codification replaced and supersedes all other non-SEC (U.S. Securities and Exchange Commission) instructions, e.g., all preceding FASB standards and guidance. It pertains for entities for interim and annual reporting periods ending after September 15, 2009, i.e., now.

This is still news because the Codification’s organization of information is substantially different than before, requiring entities to adjust. For application to environmental liabilities, is this new organization of instructions simpler for entities? Better?

First, why was the Codification created, i.e., why the change by FASB?

Before beginning the Codification project, FASB solicited and obtained feedback from entities about its project need and scope. It heard that the “then-current structure of US GAAP was unwieldy, difficult to understand, and difficult to use” to the “vast majority” of respondents (FASB, 2009b). Respondents “believed that they may have missed relevant literature when they performed research,” because of the dispersed nature of US GAAP (FASB, 2009b). The “volume, complexity, and lack of integration made it difficult” for professionals to stay current and train personnel (FASB, 2009b). It “increase[d] financial reporting risks and create[d] inefficiencies that [led] to increased costs,” respondents contended (FASB, 2009b).

For FASB, these responses confirmed the need to create for entities simpler access to US GAAP instructions, logically by locating “all the authoritative literature related to a particular Topic in one place.” (FASB, 2009b)

Next, where are the Codification’s instructions for environmental liabilities?

[Sources: FASB (Financial Accounting Standards Board), Accounting Standards Codification, http://asc.fasb.org (accessed December 4, 2009); and FASB, Accounting Standards Codification, Notice to Constituents (v. 3.0), About the Codification, October 2009.]

Environmental liabilities under FAS 157-f

Does FASB’s new FAS 157-f bring changes that affect measurement of environmental liabilities?

FASB released on May 1, 2009, the proposed staff position paper (FSP) FAS 157-f, “Measuring Liabilities under FASB Statement No. 157” [Text] (and will accept comments on the document until June 1, 2009).

FASB cited in FAS 157-f as background the concern expressed by companies about the successful determination of liability fair value when observable market information is lacking. For this and other issues it noted, FASB concluded “that the consistency in application of FAS 157 could be improved” with additional guidance, a role that FAS 157-f was drafted to serve.

The normal situation for environmental liabilities (e.g., litigation and cleanup) is no market, active or inactive, to obtain quoted prices for “identical” or “similar” liabilities—for establishing fair value. For such circumstances, FAS 157-f calls for use of:

...Another valuation technique that is consistent with the principles of Statement 157. [An example] would be an income approach, such as a present value technique. [Para. 9.d]

Application of an "income approach" already is indicated in FAS 157 guidance, which describes this approach as using:

...Valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). [Para. 18.b]

So, FAS 157-f brings no change for companies intending fair value measurement of environmental liabilities under FAS 157. That is, for cleanup-related liabilities, expected present value methodology remains suitable (and normally effective) for their fair value measurement. Meanwhile, any successful approach—income or otherwise—to measuring litigation-related liabilities must overcome the difficulty of anticipating litigation outcomes.

Concerning environmental liabilities, FASB's release of FAS 157-f, if nothing else, serves to remind companies that there is an approach for handling the uncertainties inherent in cost estimation for cleanup liabilities—and that is the application of expected present value methodology.

[See the April 10, 2009, post in Knowing Disclosure on determining fair value for environmental contingencies.]

Fair value for environmental contingencies?

Can companies determine fair value for environmental loss contingencies?

As noted in the post on April 2, 2009, FASB stepped back from its earlier requirement that loss contingency liabilities for acquired properties (e.g., from mergers and acquisitions) be measured at fair value. With its release of FAS 141R-1 [Text] on April 1, 2009, FASB requires measurement at fair value only “if [it] can be determined [emphasis added].”

Fair value measurement formerly was required (period, no excuses for uncertainty about costs) under FAS 141R, which preceded FAS 141R-1's release. Companies complained to FASB, however, that fair value measurement of litigation-related loss contingencies was too difficult. That is, litigation outcomes were too uncertain to predict, meaning litigation costs were too uncertain to measure.

So, for that and other concerns expressed about litigation-related contingencies, FASB retreated. It made recognition of (acquired) loss contingencies at fair value no longer a broad requirement, but dependent on whether the acquiring company believed that fair value could be determined on a case-by-case basis. FASB attempted no distinction between litigation-related contingencies and those that are not.

Companies routinely have environmental contingencies that are not litigation-related, or at least not primarily driven by litigation outcomes. Cleanup-related contingencies make up the largest group of those. Companies normally can determine fair value for cleanup contingencies—through application of expected present value methodology in which uncertainty about cost is incorporated (as probability) into cost estimation.

Can companies determine fair value for environmental loss contingencies? Likely yes for cleanup-related contingencies, despite cost uncertainty; expected present value methodology is an applicable tool. No may be a credible answer for litigation-related contingencies, because litigation outcomes, including costs, can be so difficult to predict.

Response to FASB's retreat from fair value

How might companies respond to FASB’s recent retreat from fair value?

As noted in the previous post, FASB stepped back from its earlier requirement that loss contingency liabilities for acquired properties be measured at fair value. With its release of FAS 141R-1 [Text] on April 1, 2009, FASB requires measurement at fair value only “if [it] can be determined.”

Formerly, under FAS 141R, released in December 2007, companies were to measure and recognize loss contingency liabilities at fair value—period, no exceptions for uncertainty about costs.

There were complaints from companies, however, that it was too difficult to determine costs for litigation-related loss contingencies. This, in part, was why FASB retreated.

So, how might companies respond to FAS 141R-1 with respect to environmental loss contingencies for acquired properties?

Setting aside consideration of litigation-driven loss contingencies, companies may well have other environmental contingencies (e.g., cleanup-related) that are amenable to fair value determination—through expected present value methodology in which cost uncertainty is made part (as probability) of cost estimation.

Should companies be motivated to apply fair value measurement to environmental loss contingencies that have not been recognized that way before?

FASB's further retreat from fair value

Fair value measurement of environmental loss contingency liabilities for acquired properties will not be required, after all.

With its release of FAS 141R-1 [Text], Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, FASB has marked a further retreat from liability (and asset) measurement at (acquisition-date) fair value. Under FAS 141R-1, dated April 1, 2009, measurement of contingencies at fair value is required only “if [it] ...can be determined." FASB gives no guidance in FAS 141R-1 about how to make that determination.

Under FAS 141R-1, if a company determines it cannot calculate fair value—e.g., because of uncertainty about factors affecting costs—then it is to apply FAS 5 and FIN 14 guidance. FAS 5 instructions allow a company to postpone recognition of a probable loss until it concludes it can reasonably estimate the amount of loss. FIN 14 allows the low value from a cost range to be the amount recognized—or no value at all—as a result of cost uncertainty.

Formerly under FAS 141R, Business Combinations, the draft revision of FAS 141 that preceded FASB's release of FAS 141R-1, companies were to measure and recognize loss contingency liabilities at fair value—period, no exceptions for uncertainty about costs. This applied for all contractual loss contingency liabilities and for noncontractual loss contingencies that were more likely than not to be liabilities. It was to be effective beginning in 2009.

Companies expressed issues with FAS 141R, however—many of them litigation-related, e.g., the difficulty of determining fair value for litigation-related contingencies, the concern for protection of supporting information that may be subject to attorney-client privilege, and the exposure of potentially prejudicial information in financial statements.

Acknowledging these issues, FASB showed in its February 25, 2009, board meeting (minutes) that it was backing away from a strict requirement for recognition at fair value. It indicated it would be making such recognition conditional on whether fair value was “reasonably estimable.” [See the March 3, 2009, post in Knowing Disclosure about FASB’s change of heart.]

Now FASB has retreated further. Under its just-released FAS 141R-1, FASB makes recognition at fair value contingent on whether fair value can be “determined,” leaving it up to companies how they go about that determination.

Environmental cleanup postponement premium

Are companies paying a premium for postponing recognition?

As noted in the March 5, 2009, post, companies applying FAS 5, Accounting for Contingencies, and FAS 141/141R, Business Combinations (Revised), have options for measuring loss contingency liability costs. One option is for companies to postpone recognition when they believe they cannot reasonably estimate liability costs. Might companies postponing recognition be paying a premium for that option?

It likely is less expensive to resolve environmental cleanup loss contingencies in the near term, rather than later. Paying a premium refers to absorbing the difference in costs for resolving later.

Why should companies expect that costs to resolve later will be higher?

First, environmental problems tend to worsen with time. For example, cleanup needs can increase where contamination sources have been insufficiently secured, e.g., against human and animal intrusion, wind transport, surface water erosion and infiltration. There may be more exposure of personnel to contaminated materials or more subsurface migration of contaminants as time passes.

Second, costs to resolve environmental cleanup tend to rise, e.g., in response to environmental problems worsening. Increases also result from cleanup requirements of regulatory authorities that become more stringent and thereby more costly to meet. They result when structural deterioration due to weathering complicates cleanup.

Third, companies that are postponing recognition of environmental loss contingencies likely also are postponing management of them, including cost management. Those companies, consequently, will be missing the development of favorable cost situations for resolving the liabilities, should they arise. By the time they do recognize and begin management, environmental problems may well have worsened and costs increased.

There appears potentially to be a considerable premium for companies to pay for postponing recognition.

[For more information, see Raymond Rose's "Reconsidering Loss Contingency Postponement—Raising the Game," Environmental Claims Journal, Corporate Environmental Disclosure Column, Scheduled for Vol. 21, Issue 2, Apr-Jun 2009.]

Situations affecting views on measurement options

How can situation affect view on measurement options?

As noted in the March 5, 2009, post, companies applying FAS 5, Accounting for Contingencies, and FAS 141/141R, Business Combinations (Revised), have options for measuring loss contingency liability costs. Might companies in different situations take differing views about those measurement options?

Here is a hypothetical example to consider, with companies in three simplified situations—not looking to acquire or be acquired, being a prospective buyer, and being a prospective seller.

First is Company X, which is not looking to acquire other companies or be acquired. It wants liabilities minimized, quarter to quarter, including environmental liabilities.

So, it postpones recognition of environmental liabilities to the extent possible, i.e., those for which it cannot reasonably estimate costs. For those in which it can estimate costs, it recognizes only minimum liability values, i.e., the low value of a range (the known minimum value). Its view is to use measurement options (under FAS 5) to minimize near-term liability recognition.

Next is Company Y, a prospective buyer. It needs liability information about companies it is considering buying in order to develop offers and, potentially, negotiate price. It wants the environmental liabilities of those companies truely identified and realistically valued. Its view as a prospective buyer is that measurement options should enable that outcome.

Company Y, the prospective buyer, may take a different view after acquisition. It can postpone recognition of (contractual) liabilities (for the acquired properties) if it cannot reasonably estimate their fair value. This comes from FASB’s recent decision about FAS 141/141R. In which case, FAS 5 applies (for loss contingencies at acquired properties), if fair value cannot be reasonably estimated.

So, after acquisition, Company Y's view may come to resemble Company X's—which is to use measurement options (under FAS 141/141R and FAS 5) to minimize near-term liability recognition.

There is also Company Z, a prospective seller. It wants to be considered for purchase, so it is motivated to meet a prospective buyer’s information needs. Its view is to use measurement options for true identification and real valuation of environmental liabilities.

[See the March 6, 2009, post in Knowing Disclosure on how individual roles can affect views on measurement options.]

Roles affecting views on measurement options

How can role affect view on measurement options?

As noted in the March 5, 2009, post, companies applying FAS 5, Accounting for Contingencies, and FAS 141/141R, Business Combinations (Revised), have options for measuring loss contingency liability costs. Might individuals in key roles within a company take different views about those measurement options?

Here is a hypothetical example to consider with simplified viewpoints of individuals in four key roles—CEO, Plant Manager, CFO, and Environmental Manager.

A company has acknowledged a liability for an environmental cleanup loss contingency at a plant site. Now it must consider what liability cost to recognize. Individuals in key roles at the company independently come to these amounts for liability cost:

• Amount A: No value, i.e., there is too much uncertainty for cost to be reasonably estimated yet, so no liability should be recognized at this time.


• Amount B: $850,000, the most likely value for resolving this liability.


• Amount C: $400,000, the low value of a cost range.


• Amount D: $632,250, the expected present value (in year one) for resolution of this liability in year five, i.e., fair value.

Amount A—no value—is the view of a CEO concerned that recognition and disclosure of this environmental liability adversely may affect near-term stock price and thereby prefers to postpone recognition.

Amount B—the most likely value—is the take on the situation by a Plant Manager. He has overseen similar environmental cleanup. He believes he knows, from his experience, the most likely amount for this work.

Amount C—the low value of a range—is how a CFO sees it, who believes a liability should be on the books but wants only a minimum amount entered.

Amount D—expected present value (fair value)—is the view of an Environmental Manager. He would like the same measurement method used for all environmental liabilities, to the extent possible, so he can compare the resulting liability values. He would like this method to produce liability values that are realistic, as well. He has the job, after all, of recommending priorities and budgets for environmental liability management.

What is the measurement outcome that best meets the company’s needs for compliance and financial management?