Tightening Standards For Reporting

Environmental Liabilities: Conditional

Asset Retirement Obligations

by Reed W. Neuman

Reed W. Neuman
is a partner at the Washington, D.C.,
law firm of O’Connor & Hannan FIN 47 significantly expands the reach of FAS 143 to many
LLP. Mr. Neuman’s practice focuses
on litigation and related risk
environmental legal obligations, thus requiring proper
management and transfer issues recognition in financial statements. As a result, many
associated with hazardous materials companies may face increased reporting obligations.
and contaminated properties.
Mr. Neuman can be reached at
rneuman@oconnorhannan.com. This
article is based on a paper the author
prepared for a seminar sponsored In an era of ever-increasing scrutiny of the accounting practices of
by the ABA’s Section of Taxation. The
views expressed herein are offered public companies, fueled in large part by the Sarbanes-Oxley Act, law-
solely for information purposes and yers recently have faced the implications of stringent new requirements
do not constitute legal advice. The in how certain environmental liabilities must be recognized and disclosed.
reader should consult an attorney
about the issues described herein. The issuance in March 2005 by the Financial Accounting Standards
The information provided herein Board (“FASB”) of FASB Interpretation No. 47 (“FIN 47”), Accounting
does not create, and receipt of it for Conditional Asset Retirement Obligations (“CAROs”) (available at www.
does not constitute, an attorney-
client relationship. fasb.org/pdf/fin%2047.pdf), has forced a fundamental reconsideration
The Practical Real Estate Lawyer | 
 | The Practical Real Estate Lawyer January 2008

of how and when material environmental liabili- regulated industries (particularly, the decommis-
ties associated with the “retirement” of corporate sioning of nuclear power plants). FASB expanded
assets (i.e., the future sale, disposal, recycling, or FAS 143 in 2001 to apply to retirement obliga-
abandonment of industrial facilities) are addressed tions generally. Although FASB’s own guidance
on financial statements. With FIN 47, FASB—the for implementation of FAS 143, which became
board responsible for setting standards for compa- applicable as of June 15, 2002, cited environmen-
nies adhering to Generally Accepted Accounting tal obligations to illustrate how the standard would
Practices (“GAAP”)—has reset the bar for inter- apply, neither 143 nor the guidance delineated the
pretation of its standard on Accounting for Asset Re- types of environmental obligations that were to be
tirement Obligations, known as Financial Accounting addressed under FAS 143. In particular, FASB pro-
Standard (“FAS”) 143. (Available at www.fasb.org/ vided no guidance as to how to address obligations
pdf/fas143.pdf.) FIN 47 became effective in De- associated with certain pre-existing contamination
cember 2005. or conditions.
Essentially, FIN 47 expands the reach of As a result, many companies and accounting
standards applicable to asset retirement obliga- advisors adopted the view that, because of uncer-
tions (“AROs”) to obligations for which the tim- tainties about the timing or method of settling a
ing or method of settlement is conditioned on legal obligation to address a historic condition (for
future events. Most typically, example, a known obligation
CAROs arise with respect to Essentially, FIN 47 expands the reach to remove asbestos material
legal obligations to conduct of standards applicable to asset from a building whose date
environmental remediation retirement obligations (“AROs”) to of renovation, demolition, or
or closure actions associated obligations for which the timing or sale could not be predicted),
with the retirement of con- method of settlement is conditioned a “fair value” of the CARO
taminated property, plants, on future events. could not be “reasonably es-
and equipment. Even if the timated” on current financial
date of settlement cannot be predicted—including statements. Others took the stance that a liability
due to reasons or events not in the company’s con- deferred for future determination did not represent
trol—FIN 47 generally requires recognition when a current “legal obligation” within the meaning of
the liability can be reasonably estimated. FAS 143. Understandably concerned that recogni-
tion and reporting of significant, known liabilities
Asset Retirement was being delayed—or ignored entirely—FASB is-
Obligations Under FAS 143 sued FIN 47 in 2005.
Generally, FAS 143 requires companies facing
existing legal obligations associated with the future FASB’s ATTEMPT TO TIGHTEN RECOG-
retirement of long-lived assets to recognize the li- NITION OF CAROs—FIN 47 • In FIN 47,
ability in its financial statements for the period in- FASB confirms how CAROs are to be treated un-
curred—typically, at the time the asset is acquired der FAS 143. Reporting companies must make pro-
or built or at such later date when a duty is created vision for a CARO liability as soon as a fair value
by law—if the present “fair value” of the liability can be reasonably estimated. As a result, account-
can be “reasonably estimated.” FASB developed ing professionals—and lawyers—will find them-
the standard in 1994 to clarify requirements appli- selves much more closely evaluating long-term and
cable to the costs of retiring assets in certain highly clearly uncertain environmental liabilities, even if

the company has no current plans or schedule to
retire the impacted asset. FASB hopes these chang-
es will produce earlier, more consistent and more
detailed recognition and disclosure of CAROs. In
particular, FIN 47 helps clarify several key issues,
including when a CARO liability should be recog-
nized, how and when a fair value may be reason-
ably estimated, and what information should be
deemed sufficient for a reporting company to make
a fair value estimation.
Accounting For Uncertainty
In large measure, the approach spelled out in
FAS 143, as expanded by FIN 47, represents FASB’s
attempt to alter traditional accounting practices.
FAS 5, Accounting for Contingencies (available at www.
fasb.org/pdf/fas5.pdf), is the general accounting
standard governing recognition and disclosure of
contingent liabilities. Under FAS 5, companies
must accrue for potential environmental liabilities
if “probable” of assertion. However, as to AROs,
FAS 143 and FIN 47 together remove probability
from that exercise. Uncertainty as to whether or
when a liability will arise is immaterial to whether
or when the liability must be recognized; that un-
certainty instead is a factor of how to determine a
fair value for the liability. Thus, the FAS 143 inqui-
ry runs to how much of an environmental liability
must be estimated, not whether or when.
In FIN 47, FASB provides examples to drive
home the point that uncertainty is not germane to
the recognition or disclosure of a CARO, only to
its valuation. In a common scenario, existing laws
typically require removal of asbestos materials be-
fore a building is demolished. However, the tim-
ing of when the asbestos actually will be removed
may depend on when the building is renovated,
demolished or sold (all events constituting “retire-
ment” of the building asset). Notwithstanding the
uncertainty of when this known obligation will be
addressed, or by whom, FIN 47 requires prompt
Environmental Liabilities | 
recognition of the liability, if a fair value can be
reasonably estimated.
Fair Value Estimation
FASB takes the position that the liability for an
ARO can be reasonably estimated if sufficient in-
formation exists to determine its present fair value.
Under FIN 47, whether a reporting company has
sufficient information may turn on a “matter of
judgment.” If it is not possible to make a determina-
tion of fair value, the company is not required to ac-
crue a liability. It is required, though, to describe the
obligation, state that a liability cannot be recognized
because its fair value cannot be reasonably estimat-
ed, and explain why the obligation is not estimable.
Under FIN 47, fair value can be regarded as
the amount at which willing parties could agree
to settle the legal obligation in question in a trans-
action. In the absence of objective, market-based
valuation for a contingent or conditional legal ob-
ligation, FIN 47 indicates that fair value can be de-
termined if:
• The acquisition price of the asset reflects its
fair value;
• An active market exists for the transfer of that
obligation; or
Sufficient information exists to calculate its expect-
ed present value.
FIN 47 itself does not prescribe how to deter-
mine if the value of an ARO is reflected in the
asset’s acquisition price. Some objective indicators
may exist if the transaction reflects an identified
price discount for the asset or the use of environ-
mental risk transfer devices such as insurance or
indemnities. Independently, comparisons can be
made of the purchase price of the contaminated
asset to similar uncontaminated assets.
Alternatively, FIN 47 envisions reference to a
market price that a willing buyer would pay for
transfer of the obligation. Increasingly, a variety of
environmental cleanup liabilities are being mon-
etized in arm’s-length transactions. The fair value