I. Introduction

This presentation addresses the taxation and financial accounting treatment of environmental remediation liabilities(costs) as promulgated by: Technical Advice Memorandum(TAM) 9315004, Revenue Ruling 94-38, TAM 9627002, The Financial Accounting Standards Board (FASB) Statement No. 121, Accounting For The Impairment Of Long-Live Assets And For Long-Lived Assets To Be Disposed Of, The American Institute of Certified Public Accountants(AICPA) Statement of Position(SOP)96-1, Environmental Remediation Liabilities, and The Securities and Exchange Commission Staff Accounting Bulletin(SAB) No. 92, Accounting And Disclosures Relating To Loss Contingencies.

II. Taxation Treatment

The tax issue of predominant concern is whether these environmental remediation costs result in a current income tax deduction under Internal Revenue Code section (§)162, or whether these costs are capital expenditures, as defined in §263, and for which a depreciation deduction may be allowed under §167. A related issue is whether (§)162(f) precludes the deduction of fines and penalties levied in connection with the environmental protection and remediation processes.

• Environmental Remediation Costs: Deductible vs. Capital Expenditures

§ 162 generally allows a deduction for the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Even though a taxpayer may incur an expense only once in the business' life, the expense may qualify as ordinary and necessary if it is appropriate and helpful in carrying on the business, is commonly and frequently incurred in the type of business conducted by the taxpayer, and is not a capital expenditure. Commissioner v. Tellier, 383 U.S. 687 (1966); Deputy v. du Pont, 308 U.S. 488 (1940); Welch v. Helvering, 290 U.S. 111(1933). Treasury Regulation (Treas. Reg.) 1.162-4 provides that the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinary efficient operating condition, may be deducted as an expense. However, repairs in the nature of replacements, to the extent, that they arrest deterioration and appreciably prolong the life of property, shall either be capitalized and depreciated in accordance with § 167 or charged against the depreciation reserve if such account is kept. § 162 has, also, been applied to allow business expense deductions for the costs of removing and disposing of waste materials produced in the taxpayer's business. See H.G. Fenton Material Co. v. Commissioner, 74 T.C. 584 (1980).

§ 263 generally precludes deductions for capital expenditures. § 263 (a)(1) provides that no deduction shall be allowed for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of any property. § 263(a)(2) provides that no deduction shall be allowed for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance has been made in the form of a deduction for depreciation, amortization, or depletion. Treas. Reg. 1.263(a)-1(b) provides that capital expenditures include amounts paid or incurred: (1) to add to the value, or substantially prolong the useful life of property owned by the taxpayer, such as plant or equipment, or (2) to adapt property to a new or different use. Amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures. Treas. Reg. 1.263(a)-2(a) provides that capital expenditures include the cost of acquisition, construction, or erection of machinery, buildings, and equipment, furniture and fixtures and similar property having a useful life substantially beyond the taxable year.

§ 263A provides that the direct costs and indirect costs properly allocable to real or tangible personal property produced by the taxpayer shall be capitalized.

§ 263A(g)(1) provides that for purposes § 263A, the term "produced" includes construct, build, install, manufacture, develop, or improve.

§ 167 generally allows as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear( including a reasonable allowance for obsolescence) of property used in a trade or business, or of property held for the production of income.

Through provisions such as § 162(a), § 263(a) and related code sections, the Service generally endeavors to match expenses with the revenues of the taxable period to which the expenses are properly attributable, resulting in a more accurate calculation of net income for tax purposes. In Welch v. Helvering, 290 U.S. 111(1933) and Deputy v. du Pont, 308 U.S. 488 (1940), the Supreme Court has specifically recognized, the "decisive distinctions[between capital and ordinary expenditures] are those of degree and not of kind." Thus in determining whether capitalization or current deduction is the appropriate tax treatment for any expenditure, it is imperative to consider the extent to which the expenditure will produce significant future benefits. See INDOPCO, Inc. V. Commissioner,112 S.Ct. at 1044-45

In April 1993, The Service addressed this overriding issue in the form of Technical Advice Memorandum(TAM) 9315004. While a TAM is in effect a private ruling, issued by the Service's national office, on a completed or past transaction relating to a particular taxpayer, it does, however, provide a basis for analysis and discussion of the issue-- in this situation, determination of whether environmental remediation expenses are "capital" expenditures or "ordinary and necessary" expenses incurred in carrying on a trade or business.           

The taxpayer in TAM 9315004 had used a lubricant containing PCBs several years before their hazards were known. The taxpayer had not broken any laws and had converted to other lubricants when the perils of PCBs were detected. Thereafter, the EPA ordered the taxpayer to cure the contaminated sites. This TAM addressed the treatment of the taxpayer's costs in complying with the EPA order:

1. Assessment costs.The TAM defines these costs as those incurred to ascertain if, and to what extent, a property is contaminated. The TAM permits full deduction of assessment costs if a property does not require remediation. Should remediation be required, the TAM prescribes that these costs are to be capitalized to the related asset and depreciated over the asset's remaining life.

2. Remediation expenditures. The TAM prescribes that such cleanup costs are to be capitalized. The Service noted that capitalization was appropriate when there is a documented remediation plan, because having such a plan suggests the remediation activities are more than incidental repairs.

3. Legal fees.The TAM states that legal fees incurred to defend the taxpayer from government and third-party claims, including the taxpayer's litigation with its insurer to establish contractual rights, are fully deductible in the year incurred. The Service views the legal fees as separate from the cleanup costs.

4. Oversight Costs. These are costs incurred to monitor and/or manage an environment cleanup. The TAM directs these to be capitalized.

5. Environmental audit expenses. The TAM states there were insufficient facts to address the treatment of the taxpayer's environmental expenses. The tax treatment of the costs of developing the taxpayer's compliance manual as required by the EPA depends on whether it is part of the remediation plan, whether it is the taxpayer's separate asset, or whether it will undergo periodic modification with concomitant recurring costs.

6. Research and development expenses. The TAM does not address the appropriate treatment of the costs of developing an alternate remediation plan. If these costs, however, are part of the plan, e.g., the taxpayer incurs these to ascertain the optimal method to cleanup the pollution, the Service generally requires these expenses to be capitalized.

In rejecting the taxpayer's position that the remediation operations were repairs, the Service concludes that these activities, taken as a whole, resulted in improvements to the taxpayer's properties. The purported improvements included curing polluted land and making it more marketable, avoiding further penalties by bringing the properties into compliance and providing a safer environment for employees and owners of neighboring properties. This conclusion, however, disregards the fact that the remediation actives restored the site to its uncontaminated state. The Service relied on earlier cases in which the taxpayer had chosen to forgo annual maintenance, which later resulted in the need for vast curative activities, was required to capitalized these expenditures. For instance, in Wolfsen Land & Cattle, 72 T.C. 1 (1979), the taxpayer was required to capitalize the cost of dredging ditches to clear a farm irrigation system of sediment because the expenditures were more than merely incidental; they made the property more efficient, productive and valuable. The TAM did not address the issue to which underlying asset the remediation expenditures should be capitalized. With the exception of the contamination of buildings, e.g., lead paint or asbestos, most pollution affects land, which is not depreciable under §167.

On June 2, 1994, the Service issued Revenue Ruling (Rev. Rul.) 94-38, 1994-1 C.B. 35. At issue was whether the costs to clean up land and to treat groundwater, that the taxpayer polluted with hazardous waste from its business, are deductible as a business expense under § 162 or must be capitalized under § 263.

The taxpayer purchased land in 1970; this land was not contaminated at the time of its acquisition. The taxpayer subsequently constructed a manufacturing plant on this property which the taxpayer continues to own and operate. The manufacturing operations discharge hazardous waste, and in the past, the taxpayer buried this waste on portions of its land.

In 1993, in order to comply with presently applicable and reasonably anticipated federal, state, and local environmental requirements, the taxpayer decided to remediate the soil and groundwater that had been polluted by the hazardous waste, and to establish an appropriate system for the continued monitoring of the groundwater to ensure that the remediation had removed all hazardous waste. Accordingly, the taxpayer began excavating the contaminated soil, transporting it to appropriate disposal facilities, and backfilling the excavated areas with uncontaminated soil. These soil remediation activities started in 1993 and were targeted to be completed in 1995. The taxpayer also began constructing groundwater treatment facilities which included wells, pipes, and other equipment to extract, treat, and monitor contaminated groundwater. Construction of the groundwater facilities began in 1993, and the facilities will remain in operation on the taxpayer's land until 2005. During this time, the taxpayer will continue to monitor the groundwater to ensue that the soil remediation and groundwater treatment eliminate the waste to the extent necessary to bring the taxpayer's land into compliance with the environmental requirements.

The effect of the soil remediation and ground water treatment will restore the taxpayer's land to essentially the same physical condition that existed prior to the contamination. During and after the remediation and treatment, the taxpayer will continue to use the land and operate the plant in the same manner as it did prior to the cleanup except that the taxpayer will dispose of any hazardous waste in compliance with environmental requirements.

The Service held that since the groundwater treatment facilities constructed have a useful life substantially beyond the taxable year of construction, the construction costs are capital expenditures under § 263(a) and Treas. Reg. 1.263(a)-2(a). The Service further stated that since construction of these facilities constitutes "production" within the meaning of § 263(A)(g)(1), the taxpayer is required to capitalize, under § 263A, the direct costs and a proper share of allocable indirect costs of constructing the facilities. The costs of the groundwater treatment facilities are recoverable under § 168, Accelerated Cost Recovery System.

The Service further opined that the soil remediation costs and ongoing groundwater treatment expenditures, other than the expenditures to construct the groundwater treatment facilities, do not produce permanent improvements to the taxpayer's land within the scope of § 263(a)(1) or otherwise provide significant future benefits. In this situation, the Service concluded that the appropriate test for determining whether expenditures increase the value of property is to compare the status of the asset after the expenditures with the status of that asset before the condition arose that necessitated the expenditures (e.g., before the land was contaminated by the taxpayer's hazardous waste). The taxpayer's remediation and ongoing groundwater treatment expenditures did not constitute improvements, because the taxpayer merely restored its soil and groundwater to their approximate condition before they were contaminated by the taxpayer's manufacturing operations. Furthermore, since the soil remediation and ongoing groundwater treatment expenditures represent ordinary and necessary expenses (these are helpful in carrying on the taxpayer's business and are commonly and frequently required in the taxpayer's business), the costs to evaluate and remediate the soil and groundwater, exclusive of the costs to construct the groundwater treatment facilities, are deductible under § 162.

In 1996, the Service issued TAM 9627002. This TAM holds that costs paid to investigate the extent of environmental contamination, including legal and consulting fees, are currently deductible under § 162.

To recap, if the remediation costs do not increase the property's value and if the expenditures are: helpful in carrying on the taxpayer's business, and are commonly and frequently incurred in the taxpayer's type of business, the remediation costs are deductible under § 162. If the property's value, after the remediation expenditures are incurred, exceeds the property's value before the condition that triggered the remediation, then the remediation is deemed to have enhanced the property's value. Consequently, the expenditures are to be capitalized under § 263.

• Tax Treatment Of Environmental Fines And Penalties

A secondary issue is the tax treatment of fines and penalties levied in conjunction with the environmental protection and remediation processes. For instance, the EPA, under CERCLA, can impose a $25,000 per day penalty on a respondent who fails to perform the response action contained in the EPA's unilateral administrative order. Additionally, the EPA may recover up to four times its costs in damages and penalties( actual costs plus treble damages). Another example is the nonconformance penalty manufacturers of heavy-duty vehicles and engines pay to the EPA, as prescribed by the Clean Air Act. This nonconformance penalty is paid to obtain the necessary certificates of conformity for vehicles and engines which exceed the set emission standard but which do not exceed the upper limit associated with that standard. If a vehicle or engine is introduced into commerce or sold without the certificates of conformity, the manufacturer is subject to a penalty of not more than $10,000 per each violation of the Act.

§ 162(f) provides: no deduction shall be allowed under § 162(a), Trade or Business Expenses, for any fine or similar penalty paid to a government for the violation of any law. Treas. Reg. 1.162-21(B) defines a fine or similar penalty to include an amount:

1. Paid pursuant to conviction or a plea of guilty or nolo contendere for a crime( felony or misdemeanor) in a criminal proceeding;
2. Paid as civil penalty imposed by Federal, State, or local law, including additions to tax and additional amounts and assessable penalties imposed by Chapter 68 of the Internal Revenue code;
3. Paid in settlement of the taxpayer's actual or potential liability for a fine or penalty(civil or criminal); or
4. Forfeited as collateral posted in connection with a proceeding which could result in the imposition of such a fine or penalty.

Treas. Reg. § 1.162-21(b)(2) provides: "Compensatory damages (including damages under section 4A of the Clayton Act) paid to a government do not constitute a fine or penalty". However, Treas. Reg. § 1.162-21(c)(2) example 7 reasons that taxpayers who are fined for violating pollution control laws can not deduct such fines.

To properly assess the appropriate treatment of the "fine or penalty", the very nature of the assessment must be scrutinized. In Rev. Rul. 88-46, 1988-1 C.B. 76, the issue was the whether the nonconformance penalty(NCP) assessed by the EPA under section 206(g)(1) of the Clean Air Act(Act) was a nondeductible "fine or similar penalty" for purposes of § 162(f).

The Service held that the NCP was not a "fine or similar penalty" for purposes of § 162(f); therefore, § 162(f) did not preclude deducting the NCP as a business expense under § 162(a). The Service based it ruling on the fact that the Act and the legislative history indicate that the NCP is primarily designed as a permissive and equalizing formula to eliminate the competitive economic advantage that a nonconforming producer might otherwise have over a conforming producer. The legislative history of the NCP shows that it is not punitive in nature.

Rather, payment of the NCP provides one of two lawful alternative ways for receiving a certificate of conformity. The other way is simply to conform to the established emission standard. Mere nonconformity within the allowable range of nonconformity is not a violation of the act if there is a payment of the NCP.

In Colt Industries, Inc., Plaintiff/Cross-Appellant v. The United States, Defendant-Appellee, 880 F.2d 1311 (CA-FC, 1989), affirming the Claims Court, 11 ClsCt 140 (1986), Crucible, Inc., an affiliated subsidiary of Colt Industries, Inc., failed to eliminate violations of the federal Clean Air Act and the federal Clean Water Act (Acts) by statutory mandated dates. The EPA pursued an injunction and civil penalties as prescribed by the Acts. In 1979, The United States District Court for the Western District of Pennsylvania signed the consent degree, and entered judgment on the complaint that the Department of Justice had filed in accord with EPA's recommendation. In satisfaction of the civil penalties, Crucible remitted checks totaling $1.6 million to the Pennsylvania Clean Air and Clean Water Funds. Colt claimed these payments as ordinary business expense deductions on its 1979 consolidated tax return. After audit of Colt's returns, the Service disallowed the deductions on the basis that these payments constituted fines or similar penalties under § 162(f). Colt paid the deficiency assessed by the Service, together with interest. When the Service denied its claim for refund, Colt filed the refund suit with the Claims Court.

Colt's position was based on two augments:

1. § 162(f) only bars deduction of those civil penalties that serve a punitive or criminal purpose, and the penalties it paid did not. Colt relied on a report of the Senate Finance Committee which says, "In approving the provisions dealing with fines and similar penalties in 1969, it was the intention of the committee to disallow deductions for payments of sanctions which are imposed under civil statues but which in general terms serve the same purpose as a fine exacted under a criminal statute."
2. The penalties it paid were compensatory, and therefore not within the scope of § 162(f).

The first augment was unacceptable to the appellate court because, as a necessary predicate according to Colt, the court would have to "determine the purpose or purposes served by the specific penalty at issue in order to ascertain whether the payment is barred from deduction." The Appellate court also stated that neither § 162(f) nor the related Treasury Regulations prescribe a "purpose" inquiry. Therefore, it was beyond the court's mandate to embark on one to make its own assessment of the deductibility of a particular penalty.

With respect to the second augment, Colt could not demonstrate how the penalties, which in its view were designed to return Crucible to the financial position in which it would have been had Crucible complied with those laws, compensate the government. In any event, the appellate court stated the EPA is not authorize under either Act to seek compensatory damages. It is limited to injunctive relief and the maximum monetary penalties prescribed by the Acts.

In True v. U.S., 90-1 USTC ¶ 50,062 (10th Cir. 1990) rev'g 603 F. Supp. 1370 (D. Wyo. 1985) the district court had allowed a deduction for the penalty imposed for oil spills pursuant to the Federal Water Pollution Prevention and Control Act(Act). The district court noted that the penalty had a "remedial purpose", because it was placed in a revolving fund used to clean up oil spills, and that it was imposed on the basis of strict liability. The Tenth Circuit concluded, however, that Congress intended to incorporate the judicial view that some strict liability penalties are nondeductible. The circuit court reasoned that, because a wholly independent provision of the Act authorized the Government to recoup costs incurred in oil cleanup operations, which appeared to be the primary compensation or remedial mechanism in the Act, the penalty section served as an additional sanction to deter and punish, not to compensate or remedy.

In S& B Restaurant, Inc. v. Comr., 73 T.C. 1226 (1980) the court concluded that payments made under a settlement allowing the taxpayer to continue to discharge sewage until it could link up with a planned sanitary sewer system were deductible. The reason was the settlement agreement constituted a "permit" to continue discharging the sewage. The court noted that the applicable statute, the Pennsylvania Clean Streams Law, had punitive and remedial aspects. However, the court found four factors indicating that the taxpayer's payments were deductible: (1) the taxpayer was obligated to connect to the sanitary system when it was ready; (2) settlement payments were equivalent to the amount the taxpayer would pay when it connected with the system; (3) the taxpayer was not permitted to build its own treatment system; and (4) the taxpayer's discharges were not environmentally harmful.

III. Financial Accounting Treatment

The financial accounting issues associated with the environmental remediation processes are: (1) whether the asset has been impaired, and thus, whether a loss should be recognized; (2) when should the remediation liabilities be recognized; (3) how should the remediation liabilities be measured:[(i) what costs to include in the remediation liability; (ii) how future events are to be treated; (iii) how to account for the division of costs among Potentially Responsible Parties (PRPs); (iv) how to account for potential recoveries; and (v) whether remediation liabilities can be discounted.]; and (4) how environmental remediation liabilities and recoveries should be reported on the financial statements.

• Impairment of Long-Live Assets

In 1995 The Financial Accounting Standards Board(FASB) issued FASB No. 121, Accounting For The Impairment of Long-Lived Assets to Be Disposed Of. This pronouncement is effective for financial statements for fiscal years beginning after December 15, 1995. This Statement establishes accounting standards for the impairment of long-lived assets to be disposed of and for long-lived assets to be held and used.

Basically, FASB No. 121 provides that long- lived assets for sale should be reported at the lower of the carrying value or the fair value less the costs to sell. Essentially, this requires the entity to record the losses, if any, on the disposal of fixed assets as soon as the entity becomes committed to sell the assets.

For long-lived assets held for use, the valuation process consists of essentially three steps:

1. Look For Signs Of Impairment. Management is required to review long-lived assets held for use to determine if "events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable." Examples of events or changes in circumstances that indicate that the recoverability of the asset's carrying amount should be assessed are: 
   (a) A significant decrease in the market value of an asset.
   (b) A significant change in the extent or manner in which an asset is used or a significant physical change in an asset. 
   (c) A significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator. 
   (d) An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset.
   (e) A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an asset used for the purpose of producing revenue. 
2. Estimate Future Cash Flows. If there are signs that an asset may be impaired, then the entity must estimate the sum of the asset's expected future cash flows and compare these cash flows(undiscounted and without interest charges) to the asset's carrying amount.[ Note: The Emerging Issues Task Force(EITF) reached a consensus in Issue No. 95-23, The Treatment Of Certain Site Restoration/Environmental Exit Costs When Testing A Long-Lived Asset For Impairment, that future cash flows for environmental exit costs that are associated with a long-lived asset and that have been recognized as a liability should be excluded from the undiscounted expected future cash flows used to test the asset for recovery under FASB No. 121. However EITF Issue No. 95-23 relates only to environmental exit costs that may be incurred if the asset is sold, abandoned, or ceases operations.]
3. Recognize Impairment. If the sum of the undiscounted future cash flows is less than the asset's carrying value, then an impairment loss should be recognized. The loss is the amount by which the asset's carrying value exceeds its fair value.

For example, a lessor determines that the building it is leasing contains asbestos and/or lead paint (a sign of impairment). The lessor would then have to compare the future, undiscounted cash flows (rental revenues less related operating expenses) to the building's carrying amount (acquisition or construction costs plus improvements less accumulated depreciation). If these future cash flows are projected to be less than the building's carrying value and the building's carrying amount exceeds the building's fair value, an impairment loss (the excess of the building's carrying value over the building's fair value) would be reported as a component of income from operations.

• Recognition of Remediation Liabilities

  FASB No. 5, Accounting for Contingencies, requires the accrual of a liability if: (a) 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 and (b) the amount of the loss can be reasonably estimated.

  The underlying cause of an environmental remediation liability is the past or present ownership or operation of a site, or the contribution or transportation of waste to a site, at which remedial actions must take place. This underlying cause must have occurred on or before the date of the financial statements.

  1. Probability Criteria. The probability criteria is satisfied, according to the AICPA's Statement of Position (SOP)96-1, Environmental Remediation Liabilities, if on or before the date the financial statements are issued:

  (a) It has been asserted(or it is probable that it will be asserted) that the entity is responsible for participating in a remediation process because of a past event; and

  (b) It is probable, based on available data, that the entity will be held responsible for participating in a remediation process because of a past event (the outcome of such litigation, etc. will be unfavorable).

  Given the legal framework within which most environmental remediation liabilities arise, The Accounting Standards Executive Committee (AcSEC) concluded if litigation has commenced or a claim or an assessment has been asserted or if such is probable and if the reporting entity is associated with the site, the outcome of such action(s) will be unfavorable.

  2. Ability to Reasonably Estimate the Liability. Since estimating environmental liabilities involves an array of issues at any point in time, it is extremely difficulty to estimate these liabilities. However, FASB Interpretation No. 14, Reasonable Estimation of The Amount of Loss, stipulates that the second criteria - "the amount can be reasonably estimated"- is met when a range of loss can be reasonably estimated. The interpretation further stipulates that if the estimated loss falls within a range of possible amounts, the best estimate of loss should be accrued. If no amount within the range is a better estimate than any other amount, the minimum amount in the range should be accrued.

  An estimate of the range of an environmental liability generally is derived by combining estimates of various components of the liability, which are themselves likely to be ranges. Thus, the overall liability that is recorded may be based on amounts representing the lower end of a cost range for some components and the best estimates within cost ranges for other components.

  For example, a sole PRP that has confirmed it sent waste to a Superfund site and agrees to perform a remedial investigation and feasibility study (RI/FS) knows that it will incur the cost of the RI/FS. However, the entity also realizes that the overall cost to remediate the site will be significantly greater than the RI/FS cost. Nevertheless, the entity, at this time, cannot estimate the total cleanup costs due to existing uncertainties regarding the kinds and quantities of hazardous substances and the technologies available to remediate the site. In this scenario, the inability to estimate the entire cleanup costs should not preclude the recognition of the cost of the RI/FS. Thus, a liability for the best estimate (or if no best estimate is available, the minimum amount in the range) of the RI/FS costs and any other component remediation costs that can be reasonably estimated should be recognized in the entity's financial statements.

  Changes in estimates of the entity's remediation liability, including revisions to the entity's estimate of its share of the liability due to the negotiation or identification of other PRPs, should be accounted for as changes in estimates-- recognized in the fiscal year in which the changes are determined.

  3. Benchmarks. Certain stages of the remediation effort or process and of PRP involvement provide benchmarks that should be considered when evaluating the probability that a loss has been incurred and the extent to which any loss is reasonably estimable. SOP 96-1 cites the following Superfund benchmarks and stipulates, that as a minimum, the estimate of the remediation liability should be evaluated as each of these benchmarks occurs:

  (a) Identification and verification of an entity as a PRP. Receipt of notification or otherwise becoming aware that an entity may be a PRP requires it to examine its records to determine whether it is associated with the site. If the entity determines that it is associated with the site, it is probable that a liability has been incurred. If all or a portion of the liability is reasonably estimable, the liability should be recognized. If the entity does not have adequate information to reasonably estimate the minimum amount in the range of its liability, the criteria for recognition would not be met. Thus this fact, if material to the entity's financial statements, should be disclosed in the footnotes.

  (b) Receipt of unilateral administrative order. An entity may receive a unilateral administrative order compelling it to take a response action at a site or risk penalties of up to four times the cost of the response action. The ability to estimate costs resulting from unilateral administrative orders varies with factors such as site complexity and the nature and extent of the work to be performed. The benchmarks that follow should be considered in evaluating the ability to estimate such costs insofar as the actions required by the unilateral administrative order involve these benchmarks. The cost of performing the requisite work generally is estimable within a range, and recognition of an environmental remediation liability for the costs of removal actions generally should not be delayed beyond this point.

  (c) Participation, as a PRP, in the RI/FS. At this stage, the entity and possibly others have been identified as PRPs, and have agreed to pay the costs of a study that will investigate the extent of the environmental impact of the release or threatened release of hazardous substances and identify site-remediation alternatives. Additionally, the total costs of the RI/FS generally is estimable within a reasonable range. Also, the identification of other PRPs and their agreement to participate in funding the RI/FS typically provides a reasonable basis for determining the entity's allocable share of the cost of the RI/FS. Further, information may be available regarding the extent of environmental impact and remediation alternatives. This data may or may not provide a basis for reasonably estimating the total remediation liability. At a minimum, the entity should recognize its share of the estimated total cost of the RI/FS. As the RI/FS proceeds, the entity's estimate of its share of the total cost of the RI/FS can be refined, and additional information may become available upon which the entity can refine its estimate of other components of the liability or begin to estimate other components.

  (d) Completion of feasibility study. The feasibility study should be considered substantially complete no later than the point at which the PRPs recommend a proposed course of action to the EPA. At this point, both a minimum remediation liability and the entity's allocated share generally will be reasonably estimable. Thus, recognition should not be delayed beyond this point, even if uncertainties, for example, regarding allocations to individual PRPs and potential recoveries from third parties, remain.

  (e) Issuance of record of decision (ROD). At this point, the EPA has issued its determination specifying a preferred remedy. Generally, the entity and other PRPs have begun, or completed, negotiations, litigation, or both for their allocated share of the remediation liability. Therefore, the entity's estimate normally can be refined based on the specified preferred remedy and a preliminary allocation of the total remediation costs.

  (f) Remedial Design Through Operation and Maintenance, Including Postremediation Monitoring. During the design phase of the remediation, engineers develop a better sense of the work to be done and are able to provide more precise estimates of the total remediation cost. Additionally, information likely will become available at various points until the site is delisted, subject only to postremediation monitoring. The entity should continue to refine and recognize its best estimate of its final obligation as this additional information becomes available.
  

• Measurement of Environmental Remediation Liabilities.

Once the entity has determined that it is probable that an environmental liability has been incurred, the entity should estimate that liability based on available information. The liability's estimation should include the entity's: (1) allocable share of the liability for a specific site, and (2) share of amounts related to the site that will not be paid by other PRPs or the government. This measurement process involves the following issues:

1. Costs to Be Included. The AcSEC concluded that the costs to be included are:

   (a)Incremental direct costs of the remediation effort (the period from the precleanup activities, such as the RI/FS, through performance of remedial activities, government oversight and post remediation monitoring.) Examples include: the RI/FS costs; costs of contractors performing the remedial actions; fees to outside law firms for the determination of the extent of remedial actions required, the type of  remediation actions to be used, or the allocation of costs among PRPs; and cost of machinery and equipment dedicated to the remedial actions and that does not have alternative use.
   The costs of services related to routine environmental compliance matters and litigation costs involved with potential recoveries are not part of the remediate effort. Litigation costs involved with potential recoveries should be charged to expense as incurred until realization of the claim for recovery is considered probable and an asset relating to the recovery is recognized. At that time any remaining such legal costs should be considered in the measurement of the recovery. 

   (b)Compensation and benefit costs for those employees who are expected to devote a significant amount of time directly to the remediation effort, to the extent of the time expected to be spent directly on the remediation effort.
   

2. Effect of Expected Future Events and Developments. The AcSEC concluded that for purposes of measuring environmental liabilities, the measurement should be based on enacted laws and adopted regulations and policies. Changes in laws, regulations, and policies should be recognized only as the changes are enacted or adopted.
3. Allocation of Liability Among PRPs. The entity's estimate of its liability should be based on its estimate of its allocable share of the joint and several remediation liability. The estimation process requires the entity to: (a) identify the PRPs for the site, (b) asses the likelihood that other PRPs will pay their full allocable share of the joint and several liability, and (c) determine the percentage of the liability that will be allocated to the entity, including its share of amounts that will not be paid by other PRPs or the government.
4. Impact of Potential Recoveries. The amount of an environmental remediation liability should be determined independently from any potential claim for recovery, and an asset relating to the recovery should be recognized only when realization of the claim for recovery is deemed probable. If the claim is the subject of litigation, a refutable presumption exists that realization of the claim is not probable. The amount of the recovery should not be discounted to reflect the time value of money if the related liability is not discounted and the timing of the recovery is dependent on the timing of the payment of the liability.
5. Discounting Remediation Liabilities. SOP 96-1 permits discounting to reflect the time value of money if the aggregate amount of the liability or component and the amount and timing of cash payments for the liability or component are fixed or reliably determinable.

FASB No. 76, Extinguishment of Debt, defines risk-free monetary assets as:

(a) Direct obligations of the U.S. government;
(b) Obligations guaranteed by the U.S. government; and
(c) Securities that are backed by U.S. government obligations as collateral under an arrangement by which the interest and principal payments on the collateral generally flow immediately through to the holder of the security.

• Display and Disclosure.

These issues are addressed in the context of : (1) balance sheet and (2) the income statement.

(1) Balance sheet display. An entity's balance sheet may include: (a) receivables from other PRPs that are not providing initial funding; (b) anticipated recoveries from insurers; and (c) anticipated recoveries from prior owners as a result of indemnification agreements.

As discussed above, these recoveries are recognizable when the recoveries' realization is probable. However, FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, addresses the issue of offsetting environmental liabilities and related recoveries in the balance sheet. This pronouncement states that offsetting is inappropriate except when a right of offset exists. A right of offset exists when all of the following conditions are met:

(a) Each of two parties owes the other determinable amounts.

(b) The reporting party has the right to setoff the amounts it owes to the other party with the amounts the other party owes it.

(c) The reporting party intends to setoff.

(d) The right of setoff is enforceable by law.

(2) Income statement display. Recording an environmental liability usually results in a corresponding charge to income. Further, since events underlying the incurrence of the obligation relate to an entity's operations, remediation costs should be charged against operations. In income statements that classify items as operating or nonoperating, the remediation-related expenses should be reported as a component of operating income. Credits arising from recoveries of environmental losses from other parties should be reflected in the same income statement line. Any earnings on assets that are reflected on the entity's financial statements and are earmarked for funding its environmental liabilities should be reported as investment income.

FASB Emerging Issues Task Force(EITF) Issues 90-8, Capitalization of Costs to Treat Environmental Contamination, and 89-13, Accounting for the Cost of Asbestos Removal, describe certain circumstances in which these remediation costs should be capitalized instead of charging income. These circumstances are:

EITF Issue 89-13. Costs incurred to treat asbestos should be capitalized when:

(a) the costs are incurred within a reasonable time period after a property with a known asbestos problem is acquired, or
(b) the costs are incurred to treat asbestos in an existing property.

EITF Issue 90-8. Environmental contamination treatment costs may be capitalization if recoverable but only if any one of the following criteria is met:

(a) The costs extend the life, increase the capacity, or improve the safety or efficiency of property owned by the entity. For purposes of this criterion, the condition of that property after the costs are incurred must be improved as compared with the condition of that property when originally constructed or acquired, if later.
(b) The costs mitigate or prevent environmental contamination that has yet to occur and that otherwise may result from future operations or activities. In addition, the costs improve the property compared with its condition when constructed or acquired, if later.
(c) The costs are incurred in preparing for sale that property currently held for sale.

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