The Sarbanes-Oxley (SOX) legislation brought the need to have transparency in financial statements to the forefront of corporate issues. And though many companies continue to look at SOX as a “Financial Department Issue”, related regulatory action and interpretations by the Financial Accounting Standards Board (FASB), connected to ‘Retired Assets’ accounting, has complicated the life of investment recovery managers. The main issue is that companies must now report asset value data related to possible future
facility retirement in current statements. Keep in mind that the impetus or thrust of SOX is to improve integrity – to force accounting accuracy and clarity.

To be very simplistic about it, including such information in current financial statements sets up huge questions related to projecting future market conditions and future company operating situations.

There are two FASB rulings involved here:
• FAS (Financial Accounting Standard) 143, Accounting for Asset Retirement Obligations, issued in June 2001, established the rules for how a company must value and report recently retired assets

(just before or just after the event, when costs and liabilities are essentially certain).
• Then in December 2005 came FASB’s ‘FIN 47’ (Financial Interpretation No. 47) “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143”. This
interpretation established that companies must book future retirement liabilities now, according to certain standards, and keep the books updated through event actuality. According to the introductory summary in the ruling document: “Diverse accounting practices have developed with respect to

the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and (or) method of settlement of the obligation are conditional on a future event.”
In other words the creative bookkeeping flexibility associated with retired assets was being eliminated in the spirit of SOX. The IR Challenge. The FASB rulings created challenges for investment recovery managers by requiring immediate quantification of potential future asset retirement before there is an actual project on their schedule. Adding to that difficulty are inter-departmental communications that must be managed and tracked-possibly over several years against an uncertain event target date. Clearly, SOX is not just an accounting issue! To obtain copies of both FASB rulings, contact the Investment Recovery Association office.
Under the new standard, many companies may have to book future cleanup costs, whether or not they can be ascertained today. Buried within the flurry of earnings releases issued during the past two weeks were reports by a handful of large companies of charges related to FIN 47, an accounting
rule that went into effect in December. The immediate result of their applications of the new standard, which governs disclosures related to future environmental liabilities, were modest hits to net income and earnings per share.

For instance, Ford Motor Co. recorded a $251 million after-tax charge to net income for 2005 and an accompanying 11 cent reduction in earnings per share. United Technologies Corp. posted a $95 million charge, which shaved 9 cents off annual EPS. Similarly, USG Corp. and ConocoPhillips
saw their annual net incomes cut by $11 million and $88 million respectively. USG’s per-share earnings dropped 25 cents, and ConocoPhillips’s fell by 7 cents. The longer-term effect of FIN 47, however, will not be apparent until companies that are bound by the new rule issue their annual
reports later this year. That’s when investors will get a look at the effect that estimated future cleanup costs will have on balance sheets. The standard is a new interpretation of FAS 143, Accounting for
Asset Retirement Obligations, which was issued in June 2001. Under the new reading, affected companies must recognize on current financial statements future environmental liabilities associated with permanently shutting down a facility. In the past, companies interpreted FAS 143 differently.
They reckoned that the liability only had to be booked when the cleanup cost and the timing of the facility closing were relatively certain. Independent auditors agreed, but the Financial Accounting Standards Board continued to mull the practical application of the rule.

Originally, FAS 143 pertained to the future cost of cleaning up nuclear power plant sites after the facilities were shuttered. The standard instructed plant owners to estimate future liabilities (including cleanup and remediation costs) using a discounted cash flow model. After that, they should recognize the charge every year until the plant entered retirement, according to FASB. From an accounting perspective, as the plant ages and moves closer to retirement, the amortized asset is written down

while the liability grows. By the time the plant is closed, the liability turns into a cash outlay. Further, power plant owners are obligated by law to eventually clean up the site, which means that the liability is a sure thing. It was that widespread certainty that led FASB to suggest that nuclear power plants were not the only facilities that should fall under the auspices of FAS 143.
For five years, FASB, auditors, and companies had tangled over the question of whether the owners of factories, warehouses, coal-fired power plants, and other industrial facilities should also be made
to recognize future environmental liabilities. Finally, on December 15, FIN 47 was released, clarifying FASB’s position: Any company required by contract or statute to perform an environmental cleanup after retiring a facility must book the future cleanup cost—whether or not it can be ascertained today.
In addition to recognizing the future environmental liability on its balance sheet, a company must also make appropriate disclosures about the cost and timing of obligations in shuttering the facility. Further, affected companies must take a one-time “cumulative” accounting charge to net income as a way of truing up their books in light of the new rule. The one-time charge is what popped up in the earnings releases over the last two weeks. In essence, those companies had to imagine that FIN 47 was in effect when they built or bought their facilities and then figure out what charges would have been taken in the time between when they built or bought the plant and December 2005.

No Sweat on the Street—The recently reported adjustments didn’t seem to bother Wall Street. Nicole Decker of Bear Stearns, for instance, didn’t mention it in her evaluation of ConocoPhillips. JSA Research’s Paul Nisbet says that despite being surprised by the United Technologies disclosure, the
charge would not hurt the company’s futureshare price in any material way. Companies that haven’t reported the charges yet,however, could face greater risks. Such companies might, for example, receive audit opinions marred by a statement of material weaknesses in their financial controls if they

fail to address the new asset-retirement cleanup reporting issues.

“Some companies may be asleep at the switch on minor accounting issues like FIN 47,” says Jay Hanson, national director of accounting at McGladrey and Pullen LLP. The sudden awareness of that kind of sleepiness might spook investors. Indeed, a study released last year by shareholder-advisory
firm Glass, Lewis & Co. revealed that on average, the day after a company disclosed a material weakness in its financial controls, its share price dropped 0.67 percent relative to market movement. After a week, the share price dropped 0.90 percent; and after 60 days, the price tumbled 4.06 percent.

“The new rule, however, just doesn’t appear on many corporate radar screens.”

A number of auditors confirm that clients come to them with questions about the FIN 47 infrequently. “Frankly,” says McGladrey’s Hanson, “most companies are consumed by efforts to comply with the new stock-option accounting rules under FAS 123R”. For now, “independent auditors are driving
this first round of FIN 47 disclosures,” says Greg Rogers, president of Advanced Environmental

Dimensions, a consulting firm.

Audit firms routinely look to each other for rule interpretation precedents and apply them in such a way that they eventually become industry wide practices, he says. But not every company needs such

prompting. Consider United Technologies. While the aerospace company’s auditors approved its application of FIN 47, its internal accounting team first brought the issue to light. Internal accountants started working on FIN 47 in May, according to Jay Haberland, vice president of business controls at United Technologies.
Companies affected by FIN 47 will likely hail from the industrial sector, and include utility, refinery, mining, and chemical companies, says Doug Reynolds, a national office partner with auditor Grant Thornton. He adds that those are the companies with enough capital to build a facility large enough to affect the environment and therefore require a cleanup contract before receiving siting permits.

Nevertheless, Reynolds points out that any company with an official pact obligating it to clean up before shuttering a site could be affected, including tiny neighborhood dry cleaners or home-heating-oil companies with oil storage tanks. Further, financially troubled companies may not

fare well under FIN 47 unless they have already recognized the risk. For example, booking a significant liability could tip the balance sheet of a distressed company into bankruptcy, Rogers contends.
At the same time, companies’ ability—or inability—to estimate their liabilities remains a major bone of contention. Estimating the future cost is complicated by unclear accounting rules, changing environmental laws, lack of accurate data about remediation fees, and new discoveries of polluted sites, according to companies that have filed comment letters on the subject with FASB. In other words, says McGladrey’s Hanson, some companies may claim that they have no idea of how to accurately estimate their future environmental liabilities.

Under the new regime, however, those companies must disclose to shareholders that estimating future clean-up liabilities is virtually impossible for them. The upside to such a statement is that the charge, if there’s pay, could likely be low-balled. The downside is that admitting that future liabilities

are unknown might be an open invitation to investor criticism, scrutiny into controls weaknesses, or a shareholder lawsuit.

Asset Lifecycle Accounting and Sarbanes-Oxley Compliance: New Opportunities
The door is open for organizations to improve the accuracy of their financial statements, reduce administrative costs and minimize taxes. Fixed assets accounting is in the spotlight like never before. Sarbanes-Oxley Section 404 brings complex requirements that demand new methodologies and new

internal processes. What’s more, other emerging regulations and filing requirements are raising yet more issues about the entire asset life-cycle accounting process.

While most industry analysis has focused on the cost/effort required to comply with these new regulatory and legal requirements, asset lifecycle accounting is an area where these efforts can be leveraged to provide measurable and sustainable operational benefits to an organization,

Reduced Administrative Costs: Increased automation and the elimination of duplicate or inefficient processes bring significant savings.
More Accurate Financial Statement Processes: Properly designed asset lifecycle processes reduce risks associated with asset capitalization and provide turnkey evidence that:
  • Assets are properly capitalized,
  • Appropriate depreciation amounts are calculated and charged to expense, and
  • Assets are removed from financial statements in the appropriate reporting period.
Preservation and Maximization of Tax Deductions: By properly leveraging the core financial statement processes, the corporate tax department can ensure that the costs capitalized for tax purposes are correct and that the most favorable tax depreciation recovery periods have been
selected to significantly accelerate the cash tax benefit.

Adapting to Changing Financial and Tax Requirements: The ability to identify changes needed in financial or tax accounting requirements for fixed assets and to efficiently integrate the changes into

financial statement results is a fundamental component of asset lifecycle accounting. Compliance with the latest financial and tax fixed assets accounting requirement in today’s dynamic environment is one of the significant challenges in designing an effective asset lifecycle process.

Emerging Best Practices: As organizations complete initial Sarbanes- Oxley compliance efforts and

finalize their tax compliance strategies, a number of best practices are beginning to emerge:

Reassessment of existing systems: As risks are identified and new controls are put in place, companies are starting to assess whether their existing system is the correct solution for their business. Are controls mainly detective or does the system provide preventive controls. Does the system allow for adequate examination and testing of controls? Companies spending large amounts of administrative time working around systems with material control weaknesses are beginning to

reassess their existing systems.
Reevaluation of the asset lifecycle: The asset lifecycle involves a number of business functions and can vary significantly depending on the type of assets capitalized. By performing a review of the
specific processes and controls associated with each phase of the asset lifecycle, from requisition to disposition, organizations can identify duplicated processes and design new processes that will reduce both costs and financial statement risk.
Consolidation and standardization of calculations: In many organizations, multiple information systems are used in the asset accounting lifecycle. The emergence of enterprise-class asset amortization and depreciation applications can help organizations use one system to manage the
asset lifecycle from post-capitalization to disposal, avoiding the long-term costs of maintaining documentation and controls for multiple asset accounting systems.

A Golden Opportunity: The world of corporate accountancy has become the world of corporate accountability. One of the most significant developments has been the extension of audit and assessments work to the systems used by corporations to manage and record financial data. As the scope of the audit has grown, areas such as fixed assets management and depreciation calculations
are subject to much closer scrutiny, additional reporting requirements, and more in-depth testing.

Organizations facing these challenges have the opportunity to use more robust systems to effectively and confidently meet their compliance requirements. The benefits a company can achieve by adopting a full lifecycle approach to asset management far exceed compliance alone.
Organizations have a golden opportunity to improve the accuracy of their financial statements, reduce administrative costs, and help preserve or minimize their effective taxation rate.
Reprinted from ASSET 2.0, the Investment Recovery Business Journal, Vol. 5, 2006

© The Investment Recovery Association