Madison, Roland L.

Saunders, Gary

English

eGrove (Univ. of Mississippi)

Woman C.P.A. Volume 46 Issue 3 Article 6 7-1984 Hazardous Wastes Disposal Costs: Their Recognition is a Social Responsibility of the Independent Auditor Gary Saunders Roland L. Madison Follow this and additional works at: https://egrove.olemiss.edu/wcpa  Part of the Accounting Commons, and the Women's Studies Commons Recommended Citation Saunders, Gary and Madison, Roland L. (1984) "Hazardous Wastes Disposal Costs: Their Recognition is a Social Responsibility of the Independent Auditor," Woman C.P.A.: Vol. 46 : Iss. 3 , Article 6. Available at: https://egrove.olemiss.edu/wcpa/vol46/iss3/6 This Article is brought to you for free and open access by the Archival Digital Accounting Collection at eGrove. It has been accepted for inclusion in Woman C.P.A. by an authorized editor of eGrove. For more information, please contact egrove@olemiss.edu. Hazardous WastesDisposal Costsof Statement of Financial Accounting Standards No. 5 “Accounting for Con­tingencies (1975).” SFAS No. 5 in­dicates in paragraph 8 that:An estimated loss from a loss con­tingency...shall be accrued by a charge to income if both of the follow­ing conditions are met:Their Recognition is a Social Responsibility of the Independent Auditora) Information available prior to issu­ance of the financial statements in­dicates that it is probable that ... a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.By Gary Saunders and Roland L. MadisonDioxin is only the latest hazardous waste material to gain national atten­tion because of inadequate disposal methods. Before dioxin, PCBs, TCE, Kepone, arsenic, lead, and a number of other toxic or carcenogenic waste products commanded the nation’s at­tention. Concern about the hazards of waste dump sites and their requisite cleanup has thrust relatively obscure locations, such as Love Canal, Times Beach, and Midland, into national pro­minence and has been responsible, at least in part, for the recent resignations of two high-level Environmental Pro­tection Agency (EPA) officials.Estimates have placed the number of hazardous waste sites in the United States as high as 51,000. The EPA in­dicated that some 57 million tons of hazardous wastes were being generated annually and approximate­ly 90 percent of those wastes were be­ing disposed of in an environmentally unsafe manner. Potential liabilities for firms generating and disposing of the waste material are staggering. One SEC accountant recently surmised that the potential liability for cleanup of the existing dump sites was in the “megabuck” range. Based on the per­vasiveness of the problem, estimates 26/The Woman CPA, July, 1984as high as $500 billion are not unreasonable.To date, the independent auditor has not been a central figure in the controversy. However, it is quite con­ceivable that audit firms will become embroiled in the economic controver­sy as the full cost of the effort to rec­tify the problem becomes more apparent. The jury is still out on the question of who will bear the expense. If resolution of the question results in requiring firms that generate such hazardous waste materials to pay even a portion of the cleanup cost, the im­pact on the financial position of those firms may be substantial. A considera­tion of the independent auditor’s role in the disposition of hazardous waste material yields some interesting possibilities.Current Treatment of Disposal CostsImmediate costs associated with the disposal of hazardous wastes are recognized in the determination of cur­rent income in accordance with generally accepted accounting prin­ciples (GAAP). Any future costs incur­red as a result of present disposals should be considered within provisions b)The amount of the loss can be reasonably estimated.The Statement further describes three points on a continuum relating to the probability that a liability has been incurred as:a) Probable. The future event or events are likely to occur.b) Reasonably possible. The chance of the future event or events oc­curring is more than remote but less than likely.c) Remote. The chance of the future event or events occurring is slight.In the event that one or both of the conditions specified in paragraph 8 are not met, but there is at least a “reasonable possibility” that a loss resulting in the impairment of an asset or the incurrence of a liability may have occurred, the contingency should be handled through disclosure. Con­tingent liabilities should not be disclos­ed, except in special circumstances, when their possibility of occurrence is remote.Since chemical processes tend to be prolific generators of hazardous wastes, a perusal of the annual reports distributed by four large chemical com­panies revealed that over the last half­dozen years, contingent liabilities arising from the current disposal of hazardous waste materials were disclosed in notes to financial statements. Understandably, the disclosures took on optimistic stance and typically included indications that resolution of the contingent liabilities would not materially affect the financial position or results of operations for the firms.Two exceptions to the ordinary foot­note disclosure merit comment. An­nual reports of the Occidental Petroleum Corporation for the 1980 and 1981 fiscal years, disclosed con­tingent liabilities without a monetary assessment in the balance sheet with footnote references. That approach, in conjunction with the typical footnote disclosure, tends to place somewhat more emphasis on significant con­tingent liabilities. Audit opinions on Allied Corporation’s statements for the 1977 and 1978 fiscal years were “qualified” because of the significance of the contingent liabilities. However, a close reading of the footnote in­dicates that contingent liabilities relating to hazardous waste disposal were not substantially responsible for the qualifications but they were a con­tributing factor. Other contingent liabilities arising from business ven­tures appear to have been a major in­fluence in arriving at the decision to qualify the opinions on Allied’s financial statements.There appears to be one common criterion currently used in the recogni­tion and subsequent disclosure of con­tingent liabilities in the financial statements examined. This criterion relates to the three points on the pro­bability distribution discussed in SFAS No. 5. For the occurrence of an event giving rise to a contingent liability to be considered “reasonably possible,” auditors apparently look for an asserted claim or assessment, i.e., a lawsuit or regulatory action. That pro­cedure is, on the surface, consistent with a provision of SFAS No. 5 which states that:Disclosure is not required of a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possi­ble claim of assessment... (p.5).Consequently, the assertion of a claim or assessment serves as an indication that a contingent liability should be recognized at least through disclosure. The same sentence continues by im­plying that a contingent liability should be disclosed when:...it is considered probable that a claim will be asserted and there is a reasonable possibility that the out­come will be unfavorable.Most liabilities presently recognized in the financial statement stem from legally enforceable obligations that are based upon contracts and exchange transactions. However, the Board ex­tended the definition conceptually to include obligations that:...stem from ethical or moral con­straints rather than rules of common or statue law, that is, from a duty to another entity to do that which an or­dinary conscience and sense of justice would deem fair, just, and right — to do what one ought to do, rather than what one is legally re­quired to do. (Statement of Financial Accounting Concepts No. 3, 1980, p. 15).Certain noncontributory pension plans that are maintained without con­tracts and compensated absences paid to employees without mandatory vesting provisions demonstrate the ap­plication of the conceptually broader social view of a liability (Statement of Financial Accounting Standards No. 43, 1980). These examples, and the preceding citations from SFAS No. 5 and SFAC No. 3 show that it may be quite appropriate to recognize some contingent liabilities before a lawsuit is filed or a regulatory body initiates action against a firm.Need For More Rigorous Interpretation of SFAS No. 5When the Hooker Chemical Cor­poration, a subsidiary of Occidental, disposed of industrial wastes at the Love Canal site during the 1940s, there was little reason to suspect that very significant future liabilities would arise. “Carcenogenic” was not the fre­quently used term that it is today. Recognition of a contingent liability stemming from the disposal probably received minimal consideration.Hooker officials apparently recogniz­ed the possibility of disaster when they twice issued strong public warnings about potential health hazards in 1957. The Niagara Falls Board of Education, using the threat of eminent domain, purchased the property for one dollar in 1953, and was considering the sale of parcels to private developers. Nonetheless, Occidental (Hooker’s parent company) very reluctantly disclosed contingent liabilities resulting from the disposal of hazar­dous wastes. In fact, the company was charged by the Securities and Ex­change Commission in 1980 with failure to disclose hundreds of millions of dollars in potential liabilities stem­ming from waste disposals at the site. Further, the SEC said that Occidental should have disclosed the potential ex­posure and costs associated with claims resulting from operations related to the environment.It is apparent that society in general and users of financial statements in particular cannot expect companies that generate and dispose of hazar­dous waste materials to vigorously pursue full disclosure of resultant con­tingent liabilities in their financial statements. The obvious advocate for society and financial statement users in the matter is the independent auditor. A more rigorous interpretation of SFAS No. 5 by the independent auditor accompanied by more ag­gressive inquiries of management and their legal council would undoubtedly result in more comprehensive disclosures. The situation, particular­ly with respect to the public’s level of environmental awareness, is substan­tially different than it was several decades ago and the public accoun­ting profession owes society and the financial community no less than full disclosure of the massive potential liabilities connected with the en­vironmentally unsafe disposal of hazardous wastes.Another aspect of the problem is the short-run tactical decision model that most industries have apparently been using in making determinations about the disposal methods to be used for hazardous wastes. The Chemical Manufacturers Association estimates that the cost of using landfills for hazar­dous waste disposal — a method typically considered environmentally unsafe — is $25 per barrel. At the same time, it estimates the cost for in­cineration of hazardous wastes, which is recognized as a more environmen­tally safe method of disposal, to be slightly more than $100 per barrel. (Time,March 29, 1982). Obviously, a short-term decision model, based on­ly on initial disposal costs, would dysfunctionally indicate the landfill disposal method as preferable.A longer-run decision model which considers all of the long-range costs of disposal, including eventual cleanup costs, would probably lead to more economic decisions, i.e. disposal of hazardous wastes by a more en­vironmentally safe method. With respect to the total costs of disposal, the EPA estimates that the monies The Woman CPA, July, 1984/27already expended at Love Canal through mid-1980 for cleanup of wastes are an astounding fifty-four times the amount that would have been required to dispose of them in­itially by an environmentally safe method. (New York Times, June 8, 1980). A more rigorous interpretation of SFAS No. 5, resulting in pressures to disclose the huge contingent liabilities at the time of disposal, might well cause firms to re-evaluate their disposal decisions and methodologies which hopefully will result in the adop­tion of more environmentally safe disposal methods.When examining current develop­ments, it may be more appropriate to consider the incurrence of a future liability (cleanup costs) as being “pro­bable” and either accrue to current in­come or, at a minimum, disclose the very real contingent liability involved with environmentally unsafe disposal of hazardous wastes. Some set­tlements, involving the payment of millions of dollars, have already been made by companies in matters relating to past disposals. It is very unlikely that the liability insurance requirements, imposed by the EPA on companies that dispose of hazardous wastes, will be sufficient to cover the eventual costs associated with materials dis­posed of in an environmentally unsafe manner. The EPA’s $1.6 billion ‘‘superfund” offers little assistance since it was established to finance the cleanup of abandoned dump sites when their owners could not be located. When owners can be found, EPA’s plan calls for requiring them to pay cleanup costs for the sites or face prosecution. The Justice Department brought felony charges before 25 grand juries in 14 states against in­dividuals accused of illegally dumping hazardous wastes. Earlier this year, two businessmen in a large midwestern metropolitan area were sentenced for illegally disposing of soil contaminated with PCBs (Akron- Beacon Journal, February 14, 1984). Consequently, the incurrence of a future liability resulting from the en­vironmentally unsafe disposal of hazardous wastes is now more likely ‘‘probable” than ‘‘remote.” Indepen­dent auditors should recognize that fact and press for recognition of those contingent liabilities particularly when considering the social and moral aspect for liability recognition as previously discussed in SFAC No. 3.SummaryIt is becoming evident that the costs to eliminate just the hazardous waste dump sites currently identified will be enormous and that total liabilities for past and future environmentally unsafe disposals could very well threaten the existence of several companies. As Polkowski observed, ‘‘Love Canal is only the tip of the iceberg... To date, industry, the general public, and Federal, State, and local governments have not confronted the totality of the waste problem facing our country. ” (GAO Review, Summer, 1981).The need for earlier recognition and fuller disclosure of contingent liabilities accruing from the environmentally un­safe disposal of hazardous wastes may represent a unique opportunity for the public accounting profession to fur­ther justify the trust placed in it by society. Authority to require earlier recognition is apparently existent in terms of generally accepted accoun­ting principles in SFAS No. 5, and con­ceptually reinforced from SFAC No. 3 from a socially expected viewpoint. Given the trend of current events toward increased corporate social accountability, a more rigorous inter­pretative stance by the accounting profession should generate strong support for a proposal of earlier liabili­ty recognition in the financial statements.Audit firms have been typified as ‘‘deep pockets” because of the number and size of litigation set­tlements arising from losses suffered by their clients’ creditors and stockholders. Earlier recognition of contingent liabilities would almost cer­tainly reduce the audit risk exposure of public accounting firms, thereby mitigating the effort required in convin­cing clients of the necessity for earlier disclosure. ΩGary Saunders, DBA, CPA, is associate professor of accounting at Kent State University, Kent, Ohio. He holds a DBA from the University of Kentucky and is certified in Ohio and West Virginia.Roland L. Madison, Ph.D., CPA, is professor and chairman of the Depart­ment of Accounting at John Carroll University, Cleveland, Ohio. His doc­torate is from the University of Nebraska-Lincoln.REFERENCES“EPA Reversal: Tightening Up on Toxic Waste.” Time, 119 (March 21, 1982) 30.Financial Accounting Standards Board (1975). Statement of Financial Accounting Standards No. 5. “Accounting for Contingencies.” (March, 1975).(1980). Statement of Financial Accounting Standards No. 43. “Accounting for Compen­sated Absences.” (November, 1980).(1980). Statement of Financial Accounting Con­cepts No. 3. “Elements of Financial Statements of Business Enterprises.” (December, 1980).Parisi, Anthony J., “Who Pays? Cleaning Up the Love Canal.” The New York Times, (June 8, 1980), Section 3, pp. 1-5.Polkowski, Frank J., “Hazardous Waste Disposal: A Staggering Problem.” GAO Review, 16 (Summer 1981), 42-46.“2 Sentenced for Dumping PCB Wastes,” Akron-Beacon Journal (February 14, 1984) Sec­tion E, p. 3.28/The Woman CPA, July, 1984

Hazardous Wastes Disposal Costs: Their Recognition is a Social Responsibility of the Independent Auditor

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Hazardous Wastes Disposal Costs: Their Recognition is a Social Responsibility of the Independent Auditor

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