Cleaning Up the Federal Government’s Accounting for ... | KPMG GOVERNMENT INSTITUTE | Issue Brief...

1 | KPMG GOVERNMENT INSTITUTE | Issue Brief

Cleaning Up the Federal Government’s Accounting for Environmental LiabilitiesIntroductionDuring the twentieth century, the scope of federal government defense-related activities increased dramatically as a result of World War II and the Cold War. These activities resulted in the creation of federally-owned plants and factories, including hundreds of nuclear facilities, large volumes of waste and nuclear materials requiring treatment, stabilization and disposal, and the world’s largest fleet of aircraft and ships. The growth of the federal government also resulted in its ownership of hundreds of buildings, many of which have been in service for decades.

The past 20 years have seen the government begin a massive effort to clean up the legacy of contamination from its past activities, and this cleanup effort has coincided with the effort to establish federal financial reporting capability, including measurement and reporting of environmental liabilities. These endeavors have made great progress, but have yet to reach their goals. After 20 years of cleanup work, the government expects the work to continue for nearly five more decades.

Moreover, the federal government’s consolidated financial statements (CFS) have yet to receive an opinion, and the Government Accountability Office’s (GAO) audit report continues to cite the government’s inability to reasonably estimate or adequately support amounts reported as environmental and disposal liabilities as a material weakness contributing to its disclaimer of opinion on the CFS.1 Furthermore, accounting for environmental liabilities is one reason the Department of Defense (DoD) is the only one of the 24 Chief Financial Officers Act2 entities not to have yet attained an opinion on its agency-wide financial statements.

Because of the long-standing nature of this material weakness, and the $349 billion of environmental liabilities included on the 2013 CFS, the KPMG Government Institute developed this Issue Brief to further explore these challenges and provide a way forward. Our research was guided by our work auditing the financial statements of 8 of the 15 cabinet agencies, during which we have developed extensive knowledge of the context of this challenge and perspective on how the federal government can address an issue that has remained

1 U.S. Government’s Fiscal Years 2013 and 2012 Consolidated Financial Statements, GAO-14-319R, February 27, 2014.

2 The Chief Financial Officers Act of 1990 (Public Law 101-576, 104 Stat. 2838, November 15, 1990)

a financial reporting problem for so long. We hope that this paper will be helpful to the Department of Defense in achieving ‘audit readiness’ for its entity-level and consolidated financial statements, and that other federal entities will find it useful in resolving control deficiencies, reviewing the conformity of their accounting policies and procedures with relevant standards, and improving their internal controls.

In the following pages this Issue Brief:

• Highlights the nature and types of environmental and disposal liabilities and the drivers of the federal government’s liability;

• Discusses the accounting for environmental liabilities, including complicating factors; and

• Illustrates common pitfalls that give rise to problems in accounting for environmental liabilities, the related accounting guidance, and how to avoid the common pitfalls.

KPMG GOVERNMENT INSTITUTE

Issue Brief

June 2014


What is an Environmental Liability and How Do We Define Cleanup Costs?Under Statement of Federal Financial Accounting Standards (SFFAS) No. 5, issued by Federal Accounting Standards Advisory Board (FASB), a liability is defined as: “A probable future outflow or other sacrifice of resources as a result of past transactions or events. General purpose federal financial reports should recognize probable and measurable future outflows or other sacrifices of resources arising from (1) past exchange transactions, (2) government-related events, (3) government-acknowledged events, or (4) nonexchange transactions that, according to current law and applicable policy, are unpaid amounts due as of the reporting date.”3

SFFAS No. 6 states that cleanup costs are the costs of removing, containing, and/or disposing of (1) hazardous waste from property or (2) material and/or property that consists of hazardous waste4 at permanent or temporary closure or shutdown of associated property, plant and equipment (PP&E).5

Based on the foregoing, an environmental liability would be a probable and measurable future outflow for cleanup costs related to past transactions or events.

3 SFFAS No. 5, paragraph 19. 4 SFFAS No. 6, paragraph 86: Hazardous waste is a solid, liquid, or gaseous waste,

or combination of these wastes, which because of its quantity, concentration, or physical, chemical, or infectious characteristics may cause or significantly contribute to an increase in mortality or an increase in serious irreversible, or incapacitating reversible, illness or pose a substantial present or potential hazard to human health or the environment when improperly treated, stored, transported, disposed of, or otherwise managed.

5 SFFAS No. 6, paragraph 85.

Examples of cleanup costs may include the costs of:

1. Isolating, removing and disposing of asbestos, lead-based paint and other hazardous substances from a building or structure;

2. Deactivating, decontaminating, decommissioning and demolishing a building or structure contaminated with hazardous substances;

3. Excavating and disposing of soil contaminated with hazardous substances;

4. Monitoring and treatment of contaminated groundwater;

5. Restoring a site to an agreed-upon condition after cleanup work is completed;

6. Site closure and post-closure activities; and

7. Post-cleanup and post-closure monitoring.

What Complicates Accounting for Environmental Liabilities?Properly accounting for environmental liabilities poses several challenges and typically requires significant data gathering. Several factors that complicate the accounting for environmental liabilities are discussed in the FASB Accounting Standards Codification (ASC), Section 410-30, Environmental Obligations. These complicating factors are common to both federal and non-federal entities. For example, an entity’s environmental liability generally does not become determinable as a distinct event, nor is the amount of the liability generally fixed and determinable at a specific point in time. Rather, the existence of a liability for environmental remediation costs


becomes determinable and the amount of the liability becomes estimable over a continuum of events and activities that help to frame, define and verify the liability.6

In addition, estimating environmental remediation liabilities involves an array of issues at any point in time. In the early stages of the process, cost estimates can be difficult to derive because of uncertainties about a variety of factors, including the extent and types of hazardous substances at a site; the range of technologies that can be used for remediation; and evolving standards of what constitutes acceptable remediation. For this reason, estimates developed in the early stages of remediation can vary significantly; in many cases, early estimates later require significant revision.7

At the early stages of the remediation process, particular components of the overall liability may not be reasonably estimable.8 Uncertainties are pervasive in the measurement of environmental remediation liabilities, and reporting entities are required to recognize their best estimate at the particular point in time of their share of the liability and to refine their estimate as events in the remediation process occur.9 If no amount within the range is a better estimate than any other amount, the minimum amount in the range is recognized and the range and a description of the nature of the contingency should be disclosed.10

The extent to which environmental liabilities may change over time is illustrated by the growth of the environmental and disposal liabilities reported on the federal government’s balance sheet, from approximately $212 billion in 1997 to $349 billion in 2013. This increase occurred despite the expenditure of roughly $100 billion on cleanup costs, which serve to reduce the liability, during that period.

Because of these difficulties, if an entity’s accounting personnel are not familiar with the relevant accounting standards or do not have experience in applying them, they are likely to fall into one or more of the 13 common pitfalls addressed in the following section.

What are the Common Pitfalls and How Can They Be Avoided?We will now discuss the 13 common pitfalls in accounting and reporting on environmental liabilities.

Pitfall 1: Recording costs only for remediation that is currently required, and not for cleanup costs that will be incurred through the end of the asset’s service life.

Scenario: A federal entity owns an office building known to contain several hazardous substances that do not present

6 ASC 410-30-25-2. 7 ASC 410-30-25-7. 8 ASC 410-30-25-10. 9 ASC 410-30-25-13.10 SFFAS No. 5, paragraph 39.

an immediate threat to the health of building occupants and are in no danger of migrating into the soil or groundwater underneath the building. Because the work to isolate, remove and dispose of these substances will not occur until the building is demolished or undergoes a major renovation, the entity determines that it should recognize the cleanup costs as the demolition or renovation occurs, and does not record an environmental liability as of the current reporting date.

Accounting Guidance: Under SFFAS No. 5, a liability for federal accounting purposes is a probable future outflow or other sacrifice of resources as a result of past transactions or events. General purpose federal financial reports should recognize probable and measurable future outflows or other sacrifices of resources arising from (1) past exchange transactions, (2) government-related events, (3) government-acknowledged events or (4) nonexchange transactions that, according to current law and applicable policy, are unpaid amounts due as of the reporting date.11 SFFAS No. 5 applies only to cleanup costs from federal operations known to result in hazardous waste which the federal government is required by federal, state and/or local statutes and/or regulations that have been approved as of the balance sheet date, regardless of the effective date, to clean up.12 Cleanup costs shall be estimated when the associated PP&E is placed in service.13 It is not acceptable to defer recognition of those costs until the remediation work takes place, even if much of the cleanup work will occur years or decades into the future.

11 SFFAS No. 5, paragraph 19. 12 SFFAS No 6, paragraph 88. 13 SFFAS No. 6, paragraph 94.

How to Avoid the Pitfall: The entity should record a liability as of the current reporting date for the estimated cost of the future cleanup work. The liability would be equal to the estimated incremental costs to isolate, remove and dispose of the hazardous substances, which are typically shown separately in the contract, as part of a demolition or renovation project. The entity could develop an estimate of these costs by using any available in-house environmental experts or hiring a contractor to conduct a property survey to determine the extent of contamination and estimate the cleanup costs. The entity also should consider disclosing the uncertainties regarding the amount of the estimate and the timing of the cleanup work. In other words, tell the story so the user can best understand the situation.

Pitfall 2: Currently recording only the liability related to friable asbestos and deferring recognition of the liability associated with non-friable asbestos until it becomes friable.

Scenario: An asbestos survey indicates that a property contains substantial quantities of asbestos-containing materials, but the majority of the asbestos is not friable (easily crumbled or pulverized). The entity plans to manage the non-friable asbestos such that it will not become friable until it is disturbed as a result of the property’s demolition or renovation.

The entity bases this accounting practice on its interpretation of paragraph 30 of FASAB’s Technical Bulletin 2006-1, Recognition and Measurement of Asbestos-Related Cleanup Costs, which states that it is possible for certain types of non-friable asbestos to remain non-friable indefinitely. Accordingly, management concluded that no liability should be recorded for non-friable asbestos-containing roofing, flooring, siding and other materials that when repaired, renovated, removed, contained, disposed of or otherwise disturbed do not become friable and do not require additional costs above and beyond normal repair, renovation, removal, containment or disposal costs to prevent them from becoming friable.14

Because it does not intend to disturb the non-friable asbestos through renovation or demolition of the property in the foreseeable future, the entity does not recognize a liability for the isolation, removal and disposal of the non-friable asbestos as of the current reporting date.

Accounting Guidance: FASAB’s Technical Bulletin 2006-1 states that if there are additional costs incurred to prevent the non-friable asbestos-containing material from becoming friable or if it could potentially become friable as part of the repair, renovation, removal, containment or disposal process, such costs should be included in the estimate of asbestos-related cleanup costs.15

How to Avoid the Pitfall: As stated above, the non-friable asbestos in the property described will become friable when disturbed. Because no building (potentially excluding

14 FASAB Technical Bulletin 2006-1, paragraph 30. 15 FASAB Technical Bulletin 2006-1, paragraph 30.

heritage assets) will last forever, there is a presumption that the disturbance will occur, and that the entity will eventually incur incremental costs to isolate, remove and dispose of the asbestos. Therefore, the entity’s assumption that it need not record a liability for future incremental costs associated with disturbing non-friable asbestos is inappropriate. It should record a liability as of the current reporting date for all of its estimated asbestos-related cleanup costs, including those for currently non-friable asbestos that will eventually become friable.

Pitfall 3: Capitalizing cleanup costs incurred during building renovations into the cost of the building.

Scenario: A federal entity enters into contracts for renovation of a building whose components contain hazardous substances. The renovation contract clearly delineates the incremental costs associated with isolation, removal and disposal of the hazardous substances. Because the cleanup work is being performed prior to the permanent shutdown and demolition of the property, and because SFFAS 6 states that where cleanup costs are an ongoing part of operations they are not subject to the environmental liability recognition guidance,16 the entity includes the cleanup costs in the amount capitalized as part of the renovation cost of the building.

Accounting Guidance: The provision of SFFAS No. 6 related to accidents and cleanup costs that are an ongoing part of operations is meant to apply to situations in which cleanup or disposal of hazardous wastes occurs repeatedly as part of operations.17 For example, a machine shop may send spent degreasing solvents to a disposal facility on a periodic basis, and it would account for the disposal costs as part of its cost of operations. Cleanup or disposal costs incurred as part of routine operations should be charge to expense as they are incurred. In the situation above, however, the cleanup is not an ongoing part of operating the buildings. Rather, the cleanup costs are being incurred due to removal and disposal of hazardous substances from the property in connection with its renovation, which is a non-routine event.

How to Avoid the Pitfall: The entity should record a liability as of the current reporting date for the estimated future costs to isolate, remove and dispose of hazardous substances, in accordance with the liability recognition provisions of SFFAS No. 6. These costs should not be capitalized, but should be charged to the cost of operations.18 The entity should also consider whether it should remove the cleanup costs that have already been capitalized and charge them to the cost of operations in the year they were incurred. As stated above, the incremental costs of the isolation, removal, and disposal of hazardous substances are typically shown separately from other costs in a construction contract, which should help the entity to develop an estimate of future costs.

16 SFFAS No. 6, paragraph 93. 17 SFFAS No. 6, paragraph 93. 18 See SFFAS No. 6, paragraph 194.


Pitfall 4: Not recording liabilities for known costs when some costs are not yet known

Scenario: A federal entity is performing a remedial investigation to determine the nature and extent of contamination at a site formerly used to produce toxic chemicals. Because the work on the investigation completed thus far indicates that extensive contamination is present, entity management expects that remediation work will be necessary, and that the investigation will be followed by a feasibility study to select a preferred remediation alternative. Because the costs of the remediation work are not yet measurable, the entity intends to record a liability for the remediation work and all other project costs when the decision-making process is completed.

Accounting Guidance: Under Statement of Federal Financial Accounting Standards (SFFAS) No. 5, an entity should record a liability for probable future costs associated with past events to the extent that those costs are measurable.19 SFFAS No. 5 states that “measurability” means that an item has a relevant attribute that can be quantified in monetary units with sufficient reliability to be reasonably estimable. Liabilities reported in the financial statements are measured by different attributes specified by various accounting standards. Several different measurement attributes are used for different items in present practice (e.g., fair market value, current cost, present value, expected value, settlement value, and historical cost).20

How to Avoid the Pitfall: It is not appropriate to defer recognition of probable and estimable environmental cleanup costs because other costs associated with the cleanup effort are not yet estimable. In the scenario described above, the costs to complete the remedial investigation, evaluate alternatives and select and plan a cleanup approach can be reasonably estimated and should be recorded as an environmental liability in the current reporting period. The costs of the cleanup work and other cost components that cannot yet be reasonably estimated should be added to the liability as they become estimable and the notes to the financial statements should explain that these estimates will be added later.21

Pitfall 5: Not recording liabilities when future costs become probable and are measurable

Scenario: In the scenario described for Pitfall 4, entity management expects remediation work to be necessary based upon the results of the remedial investigation. A feasibility study is in progress and the preparers of the study have developed preliminary cost estimates for a range of possible cleanup approaches, none of which is considered more likely than the others at the present time. Because the entity’s financial statements will be issued prior to completion of the feasibility study and the subsequent development of the cleanup plan and record of decision, the entity does not record a cleanup liability in the current period’s financial statements. 19 SFFAS No. 5, paragraphs 19 and 91. 20 SFFAS No. 5, paragraph 34. 21 SFFAS No. 5, paragraph 41.

Accounting Guidance: Under SFFAS No. 5, an entity should record a liability for probable future costs associated with past events to the extent that those costs are measurable.22 The estimated liability may be a specific amount or a range of amounts. If some amount within the range is a better estimate than any other amount within the range, that amount is to be recognized. If no amount within the range is a better estimate than any other amount, the minimum amount in the range is to be recognized and the range and a description of the nature of the contingency should be disclosed.23

How to Avoid the Pitfall: The range of potential costs developed for the feasibility study should be used to record a cleanup liability. Because no amount within the range is more likely than any other amount, a liability should be recorded for the low end of the range, and the range and a description of the nature of the contingency should be disclosed.

In this situation, it is important to recognize that the quality of an accounting estimate will often improve over time. The preliminary estimates for cleanup alternatives included in a draft feasibility study may be refined as the feasibility study goes through review and approval, and further refinements may be necessary as the project moves to a record of decision and the cleanup work begins. At each reporting date, the entity’s cleanup liability for the project should be based on the best estimate currently available. It is not acceptable to postpone liability recognition until a preliminary estimate is refined. Instead, initial liabilities for cleanup projects are often based upon preliminary “placeholder” estimates that may change in

22 SFFAS No. 5, paragraph 19. 23 SFFAS No. 5, paragraph 39.


future periods. Management can describe the nature of the estimates in the financial statement notes.

Pitfall 6: Not updating an estimate to reflect current conditions or plans, or changes in project work scope

Scenario: In the scenario above (Pitfall 5), after cleanup work begins the entity discovers that the extent of contaminated soil and the scope of work required to remove it are greater than the estimate based on the remedial investigation. Because the additional contamination and the need to expand the cleanup work scope were discovered late in the entity’s fiscal year, the re-estimate of the cleanup costs was not completed prior to the issuance of the financial statements, and the recorded cleanup liability is based on the estimate prior to the discovery of the additional contamination.

Accounting Guidance: Under SFFAS No. 6, estimates shall be revised periodically to account for material changes due to inflation or deflation and changes in regulations, plans and/or technology. New cost estimates should be provided if there is evidence that material changes have occurred; otherwise estimates may be revised through indexing.24

How to Avoid the Pitfall: Once the additional contamination is discovered, the existing estimate is no longer the best estimate available. It is, therefore, incumbent on the entity to develop an update to the estimate so that the liability in the financial statements is based on current circumstances. The quality of the updated estimate is necessarily limited by the time and information available for the update, but it is not acceptable to postpone adjustment of the liability until the next reporting period. Instead, the entity should revise the estimate as best it can prior to issuance of the financial statements and make necessary refinements later. It can explain the basis for its re-estimate in its notes to the financial statements, so the user is fully informed.

Pitfall 7: Not adjusting estimates of future costs based on actual cleanup costs.

Scenario: A federal entity performs work on a cleanup project expected to take three years to excavate and dispose of 1,200 cubic yards of contaminated soil, at a cost of $1 million per year, or $250 per cubic yard. At the end of the first year of the project, the entity had expended the full yearly budget of $1 million, but had only completed excavation and disposal of 300 cubic yards of soil, at a cost of $333 per cubic yard. The assessment of actual work completed on the project was not completed until after the entity issued its financial statements for the period. The project liability in the financial statements was $2 million, representing $1 million for each of the two remaining years in the original cost estimate.

Assuming the excavation and disposal of the remaining 900 cubic yards of soil costs $333 per yard, the most current estimate of the remaining cost to complete the project would


be $3,000,000. Therefore, the reported liability on the financial statements was understated by $1 million.

Accounting Guidance: SFFAS No. 6 requires that estimates shall be revised periodically to account for material changes due to inflation or deflation and changes in regulations, plans and/or technology. New cost estimates should be provided if there is evidence that material changes have occurred; otherwise estimates may be revised through indexing.25

How to Avoid the Pitfall: The entity should make an annual comparison of actual remediation costs to the estimated costs for each project and adjust the liability for remaining work scope as needed prior to issuance of the financial statements. Adjusting the liability based upon this comparison will ensure that the liability reflects the actual costs experienced by the entity’s cleanup program.

Pitfall 8: Excluding Certain Costs from the Liability

Scenario: A Federal entity records a liability for a cleanup project for which the remediation work is expected to take 12 years, followed by monitoring of groundwater for an indefinite period. After the cleanup is completed, the site will not be used by the entity, but will remain under the entity’s control and will be secured by a fence to deter unauthorized access. The recorded liability of $30.4 million includes estimated remediation costs of $28 million, plus eight years of monitoring – the extent of the agency’s budget planning horizon – at $300,000 per year, all of which will be incurred by and reimbursed to the contractor executing the project. 25 SFFAS No. 6, paragraph 96.


After the liability is recorded, an internal review team reviews the project and related estimates and identifies a number of costs that were not included in the liability:

• Monitoring costs for periods beyond the eight-year budget planning horizon;

• Costs to be paid by the federal entity including utilities and site security;

• Removal of monitoring wells and other closeout costs at the conclusion of monitoring;

• Costs of salaries and benefits for entity employees who devote substantial time to the remediation effort;

• Reimbursement of the state environmental protection agency for its costs of overseeing the project;

• Reimbursement of the costs of a citizen advisory group formed to provide input to the decision-making process and to monitor project execution.

Accounting Guidance: SFFAS No. 5 requires that an entity should record a liability for probable future costs associated with past events to the extent that those costs are measurable.26

How to Avoid the Pitfall: Should any of these costs be included in the liability? The answer is yes, to all of them, as explained below:

1. Post-remediation monitoring costs should be included in the liability to the extent that they are probable and reasonably estimable. This requires consideration of how long the monitoring is likely to continue, and for how long the costs may be reasonably estimated. If the answer to both of these questions is longer than eight years, the liability should include additional monitoring costs. It is not acceptable to limit costs in the liability to the costs included in the budget planning horizon – rather, all costs meeting the probable and measureable criteria should be included in the liability.

2. The liability should include not only costs to be incurred by contractors, but also costs to be paid by the entity, such as utilities and site security. These costs should be included in the liability because the cleanup effort is the sole reason that the costs are being incurred.

3. Although their timing is uncertain, the costs to shut down and remove monitoring wells and other costs to be incurred to close out the project are estimable and should be included in the liability.

4. An allocation of the estimated compensation and benefits for entity employees who will devote significant time to the remediation effort should be included in the liability.27

26 SFFAS No. 5, paragraph 19. 27 SFFAS No. 4, paragraph 90.

5. Reimbursements to regulatory agencies and citizen advisory groups for their costs related to this project should be included in the liability.

In general, the entity should include in the liability all probable and measureable costs that would not be incurred but for the cleanup project.

The entity’s omission of several categories of costs from its liability typically results from not having someone with experience in environmental remediation projects involved in estimating the liability. It is important not only to thoroughly understand the requirements of the SFFAS Nos. 5 and 6 and the related FASAB Technical Bulletins and Technical Releases, but also to have a working knowledge of the various activities entailed in remediation projects. A template or tool that lists the full range of potential costs would be helpful to those estimating environmental liabilities to help ensure completeness, so that categories of costs do not fall between the cracks and not be captured in the liability. Also, the use of specialists may be needed for the more complex estimates or areas where the agency has limited experience estimating costs.

Pitfall 9: Including Costs Not Related to Cleanup Projects in the Liability

Scenario: A federal entity operates several processing facilities that generate hazardous wastes, which are collected and disposed of as the processing equipment is maintained. These facilities also generate waste water, which must be treated to reduce contaminant levels prior to discharge into the municipal sewage system. The entity includes estimates of future waste disposal costs and wastewater treatment costs in its environmental liabilities.

Accounting Guidance: It is inappropriate to include these costs in environmental liabilities. The future costs of these activities do not meet the “past event” criterion for liability recognition in SFFAS No. 6. Finally, the treatment of wastewater is a pollution prevention activity, not cleanup of environmental contamination.

How to Avoid the Pitfall: The collection and disposal of hazardous wastes and the treatment of wastewater are parts of ongoing operations, and the entity should include their costs in the cost of operations as they are incurred.28 Future costs of these activities should not be recognized in the current period.

Pitfall 10: Capitalizing Plant and Equipment Acquired for Use in the Remediation Effort

Scenario: A federal entity with a large backlog of hazardous waste from past operations builds an incinerator to treat a portion of the waste, and constructs a lined disposal facility for permanent disposal of the hazardous waste that will not be incinerated. The entity also acquires trucks and

28 See SFFAS No. 6, paragraph 93, and FASAB Technical Release 11, Implementation Guidance on Cleanup Costs Associated with Equipment.


other equipment to construct and operate the disposal facility and capitalizes all of this plant and equipment into its PP&E accounts.

Accounting Guidance: Under SFFAS No. 6, the liability for cleanup costs should include the cost of PP&E or other assets acquired for use in cleanup activities.29

How to Avoid the Pitfall: It is not appropriate to capitalize plant and equipment used solely in cleanup of waste generated from past operations – the cost of such items to be acquired or constructed should be included in environmental liabilities. When the acquisitions or construction occur, their costs should be applied to reduce environmental liabilities. Again, a complete understanding of the context and application of the requirements of SFFAS Nos. 5 and 6 is necessary.

Pitfall 11: Including Due Care Screening Costs in the Liability

Scenario: A federal entity owns a large number of properties on sites formerly occupied by non-federal entities. Many of these properties were acquired years ago without due diligence procedures to determine whether they were contaminated with hazardous substances. After identifying significant contamination on some of the properties, the entity initiated a due care screening process to identify the presence or likely presence of contamination on all of its properties,30 and included the estimated future costs of the screening program as an environmental liability on its financial statements.

Accounting Guidance: Under SFFAS No. 6, the costs of routine screening to identify properties that have been, or are likely to be, contaminated with hazardous substances would not be an environmental liability, because until hazardous substances requiring cleanup are identified, future cleanup costs are not probable.31 Accordingly, the costs of routine screening should be expensed as part of normal operations.

How to Avoid the Pitfall: The entity should include routine due care screening costs in the cost of operations during the periods in which they are incurred.

Pitfall 12: Using Non-Representative Data to Prepare an Estimate

Scenario: A federal entity prepares an estimate of its total asbestos-related cleanup costs by collecting cost estimates from a limited number of asbestos surveys performed on individual properties during the preceding fiscal year and extrapolating the average costs from those surveys to all properties. The entity does not consider whether the cost estimates included in the surveys are representative of the asbestos-related cleanup costs for all of the properties that contain asbestos. In addition, the entity’s estimate does not

29 See SFFAS No. 6, paragraphs 100 and 103. 30 See FASAB Technical Release No. 2, Determining Probable and Reasonably

Estimable for Environmental Liabilities in the Federal Government.31 See SFFAS No, 6, paragraph 85.

identify and exclude properties that are not likely to contain asbestos.

Accounting Guidance: FASAB’s Technical Release No. 10, Implementation Guidance on Asbestos Cleanup Costs Associated with Facilities and Installed Equipment, provides a framework for identifying assets containing asbestos, and assessing the assets to collect information and/or develop key assumptions in applying acceptable methodologies to estimate asbestos cleanup costs.32

How to Avoid the Pitfall: The entity should collect additional information to identify properties likely to contain asbestos and to determine whether the estimate is reflective of the characteristics of those properties as a basis to then make necessary revisions to the estimate. The additional information could include:

1. Information to identify properties not likely to contain asbestos:

– Date of construction, which is relevant because after about 1980 asbestos was less widely used in building components, and its use was further diminished during the 1990s.

– Asset types not likely to contain asbestos, such as land, surface parking lots, roads, bridges and sidewalks.

– Leased properties for which the entity is a tenant and will not be responsible for remediation of hazardous substances.

2. For properties deemed not likely to contain asbestos, further evidence that this determination is correct.

3. Additional asbestos surveys or other information on the asbestos content and estimated cleanup costs. For example:

– Consider reassessing surveys conducted in previous years. The estimated costs in past surveys may need to be adjusted to reflect subsequent pricing changes.

– The number of surveys and the variety of properties surveyed should be sufficient to provide asbestos content data and cost factors representative of the population.

4. Other sources of cleanup costs, including remediation contracts and industry studies.

– In developing cost factors from surveys or other sources, consider differentiating between categories of asbestos, including ceiling, siding and floor tiles (measured in square feet), piping and heating ducts (measured in linear feet) and fixtures (counted individually).

– Consider costs not captured in surveys (one way to do this is to compare costs identified in a survey with costs contained in a construction contract).

32 FASAB Technical Release No. 10, paragraph 2.


5. Other pertinent factors in development of estimated costs, including:

– Property location, since construction and remediation costs may vary by region.

– Property age, since as mentioned earlier, the extent of asbestos used in building components may be greater or less, depending on the dates of construction.

The information needed to refine the estimate will depend on the nature of the entity’s properties, and the entity should develop its plan for collecting information and revising the estimate in consultation with its internal property management experts or outside experts and discuss this with its auditors.

Pitfall 13: Not Considering the Impact of Uncertainties

Scenario: A federal entity’s liability for a multi-year project, whose remediation work will begin in the upcoming fiscal year, has been derived from a summation of individual point estimates that represent what are considered to be the most likely costs for the various components of the project, based on currently available information. Although there are numerous uncertainties associated with the project, the entity’s estimates do not include ranges of potential costs to reflect the ranges of potential outcomes for the uncertainties. Instead, one number is presented.

Accounting Guidance: The estimated liability may be a specific amount or a range of amounts. If some amount within the range is a better estimate than any other amount within the range, that amount is recognized. If no amount within the range is a better estimate than any other amount, the minimum amount in the range is recognized and the range and a description of the nature of the contingency should be disclosed in the notes to the financial statements.33

How to Avoid the Pitfall: The entity should consider modifying the individual point estimates to include ranges of potential costs, to reflect the varying degrees of uncertainty inherent in the individual components of the estimate.

Once the cost ranges are developed, the entity may revise the amounts from individual estimates that are included in the liability to provide a more realistic evaluation of the ultimate costs of the project. For example, the entity’s experience with previous estimates may indicate that the midpoint of a range of estimated costs is a more realistic estimate than the other amounts within the range.

These ranges and the total program cost estimate may then be refined in future periods as the program matures and the uncertainties diminish. Finally, the methodology used in estimating the costs should be described in the notes to the financial statements.



A Way ForwardThe wide range of challenges discussed earlier illustrates the difficulties inherent in accounting for reporting on environmental liabilities. To help overcome these challenges, the following steps, based on leading practices, further support the specific accounting and operational guidance related to avoiding each of the 13 common pitfalls included in this Issue Brief.

1. Implement a due care screening process to identify property and material that may have hazardous substances requiring removal and disposal. As stated earlier, the costs of routine screening should be expensed as part of normal operations and should not be included in environmental liabilities.

2. Establish accounting policies consistent with the relevant provisions of the FASAB accounting standards and associated guidance related to environmental liabilities.

3. Establish a process, including internal controls that are designed, implemented, and operating effectively, to implement the accounting policies. This would include:

a. Establishing requirements related to the preparation, review and approval of environmental liability estimates, such as:

– Involvement of specialists in the preparation of estimates;

– Documentation of key management assumptions and other factors used in developing the estimates;

– Documented review and approval of estimates by qualified personnel.

b. Periodically updating estimates to reflect the best information available at the current time, including:

– Updates of matters affected by the regulatory decision-making process, such as the selection of a cleanup approach or the issuance of a cleanup plan, including a refined cost estimate;

– Review and update of key management assumptions and other factors;

– Comparison of actual costs to estimates;

– Documented review and approval of changes to estimates by qualified personnel.

c. Reassessing the methodology and factors used in developing cost ranges to continue to improve the estimates and reflect the uncertainties inherent in the estimates in the notes to the financial statements.

d. Reviewing environmental remediation projects or significant components of projects that are not yet included in the liability to determine whether the “probable” and “measurable” criteria established by FASAB are met. Not recognizing a liability in the proper reporting period creates a risk that the financial statements will have to be restated.

e. Identifying subsequent events (events occurring after the annual update of the liability but prior to issuance of the financial statements) and considering the need to adjust the environmental liability and/or modify the notes to financial statements as a result of subsequent events.

f. Documenting cleanup costs incurred and comparing the results to previous estimates.

4. Provide training to enable personnel to effectively implement the policies and processes outlined above to update the estimates as needed.

Finally, federal entities will find the Government Accountability Office’s (GAO) Cost Estimating and Assessment Guide: Best Practices for Developing and Managing Capital Program Costs 34 and Schedule Assessment Guide: Best Practices for Developing and Managing Capital Program Schedules 35 to be useful in their efforts to develop and maintain cost estimates for environmental liabilities as well as the full range of cost estimating required to manage programs and operations and prepare financial statements and other management reports.

34 GAO-09-3SP, March 2, 2009. 35 GAO-12-120G, May 30, 2012


http://www.gao.gov/products/GAO-12-120G

Drivers of Environmental Cleanup Liabilities The FASB’s ASC contains a useful summary of statutes enacted to impose environmental liabilities and to prevent or regulate pollution,36 to assist users in understanding the typical situations addressed by the accounting standards. This summary describes the two environmental remediation liability laws: the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), as amended by the Superfund Amendments and the Reauthorization Act of 1986,which together are referred to as Superfund, and the corrective action provisions of the Resource Conservation and Recovery Act of 1976.

American Institute of Certified Public Accountants (AICPA) Statement of Position 96-1, Environmental Remediation Liabilities, the source for the summary in the ASC, describes the steps in the decision-making process for each law and the circumstances in which an environmental cleanup liability may be imposed on an entity. For example, the steps to determine whether cleanup is necessary and to select a cleanup approach under CERCLA include the following:

• Remedial investigation: A comprehensive study, usually performed by environmental engineers, that seeks to delineate the nature and extent of hazardous substances at a site, assess potential risks posed by the site and define potential pathways for exposure. The remedial investigation usually involves extensive sampling of soil and groundwater in and around the vicinity of the site.

36 See ASC 410.30.05.

• Feasibility study: The feasibility study uses the information generated by the remedial investigation to evaluate alternative remedial actions and recommend one.

• Proposed remedial action plan, public comment and record of decision: Once the remedial investigation and feasibility study are complete, a program, or remediation approach, must be decided on for remediation of the site. The program is contained in a proposed remedial action plan, made available to interested parties for public comment. After reviewing any public comments received, the entity modifies the remedial plan, if necessary, and issues a record of decision (ROD), which specifies the remedy, as well as the time frame in which the remedy is to be implemented.

The decision-making process is done with input from and concurrence of the U.S. Environmental Protection Agency (EPA) and applicable state regulatory authorities. In many cases, EPA on behalf of the federal government and a state will execute an agreement specifying completion dates and other requirements for the cleanup program.

In addition to the environmental liability statutes, there are several statutes, such as the Clean Air Act37 and the Clean Water Act38 and their implementing regulations, enacted to prevent or regulate pollution. For example, an entity operating a coal-fired power plant must abide by the emission standards written to implement the Clean Air Act; but these pollution control statutes do not impose environmental liabilities.

37 Public Law 88-206, December 17, 1963, as amended through Public Law 108-201, February 24, 2004.

38 Public Law 92, 500, October 18, 1972; as amended by the Clean Water Act of 1977, Public Law 95-217, December 27, 1977; and the Water Quality Act of 1987, Public Law 100-4, February 4, 1987.


Final Thoughts If it is to join the ranks of federal agencies with unmodified opinions on its financial statements, among a range of challenges, the DoD is faced with resolving long-standing material weaknesses in reasonably estimating and adequately supporting amounts reported as environmental liabilities. Also, as the federal government takes the final steps needed to obtain an audit opinion on its CFS, it is important for federal entities to reduce the risks of material misstatements of their financial statements, or restatements of prior year financial statements, resulting from errors or omissions in environmental liabilities. It is our hope that by sharing our perspectives and highlighting leading practices this Issue Brief will assist federal entities in achieving these objectives.

© 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. NDPPS 286678

Contact us

Eric W. Rasmussen Partner T: +1 202-533-5222 E: [email protected]

Stephen L. Lowry, Senior ManagerT: +1 865-690-2043 E: [email protected]

About the KPMG Government Institute

The KPMG Government Institute was established to serve as a strategic resource for government at all levels, and also for higher education and nonprofit entities seeking to achieve high standards of accountability, transparency, and performance. The Institute is a forum for ideas, a place to share leading practices, and a source of thought leadership to help governments address difficult challenges, such as effective performance management, regulatory compliance, and fully leveraging technology.

For more information, visit us at: www.kpmginstitutes.com/government-institute/

This Issue Brief was authored by Stephen L. Lowry, CPA, CGFM, a senior manager in KPMG’s Federal Audit practice, who has managed audits of numerous federal government agencies and programs, with an emphasis on environmental liabilities, since 1987, and is a Fellow of the KPMG Government Institute. It was developed under the leadership of Eric W. Rasmussen, partner, KPMG’s Federal Audit practice, and Jeffrey C. Steinhoff, executive director, KPMG Government Institute, and managing director, KPMG’s Federal Advisory practice.

Jeffrey C. Steinhoff Executive Director [email protected]

kpmg.com

Cleaning Up the Federal Government’s Accounting for ... | KPMG GOVERNMENT INSTITUTE | Issue Brief...

Documents

Transcript of Cleaning Up the Federal Government’s Accounting for ... | KPMG GOVERNMENT INSTITUTE | Issue Brief...