Ambiguities in the existing international accounting standards have resulted in a lack of transparency about the decommissioning and clean-up costs incurred by pollution-prone industries, resulting in potential liabilities for taxpayers, according to ICAS
Research funded by the Scottish institute looked at the application of IAS 37: Provisions, Contingent Liabilities and Contingent Assets in accounting for the costs of decommissioning and clean-up operations in polluting industries, including oil and gas, mining and utilities.
When a company acquires certain types of long-term assets, such as an oil rig or a nuclear power plant, it incurs an inherent obligation to remove the assets, and clean-up and restore the site once the asset has reached the end of its useful life.
The research team (Giovanna Michelon from the Universities of Bristol, Mari Paananen from the University of Gothenburg and Thomas Schneider from Ryerson University) found that a critical issue crystallises where such a company becomes insolvent, which ICAS points out is a greater risk in a post-Covid world.
In these circumstances, the clean-up liability remains attached to the asset, which may therefore become less attractive to a potential buyer, and so, if eventually the asset remains unsold, the taxpayer ends up picking up the decommissioning tab.
IAS 37 mandates that the future cost of clean-up be estimated and accounted for using an appropriate discount rate to calculate the present value of these costs. However, the standard does not mandate for businesses to disclose the rate they have used, nor makes clear whether the basis for calculating the discount rate should be an accounting choice, by design or in practice.
Marie Gardner, ICAS head of research, said: ‘The research considered whether accounting according to IAS 37 is designed and applied in the best interests of not only investors and creditors but also the general public.
‘The research used a large international sample across the mining, utilities, and oil and gas sectors, and found substantial variations exist in companies’ choice to disclose the discount rate when accounting for decommissioning and environmental liabilities.’
The report makes a number of recommendations designed to improve transparency in the hope of increasing corporate responsibility for managing clean-ups.
Firstly, standards setters should require disclosure of the discount rates applied, in order to facilitate comparability and allow for users of financial statements and other key stakeholders to see inside the ‘black box’ of accounting for decommissioning liabilities.
Secondly, preparers should include and auditors should demand enhanced disclosures, covering not only the discount rate but also undiscounted future estimated cashflows and timing of decommissioning activities, augmented by a comprehensive narrative on the major uncertainties surrounding these three items.