Planning for FAS 141R

FASB issued FAS 141R in December 2007, and it will change significantly and soon how companies recognize and report contingent environmental liabilities from business combinations, e.g., from mergers and acquisitions. This change will become effective for most companies in calendar year 2009; specifically, for acquisition dates and the beginning of first annual reporting periods that occur on or after December 15, 2008. Companies should plan for this change. They no longer will be able to use FAS 5 criteria to recognize and report liabilities from business combinations, but instead will have to apply the new criteria of FAS 141R. It likely will result in the necessity for companies to determine and disclose substantially more contingent environmental liabilities and their costs than before.

Under FAS 5, disclosure is required for material contingent liabilities, including loss contingencies, that are probable and reasonably estimable, and disclosed costs are calculated at current value, i.e., normally without techniques involving expected cash flows or discounting. With FAS 141R comes the requirement to accrue and disclose all contingencies that arise from contracts, which are referred to as contractual contingencies. A contractual environmental contingency might result from a remediation consent decree signed with a regulatory authority or from an environmental indemnification agreement signed with a property purchaser, for example. Contractual liability costs will be determined and reported at fair value, which for liabilities like environmental contingencies are expected to require the application of expected cash flow techniques and discounting.

Perhaps more significantly, for all other contingencies, referred to as noncontractual contingencies, the criterion of “more likely than not” will be applied. That is, if it is more likely than not that a noncontractual contingency will give rise to a liability (as defined in FASB Concepts Statement 6, or CON 6), then it must be included among the liabilities recognized and reported at fair value. With a less stringent criterion for inclusion (i.e., a liability being more likely than not to result) and since consideration of uncertainty is enabled in expected cash flow techniques (being probability-weighted averages of possible cash flows) used in determining fair value, companies likely will have more contingencies to disclose in 2009 under FAS 141R than previously under FAS 5. There will be fewer opportunities for companies to avoid disclosure of environmental contingencies by claiming liabilities are “not probable” or costs are “not estimable,” which was possible under FAS 5.

Again, companies should be planning now for how FAS 141R significantly will change environmental disclosure for mergers and acquisitions.