Accounting Archives - Lawyer Issue

With the requirements of the Public Sector Accounting Board’s “Accounting Standard on Liability for Contaminated Sites” (PS 3260) applying to the 2014-2015 fiscal year, public sector entities (federal, provincial and municipal governments, universities, schools and hospitals) may find themselves scrambling to meet their obligations to identify, report and account for long forgotten buried liabilities. Under PS 3260 public sector entities must now account for the remediation liabilities associated with “contaminated sites”, which are sites where contamination exceeds the applicable environmental standards, but does NOT include closed solid waste landfill sites that are subject to a separate standard. PS 3260 requires that an estimate of remediation liability be included for all such contaminated sites that are no longer in active or productive use, and for which a public sector entity is responsible either as a result of legal or voluntary assumption of remediation obligations.

For example a municipality that owns an inactive maintenance shop and yard where the bulk storage of fuel, road salt, waste oil, etc. and the storage and servicing of municipal vehicles may have resulted in past releases of these contaminants at the site is likely required to identify the yard as a contaminated site under PS 3260, and would also be required to develop and provide an estimate of remediation liability for the site.

Clearly a key issue for most entities implementing PS 3260 is that there may be a lack of information not only about the sites that should be considered to be “contaminated sites” but also regarding the nature and extent of remediation liability. A critical first step for meeting the requirements of the standard is to prepare an inventory of all active and inactive potential sites with an “environmental past”. This task involves gathering all available information about such sites such as records of use, ownership, environmental site assessment reports, information from regulators, incident reports, etc. to determine whether a given site would constitute a contaminated site under PS 3260 and the public sector entity could incur liability as a result.

While preparing the inventory, information gaps will likely be identified that require existing records to be supplemented, particularly for sites with a long history of use, where the site history is unknown or where the site was subject to multiple owners, multiple uses or both. In particular, assessing whether a given site meets the criteria for a contaminated site under PS 3260 requires specific information regarding the likelihood, nature and extent of contamination at that site, and this may require the commissioning of environmental site assessments to identify and delineate whether the site has been contaminated. In addition, assessing whether a site meets the criteria also requires an understanding of the specific legal and voluntary obligations of the public sector entity for the site and for the type of contamination identified.

When a public sector entity has concluded that a given site does meet the criteria for a contaminated site under PS 3260, a reasonable estimate of the financial costs directly attributable to carrying out the required remedial actions must also be developed. Although there is some guidance provided in the standard with respect to what types of costs should be included in a remediation liability assessment, in order to yield an accurate, reasonable and defensible liability estimate, issues such as the treatment of long-term monitoring costs and the application of various types of discounts, contingencies and escalation factors are all dependent on the exercise of professional judgment and the development of reasonable working assumptions. Identifying sites and preparing liability estimates requires specialized technical and legal advice as the process of accounting for environmental liabilities remains much more of an art than a science.

Although the standard was introduced some time ago, with four years given to prepare public sector entities for the initial reporting period of 2014-2015, this issue appears to have remained a bit of a “sleeping dog.” Consequently, indications from external auditors and environmental consultants are that public sector entities may have considerable difficulty meeting their obligations for the initial reporting period. For those public sector entities that find themselves caught short by these requirements, there is still time to get the required information gathering and assessment underway, but the window for taking such steps is rapidly closing.

Britain’s biggest retailer faces a crisis situation two weeks after announcing that it overstated its first-half profit expectations by some £250-million. Tesco PLC, the multinational grocery and retail giant headquartered in England, reported on September 22, 2014 that its August 29 profit warning should have forecasted trading profit totalling £850-million, rather than the £1.1-billion that the company actually reported – an inflation of nearly 25%. The market reacted swiftly, and as of October 7, 2014 had knocked 20% (a total of about £4-billion) off the value of Tesco shares. On October 1st, Britain’s financial regulator, the Financial Conduct Authority, announced that it has launched a full investigation into the accounting scandal. As the company rushes to contain the situation and events continue to unfold, it is already clear that this is a classic example of the potentially explosive risks that public companies face every time they prepare and report their financial status to the market.

Tesco has been for years the world’s second largest retailer after Walmart, though in recent times it has faced stiff competition in Britain and Europe, together with declining profits. Its September 22 announcement was the latest and most impactful blow to Tesco’s market value and reputation. Tesco has stated that the profit overstatement was caused by apparent accounting errors – including the early booking of revenue and delayed recognition of costs – which were discovered during the preparation of its forthcoming interim results. Those results have now been delayed from October 1 to October 23. The company has already begun an independent investigation into the accounting irregularities. Four senior-ranking Tesco employees have been placed on leave while the investigation proceeds. The accounting error and misreporting, together with the precipitous drop in share value and subsequent investigations, have been widely reported in the business pages around the world.

The situation unfolding at Tesco is a prime example of how the public may react to adverse news in unpredictable ways. Even after the change to its reported profit, Tesco was still profitable. In that sense, the market’s reaction could be seen as disproportionate. However, the news has clearly shaken public confidence in the company. Commentators have suggested that in the context of the other challenges facing Tesco, it may be an indicator of deeper-lying and more serious problems. Tesco’s share price seems to have been punished so severely not because the profit in one quarter was overstated, but because people are now saying “I don’t know what I don’t know” about the company in light of the fact that this happened. The same scenario has been played out numerous times in Canada (Biovail, SNC Lavalin and others) and elsewhere. It is also likely that the market has factored in that this situation will inevitably engender other expensive and distracting consequences, including the freshly initiated regulatory investigation and rumblings of a possible class action.

Public companies must ensure that they have in place a strong corporate governance culture and robust internal systems designed to prevent accounting and other problems. Commentators have long held that the “tone at the top” is a key factor contributing to the integrity of the financial reporting process, and companies are well advised to have a careful look at the adequacy of their internal controls on a regular basis. It is always preferable to manage and minimize risk than to have to respond to a crisis. Having said that, no company, however well run, is immune to crises. Without knowing more, it is impossible to say whether the situation at Tesco could have been prevented. What is clear is that, as the Tesco case now demonstrates, a company cannot unring the bell once news of an irregularity has broken. Instead, Tesco must scramble to react to a growing crisis. People will continue to watch with interest to see how, and how well, Tesco is able to weather this storm.

Tag Archives: Accounting

Knowing Where The Liabilities Are Buried: Issues For The Public Sector Implementing Accounting Standard PS 3260

Tesco’s Accounting Scandal a Lesson for All Public Companies