RSM Resources

Like thousands of other companies, Covenant Health Systems owns several older buildings that contain asbestos, a material that builders once used to retard fires but which is now known to cause cancer. When it renovates or demolishes those structures, Convenant will have to remove the asbestos, according to new federal regulations.

Until 2005, it wasn’t clear when firms such as Massachusetts-based Covenant needed to take a charge for those environmental cleanup costs on its books. Then came Financial Interpretation No. 47 (FIN 47) from the Financial Accounting Standards Board (FASB). That ruling requires firms to "recognize a liability for the fair value... when incurred if the liability’s fair value can be reasonably estimated."

Covenant,which has about $450 million in annual revenue, operates 27 facilities— three hospitals, 16 nursing homes, three assisted-living facilities,and five residential care or housing institutions. Covenant executives believed some of the buildings contained asbestos. So, to comply with FIN 47 and account for the "fair value" of future liabilities, the organization took a $7.7 million charge against earnings in 2005.

They weren’t alone. Large companies such as Allegheny Energy, ConocoPhillips, Ford Motor Co. and United Technologies also took FIN 47 accounting hits in recent years.

"Some new accounting standards get a lot of press and a lot of attention," says Jay Hanson, national director of accounting with McGladrey and Pullen LLP. "This one didn’t get as much attention as Sarbanes-Oxley requirements, but it is important."

Before FIN 47, companies pondering future liabilities formed their own interpretations of FASB Statement No. 143 (FAS 143), issued in 2001. Some accountants recognized the "fair value of the obligation" before a facility was shuttered but hedged their bets on the timing or other factors. Others waited until the facility closed or the environmental cleanup was imminent before noting it on the books.

FIN 47 aims to end the nebulous nature of FAS 143. Anew rule now applies: If a company can determine a future liability, it needs to record the estimated final cost to shareholders now.

"Companies are always making adjustments based on the changing regulatory environment," said Fred Solomon, Allegheny Energy spokesman, in an interview with the Pittsburgh Business Times. "The federal government can make one little change, and in total, it comes out to a huge change for the nation. For us, it was a fairly small change, butwe felt it was important for us to go ahead and call it out."

But many other CEOs and CFOs at small and midsized firms have failed to act. Most companies don’t want to implement FIN 47, because doing so affects debt-to-equity ratios and other measurements lenders use to assess a firm’s financial stability, Hanson says.

But not incorporating future liabilities into today’s balance sheet has consequences. When an auditor reviews a firm’s financial data and discovers an unaccounted-for liability, it may begin to question the company’s frankness. That could result in an auditor noting a "statement of material weakness."

Such news can affect stock prices of publicly traded businesses. A Glass, Lewis & Co. study found stocks with "material weaknesses" edged 0.67 percent lower(relative to the market) one day after such an announcement. The news only got worse with time, as the same stocks slumped 0.90 percent after 30 days and 4.06 percent after 60 days.

That study was conducted in 2004 and early 2005, when many companies reported accounting abnormalities associated with Section 404 of the Sarbanes-Oxley Act of2002 (SOX).

"Since so many companies were reporting material weaknesses, the market yawned," Hanson says. But now that several years have passed since SOX triggered many of these disclosures, the market could be less forgiving.

"A material weakness now would be more of an aberration," Hanson says. "Market reaction to it could be more severe."

Convinced about the importance of complying with FIN 47? Here are a few tips:

Think more broadly than environmental cleanup.FIN 47 grew out of FAS 143, a rule focused on nuclear power plants, so a common misperception is that it pertains only to environmental issues. However, FIN 47 applies to any future cost that can be estimated, even something as simple as a lease requiring a firm to return rental space to its original form. There’s a cost to that, and it can be estimated and accounted for.

Get an estimate.Predicting future costs is notoriously difficult, especially without appropriate expertise. Pay an engineering or remediation firm to estimate the price of asbestos removal. Their estimate will probably be more accurate than yours, and an auditor is much more likely to respect it.

Don’t delay. Jack Ciesielski, publisher of the Analyst’s Accounting Observer, recently called FIN 47 a "cattle prod in the ribs for procrastinators, "because it doesn’t let companies wait for events to occur. Instead, you need to book future costs when you know them. If there’s uncertainty, build it into the estimate of obligation, Ciesielski said.

Manufacturers,health care companies and other businesses with older physical plants will likely encounter future environmental cleanup costs associated with asbestos — not to mention other possible liabilities. All companies with possible environmental or other liabilities related to their facilities should seek guidance on this new accounting wrinkle.

"It’s a costly standard to implement, but it’s got to be done," Hanson says. "Ignore FIN 47 at your peril."