Environmental provision under IAS 37

Environmental provision under IAS 37 – Although there is no formal distinction between environmental and decommissioning provisions under IFRS, in general environmental provisions exclude provisions related to damage incurred in installing an asset (see decommissioning provisions).

In a dynamic economic and regulatory climate, bringing your future into focus can be a challenge. In the area of environmental accounting, this can prove to be an even more challenging proposition, given the inherent complexity of environmental liability reporting.

Moreover, companies should be aware that unexpected expenditures and accounting adjustments—like those arising from environmental obligations—can impact capital budgeting and future earnings. Companies have found that practices vary widely across sectors and both engineering and accounting expertise are critical in assessing environmental obligations.

Management estimates and related disclosures still garner lots of attention from regulators. Companies with environmental exposures, or are subject to them as part of a deal, are often unaware of the qualitative and quantitative efforts needed to support the appropriate assessment of these obligations as well as quantifying future economic impacts.

While some companies focused on extinguishing their obligations and were able to put much of their liabilities behind them, many companies are still dealing with some of the most challenging sites, some of which are in the early stages of the environmental remediation project life cycle.

In an effort to manage the risks associated with these projects, companies can leverage engineering experts, legal counsel, and/or accounting experts. The blend of accounting and engineering expertise is critical when regularly managing and reporting these risks, acquiring a target or divesting a business with environmental exposures. Properly estimating and reporting environmental liabilities and asset retirement obligations can raise complex financial reporting and engineering/technical issues.

ENEL (an Italian multinational energy firm) had accumulated decommissioning cost to nearly 800 million euro until 1999. Nevertheless, they had not arranged any provisions regard to their decommissioning cost. Furthermore, their liabilities were transferred 100% to the Italian Ministry of Treasury through the company SOGIN (a state-ownership company) between 2000 and 2005.

They also indicated that about 80% of the total decommissioning costs have not been paid by the former generations, instead of they will be paid by future generations. Therefore, recognition of provisions is a better way to address the risk that regards to environmental liabilities and decommissioning cost.

A provision is recognised for environmental obligations when:Obligation

  • there is either a legal or constructive obligation to restore a site;
  • the damage has already occurred;
  • it is probable that a restoration cost will be incurred; and
  • the costs can be reliably estimated. [IAS 37 14]

Environmental provisions are liabilities of uncertain timing or amount. A entity records environmental provisions to capture the risks regard to environmental cost such as clean – up cost, dismantling cost, rehabilitation that they will expose in the future.

According to IAS 37, the measurement of a provision not only takes risks and uncertainties into account but also takes future events (i.e changes in the technological and law) into account.

However, these provisions do not take gains from the expected distribution of assets into account. In addition, a pre-tax discount rate is used to estimate the present value of environmental provisions.

IAS 37 documents that: “discount the provisions, where the effect of the time value of money is material, using a pre-tax discount rate (or rates) that reflect(s) current market assessments of the time value of money and those risks specific to the liability. The increase in the provision due to the passage of time is recognised as an interest expense”.

For instance, company A estimate that their future decommissioning cost over a period of 20 years is 1 billion euro. In order to calculate the present value of their future decommissioning cost, they discounted the estimated cash outflow at 2% risk-free rate, which was based on government bond rate. The present value of the decommissioning cost will be 673 million euro.

Environmental liabilities can be classified into decommissioning, remediation liabilities, and legal liabilities due to non-compliance with relevant environmental regulations.

An entity may be subject to penalties only if obligating events are detected. In our view, if an entity is obliged to self-report obligating events, then the detection risk (i.e. the possibility that the event will not be detected) should not be considered when measuring the obligation.

Examples of events that generally require self-reporting include, but are not limited to, taxes (see income tax exposures) and, in some countries, environmental contamination.

When self-reporting is not required and there is uncertainty about the amount of an obligation in respect of a past event, it may be appropriate to consider detection risk in measuring the provision (i.e. the possibility that the event will not be detected).

Future changes in environmental legislation give rise to a legal obligation only once they are virtually certain of being enacted. [IAS 37 22]

A provision is measured at the best estimate of the future clean-up costs. It reflects the amount that the entity would be required to pay to settle the obligation that has been incurred at the reporting date. [IAS 37.36]

The “best estimate” is used when environmental provisions have a range of possible outcomes or measuring the provision for a large number of items. In these situations, the “expected value” method which means using a weighted – average of all possible outcomes, was used to calculated provisions.

For instance, company B has five possible outcomes for future environmental provisions. There are 1 billion euro, 1.5 billion euro, 2 billion euro, 2.5 billion euro, 3 billion euro with the probabilities respectively 15%, 20%, 30%, 15%, 20%. The expected value will be 2.025 billion euro. In the case of a single obligation, the estimated cost is the outcome with the highest probability of happening.

Anticipated cost savings arising from future improvements in technology are considered in measuring the provision only if their existence is reasonably certain. [IAS 37 49]

The expectation that an outflow related to an obligation will be reimbursed – e.g. that an environmental obligation will be covered by an insurance policy – does not affect the assessment of the probability of an outflow for the obligation.

Determination of the appropriate amount of a provision (such as a provision for warranties, environmental costs, and site restoration costs) may be complex and often costly and time-consuming. Entities sometimes engage outside experts to assist in the annual calculations. Making similar estimates at interim dates often entails updating of the prior annual provision rather than the engaging of outside experts to do a new calculation.

If an obligation to restore the environment or dismantle an asset arises on the initial recognition of the asset, then the amount is included in the cost of the related asset and is not recognised immediately in profit or loss (see Property plant and equipment). [IAS 16 16(c)]

If an obligation to dismantle or decommission an asset or restore the environment arises after the initial recognition of the asset, then a provision is recognised when the obligation arises. In our view, the estimated cost should be recognised as an adjustment to the cost of the asset and depreciated prospectively over the remaining useful life of the asset, assuming that the liability was not created through use of the item – e.g. production of inventory (see Property plant and equipment). [IAS 37 14]

Environmental and similar funds

Sometimes funds are established to finance environmental or other remediation costs. A fund may be set up to meet the decommissioning costs of a single contributor or several contributors.

If the operator continues to bear the primary obligation for the decommissioning, then it continues to recognise a provision for its obligation and does not net its obligation with potential recoveries from the fund. [IFRIC 5 7]

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If the fund is a subsidiary, joint arrangement or associate of the operator, then it is consolidated, accounted for based on the operator’s rights and obligation to individual assets and liabilities or equity accounted, as appropriate (see Consolidation, Associates and the equity method and Joint arrangements). Otherwise, the contributor recognises the right to receive compensation from the fund as a reimbursement right. The reimbursement right is measured at the lower of: Environmental provision under IAS 37

  • the amount of the decommissioning obligation recognised; and Environmental provision under IAS 37 Environmental provision under IAS 37
  • the contributor’s share of the fair value of the net assets of the fund attributable to the contributors. [IFRIC 5 8–9] Environmental provision under IAS 37

Changes in the carrying amount of the reimbursement right other than from contributions to and payments from the fund are recognised in profit or loss in the period in which they occur. An obligation to make additional contributions is treated as a provision or contingent liability, as applicable. Environmental provision under IAS 37

A residual interest in a fund that exceeds the right to reimbursement, such as a contractual right to distributions when decommissioning has been completed, may be an equity instrument (see Equity instruments). [IFRIC 5 5, IFRIC 5 9–10] Environmental provision under IAS 37

Environmental equipmentEnvironmental equipment

Two conditions are satisfied for recognition of PPE – Environmental provision under IAS 37

  1. it is probable that future economic benefits associated with the asset will flow to the entity; and Environmental provision under IAS 37
  2. the cost of the asset can be reliably measured. Environmental provision under IAS 37

Economic benefits to be derived from an item of PPE can be direct or indirect. An item of PPE may generate economic benefit individually or in association with other assets and liabilities.

An item of PPE like safety and environmental equipment does not generate any direct economic benefit. Still such items are recognised as PPE since they generate economic benefits along with associated assets. For example, a safety equipment creates value enhancement to a chemical processing plant as the plant is not permitted to operate without the safety equipment.

Waste electrical and electronic equipment

In the EU, the costs of disposing of waste electrical and electronic equipment are borne by the producers. An entity has an obligation to contribute to waste management costs for historical household equipment (equipment sold to private households, generally before 13 August 2005) based on its share of the market in the measurement period.

The measurement period is specified in national law, which may vary from country to country. It is an entity’s participation in the market in the measurement period that is the past event that triggers the recognition of an obligation to meet waste management costs. [IFRIC 6] Environmental provision under IAS 37

Examples

Electricité de France (EDF)

In 2018 annual report, Electricité de France (EDF) – a leading producer and the largest electricity supplier in France and Europe document that they take into account several levels of risk and uncertainty factors (i.e changes in the regulations, changes in the regulatory decommissioning process, changes in discount rates) to estimate provisions.

Because there are only two times in the 2018 annual report that they mention specifically to environmental liability (environmental provision), so look at provisions of EDF in general. Note 28 below (p.93) that extract from their 2018 annual report, includes all the provisions for the 2018 fiscal year and compares to 2017 fiscal year.

EDF Note 28 Provisions

In the French context, all the details with regard to significant provisions that related to nuclear generation back-end of the nuclear cycle, plant decommissioning and last cores were indicated in note 29.1 below (p.95). Environmental provision under IAS 37

Note 29.1 Movement schedule provisions

(1) The discount effect comprises the €1,534 million cost of unwinding the discount, and the €835 million effect of the change in the real discount rate in 2018, which were recorded in the income statement for provisions with no related assets (cost of unwinding the discount). Environmental provision under IAS 37
(2) Other movements mainly include: Environmental provision under IAS 37
– reclassification of the provision for long-term radioactive waste management previously included in the provision for spent fuel management (€(298) million);
– the €718 million effect of the change in the real discount rate at 31 December 2018 for provisions with related assets.

On a year-over-year basis, total nuclear provisions increased by 2,173 million euro, or an increase of 5.8%. They document that the change in provisions regard to nuclear generation is mostly due to a lower discount rate in France (i.e the discount rate that applied to calculate nuclear provisions in France at 31 December 2018 was 3.9% incorporating an average inflation rate of 1.5%, respectively 4.1% and 1.5% at31 December 2017). Environmental provision under IAS 37

Here is the full report:

Note 1.3.2.2 Nuclear provisions

The measurement of provisions for the back-end of the nuclear cycle, decommissioning and last cores is sensitive to assumptions concerning technical processes, costs, inflation rates, long-term discount rates, the depreciation period of plants currently in operation and disbursement schedules. Environmental provision under IAS 37

As explained in note 4.1, under the proposed new PPE, two nuclear reactors would, subject to certain conditions, be shut down in 2027 and 2028, ahead of their fifth 10-year inspection. If this is confirmed in the final PPE adopted, it could lead to a change in the amount of corresponding nuclear provisions. As this situation would bring forward the shutdown of two reactors in the Group’s fleet by a few years, the potential impact on nuclear provisions could be an increase of some tens of millions of euros, with an adjustment to the relevant balance sheet assets.

These parameters are therefore re-estimated at each closing date to ensure that the amounts accrued correspond to the best estimate of the costs eventually to be borne by the Group.

The Group considers that the assumptions used at 31 December 2018 are appropriate and justified. However, any future change in assumptions could have a significant impact on the Group’s balance sheet and income statement. Environmental provision under IAS 37

The main assumptions and sensitivity analyses relating to nuclear provisions are presented in note 29.1.5.

The calculation of provisions incorporates a level of risks and unknowns as appropriate to the operations concerned. The valuation of costs carries uncertainty factors such as:

  • changes in the regulations, particularly on safety, security and environmental protection, and financing of nuclear expenses;
  • changes in the regulatory decommissioning process and the time necessary for issuance of administrative authorisation;
  • future methods for storing long-lived radioactive waste and provision of storage facilities by the French agency for radioactive waste management ANDRA (Agence nationale pour la gestion des déchets radioactifs); Environmental provision under IAS 37
  • changes in certain financial parameters such as discount rates, notably in relation to the regulatory limit, inflation rates, or changes in the contractual terms of spent fuel management.

Note 1.3.21.2 Other provisions

Other provisions primarily concern: Environmental provision under IAS 37

  • contingencies related to subsidiaries and investments; Environmental provision under IAS 37
  • tax liabilities; Environmental provision under IAS 37
  • litigation; Environmental provision under IAS 37
  • onerous contracts and losses on completion; Environmental provision under IAS 37
  • environmental schemes. Environmental provision under IAS 37

Provisions for onerous contracts primarily relate to multi-year agreements for the purchase or sale of energy: Environmental provision under IAS 37

  • losses on energy purchase agreements are measured by comparing the acquisition cost under the contractual terms with the forecast market price;
  • losses on energy sale agreements are measured by comparing the estimated income under the contractual terms with the cost of the energy to be supplied.
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The revenues and margin on Framatome’s long-term contracts are recorded under the percentage-of-completion method. When the estimated result upon completion is negative, the loss is immediately recorded in profit and loss, after deducting the loss already recognised under the percentage-of-completion method, and a provision is booked.

Provisions for environmental schemes may be established to cover the shortfall in greenhouse gas emission quotas, renewable energy certificates, and energy savings certificates, compared to the assigned targets (see note 1.3.27). Environmental provision under IAS 37

In extremely rare cases, description of a specific litigation covered by a provision may be omitted from the notes to the financial statements if such disclosure could cause serious prejudice to the Group. Environmental provision under IAS 37

Note 1.3.27 Environment Greenhouse gas emission rights

The system currently in force is described in note 49.1. Environmental provision under IAS 37

The accounting treatment of emission rights depends on the holding intention. There are two economic models, both of which coexist in the EDF group.

Rights held under the “Trading” model are included in inventories at fair value. The change in fair value observed over the year is recorded in the income statement.

Rights held to comply with regulatory requirements on greenhouse gas emissions (the “Generation” model) are recorded in intangible assets:

  • at acquisition cost when purchased on the market; Environmental provision under IAS 37
  • at nil value when allocated free of charge (in countries that still have a free allocation system).

When the estimated emissions by a Group entity over a given period are higher than the rights allocated for no consideration for the period less any allocated rights sold on the spot or forward market, a provision is established to cover the excess emissions. This provision is equal to the shortfall in rights held (difference between actual emissions and allocated rights held at the closing date). Environmental provision under IAS 37

If no emission rights are allocated free of charge, a provision is systematically recorded equivalent to the actual emissions at the closing date.

In either case, the provision is measured on the basis of the acquisition cost up to the amount of rights acquired on the spot or forward markets, and on market prices for the balance. It is cancelled when the rights are surrendered to the State. Environmental provision under IAS 37

At the closing date, the portfolio of emission rights and the obligation to surrender rights for the emissions of the year are presented gross, without netting.

If the number of purchased emission rights recorded as intangible assets at the end of the year and not subject to forward sale is higher than the number of purchased rights that will be surrendered to the State for the year’s emissions, an impairment test must be applied to the excess. If the realisable value is lower than the net book value, impairment is booked.

Note 1.3.27.2 Renewable energy certificates

The system currently in force is described in note 49.3. Environmental provision under IAS 37

The EDF group applies the following accounting treatments: Environmental provision under IAS 37

 for non-obligated electricity producers, certificates obtained based on generation output are recorded in “Other inventories” until they are sold on to suppliers;

  • for obligated producers and an entity that both produces and supplies energy and is under an obligation to sell a specified quantity of renewable energy, the Group uses the following accounting treatments for certificates obtained based on generation output: Environmental provision under IAS 37
  • up to the level of the obligation, these certificates are not recognised, Environmental provision under IAS 37
  • certificates in excess of the obligation are recorded in “Other inventories”, Environmental provision under IAS 37
  • in the specific situation when an entity is not in a position to meet its obligation at the year-end, the Group applies the following accounting treatment:
    • certificates acquired for a consideration in order to meet the obligation are recorded in intangible assets at acquisition cost, and
    • a provision is established equivalent to the shortfall in certificates compared to the obligation at the year-end. The value of this provision is based on the acquisition price of certificates already purchased on the spot or forward market, and market prices or penalty prices for the balance. The provision is cancelled when the certificates are surrendered to the State.

Forward purchases/sales of certificates related to trading activities are recorded in accordance with IFRS 9, stated at fair value in the balance sheet date. The change in fair value is recorded in the income statement. Environmental provision under IAS 37

Note 1.3.27.3 Energy savings certificates

The system currently in force is described in note 49.2. Environmental provision under IAS 37

The EDF group fulfils its obligations either by taking measures regarding its assets or actions with its final customers in order to receive energy savings certificates from the State, or by purchasing energy savings certificates directly. Environmental provision under IAS 37

Expenses incurred to meet the cumulative energy savings obligation are treated as: Environmental provision under IAS 37

  • property, plant and equipment if the action taken by the entity concerns its own assets and the expenses qualify for recognition as an asset;
  • expenses for the year incurred, if they do not meet the requirements for capitalisation or if the action taken is to encourage third parties to save energy.

Expenses incurred in excess of the accumulated obligation at year-end are included in inventories until they are used to cover the obligation. A provision is recognised if the energy savings achieved are lower than the cumulative energy savings obligation. The amount of the provision is equal to the cost of actions still to be taken to meet the obligations related to the energy sales made.

Note 1.3.27.4 Environmental expenses

Environmental expenses are identifiable expenses incurred to prevent, reduce or repair damage to the environment that has been or may be caused by the Group as a result of its activities. These expenses are treated as follows:

  • they are capitalised if they are incurred to prevent or reduce future damage or protect resources;
  • they are booked as environmental liabilities and increases to provisions for environmental risks if they correspond to an obligation that exists at the year-end and it is probable or certain at the reporting date that they will lead to an outflow of resources;
    • they are recognised as expenses if they are operating expenses for the bodies in charge of environmental concerns, environmental supervision, environmental duties and taxes, processing of liquid and gas effluents and non-radioactive waste, or research unrelated to an investment.
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Rheinisch-Westfälisches Elektrizitätswerk AG (RWE)

Rheinisch-Westfälisches Elektrizitätswerk AG (RWE) is the second largest electricity producer in Germany, mainly based on coal. In 2014, they were ranked first among European polluters due to CO2 emissions of their production units. Therefore, it is interesting to explore their dismantling and environmental provisions in their 2018 annual report. The provisions note (p.128) below was taken from the report and it included all the important provisions such as provisions for nuclear waste management, provisions for dismantling or environmental protection obligations.

Environmental provision under IAS 37

On a year-over-year basis, total provisions decreased by 5,908 million euro, or a decrease of 24%. Therefore, the depreciation of lower present value of provisions will be favourable for the income statement of company. The change in provisions is mostly due to the decrease of provisions for pensions and similar obligations. The approach to calculating provisions for nuclear waste management, provisions for mining damage and other provisions is different from Electricité de France (EDF). Environmental provision under IAS 37

RWE company used the real discount rate which was the difference between the discount rate and the escalation rate (i.e the rate based on expectations that related to the general increase in price and wage and productivity growth). For instance, the real discount rate regard to calculating provisions for nuclear waste management was negative 1.1% in 2018 annual report (p.133) and the real discount rate regard to calculate provisions for mining damage was positive 1.3% in 2018 annual report (p.135). Environmental provision under IAS 37

Here is the full report:

Note (34) Events after the balance-sheet date Environmental provision under IAS 37

In the period from 1 January 2019 until the completion of the con- solidated financial statements on 27 February 2019, the following significant events occurred:

Recommendation of the Structural Change Commission

In January 2019, the Growth, Structural Change and Employment Commission established by the German government submitted its final report. The body, which consists of representatives from industry, trade unions, science, civic initiatives and environmental organisations, recommends that Germany phase out coal by 2038.

It envisages the total capacity of lignite and hard coal-fired power stations on the market being reduced to 15 GW each by the end of 2022 through shutdowns or conversions.

The objective is to have lignite and hard coal-fired power stations with a total capacity of only 9 GW and 8 GW on the market by 2030. The government intends to submit a package of climate protection laws based on the recommendations and initiate talks with the affected companies. We report on the Commission’s recommendations and their potential consequences for RWE in detail on page 33. Environmental provision under IAS 37

Excerpt from management report (page 33)

Commission for structural change proposes roadmap for German coal phase-out.

An accelerated coal phase-out is materialising in Germany, our most important generation market. In January 2019, following lengthy consultations, the Growth, Structural Change and Employment Commission established by the German government presented a concept for the country achieving its climate protection goals in the energy sector avoiding structural upheaval, social hardship or jeopardising security of supply.

The body, which consists of representatives from industry, trade unions, the scientific community, associations, civic initiatives and environmental organisations, recommends that Germany phase out coal by no later than 2038. However, it envisages reviewing the feasibility of this goal in 2032 and possibly bringing the exit date forward to 2035.

In addition, the Commission has set milestones for the coal phase-out: it envisages the total capacity of lignite and hard coal-fired power stations on the market being reduced to 15 GW each by the end of 2022 through shutdowns or conversions. Compared to the end of 2017, this corresponds to a decrease of at least 12.5 GW, of which nearly 5 GW and 7.7 GW will be accounted for by lignite and hard coal, respectively. Environmental provision under IAS 37

These figures include shutdowns that have already occurred or have been announced as well as lignite-fired units which had not yet been placed on security stand-by at the end of 2017. The objective is to have lignite and hard coal-fired power stations with a total capacity of only 9 GW and 8 GW (excluding back-up capacity) on the market in 2030.

Moreover, the Commission recommends removing emission allowances matching the additional CO2 savings from the national auction budget, as otherwise the certificates no longer needed for the decommissioned power plants would be available to other participants in the European Emissions Trading System, enabling additional emissions from their assets.

The Commission further proposes that the German government conduct reviews in 2023, 2026 and 2029 involving an analysis of the effects of measures taken by then on security of supply, electricity prices, climate protection and structural development in the affected regions and that countermeasures be initiated if necessary. It is also recommended that policymakers implement the phase-out roadmap in agreement with the operators and grant them appropriate compensation. The Commission also deems it desirable that Hambach Forest be preserved.

With respect to relocations in the opencast mining regions, the states are being asked to enter into dialogue with the affected residents in order to avoid social and financial hardship. Layoffs and undue social and economic disadvantages for the workers should be prevented, in part by paying them an adjustment allowance.

By and large, the Commission’s proposals met with the approval of politicians and stakeholder groups. It was viewed positively that widespread consensus has now been reached, which can serve as a basis for policymakers in order to establish planning certainty for companies, employees and regions. Observers therefore anticipate that the German government will implement the main points of the Commission’s concept. Environmental provision under IAS 37

This would have serious ramifications for our Rhenish lignite business. RWE has already taken four power plant units offline prematurely under the security stand-by scheme, with a further block to follow at the end of September 2019. Additional shutdowns are therefore all the more difficult and result in burdens going far beyond the lost electricity revenue.

For instance, we would have to implement substantial job cuts and introduce redundancy programmes for the affected workers at short notice. If opencast mines are closed early, new recultivation concepts would have to be developed and the mining provisions would have to be increased as they would be used earlier.

Additional costs would be incurred if Hambach Forest were preserved, provided that this is at all technically feasible. In addition, substantial investments are needed in order to adapt opencast mines and power plants to a new operating concept. Environmental provision under IAS 37

We can only reliably estimate the burdens we will face when the government presents specific plans and initiates talks with us. We welcome the fact that the Commission has recognised the need to pay power plant operators adequate compensation and has also considered the knock-on costs for the opencast mines.

Environmental provision under IAS 37

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