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The way in which prospective buyers and sellers conduct their due diligence in transactions where contingent environmental liabilities exist will need to evolve in response to new accounting rules published by the Financial Accounting Standards Board (FASB). These rule changes will also add a level of complexity to the services provided by environmental experts on future transactions.

In December 2007, FASB issued a revision to Financial Accounting Statement No.141 (FAS-141R) for Business Combinations. Business combinations include nearly all business mergers and acquisitions. FAS-141R, which will become effective on December 15, 2008, requires that a buyer recognize all assets and liabilities (including contingent environmental liabilities) in a transaction at the “fair value.” A previous FASB pronouncement, FAS 157 Fair Value Measurements issued in December 2006, sets the framework for measuring fair value. FASB defines a “contingent liability” as a present obligation arising from past events that will require future monetary outflows.

The manner in which liabilities must be recognized under FAS 141R and FAS 157 are a major departure from the way environmental liabilities were historically recognized in business combinations. The differences between the historical recognition criteria and the new criteria are summarized in Table 1 (below).

Under the old FAS 141, accounting recognition of environmental liabilities could be deferred until the recognition criteria for FAS 5, Accounting for Contingencies, were met. FAS 5 requires recognition of a liability only if (1) the loss is “probable,” meaning it is highly likely to occur and (2) can be reasonably estimated. If a contingent environmental liability did not meet either of these requirements it did not need to be recognized on accounting statements or for business combinations.

The new FAS 141R will require that environmental liabilities be recognized at the fair value as of the acquisition date. In addition, different recognition criteria will apply depending on whether the contingencies stem from contractual or non-contractual obligations. All contractual contingencies must be recognized at fair value as of the acquisition date.

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