Substantive Tests on

Environmental Liability

What is an Environmental
Liability?
Obligationbased on
theprinciplethat a pollutingparty
shouldpayfor any and
alldamagecaused to
theenvironmentby itsactivities. In
somecountries, this is astrict
liabilityif the damage can be
attributed to a specific party.
Read more:
http://www.businessdictionary.com/definition/environmental-liabi
lity.html#ixzz3n1Vb3nvW
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What is a liability?
A liability exists if there is a probable
and measurable future outflow or
other sacrifice of resources as a
result of a past transaction or event

For example
When chemical contamination at a site
(a potential financial liability) is
identified (an event) future cost data
is estimated (a transaction) and
posted into the accounting system.

EARNINGS MANIPULATION
Environmental Liabilities
Columbia Transmission in recent years
recorded projected compliance costs
related to low levels of contamination
by PCB-based lubricating oils. . .
resulted in additional pre-tax charges
of $65 million

MANAGEMENT, AUDITOR
INCENTIVES
Management
Incentive to understate cleanup costs
Examples
Arco, Exxon, Phillips stock prices declined
due to environmental disasters

Auditor
Incentive for reasonable assurance
that material environmental liabilities
are disclosed
Shareholders may sue if unreported
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WHAT IS THE AUDITOR

TRYING TO DETERMINE?
The environmental liability source
documentation be retained for the life
of the liability.
When an audit is conducted, the auditor
examines source documentation to
support the transaction.
Source documentation might include
the assumptions used in the cost
model, and test data results

Acceptable supporting
documentation must be:
Sufficient Enough documentation
must be available for an auditor to
form an opinion.
Competent Documentation must
be valid and reliable.
Relevant Documentation must be
related to what is being supported.

Assertions
Existence or Occurrence
Management is attesting that the
account balances are not overstated
Example:
cost estimates are not included in
the account balances when they are
not a responsibility of the entity

Assertions
Completeness Management is
attesting that the account balances are
not understated.
Example:
environmental site cost estimates that
are the responsibility of the entity have
not been excluded from the account
balances

Assertions
Valuation or Allocation
Management is attesting that the
account balances are accurate
Example:
Based on known information the cost
estimate is accurate

Assertions
Rights and Obligations Management
is attesting that the account balances
are owned by (Assets) or are the
responsibility of (Liabilities) the entity.
Presentation and Disclosure
Management is attesting that the
account balances are properly
classified and appropriate disclosures
have been made.

Substantive test
Procedures
Analytical:
For example, the auditor may compare
the environmental liabilities reported
in Fiscal Year (FY) 2004 for a specific
program to the environmental
liability reported in FY 2005 for that
same program.

Substantive test
Procedures
Tracing
With a source document and follow it through
the process to the financial statements.
This verifies the completeness assertion.
Vouching
The auditor may start with an amount in the
financial statements and work back through
the process to the source document. This
procedure verifies the existence or
occurrence assertion,

Substantive test
Procedures
Computation
The auditor may check the
mathematical accuracy performed by
the auditees.
Inquiry The auditor may question or
interview individuals to obtain
testimonial evidence.

Substantive test
Procedures
External Confirmation
The auditor may request information from third
parties to corroborate evidence obtained from
the auditee.
Inspection
The auditor may obtain documentation from
examining material such as records or
documents. For example, the auditor may
examine the property record for an
environmental liability site to verify the
assumptions used when developing the estimate.

Substantive test
Procedures
Observation The auditor may directly
view actions performed by the auditee.
Sampling The auditor may apply
auditing procedures to a portion of the
universe being audited in order to
draw conclusions about the whole
universe.