Auditing for Violations of Environmental Laws
Cornell, David W., Apostolou, Barbara, The National Public Accountant
Environmental laws are becoming increasingly complex with considerable governmental emphasis on compliance. Noncompliance can result in costly cleanups, fines and penalties to a client company. Financial statements must reflect actual and potential liabilities that arise as a result of noncompliance with environmental laws and regulations. Auditors should design their audits to consider the financial statement impact of environmental cleanups and other costs of noncompliance. Proper procedures and documentation should minimize liability exposure in an environment where harmed parties are quick to sue the auditor.
Two primary issues are of concern when auditing clients involved with hazardous materials or toxic waste or who own property that may be environmentally contaminated. These issues include unrecorded loss contingencies and going concern questions. Clients may fail to record the costs of rectifying environmental problems for several reasons, such as management's lack of awareness of a problem. Management may choose to ignore environmental problems due to the magnitude of the costs of cleanup. The Environmental Protection Agency (EPA) has identified more than 27,000 hazardous waste sites in the United States with an estimated cleanup cost of $25 million. cost of environmental cleanup and decontamination could bankrupt a company that otherwise may be solvent. Thus, failure to accrue cleanup costs and the effect on a client's solvency must be addressed by the auditor.
This article examines the issue of auditing clients that are involved with hazardous waste materials. Audit procedures that should be employed in this situation are discussed along with how the auditor should handle a situation in which environmental problems are encountered. A summary of Statements on Auditing Standards that affect the audit of environmental issues is presented in Table 1. Each is discussed in the following sections.
Audit Procedures for the External Auditor
Statement on Auditing Standards (SAS) No. 12(1), Inquiry of a Client's Lawyer Concerning Litigation, Claims and Assessments, provides guidance on how the auditor should obtain evidential matter regarding uncertainties due to litigation, claims and assessments. The audit procedures discussed in SAS No. 12 should be employed to detect the presence of environmental issues as of the client's balance sheet date. These procedures include discussions with management, review of documentation supporting litigation, obtaining management representations and obtaining attorney letters. Additional audit procedures for clients exposed to environmental problems that are not considered in SAS No. 12 include an evaluation of internal controls and employing specialists perform an environmental audit of the company.
Discussions with Management
SAS No. 12 states that the auditor should ascertain management's policies and procedures for identifying, evaluating and accounting for litigation. This discussion is broad in nature and determines management's assessment of general litigation against the company. The auditor should expand the discussion to specifically address environmental issues. Inquiries about the presence of environmental litigation should also include questions about the client's involvement with hazardous materials or toxic waste and of ownership of property that may be environmentally contaminated (as well as liens thereon). If any involvement is indicated, the auditor should obtain from management a description of the items and an evaluation of present or potential litigation stemming therefrom.
Review of Documentation
Discussions with management should be followed up with a review of supporting documentation. This documentation could include correspondence with the client's legal counsel, legal documents and reports from environmental auditors (if any). Additionally, minutes of meetings of stockholders, directors and appropriate management committees should be reviewed with an eye toward discussion of environmental issues. …