Paying for the Past, Providing for the Future: 2002 Research Report on Environmental Liability in South Africa

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2002 Research Report on Environmental Liabilities in PAGE South 2 Africa

Paying for the past, providing for the future

Contents

SECTION 5

A potentially successful PFI project could still fail if an effective project procurement route is not followed.

business need. The business need and potential solutions are PAGE more 2 clearly defined by investigative PAGE 5 surveys and desktop study and examined in light of prevailing policy. The outcome of that PAGE 11 process should be a range of PAGE 17 options that could potentially address the need. In central government, these are then costed and appraised using the Treasurys PAGE 23 Green Book option appraisal methodology to identify a preferred option. The preferred procurement option is considered by comparing PAGE 30 the Net Present Values of the risk adjusted whole life costing of a conventional procurement and a PFI/PPP option. The outcome has to be considered in terms of its affordability and its attractiveness PAGE 34 to the market and this may result in an iterative process of

Paying for the past, providing for the future adjustment.

and minimise the likelihood of delay at later stages in the procurement process.

1 Introduction
It is essential to ensure that the
2 The Institutional Perspective
project
that emerges
from this of the European Communities
International
Commission
process
is affordable,
Outline Business Case (OBC)
South
Africa Government and Sector The
Associations
demonstrates value for money and
documents the development
3 The Due Diligence Perspective
will adequately address the need.
process, but it also sells the
4 The Accounting
Proceeding
to market Perspective
with an ill
project in that it demonstrates why
International
Accounting
Standards
(IAS)
defined unaffordable project will at
a particular project should be
Other
Accounting
Guidelines
best result in a long and protracted
pursued and the robustness of the
procurement
process
that
delivers
case for doing so. It should be the
5 The Auditing Perspective
IAPS 1010
Requirements
questionable
value
for money, and of the Standard
basis of the decision for
IAPS will
1010
- Illustrative
at worst
result
in failure of Audit
the Questions
proceeding to procurement and
Other
Auditing
Issues
procurement. Getting the project to
may be the basis of a decision on
the
market
requires
a
clear
and
6 The South African Legal Perspective financial support from third
realistic
programme
that
parties. It will be examined by
Legal
developments
acknowledges
the requirements of
people who have had no
Legal Liabilities
Criminal
Liability
the European public procurement
involvement in the project and
Civil Liability
regulations
and other constraints
thus needs to be presented with a
liability and the
such Ecological
as title searches
sufficient level of detail to provide
need
for planning permission.
a full understanding of the
7 Conclusion
Spending sufficient time on these
decisions that have been taken
Annexure A The Association of Chartered Certified Accountants (ACCA)
early on will reduce uncertainty
and the information supporting
Annexure B KPMG Sustainability Services

PAGE 3

SECTION 1

Introduction

INTRODUCTION As the World Summit on Sustainable Development, being held in Johannesburg this year, will testify, environmental issues are no longer merely an item of corporate social responsibility. Environmental issues today can significantly impact the business performance and financial profitability of companies. This was recently confirmed in the 2001 KPMG survey on Environmental Accounting in South Africa, where 65% of the surveyed companies regarded the potential financial impacts of environmental issues as highly significant, while the remaining 35% believed them to be moderately significant. One of the main drivers of this trend is the emergence of

PAGE 4

environmental liabilities financial
obligations that companies have to
provide for, incur and disclose, in
order to address environmental
concerns. The abovementioned
survey showed that 74% of
companies were already measuring
environmental liabilities.
Levels of disclosure, however,
remain low. For example, in the
2001 KPMG Survey of
Sustainability Reporting in South
Africa, only 31% of the All Share
Index 100 companies were
disclosing any environmentally-
related financial information in
their annual reports.
One of the reasons for low levels of
disclosure, we believe, is that
there is a lack of awareness,
guidance and clarity on
environmental liabilities what
they are, how to measure them
and when to disclose them. The
purpose of this report is to begin to
fulfil that gap.
This report looks at several
different perspectives on
environmental liabilities in South
Africa:
the institutional perspective;
the due diligence perspective;
the accounting perspective;
the financial auditing
perspective; and
the legal perspective.

Paying for the past, providing for the future

SECTION 2

The institutional perspective

THE INSTITUTIONAL PERSPECTIVE This section gives both an international and South African institutional perspective on environmental liabilities. The South African findings are based on interviews conducted with key representatives of the government departments and sector organisations referenced below, as well as relevant documentation issued by these institutions.

International Commission of the European Communities One of the most far reaching declarations on environmental liabilities is the White Paper on Environmental Liability, published by the European Commission in 2000. The following paragraphs quote some insightful sections of

Paying for the past, providing for the future the document.

Environmental liability aims at
making the causer of
environmental damage (the
polluter) pay for remedying the
damage that he/she has caused.
Environmental regulation lays
down norms and procedures
aimed at preserving the
environment. In the absence of
allocated liability, failure to comply
with existing norms and
procedures may merely result in
administrative or penal sanctions.
However, if liability is added to
regulation, potential polluters also
face the prospect of having to pay
for restoration or compensation of
the damage they caused.

Not all forms of environmental damage can be remedied through assigning liability, i.e. holding one or more party liable. For the latter to be effective: there need to be one (or more) identifiable actors (polluters) the damage needs to be concrete and quantifiable, and a causal link needs to be established between the damage and the identified polluter(s).

Therefore, liability can be applied,
for instance, in cases where
damage results from industrial
accidents or from gradual pollution
caused by hazardous substances
or waste coming into the
environment from identifiable
sources.

However, liability is not a suitable instrument for dealing with

PAGE 5 pollution of a widespread, diffuse character, where it is impossible to link the negative environmental effects with the activities of certain individual actors. Examples are effects of climate change brought about by CO 2 and other emissions, forests dying as a result of acid rain and air pollution caused by traffic. The White Papers scope of environmental liability is also very revealing, as it includes: Damage to biodiversity; Damage in the form of contamination of sites; and Traditional damage (e.g. to health or property).

South Africa Government and Sector Associations In the course of this research, no

PAGE 6

clear guidance was obtained from the Department of Environmental Affairs and Tourism regarding environmental liabilities. This in itself is a cause for concern. The Department of Water Affairs and Forestry mainly deferred to the existing legislation, while the institutions directly governing the mining sector were able to provide more detailed and specific clarification.

Department of Water Affairs and Forestry The Department of Water Affairs and Forestry (DWAF) deals with water-related liabilities in terms of the National Water Act, 36 of 1998. A liability arises when there is non-compliance with the requirements of this legislation. Industry may then be held accountable for the costs of clean up or damages.

DWAF operates on the polluter-
pays principle in the regulation
and enforcement of environmental
management. Hence, when an
activity results in damage, the
party in control of the activity (the
operator), who is regarded as the
actual polluter, has to pay the
costs of repair. Should the
operator fail to remediate the
environmental damage adequately,
DWAF may implement the
necessary steps and charge on the
costs to the polluter.

In cases where the polluting company cannot be identified or is unable to pay the clean-up costs, the government may look to third parties who in any way benefited

Paying for the past, providing for the future from the operations, or who will benefit from the rehabilitation, to share the costs. These issues are dealt with in more detail in the Legal Perspective section of this report.

Further information is available in the 1994 DWAF publication entitled: Operational guideline concerning financial provision for the rehabilitation of land disturbed by mining activities.

Department of Mineral and Energy Affairs The Department of Mineral and Energy Affairs (DME) considers environmental liability to exist when there is pollution of any element of the environment (soil, water and air, including related social impacts). Liability will be

Paying for the past, providing for the future

enforced upon the holder of a
prospecting permit or mining
authorisation when the post-
closure rehabilitation of the land
involved is unsatisfactory, i.e. it is
not in accordance with the
approved Environmental
Management Program Report and
the requirements of South African
environmental legislation.

The Department can issue a directive for a clean up or redress of the environmental liability and three possibilities can result the Department can: Order the responsible party to address the adverse environmental situation; Contract a third party to do the clean up and recoup the costs thereof at a later stage; or Assume responsibility, if they cannot find the responsible party or the party is not in a position to address the situation.

In order to minimise potential environmental liabilities, the DME is becoming more stringent in its requirement for financial provisions for rehabilitation to be set aside in a trust fund. The rehabilitation trust is a separate legal entity and is used as a funding mechanism subsequent to mine closure.

Chamber of Mines of South Africa The Chamber of Mines of South Africa exists to serve the mines (its members) and promote their interests in the South African mining industry. The Chamber considers environmental liability to arise when groundwater is

PAGE 7 polluted, tailings dams are not remediated and waste dumps are abandoned to the detriment of the environment.

The Chamber has a guideline for the administration of financial provisions for mine closure and rehabilitation, as well as guidelines for rehabilitation (for the surface coal mining industry). The financial provision for rehabilitation of land disturbed by mining activities is aimed at the following:

(a) the rehabilitation of disturbances of the surface of land and the prevention and combating of pollution of air, land, sea or other water where such disturbances and pollution are due to mining;

(b) the protection of the surface or land and water sources and the making safe of undermined ground and of dangerous excavations, tailings, waste dumps and structures made in the course of mining; and

(c) the demolition or removal of any building or structure constructed in connection with mining.

for rehabilitation, where the
provision can either be as a
provision on the financial
accounts, a security instrument
(e.g. a bank guaranteed cheque) or
a trust fund. In addition, the
Chamber has set up a central
rehabilitation fund. The main
object of the fund is to make
financial provision for expenditure,
which a member company is likely
to incur.

Further information is available in the 1980 Chamber publication entitled: Handbook of guidelines for environmental protection and rehabilitation of land disturbed by surface mining (Volume 3).

The Chamber of Mines requires a mine to make financial provision

PAGE 8

Paying for the past, providing for the future

South African Revenue Services (SARS) In terms of the Minerals Act, 50 of 1991, a trust can be created and a trust deed drafted in order to provide for rehabilitation closure costs. The application for registering a rehabilitation trust fund must be in writing to the Director General: Mining and Energy Affairs. On receipt of the application he/she will consult with the Chief Inspector and each government department charged with the administration of any law which relates to any matter affecting the environment.

The trust whose sole object is to receive, hold and apply moneys contributed to it in order to discharge obligations imposed in terms of a law is exempt from

Paying for the past, providing for the future

normal tax. Furthermore, for a provision to qualify for a deduction for tax purposes, there must be an actual payment before year end and it must be approved by SARS.

company. The calculated amount can rank as a deduction entry once accepted by SARS.

The Commissioner has to approve the trust on terms he considers necessary to ensure that its activities are wholly directed to the furtherance of its sole object. In his 2 nd edition of the Mining Tax in South Africa Hand Book, Van Blerks method of calculating rehabilitation provisions for tax purposes is the amount determined by dividing the present value of future environmental work by the estimated remaining life of the operation. The liability calculation has to be approved by the Commissioner before it can be implemented by the mining

PAGE 9

SECTION 3

The due diligence perspective

THE DUE DILIGENCE PERSPECTIVE Business transactions today must include consideration of environmental issues. Complex laws can impose significant environmental liabilities on purchasers, sellers, and lenders involved in a financial transaction, whether or not they caused the environmental impacts or own the assets. Environmental liabilities associated with mergers, acquisitions, and similar business transactions can present substantial financial risks.

For example, acquiring a firm can expose the acquirer to liabilities hidden in its target assets, such as contaminated land, or significant capital costs to upgrade processes and equipment to meet

PAGE 10

environmental legislation. Failure to identify the environmental risks and liabilities of a target entity can significantly affect the investments return, and create ongoing compliance and operational costs for the acquiring firm. Lack of a complete understanding of the true value of the target assets can in turn lead an acquiring firm to pay more for the target entity than might be appropriate.

The ISO 14015 standard on
environmental assessment of sites
and organizations gives some
useful guidance that is relevant to
due diligence investigations. In
addition, recognising that
environmental liabilities can arise
from a variety of physical and
business-related factors, the
following diagram reflects KPMGs
holistic approach to environmental
due diligence.

For these reasons, it is essential to use Environmental Due Diligence as a tool for determining environmental liabilities when financial transactions are being negotiated. This not only provides greater management assurance over the transaction, but also enhances the organisations credibility in the eyes of often skeptical stakeholders.

Typically, the physical assessment aspect of an environmental due diligence will take place in two phases. Phase I will use the method of site inspection, management interviews and documentation review to identify the potential existence of environmental liabilities related to historical or ongoing pollution or

Paying for the past, providing for the future lack of adequate controls. Should the risk be judged significant, a second phase is conducted to quantify the air, soil and water pollution impacts, through scientific sampling, testing and analysis.

Paying for the past, providing for the future

KPMGS HOLISTIC APPROACH TO ENVIRONMENTAL DUE DILIGENCE

PAGE 11

SECTION 4

The accounting perspective

THE ACCOUNTING PERSPECTIVE Environmental matters are becoming significant to an increasing number of organisations and may, in certain circumstances, have a material impact on their financial statements. This is particularly true for environmental liabilities. These issues are of growing interest to the users of financial statements and other stakeholders. Hence, the recognition, measurement, and disclosure of these matters is the responsibility of management. This section details some of the guidance on environmental liabilities that has emerged from the accounting profession, through the International Accounting Standards, as well as other practice statements and guidelines.

PAGE 12

INTERNATIONAL ACCOUNTING STANDARDS (IAS) IAS 37 on Provisions, Contingent Liabilities and Contingent Assets IAS 37 became operative for annual financial statements covering periods beginning on or after 1 July 1999. It includes guidelines on the creation of environmentally related provisions, such as for environmentally related rehabilitation.

The following definitions can be
directly applied to environmental
issues. IAS 37 defines a
contingent liability as:
(a) a possible obligation that
arises from past events and
whose existence will be
confirmed only by the
occurrence or non-occurrence
of one or more uncertain future
events not wholly within the
control of the enterprise; or
(b) a present obligation that arises
from past events but is not
recognised because:
(i) it is not probable that an
outflow of resources
embodying economic benefits
will be required to settle the
obligation; or
(ii) the amount of the obligation
cannot be measured with
sufficient reliability.

The Standard defines provisions as liabilities of uncertain timing or amount. It requires a provision to be raised when the following criteria are met: (a) an enterprise has a present obligation (legal or constructive) as a result of a past event;

Paying for the past, providing for the future

(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. The Standard notes that it is only in extremely rare cases that a reliable estimate will not be possible.

certain responsibilities; and (b) as a result, the enterprise has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

Highly relevant to environmental issues, the Standard defines a constructive obligation as an obligation that derives from an enterprises actions where: (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the enterprise has indicated to other parties that it will accept

Where some or all of the expenditure required to settle the provision is expected to be reimbursed by another party, the reimbursement should be recognised when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement should be treated as a separate asset. The amount recognised for the reimbursement

Paying for the past, providing for the future

In terms of IAS 37, gains from the expected disposal of assets should not be taken into account in measuring the provision.

should not exceed the amount of the provision.

IAS 2 on Inventories
It is often the case that
companies, especially in the
mining industry, regard their
infrastructure and waste materials
as assets with a residual value; for
example, mineral content that can
be retrieved, or recycled materials
that can be sold. The result of this
approach is that there will often be
a reduced rehabilitation liability
provided in respect of the site,
since the potential asset sales
have been netted off. This,
however, is not an acceptable
approach in terms of international
accounting standards.
IAS 2 defines inventories as assets
that are:
(a) held for sale in the ordinary

PAGE 13 course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

In terms of IAS 2, a waste site should not be accounted for as an asset, unless additional costs were incurred to convert the waste into a commercial item. If the latter is the case, the waste should then be valued at the lower of the cost and net realisable value. Alternatively, no account should be taken of current recovery operations, since offsetting the liability against future recoveries is not allowed by the accounting standards. To the extent that the waste site or infrastructure meets the definition

PAGE 14

of an asset, it should be accounted for in accordance with IAS 2 on Inventories or IAS 16 on Property, Plant and Equipment. These standards requires that an item should be recognised as an asset when: (a) it is probable that future economic benefits associated with the asset will flow to the enterprise; and (b) the cost of the asset to the enterprise can be measured reliably.

IAS 16 on Property, Plant and
Equipment
One of the most significant areas
of environmental liability is
rehabilitation. IAS 16 addresses
this issue, stating that the cost of
an item of property, plant and
equipment includes the estimated cost of dismantling and removing the asset and restoring the site, to the extent that it is recognised as a provision under the statement on provisions, contingent liabilities and contingent assets.
A provision should therefore be
recognised for the estimated
rehabilitation costs that will be
incurred during or at the end of the
life of the asset, as soon as there is
an obligation to incur the
expenditure. Rehabilitation costs
include the cost of rehabilitating
damage incurred on the initial
acquisition and set-up of an asset,
as well as damage incurred over
the life of the asset through its
use. The rehabilitation liability
should not be reduced by the
possible revenue that will be
generated from the sale of assets,

Paying for the past, providing for the future for example sale of scrap materials or reworking of a waste site. This is according to IAS 37 and it is in line with the requirements of IAS 18 on Revenue.

To the extent an obligation to decommission the asset and restore the site arises at the time the asset is first acquired, a provision should be recognised. These estimated costs should be included in the cost of the asset. Therefore, to the extent that damage is incurred in the initial set up of an asset, the anticipated cost of restoring the site and removing the asset should be recognised as a provision and as part of the cost of the asset. A provision for environmental rehabilitation costs resulting from damage caused during the period

Paying for the past, providing for the future

of operating the asset should be raised as the damage is incurred.

The corresponding debit should, however, be recognised as an expense in the period in which the obligation arises, and should not be included in the cost of the asset, since these costs do not extend the life of the asset beyond its originally envisaged term. At each reporting date, the provision recognised should be the present value of the estimated cost of site restoration and clean up based on damage incurred at the balance sheet date.

IAS 10 on Events after the Balance Sheet Date Subsequent events may also be relevant to environmental issues. IAS 10 states that subsequent events are those events, both favourable and unfavourable, that occur between the balance sheet date and the date when the financial statements are authorised for issue. Two types of events can be identified: (a) those that provide evidence of conditions that existed at the balance sheet date (adjusting events after the balance sheet date). For example, the resolution after the balance sheet date of an environmentally-related court case which, because it confirms that an enterprise already had a present obligation at the balance sheet date, requires the enterprise to adjust a provision already recognised, or to recognise a provision instead of merely

PAGE 15 disclosing a contingent liability; and (b) those that are indicative of conditions that arose after the balance sheet date (nonadjusting events after the balance sheet date). For example, an environmental spill subsequent to year-end would not require the financial statements to be adjusted; however, should it be significant, it will require additional disclosure in the financial statements as follows: the nature of the event; and an estimate of its financial effect, or a statement that such an estimate cannot be made.

PAGE 16

OTHER ISSUES IAS 36 on Impairment of Assets Where initial set up and dismantling costs are included as part of the cost of an asset and there is an indication that the asset may be impaired, the recoverable amount of the asset should be calculated in terms of IAS 36 on Impairment of Assets. If the carrying amount of the asset exceeds its recoverable amount, the carrying amount of the asset should be written down. Rehabilitation Trust Funds South African legislation requires mining companies to set funds aside for rehabilitation. Usually, separate trust funds are established and amounts are contributed to these funds to be used for rehabilitation. The amounts contributed to the funds do not necessarily bear any relation to the actual expenditure that will be incurred, although they are an attempt to estimate this future expenditure.

In addition, the contributions to
the trust do not extinguish the
entitys obligation for the
rehabilitation costs should there be
a shortfall; the trust is merely used
as a funding mechanism
subsequent to mine closure.
Where an entity has made a
contribution to a trust fund, the
expected cost of environmental
rehabilitation, based on the
damage incurred at the balance
sheet date, should be calculated.
An environmental rehabilitation
provision should be recognised for
this full amount. A separate asset
should be recognised for the

Paying for the past, providing for the future funded portion of the future liability.

These amounts should not be set off. The relationship between the asset and the liability should be disclosed in the notes. IAS 27 on Consolidated Financial Statements and Accounting for Investments in Subsidiaries, and especially SIC 12 on Consolidation - Special Purpose Entities (SPEs) should be considered to determine whether rehabilitation trust funds should be consolidated by the entity. An enterprise should consider whether it, in substance, controls the rehabilitation trust fund and should therefore consolidate it.

In most cases, it is likely that the trust fund is set up to fund an

Paying for the past, providing for the future

entities rehabilitation liability and is thus seen to be operating on behalf of an enterprise in accordance with its specific business needs.

Accounting Policies
An entity should disclose the
accounting policy adopted in
respect of provisions for site
restoration and environmental
rehabilitation. The following
illustrative accounting policy note
in the financial statements may be
provided in respect of
environmental liabilities:
Provisions are recognised when the
entity has a present legal or
constructive obligation as a result of
past events, for which it is probable
that an outflow of economic benefits
will occur, and where a reliable
estimate can be made of the amount of the obligation. Where the effect of discounting is material, provisions are discounted. The discount rate used is a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability.

A provision is raised for the present value of environmental damage incurred on the initial set up of assets and other long-term capital projects. These costs are included in the cost of the related asset.

The obligation to restore
environmental damage caused
through operations is raised as the
relevant operations take place.

Other Accounting Guidelines Due to the relatively recent

PAGE 17 introduction of IAS 37 and the progress of environmental legislation over the last few years there was a need identified to give guidance and clarity on environmental liabilities. As a result of the complexity and significance of the environmental liabilities numerous initiatives by both accounting institutes and environmental agencies have produced legislation, standards and guidelines on environmental liabilities. The following list is included for reference: United States Comprehensive Environmental Response Compensation and Liability Act or Superfund (1980); Canadian Institute of Chartered Accountants Environmental Costs and Liabilities: Accounting and Financial

PAGE 18

Reporting Issues (1993);
Institute of Chartered
Accountants in England and
Wales Financial Reporting of
Environmental Liabilities: A
Discussion Paper (1995);
American Institute of Certified
Public Accountants Statement
of Practice (SOP) 96-1
Environmental Remediation
Liabilities (1996);
United Nations Conference on
Trade and Development
(UNCTAD) Accounting and
Financial Reporting for
Environmental Costs and
Liabilities (1999);
International Federation of
Accountants Environmental
Management in Organisations:
The role of Management
Accounting (1999);
Japanese Environment Agency
Grasping Environment Cost
Accounting (1999);
Commission of the European
Communities White Paper on
Environmental Liabilities
(2000); and
Commission of the European
Communities
Recommendation on the
Recognition, Measurement and
Disclosure of Environmental
Issues in the Annual Accounts
and Annual Reports of
Companies (2001).

Paying for the past, providing for the future

SECTION 5

The auditing perspective

THE AUDITING PERSPECTIVE Due to the significant financial impacts that environmental issues may have, the International Auditing Practice Standard (IAPS) 1010 on The consideration of environmental matters in the audit of financial statements was introduced in 1998. This is equivalent to South African Auditing Standard (SAAS) 2501, adopted in 1999. This section quotes some of the guidelines on environmental liabilities included in this standard, as well as giving some additional comments of relevance. The extent to which any of the audit procedures described in this Statement may be appropriate in a particular case requires the exercise of the auditors judgment in the light of the requirements of

Paying for the past, providing for the future

the International Standards on Auditing (ISA) and the circumstances of the entity.

IAPS 1010 REQUIREMENTS OF THE STANDARD Guidance on the Application of ISA 310 Knowledge of the Business The auditor considers the industry in which the entity operates, as it may be indicative of the possible existence of environmental liabilities and contingencies. Certain industries, by their nature, tend to be exposed to significant environmental risk. These include the chemical, oil and gas, pharmaceutical, metallurgical, mining, and utility industries. (Par. 15)

Audit Materiality of ISA 320 The
Relationship between Materiality
and Audit Risk
When planning the audit, the
auditor considers what would
make the financial statements
materially misstated. The
auditors assessment of
materiality, related to specific
account balances and classes of
transactions, helps the auditor
decide such questions as what
items to examine and whether to
use sampling and analytical
procedures. This enables the
auditor to select audit procedures
that, in combination, can be
expected to reduce audit risk to an
acceptably low level.

PAGE 19

GUIDANCE ON THE APPLICATION OF ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements Changes in environmental legislation could have significant consequences for the operations of the entity and may even result in liabilities that relate to past events which, at the time, were not governed by legislation.

An example of the first category is a change in noise regulations that could curtail future use of plant or machinery. An example of the latter is an increase in standards that could render a waste generator liable for waste disposed of in previous years, even though disposal of the waste was in compliance with the then existing practice. (Par. 31)

PAGE 20

Substantive Procedures The use of professional judgment may become even more important because of a number of difficulties with respect to the recognition and measurement of the consequences of environmental matters in the financial statements, for example: noften there is a considerable time delay between the activity that basically causes an environmental issue, and the identification of it by the entity or regulators; naccounting estimates may not have an established historical pattern or may have wide ranges of reasonableness because of the number and nature of assumptions underlying the determination of these estimates; environmental laws or regulations are evolving, and interpretation may be difficult or ambiguous. Consultation of an expert may be necessary to assess the impact of these laws and regulations on the valuation of certain assets (for example, assets that contain asbestos). Making a reasonable estimate of liabilities for known obligations may also appear to be difficult in practice; or liabilities may arise other than as a result of legal or contractual obligations. (Par. 39)

Environmental Experts Management is responsible for accounting estimates included in the financial statements. Management may require technical advice from specialists such as lawyers, engineers or other environmental experts to assist in developing accounting estimates

Paying for the past, providing for the future and disclosures related to environmental matters. Such experts may be involved in many stages in the process of developing accounting estimates and disclosures, including assisting management in: identifying situations where the recognition of liabilities and related estimates is required (for example, an environmental engineer may make a preliminary investigation of a site to determine if contamination has occurred, or a lawyer may be used to determine the entitys legal responsibility to restore the site); gathering the necessary data on which to base estimates and providing details of information that needs to be disclosed in

Paying for the past, providing for the future

the financial statements (for
example, an environmental
expert may test a site in order to
assist in quantifying the nature
and extent of contamination and
considering acceptable
alternative methods of site
restoration); and
designing the appropriate
remedial action plan and
calculating related financial
consequences. (Par. 41)

Management Representations ISA 580 Management Representations requires that the auditor obtain written representations from management on matters material to the financial statements when other sufficient appropriate audit evidence cannot reasonably be expected to exist.

Much of the evidence available to the auditor with respect to the impact of environmental matters on the financial statements will be persuasive in nature rather than conclusive. The auditor may therefore wish to obtain specific representation that management: (a) is not aware of any material liabilities or contingencies arising from environmental matters, including those resulting from illegal or possibly illegal acts; (b) is not aware of any other environmental matters that may have a material impact on the financial statements; or (c) if aware of such matters, has disclosed them properly in the financial statements.

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IAPS 1010 - ILLUSTRATIVE AUDIT QUESTIONS Control environment and control procedures Is management aware of the existence, and the potential impact on the entitys financial statements, of: any risk of liabilities arising as a result of contamination of soil, groundwater, or surface water; any risk of liabilities arising as a result of air pollution; or unresolved complaints about environmental matters from employees or third parties? (Par. 20)

PAGE 22

Substantive Procedures to Detect a Material Misstatement due to Environmental Matters Completeness of Liabilities, Provisions and Contingencies Enquire about policies and procedures implemented to help identify liabilities, provisions or contingencies arising from environmental matters. (Par. 18) Enquire about events or conditions that may give rise to liabilities, provisions or contingencies arising from environmental matters, for example, Violations of environmental laws and regulations; Citations or penalties arising from violations of environmental laws and regulations; or Claims and possible claims for environmental damage. (Par. 19)

If site clean-up costs, future removal or site restoration costs or penalties arising from noncompliance with environmental laws and regulations have been identified, enquire about any related claims or possible claims. (Par. 20)

Enquire about, read, and evaluate
correspondence from regulatory
authorities relating to matters
dealing with environmental
matters and consider whether such
correspondence indicates
liabilities, provisions or
contingencies. (Par. 21)

For property abandoned, purchased, or closed during the period, enquire about requirements for site clean-up or intentions for future removal and site restoration. (Par. 22)

Paying for the past, providing for the future

For property sold during the period (and in prior periods), enquire about any liabilities relating to environmental matters retained by contract or by law. (Par. 23) Perform analytical procedures and consider, as far as practicable, the relationships between financial information and quantitative information included in the entitys environmental records (for example, the relationship between raw materials consumed or energy used, and waste production or emissions, taking into account the entitys liabilities for proper waste disposal or maximum emission levels). (Par. 24)

Accounting estimates For liabilities, provisions, or contingencies related to environmental matters consider

Paying for the past, providing for the future

whether the assumptions
underlying the estimates continue
to be appropriate. (Par. 27)
Compare estimates of liabilities
relating to one location (for
example, estimates for site
restoration or future removal and
site restoration costs at a specific
location) with:
(a) estimates of liabilities for other
locations with similar
environmental problems;
(b) actual costs incurred for other
similar locations; or
(c) estimates of costs of
environmental liabilities
reflected in the sales price for
similar locations sold during
the period. (Par. 28)
OTHER AUDITING ISSUES
Environmental managers
Environmental managers at
organisations are normally well
informed of environmental legal
requirements and the likely costs
associated with rehabilitating
environmentally damaged areas to
acceptable standards. Therefore
the auditor can often obtain a good
indication of the possible
rehabilitation costs through
discussions with these managers,
as well as reference to the
technical reports that they have
undertaken or commissioned.
However, it is sometimes the case
that there will be a conflict of
interest between environmental
management and financial
management. Financial
managements aim is to ensure

PAGE 23 maximum profits and shareholder value, whereas the environmental management will try to ensure optimal environmental responsibility.

Should there be a lack of knowledge or awareness of environmental obligations and the requirements of the international accounting standards, the danger exists that financial management can inappropriately overrule environmental management when assessing the liability for disclosure in the financial statements. Financial auditors should therefore take care to ensure that this does not occur.

PAGE 24

Environmental Management
Programme Reports
Mining companies in South Africa
are required to have an approved
Environmental Management
Programme Report (EMPR), which
serves as the legal basis for
estimating and providing for
environmental liabilities for mines
in terms of closure cost. Part Six
of the EMPR, which focuses on
mine closure, requires the mine to
indicate its closure activities,
which would normally include
costs, and activities to comply
with the environmental legislation.
The EMPR seldom contains all
relevant information on
environmental liabilities, but
remains a useful reference point.
ISO 14001
There is generally a misconception
that, when an entity has been
certified to the ISO 14001
Environmental Management
Systems standard, there is no
environmental liability or that the
liability has been properly
quantified. ISO 14001 is only an
environmental management tool
and in no way serves as a
guarantee that environmental
liabilities have been identified,
quantified and are being
adequately addressed.
Nevertheless, a good
environmental management
system will provide a useful basis
for addressing environmental
liabilities, through elements like
the complaints register, legal
register, aspects and impacts
register and external audits.

Paying for the past, providing for the future

Foreign entities A number of South African companies have subsidiaries or joint venture in other countries. The environmental legislation in many of these counties, especially in Africa, may not require any environmental rehabilitation. However, the existence of a corporate environmental policy at a holding company level creates a constructive obligation to ensure that the policy commitments are adhered to in all subsidiaries, irrespective of the country in which the operations occur.

Paying for the past, providing for the future

PAGE 25

SECTION 6

The South African legal perspective

THE SOUTH AFRICAN LEGAL PERSPECTIVE Legal developments With the coming into being of the Constitution of South Africa Act 108 of 1996 (the Constitution), the legal landscape of South Africa was profoundly altered. From being essentially state-centred in orientation, our law is now firmly human rights based. Significantly, South Africas Constitution is one of only a few constitutions in the world that entrenches a right to a healthy environment in its Bill of Rights.

To give effect to this right, the Constitution places an obligation on government to enact legislation that prevents pollution, promotes conservation, and secures ecologically sustainable

PAGE 26

development and use of natural resources. 1 Not only do recently enacted environmental laws reflect these changes, but constitutional provisions have enhanced the ability of affected persons to seek redress from the courts should non-compliance with these environmental enactments be shown to have occurred.

and other concerned citizens
wishing to take court action in
respect of environmental
transgressions. Section 38 of the
constitution has significantly
widened the ambit of persons who
may seek redress in respect of an
infringement of any right in the Bill
of Rights, including their
environmental rights.

Thus, for example, the common law requirements pertaining to legal standing upon which an aggrieved person may approach a competent court to seek relief have been relaxed significantly. 2 Traditionally, one had legal standing or locus standi, if he or she were able to show a personal interest in the matter before court. This represented a major obstacle for non-government organizations

This now includes: anyone acting as a member of, or in the interests of, a group of persons; anyone acting in the public interest; and an associate acting in the interests of its members. The National Environmental Management Act 107 of 1998 (NEMA) has further extended legal standing to enforce environmental laws to include, inter alia, any person or group of persons acting in the interests of

Paying for the past, providing for the future protecting the environment. 3 In the past another factor that has tended to inhibit persons instituting legal proceedings against financially powerful institutions has been the question of the legal costs, not only in respect of launching civil proceedings, but also in respect of a possible negative cost order being awarded against one should the application or action fail, which is customary in civil litigation.

Again, recent legislative intervention has radically redefined the issue of costs in respect of environmental litigation: In situations where any person or group of persons, acting in the interest of protecting the environment, institutes legal

Paying for the past, providing for the future

proceedings but fails to secure the relief sought, a court may decide not to award costs against such a person or group of persons if, in the opinion of the court, the persons or group of persons acted reasonably and out of due concern for the public interest or in the interests of protecting the environment. 4

NEMA further allows for attorneys and advocates providing free legal assistance to such litigants to make application to be awarded legal costs in instances where the relief sought has been successful. 5 What this means is that legal assistance can be elicited from experts and professionals by poor or indigent persons to pursue litigation for environmental degradation through the highest courts in the land, if need be, free from financial constraints. Another important constitutional right is the right is to access to information, which applies to anyone wishing to gain access to information held by the state or private person, for the exercise or protection of any right, including the environmental right. 6 The right of access to information has been given effect in NEMA 7 and in the coming into operation of the

Promotion of Access to Information Act 2 of 2000. It is now possible for anyone who can show that their right to a healthy environment is being, or may be, infringed upon, to apply to a private company for records of information which would otherwise be considered privileged.

PAGE 27

Companies may now be compelled to divulge information which might confirm poor environmental practices. Hence they may be exposed to financial risk not only in so far as the embarrassment that would be caused by disclosure and the accompanying loss of image in the market place, but also by way of confirming legal liability.

These statutory developments reflect a growing public awareness regarding the impacts that human and industrial activity is having on the environment and communities. For this reason companies are increasingly coming under public scrutiny to comply with the law. It is thus crucial that corporate entities become aware of their legally defined responsibility

PAGE 28

towards the environment and the potential legal liabilities they expose themselves to should they fail to act in accordance with this responsibility.

Legal Liabilities The body of law in South Africa referred to as environmental law is fairly extensive and complex. For this reason, liability can arise in different ways. It has been cogently argued that it is useful to group environmental liability into three categories: criminal liability, civil liability and ecological liability. 8

Criminal Liability
Criminal liability may arise in
common law as a result of a
commission of a common law
offence. However, criminal liability
pertaining to environmental
transgressions are created under
statute. Statutory provisions may
require that authority be obtained
before an activity may commence.
For example, the provisions of
Section 22 of the Environment
Conservation Act 73 of 1989,
states that no person shall
undertake an activity identified in
terms of the Act without the
written authority of the Minister.

A failure to comply with this administrative requirement is an offence. On the other hand, liability may arise as a result of a violation of a statutory duty not to cause degradation or pollution. For example Section 151 (1) of the National Water Act 36 of 1998, makes it an offence to intentionally or negligently perform an act or

Paying for the past, providing for the future omission which pollutes a water resource.

The penalties for contraventions of these statutory offences were once considered by many not to be sufficiently severe to warrant serious consideration. However, this is certainly no longer true, if indeed it ever was. It is not only the prescribed penalty that must be considered, but also the further financial ramifications that may possibly flow on conviction.

For example a contravention of Section 151(1) under the National Water Act may not only result in the penalties set out in the subsection, but entitles the court on written request from a person who suffered harm as a result of the contravention, or from

Paying for the past, providing for the future

the Minister in respect of the damage caused to a water resource, to enquire into the harm or damage, make a determination in respect thereof, and award damages or order the accused to pay for the cost of any remedial action.

Company directors, employers and employees are subject to personal liability under South Africas environmental laws. In terms of NEMA, any person who is or was a director of a firm at the time of the commission by that firm of any offence under any provision listed in Schedule 3 of the Act, is guilty of the offence, if the offence in question resulted from the failure of the director to take all reasonable steps that were necessary under the circumstances to prevent the commission of the offence. Similar provisions apply to employers, managers, agents or employees.

Furthermore, a court hearing the criminal matter may enquire into the assessment of loss and award damages in accordance thereto. The offences listed in Schedule 3 include those created in terms of most of the countrys important environmental statutes. Similarly, in terms of the Company Act 16 of 1973, a director can be removed from office in situations where the company has been found guilty of an offence and in addition, be sentenced to pay a fine or undergo imprisonment.

PAGE 29

Civil Liability Civil liability arises out of duties and obligations created under the common law but, unlike criminal liability, falls into the realm of private law. In essence, there are no separate duties and obligations specific to the environment in private law.

Instead, there is the principle that all persons owe a duty of care not to perform an act, or omit to act, the consequence of which would be the creation of a nuisance, or harm to another. The most important remedies one has in civil law, in so far as corporate environmental liabilities are concerned, are the application for an interdict, and the invitation of civil action for damages. One can make application for an interdict

PAGE 30

either by asking the court to compel a respondent company to do something, or to refrain from an activity that is likely to cause harm to the applicant. In environmental terms, an interdict could be applied to stop a polluting activity causing a nuisance. 9

An action for damages is instituted
when the defendant company has
caused the plaintiff damage,
whether to his or her person or
property. Thus the action for
damages remedy would cover
instances where a person has
suffered disease or injury, or
damage to property, or has
suffered damages due to the death
of a relative caused by the
wrongful actions of the defendant.
Although there are set
requirements that must generally be proved to succeed in an action for damages, including fault in the form of intention or negligence on the part of defendant, the law has moved in the direction of holding persons strictly liable for environmental harm.
Thus a plaintiff may not be
required to show that the
defendant acted with intent or was
negligent in causing the
environmental harm complained
of. In other words, fault becomes
irrelevant and one only need prove
that a wrongful act caused the
loss. 10 This issue is further
discussed below in terms of
ecological liability.

Recent developments in the law flowing from provisions in the Constitution discussed previously,

Paying for the past, providing for the future such as the extension of standing to institute actions, the question of legal costs, and access to information provisions, have significantly increased the likelihood of civil action being instituted against companies in respect of environmental degradation causing harm.

Ecological liability Ecological liability will not, as pointed out by Sampson, be found in legal textbooks, but it is a category of liability that fits somewhere between criminal and civil liability and has features common to both. 11 It is a useful category because of the fact that environmental liability often extends further than to direct harm to humans. Environmental degradation may well have a direct

Paying for the past, providing for the future

bearing on a persons health, but may also result in the deterioration of the general quality of the environment, damage to ecosystems, and loss of flora and fauna. 12 In essence, the distinction can be made that ecological liability would pertain to costs of clean up and rehabilitation of the environment.

NEMA imposes a duty on persons who cause, have caused or who may cause significant pollution or degradation of the environment to take reasonable measures to prevent such pollution or degradation from occurring, continuing or recurring. If such harm to the environment is authorised by law or cannot reasonably be avoided or stopped, one is then obligated to minimise such harm and to rectify such pollution or degradation to the environment. 13 Where harm has been caused, it is likely that reasonable measures referred to would include clean up and rehabilitation.

The Act further provides that the Director General may issue a directive to persons or parties responsible for pollution or degradation to remediate the pollution or degradation. Should no action be taken, the Director General has the authority to carry out all necessary measures and to claim costs from various categories of persons, including the landowner and successors-in-title. 14

The list of responsible parties
include several people who would

PAGE 31 not necessary have caused the pollution. Thus, for example, a person may have bought a property, and hence become a successor in title after the pollution had occurred. It may also include parent companies of subsidiaries.

This would obviously have a direct bearing on a financial institution, which has security over a contaminated property in terms of a loan. If on default the financial institution forecloses on the property, the financial institution becomes the owner and a responsible party, which the Director General may hold responsible for clean up.

feature of ecological liability. In other words, a landowner, for example, may be held liable for costs of remediation or clean up in respect of pollution, which was caused many years before the landowner took possession of the property. Obviously, the financial ramifications for a company finding itself in this position could be significant, considering the potential scope of the liability and the associated costs. This makes environmental due diligence, as discussed in another section of this report, critical.

Both NEMA and the National Water Act provide for historical liability, which is another unique

PAGE 32

Paying for the past, providing for the future

SECTION 7

Conclusion

CONCLUSION Government departments have their own requirements and objectives in considering environmental liabilities. These requirements are all unique to the various departments but the main objective is the same, namely to promote and regulate responsible care of the environment. Due diligence studies relating to environmental liabilities are very similar to the approach of financial audits.

In both cases, the objective is to obtain a fair presentation of the financial position of an organisation, where environmental issues may have a material impact. IAS 37 on Provisions, Contingent Liabilities and Contingent Assets

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is one of the most significant drivers in requiring environmental liabilities to be disclosed in the financial statements of organisations.

This is supported by various other statements, like IAS 16 and IAS 2, that should be considered in assessing environmental liabilities. IAPS 1010 on The Consideration of Environmental Matters in the Audit of Financial Statements can assist auditors, and the development of good practice, by providing guidance when environmental matters are significant to the financial statements of the entity. The extent to which any of the audit procedures described in this Statement may be appropriate in a particular case requires the exercise of the auditors judgment in the light of the requirements of the ISAs and the circumstances of the entity.

Over the past few years environmental legislation has become more stringent in South Africa and has introduced the scope for considerable environmental liabilities to be imposed on industry. A clear understanding of these risks is therefore essential for ensuring responsible business practice in the future.

PAGE 33

Annexure A

Annexure A The Association of Chartered Certified Accountants (ACCA) ACCA is the largest, fastest growing, global professional accountancy body, with nearly 300,000 members and students in 160 countries. ACCA headquarters is in London and it has 34 staffed offices and 34 active centres around the world.

PAGE 34

ACCA launched the worlds first
environmental reporting award
scheme in 1990. Since then ACCA
has continued to raise awareness
of environmental and social
reporting amongst the finance and
business communities, and has
contributed to the CSR debate
through its involvement with the
Global Sustainability Reporting
Initiative, the UN UNCTAD
environmental accounting
programme and the Sustainability
working party of the European
Federation of Accountants.
Further information on ACCA is
available on ACCAs website,
www.accaglobal.com/sustainability

Paying for the past, providing for the future

Annexure B

Annexure B KPMG Sustainability Services KPMG Sustainability Services is a network of professionals specialising in the areas of environment, health, safety, ethics, social accountability and certification, within KPMGs global framework of advisory and assurances services.

The Global Sustainability Network contains over 300 professionals in 27 countries. This extensive and multi-skilled resource provides our clients with a spectrum of advisory and assurance services. Through the network the various KPMG offices are able to provide support, share, compare and enhance the communication within KPMG. Our emphasis is on embedding sustainability criteria into

Paying for the past, providing for the future

organisations existing strategic processes, management systems, performance measurement and reporting practices. The benefits of this approach are a reduction in organisational risks and potential liabilities, enhancement of management effectiveness and business performance, and improvement in stakeholder relations and public reputation.

For more information, please
contact:
Mark Schonken
Sustainability Services
Phone + 27 (0)11 647 7878
Fax + 27 (0)11 484 0534
Mobile + 27 (0)83 456 5873
Email mark.schonken@kpmg.co.za
Web www.kpmg.co.za
S 24 (b).
S 38.
3
S 32.
4
S 32 (2).
5
S 32 (3).
6
S 32.
7
S 31.
8
Environmental legal compliance
audit by Ian Sampson in Ian
Sampson The Guide to
Environmental Auditing in
South Africa (2000) p2-8.
9
See Minister of Health and
Welfare v Woodcarb (Pty) Ltd and
Another 1996 (3) SA 155 (N).
10
See Lascon Properties (Pty) Ltd
v Wadeville Investments Co
(Pty) Ltd and Another 1997 (4)
SA 578 (W).
11
Op sit note 8 at p2-10.
12
Ibid.

S28.
S28(5) to (12).

PAGE 35

The Association of Chartered Certified Accountants

29 Lincolns Inn Fields London WC2A 3EE United Kingdom PAGE 36 (0)20 7396 5900 fax: +44 (0)20 7396 5959 www.accaglobal.com Paying for the past, providing for the future tel: +44