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Accounting for Pollution Expenditure

Phil Mickelson Company operates several plants at which limestone is processed into quicklime and hydrated lime. The eagle ridge plant, where most of the equipment was installed many years ago, continually deposits a dusty white substance over the surrounding countryside. Citing the unsanitary condition of the neighboring community of scales mound, the pollution of the Galena River, and the high incidence of lung disease among workers of eagle ridge, the State's Pollution Control Agency has ordered the installation of air pollution control equipment. Also, the agency has assessed a substantial penalty, which will be used to clean up Scales Mound.

After considering the cost involved (which could not have been reasonable estimated prior to the agencies actions), Phil Mickelson Company decides to comply with the agency's orders, the alternative being to cease operations at Eagle Ridge at the end of the current fiscal year. The officers of Mickelson agree that the air pollution control equipment should be capitalized and depreciated over its useful life, but they disagree over the period(s) to which the penalty should be charged.

Instructions:
Discuss the conceptual merits and reporting requirements for accounting for the penalty in each of the following ways.

1. As a charge to the current period
2. As a correction of prior periods
3. As a capitalizable item to be amortized over future periods

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Below are my answers.

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Anna Liza Gaspar

ANSWERS

Way 1
Since the penalty cost could have not been estimable in prior years and the possibility that the company would really be penalized in prior years was at best possible, the generally accepted accounting principle is to ...

Solution Summary

This solution answers questions regarding conceptual merits and reporting requirements for accounting for penalties.

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