Impact of environmental regulation on financial reporting of pollution activity: A comparative study of U.S. and Canadian firms

Business firms are under scrutiny to provide accurate environmental reporting, including capital costs and operating expenses concerning pollution. Environmental reporting is incorporated into annual financial reports as well as specialized environmental reports. The extent or value of such information is an appropriate subject for accounting research. This study investigates environmental reporting in audited financial statements of U.S. and Canadian firms prior to SOP 96-1, to determine whether environmental regulation starting with SOP 96-1 was needed. One would expect that environmental information would be useful to shareholders and others in assessing the environmental risk exposure of a firm. The key question addressed by this study is whether a firm’s reported environmental information (environmental capital costs and environmental operating costs) actually reflects the firm’s pollution. The findings suggest that many firms were failing either to record or to fund necessary environmental expenditures, and therefore, may have significant amounts of unrecorded future environmental obligations. As a result, the accounting guidance provided by FASB, starting with SOP 96-1, was appropriate for enhancing financial reporting regarding environmental matters.