BGH » Topics » Critical Accounting Policies

This excerpt taken from the BGH 10-K filed Mar 16, 2009.

Critical Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to select appropriate accounting principles from those available, to apply those principles consistently and to make reasonable estimates and assumptions that affect revenues and associated costs as well as reported amounts of assets and liabilities. The following describes the estimated risks underlying BGH’s critical accounting policies and estimates:

 

Depreciation Methods and Estimated Useful Lives of Property, Plant and Equipment

 

Property, plant and equipment is recorded at cost. Approximately 68.7% of BGH’s consolidated assets consist of property, plant and equipment such as pipeline and related transportation facilities, land, rights-of-way, buildings, leasehold improvements and machinery and equipment. The most significant of these assets are pipelines and related facilities, which, consistent with industry practice, are generally depreciated on a straight line basis over an estimated useful life of 50 years. Depreciation is the systematic and rational allocation of an asset’s cost or fair value, less its residual value (if any), to the periods it benefits. Straight line depreciation results in depreciation expense being incurred evenly over the life of an asset.

 

The determination of an asset’s useful life requires assumptions regarding a number of factors including technological change, normal depreciation and actual physical usage. If any of these assumptions subsequently change, the estimated useful life of the asset could change and result in an increase or decrease in depreciation expense that could have a material impact on our financial statements.

 

At December 31, 2008 and 2007, the net book value of BGH’s consolidated property plant and equipment was $2.2 billion and $1.8 billion, respectively. Depreciation expense was $47.4 million and $39.6 million for the years ended December 31, 2008 and 2007, respectively. BGH does not believe that there is a reasonable likelihood that there will be a material change in the future estimated useful life of these assets. In the past, BGH has generally not deemed it necessary to materially change the depreciable lives of its assets. However, a 10% reduction in the depreciable life of these assets, for example, from 50 to 45 years for pipelines and related assets, would increase annual depreciation expense, and reduce operating income by approximately $5.0 million annually.

 

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Reserves for Environmental Matters

 

As discussed under “Environmental Matters” above, Buckeye is subject to federal, state and local laws and regulations relating to the protection of the environment. Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to existing conditions caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or clean-ups are probable, and the costs can be reasonably estimated based upon past experience and advice of outside engineering, consulting and law firms. Generally, the timing of these accruals coincides with Buckeye’s commitment to a formal plan of action. Accrued environmental remediation related expenses include estimates of direct costs of remediation and indirect costs related to the remediation effort, such as compensation and benefits for employees directly involved in the remediation activities and fees paid to outside engineering, consulting and law firms. Historically, Buckeye’s estimates of direct and indirect costs related to remediation efforts have generally not required material adjustments. However the accounting estimates relative to environmental matters are uncertain because (1) estimated future expenditures related to environmental matters are subject to cost fluctuations and can change materially, (2) unanticipated liabilities may arise in connection with environmental remediation projects and may impact cost estimates, and (3) changes in federal, state and local environmental regulations can significantly increase the cost or potential liabilities related to environmental matters. Buckeye maintains insurance which may cover certain environmental expenditures. During 2008, 2007 and 2006, Buckeye incurred environmental related operating expenses, net of insurance recoveries, of $10.1 million, $7.4 million and $6.2 million, respectively. At December 31, 2008 and 2007, Buckeye had accrued $27.0 million and $22.7 million, respectively, for environmental matters.  The environmental accruals are revised as new matters arise, or as new facts in connection with environmental remediation projects require a revision of estimates previously made with respect to the probable cost of such remediation projects. Changes in estimates of environmental remediation for each remediation project will affect operating income on a dollar-for-dollar basis up to Buckeye’s self-insurance limit. Buckeye’s self-insurance limit is currently $3.0 million per occurrence.

 

Fair Value of Derivatives and Fixed-Price Sales Contracts

 

The Energy Services segment primarily uses exchange-traded petroleum futures contracts to manage the risk of market price volatility on its refined petroleum product inventories and its fixed-price sales contracts. The Energy Services segment has elected not to use hedge accounting with respect to its fixed-price sales contracts. Therefore, its fixed-price sales contracts and the related futures contracts used to offset those fixed-price sales contracts are all marked-to-market on Buckeye’s balance sheet with gains and losses being recognized in earnings during the period.  As a result, the valuations associated with these derivative instruments, including the fixed-price sales contracts, have a material impact on net income.  At December 31, 2008, BUCKEYE included in its financial statements as assets fixed-price sales contracts with values of approximately $78.4 million.  These fair values resulted from the increasingly large differences between the fixed-prices called for in the sales contracts and current prices available in spot markets. Offsetting the value of these fixed-price sales contracts were futures contracts with values of approximately $50.8 million which were recognized as liabilities.  Buckeye has determined that the exchange-traded futures contracts represent Level 1 fair value measurements, as described in Statement of Financial Accounting Standards No. 157 — “Fair Value Measurements” (“SFAS 157”) because the prices for such futures contracts are established on liquid exchanges with willing buyers and sellers and with prices which are readily available on a daily basis.

 

Buckeye has determined that the fixed-price sales contracts represent Level 2 fair value measurements under SFAS 157 because their value is derived from similar contracts for similar delivery and settlement terms which are traded on established exchanges.  However, because the fixed-price sales contracts are privately negotiated with customers of the Energy Services segment who are generally private companies that do not have credit ratings established by nationally recognized ratings agencies, the determination of an adjustment to fair value to reflect counterparty credit risk (a “credit valuation adjustment”) requires significant management judgment.  At December 31, 2008, due to a credit valuation adjustment, Buckeye had reduced the fair value of the fixed-price sales contracts by $0.6 million to reflect this counterparty credit risk.  The delivery periods for the contracts range from one to 14 months, with the substantial amount of deliveries concentrated in the first four months of 2009.

 

Because little or no public credit information is available for the Energy Services segment’s customers who have fixed-price sales contracts, Buckeye specifically analyzed each customer and contract to evaluate (i) the historical payment patterns of the customer, (ii) the current outstanding receivables balances for each customer and contract and (iii) the level of performance of each customer with respect to volumes called for in the contract.  Buckeye then evaluated the specific risks and expected outcomes of nonpayment or nonperformance by each customer and contract.  Based on its credit and performance risk evaluation, Buckeye recorded the credit valuation adjustment of $0.6 million.  If actual customer performance under these fixed-price sales contracts deteriorates (either through nonperformance with respect to contracted volumes or nonpayment of amounts due), then the fair value of these contracts could be materially less.  For example, a one percent shortfall in delivered volumes over the average life of the contracts would reduce the fair value of the contracts and, accordingly, net income, by $0.8 million.  Buckeye continues to monitor and evaluate performance and collections with respect to these fixed-price sales contracts.

 

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Accounting for Goodwill and Assessment of Goodwill Impairment

 

       BGH’s goodwill balance at year-end 2007 of $234.6 million related primarily to BGH’s acquisition of the entity that controlled the general partner interests in Buckeye.   The amount of reported goodwill increased to $433.9 million at year-end 2008 substantially as a result of Buckeyes’ acquisition of Lodi Gas, Farm & Home and the ethanol and petroleum products terminal in Albany, New York.  The initial recording of goodwill resulted from management’s allocation of the purchase price of these businesses to the assets acquired and liabilities assumed, as required under Statement of Financial Accounting Standards No. 141 — Business Combinations (“SFAS 141”).  The application of SFAS 141 requires that the total purchase price be allocated to the fair value of the assets acquired and the liabilities assumed based on an assessment of their fair values at the acquisition date, with amounts exceeding the fair values being recorded as goodwill.

 

           Under Statement of Financial Accounting Standards No. 142 — “Goodwill and Other Intangible Assets” (“SFAS 142”), goodwill and other indefinite-lived intangible assets are not amortized but are reviewed annually for impairment.  Intangible assets that have finite useful lives are amortized over such useful lives.  As a result, significant management judgment is required in the determination of the fair values of the assets acquired and the liabilities assumed, including the determination if any intangible assets have been acquired and, if so, if such intangible assets have definite or indefinite useful lives.  For intangible assets that are not indefinite, additional judgment is required in assessing such intangible asset’s estimate useful life.

 

           Subsequent to the initial recording of goodwill, SFAS 142 requires management, at least annually, to assess goodwill for impairment using a two-step methodology.  The initial step requires management to determine the fair value of each of its reporting units and compare it to the carrying value, including goodwill, of the reporting unit.  If the fair value exceeds carrying value, no impairment loss is recognized.  However, a carrying value that exceeds fair value may be an indication of impaired goodwill.  The amount, if any, of the impairment would then be measured and an impairment loss would be recognized.  The impairment testing performed annually on January 1 has resulted in the determination that no impairment had been incurred in 2008, 2007 or 2006.

 

            The determination of whether goodwill is impaired is based on management’s estimate of the fair value of Buckeye’s reporting units at each measurement date compared to their carrying values.  In the 2008 impairment test, Buckeye utilized industry-specific multiples of EBITDA to determine the terminal values of each of its reporting units.  These multiples require significant management judgment applied to each reporting unit.  Management used EBITDA multiples that it believed were reasonable based on its experience in the acquisition of similar assets in the context of current market conditions.   In the determination of estimated useful lives of intangible assets with finite lives, management considered relevant factors of useful life including, with respect to customer intangibles, the historical attrition rates for each customer.

 

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