Chapter 4 — Accounting for Asset Retirement Obligations

4.4 Initial Recognition of AROs and ARCs

ASC 410-20

25-4 An entity shall recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. If a reasonable estimate of fair value cannot be made in the period the asset retirement obligation is incurred, the liability shall be recognized when a reasonable estimate of fair value can be made. If a tangible long-lived asset with an existing asset retirement obligation is acquired, a liability for that obligation shall be recognized at the asset’s acquisition date as if that obligation were incurred on that date.

25-5 Upon initial recognition of a liability for an asset retirement obligation, an entity shall capitalize an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability. Paragraph 835-20-30-5 explains that capitalized asset retirement costs do not qualify as expenditures for purposes of applying Subtopic 835-20.

Entities are required to recognize the fair value of a liability for an ARO in the period in which it is incurred if a reasonable estimate of fair value can be made. The determination of when an ARO liability is incurred depends on the underlying facts and circumstances that create the obligation. Entities should evaluate the facts and circumstances underlying each individual ARO when determining the appropriate period for recognition. If a reasonable estimate of fair value cannot be made, recognition should occur when a reasonable estimate of fair value can be made. An obligation to perform asset retirement activities is unconditional, and an ARO should be measured and recognized regardless of whether (1) there is uncertainty about the timing or method of settlement or (2) such timing and method of settlement are conditional on a future event. Entities would factor this uncertainty into the measurement of the fair value of the ARO by using an expected present value technique. Significant judgment will often be required in the determination of whether sufficient information is available to measure the fair value of an ARO.

ASC 410-20-25-6 states that sufficient information exists to reasonably estimate the fair value of an ARO in the following situations:

When it is evident that the fair value of the ARO has been included in the purchase price of the asset.
When an active market exists for the transfer of the ARO to a third party.
When there is sufficient information to apply an expected present value technique.3

ASC 410-20-25-8 expands on the last situation above by discussing the circumstances in which an entity would have sufficient information to apply an expected present value technique. Specifically, sufficient information would exist in either of the following circumstances:

When “the settlement date and method of settlement for the obligation have been specified [in] the law, regulation, or contract that gives rise to the [ARO].”
When information is available to reasonably estimate (1) the “settlement date or the range of potential settlement dates,” (2) the “method of settlement or potential methods of settlement,” and (3) the “probabilities associated with the potential settlement dates and potential methods of settlement.”

With respect to the second circumstance above, ASC 410-20-25-11 indicates that to estimate potential settlement dates, potential methods of settlement, and the related probabilities, an entity should consider the following:

Entity’s past practice — At what point and how often have similar assets been retired in the past? What method was used to retire them?
Industry practice — At what point and how often have the entity’s competitors retired similar assets? What methods did the entity’s competitors use to retire them?
Management’s intent — Is there a plan to retire or dispose of the asset?
Estimated economic life — What is the asset’s estimated economic life? Does management plan on maintaining the asset to extend its estimated economic life? Will technological advances render the asset obsolete before the end of its economic life?

Connecting the Dots

Entities would typically have sufficient information to estimate a range of potential settlement dates, the potential methods of settlement, and the related probabilities on the basis of an analysis of the factors listed above. It would not be appropriate for an entity to delay recognition of the liability merely on the basis that management does not intend to perform the asset retirement activities in the foreseeable future. ASC 410-20-25-8 clarifies that the timing of liability recognition under ASC 410-20 should not be based on when the retirement activities are probable of being performed; rather, any uncertainty with respect to timing of settlement should be incorporated into the measurement of the obligation.

An entity that believes that it lacks sufficient information to reasonably estimate the fair value of an ARO liability must have evidence to support that assertion. For example, evidence may include a history of indefinitely extending the economic lives of other long-lived assets that are the same as or similar to the assets under the related ARO by regularly repairing and maintaining the assets. In the rare circumstances in which sufficient information does not exist, an entity must disclose that fact and the reasons why an estimate could not be made, in accordance with ASC 410-20-50-2.

Under ASC 410-20-25-6, an entity is also required to identify all AROs. Therefore, it would be inappropriate for an entity to assert that the information to reasonably estimate fair value is insufficient simply because a thorough inventory of existing AROs has not been compiled.

ASC 410-20-25-8 also addresses uncertainty with regard to estimating a range of potential cash flows associated with the AROs identified by an entity. Generally, it would be inappropriate for an entity to assert that the information to reasonably estimate fair value is insufficient because of uncertainty about the costs of performing the asset retirement activities. This is supported by paragraph B23 of the Background Information and Basis for Conclusions of FASB Interpretation 47 (an interpretation of FASB Statement 143, which is the primary guidance codified in ASC 410-20), which states, in part:

The Board concluded that an entity would generally have the ability to estimate a range of potential cash flows based on the current costs to perform the asset retirement activities under different methods of settlement that are currently available to the entity.

If an entity believes that sufficient information does not exist to reasonably estimate the fair value of an ARO, it should consider consulting with its accounting advisers and independent auditors to ensure the appropriateness of that conclusion.

As required by ASC 410-20-25-5, upon initial recognition of an ARO, entities should capitalize an ARC by (1) increasing the carrying value of the related tangible long-lived asset by the same amount as the liability or (2) recording a new long-lived asset to be depreciated over the remaining useful life of the related tangible long-lived asset. See Chapter 5 for additional industry considerations (e.g., the account debited for regulated utilities). The example below illustrates the accounting entry to record upon initial recognition of an ARO.

Example 4-1

Initial Recognition of ARO Liability

Company ABC has a new long-lived asset with an estimated useful life of 15 years. The ARO is calculated at acquisition, and the undiscounted cash flows in year 15 are determined to be $75,000. The present value of the ARO at acquisition is $22,060, which is based on a discount rate of 8.5 percent, the risk-free rate as adjusted for ABC’s credit standing. Company ABC would initially record the following journal entry to reflect this ARO:

Over the 15-year useful life, ABC will depreciate the recorded cost of the asset and accrete the liability each year by using the rate of 8.5 percent determined at acquisition. In addition, ABC will record a debit to depreciation expense and a credit adjustment to the capitalized ARC. The accretion will result in recording a debit to operating expense (i.e., accretion expense) and a credit to the ARO liability. After 15 years, provided that there are no changes to ABC’s initial assumptions, the total capitalized ARC should be $0, and the total ARO liability balance should be $75,000.

Footnotes

An entity should consider the guidance in ASC 820-10-55-4 through 55-20 on appropriate valuation techniques.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.