Chapter 4 — Accounting for Asset Retirement Obligations
Chapter 4 — Accounting for Asset Retirement Obligations
4.1 Introduction
This chapter provides an overview of the accounting and disclosure
requirements for AROs in ASC 410-20, along with certain interpretive guidance on
applying the scope, initial recognition, initial measurement, and subsequent
measurement provisions of this accounting guidance. Chapter 5 then provides examples of AROs commonly encountered in
certain industries, along with a discussion of accounting and financial reporting
issues that companies in those industries commonly encounter when accounting for
such AROs.
4.2 Overview of ASC 410-20
ASC 410-20 provides the relevant guidance on accounting for AROs and generally applies to “[l]egal
obligations associated with the retirement of a tangible long-lived asset that result from the acquisition,
construction, or development and (or) the normal operation of a long-lived asset” (ASC 410-20-15-2).
An ARO is recognized when incurred if a reasonable estimate of fair value can be made, and it should
be initially measured at fair value. If its fair value cannot be reasonably estimated, the ARO should be
recognized when a reasonable estimate of fair value can be made. Uncertainty about the timing of
settlement of the ARO does not affect ARO recognition but will affect measurement of the ARO.
When initially recognizing an ARO, an entity should capitalize the ARC by
increasing the long-lived asset’s carrying value
by the same amount as the ARO. Subsequently,
changes to the ARO should be recognized for
changes due to the passage of time (accretion of
the ARO) and revisions to either the timing or the
amount of the original estimate of cash flows used
for measuring the fair value of the liability. The
entity should recognize changes due to the passage
of time as an operating expense and an increase to
the ARO by applying an interest method allocation
to the ARO at the beginning of the period, using
the credit-adjusted risk-free rate at the time the
initial ARO was recognized and measured. Changes
in subsequent measurement of the ARO resulting
from revisions to the estimated timing or amount
of cash flows should be recognized as an increase
or decrease in the carrying amount of the ARO and
the related long-lived asset. See Chapter
5 for additional industry
considerations (e.g., the asset that is increased
for regulated utilities). The entity should
measure increases in estimated cash flows by using
the current credit-adjusted risk-free rate
(creating an additional “layer” of the ARO), and
it should measure decreases in estimated cash
flows by using the credit-adjusted risk-free rate
that existed when the ARO was initially
recognized. In addition, the entity should
subsequently recognize as expense (depreciate) the
amount capitalized as part of the cost of the
related long-lived asset by using a systematic and
rational method over the long-lived asset’s
economic useful life.
Application of the guidance in ASC 410-20 can be complex and requires
significant management estimates and judgment. The next sections further discuss the
scope of ASC 410-20 as well as the initial and subsequent recognition and
measurement provisions of this guidance, including some of the practical challenges
that entities may encounter in applying those provisions.
4.3 Scope of ASC 410-20
ASC 410-20
15-2 The guidance in this Subtopic applies to the following transactions and activities:
- Legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, or development and (or) the normal operation of a long-lived asset, including any legal obligations that require disposal of a replaced part that is a component of a tangible long-lived asset.
- An environmental remediation liability that results from the normal operation of a long-lived asset and that is associated with the retirement of that asset. The fact that partial settlement of an obligation is required or performed before full retirement of an asset does not remove that obligation from the scope of this Subtopic. If environmental contamination is incurred in the normal operation of a long-lived asset and is associated with the retirement of that asset, then this Subtopic will apply (and Subtopic 410-30 will not apply) if the entity is legally obligated to treat the contamination.
- A conditional obligation to perform a retirement activity. Uncertainty about the timing of settlement of the asset retirement obligation does not remove that obligation from the scope of this Subtopic but will affect the measurement of a liability for that obligation (see paragraph 410-20-25-10).
- Obligations of a lessor in connection with leased property that meet the provisions in (a). Paragraph 840-10-25-16 requires that lease classification tests performed in accordance with the requirements of Subtopic 840-10 incorporate the requirements of this Subtopic to the extent applicable.
- The costs associated with the retirement of a specified asset that qualifies as historical waste equipment as defined by EU Directive 2002/96/EC. (See paragraphs 410-20-55-23 through 55-30 and Example 4 [paragraph 410-20-55-63] for illustration of this guidance.) Paragraph 410-20-55-24 explains how the Directive distinguishes between new and historical waste and provides related implementation guidance.
Pending Content (Transition Guidance: ASC 842-10-65-1)
15-2 The guidance in this Subtopic applies to the
following transactions and activities:
-
Legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, or development and (or) the normal operation of a long-lived asset, including any legal obligations that require disposal of a replaced part that is a component of a tangible long-lived asset.
-
An environmental remediation liability that results from the normal operation of a long-lived asset and that is associated with the retirement of that asset. The fact that partial settlement of an obligation is required or performed before full retirement of an asset does not remove that obligation from the scope of this Subtopic. If environmental contamination is incurred in the normal operation of a long-lived asset and is associated with the retirement of that asset, then this Subtopic will apply (and Subtopic 410-30 will not apply) if the entity is legally obligated to treat the contamination.
-
A conditional obligation to perform a retirement activity. Uncertainty about the timing of settlement of the asset retirement obligation does not remove that obligation from the scope of this Subtopic but will affect the measurement of a liability for that obligation (see paragraph 410-20-25-10).
-
Obligations of a lessor in connection with an underlying asset that meet the provisions in (a).
-
The costs associated with the retirement of a specified asset that qualifies as historical waste equipment as defined by EU Directive 2002/96/EC. (See paragraphs 410-20-55-23 through 55-30 and Example 4 [paragraph 410-20-55-63] for illustration of this guidance.) Paragraph 410-20-55-24 explains how the Directive distinguishes between new and historical waste and provides related implementation guidance.
ASC 410-20 applies to legal obligations associated with the retirement of a
tangible long-lived asset. The determination of whether a legal obligation exists
should generally be clear and unambiguous. However, ASC 410-20 acknowledges in
defining the term “legal obligation” that such an obligation can be established by
an existing or enacted law, statute, ordinance, or written or oral contract, or in
accordance with the doctrine of promissory estoppel. If an entity makes a promise to
a third party, including the public at large, about its intentions to undertake
asset retirement activities, significant judgment may be required in the
determination of whether the entity has created a legal obligation under the legal
doctrine of promissory estoppel, which is defined as the “principle that a promise
made without consideration may nonetheless be enforced to prevent injustice if the
promisor should have reasonably expected the promisee to rely on the promise and if
the promisee did actually rely on the promise to his or her detriment.”1
The implementation guidance in ASC 410-20-55-2 provides the following example of a legal obligation
that may be established under the doctrine of promissory estoppel:
ASC 410-20
55-2 [A]ssume an entity operates a manufacturing facility and has plans to retire it within five years. Members
of the local press have begun to publicize the fact that when the entity ceases operations at the plant, it plans
to abandon the site without demolishing the building and restoring the underlying land. Due to the significant
negative publicity and demands by the public that the entity commit to dismantling the plant upon retirement,
the entity’s chief executive officer holds a press conference at city hall to announce that the entity will demolish
the building and restore the underlying land when the entity ceases operations at the plant. Although no law,
statute, ordinance, or written contract exists requiring the entity to perform any demolition or restoration
activities, the promise made by the entity’s chief executive officer may have created a legal obligation under the
doctrine of promissory estoppel. In that circumstance, the entity’s management (and legal counsel, if necessary)
would have to evaluate the particular facts and circumstances to determine whether a legal obligation exists.
A company’s past practice also may, but does not necessarily, create a legal
obligation. For example, a utility company may regularly remove and replace utility
poles as part of its normal operations, thereby potentially creating an expectation
that it will continue to do so. This expectation may create a legal obligation based
on the principle of promissory estoppel.2 For rate-regulated entities (such as public utilities), recovery through rates
of future removal costs alone does not create an ARO. However, rate-regulated
entities should review the applicable regulatory proceedings to determine whether a
promise to remove an asset was made for the regulator to approve the recovery of
costs in rates. If such an agreement was made and if the promisee relied on it to
his or her detriment, this may create an ARO through promissory estoppel.
Connecting the Dots
In determining whether an entity has a legal obligation under the notion of promissory
estoppel, entities must work closely with legal counsel to evaluate their own specific facts and
circumstances. When this determination is unclear, entities may wish to obtain a legal opinion to
support their conclusions.
Entities should evaluate the existence of legal obligations on the basis of current laws, regulations,
contractual obligations, and related interpretations and facts and circumstances and should not forecast
changes in laws or interpretations of such laws and regulations. The impacts of changes in laws or
regulations should be considered in the period in which such laws or regulations are enacted.
Connecting the Dots
The enactment date is the date on which all steps in the process for legislation to become law have been completed (e.g., in the United States, the date the president signs the legislation and it becomes law). For rules and regulations issued by federal regulatory agencies to implement enacted U.S. laws, the enactment date is generally the date on which final rules or regulations promulgated by the federal regulatory agency are published in the Federal Register, which may differ from the effective date of such rules or regulations. Entities may need to exercise considerable judgment and obtain the assistance of legal counsel in determining (1) the enactment date of laws and regulations implemented in jurisdictions outside the United States or (2) when regulations issued by governmental agencies to implement and interpret these laws are enacted.
The determination that a legal obligation exists is not affected by expectations
of nonenforcement, or uncertainty about enforcement, of existing laws, regulations,
or contractual provisions by governmental agencies or other third parties. However,
an entity would consider such expectations or uncertainty when measuring an ARO by
using an expected present value technique (see guidance on initial and subsequent
measurement of ARO liabilities in Sections 4.5 and 4.6). An entity may need to use significant judgment when determining
whether it has a legal obligation within the scope of ASC 410-20, and it may be
required to seek input from legal and other professional advisers in making this
determination.
Many component parts of larger systems have special disposal requirements, but there may not be a legal requirement to retire or remove the larger system to which the component parts belong. The costs associated with the legal obligation for disposal of a component part are within the scope of ASC 410-20 even though there is no legal obligation to remove the larger system. However, the cost of the replacement parts and their installation is not included in the measurement and recognition of the ARO. Further, if there is no legal obligation to remove the component part, removal costs would not be within the scope of ASC 410-20; only the disposal costs associated with the obligation to dispose of the contaminated component part, once retired and removed, are within the scope of ASC 410-20. ASC 410-20-55-10 includes the following example of component parts that wear out after a period and are subject to a special (legal) disposal requirement when removed:
ASC 410-20
55-10 [C]onsider an aluminum smelter that owns and operates several kilns lined with a special type of brick. The kilns have a long useful life, but the bricks wear out after approximately five years of use and are replaced on a periodic basis to maintain optimal efficiency of the kilns. Because the bricks become contaminated with hazardous chemicals while in the kiln, a state law requires that when the bricks are removed, they must be disposed of at a special hazardous waste site. The obligation to dispose of those bricks is within the scope of this Subtopic. The cost of the replacement bricks and their installation are not part of that obligation. . . .
4.3.1 Application of ASC 410-20 to Environmental Remediation Liabilities
The scope of ASC 410-20 is limited to those obligations that cannot be realistically avoided, assuming that the asset is operated in accordance with its intended use (i.e., resulting from the normal operation of a long-lived asset). Contamination arising out of “normal” operations generally is expected or predictable, gradual (or occurring over time), integral to operations, or unavoidable and does not require an immediate response. Contamination arising out of improper use of an asset or a catastrophic event is generally unexpected, requires immediate response or reporting, generally could have been controlled or mitigated, and is the result of a failure in equipment or noncompliance with company procedures. If an environmental remediation obligation is the result of the improper operation of an asset or the result of a catastrophic event, it would be subject to the provisions of ASC 410-30 or ASC 450, which address
the accounting for environmental obligations and contingencies, respectively.
See Chapter 1 for further discussion about the determination of whether an environmental remediation
liability is within the scope of ASC 410-20 or ASC 410-30.
4.3.2 Application of ASC 410-20 to Leases
The lease accounting guidance in ASU 2016-02 (codified in ASC 842),
which supersedes the guidance in ASC 840, is effective for public business
entities, as well as certain not-for-profit entities and employee benefit plans,
for fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years.
In June 2020, the FASB issued ASU 2020-05, which defers the
effective dates of ASC 842 for public not-for-profit entities and private
entities. The deferrals apply only if those entities have not yet issued their
financial statements (or made their financial statements available for issuance)
as of June 3, 2020. For public not-for-profit entities that are eligible for a
deferral, ASC 842 is effective for fiscal years beginning after December 15,
2019, and interim periods therein. For private entities that qualify for a
deferral, ASC 842 is effective for fiscal years beginning after December 15,
2021, and interim periods within fiscal years beginning after December 15,
2022.
Most public companies have been accounting for leases under the
new standard. As of the issuance of this Roadmap, many non-PBEs have already
adopted ASC 842. However, some non-PBEs may still be working through the
implementation process since their financial statements for fiscal years ended
after December 15, 2022, may not have been issued.
4.3.2.1 Before the Adoption of ASC 842
ASC 410-20
15-2 The guidance in this Subtopic applies to the following transactions and activities:
a. Legal obligations associated with the retirement of a tangible long-lived asset that result from the
acquisition, construction, or development and (or) the normal operation of a long-lived asset, including
any legal obligations that require disposal of a replaced part that is a component of a tangible long-lived
asset. . . .
d. Obligations of a lessor in connection with leased property that meet the provisions in (a). Paragraph
840-10-25-16 requires that lease classification tests performed in accordance with the requirements of
Subtopic 840-10 incorporate the requirements of this Subtopic to the extent applicable. . . .
15-3 The guidance in this Subtopic does not apply to the following transactions and activities: . . .
e. Obligations of a lessee in connection with leased property, whether imposed by a lease agreement or by
a party other than the lessor, that meet the definition of either minimum lease payments or contingent
rentals in paragraphs 840-10-25-4 through 25-7. Those obligations shall be accounted for by the
lessee in accordance with the requirements of Subtopic 840-10. However, if obligations of a lessee in
connection with leased property, whether imposed by a lease agreement or by a party other than the
lessor, meet the provisions in paragraph 410-20-15-2 but do not meet the definition of either minimum
lease payments or contingent rentals in paragraphs 840-10-25-4 through 25-7, those obligations shall
be accounted for by the lessee in accordance with the requirements of this Subtopic. . . .
ASC 410-20 applies to AROs of a lessor in connection with a leased property. ASC 410-20 also applies
to obligations of a lessee in connection with leased property, regardless of whether imposed by the
lease agreement or by a party other than the lessor, if those obligations do not meet the definition of
either minimum lease payments or contingent rentals under the guidance in ASC 840-10. If the lessee
obligations represent minimum or contingent rentals, they should be accounted for by the lessee in
accordance with ASC 840. As discussed in greater detail below, lessee obligations accounted for under
ASC 410-20 are initially measured at fair value, and uncertainties associated with the likelihood that the
lessor will enforce a lease provision are incorporated into the fair value measurement of the obligation.
Under ASC 840, minimum lease payments affect initial lease classification (operating vs. capital) and
subsequent accounting for leases by the lessee (the measurement of obligations under leases in
accordance with the guidance in ASC 840 is not based on fair value; therefore, any uncertainties
associated with the likelihood that the lessor will enforce a lease provision or require the payments are
not considered in the measurement of the lessee’s obligations under ASC 840).
At times, it may be challenging to distinguish between lessee obligations that meet the definition of
minimum lease payments or contingent rentals and those that do not. In a speech at the 2003 AICPA
National Conference on Current SEC Developments, the SEC staff acknowledged that diversity in practice
exists in accounting for obligations to retire a leased asset. The staff stated in the speech that it generally
has not objected to accounting for such obligations under either ASC 840 or ASC 410-20 as long as the
accounting policy is applied consistently. In addition, the staff indicated in the speech that it believes that
retirement obligations accounted for under ASC 840 should not be treated as contingent rentals since
the staff does not believe that such obligations meet the definition of contingent rentals.
Notwithstanding the views expressed in the SEC staff’s speech, and in the absence of an entity’s
consistently applied accounting policy election, we generally believe that the determination of whether
an obligation to retire (or bear the cost of retiring) a leased asset should be accounted for as a minimum
lease payment or as an ARO is a matter of judgment based on analysis of the relevant facts and
circumstances. ASC 840-10-25-5 defines minimum lease payments from the standpoint of the lessee
as “the payments that the lessee is obligated to make or can be required to make in connection with
the leased property.” Therefore, as a general rule, if the obligation is directly related to the leased asset
or to a component of the leased asset, the lessee should account for the obligation in accordance with
ASC 840. If the obligation either is related to assets (e.g., office equipment, machinery) placed in service
by the lessee at the leased premises or constitutes improvements made to the leased property by the
lessee during the lease term (i.e., leasehold improvements that are owned by the lessee), the lessee
should generally account for the obligation as an ARO in accordance with ASC 410-20.
4.3.2.2 After the Adoption of ASC 842
ASC 410-20
15-2 The guidance in this Subtopic applies to the following transactions and activities:
a. Legal obligations associated with the retirement of a tangible long-lived asset that result from
the acquisition, construction, or development and (or) the normal operation of a long-lived asset,
including any legal obligations that require disposal of a replaced part that is a component of a
tangible long-lived asset. . . .
d. Obligations of a lessor in connection with an underlying asset that meet the provisions in (a). . . .
15-3 The guidance in this Subtopic does not apply to the following transactions and activities: . . .
e. Obligations of a lessee in connection with an underlying asset, whether imposed by a lease or by
a party other than the lessor, that meet the definition of either lease payments or variable lease
payments in Subtopic 842-10. Those obligations shall be accounted for by the lessee in accordance
with the requirements of Subtopic 842-10. However, if obligations of a lessee in connection with
an underlying asset, whether imposed by a lease or by a party other than the lessor, meet the
provisions in paragraph 410-20-15-2 but do not meet the definition of either lease payments or
variable lease payments in Subtopic 842-10, those obligations shall be accounted for by the lessee
in accordance with the requirements of this Subtopic. . . .
ASC 842 does not significantly amend the scope of ASC 410-20 with respect to lessor and lessee AROs.
However, the following additional content is codified in ASC 842:
ASC 842-10
30-7 Paragraph 410-20-15-3(e) addresses the scope application of Subtopic 410-20 on asset retirement
obligations to obligations of a lessee in connection with a lease (see paragraph 842-10-55-37).
55-37 Obligations imposed by a lease agreement to return an underlying asset to its original condition
if it has been modified by the lessee (for example, a requirement to remove a lessee-installed leasehold
improvement) generally would not meet the definition of lease payments or variable lease payments
and would be accounted for in accordance with Subtopic 410-20 on asset retirement and environmental
obligations. In contrast, costs to dismantle and remove an underlying asset at the end of the lease term
that are imposed by the lease agreement generally would be considered lease payments or variable lease
payments.
To the extent that a lessee has agreed to remove modifications it has made to a
leased asset so that it can return the asset to the lessor in the asset’s
original condition (e.g., remove leasehold improvements), estimated future
payments for such work would not be considered a future lease payment. Such
an obligation would be accounted for under ASC 410-20. However, a lessee may
also be required to restore functionality, at the end of the lease term, to
a leased asset that benefits the lessor but not the lessee. The obligation
related to such restorations would be considered a future lease payment and
accounted for under ASC 842. For further discussion, see Sections 6.8 and
6.9.4 of
Deloitte’s Roadmap Leases.
Footnotes
1
See ASC 410-20-20, which cites the definition of promissory
estoppel that is used in Black’s Law Dictionary, seventh edition.
2
Wood utility poles used in certain industries are typically
treated with certain chemicals and, once removed, are subject to special
disposal requirements under existing legislation. In these circumstances,
the special disposal procedures under existing legislation create an ARO for
the disposal of the utility poles once removed, which should be accounted
for under the guidance in ASC 410-20 regardless of whether the removal or
replacement of the utility poles is considered an ARO under the doctrine of
promissory estoppel. See ASC 410-20-55-49 through 55-52.
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
We believe that 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 (an ASC 450 approach); 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
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
3
An entity should consider the guidance in ASC
820-10-55-4 through 55-20 on appropriate valuation
techniques.
4.5 Initial Measurement of AROs and ARCs
ASC 410-20
30-1 An expected present value technique will usually be the only appropriate technique with which to estimate the fair value of a liability for an asset retirement obligation. An entity, when using that technique, shall discount the expected cash flows using a credit-adjusted risk-free rate. Thus, the effect of an entity’s credit standing is reflected in the discount rate rather than in the expected cash flows. Proper application of a discount rate adjustment technique entails analysis of at least two liabilities — the liability that exists in the marketplace and has an observable interest rate and the liability being measured. The appropriate rate of interest for the cash flows being measured shall be inferred from the observable rate of interest of some other liability, and to draw that inference the characteristics of the cash flows shall be similar to those of the liability being measured. Rarely, if ever, would there be an observable rate of interest for a liability that has cash flows similar to an asset retirement obligation being measured. In addition, an asset retirement obligation usually will have uncertainties in both timing and amount. In that circumstance, employing a discount rate adjustment technique, where uncertainty is incorporated into the rate, will be difficult, if not impossible. See paragraphs 410-20-55-13 through 55-17 and Example 2 (paragraph 410-20-55-35). For further information on present value techniques, see the guidance beginning in paragraph 820-10-55-4.
AROs are initially measured at fair value. Given the lack of active markets for the transfer of such
obligations, an expected present value technique will usually be the only appropriate technique with
which to estimate the fair value of an ARO, which entails first estimating probability-weighted expected
cash flows and then discounting such expected cash flows by using a credit-adjusted risk-free interest
rate. ASC 410-20-55-13 provides the following implementation guidance related to the use of an
expected present value technique:
ASC 410-20
55-13 This implementation guidance illustrates paragraph 410-20-30-1. In estimating the fair value of a
liability for an asset retirement obligation using an expected present value technique, an entity shall begin
by estimating the expected cash flows that reflect, to the extent possible, a marketplace assessment of the
cost and timing of performing the required retirement activities. Considerations in estimating those expected
cash flows include developing and incorporating explicit assumptions, to the extent possible, about all of the
following:
- The costs that a third party would incur in performing the tasks necessary to retire the asset
- Other amounts that a third party would include in determining the price of the transfer, including, for example, inflation, overhead, equipment charges, profit margin, and advances in technology
- The extent to which the amount of a third party’s costs or the timing of its costs would vary under different future scenarios and the relative probabilities of those scenarios
- The price that a third party would demand and could expect to receive for bearing the uncertainties and unforeseeable circumstances inherent in the obligation, sometimes referred to as a market-risk premium.
Since 2021, there has been a trend of increasing inflation. Although the effects of
inflation vary by company, recent inflationary trends should be considered in the
measurement of AROs and environmental remediation liabilities.
Measuring the fair value of an ARO requires many significant management
estimates and judgments and poses several practical challenges for preparers of
financial statements. The next section and Section 4.5.2 highlight a few of these
challenges and provide guidance to help preparers address these challenges.
4.5.1 Determining an Appropriate Discount Rate
The credit-adjusted risk-free rate referred to in ASC 410-20-30-1 (reproduced in
Section 4.5) represents
a risk-free interest rate adjusted for the effect of an entity’s credit
standing, taking into consideration the effects of all terms, collateral, and
existing guarantees on the fair value of the liability. Generally, the yield
curve for U.S. Treasury securities, with a maturity matched to the expected
timing of settlement of the ARO, is used to establish the appropriate risk-free
rate for determining the credit-adjusted risk-free rate, even in periods when
yields on U.S. Treasury notes are unusually low. For subsidiaries within a
consolidated group, the discount rate (credit adjustment to the risk-free rate)
should be specific to the entity that owns the long-lived asset to which the ARO
is related and that is legally obligated for the asset retirement activity.
However, the credit adjustment should take into consideration not only the
credit standing of the entity that is legally obligated but also any other
relevant facts, such as parent or brother/sister company guarantees of the
entity’s obligations and other methods of providing assurance that the entity’s
obligations will be paid, such as surety bonds, insurance policies, letters of
credit, guarantees by other (unrelated) entities, or the establishment of trust
funds or identification of other assets dedicated to satisfying the ARO.
When determining the credit adjustment to the risk-free rate, nonpublic entities
should use the same sources of information for determining discount rates that
they use for mark-to-market calculations or determining the incremental
borrowing rates for lease accounting or other purposes. Appropriate sources of
this information for nonpublic entities might include financial institutions,
other lenders, or comparable public companies.
4.5.2 Estimating Cash Flows and Applying an Expected Present Value Technique
The guidance in ASC 410-20-55-13 (reproduced in Section 4.5) includes consideration of a
market risk premium when an expected present value technique is applied.
Accordingly, when an entity performs a marketplace assessment of the cost of
conducting required retirement activities, it must consider and determine a
market risk premium that would be required for a third party to assume the
retirement cost obligations — that is, the premium that a market participant
would demand for bearing the uncertainty associated with the cash flows. If the
entity is currently unable to obtain third-party quotes for the market risk
premium for the specific retirement obligation (e.g., nuclear decommissioning),
it should determine the premium for similar obligations (e.g., fossil plant
dismantlement) and use that market risk premium as a minimum or increase that
minimum to reflect the increased risk associated with the entity’s specific
retirement obligation. Predetermined percentage adjustments to retirement costs
related to contingencies for unspecified additional costs or changes in
estimated costs, which may commonly be used in ARO cost studies, would not be
considered an acceptable third-party market risk premium estimate. Contingency
adjustments should be specific to individual cost components of the estimate and
not universally applied to the overall cost estimate.
Entities often incorporate the use of internal resources into their remediation plans. As previously noted,
the guidance in ASC 410-20-55-13 requires the amounts included in the ARO cash flow estimate to
reflect the costs that a third party would incur to conduct the retirement activities. Therefore, in addition
to internal resources, entities need to consider incremental costs (e.g., overhead, equipment charges,
profit margin) to ensure that the amounts included in the ARO cash flow estimate reflect the costs that a
third party would incur.
Further, estimates for the demolition costs of a long-lived asset may include salvage credits for
materials that can be sold. However, it is not appropriate for an entity to include estimated salvage
credits when estimating expected cash flows to initially measure an ARO. ASC 410-20 applies only to
“retirement” costs. Any estimated salvage value should be considered in connection with the calculation
of depreciation of the related long-lived asset. The asset should be depreciated to reduce the net asset
value so that it equals the estimated salvage value at the end of the asset’s useful life.
In applying an expected present value technique, entities develop cash flow assumptions on the basis
of the various costs that are necessary to achieve the required level of remediation, which will most
likely take into consideration several possible outcomes in terms of total remediation costs required.
They then multiply those outcomes by assigned probabilities, which reflect the estimated likelihood of
occurrence of each potential outcome, to calculate the estimated expected cash flows; the sum of these
estimated expected cash flows constitutes the (undiscounted) ARO under an expected present value technique. Entities need to use significant judgment in both estimating costs (cash flows) for various
possible outcomes and assigning probabilities to the various outcomes. For a rate-regulated entity (such
as a public utility), there may be a single estimate used to calculate the retirement costs that is based on
a level of effort agreed to by a governing body, such as a state utility commission or the Federal Energy
Regulatory Commission.
When an expected present value technique is used, applying the probability
weighting method to several possible cash flow scenarios in the application of
an expected present value technique will almost certainly result in differences
between actual asset retirement cash flows or their timing and the cash flows or
timing incorporated into the initial measurement of an ARO. Further,
incorporating third-party and marketplace assumptions into the estimate of ARO
cash flows and the initial measurement of the ARO will most likely result in the
recognition of gains upon the settlement of the ARO if the entity settles the
obligation by using its own resources. These issues are addressed by the
guidance in ASC 410-20 on subsequent recognition, subsequent measurement, and
derecognition and are further discussed in Sections 4.6.1 through 4.6.3.
4.6 Subsequent Measurement of AROs and ARCs
The subsequent measurement guidance in ASC 410-20-35-1 through 35-8 is reproduced below.
ASC 410-20
Allocation of Asset Retirement Cost
35-1 A liability for an asset retirement obligation may be incurred over more than one reporting period if the
events that create the obligation occur over more than one reporting period. Any incremental liability incurred
in a subsequent reporting period shall be considered to be an additional layer of the original liability. Each layer
shall be initially measured at fair value. For example, the liability for decommissioning a nuclear power plant is
incurred as contamination occurs. Each period, as contamination increases, a separate layer shall be measured
and recognized. Paragraph 410-20-30-1 provides guidance on using that technique.
35-2 An entity shall subsequently allocate that asset retirement cost to expense using a systematic and rational
method over its useful life. Application of a systematic and rational allocation method does not preclude an
entity from capitalizing an amount of asset retirement cost and allocating an equal amount to expense in the
same accounting period. For example, assume an entity acquires a long-lived asset with an estimated life of
10 years. As that asset is operated, the entity incurs one-tenth of the liability for an asset retirement obligation
each year. Application of a systematic and rational allocation method would not preclude that entity from
capitalizing and then expensing one-tenth of the asset retirement costs each year.
35-3 In periods subsequent to initial measurement, an entity shall recognize period-to-period changes in the
liability for an asset retirement obligation resulting from the following:
- The passage of time
- Revisions to either the timing or the amount of the original estimate of undiscounted cash flows.
35-4 An entity shall measure and incorporate changes due to the passage of time into the carrying amount of
the liability before measuring changes resulting from a revision to either the timing or the amount of estimated
cash flows.
35-5 An entity shall measure changes in the liability for an asset retirement obligation due to passage of time
by applying an interest method of allocation to the amount of the liability at the beginning of the period. The
interest rate used to measure that change shall be the credit-adjusted risk-free rate that existed when the
liability, or portion thereof, was initially measured. That amount shall be recognized as an increase in the
carrying amount of the liability and as an expense classified as accretion expense. Paragraph 835-20-15-7
states that accretion expense related to exit costs and asset retirement obligations shall not be considered to
be interest cost for purposes of applying Subtopic 835-20.
35-6 The subsequent measurement provisions require an entity to identify undiscounted estimated cash flows
associated with the initial measurement of a liability. Therefore, an entity that obtains an initial measurement
of fair value from a market price or from a technique other than an expected present value technique must
determine the undiscounted cash flows and estimated timing of those cash flows that are embodied in that fair
value amount for purposes of applying the subsequent measurement provisions. Example 1 (see paragraph
410-20-55-31) provides an illustration of the subsequent measurement of a liability that is initially obtained
from a market price. (See paragraph 410-20-25-14 for a discussion on conditional outcomes.)
35-7 Paragraph 410-20-25-14 explains how uncertainty surrounding conditional performance of a retirement
obligation is factored into its measurement by assessing the likelihood that performance will be required. As
the time for notification approaches, more information and a better perspective about the ultimate outcome
will likely be obtained. Consequently, reassessment of the timing, amount, and probabilities associated with the
expected cash flows may change the amount of the liability recognized. See paragraphs 410-20-55-18 through
55-19.
Change in Estimate
35-8 Changes resulting from revisions to the timing or the amount of the original estimate of undiscounted cash flows shall be recognized as an increase or a decrease in the carrying amount of the liability for an asset retirement obligation and the related asset retirement cost capitalized as part of the carrying amount of the related long-lived asset. Upward revisions in the amount of undiscounted estimated cash flows shall be discounted using the current credit-adjusted risk-free rate. Downward revisions in the amount of undiscounted estimated cash flows shall be discounted using the credit-adjusted risk-free rate that existed when the original liability was recognized. If an entity cannot identify the prior period to which the downward revision relates, it may use a weighted-average credit-adjusted risk-free rate to discount the downward revision to estimated future cash flows. When asset retirement costs change as a result of a revision to estimated cash flows, an entity shall adjust the amount of asset retirement cost allocated to expense in the period of change if the change affects that period only or in the period of change and future periods if the change affects more than one period as required by paragraphs 250-10-45-17 through 45-20 for a change in estimate.
4.6.1 Capitalized ARCs
In subsequently accounting for the ARC capitalized as part of the tangible
long-lived asset to which the ARO is related, an
entity is required under ASC 410-20-35-2 to
allocate that ARC to expense by using a systematic
and rational method over the asset’s useful life,
which generally means that the ARC should be
depreciated along with the related long-lived
asset over the remaining economic useful life of
the asset. However, this guidance does not
preclude an entity from capitalizing an ARC and,
depending on the facts and circumstances related
to the ARO, allocating an equal amount to expense
in the same accounting period.
The examples below illustrate the subsequent recognition of ARCs as an expense
over future periods.
Example 4-2
Company P owns several forests that are used in its production of paper. The company is under legal obligation to plant a tree for each tree it cuts down as part of retiring the asset (i.e., the forest). It plants a replacement tree concurrently with cutting down a tree.
The obligating event (cutting down trees) occurs in the current period
regardless of whether the company plants the new
trees immediately or waits until the end of the
entire forest’s useful life. If the company elects
to plant the replacement tree immediately, the ARO
will equal the current cost of planting the
replacement tree. Since the company elects to
plant the replacement tree in the same period in
which it cuts down a tree, it is appropriate for
the company to allocate an equal amount of the ARC
to expense in the same accounting period.
Example 4-3
A limited-life partnership has been formed to mine minerals for the next 20
years. The partnership is legally responsible for
the reclamation of the mine and the land upon
termination of the partnership (i.e., in 20
years). In accordance with its legal obligation,
the partnership has recorded an ARO and
corresponding ARC for the present value (using 20
years) of the reclamation costs. The useful life
of the mine is expected to extend for 50
years.
Expensing reclamation costs over the life of the partnership is appropriate in this situation. Before the guidance in ASC 410-20 became effective, industry practice for coal mines was to accrue reclamation costs over the life of the mine. In this case, the reclamation costs are required at the end of the partnership agreement. The useful life of the mine is expected to extend beyond the life of the partnership; however, since the partnership is required to perform the reclamation of the mine at the termination of the partnership agreement, the amortization period of the reclamation costs would be limited to the term of the agreement.
Connecting the Dots
In accordance with ASC 360-10-35-17 (which addresses accounting for the
impairment of long-lived assets), an asset
impairment loss is recorded only when the carrying
amount of an asset is not recoverable and exceeds
the asset’s fair value. The carrying amount of a
long-lived asset is not recoverable if it exceeds
the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of
the asset. An impairment loss should be measured
as the amount by which the carrying amount of a
long-lived asset exceeds its fair value. When
performing the impairment calculation, an entity
should include capitalized ARCs in the evaluation
of the asset. However, the estimated future cash
flows related to the ARO should be excluded from
(1) the undiscounted cash flows used to test the
asset for recoverability and (2) the discounted
cash flows used to measure the asset’s fair
value.
Further, in allocating the purchase price to a long-lived asset acquired and the related ARO
assumed in a business combination transaction accounted for under ASC 805, an entity should
measure and record both of the following:
- The ARO based on the fair value of the liability by using the credit-adjusted risk-free rate as of the acquisition date.
- The associated long-lived asset at fair value without considering any future cash outflows associated with the asset retirement activities and without adjustment to add the amount of the ARO.
4.6.2 Changes in an ARO Due to the Passage of Time
An entity is required to measure changes in an ARO due to the passage of time by using the interest
method of allocation. The interest method of allocation requires an entity to use the credit-adjusted
risk-free interest rate it used on the initial measurement date when it recognizes subsequent changes
in the ARO. The amount is recognized as an increase (i.e., a credit) to the ARO, with the offsetting entry
recorded in the income statement. The amount recorded in the income statement must be classified as
an operating item and cannot be classified as interest expense. ASC 410-20-35-5 refers to this expense
as accretion expense.
To calculate the accretion expense, an entity multiplies the ARO balance at the
beginning of the period by the credit-adjusted risk-free rate that existed when
the ARO was initially recognized and, to the extent relevant, the
credit-adjusted risk-free rate(s) from subsequent remeasurements. If an ARO is
to be adjusted for both the passage of time and a revision of the estimated cash
flows, the accretion expense due to the passage of time must be recognized
first.
4.6.3 Changes in the Timing or Amount of Expected Cash Flows
When there is a change in the estimated timing or amount of expected cash flows
of the retirement activity, the carrying amount of
the liability should be adjusted either upward (as
an increase in the ARO) or downward (as a decrease
in the ARO), with the offset recorded as an
increase or decrease in the related capitalized
ARC. To calculate changes in the estimated timing
or amount of expected cash flows that result in
upward revisions to an ARO, an entity should use
its then-current credit-adjusted risk-free
interest rate. That is, the credit-adjusted
risk-free rate in effect when the change occurs
would be used to discount the revised estimate of
the incremental expected cash flows of the
retirement activity. However, if a change in the
estimated timing or amount of expected cash flows
results in a downward revision of an ARO, an
entity should discount the undiscounted revised
estimate of expected cash flows by using the
credit-adjusted risk-free rate that was in effect
on the date of initial measurement and recognition
of the original ARO and, to the extent relevant,
the credit-adjusted risk-free rate(s) from
subsequent remeasurements. The examples below
illustrate this concept.
Example 4-4
Assume that the undiscounted cost to perform a retirement activity 10 years from now is $100 and that the current credit-adjusted discount rate is 5 percent. The present value of the ARO would be accreted at 5 percent per year until year 10. In year 4, on the basis of updated information, the undiscounted cost to perform the retirement activity has increased by $5. The present value of the $5 would become a new cost layer that would be accreted at the then-current credit-adjusted discount rate (i.e., the credit-adjusted discount rate in year 4) until year 10.
Example 4-5
Assume the same facts as in the example above, except that in year 4, the
estimated undiscounted cost to perform the
retirement activity has decreased by $5. The $5
reduction in undiscounted cash flows is simply
deducted from the original year 1 layer of
undiscounted cash flows. The original 5 percent
credit-adjusted discount rate is used for the one
single layer.
Determining the appropriate unit of account for the ARO is essential to ensuring that increases and decreases
in undiscounted cash flows or timing of cash flows are appropriately reflected in new layers or deducted from
the appropriate existing layers. It is important for an entity to carefully define the ARO unit of account in the
year the ARO is incurred to properly account for subsequent changes in estimates.
When an entity is unable to identify the appropriate prior period to which downward adjustments of an ARO are related, it would be appropriate for that entity to use a weighted-average credit-adjusted risk-free rate to discount the revised estimated expected cash flows.
Connecting the Dots
There is no explicit guidance in ASC 410-20 on the frequency with which an ARO should be reassessed to determine whether there have been changes in the estimated amount or timing of cash flows. In the absence of specific guidance, an entity should evaluate whether there are any indicators that would suggest that a change in the estimate of the ARO is necessary. Events or changes in circumstances that may indicate a need for reassessment include the following:
- A change in the law, regulation, or contract giving rise to the ARO that results in a change to either the timing of settlement or the expected retirement costs.
- A change in management’s intended use of the asset, including a change in plans for maintaining the asset to extend its useful life or to abandon the asset earlier than previously expected.
- Advancements in technology that result in new methods of settlement or changes to existing methods of settlement.
- A change in economic assumptions, such as inflation rates.
An entity should analyze its specific facts and circumstances to determine whether the estimate of the ARO needs to be reassessed.
There may be situations in which the reduction of an ARO due to a revision of
the original estimate of the timing or amount of
the obligation exceeds the remaining associated
unamortized ARC. In these circumstances, questions
may arise about whether the difference should be
recorded as a credit to the income statement or as
a reduction of the carrying value of the related
asset. The accounting will depend on whether the
ARC and the related asset are viewed as a single
asset or two discrete assets.
ASC 410-20-25-5 states, in part:
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.
ASC 410-20-35-2 states, in part:
An entity shall subsequently allocate that asset retirement cost to expense using a systematic and rational method over its useful life.
ASC 410-20-25-5 appears to support a single-asset approach; however, ASC
410-20-35-2 could be interpreted to support a
two-asset approach. If the ARC and related asset
are viewed as a single asset, any downward
adjustment of an ARO in excess of the related ARC
should be recorded as a reduction of the carrying
value of the related asset (although we believe
that if the downward adjustment of the ARO results
in a reduction of the carrying amount of the
single asset to below zero, any excess should be
recorded as a credit to the income statement). If
the two-asset approach is applied, the downward
adjustment of an ARO in excess of the ARC cost
should be recorded as a credit to the income
statement.
Connecting the Dots
We believe that the single-asset approach is preferable to the two-asset approach since it appears to be the one intended by the FASB given the following excerpt from paragraph B42 of the Background Information and Basis for Conclusions of FASB Statement 143:
The Board believes that asset retirement costs are integral to or are a prerequisite for operating
the long-lived asset and noted that current accounting practice includes in the historical-cost basis
of an asset all costs that are necessary to prepare the asset for its intended use. Capitalized asset
retirement costs are not a separate asset because there is no specific and separate future economic
benefit that results from those costs. In other words, the future economic benefit of those costs lies in
the productive asset that is used in the entity’s operations.
Further, ASC 410-20-55-20 states:
Revisions to the asset retirement obligation result in adjustments of capitalized asset retirement costs
and will affect subsequent depreciation of the related asset. Such adjustments are depreciated on a
prospective basis.
As previously noted, since an ARO is required to be initially measured at fair value incorporating
marketplace assumptions, differences between estimated future costs used in the measurement of
the fair value of an entity’s ARO and actual expenditures incurred by that entity to settle the ARO may
occur, resulting in a gain or loss. For example, a gain would most likely result when an entity elects to
settle an ARO by using internal resources because the entity’s internal costs are most likely less than the
costs reflected in the fair value measurement of the ARO, which would be a function of the costs, profit
margin, and market risk premium of a third party.
A gain or loss resulting from settlement of an ARO should be recognized in the period in which the asset
retirement activities are performed. When asset retirement activities are performed over more than one
reporting period, gains or losses should be recognized pro rata in accordance with the costs incurred
during the period as compared with the total costs that the entity expects to incur to settle the ARO.
Example 4-6
Assume that (1) an entity recognized a liability for an ARO in the amount of $600,000 (based on a third-party
estimate), (2) the entity expects to incur total costs of $400,000 to settle the ARO by using internal resources,
and (3) the entity incurred $200,000 of costs during the current period. No costs were incurred by the entity
before the current period. Ignoring the effects of discounting and other changes, the entity would reduce the
ARO by $300,000 and recognize a gain of $100,000 during the current period.
Further assume that the remaining $200,000 of costs were incurred during the next reporting period. The
entity would reduce the ARO by $300,000 (the ARO would be reduced to zero) and recognize a gain of
$100,000 during the next reporting period.
It would be inappropriate to defer recognition of the entire gain or loss to the period in which the asset
retirement activities are completed and the ARO is settled. Doing so would result in overstating or
understating the ARO because the amount recognized would not be representative of the amount that
the entity would have to pay a third party to assume the costs of settling the ARO.
This approach is supported by paragraph B41 of the Background Information and Basis for Conclusions of FASB Statement 143, which states, in part:
The real issue is which period or periods should reflect the efficiencies of incurring lower costs than the costs that would be required by the market to settle the liability. The Board believes it is those periods in which the activities necessary to settle the liability are incurred.
4.7 Presentation
ASC 410-20 and ASC 230-10 include the following
guidance on presentation matters related to AROs:
ASC 410-20
45-1 Accretion expense shall be classified as an operating item in the statement of income. An entity
may use any descriptor for accretion expense so long as it conveys the underlying nature of the
expense.
45-2 See paragraph 230-10-45-17 for additional information about the classification of cash
payments for asset retirement obligations as operating items on the statement of cash flows.
45-3 Paragraph 230-10-45-17(e) states that a cash payment made to settle an asset retirement
obligation is a cash outflow for operating activities.
ASC 230-10
45-17 All of the following are
cash outflows for operating activities: . . .
e. Cash payment made to settle an asset retirement
obligation. . . .
Connecting the Dots
Classification of Liabilities
ASC 210-10-20 defines current liabilities as “obligations whose liquidation is
reasonably expected to require the use of existing resources properly
classifiable as current assets, or the creation of other current
liabilities.” Entities should consider whether the estimated ARO
expenditures over the next 12 months or operating cycle, whichever is
longer, should be classified as current. Questions that entities should
consider in making this evaluation include the following:
-
Have the necessary permits been obtained to finish the work that is estimated to be completed in the next 12 months?
-
Has approval been obtained to use existing resources to finish the work that is estimated to be completed in the next 12 months?
-
Are there any contractual or legal deadlines that require the completion of certain projects included in the ARO cash flows within the next 12 months?
Statement of Cash Flow Considerations
As indicated in ASC 410-20-45-3, “[p]aragraph 230-10-45-17(e) states that a cash payment made to settle an asset retirement obligation is a cash outflow for operating activities.”
4.8 Disclosure
ASC 410-20
50-1 An entity shall disclose all of the following information about its asset retirement obligations:
- A general description of the asset retirement obligations and the associated long-lived assets
- The fair value of assets that are legally restricted for purposes of settling asset retirement obligations
- A reconciliation of the beginning and ending aggregate carrying amount of asset retirement obligations showing separately the changes attributable to the following components, whenever there is a significant change in any of these components during the reporting period:
- Liabilities incurred in the current period
- Liabilities settled in the current period
- Accretion expense
- Revisions in estimated cash flows.
50-2 If the fair value of an asset retirement obligation cannot be reasonably estimated, that fact and the reasons therefor shall be disclosed.
ASC 410-20-50-1 and 50-2 provide disclosure requirements applicable to AROs. They require disclosure of (1) a general description of an entity’s AROs and the associated long-lived assets and (2) the fair value of any assets legally restricted for purposes of settling AROs. In addition, they require tabular reconciliation of the beginning and ending aggregate carrying amount of AROs, showing separately changes attributable to new liabilities incurred, liabilities settled, accretion expense, and revisions in estimated cash flows, whenever there is a significant change in any of these components during a reporting period. When an entity cannot reasonably estimate the fair value of an ARO, the entity is required to disclose that fact and the reasons why a reasonable estimate of the ARO’s fair value cannot be made.
Note that ASC 820-10 disclosures apply only to assets and liabilities measured at fair value in periods after initial recognition. The disclosures required by ASC 820-10 do not apply to AROs because the subsequent measurements are not at fair value.
4.8.1 Special Considerations for Oil and Gas Producing Activities
ASC 932 does not address the treatment of AROs or the related ARCs. In February
2004, the SEC’s Division of Corporation Finance
sent a letter (the “February 2004
letter”) to registrants primarily engaged in the
production of oil and gas requesting that all
registrants with subsidiaries or operations
engaged in the production of oil and gas consider
the letter in the preparation of their filings
with the SEC. The scope of the February 2004
letter is limited to disclosure requirements for
oil and gas producers.
4.8.1.1 Disclosure of Capitalized Costs Related to Oil and Gas Producing Activities
As stated in the February 2004 letter, the SEC staff believes that (1) “the reported carrying value of oil and gas properties should include the related asset retirement costs and accumulated depreciation” and (2) “depletion and amortization should include the accumulated allocation of the asset retirement costs since the beginning of the respective property’s productive life.”
Paragraph B46 of the Background Information and Basis for Conclusions of FASB
Statement 143 discusses the Board’s conclusion
about the capitalization of ARCs, stating that “a
requirement for capitalization of an asset
retirement cost along with a requirement for the
systematic and rational allocation of it to
expense achieves the objectives of (a) obtaining a
measure of cost that more closely reflects the
entity’s total investment in the asset and (b)
permitting the allocation of that cost, or
portions thereof, to expense in the periods in
which the related asset is expected to provide
benefits.” As noted in the February 2004 letter,
“[e]xcluding net capitalized asset retirement
costs from the capitalized costs disclosure would
essentially result in a presentation of
capitalized costs that is not reflective of the
entity’s total investment in the asset, which is
contrary to one of the objectives of [FASB
Statement 143 (currently codified in ASC
410-20)].”
4.8.1.2 Disclosure of Costs Incurred in Oil and Gas Property Acquisition, Exploration, and Development Activities
The SEC staff believes that an entity should include ARCs in its “costs
incurred” disclosure in the year in which the
liability is incurred, not on a cash basis. In
addition, ASC 410-20 requires an entity to
recognize the ARCs and liability in the period in
which it incurs the legal obligation — through
either (1) the acquisition or development of an
asset or (2) normal operation of the asset.
Further, as stated in the February 2004 letter,
the “cost of an asset retirement obligation is not
incurred when the asset is retired and the
obligation is settled. Accordingly, an entity
should disclose the costs associated with an asset
retirement obligation in the period in which that
obligation is incurred. That is, the Costs
Incurred disclosures in a given period should
include asset retirement costs capitalized during
the year and any gains or losses recognized upon
settlement of asset retirement obligations during
the period.”
ASC 932-235-50-18 requires an entity to disclose costs incurred during the year regardless of whether
those costs are capitalized or charged to expense.
4.8.1.3 Disclosure of the Results of Operations for Oil and Gas Producing Activities
The February 2004 letter expresses the SEC staff’s belief that the “accretion of the liability for an asset
retirement obligation should be included in the Results of Operations disclosure either as a separate
line item, if material, or included in the same line item as it is presented on the statement of operations.”
ASC 410-20-35-5 and ASC 410-20-45-1 together indicate that the accretion expense resulting from recognition of the changes in the liability for an ARO due to the passage of time should be classified as an operating item in the statement of income. Therefore, as stated in the February 2004 letter, “the accretion expense related to oil and gas properties’ asset retirement obligations should be included in the [FASB Statement 69] Results of Operations disclosure,” which is currently codified in ASC 932-235-50-23.
4.8.1.4 Disclosure of a Standardized Measure of Discounted Future Net Cash Flows Related to Proved Oil and Gas Reserve Quantities
The FASB staff and SEC staff believe that an entity should include the cash flows related to the settlement of an ARO in its “standardized measure” disclosure.
Under ASC 932-235-50-30, an entity is required to disclose as of the end of the year a standardized measure of discounted future net cash flows related to its interests in both (1) “[p]roved oil and gas reserves” and (2) “[o]il and gas subject to purchase under long-term supply, purchase, or similar agreements and contracts.” The February 2004 letter expresses the SEC staff’s belief that “the requirement to disclose ‘net cash flows’ relating to an entity’s interest in oil and gas reserves requires an entity to include the cash outflows associated with the settlement of an asset retirement obligation. Exclusion of the cash flows associated with a retirement obligation would be a departure from the required disclosure. However, an entity is not prohibited from disclosing the fact that cash flows associated with asset retirement obligations are included in its Standardized Measure disclosure as a point of emphasis.”