What amount is used to measure the fair value of an asset retirement obligation?

Description

Bloomberg Tax Portfolio 5143, Asset Retirement Obligations (Accounting Policy and Practice Series), discusses the calculation, presentation, and disclosure of asset retirement obligations and presents the differences between U.S. GAAP and IFRS in accounting for these items. The Portfolio provides in-depth, practical examples.

All companies’ financials must acknowledge that at the end of a long-lived asset’s life cleanup activities may be legally required. In the financial accounting sense, many of those activities become liabilities early in the asset’s life, often in conjunction with acquisitions. Under U.S. GAAP, the requirements concerning these “asset retirement obligations” are contained in FASB Accounting Standards Codification (ASC) 410-20 (based largely on rules in FASB Statement No. 143, Accounting for Asset Retirement Obligations, as supplemented by FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations). The liability must be measured in accordance with the provisions of ASC 820-10 (based largely on principles in FASB Statement No. 157, Fair Value Measurements). Under IFRS, parallel but not identical requirements are set forth in IASC International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets. This Portfolio compares and contrasts ASC 410-20 and IAS 37.

Asset retirement obligations essentially must be accounted for as follows. Entities recognize a liability for an asset retirement obligation when incurred if its fair value reasonably can be estimated. Entities at the same time must recognize an offsetting asset retirement cost by increasing the carrying amount of the related long-lived asset. In periods subsequent to initial recognition, entities must recognize period-to-period changes in the asset retirement obligation liability resulting from the passage of time (accretion expense) and revisions in the timing and amount of the underlying expected cash flows. Further, entities must recognize depreciation expense resulting from the systematic and rational allocation of the asset retirement cost.

This Portfolio details the requirements of ASC 410-20 focusing on definitions within this Codification Subtopic as well as initial and subsequent recognition and measurement of asset retirement obligations. The explanation includes a discussion of fair value measurements and the recognition of conditional asset retirement obligations. Explanation of the major provisions is followed by a discussion of asset impairments, effects of funding and assurance provisions, information for rate-regulated entities, required disclosures, and transition provisions. The Portfolio also discusses other issues related to asset retirement obligations, including IFRS and ongoing FASB projects, environmental remediation liabilities, and SEC issues. That is followed by an explanation of how to apply the fair value measurement principles in ASC 820-10 in accounting for asset retirement obligations. The Portfolio concludes by providing detailed examples illustrating the provisions of ASC 410-20. The Worksheets provide excerpts from financial statements of various public companies illustrating their accounting for asset retirement obligations.

This Portfolio may be cited as Bloomberg Tax Portfolio 5143, Mazza and McEwen, Asset Retirement Obligations (Accounting Policy and Practice Series).

Table of Contents

I. Scope and Purpose of Portfolio
II. Background on Accounting for Asset Retirement Obligations
III. Measuring and Recording Asset Retirement Obligations
IV. Other Issues Related to Asset Retirement Obligations
V. Fair Value Measurement of Asset Retirement Obligations
VI. Examples of Accounting for Asset Retirement Obligations

Accounting for Asset Retirement Obligations (Issued 6/01)

Summary

This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. As used in this Statement, a legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel. This Statement amends FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies.

Reasons for Issuing This Statement

The Board decided to address the accounting and reporting for asset retirement obligations because:

• Users of financial statements indicated that the diverse accounting practices that have developed for obligations associated with the retirement of tangible long-lived assets make it difficult to compare the financial position and results of operations of companies that have similar obligations but account for them differently.
• Obligations that meet the definition of a liability were not being recognized when those liabilities were incurred or the recognized liability was not consistently measured or presented.

Differences between This Statement, Statement 19, and Existing Practice

This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement differs from Statement 19 and current practice in several significant respects.

• Under Statement 19 and most current practice, an amount for an asset retirement obligation was recognized using a cost-accumulation measurement approach. Under this Statement, the amount initially recognized is measured at fair value.
• Under Statement 19 and most current practice, amounts for retirement obligations were not discounted and therefore no accretion expense was recorded in subsequent periods. Under this Statement, the liability is discounted and accretion expense is recognized using the credit-adjusted risk-free interest rate in effect when the liability was initially recognized.
• Under Statement 19, dismantlement and restoration costs were taken into account in determining amortization and depreciation rates. Consequently, many entities recognized asset retirement obligations as a contra-asset. Under this Statement, those obligations are recognized as a liability. Also, under Statement 19 the obligation was recognized over the useful life of the related asset. Under this Statement, the obligation is recognized when the liability is incurred.

Some current practice views a retirement obligation as a contingent liability and applies FASB Statement No. 5, Accounting for Contingencies, in determining when to recognize a liability. The measurement objective in this Statement is fair value, which is not compatible with a Statement 5 approach. A fair value measurement accommodates uncertainty in the amount and timing of settlement of the liability, whereas under Statement 5 the recognition decision is based on the level of uncertainty.

This Statement contains disclosure requirements that provide descriptions of asset retirement obligations and reconciliations of changes in the components of those obligations.

How the Changes in This Statement Improve Financial Reporting

Because all asset retirement obligations that fall within the scope of this Statement and their related asset retirement cost will be accounted for consistently, financial statements of different entities will be more comparable. Also,

• Retirement obligations will be recognized when they are incurred and displayed as liabilities. Thus, more information about future cash outflows, leverage, and liquidity will be provided. Also, an initial measurement at fair value will provide relevant information about the liability.
• Because the asset retirement cost is capitalized as part of the asset's carrying amount and subsequently allocated to expense over the asset's useful life, information about the gross investment in long-lived assets will be provided.
• Disclosure requirements contained in this Statement will provide more information about asset retirement obligations.

How the Statement Generally Changes Financial Statements

Because of diverse practice in current accounting for asset retirement obligations, various industries and entities will be affected differently. This Statement will likely have the following effects on current accounting practice:

• Total liabilities generally will increase because more retirement obligations will be recognized. For some entities, obligations will be recognized earlier, and they will be displayed as liabilities rather than as contra-assets. In certain cases, the amount of a recognized liability may be lower than that recognized in current practice because a fair value measurement entails discounting.
• The recognized cost of assets will increase because asset retirement costs will be added to the carrying amount of the long-lived asset. Assets also will increase because assets acquired with an existing retirement obligation will be displayed on a gross rather than on a net basis.
• The amount of expense (accretion expense plus depreciation expense) will be higher in the later years of an asset's life than in earlier years.

How the Conclusions in the Statement Relate to the Conceptual Framework

The Board concluded that all retirement obligations within the scope of this Statement that meet the definition of a liability in FASB Concepts Statement No. 6, Elements of Financial Statements, should be recognized as a liability when the recognition criteria in FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, are met.

The Board also decided that the liability for an asset retirement obligation should be initially recognized at its estimated fair value as discussed in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements.

Effective Date

This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. Earlier application is encouraged.

How is asset retirement obligation calculated?

When calculating the fair value of an asset retirement obligation what rate is used to calculate the expected cash flows?

How are asset retirement obligations classified in the fair value hierarchy?

What is asset retirement obligation IFRS?