Asset Retirement Obligations (AROs) record the costs involved in retiring an asset, such as the responsibility to remediate an asset (usually real estate) after the user is done with it or to dispose of the asset when disposal involves nontrivial expense. AROs apply to both owned and leased assets. A common example would be a gas station, whose operator is required to remove the underground fuel storage tanks to protect against leaks either at the end of the tanks' useful life, at the end of a lease (if not renewed), or when the station is closed. Another example is a leased oil well site, which must be remediated when the well is capped.
An ARO is an expense which is legally required of the operator at the retirement of the asset (including the end of a lease), which does not fit into the category of minimum lease payments under FAS 13 (for example, because it is not paid to the lessor; the work might be done by a third party, or even by the operator). It does not apply to costs associated with cleanup from an accident or improper use of an asset.
Additional examples of AROs:
- Decommissioning a nuclear power station
- Reclamation and remediation of a mine or quarry
- Removing a billboard or other leasehold improvements from leased property
- Closing a landfill
Since the obligation is a performance requirement in the future, the exact cost is normally not known in advance. Instead, the owner/lessee estimates the future cost, typically by determining the current cost and then making an estimate of inflation to determine the assumed future cost. This is then present valued back to the inception of the lease (or installation of the item that creates the obligation, whichever is later), using as the discount rate the owner's "credit-adjusted risk-free rate," to determine the initial ARO. The ARO is set up as an asset and liability. The asset is depreciated over the remaining term of the lease; the liability is accreted (liability is added, using the interest method) such that at the end of the lease, the total liability is equal to the originally estimated future cost. Once the asset is actually retired, the ARO is removed from the books, the actual expenses involved in retiring the asset are recognized, and a gain or loss is recognized for the difference. See our ARO Example for more details.
The accounting for AROs is defined for U.S. businesses and other organizations complying with U.S. GAAP by FAS 143, released in June 2001, now known as Topic 410 in the FASB Accounting Standards Codification. For entities complying with International Financial Accounting Standards (IFRS), AROs are accounted for in accordance with IAS 37, where they are called provisions. The reporting under both standards is almost identical, except that IAS 37 calls for recalculating the obligation each reporting period if the credit-adjusted risk-free rate changes.
EZ ARO provides complete ARO accounting for owned and leased assets. EZLease combines ARO and lease accounting. Don't rely on risky Excel spreadsheets; solve your ARO accounting needs with tested and reliable software.
Test out our ARO reporting in the trial version of either EZLease or EZ ARO
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