Asset Retirement Obligations ASC 410-20

1. Asset Retirement ObligationsASC 410-20 By Mengchao Ai, Lei Huang

2. Introduction • ASC 410-20 covers asset retirement obligation and the associated asset retirement cost. • ASC 410-20 applies to all entities that incur legal obligations for the retirement of tangible long-lived assets that result from the acquisition, construction, development and the normal operation of a long-lived asset.

3. Recognition • An entity must recognize the liability for an asset retirement obligation when it is incurred and at reasonable estimated fair value. • If fair value cannot be estimated reasonably, the liability should be recognized in a subsequent period when reasonable estimate can be made. • If a tangible long-lived asset with an existing asset retirement obligation is acquired, a liability should be recognized at the asset’s acquisition date.

4. Recognition • When a liability for an asset retirement obligation is recognized, an entity should capitalize an asset retirement cost by increasing the carrying amount of the related asset

5. Recognition • The obligation to perform the asset retirement activity is unconditional. • An entity should recognized a liability for the fair value of a conditional asset retirement obligation. • An expected present value technique incorporates uncertainty about the timing and method of the settlement into the fair value measurement.

6. Recognition • If required by law, regulation or contract, an entity must perform an asset retirement activity upon its dismantlement or demolishment even if the activity can be indefinitely deferred. • The obligation must be performed even if there is uncertainty about the timing and method of the settlement because the deferral cannot last forever.

7. Recognition Example: A company completes construction of and places into service an offshore oil platform on January 1, 2003. The entity is legally required to dismantle and remove the platform at the end of its useful life, which is estimated to be 10 years. On January 1, 2003, the entity should recognize a liability for an asset retirement obligation and capitalize an amount for an asset retirement costs. Journey entry on Jan. 1 Long-lived asset(asset retirement cost) Asset retirement obligation liability

8. Measurement • An expected present value is used to estimate the fair value of a liability for a asset retirement obligation. • An entity should discount the expected cash flows using a credit-adjusted risk-free rate.

9. Measurement Example: A company completes construction of and places into service an offshore oil platform on January 1, 2003. The entity is legally required to dismantle an removed the platform at the end of its useful life, which is estimated to be 10 years. Expected cash flows is $283,500. The risk-free rate of interest on Jan 1, 2003 is 5 percent. The entity adjusts that rate by 3.5 percent to reflect the effect of its credit standing. Therefore, the credit-adjusted risk-free rate used to compute expected present value is 8.5 percent. The entity assumes a rate of inflation of 4 percent over the 10-year period. On December 31, 2012, The entity settles its asset retirement obligation at a cost of $351,000 (Actual cost)

10. Measurement Solution: Expected cash flow before inflation adjustment $283,500 Inflation factor assuming 4% rate for 10 years 1.4802 Expected cash flows adjusted for inflation 419,637 Expected present value using credit-adjusted Risk-free rate of 8.5 percent for 10 years $185,815

11. Measurement

12. Measurement Journey entries: January 1, 2003 Long-lived asset( asset retirement cost) $185,815 Asset retirement obligation liability $185,815 (To record he initial fair value of the asset retirement obligation liability December 31 2003 Depreciation expense (asset retirement cost) 18,582 Accumulated depreciation 18,582 (To record depreciation on the asset retirement cost) Accretion expense 15,794 Asset retirement obligation liability 15,794 (To record accretion expense on the asset retirement obligation liability

13. Measurement Journey entries: December 31, 2012 The entity settles its asset retirement at a cost of $351,000 (Actual cost) Asset retirement obligation liability 419,637 Cash 351,000 Gain on settlement of ARO 68,637 (To record settlement of the asset retirement obligation liability)

14. Subsequent Measurement • The incremental liability incurred in a subsequent reporting period should be considered to be an additional layer of the original liability and be recognized and measured at fair value. .

15. Subsequent Measurement • Subsequently an entity should allocate that asset retirement cost to expense over its useful life. • A systematic and rational method should be used. • Application of this method does not preclude an entity from capitalizing an amount of asset retirement and allocating an equal amount to expense in the same accounting period. .

16. Subsequent Measurement • In period subsequent to initial measurement, an entity should recognized period-to-period changes in the liability resulting from the following: • The passage of time. • Revisions to either the timing or the amount of the original estimate of undiscounted cash flows .

17. Subsequent Measurement • An entity should measure changes in the liability due to passage of time by applying an interest method to the amount of the liability at the beginning of the period. • The interest rate should be credit-adjusted risk-free rate that existed when the liability was initially measured. • The amount shall be recognized as an increase in the carrying amount of the liability and as an expense classified as accretion expense .

18. Subsequent Measurement • Changes resulting from revisions to the timing or the amount of the original estimate of undiscounted cash flows should be recognized as an increase or decrease in the carrying amount of the liability • Upward revision should be discounted using the current credit-adjusted risk-free rate. • Downward revisions should be discounted using the credit-adjusted risk-free rate that existed when the original liability was recognized. • A weighted-average credit-adjusted risk-free rate should be used when the entity cannot identify the prior period to which the downward revision relates. .