With the long-term business trend toward a more balance-sheet oriented focus in accounting, FASB has fixed its attention on how entities account for obligations associated with the retirement of tangible long-lived assets. In the past, many businesses employed an income-statement approach, recognizing the costs related to such obligations ratably over an asset's life as a component of depreciation or expensing the obligations as they are incurred. FASB Statement no. 143, Accounting for Asset Retirement Obligations--which was seven years in the making--shifts to a balance-sheet approach, requiring businesses to recognize a liability for a retirement obligation when they incur it--even if that is far in advance of the asset's planned retirement. This article explains the provisions of Statement no. 143 as companies and their accountants will need to apply them.
OVERVIEW OF FASB 143
In FASB's words, Statement no. 143's stated objective is to "establish accounting standards for recognition and measurement of a liability for an asset retirement obligation and an associated asset retirement cost"
The new rules regarding the retirement of tangible long-lived assets include these features:
* A business must recognize an asset retirement obligation for a long-lived asset at the point an obligating event takes place--provided it can reasonably estimate its fair value (or at the earliest date it can make a reasonable estimate).
* The entity must record the obligation at its fair value, either the amount at which the liability could be settled in a current transaction between willing parties in an active market, or--more likely--at a substitute for market value, such as the present value of the estimated future cash flows required to satisfy the obligation.
* To offset the credit portion of the asset retirement liability entry, businesses must capitalize the asset retirement costs as an increase in the carrying amount of the related long-term asset.
* Businesses must include certain costs in the income statement during the asset's life--namely depreciation on the asset, including additional capitalized retirement costs, and interest for the accretion of the asset retirement liability due to the passage of time.
Statement no. 143 applies to tangible long-lived assets, including individual assets, functional groups of related assets and significant parts of assets. It covers a company's legal obligations resulting from the acquisition, construction, development or normal operation of a capital asset. In many cases, the presence or absence of a qualifying legal obligation will be clear. Other situations will require CPAs to carefully analyze the circumstances and the statement's detailed guidance.
The statement provides other guidance on the new standard's scope:
* A mere plan or intention to dispose of an asset does not require recognition.
* Obligations--such as environmental remediation liabilities--related to the improper operation of an asset are not covered.
* Businesses may incur retirement obligations at the inception of an asset's life or during its operating life. For example, an offshore oil-and-gas-production facility typically incurs its removal obligation when it begins operating. A landfill or a mine, however, may incur a reclamation obligation gradually over the life of the asset as space is consumed with waste or the mine is dug. In other cases, the obligation may come because of the passage of laws or regulations during an asset's life, such as environmental regulations.
Under Statement no. 143, an entity must recognize an asset retirement obligation at its fair value the amount at which an informed willing party would agree to assume the obligation. However, acknowledging that a market for settling such obligations may not exist, FASB permits CPAs to estimate the obligation's fair value and says that a present value technique is often the best approach. …