Scenario 1
A leased service station installs an underground storage tank on July 15, 2013. The tank has a useful life of 40 years. The current cost to remove it is 15,000. The estimated rate of inflation over the life of the asset is 2.3%. The credit-adjusted risk-free rate is 6.5%. The lease has an initial term of 20 years, starting February 1, 2013, with 4 5-year options. No economic penalty testing is done. ARO System Options settings are for Monthly compounding, Post-compounding, Start calculating ARO expense at Day of ARO setup.
Enter the lease first. Then on the ARO tab, enter the ARO information: Name “Tank”, Cost 15,000, begin date July 15, 2013, useful life 480 (months). The end date is calculated as the end date of the lease (January 31, 2033). Enter inflation rate of 2.3% and risk-free rate of 6.5%. Click Save and the results display: The Net ARO is 6,832.04.
Scenario 2
Same information as in Scenario 1 above, except that economic penalty testing is enabled in System Options, with a requirement to cover at least 75% of the useful life. When the ARO is saved, the first three options of the lease are marked as recognized. The end date for the ARO matches the new lease effective end date of January 31, 2048. The Net ARO is 3,736.29.
Scenario 3 (Owned asset)
The same as Scenario 1 above, except that the service station is owned, not leased. Set up the “lease” record as ARO only: Enter a lease number, descriptive information as desired, and set the Classification to ARO Only. Don’t enter rent information, or anything on the Inception tab. You don’t need to set the begin & end dates for the lease record. Instead, on the ARO tab, enter the ARO begin date as July 15, 2013, and the useful life as 480 months. EZLease calculates the ARO end date as July 14, 2053.
Complete ARO entry and click Save ARO. The Net ARO is 3,000.08.
Scenario 4
An oil driller leases a drilling site, effective August 1, 2013, which must be remediated after use. The estimated current remediation cost is 10,000. There is substantial uncertainty about the useable life, so the driller prepares a range of estimates: a 25% chance the life is 10 years, a 40% chance the life is 15 years, and a 35% chance the life is 25 years. Create one ARO with three separate layers for the different lives, putting the percentage chance in the Probability field. First layer: Name “Remediation alt 1”, begin date July 1, 2013, end date June 30, 2023, inflation rate 2.3%, risk-free rate 6.5%, probability 25%, cost 10,000. Click Save ARO Item. To create the second layer, choose Add Layer. Keep all information the same except the end date (June 30, 2028) and probability (40%); you may need to change the risk-free rate to reflect the longer life. Save ARO Item, then Add Layer again, and enter the third layer, with an end date of June 30, 2038, and probability 35%. Combined, the three layers have a Total ARO of 5,139.40.
Related links
ARO Roll forward | ARO Data Entry | Revising up an ARO | Ending an ARO | ARO Inflation Rate