FAS 143 applies to “legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition, construction, or development and (or) the normal operation of a long-lived asset.... 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.” [¶2] It does not apply to obligations that arise from accidents and other “improper operation.” The existence of surety bonds, insurance policies, or other means of covering the obligation does not eliminate the liability, though it may affect determination of the credit-adjusted risk-free rate. [¶16]
As an example, it is generally required legally that underground storage tanks used by service stations be dug up when either they reach the end of their useful life or the station is permanently closed, to reduce the risk of leaks which can contaminate groundwater and soil. Under FAS 143, the station owner (or lessee, if the station is leased) recognizes an ARO liability when the tank is installed, along with a matching asset retirement cost (ARC) asset.
Uncertainty as to the size of the cost is not a reason to exclude an asset from ARO accounting. Nor is uncertainty about whether a legal requirement will actually be enforced. Instead, uncertainty is addressed through fair value and expected present value accounting, described later. If, however, it is not possible to make a reasonable estimate of the cost, or of the asset’s life, recognition is delayed until a reasonable estimate can be made. [¶3, ¶A16]
The ARO liability is calculated by estimating the costs associated with retiring the asset, then present valuing the result. Most often, the estimated future cost is calculated by determining the current cost of the work to be done, then estimating an average inflation rate over the expected life of the asset. The present value is then calculated using a “credit-adjusted risk-free rate,” defined as “a risk-free interest rate adjusted for the effect of its credit standing. (Footnote: In determining the adjustment for the effect of its credit standing, an entity should consider the effects of all terms, collateral, and existing guarantees on the fair value of the liability.)” [¶A21, fn 18] The cost should be the cost that would be expended for a third party to do the work involved, even iff the entity expects to do the work using internal resources. [¶A20]