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Asset retirement obligations are initially recognized as a liability at fair value, with a corresponding asset retirement cost (ARC) recognized as part of the related long-lived asset. Figure PPE 3-1 highlights accounting considerations over the life of an ARO; each phase is discussed in more detail in the sections that follow.
Figure PPE 3-1
Impact of AROs on the financial statements
Phase
Balance sheet
Income statement
Statement of cash flows
Initial recognition (PPE 3.4.1) and measurement (PPE 3.4.2)
Record the ARO at the fair value of the legal obligation
Record the ARC as an increase to the carrying value of the related long-lived asset
No immediate impact
No immediate impact
Passage of time (PPE 3.4.3)
Increase the ARO through periodic accretion expense
Allocate the ARC to expense using a systematic and rational method over the related long-lived asset’s useful life
Record accretion expense as a component of operating expense
Record ARC expense as depreciation
Classify accretion and depreciation as noncash adjustments to net income within operating cash flows
Changes in expected cash flows (PPE 3.4.4.2)
Adjust the ARO for the impact of the change
Record a corresponding change to the carrying amount of the ARC
No immediate impact
Reflect change in accretion and depreciation prospectively
No immediate impact
Classify accretion and depreciation as noncash adjustments to operating cash flows
Retirement
(PPE 3.5)
Derecognize ARO as remediation costs are incurred
Derecognize any unamortized ARC
Record a gain or loss for the difference between the actual cost of settling the ARO and the recorded liability
Record a loss for any unamortized ARC
Classify cash outflows for settlement of the ARO in operating cash flows
Any settlement difference is a noncash adjustment to net income within operating cash flows

3.4.1 Initial recognition (AROs)

Asset retirement obligations are initially recognized at fair value in the period in which they are incurred and the amount of the liability can be reasonably estimated. Determining the appropriate timing of recognition may be complex if the ARO arises over a period of time or due to a change in laws. For those AROs arising from changes in laws or regulations, the ARO should be initially recognized in the period the law or regulation is enacted.
Once a reporting entity has determined whether a duty or responsibility exists upon retirement, it will then need to assess whether an obligating event has occurred that leaves it little or no discretion to avoid the future transfer or use of assets. Once that obligating event has occurred, an ARO meets the definition of a liability and qualifies for recognition.
ASC 410-20-55-4 illustrates the timing of the obligating event and recognition of an ARO:

Excerpt from ASC 410-20-55-4

...in the case of a nuclear power facility, an entity assumes responsibility for decontamination of that facility upon receipt of the license to operate it. However, no obligation to decontaminate exists until the facility is operated and contamination occurs. Therefore, the contamination, not the receipt of the license, constitutes the obligating event.

Question PPE 3-2
When should a reporting entity record an ARO related to an asset under construction?
PwC response
Construction projects often extend beyond a single reporting period. Although construction may take time to complete, the reporting entity will usually know prior to the start of construction whether it will have a related ARO.
The method used to account for AROs during construction should be based on the individual facts and circumstances. Two methods that may be appropriate are:
  • Proportionate method
The ARO is recorded proportionately as the underlying construction is completed (i.e., if 50% of the cost of the constructed asset has been incurred, 50% of the ARO would be recorded). This method may be appropriate for an ARO related to an entire facility when the reporting entity is required to remove the facility upon retirement. In that case, the cost of removing the facility would be recorded in proportion to the amount constructed.
  • Specific method
An ARO is recorded when the specific costs leading to the obligation are capitalized. For example, absent other obligations, if the cost of an ARO related to a nuclear power plant arises as a result of the fuel rods being installed, the ARO would be recorded at the time the fuel rods are installed.
Reporting entities involved in asset construction should develop policies for the recognition of AROs during the construction phase. Although there are different approaches, we generally expect the same method to be applied consistently to similar assets. While reporting entities should begin accreting an ARO immediately upon initial recognition, depreciation of the related asset retirement cost should not begin until the related asset (or component of the asset) is placed in service.
Obligations incurred, either ratably or non-ratably, throughout the operating life of a long-lived asset should be recognized concurrent with the events that create the obligations. For example, if ongoing operation of a power plant results in steady contamination that will require various levels of remediation depending on the level of contamination, the reporting entity should recognize and measure the portion of the incremental liability created in each reporting period, creating additional layers of liability. The reporting entity should allocate the asset retirement cost to expense using a systematic and rational method over its useful life.
When an ARO is incurred throughout the operating life of the asset, ASC 410-20 allows a reporting entity to capitalize an amount of asset retirement cost and allocate an equal amount to expense in the same accounting period. For example, if a reporting entity acquires a long-lived asset with an estimated life of ten years, and the reporting entity incurs one-tenth of the liability for the ARO each year, the guidance does not preclude the reporting entity from capitalizing and then expensing one-tenth of the asset retirement costs each year.

3.4.2 Initial measurement (AROs)

Asset retirement obligations are recognized at fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. Fair value should be determined under ASC 820, Fair Value Measurements.
In the rare circumstances that a reasonable estimate of fair value cannot be determined, the liability should be recognized when a reasonable estimate can be made. A reporting entity asserting that a reasonable estimate of fair value cannot be determined should have sufficient evidence to support this conclusion. It would not be appropriate to delay the recognition of an ARO on the basis that management will not perform the related asset retirement activities in the foreseeable future. If a reporting entity concludes that no obligation should be recognized because the fair value or timing of the obligation is indeterminate, the reporting entity should disclose the existence of the asset retirement obligation and the basis for not recognizing it. See FSP 11.6 for additional information relating to the presentation and disclosure of AROs.
ASC 410-20-25-6 discusses factors to consider in determining if a reasonable estimate can be made:

Excerpt from ASC 410-20-25-6

An entity has sufficient information to reasonably estimate the fair value of an asset retirement obligation if any of the following conditions exist:
a. It is evident that the fair value of the obligation is embodied in the acquisition price of the asset.
b. An active market exists for the transfer of the obligation.
c. Sufficient information exists to apply an expected present value technique.

ASC 410-20-30-1 provides further guidance on how the fair value of an ARO is usually measured.

Excerpt from ASC 410-20-30-1

An expected present value technique will usually be the only appropriate technique with which to estimate the fair value of a liability for an asset retirement obligation.

Applying the expected present value technique requires a reporting entity to incorporate assumptions about the amount and timing of costs under different future scenarios and the relative probabilities of those scenarios. ASC 410-20-25-7 indicates that uncertainty in the timing of cash flows should be incorporated in the measurement through the assignment of probabilities to those cash flows. Figure PPE 3-2 illustrates the application of the concepts of ASC 820 to asset retirement obligations:
Figure PPE 3-2
Application of ASC 820 to asset retirement obligations
Determine unit of account
The unit of account is the legal obligation, in whole or in part, to retire a long-lived asset. ASC 410 requires an ARO to be recorded at fair value when a legal obligation is incurred. When a new ARO layer is established due to a change in the timing or amount of expected cash flows, the new layer is treated as a separate unit of account.
Evaluate valuation premise
Since AROs are not commonly held as assets by other parties, a reporting entity should consider the valuation of its AROs assuming they are transferred to a market participant.
Assess principal market
It is unlikely that there is a principal market for asset retirement obligations as they are not actively traded and there is little or no observable data about the price to transfer an ARO.
Determine the most advantageous market
The most advantageous market is the market that would minimize the amount that would be paid to transfer the ARO. We expect that reporting entities will generally develop a hypothetical market to determine the fair value of AROs.
Determine valuation approach and technique
ASC 820 requires that a reporting entity consider the use of all valuation approaches and techniques appropriate in the circumstances. However, ASC 410-20-30-1 states that an expected present value technique will usually be the only appropriate technique.
ASC 410 does not preclude the use of other approaches or techniques. Consideration of market participant assumptions and the applicability of other potential approaches or techniques are consistent with the ASC 820 framework.
Determine significant inputs
The example in ASC 820-10-55-77 through ASC 820-10-55-81 details inputs commonly used in valuing AROs, including labor costs, overhead costs, compensation to a market participant for assuming the ARO, the effect of inflation on related costs, the time value of money, and nonperformance risk.
Additionally, the key factors that impact the expected present value calculation include the timing and amount of cash flows and the discount rate, as summarized in Figure PPE 3-3.
Figure PPE 3-3
Factors impacting the initial ARO measurement
Factors
Key considerations
Timing
  • Assumptions and probabilities about when the ARO may settle should be incorporated into the measurement of the ARO
  • Uncertainty about the timing of settlement does not change the fact that an ARO exists; any uncertainty should be incorporated into the analysis
  • There may be differences between the expected settlement date and the asset’s useful life (e.g., due to license dates, lease periods, history of retirement of similar AROs, etc.)
Amount
  • Fair value measurement under ASC 820 requires the use of market participant assumptions
  • The cost of third-party resources should be used in the measurement even if the reporting entity plans to settle the ARO using internal resources (i.e., include the third-party service provider’s profit margin and, if appropriate, a risk premium in the estimate of cash flows)
  • Assumptions and probability analysis about the amount at which the ARO may settle should be incorporated into the measurement
Discount rate
  • Cash flows should be discounted using a credit-adjusted risk-free rate (see PPE 3.4.3.4)
  • Funding and assurance arrangements should be considered in determining the appropriate discount rate
See Example PPE 3-5 in PPE 3.4.3.6 for an illustrative example of the expected present value technique when estimating the fair value of an asset retirement obligation.
Example PPE 3-2 includes an evaluation of whether an ARO should include the total costs of the removal and disposal.
EXAMPLE PPE 3-2
Evaluating whether an ARO should include the total costs of the removal and disposal
PPE Corp has a building with asbestos embedded within its insulation and is required to remove and dispose of the asbestos in a special manner if the building undergoes major renovations or is demolished. The costs to remove and dispose of insulation not containing asbestos is $1 per square foot and the costs to remove and dispose of insulation containing asbestos is $5 per square foot.
How should PPE Corp determine the settlement obligation?
Analysis
Consistent with ASC 410-20-25, we believe the ARO should be measured using the total cost of $5 per square foot (and not the incremental costs of $4 to remove and dispose of the asbestos) because the applicable asbestos regulations create a legal obligation to comply with certain removal and disposal procedures that should be measured at its fair value.

3.4.3 Timing of AROs

An important factor in measuring an asset retirement obligation is the length of time until its settlement. The asset’s useful life provides one data point about the potential timing of the asset retirement. However, there may be a distinction between the useful life of the asset and the date the ARO will be settled. All factors should be considered in developing retirement scenarios, including license expiration dates, the reporting entity’s retirement history, management’s plans for improvements that could extend the life of the asset, and lease terms (as applicable). ASC 410-20-25-11 provides indicators to consider in assessing the timing.

Excerpt from ASC 410-20-25-11

The estimated economic life of the asset might indicate a potential settlement date for the asset retirement obligation. However, the original estimated economic life of the asset may not, in and of itself, establish that date because the entity may intend to make improvements to the asset that could extend the life of the asset or the entity could defer settlement of the obligation beyond the economic life of the asset. In those situations, the entity would look beyond the economic life of the asset in determining the settlement date or range of potential settlement dates to use when estimating the fair value of the asset retirement obligation.

Reporting entities should ensure that differences in depreciable lives, estimated asset retirement dates, and lease and license expiration dates are supportable. Additionally, although the amount of the liability, and the corresponding asset retirement cost, may be influenced by the expected timing of when the expense will be incurred, the asset retirement cost capitalized as part of the asset will be depreciated over the depreciable life of the asset, not the period through the planned asset retirement date. Example PPE 3-3 provides details on evaluating the timing of settlement of an ARO.
EXAMPLE PPE 3-3
Evaluating the timing of settlement of an ARO
Rosemary Electric & Gas (REG) Company operates a nuclear generating plant that it operates under a license from the Nuclear Regulatory Commission. REG originally recorded an ARO based on the original license expiration date; however, management now intends to apply for a license renewal.
What should REG consider in evaluating the timing of settlement of the ARO?
Analysis
The timing of cash flows in REG’s expected present value analysis should include a scenario in which the license is renewed and decommissioning of the plant is delayed. The weight assigned to this probability should consider all relevant facts and circumstances, including:
  • Management’s past success in obtaining similar licenses
  • The political climate that could impact license renewal
  • The regulatory environment, including licensing requirements
  • Plant economics (e.g., whether is it profitable to continue operating the plant or if there are prohibitive costs associated with repowering the plant)
The outcome of this assessment may also impact the depreciable life or expected salvage value of the plant. However, the life of the plant and the timing of the asset retirement may differ. Depreciation is an accounting allocation methodology based on management’s current best estimate of the useful life and expected salvage value at the end of the life of the facility.

3.4.3.1 Uncertain timing of ARO settlement

As discussed in PPE 3.2.2, ASC 410-20-25-7 states that the obligation to perform an asset retirement activity is unconditional even though uncertainty may exist about the timing or method of settlement. Therefore, even if the timing or method of settlement is uncertain and may be conditional on a future event, if an obligation exists, it should be recognized and measured if the fair value can be reasonably estimated. ASC 410-20-25-8 states that a reporting entity would have sufficient information to apply an expected present value technique if either of the following conditions exists:
  • The settlement date and method of settlement have been specified by others
  • The information is available to reasonably estimate all of the following: (1) the settlement date or range of settlement dates; (2) the method, or potential methods, of settlement; and (3) the probabilities associated with the potential settlement dates and methods.
ASC 410-20-55 provides an example of recognition when fair value can be reasonably estimated.

ASC 410-20-55-49

Assume a telecommunications entity owns and operates a communication network that uses wood poles that are treated with certain chemicals. There is no legal requirement to remove the poles from the ground. However, the owner may replace the poles periodically for a number of operational reasons. Once the poles are removed from the ground, they may be disposed of, sold, or reused as part of other activities. There is existing legislation that requires special disposal procedures for the poles in the particular state in which the entity operates.

ASC 410-20-55-50

At the date of purchase of the treated poles, the entity has the information to estimate a range of potential settlement dates, the potential methods of settlement, and the probabilities associated with the potential settlement dates and methods based on established industry practice. Therefore, at the date of purchase, the entity is able to estimate the fair value of the liability for the required disposal procedures using an expected present value technique.

ASC 410-20-55-51

Although the timing of the performance of the asset retirement activity is conditional on removing the poles from the ground and disposing of them, existing legislation creates a duty or responsibility for the entity to dispose of the poles in accordance with special procedures, and the obligating event occurs when the entity purchases the treated poles. Although the entity may decide not to remove the poles from the ground or may decide to reuse the poles and thereby defer settlement of the obligation, the ability to defer settlement does not relieve the entity of the obligation. The poles will eventually need to be disposed of using special procedures, because the poles will not last forever. Additionally, the ability of the entity to sell the poles prior to disposal does not relieve the entity of its present duty or responsibility to settle the obligation. The sale of the poles transfers the obligation to another entity. The assumption of the obligation by the buyer affects the exchange price. The bargaining of the exchange price reflects the buyer’s and seller’s individual estimates of the timing and (or) amount of the cost to extinguish the obligation.

ASC 410-20-55-52

The asset retirement obligation should be recognized when the entity purchases the poles because the entity has sufficient information to estimate the fair value of the asset retirement obligation. Because the legal requirement relates only to the disposal of the treated poles, the cost to remove the poles is not included in the asset retirement obligation. However, if there was a legal requirement to remove the treated poles, the cost of removal would be included.

In some cases, the settlement timing may be indeterminate and thus no obligation would be recorded. If a range of possible settlement dates exists, then the period is not indeterminate, and accrual of a liability would be required. The reporting entity should develop an estimate based on the possible scenarios related to the potential timing of removal. This is consistent with the expected present value approach, which requires consideration of a variety of possible settlement dates.
Question PPE 3-3
How is the recognition of an ARO affected if the asset has an indeterminate useful life?
PwC response
There may be instances when there is no available information regarding the timing of settlement of an ARO. ASC 410-20-25-10 provides this as an example of when insufficient information exists to estimate fair value. In this case, an ARO would not be recognized until there is sufficient information to estimate fair value.
If management has the intent and ability to operate an asset indefinitely, it may be appropriate to conclude that the asset has an indeterminate life (see PPE 3.2.1 for a discussion of AROs associated with the retirement of component units). Before concluding that an asset has an indeterminate life, a reporting entity should consider, at a minimum:
  • Regulatory and license requirements
  • Results of historical operations, capital, and maintenance programs
  • Engineering analysis
  • Plans of joint owners, if applicable
  • Cash flow and earnings forecasts
  • Consideration of prior retirements of similar assets
  • Lease terms, if a lease is involved
  • Public expectations of the assets
Finally, the reporting entity should periodically reassess its obligations and should record the ARO at the time it becomes reasonably estimable. Additionally, the reporting entity should disclose a description of the obligation, the fact that a liability has not been determined because the fair value cannot be reasonably estimated, and the reasons why fair value cannot be reasonably estimated.
ASC 410-20-55-57 and ASC 410-20-55-58 provides an example of recognition when an entity has insufficient information to reasonably estimate present value. ASC 410-20-55-59 through 55-62 provides an additional example of recognition when an entity initially has insufficient information, but later has sufficient information to reasonably estimate present value.

3.4.3.2 Conditional AROs

A conditional asset retirement obligation is a legal obligation to perform an asset retirement activity where the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the reporting entity. Although uncertainty may exist about the timing and/or method of settlement for a conditional ARO, the obligation to perform the asset retirement activities are unconditional and cannot be legally avoided. A reporting entity is still required to recognize a liability for the value of a conditional ARO if the fair value of the liability can be reasonably estimated as a legal obligation to perform asset retirement activities exists. Any uncertainty in the timing and/or method of settlement would be incorporated into the measurement of the ARO at fair value.
There are two general categories of conditional AROs addressed in ASC 410-20: stand-ready obligations (ASC 410-20-55-12) and unambiguous obligations with a low likelihood of performance (ASC 410-20-25-15).
Conditional AROs–stand-ready obligations
Stand-ready obligations are legal obligations where a counterparty (e.g., government regulator or lessor) has the right to decide whether a retirement activity is required to be performed.

ASC 410-20-25-14

This Subtopic requires recognition of a conditional asset retirement obligation before the event that either requires or waives performance occurs. Uncertainty surrounding conditional performance of the retirement obligation is factored into its measurement by assessing the likelihood that performance will be required. In situations in which the conditional aspect has only 2 outcomes and there is no information about which outcome is more probable, a 50 percent likelihood for each outcome shall be used until additional information is available.

For example, a stand-ready obligation related to an option held by a lessor is common in the restaurant industry. To illustrate, a local restaurant may enter into a lease to use space for the next 10 years. The restaurant customizes the space by installing seating, a kitchen, and floors. The lease gives the lessor the option to have the customizations removed by the lessee at the end of the lease or to retain the customization if the subsequent tenant wants to retain the set up as a restaurant. This is a stand-ready obligation because the lessee needs to be prepared to comply if the lessor decides that all customizations should be removed. In contrast, a lease with an unambiguous obligation to return the space to its original condition is a clear requirement for the lessee remove all customizations. Uncertainty about whether the lessor will enforce the unambiguous obligation would cause it to be conditional.
Regardless of the uncertainty attributable to the option held by a counterparty, a legal obligation to stand ready to perform retirement activities still exists, and the counterparty may require the retirement activities to be performed. The reporting entity should consider the uncertainty about the timing and method of settlement in the measurement of the liability at fair value.
When a stand-ready obligation exists and there is limited information to assess whether the counterparty will exercise their option and require performance of the retirement obligation, it may be acceptable to start with an assumption of a 50% probability of exercise. However, all available evidence should be considered. The assignment of 50% to each of two options may not always be appropriate. Evidence may indicate that the probability that the counterparty will exercise the option should be more or less than 50% and such percentages should be factored into the determination of fair value.
If a reasonable assessment would indicate that the counterparty will require performance of the retirement obligation, for example if the asset is a nuclear power plant, the retirement obligation should be considered unambiguous regardless of whether the agreement is structured with the obligation in the form of an option.
Unambiguous obligations with a low likelihood of performance
In some cases, the likelihood of performance of the retirement activities may be low. This low likelihood of performance impacts the measurement of fair value of the ARO, but not the need to recognize an ARO.

ASC 410-20-25-15

An unambiguous requirement that gives rise to an asset retirement obligation coupled with a low likelihood of required performance still requires recognition of a liability. Uncertainty about the conditional outcome of the obligation is incorporated into the measurement of the fair value of that liability, not the recognition decision. Uncertainty about performance of conditional obligations shall not prevent the determination of a reasonable estimate of fair value. A past history of nonenforcement of an unambiguous obligation does not defer recognition of a liability, but its measurement is affected by the uncertainty over the requirement to perform retirement activities.

This guidance addresses unambiguous obligations that are "conditional" only because there is some level of uncertainty about whether a counterparty will enforce the obligation. The distinction between this category of conditional obligations and those addressed by stand-ready obligations is that the contract itself includes no optionality. The contract requires the retirement activities to be performed, and there is simply uncertainty as to whether that legal obligation will be enforced. This category of conditional obligation is closer to an unconditional obligation. Based on this view, the starting point should be an assumption of 100% probability of enforcement. The starting probability may be reduced based on available evidence.
Example PPE 3-4 further explores an unambiguous obligation.
EXAMPLE PPE 3-4
Evaluating an unambiguous obligation that may not be enforced
PPE Corp owns land that is used for industrial purposes. PPE Corp is legally obligated by the local government to return it to its original condition when the land is sold. PPE Corp estimates the present value of the legal obligation to be $1,000,000. Based on past practice, PPE Corp is aware that the local government may not enforce their obligation to return the land to its original condition. PPE Corp believes there is a 90% probability that this obligation will not be enforced.
Should an ARO be recognized and, if so, when?
Analysis
PPE Corp would need persuasive evidence to record the obligation based on unlikely enforcement. It should be able to support that an independent third party (i.e., a market participant) would similarly assume 10% probability of enforcement. If such evidence exists (e.g., past history with that governmental agency and data from other available sources) PPE Corp could assign a probability-weighted cash flow of $100,000 ((90% × $0) + (10% × $1,000,000)) to the fair value of the ARO.
See PPE 3.3.3 and LG 3.3.4 for additional accounting considerations related to AROs in the context of a lease.

Question PPE 3-4
Does an ARO exist if there is a legal obligation to dispose of an asset in a special manner upon removal, but there are no current plans to dispose of the asset?
PwC response
Yes. In some cases, a reporting entity may not be required to remove an asset that has a finite life; however, when the asset is removed, it will trigger a legal obligation upon disposal of the asset. This creates uncertainty about when the reporting entity will settle the ARO, not whether the reporting entity has an ARO. That is, an ARO still exists even if the timing of such liability is not expected to be settled in the foreseeable future. The fact that there is no obligation to remove the asset does not relieve the entity of the legal obligation associated with disposal of the asset at the time of the asset’s retirement.
For example, assume a reporting entity owns a factory that contains asbestos and there are regulations in place that require the reporting entity to appropriately handle and dispose of the asbestos in a special manner if the factory undergoes major renovations or is demolished. The reporting entity is not currently required to remove the asbestos from the factory. In this scenario, the obligation cannot be avoided through sale of the building, as the prospective buyer will either require the seller to remove the asbestos prior to sale or will factor the cost of asbestos management and abatement into the building’s purchase price. Additionally, even if there are no current plans to undergo major renovations or demolish the building, the asbestos will eventually need to be removed and disposed of in a special manner, because no building will last forever. In this example, existing laws and regulations create a duty to remove and dispose of the asbestos in a special manner; only the timing of the performance of the asset retirement activity is conditional. If the uncertainty of the timing means that a reasonable estimate of fair value cannot be made (as discussed in PPE 3.4.2), the reporting entity may be precluded from recognizing the obligation.

3.4.3.3 Estimates of future cash flows (AROs)

As discussed in ASC 410-20-55-13, a reporting entity should incorporate market participant assumptions about the expected amount of future cash flows into the fair value analysis, including evaluation of the following amounts:
  • The costs that a third party would incur to retire the asset
  • Other factors that a third party would consider in determining the cost of the settlement, such as inflation, overhead, required profit margin, and advances in technology
  • The price that a third party would require and could expect to receive for assuming the risk related to uncertainties and unforeseeable circumstances inherent in the obligation (i.e., the market risk premium)
  • The extent to which the amount of a third party’s costs or the timing of its costs would vary under different future scenarios and the relative probabilities of those scenarios
If there is a demonstrated history of technological improvements that have impacted the cost of performing the required retirement activities, and there is a reasonable basis to expect that third parties would include future cost savings due to expected technological improvements in their estimates, then we believe that these advances in technology should be incorporated into the estimated cash flows.
Due to the nature of asset retirement obligations, reporting entities may not always have directly observable or comparable information about the assumptions that market participants would use in assessing the fair value of a liability. In those cases, the reporting entity may be able to rely on information and assumptions based on its own expectations, provided there is no contrary data indicating that market participants would rely on different assumptions (e.g., if a reporting entity knows its labor costs are higher than market, the lower market rates should be used). In addition, the reporting entity should include a profit margin consistent with market participant assumptions.
Question PPE 3-5
Can the estimate of an ARO be based on the reporting entity’s own costs to settle the obligation?
PwC response
It depends. ASC 820 requires the use of market participant assumptions in measuring the ARO’s fair value, notwithstanding the reporting entity’s specific plans for retiring the asset. If market participant information and assumptions are not available, a reporting entity may rely on information and assumptions based on its own expectations, provided there is not contrary data indicating that market participants would rely on different assumptions. Excluding certain costs, assuming no profit margin, or assigning a low or zero probability to a third-party retirement scenario would be inconsistent with the requirements of ASC 410-20 and ASC 820.
Question PPE 3-6
Should salvage value be included as an offset to future cash flows in measuring the ARO?
PwC response
No. Salvage value and other related cash inflows are included in determining the depreciable base of the asset. As a result, the estimated salvage value is excluded from the cash flows used to estimate the ARO.

3.4.3.4 Discount rate for AROs

In accordance with ASC 410-20-55-15, the expected present value technique requires that the estimated cash flows be discounted using a credit-adjusted risk-free rate. The risk-free rate is the interest rate on monetary assets that are essentially risk-free (e.g., in the United States, zero coupon US Treasury instruments) and that have maturity dates that coincide with the expected timing of the estimated cash flows required to satisfy the asset retirement obligation. The risk-free rate is then adjusted to reflect the reporting entity’s risk profile, which is their credit-adjusted risk-free rate. Reporting entities should use the appropriate discount rate based on the timing of individual scenarios. For example, if there is an equal chance that retirement will occur in 2030 or 2040, the reporting entity should apply one discount rate to the 2030 retirement and another to the 2040 retirement at the date the obligation is calculated. The credit-adjusted risk-free rate in 2030 could be different from the rate in 2040 for the same reporting entity as the credit spread between the risk-free rate and the credit-adjusted rate tends to widen over time.
For subsidiaries within a consolidated group, the credit adjustment to the risk-free rate should be specific to the reporting entity that is legally obligated to perform the remediation activities. Where there are intercompany funding or assurance provisions in place (e.g., the parent company guarantees the performance of the asset retirement activities), the effect of such provisions should be reflected in the credit adjustment to the risk-free rate. See PPE 3.4.3.5 for additional information on ARO funding and assurance provisions. Additionally, see FV 8 for guidance on considering the effect of a reporting entity’s credit standing when determining the credit-adjusted risk-free rate.

3.4.3.5 ARO funding and assurance provisions

Reporting entities may be required to provide assurance of their ability to fund an asset retirement obligation. Methods of providing assurance include surety bonds, insurance policies, letters of credit, guarantees by other entities, and establishment of trust funds or other assets dedicated to satisfying the ARO. These funding and assurance provisions should not be used to reduce an ARO liability. However, the existence of such provisions may affect the determination of the credit-adjusted risk-free rate used in the measurement of the ARO.
See PPE 8.2 for information relating to the recognition of insurance receivables.
Question PPE 3-7
Is the initial measurement of an ARO impacted by funding and assurance provisions?
PwC response
Yes. These arrangements should be considered in determining the credit-adjusted risk-free rate used to discount the cash flows associated with the liability, therefore affecting the measurement of an ARO. However, in accordance with ASC 410-20-35-9, a reporting entity may not reduce the reported amount of an ARO as a result of any assurance arrangement it may have been provided, such as a surety bond, letter of credit, or trust fund. For example, the impact of establishing a nuclear decommissioning trust fund or a sinking fund arrangement should be reflected in the reporting entity’s credit adjusted risk-free rate, but not in the amount of expected cash flows to settle the ARO.
If changes occur to the funding and assurance provisions after initial measurement, there will be no effect on the initial measurement of the liability. However, the changes in these provisions should be considered if there is an upward revision or change in timing of cash flows in which the current credit-adjusted risk-free rate will be utilized (i.e., in the creation of new ARO layers).
Additionally, unless all of the conditions in ASC 210-20-45-1 are met, potential recoveries under indemnification agreements relating to AROs should not be used to offset the reported amount of the liability recorded. This is because the indemnification arrangement is considered a separate unit of account from the ARO.

3.4.3.6 Calculating an ARO using an expected present value technique

As discussed in PPE 3.4.2, ASC 410-20-30-1 indicates that given the nature of an asset retirement obligation, an expected present value technique will usually be the only appropriate technique with which to estimate the fair value of the liability for an ARO. When estimating the fair value of an ARO using this technique, a reporting entity should assign probabilities to a range of cash flow estimates, which are then discounted using a credit-adjusted risk-free rate.
Example PPE 3-5 illustrates the application of the expected present value technique to the dismantling of a nuclear power plant.
EXAMPLE PPE 3-5
Applying the expected present value technique
Rosemary Electric & Gas Company owns a nuclear power plant that it plans to decommission in 2030 and is determining the initial fair value of its asset retirement obligation.
Which scenarios might REG consider in its expected present value calculation?
Analysis
Management determines that there are three potential scenarios for retirement of the asset (amounts in millions):
Probability
Timing
Estimated third-party cost
Credit adjusted risk-free rate
Present value
Probability-weighted present value
Dismantle in 2030; use U.S. Department of Energy (DOE) disposal facilities
65%
2030; one-time cost
$1,775
10%
$161
$105
Entomb plant in 2030; ongoing monitoring for 50 years
30%
2030; Annual
1,500
10
10%
10%
137
41
Dismantle in 2030; DOE facilities are not available, third party paid to assume disposal liability
5%
2030; one-time cost
5,000
10%
455
23
Expected value
$169
Based upon the above analysis, Rosemary Electric & Gas Company would initially recognize an ARO liability of $169 million, with a corresponding ARC of $169 million.

3.4.4 Subsequent measurement (AROs)

Subsequent to initial measurement, a reporting entity should recognize changes in the asset retirement obligation that result from (a) the passage of time and (b) revisions made to the timing or amount of future cash flows. A change that is due to the passage of time should be incorporated into the liability prior to reflecting revisions as a result of changes in the timing or amount of estimated cash flows. Reporting entities should evaluate their estimates of cash flows relating to AROs each reporting period and consider whether such estimates remain appropriate or require adjustment.

3.4.4.1 Changes due to passage of time (AROs)

The asset retirement obligation liability should be adjusted for the passage of time by accreting the balance using the interest method over the period from initial measurement to the expected timing of settlement. In applying this method, the reporting entity should use the credit-adjusted risk-free rate applied when the liability was initially measured.
Changes resulting from the passage of time should be recognized as an increase in the carrying amount of the liability (i.e., accretion of the ARO), with a corresponding expense recognized as a period cost classified in the operating section of the income statement. ASC 410-20-45-1 allows this amount to be combined with other amounts as long as the description “conveys the underlying nature of the expense.” However, in accordance with ASC 835-20-15-7, accretion expense cannot be included in capitalized interest costs.

3.4.4.2 Revisions to the timing and amount of cash flows (AROs)

Changes in the estimate of timing and cost to settle the obligation as a result of continued use of the asset, changes in available technology, or other factors should be recognized in the period of change as an increase or decrease in the carrying amount of the asset retirement obligation and the related asset retirement cost. This adjustment will not have any immediate income statement impact in the period of change; however, it will impact the prospective amortization and accretion expense.
The discount rate used to calculate the new ARO and asset retirement cost “layer” will depend on whether there is an upward or downward revision in estimated cash flows, as discussed in ASC 410-20-35-8.

Excerpt from ASC 410-20-35-8

Upward revisions in the amount of undiscounted estimated cash flows shall be discounted using the current credit-adjusted risk-free rate. Downward revisions in the amount of undiscounted estimated cash flows shall be discounted using the credit- adjusted risk-free rate that existed when the original liability was recognized. If an entity cannot identify the prior period to which the downward revision relates, it may use a weighted-average credit-adjusted risk-free rate to discount the downward revision to estimated future cash flows.

As the recording of the revision for an upward adjustment to the undiscounted future cash flows represents a new liability, the upward revision follows the initial measurement guidance of ASC 410-20. The concepts of ASC 820 apply in determining this new “layer” associated with the existing ARO. The unit of account for measurement of an upward revision is specified in ASC 410-20-55-39 through ASC 410-20-55-41 as being only the incremental cash flows.
A reporting entity should be careful to evaluate revisions to the amount of cash flows and determine whether they are a change in estimate based on new information received during the current reporting period or the correction of an error in the initial estimate. Reporting entities should establish a process for evaluating their AROs on a consistent basis to capture cash flow revisions timely.
When a revision to the timing but not the amount of cash flows occurs, ASC 410-20 is not clear on how to account for the change, including which credit-adjusted risk-free rate to use when remeasuring the ARO (i.e., the current rate or the rate that was in place at the time of the original estimate). Similar to an upward revision due to an increase in estimated cash flows, we believe that changes in the timing of expected cash flows should be discounted using the current credit-adjusted risk-free when the revision is made, regardless of whether the expected timing of settlement has increased or decreased. This rate should be applied to all cash flows associated with the ARO as it is only a change in timing of cash flows. However, using the credit-adjusted risk-free rate that was in place at the time the original estimate was made may also be acceptable. Whichever method is used should be applied consistently.
If a revision is due to changes in both the timing and estimate of cash flows, reporting entities should follow the specific guidance provided in ASC 410-20 for an upward or downward revision. For example, if there is a downward revision in estimated cash flows and an increase in the timing of when the ARO is expected to be settled (i.e., the retirement will occur further into the future), the reporting entity should use the credit-adjusted risk-free rate in place at the time when the original estimate was made.
Example PPE 3-6 explores revisions of AROs and their impact to cash flows.
EXAMPLE PPE 3-6
Evaluating an upward revision in estimated cash flows
Oil Co completes construction of an offshore oil platform and places it into service on January 1, 20X1. Oil Co is legally required to dismantle and remove the platform at the end of its useful life, which is estimated to be 10 years. The expected cash flows on January 1, 20X1 are $800,000. The credit-adjusted risk-free rate is 8.5% on January 1, 20X1. On December 31, 20X1, Oil Co determines that the ARO will require $100,000 more than the original estimate of $800,000. At the time of the revision, Oil Co’s credit standing has improved, causing the credit-adjusted risk-free rate to decrease by 0.5% to 8%.
How should Oil Co record the impact of the revised cash flow estimate?
Analysis
As the revision is an upward revision in expected cash flows, the incremental cash flows of $100,000 would be present valued using the new 8% discount rate. The ARO liability would be increased, with a corresponding increase to the asset retirement cost. The amount recorded related to the original $800,000 estimate would remain unchanged on December 31, 20X1 (i.e., the discount rate for that portion of the expected cash flow would not be updated).

Question PPE 3-8
What is the impact of a downward revision of an ARO that exceeds the carrying value of the related asset retirement cost (ARC)?
PwC response
Subsequent to establishing an ARO, if a reporting entity experiences a downward revision in the liability due to a change in the expected timing or amount of cash flows, a corresponding decrease should be recorded to the asset retirement costs. Due to the differences in the pattern of accretion of the ARO and the amortization of the ARC, the reporting entity may experience a decrease in the carrying amount of the ARO that exceeds the undepreciated ARC. In such cases, the ARO liability should be reduced to reflect the change. Generally, we believe the offsetting credit should first reduce the ARC, and the additional credit should be recorded against the underlying asset to which the ARC relates, but only until the asset balance is reduced to zero. After reducing the ARC and related underlying asset balance to zero, any additional credit should be recorded to income. This is based on the premise that the ARC and related asset to which it relates are viewed as a single unit of account, which was described in paragraph B42 of the Basis for Conclusions of ASC 410-20 (FAS 143).
However, we are aware of industry practice for regulated power and utility whereby the carrying amount of the underlying asset to which the ARC relates is not reduced in this scenario (i.e., the ARC and underlying asset are not viewed as a single unit of account). In such cases, for regulated entities, the ARO is reduced to reflect the change and the remaining undepreciated ARC is derecognized with a gain recognized in the income statement for any difference.
Question PPE 3-9
Should a reporting entity remeasure an ARO that is accounted for based on a license agreement’s original term when it considers extending the term prior to extending the license agreement?
PwC response
Yes. A change to the expectation of when an ARO will be settled would be a trigger for remeasurement. A reporting entity should include in the remeasurement of its ARO a scenario in which the license agreement is renewed and retirement of the asset is delayed. The weight assigned to this probability should consider all relevant facts and circumstances, such as management’s past success in obtaining similar licenses and the economics of the asset. A change in the expectation of renewal may impact the depreciable life or expected salvage value of the asset.
1 As these costs are incurred each year, they should be discounted based on the applicable rate for each year; however, for illustrative purposes the same rate is used for all cash flows in this example.
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