United States: Accounting for the Costs of Retiring Tangible Long-Lived Assets: Environmental Implications

Since 2002, when the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) Number 143, entities that use FASB’s generally accepted accounting principles have been required to account for the costs of retiring long-lived tangible assets, asset retirement obligations (AROs). Under SFAS 143, entities are required to recognize AROs when the timing and the cost of legally-required retirement activities can be reasonably estimated.

The most straightforward application of SFAS 143 involves a nuclear generating facility, where Nuclear Regulatory Commission rules require the licensee to establish a trust to fund NRC-required decommissioning activities at the end of the useful life of the facility. Under SFAS 143, the nuclear licensee would be required to presently report the fair value of the decommissioning costs as an ARO.

By the end of 2003, those entities that comply with FASB standards should have catalogued their long-lived assets, identified those assets that have legally-required retirement obligations and, where possible, reported a fair present value of the retirement costs.

FASB reportedly became concerned that "conditional" AROs (sometimes referred to as CAROs), i.e., obligations that are contingent on some future event or decision, were being incorrectly reported. For example, for assets with no legally established retirement date, some entities would not report an ARO until or unless the entity selected a specific retirement date and/or retirement cost. Other entities would recognize the fair value of a retirement obligation only when a likely retirement date and cost could be estimated. Finally, other entities used probability analysis to calculate the fair value of a future conditional ARO.

In March 2005, FASB issued Interpretation Number 47 (FIN 47) to clarify when an entity would have sufficient information to reasonably estimate the fair value of a conditional ARO.

FIN 47 clarifies that a conditional ARO should be calculable where the retirement cost is included in the cost of acquiring the asset or where there exists an active market for the conditional ARO. In other cases, the conditional ARO should be estimated using probability analysis to estimate the reasonable life-span and retirement costs of the asset. In other words, if a probable range of likely life-spans and a probable range of likely retirement obligation costs can be reasonably estimated, the present value of the ARO should be calculated and reported. SFAS requires an explanation when the asset retirement obligation cannot be reasonably estimated.

FIN 47 also explains that the cost of removing an asset is not included in the calculation of an ARO if the asset is removed pursuant to an entity’s self-selected, rather than legally imposed, maintenance and replacement schedule. In such cases, an ARO may still exist with respect to the costs of disposing of the replaced asset, if the asset has special legally-imposed disposal obligations. Examples are discussed below.

Finally, neither SFAS 143 nor FIN 47 apply to AROs that are "immaterial." FASB did not further quantify this materiality threshold. Presumably the appropriate materiality threshold will be determined by each entity’s outside accounting consultant.

Often, there are environmental liabilities associated with the retirement of certain tangible long-lived assets. SFAS 143 makes it clear that liabilities that result from the improper operation of the asset, such as spills, are not to be included in calculating the ARO. SFAS 143 does not clearly define "improper" operations. There is some debate about whether all spills can be fairly considered to have been "improper" or whether there are spills and releases that occur as part of the normal "proper" operation of an asset. The costs of cleaning up spills and releases that resulted from "proper" operations may need to be estimated, calculated and reported as an ARO. Obvious examples of such clean ups include the costs of decommissioning a nuclear generating facility or the closing of a licensed, properly operated landfill.

If the environmental liabilities that will be incurred at retirement are the result of the improper operation of the asset, i.e., spills or other unplanned releases, then either the contamination is presently known, presently reportable under other standards and must be presently addressed, or the contamination is unknown and it may be impossible to reasonably estimate the associated liability. SFAS 143 does not mandate environmental testing or investigation.

Asbestos must be handled and removed according to state and federal legal requirements whenever an asbestos containing asset is renovated, demolished or otherwise removed. The costs of such activities are known because there is an active market for this service. Thus, when an entity is able to estimate a range of renovation or demolition dates, the costs of asbestos removal and disposal may need to be reported as an ARO. A reportable federal ARO may have been created as early as 1975, but was most likely created in 1990.

FIN 47 uses chemically treated wood poles as a clarifying example and explains that an entity with such assets, e.g., an electrical utility company’s transmission poles, must estimate the range of the useful life of the pole and the range of likely disposal costs and report accordingly. As mentioned above, the ARO does not include "removal" costs that occur as part of a scheduled maintenance or replacement. If a chemically treated pole is taken down and disposed as part of the company’s maintenance plan, only the hazardous waste disposal component of the obligation is reported as an ARO. In those states that do not have special treated wood disposal rules, this may not apply.

Some kilns, boilers or similar assets, contain ceramic bricks that become contaminated in the normal course of operation and require special disposal as hazardous waste. Again, FIN 47 explains that the ARO does not include "removal" costs associated with activities that occur as part of a scheduled maintenance or replacement, even when the disposal costs are included in estimating the ARO.

FIN 47 has created some alarm in the environmental community, since many environmental cleanup obligations are conditioned on future events. Nevertheless, as a general matter, SFAS 143 and FIN 47 will not apply to typical environmental remediation liabilities.

SFAS 143 expressly exempts cleanup obligations that result from "improper" operation of an asset. Thus, environmental damage caused by leaks, spills, or any other release that is not an intended or "proper" part of the operation of an asset, are not subject to the standard. Note, however, that there are other FASB generally accepted accounting principles that apply to environmental remediation liabilities, e.g., SFAS 5, SOP 96-1.

Environmental remediation obligations are not typically "retirement" obligations. Environmental cleanup obligations are typically triggered by the discovery of a contaminated asset, not by the retirement of the asset. Cleanup is legally required when state and federal contamination thresholds are exceeded, not when an asset is retired.

FIN 47 is effective for the 2005 accounting year. FIN 47 requires retroactive application to existing conditional AROs. In reporting a conditional ARO, an entity must recognize: (1) conditional ARO costs adjusted to March 2005 to account for cumulative accretion; (2) conditional ARO costs capitalized as an increase to the carrying amount of the asset; and (3) the accumulated depreciation on the conditional ARO capitalized cost.

Estimating and reporting AROs involves the input of operation and production personnel (to identify an entity’s long-lived tangible assets), legal counsel (to identify legal requirements associated with the retirement of the asset), engineering personnel (to identify the range of costs associated with the legally-required retirement activity), and accounting personnel (to run the probability analysis, make the materiality determination, and formally recognize the conditional ARO).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.