Recognition of Asset Retirement Obligations

Topics: Asset, Law, Obligation Pages: 5 (1208 words) Published: September 29, 2014
To: Controller of LOI, Files
From: Accounting Class
Re: Recognition of Asset Retirement Obligations for Lack of Information Date: June 2, 2014

Background
Lack of Information (LOI) owns and operates 50 warehouses throughout the country. As part of LOI’s efforts to identify potential asset retirement obligations, LOI’s internal audit group held interviews with all 50 of the warehouse managers and also performed site visits at each of the 50 locations. The related findings of the interviews and site visits noted the following facts: Number of Warehouses

State Laws
Plans to Sell
25 w/ no asbestos
N/A
N/A
2 w/ asbestos
No state requirements re: removal of asbestos when significantly renovated or demolished Under contract to sell
Buyer has option to require LOI to remove asbestos
LOI believes only 10% chance Buyer will require removal
10 w/ asbestos
State laws requiring removal of asbestos when significantly renovated or demolished To be sold w/in 5 years
13 w/ asbestos
State laws requiring removal of asbestos when significantly renovated or demolished Plan to operate indeterminately

Issue
Should LOI recognize an asset retirement obligation for each of the categories of warehouses with asbestos? Analysis
FASB Accounting Standards Codification (ASC) Subtopic 410-20 Asset Retirement Obligations presents the relevant guidance on asset retirement obligations. Per ASC 410-20-15-2, asset retirement obligations include: “a. Legal obligations associated with the retirement of a tangible long-lived asset that result from the acquisition… and (or) the normal operation of a long-lived asset...  c. A conditional obligation to perform a retirement activity. Uncertainty about the timing of settlement of the asset retirement obligation does not remove that obligation from the scope of this Subtopic but will affect the measurement of a liability for that obligation.” Additionally, ASC 410-20-15-3 excludes the following from this scope of this Subtopic: “f. An obligation for asbestos removal that results from the other-than-normal operation of an asset...”

The state laws requiring the removal of the asbestos upon significant renovation or demolition of the warehouses and the contracts requiring removal of the asbestos at the option of the buyer do not relate to the other-than-normal operation of the warehouses. As such, these requirements represent obligations that are within the scope of Subtopic. Recognition of an asset retirement obligation under ASC 410-20 requires an entity to be able to reasonably estimate the fair value of the obligation. Per ASC 410-20-25-4: “An entity shall recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made.” 

Two Warehouses without State Laws Under Contract to Sell
The sales contracts under which the Buyer may require LOI to remove the asbestos prior to the transfer of the warehouses creates Conditional Asset Retirement Obligations, which the Codification defines as: “A legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity.” Although LOI contends that the low probability of the Buyer requiring LOI to perform the removal activity, ASC 410-20-25-7 states, “An expected present value technique incorporates uncertainty about the timing and method of settlement into the fair value measurement. Uncertainty is factored into the measurement of the fair value of the liability through assignment of probabilities to cash flows.” As a result, the low probability that the Buyer will exercise its option to require LOI to remove the asbestos will be reflected in the measurement of that liability, but such probability does not affect LOI’s ability to estimate the fair value of the liability. Therefore, LOI must recognize this Conditional Asset Retirement...
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