Asset retirement obligations (AROs) are technical accounting measures used to determine the liability on assets that occur during the life of the assets. The Financial Accounting Standards Board (FASB) issues the standards regarding the recognition and accounting of these obligations. Companies must pay close attention to the accounting periods for an ARO recognition and measurement.
SFAS 143
The Statement of Financial Accounting Standard (SFAS) 143 is the leading accounting principle regarding asset retirement obligations. An ARO deals with the costs associated with the retirement of long-term assets owned by a company. Although no cash is spent by the company on the ARO, it is considered a liability for accounting purposes. An accounting liability is a probable future event that results in a loss of benefits to the company.
Examples of AROs
Most AROs fall in the manufacturing or energy industries; plants owned by these companies are sometimes required to close after the business operations have ceased at these facilities. Research and development operations will sometimes have an ARO once the R&D operations are finished and the developed product is placed into full-time manufacturing. Other tangible assets may require an ARO liability to be recorded based on the asset type and industry.
Initial Recognition
An ARO is to be recorded in the accounting period when the ARO is discovered to be a liability as defined by Generally Accepted Accounting Principles (GAAP). Two types of ARO categories exist: events involving the construction or acquisition of an asset, or events that occur during the asset's operation. When an ARO liability that falls into either of these categories occurs, a liability must be recorded to account for the ARO.
Initial Measurement
Once an ARO liability is determined to have occurred, the ARO needs to be measured and accounted for in the company's accounting department. SFAS 143 states that the ARO measurement should equal the fair value of the ARO, which is the amount a willing seller would purchase the asset for at the end of the asset's life. The Financial Accounting Standards Board (FASB) has stated that using discounted cash flows is the best way to determine the fair value of an asset.
Cash Flow Estimates
Basic cash flow estimates require a company to estimate the amount of cash it will receive in the future for an asset and discount it back to present day using a calculated interest rate. Variations on cash flow analysis are possible, but FASB has ruled that this is the best option to estimate the liabilities incurred by ARO measurements. When estimating cash flows, businesses must include such factors as inflation, overhead and profit margin in their calculations; other requirements may be necessary based on FASB's definition of discounted cash flows.
Read more : http://www.ehow.com/about_5197598_asset-retirement-obligation_.html By Osmond Vitez, eHow Contributor