Accounting Standards Codification 410 (ASC 410) was released to address the more specific topic of asset retirement obligations and environmental obligations companies have for conducting certain types of business.
Concept of ARO under ASC 410
Conceptually, an Asset Retirement Obligation (or ARO) is a liability which is setup for the eventual disposal of an asset. Certain types of assets are required by the government to be disposed of in specific ways. As there is a legal obligation to dispose of these, the cost can be estimated and therefore the expense may be accrued for ahead of time. One example would be a coal strip mining operation. Once the coal has been mined, the government typically requires the mining company to plant new grass, trees, etc. on top of the area mined rather than leave it stripped bare. The cost of the grass and tree planting would be the retirement obligation.
These use of an ARO is highly utilized in real estate type transactions, such as:
- Leased premises
- Owned premises
- Promissory estoppel
- Adjust the expected cash flows based on what the market risk. In order to do this, there must be a market risk premium, based on the risk-free interest rate to discount the future cash flows adjusted for risk.
- Adjust only the risk free interest rate to incorporate the risk premium, rather than the expected cash flows.
Check out more high level explanations of the FASB ASC in our Guide to the Accounting Standards Codification!
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