When an asset is permanently removed from service, it is counted as retired. Some processes that can lead to asset retirement include disposal because of obsolescence or a sale to another party. Long-term assets typically make up much of the assets of a company, so it is important to place controls on them to ensure the asset retirement processes fit standard accounting rules. Although these methods sometimes require the help of a certified public accountant, you can take some steps to smooth out the process.
What is Asset Retirement?
Accounting for asset retirement can be referred to as the accounting principle set by the FASB (Financial Accounting Standards Board). This principle requires public companies to acknowledge the fair value of physical, long-term assets retirement obligations. This rule ensures that the precise value of a company’s existing assets is carried on the balance sheets. This balance sheet is similar to the income statement based processes previously used by some companies. Although small businesses may not be affected by this rule, it is smart to follow it to ensure accurate accounting.
Asset Retirement Obligations (ARO)
Accounting for asset retirement obligations is designed to address a company’s legal responsibilities stemming from standard operation, growth, building, or acquisition of a physical asset. Asset retirement obligations can either be incurred at the starting point of a company’s asset life or during its operating lifetime. ARO does not cover other obligations related to an asset inappropriate operation such as those liabilities affiliated to environmental remediation processes. Check here.
Balance Sheet and Asset Retirement
According to rule 143 of FASB, a company must elevate an asset retirement obligation at the fair value of that asset. The fair value of the retired asset is a representation of the liability of the balance sheet of the company. The fair value is the amount a consenting and knowledgeable party would agree to take over the obligation of a particular asset. The FASB rule allows for a certified public accountant (CPA) to estimate the fair value if there is no available market for the retired asset or no such parties exist.
Variables and Asset Retirement
Calculating asset retirement obligations vary from case to case and can be complicated. However, there are two variables that are often used. The first variable involves estimating the cash flow that was received from the last asset. These estimates require accurate forecasts of profit margins, technological process, employee wages, and inflation rates. The level of effective interest rate is the other variable. This reflects interest rates and credit risk adjustments from year to year.
Asset Retirement Obligation Example
A typical example is an oil drilling site with a lease of 40 years. A well is created and a drilling platform is erected after about 5 years of holding the lease. The well and the platform have a 40 years estimated useful life. Presently, the cost of removing the well and platform as well as cleaning up the site is $15,000. It is estimated that the inflation for that remediation and removal work over the next 40 years is about 2.5 percent/year. So the credit-adjusted risk-free borrowing rate is 8 percent. Since the life of the well and the drilling platform can’t go beyond the life of the lease, it is expected that rig and well will be retired after 35 years. Check out this site: https://opportune.com/Investment-Banking/