Asset Retirement Obligations Flashcards
What is the definition of an asset retirement obligation?
An asset retirement obligation is a <u>legal obligation</u> associated with the retirement of a tangible long-lived asset that an entity is required to settle as a result of a law, contract, or under the doctrine of promissory estoppel.\n\n
Angora Inc. recently sold a gas station, that they were operating for 25 years. They will now have to pay $100,000 to install new gas lines for the future owners. This expense was forseeable when they purchased the gas station 25 years ago. Does the sale of the gas station qualify as the retirement of a tangible long-lived asset??
Yes - the gas station is being sold and “permanently” taking an asset out of service means that the asset is either sold, abandoned, recycled or disposed of in some manner.
What is the definition of promissory estoppel?
Promissory estoppel means that a promise without consideration is still enforceable when there has been reliance on a promise that was reasonable and foreseeable and damage would result to the party the promise was made to if not enforced.
Under IFRS, a constructive obligation is included as an ARO and a liability must be accrued. What is a constructive obligation?
<em>A constructive obligation is an obligation that derives from an entity’s actions where:</em>\n\n<em>(a) by an established pattern of past practice, published policies or a sufficiently specific current statement, an entity has indicated to other parties that it will accept certain responsibilities; and</em>\n\n<em>(b) as a result, an entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.</em>
Capital Ltd. did not recognize an ARO when they purchased a mine. They argued that they could not estimate the liability they would ultimately incur when disposing of the mine. Is Capital Ltd. correct?
Yes - an ARO is only recognized in the period incurred when a reasonable estimate of the amount of the obligation can be made.
Since AROs normally cover long periods of time, does one have to discount the ARO in estimating the liability?
No - while it may be appropriate in many cases to discount the liability, it is not obligatory and the entity should use the best technique to estimate the liability, which may or may not be discounting.
Silex Corp recently purchased a machine that manufactures bottles, for $800,000 cash. The machine is expected to last 10 years, at which point it will be scrapped and Silex will incur a cost to dispose of it. What is the journal entry, assuming an ARO in connection with disposing of the machine of $20,000, at the time of the initial purchase?
The journal entry would be:\n\nDr. machine $820,000\n\nCr. cash $800,000\n\nCr. ARO $20,000\n\nThe ARO is added to the carrying amount of the asset and Silex Corp. was able to estimate the ARO upon purchase of the machine.
ABC Ltd. purchased a machine for $400,000 cash and planned on disposing of the machine in 15 years. At that point in time they expect to have to pay $30,000 in costs, to clean up the environment. Does the ARO have to be allocated to expense over the same period as the depreciation of the machine, i.e. 15 years?
No - the entity only allocates the asset retirement cost to expense using a systematic and rational method over its useful life (e.g. usually amortized on same basis as related asset, but does not have to be). Therefore 15 years does not have to be used.
Assuming an entity is discounting an ARO and sets up the full ARO upon purchase of the asset, will there be a journal entry in subsequent years, in connection with the ARO, and if yes, which accounts will be impacted under IFRS?
There will be a yearly journal entry to account for the time value of money, i.e. each year brings the discounted liability closer to maturity and the journal entry will be a debit to accretion expense and a credit to the ARO liability.\n\n\n\n
Assuming an entity is discounting an ARO and sets up the full ARO upon purchase of the asset, will there be a journal entry in subsequent years in connection with the ARO, and if yes, which accounts will be impacted under ASPE?
There will be a yearly journal entry to account for the time value of money, i.e. each year brings the discounted liability closer to maturity and the journal entry will be a debit to interest expense and a credit to the ARO liability.\n\n
Inbal Inc. estimates it will have to spend $1,000,000 in 10 years from now to remediate a site. They plan on discounting the ARO using an 8% discount rate. What is the initial ARO liability and what is the first and 2nd year journal entries, assuming no change in their expectations re the ARO (under IFRS)?
The initial ARO liability will be $463,193 ($1,000,000 present valued back 10 years at 8%).\n\nThe first year journal entry is: Dr. Accretion expense $37,055 (8% x $463,193)\n\nCr. ARO liability $37,055\n\nThe second year journal entry is: Dr. Accretion expense $40,020 (8% x ($463,193 + $37,055))\n\nCr. ARO liability $40,020\n\n
How would a change in the ARO usually be recognized in the financial statements - as a change in accounting policy - retrospectively; as an error - retrospectively; or as a change in estimate - prospectively?
Normally, changes in the ARO result from changes in circumstances and would therefore be accounted for as a change in estimate, prospectively (unless a mistake was previously made which would constitute an error).
Renco Inc. approached their auditor in the current year and requested that the auditors reduce their ARO by $400,000, as a result of some recent preliminary studies that were published, showing that fewer cleanup activities were necessary because of improved technology. Is Renco Inc. correct?
No - Renco Inc. is not correct, as in order to reduce the ARO as a result of future technological improvements, there must be sufficient objective evidence that the technological improvements will be available. In this case, preliminary studies would not be sufficient to constitute “sufficient objective evidence” and therefore the ARO should not be reduced on this basis.
Polymer Ltd. has requested from their auditor that they reduce their ARO by $100,000 as a result of new legislation that the Liberal Party is likely to implement in parliament, assuming they have the support of the NDP. Should the auditor comply with this request?
No - the auditor should not comply with this request, as the ARO should only be reduced if the new legislation is virtually certain to be enacted. Given that the Liberals believe it is “likely” at this stage and the fact they are reliant on another Party’s consent, means that it is not “virtually certain” to be enacted and the ARO should not be reduced.
If an ARO needs to be decreased to such an extent, that the decrease will exceed the value of the asset, where would the excess amount be recognized in the financial statements (under IFRS)?
The excess amount should be recognized immediately in the income statement.
