Case Study Fasb Codification
FASB Codification/ARO Case
1. According to FASB the asset retirement obligation should be recorded in the period in which the liability meets FASB’s definition of a “probable future sacrifice of economic benefits arising from a present obligation,” and in which its amount can be reasonably measured. Uncertainty with respect to the timing or method of settlement that is conditional on future occurrences does not affect the recognition of the liability but may be factored into its measurement.
The obligation is to be recorded at fair value, which represents the amount that a third party would require to assume the liability. If an active market for these obligations does not exist, the company must use the expected present value technique
outlined in Statement of Financial Accounting Concepts 7, Using Cash Flow Information and Present Value in Accounting, which results in measuring the asset’s and related liability’s present value by using each company’s credit-adjusted rate. In this case risk-free interest rate of 9% will be used.
2. Capitalized cost of the coal mine is determined as:
Purchase of rights to operate a coal mine 15,000,000
Development costs 6,000,000
Restoration costs
3,000,000 x 20% = 600,000
4,000,000 x 30% = 1,200,000
5,000,000 x 25% = 1,250,000
6,000,000 x 25% = 1,500,000 4,550,000 x 0.77218 (PV of $1, n = 3, i = 9%) 3,513,419
Total cost 24,513,419
3. Journal entry to record the acquisition costs of the mine is
Coal mine 24,513,419
Cash 21,000,000
Asset retirement liability 3,513,419
4. FASB says that accretion expense is calculated by multiplying the beginning of the period liability balance (3,513,419) by the credit adjusted risk-free rate (9%) that existed when the liability was first measured. So, in 2013 the company will record $316,208 of accretion expense in its income statement. The liability on the other hand should be adjusted for accretion prior to adjusting for revisions in estimated cash flows.
According to FASB 45-1, accretion expense should be classified as an operating item in the income statement and “an entity may use any descriptor for accretion expense so long as it conveys the underlying nature of the expense”.
5. If the restoration costs differed from the recorded liability in three years, a loss (gain) on retirement of the obligation is recognized for the difference.
The journal entry to record the payment of the asset retirement obligation in three years is
Asset retirement liability 4,550,000
Loss on asset retirement liability 150,000
Cash 4,700,000
6. FASB says that a company should disclose all of the following information about its ARO: * A general description of the AROs and the associated long-lived assets * The fair value of assets that are legally restricted for purposes of settling AROs * A reconciliation of the beginning and ending aggregate carrying amount of AROs showing separately the changes attributable to the following components, whenever there is a significant change in any of these components during the reporting period: 1) liabilities incurred in the current period 2) liabilities settled in the current period 3) accretion expense 4) revisions in estimated cash flows. Also if the fair value of an asset retirement obligation can’t be reasonably estimated, that fact and reason should be disclosed as well.
1. According to FASB the asset retirement obligation should be recorded in the period in which the liability meets FASB’s definition of a “probable future sacrifice of economic benefits arising from a present obligation,” and in which its amount can be reasonably measured. Uncertainty with respect to the timing or method of settlement that is conditional on future occurrences does not affect the recognition of the liability but may be factored into its measurement.
The obligation is to be recorded at fair value, which represents the amount that a third party would require to assume the liability. If an active market for these obligations does not exist, the company must use the expected present value technique
outlined in Statement of Financial Accounting Concepts 7, Using Cash Flow Information and Present Value in Accounting, which results in measuring the asset’s and related liability’s present value by using each company’s credit-adjusted rate. In this case risk-free interest rate of 9% will be used.
2. Capitalized cost of the coal mine is determined as:
Purchase of rights to operate a coal mine 15,000,000
Development costs 6,000,000
Restoration costs
3,000,000 x 20% = 600,000
4,000,000 x 30% = 1,200,000
5,000,000 x 25% = 1,250,000
6,000,000 x 25% = 1,500,000 4,550,000 x 0.77218 (PV of $1, n = 3, i = 9%) 3,513,419
Total cost 24,513,419
3. Journal entry to record the acquisition costs of the mine is
Coal mine 24,513,419
Cash 21,000,000
Asset retirement liability 3,513,419
4. FASB says that accretion expense is calculated by multiplying the beginning of the period liability balance (3,513,419) by the credit adjusted risk-free rate (9%) that existed when the liability was first measured. So, in 2013 the company will record $316,208 of accretion expense in its income statement. The liability on the other hand should be adjusted for accretion prior to adjusting for revisions in estimated cash flows.
According to FASB 45-1, accretion expense should be classified as an operating item in the income statement and “an entity may use any descriptor for accretion expense so long as it conveys the underlying nature of the expense”.
5. If the restoration costs differed from the recorded liability in three years, a loss (gain) on retirement of the obligation is recognized for the difference.
The journal entry to record the payment of the asset retirement obligation in three years is
Asset retirement liability 4,550,000
Loss on asset retirement liability 150,000
Cash 4,700,000
6. FASB says that a company should disclose all of the following information about its ARO: * A general description of the AROs and the associated long-lived assets * The fair value of assets that are legally restricted for purposes of settling AROs * A reconciliation of the beginning and ending aggregate carrying amount of AROs showing separately the changes attributable to the following components, whenever there is a significant change in any of these components during the reporting period: 1) liabilities incurred in the current period 2) liabilities settled in the current period 3) accretion expense 4) revisions in estimated cash flows. Also if the fair value of an asset retirement obligation can’t be reasonably estimated, that fact and reason should be disclosed as well.