FIN 47, Conditional Asset Retirement Obligations

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FIN 47, Conditional Asset Retirement
Obligations

• NARUC Staff Subcommittee on Accounting and
  Finance
• September 19, 2005
• Casey Herman, PricewaterhouseCoopers LLP
• 312.298.4462

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FAS 143 - Asset Retirement Obligations

• Recognition of ARO liabilities at fair value when
  incurred
• Applies to unavoidable existing legal obligations
  associated with retirement as a result of
• Law or regulation
• Contractual obligation
• Promissory estoppel
• Asset retirement cost (ARC) capitalized as part
  of related asset cost, then depreciated
  systematically and rationally

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FAS 143 - Asset Retirement Obligations

• ARO could be incurred at acquisition, ratably
  over life, or upon enactment of new requirements
• Recognition of subsequent changes to ARO due to
  (i) passage of time and (ii) changes in amount
  and timing of estimated cash flows
• Special recognition situations - AROs with
  indeterminate settlement dates
• Within the scope of the standard
• Not recognized if not estimable
• Recognized when amount becomes estimable

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FIN 47 Accounting for Conditional Retirement
Obligations

• Issued March 2005
• Effective date and transition
• No later than the end of fiscal years ending
  after December 15, 2005
• Recorded as a cumulative effect
• Retrospective application for interim periods in
  2005 is permitted, but not required.

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FIN 47 Summary

• Clarifies that a legal obligation associated with
  the retirement of a long-lived asset whos (i)
  timing and (or) (ii) method of settlement are
  conditional on a future event is within the scope
  of FAS 143.
• The obligation is unconditional even though
  uncertainty exists about the timing or method of
  settlement

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FIN 47 Summary

• Accordingly, entities are required to recognize a
  liability for an ARO that is conditional on a
  future event if a fair value can be reasonably
  estimated.
• Uncertainty surrounding the timing and method of
  settlement would be factored into the measurement
  of the liability rather than the recognition of
  the liability.

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FIN 47 Summary

• An ARO would be reasonably estimable if
• Its evident that the fv of the obligation is
  embodied in the acquisition price of the asset,
• An active market exists for the transfer of the
  obligation
• Sufficient information exists to apply an
  expected present value technique

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FIN 47 Summary

• Sufficient information to apply PV techniques
  exists if either
• The settlement date and method of settlement are
  specified by others. For example by law,
  regulation or contract.
• Information is available to reasonably estimate
  (i) settlement date or range of potential
  settlement dates (ii) method or potential
  methods of settlement (iii) probabilities
  associated the potential dates and methods.

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FIN 47 Summary

• If sufficient information is not available at the
  time the ARO is incurred, recognition would be
  required in the period that sufficient
  information becomes available, and disclosure of
  the facts and reasons for the inability to
  estimate shall be disclosed.

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FIN 47 Examples

• Example 1 Chemically Treated Poles
• A telecommunications network utilizes chemically
  treated wood poles. There is no legal requirement
  to remove poles, but the owner replaces the poles
  periodically for operational reasons. Once
  removed from the ground, special disposal
  procedures are required.
• Although the entity may decide not to remove the
  polesor may decide to reuse the poles, the
  ability to defer settlement does not relieve the
  entity of the obligation.
• The poles will eventually need to be removed and
  disposed of since the poles will not last
  forever.
• Conclusion Therefore, an ARO should be
  recognized when the poles are installed.
  Uncertainty surrounding the timing and method of
  settlement should be factored into the
  measurement. If there was a legal requirement to
  remove the poles, the cost of removal would be
  included.

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FIN 47 Examples

• Example 3 Factory with Asbestos
• The factory is maintained by activities that does
  not involve asbestos removal. There is no
  special disposal of asbestos unless factory
  undergoes renovation or is demolished. The
  entity believes it does not have sufficient
  information to estimate the fair value of the ARO
  because the settlement date or range of potential
  settlement dates has not been specified by others
  and info is not available to apply a PV
  technique.
• Although the timing of the performance of the ARO
  is conditional on potential renovation or
  demolish, existing regulations establish a duty
  to the dispose the asbestos in a special manner.
• Conclusion An ARO will not be recognized until
  the range of settlement dates can be estimated.
  The entity should disclose the description of the
  obligation, the fact that the liability can not
  be estimated and the reasons why the liability
  can not be estimated.

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FIN 47 Examples

• Example 4 Factory with Asbestos
• Same facts as example three. Ten years after the
  acquisition date, the entity obtains additional
  information based on changes in demand for
  products manufactured at that factory. At that
  time, the entity has the information to estimate
  a range of potential settlement dates, the
  potential methods of settlement, and the
  associated probabilities.
• Conclusion An ARO would be recognized by this
  entity 10 years after the acquisition date
  because that is when the entity has sufficient
  information to estimate the fair value of the
  ARO.

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FIN 47 Implementation Issues

• Poles - example valuation approach
• Determine expected life of poles
• Group poles by vintage years (or some other
  method?)
• Determine removal dates (or range of dates)
• Determine the method(s) of disposal and the cost
• PV the disposal cost for each group

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FIN 47 Implementation Issues

• Asbestos - example valuation approach
• Determine the extent of asbestos in owned
  facilities
• Determine whether or not asbestos can be
  indefinitely contained
• Determine a range of possible removal dates
• Determine the method(s) of removal and cost
• Apply CON 7 model based on multiple scenarios

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FIN 47 Implementation Issues

• Nuclear generator Does ARO include removal of
  component, storage or only the disposal cost?
• Spent nuclear fuel Interim storage?
• PCB Transformer Often removed as maintenance?
• Pipeline compressor PCB damage not required
  until right of way abandoned
• Power plants - hydro-electric facilities or water
  intake systems under FERC, state or other
  regulatory licenses?
• Coal plants - ash disposal ponds?
• Natural gas fired power plants and natural gas
  pipelines or storage facilities as part of
  license agreements?

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Rate Recovery Considerations

• Differences between amounts collected in rates
  and amounts recognized in accordance with FIN 47
  should be reflected as a regulatory assets and
  liabilities, if the requirements of FAS 71 are
  met.
• Current regulatory liabilities may already
  reflect rate recovery for obligations to be
  recognized in accordance with FIN 47 (i.e.
  poles).
• Possible reclassification of regulatory
  liabilities to asset removal obligation
  liabilities.
• Profit margin embedded in the cost valuation of
  the obligation may not be probable of recovery in
  rates.

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Bookkeeping Complications - Only a Portion of
Retirement Cost is an ARO

• Cost of removal not legally required to remove
  and therefore not an ARO
• Cost of disposal if legally required once item
  is removed it is an ARO
• Salvage value is not accounted for until incurred
• Previous funding and accounting for
  cost-of-removal or negative net salvage

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FIN 47 Day 2 Accounting Matters

• Research and measurement of conditional AROs
• Component-level assets
• ARO or repairs maintenance expense
• Regulatory recovery of depreciation and accretion
  expense
• Salvage values and removal costs imbedded in
  accumulated depreciation
• Record-keeping and reporting
• Unit of accounting / property records
• Mass-units of property
• Existing regulatory liability for cost of removal
• Changes in estimate

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FIN 47 Day 2 Accounting Matters

• Example -
• You have completed the implementation of FIN 47.
  You are now incurring costs associated with the
  removal and disposal process

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FIN 47 Day 2 Accounting Matters

• Example (continued)-
• During the period, you have incurred 100 in
  costs to dispose and remove 5 poles.

Entry 1 To record disposal of the asset DR.
Plant 500 CR. A/D 500 Consistent with
historical application of composite based
depreciation.
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FIN 47 Day 2 Accounting Matters

• Example (continued)-
• During the period, you have incurred 100 in
  costs to dispose and remove 5 poles.

Entry 2 To record the cost of disposal of the
asset DR. ARO ??? DR. Reg.
Liability ??? DR. Gain/loss on
removal ??? CR. Cash 100
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• Questions?