Making Sense of Conditional Asset Retirement Obligations (FIN 47) May 25, 2006

Transcription

1 Making Sense of Conditional Asset Retirement Obligations (FIN 47) May 25, 2006

2 Agenda I. Overview of FASB 143 and FIN 47 II. Key Implementation Questions III. Environmental Specialist IV. Case Study MIT V. Case Study University of Dallas VI. Sample Calculation VII. Concluding Thoughts

3 I. Overview of FASB 143 and FIN 47

4 Issued June 2001 FASB 143 Was intended to apply to accounting for the costs of nuclear decommissioning But FASB expanded scope to include similar removal-type costs in other industries

5 FASB 143 (cont.) Requires entities to record liabilities for tangible, long-lived assets (e.g., buildings containing asbestos) that must be retired or disposed of (i.e., "settled") in a specified way by law or contract. Such liabilities are Asset Retirement Obligations (AROs)

6 FIN 47 Issued March 30, 2005 Why issued? Diverse accounting practices with respect to implementation of FASB 143 Clarifies that FASB 143 applies to all entities with legal obligations to retire long-lived assets Effective for years ending after December 15, 2005 THAT MEANS JUNE 30 TH 2006!!!

7 FIN 47 (cont.) Recognize liability for fair value of Conditional Asset Retirement Obligation (CARO) when incurred if fair value can be reasonably estimated. CARO: A legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. Presumption is nothing lasts forever

8 FIN 47 (cont.) A CARO represents incremental cost only (such as cost to dispose of utility poles rather than the cost to remove such poles) Presumption is nothing lasts forever

9 FIN 47 Basic Concepts Uncertainty surrounds timing and method of settlement Reflect it in measurement of the liability, not recognition of the liability Can the liability be reasonably estimated? Evidence that FV is in acquisition price An active market exists Sufficient information exists to apply an expected present value (PV) technique

10 FIN 47 Basic Concepts (cont.) Initial accounting impacts balance sheet (assets and liabilities) and statement of activities (cumulative effect of change in accounting) Required disclosures: Pro forma disclosure of effect if had been adopted in prior year If can t reasonably estimate will have to disclose this and reasons why

11 II. Key Implementation Questions

12 Do I Have To Develop A List Of All Facilities? If So, How? Campus master plan Campus map List of satellite offices Lease commitment schedule

13 How Can I Find Out Where Work Has Been Performed And Whether CAROs Exist? PP&E lead sheets Lease schedule Environmental reports Campus master plan Renovation plan Long-time employees Deferred maintenance list Past hazmat removal invoices Hazmat notifications to local authorities (police & fire) Minutes of the board s Grounds & Building committee

14 How Can I Estimate the Cost of Remediation? Current fair value of remediation Different remediation options Recent invoices for such work Estimates from a reputable company Where remediation has been performed, there is likely to be valuable data about the remediation cost.

15 How Do I Determine An Appropriate Inflation Rate? May use inflation factor used for budgets May want to use higher rate since specialized skills will be required Must be able to document why inflation rate (and discount rate on next page) is reasonable and appropriate

16 How Do I Determine An Appropriate Inflation Rate? Use risk-free interest rate zero coupon U.S. treasury instruments with maturity dates that coincide with settlement date CON 7 requires an adjustment to the riskfree interest rate to reflect the credit standing of the institution

17 How Do I Estimate An Appropriate Settlement Date? Get input of facilities and other campus groups Range of dates is likely with probabilities Remediation of 10, 20 and even 50 years might be reasonable Will vary depending on remediation approaches and the institution s financial viability

18 Estimating Settlement Date (cont.) Some institutions may choose: Absolute minimum to comply with the applicable legal requirements Cadillac treatment in order to address concerns from students, parents or other interested parties Consider whether dates are: Legally satisfactory? Reasonable? Feasible?

19 How Do I Determine the Probability of Each Option? Once the settlement dates are selected a probability must be assigned to each option based on the likelihood that that particular remediation option will occur at that date. The sum of the probabilities for each individual building or location must equal 100%.

20 III. Environmental Specialists Phil Hagan, JD, MBA, MPH Georgetown University John DeLaHunt, MBA Colorado College

21 Caveat The following information is advisory in nature and should not be construed as a legal opinion Most of the information is based on Federally mandated regulations It is important to evaluate each situation based on applicable regulations for your jurisdiction

22 FIN 47 Environmental Management Perspective In most cases, it will be difficult to accurately quantify liabilities based on existing information available to the university and college community In many cases, regulations do not require mitigation per se of existing liabilities The driving force for mitigation tends to be the potential liability

23 Environmental Factors Toxic contaminants/ Regulated materials Asbestos (building materials assets built pre-1980) Lead (paint, pipes assets built pre-1978) Polychlorinated biphenyls (PCBs) (electrical transformers, capacitors) Mercury (laboratories, HVAC control mechanisms) Radioactive material (laboratories, healthcare, reactors) Petroleum products (fuel and oil) Hazardous waste (laboratories, maintenance facilities)

24 Inflationary Cost Adjustments Urgency of action Planned response vs emergency response Regulations & cost of compliance Current costs Future costs increases or decreases as a result of regulatory change or change in technology Local competition for mitigation services Asbestos (school districts) Lead Based Paint (target housing) Availability of expertise and disposal sites

25 Applicable Environmental Regulations

26 Asbestos OSHA - set PEL at 12 f/cc Clean Air Act NESHAP AHERA regulations (K-12) (40 CFR 763) most asbestos use banned in US CAA NESHAP completely re-written OSHA (work practice regulations) Worker protection regulations

27 Lead Paint the CPSC banned the sale of paint containing in excess of 0.06% lead intended for consumer use Residential Property Renovation (40 CFR ) Work practice standards (40 CFR 239(c))

28 Underground Storage Tanks (USTs) Federal Underground Storage Tank (UST) Program (created by Hazardous and Solid Waste Amendments (HSWA) to the Resource Conversation and Recovery Act). 42 U.S.C. 6991(a)-(i) Remediation of spills (40 CFR 110) Compliance with RCRA standards

29 Radiation Maximum permissible dose (atomic energy commission) Early seventies - ALARA Public dose (NRC 10 CFR )

30 PCBs 1979 Toxic Substances Control Act (TSCA) regulations (40 CFR 761)

31 Mercury/Hazardous Waste 1980 Resource Conversation and Recovery Act (RCRA) (40 CFR 261)

32 Campus Perspective Asset inventory Contaminant inventory Known, suspected Develop future projected cost estimates for mitigation based on the following information: Asset/Contamination inventory Present remediation cost estimates Timeframe for mitigation Periodic re-assessment Written short & long range plans for mitigation Inflation assumptions

33 Key Campus People Environmental Manager or individual(s) with environmental responsibilities Risk Manager Legal Counsel Facilities Director Director of Planning Architect Director of Project Management Controller

34 IV. FIN 47/FAS 143 at MIT FY 2006 implementation process/issues

35 Implementation goals - Full compliance with new guidance - Implementation effort appropriate to the significance of the ARO to MIT s financial statements - Good management understanding of impact on financial statements/numbers and disclosure - Simple, well documented calculations and estimates easy to audit

36 Who has been involved? Facilities Facilities finance Facilities capital projects Legal Counsel Environmental Health & Safety staff Treasurer s Office Real Estate gifts held Real Estate assets in investment portfolio Audit Committee Senior Management

37 Process so far Overview of Fin 47 to Audit Committee & Senior Management -- summer & fall, 2005 Participation in educational events/conference calls Meetings with Facilities/EHS/Treasurer s Office staff to identify relevant obligations & develop methods to estimate Involve legal counsel to clarify relevant legislation Work with APC and other higher ed colleagues to test calculation template developed by Dale Larson

38 Possible asset retirement obligations considered - Asbestos - Lead paint - Soil remediation - Nuclear reactor - Leases (requirement to restore to space to original condition at end of lease) - Linear accelerator - Lab decontamination - Gifts of real estate - Real estate in investment portfolio

39 Challenges/Issues Identification of unabated asbestos by building extremely time-consuming in relation to $ of exposure; seeking highlevel methods to estimate exposure (by building) Legislation effective dates; asbestos, soil remediation Need to engage other offices deeply; even when ARO is not likely to be material, some analysis must be done to satisfy audit requirements Support for/documentation of assumptions Contractor risk premium Construction inflation Credit adjusted risk free rate

40 V. Case Study University of Dallas A Small Institution s perspective: Getting Started Implementation process Implementation challenges

41 Getting started Small Institution Determine what we need to do Contact audit firm, web-sites, and colleagues FAS 143 particularly Appendix D Transition entries illustrated PWC article Accounting for ARO Data elements to be collected What information and assumptions must be made?

42 Challenges Most of the data didn t reside in the accounting office My greatest fear: Preparing an accounting estimate based on committee consensus Couldn t afford nor had time to prepare asbestos surveys Motivation Helping with FIN 47 was NOT on the Facilities Dept to-do list

43 Who needed to be involved? Facilities & Planning Areas Search for existing documentation Prior year surveys what reports presently exist Past major renovations - institutional history Future major renovation projects Audit & Budget Committees Update Bank representative Advise on credit adjusted risk free rate

44 Methodology No annual budget for abatement Abatement done when major renovations occur Review existing environmental reports: Summarized By building capitalization of ARO cost always relates to the related long-lived asset Schedule by Type of abatement required Square foot flooring Square foot ceiling Linear foot piping

45 Methodology Reviewed existing environmental reports, continued Some buildings not surveyed reasonable estimate Surprises, e.g., science lab tables Prior major renovations Discussed with Facilities what abatement was completed Updated environmental report & identified buildings and area needing asbestos removal

46 Where are going with this? Obtain estimates from abatement contractors Use schedule of existing asbestos per building, sq/ln ft Forecast anticipated ARO settlement dates Planned and potential major renovation dates Meeting with Planning / VP to develop probable dates for settlement Buildings not on the near-term abatement plan A building may have multiple settlement dates Confirm liability inception date Prepare calculations, entries, and footnotes

47 VI. Sample Calculation

48 Calculation Assumptions Cost to remove asbestos current cost $375,000 Inflation rate assumed 4.5% Contractor market risk premium 5% Estimated year of settlement 2025 Liability inception date: 1973 Credit adjusted risk free rate 6.2%

49 Undiscounted Expected Cash flows FV of current abatement cost as of settlement date, 2025 $375,500, inflation 4.5% = $904,392 Contractor market risk premium 5% $904,392 x 5% = $45,220 Undiscounted cash flow at 2025 ( $ 904,392 + $ 45,220) = $949,612

50 ARO at Inception Date PV of $ 949,612 back to 1973, assume 6.2% credit adjusted risk free rate ARO liability = $41,598 Capitalize this since it is a cost of the long lived asset Entries that would have been made in 1973 Long lived Asset Dr $ 41,598 ARO Liability Cr $ 41,598

51 Accretion Expense Accretion expense through June 30, 2005 Use interest method of allocation Annual accretion is calculated at the credit adjusted risk free rate X prior year liability Accretion of ARO to beginning of fiscal year $243,540 or Sum of ($2, , ,909 thru 2005) e.g., Year 1973 accretion- ($41,598 x 6.2% = $2,579)

52 Depreciation Calculate Depreciation of ARO related Long-lived asset through 2005 Assume useful life is same as settlement date Years of useful life ( ) = 52 years Annual depreciation SL ~ $800 ($41,598 52) Accumulated depreciation through year $26,399 i.e., (33 yr x $800)

53 Cumulative Adjustment Entries Cumulative Adjustment Cumulative effect Dr $269,939 Buildings Dr $ 41,598 Accum Depreciation Cr $26,399 Depreciation through end of prior year ARO Liability Cr $285,138 Initial ARO $ 41,598 plus Accretion of ARO through end of prior year $243,540

54 Current Year Entries Current Year Entries 2006 Accretion expense Dr $17,679 ($285,139 x 6.2%) = $17,679 ARO Liability Cr $17,679 Depreciation expense Dr $800 Accum depreciation Cr $800

55 VII. Concluding Thoughts

56 Resources NACUBO website at PwC website at

57 Questions?

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