GAAP UPDATE SERVICE GAAP GOVERNMENTAL. Summary & Highlights. Asset Retirement Obligations. Analysis. Overview of an ARO

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1 GOVERNMENTAL GAAP UPDATE SERVICE GAAP Volume 15, Issue 7 April 15, 2015 Asset Retirement Obligations Summary & Highlights The Governmental Accounting Standards Board (GASB) is in the midst of a project researching asset retirement obligations (AROs). An ARO is present when there is a cost or potential cost to end operations of a capital asset. Many involve operations that are subjected to regulation (e.g., power plants of all types, dams, water or sewage treatment facilities, and similar operations). Since 1993, governments have had various forms of ARO recognition. GASB Statement No. 18, Accounting for Municipal Solid Waste Landfi ll Closure and Post- Closure Care Costs (GASB-18), presents some of the accounting and fi nancial reporting theory that is present in other forms of AROs, particularly regarding forprofi t and not-for-profi t entities. GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries (GASB-42), released in 2003, is often confused as guidance pertaining to AROs because it primarily deals with impaired capital assets. An asset is not considered retired unless the asset will no longer be used by the government. Therefore, ARO is not applicable. Furthermore, GASB Statement No. 49, Accounting and Financial Reporting for Pollution Remediation Obligations (GASB-49), released in 2006, presents a similar accounting and fi nancial reporting focus, namely the recognition of a liability by a potentially responsible party. GASB-18 and GASB-49 have specifi c exemptions for AROs. This edition of the Governmental GAAP Update Service discusses the GASB s project on AROs and why it is important for governments, particularly those with capital assets that may be subject to regulatory fi lings (e.g., utilities). Overview of an ARO Analysis AROs have been perennially discussed by stakeholders and the GASB as a potential project. Most recently, respondents to the exposure draft of what became GASB Statement No. 62, Codifi cation of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements (GASB- 62), released in 2010, were concerned that AROs were outside the scope of the exposure draft. Many public utilities voiced their concerns to the GASB through the American Public Power Association. Public utilities had an issue, given that the release of GASB-62 and the codifi cation of Financial Accounting Standards Board (FASB) Statement No. 143, Accounting for Asset Retirement Obligations (FAS-143 now ASC 410, Asset Retirement and Environmental Obligations), pre-

2 sented a lack of guidance. Regulatory bodies required recognition, yet the former FAS-143 could not be used because it confl icted with GASB standards contained in GASB-62 and the current GAAP hierarchy contained in GASB Statement No. 55, The Hierarchy of Generally Accepted Accounting Principles for State and Local Governments (GASB-55). After repeated high rankings from the members of the Government Accounting Standards Advisory Council, the project was added to GASB pre-agenda research in December 2013 and the current GASB agenda in August The project focuses on a number of topics. Deciding what constitutes an ARO is an initial focus, including what is retirement. The project will also focus on the approach to recognition and measurement of an ARO. This may include whether the costs of an ARO, if any, should be capitalized, and if so, how should they be recognized and measured. Finally, similar to all GASB projects, a focus will be on note disclosure information related to an ARO. Deliberations on AROs The GASB began its research by reviewing relevant information in the aforementioned existing GASB and FASB standards, particularly in ASC 410 and GASB-18. The GASB has tentatively concluded that a defi nition of an ARO should be based on ASC 410 s defi nition, which simply defi nes an ARO as an obligation associated with the retirement of a tangible long-lived asset (ASC ). However, what is an obligation in the sense of GASB standards? GASB Concepts Statement No. 4, Elements of Financial Statements, defi nes an obligation as a social, legal or moral requirement, such as a duty, contract, or promise that compels one to follow or avoid a particular course of action. A present obligation that is a liability is a duty or responsibility to sacrifi ce resources that the government has little or no discretion to avoid. However, obligations may be legal or other-than-legal (social or moral). Legal obligations arise from legislation, contracts, or other written or oral agreements. The GASB deliberated on the social or moral obligations piece, primarily due to the concept of promissory estoppel. Black s Law Dictionary defi nes promissory estoppel as a promise made without consideration that may be enforced to prevent injustice if the promisor should have reasonably expected the receiver of the promise to rely on the promise and if the receiver did actually rely on the promise to his or her detriment. For example, promissory estoppel could exist if the public reasonably assumed that a public utility plant should be cleaned up upon retirement. The GASB, however, has tentatively concluded that there should be limits as to what is an ARO. The GASB believes that there should be some form of legal obligation based on applicable federal, state, or local laws or regulations in place as of the balance sheet date, regardless of their effective date. Constructive obligations have been tentatively excluded from the defi nition. The defi nition of retirement in the context of a capital asset has also been discussed. The GASB has tentatively concluded that retirement of a capital asset should be the other than temporary removal of a capital asset from service. A temporary removal is an impairment in the context of GASB-42. Items in the Scope of an ARO The project then focused on what should be in the scope of an ARO. The GASB has tentatively concluded that an ARO should include: CCH Incorporated and its affi liates. All rights reserved.

3 Legal obligations associated with the retirement of a tangible capital asset that results from the acquisition, construction, or development of a capital asset (e.g., a municipal power plant); Legal obligations associated with the retirement of a tangible capital asset that results from the normal operation of a capital asset (e.g., spent fuel from a municipal power plant); and Legal obligations that require disposal of a replaced part that is a component of a capital asset (e.g., a generator that contains rare-earth materials that is part of a municipal power plant). Based on the above, especially in the 2nd and 3rd points, AROs may have an environmental remediation component. However, the GASB has tentatively concluded that fi nes, penalties, and other non-remediation outlays that are currently excluded from GASB-49 should not be included in ARO guidance. Also, existing municipal solid waste landfi ll guidance contained in GASB-18 appears not to be changing at this time. AROs may also not be present if a plan exists to sell or otherwise dispose of a capital asset. Even if an environmental remediation liability exists from an improper operation of an asset, the GASB has tentatively concluded the liability would be excluded from ARO guidance. Other exclusions or included items, including asbestos issues, have been deliberated. For now, it appears that asbestos removal that results from the other-than-normal operations of an asset appears to be excluded. However, the GASB will continue to focus on a generalguidance based approach, with specifi c guidance only included as needed to operationalize the principles. For example, the specifi c components of what could be included or excluded from an ARO may be included as questions and answers in the Comprehensive Implementation Guide. When Should a Liability Be Recognized? Liability recognition could be made on various existing methods. For example, with regard to landfi lls, a liability is recognized based on the estimated total current cost of closure and post-closure care based on the usage and capacity of the landfi ll. For pollution remediation, a liability is recognized based on the occurrence of a list of obligating events and the reasonable estimation of a total obligation. Most recently, non-exchange fi nancial guarantees include recognition of a liability when it is more likely than not a liability has incurred. The GASB believes that the best approach for the pattern of recognition of an ARO liability is to base an ARO on when the liability has incurred. This is based on the FASB guidance. The GASB has also tentatively concluded to base a liability on a hybrid approach focusing on occurrence and if the amount is reasonably estimable, with specifi c obligating events provided when needed. This approach could include external obligating events and internal obligating events. External obligating events include the approval of laws, regulations, court judgments, or contracts. However, the GASB has tentatively concluded that the initial recognition of an ARO should not include an internal event (e.g., the creation of a plan to retire the capital asset). However, an ARO may include an internal obligating event (e.g., the occurrence of contamination whether a plant is operational or not). The GASB has tentatively limited internal event recognition. The GASB has also tentatively concluded that an ARO liability should not be recognized before the capital asset is ready for operations in most circumstances. An internal event would occur upon the operation of the capital asset or if the asset is permanently abandoned 2015 CCH Incorporated and its affi liates. All rights reserved. 3

4 before it is put in operation. Finally, if a government acquires a capital asset with an ARO, it assumes the ARO obligation as of the acquisition date. What Are the Debits? The GASB has discussed whether an ARO meets the defi nition of an asset, expenditure, or deferred outfl ow of resources, in addition to a liability. The characteristics of an asset include resources that have present service capacity that a government controls. Given that a tentative decision by the GASB recognizes an ARO, including the retirement of a capital asset, an asset defi nition for an ARO does not quite fi t. There could be some costs in removing a capital asset. For acquired assets, there may be costs necessary to convert the asset into another use (e.g., converting an abandoned rail line into a park). However, that may be part of positioning the new asset for its intended use. The GASB has tentatively concluded that even though an ARO imposes a present obligation to retire the asset, the outfl ow of resources to fulfi ll the obligation does not occur at the point of inception, nor does it occur when the government makes cash payments to liquidate the liability. Instead, the costs are incurred in a systematic and rational manner as the asset provides services. For example, as the plant provides electricity, an ARO should be measured. For this reason, the GASB has tentatively concluded that the debit side of an ARO meets the defi nition of a deferred outfl ow of resources, unless the asset is abandoned permanently prior to use. Upon abandonment, it is an outfl ow. However, if the asset is subject to regulatory accounting, then the current provisions of GASB-62 would carry forward. Whatever the regulator requires for liability and expense recognition would still occur. What Is Next? Through the spring and summer of 2015, the GASB will deliberate the measurement of the obligations and how they should be recognized in subsequent periods. Regulatory accounting, note disclosures, transition, the effective date, and the costs vs. benefi ts of the new provisions will also be discussed. An exposure draft is currently expected by the end of A fi nal standard is not expected until the fall of 2016 with implementation likely, at the earliest, in periods beginning after June 15, 2017, if not later. Conclusion AROs will affect many governments, especially for public utilities. For example, the Illinois Municipal Electric Agency used FAS-143 provisions to measure ARO in its 2012 fi nancial statements. As of April 30, 2012, for the closure of an ash pond with a mine closure and reclamation at a generating facility, the ARO measured over $2.7 billion. This was for one facility. Multiply the $2.7 billion by the number of facilities nationwide and the potential ARO is staggering. The costs of an ARO are likely to be borne by ratepayers of the facility. However, most would agree there should be additional disclosure and guidance on this issue. The fi nal tally of the aggregated cost of AROs nationwide may indeed dwarf many other liabilities of state and local governments CCH Incorporated and its affi liates. All rights reserved. MGGS

5 Eric S. Berman, partner with Eide Bailly, authors articles twice a month via CCH. For more information on subscribing to the service allowing you to receive these articles upon release, Click here He also authors CCH's Governmental GAAP Library which is available in print or e-book