The term asset retirement obligation is used to describe an accounting process that recognizes the legal responsibility to dispose of assets at a future point in time. Asset retirement obligations are typically associated with long-lived assets and can involve an entire asset or a portion of it. The obligation can come about as a result of a law, statute, ordinance, or written contract.
Also known as an ARO, an asset retirement obligation is a method of accounting for costs related to the future disposal of an asset. Accounting guidance is provided in FASB's Statement of Financial Accounting Standards No. 143 - Accounting for Asset Retirement Obligations. Examples of costs typically associated with AROs include plant remediation efforts, removal of underground tanks, disposal of asbestos, restoration of office space upon lease termination, as well as the demolition of certain plants.
Businesses are required to recognize the liability associated with an ARO in the period in which the commitment occurs, including the initial construction of an asset. The process involves the creation of a liability equal to the present value of the future remediation cost as well as an asset of equal value. This mechanism effectively increases the carrying amount of the asset.
Over time, the company will include certain costs on their income statement; this includes the depreciation of the asset, capitalized retirement costs, and accretion of the asset retirement liability. Publically-traded companies are required by federal laws under the jurisdiction of the Securities and Exchange Commission (SEC) to disclose certain operating and financial information on an ongoing basis. As part of its Form 10-K filing, companies must disclose all material asset retirement obligations.