How to Account for Asset Retirement Obligations

Accounting standards require that the fair value of a liability for an asset retirement obligation (ARO) be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. With rising costs and environmental concerns in the oil and gas industry, estimates of plugging and abandonment could become more significant than in the past. The important components of calculating the asset retirement obligation for an individual well are shown in the following example:

Example:

The asset and liability are recorded at $25,675 at the spud date. The accretion expense and related liability are recorded monthly for the life of the well. Salvage value of the asset is also not allowed to be netted for purposes of determining estimated costs.

See accounting statement for illustrative examples of calculating the asset retirement obligation.  More on settling AROs to come.

Asset retirement obligations (ARO) will certainly be settled at a value that is less than or exceeds the book value of the liability at the date of settlement. Standards are not conclusive on the treatment of this difference.  The options are as follows:

• Resulting gain or loss is shown on the income statement as settlement gain (loss).
• Resulting difference is recorded against accumulated dd&a with no income statement affect.

Disclosure of the method of recording these differences is key to transparency of the financial statements.  Standards do require that amounts paid for settlement should be shown as an operating cash flow.