# Asset Retirement Obligation: Definition and Examples

![Asset Retirement Obligation](https://www.investopedia.com/thmb/xPS8QrMODrcziplPgeQnAAR7AnY=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/asset-retirement-obligation-final-854d9b0069684a5f9101b451eea24edb.png)

*— Investopedia / Zoe Hansen*

In accounting, an asset retirement obligation (ARO) describes a legal obligation associated with the retirement of a [tangible](https://www.investopedia.com/terms/t/tangibleasset.asp), [long-lived asset](https://www.investopedia.com/terms/l/longtermassets.asp), where a company will be responsible for removing equipment or cleaning up hazardous materials at some future date. AROs should be included in a company's financial statement to present a more accurate and holistic snapshot of the enterprise's overall value.

### Key Takeaways

*   Asset retirement obligations (ARO) are legal obligations associated with the retirement of tangible, long-lived assets, where a company must ultimately remove equipment or clean up hazardous materials from a leased site.
*   Companies are required to detail their AROs on their financial statements to accurately portray their overall values.
*   ARO rules are governed by the Financial Accounting Standards Board (FASB), outlined in Rule No. 143: Accounting for Asset Retirement.

## Understanding Asset Retirement Obligations

Asset retirement obligation accounting often applies to companies that create physical infrastructure which must be dismantled before a land [lease](https://www.investopedia.com/terms/l/lease.asp) expires, such as underground fuel storage tanks at gas stations. AROs also apply to the removal of hazardous elements and/or waste materials from the land, such as nuclear power plant decontamination. The asset is considered to be retired once the clean up/removal activity is complete, and the property is restored back to its original condition.

## An Example of an Asset Retirement Obligation

Consider an oil-drilling company that acquires a 40-year lease on a parcel of land. Five years into the lease, the company finishes constructing a drilling rig. This item must be removed, and the land must be cleaned up once the lease expires in 35 years. Although the current cost for doing so is $15,000, an estimate for inflation for the removal and remediation work over the next 35 years is 2.5% per year. Consequently, for this ARO, the assumed future cost after inflation would be calculated as follows: 15,000 \* (1 + 0.025) ^ 35 = 35,598.08.

## Asset Retirement Obligations Oversight

Because calculating asset retirement obligations can be complex, businesses should seek guidance from Certified Public Accountants to ensure compliance with the Financial Accounting Standards Board's [Rule No. 143](https://www.fasb.org/page/PageContent?pageId=/reference-library/superseded-standards/summary-of-statement-no-143.html&bcpath=tff): Accounting for Asset Retirement Obligations. Under this mandate, public companies must recognize the [fair value](https://www.investopedia.com/terms/f/fairvalue.asp) of their AROs on their balance sheets in an effort to render them more accurate. This represents somewhat of a departure from the income-statement approach many businesses previously used.

## Asset Retirement Obligation: Calculating Expected Present Value

To calculate the expected present value of an ARO, companies should observe the following iterative steps:

1.  Estimate the timing and cash flows of retirement activities.
2.  Calculate the credit-adjusted risk-free rate.
3.  Note any increase in the carrying amount of the ARO liability as an accretion expense by multiplying the beginning liability by the credit-adjusted risk-free rate for when the liability was first measured.
4.  Note whether liability revisions are trending upward, then discount them at the current credit-adjusted risk-free rate.
5.  Note whether liability revisions are trending downward, then discount the reduction at the rate used for the initial recognition of the related liability year.

> **Important**
>
> Asset Retirement Obligations do not apply to unplanned cleanup costs resulting from unplanned events, such as chemical spills and other accidents.