In June 2004, the Board issued a proposed FASB Interpretation, Accounting for Conditional Asset Retirement Obligations. The comment period ended August 1, 2004. To date, 31 comment letters have been received from respondents. Significant comments are summarized below.
GENERAL COMMENTS
Some respondents questioned the need for the guidance contained in the proposed Interpretation for varying reasons:
• Beresford (CL #5) said, “I believe the FASB should withdraw this proposal and instead devote immediate attention to developing a consistent and clear definition and implementation guidelines for liabilities. While the proposal deals with a relatively narrow issue, it, along with other recent FASB actions, do not help in determining how liabilities are interpreted and applied in general. . . .In my view, rather than continuing to work on what is surely a fairly narrow problem in practice, the FASB should devote more resources to the general matter of liability recognition and measurement. The current work on Revenue Recognition by necessity is closely related to liability matters. I think it would be far more productive to combine the revenue and liability reporting projects and not continue to deal with narrow issues like that in this Exposure Draft until a better, overall approach is decided on.
• Pfizer (CL #12) said that a legal obligation to perform an asset retirement activity that is conditional on a future event should be excluded from the scope of FAS 143 or, alternatively, disclosed.
• PWC (CL #24) said that while different views exist with respect to the obligating event for recognition of an asset retirement obligation (existence of a law or regulation that requires a retirement activity to be performed in relation to an asset versus retirement), in their view, “neither view of the obligating event is superior to the other. Based on FAS 143’s underlying recognition principle, one can reasonably conclude that the accounting under either approach may reflect the economic substance of the conditional asset retirement obligation.”
• American Electric Power (CL #19) questioned the value of the proposed Interpretation, stating that “the basic guidance in the ED reiterates [FAS 143] requirements and provides examples that are contradictory and cannot be applied consistently.”
Some respondents expressed concerns that the proposed Interpretation would expand the scope of Statement 143 to other obligations not considered by the FASB:
• Beresford (CL #5) said, “The asbestos and other contamination examples in Appendix A are fairly obvious. However, what about a Manhattan office tower? Would an owner be allowed to just leave an asset in place after its useful life or would the city require it to be torn down because of safety concerns? What about all of the cables buried by communications companies—might they have to be dug up at some point? There might be a long list of such conditional obligations that no one has thought of yet.”
• IMA (CL #6) raised concerns that the proposed Interpretation “broadly expands the application of FAS 143 but only highlights a small number of affected areas.”
• Lockheed Martin (CL #15) said, “We believe the ED wrongly considers the inability to estimate reasonably to be solely an issue of timing and unnecessarily deviates from principles established in FAS 5, and in so doing broadens the scope of FAS 143 beyond that to which it can be usefully or meaningfully applied.”
• ALLTEL Corporation (CL #17) said, “The Company continues to believe that conditional asset retirement obligations, such as those associated with asbestos, are outside the scope of ‘FAS 143.’”
ISSUE 1: The Board concluded that the uncertainty surrounding the timing and method of settlement should not affect whether the fair value of a liability for a conditional asset retirement obligation would be recognized but rather, should be factored into the measurement of the liability. Do you agree with the Board’s conclusion? If not, please provide your alternative view and the basis for it.
Many respondents who disagreed referred to paragraph B12 of the proposed Interpretation, which emphasizes the requirement of Statement 143 that an entity consider uncertainty in the timing and method of settlement in the measurement of a liability (at fair value), not its recognition. In large part, those respondents raised issues focusing on recognition versus measurement (at fair value), together with concerns about uncertainty associated with assets with indeterminate useful lives, and the related reporting.
Recognition versus Measurement
• Beresford (CL #5) said, “I do not believe that the Board has clearly or persuasively explained its reasoning for requiring liability treatment for asset retirements that are not likely to occur. . . .uncertainty should not be ignored in the recognition decision. It is simply illogical to recognize a liability that a company believes is highly unlikely to result in a future cash payment.”
• IMA (CL #6) said, “We believe that the need for the proposed Interpretation underscores fundamental problems with the principles in FAS 143, which we raised during the Board’s earlier deliberations leading to issuance of that standard. As a Committee, we continue to have significant concerns with the Board’s position concerning the role of uncertainty in the recognition and measurement of a liability. . . .We disagree that uncertainty about the occurrence, timing, and amount of future payments is always a measurement question. We believe it pertains first and foremost to recognition.”
• Swalwell (CL #10) said, “I do not believe a conditional asset retirement obligation meets the definition of a liability under FASB Concepts Statement No. 6 if it is not probable that the conditional event giving rise to the obligation will occur.”
• Pfizer (CL #12) said that “the level of uncertainty should be considered in the recognition of an obligation. . . .Under the current Exposure Draft, even losses that are extremely remote would be valued and recorded in a company’s financial statements given the probabilities assigned to the potential obligation. This would require significant judgment and subjectivity in developing both the assumptions and relative probabilities that would be assigned to a wide range of cash flows. In many situations, particularly where there is little historical experience, it would be extremely difficult to reliably determine these probabilities on a consistent basis for such uncertain and potentially unlikely events.”
• ALLTEL Corporation (CL #17) said that the fair value of the conditional obligations addressed in the proposed Interpretation, such as those associated with asbestos, should be excluded from the scope of FAS 143, emphasizing that “the fair value of such conditional obligations is not only inherently difficult, if not impossible, to determine, but also provides neither reliable nor relevant information to investors and other users of financial statements.”
• FPL Group, Inc. (CL #18) expressed concerns about applying the proposed Interpretation to “mass assets,” such as electric transmission and distribution systems. They said, “We believe that applying the Interpretation to mass assets is impracticable and the cost of applying it to these types of assets would significantly outweigh the benefit it provides.” They said that the FASB should make a practical exception for such assets, allowing such obligations to be recorded at the time of removal.
• PPL Corporation (CL #20) said that the resulting liabilities would not meet the definition of liabilities in Concepts Statement 6 because there is no present duty or responsibility, in particular, the liabilities for asbestos and chemically treated poles referred to in the examples in Appendix A.
• Kodak (CL #21) said that with respect to liabilities for asbestos, the obligating event does not occur until “the asbestos is disturbed.”
• Eli Lilly (CL #23) said, “We do not believe a liability should be recognized for conditional asset retirement obligations until it is probable a settlement will occur.”
• PPG Industries (CL #25) said, “In the case of AROs, the long period over which timing issues will be resolved and the breadth of settlement alternatives that exist can combine to create a level of uncertainty that cannot be objectively factored into measuring the ARO liability when the asset is constructed or purchased. In establishing this or any other accounting standard, we believe it is important that the information required to be presented in the financial statements is reliable and that reliability should not be sacrificed in the name of theoretical correctness.”
Of the respondents who agreed, KPMG (CL #7) referred to use of the term conditional, stating that, “it could be misinterpreted to suggest that the asset retirement obligation itself [rather than the timing for performing the retirement obligation] is conditional.” KPMG suggested changing the second sentence of paragraph 2 of the proposed Interpretation to state, “Accordingly, an entity shall recognize a liability for the fair value of an asset retirement obligation whose performance is conditional on a future event if the liability’s fair value can be estimated reasonably.”
Fair Value Measurement
Related comments focused on the notion of indeterminate versus determinate useful lives, which forms the basis for recognition (and measurement) decisions. In that regard, comments focused on Examples 1, 2, and 4 in Appendix A:
• Ferguson Associates (CL #1) said, “The life of a power or telecommunications system [Example 2] is just as uncertain as is the life of a refinery [Example 4], so the different ARO treatment is inconsistent. I see two options for eliminating this inconsistency. One option is to define the two renovation and/or upgrading situations in a manner that clearly distinguishes them. The other option is to recognize that the situations are identical, thereby requiring identical ARO treatment.”
• Beresford (CL #5) said, “Example 4 does not require initial accrual because the asset has ‘an indeterminate useful life.” However, it seems to me that Examples 1 and 2 are just as ‘indeterminate.’
• IMA (CL#6) said, “The examples do not provide enough information to help the reader understand why the useful lives of some assets are indeterminate and others are not.” Specifically, “The proposed Interpretation deems some long-lived assets to have indeterminate useful lives and concludes that others do not for reasons that are not articulated clearly. This guidance is critical to the consistent application of the Proposed Interpretation and has been the principal source of the implementation issues we see in practice. We do not believe that the guidance in this document will be operational unless and until more robust guidance is provided on this issue.”
• Deloitte (CL #8) said that because the set of long-lived assets with potentially indeterminate lives is significant, the Board should clarify the characteristics of an indeterminate life tangible asset (incorporating “characteristics that indicate the range of possible lives is so broad that the useful life of the tangible asset is indeterminate”). Deloitte expressed concerns that absent such clarification, unintended diversity in practice will develop.
• Swalwell (CL #10) said, “The Board needs to expand the illustrative examples contained in Appendix A. The conclusion in Example 4 is that no asset retirement obligation is recognized because, while the useful life of the refinery is not infinite, the refinery has an indeterminate useful life because of maintenance and replacement activities. However, this ‘maintenance and replacement activities’ argument (which effectively functions as a scope exception to the Statements generally intended recognition criteria) could just as easily be applied to the factory containing asbestos (Example 1) or the wood poles (Example 2), yet the conclusion in both of those examples is that an asset retirement obligation must be recognized.”
• James Redwine (CL #16) said with Example 4 should be revised to be consistent with environmental law and practice.
• American Electric Power (CL #19) said, “Examples 2 and 4 in the ED are [not] differentiated enough to be applied practically. We believe that just as the oil company in Example 4 could not estimate the fair value of its obligation to dismantle and dispose of the refinery because of an indeterminate useful life, the telecommunications entity in Example 2 may not be able to estimate the fair value of its obligation to dispose of wood poles in accordance with special procedures because the life of its integrated system is also indeterminate with proper maintenance and replacement. There is also no objective evidence on the life of a power or telecommunications system.”
• Kodak (CL #21) said, “We are not convinced that the proposed Interpretation will be applied consistently. As evidenced by the answers to the examples provided in Appendix A application of the proposed Interpretation is based, somewhat, on management’s discretion. For example, a different answer was reached in Example 4 than Examples 1, 2, and 3 because management of the oil company asserted that the refinery has an indeterminate useful life.”
ISSUE 2: The Board concluded that all retirement obligations within the scope of Statement 143 that meet the definition of a liability in Concepts Statement 6 should be recognized as liabilities. Concepts Statement 6 states that a liability has three essential characteristics. The second characteristic of a liability is that the duty or responsibility obligates a particular entity, leaving it little or no discretion to avoid the future sacrifice. The Board decided that the ability to indefinitely defer settlement of an asset retirement obligation or the ability to sell the asset does not provide the entity discretion to avoid the future sacrifice, nor does it relieve the entity of the obligation. Are there instances where a law or regulation obligates an entity to perform retirement activities but allows the entity to permanently avoid settling the obligation? If so, please provide specific examples.
Of the respondents that disagreed, many said that they do not believe that the asset retirement obligations addressed in the proposed Interpretation meet the definition of a liability in Concepts Statement 6.
• IMA (CL #6) said, “We do not believe the conditional retirement obligations that are the subject of the proposed Interpretation qualify as liabilities under the current conceptual framework. . . .The future sacrifice is not supported by evidence strong enough to make it likely to occur because the entity has the ability in many circumstances, particularly in the case of conditional obligations under the entity’s own control, to delay the retirement obligation indefinitely.” Like other respondents, IMA said that in the examples, “the conditional future event is the obligating event, not the act of contamination nor the purchase of a property containing asbestos.” • Swalwell (CL #10) said, “I do not believe a conditional asset retirement obligation
meets the definition of a liability. . .if it is not probable that the conditional event giving rise to the obligation will occur.”
• Pfizer referred to situations in which an entity can indefinitely defer settlement of an asset retirement obligation using the current guidance related to asbestos containing materials published by the EPA and NESHAP.
• Otter Tail Power Company (CL #9) referred to legal obligations for underground storage tanks under Minnesota Rule 7150.0400, Temporary Closure, and for hydroelectric generating plants under Minnesota Rule 6115.0390, Termination of Operations and Perpetual Maintenance.
• Pfizer (CL #12) agreed that asset retirement obligations that meet the definition of liabilities should be included within the scope of FAS 143, but said that the liabilities illustrated in the proposed Interpretation do not meet the definition. In that regard, Pfizer referred to situations in which an entity can indefinitely defer settlement of an asset retirement obligation under current guidance related to asbestos containing materials published by the United States Environmental Protection Agency (EPA) and National Emission Standards for Hazardous Air Pollutants (NESHAP). With respect to asbestos, Pfizer said that the obligating event is the decision that causes asbestos containing materials to become friable.
• American Electric Power (CL #19) said that, “For asbestos and poles treated with certain chemicals, we do not believe there is an existing legal obligation associated with the retirement of an asset and, thus, FAS 143 is not applicable, based on the scope defined in FAS 143, paragraph 2.”
• Kodak (CL #21) said, “Based on our understanding of the Asbestos regulations (within the United States and for many other countries), the legal obligation arises upon the disturbance of the asbestos, not the existence of the asbestos.”
Of the respondents who agreed, KPMG (CL #7) said that the Interpretation would be strengthened by including within the body of the Interpretation the three characteristics of a liability.
ISSUE 3: Issuance of Interpretation
• IMA (CL#6) believes the Board should “reassess the relevance of the financial reporting result that follows from application of the principle to the specific conditional obligations identified in the Proposed Interpretation.”
• Pfizer (CL #12) said that “we believe the judgment and subjectivity required to develop such estimates of the fair value of conditional events, including those that are very unlikely, would reduce the value of financial statements to the user community.” • Beresford (#5) suggested that “a user’s understanding would be substantially enhanced by not including such dubious liabilities in financial statements but including appropriate footnote disclosures about these matters pursuant to Statement 5 or perhaps some enhanced version of those disclosure requirements.”
• ALLTEL Corporation (CL #17) said, “the Company believes that the fair value of such conditional obligations is not only inherently difficult, if not impossible, to determine, but also provides nether reliable nor relevant information to investors and other users of financial statements.”
• PWC (CL#24) questions “the Proposed Interpretation’s usefulness from cost-benefit and operational perspectives.” They said the research, recordkeeping, and reporting that would be required to comply with the Proposed Interpretation will not result in a significant, incremental benefit to financial-statement users and other capital market stakeholders, and will be costly to preparers.
ISSUE 4: Effective Date and Transition
The proposed Interpretation for conditional asset retirement obligations would be effective no later than the end of the fiscal year ending after December 15, 2005 (December 31, 2005 for calendar-year enterprises). Restatement of interim financial information would not be permitted if the proposed Interpretation is adopted during the interim period including its required effective date or during the first interim period of that fiscal year. Restatement would be required if adopted during any other interim period during that fiscal year.
Some respondents disagreed with the need to restate interim financial information. For example, IMA (CL #6) said that it supports an effective date and transition guidance that avoids the need to restate previous interim periods. In comment letter 6, IMA addressed the effective date issue and does not agree with the Board. The respondent prefers a required effective date and transition guidance that does not require an entity to restate previous interim financial information.
PricewaterhouseCoopers (CL #24) recommends that “restatement of interim financial information should be required in accordance with the guidance in FASB Statement No. 3 (FAS 3), Reporting Accounting Changes in Interim Financial Statements.”
JP Morgan Chase & Co. (CL #28) recommends that the provision related to disclosing the pro forma impact of adoption in prior periods should be eliminated. Additionally, the respondent states that “such information is misleading since it is based on a fair value of the liability that is calculated as of the effective date of this proposed Interpretation. Further, it may be confusing since the transition provisions require a cumulative change in accounting to be recognized upon adoption.”
EXAMPLES (APPENDIX A)
In addition to comments previously discussed, other comments referred to concerns about measurement uncertainty and, in addition, suggested revisions consistent with practices in the industries illustrated:
• Beresford (CL #5) observed that Examples 1 and 2 assume that the entity is able to reasonably estimate the fair value of the respective liabilities. He said that “based on the assumed facts given, I suspect that it is very unlikely the companies in question would be able to determine such a ‘fair value.’ It would be helpful for the Board to provide real examples of where this has been done rather than simply asserting that it is possible to do so.”
• IMA (CL #6) said, “We believe that a liability is not reasonably estimable until the uncertainties surrounding timing and method of settlement are sufficiently clear that it is practicable to perform a reasonable number of discounted cash flow scenarios with probabilities that are derived based on known facts rather than on speculation. Given that the actual date of retirement may be no more than a guess because the decision to do so often can be postponed indefinitely, we believe that the underlying assumptions are not verifiable and the resulting measurement is not representationally faithful.”
• With respect to Example 1, IMA said, “While many commercial facilities built within the last 50 years contain asbestos, it is acknowledged that if the asbestos is encapsulated, the building’s environment is considered safe under present law. State and local regulations require the removal of asbestos only when it is disturbed. Therefore, it would appear that the obligating event would be the planned actions that would result in the release of the material (e.g., capital improvements, repairs, etc…) not the acquisition of the building itself.” (IMA said that in the examples, it believes that the obligating event is the conditional future event, not the act of contamination or the purchase of a property containing asbestos.)
• With respect to Example 2, IMA said that the example is ineffective because it does not reflect the actual fact patterns that are prevalent in the telecommunications industry (replacement of poles). Similarly, Otter Tail Power Company (CL #9) expressed concerns about “inaccuracies” with respect to pole removal practices that could create “misunderstanding, misinterpretations, or inaccurate disclosures.
• With respect to Example 3, IMA said, “In our view, this example appears to be focused on an operations maintenance issue, rather than an asset retirement issue. We believe that existing practices in accounting for planned major maintenance provide more relevant financial reporting results in these circumstances than would the proposed Interpretation.”
IMA (CL #6) suggested that the Board add an example incorporating the following fact pattern:
An entity is an operator of national convenience/gasoline retail stores. All of the retail locations are situated on leased ground. The standard lease has a five-year original term with three renewal options; each renewal is for an additional five years, resulting in a total lease term of 20 years. Assume that any ARO obligations are outside the scope of SOP 96-1. The entity has a 25-year operating history and currently operates 10,000 locations across the nation. In its 25 year history, the lease term in 2,000 of the locations expired. In just 50 of these 2,000 cases, the entity decided not to renew the lease. In these non-renewal situations, only 3 lessors have required site restoration actions to be taken and none of these required that the site be brought back to its original condition. In the other 47 non-renewal situations, the lessor of the land allowed the site to remain in its current state because a competitor to the national convenience/gasoline retail store had agreed to lease the space. The entity was not required to perform site restoration actions even though the contract language in the lease agreement required performance.
