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Making Sense of Conditional Asset Retirement Obligations
(FIN 47)
May 25, 2006
Agenda
I. Overview of FASB 143 and FIN 47II. Key Implementation QuestionsIII. Environmental SpecialistIV. Case Study—MIT V. Case Study—University of DallasVI. Sample CalculationVII. Concluding Thoughts
I. Overview of FASB 143 and FIN 47
FASB 143
• Issued June 2001 • Was intended to apply to accounting for the
costs of nuclear decommissioning• But FASB expanded scope to include
similar removal-type costs in other industries
FASB 143 (cont.)
• Requires entities to record liabilities for tangible, long-lived assets (e.g., buildings containing asbestos) that must be retired or disposed of (i.e., "settled") in a specified way by law or contract.
• Such liabilities are Asset Retirement Obligations (AROs)
FIN 47
• Issued March 30, 2005• Why issued? Diverse accounting practices with
respect to implementation of FASB 143• Clarifies that FASB 143 applies to all entities with
legal obligations to retire long-lived assets• Effective for years ending after December 15,
2005 – THAT MEANS JUNE 30TH 2006!!!
FIN 47 (cont.)
• Recognize liability for fair value of Conditional Asset Retirement Obligation (CARO) when incurred if fair value can be reasonably estimated.
• CARO: “A legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity.”
• Presumption is “nothing lasts forever”
FIN 47 (cont.)
• A CARO represents incremental cost only (such as cost to dispose of utility poles rather than the cost to remove such poles)
• Presumption is “nothing lasts forever”
FIN 47—Basic Concepts
• Uncertainty surrounds timing and method of settlement—Reflect it in measurement of the liability, not recognition of the liability
• Can the liability be reasonably estimated?– Evidence that FV is in acquisition price – An active market exists – Sufficient information exists to apply an
expected present value (PV) technique
FIN 47—Basic Concepts (cont.)
• Initial accounting impacts balance sheet (assets and liabilities) and statement of activities (cumulative effect of change in accounting)
• Required disclosures:– Pro forma disclosure of effect if had been adopted in
prior year – If can’t reasonably estimate will have to disclose this
and reasons why
II. Key Implementation Questions
Do I Have To Develop A List Of All Facilities? If So, How?
• Campus master plan• Campus map• List of satellite offices• Lease commitment schedule
How Can I Find Out Where Work Has Been Performed And Whether CAROs Exist?
• PP&E lead sheets• Lease schedule• Environmental reports• Campus master plan• Renovation plan• Long-time employees• Deferred maintenance
list
• Past hazmat removal invoices
• Hazmat notifications to local authorities (police & fire)
• Minutes of the board’s Grounds & Building committee
How Can I Estimate the Cost of Remediation?
• Current fair value of remediation– Different remediation options– Recent invoices for such work– Estimates from a reputable company
• Where remediation has been performed, there is likely to be valuable data about the remediation cost.
How Do I Determine An Appropriate Inflation Rate?
• May use inflation factor used for budgets • May want to use higher rate since
specialized skills will be required• Must be able to document why inflation rate
(and discount rate on next page) is reasonable and appropriate
How Do I Determine An Appropriate Inflation Rate?
• Use risk-free interest rate – zero coupon U.S. treasury instruments with maturity dates that coincide with settlement date
• CON 7 requires an adjustment to the risk-free interest rate to reflect the credit standing of the institution
How Do I Estimate An Appropriate Settlement Date?
• Get input of facilities and other campus groups
• Range of dates is likely with probabilities• Remediation of 10, 20 and even 50 years
might be reasonable• Will vary depending on remediation
approaches and the institution’s financial viability
Estimating Settlement Date (cont.)
• Some institutions may choose:– Absolute minimum to comply with the applicable
legal requirements– “Cadillac” treatment in order to address
concerns from students, parents or other interested parties
• Consider whether dates are: Legally satisfactory? Reasonable? Feasible?
How Do I Determine the Probability of Each Option?
• Once the settlement dates are selected a probability must be assigned to each option – based on the likelihood that that particular remediation option will occur at that date.
• The sum of the probabilities for each individual building or location must equal 100%.
III. Environmental Specialists
Phil Hagan, JD, MBA, MPH Georgetown University
John DeLaHunt, MBA Colorado College
Caveat
• The following information is advisory in nature and should not be construed as a legal opinion
• Most of the information is based on Federally mandated regulations
• It is important to evaluate each situation based on applicable regulations for your jurisdiction
FIN 47 – Environmental Management Perspective
• In most cases, it will be difficult to accurately quantify liabilities based on existing information available to the university and college community
• In many cases, regulations do not require mitigation per se of existing liabilities
• The driving force for mitigation tends to be the potential liability
Environmental Factors
• Toxic contaminants/ Regulated materials– Asbestos (building materials – assets built pre-1980) – Lead (paint, pipes – assets built pre-1978)– Polychlorinated biphenyls (PCBs) (electrical
transformers, capacitors) – Mercury (laboratories, HVAC control mechanisms)– Radioactive material (laboratories, healthcare, reactors)– Petroleum products (fuel and oil)– Hazardous waste (laboratories, maintenance facilities)
Inflationary Cost Adjustments
• Urgency of action – Planned response vs emergency response
• Regulations & cost of compliance– Current costs– Future costs increases or decreases as a result of
regulatory change or change in technology • Local competition for mitigation services
– Asbestos (school districts)– Lead Based Paint (target housing)
• Availability of expertise and disposal sites
Applicable Environmental Regulations
Asbestos
• 1971 - OSHA - set PEL at 12 f/cc• 1973 - Clean Air Act NESHAP• 1987 - AHERA regulations (K-12) (40 CFR
763) • 1989 - most asbestos use banned in US• 1990 - CAA NESHAP completely re-written• 1990 - OSHA (work practice regulations) • 2000 - Worker protection regulations
Lead Paint
• 1978 - the CPSC banned the sale of paint containing in excess of 0.06% lead intended for consumer use
• 1999 - Residential Property Renovation (40 CFR 745.81)
• 2000 - Work practice standards (40 CFR 239(c))
Underground Storage Tanks (USTs)
• 1984 - Federal Underground Storage Tank (UST) Program (created by Hazardous and Solid Waste Amendments (HSWA) to the Resource Conversation and Recovery Act). 42 U.S.C. § 6991(a)-(i)
• 1987 - Remediation of spills (40 CFR 110)
• 1993 - Compliance with RCRA standards
Radiation
• 1946 - Maximum permissible dose (atomic energy commission)
• “Early seventies“ - ALARA
• 1991 - Public dose (NRC 10 CFR 20.1301)
PCBs
• 1979 – Toxic Substances Control Act (TSCA) regulations (40 CFR 761)
Mercury/Hazardous Waste
• 1980 – Resource Conversation and Recovery Act (RCRA) (40 CFR 261)
Campus Perspective
• Asset inventory• Contaminant inventory
– Known, suspected• Develop future projected cost estimates for mitigation
based on the following information: – Asset/Contamination inventory– Present remediation cost estimates– Timeframe for mitigation – Periodic re-assessment
• Written short & long range plans for mitigation • Inflation assumptions
Key Campus People
• Environmental Manager or individual(s) with environmental responsibilities
• Risk Manager • Legal Counsel• Facilities Director• Director of Planning• Architect • Director of Project Management• Controller
IV. FIN 47/FAS 143 at MIT
FY 2006 implementation process/issues
Implementation goals
- Full compliance with new guidance - Implementation effort appropriate to the
significance of the ARO to MIT’s financial statements
- Good management understanding of impact on financial statements/numbers and disclosure
- Simple, well documented calculations and estimates – easy to audit
Who has been involved?
• Facilities– Facilities finance– Facilities capital projects
• Legal Counsel• Environmental Health & Safety staff• Treasurer’s Office
– Real Estate gifts held– Real Estate assets in investment portfolio
• Audit Committee• Senior Management
Process so far
• Overview of Fin 47 to Audit Committee & Senior Management -- summer & fall, 2005
• Participation in educational events/conference calls
• Meetings with Facilities/EHS/Treasurer’s Office staff to identify relevant obligations & develop methods to estimate
• Involve legal counsel to clarify relevant legislation• Work with APC and other higher ed colleagues to
test calculation template developed by Dale Larson
Possible asset retirement obligations considered
- Asbestos- Lead paint- Soil remediation - Nuclear reactor- Leases (requirement to restore to space to original
condition at end of lease)- Linear accelerator- Lab decontamination- Gifts of real estate- Real estate in investment portfolio
Challenges/Issues
• Identification of unabated asbestos by building extremely time-consuming in relation to $ of exposure; seeking high-level methods to estimate exposure (by building)
• Legislation effective dates; asbestos, soil remediation• Need to engage other offices deeply; even when ARO is
not likely to be material, some analysis must be done to satisfy audit requirements
• Support for/documentation of assumptions– Contractor risk premium– Construction inflation– Credit adjusted risk free rate
V. Case Study—University of Dallas A Small Institution’s perspective:
Getting Started
Implementation processImplementation challenges
Getting started – Small Institution
• Determine what we need to do– Contact audit firm, web-sites, and colleagues– FAS 143 – particularly Appendix D
• Transition entries illustrated– PWC article – Accounting for ARO– Data elements to be collected
• What information and assumptions must be made?
Challenges
• Most of the data didn’t reside in the accounting office– My greatest fear: Preparing an accounting
estimate based on committee consensus• Couldn’t afford nor had time to prepare
asbestos surveys• Motivation – Helping with FIN 47 was NOT
on the Facilities Dept “to-do” list
Who needed to be involved?
• Facilities & Planning Areas– Search for existing documentation
• Prior year surveys – what reports presently exist• Past major renovations - institutional history• Future major renovation projects
• Audit & Budget Committees Update• Bank representative
– Advise on credit adjusted risk free rate
Methodology
• No annual budget for abatement– Abatement done when major renovations occur
• Review existing environmental reports:– Summarized By building – capitalization of ARO cost
always relates to the related long-lived asset– Schedule by Type of abatement required
• Square foot – flooring• Square foot – ceiling• Linear foot – piping
Methodology
• Reviewed existing environmental reports, continued
– Some buildings not surveyed – reasonable estimate– Surprises, e.g., science lab tables
• Prior major renovations– Discussed with Facilities what abatement was
completed– Updated environmental report & identified buildings and
area needing asbestos removal
Where are going with this?
• Obtain estimates from abatement contractors– Use schedule of existing asbestos per building, sq/ln ft
• Forecast anticipated ARO settlement dates– Planned and potential major renovation dates– Meeting with Planning / VP to develop probable dates
for settlement• Buildings not on the near-term abatement plan• A building may have multiple settlement dates
• Confirm liability inception date• Prepare calculations, entries, and footnotes
VI. Sample Calculation
Calculation Assumptions
• Cost to remove asbestos – current cost $375,000
• Inflation rate assumed – 4.5% • Contractor market risk premium – 5%• Estimated year of settlement – 2025• Liability inception date: 1973• Credit adjusted risk free rate – 6.2%
Undiscounted Expected Cash flows
• FV of current abatement cost as of settlement date, 2025– $375,500, inflation 4.5% = $904,392
• Contractor market risk premium – 5%– $904,392 x 5% = $45,220
• Undiscounted cash flow at 2025– ( $ 904,392 + $ 45,220) = $949,612
ARO at Inception Date
• PV of $ 949,612 back to 1973, assume 6.2% credit adjusted risk free rate– ARO liability = $41,598– Capitalize this since it is a “cost” of the long
lived asset
• Entries that would have been made in 1973– Long – lived Asset Dr $ 41,598– ARO Liability Cr $ 41,598
Accretion Expense
• Accretion expense through June 30, 2005– Use interest method of allocation– Annual accretion is calculated at the credit adjusted risk
free rate X prior year liability
• Accretion of ARO to beginning of fiscal year– $243,540 or Sum of ($2,579 + 2,739 + 2,909 thru 2005)– e.g., Year 1973 accretion- ($41,598 x 6.2% = $2,579)
Depreciation
• Calculate Depreciation of ARO related Long-lived asset through 2005– Assume useful life is same as settlement date– Years of useful life – (2025-1973) = 52 years– Annual depreciation SL ~ $800 ($41,598 ÷ 52)– Accumulated depreciation through year 2005 -
$26,399 i.e., (33 yr x $800)
Cumulative Adjustment Entries
• Cumulative Adjustment– Cumulative effect Dr $269,939– Buildings Dr $ 41,598– Accum Depreciation Cr $26,399
• Depreciation through end of prior year– ARO Liability Cr $285,138
• Initial ARO $ 41,598 plus Accretion of ARO through end of prior year $243,540
Current Year Entries
• Current Year Entries 2006– Accretion expense Dr $17,679
($285,139 x 6.2%) = $17,679– ARO Liability Cr $17,679
– Depreciation expense Dr $800– Accum depreciation Cr $800
VII. Concluding Thoughts
Resources
• NACUBO website at www.nacubo.org• PwC website at www.pwc.com/education
Questions?
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