Can someone please explain how “expected cash flow adjusted for inflation and market risk” = ARO liability on settlement date? How can a “cash flow” be ARO liability?? Isn't cashflow the amount of cash in/outflow?
On January 1, 2X01, Big Oil placed in service an offshore oil platform that it constructed. Big Oil is legally required to dismantle and remove the platform at the end of its 10-year estimated life. Using expected present value techniques, Big Oil recorded an estimated asset retirement obligation (ARO) of $100,000 on January 1, 2X01. The ARO measurements on January 1, 2X01, are as follows:
Expected cash flow before inflation: $190,000
Expected cash flow adjusted for inflation and market risk: $220,000
Present value using credit-adjusted risk-free rate: $100,000
Assuming that the ARO is settled on December 31, 2X10, for $170,000, what is the gain or loss on the settlement?
A.
$70,000 loss
B.
$20,000 gain
C.
$50,000 gain
D.
No gain or loss
EXPLANATION———————
The gain or loss on the settlement of the ARO liability is the difference between the ARO liability on settlement date of $220,000 and the actual settlement cost of $170,000.
FASB ASC 410-20-40-2 requires the initial liability of $100,000 to be increased to the expected cash flow adjusted for market risk and inflation. Since the expected cash payment for the ARO liability was $220,000, a gain on settlement of $50,000 results.
Note
Accounting for ARO liability is similar to the treatment of bonds payable. The liability is initially recorded at its present value and is amortized. Amortization is recorded with a debit to accretion expense and a credit to ARO liability.
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