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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