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LOS g: Discuss the liability for closure, removal, and environmental effects of long-lived operating assets, and discuss the financial statement impact and ratio effects of that liability.

Which of the following most accurately describes the financial statements and ratio impacts of recognizing an asset retirement obligation?

A)	Depreciation will be higher; net profit margin and times interest earned will be lower.

B)	Equity will be higher; net profit margin and times interest earned will be higher.

C)	Equity will be higher; net profit margin and times interest earned will be lower.

Assets, liabilities and depreciation will be higher. Net profit margin will be lower because net income is lower and times interest earned will be lower because the interest expense is higher.

If a company is required to pay the future costs for closure, removal, or environmental effects of a long-term asset, the capitalized value of the asset:

A)	be recorded as the installed cost of the asset plus any leasehold improvements that are required to put the asset into good working order.

B)	be recorded on the balance sheet based on the market value at the time of acquisition less the cost associated with any asset retirement obligation.

C)	should include the present value of any asset retirement obligation, which is also recorded as a liability at the time of acquisition.

Any future expenditure that is required for environmental remediation must be recorded as a liability according to the present value of its expected cost at time of acquisition. The present value of the asset retirement obligation (ARO) is recognized as a liability, and the same value is added to the carrying value of the asset.

Caruso Ltd. just started operating a diamond mining site in the Arctic and intends to do so for exactly ten years. Caruso will be required to pay an estimated $2.0 million in clean-up costs of the site. The company expects to incur this expense over two years after mining activity ceases and is not permitted to deduct the costs for tax purposes until the clean-up is completed. For financial statement purposes, Caruso recognizes an asset retirement obligation (ARO) and will recognize accretion expense over the ten-year life of the asset. At the end of ten years, Caruso will recognize:

A)	a deferred tax liability.

B)	a deferred tax asset.

C)	no deferred tax items.

At the end of ten years, the asset retirement obligation (ARO) liability is equal to the full amount of the obligation of $2.0 million. At this point, the obligation has been fully recognized in the income statement but not on the tax return because the liability will be deductible for tax purposes only when it is paid. Therefore, because there is still a future benefit in the form of a deduction on the tax return, there is a deductible temporary difference and the company will recognize a deferred tax asset on its balance sheet.