Asset Retirement Obligation
Definition of 'Asset Retirement Obligation'
The ARO is recorded on the balance sheet as a long-term liability. The cost of the ARO is amortized over the useful life of the asset. The amortization expense is included in the company's income statement.
The ARO is calculated using the following formula:
ARO = Present value of future costs
The present value of future costs is calculated using the following formula:
Present value of future costs = Future costs * (1 + interest rate) ^ (number of years)
The future costs are the costs that will be incurred when the asset is retired or removed. These costs include the costs of dismantling the asset, removing the asset from the site, and restoring the site to its original condition.
The interest rate is the rate of interest that is used to discount the future costs. The interest rate is typically the company's cost of capital.
The number of years is the number of years over which the ARO is amortized. The number of years is typically the useful life of the asset.
The ARO is a significant liability for many companies. The ARO can be a significant expense for companies that have a large number of long-term assets. The ARO can also be a significant risk for companies that are not able to properly manage their AROs.
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