Asset Retirement Obligations Under ASC 842 and IFRS 16

Updated August 19, 2026

If you’ve signed an operating lease, built leasehold improvements, and determined you are legally required to remove those improvements when the lease expires, you may already be dealing with an asset retirement obligation, or ARO.

That said, not every end-of-term obligation qualifies as an ARO. Some distinctions are subtle, but they can significantly change the accounting treatment. This article summarizes the key concepts, but companies should consult their accounting advisors before making final determinations.

What Is Asset Retirement?

Asset retirement refers to the process of removing, disposing of, or decommissioning an asset that is no longer in use or has reached the end of its useful life.

An asset retirement obligation is a liability related to the retirement of a tangible long-lived asset. In many cases, the timing or method of settlement depends on a future event, such as the end of a lease term, a regulatory requirement, or the retirement of a specific asset.

In many industries, asset retirement obligations are recognized as liabilities. These obligations represent the estimated future costs of retiring certain assets, especially when environmental, safety, or contractual requirements are involved.

For lessees, AROs often come up when leasehold improvements must be removed, the leased space must be restored, or an asset must be retired at the end of a lease term.

When Is an End-of-Term Obligation an Asset Retirement Obligation?

The guidance in ASC 842, Leases, and ASC 410, Asset Retirement Obligations, can be difficult to follow. Each standard refers to the other, and both address contract requirements, regulatory requirements, and other considerations.

While the facts and circumstances matter, ASC 842 provides a helpful rule of thumb:

• If the obligation is to remove an improvement to the underlying asset, and that asset has been recognized on the lessee’s balance sheet, the obligation to remove that asset is generally accounted for as an ARO.
• If the asset is owned by the lessor, the cost to remove the asset is generally considered a lease payment. In that case, the cost increases both the lease liability and the right-of-use asset. Amortization of that asset increase then increases lease expense.

It is important to note that “ownership” in this context refers to accounting ownership, not necessarily legal ownership. Those may differ.

For example, if a company leases a building, records leasehold improvements on its balance sheet, and is legally required to remove those improvements at the end of the lease, the company may need to recognize an ARO. Under US GAAP, that generally means recording a liability for the estimated removal cost and increasing the related asset value by the same amount.

There is also a third category of end-of-lease obligations related to environmental considerations. These obligations are covered by a separate section of ASC 410.

AROs generally relate to planned retirement, removal, remediation, or restoration obligations. They are not typically used for unplanned cleanup or work that results immediately from an accident.

Examples of Asset Retirement Obligations

Asset retirement obligations can appear in different industries, but in lease accounting, they often relate to removal, dismantling, remediation, or restoration requirements at the end of a lease term.

Common examples include:

• Office restoration: A tenant installs leasehold improvements and is legally required to restore the office space to its original condition when the lease ends.
• Gas station remediation: A lessee is required to remove underground gas tanks at the end of the lease, which may involve environmental or regulatory obligations.
• Retail or restaurant buildouts: A tenant installs branded finishes, signage, kitchen equipment, or other improvements that must be removed before returning the space to the landlord.

Not every end-of-lease obligation is treated the same way. The accounting treatment depends on the nature of the asset, who has accounting ownership of the improvement, and whether the lessee has a legal obligation to remove, retire, or restore the asset.

Example 1: Office buildout owned by the lessor

Biglaw, LLC leases 40,000 square feet in a Class A office building. The landlord agrees to build out offices and conference rooms to Biglaw’s specifications at a cost not to exceed $1 million.

Biglaw approves the plans but is not involved in construction. Biglaw is also required to return the space to its original condition at the end of the lease term. However, Biglaw does not record a tenant improvement on its balance sheet.

In this case, the end-of-lease obligation is not considered an ARO. Biglaw would estimate the cost to remove the improvements at the end of the lease and treat that amount as a final lease payment. The lease liability and right-of-use asset would include the removal cost.

Example 2: Restaurant improvements owned by the lessee

Justeatz, Inc. leases 4,000 square feet for one of its restaurant locations. The space requires significant work to accommodate kitchen equipment, branded finishes, signage, and other restaurant-specific improvements.

At the end of the lease term, Justeatz is required to remove its equipment and branded materials. Justeatz pays the contractor and records a leasehold improvement on its balance sheet. The landlord later reimburses Justeatz through a tenant improvement allowance.

Although the asset and liability are reduced by the amount of the incentive, the estimated cost to remove the leasehold improvements is accounted for as an ARO.

What Is the Accounting Entry for an Asset Retirement Obligation?

When accounting for an ARO, a business must recognize the fair value of the obligation when the liability is incurred, as long as it can reasonably estimate that fair value.

If fair value cannot be reasonably estimated at the time the liability is incurred, the ARO should be recognized later, once a reasonable estimate becomes available.

After initial recognition, the company generally depreciates or amortizes the related asset retirement cost over the useful life of the asset and recognizes accretion expense on the ARO liability over time.

This does not apply when there is uncertainty only about the amount of the obligation. It applies when the entity does not have enough information to estimate the present value of the obligation. All three accounting standards contain similar provisions.

How Are Changes to AROs Accounted For?

AROs are based on forward-looking estimates, so they can change over time.

Several factors may affect the projected cost of satisfying an ARO, including:

• Inflation
• Changes in technology
• Labor and material costs
• Regulatory changes
• Changes in the expected timing of remediation
• Changes in the scope of required work

Each accounting standard provides guidance for remeasuring AROs as conditions change.

The specific factors and thresholds can vary, but each standard calls for periodic review. Companies may also need to review the obligation when they become aware of changes in relevant facts or circumstances.

Material changes are generally handled as remeasurements, similar to other lease accounting updates.

How Are Asset Retirement Obligations Treated Under ASC 842, ASC 410 and IFRS 16?

ASC 842 and ASC 410

Under US GAAP, ASC 842 addresses lease accounting, while ASC 410 addresses asset retirement obligations. In many lease scenarios, the lessee must determine whether an end-of-term obligation should be treated as a lease payment under ASC 842, an asset retirement obligation under ASC 410, or another type of obligation, such as an environmental obligation.

The classification depends on the nature of the asset, who has accounting ownership, and whether the lessee has a legal obligation to remove, retire, or restore the asset.

Under ASC 410, initial measurement starts with the expected future cost to retire the asset. Companies typically estimate the cost to satisfy the obligation, consider potential outcomes, apply expected inflation when appropriate, and discount the expected expenditure to present value.

The discounted value is recorded as the asset retirement obligation liability on the balance sheet. The offsetting debit is recorded as an asset retirement cost, which is then expensed using a systematic and rational method over the useful life of the asset.

IFRS 16 and IAS 37

IFRS 16 does not use the same distinction as ASC 842.

Under IFRS 16, an obligation to dismantle and remove an underlying asset, restore the site, or restore the underlying asset is generally accounted for under IAS 37, Provisions, Contingent Liabilities and Contingent Assets. The obligation is treated as an adjustment to the right-of-use asset.

IAS 37 starts with the best estimate of the expenditure required to settle the obligation. The future obligation is discounted using a pre-tax rate that reflects current market assessments and risks specific to the liability.

The resulting value is recognized as a provision. Interest accretion is recognized as a borrowing cost, and the provision is expensed as the right-of-use asset is amortized.

Managing AROs With Lease Accounting Software

Asset retirement obligations can create added complexity for lease accounting teams, especially when companies manage large portfolios, multiple accounting standards, or leases with custom restoration and removal requirements.

Other lease accounting inputs, including tenant improvement allowances, direct costs, lease payments, and right-of-use asset calculations, may also affect how the broader lease is measured and documented.

Lease accounting software can help teams centralize lease data, track key obligations, manage remeasurements, and maintain consistent documentation across the portfolio.

CoStar helps organizations manage lease accounting requirements, including complex lease data, reporting needs, and obligations that may affect ASC 842 compliance. For teams managing asset retirement obligations, the right lease account software can help reduce manual work and improve confidence in the accounting process.

Asset Retirement Obligation FAQs

What is an asset retirement obligation under ASC 842?

An asset retirement obligation under ASC 842 may arise when a lessee has a legal obligation to remove leasehold improvements, restore leased space, or retire a tangible long-lived asset at the end of a lease. The lease is accounted for under ASC 842, while the ARO is generally evaluated under ASC 410.

Are asset retirement obligations included in lease liabilities?

Not always. If the obligation relates to a lessee-owned asset, such as leasehold improvements recorded on the lessee’s balance sheet, it is generally evaluated as an ARO under ASC 410. If the obligation relates to a lessor-owned asset, the cost may be treated as a lease payment under ASC 842.

Who is responsible for identifying asset retirement obligations in a lease?

Accounting teams typically identify potential AROs during lease review, but they often need input from real estate, legal, facilities, and operations teams. Lease language, restoration clauses, construction responsibilities, tenant improvement allowances, and asset ownership details can all affect whether an obligation should be evaluated under ASC 410.

What lease clauses can indicate a possible asset retirement obligation?

Clauses related to restoration, removal of improvements, environmental remediation, surrender conditions, signage removal, equipment removal, or return-to-original-condition requirements may indicate a possible ARO. These clauses do not automatically create an ARO, but they should prompt further accounting review.

How can lease accounting software support ARO tracking?

Lease accounting software can help teams centralize lease terms, flag restoration and removal obligations, document assumptions, track remeasurement triggers, and connect ARO-related details to broader ASC 842 reporting workflows. This can reduce manual tracking and improve consistency across large lease portfolios.