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What Are Asset Retirement Obligations (AROs) And Leasehold Improvements Related To Lease Accounting?

What are asset retirement obligations (AROs) and leasehold improvements related to lease accounting?

One of the many nuances of lease accounting, an asset retirement obligation (ARO) is a liability related to the retirement of a tangible long-lived asset when the timing or method of settlement might be dependent upon a future event.  ARO is significant for any remediation work needed for restoration, but not for unplanned cleanup or work immediately resulting from an accident.

For example, when a company has an operating lease for a building and stipulates any leasehold improvements should be removed at the end of the lease, under GAAP the company has an ARO.  To be compliant, the company would need to record a liability for the cost to remove the leasehold improvements and increase the asset value by the same amount.

Examples of AROs may include the costs related to the following assets:

  • The removal of underground gas tanks at a gas station that need to be removed at the end of the lease
  • The dismantling of an oil rig at an oil drilling site at the end of the lease
  • Restoration of an office space upon lease termination

Companies need to take into consideration the depreciation of the asset, retirement accretion of the asset retirement liability as well as other factors. Rules associated with ARO were established by FASB (the Financial Accounting Standards Board) and are outlined in Rule No. 143: Accounting for Asset Retirement Obligations. Additional information on asset retirement obligations is available here.  Other items that impact the calculation of lease liabilities and right of use assets are tenant improvement allowances (TIA) and direct costs. CoStar Real Estate Manager software can help with lease management and lease administration for all lease types, including real estate, equipment, vehicles and other assets.

Matt Waters, CPA

Lease Accounting Subject Matter Expert with over 15 years of Management Experience in Accounting and Finance