Zimmer Chemical Co. has chemical manufacturing facilities around the world. Recently, Zimmer erected a new facility in South Korea at a cost of $48 million and plans to operate the new facility for a period of fifteen years. The South Korean government requires that, at the time Zimmer concludes operations at the facility, Zimmer dismantle the facility and clean up any chemical spills that might have occurred at the location during manufacturing operations. The estimated cost of the dismantling and cleanup is $2 million.
Zimmer’s management has concluded that the accounting for the asset retirement obligation (ARO) could be handled in one of three ways:
1. Record the $2 million as an expense at the time of dismantling and cleanup (at the end of the fifteen-year-life of the facility).
2. Increase the cost of the asset (manufacturing plant) by $2 million, for a total cost of $50 million.
3. Charge the $2 million to inventory, since the ARO should be part of production costs of inventory.
In discussions with the South Korean government, Zimmer is informed that the South Korean manufacturing facility will be required to prepare and report its financial statement in accordance with IFRS. As a result, Zimmer’s managers are attempting to decide the acceptable accounting treatment for the ARO. They assume that the accounting is the same under U.S. GAAP and IFRS. They turn to you, the outside accounting firm representative, for advice.

Required: 

Conduct research to determine the appropriate accounting recognition of the ARO under IFRS. Prepare a report to be presented to Zimmer’s management with specific authoritative literature references.