Asset Retirement Obligation, Changes in Estimate versus Errors, Writing an Issue Memo

Facts:    MegaCorp’s corparate headquarters, built in 1970, has asbestos in its insulation. The Company’s financial statement reflect a $5 million asset retirement obligation (ARO) for the eventual remediation of the asbestos. This ARO was initially estimated and recorded in 2005 when the company adopted FIN 47, Accounting for Conditional Assest Retirement Obligations. (Note: Amounts recorded for AROs are generally estimated, because it is not always possible to know how much remediating asbestos – or other like issues – will ultimately cost.) MegaCorp is public company with a calendar year-end.

While performing routine maintenance work on the facility, additional sampling identified the presence of asbestos in more places than the Company had documented during its initial estimate. The Company now believes the total cost to remediate the asbestos will be $9 million. The initial estimate ($5 million) was based on sampling around the plant for areas containing asbestos. The newly-discovered areas with asbestos were in a part of the facility that was not sampled.

Required: Assume that you are in the controller’s group of MegaCorp and have been asked to prepare an accounting issue memorandum documenting your consideration of the following issues.

1) The Company’s controller is questioning whether this liability for asbestos disposal is even necessary at all. He argues that asbestos must only be remediated if it is disturbed (such as through renovations), and points out that the company does not have any immediate plans to renovate the building. Respond to his question using authoriative guidance – is a liability even necessary, if the company’s plans for disposal or renovation of this building are uncertain?

2) Determine whether the additional liability for the newly discovered asbestos is considered a change in accounting estimate or an error. Note that this is not a change in accounting principle. Support your answer using authoritative guidance.

3) Describe how the company should record this $4 million change (prospectively, or through a retrospective adjustment)? What accounts should be debited/crebited? You can disregard use of present value for this example.

Answer rating: 100% (QA)

Solution 1 This memorandum is intended to address the accounting for the cost of legal obligations r... View the full answer