Analyzing Asset Retirement Obligations
The accounting treatment of Asset Retirement Obligations (AROs) differs from that of other obligations, particularly financial obligations. However, the economic consequenses are similar. As a result, analysts often adjust a company’s financial statements to treat the AROs as financial obligations as follows:
- The ARO is reduced by the amount of any offsetting trust funds or escrow accounts.
- The ARO is reduced by the tax rate to account for the tax savings that will result when the obligation is met.
- The remaining value of the ARO is added to long-term debt.
- Accretion expense is reclassified from operating expenses to interest expense.
By increasing the amount of long-term debt and interest expense without affecting either sales or net income, this reclassification has the effect of increasing leverage ratios such as debt/equity and reducing solvency ratios such as interest coverage.
For more information, see all articles on: Accounting, Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis, Ratio Analysis See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
