What does accretion expense mean on the CPA exam?
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Accretion expense. The increase in an asset retirement obligation from the passage of time, measured by the interest method at the credit-adjusted risk-free rate in effect when the liability was first measured. Classified as an operating item, and not interest cost for capitalization purposes.
Defined against ASC 410-20-35-5, 45-1.
Worked example
On January 1, Year 1, a company installs a cell tower it must remove at the end of a ten-year site lease. It records an asset retirement obligation of $500,000, the present value of the expected removal costs at its credit-adjusted risk-free rate of 6%. No estimates change during the first two years.
What accretion expense does the company record in Year 1 and in Year 2?
| Year 1 accretion: the opening obligation at the original rate500,000 x 6% | 30,000 |
| Obligation at the end of Year 1500,000 + 30,000 | 530,000 |
| Year 2 accretion: the larger obligation at the same rate530,000 x 6% | 31,800 |
Answer: Accretion expense is $30,000 in Year 1 and $31,800 in Year 2. It is an operating expense, separate from depreciation of the capitalized retirement cost, and it is not interest cost eligible for capitalization.
The trap: Reporting the increase as interest expense, or charging the same $30,000 every year. Accretion uses the interest method on a growing balance, at the rate in effect when the obligation was first measured, and it sits in operating expenses.
Based on ASC 410-20-35-5; ASC 410-20-45-1.
Which CPA exam sections use accretion expense?
Accretion expense appears in the FAR section of the CPA exam.
Other terms defined against ASC 410-20
- asset retirement obligation: A legal obligation associated with the retirement of a tangible long-lived asset, recognized at fair value in the period incurred, with an equal asset retirement cost capitalized into the asset.
Related terms
- interest expense: The cost of borrowing for the period, accrued as time passes rather than when the payment is made.
- functional expense: Expense classified by what it was FOR -- program, management and general, fundraising -- rather than by what it was.
- right-of-use asset: The lessee's asset representing its right to use the leased item for the lease term.
- cash equivalents: Short-term, highly liquid investments readily convertible to known amounts of cash and so near maturity that interest rate changes pose insignificant risk.
- lease liability: The lessee's obligation to make the remaining lease payments, measured at their present value.
- carrying amount: What an asset or liability is currently shown at on the balance sheet: its original amount adjusted for depreciation, amortization, impairment or accrual.