Financial Accounting and Reporting-CPA Practice Exam

In the journal entry for recognizing an ARO, which account is credited?

1. Asset Retirement Cost

2. Asset Retirement Obligation

3. Accretion Expense

4. Long-term Liabilities

The correct answer is: Asset Retirement Obligation

When recognizing an Asset Retirement Obligation (ARO) in a journal entry, the correct account to credit is the Asset Retirement Obligation account. This entry reflects the company's legal obligation to retire an asset at the end of its useful life, such as decommissioning costs for a piece of equipment or a facility. By crediting the Asset Retirement Obligation account, the company establishes a liability to reflect the present value of future costs associated with dismantling, removing, or restoring the asset, aligning with the matching principle of accounting where expenses are recognized in the same period as the related revenues. The associated debit entry typically goes to the Asset Retirement Cost account, which is classified as an asset on the balance sheet. Thus, this method properly allocates the costs to both the liability and the related asset. Accretion Expense is involved in the ongoing accounting for the ARO but is not credited in the initial recognition journal entry. Long-term Liabilities, while a category that includes the ARO, is not specifically the account that receives the credit in the journal entry.