Under ASC 842, Asset Retirement Obligation (ARO)refers to the costs to dismantle and remove an underlying asset at the end of the lease term that is imposed by the lease agreement.

To make the definition simple, it means the lessee is required to pay to bring the leased asset back to the same condition before the start of the lease agreement. The cost to pay is ARO.

For example, if the lessee rents an office in a bare-shell condition during the start of the lease. During the rental period, the lessee put carpet flooring across the whole office space. According to the lease agreement, the lessee is required to bring the office back to bare-shell condition. The lessee might need to hire workers and supplies to remove the carpet flooring and there are costs occurred. E.g. The total cost of hiring workers and supplies to remove the flooring is $5,000. The ARO is $5,000.

No. ARO is not included as part of the lease payment. During the calculation for the lease liability and Right-of-Use Asset(ROU), the ARO is excluded from the payment schedule.

Rather, the ARO has its own stand-alone calculation.

Similar to the calculation method of how lease liability is calculated, ARO needs to be actualized in net present value (NPV) at the beginning of a lease.

Based on the discount rate %, the ARO amount will be increased by the interest amount and the ARO amount will add up to the amount known at the beginning of the lease.

To read more about Asset Retirement Obligation, please also see this article.