Evaluating your electric power production assets for potential impairment

The goal of the shiny object

Those of you who have completed a Lego model with 3,000 pieces, ran a 5K or half marathon or met one of your major life or career goals have most likely experienced a feeling of satisfaction, euphoria or immense pride. Those of you that have been part of building a power plant, from idea through construction to completion, have felt a similar rush of excitement when the plant is done, and it’s running and producing electricity. It’s shiny and new. A lot of hard work, creativity and effort went into this mammoth undertaking. 

But now, some time has passed, technology and markets have changed and the shininess has gone away. However, there are other shiny objects and goals out there, and they begin to look like potential replacements or new projects to pursue. As you evaluate options, your utility may realize that it is time to implement new power supply resources, use more renewables or move to a new type of fuel. New goals and projects may drive your decision-making toward potentially closing current power plants before the end of their useful lives. The technical accounting term for this change or falling out of favor is called an asset impairment.

What determines if an asset is impaired?

For public sector utilities that follow Governmental Accounting Standards Board (GASB) standards, GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries, provides the rules for determining asset impairment. Private sector utilities will find impairment guidance in ASC 360 Property, Plant and Equipment. The rules are similar.

GASB 42 defines asset impairment as a “significant, unexpected decline in the service utility of a capital asset” (GASB 42, paragraph five) that is not expected to occur during the normal course of business. An asset’s decline in service must be both “significant” and “unexpected” to be treated as impaired. “Significant” refers to the cost-benefit of continued use. “Unexpected” refers to an event that would not have been foreseen by management. 

We know that as of the date of this article (May 2020), most everything is framed as “COVID-19” related, but impairment considerations can be attributed to many non-COVID-19 events, such as market competition, technology, changes in fuel pricing or local economic conditions. Though, these factors can be magnified through current events as well. In any case, as we move through calendar year 2020, accounting prudency requires that utilities evaluate assets for potential impairment if the situation warrants.

Questions to ask regarding potential asset impairments, especially in the area of power plants, include:

1. Market conditions: Is our power supply resource pricing competitive in our power market? If not, can it be changed to be competitive?
2. Technology: Is our power supply resource meeting environmental standards? If not, will the cost of meeting the standards be more than the market pricing and benefit received through the effort?
3. Fuel pricing: With the pricing of natural gas hovering around $2/MMBtu, is our unit no longer competitive in the market? Will we need to put our renewable energy project on hold or cancel it due to the economics of market power pricing?
4. Industry impact: Has a major industry in our community that made up 30% of our load shut down permanently? 
5. Natural disasters: Has a recent storm damaged the asset so that it will only be usable with a sizable investment?

Answering “yes” to any of these questions should trigger an evaluation of potential impairment. 

What determines if an asset is impaired?

The GASB and Financial Accounting Standards Board (FASB) accounting standards outline the approach to value an impairment, and it can be fairly complex. In the simplest example, the difference between the current book value of the asset and a valuation of the asset based on market conditions would equal the impaired value of the asset.

An impairment should be recognized as a loss in the period of determination of the impairment, impacting net income. This, in turn, raises the question of whether the amount calculated as an impairment will be recovered in utility customer rates. Rate recovery may be important as often the impaired asset has been financed with debt and a portion of that debt may still be owed to bond holders. In that situation, the utility should defer the impairment loss (under regulatory accounting, GASB 62/ASC 980) and match recognition of the loss to the period of the recovery in customer rates of the related debt payments.

Start considering assets now for potential impairment in your 2020 financial statements

The process to determine an impairment can take some time, so it is not too early to begin consideration of impairments for the current year. This article was designed to outline the high-level considerations to help your thought process. For more depth and assistance, contact our team.