Considerations for utilities — FASB followers
When assessing a lease in the utilities sector, note the following considerations:
- Power Purchase Agreements
- Pole Attachments
- Easements
These considerations are for those entities that follow the accounting standards issued by the FASB. There are some differences between the FASB and Governmental Accounting Standards Board (GASB) with respect to these issues.
Power purchase agreements
Most of these types of agreements aren’t accounted for as leases under legacy GAAP. Entities will typically just expense the power purchase costs as incurred each month. There is typically no balance sheet impact, unless a client prepays for the power under an agreement, in which case they’ll amortize the payment over the course of the agreement.
Under the new standard, some of these contracts could end up as leases. Consistent with the analysis above for oil and gas entities, to be considered a lease, an entity must meet the following two criteria:
- Identifiable asset that an entity is deemed to control
- Entity must determine if it controls the identified asset for a period of time
A contract conveys control of the identified asset if the entity has the right to direct the use of the asset and obtain substantially all the economic benefits of the identified asset from its use.
Entities in the utilities sector will need to evaluate each of these criteria to determine if they have control of the underlying generating asset or facility. This is based on whether they have the right to direct and obtain substantially all of the economic benefits — capacity and other benefits, including renewable energy credits if applicable — from the use of the asset.
In situations where power and utilities entities buy substantially all of the power from a generating asset owned by a third party under a power purchase agreement, there could be instances where this would be viewed as having control and be considered a lease in the future.
A case study from the ASC Topic 842, Leases, implementation guidance provides examples that feature a power plant.
Per these examples, indicators that generally result in a power purchase agreement qualifying as a lease include the following:
- The power plant is an identified asset, and the customer has the exclusive right to purchase all the power produced for the period of use.
- The customer directs the use of the power plant because it provides instruction to the supplier about quantity and timing of delivery of power.
- The customer has the right to substantially obtain all economic benefits from the use of the power plant over the contract term because the supplier can’t use the power plant for another purpose.
In addition to the above examples, a tolling arrangement in which a customer has a right to control the supply of fuel to the asset could be an indicator of control and should be considered.
However, even if the contract contains an identified asset, the following indicators will still generally result in a power purchase agreement not qualifying as a lease:
- The supplier is the only party that can make decisions about how the power plant is operated and maintained.
- The customer didn’t design the power plant.
- The customer doesn’t have the right to direct the use of the power plant as the customer doesn’t operate the power plant
- The customer has no right to change how and for what purpose the power plant is used during the period of use.
Entities will need to review all their contracts and agreements in this area to reevaluate whether they have the power to direct and obtain substantially all benefits from the use of the asset.
Pole attachments
A common issue for a utility entity is determining the unit of account used for assessing control. Common practice in the industry is that a telecommunications entity will attach equipment to a pole owned by a power and utility entity and in return will pay a fee.
The issue of determining the unit of account is critical because this analysis is the first step in determining which entity has the right to direct the use of the asset and obtain substantially all the economic benefits of the identified asset from its use and ultimately if the agreement contains a lease.
First, the utility entity will need to evaluate the unit of account. Upon determination of the unit of account, then the utility entity must evaluate if it controls the unit of account. Effectively, this depends on whether the portion of the pole that the telecommunications company attaches to is distinct and has a discrete functional use, or whether the larger asset, in this case, the pole is the identified asset.
The objective of the asset owner — a utility entity for example — when the asset was built or purchased is a significant consideration. For example, did the utility entity build the asset with an intention to lease out a space on the pole? That may be the case with a cell tower that has specific hosting locations designed to be leased by third parties. However, it might not be the case for an electric utility’s distribution poles that were not built with the commercial objective of leasing out a portion of the pole.
Once the unit of account is determined, the next step is to determine control and who has the rights to the economic benefits in the context of that unit of account. If the entire pole is determined to be the unit of account, then there’s a likelihood that the utility entity maintains the rights to the economic benefits. If a portion of the pole is determined to be the unit of account, it could be supported that the telecommunications entity has the right to control that portion of the larger asset.
Easements
Many power and utility entities obtain permanent or temporary easements for the purpose of accessing or crossing land to be able to construct and maintain equipment on that land.
These types of agreements have typically never been recorded as leases in the past under ASC 840. Upon adoption of ASC 842, entities will need to evaluate easements because of the new lease definition. Consistent with oil and gas entities, power and utilities entities will need to consider whether the agreement is for a period of time or perpetual and whether the entity is able obtain substantially all the economic benefit of the identified asset.
Generally, permanent easements will not meet this definition given the lack of time constraints, but many temporary easements may meet the new definition and need to be recorded as leases.
Under the new definition, “a contract is or contains a lease if the contract conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration,” with “for a period of time” being key given that some easements are temporary, and some are permanent. The same considerations oil and gas companies give to assess control, as discussed above, will need to be given by power and utility companies.
Power and utility entities can take advantage of the practical expedient that allows entities to continue to treat right-of-way and land easement contracts in accordance with legacy GAAP as long as they weren’t accounted for as leases under ASC 840.
Similar to oil and gas entities, if the contract was accounted for under ASC 840 or was modified on or after the adoption of ASC 842, the contract will need to be reassessed in accordance with ASC 842.
