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Accounting

Electric Energy Sector Says Accounting Rule Causing Losses to Profitable Contracts

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

By Denise Lugo

The Edison Electric Institute (EEI), a group that represents all U.S. investor-owned electric companies, asked the FASB in a January 9, 2020, letter to narrowly amend its lease accounting rules for sales-type leases because a pervasive negative issue has emerged.

The rules cause companies that provide the nation’s electricity to have to book an initial loss for sales-type leases, profitable contracts with payments that significantly vary, the group said.

“For sales-type leases with wholly or significant variable lease payments, the application of Topic 842 will result in the recognition of a loss at lease commencement by the lessor for profitable arrangements, and subsequent payments received by the lessor will be recognized as income in their entirety as opposed to being split between lease income and recovery of a lease receivable,” EEI’s Vice President, Richard McMahon, Jr., said.

Consolidated Energy (Con Ed), which primarily services New York; PG&E Corp., which services California; and American Electric Power, which services eastern and central states and parts of Canada, are among the many companies EEI represents.

“This is a pervasive emerging issue for our industry for arrangements involving renewable generation facilities paired with battery storage systems, which are becoming increasingly common as the technology becomes more scalable and commercially competitive,” McMahon said.

Topic 842, Leases, was issued by the FASB in February 2016 but went into effect in 2019 for public companies. The rules take effect in 2021 for private companies. The standard requires companies – for the first time – to record the full magnitude of their long-term lease obligations on the balance sheet.

Operating Lease Alternative

Arrangements for the purchase and sale of energy from renewable generation facilities, including those paired with battery storage systems, can contain a lease component, the letter states. Such arrangements result in sales-type lease classification because the lease term typically is for a major part of the economic life of the identified asset.

EEI wants the board to amend Topic 842 to require lessors to classify sales-type leases with significant variable payments as operating leases, stating this approach would be intuitive and better reflect the economics of the arrangements. This change would be narrowly applied and address only the initial classification of a subset of arrangements.

“This alternative is a pragmatic solution that addresses the lack of representational faithfulness resulting from day-one losses and the derecognition of valuable, owned property, plant and equipment on sales-type leases,” McMahon said.

The new leases rules do not allow companies to include variable payments when computing the investment in the lease. As a result little to no net investment in the lease is eligible to be recorded at the start of the lease, “proposing a loss for most if not all of the carrying amount of the identified asset when it is derecognized by the lessor,” he said.

Asked about whether the FASB plans to take up the topic, a FASB spokesperson on January 10 said, “as with all agenda requests, the FASB will review and consider it as part of our process.”

$71 Billion Sector Growth Expected

The accounting issues come at a time when the electric energy industry has been increasingly entering into arrangements for the purchase and sale of energy from renewable (solar and wind) power generation facilities that are in many cases paired with a battery storage system.

EEI said this is trend that will accelerate significantly as energy storage becomes more scalable and commercially competitive with traditional generation facilities (e.g., fossil fuel generation). The U.S. electric energy industry is forecasted to invest approximately $19 billion of capital in battery storage systems attached to renewable facilities over the next 15 years, and total capital investment in all types of battery storage facilities in the U.S. is expected to exceed $71 billion over this same period, the organization said.

Structuring, Non-GAAP Cropping Up

In its argument to advance reasons for an amendment to lease accounting, EEI also said the rules create issues they were developed to avoid. Commercial teams are structuring transactions around the accounting outcomes, for example, sacrificing real economics in order to avoid the day one loss. Lessors are also considering non-GAAP measures to explain the inconsistency in their financial results, both at the start of the lease and over the lease term, he said. This increases the burden on users to determine which measures are most meaningful.

In 2005, the SEC estimated that about $1.25 trillion in operating leases were not being reported on balance sheets. Instead they were buried in note disclosures. In its report, Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements With Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers, the regulator said issuers “see leasing as an attractive form of financing asset acquisition in part because leases can be structured so as to avoid recording debt.” And because the Enron scandal involved off-balance sheet financing scams, the SEC asked the FASB to address leases rules.

The FASB has plans this year to hold a roundtable on issues that are arising from implementing the accounting changes. (See FASB to Hold Roundtable Early Next Year on Implementation Challenges of Lease Accounting Rules in the December 10, 2019, edition of Accounting & Compliance Alert.)

 

This article originally appeared in the January 13, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

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