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The first step in evaluating the appropriate accounting for a commodity contract is to determine the unit of accounting. The unit of accounting will depend on the nature of the agreements and may be impacted by the accounting model applied to elements of the contract, as established in Step two of the commodity contract framework.
The guidance generally applicable to commodity contracts includes lease and derivative accounting, as well as specialized industry guidance
and general guidance for executory contracts. When a contract contains multiple deliverables, these accounting models require consideration of whether there are any legally separable components (i.e., freestanding elements) that should be evaluated as separate units of accounting. In addition, in some cases, multiple agreements executed at the same time and in contemplation of each other may need to be accounted for as one contract (one unit of accounting) with multiple deliverables. Considerations in evaluating the unit of accounting include:
• Freestanding elements
Features that are written in the same contract, but that may be legally detached and separately exercised would be considered freestanding instruments that should be accounted for separately — not subject to analysis in the context of the other deliverables under the contract. In such cases, once that element is separated, the remaining elements and deliverables would be evaluated in the context of the whole contract. For information on evaluating whether an element is freestanding or embedded, see UP 3.4, DH 18.104.22.168, and FG 7.3.
• Multiple agreements entered into at the same time—when lease model is applicable
ASC 840, Leases, provides specific guidance for multiple agreements executed at the same time. ASC 840-10-15-16 indicates that the determination of whether a contract contains a lease should be based on the totality of the arrangement with the third party.
… separate contracts with the same entity or [its] related parties that are entered into at or near the same time . . . [should] be evaluated as a single arrangement in considering whether there are one or more units of accounting, including a lease.
• Multiple agreements in contemplation of one another—when derivative model is applicable
ASC 815, Derivatives and Hedging (ASC 815), also discusses the accounting for multiple contracts executed at the same time. In general, ASC 815 does not require the combination of two freestanding derivatives to be viewed as one unit of accounting, unless the derivative instruments are jointly designated in a hedging relationship.
However, ASC 815-10-25-6 requires reporting entities to apply judgment to determine if separate derivatives have been executed in lieu of a structured transaction. The characteristics to consider in making this assessment are: (1) the transactions are entered into contemporaneously and in contemplation of one another; (2) they are entered into with the same counterparty; (3) they relate to the same risk; and (4) there is no substantive business purpose for structuring the transactions separately. If it is determined these characteristics are not present, the freestanding derivative instruments would be viewed as separate units of accounting.
Once the unit of accounting is determined, the reporting entity should apply the evaluation hierarchy applicable under U.S. GAAP, as further discussed in Step two. For purposes of this discussion, we have referred to the unit of accounting as the contract; however, as noted, the unit of accounting could be part of a contract or multiple contracts combined.
1Guidance originally issued as Emerging Issues Task Force (EITF) Issue No. 91-6, Revenue Recognition of Long-Term Power Sales Contracts, and EITF Issue No. 96-17, Revenue Recognition under Long-Term Power Sales Contracts That Contain both Fixed and Variable Pricing Terms, has been primarily codified as ASC 980-605-25-5 through 25-15 and ASC 980-605-25-17 and 25-18, respectively.
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