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2.3 Evaluating other contracts for leases
Publication date: 31 Mar 2023
us Utilities guide
Utilities and power companies enter other arrangements, including land easements, storage contracts, and transportation contracts, that may also be leases. While the evaluation of these contracts should generally follow the same process described in UP 2.2, certain nuances in these contracts can make the lease assessment more challenging.
2.3.1 Land easements
Land easements (or rights of way) represent the right to use, access, or cross another entity’s land for an identified purpose. Easements are typically acquired by reporting entities to construct assets such as transmission or distribution lines, pipelines, or cell phone towers. Easements may involve rights to construct assets on the surface of the earth (land or surface rights) or below the earth (underground or subsurface rights). Easements may also involve the ability to use space above the land (air rights). In addition, easements often permit the grantor to continue to access and use the land for its own purposes.
An easement may grant different rights to different aspects of a property (e.g., surface, subsurface, air). In some instances, a reporting entity may obtain the right to access a parcel of land and have additional rights to a portion of that land (e.g., it may have exclusive access to part of the property where it has the right to construct certain assets). Because of this, determining whether an easement arrangement contains a lease requires judgment. Section UP 2.3.1.1 through UP 2.3.1.3 outline the key steps in determining whether an easement arrangement contains a lease. This analysis follows the lease evaluation framework discussed in UP 2.2. See also LG 2.3 for further discussion on the lease evaluation framework.
Question UP 2-10
Does a land easement that provides for perpetual use rights meet the definition of a lease?
Does a land easement that provides for perpetual use rights meet the definition of a lease?
PwC response
It depends. A land easement arrangement may provide for perpetual use rights. To qualify as a lease, an arrangement must convey a right to use an identified asset for a period of time. Therefore, a contract that does not contain a defined term would be outside the scope of ASC 842. A reporting entity must consider the substance of the easement in determining whether it is truly perpetual. For example, the perpetual provision in a “pay-as-you-go” easement that provides the right to use land indefinitely may not be substantive if the easement holder can terminate the arrangement at any time by merely stopping the payments. In this instance, the contract is similar to a contract with perpetual renewal periods. If the easement is or contains a lease, an entity must determine how many of the renewal periods are reasonably certain of exercise by the lessee when assessing the lease term.
2.3.1.1 Land easements: Is the arrangement explicitly scoped out of ASC 842?
A reporting entity should consider whether the right to use the asset is scoped out of ASC 842. For example, an easement may be an intangible asset and required to be accounted for in accordance with ASC 350, Intangible Assets. ASC 350-10-20 defines intangible assets as “assets (not including financial assets) that lack physical substance.” ASC 805-20-55-37 provides examples of contract-based intangible assets, including use rights, such as drilling, water, air, timber cutting, and route authorities. As such, an arrangement that provides for air use rights is an intangible asset. In accordance with ASC 842-10-15-1, intangible assets are outside the scope of ASC 842.
Many arrangements that provide for underground or subsurface rights (rights to space below the earth’s surface) are similar to air use rights. We believe rights to any spaces that cannot be inhabited or accessed by human beings, such as air rights or rights to construct some underground pipelines, could be accounted for as intangible assets.
Figure UP 2-4
Examples of tangible and intangible rights
Examples of tangible and intangible rights
Property, plant, or equipment |
Intangible |
Arrangement relates to:
|
Arrangement relates to:
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If a contract conveys both surface and subsurface land rights, reporting entities should evaluate the rights separately. Such arrangements may include lease and nonlease components.
2.3.1.2 Land easements: Is there an identified asset?
If the arrangement is within the scope of ASC 842, the reporting entity will need to evaluate if the arrangement involves an identified asset. Land easements generally meet the identified asset criterion on the basis that the transaction involves an explicit portion of an identified asset. Reporting entities may also need to consider whether a right of way arrangement contains more than one identified asset. For example, some land easements for an identified parcel of land allow the grantee to use a portion of the parcel for a specific and limited purpose. This type of arrangement may contain two identified assets.
Reporting entities should review the rights provided by the easement arrangement. If more than one identified asset exists, each should be evaluated to determine if it is subject to a lease.
Figure UP 2-4 includes examples of identified assets within a typical easement arrangement.
Figure UP 2-5
Examples of identified assets in an easement arrangement
Examples of identified assets in an easement arrangement
Identified asset |
Examples |
One identified asset
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Surface land rights for a single parcel
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Multiple identified assets
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Surface land rights for multiple, distinct parcels of land
Surface land rights for a land parcel (e.g., 100 acres) and different rights for a portion of the parcel (e.g., 10 acres at a location identified in the contract)
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As discussed in UP 2.2.2.2, a portion of an asset may be an identified asset if it is physically distinct. Therefore, a contract that specifies the exact location of the portion of land would involve an identified asset. In some cases, however, the exact location of the portion within the parcel may not initially be identified. A contract that contains the right to use an asset to be identified in the future would meet the definition of a lease only when the location of the portion of the parcel is identified.Substitution rights of the grantor also need to be considered. If the grantor can require assets constructed by the grantee to be relocated at the grantee’s expense, the grantor may have substantive substitution rights and there would not be an identified asset (see UP 2.2.3.1 for discussion of substitution rights). The agreement does not involve an identified asset and would not meet the definition of a lease under ASC 842 if it is considered likely, based on the facts and circumstances present at the inception of the contract, that the grantor will require the grantee’s assets to be relocated.
2.3.1.3 Land easements: Does the purchaser have the right to control the use of the identified asset?
In determining whether an easement conveys the right to control the use of an identified asset, a reporting entity should consider whether the grantee has exclusive or shared use of an asset. If an arrangement conveys the right to control the exclusive use of an identified asset, it contains a lease in accordance with ASC 842.
Figure UP 2-5 outlines indicators of exclusive and shared use arrangements.
Figure UP 2-6
Determination of whether an easement conveys exclusive or shared use
Determination of whether an easement conveys exclusive or shared use
Type of use |
Indicators |
Example wording |
Exclusive
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Exclusive use is explicitly stated in the contract
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Exclusive use is implied in the contract
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|
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Shared
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The contract provides grantor with the ability to access and use land for other purposes without the grantee’s consent (as long as it does not interfere with the operation of grantee’s assets)
|
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Any requirements for a grantee to provide permission before the grantor can use the identified space should be assessed based on specific facts and circumstances to determine whether the arrangement provides exclusive use. If a contract provides for exclusive use to the customer, the contract contains a lease. If the contract instead provides for shared use, a reporting entity will need to evaluate whether the rights of each party are substantive. In making this determination, a reporting entity should evaluate factors such as which party makes relevant decisions about how the asset is used and the types of economic benefits each party derives from the use of the asset. Even in situations when use is shared between two or more parties, the grantee may have a lease if the grantor’s rights are non-substantive.
Examples of circumstances in which contractual shared use arrangements may be in substance exclusive use arrangements include (but are not limited to):
- Easements involving land in a geographic location with no or insignificant alternative use
- Easements involving land underlying a solar farm, in which the solar panels comprise the majority of the total land surface, and the landowner has the right to use the small portions of land in between individual solar panels
In each of these scenarios, there is no or limited alternative use for the identified asset covered by the contract. Thus, the grantee has in substance exclusive use and is deemed to receive substantially all of the economic benefits.
Example UP 2-4 and Example UP 2-5 illustrate the application of the evaluation framework in determining whether an easement arrangement is or contains a lease.
EXAMPLE UP 2-7
Easement agreement with multiple units of account
Easement agreement with multiple units of account
Rosemary Electric & Gas Company (REG) enters into an arrangement to obtain the right to access land owned by a farmer (the Grantor) for 40 years. The land is located in Iowa and is used by the Grantor to grow various crops. The contract provides the right for REG to access a specified plot of land measuring 10 acres. The contract also provides REG with the right to construct and operate transmission towers on an identified section of the 10-acre plot.
In accordance with the contract, the Grantor has the ability to use the space not occupied by REG’s transmission assets for its own purposes, as long as the Grantor’s activities do not interfere with the operation of REG’s transmission assets. The Grantor does not have the ability to access the identified subsection of the plot of land where the transmission assets will be built.
Does the arrangement contain a lease?
Analysis
Yes. The contract provides for surface land rights and conveys different rights between the specified 10-acre plot of land and the identified subsection. REG has exclusive use of the parcel where the tower will be constructed and shared access to the remaining property. Therefore, the agreement contains two components that are within the scope of ASC 842. In addition, because the contract specifies the location of both parcels of land, each is considered an identified asset.
REG has exclusive use of the identified parcel of land where the tower will be built and thus has the ability to both (1) direct how this piece of land is used and (2) obtain substantially all of the economic benefits from it. As such, REG has the right to control the use of the identified parcel of land, and the agreement contains a lease for this portion of the land parcel.
Use of the remaining portion of the 10-acre land parcel is shared between REG and the Grantor. The Grantor is able to use the land for its farming activities. Therefore, REG does not have the right to obtain substantially all of the economic benefits from use of the asset. Based on these factors, REG’s right to use of the unoccupied portion of the land parcel does not meet the definition of a lease under ASC 842.
Based on the above assessment, the agreement contains one lease component and one non-lease component. REG would need to allocate the payments made under the contract between the two components (unless it elects the practical expedient to combine the non-lease component with the lease component). See Figure UP 2-8 for details on the practical expedients related to combining lease and non-lease components.
EXAMPLE UP 2-8
Easement agreement with shared use of identified land
Easement agreement with shared use of identified land
Rosemary Electric & Gas Company (REG) enters into an arrangement to obtain the right to access a specific plot of land owned by the state of California (the Grantor) for 35 years. The contract also provides REG the right to construct, operate, use, and maintain electric lines and other structures necessary to transmit and distribute electric energy across the identified land parcel. In accordance with the agreement, the Grantor retains the right to access all land included in the agreement and may access any facility constructed by REG. The land is currently used as a state park.
Does the easement arrangement contain a lease?
Analysis
No. The contract provides surface land rights that allow REG access to the land to construct and operate transmission towers at periodic intervals. In addition, both entities are allowed access to all parts of the land, including the space beneath the transmission towers. As such, both entities have non-exclusive use of the full property.
Even after REG constructs the transmission towers, neither party has exclusive use of any part of the land. Therefore, REG will need to consider whether the Grantor’s rights to direct the use of the land or benefits received from the use of the land are substantive. The land is currently being used as a public park, which although the exact value cannot be calculated, the Grantor’s right to continue to use the land as a public park are assumed to be substantive. Therefore REG does not have the right to obtain substantially all of the economic benefits from use of the asset. Based on these facts, the right to use the parcel of land does not meet the definition of a lease under ASC 842.
Alternatively, if REG constructed a building or another structure beneath one of the transmission towers, such that the structure occupied substantially all of the space beneath the tower and precluded any alternative use of that area, REG would have in substance exclusive use of the space beneath the tower. In that scenario, the portion of the property occupied by the structure beneath the tower would be a separate lease component. Because the Grantor would not have the ability to use the space occupied by the structure, REG would have the right to obtain substantially all of the economic benefits from that part of the land. As a result, the right to use the part of land occupied by the structure underneath the tower would meet the definition of a lease under ASC 842 in this scenario. Use of the unoccupied portion of the land in this alternative scenario continues to be shared between REG and the Grantor, and the Grantor’s rights to that portion are substantive. As such the right to use the unoccupied portion of the land would not meet the definition of a lease.
2.3.2 Energy storage
As the demand for renewable energy grows, reporting entities continue to look for ways to further integrate renewable resources while maintaining the reliability of the electric grid. Shifting away from fossil-fuel energy supply will require investments in new technology to balance the intermittent nature of wind and solar facilities. Utilities and developers are increasingly focused on energy storage systems to address intermittency to better align renewable power generation with demand. The Inflation Reduction Act provides financial incentives to support investments in energy storage projects.
Figure UP 2-6 summarizes the main types of energy storage systems currently available in the market.
Figure UP 2-7
Types of energy storage systems
Types of energy storage systems
Type |
Description |
Pumped hydroelectric
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Battery
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Compressed air
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Flywheel
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Hydrogen
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Thermal
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Pumped hydroelectric facilities are currently the most prevalent type of energy storage system in the US. The use of batteries and hydrogen, however, continues to increase as technology and efficiency improves and costs decline. These facilities may be constructed as part of a power generation asset or as standalone facilities. In addition, a storage facility may be sited with any type of generation; however, the most common arrangement is to include it as part of a renewable facility.
Figure UP 2-8 illustrates a storage project that is connected to both a power generation asset and to the power grid, such that the system can be charged from either source, and discharged energy can either be released back to the grid or to a specific delivery point for consumption by the off-taker.
Figure UP 2-8
Sample structure for a hybrid storage project with a grid connection
Sample structure for a hybrid storage project with a grid connection
View image
Typical structures for storage off-take agreements include the following:
- Energy storage capacity contract
This type of agreement provides the off-taker with use of the storage project's capacity. Utilities typically enter into this type of contract to ensure the reliability of the grid and to meet resource adequacy needs required by the state or other regulators’ requirements. In some markets, these agreements may also be called resource adequacy contracts.
- Energy storage tolling agreement
Energy storage tolling agreements provide the off-taker with capacity, energy, and/or other products (e.g., ancillary services including demand response or congestion relief) generated by a storage system that is connected to the grid. In this type of structure, the off-taker will purchase and deliver power to the storage project to charge the battery for dispatch at a later time. In this type of arrangement, the off-taker typically has the authority to decide when the storage system is charged and discharged.
- Hybrid power purchase and storage agreement
A hybrid project will include a generation facility connected to a storage system. A hybrid purchase power agreement will include the purchase and sale of the power, renewable energy credits (if applicable), storage, and any other attributes from the hybrid project (e.g., ancillary services). The off-taker may use a hybrid power purchase agreement to manage the reliability of the grid (discharging renewable energy when needed) or to arbitrage power prices (storing energy when power prices are lower and discharging when prices increase).
Like other power purchase agreements, hybrid power purchase agreements can be structured in many ways to meet the needs and economic incentives of the counterparties. The contract typically outlines which party has the right to determine when and how the storage system will be used during the contract term. These rights may remain with the developer or be conveyed to the off-taker.
Commercial arrangements for energy storage projects continue to evolve along with technological advancement of storage systems and continued investment in renewable energy resources. All energy storage contracts — whether standalone or hybrid — should be evaluated using the commodity contract accounting framework discussed in UP1, including consideration of lease, derivative, and consolidation accounting. See UP 3 and UP 10 for discussion of derivative and consolidation considerations, respectively. The following discussion focuses on lease considerations.
2.3.2.1 Energy storage: Is the arrangement explicitly scoped out of ASC 842?
Generally, we would not expect a storage agreement to meet any of the scope exceptions outlined in ASC 842-10-15-1. Further discussion of scope exceptions is included in LG 2.2.
2.3.2.2 Energy storage: Does the contract include an identified asset?
An agreement involving storage generally specifies the storage system to be used to fulfill the contract. If the contract does not explicitly identify the assets, a reporting entity should consider whether the contract terms implicitly specify the storage system to be used. Factors to consider in evaluating whether a contract involves identified plant are discussed in UP 2.2.3.
A hybrid power purchase and storage agreement may convey the right to use a single or multiple asset(s). As discussed in UP 2.2.2, the assessment of identified assets should be based on the structure of the physical facility without consideration of contract pricing (i.e., whether the price of generation and storage is bundled or discrete should not impact the evaluation of whether the contract contains one or two units of account). This determination may be complex when the generation facility and energy storage function as an integrated system that produces, stores, and dispatches electricity.
In addition, a reporting entity should determine whether one or multiple customers will have contractual rights to the outputs from the identified system. For example, a portion of the capacity of an identified battery system accounted for as a separate asset may not be physically distinct. As discussed in UP 2.2.2.2, a portion of an asset that is not physically distinct is not an identified asset unless it represents substantially all of the asset's capacity and thereby provides the customer with the right to obtain substantially all of the economic benefits from the use of the asset. The evaluation is similar to that of a pipeline capacity contract discussed in UP 2.3.3.
A hybrid power purchase agreement would contain a single identified asset if the generation facility and storage system are built and configured to function as a single unit and are not physically distinct and separable assets. This would be the case, for example, if the battery and the generation facility were constructed at the same time and are interdependent such that the battery cannot operate independently of the generation resource and can only be charged by the renewable facility. In contrast, if the generation facility and the battery are physically distinct and can be operated independent of one another, they would be evaluated as two separate identified assets. This is typically the case when the system is configured such that the battery storage can operate separately from the renewable facility and can be charged and dispatched from either the renewable facility or from the grid.
In a hybrid power purchase agreement that contains two identified assets, a reporting entity must separately evaluate (1) the generation facility and (2) the storage system. The evaluation of whether the contract contains a lease of the generation facility will follow the guidance discussed in UP 2.2. This section focuses on the evaluation of whether a contract for a storage system contains a lease. This guidance would apply for both standalone storage contracts and a storage arrangement that is a separate identified asset in a hybrid purchase power arrangement.
2.3.2.3 Energy storage: Does the customer have the right to control the use of the identified asset?
As discussed in UP 2.2.3, the right to control the use of an identified asset is conveyed if the customer (1) has the right to obtain substantially all the economic benefits from use of the identified asset and (2) has the right to direct the use of the identified asset.
The economic benefits produced by a renewable generation facility (i.e., energy, RECs) differ from those produced by a storage asset (i.e., storage capacity). Similarly, the relevant decisions that impact the use of a generation facility are different from the significant decisions impacting an energy storage asset. As such, proper identification of the unit(s) of account is critical in determining whether a storage arrangement contains a lease.
Right to obtain substantially all the economic benefits
The reporting entity should consider whether it has a right to substantially all of the economic benefits from the storage system. The off-taker’s ability to use the storage and related dispatched energy is a strong indicator that it has a right to substantially all of its economic benefits from the storage system. If the customer has the option to consume all of the output of the battery before it is dispatched to the grid or can prevent others from consuming the output (right of first refusal), the arrangement likely meets this criterion.
Right to direct the use of the identified asset
Determining whether the off-taker has the right to use the identified asset requires an evaluation of the decision-making rights within the arrangement that directly impact the timing, occurrence, and quantity of economic benefits from using the storage system. Relevant decisions occurring during the term of a contract for a storage system generally include the following:
- Source of charging the system (e.g., is a battery charged from the generation facility or the power grid)
- When the storage system is charged
- When and to where stored energy is dispatched from the system
- Where the storage system is located (and if it can be easily moved)
Evaluating whether a contract conveys the right to direct the use of an identified asset focuses only on decisions that can be made during the period of use of the asset. In some cases, some or all the decisions about how and for what purpose the storage system is used may be predetermined. For example, if a battery system connected to a solar facility is automatically fully charged before generated power is dispatched to the grid, some of the decisions around charging may be predetermined. However, other decisions (such as whether power from the grid will be stored by the off-taker or when stored power is dispatched) are still relevant and should be evaluated to determine who holds those rights.
In addition to the relevant decisions noted above, a hybrid storage project will typically require that some operational activities (e.g., maintenance, scheduling, metering, communications management) to occur throughout the contract term. Operation of the system does not generally constitute a “relevant decision” under ASC 842 as it typically relates to implementing (rather than directing) decisions that impact the asset’s economic productivity.
Question UP 2-11
Do automated charging and dispatching processes preclude a customer from having the right to control the use of a storage system?
Do automated charging and dispatching processes preclude a customer from having the right to control the use of a storage system?
Not necessarily. Software can be used to automate charging and dispatch for a storage system. For example, a storage system may be configured to automatically charge using power from a renewable generation facility during periods when demand is below a certain threshold and to dispatch power to a specified delivery point during peak hours. This configuration may be contemplated in the design of the hybrid storage and outlined in the agreements. In these situations, reporting entities must determine whether there are other relevant decisions impacting how and for what purpose the storage system is used (e.g., whether the automated orders can be overridden and/or changed during the period of use) then evaluate who holds those rights. If the customer can override or change any predetermined or automated settings, it will generally have the ability to control the use of the storage system. Furthermore, if the supplier is contractually required to dispatch the energy from the storage system at the customer’s direction or in response to the customer’s demand, the customer would typically have the right to direct the use of the storage system even if the dispatch process is automated.
Example UP 2-9 illustrates the evaluation of whether a hybrid power purchase and storage agreement contains a lease.
EXAMPLE UP 2-9
Battery storage system linked to renewable generation facility
Battery storage system linked to renewable generation facility
Sunflower Power Company (SPC) owns and operates a 100 MW hybrid renewable battery storage project, SunGen. Rosemary Electric & Gas Company (REG) enters into a contract with SPC to purchase all of the capacity, electricity, and environmental attributes produced by the solar facility as well as all of the storage capacity of the attached battery system for use during a 10-year term. The contract specifies that the SunGen assets (a solar generation facility and an attached battery system) will be used to fulfill the contract. SPC does not have substantive substitution rights and cannot use the project for any other purpose or customer during the contract term.
REG was not involved in designing the project before it was constructed. SPC is responsible for operating and maintaining the project’s solar generation and battery system to satisfy minimum technical requirements. There are no decisions to be made about whether, when, or how much electricity will be produced from the solar generation facility due to the nature of the facility.
The battery system can be charged using power generated by the attached solar facility or from the grid. The contract authorizes REG to determine when the battery is charged, whether it is charged using grid power or by the SunGen solar facilities, and when any stored power is dispatched, subject to any operational limitations and dispatch parameters. REG pays SPC an energy charge for the power, RECs, and capacity from the solar facility, as well as a fixed capacity payment for use of the attached battery system.
Because the battery system and solar facility may be operated independently, the parties conclude that the use of the solar facility and the battery system are two identified assets. Does the hybrid power purchase agreement contain one or more leases?
Analysis
As the hybrid power purchase agreement contains two identified assets, REG would separately evaluate whether the hybrid power purchase agreement contains an embedded lease of either (or both) the solar generation facility and the battery system.
SunGen, solar generation facility
REG’s agreement to purchase the capacity, electricity, and environmental attributes from SPC does not meet the definition of a lease. The contract involves an identified asset (because the SunGen solar facility is explicitly specified in the contract and SPC has no substitution rights), and REG has the right to obtain substantially all of the economic benefits from use of the identified asset over the 10-year period of use. REG does not, however, have the right to control the use of the facility because it does not have the right to direct its use because (1) the decisions about how and for what purpose the plant will be used during the period of use are predetermined, (2) REG was not involved in the design (e.g., did not have input into the location and specifications of the facility that determine its output) and, (3) REG does not operate the facility.
SunGen, battery system
REG’s agreement to use the battery system does meet the definition of a lease. The contract involves an identified asset (because the SunGen battery system is explicitly specified in the contract and SPC has no substitution rights). Further, REG has the right to control the use of the battery system throughout the 10-year term:
- Economic benefits — REG has exclusive use of the battery through its contractual right to all the battery system’s storage capacity and thus has the right to obtain all of the economic benefits from the use of the battery system over the 10-year term of the agreement.
- Right to direct the use of the battery system — The relevant decisions about how and for what purpose the battery system is used include (1) the determination of when the battery is charged; (2) the determination of how the battery is charged (whether from the grid or the solar facility); and (3) when power is dispatched from the system. REG has the contractual right to make all of these decisions. Although SPC operates and maintains the battery storage system, these decisions are not relevant as they are following REG’s direction. Because SPC is prevented from using the battery system for another purpose, REG’s decision making ability, in effect, determines when and whether the storage capacity is used.
As a result, REG would conclude that it has a purchase agreement for the energy received from the facility and a lease of the storage facility.
EXAMPLE UP 2-10
Right to control – energy storage tolling arrangement
Right to control – energy storage tolling arrangement
Rosemary Electric & Gas Company (REG) enters a contract to purchase all of the storage capacity from one of SunFlower Power’s standalone battery projects over a five-year term. SPC owns and operates five standalone battery systems in Iowa with grid connections. The contract specifies the battery system to be used to fulfill the contract with REG, including its unique specifications and location. Per the terms of the contract with SPC, REG can purchase power from the grid to charge the battery system during the term of the agreement. SPC is responsible for operating and maintaining the battery system to satisfy minimum technical requirements.
The contract authorizes REG to determine when the battery is charged and when any stored power is dispatched, subject to operational limitations and dispatch parameters. REG pays SPC a fixed monthly capacity charge and a variable payment associated with charging and dispatching power from the battery.
Which party has the right to control the use of the identified asset during the period of use?
Analysis
REG has the right to control the use of the identified battery system during the period of use. Although SPC operates and maintains the battery storage system, these are not rights to direct how and for what purpose the storage system is used, as discussed in ASC 842-10-15-26.
REG decides when the battery system will be charged and discharged, thus determining how and for what purpose the battery system will be used. REG also has the right to obtain substantially all of the economic benefits from the battery system identified in the contract.
2.3.3 Other contract considerations
Power and utility companies may enter into other types of contracts, such as pipeline capacity, natural gas storage, or pole attachments, that should also be evaluated in accordance with the contract accounting framework discussed in UP 1. These contracts typically would not contain derivatives or require variable interest entity accounting; however, reporting entities will need to assess whether they are or contain a lease.
This evaluation should follow the general model outlined in UP 2.2 and further discussed in LG 2.3. In considering many of these contracts, one of the key areas of judgment is whether the identified asset is physically distinct — a requirement for lease accounting (see UP 2.2.2.2).
Question UP 2-12
Can pipeline capacity or transmission be the subject of a lease?
Can pipeline capacity or transmission be the subject of a lease?
PwC response
Yes. A pipeline and transmission lines are identifiable assets that can be used to transport a resource from one location to another. A contract for the full capacity of a pipeline or transmission line involves an explicitly identified asset.
The answer may change, however, if an entity contracts for only a portion of the capacity of a pipeline or transmission line. A portion of a pipeline (such as a lateral pipeline) or transmission line could be physically distinct (and therefore would be an identified asset) if an entity can separate and use the portion of the asset independently. “Last mile” assets (i.e., the end of a single, contiguous asset) would be evaluated in the same way. If the last mile is mechanically separable from the remainder of the asset (e.g., there is a switch that permits an entity to shut off the flow of electricity or signal to a power line), the asset would be considered physically distinct and would be an identified asset.
As noted in ASC 842-10-15-16, a contract that provides the use of a portion of the capacity of an asset that is not physically distinct is not an identified asset unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset. See LG 2.3.2.1 for the factors to consider when evaluating whether a contract provides substantially all of the economic benefits from use of an asset.
Question UP 2-13
Does a pole attachment arrangement involve a physically distinct asset?
Does a pole attachment arrangement involve a physically distinct asset?
Generally, no. When thinking about whether an asset is physically distinct, entities may need to consider the nature of the asset and evaluate how the asset was designed to be used. This evaluation could include the type of functionality the asset will provide and to what parties it will be provided.
Utilities often obtain or grant the right to attach cables, wires, and associated appurtenances to utility poles. These arrangements provide for the use of a specific spot on an electric utility pole to a third party (e.g., a cell phone carrier). Generally, the assets (i.e., the place on the pole) in these arrangements would not be considered physically distinct and thus would not be identified assets. The portion of a utility pole to be used by a third party generally cannot be physically or mechanically separated from the remainder of the pole. Further, the primary use of a utility pole is to support electrical wires and transport electricity (i.e., to permit the utility company to provide its core service). As the primary purpose is not to serve as a hosting device for third-party assets, it is not designed to be apportioned to individual users and it may therefore be reasonable to conclude that the utility pole attachments would not be considered physically distinct.
In contrast, the primary use of a cell phone tower is to sell or rent space on the tower to phone carriers. As a result, the specific hosting locations on a cell phone tower would be considered physically distinct. See LG 2.3.1.3 for further discussion on assessing whether an asset if physically distinct.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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