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2.4 Identifying components and allocating consideration
Publication date: 31 Mar 2023
us Utilities guide
After a reporting entity determines whether a power purchase or other agreement contains a lease, it will need to identify the separate components within the contract. This identification is important because it could affect lease classification of different lease components as well as ongoing recognition of revenue (or expense, from the perspective of the off-taker). ASC 842-10-15-28 contains guidance on identifying separate lease components.
Excerpt from ASC 842-10-15-28
An entity shall consider the right to use an underlying asset to be a separate lease component (that is, separate from any other lease components of the contract) if both of the following criteria are met:
- The lessee can benefit from the right of use either on its own or together with other resources that are readily available to the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee already has obtained (From the lessor or from other transactions or events).
- The right of use is neither highly dependent on nor highly interrelated with the other right(s) to use underlying assets in the contract. A lessee’s right to use an underlying asset is highly dependent on or highly interrelated with another right to use an underlying asset if each right of use significantly affects the other.
Separate lease components should be determined by considering the nature and interdependency of the individual assets covered by the arrangement. Many assets within a power plant are interrelated and might be combined into one lease component. In some cases, a reporting entity may also need to consider whether the arrangement involves assets that have different economic lives. This is because the lease classification could be different if a reporting entity elects to account for individual lease components separately. For arrangements that involve the use of a power plant, a reporting entity should consider its policy for how components are determined (i.e., whether the entire plant is defined as one unit of property or whether individual assets, such as turbines, are defined as separate components).
Power purchase agreements and other arrangements may also involve the use of land. ASC 842-10-15-29 states that land should be accounted for as a separate lease component unless the accounting effect of doing so would be insignificant.
Excerpt from ASC 842-10-15-29
The guidance in paragraph 842-10-15-28 notwithstanding, to classify and account for a lease of land and other assets, an entity shall account for the right to use land as a separate lease component unless the accounting effect of doing so would be insignificant (for example, separating the land element would have no effect on lease classification of any lease component or the amount recognized for the land lease component would be insignificant).
2.4.1 Identifying lease and nonlease components
Power purchase agreements that contain a lease may also contain nonlease components (e.g., maintenance, security, fuel) that should be accounted for using other accounting models, unless the practical expedients discussed in Figure UP 2-10 apply and are elected). The analysis performed to identify lease and nonlease components is similar to the one used to identify performance obligations under ASC 606. As discussed in LG 2.4.1, only components that are integral to the right to use an underlying asset are considered lease components. Nonlease components are distinct elements of a contract that are not related to securing the use of the leased asset. For example, power purchase agreements often provide for operating and maintenance services (O&M) within the contract. Operating the plant or performing maintenance services on behalf of the lessee are not activities that are integral to the right to use the plant to derive economic benefits. Further, these services generate a distinct economic benefit that is separate from the use of the plant. As a result, O&M services are nonlease components.
Distinguishing between lease and nonlease components is important because it is not always appropriate to record assets and liabilities associated with nonlease components. Figure UP 2-9 illustrates common examples of lease components, nonlease components, and items that would not be considered components within a typical power purchase agreement.
Figure UP 2-9
Examples of common components and non-components in a power purchase agreement
Examples of common components and non-components in a power purchase agreement
Component type |
Example |
Lease
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Nonlease
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Items that are not components
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When a power purchase agreement meets the definition of a lease, the off-taker is contracting for the use of the power plant and receives the economic benefits produced by the plant. As discussed in Figure UP 2-2, the products commonly provided in a power purchase agreement, including energy, capacity, and RECs, are considered economic benefits from using the power plant itself (i.e., the off-taker does not receive the benefit from those products unless the plant is operating). They do not represent separate assets or the right to use a separate asset. Thus, in a power purchase agreement, we believe these items are part of the power plant or generation facility and would be considered lease components.
Once lease and nonlease components have been identified, the next step is to determine and allocate contract consideration to the contract components.
2.4.2 Allocating consideration to components
As discussed in UP 1, the first step in allocating contract consideration is to allocate fair value to any derivative components. See Figure UP 1-3 for information on the overall allocation process among all contract components. Once that allocation is complete, if a contract contains one or more leases, a reporting entity will need to allocate the consideration paid or received between the lease and the nonderivative, nonlease components.
Lessors should follow relevant guidance in ASC 606 to determine how to allocate contract consideration between the lease and nonlease components. See RR 5 for guidance on this allocation method.
Lessees should allocate the contract consideration to the separate lease and nonlease components on a relative standalone price basis as described in ASC 842-10-15-33. See LG 2.4.3 for further information on lessee allocation of contract consideration.
For both lessees and lessors, the allocation may depend on whether the payments are fixed or variable. If the power purchase agreement includes variable payments (for example, if all or a portion of the payments are based on actual megawatt-hours produced by the plant), the amount of consideration allocated to the lease and nonlease components may vary based on the nature of the variable payments and the components to which they relate. See LG 2.4.6 for additional information on allocating variable consideration.
ASC 842 allows lessees and lessors to make an election to aggregate lease and nonlease components in certain circumstances. These practical expedients and related accounting treatment are summarized in Figure UP 2-10.
Figure UP 2-10
Lessee and lessor component practical expedients
Lessee and lessor component practical expedients
Qualifying conditions |
Accounting considerations if elected |
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Lessee
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Lessor
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Can elect if following conditions are met:
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The lessor in a power purchase agreement that is or contains one or more leases will need to consider the classification of the lease(s) in determining whether it can apply the component practical expedient. A power purchase agreement for a major part of the economic life of the facility would likely meet the criteria to be classified as sales type leases (by the lessor), and therefore would not be eligible for the practical expedient described above.
Lessors will need to apply judgment to determine the predominant characteristic of the combined component if the component practical expedient is elected.
Question UP 2-14
Does major maintenance represent a lease or a nonlease component?
Does major maintenance represent a lease or a nonlease component?
PwC response
The performance of major maintenance represents the transfer of a good or service to the lessee other than the right to use the underlying asset. As such, major maintenance is a nonlease component under ASC 842.
When major maintenance is included in a power purchase agreement that is a lease, the maintenance must be separated from the lease component and allocated consideration, unless able to elect the practical expedient. If the lessor elects the component practical expedient, the lessor would not need to allocate consideration between the lease component and the nonlease component. Given, however, the distinct characteristics and risks associated with major maintenance (as compared to other services the supplier may provide), these services may represent a distinct performance obligation for the lessor under ASC 606, and the timing and pattern of transfer may not be the same as the lease component (e.g., use of the generation plant). In that case, the qualifying conditions for the practical expedient would not be met, and the lessor would need to allocate consideration among the physical plant (the lease component), major maintenance, and any other lease and nonlease components.
See LG 2.4.4 for further information on lessor allocation of contract consideration.
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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