The creation, sale, and use of RECs results in a number of challenging accounting issues including contract accounting, revenue recognition, and cost allocation. The issues that may arise and the accounting outcome will depend on whether the reporting entity is generating, selling, or buying RECs. Further, as part of the initial accounting for RECs, the reporting entity should make two key accounting policy elections:
  • Are RECs inventory or intangibles?
  • Are RECs considered output?
A change in a reporting entity’s view on either of these policies would be considered a change in accounting method, which would be accounted for as a change in accounting principle in accordance with ASC 250, Accounting Change and Error Corrections. To adopt a change in method, a reporting entity would have to conclude that the new method is preferable. To determine the appropriate accounting, we recommend that reporting entities first assess these accounting policy elections based on their specific facts and circumstances and then consider the guidance related to the applicable activity (i.e., generation, sales, or purchases).

7.3.1 Key policy decision one: are renewable energy credits inventory or intangibles?

Reporting entities use various models to account for RECs. In practice, utilities and power companies typically classify RECs as (1) inventory (whether held for use or sale) or (2) intangible assets (held for use). We believe either classification is acceptable, provided the classification is applied consistently, is reasonable based on the intended use of the RECs, and is properly disclosed. There is one exception: we would generally not expect RECs held for sale to be classified as intangible assets because the activity of selling (i.e., goods held for sale in the ordinary course of business) is consistent with the definition of inventory, not intangible assets. Inventory

ASC 330-10-20 defines inventory.

Partial definition from ASC 330-10-20

Inventory: The aggregate of those items of tangible personal property that have any of the following characteristics:
a. Held for sale in the ordinary course of business
b. In process of production for such sale
c. To be currently consumed in the production of goods or services to be available for sale.

Owners of renewable energy facilities may generate and hold RECs for sale. Other entities, such as trading organizations, may engage in buying and selling RECs in the normal course of business. Furthermore, some reporting entities may purchase RECs to comply with RPS requirements. In each of these cases, the key elements of the inventory definition are met. Intangible assets

RECs held for use may also meet the definition of intangible assets in ASC 350.

Partial definition from ASC 350-10-20

Intangible Assets: Assets (not including financial assets) that lack physical substance.

RECs evidence the generation of energy from a qualifying resource. In addition, RECs lack physical substance. RECs are not financial assets because cash is not delivered; instead, the REC itself is delivered for compliance with the related RPS program. Therefore, the definition of an intangible asset is met.
RECs would be considered to have a finite life and would be subject to amortization as they are typically claimed or retired in a short period of time to meet their local RPS requirements.
Question 7-1
Do RECs meet the definition of a derivative?
PwC response
No. RECs themselves do not meet the definition of a derivative because they do not contain an underlying. An underlying is a price or index that interacts with a notional amount in a contract to determine the settlement amount; an underlying is not the asset or liability itself. Therefore, a REC does not contain an underlying and is not accounted for as a derivative.
In addition, as discussed in UP, absent contractual net settlement, physical forward contracts for the purchase or sale of RECs generally do not meet the definition of a derivative, although this conclusion could change as markets evolve. Impairment

A reporting entity’s policy on accounting for RECs either as inventory or intangible assets will impact how it considers impairment.
Impairment of RECs classified as inventory is based on the lower-of-cost-or-market model. See UP 11.2 for further information on lower-of-cost-or-market considerations for inventory.
Intangible assets
In accordance with ASC 350-30-35-14, RECs classified as intangible assets subject to amortization should be reviewed for impairment based on the guidance provided by ASC 360, Property, Plant, and Equipment (ASC 360). Any impairment measurements would also be performed in accordance with ASC 360. This guidance requires evaluation of impairment in response to events or changes in circumstances that suggest the carrying value may not be recoverable. Impairment indicators include:
  • A significant decline in the price of RECs
  • A significant change in the business or regulatory environment, such as regulatory actions or other changes impacting the need for RECs (e.g., softening or delay in mandates or expansion of allowable technologies)
If an impairment evaluation is triggered, the reporting entity should perform the analysis based on facts and circumstances existing at the balance sheet date. The reporting entity would incorporate changes in value subsequent to the balance sheet date in any impairment analysis performed in the subsequent period.

7.3.2 Key policy decision two: are renewable energy credits output?

Because the generation of power is integral to the creation of RECs, a question arises as to whether RECs are considered part of the output from a generating plant. There are two views about whether RECs are considered output. A reporting entity’s conclusion on whether RECs are output will potentially impact cost allocation, revenue recognition, and whether a contract contains a lease. In summary, the two views are as follows:
  • View A: RECs are output
    Proponents of View A believe that RECs should be considered an output from the facility where they originate. They argue that the construction of a facility and the pricing inherent in the contractual arrangements with off-takers are based on the combined benefit of energy, capacity, RECs, and any other products from the facility. View A proponents point to the fact that each of these outputs is dependent on production at the specified facility and conclude that all products sold from the specific facility are output.
  • View B: RECs are a government incentive
    Proponents of View B believe that RECs should not be considered an output. They believe that “output” is limited to the productive capacity of a specified property and relates only to those products that require “steel in the ground” (e.g., energy, capacity). Supporters of this view state that RECs do not arise as a result of the physical attributes of the property, but rather are a paper product from a government program (similar to tax incentives) created to promote the construction of renewable energy facilities.
The two views can be contrasted in that View A proponents view RECs as products created through production: an outflow. View B proponents view RECs as a benefit provided by the government to promote green energy: a benefit or inflow that conceptually is no different from the cash payments received for production. The two views are summarized in Figure 7-2.
Figure 7-2
Should renewable energy credits be considered output?
RECs are output from a facility
The utility of a renewable energy property is embodied in the environmental attributes it produces. RECs are dependent on a specified facility and are integral to the full utility/economics of the property.
• RECs are consistent with the definition of “output” in ASC 805.
• Significant economics related to a renewable power plant are embodied in the RECs.
• RECs are dependent on a specified facility.
RECs are a government incentive
RECs are intangibles that are not physically “produced or generated”; instead RECs are issued by a regulatory oversight body. RECs are a government incentive intended to further a public policy objective.
• All power plants produce (generally) the same outputs: energy, capacity, and ancillary services. RECs are a government incentive and represent an inflow or form of payment for renewable production.
• “Output” from the facility is limited to physical production; RECs lack physical substance. View A: renewable energy credits are output

Those who subscribe to View A believe that output has a broader scope than simply physical production from a specified property. Rather, the concept of output extends to any utility or benefit directly attributable to the use of the asset. Supporters of View A believe the following factors contribute to the conclusion that RECs are output from a facility.
Definition of output
The definition of output included in ASC 805 provides relevant guidance.

ASC 805-10-55-4(c)

Output. The results of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

RECs are an economic benefit obtained through the operation of a specified renewable energy facility. RECs are created by the production output of the facility (i.e., if the generation facility does not produce power, RECs are not created). The generation of renewable energy by a qualifying plant produces the right to a credit, which directly identifies with output of that specified asset. Once a generation unit is certified under a renewable energy program, the owner (operator) may sell the RECs generated through production, and those RECs are viewed as part of the utility of that plant. The sale of the RECs may be to the offtaker of the power generated or to another third party, depending on the terms of the power purchase agreement.
Economic considerations
Historically, the cost of constructing a renewable energy facility was recovered through an above-market price for power sold from the facility (effectively, the renewable energy premium was embedded in the contract price). However, the growth of RPS requirements and the need for a mechanism to track compliance led to the creation of RECs. It also divided pricing among all products from a facility, including energy, capacity, and RECs. Today, power from a renewable facility may be sold as “brown” or “dirty” power without the RECs attached; the brown power price is based on market prices of power in general and no premium is paid for the power itself. The RECs may be sold with the power (green power) or separately, and are separately priced. Green power sells for a premium, representing the value of the RECs.
As a result of these changes, the economics of a renewable energy facility are now based on the sale of capacity, energy, and RECs as individual units. The sale of brown power and capacity alone does not typically cover the cost of construction and fixed carrying costs of a renewable facility. The ability to realize income from the sale of RECs—which may be substantial—is a significant contributor to the economics of a renewable facility. RECs are usually the primary motivator for building specified renewable property (other forms of generation are typically more efficient and economic for the production of energy alone).
Therefore, because RECs represent a substantial portion of the economics of a renewable plant, View A proponents believe it is inconsistent to exclude their economic value from the determination of the accounting for contractual arrangements. That is, they believe that the economics of RECs are integral to the plant itself and thus to exclude them from an evaluation as output would be to ignore their economics.
The lease literature similarly provides useful guidance on the concept of output in the context of a discussion on economic control. Specifically, the criteria in ASC 840-10-15-6 are based on a concept that the right to use the property is conveyed through control of the property. Proponents of View A believe that control may be obtained through physical, operational, or economic control of the specified property. ASC 840-10-55-34 suggests that an arrangement whereby one party covers the fixed carrying costs of the plant provides evidence that it is remote that another entity will take more than a minor amount of the output, indicating that the arrangement is a lease (i.e., that economic control is conveyed).

ASC 840-10-55-34

All evidence should be considered when making the assessment as to the possibility that other parties will take more than a minor amount of the output, including evidence provided by the arrangement’s pricing. For example, if an arrangement’s pricing provides for a fixed capacity charge designed to recover the supplier’s capital investment in the subject property, plant, or equipment, the pricing may be persuasive evidence that it is remote that parties other than the purchaser will take more than a minor amount of the output or other utility that will be produced or generated by the property, plant, or equipment.

Considering this excerpt in the context of a renewable plant, the fact that energy and capacity payments are not sufficient to cover the fixed costs suggests that another party (the REC off-taker) is taking more than a minor amount of the utility of the property. The “utility” taken by the REC purchaser is in the form of an intangible produced by the specified property and represents an economic output of the facility.
Specified property
RECs are specific to a qualifying facility, and in a typical plant-specific arrangement the owner of the property has no obligation to deliver RECs other than those produced by the property (i.e., no replacement right or obligation) unless there is a performance guarantee. The REC off-taker is exposed to the risk of weather or other variables that may impact production; therefore, the off-taker is not economically indifferent to the source of the RECs. Instead, those RECs represent an economic benefit provided by a specific property and would be considered output of that property.
The concept of specified property is further addressed in the lease literature and is also relevant to the evaluation of whether RECs are output more broadly. ASC 840-10-15-8 states that agreements that transfer the right to use specified property, plant, or equipment meet the definition of a lease. ASC 840-10-15-10 through 15-14 provide additional guidance to determine whether an arrangement does not qualify for lease accounting because the property is not specified. Consistent with this guidance, the generation of RECs is not generic but is instead attached to operation of a specific property. As such, proponents of this view believe the RECs are an output of the property. View B: renewable energy credits are a government incentive

View B proponents focus on the fact that RECs are assets created under various government programs to incentivize green power production. Therefore, RECs are a government subsidy, similar to a tax incentive, intended to further a public policy objective. As such, RECs are not facility outputs. Because RECs are a government incentive, View B supporters believe that the accounting for RECs should follow the historical treatment of tax incentives, which are not an “output” from the facility.
Similarities with tax incentives
Supporters of View B believe that RECs are a government incentive, similar to grants, investment tax credits, production tax credits (PTCs), and other forms of renewable energy incentives, which are provided by the government to encourage the construction of renewable power plants. There are similarities and differences between RECs and PTCs.
Similar to RECs, PTCs are created and allocated to owners of qualifying facilities for each unit of production (only during the first 10 years of operation, compared with RECs, which are ongoing).
The two primary differences between PTCs and RECs are:
  • Transferability—RECs are transferable, while PTCs and ITCs are available only to the tax owner of the facility. Utilities and retail service providers use RECs to satisfy their compliance obligations. RECs can be held for future use, sold after they are earned, or transferred to another party, and have value. As a result, bilateral markets have developed for the sale of RECs, and some states are trying to increase the liquidity of the REC markets.
  • Source of funding—In the case of tax incentives, the government pays the owner of the facility directly. RECs are purchased by companies for trading, compliance obligations, or other purposes.
Proponents of View B do not believe that the differences should result in an accounting distinction for RECs. The fact that the RECs can be traded or sold and that funding comes from third parties does not change the fundamental nature of RECs as a form of payment/incentive for the production of green energy. REC programs are intended to compensate the owner/operator for the additional costs associated with a green power facility. As such, under this view, RECs are no different than tax incentives or other forms of consideration conveyed for the production of energy and treatment as an output is inconsistent with practice for tax incentives.
Renewable energy credits lack physical substance
Although View B supporters acknowledge that RECs are associated with a specified generating facility, they do not believe that RECs are an output or utility produced by the property. They believe there is no difference between the outputs from a renewable energy facility and a fossil-fuel or nuclear facility: all of these power plants provide capacity to support the system, energy for supply to customers, ancillary services, and, in some cases, steam or heat. Proponents of this view focus on the fundamental nature of RECs and the fact that they are not physically produced or generated. Renewable power plants provide no additional tangible benefit, and RECs are a piece of paper or electronic certificate that may provide economic benefit but lack physical substance. Although the value of the REC relates to the underlying plant, the REC is effectively a government subsidy of the production of green power. Based on this, View B supporters believe that they cannot be considered an output. Conclusion

We believe both views have merit and there is support for each of the positions. Therefore, we believe that the determination of whether RECs are output is an accounting policy election. However, although View B has been broadly vetted and accepted, we understand that the SEC staff has not reached a conclusion on View A.
The accounting policy election should be applied consistently, assuming reasonably similar facts and circumstances, and should also be disclosed. Furthermore, as this accounting policy election is based on a reporting entity’s perspective on the underlying nature of RECs (output or government incentive), we believe that this accounting policy election should be applied consistently within a consolidated entity.
A change in a reporting entity’s view on whether RECs are output would be considered a change in accounting method, which would be accounted for as a change in accounting principle in accordance with ASC 250, Accounting Change and Error Corrections. To adopt a change in method, a reporting entity would have to conclude that the new method is preferable.
Question 7-2
Does the determination of whether RECs are output impact the classification of RECs as inventory or intangible assets?
PwC response
No. We believe the determination of whether RECs are output is separate from the determination of whether RECs should be classified as inventory or intangible assets. As discussed in UP 7.3.1, the balance sheet classification of RECs is primarily based on the reporting entity’s intended use: RECs held for sale are generally classified as inventory while RECs held for use may be classified as inventory or intangible assets. In contrast, the evaluation of whether RECs are output is based on a reporting entity’s fundamental view of a REC as a product produced by the plant versus a government incentive. We believe that these are separate determinations because one is focused on the generation or creation of RECs (output assessment) while the other is predicated on their subsequent use (inventory versus intangible asset).
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