E.5 P&U Entities

E.5.1 Overview

Reporting entities in the P&U industry apply the same consolidation requirements as reporting entities in other industries. However, the consolidation analysis may be particularly challenging in the P&U context. This section supplements the main chapters of this publication by discussing topics that apply to P&U reporting entities in their evaluation of whether they are required to consolidate a legal entity.

E.5.2 Identification of Variable Interests

Only a holder of a variable interest can consolidate a VIE. Accordingly, as long as the legal entity being evaluated does not qualify for a scope exception, the reporting entity must determine whether its interest in a legal entity is a variable interest. Examples of potential variable interests include equity interests, debt interests, PPAs, derivative instruments, management agreements, and other operating or contractual arrangements. The determination of whether an interest is a variable interest is often complicated and should focus on the purpose and design of the legal entity being evaluated and the risks to which the legal entity was designed to be exposed. For more information about identifying variable interests, see Chapter 4.

E.5.2.1 PPAs and Tolling Arrangements

Performing the variable-interest assessment for PPAs and tolling arrangements can be particularly challenging. A reporting entity must first determine whether the arrangement is considered an operating lease under ASC 8426 or a derivative under ASC 815 and, accordingly, whether the arrangement (1) qualifies for the scope exception in ASC 810-10-55-39 for an operating lease (see Section E.5.2.1.2) or (2) is a derivative that creates (rather than absorbs) variability (see Section E.5.2.3).

If the arrangement does not meet the definition of an operating lease (or there are other elements embedded in the operating lease) or the arrangement is not a derivative that creates (rather than absorbs) variability, the determination of whether a PPA or tolling agreement is a variable interest should focus on the purpose and design of the legal entity being evaluated and the risks to which the legal entity was designed to be exposed, such as raw-material price risk, operations risk, credit risk, and electricity price risk. The evaluation should take into account the nature of the pricing in the PPA or tolling arrangement (fixed, market, cost-reimbursement, etc.) as well as any features related to the underlying plant (puts, calls, residual value guarantees).

Further, the nature of the generating facility could affect the evaluation. That is, a fixed-price forward contract to purchase electricity from a fossil-fuel facility that has not yet been generated will typically be viewed as a contract to purchase an asset (electricity) that the legal entity does not currently own because of the legal entity’s exposure to raw material price risk and O&M risk in producing the electricity. In accordance with ASC 810-10-55-27, a contract to buy an asset that is not currently owned by a legal entity at a fixed price will usually increase the legal entity’s variability (rather than absorb it). In contrast, a fixed-priced forward contract to buy electricity from a renewable energy facility that has limited exposure to raw material price risk or O&M risk would typically be evaluated in a manner similar to an interest in a legal entity that currently owns the asset, because the entity has limited exposure to raw material price risk or O&M risk. Under ASC 810-10-55-28, a fixed-price contract for the legal entity to sell and for the counterparty to buy an asset owned by a legal entity is more likely to absorb variability of the legal entity.

The reporting entity should also consider any other contracts it holds, as well as those held by its related-party group, when evaluating whether a PPA or tolling arrangement is a variable interest.

Views have differed historically on the approach a reporting entity should use to assess variability, which has somewhat hindered comparability between reporting entities. Specifically, reporting entities will apply either a cash flow approach (the legal entity’s variability arises from fluctuations in its cash flows) or a fair value approach (the source of a legal entity’s variability arises from fluctuations in the fair value of the legal entity’s net assets).

The example below illustrates how particular PPAs, tolling agreements, or similar arrangements should be evaluated in a reporting entity’s determination of whether such contracts are variable interests.

Example E-3

A legal entity (PowerCo) is created to hold a generating facility and is funded by two unrelated equity holders and one unrelated debt holder.
PowerCo uses the proceeds from the equity contributions and debt to purchase the generating facility.
As a condition of lending, the debt holder requires PowerCo to enter into a 20-year forward contract to sell 100 percent of its output to a third party.
PowerCo holds the title to the facility, which has a useful life of 40 years.

The table below outlines how to assess whether a PPA, tolling agreement, or similar arrangement between the Utility and PowerCo in the example above is a variable interest. These contracts are analyzed from the purchaser’s perspective (first column). The second column describes other arrangements entered into between the legal entity (PowerCo) and either a third party or the purchaser. Assume that the guidance on derivatives in ASC 810-10-25-35 and 25-36 does not apply and that the contract is not an operating lease. Ultimately, whether a contract is a variable interest will depend on individual facts and circumstances, including the risk profile of the production facility (i.e., renewable energy versus fossil-fuel plants).

Table E-1 Assessing Whether PPAs, Tolling Agreements, or Similar Arrangements Are Variable Interests


Type of Contract (Purchaser)	Existing Contracts for Fuel and Other Materials	Is the Purchaser’s Contract a Variable Interest?
Fixed-price forward contract to purchase electricity	Market-price forward contract to purchase fuel from a third-party provider	No. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk. The role of the fixed-price forward contract is not to transfer any portion of those risks from the equity and debt investors to the purchaser since the price paid under the forward contract does not change as a result of changes in operating costs, fuel prices, or default by the purchaser. Those risks are designed to be borne by the equity and debt investors.
Fixed-price forward contract to purchase electricity	Fixed-price forward contract to purchase fuel from a third-party provider	No. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk. The role of the fixed-price forward contract to purchase electricity is not to transfer any portion of those risks to the purchaser since the price paid under the forward contract does not change as a result of changes in operating costs, fuel prices, or default by the purchaser. Those risks are designed to be borne by the equity and debt investors and the counterparty to the fixed-price raw material supply contract.
Fixed-price forward contract to purchase electricity	Fixed-price forward contract to purchase fuel from the purchaser	Yes. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and the fuel price risk. The role of the fixed-price forward contracts held by the purchaser, when these contracts are evaluated together, transfers the fuel price risk from the equity and debt investors to the purchaser. This arrangement is equivalent to the purchaser entering into a variable-price forward contract that is designed to reimburse the legal entity for changes in fuel prices.
Fixed-price forward contract to purchase electricity	Renewable energy PPA — no fuel costs	Some reporting entities have concluded that fixed-price PPAs for renewable energy contracts do not represent variable interests under the cash flow approach. That is, the fixed-price PPA does not absorb the variability in production costs such as O&M costs or the credit risk of the purchaser. Rather, such variability is absorbed by the equity and debt investors. However, others have concluded that these contracts do represent a variable interest under the fair value approach. This conclusion is based on the fact that renewable energy resources have significantly lower variable production costs than traditional fossil-fuel generating units (i.e., they have a lower variable O&M cost profile and no fuel costs). Accordingly, by analogy to the guidance in ASC 810-10-55-28, the fixed-price-per-unit contract would absorb variability related to the underlying assets of the entity (e.g., the windmill or solar panels) if there are changes in commodity prices.*
Tolling arrangement in which the purchaser provides fuel to the legal entity at no cost or transfer of title and purchases 100 percent of the output at a specified charge per unit (conversion cost)	Agreement to provide fuel included in the tolling arrangement	Yes. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk.** The role of the tolling arrangement transfers the fuel price risk from the equity and debt investors to the purchaser. Changes in the fuel prices will be borne by the purchaser. This arrangement is equivalent to the purchaser’s entering into a variable-price forward contract that is designed to reimburse the legal entity for changes in fuel prices.
Variable-price forward contract to purchase electricity — reimburses legal entity for costs of fuel and O&M	Market-price forward contract to purchase fuel from a third-party provider	Yes. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk. The role of the variable-price forward contract is to transfer the fuel price risk and some portion of operating risk from the equity and debt investors to the purchaser. Changes in the fuel prices and O&M costs will be borne by the purchaser.
Variable-price forward contract to purchase electricity — reimburses legal entity for costs of fuel and O&M	Market-price forward contract to purchase fuel from the purchaser	Yes. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk. The role of the variable-price forward contract is to transfer the fuel price risk and some portion of operating risk from the equity and debt investors to the purchaser. Changes in the fuel prices and O&M costs will be borne by the purchaser.
Variable-price forward contract to purchase electricity — reimburses the legal entity for costs of fuel and O&M. A component of the variable-price forward contract is considered an operating lease	Market-price forward contract to purchase fuel from a third-party provider	Yes. The legal entity is designed to be subject to operating risk, credit risk of the purchaser, and fuel price risk. Although a component of the variable-price forward contract is considered an operating lease, the role of the remaining, nonlease components of the arrangement is to transfer fuel price risk and some portion of operating risk from the equity and debt investors to the purchaser. Changes in the fuel prices and O&M costs will be borne by the purchaser.
* PPAs for renewable energy that are ostensibly fixed-price-per-unit contracts often have features designed to absorb cash flow variability. For example, construction overrun contingencies or tax contingencies that can change the fixed price per unit of the facility’s output would absorb variability in the cash flows of the legal entity. It is important for a reporting entity to ensure that the PPA truly is a fixed-price-per-unit contract before concluding that the arrangement does not absorb cash flow variability. In addition, regardless of whether the PPA for renewable energy represents a variable interest, given the noncontrollable risks (i.e., risks for which there are no related activities) in a typical renewable structure, the off-taker often will conclude that it does not have power over the most significant activities since the power over the controllable risks (such as O&M) frequently rests with the owner-operator. This conclusion will depend on the particular terms of each arrangement. See Section E.5.4. ** Although the legal entity does not take title to the fuel in a tolling arrangement, the legal entity must produce electricity, which requires fuel. By supplying the legal entity with fuel at no cost, the reporting entity is implicitly absorbing fuel price risk associated with producing the electricity. This concept is consistent with the SEC’s speech on “activities around the entity” — see Section 4.3.10.1.

E.5.2.1.1 Determining Whether a PPA Is a Lease Agreement

It is not uncommon for PPAs and tolling arrangements to qualify as leases for accounting purposes. ASC 842 indicates that a lease is a contract — or part of a contract — in which a supplier conveys to a customer “the right to control the use of identified property, plant, or equipment . . . for a period of time in exchange for consideration.” The evaluation of whether a contract is (or contains) a lease under ASC 842 focuses on whether (1) there is an identified asset and (2) the customer has the right to both obtain substantially all of the economic benefits of its use and direct its use. Further, the right to control the use of a specified asset is conveyed if the customer will obtain all but an insignificant amount of the output or other utility of the asset during the term of the arrangement.

Currently there is diversity in practice related to how to evaluate whether a PPA is a lease under ASC 842 as a result of differing views about how to interpret the term “output.” For example, questions have been raised regarding whether an “output” should include both physical and intangible outputs (e.g., renewable energy credits [RECs], which represent rights for environmental benefits). A PPA may also contain a lease (i.e., there may be an embedded lease) under ASC 842. See Sections 3.2 and 3.4 of Deloitte’s Roadmap Leases for further discussion.

E.5.2.1.2 Operating Lease Scope Exception

ASC 810-10-55-39 indicates that most arrangements that qualify as operating leases (i.e., the lease does not transfer substantially all of the risks and rewards of ownership) do not absorb variability in the fair value of the VIE’s net assets. Accordingly, a lessee under a PPA or tolling arrangement that is considered an operating lease may not be considered to hold a variable interest in a VIE lessor entity.

However, it is important to remember that the exception for operating leases only applies to the lease element of an arrangement. Therefore, PPAs that qualify as operating leases may still contain variable interests to the extent that other elements (e.g., fixed-price put or call options, dismantlement/decommissioning obligations) exist in the lease. Other common features embedded in an operating lease include management or service arrangements, the obligation to absorb the variable costs of production, and raw material supply arrangements (e.g., a fuel-tolling arrangement). Reporting entities must understand the terms of the lease arrangement and identify all embedded features.

E.5.2.1.3 Finance Leases

Finance leases (including PPAs and tolling arrangements) are not eligible for the operating lease scope exception, and often the features that trigger finance lease accounting (e.g., bargain purchase options, residual value guarantees) will absorb variability. Further, just because an arrangement is a finance lease does not minimize the relevance of, or negate the need for, the consolidation analysis. Accordingly, a lessee reporting entity that enters into a finance lease would still need to assess whether it is required to consolidate the lessor. If the reporting entity is required to consolidate the lessor, any other assets or obligations of the lessor would be included in the reporting entity’s consolidated financial statements. See Section 4.3.9.2 for additional discussion.

E.5.2.1.4 Avoided Cost Pricing

It is not uncommon for a utility to purchase power from qualifying facilities under avoided-cost pricing structures in accordance with the Public Utility Regulatory Policies Act and the Energy Policy Act. Since avoided cost is generally a measure of the utility’s marginal cost to produce the same amount of energy through construction of a new plant and does not permit direct reimbursement for any of the generator’s actual costs of production, avoided-cost pricing will generally not absorb risk of the generator; however, there may be exceptions. Relevant considerations include the fuel source and operating profile of the utility’s marginal unit compared with the fuel source and operating profile of the generator and the reset period for the price schedule. In circumstances in which (1) the fuel source and operating profile of the utility’s marginal unit closely mirror that of the generator and (2) the reset period on the pricing is frequent (e.g., monthly), it may be appropriate to conclude that the PPA is absorbing variability in the legal entity. The use of a correlation analysis may be helpful to the reporting entity in making this determination.

E.5.2.1.5 Curtailment Rights

There have been questions about the effects of voluntary or economic curtailment clauses on the assessment of whether a PPA is a variable interest. Specifically, entities have asked whether the off-taker would absorb variability in the legal entity if the penalty pricing for economic curtailment was the same as the pricing that would have been due had the unit generated power. This type of penalty pricing would not, in and of itself, make a PPA a variable interest, because the off-taker is not absorbing incremental cash flow variability in curtailment scenarios.

E.5.2.2 Renewable Energy Credits

If a reporting entity concludes that RECs are an output of a specified asset and that the overall arrangement (including the benefits from the RECs) should be accounted for as a lease, the lessee would not be required to separately evaluate whether the right to receive the RECs is a separate variable interest (see Section E.5.2.1.1). See Section 3.4.1.1 of Deloitte’s Roadmap Leases for further discussion.

However, if the reporting entity concludes that the RECs are not an output of the specified asset in its evaluation of whether the arrangement is a lease, or if the sale of the RECs is not part of a lease arrangement, the reporting entity should assess the obligation to purchase the RECs separately to determine whether the right is a variable interest.

E.5.2.3 Derivative Instruments

During the development of the by-design approach, the FASB debated whether certain derivative instruments, such as interest rate swaps and foreign currency swaps, should be considered variable interests in a legal entity by the counterparty to the derivative. From an economic standpoint, these types of derivatives could be viewed as both creating and absorbing variability in a legal entity. For example, in an interest rate swap in which the legal entity pays a fixed rate and receives a variable rate, the counterparty is absorbing fair value variability and creating cash flow variability for the legal entity. Although it would be atypical for such an instrument to give the counterparty power over the legal entity, the principles in ASC 810-10-25-35 and 25-36 provide a framework for the counterparties to conclude that many of these instruments are not variable interests in the legal entity, which permits the counterparties to avoid further analysis of whether the legal entity is a VIE as well as the disclosures required by variable interest holders in a VIE.

Under ASC 810-10-25-35 and 25-36, even if a derivative instrument absorbs variability, it may be considered a creator of variability (i.e., not a variable interest) as long as it does not absorb all or essentially all of the variability from a majority of the legal entity’s assets and it possesses the following two characteristics:

“Its underlying is an observable market rate, price, index of prices or rates, or other market observable variable (including the occurrence or nonoccurrence of a specified market observable event).” (See Section 4.3.3.2 for a discussion of the meaning of the term “observable market.”)
“The derivative counterparty is senior in priority relative to other interest holders in the legal entity.”

Questions have been raised regarding the application of the derivative-specific guidance in ASC 810-10 to nonderivatives, generally in the context of unrecognized executory contracts (e.g., PPAs) that appear to both absorb risk (e.g., commodity price risk) and create new risk (e.g., credit of the off-taker). The guidance in ASC 810-10-25-35 and 25-36 is confined to derivatives (as determined under ASC 815). Accordingly, a reporting entity would be prevented from applying this guidance if, for example, there is no explicit or implicit notional amount in the PPA, or if the output under the PPA (power) does not meet the net settlement criteria in ASC 815-10-15-110 and ASC 815-10-15-119. See Section 4.3.3.1 for further discussion of the meaning of a derivative instrument in this context.

Example E-4

A reporting entity forms a legal entity to construct and hold a single plant that will produce electricity. The plant has an estimated useful life of 40 years and is financed with equity (10 percent) and nonrecourse debt (90 percent). During the formation of the legal entity, the reporting entity enters into a forward contract to buy 100 megawatts of the electricity produced by the plant, which is approximately 60 percent of the plant’s yearly electricity production, for 25 years. The forward contract is at a variable price, reimbursing the legal entity for raw materials and O&M costs. The reporting entity has no other involvement with the legal entity. The legal entity can choose to purchase the raw materials needed to produce the electricity on the spot market either when it needs them or before. Assume that the forward contract possesses the following characteristics necessary for the application of ASC 810-10-25-35 and 25-36:

The forward contract meets the definition of a derivative in ASC 815.
The forward contract’s underlying (electricity) has an observable market price.
The reporting entity is senior in priority to the legal entity’s other interest holders. (In this instance, the reporting entity’s interest is senior in priority to the nonrecourse debt; often, this is not the case.)

Further, the reporting entity has identified that the legal entity is designed to be exposed to risks related to construction, raw-material prices, O&M, and credit of the purchaser. The forward contract would probably be considered a creator of variability even though the contract absorbs the variability associated with the raw-material price risks and the O&M risk. Although the forward contract is related to a majority of the operations of the legal entity, changes in the cash flows or fair value of the forward contract are not expected to offset all, or essentially all, of the risk or return (or both) related to the output of the legal entity. Specifically, the forward contract is designed to absorb approximately 60 percent of the plant’s raw-material price risk and O&M risk, which do not constitute essentially all the risk in the legal entity.

E.5.2.4 Rate-Regulated Entities — Ratepayers Are Not Variable Interest Holders

Regulated utility companies many times enter into a PPA to purchase all the power of a power-generating plant at an amount equal to a fixed capacity payment plus the variable costs of fuel, operations, and maintenance. The regulated utility company generally expects that all of its costs incurred under the PPA will be recovered from ratepayers under the rate regulation statutes in its operating jurisdiction. Further, in many instances, the power-generating plant is the sole asset of a VIE.

Although the regulated utility is permitted to pass the costs of the PPA to its ratepayers as they are billed for services in the future, no identifiable ratepayers have the obligation to absorb the VIE’s economics at the present time. That is, an individual ratepayer does not have an obligation to absorb the variability in the PPA until the ratepayer consumes electricity in the future. Further, the ratepayer is not obligated to absorb any of the VIE’s variability if electricity is not purchased in the future (e.g., if the ratepayer uses alternative energy sources or moves to another state).

Because the individual ratepayers do not have an obligation, contractual or otherwise, to absorb the variability of the regulated utility’s arrangement with the VIE, the indirect involvement of the ratepayers does not meet the definition of a variable interest. As a result, the variability passed through the PPA between the regulated utility and the VIE is considered to be absorbed completely by the regulated utility under the VIE model, and no portion of that variability should be attributed to the ratepayers.

E.5.3 Determining Whether the Legal Entity Is a VIE

To the extent that a PPA, tolling agreement, or similar off-take arrangement is deemed to be a variable interest, or when a reporting entity has other variable interests in the legal entity (e.g., equity interests, loans, guarantees), the reporting entity is required to consider whether the legal entity is a VIE and, accordingly, whether to apply the VIE model or the voting interest entity model in performing its consolidation assessment. To determine which model to use, the reporting entity must determine whether any of the following conditions apply:

The legal entity has insufficient equity at risk to finance its activities.
The equity holders (as a group) lack any of the three characteristics of a controlling financial interest.
Members of the equity group have nonsubstantive voting rights.

If any of these conditions apply, the equity is not considered substantive, and the legal entity should be evaluated under the VIE model. Legal entities in the P&U industry often are considered VIEs because (1) the equity holders are protected from losses or their return is capped (e.g., a put or call arrangement for assets of the entity or an arrangement that protects the equity holders from commodity price risk (fuel and electricity) and O&M risk), (2) the equity holders share power with or cede power to other parties (e.g., debt investors or another party through a PPA), or (3) the equity holders have disproportionate voting rights to their profit-sharing arrangements. See Chapter 5 for further discussion of whether a legal entity is a VIE.

E.5.3.1 The Business Scope Exception

The “business scope exception” exempts reporting entities from evaluating whether a legal entity that qualifies as a business under ASC 805 is a VIE unless one or more of the four conditions discussed in Section 3.4.4 apply. While legal entities in the P&U industry may meet the definition of a business under ASC 805,7 the reporting entity often fails to meet one or more of the four conditions that preclude the use of the exception. For example, a single-plant entity that has issued debt collateralized by the asset would generally not qualify for the business scope exception because it would meet the condition in ASC 810-10-15-17(d)(4).

E.5.3.2 Limited Partnerships

Developers in the renewable energy sector often use limited partnerships or similar structures for tax purposes. For example, a developer of a renewable energy facility that does not generate sufficient taxable income to offset the tax incentives or investment tax credits generated from its operations may monetize these tax credits by identifying investors that are able to use the tax incentives and credits. These renewable “flip” structures are typically set up as tax pass-through entities to give the investors (i.e., tax-equity investors) the ability to use the tax benefits of the partnership. When evaluating these types of structures under ASC 810, reporting entities should assess whether they are limited partnerships (or similar structures) and, if so, whether the holders of equity at risk (typically, the limited partners) have substantive kick-out or participating rights. If such rights do not exist, the partnership would be considered a VIE. See Section 5.3.1.2 for further discussion of whether a limited partnership (or similar entity) is a VIE.

E.5.3.3 Tax Equity

The prevalence of tax equity in renewable flip structures has led to questions about whether tax equity qualifies as equity at risk. The answer can affect the VIE determination related to equity sufficiency and the requirement that equity holders (as a group) have the three characteristics of a controlling financial interest. Tax equity will generally qualify as “at risk” unless the return of the tax investor is somehow guaranteed by the partnership. Disproportionate equity distributions until a flip date, in isolation, would not constitute a guarantee of the tax investor’s return.

E.5.4 Determining Whether the Reporting Entity Is the Primary Beneficiary of a VIE

The evaluation of whether to consolidate a VIE focuses on whether the reporting entity has (1) the power to direct the activities that most significantly affect the economic performance of the VIE (power criterion) and (2) a potentially significant interest in the VIE (economics criterion). However, the determination is often based on which variable interest holder satisfies the power criterion since generally more than one variable interest holder meets the economics criterion. Determining which variable interest holder, if any, meets the power criterion can be challenging. Although a quantitative expected loss calculation is not required, an understanding of the economic performance of the entity is useful in the assessment of the purpose and design of the VIE and the risks the VIE was designed to create and pass along to its variable interest holders (see discussion below).

E.5.4.1 Risks of the Entity

When identifying the activities that most significantly affect the legal entity, the reporting entity should focus on the purpose and design of the VIE and the risks the VIE was designed to create and pass along to its variable interest holders. The evaluation should focus on how each risk affects the VIE’s economic performance, not just those risks that have a direct impact on the net income of the VIE.

This concept is best illustrated by an example involving a traditional PPA with fixed-capacity pricing (e.g., a fixed monthly capacity charge) and variable pricing designed to pass through the variable cost of production to the off-taker. In this arrangement, the capacity payment is designed to (1) reimburse the seller’s capital investment in the plant, (2) cover fixed production costs, and (3) provide a return to the equity holders. The variable price, on the other hand, is often a pure pass-through mechanism designed to pass fuel and variable O&M costs along to the off-taker without a profit adder. Accordingly, the decision to dispatch electricity from the plant does not have a direct bearing on the profitability of the VIE — the capacity payment, which is dependent only on the availability of the plant, determines the net income of the VIE. A narrow focus on only those risks that affect net income could lead a reporting entity to conclude that the ability to dispatch would not be considered in the analysis of which party has the power to direct the activities that most significantly affect the VIE’s economic performance because the dispatch decision does not affect earnings of the VIE.

We believe that such a conclusion would be inappropriate because it ignores the fact that the dispatch decision governs the off-taker’s variable payment obligation and therefore directly affects the VIE’s level of exposure to commodity prices that the off-taker absorbs. Note that the dispatch rights, in and of themselves, may not necessarily lead to consolidation by the off-taker. To weigh the significance of commodity-price risk in the context of the VIE’s overall risk profile, a reporting entity must consider (1) the other risks created and passed along to variable interest holders and (2) which parties have the power to direct the activities related to those risks. See Section E.5.4.3 for additional information.

Example E-5

A local utility enters into a long-term PPA with a single-plant legal entity. The PPA is a prerequisite to the legal entity’s acquisition of bank financing. The PPA is structured such that the local utility reimburses the legal entity for certain production costs, including fuel.

Although the single-plant legal entity is not a merchant operation, its risk profile is similar to that of a merchant generator. That is, the risks the legal entity is exposed to are likely to include commodity price risk (fuel and electricity), O&M risk (including efficiency and technology risk), residual value risk, remarketing risk, credit risk, regulatory risk, catastrophic risk, construction risk,8 and, in some cases, tax risk. In this example, even though the local utility absorbs 100 percent of the legal entity’s fuel price risk, that risk is still relevant to the analysis because it is absorbed by a variable interest holder, albeit not an equity owner. This view would also apply to scenarios involving tolling arrangements in which the off-taker provides the fuel input. Like the PPA, a tolling arrangement is another example of risk allocation through contracting, but the base risks remain those of a merchant generator. Further, there is no substantive difference between the provision of the fuel by the off-taker and the billing of the off-taker by the generator for fuel it procures on a dollar-for-dollar basis.

Once the risks have been identified, the reporting entity is required to identify the activities related to those risks. It is appropriate to exclude from the analysis uncontrollable risks. On the other hand, there may be situations in which the activities related to the risks are asserted to be “outside” the entity and should be included in the analysis. See Section 4.3.10.1 for a discussion of the SEC’s views on “activities around the entity.”

The example above describes the identification of risks in a single-plant entity or merchant operation. However, the risks identified could differ depending on the nature of the legal entity. For example, there may be unique considerations for equipment-leasing entities (including those related to uninstalled gas turbines, rail cars, etc.).

E.5.4.2 Risks With No Activities

While reporting entities should consider all the VIE’s risks, the VIE may be exposed to risks that do not have direct activities related to them. Accordingly, the evaluation should focus on any substantive ongoing activities that are expected to have a significant effect on the economic performance of the VIE rather than on risks that may be significant to the legal entity but are not subject to control by any party. For example, the exposure to electricity price risk in a renewable project is a function of production, which is typically affected by external factors, such as wind volume. Similarly, the occurrence of a catastrophic loss event is a noncontrollable risk that would not affect the power analysis.

E.5.4.3 Identifying the Significant Activities

After a reporting entity has identified the risks of the legal entity that are expected to have the most significant effect on the legal entity’s economic performance, the reporting entity would need to consider the level of decision making and activities related to those risks. Such decisions and related activities may include, for example, choices about when to operate the facility (dispatch rights), how to operate the facility, the purchasing of raw materials, the selling of excess output, the maintenance of the facility, the hiring and firing of employees, remarketing at the end of the PPA term, and the disposition of the plant at the end of its useful life (e.g., the decision to refurbish or dismantle the plant).

Typically, commodity price risk (electricity price risk and fuel price risk) and O&M risk will be the most significant controllable risks of a single-plant legal entity with a fossil-fuel generating asset. However, the reporting entity may need to use significant judgment in identifying the related relevant activities because the types of decisions, and the weight of those decisions, may vary on the basis of the design of legal entity being evaluated.

E.5.4.3.1 Fossil-Fuel Generating Assets

The significance of certain decisions may depend on whether the legal entity’s primary asset is a fossil-fuel generating facility (e.g., a coal-fired power plant) or a renewable energy facility (e.g., a wind or solar farm). For example, commodity price risk is inherent in a fossil-fuel-powered plant’s inputs (i.e., fuel) and outputs (i.e., electricity). Some have argued that because of the importance of O&M, it would generally be the plant’s most significant activity. However, in certain instances (see discussion below), the opportunity to recognize enhanced (or deteriorating) returns on the basis of superior (or inferior) O&M performance (i.e., the opportunity to affect the efficiency of the generating asset) may not outweigh the activities that affect the potential volatility that results from commodity price risk. Accordingly, in those instances, we would expect more weight to be placed on the power to decide when to run the plant (i.e., dispatch) than on the power to decide how to run the plant (O&M). The fuel source and expected run profile of the facility (e.g., baseload, peaking) may be relevant in the reporting entity’s assessment of the potential variability associated with commodity price risk. The nature of the off-taker’s commodity exposure (e.g., full exposure to input or output price volatility as opposed to a net exposure to the spark spread9) should also be considered. Finally, availability guarantees, minimum production guarantees, and guaranteed heat rates are examples of features that may need to be considered in the assessment of the potential variability associated with O&M.

A baseload plant is designed to run substantially all the time regardless of market conditions. Therefore, although a reporting entity (typically the power purchaser) may have the ability to make the dispatch decisions, the plant is not designed such that those decisions are likely to be exercised or have a significant impact on the plant’s economic performance. Rather, the economic performance may be most closely associated with the cash inflows from a capacity payment. Capacity cash flows typically vary only according to the availability of the plant (i.e., a payment is “all or nothing”), and therefore O&M may be the most significant activity ensuring that the plant is available and the cash inflows are received. Accordingly, on the basis of facts and circumstances, O&M and other important decisions may most significantly affect the plant’s economic performance.

On the other hand, a peaking plant is designed to be dispatched in times of peak load, when the market price of electricity is economic in comparison to the cost of producing the electricity. That is, the off-taker will dispatch when the spark spread is favorable since every dispatch decision effectively involves a purchase of fuel (e.g., natural gas) and a contemporaneous sale of electricity. If commodity price risk is the risk that most significantly affects the legal entity’s economic performance, the reporting entity that makes dispatch decisions (e.g., the off-taker) would typically be deemed to have the power over the most significant activities of the VIE unless another variable interest holder has powers that, in the aggregate, exceed the effect of dispatch. The reporting entity should consider all facts and circumstances, including the extent to which the primary dispatch decision is affected by market economics or by the off-taker’s decisions.

In all cases, a reporting entity should document its considerations related to the design, purpose, risks, and significant activities of a fossil fuel-powered plant housed in a VIE when determining which party, if any, is the primary beneficiary of the VIE.

E.5.4.3.2 Renewable Generating Assets

If no party makes dispatch decisions, which may be the case for certain renewable energy technologies such as wind and solar farms, the analysis of the power to direct the activities that most significantly affect the VIE’s economic performance should focus on the other ongoing activities (e.g., O&M).

E.5.4.4 No Ongoing Activities

In the financial services industry, there are certain so-called “auto-pilot” structures (e.g., certain resecuritization structures) that have limited, if any, ongoing activities other than the administration of payments. Many believe that for these structures, the ongoing activities do not have a significant impact on the economic performance of the legal entity and that control over such activities is not indicative of a controlling financial interest. Consequently, design decisions and risk-and-reward profiles carry more weight in the consolidation analysis. However, such an approach is not likely to apply outside of pure financial structures since most operating entities (including those with physical assets) will generally involve some ongoing activities that are expected to have a significant impact on the economic performance of the legal entity.

When there are substantive ongoing activities that are expected to have a significant effect on the economic performance of the legal entity, little or no weight would be placed on decisions made at the legal entity’s inception as part of its design, including the location of the facility. Companies in the renewable sector will need to consider whether ongoing activities (e.g., O&M) are substantive and contribute significantly to the economic performance of the legal entity. For example, if the decisions about O&M are expected to have a significant impact on the productive output of the generating unit, these activities would be deemed to contribute significantly to the economic performance of the legal entity.

E.5.4.5 Activities Over the Life of the VIE10

The evaluation of whether a reporting entity has power over a VIE should focus on the ongoing activities performed throughout the life of the VIE. Thus, variable interest holders should reassess their power related to the significant activities as their rights change or simply as their power relative to that of other variable interest holders changes over time. In other words, it is not necessary for a discrete change in power (e.g., based on a new contract) to occur for there to be a change in the primary beneficiary; the primary beneficiary could change over time as one party ceases to direct the most significant activities of the VIE (e.g., as the contract that gives the party power expires). For example, a PPA holder with dispatch rights may have power over the most significant activities of a VIE when making the consolidation assessment at inception of a long-term PPA. However, that same party may conclude that it no longer has power over the most significant activities of the legal entity as the PPA expires. This may be the case when another party has agreed to purchase the plant output at expiration of the current PPA or when the equity holder will operate the plant on a merchant basis for the remaining useful life of the facility. On the other hand, further analysis may be required when the terms of the arrangement indicate that the off-taker has the ability to remain in power after the PPA expires (see discussion below of puts, calls, and term-extending options). For nonfinancial assets or in-substance nonfinancial assets, depending on the guidance that applies to them (e.g., they may be within the scope of ASC 606, ASC 610-20, ASC 810, or other U.S. GAAP), an entity should evaluate whether there are conditions that may hinder the ability to derecognize the generating facility once it has been recognized on the balance sheet through consolidation. In other words, an entity that reaches a conclusion that deconsolidation under ASC 810 is appropriate may have to apply additional guidance, depending on the nature of the transaction, which may make derecognition challenging.

In assessing power over the remaining life of the VIE, the reporting entity must consider all contractual rights and obligations, including those that will arise in the future (e.g., a fixed-price call option or a residual value guarantee on a power plant on the expiration of the PPA) pursuant to contracts in existence as of the balance sheet date. It is not appropriate to ignore these rights simply on the basis that they are not currently exercisable. These rights are often central to the design of the VIE and should not be disregarded in the primary-beneficiary analysis. The existence of such rights, in isolation, may not be determinative in the identification of the party with power over the activities that are most significant to a VIE’s economic performance, but they are often informative in the determination of which party has that power and should be incorporated into the analysis. Relevant considerations may include the pricing of the feature (e.g., in the money) and other business factors (e.g., a utility holds a call option on a facility that it needs to serve its native load). See Section 7.2.9.1 for more information about forward starting rights and the primary-beneficiary assessment.

Although forward starting rights (including puts, calls, and forward contracts) are not ignored in the consolidation analysis, it is likely that such rights (depending on their terms) have a more meaningful impact on the analysis for VIEs with a limited life or a limited range of activities. For example, a call right held by a party on another party’s interest in an operating venture may not be given significant weight in the power analysis until exercisable if the other party’s interest gives it the substantive ability to unilaterally make the significant decisions of the VIE until its interest is bought out. On the other hand, a future call right on an asset (e.g., power plant) of a VIE whose business revolves around that asset might be given more weight in the power analysis before becoming exercisable, particularly when the party holding the call right is already exerting some degree of power over the VIE through another variable interest (e.g., an off-taker that controls dispatch under a PPA).

E.5.4.6 Multiple Parties Involved in Decision Making

It is important to remember that the primary-beneficiary analysis should take into account all parties that have power; a party with power over multiple significant activities may determine when those powers are aggregated that it has the power to direct the most significant activities of the legal entity. This concept is illustrated in ASC 810-10-25-38E.

Example E-6

Party A controls an activity that is deemed to significantly affect the economic performance of a legal entity, and Party B controls four activities, none of which individually affects the economic performance of the legal entity as significantly as the activity directed by A, but in the aggregate affect the economic performance of the legal entity more significantly than the activity controlled by A. In this example, B would have the power to direct the activities that most significantly affect the economic performance of the legal entity. This scenario might apply to an off-taker that has one significant power (e.g., dispatch) while another variable interest holder, such as the owner-operator, has several powers that are individually less significant but in the aggregate exceed the effects of the dispatch rights.

In identifying the significant risks and activities that affect the economic performance of a legal entity, as well as in assessing the “power to direct” those activities, a reporting entity must remember that ASC 810-10-25-38G indicates that the level of a reporting entity’s economic interest may indicate the amount of power that the reporting entity holds. If an off-taker concludes that the design of a legal entity and the overall substance of its PPA give it substantially all the benefits and obligations of plant ownership, but it also concludes that it is not the primary beneficiary of the VIE, the off-taker should carefully consider whether it has appropriately identified the risks and activities that affect the economic performance of the VIE and its powers related to such activities.

E.5.4.7 Multiple Parties Have Power Over the Same Activity

When multiple unrelated parties are responsible for the same significant activity or activities that most significantly affect the economic performance of different portions of the VIE, and consent is not required, a party with power over the majority of the significant activity or activities (if such party exists) has power over the VIE. To determine which party has power over the majority of the significant activities, the reporting entity will need to use judgment and consider all facts and circumstances.

E.5.4.8 Impact of Curtailment Rights

There have been questions about the effects of curtailment rights (which are often held by off-takers in renewable PPAs) on the primary-beneficiary analysis. Such questions have included whether a curtailment right (which is effectively the inverse of a dispatch) could represent the power to direct the significant activities of a VIE. If a PPA is a variable interest or the off-taker has another variable interest in the legal entity, curtailment rights may represent the power to direct an activity of the VIE. However, in most circumstances, the effects of such rights on the economic performance of the legal entity will be relatively minor. In addition, the significance of such rights will depend on the type of curtailment rights in the PPA. Emergency curtailment is unlikely to contribute significantly to economic performance because of the remote and contingent circumstances associated with their exercise.

Further, voluntary or economic curtailment rights that are not contingent upon other circumstances are rarely invoked because the scenarios that make them economical to exercise (e.g., excessive negative locational marginal pricing at the delivery location) are fairly uncommon in most markets. In assessing the effects of these rights, reporting entities should consider the expected significance of the rights in the context of overall economic performance of the VIE. In many cases, this will dilute the effects of curtailment rights and lead to a relatively low weighting in the assessment of the power to direct.

E.5.4.9 Impact of Liquidation and Withdrawal Rights

In some cases, withdrawal rights are tantamount to kick-out or liquidation rights and should be treated as such. Section 7.2.10.3 discusses situations in which withdrawal rights should be considered in a manner similar to liquidation rights in the primary-beneficiary analysis. The existence of liquidation rights (or withdrawal rights that are in-substance liquidation rights) may be applicable, for example, when a VIE owned by an engineering, procurement, and construction (EPC) contractor is established to house the construction of a new generating facility and the utility has the right to exit the VIE, take the underlying assets, and hire a replacement EPC contractor to finish the construction.

E.5.4.10 Approval of Maintenance Schedules

Approval rights over planned maintenance schedules would not represent power over O&M (unless the approval rights are accompanied by other rights related to O&M decisions). Off-takers frequently have these rights but have no ability to influence the actual work done on the facility (other than requiring compliance with prudent utility practice). These rights would generally be more akin to protective rights than participating rights of the off-taker.

E.5.5 Other Items

E.5.5.1 Separate Presentation

Given the prevalence of non-recourse-project financing in the P&U industry, reporting entities should ensure that they comply with the presentation requirements in ASC 810-10-45-25. Under those requirements, separate presentation on the face of the balance sheet is required for (1) assets of a consolidated VIE that can be used only to settle obligations of the VIE and (2) liabilities of a consolidated VIE for which the creditors do not have recourse to the general credit of the primary beneficiary. Such information is required to be presented gross (i.e., assets and liabilities cannot be “linked” or netted). See Section 11.1.1 for more information about separate presentation.

Footnotes

In many situations, the evaluation of whether a PPA is (or contains) a lease may be relatively simple; however, there is diversity in practice related to how this evaluation should be performed. See Section E.5.2.1.1 for additional information.

See discussion in Section 3.4.4.2 on ASU 2017-01, which narrowed the definition of a business. As a result of the ASU, fewer legal entities (such as single-plant entities) may meet the definition of a business on a prospective basis.

In this example, it is assumed that the evaluation is being performed over the entire life of the entity. See Section 7.2.9.2 for a discussion of evaluating entities that have multiple distinct stages.

“Net exposure to the spark spread” means that the off-taker’s contract is designed to absorb only the difference between the market price of electricity and the cost of producing that electricity.

The guidance in this section generally applies to single-plant legal entities in the operational phase. Before achievement of commercial operations, reporting entities should consider whether the power to direct the VIE’s most significant activities changes as the reporting entities move through discrete phases such as development and construction. In these scenarios, the relative certainty of successfully completing each stage is likely to be relevant to the analysis. See Section 7.2.9.2 for more information about assessing VIEs that go through discrete operational stages or phases of development.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.