2.4 Land Easements
The objectives of the land easement amendments in ASU 2018-01, which was issued in response to
feedback received by the FASB regarding implementation of ASU 2016-02, are to:
- Clarify that land easements entered into (or existing land easements modified) on or after the effective date of ASC 842 must be assessed under ASC 842.
- Provide a transition practical expedient for existing or expired land easements that were not previously accounted for in accordance with ASC 840. The practical expedient would allow entities to elect not to assess whether those land easements are, or contain, leases in accordance with ASC 842 when transitioning to ASC 842.
The amendments in ASU 2018-01 do not, and are not intended to:
- Provide illustrative or application guidance on whether land easements are, or contain, leases in accordance with the definition of a lease in ASC 842.
- Help entities identify the appropriate accounting framework for situations in which a land easement is not determined to be a lease under ASC 842.
See Section
E.3.1.2 for information about the
effective date and transition provisions of ASU 2018-01.
2.4.1 Background
Generally, an easement is a right to access, cross, or otherwise use someone
else’s land for a specified purpose. Most
easements provide limited rights to the easement
holder, such as the right to cross over land or
the right to construct and maintain specified
equipment on the land. For example, an electric
utility will typically obtain a series of
contiguous easements so that it can construct and
maintain its electric transmission system on land
owned by third parties. Easements can be perpetual
or term-based, be paid in advance or over time,
and provide the customer with exclusive or shared
use.
Historically, some companies have considered easements to be intangible assets
under ASC 350. In fact, ASC 350 contains an
example illustrating easements acquired to support
the development of a natural gas pipeline. In
contrast, some companies may have considered
easements to be leases or executory contracts.
When preparing their financial statements, many
companies have presented prepaid amounts related
to easements in the PP&E section of their
balance sheets because easements are closely
associated with the PP&E they support. We
understand that reporting requirements of the
Federal Energy Regulatory Commission may have also
influenced the balance sheet geography for
companies regulated by that agency.
Easements generally convey to the customer some rights associated with the use of land (i.e., PP&E). Therefore, questions have arisen about whether easements are within the scope of ASC 842 and, if so, whether the benefit to financial statement users of entities assessing those arrangements in accordance with the definition of a lease would outweigh the cost to the entities of doing so (both upon transition and on an ongoing basis).
2.4.2 Scope
ASU 2018-01 only addresses land easements. Although the FASB does not define
this term, ASC 842-10- 65-1(gg) and paragraph BC3
of ASU 2018-01 describe both a land easement and a
right of way as a “right to use, access, or cross
another entity’s land for a specified
purpose.”
Further, ASU 2018-01 effectively breaks land easements into two groups on the
basis of the effective date of ASU 2016-02: (1)
land easements entered into (or existing easements
modified) on or after the effective date
(collectively, “new land easements”) and (2) land
easements that existed as of, or expired before,
the effective date (collectively, “existing land
easements”).
For existing land easements that were not previously accounted for as a lease
under ASC 840, ASU 2018-01 provides a practical
expedient under which an entity may elect to “run
off” all such easements by using its historical
accounting approach for land easements.
Importantly, an entity may elect this practical
expedient even if it does not elect the package of
practical expedients in ASC 842-10-65-1(f) that
would allow the entity not to reevaluate whether
any expired or existing
contracts are or contain leases.
Connecting the Dots
No
Analogies
We think that the FASB’s use of the term “land easements” is intentional. Therefore, we do not believe that an entity should analogize to the ASU’s favorable transition practical expedient for existing land easements when considering other types of arrangements.
For new land easements, ASU 2018-01 amended the illustrative example (Example
10) in ASC 350-30- 55-30 as follows to clarify
that ASC 350 may only be applied after a new land
easement is determined not to be a lease in
accordance with the definition of a lease in ASC
842:
Entity A is a distributor of
natural gas. Entity A has two self-constructed
pipelines, the Northern pipeline and the Southern
pipeline. Each pipeline was constructed on land
for which Entity A owns perpetual easements
that Entity A evaluated under Topic 842 and
determined do not meet the definition of a lease
under that Topic (because those easements are
perpetual and, therefore, do not convey the right
to use the underlying land for a period of
time). The Northern pipeline was constructed
on 50 easements acquired in 50 separate
transactions. The Southern pipeline was
constructed on 100 separate easements that were
acquired in a business combination and were
recorded as a single asset. Although each pipeline
functions independently of the other, they are
contained in the same reporting unit. Operation of
each pipeline is directed by a different manager.
There are discrete, identifiable cash flows for
each pipeline; thus, each pipeline and its related
easements represent a separate asset group under
the Impairment or Disposal of Long-Lived Assets
Subsections of Subtopic 360-10. While Entity A has
no current plans to sell or otherwise dispose of
any of its easements, Entity A believes that if
either pipeline was sold, it would most likely
convey all rights under the easements with the
related pipeline.
In addition, paragraph BC11 of ASU 2018-01 states, in part:
The Board noted that a land easement conveys (in various forms) a right to use
land and that a right to use land needs to be
evaluated to determine whether it is within the
scope of Topic 842. Accordingly, the amendments in this Update
provide clarity that an entity should apply Topic
842 to a land easement to determine whether that
easement is or contains a lease. [Emphasis
added]
Changing Lanes
New
Land Easements Must First Be Evaluated Under ASC
842
The FASB makes its objective for new land easements very clear in paragraph BC11
of ASU 2018-01, and the amendment to ASC
350-30-55-30 helps reinforce the scope hierarchy
in GAAP with respect to such easements. That is,
all new land easements must first be assessed
under ASC 842 to determine whether the arrangement
is, or contains, a lease.
If an arrangement is not a lease, other GAAP may be applicable (e.g., ASC 350, ASC 360). However, in paragraph BC11 of ASU 2018-01, the Board explains that it intentionally did not address the appropriate accounting guidance to apply in these situations:
While there may be diversity about which guidance an entity should apply when a
land easement is not a lease, that diversity is
outside the scope of the amendments in this
Update, and, accordingly, the amendments do not
modify an entity’s accounting for land easements
that are not leases.
2.4.3 Identifying a Lease
ASU 2018-01 is not intended to provide illustrative or application guidance
about whether new land easements5 meet the definition of a lease in ASC 842.
Therefore, stakeholders and respondents may
continue to raise questions about the application
of the definition of a lease to new land easement
arrangements, and it is possible that the FASB,
IASB, and SEC staffs will want to share their
perspectives as those questions are raised.
Companies involved in land easement arrangements
should consult with their accounting advisers and
monitor developments on the topic.
The required accounting under ASC 842 ultimately depends on the facts and
circumstances of each arrangement. However, to
determine whether a new land easement contract is,
or contains, a lease in accordance with ASC
842-10-15-2 through 15-27, entities may find it
helpful to group the contracts into one of two
categories, further discussed below: (1) perpetual
easements and (2) term-based easements.
2.4.3.1 Perpetual Easements
ASC 842-10-15-3 states, in part, “A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration” (emphasis added). When a land easement is perpetual, we would not
expect the arrangement to meet the definition of a lease given the lack of a stated term. As indicated by the amendments to ASC 350-30-55-30, rights conveyed in a land easement into perpetuity (i.e., for an unlimited time) are not conveyed “for a period of time” in accordance with ASC 842-10-15-3.
Arrangements with stated terms are not considered perpetual even if the terms
are very long (e.g., 100 years). On the other
hand, a use condition contained in a perpetual
easement (e.g., when an easement conveys rights to
the customer into perpetuity, as long as those
rights are used only to run fiber-optic cable)
would not affect the conclusion that a land
easement is perpetual.
2.4.3.2 Term-Based Easements
For term-based easements, the analysis will most likely be more extensive and
involve a consideration of the right to control
the use of the underlying land. That is, in
accordance with ASC 842-10-15-4, entities will
need to assess whether the customer in the
arrangement has the right to (1) obtain
substantially all of the economic benefits from
using the land throughout the period of use and
(2) direct the use of the land throughout the
period of use. Accordingly, many easement
arrangements may not convey the right to control
the use of the land to the customer given that the
supplier continues to enjoy economic benefits
derived from the use of the land and that the
rights to direct the use of the land that are
conveyed to the customer are limited (i.e.,
generally only for a specified purpose).
For example, in an arrangement in which a utility (as the easement holder) is
allowed to run electric transmission assets
through a farmer’s fields (i.e., transmission
lines that run over or under6 the farmer’s fields), it will be important
to understand whether the farmer can still use the
acreage subject to the easement (i.e., the acreage
under or over which the lines run). If so, the
utility may conclude that it does not have the
right to control the use of the land because the
farmer retains (1) rights to direct the use of the
land (e.g., rights to farm the land), (2) economic
benefits associated with the land that are not
insignificant (e.g., the crops yielded from
farming), or (3) both (1) and (2). On the other
hand, there may be easement arrangements that
effectively convey the right to control the use of
the land to the easement holder through the rights
conveyed or through use restrictions imposed on
the landowner.
In addition, to appropriately identify the unit of account, an entity sometimes may need to more carefully consider the identified asset in an easement arrangement, as illustrated in the common scenarios below.
Example 2-77
A customer enters into a land easement arrangement with a farmer for the right to pass a natural gas pipeline under the farmer’s land. At issue is whether the identified asset includes the entire plot of land or whether the land should be broken down into surface and subsurface rights, the latter of which the parties would evaluate to determine whether the customer has the right to control the use of the land.
If the identified asset is the entire plot of land, the parties are less likely
to conclude that the customer has the right to
obtain substantially all the economic benefits
from use of the land because the farmer retains
the surface rights (e.g., to farm the land).
However, if the identified asset is only the
subsurface rights, the customer might have the
right to obtain substantially all the economic
benefits from using the area below the surface of
the land. Further, subsurface rights for the same
plot of land may also be stacked in such a way
that one customer has an easement for the depth of
5 to 10 feet below the surface while another
customer has an easement for the depth of 10 to 20
feet below the surface.
Example 2-8
A customer enters into a land easement arrangement with a farmer for the right
to construct and maintain 25 wind turbines on the
farmer’s 500-acre plot of land. Each wind turbine
will be constructed on individual acre plots. At
issue is whether the identified asset is the
entire 500-acre plot of land or whether there are
25 identified assets, each one acre of land.
As in the previous example, if the identified asset is the entire 500-acre plot of land, the parties are less likely to conclude that the customer has the right to obtain substantially all the economic benefits from use of the land because the farmer retains all of the rights to the economic benefits of the remaining 475 acres. However, if the identified assets are 25 individual acre plots of land, the customer may have the right to obtain substantially all the economic benefits from using each individual acre plot.
Connecting the Dots
An
Entity Will Need to Use Judgment to Determine the
Unit of Account
At its November 29, 2017, meeting, the FASB indicated that it would not provide
additional, formal guidance on determining the
unit of account with respect to performing the
lease assessment for an easement. However, several
Board members pointed out that an entity will need
to use judgment in determining the unit of account
and that diversity in practice could arise in this
area. Board members have publicly expressed this
view at previous meetings, including a July 2017
roundtable and an August 2017 meeting. Further, it
was noted that the need to use judgment is not
limited to scenarios involving subsurface rights
(e.g., rights to run gas pipelines underground).
Board members specifically discussed easements
that convey only surface rights, including rights
to construct renewable energy assets (e.g., wind
or solar), noting that an entity will also be
required to employ judgment in considering these
arrangements and that there could be more than one
approach to determining the unit of account.
On the basis of these views, we believe that, in practice, some will conclude that the unit of account is the entire land area defined by the easement contract (i.e., a larger area) while others will decide that a new unit of account should be established and assessed each time the easement holder occupies a portion of the land (i.e., a smaller area, such as the area taken up by a concrete pad used to serve as the foundation for a windmill or a transmission tower). We believe that either of these approaches is acceptable.
2.4.3.3 Treatment of Subsurface Rights as an Intangible Asset
As indicated in Example 2-7, certain
easements may give an entity the right to use area
beneath the surface of the land (i.e., the
subsurface). Questions have arisen about whether
land below the surface should be considered a unit
of account that is separate from the land’s
surface in the identification of whether a lease
exists. Alternatively, others have questioned
whether the right to use the subsurface is akin to
an intangible asset (e.g., air rights) that is
outside the scope of ASC 842.
We believe that it may be
appropriate for an entity to analogize to air
rights (and thus treat subsurface rights as an
intangible asset) in certain circumstances, such
as those involving the use of subsurface space to
facilitate the build-out of a gas or electric
distribution system. We generally support an
analogy to air rights given the fact that
above-ground (air) and below-ground (subsurface)
uses are often commercially interchangeable. For
example, an electric utility can run its electric
wires 35 feet above the ground or 2 feet below the
ground, either of which will accomplish the same
commercial objective. Note that this analogy does
not apply to all underground scenarios (e.g.,
those involving the basement of a building or an
underground parking garage).
We believe that when a
subsurface easement conveys rights akin to air
rights, an entity is permitted, but not required,
to consider an arrangement that provides a right
to access the subsurface as an intangible asset by
analogy to air rights. Air rights are intangible
assets under ASC 805-20-55-37, which states:
Use rights such as drilling,
water, air, timber
cutting, and route authorities are contract-based intangible
assets to be accounted for separately from
goodwill. Particular use rights may have
characteristics of tangible, rather than
intangible, assets. For example, mineral rights
are tangible assets. An acquirer should account
for use rights based on their nature. [Emphasis
added]
Under this approach,
subsurface rights are outside the scope of ASC
842. The right to use the land’s surface would be
considered a unit of account that is separate from
subsurface rights.
We generally believe that if a
company does not analogize to air rights and
instead evaluates its subsurface easements under
ASC 842, the land below the surface should be
considered a unit of account that is separate from
the land’s surface in the identification of
whether a lease exists. Some have advocated a
“vertical slice” approach (i.e., evaluating the
right to use the surface and subsurface as a
single unit of account); however, we believe that
such an approach can lead to inappropriate
conclusions (e.g., a conclusion that an entity is
not leasing the land because it is not also
receiving the subsurface rights).
Companies should apply a
consistent approach to assessing their subsurface
easements and should consider disclosing this
approach, if such disclosure would be
material.
Footnotes
5
Although this section focuses
on land easements, we believe that the concepts
discussed herein can also be applied to other
types of land-use rights, including those provided
by the government in certain jurisdictions (e.g.,
countries that prohibit land ownership by foreign
investors). We think that entities should
generally assess whether such land-use rights are
leases before considering other applicable
GAAP.
6
See Section 2.4.3.3
for additional considerations related to
subsurface easements.
7
See footnote 6.