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 16.5.3 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. See Section 16.5.2.1 for more information about this “package of three” practical expedients.

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 amends 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 easements6 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 once ASC 842 is effective will ultimately depend 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. In addition, we recommend that high-volume users of easements begin their analysis by (1) segregating term-based arrangements on the basis of similar contractual provisions and (2) investigating the rights retained by the landowner in those arrangements. This may streamline the process since many easements will have similar or identical provisions and therefore would be expected to result in similar accounting.

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 under7 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 2-67

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 2-7

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 2-6, 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

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.

See Section 2.4.3.3 for additional considerations related to subsurface easements.

See footnote 6.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.