3.4 Right to Control the Use of the Identified Asset

As discussed in Section 3.2.1, the FASB carried forward into ASC 842 the control concepts it had been developing in other areas of U.S. GAAP (e.g., ASC 810 and ASC 606). Accordingly, to have the right to control the use of PP&E in a contract in which the PP&E is an identified asset (see Section 3.3), the customer must have both of the following:

The right to obtain substantially all of the economic benefits from the use of the PP&E (i.e., the benefits or economics element, discussed in detail in Section 3.4.1).
The right to direct the use of the PP&E (i.e., the power element, discussed in detail in Section 3.4.2).

Connecting the Dots

Control in ASC 842 Versus That in ASC 606 and ASC 810

ASC 606-10-25-25 states, in part, that “[c]ontrol of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.” This guidance is consistent with ASC 842-10-15-4 on the right to control the use of an identified asset. That is, for a lease to exist, the customer must have the right to direct the use of, and obtain substantially all of the economic benefits from, the identified asset during the period of use.

ASC 842 is also consistent with ASC 606 with respect to determining when an arrangement should be accounted for as a sale. When the amount of control that a lessee has over the right to use an asset is so significant that the lessee has, effectively and economically, obtained control of the entire asset (i.e., not just control during the period of use), the lessor would account for that arrangement as a sale (i.e., as a sales-type lease; see Chapter 9 for a detailed discussion of the lessor’s lease classification and accounting).

However, the economics element of control in ASC 842 differs from that under the VIE consolidation guidance (i.e., ASC 810). Specifically, under ASC 842, the customer must have the right to obtain substantially all of the economic benefits from the use of the asset. The threshold of “substantially all the economic benefits” is different from and higher than that in ASC 810, which only requires the primary beneficiary of a VIE to absorb losses or receive benefits, either of which must only potentially be significant. Accordingly, the primary beneficiary in ASC 810 may control a VIE even when it is not exposed to substantially all of the economics of that entity.

The power element in ASC 842 differs from that in the ASC 810 VIE consolidation model as well. ASC 842 does not specifically address the concept of “shared power”; that is, ASC 842 does not address situations in which the most relevant decision-making rights related to how and for what purpose (HAFWP) the asset is used throughout the period of use are shared (see Section 3.4.2.4 for further discussion of shared power). Consolidation principles, on the other hand, do allow for the concept of shared power. Under the ASC 810 VIE consolidation model, when shared power exists, neither of the parties that share in directing the activities that most significantly affect economic performance has control (provided that they are not related parties). However, when multiple, different activities affect the economics, the control concepts in ASC 842 align more closely with those in the consolidation guidance. Specifically, in such circumstances, an entity would need to determine which of those different activities most significantly affects the economics and thus would generally conclude that one party has control under both ASC 842-10-15-20 and ASC 810-10-25-38E.

The effect of design on the control analysis under ASC 842 also differs from that under the ASC 810 VIE consolidation model. That is, under the ASC 810 VIE consolidation model, the design of the entity must be considered to determine the significant activities of the entity and who has the power to control them (and thus controls the entity). However, by itself, design does not give one party control of a legal entity, provided that ongoing operations have an effect on the economics of the legal entity. Under ASC 842, on the other hand, the customer may have power over an identified asset if it was significantly involved in the design of the asset, even if the supplier operates the asset. Design and its role in the lease identification assessment are further discussed in Section 3.4.2.

Link Between Power and Economics

The FASB makes an important point when describing the concept of the right to control the use in paragraph BC134 of ASU 2016-02:

[A] customer must have decision-making rights over the use of the asset that give it the ability to influence the economic benefits derived from use of the asset throughout the period of use. Without any such decision-making rights, the customer would have no more control over the use of the asset than any customer purchasing supplies or services. If that were the case, the customer would not control the use of the asset.

That is, with respect to the power element, the customer is making decisions about the use of the asset so that it may maximize (or minimize) the economic benefits that it will receive. ASC 842-10-15-24 makes this clear in stating that “[d]ecision-making rights are relevant when they affect the economic benefits to be derived from use.” In other words, the customer cannot just have substantially all of the economics and some rights over the use of the asset — the customer’s decision-making rights must influence the economic benefits it has the right to obtain.

Changing Lanes

Control Over the Output of PP&E Is No Longer Solely Determinative

Under ASC 840-10-15-6(c) (formerly EITF Issue 01-8), an arrangement may qualify as a lease because (1) the customer takes all (or substantially all) of the output of the PP&E and (2) the contract is priced like a lease. That is, ASC 840 differentiated between a lease contract and a service (or supply) contract on the basis of whether the supplier was pricing the contract to recover, and earn a return on, the cost of either (1) the PP&E (in which case the contract is a lease) or (2) each unit of output (in which case the contract is a service).

However, the pricing of an arrangement is not indicative of whether the customer has “power” under ASC 842. Paragraph BC134 of ASU 2016-02 explains that the pricing condition in ASC 840, which defined control on the basis of only “economics” and who controlled the output of the asset, is no longer indicative of control since the Board decided to align the new control concept with that in the revenue and consolidation guidance:

In previous leases guidance, a customer could have the right to control the use of an asset solely on the basis of obtaining substantially all of the output from that asset, assuming that the contract is priced in a particular way. This defined control on the basis of only a “benefits” element. Topics 606 and 810, however, define control to require both a “power” element and a “benefits” element. The Board decided that, to control the use of an asset, a customer is required to have not only the right to obtain substantially all of the economic benefits from use of an asset throughout the period of use (a “benefits” element), but also the ability to direct the use of that asset (a “power” element). [Emphasis added]

Moreover, the Board noted in paragraph BC105(d) of the 2013 leasing ED that removing the effect of pricing from the control concept would be advantageous because this condition had proved difficult to apply in practice.

Therefore, contracts that were or contained leases under ASC 840 solely because the customer controls the output of the underlying asset no longer meet the definition of a lease under ASC 842. We expect that the contracts most likely to be affected by this change will be off-take and purchase arrangements, such as PPAs and manufacturing supply contracts. Unless those arrangements somehow also grant the customer power through decision-making rights over the use of the asset (e.g., through dispatch rights, under which the customer determines whether, when, and how much the asset is producing), they are unlikely to be leases going forward.

Example 3-15

Power Purchase Agreement

Supplier X, a power generation company, executed a five-year PPA with Customer Z, a utility. Customer Z will purchase 100 percent of the electricity produced at X’s natural gas–fired generating facility, to be delivered on an as-available basis, because 100 percent of the facility’s production capacity is not expected to exceed the demand of Z’s end-use customers. Accordingly, Z agrees to accept whatever volume of electricity is produced at the facility.

Pricing under the PPA is a fixed capacity payment of $300,000 per month (which compensates X for reserving the facility to provide energy to Z), plus $25 per unit of electricity produced.

Under ASC 840, the contract contained a lease because (1) facts and circumstances at contract inception indicate that it is remote that parties other than Z will take more than a minor amount of the output (i.e., the electricity) produced by X’s facility during the five-year contract term and (2) the price paid by Z per unit of electricity varies with the volume of production (rather than being contractually fixed or equal to the current market price of the electricity).

However, under ASC 842, the parties will need to assess whether Z both has the power over and benefits from the economics of (i.e., whether it has the right to control the use of) the facility. Although Z obtains substantially all of the economic benefits from the facility through its purchase of 100 percent of the electricity, Z may not have the right to direct the use of the facility (i.e., it may not have power over the use of the facility).

Changing Lanes

Physical Access Is No Longer Solely Determinative

Under ASC 840-10-15-6(b) (formerly EITF Issue 01-8), an arrangement may qualify as a lease because the customer (1) takes more than a minor amount of the output of the PP&E and (2) controls physical access to the PP&E. That is, under ASC 840, the right to control the use of PP&E may be conveyed through the right to control physical access to the PP&E.

However, under ASC 842, control of physical access is not solely determinative of whether the customer has power over (i.e., whether the customer has the right to direct the use of) the PP&E. The party that controls physical access to the PP&E in an arrangement will generally have at least some (but maybe not all) decision-making rights related to when and how the PP&E is used.

Accordingly, while some contracts that are or contain leases under ASC 840 on the basis of the control over physical access may still meet the definition of a lease under ASC 842, others may not. The example below addresses one contract type that may no longer meet the definition of a lease under ASC 842.

Example 3-16

Rooftop Solar

Developer Y executes a 25-year PPA with Resident Z under which Y will install solar panels on the roof of Z’s home. In exchange, Z will purchase 100 percent of the electricity produced by the solar panels at a price that is fixed per unit of electricity. The rooftop solar panels are expected to meet 50 percent of Z’s demand for electricity.

Developer Y retains ownership of the solar panels and is responsible for any operation and maintenance that is needed throughout the contract term. However, because the panels are installed on Z’s home, Z controls physical access to them.

Under ASC 840, the contract is a lease because Z (1) will take more than a minor amount of the output (i.e., the electricity) produced by the solar panels during the 25-year contract term and (2) controls physical access to the solar panels.

However, under ASC 842, the parties need to assess whether Z has both power and economics (i.e., whether it has the right to control the use of the solar panels). Although Z obtains substantially all of the economic benefits from the use of the solar panels through its purchase of 100 percent of the electricity, Z may not have the right to direct the use of the panels (i.e., it may not have power over the use of the panels). (See Section 3.4.2.3 for additional discussion that would generally be relevant to this example.)

3.4.1 Right to Obtain Substantially All of the Economic Benefits

In accordance with the definition of a lease — and the concept of control — in ASC 842, the customer must have the right to obtain substantially all of the economic benefits from the use of the PP&E throughout the period of use. This is the “economics” element of the control concept, as discussed above. It is an important piece of the concept, because a customer would not agree to pay for a right to use PP&E unless it received the benefits resulting from that use.

This analysis is not confined to assets that physically produce outputs, and it will often be relatively simple to determine whether the customer has the right to obtain substantially all of the economic benefits from use of PP&E. For example, in a lease of an office building, it is likely to be clear whether the customer has the right to obtain substantially all of the benefits from using the office building. However, in other situations, the assessment may be more complex. The decision tree below illustrates the process an entity should consider when determining whether the customer has the right to obtain substantially all of the economic benefits from use of the PP&E.

The remainder of this section walks through this decision tree in greater detail.

3.4.1.1 Economic Benefits That Result From Use of the Asset

ASC 842-10

15-17 To control the use of an identified asset, a customer is required to have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use (for example, by having exclusive use of the asset throughout that period). A customer can obtain economic benefits from use of an asset directly or indirectly in many ways, such as by using, holding, or subleasing the asset. The economic benefits from use of an asset include its primary output and by-products (including potential cash flows derived from these items) and other economic benefits from using the asset that could be realized from a commercial transaction with a third party.

The concept of “economic benefits” in ASC 842-10-15-4(a) is described very broadly in ASC 842-10-15-17. That is, ASC 842-10-15-17 identifies all of the following as potential economic benefits that may be obtained from the use of PP&E:

Primary outputs (e.g., physical receipt of the widgets produced by or at a widget factory).
By-products (e.g., physical receipt of the steam produced as a by-product of the manufacturing process in the widget factory).
Cash flows derived from primary outputs and by-products (e.g., cash flows derived from the supplier’s selling, on the customer’s behalf, of widgets produced by or at the widget factory).
Other “economic benefits . . . that could be realized from a commercial transaction with a third party” (e.g., SO2 or other emissions credits granted by the government when the widget factory runs because it is an environmentally efficient factory, provided that those credits can be sold to others).

Economic benefits can also be obtained from nonproductive assets. For example, the economic benefits derived from the use of a warehouse include its storage capacity.

Further, ASC 842-10-15-17 indicates that economic benefits may be obtained either directly or indirectly, such as in the following ways:

Exclusive use of the asset (e.g., direct operation by the customer of the widget factory).
Holding the asset (e.g., preventing others from operating the widget factory).
Subleasing the asset (e.g., the customer subcontracts its rights to the capacity at the widget factory to another counterparty).

Because the concept of economic benefits in ASC 842-10-15-17 is broad, parties to an arrangement should first identify all economic benefits that result from use of the asset. In doing so, the parties are not considering the effects of contract terms (e.g., limitations) but are focusing on the nature of the asset. The parties can thus ensure that they are considering all of the economic benefits before they narrow the analysis to those benefits that are within the scope of the customer’s right to use the asset in the contract (see Section 3.4.1.2).

3.4.1.1.1 Tangible and Intangible Economic Benefits

The economic benefits of PP&E often may be physical, tangible outputs. For example, a PPA may give the customer the right to purchase electricity from a particular generating facility, or the customer may have the right to purchase widgets produced at a manufacturing facility.

In the context of determining whether the customer has the right to obtain substantially all of the economic benefits from use of the asset, economic benefits can be both intangible and tangible.

Benefits that result from the use of the asset and that can be realized through a commercial transaction with a third party should be considered economic benefits in the context of ASC 842-10-15-17, regardless of whether they are tangible or intangible.

One example of an intangible economic benefit is renewable energy credits (RECs), which are addressed in two places in ASC 842:

In Example 9, Case A, in ASC 842-10-55-111(a) (reproduced in Section 3.7.9), RECs are identified as a by-product of the production of electricity by a solar farm (i.e., of the use of a solar farm).
Paragraph BC135 of ASU 2016-02 states, in part, that “a customer should consider benefits relating to the use of the asset (for example, renewable energy credits received from the use of an asset or by-products resulting from the use of an asset)” (emphasis added).

RECs are used to comply with renewable portfolio standards (RPSs) within a particular jurisdiction (generally, RPSs are established by state). They serve as evidence of the use of “green” electricity that is produced by a renewable generating facility. RECs have no physical substance and are transacted only by electronic transfer among tracking accounts that are specific to each party in the RPS jurisdiction. Although they are therefore intangible, RECs have clear economic value (and sometimes an observable fair market value, depending on the jurisdiction). In addition, they are conveyed and exchanged in commercial transactions on the open market (e.g., as opposed to being claimed in an owner’s tax return).

We think that ASC 842’s discussion of RECs as intangible economic benefits demonstrates that the FASB believes intangible benefits (or outputs), which may be realized through a commercial transaction with a third party, should be considered in the analysis of whether a customer has the right to obtain substantially all of the economic benefits from use of the asset. In other words, we do not view RECs to be an “exception” or the only intangible form of economic benefit that should be considered in the analysis.

3.4.1.1.2 Economic Benefits From the Use of the Asset Versus Ownership of the Asset (e.g., Tax Attributes)

Economic benefits may be obtained directly or indirectly from the asset (e.g., by using, holding, or subleasing the asset) and may include the asset’s primary output and by-products. They may be tangible or intangible (e.g., RECs, as discussed in Section 3.4.1.1.1).

Certain types of underlying assets may provide unique tax benefits or tax attributes to the owner. Often, such tax benefits or tax attributes are provided because a government has decided to incentivize investments in the development of the assets. These benefits or attributes may be critical to a buyer’s investment decision and often economically justify an investment in an otherwise uneconomic asset or technology.

An entity should not consider any tax attributes associated with the ownership of the underlying asset — regardless of whether they arise from investment (e.g., investment tax credits [ITCs]) or the asset’s production (production tax credits [PTCs]) — when evaluating whether a customer has the right to obtain substantially all of the economic benefits from the use of the asset. Some have questioned whether the newly created transferable PTCs could be treated as economic benefits from use of the asset. While we continue to support excluding all tax credits from the evaluation, we understand that diversity may exist with respect to transferable PTCs. For further discussion, see the Connecting the Dots below on tax credit considerations after the transferability feature added by the Inflation Reduction Act.

ASC 842-10-15-17 indicates that economic benefits can be realized from a commercial transaction with a third party. Tax attributes, by nature, cannot be sold separately in a commercial transaction because they are related to the ownership of the asset.

Further, paragraph BC135 of ASU 2016-02 clearly differentiates between economic benefits resulting from use and those resulting from ownership:

[O]nly the economic benefits arising from use of an asset rather than the economic benefits arising from ownership of that asset should be considered when assessing whether a customer has the right to obtain the benefits from use of an asset. A lease does not convey ownership of an underlying asset; it conveys only the right to use that underlying asset . . . . Accordingly, the Board concluded that, when considering whether a contract contains a lease, a customer should not consider economic benefits relating to ownership of an asset (for example, tax benefits as a result of owning an asset). [Emphasis added]

This approach is consistent with how outputs are determined under ASC 840-10-15-6 and therefore is not expected to change practice upon the adoption of ASU 2016-02.

Connecting the Dots

Identifying Intangible Economic Benefits From Use

Section 3.4.1.1.1 clarifies the view that intangible benefits (or outputs) can be economic benefits from use of the asset as long as the intangible benefits (or outputs) can be realized from a commercial transaction with a third party. Further, Section 3.4.1.1.2 clearly differentiates between economic benefits from use of the asset and economic benefits from ownership of the asset. However, in practice, entities in various industries have raised questions about which intangible benefits (outputs) constitute “economic benefits from use of the asset.”

Specifically, in various scenarios, either the supplier or the customer may assert that a contract is not, or does not contain, a lease on the basis that the supplier is obtaining more than an insignificant portion of the economic benefits from use of the asset because it retains certain intangible benefits. As noted in this section, ASC 842-10-15-17 appears to create a broad concept for what may be considered economic benefits from use. Entities in these scenarios rely on that broad concept to include intangible benefits in the analysis and thus to conclude that the customer does not obtain substantially all of the economic benefits from use.

Examples of intangible benefits (or outputs) that we have seen characterized as economic benefits from use include, but are not limited to, the following:

Advertising rights or benefits that are associated with the display of a brand or image on the asset or are based on the asset’s use (e.g., advertising space on a professional race car).
Data captured by the asset about how it is used. For instance, data may be sent back to an automaker by using certain smart technology installed in a new car model. Examples of such data may include information about customer demographics, GPS information showing where the customer drives, accident information, frequency of use, or time of use.
Data generated by the asset regarding the health and function of the larger network of PP&E to which the asset is connected (e.g., data sent back by a utility meter connected to a ratepayer’s home about the speed and quality of electricity moving from the distribution line).
Remote access capabilities of the supplier so that the supplier may minimize the deployment of field technicians to diagnose and repair the asset (e.g., the supplier can log into a printer remotely, through the Internet, to troubleshoot a printer at a customer site that is not functioning properly).

At this time, stakeholders continue to consider whether certain intangible benefits (or outputs) — including those above — represent economic benefits from use. The more economic benefits from use there are for a particular underlying asset, the greater the likelihood that a supplier or customer may conclude that the customer does not obtain substantially all of the economic benefits from use of that asset. Entities that are involved in these types of arrangements should consult with their accounting advisers and monitor developments on the topic.

We think that it would be helpful for entities to consider the following questions when evaluating whether such intangible benefits (or outputs) are economic benefits from use (i.e., in determining whether such benefits have substance):

Are the benefits (or outputs) created by — or do they result from — the use of the PP&E? That is, can it be confirmed that they are not benefits solely associated with ownership of the asset?
Can the benefits (or outputs) from use be realized in a commercial transaction with a third party?
Is the generation or creation of the benefits (or outputs) passive? That is, if the customer is not actively using the asset, is the benefit still created in such a way that the benefit may not depend on the use of the asset?
How may the benefit (or output) be realized? If the benefit can only be realized by the supplier in the form of cost savings, the benefit (or output) may not be an economic benefit from use.

If such intangible benefits (or outputs) are determined to be economic benefits from use, an entity will also need to (1) identify which parties obtain the benefit(s) and (2) determine whether the amount of benefits obtained by parties other than the customer is sufficient to conclude that the customer does not obtain substantially all of the economic benefits from use of the asset. In performing the latter assessment, an entity may need to quantify the amount of benefits received by the parties in cases in which intangible benefits (or outputs) are identified. See Section 3.4.1.3 for detailed discussion.

Economic Benefits Under ASC 842 — Tax Credit Considerations Based on Transferability Feature Introduced by the Inflation Reduction Act of 2022

Tax benefits, including ITCs and PTCs, are prevalent in various industries and are often critical to the economics of the underlying project (e.g., a solar or wind farm). An ITC is a percentage-based tax credit based on the installed cost of a qualifying facility, while a PTC is based on productive output, offering credit linked to measurable electric output from a qualifying facility.

Historically, under both ASC 840 and ASC 842, tax credits available to owners of PP&E have not been considered in the evaluation of whether an arrangement contains a lease. Under ASC 840, an entity did not consider tax credits to be an “output” when assessing whether a customer obtained or controlled substantially all of the output or utility expected to be produced or generated by the PP&E. The treatment under ASC 840 was based, in part, on legacy discussions with the FASB and the SEC, which indicated that tax attributes are different from other intangible by-products of production (e.g., renewable energy credits or RECs) and should not affect the lease evaluation. ASC 842-10-15-17 states that the“economic benefits from use of an asset include its primary output and by-products (including potential cash flows derived from these items) and other economic benefits from using the asset that could be realized from a commercial transaction with a third party.” Upon public-company adoption of ASC 842, this definition effectively carried forward the legacy ASC 840 treatment of tax credits since, at the time, all tax credits had to be claimed on the owner’s tax return to be realized. That is, the tax credits were not a benefit from using the asset that could be realized in a commercial transaction with a third party.

In 2022, the Inflation Reduction Act introduced a transferability feature that allows for the one-time sale of eligible tax credits (including both ITCs and PTCs) to a third party that then uses the credits in its federal tax return to reduce its income tax liability. Because of this feature, questions have arisen about whether transferable PTCs should be viewed as economic benefits from using the asset under ASC 842. The focus has been on transferable PTCs since those credits are linked directly to production and therefore depend on asset usage. This issue can have significant accounting implications given the value of the tax credits in the context of overall project value.

As of the date of this publication, we do not believe that entities are required to view transferable tax credits as economic benefits from using the asset, irrespective of whether the credits are associated with developing and placing the asset in service (ITCs) or are based on production (PTCs). This view applies to both parties in an arrangement that involves qualifying PP&E.

On the basis of our discussions with entities in the power and utilities industry, we understand that a consensus on this issue has not yet been reached and, accordingly, that diversity in practice most likely already exists. Companies that believe transferable tax credits should be identified as an economic benefit from using the related asset are encouraged to consult with their auditors or accounting advisers.

3.4.1.2 Identifying Which Economic Benefits From Use Are Within the Scope of the Customer’s Right to Use the Asset in the Contract

Once the parties to the arrangement identify, on the basis of the nature of the asset, all of the economic benefits from use of the asset, they must identify which of those benefits are within the scope of the customer’s right to use the asset in the contract. These economic benefits are subject to the “substantially all” criterion in ASC 842-10-15-4(a) (see Section 3.4.1.3 for detailed discussion).

ASC 842-10

15-18 When assessing the right to obtain substantially all of the economic benefits from use of an asset, an entity shall consider the economic benefits that result from use of the asset within the defined scope of a customer’s right to use the asset in the contract (see paragraph 842-10-15-23). For example:

If a contract limits the use of a motor vehicle to only one particular territory during the period of use, an entity shall consider only the economic benefits from use of the motor vehicle within that territory and not beyond.
If a contract specifies that a customer can drive a motor vehicle only up to a particular number of miles during the period of use, an entity shall consider only the economic benefits from use of the motor vehicle for the permitted mileage and not beyond.

The graphic above illustrates the example in ASC 842-10-15-18(b). In this example, the supplier’s and customer’s assessments take into account the economic benefits related to only the mileage the contract permits the customer to drive a motor vehicle “during the period of use” (represented by the blue area of the circle to the left) and not the entire mileage that the vehicle may be driven on the basis of the nature of the asset (represented by the entire circle). This makes sense in light of the first paragraph of ASC 842-10-15-18, which indicates that, of the universe of economic benefits derived from the use of the underlying asset — identified in accordance with ASC 842-10-15-17 (and Section 3.4.1.1) — parties to the arrangement should only consider benefits that are within the scope of the customer’s right to use the asset in the contract. ASC 842-10-15-18 points readers to ASC 842-10-15-23 (discussed in Section 3.4.2.2) for guidance on determining the scope of the customer’s right to use the asset in the contract.

Generally, the scope of the customer’s right to use the asset will be limited by the supplier’s protective rights. With respect to the example in ASC 842-10-15-18(b), the supplier may limit the number of miles that the customer may drive the leased vehicle during the period of use so that the supplier may better protect its interest in the residual asset. The supplier’s protective rights, in this case, help ensure that the supplier can market the residual asset for a minimum value to third parties after the conclusion of the customer’s lease.

The supplier’s protective rights do not prevent the customer from obtaining substantially all of the economic benefits from use of the asset because the “substantially all” assessment is performed with respect to the economic benefits that are within the scope that is bound by those protective rights. Any economic benefits that can only be realized by going “beyond” the scope of the customer’s right to use the asset in the contract are not obtained by any party to the arrangement during the period of use.

3.4.1.3 Obtaining Substantially All of the Economic Benefits From Use

Once an entity has identified the economic benefits from use that are within the scope of the contract, the parties to the arrangement must determine whether the customer obtains substantially all of them. ASC 842-10-15-4(a) states that, to have “the right to control the use of an identified asset,” the customer must have the “right to obtain substantially all of the economic benefits from use.”

Although ASC 842 does not define “substantially all,” it uses the term frequently. The term is used, for instance, in the context of (1) whether a capacity portion of a larger asset is an identified asset (see Section 3.3.2 for detailed discussion of portions of assets and whether they are identified assets) and (2) the lease classification test (i.e., determining whether the present value of the lease payments represents substantially all of the fair value of the underlying asset).

Paragraph BC73 of ASU 2016-02 indicates that entities should be allowed to use a 90 percent threshold in determining whether the “substantially all” criterion is met in the lease classification test:

Nevertheless, the Board understands that entities need to ensure the leases guidance is operational in a scalable manner, which often requires the establishment of internal accounting policies and controls. As a result, the Board included implementation guidance in Topic 842 that states that one reasonable application of the lease classification guidance in that Topic is to conclude, consistent with previous GAAP, that . . . 90 percent or greater is “substantially all” the fair value of the underlying asset.

Likewise, we think that 90 percent should generally be used to determine whether the customer has the right to obtain substantially all of the economic benefits from use. Accordingly, if the customer has the right to obtain 90 percent or more of the economic benefits from use of the identified asset, it has met the “substantially all” criterion in ASC 842-10-15-4(a). Companies should consult with their auditors, accounting advisers, or both if they are considering the use of a different percentage threshold for this purpose.

This is consistent with interpretations of the condition in ASC 840-10-15-6(c), under which control is defined on the basis of only economics (see the Changing Lanes discussion in Section 3.4). That is, the language “it is remote that one or more parties other than the purchaser will take more than a minor amount” in ASC 840-10-15-6(c) is generally interpreted as meaning that another party will not take more than 10 percent, which is consistent with the customer’s taking 90 percent.

Example 3-17

Outsourcing Arrangement for Basketballs

Customer X enters into a contract with Supplier Y to purchase a particular size, type, quality, and quantity of basketball over a four-year period. Supplier Y has only one factory that can meet X’s needs and is unable to supply the basketballs from another factory or source them from a third-party supplier. Because Y does not have the practical ability to source the basketballs from another facility, the facility is implicitly identified in the contract.

Case A — Capacity of the Factory Exceeds the Output for Which the Customer Has Contracted

Assume that the capacity of the factory exceeds the output for which X has contracted in such a way that X only has rights to 75 percent of the capacity of the factory. In addition, Y can use the factory to manufacture basketballs for other customers. In this case, X does not have the right to obtain substantially all of the economic benefits from the use of the factory because Y can use the factory to fulfill its obligations under contracts with other customers (i.e., thereby retaining 25 percent of the economic benefits). Accordingly, X does not have the right to control the use of the facility and the contract does not contain a lease.

Case B — Output for Which the Customer Has Contracted Represents Substantially All of the Capacity of the Factory

In this case, assume that the factory was specifically designed to manufacture basketballs for X and that Y is practically limited from using the facility to manufacture any other products for any other customers. Because the factory can only be used to manufacture basketballs for X, X has the right to obtain substantially all of the economic benefits from the use of the factory. To determine whether the contract contains a lease, the parties should evaluate whether X has the right to direct the use of the factory. See Section 3.4.2 for additional information on the right to direct the use of an identified asset.

In accordance with ASC 842-10-15-4(a) and ASC 842-10-15-17 for a contract to be or contain a lease, the customer must have the right to obtain substantially all of the economic benefits from use of the asset. As discussed above, “substantially all” in this context is generally interpreted as referring to 90 percent or more of the economic benefits from use.

An entity does not necessarily have to perform a quantitative analysis to conclude that the customer has the right to obtain 90 percent or more (i.e., substantially all) of the economic benefits from use, since ASC 842 does not require such an analysis in all circumstances. If the contractual terms and conditions, as well as the related facts and circumstances, are clear on whether the customer has the right to obtain substantially all of the economic benefits from use, a quantitative analysis is not needed.

However, when it is not qualitatively clear whether the customer has the right to obtain substantially all of the economic benefits from use, a quantitative analysis may be required. We think that a quantitative analysis of the economic benefits from use might be necessary in the following situations (not all-inclusive):

The identified economic benefits from use include intangible benefits (or outputs), and those intangible benefits could be more than insignificant. (See Section 3.4.1 for more information about intangible economic benefits.) Because of the intangible nature of such benefits, a qualitative assessment alone may be insufficient for determining whether they are more than insignificant.
The economic benefits from use include by-products or co-products that may be transacted with third parties.

When economic benefits from use, including by-products or co-products, can be transacted in a secondary market with third parties, a quantitative analysis may be easier to perform. In such situations, market pricing may be both (1) readily accessible and (2) used by the parties to the arrangement in their negotiations and economic decision-making related to entering into, or not entering into, the arrangement.

Example 3-18

Sale of Energy and Renewable Energy Credits Produced by a Solar Facility

Off-Taker U enters into a PPA with Supplier G to purchase 100 percent of the electricity produced by a solar facility for 20 years. Supplier G owns the solar facility. Off-Taker U will pay $40 per unit of electricity produced.

Besides electricity, the solar facility produces one REC for every unit of electricity produced. Supplier G has separately entered into two contracts to sell RECs produced by the solar facility to third parties: 25 percent of the RECs produced are sold to Polluter A for 20 years, and 50 percent of the RECs produced are sold to Polluter B for 20 years. Supplier G retains 25 percent of the RECs produced, either for its own account or to sell in the spot market to other market participants.

Off-Taker U and G determine that if the PPA had also included the purchase of 100 percent of the RECs, G would have charged a bundled price of $50 per unit of electricity produced.

Although U has the right to obtain 100 percent of the electricity produced by the solar facility, a minimum of three additional parties have the right to obtain the RECs produced by the solar facility. As discussed in Section 3.4.1.1.1, both the electricity and the RECs are economic benefits from use of the solar facility.

On the basis of the stand-alone value of the RECs and the electricity, U and G determine that the RECs represent more than an insignificant portion of the economic benefits from use of the solar facility. Accordingly, U does not have the right to obtain substantially all of the economic benefits from use. The PPA neither is, nor does it contain, a lease for either party to the arrangement.

Connecting the Dots

Contracts in Which the Customer’s Rights to Economic Benefits Change

It is common in off-take or other supply arrangements for the economic benefits obtained by the customer to change or fluctuate, contractually, throughout the period of use. For example, a customer may obtain 100 percent of the widget-production capacity at a manufacturing facility for the first five years and then 50 percent of the widget-production capacity at that facility for the next five years. Alternatively, for an asset with a primary output and a by-product (both of which are identified as economic benefits from use), a customer may obtain 100 percent of the primary output throughout the period of use but only 50 percent of the by-product in the first five years. Questions have arisen about the period over which economic benefits should be assessed in such situations (e.g., over the full period of use, on a yearly basis, on a monthly basis).

Example 3-19

Assume that W through Z below are supply arrangements in which the contracts provide for a mix of goods that change over time and result in the customer’s obtaining the following percentage of economic benefits by year of the contract:2

Two views have emerged regarding how to assess the economic benefits in W through Z.

View A

Description

According to this view, an entity first assesses the period of use (see Section 3.5) and then determines whether the customer has substantially all of the economic benefits from use of the asset on the basis of that period. This view is based on a literal reading of ASC 842-10-15-4, which states, in part:

To determine whether a contract conveys the right to control the use of an identified asset . . . for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following:

The right to obtain substantially all of the economic benefits from use of the identified asset . . . . [Emphasis added]

In other words, View A places significant weight on the order in which the words in ASC 842-10-15-4 are written and thus suggests that an assessment of the period of use must come first.

Outcomes

View A would result in a conclusion that the customer, in each of W through Z, does not obtain substantially all of the economic benefits from use of the asset. This is because, on an aggregate basis over all 10 years, the customer does not obtain at least 90 percent (i.e., substantially all) of the economic benefits from use of the asset during the period of use. The period of use is 10 years according to this view because, as indicated in ASC 842-10-20, that is the “total period of time that an asset is used to fulfill a contract with a customer (including the sum of any nonconsecutive periods of time).”

View A is consistent with application of the guidance in ASC 840-10-15-6(c).

Shortcomings

View A potentially opens up structuring opportunities for parties to an arrangement to avoid identifying a lease. That is, in applying View A, the parties to an arrangement could avoid lease accounting by tacking on nonsubstantive periods at the end of the contract term so that the customer obtains a low percentage of the economic benefits from use.

However, some proponents of View A acknowledge that the assessment would need to contain an anti-abuse override under which, for example, the parties to an arrangement have a disincentive to structure contracts to look like X in the example above. Depending on the facts and circumstances, some proponents of View A may conclude that if there is an anti-abuse override, the period of use in X is eight years in the assessment of the economic benefits from use.

View B

Description

According to this view, an entity looks to the assessment of whether the customer has substantially all of the economic benefits from use of the asset to determine what the period of use is. This view is based on the guidance in ASC 842-10-15-5, which states the following:

If the customer has the right to control the use of an identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term. [Emphasis added]

View B is also an interpretation of the order in which the assessments should be performed that minimizes (as compared with View A) opportunities for parties to an arrangement to use structuring to avoid identifying a lease (i.e., for lessees to avoid recognizing lease assets and lease liabilities).

Outcomes

With respect to identifying the period of use, View B would result in bifurcation of the contract term into the periods during which the customer obtains at least 90 percent (i.e., substantially all) of the economic benefits from use of the asset. Effectively, according to View B, (1) the period of use is more closely aligned with the period during which the customer gets the benefits from use and (2) the period of use, as defined above and in ASC 842-10-20, may include nonconsecutive periods.

On the basis of this view, the customer obtains substantially all of the economic benefits from use during the following periods:

W: Years 3–10.
X: Years 1–8.
Y: Years 2, 4, 6, 8, and 10.
Z: Years 1–2, 4–5, and 7–8.

Accordingly, for each of W through Z, the parties to the arrangement would incorporate the periods identified above into the assessment to determine whether the customer has the right to direct the use of the asset during those periods.

Shortcomings

View B could create challenges related to applying the lessee and lessor accounting models (e.g., if Y is determined to be an operating lease, it would be more complex to determine how to recognize lease expense or lease income on a straight-line basis over nonconsecutive periods). See Section 8.4.3.4 and Chapter 9 for detailed discussion of lessee and lessor accounting, respectively.

In addition, the supply arrangements W through Z above focus on economic-benefit percentages determined annually. However, proponents of View B acknowledge that there is no basis in ASC 842 for saying that the annual level is the correct and lowest level at which the assessment should be performed. For example, if the customer can further break down the percentages of economic benefits on the basis of months, days, or even hours, there could be further bifurcation of the period of use into nonconsecutive periods. Accordingly, if the arrangement is determined to be a lease, the assessment and subsequent accounting would become more complex.

Next Steps

The issue, as well as the views, continue to evolve. Companies involved in these types of arrangements should consult with their accounting advisers and monitor developments on the topic.

3.4.1.3.1 Portion of Cash Flows Derived From Use Paid to Supplier or Third Party

ASC 842-10

15-19 If a contract requires a customer to pay the supplier or another party a portion of the cash flows derived from use of an asset as consideration, those cash flows paid as consideration shall be considered to be part of the economic benefits that the customer obtains from use of the asset. For example, if a customer is required to pay the supplier a percentage of sales from use of retail space as consideration for that use, that requirement does not prevent the customer from having the right to obtain substantially all of the economic benefits from use of the retail space. That is because the cash flows arising from those sales are considered to be economic benefits that the customer obtains from use of the retail space, a portion of which it then pays to the supplier as consideration for the right to use that space.

ASC 842-10-15-19 clarifies that cash flows derived from the use of the asset are economic benefits from use, even if a portion of those cash flows is paid to the supplier in the form of (variable) lease payments. That is, the cash flow structure in the contract should not dictate which cash flows derived from use are considered economic benefits from use or which party obtains those benefits.

In other words, a supplier generally prices a contract — and charges the customer — to earn a return of and on its investment in the underlying PP&E. It may structure the cash flows it must receive to earn that return in a number of ways. In the example in ASC 842-10-15-19, the supplier structures the cash flows to share in the customer’s benefits from using the PP&E (i.e., to share in the upside). Alternatively, it could have forecasted the customer’s sales and derived a fixed payment to achieve what is effectively the same result. In either case, the supplier would have designed the payment terms to achieve a necessary return.

Accordingly, whether the consideration in the arrangement is based on the customer’s performance in using the asset or on a fixed basis (or some other variable basis) should not affect the assessment of whether the customer obtains substantially all of the economic benefits from use. Example 4 in ASC 842 (ASC 842-10-55-63 through 55-71, reproduced in Section 3.7.4) illustrates this notion.

3.4.2 Right to Direct the Use

In accordance with the definition of a lease — and the concept of control — in ASC 842, the customer must have the right to direct the use of the PP&E throughout the period of use. This is the “power” element of the control concept, as discussed in Section 3.4. It is an important piece of the concept because a customer would not agree to pay for a right to use PP&E unless it could actually exercise that right and direct how it uses the PP&E.

ASC 842-10

15-20 A customer has the right to direct the use of an identified asset throughout the period of use in either of the following situations:

The customer has the right to direct how and for what purpose the asset is used throughout the period of use (as described in paragraphs 842-10-15-24 through 15-26).
The relevant decisions about how and for what purpose the asset is used are predetermined (see paragraph 842-10-15-21) and at least one of the following conditions exists:
1. The customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use without the supplier having the right to change those operating instructions.
2. The customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

A customer has the right to direct the use of an asset if it can determine HAFWP that asset is used throughout the period of use. The extent to which the customer directs HAFWP the asset is used will depend on whether the contract grants the customer decision-making rights over that asset. Therefore, a customer should (1) identify the decision-making rights that most affect HAFWP the asset is used during the period of use (i.e., which decision-making rights most affect the economic benefits from use of the asset) and (2) determine which party controls those rights.

In many cases, it is relatively simple to determine whether the customer has the right to direct the use of the PP&E. For example, in a lease of an office building, it is likely to be clear that the customer has the right to direct HAFWP the office building is used throughout the period of use.

However, in other situations, the assessment may be more complex. When neither party to the arrangement (i.e., neither the supplier nor the customer) controls the decision-making rights that most affect HAFWP the asset is used throughout the period of use, then HAFWP the asset is used throughout the period of use may be predetermined. In those situations, the customer only directs the use of the asset when it either (1) operates the asset throughout the period of use or (2) designed the asset so that HAFWP the asset is used throughout that period is predetermined. Alternatively, when neither party controls the decision-making rights that most affect HAFWP the asset is used throughout the period of use, then power over those rights may be shared between the supplier and the customer.

The decision tree below illustrates the process an entity should consider when determining whether the customer has the right to direct the use of the PP&E.

See Section 3.4.2.4 for further discussion of when power over the decision-making rights related to HAFWP PP&E is used throughout the period of use is shared.

As noted in Section 3.2.1, the determination of whether the customer has the right to direct the use of the asset is generally a two-step process:

Evaluate whether the customer or the supplier has the right to direct HAFWP the asset is used throughout the period of use.
If no party has the right to direct HAFWP the asset is used throughout the period of use, HAFWP the asset is used throughout that period may be predetermined. In such cases, an entity evaluates whether the customer (1) can operate the asset or (2) designed the asset in a manner that predetermined HAFWP the asset is used throughout the period of use. (However, if no party has the right to direct HAFWP the asset is used throughout the period of use, an entity may need to consider whether power over that right is shared.)

The remainder of this section addresses the above decision tree in greater detail.

3.4.2.1 How and for What Purpose the Asset Is Used Throughout the Period of Use

ASC 842-10

15-24 A customer has the right to direct how and for what purpose an asset is used throughout the period of use if, within the scope of its right of use defined in the contract, it can change how and for what purpose the asset is used throughout that period. In making this assessment, an entity considers the decision-making rights that are most relevant to changing how and for what purpose an asset is used throughout the period of use. Decision-making rights are relevant when they affect the economic benefits to be derived from use. The decision-making rights that are most relevant are likely to be different for different contracts, depending on the nature of the asset and the terms and conditions of the contract.

15-25 Examples of decision-making rights that, depending on the circumstances, grant the right to direct how and for what purpose an asset is used, within the defined scope of the customer’s right of use, include the following:

The right to change the type of output that is produced by the asset (for example, deciding whether to use a shipping container to transport goods or for storage, or deciding on the mix of products sold from a retail unit)
The right to change when the output is produced (for example, deciding when an item of machinery or a power plant will be used)
The right to change where the output is produced (for example, deciding on the destination of a truck or a ship or deciding where a piece of equipment is used or deployed)
The right to change whether the output is produced and the quantity of that output (for example, deciding whether to produce energy from a power plant and how much energy to produce from that power plant).

15-26 Examples of decision-making rights that do not grant the right to direct how and for what purpose an asset is used include rights that are limited to operating or maintaining the asset. Although rights such as those to operate or maintain an asset often are essential to the efficient use of an asset, they are not rights to direct how and for what purpose the asset is used and often are dependent on the decisions about how and for what purpose the asset is used. Such rights (that is, to operate or maintain the asset) can be held by the customer or the supplier. The supplier often holds those rights to protect its investment in the asset. However, rights to operate an asset may grant the customer the right to direct the use of the asset if the relevant decisions about how and for what purpose the asset is used are predetermined (see paragraph 842-10-15-20(b)(1)).

As noted above in ASC 842-10-15-24, a customer can direct HAFWP an asset is used throughout the period of use (and thus meets the criterion in ASC 842-10-15-20(a)) when the customer has “decision-making rights that are most relevant to changing [HAFWP] an asset is used” throughout that period. The most relevant decision-making rights are those that can affect the economic benefits that result from use of the asset (i.e., there is a direct link between the “power” and “economics” elements of the right to control the use of the asset, as discussed in Section 3.4). Paragraph BC137 of ASU 2016-02 clarifies that those are the decision-making rights that are most important to determining whether the customer has the right to control the use of the asset.

Paragraph BC137 of ASU 2016-02 also clarifies that HAFWP is a “single concept.” That is, parties to the arrangement should not assess how an asset is used separately from the asset’s intended purpose in the arrangement. Decision-making rights that affect the economic benefits derived from the use of an asset will differ depending on the nature of the asset. However, ASC 842-10-15-25 gives the following common examples of decision-making rights that affect the economic benefits derived from the use of the asset and, therefore, that govern HAFWP an asset is used:

The customer’s ability to change what type and amount of output the asset produces (e.g., the type of widget — widget X or widget Y — the PP&E produces and the volume of each).
The customer’s right to change when the asset is used (e.g., when the PP&E produces widget X).
The customer’s ability to change where the asset is used (e.g., where a truck delivers goods).
The customer’s right to change whether the asset is used (e.g., whether PP&E is operating to produce widgets and how many widgets the PP&E produces when it does operate).

In paragraph BC137 of ASU 2016-02, the Board observes that “decisions about how and for what purpose an asset is used can be viewed as similar to considering the decisions made by a board of directors when assessing control of an entity.” Specifically, under the consolidation guidance, the choices made in the execution of — or the actions taken to carry out — the decisions made by a board of directors are subordinate to the decisions themselves. Therefore, the control analysis in the consolidation guidance focuses on the power of the board to direct the most significant activities of the entity, not on who may determine how to execute those significant activities.

Similarly, ASC 842 focuses on which party may make decisions about HAFWP an asset is used throughout the period of use. The execution of (i.e., the operation and maintenance activities related to) a party’s decisions about HAFWP an asset is used is subordinate. Accordingly, ASC 842-10-15-26 clarifies that any rights to determine how the asset will be operated or maintained during the period of use are subordinate to decision-making rights about HAFWP an asset is used throughout the period of use. Further, paragraph BC137 of ASU 2016-02 notes, for instance, that “a supplier’s operational decisions would have no effect on the economic benefits derived from use of an asset if the customer decides that the asset should not be used.” Therefore, while operation and maintenance decisions are essential to ensuring the efficient use of the asset, they are subject to, and can be overridden by, the rights to change HAFWP the asset is used.

The graphic below illustrates this notion.

Connecting the Dots

Differentiating Between Rights Over Operation and Decisions About HAFWP an Asset Is Used

Paragraph BC137 of ASU 2016-02 explains that rights related to the operation and maintenance of an asset are subordinate to decision-making rights associated with HAFWP that asset is used:

In the Board’s view, the decisions about how and for what purpose an asset is used are more important in determining control of the use of an asset than other decisions to be made about use, including decisions about operating and maintaining the asset. That is because decisions about how and for what purpose an asset is used determine how and what economic benefits are derived from use.

In addition, rights over operation and maintenance are rights that are both (1) essential to the efficient use of the asset and (2) potentially protective if they are held by the supplier (i.e., because they would allow the supplier to ensure operation and maintenance practices that would protect the supplier’s investment in the asset). Therefore, it may be helpful to view rights over operation and maintenance as those that are most likely to have smaller effects on the operating margins (or the net cash flows) derived from using the asset.

By holding operation rights, the supplier may be able to lower the costs of operating the asset on the basis of its experiences in operating that asset and similar types of assets. For example, assume that a supplier knows which route is quickest when driving a delivery truck from Minneapolis to Milwaukee and therefore is able to minimize fuel costs. If the customer in this example holds decision-making rights related to when the route from Minneapolis to Milwaukee will be driven but decides not to exercise that right, no economic benefits (i.e., cash flows) will be derived. That is, the supplier’s right to choose the quickest route and thus lower operating costs is contingent on (subordinate to) the customer’s decisions.

The above example illustrates the difference between (1) the rights to operate an asset and (2) decision-making rights related to HAFWP an asset is used. That is, the latter rights have significantly more influence over the economic benefits to be derived from using the asset and, therefore, the former rights are subordinate to the latter.

Also illustrated above is another way in which the power notion in ASC 842 differs from that in the consolidation guidance in ASC 810. The party that controls operation and maintenance has power under ASC 810 in circumstances in which (1) there are ongoing operation and maintenance decisions to be made for a legal entity and (2) it is determined that those decisions reflect the activities that most significantly affect the economic performance of the legal entity. However, under ASC 842, the supplier’s control of operation and maintenance decisions may not prevent the customer from having the right to direct the use of the underlying asset throughout the period of use. Further, ASC 842 requires that when HAFWP the asset is used throughout the period of use is predetermined and the supplier controls operation and maintenance decisions, the analysis must take into account whether the customer designed the asset (see Section 3.4.2.3.2 for further discussion of design).

3.4.2.1.1 Dispatch Rights

“Dispatch rights” are rights that may be granted to a customer in an arrangement to direct the asset to be used for its intended purpose. In the power and utilities industry, such rights are common and may be granted to an off-taker (i.e., the customer) in a PPA to allow the off-taker to tell a power plant owner and operator whether to use the plant to produce electricity, when to use the plant to produce electricity, and what amount of electricity to produce.

However, dispatch rights can refer to similar rights associated with any type of asset. For example, an emergency services operator that is outsourcing to a third party can dispatch an ambulance or helicopter owned by the third party to provide the services. In addition, a customer in a manufacturing supply arrangement may have dispatch rights in connection with a widget factory (or a discrete manufacturing line within that factory) such that it can tell the owner and operator of the factory whether to produce widgets and how many widgets to produce.

Dispatch rights, when granted to the customer in an arrangement, generally convey the right to direct HAFWP an asset is used. Such rights allow the customer in an arrangement to change whether, when, and to what extent an asset is used, which generally are the decision-making rights that most affect the economic benefits to be derived from the asset’s use and thus represent the rights to determine HAFWP the asset is used throughout the period of use. Therefore, in accordance with ASC 842-10-15-24 through 15-26 and the Connecting the Dots discussion above, dispatch rights would override any rights of the asset’s owner to operate and maintain the asset. Example 9, Case C, in ASC 842-10-55-117 through 55-123 (reproduced in Section 3.7.9) illustrates the use of dispatch rights in a PPA.

In some industries, dispatch rights may be conveyed through another right (e.g., an effective dispatch right). For example, in some markets in the power and utilities industry, dispatch decisions are ultimately made by an independent system operator on the basis of a consideration of bid prices and any transmission system constraints (i.e., if there are no constraints, generating units will be dispatched economically by accepting the lowest bids first); therefore, in such cases, neither the owner nor the off-taker can mandate physical production. While the bid-in process in the power and utilities industry is not entirely the same as a dispatch right held by a customer as described above, companies should consider whether control over the bidding process in such scenarios conveys to the customer the right to direct HAFWP the asset is used, since that is the right an owner would normally exercise in these markets to influence whether, when, and to what extent the owner’s asset is used.

In a tolling arrangement, the right to provide the inputs the asset needs to produce outputs may also constitute an effective dispatch right. When a customer obtains a tolling right in an arrangement, the asset may generally only produce outputs when the customer provides the inputs that the asset needs to convert those inputs to a refined or finished product (i.e., the asset produces outputs upon the receipt of the necessary inputs). Further, the asset will generally only produce to the extent of the inputs provided; that is, the amount of outputs the asset produces is a function of the amount of inputs provided and the efficiency of the asset in converting those inputs. Therefore, in tolling arrangements, the customer will generally control the rights that most affect the economic benefits to be derived from the asset’s use — and thus the right to direct HAFWP the asset is used — by virtue of the customer’s right to provide the inputs and request conversion to outputs. Tolling arrangements are found not only in the power and utilities industry but also in basic manufacturing as well as in the metal, agriculture, and oil and gas industries.

3.4.2.1.2 Applying the Guidance in ASC 842-10-15-24 Through 15-26

The three examples below illustrate the guidance in ASC 842-10-15-24 through 15-26 and the discussion above.

Example 3-20

Exclusive Limousine Service

Customer D, a politician, enters into a contract with Company R, a limousine service provider, for transportation during the four-year term of D’s political assignment. The contract explicitly specifies the VIN of the limousine that will be used to transport D, and R is contractually restricted from substituting the limousine for reasons other than repairs or maintenance. Therefore, the parties have determined that the fulfillment of the contract depends on an identified asset.

The limousine in question is stored on R’s premises when not in use, but R may not use the limousine to transport any other customers during the four-year contract term. In addition, R provides a dedicated driver for the entire four-year contract term. The limousine will be used to transport D to various speaking and charity events according to a schedule that D provides to R on a biweekly basis. However, once the schedule is provided, the dedicated driver — an employee of R — plans the routes to and from each scheduled event.

Customer D has the right to obtain substantially all of the economic benefits from the limousine throughout the four-year period of use because it is the only customer that will be transported in the limousine during that period. In addition, although R is responsible for operating the limousine and has some discretion in route planning, D has the right to direct the use of the limousine because it is responsible for determining whether and, if so, when the limousine will operate and where it will travel.

For these reasons, D has the right to control the use of the limousine and the contract contains a lease.

Example 3-21

Refrigerated Storage Unit

Customer A enters into a contract with Company B for the exclusive use of a refrigerated storage unit for a 15-month period. Company B constructed the storage unit and is responsible for operating and maintaining it. The contract explicitly identifies the storage unit via its serial number, and B is contractually restricted from substituting the refrigerated storage facility during the contract term. Therefore, the parties have determined that the fulfillment of the contract depends on an identified asset.

Throughout the 15-month period of use, A has the right to take products out of, or put them into, the storage unit at any time without B’s consent. However, B controls physical access to the storage unit and only B’s employees are allowed inside; therefore, B is responsible for physically moving the products as A requests.

Customer A has the right to obtain substantially all of the economic benefits from the storage unit throughout the 15-month period of use because of its exclusive use of the storage unit. Although B controls physical access to the storage unit and is responsible for operating it, B does so according to A’s decisions about what products will be stored in the storage unit as well as whether and, if so, when they will be stored. Customer A therefore has the right to direct the use of the storage unit.

Because A obtains substantially all of the economic benefits from the storage unit (an identified asset) and has the right to direct its use, the contract contains a lease.

Example 3-22

Natural Gas Processing Facility

Customer U enters into a three-year contract for the exclusive use of Supplier M’s processing plant. Supplier M agrees to separate “wet” natural gas that U extracts from shale rock formations into its component products of “dry” natural gas and natural gas liquids (e.g., ethane, butane, propane).

The contract explicitly names M’s plant by address. Although M has, at times, contracted to provide varying amounts of capacity to multiple customers simultaneously, U has contracted for 100 percent of the capacity of the plant. This is the only plant M owns that is connected via a pipeline to U’s natural gas wellhead gathering system, so M does not have an alternative plant that it could substitute to fulfill its obligations under the contract. Accordingly, the parties have determined that the fulfillment of the contract depends on an identified asset.

During the three-year contract period, M’s own employees will operate and maintain the plant. Although U never has physical access to the plant, it may provide the wet gas for processing whenever it chooses and will receive 100 percent of all products yielded (i.e., 100 percent of the dry gas and natural gas liquids produced).

Customer U has the right to obtain substantially all of the economic benefits from the processing plant throughout the three-year period of use because it will receive 100 percent of the outputs (i.e., dry gas and natural gas liquids) produced by the plant. Although M is entirely responsible for operating and maintaining the plant, this contract is, in effect, a tolling agreement. That is, U determines whether and, if so, when the plant is used, as well as what amount of output it will produce, by virtue of its right to provide 100 percent of the plant’s inputs. For example, if U does not provide any wet gas, the plant does not produce dry gas and natural gas liquids. Customer U therefore has the right to direct the use of the processing plant.

Because U obtains substantially all of the economic benefits from the processing plant (an identified asset) and has the right to direct its use, the contract contains a lease.

Note that in all three of the above examples, the PP&E is kept on the supplier’s premises but the customer has the right to direct HAFWP the asset is used throughout the period of use. These three examples illustrate that the analysis should focus on the parties’ decision-making rights rather than on the location of the PP&E.

Importantly, while the customer may have the right to direct HAFWP the asset is used throughout the period of use when the asset is kept on the supplier’s premises, the inverse can also be true. That is, as the FASB staff has indicated to us, the supplier may have the right to direct HAFWP the asset is used throughout the period of use even when assets dedicated to the customer are kept on the customer’s premises.

Example 10, Case A, in ASC 842-10-55-124 through 55-126 (reproduced in Section 3.7.10) illustrates this notion, and the Connecting the Dots below discusses it in greater detail.

Connecting the Dots

Assessing Which Party Has the Right to Direct the Use of Dedicated Assets on the Customer’s Premises

We have received a number of questions regarding the outcome of Example 10, Case A, in ASC 842-10-55-124 through 55-126 (reproduced in Section 3.7.10). That example involves a contract for network services under which a telecommunications company (the supplier) installs and configures multiple servers at a customer site to support the customer’s network needs (primarily the storage and transportation of data). During the term of the arrangement, the supplier makes decisions about how to deploy the fleet of servers to satisfy customer requests. Although the arrangement involves dedicated equipment, some of which is maintained on the customer’s premises, the conclusion reached in the example is that the arrangement does not contain a lease since the customer does not (but the supplier does) have the right to direct HAFWP the individual servers are used.

Some may find this outcome counterintuitive since the servers are dedicated solely to the customer for the term of the arrangement. However, the conclusion highlights an important change from ASC 840. Specifically, for a lease to exist under ASC 842, the customer must obtain the right to control the use of the asset(s) in the arrangement and the right to control the use is not limited to having the right to all of the asset’s productive output (one of the circumstances in which an entity could conclude that an arrangement is a lease under ASC 840, as discussed in the Changing Lanes discussion in Section 3.4). Rather, the right to control the use under ASC 842 is determined in a two-part test that focuses on (1) economic benefits and (2) the right to direct the use of the identified asset(s). In the example, the second condition is not met; therefore, the arrangement does not contain a lease.

A number of stakeholders have asked about the key factors related to why the customer in the example does not have the right to direct the use of the servers. For instance, questions have been raised regarding why, if the right to dispatch a power plant (i.e., to tell the owner-operator when to produce electricity — see Section 3.4.2.1.1) conveys to the customer the right to direct the use of the plant (as illustrated in Example 9, Case C, in ASC 842-10-55-117 through 55-123, reproduced in Section 3.7.9), the right to determine when and which data to store or transport by using the network would not likewise convey to the customer the right to direct the use of the underlying servers.

We understand the following regarding the key factors behind the conclusion in Example 10, Case A:

The analysis is focusing on whether each individual server, as opposed to the entire network, is a lease. In the example, the supplier is providing a service (a network of a certain capacity and quality) by using dedicated assets. Therefore, the analysis to determine which party has the right to direct the use of the asset(s) should be performed at the asset level (i.e., at the individual server level).
The consideration of HAFWP the asset is used, as described in ASC 842-10-15-25, likewise focuses on decisions related to each individual server — not the output produced by the overall network.
The scenario involves multiple assets (multiple individual servers), and the supplier retains the discretion to deploy each individual server in whatever manner the supplier decides will best fulfill the overall network service.
Since each server on its own can perform different functions (e.g., storing data, transporting data), the supplier has the right to make meaningful decisions about which server(s) should be used to satisfy a particular customer request.
The customer cannot decide HAFWP each individual server is used and cannot prevent the supplier from making those decisions. The customer’s decisions are limited to how the customer uses the network and do not extend to the individual servers.

We think that these key factors, though they are not all-inclusive, help differentiate the conclusion in Example 10, Case A, from the conclusion in Example 10, Case B, in ASC 842-10-55-127 through 55-130 (reproduced in Section 3.7.10). In Case B, the arrangement involves a single server, and the customer makes the critical decisions about which data to store or transport by using that single server as well as about how (or whether) to integrate that single server into its broader operations. Therefore, we believe that Case B is more analogous than Case A to Example 9, Case C, which involves dispatch rights over a power plant (also a single asset).

Understanding the key distinguishing factors in the above examples should help preparers identify leases under ASC 842. However, the illustrative examples represent an application of the framework to certain stated facts and circumstances. An entity must perform a detailed analysis of its own specific facts and circumstances in such scenarios. We recommend that entities that have questions about their arrangements and whether they should be analyzed in a manner similar to the analysis in Example 10, Case A, should discuss those questions with their auditors or accounting advisers.

3.4.2.1.2.1 Assessing the Right to Direct the Use of Multiple Assets in a Single Arrangement

In an arrangement involving the use of multiple assets, the parties to the arrangement should assess whether the customer has the right to direct the use of those assets. This assessment should be performed at the individual asset level rather than at the asset group level.

As discussed in the Connecting the Dots above, this analysis should focus on decision-making rights related to each of those assets. Feedback received from the FASB and IASB staffs has indicated that this is a key element of the analysis in Example 10, Case A.

This may seem counterintuitive given the order of operations indicated by ASC 842. That is, in accordance with ASC 842-10-15, an entity should first determine whether a contract is or contains a lease before it breaks that contract into its units of account consisting of separate lease (and nonlease) components. (For additional information about separating components in a contract, see Chapter 4.) However, the guidance in ASC 842-10-15-24 through 15-26 continually uses the singular, referring to the right to direct the use of an asset or HAFWP the asset is used.

In addition, the decisions that affect the economic benefits to be derived from use of an asset are most easily identifiable at the level of the individual asset. We think that this will be especially true when each individual asset has multiple functionalities, as in Example 10, Case A (e.g., the supplier, at its discretion, may individually deploy each server for such tasks as filing, e-mail, or printing to provide the customer with a network of a certain capacity and quality). It would follow, then, that the customer has the right to direct HAFWP an asset is used when it has decision-making rights that affect the economic benefits derived from the use of the individual asset.

Example 3-23

Contract for Construction-Related Services

Homebuilder B enters into a contract with Vendor GC to provide demolition and construction services for two years. Under the arrangement, GC will use three pieces of heavy construction equipment — an excavator, a crane, and a skid loader — in the razing of real estate purchased by B and the construction of a new suburban housing development at B’s direction.

Assume that it is clear from the contract that the equipment represents identified assets and that B obtains substantially all of the economic benefits from use of each of these assets.

Each piece of equipment has multiple functionalities. For example, the crane can be used to lift heavy materials when a hook is attached or to raze existing structures when a wrecking ball is attached. Vendor GC’s own employees are deployed to operate the equipment, and B is contractually precluded from operating the equipment itself or from hiring a third party to do so.

Homebuilder B issues instructions to Vendor GC each week with a stated project. For example, B may instruct GC in the first week to raze an existing structure on a northwest parcel of the purchased land and, in the second week, it may instruct GC to lay the foundation for a new home on the southwest parcel of the purchased land.

Vendor GC retains the discretion to deploy each individual piece of equipment in whatever manner it decides will best fulfill the demolition and construction services it is providing to B. For example, to accomplish the first week’s project, GC may choose not to use the skid loader and instead save its fuel; GC may be able to complete the first week’s project solely by using the demolition-related functions of the crane and the excavator. Because each piece of equipment on its own can perform different functions, GC has the right to make meaningful decisions about which pieces of equipment should be used to satisfy each week’s project. Therefore, GC’s decision-making rights go beyond basic decisions about operating and maintaining the equipment.

Homebuilder B cannot decide HAFWP each individual piece of equipment is used to complete each week’s project, and B cannot prevent GC from making those decisions. Homebuilder B’s decisions are limited to how it will use the services provided by GC and do not extend to the individual pieces of equipment.

Accordingly, GC retains the right to direct HAFWP each piece of equipment is used. The contract does not contain a lease.

When an arrangement involves the use of a single asset that is made up of individual component assets (e.g., a power plant with two turbines that is constructed to function as a single asset), the parties to the arrangement should not break the single asset into its individual component assets to assess whether the customer has the right to direct the use of those assets (e.g., the individual turbines). Rather, such an analysis should be performed with respect to the single asset. Because the asset is built or constructed to function as a single asset, the most relevant decision-making rights will be those that affect the economic benefits to be derived from use of the single asset.

For example, it is common in the power and utilities industry for a power plant to contain two or more turbines that produce electricity (in the case of a wind facility, there may be many turbines). Those turbines will generally perform the same function (i.e., producing electricity), and the individual turbines will benefit jointly from the installation of other individual PP&E within the power plant for efficiency purposes (e.g., a single transformer). Because the individual turbines are constructed to be a part of a larger, single asset for the intended use of generating electricity as a single asset, it would be inappropriate to assess the right to direct the use of each individual turbine.

However, if the power plant was constructed to contain two or more turbines, each capable of generating electricity separately, it would be appropriate to assess the right to direct the use of each individual turbine.

These concepts would also apply to a manufacturing facility with multiple manufacturing lines that are constructed to function as a single asset. That is, it would generally be inappropriate to assess the right to direct the use of each manufacturing line separately.

As discussed above, the right to direct HAFWP an asset is used can be complex when the use of the asset is heavily influenced by activities the supplier performs (e.g., in Example 10, Case A, reproduced in Section 3.7.10). The analysis can be equally complex when the use of the asset is heavily influenced by, or depends on, infrastructure that is owned, operated, and controlled by the supplier. Section 3.4.2.1.2.2 and the Connecting the Dots discussion below discuss this complexity with respect to pipeline laterals and the first miles and last miles of tangible, integrated infrastructure systems.

3.4.2.1.2.2 Pipeline Laterals (Right to Control the Use)

Pipelines are generally constructed and operated in sprawling and integrated systems that transport natural gas, oil, and refined products from supply regions to demand regions. Some customers are connected to, and receive deliveries of transported commodities through, the pipeline system via dedicated laterals. In addition, a pipeline system must, by its nature, have starting and ending points. Therefore, other customers may be connected to the pipeline system through effective laterals, because they are connected to the first mile or last mile of the larger pipeline system.

Section 3.3.2.1 explains that laterals and first-mile/last-mile connections are physically distinct portions of the larger pipeline system. Therefore, in transportation agreements, they are identified assets in accordance with ASC 842-10-15-16. Certain of these agreements are firm; accordingly, the customer is guaranteed a certain amount of transportation capacity on the pipeline system and is given priority above other customers that do not have firm rights. At the May 10, 2017, Board meeting, the FASB and its staff discussed whether the customer in a firm transportation agreement has the right to control the use of a pipeline lateral or a first-mile/last-mile connection to the larger pipeline system.

While highlighting that the specific facts and circumstances of each arrangement must be considered, the FASB staff discussed two types of pipeline laterals on the basis of information it obtained via outreach to entities in the midstream oil and gas industry sector:

Type 1 — These “typically are connected to an integrated pipeline system”4 and are the most common type of pipeline laterals. While they cannot operate on their own, they share “supply sources with the main line and other customers.” The pipeline owner retains the ability to change the compression in the lateral to manage pressure in the lateral and on the larger system. Pressure moves commodity within the system, so changing the pressure in the lateral can affect the pressure in the larger system, thus affecting the speed at which other customers’ inventory moves through the system (and the speed at which the pipeline owner is able to provide its transportation services to others). Further, the pipeline owner retains the ability to store its own commodity in the lateral (i.e., line pack). Doing so also manages the pressure in the lateral and on the larger system.

Accordingly, the pipeline owner retains both (1) economic benefits from the asset’s use that are more than insignificant through its rights to store commodity in the lateral and to use the compression in the lateral to manage the pressure in the larger system, even though the customer decides when to receive service and at what volumes, and (2) the right to direct the use of the asset throughout the period of use because of its rights to change when, whether, and to what extent the lateral is used to manage the pipeline owner’s larger system. Depending on the significance of retained rights, the Board agreed with the staff’s analysis that Type 1 pipeline lateral contracts do not contain a lease. Type 1 pipeline laterals are expected to be the most common type.
Type 2 — These laterals “are fully capable of operating using their own dedicated assets,” and “the customer has the right to substantially all the pipeline lateral’s capacity.” The customer is able to close off this type of lateral from the remainder of the pipeline system (by closing a valve or a similar mechanism), thus preventing the pipeline owner from directing the use of the asset. In addition, closing the lateral off from the larger system allows the customer to use the lateral independently from the larger system.

The Board agreed with the staff’s analysis that a lease exists in this case, since the customer has “the right to obtain substantially all the economic benefits . . . and the right to direct the use of the pipeline lateral throughout the period of use.”

The Board agreed with the staff’s analyses, as noted above, and did not believe that any additional standard setting was required at that time.

Connecting the Dots

Right to Direct the Use of Other First-Mile/Last-Mile Assets

As indicated in Section 3.3.2.1, other first-mile/last-mile connections are identified assets in accordance with ASC 842-10-15-16. Therefore, entities must assess whether the customer has the right to control the use of such assets. We think that the FASB’s May 10, 2017, meeting discussion regarding pipeline laterals (see above) is helpful to this assessment.

The above discussion describes two types of pipeline laterals, one of which — Type 2 — can be functionally and tangibly closed off (e.g., by closing a valve or a similar mechanism) from the remainder of the larger pipeline system even though the lateral is not physically disconnected from the system. The Board generally expects that, for Type 2 laterals, the customer therefore will have the right to use the lateral independently from the larger system. The customer will thus have the right to control the use of the lateral, and the related arrangement will contain a lease.

We think that the same analysis can be applied to other types of first-mile/last-mile connections. That is, unless the customer is able to functionally and tangibly close off the first-mile/last-mile asset from the larger system, the customer will be unable to control the use of this asset. In other words, when there is no such “cut-off point,” or when the cut-off point is so near to the customer’s facility that no substantive first-mile/last-mile asset remains after that point, the related arrangement will not contain a lease.

Note that just because an asset is connected to, and requires the use of, a distribution system controlled by the owner of the system, an entity should not automatically conclude that there cannot be a lease. The first-mile/last-mile issues address specific sections or parts of the physical distribution network itself, and we generally do not expect that portions of the larger network will contain leases on the basis of the guidance above. However, arrangements related to assets that are attached to distribution networks (e.g., storage tanks, power plants) may still be identified as leases or as containing leases.

Section 3.3.2.1 includes a list (not all-inclusive) of examples that would be identified assets under the guidance in ASC 842-10-15-16. Our understanding of the most common facts and circumstances, as well as how they are related to the lateral framework discussed above, is as follows:

Electric and telecommunications (i.e., wire and cable that deliver telephone, cable television, and Internet services) — Wires and cables of this nature less commonly function as Type 2 pipeline laterals because (1) they are less likely to have a cut-off point after which the customer has the right to use the wires and cables independently from the larger system and (2) a cut-off point, if one exists, is most likely to be very close to the customer’s facility. While they may not function as Type 1 laterals because the supplier generally cannot use the first-mile/last-mile connection to manage its larger network, the important point is that they rarely function alone, without the assistance of the larger system. Accordingly, we think that it will be rare for the customer to have the right to control the use of first-mile/last-mile connections of electric and telecommunications wires and cables.
Rail — Such first-mile/last-mile connections may more closely function as Type 1 pipeline laterals if the owner of the larger rail network is able to store cars on the first mile/last mile (or miles) that connects to the customer’s facility. However, a rail may also function as a Type 2 lateral if the customer is able to functionally and tangibly close off from the rest of the rail network the portion of track that connects to its facility. In such cases, an entity should carefully consider the relevant facts and circumstances as well as the customer’s and the supplier’s decision-making rights in related arrangements.

3.4.2.1.3 Excluding Predetermined Use

ASC 842-10

15-22 In assessing whether a customer has the right to direct the use of an asset, an entity shall consider only rights to make decisions about the use of the asset during the period of use unless the customer designed the asset (or specific aspects of the asset) in accordance with paragraph 842-10-15-20(b)(2). Consequently, unless that condition exists, an entity shall not consider decisions that are predetermined before the period of use. For example, if a customer is able only to specify the output of an asset before the period of use, the customer does not have the right to direct the use of that asset. The ability to specify the output in a contract before the period of use, without any other decision-making rights relating to the use of the asset, gives a customer the same rights as any customer that purchases goods or services.

An entity should consider only decisions made during the period of use — and not before — in determining whether the customer has the right to direct HAFWP the asset is used throughout the period of use. For example, if the customer’s only decision-making right related to the use of the asset was to specify the amount, type, and quality of output to be produced by the asset as part of negotiating the contract (i.e., before the period of use), the customer cannot direct HAFWP the asset is used throughout the period of use. Example 8 in ASC 842-10-55-100 through 55-107 (reproduced in Section 3.7.8) illustrates a scenario in which the customer’s only right is to specify the output of an identified manufacturing facility.

When considered in this context, the phrase “throughout the period of use” is meant to create a break in the timeline of the use of the asset between (1) the time before the beginning of the period of use (i.e., predetermination) and (2) the time during the period of use (“period of use” is defined in Section 3.5). That is, “throughout the period of use” is synonymous with “during the period of use” in this respect. The FASB further articulated this notion in paragraph BC140 of ASU 2016-02:

Topic 842 clarifies that only decisions made during the period of use (and not before the period of use) should be considered in the control assessment, unless the customer designed the asset in a way that predetermines how and for what purpose the asset will be used. In the Board’s view, if a customer specifies the output from an asset at or before the beginning of the period of use (for example, within the terms of the contract) and cannot change those specifications during the period of use, it generally does not control the use of an asset. In that case, it would have no more decision-making rights than any customer in a typical supply or service contract. [Emphasis added]

Some decisions about HAFWP the asset will be used during the period of use may be predetermined by the nature of the asset. For example, in a lease of real estate, the decisions about where the asset may be used during the period of use are predetermined: real estate is affixed permanently to a unique space on the earth and, thus, no party to the arrangement may make such decisions.

However, even when some decisions about HAFWP the asset will be used during the period of use are predetermined, other significant decision-making rights related to HAFWP the asset will be used can most likely still be made during the period of use (e.g., when the asset is used during the period of use to produce an output that the customer specified before the period of use). Those are the decision-making rights that an entity should consider when assessing which party determines HAFWP the asset is used throughout the period of use.

The diagram below illustrates how significant decision-making rights could be granted in an arrangement. According to the diagram, an entity performing the analysis would focus on which party controls the decision-making rights in the green portion of the circle to determine whether the customer can direct HAFWP the asset is used throughout the period of use.

However, if all decisions about HAFWP the asset will be used throughout the period of use are predetermined and, therefore, no other significant decision-making rights about HAFWP the asset is used can be made during the period of use, the parties to the arrangement would consider whether the customer operates the asset throughout the period of use or designed the asset in a manner that predetermined HAFWP the asset will be used throughout the period of use in accordance with ASC 842-10-15-20(b). See Section 3.4.2.3 for a detailed discussion of those circumstances.

3.4.2.2 Protective Rights Define the Scope of the Contract

ASC 842-10

15-23 A contract may include terms and conditions designed to protect the supplier’s interest in the asset or other assets, to protect its personnel, or to ensure the supplier’s compliance with laws or regulations. These are examples of protective rights. For example, a contract may specify the maximum amount of use of an asset or limit where or when the customer can use the asset, may require a customer to follow particular operating practices, or may require a customer to inform the supplier of changes in how an asset will be used. Protective rights typically define the scope of the customer’s right of use but do not, in isolation, prevent the customer from having the right to direct the use of an asset.

Once entities identify the decision-making rights that are most relevant to changing HAFWP the asset is used throughout the period of use (i.e., the decision-making rights that can affect the economic benefits that result from use of the asset), they must identify which of those decision-making rights are within the scope of the contract. The decision-making rights that are within the scope of the contract are the rights that an entity should consider when determining whether the customer or the supplier has the right to direct HAFWP the asset is used throughout the period of use.

This concept is similar to that discussed in Section 3.4.1.2 with respect to the economic benefits that result from use of the asset. In a manner similar to the discussion for economic benefits, the scope of the contract will generally be limited by protective rights, as indicated in ASC 842-10-15-23.

The diagram in Section 3.4.1.2, therefore, is equally applicable to the determination of which party has the right to direct HAFWP the asset is used throughout the period of use. In that diagram, the economic benefits that are within the scope of the contract are bound by the blue portion of the circle. It would follow, then, that only the decision-making rights that affect those economic benefits should be factored into the analysis of which party has the right to direct HAFWP the asset is used.

Accordingly, in line with the example from ASC 842-10-15-18 and Section 3.4.1.2, it would be inappropriate to conclude that the customer is prevented from directing HAFWP the asset is used on the basis of the fact that the customer does not have all possible rights to decide where and to what extent the vehicle is used (i.e., because the customer does not have the rights to decide to drive the vehicle in all territories and for unlimited miles, respectively). Rather, the analysis would include decision-making rights related to when, whether, where, and to what extent the vehicle is driven, as limited by the protective rights in the contract.

The following examples from ASC 842 illustrate the effect of protective rights on the scope of the contract in the determination of whether the customer has the right to direct HAFWP the asset is used throughout the period of use:

Example 4 in ASC 842-10-55-63 through 55-71 (see Section 3.7.4).
Example 6, Case B, in ASC 842-10-55-85 through 55-91 (see Section 3.7.6).
Example 7 in ASC 842-10-55-92 through 55-99 (see Section 3.7.7).

The example below further illustrates this notion.

Example 3-24

Truck Rental Subject to Certain Restrictions

Customer Bucky enters into a contract with Supplier Badger for the use of a specific truck for a two-year period. Supplier Badger is not permitted to substitute the truck during the contract term. Because the truck is explicitly specified in the contract and Badger does not have a substantive substitution right, the truck represents an identified asset in the contract.

The contract stipulates that Bucky decides whether and, if so, what cargo will be transported; when cargo will be transported; and where (e.g., to which cities) the truck will deliver throughout the period of use. Bucky is required to provide a properly licensed driver and is responsible for the safe delivery of the cargo that is carried. Certain restrictions prohibit Bucky’s driver from using the truck beyond the maximum hours permitted by law or from carrying hazardous materials as cargo. Moreover, the contract prohibits Bucky from driving the truck out of the United States. Therefore, although Bucky has significant demand for its products in Alaska, it is restricted from driving the truck through Canada to get there.

Customer Bucky has the right to control the use of the identified truck for the following reasons:

Although contractual restrictions limit to what extent the truck may be driven (i.e., a maximum number of hours allowable by regulation), where the truck may be driven (i.e., only within the continental United States), and what types of cargo may be transported (i.e., no hazardous cargo), these restrictions represent protective rights that define the scope of the contract.
Because Bucky has exclusive use of the truck, Bucky has the right under the contract to obtain substantially all of the economic benefits from the use of the truck during the period of use.
Within the scope of the contract, Bucky has the right to direct HAFWP the truck is used because it decides whether the truck will be used to transport cargo, what cargo will be transported, when the truck will be driven, and where the truck will be driven.

Because Bucky has the right to control the use of the identified truck throughout the period of use, the contract contains a lease for the truck despite the existence of certain use restrictions to protect the owner’s investment in the truck.

3.4.2.3 How and for What Purpose the Asset Is Used Throughout the Period of Use Is Predetermined

HAFWP the asset is used during the period of use is predetermined when there are no decisions that are available to be made, by either the supplier or the customer, during the period of use about HAFWP the asset is used. In these instances, a “tiebreaker” notion applies under ASC 842. That is, under ASC 842-10-15-20(b), the analysis is forced toward a conclusion that one of the parties to the arrangement must have the right to direct the use of the asset.

When HAFWP the asset is used during the period of use is predetermined, the customer has the right to direct the use of the asset when it either (1) has the right to operate (or to direct others to operate) the asset throughout the period of use without the supplier having the right to change those operating instructions or (2) designed the asset (or the relevant aspects of the asset) in a manner that predetermined HAFWP the asset is used during the period of use.

In paragraph BC139 of ASU 2016-02, the FASB explains that the guidance in ASC 842-10-15-20(b) is intended to identify situations in which the customer, even when it does not have the right to direct HAFWP the asset is used, still has rights beyond those of a customer in a service arrangement:

The approach to determining whether a customer has the right to direct the use of an identified asset changes if the decisions about how and for what purpose an asset is used are predetermined. Topic 842 clarifies that if decisions about how and for what purpose an asset is used are predetermined, a customer can still direct the use of an asset if it has the right to operate the asset, or if it designed the asset in a way that predetermines how and for what purpose the asset will be used. In either of these cases, the customer controls rights of use that extend beyond the rights of a customer in a typical supply or service contract (that is, the customer has rights that extend beyond solely ordering and receiving output from the asset). In those cases, the customer has the right to make (or has made in the case of design) decisions that affect the economic benefits to be derived from use of the asset throughout the period of use.

Accordingly, even though the decisions that are most relevant to changing HAFWP the asset is used may be predetermined, the customer may still be able to make (or may have made) some decisions that affect the economic benefits to be derived from use of the asset. Therefore, it may still obtain control through both the “power” and the “economics” elements.

ASC 842-10

15-21 The relevant decisions about how and for what purpose an asset is used can be predetermined in a number of ways. For example, the relevant decisions can be predetermined by the design of the asset or by contractual restrictions on the use of the asset.

As explained in ASC 842-10-15-21, HAFWP an asset is used during the period of use may be predetermined through the following:

Design — The design of the asset may predetermine where, when, whether, to what extent, and for what type of output the asset is used. In addition, the nature of the asset will often play a role. For example, the design of a wind farm predetermines where (wherever it is installed) and for what type of output (electricity) the asset is used. In addition, because of the nature of the asset (e.g., an electricity-generating asset that depends on the wind blowing), when, whether, and to what extent the asset is used are beyond the control of any party to the arrangement (e.g., they are subject to the weather).
Example 9, Case A, in ASC 842-10-55-108 through 55-111 (reproduced in Section 3.7.9) illustrates this concept with respect to a contract to purchase electricity produced by a solar farm.
Contractual restrictions — Restrictions in the contract may predetermine where, when, whether, to what extent, and for what type of output the asset is used. Such restrictions are most likely to exist when dedicated machinery is used in certain supply arrangements or in situations in which the protective rights enforced by the supplier in the contract (see Section 3.4.2.2) are so severe that no decisions about HAFWP the asset is used can be made during the period of use.
Example 6, Case A, in ASC 842-10-55-79 through 55-84 (reproduced in Section 3.7.6) illustrates this concept with respect to a contract to transport goods via ship.

Further, the FASB discusses a manner of predetermination — predetermination through contractually negotiated terms and conditions — in paragraph BC138 of ASU 2016-02:

Nonetheless, decisions about how and for what purpose an asset is used can be predetermined. In that case, those decisions cannot be made by either the customer or the supplier during the period of use. This could happen if, for example, in negotiating the contract, the customer and supplier agree on all the relevant decisions about how and for what purpose an asset is used and those decisions cannot be changed after the commencement date.

We think that this manner of predetermination differs from the predetermination by contractual restrictions discussed in ASC 842-10-55-21. Predetermination by contractual restrictions implies that the arrangement becomes more like a service arrangement as a result of the supplier’s efforts to protect its investment in the asset. That is, the supplier is willing to provide services to the customer but unwilling to give the customer any rights to direct the use of the asset.

On the other hand, predetermination by negotiation implies that both parties agree to the terms and conditions of the arrangement in such a way that the use of the asset is predetermined. In this case, neither party is deemed to control the agreed-upon terms, since the arrangement represents an arm’s-length exchange. The example below illustrates this concept.

Example 3-25

Refrigerated Storage Unit

Assume the same facts as in Example 3-21, except that Customer A and Supplier B, when negotiating and writing the contract, agree that A will only store a certain type of carbonated beverage in the refrigerated storage unit and a specific quantity (e.g., in gallons) of the beverage. Customer A is not allowed to change the type or quantity of beverage to be stored in the storage unit during the 15-month contract term. Further, A and B agree that A will provide the beverages for storage on the commencement date and retrieve them from storage at the end of the contract term.

In this case, the contract predetermines HAFWP the storage unit will be used throughout the period of use. That is, A and B contractually agreed to what products will be stored in the storage unit, what amount will be stored, when the products will be stored, and whether anything will be stored. No decisions about HAFWP the storage unit is used during the period of use can be made by A or B during this period.

Even though these stipulations meet A’s business requirements, A is not deemed to control these aspects during the period of use because they were agreed to up front and cannot be changed. Rather, these HAFWP decisions are deemed to be contractually predetermined. Therefore, A must determine whether it either (1) has the right to operate the storage unit throughout the period of use or (2) was involved in the design of the storage unit. As stated in Example 3-21, B operates the storage unit. In addition, B had already constructed the storage unit when the contract was executed and A was not involved in the design of the storage unit. Because neither of the “tiebreaker” conditions are met, A does not have the right to direct the use of the storage unit.

Therefore, even though A obtains substantially all of the economic benefits from its exclusive use of the storage unit over the 15-month contract term, A does not have the right to control the use of the storage unit. Accordingly, B controls the use of the storage unit and, as a result, the contract does not contain a lease.

Connecting the Dots

Predetermination Is Expected in “Relatively Few Cases”

In the Background Information and Basis for Conclusions of ASU 2016-02, the FASB is careful to explain that it expects the analysis in ASC 842-10-15-20(b) to apply to “relatively few” contracts. Specifically, the Board twice indicates that it expects, in most leases, that either the customer or the supplier will have decision-making rights over HAFWP the asset is used during the period of use:

BC138. . . . The Board noted that it would expect decisions about how and for what purpose an asset is used to be predetermined in relatively few cases.

BC139. [The Board] expects that, for most leases, the assessment of whether a customer directs the use of an asset will be based on identifying the party that decides how and for what purpose an asset is used.

As a result, we expect that it will be uncommon for an entity to use the tiebreaker tests in ASC 842-10-15-20(b) to determine whether a contract is, or contains, a lease.

3.4.2.3.1 Customer Has the Right to Operate the Asset

Although rights of operation do not factor into the assessment of who directs HAFWP the asset is used, those rights can vest control of the asset to the customer in accordance with ASC 842-10-15-20(b)(1) when HAFWP the asset is used during the period of use is predetermined. The examples and discussion below provide additional insight into this condition.

Example 3-26

Shipping Charter

Customer Y enters into an arrangement with Supplier Z for the exclusive use of an explicitly identified ship.

Customer Y indirectly chooses the type of ship to be used by selecting a shipping service package. In this case, Y receives the ship at designated Port City A. The ship is predetermined to go from Port City A to Port City B during a specific time frame. Customer Y’s own crew will man, steer, and otherwise operate the ship. Customer Y and Supplier Z agree up front on the contents and amount of cargo to be shipped.

The parties conclude that the arrangement constitutes a lease of the ship for the following reasons:

The ship is explicitly specified in the arrangement, and Z does not have a substantive substitution right.
Because of its exclusive use of the ship, Y obtains all of the economic benefits from the ship during the period of use.
Because the output of the ship (i.e., the cargo and transportation capacity) is specified in the contract, the relevant decisions about HAFWP the ship is used are predetermined. However, Y has the right to operate the ship during the period of use (e.g., Y’s own operating personnel will man, steer, and otherwise operate the ship) and thus has the right to direct the use.

With respect to the “tiebreaker” conditions, rights to kick out the operator of an asset are sufficient to give the customer the right to direct the use of the asset in accordance with ASC 842-10-15-20(b). If HAFWP the asset is used during the period of use is predetermined and the supplier operates the asset, but the customer has the right to remove the supplier and hire a new operator, the customer has the right to direct others to operate the asset in accordance with ASC 842-10-15-20(b)(1). When the kick-out right is substantive (i.e., when the customer can remove and replace the operator without cause at any time), the customer — not the supplier — is the decision maker with respect to the operation of the asset.

Example 3-27

Ship

Assume the same facts as in Example 6, Case A, in ASC 842-10-55-79 through 55-84 (reproduced in Section 3.7.6). Supplier operates and maintains the ship and is responsible for the safe passage of the onboard cargo. However, in this scenario, Customer may remove Supplier at will and without cause so that it can hire another operator for the ship, or operate the ship itself, during the term of the contract.

As in ASC 842-10-55-82 and 55-83, the contract depends on the use of an identified asset and Customer has the right to obtain substantially all of the economic benefits from use of the ship, respectively. In addition, HAFWP the ship will be used is predetermined in the contract. However, in this case, Customer has the right to operate the asset throughout the period of use in accordance with ASC 842-10-15-20(b)(1).

Accordingly, the contract contains a lease of the ship.

3.4.2.3.2 Customer Has Designed the Asset

HAFWP an asset is used during the period of use can be predetermined by the design of an asset. If the customer is the party that designed the asset — or is the party that designed aspects with the most influence on HAFWP the entire asset is used — the customer had decision-making rights that extend beyond those of a typical customer in a supply or service arrangement. In those instances, in accordance with ASC 842-10-15-20(b)(2), the customer has the right to direct the use of the asset.

Example 9, Case A, in ASC 842-10-55-108 through 55-111 (reproduced in Section 3.7.9) illustrates an application of the guidance in ASC 842-10-15-20(b)(2). However, as is evident from the discussion and examples below, the complexity of applying ASC 842-10-15-20(b)(2) will often be related to determining how much involvement in the design of the asset is enough to give the customer the right to direct the use of the asset.

Connecting the Dots

Entities Need to Use Significant Judgment in Evaluating Design

We expect that entities in certain industries will need to use significant judgment in evaluating who has the right to direct the use of an asset under ASC 842, especially when HAFWP the asset is used throughout the period of use is predetermined. Although an entity may not have trouble determining whether the customer or supplier has control over the operating decisions related to the asset, the assessment of whether the customer designed the asset will often be more difficult given the different levels of influence a customer may have over the design decisions (e.g., where the asset will reside/operate, determining the technology to be used). Accordingly, we expect that this assessment will be one of the aspects of ASC 842 that will require entities to use the greatest judgment.

The example below illustrates the difficulty in applying judgment in such cases.

Example 3-28

Renewable Power Purchase Agreement

Customer X, a utility company, enters into a 20-year PPA with Supplier Y, a power generation company, to buy all of the electricity produced by a new wind farm that Supplier Y will own. Assume the following:

The wind farm is explicitly specified in the contract, and Y has no substitution rights.
The electricity cannot be provided by another asset.
Customer X hired an expert engineer to help determine the location of the wind farm and its size (i.e., the maximum electricity production capacity).
Supplier Y is responsible for constructing, operating, and maintaining the wind farm during the contract term.
All the relevant decisions about where, whether, when, and what amount of electricity will be produced are predetermined as a result of the design decisions and the nature of the asset. That is, the customer cannot change these decisions and, once the asset is constructed, the outputs derived from its use depend largely on weather.
The wind farm is in a state with an RPS, and X will receive all RECs that accrue from using the wind farm.
Supplier Y will receive PTCs that result from the operation of the wind farm.

The agreement meets the following conditions to be considered a lease:

The wind farm is an identified asset because it is explicitly identified and Y does not have substitution rights.
Customer X has the right to obtain substantially all of the economic benefits from use of the wind farm because it receives 100 percent of the electricity and RECs produced by the wind farm. PTCs do not represent economic benefits because they are an ownership attribute and cannot be monetized by sale to a third party (see Section 3.4.1.1.2).

Neither X nor Y may decide HAFWP the wind farm is used during the period of use. All relevant decisions about HAFWP the wind farm is used are predetermined by the nature and design of the wind farm. Because Y operates and maintains the wind farm throughout the period of use, X does not meet the condition in ASC 842-10-15-20(b)(1). However, X was involved in the design of the wind farm, so X must also consider whether it has the right to direct the use of the wind farm under ASC 842-10-15-20(b)(2).

We think that more information is needed before the extent of X’s involvement in the design of the wind farm can be assessed. For example, the following questions may be considered:

In determining the maximum capacity of the wind farm, did X also determine how many wind turbines would be installed, or did Y make that design decision?
How did X select the location? Did X determine that the wind farm should be constructed in Logan County, Oklahoma, within 10 miles of X’s interconnection point, or did it determine that the wind farm should be constructed on a specific plot of land in Oklahoma? Who was responsible for ultimately selecting the exact acreage where the wind farm would be constructed?
Is X’s “involvement” in the design only with respect to a competitive request for a proposal that it issued and that Y won?
Does X decide what technology to use (i.e., manufacturer and model type of turbine blades or drivetrain), and does X configure the wind farm (e.g., determine the placement of the individual turbines within the wind farm)?

Connecting the Dots

Design of a Renewable Generating Asset

As indicated in Example 9, Case A (reproduced in Section 3.7.9), as well as the examples in this section, contracts related to renewable generating assets are expected to often be subject to ASC 842-10-15-20(b)(2). That is, once a weather-dependent renewable generating asset is constructed, generally no HAFWP decisions can be made by any party during the period of use. Certain HAFWP decisions are subject to the weather and are thus outside the control of any party; otherwise, maintenance is essential to the continued operating efficiency of the generating assets once they are installed.

As illustrated in Example 3-28, the evaluation of whether a customer predetermined HAFWP a renewable generating asset is used because of the extent of its involvement in the design of the asset involves significant judgment. A customer may often be involved in some, but not all, design decisions. In such cases, the evaluation should focus on whether the customer made the design decisions that most significantly affect the economic benefits to be derived from use of the asset.

The design decisions that most significantly affect the economic benefits from use will differ depending on the nature of the asset (i.e., wind, solar) and may change as these technologies continue to develop. However, we expect that the most significant design decisions will often comprise some combination of the following:

Selecting the specific generating equipment (e.g., the wind turbines or photovoltaic cells) to be installed.
Determining the technical design and site layout (e.g., determining whether solar panels will be static or rotate with the sun).
Determining the specific location of the facility.

We understand that the power and utilities industry is working with stakeholders to develop an interpretive framework for how to assess ASC 842-10-15-20(b)(2) with respect to renewable generating assets. We continue to monitor those developments. In the meantime, we recommend that entities discuss these scenarios with their auditors or accounting advisers.

3.4.2.4 Power Over How and for What Purpose the Asset Is Used Throughout the Period of Use Is Shared

As discussed in Section 3.4, ASC 842 does not address the concept of “shared power.” That is, ASC 842 does not specifically address situations in which the power over decision-making rights related to HAFWP the asset is used throughout the period of use is shared.

Power over HAFWP the asset is used during the period of use is only considered shared when both parties to the arrangement are involved in the decision-making rights that most affect the economic benefits derived from the use of the asset. When power is shared, no single party (i.e., neither the customer nor the supplier) has the right to direct the use of the asset.

For example, assume that the ability to change when and whether an asset is used represents the decision-making rights that most affect the economic benefits derived from the use of that asset. If both the customer and the supplier must approve an order that would call that asset into use for a specific time frame, neither party controls those decision-making rights.

Connecting the Dots

Concluding That Power Is Shared

We think that, in practice, there is a high threshold for concluding that power is shared. Such a conclusion can only be reached if the customer and the supplier consent to all the decisions that most affect the economic benefits derived from the use of the asset.

Therefore, in a manner similar to that under the ASC 810 VIE consolidation model (see Section 7.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest), it is important to differentiate situations in which power is shared from those in which the supplier and the customer have power over multiple, different activities. As noted in Section 3.4, we think that, in such situations, the guidance in ASC 842 would be aligned with the ASC 810 VIE consolidation model, specifically the provisions in ASC 810-10-25-38E. That is, we think that ASC 842 requires an entity to determine which of the different decision-making rights most affects the economic benefits derived from the use of the asset. The party with the power over that decision-making right has the right to direct HAFWP the asset is used throughout the period of use.

Shared Power Is a Blind Spot

ASC 842-10-15-20 through 15-26 do not specifically address circumstances in which both the customer and supplier must consent to direct HAFWP the asset is used during the period of use. Rather, ASC 842-10-15-20 only focuses on whether the customer has the right to direct the use of the asset. Accordingly, we think it may be reasonable to conclude that, when power is truly shared between the parties, the customer does not have the right to direct the use of the asset and thus there is no lease.

However, we note that when neither the customer nor the supplier has the right to direct HAFWP the asset is used during the period of use, the decision tree in ASC 842-10-55-1 (reproduced in Section 3.2.1) would indicate that HAFWP the asset is used during the period of use is predetermined. That is, the decision tree would point an entity toward applying the tiebreaker test in ASC 842-10-15-20(b) in these situations (see Section 3.4.2.3 for detailed discussion of this guidance).

We therefore think that, when an entity is concluding that power is shared, the entity should consider this path in the decision tree. In these situations, an entity that also performs the analysis in ASC 842-10-15-20(b) can confirm that the entity does not have rights beyond those of a customer in a service arrangement.

Footnotes

Note that none of the examples W through Z have a contract year in which 0 percent of the economic benefits are conveyed to the customer. In such situations, we think that the arrangement would be indicative of having nonconsecutive periods of use, which are discussed in detail in Section 3.5.

See Section 3.4.2.4 for further discussion of when power over the decision-making rights related to HAFWP PP&E is used throughout the period of use is shared.

Quoted material in this section is from the Board’s May 10, 2017, meeting handout.

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