Renewables Spotlight — Update on Renewable Power Issues (December 2023)

Update on Renewable Power Issues

Background

We are excited to present the third installment in our Renewables Spotlight series, which focuses on emerging accounting and reporting topics that apply to the renewables industry.

The market for renewable technologies continues to grow and attract capital investment. This trend is being driven by numerous developments, including tax incentives under the Inflation Reduction Act of 2022 (IRA), state clean-energy policies, utility decarbonization, corporate renewable procurement, residential solar demand, private investment, and other clean-energy initiatives. Consequently, solar, wind, and other renewable energy facilities are being developed and deployed faster than ever, and the electric grid will require more battery storage capacity to handle this growing volume of renewables. As public and private companies navigate the continuing evolution of the renewables industry as well as legislation such as the IRA and the implementation of standards such as ASU 2016-021 (codified in ASC 8422), new accounting and reporting issues specific to entities and projects associated with renewables have emerged that are affecting the businesses of such entities as well as investors in renewable projects.

This Renewables Spotlight examines the accounting for battery energy storage systems as well as the treatment of land lease costs during construction.

Battery Storage

Battery energy storage systems (BESSs) allow a company to solve problems related to energy delivery by maximizing the use of renewable electricity and increasing the reliability of otherwise intermittent generation sources. The development of utility-scale battery storage assets in the industry is forecasted to increase significantly,3 and the high levels of solar and wind curtailment in some areas of the United States make a strong case for pairing renewables with storage. As a result, we believe that entities may derive various economic benefits from a BESS. We would generally expect that time shifting (i.e., temporarily deferring the time of consuming the electricity through the use of battery storage) would result in price arbitrage or savings, which would be a critical economic benefit in most battery storage applications. Therefore, because electricity is priced hourly or more frequently in most markets and the price of electricity typically varies substantially over the course of 24 hours, a BESS owner or off-taker can make a profit by charging the battery during hours when electricity prices are low and discharging the battery during hours when prices are higher. In addition, the BESS may create or enhance capacity value (e.g., resource adequacy) in regions where an intermittent generating facility would otherwise be ineligible for regulatory capacity. There may be other economic benefits to consider depending on the nature of the technology, the marketplace, and the needs and intentions of the parties to the arrangement.

Accounting questions have arisen in connection with power purchase agreements (PPAs) that give the off-taker rights over the electric output of a renewable-generating facility and the storage capability of a paired BESS. The accounting for such arrangements can be complex and may include the existence of embedded leases. In addition to the accounting considerations discussed below, companies may be aware of potential consolidation implications when dealing with single-asset entities that own either a generating facility paired with a BESS or, in some cases, a stand-alone BESS. Consolidation issues may be particularly relevant when the assets within the entity are contracted out to others in accordance with a PPA or other long-term arrangement.

Lease Accounting Considerations

In a “must-take” PPA, the off-taker is obligated to take delivery of all power generated by the renewable-generating facility. In our experience, must-take PPAs related to renewable-generating facilities with variable payments are generally not treated as leases under ASU 2016-02 (ASC 842). Because the off-taker does not control the generating facility, it does not have discretion over dispatch. However, when a BESS is introduced, incremental analysis will often be required, which could lead to a conclusion that an embedded lease is present in the arrangement. The discussion below highlights critical decision points related to such an incremental analysis.

Unit of Account

To evaluate whether one or more leases exist in an arrangement, an entity must first identify the units of account that are subject to the lease analysis. Specifically, in a PPA that is related to a generating facility paired with a BESS, an entity should consider whether to combine the facility and BESS for accounting purposes or evaluate them separately.

To determine the appropriate unit of account when assessing whether an arrangement is or contains a lease, an entity may consider whether the assets are physically distinct and, if so, the level of interdependency between the assets. It may be appropriate to combine two physically distinct assets when each of the assets directly affects, and is critical to, the functionality of the other. In the case of a renewable-generating facility paired with a BESS, the assets are generally physically distinct (even though they are connected to each other) and, therefore, it is often necessary to assess the level of interdependency between the two assets. In such instances, most entities have concluded that there is not a sufficient level of interdependency to warrant combining the two assets. While the BESS may be dependent on the generating facility for the electricity it will store, the function of the generating facility is not materially changed by the presence of the BESS. A useful analogy may be that of a locomotive and a rail car: The rail car depends on the locomotive to move, but the locomotive is not dependent on the presence of a rail car to be able to physically function. Therefore, the “separate unit of account” approach is the prevailing view among industry participants, and it is the one we have accepted in our audit evaluations.

Economic Benefits

When evaluating whether an arrangement is or contains a lease, an entity needs to identify the economic benefits it expects to derive from the use of the identified property, plant, and equipment (PP&E). Such identification is critical for two reasons:

It is part of the control test in ASC 842, which requires that the customer consume substantially all of the economic benefits of the PP&E. “Substantially all” in this context is deemed to represent 90 percent.4
It links directly to the identification and assessment of the rights to direct the use of the PP&E. Specifically, the relevant rights in the ASC 842 control assessment are those that affect the economic benefits to be derived from the PP&E.

Right to Direct the Use

In evaluating the right to direct the use of a BESS, an entity must first take a complete inventory of the economic benefits it expects to derive from its use. See Economic Benefits for further information.

ASC 842 focuses primarily on the decisions that affect how an asset is deployed or used — the when, where, and how decisions. These are referred to as “how and for what purpose” (HAFWP) decisions in ASU 2016-02. If all of the HAFWP decisions are predetermined (either by contract or on the basis of the nature of the asset), an entity should consider focusing on operations and design. The discussion in this section centers on the HAFWP evaluation because the off-taker typically neither operates nor designs the BESS.

If we assume that time shifting, as discussed above, is an important economic benefit in the evaluation, we would expect that the decisions regarding when to charge and when to discharge would be considered important HAFWP decisions for a BESS. Often, these decisions will be held by the same party (the off-taker); however, there could be arrangements in which they are divided among the counterparties or retained by the owner. We generally believe that these decisions may carry equal weight since the value derived from the temporary storage decision is a function of the cost savings or price arbitrage between the charge event and the discharge event. PPAs will often establish parameters with respect to allowed charge and discharge activities (e.g., minimum and maximum cycles during a year, hours of the day before or after which the activity must occur, state of charge requirements). We believe that these parameters may generally be viewed as protective rights in the arrangement and do not suggest that charge and discharge decisions are less meaningful or that an entity would disregard them when evaluating the right to direct the use of the BESS. Other relevant HAFWP decisions related to the use of a BESS will depend on the identified economic benefits as discussed above and could include strategic decisions associated with optimizing life and storage potential.

We have been asked how an off-taker can control a BESS if it cannot control the generating facility to which it is paired. In other words, if all of the HAFWP decisions regarding the use of the generating facility are predetermined on the basis of the nature of the asset (which is often the case for renewable-generating assets), how can an off-taker control a BESS that is dependent on the generating facility for electricity? When assessing the decisions related to the use of the BESS, an entity must begin with an assumption that electricity is available to be stored. The BESS exists to provide storage and arbitrage opportunities when electricity is available and, therefore, it is appropriate for an entity to make this assumption when assessing control. This also is consistent with the view that the generating facility and the BESS are separate units of account as discussed above.

In addition, we have been asked whether, in paired scenarios, the ability to “grid-charge” (i.e., charge the battery by using electricity from the grid) is critical to concluding that an off-taker has control over a BESS. This question arises in some cases as a result of contractual or physical constraints related to grid-charging and in other cases because of the federal rules on investment tax credits for renewable energy facilities that generally result in the recapture (“clawback”) of investment tax credits related to the batteries paired with solar generation5 if significant grid-charging occurs within the first five years of operations. In our view, it is not necessary for grid-charging to exist for an entity to conclude that an off-taker controls a BESS. As discussed above, when assessing the decisions regarding the use of the BESS, the entity must begin with an assumption that electricity is available to be stored. This assumption generally relies on the generating facility with which the BESS is paired. Accordingly, the ability to grid-charge would enhance an off-taker’s rights of use but is not critical to establishing such rights.

PP&E Matters

A BESS contains several components, including the battery, monitoring and control systems, and a power-conversion system. Batteries consist of individual cells that are arranged in modules and then placed into racks. Owners of a BESS have various fixed-asset accounting considerations to address. They often perform extensive replacements of components or augmentations throughout the life of a BESS to optimize performance and, in some cases, extend the life of the BESS. In addition to determining the depreciable life and creating the depreciation profile (both discussed in more detail below), owners will need to establish units of account for property accounting purposes.6 Those unit-of-account decisions that are made at the time a BESS is placed in service have an impact on whether subsequent activity, such as replacing a rack, is accounted for as a capital activity (i.e., remove and retire the old fixed asset and capitalize the new fixed asset) or as repair and maintenance activities (i.e., that would be expensed as incurred). In applications involving a BESS paired with a generating facility, owners may also need to consider how to account for the shared infrastructure and whether and, if so, how to attribute components to the generating asset, the BESS, or both.

For the BESS assets, companies may align the service life determined by engineers with the economic life forecasted by the business. Some companies use the composite method and expense major component repairs. As a result of this framework, the useful life of a BESS is not limited to the life of an individual component (although this would not be the case if companies capitalized major component replacements under a component method). The economic life of battery storage assets will vary and be most affected by (1) how the battery is engineered, operated, and maintained and (2) the economic environment in which it operates.

In practice, we are aware of a wide range of useful lives ascribed to a BESS, from as short as 10 years to as long as 25 years or more. Useful lives could differ for numerous reasons, including differences in (1) the specific technology deployed, (2) the usage assumptions (e.g., cycles per year), (3) owners’ maintenance or augmentation strategies, and (4) the unit of account used for property accounting purposes. In addition, the economic life of a BESS could depend in part on price behavior in the market in which it is deployed given the price arbitrage objective of these projects. Consequently, an owner’s estimate of forward power prices and future arbitrage value (versus the cost to maintain) will often be relevant.

Given the profile of degradation in battery cells, we have received questions regarding whether it would be necessary or acceptable to apply a depreciation method other than straight line. For example, some have asked whether a method that accelerates depreciation in the early part of the BESS life would be required. This is an evolving area and is worthy of additional consideration as battery technology advances and improves. We are also aware that some entities have applied a composite method of depreciation given the large number of components in a BESS.

Looking Ahead

As battery storage technology continues to improve and the deployment of battery storage systems rapidly increases, preparers and auditors will need to consider the additional implications of having the ability to store material amounts of electricity. For example, we may soon see the day when companies report electricity inventory (or a similar asset for the value of a charged BESS) on their balance sheets. There may also be revenue recognition implications for those that have treated forward electricity sales as performance obligations satisfied “over time.” Such treatment is generally based on a service revenue analogy and the notion that electricity, unlike storable commodities, must be consumed immediately, in a manner similar to services. To the extent that electricity can be reliably stored in large quantities, it may be necessary to revisit revenue policies and consider whether a “point-in-time” transfer model would be more appropriate under the circumstances. Likewise, the derivative accounting requirements in ASC 815 include specialized guidance for electricity contracts related to assessing their eligibility for the normal purchases and normal sales scope exception. This guidance was premised in part on the notion that electricity must be consumed immediately. It is unclear whether the FASB will revisit such guidance in light of the introduction and proliferation of large-scale battery storage technology.

Treatment of Land Lease Costs Incurred During Construction

Since the issuance of ASC 842, there has been an increased focus on the treatment of land lease costs incurred during the construction period of a fixed asset, such as a power-generating facility. While much of the focus has been on renewable generation (for the reasons discussed below), the accounting issues are not unique to generating assets or to the renewable energy sector. Note that the discussion below addresses the requirements for nonregulated development entities; it does not contemplate the accounting for regulated operations under ASC 980.

Accounting Considerations

Entities applying ASC 842 have raised questions about (1) how to account for land lease costs incurred during the construction period of a fixed asset that is affixed to the land and (2) whether those land lease costs may be capitalized by the owner/developer into the cost of the project (i.e., treated as a cost of the project and expensed ratably over the project’s useful life).

The guidance in ASC 8407 was relatively clear that land lease costs incurred during the period of construction of a fixed asset must be expensed as incurred, beginning at lease commencement (which would typically include the construction period), unless the project is eligible to be accounted for under the specialized real estate guidance in ASC 970. Such specialized guidance applies to real estate projects that are developed for “sale or rental” (see further discussion below in Scope Considerations Under ASC 970).

By contrast, under ASC 842, there has been some debate about the requirement in ASC 842-10-55-21 to expense land lease costs incurred during the construction of another asset.8 However, we have learned that some entities have interpreted ASC 842 to mirror the requirements of ASC 840, and we believe that this interpretation most likely reflects the FASB’s intent. Accordingly, upon the adoption of ASC 842, the scope requirements in ASC 970 remain relevant to an entity’s support for capitalizing land lease costs associated with a project under construction.

Unlike ASC 840, ASC 842 focuses on customer control, which is typically not present for weather-dependent assets (e.g., a dispatch right or call on instantaneous generation). Therefore, entities in the renewable energy sector may evaluate renewable PPAs differently under ASC 842 than they did under ASC 840. Specifically, while many renewable PPAs qualified as leases under ASC 840 when the customer obtained substantially all of the outputs from the generating facility, they do not necessarily qualify under ASC 842 if customer control is not established. As explained further below, this change may affect an entity’s ability to apply the capitalization guidance in ASC 970 because of its scope requirements.

For example, under ASC 840, a contract in place for the sale of the output from a generating asset may have been considered a lease and thus the project may have been within the scope of ASC 970, which provides a basis for the developer to capitalize the lease costs associated with the land for the period in which the generating asset was being constructed on such land. Under ASC 842, the contract in place for the sale of output from the generating asset may not be a lease if, for example, the contract does not convey control of the generating asset to the customer; in this case, the project would be outside the scope of ASC 970, eliminating the developer’s basis on which to capitalize the lease costs associated with the underlying land.

Scope Considerations Under ASC 970

As noted above, ASC 970 provides specialized cost accumulation guidance for real estate projects developed for “sale or rental.” It does not apply to projects developed by an entity for use in its own operations (e.g., a manufacturing facility used to satisfy one or more revenue contracts). The term “sale” is self-explanatory, but questions have arisen related to the meaning of “rental.” Within the context of ASC 970, that term has been interpreted to indicate that there is (or will be) an agreement related to the project with a third party that will qualify as a lease under U.S. GAAP (e.g., a PPA that qualifies as a lease). On the other hand, ASC 970 generally cannot be applied to an off-take contract that does not meet the definition of a lease even when such a contract is long-term in nature and permits the recovery of substantially all the owner’s invested capital.

We understand that in practice, when construction of the fixed asset commences, some developers will not know with certainty whether a project will be sold, rented, or used in their own operations. We believe that in these circumstances, intent and ability will be important considerations and the application of ASC 970 would only be appropriate when an entity has such intent and ability to sell or rent the associated project. Evidence of intent and ability may include the consideration of historical practice for similar projects, strategic decisions made during the development process, and the manner of financing. Entities in this situation may wish to develop a consistent approach to evaluating and asserting their intent and ability, which may include back-testing their actual performance against their intent to ensure that the application of ASC 970 remains appropriate under the circumstances.

Given the differing views and interpretations related to these matters, we encourage entities to consult with their auditors or accounting advisers. Entities should also be aware that in November 2023, the Edison Electric Institute and the American Gas Association submitted a request to the FASB to consider this issue and clarify whether the capitalization of construction-period lease costs is appropriate, which could involve changes to the guidance in ASC 842 or ASC 970.

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

Tax benefits, including investment tax credits (ITCs) and production tax credits (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 IRA 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.

Contacts

If you have questions about this publication, please contact the following Deloitte industry professionals:

Eileen Little Audit & Assurance Partner Deloitte & Touche LLP +1 404 786 1017 elittle@deloitte.com	Brad Poole Audit & Assurance Partner Deloitte & Touche LLP +1 713 906 8004 brpoole@deloitte.com
Tom Keefe Audit & Assurance Partner Deloitte & Touche LLP +1 504 352 0563 tkeefe@deloitte.com	Bill Graf Audit & Assurance Partner Deloitte & Touche LLP +1 847 612 8940 wgraf@deloitte.com
James Barker Audit & Assurance Partner Deloitte & Touche LLP +1 203 291 9245 jabarker@deloitte.com	Sarah Goldberg Audit & Assurance Managing Director Deloitte & Touche LLP +1 561 374 2071 sarahgoldberg@deloitte.com
	Lalitha Shankar Audit & Assurance Senior Manager Deloitte & Touche LLP +1 917 945 7911 lshankar@deloitte.com

Footnotes

FASB Accounting Standards Update (ASU) No. 2016-02, Leases.

For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

Source: https://www.eia.gov/analysis/studies/electricity/batterystorage/pdf/battery_storage_2021.pdf.

See Section 3.4.1.3 of Deloitte’s Roadmap Leases for further discussion.

For the applicable recapture rules, see Treasury Regulation Section 1.48-9(d)(6), but note that the IRA’s amendments to the Internal Revenue Code permit investment tax credits on “energy storage technology,” which is defined in such a manner that “stand-alone” storage equipment qualifies for the credit without restrictions regarding the source of the energy for conversion to electricity.

The units of account for property accounting purposes may differ from the units identified for performing a lease evaluation as discussed in Lease Accounting Considerations above. For example, the units of account for property accounting purposes may be more granular than those identified in the lease evaluation.

ASC 840-20-25-11 (superseded) stated in part, that “rental costs associated with ground or building operating leases that are incurred during a construction period shall be recognized by the lessee as rental expense. . . . This guidance does not address whether a lessee that accounts for the sale or rental of real estate projects under Topic 970 should capitalize rental costs associated with ground or building operating leases” (emphasis added).

ASC 842-10-55-21 states, in part, that “lease costs (or income) associated with ground or building leases that are incurred (earned) during a construction period should be recognized by the lessee (or lessor) in accordance with the guidance in Subtopics 842-20 and 842-30, respectively. That guidance does not address whether a lessee that accounts for the sale or rental of real estate projects under Topic 970 should capitalize rental costs associated with ground and building leases” (emphasis added). In addition, ASC 842-20-25-6 states, in part, “After the commencement date, a lessee shall recognize all of the following in profit or loss, unless the costs are included in the carrying amount of another asset in accordance with other Topics” (emphasis added).