Renewable Accounting Update - Deloitte United States...• Hypothetical Liquidation at Book Value (“HLBV”) is a balance sheet-oriented approach which provides a methodology for

2019 Deloitte Power & Utilities ConferencePower is not staticDecember 3-4, 2019

Bits, Bytes & Barrels” webinar

Renewable Accounting

Update

Allison Taylor, Partner, Deloitte & Touche LLP

Copyright © 2019 Deloitte Development LLC. All rights reserved. 3

Contents

HLBV accounting 4

Investments in renewable assets by rate-regulated entities 11

Battery storage hot topics 28

Overview of opportunities for repowering assets 38


Hypothetical liquidation at book value (HLBV) accounting


What is hypothetical liquidation at book value accounting?

In order to determine the amount allocated to each partner, an analysis of the partners’ capital accounts (as adjusted per the liquidation provisions of the partnership agreement) must be performed.

• Hypothetical Liquidation at Book Value (“HLBV”) is a balance sheet-oriented approach which provides a methodology for allocating pre-tax GAAP income or loss to an investor when the conventional pro-rata/ownership interest does not accurately reflect the economics of the structure

• HLBV calculates the amount each partner would receive if the partnership were liquidated at book value at the end of each measurement period/reporting date. The change in the allocated amount to each partner during the period is book income/loss allocated to that partner (adjusted for distributions and contributions)

• Determines how better (or worse) off the investor is at the end of the period than it was at the beginning of the period (taking into consideration only those transactions and other events recognized by the investee under U.S. GAAP)


History of HLBV

• There is currently no authoritative accounting guidance on HLBV. Methodology is derived from a proposed Statement of Position (SOP), Accounting for Investors’ Interests in Unconsolidated Real Estate Investments, dated November 21, 2000, and has been accepted in industry practice

• While HLBV was established as an approach for applying equity method accounting, it has been applied by analogy to structures consolidated under the provisions of ASC 810 for determining allocation of earnings to noncontrolling interest holder(s)

• Paragraph 19 of the proposed SOP states that, in determining how much better or worse off the investor is at the end of the period, the investor calculates “…the amount that it would receive (or be obligated to pay) if the investee were to liquidate all of its assets at recorded amounts determined in accordance with GAAP and distribute the resulting cash to creditors and investors in accordance with their respective priorities, including amounts that would be distributed to investors in satisfaction of any loans, receivables, or preferred securities held by them. The HLBV method does not take into account any costs that would be incurred if such actions were actually taken…”

• Paragraph 20 of the proposed SOP states, “In determining how cash hypothetically would be distributed to creditors and investors, the priority rights of the various creditors (including investors who are also creditors) and the priority provisions of the ownership or other related agreements are respected…”


When does HLBV apply?

• HLBV is applied to renewable energy tax equity structures which have disproportionate attributions of cash and income tax allocations to the investors

• Class A Member (Tax Equity Investor) and Class B Member (Sponsor/Developer) receive income tax allocations and cash distributions at differing percentages which are not tied to each member’s ownership interest

• For example, the Sponsor/Developer entity may receive 1% of income tax allocations and 80% of cash distributions

• Disproportionate allocations are designed such that the Tax Equity Investor, who possesses sufficient taxable income to utilize tax benefits, receives majority of tax credits and tax depreciation, while Sponsor/Developer receives the majority of cash distributions from the partnership

• Allocation percentages are typically adjusted or “flip” once the “flip point” is achieved – flip point occurs either through Tax Equity Investor achieving its target IRR (yield-based flip) or once a certain date occurs (time-based flip)

• Sponsor/Developer often exercises buy-out option to acquire Tax Equity Investor’s ownership interest during buy-out period following flip point being achieved


CashPeriod 1: 20%Period 2: 20%Period 3: 5%

Income (loss)Period 1: 99%Period 2: 67%Period 3: 5%

CashPeriod 1: 80%Period 2: 80%Period 3: 95%

Income (loss)Period 1: 1%Period 2: 33%Period 3: 95%

Partnership flip structure – illustrative example

Project LLC

Sponsor Tax Equity Investor


Steps for calculating HLBV

1.Calculate partnership’s Earnings Before Taxes (EBT)

2.Calculate net GAAP assets of the partnership – typically GAAP Equity

3.Calculate net Tax assets of the partnership – typically 704(b) Capital Accounts

4.Calculate tax gain or loss on hypothetical liquidation of the partnership

5.Allocate tax gain in accordance with liquidation provisions in partnership agreement.

Illustrative Example Liquidation Provisions:

a. Allocate gain to partner(s) with negative 704(b) capital account

b.Allocate gain to tax equity investor until their Target IRR is achieved

c. Allocate remaining gain in accordance with post-flip allocation ratios

6.Calculate partners’ claims on book value (Ending 704(b) capital account plus allocations of hypothetical tax gain from liquidation waterfall)

7.Determine change in each partner’s claim on partnership book value during the period (adjusted for contributions and distributions)


Other HLBV considerations

• Modeling considerations:

◦ HLBV model should mirror substance of the partnership arrangement/governing ownership documents, and liquidation provisions of those ownership documents

◦ Important to have diagnostic checks and controls in place around model to help ensure integrity

e.g., does the sum of the partners’ GAAP earnings allocations tie back to partnership GAAP earnings

• Complexity of accounting - need for resource(s) who understand GAAP accounting, partnership tax rules, and interpretations of governing ownership documents

• Nature of tax credits can impact HLBV earnings allocation – ITC vs PTC considerations

• Industry considerations:

◦ Opportunity for utility/energy companies to invest as tax equity investor if tax efficient


Investments in renewable assets by rate-regulated utilities


Renewable energy pricing model compared to regulated utility rate base model

Renewable energy project pricing models are similar to the ratemaking formula

Determination of PPA Rates Regulated Utility Rate Making Formula

Rate Basex Allowed Rate of Return= Required Return (i.e., operating income)+ Operating Expenses, Depreciation, Taxes

= Revenue Requirement

Construction Costsx Desired Rate of Return= Desired Return (i.e., operating income)+ Operating Expenses, Depreciation, Taxes- Tax benefits (ITCs, PTCs)- Renewable Energy Credits (RECs)= Desired Revenue (projected production x PPA Rate)


GAAP accounting considerations Common questions and issues

• Consolidation

−JVs with ownership percentages disproportionate to economics

• Can a rate-regulated entity overcome HLBV?

−Accounting for costs recoverable from customers, including intercompany transactions

• Impairment considerations


Cost disallowances ASC 980-360 35-12

35-12

When it becomes probable that part of the cost of a recently completed plant will be disallowed for rate-making purposes and a reasonable estimate of the amount of the disallowance can be made, the estimated amount of the probable disallowance shall be deducted from the reported cost of the plant and recognized as a loss. Section 450-20-55 provides guidance for making a reasonable estimate of the amount of a loss. If part of the cost is explicitly, but indirectly, disallowed (for example, by an explicit disallowance of return on investment on a portion of the plant), an equivalent amount of cost shall be deducted from the reported cost of the plant and recognized as a loss.


Cost disallowances for plants that are not recently completed are recognized in accordance with general U.S. GAAP. For example, assume that (1) a regulated utility puts a new plant into service and then goes through a rate case when the prudency of the costs is scrutinized and (2) the regulator concludes that the entire amount capitalized should be included in rate base, with depreciation expense on the entire capitalized amount included in cost of service. The plant costs are questioned a few years later in the next rate case, and the regulator disallows a specific amount of the plant cost. A disallowance charge based on ASC 980-360 should not be recorded because that plant is no longer a recently completed plant. Rather, an entity should apply the impairment criteria in ASC 360, at the appropriate asset grouping, when evaluating impairment of a plant that is not recently completed.

Plant that is not recently completed


How income taxes affect regulated ratesTax gross-up factors – applications to federal and state PTCs

• Assume a federal income tax rate of 21 percent, a state income tax rate of 5.1 percent and that stateincome taxes are deductible for federal income tax purposes (composite statutory federal and state tax rate of 25 percent)

−What is the impact on the revenue requirement of earning $100 of federal production tax credits?

−What is the impact on the revenue requirement of earning $100 of state production tax credits?

Item Decrease in Revenue Requirement

Federal production tax credit $133

State production tax credit $105


Reflecting PTCs in regulated prices Background

• Ratemaking for PTCs and recording PTCs in the regulatory books of account are not subject to the normalization requirements

• Periodic rate cases based on expected/normal operations, including estimated PTCs

−Base rates – normally re-set every few years

−Based on projected financial information for a future test period or historical information from a recent prior period or a combination of both

• Rate riders (or trackers) – ratemaking mechanism to more frequently adjust rates for volatile cost items and provide a true-up mechanism

−Examples include fuel costs, purchased power costs, demand side management costs

• Tax trackers

−Examples – specified flowthrough items, tax uncertainties (audit adjustments), tax credits

• Rate base treatment of general business tax credit carryforwards


Reflecting PTCs in regulated prices How to address volatility

• Including PTCs as part of base rates without a true-up provision

• Sharing PTCs through a rate adjustment clause (or tracker)

−Reconciled periodically with the objective of ultimately reducing regulatory tax expense by the actual amount of PTCs

• Application to PTCs – example of a “PTC tracker”

−Utility places a wind farm in service and considers the following in setting base rates

◦ Investment in plant included in rate base

◦ Regulatory depreciation expense recoverable in operating expenses

◦ Annual projected PTC reduce recoverable tax expense

−Record a regulatory asset if PTCs reflected in base rates exceed PTCs reported on tax return

−Record a regulatory liability if PTCs reflected in base rates are less than PTCs reported on tax return


PTC adjustment clause Example

• Commission sets base rates assuming $10 million of federal PTC annually

−Federal tax rate is 21%, federal/state composite tax rate is 25%

• A tracking mechanism is used to adjust rates in a future period if the amount of PTC reported on the tax return differs from the amount reflected in base rates

• For a given year, the amount of PTC reported on the tax return is $9 million (less than the amount reflected in prices charged)

−Record a regulatory asset if PTCs reflected in base rates exceed PTCs reported on tax return

DR Taxes payable 9,000,000

DR Regulatory asset ($1 million + tax gross-up) 1,333,333

CR Tax benefit (PTC) 10,000,000

CR Deferred tax liability (on regulatory asset) 333,333

To record the amount of PTC realized and the amount needed to be reflected in rates in a future year due to reducing rates by more PTC than was generated in the current year


PTC adjustment clause (cont.) Example (cont.)

In a subsequent year, the regulatory asset is recovered from customers

DR Accounts receivable 1,333,333

CR Revenue 1,333,333

DR Current tax expense 333,333

CR Taxes payable 333,333

DR Deferred tax liability (on regulatory asset) 333,333

DR Tax benefit (PTC) 1,000,000

CR Regulatory asset 1,333,333

To record the incremental revenue charged in the subsequent year in order to recover the regulatory asset recorded in a prior year related to the reduction of base rates in the prior year by more PTC that was generated in the prior year


Ratemaking restrictions for investment tax credit (ITC) ITC normalization requirements – background

• Normalization provisions require ITC benefits to be shared between

−Utilities and ratepayers

−Generations of ratepayers

• ITC benefit is spread over the regulatory life of property

−Two main options are available for ratemaking

−Internal Revenue Code (IRC) Section 50(d), former IRC Section 46(f) and Treas. Reg. Section 1.46-6

• Rules are mandatory with sanctions for violation

−ITC – Tax Reform Act of 1986 Section 211(b)

−Deferred taxes – IRC Sections 168(f)(2) and 168(i)(9)(C) and Treas. Reg. Section 1.167(l)-1(h)(5)

−Public utility property placed in service after February 13, 2008, in tax years ending after such date, qualifies for the IRC Section 48 energy credit

• Legislative intent – “subject to” v. “protected by”


ITC normalization requirementsOptions for reflecting ITC in regulated rates

• The accounting and ratemaking treatment for ITC with respect to public utility property is largely dictated by former IRC Sections 46(f)(1) and 46(f)(2)

• The IRC permits sharing of ITC benefits between utility investors and customers either as

−Option 1—ADITC rate base reduction, with no amortization through operating expenses (i.e., regulatory income tax expense)

◦ Amortization must be no less rapidly than ratably over the regulatory depreciable lives of the related property

−Option 2—Amortization of ITC “above-the-line” as a reduction in regulatory income tax expense

◦ No rate base reduction

◦ Amortization must be no less rapidly than ratably over the regulatory depreciable lives of the related property

◦ Option 2 deferred ITC should earn at least the overall cost of capital if included in the capital structure

Ratemaking Formula

Rate basex Allowed rate of return= Required return+ Operating expenses= Revenue requirement


Impact of ITC on regulated rates (Option 1)

Revenue requirement

Operating income (return)Operating expenses

Rate baseX Rate of return

Wages/salaries Pension expense Depreciation expense Current FIT expense Deferred FIT expense

<Refund of excess deferred taxes> Fuel expense

Decommissioning costsOther costs

Plant<Accumulated depreciation>

<Accumulated deferred FIT><Unamortized ITC>


Impact of ITC on regulated rates (Option 2)

Revenue requirement

Operating income (return)Operating expenses

Rate baseX Rate of return

Plant<Accumulated depreciation>

<Accumulated deferred FIT>

Wages/salaries Pension expense Depreciation expense Current FIT expense Deferred FIT expense

<Refund of excess deferred taxes><ITC amortization> Fuel expense Decommissioning costs Other costs


BackgroundUtility investments in renewable energy partnerships

• Due to bonus depreciation and other reasons, many utilities have NOL carryforwards and are not able to utilize PTCs or ITCs currently

• Investments in partnerships owning renewable generation plants by utilities and tax equity investors

• Objectives

−Utilize credits rather than carry credits forward

−Earn a return on the investment and recover the cost of the investment

−Avoid ratemaking based on application of the deferred tax and, as applicable, the investment tax credit normalization requirements


Basic structure and transaction flowUtility investments in renewable energy partnerships

Project Company

Utility Tax Equity Investor

Customers

Sale of power under PPA

Sale of power


Utility investments in renewable energy partnerships Federal income tax issues

• Production tax credit requirement that power be sold to unrelated parties – IRC Section 45(a)(2)(B) and Notice 2008-60

• Whether deferred taxes and any ITC related to the power plant owned by the project company (partnership) are subject to the normalization requirements

−Potential application of Reg. Sec. 1.46-6(b)(4) regarding indirect reductions to cost of service or rate base

−In PLR 201946007 the Internal Revenue Service ruled that a wind farm owned by a tax equity partnership owned in part by a utility that purchases the output of the power plant is not “public utility property” under IRC Section 168(i)(10)

• Loss disallowance upon sale of property between certain related parties – IRC Sections 707(b) and 267(d)

−Sales or exchanges of “property” and application of Section 263A

−In PLR 201946007 the Service declined to rule that any losses of the tax equity partnership allocated to the tax equity investor will not be disallowed under IRC Section 707(b) because, in accordance with section 6.09 of Rev. Proc. 2019-1, the Service will not issue a letter ruling or a determination letter if the request presents an issue that cannot be readily resolved before a regulation or any other published guidance is issued.


Battery storage hot topicsAccounting for battery storage agreements


• Utility Scale vs. Residential vs. Commercial & Industrial

• Established as part of an interconnected group of assets

• Attached to:

◦ Specified facility

◦ Interconnection point of multiple generating facilities or assets

• Type of technology utilized with the battery:

◦ SaaS Arrangement (cloud based)

◦ On premise software

OverviewGeneral considerations


Questions to be addressed…• What types of involvement by the purchasing party

will be deemed to constitute design of the asset? Specifying the site? Specifying the technology? Specifying the configuration and layout? Combination of factors?

All three must be present to satisfy design?

How and for what purpose• How and for what purpose decisions often predetermined • Asset owner typically responsible for O&M• Need to evaluate whether the customer designed the asset

in a way that predetermines the most relevant decisions about how and for what purpose

Dispatch and Storage• Definitions• How considered in lease assessment

OverviewConsiderations for renewable energy power purchase agreements


Identified assetUnderstanding the criteria under ASC 842

Right of substitution

• Would result in theasset not being deemed a specifiedasset

• Substitution wouldbe considered only if substantive:−Lessor has the practical ability to substitute the asset

−Lessor wouldeconomically benefit from exercising its right of substitution

Contract must dependon use of identifiedasset

• Asset may be explicitlyor implicitly specified

• Physically distinct part of a larger asset may be an identified asset

• Capacity portion of a larger asset is generally not an identified asset


Benefits related to the ownership of an asset should not be included in the assessment of whether an arrangement contains a lease

Can obtain economic benefits from the use of an asset directlyor indirectly in many ways

Economic benefits from the use of an asset include its primaryoutput and by-products, including potential cash flows derivedfrom these items

Right to obtain substantially all of the economic benefits from use

Right to control the useObtain substantially all of the economic benefits from use


• Ability to direct “how and for what purpose” the asset is used throughout the period of use; or

• Relevant decisions about “how and for what purpose” the asset is used are predetermined and either:– The customer operates the asset or– The customer designed the asset that predetermines how it will be

used over the period of use

Right to control the use (cont.) Right to direct the use

Right to direct the use of the asset throughout the period of use

Protective rights, while defining the scope of the asset use, generally do not, in isolation, prevent the customer from being able to direct the use of the asset


What are the considerations to determine the “Unit of Account” for accounting analysis?

Are there assets within the agreement that can be/have:

• Separate/Different depreciable lives?

• Separately abandoned?

• Separately disposed of?

• Separately destroyed?

• Separately warrantied?

Offtaker considerations Defining the “Unit of Account”


View A.

The unit of account is the entirety of the Facility itself. Proponents of View A believe the unit of account should be assessed from the customer’s perspective (i.e., what does the customer think they are buying).

• The customer has contracted for the purchase of solar energy as well as the capability to shift energy consumption.

• The production of the energy and the storage capability are both critical to the customer and are effectively inseparable from a value perspective.

• The decisions about how and for what purpose the battery is used are dependent on how and for what purpose the Panels are used, and therefore, the battery is not a separately identified asset.

View B.

Each physically distinct asset should be evaluatedwhen determining if a customer controls the rightto use the asset (or assets).

• The refence to “asset” throughout ASC 842 should be assessed in a manner that is similar to how individual assets are accounted for under ASC 360.

• Assets that would be separately identified as a class of asset (e.g., different depreciable life) and that would be accounted for individually if owned (e.g., could be separately abandoned, disposed of, destroyed, etc.), should be assessed separately to determine if they are subject to a lease.

Offtaker considerations Defining the “Unit of Account”


Identify the various services and/or performance obligations (including scoping):

• Does the Agreement Transfer of title (or control) of the battery?

− If not, is the battery subject to a lease?

• Did you develop a customized battery or was it separately purchased (i.e. is the battery is a readily available commodity)?

• Do you perform the installation of the battery (can the installation be outsourced)?

• Do you perform the O&M Servicing of the battery?

• What technology is utilized in the battery and who makes the charging and dispatchdecisions?

Developer/Generator considerationsUnderstanding the arrangement


Lease Model

- Are payments all variable?

- Day one loss?

- What is the unit of account subject to the lease?

- Are there non-lease components?

- What is the lease term?

Developer/Generator considerations Potential models

Revenue Model

- What are the performance obligations?

- Does the battery transfer to the customer?

- What is the transaction price?

- What is the measure of progress (how is revenue recognized)?


Overview of opportunities for repowering assets


Owners of Wind Energy have an opportunity to repower wind turbine generators to take advantage of increased efficiencies and the federal renewable electricity production tax credit.

• Owners of wind energy facilities have the opportunity to repower wind farms that are past or approaching the end of their 10-year production tax credit (“PTC”) period

• Repowering involves replacing components of wind turbine generators with new technology resulting in increased output and efficiencies.−Complete vs. partial repowers

• Facilities are considered placed in service anew, restarting the 10-year PTC period if the cost of the new property is 80% or more of the sum of the cost of the new property and the fair market value of the used property (“80-20 Rule”)

Opportunity


Background and benefit PTC

• Enacted in 1992, the PTC is an inflation-adjusted per-kilowatt-hour credit for electricity generation• Applying the inflation-adjustment factor for the 2018 calendar year, the PTC amount is as follows:

− $0.024/kWh for wind, closed-loop biomass, geothermal energy resources, and solar systems that have not claimed the Investment Tax Credit

− $0.012/kWh for open-loop biomass, landfill gas, municipal solid waste, qualified hydroelectric, and marine and hydrokinetic energy resources

• Applying the inflation-adjustment factor for the 2019 calendar year, the PTC amount is as follows:

− $0.025/kWh for wind, closed-loop biomass, geothermal energy resources, and solar systems that have not claimed the Investment Tax Credit

− $0.012/kWh for open-loop biomass, landfill gas, municipal solid waste, qualified hydroelectric, and marine and hydrokinetic energy resources

• The exact amount of the PTC for calendar 2020 and future tax years will depend on the inflation-adjustment factor (and rounding) used by the IRS in the respective tax years


Background and benefit Deadlines

• On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (“PATH”) Act of 2015 and the Consolidated Appropriations Act of 2015 (together the “2015 TaxExtenders”)

• The 2015 Tax Extenders extended the termination dates for the wind PTC:− Construction begun before 01/01/17 – 100%− Construction begun in calendar 2017 – 80%− Construction begun in calendar 2018 – 60%− Construction begun in calendar 2019 – 40%

• The Bipartisan Budget Act of 2018, enacted in February 2018, further extended the termination dates for most other types of facilities eligible for PTCs (i.e., biomass, trash, geothermal, hydro) such that construction of these facilities must begin generally before January 1, 2018


• Facilities are considered placed in service anew, restarting the 10-year PTC period if:− the cost of the new property

the cost of the new property + FMV of the used property

− FMV of the used property the cost of the new property + FMV of the used property

• Each wind turbine generator with its tower and supporting pad is a separate qualified facility for purposes of IRC Section 45(d)(1), based on IRS guidance including Rev. Rul. 94-31

• Issued in December 2016, IRS Notice 2017-04 clarified that for purposed of repowering and the 80/20 rule, the cost of new property includes all costs properly included in the depreciable basis of the new property

• Identify expenditures allocable to each new qualified facility inclusive of all allocable costs to be capitalized under IRC Sections 263A and 263(a)

• Use proper method and elections for purposes of accounting for improvements/additions and for dispositions and removal costs

• Determining FMV of the used property is critical.

Wind project repowering – 80/20 rule

> or = 80%

< 20%


Potential tax issues

• How to value the used property• Identifying expenditures allocable to each new qualified facility inclusive of all allocable costs to be

capitalized under IRC Sections 263A and 263(a)• Method of accounting and elections for purposes of accounting for improvements/additions and for

dispositions and removal costs


Valuation considerations for 80/20 rule for repowering assets

• The income approach is used to estimate the wind farm value related to cash flows, contracts, and the spot market

• The cost approach is used to:− Estimate the replacement cost new (“RCN”) less

depreciation of all the assets of the wind farm (WTGs, roads, collection system, etc.), giving special consideration to obsolescence (physical, functional, and economic)

− Cost approach of the wind farm and qualified facilities should represent the existing plant and wind turbine generator technology

• Estimate the Fair Market Value (“FMV”) of the used property of each qualified facility to be included in the 80/20 test calculation

• Calculate the ratio of the used property FMV to the total facility FMV (sum of used property FMV and new qualified facilitates) to show that it doesn’t exceed 20%


Other considerations

• Assumptions used in the repowering analysis should be consistent with other parts of the business• Consider using a specialist to assist with the valuation analysis• Evaluate what the unit of account is for the old components being replaced• Identify appropriate internal controls over the repowering analysis including information used in the

analysis/provided to specialists

This presentation contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this presentation, rendering business, financial, investment, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this presentation.

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Documents

Renewable Accounting Update - Deloitte United States...• Hypothetical Liquidation at Book Value (“HLBV”) is a balance sheet-oriented approach which provides a methodology for