New ASC 842 lease accounting in oil and gas, renewable energy and utilities

Jul 27, 2023

Accounting for leases requires lessees to record on their balance sheet a right-of-use asset and a lease liability for all leases not deemed to be short-term leases — leases with term of 12 months or less at commencement date that don't include an option to purchase the underlying asset that the lessee is reasonably certain to exercise.

Consequently, the adoption of the new leasing standard, from the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) 842, Leases, could potentially have a significant impact to an organization's financial statements, including key financial ratios and other financial metrics.

ASC 842 effective date

The effective date for adoption of ASC 842 for entities that aren't public business entities, or weren't required to adopt or didn't early adopt, is for annual periods beginning after Dec. 15, 2021, and for all interim periods within fiscal years beginning after Dec. 15, 2022.

It's important to note that all lease types aren't included. For example, not included in the scope of ASC 842 are leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources.

This includes the intangible right to explore for those natural resources and use the land in which those natural resources are contained; unless those rights of use include more than the right to explore for natural resources, where equipment used to explore for the natural resources is within the scope of ASC 842.

Practical expedients

ASC 842 allows for lessees to elect practical expedients to reduce the burden of implementation. There are three practical expedients that must be consistently applied and elected as a package. Entities don't need to reassess:

Overarching considerations

The lease term is an important consideration for all entities within the oil and gas, renewable energy and utilities sectors.

Lease term

Lease term begins at the commencement date — when the underlying asset is available for use — and is based on the noncancelable portion of the lease, plus all of the following periods covered by an option to:

Hindsight practical expedient

Entities can elect a practical expedient to use hindsight when determining the lease term upon adopting ASC 842.

Conduct a robust assessment to determine the most appropriate adoption method and election of practical expedients. These selections will likely have a significant impact on the adoption of the standard and how it impacts an entity's financial statements and related disclosures.

Oil and gas considerations

Following are some questions to consider.

Is the contract a lease?

To be considered a lease:

The joint operating agreements, also referred to as JOA, might dictate who has control of the asset.

Does the contract contain an embedded lease?

Embedded leases are more challenging to identify. Common types of contracts that may contain an embedded lease include:

To be considered a lease, there must be an identifiable asset within the scope of the contract that the entity is deemed to control.

Even if there is an identified asset, an entity will need to assess if the supplier to the contract has substantive substitution rights because this can impact the assessment of control.

Right-of-way agreements and land easements

Right-of-way agreements and land easements are common in the oil and gas industry.

A lease for the rights to use land that's solely to explore for natural resources that are contained within those rights are excluded from ASC 842.

Additionally, a perpetual land or right-of-way easement or land easement contract is outside the scope of ASC 842 because a lease is for the right to use an asset for a period of time. Careful consideration should be given to the terminology in a contract because it might appear to be perpetual when in fact it's not.

If a right-of-way or land easement is considered in the scope of ASC 842, then an entity must determine if the contract allows it to obtain substantially all the economic benefit of the identified asset.

ASC 842 provides for a practical expedient that allows entities to continue to treat its easement contracts in accordance with legacy generally accepted accounting principles as long as they weren't accounted for as leases under ASC 840. If the contract was accounted for under ASC 840 or was modified on or after the adoption of ASC 842, entities will need to assess the contract in accordance with ASC 842.

Renewable energy considerations

When assessing a lease in the renewable energy sector, there are three main considerations:

Considerations for utilities — FASB followers

When assessing a lease in the utilities sector, note the following considerations.

These considerations are for those entities that follow the accounting standards issued by the FASB. There are some differences between the FASB and Governmental Accounting Standards Board (GASB) with respect to these issues.

In conclusion

Although companies have previously been required to disclose all material leases, the requirement that they be recognized on the balance sheet will require a more thorough focus and new calculations for proper accounting as well as new disclosure requirements.

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