Impaired Power Plant Asset With Attached Debt? Use ASC 360 and ASC 980 in Tandem
Impaired power plants are part of the electric business - ASC 360 shows evaluation methods
ASC 360 ˆProperty, Plant, and Equipment for impaired assets has become a steady part of our utility accounting world. Over the years the electric utility business was known as a stable and slow moving industry. Slow and steady isn’t a bad approach sometimes. But in recent years, the electric utility power supply model is rapidly changing, as technological and political forces change the framework under which the industry provides power and services to customers. With the advent of a new administration, the outlook for the power industry over the next two years is not certain.
In any case, these changes require electric utilities to take a close look at asset utilization and the long-term viability of current power supply assets. As options are evaluated, a utility may realize that it is time to implement new power supply resources, more renewables or move to a new type of fuel. Those decisions will drive a consideration of ending the utilization of current power plants before the end of their useful lives. The technical accounting term for this change or falling out of favor is called an asset impairment.
We could get down in the weeds with this topic, but this article’s high-level discussion can give you a good head start to determining the application of the impairment rules and potential impact on your utility rates.
Key Points on Why This Approach is Beneficial
1. ASC 360 is the required approach for IOUs and Electric Co-ops - ASC 360 defines the measurement criteria for impaired assets. The basic formula is Book Value minus Assessed Value, the difference is the impairment if it is a negative number.
2. Outstanding debt on impaired assets still must be paid - Often, long-lived assets such as power plants are financed with revenue bonds. Some of the bonds may still be outstanding at the impairment date.
3. ASC 980 can alleviate the financial statement impact - ASC 980 is the tool to use to match the recognition of the impairment loss with outstanding bond payments.
Power plant impairment impact electric rates
The factors that drive impairment
Private sector utilities and electric cooperatives operating under the accounting rules in ASC 360 - Property, Plant and Equipment. The standard states that an impairment exists if the carrying value of an asset or asset group exceeds its current fair value. The testing for impairment should be done when it is determined that events or changes in circumstances show that an asset’s carrying value may not be recoverable in customer rates.
Some common events include:
1. Significant decrease in the market price of a long-lived asset or asset group
2. A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
Significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator (rate approval body)
An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group)
A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the long-lived asset (asset group)
A greater than 50% expectation that a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.
Other considerations:
1. Depreciation estimates may be changed and those changes should be considered in calculating future cash flows of the assets
2. An asset(s) should be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets
(In plain language – a group of coal power plants has an identifiable cash flow independent of gas power plants – the asset classes should be evaluated separately)
There are many factors that can impact asset rate recovery and lead to impairment, such as:
1. Technology and environmental standards that might not be able to be met without substantial investments
2. Fuel prices
3. Competition in the market
4. Damage to the assets from weather or accidents
5. Economic conditions such as a loss of a major customer or economic downturns
If any these situations occur a consideration should be made for evaluating potential impairment.
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What path should we take?
The decision possibilities when it comes to recording an asset impairment follow this approach:
Asset impairment decision grid
Calculating and recording an asset impairment
In the most direct approach, the difference between an asset or asset groups’ fair value and carrying value (book value) is the impairment. Other costs can be included (costs that deal with evaluating the fair value, potential disposal and other studies for example), but we will focus on the larger issues in this article. An impairment should be recognized as a loss in the period of determination of the impairment, impacting net income. Under ASC 360 – Property, Plant, and Equipment, once an impairment has been recognized, it cannot be reversed.
Creating a regulatory asset to recovered impaired asset costs in customer rates
An impairment should be recognized as a loss in the period of determination of the impairment, impacting net income. This, in turn, raises the question of whether the amount calculated as an impairment will be recovered in utility customer rates. Rate recovery may be important as often the impaired asset has been financed with debt, and a portion of that debt may still be owed to bondholders.
Regulatory accounting under ASC 980 can be used to recover these impaired costs from customers, on approval of the regulator (state or federal regulatory entity, Coop Board, or other body that has the authority to approve customer rates).
Under ASC 980-360-35-3, an evaluation should be made of the potential of future cash flow recovery in customer rates of the calculated impairment. The ASC standard states that the present value of future revenues to be provided in customer rates should be recorded as a regulatory asset and amortized over the period the same amounts are recovered in customer rates. The discount rate used to compute this present value should be based on the entity’s incremental borrowing rate, i.e., the rate the entity would pay through its typical borrowing sources.
Rate impact of impairment losses
Generally, as impairment losses are related to capital assets, the impairment amount should be reflected in increased customer fixed charges (demand and customer charge). We have observed some utilities include a separate impairment fixed surcharge in customer rates. We have also seen an approach to include the fixed impairment charge directly in the utility revenue requirement and in the customer fixed charge (demand and customer charge), but not separately identified on the customer’s bill. Joint power plant owners share in the impairment entry and loss.
Practical example
Here is an example of the high-level application of the impairment rules in ASC 360.
Situation: The price of natural gas has made the coal power plant units in the utility’s portfolio uncompetitive in the market. Complying with new environmental regulations would also require significant expenditures that the utility considers would not be recoverable in rates. The utility evaluates the current fair value of the assets and determines that they are impaired.
The relevant amounts to consider in the impairment evaluation follow:
Impairment calculation
Entry 1 – NOT recording a regulatory asset
The utility chooses to not record a regulatory asset for recovery of the impairment, rather, recognizing the impaired asset and absorbing the loss. The entry to record the asset impairment is:
Recording ASC 360 impairment loss
Entry 2 – Recording a regulatory asset
It is very unlikely that the utility would not record a regulatory asset for rate recovery of the impairment, unless it was disallowed by the rate regulatory body. Once approved by the rate regulatory body, the utility records a regulatory asset.
Using ASC 980 to record impairment loss
Customer rates will be increased for recovery of this asset, the asset will be amortized over the rate recovery period, and annually the asset will be increased by the utility’s incremental borrowing rate.
Amortize impairment loss using ASC 980
Review the fixed asset portfolio now for potential impairments
We recommend that you dig into the specifics of ASC 360 for some of the nuances involved with calculating asset impairment. While you may not like the impairment evaluation answer, the time to review the asset portfolio for potential impairments should happen sooner rather than later. Evaluating sooner will allow the potential regulatory process to play out to recover some or all of the impaired asset costs in customer rates.
About Russ Hissom - Article Author
Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power and utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.
Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.