Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
Business & Money
Business & Money
The application of FASB Statement No. 13 can result in unforeseen changes to the financial statements and, in turn, financial ratios of a utility.
Over the past eight months, accountants in public and private practice have seen two major pieces of guidance affect their utility clients. The Financial Accounting Standards Board (FASB) issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" and deliberated over the in-terpretation of Emerging Issues Task Force (EITF) No. 98-10.1 Both of these standards impact the determination of whether a contract is a derivative and recorded at fair value within the financial statements. However, the FASB also approved another topic of interest.
The FASB ratified EITF No. 01-08 (EITF 01-08), "Determining Whether an Arrangement Contains a Lease," which will affect any company that obtains a benefit from the use of a particular asset through a contract. For instance, if Company A contracts with Company B to purchase power from Plant X, both Company A and Company B have to evaluate that contract to determine whether a lease is present. But the focused financial executives might still be confused about how this contract might affect their company.
If the contract is considered to be a lease under EITF 01-08, the company will have to apply the requirements of FASB Statement No. 13 (FASB 13), "Accounting for Leases." The application of FASB 13 could result in unforeseen changes to the financial statements and, in turn, financial ratios of a utility.
Given the current refocusing in the market, the financial executive must take EITF 01-08 into consideration when contemplating asset transactions or contract amendments.
A utility should use a three-step process to evaluate its contracts. The first step is to determine if the contract relates to the right to use property, plant, or equipment (land and/or depreciable assets). If not, the company goes no further, as FASB 13 only applies to those items. If the contract relates to one of these items, the executive must then ask whether it relates to specific land or depreciable assets (step 2)-for example, if Company A has a contract to buy power from Company B and the contract specifically mentions that Plant X provides the power, a lease might be present. Similarly, if Company A has a contract to buy power from Company B and Company B owns only a single plant (Plant X), the contract might be a lease even if Plant X is not named in the contract. However, if the contract between Company A and Company B does not mention a specific plant and does not imply the use of a particular plant, then the contract might not be a lease.
The final step is to evaluate the right to use a facility. Under FASB 13, a right to use the asset is a key determinant, as it implies the right to control the asset.
A right to use a facility could consist of controlling its operation, controlling access to the facility, or whether one or more parties will take more than a