An evolving market demands a greater focus on power prices and required return on equity.
Valuation can be difficult even in stable markets, and executives setting...
Business & Money
minor amount of output from this facility and the price is not fixed per unit nor indexed to market prices.
For instance, assume Company A and Company B have a contract and the contract allows Company A to make decisions on when to operate, what to operate, and how to operate; or Company A sets limits on output, with no more than a prenegotiated minor amount received by another party.
In the preceding example, Company A is essentially determining the operating capacity of the facility. Therefore, evaluating a right to use is crucial because the right could imply that the party to the contract has more control of the assets than the owner of the facility providing the service.
If a contract passes these three steps the company would be required to apply the requirements of FASB 13. Upon the application FASB 13, a company must determine the type of lease. Based on this determination, the buyer could have additional assets or liabilities added to its balance sheet or the reclassification of assets and liabilities for contracts that were previously derivatives but are now leases. In addition to the modification of derivatives, revenue recognition principles would also change because revenue recognition for leases is idiosyncratic.
For instance, if the contract qualifies as an operating lease, the lessee and lessor would recognize expense and income ratably over the life of the lease. For balance sheet purposes, the lessor would continue to record an asset for the value of the lease. However, if the lease meets the requirements for sales-type lease accounting, the lessor would record an investment in the lease, which would represent the value of the minimum lease payments and the unguaranteed residual value. The difference between the minimum lease payments and the unguaranteed residual value, and the present value of the minimum lease payments and the unguaranteed residual value, would be recorded as unearned income. The unearned income would be amortized to produce a constant rate of return over the life of the lease.
Another potential scenario would be that the lease meets the requirements of a capital lease. In this instance, the lessor would derecognize the leased asset and would recognize a lease receivable for the amounts due under the lease. The lessee would record a capital lease asset and obligation. The lessor would record income over the life of the lease based on the unearned income calculation, which is dependent on whether the lease is classified as a sales type or direct financing lease.
The changes don't stop there. Most contracts contain a capacity charge and an energy charge. EITF 01-08 is applicable only to the lease element of the arrangement. Therefore, companies will have to evaluate each aspect of a contract and determine which component or components meet the lease classification criteria. If a component does not meet the lease classification criteria, it would be evaluated separately. Companies could be in situations where the original contract was a derivative, and upon applying EITF 01-08, the contract is separated into additional components. The components could potentially be a lease,