A Lease, or Not a Lease: That Is the Question

Background

Issue 01-8 was added to the EITF's agenda in July 2000, primarily as a result of diversity in practice related to determining when an energy-related contract (such as a power purchase agreement that gave the purchaser the right, but not the obligation, to purchase a specified quantity or percentage of the output of a generating facility in exchange for a fixed monthly capacity payment) was a lease, a derivative, or another executory contract subject to the guidance in EITF Issue 98-10, 'Accounting for Contracts Involved in Energy Trading and Risk Management Activities.' (Although added to the agenda in 2000, the issue was not discussed by the EITF until January 2002. Prior to that, the issue had been referred to a working group charged with making recommendations to the EITF. The working group, which included representatives from public accounting, industry and the FASB and Securities and Exchange Commission staffs, commenced its discussions in August 2001.) Contracts within the scope of Issue 98-10 could be reported at fair value, with changes in fair value recognized in earnings, while leases could not. Therefore, it was important for energy traders, who believed fair value accounting provided more relevant information to users of financial statements, to be able to conclude that a contract was not a lease. Energy traders generally argued that a contract was not a lease because a trader did not control (was not operating) the property that was producing (or transporting) the energy, was not taking all of the productive capacity of the property, and was not exposed to the normal risks and rewards of owning the asset. Rather, the energy trader was exposed to the risk of changes in commodity prices if the asset from which delivery was expected was not operating.