Accounting Considerations for Repowering: Background
As the U.S. turns all eyes to a carbon-free future, one cannot forget that renewable energy generation has been around for years. While those existing sites might be slowing down or less efficient, they could still play a significant role in helping the U.S. achieve its clean energy goals. Repowering a wind site can often consist of upgrading turbines, gearboxes, hubs, main shafts, and main bearing assemblies while upgrading solar sites includes options for the panels, inverters, and trackers. The use of the latest technology for repowering projects can significantly extend the useful life of the facility while increasing power production and efficiency or possibly provide the perfect opportunity to add battery storage. Not to mention, many of the older wind and solar farms are in prime locations where the conditions are favorable for electricity generation, interconnections to the grid, and other supporting infrastructure are already present. These factors, and the potential to requalify for or extend certain renewable energy tax incentives, can lead to repowering being a financially attractive option. However, there are unique considerations that come with upgrading or replacing such a significant portion of a fixed asset.
Often, a decision to repower a wind or solar site is made before the assets are fully depreciated, and, at times, the economics may support a repowering when the in-service assets still have significant useful life left. That begs the question of how to account for the in-service assets that will be upgraded/replaced as part of the repower efforts. A decision to repower a renewable generation site generally would not result in an immediate write-off of any existing asset that will be replaced. If the site is still generating power, then the assets would be considered held and used under the guidance in Accounting Standards Codification (ASC) 360, Property, Plant, and Equipment. However, the decision to repower a renewable energy site would likely result in an entity needing to perform a held and used impairment test based on undiscounted cash flows as outlined in ASC 360. Any resulting impairment from that test should be recognized at the time it is identified.
Individual Asset Level Depreciation
When depreciation is being recorded at the individual asset level, the useful life of the assets to be replaced should be updated to only cover the period until the point the asset is removed from service as part of the repowering effort. Also, if there are any updates to the salvage value, they should be made at that time as well. Depreciation from that point forward should result in the assets being replaced being depreciated down to the updated salvage value (if any) up to the point that the repowering event occurs.
Group or Composite Asset Depreciation
While the concept of what to do in situations where each individual asset making up the renewable energy site is tracked separately is straightforward, the appropriate treatment when group or composite depreciation methods are utilized can appear more complicated. Group depreciation is often utilized for a set of assets that are homogeneous in nature and have approximately the same useful lives. Composite depreciation, on the other hand, can be utilized for heterogeneous assets that have different useful lives, such as an entire wind generation site or an entire solar site. Under group and composite depreciation methods (collectively referred to as “group”), depreciation is recognized over the average life of the assets in the group. Generally, group depreciation methods do not result in the recognition of a gain or loss upon the retirement of an asset. For example, replacing 3% of the wind site gearboxes due to a high failure rate of that specific model would not typically result in an income statement impact under a group depreciation methodology. In those situations, the original cost of the asset is removed from property, plant, and equipment with an offset to cash for any consideration received, and the difference is recorded to accumulated depreciation. As a result, any gain or loss on that disposal is initially reflected in accumulated depreciation instead of through the income statement. Once the final assets in the group are retired, any remaining difference between the fixed asset balance and accumulated depreciation is recognized as a gain or loss in the income statement. In this example, assume the original cost of the asset to be replaced was $1,000, and the company received $100 in cash from the local scrap yard. The entry would be:
| Sample Entry to Record the Disposal of a Portion of Assets | Debit | Credit |
|---|---|---|
| Cash | $100 | |
| Accumulated depreciation | $900 | |
| Property, plant, and equipment | $1,000 |
To record the disposal of 3% of the wind site gearboxes and cash received.
However, under group depreciation, if there is an unforeseen or unexpected retirement of an asset in the group, any gain or loss should be recognized in earnings immediately. Now, you may be thinking to yourself, what about that example with the gearboxes? Isn’t a high failure rate on that particular model of those assets unexpected and unforeseen? One viewpoint is that with any type of equipment, there is the potential for mechanical or performance issues and that having an issue with a small percentage of the gearboxes in a group is to be expected. However, if a whole wind site is destroyed due to a wildfire, that would be an unexpected and unforeseen incident.
While at first glance, how to handle a repower situation might seem more complicated under group or composite depreciation, the treatment is generally very similar to when assets are tracked individually. When repowering a renewable facility, only a portion of the assets will be replaced/upgraded, while a portion of the structure will remain in place. However, once the decision is made to move forward with a repower event, assets depreciated as a group will need to be revisited, and those assets being replaced will generally need to be removed from the larger depreciation group and depreciation updated so that the assets are fully depreciated when they are removed from service for the repower. The remaining assets should also be evaluated to determine if the average useful life and salvage values are still reasonable.
You might be thinking, well, if I have group or composite depreciation, my assets have lost their individuality, how do I know what their net book value is to determine the depreciation expense needed to fully depreciate the assets by the time of the repowering? One reasonable approach would be to take the percentage of the original costs of the assets to be removed as a percentage of the total depreciation group and apply that percentage to the accumulated depreciation to determine the net book value of those assets. An example of this approach is as follows:
| Calculation of Percentage of Removed Assets to Total Depreciation Group: | |
|---|---|
| Original cost of assets to be removed | $50 |
| Total original costs of depreciation group | $1,000 |
| Percentage of removed assets to total ($50/$1,000) | 5% |
| Calculation of Depreciation to Be Accelerated for Assets to Be Removed: | |
|---|---|
| Accumulated depreciation at time of disposal determination | $600 |
| Accumulated depreciation related to removed assets (5% * $600) | $30 |
| Depreciation to be accelerated related to assets to be removed ($50 - $30) | $20 |
There could be other reasonable approaches to determining the net book value of replaced assets depending on the asset group, so the approach could be tailored based on the individual facts and circumstances.
Alternative Views
Due to renewable facilities repowering being a relatively new concept, a few alternative views are being discussed in the industry.
Addition to Be Capitalized
One view is that the assets installed as part of the repower effort are betterments that extend the life and/or increase the functionality of the renewable energy site and, therefore, can be capitalized without fully depreciating or otherwise expensing the old assets. While we probably all agree that the repowering assets do extend the life and functionality of the generation site, there are few cases in which keeping the assets on the balance sheet would be appropriate. If the assets have been replaced, they are no longer held and used under the guidance of ASC 360 and would need to be assessed for impairment.
Repairs & Maintenance
Another viewpoint is to treat the repower assets as maintenance items and expense those as incurred while continuing to depreciate the original assets over their initial useful life. Similar to the note above, if the assets are being removed from the site, then they are no longer held and used and would need to be assessed for impairment. Maintenance is generally considered to be repairs and work done on existing assets to maintain their operating condition. In a repowering scenario, the new assets are extending the site's life and are long-lived tangible assets being used to create and distribute energy. Therefore, assets utilized as part of a repower project would generally not be considered maintenance items.
Already Considered
One additional argument could be that group and composite depreciation methods take into account that the useful life of some of the assets will be less than that average life, so why consider this if a portion of the assets are replaced early given the imprecision of this method? However, a repowering scenario generally replaces a large portion of assets and the impact to the group likely would not be insignificant. Therefore, simply allowing the existing assets to continue to be depreciated as part of the group could materially misstate the financial statements.
FORVIS Can Help
If you or your organization needs assistance evaluating the accounting or tax impacts of a repower scenario, please reach out to a renewable energy professional at FORVIS.