Accounting Issues Concerning Businesses of and Investments in Renewable Energy

1. Depreciation of power generating equipment

In renewable energy businesses, investment in fixed assets accounts for the majority of the construction cost: such as solar panels in the case of solar energy and wind turbines in the case of wind energy. These fixed assets are required to be depreciated periodically in an organized and regular manner based on a reasonably comprehensive accounting method to allocate cost appropriately ("formal depreciation").

A straight-line or declining balance method is generally used for the depreciation of those assets, but in Japan, it is a common practice to apply methods stipulated in the corporation tax law when accounting for depreciation. When conducting an audit, accounting treatment following the tax depreciation method is allowed as an interim measure as long as it is not considered unreasonable in light of the company's circumstances.

Useful life is principally based on the estimated years of future use of the underlying asset. However, the useful life that is stipulated in the corporate tax law is often used as a common practice. When conducting an audit, accounting treatment to apply statutory useful lives is allowed as long as there are no facts showing apparent discrepancies.

On the other hand, when the Procurement Price Calculation Committee decided the procurement period for each area, it was determined to be 20 years for both solar and wind energy equipment, exceeding the statutory useful life for tax purposes of 17 years.

2. Special depreciation and reserve for special depreciation

For political reasons, special depreciation, including one-time depreciation, is allowed for some assets used in renewable energy businesses as part of the Green Investment Tax Credit. However, because formal depreciation is required for accounting purposes, special depreciation based on the Green Investment Tax Credit should be accounted for by recording a reserve for special depreciation.

3. Capital expenditures and repair expenses

For accounting purposes, capital expenditures are defined as expenditures that improve the value of the underlying assets, while repair expenses are defined as the cost necessary to maintain present value. The definition is clear, but practically it is often difficult to distinguish between them. Whether it is permissible to apply tax treatment to the accounting remains open for consideration.

4. Equipment lease

As part of their finance strategy, some operators use power generating equipment leased from lease companies instead of owing them themselves. In these cases, there are two types of lease accounting methods required by the current accounting standards: finance leases and operating leases. Finance leases are accounted for as sale and purchase transactions, while operating leases are accounted for as rental transactions. A finance lease is a lease contract whose term is non-cancellable, in which the lessee receives substantial economic benefit of the leased asset and bears all the costs arising from the use of the leased asset. The operating lease is defined as a lease other that in not a finance lease.

5. Accounting treatment for land lease and asset retirement obligation

Land may be leased when installing power generating equipment such as solar panels. In such cases, an obligation to remove the installed equipment and restitute the land to the owners may arise at the end of the lease term. This should be considered when assessing the life of power generating equipment, and if costs for the retirement of the equipment are expected to occur, such costs should be accrued and recorded as asset retirement obligation.

6. Assessment and recognition of impairment at period end

Power generating equipment is a fixed asset and is principally valued at cost. However, impairment accounting is required in certain cases. Impairment accounting is a treatment to reduce the book value of an asset in order to reflect the asset’s recoverability under certain conditions, when the invested amount is considered not fully recoverable because of the decline in its profitability. It should be noted that impairment accounting does not require assets to be valued at market price, but it requires a reduction in their book value in certain conditions.

7. Consolidation of financial statements when the operator is an SPE

Special purpose entities (SPEs) are often used when project financing for the construction and purchase of power generating equipment. In principle, such SPEs should be consolidated when they are deemed to be subsidiaries. However, careful consideration is necessary because in many cases, voting interests do not always have a substantial influence on the power to control those SPEs.

8. The difference between tax and accounting treatments when the operator is a conduit

To increase tax efficiency, some operators use structures called conduits in which they have SPEs own power generating equipment so that the operators does not bear tax liability. As the difference in tax and accounting treatments in such conduit structure generally results in the conduits bearing tax liability, it should be carefully considered when assessing impairment and other items that often show a significant difference.

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