Accounting for Solar Power (#381)

I’m only going to cover businesses that set up solar panels and sell the resulting power into the power grid, not the panels installed on someone’s house.

Capitalization of Solar Costs

Let’s start with the obvious accounting item, which is capitalizing the cost of the panels. This includes the cost of not just the panels, but also any associated racking systems, and batteries, and inverters. In case you’re wondering, a solar panel produces direct current, and an inverter is needed to convert direct current into alternating current, which is what your typical power grid produces. But we’re not done capitalizing yet, because we also have to capitalize the installation cost, and permitting and inspection fees, and interconnection fees. The interconnection fee is the one-time charge to hook up the solar panels to the local power grid.

And on top of all that, if you’ve taken out a loan to pay for everything, then you’re supposed to capitalize the cost of the interest incurred during the construction process. In short, pretty much every initial cost is capitalized.

Depreciation of Solar Assets

There are also depreciation issues. Solar panels have a fairly long useful life, so they can be depreciated for anywhere from 20 to 30 years, but inverters and battery storage systems wear out sooner – anywhere from five to 15 years – so you have to record these assets separately and depreciate them over different periods of time.

Impairment of Solar Assets

A further issue is the impairment of solar assets. There are lots of issues that can cause impairment. For example, solar panels naturally degrade over time. The typical degradation rate is between 0.5% and 0.8% per year, which can be worse in a harsh climate where there are greater temperature extremes or higher humidity. If there’s a higher-than-expected rate of degradation, then you have to record an asset impairment.

And there are other issues that might trigger an impairment. For example, there might be a fire, or flooding. Or, for that matter, if there’s a decline in the tariff rate on solar panels, then the market value of the existing panels declines, which triggers an impairment. Another cause is technological obsolescence, which happens whenever more efficient panels become available.

And, for that matter, you’re going to have asset impairment if there’s a long-term drop in the demand for electricity, since that lowers the revenue you can potentially receive; this last one may not be so big of an issue if you’ve entered into long-term contracts to provide electricity at fixed rates. Nonetheless, given the long-term nature of this asset, there’s a pretty good chance that one or more of these triggering events could occur over the life of a solar asset. In short, an impairment charge is quite possible, if not likely.

Revenue Recognition

The next accounting topic is revenue recognition. A solar power provider earns revenue under a power purchase agreement, where it sells electricity to a customer, usually at a set price and for an extended period of time. Under this arrangement, revenue is recognized when the system delivers electricity to the customer. If the solar array goes offline for any reason, or if it’s cloudy, or snow covers the panels, then there’s no revenue. Which is why there are so many big solar installations in warmer areas where there aren’t many clouds – it’s all about the revenue.

The business might also sell renewable energy certificates. First of all, what are they? A renewable energy certificate represents the environmental attributes of one megawatt-hour of electricity that’s been generated from a renewable energy source. So, when a solar array generates electricity, it produces two outputs, which are the actual electricity and a renewable energy certificate, which certifies that the electricity was produced from a renewable source. These certificates can be sold separately from the electricity, so that some other organization can claim to have used the renewable energy even if they didn’t directly receive the electricity. This third party would use the certificate to either meet its own sustainability goals, or meet a regulatory requirement to use renewable energy.

Under these certificate arrangements, the producer of solar power recognizes the value of these certificates when the electricity has been produced. It usually records these certificates as inventory that’s being held for sale, and values them at fair market value, which is the rate at which the certificates are trading in the local market. When it sells a certificate, it recognizes revenue when control over the certificate is transferred to the buyer.

Market prices for renewable energy certificates can have a lot of variability, even within a short period of time, so if the seller retains ownership of the certificates for an extended period of time, it might have to test them for impairment.

One more revenue issue is that the seller might sell both electricity and renewable energy certificates to the same customer. If so, it will need to break out how much of the revenue generated is associated with the electricity, and how much is associated with the certificates, and record them separately.

Decommissioning Solar Assets

Another accounting issue relates to decommissioning solar assets, which means dismantling and disposing of solar panels at the end of their useful lives. This might involve recognizing an asset retirement obligation early on, which is adjusted based on your most recent best estimates of which the decommissioning will cost.

Decommissioning can be fairly expensive, for a couple of reasons. First, some solar panels contain hazardous materials, like cadmium and lead, which require special disposal operations. And on top of that, batteries contain all kinds of toxic materials. And second, the cost to recycle panels is fairly high, and for the parts you can’t recycle, there’s a landfill charge.