Accounting for Wind Power (#382)

Asset Capitalization

The topic of this episode is the accounting issues for the wind power industry. Let’s start with the capitalization of assets. A wind power installation is comprised of turbines, blades, gearboxes, and towers. Turbines have a useful life of about 25 years, while the blades don’t last as long – usually in the range of ten to twenty years. The issue with blades is that they’re subject to weather damage, and so might have be replaced a couple of times over the life of a tower.

Gearboxes last for the shortest amount of time, usually in the range of seven to ten years, and require a lot of maintenance even during that period of time. And finally, the towers that support all of these other items can last for 25 to thirty years. They’re made of heavy steel, and so last longer than the other components.

Given the differences in asset lives, each of these asset types has to be recorded and depreciated separately.

Another issue, and one that’s similar to solar power installations, is the capitalization of interest costs. If you’ve incurred debt to pay for an investment in a wind farm, then you should capitalize the cost of the interest incurred during the construction period, and then depreciate it over the useful lives of the related assets.

Asset Impairment

A somewhat related issue is asset impairment, and this is where wind power can differ a lot from solar power installations. An issue that’s cropped up in just the past few days is that the current administration thinks that wind farms are not good, for a variety of reasons, and so is withdrawing its approval from a number of wind farms, especially off the coast. I won’t get into the reasoning, but the main point from an accounting perspective is that a withdrawn operating license means that an entire wind farm would then be inoperable, so that you’d have to write off the entire capitalized cost. All of it.

However, it’s not really that simple. You would write off a wind farm when it’s probable that the facility will not be operable – which could depend on the outcome of one or more lawsuits and regulatory challenges. And that might take years.

During that time, you’d have to get with your legal team to estimate the probability of the facility being shut down, and recognize impairment based on that analysis. This is more of a qualitative issue than a quantitative analysis, so whether an impairment should be recognized at all, and in what amount, can be really hard to determine.

But there’s more to asset impairment than just presidential disapproval. An initial site analysis for a wind farm might estimate a certain wind speed over a certain number of hours per year. If you then install the towers and find that the wind speeds are lower than expected, then that reduces the amount of revenue generated, which can trigger an impairment. And on top of that, you may find that there are mechanical failures, especially in regard to the blades and turbines. If so, you may have to write them off and install replacements.

Asset Retirement Obligations

Which brings us to asset retirement obligations. A wind farm operator will probably have to recognize a liability for the cost to dismantle a wind farm at the end of its useful life. Dismantling is not an option – a requirement to do so is usually built into the operating license.

This can be expensive, because you have to dismantle and remove some very large structures, and excavate the foundations, which can extend ten to fifteen feet underground. In addition, fiberglass blades can be very hard to recycle. This is because they’re made of a fiberglass and reinforced plastic composite, which makes them nearly impossible to melt down. Instead, they may end up in a landfill, or be shredded and used as a cement reinforcement.

You also have to remove underground cables, substations, and transmission tie-ins, and restore the land. And on top of that, the jurisdiction in which the wind farm is located might decide to tighten up its reclamation requirements at some point in the future, which can increase your obligation even more.

And, if the wind farm is located offshore, then the retirement obligation can be an order of magnitude greater, because you have to conduct seabed restoration, and remove underwater cables, and eliminate anything that could impact ship navigation.

Revenue Recognition

The next accounting topic is revenue recognition. A wind 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 a wind farm goes offline for any reason, such as when the wind speed drops, then there’s no revenue.

The business might also sell renewable energy certificates. As I mentioned in the last episode, 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 wind farm 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 wind power recognizes the value of the certificates when the electricity has been produced. It usually records them 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, 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.

Expense Recognition

There are also a couple of expense issues to be aware of. Wind farms are typically constructed on grazing or farm land, where the landowner is entitled to a percentage of the proceeds from any revenue generated, rather than just being paid a fixed fee. If so, you’ll need to calculate the amount of revenue sharing paid to the land owner, which is recorded as an expense.

Another expense is leases on land use. This is usually structured as a very long-term lease that covers the entire estimated life of the assets installed on the land. If so, you’ll need to record a long-term lease obligation, which includes the right-of-use asset.