8 Accounting Considerations for Solar and Other Renewable Energy Industries Post IRA

With the Inflation Reduction Act of 2022 (“IRA”) and increased focus on climate sustainability, there has been immense interest from international and U.S. investors to enter the clean-energy sector in the U.S.

As solar and other renewable energy industries experience significant growth, it’s a good time to consider these hot accounting topics and ask the following questions:

1.  Do you have power purchase agreements or virtual power purchase agreements?

Solar and other renewable power developers enter transactions with customers in which energy, renewable energy certificates (“RECs”), and capacity are often bundled together in a single contract with one transaction price.

Accounting analysis of this arrangement can get very complex as you need to consider various accounting guidance and interactions between such guidance. The guidance may include Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, ASC 842, Leases, and ASC 815, Derivatives (the arrangement may contain an embedded derivative).

2.  Have you set up multiple entities or Special Purpose Vehicles (“SPVs”)?

It’s common for certain solar and other renewable energy companies to set up multiple entities which are ultimately owned by a parent company or private equity group. As a result, multiple books and records may need to be set up and can get complex. For example, intercompany reconciliation and eliminations, consolidations and roll-up reporting to the parent company may be required on a regular basis. Some of the entities are also often structured as SPVs which operate as separate legal entities with their own assets, liabilities, and audit requirements. Companies should consider implementing an accounting system to manage separate books and records for the various legal entities.

3.  Are you entering a joint venture or an arrangement where you may need to consolidate?

Many solar and other renewable companies may enter joint ventures with other tax equity partners. This may be labelled as a joint venture on the legal documents but may not necessarily meet the conditions to be a joint venture under ASC 323, Investments – Equity Method and Joint Ventures (for example, have they set up a separate legal entity in relation to this venture). If it is indeed joint venture accounting, we should also consider Accounting Standards Update 2023-07 which requires a joint venture to initially measure all contributions received upon its formation at fair value.

In a separate scenario, the newly set up project entity may be considered a variable interest entity (“VIE”) under ASC 810, Consolidations, where the buyer of the solar and other renewable power would need to evaluate whether it has a variable interest in the VIE through the power purchase agreement. The reporting entity itself would also need to evaluate whether, because of its interests in the project, if it’s required to consolidate the project entity in accordance with ASC 810, Consolidations.

4.  Are you familiar with the hypothetical liquidation book value (“HLBV”) allocation method that is commonly in project entities with tax equity investors?

HLBV is a means of determining the value of the investor's share in the underlying project entity, not simply as an ownership percentage of the total entity but using a function of what the investor would receive if the entity were to be liquidated at its book valuation. HLBV is frequently used for project entities where outside tax equity investors are involved.

5.  Have you considered the useful life and depreciation method to be used for your fixed assets?

For solar and other renewable energy businesses, investment in fixed assets accounts for a significant part of the expenditure, for example, solar panels in the case of solar energy. Therefore, we should consider the appropriate accounting guidance (e.g., ASC 350) to determine the useful life of the fixed assets, which would in turn impact the depreciation charge of the fixed assets over time.

An appropriate depreciation method would also need to be determined to make sure the fixed assets are depreciated periodically in an organized and regular manner to allocate cost appropriately.

6.  Do you know of any potential asset retirement obligations (“AROs”) relating to your land leases and how to account for AROs?

This impacts most solar and other renewable companies and may involve a valuation specialist. An ARO is a legal obligation associated with the retirement of a tangible long-lived asset (e.g., obligation to reinstate the site to its original condition after the equipment is retired from the site) and initially recognized at fair value, by discounting future cash flows and recording at present value. Accretion of the ARO liability due to the passage of time is recognized as a component of operating expense. An asset retirement cost (“ARC”) would also need to be recorded (with an increase in the associated long-lived asset’s carrying value) and depreciated over the useful life of the long-lived asset.

7.  Are you aware of the requirements for impairment assessments?

This is another accounting topic many solar and other renewable companies need to tackle on a periodic basis. Since a material amount of generating equipment is fixed assets, they need to consider impairment and recoverability. Impairment accounting is a treatment to reduce the book value of an asset to reflect the asset’s recoverability under certain conditions, when the invested amount is considered not fully recoverable because of the decline in its expected future cash flow generating ability. 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.

8.  Are you aware of the tax credits relating to IRA’s Prevailing Wage and Apprenticeship Act (“PWA”) and the required compliance requirements?

The IRA makes several clean energy tax incentives available to taxpayers that satisfy certain prevailing wage and apprenticeship requirements. In general, a taxpayer that meets the PWA requirements will multiply the base amount of the tax incentive (credit or deduction) by five. Therefore, companies should consider putting a compliance program in place to ensure your contractors and any underlying subcontractors are keeping records to ensure proof of such compliance.

Accounting Best Practices for Solar and Other Renewable Energy Organizations 

The information above is for general consideration only. If you need support on analyzing and optimizing for your accounting, tax, and valuation needs, reach out to our team below and we can support you based on your specific facts and circumstances.