Energy Deals Derailed by Obscure Accounting Rule

Nearly a decade after the most elaborate exercise in accounting fraud in America’s history ended in bankruptcy and prison sentences, the U.S. energy industry has yet to escape Enron’s ghost.
Now, courtesy of esoteric changes in accounting standards being implemented by the Financial Accounting Standards Board (FASB), we can add energy efficiency and clean energy to the list of casualties killed in the name of transparency.
FASB and the International Accounting Standards Board (IASB) develop financial accounting standards for beancounters. In the wake of the Enron debacle, FASB launched an effort to develop new rules for the treatment of lease transactions. In December, FASB released a joint exposure draft for these new rules, which will soon be ready for prime time.
The new guidelines would alter reporting obligations for clean energy and energy-efficiency transactions. In short, businesses would have to bring all of these lease transactions onto their balance sheets. That sucks. Still worse, in the case of energy efficiency and clean energy, the rules will not necessarily benefit the public. Ironically, it may do the opposite by distorting high-priority environmental and energy security policy objectives endorsed by legislators locally and nationally.
Currently, businesses only include capital leases as assets on their balance sheets. By contrast, in an operating lease, the lessee can use an asset without having to assume the responsibility of ownership. The new rules would require all companies to list leases transactions as assets and liabilities on their balance sheets.
This requirement will significantly deter energy-efficiency investments for developers, companies and non-profits by souring the benefits of sale leasebacks and power purchase agreements (PPAs). PPAs are currently treated as service contracts. FASB’s new rule would require PPAs to be treated as leases rather than service contracts, which would appear on a company’s balance sheet.
Although the financial mechanics of these transactions will remain unchanged, companies who pursue energy efficiency or clean energy will have heavier balance sheets and risk being perceived as having higher leverage than they otherwise would. This could make debt more expensive for companies who perform lease transactions. And that is only one penalty for those who pursue clean energy or energy efficiencies who will also likely have higher tax exposure, more extensive disclosure requirements and steeper annual accounting costs.
Simply put, in the tragic tradition of regulatory overreaction epitomized by Sarbanes-Oxley, the “proposed” FASB rule will burn the barn to roast the pig.
Ironically, unlike Enron, companies and institutions investing in clean energy and energy efficiency are not trying to bake the books. Rather, they are pursuing a perfectly legitimate institutional objective – buying electricity or reducing energy costs – and outsourcing the hassle of owning the actual system. After all, most companies and institutions are not in the energy business but dependent on it.