Accounting for Land Easements under ASC 842
Since the implementation of ASC 842, a number of stakeholders, primarily in the oil and gas and utility industries, have inquired regarding the treatment of land easements. These types of companies can have thousands upon thousands of land easements, so making sure these entities understand how accounting for land easements under U.S. GAAP jives with the guidance in ASC 842 is important! The standard, as originally issued, did not call out land easements specifically, nor did the prior standard (ASC 840, Leases). As a result, there was a disparity in practice in how to handle the accounting for these land easements.
Because of this, the FASB issued ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842. This ASU makes it clear that all new or modified contracts for land easements must be evaluated under the guidance in ASC 842, but also provided relief upon transition for entities that might have a large number of land easement contracts already in existence. What does this all mean for a post-implementation world? Let’s find out more!
What is a land easement?
Before we go any further, let’s talk about land easements. Land easements are rights to use another’s land for a specific limited purpose. Under land easements, the entity has the right to use the land, but the title remains with the owner of the land. According to the ASU, land easements may be perpetual, or term based, provide for exclusive use or non-exclusive use (shared use) of the land, and may be prepaid or paid over a defined term. These land easements, or rights of way, are often used by telecommunication companies or utility companies when they need to have the access to land to run wires. Entities in these industries often have thousands, or even tens of thousands, of such easements.
How were they accounted for in the past? Or were they?
Under previous guidance, if contracts for land easements were accounted for, many were accounted for as operating leases. But not all land easements were accounted for as leases.
Sometimes, these contracts were prepaid, in which case, entities accounted for the land easements under ASC 360, Plant, Property & Equipment, as costs incurred to bring the related asset to the condition and location necessary for its intended use.
Some entities instead elected to account for land easements as intangible assets under ASC 350. Under the guidance in ASC 350, Intangible Assets, there was an example that described perpetual leases of land as intangible assets instead of a lease. Some entities applied this guidance by analogy to all land easements whether or not it was perpetual.
Bottom line: There was a disparity in practice.
Are land easements within the scope ASC 842? And how are they accounted for?
Land easements are in the scope of ASC 842, generally speaking. As their definition implies, they are generally rights to use a specified property. This means that land easements must be assessed to determine whether or not they meet the definition of a lease. This determination becomes the key to determining whether an easement is accounted for as a lease or as some other contract. Before we continue, let’s remind ourselves of the definition of a lease:
A lease conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration – ASC 842
Generally speaking, this means that land easements would be expected to meet the definition of a lease and be within the scope of the guidance within ASC 842. However, let’s take a look at some common examples of land easements and assess whether or not the type of easement would impact our assessment.
Perpetual land easements
Perpetual land easements are legal agreements granting one party the right to use another party’s property for a specific purpose indefinitely, meaning it does not have a set end date. At first glance we can see that this type of easement grants the right to use a specified asset. However, the definition of a lease above also states “for a specified period of time”. In this scenario, there is no specified period of time. Therefore, this type of agreement is more akin to a form of ownership of a portion of the land than a lease agreement. Perpetual land easements, therefore, are generally NOT accounted for as a lease under ASC 842. Instead perpetual land easements are more likely to be as an indefinite lived intangible asset under ASC 350.
Floating or roving land easements
A floating land easement is a type of easement that doesn’t specify the exact location of the easement on the property. It grants the right to use another’s property for a specific purpose but leaves the location of that use undefined. Sometimes this is later defined upon the occurrence of specific events (i.e., the start of construction of a pipeline). Instead of a defined location, it generally gives a defined purpose (e.g., a utility line or a driveway). These are common when the precise location of a feature, like a utility line, is not yet known. Until a location is determined, they apply to the entire location.
Just like perpetual land easements, there is a key component missing when we look at these types of easements to determine if the contract contains a lease. In this scenario, we do have a specified time period. But what we are missing is identified property, plant or equipment. In other words, we do not have a specified asset. Because we do not, these types of easements likely do not meet the definition of a lease. In fact, even if you were to say that the entire field or building were the identified asset, it still would not be a lease because the “lessee” would not have the ability to obtain substantially all the economic benefits of the asset or direct the use of the asset.
However, keep in mind that in some cases, the exact location of the easement becomes specified at a later date! If this happens, then the criteria for determining whether a contract contains a lease needs to be re-evaluated and the easement may qualify as a lease agreement at that time!
Time-based land easements
Lastly, what about time-based land easements? In this case, we do have a specified period of time. However, the other facts and circumstances of the easement can vary greatly and will need to be evaluated to determine whether or not it meets the definition of a lease!
For example, one consideration may be: does the easement grant rights to use surface land? Or subsurface land rights?
If it is for surface land, the land is specified, and the time period is specified – you most likely have a lease on your hands!
But what about subsurface land? Sometimes this happens when the grantee is using the land to construct an underground pipeline. In some cases, another party may even be using the surface land for farming or another use. Again, we’ll need to consider the definition of a lease. Do we have a specified asset (e.g., subsurface land that is 10-12 feet underground) along with a specified time-frame?
If the lease includes both surface and subsurface rights, you may need to consider if those units need to be separated into different units of account when applying the guidance within ASC 842.
How are in-scope easements accounted for under ASC 842?
Once you’ve determined that a land easement is within the scope of ASC 842, you account for it just like any other lease contract! Looking for information on how to account for leases under ASC 842? Our accounting topic page on leases provides a great overview of how leases should be accounted for. This includes:
- How to initially measure and record the lease liability and right-of-use (ROU) asset
- How to determine the lease classification
- How to subsequently measure the lease liability and ROU asset
Looking for a more comprehensive overview? Don’t miss our ASC 842: Leases course collection on the GAAP Dynamics Learning Library!!
About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We view training as an opportunity to empower professionals to make informed decisions at the right time. Whether it’s U.S. GAAP, IFRS, or audit training, we’ve trained thousands of professionals since 2001, including at some of the world’s largest firms. Our promise: Accurate, relevant, engaging, and fun training. Want to know how GAAP Dynamics can help you? Let’s talk!
Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
