A Step-by-Step Guide: Accounting for Energy Service Agreements in the Healthcare Industry

Energy service agreements can offer hospitals strategic energy modernization, but they also introduce complex accounting challenges.

Energy service agreements (ESAs) are becoming more frequent in healthcare as hospitals seek cost-effective ways to modernize their energy infrastructure without requiring significant upfront capital. These agreements, however, must be entered into with careful evaluation as they often involve long-term commitments, upfront payments, and complex accounting considerations.

Benefits of Using Energy Service Agreements

Healthcare entities are increasingly using ESAs to reduce their carbon footprint; meet their environmental, social, and governance (ESG) goals; and avoid debt on their balance sheets by structuring agreements through special purpose entities. Under the agreements, a third-party provider typically finances, operates, and maintains energy assets while the hospital benefits from improved efficiency and sustainability.

Accounting Considerations with Energy Service Agreements

While ESAs are often promoted as a way to avoid traditional debt financing, accounting standards generally require recognition of obligations associated with the agreements. A key accounting consideration is whether the ESA represents a lease, i.e., the lease of energy equipment; a service agreement, i.e., the provision of energy assets from a third party; or both. Depending on the structure of the ESA, hospitals may not report capital improvement bonds or loans, but the hospitals may still need to record capital energy-related liabilities or deferred inflows under applicable guidance.

Accounting Standards for Energy Service Agreements

Both the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) provide clear guidance related to ESA leases, revenue recognition, vendor consideration, service concession arrangements, and public-private partnerships. The FASB Accounting Standards Codification (ASC) system offers specific codes related to the implementation of ESAs for public, private, and nonprofit organizations, and the GASB provides such for governmental hospitals.

Step-by-Step Guide for Implementing Energy Service Agreements

Hospital financial leaders who are considering implementing an ESA for their institutions should keep these accounting considerations in mind:

1. All Hospitals Should Determine the Nature of the Arrangement

Energy service agreements often include one or more components:

• • • Lease component: Right to use energy infrastructure (ASC 842 or GASB 87)
    • Service component: Energy output, maintenance, and operations (ASC 606 or GASB service expense)
    • Financing component: Upfront payments or construction funding

The first step to determining the nature of the arrangement is to identify and separate components:

• • • Separate a lease, which creates a lease liability, from non-lease components for which no obligation is recorded
    • Determine if the arrangement is a public-private partnership or a service concession arrangement (records deferred inflows) versus only a service agreement (no obligation recorded)

2. Private or Nonprofit Hospitals Should Consider Lease vs Service

Lease Accounting (ASC 842)

• • • If the ESA conveys control of an identified asset, recognize
      • Right of use (ROU) asset and lease liability at present value of lease payments
      • Classify as finance lease or operating lease based on criteria, e.g., transfer of ownership, economic life
    • If received from the service provider, upfront payments are generally treated as a lease incentive, reducing the ROU asset
    • For construction-in-progress, capitalize costs until placed in service, which are then depreciated per organization policy

Service Component (ASC 606)

• • • Energy and maintenance services are non-lease components, services that do not transfer control
    • Expense as incurred unless prepaid (then record as prepaid expense) because they are not lease components

Service Concession Arrangements (ASC 853)

• • • If the hospital or organization retains ownership but grants operating rights to the third party, ASC 853 requires no derecognition of asset, and the hospital should recognize any upfront payment as a liability and amortize over term

3. Governmental Hospitals Should Consider Aspects of a Public-Private Partnership

GASB 94 (Public-Private Partnership)

• • • If the ESA meets public-private partnership or service concession arrangement definition:
      • Recognize the underlying asset at acquisition value
      • Record deferred inflow of resources for upfront consideration
      • Amortize deferred inflow as revenue over the term
    • Apply GASB 87 for leases embedded in public-private partnership
    • For construction-in-progress, capitalize improvements and then depreciate when placed in service

Service Fees

• • • Expense energy and maintenance fees as incurred

4. All Hospitals Should Be Aware of Disclosure Requirements

• • Nature and terms of ESA
  • Lease classification and payment schedule
  • Service components and expense recognition
  • ESG commitments, if applicable

Energy service agreements offer healthcare organizations a strategic path to modernize their infrastructure and achieve sustainability goals in an ever-evolving industry; however, agreements introduce complex accounting challenges. Hospital leaders should remember that although ESAs can reduce the appearance of traditional debt, the agreements do not necessarily eliminate financial obligations.

PYA Can Help

PYA’s experts understand this complexity and are ready to help you achieve proper accounting and disclosure under required standards to ensure your commitments are reflected accurately and appropriately.

References

https://storage.gasb.org/GASBS94.pdf
https://www.epa.gov/statelocalenergy/performance-contracting-and-energy-service-agreements