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q1 2019 accounting change

Discussion in 'TSLA Investor Discussions' started by neroden, Aug 6, 2018.

  1. neroden

    neroden Happy Model S Owner

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    So, I am mainly starting this thread because there's a big lease accounting change coming at the start of 2019. Tesla reported that starting Jan 1, 2019, solar leases and PPAs *will not be accounted for as leases*. Apparently they're supposed to retroactively reclassify all the old ones too (!!!) but it sounds like there may be some unspecified "practical expedients" applied.

    Anyone with more knowledge of accounting able to guess what this is going to do to the balance sheet and P&L statement? I am certain it's going to make it a lot more comprehensible -- the new GAAP treatment is a much better fit with SolarCity's business model than the old GAAP treatment was -- but it's slightly beyond me to try to guess what the results of those changes will look like.

    The only thing I can guess is that Wall Street analysts, who are typically even worse than me at deciphering the current accounting treatment, will suddenly like the look of the solar business a lot better, which should act as a "positive surprise". But I have no idea what the new numbers will look like. Does anyone else care to take a wild stab at it?
     
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  2. cpa

    cpa Active Member

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    FASB ISSUES NEW GUIDANCE ON LEASE ACCOUNTING

    I do not know how Tesla has accounted for its leases as the lessor. Correct me if I am wrong, but I recall that one of the sales features of Solar City was that the customer paid Solar City X cents per kWh with Solar City retaining all the tax credits and paying the utility. Solar City was making money on the arbitrage between what they charged the customer and the utility payments/amortization of the installation costs over the term of the lease. If that is the case, Solar City would show an amortizable asset on the books for the installation. Whether they used the true costs or a present-value cost is unknown to me.

    Payments made by the customer would then hit the income statement as revenue. Utility payments would hit the income statement as expense. The monthly amortization of the costs would also hit the books as an expense.

    With the new pronouncement, Tesla (as lessor) will now have to place on its balance sheet the discounted net present value of the equipment that is leased as an asset. It will have to place the discounted net present value of future payments to be collected by its customers over the terms of the leases. Tesla will have to separate out the true lease components from non-lease components (like warranties/maintenance, etc.) Like a lot of this accounting mumbo-jumbo that we have to do nowadays, they will be estimates, and actual results could differ materially from these estimates.

    There will be transitional accounting procedures in place, and when I started to read them, my eyes glazed over. For 2019 and 2020 financial statements, there will likely be a lot of disclosures in the notes (and perhaps even on the income statement for retrospective application of a new accounting standard.)

    I think the real nut of this will be the transitional method that Tesla uses. There will be assets and liabilities recorded on the books with the squeeze hitting the income statement as a retrospective change in accounting method. If the assets recorded > liabilities, then there will be a one-time hit to income. Conversely, if assets < liabilities, there will be a one-time hit to expenses.

    Going forward, I would hazard a guess that there won't be a material difference in the bottom line. But take everything that I write with a hefty dose of salt. I do not know how these things are recorded now; I do not know the materiality to Tesla's financial statements; I do not know if there are other costs that Tesla needs to change its current method.

    I know, I wrote a book, and did not say very much. o_O
     
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  3. adiggs

    adiggs Active Member

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    You got this far into an understandbly written thing before your eyes glazed over. I'm pretty sure I speak for almost everybody when I tell you that you got a lot further into the explanation than I did :)

    Thanks for the link - I'm pretty sure it's going to mean a lot less to me than it did to you, but at least now I can go take a crack at it and see where I end up.


    One takeaway I get is that there's going to be plenty of judgement available to management in the transition. Broadly speaking I don't see an alternative, and I'm not thrilled with that. I don't see any short term upside in a situation with lots of management discretion in how the details get reported (if its too conserviative, then the numbers will look bad in the short term; if it's too aggressive, then the spin doctors will talk about accounting shenanigans to make the short term look good).

    Maybe something we can start to tease out is the order of magnitude of the amounts that are going to be slopping about. If this is going to have impact at the 10s of millions / quarter level, that's different from billions/quarter level.
     
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  4. cpa

    cpa Active Member

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    Yes. Indeed. And it will be up to management to be able to convince the external auditors that the approach is reasonable, conservative, and verifiable. What discount rate should Tesla use for present value? Lotta wiggle room there. Will all contracts use the same discount rate, or should it be adjusted based upon when the contracts were signed? More wiggle room. How should the balance sheet amounts be amortized? Straight-line? SOYD? Should there be salvage value assigned to the panels? Should there be an allowance for uncollected receivables from the lessees?

    Anyway, you get the idea.

    Personally, back in the day, I hated new standards. They increased the work load considerably, and they were not well understood for the first couple of years.
     
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  5. neroden

    neroden Happy Model S Owner

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    #5 neroden, Aug 6, 2018
    Last edited: Aug 6, 2018
    Ha. Yeah, me too.

    Tesla does say that they expect the effects of the accounting change to be material. Which doesn't tell us much. :)

    Edit: do you have a link to the documents describing the transitional accounting procedure options? I'm going to see if I can try to figure out which one Tesla is likely to be using for most of its "legacy" leases.
     
  6. neroden

    neroden Happy Model S Owner

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    This bit I *think* I understood, though I could be wrong. The thing to note is that Tesla stated in their 10-Q that the solar leases and PPAs *would not be considered leases at all*. I don't know if this is right, but that's what they said:

    "Further, solar leases and PPAs that commence after January 1, 2019, where we are the lessor and are currently accounted for as leases will no longer meet the definition of a lease with the adoption of this ASU and will instead be accounted for in accordance with ASC 606." (ASC 606 is the revenue recognition standard)

    Effectively the new standard seems to be saying that this sort of solar lease is really a sale, since it will never be repossessed and its repossession value approaches zero. So I guess it would be accounted for as a seller-financed loan? The income stream on the "lease" is quite predictable; on the PPA slightly less predictable but still fairly predictable. I believe, though I may be wrong, that it has to be separated into an interest component of revenue (the effective interest being paid by the customer for the "zero money down" deal) and a payment-for-the-system component of revenue. The payment-for-the-system component is realized as revenue upfront even though the cash doesn't show up until later. A bad debt allowance probably has to be added, but we know from history that this is immaterial for solar panel leases/PPAs.

    The entirety of accrual accounting is based on estimates. There's a lot to be said in favor of cash accounting. :) But honest accrual accounting which attempts to reflect the true timing of the accruals serves a purpose too. (Arbitrary accrual accounting, such as materially incorrect depreciation periods, is totally useless.)
     
  7. cpa

    cpa Active Member

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    This whole exercise for us may be moot if Tesla goes private as per Musk's tweet earlier today. A private company of this magnitude will still have to follow the new rules. But the availability of the financial statements will not be nearly as easy to obtain.
    I believe that the company has the option to take the hit directly to retained earnings/deficit. Or, they can go back to 2017 and restate prior periods going forward. In either event, I am sure that there will be a 22-page footnote explaining what happened.

    Accounting Standards Update 2018-11—Leases (Topic 842): Targeted Improvements

    This might help you figure out the method that Tesla will choose.
     
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  8. mrwuffles

    mrwuffles Member

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    If stockholders were able to retain their stock in the private entity, as Elon says he'd prefer, would they be able to get a hold of financial statements?
     
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  9. cpa

    cpa Active Member

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    Yeah, the revenue recognition standard now requires companies to split out the details of a sales contract. No more bundling. The classic example cited is the purchase of 100 computers with an upgrade contract, maintenance contract, and software update contract. Sellers now must allocate the sale price among the components of the contract and take into income using a reasonable approach over the life of the agreement. The computer sale will be recognized in full upon sale. But the remaining components will be recognized pro-rata.

    Sure, over a lengthy time period, the cash method and accrual method of accounting are pretty close to equal. But the cash method is too easily manipulated by management to accomplish their inherent bias for the reporting period. We do it all the time for income tax purposes--lawfully--to minimize taxes or to take advantage of certain income tax benefits. The cash method makes it much more difficult to compare reporting periods or to evaluate the short-term needs of a company.

    Depreciation expenses arose from the dark ages of accounting to comply with the matching principle. I can't get too wrought up over the estimated useful lives. Generally, depreciation expense is not considered much by lenders and investors--they are more concerned with cash flow from operations and working capital and the ability to service debt.

    But don't get me started on amortization of true (not developed) intangibles. . . Goodwill and the like should be written off as a period cost.
     
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  10. cpa

    cpa Active Member

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    I am not a lawyer. <---Key information! :) Shareholders are entitled to receive financial statements. With public companies, you receive them via the mail or email if you are the owner of record. If you own your shares through a broker's "street name," the broker owns the shares for your beneficial interest. You do not receive reports, unless you specifically request them from your broker, or track them down online.

    Musk intimated that Tesla was contemplating ownership similar to SpaceX whereby Fidelity handled the administrative duties on behalf of all the private shareholders.

    I would guess that Fidelity would be the legal owner of the stock. We owners would be the beneficial owners of the stock. Just what information the beneficial owners of the stock would receive is a topic for speculation at this point.
     
  11. neroden

    neroden Happy Model S Owner

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    Believe it or not, shareholders are not generally entitled to receive financial statements of private companies. Shareholders have some rights under Delaware corporation law, but not a hell of a lot.
     

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