Memo: Xx Lease Analysis
[pic 1]Date:October 14, 2008To:ABC Co. 2008 Audit FileFrom:Elly ZhongSubject:XX Lease AnalysisBackgroundABC CO. acquired 37.67% of XX on July 18, 2008. The same day, ABC CO. increased its ownership from 37.67% to 48.18% by subscribing new shares XX issued that day. On July 30, 2008, XX issued additional new shares that ABC CO. subscribed to in entirety. Considering all the share purchases, ABC CO. owns 52.99% of XX effectively July 30, 2008. Such acquisition was accomplished through owning the holding company of Sacoden Investments Pte Limited (“Sacoden”), a special-purpose entity formed under the laws of Singapore.On 8/21/2008, 9/29/2008, 11/3/2008, 12/3/2008 and 12/29/2008 ABC CO. subscribed additional XX shares and increased its ownership from 52.99% to 59.94% by contributing additional amounts totaling $6.5M.XX is a power plant incorporated and domiciled in Pakistan.  Phase I consists of a 94-MW gross combined-cycle gas-fired/water desalination facility located in Phase 8 of Karachi Defense Housing Society, an up-market residential area of Karachi (retired military officers reside in the housing complex) on the coast. Phase I achieved commercial operation on April 17, 2008 and, in addition to producing 94-MW of gross power, uses its steam to produce three million gallons of desalinized water per day that serves approximately 100,000 households.
XX currently has a 30-year Power Purchase Agreement (the “PPA”) with KESC company and is paid monthly by way of capacity and energy payments in PKR. This PPA was entered into on July 29, 2005. A copy of the PPA is retained in our audit file as PF-20017.This memo is to analyze whether such an agreement is a lease under EITF 01-8 and if yes, what type of lease it is under FAS13. This memo also addresses how the company should account for this agreement.GuidanceEITF 01-8: Determining Whether an Arrangement Contains a Lease, states that any power purchase agreements involved in a business combination after May 28, 2003 should be evaluated under this guidance.  SFAS 13: Accounting for Leases, provides guidance on how to classify the lease as an operating or capital lease.AnalysisThe analysis that follows has been prepared by D&T Houston based on information obtained from ABC CO. and our reading of KESC and XX Power Purchase Agreement in PF-22017. We will first evaluate the contract using the guidance in EITF 01-8 to determine if the contract contains a lease.  The next step is to evaluate the lease under SFAS 13 to determine what type of lease it is.  Please see analysis below: