30 ASC 440 COMMITMENTS
Through-Put and Take-or-Pay Contracts
Example of a through-put contract
PERSPECTIVE AND ISSUES
Subtopics
ASC 440, Commitments, contains only one subtopic:
- ASC 440-10, Overall, which provides general guidance on financial accounting and reporting for certain commitments.
The Subtopic has two Subsections:
- General
- Unconditional Purchase Obligations.
The General Subsection provides guidance for
- Unused letters of credit
- Preferred stock dividends in arrears,
- Commitments such as those for plant acquisitions, and
- Obligations to reduce debts, maintain working capital, or restrict dividends.
The Unconditional Purchase Obligation subsection provides guidance for unconditional purchase obligations, such as throughput and take-or-pay contracts.
Scope and Scope Exceptions
ASC 440 applies to all transactions. However, for guidance on product financing arrangements, the preparer should look to ASC 470-40-15.
Overview
All significant contractual commitments must be disclosed in the notes to the financial statements. For example, lease contract provisions, pension obligations, requirements contracts, bond indenture covenants, commitments to purchase or construct new facilities, and employee share-based compensation plans are to be clearly disclosed in the notes.
DEFINITIONS OF TERMS
Purchaser's Incremental Borrowing Rate. The rate that, at the inception of an unconditional purchase obligation, the purchaser would have incurred to borrow over a similar term the funds necessary to discharge the obligation.
Take-or-Pay Contract. An agreement between a purchaser and a seller that provides for the purchaser to pay specified amounts periodically in return for products or services. The purchaser must make specified minimum payments even if it does not take delivery of the contracted products or services.
Throughput Contract. An agreement between a shipper (processor) and the owner of a transportation facility (such as an oil or natural gas pipeline or a ship) or a manufacturing facility that provides for the shipper (processor) to pay specified amounts periodically in return for the transportation (processing) of a product. The shipper (processor) is obligated to provide specified minimum quantities to be transported (processed) in each period and is required to make cash payments even if it does not provide the contracted quantities.
Unconditional Purchase Obligation. An obligation to transfer funds in the future for fixed or minimum amounts or quantities of goods or services at fixed or minimum prices (for example, as in take-or-pay contracts or throughput contracts.
CONCEPTS, RULES, AND EXAMPLES
Through-Put and Take-or-Pay Contracts
Through-put and take-or-pay contracts are sometimes used to help a supplier pay for new facilities, machines, or other expenditures. They are negotiated as a way of arranging financing for the facilities that will produce the goods or provide the services desired by a purchaser. A through-put contract is an agreement between the owner of a transportation facility or manufacturing facility (such as a pipeline) and a purchaser (such as an oil processor) that requires the purchaser to pay specified amounts at future dates to the owner in return for the transportation or manufacture of a product. A take-or-pay contract is similar. It is an agreement between a purchaser and a supplier that requires the purchaser to pay specified amounts at future dates in return for products or services. In both types of contracts, the purchaser is required to make the specified payments even if it does not receive goods or services.
Some of these contracts are reported on the statement of financial position as an asset and a liability. Others are not reported. Other than standards relating to recognition of losses on unconditional purchase obligations (ASC 330-10-35), there are no standards that require the contracts to be recognized on the statement of financial position. However, ASC 440 requires certain disclosures to be made.
Aramarck Oil contracts with the Persian Pipeline Company to ship a minimum of three million barrels a month of unprocessed sour crude oil from the Ahwaz oil field in Iran to the pipeline terminus at Char Bahar, an amount which constitutes 1/3 of the capacity of the pipeline. The contract term is twelve years. Under the contract, Aramarck is obligated to pay Persian for 1/3 of the fixed operating costs of the pipeline, depreciation, interest on the $500 million of 5% debt used to finance the pipeline (to be paid off in equal annual payments over twelve years), and a 7% rate of return on equity to Persian. Estimated annual payments are $20 million. Aramarck's disclosure of the agreement follows:
Aramarck has signed an agreement reserving pipeline capacity for twelve years. Under the terms of the agreement, Aramarck is obligated to make the following minimum payments, whether or not it ships through the pipeline:
Disclosures required by ASC 440 can be found in the Appendix.