ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The terms “we,” “our,” “ours,” “us” and “Company” refer to Covanta Holding Corporation and its subsidiaries; the term “Covanta Energy” refers to our subsidiary Covanta Energy, LLC and its subsidiaries.

Organization

Covanta is one of the world’s largest owners and operators of infrastructure for the conversion of waste to energy (known as “energy-from-waste” or “EfW”), and also owns and operates related waste transport and disposal and other renewable energy production businesses. EfW serves two key markets as both a sustainable waste management solution that is environmentally superior to landfilling and as a source of clean energy that reduces overall greenhouse gas emissions and is considered renewable under the laws of many states and under federal law. Our facilities are critical infrastructure assets that allow our customers, which are principally municipal entities, to provide an essential public service.

Our EfW facilities earn revenue from both the disposal of waste and the generation of electricity and/or steam, generally under contracts, as well as from the sale of metal recovered during the EfW process. We process approximately 20 million tons of solid waste annually. We operate and/or have ownership positions in 42 energy-from-waste facilities, which are primarily located in North America, and 5 additional energy generation facilities, including other renewable energy production facilities in North America (wood biomass and hydroelectric). In total, these assets produce approximately 10 million megawatt hours (“MWh”) of baseload electricity annually. We also operate a waste management infrastructure that is complementary to our core EfW business.

We have one reportable segment, North America, which is comprised of waste and energy services operations located primarily in the United States and Canada. We are currently constructing an EfW facility in Dublin, Ireland, which we own and will operate upon completion. We hold interests in an energy-from-waste facility in Italy and an infrastructure business in China which is engaged in energy-from-waste operations. For additional information on our reportable segment, see Note 6. Financial Information by Business Segments.

During 2016, we divested the majority of our investments in China. For additional information see Note 4. Dispositions, Assets Held for Sale and Discontinued Operations.

Summary of Significant Accounting Policies

The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The following is a description of our significant accounting policies.

Principles of Consolidation

The consolidated financial statements reflect the results of our operations, cash flows and financial position of our majority-owned or controlled subsidiaries. All intercompany accounts and transactions have been eliminated.

Equity and Cost Method Investments

Investments in unconsolidated entities over which we have significant influence are accounted for under the equity method of accounting. Investments in entities in which we do not have the ability to exert significant influence over the investees’ operating and financing activities are accounted for under the cost method of accounting. Cost-method investments are carried at historical cost unless indicators of impairment are identified. We monitor investments for other-than-temporary declines in value and make reductions when appropriate. For additional information on equity method investments, see Note 9. Equity Method Investments. For additional information on our cost method investment in China, see Note 4. Dispositions, Assets Held for Sale and Discontinued Operations.

Revenue Recognition

Our revenue is generated from the fees we earn for: waste disposal, operating energy-from-waste and independent power facilities, servicing project debt, and for waste transportation and processing; from the sale of electricity and steam; from the sale of recycled ferrous and non-ferrous metal; and from construction services. The fees charged for our services are generally defined in our service agreements and vary based on contract-specific terms. We generally recognize revenue as services are performed or products are delivered. For example, revenue typically is recognized as waste is received or processed at our facilities, metals are shipped from our sites or as kilowatts are delivered to a customer by an EfW facility or independent power production plant.

Revenue under existing fixed-price or cost-plus construction contracts is recognized using the percentage-of-completion method, measured by the cost-to-cost method. If an arrangement involves multiple deliverables, the delivered items are considered separate units of accounting if the items have value on a stand-alone basis. Amounts allocated to each element are based on its objectively determined fair value, such as the sales price for the product or service when it is sold separately or competitor prices for similar products or services.

Plant Operating Expense

Plant operating expense includes facility employee costs, expense for materials and parts for facility scheduled and unscheduled maintenance and repair expense, which includes costs related to our internal maintenance team and non-facility employee costs. Plant operating expense also includes hauling and disposal expenses, fuel costs, chemicals and reagents, operating lease expense, and other facility operating related expense.

Pass Through Costs

Pass through costs are costs for which we receive a direct contractually committed reimbursement from the municipal client that sponsors an EfW project. These costs generally include utility charges, insurance premiums, ash residue transportation and disposal, and certain chemical costs. These costs are recorded net of municipal client reimbursements in our consolidated financial statements. Total pass through costs for the years ended December 31, 2016, 2015 and 2014 were $41 million, $52 million, and $59 million, respectively.

Income Taxes

Deferred income taxes are based on the difference between the financial reporting and tax basis of assets and liabilities. The deferred income tax provision represents the change during the reporting period in the deferred tax assets and deferred tax liabilities, net of the effect of acquisitions and dispositions. Deferred tax assets include tax losses and credit carryforwards and are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

We file a consolidated federal income tax return for each of the periods covered by the consolidated financial statements, which include all eligible United States subsidiary companies. Foreign subsidiaries are taxed according to regulations existing in the countries in which they do business. Our federal consolidated income tax return also includes the taxable results of certain grantor trusts, which are excluded from our consolidated financial statements; however, certain related tax attributes are recorded in our consolidated financial statements since they are part of our federal tax return. For additional information, see Note 15. Income Taxes.

Stock-Based Compensation

Stock-based compensation for share-based awards to employees is accounted for as compensation expense based on their grant date fair values. For additional information, see Note 17. Stock-Based Award Plans.

Cash and Cash Equivalents

Cash and cash equivalents include all cash balances and highly liquid investments having maturities of three months or less from the date of purchase. These short-term investments are stated at cost, which approximates fair value. Balances held by our international subsidiaries are not generally available for near-term liquidity in our domestic operations.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable consist of amounts due to us from normal business activities. Allowances for doubtful accounts are the estimated losses from the inability of customers to make required payments. We use historical experience, as well as current market information, in determining the estimate.

Restricted Funds Held in Trust

Restricted funds held in trust are primarily amounts received and held by third party trustees relating to certain projects we own. We generally do not control these accounts and these funds may be used only for specified purposes. These funds include debt service reserves for payment of principal and interest on project debt. Revenue funds are comprised of deposits of revenue received with respect to projects prior to their disbursement. Other funds include escrowed debt proceeds, amounts held in trust for operations, maintenance, environmental obligations, operating lease reserves in accordance with agreements with our clients, and amounts held for future scheduled distributions. Such funds are invested principally in money market funds, bank deposits and certificates of deposit, United States treasury bills and notes, United States government agency securities, and high-quality municipal bonds.

Restricted fund balances are as follows (in millions):



	As of December 31,
	2016				2015
	Current		Noncurrent		Current		Noncurrent
Debt service funds - principal	$	10	$	7	$	9	$	8
Debt service funds - interest	1		—		1		—
Total debt service funds	11		7		10		8
Revenue funds	3		—		4		—
Other funds	42		47		63		75
Total	$	56	$	54	$	77	$	83

Deferred Revenue

Deferred revenue included in Accrued expenses and other current liabilities on our consolidated balance sheet consisted of the following (in millions):



	As of December 31,
	2016		2015
Advance billings to municipalities	$	5	$	6
Other	11		7
Total	$	16	$	13

Advance billings to certain customers are billed one or two months prior to performance of service and are recognized as income in the period the service is provided.

Property, Plant and Equipment

Property, plant, and equipment acquired in business acquisitions is recorded at our estimate of fair value on the date of the acquisition. Additions, improvements and major expenditures are capitalized if they increase the original capacity or extend the remaining useful life of the original asset more than one year. Maintenance repairs and minor expenditures are expensed in the period incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which generally range from three years for computer equipment to 50 years for certain infrastructure components of energy-from-waste facilities. Property, plant and equipment at our service fee operated facilities are not recognized on our balance sheet due to the adoption of the service concession arrangements guidance described in greater detail within the Accounting Pronouncements Recently Adopted discussion below. Any additions, improvements and major expenditures for which we are responsible at our service fee operated facilities are expensed in the period incurred. Our leasehold improvements are depreciated over the life of the lease term or the asset life, whichever is shorter. Upon retirement or disposal of assets, the cost and related accumulated depreciation are removed from the consolidated balance sheets and any gain or loss is reflected in the consolidated statements of operations.

Property, plant and equipment consisted of the following (in millions):



	As of December 31,
	2016			2015
Land	$	29		$	22
Facilities and equipment	4,188			3,885
Landfills (primarily for ash disposal)	63			64
Construction in progress	433			266
Total	4,713			4,237
Less: accumulated depreciation and amortization	(1,689		)	(1,547		)
Property, plant, and equipment — net	$	3,024		$	2,690

Depreciation and amortization expense related to property, plant and equipment was $185 million, $177 million, and $191 million, for the years ended December 31, 2016, 2015 and 2014, respectively. Non-cash investing activities related to capital expenditures for growth projects totaled $41 million and $26 million as of December 31, 2016 and 2015, respectively and were recorded in accrued expenses and other current liabilities on our consolidated balance sheet.

Property, plant and equipment is evaluated for impairment whenever events or changes in circumstances indicate their carrying value may not be recoverable over their estimated useful life. In reviewing for recoverability, we compare the carrying amount of the relevant assets to their estimated undiscounted future cash flows. When the estimated undiscounted future cash flows are less than the assets carrying amount, the carrying amount is compared to the assets fair value. If the assets fair value is less than the carrying amount an impairment charge is recognized to reduce the assets carrying amount to its fair value. For additional information, see Note 14. Supplementary Information - Impairment Charges.

Asset Retirement Obligations

We recognize a liability for asset retirement obligations when it is incurred, which is generally upon acquisition, construction, or development. Our liabilities include closure and post-closure costs for landfill cells and site restoration for certain energy-from-waste and power producing sites. We principally determine the liability using internal estimates of the costs using current information, assumptions, and interest rates, but also use independent appraisals as appropriate to estimate costs. When a new liability for asset retirement obligation is recorded, we capitalize the cost of the liability by increasing the carrying amount of the related long-lived asset. The liability is accreted to its present value each period and the capitalized cost is depreciated over the useful life of the related asset. We recognize period-to-period changes in the liability resulting from revisions to the timing or the amount of the original estimate of the undiscounted cash flows.

Current and noncurrent asset retirement obligations are included in Accrued expenses and other current liabilities and Other liabilities, respectively, on our consolidated balance sheet. Our asset retirement obligation is presented as follows (in millions):



	As of December 31,
	2016			2015
Beginning of period asset retirement obligation	$	30		$	28
Accretion expense	2			2
Net change ⁽¹⁾	(7		)	—
End of period asset retirement obligation	25			30
Less: current portion	—			(3		)
Noncurrent asset retirement obligation	$	25		$	27


(1)	Comprised primarily of expenditures and settlements of the asset retirement obligation liability, net revisions based on current estimates of the liability and revised expected cash flows and life of the liability.

Intangible Assets and Liabilities

Our waste, service and energy contracts are intangible assets related to long-term operating contracts at acquired facilities. These intangible assets and liabilities, as well as lease interest and other finite and indefinite-lived intangible assets, are recorded at their estimated fair market values upon acquisition based primarily upon discounted cash flows in accordance with accounting standards related to business combinations. See Note 7. Amortization of Waste, Service and Energy Contracts and Note 8. Other Intangible Assets and Goodwill.

Intangible assets with finite lives are evaluated for impairment whenever events or changes in circumstances indicate their carrying value may not be recoverable over their estimated useful life. In reviewing for recoverability, we compare the carrying amount of the relevant assets to their estimated undiscounted future cash flows. When the estimated undiscounted future cash flows are less than the assets carrying amount, the carrying amount is compared to the assets fair value. If the assets fair value is less than the carrying amount an impairment charge is recognized to reduce the assets carrying amount to its fair value. As of December 31, 2016, there were no indicators of impairment identified.

Goodwill

Goodwill is the excess of our purchase cost over the fair value of the net assets of acquired businesses. We do not amortize goodwill, but we assess our goodwill for impairment at least annually. We assess whether a goodwill impairment exists using both qualitative and quantitative assessments. When we elect to perform a qualitative assessment, it involves determining whether events or circumstances exist that indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. If based on this qualitative assessment we determine it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we did not elect to perform the qualitative assessment we will perform a quantitative assessment.

A quantitative assessment of goodwill requires a comparison of the estimated fair value of the reporting unit to which the goodwill has been assigned to its carrying value. All goodwill is related to the North America reportable segment, which is comprised of two reporting units. A reporting unit is defined as an operating segment or a component of an operating segment to the extent discrete financial information is available that is reviewed by segment management. If the carrying value of the reporting unit exceeds the fair value, the reporting unit’s goodwill is compared to its implied value of goodwill. If the carrying value of the reporting unit’s goodwill exceeds the implied value, an impairment charge is recognized to reduce the carrying value to the implied value.

There were no impairment charges recognized related to our evaluation of goodwill for the years ended December 31, 2016, 2015 and 2014.

Business Combinations

We recognize the assets acquired and liabilities assumed in a business combination at fair value including any noncontrolling interest of the acquired entity; recognize any goodwill acquired; establish the acquisition-date fair value based on the highest and best use by market participants for the asset as the measurement objective; and disclose information needed to evaluate and understand the nature and financial effect of the business combination. We expense transaction costs directly associated to the acquisition as incurred; capitalize in-process research and development costs, if any; and record a liability for contingent consideration at the measurement date with subsequent remeasurement recognized in the results of operations. Any costs for business restructuring and exit activities related to the acquired company are included in the post-combination results of operations. Tax adjustments related to previously recorded business combinations, if any, are recognized in the results of operations.

Accumulated Other Comprehensive Income ("AOCI")

AOCI, in the consolidated statements of equity, includes unrealized gains and losses excluded from the consolidated statements of operations. These unrealized gains and losses consisted of the following (in millions):



	As of December 31,
	2016			2015
Foreign currency translation	$	(41	)	$	(34	)
Pension and other postretirement plan unrecognized net gain	2			2
Net unrealized loss on derivatives	(23		)	(2		)
Accumulated other comprehensive loss	$	(62	)	$	(34	)

The changes in accumulated other comprehensive (loss) income are as follows (in millions):



	Foreign Currency Translation			Pension and Other Postretirement Plan Unrecognized Net Gain		Net Unrealized Loss on Derivatives			Total
Balance December 31, 2014	$	(12	)	$	2	$	(12	)	$	(22	)
Other comprehensive (loss) income before reclassifications	(22		)	—		10			(12		)
Amounts reclassified from accumulated other comprehensive loss	—			—		—			—
Net current period comprehensive (loss) income	(22		)	—		10			(12		)
Balance December 31, 2015	$	(34	)	$	2	$	(2	)	$	(34	)
Other comprehensive loss before reclassifications	(2		)	—		(21		)	(23		)
Amounts reclassified from accumulated other comprehensive loss	(5		)	—		—			(5		)
Net current period comprehensive loss	(7		)	—		(21		)	(28		)
Balance December 31, 2016	$	(41	)	$	2	$	(23	)	$	(62	)



Amount Reclassified from Accumulated Other Comprehensive Income
Accumulated Other Comprehensive Income Component	Year Ended December 31, 2016		Affected Line Item in the Consolidated Statement of Operations

Foreign currency translation	$	5	Gain on asset sales ⁽¹⁾
	5		Total before tax
	—		Tax benefit
Total reclassifications	$	5	Net of tax

⁽¹⁾ For additional information see, Note 4. Dispositions, Assets Held for Sale and Discontinued Operations.

Derivative Instruments

We recognize derivative instruments on the balance sheet at their fair value. The cash conversion option and note hedge were derivative instruments that were recorded at fair value quarterly with changes in fair value recognized in our consolidated statements of operations as non-cash convertible debt related expense. We have entered into swap agreements with various financial institutions to hedge our exposure to energy price risk and interest rate risk. Changes in the fair value of the energy derivatives and the interest rate swap are recognized as a component of AOCI. For additional information, see Note 13. Derivative Instruments.

Foreign Currency Translation

For foreign operations, assets and liabilities are translated at year-end exchange rates and revenue and expense are translated at the average exchange rates during the year. Unrealized gains and losses resulting from foreign currency translation are included in the consolidated statements of equity as a component of AOCI. Currency transaction gains and losses are recorded in other operating expense in the consolidated statements of operations.

Pension and Postretirement Benefit Obligations

Our pension and other postretirement benefit plans are accounted for based on actuarially-determined estimates. For additional information, see Note 16. Employee Benefit Plans.

Share Repurchases

Under our share repurchase program, common stock repurchases may be made, from time to time, in the open market, in privately negotiated transactions, or by other available methods, at management’s discretion and in accordance with applicable federal securities laws. The timing and amounts of any repurchases will depend on many factors, including our capital structure, the market price of our common stock and overall market conditions, and whether any restrictions then exist under our policies relating to trading in compliance with securities laws. Purchase price over par value for share repurchases are allocated to additional paid-in capital up to the weighted average amount per share recorded at the time of initial issuance of our common stock, with any excess recorded as a reduction to retained earnings. For additional information, see Note 5. Equity and Earnings Per Share ("EPS").

Use of Estimates

The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets or liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. Significant estimates include: useful lives of long-lived assets, asset retirement obligations, construction expense estimates, unbilled service receivables, fair value of financial instruments, fair value of the reporting units for goodwill impairment analysis, fair value of long-lived assets for impairment analysis, renewable energy credits, stock-based compensation, purchase accounting allocations, cash flows and taxable income from future operations, deferred taxes, allowances for uncollectible receivables, and liabilities related to employee medical benefit obligations, workers’ compensation, severance and certain litigation.

Reclassifications

Certain amounts have been reclassified in our prior period consolidated balance sheet to conform to current year presentation and such amounts were not material to current and prior periods. During the year ended December 31, 2016, we concluded that it was appropriate to include Net interest expense on project debt within Interest expense, net on our consolidated statement of operations because such amounts were deemed immaterial. Previously, Net interest expense on project debt was reported separately, as a component of Operating expense. For the years ended December 31, 2015 and 2014, Net interest expense on project debt of $9 million and $10 million, respectively, was reclassified to Interest expense, net on our consolidated statement of operations and as a result, Operating income increased accordingly for those periods.

Change in Estimate

Revenue under our Durham York construction contract is recognized using the percentage-of-completion method, measured by the cost-to-cost method. We evaluate the estimate of our total construction costs for the contract throughout the life of the project and make revisions to our estimated costs as necessary. During the year ended December 31, 2015, we reduced our overall profit estimate related to this construction project by $20 million. The project was completed in 2015 and no further significant construction expenses were incurred related to this project. We are currently seeking to resolve outstanding disputes with our primary contractor for the Durham-York construction project, for additional information see Note 18. Commitments and Contingencies.

Accounting Pronouncements Recently Adopted

Effective January 1, 2016, we adopted guidance concerning the presentation of debt issuance costs, which are required to be presented as a direct reduction from the carrying amount of the related debt liability. We adopted this guidance retrospectively, which resulted in a reduction in our December 31, 2015 current and non-current asset balances of $5 million and $20 million, respectively, along with a corresponding reduction in current and long-term debt balances. The December 31, 2015 balance sheet includes certain costs for Dublin project financing within current assets for debt that has not yet been drawn down. For additional information, see Note 11. Consolidated Debt.

Effective January 1, 2015, we were required to adopt guidance concerning service concession arrangements. The amendment applies to an operating entity of a service concession arrangement entered into with a public-sector entity grantor when the arrangement meets certain conditions. The amendments specify that such an arrangement may not be accounted for as a lease nor should the infrastructure used in a service concession arrangement be recognized as property, plant and equipment by the operating entity. Instead, the operating entity should refer to other guidance to account for the arrangement, such as Topic 605 of the Accounting Standard Codification - Revenue Recognition. We adopted this guidance using a modified retrospective approach which requires the cumulative effect of applying this guidance to arrangements existing at the beginning of the period of adoption be recognized as an adjustment to retained earnings. As a result, accumulated deficit as of January 1, 2015 as originally reported of $15 million increased by $45 million ($75 million reduction of property, plant and equipment, net of tax of $30 million) to $60 million.

The adoption of this guidance had the following effect on our consolidated statement of operations for the year ended December 31, 2015 (in millions, except per share amounts):



	Increase (Decrease)
Plant operating expense	$	31
Depreciation and amortization	$	(22	)
Income tax expense	$	(4	)
Net income attributable to Covanta Holding Corporation	$	(5	)
Basic and Diluted income per share	$	(0.04	)

Effective December 31, 2015, we early adopted the guidance, on a prospective basis, concerning simplified presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as non-current in the statement of financial position. Adoption of this guidance resulted in reclassification of our net current deferred tax asset of $67 million to the net non-current deferred tax asset in our consolidated balance sheet as of December 31, 2015.