New accounting rules for electricity contracts

We've seen a lot of growth in renewable energy over the last few years, and it's affecting how many manufacturing companies get their energy. Power purchase agreements (PPAs) are a key instrument for companies to achieve their sustainability goals and hedge against price wings. But these long-term electricity supply contracts are tricky for companies to deal with in their financial statements. Especially weather-dependent energy sources such as wind and solar make electricity production pretty volatile, which gets in the way of meeting the requirements for using the own-use exemption and hedge accounting and often means they have to be recognized at fair value. As a result, companies are increasingly unable to avoid unwanted fair value fluctuations in their income statements and to ensure that their financial statements provide an economically adequate representation.

For several years, there has been intensified discussion and initiatives regarding a possible amendment to the standard (see Corporate Treasury News (08/2023): Power Purchase Agreements: Is IFRS accounting on the horizon? and Corporate Treasury News (04/2024): Light at the end of the tunnel? An update on the latest developments relating to the accounting treatment of power purchase agreements). On 18 December 2024, the International Accounting Standards Board (IASB) finally published an amendment to IFRS 9 and IFRS 7, addressing the accounting treatment of contracts for the supply of energy from natural resources. This amendment relates to the conditions for applying the own-use exemption and hedge accounting. It also supplements and specifies the notes and disclosures required under IFRS 7. The IASB has explicitly narrowed the scope of the supplementary provisions so that only energy obtained directly from solar, wind or water power may be taken into account, thereby excluding any equivalent application to green hydrogen, for example. 

1. Extension of the own-use exemption
   Under IFRS 9.2.4, the scope of the own-use exemption is limited to contracts that are physically fulfilled to cover own use and do not contain any clauses for possible net cash settlement. The amendment stipulates that, when recognizing electricity supply contracts in the balance sheet, the prevailing market conditions must be taken into account in conjunction with historical, current and expected future trading and consumption patterns, in addition to the contractual terms. In particular, the remarketing of surplus energy may, under certain conditions, be compliant with the application of the own-use exemption in the future.
2. Variable notional amounts in hedge accounting
   Previously, hedge designations were limited to hedging a fixed notional amount. Under the new rules, companies can designate a variable notional amount as the underlying item in a hedging relationship, provided that the changes in the notional amount are related to changes in the production of the hedged item.
3. Increased transparency requirements under IFRS 7
   The amendment sets out more detailed disclosure requirements for contracts relating to electricity from natural sources. These are intended to give readers of financial statements a better understanding of the economic risks arising from the contracts and the impact on the company's cash flows. Disclosure requirements are particularly extensive for contracts that fall under the own use exemption and include both qualitative and quantitative information, such as the proceeds from resales.

The amendment is binding for financial years beginning on or after 1 January 2026. Early application is permitted once the EU has endorsed the amendment.

The amendment requires retrospective application of the provisions relating to the applicability of the own use exemption. As a result, existing contracts must be reassessed to determine whether they fall within the scope of IFRS 9 under the new rules. For hedge accounting, however, only forward-looking application is mandatory. Notwithstanding this, existing hedging relationships may be terminated at the date of initial application of the amendment, provided that the respective underlying and hedging transactions are designated in a new hedging relationship in accordance with the amended requirements. Given that the amendments to IFRS 7 may also result in new disclosures in the notes to the financial statements, companies should familiarize themselves with the new requirements in good time. It makes sure that regulatory requirements are met and that energy contracts are recognized in the best way possible.

And even though the IASB kept the scope pretty narrow, this long-awaited amendment finally brings some clarity to a number of practical situations that those who prepare financial statements deal with. At the same time, the amendment triggers a need for action due to a possible reassessment of PPAs previously recognized as derivatives, as well as regarding disclosure requirements for own-use accounting of PPAs or the new application of hedge accounting.

Source: KPMG Corporate Treasury New, Edition 153, April 2025
Authors:
Robert Abendroth, Partner, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Jeannine Widawski, Managerin, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG