The International Accounting Standards Board (IASB) has published an Exposure Draft proposing narrow-scope amendments to ensure that financial statements more faithfully reflect the effects that renewable electricity contracts (referred to below as power purchase agreements (PPAs)) have on a company. The proposals amend IFRS 9 Financial Instruments and IFRS 7 Financial Instruments: Disclosures.
Renewable electricity sources depend on nature and its supply cannot be guaranteed. Contracts often require buyers to take and pay for whatever amount of electricity is produced, even if that amount does not match the buyer’s needs at the time of production. These distinct market characteristics have created accounting challenges in applying the current accounting requirements, especially for long-term contracts.
IASB is seeking to address these challenges with proposed amendments to:
- the application of the own use exemption for purchasers of PPAs; and
- hedge accounting requirements for purchasers and sellers of PPAs.
The proposals are a welcome change, and address accounting challenges faced by companies entering into PPAs.
Proposals for the own use exemption
It is not always clear under IFRS 9 whether a company that enters into a PPA can apply the own use exemption for accounting purposes (especially when the purchaser does not use the entire amount of electricity produced by the power plant and has to sell the excess). If the own use exemption does not apply, PPAs are accounted for as derivatives measured at fair value through profit or loss (FVTPL). PPAs are often long-term agreements, so measuring them at FVTPL can potentially create significant volatility in the income statement over many reporting periods.
The proposed amendments would allow a company to apply the own use exemption to certain PPAs depending on:
- their purpose, design, and structure;
- the reasons for past and expected sales of unused electricity; and
- whether such sales are consistent with the company’s expected purchases or usage requirements.
More specifically, these conditions refer to the source of production of the renewable electricity – which is nature-dependent, and hence the supply cannot be guaranteed at specified times or for specified volumes (e.g. wind, sun and water), and also that the contract exposes the purchaser to substantially all the volume risk under the contract through ‘pay-as-produced’ features. Volume risk is the risk that the volume of electricity produced does not align with the purchaser’s demand for electricity at the time of production.
The proposals would require companies to apply the proposed amendments retrospectively (without requiring prior periods to be restated).
Proposals for hedge accounting
Virtual PPAs and PPAs that do not meet the own use exemption are accounted for as derivatives and measured at FVTPL. Applying hedge accounting could help companies to reduce profit or loss volatility by reflecting how these PPAs hedge the price of future electricity purchases or sales.
Under IFRS 9, to apply hedge accounting there needs to be an economic offset between changes in the value of hedging instruments and hedged transactions.
Buyers and sellers of PPAs face challenges when applying cash flow hedge accounting under IFRS 9. This is because the hedged transaction is required to be highly probable.
Subject to certain conditions, the proposals would permit companies to designate a variable nominal volume of forecast sales or purchases of renewable electricity as the hedged transaction, rather than a fixed volume based on high probability estimates. This would facilitate an economic offset between the hedging instrument and the hedged transaction, enabling companies to apply hedge accounting.
The proposals would apply prospectively but offer the option to re-designate – without discontinuation – existing cash flow hedging relationships during the first annual reporting period in which the proposals are applied.
Speak to your KPMG contact to find out more about the proposals and visit kpmg.com/ifrs to keep up to date with the latest news and discussion. Take the opportunity to provide your comments to IASB by 7 August 2024.
