The International Accounting Standards Board (IASB) issued an exposure draft (ED) Contracts for Renewable Electricity on 8 May 2024.
The ED proposes amendments to IFRS 9 Financial Instruments and IFRS 7 Financial Instruments: Disclosures to address stakeholder concerns about how IFRS® Accounting Standards apply to certain contracts for renewable electricity.
The comment period for the exposure draft closes on 7 August 2024. The IASB is expected to move quickly to issue final amendments before the end of 2024. The ED suggests an effective date of annual reporting periods beginning on or after 1 January 2025, though the IASB has asked stakeholders whether they consider this date would allow sufficient time for preparers. Early application is expected to be permitted.
Broadly, the ED proposes amendments to the following requirements in IFRS Accounting Standards:
For example, an entity may enter into a contract to purchase corn 6 months in the future at a fixed rate, with an option to settle the contract net in cash based on the movement in the price of corn from the date of the contract’s inception and the settlement date. Such a contract meets the definition of a derivative in IFRS 9, however, if certain criteria in IFRS 9.2.4 and IFRS 9.2.6 are met, the contract may be scoped out of IFRS 9.
In mid-2023, the IFRS Interpretations Committee (the Committee) discussed a request about applying IFRS 9.2.4 to physical delivery contracts to buy energy – so called ‘physical power purchase agreements’ (PPAs). The Committee observed that the purchase of renewable energy such as solar and wind via long term energy contracts with physical delivery is widespread and is increasing as renewable energy generation also increases. The request states that entities are experiencing application challenges and questions when applying the requirements in IFRS 9 particularly due to the unique characteristics of the renewable energy market and the related features of the long-term physical delivery contracts. The topic was also enhanced to cover the questions about accounting for virtual PPAs meaning PPAs that have clauses permitted or requiring net settlement of the difference between a current market price and the agreed price for the produced electricity volume of an energy production facility the contract takes reference to.
The IASB decided to undertake a narrow-scope project to amend IFRS Accounting Standards to address the application concerns raised about IFRS 9.2.4 and how it is applied to contracts for renewable electricity.
The proposed amendments would clarify that in applying the own use exemption to such contracts, an entity would consider at inception of the contract and at each subsequent reporting date:
The basis for conclusions to the exposure draft makes it clear that the intention of the IASB is not to permit any and all contracts for renewable electricity to be accounted for ‘off balance sheet’. If an entity enters into a contract that is expected to continuously deliver more electricity than the entity needs, such an ‘oversized’ contract would not be in accordance with the entity’s expected usage requirements (ED IFRS 9.BC20(a)). But if the criteria for the application of the own use exemption are met, it has to be applied mandatorily. The own use exemption cannot be applied to virtual PPAs due to them being net settlement in cash with no physical delivery of electricity.
These disclosures would not apply at the individual contract level. Entities would need to apply judgement in aggregating and disaggregating information appropriately.
Additional disclosures would also be required if an entity is a seller under contracts for renewable electricity. Such entities would be required to disclose information that enables users of financial statements to understand how these contracts affect the entity’s financial performance for the reporting period. Specifically, an entity shall disclose the proportion of renewable electricity covered by the contracts to the total electricity sold for the reporting period.
Purchasing entities would also be required to make additional disclosures, specifically:
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Source BDO Global
The comment period for the exposure draft closes on 7 August 2024. The IASB is expected to move quickly to issue final amendments before the end of 2024. The ED suggests an effective date of annual reporting periods beginning on or after 1 January 2025, though the IASB has asked stakeholders whether they consider this date would allow sufficient time for preparers. Early application is expected to be permitted.
Broadly, the ED proposes amendments to the following requirements in IFRS Accounting Standards:
The background of the issue, and the proposed amendments, are discussed in the following sections.
What is the issue?
IFRS 9.2.4 is part of the scoping section of IFRS 9, and it sets out an exemption from applying the requirements of IFRS 9 to certain contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument.For example, an entity may enter into a contract to purchase corn 6 months in the future at a fixed rate, with an option to settle the contract net in cash based on the movement in the price of corn from the date of the contract’s inception and the settlement date. Such a contract meets the definition of a derivative in IFRS 9, however, if certain criteria in IFRS 9.2.4 and IFRS 9.2.6 are met, the contract may be scoped out of IFRS 9.
In mid-2023, the IFRS Interpretations Committee (the Committee) discussed a request about applying IFRS 9.2.4 to physical delivery contracts to buy energy – so called ‘physical power purchase agreements’ (PPAs). The Committee observed that the purchase of renewable energy such as solar and wind via long term energy contracts with physical delivery is widespread and is increasing as renewable energy generation also increases. The request states that entities are experiencing application challenges and questions when applying the requirements in IFRS 9 particularly due to the unique characteristics of the renewable energy market and the related features of the long-term physical delivery contracts. The topic was also enhanced to cover the questions about accounting for virtual PPAs meaning PPAs that have clauses permitted or requiring net settlement of the difference between a current market price and the agreed price for the produced electricity volume of an energy production facility the contract takes reference to.
The IASB decided to undertake a narrow-scope project to amend IFRS Accounting Standards to address the application concerns raised about IFRS 9.2.4 and how it is applied to contracts for renewable electricity.
What is the scope of the proposed amendments?
The scope of the proposed amendments applies only to contracts for renewable electricity with both of the following characteristics:- The source of production of the renewable electricity is nature-dependent so that supply cannot be guaranteed at specified times or for specified volumes. Examples of such sources of production include wind, sun and water.
- That 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.
How would the proposed amendments affect the ‘own use exemption’ in IFRS 9?
The IASB is proposing to amend IFRS 9 to clarify how to analyse the own use exemption in the context of contracts for renewable electricity.The proposed amendments would clarify that in applying the own use exemption to such contracts, an entity would consider at inception of the contract and at each subsequent reporting date:
The basis for conclusions to the exposure draft makes it clear that the intention of the IASB is not to permit any and all contracts for renewable electricity to be accounted for ‘off balance sheet’. If an entity enters into a contract that is expected to continuously deliver more electricity than the entity needs, such an ‘oversized’ contract would not be in accordance with the entity’s expected usage requirements (ED IFRS 9.BC20(a)). But if the criteria for the application of the own use exemption are met, it has to be applied mandatorily. The own use exemption cannot be applied to virtual PPAs due to them being net settlement in cash with no physical delivery of electricity.
How would the proposed amendments affect the hedge accounting requirements in IFRS 9?
Where a contract for renewable electricity meets the scoping requirements set out above and is within the scope of IFRS 9’s requirements, the exposure draft proposes to permit entities to designate – (designation is always a choice and is not mandatory (refer to IFRS 9.6.1.2)) - a variable nominal volume of forecasted electricity transactions (sales or purchases) as hedged items in a cash flow hedging relationship, if certain criteria are met. Without the proposed amendments, this would not be possible within the existing requirements of IFRS 9 (IFRS 9.6.4.1, especially (c)). This refers to both, PPAs and virtual PPAs.Such a designation is only permissible if both criteria are met:
- The hedged item is specified as the variable volume of electricity to which the hedging instrument relates; and
- The variable volume of forecast electricity transactions designated above does not exceed the volume of future electricity transactions that are highly probable (except when the forecast relates to sales that are a proportion of the total future renewable electricity from a production facility as hedging instrument).
What disclosures would the proposed amendments introduce?
Contracts for renewable electricity with the characteristics specified in the scoping section above would also result in additional disclosures:These disclosures would not apply at the individual contract level. Entities would need to apply judgement in aggregating and disaggregating information appropriately.
Additional disclosures would also be required if an entity is a seller under contracts for renewable electricity. Such entities would be required to disclose information that enables users of financial statements to understand how these contracts affect the entity’s financial performance for the reporting period. Specifically, an entity shall disclose the proportion of renewable electricity covered by the contracts to the total electricity sold for the reporting period.
Purchasing entities would also be required to make additional disclosures, specifically:
a. The proportion of renewable electricity covered by the contracts to the total net volume of electricity purchased;
b. The total net volume of electricity purchased — irrespective of the source of production;
c. The average market price per unit of electricity in the markets in which the entity purchased electricity; and
d. If (b) multiplied by (c) differs substantially from the actual total cost incurred by the entity to purchase the volume of electricity in (b), a qualitative explanation of the key reasons for this difference.
What are the proposed transition requirements?
Different transition requirements are provided for the proposed amendments to the own use exemption and the hedge accounting requirements.Own use exemption
- Entities would be required to apply the amendment retrospectively; however, an entity would not be required to restate prior periods to reflect the application of the proposed amendments (modified retrospective approach).
- Restatement of prior periods would only be permitted if it is possible to do so without the use of hindsight.
- If prior periods are not restated, an entity would be required to recognise any difference between the previous carrying amount and the carrying amount at the beginning of the reporting period in which the entity first applies the amendments in opening equity.
- If an entity were to apply the amendments in a reporting period that includes the date the amendments are issued (i.e. 2024), an entity would be required to recognise any difference between the previous carrying amount and the carrying amount at the date when the amendments are issued in opening equity.
Hedge accounting
- Entities would apply the revised requirements prospectively to new hedging relationships designated on or after the date the amendments are first applied.
- An entity would be permitted to change the designation of the hedged item in a cash flow hedging relationship that was designated before the date the amendments are first applied. Such a change to the designation of the hedged item constitutes neither the discontinuation of the hedging relationship nor the designation of a new hedging relationship.
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Source BDO Global
