Background
On 8 May 2024, the International Accounting Standards Board (IASB) issued an exposure draft (ED) titled ‘Contracts for Renewable Electricity.’ This ED proposes amendments to IFRS 9 Financial Instruments and IFRS 7 Financial Instruments: Disclosures.
The amendment is intended to resolve a practical issue in applying these standards to some renewable electricity contracts, particularly Physical Power Purchase Agreements (PPAs) and virtual PPAs. There are concerns from stakeholders on the accounting of these contracts under existing IFRS rules.
Key Concerns and the Need for Amendments
IFRS 9 has a scope exemption for contracts to buy or sell non-financial items, providing that they are settled in cash. But these features which are unique to renewable electricity contracts – the contractual nature of dependence and that there is also a volume risk mitigated by them. have rendered it practically uncontrollable for entities applying this exemption consistently.
Examples of Issues:
a) Renewable electricity contracts usually require natural sources, like wind and solar power, and therefore it is not predictable.
b) A large volume risk to the buyer is held by the long-term PPAs; the quantity of electricity produced may always not be commensurate with their demand.
In response to these challenges, the IASB has, therefore, proposed amendments in the ED designed to address the following issues:
1. Application of own-use requirements on renewable contracts according to IFRS 9.
2. Permission of hedge accounting in case such contracts has been used as the hedging instruments as per IFRS 9.
3. Its disclosure in the financial statements to assist investors in evaluating the financial impact of these contracts on the financials of the company under IFRS 7.
These issues were highlighted by the IFRS Interpretations Committee, which recommended amending the standards.
Scope of the Proposed Amendments
The proposed amendments focus on contracts for renewable electricity that meet the following criteria:
1. The electricity is generated from natural sources, such as wind, solar, and hydro, with variability in supply.
2. Volume risk to the buyer is introduced to the contract by the ‘pay-as-produced’ feature.
These amendments, therefore, do not affect other forms of contracts.
Clarifying the ‘Own Use Exemption’ under IFRS 9
The IASB proposes clarification on applying the ‘own use exemption’ in IFRS 9 to renewable electricity contracts. For this, an entity shall consider—at contract inception and subsequently at each financial reporting date—whether the contract meets the criteria for the exemption by considering the following:
1. Determining the contract’s purpose, design, and structure allows determining whether the renewable energy volumes that are due to be delivered within the arrangement correspond to the entity’s purchase or usage. An entity shall make a reasonable estimate of the expected purchase or usage requirements for at least 12 months post reporting date.
2. Ensuring that the sale of surplus renewable electricity aligns with the entity’s anticipated purchase or usage requirements, only if all the following conditions are satisfied:
a. The sale occurs due to the entity’s exposure to volume risk, leading to discrepancies between the renewable electricity supplied and the entity’s electricity demand at the time of delivery.
b. The market’s structure and functioning where the electricity is sold prevent the entity from practically determining the timing or price of the sale of surplus electricity.
c. The entity expects to purchase substantially the same amount of electricity at approximately the same time as the sale.
The exemption does not apply to virtual PPAs, which involve net cash settlement without physical delivery of electricity.
Hedge Accounting Requirements under IFRS 9
The IASB suggests that entities should be able to designate variable nominal volumes of forecasted electricity transactions as hedged items in a cash flow hedging relationship, provided certain criteria are met. This designation allows for more effective hedging of future electricity purchases or sales, which was not feasible under the existing IFRS 9 requirements.
According to the IASB, such designation is only permissible subject to the following criteria being met:
1. The hedged item must be specified as the variable volume of electricity related to the hedging instrument.
2. The forecasted electricity transactions must be highly probable, except when the forecast relates to sales that are a proportion of total future renewable electricity production.
Disclosure Requirements under IFRS 7
IASB requires the entities to provide additional disclosures to help users understand the financial impact of renewable electricity contracts. These disclosures include:
1. The terms and conditions of the contracts
2. The proportion of renewable electricity covered by the contracts relative to the total electricity sold or purchased.
3. The average market price of electricity in relevant markets and any significant differences between this price and the actual costs incurred.
The IFRS disclosure requirements must be applied when the IFRS 9 amendments are applied.
Transition Requirements
Own Use Exemption:
- Apply the amendment retrospectively, with a modified retrospective approach permitted.
- Prior periods do not need to be restated unless possible without hindsight.
- Differences in carrying amounts are adjusted in the opening equity of the first application period.
Hedge Accounting:
- Apply the new requirements prospectively to new hedging relationships from the date of first application.
- Allow changes in the designation of hedged items in existing hedging relationships without discontinuing or redesignating the relationship.
Conclusion
The IASB’s proposed amendments to IFRS 9 and IFRS 7 aim to provide clearer guidance for accounting renewable electricity contracts. These amendments enhance the accuracy of financial reporting by addressing the challenges that such contracts pose and, therefore, facilitate the process toward renewable energy sources.
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