New IFRS rules for power purchase agreements

Accounting for long-term power purchase agreements

Long-term contracts for the supply of electricity at a fixed price are referred to as power purchase agreements (PPA). For these types of agreements, the volume for the buyer is typically not fixed. The difficulty when procuring nature-dependent electricity is that there is no certainty as to when and how strongly, for example, the wind will blow in the coming year, or the sun will shine. Consequently, the volume of electricity that is generated and thus to be purchased can vary over time. Since electricity itself cannot be stored, leaving aside battery storage, the company purchasing the electricity is effectively forced to resell the electricity that is not needed (risk of oversupply). However, the market price at the time of sale is not predictable whereby gains or losses may arise. 

On the one hand, PPAs are used to meet the own electricity requirement and, on the other hand, to hedge against future electricity price fluctuations. In view of the volatility of the volume of electricity generated, prior to the amendments to IFRS 9, it was frequently not possible to demonstrate that there was an economic relationship between the hedged item (anticipated electricity purchase) and the hedging instrument (PPA). Since, within the meaning of the previous rules, often no hedging relationship thus existed this meant that the PPA had to be accounted for as a derivative with the corresponding volatile effects in the income statement. 

In order to provide an appropriate response to these factors involved in the accounting for the purchase of electricity, the IASB has made amendments to IFRS 9 (Financial Instruments); consequently, under specific circumstances, a variable volume may be designated as a hedged item. If an agreement referencing nature-dependent electricity is used to hedge the cash flows from the anticipated electricity purchases and sales, then a variable nominal quantity of anticipated purchases and sales may be designated as a hedged item in a cash flow hedge.

As a consequence, IFRS 7 (Financial Instruments: Disclosures) was also adapted with respect to the disclosures in the notes to the financial statements.

Amendments pursuant to IFRS 9

A buyer may apply the own-use-exemption for the procurement of nature-dependent energy provided that in aggregate the buyer is a net purchaser based on a backward-looking and also a forward-looking assessment. This means that the buyer must purchase sufficient electricity in the same market to offset any unused electricity that was sold there. The assessment here is based on a period of twelve months.

Under IFRS 9, a derivative may be designated as a hedging instrument in connection with hedge accounting. Therefore, a PPA that is accounted for as derivative may be used as a hedge for anticipated electricity transactions as part of a cash flow hedge. In this way, anticipated electricity transactions in the amount of the variable nominal value of the hedging instrument are designated as hedged items. 

Amendments pursuant to IFRS 7

If an agreement is affected by the amendments and the own-use-exemption is used for this agreement, then additional information, such as the variability in the volume of electricity and the risk of oversupply relating to this agreement, will have to be disclosed. Such disclosures are: 

• details of the agreements relating to variability in volume and possibly any purchase obligations beyond own needs;
• anticipated future cash flows from unrecognised commitments to purchase electricity;
• qualitative information on whether a contract could become onerous within the meaning of IFRS 37;
• quantitative and qualitative information about the effects of the agreements on the financial performance based on the assessment for the net purchaser criterion.

Moreover, under IFRS 7.23A, the information disclosed about the risk categories needs to be disaggregated.