Renshia van Noordwyk
Shivani Raghoonandan
The International Accounting Standards Board (IASB) published an Exposure Draft in May 2024 proposing narrow-scope amendments to IFRS 9: Financial Instruments and IFRS 7: Financial Instruments: Disclosures, to ensure that financial statements more faithfully reflect the effects that renewable electricity contracts have on an entity. The comment period for this exposure draft was relatively short and closed in early August 2024. SAICA’s comment letter is available on the IASB website for perusal.
Why is the IASB proposing these amendments?
Contracts for renewable electricity can be structured in many ways. Some contracts are structured as gross settled contracts to purchase or sell renewable electricity—these are commonly referred to as physical power purchase agreements. These arrangements can either take the form of a lease which is captured by the guidance in IFRS 16 Leases or could be considered more executory in nature, provided it meets what is called the “own-use scope exception in IFRS 9”. Other contracts require a net settlement of the difference between the prevailing market price and the contractually agreed price for the volume of electricity produced from a referenced generation facility. These are commonly referred to as virtual power purchase agreements and are most likely considered derivative contracts within the scope of IFRS 9.
As renewable electricity sources are dependent on natural factors such as rays of sunshine and wind flow patterns and speed, the supply of renewable electricity cannot be controlled or guaranteed. Many of the power purchase agreements contain “pay-as-produced” features which often require a purchaser to take and pay for whatever amount of renewable electricity is produced, even if that amount does not match the purchaser’s needs at the time of renewable electricity generation. The unique nature of electricity results in economic storage challenges, which gives rise to diversity in the design of electricity markets in many jurisdictions.
The IASB had received concerns from stakeholders expressing practical challenges in the application of the “own-use” scope exception to contracts to buy and sell electricity produced from nature-dependent sources. To address these challenges, the IASB has proposed targeted amendments to IFRS 9 for contracts to buy or sell renewable electricity that have specified characteristics.
Niche scoping requirements
The scope of the proposed amendments is very narrow and may only be applied to contracts if the specified scoping criteria are met, as such the proposals cannot be applied by analogy to other types of contracts. To qualify for the scoping criteria, the contract for renewable electricity must have a nature-dependent source of production and expose the purchaser to volume risk under the contract. Contracts for renewable electricity may be accompanied by renewable electricity certificates (‘RECs’), which are typically used as a means of certifying that a purchaser has produced electricity from a renewable source. The proposed amendments do not address the accounting considerations for these RECs.
Amendments sparked with relief
Own use exception
One of the challenges with contracts for renewable electricity is the mismatch between the renewable electricity produced and the purchaser’s needs at the time of generation. The market design and operation of the electricity market may force the purchaser to sell unused electricity back into the market shortly after delivery, often resulting in the contract failing the own-use scope exception and resulting in derivative accounting. The proposed amendments are designed to provide targeted relief such that these mismatches would not necessarily prohibit an entity from accounting for these contracts as executory contracts.
Hedge accounting
The IASB noted that challenges arise in designating and measuring a hedged item with a variable nominal amount such as forecasted electricity, in applying hedge accounting requirements in IFRS 9. The proposed amendments are thus designed to provide some relief to these challenges. In South Africa, these types of contracts are currently not very common, however, as the local electricity market develops, the proposed reliefs may benefit entities applying hedge accounting.
Amplified disclosure
While the proposed amendments are set to provide relief to some of the accounting challenges for contracts for renewable electricity, the proposals set forth a list of additional disclosure requirements to achieve greater transparency about contracts for renewable electricity for which the amendments have been applied. The proposed amendments to IFRS 7 require entities to disclose information that would enable users of financial statements to understand the effects contracts for renewable electricity have on the entity’s financial performance and the amount, timing and uncertainty of the entity’s future cash flows, including the fair value of the contracts at the reporting date. Given the nature of renewable electricity, the proposals also include disclosure of some non-financial information, such as the proportion of renewable electricity relative to the total volume of electricity sold or purchased, to enable stakeholders to understand the effect of these contracts on an entity’s financial statements.
The IASB has proposed specific factors an entity would be required to consider when applying the own-use scope exception. These factors are designed to assess the reasons for the sale shortly after delivery to determine whether the contract for renewable electricity was entered into and continues to be held per the entity’s expected usage requirements.
The proposed disclosure amendments currently do not provide any relief to entities applying IFRS 19: Subsidiaries without Public Accountability: Disclosures.
Lightning transition plan and effective date
The IASB aims to issue the amendments towards the latter part of 2024 with a proposed effective date for annual reporting periods beginning on or after 1 January 2025. The IASB proposals require an entity to apply the proposed amendments to the own-use scope exception retrospectively, however, an entity is not required to restate comparative information unless doing so is possible without the use of hindsight. The proposed amendments to the hedge accounting requirements can be applied prospectively.
Charging forward
The proposed amendments to the own-use scope exception could affect entities that currently account for their physical power purchase contracts to buy or sell renewable electricity as derivatives within the scope of IFRS 9. Applying the reliefs of the proposed amendments, those entities could potentially be able to account for these contracts as executory purchase or sale contracts outside the scope of IFRS 9.
Currently, in South Africa, there is no active market for electricity trades and as a result, few power purchase contracts trigger the net-settlement provisions of IFRS 9. However, as the electricity environment is rapidly developing, more contracts could potentially be captured by the scope of the proposed amendments.
Given the short, proposed transition plan and the inherent complexities of renewable electricity contracts, entities may experience challenges in gathering the relevant information to apply the proposed reliefs and additional disclosure requirements of the proposed amendments. It is therefore recommended that entities begin to evaluate the information contained within their power purchase contracts and consider the potential accounting and disclosure implications of the proposed amendments.
