Power Purchase Agreements:

For companies, the topics "green new deal" and "green economy" are becoming increasingly important. Physical and virtual power purchase agreements (PPAs) are a key instrument for companies in this context. They can be used to secure long-term and sustainable access to renewable energies. To date, however, PPAs have posed immense challenges for companies reporting under IFRS, as the IFRS 9 rules on the "own use exemption" do not take into account the special features of these products or of non-storable commodities in general. As a result, PPAs are often accounted for at fair value through profit or loss. Even if experience shows that the course set for the transition to a green economy is not dominated by accounting, unpredictable volatility in the income statement from long-term green power purchase agreements represents a serious obstacle and will not be conducive to the rapid implementation of climate targets.

An outreach of the IFRS Interpretations Committee (IFRS IC), which is based on the following three case constellations, has now given impetus to the discussion on the own use exemption, which has been going on for some time. The discussion was triggered by an inquiry on the accounting of Green Power PPAs and on the impact of the war in Ukraine on the European energy markets. With regard to the latter, the focus was in particular on the actual offtake behavior of the companies with regard to the previously contracted volumes in response to the expected market bottlenecks as well as the postulated savings. Specifically, the IFRS IC was presented with the following cases¹:

• Fact pattern #1: pay-as-produced contracts with remarketing
• Fact pattern #2: closing of long-term supply contracts in the spot market
• Fact pattern #3: green power PPA with maximum capacity above physical demand. 

Based on the feedback from the members of the International Forum of Accountancy Standards Setters, securities regulators and major accounting firms contacted in the course of the outreach, an initial staff paper "Application of the 'own use' exception to some physical power purchase agreements"² was published in June 2023. After this initial consideration, a recommendation by the IFRS IC for a "narrow-scope standard-setting project", i.e. standard-setting in the narrower sense, was already likely. The exploration of possible amendments to IFRS 9 and concrete options for action have now been prepared for the July meeting with the IASB and a prioritized treatment of the topic has been recommended. 

A glance at the Staff Paper of July 2023 already reveals a number of directions for possible changes if the IASB follows the reasoning and proposals of the IFRS IC:

• The relevance of proper accounting for contracts for the purchase of raw materials that cannot be adequately stored seems to have been clearly recognized by the standard setters. Corresponding gaps in the existing regulations are identified in the staff paper on this point.³ 
• Despite the fact that questions regarding the appropriate treatment of the Own Use Exemption also relate to procurement contracts from conventional generation, it is intended to include only PPAs from renewable energies in the scope within the framework of the planned standardization project.⁴ For this reason, it is not expected that there will be a conclusive regulation for conventional energy products and thus also parts of the fact pattern #2.
• In line with market practice, a large number of virtual PPAs have been established in addition to physical green power PPAs. Since these do not provide for physical delivery, accounting under the own use exemption is ruled out from the outset. The IFRS IC obviously does not want to change this fact. However, in order to achieve approximately equal treatment of economically identical strategies, the IFRS IC proposes a more specific formulation of hedge accounting when virtual PPAs are designated as hedging instruments.⁵

As the IASB is being advised to tackle standard setting with high priority, it is to be hoped that such a draft will be launched soon. However, for all companies preparing their financial statements in accordance with IFRS as of 30 September or 31 December 2023, no clear requirements have yet been set beyond the identifiable directions. 

The hope for a fundamental clarification on the application of the own use regulations for non-storable commodities also appears to be unfounded based on the current state of discussion. Although the IFRS IC has indicated a fundamental understanding of the needs of users and has once again provided a starting point for further discussion in practice with an interpretation of IFRS 9.2.6(c), it is not expected to create any generally applicable regulations for energy purchase agreements.⁶

For preparers and users of financial statements as well as for auditors, the new direction of the standard setter in the area of green power PPAs has become apparent. However, until implementation in binding accounting standards, all parties involved will have to continue to deal with the previous regulations and possibly with balance sheet approaches that are difficult for the users of financial statements to understand. Following the IASB's preliminary decision on the inclusion of a project in the work program, it will now first be examined whether and how changes in the aforementioned sense can be made.⁷ Only then can a final decision be made to include the project in the IASB's work plan and to begin with the concrete adaptation of the standard.

The challenge of accounting for contracts in the context of the "green new deal" and the "green economy" has thus been recognized, but unfortunately the accounting uncertainties for future financial statements have by no means been eliminated.

Source: KPMG Corporate Treasury News, Edition 135, August 2023
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Robert Abendroth, Senior Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG

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¹ See Appendix A to Staff Paper – July 2023 – Agenda Reference 12 (retrieved from ap12a-application-of-the-own-exception-to-some-physical-power-purchase-agreements.pdf (ifrs.org)).
² Staff Paper - June 2023 - Agenda Reference 2 (retrieved from https://www.ifrs.org/news-and-events/updates/ifric/2023/ifric-update-june-2023/#2)
³ Cf. paragraphs 33-41 Staff Paper – July 2023 – Agenda Reference 12
⁴ Cf. paragraph 49 Staff Paper – July 2023 – Agenda Reference 12
⁵ Cf. paragraphs 53-60 Staff Paper – July 2023 – Agenda Reference 12
⁶ Cf. paragraph 26 Staff Paper – July 2023 – Agenda Reference 12 regarding the cumulative fulfillment of a net settlement practice and intention to generate profit from short-term price fluctuations.
⁷ Cf. IFRIC Update July 2023 Agenda Reference 12A at https://www.ifrs.org/news-and-events/updates/iasb/2023/iasb-update-july-2023/#9