Accounting challenges presented by power purchase agreements for wind energy
The energy market is facing another change: producers and large consumers are currently preparing for German Renewable Energies Act [EEG] funding for the first wind farms to expire at the end of 2020 and thus price control to also lapse. However, since producers need certainty regarding their income even without state support in order to make the necessary investments in wind farms, other mechanisms will be needed in the future to enable the energy carriers to market wind. Power purchase agreements (PPA) – long-term direct purchase agreements with major customers – are one potential solution. Such agreements are currently growing considerably in popularity, though there are legal and accounting challenges concerning how they are designed, including for customers of green electricity.
A study published by KPMG in September outlined the basics of PPAs, the opportunities they present and the accounting implications. In international accounting, these implications range from the potential consolidation of a project company to treatment as a pending procurement transaction. Conceivable interim steps include leasing according to IFRS 16 or recognition as a financial instrument pursuant to IFRS 9.
Depending on the scope defined, PPAs may be relevant for things such as centralised forward procurement of raw materials or integrated reporting of market risks for corporate treasury. In this regard, it might be especially interesting to look at cases where a PPA is to be classified as a derivative and thus causes a fluctuation in earnings due to its continuous measurement at fair value.
First, the PPA must be assessed to determine whether or not it satisfies all the characteristics of an (embedded) derivative. One controversial point in this context could be seen to be the criterion for the contract's performance based on an "underlying" value, as the ultimate purchase volume is often fully measured only after actual generation. Of course, this volume cannot be predicted accurately for a wind farm, and thus adequate determination of the contractual volume was in the past typically considered not to have been satisfied. However, IFRS 9 has provided implementation guidelines (IFRS 9.IG.B.8) that now include an example in which the amount of a derivative is also not determined from the beginning. In the case of a PPA, therefore, the expected values typically available for wind yield can be used. If there are also no significant acquisition payments, a PPA should be able to fulfil all the criteria of a derivative according to IFRS 9.
At this point, the own use exemption under IFRS 9 would need to be examined. If power from the PPA is physically settled and used for the customer's operating activities, this constitutes a pending procurement agreement. In such a case, this would not be recognised, and examined only in terms of potential onerous contracts pursuant to IAS 37.
However, if this constitutes a derivative, the green electricity customer can under certain circumstances still avoid reporting changes in fair value through profit or loss by applying hedge accounting. This is because even with non-physical settlement of electricity supplied, it may be possible to link a PPA, as a price-hedging transaction, to the risk of volatile power procurement in the future.
In addition, a PPA must be examined to assess whether is to be classified as a lease and recognised accordingly, or even if the wind farm has to be included in consolidation.
In this regard, the accounting of PPAs is not an option, but rather a consequence of the specific contractual provisions. Therefore, PPAs offer industrial enterprises a good opportunity to stock up on high-demand green electricity over the long term and on a reliable basis. However, the implications for accounting and, indirectly, risk reporting should be fully examined in good time.
Source: KPMG Corporate Treasury News, Edition 85, October 2018
© 2019 KPMG AG Wirtschaftsprüfungsgesellschaft, ein Mitglied des KPMG-Netzwerks unabhängiger Mitgliedsfirmen, die KPMG International Cooperative (“KPMG International”), einer juristischen Person schweizerischen Rechts, angeschlossen sind. Alle Rechte vorbehalten.