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Using the fair value option

Using the fair value option

Accounting mismatch at energy providers

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Christian Debus

Partner, Finance Advisory, Finance & Treasury Management

KPMG AG Wirtschaftsprüfungsgesellschaft

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Fair Value Option

Procurement strategy in energy trading

The sale and acquisition of futures contracts for energy and raw materials as well as timetables is carried out at the majority of energy providers over a liquid period of up to three years prior to actual physical delivery. One of the key metrics and performance indicators for the trade volumes that are open in this period is the profit and loss (P&L) and/or the fair value of a contract or portfolio, that is, the change in value at a given point in time compared to the trading date depending on the change in value of one or several underlyings. 

Provided these contracts meet the criteria for derivatives1 within the meaning of IFRS as well as the criteria for the own use exemption2, contrary to the standard accounting treatment for derivatives and the trading performance indicators, they are not recognised at fair value. These are not recognised in the accounts until their settlement. Pursuant to IFRS 9 and IDW RS HFA 48, contracts that meet the criteria for the own use exemption are those that "were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage requirements".

Implications of the own use exemption in practice

As the majority of contracts at an energy provider concern acquisition, sales or production transactions, these contracts fulfil the own use criteria. As a result, the performance indicators from trading or the company's core business can no longer be derived directly from the values recognised in the accounts – for example, a successful company's consistently high P&L in trading is not reflected in the financial statements due to the own use exemption. Own use contracts must be indicated as such in the financial statements and assigned to their own ledger in the portfolio structure. This generally results in a dual ledger structure in trading with separate fair value and own use ledgers. Classifying transactions according to this structure places operational restrictions on trade. For example, transactions in the own use ledger in principle solely consist of sales and acquisitions. Transactions in the opposite direction are generally not possible without violating the intention to hold them to maturity (and by extension violating the own use exemption). The Company thus is unable to operate and manage its own use ledgers taking into account current or expected market prices (e.g. reduction of positions through net settlement in cash).

Application of the fair value option in the event of an accounting mismatch

Since 2018, companies have the option in accordance with IFRS 9 to apply the fair value option to transactions previously classified as own use. This option allows companies to designate its own use contracts (in the best case, this also includes timetables) at fair value through profit and loss at the beginning of the contract. To apply the fair value option, however, certain conditions must be checked. In particular, companies must ensure that the contracts in question meet the basic criteria for derivatives within the meaning of IFRS and that an accounting treatment under the own use option constitutes an "accounting mismatch"3. This would for example be the case if acquisition transactions were recorded at fair value on the liabilities side of the balance sheet while at the same time any positive fair value arising from sales transactions were not displayed at fair on the asset side due to application of the own use exemption.

Only a test of details of the contracts and ledgers can determine whether the conditions for applying the fair value option are met. Finally, the external auditor should be consulted on the approach.

Source: KPMG Corporate Treasury News, Edition 98, January - February 2020

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1 IFRS 9 (2.4. et seqq.)
2 IDW RS HFA 48, IFRS 9.2.4
pursuant to IFRS 9.2.5. 

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