Revenue recognition when or as

Revenue recognition when or as
the entity satisfies a performance obligation

The obligation to purchase and sell electricity under a PPA generally will be viewed as a single performance obligation that is satisfied over time (when). A power and utilities entity will be required to measure its progress towards complete satisfaction of its performance obligation to deliver electricity. The objective, when measuring progress, is to depict the seller’s performance in transferring control of the electricity to the customer.

Arrangements to sell other commodities, including natural gas and physical capacity, over a contractual term, could be viewed as a single performance obligation. More judgement might be required to determine if such arrangements meet the definition of a performance obligation satisfied over time.

Different pricing conventions

Some types of sales contract are not impacted by price or volume variability but they do have different fixed pricing conventions (for example, prices per unit might be stated, but they might change over the life of the contract). Under a particular arrangement, the price per unit might step up over time, to reflect expected costs to produce or an expectation of increased market pricing over time. Alternatively, the prices might be different to reflect seasonal or time of day pricing (such as peak versus off-peak).

A contract with stated, but changing, prices for a fixed quantity delivered does not contain variable consideration, because the transaction price for the contract is known at inception and does not change. It is important for the power and utility entity to understand what is giving rise to the pricing convention. For example, the escalations might be intended to reflect the expected market price of power in the future periods which a customer would expect to pay.

The total transaction price should be recognised as revenue over time by measuring progress towards complete satisfaction of the performance obligation. The seller applies a permissible form of the ‘output’ or ‘input’ method.

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Electricity revenue recognition example

Electricity revenue recognition example

Application of the five-step model

Facts: Bundle Seller Co (‘Seller’) and Bundle Buyer Co (‘Buyer’) executed an agreement for the purchase and sale of 1oMW of electricity per hour and the associated renewable energy credits (‘RECs’) (one REC for each MWh) at a fixed bundled price (‘the agreement’ or ‘the PPA’). The contract term begins on 1 January 20X1 and ends on 31 December 20X4, and the fixed bundled price during each of those respective years is $200, $205, $210 and $215.

The increase in the bundled price represents the increase in the forward price of electricity and RECs over the term of Electricity revenue recognition examplethe agreement as of the acquisition date. Control, including title to and risk of loss related to the electricity, will pass and transfer on delivery at a single point on the electricity grid. Control, including title to and risk of loss related to RECs, will pass and transfer when the associated electricity is delivered.

Seller and other market participants frequently execute contracts for the purchase and sale of electricity and RECs on a stand-alone basis.

Seller concluded that this arrangement does not contain a lease (that is, no property, plant or equipment is explicitly or implicitly identified). The electricity element of this arrangement qualifies for the ‘own use’ exception and thus is not accounted for as a derivative. The REC element has no net settlement characteristics. As such, each element of this agreement is within the scope of IFRS 15.

Electricity revenue recognition – IFRS 15 step-by-step

Step 1 – Identify the contract with a customer

This agreement, including each of its elements (that is, electricity and RECs), is within the scope of the standard, and collection of the contract consideration is considered probable.

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Separate lease and non-lease components for real estate under IFRS 16

Separate lease and non-lease components

Many real estate leases contain multiple lease and non-lease components, which landlords need to identify and account for separately.

1 Overview

IFRS 16 requires a landlord to separate the lease and non-lease components of a contract. (IFRS 16.12, IFRS 16.BC135(b))

In practice, real estate contracts may contain:

  • one or more lease components: e.g. the right to use land and/or a building; and
  • one or more non-lease components: e.g. maintenance, cleaning and provision of utilities.

For lessors, identifying components and allocating consideration will determine the split of lease income vs revenue from contracts with customers. These amounts are often presented and have to be disclosed separately. For example, a real estate company will need to distinguish lease income from revenue for other property related services – e.g. common area maintenance (CAM). (IFRS 15.110, IFRS 15.114, IFRS 16.90)

The key steps in accounting for the components of a contract are as follows.

Identify separate lease components (go here)

Identify non-lease components (go here)

Allocate consideration (go here)

Reallocate consideration on lease modification (go here)

2 Typical lease components in real estate contracts

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Landlord Lease term – IFRS 16 Best complete read

Landlord Lease term

New guidance on lease term could impact the period over which operating lease incentives are recognised in profit or loss, particularly for renewable and cancellable leases.

1 Overview of landlord lease term

Determining the lease term is a critical estimate that is significant for the lessor. The lease term may affect the lease classification. For operating leases, it impacts the period over which lease incentives are recognised.

The lease term is the non-cancellable period of the lease, together with:

  • optional renewable periods if the lessee is reasonably certain to extend; and
  • periods after an optional termination date if the lessee is reasonably certain not to terminate early. (IFRS 16.18)

To determine the lease term, a lessor first determines the length of the non-cancellable period of a lease and the period for which the contract is enforceable. It can then determine – between those two limits – the length of the lease term.

The lessor determines the lease term at the commencement date.

The lease term starts when the lessor makes the underlying asset available for use by the lessee. It includes any rent-free periods. (IFRS 16 Definition, IFRS 16.B36)

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Landlord accounting model – IFRS 16 best replacement for IAS 40

Landlord accounting model

Landlords continue to classify leases as finance or operating leases, and continue to classify many real estate leases as operating leases.

1 Overview

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors.

What are the impacts of IFRS 16 on lessors?

Much of the guidance in IFRS 16 on lessor accounting is a ‘carry forward’ from IAS 17 Leases – literally a cut-and-paste. This reflects feedback from financial statement users and other stakeholders that lessor accounting was not ‘broken’.

However, there are a number of changes in the details of lessor accounting. For example, lessors apply the new:

  • definition of a lease (see this page);
  • guidance on separating components of a contract (see this page);
  • guidance on lease term (see this page);
  • guidance on lease modifications (see this page);
  • guidance on sub-lease (see this page); and
  • guidance on sale-and-leaseback (see this page).

The same definition of ‘lease term’ applies to both lessees and lessors. IFRS 16 includes guidance on when extension options and termination options are taken into consideration when determining the lease term. Additional guidance has been issued about determining the lease term – an estimate that could significantly impact the overall lease accounting.

In addition, IFRS 16 includes specific guidance on separating the components of a contract and accounting for lease modifications by lessors.

The new guidance may significantly impact the accounting for sub-leases and sale-and-leaseback transactions.

2 Lease classification

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Contract modifications in power and utilities – Best IFRS 15 Revenue recognition

Contract modifications in power and utilities

One of the most judgemental aspects of implementing IFRS 15 for power and utilities entities is applying the contract modifications guidance to arrangements, such as ‘blend and extend’ arrangements.

Blend and extend arrangements

Blend and extend arrangements are common in the power and utilities industry. In a blend and extend arrangement, the buyer and seller negotiate amended pricing of an existing contractual arrangement, including extending the term of the existing arrangement. It is common for the buyer to benefit from a lower blended price (original price blended with the extension period price which is at a lower rate per unit) and for the seller to benefit from an extended term (original term plus the extension period term).

Management will need to evaluate these types of modifications in order to determine how and when they will be accounted for under the contract modification provisions in IFRS 15.

Blend and extend modifications will typically fall into one of the following scenarios:

  1. The modification creates a separate contract from the existing arrangement. This would be the case if the modification results in an increase in the amount of distinct goods (such as units of electricity to be delivered), and the additional consideration reflects the reporting entity’s stand-alone selling price of the additional promised goods.
  2. The modification represents a termination of the existing agreement and the creation of a new agreement, to be accounted for prospectively. This would be the case if the modification results in an increase in the amount of distinct goods (such as units of electricity to be delivered), but the additional consideration does not reflect the reporting entity’s stand-alone selling price of the additional promised goods (for example, the price per unit of the new distinct goods is different from the market due to the blended price).

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Transaction price power and utilities under IFRS 15 – All best read

Determining the transaction price power and utilities

The determination of the transaction price in many power and utilities contracts will be fairly straightforward, particularly where the contract pricing and contract quantities are fixed; however, in practice, reporting entities often enter into contracts that contain index-based pricing, variable volume, or both.

For example, Seller might enter into a requirements contract to sell electricity to Buyer at predetermined prices, but volumes are not known at contract inception. Uncertainty exists with respect to the total consideration to be received by Seller over the term of the contract. Seller might be able to elect a practical expedient to recognise revenue based on the amount invoiced, if it directly corresponds with the value to the customer of Seller’s performance completed to date.

Contracts that contain forms of variable consideration, significant financing components, non-cash consideration and/or consideration payable to a customer are likely to be more complex and will require judgement.

Variable consideration power and utilities

Variable consideration should be estimated using the expected value method or the most likely amount method. This is not a ‘free choice’. An entity needs to consider which method it expects to better predict the amount of consideration to which it will be entitled and apply that method consistently for similar types of contract.

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IFRS 15 Power purchase agreement

IFRS 15 Power purchase agreement

It is common for customer contracts within the power and utilities industry to contain multiple performance obligations. It is essential that power and utilities entities evaluate their portfolio of customer contracts in order to identify explicit and implicit promises to transfer a distinct good or service to a customer.

A promise to transfer a series of distinct goods that are substantially the same and that have the same pattern of transfer to the customer is a performance obligation known as a ‘series’. Contracts for the sale of electricity, and many contracts for the sale of gas to residential and small commercial and industry clients, would represent such a promise.

Sometimes, two products (such as gas and electricity) are sold together. Where multiple products are sold simultaneously, generally:

  1. Gas and electricity are distinct, because (a) a customer can benefit from either gas or electricity on its own (that is, the customer can sell gas and electricity, on a stand-alone basis, into the marketplace, etc.), and (b) the promise to transfer gas or electricity is separately identifiable from other promises in the contract.
  2. The performance obligation to deliver gas and electricity, in many cases, is satisfied over time, since the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. This conclusion might not be applicable for gas or other commodity contracts, where the customer has storage facilities and does not consume the benefits of the commodity immediately as it is delivered.
  3. Each delivery of gas or electricity in the series, that the entity promises to transfer to the customer, meets the criteria to be a performance obligation satisfied over time, and the same method will be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct delivery of gas or electricity in the series to the customer.

Judgement is required to identify performance obligations in power and utilities contracts. In some jurisdictions, distribution and energy might be distinct performance obligations; while, in others, energy and distribution might be a single integrated performance obligation. This will depend on a number of factors, including whether the customer can choose amongst retailers and the relationships between the providers of distribution, the retailer and the end customer.

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Identified asset – 2 Complete with comprehensive examples

Identified asset

a term from IFRS 16 Leases. Let’s see what it is all about….

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

The key factors to consider when applying the lease definition are as follows.

Identified asset

1. Specified asset

An asset can be either explicitly specified in a contract (e.g. by a serial number or a specified floor of a building) or implicitly specified at the time it is made available for use by the customer. (IFRS 16.B13, IFRS 16.BC111)

Food for thought – What does ‘implicitly specified’ mean?

An asset is implicitly specified if the facts and circumstances indicate that the supplier can fulfil its obligations only by using a specific asset. This may be the case if the supplier has only one asset that can fulfil the contract. For example, a power plant may be an implicitly specified asset in a power purchase contract if the customer’s facility is in a remote location with no access to the grid, such that the supplier cannot buy the required energy in the market or generate it from an alternative power plant.

In other cases, an asset may be implicitly specified if the supplier owns a number of assets with the required functionality, but only one of those assets can realistically be supplied to the customer within the contracted time-frame – i.e. the supplier does not have a substantive right to substitute an alternative asset to fulfil the contract – see 3.3. For example, a supplier may own a fleet of vessels but only one vessel that is in the required geographic area and not already being used by other customers.

1.1 Capacity portions

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Payment holidays on loans

Payment holidays on loans under IFRS 9

Governments and banks have introduced payment deferral programs to support borrowers affected by Covid-19. But deferred payments are not forgiven and must be repaid in the future, raising prospective risks to the banking system. Thus, they should be designed to balance near-term economic relief benefits with longer-term financial stability considerations.

The Basel Committee on Banking Supervision (BCBS) and several prudential authorities have issued statements clarifying how payment deferrals should be considered in assessing credit risk under applicable accounting frameworks. These measures aim to encourage banks to continue lending, to avert an even deeper recession.

Prudential authorities are caught “between a rock and a hard place” as they encourage banks – through various relief measures – to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems.

In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers – amidst an uncertain outlook – should help guide banks’ efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.

What is this all about?

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