IAS 16 Generation assets for Power and Utilities

Generation assets for Power and Utilities

– are often large and complex installations. They are expensive to construct, tend to be exposed to harsh operating conditions and require periodic replacement or repair. This environment leads to specific accounting issues.

1 Fixed assets and components

IFRS has a specific requirement for ‘component’ depreciation, as described in IAS 16 Property, Plant and Equipment. Each significant part of an item of property, plant and equipment is depreciated separately. Significant parts of an asset that have similar useful lives and patterns of consumption can be grouped together. This requirement can create complications for utility entities, because many assets include components with a shorter useful life than the asset as a whole.

Identifying components of an asset

Generation assets might comprise a significant number of components, many of which will have differing useful lives. The significant components of these types of assets must be separately identified. This can be a complex process, particularly on transition to IFRS, because the detailed record-keeping needed for componentisation might not have been required in order to comply with national generally accepted accounting principles (GAAP). This can particularly be an issue for older power plants. However, some regulators require detailed asset records, which can be useful for IFRS component identification purposes.

An entity might look to its operating data if the necessary information for components is not readily identified by the accounting records. Some components can be identified by considering the routine shutdown or overhaul schedules for power stations and the associated replacement and maintenance routines. Consideration should also be given to those components that are prone to technological obsolescence, corrosion or wear and tear that is more severe than that of the other portions of the larger asset.

First-time IFRS adopters can benefit from an exemption under IFRS 1 First-time Adoption of International Financial Reporting Standards. This exemption allows entities to use a value that is not depreciated cost in accordance with IAS 16, and IAS 23 Borrowing Costs as deemed cost on transition to IFRS. It is not necessary to apply the exemption to all assets or to a group of assets.

IFRS 14 Regulatory Deferral Accounts was issued in January 2014 as an interim standard on rate-regulated activities. IFRS 14 permits first-time adopters to continue to recognise amounts related to rate regulation in accordance with their previous GAAP accounting policies on adoption of IFRS.

However, IFRS 14 requires the effect of rate regulation to be presented separately from other items to enhance comparability with entities that already apply IFRS (and therefore do not recognise such amounts). An entity that already presents IFRS financial statements is not eligible to apply the new guidance.

Depreciation of components

All components should be depreciated to their recoverable amount over their useful lives, which might differ among components. The remaining carrying amount of the component is derecognised on replacement, and the cost of the replacement part is capitalised.

The costs of performing major maintenance/overhaul are capitalised as a component of the plant, where this provides future economic benefits. Turnaround/overhaul costs that do not relate to the replacement of components or the installation of new assets should be expensed when incurred.

Turnaround/overhaul costs should not be accrued over the period between the turnarounds/overhauls, because there is no legal or constructive obligation to perform the turnaround/overhaul; the entity could choose to cease operations at the plant and hence avoid the turnaround/overhaul costs.

2 Borrowing costs

The cost of an item of property, plant and equipment might include borrowing costs incurred for the purpose of acquiring or constructing it. IAS 23 (revised) requires such borrowing costs to be capitalised if the asset takes a substantial period of time to be prepared for its intended use.

Examples of borrowing costs given by the standard are: interest expense calculated using the effective interest method (described in IFRS 9, Financial Instruments); finance charges in respect of finance leases recognised in accordance with IFRS 16, Leases; and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Borrowing costs should be capitalised while acquisition or construction is actively underway. These costs include the costs of specific funds borrowed for the purpose of financing the construction of the asset, and those general borrowings that would have been avoided if the expenditure on the qualifying asset had not been made. The general borrowing costs attributable to an asset’s construction should be calculated by reference to the entity’s weighted-average cost of general borrowings.

A Case – Utility in construction

A utility commences construction on a new power plant on 1 September 201X, which continues without interruption until after the year end 31 December 201X. Directly attributable expenditure on this asset is CU100 million in September 201X and CU250 million in each of the months of October to December 201X. Therefore, the weighted-average carrying amount of the asset during the period is CU475 million – that is, (100 million + 350 million + 600 million + 850 million)/4. The entity has not taken out any specific borrowings to finance the construction of the plant, but it has incurred finance costs on its general borrowings during the construction period. During the year, the entity had 10% debentures in issue, with a face value of CU2 billion; and it had an overdraft of CU500 million, which increased to CU750 million in December 201X and on which interest was paid at 15% until 1 October 201X, when the rate was increased to 16%. The capitalisation rate of the general borrowings of the entity during the period of construction is calculated as follows: Weighted-average borrowings during period: ((2b × 4)+(500 million × 3)+(750 million × 1))/4 = CU2,562,500,000 Capitalisation rate (total finance costs in period/ weighted-average borrowings during period) = 96,250,000/2,562,500,000 = 3.756%

The capitalisation rate, therefore, reflects the weighted-average cost of borrowings for the four-month period that the asset was under construction. On an annualised basis, 3.756% for the four-month period gives a capitalisation rate of 11.268% per annum, which is what would be expected on the borrowings profile. Therefore, the total amount of borrowing costs to be capitalised is the weighted-average carrying amount of asset × capitalisation rate = CU475 million × 11.268% × 4/12 = CU17,841,000 CU’000 Finance cost on CU2 billion 10% debentures during September–December 201X 66,667 Interest at 15% on overdraft of C500 million in September 201X 6,250 Interest at 16% on overdraft of C500 million in October and November 201X 13,333 Interest at 16% on overdraft of C750 million in December 201X 10,000 Total finance costs in September–December 201X 96,250

Utilities will sometimes use operating cash flows to finance capital expenditure during a period when there is also general financing. The borrowing rate is applied to the full carrying amount of the qualifying asset. This is the case even where the cash flows from operating activities are sufficient to finance the capital expenditure. IAS 23 (revised) does not deal with the actual or imputed cost of capital.

Example – Borrowing rate

A utility uses general borrowings and cash from operating activities to finance its qualifying assets. It has a capital structure of 20% equity and 80% current and non-current liabilities, including interest-bearing debt from general borrowings. The borrowing rate is applied to the full carrying amount of the qualifying asset, rather than to the 80% of the qualifying assets that are financed with borrowings.

A utility might contract for a power plant on a turnkey basis. Progress payments will be made by the utility over the construction period of a power plant. The borrowing costs incurred by an entity to finance prepayments made to a third party to acquire the qualifying asset are capitalised in accordance with IAS 23 (revised) on the same basis as the borrowing costs incurred on an asset that is constructed by the entity.

Capitalisation starts when all three conditions are met: expenditures are incurred, borrowing costs are incurred, and the activities necessary to prepare the asset for its intended use or sale are in progress. Expenditures on the asset are incurred when the prepayments are made (that is, payments of the instalments). Borrowing costs are incurred when borrowing is obtained. The last condition – the activities necessary to prepare the asset for its intended use or sale – is considered to be met when the manufacturer has started the construction process.

Determining whether the construction is in progress requires information directly from the turnkey supplier. A utility might hedge its borrowings. The effects of cash flow or fair value hedge relationships on borrowing costs are capitalised (this applies to both specific and general borrowings).

The hedging relationship modifies the borrowing costs of the utility related to the debt; IAS 23 requires the effective interest rate to be used as the basis for interest capitalisation. A hedge that modifies the amount of borrowing costs should be included in determining the effective interest rate. Ineffectiveness on such hedging relationships should be recognised in profit or loss.

3 Decommissioning obligations

The power and utilities industry can have a significant impact on the environment. Decommissioning (or environmental restoration work) at the end of the useful life of a plant or other installation might be required by law, the terms of operating licences or an entity’s stated policy and past practice. An entity that promises to remediate damage, even where there is no legal requirement, might have created a constructive obligation and thus a liability under IFRS. There might also be environmental clean-up obligations for contamination of land that arises during the operating life of a power plant or other installation. The associated costs of remediation/restoration can be significant; so the accounting treatment for decommissioning costs is critical.

Decommissioning provisions

A provision is recognised where an obligation exists to remediate or restore. The local legal regulations should be taken into account when determining the existence and extent of the obligation. Obligations to decommission or remove an asset are created when the asset is placed in service.

Entities recognise decommissioning provisions at the present value of the expected future cash flows that will be required to perform the decommissioning. The cost of the provision is recognised as part of the cost of the asset when it is placed in service, and it is depreciated over the asset’s useful life. The total cost of the fixed asset, including the cost of decommissioning, is depreciated on the basis that best reflects the consumption of the economic benefits of the asset.

Provisions for decommissioning and restoration are recognised even if the decommissioning is not expected to be performed for a long time (perhaps 80 to 100 years). The effect of the time to expected decommissioning is reflected in the discounting of the provision. The discount rate used is the pre-tax rate that reflects current market assessments of the time value of money. Entities also need to reflect the specific risks associated with the decommissioning liability.

Naturally, different decommissioning obligations have different inherent risks (for example, different uncertainties associated with the methods, and the costs and the timing of decommissioning). The risks specific to the liability can be reflected either in the pre-tax cash flow forecasts prepared or in the discount rate used.

A similar accounting approach is taken for nuclear fuel rods. These rods are classified as inventory, and an obligation to reprocess them is triggered when the rods are placed into the reactor. A liability is recognised for the reprocessing obligation when the rods are placed into the reactor, and the cost of reprocessing is added to the cost of the fuel rods.

Revisions to decommissioning provisions

Decommissioning provisions are updated at each balance sheet date for changes in the estimates of the amount or timing of future cash flows and changes in the discount rate. Changes to provisions that relate to the removal of an asset are added to or deducted from the carrying amount of the related asset in the current period. Changes to provisions that relate to the removal of an asset no longer used are recognised immediately in the income statement. However, the adjustments to the asset are restricted:

• The asset cannot decrease below zero and cannot increase above its recoverable amount.
• If the decrease to the provision exceeds the carrying amount of the asset, the excess is recognised immediately in profit or loss.
• Adjustments that result in an addition to the cost of the asset are assessed to determine if the new carrying amount is fully recoverable. An impairment test is required if there is an indication that the asset might not be fully recoverable.

The accretion of the discount on a decommissioning liability is recognised as part of finance cost in the income statement.

Decommissioning funds

Power and utilities companies that operate nuclear power plants might, at times, be obliged to contribute to a separate fund established to ensure that decommissioning obligations will be met in the future.

Typically, a fund is separately administered by independent trustees who invest the contributions received by the fund in a range of assets, usually debt and sometimes also equity securities. The trustees determine how contributions are invested, within the constraints set by the fund’s governing documents and any applicable legislation or other regulations.

The power and utilities entity then obtains reimbursement of actual decommissioning costs from the fund as they are incurred. However, the power and utilities entity might only have restricted access or no access to any surplus of assets of the fund over those used to meet eligible decommissioning costs.

IFRIC 5 Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds, provides guidance on the accounting treatment for these funds in the financial statements of the power and utilities entity.

Management must recognise its interest in the fund separately from the liability to pay decommissioning costs. Offsetting is not appropriate.

Management must determine whether it has control, joint control or significant influence over the fund and account for the fund accordingly. In the absence of some level of control or influence, the fund is accounted for as a reimbursement of the entity’s closure and environmental obligation; the fund is measured at the lower of the amount of the decommissioning obligation recognised and the entity’s share of the fair value of the net assets of the fund.

The movements in the fund (based on the IFRIC 5 measurement) are assessed separately from the measurement of the provision (under IAS 37). Any movements in a fund accounted for as a reimbursement asset are recognised in the income statement as finance income/expense.

4 Impairment

The utility industry is distinguished by the significant capital investment required, exposure to commodity prices and heavy regulation. The required investment in fixed assets leaves the industry exposed to adverse economic conditions and, therefore, impairment charges. Utilities’ assets should be tested for impairment whenever indicators of impairment exist. The normal measurement rules for impairment apply.

Impairment indicators

Examples of external impairment triggers relevant for the utilities industry include falling retail prices, rising fuel costs, overcapacity and increased or adverse regulation or tax changes.

Impairment indicators can also be internal in nature. Evidence that an asset or cash-generating unit (CGU) has been damaged or has become obsolete is an impairment indicator; for example, a power plant destroyed by fire is, in accounting terms, an impaired asset.

Other indicators of impairment are a decision to sell or restructure a CGU, or evidence that business performance is less than expected. Performance of an asset or group of assets that is below that expected by management in operational and financial plans is also an indicator of impairment.

Management should be alert to indicators of impairment on a CGU basis; for example, a fire at an individual Generation station would be an indicator of impairment for that station as a separate CGU.

Management might also identify impairment indicators on a regional, country or other asset-grouping basis, reflective of how it manages its business. Once an impairment indicator has been identified, the impairment test must be performed at the individual CGU level, even if the indicator was identified at a regional level.

Cash-generating units

A CGU is the smallest group of assets that generates cash inflows largely independently of other assets or groups of assets. In identifying whether cash inflows from an asset or groups of assets are largely independent of the cash inflows from other assets (or groups of assets), CGUs should be identified on a consistent basis from one period to the next for the same assets or types of asset, unless a change is justified. (If an asset is moved to a different CGU, or the types of asset that are aggregated for the asset’s CGU have changed and a material impairment is recognised or reversed, the entity should describe the current and former way of aggregating assets and the reasons for the change.)

Determining the CGU and assessing the recoverable amount for an individual CGU is difficult in situations where management has multiple assets and has the ability to choose the assets that are used. If there is an active market for the output produced by an asset or group of assets, that asset or group of assets should be identified as a CGU.

Determination of what is a CGU can be an area of significant judgement but is not an accounting policy choice. The exercise of such judgement might result in multiple assets being grouped to form a single CGU or being considered as individual CGUs. If this judgement has an impact on whether an impairment is recognised, the judgement and related assumptions might be significant enough to be disclosed as critical judgements under IAS 1.

Calculation of recoverable amount

Impairments are recognised if the carrying amount of a CGU exceeds its recoverable amount; the recoverable amount is the higher of fair value less costs of disposal (FVLCOD) and value in use (VIU).

– Fair value less costs of disposal

Fair value less costs of disposal is the amount that a market participant would pay for the asset or CGU, less the costs of selling the asset. The use of discounted cash flows to determine FVLCOD is permitted in the following situations: where there is no readily available market price for the asset; or where there are no recent market transactions for the fair value to be determined through a comparison between the asset being tested for impairment and a recent market transaction.

However, where discounted cash flows are used, the inputs must be based on external, market-based data. So, the projected cash flows for FVLCOD include the assumptions that a potential purchaser would include in determining the price of the asset. Industry expectations for the development of the asset can therefore be taken into account, which might not be permitted under VIU. However, the assumptions and resulting value must be based on recent market data and transactions.

Post-tax cash flows are used when calculating FVLCOD using a discounted cash flow model. The discount rate applied in FVLCOD is a post-tax market rate based on a typical industry participant’s cost of capital.

– Value in use (VIU)

VIU is the present value of the future cash flows expected to be derived from an asset or CGU in its current condition. Determination of VIU is subject to the explicit requirements of IAS 36, Impairment of Assets. The cash flows are based on the asset that the entity has now; they must exclude any plans to enhance the asset or its output in the future, but include expenditure necessary to maintain the current performance of the asset.

The VIU cash flows for assets under construction and not yet complete should include the cash flows necessary for their completion and the associated additional cash inflows or reduced cash outflows.

Any foreign currency cash flows are projected in the currency in which they are earned and discounted at a rate appropriate for that currency. The resulting value is translated to the entity’s functional currency using the spot rate at the date of the impairment test.

The discount rate used for VIU is always pre-tax and applied to pre-tax cash flows. This is often one of the most challenging elements of the impairment test, because pre-tax rates are not available in the marketplace, and arriving at the correct pre-tax rate is a complex mathematical exercise.

Computational shortcuts are available if there is a significant amount of headroom in the VIU calculation. However, grossing up the post-tax rate seldom, if ever, gives an accurate estimate of the pre-tax rate.

Contracted cash flows in VIU

The cash flows prepared for a VIU calculation should reflect management’s best estimate of the future cash flows expected to be generated from the assets concerned. Purchases and sales of commodities are included in the VIU calculation at the spot price at the date of the impairment test or, if appropriate, prices obtained from the forward price curve at the date of the impairment test.

There might be commodities – both fuel and the resultant electricity output – covered by purchase and sales contracts. Management should use the contracted price in its VIU calculation for any commodities unless the contract is already on the balance sheet at fair value. Including the contracted prices of such a contract would be to double count the effects of the contract. Impairment of financial instruments that are within the scope of IFRS 9, Financial Instruments, is addressed by IFRS 9 and not IAS 36.

The cash flow effects of hedging instruments, such as caps and collars, for commodity purchases and sales are also excluded from the VIU cash flows. These contracts are also accounted for in accordance with IFRS 9.

5 Arrangements that might contain a lease

Accounting in this area will change if a new leasing standard is issued as a result of the ongoing IASB project on leases. Reporting entities should continue to monitor the activities of the IASB in this area.

IFRS requires that arrangements that convey the right to use an asset in return for a payment or series of payments be accounted for as a lease, even if the arrangement does not take the legal form of a lease.

Some common examples of such arrangements include a series of power plants built to exclusively supply the rail network, or a power plant located on the site of an aluminium smelter or constructed on a build-own-operate-transfer arrangement with a national utility. Tolling arrangements might also convey the use of the asset to the party that supplies the fuel.

Such arrangements have become very common in the renewable energy business, where all of the output of wind or solar farms or biomass plants is contracted to a single party under a power purchase agreement.

IFRS 16 Leases, sets out guidelines to determine when an arrangement might contain a lease. A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration (lease payments). [IFRS 16.9]

Once a determination is reached that an arrangement contains a lease, the lease arrangement must be classified as either financing or operating, according to the principles in IFRS 16 Leases.

A lease that transfers the majority of the risks and rewards incidental to ownership of an underlying asset is a finance lease. A lease other than a finance lease is an operating lease.

The classification has significant implications in the power and utilities industry: a lessor in a finance lease de-recognises its generation assets and recognises a finance lease receivable for the net investment in the lease; a lessee in a finance lease would recognise fixed assets and a corresponding lease liability, rather than account for the power purchase agreement as an executory contract.

Classification as an operating lease leaves the lessor with the owned assets on the balance sheet and the lessee records assets representing the right to use the underlying asset during the lease term and a corresponding lease liability.

Power purchase agreements

It can be difficult to determine whether the power purchase agreement contains a lease. The purchaser might take all or substantially all of the output from a specified facility. However, this does not necessarily mean that the entity is paying for the right of use of the asset rather than for its output. If the purchase price is fixed per unit of output, or equal to the current market price at the time of delivery, the purchaser is presumed to be paying for the output rather than leasing the asset.

There has been some debate over the meaning of ‘fixed per unit of output’ in IFRIC 4, and two approaches have emerged in practice. ‘Fixed per unit of output’ is interpreted by some entities in a manner that allows for no variability in pricing whatsoever over the entire term of the contract (that is, fixed equals fixed).

However, other entities have concluded that the fixed criterion is met if, at the inception of the arrangement, the purchaser and seller can determine what the exact price will be for every unit of output sold at each point in time during the term of the arrangement (that is, fixed equals predetermined). There is support for both views, and the interpretation of ‘fixed’ is an accounting policy election. The accounting policy should be disclosed and applied on a consistent basis to all similar transactions.

The following examples aid in the application of the ‘fixed equals predetermined’ interpretation of contractually fixed per unit of output.

Similar to the ‘fixed price per unit’ criterion, the market price condition is narrowly interpreted. For example, arrangements that include caps/floors would not be considered to reflect the current market price at the time of delivery, because the price at delivery might be different from the spot market price.

Fixed price condition
Pricing is contractually predetermined and the fixed price condition is deemed to be met:	Pricing is not contractually predetermined and the fixed price condition is deemed to be not met:
1) A power purchase agreement under which the purchaser pays C40 for each megawatt-hour (MWh) of electricity received during the first year of the arrangement. The price per MWh increases by 2.5% during each subsequent year of the arrangement.	1) A power purchase agreement under which the purchaser pays C40 for each MWh of electricity received during the first year of the arrangement. The price per MWh increases during each subsequent year of the arrangement based on the annual change in the consumer price index. This price is not predetermined, because it varies with inflation from the second year on.
2) A power purchase agreement under which the purchaser pays C75 for each MWh of electricity received during peak hours and C45 for each MWh of electricity received during off-peak hours. Peak hours are defined in the agreement in a manner whereby it can be determined at the inception of the arrangement whether each point in time is considered peak or off-peak. For example: peak hours are from noon to 10:00 p.m. each day during July and August; all other times are considered off-peak.	2) A power purchase agreement under which the purchaser pays C40 per MWh plus a C30,000 per month capacity charge. The capacity charge is not payable in any month that the capacity factor drops below 30%. The pricing in this arrangement is not predetermined, because the price per MWh varies with the amount of electricity produced. Although the energy price is fixed, the amount paid per MWh includes the fee for capacity, and monthly changes in production change the average cost per MWh. For example, if the plant produces 15,000 MWh in the first month, the price is C42 per MWh (that is, C40 per MWh energy charge plus C2 per MWh allocated capacity charge). However, if the plant produces only 10,000 MWh, the price is C43 per MWh.

What is output?

It is also important to determine what output should be taken into consideration in order to test whether the contract is, in substance, a lease. One question that arises with renewable plants is whether there is a power purchase agreement for substantially all, or all, of the output, because the amount of generation is determined by an uncontrollable factor (for example, the wind, sun or rain/snowfall). The following example illustrates this concept.

Wind farm contract

Assumptions For 100% of the output of the wind farm for substantially all of the asset’s life. For substantially all of the asset’s life. Guarantees a level of availability when the wind is blowing. Allows the purchaser to agree the timing of maintenance outages. The developer/owner of the wind farm agrees to sell 100% of the output of the wind farm to a single purchaser, with the intention that the developer recovers its operating costs, debt service cost and a development premium. Wind feasibility studies are used to help the siting of wind farms and assess the economic viability early in the development stage of the project. A power purchase agreement for 100% of the output of a wind farm often contains a lease, even though the generation of electricity is contingent on the wind. The variability in output does not impact the assessment of whether the contract contains a lease.

Another question that arises in lease classification for renewable facilities is whether renewable energy certificates (RECs) are ‘output or other utility’ in terms of paragraph 9c of IFRIC 4. If the RECs are considered output and sold to another party, more than one party is consuming a substantial amount of the output of the asset under IFRIC 4.

Some governments have imposed on electricity suppliers a requirement to source an increasing proportion of electricity from renewable sources. An accredited generator of renewable electricity is granted an REC per MWh of renewable energy generated, to demonstrate that the electricity has been procured from renewable sources.

The determination of whether RECs are ‘output or other utility’ might impact the evaluation of whether a power purchase agreement contains a lease, particularly where the energy and RECs are sold to different parties.

Two approaches have emerged in practice as to what can be considered output under IFRIC 4. These are explained as follows:

• RECs are output: RECs are considered in the lease evaluation. The construction of a specified facility and the pricing inherent in the contractual arrangements with offtakers are based on the combined benefit of energy, capacity, RECs and any other output from the facility
• RECs are a government incentive: RECs are not considered as an output in the lease analysis. Output is limited to the productive capacity of the specified property and relates only to those products that require ‘steel in the ground’. RECs result from a government programme (similar to tax incentives) created to promote construction of the plant and are a paper product, not a physical output.

Although both approaches are supportable, the approach used with RECs is an accounting policy choice, to be applied consistently and to be disclosed.

6 Emissions trading schemes and certified emission reductions

EU member states have set limits on carbon dioxide emissions from energy-intensive companies under the EU emissions trading scheme. The scheme works on a ‘cap and trade’ basis, and each EU member state is required to set an emissions cap covering all installations covered by the scheme.

Even after the less specific Copenhagen Accord, the EU cap and trade scheme is still considered to be a model for other governments seeking to reduce emissions.

The European Commission presented the ‘Green Deal’, a package of measures aiming for a significant reduction of greenhouse gas emissions across all sectors. The ultimate goal is to make the EU climate neutral by 2050.

Additionally, several non-Kyoto carbon markets exist. These include the New South Wales Greenhouse Gas Abatement Scheme, and the Regional Greenhouse Gas Initiative and the Western Climate Initiative in the United States and Canada.

Accounting for emissions trading schemes

The emission rights permit an entity to emit pollutants up to a specified level. The emission rights are given or sold by the government to the emitter for a defined compliance period. Schemes in which the emission rights are tradable allow an entity to do one of the following:

• emit fewer pollutants than it has allowances for and sell the excess allowances;
• emit pollutants to the level that it holds allowances for; or
• emit pollutants above the level that it holds allowances for and either purchase additional allowances or pay a fine.

IFRIC 3, Emission Rights, was published in December 2004 to provide guidance on how to account for cap and trade emission schemes. The interpretation proved controversial and was withdrawn in June 2005 because of concerns over the consequences of the required accounting. As a result, there is no specific comprehensive accounting for cap and trade schemes or other emission allowances

The guidance in IFRIC 3 remains valid, but entities are free to apply variations, provided that the requirements of all relevant IFRSs are met. Several approaches have emerged in practice under IFRS. The scheme can result in the recognition of assets (allowances), expense of emissions, a liability (obligation to submit allowances) and, potentially, a government grant.

The allowances are intangible assets – often presented as part of inventory – and are recognised at cost if separately acquired. Allowances received free of charge from the government are recognised either at fair value, with a corresponding deferred income (liability), or at cost (nil), as allowed by IAS 20, Government Grants.

The allowances recognised are not amortised, provided residual value is at least equal to carrying value. The allowances are recognised in the income statement, because they are delivered to the government in settlement of the liability for emissions on a ‘units of production’ basis.

If initial recognition at fair value under IAS 20 is elected, the government grant is amortised to the income statement on a straight-line basis over the compliance period. An alternative to the straight-line basis can be used if it is a better reflection of the consumption of the economic benefits of the government grant.

The entity may choose to apply the revaluation model in IAS 38, Intangible Assets, for the subsequent measurement of the emissions allowances. The revaluation model requires the carrying amount of the allowances to be restated to fair value at each balance sheet date, with changes to fair value recognised directly in equity (except for impairment, which is recognised in the income statement).

A provision is recognised for the obligation to deliver allowances or pay a fine to the extent that pollutants have been emitted because an obligation is created by the emission of the greenhouse gas. The provision is commonly measured at the cost of the certificates acquired, including those acquired for nil cost (for example, under government grants) or the contracted purchase price for planned purchases of certificates.

The allowances reduce the provision where they are used to satisfy the entity’s obligations through delivery to the government at the end of the scheme year. However, the carrying amount of the allowances cannot reduce the liability balance until the allowances are delivered.

Certified emission reductions

For fast-growing countries and countries in transition that are not subject to a Kyoto target on emissions reduction, another scheme exists under the Kyoto Protocol. Entities in these countries can generate certified emission reductions (CERs). Entities can acquire CERs from existing projects, although new CER projects are not currently accepted in the EU.

CERs represent a unit of greenhouse gas reduction that has been generated and certified by the United Nations under the Clean Development Mechanism (CDM) provisions of the Kyoto Protocol.

The CDM allows industrialised countries that are committed to reducing their greenhouse gas emissions under the Kyoto protocol to earn emission reduction credits towards Kyoto targets through investment in ‘green’ projects. Examples of projects include reforestation schemes and investment in clean energy technologies.

Once received, the CERs have value because they are exchangeable for EU ETS allowances, and hence can be used to meet obligations under that particular scheme.

The pace and severity of climate change, as well as accompanying government policy, may impact the recognition, measurement and disclosure of provisions, contingencies and onerous contracts.

An entity that acquires CERs accounts for these following the ETS cost model; they are accounted for at cost, at initial recognition, and subsequently in accordance with the accounting policy chosen by the entity. No specific accounting guidance under IFRS covers the generation of CERs. Entities that generate CERs should develop an appropriate accounting policy.

Most entities that need CERs are likely to acquire them from third parties and account for them as separately acquired assets. The key question that drives the accounting for self-generated CERs is, ‘What is the nature of the CERs?’. The answer to this question lies in the specific circumstances of the entity’s core business and processes.

If the CERs generated are held for sale in the entity’s ordinary course of business, CERs are within the scope of IAS 2, Inventories. If they are not held for sale, they should be considered as identifiable non-monetary assets without physical substance (that is, intangible assets – often presented as part of inventory).

The accounting for CERs is also driven by the applicability of IAS 20 Government Grants and Disclosure of Government Assistance. If CERs are granted by a government, the accounting would be as follows:

• Recognition when there is a reasonable assurance that the entity will comply with the conditions attached to the CERs and the grant will be received.
• Initial measurement at nominal amount or fair value, depending on the policy choice.
• Subsequent measurement depends on the classification of CERs and should follow the relevant standard (that is, IAS 2 Inventory, IAS 38 Intangible Assets, or IFRS 5 Non-current Assets Held for Sale and Discontinued Operations).

IFRIC 21 Levies sets out the accounting for an obligation to pay a levy that is not income tax. The interpretation addresses the accounting for a liability to pay a levy recognised in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and the liability to pay a levy whose timing and amount is certain; it does not address the related asset or expense.

Entities are not required to apply IFRIC 21 to emissions trading schemes (application is optional), due to a scope exception in the guidance.

The interpretation is likely to result in later recognition of some liabilities, particularly in connection with levies that are triggered by circumstances on a specific date. IFRIC 21 is effective as of 1 January 2014 and applies retrospectively.

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Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities Generation assets for Power and Utilities