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.

Reporting entities commonly execute arrangements for the purchase and sale of multiple products, including electricity, capacity and ancillary services. In evaluating these contracts, reporting entities should consider whether or not each promise to transfer a good or service to the customer is distinct.

Case – Identify the performance obligations (power purchase agreement (‘PPA’))

Background

Solar Sun Power Co (‘Solar’) sells electricity and renewable energy credits (‘RECs’) to Power Buyer Co (‘Buyer’) pursuant to a three-year PPA. The PPA does not contain a lease. The electricity element qualifies for the ‘own use’ scope exception and is not accounted for as a derivative. The RECs element of this PPA is also not accounted for as a derivative (for example, the net settlement characteristic is not met). As such, each element of this agreement is within the scope of IFRS 15.

Control, including title and risk of loss related to the electricity, transfers to Buyer on delivery of the electricity at a single point within the electricity grid. Control, including title and risk of loss related to the RECs, transfers to Buyer when the associated electricity is delivered. Solar and Buyer frequently execute contracts for the purchase and sale of electricity and RECs on a stand-alone basis.

How many performance obligations are included in the PPA between Solar and Buyer?

Analysis

The electricity represents a promise to transfer to the customer a series of distinct goods that are substantially the same and that have the same pattern of transfer to the customer. The basis for the conclusion that the electricity represents one performance obligation that is satisfied over time is as follows:

  1. Buyer can benefit from the electricity on its own (that is, Buyer can sell electricity, on a stand-alone basis, into the marketplace, so the electricity is capable of being distinct).
  2. The promise to transfer electricity is separately identifiable within the PPA (that is, the electricity is distinct within the context of the contract).
  3. Electricity is not generally considered to be storable by the customer, and the performance obligation to deliver electricity is satisfied over time, since Buyer simultaneously receives and consumes the benefits of the electricity provided by Solar’s performance as Solar performs.
  4. Each distinct transfer of electricity in the series that Solar promises to transfer to Buyer meets the criteria to be a performance obligation satisfied over time, and the same method will be used to measure Solar’s progress towards complete satisfaction of the performance obligation to transfer electricity in the series to Buyer.

The monthly promise to transfer RECs to the customer during the term of the three-year PPA (36 deliveries) represents goods that are distinct, based on the following:

  1. Buyer can benefit from the RECs on their own (that is, Buyer can sell RECs, on a stand-alone basis, into the marketplace, so the RECs are capable of being distinct).
  2. The promise to transfer RECs is separately identifiable within the PPA (that is, the RECs are distinct within the context of the contract).

Each monthly promise to deliver RECs (36 deliveries) is a separate performance obligation. Based on facts and circumstances, Solar assumed that this performance obligation is satisfied at a point in time, because none of the criteria are met to account for such promises as performance obligations satisfied over time. The point at which the performance obligation for the RECs is satisfied can be subject to significant judgement is some cases.

Note: In some circumstances, the entity will register the REC with the local authority and transfer that registration to the customer. An entity needs to make a judgement about whether that process is substantive and, therefore, has an impact on the assessment of when control transfers.

Case – Identify the performance obligations (gas supply agreement)

Background

Gas Supply Co (‘Supplier’) sells gas to Power Buyer Co (‘Buyer’) pursuant to a three-year agreement with a daily stated delivery quantity. The arrangement does not contain a lease. The gas element of this agreement qualifies for the ‘own use’ scope exception and is not accounted for as a derivative. The gas element of this agreement is within the scope of IFRS 15.

Control, including title and risk of loss related to gas, transfers to Buyer on delivery of gas at the outlet of the gas pipeline. Buyer has access to gas storage facilities.

How many performance obligations are in the contract?

Analysis

The daily promise to transfer gas to the customer during the term of the three-year agreement (1,095 daily deliveries) represents goods that are distinct, based on the following:

  1. Buyer can benefit from gas on its own (that is, Buyer can sell gas, on a stand-alone basis, into the marketplace, so gas is capable of being distinct).
  2. The promise to transfer gas is separately identifiable within the agreement.
  3. Gas is considered to be storable by Buyer, and the performance obligation to deliver gas is satisfied at a point of time, because Buyer receives the benefits of gas provided by Supplier’s performance as Supplier performs.

Arrangements to sell other commodities, including natural gas and physical capacity, over a contractual term might represent a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Arrangements that meet these criteria are required to be accounted for as a single performance obligation, even though the contract contains distinct goods or services.

Case – Identify the performance obligations (gas supply agreement to a retail customer)

Background

Gas Supply Co (‘Supplier’) sells gas to retail customers. Supplier offers a free grill if a new customer concludes an agreement for three years at fixed price. The arrangement does not contain a lease. The gas element of this agreement qualifies for the ‘own use’ scope exception and thus is not accounted for as a derivative instrument. The gas element of this agreement is within the scope of IFRS 15.

Control, including title and risk of loss related to the gas, transfers to a customer on delivery of the gas at a single point at a customer’s household.

How many performance obligations are in the contract?

Analysis

The gas represents a promise to transfer to the customer a series of distinct goods that are substantially the same and that have the same pattern of transfer to the customer. The basis for the conclusion that gas represents one performance obligation that is satisfied over time is as follows:

  1. The customer can benefit from the gas, together with other resources readily available to the customer (that is, gas oven or gas heater).
  2. The promise to transfer gas is separately identifiable within the agreement (that is, the gas is distinct within the context of the contract).
  3. Gas is not generally considered to be storable by retail customers, and the performance obligation to deliver gas is satisfied over time, because the customer simultaneously receives and consumes the benefits of gas provided by Supplier’s performance as Supplier performs.
  4. Each distinct transfer of gas in the series that Supplier 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 Supplier’s progress towards complete satisfaction of the performance obligation to transfer gas in the series to a customer.

The promise to transfer a grill to a new customer, on concluding a three-year contract, represents goods that are distinct, based on the following:

  1. The customer can benefit from the grill on its own (that is, the customer can use the grill or sell it, so the grill is capable of being distinct).
  2. The promise to transfer the grill is separately identifiable within the agreement (that is, the grill is distinct within the context of the agreement).

The promise to deliver a grill is a separate performance obligation.

Case – Identify the performance obligations (design and build a power plant)

Background

Plant Builder Co (‘Builder’) enters into a contract to design and build a power plant for its customer, Facility Owner Co (‘Owner’). Builder is responsible for the overall management of the project, and it identifies various goods and services that are provided, including architectural design, site preparation, electrical services, and turbine construction. Builder regularly sells these goods and services individually to customers.

How many performance obligations are in the contract?

Analysis

The bundle of goods and services is combined into a single performance obligation. The promised goods and services are individually capable of being distinct, because Owner could benefit from the goods or services either on their own or together with other readily available resources. The goods and services are capable of being distinct, because Builder regularly sells the goods or services separately to other market participants, and Owner could generate economic benefit from the individual goods and services by using, consuming or selling them.

The goods and services are not distinct within the context of the contract, because they are not separately identifiable from other promises in the contract. Builder provides a significant service of integrating the various goods and services into the power plant that Owner has contracted to purchase; therefore, the promised goods and services are not distinct.

Take-or-pay power supply and similar long-term energy supply agreements

Long-term sales contracts are common in the power and utilities industry. Producers and buyers might enter into sales contracts that are often a year or longer in duration to secure supply and reasonable pricing arrangements. Such contracts are often fundamental to supporting the business case or to finance, develop or continue activity at a particular location.

Contracts will typically stipulate the sale of a set volume of product over the period at an agreed price. There are often IFRS 15 Power purchase agreementclauses within the contract relating to price adjustment or escalation over the course of the contract to protect the producer and/or the seller from significant changes to the underlying assumptions in place at the time when the contract was signed. Long-term commodity contracts frequently offer the counterparty flexibility and options in relation to the quantity of the commodity to be delivered under the contract.

Power and utilities entities should continue to first assess whether these arrangements convey the right to use a specific asset, and therefore constitute a lease under the leasing standards.

Only the minimum amount specified would generally be considered a contract, because this is the only enforceable part of the agreement. Options in the contract to acquire additional volumes will likely be considered a separate contract at the time when the customer exercises the option, unless such options provide the customer with a material right.

Where there is a material right, the option should be accounted for as a separate performance obligation in the original contract. A practical expedient is available to simplify the accounting for certain material rights in IFRS 15.B43.

Failed own use on trading contracts

Power and utilities entities might enter into contracts to supply the commodities. Contracts to buy or sell non-financial assets (such as commodities) that can be settled net are within the scope of IFRS 9, unless the ‘own use’ exemption is met. Contracts that fail the ‘own use’ exemption and are within the scope of IFRS 9 meet the definition of derivative financial instruments, and they should be accounted for at fair value through profit or loss.

Commodity contracts could fail the ‘own use’ exemption even though they eventually result in a physical delivery of goods (for example, if the entity has a practice of settling similar contracts net in cash). IFRS 9 also permits an election not to apply the ‘own use’ exception to certain contracts in certain circumstances, which is discussed further in the Financial Instrument chapter of this guide.

Where the contract is accounted for as a derivative, it would be recorded at fair value through profit or loss, with fair value changes recognised in other income/expense until delivery of the commodity. The entity should then generally recognise revenue for the sale of the commodity under IFRS 15, on control transferring to the customer, where such sales are an output of the entity’s ordinary activities in exchange for consideration.

An alternative approach is that the contract continues to be accounted for as a derivative financial instrument within the scope of IFRS 9 (or IAS 39) and not within the scope of IFRS 15 (see para 5(c) of IFRS 15), and therefore it does not give rise to ‘revenue from contracts with customers’ or related cost of sales.

Case – Failed ‘own use’ in trading contract (IFRS 15 revenue approach)

Background

On 1 August 20X6, entity A enters into a contract with a customer to sell 100 Mt of fuel oil with physical delivery of $300 per Mt. Although entity A intends to settle the contract physically, the contract is assumed to fail the ‘own use’ exemption and thus to fall within the scope of IFRS 9.

Entity A’s reporting period ends on 30 September 20X6. The sales contract is settled on 1 November 20X6. Entity A delivers fuel oil in return for cash of $30,000. Entity A measures inventory at fair value.

Forward price

Fair value changes

01/08/20×6

300

30/09/20×6

310

-1,000

01/11/20×6

325

-2,500

How should entity A measure its revenue?

Analysis

Until delivery of the commodity, the contract is accounted for under IFRS 9 as a derivative, with fair value changes recognised in other income/expense. At delivery, entity A recognised the consideration received for the sale of the commodity (including the settlement of the fair value of the derivative contract) as revenue under IFRS 15.

The following journal entries illustrate this approach:

On 30 September 20X6

IFRS 15 Power purchase agreement

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IFRS 15 Power purchase agreement

Other expense

1,000

Derivative

1,000

On 31 October 20X6

Other expense

1,500

Derivative

1,500

On 1 November 20X6

Cash

30,000

Derivative

2,500

Revenue

32,500

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