IFRS Challenges For Corporate PPA Derivative Accounting
derivative assessment considerations should be addressed under both U.S. GAAP and IFRS when accounting for corporate power purchase agreement ("Corporate PPA") contracts.
Renewable energy power producers may not be aware of reporting challenges under International Financial Reporting Standards ("IFRS") for contracts often utilized in project finance to develop new wind or solar facilities. Project financing generally requires the execution of offtake arrangements to achieve more predictable cash flows, and corporate power purchase agreements (“Corporate PPAs”) are commonly utilized by renewable energy companies for this purpose.
A Corporate PPA, sometimes referred to as a virtual power purchase agreement, is a hybrid agreement that includes a contract for differences, along with an agreement to deliver the related renewable energy credits from the project. Under a Corporate PPA, there’s no physical delivery of electricity. Rather, the agreement specifies a periodic payment to be made based on the difference between an agreed upon fixed price and a floating market price, generally at a market hub or a project node.
"Companies must assess whether a Corporate PPA is within the scope of derivative accounting under U.S. GAAP, IFRS or under both standards."
While Corporate PPAs require Dodd-Frank reporting, they often escape derivative accounting under U.S. Generally Accepted Accounting Principles (“U.S. GAAP”). However, those reporting under IFRS may not be as fortunate.
The following provides an overview of the derivative assessment considerations under both U.S. GAAP and IFRS. This comparison highlights key factors that may result in a different conclusion for IFRS when compared to U.S. GAAP.
Derivative Assessment Considerations
Companies must assess whether a Corporate PPA is within the scope of derivative accounting under U.S. GAAP, IFRS or under both standards. U.S. GAAP defines a derivative contract as a financial instrument or other contract with all the following characteristics: Corporate PPAs generally contain three of the four characteristics noted above leaving the accounting assessment to hinge on whether the contract contains a notional amount. Oftentimes, these contracts can be structured in a way where there’s no reliably determinable notional amount. Accordingly, Corporate PPAs often escape derivative accounting under U.S. GAAP absent any contractual or minimum volumes specified in the contract.
"Determining the fair value of derivative contracts may be challenging, and the change in fair value could be a significant source of earnings volatility."
IFRS, on the other hand, doesn’t require a notional amount in order to meet the definition of a derivative. IFRS defines a derivative contract as a financial instrument or other contract with all the following characteristics: See the following example from IFRS 9:IG.B.8:
Accordingly, Corporate PPAs typically meet the definition of a derivative under IFRS. Accounting professionals reporting under IFRS should be aware of this difference from U.S. GAAP, especially if dual reporting under both U.S. GAAP and IFRS are required. Many more contracts could be subject to derivative accounting.
Derivative accounting requires the contract to be recorded on the balance sheet based on the fair value of the contract. Unless hedge accounting is elected, changes in fair value of the derivative are recognized in earnings as changes occur. Determining the fair value of derivative contracts may be challenging, and the change in fair value could be a significant source of earnings volatility. Many companies may require assistance from a specialist to determine the fair value of the instruments and assist with the associated reporting. Opportune LLP is a trusted advisor that assists renewable energy clients in all aspects discussed above.
About the Authors:
Matt Smith is a Director in Opportune LLP's Financial Instruments Group. Matt assists companies with their accounting for complex financial instruments under both U.S. GAAP and IFRS. With 15 years of client service experience at Opportune and EY, Matt has gained extensive knowledge and expertise in derivative valuation and hedge accounting, stock-based compensation, debt and equity financing activities, embedded derivative assessments, Dodd-Frank compliance and SEC reporting. Matt has an undergraduate degree in Accounting from Oral Roberts University. He is also a member of the American Institute of Certified Public Accountants.
Ethan Blain is a Manager in Opportune LLP's Financial Instruments Group. Ethan assists companies with their derivative valuation, hedge accounting, documentation, and disclosure requirements. His background includes technical accounting research, SEC financial reporting, derivative valuation and hedge accounting. Ethan holds a BS degree in accounting and an MBA degree from Oral Roberts University. He is also a member of the American Institute of Certified Public Accountants.