Mastering the Challenge IFRS Power Utilities GL IFRS

Mastering the challenge

Practical IFRS guidancefor power

and utilities

2 Mastering the challenge: Practical IFRS guidance for power and utilitiesMastering the challenge: Practical IFRS guidance for power and utilities

Content

Introduction 4

A Wholesale fuel sourcing and sales 5 1 Fuel purchase and sales contracts 5 1.1 Scope of IAS 39 5 1.2 Embedded derivatives in commodity purchase contracts 10 1.3 ‘Day-1profit’–long-termfuelpurchasecontractsmeasured at fair value 11

B Generation 12 1 Generation property, plant and equipment 12 1.1 Components approach and annual review of depreciation inputs 12 1.2 Liquidateddamages 12 2 Decommissioningprovisions 12 2.1 Recognisingandmeasuringadecommissioningprovision 12 2.2 Changesinanexistingprovision 13 2.3 Investmentinexternaldecommissioningfunds 13 3 Treatment of nuclear fuel elements and related provision for disposal 14 4 Emissionrightsunderacapandtradeschemeandsimilarschemes 14 4.1 Emissionrightsunderacapandtradescheme 14 4.2 Certifiedemissionsreductions 16 4.3.Greenorrenewablecertificates 17 5 Arrangementscontainingalease 18 5.1 Specificassetorassets 19 5.2 Portions of assets 19 5.3 Arighttousetheitem 19 5.4 Other considerations 19 6 Othercontracts 20 6.1 Tollingcontracts 20 6.2 Compulsoryyieldofpower 20 7 Powerstationreoptimisation 20

C Transmission and distribution 21

1 Property,plantandequipment–transmissionanddistributionnetworks 21 2 Impairmentofpowerstationsandgrids 22 2.1 Indicators of impairment 22 2.2 Determiningthecashgeneratingunit(CGU)forpowerstations 23 3 Gasinadistributionnetworkorstorage 23 4 Rateregulatedactivities 23 4.1 Scope of proposals 23 4.1 Recognitionandmeasurement 24 5 Serviceconcessionarrangements 25 5.1 Scope 25 5.2 Accountingtreatment 25 6 Arrangementsthatmaycontainalease-transmissioncontractsand capacitycontracts 26

Mastering the challenge: Practical IFRS guidance for power and utilities 3Mastering the challenge: Practical IFRS guidance for power and utilitiesMastering the challenge: Practical IFRS guidance for power and utilities

D Retail customers 27

1 Connectionfeesandtransfersofassetsfromcustomers 27 1.1 Connectionfeesandcosts 27 1.2 Transfersofassetsfromcustomers 27 2 Customeracquisitioncosts 28 3 ApplicationofIAS39toretailcustomercontracts 28

E Support functions and risk management 29

1 Riskmanagement 29 1.1 Marketriskdisclousuresnon-financialitems 29 2 Revenuepresentation–grossornet? 30 3 Commodityhedgeaccounting 31 4 EmissionrightsandCERswaps 32 4.1 Scope of IAS 39 32 4.2 Receiptofcash–swapisnotwithinthescopeofIAS39 32 4.3 If the swap is within the scope of IAS 39: 32 4.4 Determiningfairvalue 32 4.5 Impact on net liability method 32 5 Weather derivatives 32

F Business combinations 33

1 Emissionrightsacquiredinabusinesscombination 33 2 Reassessment of embedded derivatives 33 2.1 Reassessmentofembeddedderivatives-general 33 2.2 Reassessment of embedded derivatives in a business combination 33

Contacts 34


Introduction

Many power and utility entities either report under International Financial ReportingStandards(IFRS),ortheyreportin a jurisdiction which is in the process of or planningtoconverttoIFRS.IFRSrequiresextensivejudgementtobeappliedintheselectionandapplicationofaccountingtreatments.Thiscanbechallengingbecause IFRS does not deal with many aspectsoffinancialreportingthatarespecifictothepowerandutilitiesindustry.

•Transmission and distribution • Retail customers• Supportfunctionsandriskmanagement• Business combinations

In this publication, we focus on industry specificissues.Forfurtherinformationaboutgeneralfinancialreportingissues,refer to our annual International GAAP publication.

Toassistfinancialmanagersandexecutivesinmakingthesejudgements,Ernst&Young’sGlobalPowerandUtilitiesCentreispleased to provide you with Mastering the challenge – practical IFRS guidance for power and utilities. We have analysed the issuesbythewayinwhichyouorganiseyour business:

•Wholesalefuelsourcingandsales•Generation


A Wholesale fuel sourcing and sales

A.1 Fuel purchase and sales contracts A.1.1 Scope of IAS 39

Power and utility entities often enter into long-termcommoditypurchasecontracts tomeetcontractualobligationstosupplytheir customers. They may also enter into long-termsalescontractswithmajorcustomers or with other power and utility entities,forexample,tosecureacertainvolume of sales. Generally, such contracts are entered into for the purpose of the receiptorsaleofacommodity(e.g.,oil,gas,coaland/orpower)inaccordance withanentity’sownuserequirements.Dependingonthetermsofthecontract,these may be outside the scope of IAS 39 Financial Instruments: Recognition and Measurement, or they may be accounted for off balance sheet.

TheInternationalAccountingStandardsBoard(IASBortheBoard)believesthatacommodity contract that can be net settled and is not entered into for the purpose of the purchase or sale of a commodity in accordancewithanentity’sexpectedpurchase,saleorusagerequirements(ownuse),shouldbeaccountedforasifitisafinancialinstrument.Forpowerandutilityentitiesthenon-financialitemisusuallyacommodity. We refer to contracts for power andutilitygenerallyascommoditycontracts in this section.

Commodity contracts that are within the scope of IAS 39 are considered to be derivatives. Consequently, they are

measuredatfairvaluethroughprofitorloss which creates volatility in the income statement. This income statement volatility canbedifficulttoexplainasthesecontractsare often used to purchase or sell commodities in transactions that entities considerpartoftheir‘normal’businessactivities.

In this section we discuss:

• The various ways in which a contract can be net settled

• If net settlement is possible per IAS 39, whentheownuseexemptioncanbeapplied

• Other issues to consider.

A.1.1.1 Net settlement: general requirements

If a commodity contract can be settled neteitherincashoranotherfinancialinstrument,orbyexchangeoffinancialinstruments, it must be accounted for as a financialinstrumentwithinthescopeofIAS39. IAS 39 describes various situations in which a contract can be considered to be net settled. A contract can be net settled if:

•The terms of the contract permit either party to settle it net in cash or another financialinstrument,orbyexchangingfinancialinstruments

•Thereisapracticeofsettlingsimilarcontractsnetincashoranotherfinancialinstrument,orbyexchangingfinancialinstruments(whetherwiththe

counterparty,byenteringintoanoffsettingcontractorbysellingthecontractbeforeitsexerciseorlapse)

•For similar contracts, the entity has a practiceoftakingdeliveryoftheunderlyingcommodityandsellingitwithin a short period for the purpose of generatingaprofitfromshort-termpricefluctuationsorbroker-dealer’smargin,for similar contracts

•The commodity is readily convertible to cash

•There is a written option to buy or sell a non-financialitemthatcanbesettlednetincashoranotherfinancialinstrument,orbyexchangingfinancialinstruments

IAS 39 deems that contracts that are net settled in accordance with these provisions do not qualify for own use as they are not entered into for the purpose of the receipt or delivery of the commodity in accordance withtheentity’sexpectedpurchase,saleorusagerequirements.Theyareautomaticallywithin the scope of IAS 39. Note that neither‘similar’contractsnor‘practice’aredefinedbythestandardandarediscussedfurther below.

TheflowchartinBox1illustratesthevariousexamplesofnetsettlementdescribed above and how they interact with own use. In this section we describe each stepintheflowchart.Embeddedderivatives are considered in section A.1.2.


Is the contract required to be net settled?Thefirststepistodeterminewhetherthecontract is required to be net settled in cash oranotherfinancialinstrument,orbyexchangingfinancialinstruments.Ifso,itisautomaticallywithinthescopeofIAS39–itcannot be entered into for own use. For example,anentitypurchasescoalunderfloatingpricecontracts.Toavoidexposuretothemarketprice,theyenterintoaswaptofixthepriceofcoal.Theswaphasaclause that states that settlement will occur throughreceiptorpaymentofthedifferencebetweentheagreedfixedpriceandaspecifiedcoalindexatmaturitydateand that no coal will be delivered or received.

IAS 39 paragraphs 6(b) or 6(c)?If it is not certain that the contract will be net settled, net settlement in accordance withIAS39.6(b)or(c)shouldbeconsiderednext.Acommoditycontractis

automatically within the scope of IAS 39 ifitis‘similar’toothercontractswitha‘practice’ofnetsettlement.Theterms‘similar’and‘practice’arenotdefined.Therefore,applyingtheseparagraphsrequirestheapplicationofjudgment.Below, we discuss the requirements of IAS39.6(b)or(c).Inaddition,weconsiderhowwebelieve‘similar’shouldbeinterpreted;thedifficultyofdetermining‘practice’andsomeindicatorsthatwebelievecanbeappliedwhendeterminingwhetheracontractis‘similar’.

IAS 39.6(b)A commodity contract is scoped within IAS39ifthereisapastpracticeofsettlingsimilar contracts net in cash or another financialinstrument,orbyexchangingfinancialinstruments.Anexampleofcashnet settlement was provided above. However, a commodity contract is often netsettledbyanotherfinancialinstrument(commoditycontract).Theother

commoditycontract‘offsets’theoriginalcontract.Thereisnodefinitionof‘offsetting’inthecontextofthisparagraph.Itcanbeinterpretedasmatchingtheposition of a contract with equal and oppositemovementsinrisk,forthepurposeoflimitingoreliminatingrisk.Acontract is offset if the new contract offsets allrisks,otherthancreditrisk.Seebelowfor further discussions of indicators of whetheracontractisnetsettledaccordingtoIAS39.6(b)or(c).

IAS 39.6(c)AcontractisnetsettledperIAS39.6(c)iftheentityhasapracticeoftakingdeliveryoftheunderlyingcommodityandsellingitwithin a short period after its delivery to generateprofitfromshort-termpricefluctuationsoradealer’smargin.Powerand utility entities must carefully assess contracts to determine whether they are takingdeliveryofanunderlyingcommodityfor a short period to then sell it to obtain profitfromshort-termpricefluctuationsoradealer’smargin.Forexample,thismayoccur if a power and utility entity has signedafixedpricelong-termpurchasecontract at a price lower than the current spotmarketprice.Totakeadvantageofthislowpricetheypurchasevolumesinexcessof their physical requirements to sell directlytothewholesalemarketforprofit.

‘Similar’ contracts and ‘past practice’InthecontextofIAS39.6(b)or(c),webelievethat‘similar’shouldbeinterpretedwith reference to the purpose of the commodity contract within the power and utilityentity’sbusiness.Therefore,contracts with identical form may be considered dissimilar due to their intended use(e.g.,physicalsupplyvs.proprietarytrading).Theintentionofacontractshouldbe documented at its inception. However, an entity should be able to demonstrate that it has appropriate processes and controlsinplacetoadequatelysegregatecontracts with different intentions.

Thestandardcontainsnofurtherguidanceonwhatdegreeofpastpracticeofnetsettlementpreventsanentityfromtreatingsimilar contracts as own use. We do not

Box1:Flow-charttodeterminewhetheracontracttobuyorsellanon-financialitemfalls within the scope of IAS 39

Is the contract required to be net settled?

Written option

IAS 39 para 6 (b) or 6 (c)? For similar contracts, the entity has a practice of: 6(b) Netsettling;or6(c) Takingdeliveryandsellingtogenerate profit from short-term pricefluctuationsordealers’margin

No

IAS 39 para 6 (a) or 6 (d)?6(a) Is it explicitintheterms of the contract that any party can settle; or6(d) Thenonfinancialitem is readily convertible to cash

No

Yes

NonIAS 39

No

NonIAS 39

Yes

IAS 39Yes

IAS 39Yes

IAS 39No "Own Use" exemption

Consider embedded derivatives

No

IAS 39Yes


believe that any net settlement automatically taintsanentity’sabilitytoapplyownuse,forexample,whereanentityisrequiredtocloseout(oroffset)anumberofcontractsorsellamountspurchaseddirectlytothemarketasaresultofanunexpectedmajordisruptionarisingfromexternaleventsataproductionfacility.However,judgmentwillalwaysneedto be applied based on the facts and circumstances of each case.

Factor Indicator of trading activities Indicator of transactions in accordance with expected purchase, sale or usage requirements

Howtheentityintendstoprofitfrom the contract

Theentityseekstoprofitfromshort-termpricefluctuationsorbymakingamarginbetweenthebidandaskprices.Thismayinvolvetakingpriceexposureandactivelymonitoringmovementsinpriceandclosingoutpositionstocapturemoreprofitfromsuchmovements.

Generationofaprofitmarginbycreatingamarketbetweennormalbuyersandsellersofacommodity,byenteringintoback-to-backsalesandpurchasecontractswith a stable customer base, at a relatively consistent spread, such that the current spot or future price is less relevant.

Customerbase/contractcounterparty Counterpartiesvarybasedonmarketconditions as, typically, the entity or the customerinitiatesthetradeduetomarketopportunity.

Trades are usually with a stable customer base who are normally producers or users withinthevaluechain(refertothevaluechainindicatorbelow).

Howanentitymanagesitsbusiness Businessismanagedbasedona“marktomarket”profitreflectingthefairvaluechangesofcontracts.

Businessismanagedbasedonaplannedproduction or sale process and customer supply and demand, and is measured basedongrossmargin.

How staff are remunerated Remunerationincludesasignificantbonuscomponent,basedonmarktomarketprofitsofthecontracts.

Remunerationisunlikelytoincludesignificantbonusesbasedonmarktomarketprofitsofthecontracts.

Whethervalueisaddedbylinkingparties in the value chain.

Sales and purchases contracts made with counterpartiesthatalsotradeand/orarenot end users of the commodity themselves may indicate that the entity intendstoprofitfromtradingratherthanfromcreatinglinksbetweenvariouscounterparties in the commodity value chain.

The entity enters into purchase and sales contracts with producers and users of the commoditycreatinglinkswithinthevaluechain for the commodity. This may include repackaging,butitisnotnecessarytorepackagethecommoditytobeeligiblefortheexpectedpurchase,saleorusageexpectation.

Settlement of the contracts Contractsareregularlysettlednet,forexample,byenteringintooffsettingcontracts with the same counterparty and physicallydeliveringthenetdifferencebetweenthecontracts(notethatthiswouldautomaticallybringsuchcontractsintothescopeofIAS39).

Contracts are always settled by physical delivery.

Indicators for being in the scope of IAS 39.6(b) or (c)Individual facts and circumstances must be examinedtodeterminewhetheracontractissimilartoothernetsettledcontracts.Box2 contains some of the factors to consider inmakingthisassessment.Thisisnotanexhaustivelistandtheweightappliedtoeachfactorrequiresjudgmentand,inmanysituations,mixedfactorsmaybepresent.Considerationofanentity’scontrol

environment may be warranted where seeminglysimilarcontractsareenteredintofor different purposes.

Contracts entered into by a commodity broker-traderwhomeasuresitsinventoriesat fair value less costs to sell in accordance with IAS 2 Inventories are considered to be netsettled.However,determiningwhetherother, similar, activities are within the scope ofIAS39requiresjudgment.

Box 2: Indicators of being in the scope of IAS 39.6(b) or (c)


IAS 39 paragraphs 6(a) or 6(d)?Net settlement in accordance with IAS 39.6(a)or(d)mustbeconsideredifthecommodity contract is neither net settled with certainty nor is net settled per IAS 39.6(b)or(c).

Paragraph 6(a) – explicit net settlement termsIfthereisanexplicitnetsettlementtermina commodity contract, then it must be assessed to determine whether it is for own useand,therefore,notwithinscope(referbelow).Itcanbedifficulttoidentifywhenanetsettlementtermexists.Forexample,incommodity contracts a non-performance clause may be a net settlement term. It is common for commodity contracts to have penaltyclausesrelatingtonon-deliveryorincompletedelivery(bytheseller)andnon-acceptance of all or part of the delivery (bythebuyer)ofcontractedquantities.Penaltiesmaybeafixedsumoranotherform of payment to ensure that the non-defaultingpartyisnotdisadvantaged.Generally, such clauses do not constitute net settlement in accordance with IAS 39.5. However,weconsiderthata‘symmetrical’variabledefaultclauseisanexampleofanet settlement in cash clause per IAS 39.5. A default clause is symmetrical and variable if the normal contractual price per unit of commodityisfixedandanypenaltypaymentismadeforquantitiesnottakeninbothofthefollowingcircumstances,ifthebuyer defaults:

• The buyer must pay the seller the differencebetweenthefixedcontractpriceandprevailingmarketprice,ifmarketpriceislowerthanthecontractprice

• The seller must pay the buyer the differencebetweenthefixedcontractpriceandprevailingmarketprice,ifmarketpriceishigherthanthecontractprice.

A default clause is only symmetrical and variable if both the buyer and seller must makeapaymentasdescribedabove.SeeExample1.

A symmetrical variable penalty clause requiresthedefaultingpartytocompensatefor losses suffered. However, it also providesthedefaultingpartywiththerighttoreceiveanygainitscounterpartyrealisesas a consequence of its own default. In this casetheselleriseffectivelyactingasthebuyer’sbroker.Forexample,ifthebuyertakeslessthantherequiredquantityasperthecontract,theselleriseffectivelysellingitonthemarketonthebuyer’sbehalf.Thisis net settlement because it is effectively thesameasthebuyertakingtheminimumquantityandsellingthequantitythatisnotrequiredonthewholesalemarket.Symmetrical variable penalty clauses are often used by counterparties that enter into the commodity contract for speculative purposes.

Althoughsuchasymmetricalvariablepenalty clause is a net settlement clause, the contract may still be outside the scope ofIAS39iftheclauseisnotexercisedandthecontractqualifiesfortheownuseexemption.

Paragraph 6(d) – Commodity is readily convertible to cashIf a commodity is readily convertible to cash it is within the scope of IAS 39, unless the contract is for own use. The term ‘readily convertibletocash’isnotdefinedfurtherinIAS 39. We consider that a commodity is probably readily convertible to cash if: its unitsarelargelyfungible;thereisanactivemarketwithreadilyavailablequotedspot

prices;andthemarketcanabsorbthequantity held by the entity without significantlyaffectingthemarketprice.Suchanassessmentrequiresjudgment.Factors to consider also include the non-financialitem’squality,locationorothercharacteristicssuchassizeorweight.Forexample,whenconsideringlocation,aparticular item may be readily convertible to cash in one location but not in another. A significantefforttosellthenon-financialitem(oftenbecauseoftransportationneeds)mayindicatethatitisnotreadilyconvertible to cash.

Written optionThenextissuetoconsideriswhetherthecontract is or contains a written option if the contract is not net settled in any other manner. A written option to buy or sell a non-financialitemisautomaticallywithinthe scope of IAS 39 if it can be settled net, accordingtothetermsofthecontract,orwheretheunderlyingnon-financialitemisreadilyconvertibletocash(refertothediscussionaboutIAS39.6(a)and(d)above).

Written options in commodity contracts arisewhereasellerhasgiventhebuyersomevolumetricflexibilityoverthecontractual volumes. Therefore, the buyer can nominate how much they will buy in a givenperiod,usuallywithinaspecifiedrange.Consequently,commoditycontractsmust be analysed to determine whether the volumetricflexibilitygivenbytheseller

Example 1– Symmetrical default clause

EntityAsellselectricitytoEntityBfor30CUperMWh,andincludesaminimumof10,000MWh.ForeachMWhthatEntityBdoesnottake,entityB:•MustpayEntityAthedifferencebetween30CUandprevailingmarketprice,ifmarketpriceislowerthan30CU

•Receivesthedifferencebetween30CUandprevailingmarketprice,ifmarketpriceishigherthan30CU.

InbothFebruaryandMarch,EntityBdidnottakedeliveryof100MWh.InFebruary,themarketpricewas33CUandinMarchitwas29CU.Theresultingpaymentswere:•InFebruary,EntityBreceived300CU((33CU–30CU)x100MWh)fromEntityA•InMarch,EntityBpaid100CU((29CU–30CU)x100MWh)toEntityA


Example 2 – Written option in a wholesale gas sales contract

EntityAsellsEntityBgasunderafixedpricecontractforsixmonths.EntityBmustpurchaseaminimumof80,000thermsaday,buthastheabilitytopurchaseupto100,000thermsaday.EntityBhasadirectconnectiontothegasnetworkandcanbuyandselldirectlyfrom/tothewholesalemarket.EntityBprimarilyenteredintothecontracttopurchasethegastoburninitsgas-firedpowerstationtogenerateelectricity.However,thevolumesareinexcessofEntityB’sneedsinsomemonths.Whenthisoccurs,andthemarketpriceishigherthanthecontractprice,EntityBwilltakedeliveryoftheexcessgasandsellitontothemarkettomakeaprofitfromshort-termpricefluctuations.Therefore,thecontractisawrittenoptionfromEntityA’sperspective. Entity A can choose to either fair value the full contract or just the writtenoptioncomponent(the20,000thermsperday),assumingthatthecontractisnotnetsettledinanyothermanner.TheaccountingpolicychosenbyEntityAmustbe applied consistently to all written option contracts.

constitutesa‘writtenoption’fromtheseller’sperspective.Flexibilityfromthepurchaser’spointofviewisnotawrittenoption - it is a purchased option.

Many commodity contracts contain volumetricflexibility.Therearetwomaintypes of contracts with volumetric flexibility:somewholesalecontractsandmost‘end-user’customercontracts.Wholesale contracts with volumetric flexibilityassistpurchasersastheycanalterthe volume purchased in the event of changesindemandorconsumption.Wholesale contracts and contracts with largeend-usercustomers(e.g.,factories)oftenstipulateaminimumtake-or-payvolumeandsomevolumetricflexibility.However,smallend-users(e.g.,households)generallyhavefullvolumetricflexibility.Therefore,differentcommoditycontracts must be analysed based on facts and circumstances to determine whether volumetricflexibilityconstitutesawrittenoption, in accordance with IAS 39, from the seller’sperspective.

InMarch2007,theInternationalFinancialReportingInterpretationsCommittee(IFRIC)consideredwhatismeantbya‘writtenoption’withinthecontextofIAS39.7.Thefocusofitsconsiderationwasaccountingforenergysupplycontractstoretail customers. It did not add this item to itsagendaasitexpectedlittledivergenceinpractice. However, it noted that such retail contracts are not capable of net cash settlement in accordance with IAS 39.5 and IAS39.6.Retailenergycontracts,withvolumeflexibilitytomeetthepurchaser’svariableusagerequirements,arenotwritten options, when:• Thenon-financialitemisessentialtothe

customer • The purchaser does not have access to a marketwherethenon-financialitemcanbe resold and, therefore, cannot be net cash settled

• The purchaser cannot easily store the non-financialiteminsignificantamounts;and

• The supplier is the sole provider of the non-financialitem

Insuchcases,thecustomerwillonlytakethe volume it requires to meet its needs and hasnopracticalabilitytosellanyexcessamounttotakeadvantageofanypricedifferential between the contract and marketprice.Thismaybethecaseforaresidential customer. However, some commodity contracts may meet the definitionofawrittenoptionwithinthescope of IAS 39, if the purchaser has the ability to sell variable volumes purchased to thewholesalemarketforthepurposesofmakingarbitrageprofits.Suchpurchaseswouldbemadeforarbitrageprofit-makingratherthantobe‘used’bytheentity.Thisismorelikelytobethecaseforawholesalecontractorsomelargeend-usercustomers.Tomakethatassessment,anentitywouldneedtounderstanditscustomers’businesswhichcanprovedifficultinpractice.SeeExample2.

Ifthevolumetricflexibilitydoesrepresentawrittenoption,theownuseexemptioncannot be applied and the contract will be within the scope of IAS 39. An entity can choose to either fair value an entire contractcontainingawrittenoption,orseparately value the written option, if possible.Thechosenaccountingpolicymust be applied consistently. Note that the valuation of a contract with volumetric flexibilityislikelytobecomplex.

Further to the rejection notice issued in March2007,theIFRICbegantodiscussif

volumetricflexibilityshouldbebifurcatedfrom the host contract in November 2009. Asofthetimeofwriting,nodecisionhasbeenmadebytheIFRIC.Thefinaldecisionwillhaveasigificantimpactonhowpowerand utility entities account for written options, and potentially other contracts.

Own use exemptionThefinalstepinthedecisiontreeistoestablish whether a contract can be net settledinaccordancewithparagraph6(a)or6(d)ofIAS39andisnotawrittenoption, an entity should consider whether theownuseexemptionapplies.Acommodity contract is entered into for a powerandutilitiesentity’sownuseifthepurpose of the receipt or delivery of the commodity is in accordance with the entity’sexpectedpurchase,saleorusagerequirements.Thereisnofurtherguidanceinthestandardtointerpretthemeaningofownuse.However,webelievethatapplyingtheindicatorsofbeinginthescopeofIAS39.6(b)or(c),asdescribedabove,willhelpentitiesmakethisassessment.

For a contract to be accounted for as own useuntilmaturityitmust(a)havebeenenteredintoand(b)continuetobeheldfor own use. Consequently, an own use contract can fall within the scope of IAS 39 after its inception. However, a contract within scope of IAS 39 can never be classifiedasownuse.


A.1.1.2Balancesheetclassificationofderivatives: current vs. non-current

Allrecognisedcommodityderivativecontracts must be presented on the balance sheet.Theclassificationoftheseassetsandliabilities has always been an issue for preparersoffinancialstatements.

An amendment was made to IAS 1 Presentation of Financial Statements to clarify that all derivatives should be classifiedascurrentornon-currentonthebasisoftheirsettlementdates(paragraphBC38CofIAS1).Thisclarifiedthatderivatives(notdesignatedasahedginginstrumentinaneffectivehedge)classifiedas‘held-for-trading’neednotbepresentedas current. IAS 1 only requires that assets andliabilitiesbeclassifiedascurrentiftheyareheld‘primarilyforthepurposeofbeingtraded’.Someentitieshadpreviouslyinterpreted this to mean that any derivative mustbeclassifiedascurrent.Theamendment does not address how to split thecarryingamountofderivativeswithstaggeredsettlementdatesintocurrentand non-current components. Consequently, entities will need to apply judgmentwhendetermininganappropriatesplit.

A.1.1.3 Commodity contract entered into partly for expected purchase requirements

An entity may enter into a contract that is partlyfortheentity’sownuse,butthecontractualvolumesexceedexpectedusagerequirements. An entity can split this contract into two components: the volumes for own use can be accounted for as such andthevolumesexceedingexpectedusagerequirementsasbeingwithinthescopeofIAS 39. This split must be based on volumes, not time.

Anysuchdesignationshouldbemadeatthe inception of the contract and the entity should ensure that the volumes sold to the

marketdonotexceedthevolumedesignatedasafinancialinstrument.Ifthisoccurs, the entire contract may need to be treatedasafinancialinstrumentfromthatpoint onwards. It may also call into question whether other contracts split between own useandfinancialinstrumentcomponentscan continue to be split in this way. Therefore,wheredemandcanfluctuatecomparedtoexpectations,itisadvisabletoallowsome‘head-room’anddesignatealower volume as own use.

A.1.2 Embedded derivatives in commodity purchase contracts

Identifyingandaccountingforembeddedderivativesischallenging.Thissectionhighlightsthekeyareaswhereissuesmayarise for power and utility entities. For a comprehensive discussion of embedded derivatives refer to International GAAP.

Long-termcommoditypurchasecontractsmay contain contractual terms such as:• Pricingclausesbasedonindices(e.g.,inflation,etc)orthepricesofothercommodities(forexampleoil,gasorpower)

• Currency denominations that are different from the functional currencies ofthecontractingpartiesinvolved

Theseareexamplesofembeddedderivatives. An embedded derivative is a component of an instrument that also includes a non-derivative host contract (IAS39.10).Theembeddedderivativecausessomeofthecashflowsofthecombined instrument to vary in a similar way to a stand-alone derivative. Some or all ofthecashflowsrequiredbythecontractwouldbemodifiedaccordingtoaspecifiedcommodityprice,foreignexchangerate,indexofpricesorrates,orotherunderlyingvariable.

Embedded derivatives must be separated from their non-derivative host contracts if

theymeetthecriteriainIAS39.11.Thekeycriterionimpactingpowerandutilityentities is whether an embedded derivative is‘closelyrelated’ornottoitshostcontract. If an embedded derivative is not closely related to its host contract it must be:• Separated from its host contract; and• Accounted for separately as a stand-

alone derivative, measured at fair value (exceptwheretheentirecontractismeasuredatfairvaluethroughprofitorloss)

An embedded derivative is not closely related if its economic characteristics and risksarenotcloselyrelatedtotheeconomiccharacteristicsandrisksofitshostcontract.IAS39doesnotdefinecloselyrelated. Instead, it provides a series of exampleswhenanembeddedderivativeisor is not closely related to its host contract (IAS39AG27–AG33).Makingthisdetermination for commodity contracts requiresjudgment.Wediscusstwopowerandutilityindustry-specificconsiderationsbelow.

The reassessment of embedded derivatives is addressed in section F.2.

A.1.2.1 Inputs, ingredients, substitutes and other proxy pricing mechanisms

Itiscommonforthepricingofcommoditycontracts to be determined by reference to thepriceofinputsinto,ingredientsusedtogenerate,orsubstitutesfor,thenon-financialitem.Thisiscommonwhenthecommodity in the host contract is not quotedinanactivemarket.Insuchcases,prices in commodity contracts are usually linkedtoanothercommoditywhichcouldbe considered a substitute for the underlyingcommodity.Forexample,thepriceofagascontractmaybelinkedtoanoilindex.Alternatively,thepricemaybelinkedtoaninputoringredient.Forexample,anelectricitycontractmaybelinkedtothepriceofcoalorgasasthese


commodities are commonly used in power stationstogenerateelectricity.Thereisnospecificguidancetodeterminewhethersuch features are closely related to their host contracts.

Therefore, we believe that such embedded derivatives are closely related to their host only when, at the time that the contract was entered into:• Themechanismisnotsignificantlyleveraged;and

• Thepricingfeaturewasusedbecause:• Themarketfortheunderlyingphysical

commodity was not active; and • Thepricingmechanismspecifiedinthe

contract was commonly used for the commodity concerned.

Apricingmechanismbasedoninputsandingredientsisnotleveragedifthepercentageofthepricedrivenbytheinputoringredientisdirectlyproportionaltotheproportionrequiredforuse,e.g.,inproduction.Itisamatterofjudgmenttodeterminewhetheramarketisactiveornot.Thiscanbecomemoredifficultifamarketincreasesinactivityovertime.Suchan embedded derivative is not closely relatedifthereisanactivemarketfortheunderlyingcommodity,asthereisnoneedforanalternativepricingmechanism.Theuseofsuchapricingmechanismisastrongindication that the entity has entered into a speculative position and we would not normally consider such features to be closely related to the host.

A.1.2.2 Floors and caps

Floors and caps should also be considered to determine whether they are closely related to their host contract. Provisions thatestablishacapandaflooronthepriceto be paid or received for the commodity are closely related to the host contract if boththecapandfloorwereoutofthemoneyatinceptionandarenotleveraged.The reassessment of embedded derivatives is addressed in section F.2.

A.1.3 ‘Day-1 profit’ – long-term fuel purchase contracts measured at fair value

A commodity contract that is within the scope of IAS 39, is measured at fair value throughprofitorloss.

If an instrument is quoted in an active marketandtheentityhasimmediateaccesstoanothermorefavourableactivemarketinthesameinstrument,theinstrument’sinitial fair value is determined by reference tothemoreadvantageousmarket(adjustedforanydifferencesbetweentheinstruments,e.g.,creditrisk).Theuseofthemoreadvantageouspricemaygiverisetoagain,whichisknownasadayoneprofit.Anentitymusthoweverconsiderwhether it has immediate access to a more favourablemarketifsomeeffortisrequiredto transport the commodity to that other market.

Ifthetermofthecontractextendsbeyondtheliquidperiodfortheunderlyingcommodity,(periodforwhichtherearequotedpricesinanactivemarket)orifthereisnoactivemarketforthecommodityitislikelythatamodelwillbeusedtodetermine its fair value. For such contracts, the initial fair value should be determined usingavaluationtechnique,usingthetransactionpriceasastartingpoint.Animmediateprofitresultingfromthedifference between the valuation and the transactionpricecanonlyberecognisedifthe valuation is supported by prices of other transactions in the same instrument or a valuation technique is used in which all inputsarefromobservablemarkets.

Theactivemarketforlong-termfuelpurchasecontractsoftenextendsforashorter period than the maturity of a contract. As a result, the criteria for recognitionofthedayoneprofit(orloss)willoftennotbemetandnodayoneprofitwillberecogniseduponinitialrecognitionofthe contract. If an immediate or day one

profitcannotberecogniseditmustbedeferred.Anydayoneprofitcanonlysubsequentlyberecognisedtotheextentthatitarisesfromachangeinafactor,includingtime,whichamarketparticipantwouldconsiderwhensettingaprice.Duetoalackofclearguidanceaboutthetreatmentofthereleaseofadayonegaininthestandard,thereismixedpracticeinthe industry.

One possible view is that, at inception, an entity re-calibrates its model such that the fairvalueofthemodelreflectsthetransactionprice(usuallynil).Thiscanbedonebyalteringthemarketpricesintheilliquidpartofthemodeltoforceanilgainor loss. The entity would then subsequently updateitsmodeltotakeintoaccountpricemovements in the various periods as follows:

• During the liquid period(quotedmarketpricesareavailable):updatethemodelforallpricemovementsandrecogniseresultinggainsandlosses

• During the semi-liquid period (somelimitedquotedpricesareavailable):update prices based on reasonable marketinformationandrecogniseresultinggainsandlosses.Forexample,in this period only seasonal prices may bequoted.Anentitymay‘shape’thesepricestotakeaccountofmoregranularseasonality,forexample,todeterminemonthly prices within the relevant season

• During the illiquid period (noquotedpricesareavailable):onlyupdatepriceswherethereisafundamentalchangeinmarketparticipants’expectations(forexample,agenerallyacceptedchangeinthelong-termviewofprices)


B Generation

B.1 Generation property, plant and equipment Accountingforproperty,plantandequipment(PP&E)isanimportantissuefor power and utility entities as most are capitalintensive.Wediscusstwokeyindustry issues: the components approach andtheimpactofliquidateddamages.Rateregulatedactivities,impairmentandrenewalsaccountingisconsideredinsection C.

B.1.1 Components approach and annual review of depreciation inputs

IAS16Property, Plant and Equipment requiresthat‘significantparts’ofanassetmustbedepreciatedseparately.Significantpartshaveacostwhichissignificantrelative to the total cost of the asset. In addition,IAS16requiresthatanentityderecognisesanexisting‘part’ifitisreplaced(whetherithasbeenseparatelydepreciatedornot).Thecarryingvalueofthe part that has been replaced can be estimatedusingthecostofthereplacementasanindicatorofitsoriginalcost,ifnecessary.‘Parts’areundefined.Thisiscommonlyknownasthe‘componentsapproach’.

To apply the components approach appropriately, an in-depth analysis is requiredtoidentifythesignificantcomponentsthatmakeupplantoragrid/network(grids/networksareconsideredseparatelyinsectionC).Applyingthecomponents approach to a power and utilityentityrequirestechnicalknowledgethat may necessitate the involvement of engineersandotheroperationsstaff.Factors to be considered are technical design,long-termmaintenanceandreplacement plans and split of the asset for operational purposes, etc.

B.1.2 Liquidated damages

An entity may receive compensation (liquidateddamages)asaresultofdelaysby sub contractors. This would occur where a power and utility entity has contracted anotherentitytobuilditsPP&Esuchaspower plants and turbines. Normally, IAS 16requiresthatthesedamagesreceivedaresetoffagainsttheprojectcost.However, we believe that liquidated damagesreceivedshouldberecognisedasincome if the construction contract specifiesthatliquidateddamageswillbepayable as compensation for loss of revenuearisingfromcontractdelays,andthe basis of calculation is clearly related to income lost.

B.2 Decommissioning provisionsMany power and utility entities have obligationstodismantleorremoveitemsofPP&Eortorestoreasitetocertainminimumstandardsattheendofanasset’slife(forexample,anuclearpowerplant).Theseobligationsareoftenreferredtoasdecommissioningandrestorationliabilitiesorassetretirementobligations(or‘AROs’).Theseobligationsareaccountedforunder:• IAS16Property, Plant and Equipment• IAS37Provisions, Contingent Liabilities

and Contingent Assets• IFRIC 1 Changes in Existing

Decommissioning, Restoration and Similar Liabilities

• IFRIC 5 Rights to Interests arising from Decommissioning, Restoration, and Environmental Rehabilitation Funds

In this section, we discuss associated industry issues: when a provision should be recognisedandhowtomeasureit;theimpactofchangesonaprovision;accountingforexternalwastefunds;andnuclear fuel elements and their disposal.

B.2.1 Recognising and measuring a decommissioning provision

Assoonasanobligationtodecommissionconstructionactivitiesexists,IAS37requiresthataliabilityberecognised.ThiswouldoccurwhenthePP&Eisconstructedand is ready to be used. The total decommissioningcostisestimatedanddiscountedtoitspresentvalue.IAS16requires that this amount is added to the relevantPP&E’scost.TheprovisionthatconstitutespartofthecostofthePP&E,excludesanyprovisionfordecommissioningwhichisrecognisedasaresultofproducinginventory.Insubsequentperiods,thePP&E(includingtheinitialestimated


decommissioningcost)isdepreciatedoverits useful life. The discounted provision is unwoundthroughtheincomestatementasafinancecost.

B.2.2 Changes in an existing provision

ThereisnoguidanceinIAS37todeterminehowsubsequentchangesinthebestestimateofthedecommissioningobligationarereflectedintheprovision.NoristhereguidanceinIAS16todeterminetheimpactofchangesintheestimateofthedecommissioningobligation.IFRIC1wasdevelopedtoprovidethisguidance.

The provision increases as time passes due totheunwindingofthediscount.IFRIC1statesthatthismustberecognisedintheincomestatementasafinancecostasitoccurs.ThefinancecostisnotaborrowingcostasdefinedinIAS23Borrowing Costs. Therefore, it cannot be capitalised under IAS 23. The interpretation also deals with thefollowingchangesinestimates,whichresult in adjustments to the provision and mayberecognisedinthecarryingamountoftherelevantitemofPP&E:• Achangeintheestimatedoutflowstosettletheobligation;or

• Achangeinthecurrentmarket-baseddiscount rate.

If the historical cost method is used to recordPP&E,thesechangesintheliabilityresultinachangeinthecarryingvalueofthePP&E.Anincreaseinthecarryingvaluewould require entities to consider whether therevisedcarryingamountneedstobetested for impairment. A decrease in the carryingvalueofthePP&Ecanonlyreducethecarryingvaluetonil.Anyexcessisrecognisedintheincomestatement.WehaveonlydiscussedtheimpactofchangesinprovisionswhenthePP&Eismeasuredathistorical cost. Different rules apply if the

PP&Eismeasuredusingtherevaluationmodel. As this is model is not commonly applied in the power and utility industry, it is not addressed in this publication.

B.2.3 Investment in external decommissioning funds

In some countries, power and utility entities contribute to a separate fund established to meetdecommissioningobligationstobeincurred in the future. Such funds are typically set up in the nuclear industry and maytakevariousforms.Theymaybesetuptomeetthecostsofasingleoperatororagroupofoperators.Fundsmaybeorganisedtocovertheentirenuclearindustry in one country. Generally, the funds are administered by independent trustees.Theobligatedentitiescontributefunds, which are invested by the trustees. Althoughthefundsarecreatedtomeetdecommission costs, the contributors to the fundwouldnormallyretaintheobligationtopaythedecommissioningcosts.

IFRIC 5 applies to a contributor who has interestsindecommissioningfunds,where:• Thefund’sassetsareadministeredseparately,eitherinaseparatelegalentityorassegregatedassetsinanotherentity; and

• Thecontributor’srighttoaccesstheassets is restricted.

Note that a residual interest in a fund (beyondreimbursement),suchasarighttodistributionafteralldecommissioninghas been completed, is not within the scope of IFRIC 5 and may be an equity instrument within the scope of IAS 39.IFRIC 5 addresses:• How a contributor should account for its

interest in a fund; and• Howacontributor’sobligationtomake

additional contributions should be accounted for.

B.2.3.1 Accounting for an interest in a fund by a contributor

Acontributormustrecogniseitsobligationtopaydecommissioningcostsasaliabilityand its interest in the fund separately, unless the contributor is not liable for decommissioningcostsifthefundfailstopay(IFRIC5,paragraph7).Ifacontributor has control, joint control or significantinfluenceoverthefundasdefinedinIAS27Consolidated and Separate Financial Statements,IAS28Investments in Associates, IAS 31 Interests in Joint Ventures or SIC 12 Consolidation – Special Purpose Entities, it should account for its interest in the fund in accordance withtherelevantstandard(IFRIC5,paragraph8).Ifthefunddoesnotfallwithin the scope of any of these standards, thecontributorshouldrecognisetherightto receive reimbursement from the fund as areimbursementrightunderIAS37.Thereimbursementrightiscappedattheloweroftheamountofthedecommissioningobligationorthecontributor’sattributableshare of the fair value of the net assets of thefund(IFRIC5,paragraph9).

B.2.3.2 Accounting for obligations for additional contributions

Acontributormayincuranobligationtomakepotentialadditionalcontributions. Forexample,intheeventofbankruptcy of another contributor, or if the value of the investment assets held by the fund decreasestotheextentthattheyareinsufficienttofulfilthefund’sreimbursementobligations.SuchobligationsareaccountedforascontingentliabilitieswithinthescopeofIAS37(IFRIC5,paragraph10).


B.3 Treatment of nuclear fuel elements and related provision for disposal

Nuclear fuel elements can be considered as itemsofPP&Eastheyareheldforuseinthe production of electricity. However, nuclear fuel elements could also meet the definitionofinventoriesperIAS2astheyare consumed in the production process. Consequently,webelievethatclassificationas inventories is also acceptable.

If nuclear fuel elements are treated as PP&E,thedecommissioninganddisposalcostsarerecognisedaspartofthecostofPP&EinaccordancewithIAS16andasaliabilityinaccordancewithIAS37.Effectsofsubsequenteventswhichchangethemeasurement of the liability are accounted forunderIFRIC1(refertosectionB.2above).Ifnuclearfuelelementsaretreatedasinventory,thesameaccountingtreatment,withregardtothedecommissioninganddisposalcosts,isappliedasinthecaseofitemsofPP&E.

B.4 Emission rights under a cap and trade scheme and similar schemes

Many countries have developed schemes to reduce the emission of pollutants or to encouragedevelopmentofpowergenerationcapacityfromeitherrenewableorlesspollutingtechnology.Thissectiondiscussestheaccountingissuesassociatedwith some of the most common schemes, including:• Emissionrightsunderacapandtrade

scheme• Certifiedemissionsreductions• Greenorrenewablecertificates

B.4.1 Emission rights under a cap and trade scheme

Somecountriesseektoreduceemissionsbyallocatingemissionrightstoentitiesup

toatargetlevelofemissions(acap)andallowtradingoftheemissions.Thesearegenerallyissuedforspecifiedcomplianceperiods which last a certain number of years. In December 2004 the IFRIC issued IFRIC 3 Emission Rights. However, that was subsequently withdrawn. At the time of writing,thereisnoissuedguidancefromtheIASBdealingwithaccountingforemissionrights.However,thereisanactiveprojectontheBoard’sagenda–Emissions Trading Schemes.UntiltheIASBissuesdefinitiveguidancepowerandutilityentitiesneedtoselectanaccountingpolicy.Possible policies are discussed in further detail below.

B.4.1.1 IFRIC 3 (now withdrawn)

IFRIC 3 applies to entities currently participatinginacapandtradescheme.ItrequiresthatemissionrightseitherboughtbyorgrantedtotheentityareaccountedforasintangibleassetsunderIAS38Intangible Assets. They are initially measured at fair value. In the case of grantedallowances,anydifferencebetweentheamountanentitypaidfortheright(generallynil)anditsfairvalueisaccounted for under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance. The amount is recognisedasdeferredincomeonthebalancesheetandisrecognisedinincomeover the period the emissions are made (thecomplianceperiod),regardlessofwhetherallowancesareheldorsold.UnderIAS38,theentityhastheoptiontomeasuretheallowancesatcost(fairvalueatgrantdate)oratfairvalue.Thelatterisonly allowed when there is an active market.Underthefairvalueoption,any re-measurement to fair value will be accountedforasarevaluationthroughother comprehensive income.

As emissions are made a liability is recognised.Thisliabilityismeasuredasthebest estimate to settle the present obligationatthebalancesheetdate.Thisisusuallythespotmarketpriceofthenumberof allowances to cover emissions made at the balance sheet date.

B.4.1.2 Alternative accounting policies

Many entities have applied alternative accountingpoliciesasIFRIC3oftenresultedinaccountingmismatches(eithera measurement mismatch when emission rightsaremeasuredatcost,orarecognitionmismatchwhenemissionrightsaremeasuredatfairvaluethroughothercomprehensiveincome).

Themainalternativeaccountingpoliciesapplied include:• ‘Netliability’approaches;and• The‘governmentgrants’approach. Net liability approachUnderthe‘netliability’approachemissionallowancesgrantedforfreearerecognisedbutmeasuredatanominalamount(i.e.,zero).Theentityrecordsaliability,underIAS37,onlytotheextentthatactualemissionsmadeexceedtheemissionsrightsgrantedandstillheld.Theprovisionismeasuredatthecurrentmarketpriceofemission allowances. No provision is recognisedfortheexpectedfutureshortfallofemissionsallowancesas,atthereportingdate, there is no liability in respect of future emissions.The‘obligatingevent’istheemission itself.

Some schemes cover more than one year. Sometimes an entity is unconditionally entitled to receive allowances for a certain number of years and to carry-over emissions allowances to future years. In suchcases,whenapplyingthenetliabilityapproach, an entity may choose to measure deficitsonthebasisof:• Anannualallocationofemissionrights(thisseemstobethemethodcurrentlyapplied by most of the power and utility entitiesinEurope),or

• An allocation that covers the entire currentphaseofthescheme(providedthat the entity is unconditionally entitled to all the allowances for the current phaseofthescheme).

The method chosen must be applied at eachreportingdate.Iftheannualallocationbasisischosen,anydeficitismeasuredonthisbasisandrightscannotbecarriedbetween years.


Any liability is measured at the best estimateofexpenditurerequiredtosettletheobligationatthebalancesheetdate.Theobligationismeasuredatthespotmarketpriceofthenumberofallowancesto cover emissions made to the balance sheet date, unless the entity applies an accountingpolicywherepurchasedrightsimpact the measurement of the provision. Refer to Purchased emission rights – impact on net liability approach below.

Purchased emission rights – impact on net liability approachEntitieswilloftenpurchaseemissionrightstocoveranyshortfallingrantedrights.(sectionF.1addressestheaccountingforemissionrightsinabusinesscombination).Anentitycanchooseanaccountingpolicywherebythesepurchasedrightsimpacttheapplication of the net liability approach. The two main methods to do this are the ‘carryingvaluemethod’andthe‘reimbursementrightsapproach’.Thesearedescribedbelow.Accountingforforwardcontractsoveremissionrightsisdiscussedat section B.4.1.5.

Carrying value methodAn entity may measure the provision for emissionsbasedonthecarryingamountofemissionrightsithasonhand.Theprovisionforanyexcessemissionsisbasedonthemarketpriceatthereportingdate.

Reimbursement rights approachAlternatively, an entity may view their purchasedemissionrightsasreimbursementrightsinrespectoftheirliability.Therefore,totheextentthenumberofemissionrightsonhanddoesnotexceedthenumberofemissionrightsnecessarytosettletheliability,itcanre-measurethesepurchasedrightstofairvalue(marketpriceatreportingdate)throughprofitandloss.Consequently,part ofthepurchasedrightsandtheprovisionwillbemeasuredatmarketprice.

Government grants approachAnentitymayinitiallyrecognisetheemissionrightsgrantedbythegovernmentattheirfairvalue(ratherthanatanominalamount,i.e.,zero).Thesegrantedrightsaremeasuredatfairvalueatgrantdateanddeferredincomeisrecognisedforthedifferencetotheamountpaid(generally

nil).Thedeferredincomeisreleasedtotheincome statement on a systematic basis over the compliance period. The liability is recognisedwhenemissionsaremade.Thisis similar to the requirements under IFRIC 3, however different alternatives for the measurement of the liability can be applied.

The liability can be measured either at:• Thefairvalueoftheemissionrightsatthereportingdate;or

• Thecarryingamountoftherightsinhandand at fair value for any shortfall (consistentwiththe‘carryingvalue’approach).

Whenmeasuringtheliabilityatthefairvalueoftheemissionrightsatthereportingdate,theentitycouldmeasurethegrantedrights,which it will use to settle the liability to fair valuethroughprofitandloss(consistentwiththe‘reimbursementrightsapproach’).

Summary of alternative accounting policiesTherecognitionandmeasurementofaprovisionunderthegovernmentgrantsapproach and net liability approach are also describedinBox3.

No

NoYes

Yes

Measure provision:

Number ofemissionsmadexmarket value ofemissionrightsatbalance sheet date

Remeasureemissionrightsheldto remitatmarket value at balance sheet date throughP&L?

Provision measured at fair value at balance sheet date?

Governmentgrants' approach1

Measure provision:

Emissionrightsheldandgranted at carryingamount+emissionsmadewherenorightisheldatthemarket value ofemissionrightsatbalance sheet date

Will offset the impact of the measurement of the provision throughtheincome statement. The net impact on the income statement will depend on the amortisation of the deferred income also (refer1)

1 UndertheGovernment Grants approach,granted emissions are initially mesured at fair valueatgrant date. Deferred income is credited and released to the P&L over the allocation period 2 UndertheNetLiability approach,grantedemissionrightsmustbemeasured at nominal amount, i.e. nil

Method equivalent to IFRIC 3. Impact on income statement from recognitionof the provision will be offset by the amortisation of the deferred income but will not match this exactly

Measure provision:

Number ofemissionsmadexmarket value ofemissionrightsatbalance sheet date

Measure provision:

Emissionrightsheldandgranted at carryingamount+emissionsmade wherenorightisheldatthemarket value ofemissionrightsatbalance sheet date

NoYes

Provision measured at fair value at balance sheet date?

'Net liability' approach(provision recognisedasemissionsexceed grantedrightsstillheld)2

Provision recognisedonagross basis as emissions are made?

Yes No

Remeasure pruchased emissionrightsheldto remit at market valueat balance sheet date throughP&L?

Will offset the impact of themeasurement of the provision throughtheincome statement

The impact of measurement of the provision throughtheincome statement is not offset

Yes No

Box 3: Summary of alternative accounting policies for emission rights under a cap and trade scheme and similar schemes


B.4.1.3 Amortisation and impairment testing of emission rights

Generally,emissionrightsshouldnotbeamortised. In a cap and trade scheme, the economicbenefitsareonlyconsumedwhentherightissurrenderedtosettleobligationsarisingfromemissionsmade(orbysellingittoanotherparty),atwhichpoint,itwillbederecognised.However,itisnecessaryto perform an impairment test, in accordancewithIAS36,wheneverthereisan indication of impairment.

Emissionrightsthatareheldbyanentityforthepurposeofsettlingitsobligations(ratherthanforsaleonthemarket)areoften tested for impairment as part of a largercashgeneratingunit.Therefore,there is not an automatic impairment chargewhenanindicatorofimpairmenttriggersanimpairmenttestandthemarketvalueofanemissionrightislowerthanitscarryingamount.

B.4.1.4 Sale of emission rights

The sale of an emission allowance that was recognisedasanintangibleassetisrecorded as a sale at the fair value of the consideration received. Any difference between the fair value of the consideration receivedanditscarryingamountshouldberecordedasagainorloss,irrespectiveofwhether this creates an actual or an expecteddeficitinallowancesheld.Ifitcreatesanactualdeficit,anadditionalliabilitywillhavetoberecognisedwithachargetotheincomestatement.

B.4.1.5 Forward contracts for emission rights

If an entity enters into a forward contract to sellorpurchaseanemissionright,IAS39paragraph5isappliedtodeterminewhether the contract is a derivative within the scope of IAS 39. Refer to section A.1.1 for an overview of the scope of IAS 39. Whenmakingtheassessmentforforwardsales contracts, entities should consider thatthequantityoftheemissionrights

received is not within the control of the entity. In some cases entities receive more rightsthantheyexpecttouseandtheysellthoserightsonthemarketthroughforwardcontracts. If the entity does not have a past practice of net settlement or an intention of activelytradingemissionrights,theforward contract may have been entered intofor‘ownusepurposes’andwouldnotbewithinthescopeofIAS39.Althoughitisnottheentity’sbusinesstosellemissionrightsforwardsitcouldstillbeconsideredto be a normal sale transaction as the quantityofemissionrightsreceivedisnotwithin the control of the entity.

An entity may also enter into forward contractstopurchaseemissionrights.Thismay be to supplement a shortfall in emissions held compared with actual or projected emissions. An entity must assess whether it has a past practice of net settlement or an intention of actively tradingemissionrights.Iftheforwardcontract has been entered into for ‘own use’purposes(andmeetsallothercriteriaasdiscussedinsectionA)thenitwouldnotbewithinthescopeofIAS39iftherightswill be physically delivered under the contract.

However, an entity may actively trade emissionrightsatthesametimeandbeunable to determine which forward contracts will result in a purchase or sale of emissionrightsforownuse.Ownuseaccountingcannotthenbeappliedifthereare no controls in place to separate forward contractsenteredintofortradingpurposesand those for own use.

B.4.1.6 Accounting by brokers/traders

Abroker-tradermayholdemissionrightsfor sale in the ordinary course of their business.Therefore,theserightsmeetthedefinitionofinventoryandcanberecordedat either the lower of cost and net realisable value or at fair value less costs to sell in accordance with their policy as permitted by IAS 2.

B.4.2 Certified emissions reductions

UndertheKyotoprotocol,theCleanDevelopmentMechanism(CDM)allows‘Annex1’countries(mainlydevelopednations)toinvestin‘clean’projectsindevelopingcountries(‘host’countries)andtoreceiveCertifiedEmissionReductions(CERs)inreturn.CERscaneitherbeusedbyanentity,uptoacertainlimit,tofulfilitsobligationsundersomeemissionstradingschemes(forexample,theEuropeanUnionemissionstradingscheme)ortheycanbesold to other entities. Only projects that meet‘additionality’criteriaqualifyasCDMprojects.Akeyaspectofadditionalityisthat the project produces lower emission thanalessexpensivealternativeandthatthe project would not have been implemented without the additional incentive provided by CERs. The process for approvingtheissuanceofCERsthroughtheCDMregistrationiscomplexanddependsonseveralqualificationcriteria.CERsareissued only for actual reductions of greenhousegasemissionsachievedbyaregisteredproject,belowthesetbaseline,thathasbeenverifiedandcertifiedbyarelevant independent authority.

The CER scheme is a ‘baseline and credit scheme’.EntitiesearnCERsforemissionsreductions below a set baseline. This is a different model to a cap and trade scheme, inwhichanaggregatecaponemissionsisdistributedintheformofemissionrightsallowances. The withdrawn IFRIC 3 addressed cap and trade schemes only and, therefore,isnotapplicablebyanalogytoCERs.Belowwediscusstheaccountingfor:• AprojectpromoterthatisgrantedCERs• A purchaser of CERs• Forward contracts for CERs• Accountingbybrokers/traders.

AccountingforCER/emissionrightsswapsis discussed at section E.4.


B.4.2.1 A project promoter that is granted CERs

CERsaregovernmentgrants.Therefore,webelievethattheymustberecognisedwhenthere is reasonable assurance that the entityinvestingintheCDMschemewillcomply with the conditions attached to receivingtheCERs.TheearliestpointthatCERscanberecognisediswhentheactualemission reductions have been realised and the entity has reasonable assurance that thereductionswillbeconfirmedduringtheverificationandcertificationprocessbytherespective independent authority. When makingthisassessmenttheentitymusttakeallcontractualtermsandconditionsinto account.

Initial recognition TheCERswillusuallyberecognisedasintangibleassetsperIAS38.However,itmaybeappropriatetorecogniseCERsasinventory in accordance with IAS 2 if they are held for sale in the ordinary course of business or to settle an emissions liability in the ordinary course of business. The CERs can be measured initially at fair value or nominalvalue(i.e.,nil).CDMprojectsoftenresultinhighercoststhanotherprojects. Therefore, an entity may want to recognisethegrantsatfairvalueto(partly)offsetthehigheroperatingorinvestment costs. If the CERs are recognisedatfairvalue,thegrantisrecognisedintheincomestatementinconnection with the related costs. The costs will usually have been incurred before the CERsaregranted.Insuchcases,thegrantisrecognisedintheincomestatementimmediately.However,iftheexpensesincurred to achieve emission reductions havebeencapitalised,thegrantiseitherdeductedfromtheassetorrecognisedasdeferredincome.Inbothcases,thebenefitfromthegrantisrecognisedinincomeoverthe life of the asset to which it relates.

Subsequent recognitionWhenCERsarerecognisedasintangibleassets, they are subsequently measured at cost or the revalued amount. If an entity wishes to apply the revaluation model permittedunderIAS38,itmustfollowtheguidanceinthatstandardforthesubsequentrevaluation,includingtherequirementthatanactivemarketexists,asdefinedinthestandard.Ifanentitymeasures the CERs at cost, they will not normallybeamortisedasthebenefitsarenot consumed while the CERs are held, but are realised by either settlement of an existingemissionliabilityorthroughsale.However,IAS36Impairment of Assets should be applied to determine when an entityshouldrecogniseanimpairmentloss.

WhentheCERsarerecognisedasinventory,they are subsequently measured at the lower of cost or net realisable value, in accordance with IAS 2.

B.4.2.2 A purchaser of CERs

An entity that purchases CERs will often recordthemasintangibleassetsatcost,withsubsequentmeasurementatcost(orlowerrecoverableamount)orattherevaluedamount(assumingtherequirementsofIAS38aremet).Purchased CERs will be accounted for in the samewayaspurchasedemissionrights.Refer to section B.4.1.2 for further details.

B.4.2.3 Forward contracts for CERs

If an entity enters into a forward contract in relationtotheCERs,paragraph5ofIAS39is applied to determine whether the contract is a derivative scoped into IAS 39. Refer to section 4.1.5 for further details.


Abroker/traderaccountsforCERsinthesame way as they would account for emissionrights,asdescribedinsectionB.4.1.6above.

B.4.3 Green or renewable certificates

Some countries have schemes to promote electricity production from renewable sources. This is often achieved by the governmentgrantingcertificatestotheproducersof‘green’energy,whichmaybereferredtoasgreencertificates,renewableenergycertificates(RECs),tradablerenewablecertificatesorrenewableobligationcertificates,orsimilar.Usually,entities that distribute electricity must obtainacertainpercentageofpowerdelivered to customers from renewable sources. A distributor must obtain and remitgreencertificatesfortherequiredamountofrenewableenergy.Greencertificatesareeitherpurchaseddirectlyfromthegeneratorofrenewableenergyorfromamarket.Ifthedistributordoesnothavetherequirednumberofcertificates,itmustpayapenaltytothegovernment.Therequirementtoremitcertificatescreatesamarketandgivesvaluetogreencertificates.Thisenablesproducersofrenewableenergytoobtainreimbursementforthecostsofproducingrenewableenergy(whicharegenerallyhigher)and/orencouragesproducerstoproduceelectricity from renewable sources. Below wediscusstheaccountingfor:• Producersofrenewableenergy• Distributorsofrenewableenergy(includingthosethatdoandthosethatdonotalsoproducerenewableenergy)

• Accountingbybrokers/traders

B.4.3.1 Accounting by producers of renewable energy

Greencertificatesaregovernmentgrantsandshouldberecognisedasintangibleassets when there is reasonable assurance that the entity will be entitled to them, whichisthepointintimewhenthegreenelectricityisproduced.Governmentgrantsmay be measured initially at either fair valueornominalvalue(cost).Ifthe


certificateisinitiallyrecognisedatfairvalue,thecreditiseitherrecognisedasareduction in production costs in that period, asthegrantistocompensateforthehighercostofproducingfromrenewablesources,orasotherincome.Thecertificatecanbesubsequently measured at fair value, if both anactivemarketandtheotherrequirementsofIAS38aremet.NotethatitmaybeappropriatetorecognisegreencertificatesasinventoryinaccordancewithIAS 2 if they are held for sale in the ordinary course of business or to settle an emissions liability in the ordinary course of business. This is consistent with the accountingforCERsinsectionB.4.2.1.

B.4.3.2 Accounting by distributors of renewable energy

Distributor also produces renewable energyA distributor which also produces renewableenergycaneitheruseitsgrantedcertificatestoremittothegovernmenttosatisfy its own requirements or sell them to themarket.Consequently,theaccountingthat can be applied is, in principle, the same asthatdiscussedforemissionrightsin

sectionB.4.1above.Inthecaseofgreencertificates,thedistributorincurstheobligationtoremitcertificatesand,assuch,recognisesaprovision,as(green)salesarerecognised;whereasinthecaseofemissionrightstheobligationarises,andthereforeaprovisionisrecognised,asemissions are made.

Distributor does not produce renewable energyA distributor that does not produce renewableenergymustrecogniseaprovision as sales are made. The provision ismeasuredatthefairvalueofgreencertificatestoberemittedateachreportingdate.Iftheentitypurchasescertificatestomeetitsobligationtheycaneitherbeconsideredreimbursementrightsortheprovision can be measured on the basis of thecarryingvaluemethodasdescribedinsection B.4.1.2 above.


Abroker/traderaccountsforgreencertificatesinthesamewayastheywouldaccountforemissionrights,asdescribedinsectionB.4.1.6above.

B.5 Arrangements containing a lease The purpose of IFRIC 4 Determining whether an Arrangement Contains a Lease istoidentifyanarrangementwhich,insubstance,isalease(evenifthecontractdoesnotusetheterm‘lease’).Thesearrangementsconveyrightstouseitemsforagreedperiodsoftimeinreturnforapayment or series of payments. IFRIC 4 providesguidancetodeterminewhetherpaymentisbeingmadeunderanarrangementfortherighttousetheasset(therefore,insubstance,alease)orfortheactualoutputfromtheasset(notalease).

The interpretation focuses on contracts suchasoutsourcingandtake-or-paycontracts. The latter are common in the power and utilities industry. IFRIC 4 is applied to determine whether a contract is or contains a lease. If a contract is or does contain a lease, it is accounted for in accordancewithIAS17Leases.

Anarrangementisorcontainsaleaseifthefollowingconditionsaremet:• Fulfillmentofthearrangementisdependentontheuseofaspecificassetorassets(theasset);and

• Thearrangementconveysarighttousethe asset. This occurs if one of the followingaremet:• The purchaser can directly or indirectly

operate the asset as it determines, whileobtainingorcontrollingmorethananinsignificantamountofitsoutput;

• The purchaser can control physical accesstotheunderlyingasset,whileobtainingorcontrollingmorethananinsignificantamountofitsoutput;or

• It is remote that one or more other parties(otherthanthepurchaser)willtakemorethananinsignificantamountoftheoutputoftheassetduringthetermofthearrangementandthepriceof the output that the purchaser will payisneithercontractuallyfixedperunit of output nor equal to the current marketpriceperunitofoutputatthetime of delivery.


B.5.1 Specific asset or assets Anarrangementwillnotcontainaleaseunlessitdependsonaspecificassetorassets. If the seller is allowed and has the economic and practical ability to provide theoutputspecifiedinthecontractusingotherassetsnotspecifiedintheagreement,thearrangementwillnotcontain a lease.

Forexample,whendeterminingwhetheracontract to purchase electricity from a powerstationmeetsthespecificassettestconsiderthefollowing:• Does the contract specify that the electricitybesuppliedfromaspecificpowerstation?

• Does the contract allow the electricity to besourcedfromelsewhere?Ifso,thecontract may not be dependent on a specificasset.However,ifitisnotfeasible to source from elsewhere then the contract may be dependent on a specificasset.

B.5.2 Portions of assets IFRIC 4 does not address how to determine whenaportionofalargerassetisitselftheunderlyingassetforthepurposeofapplyingIAS17.However,arrangementsinwhichtheunderlyingassetwouldrepresentaunitofaccountineitherIAS16orIAS38arewithinthescopeofIFRIC4(IFRIC4,paragraph3).Themeaningof‘unitofaccount’isunclear.Therearemanycontracts in the power and utilities industry where this may be an issue.

Forexample,anentitymayhaveashareinpartofthecapacityofagaspipeline.However, the share of capacity cannot be regardedasaseparate‘portion’,asthelease of some capacity requires the user to be able to utilise the rest of the asset. Similarissuesexistifanentity,forexample,obtains the entire capacity of one turbine in a power station or a portion of the capacity ofawindfarmwhichhassharedsupportinginfrastructure.

B.5.3 A right to use the item

Ifthearrangementisbaseduponaspecificasset, the entity must determine whether thearrangementconveysarighttousetheasset. The entity must consider the tests mentioned in section B.5 above. It is often difficulttodeterminewhetherarighttousethe item has been conveyed. This is considered below.

B.5.3.1 Fixed price per unit of output and current market price per unit of output at the time of delivery

Somebelievethattheterm‘fixedprice’shouldbeinterpretedasabsolutelyfixed,with no variance per unit based on underlyingcostsorvolumes,includingdiscountsorsteppedpricing.Anypricingthatislinkedtotheperformanceoftheunderlyingasset(e.g.,efficiencies,estimatedcostsplusamargin)canindicatethat the purchaser has use of the underlyingasset.

Othersinterpretcertainfixedpricesas‘fixed’accordingtoIFRIC4.Forexample:afixedpriceperunitadjustedforinflation;orafixedpercentageincrease;orsteppedpricesfordifferenttimeperiods(notlinkedto different levels of production within the oneperiod).Theyconsiderthisacceptable,aslongasthepriceisnotlinkedtotheunderlyingperformanceoftheasset.Steppedpricingdoesnotmeanprice‘fixedperunitofoutput’.Inparticular,asthesteppedpricingisagreedinadvance,itisnotequaltothecurrentmarketpriceperunit as of the time of delivery of the output.

‘Currentmarketpriceperunitofoutput’meansthatthecostissolelyamarketpricefor the output of the asset without any otherpricingfactors.A‘marketpriceperKWhpluspercentchangeinthepriceofnaturalgas’wouldnotbethecurrentmarketpriceperunitoftheoutputoftheasset.Priceincreasesbasedonageneralindexsuchasaretailpricesindexareunlikelytoresultinacurrentmarketpricefor the output in question.

Somebelievethat‘currentmarketprice’means,forexample,thespotpriceofelectricity at the date of delivery, without any adjustment factors. Others believe that currentmarketpricecanalsobeinterpretedtomean,forexample,basedonaforwardmarketprice.

Ifthepriceperunitisnotfixed,oratamarketpriceperunitofoutput,thesubstanceofthearrangementmaybetopassontheeconomicrisksassociatedwithproducingtheoutput.Thiswouldeffectivelymean that the purchaser of the electricity is usingtheasset;thereforeitwouldqualifyasalease.ArrivingattheseconclusionsisjudgmentalandIAS1wouldnormallyrequiredisclosureofsuchkeyjudgments.

B.5.4 Other considerations

B.5.4.1Leaseclassification

IfanarrangementiswithinthescopeofIFRIC 4, it is necessary to determine whetheritisanoperatingleaseorafinancelease.TheguidancetomakethisdeterminationisfoundinIAS17.Iftheleaseisclassifiedasanoperatinglease,itisnecessary to disclose the minimum lease payments under the contract.

B.5.4.2 Interaction with IAS 39Ifanarrangementis,orcontains,aleaseitisautomaticallyexcludedfromthescopeofIAS39,exceptinrespectofembeddedderivatives and for the purposes of derecognition.Anyembeddedderivativesthat are not closely related to their host contract must still be separated and accountedforatfairvaluethroughprofitorloss. Refer to section A.1.2 for more information about embedded derivatives.


B.6 Other contracts

B.6.1 Tolling contracts

Generatorsmay‘lockin’returnsbycontractingoutpowerplantcapacityunder‘tollingcontracts’.Atollingagreementmaybecharacterisedasanagreementwhereby• Onepartyowns(andbearstheriskson)

the inputs to and outputs from a process. Thispartyhastherightsto(aportionof)theprocesscapacity(thetollee).

• Another party may own a facility and agreetooperatetheprocessorfacility.Theychargeatollingfeee.g.,perunitofinput that is transformed, or per unit of capacitytowhichrightsaregranted(thetoller).

Notethattollingcontractsalsoneedtobeassessedforanumberofissues,including:• Whether the contract is a lease or

contains a lease: An assessment should be made to determine whether such an arrangementcontainsalease(refertosectionB.5).

• ScopeofIAS39:tollingcontractsusuallyrequire physical delivery of the output andaregenerallynotsettledonanetbasis. Therefore, they are usually accountedforbygeneratorsasownusecontracts(refertosectionA.1)

• Embedded derivatives: such an arrangementmaycontainoneormoreembeddedderivative(s)thatmightneedtobeaccountedforseparately(refertosectionA.1.2)

• Onerous contract: if an entity has entered intoatollingcontractthatisonerous(i.e.,wheretheunavoidablecostsofmeetingtheobligationsunderthe

contractexceedtheeconomicbenefitsexpectedtobereceivedunderit)theexcessofthecostsoverthebenefitsofthecontractshouldberecognisedasaprovision.IAS37requiresthatonerouscontractsberecognisedandmeasuredasapresentobligation.Measurementisbased on the unavoidable costs under a contractandreflecttheleastnetcostofexitingthecontract,and

• Revenuerecognitionandrevenuepresentation: since the tollee often owns the inputs and receives respective output,revenuefromprovidingtheinputsmaynotberecognisable.Thetoller in contrast will need to assess what to present as revenues as they may neither own the inputs nor the outputs.

Severalvariantstotollingcontractsareobservable.Accordingly,theaccountingconsequencemayvarysignificantlyfromcase to case.

B.6.2 Compulsory yield of power

In some jurisdictions, power and utility entitiesaregrantedtherighttodevelopapowerplantbythegovernment.Inreturn,they must deliver a particular quantity of poweratabargainpricetothelocalgovernment.

Power and utility entities must consider whether:• ThecontractwiththegovernmentiswithinthescopeofIAS39(refertosectionA.1)

• Zhecontractisonerous(refertosectionB.6.1).

B.7 Power station reoptimisation

The forecast utilisation of a power plant oftenchangesovertimeduetoalterationsinexternalmarketandinternalfactors.Thisoften means that the volume of fuel purchased and output sold under forward contractsneedstobemodified.Thismaybeachieved,forexample,bytakingmoreorless fuel from contracts with volumetric flexibilityand/orbuyingorsellingcontractswithoffsettingvolumesinthemarket.

Theexternalmarketfactorsconsideredwhendeterminingforecastgenerationprofilesusuallyinclude:weatherpredictionsandtheirimpactondemand;averagecustomerdemandprofiles;andtheentity’sexpectationsofothercommodityprices,includingrelatedpricessuchasemissionrights(e.g.,asthismayimpactthedecisionwhethertogenerateorbuyfromthemarkettosupplycustomers).Thislatterfactor is often referred to as price ‘optimisation’.Internalfactorstoconsiderincludethepowerplant’smarginalcostsofproduction and power plant technical constraints.Forexample,anindividualpower plant may have a load restriction due to physical constraints or a limit on the production of certain emissions, such as sulphurdioxide.Sometimesadjustmentstothe volumes purchased must be made in theveryshort-term(e.g.,intheweekorhoursleadinguptodelivery)duetochangesincustomerdemand.Thisisoftenreferredtoas‘balancing’activity.

Consequently, an entity will need to consider whether activities to alter volumes purchased or sold under contract are within thescopeofIAS39.Theimpactofchangescancauseall‘similar’contractstobeaccountedforasfinancialinstrumentsaswell. Refer to sections A.1 and section E.1 for further information.


C Transmission and distribution

C.1. Property, plant and equipment – transmission and distribution networks

As discussed in section B.1.1, one of the keyissuesforpowerandutilityentitiesisapplyingthe‘components’approachwhenaccountingforPP&E.Whenapplyingthecomponents approach to transmission and distributionnetworks,numerousconsiderationsneedtotakenintoaccount.Box4listssometheseconsiderations.TheconsiderationsoutlinedinBox4arenotanexhaustivelistofissues,rathertheyarepointstoconsiderwhenapplyingthecomponents approach.

• Different useful lives must be applied to ‘maingrids’and‘subgrids’aswellas‘powergrids’and‘gasgrids’;

• Theresidualvalueofthegridissignificantduetotheneedforcontinuous renewal

• Usefullifeisimpactedbyserviceconcessionarrangementswiththemunicipality/localauthority(refertosectionC.5)

• Extensionsofgridsshouldbecapitalised

• To apply a materiality threshold to renewalsofgridstodeterminewhethertheyarecapitalisedorrecognisedasmaintenanceexpenditure

• Theusefullifeofthegridneedstobecontinuouslyextendedduetoitsrenewal. Note that this point should be considered in conjunction with the previous point and also that a replacement part has a new useful life over which that part should be depreciated

• Similarcomponentsofagrid(likepolesorcables)canbegroupedasoneitemofPP&Einthefixedassetregister

• Theimpactofextensionshasanimpactontheusefullifeofagrid.Forexample,ifagridhasanoriginalusefullifeof40yearsandfiveyearslateranextensionisconstructed, then the useful life of this extensionmaybe40years(not35).Considerwhetherthiscanbejustifiedbythe different maintenance cycles between the‘old’partofthegrid(whichwillbereplacedin35years)andtheextension(whichwillbereplacedin40years)

• Atleastthefollowingcomponentsneedtobeidentifiedasseparateitems• High-Voltagegrids– Land– Buildings(forexample,buildingsforsub-stations)

– Technicalequipment(forexample,protectionandmeasurement equipment, control devices)

– Overheadlines(forexample,380/230KVsteel)

– Cable(e.g.380/230KV)– Currenttransformers

• Distributiongrid– Land– Buildings(forexample,sub-plantbuildings)

– Piping– Cabletunnel– Cable– Cablesforcommunication(under/overground)

– Openwire(steel,concreteandwood)

– Sub-station–withoutbuildings– Sub-station–technical

equipment– Powersub-stations–withoutbuildings

– Powersub-stations–technicalequipment

– Powersub-stations(poles,steelandwood)

– Cableforconnectiontocustomers

– Openwireforconnectiontocustomers

– Countersandmeasuringdevices– mechanical– Countersandmeasuringdevices– electronic– Mobilepowersets

In some jurisdictions infrastructure assets, suchaspowerdistributionnetworks,wereaccountedforusingrenewalsaccountingunder their national GAAP. Renewals accountingrequiresthatthelevelofannualexpenditurerequiredtomaintaintheoperatingcapacityoftheinfrastructure

assetisrecognisedintheincomestatementasanexpenseisasurrogateforthedepreciationnormallychargedfortheperiod,onthegroundsthatnousefullifecan be reliably estimated. Renewals accountingisprohibitedunderIAS16.

Box 4 – Considerations when applying the components approach.


C.2 Impairment of power stations and grids Impairment is one of the other major issues toconsiderwhenaccountingforPP&E.WediscusssomeofthekeyissuestoconsiderwhenapplyingIAS36topowerstations,gridsandrelatedassets.

C.2.1 Indicators of impairment

A power and utility entity must assess whether there is an indicator of impairment ateachreportingdate.Ifanindicatorexistsan impairment test must be performed in accordancewithIAS36.Thestandardprovidesexamplesofinternalandexternalindicators of impairment. In addition, an entity must consider any other relevant indicators.Someexamplesofindicatorsofimpairmentthatsuggestapowerplantoragridmaynotbegeneratingsufficientincrementalcashflowstorecoverthecostsincurred to build or acquire and decommissiona(groupof)asset(s)areincludedinthetabletotheright.

External indicators Internal indicators

Newand/orcheapertechnology

Changesindemandpatterns

Overcapacityinthemarket

ReductioninthesparkspreadasaresultofreducedsellingpriceperMWhorincreasedprice of fuel per MWh

Changeinincentives

Changesintheenvironmentalandregulatoryenvironmentgoverningtheinstallation,operationanddecommissioningof the power station

Anincreaseinpriceofemissionrights(orsimilar)andofdeficiencypayments

Reductionofgridfeesduetoregulation

Newcompetitorsinthemarket

Increased cost of capital

Increased maintenance costs, refurbishment, or major inspections

Increased cost of distribution

Changeinusefullifeduetocontractualarrangements

Operationalissuesincludingunplannedoutages

Physicaldamagetotheasset

Asignificantincreaseinanydecommissioningprovisionclosetotheend of the production phase


C.2.2 Determining the cash generating unit (CGU) for power stations

IAS36providesspecificguidancetodetermineCGUs.ItstatesthataCGUisthesmallestidentifiablegroupofassetsthatgeneratescashinflowsthatarelargelyindependentofthecashinflowsfromotherassetsorgroupsofassets.EntitiesmustconsiderwhetherthereisanactivemarketfortheoutputofanassetwhenidentifyingCGUs.Ifthereisanactivemarketfortheoutputproducedbyanassetorgroupofassets,theassetsareidentifiedasaCGU,even if some or all of the output is used internally. The standard states that the existenceofanactivemarketmeansthattheCGUcouldgeneratecashinflowsindependently from the rest of the business bysellingoutputonthatmarket.Whetheranactivemarketfortheoutputexistsornot must be assessed on a case-by-case basis.

This requirement may impact power and utilityentities.Forexample,entitieswithmorethanonepowerstationoftenmanageproduction from multiple power stations on a portfolio basis. Such entities must carefullyconsiderwhetherall(oraclusterof)powerstationsarepartofthesameCGU,orwhethereachpowerstationispartofaseparateCGU.

C.3 Gas in a distribution network or storagePower and utility entities which distribute gasorhavegasinstorageoftenmustretainacertainquantityofgasintheirgasdistributionnetworkorstoragefacilitytoensure that the appropriate pressure is maintained for operational purposes. Such gasshouldbeaccountedforasPP&Eifitis:• Not held for sale or consumed in

production;• Necessarytooperateorbenefitfromanassetduringmorethanoneoperatingcycle; and

• Itscostcannotberecoupedthroughsale(oritbecomessignificantlyimpaired

after it has been used to operate the assetortoobtainbenefitfromthatasset).

This applies even if the part of inventory thatisdeemedtobeanitemofPP&Ecannot be separated physically from the rest of inventory.

C.4 Rate regulated activitiesIn many countries the provision of utilitiestoconsumersisregulatedbythegovernment.Theregulator,usuallyanagencyofthegovernment,setsorsupervisestheprices.Regulatorymechanisms vary from jurisdiction to jurisdiction.Theregulatormaysettheprices in a manner that enables the entity to recover past or scheduled future costs. Conversely,theregulatormayalsodecidethat prices should be reduced in the future toreturntocustomersexcessamountscollected in past periods. Consequently, the future price that a utility is allowed to chargeitscustomersmaybeinfluencedbypast cost levels and investment levels.

UnderanumberofnationalGAAPsaccountingpracticeshavedevelopedwhereby an entity accounts for the effects ofregulationbyrecognisinga‘regulatory’asset(orliability)thatreflectstheincrease(ordecrease)infuturepricesapprovedbytheregulator.

Historically,theseregulatoryassetsandregulatoryliabilitieshavegenerallynotbeenrecognisedunderIFRS.During2008the IFRIC considered for a time whether regulatedentitiescouldorshouldrecognisean asset or a liability as a result of regulationbyregulatorybodiesorgovernments.TheIFRICagaindecidednottoaddtheissuetoitsagenda,comingtothe same conclusion as before that whilst rateregulationiswidespreadandsignificantlyaffectstheeconomicenvironmentofregulatedentities,theredidnotseemtobesignificantdivergenceinpractice for entities that were already

applyingIFRS.ThecurrentconsensusamongexistingIFRSreporterswasthatnoregulatoryassetsorliabilitiesarerecognised,unlesstheymeetthedefinitionofafinancialassetorafinancialliability(theseariseinfewregulatoryregimes)

However, the IASB decided to add a project onrate-regulatedactivitiestoitsagenda.TheBoardacknowledgedthatthiswasamatterofsignificantinterestinanumberofcountriesthatwouldbeadoptingIFRSinthenearfutureandwhererecognitionofregulatoryassetsandliabilitieswaseitherpermitted or required. In July 2009, the IASBissuedanexposuredraftonrate-regulatedactivities,whichisdiscussedbelow.

C.4.1 Scope of the proposals

The scope of the proposals is intended to be restrictive,applyingonlytoentitieswhoseoperatingactivitiesmeetbothofthefollowingcriteria:• Anauthorisedbody(the‘regulator’)

establishes the price the entity must chargeitscustomersforthegoodsorservices that the entity provides and the customers are bound by that price

• Thepriceestablishedbyregulation(the‘rate’)isdesignedtorecoverthespecificcoststheentityincursinprovidingtheregulatedgoodsorservicesandtoearnaspecifiedreturn(cost-of-serviceregulation).Thespecifiedreturncouldbeaminimumorrangeandneednotbefixedorguaranteed

Cost-of-serviceregulationisdefinedas‘aformofregulationforsettinganentity’sprices(rates)inwhichthereisacause-and-effectrelationshipbetweentheentity’sspecificcostsanditsrevenues’.Formsofregulationthatestablishdifferentratesfordifferentcategories,suchasdifferentclasses of customers or volumes purchased, are within this scope provided that the regulatorapprovesthedefinitionandtherateforeachofthosecategoriesandthatallcustomersofthesamecategoryareboundbythesamerate.Forexample,therate-regulatedactivitiesofanentitywould


notbeexcludedfromtheproposalssimplybecausetheentityisalsoengagedinunregulatedactivities.However,regulatorymechanismsapplyingtargetedorassumedcosts,suchasindustryaverages,ratherthananentity’sspecificcosts,areoutsidethe scope of the proposals.

The scope of the proposals is limited to regulationbasedonanentity’sactualcostsbecause the Board has concluded that a regulatoryassetcanonlybedeemedtoexistiftheentity’srightsunderrate-regulationrelatestoidentifiablefuturecashflowslinkedtocostsitpreviouslyincurred,ratherthanrelatingtoanyexpectationoffuturecashflowsbasedontheexistenceofpredictable demand. Such a ‘cause-and-effectrelationship’mustbeevidentforanassettoexist.

It is clear that a scope restriction would be required,becauseentitiesoperatingoutsidearegulatoryenvironmentmightlookforsimilar cause-and-effect relationships. For example,ifacustomercontractuallyagreesto suffer a future price increase on the basis ofdatademonstratingthatitssupplierhadincurredhigher-than-reasonableproduction costs in the past, the supplier mighttrytoarguethatthereisjustascompellingacaseforrecognisinganintangibleassetfortherighttofuturepriceincreases.

Inaddition,giventhewiderangeofregulatoryframeworksworldwide,itwillbeimportant that such a scope restriction clearlyidentifieswhichregimeswouldfallunder the scope of the proposals and which would not.

C.4.2 Recognition and measurement

TheExposureDraft(ED)proposesthatwhenanentityfallingwithinitsscopehastherighttoincreaseortheobligationtodecrease rates in future periods as a result oftheactualorexpectedactionsoftheregulator,itshallrecognise:• Aregulatoryassetforitsrighttorecoverspecificpreviouslyincurredcostsandtoearnaspecifiedreturn;or

• Aregulatoryliabilityforitsobligationtorefund previously collected amounts and topayaspecifiedreturn.

Accordinglyaregulatoryasset(orliability)isrecognisedtoreflectamountsthatwouldotherwise be recorded in that period in the statement of comprehensive income as an expense(orrevenue).Thatassetorliability should be carried initially and at the endofsubsequentreportingperiodsatitsexpectedpresentvalue.Suchanexpectedpresentvaluewouldcomprisethefollowingelementsforaregulatoryassetoraregulatoryliability:• Anestimateofthefuturecashflowsthatwillariseinarangeofpossibleoutcomes

• An estimate of the probability of each outcomeoccurring

• The time value of money, represented by thecurrentmarketrisk-freerateofinterest

• Thepriceforbearingtheuncertaintyinherentintheregulatoryassetorregulatoryliability.

Theproposalsalsorequirethatregulatoryassets are subject to a test of recoverability, wherebytheentityconsiderstheextenttowhich it will recover the previously incurred

costs from its customers. This consideration shouldtakeintoaccounttheneteffectthatthe imposed increase or decrease in prices isexpectedtohaveonthelevelofcustomerdemandorcompetitionduringtheperiodofcost recovery. If an entity concludes that it is not reasonable to assume that it will be abletocollectsufficientrevenuesfromitscustomers to recover its costs, this is an indicationthatthecash-generatingunitinwhichtheregulatoryassetsandregulatoryliabilities are included may be impaired and it will have to be tested for impairment in accordancewithIAS36.

Regulatoryassetsandliabilitieswouldbepresented separately from other assets and liabilities on the face of the balance sheet, classifiedascurrentandnon-currentitems.Offsettingwouldonlybeallowedforeachcategoryofassetorliabilitysubjecttothesameregulator.TheEDalsoproposedextensivedisclosurerequirements.

Atthetimeofwritingitisdifficulttodeterminehowthisexposuredraftwillbereceived.Somemightpointtothewaythata customer base acquired in a business combinationisrecognisedasanintangibleassetandregardtheexposuredraftasalogicalextensionofthisthinkingtoassetsand liabilities that arise in situations where aregulatoriseffectivelynegotiatingonbehalf of a whole customer base. Others mightpointtothecurrentlackofdiversityin practice and question the need for the proposednewstandard.ThechallengefortheIASBwillbetwofold:todefineclearlysituationsandregulatoryenvironmentsinwhichitisappropriatetorecogniseregulatoryassetsandliabilitiesandtomakethe case for its proposals to current users of IFRS.


C.5 Service concession arrangements‘Serviceconcessionarrangements’(SCAs)have evolved over recent years as a mechanismforprovidingpublicservices.Undersucharrangements,privatecapitalisusedtoconstructand/ormaintaintheinfrastructure used to provide major facilitiesforpublicuse,includingwaterdistributionfacilitiesandenergysupplynetworks.IFRICInterpretation12Service Concession Arrangements addresses the accountingforSCAs.

C.5.1 Scope

IFRIC 12 applies to public-to-private SCAs if the infrastructure is constructed or acquired by the operator as part of the arrangementorisprovidedaccessbythegrantorand:• Thegrantorcontrolsorregulateswhat

services the operator must provide with the infrastructure, to whom it must provide them, and at what price; and

• Thegrantorcontrols–throughownership,beneficialentitlementorotherwise–anysignificantresidualinterestintheinfrastructure(ifitexists)at the end of the term of the arrangement.Ifthereisnosignificantresidual interest at the end of the arrangement(thatis,thearrangementisfortheentireusefullifeoftheasset)thegrantorisstillconsideredto“control”theinfrastructure,. Hence it will be in scope.

InfrastructureassetsthatareexistingassetsoftheoperatorpriortoenteringintothearrangementarenotwithinthescopeoftheinterpretationandIAS16willcontinue to apply to such assets.

If the contract is within the scope of IFRIC 12 it is not within the scope of IFRIC 4.

C.5.2 Accounting treatment

Infrastructure within the scope of IFRIC 12 shouldnotberecognisedasPP&Eoftheoperatorasthegrantorisconsideredtocontrol the assets. Instead, if the operator providesconstructionorupgradeservicesitrecognisestheconsiderationreceivedorreceivableaseitherafinancialassetoranintangibleasset.

Afinancialassetisrecognisedtotheextentthat the operator has an unconditional contractualrighttoreceivecashorother

financialasset(s)fromthegrantorforconstruction services. An unconditional rightalsoexistswhenthegrantorguaranteestheoperator’scashflowsbyagreeingtopayeither(i)specifiedordeterminableamountsor(ii)theshortfall,if any, between user payments and specifiedordeterminableamounts.Inthesecircumstancesthegrantorbearstherisk(demandrisk)thatthecashflowsgeneratedbytheusersofthepublicservicewillnotbesufficienttorecovertheoperator’sinvestment.Thefinancialassetisrecognisedduringtheperiodof

Box 5: Decision tree to determine if an arrangement is within the scope of IFRIC 12

Doesthegrantor control or regulatewhat services the operator mustprovide with the infrastructure,to whon it must provide them,and at what price?

Outside thescope ofIFRIC 12

Doesthegrantor control throughownership,beneficialentitlementorotherwise, anysignificant residualinterest in the infrastructure at the end of the service arrangement?1

No

No

No

Yes

Is the infrastructure constructedor acquired by the operator froma third party for the purpose ofthe service arrangement?

1 Iftheassethasnosignificant residual interestasitisa“wholeoflife” arrangement,thegrantor is consideredto control ownership.

2 Asset owned by the operator before the arrangementisentered into, that are to be used in the arrangementare outside the scope of this interpretation.

Within the scope of IFRIC 12:Operator does not recogniseinfrastructure as property, plant and equipment or a leased asset

Is the infrastructure existinginfrastructure ofthegrantorto which the operator isgiven access for the purpose of the service arrangement?

Yes No2

Yes Yes


constructiongivingrisetorevenuesfromconstruction, which are then recovered duringtheperiodofuseoftheassetastheoperatorreceivestheguaranteedcashflows.

Anintangibleassetisrecognisedtotheextentthattheoperatorreceivesarighttochargeusersforthepublicservice.Inthesecircumstancestheoperator’srevenueisconditionalonusageanditbearstherisk(demandrisk)thatthecashflowsgeneratedbyusersofthepublicservicewillnotbesufficienttorecoveritsinvestment.Theoperatorhasnocontractualrighttoreceivecashwhenpaymentsarecontingentonusage,evenwhentheoperator’sreturnisverylowrisk.Theconstructionservicesareexchangedfortheintangibleassetbeingtherighttochargeusersofthepublicservice, and revenues are subsequently generatedfromusers.

When the operator is paid for its services partlybyafinancialassetandpartlybyalicencetochargeusers,thegrantorandoperatorsharethe(demand)risk.Inthiscase both components of the consideration aretoberecognisedseparately.

WhentheoperatorcapitalisesborrowingcostsunderIAS23onlyanintangibleassetinanSCAmeetsthedefinitionofa“qualifyingasset”.Whenafinancialassetisrecognised,itwillnotbeaqualifyingasset,althoughitwillaccrueinterestasitismeasured at amortised cost.

MostSCAscontaincontractualobligationsto:(a)maintaintheinfrastructuretoaspecifiedlevelofserviceabilityor(b)restoretheinfrastructuretoaspecifiedconditionbeforeitishandedbacktothegrantorattheendoftheservicearrangement.Totheextentthatanintangibleassetisrecognised,thesecontractualobligationstomaintainorrestoreinfrastructureshouldberecognisedandmeasuredinaccordancewithIAS37,i.e.,atthebestestimateoftheexpenditurethat would be required to settle the present obligationatthebalancesheetdate.Anyupgradeelementiscapitalisedaspartoftheintangibleasset.

DisclosurerequirementswithregardtoSCAs are set out in SIC-29 Service Concession Arrangements: Disclosures.

C.6 Arrangements that may contain a lease - transmission contracts and capacity contracts

In section B.5. we discussed instances where power and utility entities may have entered into contracts which are or contain alease.Arrangementswhereapowerandutility entity enters into a contractual arrangementconveyingtherighttouseapart of its transmission assets to third parties may also be or contain leases. For example,consideracontractforcapacityinagaspipelinetotransportgasfromonephysical location to another; or a contract forcapacityinagasstorageunit.Forfurther information, refer to section B.5. In particular, consider whether the arrangementisforaportionofanasset,asdiscussed in section B.5.2.


D Retail customers

Power and utility retail customer contracts aregenerallyeither‘end-user’customers,suchashouseholdsorlargerindustrialandcommercialcustomers(e.g.,factoriesorshops).Inthissection,wediscussissuesassociated with connection fees and transfers of assets from customers; customer acquisition costs; and the impact ofIAS39inthecontextofretailcustomers.

D.1 Connection fees and transfers of assets from customers

Power and utility entities may receive items ofPP&Efromtheircustomers,orcashtoacquireorconstructspecificassetsfromtheir customers. These assets are used to connectcustomerstoanetworkand/orprovidethemwithongoingaccesstoasupplyofgoodsand/orservicessuchaselectricity,gasandwater.Thediversityofaccountingmethodsusedbyentitiesfortheassets they received led the IFRIC to issue InterpretationIFRIC18Transfers of Assets from Customers. The interpretation providesguidanceonwhenandhowanentityshouldrecognisesuchassets.

This interpretation is to be applied prospectively to all transfers of assets from customers received on or after 1 July 2009. Entities may choose to apply this interpretation to earlier periods, provided valuations were obtained at the time those transfers occurred.

D.1.1 Scope of the interpretation

IFRIC18appliestoallentitiesthatreceivean item of property, plant and equipment or cash for the acquisition or construction of such items from customers. These assets must then be used to connect the customer toanetworkortoprovideongoingaccess

toasupplyofgoodsorservices,orboth.However,ifthetransferisagovernmentgrant(withinthescopeofIAS20)ortheasset is used in a service concession arrangement(refertosectionC.5),theinterpretation will not apply.

D.1.2 Recognising an asset

Thefirststepisdeterminingwhethertheassetqualifiesforrecognition.Anassessment must be made to determine whether the transferred item meets the definitionofanassetassetoutintheIFRSFramework.Akeyelementinthisdefinitionisestablishingwhethertheentityhascontroloftheitem.Therightofownershipmay be transferred, but this is not indicative that control has transferred. This will require an analysis of all facts and circumstances, such as, can the entity:• Exchangetheassetforotherassetsto

deliver the same service • Employtheassettoproduceothergoods

or services or settle a liability• Chargeapriceforotherstouseit• Decide how the transferred asset is

operated and maintained and when it is replaced

Ifthedefinitionismet,theassetismeasured at its fair value, which becomes

itscostoninitialrecognition.Whencashistransferred, the entity assesses whether the asset to be constructed meets the definitionofanasset–thatis,itwillbewithintheentity’scontrolwhenitiscompleted.

D.1.3 Recognising revenue

Iftheassetisrecognisedatfairvalue,itisaccountedforasan‘exchangetransaction’.That is, the entity is considered to have receivedtheassetinexchangeforthedeliveryofservices.Examplesofservices(tobe)deliveredbytheentityincludeconnectiontoanetworkand/orprovidingongoingaccesstoasupplyofgoodsorservices. Entities must determine each identifiableservicewithintheagreementandrecogniserevenueaseachserviceisdelivered. The fair value of the total considerationreceived(theassetorcashtoacquiretheasset)isallocatedtoeachoftheseidentifiableservice(s).

Thefollowingisasummaryofthefeaturesidentifiedintheinterpretationthatindicatetheserviceisaconnectiontoanetwork(whichisdeliveredimmediately)andfeatures that indicate the service is to provideongoingaccesstoasupplyofgoodsorservices(whichisdeliveredovertheperiodofthearrangement):

Connection to a network Ongoing access to a supply of goods/services

Connection is delivered to the customer and represents stand-alone value for that customer

Goods or services received via the connectionarechargedatapricelowerthan that paid by other customers who have not contributed an asset

Fair value can be reliably measured

Goods or services received via the connectionarechargedatthesamepricepaid by other customers who have not contributed an asset


Wheretheidentifiableserviceisprovidingongoingaccesstoasupplyofgoodsorservices,thetermsofthearrangementwiththe customer will determine the period over whichrevenuemustberecognised.Intheabsence of such a term, revenue is recognisedoveraperiodnolongerthantheuseful life of the respective transferred asset.TheaccountingcanbesummarisedinthedecisiontreeinBox6.

D.1.4 Impacts

Asdifferingpracticehavedeveloped,manypower and utility entities may need to changetheirrevenuerecognitionpolicies,thereforehavingapossiblesignificantimpactontheirfutureoperatingresultsandnet assets positions.

The requirement for the entity to assess whether or not it controls the asset may result in situations where no asset is actuallyrecognised.Entitieswillneedtocarefullyassessallconditionssurroundingtheuseoftheassettomakethisdetermination–whichwillinvolveathoroughreadingoftheagreementandthelawssurroundingtheoperationsofthebusiness.

Inprovidingthecustomerwithongoingaccessand/orgoods/services,entitiesmayhavedifficultiesinassessingtheperiodover which the revenue should be recognised.Itwillbenecessaryforentitiestomakedetailedassessmentsoftheircustomers’agreementsandassetusageinorder to determine the appropriate period. In some cases information systems may need to be enhanced to capture relevant data for this assessment, and to amortise the revenue over the period this service is provided.

Box 6: Accounting decision tree for transfers of assets from customers

Recogniserevenue overthe period that accessis proved*

*Iftheagreementissilent,thisisnolongerthanthelife of the related asset.

Ongoingaccess togoods/services

Connection tonetwork

Identify the service(s)beingprovided inexchangefor the asset

Entity receivingtheasset recognisestheasset at fait value

Recogniserevenue whenthe connection to thenetworkiscompleted

Yes No

Is the transferred item “an asset controlled bythe entity”?

Entity receivingtheasset does not recognisean asset

D.2 Customer acquisition costsA power and utilities retailer may have developed a portfolio of customers or built marketshareasaresultofmarketingefforts. Consequently, the retailer may expectthatcustomerswillcontinuetopurchase commodities from them. Torecogniseanintangibleasset,anentitymustdemonstrateidentifiability,controlandtheexistenceoffutureeconomicbenefits.Expenditureonitemsthatdonotmeetallthreecriteriawillbeexpensedwhen incurred, unless they have arisen in thecontextofabusinesscombination,where they will form part of the calculation ofgoodwill(refertoIFRS3Business Combinations).

Intheabsenceoflegalrightstoprotectorcontrol the relationship with customers, a power and utility entity usually has insufficientcontrolovertheretentionofcustomers for the customer relationships to meetthedefinitionofintangibleassets.Consequently, all costs in respect of internally developed customer relationships areexpensedasincurred.

However,someexchangetransactionsinvolvingnon-contractualcustomerrelationships(otherthanaspartofabusinesscombination)mayprovideevidence that the entity is able to control theexpectedfutureeconomicbenefits,evenintheabsenceoflegalcontrol,andthat the customer relationships concerned are separable. An entity must carefully consider whether such customer relationshipsmeetthedefinitionofanintangibleassetinaccordancewithIAS38.

D.3 Application of IAS 39 to retail customer contractsIt is possible that some retail customer contracts are within the scope of IAS 39. To assess whether they are within scope refer to section A.1. Issues which more commonly arise for retail customer contracts are discussed in section A.1.1 and include:• Symmetrical default clauses• Volumeflexibility(apotentialwrittenoption)


E Support functions and risk management

E.1 Risk management

Powerandutilityentitiesareoftenexposedtotheriskthatthepricesoftheircommodityinputsandoutputswillchange.Thisexposureoccursformanyreasons,forexample,ifanentitymustpurchaseallofitsfuelfromthemarketthereistheriskthatthe price of fuel will increase and its cost mayexceedthepriceforwhichoutputcanbesold.Torespondtosuchpriceriskmanypower and utility entities have established centralisedtradingorriskmanagementunits.Theroleofatradingunitmaybelimitedtomarketriskmanagementoritmayincludeprofitoptimisation(whichmayormaynotincludeproprietary/speculativetradingactivities).

Iftheprimaryintentionofatradingunitisriskmanagement,thetradingunitmaybemorelikelytoenterintocontractsthatqualifyfortheownuseexemption(refertosectionA.1).However,thisisnotalwaysthe case because they may fail the test of paragraph57ofIAS39.Ifthetradingunitistradingonaspeculativebasis,thesecontracts will be accounted for as derivative financialinstruments.

Tradingunitsoftenoperateasinternalmarketplacesinpowerandutilityentities.Theybuyfuelfromtheexternalmarketandsellittothe‘generationunit’sothatthegenerationunitcanproducepower.Thepowerproducedbythegenerationunitispurchasedbythetradingunitwhichsellsitto the retail unit so that it can meet its customers’demandorsellthepowertothewholesalemarket.Asthetradingunitacquiresallofapowerandutilityentity’sexposuretothevariouscommodityrisks,itisalsoinapositiontoeconomicallyhedgethoserisksintheexternalmarkets.

A power and utility entity may be able to maintainseparatetradingandphysicalbooksand,therefore,accountforthe‘physical’contractsasownuse.However,entities must consider whether any activity to optimise the price obtained for commodity purchases or sales constitutes netsettlementofcontractsand‘taints’the

forwardcontractsinthephysicalbookand,therefore, they must all be accounted for as derivatives. Refer to section A.1 for further informationaboutownuseandsectionB.7for information about optimisation.

Power and utility entities should consider thatIFRS7Financial Instruments: Disclosuresrequiresextensivedisclosuresoffinancialinstruments,includingcommodityfinancialinstruments.However,theextentofdisclosurerequireddependsontheextentoftheentity’suseoffinancialinstrumentsandofitsexposuretorisk. IFRS7requiresdisclosureofinformationthatenablesusersoftheentity’sfinancialstatements to evaluate:• Thesignificanceoffinancialinstrumentsforanentity’sfinancialpositionandperformance

• Thenatureandextentofrisksarisingfromfinancialinstrumentstowhichtheentityisexposedatthereportingdate.Thesedisclosuresfocusontherisksthatarisefromfinancialinstrumentsandhowtheyhavebeenmanaged.Theseriskstypically include, but are not limited to creditrisk,liquidityriskandmarketrisk.

E.1.1 Market risk disclosures – non-financial items

TherequirementsofIFRS7includesensitivityanalysesforeachtypeofmarketrisk.Whenanentitypreparesitsownsensitivityanalysisformanagementpurposes,suchasvalue-at-risk,thatreflectsinterdependenciesbetweenriskvariables, it may use that analysis for the purposeoftheIFRS7disclosures.

UnderIFRS,anentity’scommoditycontracts may be considered: • Within the scope of IAS 39 because they wereenteredintoprimarilyfortradingpurposesorfailtheexpectedusageparagraphs5-7

• Contracts entered into and held for the entity’sexpectedpurchase,saleorusagerequirements.

Allcommoditycontractsmayexposetheentitytoforeigncurrencyorcommoditypricerisk.IFRS7doesnotapplytocontractstobuyorsellanon-financialitemthat are outside the scope of IAS 39. Therefore, it does not apply to contracts enteredintoandheldfortheentity’sexpectedpurchase,saleorusagerequirements.However,financialinstruments held by an entity may be designatedashedginginstrumentsfor‘expectedusage’commoditycontractsand,hence,managementmaymanageitsrisksfrom these contracts collectively.

Iftheinformationprovidedtomanagementtomanageforeigncurrencyorcommoditypriceriskincludesbothfinancialinstrumentsandexpectedusagecontracts,itislikelytobethemostusefulinformationtopresentmarketriskdisclosuresforbothfinancialinstrumentsandexpectedusagecontracts because it provides a comprehensivepicturebyreflectingthecombinedmarketriskexposuresinherentinpositions, or transactions concerned, based onthewaytheentitymanagestheserisks.We believe it is best practice to include ‘expectedusage’contractsintheIFRS7marketriskdisclosureswhenitprovidesthemost relevant information. Inclusion or exclusionshouldbeclearlydisclosed.

IFRS7requiresasensitivityanalysisbepreparedforeachsignificanttypeofmarketrisk.Inthissituation,priceriskwouldbedisclosedseparatefromothermarketrisks,butmayincludebothfinancialinstrumentsandexpectedusagecontracts,forexample,‘expectedusage’contactsandderivativefinancialinstrumentsregardedbymanagementashedgesofsuchcontacts.

If a sensitivity analysis is prepared, amountsrelatingtofinancialinstrumentswithinthescopeofIFRS7andthoserelatingtoexpectedusagecontractsoutsidethescopeofIFRS7shouldeachbedisclosed separately, with additional qualitativeand/orquantitativeinformationregardingtherisksassociatedwiththeexpectedusagecontracts.


IFRS7permitsanentitytoprepareasensitivityanalysis(suchasvalue-at-risk‘VaR’)thattakesaccountoftheinterdependenciesbetweenriskvariables.Inthissituation,foreigncurrencyandpriceriskwouldbeincludedwithallothermarketriskvariables.

IfaVaRanalysisisprepared,theentitywillnot be able to separately disclose amounts relatingtofinancialinstrumentswithinthescopeofIFRS7andthoserelatingtoexpectedusagecontractsoutsidethescopeofIFRS7unlessitpreparesseparateVaRamountsforeachaspartoftheriskmanagementinformationprovidedtomanagement.WebelievethatasingleVaRamountwhichincludesnon-financialitemsoutsideofthescopeofIAS39andfinancialinstruments within the scope of IAS 39 to bedisclosed,ispossible,ifthisVaRanalysisisactuallyusedbymanagementtomanagemarketrisk.

E.2 Revenue presentation – gross or net?Determiningwhetherthereceiptsandpayments from commodity contracts shouldbepresentedgrossornetwilldepend on the relevant facts and circumstances. As part of the 2009 Annual Improvements project, the IASB amended theAppendixtoIAS18Revenue and providedguidanceonthedeterminationifanentityisactingasaprincipaloranagent.ForentitiesthathadlookedtoUSGAAPforguidanceinthisareapriortotheamendment, it should not fundamentally changepreviousdecisions.

Energycontractstowhichtheownuseexemptionappliesgenerallyresultingrossinflowsoroutflowsofeconomicbenefitsandareoftenpresentedgross.Activitieswhichareanormallinkinthevaluechainwillusuallyfallintothiscategory.

Contracts that are within the scope of IAS 39 must be accounted for as if they werefinancialinstrumentsandmeasuredatfair value. Many commodity contracts that areaccountedforasfinancialinstrumentsareenteredintoforproprietarytrading/

speculativepurposes.Theinflows(oroutflows)ofbenefitsfromsuchactivitiesare,insubstance,limitedtothetradingmarginandthesecontractsareusuallypresented on a net basis. Some commodity contractsareaccountedforasfinancialinstruments, however, are not entered into forproprietary/speculativetradingpurposes.It is not necessarily clear whether such contracts should be presented on a net or grossbasisasitisnotalwaysclearwhichcontracts ultimately result in physical delivery.

Findingthemostrelevantpresentationpolicyforintegratedpowerandutilityentitiescanbecomplex,asoftentheseentitiesaremadeupofthefollowingbusinessunits:• Generation Unit –operatespowerplantsandsellspowertothetradingunit

• Trading Unit –managesriskscentrally;entersintocontractswiththegenerationunitandthesalesunit;entersintoenergycontractsonthewholesale-market

• Sales Unit –sellsenergytoretailcustomersandlocalorregionalpowerand utilities

Box7summarisesthevarioussalestransactions that could occur in the operationsofanintegratedpowerandutility entity:

Generation unit

OTC-MarketEnergy exchange

Trading unit

sales and purchase due toreadjustment of hedge ratio

Volume: 10 TWhValue:EUR0,4bn Sales unit

Production 100 TWh

Sales:170TWhRevenue:EUR6,8bn

Purchases: 150 TWhRevenue:EUR6,0bn

Sales: 110 TWhRevenue:EUR4,4bn

Sales:80TWh

Revenue: EUR12,0bn

Purchases: 90 TWhCost ofsales:EUR3,6bn

Demand:80TWh

Retail customers

Box 7: Example of various sales transactions of an integrated power and utility entity


Whenreportingconsolidatedresults,revenues are based on sales to third parties whichwouldbethetradingunit’sandthesalesunit’ssalesof‘physical’power–regardlessofwhethergeneratedbythegenerationunitorpurchasedfromthirdparties. Other transactions are usually presented on a net basis.

However, while it is easy to identify the salesunit’ssalesofphysicalproduction(intheexampleabovethesalesunitsellspowerof80TWhandrealisesrevenuesofEUR12bn)itwilloftenbedifficulttoidentifytheproportionofthetradingunit’ssalesthatrepresentssalesof‘physical’production(intheexampleabovethetradingunitsellspowerof170TWhforatotalconsiderationofEUR6.8bn.However,notalloftheunderlyingsalecontractswillrepresentsalesof‘physical’production).Therefore, whether a sales transaction givesrisetorevenuesdependsuponthespecificcircumstancesevaluatedagainsttheguidanceinIAS18.

E.3 Commodity hedge accountingHedgeaccountingisacomplextopic.Inthissectionweonlydiscusssomehigh-levelissuestoconsiderwhenapplyingcashflowhedgingtocommoditycontracts.Forfurther information on the requirements of hedgingrefertoInternationalGAAP.

Cashflowhedgingmaybeimportanttopower and utility entities when forward commodity contracts are within the scope ofIAS39.Forexample,whenforwardpurchase or sales contracts for a commodity are within the scope of IAS 39 and there is a clear demand requirement fortheentitytofulfil.Hedgeaccountingisalso often applied when commodity contracts are denominated in a currency otherthantheentity’sfunctionalcurrency.Forexample,acoalfiredpowerstationmaypurchasecoalunderUSdollar-denominatedforwardcontractsandtheentity’sfunctionalcurrencyisEuros.Varioustypesof derivative contracts are available to hedgethesepriceandcurrencyrisks.

Inorderforahedgetoqualifyforhedgeaccounting,allofthefollowingconditionssetoutinIAS39mustbemet.Thegeneralconditions are that:• Thehedgingrelationshipmustbedesignatedanddocumented,togetherwiththeentity’sriskmanagementobjectiveandstrategyinundertakingthehedge

• Thehedgemustbeexpectedtobehighlyeffective

• Forcashflowhedges,theforecasttransaction that is the subject of the hedgemustbehighlyprobableandmustpresentanexposuretovariationsincashflowsthatcouldultimatelyaffectprofitorloss

• Theeffectivenessofthehedgecanbereliably measured

• Thehedgemustbeassessedonanongoingbasisanddeterminedtohavebeenhighlyeffectivethroughoutthefinancialreportingperiodsforwhichthehedgewasdesignated.

Ifthehedgeditemisanon-financialitem(forexample,acontracttopurchaseorsellfuel,whichisoutsidethescopeofIAS39),itcanonlybedesignatedasahedgeditem:• Forforeigncurrencyrisks;or• Initsentiretyforallrisks

Thisisrequiredbecauseofthedifficultyofisolatingandmeasuringtheappropriateportionofthecashflowsorfairvaluechangesattributabletospecificrisksotherthanforeigncurrencyrisks.

Oneofthemainareasofjudgmenttoconsideristhefrequencyoftestingeffectivenesswhenapplyinghedgeaccountingtocommoditycontracts.Forexample,ifanentityhedgesforwardpowerpurchasesandthemarketsettleseveryhalfhour, entities must consider whether effectiveness needs to be calculated every halfhourorwhetheralongertimeperiodisacceptable.


E.4 Emission rights and CER swapsSome power and utility entities have enteredintoforwardagreementstoswapsomeoftheirgrantedemissionrightsforCERs. Typically, a power and utility entity enters into the swap with an investment bankandthepowerandutilityentityagreestodeliveraspecifiedamountofemissionrightsinexchangeforanequalnumberofCERs and a cash receipt. Such swaps are generallygovernedbymasternettingagreementswhichusuallyincludeprovisions for non-delivery in which the defaultingcounterpartyisrequiredtopay apenalty.Thispenaltymaybefixedorvariable and is intended to reimburse the counterparty for undelivered emission rightsorCERsandotherreasonablecosts.ForbackgroundinformationaboutCERsrefer to section B.4.2.

Wediscussthefollowingkeyaccountingissues:• Whether the swap is within the scope of

IAS 39• How to account for the receipt of cash.• Determiningfairvalue• Impact on net liability method

E.4.1 Scope of IAS 39

The swap will be within the scope of IAS 39 ifitisheldfortradingpurposesand/orwillbe net settled. It will be outside the scope if it is not net settled and is entered into and held for own use purposes. The swap is likelytobeenteredintoforownusepurposes if the CERs to be received will be usedtosatisfyobligationsresultingfromthe emission of CO2. Note that if the swap contains penalty payment provisions for non-delivery the entity should consider whether these are net settlement clauses. Refer to section A.1 for more information.

E.4.2 Receipt of cash – swap is not within the scope of IAS 39

If the cash is received before the swap maturesdeferredincomeisrecognisedinrespect of that amount as the emission rightshavenotyetbeendelivered.Oncetheswapmatures,theCERsarerecognisedat their fair value and any difference between:• The total of the cash received and the fair

value of the CERs received; and • Thecarryingvalueoftheemissionrightgivenup(whichmaybenil)

isrecognisedasagain(orloss).Anydeferredincome(fromtheinitialcashreceipt,ifany)isrecognisedintheincomestatement,aspartofthisnetgain(orloss).

E.4.3 Receipt of cash - swap is within the scope of IAS 39

Before maturity, the swap is measured at fairvaluewithanyfairvaluechangesrecognisedinprofitandloss,unlesshedgeaccountingisapplied.Anycashreceivedbeforetheswapmaturesisoffsetagainstthe fair value of the swap. When the swap matures, the difference between:• the total cash and the fair value of the

CERs received; and • thetotalofthecarryingvalueoftheemissionrightsgivenupandthefairvalueoftheswapgivenup

isrecognisedasagain(orloss).

E.4.4 Determining fair value

The fair value of the CERs is determined by referencetoanactivemarketforCERsor,ifnoactivemarketexists,onabasisthatreflectstheamounttheacquirerwouldhavepaidfortherightsinanarm’slengthtransactionbetweenknowledgeablewillingparties, based on the best information available.

E.4.5 Impact on net liability method

If the entity applies the net liability method toaccountforitsemissionrightsandobligations,theswapmayimpacttheliabilityrecognised.TheCERcannotbeconsideredagrantedrightandisinitiallyrecognisedatfairvalue.Therefore,iftheCERreplacesagrantedemissionright,theprovision must be increased by the relevant amount(refertosectionB.4)

E.5 Weather derivatives

Some contracts require a payment based onclimaticvariables(oftenreferredtoas‘weatherderivatives’)orongeologicalorother physical variables. Such contracts are within the scope of IAS 39, unless they meetthedefinitionofaninsurancecontract. Generic or standardised contracts willrarelymeetthedefinitionofinsurancecontractsbecausethevariableisunlikelytobespecifictoeitherpartytothecontract.The two different types of contracts are those that require a payment:• Onlyifaparticularleveloftheunderlyingclimatic,geological,orotherphysicalvariable adversely affects the contract holder. These are insurance contracts as definedinIFRS4

• Basedonaspecifiedleveloftheunderlyingvariable,regardlessofwhether there is an adverse effect on the contract holder. These are derivatives and within the scope of IAS 39.

If a weather derivative is within the scope of IAS 39, it must be measured at fair value,withchangesinfairvaluerecognisedinprofitorloss.


F Business combinations

Businesscombinationsisacomplexareaoffinancialreporting.Wehighlighttwoindustry-specificissuesinthissection:emissionrightsandreassessmentofembedded derivatives.

F.1 Emission rights acquired in a business combination

Theaccountingtreatmentforemissionrightsacquiredinabusinesscombinationmay be different.

In a business combination an acquirer must recognisetheacquiree’sidentifiableintangibleassets(includingemissionrights)attheirfairvalues,whenthatvaluecan be measured reliably. Therefore, any emissionrightsrecordedatnilintheacquiree’sfinancialstatementswillberecognisedatfairvalueintheacquirer’sconsolidatedfinancialstatements.Consequently, an acquirer cannot apply the netliabilityapproachtoemissionrightsacquired in a business combination, as the rightswerenotgrantedthroughagovernmentgrant.Instead,theacquirershouldtreatacquiredemissionrightsinthesamewayaspurchasedemissionrights.Anacquireemayapplyanaccountingpolicyinitsseparatefinancialstatementswherebyitsowngrantedemissionrightsaremeasuredatfairvalueandrecognisedeferred revenue. On consolidation, the deferred income must be reversed by the acquirerastheemissionrightswereacquired in a business combination rather thanbyagovernmentgrant.

Inaddition,anacquirercanonlyrecogniseaprovisionforitsacquiree’sactualemissions that have occurred up to the reportingdate(andnotforforecastemissions).Therefore,anacquirermayreportahigheremissionexpenseinitsincome statement in the compliance period in which it acquires a business.

Theemissionrightsheldbytheacquireerelatetospecificitemsofproperty,plant,and equipment. Therefore, entities must ensurethatthereisnodoublecountingoftherightsheldwhendeterminingthefairvalue of these assets.

Refer to section B.4 for more information aboutemissionrights.

F.2 Reassessment of embedded derivatives F.2.1 Reassessment of embedded derivatives – general

An initial assessment is made to determine whether an embedded derivative is closely related to its host contract. However, IAS39provideslittleguidancetodeterminewhether to revisit this initial assessment throughoutthelifeofthecontract.Therefore, the IFRIC published IFRIC 9 Reassessment of Embedded Derivatives. Consequently, entities must assess whether an embedded derivative needs to be separated from its host contract and accounted for as a derivative when the entityfirstbecomesapartytothe contract. IFRIC 9 also states that subsequentreassessmentisgenerallyprohibited. However, reassessment must occurifthereisachangeinthetermsofthecontractthatsignificantlymodifiesthecashflowsthatotherwisewouldberequiredunderit.Whendeterminingwhetherasignificantmodificationhasoccurred,anentityshouldconsidertheextenttowhichtheexpectedfuturecashflowsassociatedwith the embedded derivative, the host contractorbothhavechangedandwhetherthechangeissignificantrelativetothepreviouslyexpectedcashflowsonthecontract.

F.2.2 Reassessment of embedded derivatives in a business combination

IFRIC 9 does not deal with the acquisition of contracts with embedded derivatives in a business combination or their possible reassessment at the date of acquisition. However,IFRS3(asrevisedin2008)doesdeal with this issue. Therefore, until IFRS 3 (asrevisedin2008)isapplied,entitiescanmakeanassessmenttodeterminewhetherembedded derivatives are closely related to their host contracts at either:• The date of the business combination

based on the terms of the contract at that date; or

• Thedatetheacquiredentityfirstbecameparty to the contract unless the business combinationsignificantlymodifiesthecashflowsunderthecontract

Whichever policy is adopted should be applied consistently.

However,IFRS3(asrevisedin2008)requires the acquirer to assess the acquiree’scontractsbasedontheconditions as at the date of acquisition, as if the contracts themselves had been acquired.Therefore,theaccountingpolicychoice described above is removed.

Refer to section A.1.2 for more information on embedded derivatives.

34 Mastering the challenge: Practical IFRS guidance for power and utilities

Global IFRS Power & Utilities contacts

Gerd Lützeler GlobalIFRSPower&UtilitiesLeaderDirecttel:+49211935218614E-mail:[email protected]

Nabeel PabaniGlobal IFRS ServicesDirecttel:+442079511105E-Mail:[email protected]

BrazilAderbal HoppeDirecttel:+551125733476Email:[email protected]

Canada Ivan Robert Chittenden Directtel:+14169433110Email:[email protected]

China YanFengXieDirecttel:+861058153540Email:[email protected]

Czech Republic MartinSkacelikDirecttel:+420225335375Email:[email protected]

France Sophie Ganter Directtel:+33146934797Email:[email protected]

Germany Olaf Boelsems Directtel:+49403613217715Email:[email protected]

India RajAgrawalDirecttel:+911244644000Email:[email protected]

JapanNicolaSawakiDirecttel:+81335031100Email:[email protected] Netherlands Gerard van Santen Directtel:+31884075030Email:[email protected]

Norway Robert Madsen Directtel:+4724002102Email:[email protected]

Oceania Carolyn Pedic Directtel:+61392888358Email:[email protected]

PolandAnnaSirockaDirecttel:+48225577936Email:[email protected]

South East EuropeHelenNikandrouDirecttel:+302102886185Email:[email protected]

South KoreaJohnM.GallagherDirecttel:+82237876411Email:[email protected]

SpainFrancisco Rahola Carral Directtel:+34944243777Email:[email protected]

Switzerland Alessandro Miolo Directtel:+41582864654Email:[email protected]

United Kingdom David Coulon Directtel:+442079512248Email:[email protected]

United States KatrinaKimpelDirecttel:+12023278328Email:[email protected]

Mastering the challenge: Practical IFRS guidance for power and utilities

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