The challenges of accounting for nature-dependent power purchase agreements

As we’ve discussed previously, the consistent application of accounting standards can be challenging when markets and/or products change over time in ways unanticipated by the standard setters. In such circumstances, auditors and preparers have to interpret and apply accounting standards that weren’t necessarily written with an entity’s products or service’s particular circumstances or features in mind. While there is an applicable accounting standard, the definitions, criteria and/or reporting requirements it contains don’t entirely match up with the key features of the transaction or event.

A good example of this was the recent discussion around, and subsequent amendments to the accounting requirements for contracts referencing nature-dependent electricity (CRNEs).

Background

In December 2024, the IASB issued Contracts Referencing Nature-dependent Electricity, which amended IFRS 9 Financial Instruments and IFRS 7 Financial Instruments: Disclosures to provide some targeted financial reporting relief to entities regarding CRNEs.

The catalyst for the IASB’s deliberations on CRNEs was a submission to the IASB’s Interpretation Committee (IFRIC) about the application of paragraphs 2.4-2.6 of IFRS 9 to:

• Power purchase agreements (PPAs) for renewable energy, and 
• Virtual PPAs if the customer takes delivery of the renewable energy certificates (RECs) associated with the counterparty’s electricity generation.

Specifically, whether they qualify for the own use exemption under IFRS 9 and therefore qualify to be treated as an executory contract.     

What is the own use exemption

Paragraph 2.4 clarifies that IFRS 9 must be applied to those contracts to buy or sell a non-financial item that can, among other things, be settled net in cash. However, IFRS 9 is not applied to contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements.

Issue 1: PPAs for renewable energy

The submission to the IFRIC outlined three separate fact patterns, two of which related to PPAs with the following common features: 

• An entity enters a long-term contract to acquire a fixed amount of energy from a renewable energy source over the term of the contract
• As a consequence of: (i) the continuous nature and variable production of renewable energy; (ii) the ‘9am-5pm weekday’ electricity demands of the entity; and (iii) the volatile nature of electricity, mismatches between the demand profile of the entity and the supply profile of the electricity producer would often arise, and 
• To deal with any mismatches in demand and supply of electricity, and in the absence of feasible options to store the electricity, the excess supply is automatically fed into the electricity grid and sold to third parties. 

Questions asked

The submitter was seeking clarification as to whether it could apply the own use exemption to PPAs for renewable energy supply with these features (and therefore treat them as executory contracts rather than financial instruments), notwithstanding that there was likely to be:

• Netting of cash flows between the contracting parties as a consequence of excess electricity supply being fed back into the electricity grid, and
• Gains and losses realised by the entity due to differentials in the cost of the excess electricity supplied under the contract vis-à-vis the price attributed to the sales by the electricity supplier or other party.

IFRIC observations

Based on stakeholder feedback, the IFRIC noted that the fact patterns were relatively common across many jurisdictions, accounting for these fact patterns has a material effect on the financial statements of parties to CRNEs if required to be accounted for under IFRS 9, and there is diversity in accounting practices on CRNEs across jurisdictions. 

Stakeholder feedback also noted a number of challenges with applying the requirements in paragraphs 2.4-2.6 of IFRS 9 to PPAs for renewable energy supply. These include how to interpret what is meant by ‘similar contracts’, ’short period after delivery’ and ‘expected purchase, sale or usage requirements’, as well as whether CNREs can be ‘bifurcated’ between a portion that meets the own use criteria and a portion that could be accounted for under IFRS 9. 

Issue 2: Virtual PPAs

Other application issues noted by stakeholders in the IFRIC submission related to virtual PPAs and whether they meet the own use exemption in IFRS 9 (and therefore qualify to be treated as an executory contract) if the customer takes delivery of the renewable energy certificates (RECs) associated with the counterparty’s electricity generation.

The IFRIC’s deliberations on these issues are particularly relevant to the Australian context. The IFRIC staff noted that the financial reporting implications for entities treating PPAs as financial instruments with ‘contract for difference’ (derivative) components are more significant in jurisdictions with ‘gross pool’ electricity markets, such as Australia.

Gross pool electricity markets

In gross pool electricity markets, all purchases and sales of electricity are cleared through a market operator on a gross basis, without the market operator taking delivery or on-selling electricity.

In Australia, the Australian Energy Market Operator (AEMO) is the market operator for Eastern Australia (including South Australia) and Western Australia, and in the Northern Territory the market operator is the Northern Territory Electricity System and Market Operator (NTESMO).

All sales and purchases of electricity in the Australian wholesale electricity market are settled at spot prices via the relevant market operator acting as a clearing house. Accordingly, in Australia, as with other jurisdictions with gross pool electricity markets, electricity contracted for under a PPA is never considered to be physically delivered to the electricity customer, and any difference between the fixed price in the PPA and the spot price is always settled net (rather than the contract being settled physically) between the electricity generator and the customer.

Rather than attempting to resolve the issue with an Interpretation, the IFRIC recommended the IASB consider undertaking a narrow-scope standard-setting project to address the application of paragraph 2.4 of IFRS 9 to PPAs. The IASB commenced this process in December 2023, culminating in the publication of amendments to IFRS 9 for Contracts Referencing Nature-dependent Electricity in December 2024.

In future editions of Corporate Reporting Insights, we will take a closer look at the changes arising from the IASB’s amendments to IFRS 9 and IFRS 7 and their accounting implications for CRNEs in the Australian context.

Need assistance?

You can find more information about accounting for PPAs in our webinar. If you need assistance accounting for PPAs, reach out to our IFRS & Corporate Reporting team for help.