Education session—potential amendments to IFRS 9 (Agenda Paper 3)

In December 2023, the IASB tentatively decided to undertake a narrow-scope standard-setting project to amend IFRS 9 to address concerns about the accounting for power purchase agreements (PPAs). It was tentatively decided to explore an approach that includes amending the own use requirements and hedge accounting requirements. The purpose of this meeting was for the staff to share its preliminary views. The IASB was not asked to make any decisions.

PPAs and the own-use requirement

In general the own-use requirements work well for most contracts, however for PPAs, the challenge arises due to power being delivered to an entity and if the entity is not able to use the power within a short period, the power has to be sold back to the market at spot. The sale is not to profit from short term price fluctuations, but is still not consistent with the own use requirements. The staff considered that the accounting challenges could be resolved by adding application guidance to IFRS 9, explaining how the own use assessment is applied.

The staff suggested adding application guidance for non-financial items with the following characteristics:

• The supply/production of the item is weather (and location) dependant such that the timings and/or volume of the item supplied are not necessarily aligned with the demand for the item.
• The purchaser cannot avoid taking delivery of the non-financial item when produced due to the legal structure of the market the non-financial items is transacted in.
• The market structure requires any quantities of the items that an entity is unable to use within a specified short period following deliver, is put back into the market at the prevailing market rate at that point. For this purpose, the timing of any resulting sales are determined by the market structure and the entity has no control/discretion over the timing or price of resulting sales.

If a contract to buy a non-financial item has the above characteristics, the contract is and continues to be held for the entity’s expected purchase, sale or usage requirements only if:

• the purpose, design and structure of the contract is to ensure the supply of the non-financial item in quantities that are consistent with an entity’s expected own use requirements over the life of the contract. For example, a contract would fail the own use requirements if the entity contracted for more than its expected purchase requirements; and
• sales of the non-financial item shortly after delivery arising from short-term mismatches between supply and demand are not inconsistent with an entity’s own usage requirements if:
  • the contracted volumes over the remaining life of the contract are still based on the entity’s expected usage requirements;
  • the entity has used a volume of the non-financial item that is equal to, or more than, the volumes of the non-financial items delivered since inception of the contract; and
  • sales are not made to generate a profit from short-term fluctuations in the market price of the non-financial item.

In terms of disclosures for long-term PPA contracts that are not accounted for in accordance with IFRS 9 and subject to IFRS 7 the staff suggested adding the following disclosure objective: ‘to enable investors to understand the effect of the contracts on an entity’s future cash flows.’ Information disclosed will include the type of pricing, the price agreed in the PPA, the proportion of such contracts compares to total sales/purchases of the same non-financial item, the effect of the PPA on revenue and expenses during the period and an indication of the fair value of the contract at the reporting date.

IASB discussion

There were mixed views on creating application guidance to address PPAs. Some IASB members considered this as a clarification of the current guidance and therefore beneficial. In their view, the intent and economics of the PPA agreements were for own use and the accounting should follow suit. However, other IASB members considered that IFRS 9 has clear principles, and the IASB should not create exemptions for each challenge that is raised by stakeholders.

Overall, IASB members agreed that there is a market need in this area and that if the project scope is kept narrow then this issue could be addressed.

Some IASB members raised a concern with regard to the following requirement: ‘the entity has used a volume of the non-financial item that is equal to, or more than, the volumes of the non-financial items delivered since inception of the contract’. They considered that ‘equal or more than’ is too strict and a range might be more useful. The staff agreed to look at the wording in this area. The staff confirmed that the contract is a unit of account and cannot be separated into different components.

IASB members also raised the point that if storage for electricity is made possible, then this could impact the own use requirement.

In addition, IASB members raised concerns around disclosures. The staff noted that investors considered that recording these contracts at fair value would not necessarily provide useful information. However, they would still like some transparency around these contracts. IASB members highlighted the sensitivity around disclosing items such as ‘fixed price paid’, noting that companies would not want to disclose this information. IASB members also considered that companies would not want to disclose the effect on revenue and expenses in the absence of PPAs as this would be a hypothetical scenario. The Chair asked whether these disclosures are only for PPA contracts or would cover all own use contracts. The staff noted that for the purposes of this narrow scope project, it was only for PPAs. Other IASB members thought it might be worth considering these for all own use contracts.

An IASB member queried the use of the term ‘ensure’ in the following requirement: ‘the purpose, design and structure of the contract is to ensure the supply of the non-financial item in quantities that are consistent with an entity’s expected own use requirements over the life of the contract.’ He asked whether ‘making the supply highly probable’ would be a better term to use. The staff challenged that it is unlikely that an entity will be able to meet the highly probable requirement for each delivery of electricity.

Virtual PPAs (vPPAs) and hedge accounting requirements

The challenge focuses on how to designate the vPPAs as a hedging instrument in a cash flow hedging relationship that better reflect the results of the entity’s risk management strategy.

A vPPA (the hedging instrument) meets the definition of a derivative in IFRS 9 and is measured at fair value through profit or loss. Typically, the volume assumptions of vPPA for fair value measurement of these derivatives are based a probability of 50% (P50 estimate).

For a forecast transaction (the spot sale or purchase of electricity) to qualify as a hedged item, the identified transaction (or proportion of the transaction to be designated) has to be highly probable. Typically, in a hedging relationship, the uncertainty in the relationship comes from the price component changes. But in vPPAs, there is also uncertainty about the nominal amount as it can be variable. The staff has therefore focused on the determination of the component of the nominal amount and not the price component.

For both the forecasted sales and forecasted purchases, the designated volumes in the hedged item must prospectively achieve offset with the designated hedging instrument. As a result, the vPPA hedging relationship may not qualify due to the economic relationship requirement not being met.

The staff suggested further exploring potential amendments to the hedge accounting requirements including:

• Designation of a proportion (including 100%) of the total but uncertain volume of sales or purchases of non-financial items (with particular characteristics). For example, 90% of the total output sales of a facility (i.e. 90% of every sale) for a specified period.
• Designation of a quantity of forecasted sales or purchases that are expected (but not necessarily highly probable) to the extent that such volume is expected to be mirrored by the vPPA. Such designation would only relate to the volume and not the other terms of the vPPA. In other words, the hedged item will not simply replicate the terms of the vPPA.
• For the purpose of assessing the economic relationship, differences in assumptions between the hedged item and hedging instrument with regards to the expected vs highly probable volume do not cause a break in the economic relationship. However, for all other assumptions such as pricing assumptions the assessment continues to consider the possible behaviour over the hedged term.

IASB discussion

The staff highlighted that in the analysis volatility related to price was ignored and instead the focus was on volume uncertainty. The volatility in pricing has a true economic effect and should flow through the financial statements, however the volume volatility does not have an economic effect.

The staff also made it clear that the focus is on the purchaser side as there is less of an issue from the seller side. This is because the seller receives a fixed price for all the sales and the variability in volumes is matched by the vPPA.

Overall, IASB members were supportive of exploring a solution. IASB members highlighted that any change would have to be narrow and ring-fenced, and specifically for contracts with the same unique characteristics as described in the own use section. Unlike own use, this would create an exception to the hedge accounting principles.

The other option raised was to wait for the post-implementation review on the IFRS 9 hedge accounting requirements and analyse the overall principles for hedge accounting. However, this would be a longer term project.

The staff confirmed that this will only affect IFRS 9 and not IAS 39, as all questions received have been in the context of IFRS 9.