Accounting for contracts referencing nature-dependent electricity: New IASB amendment
IASB introduces new guidance for contracts that have exposure to variability in electricity supply
Swiss companies are increasingly entering into "green" Power Purchase Agreements (PPAs) to reduce their carbon emissions to net zero. Variability arises from these PPAs because the source of electricity production depends on uncontrollable natural conditions, e.g., weather conditions. To address the accounting challenges posed by such contracts, the International Accounting Standards Board (IASB) has introduced new amendments to the IFRS Accounting Standards effective from 1 January 2026.1
This article explains the key aspects of the IASB amendments, their practical implications for companies, and how Swiss companies can prepare for these changes.
Introduction to Power Purchase Agreements (PPAs) in the Context of Net Zero
To align with the Federal Council's objective of achieving net-zero greenhouse gas emissions by 20502, Swiss companies are reevaluating their energy procurement strategies with the aim of reducing their carbon emissions and attaining carbon neutrality. Key concerns in this context include supply security, affordability, and the renewable nature of electricity sources. Power Purchase Agreements (PPAs) often represent an efficient and reliable option for energy procurement. However, the emergence of new products and technologies, along with the consequences of high energy prices, is creating uncertainties in the accounting treatment of these contracts.
PPAs are typically long-term electricity supply contracts3 between a seller and a buyer, whereby the electricity is sourced from renewable energy facilities. They allow buyers to secure "green" electricity over the long term, enabling price stability while supporting the expansion of renewable generation facilities. PPAs also offer buyers an opportunity to reduce their carbon emissions and implement their transition plans to net zero effectively. Typically, PPAs include "pay-as-produced" features, where the electricity producer's volume risk is transferred to the electricity buyer. Rather than receiving a fixed nominal quantity, the buyer receives a share of the actual electricity generated (e. g., 40% of the out¬put from a solar farm).
Key Challenges:
Buyers have experienced challenges when applying the requirements of IFRS 9 Financial Instruments to physical delivery contracts4 for renewable energy purchases. This is due to:
- the characteristics of renewable electricity production sources and the design and operation of the market in which the electricity is sold;
- the fact that the "pay-as-produced" features require the purchaser to buy electricity generated from a reference production facility at the time it is produced. These features expose the purchaser to essentially all the risk that the volume of electricity produced may not match the purchaser's demand at the time of production.
PPA-related risks and accounting can be complex. Depending on the structure of the contract(s), the impact on the financial statements may be substantial. In response to certain accounting challenges posed by IFRS 9, the International Accounting Standards Board (IASB) published amendments to IFRS 9 Financial Instruments and IFRS 7 Financial Instruments: Disclosures titled Contracts Referencing Nature-dependent Electricity on 18 December 2024.
The amendments aim to enable entities to include information in their financial statements that, according to the IASB, more faithfully represent contracts referencing nature-dependent electricity. This article explains the IASB amendments and highlights practical considerations for entities affected by these changes.
Scope of the IASB amendments
The amendments to IFRS 9 and IFRS 7 apply to contracts referencing nature-dependent electricity. These contracts are characterised by contractual features exposing an entity to variability in the underlying quantity of electricity, as the electricity is generated from sources dependent on uncontrollable natural conditions. This variability is typically associated with renewable energy sources, such as sun and wind power. For instance, solar electricity generation fluctuates according to uncontrollable natural factors like daylight availability and weather conditions such as cloud cover. Contracts referencing nature-dependent electricity encompass both contracts to purchase or sell nature-dependent electricity (i. e., physical delivery PPAs) and financial instruments that reference such electricity (i. e., virtual PPAs5).
Own-use exemption clarified
Some contracts referencing nature-dependent electricity require an entity to buy and take delivery of the electricity when it is generated. These contractual features expose the entity to the risk of being obliged to buy electricity during a delivery interval when it cannot use the electricity. Furthermore, the entity might lack the practical ability to avoid selling unused electricity, as the design and operation of the electricity market in which the contract is executed may require any unused electricity to be sold within a specified timeframe.
The new application guidance clarifies that, when an entity applies the own-use requirements in IFRS 9:2.47, such sales are not necessarily inconsistent with the contract being held in accordance with the entity's expected usage requirements. An entity enters into and continues to hold such a contract in accordance with its expected electricity usage if the entity has been, and expects to remain, a net purchaser of electricity for the contract period. An entity is considered a net purchaser of electricity if it buys sufficient electricity to offset the sales of any unused electricity within the same market where the electricity was sold.
The IASB included the "reasonable amount of time" requirement to ensure that an entity selling unused electricity purchases at least an equivalent amount of electricity in good time. The IASB intends for a "reasonable amount of time" to represent a short period. In the exposure draft (ED), the IASB gave one month as an example of what may be considered a reasonable amount of time. However, the IASB acknowledged that factors such as the seasonal cycle of the natural source of electricity generation and the cyclicality of an entity's operations might influence the period needed to offset sales with purchases. The IASB therefore decided to set a maximum period of 12 months, which it considers to represent a full cycle.
Hedge accounting requirements
Some contracts referencing nature-dependent electricity may be designated as hedging instruments in hedges of forecast electricity transactions. For such hedging relationships, the amendments permit an entity to designate as the hedged item a variable nominal amount of forecast electricity transactions that aligns with the variable amount of nature-dependent electricity expected to be delivered by the generation facility as referenced in the hedging instrument. All other hedge accounting requirements in IFRS 9, including the requirement to formally document the hedging relationship, continue to apply to such arrangements.
If the cash flows of a contract referencing nature-dependent electricity, designated as the hedging instrument, are conditional on the occurrence of a forecast transaction designated as the hedged item in accordance with the amendments, that forecast transaction is presumed to be highly probable.
The amendments also include an illustrative example demonstrating one possible approach for an entity to designate forecast electricity purchases as the hedged item with a variable nominal amount in a cash flow hedge, in accordance with the newly added requirements in IFRS 9.
The IASB acknowledged that, in a hedge of variable electricity sales hedge ineffectiveness caused by volume uncertainty should not arise, as the volume of sales and the volume of electricity covered by the contract referencing nature-dependent electricity are typically fully aligned. As a result, such alignment does not create hedge ineffectiveness due to volume mismatches from an economic perspective. However, the IASB noted that hedge ineffectiveness for forecast electricity transactions could originate from other sources, particularly in the case of electricity purchases. Therefore, under the amendments, to determine hedge ineffectiveness, an entity would include in the measurement of both the hedged item and the hedging instrument any pricing differences or other differences that represent actual economic effects.
Disclosures
Under the amendments, an entity is required to disclose, in a single note to its financial statements, information about contracts to buy nature-related electricity that meet the own-use requirements under IFRS 9. Specifically, the entity must disclose information that enables users of the financial statements to understand the effects of these contracts on the amount, timing, and uncertainty of its future cash flows, and on its financial performance. To meet these objectives, the entity is required to disclose:
1.Information about contractual features that expose the entity to:
- variability in the underlying amount of electricity;
- the risk that the entity would be required to buy electricity during a delivery interval in which the entity cannot use the electricity.
2. Information about unrecognised commitments arising from such contracts as at the reporting date, including:
- the estimated future cash flows from buying electricity under these contracts;
- qualitative information about how the entity assesses whether a contract might become onerous, including the assumptions the entity uses in making this assessment.
3. Qualitative and quantitative information about effects on the entity's financial performance for the reporting period, in particular:
- the costs arising from purchases of electricity made under the contracts, disclosing separately how much of the purchased electricity was unused at the time of delivery;
- the proceeds arising from sales of unused electricity;
- the costs arising from purchases of electricity made to offset sales of unused electricity.
For contracts to purchase or sell nature-related electricity that have been designated as part of a cash flow hedging relationship, an entity is required to disaggregate the disclosed information by risk category, in accordance with IFRS 7:23A, regarding the terms and conditions of the hedging instruments.
If an entity discloses information about other contracts referencing nature-dependent electricity entered into in relation to its electricity purchases (regardless of whether these contracts meet the own-use exemption under IFRS 9) in other notes within its financial statements, the entity must include cross-references to those notes in the single note mentioned above.
Effective date and transition
The amendments are effective for annual periods beginning on or after 1 January 2026, with earlier application permitted.
The amendments to the own-use exemption in IFRS 9 are required to be applied retrospectively in accordance with IAS 8, based on the facts and circumstances at the date of initial application (i. e., the date when an entity first applies the amendments). The date of initial application is the beginning of a reporting period, which might differ from an annual reporting period.
An entity is not required to restate prior periods to reflect the application of these amendments but is permitted to do so if it can be achieved without the use of hindsight. If the entity does not restate prior periods, it is required to recognise any difference between the previous carrying amount and the carrying amount at the date of initial application of these amendments in the opening retained earnings (or other component of equity, as appropriate) at the beginning of that reporting period.
If a contract referencing nature-dependent electricity falls outside the scope of IFRS 9 as a result of applying the amendments to the own-use requirements, an entity is permitted, at the date of initial application, to irrevocably designate this contract as measured at fair value through profit or loss in accordance with IFRS 9:2.5.
An entity is required to apply the amendments to the hedge accounting requirements prospectively to new hedging relationships designated on or after the date of initial application. An entity is permitted, at the date of initial application, to discontinue a hedging relationship in which a contract referencing nature-dependent electricity has been designated as the hedging instrument, if the same hedging instrument is designated in a new hedging relationship in accordance with the amendments.
|
|
|
|---|---|
|
Own use exemption |
|
|
Hedge accounting |
|
|
Disclosures |
|
Conclusion
As Swiss companies continue their efforts to reduce carbon emissions and achieve carbon neutrality, they are increasingly entering into contracts referencing nature-dependent electricity, e.g., solar or wind power, which depend on uncontrollable weather conditions. The variability inherent in electricity production has created challenges in accounting for these contracts, which the IASB has addressed through recent amendments. Swiss companies face practical considerations when adopting these amendments, including whether their PPAs depend on uncontrollable natural conditions and determining whether they qualify as a net purchaser of electricity eligible for the own-use exemption. Given that PPAs are not standardised but individually structured in various ways, a detailed analysis of each contract's specific circumstances is essential to assess whether the criteria for applying the own-use exemption or for designation as a hedging instrument are met. We expect the market for PPAs in Switzerland to grow in the coming years and recommend that companies carefully evaluate the accounting treatment of these contracts.
