www.pwc.com/powerandutilities Financial reporting in the power and utilities industry International Financial Reporting Standards 2nd edition Foreword Of course, it is not just the IFRSs that International Financial Reporting are constantly evolving, but also the Foreword Standards (IFRS) provide the basis for operational issues faced by power and company reporting in an increasing utilities companies. We look at some of number of countries around the world. the main developments in this context Over 100 countries either use or are with a selection of reporting topics that adopting IFRS reporting. The pace of are of most practical relevance to power standard-setting from the International and utilities companies’ activities. Accounting Standards Board (IASB) has been intense in recent years, with a This publication does not seek to constant flow of changes for companies describe all IFRSs applicable to power to keep up with. and utilities entities. The ever-changing landscape means that management One of the biggest challenges of any should conduct further research and reporting standard is how best to seek specific advice before acting on interpret and implement it in the any of the more complex matters raised. context of a specific company or PwC has a deep level of insight into and industry. In general, IFRS is short on commitment to helping companies in industry guidance. PwC is filling this the sector report effectively. For more gap with a regularly updated series information or assistance, please do not of publications that take a sector- hesitate to contact your local office or by-sector look at IFRS in practice. one of our specialist power and utilities In this edition, we look at the issues partners. faced by utilities companies. We draw on our considerable experience of helping utilities companies apply IFRS effectively and we include a number of real-life examples to show how companies are responding to the various challenges along the value chain. Manfred Wiegand Norbert Schwieters Global Power & Utilities Leader Global Power & Utilities IFRS Group September 2011 Financial reporting in the power and utilities industry 3 Contents Introduction 7 1 Power and Utilities value chain and significant accounting issues 9 1.1 Overview 10 1.2 Generation 11 1.2.1 Fixed assets and components 11 1.2.2 Borrowing costs 11 1.2.3 Decommissioning obligations 13 1.2.4 Impairment 14 1.2.5 Arrangements that may contain a lease 15 1.2.6 Emission trading scheme and certified emission reductions 17 1.3 Transmission and distribution 19 1.3.1 Fixed assets and components 19 1.3.2 Customer contributions 20 1.3.3 Regulatory assets and liabilities 21 1.3.4 Line fill and cushion gas 21 1.3.5 Net realisable value of oil inventories 22 1.3.6 Network operation arrangements 22 1.4 Retail 23 1.4.1 Customer acquisition costs 23 1.4.2 Customer discounts 23 1.5 Entity-wide issues 23 1.5.1 Concession arrangements 23 1.5.2 Business combinations 24 1.5.3 Joint ventures 25 4 Financial reporting in the power and utilities industry 2 Financial instruments 29 Contents 2.1 Overview 30 2.2 Scope of IAS 39 30 2.3 Application of “own use” 32 2.4 Measurement of long-term contracts that do not qualify for “own use” 34 2.5 Take-or-pay contracts and volume flexibility (optionality) 35 2.6 Embedded derivatives 37 2.7 Hedge accounting 39 2.8 Trading and risk management 41 3 Future developments – standards issued and not yet effective 43 3.1 Overview 44 3.2 Consolidation and joint arrangements 44 3.2.1 Consolidation 44 3.2.2 Joint arrangements 44 3.3 Fair value measurement 47 3.4 Financial instruments 47 Appendices 53 A Financial statement disclosure examples 54 B US GAAP/IFRS differences 69 Acknowledgements 78 Contact us 79 Financial reporting in the power and utilities industry 5 Introduction Introduction What is the focus of this What is included? publication? This publication includes a discussion This publication considers the major of issues that we believe are of financial accounting practices adopted by the reporting interest due to their particular utility industry under International relevance to power and utility entities and/ Financial Reporting Standards (IFRS). or historical varying international practice. The need for this publication has arisen We focus our discussion not only on how due to the following factors: the transition to IFRS has affected the • The adoption of IFRS by power and power and utility industry, but also on how utility entities across a number of the industry is dealing with the following jurisdictions, with overwhelming factors: acceptance that applying IFRS in this • Significant growth in corporate industry will be a continual challenge acquisition activity • Ongoing transition projects in a • Increased globalisation number of other jurisdictions, from • Change in political landscape towards which companies can draw upon the sustainability and renewable energy often existing interpretations of the industry leading towards more regulation • Continued increase in its exposure to sophisticated financial instruments Who should use this publication? and transactions • An increased focus on environmental and This publication is intended for: restoration liabilities • Executives and financial managers in the power and utility industries who are often faced with alternative accounting PwC experience practices • Investors and other users of power and This publication is based on the experience utility industry financial statements, gained from the worldwide leadership so they can identify some of the position of PwC in the power and utility accounting practices adopted to reflect industry. This leadership position enables unusual features unique to the industry PwC’s Global Power & Utilities Centre of • Accounting bodies, standard-setting Excellence to make recommendations and agencies and governments throughout lead discussions on international standards the world interested in accounting and and practice. reporting practices and responsible for establishing financial reporting We hope you find this publication useful. requirements Financial reporting in the power and utilities industry 7 1 Power & Utilities value chain and significant accounting issues Power 1 Power & Utilities value chain and significant accounting issues Financial reporting in the power and utilities industry 9 1 Power & Utilities value chain and significant accounting issues 1.1 Overview businesses may be split by regulation into generation, transmission, distribution and retail businesses. A traditional integrated power entity (utility) generates Competition may then be introduced for the generation electricity and sends it around the country or region via and retail segments. Generators will look to compete high-voltage transmission lines, finally delivering it to on price and secure long-term fuel supplies, balancing customers through a retail distribution network. Some this against potentially volatile market prices for utilities also or exclusively transport water and/or gas. wholesale power. The distribution business may see As the industry continues to evolve, many operational the incumbent operator forced to grant other suppliers and regulatory models have emerged. Generators access to its network. Power customers are beginning continue to diversify supplies; fossil fuels still dominate to behave like any other group of retail customers, but there is an increasing focus on bio-fuels, co- exercising choice, developing brand loyalty, shopping generation and renewable sources such as wind, solar for the best rates or looking for an attractive bundle and wave power. Some governments are supporting of services that might include gas, phone, water and the construction of new nuclear power plants, and internet as well as power. in some countries, construction has already started; other governments are reconsidering or reversing their The power and utility industry is highly regulated, support in response to the Fukushima event. with continuing government involvement in pricing, security of supply and pressure to reduce greenhouse The regulatory environment can be complex and gas emissions and other pollutants. Add this to a challenging and may differ between geographies background of increased competition and a challenging or even within a country. Pressure to introduce financial environment and difficult accounting issues and increase competition and to diversify supply is result. This publication examines the accounting issues apparent, as well as schemes that create financial that are most significant for the utilities industry. The incentives to reduce emissions and increase the issues are addressed following the utilities value chain: use of renewable sources. Previously integrated generation, transmission and distribution and issues that affect the entire entity. Power and Utilities Value Chain and Significant Accounting Issues • Fixed assets and components • Fixed assets and components • Customer acquisition costs • Borrowing costs • Customer contributions • Customer discounts • Decommissioning obligations • Regulatory assets and liabilities • Impairment • Line fill • Arrangements that may contain a lease • Network operation agreements • Emission trading scheme and CER • Regulatory assets and liabilities Generation Transmission & Distribution, Transport Retail Support Functions/Trading and Risk Management • Concession arrangements • Business combinations • Joint ventures • Financial instruments • Lease arrangements • Trading and risk management 10 Financial