Applying IFRS in Power & Utilities

IASB proposed standard

The revised revenue

recognition proposal
power and utilities
March 2012

2011 Europe, Middle East, India and Africa

tax policy outlook

Introduction
The revised revenue recognition proposal issued by the
International Accounting Standards Board (IASB) and the
Financial Accounting Standards Board (FASB) (collectively, the
Boards) could result in changes in current practice for the timing
and amount of revenue recognition for power and utilities (P&U)
entities. In particular, we focus on the following key areas in this
publication:
Accounting for contract modifications
Assessing whether goods and services are distinct and

identifying separate performance obligations

Allocating the transaction price for power purchase

arrangements and other long-term utility contracts

Take-or-pay arrangements

The issues discussed here are intended to provoke thought and

to assist entities in formulating ongoing feedback to the Boards
that can help in the development of a high-quality final
standard. Nevertheless, these discussions do not represent
our final or formal views as the elements of the Exposure Draft
(ED) are subject to change and additional issues may be
identified on further deliberations by the Boards before a final
standard is issued.
This publication supplements the more comprehensive analysis
of the revised revenue recognition proposal, which is discussed
in our publication entitled Revenue from contracts with
customers the revised proposal (general Applying IFRS). Our
general Applying IFRS also highlights some issues for entities
to consider in evaluating the impact of the ED and some of the
expected changes to current IFRS.

What you need to know

The IASB and the FASB have issued a second exposure draft of

their converged revenue model that is closer to current IFRS

and US GAAP than their 2010 proposal.
The proposed model would apply to revenue from contracts with

customers and would replace all the revenue standards and

interpretations in IFRS, including IFRIC 18 Transfers of Assets
from Customers
Although the proposed model is not expected to have a

significant impact on many transactions within the industry,

the effect on certain arrangements that are common for P&U
entities is still unclear.
The proposal will significantly increase the volume of financial

statement disclosures.
The IASB and FASB will hold outreach events to gather

feedback. P&U entities should review the proposal and share

any concerns with the IASB and FASB.

Contents
Overview and scope

Contracts in the scope of multiple IFRSs

Collaborative arrangements

Step 1: Identify the contract(s) with a customer

Existence of a contract

Contract modifications

Step 2: Identify the separate performance obligations

Green or renewable certificates

Long-term service arrangements

Step 3: Determine the transaction price

Variable consideration

Contributions from customers and upfront fees

10

Time value of money

11

Step 4: Allocate the transaction price to separate performance obligations

11

Determining the standalone selling price

11

Contingent consideration

14

Step 5: Recognise revenue when the entity satisfies each performance obligation

15

Performance obligations satisfied over time

15

Constraining the cumulative amount of revenue recognised

16

Other recognition and measurement concerns

16

Take or pay arrangements

16

Onerous performance obligations

18

Disclosures 18
Next steps

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

18

Overview and scope

The Boards proposal specifies the accounting for all revenue
arising from contracts with customers and affects all entities that
enter into contracts to provide goods or services to their
customers, unless those contracts are in the scope of other IFRS
requirements.
The principles in the proposed standard would be applied using the
following five steps:
1. Identify the contract(s) with a customer
2. Identify the separate performance obligations in the
contract(s)
3. Determine the transaction price
4. Allocate the transaction price to the separate performance
obligations
5. Recognise revenue when the entity satisfies each
performance obligation
The proposed standard would also apply to the measurement and
timing of the recognition of gains and losses on the sale of certain
non-financial assets, such as property, plant and equipment.
Under the proposal, entities would need to exercise judgement
when considering specific facts and circumstances reflected in the
written and implied terms of contracts with customers. Entities
would also have to apply the requirements of the proposal
consistently to contracts with similar characteristics and in similar
circumstances. A complete discussion of the proposed standard
related to accounting for contract(s) with a customer can be found
in Applying IFRS: Revenue from contracts with customers the
revised proposal (January 2012) (general Applying IFRS).1
The Boards are proposing that entities adopt the new standard
retrospectively for all periods presented in the period of adoption,
although the ED provides some limited relief from full retrospective
adoption. We expect the effective date would be no earlier than
annual periods beginning on or after 1 January 2015. The Boards
will determine the exact date of adoption during further
redeliberations.

Contracts in the scope of multiple IFRSs

P&U entities often enter into transactions that would be partially
within the scope of the proposed revenue recognition standard and
partially within the scope of another standard (i.e., embedded
derivatives, leases and service concessions).
Generally, entities entering into transactions that fall within the
scope of multiple accounting standards currently separate those
transactions into the individual elements to account for them under
the respective standard(s). The ED does not propose to change this
practice. However, the ED does clarify that any separation and
measurement guidance in other applicable IFRSs takes precedence
over the model in this ED. Accordingly, if the other standard does
not specify how to separate and/or initially measure any parts of
the contract, the entity would apply the proposed standard to
separate and/or initially measure those parts of the contract.
A further consideration is the interaction between the proposed
revenue recognition model and the proposed lease model. Although
the criteria for determining what is or is not a lease are not
expected to change significantly under the proposed leasing ED,
this assessment will take on increased importance as operating
leases are moved onto the balance sheet.
The current accounting for operating leases and service contracts
is often similar. Therefore, entities may not have differentiated
arrangements which were service contracts and operating leases.
Consequently, it is possible that not all embedded leases that exist
within arrangements have been identified, extracted and/or
accounted for as such.

How we see it
Given the proposed accounting for operating leases is expected
to be completely different from current standards, the
assessment of whether an arrangement is a service contract or
an operating lease will have significantly different accounting
implications. As a result, P&U entities may need to evaluate
current and future contracts more closely.

1 Available at ey.com/ifrs.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

If each party has the unilateral right to terminate a wholly

unperformed contract without compensating the counterparty,
then the proposed standard states that a contract does not exist
and its accounting and disclosure requirements would not apply.

Collaborative arrangements
The ED also explains that a counterparty to a contract may not
always be a customer. Instead, the counterparty may be a
collaborator or partner that shares in the risks and benefits of
developing a product to be sold. Contracts with collaborators or
partners are sometimes observed in the P&U industry. For example,
where two parties collaborate in the development and operation of
a power plant and one of the parties in the arrangement purchases
an amount of the power produced.
The Boards indicated that revenue could be recognised from
transactions with partners or participants in a collaborative
arrangement only if the other party to the arrangement meets the
definition of a customer. However, the Boards decided not to
provide further guidance to clarify whether parties to these
arrangements would meet the definition of a customer.
In the Basis for Conclusions to the ED, the Boards explain that it
would not be possible to provide application guidance that applies
to all collaborative arrangements. Therefore, the parties to
the arrangement would need to consider all of the facts and
circumstances to determine whether a supplier/customer
relationship exists that would be subject to the proposed standard.

How we see it
The proposed standard is clear that contracts amongst
collaborators in which the counterparty is not a customer
are out of the scope of the proposed standard. As no
new application guidance is being provided for these
arrangements, we believe that entities will likely reach similar
conclusions as today about whether a contract is a revenuegenerating transaction or an arrangement with a collaborator
or a partner. Many entities account for those transactions in
accordance with, or by analogy to, the current revenue
recognition standards. However, it is not clear if the removal
of these transactions from the scope of the revenue standard
would prohibit companies from using the revenue standard
by analogy.

Step 1: Identify the contract(s)

with a customer
To apply the proposed model, an entity must first identify the
contract, or contracts, to provide goods and services to its
customer. Any contracts that create enforceable rights and
obligations would fall within the scope of the proposed standard.
The enforceable rights and obligations may be written, oral or
implied by the entitys customary business practice.
Generally, the step for identifying the contract with the customer
would not differ significantly from current practice in
the P&U industry. For example, the proposed requirement for
combining two or more contracts entered into with the same
customer at, or near, the same point in time into a single contract
for accounting purposes is consistent with existing standards.
However, there could be differences for P&U entities in determining
whether a contract exists, as well as the accounting for contract
modifications.

Existence of a contract
Termination clauses are an important consideration when
determining whether a contract exists for the P&U industry. Any
arrangement in which the vendor has not provided any of the
contracted goods or services and has not received, or is not entitled
to receive, any of the contracted consideration is considered to be
a wholly unperformed contract. If each party has the unilateral
right to terminate a wholly unperformed contract without
compensating the counterparty, then the ED states that a contract
does not exist and its accounting and disclosure requirements
would not apply.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Illustration 1 Wholly unperformed supply contract

Entity A enters into a one-year contract to supply electricity
to Customer B at a monthly fixed price per megawatt hour
(MWh). If the contract does not include a minimum contracted
volume that Customer B is required to purchase, and there is
no penalty within the contract for non-delivery by Entity A or
non-purchase from Customer B, then the contract would be
considered to be a "wholly unperformed" contract.

Illustration 2 Supply contract with obligation to

perform
Entity A enters into a one year contract to supply electricity
to Customer B at a monthly fixed price per MWh. Entity A is
obligated to provide electricity to Customer B if it should
request these volumes. However, Customer B is obligated to
pay a significant penalty if it changes electricity providers.
As Entity A does not have the unilateral right to terminate the
contract and Customer B is required to pay compensation for
termination, the contract would be in scope of the ED.

Contract modifications
Contract modifications are a common occurrence in the P&U
industry. In many cases, the modification will extend the period
of the contract combined with changing the contract price. For
example, a P&U entity might decide to extend the period of a
contract and create a blended price for the remaining units of the
extended contract period. In some cases, this blended price would
reflect the pricing for the remaining undelivered units in the
original contract combined with a separate price for the additional
units added to the contract. In other cases, there may be additional
factors used in determining the modified contract price.

When a contract is modified, entities would first need to determine

if the contract modification represents a separate contract or a
modification of the existing contract when additional goods or
services are to be provided. A contract modification is deemed to
be a separate contract if both of the following criteria are met:
The additional goods or services are distinct

And
The price of the additional goods or services reflects the

standalone selling price and any appropriate adjustments to that

price to reflect the circumstances of the particular contract
If it is determined that the modification is not a separate contract,
an entity would account for the effects of these modifications
differently, depending on which of the following scenarios is
most applicable:
1. The goods and services not yet provided are distinct from the
goods and services provided before the modification of the
contract.
2. The goods and services not yet provided are not distinct from
the goods and services provided before the modification of the
contract (i.e., all promised goods are part of a single
performance obligation).
3. The goods and services not yet provided are a combination of
1 and 2 above.
Contract modifications that modify or remove previously agreed to
goods and services would not be treated as separate contracts.
However, as long as the modified goods and services are distinct
from the goods and services provided before the modification, the
entity would treat the contract modification as the termination of
the old contract and the creation of a new contract for all remaining
unsatisfied performance obligations.
Although this may sound straight forward, the assessment of
modifications could require the application of judgement,
particularly in determining whether the additional consideration
reflects the standalone selling price of the additional goods or
services. This is illustrated in the example on the following page.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Illustration 3: Energy contract extension

Entity C has a contract to supply 100,000 MWh of energy per year to Customer D for the next 10 years at a fixed price of CU 55/MWh.
After 5 years have elapsed, Entity C and Customer D agree to extend the contract by an additional 5 years. The price per unit for the
remaining 10 years of the modified contract will now be CU 65/MWh.
Entity C has determined that each individual MWh is a distinct performance obligation under the original contract and the current spot
price represents the separate standalone selling price for each unit delivered (see Steps 2 and 4 below for further discussion).
Scenario 1: The modified price was based on blending the original contract price for the remaining years 6 to 10 (CU 55/MWh) with the
market price for the additional volumes from years 11 to 15 (CU75/MWh).
Years 6-10 pricing:

100,000 MWh x 5 years x CU 55/MWh

CU 2,750,000

Years 11-15 pricing:

100,000 MWh x 5 years x CU 75/MWh

CU 3,750,000
CU 6,500,000

The remaining contract consideration of CU6,500,000 is divided by the undelivered volumes in the modified contract of 1,000,000 MWh
(100,000 x 10 years) resulting in the revised contract price of 65/MWh.
In this scenario, the modification results in additional volumes of 500,000 MWh (100,000 x 5 years) for the added period of years 11-15
and additional consideration of CU 3,750,000. The additional consideration resulting from the modification reflects the market price of
the additional goods to be delivered. As such, the entity could view this additional consideration to represent the standalone selling price
of the additional 500,000 MWh to be delivered as a result of the modification. Under this view, the modification would be accounted for
as a separate contract.
This would result in the following revenue recognition profile (ignoring the impact of the time value of money discussed in Step 3 below):
Contract period
Years 1-5

Volumes
(10,000 x 5 years)

Allocated
price (CU/MWh)

Revenue
recognised (CU)

Contract cash
flow (CU)

Accrued (deferred)
revenue (CU)

500,000

55

27,500,000

27,500,000

Years 6-10

500,000

55

27,500,000

32,500,000

(5,000,000)

Years 11-15

500,000

75

37,500,000

32,500,000

92,500,000

92,500,000

1,500,000

Scenario 2: The additional consideration resulting from the contract modification was not based on the standalone selling price of the
additional units, but instead, the pricing includes a discount for other factors (i.e., a discount in recognition of the significant volumes
that will be delivered under the modified contract). In this scenario, the modification would not be considered a separate contract. In
effect, the entity would account for the contract modification as a termination of the original contract and the creation of a new contract.
This would result in the following revenue recognition profile for Entity C:
Volumes
(10,000 x 5 years)

Allocated
price (CU/MWh)

Revenue
recognised (CU)

Contract
cash flow (CU)

Accrued (deferred)
revenue (CU)

Years 1-5

500,000

55

27,500,000

27,500,000

Years 6-10

500,000

65

32,500,000

32,500,000

Years 11-15

500,000

65

32,500,000

32,500,000

92,500,000

92,500,000

Contract period

1,500,000

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

The scenarios on the previous page illustrate when the contract

modification relates to goods and services that are distinct from
those previously provided under the contract and each individual
MWh is a separate performance obligation. If the goods or services
in the modified contract are not distinct from goods or services
previously provided under the contract, an entity must account
for the modification as if it were part of the original contract.
The result would be allocating a portion of the change in
compensation from the modified contract to goods or services that
have already been provided (i.e., changing the amount of revenue
previously recognised). This could mean recording a cumulative
catch-up entry to either increase or decrease prior period revenue
recognised, depending on whether the modified contract
compensation is higher or lower than the original contract.

How we see it
There is variability in how the contract modification rules within the
ED should be applied by P&U entities. Basic considerations, such as
determining the performance obligation within the contract, could
significantly impact the accounting. In addition, significant
judgement would need to be applied in determining whether the
additional consideration resulting from the modification reflects
the entitys standalone selling price for the additional volumes (plus
any appropriate adjustments to that price to reflect the facts and
circumstances of that particular contract).
Another modification that could occur for P&U entities is when the
parties change the contract pricing for the remaining contract
period without modifying the goods or services to be delivered
under the contract (i.e., no changes in the scope of the contract).
This type of modification may involve a payment from the
counterparty as a result of the modification.
While the amounts allocated to performance obligations would be
updated to reflect changes in the estimated transaction price as
goods and services are delivered, the standalone selling prices used
to perform the allocation would not be updated to reflect changes
in the standalone selling prices after contract inception. This means
that changes in the total transaction price would be allocated to the
separate performance obligations on the same basis as the initial
allocation.
The proposed model would require contingent consideration
associated with a modification to be allocated entirely to a distinct
good or service if certain criteria are met. This can have significant
implications depending on how the contract is modified.

The following example illustrates some of the considerations that

would be made when only the transaction price of a contract is
modified.

Illustration 4 Modification of the pricing of a power

contract
Entity E enters into a 10-year power purchase arrangement
with Customer F to deliver 100,000 MWh/year at a fixed price
of CU 60/MWh. Assume that Entity E determines that each
individual MWh is a distinct performance obligation under the
original contract and the standalone selling price is determined
based on the spot rate (see Steps 2 and 4 below for further
discussion). As a result, each MWh is allocated CU 60 of the
transaction price.
After 5 years, Entity E has delivered 500,000 MWh (100,000
MWh x 5 years) and recognised revenue of CU 30,000,000
(500,000 MWh x CU 60/MWh) under the contract. Customer F
decides that it would like to unwind its fixed price power
purchase arrangement to change to a market price. Entity E
agrees to modify the contract so that the pricing will
be based on the market price for power. Customer F pays
CU 5,000,000 to compensate Entity E as the fixed price of the
original contract is currently higher than the market price.
The modified price per MWh is now based on a highly variable
market price and Entity E concludes that this would be
considered contingent consideration that can be allocated
directly to the undelivered 500,000 MWh in the modified
contract (refer to Contingent consideration Section in Step 4
below). However, the payment of CU 5,000,000 would be
treated as a change in the transaction price. As a result,
Entity E would need to allocate this amount to the total units
to be delivered under the contract based on the original
standalone selling price (i.e., CU 2,500,000 would be allocated
to the units already delivered and CU 2,500,000 would be
allocated to the undelivered units).
In practice, there are a number of other considerations that could
make the analysis of contract modifications complex. These
include: contracts that deliver volumes over time at a fixed price
per unit with variable volumes required to be delivered; contracts
that are originally priced on a variable price per unit; and contracts
that are bundled with other goods or services. As such, the
individual facts and circumstances of each contract modification
need to be carefully considered under the proposed standard.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Properly identifying performance

obligations within a contract would
be a critical component of the
proposed revenue standard.

Step 2: Identify the separate

performance obligations
The goods or services promised in a customer contract (either
explicitly stated in the contract or implied by customary business
practices) are referred to as performance obligations in the ED.
Goods and services would be accounted for as separate
performance obligations when they are distinct, meaning they are
sold separately or the customer can benefit from the good or
service on its own or together with other resources that are readily
available to the customer. These resources can be offered by the
entity or by another entity. If a good or service is not distinct, it
would be combined with other goods or services until a distinct
performance obligation is formed.
Once an entity determines whether the individual goods and
services would be distinct, the entity would have to consider the
manner in which the goods and services have been bundled in an
arrangement. The manner in which the goods and services have
been bundled may lead an entity to determine that it is appropriate
to account for otherwise distinct goods or services as a single
performance obligation.
To account for a bundle of goods and services as one performance
obligation: (a) the goods and services must be highly interrelated
and transferring the goods and services to the customer requires a
significant service of integrating the goods or services into the
combined item(s) for which the customer has contracted; and
(b) the bundle of goods and services is significantly modified or
customised to fulfil the contract.
The Boards also provided a practical expedient whereby an entity
could choose to account for two or more distinct goods or services
in a contract as a single performance obligation, if those goods or
services have the same pattern of transfer to the customer. It is our
understanding that consecutive delivery would likely meet the
criteria of having the same pattern of transfer (i.e., delivery of a
specific number of units of production over a period of time to the
customer until the full contracted volumes are delivered). The
potential impact of applying the practical expedient would depend
on the individual contracts. We will discuss some of these
considerations below in Step 4.

How we see it
Based on the criteria provided by the Boards for determining
separate performance obligations, we believe that individual
units of production delivered in many power and utility
arrangements would be considered to be separate performance
obligations.
However, by virtue of the practical expedient provided, we
believe that, as these performance obligations are transferred
consecutively with a similar pattern of transfer to the customer,
multiple performance obligations could be combined into one
performance obligation. This grouping could be applied to any
number of discrete time periods (e.g., weeks, months, years) or
to the entire contract.

Green or renewable certificates

Some countries have schemes to promote electricity production
from renewable sources. This is often achieved by the government
granting certificates to the producers of green energy, which may
be referred to as green certificates, renewable energy certificates
(RECs), tradable renewable certificates or renewable obligation
certificates. Usually, P&U entities that distribute electricity must
demonstrate that a certain percentage of power delivered to
customers is obtained from renewable sources. A distributor must
obtain and remit green certificates for the required amount of
renewable energy. Green or renewable certificates are either
purchased directly from the generator of renewable energy or from
the market in locations where a market exists.
As the schemes for green or renewable credits vary significantly
from country to country, the specific terms and conditions need
to be carefully considered, particularly in those areas where the
green or renewable certificates cannot be sold separately from
the energy.
It is important to note that the revised ED has a broader definition
of 'distinct' than the original ED that would allow entities to
consider whether the customer can benefit from the good or
service on its own or together with other resources that are readily
available to the customer. This means that, provided the green
or renewable credit can be expected to provide a benefit to the
customer (e.g., a refund from the government) that is separate
from the benefit the customer receives from consuming/
distributing the energy, it could be considered a separate
performance obligation.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

For many transactions, this would result in the green or renewable

certificates being treated as a separate performance obligation.
However, there could still be issues when the customer in the
contract is an intermediary who is, in turn, required to sell the
combined product to the end user of the energy. In this case, the
customer cannot benefit from the good or service on its own. It is
unclear whether an entity would look through the contract when
the customer in the contract is an intermediary.
Although the determination of whether green or renewable
certificates are separate performance obligations will likely not
impact the revenue recognition in the majority of transactions,
there could still be differences. One difference may result when
there is a delay in transfer of the title of the certificates (e.g., as a
result of government certification) which could indicate that control
has not yet passed to the customer and therefore revenue cannot
yet be recognised. Refer to our general Applying IFRS publication
for further discussion of the transfer of control.

Long-term service arrangements

Step 3: Determine the

transaction price
The ED defines the transaction price as the amount of
consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a
customer, excluding amounts collected on behalf of third parties
(for example, sales taxes). In some cases, the transaction price is
readily determined because the entity receives payment at the
same time it transfers the promised goods or services and the
price is fixed.
Determining the transaction price may be more challenging when it
is variable in amount, when payment is received at a time different
from when the entity provides goods or services or when payment
is in a form other than cash.

Variable consideration

It is common for entities in the P&U industry to enter into

arrangements to provide services on a long-term basis, such as
multi-period operating arrangements. Under the ED, there appears
to be flexibility on how an entity could identify the performance
obligations in those arrangements. For example, a three-year
operating agreement could be considered a single performance
obligation representing the entire contractual period, or it could be
divided into smaller periods (i.e., daily, monthly or yearly).

The transaction price reflects an entitys expectations about the

consideration it will be entitled to from the customer. A portion of
the transaction price could vary in amount and timing due to
discounts, rebates, refunds, credits, incentives, bonuses, penalties,
contingencies or concessions. For example, a portion of the
transaction price would be variable at contract inception if it
requires meeting specified performance conditions and there is
uncertainty regarding the outcome of such conditions.

In long-term service agreements when the consideration is fixed,

the accounting generally will not change regardless of whether a
single performance obligation or multiple performance obligations
are identified. However, in arrangements involving variable
consideration, this issue could have a significant effect, especially
if the entity believes it is appropriate to allocate the variable
consideration to a single performance obligation. See Step 4
below for further discussion on allocating variable consideration.

When a contract contains variable consideration, an entity would

estimate the transaction price using whichever of the following two
methods better predicts the ultimate consideration to which the
entity will be entitled:
outcomes of a contract and the probabilities of those outcomes
Or
Most likely outcome approach the entity would predict the

most likely outcome

How we see it
Given the potentially significant effect the determination of
separate performance obligations can have on the allocation and
recognition of variable consideration, we believe the Boards
should provide further clarity on how an entity should make this
determination for long-term service arrangements.

Expected value approach the entity would identify the possible

The entity would apply the selected method consistently

throughout the contract and would update the estimated
transaction price at each balance sheet date.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Determining the transaction price may be more challenging

when it is variable in amount, when payment is received
at a time different from when the entity provides goods or
services, or when payment is in a form other than cash.

For the P&U industry, variable consideration does not just refer to
charging a different price per unit delivered or linking the price to a
variable reference price, but would also include variability in the
transaction price based on the number of units that will ultimately
be delivered under the contract.

How we see it
The treatment of variable consideration under the ED could
represent a change from current practice for certain contracts in
the P&U industry.
Currently, IFRS preparers often defer measurement of variable
consideration until revenue is reliably measurable, which could
be when the uncertainty is removed or when payment is due.
The ED would require entities to estimate variable consideration
at contract inception and only provides a restriction on
recognising variable amounts that are not reasonably assured.

Contributions from customers and upfront fees

P&U entities may receive items of property, plant and equipment
from their customers, or cash from their customers to acquire or
construct specific assets. These assets are often used to connect
customers to a network and/or provide them with ongoing access
to a supply of goods and/or services such as electricity, gas
or water. These contributions are currently in the scope of
IFRIC 18 Transfers of Assets from Customers, except when they
relate to government grants (IAS 20 Accounting for Government
Grants and Disclosure of Government Grants) or service
concessions (IFRIC 12 Service Concession Arrangements). The ED
would replace IFRIC 18 and transactions that include contributions
from customers that are outside the scope of IAS 20 and IFRIC 12
would be accounted for under the ED.

Transactions in which the customer contributes goods or services

(such as property, plant or equipment) to facilitate the fulfilment of
the contract are common in the P&U industry. In these transactions,
if the entity obtains control of the contributed goods or services, it
should consider them as non-cash consideration and account for
that consideration as described above. This is consistent with
current treatment under IFRIC 18.
In many cases, the asset or consideration transferred is an upfront
fee in exchange for the delivery of services. These upfront fees are
often related to connecting a customer to a transmission network
and/or providing ongoing access to a supply of goods or services.
Upfront fees may also be paid to grant access to or a right to use a
facility, product or service. Often the upfront amounts paid by the
customer are non-refundable.
Entities must evaluate whether non-refundable upfront fees relate
to the transfer of a good or service that needs to be identified as
a separate performance obligation (based on the criteria to be
considered a distinct good or service in Step 2 above). In most
situations, the upfront fee does not relate to any transfer of a
goods or services. Instead, it is an advance payment for future
goods or services.
Additionally, the existence of a non-refundable upfront fee may
indicate that the arrangement includes a renewal option for future
goods and services at a reduced price (if the customer renews the
agreement without the payment of an additional upfront fee). For
example, if the upfront fee is associated with an arrangement that is
month to month, the entity may determine that the ability to renew
each subsequent month without having to pay any connection fee
represents a material right. The up-front payment would be
recognised over the period when those goods and services are
provided (i.e., the customer relationship period in this case).

Under the ED, when an entity receives, or expects to receive,

non-cash consideration, the transaction price is equal to the fair
value of the non-cash consideration. This would only apply to
transactions that are in the scope of the ED (i.e., contracts with
customers). An entity would measure the fair value of the non-cash
consideration in accordance with IFRS 13 Fair Value Measurement
when a reliable estimate of fair value can be made.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

10

Time value of money

Determining the standalone selling price

For certain transactions, the timing of the payment does not match
the timing of the transfer of goods or services to the customer
(e.g., the consideration is prepaid or is paid well after the services
are provided). While the time value of money would have to be
considered in an arrangement, the Boards tried to reduce the
number of contracts to which that provision would apply. Under the
ED, the time value of money would be considered only when there
is a significant financing component in an arrangement. In addition,
an entity would not be required to assess whether the arrangement
contains a significant financing component unless the period
between the customers payment and the entitys satisfaction of
the performance obligation is greater than one year.

To allocate the transaction price on a relative selling price basis, an

entity must first determine the standalone selling price for each
performance obligation. Under the ED, the standalone selling price
would be the price at which an entity would sell a good or service
on a standalone basis at contract inception. Although this is not
explicitly stated in the ED, we believe a single good or service could
have more than one standalone selling price that is, the entity
may be willing to sell a performance obligation at different prices to
different customers.

IAS 18 does not explicitly address time value of money. It is

implicitly incorporated in the requirement to recognise revenue
at the fair value of the amount to be received. However, there is
divergence in practice of incorporating the impact of the time value
of money. For additional guidance on accounting for the time value
of money, see Section 4.2 of our general Applying IFRS publication.

Step 4: Allocate the

transaction price to separate
performance obligations
Once the performance obligations are identified and the
transaction price has been determined, the ED would require an
entity to allocate the transaction price to the performance
obligations, generally in proportion to their standalone selling
prices (i.e., on a relative standalone selling price basis).

11

The ED indicates that, when available, the observable price of a

good or service sold separately provides the best evidence of
standalone selling price. When the standalone selling price is
not observable, the ED provides some examples of alternative
techniques that may be used. When an entity must estimate the
standalone selling price, the ED is clear that the entity should not
presume that a contractually stated price or a list price for a good
or service is the standalone selling price. Further discussion can be
found in Section 5 of our general Applying IFRS publication.
One thing that is not clear in the ED is how to determine the
standalone selling price at contract inception when there is only
one type of good (e.g., a unit of energy), and the contract requires
selling multiple units of that good in succession. Specifically, should
the standalone selling price of one MWh of energy to be sold/
delivered today be different to a MWh of energy which you expect
to sell/deliver at a future date (e.g., forward price in two, five or
even 10 years' time)? Using the spot price for all performance
obligations would result in an identical standalone selling price for
each performance obligation (i.e., each unit delivered). The forward
price would result in a different standalone selling price for each
performance obligation. This could impact the allocation of the
transaction price (increasing the complexity of applying Step 4 of
the model) and ultimately the pattern of revenue recognition. The
following examples illustrate some of the complexities and potential
differences in outcomes between using a spot price and a forward
price as the standalone selling price.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Illustration 5: Estimating the standalone selling prices

For simplicity, the scenarios below use yearly pricing for purposes of estimating the standalone selling price for the forward prices.
We also assume the practical expedient has been applied to group distinct goods together into one-year performance obligations as
discussed above in Step 2.
Scenario 1: Fixed price contract
Entity G enters into a three year fixed price contract with Customer H to deliver 1,000,000 units of electricity each year for a
fixed price of CU65/MWh. There is an active market for electricity and the forward prices are as follows at contract inception:
Year 1 CU60/MWh, Year 2 CU70/MWh, Year 3 CU75/MWh.
Fixed price contract
Spot price
(i.e., same standalone selling price for each unit)

Forward price
(i.e., different standalone selling price for each unit)

Current
practice (CU)

Calculation1

Revenue (CU)

Selling price

% of price
allocated 2

Revenue (CU)

65,000,000

1,000,000 x CU 65

65,000,000

1,000,000 x CU 60

29%

56,550,000

65,000,000

1,000,000 x CU 65

65,000,000

1,000,000 x CU 70

34%

66,300,000

65,000,000

1,000,000 x CU 65

65,000,000

1,000,000 x CU 75

37%

Year

195,000,000

195,000,000

72,150,000
195,000,000

Note 1 For the spot price-based standalone selling price, the transaction price is allocated based on the average price per unit of
CU 195,000,000 / 3,000,000 units
Note 2 For the forward price-based standalone selling price, the percentage calculated to allocate the transaction price of
CU 195,000,000 is based on the standalone selling price for the year divided by the total standalone selling price of the entire
contract.
As can be seen in this scenario, the assumption that each unit delivered has the same standalone selling price would result in the same
accounting currently used in practice.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

12

Illustration 5 (continued): Estimating the standalone selling prices

Scenario 2: Stepped price contract
Entity I enters into a three-year fixed price contract with Customer J to deliver 1,000,000 units of electricity each year with the
following fixed prices: Year 1 CU 60/MWh, Year 2 CU 70/MWh, Year 3 CU 75/MWh. The contract pricing is also equal to the
forward prices in the active market at contract inception.
Stepped price contract
Spot price
(i.e., same standalone selling price for each unit)

Forward price
(i.e., different standalone selling price for each unit)

Current
practice (CU)

Calculation1

Revenue (CU)

Selling price

% of price
allocated2

Revenue (CU)

60,000,000

1,000,000 x CU 68.33

68,333,333

1,000,000 x CU 60

29%

60,000,000

70,000,000

1,000,000 x CU 68.33

68,333,333

1,000,000 x CU 70

34%

70,000,000

75,000,000

1,000,000 x CU 68.33

68,333,333

1,000,000 x CU 75

37%

75,000,000

Year

205,000,000

205,000,000

205,000,000

Note 1 For the spot price-based standalone selling price, the transaction price is allocated based on the average price per unit of
CU 205,000,000 / 3,000,000 units.
Note 2 For the forward price-based standalone selling price, the percentage calculated to allocate the transaction price of
CU 205,000,000 is based on the standalone selling price for the year divided by the total standalone selling price of the entire
contract.
As can be seen in this scenario, assuming that each unit delivered has the same standalone selling price would result in different
accounting compared to current accounting practice. In this scenario, a similar revenue recognition profile to current practice would be
achieved using a forward price as the standalone selling price because (for simplicity) we have assumed that the forward prices of
energy have been built into the pricing of the contract.

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Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Decisions about the identification of the performance

obligations within a contract and how the standalone selling
price is determined can significantly impact the complexity
of applying the model and the revenue recognition profile.

It is important to note that the revenue recognised will depend

significantly upon how the performance obligations are
determined. An entity could also apply the practical expedient to
the entire contract (i.e., to treat multiple units with the same
pattern of transfer as one combined performance obligation). As a
result, the pricing would be smoothed such that each unit delivered
would have an equal amount of revenue allocated. For Scenario 1,
using the practical expedient to treat the entire contract as one
performance obligation would result in the same revenue
recognition as IAS 18 (regardless of whether a spot or forward
price is used to determine the standalone selling price).

How we see it
The examples above demonstrate how decisions about the
identification of the performance obligations within a contract
and how the standalone selling price is determined can
significantly impact the complexity of applying the model and the
revenue recognition profile. For example, stepped price contracts
could end up with smoothed revenue profiles; or fixed price
contracts could end up with gradually increasing recognition
profiles depending on whether a spot price or a forward price is
used.
Given this, we believe the Boards should provide additional
guidance and clarity on these key decisions in the final standard.

Contingent consideration
The Boards proposed an exception to the relative selling price
method of allocating the transaction price that would require
contingent consideration to be allocated entirely to a single
performance obligation when both of the following criteria are met:
The contingent payment terms for the distinct good or service

relate specifically to the entitys efforts to transfer that good or

service (or to a specific outcome from transferring that good or
service).
And
Allocating the contingent amount of consideration entirely to

the distinct good or service is consistent with the overall

principle for allocating consideration (i.e., the amount ultimately
allocated to each separate performance obligation results in an
amount that depicts the amount of consideration to which the
entity expects to be entitled in exchange for satisfying each
separate performance obligation).

This proposed approach for contingent consideration would also

apply to subsequent changes in the transaction price. A common
example of a P&U contract that would likely fall under this exception
is a production contract with pricing that is based entirely on a
reference or market price (e.g., price based on the average spot
price for the month in which the product is delivered). In this case,
each unit delivered would likely be determined to be a distinct
good. Therefore, when each unit is delivered and the transaction
price is known, the model would allow the entity to allocate that
known part of the transaction price entirely to that distinct good. It
would not be required to allocate that known transaction price over
the total number of performance obligations. The result is that
revenue would be recognised consistently with current IAS 18 for
these contracts.
Even when the practical expedient is applied and the performance
obligations are bundled into one performance obligation, the
individual goods (e.g., units of energy delivered) would still be
distinct. As such, we believe the provisions relating to allocation of
a variable transaction price to distinct goods could still be applied in
this situation.
In addition to contracts with entirely variable per unit pricing, P&U
entities may enter into contracts that have per unit pricing with
both a fixed and variable element. For example, an entity could
enter into a fixed price contract to deliver energy that includes an
adjustment for inflation (i.e., contract price is fixed plus an inflation
index in following years) in each of the subsequent years of the
contract. As the inflation adjustment can be linked directly to the
distinct performance obligations in these separate years, the
impact of inflation would not be required to be allocated to energy
delivered in other years of the contract.

How we see it
The changes that have been made to the ED regarding the
allocation of contingent consideration could result in the
contract price allocated to each individual performance
obligation (e.g., unit of energy delivered) better reflecting the
underlying economics of the contract than what was proposed
in the original ED. However, this may not be the case when
estimates of these market costs (e.g., adjustments for
consumer price index) are embedded as a fixed price in the
contract at inception, potentially resulting in economically
similar contracts having different revenue recognition profiles.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

14

Step 5: Recognise revenue

when the entity satisfies each
performance obligation
Under the ED, an entity would recognise revenue when each
performance obligation is satisfied. This would occur when the
goods or services are transferred to the customer and the customer
obtains control. The ED indicates that certain performance
obligations are satisfied as of a point in time. Therefore, revenue
would be recognised at that point in time. However, other
performance obligations are satisfied over time. As such, the
associated revenue would be recognised over the period the
performance obligation is satisfied (e.g., the monthly facilities
service contract). Section 6 of our general Applying IFRS
publication outlines the relevant considerations for assessing
when control has passed.

Performance obligations satisfied over time

For performance obligations satisfied over time, an entity will need
to decide how it will measure its progress towards complete
satisfaction of those performance obligations. Two appropriate
methods of measuring progress provided in the ED include output
methods and input methods. Output methods recognise revenue on
the basis of the value to the customer of the goods or services
transferred to date (e.g., units produced or delivered, milestones
reached). Input methods recognise revenue based on the entitys
efforts or inputs to the satisfaction of a performance obligation
(e.g., resources consumed, labour hours expended, costs incurred)
relative to the total expected inputs.
For power purchase arrangements and other contracts to deliver
units of production, in which each unit delivered is treated as a
separate performance obligation, we believe these would be
considered to be satisfied at a point in time. However, when an
entity elects to apply the practical expedient and treat all units
to be delivered under the contract as one single performance
obligation or separate annual (or weekly, monthly, quarterly)
performance obligations, we believe these would be considered
to be satisfied over time.

15

Given the nature of unit purchase arrangements (e.g., power

purchase arrangements), the output method would likely be chosen
by many entities to measure progress towards satisfaction of this
performance obligation in the case where the entity treats these as
an obligation settled over time. For example, an entity could choose
to measure progress as units delivered to date as compared to total
units to be delivered under the contract.
In addition, the ED states that if an entity has a right to invoice a
customer in an amount that corresponds directly with value to the
customer of the entitys performance completed to date, the entity
would recognise revenue in the amount to which the entity has a
right to invoice. For example, we would expect a contract to deliver
units based on a market price to meet the criteria of the invoice
amount directly corresponding to the value to the customer of units
delivered to date. The result is a simplified approach to accounting
for these contracts if the practical expedient is taken and an entity
chooses to apply the invoicing output method.
However, it is unclear how the value to the customer of the entitys
performance completed to date is meant to be interpreted in other
cases. Is this meant to be fair value, the standalone selling price
that would otherwise be allocated or some other consideration?
Also, at what date would this value be determined? For example,
fair value of a unit delivered in year 5 of a contract would be
different at contract inception as compared to the point in year 5
when the unit is actually delivered.

How we see it
Using the invoicing method as a measure of progress towards
satisfying a performance obligation in unit based delivery
contracts that an entity has elected to treat as a combined
performance obligation that is satisfied over time, would greatly
simplify the accounting for these contracts. However, it is
unclear in the ED under what circumstances the invoicing
method could be applied.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Constraining the cumulative amount of revenue

recognised
Although an entity is required to estimate the total transaction
price, the amount of revenue the entity could recognise may be
constrained in certain circumstances. The ED states that the
cumulative amount of revenue an entity would be able to recognise
for a satisfied performance obligation is limited to the amount to
which the entity is reasonably assured to be entitled (refer to
Section 6.3 of our general Applying IFRS publication for further
guidance on determining when the amount to which an entity
expects to be entitled is reasonably assured).
The examples cited in the ED relate to assessing the types of
variable consideration in which an entity would not be reasonably
assured to be entitled are sales-based royalties associated with
the licence to use intellectual property and asset management
fees based on the value of the underlying assets at a defined
measurement date in the future. In addition to those examples,
we believe settlement of long-term commodity supply
arrangements based on market prices at the future delivery date
would also be variable consideration in which an entity is not
reasonably assured to be entitled to the payment.

Other recognition and

measurement concerns
Take or pay arrangements
A take-or-pay contract is a supply agreement between a customer
and a supplier in which the price is set for a specified minimum
quantity of a particular good or service and the price is payable
irrespective of whether the good or service is taken by the
customer. Take-or-pay contracts are commonly used in the P&U
industry and may involve the supply of gas, transmission capacity
or electricity. These contracts can be long-term in nature and
contain terms and conditions with varying degrees of complexity
(e.g., fixed or stepped volumes; simple fixed, stepped or variable
pricing). Several of the issues under the ED for these complex
terms are discussed above under Step 4.

The initial 'contract' to be accounted for in a take-or-pay

arrangement would often be the minimum amount specified in
the contract, as this is generally the only enforceable part of the
arrangement. However, this may not always be the case and an entity
needs to carefully consider these potential additional volumes when
identifying its performance obligations in Step 2 above.
There may be instances in which the option to obtain additional
volumes provides a material right to the customer that it would not
receive without entering into that contract. The ED notes that such
a right would be material only if it results in a discount that the
customer would not otherwise receive (e.g., a discount that is
incremental to the range of discounts typically given for those
goods or services to that class of customer in that geographical
area or market). If the option does provide a material right to the
customer, the option would be accounted for as a separate
performance obligation in the original contract. Further details on
identifying the contract and accounting for these options, can be
found in Section 2 and Section 3.7 our general Applying IFRS
publication.
In addition, terms related to payments made for volumes not taken
(i.e., when the customer does not take the minimum quantities
specified) can vary. For example, some take-or-pay arrangements
might include a clause that allows the customer to 'make up' the
volumes not taken at a later date. The ability to make up the
unused volumes means that consideration has been received in
advance by the producer for a product that has not yet been
delivered. Alternatively, the contract may contain a 'use it or lose it'
clause, under which the customer cannot make up the unused
volumes in the future. In such a situation, this payment would be
more akin to a type of penalty payment.
The ED discusses the concept that in certain industries customers
may pay for goods or services in advance, but may not ultimately
exercise all of their rights to these goods and services either
because they choose not to or are unable to. The ED refers to these
unexercised rights as breakage.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

16

The proposed revenue recognition

model could have practical implications
for, and may increase complexity of, the
accounting for take-or-pay contracts.

In take-or-pay contracts, the unexercised rights are effectively

breakage. However, it is not clear if the proposed requirements on
breakage would be applicable. If they do apply, the unexercised
rights would be accounted for as follows:
If an entity is reasonably assured of a breakage amount, the

entity should recognise the expected breakage as revenue in

proportion to the pattern of transfer of goods or services to the
customer.
If an entity is not reasonably assured of a breakage amount, it

should recognise the expected breakage as revenue when the

likelihood of the customer exercising his or her rights on
remaining balances becomes remote.
It is also important to note that there is some uncertainty in the
ED as to how the requirements for recognising breakage amounts
would be applied when they are considered to be reasonably
assured. The ED requires that the entity would recognise the
breakage amount as revenue "... in proportion to the pattern of
rights exercised by the customer." This suggests that the entity
would have to take into account either:
The rights already exercised by the customer to date compared

with those the entity expects the customer will still exercise.
This would allocate the breakage amounts to all performance
obligations (satisfied and still to be satisfied) in the contract.
Or
Only the rights that have been exercised in the contract. This

In take-or-pay contracts, in which payments received for unused

volumes can be applied to future volumes, the seller has received
consideration in advance for an unsatisfied performance obligation.
This amount represents a contract liability, which will differ from
current treatment under which such amounts are referred to as
deferred or unearned revenue.
When determining how to account for the contract liability
on make-up volumes, the ED requires that the transaction price in
a contract must be adjusted to reflect the time value of money if
the contract has a financing component that is significant to the
contract.

How we see it
The ED could have practical implications for, and may increase
the complexity of, accounting for take-or-pay contracts. This
complexity arises on determining the performance obligations
(whether to combine these using the practical expedient),
determining the standalone selling price (spot or a forward price)
and taking into consideration the unexercised rights.
In addition, the ED is unclear on how or whether the
requirements for recognising breakage amounts would be
applied in take-or-pay contracts, which could lead to divergence
in practice. As such, we recommend the Boards clarify what is
meant by recognising revenue "in proportion to the pattern of
rights exercised by the customer".

would lead to full recognition of the breakage amount when

reasonable assurance is achieved (or when the likelihood of the
customer exercising the rights when reasonable assurance is not
achieved).

17

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

Onerous performance obligations

The ED would require an entity to recognise a liability and a
corresponding expense when certain performance obligations
(that is, performance obligations satisfied over time and that time
period is greater than one year) become onerous. Section 7.2 of
the general Applying IFRS publication provides further details on
applying the onerous contract provisions of the ED.
As mentioned, the onerous contract performance obligation
assessment would be required only when performance obligations
are satisfied over time. As such, an entitys determination of the unit
of account for long-term contracts may impact the onerous test.
Another important aspect to consider in connection with the
onerous performance obligation assessment is the cost of settling
the performance obligation. Under the ED, a performance
obligation is deemed onerous when the lesser of the following
costs exceeds the allocated transaction price:
The costs directly related to satisfying the performance

obligation (i.e., direct costs)

The amount the entity would pay to exit the performance

obligation
P&U entities that identify performance obligations that are settled
over time may have difficulty determining the costs that are
directly related to satisfying the specific performance obligations.
In some cases, there is no direct link between costs and a specific
revenue contract (or the individual performance obligations within
that contract). For example, an entity may produce electricity
from several power plants (with different cost structures) into a
grid that fulfils multiple customer contracts.

Disclosures
In response to criticism that the current revenue recognition
disclosures are inadequate, the Boards have tried to create a
comprehensive and coherent set of disclosures. As a result,
the ED includes an overall objective that the revenue recognition
disclosures should enable users of the financial statements to
understand the amount, timing and uncertainty of revenue and
cash flows arising from contracts with customers. The ED states
that preparers would meet that objective by providing both
qualitative and quantitative disclosures about:
Contracts with customers These disclosures would include

disaggregation of revenue, reconciliation of contract asset and

liability balances (including liabilities due to onerous
performance obligations) and information about an entitys
performance obligations.
Significant judgements (including changes in those judgements)

This would include disclosures about judgements that

significantly affect the determination of the transaction price,
the allocation of the transaction price to performance obligations
and the determination of the timing of revenue recognition.
Assets recognised resulting from costs incurred to obtain or

fulfil a contract.
The Boards have clarified that the disclosures they listed in the ED
are not intended as a checklist of minimum requirements. Instead,
entities would have to determine which disclosures are relevant to
them. Entities also would not have to disclose items that are not
material.

Next steps
Given the potential consequences, we encourage P&U entities to
gain an understanding of the ED and how it may affect their
particular facts and circumstances and provide the Boards with
feedback. Although comments are due by 13 March 2012,
the Boards also plan various outreach efforts to gather more
feedback. Entities that would like to participate should express
their interest to the Boards.

Entities should also continue to consider the impact the changes

may have on their business and discuss these potential changes
with their Audit Committee, the Board of Directors and auditors.

Applying IFRS in Power & Utilities The revised revenue recognition proposal power and utilities

18

Ernst & Youngs Global Power & Utilities Center

In a world of uncertainty, changing regulatory frameworks and environmental
challenges, utility companies need to maintain a secure and reliable supply, while
anticipating change and reacting to it quickly. Ernst & Young's Global Power & Utilities
Center brings together a worldwide team of professionals to help you achieve your
potential a team with deep technical experience in providing assurance, tax,
transaction and advisory services. The Center works to anticipate market trends,
identify the implications and develop points of view on relevant industry issues.
Ultimately it enables us to help you meet your goals and compete more effectively.
Its how Ernst & Young makes a difference.

Contacts
Global Power and Utilities Leader
Ben van Gils
Direct tel: +49 211 9352 21557
Email: ben.van.gils@nl.ey.com
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Dennis Deutmeyer
Direct tel: +1 212 773 9199
Email: dennis.deutmeyer@ey.com
Global Assurance Power & Utilities Leader
Charles-Emmanuel Chosson
Direct tel: +33 1 46 93 71 62
Email: charles-emmanuel.chosson@fr.ey.com
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Louis-Mathieu Perrin
Direct tel: +33 1 46 93 46 14
Email: louis-mathieu.perrin@fr.ey.com

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