IFRS 15 New Revenue Model: Spotlight on Power

Directors’ Alert 2017

The revenue and profit recognition profile of power companies may be significantly impacted by IFRS 15 as the new Standard is more detailed and more prescriptive than the existing guidance and introduces new complexities.
In particular, power companies will need to consider:
The impact of new guidance where pricing mechanisms include variable amounts:

Companies in the power sector often negotiate contracts that include some form of variable pricing arising from uncertain or contingent events (for example, adjustments to otherwise fixed unit pricing that are based on production exceeding or falling short of contractually specified minimum or maximum volumetric bands, stepped pricing or heat‑rate based pricing structures).

Under IFRS, variable consideration is only included in the transaction price if it is highly probable that the amount of revenue recognised would not be subject to significant future reversals when the uncertainty is resolved. This approach to variable and contingent consideration is different from that previously reflected in IFRSs.

The accounting for breakage;

In the power sector, it is not uncommon for customers to agree, under a ‘take or pay’ contract, to purchase a specified minimum quantity of a particular good or service (such as the supply of gas or electricity) over a specified period of time. However, the customer has to pay the full amount stated in the contract, irrespective of whether the customer takes delivery of the minimum quantity. In some cases, the contract allows customers to defer the purchase of the remaining units to a later date, although there is no compulsion to do so. In a scenario in which customers do not always exercise all of their contractual rights, the unexercised rights are often referred to as ‘breakage’. Previously, IFRSs included only limited guidance on accounting for such unexercised rights, as such, a variety of practices may currently be used in accounting for breakage. IFRS 15 includes specific guidance on breakage, which is applicable to all revenue transactions with customers. If an entity expects to benefit from breakage, it should recognise the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer (i.e. by comparing the goods or services delivered to date with those expected to be delivered overall).
Whether particular costs relating to obtaining a contract must be capitalised;

The new Standard introduces specific criteria for determining whether to capitalise certain costs, distinguishing between those costs associated with obtaining a contract (e.g. sales commissions) and those costs associated with fulfilling a contract. In the power sector, this becomes an issue because significant costs may be incurred that are directly attributable to obtaining contracts with customers, for example, sales commissions that are only payable if a contract is obtained. At present, different entities might treat these costs differently. The new Standard will require entities to capitalise success fees, which will have an impact on operating profits. In addition, the new Standard requires capitalised contract costs to be amortised on a systematic basis that is consistent with the pattern of transfer of the goods or services.

Other areas of impact include:
how to account for contract modifications;
• the extent to which distinct goods or services are supplied, which should be accounted for separately;
• when upfront fees should be recognised as revenue; and
• the appropriate accounting for exchanges of goods and services.

IFRS 15 introduces new requirements to move to a more conceptual approach. The complexity of applying this approach and of producing the detailed disclosures required by the new Standard in the power sector may require modifications to existing accounting processes. Entities should ensure they allow sufficient time to develop and implement any required modifications to processes.

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