Get ready for reporting changes

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Recent changes to International Financial Reporting Standards (IFRS) could have major implications for utility companies’ financial statements. Dennis Deutmeyer comments on the main aspects of two new standards: IFRS 10 and IFRS 11.

Financial reporting plays a key role in providing transparency on the long-term impact of utilities’ business decisions and accountability for those decisions. IFRS 10 and 11, which were effective 1 January 2013, could influence how power and utility (P&U) companies present investees in their financial statements.

IFRS 10: Consolidated Financial Statements

What is changing? Group structure, including interest in structured entities.

How could it impact financial statements? A new and broader definition of “control” may result in changes to a consolidated group.

What will it mean for utilities? Companies will need to evaluate whether they have the ability to use their power to affect the returns from their involvement with the investee. Additional considerations will be needed when control is not clearly held through voting rights.

The change will be particularly relevant to a P&U vehicle’s investments in power generators, transmission and distribution companies and renewable energy projects. It is an area where careful judgment will need to be exercised — there are no “bright lines” — and the issue of whether control is held must be regularly reassessed to ensure continued compliance with financial reporting regulations.

IFRS 11: Joint Arrangements

What is changing? Reassessment of classification of joint arrangements.

How could it impact financial statements? There will be considerable changes for vehicles that applied the proportionate consolidation method to arrangements previously classified as jointly controlled vehicles.

What will it mean for utilities? This is perhaps the biggest change to P&U companies’ financial reporting, due to the extensive joint arrangements that exist in the sector. For example, a wind farm project may involve several power generators.

Under IFRS 11, utilities must assess whether joint control exists, and then evaluate the arrangement’s legal structure, contractual terms and other facts and circumstances to determine whether a joint arrangement is classified as a “joint venture” or a “joint operation.”

A joint venture classification results in equity method accounting; while a joint operation classification would result in the vehicle recognizing its share of the arrangement’s assets, liabilities, revenues and expenses.

As with IFRS 10, definitive answers are hard to find but the process may start by identifying all joint arrangements and assessing whether each arrangement is structured through a separate vehicle – if not, it will be considered a joint operation.

However, further analysis is necessary if an arrangement is in a separate vehicle. For example, we have seen the terms of a joint arrangement structured through a separate vehicle require the parties to purchase all of the output at prices that will ensure the arrangement covers its costs.

By default, the parties are responsible for the liabilities of the arrangement, despite the fact that it is legally structured as a separate vehicle, which may result in the arrangement being considered a joint operation. Contracts will need to be examined carefully and discussions should include all participants in the joint arrangement.

Understand the impact

While IFRS 10 and 11 are not the only changes to IFRS — information on other amendments can be found in Reporting — it is these that warrant particular attention from P&U companies.

As joint arrangements become increasingly common in the sector, as a means to share risks, costs and enter new markets, it is critical that the specific facts and circumstances of each arrangement be evaluated to determine the appropriate accounting.

Utilities must understand the changes, assess how they impact their own situation and exercise careful judgment — often with the help of external advisors — to apply them successfully.

When are these changes effective?

These IFRS changes will need to be reflected in the 31 December 2013 financial statements.

How we can help

We provide up-to-date knowledge and insights to help P&U companies deal with the widespread implications of IFRS. Our business-based approach helps utilities manage both financial accounting and reporting issues while understanding how IFRS affects critical decisions.