As interest in cross-border and pan-European renewable power purchase agreements (PPAs) grows, companies operating under IFRS guidelines are looking for new innovative deal structures to overcome accounting hurdles. But for many organizations, it can be tricky. In this article, Ally Charlton answers some common questions about IFRS accounting considerations, and outlines 3 key tips for executing a successful deal.
Ally Charlton is a Cleantech Client Manager at Schneider Electric Energy and Sustainability Services, and a subject matter expert for accounting issues relating to renewable energy power purchase agreements (PPAs).
What are U.S. GAAP and IFRS accounting?
Global corporations operate under one of two main accounting frameworks. Public companies headquartered in the United States must abide by U.S. Generally Accepted Accounting Principles (GAAP), while entities with headquarters outside of the U.S. are subject to the International Financial Reporting Standards (IFRS). They are broadly aligned, but there are a few key differences with particular relevance for PPAs.
Why can it be difficult to sign a VPPA if your company is subject to IFRS accounting?
Under IFRS accounting guidelines, virtual (or financial) power purchase agreements (VPPAs) typically meet the definition of a derivative, triggering the use of mark-to-market accounting. This means that companies have to record the value of the contract on their balance sheet, re-calculate that value on a periodic basis, and report the change in value as a profit or loss for the period. Energy markets are volatile, and the forward prices used to value the PPA can change dramatically from year to year. Since PPAs are long-term contracts, the impact of these changes is amplified over many years, leaving the company vulnerable to potential large swings in their financial results. While these losses or gains would only occur ‘on paper’, that doesn’t make them look any less intimidating to stakeholders, and can make it more difficult to secure executive buy-in for the PPA.
However, the market also offers a variety of ways to mitigate this risk. Part of our role at Schneider Electric Energy & Sustainability Services (ESS), is to help clients navigate these options.
How can companies address these difficulties?
The European PPA market is particularly interesting because it’s subject to constant market developments in a variety of countries. With growing interest from companies to explore cross-border or pan-European deal structures, it’s important to understand how these market dynamics might affect your organization’s accounting practices. Increased flexibility and opportunity to leverage innovative deal structures such as market-following pricing or collar structures can help mitigate the impact of mark-to-market accounting for VPPAs. However, it’s important to recognize that these are very complex processes that need to be addressed with high diligence and careful attention to each individual company’s circumstances.
There are three key things that I’d advise any firm reporting under IFRS to take into consideration when entering a renewable PPA process.
1. Arm Yourself with Knowledge
Selecting a deal structure that fits your company portfolio and satisfies your stakeholders is key to executing a successful deal. But to do so, you need in-depth knowledge about the market(s) you plan to enter, and detailed information about how future market trends might affect your financial reporting. At Schneider Electric, we help our clients quantify the benefits and risks of a project, factoring in the implications of different accounting treatments as well as the expected annual cash flows under different market scenarios, to allow them to make well-informed decisions.
2. Look at the Market For Inspiration
The European market presents an exciting opportunity to explore new deal structures. However, it can be difficult for companies to know what types of deal structures have been done, and how to replicate those to suit their own unique profile as most companies don’t publicize these details. One of the main benefits of working with an experienced PPA advisor is our ability to share knowledge across scenarios/borders and leverage our extensive global network to find new ways to structure deals. Our local experts work with clients to translate and globalize the knowledge we draw from our broader operations and apply it to individual corporate processes.
3. Streamline Internal Communication
Ensuring internal alignment is key to PPA success. Since the process is highly complex and requires involvement from many internal divisions, transparency and communication are crucial. This becomes extra important for entities reporting under IFRS, due to the effects of mark-to-market accounting. When we work with our clients, one of our main priorities is that a company’s internal stakeholders are well-aligned on the process and receive necessary information and training. Our team also works to help align our client’s internal accounting team with the firm’s external auditors, including PPA experts within those audit firms.
Get in touch with our team of experts to see how you can successfully structure a pan-European PPA.
While we strive to provide the best and most up-to-date information, we’re advisors, not accountants or lawyers. None of the content in this article is intended to be accounting or legal advice. If you have questions that require professional guidance, we encourage you to consult a CPA or an attorney.