PROFESSIONAL SERVICES
ACCOUNTING FOR EMR
when the contract is awarded or when the initial obligations are met and generation has started?
UNCERTAINTIES AHEAD
Contracts for Differences (CfDs) are central to delivering Electricity Market Reform (EMR) in the UK. But the changes give rise to uncertainty around the accounting treatment, made all the more pertinent because of forthcoming fundamental changes to UK accounting standards.
EMR PROGRAMME AIM The EMR programme is being introduced with the aim of delivering green, reliable electricity for the future, at the lowest possible cost. CfD auctions begin in October 2014 and wind generators will need to understand the impact of the CfD model on the accounting and cash tax profile for each project.
In advance of the introduction of the EMR programme, eight projects (including six wind) have already been given a CfD, known as an investment contract under the ‘Final Investment Decision
Enabling for Renewables’ programme.
NOTHING STRAIGHTFORWARD With such CfDs in the energy market being both new and complex, accounting for them is unlikely to be straightforward and many approaches have been proposed – as a derivative, as a grant or simply on an accruals basis.
Treatment as a grant would likely lead to less volatility in the profit and loss account but there would still be questions to be resolved, such as whether it should be accounted for when the energy is generated or capitalised at opening fair value, and whether it should be a revenue or capital item.
POSSIBLE OUTCOMES
This debate has some way to run, but in the end, while it would impact the earnings profile of the project, the corporation tax profile will always be based on treating the CfD as a derivative contract and basing taxable amounts on accounting profits and losses.
If certain UK tax provisions known as the ‘Disregard Regulations’ apply, then the fair value of profits and losses on CfDs would be disregarded as they arise and only brought into account for tax purposes when the related income is brought into the profit and loss account, yielding a profile of taxable profit/loss more akin to accruals accounting.
DECISIONS
Companies will need to decide in due course whether to opt into this regime or (if relevant criteria can be met) to rely on hedge accounting to dampen the cash tax impact of fair value volatility. Ongoing consultation by HMRC could potentially impact the taxation of derivatives in the future and needs to be monitored.
Kate Mitchell
Another factor is whether the business prepares its accounts using UK GAAP or IFRS, although the forthcoming introduction of accounting standard FRS 102 will align the two.
EXAMPLE
By way of example of the potential complexity, if accounted for as a derivative, the contract would need to be fair valued on day 1 and then over the life of the contract. However, there are difficulties in establishing when ‘day 1’ should be – should the asset and gain be accounted for
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EARLY ENGAGEMENT ADVISED Whilst some businesses may regard the existence of uncertainties over certain aspects of the accounting and tax as a reason to adopt a ‘wait and see’ approach, in our view there is merit to be had in engaging early in the debate so that the different technical arguments can be understood and an appropriate, well considered approach adopted for financial modelling purposes or in the financial statements of the business.
Kate Mitchell PwC
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