IFRS 15 Application for the Power and Utilities Industry

International Financial Reporting Standard 15 (IFRS 15) provides a single model for recognizing revenue from customer contracts. The core principle is to recognize revenue as goods or services are transferred to a customer, in an amount the company expects to receive. For the power and utilities sector, applying this standard presents unique challenges. Companies must navigate issues like identifying distinct promises, estimating variable payments, and timing revenue recognition for continuously delivered services.

The Five-Step Revenue Recognition Model

IFRS 15 structures revenue recognition around a five-step model. The first step is to identify the contract with a customer, which is an agreement that creates enforceable rights and obligations. For a contract to fall under IFRS 15, it must be approved, identify each party’s rights, specify payment terms, and have probable collectibility.

The second step is to identify the performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to a customer. A good or service is distinct if the customer can benefit from it on its own and if the promise to transfer it is separately identifiable from other promises in the contract.

The third step is to determine the transaction price, which is the amount of consideration a company expects to receive for transferring the promised goods or services. This price can include fixed amounts, variable amounts, or both. Variable consideration is only included if it is highly probable that a significant reversal of recognized revenue will not occur later.

After determining the transaction price, the fourth step is to allocate it to the distinct performance obligations based on their relative standalone selling prices. If a standalone price is not directly observable, a company must estimate it using an approved method.

The final step is to recognize revenue when the company satisfies a performance obligation by transferring control of a good or service to the customer. A performance obligation can be satisfied at a point in time or over time. Revenue is recognized over time if the customer simultaneously receives and consumes the benefits, the company’s performance creates an asset the customer controls, or the performance creates an asset with no alternative use.

Identifying Performance Obligations in Utility Contracts

In the power and utilities industry, the primary promise in most arrangements is the continuous supply of a commodity like electricity, natural gas, or water. IFRS 15 allows this supply to be treated as a single performance obligation satisfied over time, as it consists of a series of distinct but substantially similar goods with the same pattern of transfer.

Services provided alongside the commodity, such as connection or setup activities, require careful analysis. A utility company must determine if connecting a customer to the grid is a distinct service or an administrative task. Since a connection service has no value without the subsequent energy supply, these upfront activities are generally not separate performance obligations, and any fees are part of the total transaction price for the energy.

The market structure also influences this analysis. In deregulated markets, where transmission and distribution may be handled by different entities, a utility must assess its promise to the customer. If the company is responsible for ensuring the energy reaches the customer, then transmission and distribution are part of the single performance obligation for the energy supply.

Modern utility contracts may also bundle goods like smart meters with the service. The utility must assess if these goods are distinct. A smart meter is distinct if the customer owns it and could use it with another provider. If so, a portion of the transaction price must be allocated to the meter and recognized as revenue when control transfers to the customer.

Determining the Transaction Price

The transaction price in utility contracts is often complicated by variable consideration. Most revenue comes from usage-based fees, where the final amount depends on the volume of the commodity consumed. Companies must estimate the expected revenue from these variable tariffs, which can include tiered pricing or time-of-day rates.

The estimation of variable consideration is subject to a constraint, requiring that a company only include an amount to the extent that it is highly probable a significant revenue reversal will not occur. For utilities, this involves forecasting customer consumption based on historical data and weather forecasts. This constraint ensures that recognized revenue is not overstated before final consumption is known.

Utility contracts also include other forms of variable consideration, such as rebates for achieving energy efficiency goals or penalties for failing to meet service-level targets. These potential adjustments must be estimated and factored into the transaction price using the method that best predicts the final amount.

Some long-term agreements with large customers may contain a significant financing component if payment timing provides a benefit to either the customer or the company. If such a component exists, the transaction price must be adjusted for the time value of money. As a practical expedient, this adjustment is not required if the period between payment and transfer of goods is one year or less.

Recognizing Revenue Over Time

For power and utility companies, performance obligations are almost always satisfied over time. The continuous supply of electricity, gas, or water fits the criteria for “over time” recognition because the customer simultaneously receives and consumes the benefits as the utility performs.

To recognize revenue over time, a company must select a method to measure its progress. For utilities, the most logical approach is an output method, which recognizes revenue based on direct measurements of the value transferred to the customer. The specific measure is the quantity of the commodity delivered, such as kilowatt-hours of electricity or gallons of water. This method provides a faithful depiction of performance, as each unit delivered represents value transferred.

A practical challenge is the existence of unbilled revenue at the end of a reporting period. Customer meters are read on various cycles, so there is always a period where customers have consumed energy that has not yet been invoiced. IFRS 15 requires companies to estimate this consumed but unbilled quantity and recognize the corresponding revenue in the period the consumption occurred.

Specific Application Issues

Utility companies face several other application issues under IFRS 15.

• Contract Costs: The standard distinguishes between the incremental costs of obtaining a contract and the costs to fulfill it. Incremental costs, like a sales commission, are recognized as an asset and amortized over the contract term if recoverable. Costs to fulfill a contract are also capitalized if they generate or enhance resources used to satisfy future performance obligations.
• Principal vs. Agent: A utility must determine if it is a principal (controlling the good or service before transfer) or an agent (arranging for another party to provide it). This affects whether revenue is reported on a gross basis (as a principal) or a net basis (as an agent). A company that generates its own power is a principal, while one that only arranges for another’s power to be provided for a fee is an agent.
• Contract Modifications: A contract modification is a change in the scope or price of a contract. If a modification adds distinct goods or services at their standalone selling prices, it is treated as a new contract. Otherwise, the modification is accounted for by adjusting the revenue for the existing contract, either on a cumulative catch-up basis or prospectively.