Impact of Ifrs Power and Utilities

ENERGY & NATURAL RESOURCES

Impact of IFRS: Power and Utilities kpmg.com/ifrs

KPMG International

Contents Overview of the IFRS conversion process

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Accounting and reporting issues 3 1. Property, plant and equipment 4 2. Leases 6 3. Service concessions, and regulatory assets and liabilities 8 4. Impairment of non-financial assets 11 5. Decommissioning and environmental provisions 12 6. Revenue recognition 13 7. Financial instruments 14 8. Emissions allowances and carbon trading schemes 17 9. First-time adoption of IFRS 18 10. Presentation of financial statements 20 Information technology and systems considerations From accounting gaps to information sources How to identify the impact on information systems

22 22 23

Power and utilities accounting differences and respective system issues Parallel reporting: Timing the changeover from local GAAP to IFRS reporting Harmonisation of internal and external reporting

25 26 28

People: Knowledge transfer and change management 29 Business and reporting Stakeholder analysis and communications Audit Committee and Board of Directors considerations Monitoring peer group Other areas of IFRS risks to mitigate Benefits of IFRS

30 30 30 31

KPMG: An Experienced Team, a Global Network

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Contact us

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Impact of IFRS: Power and Utilities 1

Foreword The power and utilities industry has faced many changes in recent years. Conversion to IFRS is another change that will require planning and focus from affected companies.

projects should be added to the IASB’s active agenda is expected when the IASB considers responses to its Agenda Consultation 2011, which are due by 30 November 2011.

Many countries converted to IFRS in 2005 and conversions are imminent for other countries such as Canada and South Korea in 2011 and Mexico in 2012. Japan has permitted the early adoption of IFRS by listed companies from years ending on or after 31 March 2010 and is expected to announce a final decision on whether to mandate adoption in 2012. The US will likely announce later in 2011 or 2012 its plan as to how IFRS might be incorporated into the financial reporting requirements for US domestic issuers.

This publication looks at some of the main accounting issues for power and utility companies. It considers currently effective standards and notes future developments that could impact accounting in the industry.

Companies in the power and utilities industry are subject to a range to regulatory models, they are frequently involved in trading activity, and certain sectors are capital intensive. These factors add to the complexity of financial reporting in this industry. As countries around the world convert to IFRS, accounting approaches for affected companies will need to be re-assessed. As countries adopt a single set of high quality, global accounting and financial reporting standards there should be greater global consistency and transparency. However, there are features of power and utilities operations in which IFRS does not provide specific guidance, such as regulatory assets and liabilities, and emissions trading. The IASB has projects to address some of these matters and a decision on which

This publication also discusses the IFRS conversion project as a whole, including the importance of the conversion management process, and considers the impact of IFRS conversion across an organisation. Any conversion project will be significantly more detailed than merely addressing the issues discussed in this publication. However, making a head start in identifying the accounting and business related issues on conversion can avoid accounting challenges in the years to come. While the main audience of this publication are those contemplating IFRS conversion, we hope that there is something stimulating and thoughtprovoking for those already dealing with IFRS in the power and utilities industry.

Jimmy Daboo Global Energy & Natural Resources Auditing and Accounting Leader KPMG in the UK

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

2 Impact of IFRS: Power and Utilities

Overview of the IFRS conversion process Addressing challenges and opportunities of conversion for all aspects of your business All IFRS conversions have consistent themes and milestones to them. The key is to tailor the conversion specifically to your own issues, your internal policies and procedures, the structure of your group reporting, the engagement of your stakeholders and the requirements of your corporate governance. There may be similarities

among power and utility companies. However, there always will be differences in the corporate DNA that makes one conversion project different from the next. The IFRS Conversion Management Overview diagram below presents a holistic approach to planning and implementing an IFRS conversion by helping ensure that all linkages and dependencies are established between accounting and reporting, systems and processes, people and

the business. The conversion should address proactively the challenges and opportunities of adopting IFRS for all aspects of your business. This includes, for example, consideration of the impact of IFRS transition on the regulatory aspect of your operations, which may vary depending on state, federal, international, product, reporting and competitive requirements.

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

Impact of IFRS: Power and Utilities 3

Accounting and reporting issues Early identification of differences is critical to a successful conversion project The first and fundamental area to tackle is accounting and reporting. Getting a timely and accurate assessment of the impact of IFRS and ensuring that the ‘gap analysis’ is correct are critical steps to a successful transition. Based on our experience of IFRS conversions, we outline below the ‘Top Ten’ list of accounting issues for power and utility companies to consider when converting to IFRS, and provide a glimpse of the issues to be considered. This is not meant to be a comprehensive list; indeed it does not cover many areas that power and utility companies need to consider. Owing to their generic nature there are material accounting

topics (such as defined benefit pension scheme accounting, share-based payments and business combinations) that we have not considered in this publication.

•• Accounting requirements may require careful consideration of contract terms, for example, those terms outlined in service concession arrangements.

In our experience, these issues are significant to power and utility companies for the following reasons.

•• Judgement may be required in selecting significant accounting policies and approaches that impact future results.

•• Issues may be pervasive across the sector and will require significant time and cost to evaluate and implement. For example, accounting for power purchase agreements. •• Conversion may have significant impact on information systems, accounting processes and systems, for example, the impact of different depreciation and amortisation policies may lead to adjustments in the fixed asset sub-ledger.

•• Accounting and reporting requirements may be subject to future change for which organisations need to be prepared. We recommend KPMG’s publication The Application of IFRS: Power and Utilities for greater detail on the issues raised in this document, and examples of disclosures from existing IFRS power and utility companies.

Top Ten Issues 1

Property, plant and equipment

6

Revenue recognition

2

Leases

7

Financial instruments

3

Service concessions and regulatory assets and liabilities

8

Emissions allowances and carbon trading schemes

4

Impairment of non-financial assets

9

First-time adoption of IFRS

5

Decommissioning and environmental provisions

10

Presentation of financial statements

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

4 Impact of IFRS: Power and Utilities

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Property, plant and equipment

Property, plant and equipment is significant to the balance sheet of most power and utility companies. Some issues present significant areas of judgement Most aspects of the utility value chain are capital intensive. The significance of the costs involved makes the accounting for property, plant and equipment an important issue in the sector. Property, plant and equipment is accounted for in accordance with IAS 16 Property, Plant and Equipment. Assets generally are recognised initially at cost, which includes all expenditure directly attributable to bringing the asset to a working condition for its intended use. Costs incurred need not be external or incremental in order to be directly attributable. IAS 16 allows a class of property, plant and equipment to be revalued to fair value subsequent to initial recognition, if certain conditions are met. In KPMG’s 2008 survey The Application of IFRS: Power and Utilities, only one of the 25 power and utility companies included in the survey revalued any classes of property, plant and equipment. There are other IFRS-specific considerations to be applied to the accounting for property, plant and equipment, some of which can present significant areas of judgement for power and utility companies.

Component accounting Companies need to consider the impact of identifying and depreciating assets on a more detailed component basis A power and utility company is required to allocate the initial carrying amount of an item of property, plant and equipment into its significant parts or components, and depreciate each part separately. For each component the appropriate depreciation method, rate and period needs to be considered. A separate component may be either a physical component or a non-physical

component that represents a major inspection or overhaul. An item of property, plant and equipment is separated into components when those parts are significant in relation to the total cost of the item. This does not mean that a company should split its assets into an infinite number of components if the effect on the financial statements would be immaterial. The standard does allow companies to group and depreciate components within the same asset class together, provided that they have the same useful life and depreciation method. Judgement is required to develop an appropriate depreciation policy for any such homogenous assets. Companies need to consider the impact, including on accounting systems, of recording and depreciating assets on a much more detailed level when compared to previous GAAP.

Depreciation Companies choose the most appropriate depreciation method IFRS does not specify one particular method of depreciation as preferable. Companies have the option of using the straight-line method, the reducing balance method or the unit-ofproduction method, as long as it reflects the pattern in which the economic benefits associated with the asset are consumed. In some countries that do not apply IFRS, it has been common to apply ‘renewals accounting’ in the power and utilities industry. Under renewals accounting, depreciation is not recognised on the basis that the assets are maintained at a certain performance/service level and all maintenance costs, including

component replacement costs, are expensed as incurred. It is argued that the amount recognised in profit or loss in respect of the upkeep of the assets is similar to the depreciation charge that would have been recognised. Another variation is condition-based depreciation whereby the condition of the asset is assessed and depreciation is measured as the increased cost required to restore the asset to a predetermined performance or service level. In our view, these methods are not acceptable under IFRS unless the impact is immaterial.

Major inspection or overhaul costs Shutdown costs are recognised on the balance sheet if they meet the definition of an asset Maintenance and overhaul shutdowns of facilities such as power stations occur regularly in the power and utilities industry, and are essential to ensure the efficient and safe running of plants. Subsequent expenditure on an item of property, plant and equipment is recognised as part of its cost only if it meets the general asset recognition criteria, i.e. it is probable that future economic benefits associated with the item will flow to the company and the cost of the item can be measured reliably. Major inspections and overhauls are identified and accounted for as a separate component if that component is used over more than one period. Component accounting for inspection and overhaul costs is intended to be used only for major expenditure that occurs at regular intervals over the life of an asset; costs associated with routine repairs and maintenance are expensed as incurred.

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

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Spare parts Classification of spare parts depends on the expected timing of usage Stocks of major spare parts, stand-by and servicing equipment are classified as property, plant and equipment if they are expected to be used for more than one period. In contrast, consumables and minor spare parts are classified as inventory.

Compensation received Judgement applied in accounting for compensation from contractors When constructing a new plant, agreements between the contractor and the company commonly contain compensation provisions that operate in the event that commissioning deadlines are not met by the contractor. IFRS includes specific guidance on compensation received for the loss or impairment of property, plant and equipment, and on income that is incidental to the construction of property, plant and equipment. However, there is no specific guidance on receipts for compensation or damages paid by the contractor, and often judgement is required in assessing whether recognition

in profit or loss and/or against the carrying amount of the related asset is more appropriate.

Government grants Recognition in profit or loss to match related costs Power and utility companies often receive contributions from governments towards infrastructure and transmission facilities, such as subsidies and cash payments. Government grants are accounted for in accordance with IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, and are recognised as income on a systemic basis to match the related costs that they are intended to compensate. Grants that relate to the acquisition of an asset are recognised in profit or loss as the asset is depreciated or amortised. Government grants related to assets may be either deducted from the cost of the asset (net presentation), or recognised separately as deferred income that is amortised over the useful life of the asset (gross presentation).

Transfer of assets from customers Consideration of which party controls the asset In the power and utilities industry a company may receive items of property, plant and equipment from its customers that must be used to connect those customers to a network and provide ongoing access to a supply of commodities such as electricity, gas or water. Alternatively, a company may receive cash from customers to purchase or construct such assets. When the arrangement is not a government grant (see above) or a service concession (see section 3), the accounting is guided by IFRIC 18 Transfers of Assets from Customers. Whether the transferred item is an asset of the utility company depends on whether the company controls the item, regardless of who holds legal title. Judgement is requirement in making this assessment. If the transferred item is deemed to meet the definition of an asset, then it is recognised as property, plant and equipment and in revenue. The timing of revenue recognition is determined by reference to the timing of services provided to the customer.

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

6 Impact of IFRS: Power and Utilities

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Leases

A number of arrangements not in the legal form of a lease may still contain lease transactions for accounting purposes. Proposed changes to lease accounting requirements for lessees would bring almost all leases into the balance sheet Power and utility companies often use lease transactions to supplement the significant investments made in property, plant and equipment. Lease accounting does not just apply to contracts in the legal form of a lease. This means that the substance of all commercial arrangements needs to be considered. This is particularly relevant to the power and utilities industry as many of the long-term commitments associated with the procurement or sale of power have lease characteristics.

Current accounting for leases Identification of finance leases and operating leases Leases are accounted for and presented in accordance with IAS 17 Leases. The accounting treatment of a lease does not depend on which party has legal title to the leased asset, but rather on which party bears the risks and rewards incidental to ownership of the leased asset. Under IFRS each lease is classified as either a finance lease or an operating lease. A lease is a finance

lease when substantially all of the risks and rewards of owning the leased asset are transferred from the lessor to the lessee. An operating lease is a lease other than a finance lease. Under a finance lease, the lessor recognises a finance lease receivable and the lessee recognises the leased asset and a liability for future payments. An operating lease is accounted for like an executory contract and the lessee does not recognise the asset.

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

Impact of IFRS: Power and Utilities 7

There is no single test to determine whether a lease is a finance lease; the terms of the arrangement must be considered to determine if the risks and rewards have been transferred. One consideration is the lease term. If the lease term is for a major part of the economic life of the leased asset, then the agreement usually is classified as a finance lease. IFRS does not define what is meant by the ‘major part’ of an asset’s economic life. For power and utility companies it may require significant judgement to determine the useful life of an asset due to the major refurbishments and refits that it may undergo during its life.

Identifying lease arrangements Arrangements not in the legal form of a lease may require lease accounting. Definition of a lease Legal definitions of a lease vary between jurisdictions, IFRS focuses on the economic substance of the agreement. Lease accounting is applicable to contracts that meet the definition of a lease under IFRS, regardless of their legal definition. Unless an arrangement is in the scope of IFRIC 12 (see section 3), then IFRIC 4 Determining whether an Arrangement Contains a Lease applies. The assessment of whether an arrangement contains a lease depends on whether fulfilment of the arrangement is dependent on the use of a specific asset or assets, and whether the arrangement conveys a right to use the asset(s). Specifically, under IFRIC 4 a lease exists if any of the following conditions is met. •• The purchaser has the ability or right to operate the asset or to direct how others should operate the asset, and at the same time obtains or controls more than an insignificant amount of the asset’s output. •• The purchaser has the ability or right to control physical access to the asset, while obtaining or controlling more than an insignificant amount of the asset’s output. •• The possibility that another party will take more than an insignificant amount of the asset’s output during the term

of the arrangement is remote, and the price paid by the purchaser for the output is neither a contractually fixed price per unit of output, nor the market price per unit of output. When an arrangement contains a lease and a service component, IFRIC 4 requires the separation of payments between the two components on the basis of their relative fair values. Applicability to power purchase agreements Many long-term contracts associated with the procurement or sale of power have lease characteristics. For example, a power generator may contract the long-term sale of its output to a national utility company. Such a power purchase agreement (PPA) often will be necessary to secure project finance for the plant on economic terms. Many such PPAs are likely to have lease characteristics as the purchaser effectively has the right to use the plant in return for regular payments. The asset under the arrangement need not be identified explicitly in the agreement. For example, a power plant may not be named specifically in the agreement but, due to the location of the plant and the proximity to the area of supply, it would be impracticable to use an alternate power plant to meet the obligations under the agreement.

Future developments

leases. A lessee would recognise a ‘right-of-use’ asset representing its right to use the leased asset, and a liability representing its obligation to pay lease rentals. •• For lessors, the exposure draft proposed two accounting approaches. – Performance obligation approach. If a lessor retains exposure to significant risks and benefits associated with the underlying asset, then it would apply the performance obligation approach to the lease; otherwise it would apply the derecognition approach to the lease. Under the performance obligation approach, the lessor would continue to recognise its interest in the underlying asset and, at commencement of the lease, would recognise a new asset (the lease asset) representing its right to receive lease payments from the lessee over the lease term and a liability representing its obligation to deliver use of the underlying asset to the lessee. – Derecognition approach. Under the derecognition approach, the lessor would recognise an asset representing its right to receive lease payments from the lessee, derecognise a portion of the underlying asset representing the lessee’s rights, and reclassify the remaining portion as a residual asset representing its right to the underlying asset at the end of the lease term.

Changes are expected to require lessees to recognise almost all leases in the balance sheet.The future of lease accounting for lessors is not yet clear. The IASB and the US Financial Accounting Standards Board are working on a joint project to develop a comprehensive set of principles for lease accounting. In August 2010 the Boards published Exposure Draft Leases. The exposure draft proposed the following approaches to lessee and lessor accounting.

The Boards have been redeliberating the proposals contained in the exposure draft. For lessees, the Boards have tentatively decided to proceed with the right-of-use model proposed in the exposure draft, revising the proposals regarding lease term, purchase options and contingent rents. For lessors, the Boards’ discussions have focused on a revised version of the derecognition approach.

•• For lessees, the exposure draft proposed to eliminate the requirement to classify a lease contract as an operating or finance lease; instead, it proposed a single accounting model to be applied to all

The Boards concluded that the decisions taken to date were sufficiently different from those published in the original exposure draft to warrant re-exposure of the revised proposals. A revised exposure draft is expected later in 2011.

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8 Impact of IFRS: Power and Utilities

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Service concessions, and regulatory assets and liabilities

Service concession and other arrangements with governments or regulators are common features of the power and utilities industry. Agreements need to be reviewed to ensure that the appropriate accounting is applied Relationships and arrangements with governments and regulatory agencies are important features of the power and utilities industry. Accounting for arrangements such as service concessions, supply guarantees and tariff regulation will require careful consideration on transition to IFRS. Accounting guidance exists for some aspects of these arrangements, but judgement is required to determine the nature of the arrangement and to apply the appropriate accounting policy.

Service concession arrangements Guidance is provided on accounting for service concession arrangements In some countries, governments have introduced contractual service arrangements to attract private sector participation in the development, financing, operation and maintenance of public service infrastructure such as water distribution facilities or energy supply networks. IFRIC 12 Service Concession Arrangements gives guidance on the accounting by operators for certain of these public-to-private service concession arrangements. It applies to arrangements in which the public sector controls or regulates the services provided and their prices, and controls any significant residual interest in the infrastructure. The accounting guidance applies to arrangements in which the private sector company (the operator) incurs expenditure in the early years of the arrangements, as it constructs or upgrades public service infrastructure. The operator typically receives cash only once the infrastructure is available for use.

For arrangements in the scope of IFRIC 12, the infrastructure is not recognised as property, plant and equipment of the operator. Revenue and costs relating to constructing or upgrading infrastructure are measured under IAS 11 Construction Contracts.

Regulatory assets and liabilities Currently no specific accounting guidance on accounting for rateregulated activities Rate regulation is a restriction in the setting of prices that can be charged to customers for services or products. Generally, it is imposed by regulatory bodies or governments. IFRS currently does not have any specific guidance on accounting for activities in a rateregulated environment and the general requirements of other IFRS are applied. In our view an asset cannot be recognised solely because a regulator has agreed to increased pricing in the future, although a liability may be recognised in certain circumstances. The apparent disconnection between the industry business model and accounting has raised concerns in the industry. In December 2008 the IASB added a project on rate-regulated activities to its agenda. The objective of the project was to determine whether IFRS should be amended to require certain regulated entities to recognise assets or liabilities arising from the effects of price regulation and/or to require specific disclosures that help financial statement users to understand the regulatory environment in which the company operates.

that a regulatory asset represent the right to recover specific previously incurred costs and to earn a specified return by increased pricing in the future; a regulatory liability would represent an obligation to refund collected amounts and to pay a specified return by decreasing prices in future periods. The project currently is inactive, and the IASB will decide whether or how to progress the project when it considers responses to its Agenda Consultation 2011, which are due by 30 November 2011.

Supply guarantees Recognition and disclosure depends on the terms of the guarantee Due to the significance of power and utility companies to critical services and an increasing focus by government on energy security, many agreements between government/regulatory bodies and power and utility companies are entered into to guarantee supply. The accounting for and disclosure of these agreements will vary. In some instances, these guarantees may give rise to liabilities, and in others contingent liabilities; and in some cases there may simply be discussion as part of management’s commentary on operations.

In July 2009 the IASB published Exposure Draft Rate-regulated Activities. The exposure draft proposed

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

Impact of IFRS: Power and Utilities 9

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

10 Impact of IFRS: Power and Utilities

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

Impact of IFRS: Power and Utilities 11

4

Impairment of non-financial assets

A one-step approach requires impairment losses to be recognised when the carrying amount of an asset exceeds its recoverable amount Long-life assets Annual consideration of impairment indicators For non-current assets (other than goodwill and indefinite-lived intangible assets) IAS 36 Impairment of Assets requires companies to assess, at the end of each reporting period, whether there are any indicators that an asset is impaired. If there is such an indication, then recoverable amount must be assessed. An impairment loss is recognised for any excess of carrying amount over recoverable amount. If recoverable amount cannot be determined for the individual asset, because the asset does not generate cash inflows independent from those of other assets, then the impairment loss is recognised and measured based on the cash-generating unit to which the asset belongs. Cash-generating units (CGUs) A CGU is the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other assets or group of assets of the power and utility company. The determination of the relevant CGUs can be complex in the power and utilities industry. For example, power stations may be managed as a portfolio to optimise overall performance. And different elements of the value chain – fuel procurement, generation, transmission and distribution and customer supply – may be vertically integrated. In identifying whether cash inflows from assets or CGUs are largely independent of the cash inflows from other assets or CGUs, various factors are considered. These include the manner in which management monitors operations and makes decisions about continuing or disposing of assets and/or operations.

One complexity that power and utility companies may face is the treatment of peaking plants. Many companies seek to minimise their costs using a variety of different types of generation facilities to meet demand. Some peaking plants are operated only when the electricity spot price reaches a certain level, indicating a shortage of supply that the company can take advantage of for a short period until the demand and supply equilibrium is restored. Judgement is required in assessing whether a peaking plant is a separate CGU. Indicators of impairment Some examples of indicators of impairment are outlined below. •• Market value has declined significantly or the company has operating or cash losses. •• Technological obsolescence. For example, in response to the development of alternative sources of power such as solar, wind, geothermal or hydro. •• Competition. For example, an increase in net customer churn, i.e. the amount of new customers gained is lower than the amount of existing customers lost during a period. •• Market capitalisation. For example, the carrying amount of the power and utility company’s net assets exceeds its market capitalisation. •• Significant regulatory changes. For example, increased regulation of environmental rehabilitation processes, or a decrease in prices in a regulated price environment. •• Physical damage to the asset. For example, damage to a transmission system due to a storm. •• Significant adverse effect on the company that will change the way in which the asset is used/expected to be used. For example, the

introduction of measures by some governments to phase out coal-fired generation plants.

Goodwill Impairment testing at least annually Under IFRS, power and utility companies are required to test goodwill (and intangible assets with indefinite lives) for the purposes of impairment at least annually, irrespective of whether indicators of impairment exist. Additional testing at interim reporting dates is required if impairment indicators are present. Goodwill by itself does not generate cash inflows independently of other assets or groups of assets and therefore is not tested for impairment separately. Instead, it should be allocated to the acquirer’s CGUs that are expected to benefit from the synergies of the related business combination. Goodwill is allocated to a CGU that represents the lowest level within the company at which the goodwill is monitored for internal management purposes. The CGU cannot be larger than an operating segment as defined in IFRS 8 Operating Segments, before aggregation. An impairment loss is recognised and measured at the amount by which the CGU’s carrying amount, including goodwill, exceeds its recoverable amount.

Impairment reversals Reversal of impairment losses restricted Impairment losses related to goodwill cannot be reversed. However, for other assets companies assess whether there is an indication that a previously recognised impairment loss has been reversed. If there is such an indication, then impairment losses are reversed if recoverable amount has increased, subject to certain restrictions.

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12 Impact of IFRS: Power and Utilities

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Decommissioning and environmental provisions

IFRS generally will result in the earlier recognition of provisions than many national GAAPs Power and utility companies often are exposed to legal, contractual and constructive obligations to meet the costs of decommissioning and dismantling assets at the end of their life, in addition to restoring the site.

Timing of recognition A present obligation that is more likely than not Decommissioning and environmental provisions are covered by IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Recognition of a provision is required when there is a present obligation and an outflow of resources is probable. Probable is defined as more likely than not. A present obligation can be legal or constructive in nature. For power and utility companies a legal obligation for decommissioning and site restoration may be required by legislation or regulatory requirements. The obligation to make good damage or dismantle equipment is provided for in full when the damage is caused or the

asset installed. This may result in the recognition of additional amounts or earlier recognition of such amounts in IFRS financial statements compared to previous GAAP. When the provision arises on initial recognition of an asset, the corresponding debit is treated as part of the cost of the related asset and is not recognised immediately in profit or loss.

Measurement Judgement is required to arrive at the ‘best estimate’ The provision is measured at the best estimate of costs to be incurred. This takes the time value of money into account, if material. The best estimate may be based on the single most likely cost of decommissioning and must take uncertainties into account in either the cash flows or discount rate used in measuring the provision.

of decommissioning may also affect the timing by extending the existing expected life of a plant. The estimate is updated at each reporting date.

Future developments The IASB is reviewing accounting for provisions In 2005 the IASB began reviewing the accounting for provisions and an exposure draft was issued, which would have resulted in changes to both the timing of recognition and the measurement of provisions. In 2010 the IASB issued a limited reexposure of the 2005 proposals, which included a focus on the measurement of provisions involving services, e.g. decommissioning. The project currently is inactive, and the IASB will decide whether or how to progress the project when it considers responses to its Agenda Consultation 2011, which are due by 30 November 2011.

There are many complexities in calculating an estimate of expenditure to be incurred. Technological advances that may reduce the ultimate cost

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Impact of IFRS: Power and Utilities 13

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Revenue recognition

Power and utility companies face challenges when applying the revenue recognition requirements under IFRS due to common industry arrangements that can give rise to estimation uncertainty The sale of power and utility products and services is accounted for in accordance with IAS 18 Revenue. One important consideration for power and utility companies normally is whether revenue can meet the IAS 18 criterion of being estimated reliably.

Revenue estimation Revenue estimations are important for many retail power and utility companies because meter readings do not necessarily coincide with reporting periods. Companies must develop models to estimate revenue within acceptable bounds of accuracy. This estimate generally is based on historical customer trends, seasonal and weather variation factors, actual generation for the period and existing tariff schedules. The significance of this estimate may give rise to additional disclosures of estimation uncertainty in the financial statements.

Other specific revenue recognition issues Customer discounts and incentives Power and utility companies sometimes offer customers a cash incentive to change their utility provider, or to renew their supply agreement. If the benefit that the company receives from the

customer by providing the cash incentive is the ‘right’ to perform under a contract (e.g. the right to provide electricity and gas services in the future), then the cash payment would qualify as a cash incentive. A cash incentive is included as a reduction in the measurement of revenue. In our experience, this reduction in revenue will be spread over the life of the customer contract. Some power and utility companies offer an early settlement discount to their customers. If it is probable that an early settlement discount will be taken, and the amount can be measured reliably, then generally we would expect the discount to be recognised as a reduction of revenue as the sales are recognised. Take-or-pay contracts Take-or-pay contracts often are used in the wholesale supply of gas or electricity, typically requiring the customer to pay for a specified minimum volume of delivery each year. If the minimum volume is not taken, then the customer still will be required to pay for the deficiency between the volume of gas or electricity consumed and the contract volume. Power and utility companies need to consider the treatment of deficiency payments, particularly when the customer is

likely to offset the deficiency payment against future purchases in excess of the minimum requirement. It may be appropriate to defer the recognition of revenue from the deficiency payment until the customer takes up deficiency volumes.

Future developments A new standard on revenue recognition is expected The IASB and the US Financial Accounting Standards Board are working on a joint project to develop a comprehensive set of principles for revenue recognition. An exposure draft published in 2010 proposed a single revenue recognition model in which an entity would recognise revenue as it satisfies a performance obligation by transferring control of promised goods or services to a customer. The model was proposed to be applied to all contracts with customers except leases, financial instruments, insurance contracts and non-monetary exchanges between entities in the same line of business to facilitate sales to customers other than the parties to the exchange. The Boards redeliberated the proposals contained in the exposure draft during the first half of 2011 and agreed tentatively to revise a number of aspects of the proposals, including the criteria for identifying separate performance obligations, the guidance on transfer of control, and the measurement of the transaction price, particularly for arrangements including uncertain consideration. The Boards concluded that, although there was no formal due process requirement to reexpose the proposals, it was appropriate to go beyond established due process given the importance of this topic to all entities. A revised exposure draft is expected in the second half of 2011.

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14 Impact of IFRS: Power and Utilities

7

Financial instruments

The conversion process must include a review of the existence, classification and accounting for financial instruments including derivatives. Future changes in the accounting are expected Power and utility companies generally have financial instrument accounting issues owing to the significant commodity price risk that they face and the structures that are put in place to manage this and other exposures such as currency and interest rate fluctuations. Most power and utility companies use derivatives in risk management activities. A thorough review of existence, classification and accounting for financial instruments will be required on conversion.

Current requirements Accounting and disclosure requirements may be significantly different from previous GAAP As it currently stands, IAS 39 Financial Instruments: Recognition and Measurement requires financial assets to be classified into one of four categories: at fair value through profit or loss; loans and receivables; held to maturity; and available for sale). Financial liabilities are categorised as either financial liabilities at fair value through profit or loss or ‘other’ liabilities. Financial assets and financial liabilities are measured initially at fair value. After initial recognition, loans and receivables and held-to-maturity investments are measured at amortised cost. All derivative instruments are measured at fair value with gains and losses recognised in profit or loss except when they qualify as hedging instruments in a cash flow or net investment hedge. A financial asset is derecognised only when the contractual rights to cash flows from that particular asset expire or when substantially all risks and rewards of ownership of the asset are transferred. A financial liability is derecognised when it is extinguished or when the terms are modified substantially.

Contracts to buy and sell power and other non-financial items may be included in the scope of the financial instruments standards. There is an exemption for contracts that are held for physical delivery or receipt for the company’s expected purchase, sale or usage requirements (the ‘own use exemption’). However, specific conditions must be met to apply this exemption, and its applicability should be reviewed carefully. Specific types of power and utility contracts also commonly contain embedded derivatives that may need to be accounted for separately. For example, long-term supply contracts of electricity may be linked to commodity prices. The indexed pricing element of the contract may meet the criteria of being an embedded derivative. Embedded derivatives that are not closely related to the host contract must be separated from the host contract and accounted for separately. Larger power and utility companies often have energy trading divisions through which risks are managed and energy trading conducted. Such divisions, and smaller companies, often enter into derivative arrangements to hedge their risks. A hedge accounting option is available for these and other financial instruments. The decision to apply hedge accounting is made on a transaction-by-transaction basis. This allows a company to selectively measure assets, liabilities, firm commitments and certain forecast transactions on a basis different from that otherwise required by IFRS, or to defer in equity the recognition of gains or losses on derivatives. Hedge accounting is permitted only when strict documentation and effectiveness requirements are met. There are three

hedge accounting models: fair value hedges of fair value exposures, cash flow hedges of cash flow exposures, and net investment hedges of currency exposure on a net investment in a foreign operation.

Forthcoming requirements Simplified classification In November 2009 the IASB published the first chapters of IFRS 9 Financial Instruments, which will supersede the requirements of IAS 39 Financial Instruments: Recognition and Measurement on the classification and measurement of financial assets. In October 2010 requirements with respect to the classification and measurement of financial liabilities and the derecognition of financial assets and financial liabilities were added to IFRS 9. Most of these requirements have been carried forward without substantive amendment from IAS 39. However, to address the issue of own credit risk some changes were made to the fair value option for financial liabilities. The effective date of IFRS 9 is periods beginning on or after 1 January 2013 but an exposure draft, open for comment until 21 October 2011, requests views on whether the effective date should be pushed back to 1 January 2015. IFRS 9 includes two primary measurement categories for financial assets: amortised cost and fair value. Other classifications, such as held to maturity and available for sale, have been eliminated. The classification and measurement requirements for financial liabilities are generally unchanged other than a change to the treatment of changes in fair value as a result of own credit risk.

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Impact of IFRS: Power and Utilities 15

Future developments The IASB’s review of financial Instruments accounting may result in significant changes The IASB continues to work on elements of its comprehensive financial instruments project, most notably hedging and impairment. In November 2009 the IASB issued Exposure Draft Financial Instruments: Amortised Cost and Impairment, with supplementary proposals in January 2011 relating to the

impairment of financial assets managed in an open portfolio (the supplement). The supplement proposes to replace the incurred loss approach to impairment of financial assets with an approach based on expected losses. Extensive disclosures were also proposed. The IASB issued Exposure Draft Hedge Accounting in December 2010, proposing significant changes to the current hedge accounting requirements. The proposals were designed to

integrate hedge accounting more closely with risk management policies and objectives. For companies applying hedge accounting to commodity price transactions, the process for assessing hedge effectiveness would change. The proposals also expanded the range of instruments that can be designated as hedged instruments. IASB deliberations on both projects are ongoing.

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16 Impact of IFRS: Power and Utilities

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Impact of IFRS: Power and Utilities 17

8

Emissions allowances and carbon trading schemes

No specific IFRS guidance on accounting for emissions allowances A rising number of country and jurisdiction-specific carbon trading and emissions allowances schemes are being implemented by governments around the world. IFRS does not have any specific guidance on accounting for emission allowances received. The general requirements of other IFRS are applied, e.g. IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, IAS 38 Intangible Assets and/or IAS 2 Inventories. In KPMG’s December 2008 publication The Application of IFRS: Power and Utilities, the majority of companies included in the survey recognised emissions allowances received free

from the government at a nominal amount. Other companies surveyed recognised allocated allowances at market value. Most companies did not recognise a provision in respect of emissions obligations. In December 2007 the IASB and the FASB announced a joint project of the accounting for emission allowances. The project has a broad scope and addresses different types of emissions schemes. The project currently is inactive, and the IASB will decide whether or how to progress the project when it considers responses to its Agenda Consultation 2011, which are due by 30 November 2011.

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18 Impact of IFRS: Power and Utilities

9

First-time adoption of IFRS

An early understanding of the numerous mandatory exemptions and optional exemptions from retrospective application of IFRS that are available is key for a successful transition to IFRS Selecting accounting policies at the time of preparing the opening IFRS balance sheet not only affects the first IFRS financial statements but also the financial statements for subsequent periods. IFRS 1 First-time Adoption of IFRS allows a company converting to IFRS a number of reliefs from the retrospective requirements that otherwise would apply. Without any relief, a company would be required to retrospectively implement IFRS from the start of its corporate history. IFRS 1 seeks to ensure that a company’s first IFRS financial statements contain high-quality information that is transparent for users and comparable over all periods presented. The guidance in IFRS 1 aims to provide a suitable starting point for subsequent accounting under IFRS that can be generated at a cost that does not exceed the benefits. Power and utility companies will need to go through each of the available options in IFRS 1 and decide which are the most appropriate for them. We note some examples to consider below.

Business combinations One of the most commonly used IFRS 1 exemptions is the choice not to restate pre-IFRS business combinations. Acquisitive power and utility companies will not wish to revisit previous acquisition accounting under previous GAAP, unless there is a significant benefit, such as a downward adjustment to goodwill on IFRS transition so as to avoid impairment write-offs to profit or loss in the future.

Deemed cost election: General Another exemption choice that all power and utility companies review,

but do not always take, is the deemed cost election under IFRS 1. Historic cost assets can be brought onto the power and utility company’s first IFRS balance sheet at deemed cost at the date of transition. The exemption applies to individual items of property, plant and equipment, investment property and intangible assets, subject to meeting certain criteria. Deemed cost may be (1) fair value at the date of transition; (2) a previous GAAP revaluation broadly similar to fair value under IFRS, or cost or a depreciated cost measure under IFRS adjusted to reflect changes in a general or specific price index; or (3) an eventdriven fair value. Unlike other optional exemptions, the event-driven fair value exemption under IFRS may be applied selectively to the assets and liabilities of a first-time adopter if specific criteria are met.

Deemed cost election: Rateregulated operations A further optional exemption permits a first-time adopter to use the carrying amounts determined under previous GAAP as deemed cost for items of property, plant and equipment or intangible assets used in certain rateregulated operations, even though these carrying amounts may include amounts that do not qualify for capitalisation under IFRS. This exemption is relevant to the extent that a power and utility company decides against the general deemed cost election. The exemption may be applied on an item-by-item basis provided that each item to which it is applied is tested for impairment at the date of transition. For more information on the relief available upon the adoption of IFRS, we recommend KPMG’s publication IFRS Handbook: First-time Adoption of IFRS.

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Impact of IFRS: Power and Utilities 19

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20 Impact of IFRS: Power and Utilities

10

Presentation of financial statements

Regardless of accounting differences that emerge from the assessment of accounting policies, power and utility companies need to review the presentation of their financial statements prepared under IFRS IAS 1 Presentation of Financial Statements does not prescribe specific formats to be followed. Instead, it provides the minimum requirements for the presentation of financial statements, including the content and guidelines for structure. In our experience, power and utility companies consider the presentation adopted by other power and utility companies in the sector. However, the format of financial statements of power and utility companies is quite varied. Under IAS 1 companies present ‘complete’ financial statements along with comparatives, which comprise: •• Statement of financial position (balance sheet)

Probably the most sensitive of these financial statements is the statement of comprehensive income. IFRS stipulates required line items but management selects the method of presentation that is most reliable and relevant. The standard provides companies the option to present an analysis of expenses either on the basis of nature (e.g. depreciation, purchases of material, transport costs etc.) or based on function (e.g. selling costs, administrative costs, cost of sales etc.). A company that discloses information based on function is still required to disclose, in the notes to the financial statements, certain expenses by nature including depreciation and employee benefits expense.

•• Statement of comprehensive income presented either in a single statement of comprehensive income that includes all components of profit or loss and other comprehensive income; or in the form of two consecutive statements, one being the income statement and the other the statement of comprehensive income. A statement of comprehensive income begins with the profit or loss as reported in the income statement and displays separately the various components of other comprehensive income. •• Statement of changes in equity •• Statement of cash flows •• Notes comprising a summary of significant accounting policies and other explanatory information. A first-time adopter is required to present the balance sheet at the start of its earliest comparative period. Subsequent to the adoption of IFRS, this third balance sheet is presented only in certain circumstances.

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Impact of IFRS: Power and Utilities 21

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22 Impact of IFRS: Power and Utilities

Information technology and systems considerations A major effect of converting to IFRS will be the increased burden throughout the power and utility organisation of capturing, analysing, and reporting new data to comply with IFRS requirements. Making strategic and tactical decisions relating to information systems and supporting processes early in the project helps limit unnecessary costs and risks arising from possible duplication of effort or changes in approach at a later stage. Much depends on factors such as: •• the type of enterprise system and whether the vendor offers IFRSspecific solutions;

•• whether the system has been kept current, as older versions first may need updating; and •• the level of customisation, as the more customised the system, the more effort and planning the conversion process will likely take.

From accounting gaps to information sources The foundation of the project, as described earlier, is to understand the local GAAP to IFRS accounting differences and the effects of those differences. That initial analysis needs to be followed by determining the effect of those accounting gaps on

internal information systems and internal controls. What power and utility companies need to determine is which systems will need to change and translate accounting differences into technical system specifications. One of the difficulties that power and utility companies may face in creating technical specifications is to understand the detailed end-to-end flow of information from the source systems, such as project or site operational subledgers to the general ledger and further to the consolidation and reporting systems. The simplified diagram below outlines a process that organisations can adopt to identify the impact on information systems.

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Impact of IFRS: Power and Utilities 23

How to identify the impact on information systems There are many ways in which information systems may be affected, from the initiation of transactions through to the generation of financial reports. The following table shows some areas in which information systems change might be required under IFRS depending on facts and circumstances. Change

Action

New data requirements New accounting disclosure and recognition requirements may require more detailed information, new types of data, and new fields; and information may need to be calculated on a different basis.

Modify: •• general ledger and other reporting systems to capture new or changed data; and •• work procedure documents.

Changes to the chart of accounts There will almost always be a change to the chart of accounts due to reclassifications and additional reporting criteria.

Create new accounts and delete accounts that are no longer required.

Reconfiguration of existing systems Existing systems may have built-in capabilities for specific IFRS changes, particularly the larger enterprise resource planning (ERP) systems and high-end general ledger packages.

Reconfigure existing software to enable accounting under IFRS (and parallel local GAAP and/or regulatory reporting frameworks, if required).

Modifications to existing systems New reports and calculations will be required to accommodate IFRS. Spreadsheets and models used by management as an integral part of the financial reporting process should be included when considering the required systems modifications. New systems interface and mapping changes When previous financial reporting standards did not require the use of a system or when the existing system is inadequate for IFRS reporting, it may be necessary to implement new software. When introducing new source systems and decommissioning old systems, interfaces may need to be changed or developed and there may be changes to existing mapping tables to the financial system. When separate reporting tools are used to generate the financial statements, mapping these tools will require updating to reflect changes in the chart of accounts.

Make amendments such as: •• new or changed calculations •• new or changed reports •• new models.

Implement software in the form of a new software development project or select a package solution. Interfaces may be affected by: •• modifications made to existing systems •• the need to collect new data •• the timing and frequency of data transfer requirements.

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24 Impact of IFRS: Power and Utilities

Change Consolidation of entities Under IFRS, there is the potential for changes to the number and type of entities that need to be included in the group’s consolidated financial statements. For example, the application of the concept of ‘control’ may be different under IFRS (based on IFRS 10 Consolidated Financial Statements from 1 January 2013) and previous GAAP. Reporting packages Reporting packages may need to be modified to: •• gather additional disclosures in the information from branches or subsidiaries operating on a standard general ledger package; or •• collect information from subsidiaries that use different financial accounting packages. Financial reporting tools Reporting tools can be used to: •• perform the consolidation and prepare the financial statements based on data transferred from the general ledger; or •• prepare only the financial statements based on receipt of consolidated information from the general ledger.

Action Update consolidation systems and models to account for changes in consolidated entities.

Modify reporting packages and the accounting systems used by subsidiaries and branches to provide financial information.

Modify: •• reporting tools used by subsidiaries and branches to provide financial information; •• mappings and interfaces from the general ledger; and •• consolidation systems based on additional requirements such as segment reporting in some cases.

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Impact of IFRS: Power and Utilities 25

Power and utility accounting differences and respective system issues The following table outlines some of the salient accounting differences that we have noted earlier, together with potential systems and process impacts. Accounting differences

Potential systems and process impact

Property, plant and equipment

•• Impact of changes to depreciation methods and useful lives on the posting specifications of the fixed assets sub-system. •• Impact on master data settings and structure based on a component approach to asset depreciation. •• Impact on transition to IFRS of data conversion.

Leases

•• Impact on contract sub-process and interface with the accounting systems to clearly identify arrangements that will be accounted for as leases under IFRS. •• Impact on master data settings of changes to accounting approach.

Decommissioning and environmental provisions

•• Accounting systems need to identify discount rates specific to each liability. This may lead to changes in the sub-ledger and provision calculation models as well as the general ledger.

Revenue recognition

•• Clear identification of transactions with out of the ordinary revenue recognition characteristics. Changes to the mapping of such transactions within accounting systems. •• Impact of cash incentives on revenue recognition settings.

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26 Impact of IFRS: Power and Utilities

Parallel reporting: Timing the changeover from local GAAP to IFRS reporting Conversion from local GAAP to IFRS will require parallel accounting for a certain period of time. At a minimum, this will happen for one year as local GAAP continues to be reported, but IFRS comparatives are prepared prior to the go-live date of IFRS. Parallel reporting may be created either in the real-time collection of information through the accounting source systems to the general ledger or through ‘top-side’ adjustments posted as an overlay to the local GAAP reporting system. The manner and timing of processing information for the comparative periods in real-time or through top-side adjustments will be based on a number of considerations: Parallel accounting option in comparative year

Effect

Considerations

Parallel accounting through top-side adjustments

•• No real-time adjustments to systems and processes will be required for comparative period. •• Local GAAP reporting will flow through sub-systems to the general ledger, i.e. business as usual. •• Comparative period will need to be recast in accordance with IFRS, but can be achieved off-line. •• Migration of local GAAP to IFRS happens on first day of the year in which IFRS reporting commences.

•• Less risky for ongoing local GAAP reporting requirements in comparative year. •• Available for all, but more typical when there are is a lower volume of transactions to consider. •• More applicable to small/less complex organisations or when few changes are required.

Real-time parallel accounting

•• Consideration needed for ‘leading ledger’ in comparative year being local GAAP or IFRS, i.e. which GAAP will management use to run the business. •• If leading ledger is IFRS in comparative year, then conversion back to local standards is necessary for the usual reporting timetable and requirements. •• Changes to systems and information may continue to be needed in the comparative year if the IFRS accounting options have not been fully established. •• Migration to IFRS ledgers needed prior to first day of the year in which IFRS reporting commences.

•• Real-time reporting of two GAAPs in comparative year has benefits, but puts more stress on the finance group. •• Typically used when tracking two sets of numbers for large volume of transactions will make systemisation of comparative year essential. •• More applicable for large/complex organisations with many changes. •• Strict control on system changes will need to be maintained over this phased changeover process.

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Impact of IFRS: Power and Utilities 27

Most major ERP systems (e.g. SAP®, Oracle®, Peoplesoft®) are able to handle parallel accounting in their accounting systems. The two common solutions implemented are the Account solution or the Ledger solution. Depending on the release of the respective ERP systems, one or both options are available for the general ledger solution.

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28 Impact of IFRS: Power and Utilities

Harmonisation of internal and external reporting Power and utility companies should consider the impact of IFRS changes on data warehouses and relevant aspects of internal reporting. In many companies, internal reporting is performed on a basis similar to external reporting, using the same data and systems, which will therefore need to change

to align with IFRS. One key difference that may remain after transitioning to IFRS is the reporting of regulatory assets and liabilities. The following diagram represents the possible internal reporting areas that may be affected by changing systems to accommodate the new IFRS reporting requirements.

The process of aligning internal and external reporting typically will involve the following. •• When mappings have changed from the source systems to the general ledger, mappings to the management reporting systems and the data warehouses also should be changed. •• When data has been extracted from the source systems and manipulated by models to create IFRS adjustments that are processed manually through the general ledger, the impact of these adjustments on internal reporting should be carefully considered. •• Alterations to calculations and the addition of new data in source systems as well as the new timing of data feeds could impact key ratios and percentages in internal reports, which may need to be redeveloped to accommodate them.

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Impact of IFRS: Power and Utilities 29

People: Knowledge transfer and change management When your company reports for the first time under IFRS, the preparation of those financial statements will require IFRS knowledge to have been successfully transferred to the financial reporting team. Timely and effective knowledge transfer is an essential part of a successful and efficient IFRS conversion project. The people impacts of IFRS range from an accounts payable clerk coding invoices differently under IFRS to Audit Committee approval of disclosures for IFRS reporting. There is a broad spectrum of people-related issues, all of which require an estimation of the changes that are needed under the IFRS reporting regime. The success of the project will depend on the people involved. There needs to be an emphasis on communications, engagement, training, support and senior sponsorship, all of which are part of change management. Training should not be underestimated and companies often don’t fully appreciate the levels of investment and resource involved in training. Although most conversions are driven by a central team, you ultimately need to ensure that the conversion project is not dependent on key individuals and is sustainable in the long term across the whole

organisation. Distinguishing between different audiences and the nature of the content is key to successful training. The following are some useful knowledge transfer pointers. •• Training tends to be more successful when tailored to the specific needs of the company. Few companies claim significant benefit from external nontailored training courses. •• Geographically disparate companies are considering web-based training as a cost and time-efficient method of disseminating knowledge. •• More complex areas such as revenue recognition or accounting for service concessions tend to be best conveyed through ‘workshop’ training approaches in which companyspecific issues can be tackled.

of the core central team along with a second technical expert, often an external advisor. •• Some companies use training as an opportunity to share their data collection process for group reporting at the same time. Even with the best planning and training possible, it is critical that an appropriate support structure is in place so that the business units implement the desired conversion plans properly. IFRS knowledge only really becomes embedded in the business when the stakeholders have the opportunity to actually prepare and work with real data on an IFRS basis. We recommend building dry runs into the conversion process at key milestones to test the level of understanding among finance staff.

•• Many companies manage their training through a series of site visits; typically partnerships of one member

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30 Impact of IFRS: Power and Utilities

Business and reporting One of the challenges of IFRS convergence stems from the number of stakeholders that have a vested interest in the financial performance of the company. Your project will have to deal with a large number of internal and external stakeholders so as to manage one fundamental issue – the operational performance stays the same but the ‘scoreboard’ of the financial statements gives a different result under IFRS. The measurement of operational performance cuts across all parts of an organisation and effects the internal business drivers and external perceptions of the company. The assessment of who those affected groups are, and when the appropriate time for communications will be, is a key component of an IFRS conversion project.

Stakeholder analysis and communications A thorough review of the internal and external stakeholders is an essential first step. Certain less obvious internal stakeholder groups may be engaged only in the conversion process at a late stage but the awareness of when to engage those groups is necessary. For example, most power and utility companies have union representatives that will need to be involved for changes to compensation schemes if, for example, bonuses are based on earnings per share measures that will alter under IFRS. However there is little point bringing the unions or human resource (HR) groups into detailed accounting discussions early on in the conversion process. In a similar context, external stakeholders should be properly identified and communicated with throughout the IFRS conversion. Examples include groups such as tax authorities, regulators, industry analysts and the financial media. Every identified group must be factored into the timing of when and how to present changes in operational reporting because of IFRS. Furthermore, for internal stakeholders, project related deliverables need to be incorporated into the IFRS project’s

objectives to help ensure their successful achievement. For example, many power and utility companies may operate under regulations and should be discussing changes in key metrics with regulators during the conversion process. This is particularly important if the company reports to the regulator using GAAP numbers which will change under IFRS. A common failure of all industries is the lack of a communications strategy through which companies ensure that all key stakeholder groups are fully informed of the project’s progress. At a minimum this includes the quarterly and annual disclosures in the financial reports, but may need a much broader communications strategy.

Audit Committee and Board of Directors considerations The Audit Committee and Board of Directors should be actively informed and included in the process so that they are appropriately engaged in the conversion process and do not become a bottleneck for certain key decisions. All IFRS conversions should ensure that Board and Audit Committee meetings are acknowledged on the project plan as these meetings can drive key deliverables and provide incentive for timely delivery. Other senior management groups also need to have tailored and periodic training to suit their knowledge requirements so as to not overwhelm them with accounting theory on IFRS. Clearly there is a balance to be struck between the accounting understanding required and the responsibilities of the group undergoing the training.

Monitoring peer group The power and utility community often uses industry benchmarks and peer group comparisons. As such, most power and utility companies in a given geography will want to know what their peers are doing as it relates to IFRS and what choices and options are being taken by others. Investors and analysts may also want to be able to look across power and utility companies and be aware of the differences, so as to factor those differences into their various buy/ sell/hold recommendations. Management will need to assess its power and utility peer group, but the manner in which this is achieved may vary depending on the working relationship with its peers. Past practice has seen sector groups form that informally share updates on the accounting interpretations, practical issues and choices being made throughout the IFRS conversion projects, as well as more formal discussions occurring through the facilitation of industry bodies.

Other areas of IFRS risks to mitigate A quality IFRS conversion needs to enable an accounting process involving change management and complexity to be as risk-free as possible. It is essential that a power and utility company does not miss deadlines, or issue reports including errors. As such, the stakes are high when it comes to IFRS conversions and power and utility companies are no different in this regard. There are a number of areas to consider, but the two main ones are around the use of the external auditor and the internal control certification requirements.

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Impact of IFRS: Power and Utilities 31

The close co-operation and use of the company’s auditors should be an integral part of the IFRS governance process of the project. There needs to be explicit acknowledgement on the part of the company for frequent auditor involvement. Clear expectations should be set around all key deliverables, including timely IFRS technical partner involvement. The Audit Committee also needs to ensure that the external audit teams have reviewed changes to accounting policies alongside the approval by Audit Committee. Proper planning for new and enhanced internal controls and certification process as part of your IFRS conversion

should be considered. Assessment of internal control design for accounting policy management as well as financial close processes are integral and companies need to be aware of the impact of any manual work-arounds used. Documentation of new policies, procedures and the underlying internal controls will all need to be reflected as part of the IFRS process.

Benefits of IFRS While the majority of this paper has focused on the micro-based risks and issues associated with IFRS and IFRS conversions, senior management should not lose sight of the macro-

based benefits to IFRS conversion. IFRS may offer more global transparency and ease access to foreign capital markets and investments, and that may help facilitate cross-border acquisitions, ventures and spin-offs. For example, and as a final thought, by converting to IFRS, power and utility companies should be able to present their financial reports to a wider capital community. If this lowers the lending rate to that company by, say, a quarter of a percentage point for the annuity of the instrument, then the benefits are clearly measurable despite the short-term pain of the finance group through the IFRS conversion process.

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32 Impact of IFRS: Power and Utilities

KPMG: An Experienced Team, a Global Network KPMG’s Energy & Natural Resources practice

KPMG’s Global Power & Utilities Practice

KPMG’s Global Energy & Natural Resources (ENR) practice offers customised, industry-tailored Audit, Tax and Advisory services that can lead to comprehensive value-added assistance for your most pressing business requirements.

KPMG member firms offer global connectivity. We have 12 dedicated Power & Utilities Centres of Excellence in key locations around the world, working as one global network. They are a direct response to the rapidly evolving power and utilities sector and the specific challenges that this is placing on industry players.

KPMG’s Global ENR practice is dedicated to supporting all organisations operating in the Power & Utilities, Mining, and Oil & Gas industries globally in understanding industry trends and business issues. Our professionals, working in member firms around the world, offer skills, insights and knowledge based on substantial experience working with ENR organisations to understand the issues and help deliver the services needed for companies to succeed wherever they compete in the world. KPMG’s Global ENR practice, through its global network of highly qualified professionals in the Americas, Europe, the Middle East, Africa and Asia Pacific, can help you reduce costs, mitigate risk, improve controls of a complex value chain, protect intellectual property, and meet the myriad challenges of the digital economy. For more information, visit kpmg.com and kpmgglobalenergyinstitute.com

Located in Budapest, Calgary, Dallas, Essen, Hong Kong, Johannesburg, London, Melbourne, Moscow, Paris, Sao Paulo, and Tokyo, the centres support companies in the upstream, downstream and service industries around the world, helping them to anticipate and meet their business challenges. In each centre, there are professionals with practical, in-depth power and utilities experience. They draw on our wider global network of power and utilities practitioners to provide our clients with immediate access to the latest industry knowledge, skills, resources and technical developments.

emerging issues and discuss what is on our clients’ management agendas. The centres also produce regular surveys and commentary on issues affecting the sector, business trends, changes in regulations and the commercial, risk and financial challenges of doing business.

Your conversion to IFRS As a global network of member firms with experience in more than 1,500 IFRS convergence projects around the world, we can help ensure that the issues are identified early, and can share leading practices to help avoid the many pitfalls of such projects. KPMG firms have extensive experience and the capabilities needed to support you through your IFRS assessment and conversion process. Our global network of specialists can advise you on your IFRS conversion process, including training company personnel and transitioning financial reporting processes. We are committed to providing a uniform approach to deliver consistent, high-quality services for clients across geographies.

Our Centres of Excellence also enable us to transfer knowledge and information globally, quickly and openly. With regular calls and effective communications tools, we share observations and insights, debate new

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Contact us Global Energy & Natural Resources Practice Global Chairman Michiel Soeting KPMG in the UK T: +44 20 7694 3052 E: [email protected] Global Head of Audit for ENR Jimmy Daboo KPMG in the UK T: +44 20 7311 8350 E: [email protected] Global Head of Power & Utilities Peter Kiss KPMG in Hungary T: +36 (1) 887 7384 E: [email protected] Regional ENR Leaders Australia Anthony Jones KPMG in Australia T: +61 (2) 9335 7238 E: [email protected] Austria Helmut Kerschbaumer KPMG in Austria T: +43 (1) 31332 230 E: [email protected] Brazil Vania Andrade de Souza KPMG in Brazil T: +55 (21) 3515 9421 E: [email protected] Canada Michael McKerracher KPMG in Canada T: +1 403 691 8056 E: [email protected] Chile Patrick Hanley KPMG in Chile T: +56 (2) 798 1230 E: [email protected]

China

Portugal

Terry Chu KPMG in China T: +86 (10) 8508 7035 E: [email protected]

Jean Gaign KPMG in Portugal T: +351 (210) 110 093 E: [email protected]

Denmark

Russia

Peter Gath KPMG in Denmark T: +45 3818 3538 E: [email protected]

Andrew Korn KPMG in Russia T: +7 (495) 937 4438 E: [email protected]

France

Singapore

Jacques-Francois Lethu KPMG in France T: +33 (1) 5568703 E: [email protected]

Kam Yuen Lau KPMG in Singapore T: +65 (6213) 2550 E: [email protected]

Germany

Sharad Somani KPMG in Singapore T: +65 6213 2052 E: [email protected]

Olaf Koeppe KPMG in Germany T: +49 30 2068 1149 E: [email protected] India Hiranyava Bhadra KPMG in India T: +91 (22) 3983 6000 E: [email protected] Italy Renato Naschi KPMG in Italy T: +39 06 809 611 E: [email protected] Japan Mina Sekiguchi KPMG in Japan T: +81 (3) 5218 6700 E: [email protected] Netherlands Hans Bongartz KPMG in The Netherlands T: +31 10 453 4466 E: [email protected]

South Africa De Buys Scott KPMG in South Africa T: +27 (11) 647 8982 E: [email protected] Spain Francisco Alvarez-Ossorio Laborde KPMG in Spain T: +34 91456 3519 E: [email protected] Sweden Johan Dyrefors KPMG in Sweden T: +46 (8) 723 9796 E: [email protected] United Kingdom Mark Powell KPMG in the UK T: +44 (0) 20 7694 1712 E: [email protected] United States Darin Kempke KPMG in the US T: +1 267 256 1640 E: [email protected]

© 2011 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.

Other KPMG publications We have a range of IFRS publications that can assist you further, including: • The Application of IFRS: Power and Utilities • Insights into IFRS • IFRS compared to US GAAP • IFRS Handbook: First-time adoption of IFRS • New on the Horizon publications that discuss consultation papers • First Impressions publications that discuss new pronouncements • Illustrative financial statements for annual and interim periods • Disclosure checklist.

Acknowledgements We would like to acknowledge the authors and reviewers of this publication, including: Pamela Taylor

KPMG International Standards Group (part of KPMG IFRG Limited)

Anthony Jones KPMG in Australia Nicole Perry

KPMG in Australia

www.kpmg.com/ifrs The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2011 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Publication name: Impact of IFRS: Power and Utilities Publication number: 314697 Publication date: September 2011