Priyanshu Gundana, Partner, Price Waterhouse & Co.
The power sector in India is governed by the Electricity Act, 2003 (Act). The sector is divided into three major divisions - generation, transmission and distribution. A traditional integrated power entity (utility) generates electricity and sends it around the country or region via high-voltage transmission lines, finally delivering it to customers through a retail distribution network.
Distribution of power was mostly owned by state distribution companies (discoms) in the past, now after privatisation there are also privately owned companies that undertake distribution of power in some states or cities. The government has set up the Regulatory Commissions, which regulate the electricity sector and determine the tariff for distribution and transmission companies as well as the tariff of the generation plants which sell the power to the distribution companies.
There are two methodologies based on which tariff is fixed by the regulators, i.e. cost-plus approach and tariff-based competitive bidding system. In the cost-plus approach, an agreement is entered into between the generator and the distribution company. Tariff is determined by the regulator, based on the built-up cost for the power plant. Whereas in the bidding system, the discoms call for bids from power developers and the one bidding the lowest tariff gets to set up the project. Regulators are in favour of tariff-based competitive bidding regime for future power projects, citing that tariffs obtained through bidding were lower than the levelised tariff under the cost-plus approach.
These contracts are generally accounted as normal sales and purchase transactions in the Indian GAAP. Under Indian Accounting Standard (Ind AS) the accounting differs based on the terms and conditions of each contract and there is no single solution for all type of contracts. This may also lead to recognition of assets from the books of generator. The power purchase agreements (PPA) with the distribution company may be accounted as service concession arrangements or lease depending on the factors showed in the table.
Service concession arrangements: The company first has to assess whether the PPA gets covered under service concession arrangements. Under the old Indian GAAP, the ICAI issued an exposure draft guidance note on 'Accounting for Service Concession Arrangements by Concessionaires', which was not finalised. Hence there was no standard practice followed by companies. Under Ind AS Appendix A of Ind AS 11 applies to the companies on fulfilling of the below two conditions:
Grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them, and at what price the service is provided.
Grantor controls, through ownership, beneficial entitlement or otherwise, any significant residual interest in infrastructure at the end of the arrangement.
The Appendix also covers PPA which is for the entire useful life of the plant. Another way in which the grantor i.e. regulator, is able to exercise control of the residual infrastructure is through a call option/right of refusal to acquire the infrastructure asset at the end of the concession period. Such a call option would effectively prevent the operator from selling or pledging the asset.
This means that the grantor has full control of the right to use the infrastructure throughout the concession period and hence, the second condition of the control test is met. It does not matter whether the option exercise price is at fair value at the date of exercise (where the operator bears the residual value risk), or is pre-determined (where the grantor bears the residual value risk). The fact is that the call option allows the grantor to control the right to use the infrastructure and, hence, it's residual is sufficient for the concession arrangement to fall within service concession scope.
Here, the operator is providing two types of services - construction service and operation and maintenance (O&M) service. The operators do not have control over the infrastructure, hence it should not be recognised as its property, plant and equipment. The operator acts as a service provider under the arrangement. It recognises the expenditure incurred as an 'intangible asset' (right to collect from customers' or 'financial asset'; right to collect from grantor).
Further, under the intangible asset model, toll charges collected from users are recognised as revenue. Simultaneously, the company will amortize the intangible asset to the statement of profit and loss (P&L) over the term of the concession period. In the financial asset model, the operator will recognise interest income over the financial asset created and will allocate the amount received from grantor between the recovery of financial asset and interest using effective interest rate method. Accounting for concession arrangements typically involves an extensive use of estimates and valuations, which are expected to have a significant impact on the company's financial statements.
Lease arrangements: Companies should also evaluate whether PPA may be classified as lease under Ind-AS 17. Appendix C to Ind-AS 17 provides the following two criteria, which if met, will indicate the existence of a lease:
(a) Fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset), and
(b) The arrangement conveys a right to use the asset.
An arrangement conveys the right to use if any of the following conditions are met: -The purchaser has the ability or right to operate the asset, or direct others to operate the asset in a manner it determines while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
-The purchaser has the ability or right to control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
-Facts and circumstances indicate that it is remote that one or more parties other than the purchaser will take more than an insignificant amount of the output or other utility that will be produced or generated by the asset during the term of the arrangement, and the price that the purchaser will pay for the output is neither contractually fixed per unit of output nor equal to the current market price per unit of output as of the time of delivery of the output.
Generally in case of a cost plus model there is a single procurer of power and the price is not fixed per unit of output. Hence, these PPA may be classified as lease. Once a determination is reached that an arrangement contains a lease, the lease arrangement must be classified as either financing or operating, according to the principles in Ind AS 17. Such accounting may have significant impact on the financial statements of companies. To illustrate if a discom purchases 100 per cent power from a coal generation plant in cost plus model. In such case, this arrangement could be determined to be a finance lease which will lead to the power producing entity to derecognise its plant and recognise lease payments receivable. On the other hand, the discom will recognise asset and finance lease liability in its book.
There has been focused of the government in increasing the use of power of renewable source of energy. The PPA in relation to renewable energy are done, as far as possible, through competitive bidding process and has fixed levelised tariff over the term of the contract.
Further, there can be contracts in which the generator has the right to sell power even to third parties. In such case, the PPA may not be classified as lease, since the price that the procurer will pay for the output is contractually fixed per unit and there is a possibility that the output will be purchased by more than one party.
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