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Task Force to Examine Specialized Electricity Contracts

The FASB’s Emerging Issues Task Force (EITF) has started discussions on whether certain electricity contracts in nodal energy markets should qualify for the normal purchases and normal sales scope exception in derivatives accounting. Most electricity companies do not want to follow derivatives accounting, which would require them to mark the contracts to market.

The FASB’s Emerging Issues Task Force (EITF) is exploring whether certain contracts for future delivery of electricity should have to follow derivatives accounting.

At issue is whether the physical delivery of electricity through a nodal energy market should qualify for the normal purchases and normal sales scope exception in Topic Topic 815, Derivatives and Hedging.

Most electricity companies believe they should qualify for the exemption, a FASB staff accountant told the task force at an education session on January 22, 2015.

“They do not convert the contract to cash, so the intent is not to speculate on the price of electricity,” FASB fellow Mark Pollock said. “They’re not trading electricity; they actually do take physical ownership of electricity they bought on a forward basis.”

The task force did not take action during the education session. The group is expected to meet in March to decide whether to draft a proposal to send to the FASB to clarify this accounting issue. The EITF is working on the issue as EITF Issue 15-A, “Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets.”

Under Topic 815, a contract for the physical delivery of electricity on a forward basis meets the definition of a derivative when it meets several criteria. Derivatives must be recognized at fair value each period as an asset or liability with changes in recognized in earnings.

There is an exception, however, for what the standard-setter calls “normal purchases and normal sales.” These transactions can be accounted for under the accrual method, which is considered less complex than following derivatives guidance.

FASB staff research revealed that many companies that operate in nodal energy markets take this exemption, even though they technically do not qualify for it. Analysts and investors, furthermore, said they did not believe marking revenue and cost of sales transactions to market “would be helpful for routine transactions,” according to papers produced for the meeting.

“Derivatives are generally used in hedging situations or as protection from future variability,” said EITF member Terri Campbell, managing director with Liberty Mutual Group Asset Management Inc.

Much of the January 22 discussion was spent explaining what nodal energy markets are. FASB research staff members said electricity is produced at a few large, regional generating plants and is transmitted over wires to customers. In the past, power companies owned and operated their own electricity grid transmission systems.

In the early 20th century, power companies formed “interconnection” groups whereby several companies in the same region connected their systems, in part to improve grid reliability and to reduce costs. In recent years, changes in U.S. energy policy encouraged companies to join regional transmission organizations, where day-to-day operations are managed by independent system operators.

These operators charge electricity companies for their use of the grid. Charges are based on the differences between pricing at delivery and withdrawal locations, which are called nodes.

A so-called nodal energy market promotes low-cost transmission paths and more efficient electricity generation, the research team told the task force.