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7.5 Renewable energy credits sales
Publication date: 20 Jul 2016
us Utilities guide
A reporting entity engaged in the sale of RECs will need to determine how and when to recognize revenue related to the REC sales. In addition, it will need to consider the related expense recognition. To make those determinations, a seller of RECs should consider (1) its accounting policy regarding RECs as output and (2) the form of arrangement used to sell the RECs (whether the RECs are being sold on a stand-alone basis through a forward contract or in combination with energy or other products).
Any time RECs are sold, a reporting entity should first apply the commodity contract accounting framework (see UP 1). Once the contract model is established, the reporting entity will need to consider the terms of its contractual arrangements and the specific requirements of the applicable RPS program to determine how and when to recognize revenue. Finally, the reporting entity should consider the method by which expense is recorded related to the RECs sold.
After identifying the contract deliverables and unit of accounting, the parties should first determine whether the agreement contains a lease. If lease accounting does not apply, the contract should then be assessed to determine if it is a derivative in its entirety. The reporting entity should then assess whether it includes one or more embedded derivatives (unless the contract is a derivative in its entirety). If neither lease nor derivative accounting apply, the parties would account for the REC agreement as an executory contract (i.e., on an accrual basis).
7.5.1 Accounting for stand-alone forward renewable energy credit contracts
In some jurisdictions, reporting entities may satisfy their RPS requirements by purchasing RECs on a stand-alone basis. The ability to separate a REC from the associated energy allows for the creation of a tradable unit that can be purchased and sold without the physical constraints of a power market. Financially-settled forward contracts for RECs, as well as options or swaps involving RECs, generally meet the definition of a derivative and such contracts are not further discussed herein. In contrast, we discuss the accounting for physically-settled forward contracts for RECs in 7.5.1.2.
7.5.1.1 Lease accounting
If the reporting entity accounts for RECs as output, a contract for the purchase of RECs that is sourced from a specified power plant could qualify as a lease. However, because power plants also produce other outputs such as power and capacity, it is unlikely that the RECs alone would represent 90 percent of the total value of a plant’s outputs. As such, this type of contract is generally not expected to meet the definition of a lease.
7.5.1.2 Derivative accounting
If the contract does not contain a lease, a reporting entity should next assess whether it is a derivative in its entirety.
Figure 7-4 highlights the evaluation of a typical forward contract for the physical purchase or sale of RECs.
Figure 7-4
Does a REC forward contract meet the definition of a derivative?
Does a REC forward contract meet the definition of a derivative?
Guidance
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Evaluation
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Comments
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Notional amount and underlying
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Met
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Initial net investment
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Met
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Net settlement
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Generally not met
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REC forward contracts that are physically settled generally will not meet the definition of a derivative instrument; however, each contract should be evaluated in the context of its individual facts and circumstances. In general, we would not expect a physically settled contract for RECs to be accounted for as a derivative because they fail the net settlement criterion.
Net settlement. The contract can be settled net by any of the following means:
1. Its terms implicitly or explicitly require or permit net settlement.
2. It can readily be settled net by a means outside the contract.
3. It provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.
Following are factors to consider in assessing whether REC forward contracts meet the net settlement criterion. See UP 3.2.3 for further information on the overall application of the net settlement criterion.
- Net settlement under contract terms
When evaluating whether the net settlement criterion is met, a reporting entity should first consider whether the contract explicitly or implicitly provides for net settlement of the entire contract. Forward contracts for RECs typically require physical delivery and do not permit explicit net settlement. However, reporting entities should evaluate the type of contract and its terms to determine that there are no implicit net settlement terms or liquidating damage provisions that may imply that the contract could be net settled.
- Net settlement through a market mechanism
In this form of net settlement, one of the parties is required to deliver an asset, but there is an established market mechanism that facilitates net settlement outside the contract. ASC 815-10-15-110 through 15-116 provide guidance on indicators to consider in assessing whether an established market mechanism exists. A key aspect of a market mechanism is that one of the parties to the agreement can be fully relieved of its rights and obligations under the contract. We are not aware of any markets for RECs in the United States in which a provider has the ability to be relieved of its full rights and obligations under a previously-executed contract.
- Net settlement by delivery of an asset that is readily convertible to cash
The key factor in assessing whether an asset is readily convertible to cash is whether there is an active spot market for the particular product being sold under the contract. Current market conditions should always be considered in this analysis. To be deemed an active market, a market must have transactions with sufficient frequency and volume to provide pricing information on an ongoing basis. In addition, quoted prices from that market will be readily available on an ongoing basis. See UP 3.2.3.3 for further information on the determination of whether a market is active. Based on the current structure of the markets, we are not aware of any active spot markets for RECs in the United States.
Based on these observations, we believe that derivative accounting is generally not applicable to these physically-settled forward contracts. However, a reporting entity should evaluate all facts and circumstances in concluding on the appropriate accounting for a specific REC contract and monitor its conclusion periodically because markets evolve, potentially rendering this type of contract a derivative.
In addition, if the contract does not meet the definition of a derivative in its entirety, the reporting entity should evaluate the contract to determine if there are any embedded derivatives that require separation.
Conditionally designating REC contracts as normal purchases and normal sales
Reporting entities may also consider conditionally designating REC contracts under the normal purchases and normal sales scope exception if physical delivery is probable throughout the life of the contract and the other criteria for application of this exception are met (ASC 815-10-15-22 through 15-51, as applicable).
If a conditionally-designated normal purchases and normal sales contract meets the definition of a derivative at a later date, it would be accounted for as a normal purchases and normal sales contract (i.e., not as a derivative) from the time the contract becomes a derivative, provided the reporting entity appropriately documents the election and the relevant criteria are met. Absent such a designation, the reporting entity would be required to record the contract at its fair value at the time it becomes a derivative. See UP 3.3.1 for further information on the normal purchases and normal sales scope exception.
7.5.1.3 Executory contract accounting
We would generally expect a stand-alone REC contract to be accounted for as an executory contract. In such cases, reporting entities should evaluate whether there are any embedded derivatives (e.g., pricing mechanisms) that require separation from the host contract (see UP 3.4 for information on evaluating embedded derivatives).
7.5.2 Accounting for the forward sale or purchase of renewable energy credits within a power purchase agreement
It is common for RECs to be sold within a power purchase agreement that includes other elements such as energy and capacity. Similar to a stand-alone contract for RECs, these contracts should be evaluated under the commodity contract accounting framework. After the reporting entity determines the appropriate accounting model(s), it will need to consider the allocation of the revenue or cost among lease, derivative, and other elements, as applicable.
7.5.2.1 Lease accounting
ASC 840 provides guidance for determining whether an agreement that transfers the right to use identified property, plant, or equipment should be accounted for as a lease. An arrangement contains a lease if both of the following conditions are met:
- Fulfillment of the arrangement is dependent on the use of specified property, plant, or equipment
- The arrangement conveys the right to control use of the property, plant, or equipment
These criteria consider whether the purchaser has the right or ability to control the property, plant, or equipment, including whether it is remote that one or more parties other than the purchaser will take more than a minor amount of output or other utility from the property, plant, or equipment. In general, a contract for a sale of substantially all of the energy, capacity, and RECs from a specified facility to a single party will contain a lease.
Energy and renewable energy credits sold to separate parties
In some situations, a reporting entity may sell energy and capacity from a specified property to one off-taker while retaining the RECs or selling them to a different counterparty. In such cases, the contract for the sale of RECs should be evaluated consistent with the lease discussion.
A reporting entity’s policy on RECs as output may impact the lease evaluation. For example, if the reporting entity accounts for RECs as output, then sales of the RECs to one party and the energy and capacity to another may result in a conclusion that the arrangement does not contain a lease because the RECs represent more than a minor amount of the plants total output going to a different party. However, if the reporting entity’s policy is that RECs are not output, the contract for energy and capacity may contain a lease.
7.5.2.2 Derivative accounting
If a reporting entity concludes that a contract for the sale of energy and RECs is not a lease, it should then assess whether the contract is a derivative in its entirety. Typically, this type of combined contract does not meet the definition of a derivative in its entirety because it lacks the net settlement criterion. Further, the reporting entity would then evaluate whether the contract contains an embedded derivative that requires separation.
As discussed in UP 7.5.1.2, based on our understanding of current markets in the United States, the REC portion of the contract usually will not qualify as a derivative (absent contractual net settlement provisions). However, the reporting entity should evaluate the sale of energy, capacity, and other products (as applicable) to determine if the contract contains any embedded derivatives that require separation. See
UP 3.4.3 for further information on evaluating these types of contracts.
UP 3.4.3 for further information on evaluating these types of contracts.
7.5.3 Allocation of consideration
The recognition of revenue for a REC contract is determined by the conclusion as to whether it is accounted for as part of the overall lease of a facility or following an executory contract accounting model. Figure 7-5 summarizes potential revenue recognition models for RECs.
Figure 7-5
Seller considerations in renewable energy credit revenue allocation and recognition
Seller considerations in renewable energy credit revenue allocation and recognition
Type of sale
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Output?
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Evaluation
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Contract contains a lease
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Yes
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• RECs are part of the lease of the facility, therefore payments received are part of lease revenue.
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No
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• RECs are accounted for following an executory contract model; see below.
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Executory contract
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Either
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• RECs are accounted for following an executory contract model; other contractual elements should follow the applicable model (derivative or executory contract).
• Reporting entities should consider timing of revenue recognition for the sale of RECs.
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As noted in Figure 7-5, in general, revenue should be allocated to RECs and separately recognized in all cases, except when RECs are considered output and are sold as part of a lease.
7.5.3.1 Renewable energy credits sold as part of a lease
When RECs are part of the output of a facility and that facility is leased to another entity, the RECs are part of the overall usage of the facility. In such cases, the reporting entity is leasing its facility, and the lessee is using the facility to generate electric energy and RECs (generation activities may be performed by the reporting entity on the lessee’s behalf if the reporting entity is the operator of the facility). Therefore, the reporting entity should not separately allocate revenue for the sale of RECs. Instead, the sale of RECs is part of the overall lease. Because lease accounting is applicable, the timing of revenue recognition should follow the appropriate lease accounting guidance, considering factors such as potential levelization of lease payments and the classification of the lease.
If, however, the reporting entity’s policy is that RECs are not output, then the sale of RECs is not part of the lease of the facility. Instead, that portion of the contract represents a nonlease element. The reporting entity should apply the lease accounting guidance to allocate consideration received between the lease and nonlease elements of the contract (as discussed in UP 2.3). The reporting entity should then apply an executory accounting model for the sale of RECs, including consideration of the appropriate timing of revenue recognition.
7.5.3.2 Renewable energy credits sold as part of a contract that is not a lease
When RECs are sold as part of a contract that contains other components (such as energy) and the contract does not contain a lease, a reporting entity should follow an executory accounting model for the sale of RECs (assuming the REC sale does not meet the definition of a derivative). In performing the allocation of consideration under an executory contract model, reporting entities should consider ASC 605-25, which provides guidance for multiple-element arrangements. In addition, reporting entities should consider the appropriate timing for revenue recognition (see UP 7.5.4.1).
The same revenue recognition considerations also would be applied to a stand-alone contract for the sale of RECs.
7.5.4 Revenue recognition
When a reporting entity determines that the sale of RECs should be accounted for following an executory contract model, it should consider the timing of revenue recognition. In many cases, the administration of the RPS or REC program is performed by the regional transmission organization, or some other organization on behalf of the state government or public utility commission. The administrator will typically track serial or reference numbers of RECs generated and remitted and hold accounts for each participant in the program.
As a first step in the process, a facility is typically certified as an eligible renewable energy resource, which allows the owner of that facility to participate in the state’s or region’s renewable energy program, as applicable. In most cases, a certified power generator will submit meter data to the program administrator upon generation of electricity. The generator typically has a legal right to a REC upon generation of power from the certified source; however, the RECs will not be received until after the administrator completes its settlement process. This normally involves a reconciliation of meter data in a manner consistent with the local market settlement system as well as other validation as required in that market. RECs awarded to the generator are specifically identified and credited to its account once the settlement process has been completed; there is typically a delay between the time the associated power is generated and the time the REC settlement process is complete.
Each jurisdiction operates a slightly different program, and the time between generation of the associated power and receipt of the REC can vary. For example, in certain regions, RECs are credited on a monthly basis, while in others the REC is credited to the generator’s account in the month following the quarter the power was generated. In addition, some regions allow automatic transfer of RECs from the generating entity to the purchasing entity, while other administrators require the generator to manually transfer the RECs each period.
7.5.4.1 Timing of revenue recognition
The timing of recognizing revenue will be dependent on whether the criteria has been met under the applicable guidance. The current criteria to be considered is discussed below; however, this evaluation should follow the accounting guidance that is effective when the transaction takes place. This evaluation may change when the new revenue standard (ASC 606) is effective for the reporting entity.
ASC 605 provides guidance on the appropriate timing for revenue recognition when lease and derivative accounting is not applicable.
Excerpt from ASC 605-10-S99-1
SAB Topic 13.A.1, Revenue Recognition—General
The staff believes that revenue generally is realized or realizable and earned when all of the following criteria are met:
Persuasive evidence of an arrangement exists,
Delivery has occurred or services have been rendered,
The seller’s price to the buyer is fixed or determinable, and
Collectibility is reasonably assured.
In the typical transaction for the sale of RECs, there is persuasive evidence of an arrangement (i.e., a contractual arrangement such as a power purchase agreement), the seller’s price to the buyer is fixed per REC, and collectibility is reasonably assured (subject to default risk in the normal course). However, in a combined sale of energy and RECs, the physical REC certificate will usually be delivered sometime after the electricity has been generated. Delivery of the REC will follow the applicable administration and reconciliation process. As such, it is important to consider the method and timing of delivery in determining when revenue should be recognized.
Whether delivery of a REC has occurred will depend in part on the manner in which the relevant RPS program operates. In some cases, the delivery of the power and related REC are separate, with the REC being delivered sometime after the power has been generated. For example, some power purchase agreements state that title to the REC will transfer upon delivery of the REC into the account of the buyer (which does not occur until completion of the administration and reconciliation process described above).
In other cases, the risks and rewards of ownership may be transferred simultaneous with the generation of power. In those circumstances, assuming all other revenue recognition criteria have been satisfied, a reporting entity may conclude that delivery of the RECs has occurred and that revenue can be recognized for both power and RECs at the time the power is generated.
In reaching a conclusion about the appropriate timing of revenue recognition, a reporting entity should evaluate specific contractual arrangements for the sale of RECs and the conditions of the relevant state or local program. Figure 7-6 highlights key factors to consider.
Figure 7-6
Determining when revenue should be recognized for the sale of renewable energy credits
Determining when revenue should be recognized for the sale of renewable energy credits
Indicators that revenue should be recognized when RECs are transferred
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Indicators that revenue should be recognized when power is generated
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Each state will have different parameters, depending on the program.
For example, California and Texas have programs that could lead to different accounting results, as indicated in the following examples.
EXAMPLE 7-1
Accounting for renewable energy credit sales in California
California’s state renewable energy program is known as the Renewable Portfolio Standard (RPS). The mechanism for administering the RPS’ recognized renewable energy certificates (RECs) is known as Western Renewable Energy Generation Information System (WREGIS). Any entity that wishes to own RECs must register with the WREGIS administrator to establish an account. Account holders may register a generating unit (a renewable energy facility) and designate an active subaccount into which RECs will initially be deposited. After a generating unit reports generation for a given month, RECs are created for each megawatt-hour of renewable energy and assigned a unique serial number, which could also be in a batch. The RECs are created in the generating unit’s assigned active subaccount within the generating unit owner’s account. The RECs may be deposited directly into the off-taker’s account via a forward certificate transfer, or transferred monthly via a one-time transfer.
Ivy Power Producers (IPP) enters into an agreement to deliver all of the energy, capacity, and RECs from its Wisteria Wind Power Project, a 40 MW wind facility, to Rosemary Electric & Gas Company (REG). The Wisteria Wind facility is located within the Western Interconnection, which is covered by WREGIS. Assume that IPP has an accounting policy that RECs are not output. Under the terms of the agreement between IPP and REG, IPP is required to designate REG as the transferee of a forward certificate transfer, such that the RECs generated by Wisteria will be automatically deposited in REG’s account. In addition, the contract specifies that REG has ownership of all environmental attributes at the time of generation, including RECs and any other benefits.
When should IPP recognize revenue related to the sale of the RECs to REG?
Analysis
Under the contract terms, performance is completed and delivery occurs at the time the power is generated and delivered. In addition, title to the environmental attributes transfers at the time of generation and IPP has fulfilled the requirements of the contract by pre-certifying the plant and designating REG as the recipient.
IPP should be able to reliably calculate the number of RECs generated in a given period and would have fulfilled all of the contract terms at the time of generation. Therefore, in this case, it would be appropriate for IPP to recognize revenue for the sale of RECs under the contract at the time power is generated.
EXAMPLE 7-2
Accounting for renewable energy credit sales in Texas
The Renewable Energy Credit Program in Texas is administered by the Electric Reliability Council of Texas. ERCOT will post the exact RPS requirements for each participant on March 1 of the year following the year in question. For example, a participant will know exactly what its RPS requirements for 2014 are on March 1, 2015. The participant then has until March 31 to comply with that requirement. Participants may submit RECs in March from their Texas REC Program account in satisfaction of their requirement. However, the actual transfer of the RECs cannot occur until the RECs are allocated into the participant’s account. RECs are not credited to the account of the generator until after meter data has been supplied to ERCOT and a reconciliation has been completed (this typically occurs at least 59 days after the end of each quarter).
Ivy Power Producers (IPP) enters into an agreement to sell all of the energy, capacity, and RECs from its Willow Wind Power Project, a 100 MW wind facility, to Rosemary Electric & Gas Company (REG). The Willow Wind project is located within ERCOT. Assume that IPP has an accounting policy that RECs are not output. Under the terms of the agreement between IPP and REG, IPP is required to deposit all RECs generated by the Willow project in REG’s account once received from the state.
When should IPP recognize revenue related to the sale of the RECs to REG?
Analysis
IPP should not recognize revenue until delivery of the RECs into REG’s account. The act of transferring the RECs to the purchaser has not been completed at the time of generation. Until credited to the purchaser’s account, the RECs cannot be used by the purchaser.
7.5.5 Expense recognition
Reporting entities selling RECs need to consider expense recognition. Expense recognition for reporting entities selling RECs is applicable when the following circumstances are all present:
- RECs are accounted for as output (as discussed in UP 7.4.1, costs of generating RECs are allocated to RECs accounted for as output)
- Sale of RECs follows an executory contract model (not lease or derivative)
- Recognition of REC revenue occurs later than recognition of revenue from the energy and other products produced by the plant
If all of these conditions are present, the reporting entity should recognize REC expense at the time of recognition of the related REC sale. In other circumstances, cost allocation is not applicable (e.g., RECs are not output) or not meaningful (e.g., REC revenue is recognized at the same time as the related power revenue). See Figure 7-3 for a summary of fact patterns when cost allocation would be applicable.
In addition, RECs generated for sale are generally accounted for as inventory. As such, the reporting entity should adopt an appropriate inventory model (e.g., specific identification, weighted-average cost, or first-in, first-out) for expense recognition. See UP 7.4.1 and UP 7.6 for further information on allocating costs to RECs at the time of generation or purchase, respectively.
7.5.5.1 Expense recognition for RECs classified as intangible assets
The cost of RECs that a reporting entity classifies as intangible assets and uses for compliance should be allocated against the compliance liability at the time they are surrendered.
In addition, as discussed in UP 7.3.1, we would generally expect a reporting entity to account for RECs held for sale as inventory. However, in some circumstances, a reporting entity may sell a REC that was accounted for as an intangible asset. In such cases, we believe that the reporting entity should follow an expense model similar to that used for RECs classified as inventory. The cost of RECs classified as intangible assets should be recorded as an expense when sold.
Question 7-3
When should the cost of RECs be recognized if they are held for trading purposes?
When should the cost of RECs be recognized if they are held for trading purposes?
PwC response
If a reporting entity purchases and sells RECs (i.e., in a trading capacity), it will have a cost basis in its REC inventory because the cost of purchasing RECs should always be recognized, regardless of whether RECs are deemed output. Therefore, in a trading scenario, assuming that an executory contract model is applied, the cost of the REC should be recognized in the income statement at the time the related revenue for the sales is recognized.
1 For information about RPS and REC programs in states, see the Database of State Incentives for Renewables and Efficiency at www.dsireusa.org.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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