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7.6 REC purchases
Publication date: 20 Jul 2016
us Utilities guide
Reporting entities may purchase RECs to comply with RPS requirements or for resale. In all cases, the reporting entity will need to determine the appropriate cost basis for the RECs; neither the classification of RECs as inventory or intangibles nor the policy of whether RECs are output impacts this requirement.
The determination of the appropriate basis for purchased RECs may be straightforward when RECs are purchased in a stand-alone agreement: the cost basis is the purchase price. However, the determination of the cost of RECs can become more complex when RECs are purchased in a contract with other products or services. In such cases, the first step is to determine the appropriate accounting for each of the deliverables in the contract. See UP 7.5.2 for information on applying the commodity contract accounting framework to contracts containing RECs.
After identifying the appropriate accounting models, the reporting entity should follow the applicable allocation methodologies. Key considerations in allocating costs to RECs are summarized in Figure 7-7. See UP 1 for further information on the overall cost allocation models.
Figure 7-7
Cost allocation for purchased renewable energy credits
Cost allocation for purchased renewable energy credits
Type of purchase |
Output? |
Evaluation |
Included as part of lease of a facility |
Yes |
Allocate lease consideration among energy, RECs, and other products produced by the plant |
Included as part of lease of a facility |
No |
Allocate contract consideration between lease and nonlease elements; RECs are a nonlease element of the contract |
Included as part of a multiple-deliverable contract containing an embedded derivative for the forward purchase of energy |
Either |
Allocate consideration using hybrid instrument guidance in ASC 815-15-30-4 for non-option embedded derivatives |
As noted in Figure 7-7, costs should always be allocated to purchased RECs, irrespective of a reporting entity’s policy on RECs as output, because it is paying for the RECs. However, the method of allocating the contractual cash flows may differ depending on the type of contract (i.e., lease, derivative, or executory contract). See also Question 7-4 regarding expense recognition related to RPS liabilities based on REC purchases.
The method by which costs are allocated to RECs generally should be established at the inception of the contract, although this may vary depending on the accounting model applied:
- Contract contains a lease—method of allocation should be established at lease inception
- Contract contains a derivative—method of allocation should be established at contract inception; pricing should be allocated to the derivative component such that the fair value is initially zero (for non-option derivatives)
- Entire contract is accounted for as an executory contract—method of allocation should be established at contract inception using the guidance in ASC 605
Although a contract containing multiple deliverables may separately price the RECs, a reporting entity should estimate the REC cost based on available market information, including the market price of RECs and green power, where available.
7.6.1 Application examples
The following examples are provided to illustrate the allocation of costs to purchased RECs.
EXAMPLE 7-3
Allocation of costs—bundled contract for energy and RECs, energy is not a derivative
Allocation of costs—bundled contract for energy and RECs, energy is not a derivative
Rosemary Electric & Gas Company (REG) enters into a five-year forward contract with Ivy Power Producers (IPP) for the purchase of 50 percent of the energy and RECs from the Wisteria Wind Power Project. REG determines that the contract does not contain a lease. Furthermore, because there is no notional, the contract does not contain a derivative for the energy component. Therefore, the entire contract will be accounted for as an executory contract.
The contract specifies that the selling price of the energy is $80/MWh and the RECs are $30/REC.
How should REG allocate the total contract consideration between energy and RECs?
Analysis
REG should determine the fair value of each of the products sold and then allocate the total contract consideration based on the relative fair value of the deliverables. Although the price of each REC is specified, REG should not automatically allocate costs based on the contract amounts. These amounts may not necessarily represent the fair value of the two products provided.
EXAMPLE 7-4
Allocation of costs—bundled contract for energy and RECs, energy is a derivative
Allocation of costs—bundled contract for energy and RECs, energy is a derivative
Assume the same facts as in Example 7-3, except that in this case the contract specifies a fixed quantity per period. REG concludes that the energy portion of the contract should be accounted for as a derivative. The contract price is $110/MWh and the average forward price for energy is $80 at inception. In addition, REG concludes that the REC portion of the contract is not a derivative because the REC sales do not meet the net settlement criterion.
How should REG allocate the total contract consideration between energy and RECs?
Analysis
ASC 815-15-30-4 requires that an embedded forward contract that is a derivative and separated from its host contract should be initially recorded at fair value (i.e., generally at zero, resulting in no day one gain). Based on the forward price, $80/MWh of consideration should be allocated to the energy sales (resulting in a day one fair value of $0). The embedded energy derivative would be marked-to-market subsequent to bifurcation based, in part, on this allocated pricing.
REG would allocate the remaining consideration ($30) to the RECs and recognize it over the term of the contract. It would not adjust the allocation established at the beginning of the contract for subsequent changes in prices.
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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