Review of financial reporting – enforcement decision – Agder Energi AS
Published: 29 June 2016
Last updated: 22 March 2019
Finanstilsynet has reviewed one matter in the financial statements of Agder Energi AS that concerns the accounting treatment of power contracts with embedded foreign currency derivatives.
Agder Energi enters into long-term contracts to supply power to energy-intensive industry. The contracts are bilateral and the parties negotiate on volume, duration, delivery site, price and settlement currency. Virtually all contracts after 2010 are denominated in euro. The parties to the contracts thus incur exposure both to power prices and to the euro.
A power supply contract that is settled in a currency other than the company's own functional currency is a hybrid instrument that consists of a contract for physical delivery of power in the future (the host contract) with power price exposure and an embedded derivative with euro exposure.
Under IFRS the host contract shall not be accounted for when entered into so long as it is entered into and continues to be held for the purpose of the delivery of power in accordance with the entity's expected sale or usage requirements. The power contract will only be recognised as income upon delivery of the power. The exposure to future power prices will therefore not be reflected in the financial statements upon entry into the contract. Embedded derivatives shall as the main principle be separated from the host contract and accounted for as a derivative, which means at fair value through profit or loss. Embedded derivatives shall however not be separated if they have economic characteristics and risks that are closely related to the economic characteristics and risks of the host contract.
The exception from the main principle that embedded derivatives shall be separated from the host contract applies in three specific situations. One of them is where the currency is a currency that is commonly used in contracts to purchase or sell non-financial items in the economic environment in which the transaction takes place. The other situations are not relevant in this particular instance.
Agder Energi does not separate embedded foreign currency derivatives, but accounts for them as part of the power contract.
In Finanstilsynet's assessment the "economic environment" has to be understood as an area where transactions of non-financial items occur and where one or more foreign currencies are commonly used. In Norway, only the Norwegian krone is commonly used in domestic business transactions involving non-financial items. Contracts between two Norwegian companies that are settled in euro therefore include a foreign currency derivative that is not closely related to the host contract. The foreign currency derivative has to be separated and accounted for at fair value at each reporting date.
Agder Energi does not agree to Finanstilsynet's assessment and states that their accounting practise is in line with IFRS. Finanstilsynet has therefore ordered Agder Endergi to change their accounting treatment of embedded derivatives.
Deputy Director General Anne Merethe Bellamy: +47 22 93 98 43, mobile: +47 908 78 449
Head of Section Christian Falkenberg Kjøde: +47 22 93 99 46, mobile: +47 909 47 914