Engineering, procurement and construction (EPC) contracts are evolving as utilities seek to spread risks, contain costs, and execute their business strategies. As a result, turnkey contractors are...
Energy Earnings and FASB: A Volatile Mix
contract inception, and throughout its term, that physical delivery will occur.
In our earlier figures, if the natural gas in question would be placed in storage during the delivery month, and it was purchased for the purpose of supply to the company's customers, it could have been placed in inventory at cost on the day it was received. As with traditional accrual accounting, the purchase into inventory is booked as an asset.
Be aware, however, that behavior subsequent to contract execution can be interpreted as preventing the normal purchase or sale exemption treatment under FASB 133. These activities tend to indicate that the energy procurement agreement was entered into to generate profits from the price movement of the commodity, i.e., physical arbitrage. Such activities include: net settlement of the agreement with the same counterparty; flash title transactions (short term holding of title with no corresponding physical movement); and uniqueness of the transaction itself (not having similar agreements in the past or in the future).
Given the nature of earnings volatility in energy, however, the decision as to the accounting treatment of any purchase or sale should be made within the scope of a comprehensive risk management policy. That policy should require the use of techniques not discussed here to quantify the probability of market price movements and its impact on cash flow to the company. It is only when the board of directors, executive management, and the corporate auditor has a thorough understanding of the risks undertaken by the firm in its day-to-day activities that the choices available for accounting treatment will be made for the benefit of all corporate stakeholders.
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