The Financial Accounting Standards Board has issued an accounting standards update on derivatives and hedging related to electricity contracts.

FASB noted that Topic 815 in its accounting standards codification, Derivatives and Hedging, requires that a derivative contract be recognized at fair value unless the contract qualifies for a scope exception. One of those scope exceptions is the normal purchases and normal sales scope exception. Normal purchases and normal sales contracts are those that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold by a reporting entity over a reasonable period in the normal course of business.

The amendments apply to entities that enter into contracts for the purchase or sale of electricity on a forward basis and arrange for transmission through or delivery to a location within an energy market in which one of the contracting parties incurs charges or credits for the transmission of that electricity based in part on locational marginal pricing differences payable to, or receivable from, an independent system operator.

The amendments specify that the use of locational marginal pricing by an independent system operator does not constitute net settlement of a contract for the purchase or sale of electricity on a forward basis that necessitates transmission through, or delivery to a location within, an energy market, even in scenarios in which legal title to the electricity is conveyed to the independent system operator during transmission.

Thus, the use of locational marginal pricing by the independent system operator does not cause that contract to fail to meet the physical delivery criterion of the normal purchases and normal sales scope exception.

If the physical delivery criterion is met, along with all of the other criteria of the normal purchases and normal sales scope exception, an entity may elect to designate that contract as a normal purchase or normal sale.

The amendments specify that the use of locational marginal pricing by the independent system operator does not constitute net settlement of the contract. They are effective upon issuance and should be applied prospectively, so an entity will have the ability to designate on or after the date of issuance any qualifying contracts as normal purchases or normal sales.

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