The following article is based on my own interpretation of the said events. Any material borrowed from published and unpublished sources has been appropriately referenced. I will bear the sole responsibility for anything that is found to have been copied or misappropriated or misrepresented in the following post.
Malav Shah, MBA 2014-16, Vinod Gupta School of Management, IIT Kharagpur
Government has recently announced a few changes in the Indian Accounting Standards abbreviated as Ind-AS. According to new norms, if a state government hands over a power plant to a power company with a power purchase agreement (PPA) with an assurance that it will buy all the electricity produced; such power plant will be considered as a ‘financial asset’ in the balance sheet of the company. If there is no assured return then the plant to be considered an ‘intangibles assets.’
Power purchase agreement is a contract between two parties, one who generate electricity for the purpose of sell and the other, who purchases the electricity. Currently, the power plant handed over to companies under such PPA are considered as a ‘fixed assets’ by power companies and income from these plants are considered and operational income.
Take a case of a company making a contract of an amount Rs. 500 Crore under PPA and expecting Rs. 300 Crore as a revenue over a period of time. Then, under the new norms significant amount will be counted as an ‘interest income’ rather than operational earnings.
Earning Before Interest, Tax, Depreciation and Amortization (EBITDA) is a very popular indicator to measure company’s operational excellence. Company’s operating earnings will reduce significantly if a revenue from such PPA be considered under ‘interest income’ as it is not a part of EBITDA. This changes will not affect the power companies profits. However, it can affect the investors who use EBITDA to measure company’s profitability.