Remi Forgeas
Remi Forgeas

Exposure Draft on Rate-Regulated Activities

How the International Accounting Standards Board (IASB) perfectly illustrates the convergence process with U.S. GAAP.

October 26, 2009
by Remi Forgeas, CPA

The issuance, last July, by the International Accounting Standard Board (IASB) of its exposure draft on rate-regulated activities provides a perfect illustration of the convergence process between U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The exposure draft also shows the limits of the exercise.

IFRS Does Not Address Specific Industry Issues

IFRS being principle based, they do not generally include industry-specific guidance. In particular, IFRS does not address the accounting for companies operating in rate-regulated activities. A key specificity for a company operating in such a business line is that it does not set its own tariffs. Tariffs are determined directly or indirectly by an independent authority. As a general principle, these tariffs are set to a level that authorizes the company to receive a certain rate of return on its investments. Determination of tariffs is made by regulators through rate cases presented by companies.

GAAP’s History of Guidance for Rate-Regulated Industry

The Financial Accounting Standards Board (FASB) issued a standard in 1982 to address the specificities faced in such an environment: SFAS 71 Accounting for the Effects of Certain Types of Regulation (ASC 980 under the new GAAP codification). Under this standard, if regulation provides assurance that incurred costs will be recovered in the future, this standard will require companies to capitalize on those costs. If current recovery is provided for costs that are expected to be incurred in the future, the standard requires companies to recognize those current receipts as liabilities. These items are presented separately on the balance sheet and are usually described as regulatory assets or regulatory liabilities.

Without a proper set of rules similar to the ones existing for GAAP, adopting IFRS by utility companies indicated would be difficult. One practical hurdle is that regulated assets or liabilities do not meet definition of assets and liabilities under the current IFRS framework. Whereas rate cases presented to regulators are built using financial statements as a key supporting document, companies applying IFRS would need to develop a second set of books (to be reconciled to issued financial statements) in order to identify deferred costs and revenue to be included in their rate cases.

Obviously, U.S. utilities are not the only ones dealing with these complexities. Companies in other countries adopting IFRS either maintained in place their existing procedures or applied principles set in SFAS 71. Finally, experience shows there was limited divergence in approach followed by these non-US utility companies.

IASB’s Decision to Issue Accounting Standards

Since 2005, the International Financial Reporting Interpretations Committee (IFRIC) is consulted regularly regarding the possibility of recognizing liabilities or assets as a result of rate regulation. The issue was added to the IFRIC Issues list in early 2008. In November 2008, IFRIC concluded that this issue did not meet its agenda criteria, mainly because “divergence in practice in jurisdictions using IFRS does not seem to be significant.” This decision of the IFRIC shows how it provides additional guidance on pre-existing rules when it is noted that preparers apply them with significant diversity.

In December 2008, the IASB, considering the importance of this issue, decided to add this project to its agenda.

The IASB held several public meetings during the first half of 2009 on this matter and finally issued an Exposure Draft (ED) on Rate-Regulated Activities in July 2009. This ED is open for comments until November 20, 2009 and the standard is expected to be issued by the end of June 2010.

The Basis of Conclusions, which accompanies the ED provides an economic background of the rate-regulation. Three characteristics are identified:

  • Entities face restrictions on price setting for their services or products;
  • Prices must be reasonable for customers; and
  • Prices must allow entities to earn a fair rate of return.

Entities subject to regulated activities are usually in a dominant market position or a monopoly. In order to mitigate their power, regulators set tariffs and act on behalf of customer base.

As a general principle, tariffs are set to cover allowed operating costs (“allowed” meaning accepted by the regulator for consideration in the tariff determination) and the costs to finance the infrastructures and related assets (usually called rate base) and other assets and liabilities. The cost of financing the rate base is determined using a weighted cost of capital, which approximates the rate of return on capital and the borrowing rate is used for other balance sheet items.

Under the current IFRS framework, regulated assets and liabilities cannot be recognized. The ED identifies when regulatory assets and liabilities may exist and be recognized. The main criterion is that the regulator’s action provides reasonable assurance of economic benefit. In other words, the entity must be ensured that it will be compensated for previously incurred costs (regulatory assets) or it will be obligated to return to customers previously collected amounts (regulatory liabilities).

After the initial recognition, regulatory assets are subject to the test for impairment in accordance with IAS 36 Impairment of Assets.

Finally, the ED provides requirement with regards of disclosures.

Exposure Draft’s Similarities and Major Differences With SFAS 71

Considering that previously there was no guidance under IFRS for the recognition of regulatory assets and liabilities, the issuance of the ED is viewed as a major step forward in the convergence toward US GAAP. However, differences noted between the US GAAP standard and the ED may create major difficulties at the time of implementation in the U.S:

  1. Requirement in the ED measures the regulated assets/liabilities at present value, whereas they are recorded at cost under GAAP; and
  2. The mandatory componentization of fixed assets under IFRS (IAS 16) (not strictly related to this ED).

These differences will have significant impact for US utilities at the time of the transition, in terms of implementation costs and going forward in discussions with regulators, which favor historical data.


After years of discussions on the lack of guidance in IFRS for rate-regulated activities, the IASB has decided to issue a standard that could be viewed as industry specific. The resulting ED is similar to the existing GAAP standard, but not identical. Therefore, even if the transition to IFRS for utility companies becomes easier, it will still represent a major project.

Going forward regulators and other participants must understand these differences and review their processes as necessary to continue to fulfill their objective of protecting customers against excessive prices and, at the same time, authorizing a reasonable rate of return for companies.

Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Remi Forgeas, CPA, who is an audit and assurance partner for Mazars in the U.S. For U.K. IFRS, you can contact Steven Brice, who is a technical partner in the financial reporting advisory group for Mazars in the U.K.

* The views expressed in this article are the author’s own.