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Rate-regulated activities (IASB only)

Date recorded:

In December 2012, the IASB tentatively decided to develop an Exposure Draft for an interim Standard that will permit the continuation (‘grandfathering’) of existing practice for many entities that currently recognise regulatory deferral account balances in their financial statements, in accordance with their jurisdictionally accepted accounting principles (local GAAP). The interim Standard would avoid these entities having to make a major change to their accounting policies that might be followed by another major change once the comprehensive project is completed.

Some IASB members expressed some concern about reducing comparability in IFRS reporting by rate-regulated entities.  It was therefore considered necessary that some restrictions were imposed on wholesale grandfathering in the preparation of IFRS financial statements.  The IASB asked the staff to develop a [draft] interim Standard that:

  1. permits ‘grandfathering’ of existing recognition and measurement policies for those entities that currently recognise regulatory deferral account balances in financial statements in accordance with their local GAAP;
  2. requires that such regulatory account balances are identified and presented as separate line items in the financial statements, with additional disclosure requirements; and
  3. contains some impairment test requirements (as is currently required in IFRS 6 Exploration for and Evaluation of Mineral Resources).

In the January 2013 IASB Board meeting, the staff presented their recommendations for the content of the [draft] interim Standard.  They noted that they used the 2009 ED as a starting point for their recommendations taking into account the comments on the 2009 ED.

The Staff presented 6 papers to the Board – scope, recognition and measurement, presentation, disclosure, transition and consequential amendments and due process.

Before the decision making session, the Staff had held an education session (based upon these 6 papers) with the IASB members to run through any Board concerns before decisions were made in a later session.  Various concerns were raised by the Board members in the education session around:

  • Clarification of the scope of the [draft] interim standard (would it apply to those rate regulated entities that only recognise regulatory deferral account balances or would the scope be wider)
  • The interaction of the [draft] interim standard and the exemption in IFRS 1 relating to deemed cost (i.e. if entities had previously recognised such regulatory deferral balances within PPE, how will those balances be dealt with under the [draft] interim standard and will the entities be allowed to carry over the total PPE balance, which includes the regulatory deferral account balances, under the deemed cost exemption when transitioning to IFRS).  Some concerns raised by Board members were that if the entities were not allowed to include the regulatory deferral account balances within the deemed cost of the PPE then they would have to disaggregate their existing PPE balance pre IFRS transition between the “standard” IAS 16 aspects and those that were capitalised to PPE in accordance with the entity’s local accounting policies for rate regulated activities.  It was considered that this would be a burden.
  • Offsetting – some members disagreed that this should be allowed.  Some said that this would reduce comparability.
  • Impairment.  Board members questioned how a regulatory deferral account balance would be impaired – those that were carried forward as part of the cost of PPE, those that were no longer deemed allowable by the regulator (it was suggested that these should be written off immediately) and those that were carried forward as allowable by the regulator.  Questions arose as to whether the regulatory deferral account balances should be impaired at a CGU level and if so, how the allocation of impairment would be made.

After the education session the Staff held a decision making session with the IASB.  The pertinent points regarding the Staff recommendations for each paper and the tentative Board decisions are as follows:

Scope

The Staff recommended to the Board that the scope of the [draft] interim Standard should be restricted to entities with operating activities that are subject to rate regulation by an authorised body and for which the rate-setting mechanism is based upon allowable costs (i.e. those costs that for which the regulated rate is intended to provide recovery, normally defined within the rate regulation of by the rate regulator).  It was noted that this scope was wider than the 2009 ED so that it appropriately captures a wider variety of regulatory regimes.

The Staff noted that recognition restrictions (see “recognition and measurement” below) will prevent entities that currently do not recognise regulatory deferral account balances (often referred to as regulatory assets or regulatory liabilities) within financial statements from starting to do so when applying the [draft] interim Standard.

The Staff noted that many respondents to the 2009 ED commented that the scope was too narrow and would exclude many entities that currently recognise regulatory deferral account balances in their financial statements in accordance with local GAAP. This was in relation to the criterion in paragraph 3(b) in respect of “cost of service” regulation which it was noted many rat regulated entities do not follow.  Hence the Staff recommendation is to remove the criterion relating to the “cost of service” regulation to widen the scope and allow entities applying formula-driven rate-setting mechanisms.

The Staff propose that the scope of the [draft] interim Standard should be as follows:

An entity shall apply this [draft] IFRS to its operating activities that meet the following criteria:

  1. an authorised body (the regulator) establishes the maximum price the entity must charge its customers for the goods or services the entity provides, and that price binds the customers; and
  2. the price established by regulation (the rate) is designed to recover the entity’s allowable costs of providing the regulated goods or services and to restrict the return that the entity can earn.

The Staff asked the Board whether they agreed with the scope criteria

At the decision making session the Staff noted the Board concerns regarding scope.  The Staff clarified that the [draft] interim standard would only apply to regulatory deferral account balances after other standards had been applied.  An example given was for PPE where an entity had been capitalising regulatory deferral account balances within PPE.  Upon adoption of IFRS, when IFRS 1 is applied these balances will be carried forward within PPE and be accounted for under IAS 16.  Only costs incurred since IFRS transition would be captured by the interim standard and would be presented separately as either regulatory assets or regulatory liabilities.

Within the education session Board members had asked whether the interim standard would apply to first time IFRS adopters.  The Staff noted that this would not have to be essential as restrictions could be built into the standard to restrict entities changing their accounting policies.  A number of Board members expressed a preference for the interim standard to make it explicit that it relates only to first time adopters.  The Staff agreed to make these amendments.

One Board member questioned the scope criteria (b), above, which states that the regulator must establish the maximum price.  He questioned, what would happen if the regulator only set a price but no maximum – would this exclude such entities from the scope? The Staff noted that the wording can be amended in drafting to make this clearer that it was not a single price or maximum price set by the regulator.

With the inclusion of the above amendments, and understanding the Staff clarifications, the majority of the Board members tentatively agreed to the Staff proposals regarding the scope of the [draft] interim Standard.

Recognition and Measurement

The Staff set out a recommendation that the [draft] interim Standard should not contain specific recognition or measurement criteria for such balances, but should instead require an entity within the scope of the [draft] interim Standard to determine its own recognition, initial measurement and subsequent measurement accounting policies.  The Staff noted that these recognition and measurement policies should be based upon the entity’s existing accounting policy which should be generally accepted in accordance with the entity’s local GAAP.

It was highlighted that there is still some confusion as to whether regulatory deferral account balances meet the definition of assets and liabilities under the IFRS Framework definitions and hence, due to this uncertainty, the Staff did not want the [draft] interim standard to be constrained by the recognition criteria for assets and liabilities in the Framework (it would be addressed in the more comprehensive project on rate-regulated activities).

The Staff noted that the main purpose of the [draft] interim standard was to permit grandfathering of existing recognition and measurement accounting policies on first time adoption of the [draft] interim Standard.

To achieve this, the Staff noted that the [draft] interim Standard will need to contain a temporary exemption from paragraph 11 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.  This paragraph requires that, in developing an accounting policy, the entity would need to consider the definitions of assets and liabilities in the Framework.  It was noted that this would be consistent with the approach taken in IFRS 6 Exploration for and Evaluation of Mineral Resources.

It was noted that some IASB members had expressed concern that an interim Standard instead of IFRS 1 might allow entities that currently do not recognise regulatory deferral account balances in accordance with IFRS to do so.  The Staff noted that these policies should conform to an entity’s existing accounting policies but only if they are generally accepted in accordance with the entity’s jurisdictionally accepted accounting principles (local GAAP).  Consequently entities that currently do not recognise regulatory deferral account balances would not be permitted to start doing so on application of the [draft] interim standard.  The Staff also noted that changes to existing accounting policies would also be restricted.  Such restrictions would be comparable to those in IFRS 4 and IFRS 6.

There was confusion in the 2009 ED as to whether the deferral account balance should be assessed for impairment separately of as part of the related CGU that produces the rate-regulated revenues.  It was agreed that a review for impairment was required.

The Staff noted that the [draft] interim standard should require an entity to assess the recoverability of any regulatory deferral account balances and to recognise impairment of that balance for any amounts that may not be recoverable.  The Staff recommended that there should be an exemption from the requirement to apply IAS 36 to the regulatory deferral account balances.  However, the Staff did note that the impairment of a regulatory deferral account debit balance may indicate that the related assets within the CGU that produces the rate-regulated revenues are impaired.  In these situations IAS 36 would be used to assess the CGU for impairment.

It was also recommended that an entity should derecognise the entire carrying amount of any regulatory deferral account balances when the related underlying activities cease to meet the scope criteria.

The Staff asked the Board whether they agreed with their recommendations.

One Board member noted that it would be a good idea to get scope exemptions in other standards in order to avoid conflict in accounting.  For instance in IAS 16 some regulatory costs may not be able to be capitalised but under the [draft] interim standard they would be.  The Staff commented that this would not be required if the interim standard made it clear that it only related to balances not covered under other Standards – i.e. the residual.  This could be made clearer in the drafting.

One Board member noted that the basis for conclusions to the interim standard should include a comment that the interim standard is not attempting to deal with whether a regulatory deferral account balance meets the definition of an asset or liability under IFRS.  The Staff noted that this would be included and the basis for conclusions would note that the standard is not attempting to pre judge the outcome of the main project and that this is a short-term practical solution.

Various Board members expressed concern regarding the Staff proposals for impairment and expressed a view that more was required in the [draft] interim standard regarding recoverability and impairment.  One noted that consideration needs to be made between impairment of those balances included in, for instance, PPE and those that are not.  Another Board member questioned why IAS 36 could not be applied.

The Staff noted that the wording of the [draft] interim standard could be amended to state more clearly that where balances are anticipated to be allowed by the regulators, the entity needs to apply judgement as to whether these will be recoverable.  Where these are not recoverable they should be written off immediately.  For those balances that are approved by the regulators and hence are carried forward, there will be impairment considerations.

One Board member stated that he did not agree with the proposals that the interim standard would allow an entity to use their own local accounting policies for recognition and measurement but then the Staff were attempting to define impairment and recoverability requirements.  He questioned why local impairment rules could not be applied.  This view was shared by some other Board members.  The Staff noted that an entity should therefore have to perform an assessment whether there is an indicator of impairment and then if there was then the entity should use their local GAAP rules for impairment.  This was essentially the original Staff proposal but would be made much clearer in the [draft] interim Standard.

The Board members tentatively agreed to the Staff proposals with the following amendments:

  • Amendments to the [draft] interim standard as noted above – basis for conclusions, drafting points, clear wording that if the balance is not expected to be recoverable then it should be written off immediately;
  • The [draft] interim standard will make it clear that the local GAAP impairment rules should be followed – essentially grandfathering these rules as with recognition and measurement.

Presentation

 

It was noted that the 2009 ED contained little guidance on general presentation.  The 2009 ED proposed that regulatory deferral amounts were capitalised as part of (for instance) PPE or intangible assets for financial reporting purposes.  Responses to this proposal were mixed and many rejected this proposal noting that these transactions should be included within a regulatory line item for regulatory deferral account balances in the statement of financial position.

The Staff noted that they agreed with the views of these objectors.

The Staff recommended that:

  1. all regulatory deferral account debit balances and all regulatory deferral account credit balances should be presented as separate line items immediately below a subtotal for “Total assets (or liabilities) before regulatory amounts”; (the Staff noted that this would provide more useful information about the regulatory environment and would be consistent with the enhancing qualitative characteristic of comparability in the Conceptual Framework.  Specifically it would allow users to more directly compare PPE or internally generated intangible assets of comparable rate-regulated entities and would result in consistent application of IFRSs for all other transactions).
  2. the impact of rate regulation should be isolated such that all other items in the financial statements, including property, plant and equipment and intangible assets, should be presented in accordance with IFRS in the same way as for a non-rate-regulated entity (the Staff noted that this treatment will introduce some inconsistency of accounting treatment in IFRS financial statements between rate-regulated entities and non-rate-regulated entities, and between those rate-regulated entities that currently do not recognise regulatory deferral account balances and those that will be allowed to do by grandfathering existing local GAAP policies);
  3. any regulatory deferral account debit balances and credit balances should be offset if they arise with the same regulator and are taken into account by the regulator in setting the rate for the same rate-regulated activities;
  4. the current and non-current amounts of any net regulatory deferral account debit balance and net regulatory deferral account credit balance should be presented separately only in the notes; and
  5. that the net movement between the opening and closing balance of all regulatory deferral accounts should be presented in profit or loss as a separate line item immediately below a subtotal for “Profit (or loss) before taxation and regulatory amounts”.

The Staff asked the Board whether they agreed with their recommendations.

 

One Board member expressed some concern at only showing one line item for the regulatory deferral account balances in the statement of financial position.  He wanted this line item to be disaggregated to provide more information to users of financial statements.  The Staff commented that this detail would be provided in the notes.

Another Board member expressed a view at the education session that offsetting should not be allowed.  The Staff agreed and noted that this would be removed from the [draft] interim Standard.

One member noted that deferred tax should also be shown separately for the regulatory deferral account balances although this did not receive much support.

The Board members tentatively agreed to the Staff proposals with the following amendments:

  • The removal of the offsetting recommendation.
  • Deferred tax would not to be shown separately for the regulatory deferral account balances.

Disclosure

The Staff noted that regulatory deferral accounts are generally not recognised within those entities that present their financial statements in accordance with IFRS.  The Staff did not, however, that there was evidence that many entities subject rate regulation do disclose some information about the rate regulated environment in which they operate – commonly presented in the management commentary.  Respondents to the 2009 ED noted that the proposals to give the disclosures for each set of operating activities that was subject to a different regulator was impractical or onerous.

The Staff proposed that the disclosure requirements in the 2009 ED are retained but with the following substantive modifications:

  1. all entities that have activities subject to rate regulation should disclose that fact and provide a qualitative description of the nature and extent of the effect of rate regulation on those activities, either in the financial statements or in the accompanying management commentary (with a cross-reference from the financial statements);
  2. rate-regulated entities that do not recognise regulatory account balances need only disclose the qualitative information in paragraphs (a) above and (d) below, but more detailed qualitative and quantitative information should be disclosed when regulatory deferral account balances are recognised in the financial statements in accordance with the [draft] interim Standard;
  3. these more detailed disclosures may be aggregated for similar activities that are subject to similar regulation imposed by different regulators instead of being presented for each individual regulator;
  4. for each set of rate-regulated activities that are material to the financial performance or position of the entity, the identity of the rate regulator should be disclosed;
  5. a statement that the regulator does not permit a return on investment for a regulatory deferral account balance should be disclosed, together with the amount of the restricted balance recognised and the remaining recovery period applicable to that amount;
  6. the rate of return or discount rate that an entity is required or permitted to adjust a regulatory deferral account for the time value of money should be disclosed, together with the amount of the related account balance and the remaining recovery period applicable to that amount;
  7. the amount of, and reason for, any reduction in a deferral account balance resulting from an assessment that the amount is no longer recoverable should be disclosed; and
  8. the impact of rate regulation on the amounts of current and deferred tax recognised and the related net regulatory deferral account debit and credit balances should be disclosed.

The Staff asked the Board whether they agreed with their recommendations.

 

At the education session a number of Board members objected to recommendation (a), above, noting that these disclosures should only apply to those entities that do recognise regulatory deferral account balances and not to those that do not.

 

The Board members tentatively agreed to the Staff proposals with the amendment that only those entities recognising regulatory deferral account balances would have to provide the recommended disclosures.  There were also other drafting points that were proposed.

Transition and consequential amendments

 

The Staff noted that they did not expect the presentation proposals in the [draft] interim standard to have a major impact on existing IFRS preparers.

The Staff proposed that the [draft] interim standard:

  1. proposes retrospective transition of the [draft] requirements (the Staff noted that the [draft] interim standard was intended to permit entities that currently recognise regulatory deferral account balances in their financial statements to continue to do so, using their existing recognition and measurement policies.  The Staff noted that these amounts will have already been recognised in the financial statements and hence retrospective application should be appropriate);
  2. does not propose any additional relief from retrospective application to that already in paragraph D5B of IFRS 1 First-time Adoption of International Financial Reporting Standards; and
  3. proposes a consequential amendment to paragraph D5B of IFRS 1 to amend the scope of the existing exemption in paragraph D8B to match the revised scope of the [draft] interim Standard.

The Staff asked the Board whether they agreed with their recommendations.

No significant comments were received on this paper.  The Board members tentatively agreed with the Staff recommendations.

Due Process

The Staff asked the IASB members:

  1. if they were satisfied that the due process steps performed were sufficient for the Staff to begin the balloting process;
  2. if any IASB members intend to dissent to the proposal and, if they do, their reason for doing so; and
  3. if the IASB members agree with the Staff recommendation that the comment period for the Exposure Draft should be 120 days.

The Staff highlighted that they expected the Exposure Draft to be completed next week and were intending on getting the interim Standard out in December.

 

No significant comments were received on this paper.

The Board members tentatively agreed that sufficient due process steps had been performed that were sufficient for the Staff to begin the balloting process.

Four IASB members intend to dissent from the preparation of the Exposure Draft.

 

The Board members tentatively agreed with the Staff recommendation that the comment period should be 120 days.

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