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Rate-regulated activities (education session)

Date recorded:

This was an education session.

The Board continued to discuss the proposed model for rate-regulated activities. The Staff presented Agenda Paper 9B, Rate adjustment examples. AP 9A summarises the principles underlying the model and the Board’s discussions to date.

Background

In this paper, the Staff use numerical examples to illustrate:

  • When and at what amount originating regulatory rate adjustments are recognised under the model; and
  • When and at what amount these regulatory rate adjustments are reversed.

In each example, the Staff explain how the regulatory adjustments meet the definition of an asset or a liability in terms of the revised Conceptual Framework, and how such regulatory assets and liabilities should be derecognised as the related rights are consumed and obligations are fulfilled.

The Staff considered each of the following five adjustments separately over a three-year period:

  • Example 1—input price variance. The regulatory agreement allows the entity to adjust the regulated rate in future periods to cover actual costs incurred. In one of the years under consideration, the actual input costs were higher than estimated.
  • Example 2—maintenance timing difference. The entity carries out maintenance works in year two but the related cost is recovered from the customers over years one to three.
  • Example 3—accelerated depreciation. The cost of new software acquired is amortised over three years. However, the full cost is recovered from the customers over the first two years.
  • Example 4—regulatory capitalisation of costs. Expenditure incurred is expensed in year one, but the costs are recovered from the customers over ten years.
  • Example 5—prefunding of construction. The entity receives funding from the customers in advance of certain construction work. The work is carried out in year two but the related asset will be depreciated over a ten-year period.

Of particular interest is example 5. This example shows how the regulatory liability arising from funding received in advance is not reversed when the construction work is performed. Instead, the regulatory liability is reversed over the period during which the constructed asset is consumed, because, as the Staff put it, the regulatory liability is fulfilled by charging the customers a lower, unfavourable rate (to the entity) in those subsequent years.

Next steps

The Staff plan to discuss the following topics in the next meeting: (1) introducing uncertainty into these examples, (2) concepts around the basis of measurement, and (3) whether uncertainty should be reflected through recognition or measurement.

The Staff expect to ask the Board to decide on the form of the next consultation document, i.e. a discussion paper or an exposure draft, by the end of 2017.

Discussion

Apart from two members, the Board generally agreed with the examples presented by the Staff. No substantive comments were made on the examples.

One Board member reiterated his concerns that the proposed model might not stand up to real life challenges. This is especially so when, in practice, there is often no clear linkage between the many rate adjustments and the events which give rise to those adjustments.

Another Board member with a strong objection to the model believed that the model is applying the matching principle to match costs with revenue. He questioned why it is allowed for rate regulated entities when matching is prohibited in all other cases. Another member responded that the perceived matching is a natural result of the scope of the model, which by definition involves a tripartite agreement between a rate regulator, a regulated entity and its customers. To this member, the question is rather whether the Board is comfortable that entities with specified rate-regulated characteristics (which will be developed further) are subject to sufficiently different economics from non-regulated entities that justifies their being accounted for in a different way. The scope of the model will be discussed at a future meeting.

Two Board members also asked the Staff to articulate better what exactly is the resource that the entity controls which gives rise to the regulatory asset. They agreed to leave that discussion for a future meeting.

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