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Rate-regulated Activities

Date recorded:

Feedback summary—Overview (Agenda Paper 9)

Background

In January 2021, the Board published Exposure Draft ED/2021/1 Regulatory Assets and Regulatory Liabilities. The comment letter period for the ED ended in July 2021. In this session, the staff gave an overview of the feedback received on the ED.

The proposals in the ED have been generally well-received by respondents. Most respondents expressed support for the objective of the ED to provide relevant information that faithfully represents how regulatory income and regulatory expense affect an entity’s financial performance and how regulatory assets and regulatory liabilities affect its financial position. Some of these respondents also acknowledged there is a need for a Standard that addresses the accounting for regulatory assets and regulatory liabilities.

Most respondents agreed with:

  • The proposed definitions for regulatory assets and regulatory liabilities and that they meet the definitions of assets and liabilities in the Conceptual Framework
  • The existence threshold of ‘more likely than not’ for recognising regulatory assets and regulatory liabilities
  • Using a cash-flow-based measurement technique to measure regulatory assets and regulatory liabilities that would involve estimating uncertain cash flows using the ‘most likely amount’ or the ‘expected value’ method
  • Using the regulatory interest rate for a regulatory asset or regulatory liability as the discount rate for that regulatory asset or regulatory liability

However, the following aspects of the proposed model raised most concerns amongst respondents:

  • Scope
  • Returns on assets not yet available for use
  • Regulatory assets and regulatory liabilities arising from differences between assets’ regulatory recovery pace and their useful lives
  • Minimum interest rate
  • Interaction with IFRIC 12

Board discussion

One Board member was pleased to see that respondents seemed to agree with the Board’s approach of not creating a new model for regulatory assets and liabilities but using existing IFRS and tailor them to the particularities of those assets and liabilities. It was also noted that it was interesting to see how different the regulatory environment was in different jurisdictions and that that fact should be kept in mind when finalising the proposals.

Scope

Many respondents agreed with the proposed scope—that is, to apply the new Standard to all of an entity’s regulatory assets and regulatory liabilities. However, many respondents were also uncertain about which regulatory agreements, arrangements or activities would be within the scope of the proposals. Some of these uncertainties are due to the perceived lack of clarity about:

  • The interaction between the proposals and other Standards (mainly IFRS 9, IFRS 17 and IFRIC 12
  • The proposed definition of ‘regulatory agreement’ and whether a regulator is needed for regulatory assets or regulatory liabilities to exist. According to these respondents, both the broad proposed definition of ‘regulatory agreement’ and the lack of definition of ‘regulator’ may capture a wide range of activities and arrangements that should not be included in the scope and may make consistent application of the final requirements difficult

Board discussion

The Board members discussed mostly the comments received on scope and particularly how the new Standard would interact with other IFRS Standards. In general Board members advised that the scope should be narrow, clear and targeted to avoid confusion about what is included and what is not. It was suggested to give instructions of how other Standards apply (including Interpretations like IFRIC 12) when applying the new Standard.

On the proposed scope exclusion for insurance contracts that could be subject to rate regulations, Board members warned not to make the scope exclusion too wide so that not all contracts are scoped out just because the customer might be offered an additional insurance contract, for example a water company offering additional coverage for pipe damage. The staff responded that currently there was not much evidence for how insurance contracts are affected by the new Standard, so might be simple to scope them out altogether. One Board member suggested that this would be wise, given IFRS 17 has not been widely applied and any issues between IFRS 17 and the new Standard cannot be reliably predicted at this point.

The Board members also discussed the boundary of the Standard with many of the Board members suggesting to define the term ‘regulator’ in order to make the boundary clearer. With regard to enforceability, Board members acknowledged the challenges, but suggested to retain the term as a criterion.

Returns on assets not yet available for use

Most respondents disagreed that an entity should reflect returns on an asset not yet available for use in the period when the asset is being used to supply goods or services to customers. According to these respondents the proposals would:

  • Not reflect the economic substance of the regulatory agreements
  • Not result in useful information
  • Be costly to implement
  • Be inconsistent with US GAAP

Board discussion

Board members noted that the accounting should follow the regulatory agreement. It was noted that the issue of construction work and useful lives (see below) are the most pervasive issues that arose in the comment letters. One Board member said that before making any decisions with regard to these issues, the Board would have to decide whether they retain the model proposed in the ED or whether a new model should be proposed.

Regulatory assets and regulatory liabilities arising from differences between assets’ regulatory recovery pace and their useful lives

Many respondents disagreed with recognising regulatory assets or regulatory liabilities because of differences between the period that the regulatory agreements permit an entity to recover an asset (the regulatory recovery pace) and the asset’s useful life. According to these respondents, the proposals would:

  • Not reflect an entity’s rights and obligations from their regulatory agreements
  • Neither meet the proposed regulatory asset and regulatory liability definitions in the ED nor the asset and liability definitions in the Conceptual Framework
  • Not result in useful information
  • Be costly to implement

Board discussion

Board members noted that respondents find the model proposed in the ED costly and complex and asked to use regulatory accounting instead. Some respondents noted that they would be required to track thousands of assets that have so far not been tracked. While this might be the case, it was acknowledged that it is always difficult to develop an industry standard and it will be a big change for some and a smaller change for others. Often, preparers’ reluctance is based in the system change that may be costly, however, once the system is changed, the ongoing preparation should not cause more cost than before. Nonetheless, Board members said that it should be explored whether there are areas in which complexity and costs could be reduced. One Board member said that while the cost concern is valid, it could be that the complexity concern is overestimated by some respondents as the new model might seem a big change for them.

Recognition, measurement and discount rate

Some users commenting on the recognition and measurement proposals were concerned about the volatility that may arise in profit or loss if entities recognise regulatory assets that are not subsequently recovered. They pointed out that the proposals on recognition and measurement would require management to make judgements and that disclosure of those judgments in the notes would be useful.

An accounting firm said that the proposal to require an entity to apply the ‘more likely than not’ recognition threshold is a departure from the Conceptual Framework and asked the Board to further explain the reason for the departure and the potential consequences.

Most of the users commenting on the measurement proposals agreed with the cash flow-based measurement technique and with using the regulatory interest rate as the discount rate.

Most of the users commenting on the discount rate agreed with the proposal to use the regulatory interest rate as the discount rate.

Board discussion

With regard to respondents’ comments on the departure from the Conceptual Framework, Board members said that ‘more likely than not’ was indeed a departure from the asset definition in the Conceptual Framework, but one that might be warranted. It should however only be done if there was compelling evidence for the departure. In this sense, one Board member did not understand why respondents’ call for using a higher probability threshold was less of a departure from the Conceptual Framework. The Vice Chair said that the Conceptual Framework says that even if the asset definition is met, more considerations have to be made before recognising it. The proposed model was therefore not an incorrect application of the Conceptual Framework, but a matter of judgement. It should be clearly explained though why the Board decided for a departure here.

On measurement, one Board member said that it was not clear whether preparers could change between expected value and most likely amount. There is also an inconsistency with regard to impairment. In the proposal, the Board stated that impairment was not necessary as the amounts would be reassessed constantly. However, under the ‘most likely amount’ approach, there might not be a reassessment as the most likely amount stays the same over several periods.

Minimum interest rate

Most respondents disagreed with the proposal for an entity to use the minimum interest rate as the discount rate when the regulatory interest rate provided for a regulatory asset is insufficient to compensate the entity for the time value of money and for uncertainty in the future cash flows arising from that regulatory asset. These respondents are concerned about the complexity of the proposals and believe that the costs of applying them would outweigh any benefits.

Board discussion

The Board members acknowledged the concerns raised with regard to the minimum rate and said that where possible, the Board should reduce complexity when developing the final standard. However, the minimum interest rate was required due to the low interest rate environment. The Vice Chair said that the issue had been discussed when developing the ED and when drafting the papers on this topic, the staff should remind the Board of what had been discussed and what had been decided based on those discussions.

Interaction with IFRIC 12

Many respondents asked the Board to clarify the interaction between the proposals and IFRIC 12. Most respondents commenting on this topic suggested the Board provide detailed guidance and illustrative examples on how an entity would account for regulatory assets and regulatory liabilities applying the financial asset, the intangible asset or a hybrid model in IFRIC 12.

Board discussion

Board members agreed that the interaction between the new Standard and IFRIC 12 should be clarified, although one Board member said that many of the questions raised were application questions of IFRIC 12 and not of the interaction. With regard to the priority, it should be clear that IFRIC 12 applies first to items within its scope and then the new Standard would be applied as an overlay. One Board member said it should be explained to preparers who have IFRIC 12 contracts why they might be within the scope of the new Standard as well.

Next steps

The feedback received on the following topics of the ED will be presented at the November 2021 Board meeting:

  • Presentation in the statement(s) of financial performance
  • Disclosure
  • Effective date and transition
  • Likely effect of the proposals

Agenda Papers 9A-9H

These agenda papers contain the detailed feedback on each of the areas in the ED.

 

Correction list for hyphenation

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