Rate-regulated Activities

Date recorded:

Cover note (Agenda Paper 9)

At this meeting, the IASB continued redeliberating the proposals in Exposure Draft ED/2021/1 Regulatory Assets and Regulatory Liabilities with regard to total allowed compensation.

The cover paper was not discussed during the meeting.

Components of total allowed compensation (Agenda Paper 9A)

This paper analysed feedback about whether the proposed components of total allowed compensation appropriately reflect the economics of incentive-based schemes.

Specifically, some respondents to the ED said that:

  • The proposed components of total allowed compensation fit well with the features of cost-based schemes. This is because cost-based schemes mainly aim to entitle entities to recover their costs and obtain a return on their investments. However, the proposed components do not work well with incentive-based schemes because these schemes may give entities an ‘allowed revenue’ amount as well as compensation that entitles an entity to, for example, pass demand risk to customers or to recover some specific costs. In this circumstance, these respondents suggest total allowed compensation consists of the allowed revenue for the period plus some differences in timing that may arise or reverse in that period (for example, volume variances)
  • The proposals appear to assume some components of total allowed compensation would be present in all regulatory agreements. However, some regulatory agreements may not:
    • Provide for any form of profit because the regulator determines regulated rates with the aim that the entity achieves breakeven results
    • Provide regulatory interest on regulatory assets or charge regulatory interest on regulatory liabilities. For example, in determining the regulated rate, a regulatory agreement may allow an entity to receive a regulatory return on the regulatory capital base that would provide an overall adequate compensation. As a result, these regulatory agreements do not determine a compensation or a charge for the time value of money and uncertainty in the cash flows of any regulatory assets or regulatory liabilities
  • Some regulatory agreements may include components that are not included in the ED. For example, some regulatory agreements allow entities to recover volume variances in future periods so that entities are able to recover their allowed revenue. These volume variances however bear no relation to allowable expenses or target profit, consequently, according to these respondents, it is not clear how the proposals would treat these regulatory agreements

Staff recommendation

To address the feedback, the staff recommended the application guidance of the final Standard does not specify the components of total allowed compensation, but rather focuses on helping entities identify differences in timing. The application guidance will focus on the most common differences in timing that may arise from different types of regulatory schemes.

IASB discussion

IASB members agreed that it is sensible to focus on timing differences given the feedback received. One IASB member warned that going back to an allowable revenue model would be the wrong direction given the progress that has already been made on the total allowed compensation concept.

IASB decision

All IASB members supported the staff recommendation.

Total allowed compensation—Regulatory returns on an asset not yet available for use (Agenda Paper 9B)

This paper analysed feedback on the proposed treatment of regulatory returns on an asset not yet available for use. Specifically, most respondents to the ED disagreed with the proposal for an entity to reflect regulatory 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

Many respondents said regulatory returns on an asset not yet available for use compensate entities for fulfilling the following obligations during the construction period:

  • The construction of the asset—continuous investment in the network to ensure reliable, secure and efficient supply of goods or services to customers
  • The provision of capital (debt and/or equity) to fund investment in the network

Staff recommendation

The staff recommended:

  • The final Standard should specify that when a regulatory agreement entitles an entity to regulatory returns on an asset not yet available for use, these returns form part of the total allowed compensation for goods or services supplied during the period in which the entity incurs the capital outlay to construct the asset— that is, the construction period
  • The final Standard should provide guidance on how the provisions of the regulatory agreement may affect the amount of regulatory returns on an asset not yet available for use to which an entity is entitled during the construction period.
  • The staff should analyse further whether an entity’s capitalised borrowing costs should affect the recommended treatment of regulatory returns on an asset not yet available for use described above.

IASB discussion

Most IASB members seemed to agree that the topic should be revisited as the prohibition in the ED to include returns on an asset not yet available for use in the total allowed compensation seems too absolute.

The discussion was mainly around which goods or services are provided during the construction phase. The staff’s view was that there is only one service which is the provision of capital. That view was based on outreach in two jurisdictions. However, some IASB members disagreed with this and thought that in other jurisdictions it could also be construction services, which would require the application of recognition requirements in IFRS 15. The provision of capital does not have that recognition question, only a measurement question.

The staff suggested to first clarify whether there was support amongst IASB members on whether the prohibition in the ED should be removed. If yes, the second question would be whether the goods or services provided would always be the provision of capital or if it could also include construction services. If the latter, then the IASB should decide on how the provision of construction services should be recognised.

IASB decision

The IASB voted on the first part of the question (i.e. whether the prohibition should be removed), which was supported by all IASB members.

After some discussion on how to word the remaining questions to the IASB, the staff suggested that the topic should be brought back to another session later in the same week to allow for sufficient time to consider all consequences of rephrasing the questions.

Total allowed compensation — Regulatory returns on an asset not yet available for use (Addendum) (Agenda Paper 9C)

This paper supplements the staff analysis and recommendations in Agenda Paper 9B.

Staff recommendation

The staff recommend the final Standard specifies that:

  • When a regulatory agreement entitles an entity to include regulatory returns on an asset not yet available for use in the regulated rates, these returns typically relate to the provision of capital to finance the construction of the asset (Recommendation 1)
  • When an entity has an enforceable present right to regulatory returns on an asset not yet available for use, those returns form part of the total allowed compensation for goods or services supplied during the period in which the entity provides the capital to construct the asset (the construction period) (Recommendation 2)
  • In assessing whether an entity has an enforceable present right to regulatory returns on an asset not yet available for use, the final Standard distinguishes between cases when:
    • The returns are included in regulated rates charged during the construction period—in this case, the fact that a regulatory agreement entitles an entity to include regulatory returns on an asset not yet available for use during the construction period and the entity charges those returns during that same period provides evidence the entity has an enforceable present right to these returns. In this case, however, the final Standard would provide guidance on when the terms of the regulatory agreement may affect the amounts of regulatory returns that the entity should reflect in profit or loss during the construction period
    • The returns are included in rates charged during the operation period—in this case, an entity would need to assess whether it has an enforceable right to payment for the regulatory returns relating to the capital invested in constructing the asset to date—that is, for the regulatory returns accumulated to date. In making this assessment, the entity would need to consider the terms of the regulatory agreement and the legal environment in which the regulatory agreement is enforceable. If the entity concludes it has an enforceable present right to regulatory returns on an asset not yet available for use during the construction period, it would account for a regulatory asset and measure that regulatory asset applying the measurement requirements in the final Standard (Recommendation 3).

IASB discussion

IASB members expressed concern about Recommendation 1. It was noted that adding these words to the Standard would be a rule rather than a principle. IASB members explored whether this could instead be a rebuttable presumption or a practical expedient if unbundling into finance and construction services was impracticable. Then again, this could lead to abuse if entities prefer to treat these as construction services, for example for tax reasons. One IASB member wondered whether the Standard could not just state that these returns relate to the provision of goods or services provided during the construction period to make sure it covers regulatory agreements in all jurisdictions. The staff responded that it was important to use the drafting in Recommendation 1 to make clear that this is different to what was proposed in the ED. However, IASB members thought that this explanation would be better suited for the basis for conclusions (BC) and that only Recommendation 2 should be added to the Standard as it meets the requirement for a principle. The staff also cited comparability as a reason to add this rule to which an IASB member replied that forcing dissimilar items (construction and finance) into the same accounting treatment was not the aim of the comparability characteristic.

IASB decision

The Chair asked whether the IASB agree with the following:

  • Do not add Recommendation 1 to the Standard and instead explain in the BC how the principle is different from the ED
  • Add Recommendation 2 to the Standard as a principle
  • Add Recommendation 3 to the Standard as application guidance on how to perform the assessment

8 of 9 IASB members present supported this suggestion.

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