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Rate-regulated activities

Date recorded:

Agenda Papers 9–9E

Background

The Board has been discussing an accounting model (the ‘model’) that aims to provide useful information about the rights and obligations that are created by defined rate regulation. So far, the Board has reached tentative decisions on proposals for the scope of the model, unit of account, the recognition of regulatory assets and regulatory liabilities and the measurement of regulatory assets.  

Staff analysis

Interactions between the model and IFRS Standards

The model applies a ‘supplementary approach’: the information it provides supplements the information provided by applying current IFRS Standards. Because IFRS 14 Regulatory Deferral Accounts applies a similar approach, the staff has focused on whether the requirements and guidance for the interactions between IFRS 14 and other Standards should be included in the model. The staff views that many of such requirements and much of the guidance included in IFRS 14 would not be valid for the model and therefore should be excluded, with limited exceptions.

The staff has also reviewed the requirements in other IFRS Standards not referred to in IFRS 14 to identify whether the model should deal with any interactions with those other Standards. This analysis is still on-going.

Presentation requirements

The Board has previously noted that the regulatory assets do not fit neatly into any of the defined categories of assets accounted for using existing IFRS Standards and similar observations can be made for regulatory liabilities. Accordingly, separate presentation of the regulatory assets and liabilities on the statement of financial position would be appropriate. Offsetting would not be appropriate unless specific criteria are met.

The staff considered whether it would be feasible to disaggregate regulatory balances between current and non-current amounts and understand from a consultation held that it typically is because of the level of detail needed to comply with record-keeping requirements in regulatory agreements.

The staff considered the advantages of presenting two line items for regulatory income and regulatory expense in the income statement but noted that the users need more detailed information about the different components of regulatory income and expense. This additional granularity would be better provided through disclosures in the notes and a net presentation of regulatory income and expense is therefore the staff’s preference. The staff also rejected the idea to present regulatory interest or return separately from other components of regulatory income/expense. Given that regulatory agreements use an overall return that includes both financing and operating features, a separate presentation would require a judgmental and onerous process to identify and quantify all possible components of the interest or return rate. The staff considered that regulatory income and expense form part of an entity’s operating activities and reflects differences in the timing of revenue recognition rather than expense recognition, and accordingly presenting this line item immediately below the revenue line item would provide the most useful information.

The staff also viewed that the nature of any regulatory income/expense recognised in other comprehensive income is different from the nature of the underlying items to which they relate (for example, pension costs or cash flow hedges) because the predominant nature is regulatory and therefore these amounts should be presented separately.

Disclosure objectives and requirements

In light of the views expressed by some Board members in July 2018, the staff reassessed the draft disclosure objective it had provided to the Board at the time. The staff considered that this objective should be focused on the effects that the transactions or other events that give rise to regulatory timing differences have on the entity’s financial performance and financial position, rather than being broader to include the provision of information about the general regulatory and economic environment and about all effects that defined rate regulation has on the entity’s financial performance, financial position and cash flows.

In addition, the staff considered specific disclosure objectives and requirements supporting those, noting that different levels of aggregation may be appropriate because the characteristics of the regulatory income/expense differ from the characteristics of the regulatory assets and liabilities. For example, the staff believes that the regulatory income/expense line item(s) should be further disaggregated whereas it would be sufficient to present a maturity analysis for all regulatory assets and liabilities. 

The agenda papers include illustrative disclosures.

Staff recommendations

The staff made the following recommendations in relation to the interactions with other Standards:

  • The model should contain exceptions to the measurements requirements of IAS 36 Impairment of Assets and IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
  • The Board should make consequential amendments to IAS 36 and IFRS 5 to confirm the exceptions to the scope of the measurement requirements for regulatory assets and regulatory liabilities.
  • The Board should not retain in the model the exceptions to the requirements of IFRS 3 Business Combinations provided by IFRS 14.
  • The Board should not retain in the model an explicit requirement to apply other IFRS Standards, such as IAS 10 Events after the Reporting Date, to regulatory assets, regulatory liabilities and regulatory income/(expense).
  • The description of the model should include application guidance about the interaction with IAS 12 Income Taxes, similar to the application guidance in IFRS 14:B10.
  • The presentation and disclosure requirements in IFRS 14 requiring regulatory items to be isolated from assets, liabilities and net income/(expense) by use of sub-totals should not be retained in the model.
  • Requirements and application guidance relating to interactions between the model and other IFRS Standards should be contained within the Standard.

The staff made the following recommendations in relation to presentation:

  • In the statement of financial position, an entity should (i) present regulatory assets separately from regulatory liabilities as separate line items, (ii) offset regulatory assets and regulatory liabilities if, and only if, these assets and liabilities are reflected in the same adjustment to the rate(s) charged to customers and, consequently, have the same pattern and timing of reversal, arise in the same regulatory regime and the entity has a legally enforceable right to offset them, and (iii) classify regulatory assets and regulatory liabilities as current or non-current, except when a presentation based on liquidity provides information that is reliable and more relevant.
  • In the income statement, an entity should (i) present regulatory income and regulatory expense netted as a separate line item, (ii) include regulatory interest income and regulatory interest expense within the regulatory income/(expense) line item, and (iii) present the regulatory income/(expense) line item immediately below the revenue line item.
  • In the statement of other comprehensive income, an entity should present separate line items for amounts of regulatory income/(expense) relating to items presented in other comprehensive income, classified according to whether the underlying item to which the regulatory income/(expense) relates will be reclassified subsequently to profit or loss.
  • Consequential amendments should be made to IAS 1 Presentation of Financial Statements to add the line items for regulatory assets, regulatory liabilities and regulatory income/expense to the lists of items required to be presented.
  • An entity should not be prohibited from disaggregating the required line items and presenting additional line items or subtotals in the primary statements when such presentation is relevant to an understanding of the entity’s financial position and/or financial performance, as required by IAS 1.

The staff proposed to the Board a revised draft overall disclosure objective: “An entity shall disclose information that helps users of financial statements to understand how the origination and reversal of regulatory timing differences affected the entity’s financial performance and financial position. This information will be useful when it will help users to understand and assess the entity’s financial performance, financial performance trends and assess the amounts, timing and uncertainty of (prospects for) its future cash flows.”

In addition, the staff recommended three specific disclosure objectives in relation to (i) how regulatory timing differences affected the relationship between the entity’s financial performance, (ii) the amount, timing and uncertainty of future cash flows from regulatory assets and liabilities, and (iii) changes in the carrying amounts of regulatory assets and liabilities.

To meet those disclosure objectives, the staff included four disclosure requirements including:

  • A breakdown of the regulatory income/expense line items
  • A maturity analysis for the regulatory assets and liabilities
  • The discount rate or ranges of discount rates used to discount the estimated cash flows of the regulatory assets and liabilities
  • A reconciliation of the carrying amount of regulatory assets and liabilities from the beginning to the end of the period

In addition, the staff recommended an overarching requirement to assess whether the information provided is sufficient to meet the overall disclosure objective. If not, any additional information needed should be disclosed.

The staff also asked the Board whether any other specific disclosure objectives and/or disclosure requirements should be added.

Discussion

Interactions between the model and IFRS Standards

The Board discussed in depth the staff recommendation to apply the requirements of IFRS 3 to the model without exceptions. One Board member stressed that the costs of requiring entities to fair value the regulatory assets acquired and regulatory liabilities assumed on a business combination outweigh the benefits.

The staff recommendation was based on the fact that at the acquisition date, the fair value of a regulatory timing difference would “typically approximate to the carrying amount determined by using the measurement technique” of the model. Board members agreed that this would often be the case, but not always.

Another Board member thought that given that the fair value does not always approximate to the carrying amount, an exception to the requirements of IFRS 3 should be granted. She noted that measuring the regulatory assets and liabilities at fair value at the acquisition date would give rise to a day 2 gain or loss at the end of the reporting period when the entity reverts to apply the discount rate prescribed by the model.

Other Board members saw merits in measuring the regulatory assets and liabilities at fair value on acquisition, noting that this would reflect what an acquirer is willing to pay for the business, and that if no adjustment was made, the difference would go to goodwill.

As a result of these discussions, the Board asked the staff to consider the question of the day 2 accounting for regulatory assets and liabilities following a business combination when developing the guidance on ‘reasonable rate’. The Board also asked the staff to assess further the merits of using fair value accounting on a business combination taking into account the fact that the fair value and carrying amount of a regulatory asset or liability would be close, and considering both the costs and benefits of a fair value approach. Accordingly, the Board decided not to make a decision on the staff recommendation on IFRS 3 at the meeting. 

Board members also debated whether the model should provide an exception to the measurement requirements of IAS 36. The staff recommendation was based on the fact that the regulatory assets would be measured based on estimated cash flows, including consideration of expected defaults.  One Board member challenged this assumption, noting that the regulatory asset represents the right to change the rate charged to customers, not the right to collect certain amounts. Accordingly, the estimated cash flows would factor in expectations of variability in quantity, but not the exposure to credit risk. Another disagreed, noting that if the risk of non-payment is typically factored into the price that an entity can charge to customers for rate-regulated goods or services, there may be further instances that need to be reflected into the estimates of cash flows, for example if a large customer is at risk of defaulting. The staff concurred with that latter view.

One Board member asked the staff, when developing guidance about the interaction with IAS 12, to acknowledge that there could be some degree of accounting mismatch due to the fact that the carrying amount of the regulatory asset or liability would be discounted while the carrying amount of the related tax asset or liability would not be.

On the recommendation that any requirements and application guidance relating to interactions between the model and other IFRS Standards should be placed within the Standard on rate-regulated activities and not in the other Standards, it was noted that there should be one exception for IFRS 1 First-time Adoption of International Financial Reporting Standards.

Presentation

The Board discussed whether an entity should be required or permitted to offset regulatory assets and regulatory liabilities if the conditions noted in the staff paper are met. Most Board members did not want to force entities to offset, noting it could be difficult for preparers to ensure that all elements requiring netting have been identified. Some also noted that there could be uncertainty where a formal ruling has not been agreed yet, or more rarely where a regulator modifies their initial ruling. The staff viewed that there will also be judgement in how much grouping should be made and accordingly they favoured permitting rather than requiring entities to offset.

Those who wanted the offsetting requirements to be mandatory noted that showing an asset and a liability when there is going to be a single net flow did not appear to be faithful representation. One Board member added that if an asset and a liability are going to be reflected in the same adjustment, then it would not be a burden for entities to identify them. The staff concurred but noted that the assessment is generally done on an item-by-item basis, and for netting purposes, entities would have to do a further step to group items together.

The staff also agreed to reword the conditions for offsetting after a Board member noted that if the regulatory assets and liabilities are reflected in the same adjustment to the rate(s) charged to customers, then by definition they would arise in the same regulatory regime.

On the profit or loss section, Board members agreed with the staff recommendation to present regulatory income and expense net below the revenue line item but debated whether there should be a subtotal for revenue and regulatory income/expense, and whether that subtitle could be called revenue.

One Board member wanted to prevent entities from presenting such a subtotal, on the basis that regulatory income or expense does not represent revenue from contracts with customers.

Another Board member, on the contrary, thought the subtotal line should be required and titled revenue, because only the combination of IFRS 15 revenue and the regulatory income/expense represents the full revenue of the entity. The regulatory income/expense captures the supplement (plus or minus) to the amount that has been invoiced to the customer and that the entity has earned out of the same performance obligation. She also noted that the Board should clarify whether revenue as defined in IAS 1 only includes revenue recognised in accordance with IFRS 15 or can encompass other types of income. Other Board members noted it could be a useful subtotal and they would allow it for that reason.

Board members also debated whether regulatory interest income or expense should be presented with regulatory income/expense or separately. Most agreed not to separate in order to not complicate the presentation requirements. One Board member also thought this was the most relevant presentation.

One Board member who opposed the staff recommendation noted that the different nature of the regulatory interest income or expense (which is the unwinding of the time value of money) from the underlying regulatory income or expense (which is compensation for goods or services provided) would require a separate presentation. Another Board member wanted to have an invitation to comment to confirm the Board’s understanding that the regulatory interest income/expense is not such valuable information to the users of the financial statements that it would always require separate presentation.

The staff paper stated that compensation provided through the regulatory interest or returns is not related to an entity’s financing activities. A Board member wanted the staff to clarify that it is also not related to an entity’s investing activities.

The staff paper argued that when a regulatory timing difference relates to an event or transaction that cause the recognition of income or expense presented in other comprehensive income (“OCI”), then the related movement in regulatory timing differences should also be reflected in OCI. Although the Board members agreed that underlying items can appear in OCI, they disagreed with the staff recommendation. In particular, they thought the model does account for the right to increase and the obligation to decrease the rates charged to customers in the future and not for the costs incurred in relation to the rate-regulated activities. Accordingly, the presentation of the underlying transaction is irrelevant and all amounts of regulatory income/expense should be presented in the profit or loss section. However, the staff considered that such presentation would be confusing for the users.

The Board asked the staff to prepare an illustrative example to consider this question further.

Disclosure objectives and requirements

One Board member asked the staff to review the wording used in the disclosure objectives and requirements to ensure that the wording reflects the fact that the model is based on the requirements of the Conceptual Framework in relation to the recognition of assets and liabilities.

Board members agreed that there should be no disclosure requirements in relation to the general regulatory and economic environment. One noted that some of that information should be captured though as part of a description of the risks and uncertainties that an entity faces. The staff clarified that under the specific disclosure objective for the amount, timing and uncertainty of future cash flows from regulatory assets and regulatory liabilities entities would be required to provide quantitative disclosure on risks and uncertainties. They also clarified that the Specific disclosure objective for financial performance focuses on what causes the regulatory income/expense amount recognised in profit or loss and does not require to consider all items impacted by regulatory agreements.

One Board member thought there should be an objective in relation to the nature and characteristics of the rate regulation agreement(s) that the entity has entered into, such as for example the duration of the agreements.  Another Board member thought it could be difficult to convey this information concisely for entities that operate in many different jurisdictions.

Board members made various comments in relation to the proposed disclosure requirements for the staff to take into consideration when drafting further guidance.

One Board member asked whether the time bands in the maturity analysis should include one to two years separately. She also wanted the staff to consider whether there should be disaggregation by regulator and to incorporate an example on that basis. She thought the Board should also consider whether it is more useful information to present the regulatory adjustments by the underlying nature of the activity, as implied in the staff paper, or by the characteristics of the adjustment. Another Board member considered there may be a need for additional guidance on the level of granularity required in the maturity analysis.

Decisions

The Board unanimously supported all of the staff recommendations on the interaction between the model and other IFRS Standards, except for the recommendation not to retain in the model exceptions to the requirements of IFRS 3 provided by IFRS 14 (question 2 in Agenda Paper 9B) For this the Board asked the staff to perform more analysis before considering it again.

No Board members supported the staff recommendations that an entity should be required to present in OCI amounts of regulatory income/expense relating to items presented in OCI. The Board approved all the other staff recommendations in relation to presentation (Agenda Paper 9C) as follows:

  • Q1a: 13 approved
  • Q1b was reworded as follows: “Does the Board agree that an entity should be permitted to offset regulatory assets and regulatory liabilities if certain conditions are met?” 10 Board members approved this recommendation, while 3 Board members would want entities to be required to offset if the conditions are met.
  • Q1c: 13 approved
  • Q2a: 13 approved
  • Q2b: 12 approved
  • Q2c: 13 approved
  • Q3: 11 approved

The Board unanimously approved the staff recommendations on disclosure objectives and requirements, subject to specific suggestions in terms of wording. They asked the staff to consider an additional specific disclosure objective providing some context on the entity’s regulatory agreement(s) and/or regulatory regime.

Correction list for hyphenation

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