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17.4 Regulatory liabilities
Publication date: 31 Aug 2023
us Utilities guide
ASC 980-405-25-1 provides specific criteria for recognition of three types of regulatory liabilities that may arise as a result of actions of a regulator:
- Refunds of amounts previously collected from customers (UP 17.4.1)
- Current collections for future expected costs (UP 17.4.2)
- Refunds of gains (UP 17.4.3)
These liabilities are a regulated utility’s obligations to its customers. Recognition and measurement of the three general types of regulatory liabilities is further discussed in this section.
Question UP 17-14
Should a regulated utility recognize liabilities required under US GAAP for entities in general?
Should a regulated utility recognize liabilities required under US GAAP for entities in general?
PwC response
Yes. A regulated utility may be eligible for rate recovery of amounts that are recorded as a liability under US GAAP (e.g., incurred but not reported personal injury claims, environmental liabilities). Regulated utilities may question whether such liabilities should be recorded in the financial statements. Liabilities that are recorded pursuant to US GAAP in general are not within the scope of ASC 980-405-25-1 because they are not created or imposed by the actions of the regulator. Therefore, the requirement to recognize such liabilities does not depend on whether the regulator has provided recovery of the costs relating to such liabilities.
ASC 980-405-40-1 specifically indicates that a regulator can only eliminate a liability that was previously imposed by its actions. Therefore, in addition to potential regulatory liabilities, regulated utilities should record all liabilities that would be recorded by entities in general. If the liability will be recoverable through rates, the regulated utility may be able to record a regulatory asset, assuming the criteria in ASC 980-340-25 are met.
Question UP 17-15
How should a regulated utility account for future rate reductions?
How should a regulated utility account for future rate reductions?
PwC response
A regulator may require that a regulated utility reduce customers’ rates in future periods that do not relate to existing conditions. For example, a regulated utility may be required to provide future rate concessions as part of a general rate case or may reduce future rates in the form of credits that are agreed to in connection with a business combination (merger credits) or a FERC license renewal. The effects of regulator-ordered future rate reductions should not be accrued in advance, but should be recognized as reduced revenue in future periods. Such future obligations do not meet the general definition of a liability under Statement of Financial Accounting Concept 6: Elements of financial statements (CON 6).
CON 6, paragraph 35
Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
Future rate reductions do not represent an obligation to transfer assets (i.e., no cash consideration will be transferred) nor an order by a regulator to refund amounts previously collected from customers. Rather, they represent a requirement to accept a reduced return on future sales (whether provided directly through a rate credit or through a reduction of costs allowed in establishing future rates). There is also no obligation to provide future service outside of what would otherwise be provided in the normal course of business. Therefore, the CON 6 criteria are not met and no liability should be recorded under US GAAP applied by entities in general.
Some may view the agreement to provide future rate reductions as an onerous contract or agreement with the regulator because the regulated utility is agreeing to provide service in the future at reduced rates. However, even if this agreement is viewed as a contractual commitment, a liability should not be recognized for expected losses on executory contracts prior to those losses being incurred, unless specifically permitted in authoritative guidance.
Furthermore, as summarized in Figure UP 17-6, future rate concessions typically do not meet the definition of a regulatory liability.
Figure UP 17-6
Are future rate reductions regulatory liabilities?
Are future rate reductions regulatory liabilities?
Guidance |
Evaluation |
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A regulator may require refunds to customers. . . . Refunds that meet the criteria of . . . loss contingencies (see ASC 450-20-25-2) shall be recorded as liabilities. (UP 17.4.1)
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ASC 450-20-25-2 requires accrual of a loss contingency if it is both probable that a liability has been incurred and the liability is reasonably estimable. Future rate reductions do not meet the criteria for accrual of a loss contingency; therefore, no regulatory liability should be recorded.
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A regulator can provide current rates intended to recover costs that are expected to be incurred in the future with the understanding that if those costs are not incurred future rates will be reduced by corresponding amounts. (UP 17.4.2)
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ASC 980-405-55-1 states that a regulator may direct a regulated utility to include an amount for a contingency in allowable costs for rate-making purposes even though the amount does not meet the criteria in ASC 450-20 for recording.
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A regulator can require that a gain or other reduction of net allowable costs be given to customers over future periods. (UP 17.4.3)
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If future rate reductions do not represent the return of prior gains nor reductions of net allowable costs to customers over future periods, a regulated liability should not be recorded.
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Amounts should not be recognized in connection with a commitment to provide future rate reductions until the rate reductions occur, consistent with the guidance for commitments.
17.4.1 Refunds of previous customer collections
ASC 980 includes guidance that applies to any regulator-imposed refund of amounts previously collected from customers. Typical examples of these types of regulatory liabilities include:
- Revenue billed subject to refund
- Excess collections of allowable costs included in rates that were lower than anticipated (e.g., balancing accounts)
Excerpt from ASC 980-405-25-1(a)
A regulatory may require refunds to customers. Refunds can be paid to the customers who paid the amounts being refunded; however, they are usually provided to current customers by reducing current charges. Refunds that meet the criteria of accrual of loss contingencies (see paragraph 450-20-25-2) shall be recorded as liabilities and as reductions of revenue or as expenses of the regulated entity.
Regulated utilities should evaluate potential regulatory liabilities associated with refunds to customers of previously collected amounts in accordance with the guidance for loss contingencies in ASC 450-20-25-2. A liability should be recognized if it is probable that the loss was incurred at the balance sheet date and the loss is reasonably estimable. Specific considerations with respect to certain types of refunds are further discussed in the following sections.
17.4.1.1 Revenue subject to refund
Regulators may allow a regulated utility to begin billing requested revenue increases in advance of a ruling on the request. Although the regulator authorizes the regulated utility to bill its customers, the regulated utility and the regulator both understand that the authority to bill does not represent approval of the rates. A subsequent ruling by the regulator may result in the regulated utility having to refund all or certain amounts billed in advance.
Revenues collected subject to refund may be substantial in amount and judgment may be required to determine the appropriate recognition.
In accordance with ASC 980-405-25-1(a), a regulated utility collecting revenue subject to refund should consider whether a regulatory liability should be recorded based on its best estimate of a probable loss, consistent with the guidance in ASC 450-20-25-2. Before recognizing revenue subject to refund, regulated utilities should consider actions taken in past cases in the regulatory jurisdiction, opinion of legal counsel, and other factors. See UP 17.8.2 for information on disclosure requirements for revenue subject to refund.
Question UP 17-16
How do you recognize revenue subject to refund when there is a wide range of potential outcomes?
How do you recognize revenue subject to refund when there is a wide range of potential outcomes?
PwC response
If a regulated utility believes it is probable that some amount of refund will be required, but the range of potential refunds is so wide that it is difficult to estimate, it may be difficult to support the recognition of revenue prior to the approving rate order.
Excerpt from ASC 980-605-30-2
If the range of possible refund is wide and the amount of the refund cannot be reasonably estimated, there may be a question about whether it would be misleading to recognize the provisional revenue increase as income.
Consistent with this guidance, if a regulated utility is unable to reliably estimate the amount of potential refund, it should defer recognition of any amounts collected that are subject to refund.
Timing of recognition
In general, a regulated utility should recognize amounts previously deferred or reverse revenue previously recognized (i.e., if it becomes probable that a refund will be required) in the period in which the order is received or the probability assessment changes. However, there is an exception to this general rule for certain rate impacts that occur in interim periods.
ASC 250-10-45-25 through 45-26 require restatement of prior interim periods of a current fiscal year for certain types of income statement adjustments that meet specified criteria. This guidance is referenced by ASC 980-250-55-4 through 55-5 in the context of refunds to customers. In accordance with this guidance, a reporting entity should restate prior interim periods for revenue subject to refund if all of the following criteria in ASC 250-10-45-25 are met:
Excerpt from ASC 250-10-45-25
- The effect of the adjustment or settlement is material in relation to income from continuing operations of the current fiscal year or in relation to the trend of income from continuing operations or is material by other appropriate criteria.
- All or part of the adjustment or settlement can be specifically identified with and is directly related to business activities of specific prior interim periods of the current fiscal year.
- The amount of the adjustment or settlement could not be reasonably estimated prior to the current interim period but becomes reasonably estimable in the current interim period.
ASC 250-10-45-25 goes on to state that the receipt of a final rate order would result in criterion (c) being met. Therefore, if a regulated utility receives a final rate order related to revenue subject to refund that was previously billed and the order impacts rates of a prior interim period, the regulated utility will need to consider the appropriate period in which to record an adjustment, if necessary, to amounts previously recognized. Figure UP 17-7 summarizes the financial statement impact if all of the criteria are met.
Figure UP 17-7
Accounting for adjustments resulting from a rate-order
Accounting for adjustments resulting from a rate-order
Period to which settlement applies |
Period impacted |
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Prior fiscal year(s)
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Restate the first interim period of the current fiscal year to include the amounts
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Prior interim periods of current fiscal year
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Restate the applicable interim periods of the current fiscal year to include the amounts
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Current interim period
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Record in current interim period
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In determining whether to adjust the prior period statements, the reporting entity should consider materiality and whether the order relates to revenue subject to refund and, if so, whether all of the other criteria in ASC 250-10-45-25 are met.
Question UP 17-17
Does the guidance on restatement of prior interim periods apply to adjustments other than revenue subject to refund (e.g., a rate increase)?
Does the guidance on restatement of prior interim periods apply to adjustments other than revenue subject to refund (e.g., a rate increase)?
PwC response
No. The question of whether the guidance on interim period adjustments applies to any type of rate adjustments stems from the ASC 250-10-45-25 reference to “utility revenue under rate-making processes” in discussing situations when the guidance applies. We believe application of this guidance should be limited to situations involving changes to amounts previously recognized when a regulated utility has billed revenue subject to refund. In the deliberations leading up to the issuance of both FAS 16 and FAS 71, the application of the interim adjustment guidance was discussed only in the context of customer refunds. Furthermore, ASC 980-250 discusses the interim guidance only in the context of customer refunds. Therefore, we believe that the guidance should not be applied more broadly and application should be limited to revenue subject to refund.
17.4.1.2 Balancing accounts
Some forms of regulatory mechanisms result in balances that change from being a regulatory asset to a regulatory liability from period to period, and vice versa. This typically occurs due to over- and under-collections of billings as compared to actual costs incurred. Common examples include natural gas balancing accounts, alternative revenue arrangements, pension amounts, and gains/losses (realized and unrealized) that are passed on to ratepayers as reductions or increases in rates, respectively. In those cases, reporting entities should evaluate the guidance that applies to regulatory assets or regulatory liabilities depending on whether the balance is an asset or liability. These types of regulatory accounts are discussed in UP 17.3.
17.4.2 Current collections for future expected costs
This type of regulatory liability arises when a regulator provides current rates intended to recover costs that are expected to be incurred in the future, with an understanding that future rates will be reduced if those costs are not incurred.
A regulated utility should record a regulatory liability (instead of revenue) for amounts collected in advance of the related expenditures, if it is required to refund any amounts not expended. Amounts recorded as a regulatory liability would be recognized in income when the associated costs are incurred.
Excerpt from ASC 980-405-25-1(b)
A regulator can provide current rates intended to recover costs that are expected to be incurred in the future with the understanding that if those costs are not incurred future rates will be reduced by corresponding amounts. If current rates are intended to recover such costs and the regulator requires the entity to remain accountable for any amounts charged pursuant to such rates and not yet expended for the intended purpose, the entity shall not recognize as revenues amounts charged pursuant to such rates. The usual mechanism used by regulators for this purpose is to require the regulated entity to record the anticipated cost as a liability in its regulatory accounting records. Those amounts shall be recognized as liabilities and taken to income only when the associated costs are incurred.
Some common items that may be subject to this type of tracking mechanism include storm costs, environmental costs, or other contingent expenditures. For example, a regulator may provide recovery in current rates for a future contingency that would otherwise not meet the definition of a liability under ASC 450. In this situation, the regulated utility is typically required to track such amounts and refund customers to the extent of any unused collections.
17.4.2.1 Application example — evaluating current collections for future expected costs
Example UP 17-1 illustrates considerations in evaluating the accounting for amounts collected in advance of being incurred.
EXAMPLE UP 17-1
Accounting for storm costs included in base rates
Accounting for storm costs included in base rates
Rosemary Electric & Gas Company (REG), a regulated utility subject to ASC 980, operates in a region where major storms are a common occurrence. To ensure sufficient and timely cash flows to quickly make needed repairs resulting from storms, the regulator allows REG to collect $50 million each year for contingent storm costs. However, the regulator requires that any amounts not spent in a given year be returned to customers in the subsequent year.
Should REG record a regulatory liability for amounts collected until storm costs meeting the specified criteria are incurred?
Analysis
Yes. Because REG is required to track associated costs and return unused amounts to customers, REG should record a regulatory liability for amounts collected until storm costs meeting the specified criteria are incurred. If REG experiences qualifying storm costs during the year, it would recognize the costs in the income statement when incurred, with a corresponding reduction to the liability and increase in revenues.
17.4.3 Refunds of gains
Regulators may require a regulated utility to partially or wholly share gains with its ratepayers. Common examples of such gains may include amounts arising from the sale of utility property, debt extinguishments, or investment income associated with debt and equity securities (including amounts earned from investments such as nuclear decommissioning trust funds). Such gains are typically provided to ratepayers over a period of time in the form of reduced rates.
A regulator can require that a gain or other reduction of net allowable costs be given to customers over future periods. That would be accomplished, for rate-making purposes, by amortizing the gain or other reduction of net allowable costs over those future periods and reducing rates to reduce revenues in approximately the amount of the amortization. If a gain or other reduction of net allowable costs is to be amortized over future periods for rate-making purposes, the regulated entity shall not recognize that gain or other reduction of net allowable costs in income of the current period. Instead, it shall record it as a liability for future reductions of charges to customers that are expected to result.
ASC 980-405-25-1(c) requires deferred gains that will be returned as a regulatory liability to be amortized over the period that rates are reduced. In evaluating whether to recognize a gain, a regulated utility will need to evaluate whether it is probable that some or all of the gain will be returned to ratepayers.
17.4.3.1 Application example — accounting for gains to be refunded
Example UP 17-2 illustrates considerations in evaluating the accounting for a gain to be returned to customers.
EXAMPLE UP 17-2
Accounting for a gain on sale of land
Accounting for a gain on sale of land
Rosemary Electric & Gas Company sells excess land with a carrying value of $25 million for $40 million. The land was originally purchased by REG to construct an operations center; instead, REG ultimately agreed with its regulator that it would build two operations centers at other locations. The cost of construction will be included in rate base. At the time of the sale, the regulator approves the transaction but does not determine the required treatment of the gain (i.e., whether REG’s shareholders will retain the gain or whether the gain will be partially or wholly returned to customers). That determination is expected to be made in the next general rate case. However, for prior property sales, REG has been required to return between 75-100 percent of any gains to its ratepayers.
Should REG defer the gain and record a regulatory liability?
Analysis
Yes. Because of its history involving similar transactions and the expectation that the new land acquired to construct the operations centers will be included in rate base, REG determines that it is probable that all of the gain will be used to reduce future rates to customers. As a result, REG defers the gain and records a regulatory liability.
17.4.4 Subsequent accounting
Regulatory liabilities may be settled in a variety of ways. Liabilities may be refunded to customers, offset against regulatory assets in a rate case, or taken to income when costs associated with a liability for recovery of future costs are incurred. Additionally, actions of a regulator can eliminate a liability provided that the liability was imposed by the actions of the regulator. Although ASC 980 indicates when regulatory liabilities should be recognized in income and cross-references to ASC 225-10-S99-2 for general considerations regarding appropriate income presentation, it does not specify where within the income statement the amortization of a regulatory liability should be recorded.
A regulated utility may present the amortization of specific regulatory liabilities as a separate line item, a reduction to revenue, or within related expense accounts. However, a regulated utility should present the amortization of similar regulatory liabilities consistently within the income statement and from period to period.
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