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18.6 Depreciation
Publication date: 22 Nov 2023
us Utilities guide
In general, regulated utilities record depreciation of utility plant over a period and in a pattern that is consistent with recovery periods approved in the regulatory process. This section discusses some of the challenges arising from the interaction between regulatory recovery and depreciation requirements under US GAAP for entities in general. See UP 12.3 for further information on accounting for depreciation not specific to a regulated environment.
18.6.1 Phase-in plans
ASC 980-340 provides guidance on accounting for phase-in plans. Under a phase-in plan, a regulator delays a regulated utility’s recovery of utility plant, typically to avoid rate shock (i.e., significant increases in rates).
Definition from ASC 980-340-20
Phase-In Plan: Any method of recognition of allowable costs in rates that meets all of the following criteria:
a. The method was adopted by the regulator in connection with a major, newly completed plant of the regulated entity or of one of its suppliers or a major plant scheduled for completion in the near future.
b. The method defers the rates intended to recover allowable costs beyond the period in which those allowable costs would be charged to expense under generally accepted accounting principles (GAAP) applicable to entities in general.
c. The method defers the rates intended to recover allowable costs beyond the period in which those rates would have been ordered under the rate-making methods routinely used prior to 1982 by that regulator for similar allowable costs of that regulated entity.
In general, phase-in plans include any form of ratemaking whereby plant-related costs are deferred and included in rates over a period that is longer than the costs would otherwise be recognized under US GAAP, including:
- A phased inclusion of utility plant in rate base
- Straight-line recovery of a lease relating to recently completed plant that is accounted for as a finance lease under US GAAP
- Alternative methods of depreciation that would not be permitted under US GAAP, such as a sinking fund or annuity approach (whereby the depreciation increases over time)
- A lower rate of depreciation on rate base than otherwise would be recognized under US GAAP (e.g., a longer useful life being used for ratemaking purposes)
ASC 980-340-25-2 and 25-3 provide the general guidance for phase-in plans.
If a phase-in plan is ordered by a regulator in connection with a plant on which no substantial physical construction had been performed before January 1, 1988, none of the allowable costs that are deferred for future recovery by the regulator under the plan for rate-making purposes shall be capitalized for general-purpose financial reporting purposes (hereinafter referred to as financial reporting). Allowable costs that are deferred for future recovery by the regulator under the plan consist of all allowable costs deferred for rate-making purposes under the plan beyond the period in which those allowable costs would be charged to expense under generally accepted accounting principles (GAAP) applicable to entities in general.
As noted in this guidance, a regulated utility may not defer any amounts associated with a phase-in plan on a plant for which no substantial construction had been performed prior to January 1, 1988.
Due to this timing requirement, we generally would not expect any amounts related to a phase-in plan for new plants or plant additions placed into service now to qualify for deferral. As a result, any deferral of plant recovery imposed by the regulator, or effects of a delay of or adjustment to depreciation expense required by US GAAP applicable to entities in general, should be immediately expensed.
ASC 980-340-55 provides implementation guidance, including illustrative examples, on the accounting for phase-in plans.
Question UP 18-2
Does the guidance on phase-in plans apply only to newly constructed plant?
Does the guidance on phase-in plans apply only to newly constructed plant?
PwC response
Generally, yes. The guidance prohibits recognition of any costs deferred by a regulator on a newly-completed plant (unless the plant was completed or substantial construction had been performed by January 1, 1988, which would not apply to any current construction). We believe that this guidance applies to any major plant, or plant addition, that has not been through a previous rate case. See Question 18-8 for a similar discussion of the meaning of “recently completed plant.”
Question UP 18-3
Is it ever acceptable to recognize a depreciation related regulatory asset arising from newly-completed plant?
Is it ever acceptable to recognize a depreciation related regulatory asset arising from newly-completed plant?
PwC response
Generally, no. The guidance limits deferral of any plant-related costs associated with a phase-in plan unless the plant was completed or substantial construction had been performed by January 1, 1988. Therefore, a phase-in plan associated with a new plant would not be eligible for deferral of plant-related amounts as a regulatory asset.
However, there are limited circumstances when a depreciation deferral would not meet the definition of a phase-in plan. The definition of a phase-in plan includes the following criterion:
Excerpt from ASC 980-340-20
Phase-in Plan:
c. The method defers the rates intended to recover allowable costs beyond the period in which those rates would have been ordered under the rate-making methods routinely used prior to 1982 by that regulator for similar allowable costs of that regulated entity.
In accordance with this guidance, a depreciation deferral scheme would not meet the definition of a phase-in plan if the regulator had followed a similar approach for recovery of similar assets for that specific utility prior to 1982. This exception is interpreted narrowly. Therefore, the phase-in plan guidance would still apply if the depreciation method was used by another regulator, by other utilities, or for other assets of the same utility. As such, in general, any deferral of depreciation on newly-constructed assets is prohibited.
Question UP 18-4
Is it acceptable to recognize a regulatory asset associated with decelerated cost recovery of an existing plant?
Is it acceptable to recognize a regulatory asset associated with decelerated cost recovery of an existing plant?
PwC response
Generally, no. Current recovery of costs is a basic premise of regulatory accounting. In the Basis for Conclusions of FAS 92, the FASB discussed its concern with rate plans that delayed recovery of plant costs and how these arrangements may raise questions about the application of regulatory accounting. Therefore, we generally believe that reporting entities should not record regulatory assets as a result of a regulator plan to delay recovery of plant costs.
In general, a regulated utility that receives an order to slow down depreciation or delay recovery of plant costs should recognize depreciation based on US GAAP requirements and no regulatory assets or embedded regulatory assets should be recognized. However, there are many different regulatory approaches for plant recovery and there may be situations when recognition of a depreciation-related regulatory asset would be appropriate.
Given the complexity and the judgment required, a reporting entity should consider discussing the facts and circumstances with an advisor prior to recognition of depreciation following a pattern slower than that allowed under US GAAP for reporting entities in general.
Question UP 18-5
Are newly-created regulated entities required to apply the phase-in plan guidance?
Are newly-created regulated entities required to apply the phase-in plan guidance?
PwC response
Yes. The guidance on phase-in plans applies to all entities subject to ASC 980. Furthermore, in evaluating whether a cost recovery scheme is subject to the phase-in plan guidance, such entities would not be eligible for the limited exception discussed in Question 18-3, as a newly created entity would have no history with the regulator prior to 1982. However, we believe that a reporting entity could consider the experience of a predecessor entity in considering whether this exception applies.
18.6.2 Accelerated cost recovery of plant
Regulators may at times require a regulated utility to apply a depreciation method for ratemaking purposes that is faster than straight-line depreciation for financial reporting purposes. Such an approach gives rise to a regulatory liability. The resulting regulatory liability should not be embedded within accumulated depreciation but instead should be presented separately on the balance sheet. In addition, the resulting regulatory liability should be disclosed. If the amount of the regulatory liability is not known, the regulated utility should provide additional disclosure, including:
- The consequence of the ratemaking process to the recognition of depreciation expense
- The extent to which regulatory recovery periods differ from the useful lives that would have been used absent regulatory accounting
- A statement that quantification of the cumulative effect of the difference cannot be determined
In addition, the effect of classifying accelerated recovery within utility plant results in a difference between the carrying amount of the utility plant under US GAAP for reporting entities in general and the recorded amount based on the regulator’s actions. Any such amounts should be written off when discontinuing the application of regulatory accounting (see UP 17.8).
18.6.3 Other depreciation recovery methods
In some situations, a regulator or regulated utility may propose changes to depreciable lives or methods impacting the timing or amount of recovery of specific plant assets resulting in amounts that would differ from accounting based on US GAAP for reporting entities in general. For example, during the deregulation of certain service territories in the past, there were proposals to transfer accumulated depreciation between asset classes or to record incremental depreciation under specific conditions, such as during periods of extra profits or in response to other cost reductions. It was concluded that those proposals did not appear to conform to either US GAAP for entities in general or deferral under ASC 980. Thus, we would not expect these types of transactions to be reflected in the US GAAP financial statements if proposed in the future.
In addition to the examples above, regulators or regulated utilities may propose various other methods to recover utility plant assets, including plans that may not result in systematic and rational depreciation nor be directly linked to the underlying cost and life of the specific plant. In evaluating the accounting for these types of arrangements, regulated utilities should ensure that the depreciation method applied does not result in recognition over a period that would be longer than that permitted under US GAAP for entities in general (see UP 18.6.1 and the response to Question 18-4).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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