The accounting for the equity component of allowance for funds used during construction (AFUDC) is similar to flow-through and results in a deferred tax liability in accordance with ASC 980-740-25-1(b). It also creates a related regulatory asset if the corresponding future revenue is probable of recovery. Equity AFUDC capitalized for accounting and regulatory purposes is a component of construction cost and is depreciated once the utility plant is placed in service (i.e., it gives rise to accounting basis). However, for income tax purposes, neither the amount originally capitalized for accounting purposes nor the subsequent depreciation of that amount enters into the determination of taxable income. Because equity AFUDC is not capitalized into utility plant for tax purposes (i.e., it does not give rise to a tax basis), the book basis of utility plant will exceed the tax basis of utility plant by the capitalized equity AFUDC amount.

Under ASC 740, a deferred income tax liability is required for this temporary difference. However, regulators typically permit recovery of the equity AFUDC through depreciation without an income tax effect. Therefore, equity AFUDC capitalized for accounting purposes results in the recognition of a deferred tax liability and a “grossed-up” regulatory asset. The gross regulatory asset represents probable future revenue related to the recovery of future income taxes related to the equity AFUDC temporary difference. ASC 980-740-55-8 through 55-11 provide an example of the accounting for the income tax effects of the equity component of AFUDC. The mechanics of accounting for the tax effects of equity AFUDC are similar to those for the flow-through temporary difference illustrated in Example 19-1.

ASC 740 requires deferred income tax assets and liabilities to be adjusted for the effect of a change in enacted tax rates. Regulated utilities likewise are required to adjust deferred income tax assets and liabilities for changes in tax rates or laws, pursuant to ASC 980-740-25-1(c).

A regulated utility may have unique considerations when income tax rates are changed. A regulator may require a regulated utility to pass the effect of reduced income tax rates on to customers as savings over future periods, or it may permit the utility to charge customers for the effect of increased income tax rates. As a result, changes in enacted tax rates may result in a direct adjustment of previously recorded income tax-related regulatory assets or liabilities (see UP 19.2.3.2 for further information on changes related to normalized differences for which regulatory assets and liabilities were not previously recorded). Furthermore, Section 203(e) of the Tax Reform Act of 1986 (TRA) provided a normalization requirement for the excess deferred income taxes created by the TRA’s accelerated depreciation-related tax rate changes. These rules required that the excess deferred taxes be used to reduce customer rates over the lives of the related property. No such Internal Revenue Service (IRS) requirements exist for deferred income taxes related to other temporary differences (see UP 19.3.2.4).

Depending on the regulatory requirements, the impact of remeasuring deferred income taxes as a result of an enacted tax rate change may:

Investment tax credits are current year reductions in income taxes payable (with unused amounts eligible for carryover) for qualifying property additions. Historically, accounting for ITCs followed the guidance now codified as ASC 740-10-25-45 through 25-46 and ASC 740-10-45-26 through 45-28.

Most regulated utilities account for ITCs using the deferral method because that method more closely mirrors the ratemaking treatment needed to meet normalization requirements. However, the “gross-up” deferral method is also acceptable (see TX 3.2.3). Normalization requires that ITCs related to utility plant be “shared” between ratepayers and shareholders, typically over the book life of the related property (see UP 19.3.2.1). Under ASC 740, ITCs that are accounted for under the deferral method are considered a reduction in the book basis of the asset. This reduction creates a temporary difference resulting from lower taxable income when the book basis of those assets is recovered in future years. The accumulated deferred ITC temporary difference gives rise to a deferred tax asset and a “grossed-up” regulatory liability that represents the probable future reduction in revenue required for future income taxes as the deferred ITC is amortized. See TX 3.2.3 for further information on accounting for credits and other tax incentives.

In the United States, the American Recovery and Reinvestment Act of 2009 (ARRA) allowed taxpayers to choose a cash grant in lieu of an ITC for certain qualifying energy-related facilities or property that have begun construction prior to the end of 2012. As a result, certain ITCs may be accounted for differently from the traditional ITC accounting model. See UP 16 for further information on the accounting for government incentives, including grants and ITCs received pursuant to Section 1603 of ARRA.

Generally, yes. The difference between the tax basis and book basis of utility plant generally comprises multiple temporary differences, which may be caused by factors including:

The transition rules for FASB Statement No. 109, Accounting for Income Taxes, provided that when it was impracticable to determine the components, it was permissible to combine all plant-related temporary differences into a single plant-related temporary difference. However, this approach can be challenging for regulated utilities. Regulatory assets arising from temporary differences should be recorded only if they are probable of recovery under ASC 980-340-25-1. Making the probable determination may be difficult if the regulated utility does not individually track and evaluate the temporary differences.