Rate-Regulated Operations

Status: Final Handbook material and accompanying Background Information and Basis for Conclusions issued.

International Activities

As a result of the impending move to IFRSs for publicly accountable enterprises in Canada, and the fact that IFRSs do not specifically address rate-regulated operations, the IASB has received a number of enquiries from Canadian companies regarding:

• the application of IFRSs to entities subject to rate regulation; and
• a past decision of the International Financial Reporting Interpretations Committee (IFRIC) not to add to its agenda a project on regulatory assets.
  

The IASB and AcSB agree that the most effective way to respond to these enquiries is through an open letter on the AcSB’s web site, rather than the IASB responding to companies individually. Accordingly, the IFRIC Coordinator has written to the AcSB Chair on this subject. The letter is available here (PDF).

The AcSB is also involved in activities of the National Standard Setters on this topic. In September 2007, the NSS decided to collaborate with the European Commission (EC) Roundtable for the Consistent Application of IFRS in preparing a new project proposal to IFRIC. The proposal would ask IFRIC to add to its agenda a project to provide interpretative guidance on rate-regulated operations in the short term. The NSS also decided to give further thought to possibly issuing a discussion paper on rate-regulated operations.

The AcSB encourages industry groups in Canada to become more directly involved in efforts to resolve outstanding issues relating to the future adoption of IFRSs. Specifically with respect to rate-regulated industries, the AcSB suggests that these industries form a cross-industry working group, as soon as possible, to collaborate in:

• the formulation of issues that might be addressed by IFRIC; and
• the identification and resolution of common issues that would not be dealt with by IFRIC but must be resolved by the changeover date (for example, transitional issues specific to entities subject to rate regulation).

AcSB staff is available to assist where possible. For example, staff can share its understanding of how the IASB and IFRIC operate, and provide its views on whether the issues identified by the group have been expressed in a manner that is useful to standard setters. Lastly, the AcSB encourages Canadian entities subject to rate regulation to establish contact with their international counterparts, with a view to sharing information on IFRSs and their application to rate-regulated operations.

Background
Activities to Date
Related Information
Contact Information 

Background

Reasons for the Project
In March 2002, the AcSB approved a project examining the need to modify existing Canadian accounting standards to deal specifically with the unique characteristics of rate-regulated operations. The project was undertaken for the following reasons:

• Currently, the Handbook provides limited guidance on rate-regulated operations (only some Sections explicitly address rate-regulated operations, and permit a treatment that differs from that required in the absence of rate regulation). Consequently, financial statement preparers have been forced to analogize, or have adopted industry practice or relied on US GAAP when dealing with areas in which Canadian GAAP is silent.
• In the late 1990s, after becoming aware of certain accounting and financial reporting issues related to rate-regulated operations and in light of the changing regulatory environment (for example, increased deregulation), the AcSB and the Public Sector Accounting Board (PSAB) jointly commissioned a research study on the topic. In 2002, the CICA published a Research Report, “Financial Reporting by Rate-Regulated Enterprises.” The report recommended that the AcSB issue a new Section on accounting for the effects of rate regulation.

The issuance, in July 2003, of Section 1100, Generally Accepted Accounting Principles, provided further support for undertaking this project. Section 1100 removed industry practice as a primary source of Canadian GAAP but granted entities subject to rate regulation temporary relief from applying the Section. This exemption would no longer be required with the completion of the Rate-Regulated Operations Project. 

This project was undertaken as a domestic project, not intended specifically as part of the AcSB’s efforts (under its previous Strategic Plan) to support the international convergence of accounting standards while harmonizing with US GAAP.  Nonetheless, the AcSB recognized that the project could result in Canadian GAAP moving closer to the standards of either the Financial Accounting Standards Board (FASB) in the US or the International Accounting Standards Board (IASB) with respect to the treatment of rate-regulated operations. While the FASB has issued several standards directly pertinent to this subject, most notably Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS 71) (available on the FASB website, under FASB Pronouncements), IASB standards do not specifically address rate-regulated operations. Unlike the AcSB, neither of these standard setters is currently examining, or has immediate plans to examine, this topic.

Key Issues
The project, as originally planned, was intended to address the following key recognition and measurement issues:

• whether, and if so, under what circumstances, rate regulation may create assets and liabilities meeting the asset and liability definitions of Section 1000, Financial Statement Concepts; and
• if rate regulation creates assets and liabilities meeting the conceptual framework definitions, how these items should be measured.

Since rate regulation is an important consideration in evaluating the financial performance of entities with rate-regulated operations, the project also considered how best to meet user needs through disclosures in the general purpose financial statements of such entities.

Activities to Date

Recognition and Measurement Issues
The AcSB commenced its deliberations by focusing on the key issue of whether, and if so, under what circumstances, rate regulation may create assets and liabilities meeting the asset and liability definitions of Section 1000, Financial Statement Concepts. After a preliminary discussion of the arguments in favour of recognizing regulatory assets and liabilities, the AcSB expressed serious misgivings about whether these items meet the conceptual framework definitions.

Stakeholders subsequently provided input on this issue by participating in roundtable discussions held by staff in March 2004 (in Toronto and Calgary). After considering this input, the AcSB:

• agreed that the GAAP conceptual framework should apply equally to all entities, whether or not they are subject to rate regulation; 
• acknowledged the possibility that rate regulation may give rise to assets and liabilities as defined in Section 1000 (in which case the issue becomes whether they satisfy the recognition criteria and how they should be measured), and asked staff to undertake an analysis to determine the circumstances in which this may occur; and
• noted that there appears to be significant diversity in practice in accounting treatments adopted and that the related disclosures could be improved, and asked staff to investigate how such improvement could be accomplished as an interim measure pending completion of the full project (see Disclosure below).

After further deliberations on recognition issues relating to rate-regulated operations, the AcSB:

• agreed that in order for rate regulation to create an asset or liability, the regulator’s actions must result in the entity having an unconditional right (or obligation) to charge higher (or lower) rates in the future;
• agreed that the right or obligation conferred by the regulator should be capable of meeting the criteria under Section 1581, Business Combinations, for recognizing an identifiable intangible asset separately from goodwill; and
• directed staff to invite entities subject to rate regulation and other interested stakeholders to provide actual fact patterns demonstrating how a regulator’s actions can create unconditional rights and obligations meeting the above-mentioned criteria.

In March 2005, the AcSB issued an Invitation to Submit Fact Patterns (by May 31, 2005). Staff have analyzed the submissions received.

At its December 2004 meeting, the AcSB considered the need to eliminate, within a reasonable period of time, the existing deferral of the requirement to apply Section 1100, Generally Accepted Accounting Principles, to the recognition and measurement of assets and liabilities arising from rate regulation. Decisions on making such a change and its effective date were left to a future meeting.

Disclosure
Acting on the AcSB’s request to investigate how disclosures could be improved in the short term, staff proposed the issuance of an Accounting Guideline dealing only with disclosures as an interim measure, pending completion of the project (since the project was intended to address all aspects of accounting for rate-regulated operations, including disclosure, it was expected that the Accounting Guideline would be withdrawn once any new standard became effective). A Draft Guideline was developed after considering the input received at the stakeholder roundtable discussions, reviewing pertinent disclosure requirements under Canadian and US GAAP and securities regulations, and examining the current disclosure practices of Canadian and US entities subject to rate regulation.

In October 2004, the AcSB issued the Draft Guideline for comment. After reviewing respondent comments and subsequent changes to the Draft Guideline, the AcSB approved a final Guideline.

AcG-19 was issued in May 2005, followed by a Background Information and Basis for Conclusions document in October 2005. The new disclosure requirements are effective for fiscal years ending on or after December 31, 2005 (preparers should look to Section 1751, Interim Financial Statements, to determine the extent to which interim periods ending after the Guideline’s effective date may also be affected).

The Effects of the Strategic Plan
The AcSB recently adopted a Strategic Plan for the period 2006-2011. For public companies, the Strategic Plan calls for the convergence of Canadian GAAP with International Financial Reporting Standards (IFRSs) over a transitional period currently expected to be about five years. As noted above under Reasons for the Project, IFRSs do not specifically address rate-regulated operations. Thus, entities subject to rate regulation must comply with IFRSs, with no special allowances for their circumstances.

The AcSB considered the effects on this project of its new Strategic Plan, including the future disposition of the Section 1100 temporary exemption described above, and whether the existing Handbook guidance on rate-regulated operations should be eliminated, revised or augmented. The AcSB decided that the project, as originally planned, should be discontinued. It further decided, subject to exposure of its proposals, that:

• the temporary exemption in Section 1100, Generally Accepted Accounting Principles, providing relief to entities subject to rate regulation from the requirement to apply the Section to the recognition and measurement of assets and liabilities arising from rate regulation should be removed;
• the explicit guidance for rate-regulated operations provided in Section 1600, Consolidated Financial Statements, Section 3061, Property, Plant and Equipment, Section 3465, Income Taxes, and Section 3475, Disposal of Long-Lived Assets and Discontinued Operations, should be removed; and
• AcG-19 should be retained as is (except for consequential amendments resulting from the revisions to Sections 1600, 3061, 3465 and 3475 described above).

When making these decisions, the AcSB observed that relying on Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS 71), as an other source of GAAP in the absence of Handbook guidance addressing the specific circumstances of entities subject to rate regulation is consistent with Section 1100, when the qualifying criteria of FAS 71 are met and it is applied as the FASB intended.

In May 2006, the AcSB directed staff to prepare an Exposure Draft for public comment based on its preliminary decisions.

In July 2006, the AcSB considered the implications for certain entities of its proposal to remove all recognition and measurement guidance in the Handbook specific to rate-regulated operations, including the definitions of a rate-regulated enterprise found in the affected Sections. The AcSB observed that this proposal, if adopted, would result in entities no longer being able to rely on the current Handbook definition. This definition is less restrictive than the one in FAS 71, most notably regarding the requirement for an independent, third party regulator. The AcSB also observed that this could be a particular concern for certain public sector entities.

The AcSB decided to continue with its proposal. The AcSB noted that any entity choosing to rely on FAS 71 in accordance with the provisions of Section 1100 must also apply the definition of a rate-regulated enterprise in FAS 71. The AcSB considered and rejected introducing elsewhere in the Handbook a definition that differs from the one in FAS 71.

An Exposure Draft and accompanying Background Information and Basis for Conclusions document were issued in March 2007, with comments due by June 30, 2007.

In July 2007, the AcSB reconsidered the compatibility of its proposals with the Strategic Plan, in light of comments received on the Exposure Draft. The AcSB saw no reason not to proceed with its normal due process, including a full analysis of the comments received and the redeliberation of its proposals.

This analysis and redeliberation occurred in August 2007, at which time the AcSB decided to:

• proceed with its proposal to remove the temporary exemption in Section 1100;
• amend Section 3465 to require the recognition of future income tax liabilities and assets as well as a separate regulatory asset or liability for the amount of future income taxes expected to be included in future rates and recovered from or paid to future customers; and
• retain AcG-19 (after some consequential amendments) during the transition period to full adoption of IFRSs for publicly accountable enterprises.

The amendments to Sections 1100 and 3465 will apply to interim and annual financial statements relating to fiscal years beginning on or after January 1, 2009, and will result in consistency between all Handbook Sections providing guidance relating specifically to rate-regulated operations and the corresponding guidance under US GAAP. The amendment to Section 1100 will apply prospectively, as per paragraph 1100.33. The amendment to Section 3465 will apply retrospectively without restatement. Any necessary cumulative catch-up adjustment would be made to opening retained earnings in the year of change.

The AcSB stopped short of withdrawing all existing Handbook recognition and measurement guidance relating specifically to rate-regulated operations effective 2009, as had been proposed in the Exposure Draft. The AcSB believed there was benefit to such a withdrawal, and noted that the decisions taken may not have a much different effect on practice than the Exposure Draft proposals. At the same time, it acknowledged the concerns expressed by respondents about the ability of Canadian entities to rely on US GAAP in this area, and to influence the development of any future IFRS guidance on rate-regulated operations, once the Handbook guidance had been removed.

The AcSB noted the high degree of support expressed by respondents for retaining AcG-19 during the transition period. It also noted that respondents appeared focused on the current uncertainty about whether the accounting prescribed by FAS 71 and Handbook Sections with recognition and measurement guidance relating specifically to rate-regulated operations is compatible with IFRSs, and, therefore, what will transpire upon changeover to IFRSs. The AcSB has brought this issue to the attention of other national standard setters and the IASB, and continues to follow up on it. The AcSB decided that the final Background Information and Basis for Conclusions for this project would not express any views of the AcSB regarding this issue or the status of FAS 71 as an “other source of GAAP” within the Canadian GAAP hierarchy.

Related Information

• Responses to the AcSB's Exposure Draft are available here
• CICA Research Report, “Financial Reporting by Rate-Regulated Enterprises” (2002) (available for purchase through the CICA order desk)

Contact Information

Questions or comments on this project should be directed to:

Karen Jones, CA
Principal, Accounting Standards
Telephone:  +1 (416) 204-3463
Fax:  +1 (416) 204-3412

Canadian Accounting Standards Board
277 Wellington Street West
Toronto ON  M5V 3H2  Canada