The IASB’s project to create a new accounting standard on Regulatory Assets and Regulatory Liabilities for rate-regulated sectors (including water, electricity, gas networks and certain airports) is pushing ahead. The IASB is making a concerted effort each month to redeliberate key topics, with the intention of publishing the new standard in 2023.
While there is consensus around the overarching aims and objectives, a number of areas of debate are coming into focus as discussions progress. One of these is the topic of regulatory versus accounting (or statutory) asset bases.
Differences between regulatory and accounting asset bases
On the face of it, the proposal in the IASB’s Exposure Draft (ED) looks innocent enough. The concept is that if a regulatory agreement treats depreciation of an asset as an allowable expense, that cost should be recognised for accounting purposes over the same period as the asset’s useful life. But it quickly becomes complex where that asset is treated differently and amortised on a different basis for regulatory purposes.
For example, say you spend 100 on capex for which the accounting depreciation period is 20 years. You would record 5 of accounting depreciation per year over 20 years. If under the regulatory agreement you recover that through regulatory depreciation over 10 years, you would record the related income of 10 per year over 10 years. Under the ED, to align the income with accounting useful life, you would defer the income and record 5 per year over 20 years. However, cash hasn’t changed – you’d still be receiving 10 per year in cash. So, you would need to record a liability – rather like deferred income. The liability would build up over the first 10 years and then unwind over the next 10 years.
The task becomes more complex still because, under the ED, this would need to be carried out at the level of individual assets – the standard would in effect seek to match each fixed asset with a corresponding regulatory asset. However, regulatory assets (in the UK) are currently valued at a total level – not split into individual components – and are very often different to the fixed asset register (FAR). Regulatory and statutory asset bases have varied since privatisation. There are different methods for treating additions, adjustments and depreciation – as well as indexation. Regulatory assets are indexed each year with RPI or CPIH, while there is a historical cost accounting approach for statutory assets (FAR).
As a result of these variances, there are likely to be material complexities which preclude detailed reconciliation between regulatory and statutory asset bases. This would also be exacerbated by limited, or no, historical data availability.
Real world financial impacts
If regulatory income is accounted for in line with the ED’s proposals, on transition there could be significant assets or liabilities recorded. If your regulatory asset life is shorter than the statutory asset life, you would record a liability on transition. The opposite entry to this liability would be to retained earnings. Our expectation is that there could be an immediate hit to distributable reserves in this case – which could impact on dividend flow to shareholders bearing in mind regulated entities tend to be the primary source of group profits. There could also be an impact on covenants, for example where they’re linked to EBITDA, cash flow from operations or movements in working capital.
On the other hand, if your regulatory life is longer than the statutory asset life, you would record an asset on transition. We believe this may be taxable in the year of adoption – creating what could potentially be a significant cash tax outflow.
Practical expedients needed?
These factors have led to significant concern being voiced by some preparers, regulators and users around whether a reconciliation is practicable and, indeed, even if it is, whether there would be a benefit to reconciling two asset bases which are conceptually very different.
One group who may not welcome the change is ratings agencies. Many of the ratios they use to assess credit quality are based on EBITDA. However, under the proposals, EBITDA will move further away from cash, potentially moving up or down. Additional information would be required to strip out long-term non-cash revenue components. Ratings agencies may have to undertake significant effort only to get them back to where they were before.
Preparers have concerns too. A common theme is concern that the proposals could result in misleading information for UK investors as well as significant costs to implement and maintain. Many believe that adjustments to the proposed model or practical expedients are needed – including a modified retrospective approach to transition.
Get your voice heard
The IASB has already shown its willingness to listen and respond to feedback on the proposals. KPMG recently facilitated a round table discussion between the IASB and regulators, preparers and users where this issue was discussed. There is still a window of opportunity to submit feedback to the IASB – but that window is closing fast.
If you have views on this or other issues, we encourage you to share them and get your voice heard. It is in everyone’s interests that we end up with workable rules that improve the quality of information for users.