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Ready for IFRS?

International reporting standards are coming for U.S. public companies.

Fortnightly Magazine - January 2009

whether to proceed with mandatory adoption of IFRS.

While there are differences between U.S. GAAP and IFRS, the general principles, conceptual framework and accounting results between them are often the same, or similar, for most commonly-encountered transactions.

In general, IFRS standards are broader than their U.S. counterparts, with limited interpretive guidance. While U.S. standards contain underlying principles as well, the strong regulatory and legal environment in U.S. markets has resulted in a more prescriptive approach—with far more “bright lines,” comprehensive implementation guidance and industry interpretations.

The International Accounting Standards Board (IASB) generally has avoided issuing interpretations of its own standards, preferring instead to leave implementation of the principles embodied in its standards to preparers and auditors, and its official interpretive body, the International Financial Reporting Interpretations Committee (IFRIC).

IFRS Challenges

The more principles-based approach offered by IFRS will present some unique challenges for the regulated utility industry. With IFRS likely to arrive in the near—rather than distant—future, affected utilities should consider the implications of IFRS and start planning now.

Accounting by regulated entities: Under U.S. GAAP, FASB Statement No. 71, Accounting for the Effects of Certain Types of Regulation, regulated entities are allowed to account for certain incurred costs that will be able to be recovered through future rates as regulatory assets. Conversely, amounts previously collected but owed back to ratepayers are accounted for as regulatory liabilities. There is no comparable provision under IFRS, which means that, from the regulatory-asset perspective, certain costs (including stranded costs from deregulation, fuel recoveries, storm damage, environmental remediation, and losses on refinancing to a name a few) will need to be written-off (despite the regulatory provision to recover such costs from ratepayers in the future). This would result in the recording of future revenues with no corresponding cost recognition.

Property, plant and equipment: Accounting for items such as property, plant and equipment may be more granular under IFRS than under U.S. GAAP. IFRS requires companies to account for fixed assets at the component level, which is defined as the unit of measurement to separately identify an asset, or part thereof, with a separately identifiable estimated useful life. Although most utilities account for assets using a retirement-unit level, reviewing current fixed-asset accounting records will help utilities determine which components should be depreciated over what estimated useful lives.

Lack of a parallel standard to Statement No. 71 in IFRS will mean that the treatment of gains and losses arising from disposal of assets belonging to regulated entities also will require review, as will the treatment of impairments and decommissioning obligations for current operating assets—particularly as the trend toward new nuclear generation and expansion into alternative energy sources continues. Policies that bear reviewing include those relating to allowable capitalized costs and accounting for subsequent replacement of components to make sure amounts are not overcapitalized on a company’s balance sheet.

Financial instruments: This area poses probably the biggest conversion challenge. Commodity contracts and hedging activity play a significant part in the operations of utilities. Although the two relevant accounting standards, FASB Statement No. 133, Accounting for Derivative