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IFRS and You

How the new standards affect utility balance sheets.

Fortnightly Magazine - December 2010

the allowed return on equity; 2) make adjustments to the fair value component of income for regulatory purposes; or 3) average income over a number of periods to dampen the impact of any one period’s change in fair value. Regardless of the method chosen, it’s important that stakeholders agree how to handle these facets of the ratemaking process in advance of IFRS implementation, so that controversy after the fact can be minimized.

Regulatory Preparation

A key issue for utilities in North America is how a switch to IFRS will impact regulatory reporting and decision making. 17 Canada is set to adopt IFRS by year-end, and the Securities and Exchange Commission (SEC) continues to support a convergence of U.S. GAAP and IFRS. 18 Thus, it’s important that regulated entities prepare for the upcoming accounting changes. To do so, regulated entities, regulators, and other stakeholders need to address the impact of the accounting changes on regulatory policy and practice.

Fundamentally, the transition and convergence to IFRS could affect the calculation of rate base and the revenue requirement. There are two potential solutions to changes in the data upon which regulators base their decisions. Regulated entities could prepare two sets of books, which would be costly and would inevitably lead to controversy as stakeholders review two different sets of financial information. Alternatively, regulatory policy and practice could be modified to rely on IFRS in the same manner as GAAP is used today. Regardless of the policies put in place, neither regulated utilities nor customers should become winners or losers.

If a company decides to prepare two separate sets of books, then it also needs to recognize the associated costs. Companies will have to finance additional software, personnel, and potential legal activity that two sets of books might create. Further, it’s important to take a holistic approach and consider the impact on not only the regulatory environment, but also on the utility’s financial and tax reporting and how this information is used by the financial community, regulators, customers, and other stakeholders.

First, if the regulatory environment will rely on the financials that result from IFRS, it’s important to prepare for a transition and to build a consensus about which areas, if any, need a unique (non-IFRS) treatment. Clearly, if the IASB doesn’t adopt the draft proposal or a similar statement, the largest such issue is regulatory assets and liabilities. If IASB were to adopt the current proposal, a decision would need to be made regarding the treatment of regulatory assets and liabilities for entities subject to regulation other than cost-of-service. Second, if the switch to component depreciation changes the timing of the depreciation amount, how does one ensure that there’s neither a rate shock nor an insufficient cash flow effect on the utility? It may be necessary to create a special mechanism that allows for a phased-in switch to the new depreciation rates. This would smooth out rate changes and thus prevent rate shock if the new rates are higher. Third, because the measurement of the asset retirement obligation will differ from current practice and be