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IFRS and You

How the new standards affect utility balance sheets.

Fortnightly Magazine - December 2010

Over the next year (or years), companies in Canada and the United States will make the transition toward adopting International Financial Reporting Standards (IFRS). These standards will have a significant impact on the reporting requirements and financial disclosures of regulated companies, largely because a regulated company’s financial information is used not only for financial reporting purposes, but also for ratemaking purposes. In particular, most electric, gas, water and pipeline utilities in North America are regulated on a cost-of-service basis, which allows them to recover costs they incur in providing service, including their cost of capital. 1 Because cost-of service regulation creates a strong link between the utility’s cost and assets, the measurement of these costs and assets and how they’re reported on the financial statements becomes important. 2, 3

The financial reporting requirements of IFRS and GAAP differ in some key ways that affect utilities. 4 First, under U.S. and Canadian GAAP, regulatory assets and liabilities are recognized in the financial statements, whereas IFRS has yet to implement specific guidelines for regulatory assets and liabilities. 5 As such, the potential effect of removing regulatory assets and liabilities from utilities’ balance sheets merits examination. 6 Second, a major difference between U.S. and Canadian GAAP and IFRS is the accounting for depreciation, asset impairment, the potential for revaluations of assets, and the treatment of power purchase agreements. Regulated utilities are capital intensive, so changes in the treatment of long-lived assets will have a substantial impact on regulated companies. Third, IFRS has stricter rules for what IFRS calls “own use” for their purchases of commodities and power. These rules could substantially affect regulated utilities that rely on the normal use and purchase exemption rather than on fair value (derivatives) accounting for these purchases. Finally, IFRS eliminates asset smoothing for pension gains and losses. As a result, companies need to consider how regulatory allowances for pension costs are recovered in rates.

Regulatory Assets and Liabilities

Under current IFRS, regulatory assets and liabilities aren’t recognized and would be removed from many utilities’ balance sheets. 7 Only those utilities with traditional cost-of-service regulation would be able to recognize regulatory assets and liabilities. Utilities with revenue and price regulation, or other forms of incentive regulation, would fall under the current guidelines. Utilities are logically concerned about this change as illustrated in a letter to the Securities and Exchange Commission from water utility SJW Corp., which states:

SJW Corp.’s understanding is that the IFRS has no equivalent standard comparable to SFAS 71 and therefore regulated assets and liabilities may not be deferred except in certain rare circumstances. The absence of similar regulatory recognition under IFRS