The International Accounting Standards Board (IASB) is proposing a new accounting standard ‘Regulatory Assets and Regulatory Liabilities’ to replace IFRS 14 Regulatory Deferral Accounts. This new standard would require companies subject to rate regulation, including the utilities and public transport industries, to give investors better information about their financial performance.
Rate regulation affects the amount and timing of a company’s revenue, profit and cash flows by specifying:
- how much compensation the company can charge customers for goods or services supplied in a period; and
- when the company can include that compensation in the rates it charges customers.
In some cases, a company supplies goods or services in a different reporting period from when the company can charge customers for those goods or services and, as a result, the compensation received is reflected in revenue in a different period.
When these timing differences occur, the revenue a company reports for a period in its income statement and the assets and liabilities it reports in its balance sheet do not give a complete picture of the amount that the rate regulation entitles charge for goods or services supplied in that period.
The timing differences cause two effects:
1. Cash flows relating to the supply of goods or services in one period are shifted to another period.
2. The regulatory agreement provides or charges regulatory interest. This compensates the company for the time lag until the recovery of a regulatory asset or charges for the time lag until fulfilment of a regulatory liability. Therefore, the cash flows arising from a regulatory asset or regulatory liability include regulatory interest.
Without information about timing differences, investors have an insufficient basis for understanding the effects on a company’s financial performance, financial position, and prospects for future cash flows.
Some regulatory agreements do not create regulatory assets or regulatory liabilities eg placing a cap on the price that companies can charge customers for their goods or services. Regulatory assets or regulatory liabilities are not created if the agreement does not give rise to:
- rights to increase future rates because of goods or services already supplied; or
- obligations to decrease future rates because of amounts already charged to customers.
The proposed Standard would introduce a requirement for companies to give investors information about differences in timing by reporting regulatory assets and regulatory liabilities in their balance sheet, and related regulatory income and regulatory expenses in their income statement. This information would supplement the information that companies already provide by applying IFRS Standards (including IFRS 15 Revenue from Contracts with Customers) and would require a company to reflect the total allowed compensation for goods or services supplied as part of its reported financial performance for the period in which those goods or services are supplied.
The exposure draft is open for comment until 30 July 2021.