The transition to IFRS will have important implications for the regulated utilities sector. For the first time government based accounting will have to be supplanted with investor friendly GAAP. I have outlined on this post of the areas of importance. So, read on…
The assets of a utility may be owned by the government or directly owned by the utility company for a period of time prior to being returned to the government. The recognition (or not) of these assets will reflect the detailed substance of the agreement between the government and the service provider. For example, if the asset is merely used by the utility company and the key risks rest with the government then it would appear highly likely that the asset would not be recognized on the company’s balance sheet. If an asset were to be recognized then the depreciation period would be a function of the period over which the utility company is expected to use the asset.
Licenses Used By Utilities Companies
If a utility corporation purchases the right to use the asset from the government then it will be recognized as an intangible asset.
One of the key challenges for companies in these industries is to deal with future “dismantling” costs. These costs are difficult to identify and are not required to be paid for a very long period. Under IFRS, the best estimate of the cost of decommissioning is added to the cost of the asset. The other entry is to establish a provision. The provision is thus established but not yet expensed. Instead the “expense” is achieved by virtue of higher depreciation on the higher cost. The provision estimate is also discounted to present value. This is unsurprising given that IFRS do tend to require discounting of long-term provisions (e.g. decommissioning costs) as it is in these cases where it is material.
In summary the entries that will flow through the financials will be:
- Estimate a provision for future asset retirement obligations; increase the cost of fixed assets by the present value of this estimate; record the provision at the same amount.
- Depreciate the asset [including the decommissioning cost component] as normal over its useful life.
- Accrete the provision over its ‘life’ to the undiscounted amount. This is achieved by charging an annual interest cost.
There is no extant IFRS on concession accounting, yet this is a crucial issue in a sector that obtains its permission to operate [the concession to operate] from the government. The IASB is currently debating this issue. The following are the key questions that are being debated:
- Who owns the fixed asset (building on the comments above)?
- If not ownership what is the nature of the relationship?
- How can concession contracts be separated? [They contain hugely complex and divergent clauses]
- Which model of accounting should drive the treatment?
Here are models available for the above forth question:
- Model 1: Intangible asset model – concession is treated as an intangible.
- Model 2: Receivable model – operator recognizes the construction revenues as the asset is built and remaining revenues as earned. No fixed asset is recognized.
- Model 3: Physical asset model – recognize the constructed asset on balance sheet.
Utility companies are often allocated (e.g. by a government) emission rights. These rights come with a target level [so called “cap”] and companies are allowed to trade the rights attached. [The schemes are often referred to as “cap and trade”]. Some of the key issues are:
- Should an asset be recognized? An asset should be recognized when the rights were received, and it should be classified as an intangible asset.
- What value should be ascribed to the asset? The asset should initially be recognized at cost where there was a cost or at fair value where there was no initial cost.
- Should the asset be revalued? Initially the IASB’s thinking was that the asset should not be subsequently re-measured at fair value; however they noted the staff’s concerns around potential mismatches between recording the asset at cost and re-measuring to fair value at each reporting date any emission liabilities recognized under IAS 37; in early 2004 the IASB’s IFRIC committee decided that emission rights and liabilities should be measured at fair value, with changes in value recognized in profit and loss.
- If an asset is recorded what would the other entry be? When an asset is recognized, a liability should be recognized in the amount of the minimum obligation assumed by accepting the asset.
- Will such a value always be the same as the asset value above? If not how will it balance? These two amounts [from last point above] would differ in each situation, and consequently the asset and liability would not necessarily be recognized initially at the same value. To the extent the initial values of the asset and liability differed, IFRIC believed the remaining credit should be treated as deferred income under IAS 20, Accounting for Government Grants and Disclosure of Government Assistance [i.e. treated as a government grant].