There was an initial discussion on recognition of regulatory assets and liabilities under IFRSs in 2005 and an Exposure Draft was released in 2009. However, no consensus was reached at that time and the project was suspended after all. However, due to continuous requests for clear guidance, the project resumed in September 2012. In 2013, Consultative Group was established to help the IASB and its staff in identifying issues, alternative approaches, and priorities. As a result, a Discussion Paper is now targeted to be released during the third quarter of 2014.

The schemes of rate regulation applied by countries around the world differ from one another but overall there are two main types of regulation: cost plus and incentive-based.  In Korea, the major energy companies like Korea Electric Power Corp. (KEPCO), Korea Gas Corporation (KOGAS) and Korea District Heating Corp. (KDHC) are good examples of rate regulated companies. These three companies have slightly different types of regulation. For example, the fuel cost pass-through adjustment (FCPTA) has been implemented at KOGAS but KEPCO’s FCPTA was cancelled. KDHC has both cost plus and incentive based schemes. However, in the case of KDHC, if the government does not approve the recovery within a year the recovery becomes ineffective.

If we take the example of the UK’s electricity and gas, the price controls set the maximum amount of revenue which energy network owners can raise through the charges they levy on users of their networks to cover their costs and earn a return on capital in line with agreed expectations. The price control is set based on forecasted costs and includes uncertainty mechanisms to allow for changes in demand, most of which have to be forecasted years in advance.

As for Germany’s air traffic service, to ensure a long-term full-cost recovery mechanism, yearly differences between budgeted and actual financial results of year ‘n’ are currently transferred into the year ‘n+2’. The forecasted total costs of year ‘n+2’ are based on an estimate of customer demand for year ‘n+2’.

Canadian electricity companies fall into two general categories within Canada. Many companies are government-owned utilities, while others are investor-owned utilities. A utility could operate under an incentive-based form of regulation. Typically, the rates set under incentive-based regulation are determined based on costs-of-service plus a reasonable return. For subsequent periods, the rates are modified using a formula-based approach. In real life transactions, regulatory assets and liabilities are measured and traded in Canada.

The gas and electricity industry in the USA is subject to rate regulation and three types of regulatory mechanisms exist: Actual Cost Recovery Mechanism (Trackers), Policy, and Incentive. Companies are allowed to recover utilities' operating cost and to earn a reasonable return, however regulators can allow utilities to defer all or part of a cost for their own purposes.

Brazilian utility companies are a mix of the private sector (more commonly comprised by energy distributors and transmitters) and government entities (more commonly energy generators). The regulator divides the costs of distribution companies between (i) costs that are not under the control of the distributor, named as Parcel A Costs, and (ii) costs that are under control of distributors, or Parcel B Costs. Regarding Parcel A costs, if a deviation occurs related to those comprised on the tariff, the operator has a right to receive from (or an obligation to refund) in the next annual tariff adjustment and, therefore, a regulatory asset (or liability) should be recorded.

Regarding the possible basis for recognition of assets arising from rate regulation, we may analyze it from three different angles: i) Conceptual Framework ii) revenue recognition, and iii) intangible assets.
i) Conceptual Framework
As the current Conceptual Framework defines ‘asset’ as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity, the right to recover specific previously incurred costs and to earn a specified return may create a resource. In addition, the new DP/2013/1 defines resource as ‘a right or other source of value, that is capable of producing economic benefits’ and does not require a new stream of economic benefits. Based on this, the entity may have control over that specific right to recover the incurred costs although the inflow of the benefits is not clear. If there is a direct relationship between costs incurred or sales in the current period and the right to recover incurred costs and approved return for the current sales, the right should be seen as a result of the rate regulation over the current sales.

ii) Revenue recognition
If the right to recover the costs and approved return is obtained as a part of consideration for the entity’s current sales of goods or services subject to rate regulation, an asset would be recognized when that portion of consideration is recognized as revenue. According to the price setting mechanism the rate regulation ensures the entity to charge customers to the extent of the target return and costs incurred in relation to sales occurring in the current period, which would be total transaction price of the current sales. This is also workable under IFRS 15, “Revenue from Contracts with Customers” as long as there is a contractual relation between the entity and the customers since most of the regulated industries are in a monopoly or near-monopoly situation.

iii) Intangible assets
IAS 38.12 states that an asset is identifiable if it is separable or arises from contractual or other legal rights. We think that the right subject to rate regulation meets the latter requirement for identifiability because the right arises from ‘contractual or other legal rights’. Contractual or other legal rights are an integral aspect of regulations and therefore the economic resource that should be accounted for in rate regulated activities is the contractual or other legal right to recover the incurred cost.
The possible basis for recognition of liabilities from rate regulation comes from three ways: i) Conceptual Framework, ii) provision under IAS 37, and iii) financial liability

i) Conceptual Framework
The current Conceptual Framework defines a ‘liability’ as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A rate-regulated entity may have an obligation to decrease future selling price if the incurred cost in the previous period is less than its costs and allowable return or if it sold more goods or services than anticipated in previous periods. This obligation comes from the rate-regulation mechanism, which gives the regulator the authority to adjust the selling price of goods or services which the rate-regulated company provides. In addition, considering the characteristics of the regulated activities, it would not be practical to assume that a regulated entity may stop operation. Therefore, the entity has a present obligation and regulatory liability can be recognized when the entity overcharged its costs above its actually incurred or allowed costs.

ii) Provisions under IAS 37
If the entity meets the definition and recognition criteria of liabilities under Conceptual Framework, the following criteria are met.
 A regulatory entity does not have discretion to discontinue its operation due to regulation.
 The regulation restricts the regulated entity’s profit margin at a pre-determined level, and the entity has to refund the excess through future sales.
 The entity reported excess margin in the previous period.
 It is probable that the entity will refund a specific amount through future sales price, according to the related regulation.
 The regulation includes the price adjustment mechanism in enough detail to determine the amount to refund.

iii) Financial liability
Considering the obligation at a quasi-contract level with collective customers, the obligation to refund directly affects future cash inflows from future sales. Although the contract with collective customers does not explicitly permit or require net settlement with future receivables, the method of refund is the same with net settlement. The entity has obligation to refund a certain amount of cash to collective customers according to the regulation, however, rather than actual refund, the regulation requires reducing future receivables from customers in the form of price adjustment. The rate regulation may have changed the method of settling obligation; however, it does not change the nature or existence of the obligation of regulated entity. Therefore, the obligation of a regulated entity to refund constitutes a financial liability.

In conclusion, we may suggest the followings:

As the monopoly or near-monopoly company or industry with single supplier of essential goods or service have common features that can create rights and obligations there is a possibility for the entities to recognize regulatory assets and liabilities. However, it is not 100% clear due to the fact that there is no perfect accounting model as of today. The accounting for rate-regulated activities has some similarities with intangible assets,
IFRIC 12, provision, deferred income taxes, and revenue recognition but these are not sufficient enough to support recognition and measurement of rate-regulated assets or liabilities.

As such, we propose to establish a holistic approach to the accounting for rate-regulated activities. Like IFRS 14, “Regulatory Deferral Accounts”, we need to create brand new items of regulatory assets and liabilities that do not belong to any categories of assets and liabilities beforehand. Further, the requirement of more disclosures in the footnotes to the financial statements may help the readers better understand the accounting for rate-regulated activities. Even though we have not found the perfect accounting model for rate-regulated activities, the accounting for rate-regulated activities will bring more meaningful information to the stakeholders of the related entities.