Authored by Russ Hissom
As a public utility, you may have heard of GASB 62, but you may not know if this Governmental Accounting Standards Board guidance on regulated operations applies to you. Well, many public utilities are regulated – at the federal, state and/or local level. To find out if yours is, consider: does my utility have an oversight body with the authority to approve rate changes? Are these rates designed to recover the cost of providing service and charged without adjustment for demand or competition?
If you answered “yes” – jackpot! Your utility is regulated and can utilize the rules of GASB 62. Read on to learn about allowable uses of regulatory accounting, including an example of rate stabilization, under GASB 62.
Standard uses of regulatory accounting under GASB 62
When considering use of a regulatory deferral, you must determine intent. For example, how will my utility recover these costs from ratepayers or defer revenue recognition to future periods to mitigate rate impacts? Typical uses of regulatory assets and liabilities include:
- Extraordinary maintenance costs such as planned unit outages, weather damage or other unforeseen events
- Premature losses on asset retirements
- Decommissioning of generating units
- Future recoverable costs, i.e. the difference between depreciation and debt service on bond financed plant – when rates are designed to recover debt service
- Long-term deferred receivables
- Deferred power costs to be recovered in the future
- Mark to market derivative and investment losses
- Advanced debt refunding losses
- Rate stabilization (funded or unfunded) – the difference of earnings over bond coverage to be used in future periods to offset anticipated increases in power costs and other expenses
- Deferred costs collected in rates now that will be expended in future periods – such as those for future maintenance projects or decommissioning expenses
- Contributions in aid of construction
The primary purpose of GASB 62 is to recognize expenses and the revenues from rates designed to recover those costs in the same period. This standard recognizes that rate regulated utilities often have to consider rate stability, and thus recover costs over different periods than those costs would be recognized as expenses under generally accepted accounting principles.
Using GASB 62 for rate stabilization
In the utility business, like any other, there will be good earning years and poor earnings years. It is not always feasible to raise rates, even when finances may show the need for a rate increase.
Rate stabilization is a tool to help manage earnings. You heard right: “Manage earnings” in a manner sanctioned by accounting standards, in this case GASB 62. However, this needs to be properly approved and established by your rate regulator.
The most common factor in managing earnings is to ensure the utility meets its bond coverage requirement. Bond coverage is the earnings needed to meet annual bond principal and interest payments, plus a multiple (or cushion). Bond coverage is mandated by the utility’s bond covenant that was entered into when the utility issued revenue bond debt.
Year 1 example
For example, the utility has $20 million in revenue bonds. This year’s bond payment is $1 million (principal and interest). The bond covenant states the utility must generate earnings to maintain bond coverage of 1.5x. What is the earnings the utility must generate?
|Bond principal and interest||$1,000,000|
|Coverage requirement||___ __x 1.5|
Earnings for coverage requirements are calculated on a cash flow basis. Here’s the sample calculation of bond coverage earnings:
|Operation and maintenance expenses|
(do not include depreciation)
|Earnings per bond covenant coverage calculation||$ 3,000,000|
The utility has $3 million in earnings and needed $1.5 million. So, in theory the utility has $1.5 million available for rate stabilization reserves. An entry could be made to establish a regulatory liability for rate stabilization reserves and defer those earnings for use in future years. The entry in Year 1 would be:
|Other deferred inflows – rate stabilization reserves||$1,500,000|
In order to utilize GASB 62 and establish a rate stabilization reserve, the rate regulator needs to approve a policy that outlines what revenues can be deferred and what future costs will result in the application or recognition of such revenues. One caveat: GASB 62 allows making the entry above but does not mandate that cash be set aside in a rate stabilization reserve account. To ensure there’s available cash for use in future years, any amounts recorded as rate stabilization should also be funded by an equal amount in a rate stabilization cash account.
Year 2 example
Operations in the second year are a bit bumpy. Costs have increased though the utility hasn’t been unable to pass a rate increase. Required bond coverage is $1.5 million for the year. The utility’s bond coverage earnings for the year are as follows:
|Operation and maintenance expenses|
(do not include depreciation)
|Earnings per bond covenant coverage calculation||$ 1,000,000|
The utility has $1 million in earnings and needed $1.5 million. Technically it does not meet bond coverage. However, if the rate regulator approved the application of rate stabilization to meet debt coverage, then we can recognize $500,000 of the previously deferred rate stabilization reserves. The entry in Year 2 would be:
|Other deferred inflows – rate stabilization reserves||$500,000|
In compliance with the approved policy, the utility has met bond coverage. There is still $1 million of rate stabilization reserves available for future years.
As in making a recipe, assemble all the right ingredients before beginning the process of using GASB 62. Use long-term planning to determine the amount and timing of rate increases. Make sure budgets reflect your best forecast of operations for short and long-term scenarios. And during budgeting process, figure in the use or deferral of rate stabilization.
Document your utility’s cost or revenues for deferral and seek governing board approval through a blanket resolution for routine items or by passing resolutions for specific material items. Documentation should reflect the cost or revenues to be deferred, pertinent transaction details and the intended rate recovery or revenue return period. Reflect changes in circumstances in future accounting from the point of those changes. And finally, use the tool of rate stabilization to help manage your utility’s finances.
For more information on this topic, or to learn how Baker Tilly energy and utility specialists can help, contact our team.