FEDERAL ENERGY REGULATORY COMMISSION
WASHINGTON. D C 20426
In Reply Refer To:
April 23, 1993
TO ALL JURISDICTIONAL PUBLIC UTILITIES, LICENCES,
AND NATURAL GAS COMPANIES
SUBJECT: ACCOUNTING FOR INCOME TAXES
In February 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). This Statement was the culmination of a process which the FASB began in 1982 to reexamine the accounting standards for income taxes. SFAS 109 superseded Accounting Principles Board Opinion No. 11, Accounting for Income Taxes (APB 11).
Under SFAS 109, a current or deferred tax liability or asset is recognized for the current or deferred tax consequences of all events that have been recognized in the financial statements or tax returns, measured on the basis of enacted tax law. Under APB 11, deferred tax consequences were recognized based on the differences between the periods in which transactions affect taxable income and the periods in which they enter into the determination of pretax accounting income. The change affects significantly the measurement and recognition of current and deferred income taxes reported in general purpose financial statements.
Public utilities, licensees, and natural gas companies are required to implement the provisions of SFAS 109 in general purpose financial statements issued to the public no later than the first quarter of 1993. The Statement however encouraged earlier application.
The FERC's Uniform Systems of Accounts generally provide that an entity follow comprehensive interperiod income tax allocation except that an entity is not required to adopt comprehensive interperiod income tax allocation until the deferred income taxes are included as an expense in its rate levels by regulatory authorities.
Since the issuance of Order No. 144 in 1981, the FERC's regulations have required companies to determine the income tax allowance included in jurisdictional rate levels on a fully normalized basis. Also, Order No. 144 requires an entity to compute the income tax component in its cost of service by making provision for any excess or deficiency in deferred taxes under the following circumstances: (1) if the entity has not provided deferred taxes in the same amount that would have accrued had tax normalization been applied for tax effects of timing difference transactions originating at any time prior to the test period; or (2) if, as a result of changes in tax rates, the accumulated provision for deferred taxes becomes deficient in or in excess of amounts necessary to meet future tax liabilities as determined by application of the current tax rate to all timing difference transactions originating in the test period and prior to the test period. Therefore, the FERC's accounting and rate regulations, when read together, already require use of a liability method somewhat similar to SFAS 109 for the jurisdictional portion of an entity's business.
The primary conceptual difference between SFAS 109 and the FERC's method relates to how regulatory assets and liabilities are recognized. Under the FERC approach, regulatory assets and liabilities are effectively netted against the deferred tax asset and liability accounts or, in some cases, not reported until related revenues are recognized. Under SFAS 109 all tax related regulatory assets and liabilities are shown broad. Certain other differences between the FERC's Uniform Systems of Accounts and SFAS 109 are discussed in the guidance that follows.
It is axiomatic that accounting statements issued by the FASB for use in general purpose financial statements of business entities should not, in itself, have an economic rate effect on a regulated entity or its customers. SFAS 109, in the main, requires costbased regulated entities to account for and report deferred tax assets and liabilities separately from related regulatory assets and liabilities. In general, such increases in the level of detail for an entity's assets and liabilities enhance disclosure, making financial information more useful to its users. The enhanced disclosure required by SFAS 109 may also prove useful for regulatory purposes. Moreover, adoption of SFAS 109 for FERC accounting and reporting purposes would result in financial information reported to the FERC and the public using the same accounting standard an objective having considerable merit in its own right.
Therefore, public utilities, licensees, and natural gas companies shall adopt SFAS 109 for financial accounting and reporting to FERC. In order to insure that the FERC continues to have the financial information it needs for regulatory purposes however, entities shall conform their accounting and reporting to the guidance provided in this letter. Neither SFAS 109 nor the guidance contained in this letter for implementing the standard for FERC financial accounting and reporting purposes relieves entities from the requirements of Section 154.63a, Tax normalization for interstate pipelines, or Section 35.24, Tax normalization for public utilities, of the Commission's regulations.
The Commission delegated authority to the Chief Accountant under 18 C.F.R. 375.303 to issue interpretations of the Uniform System of Accounts for public utilities, licensees and natural gas companies and sign correspondence on behalf of the Commission relating to Annual Report Nos. 1, lF, 2, and 2F. The guidance provided herein constitutes final agency action pursuant to this authority. Within 30 days of the date of this letter, interested parties may file a request for rehearing by the Commission under 18 C.F.R. § 385.713.
1. EARLY ADOPTION
Question: SFAS 109 is effective for fiscal years beginning
after December 15, 1992, but the FASB encourages
earlier application. May an entity implement SFAS
109 for FERC accounting and reporting requirements
prior to January 1, 1993?
Response: An entity implementing SFAS 109 in its general purpose financial statements prior to the Statement's required effective date, may also adopt the Statement for FERC accounting and reporting purposes. An entity however shall not implement SFAS 109 for FERC accounting and reporting purposes before it implements the Statement in its general purpose financial statements. Entities shall implement SFAS 109 for FERC accounting and reporting purposes no later than fiscal years beginning after December 15, 1992.
2. METHOD OF ADOPTION
Question: In the first year applied, SFAS 109 permits an entity to either (1) include the cumulative effect of the accounting change in the determination of current year net income, as provided for in APB Opinion No. 20, Accounting Changes; or (2) restate financial statements for prior periods to conform to the provisions of the Statement. Are both of these procedures acceptable to the FERC?
Response: No. In reporting to the FERC, the effect of initially applying this statement shall be reported as the cumulative effect of a change in accounting principle in accordance with the provisions of APB 20. An entity will not be permitted to restate prior years financial statements.
3. FERC APPROVAL TO ADJUST THE DEFERRED TAX ACCOUNTS
Question: The instructions to the Uniform Systems of Accounts presently restrict the use of the deferred tax balance sheet accounts to the purposes set forth in the text of the accounts unless prior Commission approval is obtained. Do the adjustments to the deferred tax accounts for the implementation of SFAS 109 fall within this restriction?
Response: Yes. This letter however, will constitute the requisite authority for making adjustments to the deferred tax accounts when the application of SFAS 109 does not affect net income (i.e. the deferred tax adjustments are accompanied by the recordation of equal regulatory assets or liabilities). Entities shall request and obtain specific FERC approval for all other adjustments to the deferred tax accounts, including those related to nonjurisdictional activity. The filing shall include a complete explanation of and justification for an entity's proposed accounting.
4. REPORTING ANY NET INCOME EFFECT
Question: If the initial implementation of SFAS 109 affects net income and an entity obtains FERC approval to adjust its deferred tax accounts, where should the income effect be reported in FERC financial reports (i.e. FERC Form Nos. 1, 1-F, 2 and 2-A etc.)?
Response: The FERC report forms do not currently have a line for reporting the cumulative effect of a change in accounting principle. Therefore, the effect on net income shall be reported on the income statement on the lines designated for extraordinary income or deductions, as appropriate, in FERC financial reports. To identify that the effects on net income resulting from the initial adoption of SFAS 109 are not an "extraordinary item" as that term is defined in the Uniform Systems of Accounts, entities shall also disclose in a footnote to the financial statements the full particulars of any amounts reports as the cumulative effect of a change in accounting principle.
5. DISCONTINUANCE OF NET-OF-TAX ACCOUNTING
Question: SFAS 109 prohibits net-of-tax accounting and reporting in general purpose financial statements. May entities continue to account and report to FERC on a net-of-tax basis?
Response: No. The present instructions to the Uniform Systems of Accounts require entities to record and report the deferred tax consequences of transactions, events, and circumstances in the appropriate deferred tax accounts. While the FERC has always preferred gross-of-tax financial accounting and reporting, it permitted an exception to this general requirement where a net-of-tax allowance for funds used during construction (AFUDC) rate was prescribed by a regulatory body in setting an entity's rate levels. The FERC granted this exception to avoid the burden of maintaining duplicate records for utility plant on a net-of-tax basis for one jurisdiction and a gross-of-tax basis for another.
Because SFAS 109 prohibits netoftax accounting and reporting in general purpose financial statements, the reasons for permitting the exception to the general requirement are no longer relevant. Therefore, entities shall discontinue the use of netoftax AFUDC rates.
Question: SFAS 109 considers the equity component of AFUDC a temporary difference for which deferred income taxes must be provided. How should an entity record the deferred tax liability for the equity component of AFUDC and the related regulatory asset in its accounts?
Response: An entity shall record the deferred tax liability for the equity component of AFUDC in Account 282, Accumulated Deferred Income Taxes Other Property, and any corresponding regulatory asset in Account 182.3, Other Regulatory Assets. The regulatory asset is itself a temporary difference for which deferred incomes taxes shall be recognized and recorded in Account 283, Accumulated Deferred Income Taxes Other. This accounting shall be followed for the adjustments required upon initial application of the statement and for all amounts of equity AFUDC capitalized in subsequent periods.
7. ADJUSTING NETOFTAX COMPONENTS OF UTILITY PLANT
Question: Upon initial application of SFAS 109, an entity must adjust any netoftax components of construction workinprogress and plant in service. How should an entity account for these adjustments?
Response: Entities that previously accounted for certain components of plant cost on a netoftax basis, primarily the borrowed funds component of AFUDC, have effectively recorded the deferred income tax effects of those components directly in the plant accounts. The deferred income taxes were computed using the income tax rates in effect when the items were capitalized.
For constructionworkinprogress, an entity shall transfer the deferred income taxes actually included therein to Account 282, Accumulated Deferred Income Taxes Other Property. If the amount transferred to Account 282 is greater or less than the amount needed to meet the future tax liability related to those items based on current tax rates, additional adjustments to the deferred tax liability shall be made consistent with SFAS 109. If as a result of action by a regulator it is probable that such excess or deficiency will be returned to or recovered from customers in rates, an asset or liability shall be recognized for that probable future revenue or reduction in future revenue in Accounts 182.3, Other Regulatory Assets, or 254, Other Regulatory Liabilities, respectively. That asset or liability is also a temporary difference for which a deferred tax asset or liability shall be recognized in Account 190, Accumulated Deferred Income Taxes, or Account 283, Accumulated Deferred Income Taxes Other, as appropriate.
Similar accounting is to be followed for plantin-service items when the required information is available. However, in order to properly adjust the plantinservice account an entity will need to determine the specific amounts of borrowed funds and equity AFUDC capitalized in prior periods, the extent to which those amounts and other netoftax components have been depreciated, the specific property units to which the amounts have been assigned and the extent to which property retirements affect the accounts in which the income tax effects now reside. In virtually all instances that information will simply not be available or will be too costly to develop. In that situation, an entity shall not adjust the plantinservice accounts based on estimates or presumed relationships. Instead, an alternate method shall be used to determine the necessary adjustments.
Under the alternate method, any difference between the reported amount and the tax basis of plant is a temporary difference for which a deferred tax liability shall be recorded in Account 282. If as a result of action by a regulator, it is probable that amounts required for settlement of that deferred tax liability will be recovered from customers through future rates, a regulatory asset equal to that probable future revenue should be recorded in Account 182.3. That asset is also a temporary difference for which a deferred tax liability shall be recognized in Account 283, Accumulated Deferred Income Taxes Other.
8. CHANGES IN TAX LAW OR RATES
Question: How should an entity record the effect of a change in tax law or rates that occurs after the year of initial implementation of SFAS 109?
Response: The entity shall adjust its deferred tax liabilities and assets for the effect of the change in tax law or rates in the period that the change is enacted. The adjustment shall be recorded in the proper deferred tax balance sheet accounts (Accounts 190, 281, 282 and 283) based on the nature of the temporary difference and the related classification requirements of the accounts. If as a result of action by a regulator, it is probable that the future increase or decrease in taxes payable due to the change in tax law or rates will be recovered from or returned to customers through future rates, an asset or liability shall be recognized in Account 182.3, Other Regulatory Assets, or Account 254, Other Regulatory Liabilities, as appropriate, for that probable future revenue or reduction in future revenue. That asset or liability is also a temporary difference for which a deferred tax asset or liability shall be recognized in Account 190, Accumulated Deferred Income Taxes or Account 283, Accumulated Deferred Income Taxes Other, as appropriate.
9. FLOWTHROUGH ITEMS
Question: An entity adopting SFAS 109 previously flowed through the tax benefits of certain temporary differences in rates when the differences originated. How should the Company recognize the deferred income taxes attributable to these temporary differences in its accounts?
Response: Deferred income taxes on all temporary differences, including differences where the related income tax effects have been or are presently flowed through in rates, should be recorded in Accounts 190, 281, 282 and 283 based on the nature of the temporary difference and the classification requirements of those accounts. If as a result of action by a regulator, it is probable that the future increase or decrease in taxes payable due to flow through ratemaking practices will be recovered from or returned to customers through future rates, an asset or liability shall be recognized in Account 182.3, Other Regulatory Assets, or Account 254, Other Regulatory Liabilities, as appropriate, for that probable future revenue or reduction in future revenue. That asset or liability is also a temporary difference for which a deferred tax asset or liability shall be recognized in Account 190, Accumulated Deferred Income Taxes or Account 283, Accumulated Deferred Income Taxes Other, as appropriate.
10.NOL AND TAX CREDIT CARRYFORWARDS
Question: How should an entity account for the income tax effect of a net operating loss (NOL) carryforward or a tax credit carryforward?
Response: An entity shall record the income tax effects of a NOL carryforward and a tax credit carryforward in a separate subaccount of Account 190, Accumulated Deferred Income Taxes Debit. In the event that it is more likely than not (a likelihood of more than 50 percent) that some portion of its deferred tax assets will not be realized, an entity hall record a valuation allowance in a separate subaccount of Account 190. The entity shall disclose full particulars as to the nature and amount of each type of operating loss and tax credit carryforward in the notes to the financial statements.
11. ALTERNATIVE MINIMUM TAX CREDIT CARRYFORWARD
Question: How should an entity record an alternative minimum tax credit carryforward?
Response: SFAS 109 requires a deferred tax liability or asset to be recognized for the estimated future tax effects attributable to temporary differences and carryforwards. Under SFAS 109, the AMT is viewed as a tax credit carryforward. Therefore, an entity shall record an alternative minimum tax credit carryforward in a separate subaccount of Account 190, Accumulated Deferred Income Taxes.
12. REGULATORY ASSETS AND LIABILITIES
Question: Where an entity recognizes regulatory assets or liabilities in connection with a change in its deferred tax assets and liabilities, should an entity record the change in the required deferred income tax balances in the appropriate income tax expense accounts and separately recognize the creation of regulatory assets and liabilities in a different income statement account? If so, which income statement account should be used to record the creation of regulatory assets and liabilities?
Response: The FERC recently considered the proper accounting for regulatory assets and liabilities in a rulemaking proceeding, Docket No. RM921000. Under the final rule issued in that proceeding (Commission Order No. 552 issued March 31,1993), an entity is not required to use income statement accounts to recognize regulatory assets and liabilities related to changes in deferred tax assets or liabilities when an equal and corresponding deferred tax asset or liability is recorded.
13. COSTOFSERVICE TARIFFS
Question: An entity has a costofservice tariff under which monthly billings are based on recorded amounts under FERC's Uniform Systems of Accounts. Under the tariff, only the amounts recorded in certain specified accounts affect the monthly billings. For example, the tariff may specify that Account 282 must be included in the determination of rate base but is silent with respect to Account 254. If implementing SFAS 109 for FERC accounting and reporting results in a reduction in the balance in Account 282 but a corresponding and equal increase in Account 254 (to recognize a regulatory liability) may an entity adjust its monthly billings to give proper effect to the revised accounting for income taxes?
Response: Adoption of SFAS 109 for FERC accounting and reporting purposes should not affect the measurement of cost included in an entity's billing determinations. If an entity's billing determinations would be affected by adoption of SFAS 109, because of the provisions of its tariffs, the entity shall make a filing with the proper rate regulatory authorities prior to implementing the change for tariff billing purposes.
14. INVESTMENT TAX CREDITS
Question: Some entities accounted for investment tax credits using the deferral method. SFAS 109 views deferred investment tax credits as a temporary difference (i.e. as a reduction in the book basis of the property) for which deferred income taxes are required. How should the deferred income taxes be recorded?
Response: The deferred income taxes attributable to deferred investment tax credits shall be recorded in a separate subaccount of Account 190, Accumulated Deferred Income Taxes. If as a result of action by a regulator it is probable that the reduction in future taxes payable due to the tax deductibility of the higher tax basis of the property will be returned to customers in rates, a regulatory liability shall be recorded for the amount by which future rates will be reduced. The regulatory liability shall be recorded in Account 254, Other Regulatory Liabilities. The regulatory liability is itself a temporary difference for which deferred incomes taxes shall be recognized. Those deferred income taxes shall also be recorded in Account 190.
15. FINANCIAL STATEMENT DISCLOSURE
Question: SFAS 109 requires certain financial statement disclosures concerning income taxes. Should entities disclose the same information in financial statements filed with FERC?
Response: Yes. In addition to the disclosure requirements specified elsewhere in this letter, entities shall follow the disclosure requirements of SFAS 109 in any financial statements filed with the FERC. The required information shall be shown in the Notes To Financial Statements.
16. CLASSIFICATION OF CURRENT PORTION OF DEFERRED INCOME TAXES
Question: SFAS 109 requires entities that prepare classified statements of financial position to separate deferred tax liabilities and assets into current and noncurrent amounts. Should entities reclassify the current portion of deferred tax liabilities or assets to current accounts, such as Account 174, Miscellaneous Current and Accrued Assets, or Account 242, Miscellaneous Current and Accrued Liabilities, for FERC accounting and financial reporting purposes?
Response: No. All deferred tax liabilities and assets shallbe recorded in Accounts 190, 281, 282, or 283, asappropriate, and the current portion of thoseamounts shall not be reclassified to otheraccounts for FERC reporting purposes.
17. CONSOLIDATED INCOME TAXES
Question: Prior to SFAS 96, the FASB (or its predecessor) had not issued any specific pronouncements related to how an entity that joins in the filing of a consolidated income tax return should determine income tax expense in its separately reported financial statements.
Footnote 12 of SFAS 96 provided that the consolidated amount is the amount of current and deferred taxes reported in the consolidated financial statements for the group, or the amount that would be reported if such financial statements were prepared. Under SFAS 96, the sum of the amounts allocated to members of the group (net of consolidation eliminations) would equal the consolidated amount.
SFAS 109 modified the requirements set forth in SFAS 96. SFAS 109 does not require one particular method to allocate the consolidated income tax liability between members of a group. Instead, SFAS 109 permits a number of methods, including methods in which the sum of the amounts allocated to individual members of the group may not equal the consolidated amount. SFAS 109 specifically states that a method that allocates current and deferred taxes to members of the group as if each member were a separate taxpayer (separate return method) is consistent with the statement's criteria.
Will the FERC permit an entity to use a separate return method for FERC financial accounting and reporting?
Response: No. The FERC has issued several decisions rejecting the use of the separate return method for determining income tax expense when an entity files as part of a consolidated group. Instead, the FERC relies on the standalone method of allocating income taxes between members of a consolidated group.
Under the standalone method the consolidated tax expense is allocated to individual members through recognition of the benefits/burdens contributed by each member of the consolidated group to the consolidated return. Under the standalone method, the sum of amounts allocated to individual members equal the consolidated amount.
Russell E. Faudree Jr.