ASC

ASC 740-980

Regulated Operations

740 Income Taxes

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In brief

AdvancedIncome taxesIndustry-specificRecognitionSubsequent measurement

This subtopic applies ASC 740 to entities whose rates are regulated and that meet the criteria in 980-10-15-2. It prohibits net-of-tax accounting, requires a deferred tax liability for tax benefits flowed through to customers and for the equity component of the allowance for funds used during construction (AFUDC), and requires deferred taxes to be adjusted for enacted changes in tax law or rates. When it is probable that a regulator will allow recovery from (or require refund to) customers of those future tax amounts, the entity recognizes a separate regulatory asset or liability, which is itself a temporary difference generating additional deferred tax.

Key points (7)
  • For entities meeting paragraph 980-10-15-2, net-of-tax accounting and reporting is prohibited, a deferred tax liability must be recognized for tax benefits flowed through to customers when temporary differences originate and for the equity component of AFUDC, and deferred tax liabilities/assets must be adjusted for enacted changes in tax laws or rates (740-980-25-1).
  • If regulator action makes it probable the future increase or decrease in taxes payable will be recovered from or returned to customers through future rates, a regulatory asset or liability is recognized under 980-340-25-1 and 980-405-25-1, and that asset or liability is itself a temporary difference requiring a deferred tax liability or asset (740-980-25-2).
  • The regulatory asset and the related deferred tax liability are displayed separately and are not offset for general-purpose financial reporting (740-980-55-1).
  • The regulatory asset is grossed up for the tax on the recovery itself: 34% x ($26,000 AFUDC equity + A) = A, giving A = $13,394 (740-980-55-9).
  • Where the deferred tax liability represents amounts already collected from customers, no regulatory asset exists; a rate-rate decrease creates a probable refund liability grossed up as $4,000 + (30% x R) = R, so R = $5,714 (740-980-55-13).
  • A regulated entity capitalizes an otherwise-expensed cost only if future revenue at least equal to the cost is probable from including it in allowable costs, and the evidence shows the revenue recovers the previously incurred cost rather than funding similar future costs (740-980-55-1).
  • For an abandoned plant, the abandonment loss is deductible for federal tax purposes when abandonment occurs regardless of rate-making treatment, and deferred taxes on the remaining asset and related recovery asset are recorded under Subtopic 740-10 (740-980-55-4 through 55-6).

For students. Exam questions here hinge on the gross-up math: because the regulatory asset (or refund liability) is itself taxable/deductible, you must solve the circular equation rather than simply multiplying the tax rate by the AFUDC equity amount. A common misunderstanding is netting the regulatory asset against the deferred tax liability — the guidance requires separate display and forbids net-of-tax presentation.

regulated operationsallowance for funds used during constructionflow-through tax benefitsregulatory assetregulatory liabilitydeferred tax liabilityenacted tax rate changenet-of-tax accounting prohibition

Machine-generated study aid for ASC 740-980. Check the source paragraphs below.

740-980-05Overview and Background

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740-980-05-1
This Subtopic provides guidance on accounting for income taxes for entities with regulated operations.

740-980-15Scope and Scope Exceptions

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Overall Guidance

740-980-15-1
This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section 980-10-15.

740-980-25Recognition

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Income Taxes Applicable to Regulated Entities

740-980-25-1
For regulated entities that meet the criteria for application of paragraph 980-10-15-2, this Subtopic specifically:
  1. a
    Prohibits net-of-tax accounting and reporting
  2. b
    Requires recognition of a deferred tax liability for tax benefits that are flowed through to customers when temporary differences originate and for the equity component of the allowance for funds used during construction
  3. c
    Requires adjustment of a deferred tax liability or asset for an enacted change in tax laws or rates.
740-980-25-2
If, as a result of an action by a regulator, it is probable that the future increase or decrease in taxes payable for (b) and (c) in the preceding paragraph will be recovered from or returned to customers through future rates, an asset or liability shall be recognized for that probable future revenue or reduction in future revenue pursuant to paragraphs 980-340-25-1 and 980-405-25-1. That asset or liability also shall be a temporary difference for which a deferred tax liability or asset shall be recognized.
740-980-25-3
Example 1 (see paragraph 980-740-55-8) illustrates recognition of an asset for the probable revenue to recover future income taxes.
740-980-25-4
Example 2 (see paragraph 980-740-55-13) illustrates adjustment of a deferred tax liability when the liability represents amounts already collected from customers.

740-980-55Implementation Guidance and Illustrations

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Implementation Guidance

740-980-55-1
Paragraph 980-340-25-1 requires a regulated entity that applies this Topic to capitalize an incurred cost that would otherwise be charged to expense if the following criteria are met:
  1. a
    It is probable that future revenue in an amount at least equal to the capitalized cost will result from inclusion of that cost in allowable costs for rate-making purposes.
  2. b
    Based on available evidence, the future revenue will be provided to permit recovery of the previously incurred cost rather than to provide for expected levels of similar future costs.
If the income taxes that result from recording a deferred tax liability in accordance with Subtopic 740-10 meet those criteria, an asset is recognized for those income taxes when the deferred tax liability is recognized. That asset and the deferred tax liability are not offset for general-purpose financial reporting; rather, each is displayed separately.
740-980-55-2
When a loss on abandonment is recognized, the amount of deferred income taxes related to the remaining asset shall be determined as indicated in the following guidance.
740-980-55-3
While under construction, a utility's plant has a recorded cost that consists of the following three separate elements for income tax purposes:
  1. a
    Costs that will be deductible in the future, either as depreciation or (in the event that the plant is abandoned) as an abandonment loss
  2. b
    Costs that have been deducted in the past
  3. c
    Costs that are never deductible (the allowance for equity funds used during construction).
740-980-55-4
An abandonment loss generally is deductible for federal income tax purposes when the abandonment occurs. That tax deduction is allowed without regard to the rate-making treatment applied to the recorded cost of the abandoned plant.
740-980-55-5
When a regulator is expected to provide recovery of the cost of an abandoned plant without return on investment, Subtopic 980-360 requires a portion of the cost of the abandoned plant to be recognized as a loss, equivalent to the present value of the effective disallowance of return on investment.
740-980-55-6
Deferred income tax liabilities, related to the remaining asset and the recovery of a separate asset recognized to reflect the future revenue that is expected to be provided in rates by the regulator when the income taxes become payable, shall be recorded under the requirements of Subtopic 740-10.

Illustrations

740-980-55-7
All the Examples assume that the entity meets the criteria in paragraph 980-10-15-2 for the application of this Topic by the entity.
740-980-55-8
This Example illustrates the guidance in paragraphs
980-740-25-1 through 25-2
. The following Cases illustrate the recognition of an asset related to a deferred tax liability:
  1. a
    Recognition of an asset for the probable future revenue to recover future income taxes related to the deferred tax liability for the equity component of the allowance for funds used during construction (Case A)
  2. b
    A subsequent adjustment of deferred tax liability for an enacted change in tax rates (Case B).
740-980-55-9
Cases A and B share all of the following assumptions:
  1. a
    During Year 1, the first year of operations, total construction costs for financial reporting and tax purposes are $400,000 (exclusive of the allowance for funds used during construction).
  2. b
    The enacted tax rate is 34 percent for all future years.
  3. c
    Allowance for funds used during construction (consisting entirely of the equity component) is $26,000. The asset for probable future revenue to recover the related income taxes is calculated as follows:
    • 34 percent of ($26,000 + A) = A (where A equals the asset for probable future revenue)
  4. d
    A = $13,394.
740-980-55-10
At the end of Year 1, the related accounts are as follows.
  • Construction in progress " $426,000 " Probable future revenue " $13,394 " "Deferred tax liability [34 percent of ($26,000 + $13,394)]" " $13,394 "
740-980-55-11
In this Case, if the allowance for funds used during construction had consisted entirely of a net-of-tax debt component in the amount of $26,000, the related accounts and their balances at the end of Year 1 would be construction in progress in the amount of $439,394 and a deferred tax liability in the amount of $13,394.
740-980-55-12
This Case illustrates adjustment of a deferred tax liability for an enacted change in tax rates. In this Case, a change in the tax rate from 34 percent to 30 percent is enacted on the first day of Year 2. As of the first day of Year 2, the related accounts are adjusted so that the balances are as follows.
  • Construction in progress " $426,000 " Probable future revenue " $11,143 " "Deferred tax liability [30 percent of ($26,000 + $11,143)]" " $11,143 "
740-980-55-13
This Example illustrates adjustment of a deferred tax liability for an enacted change in tax rates when that deferred tax liability represents amounts already collected from customers for the future payment of income taxes discussed in paragraphs
980-740-25-1 through 25-2
. In that case, there would be no asset for probable future revenue. This Example has the following assumptions:
  1. a
    Amounts at the end of Year 1, the current year, are as follows.
    • Construction in progress for financial reporting " $400,000 " Tax basis of construction in progress " $300,000 " "Deferred tax liability (34 percent of $100,000)" " $34,000 "
  2. b
    A change in the tax rate from 34 percent to 30 percent is enacted on the first day of Year 2. As a result of the reduction in tax rates, it is probable that $4,000 of the $34,000 (previously collected from customers for the future payment of income taxes) will be refunded to customers, together with the tax benefit of that refund, through a future rate reduction. The liability for the future rate reduction to refund a portion of the deferred taxes previously collected from customers is calculated as follows:
    • $4,000 + (30 percent of R) = R (where R equals the probable future reduction in revenue)
  3. c
    R = $5,714.
740-980-55-14
As of the first day of Year 2, the related accounts are adjusted so that the balances are as follows.
  • Construction in progress " $400,000 " Probable reduction in future revenue " $5,714 " "Deferred tax liability [30 percent of ($100,000 — $5,714)]" " $28,286 "

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