rate-making

This subtopic addresses loss contingencies for entities with regulated operations (rate-regulated utilities). Its core rule: when a regulator allows an entity to recover an amount for a contingency in rates even though the amount does not meet the accrual criteria of 450-20-25-2, and the regulator requires the entity to remain accountable for amounts collected but not yet spent for the intended purpose, the increased charges to customers give rise to a liability rather than income.

This Subtopic modifies the general rule that gains and losses on early extinguishment of debt hit income immediately (Subtopic 470-50) for entities whose rates are set by a regulator. If the regulator will recover a reacquisition loss through future rates, the regulated entity capitalizes the excess of reacquisition price over net carrying amount as a regulatory asset; if the regulator will reduce future rates for a gain, the entity records a regulatory liability. Either amount is amortized as an adjustment of interest expense over the period reflected in rate-making.

This Subtopic addresses compensated absences and other compensation-related costs for entities with regulated operations. Even though a regulator may allow such compensation in rates only when paid, the entity must still accrue the liability under Topic 710 because regulator rate actions cannot eliminate obligations the regulator did not impose. Because the cost will be recoverable in future rates as paid, the entity simultaneously records a regulatory asset representing the probable future increased revenue.

This Subtopic governs how entities with regulated operations account for the financing cost of construction — the allowance for funds used during construction (AFUDC), which includes both a computed interest component and a designated cost of equity funds. When a regulator requires such capitalization, the rate-making amount (not the amount computed under Subtopic 835-20) is capitalized for financial reporting purposes, but only if subsequent inclusion in allowable costs for rate-making purposes is probable. The credit is reported in the income statement as other income, a reduction of interest expense, or both.