What it means
Utilities such as electricity, gas and water companies have their prices set or approved by a regulator. The regulator lets the company charge enough to cover its costs and earn a fair return.
Sometimes the company incurs a cost that is not yet included in prices, and the regulator agrees to let it recover that cost over time. When recovery is probable, accounting standards for regulated operations let the company record the cost as an asset rather than an immediate expense.
Examples include storm restoration costs, pension costs, fuel cost differences and the cost of retiring plant early. The asset is then reduced, or amortised, as the money is collected through customer rates.
The main benefit is matching. The cost is shown in the same periods as the revenue that recovers it, so the company's profit is not distorted by a large one-off charge.
Customers pay the costs over several years instead of facing a sharp price rise at once. The key condition is that recovery must be probable.
If the regulator signals that it will disallow the cost, the company must write off the regulatory asset and take the loss. This makes the regulator's decisions a central risk for utility finances, and analysts watch rate case outcomes closely.
There is also a mirror image, called a regulatory liability, which arises when the company has collected more than it should and owes customers a refund through future rates. Different accounting frameworks treat these items differently, and in some jurisdictions they are not recognised at all.
Anyone comparing utilities across countries should check the accounting basis. Analysts treat regulatory assets with some caution.
A large balance means the company is relying on future customer payments and on the regulator's continuing goodwill, so its quality depends on the regulatory climate. Many investors also look at how quickly the balance is being recovered and whether the company earns a return on it.
In practice
Real-world examples.
Example
A water utility spends $3,000,000 to repair mains after a flood. The regulator approves recovery over three years, so the utility records a regulatory asset and expenses $1,000,000 per year as rates collect the money. Each year's expense is matched by the extra revenue collected.
Example
An electricity company's fuel costs exceed the amount built into rates for the year. The regulator permits the company to recover the difference in future bills, so the shortfall appears as a regulatory asset.
Example
A gas utility retires an old pipeline early. The undepreciated cost is moved to a regulatory asset because the regulator will allow it to be recovered over time. The finance team records the recovery period in the notes to its financial statements so investors can see when the balance will clear.
Formula
Calculation
Annual amortisation = regulatory asset / recovery period in years
A utility incurs $12,000,000 in storm restoration costs, and the regulator allows recovery through customer rates over five years. It records a regulatory asset of $12,000,000. Annual amortisation = $12,000,000 / 5 = $2,400,000. After the first year the asset balance is $12,000,000 - $2,400,000 = $9,600,000.Case study
Seen in the real world.
Eastgate Power is an illustrative, fictional electricity utility that suffered a severe storm. Restoration cost $18,000,000, equal to almost a full year of its profit, and the finance team had to decide how to account for it.
The regulator approved recovery over six years, so Eastgate recorded a regulatory asset and amortised $3,000,000 a year as the extra revenue arrived. Profit remained steady and the dividend was protected. The illustrative lesson is that the regulator's approval turned a painful one-off cost into a manageable, scheduled recovery.
Eastgate's finance director also briefed its lenders and bond investors on the approved recovery schedule, showing how the balance would fall each year. The disclosure supported the company's credit rating and kept its borrowing costs steady through the recovery period.
Watch out
Common mistakes.
- Recording a regulatory asset without evidence that recovery is probable, when the accounting standard requires that the regulator's approval is likely.
- Treating it like an ordinary asset that can be sold, when it represents a right to future recovery through rates.
- Ignoring the write-off risk, when a disallowance by the regulator can remove the asset in a single period.
Questions
People also ask.
Which companies use regulatory assets?
Rate-regulated businesses such as electricity, gas and water utilities, and sometimes other regulated sectors.
What happens if the regulator rejects recovery?
The company writes off the asset and records the loss in profit and loss immediately, which can cause a sharp one-off drop in reported earnings.
Does recovery include a return?
Often the regulator allows a return on the unrecovered balance, but this depends on the regulator's decision and differs between cost types and jurisdictions.
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