FEDERAL ENERGY REGULATORY COMMISSION
WASHINGTON. D C 20426
In Reply Refer To:
AI935000
April 23, 1993
TO ALL JURISDICTIONAL PUBLIC UTILITIES, LICENCES,
AND NATURAL GAS COMPANIES
SUBJECT: ACCOUNTING FOR INCOME TAXES
Early Adoption
Method of Adoption
FERC Approval to Adjust the Deferred
Tax Accounts
Reporting Any Net Income Effect
Discontinuance of Net-of-Tax
Accounting
Equity AFUDC
Adjusting Netoftax Components of
Utility Plant
Changes in Tax Lase or Rates
Flowthrough Items
NOL and Tax Credit Carryforwards
Alternative Minimum Tax Credit Carryforward
Regulatory Assets and Liabilities
Costofservice Tariffs
Investment Tax Credits
Financial Statement Disclosure
Classification of Current Portion
of Deferred Income Taxes
Consolidated Income Taxes
INTRODUCTION
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 SFAS 109 superseded Accounting Principles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.
6.EQUITY AFUDC
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.
Chief Accountant