On December 20, 2001, the U.S. Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking on Accounting and Reporting of Financial Instruments, Comprehensive Income, Derivatives and Hedging Activities (NOPR). The Federal Register published the NOPR on January 8, 2002. The purpose of the NOPR is to amend the FERC’s Uniform Systems of Accounts for jurisdictional public utilities and licensees, natural gas companies and oil pipelines to provide uniform accounting and reporting rules for those types of transactions. Comments on the NOPR are due March 11, 2002.
The FERC proposes to establish uniform accounting and reporting requirements "for the recognition of changes in the fair value of certain security investments, items of other comprehensive income, derivative instruments, and hedging activities" by incorporating, as part of the FERC reporting requirements, the principles contained in certain Financial Accounting Standards (FAS) statements issued by the Financial Accounting Standards Board (FASB). Although some companies already have implemented elements of the FASB rules in their accounting to FERC, the standards have not been implemented uniformly. Thus, the FERC seeks to adopt, as part of its Uniform Systems of Accounts, the accounting procedures indicated in the NOPR.
According to the FERC, as the industries it regulates continue to restructure, fair value will become an increasingly important economic measurement tool. The objective of the proposed rule is to establish a uniform accounting and reporting system that will capture this useful financial information in a manner that the FERC can utilize as it analyses profitability, efficiency and risk management and as part of its overall monitoring efforts. Additionally, this information will assist investors, creditors and other interested parties in making investment, credit and additional related decisions.
The FERC also seeks comment on whether (and if so, to what extent) it should require entities with market-based rates to follow the Uniform Systems of Accounts and proposed regulations, including what financial information, if any, these entities should report and how frequently it should be reported. Traditionally, these entities have been exempt from the FERC’s reporting requirements and, without change, would be exempt from the currently proposed rule.
The FERC also seeks comment on whether it should rescind the blanket authorizations currently granted under Part 34 of the FERC’s regulations to entities with market-based rates and require them to comply with Part 34 filing requirements with respect to all future issuance of securities and assumptions of liabilities.
The FERC concludes that the new reporting requirements will not be a significant reporting burden to the industry because the companies are already compiling the information for internal and external uses. The FERC estimates that it will take companies approximately two hours to comply with the proposed reporting requirements.
Over the past few years, the FASB has issued several Financial Accounting Standard statements that the FERC is considering incorporating in its reporting requirements. FAS 115, Accounting for Certain Investments in Debt and Equity Securities, addresses accounting and reporting for equity securities investments with easily established fair value and for all debt securities investments. FAS 115 requires entities to classify investments in securities into one of three categories: held-to-maturity, trading or available-for-sale. Entities must recognize unrealized gains and losses accordingly in their practices.
FAS 130, Reporting Comprehensive Income, established standards for reporting "comprehensive income." Comprehensive income consists of "traditional net income plus items of ‘other comprehensive income.’"
FAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended by FAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, was issued to clarify accounting guidelines with respect to the effects of derivative transactions and hedging activities. FAS 133 and FAS 138 require accounting methods that provide users of financial statements with information concerning a company’s risk management strategy and the role derivatives and hedging play in the company’s overall risk management strategy.
Proposed Changes to the FERC’s Uniform Systems of Accounts
Accounting for Trading and Available for Sale Type Securities
Currently, under the FERC’s Uniform Systems of Accounts, securities are recorded at cost and entities are not required to report subsequent changes in the fair value of security investments. As a result, these changes are not reflected in entities’ financial statements. While the Uniform Systems of Accounts for oil pipelines do require some adjustment to the carrying value of security investments, this is required only when certain conditions are met.
The FERC believes that regulators, including the FERC itself, investors, creditors and others making credit decisions will benefit from fair value measurement of trading and available-for-sale type securities. Therefore, the FERC proposes to amend its security investments accounts by adding language that will allow the recognition of changes in the fair value of trading and available-for-sale type of securities resulting from unrealized holding gains and losses. The FERC also proposes to amend its oil pipeline general instructions to provide consistency with other proposed changes.
Accounting for Other Comprehensive Income
The FERC also proposes to revise its Uniform Systems of Accounts for public utilities, gas companies and oil companies in order to account for items of other comprehensive income. The FERC proposes to create two new accounts, an "Accumulated Other Comprehensive Income" account and an "Other Comprehensive Income" account. Amounts would be transferred between the two accounts at year’s end to capture the other comprehensive income activity for a single year. This amount would then be reported to the FERC in a proposed new schedule, "Statement of Comprehensive Income and Hedging Activities."
Supporting records for each category of comprehensive income will be required for all accounts. According to the FERC, this is necessary to enable entities to identify the amounts associated with an item when determining current and subsequent period earnings. Reclassification adjustments for other comprehensive income also will be required to ensure that items in net income are not also counted as other comprehensive income. The FERC believes that this approach will eliminate the need to create a new account to capture amounts solely related to the reclassification adjustment.
Accounting for Derivatives and Hedging Activities
Currently, changes in the fair value of derivative instruments used in hedging and non-hedging activities are not recorded under the Uniform Systems of Accounts. The FERC believes that amending its recording requirements to recognize this information will improve transparency and completeness with respect to these activities.
The FERC proposes to amend the Uniform Systems of Accounts by adding a new general instruction that would require public utilities, gas companies and oil companies to record changes in the fair value of derivative instruments designated as cash flow hedges to other comprehensive income. The new instruction also would require jurisdictional entities to record changes in the fair value of derivative instruments designated as fair value hedges and concurrently charge a sub-account of the asset or liability carrying the item being hedged. In this manner the "ineffective portion of the cash flow hedge will be charged to the same income or expense account that would have been charged if the hedge item had been disposed of, or otherwise settled."
The FERC proposes to make consistent its accounting methodologies for hedge transactions related to exchange traded allowance futures contracts and the proposed accounting methodology for derivatives by making "technical changes" to its existing general instructions. The FERC also proposes to include exchange traded allowance futures in the accounting framework for derivatives.
The FERC proposes to establish new derivative asset and derivative liability accounts where amounts related to changes in the fair value of derivative instruments not designated as a cash flow or fair value hedges would be recorded. The FERC recognizes that derivative instrument change in value may be used by regulators in developing rates under certain circumstances, not withstanding the fact that the derivative instrument is not part of a fair value or cash flow hedge. Where this occurs, the FERC proposes that companies reclassify those amounts to the utility operating revenue or expense account that will be charged with the transaction when it settles.
The FERC also recognizes that companies are required to record derivative assets and liabilities as current or long-term on their balance sheets. Therefore, the FERC will allow companies to create current and long-term sub-accounts associated with the proposed new derivative balance sheet account. According to the FERC, this will help facilitate reporting of these items to shareholders. In addition, FERC proposes that if the derivative instrument does not qualify for hedge accounting, but it is probable that changes in the fair value will be used in future rate development, the FERC’s existing accounting regulations for the recognition of regulatory assets and regulatory liabilities must be followed.
The FERC proposes to establish new asset and liability accounts to include amounts related to changes in the fair value of derivative instruments designated as a cash flow or fair value hedges.
Proposed Changes to the FERC Annual Reports Form
According to the FERC, one new schedule and changes to certain existing balance sheet schedules are required to implement the proposed accounting changes. Currently, companies have a choice with respect to the format of their financial statement, whether they report certain items net of reclassification adjustments and whether they report these amounts on a net-of-tax or pre-tax basis. All companies must, however, meet certain footnote disclosure requirements.
The new schedule, "Statement of Comprehensive Income and Hedging Activities," will include instructions on the proper footnote disclosures for the FERC Forms 1, 1-F, 2, 2-A and 6. The schedule is intended to provide for transparency regarding the components of other comprehensive income and is consistent with the FASB concepts. The FERC intends for its proposed format to avoid duplicating data required by other schedules.
The new schedule will require companies to show the components of other comprehensive income and to report as footnotes to the schedule those categories of other comprehensive income on a net-of-tax basis, where appropriate, including the related tax effects allocated to each component; accumulated other comprehensive income balances at year end by category; and fair value hedge balances at year end by category.
Regulatory Flexibility Act Statement
Under the Regulatory Flexibility Act, the FERC is required to consider the impact of the proposed rule on small entities. The FERC concludes that the proposed rule will not have an impact on small entities because most filing companies regulated by the FERC do not fall within the "small entity" definition.
As indicated above, the FERC does not believe that the new reporting requirements will be "a significant reporting burden to the industry"" because companies are already compiling this information for internal and external use. If the requirements do present an undue burden to small businesses, however, companies can seek a waiver of the requirements from the FERC.
The FERC currently is seeking comments with respect to the NOPR. The comments should include an executive summary of the issues addressed. In addition, the FERC requests that commenters identify and label appropriately each specific question posed by the NOPR that is addressed in their comments. Commenters separately should identify additional issues raised in their comments. Comments are due by March 11, 2002.