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Utilities Unbundled - US GAAP: tangible benefits - handle with care - EY - Global

Utilities Unbundled    issue 12

US GAAP: tangible benefits – handle with care

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Defining and accounting for tangible benefits can be as complex and burdensome as any other key aspect of a major investment ― so approach the task with care.

When regulators are considering an approval for a new license, a business combination, or the transfer ownership of an existing operating license, they sometimes ask for a demonstration of what tangible benefits the public or consumer base will get as a result of the approval. This is a way of protecting the public or other stakeholders.

The concept is widely used in the regulatory world, but is particularly prevalent in the broadcasting, telecommunications and utilities (electricity and water) sectors.

For utilities subject to rate regulation, regulators in many jurisdictions put the onus on the acquirer to demonstrate that the transaction is in the best interest of ratepayers.

Regulators will pin down specific benefits – and they have to be genuine
Often, regulators include specific criteria that require the benefits to be directed to projects and initiatives that would not otherwise be undertaken or realized in the absence of the transaction. The applicant has to demonstrate that expenditures proposed as tangible benefits flow predominantly to third parties, such as consumers.

A company cannot argue that a planned capital improvement program in say, electricity transmission lines, could be viewed as a tangible benefit to ratepayers if those improvements would be undertaken in any event, even if the desired acquisition transaction did not proceed.

In the utilities sector, when applying for regulatory approval for an acquisition, the application is commonly required to promise the delivery of some significant tangible benefits, which must be agreed by the regulator before approval is granted. This can range from 1% to 10% of the deal value, depending on the nature of the approval sought and the size of the deal. The regulator will generally add any assumed debt in the acquisition to the deal value, not just to the net purchase price.

Because regulators do not solicit competing applications to transfer ownership, the onus is on the applicant to demonstrate that the tangible benefits proposed in the application are commensurate with the size and nature of the transaction.

Accounting for benefit is highly complex

There are two ways that the cost of the tangible benefits obligation can be accounted for, depending on the characteristics of the benefit:

  1. They can be expensed in future years as and when they are incurred, in which case they do not form part of the purchase price allocation, but are recognized as expenses in the appropriate future periods.
  2. Alternatively, they can be recognized as part of the purchase price allocation and capitalized (thereby forming part of the goodwill or intangible assets) if they are (a) paid directly to a third party (and non-refundable) or (b) recognized as a liability at the time of closing.

It is important for acquirers to consider the implications of this before developing the tangible benefit package submitted to the regulator for approval, if their objective is to have the cost of the tangible benefit package included in the purchase price allocation. In this way, they can structure the tangible benefit package with the appropriate characteristics and criteria to qualify for capitalization.

To qualify as part of the purchase price allocation, the benefit characteristics must meet the recognition criteria required by the acquirer’s basis of accounting (IFRS or US GAAP).

For example, if the proposed benefit is in the form of a commitment to undertake future upgrades to network or customer service, or even future rate reductions, these would generally not be considered to meet the definition of a liability since there has been no obligating event, the amount is not measurable, etc. As such, they would be accounted for as the costs are incurred in future years. However, if the proposed tangible benefits are paid on closing, say in trust to the regulator (non-refundable) for rebates to the customers, then immediate recognition in the purchase price equation could be appropriate.

It is also important to consider the tax impacts of each component in the tangible benefit package. They must be assessed separately, as different types of transactions may require different tax treatments. Immediate rebates to customers paid on closing could qualify as a current tax deduction, while future network upgrades are likely to be capitalized for tax (and accounting) when they are actually incurred.


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