Legal and regulatory accounting in the electrical energy sector

part five

This is a continuation of my discussion of the main differences between legal and regulatory accounting rules that govern the energy sector

4. The two parts of the Regulatory Asset Base (RAB)

Although RAB is the general term used to refer to regulatory assets used in the provision of efficient regulated energy services, it can also be referred to based on two aspects:

Physical aspect—which is the material aspect or the physical assets themselves; and

The investment or financing aspect— refers to funds used to finance the acquisition of property, plant and equipment, which may be a combination of debt and equity.

The above can be illustrated using the statutory accounting equation of:


A more refined illustration would be:

UTILITIES + WORKING CAPITAL = DEBT + CAPITAL (including retained earnings)

It is best to visualize the RAB in terms of these two aspects to eliminate some confusion that results from using only one, the physical aspect of the RAB. Currently, the optimized RAB is used in carried forward balances and in the calculation of amortization or principal repayment. Under performance-based regulation, return on capital (ROC) also uses RAB as the basis on which to apply WACC to arrive at OC.

It is expected that the total debit and total credit in the above equation will always be equal. However, for regulatory accounting purposes, it will not be the same. Therefore, it will be better for the ROC to be obtained using the aspect of physical assets as the basis and, for the ROC to use the concept of financial or investment capital as the basis. In this way, the debt ratio, applicable interest rates and other adjustments will be correctly recognized. In this regard, the Board, the Distribution Department (DU) and the external auditor should agree to use a common template to review the different adjustments to be made to arrive at the two different RAB balances, which should be periodically reconciled.

For a better understanding of the reconciliation, explanations should be provided for each of the items that appear in the reconciliation template. For example, while donated assets may be excluded from RAB in the calculation of ROC, they may be included in RAB in the calculation of depreciation so that sinking funds can be accumulated if the condition of the gift makes the DU responsible for the replacement.

Financial and regulatory accounting would be better appreciated if there was good coordination between the auditors and the regulator to ensure that the different practices between the two are properly recognized and, if material, should be disclosed in the financial statements for a better understanding of distribution utility business. After all, there is a commonality of purpose between the regulator and the auditor with respect to appropriate communications and reporting to the public.

To be continued

Alfredo J. Non is a CPA by profession and a former partner of SGV & Co. He served as commissioner of the Energy Regulatory Commission until the end of his term in 2018. He has also served as a director and managing director of several private companies and former professor of financial management at the Ateneo Graduate School of Business.

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