Proposals to Ensure Regulations Are Consistent with GAAP and to Improve Definitions for Financial Performance Measures
Consistency of the Financial Statements with GAAP
34. The Ministry has reviewed its approach to the applicability of GAAP to the financial statements disclosed under the Regulations, and has concluded that these statements should be GAAP complaint. GAAP is the authoritative set of rules for accounting purposes in New Zealand, and it seems sensible to base the regulatory accounts on this firm foundation.
35. The earlier proposal that conflicts between GAAP and the Regulations with respect to the financial statements should be resolved in favour of the Regulations (i.e. the Regulations would take precedence), has accordingly been dropped. The Electricity Act 1992 requires that the disclosed financial statements comply with GAAP, and the Ministry does not propose to amend this requirement.
36. The revised approach will have the following implications:
- The present requirement that financial statements include only (i) the profit and loss statement and balance sheet (including notes to the statement and balance sheet), and (ii) a statement of accounting policies, would be extended so that cash flow statements and statements of movements in equity would need to be disclosed. The Ministry understands that the additional compliance costs will be minimal.
- The form that accompanies the statements (and, for consistency, the form that accompanies the performance measures) would be extended to describe:
- The work done by the auditor;
- The scope and limitations of the audit;
- The existence of any relationship (other than that of auditor) which the auditor has with, or any interests which the auditor has in, the electricity company;
- Whether the auditor has obtained all information and explanations that he or she has required;
- Whether, in the auditor's opinion, as far as appears from an examination of them, proper accounting records have been kept by the electricity company; and
- Whether, in the auditor's opinion, the financial statements comply with the financial reporting requirements of the Regulations, and if they do not, the respects in which they fail to comply.
- Under recently agreed policy, auditors were to attest that the accounts have been prepared in accordance with the Regulations, rather than requiring that they provide a true and fair view and have been prepared in accordance with the Regulations. In view of the proposal above that the financial statements be GAAP compliant, the Ministry proposes to re-insert the true and fair view wording in the form signed by auditors (Form 1 of the Regulations).
- Certain other information not provided for in GAAP would be required in the disclosed accounts (e.g. the requirement for disclosure of minimum line items).
- Harmonisation with GAAP would be introduced in relation to areas covered by both GAAP and the Regulations (e.g. terminology such as "financial report", "statement of financial performance", "statement of financial position", and definitions such as "depreciation" and "subsidiary").
37. The following points might also be noted:
- Application of ACAM will define the entity for disclosure reporting.
- The definitions and other requirements relating to disclosure of performance measures are set out in the First Schedule of the Regulations. A requirement to follow GAAP in relation to the financial reports does not mean that the requirements in the First Schedule need to follow GAAP.
Financial Performance Measures: Amending the Definition of EBIT to Eliminate Any Amortisation of Goodwill
38. The Ministry has considered the treatment of goodwill in the accounts of line businesses. Under the Regulations, goodwill is eliminated from the asset base for determining the profitability performance measures. If goodwill was not eliminated from the accounts of line businesses, the constraint that ODVs place on the value of line businesses could be undermined. This would allow line businesses to hide ARPs in excess of WACC.
39. An additional issue that has come to our attention is that goodwill can be amortised over time, thus reducing EBIT and the profitability performance measures. This also has the effect of undermining the constraint that ODVs place on line businesses' values. Purchase prices above ODV-based values can be recovered without showing up in ARPs that exceed WACC.
40. The Ministry recognises that there are circumstances which justify line businesses being purchased at prices above their ODV-based value. An example is where the purchaser is able to increase the efficiency of the line business, and decrease the line charges. It is reasonable for such purchasers to be "rewarded" by higher rates of return (including ARPs that exceed WACC). These rewards should be transparent so that they can be scrutinised by consumers and other interested parties.
41. Accordingly, the Ministry proposes to amend the definitions that apply to the performance measures in the First Schedule to ensure that any amortisation of goodwill is eliminated.
Energy Markets Policy Group
Resources & Networks Branch
Ministry of Commerce
September 1998
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