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Breaking free from conventional GAAP.

Satisfying Third-Party Accounting Requirements For Utilities and Other Specialized Industries

Accountants frequently turn away from Generally Accepted Accounting Principles (GAAP) to other comprehensive bases of accounting (OCBOA) in satisfying third-party accounting requirements for utility, health care, real estate and other industries. A recent survey by the private companies practice section of the American Institute of Certified Public Accountants (AICPA) showed that 81% of respondents have use OCBOA financials for their clients, and 36% said they have clients who could benefit for OCBOA.[1] These special reports, used to disclose restricted historical information, contain the same limitations, as standard audit reports, including providing only reasonable assurance that the statements present the entity's economic transactions and events.

Until recently, accountants and auditors departing from GAAP faced confusing rules. To remove the confusion, the AICPA issued, effective July 1989, Statement of Auditing Standards (SAS) No. 62, Special Reports, clarifying the individual auditor's role in preparing financial statements in conformity with a comprehensive basis of accounting other than GAAP; specified elements, accounts or items of a financial statement; compliance with contractual agreements or regulatory provisions related to audited financial statements; and financial information or audit reports presented in a prescribed form or schedule.

Governance boards, lenders, regulators and other users of financial statements should be aware of the provision of SAS No. 62. This article highlights key provisions and offers sample documents for the utility industry that can also be applied to other industries.

Other Comprehensive Basis

of Accounting Reports

To comply with regulatory requirements and to provide important information to financial statement users, many utilities must report their financial results to regulators using OCBOA such as the Federal Energy Regulatory Commission (FERC) Uniform System of Accounts in which all subsidiaries are reported on the equity method of accounting, due to a regulatory emphasis upon utility operations versus non-utility subsidiary operations. The result differs from conventional financial statements prepared in accordance with GAAP, which employ consolidation accounting for majority owned subsidiaries.

Terms such as "Balance Sheet" and "Income Statement" usually apply only to financial statements prepared in conformity with GAAP. Therefore, OCBOA financial statements must be retitled. Under OCBOA, a FERC Uniform System of Accounts balance sheet might be retitled, "Balance Sheets - Regulatory Basis."

As Exhibit 1 illustrates, the OCBOA report parallels the standard audit report except that it includes an explanatory paragraph that explains the OCBOA and makes reference to a footnote description of the reporting basis. The OCBOA additions to a standard report are in brackets. As in current audit reports, the OCBOA report distinguishes between the client's and the auditor's responsibility and emphasizes the inherent limitations of the audit process.

Exhibit 1 Independent Auditor's Special Report Under RAP (Regulatory Accounting Principles)

To XYZ Utility Company:

We have audited the accompanying balance sheet {- regulatory basis} of XYZ Utility Company as of December 31, 19x1 and 19x0 and the related statements of income - regulatory basis, retained earnings {-regulatory basis} and cash flows - regulatory basis for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based. on our audits.

We conducted our audit in accordance with generally accepted auditing standards. These standards require that we planned and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide reasonable basis for our opinion.

{As described in Note X, these financial statements were prepared in accordance with the accounting requirements of the Federal Energy Regulatory Commission (FERC) as set fourth in its applicable Uniform System of Accounts and published accounting releases, which is a comprehensive basis of accounting other than generally accepted accounting principles.}

In our opinion, the financial statements referred to above present fairly, in all material respects, the {assets, liabilities and proprietary capital of} XYZ Utility Company as of December 31, 19x1 an 19x0, and its results of operations and cash flow for the years then ended{, in accordance with the accounting requirements of the FERC as set forth in its applicable Uniform System of Accounts and published accounting releases}.

{This report is intended solely for the information and use of the board of directors and the management of XYZ Utility Company and for filing with the FERC and should not be used for any other purpose.}

GAAP and OCBOA Reports

on Specified Elements or

Accounts

Utility management often must submit "audited" reports on certain aspects or accounts of the financial statements. Lenders, for example, may require utilities to report cash flow from operations according to a predetermined methodology - which need not conform with GAAP. The utility and the lender could agree that customers' deposits in aid of construction (CIAC) should be incorporated in cash flow from operations, even though such a practice violates GAAP. Or they could agree to include a portion of a nonutility cash flow in the utility's operating cash flow according to some formula.

Since an audit of a specified element or account can be no better than the reliability of the underlying financial statements, this type of special report cannot be issued for financial statements receiving an adverse opinion or a disclaimer of opinion. However, the auditors need not audit the entire financial statements to express an opinion on one or more specified accounts or items as long as they do not report on so many elements, accounts or items as to constitute a "major" portion of the financial statements.

Compliance With Aspects of

Contractual Agreements or

Regulatory Provisions

Utilities often must provide "audited" special reports in conformity with contractual agreements or regulatory provisions. For example, loan agreements may impose covenants on the borrower's activities involving matters such as sinking fund payments, interest payments, dividend payment restrictions and the use of proceeds of sales of property.

Auditors may now render a negative assurance report on compliance with contractual agreements if they have audited the underlying financial statements and not issued an adverse opinion or a disclaimer of opinion. (To illustrate, negative assurance means that in an audit of the financial statements, nothing came to the auditors' attention that caused them to believe that the entity failed to comply with its debt covenants. Positive assurance would mean that in their opinion the entity did comply with its debt covenants.) The negative assurances may be given in one or more paragraphs of the auditor's report accompanying the financial statements or in a separate report. The auditor should ordinarily also state that the audit was not directed primarily toward obtaining knowledge of noncompliance. Exhibit 2 provides a general example of a Report on Compliance with a Contractual Provisions.

Exhibit 2 Independent Auditor's Report On Compliance With Contractual Provisions of A Loan Covenant

Board of Directors XYZ Utility Company

We have audited, in accordance with generally accepted auditing standards, the balance sheet of XYZ Utility Company as of December 31, 19x1, and the related statements of earnings, retained earnings and cash flows for the year then ended, and have issued our report thereon dated February 15, 19x2.

In connection with our audit, nothing came to our attention that caused us to believe that the Company failed to comply with the terms, covenants, provisions or conditions of sections _____ to _____, inclusive, of the Agreement dated July 20, 19x0, with ABC BankCorp insofar as they relate to accounting matters. However, our audit was not directed primarily toward obtaining knowledge of such noncompliance.

This report is intended solely for the information and use of the boards of directors and managements of XYZ Utility Company and ABC BankCorp and should not be used for any other purpose.

Incomplete Presentations

Otherwise Prepared in

Conformity with GAAP or

OCBOA

Utilities may be asked to provide financial information to meet the special purposes of regulatory agencies or parties to an agreement. For example, a buy-sell agreement may specify a schedule of gross assets and liabilities of the utility but be limited to the assets to be sold, and the liabilities transferred pursuant to the agreement. Such presentations differ from complete financial statements only to the extent necessary to meet the special purposes for which they were prepared. Therefore, the measurement of materiality should be related to the presentation taken as a whole. The statements should include appropriate disclosures and be suitably titled. An example of such presentation is given in Exhibit 3.

Exhibit 3 CPA Report On Net Assets To Be Sold Under A Sales Contract

Board of Directors ABC Power Company

We have audited the accompanying statement of net assets sold of XYZ Company as of June 30, 19x1. This statement of net assets sold is the responsibility of XYZ Utility Company. Our responsibility is to express an opinion on this statement based on our audit.

We conducted our audit in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the statement of net assets sold is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall statement presentation. We believe that our audit provides reasonable basis for our opinion.

The accompanying statement was prepared to present the net assets of XYZ Utility Company sold to ABC Power Company pursuant to the purchase agreement described in Note B, and is not intended to be a complete presentation of XYZ Utility Company's assets and liabilities.

In our opinion, the accompanying statement of net assets sold presents fairly, in all material respects, the net assets of XYZ Utility Company, as of June 30, 19x1, sold pursuant to the purchase agreement referred to in Note B, in conformity with generally accepted accounting principles.

This report is intended solely for the information and use of the board of directors and the management of ABC Power Company and XYZ Utility Company and should not be used for any other purpose.

The auditor should highlight provisions of such agreements that depart from GAAP or OCBOA. For example, if the above parties negotiated the Provision for Uncollectible Account losses as $1 million, the report should disclose this balance and state that the $1 million, as disclosed in Note X, is not intended to conform with GAAP.

Conclusion

The financial statements of utility companies and other specialized industries often depart from GAAP. In these circumstances, regulators, lenders and other interested parties need to know the general features of OCBOA reports dictated by SAS No. 62 and how they differ from conventional financial statements. As these reports find wider use, a reporting entity can achieve more credible financial statements, often at a significant time and cost savings.

References

[1] O'Dell, Judith H. and Jacob J. Cohen, "The OCBOA Solution: Bottom-Line Relief for Small Business Clients," Journal of Accountancy, February 1991, pp. 89-90.

Alan Reinstein, CPA, DBA, is professor and chair of the accounting department at Wayne State University in Detroit, Michigan. He is on the editorial boards of several academic and professional journals and serves on the boards of the Michigan Association of CPAs (MACPA) and of the Detroit Chapters of the Institute of Management Accounting. He also chairs a committee of the American Accounting Association and serves on a task force for the Accounting Education Change Commission. He has written many articles for professional and academic journals.

Anthony J. Budzinski, II, CPA, is a senior manager at Arthur Andersen & Co. in Detroit, Michigan. A member of the MACPA and the American Institute of CPAs, he has more than 10 years of experience working with utility companies. He is an active participant and frequent speaker for the Michigan Electric and Gas Association and the Michigan Cooperative Accountants Association.
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Title Annotation:generally accepted accounting principles
Author:Reinstein, Alan; Budzinski, Anthony J., II
Publication:The National Public Accountant
Date:Apr 1, 1992
Words:2005
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