Towards introduction of uniform energy accounting in Bangladesh
Tuesday, 22 December 2009
Jamaluddin Ahmed
ECONOMIC theory suggests that a monopolist will have strong incentives to reduce quantities and raise prices, reducing total welfare in society (Berg and Tschirhart, 1988) which creates an element tending to reflect market failure. The solution to this market failure is to impose certain restrictions on the behaviour of the firm through direct or indirect regulations of profit, prices and service conditions. Although natural monopolies have been regulated for well over a century, the economic theory, until the late 1970s and early 1980s, did not consider accounting information to be one of the key elements of regulatory game. Laffout (1999) points out two important theoretical milestones. First, Loeb and Magat (1979) propose viewing regulation a contractual relationship in which regulator, the principal attempts to control a firm, the agent. They emphasize that the main difficulty is the regulator's lack of information about the regulated firm. Second, Baron and Myerson (1982) show that there is a trade-off between efficiency and the unavoidable information rents that must be given up to a regulated firm when regulator wants a project to be realized but does not know the cost of regulated firm. On appearance of these studies, economists understood regulation a game of two players -- the regulator and the firm that do not share the same information. Laffout and Tirole's (1994) model with cost or profit observability and with asymmetry of information about the firm's technology and cost reducing efforts, become the basic paradigm of the theoretical analysis of regulation.
Though the economic theory moved toward highlighting the role of information in regulation, regulatory practice in many countries appeared to move in the opposite direction. Here the example can be cited about introduction of price cap regulation in the United Kingdom with RPI-X. After many years of regulatory practice in the wake of many countries' restructuring of infrastructure sectors in the 1990s, this false perception is rapidly vanishing, and the unavoidable need for a reliable information system that enables regulators to fulfill their complex objectives has become even clearer. Estache and Burus (1999) pointed out that the initial ineffectiveness of regulation resulting from information gaps creates allocative ineffectiveness but just carries important political and social ramifications, which can endanger the stability of regulatory regime. In developing countries, this influences the efficient operation and the cost of investment. This often ends up threatening the sustainability of the increased role of the private sector in the delivery of infrastructure service and ultimately, the foundations of overall reform process itself.
The context is one in which a uniform regulatory accounting system is an important source of reliable information for regulators to use to adequately fulfill their duties. Good, accurate, and consistent information provides the basis of effective regulation. Regulatory accounting can establish a reasonably defined and stable reporting regime. Byatt (1991) pointed out that stability in the reporting cycle and avoidance of ad-hoc requests should assist those planning and managing the industry. It should also facilitate the integration of information system for both internal and external reporting.
From an economic perspective, public service regulation seeks to secure four basic objectives: Sustainability, allocative efficiency, productive efficiency and equity (Estache et al, 2002). As long as economic and financial sustainability is an objective, regulation has to use the firm's own data on costs, resources, assets, and liabilities (Grifell-Tatgie and Lovell, 2003). The main source of information, though clearly not the only one, is the firm's accounting information. The requirement to use this information is reinforced by the adoption by the courts in a range of countries that have regarded the actual costs and financial conditions of the utility as key elements to be taken into account by the regulator. The nature of traditional financial accounting information and some basic underlying principles of accounting in general make these data useful from a regulatory standpoint but these are still far from sufficient.
Traditional accounting information and some of the basic underlying principles of accounting make this information useful for regulatory purposes. Nevertheless, regulatory purposes differentiate the regulator's needs met by traditional accounting information in several areas. Financial accounting information focuses on the firm, whereas the regulator focuses mainly on the regulated activities of the firm. From a regulatory perspective, the co-existence of regulated and unregulated activities within the firm calls for the separation of the cost and revenue of the two types of activities. Moreover, some firms may engage in activities subject to regulation by different regulators. Separation of information related to each of the activities but particularly to the regulated and unregulated activities, places an important limitation on traditional accounting when used by a regulator.
The focus of accounting within a firm may not be sufficient when a regulator regulates more than one firm in the same activity. Applying certain regulatory tool, such as yardstick competition, calls for a degree of homogeneity in the identification of accounts that is not always achieved by generally accepted accounting principles. Accounting is usually based on a temporal cost imputation rule that may not always reflect regulatory needs. The regulator can determine tariffs that allow the recovery of costs when these costs are incurred or when the costs would be recognized in the financial accounts of the firm. Most regulatory agencies do not allow an asset to be included in the asset base until the assets are in service. To cover financial costs associated with long maturity projects, regulatory practice allows capitalization of the financial costs incurred during constructions. This strategy also departs from the accounting practices of unregulated firms and from generally accepted accounting principles.
General accounting principles are inadequate for dealing with common costs that need to be allocated not only among different regulated services but also between the regulated and unregulated activities of the firm because different allocation criterion will substantially affect achievement of regulatory objectives. As the mere existence of both regulated activities and unregulated ones within a firm assumes some degree of complementary or economies of scope between them; otherwise, the firm would not need to develop the activities jointly. This leads to the existence of common costs. A regulated firm would have strong incentives to allocate common costs to its regulated activity rather than to any of its competitive activities. These examples are only illustrative ones of the limitation of traditional accounting data for the regulatory purposes. These limitations make it necessary to complement generally accepted accounting principles with specific rules and norms that make accounting information useful for regulatory purposes. A system of management or cost accounting -- more elaborate than that of the firm is using -- may be needed to properly identify the revenues and costs associated with regulated activities and unregulated ones. In other cases, management may already collect similar information for its own purposes, and regulatory compliance may entail reallocations or modifications of existing cost allocation rules for the purpose of harmonization with regulatory requirements.
The need for information for regulation goes beyond accounting data. Regulation also requires information related to the physical aspects of the service and various dimensions of the quality of service. This information is not costless. The regulator must define precisely the acceptable bases for cost allocations and formats and contents of information presented, as well as detailed process for sharing and validating information. Validation is itself a demanding process. Private operators think that because their accounting data have been validated by their auditor and their board, the regulator is not entitled to reassess the data. This belief is a major point of possible misunderstanding of the regulator's role. Accounting data that are valid from legal and fiscal points of view are not necessarily valid from an economic point of view. One of the duties of a regulator is to validate operator's data economically, proper allocation of revenues and costs, and efficient level of costs. But the requirement should be cost effective and no more stringent than necessary.
The newly-formed Bangladesh Energy Regulatory Commission (BERC) started its work and consultants from the USAID are helping them to organize functioning of the BERC. Energy generation, transmission and distribution companies are licensed under the BERC with their information. Licencees are appearing at the public hearing before stakeholders and civil society to get approval of their prices under the auspices of the BERC.
Licencees' demand for fixation and approval of prices are presently based on accounting information which are generated through application of traditional accounting practices.
The traditional accounting practice applied to energy companies of Bangladesh suffers from limitations stated above. Specially, government owned companies / corporations suffer from severe lack in application of standard practice of commercial accounting, mostly on cash basis and some use mixture of cash and accrual system. This significantly deviates from internationally accepted best accounting practices, in terms of recognition of assets, liabilities, income and expenses and disclosure thereof. For example, the Bangladesh Power Development Board, Petro Bangla and its subsidiary companies, Bangladesh Petroleum Corporation and its subsidiaries and Rural Electrification Board and Polly Biddut Samities under it, follow either cash or mixture of cash and accrual accounting. Many of such corporations and their subsidiaries do not have accounting and financial reporting system, in the line with accepted practice of accounting.
Given all these limitations, the solution lies in the developing a uniform energy accounting. Only then the BERC would be able to make comparison of reliable and dependable accounting figures. This approach for uniform energy accounting should come from the BERC for the Licencee companies. This needs introduction of uniform energy accounting to each licensee companies. Once uniform energy accounting records are prepared following the principles laid down on recognition of assts, liabilities, incomes and expenses and their disclosure, then the step can be taken to proceed with energy auditing by the right auditors with core competency in the area. This would help the BERC to test reliability of financial information among the licensees. Decision-making will then be more dependable.
Jamaluddin Ahmed PhD FCA is a Partner of Hoda Vasi Chowdhury Chartered Accountants, an Independent Correspondent firm to Deloitte Touch Tohmatsu and Treasurer of Bangladesh Economic Association. He can be reached at e-mail: jamal@hodavasi.com
ECONOMIC theory suggests that a monopolist will have strong incentives to reduce quantities and raise prices, reducing total welfare in society (Berg and Tschirhart, 1988) which creates an element tending to reflect market failure. The solution to this market failure is to impose certain restrictions on the behaviour of the firm through direct or indirect regulations of profit, prices and service conditions. Although natural monopolies have been regulated for well over a century, the economic theory, until the late 1970s and early 1980s, did not consider accounting information to be one of the key elements of regulatory game. Laffout (1999) points out two important theoretical milestones. First, Loeb and Magat (1979) propose viewing regulation a contractual relationship in which regulator, the principal attempts to control a firm, the agent. They emphasize that the main difficulty is the regulator's lack of information about the regulated firm. Second, Baron and Myerson (1982) show that there is a trade-off between efficiency and the unavoidable information rents that must be given up to a regulated firm when regulator wants a project to be realized but does not know the cost of regulated firm. On appearance of these studies, economists understood regulation a game of two players -- the regulator and the firm that do not share the same information. Laffout and Tirole's (1994) model with cost or profit observability and with asymmetry of information about the firm's technology and cost reducing efforts, become the basic paradigm of the theoretical analysis of regulation.
Though the economic theory moved toward highlighting the role of information in regulation, regulatory practice in many countries appeared to move in the opposite direction. Here the example can be cited about introduction of price cap regulation in the United Kingdom with RPI-X. After many years of regulatory practice in the wake of many countries' restructuring of infrastructure sectors in the 1990s, this false perception is rapidly vanishing, and the unavoidable need for a reliable information system that enables regulators to fulfill their complex objectives has become even clearer. Estache and Burus (1999) pointed out that the initial ineffectiveness of regulation resulting from information gaps creates allocative ineffectiveness but just carries important political and social ramifications, which can endanger the stability of regulatory regime. In developing countries, this influences the efficient operation and the cost of investment. This often ends up threatening the sustainability of the increased role of the private sector in the delivery of infrastructure service and ultimately, the foundations of overall reform process itself.
The context is one in which a uniform regulatory accounting system is an important source of reliable information for regulators to use to adequately fulfill their duties. Good, accurate, and consistent information provides the basis of effective regulation. Regulatory accounting can establish a reasonably defined and stable reporting regime. Byatt (1991) pointed out that stability in the reporting cycle and avoidance of ad-hoc requests should assist those planning and managing the industry. It should also facilitate the integration of information system for both internal and external reporting.
From an economic perspective, public service regulation seeks to secure four basic objectives: Sustainability, allocative efficiency, productive efficiency and equity (Estache et al, 2002). As long as economic and financial sustainability is an objective, regulation has to use the firm's own data on costs, resources, assets, and liabilities (Grifell-Tatgie and Lovell, 2003). The main source of information, though clearly not the only one, is the firm's accounting information. The requirement to use this information is reinforced by the adoption by the courts in a range of countries that have regarded the actual costs and financial conditions of the utility as key elements to be taken into account by the regulator. The nature of traditional financial accounting information and some basic underlying principles of accounting in general make these data useful from a regulatory standpoint but these are still far from sufficient.
Traditional accounting information and some of the basic underlying principles of accounting make this information useful for regulatory purposes. Nevertheless, regulatory purposes differentiate the regulator's needs met by traditional accounting information in several areas. Financial accounting information focuses on the firm, whereas the regulator focuses mainly on the regulated activities of the firm. From a regulatory perspective, the co-existence of regulated and unregulated activities within the firm calls for the separation of the cost and revenue of the two types of activities. Moreover, some firms may engage in activities subject to regulation by different regulators. Separation of information related to each of the activities but particularly to the regulated and unregulated activities, places an important limitation on traditional accounting when used by a regulator.
The focus of accounting within a firm may not be sufficient when a regulator regulates more than one firm in the same activity. Applying certain regulatory tool, such as yardstick competition, calls for a degree of homogeneity in the identification of accounts that is not always achieved by generally accepted accounting principles. Accounting is usually based on a temporal cost imputation rule that may not always reflect regulatory needs. The regulator can determine tariffs that allow the recovery of costs when these costs are incurred or when the costs would be recognized in the financial accounts of the firm. Most regulatory agencies do not allow an asset to be included in the asset base until the assets are in service. To cover financial costs associated with long maturity projects, regulatory practice allows capitalization of the financial costs incurred during constructions. This strategy also departs from the accounting practices of unregulated firms and from generally accepted accounting principles.
General accounting principles are inadequate for dealing with common costs that need to be allocated not only among different regulated services but also between the regulated and unregulated activities of the firm because different allocation criterion will substantially affect achievement of regulatory objectives. As the mere existence of both regulated activities and unregulated ones within a firm assumes some degree of complementary or economies of scope between them; otherwise, the firm would not need to develop the activities jointly. This leads to the existence of common costs. A regulated firm would have strong incentives to allocate common costs to its regulated activity rather than to any of its competitive activities. These examples are only illustrative ones of the limitation of traditional accounting data for the regulatory purposes. These limitations make it necessary to complement generally accepted accounting principles with specific rules and norms that make accounting information useful for regulatory purposes. A system of management or cost accounting -- more elaborate than that of the firm is using -- may be needed to properly identify the revenues and costs associated with regulated activities and unregulated ones. In other cases, management may already collect similar information for its own purposes, and regulatory compliance may entail reallocations or modifications of existing cost allocation rules for the purpose of harmonization with regulatory requirements.
The need for information for regulation goes beyond accounting data. Regulation also requires information related to the physical aspects of the service and various dimensions of the quality of service. This information is not costless. The regulator must define precisely the acceptable bases for cost allocations and formats and contents of information presented, as well as detailed process for sharing and validating information. Validation is itself a demanding process. Private operators think that because their accounting data have been validated by their auditor and their board, the regulator is not entitled to reassess the data. This belief is a major point of possible misunderstanding of the regulator's role. Accounting data that are valid from legal and fiscal points of view are not necessarily valid from an economic point of view. One of the duties of a regulator is to validate operator's data economically, proper allocation of revenues and costs, and efficient level of costs. But the requirement should be cost effective and no more stringent than necessary.
The newly-formed Bangladesh Energy Regulatory Commission (BERC) started its work and consultants from the USAID are helping them to organize functioning of the BERC. Energy generation, transmission and distribution companies are licensed under the BERC with their information. Licencees are appearing at the public hearing before stakeholders and civil society to get approval of their prices under the auspices of the BERC.
Licencees' demand for fixation and approval of prices are presently based on accounting information which are generated through application of traditional accounting practices.
The traditional accounting practice applied to energy companies of Bangladesh suffers from limitations stated above. Specially, government owned companies / corporations suffer from severe lack in application of standard practice of commercial accounting, mostly on cash basis and some use mixture of cash and accrual system. This significantly deviates from internationally accepted best accounting practices, in terms of recognition of assets, liabilities, income and expenses and disclosure thereof. For example, the Bangladesh Power Development Board, Petro Bangla and its subsidiary companies, Bangladesh Petroleum Corporation and its subsidiaries and Rural Electrification Board and Polly Biddut Samities under it, follow either cash or mixture of cash and accrual accounting. Many of such corporations and their subsidiaries do not have accounting and financial reporting system, in the line with accepted practice of accounting.
Given all these limitations, the solution lies in the developing a uniform energy accounting. Only then the BERC would be able to make comparison of reliable and dependable accounting figures. This approach for uniform energy accounting should come from the BERC for the Licencee companies. This needs introduction of uniform energy accounting to each licensee companies. Once uniform energy accounting records are prepared following the principles laid down on recognition of assts, liabilities, incomes and expenses and their disclosure, then the step can be taken to proceed with energy auditing by the right auditors with core competency in the area. This would help the BERC to test reliability of financial information among the licensees. Decision-making will then be more dependable.
Jamaluddin Ahmed PhD FCA is a Partner of Hoda Vasi Chowdhury Chartered Accountants, an Independent Correspondent firm to Deloitte Touch Tohmatsu and Treasurer of Bangladesh Economic Association. He can be reached at e-mail: jamal@hodavasi.com