Accounting separation1, which is the process of separating costs and revenues of regulated operations from non-regulated operations, is another important aspect of determining the overall price level for the operator. It is not unusual for an operator to provide services that the regulator does not regulate. For example, an operator may provide utility services in another country, offer utility services that have been deregulated, or offer non-regulated, non-utility services such as data processing. Accounting separation places the associated costs and revenues of these operations below the line.
A regulator’s accounting separations policies typically prescribe (1) accounts used to record only regulated activities, accounts used only for non-regulated activities, and accounts used for both types of activities; (2) how the costs and revenues in accounts that are used for both regulated and non-regulated activities are to be divided between the two types of activities; (3) how the operator is to value transactions between the regulated portion of the business and the non-regulated portions of the business (called transfer pricing); and (4) reporting and auditing requirements.
Some regulators use the term “ring fencing” to be synonymous with accounting separations. Other regulators use the term ring fencing more broadly by including such practices as providing different regulatory treatment for different services. Throughout the rest of this Overview, the terms “ring fencing” and “accounting separations” will be used interchangeably.
- Ring Fencing and Control of Cross Subsidization in Financial Analysis examines the same.