The term regulatory liability refers to specific revenues or gains that a government agency permits a regulated utility to defer to its balance sheet. Accounting for regulatory liabilities allows public utilities to defer the recognition of certain gains; bypassing the income statement in the near term by moving these gains to the balance sheet.
FASB's SFAS 71 Accounting for the Effects of Certain Types of Regulation, provides GAAP guidance to those accounting standards that are unique to regulated utilities. Specifically, these companies may be permitted to collect revenues under certain conditions, while at the same time bypassing their income statement. Generally, regulated utilities may be able to collect revenue, or realize a gain, and bypass their income statement if it is probable that through the ratemaking process there will be a corresponding decrease to future rates or the money collected will be used to fund a program.
In practice, companies will defer a gain to a regulatory liability account if a written order is received from a regulating agency. That order must implicitly or explicitly allow for such treatment, and the company must believe there is a probability of a favorable ratemaking outcome. For example, a company may have a regulatory liability that represents the "cost of removal," which is an offset to the money collected from ratepayers to remove an asset from service in the future. Other examples of regulatory assets include rate reduction bonds, employee benefits plans, over-collection of revenues, and asset retirement or decommissioning costs.
Regulatory liabilities are reported as part of the company's Form 10-K filing and will be classified into two groups. Current regulatory liabilities are those the company expects to fund in one operating cycle or one year, while non-current regulatory liabilities are expected to be funded over a longer timeframe.