NOTE 2 – ACCOUNTING FOR RATE REGULATION

We are subject to the accounting requirements related to regulated operations. In accordance with these accounting requirements, some revenues and expenses have been deferred at the discretion of our Board, which has budgetary and rate-setting authority, if it is probable that these amounts will be refunded or recovered through future rates. Regulatory assets are costs that we expect to recover from our Members through rates approved by our Board in accordance with our rate policy. Regulatory liabilities represent probable future reductions in rates associated with amounts that are expected to be refunded to our Members based on rates approved by our Board in accordance with our rate policy. We recognize regulatory assets and liabilities as expenses or as a reduction in expenses concurrent with their recovery in rates.

Regulatory assets and liabilities are as follows (dollars in thousands):


	June 30,		December 31,
	2016		2015
Regulatory assets
Deferred income tax expense (1)	$	28,067	$	28,629
Deferred prepaid lease expense- Craig 3 Lease (2)		12,947		16,183
Deferred prepaid lease expense- Springerville 3 Lease (3)		91,732		92,878
Goodwill – J.M. Shafer (4)		59,117		60,541
Goodwill – Colowyo Coal (5)		40,810		41,327
Deferred debt prepayment transaction costs (6)		171,130		175,444
Interest rate swaps (7)		12,644		—
Other		—		79
Total regulatory assets		416,447		415,081

Regulatory liabilities
Deferred revenues (8)		45,000		45,000
Membership withdrawal (9)		47,572		—
Other		113		—
Total regulatory liabilities		92,685		45,000
Net regulatory asset	$	323,762	$	370,081

(1)

A regulatory asset or liability associated with deferred income taxes generally represents the future increase or decrease in income taxes payable that will be received or settled through future rate revenues.

(2)

Deferral of loss on acquisition related to the Craig Generating Station Unit 3 prepaid lease expense upon acquisitions of equity interests in 2002 and 2006. The regulatory asset for the deferred prepaid lease expense is being amortized to depreciation and amortization expense in the amount of $6.5 million annually through the remaining original life of the lease ending in 2018 and recovered from our Members in rates.

(3)

Deferral of loss on acquisition related to the Springerville Generating Station Unit 3 (“Springerville Unit 3”) prepaid lease expense upon acquiring a controlling interest in the Springerville Unit 3 Partnership LP (“Springerville Partnership”) in 2009. The regulatory asset for the deferred prepaid lease expense is being amortized to depreciation and amortization expense in the amount of $2.3 million annually through the 47-year period ending in 2056 and recovered from our Members in rates.

(4)

Represents goodwill related to our acquisition of Thermo Cogeneration Partnership, LP (“TCP”) in December 2011. Goodwill is being amortized to depreciation and amortization expense in the amount of $2.8 million annually through the 25-year period ending in 2036 and recovered from our Members in rates.

(5)

Represents goodwill related to our acquisition of Colowyo Coal Company LP (“Colowyo Coal”) in December 2011. Goodwill is being amortized to depreciation and amortization expense in the amount of $1.0 million annually through the 44-year period ending in 2056 and recovered from our Members in rates.

(6)

Represents transaction costs that we incurred related to the prepayment of our long-term debt in 2014. These costs are being amortized to depreciation and amortization expense in the amount of $8.6 million annually over the 21.4-year average life of the new debt issued and recovered from our Members in rates.

(7)

Represents deferral of the unrealized loss related to the change in fair value of forward starting interest rate swaps that were entered into in order to hedge interest rates on anticipated future borrowings. Upon settlement of these interest rate swaps, the realized gain or loss will be amortized to interest expense over the term of the associated long-term debt borrowing. See Note 6 – Long-Term Debt and Note 10 – Fair Value.

(8)

Represents deferral of the recognition of $10 million of non-member electric sales revenue received in 2008 and $35 million of non-member electric sales revenue received in 2011. These deferred non-member electric sales revenues will be refunded to Members through reduced rates when recognized in non-member electric sales revenue in future periods.

(9)

Represents the deferral of the recognition of other income of $47.6 million recorded in connection with the June 30, 2016 withdrawal of KCEC from membership in us pursuant to the Withdrawal Agreement. See Note 1 – Presentation of Financial Information.