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 of Directors (“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 member distribution systems (“Members”) based on 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 as expenses and regulatory liabilities as operating revenue, other income, or a reduction in expense concurrent with their recovery in rates.

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


	March 31,		December 31,
	2018		2017
Regulatory assets
Deferred income tax expense (1)	$	17,205	$	17,205
Deferred prepaid lease expense – Craig Unit 3 Lease (2)		1,618		3,237
Deferred prepaid lease expense – Springerville Unit 3 Lease (3)		87,723		88,296
Goodwill – J.M. Shafer (4)		54,131		54,843
Goodwill – Colowyo Coal (5)		39,002		39,261
Deferred debt prepayment transaction costs (6)		156,031		158,187
Deferred Holcomb expansion impairment loss (7)		93,494		93,494
Total regulatory assets		449,204		454,523

Regulatory liabilities
Interest rate swap - unrealized gain (8)		8,357		4,311
Interest rate swap - realized gain (9)		4,559		4,614
Deferred revenues (10)		30,327		30,327
Membership withdrawal (11)		42,572		42,572
Total regulatory liabilities		85,815		81,824
Net regulatory asset	$	363,389	$	372,699

(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)

Represents deferral of the 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 was being amortized to depreciation, amortization and depletion expense in the amount of $6.5 million annually through December 31, 2017, and $1.6 million for the three month period ending March 31, 2018, and recovered from our Members in rates. The remaining $1.6 million will be recognized as depreciation, amortization and depletion expense for the three month period ending June 30, 2018, and recovered from our Members in rates.

(3)

Represents deferral of the 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, amortization and depletion 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 in December 2011. Goodwill is being amortized to depreciation, amortization and depletion 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, amortization and depletion 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, amortization and depletion 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 impairment loss related to development costs, including costs for the option to purchase development rights for the expansion of the Holcomb Generating Station. The plan for the recovery from our Members in rates has not been determined by our Board. Once the plan for recovery is determined, the deferred impairment loss will be recognized in other operating expenses.

(8)

Represents deferral of an unrealized gain related to the change in fair value of a forward starting interest rate swap that was entered into in 2016 in order to hedge interest rates on anticipated future borrowings. Upon settlement of this interest rate swap, the realized gain or loss will be deferred and subsequently recognized as interest expense when amortized over the term of the associated long-term debt borrowing. See Note 8 – Long-Term Debt and Note 15 – Fair Value.

(9)

Represents deferral of a realized gain of $4.6 million related to the October 2017 settlement of a forward starting interest rate swap that was entered into in 2016. This realized gain was deferred as a regulatory liability and is being amortized to interest expense over the 12-year term of the First Mortgage Obligations, Series 2017A. See Note 8 – Long-Term Debt.

(10)

Represents deferral of the recognition of non-member electric sales revenues. 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.

(11)

Represents the deferral of the recognition of other income recorded in connection with the withdrawal of a former Member from membership in us. This deferred membership withdrawal income will be refunded to Members through reduced rates when recognized in other income in future periods.