DEFINITION of 'Regulatory Asset'

Specific costs or revenues that a regulatory agency permits a U.S. public utility (usually
an energy company) to defer to its balance sheet. These amounts would otherwise be
required to appear on the company's income statement and would be charged against
current expenses or revenues.

BREAKING DOWN 'Regulatory Asset'

The accounting methods used to disclose regulatory assets may cause differences in
how an electric utility company's financial condition is reported. For example, under U.K.
GAAP, these assets are currently recorded on the balance sheet.

Under recently developed International Financial Reporting Standards, regulatory

assets are not permitted to be recognized on the balance sheet. Instead, costs will be
charged to the income statement when incurred, and recoveries from customers will be
recognized when receivable.

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Deferred Charge
A deferred charge is a long-term prepaid expense that is treated as an asset on
a balance sheet and is carried forward until it is actually used. Deferred charges often
stem from a business making a payment for a good or service that it has not yet
received, such prepaying insurance premiums or rent.

BREAKING DOWN 'Deferred Charge'

There are two systems of accounting: cash accounting and accrual accounting. Cash
accounting records revenue and expenses as they are paid. Accrual accounting records
revenue and expenses as they are incurred. When cash exchanges hands, it does not
mean that the company records the cash as a revenue or expense. If the revenue or
expense is not incurred in the period when the cash exchanges hands, it is booked as
deferred revenue or deferred charges.
Deferred Charge Example
It is not unusual for a company to pay for a year of rent in advance to receive a
discount. This advanced payment is recorded as a deferred charge on the balance
sheet. Each month, the company recognizes a portion of the prepaid rent as an
expense on the financial statements. The cash paid out for rent is a deferred charge.
This is also considered to be an asset until it is fully expensed. Each month, another
entry is made to move cash from the deferred charge on the balance statement to the
rental expense on the income statement.

Deferred charges are actually a long-term version of prepaid expenses, referring to

payments that the company has made prior to receiving the corresponding good or
service. Prepaid expenses are a current account, whereas deferred charges are a non-
current account.

Deferred Charge Vs. Deferred Revenue

Recording deferred charges ensures that a company's accounting practices are
operating within generally accepted accounting principles (GAAP) by
matching revenues with expenses each month. A company
may capitalize the underwriting fees on a corporate bond issue as a deferred charge,
subsequently amortizing the fees over the life of the bond issue.

Deferred revenue, on the other hand, refers to money that the company has received as
payment before a product or service has been delivered. A prime example of a deferred
revenue is the opposite side of the rental agreement. A tenant who pays for rent one
year in advance may have a happy landlord, but that landlord must account for the
rental revenue over the life of the rental agreement, not in one lump sum. As each
month approaches, the company uses a portion of the funds from deferred revenue and
recognizes this portion as revenue in the financial statements. As is the case with
deferred charges, deferred revenue ensures that revenues for the month are matched
with the expenses incurred for that month.

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What is 'Return Of Capital'

Return of capital is a payment received from an investment that is not considered
a taxable event and is not taxed as income. Instead, return of capital occurs when an
investor receives a portion of his original investment, and these payments are not
considered income or capital gains from the investment.
Note that a return of capital reduces an investor's adjusted cost basis. Once the stock's
adjusted cost basis has been reduced to zero, any subsequent return will be taxable as
a capital gain.

BREAKING DOWN 'Return Of Capital'

Cost basis is defined as an investors total cost paid for an investment, and cost basis
for a stock is adjusted for stock dividends and stock splits, as well as for the cost of
commissions to purchase the stock. Its important for investors and financial advisors to
track the cost basis of each investment so that any return of capital payments can be
identified.

How Capital Gains Are Calculated

When an investor buys an investment and sells it for a gain, the taxpayer must report
the capital gain on a personal tax return, and the sale price less the investments cost
basis is the capital gain on sale. If an investor receives an amount that is less than or
equal to the cost basis, the payment is a return of capital and not a capital gain.

Instances Where Stock Splits Impact Return of Capital

Assume, for example, that an investor buys 100 shares of XYZ common stock at $20
per share and the stock has a 2-for-1 stock split, so that the investors adjusted holdings
total 200 shares at $10 per share. If the investor sells the shares for $15, the first $10 is
considered a return of capital and is not taxed. The additional $5 per share is a capital
gain and is reported on the personal tax return.

Factoring in Partnership Return of Capital

A partnership is defined as a business in which two or more people contribute assets
and operate an entity to share in the profits. The parties create a partnership using a
partnership agreement, though calculating return of capital for a partnership can be
difficult.

A partners interest in a partnership is tracked in the partners capital account, and the
account is increased by any cash or assets contributed by the partner, along with the
partners share of profits. The partners interest is reduced by any withdrawals or
guaranteed payments, and by the partners share of partnership losses. A withdrawal up
to the partners capital account balance is considered a return of capital and is not a
taxable event. Once the entire capital account balance is paid to the partner, however,
any additional payments are considered income to the partner and are taxed on the
partners personal tax return.
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What is 'Return On Invested Capital - ROIC'

A calculation used to assess a company's efficiency at allocating the capital under its
control to profitable investments. Return on invested capital gives a sense of how well a
company is using its money to generate returns. Comparing a company's return on
capital (ROIC) with its weighted average cost of capital (WACC) reveals whether
invested capital is being used effectively.

One way to calculate ROIC is:

This measure is also known as "return on capital."

BREAKING DOWN 'Return On Invested Capital - ROIC'

Invested capital, the value in the denominator, is the sum of a company's debt and
equity. There are a number of ways to calculate this value. One is to subtract cash
and non-interest bearing current liabilities (NIBCL) including tax liabilities
and accounts payable, as long as these are not subject to interest or fees from total
assets.

Another method of calculating invested capital is to add the book value of a company's
equity to the book value of its debt, then subtract non-operating assets, including cash
and cash equivalents, marketable securities and assets of discontinued operations.

Yet another way to calculate invested capital is to obtain working capital by

subtracting current liabilities from current assets. Next you obtain non-cash working
capital by subtracting cash from the working capital value you just calculated. Finally
non-cash working capital is added to a company's fixed assets, also known as long-term
or non-current assets.

The value in the numerator can also be calculated in a number of ways. The most
straightforward way is to subtract dividends from a company's net income.

On the other hand, because a company may have benefited from a one-time source of
income unrelated to its core business a windfall from foreign exchange rate
fluctuations, for example it is often preferable to look at net operating profit after taxes
(NOPAT). NOPAT is calculated by adjusting the operating profit for taxes: (operating
profit) * (1 - effective tax rate). Many companies will report their effective tax rates for
the quarter or fiscal year in their earnings releases, but not all. Operating profit is also
referred to as earnings before interest and tax (EBIT).

ROIC is always calculated as a percentage and is usually expressed as

an annualized or trailing twelve month value. It should be compared to a company's cost
of capital to determine whether the company is creating value. If ROIC is greater than
the weighted average cost of capital (WACC), the most common cost of capital metric,
value is being created. If it is not, value is being destroyed. For this reason ROIC is one
of the most important valuation metrics to calculate. That said, it is more important for
some sectors than others, since companies that operate oil rigs or manufacture
semiconductors invest capital much more intensively than those that require less
equipment.

One downside of this metric is that it tells nothing about what segment of the business is
generating value. If you make your calculation based on net income (minus
dividends) instead of NOPAT, the result can be even more opaque, since it is possible
that the return derives from a single, non-recurring event.

ROIC provides necessary context for other metrics such as the P/E ratio. Viewed in
isolation, the P/E ratio might suggest a company is oversold, but the decline could be
due to the fact that the company is no longer generating value for shareholders at the
same rateor at all. On the other hand, companies that consistently generate high
rates of return on invested capital probably deserve to trade at a premium to other
stocks, even if their P/E ratios seem prohibitively high.

In Target Corp.'s (TGT) first-quarter 2015 earnings release, the company calculates its
trailing twelve month ROIC, showing the components that go into the calculation:

TTM TTM
(All values in million of U.S. dollars)
5/2/15 5/3/14
Earnings from continuing operations before
4,667 4,579
interest expense and income taxes
+ Operating lease interest * 90 95
- Income taxes 1,575 1,604
Net operating profit after taxes 3,181 3,070

Current portion of long-term debt and other

112 1,466
borrowings
+ Noncurrent portion of long-term debt 12,654 11,391
+ Shareholders' equity 14,174 16,486
+ Capitalized operating lease obligations * 1,495 1,587
- Cash and cash equivalents 2,768 677
- Net assets of discontinued operations 335 4,573
Invested capital 25,332 25,680
Average invested capital 25,506 25,785

After-tax return on invested capital 12.5% 11.9%

It begins with earnings from continuing operations before interest expense and income
taxes ($4,667 million), adds operating lease interest ($90 m), then subtracts income
taxes ($1,575 m), yielding a net profit after taxes of $3,181 m: this is the numerator.
Next it adds the current portion of long-term debt and other borrowings ($112 m), the
noncurrent portion of long-term debt ($12,654 m), shareholders equity ($14,174 m) and
capitalized operating lease obligations ($1,495 m). It then subtracts cash and cash
equivalents ($2,768 m) and net assets of discontinued operations ($335 m), yielding
invested capital of $25,332 m. Averaging this with the invested capital from the end of
the prior-year period ($25,680 m), you end up with a denominator of $25,506 m. The
resulting after-tax return on invested capital is 12.5%.

This calculation would have been difficult to obtain from the income statement and
balance sheet alone, since the asterisked values are buried in an addendum. For this
reason calculating ROIC can be tricky, but it is worth arriving at a ballpark figure in order
to assess a company's efficiency at putting capital to work. Whether 12.5% is a good
result or not depends on Target's cost of capital. Since this is often between 8% and
12%, it is likely that Target is creating value, but slowly and with a thin margin for error.

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