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Letters to the Editor

Fortnightly Magazine - January 2006

the book reserves was reversed at the time SFAS 143 was adopted. This was done by all regulated entities in response to the position expressed by the Securities and Exchange Commission (SEC) that generally accepted accounting principles (GAAP) dictates cost of removal be expensed at the time incurred, rather than accrued as a component of depreciation. This was done for financial accounting purposes, but not for regulatory accounting and ratemaking purposes, because Uniform Systems of Accounts specify that cost of removal be recorded as a component of depreciation. Majoros notes similar transactions by electric utilities at the time industry restructuring caused certain power plants to no longer qualify for SFAS 71. Contrary to Majoros’ assertion, rate base was not affected by these transactions. I am convinced that the SEC’s interpretation of GAAP is incorrect, for reasons that are beyond the scope of these comments. However, regulated entities are forced to reverse for financial accounting purposes any previously accrued cost of removal for operations no longer qualifying for SFAS 71 for as long as the SEC’s current interpretation of GAAP remains.

The fact that rate base was not affected by these telephone industry actions is demonstrated by a recent proceeding in the state of Washington in which one of Mr. Majoros’ partners testified on depreciation. The proceeding involved the intrastate business of Verizon, and all parties incorporated cost of removal into their proposed depreciation rates and recognized that Verizon’s book reserve for regulatory accounting and ratemaking purposes includes cost of removal. Verizon’s interstate business is subject to Federal Communications Commission (FCC) jurisdiction. The FCC allows depreciation rates to be based on specified ranges of lives and net salvage ratios without question, but allows departure from the ranges upon proof of need. The FCC’s net salvage ranges recognize cost of removal.

Majoros uses a phrase he has coined “Traditional Inflated Future Cost Approach,” which I interpret as implying there is something amiss with how the cost of removal component of depreciation rates is determined. This is an accurate phrase, but the implications Majoros seems to be drawing from it are not correct.

“Inflated” means nothing more than, when past experience is considered in determining the cost of removal expected to be incurred upon the retirement of surviving assets, it is typical to relate the recorded cost of removal to the recorded original cost of the retired assets. This relationship reflects the cost of removal at the price level when incurred and the retired assets at the price level when placed in service. Therefore, labor cost escalation over the asset lifetime is inherent in the relationship.

“Future” means nothing more than depreciation rates being required to reflect future cost of removal, i.e., the expected amount at the price level at the time incurred.

The terminology typically utilized by depreciation analysts and regulators to recognize this situation is “Traditional Method” or “Traditional Approach.”

Majoros notes that increases in depreciation expense cause increases to revenue requirements, but fails to mention that this is a short-term phenomenon. He notes that depreciation expense accumulates in the book reserve,