The recent breakout of the benchmark 10-Year Treasury yield from the recent mid-4 percent yield band to approximately 5 percent (with some market expectation that it may increase further)...
Depreciation Shell Game
Accounting reforms might force regulators to abandon their live-now, pay-later practices.
When an advisory committee of the Securities and Exchange Commission (SEC) voted recently to phase out special accounting treatment for various industries, it signaled the end may be near for power plant depreciation deferral mechanisms. Such mechanisms are a mainstay of regulatory accounting in many states, and their discontinuation could send plant owners and regulators back to the drawing board to find a new, GAAP-compliant way to recognize asset depreciation in financial reports.
Specifically, the Advisory Committee on Improvements to Financial Reporting issued a report on Valentine’s Day 2008 recommending the Financial Accounting Standards Board (FASB) avoid special treatment for various industries in its accounting rules on transactions and activities. 1 The committee identified 18 industries, including “regulated operations,” as having industry-specific guidance— i.e., exceptions to generally accepted accounting principles (GAAP) —that can create problematic complexities and inconsistencies in financial reports.
For investor-owned utilities and other public companies that own power plants, an important example of such guidance is SFAS 71, Accounting for the Effects of Certain Types of Regulation (see sidebar, “GAAP and Depreciation Deferral”) . SFAS 71 allows utilities to use special regulatory accounting for their income statements, with the differences from GAAP disclosed on the balance sheet as regulatory assets and liabilities.
Depreciation deferral mechanisms, imposed by regulators in many states, conflict with GAAP in the way they determine a power plant’s life span, as well as the way they deal with upgrades, operational changes and ultimately end-of-life demolition and removal costs.
Rescinding SFAS 71 and related accounting standards specific to regulated entities would, in most cases, preclude regulatory depreciation from being reflected in financial statements, except to the extent reflected in recorded revenues. While this trend will create short-term confusion for industry CFOs and regulators, it’s a good thing for the industry—especially its shareholders and ratepayers—because these mechanisms too often lead to misleading regulatory accounting, and can increase ratepayer costs over the life of the affected assets.
Mind the GAAP
Some depreciation deferral mechanisms apply to the investment portion of depreciation, and some apply to the salvage and cost of removal portion. Mechanisms related to end-of-life issues pose particularly significant uncertainties for utility regulation and financial reporting.
The reliability of any electric generating unit deteriorates with age, and steam and nuclear units typically deteriorate sufficiently by an age of about 30 years to require remedial actions that influence certain of these deferral mechanisms. The available actions include: retirement; changing the mode of operation to peak load or standby service; and reconditioning through refurbishment or repowering by boiler replacement.
Prior to 10 or 15 years ago, the most common remedial action for steam units was to change the mode of operation, and today the most common action is to recondition the unit. Initially, the