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Depreciation Shell Game

Accounting reforms might force regulators to abandon their live-now, pay-later practices.

Fortnightly Magazine - April 2008

to increase at each recalculation, if the life span does not change. This conflicts with the typically decreasing pattern of usage for steam units and constant pattern for nuclear units, so it brings SFAS 71 into play. This increasing pattern of rates qualifies as a phase-in plan under SFAS 92. However, SFAS 92 gives Missouri a way out, because it requires the phase-in plan to be more deferred than under the ratemaking policy in place prior to 1982, and Missouri’s plan was in place prior to 1982.

Altered Operation Mode

GAAP and the FERC Electric Uniform System of Accounts specify that depreciation is to be systematic and rational, with rational meaning depreciation be recorded in a way that’s consistent with the usage of the asset. For regulated entities, such as electric utilities, which are required to practice the group concept of depreciation, this requirement is accomplished by the pattern of depreciation rates being the same as the pattern of asset usage.

Reconditioning to extend life involves substantial expenditures, and regulators commonly dictate that the extended life be recognized in depreciation rates immediately, and that the related expenditures not be recognized until after they have been recorded. This is the same treatment of interim additions addressed above and has the same implications for financial reporting.

Changing to a peak load or standby mode of operation late in life results in little or no usage from then on, causing a rather distinctive lifetime pattern of usage. This pattern is what the units-of-production (UOP) depreciation procedure was devised to address, but UOP rarely is applied to power plants. While UOP is valid for this situation, there are several ways to determine depreciation rates based on life defined by time (rather than by production) that will emulate this usage pattern. Regulators, however, do not allow their use. Texas has gone so far as to interpret its Substantive Rules for regulatory depreciation as allowing only life defined by time. However, the Texas restructuring included generation, so power plant owners in Texas now can use UOP depreciation methods.

A pattern of depreciation rates different from the pattern of usage is inconsistent with GAAP, so it would trigger SFAS 71 provisions.

Terminal Demolition Costs

To satisfy laws, regulations and public safety considerations, regulated entities remove utility assets or safely abandon them in place at the end of their useful lives. Steam stations eventually are removed, and their removal expenditures substantially exceed their salvage proceeds. Missouri does not allow estimated terminal net removal costs to be recognized in depreciation for steam plants, but it does for nuclear plants through decommissioning fund contributions and for other types of energy utility assets through depreciation.

The Uniform Systems of Accounts that jurisdictional entities must comply with specify that removal costs must be a component of depreciation, but the FASB and SEC preclude removal costs from being recorded as depreciation for financial reporting purposes. This FASB and SEC exclusion is the result of misinterpreting the GAAP definition of depreciation accounting, the reasons for which are beyond the scope of this discussion. However, as long