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Depreciation Shell Game

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

Fortnightly Magazine - April 2008

as FASB and SEC hold this position, depreciation rates excluding removal costs can be utilized for income statements without recording a regulatory asset or liability.

Unlike Missouri, most states allow terminal demolition costs to be reflected in the depreciation rates for non-nuclear generating units. (Such costs are not reflected in depreciation rates for nuclear units, because the NRC requires that decommissioning costs be funded externally.) The more common deferral mechanism for the demolition costs of non-nuclear power plants is to require recognition of site-specific cost estimates at the current price level, rather than at the price level expected at the time of demolition. However, regulators have used other mechanisms, such as placing a cap on the extent of demolition costs allowed to be reflected in power plant depreciation rates, and amortizing demolition costs over some specified period of time, after the expenses have been recorded in the book reserve.

Rational Depreciation

Missouri has not restructured its utility industry, so it makes a convenient example for analysis. But Missouri is by no means unique. Many states impose these deferral mechanisms, which is unfortunate because they lead to financial reporting that doesn’t accurately disclose the results of operations and the current financial position—and ultimately create higher costs for ratepayers. Energy cost increases imposed by regulatory practices are particularly interesting, because they make it more difficult for those involved with area development to attract new businesses and to expand existing businesses. 5

Michigan provides an interesting illustration. Early last year the state’s Public Service Commission sent a report to Gov. Jennifer Granholm, asserting the “current market structure does not provide sufficient certainty to finance a major generating plant on reasonable terms.” The report makes some recommendations for actions needed to address this situation. 6

Adequate capital recovery is an attribute of a regulatory environment consistent with addressing this situation. Michigan’s restructuring has not deregulated power plants, so the state continues to practice some of the power plant deferral mechanisms that increase risks and costs. Conspicuous by its absence from the commission’s recommended actions is the abandonment of its power plant depreciation deferral mechanisms.

Eliminating power plant regulatory depreciation deferral mechanisms—as might happen if FASB follows the SEC committee’s recommendations—would benefit ratepayers and the economic viability of utility service territories. It would reduce power costs in the long-term, and also would benefit users of financial statements by more accurately disclosing the results of utility operations and their current financial positions.

 

Endnotes:

1. Progress Report of the Advisory Committee on Improvements to Financial Reporting to the U.S. Securities and Exchange Commission , Feb. 14, 2008.

2. The author’s letter to the editor in the December 2007 issue of Fortnightly asserts certain power-plant depreciation issues merit attention by the Missouri Public Service Commission. This article identifies the Missouri practices mentioned in that letter.

3 . Missouri Case No. ER-2004-0570 (Empire District Electric Co.)

4 . Missouri Case No. ER-2007-0002.

5 . Large energy users consider the quality of regulation when evaluating new sites or expansion of existing sites. The author has assisted some to do so.

6.