Over the next year (or years), companies in Canada and the U.S. will make the transition towards adopting International Financial Reporting Standards (IFRS). These standards will have a...
Depreciation Shell Game
Accounting reforms might force regulators to abandon their live-now, pay-later practices.
old in museums, it is unusual to encounter 100-year old equipment in operation. Such unrealistically long life spans resulting from regulatory approaches to depreciation rates are inconsistent with GAAP, and therefore require the company to apply the provisions of SFAS 71.
In addition, unrealistic life spans may impose a need to test for asset impairment. The life spans of nuclear units are imposed by the termination dates of Nuclear Regulatory Commission (NRC) operating licenses, rather than estimated by planners or operators, and such dates typically serve as the basis for their regulatory depreciation. NRC licenses initially were issued for a term of 40 years that began at the issue date of the construction permit. This resulted in operating life spans shorter than 40 years for units that experienced delays in construction and operation, which prompted the NRC to change the 40-year term to start at the issue date of the operating license and to modify existing licenses accordingly. The NRC later began allowing 20-year extensions to operating licenses of existing units through license renewals, upon request and demonstration of adequate equipment condition.
Whether operating licenses are renewed or not, actual operating life spans are unlikely to be as long as is allowed, because of the increasing difficulty in justifying large capital and maintenance expenditures as the license termination date approaches. No nuclear unit has yet to reach the life span allowed by its original operating license, but some are getting close.
Missouri requires nuclear depreciation rates to presume operation until the termination dates of operating licenses, and in some cases to presume a renewed license that does not exist. However, the actual operating license and the likelihood of early retirement would need to be recognized for GAAP depreciation purposes. As a result, the depreciation rates for financial accounting purposes are higher than they are for regulatory accounting, again bringing SFAS 71 into play. The potential for not receiving a license renewal and for early retirement would impose a need to periodically test for asset impairment.
All types of generating units experience component replacements and the addition of new components during their lifetimes, as part of routine maintenance and repairs. The depreciation terminology for this activity is “interim additions and retirements.” Average service life applies to the depreciable investment, which interim additions and retirements cause to be considerably shorter than the life span of the unit. For example, Ameren UE testimony in a 2007 case shows the average service life experienced by two retired steam units was about half of their life span. 4
It’s quite common for power plant depreciation rates based on estimated generating unit retirement dates to recognize estimated future interim retirements, but to exclude recognition of future interim additions—most of which are for replacement of the estimated interim retirements—until after they have occurred. For example, Missouri does this for nuclear units. Interim additions have more influence on depreciation rates than do interim retirements, because their magnitude is typically five to 10 times the magnitude of interim retirements.
Deferring the recognition of interim additions causes the depreciation rate