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Fixing Depreciation Accounting

Accumulated provisions for depreciation belong on the right side of the balance sheet.

Fortnightly Magazine - October 2008

large energy users typically work from multiple locations, so they can shift production between locations in reaction to regulatory decisions—and sometimes they do. Large energy users participating in regulatory proceedings typically emphasize long-term considerations, through addressing cost-allocation (equity) issues, rather than issues concerning the magnitude of cost of service. It’s not unusual for such users to react to a business-climate deterioration signal by shifting from emphasizing equity to emphasizing the near-term cost-of-service magnitude in their participation in regulatory proceedings.

SFAS 143 is an example of the movement away from emphasizing matching to emphasizing fair value. It segregates retirement obligations (removal expenditures) imposed by law, statute, regulation or contract (legal obligations) from depreciation, and specifies that such obligations be recorded as liabilities—not as depreciation. The specified treatment is to record the initial discounted amount of the expected expenditure as part of the depreciable cost of the related asset and as an initial liability, and to record future accretion—due to the discounting unwinding over time—as accretion expense. This treatment is a single-payment (prepaid) annuity, but is recorded in a manner that gives it a structure similar to a multiple-payment annuity—the typical form of sinking-fund depreciation.

SFAS 92, Regulated Enterprises—Accounting for Phase-in Plans , defines annuity methods of depreciation as phase-in plans that are precluded from use for either regulatory or financial accounting purposes, unless the practice was regulatory policy prior to 1982. SFAS 143 side steps this limitation by classifying legal obligations as liabilities, so the specified treatment is not required to be “rational.” Also, SFAS 92 is interpreted as applying only to investment, which is another consequence of the accumulated provision being on the left side of the balance sheet.

The deferral inherent in SFAS 143 treatment is evident in the obligation for decommissioning a nuclear generating unit, which is the obligation that prompted issuance of SFAS 143. A nuclear unit that receives a renewed operating license from the Nuclear Regulatory Commission is likely to have an operating life span of about 55 years. If decommissioning occurs 10 years after operations cease and the SFAS 143 discount rate is 8 percent, then 99.3 percent of the obligation would be recorded as accretion over 65 years, with the accretion amount recorded during the final year being 137 times the amount recorded during the first year, and 54 percent of the total accretion being recorded after the unit ceases to operate and generate revenues—and, for a single-asset entity, after the enterprise ceases to be viable. This is really strange accounting.

Intergenerational Equity

The exposure draft of what eventually became SFAS 143 called for liability treatment of both legal and constructive obligations, which is the same as for international standards. However, SFAS 143 was limited to only legal obligations when FASB concluded that constructive obligations could not be defined tightly enough for consistent application, which suggests the international standard is not consistently being applied.

Limiting SFAS 143 to legal obligations did not preclude inconsistent application, and the FASB felt the need for clarification through issuing FASB Interpretation 47, Accounting for Conditional Asset Retirement Obligations , (FIN