Severe upward pressure on electric rates after a decade of stability has regulators, legislators, utility executives, consumer advocates, and myriad other stakeholders searching for solutions....
Main Street Gold Mine
Funds collected for cost-of-removal liabilities could finance capital spending.
isn’t a corresponding cash outflow associated with depreciation expense. Hence, depreciation increases Main Street prices and the utilities’ bank accounts. Recent smart-meter applications are requesting accelerated depreciation of existing meters to pay for the new meters. In those circumstances, Main Street customers, rather than Wall Street investors, will pay for the smart-meter investment.
In addition to accelerated depreciation rates, another little-understood source of Main Street funding has been the inclusion of inflated future cost-of-removal ratios in annual depreciation rates. The resulting higher depreciation rates have led to cash collections from Main Street customers that have exceeded vastly the utilities’ actual cost-of-removal expenditures. Utilities have accounted for these excess collections as increases to their accumulated depreciation accounts. Accumulated depreciation is a balance sheet contra-account reflecting the level of investment in property, plant and equipment written off in the form of annual depreciation expense. Inflated cost-of-removal ratios have resulted in accumulated depreciation balances far greater than required for capital recovery over the life of the capital assets.
General purpose financial statements, prepared in accordance with generally accepted accounting principles (GAAP), recognize the excess charges as a liability to ratepayers. Paragraph B.73 of the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standard 143 (SFAS 143) required utilities to reclassify the excess depreciation charges from accumulated depreciation into a regulatory liability account. The excess funds were reclassified as a regulatory liability because, per SFAS 71, “Rate actions of a regulator can impose a liability on a regulated enterprise. Such liabilities are usually obligations to the enterprise’s customers.”
For example, “a regulator can provide current rates intended to recover costs that are expected to be incurred in the future with the understanding that if those costs are not incurred, future rates will be reduced by corresponding amounts. If current rates are intended to recover such costs and the regulator requires the enterprise to remain accountable for any amounts charged pursuant to such rates and not yet expended for the intended purpose … those amounts shall be recognized as liabilities and taken to income only when associated costs are incurred.”
While this understanding with regard to costs of removal has been in most cases implicit, it has been sufficiently clear that, in response to FASB 143 and FASB 71, leading investor-owned utility companies have recorded a significant cost-of-removal regulatory liability for GAAP financial reporting purposes ( see Figure 1 ).
The cost-of-removal regulatory liability of the companies ranked in the 2010 Fortnightly 40 report (September 2010) is surprisingly large. They collectively reported a $16.1 billion regulatory liability as of Dec. 31, 2007, which increased to $16.8 billion at the end of 2008, and to $16.9 billion for 2009. We also note that six companies that weren’t included in the 2009 F40 made it into Fortnightly’s top-40 ranking in 2010. Combined, those companies reported an additional $5 billion regulatory liability at the end of 2009.
This cost-of-removal regulatory liability is a pot of gold, prepaid by Main Street customers, that utilities could use for future environmental and smart-grid capital improvements. Utilities have the cash—they collected