Removal cost is the expenditure involved with physical removal or safe abandonment of an asset, and is not a trivial matter, because it is not unusual for such expenditures for long-lived property...
Letters to the Editor
Gold Mine or Fool’s Gold?
The stated premise of “ Main Street Gold Mine ” (Michael Majoros et al., October 2010) —that “funds collected for cost-of-removal liabilities could finance capital spending”—is not valid.
“Main Street Gold Mine” views the accumulated provision for depreciation (book depreciation reserve) as being cash that is readily available for financing capital expenditures. This is not so. A book reserve represents the accumulation of recorded depreciation expenses, retirements, salvage proceeds, and removal expenditures, of which only the salvage proceeds and removal expenditures represent cash transactions. The depreciation expense portion is comprised of non-cash transactions that allocate over the life of the related assets that are consumed in the process of providing goods or services 1) known capital expenditures after they have been made, 2) estimated salvage proceeds prior to being received, and 3) estimated expenditures for removal or abandonment prior to being spent. Retirements are also non-cash transactions that are the original cost amounts recorded when the capital expenditures were originally made.
While utility regulation results in ratepayers being charged with the depreciation expenses during the time the assets are being consumed through providing service, the resulting cash receipts are utilized for general corporate purposes. Far from being cash, the book reserve represents ratepayer-supplied funds for which rate-base regulation provides a credit at the authorized cost of capital, and these funds have already been utilized. Therefore, the article incorrectly presumes that the book reserve represents cash, and that a utility can spend each dollar of ratepayer-supplied funds more than once.
It is not surprising for book reserves to include components for removal costs, because this represents that portion of the expected removal expenditures that have already been charged to ratepayers as the related assets are being consumed while providing service. This situation is inherent in the accrual accounting that is dictated by the Uniform Systems of Accounts that jurisdictional enterprises are required to follow.
Main Street Gold Mine discusses the influence of depreciation on cost of service, but addresses only one of its two influences. The influence discussed is the annual impact of depreciation expenses. The influence not discussed is the cumulative impact of depreciation expenses on the book reserve that is a negative component of rate base. When dealing with investment, the rate base begins at 100 percent and decreases to zero, so both the annual and cumulative influences on cost of service are positive. When dealing with removal expenditures, the rate base begins at zero and decreases to negative 100 percent, so the annual and cumulative influences offset. For removal, the cumulative influence of the negative rate base eventually overwhelms the annual influence, which causes ratepayers compensating a utility for removal expenditures to actually receive a credit over the life of the typically long-lived assets. Therefore, contrary to the article, recognizing estimated removal expenditures as a component of depreciation actually decreases the cost of service over asset life.
This situation is addressed in considerable detail by my August 2009 Fortnightly article, “ An Indicator of Fairness ,” and so is not addressed further here, except to