In “Rate-Base Cleansings: Rolling Over Ratepayers” (November 2005, p.58), Michael Majoros urges state public utility commissions to recognize a refundable regulatory liability for past charges to ratepayers for non-legal asset retirement costs. “Unless the state PUCs specifically recognize the liabilities, the utilities will have the opportunity to institute a rate-base ‘cleansing’ by transferring ratepayer-fronted money into income.” The author’s criticism of the prescribed accounting for discontinuation of FASB Statement No. 71 (euphemistically labeled “rate–base cleansing”) is grossly misplaced.
Regulatory assets and liabilities can be created either a) within the accounting framework of financial reporting required for non–regulated enterprises; or b) within the accounting framework for regulated utilities prescribed by the Uniform System of Accounts (USOA). Differences between financial accounting and regulatory accounting are permitted under generally accepted accounting principles (GAAP) provided the general-purpose financial statements of a regulated entity are prepared in conformance with the provision of FASB 71. In particular, if current recovery is provided under regulation for costs (that would not be recognized in the accounting framework for non-regulated enterprises) that are expected to be recovered in the future, FASB 71 requires a regulated entity to recognize these current receipts as liabilities.
Regulated assets and liabilities created within the framework of regulatory accounting prescribed by the USOA arise from specific revenues, expenses, gains, or losses that would have been included in net income in one period under the requirements of the USOA but for it being probable that a) such items will be included in different periods for the purpose of developing rates charged for utility services; or b) refunds to customers are not provided in other USOA accounts.
The reporting of a regulatory asset or liability is dependant upon the accounting framework in which the asset or liability arises. In the case of removal costs (or non-legal asset retirement obligations), the accounting framework for reporting a regulatory liability is GAAP for non-regulated enterprises. This liability does not create or imply an obligation to refund past charges to ratepayers. It simply means that regulation is permitting recovery of a future cost that would otherwise be reported as a current expense for a non-regulated enterprise.
Including cost of removal as a component of depreciation rates is widely recognized and accepted by a substantial majority of state regulatory commissions as a standard ratemaking principle. Net salvage is included as a component of depreciation rates to equitably distribute cost of removal (less salvage) over the periods in which the assets that created the cost are used to provide utility service. Any concern over the magnitude or timing of these charges is properly addressed in the course of conducting depreciation studies. Ratepayers are not entitled to a refund of costs recognized to provide services they have already received.
Karen G. Kissinger
Vice President, Controller & Chief Compliance Officer, Tucson Electric Power Co.
I would like to comment on the article by Michael J. Majoros Jr. (“Rate-Based Cleansings: Rolling Over Ratepayers,” November 2005, p. 58).
I find it interesting that Majoros is critical of the traditional method of depreciation while overlooking an accounting standard (SFAS No.143) that could be much more devastating on the ratepayers. True, the traditional depreciation capital recovery schedule is “front-end” loaded, as illustrated in Exhibit 1 below, because the ARO is non-discounted, but it recoups no more than the ARO cost of removal by the end of the ARO’s life. In Exhibit 1, the future worth (FW) of the return and depreciation of $422,500 is equal to the $422,500 ARO in 10th year. Unlike the SFAS No.143 capital recovery schedule as illustrated in Exhibit 2, the future worth of the return (or accretion) and depreciation of $643,698 exceeds the $422,500 in the 10th year by 52 percent. The situation becomes worse as illustrated in Exhibit 3, with an increase in the ARO life. In fact, ARO lives over 50 years are not uncommon, resulting in overstatements of well over 175 percent.
Common sense would show that there is something dreadfully wrong here. If Majoros is truly interested in the ratepayers’ welfare, he would be advocating a capital recovery schedule such as the one shown in Exhibit 4 and help “cleanse” the flawed SFAS No.143 accounting standard and save the ratepayers billions of future dollars.
Regina, Saskatchewan, Canada
The Author Responds
Karen Kissinger is the vice president, controller, and chief compliance officer of Tucson Electric Power Co. (TEP), a specific company I addressed in my November 2005 article. I reported that TEP already had transferred previously collected but unspent money from its ratepayers into its income. TEP collected the money from its ratepayers to provide for production plant removal costs TEP will not incur. Instead of returning the excess collections to ratepayers, TEP gave it to its shareholders. I also predicted that TEP would do it again for its remaining regulated plant accounts if it has an opportunity to do so.
Kissinger’s last sentence corroborates everything I reported. According to Kissinger, “Ratepayers are not entitled to a refund of costs recognized to provide services they have already received.” To make it clear, Kissinger is saying that even though TEP charged its ratepayers substantial sums that TEP will not spend for its intended purpose, TEP intends to keep the money and transfer it to its shareholders if possible. Clearly, neither Kissinger nor TEP wants any local public service commission to protect that money on behalf of ratepayers.
Don Bjerke claims that I have “overlooked an accounting standard (SFAS No. 143) that could be much more devastating on the ratepayers.” What Mr. Bjerke overlooks is that I specifically recognized SFAS No. 143 in the first sentence of my article. SFAS No. 143 highlighted the excess charges that TEP already has transferred into its corporate income and the remaining excess money that TEP’s Kissinger would like to keep rather than return to ratepayers.
Bjerke’s primary misunderstanding is that he focuses his attention on asset retirement obligations (ARO), which are legal obligations to spend money at the end of a plant asset’s life. Although Bjerke addresses “legal AROs,” my article is about “non-legal AROs” where there is no obligation, legal or otherwise, to spend any money at the end of a plant asset’s life.
None of Bjerke’s tables addresses non-legal AROs; he missed the point. His tables should have addressed the “consumers’ discount rate” which is always higher than a public utility’s cost of capital. If he had done so, he may not be so enamored with front-loaded revenue requirements. For more information on this subject, see www.snavely-king.com/ Think Pieces/Debate on the Use of Customer Discount Rates.—Michael Majoros
An article in your most recent issue of Public Utilities Fortnightly (“Rate-Case Mania: Lessons for a New Generation,” February, p. 36), has some fundamental flaws in its representation of the rate-case process. On p. 40, the section titled “Rate Design” is not technically correct. First of all the Cost of Service or General Rate Case proceeding is comprised of three major areas: (1) establishment of revenue requirement; (2) cost allocation; and (3) rate design. Cost allocation is a totally separate exercise from rate design. Thus, the representation that disputes over rate design focus on the appropriate allocation factor for assigning costs is not correct. That is a dispute in the cost allocation process after the revenue requirement has been established. Rate design is a process that occurs after steps 1 and 2 and employs the allocated revenue requirements for each customer class along with historical consumption and load characteristics of that class to determine the best way to recover the revenue requirement from that customer class (typically based upon a load forecast for the test year).
The second major flaw in the article is most concerning. The core concept of revenue requirement is completely incorrect as depicted in the box on the top of p. 40. The return on rate base is not just the authorized return on equity, which is what the box implies; rather, it is the weighted average cost of capital (WACC) that considers the cost of all sources of capital proportionately. Secondly, Rate Base is not Debt + Equity, it is the total plant in service less accumulated depreciation plus other items such as CWIP, Plant Held for Future Use, Materials & Supplies, Prepayments, etc.
Melissa D. Lee, Senior Economist
ERG Consulting Group, LLC
The Author Responds We would like to thank Melissa Lee for expressing an interest in improving the exegesis of our article. With respect to her first point, on whether to characterize the rate-case process as consisting of one, two, or three parts, we fail to understand her objection. With reference to her second point, we acknowledge a typographical error in the box. The term “rate-of-return” should have been used in place of “ROE.” The discussion in the body of the article, however, makes clear what we meant. Finally, it is difficult in a brief tutorial to discuss all the factors that go into a rate case. However, our article does not carry any mistakes, let alone any serious mistakes as she alleges. Out of the many factors that she chooses to mention with respect to defining rate base, the explanation of rate base in the box is correct. This should be clear by Lee’s own application of the weighted average cost of capital to rate base.—Ahmad Faruqui and Robert Earle
Thanks for writing that bold and timely piece on the proposed FPL-Constellation combination in the February issue. Given the growth in the FPL service territory and the recent hurricanes, it seems that FPL is one utility that is likely to need lots of capital in the future to carry out its public service obligations.
It is my understanding—and I could be incorrect—that no state-of-Florida regulatory approval is required to close this deal. Given FPL’s obvious capital requirements and some of the concerns set forth in your piece, this circumstance appears unfortunate (from an FPL ratepayer perspective) if indeed no Florida regulatory review is required.
Howard M. Spinner, Director – Division of Economics and Finance
Virginia State Corporation Commission