Ratable treatment of removal costs through depreciation should be favored.
John Ferguson, CDP, formerly was a principal with Deloitte & Touche, and now edits the periodic letters on current issues for the Society of Depreciation Professionals. This article reflects the views of the author and not Deloitte or the Society. Email him:email@example.com.
Rate-base regulation causes depreciation to be reflected in cost of service both annually and cumulatively—annually through the depreciation expense component and cumulatively through the return and related income taxes component as the annual depreciation expenses accumulate in the book reserve. The cumulative component eventually overwhelms the annual component, thereby causing the initial impact of any depreciation change to reverse in just a few years. This reversal allows the treatment of depreciation (especially the removal cost component) to demonstrate whether regulation emphasizes the near-term or the long-term, thereby providing a basis for judging its fairness.
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 to exceed the related depreciable investment amounts. Those emphasizing the near-term favor removal-cost deferral mechanisms that shift recording and recovery to future ratepayers—a process that increases the costs to be borne by ratepayers through two influences. One influence is the resulting rate-base inflation that increases the total cost of service ratepayers will bear over the life of the assets. The other influence is the inherent increase in regulatory risk, which increases the cost of capital.