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are also non-cash transactions that are the original cost amounts recorded when the capital expenditures were originally made.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 note that Figure 3 of the article shows ratepayers as being charged $3.98 for each dollar spent on investment for 60-year property and as receiving a credit of $2.79 for each dollar spent on removal.
“Main Street Gold Mine” asserts “[I]nflated cost-of-removal ratios have resulted in accumulated depreciation balances far greater than required for capital recovery over the life of the capital assets,” which seems to be interpreting capital recovery as being limited to investment. However, in the context of regulatory accounting, capital recovery has a broader meaning, as it includes investment, salvage, and removal.
“Main Street Gold Mine” asserts that paragraph B.73 of Statement of Financial Accounting Standard 143, “Accounting for Asset Retirement Obligations” (SFAS 143), requires utilities to classify removal costs as a regulatory liability. SFAS 143 identifies its paragraph “B” section as being “Background Information and Basis for Conclusions.” All paragraph B.73 does is acknowledge that enterprises qualifying for SFAS 71, “Accounting for the Effects of Certain Types of Regulation,” can reflect regulatory accounting in their income statements, provided they disclose any differences from financial accounting in their balance sheets as regulatory assets or liabilities. Therefore, contrary to the article, paragraph B.73 does not specify the accounting for removal costs.
“Main Street Gold Mine” states that the International Accounting Standards Board (IASB) in July 2009 issued for comment an exposure draft on rate-regulated activities that could result in something similar to SFAS 71. Whether this will happen remains to be seen, because the comments received did not disclose any consensus, there is no consensus among the IASB members, and the IASB’s staff has since asserted that existing International Financial Reporting Standards (IFRS) do not permit recognition of regulatory assets and liabilities.
“Main Street Gold Mine” refers to my October 2008 Fortnightly article, “Fixing Depreciation Accounting,” as confirming that “[T]he SEC’s impending move to IFRS poses a question regarding the disposition of the utilities’ cost-of-removal liability… Ferguson proposed that when these companies move to IFRS, they should transfer the regulatory liabilities to their equity accounts.” [Editor’s note: Erroneous reference to “November 2008” omitted.] My October article addresses whether the book reserve should be shown on the left side of the balance sheet as a contra-asset or on the right side as a source of capital, and does not address how the removal cost portion of book reserves should be dealt with if the SEC adopts IFRS as U.S. GAAP without there being an IFRS equivalent to SFAS 71.
Debt is recorded on the right side of the balance sheet in recognition that it is a source of capital, but users of financial statements recognize that it is not cash. Likewise, users of financial statements would recognize that moving the book reserve to the right side would not cause it to suddenly become cash.
–John Ferguson, CDP
The Author Responds:
Mr. Ferguson wrongly asserts “‘Main Street Gold Mine’ views the accumulated provision for depreciation (book depreciation reserve) as being cash that is readily available for financing capital expenditures.” Nothing could be further from the truth. “Main Street Gold Mine” views a public utility’s regulatory liability for non-legal future removal costs as cash that is readily available for financing required environmental and smart grid infrastructure projects. Accumulated depreciation and regulatory liabilities are different animals—the former represents capital recovery collected from ratepayers and the latter represents a collection from ratepayers for an un-incurred future cost.
This is an accounting distinction that most accountants probably understand. Instead of using the cash for its intended purpose, Mr. Ferguson proposes to transfer the unspent cash into the utilities’ equity accounts and then increase customer rates to fund these future infrastructure expenditures. “Main Street Gold Mine” proposes to use the unspent cash to fund the future infrastructure expenditures, thus reducing the need for customer rate increases for that purpose.
Consider the facts to which Mr. Ferguson concedes:
• Utilities collected the cash;
• Utilities do not have a legal obligation to incur such future costs;
• Utilities have not spent the cash on its intended purpose;
• GAAP does not allow the excess money to be included in accumulated depreciation; and
• GAAP requires the utilities to report the excess collections as regulatory liabilities (amounts owed to customers).
Mr. Ferguson alleges on behalf of the utilities that they have already spent the money and, therefore, should take it into their equity accounts as income. On behalf of Main Street, I do not concede that utilities spent the money, because they collected it for a cost they have not incurred, and nobody told them they could spend for any other purpose. That is why GAAP requires the utilities to report the excess cash as a regulatory liability. The article proposes that the utilities use the excess money they collected from Main Street so that Main Street not be charged more than necessary for the future infrastructure expenditures required in today’s environment.
Perhaps all of the utilities could transfer the excesses they have collected into a national fund for infrastructure renewal and improvement, similar to the Universal Service Fund used in the telecommunications industry.
–Michael Majoros Snavely King Majoros & O’Connor, Inc. Washington, D.C.
Corrections: In the November 2010 article, “Legal Battleground,” we misspelled the name of law firm Brydon, Swearengen & England. In the October 2010 “People” department, we misspelled the names of Southern Company CFO Art P. Beattie and Georgia Power CFO W. Paul Bowers. Fortnightly sincerely regrets these errors and has corrected them in the online versions of the respective articles.