Southern California Business Insurance Quote

Document Sample
Southern California Business Insurance Quote Powered By Docstoc
					Rebuttal Testimony of William M. Stout, P.E.

          On Depreciation Issues

       In Southern California Edison

          2006 General Rate Case




         California Public Utilities Commission

                      A.04-12-014

                       May 2005
 1                                      I. QUALIFICATIONS

 2   Q. PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.

 3   A.   My name is William M. Stout, and my business address is 207 Senate

 4        Avenue, Camp Hill, Pennsylvania.

 5   Q.   BY WHOM ARE YOU EMPLOYED AND IN WHAT CAPACITY?

 6   A.   I am President of the Valuation and Rate Division of Gannett Fleming, Inc.

 7   Q. PLEASE DESCRIBE THE VALUATION AND RATE DIVISION OF GANNETT

 8        FLEMIING, INC.

 9   A.   The Valuation and Rate Division of Gannett Fleming, Inc., provides consulting

10        services to public utilities and railroads.    The Gannett Fleming affiliated

11        companies employ nearly 1,900 people in over 50 offices throughout the

12        United States.

13        The Valuation and Rate Division of Gannett Fleming, Inc., has a long history

14        of client services encompassing valuations; depreciation studies; revenue

15        requirement, cost allocation and rate design studies; analyses of accounting

16        systems; and acquisition and feasibility studies.

17   Q. PLEASE STATE BRIEFLY YOUR EDUCATIONAL BACKGROUND AND

18        EMPLOYMENT EXPERIENCE.

19   A.   I have a Bachelor of Science degree in Management Engineering from

20        Rensselaer Polytechnic Institute.        While attending Rensselaer, I was

21        employed by the Valuation Division of Gannett Fleming Corddry and

22        Carpenter, Inc., during the summers of 1970, 1971 and 1972. My principal

23        assignments related to valuation studies and computer programming.




                                               1
 1        After my graduation in June 1973, I was employed by the Valuation Division

 2        as a Valuation Engineer. The scope of my activities included assembly of

 3        basic data, statistical service life analyses utilizing the retirement rate and

 4        simulated plant record methods, field surveys, preparation of preliminary

 5        estimates of service life and salvage, calculation of annual and accrued

 6        depreciation, and preparation of reports presenting the results of the studies.

 7        In January 1980, I was assigned to the position of Manager of Depreciation

 8        and Cost Allocation Studies conducted by the Valuation Division. In June

 9        1982, subsequent to a corporate reorganization, I became a Vice President of

10        Gannett Fleming Valuation and Rate Consultants, Inc. I became a Senior

11        Vice President in 1991 and attained my current position of President in 1994.

12   Q. ARE YOU A REGISTERED PROFESSIONAL ENGINEER?

13   A.   Yes. I am registered in the Commonwealth of Pennsylvania.

14   Q. ARE YOU A MEMBER OF ANY PROFESSIONAL SOCIETIES?

15   A.   Yes, I am a member of the National and Pennsylvania Societies of

16        Professional Engineers, the Institute of Industrial Engineers, and the Society

17        of Depreciation Professionals (SDP). I am a former member of both the Rates

18        & Charges Subcommittee of the American Water Works Association and the

19        Accounting Services Committee of the American Gas Association (AGA) and

20        a past president of SDP.

21   Q. DO YOUR PROFESSIONAL ACTIVITIES INCLUDE PARTICIPATION IN

22        CONTINUING PROFESSIONAL EDUCATIONAL PROGRAMS?




                                               2
 1   A.   Yes. I have completed the "Fundamentals of Life Estimation," "Forecasting

 2        Service Life," and "Making and Administering [Depreciation] Policy" programs

 3        conducted by the Center for Depreciation Studies at Western Michigan

 4        University.   In 1985 I became a member of the faculty of Depreciation

 5        Programs, Inc., lecturing on "Forecasting Service Life," "Fundamentals of

 6        Salvage Analysis", and "Managing a Depreciation Study". I also have been

 7        an instructor at the annual Advanced Accounting Seminar sponsored by AGA

 8        and the training programs offered by SDP.

 9   Q. HAVE YOU PREVIOUSLY TESTIFIED ON THE SUBJECT OF DEPRECIA-

10        TION?

11   A.   Yes. Since January 1978, I have testified in support of depreciation studies

12        for over 30 companies including electric, gas, telephone, and water utilities. I

13        have testified before the California Public Utilities Commission, the Texas

14        Public Utility Commission, the Pennsylvania Public Utility Commission, the

15        Georgia Public Service Commission, the Public Service Commission of

16        Indiana, the New York Public Service Commission, the Alaska Public Utilities

17        Commission, the Alberta Energy & Utilities Board, the Newfoundland Board of

18        Commissioners     of   Public   Utilities,   the   Federal   Energy   Regulatory

19        Commission, the National Energy Board of Canada, the Canadian Radio-

20        Television and Telecommunications Commission and the United States Tax

21        Court on the subject of depreciation.

22

23                                   II. INTRODUCTION




                                                3
 1   Q.   WHAT     IT   THE    PURPOSE       OF    YOUR       TESTIMONY      IN   THIS

 2        PROCEEDING?

 3   A.   The purpose of my testimony is to rebut the Direct Testimony of Bernard

 4        Ayanrouh submitted on behalf of the Office of Ratepayer Advocates (ORA)

 5        and the Direct Testimony of Michael J. Majoros, Jr., submitted on behalf of

 6        The Utility Reform Network (TURN).

 7   Q.   WHAT IS THE SUBJECT OF YOUR REBUTTAL TESTIMONY?

 8   A.   The subject of my rebuttal testimony is net salvage. Within the overall topic

 9        of net salvage, I will discuss third party reimbursements, depreciation

10        concepts,     “excessive    depreciation”,    the    differences    between

11        financial/regulatory reporting and ratemaking, Southern California Edison‟s

12        (SCE) accumulated depreciation deficiency, the likelihood and potential

13        consequences of deregulation of SCE‟s delivery business, the estimation of

14        future net salvage, the treatment of net salvage used in other jurisdictions

15        and recommended in authoritative texts, and the alternatives to accrual

16        accounting proposed by Mr. Majoros.

17                       III. THIRD PARTY REIMBURSEMENTS

18   Q.   ORA DEPRECIATION WITNESS MR. AYANROUH HAS ADJUSTED HIS

19        ESTIMATES OF FUTURE NET SALVAGE BASED ON SCE‟S CHANGE IN

20        ACCOUNTING FOR REIMBURSEMENTS.                      IS MR. AYANROUH‟S

21        UNDERSTANDING         OF    THE    COMPANY       ACCOUNTING        CHANGE

22        CORRECT?




                                             4
 1   A.   No, it is not. Mr. Ayanrouh states that SCE previously recorded the entire

 2        reimbursement to the Accumulated Provision for Depreciation. This is not

 3        the case. SCE never charged the entire amount of the reimbursement to

 4        accumulated depreciation as salvage. The change made by SCE was to

 5        assign as gross salvage the portion of the monies received that reimbursed

 6        the Company for its net cost of retiring the old asset and to assign as a

 7        contribution in aid of construction the portion of the monies received that

 8        reimbursed the Company for the construction of the replacement asset.

 9        Previously, SCE also assigned monies to gross salvage for the net book

10        value of the asset being retired. Such amounts would now effectively be

11        considered a reimbursement for the amount expended on the new plant.

12        The difference between the amount recorded as gross salvage using the

13        new approach and the amounts recorded previously is relatively small

14        compared to the overall amount of reimbursement.              Mr. Ayanrouh‟s

15        assumption regarding the impact of the change is incorrect.

16   Q.   WHAT IS THE RATIONALE FOR THE CHANGE IN ACCOUNTING

17        PRACTICE REGARDING THIRD PARTY REIMBURSMENTS?

18   A.   The new approach better aligns the accounting with the purpose of the

19        reimbursement, i.e., to make the Company whole for the current

20        expenditures imposed on it by the third party. As compared to the previous

21        accounting, this approach reduces the amount of gross salvage recorded to

22        Accumulated Provision for Depreciation and reduces the amount of net




                                            5
 1        plant recorded to Electric Plant in Service.   The improved alignment of

 2        amounts received with their intended purpose is appropriate.

 3   Q.   DO THE HISTORICAL INDICATIONS OF NET SALVAGE PERCENTS

 4        REQUIRE ADJUSTMENT TO REFLECT GREATER AMOUNTS OF

 5        GROSS SALVAGE AS DONE BY MR. AYANROUH?

 6   A.   The estimates of net salvage should not be adjusted to reflect additional

 7        amounts of gross salvage. The amounts reflect the current and prospective

 8        practice which is reasonable as it better aligns the reimbursement amounts

 9        with the costs they are intended to offset.

10

11                        IV. TURN’S NET SALVAGE POSITION

12   Q.   PLEASE SUMMARIZE THE POSITION OF TURN WITNESS MR.

13        MAJOROS REGARDING THE RATEMAKING TREATMENT OF NET

14        SALVAGE FOR SCE.

15   A.   Mr. Majoros has proposed that the net salvage component of the annual

16        depreciation accrual rate be eliminated and replaced with a net salvage

17        expense allowance based on the annual average net salvage costs

18        experienced during the most recent five-year period.

19   Q.   WHAT ARE THE BASES FOR HIS PROPOSAL?

20   A.   The bases for the proposal of Mr. Majoros as stated on page 6 of his direct

21        testimony are his view that SCE‟s proposal results in “excessive

22        depreciation”, recent accounting pronouncements, and his opinion that SCE




                                              6
 1        does not have an accumulated depreciation deficiency, but rather, a

 2        significant liability to ratepayers.

 3   Q.   IS IT APPROPRIATE FOR RATEMAKING PURPOSES TO EXPENSE NET

 4        SALVAGE COSTS IN THE MANNER PROPOSED BY MR. MAJOROS?

 5   A.   No, it is not. The amount of net salvage that should be included in the annual

 6        cost of service and collected from current customers is a portion of the net

 7        salvage related to the current plant in service as a result of allocating these

 8        costs to each year of service rendered by such plant. The amount should not

 9        reflect only the current net salvage costs. Current net salvage costs are

10        related to plant that previously rendered service.

11                 Allocating net salvage costs during the life of the related plant is

12        more appropriate and equitable and is in accord with authoritative texts.

13        Delaying collection until such costs are incurred results in a charge to

14        customers for plant from which they did not receive service and, as a result of

15        the delay in recovery, also results in higher revenue requirements related to

16        net salvage.

17   Q.   PLEASE EXPLAIN YOUR LAST STATEMENT RELATED TO THE

18        REVENUE REQUIREMENTS RELATED TO NET SALVAGE.

19   A.   The revenue requirements that result from the expensing option proposed

20        by Mr. Majoros are greater than the revenue requirements that result from

21        accruing for net salvage during the life of the related asset. Although a

22        comparison of the current revenue requirements related to a net salvage

23        accrual and the current revenue requirements related to expensing of net




                                                 7
 1        salvage may indicate that the accrual is higher at a single point in time, over

 2        time the revenue requirements and the present value of those revenue

 3        requirements will be less if the net salvage cost is accrued over the life of

 4        the asset.

 5                The reason for the lower revenue requirements with the accrual of

 6        net salvage is the impact of the accruals on rate base. That is, as net

 7        salvage accruals are recorded to the depreciation reserve, the balance in

 8        the reserve increases and reduces subsequent determinations of rate base

 9        in comparison to Mr. Majoros‟ expensing proposal.

10   Q.   DO YOU AGREE WITH MR. MAJOROS‟ PROPOSAL AND THE

11        CONSIDERATIONS ON WHICH IT IS BASED?

12   A.   No, I do not.    Mr. Majoros is proposing a radical departure from the

13        traditional approach that has been used by SCE and other California utilities

14        for decades. Other than his opinion that the amount proposed by SCE is

15        “excessive” and his characterization of SCE‟s regulatory liability related to

16        assets for which it does not have an asset retirement obligation, Mr.

17        Majoros‟ sole evidence in support of his proposal are the recent accounting

18        pronouncements that apply to financial accounting. In effect, Mr. Majoros

19        has imposed a standard for financial accounting on the ratemaking process.

20        This is inappropriate and does not incorporate all the factors that should be

21        considered in ratemaking, particularly the equitable treatment of different

22        generations of customers. Mr. Majoros‟ proposal suffers from short-term

23        thinking. It is designed to reduce rates for today‟s customers, but does so




                                              8
 1        at the expense of tomorrow‟s customers. The Commission should reject

 2        this radical proposal and continue with traditional accrual accounting for net

 3        salvage. The remainder of this statement, as well as the statements of

 4        Messrs. Pierce and Umbaugh, will address the concepts and theories put

 5        forth by Mr. Majoros and also his criticisms of the traditional approach to

 6        accruing for net salvage.

 7                           V. DEPRECIATION CONCEPTS

 8   Q.   IN EXHIBIT ___(MJM-1), MR. MAJOROS HAS PROVIDED A DISCUSSION

 9        OF    DEPRECIATION          CONCEPTS.           DO     YOU      HAVE      ANY

10        DISAGREEMENTS          WITH     THE     STATEMENTS        MADE      IN   THIS

11        DOCUMENT?

12   A.   Yes, I do. Mr. Majoros‟ concept of public utility depreciation is not the same

13        as the concept set forth in the Uniform System of Accounts and authoritative

14        texts on the subject. He states on page 1 of Exhibit___(MJM-1) that “public

15        utility depreciation is straight line capital recovery” and “is accomplished by

16        allocating the original cost of assets to expense…” He repeats this concept

17        again at the bottom of page 2. Depreciation is not simply the allocation of

18        original cost to expense.      The Uniform System of Accounts defines

19        depreciation as “the loss in service value not restored by current

20        maintenance incurred in connection with the consumption or prospective

21        retirement of property in the course of service from causes which are known

22        to be in current operation and against which the utility is not protected by

23        insurance.” The operative words in this definition that differ markedly from




                                              9
 1        Mr. Majoros‟ definition are service value. The Uniform System of Accounts

 2        goes on to define service value as “the difference between the original cost

 3        and the net salvage value of the utility plant”, not as just the original cost.

 4        The service value rendered by an asset, i.e., depreciation, must reflect both

 5        its original cost and its net salvage.

 6   Q.   DOES THE UNIFORM SYSTEM OF ACCOUNTS ALSO ADDRESS THE

 7        MANNER IN WHICH DEPRECIATION IS TO BE RECOGNIZED?

 8   A.   Yes, it does. The Uniform System of Accounts requires that depreciation be

 9        recognized through accrual accounting. That is, the service value of an

10        asset must be accrued during the life of the asset. Since net salvage is a

11        part of the service value, it must be accrued during the life of the related

12        asset in order to comply with the Uniform System of Accounts. Mr. Majoros‟

13        proposal to expense net salvage is in conflict with the Uniform System of

14        Accounts.

15   Q.   SHOULD RATEMAKING NECESSARILY BE DRIVEN BY THE UNIFORM

16        SYSTEM OF ACCOUNTS?

17   A.   Not necessarily. However, the Uniform System of Accounts was developed

18        for public utilities and adopted by regulatory commissions to provide useful

19        information for regulatory reporting and ratemaking purposes. This can not

20        be said of GAAP. In particular, the definition of depreciation used in the

21        Uniform System of Accounts considers issues such as customer equity and

22        matching that are no longer reflected in GAAP.




                                               10
 1   Q.   PLEASE CONTINUE WITH YOUR REVIEW                        OF MR. MAJOROS‟

 2        DISCUSSION OF DEPRECIATION CONCEPTS AS PRESENTED IN HIS

 3        EXHIBIT___(MJM-1).

 4   A.   Mr. Majoros makes several inaccurate or misleading statements throughout

 5        this exhibit. On page 1, he states that ”in certain jurisdictions public utility

 6        depreciation rates incorporate net salvage factors”.         A more accurate

 7        statement would be “in nearly all jurisdictions public utility depreciation rates

 8        incorporate net salvage factors”. I will discuss the policy of several state

 9        commissions on this subject later in my testimony. At the top of page 5, he

10        states “Some utilities, such as SCE, include net salvage in the depreciation

11        rate calculation.” The accuracy of this statement also would be improved by

12        stating “Nearly all utilities, including SCE, include net salvage in the

13        depreciation rate calculation.”

14                 On page 3, Mr. Majoros states “…but no cash flows out of the

15        company for depreciation expense.” This is a true statement, but also may

16        leave an incorrect impression.        In order for the company to record

17        depreciation expense, it must have first experienced a cash outflow which is

18        represented by the original cost of the asset.

19                 Mr. Majoros claims on page 5 that the net salvage adjustment in

20        the numerator of the equation for the annual depreciation accrual rate is

21        “equivalent to capitalizing or adding the estimated cost of removal to the

22        original cost of the asset”. This is only true mathematically with respect to

23        the formula for the annual depreciation accrual. It is not true conceptually




                                              11
 1   and such amounts are not capitalized for rate base or any other purpose.

 2   He goes on to say in the concluding paragraph on page 5 that “when

 3   negative net salvage is included in the depreciation rate there will not be an

 4   equality of plant and reserve at the end of an asset‟s life because the

 5   Company will have charged more depreciation than it paid for the original

 6   cost of the asset.” Of course they will have charged more than the original

 7   cost. The total depreciation expense must equal the sum of the original cost

 8   and the negative net salvage, not just the original cost.          This is in

 9   accordance with the definition of depreciation as set forth in the Uniform

10   System of Accounts and authoritative texts on the subject of public utility

11   depreciation. Once the net salvage costs are incurred, the equality of plant

12   and reserve at the end of an asset‟s life is restored.

13           Mr. Majoros continues his assault on net salvage at the top of page

14   6 by implying that the equality of depreciation expense with company

15   expenditures, original cost and negative net salvage, “will only be achieved

16   if the Company actually spends the additional money at the end of the

17   asset‟s life. However, unless the Company has a legal liability to remove

18   the asset, it is not required to spend the money.” While SCE does not have

19   a legal obligation to remove plant, it does have an obligation to provide

20   service. In order to provide service, SCE must continually renew its plant by

21   adding new assets and retiring old assets.          SCE has been spending

22   significant sums to retire plant for many years. I see no reason to suspect

23   that it will not continue to do so for many more to come. It is not as though




                                         12
 1       there is room along the pole line or in the substation to leave the existing

 2       facilities in place when they are replaced. Mr. Majoros then suggests that

 3       the amounts recovered from ratepayers for negative net salvage could be

 4       used to pay “salaries, dividends, etc.” While it is true that dollars paid by

 5       customers are not earmarked, it is disingenuous to suggest that dollars

 6       recovered for negative net salvage would be used for anything other than

 7       plant expenditures. Each year SCE spends significantly more on plant, both

 8       its installation and removal, than it recovers in depreciation expense.1

 9               On page 9, Mr. Majoros concludes his discussion of Depreciation

10       Concepts with an unsupported claim that “Many of SCE‟s proposed

11       depreciation rates contain negative net salvage factors which charge too

12       much for future cost of removal because they are too negative.” Having

13       established this unsupported supposition, he concludes “The combination of

14       these two factors, i.e., understated lives and overstated cost of removal

15       ratios, compounds the excessive depreciation rate problem.” While that

16       would be a true statement if the supposition were correct, it does not

17       comport with the overwhelming evidence in this proceeding. In my opinion,

18       many of SCE‟s existing depreciation rates contain negative net salvage

19       factors which charge too little for future cost of removal.and compound the

20       inadequate depreciation rate problem.


     1
      SCE said as much in a response to DR-TURN-DEP-03, Question 11 (e):
     “SCE’s capital requirements for both plant additions and cost of
     removal have been much greater than the cash flow derived from
     authorized revenue associated with depreciation accruals. For example,
     the depreciation accrued over the year 2003 is approximately $732.1
     million, far less than the average annual capital spending presented in
     this proceeding of $1.8 billion.”


                                            13
 1                           VI. EXCESSIVE DEPRECIATION

 2   Q.   AT THE TOP OF PAGE 9 OF HIS DIRECT TESTIMONY AND IN

 3        EXHIBIT___(MJM-4),      MR.    MAJOROS        REFERS      TO    THE        TERM

 4        EXCESSIVE DEPRECIATION. PLEASE COMMENT.

 5   A.   Mr. Majoros expresses his concern over the possibility that the Company‟s

 6        depreciation rates will produce depreciation expense that is “more than

 7        necessary to return ...capital investment over the life of an asset.” He cites

 8        the 1934 decision of the U.S. Supreme Court in Lindheimer v. Illinois Bell

 9        Telephone Company in support of his concern. In Lindheimer, the Court

10        held that the company‟s depreciation was excessive and, therefore,

11        represented a contribution of capital. The court determined that the annual

12        depreciation allowances that resulted from the “studies of the „behavior of

13        large groups‟ of items” must “meet the controlling test of experience.” Mr.

14        Majoros failed to include in his quote the very next sentence in which the

15        controlling test used by the court was described:

16                “ In this instance, the evidence of expert computations of the
17                amounts required for annual allowances does not stand
18                alone. In striking contrast is the proof of the actual condition
19                of the plant as maintained...”
20
21        The concept of physical depreciation referred to in this sentence is no

22        longer used in the determination of rate base in public utility regulation.

23        Instead, largely as a result of the 1944 decision of the U. S. Supreme Court

24        in Federal Power Commission et al v. Hope Natural Gas Co., net investment

25        has become the primary, if not exclusive, means of determining rate base.

26        In this approach, the Accumulated Provision for Depreciation as recorded



                                             14
 1        on the company‟s books is deducted from original cost. The Accumulated

 2        Provision for Depreciation reflects the past allowances for depreciation

 3        whether they have been excessive or inadequate.            Thus, these past

 4        allowances are used to limit the amount on which the utility is permitted to

 5        earn a return and, in jurisdictions such as California that adjust the annual

 6        depreciation to reflect the level of the Accumulated Provision for

 7        Depreciation as compared to the calculated or theoretical reserve, they also

 8        are used to limit the amount that will be recovered through future

 9        depreciation allowances.

10                VII. FINANCIAL ACCOUNTING AND RATEMAKING

11   Q.   BEGINNING ON PAGE 9 OF HIS TESTIMONY, MR. MAJOROS

12        DISCUSSES FINANCIAL ACCOUNTING STANDARD (FAS) NO. 143,

13        FEDERAL ENERGY REGULATORY COMMISSION (FERC) ORDER NO.

14        631, AND HIS VIEW OF THEIR APPLICABILITY TO THIS PROCEEDING.

15        DOES FAS NO. 143 HAVE ANYTHING TO DO WITH RATEMAKING IN

16        GENERAL AND THIS PROCEEDING IN PARTICULAR?

17   A.   No, it does not. In fact, after 30 pages of trying to convince the reader that

18        the addition of FAS No. 143 to Generally Accepted Accounting Principles

19        (GAAP) will somehow lead to enlightenment, Mr. Majoros finally comes to

20        the conclusion on page 39, line 29, that “GAAP does not control

21        ratemaking…”     Generally Accepted Accounting Principles (GAAP), as

22        embodied in the statements of the Financial Accounting Standards Board

23        (FASB), have in recent years moved away from the matching principle in




                                             15
 1        favor of an asset and liability based approach. While this movement may

 2        improve a potential investor‟s ability to ascertain a company‟s financial

 3        condition, compliance with such standards for ratemaking purposes would

 4        violate principles of customer equity. Please refer to the Direct Testimony of

 5        Jan Umbaugh for a more in-depth discussion of FAS No.143.

 6                 Expensing the costs of retiring plant, the effect of Mr. Majoros‟

 7        proposal, results in charges to today‟s customers for plant that served

 8        customers in the past. This approach violates the principles of matching

 9        and customer equity and has no place in ratemaking or regulatory

10        accounting.

11                 Further, the legal obligation standard of FAS No. 143 for

12        recognizing a liability to retire plant does not recognize the reality of ongoing

13        utility operations. Although the utility may not have a legal obligation to

14        remove plant, it nevertheless does so on a regular basis and will continue to

15        do so in the future.       The Uniform System of Accounts states that

16        depreciation represents the loss in service value, where service value is the

17        original cost less net salvage. Thus, net salvage is a capital cost to be

18        recovered through depreciation accruals.         It is appropriate that such

19        recovery comes from the customers served by the related plant.

20   Q.   DOES FERC ORDER NO. 631 HAVE ANY IMPACT ON THIS

21        PROCEEDING?

22   A.   Not really. FERC Order No. 631 modified the Uniform System of Accounts

23        to allow utilities to record the entries required for financial reporting by FAS




                                              16
 1        No. 143 on the books maintained for regulatory accounting.            FERC

 2        specifically stated that the order did not affect existing tariffs. The order

 3        simply provides the accounting structure that enables the identification of

 4        amounts for use in financial statements and those for use in ratemaking

 5        proceedings.

 6   Q.   ON PAGE 11, LINES 17 THROUGH 19, MR. MAJOROS STATES THAT

 7        THERE IS A “NEED FOR THE CPUC TO SPECIFICALLY RECOGNIZE A

 8        REGULATORY LIABILITY FOR REGULATORY AND RATE-MAKING

 9        PURPOSES.” DO YOU AGREE?

10   A.   No, I do not. As I stated above, FAS No. 143 is a financial accounting

11        standard and, as Mr. Majoros agrees, does not control ratemaking. There is

12        no need to recognize a financial accounting entry for ratemaking purposes,

13        particularly when it is contrary to the cardinal ratemaking tenet of

14        intergenerational equity.

15                VIII. ACCUMULATED DEPRECIATION DEFICIENCY

16   Q.   MR. MAJOROS STATES ON PAGE 8, LINES 7 THROUGH 9, THAT “SCE

17        DOES NOT HAVE AN ACCUMULATED RESERVE DEFICIENCY, IT HAS

18        A HUGE ACCUMULATED DEPRECIATION RESERVE EXCESS. DO YOU

19        AGREE?

20   A.   No, I do not.    Mr. Majoros bases his conclusion on his calculations of

21        theoretical accumulated depreciation and the incorporation of            the

22        accumulated depreciation excess related to Nuclear Production Plant. First,

23        the accumulated depreciation excess for Nuclear Production Plant is the




                                            17
 1        result of specific orders of the CPUC intended to reduce the amount of

 2        unrecovered costs for these plants. Second, the theoretical accumulated

 3        depreciation calculated by Mr. Majoros for the other functions does not use

 4        the more accurate formula that is used by SCE.             Mr. Majoros has

 5        determined future accruals based on whole life accruals that were

 6        calculated using future net salvage, rather than using average net salvage,

 7        consistent with the average service life procedure. These amounts, i.e.,

 8        future net salvage and average net salvage, are often sufficiently close to

 9        one another that the use of Mr. Majoros‟ approach is adequate. However,

10        when average and future net salvage are different, the formula that he used

11        is incorrect. Thus, he can not replicate Mr. Pierce‟s calculations and his

12        conclusions are based on his inaccurate calculations.

13   Q.   MR.    MAJOROS         ALSO      DISCUSSES     THE   RECORDING       OF   A

14        REGULATORY           LIABILITY    BY     SCE   FOR   ITS   ACCUMULATED

15        DEPRECIATION RELATED TO THE FUTURE REMOVAL COST OF

16        ASSETS FOR WHICH IT DOES NOT HAVE A LEGAL OBLIGATION TO

17        RETIRE THE PLANT ON PAGES 10 AND 11 OF HIS TESTIMONY. DOES

18        THE REGULATORY LIABILITY RECORDED BY SCE REPRESENT A

19        DEPRECIATION RESERVE EXCESS AS HE INDICATES AT THE TOP OF

20        PAGE 11?

21   A.   Absolutely not.      The amount recorded as a regulatory liability for these

22        assets represents the extent to which past accruals have exceeded past

23        costs of retiring.     They do not represent an indication of whether that




                                              18
 1        amount, along with future accruals, will be sufficient to offset future costs of

 2        removal.   Past accruals need to have exceeded past costs in order to

 3        recognize the cost of removal portion of the service value rendered in the

 4        past by assets presently in service. In fact, as demonstrated by Mr. Pierce

 5        in his direct evidence, these past accruals have been inadequate or

 6        deficient. Mr. Majoros reaches his conclusion by assuming that accrual

 7        accounting will be abandoned and future costs of removal will be treated as

 8        an operating expense, thus eliminating the need for the past accruals.

 9        Making such a statement without notifying the reader of such a significant

10        assumption is misleading.

11                          IX. THE DEREGULATION SCARE

12   Q.   ON PAGES 14 THROUGH 19, MR. MAJOROS RAISES THE SPECTER

13        THAT THE PAST ACCRUALS TOWARD FUTURE COST OF REMOVAL

14        “WILL DISAPPEAR FROM THE SCENE…” WHAT APPEARS TO BE THE

15        GENESIS OF HIS CONCERN?

16   A.   Mr. Majoros states that he is “concerned with SCE‟s stated proviso” in

17        response to a data request in which the Company said “...provided that SCE

18        remains a regulated utility…”

19   Q.   SHOULD THIS STATEMENT BE A CAUSE FOR CONCERN?

20   A.   No, it should not. Apparently, as noted above, Mr. Majoros is not familiar

21        with the concept of qualifying statements.       SCE‟s proviso represents a

22        qualification of a statement made in response to a data request. The data

23        request related to financial accounting. Certain entries made for financial




                                              19
 1        accounting purposes are done pursuant to Statement of Financial

 2        Accounting Standard No. 71, Accounting for the Effects of Certain Types of

 3        Regulation.   If SCE were not regulated, this standard would not apply.

 4        Thus, in its response, it simply qualified its answer that continued reliance

 5        on SFAS No. 71 presumes continued regulation of SCE.              No hidden

 6        agendas, no undercurrents, simply a qualification to a statement in order

 7        that the statement is complete.


 8   Q.   IN THE EVENT THAT SCE‟S DELIVERY BUSINESS IS DEREGULATED,

 9        DO YOU BELIEVE THAT THE PAST ACCRUALS FOR FUTURE NET

10        SALVAGE WILL DISAPPEAR?


11   A.   No, I do not. I‟m certain that such deregulation would be the subject of

12        proceedings before the CPUC and that the Commission, SCE, and groups

13        such as TURN would work together to develop an equitable transition from

14        regulation to deregulation. For further confirmation of this certainty, please

15        refer to the description of a similar situation that occurred for SCE as set

16        forth in the Rebuttal Testimony of Rob Pierce.


17   Q.   ON PAGE 19, LINES 8 THROUGH 11, MR. MAJOROS MAKES THE

18        FOLLOWING STATEMENT:


19                “THEREFORE, AT THE MOMENT, THERE IS NO
20                REGULATORY RECOGNITION OF SUCH A LIABILITY
21                AND THERE IS NO PROVISION FOR A REFUND TO
22                RATEPAYERS IF THE AMOUNTS THEY HAVE PAID ARE
23                NOT   SPENT   ON   COST   OF   REMOVAL    OR
24                DISMANTLEMENT.”



                                             20
 1        IS THIS STATEMENT CORRECT?

 2   A.   No, it is not.   Although the amount which Mr. Majoros is referring to is

 3        recorded as a regulatory liability for financial reporting purposes, for

 4        ratemaking purposes it is reflected in the Accumulated Provision for

 5        Depreciation. This amount is deducted from rate base and also is deducted

 6        from the determination of future accruals when calculating annual

 7        depreciation. If the past accruals recorded to this account for future cost of

 8        removal are not so spent, there is a provision in remaining life depreciation

 9        for the reduction of future accruals. There are regulatory mechanisms that

10        recognize this amount.     They are called net investment rate base and

11        remaining life depreciation.

12   Q.   IS THERE A NEED FOR THE PAST ACCRUALS FOR FUTURE NET

13        SALVAGE TO BE SPECIFICALLY RECOGNIZED AS A REGULATORY

14        LIABILITY FOR RATEMAKING PURPOSES?

15   A.   No, there is not. These amounts are separately identified in SCE‟s books

16        and records for Account 108, Accumulated Provision for Depreciation, and

17        used in its determination of rate base and its calculations of remaining life

18        depreciation rates. This treatment has afforded protections to ratepayers for

19        many years and is adequate to do so for many more.

20   Q.   ON PAGE 21, MR. MAJOROS OFFERS THREE ALTERNATIVES FOR

21        DISPOSITION OF THE REGULATORY LIABILITY: (1) A PERMANENT

22        RATE BASE OFFSET, (2) AMORTIZATION BACK TO RATEPAYERS,




                                             21
 1         AND (3) ONGOING REMAINING LIFE COST OF REMOVAL RATE.

 2         WHICH DO YOU RECOMMEND?

 3   A.    I recommend that the past accruals for future costs of removal be reflected

 4         in the calculation of an ongoing annual depreciation rate related to the

 5         recovery of cost of removal from customers receiving the service provided

 6         by the plant for which the removal costs will be incurred. Such accruals will

 7         offset rate base until the amounts are expended for removal cost. There is

 8         no need for a separate amortization to ratepayers and it would not be

 9         appropriate to do so.

10                          X. ESTIMATION OF NET SALVAGE

11   Q.    BEGINNING ON PAGE 23 OF HIS TESTIMONY, MR. MAJOROS

12         DESCRIBES WHAT HE REFERS TO AS THE TRADITIONAL INFLATED

13         FUTURE COST APPROACH OR TIFCA. ARE YOU FAMILIAR WITH THE

14         APPROACH BEING DESCRIBED BY MR. MAJOROS?

15   A.    Yes, I am.

16   Q.    HAVE YOU EVER HEARD OR READ OF IT REFERRED TO AS “TIFCA”?

17   A.    No, I have not. The name and related acronym have been constructed by

18         Mr. Majoros.2

19   Q.     ON PAGE 24, MR. MAJOROS STATES THAT “TIFCA” NET SALVAGE

20         STUDIES RELATE REMOVAL COSTS IN CURRENT DOLLARS TO

21         RETIREMENTS IN HISTORICAL DOLLARS. IS THAT CORRECT?

22   A.    Yes, it is. Traditional studies of net salvage use as their statistical bases


     2
         Response to DR-SCE-TURN-DEP-01



                                             22
 1        data that relate the cost of retiring an asset or group of assets to its original

 2        cost.

 3   Q.   WHAT WERE THE STATISTICAL BASES FOR MR. PIERCE‟S NET

 4        SALVAGE ESTIMATES?

 5   A.   The statistical bases for his estimates of net salvage were the historical net

 6        salvage costs as a percent of the original cost of the retired assets that

 7        produced the gross salvage or required the costs to remove.

 8   Q.   DOES THE USE OF THIS STATISTICAL BASIS RESULT IN THE

 9        COLLECTION OF FUTURE INFLATED COSTS TO REMOVE FROM

10        CURRENT CUSTOMERS?

11   A.   Yes, to a certain extent. The reliance on historical indications of net salvage

12        as a percent of the original cost retired will result in the collection of net

13        salvage costs at a future price level. However, such reliance also assumes

14        that there will be substantial improvements in technology, comparable or

15        lesser environmental regulations and a significant reduction in inflation.

16   Q.   HOW     DOES     USE    OF    NET     SALVAGE      PERCENTS        THAT      ARE

17        COMPARABLE TO THE HISTORICAL INDICATIONS ASSUME THESE

18        EVENTS?

19   A.   The net salvage percents, that is the net salvage costs divided by the

20        original costs of the assets that have been retired and expressed as

21        percents, are related to the retirement of plant that on average is

22        significantly younger than the average service life of the plant in service, on

23        an original cost dollar weighted basis. For example, the average age of




                                              23
 1        retirements of distribution overhead conductors during the period 1994

 2        through 2003 was 13.2 years. This amount is less than one-third of the

 3        average life of 45 years estimated for this account.

 4                 The average net salvage percent related to these retirements,

 5        made on average at age 13.2, was negative 102 percent. That is, after 13.2

 6        years in service, the plant was retired and the cost to remove the plant, as a

 7        result of inflation, technological changes and other factors, was 102 percent

 8        of the cost to install the same plant.

 9                 The future retirements of the total current distribution overhead

10        conductors in service will have an average age that actually exceeds the

11        average life.   Thus, future retirements will be of plant that has been in

12        service nearly four times as long as the plant retired during the period

13        1994-2003. For retirements at such ages to experience net salvage that is

14        120 percent of the cost to install, the estimate of Mr. Pierce, there will have

15        to be a reduction in the rate of inflation adjusted for technological

16        improvements.        If the rate of inflation adjusted for technological

17        improvements that occurred between the installation and retirement of plant

18        retired during the period 1994-2003 occurred over a period that is nearly

19        four times as long, the net salvage cost would be much greater as a percent

20        of the original cost of the plant retired.

21   Q.   WHAT IS THE IMPLICATION OF THE ASSUMPTION THAT THE FUTURE

22        RATE      OF      INFLATION         ADJUSTED      FOR     TECHNOLOGICAL

23        IMPROVEMENTS WILL BE LESS THAN THE HISTORICAL RATE?




                                                24
 1   A.   The implication of this assumption as reflected in Mr. Pierce‟s estimates of

 2        net salvage percents is that the resultant net salvage accruals are most

 3        likely inadequate to recover the total net salvage costs over the entire life

 4        cycle of the plant currently in service.

 5   Q.   DO YOU HAVE ANY CONCERN THAT THE LEVEL OF NET SALVAGE

 6        COSTS INCURRED WILL BE LESS THAN THE AMOUNTS THAT MR.

 7        PIERCE HAS ESTIMATED?

 8   A.   No, I do not. Net salvage costs will be incurred. The estimates that have

 9        been made by Mr. Pierce will almost certainly result in the recovery of less,

10        not more, net salvage than the actual costs incurred.

11   Q.   IS IT APPROPRIATE TO ASK CURRENT CUSTOMERS TO PAY FOR

12        FUTURE COSTS OF REMOVAL AT A PRICE LEVEL THAT IS GREATER

13        THAN TODAY‟S PRICE LEVEL?

14   A.   Yes, it is. The future cost to remove an item of plant is part of the service

15        value that it renders to current customers and a ratable portion of such costs

16        should be recovered from these customers.          That is the definition of

17        depreciation, i.e., the loss in service value during a specific period.    As

18        these future costs are recovered from current customers, they are deducted

19        from rate base. This deduction in the amount on which the utility is entitled

20        to earn a fair return, in effect, represents an amount on which the customer

21        earns a return. That is, as customers provide for the future cost of removal,

22        they receive a return on such amounts.        This is fair compensation for

23        making payment prior to the cost incurrence by the utility.       Further, as




                                               25
 1        already noted, by charging customers for these costs during the life of the

 2        plant; the customers that benefit from the plant, or consume its service

 3        value, are the ones that pay for such service. Customers paying today for

 4        future costs of removal and receiving a return on such payments is no

 5        different than the utility recovering today amounts that it invested many

 6        years ago, but on which it earned a return until the amount was recovered

 7        from customers.

 8   Q.   WHY ARE THE CURRENT NET SALVAGE ACCRUALS SO MUCH

 9        GREATER THAN THE CURRENT EXPERIENCE?

10   A.   The difference in price level as described above is part of the difference.

11        Another significant difference is that the current experience is related to

12        plant retirements that largely come from an older plant base that was

13        constructed to serve fewer customers, whereas the current net salvage

14        accruals relate to the plant presently in service that serves a much larger

15        customer base.

16   Q.   IS IT APPROPRIATE FOR SCE TO COLLECT AMOUNTS FOR FUTURE

17        NET SALVAGE COSTS THAT ARE GREATER THAN THE AMOUNTS

18        CURRENTLY EXPENDED FOR SUCH COSTS?

19   A.   Yes, it is.   Although the amount that SCE proposes to collect from

20        customers for future net salvage costs is greater than the amount currently

21        expended for such costs, the amount that SCE spends for plant additions is

22        far greater than the amount that it proposes for the recovery of original cost.

23        If net salvage accruals should be limited to current net salvage




                                             26
 1        expenditures, why shouldn‟t the portion of depreciation expense related to

 2        the recovery of original cost be increased to the current level of plant

 3        additions? For example, in the year 2003, SCE‟s total plant additions were

 4        $991 million. Adding the net salvage costs of $87 million for that year to this

 5        amount results in total expenditures of $1,078 million in 2003. This total

 6        expenditure is approximately $346 million, or 47% greater than the 2003

 7        recorded level of depreciation expense that includes the recovery of past

 8        original costs and future net salvage costs. When both sides of the coin are

 9        considered, the amount for recovery of costs is far less than actual

10        expenditures.   Equity considerations require that customers pay for the

11        service value, original cost less net salvage, of the plant from which they

12        receive service. The fact that this results in accruals for net salvage that are

13        greater than the currently experience is not unfair.

14   Q.   WHY IS IT MORE APPROPRIATE AND EQUITABLE TO RECOGNIZE

15        NET SALVAGE COSTS DURING THE LIFE OF THE RELATED PLANT?

16   A.   The net salvage cost of an item of plant is a part of its service value and,

17        therefore, it is a part of the item‟s cost of providing service. The cost of the

18        item providing service should be collected from the customers that receive

19        the service. Thus, an allocable portion of the net salvage cost should be

20        recovered each year from the customers receiving the value of the service

21        rendered by the item of plant in the same way that an allocable portion of

22        the item‟s original cost is recovered from such customers each year. This




                                              27
 1        approach is equitable in that customers are responsible for the costs of

 2        plant that provide service to them. This is a sound ratemaking principle.

 3                In contrast, expensing of net salvage recovers this entire element of

 4        an item‟s cost of service from customers that either did not receive service

 5        from the item or, if the customer has received service from the Company for

 6        a number of years, received only a portion of the item‟s service value. This

 7        is not equitable and violates the principle that customers should pay the

 8        costs of the plant that provides service to them.

 9   Q.   PLEASE ILLUSTRATE THIS PRINCIPLE AS IT APPLIES TO NET

10        SALVAGE COSTS WITH A SIMPLE EXAMPLE.

11   A.   Consider a single customer, Customer A, served by a section of distribution

12        pole line that does not provide service to other customers. The original cost

13        of the pole line is $4,500 and it is installed when the customer is added to

14        the system. The estimated life of the pole line is 45 years and the estimated

15        net salvage is negative 50 percent. The annual depreciation expense to be

16        recovered from this customer using the straight line accrual of net salvage is

17        $150 per year ($4,500 x 1.50 / 45 years). The annual depreciation expense

18        to be recovered from this customer using the expensing of net salvage

19        approach is $100 per year ($4,500 / 45 years).

20                In year 30, the customer moves out and another customer,

21        Customer B, moves into the residence served by this pole line. During the

22        30 years, a total of $4,500 ($150 x 30 years) was collected from the




                                             28
 1   Customer A under the straight line accrual of net salvage. Only $3,000

 2   ($100 x 30 years) would be collected under the expensing approach.

 3           At the end of year 45, the pole line is replaced at a total cost of

 4   $6,750, $2,250 to remove the old pole line and $4,500 to install the new

 5   pole line. (I have excluded inflation from the example to promote a better

 6   understanding of the principle.) Under the straight line accrual method, the

 7   depreciation expense in year 46 would continue at $150 ($4,500 x 1.50 / 45

 8   years). Under the expensing method proposed by Mr. Majoros, the sum of

 9   the depreciation and net salvage expense would be $550 ($4,500 / 45 years

10   + $2,250/5) in years 46 through 50 and then decline once again to $100

11   ($4,500 / 45 years) in years 51 and later.

12           At the end of year 60, after 30 years as a customer, Customer B

13   moves out of the residence. The total depreciation expense collected from

14   this customer during years 31 through 60 under the straight line accrual

15   method of net salvage is $4,500 ($150 x 30 years), the same as was

16   collected from Customer A for a similar amount of service. However, the

17   total amount of depreciation and net salvage expense collected from

18   Customer B using the expense approach is $5,250 ($100 x 25 years + $550

19   x 5 years), significantly more than the $3,000 collected from Customer A.

20           This illustrates the inequity, i.e., customers paying different

21   amounts for the same service, of the expensing approach. The example

22   also confirms the equity, i.e., customers paying the same amount for the




                                        29
 1        same service, and the sound ratemaking policy embodied in the straight line

 2        accrual method of net salvage that is used by nearly all regulatory bodies.

 3   Q.   DOES THIS SIMPLE EXAMPLE REALLY APPLY OVER TIME GIVEN THE

 4        EXISTENCE OF INFLATION AND SERVICE BEING PROVIDED TO MANY

 5        CUSTOMERS, NOT ONE CUSTOMER?

 6   A.   Yes, it does. Although the addition of customers and the introduction of

 7        inflation into the simple example described above make it complex, the

 8        principle that is illustrated remains the same. The real system is only the

 9        summation of many, many instances that are identical to the illustration.

10    XI. DEPRECIATION TEXTS AND TREATMENT IN OTHER JURISDICTIONS

11   Q.   DO AUTHORITATIVE TEXTS ON DEPRECIATION SUPPORT MR.

12        MAJOROS‟ PROPOSAL RELATED TO NET SALVAGE?

13   A.   I am not aware of any authoritative texts on the subject of depreciation that

14        support this proposal to expense net salvage costs. The two depreciation

15        texts most often cited by depreciation experts as being authoritative support

16        the traditional approach that I have proposed. Public Utility Depreciation

17        Practices, published in 1996 by the National Association of Regulatory

18        Utility Commissioners states:

19                Closely associated with this reasoning are the accounting
20                principle that revenues be matched with costs and the
21                regulatory principle that utility customers who benefit from
22                the consumption of plant pay for the cost of that plant, no
23                more, no less. The application of the latter principle also




                                             30
 1                   requires that the estimated cost of removal of plant be
 2                   recovered over its life.3
 3
 4        Depreciation Systems, another widely accepted text states the concept in

 5        this manner:

 6                   The matching principle specifies that all costs incurred to
 7                   produce a service should be matched against the revenue
 8                   produced. Estimated future costs of retiring of an asset
 9                   currently in service must be accrued and allocated as part of
10                   the current expenses.4

11   Q.   MR. MAJOROS SUPPORTS THE EXPENSING APPROACH OF NET

12        SALVAGE BASED ON CITATIONS FROM PAGES 157 AND 158 OF

13        PUBLIC UTILITY DEPRECIATION PRACTICES. DO YOU AGREE THAT

14        THIS TEXT SUPPORTS THE EXPENSING APPROACH?

15   A.   No, I do not. As evidenced by the quotation that I cited above, clearly

16        NARUC supports the traditional approach suggested by SCE. The section

17        that Mr. Majoros refers to does not articulate NARUC‟s position on net

18        salvage, but rather points out that there is a small minority of jurisdictions

19        that have expensed net salvage.

20   Q.   WHAT OTHER STATE COMMISSIONS HAVE ALLOWED HIS 5-YEAR

21        NET SALVAGE APPROACH?

22   A.   The Pennsylvania Public Utility Commission uses the 5-year net salvage

23        amortization pursuant to a 1962 court order interpreting and applying unique

            3
                Public Utility Depreciation Practices. Page 157. National Association of

     Regulatory Utility Commissioners. 1996.
            4
                Depreciation Systems, Wolf, Frank K. and W. Chester Fitch. Page 7. Iowa

     State University Press. 1994.



                                                 31
 1        Pennsylvania law. The Kentucky Public Service Commission used it for two

 2        small electric cooperatives that did not maintain detailed records of cost of

 3        removal and gross salvage by account. In other Kentucky cases, where the

 4        utility maintains detailed records of net salvage as SCE does, the traditional

 5        methodology that I have used is adopted. The Board of Public Utilities of

 6        the State of New Jersey and the Georgia Public Service Commission have

 7        also used the expensing or five-year amortization approach.


 8   Q.   WHAT IS THE TREATMENT GIVEN TO NEGATIVE NET SALVAGE IN

 9        THE DETERMINATION OF THE ANNUAL DEPRECIATION RATES IN

10        THE VAST MAJORITY OF STATE COMMISSIONS?


11   A.   To the best of my knowledge, the 46 state utility commissions not

12        mentioned above each use the traditional treatment of incorporating

13        negative net salvage in the determination of an appropriate depreciation

14        rate, which is consistent with SCE‟s approach in this case.


15   Q.   HAVE ANY OF THESE COMMISSIONS RECENTLY DEALT WITH THIS

16        ISSUE?


17   A.   Yes, the Missouri Public Service Commission and the Indiana Utility

18        Regulatory Commission both recently affirmed the use of the traditional

19        straight line accrual of net salvage during the life of the related property.


20   Q.   PLEASE     DESCRIBE       THE     MANNER      IN WHICH        THE    MISSOURI

21        COMMISSION DEALT WITH THE ISSUE OF NET SALVAGE?



                                              32
 1   A.   The Missouri Public Service Commission has been dealing with the issue of

 2        net salvage for a number of years. It had originally adopted the expensing

 3        approach in a few cases while continuing to adopt the traditional straight

 4        line accrual method in another case. Laclede Gas Company appealed its

 5        case in which the Commission effectively adopted the expensing approach.

 6        The order was remanded to the Commission by the courts. During the

 7        remand proceeding the Commission accepted additional evidence on the

 8        subject of net salvage. In its final order, the Commission concluded:


 9                   “The Commission finds that the fundamental goal of
10                   depreciation accounting is to allocate the full cost of an
11                   asset, including its net salvage cost, over its economic or
12                   service life so that utility customers will be charged for the
13                   cost of the asset in proportion to the benefit they receive
14                   from its consumption. The Commission further finds that the
15                   method utilized by Laclede is consistent with that
16                   fundamental goal.”

17   Q.   WHAT CONCLUSIONS DID THE INDIANA COMMISSION REACH IN ITS

18        RECENT RULINGS ON THIS SUBJECT?


19   A.   The Indiana Utility Regulatory Commission considered the net salvage

20        issue in its 2004 order involving PSI Energy.          It dealt with net salvage

21        related both to production plant and to delivery assets, i.e., transmission

22        and distribution plant.       The Commission‟s conclusions regarding the

23        appropriate recognition of net salvage for both types of facilities are as

24        follows:


25                   “The next issue is the timing of the collection of such costs.
26                   The parties did not disagree that dismantling costs are a part
27                   of the cost of current facilities providing current service. They


                                                33
 1   disagreed as to the timing of the collection of such costs and
 2   their amount. This Commission can either find that current
 3   customers should pay a share of dismantling costs, which
 4   will not be incurred for a number of years, or, in the
 5   alternative, conclude that these costs should be passed on
 6   to a future generation of customers. This Commission does
 7   not believe that the latter alternative constitutes sound
 8   regulatory policy, or is based on sound ratemaking
 9   principles. Current customers are receiving service from
10   PSI's generation facilities. A part of the costs of those
11   facilities is dismantlement upon retirement. Therefore, we do
12   not believe it would be appropriate for the Company to
13   backload the dismantlement costs for future ratepayers to
14   pay when the facilities associated with these costs are
15   providing service to current customers. Rather, we find it is
16   appropriate that these costs be shared by all customers that
17   received service from PSI's generation facilities. Accordingly,
18   this Commission finds that dismantlement costs are properly
19   included in determining the depreciation rates approved in
20   this cause.

21                              …


22   We believe that there is a sound basis for the traditional
23   approach on this issue that is utilized by a majority of states.
24   Utilizing historical averages as an item to be expensed to
25   current customers means that these customers will be
26   paying for salvage costs at levels that may not be sufficient.
27   That means that the next generation of customers will be
28   paying for salvage costs related to facilities from which they
29   may never have received service. The use of best estimates
30   of future salvage costs addresses this inequity. Moreover,
31   use of historical averages for dismantling costs does not
32   take into account the current configuration of PSI's system
33   with regard to its production, transmission, distribution and
34   general facilities. Facilities in service 40-50 years ago did not
35   take into account the significantly enhanced customer base
36   that PSI now serves, nor the current configuration of PSI's
37   facilities that serve these customers. It seems appropriate to
38   utilize best cost estimates for net salvage values taking into
39   account specific facilities now serving PSI's customers in
40   developing depreciation rates that today's customers should
41   pay. Accordingly, we find that the use of historical averages
42   for net salvage values with regard to transmission,
43   distribution and general plant for the purpose of expensing



                                34
 1                them outside the context of the depreciation determination
 2                should be, and hereby is, rejected.

 3   Q.   WHAT     HAS    BEEN     THE    TREATMENT       OF    NET    SALVAGE      IN

 4        CALIFORNIA?

 5   A.   The California Public Utilities Commission has consistently used the

 6        traditional straight line accrual of net salvage as described in its Standard

 7        Practice U-4, Determination of Straight-Line Remaining Life Depreciation

 8        Accruals.

 9                        XII. THE MAJOROS ALTERNATIVES

10   Q.   BEGINNING ON PAGE 40 OF HIS TESTIMONY, MR. MAJOROS

11        PROVIDES THE COMMISSION WITH FOUR ALTERNATIVES TO THE

12        TRADITIONAL      STRAIGHT      LINE    ACCRUAL     FOR NET       SALVAGE.

13        PLEASE COMMENT ON HIS FIRST APPROACH: “EXPENSING”.

14   A.   The first alternative offered by Mr. Majoros is the cash basis or expensing

15        approach.   This is the alternative that I have referred to throughout my

16        testimony. Expensing does not charge the appropriate customers for the

17        cost of retiring an asset and should be rejected. It defers the recovery of

18        cost to customers that are no longer, or never were, served by the asset.

19        Mr. Majoros also suggests that a portion of the cost of retiring assets be

20        charged to the cost of the replacement asset. This is worse, as it further

21        defers the recovery of a cost properly attributable to the customers served

22        by the asset.   Mr. Majoros states that the allocation of costs between

23        installation and removal is “somewhat arbitrary.” This is not the case. The

24        allocations are based on analyses of the effort required to do the several



                                            35
 1        tasks required to install and remove the asset. The resultant allocations are

 2        reasonable for both accounting and ratemaking purposes.

 3   Q.   PLEASE COMMENT ON HIS SECOND APPROACH: “NORMALIZED NET

 4        SALVAGE ALLOWANCE.”

 5   A.   Mr. Majoros characterizes his normalized net salvage approach as

 6        representing an accrual basis. This is not true. The addition to depreciation

 7        expenses of an amount based on historical average net salvage amounts

 8        does not represent an accrual for the future cost of retiring assets. He

 9        states it is similar to the cash basis.     It is the cash basis.    The only

10        difference is that he has called it depreciation expense and charged it the

11        Accumulated Provision for Depreciation rather than calling it an operating

12        expense. For ratemaking purposes, this is the same approach and should

13        be rejected for all the reasons that I discussed above for expensing.

14   Q.   PLEASE COMMENT ON HIS THIRD APPROACH: “SFAS NO. 143 FAIR

15        VALUE ACCRUAL.”

16   A.   Although he presents this approach in his testimony, Mr. Majoros actually

17        does not recommend it to the Commission. I agree with Mr. Majoros that it

18        is complicated.    I also believe that the pattern of recovery using this

19        approach would not be appropriate. The pattern of recovery would be a

20        sinking fund, not a straight line. Such a pattern suggests that the service

21        value is being rendered in ever increasing amounts as the asset ages. This

22        is certainly not the case and is another reason for rejecting this approach.




                                             36
 1   Q.   PLEASE COMMENT ON HIS FOURTH APPROACH: ”NET PRESENT

 2        VALUE ACCRUAL.”

 3   A.   The net present value accrual simply removes inflation from the estimated

 4        future net salvage. The sum of the accruals based on the present value will

 5        be significantly less than the amount required to retire assets at the end of

 6        their lives. Mr. Majoros makes no provision for this shortfall. Thus, there is

 7        an inherent flaw in this approach. Further, if the service value of the asset is

 8        to be adjusted to current price levels, then the future net salvage and the

 9        historical original cost should both be adjusted. I suspect Mr. Majoros would

10        reject this modification to his net present value approach. I recommend that

11        the Commission reject this alternative as well.

12                           XIII. SUMMARY AND CONCLUSION

13   Q.   PLEASE SUMMARIZE YOUR REBUTTAL TESTIMONY.

14   A.   The net salvage proposals of Messrs. Ayanrouh and Majoros should be

15        rejected. Mr. Ayanrouh‟s adjustments related to third party reimbursements

16        are not appropriate, flawing his estimates of net salvage. Mr. Majoros‟s

17        attempt to substitute financial accounting standards for sound ratemaking

18        policies is unreasonable.     Depreciation is the loss in service value and

19        service value is the original cost less net salvage. Depreciation, including

20        both the original cost and net salvage, should be recognized ratably during

21        the life of the related asset. Expensing net salvage after the related asset is

22        retired conflicts with the regulatory principle of intergenerational equity.




                                               37
 1                The traditional approach to estimating future net salvage used by

 2        SCE is appropriate and results in estimates of net salvage that actually may

 3        understate future net salvage costs. Mr. Pierce‟s estimates of net salvage

 4        and survivor curves indicate that there is a significant deficiency in the

 5        Accumulated Provision for Depreciation. Mr. Majoros‟ contention that there

 6        is an overaccrual is incorrect and is premised on both an erroneous

 7        calculation and an incorrect assumption, i.e., the elimination of accrual

 8        accounting for net salvage.    The regulatory liability recorded on SCE‟s

 9        financial statements is the amount of past accruals toward future net

10        salvage, it is not a reserve excess. The disposition of such amounts would

11        be the subject of regulatory proceedings in the event that SCE‟s delivery

12        business was deregulated.

13                The four alternatives proposed by Mr. Majoros should be rejected.

14        None of the alternatives provides for both complete capital recovery and

15        intergenerational equity. The depreciation rates proposed by SCE should

16        be adopted.

17   Q.   DOES THIS CONCLUDE YOUR REBUTTAL TESTIMONY?

18   A.   Yes, it does.




                                            38

				
DOCUMENT INFO
Description: Southern California Business Insurance Quote document sample