Rebuttal Testimony of William M. Stout, P.E.
On Depreciation Issues
In Southern California Edison
2006 General Rate Case
California Public Utilities Commission
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 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?
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-
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.
23 II. INTRODUCTION
1 Q. WHAT IT THE PURPOSE OF YOUR TESTIMONY IN THIS
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
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
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.
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
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
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
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
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
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
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.
1 Q. PLEASE CONTINUE WITH YOUR REVIEW OF MR. MAJOROS‟
2 DISCUSSION OF DEPRECIATION CONCEPTS AS PRESENTED IN HIS
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
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
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.
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.”
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...”
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
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
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
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
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
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
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
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
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
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
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
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,
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
Response to DR-SCE-TURN-DEP-01
1 data that relate the cost of retiring an asset or group of assets to its original
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
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
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?
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
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
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
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
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
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
1 requires that the estimated cost of removal of plant be
2 recovered over its life.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
Public Utility Depreciation Practices. Page 157. National Association of
Regulatory Utility Commissioners. 1996.
Depreciation Systems, Wolf, Frank K. and W. Chester Fitch. Page 7. Iowa
State University Press. 1994.
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
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?
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
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
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.
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
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
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
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
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.
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.
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.