November 3, 2008
TO: Membership of the Society of Depreciation Professionals
FROM: John Ferguson, Chairman, SDP Current Issues Committee
The purpose of the Current Issues letters is to inform the Society membership on
depreciation related issues. The views expressed in the letters are the views of the
authors and do not reflect any formal position of the Society. The Society hopes that
these letters will prompt discussion among members and lead to an increased
understanding of the issues facing our members. All members are encouraged to submit
their ideas and comments for consideration in a future letter. Comments should be
addressed to John Ferguson (firstname.lastname@example.org). Rod Daniel will distribute the letters
via email to all members and each letter is posted on the SDP web site (www.depr.org).
All prior Committee letters are posted on the members-only section of the Society web
site. Therefore, any prior letter mentioned by this letter is available to members.
Society 2008 Annual Meeting and Training
The meeting and training were held in Greenville, South Carolina during the week of
September 21. The meeting demonstrated that a subject currently on the minds of the
attendees is the potential for International Financial Reporting Standards (IFRS) to
replace U.S. GAAP. This subject is likely to be the major theme of the 2009 meeting,
which will be held October 5 and 6 in Albuquerque. Canada is already well along in
adopting international standards, and the Securities and Exchange Commission
announced in late August a “roadmap” for moving to IFRS that is addressed by a later
section of this Committee letter.
A shift from U.S. GAAP to international standards will be of considerable interest to
regulated entities and their regulators, because international standards allow the group
concept of depreciation accounting to be utilized for mass property, but for other property
the component concept is required, and there is no international standard equivalent to
SFAS 71, Accounting for the Effects of Certain Types of Regulation, that allows
qualifying entities to utilize accounting practices that are inconsistent with GAAP.
Comment: The next section of this Committee letter provides some
thoughts on certain of the plant and depreciation accounting aspects of this
The initial presentation at the meeting addressed what the attendees would like the
Society to be in the future, and included a questionnaire, the results of which were
disclosed and discussed at the end of the day. More complete results are likely to be in a
future Society Newsletter or posted on the Society web site, if not both. Among the
suggestions was a course on depreciation for appraisal purposes, which Susan Jensen
indicated she and the trainers will consider.
A presentation by Deloitte included several examples of fraud related to depreciation by
entities that are not subject to price regulation:
False in-service dates that increase the amount of tax depreciation during
the first year;
Retrospective recognition of decreased depreciable lives; and,
Failure to consider depreciation as part of an impairment review.
Presentations by Deloitte, PowerPlan, and Society member, John Lacey, got into the shift
to international accounting standards. Dr. Lacey traced U.S. GAAP from its principle-
based origin to its currently being rule-based, stating that the shift occurred in reaction to
judicial concerns that being principle-based does not provide sufficient clarity for
deciding what the principles mean, and asserting that international standards are moving
from being principles-based toward being rules-based.
The Society web site is being redesigned, and is expected to be operational by year-end.
At the meeting I was made aware of the following proceedings in which the treatment of
salvage and/or cost of removal is an issue, and which may be addressed by future
Committee letters, once all the testimony has been filed. They are mentioned now so that
anyone wanting to follow them can do so.
Michigan Case No. U-15629 of Consumers Energy Company. This
proceeding involves Consumers’ gas property, and is the first of the
depreciation proceedings directed by the Order in Case. No. U-14292,
which was a generic proceeding concerning adoption of SFAS 143,
Accounting for Asset Retirement Obligations, and the treatment of cost of
removal not qualifying for SFAS 143. Case No. U-14292 is addressed by
several prior Committee letters, the most recent being that of July 13, 2007
(pages 2 - 4) on the second Order in the proceeding that required the new
depreciation studies to address the following treatments for cost of
The current method, which for Consumers is the average factors
experienced during the prior five-years, both with and without
standard retirement units that were proposed by the Staff for
transmission mains, distribution mains, and services;
An inflation adjustment recognizing the standard retirement units,
whereby hybrid cost escalation rates derived from reported
Consumer and Producer Price Indexes are substituted for actual
cost escalation rates; and,
SFAS 143 treatment, both with and without the standard retirement
For Case No. U-15629, Consumers also presents the traditional method,
whereby past salvage and cost of removal amounts are related to original
cost amounts of the associated property that was retired, and does not
present studies that recognize the proposed standard retirement units,
because of the high cost involved to adjust historical data (estimated to
take 80 people at least a year). However, Consumers provides an estimate
of the additional maintenance expenses during 2007 that would have been
recorded if the proposed standard units were then in place.
New Jersey Board of Public Utilities Docket No. WR08010020 of the
New Jersey American Water Company. An intervener proposes that
salvage and cost of removal be treated on a cash basis and the previously
accrued salvage and cost of removal recorded in the accumulated
provision for depreciation be returned to ratepayers, and asserts that whole
life depreciation rates are preferable to remaining life rates. Such salvage
and cost of removal proposals have been addressed by prior Committee
letters, but the assertion concerning whole life rates has not been.
However, this being a water proceeding is reason enough for addressing,
because prior letters have not addressed a water proceeding.
Oklahoma Cause No. PUD 200800144 of the Public Service Company of
Oklahoma (PSO). PSO testimony addresses the Pennsylvania method for
treating the salvage and cost of removal, whereby salvage and cost of
removal are eliminated from depreciation rates and any such amounts
recorded in the accumulated provision for depreciation are amortized to
expense over the following five years. This testimony is in response to the
Order in PSO’s Cause No. PUD 200600285 that required PSO to address
this method in its next rate case. The uniqueness of this method (I do not
believe any other jurisdiction has adopted it), and my observation that it is
not well understood are reasons for addressing the proceeding.
The structure of the Order in Cause No. PUD 200600285 allows
addressing the depreciation aspects of that proceeding, which is the final
section of this Committee letter.
Some Thoughts on Potential Implications of Substituting International Accounting
Standards for U.S. GAAP - Comment
International standards allow the recording of property to reflect either cost or fair value,
whereas U.S. GAAP allows only cost. However, U.S. GAAP requires certain financial
instruments to be based on fair value (mark-to-market), and there is a current move to
expand the application of fair value beyond this. The next section of this letter
demonstrates that there is concern about this expansion. The financial market crisis
currently being experienced in the U.S. and elsewhere is being blamed, at least in part, on
mark-to-market accounting for financial instruments, and the Financial Accounting
Standards Board (FASB) and Securities and Exchange Commission (SEC) have already
begun to react to the situation by limiting (at least temporarily) the application of such
accounting. My experience with property recorded at fair value is limited to a single
entity, which may not provide an accurate view. This entity discloses to stockholders that
property is recorded at fair value, but does not disclose the basis for the amounts or their
impact on the income statement and balance sheet.
The determination of fair value of property requires an appraisal, but international
standards do not require that qualified appraisers be involved. The savings and loan
situation of the 1980s and the current sub-prime mortgage situation demonstrate that
claimed qualifications do not provide auditors with a sound basis for judging the validity
of the work of appraisers, which will require addressing the validity of appraisals
directly. However, the Sarbanes-Oxley Act prevention of audit firms from providing
appraisal services to their audit clients may keep such firms from having appraisers on-
staff that are qualified to judge the validity of claimed fair value amounts.
Both U.S. GAAP and international accounting standards preclude recording an equity
component in the financing cost capitalized as a component of construction costs, but
U.S. regulatory accounting does. IFRS 1, First-time Adoption of International Financial
Reporting Standards, allows regulated enterprises two options for dealing with this equity
component – identification and elimination through retrospective restatement, or adoption
of fair value. Last month, the International Accounting Standards Board issued for
comment several amendments to IFRS 1, one of which would exempt regulated
enterprises from either of these two options, in recognition of their not being cost-
U.S. Uniform Systems of Accounts specify that jurisdictional entities practice the group
concept of depreciation for all their property. Under the component concept required by
international standards for property other than mass property, which I usually refer to as
the item concept, each component is depreciated individually, interim additions and
retirements are expensed, gains or losses are recorded for components retired prior to
reaching their depreciable life, and depreciation ceases when the depreciable life is
Regulated entities have two basic types of property – location-type and mass-type – to
which three basic depreciation approaches are applied – life span, average life, and
amortization. The life span approach is commonly adopted in the U.S. for some types of
location-type property, such as power plants, with interim additions and retirements being
recognized in the depreciation rates. The average life approach, whereby variation of the
age of retirements around the average life is recognized by dispersion patterns, is applied
to most classes of location-type and mass-type property. The amortization approach is
applied to mass-type property for which lack of retirement reporting has prompted the
recording of retirements to be based on attained age rather than field reporting.
International acceptance of the group concept is predicated on its ability to match the
recording of depreciation to the life experienced by a group of mass-type property. This
matching concept is interpreted as allowing the group concept for only mass-type
property, but is identical to the “rational” requirement of the U.S. GAAP definition of
depreciation accounting, which allows group depreciation for all property. This different
interpretation of matching raises a question about whether the average life or broad group
procedure would be acceptable under international standards, because its presumption
that every component of a group retires at an age equal to the average life of the group is
clearly false. Therefore, international standards may require adoption of the equal life
group procedure for mass-type property.
The component concept is likely to be practical as a substitute for the life span approach,
because it is merely the life span approach utilized for regulatory accounting, without
recognizing interim additions and retirements through depreciation. However, the
component concept would not be practical for location-type property for which the
average life approach is typically utilized in the U.S., such as electric transmission lines
and substations, gas measuring and regulating stations, and general purpose buildings,
because there are too many locations.
Entities practicing the component concept typically adopt depreciable lives that are
shorter than expected, in order to limit or eliminate the recording of gains or losses and
differences between book and tax depreciation. While inconsistent with the concept that
the recording of depreciation match asset usage, depreciation based on such lives is
considered conservative and acceptable for financial reporting purposes. When properly
done, the life span approach for regulatory purposes more accurately matches the
recording of depreciation with asset usage than does the component concept, so should
not be precluded by international standards. The key words here are “properly done,”
because regulators commonly preclude the recognition of future interim additions in
depreciation until after they have been recorded, which causes the depreciation rate to
increase at each recalculation, if the estimated life span does not change. If SFAS 71,
Accounting for the Effects of Certain Types of Regulation, is rescinded, this deferral
mechanism could no longer be applied, because an increasing depreciation rate is
inconsistent with the U.S. GAAP requirement that depreciation be “rational.” While the
life span approach applied on a group basis that recognizes future interim additions and
retirements is consistent with the purpose of depreciation accounting under international
standards, it is not currently allowed. I view this situation as demonstrating that the
group concept is insufficiently understood, and that a concerted effort on the part of those
having sufficient understanding will be necessary to change things. I have observed that
direct involvement in the determination of depreciation rates for the group concept is
required to fully understand the concept. Therefore, Society members may be the only
source of expertise that can be drawn upon by the accounting profession to develop
sufficient understanding of the group concept to allow this concept to be applied to all
types of property under international standards.
The amortization approach is commonly adopted in the U.S. for property for which
retirements go unreported, thereby improving the match between depreciation and
property usage. Therefore, this approach should be acceptable under international
standards. However, lack of understanding may get in the way of recognizing this.
International standards require that depreciable lives be reviewed at least annually. This
is too often for entities practicing the group concept, because their depreciable lives can
be expected to be more accurate than for entities practicing the component concept. As
noted above, entities practicing the component concept typically adopt lives shorter than
are expected. When adopting its rules for replacement cost accounting, which led to the
FASB issuing SFAS 33, Financial Reporting and Changing Prices, the SEC recognized
that reporting entities are likely have fully depreciated assets that remain in service and
provided guidance on how to deal with such assets. This recognition suggests that U.S.
entities practicing the component concept in the past have not increased the depreciable
lives of components expected to remain in service beyond the existing lives. Annual
review of depreciable lives seems reasonable for entities practicing the component
concept, so that depreciable life can be increased when a component approaches and is
expected to exceed its existing life. However, the SEC recognition of fully depreciated
assets noted above in this paragraph suggests that such mid-course life changes would
require altering past practices.
International accounting standards specify that legal and constructive asset retirement
obligations be recorded as liabilities, rather than as depreciation. Including constructive
obligations is a significant difference from U.S. GAAP. The exposure draft of what
eventually became SFAS 143, Accounting for Asset Retirement Obligations, called for
liability treatment of both legal and constructive obligations. However, SFAS 143 was
limited to only legal obligations when the FASB concluded that constructive obligations
could not be defined tightly enough for consistent application. Limiting SFAS 143 to
legal obligations did not preclude inconsistent application, as the FASB felt the need for
clarification through later issuing FASB Interpretation 47, Accounting for Conditional
Asset Retirement Obligations, (FIN 47). FIN 47 improved the consistency of reporting,
but did not eliminate the problem, which is due, in part, to the difficulty in applying
SFAS 143 by entities practicing the group concept of depreciation accounting.
The liability accounting treatment dictated by U.S. GAAP and international standards is
as a prepaid annuity, which is backend loaded. This deferral is evident from the
obligation for decommissioning a nuclear generating unit, which is the obligation that
prompted SFAS 143 to be issued. Such a unit that receives a renewed operating license
from the Nuclear Regulatory Commission is likely to have an operating life span of about
55 years. If decommissioning occurs ten years after operations cease and the SFAS 143
discount rate is 8%, 99.3% of the obligation would be recorded as accretion over 65
years, with the accretion amount recorded during the final year being 137 times the
amount recorded during the first year and 54% of the total accretion being recorded after
the unit ceases to operate and generate revenues and, for a single-asset entity, after the
enterprise ceases to be viable.
The deferral inherent in the liability treatment of asset retirement obligations means that
gains or losses (perhaps substantial) would be recorded if the removal date is not
accurately estimated. The above nuclear decommissioning example demonstrates that
arbitrarily short depreciable lives would not provide a suitable basis for recording asset
Cost of removal not qualifying for liability treatment is expensed under both U.S. GAAP
and international accounting standards. As is evident from these periodic letters, I
believe this requirement for U.S. GAAP is a consequence of misinterpretation of the
meaning of “salvage” in the GAAP definition of depreciation accounting. The FASB and
SEC interpret “salvage” as meaning “gross salvage,” whereas I am convinced the
definition was intended to mean “net salvage.” I view this misinterpretation as being
partly a consequence of the shift shortly after World War II of the accumulated provision
for depreciation from being recognized as a source of capital on the right side of the
balance sheet to being a contra-asset on the left side, which is addressed by the July 28,
2008 Committee letter (pages 3 - 5), and not repeated here.
Advisory Committee on Improvements to Financial Reporting
This Committee advises the Securities and Exchange Commission (SEC), and the
January 23, 2008 Committee letter (page 4) addresses certain of its intended
recommendations, the February 29 letter (pages 1 - 4) addresses a draft progress report,
and the June 30 letter (pages 5 and 6) addresses the aspect of a Subcommittee report
concerning the use of fair value for financial reporting purposes. This discussion is
prompted by the August 1, 2008 Final Report of the Advisory Committee that has been
submitted to the SEC, and can be found at http://sec.gov/about/offices/oca/acifr/acifr-
The Final Report includes ten recommendations concerning substantive complexity, six
concerning the standards-setting process, five concerning the audit process and
compliance, and five concerning delivering financial information, The themes
underlying the recommendations are stated to be:
Increasing the usefulness of information in SEC reports;
Enhancing the accounting standards-setting process;
Improving the substantive design of new accounting standards;
Delineating authoritative interpretive guidance; and,
Clarifying guidance on financial restatements and accounting judgments.
The Advisory Committee:
Limits its scope as it relates to international matters and its deliberations to
matters involving SEC registrants;
Avoids recommendations requiring legislative action or attempting to
address all perceived shortcomings;
Believes the principles underlying its recommendations would be relevant
to any accounting standards-setter, but does not focus directly on issues
concerning the convergence of U.S. and international standards, and
recognizes the application of these principles and specific
recommendations could be impacted by the path and pace of this
convergence – for example the recommendation concerning elimination of
industry-specific guidance, i.e., SFAS 71, Accounting for the Effects of
Certain Types of Regulation;
Broadly supports the move to a single set of high-quality global
accounting standards, coupled with enhanced international coordination to
foster their consistent interpretation and to avoid jurisdictional variants;
Believes that if convergence does not occur within a few years, the
Financial Accounting Standards Board (FASB) and SEC should consider a
systematic rethinking of U.S. GAAP;
Recognizes that the mixed attribute system will continue, and that it would
be helpful to portray for investors the different sources of changes to a
company’s income – for example, distinguishing cash receipts from
unrealized changes in fair value; and,
Recognizes that the need to evaluate the usefulness of financial reporting
does not end with its Final Report, and recommends creation of a
Financial Reporting Forum that would meet regularly to discuss current
pressures on the financial reporting system and how constituents are
meeting these challenges.
Most of the recommendations are addressed to the SEC, but some are addressed to other
organizations, such as the Financial Accounting Foundation, FASB, and Public Company
Accounting Oversight Board (PCAOB), and to industry groups, such as the CFA
Institute, Financial Executives International, and National Investor Relations Institute.
The current financial market crisis demonstrates the significance of the accounting
judgments aspect of the Final Report, which is not addressed by the prior Committee
letters. The Advisory Committee recommends that the SEC and PCAOB adopt policy
statements concerning the exercise of accounting and audit judgments, in order to provide
more transparency into how regulators will evaluate the reasonableness of such
judgments. Factors considered to be important in the evaluation process are stated to be:
Including the available alternatives that were identified;
The robustness of the analysis of available literature and review of
The degree to which the approach is consistent with current accounting
How the conclusions meet information needs of investors.
These factors will encourage preparers and auditors to follow a disciplined judgment-
making process that will include the contemporaneous documentation necessary to ensure
that the evaluation of a judgment is based on the same facts that were reasonably
available at the time the judgment was made.
Use of International Financial Reporting Standards (IFRS) by U.S. Enterprises
In late August, the Securities and Exchange Commission (SEC) voted to publish for
public comment a proposed process that could lead to the use of IFRS by all U.S. issuers.
The Commission would make a decision in 2011 as to whether adoption of IFRS is in the
public interest and would benefit investors. The SEC refers to its proposed process as a
“roadmap,” but has yet to publish it, which may be a consequence of preoccupation with
the current financial market crisis. Once posted, there will be a 60 day comment period.
This discussion relies on materials prepared by Deloitte that were provided by a Society
The proposed roadmap sets the following milestones that, if achieved, could lead to a
decision for mandatory adoption of IFRSs by all enterprises beginning with fiscal years
ending on or after December 15, 2016;
1. Improvements in accounting standards.
2. Funding and accountability of the International Accounting
Standards Committee Foundation.
3. Improvement in the ability to use interactive data for financial
4. Education and training on IFRSs in the United States.
5. An option for early adoption by certain eligible entities for fiscal
years ending on or after December 15, 2009 – U.S. issuers that are
among the 20 largest companies in its industry globally as
measured by market capitalization (estimated to be about 110
6. Anticipated timing of future rule-making by the SEC – based on
the progress of Milestones 1 - 4 and the experience gained from
Milestone 5, the SEC will determine in 2011 whether to require
adoption of IFRSs by all U.S. issuers, and, if so, will set the date
and approach for transition by other entities, which could occur
prior to 2014.
7. Potential implementation of mandatory use, perhaps with transition
for large accelerated filers for fiscal years ending on or after
December 15, 2014, for accelerated filers for fiscal years ending on
or after December 15, 2015, and for non-accelerated filers for
fiscal years ending on or after December 15, 2016.
Milestones 1 through 4 are issues that need to be addressed before adoption of IFRSs can
be made mandatory.
A company opting for early adoption under Milestone 5 would still provide some
financial information relating to U.S. GAAP, and the proposal asks for comments on the
following alternatives for presenting this information;
Alternative A – The U.S. issuer would provide a one-time reconciliation
from U.S. GAAP to IFRSs that covers one year (the year of transition).
The reconciliation would appear as a note to the audited financial
statements in a manner consistent with the requirements under IFRS 1,
First-time Adoption of International Financial Reporting Standards.
Alternative B – The U.S. issuer would be required to provide, on an
ongoing basis, an unaudited reconciliation from IFRSs to U.S. GAAP for
the three years of IFRS financial statements included in the Form 10-K.
Comment: Numerous of these periodic Committee letters address aspects of a move by
the U.S. to be more consistent with or to adopt IFRSs, among them;
The prior section of this letter.
June 30, 2008 (pages 5 and 6).
May 9, 2008 (pages 4 - 6).
February 29, 2008 (pages 1 - 4).
January 23, 2008 (pages 1 - 3).
November 19, 2007 (pages 3 - 5).
July 23, 2007 (page 2).
May 10, 2007 (pages 7 and 8).
January 16, 2007 (pages 1 and 2).
August 1, 2006 (pages 5 - 10).
June 23, 2006 (pages 1 - 3).
March 22, 2006 (pages 2 and 3).
May 17, 2004.
San Diego Gas & Electric Company and Southern California Gas Company 2007
General Rate Cases
These proceedings are California Applications 06-12-009 and 06-12-010, respectively,
and the Proposed Decisions are addressed by the July 28, 2008 Committee letter (pages 6
and 7) and the Final Decision by the August 18, 2008 letter (pages 2 and 3). On August
28, the Division of Ratepayer Advocates (DRA) and The Utility Reform Network
(TURN) filed an Application for Rehearing, which prompts this discussion, as
depreciation is one of several issues that are stated to prompt the request for rehearing.
The Application states:
Decision 08-07-046 adopts Settlements to which DRA, TURN and the
Sempra Utilities are signatories and which resolve all issues associated
with the test year revenue requirements for the utilities. Although this
Decision adopts these settlements, it includes language which, if allowed
to stand, violates the rights of DRA and TURN and potentially other
consumer advocates under the Constitutions of the United States and the
State of California. D.08-07-046 also contains language which
impermissibly attempts to bind future Commissions, gives the appearance
of prejudging evidence in future proceedings, and is arbitrary and
The DRA and TURN ask for rehearing and removal of certain language and
corresponding Findings of Fact and Conclusions of Law, including the depreciation
section and three of its related Findings of Fact.
Comment: I understand that responses to the Application have been fined and that the
Commission has not yet reacted.
Oklahoma Cause No. PUD 200600285 of the Public Service Company of Oklahoma
This proceeding is mentioned in the initial section of this Committee letter as ordering
PSO to address the Pennsylvania method for treating salvage and cost of removal in its
next rate case. This discussion relies on the Order (number 545168), as it summarizes the
testimony of every witness in the proceeding.
PSO requested a depreciation increase of 5.6%, and three interveners – the Attorney
General (AG), the Oklahoma Industrial Energy Consumers (OIEC), and Wal-Mart – and
the Staff proposed decreases ranging from 24.1% to 32.3%. All parties recommend
remaining life depreciation rates and adopt the lives and curves for Transmission,
Distribution, and General Plant recommended by PSO.
For power plants, PSO utilized a life span approach based on generating unit life spans
determined by PSO’s Generation Department. PSO’s approach recognizes future interim
retirements, but not future interim additions, and net salvage factors based on site-specific
removal cost estimates of 130 plants of 27 other utilities, with no cost escalation
recognized for gas and oil units since 2000 and for coal units since 1995. For
Transmission, Distribution, and General Plant, PSO’s lives are based on actuarial
analyses of undisclosed periods of history and the salvage and cost of removal factors are
based on analyses of the past 21 years.
The AG asserts:
PSO’s 42-year life span for coal units reflect unusual and unacceptable
practices that do not reflect the underlying beliefs or expectations of its
Engineering Department or of its depreciation experts, nor does it comply
with standard industry expectations or what is testified to in other
jurisdictions for affiliates of PSO;
Changing the life span for coal units to 60 years is not only appropriate, it
is in line with how PSO expects to operate the units;
PSO has elected to utilize unsubstantiated demolition cost information
from its prior consultant as the basis for its power plant net salvage, a
comparison of the data with actual values utilized by many of the 27
utilities represented demonstrates the complete disconnect between such
values and reality, and negative 5% was utilized by many of PSO’s sister
operating companies prior to deregulation in Texas;
PSO ignored its own net salvage experience with previously retired
The results of the power plant demolition cost studies produce too wide a
variation of removal costs;
The wide variation in contingency costs represent a flaw in the demolition
PSO blindly accepted historical experience for Transmission, Distribution,
and General Plant salvage and cost of removal, so is devoid of the
evaluation phase of a depreciation study that its prior consultant says is
Comment: Those who have taken the Society training courses in
recent years have heard my opinion that this phase of a study is
optional, and that whether it is done or not is a management policy
The blind reliance on history makes, in many instances, the net salvage
factors the most negative by far of any utility that can be identified in the
PSO should have recognized the likely cost reduction from economies of
scale when it retires a greater amount of plant annually in the future; and,
The net salvage factors for several Transmission and Distribution accounts
should be less negative than proposed by PSO.
The AG recommends a life span of 60 years for coal units, negative 5% power plant net
salvage factors, with an alternative of positive 10% as a first step toward recognizing that
many, if not all, of PSO’s units could be sold in the future, and net salvage factors for
three Transmission accounts and seven Distribution accounts less negative than proposed
The OIEC asserts:
PSO’s 42-year life span for coal units is inconsistent with PSO’s responses
to data requests and AEP’s use of 60 years for coal units in other states;
PSO’s cost of removal calculations embed extreme levels of estimated
future inflationary increases in current rates through a flawed
mathematical approach that can no longer be characterized as just and
reasonable for ratemaking purposes – because the factors are calculated
from cost of removal amounts recorded at current price levels and
retirement amounts recorded at historical price levels;
There is an excessive current charge to ratepayers that assumes past
inflation rates will be sustained in the future and that ratepayers should
pay now for future inflation that has not yet occurred;
Removal costs should be included at current values, as is required by
SFAS 143, Accounting for Asset Retirement Obligations, and the
accounting profession not yet addressing assets without retirement
obligations is no excuse for PSO embedding inflation in removal cost
The estimated removal costs requested by PSO are nearly four times the
amounts actual being incurred; and,
The Pennsylvania method of treating cost of removal has been adopted by
New Jersey and Delaware, was recommended by the Kansas Staff in a
recent proceeding, and was found to be reasonable in a recent Texas
Railroad Commission proceeding and should be considered in the next
proceeding of the utility (Atmos Energy).
Comment: The proceedings I am aware of in which the Delaware
Commission departed from its Uniform Systems of Accounts
requirements of accrual accounting for net salvage are Delmarva
Power & Light Company Docket Nos. 05-304 (electric property)
and 06-284 (gas Property). The Order in Docket No. 05-304 is
addressed by the June 23, 2006 Committee letter (pages (4 - 7) and
the Staff testimony in Docket No. 06-284 is addressed by the May
2, 2007 letter (pages 1 - 3). In Docket No. 06-284, the Staff
proposed that the net salvage deferral mechanism adopted in
Docket No. 05 - 304 for electric property be extended to the gas
property, and the proceeding was settled based on the Staff’s
proposal. As is noted by these two Committee letters, the
Delaware deferral mechanism is cash treatment, not the
Pennsylvania method, which is less deferred than is the
Pennsylvania method, thereby imposing less extra cost on
The OIEC recommends 60-year life spans for coal units, rejection of PSO’s proposed
increases to its cost of removal factors, as a minimum, and consideration by the
Commission of the Pennsylvania method, whereby (according to the OIEC) a normalized
level of actual removal cost expenditures is included in depreciation rates, rather than an
estimated level of future expenditures.
Comment: I have observed that the Pennsylvania method is not well
understood, and this situation is evident in this proceeding.
PSO’s 42-year life span for coal units results in accelerated recovery of
investment, violates cost causation principles, and industry data indicates a
60-year life span is appropriate and is utilized by other utilities;
PSO’s negative net salvage for steam stations is overstated and does not
properly reflect the value these sites will have as future generating sites;
PSO’s Transmission, Distribution, and General Plant net salvage
components reflect estimates of future inflation that unnecessarily raise
rates to today’s ratepayers and can produce intergenerational inequities;
PSO’s Transmission, Distribution, and General Plant depreciation rates
include an annual net salvage component nearly five times the average
annual amount recorded during the last five years and four times the
annual amount recorded during the last 10 years; and,
Over the last 49 years the annual rate of inflation measured by the
Consumer Price Index (CPI) was 4.1% and the Gross National Product
Pride Deflator was 3.6%, while the U.S. Department of Energy indicates
the annual CPI for the next 25 years will be about 1.8% and the Survey of
Professional Forecasters projects the annual CPI during 2007 - 2016 to be
Wal-Mart recommends 60-year life spans for coal units, and if the Commission decides
to continue reflecting future inflation in net salvage, it should rely on forecasts of future
inflation, rather than on historic levels, which would decrease PSO’s proposed net
salvage factors by 50%.
The Staff states its depreciation adjustment is based on a review of the recommendations
of the AG. However, the amount stated as being the Staff’s decrease from PSO’s
existing rates is about 3% higher than is the AG’s stated decrease.
Comment: This may be a consequence of application of the rates to
depreciable plant balances at a different point in time.
In rebuttal, PSO faults the AG, the OIEC, and Wal-Mart for:
Not basing their proposed 60-year life span for coal units on any internal
or external unit conditions that will affect their life;
Not recognizing that a unit-specific assessment is critical for determining
Misreading selected AEP emails that discuss the factors that influence the
PSO life spans and the 60-year life spans utilized for AEP’s eastern fleet
of coal units; and,
Not recognizing that AEP’s eastern fleet is more than 20 years older than
PSO’s units and has experienced significant component replacements that
have not been experienced by PSO’s units.
In rebuttal, PSO faults the AG and OIEC for proposing Transmission and Distribution
Plant net salvage factors that are more likely to produce intergenerational inequities than
the factor calculations in the Company depreciation study.
In rebuttal, PSO faults the AG and Wal-Mart for not providing documentation or support
that would allow testing the validity of negative 5% net salvage for power plants.
In rebuttal, PSO faults the AG for:
Not recognizing that PSO’s Generation Department is staffed by people
knowledgeable about the operating, environmental, economic, physical,
and technological conditions at the Company’s stations; and,
Claiming there will be future economies of scale, when the nature of
transmission and distribution property invalidates such a claim.
In rebuttal, PSO faults the OIEC for claiming there is a mathematical flaw in the
calculation of net salvage factors.
In rebuttal, PSO faults Wal-Mart for claiming the value of power plant site reuse should
be considered when determining salvage values.
The Order adopts 60-year life spans for the coal units, rejects PSO’s proposed changes to
net salvage factors, and specifies that PSO address the Pennsylvania method in its next
rate case, which is Cause No. PUD 200800144 referred to in the initial section of this
Comment: Recognizing future interim retirements in depreciation rates, but not future
interim additions, causes the power plant depreciation rates to increase at the time of each
future recalculation, if life spans do not change, which is inconsistent with the pattern of
future usage of such assets. The power plant rates proposed by all the parties to the
proceeding and adopted by the Commission are inconsistent with the GAAP requirement
that depreciation be “rational.” Therefore, the rates authorized for regulatory accounting
purposes cause a difference from GAAP that SFAS 71, Accounting for the Effects of
Certain Types of Regulation, states is to be recorded as a regulatory asset.