Depreciation Accounting

DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 101

[Docket No. RM99-7-000]

Depreciation Accounting

July 29, 1999.

AGENCY: Federal Energy Regulatory Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Federal Energy Regulatory Commission (Commission) proposes

to amend its regulations to set forth uniform standards based on the

straight-line method of depreciation and the assets' estimated useful

service lives for determining depreciation for accounting purposes.

DATES: Comments on the proposed rulemaking are due on or before October

4, 1999.

ADDRESSES: File comments on the notice of proposed rulemaking with the

Office of the Secretary, Federal Energy Regulatory Commission, 888

First Street, N.E., Washington, D.C. 20426. Comments should reference

Docket No. RM99-7-000.

FOR FURTHER INFORMATION CONTACT:

Gregory Berson (Technical Information), Office of Finance, Accounting

and Operations, 888 First Street, N.E. Washington, D.C. 20426 (202)

219-2603;

Amy L. Blauman (Legal Information), Office of the General Counsel, 888

First Street, N.E., Washington, D.C. 20426, (202) 208-2143

SUPPLEMENTARY INFORMATION: In addition to publishing the full text of

this document in the Federal Register, the Commission also provides all

interested persons an opportunity to inspect or copy the contents of

this document during normal business hours in the Public Reference Room

at 888 First Street, N.E., Room 2A, Washington, D.C. 20426.

The Commission Issuance Posting System (CIPS) provides access to

the texts of formal documents issued by the Commission from November

14, 1994, to the present. CIPS can be accessed via Internet through

FERC's Home page (http://www.ferc.fed.us) using the CIPS Link or the

Energy Information Online icon. Documents will be available on CIPS in

ASCII and WordPerfect 6.1. User assistance is available at 202-208-2474

or by E-mail to [email protected].

This document is also available through the Commission's Records

and Information Management System (RIMS), an electronic storage and

retrieval system of documents submitted to and issued by the Commission

after November 16, 1981. Documents from November 1995 to the present

can be viewed and printed. RIMS is available in the Public Reference

Room or remotely via Internet through FERC's Home page using the RIMS

link or the Energy Information Online icon. User assistance is

available at 202-208-2222, or by E-mail to [email protected].

Finally, the complete text on diskette in WordPerfect format may be

purchased from the Commission's copy contractor, RVJ International,

Inc. RVJ International, Inc. is located in the Public Reference Room at

888 First Street, N.E., Washington, D.C. 20426.

I. Introduction

The Federal Energy Regulatory Commission (Commission) proposes to

amend the General Instructions of 18 CFR Part 101 to establish, for

those public utilities and licensees that are subject to Part 101,

criteria for determining depreciation for accounting purposes.

II. Background

A. Commission Authority

The Commission has authority under section 301 of the Federal Power

Act (FPA) 1 over the accounting practices of public

utilities and licensees. Pursuant to section 301, the Commission has

prescribed a Uniform System of

Accounts (USofA) 2 that must be followed by these

jurisdictional entities.

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\1\ 16 U.S.C. 825.

\2\ See 18 CFR Part 101.

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The Commission also has authority under section 302 of the FPA

3 over the depreciation accounting practices of public

utilities and licensees. This includes the authority to determine and

fix proper and adequate depreciation rates for accounting purposes.

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\3\ 16 U.S.C. 825a.

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The Commission believes it has a statutory obligation to ensure

that proper amounts of depreciation are charged to expense in each

financial reporting period. In order to fulfill this statutory

obligation, the Commission had required public utilities and licensees

to obtain Commission approval prior to changing their depreciation

rates for accounting purposes. See, e.g., MidAmerican Energy Co., 79

FERC para. 61,169 (1997), reh'g denied, 81 para. FERC 61,081 (1997).

However, a recent decision of the U.S. Court of Appeals for the

District of Columbia Circuit, Alabama Power Company, et al. v. FERC,

160 F.3d 7 (D.C. Cir. 1998) (Alabama Power), overturned the

Commission's action on procedural grounds.

In light of Alabama Power, we decide here to proceed with a

rulemaking to establish the principles that public utilities and

licensees subject to Part 101 must follow in determining depreciation

rates for accounting purposes.4 We are not proposing to

ascertain, determine, and fix individual company depreciation rates as

part of this rulemaking. Instead, we provide a regulatory framework for

monitoring depreciation accounting practices and for taking action in

individual cases if and when the need arises--to ensure that public

utilities' and licensees' 5 books reflect proper

depreciation amounts.

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\4\ The proposed rules would not apply to public utilities and

licensees that have obtained waivers from our accounting

requirements under 18 CFR Part 101.

\5\ Henceforth in this narrative preamble, our use of

``utilities'' is intended to encompass both public utilities and

licensees; we will refer to ``utilities'' for ease of reading. See

18 CFR Part 101 Definition No. 39.

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B. Utility Depreciation Principles

Expenditures for utility plant and other long-lived assets that

will be used in the production of utility products and services are

typically made in one year but are expected to produce benefits over a

number of years. These assets also have finite useful lives, and their

value will be substantially diminished at the end of their useful

lives.6 Depreciation represents the cost of using up the

assets' service potential during their useful lives.

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\6\ In some cases, assets have negative salvage value, i.e., the

utility will have to pay additional costs to remove the asset and

restore the plant site at the end of the asset's life.

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Depreciation is a process of cost allocation, not of

valuation.7 The primary objective of depreciation accounting

is to allocate the cost of utility property to the periods during which

the property is used in utility operations, i.e., over the useful

service life, in a systematic and rational manner.8

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\7\ See FASB Original Pronouncements, Accounting Research

Bulletin No. 43, Chapter 9, Section C, para. 5 (1998).

\8\ The Commission's Uniform System of Accounts for electric

utilities defines depreciation as follows:

Depreciation, as applied to depreciable electric plant, means

the loss in service value not restored by current maintenance,

incurred in connection with the consumption or prospective

retirement of electric plant in the course of service from causes

which are known to be in current operation and against which the

utility is not protected by insurance. Among the causes to be given

consideration are wear and tear, decay, action of the elements,

inadequacy, obsolescence, changes in the art, changes in demand, and

requirements of public authorities.

18 CFR Part 101 Definition No. 12.

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Generally, the amount of annual depreciation is determined by

multiplying the asset's depreciable base (original cost less estimated

salvage value) by a depreciation rate. The depreciation rate is a

function of the chosen depreciation method and the asset's useful

service life. The depreciation method (e.g., straight line, double-

declining balance, sum of the years digits, etc.) determines the timing

of the recognition of depreciation expenses. The asset's useful service

life, expressed in units of time or production, is based on estimates

of the physical, economic or productive life of the asset.

Depreciation accounting is not intended to achieve a desired

financial objective, such as an increase or decrease in reported net

income or an adjustment in plant costs to perceived market values.

Rather, depreciation accounting reflects the decrease in service value,

i.e., the using up of the productive capacity of the asset, over its

service life. The decrease in service value is estimated using a

systematic and rational method to allocate the original cost of assets

to the periods over which they are used in utility service--factors

that are independent of both an entity's profitability and asset market

values.

Recognition of depreciation expenses for accounting purposes is not

dependent on the rate recovery of the cost of utility plant. When

differences arise between accounting depreciation and rate recovery of

the cost of utility plant, the USofA requires utilities with cost-based

rates to account for the differences as regulatory assets and

liabilities.\9\ In this way, utilities can easily keep track of any

differences between accounting depreciation and ratemaking recovery of

plant costs in their various regulatory jurisdictions.

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\9\ See 18 CFR Part 101 Definition No. 30, Accounts 182.3 and

254.

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C. Reasons for This Rule

The Commission believes it must standardize depreciation accounting

practices in order to maintain its ability to determine just and

reasonable, cost-based utility rates and to ensure the reasonableness

and reliability of financial information used by regulators, investors,

consumers, and the general public.

Since depreciation is a significant portion of the total cost of

providing utility service, the determination of the appropriate amount

of depreciation is of concern to this Commission, State commissions,

utility management, investors, consumers and others who have an

interest in or are affected by the financial performance of these

entities. Because the Commission uses depreciation recorded on a

utility's books as a starting point for determining cost-based utility

rates,\10\ to protect consumers and to guard against abuses, the

Commission must have assurance that such depreciation expenses are

proper.\11\ Moreover, standardizing depreciation accounting practices

will better ensure that utilities' financial information, reported to

regulators, utility investors, utility consumers and the general

public, is reasonable and reliable.

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\10\ The Commission typically permits a utility to recover its

investment in utility property over its useful life through

inclusion of depreciation expense in the cost of service used to set

the utility's cost-based rates. The Commission also typically allows

a utility to earn a return on its undepreciated investment in

utility property.

\11\ For example, a utility could, through inappropriate

depreciation practices, over-recover the cost of utility plant,

inappropriately attempt to mitigate stranded costs or shift benefits

from asset sales to shareholders or particular customer groups. See,

e.g., Midwest Power Systems Inc., 67 FERC para. 61,076 at 61,208

(1994); South Carolina Electric & Gas Co., 76 FERC para. 61,338 at

62,616-19 (1996), reh'g denied, 79 FERC para. 61,083 (1997); accord,

Ohio Edison Co., et al., 84 FERC para. 61,157 at 61,860-63 (1998).

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Additionally, by establishing generally applicable rules relating

to depreciation accounting, this rulemaking is intended to satisfy the

procedural prerequisite of FPA section 302 that the Court, in Alabama

Power, supra, found necessary to enable the Commission to set

individual utility

depreciation rates for accounting purposes.

Therefore, we are proposing here that utilities subject to Part 101

follow uniform standards in determining depreciation rates for

accounting purposes. This will ensure that depreciation for accounting

purposes is recorded in accordance with sound depreciation principles

and thus, in particular, meets this Commission's regulatory needs.\12\

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\12\ Standardizing utilities' depreciation accounting practices

will, for example, provide a greater level of assurance that

depreciation accounting will not be used to achieve inappropriate

ends. See supra note 10.

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We invite interested parties to present their views on this

proposal through the written comment procedures outlined below.

III. Discussion

The current USofA for utilities contains limited guidance on

depreciation accounting. The USofA defines depreciation and its related

components,\13\ and provides various accounts for the recording of

depreciation,\14\ but does not state how utilities are to determine the

rates used to calculate the amount of depreciation to be recorded in

the accounts.

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\13\ See, e.g., 18 CFR Part 101, Definition Nos. 10, 12, 19, 34-

36 (1999).

\14\ See, e.g., 18 CFR Part 101, Accounts 108, 110, 119, and 403

(1999).

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In light of the foregoing, the Commission proposes to revise its

USofA to require uniform and consistent determinations of depreciation

rates for accounting purposes. We also take this opportunity to outline

how we intend to oversee utility depreciation practices in the

foreseeable future.

A. Regulatory Framework

The Commission proposes to require utilities subject to Part 101 to

use depreciation rates for accounting purposes that are based on the

straight-line method of depreciation and the assets' estimated useful

service lives.\15\

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\15\ The USofA defines service life as ``the time between the

date electric plant is includible in electric plant in service, or

electric plant leased to others, and the date of its retirement. If

depreciation is accounted for on a production basis rather than on a

time basis, then service life should be measured in terms of the

appropriate unit of production.'' 18 CFR Part 101 Definition No. 35.

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A straight-line method of depreciation is one that allocates the

service value \16\ of depreciable property to expense in equal monthly

charges over the property's useful service life. It is the method

typically used by utilities today.\17\

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\16\ The USofA defines service value as ``the difference between

original cost and net salvage value of electric plant.'' 18 CFR Part

101 Definition No. 36.

\17\ See, e.g., J. Suelflow, Public Utility Accounting: Theory

and Application 96 (1973) (``Straight line is the predominant method

used by utilities and sanctioned by most regulatory bodies.'');

Deloitte Haskins & Sells, Public Utilities Manual 23 (1980) (``[T]he

straight-line concept is applied almost universally for both

accounting and rulemaking. * * *''); C. Phillips, The Regulation of

Public Utilities: Theory and Practice 272 (3d ed. 1993) (The

straight line method * * * is the simplest and most commonly

used.''); L. Hyman, America's Electric Utilities: Past, Present and

Future 292 (5th ed. 1994) (``The book depreciation rate is a

straight line rate for most utility companies.''); accord

Depreciation Subcommittee of the NARUC Committee on Engineering,

Depreciation, and Valuation of the National Association of

Regulatory Utility Commissioners, Public Utility Depreciation

Practices 12 (1968) (``In the two decades, since the Report of the

Committee on Depreciation of the NARUC was published in 1943, the

use of the straight-line method for accounting and rate-making

purposes has became almost universal for public utilities.'').

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The Commission proposes that the depreciation period for utility

property be its estimated useful service life. The current practice of

estimating useful service lives of assets based on engineering or other

studies of the expected physical, economic, or productive lives over

which the assets will provide utility service, would continue.\18\

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\18\ Changes in estimated useful service lives would be based on

updated depreciation study results that demonstrated different

service lives (shorter or longer) were appropriate.

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Where composite depreciation rates are used, they would be based on

the weighted average estimated useful service lives of the assets

comprising the composite group.

The Commission believes that computing depreciation on a straight-

line basis over assets' estimated useful service lives will produce

more relevant and reliable financial information for regulatory and

financial reporting purposes than other depreciation techniques (e.g.,

accelerated depreciation, retirement method, sinking fund depreciation,

etc.) that do not ratably allocate plant costs to each accounting

period. Because of the relatively consistent operation of utility plant

over time, the use of the straight-line method and estimated useful

service lives appears to provide the most practical way to measure the

amount of depreciation consumed each year in producing utility products

and services. The straight-line method is also simple in its

application in contrast to other depreciation techniques. It is, as

well, the standard method for business in general, conforms to

generally accepted accounting principles (i.e., systematic and

rational) and, as noted, is the method typically used by utilities

today.\19\

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\19\ See supra note 17.

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B. Future Commission Action

We also take this opportunity to explain how the Commission intends

to exercise its authority over depreciation accounting in the

foreseeable future.

On a case by case basis, e.g., in conjunction with audits,

complaints, etc., it may become necessary, as a result of these

proceedings, for the Commission from time to time to ascertain and

determine, and by order fix, the accounting depreciation rates for

individual utilities pursuant to FPA section 302. However, unless

otherwise ordered by the Commission, individual utilities will not be

required to file their accounting depreciation rates with us for our

approval. This approach is consistent with our efforts to reduce

regulatory burdens to the degree possible and facilitate the transition

to competition in the electric utility industry.

IV. Environmental Statement

The Commission excludes certain actions not having a significant

effect on the human environment from the requirement to prepare an

environmental assessment or an environmental impact statement.\20\ The

promulgation of a rule that is procedural or that does not

substantially change the effect of legislation or regulations being

amended raises no environmental considerations.\21\ The instant

proposed rule amends Part 101 of the Commission's regulations to codify

prevalent utility practice and does not substantially change the effect

of the underlying legislation or the regulations being revised.

Likewise, approval of actions under section 301 of the FPA, relating to

accounting orders, also raises no environmental considerations. The

instant rule fundamentally involves accounting matters, establishing

standardized depreciation accounting practices. Accordingly, no

environmental consideration is necessary.

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\20\ 18 CFR 380.4.

\21\ 18 CFR 380.4(a)(2)(ii).

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V. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-612, requires

rulemakings to contain either a description and analysis of the effect

that the proposed rule will have on small entities or a certification

that the rule will not have a significant economic impact on a

substantial number of small entities.

In Mid-Tex Elec. Coop. v. FERC, 773 F.2d 327 (D.C. Cir. 1985), the

court found that Congress, in passing the RFA, intended agencies to

limit their consideration ``to small entities that would be directly

regulated'' by proposed rules. Id. at 342. The court further concluded

that ``the relevant `economic impact' was the impact of compliance with

the proposed rule on regulated small entities.'' Id. at 342.

The Commission certifies that, given the entities subject to this

proposed rule and their current depreciation accounting practices, this

proposed rule will not have a significant economic impact upon a

substantial number of small entities.

VI. Public Reporting Burden and Information Collection Statement

The Commission proposes to amend 18 CFR Part 101 by standardizing

the method for determining depreciation rates for accounting purposes.

Because the proposed rule simply standardizes the method of calculating

depreciation rates, without adding or changing any reporting

requirements, it does not impose any additional public reporting

burden.

Interested persons may obtain information on the reporting

requirements by contacting the following: Federal Energy Regulatory

Commission, 888 First Street, NE, Washington, DC 20426 [Attention:

Michael Miller, Capital Planning and Policy Group, Phone: (202) 208-

1415, Fax: (202) 208-2425, E-mail: [email protected]].

To submit comments concerning collections of information and

associated burden estimate(s), please send your comments to the contact

listed above and to the Office of Management and Budget, Office of

Information and Regulatory Affairs, Washington, DC 20503, [Attention:

Desk Officer for the Federal Energy Regulatory Commission, Phone: (202)

395-3087, Fax: (202) 395-7285].

VII. Public Comment Procedures

Prior to taking final action on this proposed rulemaking, we are

inviting written comments from interested persons. The Commission also

is notifying each State commission having jurisdiction with respect to

any public utility involved and is giving reasonable opportunity to

each State commission to present its views for our consideration. All

comments in response to this notice should be submitted to the Office

of Secretary, Federal Energy Regulatory Commission, 888 First Street,

NE, Washington, D.C. 20426, and should refer to Docket No. RM99-7-000.

An original and fourteen (14) copies of such comments should be filed

with the Commission on or before October 4, 1999.

In addition to filing paper copies, the Commission encourages the

filing of comments either on computer diskette or via Internet E-Mail.

Comments may be filed in the following formats: WordPerfect 8.0 or

lower version, MS Word Office 97 or lower version, or ASCII format.

For diskette filing, include the following information on the

diskette label: Docket No. RM99-7-000; the name of the filing entity;

the software and version used to create the file; and the name and

telephone number of a contact person.

For Internet E-Mail submittal, comments should be submitted to

``[email protected]'' in the following format. On the subject

line, specify Docket No. RM99-7-000. In the body of the E-Mail message,

include the name of the filing entity; the software and version used to

create the file, and the name and telephone number of the contact

person. Attach the comments to the E-Mail in one of the formats

specified above. The Commission will send an automatic acknowledgment

to the sender's E-Mail address upon receipt. Questions on electronic

filing should be directed to Brooks Carter at: 202-501-8145, E-Mail

address: [email protected].

Commenters should take note that, until the Commission amends its

rules and regulations, the paper copy of the filing remains the

official copy of the document submitted. Therefore, any discrepancies

between the paper filing and the electronic filing or the diskette will

be resolved by reference to the paper filing.

All written comments will be placed in the Commission's public

files and will be available for inspection in the Commission's Public

Reference room at 888 First Street, N.E., Washington D.C. 20426, during

regular business hours. Additionally, comments may be viewed, printed

or downloaded remotely via the Internet through FERC's Homepage using

the RIMS or CIPS link. RIMS contains all comments but only those

comments submitted in electronic format are available on CIPS. User

assistance is available at 202-208-2222, or by E-Mail to

[email protected].

List of Subjects in 18 CFR Part 101

Electric power, electric utilities, reporting and recordkeeping

requirements, Uniform System of Accounts.

By direction of the Commission.

David P. Boergers,

Secretary.

In consideration of the foregoing, the Commission proposes to amend

Part 101, Chapter I, Title 18 of the Code of Federal Regulations, as

set forth below.

PART 101--UNIFORM SYSTEM OF ACCOUNTS PRESCRIBED FOR PUBLIC

UTILITIES AND LICENSEES SUBJECT TO THE PROVISIONS OF THE FEDERAL

POWER ACT

1. The authority citation for Part 101 continues to read as

follows:

Authority: 16 U.S.C. 791a-825r, 2601-2645; 31 U.S.C. 9701; 42

U.S.C. 7102-7352, 7651-7651o.

2. In Part 101, General Instructions, paragraph 22 is added to read

as follows:

General Instructions

* * * * *

22. Depreciation Accounting

A. Method. Utilities must use the straight-line method of

depreciation. The straight-line method allocates equal amounts of the

service value of utility property to expense during each year of the

property's useful service life.

B. Service Lives. Estimated useful service lives of depreciable

property must be supported by engineering or other depreciation

studies.

C. Rate. Utilities must use percentage rates of depreciation that

are based on the straight-line method and the estimated useful service

lives of depreciable property. Where composite depreciation rates are

used, they should be based on the weighted average estimated useful

service lives of the depreciable property comprising the composite

group.

[FR Doc. 99-20010 Filed 8-3-99; 8:45 am]

BILLING CODE 6717-01-P