John S. Ferguson, Ferguson Associates
Utility asset accounting is in a state of flux that deserves understanding.
The Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants recently submitted a proposed statement of position (SOP) on property, plant and equipment (PP&E) accounting to the Financial Accounting Standards Board (FASB) for concurrence that would have an impact on the accounting processes and financial statements of utilities. The FASB rejected the proposal but indicated an intention to retain the work of AcSEC for use in connection with any future efforts to decrease differences between international accounting standards and U.S. GAAP. Further, AcSEC and the FASB staff are reviewing the submittal for FASB concurrence to determine if any aspects should be addressed by FASB staff positions (FSPs). Therefore, some portions of the SOP may be resurrected, prompting this discussion.
One reason given for rejection was differences from international accounting standards. Therefore, future efforts to reduce differences between standards seems likely.
The SOP more specifically defined the dividing line that distinguishes capital expenditures from period expenses and would have resulted in less capitalization for most entities. In addition to modifying capitalization practices, the SOP would have affected utility treatment of removal costs and use of the group concept of depreciation accounting.
An SOP applies to financial accounting. Therefore, entities that qualify for the special accounting allowed by SFAS 71, Accounting for the Effects of Certain Types of Regulation, would have income statements that reflect regulatory accounting, with any differences from financial accounting shifted to the balance sheet.
Relying on SFAS 71 would require maintaining multiple sets of records. The extent of this effort might have prompted adopting some aspects of the SOP for regulatory accounting purposes.
Federal and state regulators have long dictated that jurisdictional entities base their capitalization policy on retirement units that are physical descriptions of PP&E items. This use of physical descriptions is consistent with the SOP, and such descriptions are the key to accurate accounting records, as they assure retirement of replaced assets, financial statements that reflect a clear and consistent distinction between capital and expense transactions, and easy monitoring for consistent application.
The SOP specified that asset components (retirement units) be separately identified and recorded from the outset. However, segregation at the time placed in service would not be cost effective for some types of utility assets, such as power plants. Regulators recognize that it makes no sense to require complete segregation for asset types having only a small portion of their components replaced over their lifetime. If the SOP had been adopted, some utilities would have been forced to further segregate recorded investment amounts.
The SOP defined four stages of PP&E projects-preliminary, pre-acquisition, acquisition or construction and in-service-and specified the appropriate accounting (capitalization versus expense) for each stage. Uniform systems of accounts allow the costs of feasibility studies to be accumulated in a balance sheet account until such time as project initiation or abandonment is decided upon.
The SOP declared that the cost of planned major maintenance (overhaul) activities must be expensed, except to the extent that PP&E components are replaced in the process. This treatment is the same as specified by uniform systems of accounts, so would not have been significant to most utilities, but would have been significant to independent power producers that accrue such activities prior to expenditure or amortize them after expenditure.
The SOP stated that occupancy costs and the costs of several specified functions are to be excluded from administrative and general overheads and be charged to expense when incurred. Conspicuously absent from the specified functions were activities such as engineering, purchasing, PP&E accounting and storeroom operations that are directly related to PP&E. The additional effort to maintain multiple sets of records to track overhead differences might have prompted entities qualifying for SFAS 71 to adopt the SOP treatment of overheads for regulatory accounting purposes.
The SOP dealt with removal costs that do not qualify for liability treatment under SFAS 143, Accounting for Asset Retirement Obligations, and did not alter the current ratable treatment of salvage proceeds through depreciation. As do uniform systems of accounts, the SOP recognized that removal cost expenditures can be incurred even if physical removal does not occur, but called for expensing them.
The SOP provided two expensing options: (1.) expensing when incurred or (2.) recording an amount not to exceed salvage value ratably through depreciation. Most utility PP&E experiences little salvage and high removal cost expenditures, both of which Uniform Systems of Accounts specify be recorded ratably through depreciation. Ratable treatment matches the recording of removal costs to the usage or revenue generating capability of PP&E. In my opinion, the SOP mismatch with the usage of the related asset would have precluded the financial statements of entities having removal costs large relative to recorded asset costs (i.e., utilities) from accurately depicting their financial position and results of operations.
Segregating the removal cost component of depreciation accruals is not difficult for most utilities, and maintaining removal costs as a separate depreciation reserve component is already an FERC requirement. Therefore, record keeping needs would have been unlikely to prompt adopting expensing when incurred for regulatory accounting purposes. However, certain entities have complications imposed by regulators. For example, Missouri sometimes imposes a cash basis for both salvage and removal costs, which is consistent with the SOP for removal costs and would have dictated reporting regulatory liabilities for salvage differences.
The income statements of entities that qualify for SFAS 71 could continue to match removal costs with asset usage. However, the initial revenue requirement decrease from expensing removal costs when incurred for ratemaking and regulatory accounting purposes may be attractive to regulators, leading to ignoring Uniform Systems of Accounts requirements for accrual accounting. I observed an increase in expensing proposals after the FASB issued its 1996 exposure draft for what eventually became SFAS 143, and adoption of the SOP would have undoubtedly made such proposals more common. The initial revenue requirement impact of expensing eventually reverses with a vengeance, so precluding accrual accounting for removal costs is detrimental to customers and to the economy of the service territory.
Ferguson is a PE with more than 40 years of utility consulting experience. He is currently the owner and principal of Ferguson Associates and can be reached at email@example.com.