1

8 Rebuttal Testimony of Jan Umbaugh

9 On Depreciation Issues
10 In Southern California Edison
11 2006 General Rate Case
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15

16

17

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1 Q. PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.

2 A. My name is Jan A. Umbaugh, and my address is Suite 900, 1645 Palm

3 Beach Lakes Blvd, West Palm Beach, Florida 33401.

5 Q. WHAT IS YOUR OCCUPATION AND WITH WHOM ARE YOU ASSOCIATED?

6 A. I am a Certified Public Accountant and a partner with the firm of Deloitte

7 & Touche LLP (“Deloitte &Touche” or the “Firm”), an international public

8 accounting firm.
9

10 Q. PLEASE DESCRIBE YOUR BACKGROUND AND PRESENT WORK

11 RESPONSIBILITIES.

12 A. I graduated from Ball State University in Muncie, Indiana, in 1969 with a

13 Bachelor of Science degree, majoring in accounting. Since 1969, I have

14 been employed by Deloitte & Touche or its predecessors in Detroit, New

15 Orleans, Raleigh, St. Louis, Washington, D.C.` (National Office-Public

16 Utilities), and West Palm Beach. My responsibilities have been

17 concentrated in public utilities throughout my career. I currently serve as

18 the Firm’s Industry Professional Practice Director for the public utility

19 industry. In this role, I serve as the Firm’s lead technical accounting and

20 auditing partner for the utility industry. My responsibilities center on

21 providing assistance to the Firm’s personnel and our public utility clients

22 concerning a variety of public utility accounting, tax, and regulatory

23 matters. These responsibilities include accounting research and

24 consultation, preparation and presentation of training programs,

25 coordinating Firm responses to accounting and regulatory rules proposals,

26 assistance in interpreting and applying specific accounting and regulatory

27 rules, concurring review of audit reports on utility clients’ financial

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1 statements, and participation in a variety of engagements, including the

2 preparation of testimony and supporting data on utility rate and

3 accounting matters. I have served as lead client service partner on such

4 audit clients as Entergy Corporation, Florida Public Utilities, FPL Group,

5 IPALCO Enterprises, MCN Energy, Progress Energy, Tucson Electric Power,

6 and Wabash Valley Power Association.

7 I have presented testimony as an expert witness before the Federal

8 Energy Regulatory Commission (“FERC”) and before courts or regulatory

9 agencies in Alabama, Arizona, California, Florida, Georgia, Indiana,

10 Michigan, Mississippi, New Jersey, New Mexico, Ohio, Rhode Island, South

11 Carolina, South Dakota, Texas, West Virginia, and Ontario, Canada.

12 My professional affiliations include the American Institute of Certified

13 Public Accountants (“AICPA”) and the Florida, Missouri and North Carolina

14 state societies of Certified Public Accountants. I am a licensed CPA in the

15 states of Florida, Missouri, and North Carolina. I served two terms as a

16 member of the AICPA’s Public Utility Committee and am a contributing

17 author of Accounting for Public Utilities published by Matthew Bender.

18 I also prepared Deloitte & Touche’s comments to the FERC in Docket

19 RM02-7 in which FERC Order 631 was issued and participated in FERC’s

20 roundtable to discuss issues that were being considered by the FERC in

21 this docket.

22

23 Q. WHAT IS THE PURPOSE OF YOUR REBUTTAL TESTIMONY IN THIS

24 PROCEEDING?

25 A. I have been asked by Southern California Edison (SCE or the Company) to

26 discuss the scope of Statement of Financial Accounting Standards No.

27 143, Accounting for Asset Retirement Obligations (“FAS 143”) and a March

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1 2005 interpretation of FAS 143, FASB Interpretation No. 47, Accounting for

2 Conditional Asset Retirement Obligations (FIN 47) in response to

3 assertions made by TURN witness Michael J. Majoros. In particular, I am

4 going to discuss the original intent behind the project carried out by the

5 Financial Accounting Standard Board (FASB) that resulted in the

6 implementation and guidance provided in FAS 143, in addition to why FAS

7 143 accounting has no impact on ratemaking. I will also discuss Federal

8 Energy Regulatory Commission (FERC) Order No. 631, Accounting,

9 Financial Reporting, and Rate Filing Requirements for Asset Retirement

10 Obligations (FERC Order No. 631), which addresses the regulatory

11 accounting for asset removal costs and the application of FAS 143 under

12 the FERC Uniform System of Accounts. Furthermore, I will also discuss

13 how SCE’s depreciation accounting and their current depreciation rates,

14 as determined under this Commission’s rulemaking, are consistent with

15 current GAAP and regulatory accounting rules, contrary to assertions

16 made by TURN’s witness.

17

18 Q. WOULD YOU PLEASE SUMMARIZE YOUR POSITION REGARDING FAS 143

19 AND FERC ORDER NO. 631?

20 A. FAS 143, is a financial accounting requirement that deals with the

21 identification, measurement, and recording of legal obligations associated

22 with retirements of tangible, long-lived assets. FAS 143 is designed to

23 standardize the way that companies measure and report accounting costs

24 when there is a legal obligation to remove or dispose of an asset. This

25 intent is clearly stated in the Summary of the FAS 143 publication. FAS

26 143 was not intended to, nor does it, address regulatory accounting or

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1 ratemaking treatment for rate-regulated utilities. To the contrary, FAS 143

2 explicitly recognizes that differences may arise for rate-regulated entities.

3 FERC Order No. 631 is a regulatory accounting requirement that

4 supports FAS 143 by amending FERC’s Uniform System of Accounts

5 (USoA) to account for asset retirement obligations (AROs) and also

6 continues existing accounting, as FAS 143 does, in allowing recognition of

7 differences that may arise for rate-regulated entities. FERC also

8 concluded there was no reason to fundamentally change regulatory

9 accounting concepts for costs that do not qualify as legal retirement

10 obligations (i.e., Non-AROs).

11 Finally, I conclude that the use of traditional depreciation accrual

12 methodologies used in ratemaking to determine cost of removal provides

13 the most theoretically sensible method for ratemaking. Ratemaking for

14 cost of removal should not be changed as a result of FAS 143.

15

16 Q. WOULD YOU PLEASE EXPLAIN THE IMPORTANCE OF THE TERMS FINANCIAL

17 ACCOUNTING, REGULATORY ACCOUNTING, AND RATEMAKING?

18 A. It is important to distinguish these three terms because each of them are

19 different and are each governed by different principles and requirements.

20 Mr. Majoros throughout his testimony confuses these three accounting

21 concepts and uses FAS 143, which is a standard used for financial

22 accounting, and FERC Order No. 631, which is a standard for regulatory

23 accounting, to justify illogical changes to traditional ratemaking policies.

24 Each of these accounting concepts serves a different purpose.

25 Financial accounting is used in developing financial statements for

26 reporting financial information in accordance with Generally Accepted

27 Accounting Principles (GAAP). The Securities and Exchange Commission

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1 (SEC) and Public Company Accounting Oversight Board (PCAOB) require

2 that companies with securities registered under the SEC rules utilize GAAP

3 in their reporting to the public. Its purpose is to establish general

4 principles and provide consistency in accounting across all companies,

5 which provides users comparability among the companies. The focus of

6 the FASB in recent years has been on the balance sheet, increasing the

7 consistency of asset and liability recognition, with less concern about the

8 income statement of matching revenues and expenses within the same

9 periods.

10 Statement of Financial Accounting Standards No. 71, Accounting for

11 the Effects of Certain Types of Regulation (FAS 71) provides guidance to

12 recognize the effects of utility regulation in GAAP financial statements

13 under certain circumstances. However, financial accounting standards do

14 not dictate requirements for regulatory accounting (although regulatory

15 accounting may at times adopt financial accounting standards or be

16 modified to more closely align with financial accounting) or for ratemaking

17 treatment.

18 Regulatory accounting is governed by the FERC and by various state

19 and local regulatory bodies. It is used in developing various FERC and

20 state regulatory reports, of which FERC Form 1 is the most widely

21 recognized for electric utilities. The purpose of regulatory accounting is to

22 provide accounting information in a manner that assists utility regulators

23 in their ratemaking treatment of regulated companies. As a result, certain

24 accounting concepts and presentations under regulatory accounting may

25 differ from those used under GAAP financial accounting. Regulatory

26 accounting provides reporting continuity among rate-regulated entities

27 where the ratemaking treatment is similar but would be substantially

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1 different from the accounting used by companies that are not subject to

2 rate regulation.

3 Under ratemaking treatment for most utilities in the United States,

4 including SCE, the utility is granted the opportunity to recover prudently

5 incurred expenses and earn a reasonable return on its investment. In

6 return for those privileges, the utility, including SCE, is subject to cost and

7 price regulation of its regulatory commission and required to provide safe

8 and reliable service. Cost and price regulation should follow the public
9 interest goals of intergenerational equity which, in utility regulation,

10 essentially prescribes that ratepayers in one period should pay the costs

11 of the service they receive and should not subsidize or be subsidized by

12 the costs for ratepayers that receive service in another period. In order to

13 achieve intergenerational equity in regards to capital recovery, costs

14 associated with an asset should generally be recovered over the period

15 that the asset provides service, not before the asset provides service and

16 not in the period the asset is retired.

17 My primary focus will be on the financial accounting requirements of

18 FAS 143, and the regulatory accounting requirements of FERC Order No.

19 631.

20

21 Overview of FAS No. 143

22 Q. WHAT IS THE PURPOSE OF FAS 143?

23 A. FAS 143 is a financial accounting pronouncement and is part of a broader

24 focus by the Financial Accounting Standards Board (FASB) to standardize

25 reporting to users of financial statements that will ensure their awareness

26 of future legal obligations associated with the removal or disposal of

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1 tangible long-lived assets. FASB states that the reasons for addressing

2 the accounting and reporting of AROs is because:

3
4  Users of financial statements indicated that the diverse
5 accounting practices that have developed for obligations
6 associated with the retirement of tangible long-lived assets make
7 it difficult to compare the financial position and results of
8 operations of companies that have similar obligations but
9 account for them differently.

10  Obligations that meet the definition of a liability were not being

11 recognized when those liabilities were incurred or the recognized
12 liability was not consistently measured or presented.

13 The anticipated benefits of FAS 143 include the fact that financial

14 statements of different entities will be more comparable since all asset

15 retirement obligations (AROs) that fall within the scope of FAS 143 will be

16 accounted for consistently for financial reporting. Before the issuance of

17 FAS 143, few companies other than regulated utilities recognized any

18 costs of removal in their GAAP financial reporting until the costs were

19 actually paid. Even regulated utilities usually accrued estimated nuclear

20 decommissioning and other legal AROs over the life of the property as a

21 component of depreciation, but used widely varying assumptions to

22 measure those costs. Additional benefits include:

23
24  AROs will be recognized when they are incurred and will be
25 displayed as liabilities.

26  AROs will be measured on a consistent basis

27  disclosure requirements contained in FAS 143 will provide more

28 information about AROs
29

30 Q. WHAT IS THE BACKGROUND OF FAS 143?

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1 A. The project that resulted in the issuance of FAS 143 was launched in order

2 to address concerns originally raised by the SEC about the “accounting for

3 the costs of nuclear decommissioning” and “similar closure or removal-

4 type costs in other industries.” This issue was first raised by the SEC staff
1

5 in the early 1990s because of concerns with the diversity in practice

6 regarding the recognition of nuclear decommissioning liabilities (most

7 companies only recognized whatever amounts had been recovered in

8 rates) and that if nuclear plants were shut down prematurely, the full
9 liability would not have been recognized. As a result of the concerns

10 raised by the SEC, the Edison Electric Institute (an electric utility trade

11 association) asked the FASB to address the issue of asset retirement

12 obligations on a broader basis. The scope of the project widened during

13 its development to incorporate other “legal” asset retirement obligations

14 and to specifically exclude non-AROs. However, the overall intent was

15 (and still is) to help standardize financial reporting of legal obligations for

16 the benefit of the financial community.

17

18 Q. WOULD YOU PLEASE SUMMARIZE FAS 143?

19 A. FAS 143 addresses required financial accounting and reporting under

20 GAAP for costs of “legal obligations associated with the retirement of a

21 tangible long-lived asset.” FAS 143 applies to all entities, including rate-

22 regulated entities, that may have Asset Retirement Obligations (AROs).

23 Furthermore, the statement only applies to the retirement of a tangible

24 long-lived asset that results from “acquisition, construction, or

25 development and (or) normal operation of a long-lived asset.” The most

2

26 common AROs in the electric utility industry include such obligations as

21 SFAS No. 143, Appendix B, paragraph B3

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1 nuclear and coal plant decommissioning at the end of or after their useful

2 life. The FAS 143 ARO definition should not to be taken to mean, as Mr.

3 Majoros holds, that the accounting community does not believe that there

4 are no other long-lived assets that will incur removal and disposal costs.

5 For example, to date, the retirement obligations for the majority of the

6 industry’s transmission and distribution assets have not been classified as

7 AROs. Although Non-AROs do not meet the accounting requirements

8 established by SFAS 143 for recognizing ARO liabilities, it does not mean
9 that these removal costs will not be incurred. The recorded costs used in

10 SCE’s net salvage study clearly indicates that removal costs are incurred

11 for Non-ARO’s.

12

13 Q. WOULD YOU PLEASE EXPLAIN THE INITIAL RECOGNITION AND

14 MEASUREMENT OF THE LIABILITY FOR AN ARO?

15 A. The initial measurement of the ARO liability is estimated at fair value as

16 discussed in FASB Concepts Statement No. 7, Using Cash Flow Information

17 and Present Value in Accounting Measurements. The fair value of an

18 asset retirement obligation is the amount the liability could be settled for

19 with a willing third party. The fair value of a liability is best determined

20 using quoted market prices; however, there is generally no active markets

21 for asset retirement obligations. In lieu of a market valuation, a present

22 value technique can be relied upon as a proxy, by using a probability

23 weighted estimation of future cash flows. Under FAS 143, the full

24 estimated liability to eventually settle the ARO obligation will be

22 SFAS No. 143, paragraph 2. This means that FAS 143 does not apply to temporary removal
3 or maintenance activities.

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1 measured on a discounted basis rather than only recording the

2 undiscounted amount of the obligation that had been recovered to date.

3 The initial liability is offset by capitalizing an equivalent asset

4 retirement cost as part of plant in service. This asset retirement cost

5 amount is subject to straight-line depreciation, generally over the same

6 depreciation life of the underlying asset. “Accretion” of the discounted

7 liability amount originally recorded will be charged to operating expense

8 and increase the liability to the estimated settlement amount by the

9 estimated settlement date (which may be several years after the related

10 asset is retired). In addition, the FAS 143 liability is displayed as a

11 separate liability on the balance sheet (not included in accumulated

12 depreciation as was often the case before FAS 143).

13

14 Q. WHEN WAS FAS 143 EFFECTIVE?

15 A. FAS 143 became effective January 1, 2003 for companies whose fiscal

16 year ends on December 31.

17

18 Q. WHAT IS THE IMPACT ON REGULATED ENTITIES RESULTING FROM FAS 143?

19 A. The impact on regulated entities resulting from FAS 143 is generally net

20 income neutral, since regulatory assets and regulatory liabilities will be

21 reflected on the balance sheet, as long as the recovery of the regulatory

22 assets and regulatory liabilities are probable under FAS 71. Timing

23 differences between ratemaking and financial accounting for cumulative

24 effects of initially implementing FAS 143 and the ongoing net expenses

25 that would have occurred in an unregulated environment would be

26 reflected as regulatory assets and regulatory liabilities in a regulatory

27 environment.

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2 Q. IS THE ACCOUNTING FOR REGULATORY LIABILITIES AND ASSETS A NEW

3 REQUIREMENT RESULTING FROM THE ISSUANCE OF FAS 143?

4 A. No. Recognition of regulatory liabilities and assets is not new and is not

5 specific to issues raised by FAS 143. Regulatory liabilities and assets are

6 accounted for under the auspices of FAS 71, was issued in December

7 1982, predating FAS 143 by nearly 20 years. Regulated entities will

8 recognize a regulatory liability or asset whenever there is a timing

9 difference in the recognition of expenses or revenues between financial

10 accounting and ratemaking and the conditions of FAS 71 are met.

11 A common example in the industry is a regulatory asset for flow-

12 through taxes. This regulatory asset recognizes the temporary income

13 tax differerences resulting from differing treatment of items such as

14 depreciation. The 2004 financial statements for SCE show the regulatory

15 asset for flow through taxes to be $1.0 billion at year-end 2004. SCE

16 expects to recover this amount in the future.

17

18 Q. DOES SFAS 143 ADDRESS RATEMAKING FOR AROS OR OTHER COSTS OF

19 REMOVAL?

20 A. No. FAS 143 does not address ratemaking treatment at all. The manner

21 in which removal and disposal costs are treated for financial reporting

22 purposes and the way in which they traditionally have been treated for

23 ratemaking purposes are different. There is, however, nothing in FAS 143

24 that precludes SCE and other utilities from continuing to recover removal

25 costs in the approved depreciation rates, whether or not those costs fall

26 within the scope of FAS 143. In fact, the guidelines of FAS 143 explicitly

27 recognize that:

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1 Many rate-regulated entities currently provide for the costs related to

2 the retirement of certain long-lived assets in their financial statements
3 and recover those amounts in rates charged to their customers. Some
4 of those costs result from asset retirement obligations within the scope
5 of this Statement; others result from costs that are not within the
6 scope of this Statement. The amounts charged to customers for the
7 related to the retirement of long-lived assets may differ from the period
8 costs recognized in accordance with this Statement, and, therefore,
9 may result in a difference in the timing of recognition of period costs
10 for financial reporting and rate-making purposes.” (par. 20, emphasis
11 added)

12 FAS 143 guidelines provide that if the requirements for FAS 71 are met,

13 the rate-regulated entity would recognize a regulatory asset or liability for

14 the differences in timing inherent in the depreciation for ratemaking and

15 financial reporting.

16

17 Q. DOES GAAP PRESCRIBE METHODS OR PROCEDURES FOR COST RECOVERY

18 FOR RATE-REGULATED UTILITIES?

19 A. No. GAAP does not prescribe the method or procedures for cost recovery

20 of rate-regulated utilities. The utility is subject to regulation by this

21 Commission according the jurisdiction granted it under the state

22 constitution and by statute. SCE records its costs according to the

23 Commission’s decisions and rulemaking. The longstanding ratemaking

24 procedures for capital recovery that have been established by this

25 Commission support intergenerational equity, and are consistent with the

26 regulatory compact. As stated before, accounting authorities recognize

27 the differences that may occur in the timing of cost recognition for rate-

28 regulated industries, and has established standards to report that – i.e.,

29 FAS 71.

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1 Q. ARE THERE ANY REASONS THAT THE FAS 143 METHOD SHOULD NOT BE

2 USED FOR RATE RECOVERY PURPOSES?

3 A. Yes. The FAS 143 accounting method utilizes several scenarios of

4 estimated removal cost for each asset and then assigns a probability to

5 each scenario to arrive at a weighted average estimated cost. The FAS

6 143 cost estimates require an assumption of what a third party would

7 require to perform the work including their required profit margin, even if

8 the company intends to perform the work internally. This weighted cost
9 estimate is then discounted based on an estimated “credit-adjusted risk-

10 free rate” (essentially the specific company’s then current unsecured debt

11 borrowing rate) and then accreted back up to the ultimate estimated

12 liability over the time period until the liability is estimated to be settled.

13 As a result of these calculations, the total cost recognition is back loaded

14 over time, and therefore does not meet the ratemaking goals of

15 intergenerational equity. Second, this method is complex and utilizes

16 multiple assumptions. Therefore, this method would not be practical for

17 mass property items with indeterminate specific lives for each piece of

18 equipment. By contrast, the traditional method of cost of removal is

19 based on historical actual experience by functional area and account

20 which can be applied broadly. Third, this method would not be practical

21 even for assets other than the mass property items due to the complexity

22 of the analyses that would be needed. Ultimately, Mr. Majoros, himself,

23 recommends that the FAS 143 approach not be used because the method

24 is too complicated. 3

25

23 Direct Testimony of Michael J. Majoros, Jr., Page 44

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1 Q. DO YOU AGREE WITH MR. MAJOROS’ ASSERTION THAT FOR NON-AROS,

2 “THE FUTURE COST OF REMOVAL INCLUDED IN SCE’S CURRENT

3 DEPRECIATION RATES AND MR. PIERCE’S PROPOSED DEPRECIATION RATES

4 IS AVOIDABLE?”

5 A. No, I do not. The assertion made by Mr. Majoros, is based on faulty logic.

6 His assertion wrongly assumes that unless a removal or disposal cost does

7 flow from a legal obligation, then there is no probability that it will occur,

8 and therefore is avoidable:

9

10 NO LEGAL OBLIGATION  NOT PROBABLE  AVOIDABLE

11

12 It is wrong to assume that a business would expect to incur removal costs

13 only if it has a legal obligation to do so. This assumption simply

14 contradicts the recorded history, not only at SCE, but across the industry.

15 Utilities do not have a legal obligation to incur many of the projected costs

16 represented in their cost of service -- and the absence of a legal obligation

17 or a “promise to spend the money” does not mean that the incurrence of

18 these costs is not probable. SCE incurs several million dollars of removal

19 costs each year. Based on prior experience, SCE expects to incur removal

20 costs in order to replace property units that wear out, become obsolete, or

21 are removed for other reasons. It is probable that such costs will be

22 incurred in order for the utility to meet its obligation to serve customers.

23 However, the utility obligation to provide service is not the type of legal

24 obligation that creates an ARO under FAS 143.

25 Mr. Majoros makes the conclusion that “By definition, non-legal AROs

26 are not recognized as liabilities because they are not probable.” To

27 support such a conclusion, requires Mr. Majoros to apply a fallacious logic.

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1 He assumes that since, according to FAS 143 requirements, all legal AROs

2 are probable, therefore all Non-AROs must not be probable. The

3 requirement of being “probable” is only one element of the determination

4 of whether a retirement obligation falls under the ARO requirements of

5 FAS 143. It should not be used to imply that all other asset retirement

6 obligations are not probable. The reality is that Non-AROs are not

7 recognized as liabilities under the requirements of FAS 143 simply

8 because there are no legal obligations to retire the underlying assets. Mr.
9 Majoros uses the definition of probable, cited from FAS 143, severely out

10 of context. The definition of “probable” in FASB Concepts Statement No.

11 6, Elements of Financial Statements, as quoted in FAS 143, is made in

12 context to the “Initial Recognition and Measurement of a Liability for an

13 Asset Retirement Obligation.” The term “probable” is used in

4

14 determining liabilities for legal asset retirement obligations, not to

15 determine if there is any asset retirement obligation. There are logical

16 steps in determining whether an ARO liability should be recognized for an

17 asset.

18 I am not aware of any business that relies upon legal requirements as

19 the sole guideline in estimating likelihood of costs it will incur in a future

20 period. In answer to Mr. Majoros’ question as to “Why would SCE spend

21 billions of dollars on removal costs that it does not need to spend?” I 5

22 would reply: SCE needs to spend money on removal costs if it wants to

23 stay in the business of providing safe, reliable electrical service to its

24 customers.

25

24 FAS No. 143, Paragraphs 3-10

35 Direct Testimony of Michael J. Majoros, Jr. on Behalf of The Utility Reform Network, page 37.

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1 Q. DOES FAS 143 REQUIRE THE REVERSAL OF PAST REGULATORY RECOGNITION

2 OF COSTS OF REMOVAL OR PROHIBIT CONTINUED RECOGNITION OF SUCH

3 COSTS?

4 A. No. As I mentioned earlier, FAS 143 only addresses financial reporting under

5 GAAP and does not address regulatory accounting or ratemaking. In fact,

6 GAAP accounting provides a mechanism (the recording of regulatory assets

7 and liabilities) to recognize the economic effects of utility ratemaking that

8 differ from GAAP accounting for unregulated enterprises.

9 Q. DOES FAS 143 REQUIRE THAT NON-AROS BE REMOVED FROM ACCUMULATED

10 DEPRECIATION?

11 A. No. FAS 143 actually does not specifically address accounting for non-AROs.

12 Paragraph B73 of FAS 143, which provides background information but is not

13 part of the actual standard, suggests that non-AROs should be recorded as

14 regulatory liabilities if the conditions of FAS 71 are met. Nowhere in FAS 143

15 or FAS 71 does it require that regulatory liabilities must be recorded in

16 separate liability accounts rather than within accumulated depreciation.

17 However, in late 2003 and early 2004, the SEC issued a number of comment

18 letters requesting that the non-ARO obligation be reported as a separate

19 liability and not netted within accumulated depreciation.

20

21 Q. HOW DOES THE RECENTLY ISSUED FIN 47 IMPACT FAS 143?

22 A. FASB Interpretation No. 47, Accounting for Conditional Asset Retirement

23 Obligations – an interpretation of FASB Statement No. 143 (FIN 47), was

24 issued in March, 2005. FIN 47 will require companies to record additional

25 AROs as a result of conditional obligations to remove or dispose of assets.

26 Paragraph A15 of FAS 143 had provided an example that concluded that if

27 there was not a legal obligation to remove a component of an asset, but

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1 there was a legal obligation to dispose of it once it was removed, then the

2 liability should be recorded when the obligation occurs (i.e., when the asset

3 was removed). The essence of FIN 47 is that since there is a legal obligation

4 to dispose of an asset (e.g., a treated wood utility pole) once it is removed,

5 and it will eventually wear out and be removed, 6

then the legal “disposal”

6 cost obligation should be recorded when the asset is placed in service.

7 Because there is often not a legal obligation to remove the asset when it

8 wears out, the “removal” cost obligation would still not qualify as an ARO and
9 would not be recorded under FAS 143.

10 The effective date of FIN 47 is “no later than the end of fiscal years ending

11 after December 15, 2005 (December 31, 2005, for calendar-year

12 enterprises).” 7

13

14 Q. WILL THE IMPLEMENTATION OF FIN 47 REQUIRE ANY NEW ACCOUNTS OR

15 ACCOUNTING BY THE COMMISSION?

16 A. No. FIN 47 does not require any new accounts or accounting by the

17 Commission beyond those identified in FERC Order 631. The accounting

18 required under FERC Order No. 631 adequately addresses all ARO

19 regulatory accounting requirements. While FIN 47 will cause certain

20 additional ARO liabilities to be recorded, it does not change any of the

21 fundamental accounting requirements of FAS 143 or FERC Order No. 631.

22

23

24FERC Order No. 631

26 FIN 47, paragraph A4 of Appendix A, Illustrated Examples, states that “The poles will
3 eventually need to be disposed of using special procedures, because the poles will not last
4 forever” (emphasis added).
57 FIN 47, par. 8.

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1 Q. WOULD YOU PLEASE SUMMARIZE THE ACCOUNTING REQUIRED BY FERC

2 ORDER NO. 631.

3 A. FERC Order No. 631 is a regulatory accounting requirement that was

4 issued to update the accounting and regulatory reporting requirements for

5 AROs under the Uniform System of Accounts (USoA). Specifically, FERC

6 established new balance sheet and income accounts and revised the

7 definitions and general instructions to accommodate FAS 143 for AROs.

8 This is part of FERC’s ongoing effort to address emerging accounting

9 developments. FERC’s stated purpose upon issuance of Order No. 631

10 was to improve the usefulness and transparency of financial information

11 provided to the users of the FERC Forms by establishing continuity

12 between financial and regulatory accounting and reporting requirements

13 for legal obligations associated with the retirement of tangible long-lived

14 assets.

15

16 Q. DOES FERC ORDER NO. 631 CHANGE THE REGULATORY ACCOUNTING FOR

17 REMOVAL COSTS FOR NON-AROs?

18 A. No. The FERC order does not change its accounting for the cost of

19 removal amounts for non-AROs under Code of Federal Regulations, Parts

20 101, Public Utilities and Licensees. Jurisdictional entities continue to

21 account for such costs consistent with the requirements of the USoA.

22 FERC simply concludes that utilities are to maintain subsidiary records for

23 identifying the cost of removal in depreciation accruals. This is not a

24 change in accounting, just a change in record keeping detail. FERC Order

25 No. 631 did not adopt FAS 143 or the SEC guidance requiring

26 reclassification of the regulatory liability outside of accumulated

27 depreciation, but simply modified FERC regulatory accounting

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1 requirements and added certain regulatory disclosure requirements to

2 accommodate certain of the FAS 143 financial accounting presentations.

4 Q. MR. MAJOROS EXPRESSES CONCERN THAT “SCE HAS NOT DISCLOSED

5 THAT [COST OF REMOVAL] AMOUNTS ARE TO BE SPECIFICALLY IDENTIFIED

6 IN SEPARATE SUBACCOUNTS OF DEPRECIATION EXPENSE AND

7 ACCUMULATED DEPRECIATION.” IS THERE SUCH A REQUIREMENT AND IS

8

8 CONCERN WARRANTED?
9 A. No. There is absolutely no reason to raise an alarm or be concerned. I

10 have reviewed SCE’s accounting for depreciation accrual and removal

11 costs and have found SCE to be in accordance with financial reporting and

12 regulatory accounting requirements.

13 There is no such requirement for financial reporting and, contrary to

14 Mr. Majoros inference, FERC USoA simply requires that separate subsidiary

15 records be maintained to identify the accrual of removal cost in

16 accumulated depreciation. This is not as rigorous a requirement as Mr.

17 Majoros makes it out to be. “Maintaining subsidiary records” is not the

18 same as a need to be “specifically identified in separate subaccounts of

19 depreciation expense and accumulated depreciation.” FERC established

20 this requirement to simply help facilitate external reporting and regulatory

21 analysis if the need arises to identify the amounts.

22

23 Q. DOES FERC ORDER NO. 631 PRESCIBE RATEMAKING TREATMENT FOR

24 REMOVAL COSTS?

25 A. No. FERC Order No. 631 does not address ratemaking recovery of

26 removal costs. To the contrary, rather than requiring a change in

28 Direct Testimony of Michael J. Majoros on Behalf of The Utility Reform Network, page 12.

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1 ratemaking treatment, the Order accommodates existing ratemaking

2 treatment by supporting the recording of regulatory assets and liabilities

3 to reflect the differences as prescribed in FERC Order No. 552 under the

4 auspices of FAS 71. This treatment is consistent with FAS 143, as

5 previously discussed.

7 Q. ARE YOU AWARE OF ANY UTILITY COMMISSIONS THAT HAVE ADOPTED FAS

8 143 FOR RATEMAKING PURPOSES?

9 A. No. FAS 143 inappropriately spreads those costs unevenly over

10 generations of customers. FERC and most state commissions had

11 provided for rate recovery of both legally and non-legally required costs of

12 removal as a component of depreciation expense long before FAS 143 was

13 issued. Few companies outside the regulated (or previously regulated)

14 utility industries and the oil and gas industry recognized costs of removal

15 in advance of spending funds for the removal activity. Since FERC and

16 state regulatory commissions have more extensively studied depreciation

17 and removal costs and how they should be treated for ratemaking

18 purposes than the FASB, I would not expect FERC or any state commission

19 to adopt FAS 143 for ratemaking purposes.

20

21

22 Q. DO YOU AGREE WITH MR. MAJOROS THAT THE COMMISSION MUST

23 SPECIFICALLY RECOGNIZE THE REGULATORY LIABILITY TREATMENT FOR

24 NON-AROS IN THIS CASE?

25 A. No, I do not believe that is necessary. As the FERC recognized in FERC

26 Order 631, the FERC USoA prohibits the removal of amounts from

27 accumulated depreciation other than for the prescribed purposes (i.e., the

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1 payment of costs of removal) (18CFR101 Account 108, Instruction E).

2 Therefore, SCE would not be permitted to deduct amounts previously

3 accrued for removal costs from accumulated depreciation and record

4 them in income without the Commission’s approval as long as they

5 remain subject to the Commission’s regulation. In each of the examples

6 cited by Mr. Majoros where previously recorded removal cost accruals

7 were recognized in income, the impacted portions of those companies’

8 operations had ceased meeting the cost-based regulation requirements of

9 FAS 71. The non-AROs are also recognized as regulatory liabilities under

10 paragraph 11b of FAS 71 based on the “expectation” that those costs will

11 be incurred in the future, but with the “understanding” that the utility will

12 remain “accountable” for those costs and that future rates could be

13 reduced. The treatment of any previously recovered amounts for non-

14 AROs would best be considered when and if any of SCE’s operations cease

15 to be cost-based regulated by the Commission in the future.

16

17 Conclusions

18 Q. WHAT IS YOUR POSITION REGARDING A CHANGE IN REGULATORY

19 RECOVERY FOR AROs?

20 A. Contrary to Mr. Majoros’ proposal, specific recognition and recovery of

21 ARO costs in rates is not necessary since the recovery of removal costs

22 are currently, and appropriately, provided as part of the depreciation

23 rates. FAS 71 and FERC Order No. 631 provide the basis for making any

24 necessary accounting entries for the proper balance sheet classification of

25 amounts recovered and costs incurred for financial or regulatory

26 accounting. The important understanding that needs to occur is that a

27 revenue requirement for removal cost is created at the moment an asset

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1 is placed into service. While the revenue requirement can be achieved by

2 recovering the cost of removal at a single point in time, as Mr. Majoros’

3 cash basis and normalized net salvage allowance approach attempt to

4 accomplish, both approaches blatantly ignore the principles of

5 intergenerational equity. Both approaches will burden those ratepayers in

6 the period that the removal cost is incurred for an asset whose service

7 started well before that period. Mr. Majoros’ net present value approach

8 will undoubtedly result in an extreme back loading of costs, since it

9 recovers the present value of the cost of removal and not the cost that

10 will actually be incurred. This will, unfortunately, result in a deferral of the

11 remaining costs to future rate-payers, after the asset is retired from

12 service.

13

14 Q. YOU STATED EARLIER IN YOUR TESTIMONY THAT USE OF TRADITIONAL

15 ACCRUAL DEPRECIATION METHODOLOGIES TO DETERMINE COST OF

16 REMOVAL PROVIDES THE MOST THEORETICALLY SENSIBLE METHOD FOR

17 RATEMAKING. PLEASE EXPLAIN.

18 A. Depreciation accounting is defined by the American Institute of Certified

19 Public Accountants in the following way:

20 Depreciation accounting is a system of accounting which aims to

21 distribute the cost or other basic value of tangible capital assets, less
22 salvage value (if any), over the estimated useful life of the unit (which
23 may be a group of units) in a systematic and rational manner. It is a
24 process of allocation, not valuation. 9

25 Depreciation accounting should, to the extent possible, reflect the

26 consumption of physical assets or the pattern of revenues derived from

27 assets. The matching principle is often referred to as the cause-and-effect

29 The definition of depreciation accounting by the American Institute of Certified Public

3 Accountants, 1961, par. 56.

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1 principle. The matching principle is also an essential element of the

2 regulatory philosophy which has become known at intergenerational

3 equity. Intergenerational equity means that the costs generated from a

4 resource are borne by the generation of customers that benefited from

5 the consumption of that resource.

6 It is appropriate for SCE to include cost of removal as it has

7 traditionally, as part of its depreciation rates, which results in an equitable

8 distribution of the revenue requirement for recovery of the removal cost

9 over the period in which the asset that created the requirement is used to

10 provide utility service.

11

12 Q. DOES THIS CONCLUDE YOUR REBUTTAL TESTIMONY?

13 A. Yes, it does.

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