Basic Concepts in FERC and Utility Accounting APPA Business and Finance Workshop Savannah, Georgia

1. Basic Concepts in FERC and Utility Accounting • APPA Business and Finance Workshop • Savannah, Georgia • September 14, 2009 • Thomas Unke, • Baker Tilly Virchow Krause

2. Agenda • Learn the BASICS of the FERC Chart of Accounts • Discuss what it means to “Utility Accounting” • Learn how to practically apply the FERC Chart of Accounts • Address the common complexities with utility accounting

3. Housekeeping • Enjoy ourselves • Questions at anytime • 15 minutes at end for questions and dialogue too

4. Origin of FERC Uniform System of Accounts (USOA) • 1922 National Association of Regulatory Comm. (NARUC) • Recommended uniform structure • Still exists, sets for water & sewer • Not universally adopted - state commissions had own • 1935 Expanded Federal Power Commission (FPC) • Wholesale power sales in interstate commerce • Issued original USOA in 1937 - states begin adopting • 1977 FERC (Dept of Energy) Succeeds FPC • USOA continued with some revisions over time • Represents the standard accounting system for elect. utility industry

5. Why did FERC create the USOA? • Consistency in monitoring allowed for easier administration to monitor and regulate those who are regulated by FERC.

6. Accounting for Public Power Systems - Torn Between 2 Worlds • Not Really an Investor Owned Utility (IOU) or a Governmental Entity • Many must operate as a unit of govt. • Utilize acctg. system used by the govt. - fund accounting • Enterprise fund system which is based on organization, • Responsibility and resource-oriented structures - not activities • Need USOA for Management & Industry Comparability Purposes • Captures functional cost info • Production, transmission, distribution, customer, administrative • Operation, maintenance, capital, non-current • Includes detailed descriptions of accounts considered “standard”

7. Why Public Power Systems Use FERC - USOA • Most Compelling Reason is to Satisfy Regulatory Requirements • How do we Justify Expanding our Accounting System to USOA to our City Govt. if not Regulated ? • Consistency • Capital vs expense • Capital intensive organization • Impacts rates (exp = current; cap = over time thru depreciation) • Recoverable costs • “above” & “below the line” costs (IOU oriented, pass-thru)

8. Implementation of FERC USOA and the difference to fund accounting • Govt. Fund Accounting vs FERC • What does it cost when a customer flips on his lights ? • Govt. fund accounting answers based on resources consumed • Labor • Benefits • Materials & supplies • Contractual services • etc. • FERC accounting answers based on functional activity cost

9. Don’t do that! Do this! FERC USoA Has Instructions to follow some are obvious…some are not INSTRUCTIONS • There are 24 General Instructions in FERC • establishes general record keeping rules • 16 Electric Plant Instructions • addresses balance sheet items • 4 Operating Expense Instructions • covers items impacting income statement Here are your instructions Follow these rules ! HELP!!!

10. What is the Uniform System of Accounts? What are its Contents? • Code of Federal Regulations (Part of the Federal Register) • CFR, Title 18 • Parts 1-399 • Eleven Sections

11. FERC’s USoA’s • FERC Sections 1-2 • Commission Order of Applicability • Definitions • FERC Sections 3-5 • General Instructions • Electric Plant Instructions • Operating Expense Instructions

12. FERC’s USoA’s • FERC Sections 6-7 • Balance Sheet Chart of Accounts and Descriptions • Electric Plant Chart of Accounts and Descriptions • FERC Sections 8-11 • Income Chart of Accounts and Descriptions • Retained Earnings Chart of Accounts and Descriptions • Operating Revenue Chart of Accounts and Descriptions • Operation and Maintenance Expense Chart of Accounts and Descriptions

13. FERC Buckets What does it cost when a customer flips on his lights ? FERC’s Answer- Muni Govt. no FERC accts. Power Production 500-557 accts. Transmission 560-574 accts. Distribution 580-598 accts. Human resources, P a y r o l l Admin. & Gen’l 920-935 accts. Cust. Svc/Info 906-910 accts. Customer Accts 901-905 accts.

14. You Can Find of FERC’s USoA’s at: • FERC website: • www.ferc.gov/legal/ferc-regs/acct-matts/usofa-electric.asp • Mail: • U.S. Government Printing Offices, Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328 • Call: • (202) 512-1800 • Ask for the Code of Federal Regulations, Title 18, Parts 1-399.

15. FERC Buckets vs Governmental Accounting • FERC buckets would be easy to use except for: • Incorporating into city systems • Budget requirements unique to each utility • Resource costing by department, location, etc.

16. Next Session: • Utility Accounting

17. Utility Accounting is also known as“Regulatory Accounting” • Most utilities follow regulated pronouncements: • #71, 90, 92, 101. • As well as, #106, 137 138, 143, 144 • These pronouncements are elective which means they don’t need to be followed if you choose not to

18. The big one is….. • Statement of Financial Accounting Standard #71 • (This has been updated by the new FASB Codification)

19. SFAS 71 Definitions What regulatory assets or liabilities do you have to account for ? • REGULATORY ASSET What is your definition of a regulatory asset? …represent incurred costs that are deferred because recovery will come through future rates. • REGULATORY LIABILITY What is your definition of a regulatory liability? …represent obligations to make refunds associated with costs not likely to be incurred in the future.

20. Rate Regulation and GAAP • Basic difference centers around timing of cost/revenue recognition • Regulators may require capitalization (deferral) of expenses that would normally be expensed by a non-regulated business following GAAP • Often have material impact on financials • Creates inconsistencies in financial reporting • Can’t ignore the “economic realities” of regulation

21. SFAS 71 Intent and Purpose • Attempted to define when acceptable departure from GAAP • Intended to apply to the general purpose financial statements • of regulated enterprises • Does not apply to financial statements submitted to regulator • Recognizes regulatory deviations from GAAP for rate making • However, emphasizes GAAP must be followed unless issue is • related to the economic effects of rate-making • Does not identify who must comply with its guidelines

22. SFAS 71 Definition of “Regulated” • Independent 3rd party regulator (most muni’s don’t) • Rates intended to recover specific costs of regulated activities • Rates are reasonable and likely to be collected No, there is no definition of “reasonable”

23. SFAS 71 General Standards • Before costs, which would under GAAP be expensed, are capitalized (deferred), it must be probable that the regulator will allow recovery through future rates • A regulatory liability can be imposed on an enterprise by the regulatory body – refunds or rate adjustments • Rate actions by regulator can reduce/eliminate value of an asset If asset disallowed, it cannot be expected to produce revenue in the future through the rate-making process and since the asset is “impaired” it must be written down

24. SFAS 71 and SFAS 101 • Does not set specific guidelines for other regulatory deviations from GAAP (left up to regulatory jurisdiction) • If conflict with other GAAP– then SFAS 71 should be followed • Regulated companies following SFAS 71 are GAAP compliant • Due to deregulation and intro of “competition” • SFAS 101 issued • If now “unregulated” - SFAS 71 no longer applies • SFAS 101 deals with “discontinuance” of SFAS 71 • Defines transitional reporting requirements

25. Next Session: • Common Accounting Complexities

26. Construction or MaintenanceThe Basic Concept is Simple

27. What is Construction • Construction (aka Capitalized costs) - Means recording cost of asset to the utility’s balance sheet • Costs include: • Direct (labor & material) • Indirect (labor, supervision, tools, insurance, etc.) • Selling, general and administrative • Construction costs are capitalized as an asset when placed into service. • Expenses are accumulated in construction in progress (CIP) until they are placed into service. • Why capitalize? • Benefits are for the future

28. Construction (cont.) • Treatment of capitalized construction costs • Examples include buildings, equipment and infrastructure (substations, water mains, etc.) • Capitalized assets are depreciated over the useful life of the asset • Depreciation is the reduction in value of an asset due to usage, passage of time, etc. • Retired (taken off the books) when asset is taken out of service

29. Maintenance • Expenses incurred to sustain an asset’s life • Includes expenses incurred to: • fix/repair assets • Prevent problems in the future • Keep the asset in working order • Expenses that enhance the life and/or use of the asset may be considered capital assets (improvements) • Examples • Painting a water tower • Repairs of meters, transformers, equipment

30. Industry Experience • Inconsistencies with accounting treatment have continued to persist over the years. • Tolerance levels for accuracy and the increased fiduciary expectations over utility assets have prompted serious assessments of current utility practices.

31. Simple Facts For All Public Power Utilities • Utility plant in service represents one of the largest assets owned by city government. • Utility plant is the basis for determine just and reasonable rates. • Utilities are more keenly aware of the ability to shift costs to manage results which have increased scrutiny

32. What are the problems? • Insufficient standard industry guidance to determine when capitalization or expense recognition is appropriate. • Sins of the past. Ambiguous capitalization of construction and single mass assets make it extremely difficult to properly reflect retirements. • Changes in technology and software have both changed the manner in which construction costs can be accounted for and the life of originally recorded assets.

33. What are the problems, continued • Technology changes allow utilities to become increasingly accurate for plant accounting, but the process utilities follow to accumulate and track construction hasn’t • The introduction of new utility services (i.e. telcom) creates more challenges relative to plant accounting, cost allocation and retirement accounting.

34. Common complexity topics • Retirement accounting • how to retire an asset that isn’t a specified retirement unit • Technology spending • how and when to capitalize • Capitalization Policies • what is reasonable and makes sense for your utility

35. Retirement Accounting Gets Cluttered When Ineffective Capitalization Exists • Broad capitalizations in previous years makes retirements extremely difficult and usually serves as the basis to capitalize future costs. • Inadequate communications of retired assets from operations staff makes retirements extremely difficult • Given depreciation methods such as individual or group/class asset depreciation, utilities usually do not properly reflect asset retirements properly.

36. Broad Capitalizations Increases Confusion • First, implement a strategy to fix the issue going forward • Establish a method to determine manageable cost pools when unitizing assets upon project completion and if your assets values tend to very large, work with the engineers to establish retirement units that focus on identifiable units • Try to stay away from non-mass units titled “2004 substation project”. Try for: • Arthur road buss bar; Arthur road fuse link, etc. • Focus on allocating costs to units that have similar useful lives. This will increase the probability of not having to make partial retirements.

37. Focus on Established Unit of Property Policies to Assist With Work Order Closings. • The majority of public power utilities do not use unit of property accounting. • Units of property help provide employees the ability to determine if maintenance or replacement has occurred.

38. Technology Spending • Look to SOP 98-1 • What about systems planning costs before development occurs? • What to do with in-house development costs and the development of utility-owned intellectual property? • How to account for the costs of hardware when hardware costs fall below your capitalization limits.

39. System Planning Costs Before Development • Costs associated with investigating alternatives should be expensed as these costs do not enhance the future asset – they help you make a better decision • All costs incurred up to the time of final project selection should be expensed including travel and site visits

40. Dealing With Large Planning Investments for Technology • Some states have allowed deferral of costs for future rate recovery if current rates are not sufficient to cover the costs. • For those implementing FAS #71, options for deferral may be available assuming they meet FAS #71 criteria.

41. In-house Development Costs • In-house development typically begins upon the formal approval for the project and a project leader has been assigned to control project. • Capitalize all direct costs associated with development. This process differs greatly among utilities.

42. In-house Development Costs, cont. • Utility A – Capitalize only direct costs. • Utility B – Capitalize labor costs and indirect costs up to a cap. • Utility C – Only programming costs and related loadings.

43. In-house Development • Auditors have a responsibility to determine reasonableness and ensure materially correct financial statement presentation. • All of the previous examples should be allowable for external auditors.

44. Hardware Investment Accounting Options • When hardware that, on a per unit basis falls below your capitalization criteria, is purchased in bulk the assets may be capitalized as a group asset. • Regardless of whether or not the hardware assets are capitalized, these assets should still be tracked for control purposes

45. Hardware Investment Accounting • Calls to several large utilities (including IOUs) provided differing aspects of capitalization. • The majority do capitalize assets as classes of costs if the joint purchase is over a certain dollar limit. • Most also acknowledged that it will eventually be problematic for future retirements, however.

46. Capitalization Policies • What is your threshold? • Do you feel it is reasonable? • How often is it updated?

47. Lease payments • Always consider lease payment for consideration of a fixed asset addition rather than operating expense. • 4 criteria to determine capital treatment.

48. Quiz time • Replace a roof • Move lines for a road widening project • Installation costs of a transformer • Buy $20,000 of chairs that cost $100 each.

49. Questions? • Thanks for attending this session

50. About the Instructor • Tom is a partner with Baker Tilly Virchow Krause, LLP and is the leader of Baker Tilly’s Energy and Utility team. He has over 19 years of expertise working with public utilities, cooperatives and investor-owned utilities. He is the instructor of APPA’s advance utility accounting course and currently uses his experience to service utilities around the nation with energy market and financial consulting as well as providing auditing services to them. He is married and has two daughters and resides in Madison, WI Thomas E. Unke, CPA Partner 608.240.2394 Thomas.unke@bakertilly.com