Best practices in accounting for electric utilities and gas utilities

Even though your electric coop or utility is not Federal Energy Regulatory Commission (FERC) regulated, FERC compliance audit provide insights into areas to consider for general accounting and ratemaking. This article provides an overview of the latest FERC compliance audit findings. It is a good read to review the entire report.

If FERC regulates your organization, you definitely should read on.

 Key Points on the FERC 2023 Compliance Report

 1. The 2023 FERC Report on Enforcement details areas examined for electric and gas accounting and rate filings compliance with FERC directives and orders.

2. The Report includes valuable information for consideration by any electric or gas co-op or utility in its general accounting and developing cost of service studies and customer rates.

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The FERC 2023 Report on Enforcement

That sounds like an ominous title, but it is a report prepared by the FERC Office of Enforcement staff. The Report is issued to inform the public and regulated entities of its activities during the most recent Federal Year. It covers a number of areas from the Division of Investigations, the Division of Audits and Accounting, and the Division of An- alytics and Surveillance.

While the entire Report makes for a good read and gives you a feel for current is- sues in the electric markets (the analysis of market data on pricing and transactions that FERC does that leads to further investigation is interesting), our discussion in this article is on the report section from the Division of Audits and Accounting.

FERC and electric and gas rates, why should this matter to you?

FERC regulates interstate rates for electric transmission and wholesale power rates, and interstate natural gas rates. While this may not impact your electric or gas co-op or utility, it is worth noting what items FERC questions in its review and approval of electric rate and other compliance proceedings. FERC’s approach defines the best practices allowable in developing electric cost of service studies and designing electric rates.

The FERC Division of Audits and Accounting noted items that needed addressing in their audits. Items of note are discussed next.

Issues with allocating labor and over-heads to construction projects

The FERC report notes: “Companies have charged labor and labor-related costs to construction projects without using an appropriate cost allocation method or time tracking process to ensure capitalized labor costs have a definite relation to construction. Specifically, DAA has observed that allocation methods were not properly de- signed, nor were the allocation results sufficiently monitored to ensure that costs charged were appropriately allocated to capital projects.

In simpler terms, this indicates a preference for direct timekeeping systems and, when that is not possible, for utilities to use allocation methods that are appropriately designed to take into account the various activities of utility personnel that aren’t working 100% of their time on construction projects.

Our comments

If you cannot directly charge time to projects efficiently in your utility, several methods for allocating non-construction labor overheads can be used:

- Time studies of activities for a month, then using the percentage allocation for the entire year

- Industry standard formulas, such as the Three-Point or Massachusetts For- mula

It is best to have a system in place that correctly and consistently allocates costs to projects. It is vital and appropriate to ensure construction projects include support costs, including labor-related overheads.

Issues with applying the Allowance for Funds Used During Construction (AFUDC)

AFUDC is the cost of capital of funds used in construction projects. When funds are designated for specific activities (investments, construction, programs), there is an op- portunity cost of using the funds rather than keeping them idle. The FERC Uniform System of Accounts includes a detailed explanation of how AFUDC should be calcu- lated. Basically, the calculation consists of the interest cost of funding construction projects with a combination of short-term debt, long-term debt, investor-financing (common and preferred stock), and internal reserves. AFUDC rates vary from 5% of the total project costs for municipal utilities to 10% or more for investor-owned utili- ties, so the balance of AFUDC in a project can be substantial.

The FERC report includes some of the following:

- Improperly excluding certain short-term debt or long-term debt amounts from the AFUDC rate calculation

- Computing AFUDC on contract retention and other noncash accruals

- Improperly using monthly equity and long-term debt balances instead of prior-year-end balances in computing the AFUDC rate

- Improperly using fiscal year-end book balances for long-term debt and common equity amounts when computing the AFUDC rate, rather than the calendar year-end balances reported in FERC Form No. 1

- Improperly including Account 216.1, Unappropriated Undistributed Subsidiary Earnings, and Account 219, Accumulated Other Comprehensive Income, balances as part of the equity component of the AFUDC formula

- Improperly accruing AFUDC on inactive or suspended construction projects

- Improperly including in the short-term debt rate of interest recorded on transmission and interconnection study advances received from customers

- Improperly compounding AFUDC on a monthly basis rather than a semi-annual basis

- Improperly calculating AFUDC on projects already receiving incentive rate treatment permitting the projects’ CWIP to be included in rate base

Our comments

We recommend including AFUDC in all construction activities in your electric co-op or utility. A best practice is to follow the FERC Uniform System of Accounts calculation us- ing planned project funding and debt and equity amounts recorded in your organization’s latest audited financials. Once calculated, stick to using the AFUDC rate for the entire year. The rate should be adjusted annually.

Issues with amounts included in electric rate filings

The FERC Division of Audits reviews utility rate applications by utilities to determine items that should or should not be included in formula rate recovery mechanisms and differences between amounts reported in the Annual FERC Form 1 and rate applications.

Some areas noted in their Report:

- Improperly excluding revenue credits for transmission-related areas, such as pole attachment or rental revenues

- Refunds of income taxes not included in rate filings

- Issues related to deferred income taxes adjustments

- Improper inclusion of internal merger costs

- Including unapproved Asset Retirement Obligation (ARO) costs

- Including regulatory assets in rate filings where FERC had not approved recovery of those regulatory assets

- Improperly including administrative and general costs in rate filings for non-utility expenses

- Improperly including EV charging stations in general plant, where FERC considers them to be distribution plant

The Report noted similar issues with gas rate filings in administrative and general charges in rate filings.

Our comments

Whether or not your utility is regulated by FERC, reviewing the list of areas the Report mentions is a good practice when preparing your next cost of service study. Including supporting documentation for items included in the cost of service studies will make it easier to discuss why an item was not included with management, oversight Boards, and ratepayers.

What should you do with this information?

This information includes insights into best practices in accounting and electric and gas rate development from the regulator point of view. While we advocate innovation in electric accounting, it is helpful to consider the regulator view when considering transactions to include in cost of service studies or accounting approaches ratepayers.

Where can you obtain the report?

The report can be viewed here. It is lengthy, but will provide you with much greater insights.

About Russ Hissom - Article Author

Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power and utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.  

Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.

The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.