In this podcast episode, we discuss several unique accounting issues for public utilities.
What is a Public Utility?
First of all, what is it? A public utility is a business that performs a public service, and it’s normally regulated. It usually provides electricity, natural gas, or telephone service. For this episode, we’ll be talking about electric utilities.
If an electric utility is part of a local city government, then it generates reports based on governmental accounting standards. It’s usually reported as an enterprise fund, which is a self-supported government fund that sells goods and services to the public for a fee. Or, when a utility is privately-owned, it generates financial reports based on generally accepted accounting principles.
How to Classify Public Utility Accounting Transactions
In a public utility, one of the most important decisions for the accountant is whether an expenditure should be classified as a capital expenditure or as an operation and maintenance expense. The cost of a capital expenditure is recovered through a utility’s rate structure over several years, while an operation and maintenance expense is recovered more quickly through its rate structure.
Public Utility Rate Structures
Which brings up the rate structure. A regulated utility is allowed a certain rate of return on its rate base. This return is designed to give a utility a fixed rate of return on its operating margin. The rate base is the original cost of a utility’s plant, minus its accumulated depreciation. So, given the importance of the rate structure, it makes a lot of sense to be absolutely certain about which expenditures are classified as assets and the amount of depreciation charged.
A utility’s rates are intended to reimburse it for all operating expenses incurred. Conversely, it’s non-operating expenses are not recovered through the rates it charges to customers. Non-operating expenses usually relate to investment losses, or losses on the sale of property.
The Uniform System of Accounts
Based on what I’ve just said, the key issue in this industry is exactly which account is used to record a transaction. It’s based on some strict guidelines laid down by the Federal Energy Regulatory Commission, that itemize a complete chart of accounts and really detailed instructions for which transactions go into each of these accounts. The chart of accounts is called the Uniform System of Accounts.
And believe it or not, this uniform system is part of federal law – it has nothing to do with any of the usual accounting regulations. To find it, go to section 7 of the Code of Federal Regulations, Subpart B. It’s enormous. If you were to print it out – which I do not recommend – it would be 273 pages long.
An unusual aspect of this account structure is that it’s based on the activity-based costing system, where costs are linked to specific activities. By using this approach, you can determine the entire cost to conduct an activity, such as electricity generation or meter reading. For example, the cost of the miles that a truck is driven is then charged to a construction project to build a power transmission line. And the cost of the person driving that truck is also charged to the construction project, based on the hours of his time spent driving the truck. It makes for a pretty long chart of accounts.
I’ll just touch on a few of these accounts, so you can get a feel for the level of detail. There’s a set of expense accounts for steam power generation, another set of accounts for nuclear power generation, and even more accounts for hydraulic power generation. And then we have nuclear fuel expense, operation supervision, maintenance of structures, meter reading expenses, regulatory commission expenses, and – my favorite – customer service expenses. Didn’t know they had customer service. They also have power transmission expenses, such as overhead line expenses, underground line expenses, and load dispatching.
Regulators need this boatload of information, so that they can set rates.
Public Utility Work Orders
And then we have work orders. Construction of power generation and distribution facilities constitutes most of a utility’s capital expenditures, and that flows through a work order. So, a utility needs to have a work order system that accumulates costs for each project. And that means being able to charge employee hours to specific work orders, as well as charging supplier invoices to work orders when they’re first logged into the accounting system.
A utility construction project might very well have interest capitalized into it. The amount of interest expense that can be capitalized is not based on GAAP rules, though. Instead, it’s based on a formula put out by the Federal Energy Regulatory Commission, which takes into account all of a utility’s costs of financing, including the cost of its long-term debt, and short-term debt, and common equity.
And it gets more complicated. When work orders are completed and costs are assigned to specific capital assets, the costs collected under those work orders are assigned to specific assets, which are called retirement units. A retirement unit is an asset whose cost will deducted from a utility’s accounts when it’s retired. For example, each individual pole on which power lines are strung can be classified as a retirement unit.
As you might expect, when the accounting system has to track the cost of each retirement unit, as well as its description, location, and so on, the system is going to be pretty massive. These records are called continuing property records. A decent-sized utility is going to need several accountants just to maintain these records.
Asset Retirement Obligations
And then we have asset retirement obligations, or AROs. This is the expected cost to retire an asset, and a utility has to record this obligation up front, maybe years before an asset is actually retired. The classic example of this in the utility industry is a nuclear power plant, where the retirement cost is incredibly high. The accounting for AROs is complicated, because the liability has to be constantly revisited over time, to see if the liability amount has changed. If so, the accountant has to record layers of adjustments to the liability. And again, for a larger utility, you might have an accountant who just does this.
Another large item for a utility is bond transactions. Utilities need to buy a lot of assets, and they get the funding for it from bond issuances. So, the accounting staff has to account for the sale of bonds, and fun items like unamortized discounts or premiums on long-term debt – as well as paying off the bonds.
So in short, public utilities are a tough environment for the accountant. There’s massive amounts of work to do in recording transactions in exactly the right accounts, and tracking fixed assets, and in a swarm of other areas. On the other hand, given the amount of work, you’re never going to be laid off.