Opinion ID: 2332363
Heading Depth: 1
Heading Rank: 5

Heading: working capital allowance cash advanced for expenses

Text: Both the Commission and New England are agreed that, in addition to fixed plant and property, New England's rate base must include an allowance for working capital. Working capital consists of the additional funds, provided by the investors, which may be required by the utility to meet its day-to-day operating expenses, such as maintaining an inventory of materials and supplies, meeting certain operating expenses which must be paid before the revenues associated with these expenses are received, and keeping a certain amount of cash on hand for daily operations. The issue before us involves one particular item included in the working capital, i. e. cash advanced for expenses. The Third Circuit's opinion in Alabama-Tennessee Natural Gas Co. v. Federal Power Commission, 203 F.2d 494 (3d Cir. 1953), explains the function of this item: Working capital, in the context of public utility rate regulation, has been defined as the allowance for the sum which the Company needs to supply from its own funds for the purpose of enabling it to meet its current obligations as they arise and to operate economically and efficiently. Barnes, The Economics of Public Utility Regulation (1942) 495. Since it is normally contemplated that all operating expenses will eventually be paid for out of revenues received by the Company, the need for working capital arises largely from the time lag between payment by the Company of its expenses and receipt by the Company of payments for service in respect of which the expenses were incurred. 203 F.2d at 498 (emphasis in original). See generally, 1 A. Priest, Principles of Public Utility Regulation 183-87 (1969). In a widely quoted statement, the Pennsylvania Supreme Court described this item thusly: Cash working capital ordinarily is the amount of cash required to operate a utility during the interim between the rendition of service and the receipt of payment therefor. City of Pittsburgh v. Pennsylvania Public Utility Commission, 370 Pa. 305, 309, 88 A.2d 59, 61 (1952). This interim period is known in the utility industry as the lag. Rhode Island Consumers' Council v. Smith, 113 R.I. 232, 237, 319 A.2d 643, 646 (1974). As the Court explained in Alabama-Tennessee Natural Gas Co. v. Federal Power Commission, supra , such lag may work in both directions: But there are time lags which work in favor of the Company as well as those which work against it. The Company no more pays immediately every liability accrued than do its customers. In determining the need for working capital, the Commission may quite reasonably and properly take into account factors which reduce the need as well as those which increase it. 203 F.2d at 498. Although the Commission's decree and the briefs of the parties provide little explanation of the function of lag days, we have gathered the following understanding from our reading of the record on this matter. As indicated earlier, the utility's receipt of revenues or customer payments for services provided often tends to lag behind the date upon which the utility incurred expenses with respect to the provision of such services. Thus, the utility requires a cash advanced for expenses working capital allowance to cover expenses during those lag days. The calculation of the utility's net lag involves the subtraction of its average expense lag from its average revenue lag. Revenue lag is simply the time span over which revenues lag behind expenses. On the other hand, expense lag involves the converse situation, where the utility's expense payments lag behind the date upon which the utility receives the products or services for which it is paying. This is the type of time lag the Court in Alabama-Tennessee Natural Gas Co. v. Federal Power Commission, supra , described as working in favor of the utility and, which negates the need for working capital. Thus, the revenue lag and the expense lag are combined to determine the net lag days for which the utility requires cash working capital. The License Contract payments at issue involve an expense lag, in that the Commission found payment of the License Contract expense lagged 55 days behind the time when such service was provided, thereby reducing the amount of cash working capital required by New England. Under the License Contract dated July 15, 1930, American Telephone & Telegraph provides considerable services and privileges to New England, including the use of patents, research and development, advice and assistance in matters concerning the conduct of business, and advice and assistance in financing. The contract originally provided that American Telephone & Telegraph was to receive payment for its services as follows: In consideration of the premises and for all benefits accruing to the Licensee hereunder, the Licensee shall pay to the Licensor a sum equal to two and one-half per cent. (2½%) of the total gross earnings of the Licensee, which shall be payable in monthly installments, as herein provided, and in accordance with the established practice of the parties hereto, and shall be computed as follows: . . . . . The amount of each installment of said sum equal to two and one-half per cent. (2½%) of the Licensee's total gross earnings due for each month shall be determined by such total gross earnings of the second preceding month, computed in the manner aforesaid, and a statement, over the signature of the proper accounting officer of the Licensee, of its total gross earnings for each calendar month, computed in the manner aforesaid, shall be sent to the Comptroller of the Licensor, or to such other officer of the Licensor as it may theretofore designate, on or before the twenty-fifth day of the next succeeding month and payment in New York funds shall be made on or before the tenth day of the month next following, that being the month for which such payment is due. Since October 1974, American Telephone & Telegraph accepts, as payment for services rendered, New England's allocated share of the actual costs incurred by American Telephone & Telegraph in rendering License Contract services, but not to exceed the rate of 2½% of gross earnings provided in the contract. New England receives its bill from American Telephone & Telegraph for services rendered under the License Contract, on the first day of the month and pays it 9 days later. (Lag days are generally measured from the middle of the month during which the services are rendered.) New England argues that, under the License Contract, the bill it receives on the first of the month is for an expense incurred during that month. [33] In other words, the payment it makes during a particular month is for an expense incurred in that month. Thus, New England calculates an expense lag with respect to License Contract payments of about negative 6 days (payment made on the ninth day of the month for an expense incurred during the middle of same month). The Commission rejected New England's approach and found that payments for License Contract services lagged 55 days behind the date the expense was incurred (45 days from the middle of the second preceding month to the first of the month when the bill is received plus 9 days until the bill is paid). The Commission reasoned that the expense was incurred during the month which was used to determine New England's allocated share of AT&T's cost of rendering such service. In other words, New England incurred the expense during the same month AT&T incurred the cost in rendering its License Contract service, i. e. the second preceding month. This is the same method the Commission used to determine New England's License Contract expense (as opposed to License Contract expense lag for working capital purposes) for the 1976 test year. The Commission found that, for ratemaking purposes, New England's License Contract expense for 1976 was not the payments actually made to AT&T in 1976, but, rather, was New England's allocated share of the costs incurred by AT&T while rendering License Contract services during 1976. The Commission stated: New England Telephone's test year expenses should be based upon the incurrence of costs, not a cash payment, and that test year revenues should be based on the rendering of service, not cash receipts. Such accrual accounting techniques, in our opinion, produce a proper matching of test year revenues and expenses. Re New England Telephone and Telegraph, ___ P.U.R. 4th ___, ___ (Me. Pub.Util.Comm.1977). The Commission reasoned, once the proper amount of test year expense is determined, the lag days automatically follow. Id. at ___. Accordingly, it determined New England's 1976 License Contract expense and New England's License Contract expense lag days on the basis that the expense was incurred during the month that AT&T incurred its costs which were to be allocated to New England under the contract. Therefore, New England's License Contract payment during any particular month was for services rendered and expenses incurred with respect to the second preceding month. We find no error in the Commission's reasoning. New England argues that this issue is controlled by its interpretation of the provisions of the License Contract. We disagree. This is not a matter of contract law, but is a matter of regulatory law. The Commission is not bound by the provisions of the contract for these purposes. It must make an independent and reasoned judgment as to when the License Contract expense is incurred for rate-making purposes. As we recently stated in Mechanic Falls Water Co. v. Public Utilities Commission, Me., 381 A.2d 1080 (1977), [W]e know of no legal requirement that the Commission accept the Companies' method of bookkeeping in setting an appropriate service fee. Id. at 1099. We find that the Commission's approach is a reasonable method to account for expenses incurred during the 1976 test year. The Commission relates expenses to the time when they are incurred with respect to the utility's rendition of services to its customers and not to the time when the utility chooses to pay its bills. For example, New England's allocated share of costs incurred by AT&T in rendering License Contract services in October are treated as an expense incurred in October by New England and not as an expense incurred in December when New England pays its bill to AT&T, which bill is calculated on the basis of AT&T's October costs. Thus, expenses are matched with services rendered and revenues received. The Commission's finding of a 55-day lag for the License Contract expense was reasonable and supported by substantial evidence. [34] We find no error therein.