Opinion ID: 1541219
Heading Depth: 1
Heading Rank: 3

Heading: The Uniform System of Accounts

Text: The FPC initially promulgated uniform accounting systems in 1937 and 1940 for electric utility and natural gas companies, respectively. See Kripke, A Case Study in the Relationship of Law and Accounting: Uniform Accounts 100.5 and 107, 57 Harv.L. Rev. 433, 435 (1944). It did so out of a concern about the difficulty of determining the true value of utility properties allowed to comprise the rate base. During the 1920s, a period of rapid turnover and consolidation of ownership, regulatory commissions were confronted by accelerating inflation of book costs as utility properties continually changed handssometimes at arm's length but often in transactions between affiliates at prices designed to maximize the share at the top of the corporate pyramid. See Duke Power Co. v. Federal Power Comm'n, 130 U.S.App.D.C. 389, 393, 401 F.2d 930, 934 (1968). In many cases, therefore, the purchase pricesand, consequently, the rate basesfor utility properties were derived from book values reflecting the capitalization of hopes (more commonly characterized as water). Accordingly, corresponding to an approach taken by the Federal Communications Commission (FCC) a few years earlier in 1935, the FPC's new system divided utility property book values into three categories: (1) the original cost of the property to the first company that devoted it to public service; (2) an acquisition adjustment account reflecting the difference between the utility's own acquisition cost and the depreciated original cost of the property; and (3) any further appreciation reflected in writeups by the company over the sum of the first two categories. Kripke, supra at 436. At the time these accounting rules were promulgated, utility companies were entitled to a financial return (called fair value) computed on a rate base utilizing reproduction costs, which commonly combined all three of the FPC categories. See, e. g., The Minnesota Rate Cases, 230 U.S. 352, 454-55, 33 S.Ct. 729, 57 L.Ed. 1511 (1913); Willcox v. Consolidated Gas Co., 212 U.S. 19, 41, 52, 29 S.Ct. 192, 53 L.Ed. 382 (1909); Smyth v. Ames, 169 U.S. 466, 546-47, 18 S.Ct. 418, 42 L.Ed. 819 (1898). Justice Brandeis, however, dissenting in Southwestern Bell Tel. Co. v. Public Serv. Com'n, 262 U.S. 276, 289, 43 S.Ct. 544, 67 L.Ed. 981 (1923), had attacked the reproduction cost approach, arguing that investors should be entitled only to a return on the capital prudently invested in the enterprise, not on the appreciating value of the property acquired. Utility companies understandably feared, therefore, that the FPC's uniform accounting system, by segregating cost data, presaged an effort to contract each utility's rate base from reproduction costs to original cost. The regulatory agencies sought to avoid judicial scrutiny of their new accounting systems by insisting that these systems would not be considered conclusive for ratemaking purposes. The Supreme Court accepted such assurances, holding in American Tel. & Tel. Co. v. United States, 299 U.S. 232, 57 S.Ct. 170, 81 L.Ed. 142 (1936), that FCC accounting did not violate due process because it merely was a system of notation, without substantive significance. [7] In reaching this conclusion, however, the Court was not oblivious to the powerful influence that the regulatory commissions' accounting systems inevitably would have on ratemaking. In fact, two years before the American Tel. & Tel. Co. decision, the Court already had recognized the significance of the accounting system for the rate structure. In Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 54 S.Ct. 658, 78 L.Ed. 1182 (1934), the Court had held that annual depreciation charges were properly limited to computations based on original cost rather than reproduction cost. Greater charges for depreciation, the Court had said, would be tantamount to capital contributions. Id. at 169, 54 S.Ct. 658. By the 1940s, the Supreme Court was ready to allow federal regulatory agencies to utilize the new accounting systems, as the utility companies had feared, to abandon the fair value doctrine of ratemaking. In the spirit of Justice Brandeis' dissent in Southwestern Bell Tel. Co., supra, the Supreme Court held that utility investorswhile entitled to a fair rate of return on the historical cost attributable to their capital investmenthave no constitutional entitlement to a return on the increased value, if any, represented by reproduction cost over original cost. Federal Power Comm'n v. Hope Natural Gas Co., supra ; Federal Power Comm'n v. Natural Gas Pipeline Co., supra . Consequently, the FPC and state regulatory commissions received for the first time a green light for rate orders based solely on historical costs. These cases, however, went further than mere justification of historical cost-based rates. Their principal significance lies in two broader departures from previous holdings: (1) the Court shifted away from a focus on particular property values and rates of return to a more general, limited concern about the financial integrity of the company whose rates are being regulated. Federal Power Comm'n v. Hope Natural Gas Co., supra, 320 U.S. at 603, 64 S.Ct. 281, 288, and (2) the Court emphasized granting considerable deference to the expertise of a regulatory commission in arriving at a proper ratemaking judgment. As a constitutional matter, according to three concurring Justices, [i]rrespective of what the return may be on fair value, if the rate permits the company to operate successfully and to attract capital all questions as to just and reasonable are at an end so far as investor interest is concerned. Various routes to that end may be worked out by the expert administrators charged with the duty of regulation. It is not the function of the courts to prescribe what formula should be used. The fact that one may be fair to investors does not mean that another would be unfair. The decision in each case must turn on considerations of justness and fairness which cannot be cast into a legalistic formula. The rate of return to be allowed in any given case calls for a highly expert judgment. That judgment has been entrusted to the Commission. There it should rest. [ Federal Power Comm'n v. Natural Gas Pipeline Co., supra, 315 U.S. at 607, 62 S.Ct. at 753 (Black, Douglas, and Murphy, JJ., concurring).] The Supreme Court therefore, by the early 1940s, had shifted the utility investor's constitutional right from a just and reasonable rate of return based on current fair value of particular assets to a rate of return on an original cost rate base, with the particular rate being justified by the regulatory commission's expert view of the company's needs. A commission need only assure the financial integrity of the enterprise, including an ability to attract capital and compensate its investors for the risk assumed, even though the approved rate may produce only a meager return on the so-called `fair value' rate base. Federal Power Comm'n v. Hope Natural Gas Co., supra, 320 U.S. at 605, 64 S.Ct. at 289. In facilitating this transition from the fair value to the financial integrity approach, the Uniform System of Accounts did not become a sacred premise for ratemaking. Although the System had provided the mechanism for accomplishing a rejection of the fair value doctrine, it was clear all along, as enunciated in American Tel. & Tel. Co., supra, that accounting decisions, as such, could not be considered determinative for ratemaking itself. See United States v. New York Telephone Co., 326 U.S. 638, 653, 66 S.Ct. 393, 90 L.Ed. 371 (1946); Colorado Interstate Gas Co. v. Federal Power Comm'n, 324 U.S. 581, 608, 65 S.Ct. 829, 89 L.Ed. 1206 (1945); Northwestern Electric Co. v. Federal Power Comm'n, 321 U.S. 119, 125, 64 S.Ct. 451, 88 L.Ed. 596 (1944); American Power & Light Co. v. Securities and Exchange Comm'n, 158 F.2d 771 (1st Cir. 1946), cert. denied, 331 U.S. 827, 67 S.Ct. 1348, 91 L.Ed. 1842 (1947). In our own jurisdiction, for example, there is significant precedent demonstrating that circumstances will dictate ratemaking judgments independent of the uniform accounting system. For example, in Re D.C. Transit System, Inc., 30 P.U.R.3d 405, aff'd, 110 U.S.App.D.C. 241, 292 F.2d 734 (1961), the Commission's predecessor, the District of Columbia Public Utilities Commission (PUC), abandoned the normal accounting treatment when D.C. Transit System, Inc. sold its Fourth Street shops and Southern carhouse to the Redevelopment Land Agency. If the $1.921 million of the sales proceeds attributable to depreciable property had been credited to the depreciation reserve, as required by the Uniform System of Accounts, that reserve would have swollen to 180% of the original cost of the properties. The PUC accordingly deviated from the accounting rules by allowing the company to credit to earned surplus the amount by which the proceeds attributable to the depreciable property exceeded the original cost. [8] The PUC noted: While fully cognizant of the desirability of adhering to the Uniform System of Accounts under normal conditions, we have never recognized the Uniform System of Accounts as an inflexible code from which departures in special or unusual circumstances would not be permitted when authorized by the commission. [ Id. at 410.] See Democratic Central Committee I, supra 158 U.S.App.D.C. at 40-41, 485 F.2d at 819-20. There have been instances where the FPC, too, has rejected strict application of the uniform accounting rules in ratemaking proceedings. Manufacturers Light & Heat Co., 44 F.P.C. 314, 321-25, rehearing denied, 44 F.P.C. 1138 (1970) (contrary to uniform accounting rules, FPC granted above the line recognition of gains and losses in company's reacquisition of debt securities); United Gas Pipe Line Co., 31 F.P.C. 1180, 1189 (1964) (contrary to uniform accounting rules, FPC allowed above the line treatment of reasonable charitable contributions as an operating expense). It thus appears that there is no mandatory relationship between the Uniform System of Accounts and the Commission's ratemaking. We must therefore examine the details of the System to determine whether the Commission's per se reliance on it for ratemaking, as a matter of expert judgment, would appear, nonetheless, to be sound.
A regulated company's balance sheet segregates the utility plant assets (including land), which are used and useful in serving the public, from the company's other assetscalled nonutility property which are carried on the books, most commonly, as investments. Suelflow, supra at 25-31. [9] Similarly, the company's income statement carefully separates utility operating income and related expenses from its other income arising out of activities beyond the Commission's jurisdiction. Id. at 20-25. Gains and losses on utility operations generally are allocated above the line to the ratepayers, whereas nonutility gains and losses are allocated below the line to the investors. Id. at 23-24. In a sense, therefore, each public utility is at least two companies: one serving and accountable to the public (through the good offices of the Commission) and the other accountable solely to its investors. These allocations either to ratepayers or to investors are implemented on the company's books through use of accounts established under the Uniform System to reflect transactions with specified consequences above or below the line. Fundamentally, therefore, a utility's accounting system is designed to channel entries into accounting categories intended to have a prescribed impact on periodic ratemaking. Id. at 24. When the Uniform System of Accounts is carefully examined, three characteristics having a bearing on this case became apparent. First, when property owned by a utility company is sold, the System does not generally favor either the shareholders or the ratepayers; the System allocates gains (or losses) to one group or the other, depending on specified circumstances. Second, there are a number of significant exceptions to the allocation principles themselves, making generalizations even more difficult. Third, the System calls for the exercise of substantial discretion by the regulatory commission in determining whether a particular transaction is better characterized one way or another under the System, often with significant consequences above or below the line. Given respondents' substantial reliance on this accounting System as a basis for ratemaking, it is crucial to understand the extent to which the System's fixed principles, subject to various exceptions, applied with the Commission's discretionary hand, can be said to provide a coherent defense to petitioners' assertions. There is a threshold distinction in the System between utility property that is operating and nonoperating. When a utility's operating unit or system is sold, the gain or loss [10] on both plant and land is allocated below the line to the shareholders[u]nless otherwise ordered by the Commission. [11] Usually, therefore, the only benefit to the ratepayers is removal of the residual book value of the facility from the rate base. Whenever utility property becomes non-operating, however ( i. e., it is retired from active service rather than sold as an operating facility), the accounting becomes more complexsometimes to the ratepayers' benefit. If the property is merely transferred out of the rate base but retained by the company as nonutility property, the ratepayers receive the benefit of removal from the rate basethe same benefit they would have received if the property instead had been sold as an operating unit. Account 121. Thereafter, if this nonutility property is sold, all gains or losses on both land and depreciable plant facilities accrue to the shareholders. Accounts 421.1 and 421.2; Plant Instr. 7.E., 10.1. If, on the other hand, nonoperating utility property is sold immediately upon its retirement, without prior transfer out of the rate base to a nonutility account, all proceeds allocable to the sale of land will accruegain or lossto the shareholders; but, contrary to the results when operating or nonutility property is sold, all proceeds of the depreciable plant facility upon retirement will be allocated to the ratepayers. Account 108, Plant Instr. 10.B., 10.F. Thus, if the net salvage value of the electric or gas plant facility exceeds depreciated book costs, ratepayers will gain from the transaction. But see Re D.C. Transit System, Inc., supra (discussed in Part III.A., supra ). Otherwise, of course, ratepayers will break even or lose. [12] In summary, under the general accounting rules applicable to dispositions of land (in contrast with depreciable plant facilities), gains or losses are not credited or charged to the ratepayers under any circumstance. Whether land is sold as part of an operating unit, or sold immediately upon retirement from service, or sold after transfer to the status of nonutility property, the Uniform System of Accounts generally provides that the shareholders alone shall benefit from any gainand bear any loss. These general rules, however, are subject to a number of significant exceptions. For example, as an incentive for utility companies to acquireindeed to stockpileland (or to retain retired land) for future use as the need may arise, the Uniform System permits a utility company to add such land to the rate base, even though it may never be used in service. Account 105. There is, nevertheless, a quid pro quo for the ratepayers. Upon disposition of land held in this account, all gains (or losses) are allocated above the line. Accounts 105, 411.6, 411.7. This approach reflects a policy that the ratepayers should underwrite the costs of long-range planning but, as a matter of equity, should receive all gains from dispositions of land held for use but never used. See Accounting Treatment for Land Held for Future Utility Use and for Profits or Losses Realized Through Sales of Those Lands, 45 F.P.C. 106 (1971). Another exception pertains to unforeseeable extraordinary losses on property abandoned or otherwise retired from service, Account 182, i. e., losses (usually exceeding five percent of income) which could not reasonably have been foreseen and provided for. Id. See Gen. Instr. 7. Normally, such losses would be borne by the shareholders in the sense that the normal depreciation chargeable to the ratepayers would not cover the loss as rapidly as the extraordinary loss provisions permit. In the Commission's discretion, however, they can be shifted to the ratepayerswhich is likely to happen unless the utility is earning a sufficient return and the company has ample time to recover fully the cost of plant through depreciation. Suelflow, supra at 73. See Account 182, Gen. Instr. 7. [13] In simplified form, therefore, the accounting treatment which the Uniform System generally accords gains and losses on dispositions of utility property can be depicted as follows: I. OPERATING UNIT OR SYSTEM II. NONOPERATING FACILITY [Gains or losses on plant A. Depreciable B. Nondepreciable facilities and land allocable (Plant) (Land) to shareholders] 1. Sold upon retirement 1. Sold upon retirement [Gains or losses allocable [Gains or lossed allocable to ratepayers] to shareholders] 2. Transferred to 2. Transferred to nonutility property nonutility property account; sold account; sold thereafter thereafter [Elimination from [Elimination from rate base; gains or rate base; gains or losses allocable to losses allocable to shareholders] shareholders] 3. Sold after placement 3. Sold after placement in held for in held for future use account future use account [After elimination [After elimination from rate base, gains from rate base, gains or losses allocable or losses allocable to shareholders] [14] to ratepayers] From this discussion it should be clear that respondents' defense on the basis of adherence to the Uniform System of Accounts may be question-begging, given the considerable room for Commission discretion in characterizing and approving particular accounting entries. For example, the determination as to whether a particular sale involves an operating or retired facilitywhich often is far from clear may determine, as an accounting matter, whether the transaction shall be treated below or above the line. [15] Similarly, the Commission has discretion over inclusion and removal of land, especially retired land, in the held for future use accounta critical determination as to allocation of potential gains and losses to ratepayers or shareholders. The Commission, moreover, has discretion to determine whether retired property shouldor should notbe transferred to a nonutility property account, with the consequent impact on rate base and eventual allocation of the proceeds upon sale. Finally, the allocation of an extraordinary loss to ratepayers or shareholders is discretionary. This is not to say that reliance on the Uniform System as a basis for ratemaking is unjustified in the present case. Obviously, the System, which is designed to assist in ratemaking, reflects years of fine tuning premised on expert views about balancing investor and consumer interests. Moreover, many of the prescribed accounting treatments discussed above, subject to the Commission's discretionary gloss, are not relevant to this case. Despite these considerations, however, we must conclude that because of the substantial discretion of the Commission under the System, a defense of particular ratemaking based on per se application of that System says little more than ratemaking based on expert Commission discretion. Thus, before we can draw a conclusion as to whether reliance on the Uniform System in this case provides a rational connection between the companies' land transactions and the Commission's decision to place them for ratemaking purposes below the line, we have to examine the System very carefully as applied here.
The precise question is this: have petitioners made a convincing showing that the Commission's rate determinations are unreasonable, unjust, or discriminatory, D.C.Code 1973, § 43-301, because the decision in each case to allocate gains on particular dispositions of retired land exclusively to the investors is not rationally connected by reliable, probative, and substantial evidence, D.C.Code 1977 Supp., § 1-1509(e), to the rate of return selected? Thus, we are asked to relate gains on particular land transactions to the Commission's determination of an overall rate of returna complex inquiry. [16]