Opinion ID: 2339319
Heading Depth: 1
Heading Rank: 1

Heading: depreciation deficiency and reduction of rate base

Text: In 1976 the company engaged Reginald R. Bird, a vice president of Stone & Webster Management Consultants, Inc., to perform a depreciation study of the company's plant in service as of December 31, 1976. Upon completing this study in 1977, Mr. Bird recommended that the annual composite depreciation rate be increased from 2.44 percent to 2.68 percent of the company's total depreciable plant. In an ensuing rate case (P.U.C. Docket No. 1258), based upon tariffs filed by the company on December 13, 1976, the commission, in an October 14, 1977 report and order, allowed tariffs which included the increased depreciation rate. This order was not appealed. On December 27, 1978, the company filed for new rate increases but did not request any change in the depreciation rate that had been approved in 1977 (P.U.C. Docket No. 1258) since no further depreciation study had been performed since 1976. The division analyzed the 1977 Bird study and contended that the changed rate of depreciation, had it been applied in prior periods, would have resulted in a total theoretical accrued depreciation reserve that would have been greater by $4,305,940 than what was actually accrued on the company's books as of September 30, 1978 (the end of the test year on which the new tariff filing was based). The division and the commission labeled this sum as a deficiency. The division contended that the rate base should be decreased by the amount of this deficiency and that the company be denied permission to recover the deficiency over the remaining useful life of the assets. The commission reduced the rate base by $4,305,940 but allowed the company to continue to deduct the same percentage for depreciation that had been previously approved, since th[e] evidence does not suggest that the deficiency is long standing or that the Company has profited from it. The commission went on to state: In this case the Commission is also mindful of the fact that while the subject of valuation (rate base) was not addressed in the last case, the Division did accept the prospective application of the depreciation rate proposed by the Company. In light of The Division's position in the prior case and the evidence referred to above, the Commission is not inclined to upset the depreciation rate which was established in the prior case on the basis of this record. Both parties seek review of this order. Essentially both parties agree that depreciation constitutes a means of amortizing the cost of assets over the probable useful life of such assets. As pointed out by James C. Bonbright in Bonbright, Principles of Public Utility Rates 213 (1961): In modern regulation, the allowances for `depreciation' both as operating expenses and as deductible reserves are designed to cover so-called functional depreciation including obsolescence and not merely physical deterioration or wear and tear. Hence the allowances must be based on estimates or plausible assumptions as to the effect of obsolescence on useful-life expectancies. But neither a corporate management nor a commission can hope accurately to predict, years in advance of the event, the dates as of which old properties may need to be retired for reasons of `extraordinary obsolescence.' To a material extent, the harm arising from this lack of prophetic vision can be minimized by midstream re-estimates of remaining-life expectancies and hence by reasonable step-ups or step-downs in annual depreciation charges, so that the dates of complete amortization can be made to correspond fairly well to the dates of the actual retirement. This procedure is much more readily employed under `group methods' of depreciation accounting, whereby the premature retirements of some assets are offset by the longevity of other assets in the same group. There is no question that the company in this instance has within its rate base a highly complex multiplicity of assets, plant, and equipment, with varying periods of anticipated life. Normally the cost of an asset would be amortized over its probable useful life minus a net salvage value. Obviously, this probable useful life is only an approximation which may be modified by unanticipated obsolescence due to technological changes, changes in federal statutes and regulations, and changes in sources and types of energy supplies. Additionally, the severe impact of inflation has introduced a concept of negative salvage value whereunder significant additional costs would be incurred upon the retirement of a given asset. There is no evidence in the record to indicate in any way that the company was imprudent or negligent in failing to revise its depreciation figures prior to 1976 to reflect these changes. No challenge was raised to the modified depreciation percentages in the previous rate hearing (P.U.C. Docket No. 1258). There is no evidence in the record to indicate that the company has recovered the deficiency in any other way than by allocation to annual depreciation expense. The commission's specific finding that the company has not profited from the deficiency strongly indicates that there has been no recovery of the sums represented by this deficiency through rate of return or otherwise. It also seems obvious that an element of this deficiency is the negative salvage value to be incurred upon the retirement of the asset. This negative salvage value, although a part of the deficiency, has never been a part of the rate base. In the regulation of public utilities, a stable and, insofar as practicable, a simple method of allocating cost is to be desired. No system of depreciation, straight-line or otherwise, can result in a perfect allocation of cost with uniform temporal apportionment. Bonbright, supra at 208, addresses this problem as follows: Aware of the vague and unsatisfying nature of any attempt to rationalize the choice of a method of depreciation accounting by reference to some basic 'theory' of temporal cost apportionment, such as a relative-benefit theory, one may be tempted to conclude that, within wide limits, any method of amortization is as good as any other. This conclusion, however, does not follow. For the relative merits of alternative methods are subject to appraisal in the light of criteria of usefulness other than those suggested by any assumed ideal standard of fairness among the consumers of different periods. The importance properly attached to other criteria is all the greater in view of the fact that most public utility consumers are fairly steady customers and hence that any chosen method of cost amortization, consistently followed, will to a material degree offset in a later period of time deficiencies or excesses of an earlier period. (First emphasis added; second in the original). In response to a similar problem, the New York Public Service Commission in Iroquois Gas Corp., 85 P.U.R.3d 356 (N.Y. Pub. Serv. Comm'n 1970), declined to penalize a company whose book account for depreciation had developed a $3,962,340 deficiency resulting from changes in negative salvage and average service life. Having been persuaded that the revisions in depreciation that had been made reflected prudent practices, the New York commission held that exclusion of the deficiency from the rate base would deny Iroquois a full and proper return on its investment. The New York commission posed the question as not whether the consumer is being required to pay for the company's mismanagement but, rather, whether a company should be required to operate unconditionally at its peril with respect to the uncertainties of business. Id. at 359-60. The New York commission considered the answer to the latter question to be clearly in the negative, and so do we. Having previously approved a revised depreciation rate in an order from which no appeal was taken, and having found in essence that the company had not recovered the costs represented by the deficiency in its book account in any other way, the commission would be acting confiscatorily to remove this so-called deficiency from the rate base, thereby penalizing the company for its lack of precise clairvoyance. The division cites Narragansett Electric Co. v. Kennelly, 88 R.I. 56, 76, 143 A.2d 709, 721 (1958), for the proposition that property not actually used and useful does not properly belong in the rate base. Not a shred of evidence is present in this record to indicate that the discrepancy between book-value depreciation and the hypothetical accrued depreciation that would have resulted from the retroactive application of the revised rates in any way represents property not actually used or useful in the light of the composite depreciation account utilized by the company. Thus, the commission erred as a matter of law in reducing the rate base by the sum of $4,305,940. The commission was correct in allowing the depreciation rates that it had previously approved in 1977 to continue. The rates the commission had previously set in Docket No. 1258, including the depreciation factor, were presumptively valid. See Narragansett Electric Co. v. Kennelly, 88 R.I. at 84, 143 A.2d at 725; see also Blackstone Valley Chamber of Commerce v. Public Utilities Commission, R.I., 396 A.2d 102, 104 (1979); United States v. Public Utilities Commission, R.I., 393 A.2d 1092, 1095 (1978). The party seeking to change such a previously approved rate has the burden of persuasion on this issue. United States v. Public Utilities Commission, 393 A.2d at 1094; Narragansett Electric Co. v. Kennelly, 88 R.I. at 84, 143 A.2d at 725. As the commission pointed out in its report and order, [t]he Division offered no evidence on this issue. Thus, the commission found as a fact that the division had failed to sustain its burden of persuasion in respect to the previously revised rate of depreciation. Generally, a finding of fact by the commission, based upon substantial evidence or a presumptively valid prior determination, is unassailable on review. See Valley Gas Co. v. Burke, R.I., 406 A.2d 366, 369 (1979); Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 277, 302 A.2d 757, 762 (1973). In the instant case the principles applied by the commission were consistent with those applied in Valley Gas Co. v. Burke, supra . In Valley Gas, the commission rejected the utility's request to amortize a depreciation deficiency, on the ground that the utility had failed to sustain its burden of proving that the deficiency had not been otherwise recovered. In this case the company had sustained its burden of persuasion in the prior hearing and the division failed to sustain its burden of showing that the prior determination was improper or unjust. Thus, the commission's finding on this issue is sustained.