Opinion ID: 2363714
Heading Depth: 1
Heading Rank: 1

Heading: Accounting Adjustments

Text: The company's intrastate rate base, to which the commission applies a rate of return deemed by it sufficient to allow the company to attract investment capital as well as to maintain its credit, often includes an allowance for working capital. Cash working capital has long been accepted to represent the amount of cash required to operate a utility during the interim (the lag) between the rendition of service and the receipt of payment therefor. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 288-89, 302 A.2d 757, 768 (1973). [4] Working capital determinations made in the course of rate proceedings have frequently been the subject of review by this court. We have said that an allowance in rate base for working capital is not something to which a utility is entitled as a matter of right. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 408, 368 A.2d 1194, 1202-03 (1977); Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 401, 322 A.2d 17, 26 (1974). Rather, determination of an allowance is a question of fact to be decided by the commission on the basis of the specific facts of the case before it. New England Telephone & Telegraph Co. v. Public Utilities Commission, 116 R.I. 356, 385, 358 A.2d 1, 18-19 (1976); Rhode Island Consumers' Council v. Smith, 113 R.I. at 401, 322 A.2d at 26. Because the role of factfinder is that of the commission alone, see § 39-5-3, we review only to determine whether the commission's decision is fairly and substantially supported by legal evidence and sufficiently specific to enable us to ascertain if the facts upon which [it is] premised afford a reasonable basis for the result reached. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 277, 302 A.2d 757, 762 (1973). In this case our concern with working capital lies in three areas: gross receipts tax expense, accrued interest expense, and average cash allowance.
A recurrent area of dispute between the company and the division in recent years has involved the treatment of the Rhode Island gross receipts tax for purposes of working capital analysis. Specifically, the commission has examined the question whether the tax is and ought to be treated as a current one for ratemaking purposes or whether, as the company has argued, it is in fact a prepaid tax. The effect of what the company sees as a prepayment is to create a very substantial laga prolonged period during which the company claims that investors are entitled to a return on money temporarily len[t] to the company by them in order to meet the tax expense. See Providence Gas Co. v. Burman, R.I., 376 A.2d 687, 693 n. 4 (1977). In the company's two most recent general tariff filings, including that presently under consideration, the commission has quite clearly opted to treat what it believes is a tax paid currently as a current tax. We approved the logic of this position in New England Telephone & Telegraph Co. v. Public Utilities Commission, R.I., 376 A.2d 1041, 1051-52 (1977), where we upheld the commission's factual determination that the effect of a gross receipts tax paid both currently and on the basis of current revenue levels is such as to require no working capital allowance. We consequently upheld as well the commission's decision to account for any actual discrepancy between the level of test-year revenues and the level of corresponding gross receipts tax expense solely by means of an expense adjustmentthe ultimate cost of state tax adjustmentused for this purpose by the company itself. Id. at 1052. In this proceeding the company apparently does not dispute the testimony of division witness Aarne Hartikka (Hartikka)testimony incorporated by the commission into its report and orderthat [t]he effect of [the ultimate cost of state tax] adjustment is to build into the Company's revenue requirement the actual tax relating to current year's revenues    . Rather, it contends that the expense adjustment is alone insufficient to account for the claimed lag and that a working capital allowance is, therefore, necessary. Despite protests to the contrary by the company, we feel that its argument in this proceeding is precisely the same as that urged unsuccessfully by it in New England Telephone & Telegraph Co. v. Public Utilities Commission, R.I., 376 A.2d 1041 (1977). For the following reasons we uphold the commission's finding that the only adjustment which can be properly made is the ultimate cost of state tax adjustment   . In New England Telephone & Telegraph Co. v. Public Utilities Commission, 376 A.2d at 1051, we explained as follows (and in somewhat simplified form) the operation of the gross receipts tax: Initially, the tax was payable in full on March 1 of each year, based on the gross receipts of the utility company for the prior year. In 1968 the payments were accelerated by chapter 26 of title 44. After 1968, the tax formerly due on the first day of March in year two was thereafter to be paid during year one; i. e., the tax was paid in the same year as the receipts upon which it was based were received. Certainly, the company could not claim a return on amounts expended to pay a current tax. Id. at 1052. The actions of the commission, both in this general filing and in the last such filing, reveal its position that the tax operates essentially as a current tax. That being the case, the company's accounting procedures alone cannot bind the commission in its treatment of expense items for ratemaking purposes. Providence Gas Co. v. Burman, R.I., 376 A.2d 687, 699 (1977); New England Telephone & Telegraph Co. v. Public Utilities Commission, 116 R.I. 356, 386, 358 A.2d 1, 19 (1976). An examination of the theory urged by the company reveals ample justification for the commission's having rejected it. The company's reasoning on this issue has been that the gross receipts tax as it was originally promulgated was an expense of year two, the year in which it was paid in full, rather than of year one, the year in which the receipts upon which it was based were collected. Consequently, when the tax was accelerated in 1968, it became a prepaymenta payment in year one of the taxes due in year two. New England Telephone & Telegraph Co. v. Public Utilities Commission, R.I., 376 A.2d 1041, 1051 (1977). The company's conclusion is therefore that the money to pay the tax is provided by investors. Neither the division nor the commission itself contests the fact that the company treats the tax as a prepayment. Indeed, the commission makes much of the fact that New England, alone among utilities in Rhode Island, accounts for the [expense] by charging it to income in the subsequent year. However, the commission obviously looked behind the prepayment label as applied to the gross receipts tax expense. We have as a rule refused to interfere with the commission's methodology as long as the end result is fair and reasonable. New England Telephone & Telegraph Co. v. Public Utilities Commission, 116 R.I. 356, 386, 358 A.2d 1, 19 (1976); Narragansett Electric Co. v. Kennelly, 88 R.I. 56, 71-72, 143 A.2d 709, 718-19 (1958). See FPC v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 287-88, 88 L.Ed. 333, 345 (1944). The company has failed to convince us that the commission acted unfairly or unreasonably in determining that the company's gross receipts tax expense is wholly and properly accounted for by use of the ultimate cost of state tax adjustment. [5]
The company contends that the commission erroneously adopted Hartikka's proposal that the company's working capital requirement be reduced to reflect the availability of approximately $822,000 in accrued interest on long-term debt. It was Hartikka's position that the company pays interest on its long-term debt at 6-month intervals in arrears and that the resulting substantial delay before payment of the expense should not be ignored for ratemaking purposes. The commission explicitly adopted Hartikka's position that the availability of funds ought to control the consideration whether to include accrued interest expense as a source of the company's working capital. It incorporated with approval Hartikka's statement that [w]hat matters is not who supplies the funds, but rather the relationship between cash flows inward and cash flows outward. Indeed, in rejecting the company's argument that it should earn a return on accrued interest because it is investor-supplied capital, the commission said only that [a]ll of the Rhode Island decisions on this point have recognized the critical issue to be the availability of funds, not their source. Unfortunately, the commission has misconceived the thrust of our prior decisions. Although funds must, of course, be available for use before they can operate to reduce the company's working capital requirement, e. g., Public Service Commission v. Continental Telephone Co., Nev., 580 P.2d 467, 470 (1978), we have long accepted the traditional definition of rate base as including working capital supplied by investors but not funds supplied by consumers. See Providence Gas Co. v. Burman, 376 A.2d 687, 693 n. 4 (1977); Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 394, 322 A.2d 17, 23 (1974). Indeed, in Rhode Island Consumers' Council v. Smith, supra , we upheld on the facts the commission's decision to exclude this very itemaccrued interest expenseas a source of the company's working capital. Although the commission has broad discretion in making adjustments to test-year data, Narragansett Electric Co. v. Harsch, 117 R.I. 395, 417, 368 A.2d 1194, 1207 (1977), it is not free to ignore a rule of law applicable to the matter before it. New England Telephone & Telegraph Co. v. Public Utilities Commission, 116 R.I. 356, 379, 358 A.2d 1, 16 (1976). In this case the law is found in our definition of those general types of funds that are includable as part of the company's working capital requirement. While w. might normally remand an issue of this kind to the commission for further consideration, we feel that such a course is unnecessary in this proceeding in light of the fact that the commission questioned only whether the source of the funds was to have legal significance. For that reason we remand with the direction that the commission exclude the disputed amount as a source of working capital.
When the company submitted its request for a working capital allowance, it included an adjustment designed to ensure the availability of what it labels average cash. The term average cash has been defined for us by the company as the relatively modest cash required to provide for day-to-day contingencies. That modest amount adds $515,819 to the company's working capital requirement and thus to its rate base, upon which it earns a return. So far as we can tell, the only meaningful reference to the problem of average cash is contained in the company's response to a commission data request, the key to which is the company's assertion that [t]here is, of course, in any business the need to maintain cash balances. [6] The commission, over the division's objection, granted the company's request for an allowance, stating only that [i]n the absence of record evidence, we are unable to make a factual determination as to the reasonableness of excluding average cash. We decline to do so in the absence of    testimonial support. The Legislature has placed upon the public utilitynot upon the division the burden to prove the necessity and reasonableness of proposed rate hikes. General Laws 1956 (1977 Reenactment) § 39-3-12. The commission's brief comments leave us uncertain whether the commission was in fact shifting the burden of proof or whether it reached its decision because it was for specific reasons satisfied with the company's position and because of an absence of contradictory evidence from the division. We remand in order to give the commission an opportunity to clarify this portion of its report and order.

The company charges that the commission erroneously accepted Hartikka's recommendation that test-year earnings should be adjusted upward to recognize the effect of post-test-year changes in directory advertising revenues and expenses. Specifically, Hartikka proposed to recognize additional revenues of $502,000, which produced an overall increase in test-year earnings of $177,000. The company's response was essentially that the expenses associated with those revenues were so speculative that the commission should have disregarded this new revenue. The task of the commission is to base future rates upon known past and present conditions through the use of data generated during a specific test period. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 416, 368 A.2d 1194, 1206 (1977); Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 278, 302 A.2d 757, 763 (1973). However, in order to ensure that the test year is representative of the conditions that will prevail when the new rates take effect, Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 397, 322 A.2d 17, 24 (1974), the commission has both the authority and responsibility to undertake a reasoned exercise of its discretion in altering test-year data to reflect changes of known magnitude occurring subsequent to the test year. Northwestern Bell Telephone Co. v. State, Minn., 253 N.W.2d 815, 822 (1977). Yet, despite the broad discretion it possesses in this area, the commission generally considers only post-test-year revenue and expense changes that affect test-year results with certainty. Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 393, 322 A.2d 17, 22 (1974). See also Narragansett Electric Co. v. Harsch, 117 R.I. at 416-17, 368 A.2d at 1206-07. To factor in changes of unknown magnitude would in most cases increase what speculation already exists in the ratemaking process and thereby tend to undermine the effectiveness of the test-year concept. Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 242-43, 136 A.2d 726, 735-36 (1957); Public Service Co. v. State, 102 N.H. 150, 162-63, 153 A.2d 801, 810 (1959). On the other hand, we have never determined that the commission is entirely without discretion to adjust test-year data unless all relevant figures are ascertainable with complete exactitude. To do so would be, in our opinion, to bind the commission's hands in cases where flexibility is necessary to `do justice,' to decide what is just and reasonable based on the evidence before it. Rhode Island Consumers' Council v. Smith, 111 R.I. at 289, 302 A.2d at 769, quoting Narragansett Electric Co. v. Kennelly, 88 R.I. 56, 73, 143 A.2d 709, 719 (1958). When the commission for articulated reasons determines that its figures are reliable and finds that an adjustment of the type made here is necessary to ensure that test-year data remain representative, we see no reason to deny the commission the discretion to act solely because it cannot do so with complete precision. Cf. General Telephone Co. v. Public Service Commission, 78 Mich.App. 528, 539-40, 260 N.W.2d 874, 879 (1977) (once anticipated increases in directory advertising revenues were recognized, commission should have considered as well somewhat speculative wage increases). With respect to the present controversy, there apparently exists little dispute that the $502,000 in increased revenues associated with the directory advertising rate increases constitute just the sort of known and measurable future economic condition of which the authorities overwhelmingly approve. Narragansett Electric Co. v. Harsch, 117 R.I. at 418, 368 A.2d at 1207. Both the commission and the division agree, however, that the adjustment urged by Hartikka and accepted by the commission incorporates an expense figure that is not so thoroughly based on fact. The company contends that the expense figure is speculative and may therefore not be considered, with the result that it is equally inappropriate to consider the effect of the increased revenues; in so arguing it appears to rely upon the simple proposition that an adjustment for changes in revenues occurring after the test year should require a commensurate change in expenses in the same period. City of Pittsburgh v. Public Utility Commission, 187 Pa.Super. 341, 363, 144 A.2d 648, 660 (1958). See also City of Los Angeles v. Public Utilities Commission, 7 Cal.3d 331, 346-47, 102 Cal.Rptr. 313, 325, 497 P.2d 785, 797 (1972). Although we have already stated that the general rule can accommodate less than mathematical precision, and have thereby affirmed that the treatment of post-test-year occurrences is, to a large extent, within the discretion of the commission, Narragansett Electric Co. v. Harsch, 117 R.I. at 417, 368 A.2d at 1207, the commission has in this case failed to demonstrate that its findings are based upon legally probative evidence; consequently, we must remand with directions that the commission provide us with that information or, if necessary, alter its decision. Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 283, 302 A.2d 757, 765 (1973). In its report and order the commission stated that rejection of Hartikka's recommended adjustment would unfairly penalize the ratepayers. It may well be that to ignore altogether known revenues of such magnitude would detract from the representative nature of the test year, at the consumer's expense. This is especially so because, despite the protests of the company's accounting witness, John F. O'Neill (O'Neill), that an analysis of the relevant expenses would be quite long and complex because it involves a great number of departments and a great number of different items   , the company itself had already adjusted test-year data to reflect increased wage expense, which company figures in turn suggest accounted for about half of the total directory advertising expense. On the other hand, the report and order reveals that Hartikka based part of his calculations on the assumption that directory advertising expense would increase by the same percentage that directory advertising revenues would be increased   a theory that standing alone is too speculative to be relied upon. Cf. General Telephone Co. v. Public Service Commission, 78 Mich.App. 528, 540, 260 N.W.2d 874, 879 (1977) (conclusion that directory advertising revenues will increase at same rate as in past was probably too speculative for adoption). If and to the extent that the commission adopted that formula as a measure of directory advertising expense, we direct that on remand it exclude the arrived-at sum as an adjustment to test-year data. In conclusion, we must remand so that the commission can detail its reasons for having adopted Hartikka's methodology, [7] both in general and specifically with regard to the expense that was not wage related, and so that it can as well reconsider and perhaps modify its decision in light of what we have said here.
During the course of the hearings and in his prepared testimony, Hartikka recommended that certain out-of-period accounting entries adopted by the company be excluded from computation of the company's overall expense figure. The company's adjustments were intended to reflect what it considered typical expense changes of various kinds, namely, changes in the level of unemployment taxes, social security tax accruals, and medical insurance expenses. The commission accepted Hartikka's proposal to eliminate those out-of-period entries, thereby increasing pro forma intrastate earnings for the test period by $72,000. The problem facing the commission in treating these out-of-period accounting entries is not unlike that which we have just discussed concerning directory advertising revenues. The commission must, when necessary, adjust test-year data so that it will reflect typical operating conditions and thereby hopefully prove representative of future conditions. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 416-17, 368 A.2d 1194, 1206-07 (1977); Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 397, 322 A.2d 17, 24 (1974). The commission had before it Hartikka's testimony that the disputed entries would have distort[ed] the company's actual test-year operating results; Hartikka had as a general matter suggested on cross-examination that, although future periods will probably require their own out-of-period adjustments, the unpredictability of the type, amount, and impact of such adjustments upon earnings makes untenable any theory that future periods will be affected in much the same way as was a given test year. Notwithstanding an apparent abundance of oral testimony before the commission both in support of and in opposition to use of the company's out-of-period entries as acceptable indicators of similar future adjustments, the commission found in its report and order that the company had waived whatever objection it might have had to Hartikka's proposal. The commission's conclusion might have resulted in part from the company's failure to brief its position with the vigor characteristic of its other efforts; indeed, the company had confined its remarks on the issue to a footnote in its brief to the commission, declaring there, in part, that [t]he position of the parties is sufficiently clear on the record   . Our review of the commission's decision to accept Hartikka's recommendation cannot, however, turn upon the question of the existence and effect of an alleged waiver, because, in our opinion, the commission itself did not so limit its determination. Rather, despite its reference to waiver, the commission found quite specifically and as a matter of fact that [t]he out-of-period accounting entries    would, if included in test period operating results, have a distorting effect. Although that finding is presented without elaboration of any kind, it nonetheless makes clear both that the commission felt that there existed sufficient evidence of the type properly relied upon in making necessary factual determinations, and that the commission in fact acted on the basis of that evidence. Having so acted, it was incumbent upon the commission to support factually and legally its decision that exclusion of the entries was necessary to avoid distortion of the company's test-year operating results. E. g., Rhode Island Consumers' Council v. Smith, 111 R.I. 271, 285-86, 302 A.2d 757, 766-67 (1973). We must mow remand this matter to the commission so that it may discharge that responsibility in a supplementary decision. [8]
The final expense item challenged by the company raises a question not previously before the commission in the context of a New England tariff filing. The company contends that the commission acted arbitrarily when it adopted an adjustment designed to reflect supposed tax savings related to the company's participation in a consolidated federal income tax return filed by the American Telephone and Telegraph Company (AT&T). The company has, for the past several years, joined the many other Bell System operating companies that, along with Western Electric, participate in AT&T's consolidated return. Certain tax advantages flow to AT&T as a result of that consolidated return, the most obvious being that the tax liability of the system as a whole is less than what it would be if the affiliated companies each filed a separate return. This situation exists in large part because AT&T itself issues a significant portion of the debt capital raised to finance system operations, with the result that the accompanying interest expense deductions are available to AT&T in the computation of its tax liability. There seems to be no dispute that, because of the system's internal accounting practices, AT&T itself retains the tax benefits resulting from the interest expense and does not utilize the savings so as to credit its operating companies, such as New England, directly. See also Mountain States Telephone & Telegraph Co. v. Public Utilities Commission, Colo., 576 P.2d 544, 550 (1978); Chesapeake & Potomac Telephone Co. v. Public Service Commission, 230 Md. 395, 411-12, 187 A.2d 475, 484 (1963). The company's position is essentially that the commission must for ratemaking purposes proceed as if there were no overall tax savings whatsoever; it argues that to use as a cost of service anything but what the company would pay in taxes if it filed a separate return is no less than to claim as a tax deduction the interest expense of another corporation. Hartikka, on the other hand, argued that, absent an adjustment to reflect an operating company's proportionate share of the total savings and thereby to lower that company's stated tax liability, the Bell System as a whole would earn revenues including provisions for federal income taxes greater than the taxes actually payable   . See also FPC v. United Gas Pipe Line Co., 386 U.S. 237, 244, 87 S.Ct. 1003, 1007, 18 L.Ed.2d 18, 24 (1967). The commission agreed with Hartikka's assessment of the problem and accepted as the solution a tax adjustment recommended by an accounting committee of the National Association of Railroad and Utility Commissioners (NARUC). Hartikka explained that the NARUC adjustment, which takes into consideration the fact that the company is not wholly owned by AT&T, allocates total system debt among the operating companies in proportion to their relative average capital obligations associated with AT&T ownership. The difference between the allocated debt and the debt of each company constitutes the AT&T debt allocated to that company, which in turn determines the amount of interest expense allocated. Using this formula, Hartikka concluded that the company's share of the AT&T tax savings applicable to its intrastate operations totalled $139,332 for 1975 and $238,073 for 1976, or $196,931 for the test year. The effect of the decreased tax liability recognized by the commission was to increase the company's pro forma intrastate earnings by $144,000. We have stated in the past that, when reviewing a decision of the commission, our concern is not with the method used to attain a particular result but with the fairness and reasonableness of the end result itself. Narragansett Electric Co. v. Harsch, 117 R.I. 395, 418, 368 A.2d 1194, 1208 (1977), citing FPC v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 287-88, 88 L.Ed. 333, 344-45 (1944). In this case we find nothing to indicate that the commission's action was unjustified. Indeed, keeping in mind that the determination of what is fair and reasonable requires a balancing of investor and consumer interests, FPC v. Hope Natural Gas Co., 320 U.S. at 603, 64 S.Ct. at 288, 88 L.Ed. at 345, we agree with one commentator's statement that in general [i]t seems difficult to resist the    argument that a Bell subsidiary's ratepayers should not be called upon to meet tax outlays greater than the subsidiary's allocated proportion of the system's tax liability   . 1 Priest, Principles of Public Utility Regulation 58 (1969). The commission utilized the NARUC tax adjustment in order to ensure that recovery not be allowed for an overall tax expense never in fact incurred. Rhode Island Consumers' Council v. Smith, 113 R.I. 384, 396, 322 A.2d 17, 23 (1974), citing FPC v. United Gas Pipe Line Co., 386 U.S. 237, 244, 87 S.Ct. 1003, 1007, 18 L.Ed.2d 18, 24 (1967). Contrary both to the suggestion of the company and to the view of the minority of jurisdictions to consider this problem, e. g., Re Diamond State Telephone Co., 1 Storey 532-33, 51 Del. 525, 532-33, 149 A.2d 324, 328-29 (1959); General Telephone Co. v. Public Utilities Commission, 174 Ohio St. 575, 577-80, 191 N.E.2d 341, 343-44 (1963), we do not feel that adoption of the NARUC formula either improperly ignores the separate corporate identities of New England and AT&T or in any impermissible way invades the conceded prerogatives of New England's management to achieve what it considers its maximum prudent debt ratio. Indeed, if there has been any limited disregard of separate corporate identities, it is unquestionably because AT&T and New England themselves have chosen to disregard their separateness for income tax purposes. The NARUC adjustment recognizes only that it is the commission's responsibility to determine the company's allowable tax expense and that its duty cannot be discharged properly if the commission is bound by figures that would appear on a separate return that the company in fact did not file. See Chesapeake & Potomac Telephone Co. v. Public Service Commission, 230 Md. 395, 413, 187 A.2d 475, 485 (1963); United Inter-Mountain Telephone Co. v. Public Service Commission, Tenn., 555 S.W.2d 389, 393 (1977). We hold that the commission did not abuse its discretion by disallowing a claimed federal income tax expense that was greater than the company's proportionate share of the consolidated tax liability.