Regional Workshop on Uniform System of Accounts and Regulatory

Reporting

Regional Workshop on Uniform System of Accounts and Regulatory

Reporting

Thomas WelchPierce Atwood LLP

19-20 May, 2008Bucharest, Romania

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Comparison of Charts of Accounts and Reporting Forms

● Where can comparable information be found?

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Charts of Accounts: RAB (Disco)

● USOA (FERC): Net Plant: Accounts 101-115

● Albania Account 20

● Republic of Srpska Account 02

● Georgia Accounts 2115-2125

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Charts of Accounts: RAB (cont.)

● Macedonia Accounts 20-29

● Other?

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Charts of Accounts: Metering Equipment

● Albania Account 20.4.50

● Georgia Account 2150/Schedule A (?)

● Macedonia Account 022 (sub-account?)

● Romania Account 213 (sub-account?)

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Charts of Accounts: Metering Equipment

● USOA (FERC) Account 370

● Other?

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Additional Areas for Comparison?

● Each participant select one area and locate the information in each of the charts of accounts

● Present results

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Use of Reporting Forms -- Find the following:

● Salaries● Sales● Cash balances● Revenues from connection charges● Labor costs per kWh● Depreciation cost/kWh● Other items for analysis and comparison?● Importance of transparent and available information

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Treatment of Substantive Issues

● Following slides assembled from responses to questionnaire

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Valuation of AssetsBasic Principle – Original Cost Less

Accumulated Depreciation (Georgia)

Privatization of Distribution Networks and six HPPs (2007). Cost of assets was equal to that of under original cost less accumulated depreciation

Assets used in non-regulated activities are not considered in tariff calculations

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ANRE

Assets valuation (Romania)Assets valuation (Romania)The valuation at the time ofprivatization:

• Book value - year 2003;• Maximum value : 200%;• No assets excluded.

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Asset Valuation (Albania)

● How assets are valued, including valuation at the time of privatization and the exclusion of older assets from rate base Original cost less accumulated depreciation? Fair value? The assets are valued at Fair Value. The impairment test is to be

completed before the privatization procedure starts; the assets- those are old and are not in use, are to be excluded from the RAB. Assets acquired by donations are excluded from the RAB as well. Assets held for future use is the amount of assets that is not being used currently by the Licensee in the provision of service. In principle assets that qualifies for this category is limited to land and construction rights acquired by the Licensee. The time aspect of the acquisition plays an important role when deciding whether the property can qualify as asset held for future use. Assets held for future use may be included in the rate base only with the Regulator’s approval.

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Asset Valuation (Serbia)

● Property, plant and equipment are stated at historical cost less accumulated depreciation and accumulated impairment in value.

● Depreciation is calculated on a straight-line basis over the remaining estimated useful life of the asset as follows: Buildings 15-76 years Transformers 12-34 years Power transmission lines 14-46 years Vehicles 2-5 years Computers and computer equipment 3-4 years Office equipment 5-9 years

● The first evaluation of assets was at the beginning of year 2004.

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Asset Valuation (Hungary)

● How assets are valued, including valuation at the time of privatization and the exclusion of older assets from rate base The most common method which the regulatory agency

used and uses is that it considers the original costs of the assets and accounts for inflation and industry specific depreciation

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Asset Valuation (Kosovo)

● Existing assets – pre-2006 assets valued at zero. Allowances are made for maintenance costs and replacement of assets when required

● New assets – valued at original cost. A nominal return is allowed

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1. Asset evaluation (Ukraine)1. Asset evaluation (Ukraine)

• For the majority of Ukrainian distribution companies assets are apprised by their remaining book value

• For 5 companies privatized in 2001, their purchase value is used as a rate base

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How assets are valued?Basis: Rulebook on tariff methodology and tariff procedure GUIDELINES for implementation of regulatory chart

of accountsFixed assets are valued at purchase costs or fair value, if revaluation occurs after acquisition.Valuation has to be performed in accordance with IAS and IFRS.Assets are not excluded from regulatory assets base because of age, but only for use in operation.

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Treatment of O&M CostsActivities Provided Outside the Utility (Georgia)

Only the costs that are necessary to carry out regulated activities are treated in tariffs

Costs should incur at reasonable (acceptable) prices

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ANRE

O&M Costs (Romania)O&M Costs (Romania)

If the activity is provided by an economic entity, outside the utility (external costs):– Auctions

If there are not Auctions:– The O&M costs are updated/

indexed to inflation index

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Treatment of O&M supplied by others (Serbia)

● Repairs and maintenance are accounted to expenses as incurred.

● To apply any O&M costing methodology to a specific facility, it is necessary to make adjustments that consider its physical condition, spare parts and type of construction and costs of services.

● Approximately, maintenance costs where the activity is provided by a person or company outside the utility are one-half of all planned maintenance costs. Costs are valued by market value and they are treated as services.

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Treatment of O&M supplied by others (Hungary)

● How are costs evaluated for reasonableness? In Hungary the price regulatory period is four year long and

there is a quasi price-cap regulation. The new regulatory period will start from 2009. During the preparation of the previous regulatory period O&M costs where the activity was provided by a person or company outside the utility was not relevant, companies did not do any outsourcing. So there is no experience yet. But now this issue became a relevant problem because companies began to outsource many activities. The regulatory agency does not yet know how to treat these kinds of costs. Since these outside companies are not under the scope of the agency the agency cannot really do else but to accept these costs.

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O&M Supplied by others (Kosovo)

● All externally purchased O&M services are subject to the Public Procurement law in Kosovo.

● Regulatory audit will monitor the justification for the purchased services and control if these services are under regular O&M

● cost presented by company, avoiding duplication of the costs.

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2. Treatment of O&M costs where the activity is 2. Treatment of O&M costs where the activity is provided by a person or company outside the utility provided by a person or company outside the utility (Ukraine)(Ukraine)

• Irrelevant for the Ukrainian electric power sector – Applicable Law of Ukraine doesn’t stipulate that the regulated

activity can be provided by a person or company outside the utility

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Treatment of O&M costs a. How are costs evaluated for reasonableness?

Reasonableness of costs is assessed according to the nature of cost analyzing its purposefulness, analyzing quantities and prices and using benchmarking.

Reasonableness of costs to be recovered from tariffs is assessed taking into consideration prevailing conditions and available information when the decision to incur costs was brought.

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Treatment of O&M costs Reasonableness of costs of “hired services”

is assessed against basic principle of prudence: company cannot perform the service with its

own resources (lack of equipment or qualified staff)

prudence in acquisition (procured in the process of public tendering or otherwise proved to be the most convenient option)

If the company maintain its assets, it should not be costly more than if performed by third person.

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Allocation of Costs Between Regulated and Non-regulated Activities (Georgia)

List of costs related to regulated activities is defined in the methodology of setting tariffs

According to The Law the Licensees are required to keep separate accounting of costs and revenues for regulated and non-regulated actitivties.

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ANRE

Cost Allocation (Romania)Cost Allocation (Romania)The Romanian Energy Law (no.13/2007) specify for all License holders:

• Article 17:“To keep separate accounts for each activity that is within the object of the license granted by the competent authority for the vertically or horizontally integrated undertaking in the electricity sector, in the same way as it is proceeded when the respective activity is performed by separate sector undertakings and to draw up financial reports as per the standard format

issued by the competent authority” • Article 11:

“Effective separation of accounts, according to Art. 17, in order to avoid cross-subsidies among electricity generation, transmission, distribution and supply”

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ANRE

Cost AllocationCost Allocation• The keys are defined in the IT

software used for costs management (e.g: SAP);

• The Regulator is informed about the allocation keys;

• The Regulator aims keys that will not change in time (in a regulatory period);

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ANRE

Cost AllocationCost Allocation

The Allocation of Costs – Major requirement:

– The existence of a clear financial separation between:

Licensed and Non-licensed Activities;Regulated and Non-regulated Activities.

In order to:avoid cross-subsidies

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ANRE

Chart of Accounts Workshop

In accordance with the Rulebooks on the method and conditions for regulating prices on regulated activities, the assets valuation concept for the regulatory assets is the concept of original cost less accumulated depreciation (book value of assets)

The operating and maintenance costs, according with the Rulebooks, reflect the normalized costs necessary to perform the regulated activity.

The Regulator recognize the normalized costs in the procedure for approval and control of the price

The principles for calculating of the normalized costs are determinate with the Methodologies for calculation of regulated revenue and price of the regulated activity. According to this principles,- the level of the costs for current maintenance, repair and maintenance services is up to 25% of the calculated annual deprecation, - the level of other services is up to the level of their average three-year participation (as%) in the costs for materials, energy, spare parts and inventory.

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ANRE

Cost AllocationCost Allocation

The basic Criterion for cost allocation between Regulated and Non-regulated activities:

– Sharing the costs by types of items:

•Direct Costs;• Indirect Costs;•Overhead Costs.

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ANRE

Cost AllocationCost Allocation

Costs allocation between “parent” and “daughter” companies:

Not allowed

For Indirect and Overhead Costs:Allocation Keys;

Different keys for different activities;

The keys are set by each utility

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ANRE

Cost AllocationCost Allocation• The keys are defined in the IT

software used for costs management (e.g: SAP);

• The Regulator is informed about the allocation keys;

• The Regulator aims keys that will not change in time (in a regulatory period);

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ANRE

Cost AllocationCost Allocation

• Examples of allocation keys:– Percentage (%) – for indirect costs;– Number of persons directly involved in

the activity – for overhead costs;For O&M costs:

– Number of meters, – Number of telecom equipments,– Number of lines - equivalent Km.

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Cost allocation between regulated and non-regulated activities (Hungary)

● What are the allocation keys? Mostly revenue is the allocation key.

● Are there different keys for different activities, and if so what are they? Earlier the regulatory agency tried to use asset value as

allocation key but it was unreliable. Now they only use revenues.

● How are keys determined? By %. There is no correction factor.

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Cost allocation between regulated and non-regulated activities (Serbia)

● All costs are decreased by the amount of non-regulated revenues and then they are distributed between on two main regulated activities. A "postage stamp" approach has been chosen: - assigns some costs to two main activities directly - aggregates all remaining costs and then on the basis of a

single allocation key divides this total to regulated activities

● Allocation keys for costs allocation between two main regulated activities are assets value and number of employees.

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Cost allocation between regulated and non-regulated activities (Albania)

● How are costs evaluated for reasonableness? – the costs related to the non regulated activities are to be included separately from those regulated. There is no any specific determination of reasonable costs. It is important that all costs to be clearly recorded (i) by functions; (ii) by nature; (iii) By groups of consumers; and (iv) by voltage levels, and to be allocated clearly for regulated and non-regulated activities, etc. Case by case the costs of outsource services will be analyzed by the regulator, and in case of disputes the regulator may intervene in adjusting the costs with the market price for tariff purpose. Example: penalties or expenses for financial support for other activities (sponsorship) are not considered by the regulator.

● The method for allocating costs between regulated and non-regulated activities, and between “parent” and “daughter” companies What are the allocation keys? – there is no any method for allocating costs

between regulated and non-regulated activities, and between “parent” and “daughter” companies. The company will propose such allocation factors and the regulator will approve those.

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Cost Allocation (Kosovo)

● Costs are allocated between activities using the divisional allocations already applied by licensees for budgeting purposes so the cost are allocated for each unbundled activity, used for providing public services. The categories of costs are in compliance with Regulatory Accounting Guidelines which includes: OPEX, CAPEX, and they are subdivided in respective components such as: fuel cost, repair and maintenance cost, personnel cost, sales and administration, and depreciation. CAPEX includes ROR on RAB. There are no “daughter” companies.

● HQ costs are allocated across divisions in proportion to their share of total staff numbers.

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The method for allocating costs Our favorite question in tariff case:What tasks, in what scope and at which price were performed

by parent company for your behalf? If any service is performed by related party, it should be

procured in fair procedure. Allocation of costs that cannot be procured externally

Allocation of costs of management, sale, marketing, quality management, legal and HR, public relations, call centers etc on different activity within the company

Allocation of administrative and general corporative costs of related party on different activities is disclosed in the reporting forms. In the tariff application form applicant explains every allocation key applied for allocation of costs.

The allocation keys have to be defined in advance as a part of the company’s accounting policies.

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Construction in Progress (Serbia)

● The Regulatory body allows recovery of the cost of new construction before the plant is put into service. The amount of this recovery is one-half of the depreciation costs of the assets to be put into service in the next year.

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3. Cost Allocation (Ukraine)3. Cost Allocation (Ukraine)

• In conformance with Rules and Conditions regulating electricity distribution and supply activities, licensee should have unbundled book accounting and prepare financial reports separately for each type of activities (regulated and non-regulated)

• Licensee has to allocate costs between regulated and non-regulated activities reasonably (according to its accounting policy) and provide an explanations of cost allocation, supported by necessary documentation, in a case of NERC ’s inquiry

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Chart of Accounts Workshop cont.

The allocation keys between regulated and non-regulated activities are:- value of assets- number of employees- financial indicators

According to the provisions of the Low on Trade Companies, the company shall prepare and announce consolidated annual accounts and issue a report on managing and operating a group of companies, if it has majority participation in one or more companies.

Consolidated annual accounts shall include the consolidated balance sheet, consolidated income statement, consolidated cash flow, consolidated movement of capital and notes.

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Disallowable Costs in Setting Tariffs

(Georgia)

Only the costs necessary for carrying out regulated activities are subject to inclusion in tariff calculation

All other costs remain as disallowable

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ANRE

Disallowed Costs (Romania)Disallowed Costs (Romania)

• There is no any “prudency test” – for O&M Costs;– for investments (capex).

• The max. limit for distribution price increase: 18% - during the first regulatory period (2005-2007);

• The max. limit for distribution price increase: 12% - in the second regulatory period (2008-2012);

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Basis for disallowing costs (Hungary)

● There is a list which is based on historical experience, but the final result is always the result of the discussion between the company and the agency. So there is no objective test or list.

● Examples for items that are always disputed: These companies pay enormous amounts to consultants.

The agency does not want to allow all of these costs. These companies still own holiday hotels which was a

common thing in the communist era. The agency does not want to allow the costs emerging from these hotels.

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Basis for disallowing costs (Serbia)

● An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected to arise from the continued use of the asset. Any gain or loss arising on derecognizing of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the item) is included in the income statement in the year the item is derecognized.

● We have the set of technical and financial criteria to measure costs in a mean that we primarily invest in new facilities, equipment etc. that would improve Transmission as well as revitalization of existing facilities. The Regulatory body reviews the costs and determines their reasonableness. The Regulatory body analyzes Company’s cost dynamic in last couple of years.

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Basis for disallowing costs (Albania)

● The basis upon which costs are disallowed, and examples of disallowances Is there a “prudency” test? There is not yet a “prudency test” upon which

costs are disallowed. But case by case, when certain costs seem to be significantly high, are adjusted by the regulator (referring to the respective market price) or are rejected (penalties, or public awareness’ costs)

Is there a “used and useful” standard? The licensees have the obligation to ensure that only assets that are used and useful, and prudently acquired, are included in the regulated asset accounts. The Regulator has the right to determine whether an asset was actually put in service, for what period it has been useful and whether it was useful in providing the service indicated. If it proves that the asset does not satisfy the requirements the Regulator may decide to exclude the asset (fully or partially) from the regulatory asset base. This requirement is introduced to differentiate the set of assets needed to perform operations from excess capacity and consequently to satisfy prudent investment standards.

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The basis upon which costs are disallowed

Generally, only major costs are analyzed. If the asset is not included in the regulatory

assets base, no related cost is allowed. If any cost is not procured prudently, it is

allowed at lower rate or totally disallowed. If distribution has losses of electricity higher

than approved it will be at its own costs.

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Cost Disallowance (Kosovo)

● Costs are reviewed on an ex-ante basis, based on demonstration that expenditures pass ‘prudence’ and ‘used and useful’ tests. Comparisons are made with previous years’ expenditures (allowed and actual).

● The Regulator at its discretion (using the regulatory audit function) performs a “used and useful test” on any item of property reported into the rate base. For example the test shall verify that the Licensee has excluded all of the following items when reporting the rate base: property used for non utility purposes, duplicate and unnecessary property, obsolete and inadequate property, overdeveloped property abandoned and superseded property, facilities for future needs, investment property.

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4. Cost allowance (Ukraine)4. Cost allowance (Ukraine)

• In accordance with the Law of Ukraine “On Natural Monopolies” and “On Electric Power Sector” : – Costs, which accordingly to the taxation laws of Ukraine are

considered to be total costs of production and turnover, are taken into account for the tariff (price) setting

– All the other costs are disallowed

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New Construction (Georgia) Investors start to recovery the costs

for new constructions only after the plant is put into service

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ANRE

Cost of new construction Cost of new construction (Romania)(Romania)

• In Romania, there are not allowed costs of new construction, before the plant is put into service;

• The investment costs will be recovered - based on the future price/tariff (the assets’ depreciation is a cost element).

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Construction in Progress (Hungary)

● In Hungary generation is not regulated only distribution and transmission. In case of new assets in these companies, there isn’t any recovery allowed before the assets are put in service.

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Chart of Accounts Workshop cont.

The Regulator recognized the cost of new construction according the investment plan, and the rate of realized investment in the previous period.

According the Rulebook and Methodology, the Regulator requests and the company is obliged to submit a plan about constructing new facilities during the regulated period, with the value of the planned investment, realization dynamics for the whole period and sources of capital for the investment.

Also, the company is obliged to submit the investment plan from the previous period with planned investments and realized investments.

The costs of new investments appear in financial statement, in the balance sheet as tangible assets in preparation.

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Construction in Progress (Albania)

● The average cumulative nominal amount of investments, which will be invested during the regulatory period, will be approved by ERE. Assets that do not support the licensed service will be disallowed from the regulatory asset base. Examples of disallowed assets include assets used for non-licensed activities, recreational facilities, and assets purchased by the distribution system operator above market value. The ERE based on its consultant or its own staff evaluation should determine the market value only in cases of disputed levels of investment. The amount of investments approved by the Regulator is part of RAB and a recovery is allowed on that.

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Construction in Progress (Kosovo)

● Capital expenditure costs are currently passed through to allowed revenues in the year in which they are incurred, due to cash flow constraints. Longer-term, this will move to including assets in RAB on commissioning.

● Capital expenditures are reconsolidated in next price review, by reconciling of allowed and actually executed capital expenditures

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5. Treatment of the cost of new construction 5. Treatment of the cost of new construction before the plant is put into service (Ukraine)before the plant is put into service (Ukraine)

• The book value of incompleted construction consists of payments charged for its acquisition or building

• Incompleted construction are not considered to be the capital assets as they are not used in the regulated activity, by that time the plant is put into service

• Hence, the charges for acquisition or building of such incompleted constructions are not liable to depreciation or recovery.

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Treatment of the cost of new construction

New construction is not included in the rate base, unless the applicant can prove that it will be commissioned during the tariff period.

The assessment is based on the data in the reporting forms and, if necessary, documents and evidence.

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Supply Cost (Georgia)

Different sources of supply bear different costs

High volatility is forcastable to some extent

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ANRE

Supply Costs (Romania)Supply Costs (Romania)

• The Romanian electricity market consists in:

• One Regulated Area;• One Non-regulated (Free) Area;

• The Regulated Area is working as “smoothing” mechanism for the Non-regulated Area – in order to avoid the high volatility of the prices (on the free market)

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ANRESupply CostsSupply Costs• Inside the Regulated Area:

For regulated entities

• To avoid high volatility of supply, the competent authority (ANRE) regulate the activities on the “whole route”:

–Generation;–Transmission;–Distribution;–Supply.

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Supply cost volatility (Hungary)

● Since there are long term power purchase agreements there is not much volatility, therefore this issue is not addressed in Hungary yet.

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Supply cost volatility (Serbia)

● All purchase in Company is done under the Procurement law of the state.

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Supply cost volatility (Albania)

● – Our example is the cost of purchasing the electricity in the competitive market, which are subject of volatility. A WCA is prescribed in the tariff methodology, for electricity purchase from the competitive market. The working capital allowance in the regulatory rate base should be based on a study of the funds required to maintain a suitable level of material and supplies and the cash required to meet current obligations and to maintain minimum back accounts. Any such study will be included in the rate application by the distribution system operator to the ERE. In absence of the study, the distribution system operator may provide an estimate of the working capital allowance with written evidence justifying such an estimate.

● In the manual of USoA, the most accurate, and therefore the most complex method of determining working capital requirements is the so called performance of a “lead-lag” study. This is a comprehensive task conducted to compare the difference in the timing lead or the timing lag between cash inflows and outflows. The study requires detailed analysis of company expenditures to determine the time at which the enterprise actually must pay for its expenses and compares this with the time at which it receives payment for those expenses. The time difference under the lead and lag method is then multiplied by the average daily operating expenses to arrive at the required level of working capital for inclusion in the regulatory base.

● An alternative to this method is to estimate the appropriate level of working capital using income statement and balance sheet information on the average level of inventory, the average daily level of expenses incurred by the Licensee (including operating, maintenance, administrative and general, taxes, etc.) and the interval between cash outflow and inflow.

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Supply Costs (Kosovo)

● Supply costs are reset annually based on actual market costs incurred in previous years, evidence on current regional market prices and allowed mining and generation costs. In order to avoid the big changes ‘smoothing’ mechanisms were applied only in first year of price control review ( transmission and distribution). ERO has allowed revenues and has approved for KEK JSC’s and KOSTT JSC’s network infrastructure businesses in 2007 included a ‘smoothing’ adjustment, which under recovered allowed revenues in 2007 will be compensated by allowing over-recovery in later years of the price control period.

● For the Supply it is not applicable smoothing mechanism.

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6. Treatment of supply costs (Ukraine)6. Treatment of supply costs (Ukraine)• Retail tariffs are fixed by suppliers on their own, adhering

to conditions and rules regulating electricity supply activities, based on the wholesale market price and transmission and supply charges approved by the NERC: – Transmission and supply tariffs are fixed on annual basis– The forecasted wholesale market price is fixed by the NERC

monthly. – The actual wholesale market price is fixed by the wholesale

supplier on the hourly basis, depending on daily consumption and power bids

– The NERC continuously monitors and analyses the wholesale market price balancing it within the forecasted levels

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Benchmarking Template

● Common Reporting Form Format Develop from existing forms

● What is common to all?

● What could be added?

● Publish Reporting Forms● E-Mail inquiries and posting

Has any regulator/company dealt with a particular issue? Post new decisions and filings and alert others

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Discussion of Survey

● What have you applied from the workshops?● How has CoA and Reporting Form information been

used in carrying out your responsibilities?● What changes/new developments with respect to

CoA and Reporting Forms in the past year?● What additional work/changes are planned?● What future assistance/follow up would be most

useful?