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© Baker Tilly Virchow Krause, LLP Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International. Presented by: Russ Hissom, CPA Partner Baker Tilly Energy and Utilities Group 1 Using Regulatory Accounting in Developing Rate Structures

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Page 1: Using regulatory accounting in developing utility rate ... · Using Regulatory Accounting in Developing Rate Structures. ... over future periods for rate-making purposes, ... except

© Baker Tilly Virchow Krause, LLPBaker Tilly refers to Baker Tilly Virchow Krause, LLP,

an independently owned and managed member of Baker Tilly International.

Presented by: Russ Hissom, CPA PartnerBaker Tilly Energy and Utilities Group

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Using Regulatory Accounting in Developing Rate Structures

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Goals for this session

>Discuss the background of regulatory accounting and its use in utility accounting

>Discuss its role in the ratemaking process

>Demonstrate its application in a number of utility transactional areas

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Instructor Information

Russell Hissom, CPA, Partner, in the Energy and Utilities Group since 1983. Russ has extensive experience with contract compliance audits under jointly owned electric generation contracts, overhead cost allocation studies, enterprise risk management implementation projects, benchmarking studies, work order asset management implementation projects, management audits, financial and compliance audits of electric utilities, and specialized risk management and operational and financial training for utilities. He has spoken nationally on a variety of utility topics for organizations such as APPA, the Society of Corporate Compliance and Ethics and NERC Regional Audit Organizations.

Contact [email protected] or call 608 240 2361

– Check out our Energy and Utilities Finance, Accounting and Consulting Issues Forum on LinkedIn at:

http://www.linkedin.com/groups?mostPopular=&gid=2546046

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About Baker Tilly

Company OverviewFirm established in 1931—an 80 year history of focusing on client needs and providing outstanding service

16th largest Public Accounting and Consulting Firm in USA (Public Accounting Report’s ―Top 100 2008‖)

Over 170 partners and more than 1,300 professionals = Depth of Resources

Seamless global services through Baker Tilly International (BTI)

Industry Awards for Outstanding Service and Employee Satisfaction

Nationwide energy practiceNationwide energy practice with more than 100 electric utility clients across North America – our Energy and Utilities Group is focused just on utilities

Proud supporter of Industry Associations

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> Introduction

>GASB 62 Codification of Accounting and Financial Reporting

Guidance Contained in Pre-November 30, 1989 FASB and

AICPA Pronouncements

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Agenda

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•GASB No. 62 outlines the concept of regulatory accounting for entities or operations that are rate regulated

•Under GASB 62 a utility matches the regulated rate recover of deferred costs if two key criteria are met (a) future recovery is probable and (b) it is clear that future recovery is based on prior costs and not similar future costs.

GASB 62 – Regulated Operations

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• GASB 62 (Regulated Operations) is the accounting tool used by public utilities where strictly following GASB does not necessarily meet their business model and the intent of certain accounting transactions that will benefit future periods or be charged against future periods.

• All utilities are regulated through approval authority over rates by their governance bodies (Boards, Commissions) or State Regulators

• This standard deals with the matching concept of the intent of rate recovery to expenses incurred or revenues collected

GASB 62 – Regulated Operations

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• The rules to create a regulatory asset

• It is probable that future revenue in an amount at least equal to the capitalized cost will result from inclusion of that cost in allowable costs for rate-making purposes.

• It is reasonable to assume that rates set at levels that will recover the regulated business-type activity's costs can be charged to and collected from customers.

GASB 62 – Regulated Assets

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• Matching

• Manage earnings and bond coverage

• Smooth rate recovery

• Fund now for future expenditures

• Stash earnings for future cost increases and customer rate mitigation

GASB 62 – Regulated Operations - Why do I want to do this?

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The rules to create a regulatory liability

• A regulator can require that a gain or other reduction of net allowable costs be given to customers over future periods. That would be accomplished, for rate-making purposes, by amortizing the gain or other reduction of net allowable costs over those future periods and reducing rates to reduce revenues in approximately the amount of the amortization.

• If a gain or other reduction of net allowable costs is to be amortized over future periods for rate-making purposes, the regulated business-type activity should not recognize that gain or other reduction of net allowable costs in the current period. Instead, it should be deferred for future reductions of charges to customers that are expected to result.”

GASB 62 – Regulated Liabilities

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A regulator can cause immediate “impairment” of the asset

> In future rate adjustments, if the cost recovery is not allowed, it is considered impaired and should immediately be adjusted through earnings

GASB 62 – Impairments

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Deferral of cost should identify a time-certain recovery period

> Indefinite or unknown recovery periods tend to not meet the definitions of regulatory accounting

> What’s the exit strategy for your regulated items?

GASB 62 – Timing is Everything

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Booking a transaction under GASB 62 without board approval does not meet the GASB 62 standard requirements

GASB 62 – Timing is Everything

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GASB 62 – Regulated Assets

Transaction ClassificationExtraordinary maintenance Regulatory assetLoss on asset retirement Regulatory assetFuture recoverable costs Regulatory assetDeferred power costs Regulatory assetUnrealized derivative losses Regulatory assetAdvance refunding losses Deferred outflowPollution remediation Regulatory assetDecommissioning expenses Regulatory assetStorm costs Regulatory assetOther post employment benefits Regulatory assetDebt issuance costs Regulatory asset

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GASB 62 – Regulated Liabilities

Transaction ClassificationRate stabilization Deferred inflowContributions in aid of construction Deferred inflowUnrealized derivative gains Regulatory liabilityRefunds Regulatory liability

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Regulatory accounting - IOUs

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Regulatory accounting - IOUs

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Regulatory accounting – Public Power

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Regulatory accounting – Public Power

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Regulatory accounting – Public Power

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•Difference between bond principal and depreciation on assets

•Proper matching

•Smoothes earnings

•This is GASB 62 Regulated Operations accounting treatment

Regulatory accounting –Future Recoverable Costs

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Regulatory accounting –Future Recoverable Costs

Year Depreciation Bond Principal Difference Cumulative1 1,000,000 671,600 (328,400) (328,400) 2 1,000,000 698,464 (301,536) (629,936) 3 1,000,000 726,403 (273,597) (903,533) 4 1,000,000 755,459 (244,541) (1,148,075) 5 1,000,000 785,677 (214,323) (1,362,398) 6 1,000,000 817,104 (182,896) (1,545,294) 7 1,000,000 849,788 (150,212) (1,695,505) 8 1,000,000 883,780 (116,220) (1,811,726) 9 1,000,000 919,131 (80,869) (1,892,595)

10 1,000,000 955,896 (44,104) (1,936,698) 11 1,000,000 994,132 (5,868) (1,942,566) 12 1,000,000 1,033,897 33,897 (1,908,669) 13 1,000,000 1,075,253 75,253 (1,833,416) 14 1,000,000 1,118,263 118,263 (1,715,152) 15 1,000,000 1,162,994 162,994 (1,552,159) 16 1,000,000 1,209,514 209,514 (1,342,645) 17 1,000,000 1,257,894 257,894 (1,084,751) 18 1,000,000 1,308,210 308,210 (776,541) 19 1,000,000 1,360,538 360,538 (416,002) 20 1,000,000 1,416,002 416,002 (0)

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Regulatory accounting –Future Recoverable Costs

-2,500,000

-2,000,000

-1,500,000

-1,000,000

-500,000

0

500,000

1,000,000

1,500,000

2,000,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Depreciation Bond Principal Cumulative

Future Recoverable Costs

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Regulatory accounting –Future Recoverable Costs

(0.50)

-

0.50

1.00

1.50

2.00

2.50

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Coverage w/o FRC Coverage w FRC Difference

Bond Coverage

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• GASB 33 treatment (non-exchange) of CIAC is a fit for general fund accounting – not utilities

• Required accounting is a violation of the matching principal

• Earnings are skewed

• What about replacement?

• GASB 62 Regulated Operations accounting fixes this

GASB 62 – Contributions in Aid of Construction

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• Utility receives contributed plant of $3 million of infrastructure

• What does GASB 33 require?

GASB 62 – Contributions in Aid of Construction - Example Problem

Debit Credit

Plant in Service 3,000,000$ Revenues 3,000,000$ Depreciation Expense (Annual) 100,000$ Accumulated Depreciation 100,000$

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• What does GASB 62 allow?

GASB 62 – Contributions in Aid of Construction - Example Problem

Debit Credit

Plant in Service $ 3,000,000

Deferred Inflow of Resources - CIAC Revenues $ 3,000,000

Deferred Inflow of Resources - CIAC Revenues $ 100,000

Depreciation Expense $ 100,000

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GASB 62 – Contributions in Aid of Construction - Example Problem

Statement of Revenues, Expenses and Changes in Net PositionRegulatory Accounting and Contributions - Impact on Earnings

Using GASB 33 Treatment

Description Year 1 Year 2 Year 3 Year 4 Year 5

Operating revenues 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$

Operating expenses:

Operation and maintenance expenses 35,000,000 35,000,000 35,000,000 35,000,000 35,000,000 Depreciation 100,000 100,000 100,000 100,000 100,000 CIAC amortization - - - - -

Total Operating Expenses 35,100,000 35,100,000 35,100,000 35,100,000 35,100,000

Operating Income 14,900,000$ 14,900,000$ 14,900,000$ 14,900,000$ 14,900,000$

Non-Operating Revenues/(Expenses)

All items (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000)

Income before Contributions 13,900,000$ 13,900,000$ 13,900,000$ 13,900,000$ 13,900,000$

Contributions in Aid of Construction 3,000,000 - - - -

Change in Net Position 16,900,000 13,900,000 13,900,000 13,900,000 13,900,000

Net Position Beginning of Year 0 16,900,000 30,800,000 44,700,000 58,600,000

Net Position End of Year 16,900,000$ 30,800,000$ 44,700,000$ 58,600,000$ 72,500,000$

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GASB 62 – Contributions in Aid of Construction - Example Problem

Statement of Revenues, Expenses and Changes in Net PositionRegulatory Accounting and Contributions - Impact on Earnings

Using GASB 62 Treatment

Description Year 1 Year 2 Year 3 Year 4 Year 5

Operating revenues 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$

Operating expenses:

Operation and maintenance expenses 35,000,000 35,000,000 35,000,000 35,000,000 35,000,000 Depreciation 100,000 100,000 100,000 100,000 100,000 CIAC amortization (100,000) (100,000) (100,000) (100,000) (100,000)

Total Operating Expenses 35,000,000 35,000,000 35,000,000 35,000,000 35,000,000

Operating Income 15,000,000$ 15,000,000$ 15,000,000$ 15,000,000$ 15,000,000$

Non-Operating Revenues/(Expenses)

All items (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000)

Income before Contributions 14,000,000$ 14,000,000$ 14,000,000$ 14,000,000$ 14,000,000$

Contributions in Aid of Construction - - - - -

Change in Net Position 14,000,000 14,000,000 14,000,000 14,000,000 14,000,000

Net Position Beginning of Year 0 14,000,000 28,000,000 42,000,000 56,000,000

Net Position End of Year 14,000,000$ 28,000,000$ 42,000,000$ 56,000,000$ 70,000,000$

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Regulatory accounting – Unrealized Gains/Losses on Ineffective Derivatives

• Effective derivative contracts are deferred inflows or outflows

• Ineffective derivative contracts lose their eligibility to live on the Statement of Net Position and are banished to the income statement

• Regulatory accounting allows ineffective contracts to stay on the SONP as Regulatory Assets or Regulatory Credits

• Here’s a comparison

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Regulatory accounting – Unrealized Gains/Losses on Ineffective Derivatives

NON-OPERATING REVENUES (EXPENSES) Investment income 6,370 5,358 Interest expense (37,747) (32,388) Capitalized interest 3,102 1,207 Amortization of debt discount and issuance costs (808) (725) Amortization of premium 892 905 Amortization of loss on refunding (1,909) (2,043) Gains/(losses) on ineffective hedges (3,154) 3,166 Total Non-Operating Expenses (33,254) (24,520)

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• Plant decommissioning in 30 years

• Collecting $100,000/year now in rates

• What does GAAP require?

GASB 62 – Decommissioning -Example Problem

Debit Credit

Cash 100,000$ Revenues 100,000$

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• What does GASB 62 allow?

GASB 62 – Decommissioning -Example Problem

Debit Credit

Cash 100,000$ Deferred Inflow of Resources - Decommissioning Expense 100,000$

What is the exit strategy?

Decommissioning Expense 3,000,000$ Cash/Accounts Payable 3,000,000$

Deferred Inflow of Resources - Decommissioning Expense 3,000,000$ Revenues 3,000,000$

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Effective for periods beginning after December 15, 2012.

Defines deferred outflows of resources and deferred inflows of resources as established by GASB 63.

• Deferred outflows of resources exist when the utility uses resources in the current period for the benefit of a future reporting period. They have a positive effect on net position – similar to assets.

• Deferred inflows of resources are the result of transactions in the current period that will be earned in a future period and have a negative effect on net position – similar to liabilities.

GASB 65 - Items Previously Reported as Assets and Liabilities

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Some Key items to be reported as deferred inflows or outflows:

• Unamortized loss on advanced refunding

• Regulated Operation Credits (FAS 71/ASC 980/GASB 62) with the exception of refunds imposed by a regulator

• Contributions (voluntary non-exchange transactions) when resources have been received before timing requirements have been met, but all eligibility requirements have been met

• Change in fair value of effective derivatives (GASB 53)

GASB 65 - Items Previously Reported as Assets and Liabilities

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Other Changes:

• Debt issuance costs, except those related to prepaid insurance costs, should be expensed when incurred

• The use of the term deferred should be limited to items reported as deferred outflows of resources or deferred inflows of resources

Accounting changes related to GASB 65 should be applied retroactively.

GASB 65 - Items Previously Reported as Assets and Liabilities

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•Under GASB 62 a utility matches the regulated rate recover of deferred costs if two key criteria are met (a) future recovery is probable and (b) it is clear that future recovery is based on prior costs and not similar future costs.

•The question then is "Are the debt issuance costs recovered through rates?"

GASB 65 – Impact on rates

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•If rates are designed on the cash basis and amount borrowed for debt issuance costs is included in the revenue requirement on a systematic basis over the life of the debt similar to interest expense then the answer is yes.

GASB 65 – Are debt issuance costs recovered through rates?

Revenue Requirement Component AmountOperation and maintenance expenses $10,000,000Routine capital improvements 1,000,000Debt service (A) 2,000,000

Total Revenue Requirement $13,000,000

(A) Debt service principal payments include debt issuance costs

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•If the utility designs rates on the utility basis and the return on rate-base is designed to recover the cost of financing including debt service and borrowed issuance costs then the answer is also yes.

GASB 65 – Are debt issuance costs recovered through rates?

Revenue Requirement Component AmountOperation and maintenance expenses $10,000,000Depreciation 1,000,000Return on ratebase (A) 2,000,000

Total Revenue Requirement $13,000,000

(A) Designed to recover full costs of debt service including issuance costs

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•If the utility has specifically excluded the recovery of debt issuance costs from its revenue requirement then the answer is no.

GASB 65 – Are debt issuance costs recovered through rates?

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•If the utility’s rate methodology provides recovery for debt issuance costs the utility can choose to follow GASB No. 62 and record the costs as a regulatory asset and amortize them over the life of the related debt – assuming that is the recovery period.

•As with any application of regulatory accounting this should be approved by the governing body along with the recovery period and if material the policy should be disclosed in the notes to the financial statements.

GASB 65 – Recording Debt Issuance Costs

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•If the utility’s revenue requirement does not provide for recovery of the debt issuance costs future costs should be reported as a non-operating expense in the year incurred.

•The financial statements should be restated to eliminate the deferral of any prior issuance costs from the statement of net assets and recognize them as an expense either in the year incurred if that year is presented or as an adjustment to the net position for the first year presented.

•If a restatement is required the details of this should be disclosed in the footnotes.

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GASB 65 – Recording Debt Issuance Costs

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Sample application:

•Debt issue - $50,000,000

•Debt issuance costs - $500,000

•Cash received - $49,500,000

Are debt issuance costs included in utility rates charged to customers?

- No

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GASB 65 – Recording Debt Issuance Costs

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Journal entries – Debt issuance costs are recovered through utility rates

Account Debt CreditCash $49,500,000

Regulatory assets $500,000

20xx bond issue $50,000,000

1. Record bond issue and bond issuance costs

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GASB 65 – Recording Debt Issuance Costs

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Journal entries – Debt issuance costs are recovered through utility rates

Account Debt Credit

Non-operating expenses – Amortization of regulatory assets

$25,000

Regulatory assets $25,000

2. Record amortization of regulatory deferred outflow for bond issuance costs recovered in utility rates over 20 years

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GASB 65 – Recording Debt Issuance Costs

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119. The Board believes that Statement 62 indicates there is a relationship between the distinction of current and noncurrent elements and the order of liquidity. Deferred outflows of resources and deferred inflows of resources are defined as the consumption or acquisition of net assets, respectively, that relate to a future period.

The Board believes as the consumption of net assets or acquisition of net assets has occurred and there is no further relationship to cash, a distinction between current and noncurrent is not applicable.

GASB 65 – Financial Statement Presentation

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•Revenue requirement is prepared using one of two methods:

Impact on Rates

Method ComponentsUtility method O&M + Depreciation + Return on

Ratebase

Cash basis O&M + Debt Service + Routine Capital

•In theory both methods get you to the same place

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GASB 62 – Potential Rate Impacts

Statement of Revenues, Expenses and Changes in Net PositionRegulatory Accounting - Overall Impact

Description Year 1 Year 2 Year 3 Year 4 Year 5

Operating revenues 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$ 50,000,000$ Rate stabilization 1,000,000 1,000,000 - (1,000,000) 1,000,000 Decommissioning revenues (100,000) (100,000) (100,000) (100,000) (100,000)

Tota Operating Revenues 50,900,000$ 50,900,000$ 49,900,000$ 48,900,000$ 50,900,000$

Operating expenses:

Operation and maintenance expenses 35,000,000 35,000,000 34,000,000 33,000,000 35,000,000 Depreciation 100,000 100,000 100,000 100,000 100,000 CIAC amortization (100,000) (100,000) (100,000) (100,000) (100,000)

Total Operating Expenses 35,000,000 35,000,000 34,000,000 33,000,000 35,000,000

Operating Income 15,900,000$ 15,900,000$ 15,900,000$ 15,900,000$ 15,900,000$

Non-Operating Revenues/(Expenses)

Investment income 500,000 500,000 500,000 500,000 500,000 Interest expense (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) Unrealized gains/losses on ineffective derivatives 400,000 (1,000,000) 300,000 200,000 (250,000) Regulatory treatment of unrealized gains/losseson ineffective derivatives (400,000) 1,000,000 (300,000) (200,000) 250,000

Total Non-Operating (500,000) (500,000) (500,000) (500,000) (500,000)

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GASB 62 – Potential Rate Impacts

Statement of Revenues, Expenses and Changes in Net PositionRegulatory Accounting - Overall Impact

Description Year 1 Year 2 Year 3 Year 4 Year 5Income before Contributions 15,400,000$ 15,400,000$ 15,400,000$ 15,400,000$ 15,400,000$

Contributions in Aid of Construction - - - - -

Change in Net Position 15,400,000 15,400,000 15,400,000 15,400,000 15,400,000

Net Position Beginning of Year 0 15,400,000 30,800,000 46,200,000 61,600,000

Net Position End of Year 15,400,000$ 30,800,000$ 46,200,000$ 61,600,000$ 77,000,000$

Regulatory accounting items 400,000$ 1,800,000$ (500,000)$ (1,400,000)$ 1,050,000$

Rate impact of regulatory accounting (based on unadjusted customer revenues) 0.80% 3.60% -1.00% -2.80% 2.10%

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• Utilities that previously followed FAS 71/ASC 980 now follow GASB 62 – Regulated Operations

• Utilities are not required to follow Regulated Operations in GASB 62 – Transactions must be governing body approved

• Following regulated accounting helps to more accurately reflect the intent of the accounting treatment of revenues and expenses in customer rates

• This helps to mitigate and smooth rate impacts to customers

• Following regulated accounting rules makes a public power utility more comparable to its peer investor owned counterpart

GASB 62 – Regulated Operations Summary

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Discussion and Comments

Thank you!

Contact [email protected] (608 240 2361) for more information

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