ROR – Part 2

Revenue Imputation

In some instances, regulators find that the regulated operations of the company are responsible for bringing the company revenues that are not shown on the company’s regulated accounting records. Examples include advertising revenue for directories and government subsidies. Regulators can use a tool called imputation to account for this revenue that is missing from the accounting records. Revenue imputation decreases the revenues that need to be collected from regulated services.

Valuing Rate Base

The objective is to determine the amount of capital that the company uses (or needs to use) to provide the regulated services. Rate base includes the plant in service (that is determined to be prudent) and working capital. In the case where there are no privately owned assets (e.g., like the Manilla Water concessions), the rate base is the value of the concession contract.

List of basic decisions should include the following

• Time period for which to measure the rate base (often called the test period)
• Method for assessing the size of the rate base during that time period
• Method for assigning monetary values to plant in service
• Choosing the time period for which to measure the rate base

The assets used to provide service may be valued based on a historical period or a future period. This period is usually at least one year in length and is often referred to as a test year or a test period.

A test period should:

• represent the periods over which the prices will actually be charged
• be sufficiently long to represent normal operations; e.g., permit offsetting fluctuations such as seasonal changes
• Under PCR, it would generally be appropriate to choose a test year that is near the time of the price review. However, PCR systems often use all of the years since the last price review as the test period.
• Determining the amount of plant during the test period
• Once the test period is chosen, the amount of plant in service may be valued in one of three ways: (1) average monthly balances; (2) the end-of-period balance; or (3) average beginning-of-year and end-of-year balances.
• Average monthly balance simply estimates the arithmetic average of the plant in service at the end (or beginning) of each month.
• End-of-period balance uses the plant in service at the end of the year.
• Average beginning-of-year and end-of-year balances simply estimates the arithmetic average of the first month's and last month's plant in service.

Examples

Prudence Concept

In some jurisdictions, assets must be considered both prudent and used and useful before being allowed in the rate base. Prudent means that the investment is reasonable based on cost-minimizing criteria.

For example, a company might have decided to construct a building. After starting construction, the company discovers that it would be more economical to lease the building space from another company than to finish and operate the new building. If this company finishes the new building anyway, the costs that could have been avoided could fail a prudence test.

Used and Useful Concept

Used and useful means that the asset is actually being used to provide service and that it is contributing to the provision of the service. For example, if a company has excessive numbers of fixed lines to serve a specific neighborhood, the regulator might not include some of the investment in the rate base because, even though all of the lines are used, many are not needed so they are not really useful.

An asset that is prudently placed, but not used for its entire depreciation life, might not be used and useful. However, the costs might be recovered anyway because the unrecovered costs are considered stranded costs.