Saturday, September 5, 2015

Public Utility Depreciation by NARUC

I don’t usually read reference books, or textbooks, all the way through like I did with Public Utility Depreciation Practices. Because of my new job as a “depreciation engineer,” I undertook reading this guide from the National Association of Regulatory Utility Commissioners (NARUC).

The title describes the content of the book. It includes some historical and legal background, but the bulk of the book is aimed at the practicalities of determining depreciation expenses.

The main elements going into depreciation rate determination are depreciation base, service life, net salvage, and depreciation computation methods. Depreciation base is the starting point; it represents the initial investment of capital that is to be recovered as a cost through depreciation. Generally it is the book cost (original cost of the infrastructure including materials, equipment, labor and related costs).

Most methods of computing depreciation are referred to as age-life methods. These methods spread the cost of the expected life of a piece of infrastructure. The preferred method is straight line depreciation. To apply these methods, one will need to know or estimate the life of the infrastructure under consideration and the net salvage value. The depreciation rate is the difference between the base and the net salvage, divided by the life of the infrastructure. With the exception of unique pieces, like types of infrastructure are lumped together because they are expected to have a similar life (wooden poles, steel poles, copper wire, conduit, etc.).

Life expectancy can be estimated by several methods. Survivor curves are developed from statistical studies of the life of particular types of infrastructure, though other methods may be used depending on the type and quality of data available.

Net salvage is estimated based on experience. The gross salvage is the price received for the equipment or materials retired. The cost of removal is subtracted from this to calculate the net salvage. Sometimes it can cost more to remove infrastructure than the value of the retired equipment and materials, so net salvage can be negative.

Calculating depreciation is more art than science. Projections of future values are inherently tricky. Growth can cause infrastructure to become inadequate before it is expected, or slower than expected growth can extend the life infrastructure. New regulations can make infrastructure obsolete in an instant, as can new technologies. In addition, utilities are constantly adding and retiring infrastructure. Amidst this uncertainty, regulators must balance the level of service needed by utility customers with the returns needed by utility investors in a complex environment.

Admittedly, a book from 1968 may seem dated. However, many of the practices described are still in use. Government regulation of monopoly utility rates in the United States has been occurring for more than a century, and the practices to not change rapidly. Even so, some of the practices described were considered obsolete, or near obsolescence, at the time of publication, and are not likely to be encountered now unless you’re a financial historian combing through moldy account books.

National Association of Regulatory Utility Commissioners. Public Utility Depreciation Practices. 1968. Washington, DC: Author, 1974.