A. Financing By Electric Utility Companies Through Use Of Construction Intermediaries
Facts: Some electric utility companies finance construction of a generating plant or their share of a jointly owned plant through the use of a “construction intermediary” which may be organized as a trust or a corporation. Typically the utility assigns its interest in property and other contract rights to the construction intermediary with the latter authorized to obtain funds to finance construction with term loans, bank loans, commercial paper and other sources of funds and that may be available. The intermediary’s borrowings are guaranteed in part of the work in progress but more significantly, although indirectly, by the obligation of the utility to purchase the project upon completion and assume or otherwise settle the borrowings. The utility may be committed to provide any deficiency of funds which the intermediary cannot obtain and excess funds may be loaned to the utility by the intermediary. (In one case involving construction of an entire generating plant, the intermediary appointed the utility as its agent to complete construction.) On the occurrence of an event such as commencement of the testing period for the plant or placing the plant in commercial service (but not later than a specified date) the interest in the plant reverts to the utility and concurrently the utility must either assume the obligations issued by the intermediary or purchase them from the holders. The intermediary also may be authorized to borrow amounts for accrued interest when due and those amounts are added to the balance of the outstanding indebtedness. Interest is thus capitalized during the construction period at rates being charged by the lenders; however, it is deductible by the utility for tax purposes in the year of accrual.
Question: How should construction work in progress and related liabilities and interest expense being financed through a construction intermediary be reflected in an electric utility’s financial statements?
Interpretive Response: The balance sheet of an electric utility company using a construction intermediary to finance construction should include the intermediary’s work in progress in the appropriate caption under utility plant. The related debt should be included in long-term liabilities and disclosed either on the balance sheet or in a note.
The amount of interest cost incurred and the respective amounts expensed or capitalized shall be disclosed for each period for which an income statement is presented. Consequently, capitalized interest included as part of an intermediary’s construction work in progress on the balance sheet should be recognized on the current income statement as interest expense with a corresponding offset to allowance for borrowed funds used during construction. Income statements for prior periods should also be restated. The amounts may be shown separately on the statement or included with interest expense and allowance for borrowed funds used during construction.
A note to the financial statements should describe briefly the organization and purpose of the intermediary and the nature of its authorization to incur debt to finance construction. The note should disclose the rate at which interest on this debt has been capitalized and the dollar amount for each period for which an income statement is presented.
B. Removed by SAB 103
C. Jointly Owned Electric Utility Plants
Facts: Groups of electric utility companies have been building and operating utility plants under joint ownership agreements or arrangements which do not create legal entities for which separate financial statements are presented.1 Under these arrangements, a participating utility has an undivided interest in a utility plant and is responsible for its proportionate share of the costs of construction and operation and its entitled to its proportionate share of the energy produced.
During the construction period a participating utility finances its own share of a utility plant using its own financial resources and not the combined resources of the group. Allowance for funds used during construction is provided in the same manner and at the same rates as for plants constructed to be used entirely by the participant utility.
When a joint-owned plant becomes operational, one of the participant utilities acts as operator and bills the other participants for their proportionate share of the direct expenses incurred. Each individual participant incurs other expenses related to transmission, distribution, supervision and control which cannot be related to the energy generated or received from any particular source. Many companies maintain depreciation records on a composite basis for each class of property so that neither the accumulated allowance for depreciation nor the periodic expense can be allocated to specific generating units whether jointly or wholly owned.
Question: What disclosure should be made on the financial statements or in the notes concerning interests in jointly owned utility plants?
Interpretive Response: A participating utility should include information concerning the extent of its interests in jointly owned plants in a note to its financial statements. The note should include a table showing separately for each interest in a jointly owned plant the amount of utility plant in service, the accumulated provision for depreciation (if available), the amount of plant under construction, and the proportionate share. The amounts presented for plant in service or plant under construction may be further subdivided to show amounts applicable to plant subcategories such as production, transmission, and distribution. The note should include statements that the dollar amounts represent the participating utility’s share in each joint plant and that each participant must provide its own financing. Information concerning two or more generating plants on the same site may be combined if appropriate.
The note should state that the participating utility’s share of direct expenses of the joint plants is included in the corresponding operating expenses on its income statement (e.g., fuel, maintenance of plant, other operating expense). If the share of direct expenses is charged to purchased power then the note should disclose the amount so charged and the proportionate amounts charged to specific operating expenses on the records maintained for the joint plants.
D. Long-Term Contracts For Purchase Of Electric Power
Facts: Under long-term contracts with public utility districts, cooperatives or other organizations, a utility company receives a portion of the output of a production plant constructed and financed by the district or cooperative. The utility has only a nominal or no investment at all in the plant but pays a proportionate part of the plant’s costs, including debt service. The contract may be in the form of a sale of a generating plant and its immediate lease back. The utility is obligated to pay certain minimum amounts which cover debt service requirements whether or not the plant is operating. At the option of other parties to the contract and in accordance with a predetermined schedule, the utility’s proportionate share of the output may be reduced. Separate agreements may exist for the transmission of power to the utility’s system.2
Question: How should the cost of power obtained under long-term purchase contracts be reflected on the financial statements and what supplemental disclosures should be made in notes to the statements?
Interpretive Response: The cost of power obtained under long-term purchase contracts, including payments required to be made when a production plant is not operating, should be included in the operating expenses section of the income statement. A note to the financial statements should present information concerning the terms and significance of such contracts to the utility company including date of contract expiration, share of plant output being purchased, estimated annual cost, annual minimum debt service payment required and amount of related long-term debt or lease obligations outstanding.
Additional disclosure should be given if the contract provides, or is expected to provide, in excess of five percent of current or estimated future system capability. This additional disclosure may be in the form of separate financial statements of the vendor entity or inclusion of the amount of the obligation under the contract as a liability on the balance sheet with a corresponding amount as an asset representing the right to purchase power under the contract.
The note to the financial statements should disclose the allocable portion of interest included in charges under such contracts.
E. Classification Of Charges For Abandonments And Disallowances
Facts: A public utility company abandons the construction of a plant and, under the provisions of FASB ASC Subtopic 980-360, Regulated Operations — Property, Plant, and Equipment, must charge a portion of the costs of the abandoned plant to expense.3 Also, the utility determines that it is probable that certain costs of a recently completed plant will be disallowed, and charges those costs to expense as required by FASB ASC Subtopic 980-360.
Question: May such charges for abandonments and disallowances be reported as extraordinary items in the statement of income?
Interpretive Response: No. The staff does not believe that such charges meet the requirements of FASB ASC Subtopic 225-20, Income Statement — Extraordinary and Unusual Items, that an item be both unusual and infrequent to be classified as an extraordinary item. Accordingly, the public utility was advised by the staff that such charges should be reported as a component of income from continuing operations, separately presented, if material.4
FASB ASC paragraph 225-20-45-2 indicates that to be unusual, an item must “possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.” Similarly, that paragraph indicates that, to be infrequent, an event should “not reasonably be expected to recur in the foreseeable future.”
Electric utilities operate under a franchise that requires them to furnish adequate supplies of electricity for their service area. That undertaking requires utilities to continually forecast the future demand for electricity, and the costs to be incurred in constructing the plants necessary to meet that demand. Abandonments and disallowances result from the failure of demand to reach projected levels and/or plant construction costs that exceed anticipated amounts. Neither event qualifies as being both unusual and infrequent in the environment in which electric utilities operate.
Accordingly, the staff believes that charges for abandonments and disallowances under FASB ASC Subtopic 980-360 should not be presented as extraordinary items.5
F. Presentation Of Liabilities For Environmental Costs
Facts: A public utility company determines that it is obligated to pay material amounts as a result of an environmental liability. These amounts may relate to, for example, damages attributed to clean-up of hazardous wastes, reclamation costs, fines, and litigation costs.
Question 1: May a rate-regulated enterprise present on its balance sheet the amount of its estimated liability for environmental costs net of probable future revenue resulting from the inclusion of such costs in allowable costs for rate-making purposes?
Interpretive Response: No. FASB ASC Subtopic 980-340, Regulated Operations — Other Assets and Deferred Costs, specifies the conditions under which rate actions of a regulator can provide reasonable assurance of the existence of an asset. The staff believes that environmental costs meeting the criteria of FASB ASC paragraph 980-340-25-16 should be presented on the balance sheet as an asset and should not be offset against the liability. Contingent recoveries through rates that do not meet the criteria of FASB ASC paragraph 980-340-25-1 should not be recognized either as an asset or as a reduction of the probable liability.
Question 2: May a rate-regulated enterprise delay recognition of a probable and estimable liability for environmental costs which it has incurred at the date of the latest balance sheet until the regulator’s deliberations have proceeded to a point enabling management to determine whether this cost is likely to be included in allowable costs for rate-making purposes?
Interpretive Response: No. FASB ASC Subtopic 450-20, Contingencies — Loss Contingencies, states that an estimated loss from a loss contingency shall be accrued by a charge to income if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated.7 The staff believes that actions of a regulator can affect whether an incurred cost is capitalized or expensed pursuant to FASB ASC Subtopic 980-340, but the regulator’s actions cannot affect the timing of the recognition of the liability.
Registrants are reminded that the arrangement may contain a guarantee that is within the scope of FASB ASC Topic 460, Guarantees. Further, registrants should consider the guidance of FASB ASC Topic 810, Consolidation. Also, registrants would need to consider whether the arrangement contains a derivative that should be accounted for according to FASB ASC Topic 815, Derivatives and Hedging.
FASB ASC paragraphs 980-360-35-1 through 980-360-35-3 requires that costs of abandoned plants in excess of the present value of the future revenues expected to be provided to recover any allowable costs be charged to expense in the period that the abandonment becomes probable. Also, FASB ASC paragraph 980-360-35-12 requires that disallowed costs for recently completed plants be charged to expense when the disallowance becomes probable and can be reasonably estimated.
Additionally, the registrant was reminded that FASB ASC paragraph 225-20-45-16 provides that items which are not reported as extraordinary should not be reported on the income statement net of income taxes or in any manner that implies that they are similar to extraordinary items.
The staff also notes that FASB ASC paragraphs 980-360-35-1 through 980-360-35-3 and 980-360-35-12, in requiring that such costs be “recognized as a loss,” do not specify extraordinary item treatment. The staff believes that it generally has been the FASB’s practice to affirmatively require extraordinary item treatment when it believes that it is appropriate for charges or credits to income specifically required by a provision of a statement.
FASB ASC paragraph 980-340-25-16 requires a rate-regulated enterprise to capitalize all or part of an incurred cost that would otherwise be charged to expense if it is probable that future revenue will be provided to recover the previously incurred cost from inclusion of the costs in allowable costs for rate-making purposes.
Registrants also should apply the guidance of FASB ASC Subtopic 410-30, Asset Retirement and Environmental Obligations — Environmental Obligations, in determining the appropriate recognition of environmental remediation costs.
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