Regional Workshop on Uniform System of Accounts and Regulatory Reporting

Regional Workshop on Uniform System of Accounts and Regulatory Reporting Thomas Welch Pierce Atwood LLP 19-20 May, 2008 Bucharest, Romania

Comparison of Charts of Accounts and Reporting Forms • Where can comparable information be found?

Charts of Accounts: RAB (Disco) • USOA (FERC): • Net Plant: Accounts 101-115 • Albania • Account 20 • Republic of Srpska • Account 02 • Georgia • Accounts 2115-2125

Charts of Accounts: RAB (cont.) • Macedonia • Accounts 20-29 • Other?

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?)

Charts of Accounts: Metering Equipment • USOA (FERC) • Account 370 • Other?

Additional Areas for Comparison? • Each participant select one area and locate the information in each of the charts of accounts • Present results

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

Treatment of Substantive Issues • Following slides assembled from responses to questionnaire

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

Assets valuation (Romania) The valuation at the time of privatization: • Book value - year 2003; • Maximum value : 200%; • No assets excluded.

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 principleassets 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.

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.

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

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

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

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

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

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

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.

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.

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.

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

Treatment of O&M costs • 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.

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.

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.

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”

Cost 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);

Cost 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

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.

Cost 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.

Cost Allocation Costsallocation 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

Cost 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);

Cost 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.

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.

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.

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.

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.

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.

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.

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

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.

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

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);

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.

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.

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.

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.

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.

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

Regional Workshop on Uniform System of Accounts and Regulatory Reporting