PREPARING FOR A DEPRECIATION STUDY

MAY 22, 2017

John J. Spanos & Ned W. Allis

INTRODUCTION

Depreciation Study

• Phase 1 – Planning• Phase 2 – Data Collection• Phase 3 – Analyses • Phase 4 – Evaluation and Forecasting• Phase 5 – Depreciation Calculations• Phase 6 – Report Preparation and Testimony

Phases of a Depreciation Study

PHASE 1Planning a Depreciation Study

Define Study Objectives

Review Accounting Records

Review Engineering & Operating

Records

Discuss Study with Management

Design Data Collection, Review, & Control Systems

Present Study Plan to Management with

Time and Cost Estimates

Phase 1. Planning

• Define Study Objectives– What are the study goals?– How will these goals be achieved?– How will the depreciation analyses be supported?

Outside Consultant Company Personnel

Phase 1 - Planning

• Depreciation Study Objectives– Some Considerations

Define the scope of the Project (e.g., is Study filed in connection with a rate case or not).

Available historical data (accounting / engineering) Condition of property accounting database Available staff resources Timing / length of the study Perform in-house or hire a outside consultant

Phase 1 - Planning

• Discuss study with other departments (regulatory, finance, legal, accounting, engineering)

• Discuss their needs and desired outcomes• Explain their roles and time commitments• Rate case budget

Phase 1 - Planning

• Design a Detailed Plan for Management• Plan should indicate each task, parties responsible for its

completion and timing• Gantt Chart is a helpful management tool for accomplishing such

as task.• Review the plan with Management• Phase 1 ends with the Approval of the Plan

Phase 1 - Planning

Sample Gantt Chart – Depreciation Study

PHASE 2Data Collection

Approval of Study

Plan

Make Data Requirements

List

Write Instructions for

Data Collection

Assemble Life and Salvage

Data

Review and Correct Data

Audit Life and Salvage Data

Phase 2 – Data Collection

• Create Data Requirements (DR) List• DR List includes the various data needed to perform a

depreciation study• DR List should specify estimated completion date and party

responsible for its assembly and the preferred data format and data layout (e.g., Excel)

• DR List generally includes:– Service Life Data (a.k.a., Plant Accounting Data) – Net Salvage Data (Cost of Removal and Gross Salvage)– Annual Plant and Reserve Statements– Current Rates in Effect

Phase 2 – Data Collection

• Data for Actuarial Analysis– Additions– Retirements– Transfers– Balances– Other Transactions?

Sales, Acquisitions, Adjustments• Transactions available by vintage

– a.k.a. “Aged” Data

Data Assembly

• Sources:– Plant Accounting / Fixed Asset System– Previous Depreciation Studies

• How much history?– As much as possible– Consider Life Cycle of Property Studied

Data Assembly

• Check for Errors– Credit Balances– Debit Retirements

• Look for Unusual Transactions– Large Retirements– Early/Young Retirements– Large Transfers

Data Review

• The historical service life data (a.k.a., plant accounting data) is critical to the service life analyses and ultimately to the results of the study.

• Errors or data inconsistencies can undermine the validity of your study results.

• Review the data frequently, at least annually.• Make corrections to the data as needed. Document correcting

entries.• Identify non-recurring retirement transactions from the analyses

as appropriate.

Data Review

• Ideally, data used in the study should be reconciled to Continuing Property Record which should reconcile to the General Ledger

• The sum of the plant activity should equal the plant balance• If it does not, be prepared to explain the difference• Identify data anomalies

Data Audit

• Engineering– Digital Maps of U/G assets (pipelines, mains)– Digital Maps of O/H assets (lines, cable, transformers)– Pole database – Size, type, year installed– Hydrants– Track charts, bridge database, locomotive and freight car fleet– Customer Information System (CIS)– Meter information – Size, type, year installed– Service lines – Size, type, year installed

Sources of Info Other Than Property Accounting

• Make arrangements to interview Accounting, Engineering & Operations personnel and other technical subject matter experts (SMEs)

• Prepare interview questions• Make a list of the major facilities to tour• Arrange field trip of facilities• Interview Engineering & Op Management staff to discuss plans,

outlook and retirement programs (e.g., cast iron mains, non-AMI meters)

Field Trip and Management Meetings

• Why is it important to perform?– Information from operations personnel help make a better forecast– Provides helpful information and perspective in interpreting the

historical SL and NS data– Provides information about the future with respect to company

plans and how those plans may affect existing assets– Provides insight in company accounting practices and how they

have shaped the historical data.

Management Meeting Interviews

• Review current and past accounting practices– Capitalization policies– Retirement unit definition– Work crew labor allocation – Install/Remove– Retirement pricing models

• Assess their impact on life and net salvage

Accounting Practices and Policies

PHASE 3Analysis -

Life and Net Salvage

• Analyses of Historical Data– Life Analysis

Average Service Life and Dispersion Curve (a.k.a., Survivor Curve)– Net Salvage Analysis

Gross Salvage Cost of Removal or Cost of Retiring

Phase 3 - Analysis

Data Review

Preliminary Life & NS Analysis

Management Meeting, Site

Visits

Final Life Analysis

Life and Net Salvage (NS) Analysis

• Aged Data– Vintage year of activity is known– Actuarial analysis is used

Develop original life tables Match Iowa curves to original life tables

• Unaged Data– Vintage year of activity is unknown– Semi-Actuarial analysis

Simulated Plant Record (SPR) Determine Iowa curves that best match unaged activity

• Life Span Method– Property such as power plants where all assets retired concurrently

Life Analysis

Actuarial Life Analysis

0

10

20

30

40

50

60

70

80

90

100

0.0 5.0 10.0 15.0 20.0 25.0

Original CurveIowa 12-R2.5

• Traditional net salvage analysis where both gross salvage and cost of removal are expressed as a percent of retirements.– Gross Salvage % = Gross Salvage ($) / Retirements– Cost of Removal (COR) % = COR ($) / Retirements– Net Salvage = Gross Salvage less COR

• Long term and moving averages used to smooth historical data

• Use alternative analytical methods if needed– E.g., decommissioning study for terminal net salvage

Net Salvage Analysis

Net Salvage Analysis

Net Salvage %

3 Year Average

(65) Estimate

0%

20%

40%

60%

80%

100%

120%

1970 1975 1980 1985 1990 1995 2000 2005 2010

PHASE 4Evaluation

Life and Net Salvage Estimation

• Life Analysis vs. Life Estimation– Life Analysis relates to past mortality experience– Life Estimation pertains to the future

• What is the goal?• Analyst must use informed judgment to determine the best

estimate

Life Estimation

• Questions for Engineering and other SMEs– Account information and content– Causes of retirements– Changes in management plans– Changes in maintenance– Changes in technology– Unusual transactions– Goal – Are past forces of retirement similar to future forces of

retirement. Why / why not?

Management Meeting with Subject Matter Experts (SMEs)

• Do you need additional analyses?• Do you need to adjust data?• Does management meeting information lead to different

estimates?• Does the management meeting information influence your life or

net salvage estimates?

Final Life and Net Salvage Estimates

• Final Assessment – Put on your thinking cap– Synthesize the historical analyses with the information regarding

future conditions obtained through management meetings, field trips, forecasted data.

– Use professional judgment and make your best forecast based on available information

Phase 4 - Evaluation

Life Estimation

• Documentation– Field trip notes and photos– Interview notes (a.k.a., management meeting notes)– Data corrections and changes– Unique accounting practices or changes (e.g., change in retirement

units, retirement pricing method, etc.)– Documents related to life and net salvage analyses

Phase 4 - Evaluation

PHASE 5Depreciation Calculations

• Depreciation calculations result in the following for each account or depreciable group (in general):– Annual accrual rate– Annual accrual amount– Calculated accrued depreciation (a.k.a., theoretical reserve)– Composite remaining life

• Function of life and net salvage estimates, plant and reserve balances, and depreciation system

Phase 5 - Calculations

• Defining a Depreciation System– Methods of Allocation– Group Procedures– Bases for Allocation or Technique

– Management needs to decide which options to choose in order to define their depreciation system.

Phase 5 - Calculations

• Methods of Allocation– Straight Line (SL) Method of Depreciation– Accelerated Methods of Depreciation– Decelerated (or deferred) Methods of Depreciation

• Note: Most utilities use straight line method for book and ratemaking purposes

Defining a Depreciation System

• Depreciation Calculation “Procedure”• Average Service Life (ASL), a.k.a., Average Life Group (ALG)

– Broad Group– Vintage Group

• Equal Life Group (ELG), a.k.a., Unit Summation• Probable Life (not common in ratemaking, used for valuation

purposes primarily)

Defining a Depreciation System

Average Service Life Procedure

Equal Life Group Procedure

•

Defining a Depreciation System

PHASE 6Report Preparation and Testimony

• Elements of a Report– Executive Summary– Objective of Study and Report– Statement of Methods and Procedures– Analysis and Explanation– Supporting Schedules and Documentation– Results and Conclusions

Report Preparation

• Anatomy of the court procedure– Direct Case (each party)– Discovery process– Rebuttal testimony– Surrebuttal testimony– Hearings

Cross-examination Redirect examination

– Briefs

Preparation for Testimony

• Are you qualified?• Define “expert” witness

– Person with the requisite education, special or advanced training and appropriate work experience

– Opposition may try to attack your qualifications in order to disqualify your testimony

– Expert witness can offer his / her professional opinion.

Testifying as an Expert Witness

• Credibility of study– Who commissioned it? Who performed it?– How long did it take?– Was it a complete and thorough study?– Did you adhere to recognized industry techniques?– Does author / expert have a broad knowledge of subject matter

and of the industry?

Report Preparation and Testimony

• Management should review overall forecasts and estimates of depreciation study to assure conformance to corporate plans and goals.

• Consider the following management roles:– Capital Recovery Manager’s role– Legal’s Role– Revenue Requirement– Finance– Engineering & Operations– Marketing

Management Review

• Summary of Manager’s Role– Planning, overseeing, judging, approving– Presenting results

• Manager Defense of the Study– Attending technical vonferences with various stakeholders– Responding to questions and data requests– Testifying

Management Review

• Commentary - Management approves the risk of investing in their network usually with commission review and oversight; therefore, the risk of capital recovery exemplified in the depreciation rates is also management’s responsibility.

Management Review

Questions?

www.gfvrc.comwww.gannettfleming.com

Gannett Fleming Valuation and Rate Consultants, LLC

John J. Spanos Ned W. Allis

Sr. Vice President Supervisor, Depreciation Studies

P.O. Box 67100 • Harrisburg, PA 17106-7100 P.O. Box 67100 • Harrisburg, PA 17106-7100

207 Senate Avenue • Camp Hill, PA 17011-2316 207 Senate Avenue • Camp Hill, PA 17011-2316

(717) 763-7212, ext. 2246 (717) 763-7212, ext. 2295

jspanos@gfnet.com nallis@gfnet.com