16 Tex. Admin. Code § 24.41 - Cost of Service
(a) Components
of cost of service. Rates are based upon a utility's cost of rendering service.
The two components of cost of service are allowable expenses and return on rate
base.
(b) Allowable expenses. Only
those expenses that are reasonable and necessary to provide service to the
ratepayers may be included in allowable expenses. In computing a utility's
allowable expenses, only the utility's test year expenses as adjusted for known
and measurable changes will be considered. A change in rates must be based on a
test year as defined in §
24.3(37) of this
title, relating to Definitions of Terms. Payments to affiliated interests for
costs of service, or any property, right, or thing, or for interest expense are
not allowed as an expense for cost of service except as provided in Texas Water
Code (TWC) §13.185(e).
(1) Components of
allowable expenses. Allowable expenses, to the extent they are reasonable and
necessary, may include, but are not limited to, the following general
categories:
(A) Operations and maintenance
expense incurred in furnishing normal utility service and in maintaining
utility plant used by and useful to the utility in providing such service.
(B) Depreciation expense based on
original cost and computed on a straight-line basis over the useful life of the
asset as approved by the commission.
(i)
Depreciation expense is allowed on all currently used and useful depreciable
utility property owned by the utility and depreciable utility plant, property
and equipment retired by the utility, subject to the requirements of
subparagraph (c)(2)(C) of this section. Depreciation expense is not allowed for
property provided under explicit customer agreements or funded by customer
contributions in aid of construction. Depreciation expense is allowed for all
currently used and useful developer or governmental entity contributed
property. A utility must calculate depreciation on a straight-line basis over
the expected or remaining life of the asset, but is not required to use the
remaining life method if salvage value is zero. A utility that does not use
group depreciation and proposes to change the useful life of an asset with an
accumulated depreciation balance must not change the accumulated depreciation
balance and must adjust depreciation expense going forward based on the changed
useful life.
(ii) The depreciation
accrual for all assets must account for expected net salvage value in the
calculation of the depreciation rate and actual net salvage value related to
retired plant. The utility must submit sufficient evidence with the application
establishing that the estimated salvage value, including removal costs, is
reasonable. For a utility that uses group accounting, salvage value will be
applied to the asset group in depreciation studies. For a utility that uses
itemized accounting, salvage value will be applied to specific assets.
(C) Assessments and
taxes other than income taxes.
(D)
Federal income taxes on a normalized basis. Federal income taxes must be
computed according to the provisions of TWC §13.185(f), if applicable.
(E) Funds expended in support of
membership in professional or trade associations, provided such associations
contribute toward the professionalism of their membership.
(F) Advertising, contributions and donations.
The actual test year expenditures for advertising, contributions, and donations
may be allowed as a cost of service provided that the total sum of all such
items allowed in the cost of service must not exceed three-tenths of 1.0%
(0.3%) of the gross receipts of the utility for services rendered to the
public. The following expenses are the only expenses that may be included in
the calculation of the three-tenths of 1.0% (0.3%) maximum:
(i) funds expended advertising methods of
conserving water;
(ii) funds
expended advertising methods by which the consumer can achieve a savings in
total utility bills; and
(iii)
funds expended advertising water quality protection.
(G) Credit card and electronic payment
processing fees. Expenditures or fees charged by banks or companies for
accepting and processing credit card, debit card or other forms of electronic
payment from customers for water and sewer utility service may be allowed as a
cost of service.
(2)
Expenses not allowed. The following expenses are not allowed as a component of
cost of service:
(A) legislative advocacy
expenses, whether made directly or indirectly, including, but not limited to,
legislative advocacy expenses included in professional or trade association
dues;
(B) funds expended in
support of political candidates;
(C) funds expended in support of any
political movement;
(D) funds
expended in promotion of political or religious causes;
(E) funds expended in support of or
membership in social, recreational, fraternal, or religious clubs or
organizations;
(F) funds promoting
increased consumption of water;
(G) funds expended to mail any parcel or
letter containing any of the items mentioned in subparagraphs (A) - (F) of this
paragraph;
(H) interest expense of
processing a refund or credit of sums collected in excess of the rate ordered
by the commission;
(I) any
expenditure found by the commission to be unreasonable, unnecessary, or not in
the public interest, including, but not limited to, executive salaries,
advertising expenses, rate case expenses, legal expenses, penalties and
interest on overdue taxes, criminal penalties or fines, and civil penalties or
fines; and
(J) the costs of
purchasing groundwater from any source if:
(i) the source of the groundwater is located
in a priority groundwater management area; and
(ii) a wholesale supply of surface water is
available.
(c) Return on rate base. The return on rate
base is the rate of return times rate base.
(1) Rate of return. The commission will allow
each utility a reasonable opportunity to earn a reasonable rate of return,
which is expressed as a percentage of invested capital, and will fix the rate
of return in accordance with the following principles.
(A) The return should be reasonably
sufficient to assure confidence in the financial soundness of the utility and
should be adequate, under efficient and economical management, to maintain and
support its credit and enable it to raise the money necessary for the proper
discharge of its public duties.
(B) The commission will consider the
utility's cost of capital, which is the composite of the cost of the various
classes of capital used by the utility.
(i)
Debt capital. The cost of debt capital is the actual cost of debt, plus
adjustments for premiums, discounts, and refunding and issuance costs.
(ii) Equity capital. For companies
with ownership expressed in terms of shares of stock, equity capital commonly
consists of the following classes of stock.
(I) Common stock capital. The cost of common
stock capital must be based upon a fair return on its value.
(II) Preferred stock capital. The cost of
preferred stock capital is its annual dividend requirement, if any, plus an
adjustment for premiums, discounts, and cost of issuance.
(C) The commission will consider
the efforts and achievements of the utility in the conservation of resources,
the quality of the utility's services, the efficiency of the utility's
operations, and the quality of the utility's management, along with other
relevant conditions and practices.
(D) The commission may consider inflation,
deflation, the growth rate of the service area, and the need for the utility to
attract new capital.
(2) Rate base. The rate of return is applied
to the rate base. Assets retired before June 19, 2009, must be removed from
rate base before the rate of return is applied to the rate base. Components to
be included in determining the rate base are as follows:
(A) If a utility or its facilities were
valued using the process for establishing fair market value in Texas Water Code
(TWC) §13.305, the dollar value of the "ratemaking rate base," as defined
in TWC § 13.305(a)(2) and §
24.238(b)(4) of
this title, relating to Fair Market Valuation, less accumulated depreciation.
(i) The installation date of the ratemaking
rate base is the filing date of the commission's final order approving the
acquisition of the ratemaking rate base in an application filed under TWC
§13.301.
(ii) The ratemaking
rate base will include an accrual for Allowance for Funds Used During
Construction (AFUDC), as defined in §
24.238(b)(2) of
this title, relating to Fair Market Valuation, for any post-acquisition
improvements to the ratemaking rate base. The accrual will begin on the date
the improvement cost was incurred and end on the earlier of:
(I) the fourth anniversary of the date the
improvement was placed in service; or
(II) the filing date of the commission order
in which the ratemaking rate base is first approved by the commission as part
of the rate base set in a base rate proceeding.
(iii) For book and ratemaking purposes,
depreciation on any post-acquisition improvement to the ratemaking rate base
will be deferred and considered in the utility's next base rate proceeding.
(iv) Transaction and closing costs
associated with the acquisition will be reviewed in the acquiring utility's
first base rate proceeding after the transaction has been concluded.
(B) Original cost, less
accumulated depreciation, of utility plant, property, and equipment used by and
useful to the utility in providing service.
(C) Original cost, less net salvage and
accumulated depreciation at the date of retirement, of depreciable utility
plant, property and equipment retired by the utility.
(i) For original cost under this subparagraph
or subparagraph (B) of this paragraph, the commission may adjust rate base and
the rate of return on equity associated with the cost of plant and equipment
that has been estimated by trending studies or other methods not based on or
verified by historical records.
(ii) Original cost in this subparagraph or
subparagraph (B) of this paragraph is the actual money cost, or the actual
money value of any consideration paid other than money, of the property at the
time it was dedicated to public use, whether by the utility that is the current
owner or by a predecessor. Assets may be booked in itemized or group
accounting, but all accounting for assets and their retirements must be
supported by an approved accounting system.
(iii) On all assets retired from service, the
original cost of an asset must be the book cost less net salvage value. If a
utility calculates annual depreciation expense for an asset with allowance for
salvage value, then it must account for the actual salvage amounts when the
asset is actually retired. The utility must include the actual salvage
calculation in its net plant calculation in the first full rate change
application, excluding alternative rate method applications as described in
§
24.75 of this title, relating to
Alternative Rate Methods, it files after the date on which the asset was
removed from service, even if it was not retired during the test year. Recovery
of investment on assets retired from service before the estimated useful life
or remaining life of the asset must be combined with over-accrual of
depreciation expense for those assets retired after the estimated useful life
or remaining life and the net amount must be amortized over a reasonable period
of time taking into account prudent regulatory principles.
(iv) Accelerated depreciation is not allowed.
(v) For a utility that uses group
accounting, all mortality characteristics, both life and net salvage, must be
supported by an engineering or economic based depreciation study for which the
test year for the depreciation is no more than five years old in comparison to
the rate case test year. The engineering or economic based depreciation study
must include:
(I) investment by homogenous
category;
(II) expected level of
gross salvage by category;
(III)
expected cost of removal by category;
(IV) the accumulated provision for
depreciation as appropriately reflected on the company's books by category;
(V) the average service life by
category;
(VI) the remaining life
by category;
(VII) the Iowa
Dispersion Pattern by category; and
(VIII) a detailed narrative identifying the
specific factors, data, criteria and assumptions that were employed to arrive
at the specific mortality proposal for each homogenous group of property.
(vi) Reserve for
depreciation under this subparagraph or subparagraph (B) of this paragraph is
the accumulation of recognized allocations of original cost, representing
recovery of initial investment, over the estimated useful life or remaining
life of the asset. Depreciation must be computed on a straight-line basis over
the expected useful life or remaining life of the item or facility regardless
of whether the salvage value is zero or not zero.
(I) If individual accounting is used, the
following requirements apply to retirements:
(-a-)
Accumulated depreciation must be calculated based on book cost
less net salvage value of the asset.
(-b-) The utility must provide evidence
establishing the original cost of the asset, the cost of removal, salvage
value, any other amounts recovered; the useful life of the asset, or remaining
life as may be appropriate; the date the asset was taken out of service; and
the accumulated depreciation up to the date it was taken out of
service.
(-c-) The utility must
show that it used due diligence in recovering maximum salvage value of a
retired asset.
(-d-) The utility
must continue booking depreciation expense until the asset is actually retired,
and the reserve for depreciation must include any additional depreciation
expense accrued past the estimated useful or remaining life of the
asset.
(-e-) The retirement of a
plant asset from service is accounted for by crediting the book cost to the
utility plant account in which it is included. Accumulated depreciation must
also be debited with the original cost and the cost of removal and credited
with the salvage value and any other amounts recovered.
(-f-) Retired assets must be specifically
identified.
(-g-) The requirements
relating to the accounting for the reasonableness of retirement decisions for
individual assets and the net salvage value calculations for individual assets
apply only to a utility using itemized accounting.
(II) For a utility that uses group
accounting, the depreciation study must provide the information in subclause
(I) except that retirements may be accounted for by category. Retired assets
must be reported for the asset group in depreciation studies.
(III) TWC §13.185(e) applies to utility
business transactions with affiliated interests involved in the retirement,
removal, or recovery of assets.
(IV) For assets retired after June 19, 2009,
the retired assets must be included in the utility's first application for a
rate change after the date the asset was retired and must be specifically
identified if the utility uses itemized accounting.
(vii) the original cost of plant, property,
and equipment acquired from an affiliated interest may not be included in
invested capital except as provided in TWC §13.185(e);
(viii) utility property funded by written
customer agreements or customer contributions in aid of construction such as
surcharges must not be included in original cost or invested capital.
(D) Working capital
allowance to be composed of, but not limited to the following:
(i) reasonable inventories of materials and
supplies held specifically for purposes of permitting efficient operation of
the utility in providing normal utility service.
(ii) reasonable prepayments for operating
expenses. Prepayments to affiliated interests are subject to the standards set
forth in TWC §13.185(e); and
(iii) a reasonable allowance for cash working
capital. The following will apply in determining the amount to be included in
invested capital for cash working capital:
(I) Cash working capital for utilities must
not exceed one-eighth of total annual operations and maintenance expense,
excluding amounts charged to operations and maintenance expense for materials,
supplies, fuel, and prepayments.
(II) For Class C and Class D utilities,
one-eighth of operations and maintenance expense excluding amounts charged to
operations and maintenance expense for materials, supplies, expenses recovered
through a pass-through provision or through charges other than base rate and
gallonage charges, and prepayments will be considered a reasonable allowance
for cash working capital.
(III)
For Class B utilities, one-twelfth of operations and maintenance expense
excluding amounts charged to operations and maintenance expense for materials,
supplies, expenses recovered through a pass-through provision or charges other
than base rate and gallonage charges, and prepayments will be considered a
reasonable allowance for cash working capital.
(IV) For Class A utilities, a reasonable
allowance for cash working capital, including a request of zero, will be
determined by the use of a lead-lag study. A lead-lag study will be performed
in accordance with the following criteria:
(-a-) The lead-lag study will use the cash
method. All non-cash items, including but not limited to depreciation,
amortization, deferred taxes, prepaid items, and return, including interest on
long-term debt and dividends on preferred stock, will not be
considered.
(-b-) Any reasonable
sampling method that is shown to be unbiased may be used in performing the
lead-lag study.
(-c-) The check
clear date, or the invoice due date, whichever is later, will be used in
calculating the lead-lag days used in the study. In those cases where multiple
due dates and payment terms are offered by vendors, the invoice due date is the
date corresponding to the terms accepted by the utility.
(-d-) All funds received by the utility
except electronic transfers will be considered available for use no later than
the business day following the receipt of the funds in any repository of the
utility, e.g., lockbox, post office box, branch office. All funds received by
electronic transfer will be considered available the day of receipt.
(-e-) The balance of cash and working funds
included in the working cash allowance calculation will consist of the average
daily bank balance of all non-interest bearing demand deposits and working cash
funds.
(-f-) The lead on federal
income tax expense must be calculated by measurement of the interval between
the mid-point of the annual service period and the actual payment date of the
utility.
(-g-) If the cash working
capital calculation results in a negative amount, the negative amount must be
included in rate base.
(V) If cash working capital is required to be
determined by the use of a lead-lag study under subclause (IV) of this clause
and either the utility does not file a lead-lag study or the utility's lead-lag
study is determined to be unreliable, in the absence of persuasive evidence
that suggests a different amount of cash working capital, zero will be presumed
to be the reasonable level of cash working capital.
(VI) A lead lag study completed within five
years of the application for a rate or tariff change is adequate for
determining cash working capital unless sufficient persuasive evidence suggests
that the study is no longer valid.
(VII) Operations and maintenance expense does
not include depreciation, other taxes, or federal income taxes, for purposes of
subclauses (I), (II), (III) and (V) of this clause.
(3) Deduction of
certain items from rate base. In the consideration of applications filed under
TWC §13.187 or §13.1871, the commission will deduct certain items
from rate base, including but not limited to the following:
(A) accumulated reserve for deferred federal
income taxes;
(B) unamortized
investment tax credit to the extent allowed by the Internal Revenue Code;
(C) contingency and property
insurance reserves;
(D)
contributions in aid of construction; and
(E) other sources of cost-free capital, as
determined by the commission.
(4) Construction work in progress (CWIP). The
inclusion of CWIP is an exceptional form of relief. Under ordinary
circumstances, the rate base consists only of those items that are used and
useful in providing service to the public. Under exceptional circumstances, the
commission may include CWIP in rate base to the extent that the utility has
proven that:
(A) the inclusion is necessary
to the financial integrity of the utility; and
(B) major projects under construction have
been efficiently and prudently planned and managed.
(5) Requirements for post-test year
adjustments.
(A) A post-test year adjustment
to test year data for known and measurable rate base additions may be
considered only if:
(i) the addition
represents a plant which would appropriately be recorded for investor-owned
utilities in National Association of Regulatory Utility Commissioners (NARUC)
account 101 or 102;
(ii) the
addition comprises at least 10% of the utility's requested rate base, exclusive
of post-test year adjustments and CWIP;
(iii) the addition is in service before the
rate year begins; and
(iv) the
attendant impacts on all aspects of a utility's operations, including but not
limited to, revenue, expenses and invested capital, can with reasonable
certainty be identified, quantified and matched. Attendant impacts are those
that reasonably result as a consequence of the post-test year adjustment being
proposed.
(B) Each
post-test year plant adjustment described by subparagraph (A) of this paragraph
will be included in rate base at the reasonable test year-end CWIP balance, if
the addition is constructed by the utility, or the reasonable price, if the
addition represents a purchase, subject to original cost requirements, as
specified in TWC §13.185.
(C)
Post-test year adjustments to historical test year data for known and
measurable rate base decreases will be allowed only if:
(i) the decrease represents:
(I) plant which was appropriately recorded in
NARUC account 101 or 102;
(II)
plant held for future use;
(III)
CWIP, not including mirror CWIP; or
(IV) an attendant impact of another post-test
year adjustment.
(ii)
the decrease represents a plant that has been removed from service, sold, or
removed from the utility's books prior to the rate year; and
(iii) the attendant impacts on all aspects of
a utility's operations, including but not limited to, revenue, expenses and
invested capital, can with reasonable certainty be identified, quantified and
matched. Attendant impacts are those that reasonably result as a consequence of
the post-test year adjustment being proposed.
(d) Recovery of positive
acquisition adjustments.
(1) When a utility
acquires plant, property, or equipment for which commission approval is
required under §
24.239 of this title, relating to
Sale, Transfer, Merger, Consolidation, Acquisition, Lease or Rental, a positive
acquisition adjustment will be allowed to the extent that the acquiring utility
proves that:
(A) the property is used and
useful in providing retail water or sewer service at the time of the
acquisition or as a result of the acquisition;
(B) reasonable, prudent, and timely
investments will be made, if required, to bring the system into compliance with
all applicable rules and regulations;
(C) as a result of the transaction:
(i) the customers of the system being
acquired will receive higher quality or more reliable retail water or sewer
service or that the acquisition was necessary so that customers of the
acquiring utility's other systems could receive higher quality or more reliable
retail water or sewer service;
(ii) regionalization of retail public
utilities, meaning a pooling of financial, managerial, or technical resources
that achieve economies of scale or efficiencies of service, was achieved; or
(iii) the acquiring utility will
become financially stable and technically sound as a result of the acquisition,
or the system being acquired that is not financially stable and technically
sound will become a part of a financially stable and technically sound utility;
(D) any and all
transactions between the buyer and the seller entered into as a part or
condition of the acquisition are fully disclosed to the commission and were
conducted at arm's length;
(E) the
actual purchase price is reasonable in consideration of the condition of the
plant, property, and equipment being acquired; the impact on customer rates if
the acquisition adjustment is granted; the benefits to the customers; and the
amount of contributions in aid of construction in the system being acquired;
and
(F) the rates charged by the
acquiring utility to its pre-acquisition customers will not increase
unreasonably because of the acquisition.
(2) The owner of the acquired retail public
utility and the final acquiring utility must not be affiliated. In a
multi-stage transaction in which a purchase of voting stock or acquisition of
controlling interest transaction under §
24.243 of this chapter, relating
to Purchase of Voting Stock or Acquisition of Controlling Interest in a
Utility, is followed by a transfer of assets in what is essentially a single
sales transaction, a positive acquisition adjustment is allowed only where the
multi-stage transaction was fully disclosed to the commission in the
application for approval of the initial stock or change of controlling interest
transaction.
(3) The amount of the
acquisition adjustment approved by the regulatory authority must be amortized
using a straight-line method over a period equal to the weighted average
remaining useful life of the acquired plant, property, and equipment, at an
interest rate equal to the rate of return determined under subsection (c) of
this section. The acquisition adjustment may be treated as a surcharge and may
be recovered using non-system-wide rates.
(4) The authorization for and the amount of
an acquisition adjustment will be determined only as a part of a rate change
application.
(5) The acquisition
adjustment will be included in rates only as a part of a rate change
application.
(e)
Negative acquisition adjustment. When a utility acquires plant, property, or
equipment under §
24.239 of this chapter, relating
to Sale, Transfer, Merger, Consolidation, Acquisition, Lease or Rental, and the
original cost of the acquired property less depreciation exceeds the actual
purchase price, the utility must record the negative acquisition adjustment
separately from the original cost of the acquired property. For purposes of
ratemaking, the following will apply:
(1) If
a utility acquires plant, property, or equipment from a nonfunctioning retail
public utility through a sale, transfer, or merger, receivership, or the
utility is acting as a temporary manager, a negative acquisition adjustment
must be recorded and amortized on the utility's books with no effect on the
utility's rates.
(2) If a utility
acquires plant, property, or equipment from a retail public utility through a
sale, transfer, or merger and paragraph (1) of this subsection does not apply,
the commission may recognize the negative acquisition adjustment in the
ratemaking proceeding, by ordering the amortization of the negative acquisition
adjustment through a bill credit for a defined period of time or by other means
determined appropriate by the commission. Except for good cause found by the
commission, the negative acquisition adjustment will not be used to reduce the
balance of invested capital.
(3)
Notwithstanding paragraph (2) of this subsection, the acquiring utility may
show cause as to why the commission should not account for the negative
acquisition adjustment in the ratemaking proceeding.
(f) Subsections (d) and (e) of this section
do not apply to plant, property, or equipment acquired through a transaction
based on the fair market valuation process set forth in §
24.238 of this title, relating to
Fair Market Valuation.
(g)
Intangible assets will not be allowed in rate base unless the requirements in
paragraphs (1), (2) and (3) of this subsection are met. If the requirements in
paragraphs (1) and (2) of this subsection are met, but the requirement in
paragraph (3) of this subsection is not met, the amount will be amortized over
a reasonable period and the amortization will be allowed in the cost of service
as a non-recurring expense. Unamortized amounts will not be included in rate
base. The requirements are as follows:
(1)
The amount requested has been verified by documentation as to amount and exact
nature;
(2) Testimony establishes
the reasonableness and necessity and benefit of the expense to the customers;
and
(3) Testimony establishes how
the amount is properly considered an actual asset purchased or installed, or a
source of supply, such as water rights.
Notes
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