4. Accounting and Ratemaking Rules

The objectives for this rulemaking are to:

- adopt policies, practices, rules, and procedures that govern the application, usage, ratemaking, retirement, and sale of all future state grant-funded utility plant;

- limit rules adopted in this proceeding to state-financed grants;⁹ and

- ensure that utilities do not receive a windfall or shareholders benefit from grant-funded facilities even if, years later, the utility itself or the individual, grant-funded facility is subsequently leased or sold.

In the following sections, we adopt rules that meet all of these objectives. In adopting these rules, we use the ratemaking term "plant" rather than the OIR's term "facilities".

4.1 Recording Future State Grant-Funded Plant

While our discussion here references existing DHS rules for Proposition 50 grants, the rules we adopt shall apply to all future state grants to investor-owned water utilities.

DHS criteria and guidelines require matching funds for Proposition 50 grants that are not for disadvantaged communities or small water systems. A utility must apply to the Commission, either in a general rate case or by separate filing, for authority to collect from its customers for the non-grant-funded investment and for approval of the financing it proposes. The non-grant-funded portion of a construction project shall be recorded in accordance with USOA Account 100-1 - Utility Plant in Service. ¹⁰ This non-grant-funded portion, if determined to be reasonable by this Commission, shall earn a return and be eligible for a gain on its sale.

The parties that address this issue (CWA, ORA, and Park) all agree that grant-funded plant should be accounted for in the same manner as Contributions in Aid of Construction (CIAC), but as a distinct account and record; ORA and Park specify that the distinct account should not be a sub-account in CIAC. We agree with ORA and Park that CIAC differs in one significant aspect from grant-funded projects: CIAC is used to fund a utility plant project in its entirety, while state grant-funded projects can be jointly funded by grant funds and utility matching funds. The utility must separately track grant funds because of their unique characteristics and the unique rules we adopt here. This approach will also ensure that the grants are separately reported in audited financial statements and reports filed with the Commission. Further, there is a need for a clear audit trail between the utilities' fixed asset accounting system and the general ledger; utilities shall modify, as necessary, their work order tracking systems so that grant-funded projects can be reviewed and audited.

We shall adopt Park's recommendation to establish a new account, Account 266, and ORA's recommendation to title this account "Publicly Funded Grant Plant," and limit Account 266's use to government grants. In establishing this account, we generally follow the existing format for Account 265 as it pertains to ratemaking and accounting. Contributions are not included in the determination of rate base; therefore, by using the existing accounting rules for CIAC, this Commission ensures that no return shall be earned by a water utility on state grant-funded plant.

When grant funds are initially received from the funding agency, the utility shall place these funds in a dedicated account. On the books of the utility, it shall record the grant funds as a Debit to Account 121-3 - Cash-Miscellaneous Special Deposits and a Credit to Account 266-00 - Contributions - Publicly Grant-Funded Plant. As the grant-funded plant is being constructed, the utility shall record those dollars expended as a Debit to Account 100-3 - Construction Work in Progress (CWIP) and a Credit to Account 121-3 - Cash-Miscellaneous Special Deposits. When the authorized plant (authorized by the DHS or funding agency) has been constructed, a second set of entries shall be recorded as a Debit to Account 100 - Utility Plant¹¹ and a Credit to Account 100-3 - CWIP for the publicly grant-funded amount.¹²

4.2 Operating Expenses, Administrative and General Expenses,
and Taxes

Operating expenses, administrative and general expenses, and taxes associated with grant-funded plant, but not funded with grant funds, shall be allowed in the determination of rates charged by the utility, if determined to be reasonable by this Commission. These expenses are allowed ratemaking recovery because they are not funded with government funded contributions and are necessary to the maintenance of the plant that has been constructed. The reasonableness of these expenses shall be reviewed in the normal course of the general rate case process. Any indirect benefits resulting from grant-funded plant, such as reductions in operating expenses resulting from infrastructure improvements, should be projected as cost savings and imputed into the utilities' present base margin revenue requirement.¹³

Unless the utility has received authorization from DHS or the funding agency, grant funds shall not be spent on expenses. We agree with ORA and Park that grant funds that are expended for expenses authorized by DHS or another funding agency must not be included in the determination of the Results of Operations and the forecast of future expenses in a general gate case. CWA believes that inclusion or exclusion of operating expenses funded by grant funds should be determined on the specific circumstances of the case. We disagree. However, we do authorize that once the grant funds are no longer available and the utility is required to pay for these expenses out of its own funds, then these expenses shall be included in the Results of Operations and the forecast of future expenses in a general rate case.

4.3 Depreciation

ORA and Park recommend that depreciation should be calculated using the existing methodology detailed in the Commission's Standard Practice U-4, while CWA recommends that straight-line depreciation should be used, as proposed in the OIR. We find no reason to deviate from our existing practice and, therefore, agree with ORA and Park that the existing rules should be followed. This means that depreciation on Proposition 50 grant-funded plant is recorded as a Debit to Account 266-01 and a Credit to Account 250 - Reserve for Depreciation of Utility Plant. The depreciation amount accrued each year shall be calculated in the same way as non-contributed plant (Standard Practices U-04-SM and U-04-W).

We agree with CWA that grant funds used to acquire land should not be amortized and included in the depreciation category; we also agree with ORA's recommendation that this apply to all non-depreciable property, which includes water rights.

While depreciation expenses from grant-funded plant should be excluded from ratemaking as a deduction, ORA and Park are correct in recommending that the utilities should deduct the depreciation expenses for income tax purposes and flow through to their customers any benefits derived from the tax deduction in the most direct fashion possible. We adopt this recommended rule.

⁹ A separate proceeding, R.04-09-003, addresses for all Commission-regulated utilities the issue of gain on sale of utility plant from all financing sources other than Proposition 50 grants.

¹⁰ USOA Account 100-1 - Utility Plant in Service (Class A), Utility Plant Instruction 3.A. "All amounts included in the accounts for tangible utility plant consisting of plant acquired as an operating unit or system shall be stated in accordance with the provisions of Utility Plant Instruction 4-B. All other tangible utility plant shall be included in the accounts at the cost incurred by the utility."

¹¹ USOA for Class B, C, and D Water Utilities - Account 101-Water plant in service.

¹² An example of how to record Proposition 50 grant-funded plant is as follows: Utility receives $1,000,000 of Proposition 50 grant funds to pay for the construction of a new treatment plant. The total cost of the plant is $2,000,000 ($1,000,000 of Proposition 50 funds and $1,000,000 of utility funds). First, the $1,000,000 of Proposition 50 grant funds shall be recorded as a Debit to Account 121-3 - Cash-Miscellaneous Special Deposits and a Credit to Account 266-00 - Contributions-Publicly Grant-Funded Plant. Second, as the construction of the plant proceeds, the $1,000,000 of Proposition 50 grant funds shall be recorded as a Debit to Account 100-3 - Construction Work in Progress (CWIP) and a Credit to Account 121-3 - Cash-Miscellaneous Special Deposits. Lastly, when the construction is completed, the $1,000,000 of grant funds are then Debited to Account 100-1 - Utility Plant in Service and Credited to Account 100-3 - CWIP. The utility funded portion of the construction would also be recorded as a Debit to Account 100-1 - Utility Plant in Service, upon completion and credited to the specific funding mechanism (examples include Cash, Accounts Payable, Notes Payable, or Retained Earnings). This results in the total value of the asset of $2,000,000 being recorded in Account 100-1 - Utility Plant in Service. Since the $1,000,000 that represents Proposition 50 grant funds is recorded in Account 266-00, it is deducted from Utility Plant in the calculation of Rate Base.

¹³ Any difference between the projected and actual savings should be trued up prospectively in each water utility's general rate case. The purpose of this rule is to prevent utilities from profiting from indirect benefits that can be predicted in the calculation of revenue requirement.