United States: FERC Issues New Rules Governing the Accounting, Reporting and Rate Filing Requirements for Asset Retirement Obligations

The Federal Energy Regulatory Commission ("FERC" or "Commission") has issued new regulations that address the accounting, financial reporting, and rate filing requirements applicable to asset retirement obligations imposed on public utilities, hydroelectric licensees, natural gas companies, and oil pipeline companies. Order No. 631, FERC Docket No. RM02-7-000 (April 9, 2003). The effective date for the new accounting and reporting requirements is January 1, 2003 for a jurisdictional entity whose fiscal year begins on January 1, 2003. For a jurisdictional entity whose fiscal year begins after January 1, 2003, the new rules are effective for accounting and reporting purposes as of the first day of the entity’s fiscal year. The purpose of the change, according to FERC, is to improve visibility, completeness, and consistency of financial reporting for legally required retirement costs.

An asset retirement obligation is a legal obligation associated with the retirement of a tangible, long-lived asset that an entity is required to retire as a result of an existing law, statute, ordinance, or contract. For example, a public utility may have a legal obligation to decommission a nuclear power plant pursuant to Nuclear Regulatory Commission regulations, which could require the utility to dismantle and remove a nuclear reactor vessel and related facilities. Similarly, when retiring a compressor station, a natural gas pipeline company could be legally required to remove the compressor station and related piping pursuant to state regulations or local ordinances. Removal costs that do not arise from a regulatory or contractual obligation are not governed by the new rule.

Consistent with Financial Accounting Standards Board ("FASB") Standard No. 143, issued June 2001, the FERC’s new rule requires that a jurisdictional entity recognize a liability for the fair value of an asset retirement obligation (calculated on a net present value basis) at the time the asset is constructed, acquired, or when a change in a law creates a legal obligation to perform the retirement activities. Upon initial recognition of that liability, the business entity is to increase the cost of the asset that must be retired by the amount of the recognized retirement liability. These capitalized asset retirement costs are then depreciated over the life of the asset. The Commission noted that the accounting called for in the new rule would produce the same results as the application of FASB 143.

The Commission explained that its new rule would improve consistency in accounting and reporting of legal obligations related to the retirement of tangible, long-lived assets. Currently, businesses account for such legal obligations in various ways. Some jurisdictional entities do not recognize costs associated with legal asset retirement obligations in their accounts. Other jurisdictional entities recognize such amounts only in the rate-setting process as a component of accumulated depreciation. The new rule also provides industry stakeholders with more transparent disclosure of the costs related to the legal obligation. All affected entities will now separately account and report the liability for the asset retirement obligations, capitalize the asset retirement costs, charge earnings for depreciation of the asset, and charge operating expense for the accretion of the liability.

The Commission established new FERC accounts in which to record: (1) the costs associated with legal liabilities related to future retirement or decommissioning of long-lived assets; (2) increases or decreases in such liabilities due to the passage of time; (3) the capitalization of liability for an asset retirement obligation; (4) the depreciation expense recorded on capitalized retirement costs; and (5) gains or losses resulting from the settlement of asset retirement obligations as well as gains or losses from the disposition of the asset. In addition to modifying its Uniform System of Accounts, the Commission revised the following Annual Reports: FERC Form No. 1, Annual Report of Major Public Utilities, Licensees and Others; FERC Form No. 1-F, Annual Report of Nonmajor Public Utilities and Licensees; FERC Form No. 2, Annual Report of Major Natural Gas Companies; FERC Form No. 2-A, Annual Report of Nonmajor Natural Gas Companies; and FERC Form No. 6, Annual Report of Oil Pipeline Companies. Appendix B to the new rule includes a summary of the changes to these forms.

The Commission also included a requirement that jurisdictional entities keep subsidiary records and supporting documentation for each legal asset retirement obligation in order to be able to furnish the full details of the identity and nature of the legal obligation, the year the obligation was incurred, the identity of the plant giving rise to the obligation, the full details of each cost component, and the supporting computations for measuring the asset retirement obligation.

Jurisdictional entities may recognize the initial application of the new accounting requirements by establishing a cumulative effect adjustment, defined as the difference between (1) the amounts of previously accrued accumulated legal obligations associated with the retirement of the asset recognized in the entity’s balance sheet prior to adopting the new accounting requirements, and (2) the amount that will be recognized on the entity’s balance sheet under the new accounting requirements.

The Commission did not require jurisdictional entities with stated-rate tariffs to make any tariff filings related to asset retirement obligations set forth in the new rule. However, jurisdictional companies with formula-rate tariffs are not allowed automatically to include any cost components related to asset retirement obligations in their formula rate billing determinations; instead, they must secure Commission approval prior to reflecting such costs in rates. The Commission will address such requests on a case-by-case basis. This is because the new accounting rules require the recording of an asset retirement cost, whereas no actual cash expenditure occurs until the long-lived asset is retired from service.

According to the Commission, it would be inappropriate for jurisdictional entities to include asset retirement costs in rate base and collect a rate of return allowance and related income taxes on these amounts in jurisdictional rates. The Commission therefore adopted new regulations requiring jurisdictional companies that have recorded an asset retirement obligation on their books in accordance with the new rule to provide, as part of any initial rate filing or general rate change filing, a schedule identifying all asset retirement obligations included in the cost of service computation supporting the proposed rates. If the jurisdictional entity is not seeking to recover the costs of asset retirement obligations in rates, the entity must remove all asset retirement obligation-related cost components from its cost of service. Any entity seeking to recover such costs in rates must provide a detailed study that supports the amounts proposed to be collected in rates.