1. DEPRECIATION & CAPITAL RECOVERY UNDER LIBERALIZATION ITU/BDT ARAB REGIONAL WORKSHOP ON “SECTOR REFORM & LIBERALIZATION” MARCH 9-11, DR. ALY ELFAR, PROFESSIONAL ENGINEER FARCONSULT INC. OTTAWA, CANADA TEL

2. WILL DISCUSS THE FOLLOWING:
REVENUE REQUIREMENT
COST/REVENUE ASSIGNMENT
DEPRECIATION
STRANDED INVESTMENT

3. REVENUE REQUIREMENT (RR)
USED MAINLY WITH WHAT IS CALLED RATE-OF-RETURN (ROR) REGULATION.
TWO BASIC STEPS IN THE REGULATION OF PRICES.
FIRST STEP IS DETERMINING TOTAL ALLOWABLE REVENUES OR REVENUE REQUIREMENT (RR), I.E. TOTAL COST OF SERVICE.
SECOND STEP IS ESTABLISHING OF INDIVIDUAL RATES OR RATE SCHEDULES THAT WILL YIELD THE AMOUNT DETERMINED IN THE FIRST STEP.

4. RR IS DETERMINED BASED ON EITHER OF:
RR = OPERATIONS EXPENSE + DEPRECIATION EXPENSE + TAXES (RATE BASE*RATE OF RETURN) RATE BASE IS EQUAL TO GROSS VALUATION MINUS ACCUMULATED DEPRECIATION. USUALLY RATE BASE IS BASED ON HISTORICAL COST.
RR = OPERATIONS EXPENSE + DEPRECIATION EXPENSE + TAXES + INTEREST PAID ON DEBT + DIVIDENDS ON PREFERRED SHARES + (COMMON SHAREHOLDERS’ EQUITY * RATE OF RETURN ON COMMON EQUITY).
REPLACING ROR REGULATION WITH PRICE-BASED (INCENTIVE REGULATION) STARTED IN THE UK IN 1983 & LATER ADOPTED IN THE U.S. & CANADA. REFERRRED TO AS PRICE CAP REGULATION.
VARIOUS STEPS ARE GENERALLY NECESSARY TOWARDS ADOPTION OF INCENTIVE REGULATION. EXAMPLES INCLUDE RATE REBALANCING & SPLIT RATE BASE.

5. COST/REVENUE ASSIGNMENT TO BUSINESS SEGMENTS & SERVICES
ACCOUNTING SEPARATION OF THE COMPANY’S REVENUES, INVESTMENT & COSTS TO BROAD SERVICE CATEGORIES (BSC)
RECONCILES TO THE COMPANY’S FINANCIAL STATEMENT. ADJUSTED FOR REGULATORY PURPOSES ACCORDING TO REQUIREMENTS
IS A TOOL TO DETECT AND QUANTIFY CROSS-SUBSIDY BETWEEN BROAD SERVICE CATEGORIES
ASSIGNMENT METHODOLOGY SHOULD SATISFY REGULATORY & MANAGEMENT NEEDS
BSCs COULD BE ACCESS, MONOPOLY LOCAL, COMPETITIVE TOLL, COMPETITIVE NETWORK, COMETITIVE TERMINAL MULTILINE & DATA, COMPETITIVE TERMINAL, OTHER & COMMON

6. STUDY PRODUCES TWO PRINCIPAL REPORTS.
AVERAGE NET INVESTMENT BASE REPORT. EQUIVALENT TO BALANCE SHEET FOR THE BSCs
REVENUE SURPLUS/SHORTFALL REPORT. EQUIVALENT TO INCOME STATEMENT FOR THE BSCs.
SURPLUS/SHORTFALL IS AN INDICATOR OF CROSS-SUBSIDY BETWEEN CATEGORIES.

7. DEPRECIATION DEPRECIATION MAY REFER TO : DECREASE IN VALUE
A COST ALLOCATION
PHYSICAL IMPAIRMENT

8. DEFINITION & OBJECTIVES OF DEPRECIATION
DEPRECIATION IS THE EXPIRATION OR CONSUMPTION, IN WHOLE OR IN PART, OF SERVICE LIFE OR UTILITY OF PROPERTY RESULTING FROM THE ACTION OF ONE OR MORE OF THE FORCES OPERATING TO BRING ABOUT THE RETIREMENT OF SUCH PROPERT FROM SERVICE
THE FORCES SO OPERATING INCLUDE WEAR & TEAR, DECAY, ACTION OF THE ELEMENTS, INADEQUACY, OBSOLESCENCE, AND PUBLIC REQUIREMENTS.
THE TWO TRADITIONAL OBJECTIVES OF DEPRECIATION ACCOUNTING ARE :
(1) TO DETERMINE THE EXPENSES ATTRIBUTABLE TO EACH YEAR’S OPERATION; AND
(2) TO RECOVER THE CAPITAL INVESTED IN DEPRECIABLE PLANT OVER ITS USEFUL LIFE

9. DEPRECIATION EXPENSE & RESERVE
IN CAPITAL INTENSIVE INDUSTRIES, DEPRECIATION MAY ACCOUNT FOR UP TO 30% OF OPERATING EXPENSES.
DEPRECIATION IS A MAJOR DETERMINANT OF:
1- INTERNALLY GENERATED FUNDS
2- BOTTOM LINE INCOME FIGURES
3- REVENUE REQUEREMENTS
4- PRODUCTS & SERVICES PRICES
5- INVESTMENT COMMUNITY LOOK AT THE ENTERPRISE

10. STRANDED INVESTMENT
UNDERDEPRECIATED OBSOLESCENT PLANT WITH NO OR LITTLE FUTURE REVENUE GENERATING CAPABILITIES
RECOVERY OF NET CARRYING AMOUNT IS DOUBTFUL
VALUE IS LESS THAN NET CARRYING AMOUNT
PRESENT VALUE (PV) OF FUTURE CASH FLOWS IS < NBV, OR = PV OF EXPEXTED CASH FLOWS UNDER “FAIR” REGULATION MINUS EXPECTED CASH FLOW UNDER COMPETITION
WHEN THE NET CARRYING AMOUNT OF A CAPITAL ASSET, LESS RELATED ACCUMULATED PROVISION FOR FUTURE REMOVAL & SITE RESTORATION COSTS AND FUTURE INCOME TAXES, EXCEEDS THE NET RECOVERABLE AMOUNT, THE EXCESS SHOULD BE CHARGED TO INCOME

11. CAUSES OF STRANDED INVESTMENT
THESE CAUSES ARE NOT MUTUALLY EXCLUSIVE
PRICES DECREASE
AMOUNT OF OUTPUT DECREASES
DURATION OF OUTPUT DECREASES
SIGNIFICANT TECHNOLOGICAL DEVELOPMENTS
MARKET DECLINE FOR SERVICE OR PRODUCT DUE TO COMPETITION OR OTHER FACTORS
INABILITY TO COMPLETE A CAPITAL ASSET UNDER DEVELOPMENT OR CONSTRUCTION
CONTRACTUAL, REGULATORY OR LEGAL OBLIGATION. (FUEL, PURCHASED POWER, NUCLEAR DECOMMISSIONING)

12. MEASUREMENT BOTTOM UP. ASSET BY ASSET APPROACH
ASSET NBV MINUS ASSET MARKET VALUE ONE APPROACH IS TO CALCULATE THE DIFFERENCE BETWEEN CURRENT BOOK VALUE RESERVE USING REGULATORY LIVES & THEORETICAL RESERVE USING “ECONOMIC LIVES”
TOP DOWN. LOST REVENUE APPROACH. REVENUE THAT CUSTOMER WOULD HAVE PAID MINUS COMPETITIVE MARKET REVENUE

13. MITIGATING METHODS
WORK HARDER AT DEPERECIATION STUDIES REFLECTING FUTURE USAGE PERIODS & PATTERNS AS WELL AS MARKET & TECHNOLOGICAL CHANGES
RATE MAKING
PRICING FREEDOM
COMPETITIVE TRANSITION CHARGES
RENEGOTIATE CONTRACTS