regulatory accountingsari-energy.org/oldsite/pagefiles/what_we_do/... · compliance) • data...

Regulatory Accounting

August 24, 2010

Bengaluru, India

Resource persons: V.G. Pandit, Financial Advisor, KPTCL & M.D.Ravi, DCA, KPTCL

Contents • Regulatory framework

• Regulatory Organization & processes

• Initial Regulatory Practices

• Multi Year Tariff Regulations of KERC – Salient features

– Framework

– Elements

– Approach

• Contents of MYT filing

• Principles for computation of ARR & Tariff

• True up

Regulatory framework • Framework – explains the environment under which the sector

works

• Features of Electricity Act 2003

– Generation delicensed and captive generation is being freely permitted

– Government owned Transmission Utilities

– Provision for private transmission licensees

– Introduction of open access in a phased manner

– Current level of cross subsidy to be gradually phased out

– Recognizing trading as a distinct activity

– Decentralized management of distribution through Panchayats, Users

Associations, Cooperatives or Franchisees is permitted for rural areas

– ATE creation

– Anti-theft measures

Regulatory Organisation • Commissioners (with one as Chairman) –

– Supported by advisory staff – tariff, technical matters and finance

• Defines own rules of conduct

– Public hearing (chance for the public to represent arguments for/against the proposal under discussion, with equal chance to the licensee to defend its proposal)

– Advisory committee

• Invites to eminent specialities

• Passes order based on detailed consultations, after giving due chance to licenses

• Usually public hearing process (for tariffs) takes around 3 to 4 months

• General area of operations – State in which incorporated. CERC looks after inter-state operations of NTPC, NHPC, NPC, PGCIL and traders

• Sets out regulations (through consultative process) – defining various forms/formats, principles to follow, data requirement &disclosure etc

Regulatory Process

• Licensing

– Company applies for license – ERC satisfies itself on the viability

and organisational capability of the company

– Conducts public hearing on the proposal and invites arguments

from cross-section of public for/against

– Elicits technical analysis from the staff and rejoinders from

Licensee on staff’s position

– Prepares an order disposing off the application – either granting

the request or against it

ARR and Tariffs application

• Process well defined in the act – process not to exceed 120 days

from the filing to effective date.

• Detailed formats prescribed – forms a part of affidavit

• Disclosures ranges from financial statement to quantitative details

• Public consultations/ staff analysis/ licensee rejoinders

• Orders passed with/without directives (specific instructions for

compliance)

• Data discovery – Transparent (far from opaque pre-ERC) price

setting process

• Areas of concern – viability of utility, consumer bias, political

backing for agricultural tariff

Accounting framework – so far

• Utilities has ESAAR 1985 – common set of rules required to be

followed by SEBs

• Corporatisation – companies to follow the prescription under sec

209(1)(d), 211 – Accounting standards and Indian GAAP

• ICAI – recommendatory reconciliation between ESSAR and

Accounting standards

• Best practices – full disclosure to enable various stakeholders

understand the implicit and explicit assumptions in the financial

statement

General license conditions in India regarding Accounts Maintenance

• Financial year shall be from 1st day of April to the following thirty first day of March

• In respect of each separate business keep such accounting records as if it were carried on by a separate company

• Prepare on consistent basis from such accounting records and deliver to the Commission – The Accounting statements

– In respect of every six months of each financial year, and interim P&L account and Balance sheet together with supporting documents and the information as the Commission may prescribed from time to time

– Auditor’s report in respect of the accounting statement

• Shall not change the basis of charge or apportionment or allocation with out the approval of the Commission

• Shall be in accordance with the Provisions of the Indian Companies Act 1956

Some of the License conditions • License to account businesses segment-wise A retail supply and

distribution wires licensee to account for each business separately.

It should also report any other business income separately (eg.

Renting its right-of-way for broadband)

• Accounting process – follow the GAAP principles

• Special formats prescribed for submitting annual revenue

requirements

• Certain quantitative details are requested to support financial

statements – Eg merit order of generation, supply demand position

monthly etc

Conceptual issues • Return on Net Fixed Assets

• RoE

• Performance Based Regulations

• Historical Cost and LRMC

• Cost to serve (CoS)

• Cross subsidies reduction

• Paying capacity

• Lifeline concept

Regulatory Accounting – what does it mean?

Balance Sheet

Profit & Loss

Technical Details

Developed using GAAP

Annual Projections for Multi Year

Costing Details

RAG

Cost Approvals

Capex Approvals

Setting of RoE

Rate Setting for Various consumer categories

Regulatory accounting - Infn. requirement processes

Data

validation at ERC

Submission

of info by.

utilities

Data access

for all stake holders

Public Hearing,

Orders on ARR

& Tariff

Regulatory

information

Preparation

of Info. by

Utilities

This slide captures only the ARR/Tariff filing processes and not the entire RIMS

CAM ERC Templates CoA

CoS study

ARR

Tariff filing

Directives comp.

Discussions &

resubmission

of information

Reply’s to

objections

Personal

Appearance in

hearings

Legal recourse

Implementation

Salient features of Multi Year Tariff

• Develops Regulatory certainty for all stakeholders – Utility, Consumers,

Government etc

• Framework for a certain “Control Period” (usually 3 or 5 years)

• Puts in place principles of regulating various cost and revenue elements

• Moves the concept of price setting from a “Cost +” to “Performance

based”

• Encourages utilities to perform better as it provides necessary incentives

to become more efficient in operations

• Lays down principles of regulation for returns i.e. ROE, ROCE, RNFA etc.

• Lessens the risks that are external to the utility – like Power purchase etc.

MYT Framework

Regulatory Methodology

Base Data Preparation

Filing

Hearing Orders

Annual Filing

Review

Subsequent Control Period

Annual Filing

Review

Annual Filing

Review

Control Period

“Controllable Costs” Set for the entire period

“Un Controllable Costs” To be filed annually and reset

National Tariff Policy talks about recovery of Uncontrollable items as quickly as possible

……….

MYT Frame work

• Control Period- at the commencement of which a forecast of the ARR

shall be filed for approval of the Commission.

• Forecast of ARR during the Control Period shall be based on

reasonable assumptions related to the expected behavior of the

various operational and financial variables

• Trajectory for specific variables as may be stipulated by the

Commission by prescribing incentives and disincentives

MYT Frame work

• Annual Review of performance vis-à-vis the approved forecast –both

controllable and uncontrollable factors.

• Mechanism for pass through of approved gains or losses on account of

uncontrollable factors.

• Mechanism for sharing approved gains or losses arising out of

controllable factors

• Annual determination of tariff for each financial year within the control

period, based on the approved forecast and results of the annual

performance review.

Elements of MYT

• Year of implementation- Control period commencing from FY 07-08

• Control period – First 3 years, Thereafter 5 years or as fixed by KERC

• Filing to be made 120 days before the commencement of the control

period i.e. by November 30 for tariffs to be effective from 1st April

• Segregation of accounts into – Wires and supply business

• ARR for wires and supply business to be filed separately

MYT approach • Base Year: Values for the Base Year of the Control Period will be

determined based on the audited accounts available, best estimate for the

relevant years and other factors considered appropriate by the

Commission, and after applying the tests for determining the controllable

or uncontrollable nature of various items. The Commission will not

normally revisit the performance targets during the Control period.

• Targets: Will be set for items that are deemed by the Commission as

“controllable”. Trajectory for specific variables may be stipulated by the

Commission where the performance of the applicant is sought to be

improved upon through incentives and disincentives. Such variables for

which trajectory may be stipulated include, but not limited to, distribution

losses and collection efficiency.

Controllable and uncontrollable items The Expenditure of the Distribution Licensee considered as “Controllable”

“Uncontrollable” are as follows:-

Distribution and retail supply

ARR Item “Controllable” /“Uncontrollable”

Power Purchase Uncontrollable

Repairs & Maintenance Controllable

Employee cost Controllable

A&G expenses Controllable

Interest & Finance charges Controllable

Expenses on account of inflation Uncontrollable

Return of equity Controllable

Depreciation Controllable

Taxes on income Uncontrollable

Non-tariff income Controllable

Contents of MYT filing

• ARR for distribution wires shall contain:-

– O&M costs - Include employee-related costs, R&M, and A & G costs,

estimated for the Base Year and the actual for the previous year prior to the

Base Year in complete detail together with the forecast for each year of the

Control Period based on the norms proposed by Licensee including indexation

and other appropriate mechanisms

– Detailed scheme/project-wise Capital Investment Plan with a capitalisation

schedule covering each year of the Control Period

– A proposal for appropriate capital structure to meet the capital investment

plan with details of cost of financing including interest cost on debt and return

on equity;


• ARR for distribution wires shall contain:-

– Range of Distribution losses (upper and lower) for each year of the Control

Period for the purpose of incentive / penalties.- File trajectory of the loss

levels in respect of technical and commercial losses for each of the years of

the control period backed up by proper studies to justify the loss levels

indicated.

– Details of depreciation and capitalisation schedule for each year of the Control

Period

– Description of external parameters proposed for indexation

– Details of taxes on income

– Any other relevant expenditure

– Proposals for sharing of gains and losses

– Proposals for efficiency parameter targets

– Proposals for rewarding efficiency in performance;


• ARR for retail supply shall contain:-

– Range Power purchase costs for each year of the Control Period

– All other items mentioned for the distribution business to the extent

applicable and in accordance with the cost allocation statement

– Expected revenue from charges at the existing tariff including non-

tariff income, tariff from wheeling of electricity, income from Other

Business, Receipts on account of cross-subsidy surcharge and

additional surcharge if any

– Any other matter considered appropriate.

Contents of MYT filing • Capital Investment Plan: To be filed for Commission’s approval along with

the MYT filing for the Control Period

• Perspective Plan:

– To be filed on 1st April of the year preceding the first year of the Control

period.

– Perspective plan in the first instance shall for a period of 5 years from

2007-08 to 2011-12 so as to coincide with the 11th plan period.

– Thereafter the perspective plan shall be for a period of 5 years.

– The Perspective Plan for the Control Period shall contain:- • Sales Forecast

• Power Procurement Plan

• Capital investment Plan in accordance with the Practice Directions issued in respect of capital

investment programme and also consistent with the Guidelines on Load Forecast.

• Provided that the Perspective Plan for the first Control Period may be filed along with the MYT

filings for ARR of the first Control Period.

Principles for computation of ARR & Tariff

• Power Purchase cost

– Allowed to recover the PP cost based on the Load Forecast approved

– Commission will adopt the sales forecast, loss trajectory and power procurement

plan approved for determining Power Procurement

– Approved retail sales level will be grossed up by normative level of T&D losses as

indicated in the MYT trajectory for allowing power purchase qty.

– While approving the PP cost, principles of merit order (order of VC) will be

followed

– Foreign exchange risk variation is not a pass through (except in case of approved

PPAs)

– Cost not explicitly not allowed by the commission shall not be included

– Transmission and SLDC charges will be allowed at approved rates


• Treatment of distribution losses

– In case the actual distribution loss exceeds the normative loss level

approved by the Commission, such excess loss shall be to the account of

the Distribution Licensee

– In case the actual distribution loss is less than the approved loss level,

such savings shall be shared between the distribution licensee and the

consumers in the ratio of 70:30 during the first Control Period and in the

ratio as may be decided by the Commission in the subsequent Control

periods

– Commission may stipulate a time period beyond which the Distribution

Licensee shall not be permitted to recover, energy losses arising out of

theft, pilferage, failure to meter or bill for electricity transmitted.


• Capital investment

– Actual expenditure incurred on capital investment will form the

basis for determination of ARR/tariff.

– Will include capitalized initial spares subject to a ceiling norm at

1.5% of original project cost.


• Debt-Equity ratio

– For financing of future capital cost of projects - Debt : Equity ratio will be 70:30.

Licensee is free to have higher quantum of equity investments. The equity in

excess of this norm will be treated as loans advanced at the weighted average

rate of interest. In case of equity below the normative level, the actual equity

would be used for determination of RoE Equity in tariff computations.

– Savings in cost on account of subsequent restructuring of debt will be allowed to

be shared between the Licensee and the Consumers in the ratio of 70:30 during

the first Control Period and in such proportion as may be decided by the

Commission in the subsequent Control periods.


• Interest on capital loan

– Existing loans – Loans and repayments as admitted by KERC on Loans outstanding

– Fresh loans-on normative basis

– In case any moratorium period is availed of by the Distribution Licensee, depreciation

provided for in the tariff during the years of moratorium shall be treated as repayment

during those years and interest on loan capital shall be calculated accordingly

– Foreign exchange variation risk, if any, shall not be a pass through. Appropriate costs

of hedging and swapping to take care of foreign exchange variation will be allowed


• Depreciation

– Computation methodology defined. – Historical cost, SLM, Maximum 90% Dep,

Residual value 10%

– Chargeable from the first year of operation. In case of operation of the asset for part

of the year, depreciation shall be charged on pro rata basis

– The above said rate of depreciation are applicable both for the purpose of tariff as

well as accounting

– Commission may allow ‘advance against depreciation’ to the extent of difference

between the amount of depreciation computed and the debt repayment for the

financial year

– Benefit of reduced tariff after the assets have been fully depreciated will be available

to the consumers

Principles for computation of ARR & Tariff • RoE

– RoE will be computed on the equity base determined and shall be @ 14%

per annum.

– For the purpose of RoE, any cash resources available from its share

premium account or from internal resources that are used to fund the

equity commitments of the project under consideration shall be treated

as equity.

• O&M expenses

– O&M expenses for the Base Year, if required, will be used for projecting

the expenses for each year of the control period.

– Licensee is required to propose appropriate Inflation Factor Norms for

O&M for the first control period.


• Interest on WC

– Working capital will cover:

• O&M expenses for one month

• Maintenance spares @ 1% of the historical cost of assets at the

beginning of the year &

• Receivables equivalent to two month’s average revenue.

– Rate of interest on working capital will be equal to the STPLR of State

Bank of India as on 1st April of the year

– The interest on working capital will be payable on normative basis.


• Taxes on income

– Taxes on Income, if any, on the licensed business is treated as an expense and recoverable through ARR/tariff.

– Tax on any income stream will not be a pass through & will be payable by the Licensee.

– The benefit of tax holiday as applicable in accordance with IT Act 1961 will be passed on to the consumers.

– Credit for carry forward losses & unabsorbed depreciation, if any, will be passed on by Licensee to the beneficiaries.

• Non-tariff income

– All income being incidental to distribution business – viz. Profit from disposal of assets, income from investments, rents,, penalties and any other miscellaneous receipts

ARR formats Forms for Filing ERC under MYT Framework

Sl. No

Item Transmission/ Distribution

Form No.

I Revenue Requirement and Gap RR-Gap

1 Profit and Loss Account A1

2 Balance Sheet A2

3 Cash flow Statement A3

4 Aggregate Revenue Requirement A4

5 Cost of Purchased power T1/D1

6 Revenue from Sale of power T2/D2

7 Revenue from Subsidies and Grants T3/D3

8 Non-tariff Income T4/D4

9 Repairs and maintenance costs T5/D5

10 Employee costs T6/D6

11 Employee costs- Additional information T6A/&D6A

12 Administration and General charges T7/D7

13 Depreciation T8/D8

ARR formats Forms for Filing ERC under MYT Framework

Sl. No

Item Transmission/ Distribution

Form No.

14 Loans and Debentures and interest charges T9/D9

15 Sale and Leaseback of Assets T9A/D9A

16 Details of expenses capitalised T10/D10

17 Other Debits T11/D11

18 Extraordinary items T12/D12

19 Net prior period credits/(Charges) T13/D13

20 Contributions, Grants & subsidies towards cost of capital Assets T14/D14

21 Gross Fixed Assets T15/D15

22 Net Fixed Assets T16/D16

23 Work in progress (Capital expenditure) T17/D17

24 Receivables against Sale of Power (DCB) T18/D18

25 Tariff category wise DCB T18/D18A

26 Energy flow diagram for distribution system T19/D19

ARR formats

Tariff proposal formats

Sl. No

Item Company

1 Tariff charges – Current and proposed

Forms 20 to 24

2 Revenue at current tariff charges and proposed tariff charges

3 Expected Revenue when proposed tariff is Introduced for a Part Year

4 Embedded cost of service/per Kwh –category wise

5 External subsidy allocation to among consumers classes

True up

• Some ERCs in countries like UK, USA, Australia, South Africa have prescribed

a separate set of accounting principals and polices for regulatory accounting

along with USOA.

• The regulatory accounts by the utilities in these countries shall have to be

prepared in accordance with the accounting principles and policies set out

in the regulatory accounting guidelines

• But in countries like India, till now such prescriptions are not there.

Standardization of regulatory accounts is under consideration

• Annual reporting of accounts is distinct from the accounts used for

ARR/tariff filings

• Hence true up with statutory accounts is necessary

Areas for reconciliation/true-up

• In the current context of Electricity utilities are following the

Provisions of the Companies Act, the key areas for reconciliation

are:-

– Allowance/ disallowance for efficiency gains/losses

– Regulatory asset

– Subjecting capex to prudence check

– Limiting the borrowings/equity to normative

percentages

– Cap on allowing interest on borrowings

– Allowing working capital as per normative rates


– Allowance of O&M expenses w/r to indexation and

not as per actuals

– Advance Against Depreciation (AAD)

– Disallowance of certain costs by the commission

– Imposing of fines for non-compliance of directives

– Allowing IT paid as per actuals


– Terminal benefits –Allowing only the contribution

paid in cash and not the provision made

– Bad debts –Provision v/s write off

– Other issues like

• Revaluation of Assets

• Impairment of assets

• Deprecation on Consumer contribution/grants

Thank you

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