Conservative Accounting - Best Practices for Your Financials and Ratepayers?
How Electric Cooperatives and Public Power Utilities Can Unlock Better Cost Recovery and Rate Stability
Conservatism in accounting practices can be interpreted in several ways:
- Adhering to accounting standards, which demands transparency and a conservative approach to recording transactions.
- Ensuring financial prudence, regulatory compliance, and the capability to meet long-term service obligations.
However, an overly conservative approach in accounting can result in missed opportunities to optimize business management and enhance customer service.
In this series of articles, I will discuss my observations on how some electric cooperatives and public power utilities may excessively apply conservative accounting practices, thereby missing opportunities to improve cost recovery, stabilize revenues, and smooth customer rates.
I am not advocating for cooperatives or utilities to disregard accounting standards—these standards must certainly be followed. Instead, I am highlighting the underutilization of certain standards and practices that could benefit both the organization and its ratepayers.
Specifically, the tools that are often underutilized include regulatory accounting (ASC 980/GASB 62) and robust work order construction processes.
Electric Cooperatives and Public Power Utilities Can Utilize the Same Accounting Tools as Investor-Owned Utilities
I have observed that some smaller and mid-sized power organizations do not consider the accounting tools and processes used by regulated investor-owned utilities (IOUs) as applicable to their own operations. However, any power organization can utilize these tools.
The first step towards embracing these tools is to start thinking of the organization as operating like an IOU. This shift in mindset will enable cooperatives and public power utilities to explore and implement these beneficial accounting practices and the benefits use of these tools will bring.
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The Benefits a Robust Work Order Accounting Process Can Bring
A work order records the cost of utility construction. Why does a robust work order accounting process matter? The outputs of a work order system are fixed asset values and the related depreciation expense of those fixed assets.
Depreciation expense or the replacement value of routine capital projects is recovered in utility rates. Undervaluing construction projects leads to lower fixed asset values, which will underrecover in customer rates the replacement costs of fixed assets.
Fully costing construction projects means including not just the material and labor costs of construction, but all construction overheads. These overheads include labor overheads, materials management, equipment costs, the allowance for funds used during construction, and accounting, finance, and administrative support.
Construction Overheads Include:
- Labor overheads
- Materials management
- Equipment costs
- Allowance for funds used during construction (AFUDC)
- Accounting, finance, and administrative support
These overheads are costs that are incurred on every construction project. Even if your organization doesn't record these overheads through the work order process, when it is time to replace the fixed assets at the end of their useful lives, these overhead costs will still be needed for the asset replacement. So, under-recording the initial construction overheads will lead to inadequate revenue recovery for the asset replacements. This will necessitate the co-op or utility digging into reserves to fund the asset replacement.
The moral of the story is, recover those overheads by setting up the front-end processes to record the costs. Above in this article are links to more detailed presentations on the calculation and recording methods used for each overhead.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists, LLC. You should seek formal advice on this topic from your accounting or legal advisor.