©2003 Jones Day. All rights reserved.

April 2003 Vol. 33

Energy Bulletin: FERC Issues New Rules Governing the Accounting,Reporting and Rate Filing Requirements for Asset Retirement ObligationsThe 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 pub-

lic 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 asso-

ciated 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 util-

ity 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. Simi-

larly, when retiring a compressor station, a natural gas pipe-

line company could be legally required to remove the com-

pressor station and related piping pursuant to state regula-

tions 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 li-

ability for the fair value of an asset retirement obligation (cal-

culated 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 capi-

talized 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 im-

prove consistency in accounting and reporting of legal obli-

gations related to the retirement of tangible, long-lived as-

sets. Currently, businesses account for such legal obligations

in various ways. Some jurisdictional entities do not recog-

nize 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 in-

dustry 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

2

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 re-

sulting 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, Licens-

ees 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 Compa-

nies; and FERC Form No. 6, Annual Report of Oil Pipeline

Companies. Appendix B to the new rule includes a sum-

mary of the changes to these forms.

The Commission also included a requirement that juris-

dictional 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 obliga-

tion, the full details of each cost component, and the sup-

porting computations for measuring the asset retirement

obligation.

Jurisdictional entities may recognize the initial applica-

tion of the new accounting requirements by establishing a

cumulative effect adjustment, defined as the difference be-

tween (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 as-

set retirement obligations set forth in the new rule. How-

ever, 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 Commis-

sion approval prior to reflecting such costs in rates. The Com-

mission 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 inappropri-

ate for jurisdictional entities to include asset retirement costs

in rate base and collect a rate of return allowance and re-

lated income taxes on these amounts in jurisdictional rates.

The Commission therefore adopted new regulations requir-

ing jurisdictional companies that have recorded an asset re-

tirement obligation on their books in accordance with the

new rule to provide, as part of any initial rate filing or gen-

eral rate change filing, a schedule identifying all asset retire-

ment obligations included in the cost of service computa-

tion supporting the proposed rates. If the jurisdictional en-

tity is not seeking to recover the costs of asset retirement

obligations in rates, the entity must remove all asset retire-

ment obligation-related cost components from its cost of ser-

vice. Any entity seeking to recover such costs in rates must

provide a detailed study that supports the amounts proposed

to be collected in rates.

Further InformationThis Energy Bulletin is a publication of Jones Day and should

not be construed as legal advice on any specific facts or cir-

cumstances. The contents are intended for general infor-

mational purposes only and may not be quoted or referred

to in any other publication or proceeding without the prior

written consent of the Firm, to be given or withheld at its

discretion. The mailing of this publication is not intended

to create, and receipt of it does not constitute, an attorney-

client relationship.

Readers are urged to consult their regular contacts

at Jones Day or the principal author of this publication,

William J. Harmon (telephone: 312-269-4160; e-mail:

wjharmon@jonesday.com), concerning their own situations

or any specific legal questions they may have. General e-

mail messages may be sent to counsel@jonesday.com. We

invite you to visit our Web site at www.jonesday.com.

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