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Accounting Change

2011 Rate Authorization
Allowed operating costs $ 1,120 million
Assets in service $3,200 million
(times) Allowed rate of return X 8.75% = 280 million
Revenue requirement $ 1,400 million
(divided by) Estimated energy demand / 14,000 million
Rate allowed per kwh $ 0.10 million

Shortly after the 2011 rate was set, the company's financial reporting staff circulated an internal. Memo recommending the following accounting changes:
• Extended plant depreciation life by five years to reflect current utilization forecasts. This would add $175 million to the asset base and reduce annual depreciation (an operating cost) by $5 million.
• Increase estimated bad debt expense from 1% to 1.5% of sales to reflect current forecasts of customer defaults. This would add $7 million to operating costs and reduce total assets by the same amount.
• Amortize 2010 hostile takeover defense costs of $4.5 million over three years rather than take the entire expense in 2010. This would increase 2011 operating costs by $1.5 million and add $3 million to the asset base.
• Write up fuel and materials inventories to their current replacement value. This would add $60 million to the asset base, but it would have no impact on 2011 operating costs.

a. Assess the impact of each proposed change on the company's 2011 revenue requirement and rate per kilowatt-hour, assuming that regulators will approve the accounting changes and adjust the allowed rate accordingly.
b. As a member of the state utility commission, comment on the merits of each proposed accounting change.

Solution Preview

See the attached file.

2011 Rate Authorization
Allowed operating costs $ 1,120 million
Assets in service $3,200 million
(times) Allowed rate of return X 8.75% = 280 million
Revenue requirement $ 1,400 million
(divided by) Estimated energy demand / 14,000 million
Rate allowed per kwh $ 0.10 million

Shortly after the 2011 rate was set, the company's financial reporting staff circulated an internal. Memo recommending the following accounting changes:
• Extended plant depreciation life by five years to reflect current utilization forecasts. This would add $175 million to the asset base and reduce annual depreciation (an operating cost) by $5 million.
• Increase estimated bad debt expense from 1% to 1.5% of sales to ...

Solution Summary

The solution assesses the impact of each proposed change on the company's 2011 revenue requirement and rate per kilowatt-hour, assuming that regulators will approve the accounting changes and adjust the allowed rate accordingly.

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