Earnings Measurement

Asset Valuation Techniques

Core References

Restructuring and Managing the Enterprise in Transition
Washington, D.C.: The World Bank, 1998, Chapters 2-3.
Crum, Roy L., and Itzhak Goldberg

Focuses on transitioning economies. Describes asset valuation for the balance sheet and techniques for adjusting for inflation.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapter 7.
Green, Richard, and Martin Rodriguez Pardina

Considers regulatory treatment of investment, depreciation, and the asset base. Examines whether to value assets at historical cost or replacement cost. Also considers valuation at time of privatization.

Privatisation of Utilities and the Asset Value Problem
CMPO, University of Bristol, 2001.
Grout, Paul A., Andrew Jenkins, and Ania Zalweska

Examines the effects of the market value approach to asset valuation. Finds that this approach magnifies and entrenches errors. Recommends the regulatory agency estimate its own value of the company.

Replacement Cost Asset Valuation and Regulation of Energy Infrastructure Tariffs
ABACUS 39(1): 1-41, 2003.
Johnstone, D. J.

Examines the consequences of valuing assets based on an optimized replacement cost methodology. Argues that the approach values sunk infrastructure as if it were new infrastructure.

The Economics of Regulation: Principles and Institutions
Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapters 2 and 4.
Kahn, Alfred

Describes how to determine the rate base. Provides analysis of U.S. legal issues in rate base valuation. Considers fair value, current value, and original cost. Describes the problems of each for the regulatory process. Examines choices of replacement versus original cost in the context of efficient pricing.

Sectoral References

TELECOMMUNICATIONS

Current Cost Accounting Methodology for Telstra’s Subsequent Reports under the Accounting Separation Regime: Framework Document
January 2004.
Australian Competition and Consumer Commission

Describes regulator’s requirements for accounting separations for dominant telecommunications operator under a current cost accounting scheme. Outlines government’s requirements and regulator’s objectives. Describes anti-competitive conduct that is of concern. Considers issues of asset valuation and capital maintenance. Summarizes international developments.

TRANSPORTATION

A Contrasting Approach to Road Sector Reforms: The Case Study of Uganda Experience
Sub-Saharan Africa Transport Program Discussion Paper, number 1, World Bank, Washington, D.C., 2003.
Kumar, Ajay

Documents Uganda’s experience some aspects of design and implementation of road management and financing reforms. Key features of the reform process were: (a) development of an analytical basis to review different road financing and management options; (b) commitment and ownership of the reform program; (c) perception of transport as one of the important sectors of the economy; and (d) development of a sector investment policy and plan.

WATER

Review of Asset Values, Costs and Cost Allocation of Western Australian Urban Water and Wastewater Service Providers: General Principles and Methodology
Melbourne, Australia; The Allen Consulting Group, 2005.
Allen Consulting Group

Examines the appropriate regulatory asset value, forecasting operating expenditure, evaluation of capital expenditures, cost allocation methodologies, and estimating short-run marginal costs and long-run marginal costs of water and sewerage service provision.

The Capital Structure of Water Companies
October 11, 2002.
OXERA

Examines appropriate capital structure for water companies in the U.K. Considers effects of capital structure on the cost of capital, whether an operator should be expected to choose an optimal capital structure from the regulator’s perspective, and appropriate regulatory responses to capital structure issues.

Tariff Setting Guidelines: A Reduced Discretion Approach for Regulators of Water and Sanitation Services
Public-Private Infrastructure Advisory Facility (PPIAF), Working Paper no. 8, 2009.
Shugart, Chris and Ian Alexander

Provides specific guidelines for tariff setting for water and sanitation services, in addition to describing basic principles. Addresses price reviews, allowed revenue, appropriate amounts for operating expenses, valuing regulatory assets, foreign exchange adjustments, cost of capital, capital maintenance charges, capital expenditures, and extraordinary reviews.

Other References

Valuation: Measuring and Managing the Value of Companies
Wiley Publishers, 2000, Chapter 1.
Copeland, Thomas E., Tim Koller, Jack Murrin

Describes why valuing companies is important for all stakeholders and how shareholders move capital among enterprises based on return on investment.

Regulatory Opportunism and Asset Valuation: Evidence from the US Supreme Court and UK Regulation
CMPO, University of Bristol, 2001.
Grout, Paul A. and Andrew Jenkins

Compares the evolution of the treatment of the asset base in the U.S. and the U.K. Finds that operators and regulators both behave opportunistically with respect to asset valuation policies, namely that policy preferences are influenced by how the policies affect prices.

Key Words

Rate base, Assets, Original cost, Replacement cost, Fair value, Current cost, Regulatory Assets

Principles and Practices of Cost Accounting for the Treatment of Operating Costs, Capital Expenditures, Depreciation, Unpaid Bills, Customer or Government-Provided Capital, and Imputed Revenue

Core References

Principles for determining regulatory depreciation allowances
Note to the Independent Pricing and Regulatory Tribunal of New South Wales, September 2003.
The Allen Consulting Group

Develops guidelines for deprecation based largely on efficiency considerations. Examines the implications of these guidelines for regulatory depreciation policies.

Infrastructure Concessions, Information Flows, and Regulatory Risk
Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999.
Burns, P., and A. Estache

States that the regulator needs to evaluate operating costs, which may be based on other firms (exogenous information) or firm-specific information (historical or current). Considers how incentives affecting operating expenditure and investment work together. Explains that if operating expenditure is subject to strong incentives through yardstick competition but capital expenditure is automatically rolled forward into a regulatory asset base, this may distort efficiency incentives and input choices. Examines when privatized utilities sell assets at a value quite different from (usually less than) the current cost valuation. Says that where possible, regulators have steered away from using current cost values as a basis for regulation and instead have derived a regulatory value based on the flotation value of the assets, rolled forward by net investment.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapters 6 – 8.
Green, Richard, and Martin Rodriguez Pardina

Examines operating costs, investments, and revenues. Considers forecasting of operating expenses, yardstick competition, depreciation methods, and revenue forecasting.

The Economics of Regulation: Principles and Institutions
Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapters 2 and 4.
Kahn, Alfred

Discusses the regulation of operating costs and investments. Considers incentives to overstate costs, effects of deprecation on earnings, transfer pricing, practical problems of overseeing expenditures, efficiency standards, the role of depreciation and the effects of technology change on depreciation, and taxes. Explains that regulators set standards for operating costs and conduct audits to ensure that operators do not inflate costs. Also explains that depreciation is the return of capital expenses to investors.

Rate Case and Audit Manual
Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003.
NARUC Staff Subcommittee on Accounting and Finance

Describes rate base development and expense and revenue items. With respect to rate base, considers general principles, plant held for future use, plant under construction, cash working capital, customer deposits, prepayments and aid to construction, deferred income taxes, and depreciation reserves. Regarding expenses, considers depreciation, salaries, fuel, pensions, postretirement benefits, regulatory expenses, contract services, and insurance. Regarding revenues, considers unbilled revenue, unregulated revenue, and unpaid bills. Also examines affiliate transactions.

Key Words

Assets, Valuation, Costs, Capital Expenses, Operating Expenses, Investment, Information, Accounting, Depreciation

Treatment of Investment in Price Controls and the Development of the Rate Base

Core References

The Regulation of Investment in Utilities: Concepts and Applications
Washington, D.C.: The World Bank, 2005.
Alexander, Ian, and Clive Harris

Examines approaches for determining whether assets should be included in the rate base.

Discusses how to treat investment over- or under-spend relative to forecasts at each regulatory review. Holds that investment may be postponed or even canceled, often for legitimate reasons. Investment also is often lumpy, which makes forecasting investment difficult and wrought with errors. Examines the operator’s incentive to pass the cash that would have been used for investment to shareholders and the effects of clawing back money on investment incentives.

Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation
New York: Springer. 2006.
Pedell, Burkhard

Examines different approaches for valuing rate base. Provides case examples of gas utilities in New Zealand.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapters 5 and 7.
Green, Richard, and Martin Rodriguez Pardina

Explains that the operator has an incentive to overstate future investment needs, so the regulator may need to assess the forecasts. Describes how to protect the operator from attempts by the regulator to reduce asset base. Describes how, after an opening asset base has been set, the future asset base level is calculated by adding actual investment and subtracting depreciation from the initial asset base. Discusses the effects of depreciation on the present value of the company and current and future consumers. Depreciation policies are examined.

Rolling forward the regulatory asset bases of the electricity and gas industries: Discussion Paper
Independent Pricing and Regulatory Tribunal in New South Wales, 1999.
IPART

Examines issues of initial valuation of the rate base, customer provided capital, depreciation, indexation, stranded assets, incorporating new assets, and regulatory accounts.

Rate Case and Audit Manual
Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003.
NARUC Staff Subcommittee on Accounting and Finance

Describes rate base development and calculation. Considers general principles, plant held for future use, plant under construction, cash working capital, customer deposits, prepayments and aid to construction, deferred income taxes, and depreciation reserves.

Sectoral References

TRANSPORTATION

Western Grain Railway Revenue Cap Interpretations
Ottawa – March 16, 2001.
Canadian Transportation Agency

Provides an interpretation of the Canadian statutes that set the policy framework for a revenue cap on the movement of grain by the Canadian railways.

Questions and answers on the Railway Revenue Cap
Ottawa – 2008.
Canadian Transportation Agency

Explains the operations of the revenue cap on grain transportation. Two examples are used to illustrate how the maximum revenue under the cap would be calculated.

WATER

Other References

Asset Accumulation and its Effects on NIE’s Transmission and Distribution Price Control: A Consultation Paper
Director General of Electricity Supply for Northern Ireland, 2000.
Ofgem

Studies an operator’s investment patterns, benchmarks these patterns against other operators, and examines how these patterns affect prices and quality.

Key Words

Rate base, Costs, Assets, Asset valuation, Investment, Information, Prudency, Used and useful

Taxation

Core References

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapters 5 and 7.
Green, Richard, and Martin Rodriguez Pardina

Discusses effects of corporate taxes on regulated companies, including the effects on cash flow and the cost of debt.

The Economics of Regulation: Principles and Institutions
Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapter 2.
Kahn, Alfred

Discusses effects of corporate taxes on cash flow and the cost of debt.

Rate Case and Audit Manual
Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003.
NARUC Staff Subcommittee on Accounting and Finance

Describes treatment of taxes for calculating revenue requirement, applying tax reserves, and estimating tax effects.

Sectoral References

TRANSPORTATION

Road User Taxation in Selected OECD Countries
Sub-Saharan Africa Transport Policy Program Working Paper Series, number 3, World Bank, Washington, D.C., 1993.
Creightney, Cavelle

Examines issues related to road user taxation, in a selection of “most successful countries”. On the basis of six case studies, provides a comparative review of policy towards road user taxation, as well as each country’s approach towards determining the actual rate, or level of tax. Portrays the decision-making process, and the balance between theoretical organization considerations on the one hand, and broader economic, or political considerations on the other. While the focus of this paper is on a selection of developed countries, it is intended to provide insights for developing practical guidelines that improve road users’ taxes in Sub-Saharan Africa.

Key Words

Taxes, Assets, Depreciation, Taxation, Cost of capital, Debt, Cash flow

Case Studies

Current Cost Accounting Methodology for Telstra’s Subsequent Reports under the Accounting Separation Regime: Framework Document
January 2004.
Australian Competition and Consumer Commission

Jamaica Public Service Company Limited Tariff Review for Period 2009-2014
September 2009.
Office of Utilities Regulation (OUR)

Final Determinations. Future Water and Sewerage Charges 2000-05: Periodic Review 1999
November 1999.
OFWAT