SOAH DOCKET NO PUC DOCKET NO.

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1 SOAH DOCKET NO PUC DOCKET NO REVIEW OF THE RATES OF SHARYLAND UTILITY COMPANY BEFORE THE STATE OFFICE OF ADMINISTRATIVE HEARINGS DIRECT TESTIMONY AND EXHIBITS OF DAVID J. GARRETT ON BEHALF OF THE CITY OF MISSION FEBRUARY 28, 217

2 TABLE OF CONTENTS I. INTRODUCTION... 4 II. EXECUTIVE SUMMARY... 5 III. REGULATORY STANDARDS... 9 IV. ANALYTIC METHODS V. ACTUARIAL ANALYSIS A. Account 352 Structures and Improvements... 2 B. Account 353 Station Equipment C. Account 354 Towers and Fixtures D. Account 355 Poles and Fixtures E. Account 356 Overhead Conductors and Devices VI. SIMULATED PLANT RECORD ANALYSIS A. Account 362 Station Equipment B. Account 365 Overhead Conductors and Devices C. Account 367 Underground Conductors and Devices D. Account 368 Line Transformers E. Account 369 Services VII. CONCLUSION AND RECOMMENDATION /245 For the City of Mission

3 APPENDICES Appendix A: Appendix B: Appendix C: Appendix D: The Depreciation System Iowa Curves Actuarial Analysis Simulated Life Analysis LIST OF EXHIBITS Exhibit DJG-1 Exhibit DJG-2 Exhibit DJG-3 Exhibit DJG-4 Exhibit DJG-5 Exhibit DJG-6 Exhibit DJG-7 Exhibit DJG-8 Exhibit DJG-9 Exhibit DJG-1 Curriculum Vitae Summary Rate and Accrual Adjustment Detailed Rate and Accrual Adjustment Depreciation Rate Development Account 352 Detailed Curve Comparison Account 356 Detailed Curve Comparison Simulated Plant Record Analysis and Graphical Balance Fit Summaries Actuarial Observed Life Tables and Iowa Curve Fitting Simulated and Actuarial Remaining Life Development Depreciation Study Samples 3/245 For the City of Mission

4 I. INTRODUCTION Q. STATE YOUR NAME AND OCCUPATION A. My name is. I am a consultant specializing in public utility regulation. I am the managing member of Resolve Utility Consulting, PLLC. I focus my practice on the primary capital recovery mechanisms for public utility companies: cost of capital and depreciation. Q. SUMMARIZE YOUR EDUCATIONAL BACKGROUND AND PROFESSIONAL EXPERIENCE A. I received a B.B.A. degree with a major in Finance, an M.B.A., and a Juris Doctor from the University of Oklahoma. I worked in private legal practice for several years before accepting a position as assistant general counsel at the Oklahoma Corporation Commission in 211. At the Oklahoma commission, I worked in the Office of General Counsel in regulatory proceedings. In 212, I began working for the Public Utility Division as a regulatory analyst providing testimony in regulatory proceedings. After leaving the commission I formed Resolve Utility Consulting, PLLC, where I have represented various consumer groups and state agencies in utility regulatory proceedings, primarily in the areas of cost of capital and depreciation. I am a Certified Depreciation Professional with the Society of Depreciation Professionals, and I currently serve on the society s board of directors as president. I am also a Certified Rate of Return Analyst with the Society of Utility and Regulatory Financial Analysts. A more complete description of my qualifications and regulatory experience is included in my curriculum vitae. 1 1 Exhibit DJG-1. 4/245 For the City of Mission

5 Q. DESCRIBE THE PURPOSE AND SCOPE OF YOUR TESTIMONY IN THIS PROCEEDING A. I am testifying on behalf of the City of Mission ( Mission ) regarding the proposed depreciation rates of Sharyland Utilities, L.P. ( Sharyland or the Company ). I am responding to the Company s depreciation study sponsored by Mr. Dane A. Watson. II. EXECUTIVE SUMMARY Q. SUMMARIZE THE KEY POINTS OF YOUR TESTIMONY. 4 5 A. In the context of utility ratemaking, depreciation refers to a cost allocation system designed to measure the rate by which a utility may recover its capital investments in a 6 systematic and rational manner. The table below compares the proposed depreciation 7 expense amounts by plant function as of the study date. Figure 1: Depreciation Expense Comparison by Plant Function Plant Plant Company Mission Mission Function 12/31/215 Proposal Proposal Adjustment Transmission $ 98,453,92 $ 23,653,6 $ 2,555,974 $ (3,97,86) Distributrion 474,368,417 15,788,982 12,983,161 (2,85,821) General 31,51,516 1,215,98 1,215,98 - Total $ 1,485,873,25 $ 4,657,139 $ 34,754,233 $ (5,92,96) In recommending depreciation rates in this case, I employed a well-established depreciation system using actuarial analysis and simulated plant record analysis to statistically analyze the Company s depreciable assets. Mission s total adjustment reduces the Company s proposed annual depreciation expense by $5.9 million when applied to plant balances at December 31, /245 For the City of Mission

6 Q. SUMMARIZE YOUR ADJUSTMENTS BY ACCOUNT A. I am proposing adjustments to several of the Company s transmission and distribution accounts, which are summarized as follows by my proposed rates, annual accruals, and adjustments to the Company s proposal. Figure 2: Detailed Proposals by Account Account Description Rate Accrual Adjustment 352 Structures & Improvements 1.61% $ 1,117,9 $ (341,778) 353 Station Equipment 1.88% 6,49,742 (1,79,89) 353 Transmission OCC Equipment 9.91% 554, Towers & Fixtures 1.78% 4,785,868 (574,761) 355 Poles & Fixtures 2.62% 2,644,424 (149,248) 356 Overhead Conductor & Devices 2.61% 5,155,425 (215,183) 359 Roads and Trails 1.51% 248,772 (26,27) Total Transmission Plant 2.1% 2,555,974 (3,97,86) Distribution Plant 361 Structures & Improvements 1.79% 317,291 (6,311) 362 Station Equipment 1.82% 1,273,911 (718,87) 364 Poles, Towers & Fixtures 4.1% 5,25,443 4,5 365 Overhead Conductor & Devices 2.15% 1,981,521 (1,19,174) 366 Underground Conduit 1.58% 11,916 (14,63) 367 Underground Conductor & Devices 2.32% 485,244 (133,657) 368 Line Transformers 2.38% 1,998,426 (39,37) 369 Services 2.28% 826,796 (554,282) 37 Meters 4.1% 67, Installations On Customer Premises 4.83% 49, Street Light & Signal Systems 3.89% 126, Total Distribution Plant 2.74% $ 12,983,161 $ (2,85,821) Q. PLEASE SUMMARIZE THE PRIMARY FACTORS DRIVING MISSION S ADJUSTMENT. 4 5 A. As discussed above, I am proposing adjustments to several of the Company s transmission and distribution accounts. For most of these accounts, the remaining lives I propose are 6/245 For the City of Mission

7 longer than those proposed by the Company, which results in lower depreciation rates and expense. My understanding of the regulatory standards governing utility depreciation expense, as further discussed below, is that the Company must provide convincing and adequate data to demonstrate that its proposed depreciation rates are not excessive. 2 However, because the Company s actuarial data used to conduct the depreciation study is insufficient to provide reliable indications of the average service lives of the Company s accounts, the Company has not demonstrated that its proposed rates are not excessive. Under these circumstances, it is important to make sure that the service lives adopted by the Commission are reflective of industry norms. Applying this standard will help reduce the negative financial impact to customers while avoiding financial harm to the Company. The accounts to which I propose adjustments are further discussed below. Q. DESCRIBE WHY IT IS IMPORTANT NOT TO OVERESTIMATE DEPRECIATION RATES A. Under the rate base rate of return model, the utility is allowed to recover the original cost of its prudent investments required to provide service. Depreciation systems are designed to recover those costs in a systematic and rational manner specifically, over the service life of the utility s assets. If costs are recovered too quickly by assuming shorter service lives, it encourages economic inefficiency. Unlike competitive firms, regulated utility companies are not always incentivized by natural market forces to make the most economically efficient decisions. If a utility is allowed to recover the cost of an asset before the end of its useful life, this could incentivize the utility to unnecessarily replace the asset 2 See Lindheimer v. Illinois Bell Tel. Co., 292 U.S. 151, 167 (1934). 7/245 For the City of Mission

8 in order to increase rate base, which results in economic waste. Thus, from a public policy perspective, it is preferable for regulators to ensure that assets are not depreciated before the end of their true useful lives. While underestimating the useful lives of depreciable assets could financially harm current ratepayers and encourage economic waste, there is little corresponding risk of harm to the Company if depreciable lives are slightly overestimated. This is because if an asset s life is overestimated early on, there are a variety of measures that regulators can use to ensure the utility is not financially harmed. One such measure would be adjusting the depreciation rates in future proceedings based on more complete data. Another measure would be the use of a regulatory asset account if an unrecovered balance remains when assets are retired. In that case, the Company s original cost investment in these assets would remain in the Company s rate base until they are recovered. Thus, the process of depreciation strives for a perfect match between actual and estimated useful life. When these estimates are not exact, however, for the reasons stated above, it is therefore better that useful lives are overestimated rather than underestimated. Q. WHAT IS YOUR RECOMMENDATION TO THE COMMISSION? A. I recommend that the Commission adopt the depreciation rates listed in Exhibit DJG-3. These rates should be applied to updated plant balances to determine the Company s depreciation expense included in rates. 8/245 For the City of Mission

9 III. REGULATORY STANDARDS Q. DISCUSS THE STANDARD BY WHICH REGULATED UTILITIES ARE ALLOWED TO RECOVER DEPRECIATION EXPENSE A. In Lindheimer v. Illinois Bell Telephone Co., the U.S. Supreme Court stated that depreciation is the loss, not restored by current maintenance, which is due to all the factors causing the ultimate retirement of the property. These factors embrace wear and tear, decay, inadequacy, and obsolescence. 3 The Lindheimer Court also recognized that the original cost of plant assets, rather than present value or some other measure, is the proper basis for calculating depreciation expense. 4 Moreover, the Lindheimer Court found: [T]he company has the burden of making a convincing showing that the amounts it has charged to operating expenses for depreciation have not been excessive. That burden is not sustained by proof that its general accounting system has been correct Thus, Sharyland must make a convincing showing that its proposed depreciation rates are not excessive. Q. HAS SHARYLAND MADE A CONVINCING SHOWING THAT ITS PROPOSED DEPRECIATION RATES ARE NOT EXCESSIVE? 9 1 A. No. Obtaining reliable indications of the average service lives of grouped property requires sufficient retirement experience. In short, depreciation professionals use past retirement 3 Lindheimer v. Illinois Bell Tel. Co., 292 U.S. 151, 167 (1934). 4 Id. (Referring to the straight-line method, the Lindheimer Court stated that [a]ccording to the principle of this accounting practice, the loss is computed upon the actual cost of the property as entered upon the books, less the expected salvage, and the amount charged each year is one year's pro rata share of the total amount. ). The original cost standard was reaffirmed by the Court in Federal Power Commission v. Hope Natural Gas Co., 32 U.S. 591, 66 (1944). The Hope Court stated: Moreover, this Court recognized in [Lindheimer], supra, the propriety of basing annual depreciation on cost. By such a procedure the utility is made whole and the integrity of its investment maintained. No more is required. 5 Id. at /245 For the City of Mission

10 experience to estimate the future mortality characteristics and average service lives of grouped asset accounts. For many of the accounts in this case, the Company has not provided enough historical data to obtain a reliable indication of future retirement patterns and average remaining life. For example, there were only 1 years of retirement history for some accounts containing assets that are expected to survive more than 7 years. This does not mean the Company withheld information, or that the information provided was inaccurate; rather, it means that it will take more time for the Company to obtain a sufficient retirement history of actuarial data in order to provide a more objective basis upon which to reliably estimate the average service lives of these accounts. This concept is illustrated and explained further below. Under these circumstances, it is important that the Commission take a more conservative approach to ensure that the Company s depreciation rates are not too high. Doing so will incentivize economic efficiency and reduce the negative financial impact to ratepayers while avoiding financial harm to the Company. Q. DOES MR. WATSON ALSO AGREE THAT THE COMPANY S DATA IS INSUFFICIENT? A. Yes. For every account that was analyzed using actuarial analysis, Mr. Watson correctly acknowledges that the Company s data was either insufficient or limited. 6 Q. SHOULD DEPRECIATION REPRESENT AN ALLOCATED COST OF CAPITAL TO OPERATION, RATHER THAN A MECHANISM TO DETERMINE LOSS OF VALUE? A. Yes. While the Lindheimer case and other early literature recognized depreciation as a necessary expense, the language indicated that depreciation was primarily a mechanism to 6 See Exhibit DAW-2 (Depreciation Study), pp /245 For the City of Mission

11 determine loss of value. 7 Adoption of this value concept would require annual appraisals of extensive utility plant, and is thus not practical in this context. Rather, the cost allocation concept recognizes that depreciation is a cost of providing service, and that in addition to receiving a return on invested capital through the allowed rate of return, a utility should also receive a return of its invested capital in the form of recovered depreciation expense. The cost allocation concept also satisfies several fundamental accounting principles, including verifiability, neutrality, and the matching principle. 8 The definition of depreciation accounting published by the American Institute of Certified Public Accountants ( AICPA ) properly reflects the cost allocation concept: Depreciation accounting is a system of accounting that aims to distribute cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation Thus, the concept of depreciation as the allocation of cost has proven to be the most useful and most widely used concept. 1 7 See Frank K. Wolf & W. Chester Fitch, Depreciation Systems 71 (Iowa State University Press 1994). 8 National Association of Regulatory Utility Commissioners, Public Utility Depreciation Practices 12 (NARUC 1996). 9 American Institute of Accountants, Accounting Terminology Bulletins Number 1: Review and Résumé 25 (American Institute of Accountants 1953). 1 Wolf supra n. 7, at /245 For the City of Mission

12 IV. ANALYTIC METHODS Q. DISCUSS YOUR APPROACH TO ANALYZING THE COMPANY S DEPRECIABLE PROPERTY IN THIS CASE A. I obtained and reviewed all of the data that was used to conduct the Company s depreciation study. The depreciation rates proposed by Mr. Watson were developed based on depreciable property recorded as of December 31, 215. I used the same data and plant balances to develop my proposed depreciation rates. 11 I used a reasonable depreciation system to develop my proposed depreciation rates. Q. DISCUSS THE DEFINITION AND PURPOSE OF A DEPRECIATION SYSTEM, AS WELL AS THE DEPRECIATION SYSTEM YOU EMPLOYED FOR THIS PROJECT A. The regulatory standards set forth above do not mandate a specific procedure for conducting depreciation analysis. These standards, however, direct that analysts use a system for estimating depreciation rates that will result in the systematic and rational allocation of capital recovery for the utility. Over the years, analysts have developed depreciation systems designed to analyze grouped property in accordance with this standard. A depreciation system may be defined by several primary parameters: 1) a method of allocation; 2) a procedure for applying the method of allocation; 3) a technique of applying the depreciation rate; and 4) a model for analyzing the characteristics of vintage property groups. 12 In this case, I used the straight line method, the average life procedure, the remaining life technique, and the broad group model to analyze the Company s 11 See Exhibit DJG See Wolf supra n. 7, at 7, /245 For the City of Mission

13 actuarial data; this system would be denoted as an SL-AL-RL-BG system. This depreciation system conforms to the regulatory standards set forth above, and is commonly used by depreciation analysts in regulatory proceedings. I provide a more detailed discussion of depreciation system parameters, theories, and equations in Appendix A Q. ARE THERE OTHER REASONABLE DEPRECIATION SYSTEMS THAT ANALYSTS MAY USE? A. Yes. There are multiple combinations of depreciation systems that analysts may use to develop deprecation rates. For example, an analyst might choose to use the whole life technique instead of the remaining life technique, or choose to use the equal life group model instead of the broad group model. As long as the depreciation system facilitates the systematic and rational allocation and recovery of capital investments, it should be considered reasonable. Q. DID YOU USE THE SAME DEPRECIATION SYSTEM AS MR. WATSON USED IN THIS CASE? A. Yes, I used the same depreciation system that Mr. Watson used. 13 Although some of our assumptions and inputs differed, the analytical system we used is essentially the same. Q. DESCRIBE THE COMPANY S PLANT DATA AND HOW IT AFFECTED YOUR APPROACH AND ANALYSIS IN THIS CASE A. For some accounts, including the transmission accounts and two distribution accounts (Accounts 361 and 366), I used actuarial analysis on the aged data provided by the Company. Aged data refers to a collection of property data for which the dates of 13 See Exhibit DAW-2 (Depreciation Study), p. 5. There, Mr. Watson states that he used the straight-line, broad group, remaining life depreciation system. 13/245 For the City of Mission

14 placements, retirements, transfers, and other actions are known. In keeping aged data, when a utility retires an asset, it would not only record the year it was retired, but it would also track the year the asset was placed into service, or the vintage year. The Company, however, did not have aged data available for all of its accounts. When aged data is not available, the year-end balances of each account are known, but analysts must simulate an actuarial analysis by estimating the proportion that each vintage group contributed to year-end balances. For this reason, simulated data is not as reliable as aged data. In order to analyze accounts that do not contain aged data, analysts use the simulated plant record ( SPR ) method. Because the analytical approach is not the same for actuarial and simulated data, I will separately discuss each approach and the corresponding accounts below. V. ACTUARIAL ANALYSIS Q. DESCRIBE THE GENERAL PROCESS YOU USED TO SORT AND ANALYZE THE COMPANY S DEPRECIABLE PROPERTY DATA A. The study of retirement patterns of industrial property is derived from the actuarial process used to study human mortality. Just as actuaries study historical human mortality data in order to predict how long a group of people will live, depreciation analysts study historical plant data in order to estimate the average lives of property groups. The most common actuarial method used by depreciation analysts is called the retirement rate method. In the retirement rate method, original property data, including additions, retirements, 14/245 For the City of Mission

15 transfers, and other transactions, are organized by vintage and transaction year. 14 The retirement rate method is ultimately used to develop an observed life table, ( OLT ) which shows the percentage of property surviving at each age interval. This pattern of property retirement is described as a survivor curve. The survivor curve derived from the observed life table, however, must be fitted and smoothed with a complete curve in order to determine the ultimate average life of the group. 15 The most widely used survivor curves for this curve fitting process were developed at Iowa State University in the early 19s and are commonly known as the Iowa curves. 16 A more detailed explanation of how the Iowa curves are used in the actuarial analysis of depreciable property is set forth in Appendix C. Q. DESCRIBE THE APPROACH YOU USED TO ESTIMATE THE AVERAGE SERVICE LIVES OF THE COMPANY S GROUPED ASSET ACCOUNTS A. I used all of the Company s aged property data to create an observed life table ( OLT ) for each account. The data points on the OLT can be plotted to form a curve (the OLT curve ). The OLT curve is not a theoretical curve, rather, it is actual observed data from the Company s records that indicate the rate of retirement for each property group. An OLT curve by itself, however, is rarely a smooth curve, and is often not a complete curve (i.e., it does not end at zero percent surviving). In order to calculate average life (the area 14 The vintage year refers to the year that a group of property was placed in service (aka placement year). The transaction year refers to the accounting year in which a property transaction occurred, such as an addition, retirement, or transfer (aka experience year). 15 See Appendix C for a more detailed discussion of the actuarial analysis used to determine the average lives of grouped industrial property. 16 See Appendix B for a more detailed discussion of the Iowa curves. 15/245 For the City of Mission

16 under a curve), a complete survivor curve is needed. The Iowa curves are empiricallyderived curves based on the extensive studies of the actual mortality patterns of many different types of industrial property. The curve-fitting process involves selecting the best Iowa curve to fit the OLT curve. This can be accomplished through a combination of visual and mathematical curve-fitting techniques, as well as professional judgment. The first step of my approach to curve-fitting involves visually inspecting the OLT curve for any irregularities. For example, if the tail end of the curve is erratic and shows a sharp decline over a short period of time, it may indicate that this portion of the data is less reliable, as further discussed below. After inspecting the OLT curve, I use a mathematical curvefitting technique which essentially involves measuring the distance between the OLT curve and the selected Iowa curve in order to get an objective, mathematical assessment of how well the curve fits. After selecting an Iowa curve, I observe the OLT curve along with the Iowa curve on the same graph to determine how well the curve fits. I may repeat this process several times for any given account to ensure that the most reasonable Iowa curve is selected. Q. DO YOU ALWAYS SELECT THE MATHEMATICALLY BEST-FITTING CURVE? A. Not necessarily. Mathematical fitting is an important part of the curve-fitting process because it promotes objective, unbiased results. While mathematical curve fitting is important, however, it may not always yield the best, most reasonable result. Q. DESCRIBE WHAT YOU MEAN BY THE BEST RESULT A. In general, the best result for each account would be achieved by selecting the Iowa curve that most accurately reflects the future retirement pattern and average remaining life of the 16/245 For the City of Mission

17 assets within that account. The process of selecting the best curve would include mathematical and visual Iowa curve-fitting techniques, along with professional judgment. Sometimes the mathematically best fitting curve indicates an average life that is unreasonable, especially when there is insufficient retirement history in the account. In this case, for example, the mathematically best fitting Iowa curve for Account 353 (Station Equipment) is the R3-145 curve. Choosing the R3-145 curve for this account necessarily suggests that the assets in this account will have an average service life of 145 years, meaning some assets will survive much longer. However, professional judgement, including observations of this account among other electric utilities, should lead an analyst to conclude that a 145-year average life for this account is not reasonable, despite the fact that it would be based on the current best-fitting Iowa curve from a mathematical standpoint. Once the Company experiences more retirement history in this account, a survivor curve pattern should develop that would indicate the average life for the assets in this account are in the range of 5 6 years. Q. SHOULD EVERY PORTION OF THE OLT CURVE BE GIVEN EQUAL WEIGHT? A. Not necessarily. Many analysts have observed that the points comprising the tail end of the OLT curve may often have less analytical value than other portions of the curve. In fact, [p]oints at the end of the curve are often based on fewer exposures and may be given less weight than points based on larger samples. The weight placed on those points will depend on the size of the exposures Wolf supra n. 7, at /245 For the City of Mission

18 Q. DID SHARYLAND S LACK OF SUFFICIENT ACTUARIAL DATA IN THIS CASE INFLUENCE YOUR APPROACH AND ANALYSIS? A. Yes. As discussed above, the actuarial data provided by the Company was insufficient to obtain a reliable indication of the average service life. I will illustrate this fact below. In cases where there is sufficient data, it is preferable to place more emphasis on the statistical analysis of the data provided by the utility being studied. Because Sharyland s data is insufficient, however, I gave more consideration to the service lives observed across the electric utility industry. Below I will further discuss approach and analysis for each of the Company s transmission accounts for which there was limited actuarial data provided. Q. PLEASE ILLUSTRATE WHY THE COMPANY S ACTUARIAL DATA IS INSUFFICIENT TO GIVE A CLEAR INDICATION OF FUTURE RETIREMENT PATTERNS AND AVERAGE LIFE A. As discussed above, depreciation analysts use utility actuarial data to construct an observed life table ( OLT ) for each account. An OLT curve, however, is often not a complete curve (i.e., it does not end at zero percent surviving). For this reason, it is sometimes called a stub survivor curve. In order to calculate average life (the area under a curve), however, a complete survivor curve, such as an Iowa curve, is required. The graph below shows an example of a typical OLT stub curve that is generated from actuarial data using the retirement rate method. If a utility does not have sufficient actuarial retirement history, the data will produce a shorter OLT stub curve. 18/245 For the City of Mission

19 Figure 3: OLT Stub Curve Example The first seven data points (the clear diamonds) show an OLT curve that is arguably too short to provide a good foundation for Iowa curve fitting. This graph also shows three Iowa curves. If an analyst were working with only the first seven data points of the OLT curve, it would be difficult to determine the best fitting Iowa curve, since many Iowa curves have similar shapes toward the top portion of the curves. However, as shown in the graph, when more data points are added to the OLT curve to form a longer stub curve, the bestfitting Iowa curve becomes more clear. In this case, all of Sharyland s OLT curves for its actuarial accounts are too short to provide a good indication of the average life. Therefore, it is helpful to look to other recommended service lives across the industry that were based on more complete actuarial data. Over time, as Sharyland accumulates more actuarial 19/245 For the City of Mission

20 1 2 retirement history, the Iowa curve fitting process will become more valuable as an indicator of average service life. A. Account 352 Structures and Improvements Q. DISCUSS THE COMPANY S POSITION ON ACCOUNT A. In his depreciation study, Mr. Watson acknowledged that [t]here was insufficient data to perform actuarial analysis for this account. 18 Nevertheless, Mr. Watson proposed an Iowa R3-5 curve for this account, which corresponds to a depreciation rate of 2.1% and an annual accrual of $1.5 million. 19 This recommendation results in an estimated life of only 5 years for this account. Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. An estimated average life of only 5 years is far too short for this account. Since the actuarial data provided by the Company for this account is insufficient, it is instructive to consider the average lives observed for other utilities with more reliable actuarial data. For transmission structures and improvements, the majority of depreciation studies I have reviewed utilized average lives of around 65 years Id. at Exhibit DAW-2 (Depreciation Study), pp. 55, See generally the following depreciation studies: (1) El Paso Electric 214 depreciation study, TX PUC, No ; (2) Idaho Power Company 215 depreciation study, ID PUC, No. IPC-E-16-23; (3) Oklahoma Gas and Electric Co. 214 depreciation study, OK PUC, No ; (4) Public Service Company of Oklahoma 214 depreciation study, OK PUC, No ; and (5) Southwestern Electric Power Company 215 depreciation study, TX PUC, No Relevant portions of these depreciation studies are attached hereto as Exhibit DJG-1. Full copies of the studies are publicly available, and can also be provided upon request. 2/245 For the City of Mission

21 Q. ALTHOUGH THE ACTUARIAL DATA PROVIDED BY THE COMPANY FOR THIS ACCOUNT IS RELATIVELY INSUFFICIENT, ARE THERE STATISTICAL INDICATIONS THAT THE COMPANY S PROPOSED SERVICE LIFE IS TOO SHORT FOR THIS ACCOUNT? A. Yes. The graph below shows the OLT curve for this account, along with the proposed Iowa curves. Just as illustrated above, the OLT curve is too short to provide much statistical value from a curve-fitting standpoint. This OLT curve however, is arguably long enough to show that the Company s proposed curve / average service life is too short. The OLT curve in this graph is represented by the black triangles. Because there is an insufficient history of retirement data, the OLT curve is relatively flat, and has not yet begun to decline in the form of a typical survivor curve. Figure 4: Account 352 Structures and Improvements 8 9 However, notice that by selecting the R3-5 curve to represent the mortality characteristics of this account, the Company is suggesting that around the 15-year age interval, the 21/245 For the City of Mission

22 percentage surviving in this account began to steadily decline. As the OLT curve shows, however, this has not been the case. Therefore, even the limited actuarial data available still demonstrates that the Company s selected Iowa curve has diverged from the actuarial data, resulting in an average service life that is too short. Q. IS YOUR SELECTED IOWA CURVE A BETTER MATHEMATICAL FIT TO THE OLT CURVE? A. Yes. Although, as discussed above, the limited actuarial data provided by the Company is not ideal for conventional mathematical curve-fitting techniques, the Iowa R4-65 curve I selected nonetheless provides a better mathematical fit to the OLT curve than the Company s selected curve. Mathematical curve fitting essentially involves measuring the distance between the OLT curve and the selected Iowa curve. The best mathematicallyfitted curve is the one that minimizes the distance between the OLT curve and the Iowa curve, thus providing the closest fit. The distance between the curves is calculated using the sum-of-squared differences ( SSD ) technique. In Account 352, the total SSD, or distance between the Company s curve and the OLT curve is.61, while the total SSD between R4-65 and the OLT curve is only This is because the Company s selected curve begins declining too early. Thus, the R4-65 curve I selected provides a better mathematical fit. Q. WHAT IS YOUR RECOMMENDATION FOR ACCOUNT 352? A. I propose the Iowa R4-65 curve be used to calculate the remaining life and depreciation rate for this account. An average life estimate of 65 years is reasonable when compared to 21 Exhibit DJG-5. 22/245 For the City of Mission

23 the average lives observed throughout the industry for this account. Additionally, the R4-65 curve provides a better fit to the limited actuarial data available, as the Company s selected curve is clearly too short. In light of these observations, along with the fact that the Company did not provide sufficient actuarial data for this account, it is clear that the Company has failed to make a convincing showing that its proposed rates are not excessive. Applying the R4-65 curve to this account results in a remaining life of 62.7 years, a depreciation rate of 1.61%, and an annual accrual of $1.1 million. 22 B. Account 353 Station Equipment Q. DISCUSS THE COMPANY S POSITION ON ACCOUNT A. Mr. Watson proposed an Iowa R5-45 curve for this account, which corresponds to a depreciation rate of 2.43% and an annual accrual of $7.8 million. 23 In his depreciation study, Mr. Watson acknowledged that [t]here was insufficient data to perform actuarial analysis for this account. 24 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. An estimated average life of only 45 years is far too short for this account. Since the actuarial data provided by the Company for this account is insufficient, it is instructive to consider the average lives observed for other utilities with more reliable actuarial data. 22 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 23 Exhibit DAW-2 (Depreciation Study), pp. 55, Id. at /245 For the City of Mission

24 1 2 With respect to Account 353, I have observed depreciation studies proposing average lives of approximately 54 years, and as much as 6 years. 25 Q. WHAT IS YOUR RECOMMENDATION FOR THIS ACCOUNT? A. In the interest of reasonableness, I am proposing an average life of 54 years, which is longer than the average life proposed by the Company, but still shorter than some of the average lives proposed by utilities for this account. All else held constant, shorter average lives result in higher depreciation rates. In light of these observations, along with the fact that the Company did not provide sufficient actuarial data for this account, the Company has not made a convincing showing that its proposed rates are not excessive. Specifically, I propose an R5-54 curve to describe the future mortality rate and average service life for this account. The curve shape is the same as the one proposed by the Company, but an average life of 54 is much more reflective of industry norms than an average life of only 45 years. Applying these parameters to this account results in a remaining life of 5.4 years, a depreciation rate of 1.88%, and an annual accrual of $6 million. 26 C. Account 354 Towers and Fixtures Q. DISCUSS THE COMPANY S POSITION ON ACCOUNT A. Mr. Watson proposed an R3-6 curve for this account, which corresponds to a depreciation rate of 2.% and an annual accrual of $5.4 million. 27 In his depreciation study, Mr. 25 See generally depreciation studies supra n. 2; see also Exhibit DJG See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 27 Exhibit DAW-2 (Depreciation Study), pp. 55, /245 For the City of Mission

25 1 2 Watson again acknowledged that with respect to Account 354, [t]here was insufficient data to perform actuarial analysis for this account. 28 Q. DO YOU AGREE WITH THE COMPANY S RECOMMENDATION FOR THIS ACCOUNT? A. No. An estimated average life of only 6 years is too short for this account. Because the actuarial data provided by the Company for this account is insufficient, I considered the average lives observed for other utilities with more reliable actuarial data. With respect to Account 354, I have observed depreciation studies proposing average lives of about 7 years, and as much as 75 years. 29 Q. ARE YOU RECOMMENDING A 75-YEAR AVERAGE LIFE FOR THIS ACCOUNT? A. No. In the interest of reasonableness, I am proposing an average life of only 67 years, which is considerably shorter than the depreciable lives I have observed for this account. In light of my observations, and because the Company did not provide sufficient actuarial data for this account, the Company has not made a convincing showing that its proposed rates are not excessive. I propose an R4-67 curve to describe the future mortality rate and average service life for this account, which equates to a remaining life of 64.4 years, a depreciation rate of 1.78%, and an annual accrual of $4.8 million Id. at See generally depreciation studies supra n. 2; see also Exhibit DJG-1. 3 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 25/245 For the City of Mission

26 D. Account 355 Poles and Fixtures Q. DISCUSS THE COMPANY S POSITION ON ACCOUNT A. Mr. Watson proposed an R curve for this account, which corresponds to a depreciation rate of 2.77% and an annual accrual of $2.8 million. 31 In his depreciation study, Mr. Watson acknowledged that there was limited actuarial life analysis for this account. 32 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. Because the actuarial data provided by the Company for this account is limited, the Company has not made a convincing showing that an average life of only 54 years is appropriate. With respect to Account 355, I have observed depreciation studies proposing average lives up to 65 years for this account. 33 Q. ARE YOU RECOMMENDING A 65-YEAR AVERAGE LIFE FOR THIS ACCOUNT? A. No. In the interest of reasonableness, I am proposing an average life of only 56 years, which is shorter than what other utility witnesses have proposed for this account. In light of these observations, along with the fact that the Company did not provide sufficient actuarial data for this account, I propose an R3-56 curve for this account, which results in a remaining life of 49. years, a depreciation rate of 2.62%, and an annual accrual of $2.6 million Exhibit DAW-2 (Depreciation Study), pp. 55, Id. at See generally depreciation studies supra n. 2; see also Exhibit DJG See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 26/245 For the City of Mission

27 E. Account 356 Overhead Conductors and Devices Q. DISCUSS THE COMPANY S POSITION ON ACCOUNT A. Mr. Watson proposed an R3-55 curve for this account, which corresponds to a depreciation rate of 2.72% and an annual accrual of $5.4 million. 35 In his depreciation study, Mr. Watson acknowledged that there was limited actuarial life analysis for this account. 36 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. Again, the Company s limited data does not support an estimated average life of only 55 years. For Account 356, it is more typical to see average life proposals closer to 65 years. 37 Q. ARE YOU RECOMMENDING A 65-YEAR AVERAGE LIFE FOR THIS ACCOUNT? A. No. In the interest of reasonableness, I am proposing an average life of only 57 years, which is shorter than what other utility witnesses have proposed for this account. In light of these observations, along with the fact that the Company did not provide sufficient actuarial data for this account, the Company has not made a convincing showing that its proposed rates are not excessive. Specifically, I propose an R3-57 curve for this account, which results in a remaining life of 52.9 years, a depreciation rate of 2.61%, and an annual accrual of $5.2 million Exhibit DAW-2 (Depreciation Study), pp. 55, Id. at See generally depreciation studies supra n. 2; see also Exhibit DJG See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 27/245 For the City of Mission

28 Q. DESPITE THE FACT THAT THE ACTUARIAL DATA PROVIDED BY THE COMPANY FOR THIS ACCOUNT IS RELATIVELY LIMITED, ARE THERE STATISTICAL INDICATIONS THAT THE COMPANY S PROPOSED SERVICE LIFE IS TOO SHORT FOR THIS ACCOUNT? A. Yes. The graph below shows the OLT curve for this account, along with the proposed Iowa curves. As with the graph above, the OLT curve in this graph is represented by the black triangles. The graph also shows the R3-5 curve selected by Mr. Watson along with the R3-57 curve I selected. Figure 5: Account 356 Overhead Conductors and Devices Because there is limited retirement data available, the OLT curve is relatively flat, but has started to partially decline to form a typical upper portion of a survivor curve for this account. Since there is no way to visually determine which Iowa curve provides the better fit, mathematical curve-fitting techniques may be instructive 28/245 For the City of Mission

29 Q. IS YOUR SELECTED IOWA CURVE A BETTER MATHEMATICAL FIT TO THE OLT CURVE? A. Yes. Although, as discussed above, the limited actuarial data provided by the Company is not ideal for conventional mathematical curve-fitting techniques, the R3-57 curve I selected nonetheless provides a better mathematical fit to the OLT curve than the Company s selected curve. Mathematical curve fitting essentially involves measuring the distance between the OLT curve and the selected Iowa curve. The best mathematicallyfitted curve is the one that minimizes the distance between the OLT curve and the Iowa curve, thus providing the closest fit. The distance between the curves is calculated using the sum-of-squared differences ( SSD ) technique. In Account 356, the total SSD, or distance between the Company s curve and the OLT curve is.9, while the total SSD between R3-57 curve and the OLT curve is only Thus, the R3-57 curve I selected provides a better mathematical fit. Regardless, in consideration of the limited data provided by the Company, along with the statistical analysis and industry observations regarding this account, it is clear that the Company has not made a convincing showing that the depreciation rate it proposed for this account is not excessive. VI. SIMULATED PLANT RECORD ANALYSIS Q. DESCRIBE THE SIMULATED PLANT RECORD METHOD A. As discussed above, when aged data is not available, we must simulate the actuarial data required for remaining life analysis. For many of the distribution accounts in this case, Mr. Watson conducted his analysis using the simulated plant record ( SPR ) model, and I did 39 Exhibit DJG-5. 29/245 For the City of Mission

30 1 2 the same. The SPR method involves analyzing the Company s unaged data by choosing an Iowa curve that best simulates that actual year-end account balances in the account. 4 Q. DESCRIBE THE METRICS USED TO ASSESS THE FIT OF SELECTED IOWA CURVE IN THE SPR MODEL A. There are two primary metrics used to measure the fit of the Iowa curve selected to describe an SPR account. The first is the conformance index ( CI ). The CI is the average observed plant balance for the tested years, divided by the square root of the average sum of squared differences (the SSD discussed above) between the simulated and actual balances plant balances. 41 A higher CI indicates a better fit. Alex Bauhan, who developed the CI, also proposed a scale for measuring the value of the CI, as follows. Figure 6: Conformance Scale CI Value > 75 Excellent 5 75 Good 25 5 Fair < 25 Poor The second metric used to assess the accuracy of an Iowa curve chosen for SPR analysis is called the retirement experience index ( REI ) which was also proposed by Bauhan. The REI measures the length of retirement experience in an account. A greater 4 A detailed discussion of the SPR method is included in Appendix D. 41 Bauhan, A. E., Life Analysis of Utility Plant for Depreciation Accounting Purposes by the Simulated Plant Record Method, 1947, Appendix of the EEl, /245 For the City of Mission

31 1 2 retirement experience indicates more reliability in the analytical results for an account. Bauhan proposed a similar scale for the REI, as follows. Figure 7: Retirement Experience Scale REI Value > 75% Excellent 5% 75% Good 33% 5% Fair 17% 33% Poor % 17% Valueless According to Bauhan, [i]n order for a life determination to be considered entirely satisfactory, it should be required that both the retirements experience index and the conformance index be Good or better. 42 I considered both of these scales in assessing my SPR analysis for each account, as further described below. A. Account 362 Station Equipment Q. DESCRIBE THE COMPANY S ESTIMATE FOR ACCOUNT A. Mr. Watson selected the R3-4 curve for this account, which results in a depreciation rate of 2.85% and an annual accrual of $2 million. 43 Under the testing band of , the R3-4 curve has a poor CI Id. (emphasis added). 43 Exhibit DAW-2 (Depreciation Study), pp. 55, See Exhibit DJG-7. 31/245 For the City of Mission

32 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. An estimated average life of only 4 years is far too short for this account. Because the Company s recommended Iowa curve results in a poor CI according to the metric table above, the statistical results should be considered with caution, if not disregarded entirely. I would note, however, that this is not a direct criticism of Mr. Watson s work, as all of the Iowa curves applied to the full test band period result in poor CI scores. Regardless, the Company has made a convincing showing that its proposed rates are not excessive. This is especially true in light of the average lives proposed by other electric utilities for this account. With respect to Account 362, I have observed depreciation studies proposing average lives in the range of 55 6 years, which is much longer than the 4- year average life proposed by Sharyland. 45 Q. WHAT IS YOUR RECOMMENDATION FOR ACCOUNT 362? A. I selected the R curve for this account, which has a higher CI score and a lower REI score than the Company s proposed curve. As discussed above, however, all of the CI scores for the entire testing period are poor, so it is instructive to consider other service life proposals for this account, which were based on more accurate actuarial data. This is not to suggest that the SPR method cannot be the basis for valuable statistical analysis; however, Iowa curve proposals based on the SPR method should have adequate CI and REI scores, and that is not the case here. An average life of 58 years is reasonable and conservative in light of the average lives proposed by other electric utilities for this account. 45 See generally depreciation studies supra n. 2; see also Exhibit DJG-1. 32/245 For the City of Mission

33 1 2 Applying the R curve to this account results in a remaining life of 51.5 years, a depreciation rate of 1.82%, and an annual accrual of $1.3 million. 46 B. Account 365 Overhead Conductors and Devices Q. DESCRIBE THE COMPANY S ESTIMATE FOR ACCOUNT A. Mr. Watson selected the R3-43 curve for this account, which results in a depreciation rate of 3.26% and an annual accrual of $3 million. 47 Under the testing band of , the R3-43 curve has a fair CI, which would be considered unsatisfactory according to Bauhan, as discussed above. 48 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. In my opinion, an estimated life of 43 years is too short for this account. Because the Company s recommended Iowa curve results in a fair CI according to the metric table above, the statistical results should be considered with caution. Q. WHAT IS YOUR RECOMMENDATION FOR ACCOUNT 365? A. I selected the R curve for this account, which has, relative to the Company s selected curve, a considerably higher and good CI score of 61, albeit a lower REI score. It is also sometimes helpful to consider multiple test band periods in SPR analysis in order to observe potential trends in the data. For account 365, the two most recent five-year test band periods of and produced average lives in excess of 57 years 46 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 47 Exhibit DAW-2 (Depreciation Study), pp. 55, See Exhibit DJG-7. 33/245 For the City of Mission

34 with excellent CI scores, albeit low REI scores. 49 Regardless, the Iowa curve proposed by the Company for this account should be considered relatively unreliable from a statistical standpoint. Under these circumstances, it is better for the Commission to lean towards lower, yet reasonable depreciation rates (i.e., longer service lives) until the Company has enough retirement experience to be able to produce more reliable data for statistical analysis. Doing so will not financially harm the Company, and will provide ratepayers with some financial relief by reducing the impact of potential rate increase. Applying the R curve to this account results in a remaining life of 45.1 years, a depreciation rate of 2.15%, and an annual accrual of $2 million. 5 C. Account 367 Underground Conductors and Devices Q. DESCRIBE THE COMPANY S ESTIMATE FOR ACCOUNT A. Mr. Watson selected the R4-39 curve for this account, which results in a depreciation rate of 2.96% and an annual accrual of $.6 million. 51 Under the full testing band period, the R4-39 curve has a poor CI of only Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. The Company s proposed service life of only 39 years is far too short for this account. Because the Company s recommended Iowa curve results in a poor CI according to the metric table above, the statistical results should be considered with caution, if not 49 See Exhibit DJG-7. 5 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 51 Exhibit DAW-2 (Depreciation Study), pp. 55, See Exhibit DJG-7. 34/245 For the City of Mission

35 disregarded entirely. The Company has not made a convincing showing that its proposed rates are not excessive for this account. This is especially true in light of the average lives proposed by other electric utilities. For Account 367, depreciation studies I have observed propose average lives of closer to 55 years, and even up to 65 years, which are much longer than the 39-year average life proposed by Sharyland. 53 Q. WHAT IS YOUR RECOMMENDATION FOR ACCOUNT 367? A. I selected the R curve for this account, which has a higher CI score and a lower REI score than the Company s proposed curve. However, nearly all of the CI scores for the entire testing period are poor, and no curve produced a good score on both the CI and REI scales. Therefore, it is appropriate to consider other service life proposals for this account, which were based on more accurate actuarial data. Although the SPR method can be valuable for statistical depreciation analysis, Iowa curve proposals based on the SPR method should have adequate CI and REI scores, and that is not the case here. An average life of 47 years is reasonable and very conservative in light of the average lives I have seen proposed by other electric utilities for this account, which are around 55 years. Applying the R curve to this account results in a remaining life of 38.8 years, a depreciation rate of 2.32%, and an annual accrual of $.5 million See generally depreciation studies supra n. 2; see also Exhibit DJG See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 35/245 For the City of Mission

36 D. Account 368 Line Transformers Q. DESCRIBE THE COMPANY S ESTIMATE FOR ACCOUNT A. Mr. Watson selected the R4-44 curve for this account, which results in a depreciation rate of 2.75% and an annual accrual of $2.3 million. 55 Under the full testing band period, the R4-44 does not produce a good CI. 56 Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. For most of the accounts discussed in this section, the data provided by the Company did not produce any Iowa curves that could be considered good under both the CI and REI scales. For Account 368, however, there are a few Iowa curves that meet these requirements, although the Company s proposed curve was not among them. The longest average life with good CI and REI scores is 53 years. 57 Q. DID YOU RECOMMEND A 53-YEAR AVERAGE LIFE FOR ACCOUNT 368? A. No. Although the L curve qualifies as good under both the CI and REI scales, I propose using the L3-49 curve for this account, which also qualifies as good under both scales. Applying the L3-49 curve to this account is reasonable under the circumstances, and results in a remaining life of 39.4 years, a depreciation rate of 2.38%, and an annual accrual of $2 million Exhibit DAW-2 (Depreciation Study), pp. 55, See Exhibit DJG-7 57 See id. 58 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 36/245 For the City of Mission

37 E. Account 369 Services Q. DESCRIBE THE COMPANY S ESTIMATE FOR ACCOUNT A. Mr. Watson selected the R curve for this account, which results in a depreciation rate of 3.81% and an annual accrual of $1.4 million. 59 Under the full testing band period, this curve produces an extremely poor CI of only Q. DO YOU AGREE WITH THE COMPANY S POSITION? A. No. An estimated average life of only 38 years is far too short for this account. Because the Company s recommended Iowa curve results in a very poor CI according to the metric table above, the statistical results should be disregarded. The Company has not made a convincing showing that its proposed rates are not excessive for this account. This is especially true in light of the average lives proposed by other electric utilities. For Account 369, the depreciation studies I have observed typically propose average lives in the range of 5 6 years. 61 Q. WHAT IS YOUR RECOMMENDATION FOR ACCOUNT 369? A. I selected the R.5-5 curve for this account. A 5-year average life is toward the bottom end of the range of observed average life proposals for this account. Since all of the CI scores for the full testing period are poor, it is necessary in this case to consider other service life proposals for this account, which were based on more accurate actuarial data. An average life of 5 years is reasonable in light of the average lives I have seen proposed 59 Exhibit DAW-2 (Depreciation Study), pp. 55, See Exhibit DJG See generally depreciation studies supra n. 2; see also Exhibit DJG-1. 37/245 For the City of Mission

38 1 2 3 by other electric utilities for this account. Applying the R.5-5 curve to this account results in a remaining life of 38.4 years, a depreciation rate of 2.28%, and an annual accrual of $.8 million. 62 VII. CONCLUSION AND RECOMMENDATION Q. SUMMARIZE THE KEY POINTS OF YOUR TESTIMONY A. I employed a well-established depreciation system and used actuarial and simulated analysis to statistically analyze the Company s depreciable assets in order to develop reasonable depreciation rates in this case. When the actuarial and simulated data were either limited or insufficient, I considered the service lives proposed by other utilities based on more accurate actuarial data, and generally selected shorter average lives than what I had observed, which results in conservative and reasonable depreciation rate estimates. Q. WHAT IS MISSION S RECOMMENDATION TO THE COMMISSION REGARDING TO DEPRECIATION RATES? 1 11 A. Mission recommends that the Commission adopt the proposed Iowa curves and depreciation rates presented in Exhibit DJG Q. DOES THIS CONCLUDE YOUR TESTIMONY? A. Yes, including any exhibits, appendices, and other items attached hereto. I reserve the right to supplement this testimony as needed with any additional information that has been requested from the Company but not yet provided. 62 See Exhibit DJG-4 for depreciation calculations; see also Exhibit DJG-9 for detailed remaining life calculations. 63 These rates should be applied to updated plant balances in order to determine the final depreciation expense adjustment. 38/245 For the City of Mission

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40 Appendix A APPENDIX A: THE DEPRECIATION SYSTEM A depreciation accounting system may be thought of as a dynamic system in which estimates of life and salvage are inputs to the system, and the accumulated depreciation account is a measure of the state of the system at any given time. 64 The primary objective of the depreciation system is the timely recovery of capital. The process for calculating the annual accruals is determined by the factors required to define the system. A depreciation system should be defined by four primary factors: 1) a method of allocation; 2) a procedure for applying the method of allocation to a group of property; 3) a technique for applying the depreciation rate; and 4) a model for analyzing the characteristics of vintage groups comprising a continuous property group. 65 The figure below illustrates the basic concept of a depreciation system and includes some of the available parameters. 66 There are hundreds of potential combinations of methods, procedures, techniques, and models, but in practice, analysts use only a few combinations. Ultimately, the system selected must result in the systematic and rational allocation of capital recovery for the utility. Each of the four primary factors defining the parameters of a depreciation system is discussed further below. 64 Wolf supra n. 7, at Id. at 7, Edison Electric Institute, Introduction to Depreciation (inside cover) (EEI April 213). Some definitions of the terms shown in this diagram are not consistent among depreciation practitioners and literature due to the fact that depreciation analysis is a relatively small and fragmented field. This diagram simply illustrates the some of the available parameters of a depreciation system. 4/245 For the City of Mission

41 Appendix A Figure 8: The Depreciation System Cube 1. Allocation Methods The method refers to the pattern of depreciation in relation to the accounting periods. The method most commonly used in the regulatory context is the straight-line method a type of age-life method in which the depreciable cost of plant is charged in equal amounts to each accounting period over the service life of plant. 67 Because group depreciation rates and plant balances often change, the amount of the annual accrual rarely remains the same, even when the straight-line method is employed. 68 The basic formula for the straight-line method is as follows: NARUC supra n. 8, at Id. 69 Id. 41/245 For the City of Mission