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FERC Enforcement Report brief: Proactive steps to avoid FERC noncompliance

What energy and utility companies can learn from the 2021 enforcement report

Facing an audit by the Federal Energy Regulatory Commission (FERC) can be time-consuming and labor intensive. Addressing or remediating non-compliance issues can be costly as well as reputationally damaging as issues are made public. That’s why understanding what FERC looks for when it reviews accounting and ratemaking activities can help regulated energy and utility companies avoid future issues — not just with FERC but with other regulatory bodies that may focus on the very same areas.

To help accounting professionals at regulated electric, gas and oil companies avoid findings of noncompliance and minimize financial impacts, we’ve analyzed FERC’s most-recent 2021 Report on Enforcement, highlighting the top themes and common, recurring issues that emerged. We focus on the findings of the Division of Audits and Accounting as they relate to accounting and ratemaking. Beyond a recap of highlights, you’ll find a checklist with guidance intended to help your organization examine its own processes and take proactive steps today.

“Reviewing FERC’s enforcement report holistically points to a regulatory body that is increasing its scrutiny of FERC filers. In our view, many of the findings relate to matters that FERC has highlighted in the past and therefore could have been prevented if the appropriate policies, processes and controls had been adopted. Now is the time to take proactive steps to review existing processes to eliminate or mitigate the consequences of future findings.”

Sean Riley, PwC Partner

Top focus areas and takeaways you can use

Indirect cost capitalization

FERC’s Uniform System of Accounts (USofA) allows for the capitalization of indirect, general and administrative-type costs. However, it requires that the allocation have a “definitive” relation to construction and not be “arbitrary.” FERC and other regulators have observed that companies frequently use too broad of a metric for allocating the associated costs to capital, including labor capitalized over total labor. Regulators have deemed such an approach to be “arbitrary” and have disallowed capitalized costs in these instances. 

Takeaway you can use

Ultimately, regulators look for capitalized costs to be supported by direct-time charges to capital projects, which in many cases may be impractical, or require the use of a periodic time study. Further, regulators may challenge the specific activities being capitalized. Companies should assess whether their current overhead cost-capitalization process could result in regulatory scrutiny. In these cases, it may be appropriate to update policies and procedures and proactively perform a time study. Not only have we seen this issue raised by FERC, but state regulators have also challenged methodologies on similar grounds.

AFUDC accounting

FERC has found issues with both the calculation of the AFUDC rate as well as in the Construction Work in Progress (CWIP) balance to which the AFUDC rate is applied. Order 561, issued many years ago, describes the appropriate formula and inputs to be used. It appears that any FERC audit or review will include a comparison of the company’s calculation to the factors contained in that order. Any exceptions to the Order 561 rules must be accompanied by a waiver. Those without one will likely result in a compliance issue, leading to a request to recalculate the amount of AFUDC capitalized and correct for all periods, including making appropriate refunds. This would include impacts on net plant, depreciation expense, accumulated depreciation, accumulated deferred income taxes and the resulting revenue requirement.

Takeaway you can use

Energy and utility companies should evaluate their methodology for AFUDC, comparing it to Order 561. This means looking at how they determined the AFUDC rate as well as the balance to which it was applied. Be sure to include the common noncompliance areas highlighted in FERC’s report. It may be apparent, but the methodology in this area has likely been applied for many years, which could impact the total amount at issue and how far back corrections may be needed. As an example, FERC noted in its newest report that it had recently affirmed one company’s 2015 audit finding, subsequently requiring the removal of over $51 million in inappropriately calculated AFUDC from the plant balance sheet. 

Further, state commissions may have their own unique formulas for calculating AFUDC. Care should be taken to ensure that the correct calculation is used for the proper set of jurisdictions when doing ratemaking.

Classification of assets and costs

FERC frequently identifies assets and costs misclassified between distribution and transmission as well as costs recorded above the line which should be below the line costs. Examples of this latter scenario include:

  • Merger and acquisition costs

  • Employment discrimination settlement payments

  • Lobbying expenses

  • Charitable contributions

  • Penalties

In addition, FERC’s USofA includes detailed definitions of the types of costs which should be recorded in each account. FERC has identified companies using accounts inappropriately. Scrutiny is elevated when the account being used has a potential impact on ratemaking. Some of these common accounts are:

  • 900 series general and administrative accounts: FERC has identified below the line costs and costs that are more properly charged to specific operation and maintenance accounts inappropriately included as general and administrative (G&A) expenses

  • Account 165 - Prepayments: FERC has repeatedly found commitment fees, Investment Tax Credit (ITC) carryforwards, tax refunds and other balances improperly included in this account

Takeaway you can use

Performing a periodic review of your company’s policies and procedures for these types of costs may reveal inadequate processes and controls to ensure proper classification of assets and costs. Further, using data mining technologies may help companies identify costs that should be reclassified.

Common formula rate errors

Many electric utilities use formula rates filed with FERC for transmission tariffs. In these cases, FERC Form No. 1 serves as the primary source of inputs to those formula rates. Common formula rate errors have included:

  • Improper presentation and/or exclusion of excess accumulated deferred income taxes

  • Inclusion of storm cost estimates, as opposed to actuals, or double counting storm costs

  • Use of consolidation accounting when this is prohibited by FERC rules absent explicit commission approval

  • Inclusion of asset retirement obligation (ARO) balances in formula rates without commission approval

  • Amortization of regulatory assets without commission approval

  • Errors, omissions and miscalculations related to various accounts

Takeaway you can use

FERC commonly reviews formula rate filings, identifying various errors that could result in overbillings to customers. Many of these errors could be prevented with more effective coordination between accounting, tax and regulatory teams as well as through improved processes and controls. Companies may want to consider reassessing their processes and reviewing their filings for these common mistakes.

Gas tariff provisions

FERC has identified issues relating to Order No. 636 which requires that interstate natural gas pipelines maintain a tariff containing provisions regarding their services to effectively manage their systems. The commission identified several issues where companies were not following their approved tariff. Examples included the following: 

  1. Valuation of system gas during cash-out procedures.

  2. Inconsistencies in the management of imbalances and Operating Balance Agreements (OBAs).

  3. Policy for crediting reservation charges during a force majeure event.

  4. Penalty revenues that do not follow the method prescribed in the tariff.

Takeaway you can use

Each pipeline’s individual FERC tariff filing describes the methods for determining provisions for certain items. It’s a best practice to perform a review of your company’s accounting policies and procedures with your individual FERC tariff filing to make sure they’re aligned. Ensuring good coordination between groups responsible for accounting and regulatory is key to making sure provisions in the tariff are applied correctly in the company’s books.

System gas accounting

FERC identified several common issues in system gas accounting:

  1. Shipper imbalance payables and receivables were inappropriately netted with netted imbalance cash-out settlement losses.

  2. Lost and unaccounted-for gas and fuel used for underground storage compressor stations were recorded in the wrong account.

  3. Revenues from cash-out sales were recorded in the wrong account.

Takeaway you can use

FERC commonly reviews Form No. 2 to ensure balances are included in the correct accounts. These issues could be avoided by understanding and researching the prescribed accounts that should be used for these items. For shipper imbalances, remember that there are prescribed accounts for these balances and, generally, should not be netted when there are both payables and receivables. Lost and unaccounted-for gas and fuel used for underground storage compressor stations should be recorded in a transmission expense account rather than in production and gas storage expense accounts. Additionally, cash-out sales revenue should be recorded in a sales for resale account rather than a revenue account.

Natural gas misclassifications and filings

FERC frequently identifies items that are incorrect with regards to accounting and financial reporting within Form No. 2 filings. Some examples are included here.

Misclassifications

  • Items between operating and non-operating expense

  • Donations, penalties / fines, and lobbying activities

  • Membership dues

  • Costs within general and administrative expenses and operating expense

Reporting and filing

  • Improper allocation of costs and the improper use of allocation methodologies that are not supported by a time study

  • Improper accounting for minor items of property as capital expenses

  • Noncompliance with FERC Form No. 2 financial reporting requirements

  • Omitted required footnote disclosures

  • Failure to file journal entries with FERC for approval of sales and purchases

Takeaway you can use

Many of these findings are recurring in the annual enforcement report. A company’s self-review of their filings for these common errors would make for more accurate and better reporting as well as significantly cut down on the time and effort utilized by companies if chosen for audit by FERC. We have seen instances where audits can take large amounts of time and take focus away from several individuals at a company to address the findings similar to the ones noted above. Companies should proactively address these items to mitigate negative consequences of a potential FERC audit.

Oil pipeline audits

FERC also performs oil pipeline audits as part of its annual plan. These audits focus on accounting and financial reporting with an emphasis on Page 700 (Annual Cost of Service-Based Analysis Schedule) of FERC Form No. 6. We have summarized some of the oil industry related findings as follows:

  • Carrier property that is not in service is incorrectly included within Page 700

  • Misclassification of idled carrier property that has no plan for future use and misclassification of the related depreciation

  • Use of depreciation rates that are not based on a depreciation study and/or are not approved by the Commission

  • Improper use of the component method rather than the composite method of depreciation without commission approval

  • Use of outdated or stale depreciation studies

  • Misclassification of operating and non-operating expense

  • Improper accounting for equity method investments

  • Use of an unacceptable method to calculate the return on equity

Takeaway you can use

As many of the findings are around property and depreciation rates used, it’s important that companies actively monitor these balances and rates used in Form No. 6 filings to avoid restatements. Companies should also consider whether they need an updated depreciation study for approval by the commission if they believe depreciation rates have changed. Given the commission has frequent findings from audits, we encourage companies to align with regulatory groups and refresh policies and procedures periodically.

Other areas of noncompliance

FERC performs risk-based audits considering a company’s ability to demonstrate a robust compliance environment. As a result, FERC discovers a variety of areas of noncompliance as it reviews filings. Some of these areas include:

  • Use of depreciation rates not approved by FERC

  • Not following FERC Form 1 or Form 2 instructions and, therefore, not reporting all information required

  • Inconsistent application of internally calculated cost allocation percentages used to allocate costs between electric and gas utility businesses

  • Improper aggregation of maintenance expense with operating expense

  • Improper allocation of certain operating expenses among affiliates to unrelated jurisdictional companies 

Takeaway you can use

While some of these findings may be new, many have appeared in prior enforcement reports. As a result, it appears that jurisdictional companies are not referencing the FERC enforcement report and reviewing their own filings for these common errors. The cost and distraction of a FERC audit can be significant. FERC does encourage self reporting to mitigate the impacts of a FERC audit. We have observed instances in which the remediation process for FERC findings can be extremely time consuming, lasting for many months if not years. We encourage our clients to proactively address these items to mitigate negative consequences of a potential FERC audit. 

FERC enforcement at a glance

$463M

in refunds and recoveries over last four years, $18.5M in 2021.

64

findings of noncompliance.

250 

recommended corrective actions.

FERC Report on Enforcement covering an audit period of October 1, 2020, through September 30, 2021.

How PwC can help

PwC’s Complex Accounting & Regulatory Solutions is dedicated to helping companies in the energy, power and utilities industries manage regulatory risk and help solve complex accounting problems related to regulatory accounting. Our seasoned team has deep experience working with regulated entities and their regulators. We can help companies reduce risk and achieve optimal outcomes related to interactions with regulators.

Contact us

Sean P. Riley

US Energy, Utilities, & Mining Partner, PwC US

Richard Call

US Energy, Utilities & Mining Partner, PwC US

Alan Felsenthal

US Energy, Utilities & Mining Managing Director, PwC US

Mark Panza

Managing Director, Energy, Utilities, and Mining, PwC US

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