2018 General Rate Case

Transcription

1 Application No.: A.1-0- Exhibit No.: SCE-0, Vol. Witnesses: M. Childs D. Gunn P. Hunt D. Lee J. McCarson (U -E) 01 General Rate Case Public Version Before the Public Utilities Commission of the State of California Rosemead, California September 1, 01

2 SCE-0: Results of Operations Volume - Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents Section Page Witness I. SUMMARY OF ELECTRIC PLANT AND RESERVE...1 D. Gunn A. Purpose...1 B. Summary of Electric Plant-In-Service and Reserve...1 C. Recorded Plant Recording Plant: Work Order Closing Process.... Plant Held for Future Use (PHFFU).... Rate Base for Aged Pole Replacements... D. Estimated Plant Balances Forecasting Capital... Forecasting Process... Direct Capital Expenditures... Costs of Removal (COR)... Corporate Overheads... Allowance for Funds Used During Construction (AFUDC)... Contributions in Aid of Construction (CIAC)... The Date Construction Costs are Estimated to Close to Electric Plant-In-Service... (1) Specifics... () Blanket-Specifics... () Blankets... Repair-Eligible Additions... -i-

3 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness Changes in Accounting Treatment.... Forecasting Retirements... Vintage Retirements... Retirements as a Ratio of Plant Balances... E. Allowance for Funds Used During Construction (AFUDC)...1 P. Hunt F. Gains and Losses...1 D. Gunn G. Weighted Average Depreciation Reserve...1 II. DEPRECIATION EXPENSE...1 A. Purpose...1 B. Annual Depreciation Expense...1 III. TAXES...1 M. Childs A. Purpose Forecast Tax Expense...1. Extension of the TAMA...0 B. Taxes Based On Income Methodology to Calculate Income Tax Expense...0 Income Tax Methodology...0 Schedule M Adjustments... (1) Tax Depreciation... () Uniform Capitalization of Interest and Mixed Service Costs... () CIAC... () Non-Deductible Meals... -ii-

4 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness () Ad Valorem Lien Date Adjustment... () Removal Costs... () Repair... () Capitalized Software... () Synchronized Interest... () Accrued Vacation... () Preferred Dividend Deductions... (1) Manufacturer s Deduction... (1) Deduction of State Income Taxes... The Employee Stock Ownership Plan (ESOP) Dividend Deduction.... SCE s Proposals Are Consistent with Commission Decisions, Commission Policies and Tax Rules... Compliance Requirements of SCE s 01 Decision... (1) Tax Accounting Memorandum Account... () Allocation of Income Tax Expense Between FERC and CPUC; Revised Repair Deductions of Pole Loading Costs... () Rate Base Offset for Repair Change...0 () TIPA 01 Bonus Impact in Advice Letter -E...1 Commission Policies...1 -iii-

5 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness (1) Separate Return Basis...1 () Disallowed Costs and Shareholder Funded Costs are the Property of Shareholders, and Not Customers... IRS Rules... (1) Private Letter Ruling - ADIT/NOL Adjustment to Rate Base... () PLR Normalization on Rate Base Offset.... Tax Accounting Method Changes... Generation Repairs... Uniform Capitalization of Interest.... New Tax Legislation Since Last GRC... C. Payroll Taxes Old-Age, Survivors, and Disability Insurance (OASDI) Tax.... Hospital Insurance (HI) Tax.... Federal Unemployment Tax Act (FUTA) Tax.... State Unemployment Insurance (SUI) Tax.... California Employment Training (CET) Tax.... Miscellaneous Tax... D. Property Taxes... D. Lee 1. Purpose.... Methodology... California Property Taxes... -iv-

6 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness Arizona Property Taxes... Nevada Property Taxes... Washington D.C. Property Taxes...0 IV. RATE BASE...1 D. Gunn A. Purpose...1 B. Description and Methodology Fixed Capital.... Adjustments Customer Advances for Construction (Customer Advances)... J. McCarson. Working Capital Items... Materials and Supplies Inventory (M&S)... (1) Estimation Approach... () Transmission and Distribution M&S... () Generation M&S... () Information Technology and Transportation Services Division M&S...0 () M&S Rate Base Adjustments... () Total M&S Inventory... Mountainview Emission Credits Inventory.... Cash Working Capital... (1) Operational Cash Requirement... () Lead Lag Study...1 C. Working Capital Adjustments: Customer Deposits...1 P. Hunt -v-

7 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness 1. Introduction...1. Background.... Customer Deposits are Debts with Financial Consequences... Financial Impacts of Offsetting Rate Base with Customer Deposits... The Role of Equity Financing.... Standard Practice U-1 Principles... SP U-1 and Working Cash... Typical Deductions from Operational Cash Requirements.... Customer Deposits Are Not Permanent.... Impact of the Rate Base Offset...0 The Use of a Rate Base Offset Provides Excess Rewards to Customers...0 The Rate Base Offset for Customer Deposits is Inconsistent with Treatment of Fuel Inventory...1. Balancing Account Considerations.... A Change in Policy is Warranted.... Role for Customer Deposits in Outreach to Minority Suppliers and Communities... D. Deductions for Reserves... D. Gunn 1. Accumulated Depreciation Reserve.... Accumulated Amortization.... Accumulated Deferred Taxes Plant... -vi-

8 SCE-0: Results of Operations Volume Plant and Reserve, Depreciation Expense, Taxes, and Rate Base Table Of Contents (Continued) Section Page Witness. Accumulated Deferred Taxes Uniform Capitalization.... Accumulated Deferred Taxes CIAC.... Accumulated Deferred Taxes Vacation Accrual.... Unfunded Pension Reserve... J. McCarson Appendix A AFUDC Rate Formula Appendix B Confidentiality Declaration of Connie J. Erickson -vii-

9 I. SUMMARY OF ELECTRIC PLANT AND RESERVE A. Purpose This chapter summarizes SCE s electric weighted average plant and reserve balances as of recorded year 01 and expected balances for the estimated years 01 through 00. This chapter also summarizes SCE s plant work order closing process and its approach to converting capital expenditures to Electric Plant-In-Service. 1 This testimony, combined with the other testimony on SCE s capital expenditures in this GRC filing, demonstrates that SCE s Electric Plant-In-Service estimates are reasonable and should be adopted. B. Summary of Electric Plant-In-Service and Reserve Table I-1 shows Electric Plant-In-Service on a weighted average basis for the periods. These plant balances are summarized by FERC class of plant for both tangible and intangible plant. Both tangible and intangible plant is included in SCE s accumulated depreciation and total Electric Plant-In-Service (Line of Table I-1) is included in Chapter IV, Rate Base, specifically Table IV-1 of this Exhibit. 1 Electric Plant-In-Service includes FERC Account 1 (Electric Plant-In-Service) and FERC Account (Completed Construction Not Classified a placeholder for in-service costs when complete accounting is not yet available). In this context, Depreciation will include both amortization (for intangibles) and depreciation (for tangibles). 1

10 Table I-1 Summary of Electric Plant-In-Service Weighted Average Balances (Nominal $000) Line Recorded Estimated No. Class of Plant Plant Generation 1. Palo Verde 1,01, 1,,0,01,,0,,01,0,1,0. Pebbly Beach,,,,, 0,. Mountainview,1, 0,0 0, 0,1 0,. Peakers,, 0, 0,1 0, 1,1. Solar PV, 1,01 1, 1,,0,. Fuel Cell, 1, 1, 1, 1, 1,. Other Production Hydro 1,1,1 1,0, 1,, 1,1,1 1,,1 1,1,0. Total Generation,0,0,,,,,0,0,1,1,,0 Transmission. Land,,1 0,, 0,0 0,1. Substations,,0,0,01,,,0,0,,,0, 1. Lines,,,0,0,0,,,,00,,, 1. Total Transmission,01,0,, 1,01,0 1,1,1 1,1, 1,1, Distribution 1. Land,,1, 1, 1,0,0 1. Substations,,1,,,01,,,,,0,, 1. Lines 1,, 1,0, 1,,0 1,01,1,,1,, 1. Total Distribution 1,0,1 1,1,,,0,1,,,1,,1 1. General,0,1,1,,,,,,0,0,,0 1. Total Plant-In-Service,1,1 0,1,00,1,1,,1 0,,0,, Intangible Plant 0. Mountainview Intangibles,0,0,0,0,0,0 1. Radio Frequency 1, 1, 1, 1, 1, 1,. Hydro Relicensing 1, 1, 1, 1,0 1,1 1,. Miscellaneous Intangibles 1. Capitalized Software 1,,0 1,, 1,, 1,1, 1,,0 1,,. Total Intangible Plant 1,1,0 1,,0 1,,0 1,,0 1,, 1,0,. Total Plant-In-Serivce 0,00,0,,01,0,,,01 1,,,, 1 C. Recorded Plant The recorded weighted average plant balances shown in Table I-1 for 01 are from SCE s General Ledger for the 1-month period ending December 1, 01. The total recorded Electric Plant- Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. 1 (Recorded 01 Plant). The calculation of the 1-month weighted average is described in Chapter IV, Rate Base, in this Volume.

11 In-Service used to develop these averages reconciles to SCE s 01 FERC Form 1 and General Ledger as of December 1, Recording Plant: Work Order Closing Process During construction of a project, a work order is opened to record and accumulate all of the project s construction costs. During this period, the accumulated work order costs are referred to as Construction Work In Progress (CWIP-FERC Account ) or Removal Work in Progress (RWIP- FERC Account ) for installation-related and removal-related work, respectively. Upon project completion, the work order is identified as ready-for-service and all accumulated construction costs, including overheads, are transferred to Electric Plant-In-Service for installation costs or Accumulated Depreciation for removal costs. Both accounts are included in SCE s recorded Rate Base presented in Table IV-1.. Plant Held for Future Use (PHFFU) PHFFU (FERC Account ) is typically land or land rights purchased in advance of when assets are constructed. At year-end 01, the CPUC jurisdictional balance of PHFFU was $. million and is included in the respective land components in Table I-1. Additionally, all of SCE s forecast land and land rights purchases included in this filing meet California Public Utilities Commission (CPUC or Commission) guidelines for inclusion in Rate Base.. Rate Base for Aged Pole Replacements In the 01 GRC Decision, the Commission approved only part of SCE s Aged Pole program to systematically replace aged poles on a proactive basis. As shown in Table I-, below, the Commission authorized SCE s replacement of more than 1,000 aged poles over the period 01 to 01. SCE actually replaced, more poles than what the Commission authorized. In adopting only Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. 1 (Recorded 01 Plant). See Exhibit SCE-0, Vol. 0 for further discussion of accruals for cost of removal. While SCE s recorded Rate Base is trued-up each month to reflect ongoing additions and reductions (e.g., depreciation), Commission-authorized Rate Base is trued-up only subject to a Commission order, typically in connection with a GRC. Refer to WP SCE-0 Vol. 0, Chapters I & II, p. (Summary of Recorded PHFFU). D See A.1--00, Exhibit SCE-0 Volume 0, Part and Exhibit SCE-0, Volume 0 of this GRC for a discussion about the aged pole program. D.1--01, p..

12 part of SCE s forecast of poles to be replaced in the Aged Pole Replacement program, the Commission recognized that a portion of the aged poles actually replaced by SCE in 01 are in fact providing value to customers because some of the replaced poles may have otherwise failed in service. 1 As a result of the 01 GRC Decision, the Company did not collect the revenue requirement on these aged poles during the period Starting in 01, SCE s plant balances will reflect the remaining book value of the replacement poles. Table I- Aged Pole Forecast Quantities and Actual Capital Expenditures Compared to Authorized Line 01 GRC No. Item Total Units GRC Forecast,000 1,00 1,,. Actual, 1, 1,,1. Authorized,,000-1,. Auth. Less Actual - (,) (1,) (,) Capital Expenditures ($000s). 01 GRC Forecast $,0 $1,1 $, $,1. Actual $,0 $00,0 $0, $,1. Authorized $,0 $,000 $0 $1,0. Authorized Less Actual $0 -$,0 -$0, -$, 1 1 D. Estimated Plant Balances The estimated weighted average Electric Plant-In-Service balances for years in Table I-1 are calculated using a 1-month weighted average of forecast plant balances. The estimated monthly plant balances are determined by adding forecast plant additions to, and subtracting forecast retirements from, the recorded 01 Electric Plant-In-Service balance. The method for determining the monthly capital additions and retirements begins with the capital budgeting process, 1 resulting in forecast capital 1 Id., p.. The Commission found that [t]he fact that the new poles provide service to customers and are used and useful is insufficient to prove that the expenditures to purchase and install the poles should be recovered from rates, a question the Commission determined turns on the prudency of the investment. SCE believes that the Commission s determination of imprudence was limited to a finding as to the timing of the pole replacements, not as to whether the new poles themselves are used and useful to customers. 1 Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. - (Capital Additions Forecast Example).

13 expenditures. As these forecast capital expenditures close to Electric Plant-In-Service, they are added to recorded plant as discussed below. 1. Forecasting Capital All estimated capital additions shown in this GRC are derived from forecast capital expenditures included in SCE s Capital Budget and Forecast (Capital Budget), which was approved by SCE s Board Of Directors in June 01 and reviewed again in August 01, and the construction costs already spent and included in CWIP at year-end 01. To determine the Electric Plant-In-Service balance included in Rate Base, we first convert the capital expenditures into plant additions. SCE developed a forecast process to estimate additions to Electric Plant-In-Service by replicating our accounting practices for the items presented in the Capital Budget. This process is discussed in more detail below. Forecasting Process The Capital Budget, the beginning balance of CWIP, and capitalized corporate overheads provide the basis of SCE s capital additions forecast. The forecast mirrors the work order closing process, incorporating various parameters (e.g., spending patterns, closing lag, Contributions in Aid of Construction (CIAC), etc.) to estimate the capital additions to be recorded to Electric Plant-In- Service. The methodology uses CWIP work order and Work Breakdown Structure (WBS) information together with project-specific information provided in the Capital Budget and then applies recorded averages or trends as necessary to project monthly capital additions. Figure I-1, below, contains a simplified flow diagram of SCE s forecasting method. The sections following the diagram discuss all of the components and their role in the forecasting process.

14 Figure I-1 Capital Additions Forecasting Process The annual direct capital expenditures are forecast in the Capital Budget. The capitalized portions of A&G and Property Taxes are allocated pro-rata, based on the total of Directs, P&B, Payroll Taxes, and Injuries & Damages. At the same time the accumulated costs are spread out monthly (using the results of the expenditure timing analysis), the accumulated cost is reduced for a percentage of the estimated cost of removal (COR). Monthly plant additions are added to the recorded plant balance. The estimated monthly plant balance is used to calculate the weighted average plant that is included in Rate Base. Direct Capital Expenditures + P&B, Payroll Taxes, Injuries & Damages (Corporate Overheads) + A&G and Property Taxes (Corporate Overheads) - CIAC - Cost of Removal (COR) + AFUDC = Monthly Plant Additions The capitalized portions of Pensions and Benefits (P&B), Payroll Taxes, and Injuries & Damages are allocated prorata, based on the estimated labor cost portion of the direct capital expenditures. After loading the total direct capital expenditures with capitalized corporate overheads, a percentage of the total cost is estimated as CIAC, reducing the amount estimated as Plant- In-Service. AFUDC is calculated by applying the estimated rate to the accumulated balances on a monthly basis. 1 Direct Capital Expenditures SCE s Capital Budget contains estimated 01 through 00 direct capital expenditures. Direct capital expenditures include costs for materials, direct labor, costs for removal, and divisional overheads. Divisional overheads are costs that support a group of construction projects within a division of the company (i.e., costs that cannot be assigned to any one particular project). These costs include divisional management, administration and accounting, and costs for supplies and tools. Supply costs include purchasing, storing, handling and distributing the materials and supplies stored in inventory. Tool costs include tools and related equipment that are $00 or less per unit, as well as the depreciation charges for tools and equipment in Electric Plant-In-Service.

15 1 1 1 Table I-, below, shows each SCE Organizational Unit (OU) presenting testimony in this GRC about its direct capital expenditure estimates for Table I- also provides an Exhibit/Witness listing where each of the direct capital expenditures are addressed. 1 Table I- Directory Of Capital Expenditures Line No. Operating Unit Exhibit Witness 1. Palo Verde SCE-0, Volume 01 Tom Champ. Mountainview & Peakers SCE-0, Volume 0 Serge Handschin. Hydro SCE-0, Volume 0 Timothy Condit. Solar Photovoltaic & Fuel Cells SCE-0, Volume 0 Pt. 1 Serge Handschin. Pebbly Beach SCE-0, Volume 0 Pt. Anthony Edeson. Transmission & Distribution SCE-0, Volumes - Various. Customer Service SCE-0 Various. Information Technology & Capitalized Software SCE-0 Various. Power Procurement SCE-0, Volume 0 Joanne Tran. Operational Services SCE-0, Volume - Various. Business Resiliency & Corporate Security SCE-0, Volume 1 & Various Costs of Removal (COR) COR, are capital costs related to removing and disposing of a plant asset. COR is included in the direct capital expenditure budget as a direct expenditure. COR is not capitalized to Electric Plant-In-Service but is instead recorded as a debit (decrease) to SCE s Accumulated Depreciation. To estimate plant additions, SCE offsets the direct capital expenditures for amounts expected to be allocated to COR. 1 It should be noted that, the COR embedded in the direct capital expenditures is not the same as the COR recovered through depreciation accruals. The former represents the cash outlay that will be made during for the assets expected to retire in those years; the latter is the accrual for the future removal of all existing assets. In accounting terms, the accrual for COR credits (increases) accumulated depreciation reserve as a provision for future removal cost. The cash outlay 1 Testimony and workpapers are provided for each project exceeding $ million in cost over the period. 1 Each Budget item is cross-referenced to the appropriate Exhibit. Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. -0 (Adjusted Capital Budget). 1 Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. 0- (Cost of Removal Analysis) for the list of recorded percentages used by class of plant.

16 debits (decreases) the accumulated depreciation reserve for the previously accrued provision for removal cost. For example, assume a distribution pole with a 0-year service life and an expected cost of removal of $1,00. The annual depreciation expense for COR will be $0 ($1,00 / 0). At the end of 0 years, the accumulated depreciation will have been credited for the total $1,00. In the year the pole is expected to retire, $1,00 is included in SCE s capital budget and allocated to RWIP for the $1,00. Upon completion of the project, SCE will reclassify the $1,00 of RWIP to the accumulated depreciation reserve, offsetting the accrued COR of that pole. Corporate Overheads Capitalized Corporate Overheads, similar to capitalized divisional overheads, are allocated to SCE capital projects. Unlike divisional overheads, however, Corporate Overheads support all SCE projects rather than specific OU projects. Recorded corporate overheads are allocated monthly through work order cost elements. Forecast capitalized corporate overheads consist of costs for Corporate Administrative and General (A&G), 1 Pensions & Benefits (P&B), 1 Payroll Taxes, 1 Property Taxes, 0 and Injuries & Damages. Corporate overheads are included in SCE s plant forecast by allocating them prorata to eligible capital expenditures. Capitalized overheads for P&B, Payroll Taxes, and Injuries & Damages are allocated to capital projects based on their proportional share of estimated SCE labor costs. A&G and Property Taxes are allocated pro-rata based on total construction cost (Direct Expenditures, P&B, Payroll Taxes, Injuries & Damages) consistent with SCE s plant accounting process. Allowance for Funds Used During Construction (AFUDC) Accruing for AFUDC is the generally accepted regulatory accounting procedure to capitalize the cost of debt and equity funds used to finance capital projects. 1 The annual estimated AFUDC rates are developed from estimates of costs of debt and equity required to fund the forecasted construction estimates. The estimated amount of AFUDC to include in the estimated plant additions is determined by applying the estimated AFUDC rates to the accumulated capital costs, similar to a 1 See SCE-0 Vol. 0 Capitalized Administrative and General Expense. 1 See SCE-0 Vol. 0, Capitalized Pension & Benefits Expense. 1 See Chapter III of this volume ( Taxes ). 0 Id. 1 FERC 1 Code of Federal Regulation, Electric Plant Instruction Components of Construction Cost, subparagraph 1 Allowance for Funds Used During Construction. Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. 1- (Corporate Overheads and AFUDC).

17 compounding monthly interest calculation. See Chapter I, Section E below for a more detailed discussion of AFUDC. Contributions in Aid of Construction (CIAC) Some of SCE s construction costs are borne by third parties. For example, when a car hits one of SCE s distribution poles, the cost of replacing the pole (and removing the existing one) is often paid for by other parties. Such amounts are recorded as CIAC, which offset recorded expenditures for installation, cost of removal, and related expense on a pro-rata basis. Prior to 01, CIAC sequentially offset related expense, cost of removal, and plant in service. If there were any excess funds, the residual was credited to Other Operating Revenue (OOR). To properly offset estimated capital additions for CIAC, we reduce our estimates by a percentage estimated as CIAC, which is applied on a project-specific basis. Recorded year-end 01 reimbursements are applied to recorded CWIP and RWIP to remove their effect from the forecast. The Date Construction Costs are Estimated to Close to Electric Plant-In-Service SCE s forecast of plant additions does not include costs until the date projects are expected to be placed in service. Correctly forecasting the level of plant additions each year relies on estimating when construction costs are expected to be in service. For example, we may estimate expenditures for a specific project in years 01-00, but the project may not be completed and placed into service until September of 00. Our Electric Plant-In-Service estimate should reflect the estimated in-service date of September, 00. Rather than assume that a percentage of annual capital spending will close each year, SCE uses project-specific information whenever possible to estimate when the costs should be included in Electric Plant-In-Service. The budget items in SCE s Capital Budget are divided into three closing categories, determined by the type of construction work each budget item represents and how the work orders will most likely be processed. The three categories are discussed below. (1) Specifics Specific type budget items are a single construction effort (e.g., construction of a substation) in which all of the estimated costs will close to plant when the asset is In April 01 SCE upgraded PowerPlan, our capital accounting system of record. As part of the upgrade, SCE eliminated its custom CIAC code in favor of the standard PowerPlan pro-rata allocation methodology. Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. -0 (Adjusted Capital Budget) for an itemized list of budget items and the CIAC percentage.

18 placed in service. The in-service date shown in the Capital Budget is used to estimate the month and year the total accumulated construction costs will close to plant. Recorded year-end 01 CWIP work orders are synchronized with the capital budget to identify what costs are part of a specific project. The CWIP work order is then assigned the same in-service date as the project in the Capital Budget. () Blanket-Specifics Blanket-Specifics are budget items that are often considered blanket budget items because the estimated capital expenditures represent multiple construction efforts that are placed into service separately. A majority of SCE s distribution budget items fall into this category. A good example of a blanket-specific type of project is SCE s pole loading program. These budget items encompass multiple work orders, each of which is for a distinctive construction effort. Blanket-Specifics are forecast to close to plant within a certain period of time after money is spent. For example, a four-month lag indicates that expenditures forecast in January would close to plant in May, with all respective overheads and adjustments. Blanket-Specific work orders in recorded year-end 01 CWIP are closed evenly over the lag time. For example, a fourmonth lag will close a Blanket-Specific CWIP work order evenly over the first four months of 01. The lag times used in the capital additions forecast were developed through analyzing recorded work orders, by class of plant, for the length of time (in months) they remained in CWIP before being closed to plant. () Blankets Blankets represent expenditures for assets requiring minimal or no construction effort to place in service. Furniture and Equipment is an example of a blanket budget item. Charges to blanket work orders are recorded to plant one month after the money is spent. For example, expenditures forecast in January will close to plant in February. All blanket work orders in recorded year-end 01 CWIP are closed in January of 01. Repair-Eligible Additions Each capital addition is multiplied by the repair eligibility ratio to estimate the total annual capital additions eligible for tax repair deductions. For a discussion of the development of the ratios used to support calculation of the repair-eligible additions, refer to Chapter III of this Volume Taxes. Changes in Accounting Treatment Periodically, SCE evaluates its capitalization accounting policies to evaluate whether they are aligned with current construction practices. As a result of these reviews, SCE plans to

19 capitalize (1) temporary facilities (shoofly) constructed in support of capital construction, and () certain activities system operators perform in support of capital construction. Both were previously charged to expense. These costs will now be capitalized as part of the underlying construction project.. Forecasting Retirements SCE uses two methods to forecast plant retirements depending on the class of plant: (1) vintage retirements, based on the vintage year balances and service lives, and, () retirement ratios. Each is discussed below. Vintage Retirements SCE uses vintage year accounting for a majority of its General & Intangible (G&I) Plant accounts consistent with FERC Accounting Release No. 1. This approach allows SCE to record only the total cost of capital additions for the year as a vintage group for each account, eliminating the need to maintain property records of individual items. The vintage groups are then retired according to the service life of the Plant Account/Subaccount. SCE began applying vintage retirement accounting for capitalized software in 00. All vintage retirements are applied mid-year. Retirements as a Ratio of Plant Balances Estimated plant retirements for all other classes of plant are based on historical average ratios of retirements to plant balances. The retirements in this category represent final retirements for mass property (e.g., transmission and distribution assets), and interim retirements for generation stations. The retirements for these classes of plant are difficult to predict, as they follow no recognizable historical pattern. For this reason, forecast retirements are calculated by applying this average historical rate and are applied mid-year. A shoofly is a temporary electrical line on temporary poles that is used during construction to maintain electrical service to the area while allowing portions of a permanent line to be taken out of service, helping to help ensure safe working conditions during construction activities. Activities include writing and executing switching programs to electrically isolate, energize, or test equipment in the field in support of capital work. Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. - (Vintage Retirements). Applicable to FERC Plant Accounts 0, and 1 through. Refer to WP SCE-0 Vol. 0, Chapters I & II, p. - (Retirement Ratios) for the development of retirement ratios.

20 E. Allowance for Funds Used During Construction (AFUDC) AFUDC is the standard way of capitalizing equity and debt costs incurred for financing CWIP. Capitalizing these costs helps to ensure that full construction costs are paid by customers who received the services provided by the capital projects. 0 It also helps ensure that investors costs incurred during construction are fully recovered after the capital projects enter service. The formula for the AFUDC rate is prescribed by the FERC Uniform System of Accounts, 1 which SCE must follow. Appendix A provides more detail regarding the AFUDC rate formula. The formula can be expressed in a short-hand way as AFUDC = STD STD s + WACC 1 if STD is less than CWIP, or CWIP CWIP AFUDC = s if STD is greater than or equal to CWIP where AFUDC is the AFUDC rate, s is the cost of short-term debt, STD is the average level of short term debt in a year, CWIP is the average CWIP balance in a year, and WACC is the weighted average cost of permanent capital (common equity, preferred equity, and long-term debt). WACC can be approximated by SCE s authorized return on rate base as set by the Commission. What the formulas above show is that the ratio of short-term debt to the CWIP balance is the primary driver of the AFUDC rate. SCE has been granted two waivers by FERC to exclude short-term debt devoted to finance balancing accounts and short-term debt devoted to finance fuel inventories from the calculation of short-term debt in the AFUDC rate calculation. Recently, SCE was granted a third waiver to exclude short-term debt and long-term debt associated with the financing of the SONGS & settlement regulatory asset. The FERC s regulations do not dictate how a utility should finance its construction activities, but instead establish formulas to allow recovery of capital financing costs incurred during construction 0 Because AFUDC is capitalized, it is a non-cash return. Cash earnings associated with AFUDC only appear when AFUDC is included in rate base and the associated return of and on capital is charged in customer rates. Only when CWIP is included in rate base, which is an exception to standard ratemaking, does CWIP provide cash earnings while a project is under construction. 1 Title 1, Code of Federal Regulations, Chapter I, Subchapter C, Part 1, Electric Plant Instructions, Section.A(1). Available at D.0-1-0, Appendix A- ( Affiliate Transaction Rules Applicable to Large California Energy Utilities ), Section V.B.1: Utility books and records shall be kept in accordance with applicable Uniform System of Accounts (USOA) Refer to WP SCE-0 Vol. 0, Chapter I, pp. 0. 1

21 periods specifically, to make sure that short-term debt costs incurred are properly recovered. FERC does not mandate the amount of short-term debt to use. In fact, SCE uses its short-term debt capacity for several purposes: general corporate short-term borrowing, financing balancing account undercollections, financing fuel inventories, and financing collateral for power procurement transactions. Because SCE uses short-term debt for these multiple purposes, and because it is prudent for SCE to keep a reserve level of short-term debt capacity in the event of unforeseen financing needs, SCE s short-term debt capacity will often exceed its short-term debt outstanding by a substantial margin. In the rulemaking that resulted in the AFUDC formulas, various utilities argued that short term debt is not necessarily the first source of construction funds, as would be indicated by the formulas. The Federal Power Commission (FPC, the FERC s predecessor) agreed that [i]t is generally impossible to specifically trace the source of funds used for various corporate purposes and it was not the purpose of our proposed rule to do so. Rather, the FPC found that short-term debt was not ordinarily included in rate proceedings, yet it was a reasonable cost of service that should be recovered. The FPC used the AFUDC formula to permit the recovery of the cost of short-term debt through rates. There was no intention to mandate the use of short-term debt for construction purposes. SCE s projected AFUDC rates through the post-test year period are shown in the following Table I-. Order No. 1, F.P.C. 0, 0 (1), aff d in relevant part by Order No. 1-A, F.P.C. (1). Refer to WP SCE-0 Vol. 0, Chapter I, pp. 1. Order No. 1, F.P.C. at 0-0. Id. at 0. Id. Id. at 0-0. The 01 AFUDC rate is based on a June 01 forecast. See WP SCE-0 Vol. 0, Chapter I, pp. 1. 1

22 Table I- Forecast AFUDC Rate Year AFUDC Rate 01.0% 01.0% 01.1% 01.% 00.% 1 F. Gains and Losses The gains and losses on minor sales of property are allocated between customers and shareholders pursuant to Commission policy. 0 These sales are for non-operating property originating in FERC Accounts 1 or and transferred to FERC Account prior to sale. Gains and losses on major sales such as the divestiture of power plants and the sale of SCE Streetlights are treated individually at the Commission and are not included in this filing. 1 The allocation of the gains and losses on the sales included in this filing are based on a two-step process: (1) the amount of time the property was included in rate base; and () whether or not the property was depreciable. Table I- summarizes the results of these two steps for the gains and losses on sales of assets recorded for the past three years, 01 through 01. A three-year recorded average is a reasonable estimate of annual customer gains/losses. This estimate is used in SCE-0, Volume 01, in the calculation of OOR. 0 D as modified by D This filing also excludes routine asset sales where the sale price is greater than $0 million or where the aftertax gain or loss is greater than $ million (D as modified by D.0-1-0). The gain or loss based on time in rate base is allocated: 0 percent to customers for depreciable assets; and percent to customers for non-depreciable assets. 1

23 Table I- Allocation of Gains/Losses Customer/Shareholder (Nominal $) Allocated to Allocated to Customers Shareholders Year Depreciable Non-Depreciable Non-Utility Total 01 $, $, $ 1,0 $, 01,,, 1,1,, 01 (,) 1,0 () 1,0 Average, 1,, 1,0, Percent to Customers 0% % 0% Customer Allocation,,00 0,1 Shareholder Allocation 0 1,,,0 1 G. Weighted Average Depreciation Reserve The weighted average depreciation reserves for recorded year 01 and forecast years 01 through 00 are presented in Table I-. The weighted average depreciation reserve is also shown in Chapter IV, Rate Base. RWIP does not have depreciation expenses because it represents dollars that have been spent to remove facilities but have not yet been closed to accumulated depreciation. The resulting balance decreases total accumulated depreciation for rate base purposes. 1

24 Table I- Total Depreciation Reserve and Accumulated Amortization Weighted Average Balances (Nominal $000) Line Recorded Estimated No. Class of Plant Accumulated Depreciation Generation 1. Palo Verde 1,, 1,, 1,1, 1,, 1,0, 1,,0. Pebbly Beach,1,0,0,,0,. Mountainview 1,,, 0, 0,,. Peakers 1, 1,, 1,0 1, 1,1. Solar PV,,,01, 1,1 1,. Fuel Cell,,1,,,1,. Other Production 1, Hydro, 1,0, 0,,1,0. Total Generation,1,,0,0,,,,1,,,, Transmission. Land 0,,0, 1,0,,0. Substations 0,,, 1,00, 1,01,1 1,,1 1. Lines 1,0,1 1,1,1 1,, 1,1, 1,1,0 1,, 1. Total Transmission,0,,,1,,,,0,0,,1, Distribution 1. Land,,,1,1,1 1,0 1. Substations,,1 1, 0, 0,, 1. Lines,1,0,,,1,00,,0,,,,0 1. Total Distribution,,0,,1,,1,0,0,,0,,0 1. General, 1,0,0 1,0, 1,0,1 1,0, 1,1, 1. Total accumulated Depreciation 1,1, 1,1, 1,0, 1,01, 1,0, 1,0, Accumulated Amortization 0. Mountainview Intangibles 1, 1, 1, 1,0 0,1 1, 1. Radio Frequency,,,1,,,. Hydro Relicensing,,,1 0,,,0. Miscellaneous Intangibles (1) (). Capitalized Software 1, 1,0,,,,. Total Accumulated Amortization,0,,0,0,0 0,. Weighted Average RWIP - (,1) (,1) (,) (,) (0,0) Total Accumulated Depreciation. and Amortization 1,1, 1,, 1,,0 1,, 1,, 1,0, 1

25 II. DEPRECIATION EXPENSE A. Purpose To provide service to its customers, SCE incurs expenses and makes capital expenditures. Generally Accepted Accounting Principles (GAAP) and application of the FERC Uniform System of Accounts govern whether a particular cost should be capitalized or expensed. While SCE earns a return on its capital assets by applying an authorized rate of return to its (Rate Base), SCE s return of investors capital is made through depreciation expense. Depreciation provides a mechanism for the recovery of the original cost of the capital expenditures and the future cost to retire those assets over their useful life. The depreciation expense accruals for proposed in this (second) volume of Exhibit SCE-0 are designed to accomplish this latter objective and are shown in Table II-, below. The third volume of Exhibit SCE-0 sets forth the results of SCE s depreciation study, including proposed parameters and rates for all plant accounts, and explains how SCE addressed the depreciationrelated compliance objectives from the 01 GRC Decision. For 01, SCE proposes total company depreciation expense of $,00 million, a $ million, or 1 percent, increase over the level recorded in 01 based on 01 GRC authorized rates. Table II- Depreciation Expense Proposal Depreciation Line Expense No. Item (Nominal $M) 1. Recorded 01 Depreciation Expense $1,. Change due to Plant Growth $. Change due to Depreciation Study $1. Proposed 01 Depreciation Expense $, B. Annual Depreciation Expense The annual depreciation expense recorded in 01 and forecast for 01 through 00 is presented by class of plant in Table II- below. Refer to WP SCE-0 Vol. 0, Chapters I & II, pp. (Recorded 01 Depreciation Expense). 1

26 Table II- Recorded and Estimated Depreciation Expense (System Basis, Nominal $000) Line Recorded Estimated No. Class of Plant Depreciation Generation 1. Palo Verde, 1,0 1, 1, 0,,1. Pebbly Beach,0,1,,0,,0. Mountainview 1,0 1,,0,0,,. Peakers,000,0,1,,,0. Solar PV 1, 1, 1,,,,. Fuel Cell 1,0 1, 1, 1, 1, 1,. Other Production () () () Hydro,0,,,, 0,. Total Generation,,1,01, 1, 1, Transmission. Land,,,00,,,. Substations 1, 1,1 1, 1,1 00, 1, Lines 1,00,1 1, 1,1,0 01, 1. Total Transmission, 0,,0,1,1 1, Distribution 1. Land 1,1 1,1 1, 1,0 1, 1. Substations,1,,1 0,1,, 1. Lines,,,1, 1,0,0 1,,0 1. Total Distribution,,, 1,0, 1,1,0 1,1, 1. General,1,00,,,, 1. Total Depreciation 1,1, 1,, 1,,0 1,, 1,,01,0,0 Amortization 0. Mountainview Intangibles 1,1 1, 1, 1,1 1,1 1,1 1. Radio Frequency. Hydro Relicensing,,0,01,0,,. Miscellaneous Intangibles Capitalized Software,,1,1,1,,0. Total Amortization,,, 1,0, 1, Total Depreciation and. Amortization 1,, 1,,00 1,0,,00,,,0,0, 1

27 III. TAXES This chapter summarizes the basis for SCE s proposed total tax expense of $0 million for 01, and its proposed tax adjustments to rate base. This chapter also explains the reasons why SCE proposes to extend the Tax Accounting Memorandum Account ( TAMA ) to, among other things, true up forecast tax repair benefits that are flowed through to customers to reflect the actual recorded amounts. SCE also addresses tax-related compliance directives from the 01 GRC. A. Purpose 1. Forecast Tax Expense This chapter includes SCE s estimated income tax expense, payroll tax expense and property tax expense for test year 01, and provides supporting descriptions and documentation to demonstrate that the tax expense amounts are just and reasonable. Section B of this chapter describes taxes based on income. Section C describes payroll taxes, and section D describes property taxes. This chapter also reflects recorded tax expense for base year 01 and estimated tax expense for forecast years as well as attrition years If the Commission adopts levels of cost-of-service expense or capital expenditures that are different from what has been proposed in this testimony and related exhibits, SCE s income, payroll and property tax expense will be recalculated to reflect the impact of any changes. Federal, state and local tax laws, as enacted through the date of the filing of this GRC, are reflected in the tax estimates. Table III- below summarizes the tax expense amounts for recorded 01 and estimated 01 through 00. Table III- Summary of Total Taxes (Nominal $000) 1

28 Extension of the TAMA Ordering Paragraph 0 of SCE s 01 GRC Decision authorized SCE to create a twoway Tax Accounting Memorandum Account (TAMA) to track all tax changes during this General Rate Case period. SCE proposes to extend all of the applicable provisions of TAMA to years 01 through 00. This proposed extension will continue to mitigate any tax-related ratemaking implications resulting from estimating differences between forecast and incurred repair deductions, changes in tax law and guidance associated with tax depreciation, and the impact of any tax accounting method changes. The forecast tax expense in this volume is predicated on the Commission s approval of SCE s request to extend TAMA to years 01 through 00. Upon Commission approval of SCE s proposal to extend the TAMA through 00, SCE will include in its Tier 1 advice letter implementing the 01 GRC changes to Preliminary Statement Part N. to reflect the extension of the TAMA over the 01 GRC cycle. B. Taxes Based On Income This section provides SCE s recorded 01 income tax expense and estimated income tax expense for years 01 through 00. Subsection 1 describes the methodology used to compute income tax expense and deferred tax rate base adjustments. Subsection provides the income tax-related compliance information required by SCE s 01 GRC and describes how SCE s ratemaking treatment of taxes is consistent with the tax code and related guidance, as well as tax-related regulatory policies and other prior decisions adopted by this Commission. Subsection also describes SCE s currently effective TAMA that records and updates revenue requirements for changes in repair deductions, changes to tax law or tax guidance regarding tax depreciation, and changes to accounting methods and other specified tax changes that occur over the 01 GRC cycle (01 01). Subsection describes tax accounting method changes, and subsection describes recent tax-related legislation. 1. Methodology to Calculate Income Tax Expense Income Tax Methodology Income tax expense is a function of cost-of-service amounts and capital expenditures adopted by this Commission, as adjusted to comply with income tax rules. The methodology used to compute income tax expense is dictated by: (1) federal and state tax laws, D (SCE s 01 GRC). Compliance with the 01 GRC decision is discussed in more detail at Chapter III, Section B..a., below. 0

29 regulations and other tax guidance; and, () ratemaking policies and procedures prescribed by the Commission. Total income tax expense is equal to the current federal and state income tax expense amounts plus the deferred income tax expense amount. This result is adjusted further for any appropriate credits that reduce income tax expense to derive the final total income tax expense amount. Current income tax expense is computed based on taxable income. Taxable income is calculated by adjusting net operating revenue as authorized in this rate case to conform to federal and state tax rules. These adjustments are commonly referred to as Schedule M adjustments. Taxable income is then multiplied by the applicable federal and state income tax rate to compute the current income tax expense (when there is taxable income) or benefit (when there is a taxable loss). To compute the deferred income tax expense, Schedule M adjustments that are subject to normalization tax treatment are multiplied by the applicable income tax rate. The Federal Internal Revenue Code (IRC) requires normalization tax treatment for Schedule M adjustments that adjust cost-of-service depreciation expense amounts to conform with tax depreciation deductions permitted by IRC Section 1. Additionally, the benefits associated with investment tax credits are also subject to the normalization provisions of the IRC. Normalization can also be mandated or required by this Commission. Schedule M adjustments not subject to the normalization parameters described above are accorded flow-through tax treatment. Under flow-through tax treatment, no deferred income tax expense or benefit would be computed on flow-through Schedule M adjustments. Only the current tax expense would be affected by the Schedule M adjustment. Finally, the total income tax expense amount includes reductions for any tax credits or other permissible adjustments to the tax liability. IRC 1(i)(). IRC 0(d)(). Detailed descriptions of the Schedule M adjustments and applicable normalization or flow-through treatment are provided in subsection (b) immediately below. For an illustration of the difference between flow-through and normalization ratemaking, refer to WP SCE-0 Vol. 0, Chapter III, Book A, pp These adjustments include IRC-permitted investment tax credits, grants in lieu of investment tax credits permitted under section of the American Recovery and Reinvestment Act of 00, and research tax credits permitted under IRC 1. 1

30 Schedule M Adjustments This section describes the Schedule M adjustments required under the applicable tax rules. It also indicates whether the adjustments follow flow-through tax ratemaking treatment or normalization treatment as required by the IRC or as allowed by this Commission. Table III- and Table III- below list the federal and state Schedule M adjustments forecast in this volume and are explained in the following sections. Table III- Federal Schedule M Adjustments (Nominal $000) Table III- State Schedule M Adjustments (Nominal $000)

31 (1) Tax Depreciation For Federal income tax purposes, assets placed in service after are subject to the accelerated cost recovery depreciation system under IRC Section 1. 0 The depreciation rates under IRC Section 1 and related guidance generally provide greater annual depreciation deductions in the early years of an asset s life than typically allowed for financial reporting purposes. In recent years, IRC Section 1 has been amended to allow additional first-year bonus depreciation deductions. SCE utilizes ACRS/MACRS depreciation, including bonus, to the extent permitted by the IRC, and has reflected these depreciation amounts in this GRC proceeding. As previously stated in this testimony, differences between tax depreciation deductions permitted under IRC Section 1 and depreciation expenses permitted for ratemaking and financial reporting purposes are subject to the normalization requirements. Assets placed in service prior to are subject to the depreciation provisions that existed at that time, which was generally IRC Section 1. Pre- depreciation was calculated using the Asset Depreciation Range System (ADR), which utilizes a double-declining balance depreciation method that switches to a straight-line method when book depreciation exceeds the doubledeclining balance method. California has not adopted the ACRS/MACRS depreciation convention and, instead, uses the ADR methodology for all tax years. The ADR rules are not subject to the normalization requirements, therefore flow-through tax treatment applies to federal tax depreciation adjustments on pre- assets and almost all state tax depreciation differences. () Uniform Capitalization of Interest and Mixed Service Costs For tax purposes, SCE is required under the capitalization provisions of IRC Section A to capitalize interest and other indirect costs attributable to self-constructed assets used in its electric generation, transmission and distribution lines of business. To comply with these rules, SCE makes three primary adjustments, (1) reverses certain amounts capitalized for ratemaking purposes, () capitalizes interest under IRC Section A, and () capitalizes other indirect mixed service costs under IRC Section A. For financial reporting and ratemaking purposes, SCE capitalizes financing costs attributable to self-constructed assets based on the AFUDC rates that are prescribed by 0 Accelerated Cost Recovery System, commonly referred to as ACRS, for property placed in service after and before 1, and Modified Accelerated Cost Recovery System or MACRS for property placed in service after 1.

32 this Commission and applied to the construction base. These capitalized amounts are reversed for tax purposes and the differences attributable to AFUCD Debt are subject to normalization tax treatment while differences attributable to book AFUDC Equity are subject to flowed-through tax treatment. The capitalized interest amount for tax purposes is based on long-term interest rates applied to the construction base. This adjustment is the tax equivalent of AFUDC Debt and is also subject to normalization tax treatment. IRC Section A also requires capitalization of all direct and indirect costs that are incurred in the production of inventory. Indirect costs include mixed service costs, which are O&M expenditures allocated partially to capital assets. Because SCE is a utility that does not produce inventory per se, these rules result in an accelerated tax deduction. While the current tax deduction associated with mixed service costs is not subject to the normalization requirements of IRC Section 1, SCE proposes to continue to normalize these adjustments consistent with the other tax adjustments subject to IRC Section A described above. SCE is recording the appropriate reduction to rate base to account for these differences. () CIAC For tax purposes, CIAC is generally required to be included in the utility s taxable income. The value of the related asset must be capitalized and depreciated over its applicable tax life. For financial reporting purposes, CIAC is not treated as income and does not have a basis for future book depreciation. Differences between these two methods are treated by SCE under the Method ratemaking mechanism prescribed in D Under Method, SCE collects the cost of the facility (i.e., the CIAC) from the contributor as well as an additional amount (the income tax component of the contribution or ITCC) to partially compensate SCE for the additional up-front tax liability as a result of this taxable transaction. The ITCC is amortized for ratemaking purposes as other operating revenue over the tax life of the related property. The unamortized ITCC balance, also referred to for ratemaking purposes as deferred revenue, and the accumulated deferred income tax associated with the undepreciated tax basis, are both components that adjust rate base. Differences between tax and book treatment of CIAC are normalized consistent with D () Non-Deductible Meals Only 0 percent of expenses incurred for business-related meals are generally permitted to be deductible for tax purposes. This Schedule M makes the adjustment for the

33 disallowed portion of business-related meals. The non-deductible meals is a permanent Schedule M adjustment that is accorded flow-through tax treatment. () Ad Valorem Lien Date Adjustment For income tax purposes, property taxes are deductible in their entirety on their lien date. For financial reporting purposes, property taxes are accrued and expensed ratably over the period to which they relate. Flow-through tax treatment is utilized for these differences. () Removal Costs Removal costs are deductible for income tax purposes when they are incurred. For financial reporting and ratemaking purposes, removal costs are estimated and accrued in book depreciation expense. Removal costs associated with assets depreciable under IRC Section 1 are subject to normalization tax treatment, whereas removal costs associated with assets not depreciable under IRC Section 1 (generally, pre- vintages and California tax treatment) are subject to flowthrough tax treatment. () Repair This Schedule M adjustment reflects the difference between expenditures that are permitted for tax purposes to be deducted when incurred as repairs and those same expenditures required to be capitalized for financial reporting purposes. SCE applies the repair deduction consistent with the guidance provided in IRS Revenue Procedures 0- and 01-. These revenue procedures provide more expansive definitions of units of property that generally result in the deduction for tax purposes of expenditures that are typically capitalized for financial reporting purposes. Repair deductions are not required by the IRC to be normalized. SCE utilizes the flow-through tax treatment for these differences. Pursuant to SCE s 01 GRC, repair deductions incurred in 01 through 01 are subject to SCE s TAMA, which will adjust revenue requirements for any changes in authorized versus actual repair deductions. As indicated in Section A., above, SCE proposes that the TAMA be extended over this GRC cycle to include activity for the years 01 through In this way, customers will receive the full benefit in rates of the actual repair deductions recorded. 1 See Section A..

34 () Capitalized Software For financial reporting purposes, costs associated with internally developed software are typically capitalized and amortized over their book lives. For income tax purposes, certain portions of those costs may be deducted when incurred. The remaining costs are capitalized and amortized for tax purposes under IRC Section 1(f) over a three-year period. Tax adjustments related to internally developed capitalized software costs are subject to flow-through tax treatment. () Synchronized Interest This Schedule M deducts the interest expense associated with the rate-ofreturn debt component on rate base. For state tax purposes, the interest deduction is based on rate base net of any deferred ITC because these credits are not available for state income tax purposes. SCE utilizes the flow-through tax treatment for this deduction. () Accrued Vacation For financial reporting purposes, vacation expense is determined by the amount of vacation earned during the year. For income tax purposes, vacation must be earned during the year and paid within two and a half months after the end of the tax years to be deductible in the year earned. Otherwise, it is deductible in the following year when paid. Normalization tax treatment is utilized for this timing difference. () Preferred Dividend Deductions IRC Section permits the deduction of dividends from certain preferred stock of public utilities. Although this tax code section was repealed in 01, the amendment made by this act did not apply to preferred stock, such as SCE s, that were issued prior to October 1, 1. SCE will continue to include this Schedule M deduction in this rate proceeding. The adjustment is a permanent Schedule M deduction that is accorded flow-through tax treatment. (1) Manufacturer s Deduction IRC Section 1 permits a deduction for a percentage of net income derived from the generation of electricity. The deduction is equal to nine percent of the lesser of the qualified production activities income or the total taxable income. SCE has included the calculation of the estimated manufacturer s deduction in its forecast of income tax expense. The manufacturer s deduction is a permanent difference that is accorded flow-through tax treatment. Section 1 is a federal-only tax adjustment.

35 (1) Deduction of State Income Taxes IRC Section 1 permits the deduction of state income taxes. Consistent with D.--0, the prior year California Corporate Franchise Tax will be reflected in the current year calculation of Federal income tax expense. This timing delay does not apply to other state income tax deductions. This is a federal-only income tax adjustment that is reflected in the computation of the current federal income tax expense portion of the RO Model. The Employee Stock Ownership Plan (ESOP) Dividend Deduction In prior GRC proceedings, SCE included Schedule M deductions for stock dividends paid by Edison International (the parent company of SCE) into the ESOP maintained by SCE. In this GRC, SCE proposes to make a change consistent with PG&E s Commission-approved treatment of the same issue. Shareholders of Edison International fund the cost of dividends paid by Edison International on stock held within the ESOP. The deduction arises when Edison International declares and pays a general common dividend out of its retained earnings, and the dividend is received on Edison International stock in which the employee (or retiree) has decided to invest and hold within the ESOP. The ESOP deduction does not arise from employee s wages or any other expenses included in this proceeding s cost-of-service ratemaking, but instead arises when Edison International matches employee contributions to their 01(k) plans. In one of the Commission s prior decisions offering guidance on the ratemaking treatment of income taxes, (D or OII ), the Commission held that only cost-of-service expenses are considered in matching deductions for those expenses used in forecasting income tax for ratemaking purposes. The cost of Edison International stock dividends paid into the ESOP are not included in the cost of service for ratemaking purposes. The Commission also determined in D.-0-0 that when deductions were not part of a utility s cost of service, but were generated with shareholder funds, the deductions are the property of shareholders and not customers. This included deductions derived from disallowed costs incurred in excess of those included in rates, as well as deductions for discretionary uses of net earnings by shareholders. In D (the decision resolving PG&E s 01 GRC), the Commission declined to recognize the ESOP dividends as a source of tax deduction for

36 ratemaking purposes and concluded that the ESOP tax deduction is appropriately treated as a shareholder asset. There is no principled reason for treating SCE s ESOP deduction differently than PG&E s. Consistent with the underlying rationale adopted by the Commission s decisions regarding the ratemaking treatment of tax deductions funded by shareholders (including dividends paid into an ESOP), SCE has not included ESOP dividend deductions in its calculation of Federal income tax expense for ratemaking purposes.. SCE s Proposals Are Consistent with Commission Decisions, Commission Policies and Tax Rules Compliance Requirements of SCE s 01 Decision This subsection provides the following income tax-related compliance information required by SCE s 01 Decision. (1) Tax Accounting Memorandum Account Ordering Paragraph 0 of SCE s 01 GRC Decision states that SCE is authorized to create a two-way Tax Accounting Memorandum Account (TAMA) to track all tax changes during this General Rate Case period. On November, 01, SCE filed Advice Letter 1-E, Implementation of the Test Year 01 General Rate Case Adopted Revenue Requirement, 01 GRC Post Test Year Revenue Requirement and Ratemaking Mechanisms in Accordance with Decision , that included Preliminary Statement Part N., the TAMA. Preliminary Statement Part N..a. states that the purpose of TAMA is to track the ratemaking implications resulting from 1) any tax accounting method change for tax years 01 through 01, ) any change to tax law or tax guidance regarding tax depreciation or tax repair deductions for tax years 01 through 01, ) any change to non-pole loading-related repair deductions between authorized and recorded for 01 through 01, ) any tax audit, appeals or litigation adjustments impacting items 1, and ) any change resulting from a private letter ruling SCE receives from the IRS regarding the normalization requirements associated with the Commission s implementation of rate base offset described in subparagraph () below. The preliminary statement also D.1-0-0, page. SDG&E s treatment of the ESOP deduction is also consistent with SCE s proposal. See D.0-0-0, as modified by D The Commission did not decide the ESOP issue as a matter of policy in these decisions, which were issued in connection with a non-precedential settlement, but SDG&E s treatment of the ESOP deduction is consistent with PG&E s.

37 states that TAMA shall remain open until the IRS and California Franchise Tax Board s audit periods for tax years 01 through 01 are closed statutorily. On March 1, 01, SCE filed Advice Letter 1-E-B to modify TAMA to include 1) changes that impact depreciation and/or repair deductions resulting from the Tax Increase Prevention Act of 01 (TIPA 01) and the Protecting Americans from Tax Hikes Act of 01, ) clarification that TAMA may only be closed upon Commission approval of such request, ) clarification that the TAMA balance will be transferred to the balancing account only upon Commission approval, ) clarification that the TAMA advice letter shall have a Tier designation, and ) a statement that SCE would propose how to address future activities in TAMA in this (01 GRC) proceeding. On May 1, 01, SCE filed Advice Letter 1-E for Commission review of the operation of TAMA for 01. This advice filing reflected differences attributable to the extension of bonus depreciation through 01 and net repair deductions for 01. Advice Letter 1-E was approved effective June 0, 01. SCE expects to file similar advice letters in 01 and 01 once recorded values become available. In June, SCE transferred the year-end net over-collection in the TAMA of approximately $0 million to its Base Revenue Requirement Balancing Account to be refunded to customers. () Allocation of Income Tax Expense Between FERC and CPUC; Revised Repair Deductions of Pole Loading Costs SCE s 01 Decision adopted SCE s proposed formula to allocate total income tax expense between FERC and CPUC jurisdictions, and the revised estimate of repair deductions attributable to the Pole Loading Programs in The decision also required SCE to present a net present value estimate of these changes, as measured from 01, in its next GRC. The estimate should take into account the entire tax lives of the relevant depreciable assets. SCE includes in this proceeding a net present value estimate of these changes that takes into account the entire tax lives of the relevant depreciable assets as measured from 01. The net present value estimate is a net benefit to customers of $0 million. Refer to WP SCE-0 Vol. 0, Chapter III, Book A, pp. 1.

38 () Rate Base Offset for Repair Change SCE s 01 Decision implemented an offset to SCE s rate base for the tax-related net present value associated with repair deductions. The offset was calculated based on forecast repair deductions in the 01 GRC that were incremental to what the Commission had authorized in rates (in the 01 GRC). The offset was implemented as a direct line item adjustment to rate base, independent of other factors, and the value of the offset is to be reduced over the course of years (01 to 0). SCE continues to include this offset to rate base in this GRC for years 01 through 00 as a separate adjustment outside of the tax expense calculations. () TIPA 01 Bonus Impact in 01 In its 01 GRC proceeding, SCE provided a separate post-hearing exhibit (Exhibit SCE-) that updated revenue requirement for the impact associated with the extension of federal bonus tax depreciation as a result of the enactment of TIPA 01. In Exhibit SCE-, SCE noted that 01 tax depreciation was estimated to increase by approximately $ million because of the retroactive extension of bonus depreciation, and also noted that 01 rate base would have increased by $ million (as a result of the related ratemaking changes to working cash and inclusion of the NOL/ADIT adjustment to rate base). The 01 bonus extension resulted in a decrease in revenue requirement of $ million due primarily to additional ADIT liability that reduced 01 rate base by $ million. In SCE s 01 Decision, the assigned ALJ queried whether benefits of the tax change were flowed-through to shareholders in 01 in exchange for long-term cost increases to customers: In the 01 GRC, parties should address this subject, if it has not been addressed in another sooner. SCE shall include the impacts of this change in the Tax Accounting Memorandum Account. The tax benefits from the 01 extension of bonus were not flowed through to shareholders in 01 in exchange for long-term cost increases to customers. The change in 01 tax depreciation was subject to the normalization requirements that prohibit the immediate flowthrough of tax benefits. The 01 tax benefit from the additional bonus tax depreciation reduces rate base (independent of other secondary RO Modeling impacts, such as working cash adjustments). As previously noted in Exhibit SCE- of SCE s 01 GRC, revising 01 rates to reflect the extension of bonus depreciation would have increased 01 rate base by $ million due to the resulting adjustment to working cash and the required NOL/ADIT normalization D , page. 0

39 adjustment and, as a result, would have increased the 01 revenue requirement. TIPA 01 was signed into law on December 1, 01 which was after the Commission approved SCE s 01 post-test year revenue requirement on January, 01 and, as such, 01 authorized rates were not increased to reflect the extension of bonus depreciation. SCE s 01 general rates reflect the rate base implications from the extension of 01 bonus depreciation, and will not need to be reflected again in the TAMA. Advice Letter -E SCE filed Advice Letter -E on February, 01 to reduce its Base Revenue Requirement Balancing Account (BRRBA) by $ million to account for recorded repair deductions over the amounts used to compute the rate base offset described in Chapter III.B.(a)(), above. This adjustment to BRRBA provided customers with the cumulative tax benefits of the incremental repair deductions as if they had been included in the rates implementing those GRCs at the outset. The $ million includes the impact from the generation-related repair deduction change in accounting method effective for tax year 01. The CPUC Energy Division approved the advice filing on April 1, 01. Commencing with this GRC proceeding, SCE will recover the tax expense associated with these incremental repair benefits (that were provided to customers as credits in the BRRBA) in the GRC revenue requirement. Commission Policies (1) Separate Return Basis One of the fundamental tax-related issues addressed in this Commission s OII included whether, for purposes of computing estimated test-year income tax expense for ratemaking purposes, the impact of nonutility and affiliated entities operations as reflecting in consolidated income tax returns should be considered. In D.-0-0, the Commission stated in Findings of Fact 1 that it is the practice of the Commission, in calculating income tax expense, to assume a separate return basis considering solely utility operations. That decision also found in Conclusion of Law that the separate return method is the more reasonable basis for calculating testyear income tax expense. SCE follows this finding of fact and conclusion of law in its GRC proceedings, including this one. See Section B..(a) for description of the change. 1

40 () Disallowed Costs and Shareholder Funded Costs are the Property of Shareholders, and Not Customers Another issue presented in OII was whether expenses not borne by customers should be included as income tax deductions in computing estimated test-year income tax expense. The Commission stated, in D. -0-0, that the Commission has consistently calculated income taxes for ratemaking purposes based on the cost of service developed from authorized expenses. In that decision, the Commission also stated that if the Commission were to include expenses not subject to rate recovery as a deduction in calculating taxable income, stockholders would be penalized by a reduction in their net income equal to the full amount of the expenditures, because they would have no offsetting tax deduction. Conclusions of Law # states that the Commission s method of excluding expenses not borne by customers in the calculation of test-year income tax expense is reasonable and should continue. SCE follows this conclusion of law in this GRC proceeding. IRS Rules (1) Private Letter Ruling - ADIT/NOL Adjustment to Rate Base On June 1, 01, SCE received Private Letter Ruling (PLR) 00. In this ruling, the IRS concluded that the tax normalization rules required SCE to reduce its ADIT liability balance for ratemaking purposes for the portion of ADIT attributable to the forecasted net tax operating loss carry-forward amount. SCE filed Advice Letter 0-E on August 1, 01 to revise the revenue requirement associated with SCE s GRC as a result of this private letter ruling. This advice letter was approved effective September 1, 01. SCE continues to adhere to these tax normalization rules, where appropriate, in this GRC proceeding. () PLR Normalization on Rate Base Offset As stated in Section B..(a)() of this chapter, SCE s 01 Decision implemented an offset to SCE s rate base for the tax-related net present value associated with repair deductions not included SCE s 01 GRC. With regard to this rate base offset, the Commission stated that it fully intends for SCE to comply with the normalization rules, and that if SCE decides to request a private letter ruling for this issue, SCE shall file and serve a copy of its request to the IRS as a Tier 1 Advice Letter at least 0 days before sending the request to the IRS. In the D. -0-0; P.U.R. th, p.. Id., p. 1.

41 event that SCE receives a relevant IRS ruling contradicting this decision, then it shall comply with the IRS s interpretation of the applicable tax laws by filing a Tier advice letter with this Commission to seek an appropriate adjustment to its revenue requirement and/or rate base. SCE filed Tier 1 Advice Letter 0-E on January 0, 01 with a copy of its ruling request. On February, 01, SCE filed its ruling request with the National Office of the IRS. On June, 01, SCE received a copy of its private letter ruling from the IRS stating that [t]he reduction of Taxpayer s rate base by the rate base offset described above will not be inconsistent with and therefore, will not violate the normalization rules provided by 1(i)() and Treasury Regulations 1.1(l)-1.. Tax Accounting Method Changes Change of tax accounting methods for periods beginning 01 through 01 are subject to SCE s TAMA. As noted in Section A. and B..(a)(1), SCE requests in this proceeding to extend TAMA subject to the same scope set forth in the 01 GRC Decision for 01 through 00. In this way, any applicable changes will be reflected in rates. Generation Repairs SCE filed a request to change income tax accounting method associated with generation-related repair deductions for tax year beginning 01. The request was filed with SCE s 01 income tax return. The purpose of the change was to apply the safe harbor definitions of IRS Revenue Procedure 01- to generation-related property. This change of accounting is not reflected in SCE s TAMA because the accounting change was filed in 01. However, in Advice -E (filed on February, 01), SCE included the income tax benefits from this change for tax year beginning 01 as part of the $ million reduction to revenue requirement through its Base Revenue Requirement Balancing Account (BRRBA). The CPUC s Energy Division approved this advice filing on April 1, 01. Uniform Capitalization of Interest As discussed above, the Company reverses book AFUDC amounts (i.e., debt and equity) capitalized for ratemaking purposes and, instead, capitalizes interest and other indirect cost under IRC Section A for tax purposes. Historically, these adjustments have immediately been recorded to tax basis and depreciated accordingly. However, all three adjustments are a function of See Section B..(b) for further details about AL -E.

42 construction in progress and therefore should not impact the tax fixed asset basis until the related work order is closed to the book fixed asset system. In April of 01, the Company went live with an upgraded fixed asset system that now allows SCE to track these capitalized costs to work orders in progress. Therefore, the Company will file an accounting method change in 01 to change the timing of when these adjustments impact tax basis consistent with the new work order tracking. The cumulative prior year adjustment has been included in rate base for this GRC and this new methodology has been used to capitalize tax basis beginning in 01. This new accounting method will not change the yearly schedule M-1 s for AFUDC Debt, AFUDC Equity, and Capitalized Interest. This accounting change only delays when these adjustments are capitalized to tax basis and depreciated for the tax return purposes. The TAMA will incorporate any 01 and 01 rate impacts, while the impacts for 01 and later years have been forecast and included in the 01 GRC.. New Tax Legislation Since Last GRC On December 1, 01, the Protecting Americans from Tax Hikes Act of 01 (01 Act) was signed into law. Section 1 of the 01 Act extended bonus depreciation through 01. Qualified property placed in service on or after January 1, 01 and before January 1, 01 will be eligible for first-year bonus depreciation of 0 percent. Property placed in service after December 1, 01 and before January 1, 01 will be eligible for 0 percent bonus depreciation, and property placed in service after December 1, 01 and before January 1, 00 will be eligible for 0 percent bonus depreciation. Bonus depreciation is set to expire after December 1, 01. The 01 ratemaking implications from the 01 Act have been incorporated into SCE s TAMA Advice Letter 1-E, 0 and the bonus depreciation provisions for all of the extended periods 01 through 01 have been reflected in the forecast tax depreciation of this GRC proceeding. C. Payroll Taxes This section includes federal payroll taxes, state payroll taxes, and other miscellaneous taxes that are levied on SCE, and describes the assumptions and methodologies used to calculate these payroll tax amounts. Payroll taxes are based on 01 recorded employee taxable wages that are subsequently forecast to reflect any proposed changes to the number of employees and other labor factors for each estimated year. Payroll taxes levied on the employer are the only taxes included in this section. If the 0 Section B..(a)(1).

43 Commission adopts labor levels or wage assumptions that are different than what has been proposed in this testimony and related exhibits, SCE s payroll tax amounts will be recalculated to reflect the impact of any changes. 1. Old-Age, Survivors, and Disability Insurance (OASDI) Tax OASDI is a component of the Federal Insurance Contribution Act (FICA) tax levied pursuant to IRC Section 1 on both employers and employees at the rate of. percent of applicable wages paid to employees. The OASDI program limits the amount of earnings subject to taxation for a given year. In 01, the limitation is $,00. Wages used to derive this tax are calculated in a manner described above. For employees with wages equal to or below the limit, the OASDI tax is applied to their entire wages. For employees earning more than the wage base for the year, the amount of wages subject to the OASDI tax is derived by multiplying the number of those employees by the wage base amount. This total, along with the wages of employees earning under the wage base, are combined and multiplied by the OASDI rate to derive total OASDI amounts incurred by SCE. Finally, the total amounts are reduced for the capitalized portion based on the capitalized Pension & Benefit rates.. Hospital Insurance (HI) Tax HI tax is the other component of the FICA tax that is levied on both employers and employees, but at a rate of 1. percent. Wages used to derive this tax are calculated in the manner described above, and because HI does not have a limit, total applicable wages are subject to this tax.. Federal Unemployment Tax Act (FUTA) Tax FUTA tax is levied on employers by IRC Section 01 and applies to the first $,000 of wages earned by each employee. The statutory rate is. percent, although the rate is offset by taxes paid to a state unemployment fund that reduces the rate to 0. percent. The method used to calculate FUTA is consistent with the method used to compute OASDI tax expense, but with a $,000 limit.. State Unemployment Insurance (SUI) Tax In addition to FUTA, California levies on employers an unemployment tax on the first $,000 of wages earned by each employee. The tax rate depends on each employer s unemployment experience. SCE s 01 SUI rate is. percent. For estimating purposes, the 01 rate has been used in the forecast years. The SUI tax is computed in a manner consistent with the methodology used to compute the FUTA tax.

44 California Employment Training (CET) Tax California levies an employment training tax on in-state employers at a rate of 0.1 percent of the first $,000 of wages earned by each employee. The tax is calculated consistent with the methodology used to compute FUTA tax.. Miscellaneous Tax Miscellaneous taxes include city business license tax, hazardous waste tax, federal highway use tax, excise taxes, certain non-california payroll taxes, and other local, state and federal miscellaneous taxes, in addition to taxes charged to and by operators of jointly-owned facilities. D. Property Taxes 1. Purpose This section describes SCE s obligation to pay ad valorem (property) taxes to the taxing authorities of each state in which taxable property is located. SCE property, outside the state of California, subject to ad valorem taxes include an interest in a nuclear generating power plant in Arizona, transmission-related properties in Arizona and Nevada, vacant land subject to local assessment in Nevada, and various assets in Washington, D.C.. Methodology SCE pays property taxes in California, Arizona, Nevada, and Washington D.C. The calculations of the amounts for each of these taxing jurisdictions are shown in workpapers. 1 A description of the methodologies used for each state and Washington D.C. is provided below. Table III- 1 provides a summary of SCE s property taxes for recorded year 01 and forecast years 01-00, on a calendar year basis. 1 Refer to WP SCE-0 Vol. 0, Chapter III, Book B, pp..

45 Table III-1 Summary of Property Taxes (Nominal $000) Recorded Estimated Line No. Item California,001,1,1,,0 1,. Arizona,1,,,,,. Nevada Washington D.C Total,0,,,0,, California Property Taxes The California State Board of Equalization (SBE) derives both a Cost Indicator and a Capitalized Earnings Indicator of market value. The two indicators are then correlated by the SBE to derive a unitary market value corresponding to our utility property. Once market value has been determined, the SBE allocates the unitary value to the various counties based upon the Reconstruction Cost New Less Depreciation (RCNLD) of the property. The counties use these allocated values to determine the taxes payable by SCE. For purposes of this proceeding, SCE derived the ratio of the Cost Indicator to the SBE adopted market value for the most recent fiscal year. This ratio was then applied to the forecast Cost Indicators to estimate the corresponding adopted market value. In California and Arizona, the taxing jurisdictions (BOE and DOR, respectively) determine the market value of our assets. Therefore, the assessed value and the market value of SCE s property are equal. In Nevada, the market value is derived at % of the assessed value. Property taxes are recorded for ratemaking and financial reporting purposes during the fiscal property tax year beginning July 1 and ending June 0 of the following year. Property taxes related to CWIP are capitalized and collected through the work order system as part of overheads. The amount charged to capital is based upon the Historical Cost Less Depreciation (HCLD) method adopted in D. in our Test Year GRC (A.1). In that decision, property taxes charged to CWIP were based upon the reported value of CWIP as a percentage of total HCLD (including CWIP) multiplied by total property taxes. Property taxes relating to capital are developed in this application following that methodology. The balance of property taxes is collected through expense.

46 Total property taxes are estimated by multiplying the total estimated assessed value by the system average tax. Property tax rates for forecast years reflect a trended value based upon the prior five recorded fiscal years. The fiscal year amounts are converted to a calendar year basis and capitalized taxes are subtracted to derive the property tax expense. The difference between the fiscal year expense and the calendar year expense is referred to as the lien date adjustment. The fiscal year expense is deductible on SCE s income tax return; therefore, the lien date adjustment is used to determine the revenue requirement associated with property taxes. California ad valorem taxes are summarized in workpapers. Arizona Property Taxes SCE is a 1. percent co-owner of the Palo Verde Nuclear Generating Station (Palo Verde). Palo Verde is a nuclear power plant located approximately miles west of Phoenix, Arizona. Other co-owners of Palo Verde are Arizona Public Service (.1 percent), Southern California Public Power Authority (. percent) and the Los Angeles Department of Water and Power (. percent). SCE also owns transmission property in Arizona. For utility properties located in Arizona, the Arizona Department of Revenue (DOR) is responsible for determining the full cash value (FCV), which is the basis for deriving the assessment and related property tax. The (DOR) values transmission and distribution plant equal to the recorded Historical Cost Less Depreciation of the property. The FCV of generation plant is valued at the Reconstruction Cost New Less Depreciation (RCNLD) of the property. The DOR derives RCNLD by applying Marshall and Swift Cost Indices to the vintage historical cost of the property and depreciating on a straight-line basis over years. The FCV is multiplied by an assessment ratio of 0 percent to determine assessed value. Assessed value is allocated on a pro-rata basis to the counties in which the properties are located based upon the corresponding net book value. The corresponding county tax rates are applied to the allocated value to determine the related property tax amount. The Arizona property tax year is the period July 1 through the following June 0. The lien date for the property tax year is January 1 of the prior calendar year. Thus, for example, fiscal year is based upon plant as of January 1, 01, Refer to WP SCE-0 Vol. 0, Chapter III, Book B, p.. Refer to WP SCE-0 Vol. 0, Chapter III, Book B, p..

47 resulting in an 1-month lag between the lien date and the beginning of the fiscal year. Property tax rates for forecast years are based upon fiscal year 01-01, the most recent year for which data are available. Arizona property taxes are summarized in workpapers. For ratemaking and financial reporting purposes, SCE records Arizona property taxes on a fiscal year similar to California. The methodology for conversion to a calendar year basis, capitalization of taxes, and derivation of the lien date adjustment is also similar to that used in California. Nevada Property Taxes For SCE s properties located in Nevada, the determination of market value is made by both the Nevada Department of Taxation (DOT) and at the local county level. Historically, the properties assessed by the DOT included all SCE properties within the state, including transmission lines, transmission substations, and the Mohave Generating Station (Mohave). Since the decommissioning of the Mohave plant, SCE has continued to jointly own the vacant land. The Clark County Assessor s Office assesses the vacant land at the local county level. For all other SCE property in Nevada, the DOT assesses the property as stateassessed property. The DOT determines the assessment using two indicators of value: HCLD and Capitalized Earnings. The two indicators are correlated by the DOT to derive a unitary market value for the property. The market value is then multiplied by an assessment ratio of percent to determine the assessed value. In determining market value for the forecast periods, the ratio of market value to net book taxable value was computed for fiscal year 01-01, the latest year for which such information is available. The ratio was then applied to the estimated net book values to estimate the corresponding market value. Assessed value is allocated to the counties based upon the miles of transmission lines located within each county. The corresponding county tax rates are applied to the allocated value to determine the related property tax amount. Property tax rates for forecast years reflect a trended value based upon the prior five recorded fiscal years. The Nevada property tax year is the period July 1 through the following June 0 and, like Arizona, is based on a lien date of January 1 of the prior calendar year. Nevada property taxes are summarized in workpapers. Refer to WP SCE-0 Vol. 0, Chapter III, Book B, p.. Refer to WP SCE-0 Vol. 0, Chapter III, Book B, p. -.

48 1 1 For ratemaking and financial reporting purposes, SCE records Nevada property taxes on a fiscal year similar to California. The methodology for conversion to a calendar year basis, capitalization of taxes, and derivation of the lien date adjustment is also similar to that used in California. Washington D.C. Property Taxes The Government of the District of Columbia establishes the assessed value of SCE s property at 0 percent of the HCLD of operating property, less an exclusion of two hundred twenty five thousand dollars. The Washington, D.C. property tax rate is. percent. The Washington, D.C. property tax year is the period July 1 through the following June 0. For ratemaking and financial purposes, SCE records Washington, D.C. property taxes on a fiscal year similar to California. The methodology for conversion to a calendar year basis, capitalization of taxes, and derivation of the lien date adjustment is also similar to that used in California. 0

49 1 1 IV. RATE BASE A. Purpose This chapter represents SCE s 01 recorded and estimated Rate Base, as shown in Table IV-1. Rate Base consists of the depreciated asset value of SCE s property that is used to provide service to its customers. The major components of Rate Base are Fixed Capital, Adjustments, Working Capital and Deductions for Reserves. Each of these components is described below in the section titled Description and Methodology. B. Description and Methodology Rate Base is computed on an original cost basis and is presented as a 1-month weighted average to reflect the changes in rate base occurring throughout the year. The fixed capital forecast is based on our Capital Budget. Electric Plant-in-Service, Accumulated Depreciation, and capital-related Accumulated Deferred Taxes are described above in Chapters I, II, and III. Thirteen-month averages are calculated using CPUC-prescribed methodology. This method sums all monthly balances from December of the prior year to December of the current year. This amount is reduced by onehalf of the first and last months balances and divided by 1 to arrive at the average for the period. 1

50 Table IV-1 Summary of Electric Rate Base Weighted Average Balances (Nominal $000) Line Recorded Estimated No. Item FIXED CAPITAL 1. Electric Plant in Service,1,1 0,1,00,1,1,,1 0,,0,,. Capitalized Software 1,,0 1,, 1,, 1,1, 1,,0 1,,. Other Intangibles 1, 1,1,,,,1. Total Fixed Capital 0,00,0,,01,0,,,01 1,,,, ADJUSTMENTS. Customer Advances for Construction (,) (,0) (,01) (,0) (,0) (1,0). Customer Deposits Total Adjustments (,) (,0) (,01) (,0) (,0) (1,0) WORKING CAPITAL. Materials & Supplies 0,0 1,0 0,0,,1,01. Mountainview Emission Credits,01,,0, 1,. Working Cash,0, 1,,01,,. Total Working Capital,0,1,0 0,0,, DEDUCTIONS FOR RESERVES 1. Accumulated Depreciation Reserve (1,1,) (1,0,) (1,1,) (1,,) (1,1,0) (1,0,0) 1. Accumulated Amortization (,0) (,) (,0) (,0) (,0) (0,) 1. Accum. Def. Taxes - Plant (,,00) (,0,01) (,,) (,0,0) (,1,) (,0,) 1. Accum. Def. Taxes - Uniform Capitalization Accum. Def. Taxes - CIAC,,1, 1, 1,,1 1. Accum. Def. Taxes - Vacation Accrual 0, 1, 1, 1,0 1, 1,0 1. Unfunded Pension Reserve (,1) (0,) (,00) (,0) (,) (1,0) 1. Total Deductions for Reserves (1,,1) (1,1,) (1,1,) (1,,) (0,,1) (1,,1) 0. RATE BASE,,,,,0,1,00,1 1,,,1, 1. DEPR'N & AMORT EXPENSE 1,, 1,,00 1,0,,00,,,0,0, 1 1. Fixed Capital Fixed Capital is SCE s Electric Plant-In-Service and Intangible Plant. The discussion of Fixed Capital is addressed in Chapter I above and summarized in Table I-1.. Adjustments Customer Advances for Construction (Customer Advances) Customer Advances represent refundable amounts provided by applicants (generally developers) in advance of constructing new distribution facilities that will later be served by SCE. Developers are required to advance the construction costs that exceed a Commission-specified allowance formula pursuant to SCE Tariff Rule 1 - Distribution Line Extension. These funds are a liability to SCE until reimbursed to the developers or forfeited by developers to SCE after years. Refer to WP SCE-0 Vol. 0, Chapter IV, pp - (Summary of Electric Rate Base).

51 Consistent with Commission rules, SCE does not pay the developers interest for holding these monies. As an interest-free source of funds, the Customer Advances are a proper offset to rate base. The average balance of Customer Advances is influenced by development cycles, which are affected by changes in interest rates and development incentives to boost the economy in certain areas. Generally, refunds of Customer Advances are triggered by meter sets. Historically, trending of Customer Advances lags meter sets as refunds occur primarily in years through following receipt of the Customer Advance. This is why, as shown in Figure IV-, below, SCE forecasts the average balance of Customer Advances to increase through 00 while meter sets are projected to level off in 00. At the end of ten years, any remaining balance is forfeited by the developer and converted to CIAC, offsetting plant. Figure IV- Average Customer Advances / Annual Meter Sets Over 0 percent of Customer Advances are associated with electric construction. The remaining balance of Customer Advances is generally associated with temporary services. These two groups of Customer Advances were estimated separately. The Customer Advances associated with electric construction was forecast by analyzing the inflows (cash advances) and the outflows (refunds/forfeitures). Inflows were forecast based on the relationship between cash advances and the number of meter sets over the last five-year period to reflect recent economic conditions. From 0 Refer to WP SCE-0 Vol. 0, Chapter IV, p. (Average Customer Advances / Annual Meter Sets).

52 through 01, cash advances averaged $ per meter set (in constant 01 dollars). This average advance per meter was applied to the forecast meter sets and adjusted for inflation. The estimated account outflows were developed using an experienced refund pattern over the ten-year refund period. Figure IV- depicts this pattern. Figure IV- Refund Pattern for Customer Advances Over Year Refund Period- Electric Construction Combining the estimated cash advances (inflows) and the estimated refunds (outflows) produces a forecast of the Customer Advances Electric Construction. The Customer Advances Temporary Services balances were analyzed separately, as these cash advances and refunds do not necessarily correspond with meter sets. The basis for the forecast of Temporary Services is a five-year average of recorded balances for 0 through 01. The forecast is shown in Table IV-1, below. Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1 (Refund Pattern for Customer Advances).

53 CIAC represents the average amount of Customer Advances Electric Construction that will not be returned to customers within the -year refund period. The amount forecasted to offset Electric Plant-In-Service is shown in Table IV-1, below. The CIAC forecast amount has decreased from 01 recorded due to lower cash advances received from developers in the tenth year preceding the forecasted year. Table IV-1 0 Average Customer Advances for Construction Average Balances (Nominal $000) Line Recorded Forecasted No. Item Electric Construction,,0,,1,,0 Temporary Services,01,,0,0,, CIAC,, 1, 1 Total,,0,01,0,0 1, Working Capital Items Working Capital for ratemaking purposes is the average additional expenditures required of shareholders on a continuing basis beyond the capital expenditures in Electric Plant-In-Service and other specified rate base items. For SCE, these rate base components include Materials and Supplies Inventory, Mountainview Emission Credits Inventory and requirements for Cash Working Capital. These items are discussed separately below. Materials and Supplies Inventory (M&S) 1 M&S Inventory is maintained for new plant construction and O&M activities required to operate existing plant. The inventory is required to meet the demands of both planned projects and emergency situations. To maintain the balance between material needs and client response time, SCE has M&S inventory located at numerous sites throughout our 0,000-plus square mile service area. Table IV-1 below shows the historical M&S Inventory levels for 0 through 01. The M&S balance grew at a five-year average annual growth rate of. percent since 0. 0 Refer to WP SCE-0 Vol. 0, Chapter IV, p. (Average Customer Advances). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 (Materials and Supplies).

54 Table IV Recorded M&S Inventory Average Balances - SCE Share (Nominal $000) Year Growth Rate 1,, 1, 1,1,0.% 1 Table IV-1 below shows the forecast M&S Inventory levels for 01 through 00. Given continuing increases in maintenance and capital expenditures, annual increases in estimated M&S levels are projected to average. percent during the forecast period. Table IV Forecast M&S Inventory Average Balances SCE Share (Nominal $000) Year Growth Rate 1,0 0,0,,1,01.% 1 1 (1) Estimation Approach SCE s estimated M&S requirements have grown primarily as a result of increased T&D construction activity offset by decreases (savings) from general inventory management process improvements. SCE s analysis separately considers the historical trends of different types of M&S inventories and the factors affecting the inventory requirements. Specifically, the inventories were analyzed by category: (1) T&D, () Generation, and () Information Technology (IT) and Transportation Services Division (TSD). T&D-related inventory requirements are tied to the level of construction activity. Generation-related inventory requirements are not only based upon construction projects, but also reflect the need for unique spare parts that have a long-lead replacement time. Finally, IT and TSD inventory is anticipated to increase due to operational requirements. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (0-01 Recorded M&S Inventory). Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1 (01-00 Forecast M&S Inventory).

55 In addition, SCE adjusts rate base to reflect certain accounting requirements associated with the M&S program for example, unpaid sales tax liabilities and unpaid invoices. () Transmission and Distribution M&S Jointly, SCE s Supply Management Organization and T&D Operating Unit manage T&D M&S through the operation of over 0 storage locations. This inventory supports current T&D project expenditures, such as infrastructure replacement and maintenance programs, as well as providing emergency inventory stock. The majority of the material usage and inventory levels are directly related to T&D s annual capital expenditures. The material consists of items such as poles, cross arms, pole hardware, conductor, insulators, lightning arrestors, transformers, switches, fuses, fuse holders, enclosures, underground components, and so forth. These materials are considered mass property equipment and are purchased in large quantities. Figure IV-, below, compares the three-year rolling average trend for T&D capital expenditures and T&D M&S inventory, which reflect recent improvements in inventory management practices. A regression analysis of this data indicates that for each $1 million in incremental T&D construction expenditure there is a need for approximately $,000 in additional T&D M&S inventory to support the project activity. The historical correlation between the construction expenditures and inventory is good resulting in a regression with a R square of 0..

56 Figure IV- Comparison of Construction Expenditures and T&D M&S Inventory (Three-Year Rolling Average Year-End Balances) (Nominal $000),0,,,0,1,00,,1 1, 1 1, 1, 1, 1 1 1, 1 1, 1,0 1, M&S -Year Avg. Capital Expenditures -Year Avg. 1 The T&D capital expenditures supported by T&D M&S are forecast to be $1.1 billion. This represents a five-year annual growth rate of. percent, and will require a corresponding increase in supporting T&D M&S inventory levels. Applying the incremental inventory capital expenditures relationship to the forecast capital expenditures (excluding incentive projects), results in the T&D M&S inventory levels shown in Table IV-1 below. Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 0 (Comparison of Construction Expenditures and T&D M&S Inventory). Id., p..

57 Table IV Forecast T&D M&S Inventory Average Balances - SCE Share) (Nominal $000) Recorded Forecasted Year Growth Rate 1,0 1,0 1, 00,1 0, 0,1.% SCE s 01 average amount for T&D M&S inventory was authorized at $.M. The authorized amount is net of targeted reductions to average T&D M&S inventory of $1.M as a result of projected inventory carrying cost reductions from SCE s Operational Excellence (OpX) initiatives. Recorded average 01 T&D M&S inventory was $1.0M. The reasons for the variance between 01 authorized and recorded levels are discussed below. First, the OpX initiatives forecast by SCE assumed savings from both the Transformer and Meter commodity groups which do not properly belong to T&D M&S inventory. The $M of inventory cost reductions for these commodity groups properly belongs to capital, not T&D M&S inventory, because the vast majority of purchased meters and transformers are pre-capitalized to Electric Plant-In-Service. Secondly, due to T&D Grid improvement efforts, the switches component of T&D M&S inventory has increased from $1.M at year-end 01 to $.M at year-end 01. Third, the wood poles component of T&D M&S inventory has increased from $.M to $.M as a result of operational demands, such as pole inventory required to support the aged pole and pole maintenance programs. () Generation M&S The Generation M&S inventory consists primarily of those balances required for supporting SCE s generation facilities. As shown in Table IV-1, from 0 to 01, the Generation-Related M&S has increased about. percent per year. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (01-00 Forecast T&D M&S Inventory). D.1--01, p..

58 Table IV-1 Recorded Generation M&S Inventory (Average Balances - SCE Share) (Nominal $000) -Year Line No. Item Growth Rate 1 PVNGS,,,1,1 0,.% Hydro,0,,1,0,.% Mountainview,,,1,1, 0.% Peaker Project % Solar 0 N/A Current Generatio 0,1,,,,1.% 1 Based upon historical trends and expectations for the future, SCE anticipates a relatively flat Generation M&S inventory requirement, with a slight reduction for through 00. Table IV-1 below provides the forecast for Generation M&S inventory. Table IV-1 Forecast Generation M&S Inventory (Average Balances - SCE Share) (Nominal $000) Recorded Forecasted -Year Line No. Item Growth Rate 1 PVNGS 0, 0,0 0, 0,1,01, -1.1% Hydro,,,,,, 0.0% Mountainview,,,,,, 1.% Peaker Project 1 1,0 1,0 1,0 1,0 1,0.% Solar.0% Current Generatio,1 0,1,,,0,1-0.% () Information Technology and Transportation Services Division M&S SCE also maintains IT and TSD M&S inventories. The IT M&S inventory consists of items such as fiber optic cable, modules, breakers, switches, terminals, and power supplies. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (Recorded Generation M&S Inventory). Id. 0

59 These items are needed to support various information systems infrastructure throughout SCE. TSD M&S inventory consists of materials needed to support SCE s transportation fleet of vehicles and aircraft. These include items such as lubricants, replacement parts, batteries, tires, and other related items. As shown in Table IV-0, below, over the past five years, the inventory requirements for these items experienced a net increase of.0 percent. Table IV-0 0 IT and TSD M&S Inventory (Average Balances - SCE Share) (Nominal $000) -Year Line No. Item Growth Rate 1 IT,0,1,,,1.% TSD % Total IT/TSD,,0,,,1.% 1 As shown in Table IV-1, below, SCE is forecasting IT M&S inventory requirements to grow at an average of about. percent annually for 01 through 00. This increase in inventory requirements result from overall cost increases and expansion in the use of technology resulting from needed improvements in critical IT areas such as fostering information security and managing technologies on the smart grid. TSD M&S growth largely results from changing the maintenance of SCE s medium and heavy-truck fleet to an in-house model to improve vehicle repair turnaround times. 0 Refer to WP SCE-0 Vol. 0, Chapter II, p. (IT and TSD M&S Inventory). 1

60 Table IV-1 1 Forecast IT and TSD M&S Inventory (Average Balances - SCE Share) (Nominal $000) Recorded Forecasted -Year Line No. Item Growth Rate 1 Info. Tech.,1,,0,1,0,.% Transp. Serv % General,1,,00,1,1,.% 1 () M&S Rate Base Adjustments In addition to the M&S inventory program, described above, rate base needs to be reduced to reflect certain accounting adjustments, including unpaid sales tax liabilities and unpaid invoices. Sales tax liabilities are not paid until after the material has been issued from inventory and consumed. When issued, the value of the material consumed includes its original cost and sales tax. M&S Inventory is reduced by the original cost of the material and a sales tax liability is established. Because the material consumed includes sales tax, the sales tax liability should result in an offset to rate base until it is paid. () Total M&S Inventory Table IV-, below, presents the total forecast inventory requirements for the M&S categories presented above. 1 Id.

61 Table IV- Total M&S (Average Balances - SCE Share) (Nominal $000) Recorded Forecasted Line No. Item Transm. & Distr. 1,0 1,0 1, 00,1 0, 0,1 Current Generation,,0,,,0,0 Other Generation,,1,1,1,1,1 General,1,,00,1,1, Rate Base Adjust. Accounting Adjust. (1,00) (1,) (0,) (,1) (,0) (,0) Total,0 1,0 0,0,,1, Mountainview Emission Credits Inventory South Coast Air Quality Management District (SCAQMD) rules and regulations for NOx emissions require RECLAIM Trading Credits (RTC) to operate the Mountainview plant. The total RTC emission credits, available to Mountainview at acquisition, were originally valued at $1. million. The emission credits are based upon the associated pounds of NOx credits per year and projected annual value of those credits, annually through 0. In D.0-0-0, the Commission authorized the transfer of the Mountainview Emission Credits Inventory to SCE s utility rate base. As of December 1, 01, SCE has an unrecovered balance of RTC emission credits of $.0 million. In addition, SCAQMD required Mountainview to acquire $1,000 of volatile organic compounds (VOCs) during 00 in order to obtain a modified emissions permit. The unrecovered balance of VOCs as of December 1, 01 was $0,. These emission credits are recovered as O&M costs in ERRA as they are consumed. Based upon the forecast purchases and scheduled consumption, the average Mountainview Emission Credits Inventory reduces over time and is shown in Table IV-, below. Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1 (Total M&S). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Mountainview Emission Credits Inventory).

62 Table IV- Mountainview Emission Credits Inventory (Average Balances) (Nominal $000) Line Recorded Forecasted No. Item Emission Credits,01,,0, 1, Cash Working Capital Working cash is the capital supplied by shareholders to meet day-to-day utility operational requirements by bridging the gap between the time when expenditures are required for services and the time when revenues are collected for those services. Working cash is included in rate base to compensate shareholders for this. Table IV-, below, presents the total forecast requirement for Working Cash. SCE s working cash estimate is developed using the lead-lag approach set forth in Commission Standard Practice U-1. The lead lag approach determines the funds required to pay operating expenses in advance of receiving customer revenues. It requires a comprehensive analysis of transactions to determine the net lag days between: (1) the time utility services are rendered, and the receipt of the associated revenues for those services (Revenue Lag); and () the time between the recording of utility costs such as purchased power, labor, materials, and so forth, and the payment for those costs (Expense Lag). The lead-lag approach, however, does not fully account for all working cash requirements. Therefore, the utility s operational cash requirements are added to (or subtracted from) the lead-lag working cash. The operational cash requirements include: (1) additional investor-supplied funding amounts, (e.g., minimum bank balances, special deposits, prepayments); and () other working cash not supplied by investors (e.g., accrued vacation, Utility User Taxes). The Standard Practice U-1 provides that working cash include both the lead-lag and operational cash requirements components. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (Mountainview Emission Credits Inventory).

63 Table IV- Summary of Working Cash Weighted Average Balances (Nominal $000) Line No. Item Description Recorded Forecast Operational Cash Requirement 1 Cash,,00,00,00,00,00 Special Deposits Working Funds Prepayments,1,1,1,1 0,1 0, Other Accts Rec. & Res. for Uncollectible,,,,0,00,1 Less: Paid Absence (1,) (,) (,) (,0) (,0) (,0) Long-Term Incentive Plan (,1) (,) (1,) Workers Comp & Inj. & Dam. Claims (,) (1,) (,0) (,1) (,) (,) User Taxes (,) (,0) (,) (0,0) (0,0) (1,) Operational Cash Requirement (,) (,) (,1) (,) (0,0) (0,) Lead-Lag Working Cash Requirement,,,,0,0, 1 Total Cash Working Capital Requirement,0, 1,,01,, (1) Operational Cash Requirement Operational Cash is the average balance of funds SCE investors have furnished for the utility to meet its daily operational needs. Balance sheet accounts consisting of amounts supplied by investors for operational needs are included, provided that the amounts: (1) are necessary to maintain minimum balances; () are recoverable from customers; () are non-interest bearing; and () represent carrying costs that are not recovered from customers elsewhere. The two components of operational cash requirements include investor- supplied funding (Inclusions to Operational Cash) offset by other working cash not supplied by investors (Deductions to Operational Cash). (a) Supplied by Investors Operational Cash supplied by investors include Cash-Bank Balances; Special Deposits; Working Funds; Prepayments; Gas Option Premiums; and Other Accounts Receivable. These account balances reflect amounts that are supplied by investors.

64 (i) Cash-Bank Balances The diverse nature of SCE s cash transactions requires the use of multiple banks and separate bank accounts to provide various services including balance reporting, check processing, electronic funds transfers and depository services. Due to operational constraints and standard banking practice, SCE must maintain the average minimum bank balances that it requests to operate effectively. This includes a $00,000 bank required minimum from JP Morgan. (ii) Special Deposits Relocation Escrow Special Deposits represent funds managed by outside parties on SCE s behalf. SCE s Relocation Escrow is neither interest bearing nor recovered in other ratemaking mechanisms elsewhere. Therefore, it is included in rate base for GRC purposes. (iii) Working Funds Working Funds represent cash advanced to officers, agents, employees, and others as petty cash or working funds that are required for operational needs. (iv) Prepayments Prepayments include prepaid rents, software license fees, insurance, gas option premiums, and other miscellaneous prepayments that have not yet been accrued to operating expenses. Because SCE has advanced these funds and they are not reflected in the lead-lag analysis, the average balance is includable in working cash. (v) Other Accounts Receivable Other Accounts Receivable incorporates miscellaneous accounts, including receivable balances for PBOP trust reimbursements, damage claims, relocation services and interconnection services. These balances are incorporated net of allowance for doubtful accounts (i.e., uncollectibles). There are a total of 1 accounts related to Other Accounts Receivable that were incorporated into working cash. Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Cash-Bank Balances). FERC Account 1 Special Deposits - Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Special Deposits Relocation Escrow). FERC Account 1 Working Funds - Refer to WP SCE-0 Vol. 0, Chapter IV, pp (Working Funds). FERC Account 1 Prepayments - Refer to WP SCE-0 Vol. 0, Chapter IV, pp. -. (Prepayments). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Other Accounts Receivable).

65 (b) Not Supplied by Investors Deductions to the Operational Cash Requirement include Paid Absence; Utility User Taxes; FAS 1 Long-Term Incentive Plans (LTIP); Workers Compensation and Injuries & Damages Reserves; and Unfunded Pensions. These account balances reflect amounts that are not supplied by investors and are a liability to SCE until the amounts are paid out. (i) Paid Absence 0 Paid Absence includes the value of vacation and sick time earned that has not yet taken by employees. These amounts are a reduction to rate base because they represent a liability to SCE until the employees take the time off. (ii) User Taxes and Other Fees 1 User Taxes are amounts collected from utility customers on behalf of city and state authorities. These funds are available to the utility until they get paid to the proper taxing authority and therefore represent a reduction to rate base. SCE includes the average balances collected for City Utility Taxes, California Energy Resources Surcharges, Santa Barbara and Ventura City Surcharges, and CPUC Reimbursement Fees in working cash. (iii) FAS 1 Long-Term Incentive Plans FAS 1 Long-Term Incentive Plans (LTIP) are SCE liabilities that include Stock Options, Restricted Stock Units, and Performance Shares. Recovery for the associated expenses are being requested beginning in the 01 Test Year. Since expense will be accrued and recovered in advance of payments, the accumulated liability associated with the LTIP expenses is being included as a reduction to rate base. Because, for tax purposes the revenues for LTIP accruals are taxed immediately upon receipt, whereas a tax deduction is taken only when payment is made, the full amount is unavailable to the company. As a result of this timing difference, SCE only includes 0 percent of the net accrual reserve amount as an offset to rate base (i.e., it has been reduced for taxes paid). 0 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Paid Absence). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (User Taxes and Other Fees). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (FAS 1 Long-Term Incentive Plans). Refer to SCE-0 Vol. 0, Chapter VII. I.R.C., Sec. and 0.

66 (iv) Uncollectible Reserves Uncollectible Reserves represent the balance of accruals for estimated uncollectibles that have not yet been written off. Since the Revenue Lag in the Lead Lag portion of the working cash study reflects the collection period covering the time that a customer bill is generated until the time that it is either paid or written off, the Uncollectible Reserves must be included as a rate base offset. Since for tax purposes the revenues for uncollectible accruals are taxed immediately upon receipt, whereas a tax deduction is taken only when the receivable is written-off, the full amount is unavailable to the company. As a result of this timing difference, SCE only includes 0 percent of the net accrual reserve amount as an offset to rate base (i.e., it has been reduced for taxes paid). (v) Workers Compensation and Injuries & Damage Claims Reserves To the extent that Workers Compensation and Injuries & Damage Claim Reserves represent funds provided by customers in advance of SCE s payment of these claims, they should be a reduction to rate base. In the case of Workers Compensation and Injuries & Damage Claim Reserves, this customer pre-funding is represented by the amounts associated with the Commission authorized levels of Account -Workers Compensation Reserve and Injuries and Damage Claims Accruals, not the recorded amounts required by the Generally Accepted Accounting Principles (GAAP). Since these revenues are subject to income tax and cannot be deducted until paid, the amount available as a rate base offset is the after tax amount. Workers Compensation and Injuries & Damage Claim Reserves represent a liability to SCE and is a reduction to rate base. As of December 1, 01 the balance in this account is about $1 million. However, this recorded reserve balance does not consist entirely of amounts recovered in rates and does not directly correspond to the authorized expense amounts for Account -Workers Compensation Reserve and Injuries and Damage Claims Accruals. There are two components to this liability. First, the Workers Compensation Reserve represents liabilities associated with claims made by employees. Similarly, the Injuries and Damage Claims Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 0 (OAR & Uncollectible Reserves). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. - (Workers Compensation and Injuries & Damage Claims Reserves).

67 1 1 represent liabilities associated with claims made by third parties. Both components represent a liability to SCE and is a reduction to rate base. The recorded balances do not correspond to ratemaking, but rather are dictated by GAAP. GAAP requires that these liabilities include known claims as well as losses incurred but not reported. The account balance reflects the total Workers Compensation and Injuries & Damage Claim liability regardless of whether the claim falls into a category recovered through authorized Account expense, recovered through insurance, reserved by shareholders, or recorded as a liability in advance of being recorded as an Account expense (i.e., expensed on a payas-you-go basis). The recorded account balance neither represents available cash funds, nor a balance of funds provided by customers in advance of claim payments, but is required by GAAP accounting. A comparison of the historical authorized accruals and the actual payments made for Workers Compensation and Injuries & Damage Claim liabilities shown in Table IV-, below, demonstrates that customers have not funded the $1 million account balance.

68 Table IV- Workers Compensation and Injuries & Damages Claims Authorized Accruals and Recorded Payments (Nominal $) Authorized Accruals Recorded Payments Difference 1,, (1,,00) (1,,1) 1,, (,,) (,,1) 1,1,0 (,0,) (1,,) 1,,0 (,,) (1,,) 1,1,0 (,00,) (1,1,) 000,, (,,) (1,,1) 001,0,1 (,,1) (1,,) 00,,1 (0,,1) (0,,0) 00 1,,1 (,,) (,,0) 00 0,0, (,1,),0, 00 0,0, (,,) 1,, 00,,1 (,0,),1, 00,,1 (,1,),00,1 00,,1 (,,),1, 00,, (,,) (0,0) 0,0,00 (,,1) (,,1) 0 0,0, (,,0) (,00,) 01,0,1 (,,),1,01 01,0, (,,) 1,,0 01,, (,1,),, 01,,1 (,0,1) (1,,) Total,1,1 (,,) (0,,1) 1 Table IV- above shows that since 1 payments have exceeded authorized accruals by $0. million. Consequently, a proper evaluation of the rate base impact stemming from Workers Compensation and Injuries & Damage Claim accruals focuses on the authorized amounts in Account -Workers Compensation and Injuries & Damage Claims expense, not the recorded balances required to comply with GAAP. Recently authorized Account Workers Compensation and Injuries & Damages expenses have increased, and have begun to exceed the payments. To the extent that the forecasted Account accruals for Workers Compensation and Injuries & Damages exceed current payments, SCE has use of these monies and there should be a rate base reduction. An analysis of Id., p. 0

69 Workers Compensation and Injuries & Damage Reserves demonstrates that the balance has turned over an average of every 1. months. That is, SCE has use of these Workers Compensation and Injuries & Damage net accruals for an average of about.1 years. Applying a.1 year turnover period to the authorized net accruals yields the pre-tax balances shown in Table IV-, below. Because, for tax purposes, the revenues for Workers Compensation and Injuries & Damage accruals are taxed immediately upon receipt, whereas a tax deduction is taken only when payment is made, the full amount is unavailable to the company. As a result of this timing difference, SCE only includes approximately 0 percent of the net accrual reserve amount (i.e., it has been reduced for taxes paid). The average after-tax rate base offset for Workers Compensation and Injuries & Damage Reserve is shown in Table IV-, below. Table IV- Average Workers Compensation and Injuries & Damage Reserves (Nominal $000) Line No. Item Authorized Forecast Pre-Tax Balance (,) (1,1) (,) (,) (,) (,0) Less Taxes (,1) (0,0) (,0) (,00) (,01) (,) After-Tax Balance (0,) (,) (,) (,) (,) (,0) Avg After-Tax Balance (,) (1,) (,0) (,1) (,) (,) () Lead Lag Study SCE s lead-lag study determines the funds required from investors to cover the timing difference between when operating expenses are paid and when revenues are received. As previously described, the analysis determines the net lag days between the weighted average revenue lag days and the weighted average expense lag days. Analysis of 01 information determined that, on the average, the company pays expenses 1.1 days in advance of receiving offsetting revenues from its customers. SCE s 01 expenses are estimated at about $0. million per day. Multiplying the net lead days by the average daily expense results in the average Lead-Lag Working Cash Requirement of $ million to compensate investors for the amounts they pay in advance of collecting revenues from customers. Refer to Table IV- for a summary of the lead lag study. Id., p. 1 1

70 (a) Revenue Lag Revenue lag is the number of days from the time service is delivered to the time the customer payment is made available in SCE s bank account. The revenue lag is measured starting from the midpoint of the service period to the point that the payment has cleared the bank. To measure this midpoint, Standard Practice U-1, prescribes the ratio of Accounts Receivable to Sales Method plus the Bank Lag. Using this method, SCE has calculated a. day revenue lag as shown in Figure IV-, below. Figure IV- Revenue Lag Accounts Receivable to Sales Method The Accounts Receivable to Sales Ratio is calculated by dividing Net Accounts Receivable by Daily Billed Revenue. The net accounts receivable is determined by using end-of-month recorded billed and unbilled revenue less adjustments for pass-through items billed to the customer (e.g., CDWR, Utility Users Tax, etc.) The daily billed revenue is calculated by dividing the annual billed sales by. Bank Lag (Cash Availability Lag) The average number of days from the receipt of the Customer Payment to the availability of the funds in the bank. Analysis of recent billing data reveals that SCE s bank lag is 0. days. Refer to WP SCE-0 Vol. 0, Chapter IV, pp. - (Revenue Lag).

71 (b) Expense Lags 0 Expense Lags is the average time from recording the various operating costs to render service advanced by external vendors and suppliers, investors, employees, and taxing agencies to the date of payment for those expenses. As shown in Table IV-, SCE s estimated expense lags average 0. days for the test year 01. The expense lags were developed using 01 recorded payments incurred to serve customers. 1 The lags are determined by calculating the average number of days from the date (or midpoint of a service period) that SCE records as accrued expense until the time SCE s payment to the vendor or payee sclears the bank for that expense. 0 Refer to WP SCE-0 Vol. 0, Chapter IV, pp - 1 (Expense Lags). 1 The exception is the Federal and California tax lags, which were developed using statutory tax law requirements.

72 Table IV- Lead Lag Summary Test Year 01 (Nominal $000) Average Dollar Line Number of Day No. Item Expenses Lag Days Lags A B C D E=C*D 1. Total Fuel 1,1.1,,. Purchase Power QF USPS. Purchase Power QF EFT. Purchase Power Non-QF. Subtotal (Lines 1-),0,.1 1,,. Company Labor 1,0 1.1,,. Short Term Incentive Plan 1,.,0,1. Other O&M expenses 1,0,.,01,0. Goods & Services,.,,. Materials Issued from Stores, Insurance Provisions & Line Rent, Injuries and Damages, Funded Pension Provisions, (1.) (1,,0) 1. Benefits & Unfunded Pension Provisions,1.1, 1. P.B.O.P Provisions,.,, 1. Franchise Requirements,.,, 1. Uncollectibles, Sub-Total (Lines - 1),0,1. 1,01, 1. Depreciation,01, Decommissioning Taxes - Other Than Income,1 0.,0,0. Taxes - Based on Income,.,1,0. Total Operating Expenses,, 0.,,1. Average Days Lag in Collection of Revenues.. Average Days Lag in Payment of Expenses 0.. Excess Revenue Lag 1.1. Average Daily Expense 0,. Working Cash,0 1 (i) Fuel Fuel costs represent the natural gas, diesel, propane and nuclear fuel amounts used by SCE s generating stations. The overall average lag days are calculated by dollar weighting for each fuel type. For natural gas, the expense lag is 0. days. The expense lag days for diesel fuel and propane fuel (Catalina micro turbines) are 1. and. days, respectively. The nuclear fuel lag days are set at zero because the nuclear fuel capital expenditure is amortized uniformly Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 0 (Fuel).

73 over the service period. Nuclear fuel other waste disposal, on the other hand, has an expense-lag of.1 days. The estimated 01 overall dollar weighted average expense lag for fuel is.1 days. (ii) Purchased Power Purchased power costs represent the largest single expense affecting SCE s working cash needs. SCE s purchased power costs were categorized as (1) Qualifying Facilities (QF) paid via United States Postal Service (QF-USPS), () Qualifying Facilities paid via Electronic Fund Transfer (QF-EFT), and () Non-QF Bilateral and Firm agreements, Power Exchange, and other energy related costs (Non-QF). The 01 estimated lag days are,, and days, respectively. These purchased power lag days reflect the average time from the service period when SCE receives the energy to the dates when the payments for the energy clear the bank. The purchased power expense lags were developed using the recorded payments for year 01 for each type of agreement. The composite lags were developed using 01 forecasted expense to ensure forecasted shifts between the different types of agreements were captured in the overall weighting. QF-EFT payments have payment lags of days, about days shorter than QF-USPS payments which have a day lag. Since the last GRC, EFT payments for QF purchases have shifted further towards the EFT payment method to days (in 01). Non-QF expense lags have slightly increased from in (iii) Company Labor Company labor includes both SCE labor and balancing account labor. SCE determined an average expense lag of 1.1 days between the time that SCE receives service from employees to the day when the paychecks are deposited and clear the bank. Since SCE pays its employees on the Friday following its two week payroll cycle, the underlying expense lag is 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. - (Purchased Power). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 - (Company Labor).

74 days. That is, seven days from the midpoint to the end of the payroll period, plus five days to payday Friday. While most employees receive their pay by direct deposit on payday, about. percent of employees receive negotiable checks instead of direct deposit, which take an average of. additional days to clear the bank. Company labor also includes accruals for Paid Absence and Long-Term Incentives. These accruals have a zero day lag because they represent an immediate offset to rate base in Operational Cash. (iv) Short Term Incentive Plan (STIP) The expense lag for STIP represents the time lag between the expense accrual and the payment of such costs. STIP is accrued during the calendar year and paid the first quarter of the following year. About percent is paid mid-march and percent is paid mid- February, resulting in a weighted average expense lag of. days. The associated FICA taxes are included in the estimated expense and the longer STIP expense lag is applied to these taxes. (v) Other O&M Expenses Other O&M expenses represents non-labor expenses associated with balancing accounts. The average expense lag is. days. The purpose of this item is to include the balancing accounts expense lag to compensate investors for the time between the recording of utility costs and payment of those costs. We determined the associated working cash requirement using a three-year average of recorded expenses. (vi) Goods & Services The expense lag for Goods & Services represents the time lag between the accrual and the payment of such costs. The average expense lag is. days. This lag reflects PO and Non PO Goods & Services invoices paid during 01. (vii) Materials Issued From Stores; Insurance Provisions & Line Rents; and Injuries & Damages Materials Issued from Stores represents the amounts charged to maintenance expense on a daily basis so the lag days are zero. Insurance Provisions & Line Rents represent prepaid amounts for property insurance and for right-of-way facilities located on public Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Short Term Incentive Plan). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Other O&M Expenses). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Goods & Services). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 (Materials Issued From Stores; Insurance Provisions & Line Rents; and Injuries & Damages).

75 or federal lands and are included in working cash. Injuries and Damages represent accruals to cover losses incurred through claims and suits of injuries and damages to persons and property that are also in working cash. (viii) Funded Pension Provisions The expense lag for Funded Pension Provisions utilizes an accrual pattern based upon the monthly distribution percentage for base revenues and the timing of payments made to the trust accounts. The lag days are -1. for Pensions. (ix) Benefits & Unfunded Pension Provisions 1 Benefits and Unfunded Pension Provisions are included in the lead lag study to compensate investors for the lag between when the expenses are accrued and the revenues are collected. The expense lag for Benefits represents the period from when the expenses are accrued to the time they are paid. Unfunded provision expense is accrued monthly and the accumulated provision is an immediate offset to rate base because it represents a liability to SCE until the funds are paid out. Because the provision is accrued uniformly on a daily basis the associated expense lag is zero days. This results in an overall composite lag of.1 days for Benefits and Unfunded Pensions Provisions. (x) Post-Retirement Benefits Other Than Pensions (PBOPs) 1 The expense lag for PBOPs utilizes an accrual pattern based upon the monthly distribution percentage for base revenues and the timing of payments made to the trust accounts. The lag days are. for PBOPS. The composite PBOP lag includes the Pay-As- You-Go Claims which assumes a zero day lag. The lag days for PBOP decreased from 1. authorized in 01 because Pay-As-You-Go Claims have grown in relation to VEBA contributions. (xi) Franchise Requirements Franchise Fees are amounts billed to SCE by municipalities for service within their jurisdictions. Each municipality has different franchise requirements based on a formula that incorporates line miles in each service area and the revenues received from utility customers. Payments vary depending on the Franchise Requirements for each city and county. The lead Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Funded Pension Provisions). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 (Benefits & Unfunded Pension Provisions). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Post-Retirement Benefits Other Than Pensions). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Franchise Requirements).

76 lag for Franchise Requirements is the time between SCE incurring the expense and the time the fees are paid. The lag for Franchise Requirements is. days. The lag estimate is based on 01 payments made for the service agreements in 01 and estimated payments for 01. (xii) Depreciation Expense Depreciation expense is included in the lead lag study to compensate investors for the lag between when the expenses are accrued and when the revenues are collected. The provision expense is accrued monthly and the accumulated provision is an immediate offset to rate base. Because the monthly depreciation expense is accrued uniformly on a daily basis the associated expense lag is zero days. (xiii) Nuclear Decommissioning The expense lag for decommissioning is the average time between the date SCE has the funds available from the accrued decommissioning contribution and the date the funds are deposited in the nuclear decommissioning trust funds. SCE is not seeking new contributions for SONGS or Palo Verde because the trust funds are sufficient to meet the future costs of decommissioning based on the current forecast. Therefore, the expense lag for nuclear decommissioning contributions is zero days. (xiv) Taxes Income & Other Than Income The expense lag for Income Taxes represents the period from when the current tax expenses are accrued to the time they are due by statutory law. Unlike other expense transactions where the related payment obligations are not subject to formal arrangements or are subject to various formal arrangements that are based on negotiated terms with the vendors, the amount of income taxes to be paid and when such tax payments are to be made are specifically defined by statutory law. Relying on statutory tax law represents a fair, reasonable and balanced approach in projecting the expense lag for income taxes. Internal Revenue Code Section (IRC ) specifies whether estimated corporate income taxes should be paid and, if so, the amount requires corporations, such as SCE, to make estimated tax payments throughout the year, and specifically dictates how and Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Depreciation Expense). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. (Nuclear Decommissioning). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 (Taxes Income & Other Than Income).

77 when those estimated tax payments are to be made. Failure to comply with those rules will result in underpayment penalties assessed against the taxpayer. As a general rule, to avoid penalties and interest, corporations are required to make installment payments throughout the year on April 1, June 1, September 1 and December 1. The amount of any required installment shall be percent of the required annual payment. For large corporations, such as SCE, the required annual payment must be 0 percent of the current year tax. When the RO Model forecasts current federal taxable income, the Federal Income Tax lag associated with making payments in the amounts and on the dates required by IRC is. days. When the RO Model forecasts no current federal taxable income (i.e., a federal net operating loss), the Federal Income Tax lag will be zero. Table IV- illustrates the lead-lag days analysis for SCE s Federal Income Tax. Table IV- Federal Income Tax (Lead-Lag Days Analysis) Accrual Midpoint /1/1 /1/1 /1/1 1/1/1 /1/01 () () 1 Required %'s % % % % (.) (.00) Proposed Lag (Days) California generally follows the federal tax code in requiring SCE to make estimated tax payments throughout the year. To avoid penalties and interest, total installment payments must be equal to at least 0 percent of the required annual payment by April 1, 0 percent of the required annual payment by June 1, and 0 percent of the required annual payment by December 1. The State Income Tax lag associated with making payments in the amounts and on the dates required by California statutory Revenue & Taxation Code Section is. days when the RO Model forecasts current state taxable income. When the RO Model forecasts no current state taxable income, the State Income Tax lag will be zero. Table IV- illustrates the lead-lag days analysis for SCE s State Income Tax. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (Federal Income Tax).

78 Table IV- California Income Tax (Lead-Lag Days Analysis) Accrual Midpoint /1/1 /1/1 /1/1 1/1/1 /1/01 () () 1 Required %'s 0% 0% 0% 0% (.0) (.0) -.0 Proposed Lag (Days).0 1 The expense lag study for Taxes Other than Income, as shown in Table IV-0, determines the time between SCE incurring the tax accrual to the time when the payments are made. These taxes are associated with property taxes, payroll taxes (e.g., employer portion of Federal Insurance Contributions Act tax, Federal Unemployment Tax Act tax, and California Unemployment Insurance tax) and miscellaneous taxes (e.g., city business license tax, hazardous waste tax, highway use tax, and excise tax), each of which have a different lead lag day. FICA expenses associated with STIP receive the longer lags associated with STIP expenses. See discussion of STIP expenses above. Refer to WP SCE-0 Vol. 0, Chapter IV, p. (California Income Tax). 0

79 Table IV-0 Taxes Other Than Income (Lead-Lag Days Analysis) Lag Days Ad Valorem - Arizona. Ad Valorem - California. Ad Valorem - Nevada (.) Total Ad Valorem. Federal Insurance Contribution Act (F.I.C.A.) 1.0 Federal Unemployment Taxes Act (F.U.T.A.). State Unemployment Insurance Act (S.U.I.) 1. Total Taxable Wage Taxes 1. Total Weighted (xv) Provisions for Uncollectibles Provision for non-grc uncollectibles represent accruals for customer receivables that will not be collected and will eventually be written off. The amount is estimated by adding fuel, purchased power and other non-labor expense, and multiplying the sum by the uncollectible rate. Since these accrued expenses are offset in rate base (allowance for doubtful accounts), the expense lag days are zero. C. Working Capital Adjustments: Customer Deposits 1. Introduction This section discusses the policy of adjusting working cash for SCE s customer deposits. Customer deposits are funds collected from customers for security against non-payment that will be returned to those same customers or used as a credit against their bills in the event of non-payment. In SCE s previous GRC decisions, the Commission has required SCE to offset rate base by the amount of customer deposits. Yet, SCE remains the only California energy utility subject to this policy. In this application, SCE requests that the Commission reconsider its policy on SCE s customer deposits; SCE proposes a different treatment that is analogous to the treatment recently adopted for Pacific Gas and Electric Company (PG&E) in D Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1 (Taxes Other Than Income). Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Provisions for Uncollectibles). D (mimeo), pp. -0, Findings of Fact 0-, pp Available at 1

80 As discussed in detail below, customer deposits are debts of the utility, and thus are fundamentally different from other working cash adjustments. Imposing a rate base offset inappropriately treats this debt as if it were like common equity that never needs to be paid back. To the contrary, customer deposits are like other debts, with negative implications for credit quality. Furthermore, these deposits are dependent upon Commission policies and other factors outside of SCE s control. For these reasons, it is simply incorrect to treat them as long-term funding. Indeed, as discussed below, in the FERC Uniform System of Accounts, which SCE must follow, customer deposits are included in Current and Accrued Liabilities because they have the characteristics of short-term debt. Finally, this section recommends that the Commission maintain the policy approved in SCE s 01 and 01 GRCs, allocating up to percent of customer deposits to SCE s minority and community bank program.. Background Prior to SCE s 00 GRC, the Commission uniformly applied the same ratemaking approach outlined in Standard Practice (SP) U-1 to the customer deposits of all large California energy utilities. Adopted in 1, SP U-1 states that interest-bearing customer deposits are to be excluded from working cash adjustment calculations. Subsequently, the interest rate on customer deposits was set at the utility s short-term borrowing rate in a Commission decision that also governs the interest rate calculated on balancing account over- and under-collections. 1 However, in response to TURN s proposal in SCE s 00 GRC, 1 the Commission decided that a portion of SCE s customer deposit balances should be treated California Public Utilities Commission Utilities Division, Determination of Working Cash Allowance, Standard Practice U-1, September 1, 1, p. -. Refer to WP SCE-0 Vol. 0, Chapter IV, pp D.1, CPUC d 1, 01-0, Cal. PUC LEXIS 0, *-. D.1 (copy of signed decision), pp. -. Available at ftp://ftp.cpuc.ca.gov/legacycpucdecisionsandresolutions/decisions/decisions_d01_to_d_d 001_to_D00/D1_01_O.pdf. 1 See A , TURN, Report on Various Results of Operations Issues in Southern California Edison s 00 Test Year General Rate Case, December, 00, pp. -. Refer to WP SCE-0 Vol. 0, Chapter IV, pp..

81 like a source of permanent working capital and included as an offset to rate base. 1 SCE disagrees with this finding and has argued against it in subsequent proceedings. The Commission has continued to authorize an offset for customer deposits in SCE s GRCs, but has only applied this policy to SCE. Currently for PG&E, the Commission has adopted an interim treatment of recognizing customer deposits as debt in PG&E s authorized capital structure and reducing the GRC revenue requirement by the product of the current amount of customer deposits and the difference between the authorized embedded cost of debt and the projected interest rate that will be paid on customer deposits during the test year. 1 The final disposition of the issue is to be determined in PG&E s next CPUC cost of capital application. 1 In an earlier GRC decision for PG&E, the Commission explained that its treatment for SCE was anomalous: The largest issue regarding working cash is whether to adopt Aglet s and TURN s proposal to treat customer deposits as a reduction to working cash. We decline to adopt their proposal. The record shows that PG&E and the Settlement Agreement calculated working cash in accordance with SP U-1, which has been in effect since 1. As such, we view the Settlement outcome on working cash as presumptively reasonable. Aglet and TURN raise several arguments for why it is appropriate to depart from a key element of SP U-1. Perhaps their best argument is that the Commission s decisions in the two most recent GRCs for SCE departed from SP U-1 and deducted customer deposits from working cash. They assert that the Commission should treat PG&E the same as SCE. We disagree. Our review of Commission precedent reveals that SCE is somewhat of an aberration in this regard. In the last two years alone there have been numerous Commission decisions that relied on SP U-1 to determine working cash. See, for example, D and D In the 01 GRCs for SDG&E and SoCalGas, the Commission adopted a settlement that adjusted the revenue requirement in a way similar to the PG&E approach, treating customer deposits as debt financing rate base. 1 Although the settlement is not precedential, and the decision did not address 1 D (mimeo), p.. Available at 1 D (mimeo), pp Id. 1 D (mimeo), pp Available at 1 D.1-0-0, pp.1-1, -. Available at

82 the policy issue of whether customer deposits should be treated this way in the future, the Commission was required to find the result reasonable and consistent with public policy. 1. Customer Deposits are Debts with Financial Consequences SCE collects deposits from its customers pursuant to Rules and of its tariffs, which provide for the establishment of credit (Rule ) and the amount of deposits (Rule ) to establish credit when required. Normally, customer deposits are refunded with interest after twelve months of satisfactory payments. Customer deposits are debts owed to customers, and bear interest like other types of utility debt. As TURN has stated: they are short-term loans from individual customers which are paid at a short-term interest rate... The FERC Uniform System of Accounts records customer deposits in Current and Accrued Liabilities (Account ) and includes interest on customer deposits in Other Interest Expense (Account 1). Similarly, interest paid on customer deposits is included in SCE s interest expense on its financial statements. Because of the requirement that customer deposits normally are refunded to customers after twelve months, customer deposits are most like other short-term debt (maturity of one year or less) in the utility s liabilities. As discussed in sections (a) and (b) below, the policy of offsetting rate base with customer deposits increases the percentage of debt and reduces the percentage of equity in the Commission s ratemaking capital structure. Increasing debt and reducing equity has negative financial impacts and should not be carried out without careful consideration. Financial Impacts of Offsetting Rate Base with Customer Deposits Figure IV-, below, shows the impacts of offsetting rate base with customer deposits. As the chart shows, without a customer deposits offset, rate base is assumed to be financed with a combination of long-term debt, preferred equity and common equity (see center column). The percentage share of each component is set by the Commission in cost of capital proceedings, and the 1 Rule 1.1(d) of the Commission s Rules of Practice and Procedure ( The Commission will not approve settlements... unless the settlement is reasonable in light of the whole record, consistent with law, and in the public interest. ) A.-0-0, TURN, Prepared Testimony of William B. Marcus on behalf of Toward Utility Rate Normalization, August 1, 1, p. (emphasis in original). Refer to WP SCE-0 Vol. 0, Chapter IV, pp.. Title 1, Code of Federal Regulations, Chapter I, Subchapter C, Part 1. Available at

83 resulting capital structure ratios are used to determine the rate of return on rate base. When rate base is offset by customer deposits, the relative proportions of long-term debt, preferred, and common equity in the ratemaking capital structure remain the same, but customer deposits are now included as a new debt layer. In effect, customer deposits have increased the amount of debt and reduced the equity in the ratemaking capital structure, as shown in the column on the right. The reduced equity ratio results in lower company earnings, even if the Commission compensates the utility for the interest paid to customers on their deposits. As discussed in the next section, these earnings play an important role in maintaining credit quality. Figure IV- Impact of Customer Deposits on Rate Base Financing Rate Base Financing Customer Deposits Debt Debt Higher Debt Rate Base Preferred Preferred Equity Equity Lower Equity Without Customer Deposits With Customer Deposits The Role of Equity Financing The use of equity financing is sometimes disfavored by regulators because the required return on equity is substantially greater than the cost of debt. However, equity financing is critical to maintaining credit quality, and in times of financial stress, can make the difference that enables a company s survival. Common equity has two key features that can help a company maintain its financial strength. Most importantly, common equity is perpetual financing; that is, it has no maturity

84 date and thus never has to be paid back. Second, common equity dividends are paid at management s discretion and can be suspended if financial circumstances warrant. In contrast, debt has a fixed maturity date and interest payments are due at fixed intervals. Failure to pay either interest or principal on debt when it is due places a company in default, and potentially, in bankruptcy. The credit rating agencies, bond investors, and equity investors all monitor a company s financial strength based on several credit metrics. Although debt and equity ratios are considered, greater focus is placed on measures that assess a company s cash flow. At the most basic level, a lender needs to be assured that a company will have enough cash on hand to pay interest expense and other ongoing fixed payments when they are due. As Standard and Poor s states: Cash flow analysis is usually the single most critical aspect of credit rating decisions. 1 Cash flow adequacy is measured by various coverage ratios, which compare operating cash flow to interest expense. As an example, lenders and rating agencies commonly calculate EBITDA/interest as earnings 1 (E) before (B) interest expense (I), income taxes (T), depreciation (D) and amortization (A), divided by interest expense (I). This measure calculates the number of times a company s cash flow will cover its interest payments after its operating expenses are paid. In other words, it shows the strength of a company s cash flow in comparison to the ongoing fixed costs represented by interest expense. As discussed above, interest on customer deposits is included in recorded interest expense, and thus is part of reported interest coverage calculations. It is wrong to conclude that providing recovery of the interest paid on customer deposits is enough to negate the negative impacts of the customer deposits rate base offset. Compensating SCE for the interest expense does not counter the reduced equity earnings from lower rate base, which was approximated $ million in The reduced earnings will continue to have a negative impact on EBITDA and other cash flow measures, weakening credit quality. 1 Standard and Poor s, Criteria Corporates General: 00 Corporate Criteria: Analytical Methodology, April 1, 00 (most recent periodic review December 1, 01), available at (registration required). 1 The EBITDA formula usually defines earnings as operating profits. 1 This calculation includes common equity and preferred equity.

85 Standard Practice U-1 Principles As the above citation from the Commission s 00 PG&E GRC decision indicates, 1 the Commission itself has questioned the basis for the deduction of customer deposits from rate base, calling it an aberration from the Commission precedent. 1 The citation points to the Commission s practices regarding calculation of working cash as described in SP U-1, entitled Determination of Working Cash Allowances. SP U-1 has governed working cash calculations for over 0 years since its release in 1. While SP U-1, like other Commission policies, may be reviewed and altered if no longer valid, the vast majority of SP U-1 s methodology remains in use and is unquestioned in California GRCs. In fact, in 00, the Commission s Water Division relied on the original SP U-1 as the basis for its own working cash procedures, issued as SP U-1-W. 1 SP U-1 and SP U-1-W issue the same directive regarding customer deposits: only non-interest bearing customer deposits are to be considered in working cash calculations. 1 SP U-1 does not explain the reasoning behind this directive. However, by reviewing other sections of SP U-1 and assessing the other components of working cash, the wisdom of the rationale with respect to customer deposits becomes clear. Customer deposits differ from other working cash adjustments in important ways, most fundamentally in their financial impact on the company. SP U-1 and Working Cash As SP U-1 states: The reason for allowing cash working capital in the rate base is to compensate investors for funds provided by them which are permanently committed to the business for the purpose of paying operating expenses in advance of offsetting revenues from its customers and in order to maintain minimum bank balances. 1 In other words, working cash must be provided so that the utility can pay its bills on a timely basis when the revenues received lag behind. SP U-1 identifies a two-step procedure for developing the working cash allowance. First, the process must determine the operational cash requirement; that is, the funds required 1 D D (mimeo), p California Public Utilities Commission Water Division, Determination of Working Cash Allowances, Standard Practice U-1-W, March 00. Refer to WP SCE-0 Vol. 0, Chapter IV, pp.. 1 SP U-1, p. - and SP U-1-W, p SP U-1, p. 1-.

86 in order for the utility to perform its day-to-day operational requirements efficiently and economically. Second, the procedure subtracts from this requirement the working funds that are available. As SP U-1 states: the amount subtracted from the operational cash requirement represents a source of interest-free working funds available to the utility due to the fact that revenues are collected prior to the payment of employees wages, taxes, and the utility s creditors. This description of working funds adds further weight to the Standard Practice s directive on customer deposits. Working funds are by definition interest-free; their availability stems from timing differences in collection prior to payment of operating expenses. Some examples of typical deductions from the operational cash requirement will make this clear. Typical Deductions from Operational Cash Requirements Consistent with SP U-1, SCE conducts a detailed lead-lag analysis that considers the timing of the majority of its revenue collections and bills paid. In addition, a number of specific deductions from operational cash requirements are made in recognition of timing differences between when revenues are collected in rates and when amounts are paid. These deductions take the form of accruals for future payouts, such as unused employee vacation and sick leave, utility user taxes, longterm incentive plans, and reserves for workers compensation and injuries and damages. Each of the deductions listed above takes a similar form: they are accruals collected in utility rates with the expectation of future payments to various creditors, including employees, cities and claimants. SP U-1 explicitly excludes interest-bearing customer deposits from these deductions. The payment of interest is the most obvious difference between customer deposits and other deductions from operational cash requirements. However, there is another difference: the other deductions represent timing differences between revenues collected in rates and amounts paid. Customer deposits differ in that they are funds collected from customers for security against non-payment that will be returned to those same customers or used as a credit against their bills in the event of non-payment. As a result, customer deposits do not represent timing differences between funds collected in rates and amounts paid out to creditors. Under cost-of-service ratemaking, utilities are entitled to recover their reasonable costs of providing service. Costs not paid by defaulting customers are borne by other customers. Thus, SP U-1, p. 1-. Id.

87 customer deposit policies are set in place to benefit all customers by keeping uncollectible accounts to a minimum. As such they are distinctly different from the other reserves and accruals deducted from operational cash requirements. More importantly, these differences are not simply cosmetic. As described in the next section, customer deposits differ fundamentally in that they are short-term debts, not accruals. As will be discussed, using customer deposits to offset rate base has financial consequences that the Commission should take into consideration.. Customer Deposits Are Not Permanent SCE s 01 decision notes TURN s argument that customer deposits represent a source of capital the utility has on a permanent basis. However, recent data show that this funding source is not stable. Between 00 and 01, SCE s customer deposit balance has declined by 1 percent, primarily as a result of changes in Commission credit policies. 1 In 0, the Commission established a proceeding to address the increasing number of customer disconnections for non-payment due to the economic recession. This proceeding resulted in a number of changes to customer deposits policy. For example, SCE s deposit requirement for reestablishment of service after disconnect has declined from twice a customer s maximum monthly bill to twice the average monthly bill. 1 Furthermore, customers in SCE s CARE program were no longer required to pay additional deposits in the event of disconnection. Finally, customers enrolled in SCE s on-line direct payment program were no longer required to make any deposits at all. Some of these policies have reached their sunset date in 01. While some of these policies will reach the sunset date of December 1, 01, based on a Commission approved settlement agreement in the Residential Disconnection OIR. 1 Although customer deposits are now back to pre-recession levels, the 1 percent reduction in deposits between 00 and 01 makes clear that these funds are affected by events beyond SCE s control and are not necessarily permanent. 1 In 00, SCE s customer deposits totaled $ million, compared with $1 million in See D.-0-0, Interim Decision Implementing Methods To Decrease The Number Of Gas And Electric Utility Service Disconnections, p.. Available at 1 D Available at

88 Impact of the Rate Base Offset Relative to the size of SCE s rate base, SCE s 01 customer deposits offset of $ million may seem inconsequential. However, the relative reduction in equity and increase in debt are not minor. The Commission limits variation in the California electric utilities equity ratios, requiring that the ratemaking equity ratio be maintained on average. 1 In addition, a utility must notify the Commission and request a waiver if its equity ratio falls one percentage point or more below authorized. 1 The impact of SCE s rate base offset on ratemaking equity (including common and preferred) based on SCE s 01 rate base and authorized capital structure is 0. percentage points. 1 Although currently below the waiver request level, an increase of this amount would certainly garner Commission scrutiny in Cost of Capital Proceedings. As SCE has indicated in the past, this amount on its own would not be sufficient to cause a ratings downgrade. But this does not mean the Commission should ignore its consequences. The effects of the adjustment will show up in the Company s credit ratios, and it will weaken SCE s credit quality relative to its California peers. SCE will continue to face challenges from the extensive capital expenditures needed to support the Commission s goals, including transmission to support renewables and smart meters to improve efficient electricity usage. Furthermore, as Standard and Poor s notes California energy policy is complex and dynamic and has shown itself capable of introducing rapid change that could upend what currently is a stable environment for regulated electric utilities. 1 As a result, SCE s current credit ratings cannot simply be taken for granted. The Use of a Rate Base Offset Provides Excess Rewards to Customers The customer deposits rate base offset provides customers as a class a rate of return equal to the long-term weighted average cost of capital (WACC). Including the effects of income taxes, the rate customers presently receive is. percent. 1 Individual customers deposits earn the 1 D.-01-0, Ordering Paragraph 1, Condition, 1 Cal. PUC LEXIS, *-*. Available at ftp://ftp.cpuc.ca.gov/legacycpucdecisionsandresolutions/decisions/decisions_d000_to_d/ D0_1_A000.pdf. 1 D.0-1-0, (mimeo), p.. Available at 1 Refer to WP SCE-0 Vol. 0, Chapter IV, p.. 1 Standard and Poor s, Ratings Direct Southern California Edison Co., July 0, 0, p.. 1 Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1. 0

89 short-term commercial paper rate; the difference between this rate and the WACC is spread across all customers through rates. Applying the short-term interest rate to customer deposits is reasonable based upon the deposits risk profile. Individual deposits are held only until a customer has established a record of good credit. Because each individual deposit is short-term in nature and the principal is repaid in full, it is appropriate to provide customers a relatively low interest rate on their outstanding balance. Customer deposits earn the same rate SCE pays its other short-term lenders, who bear equivalent risk. Customer deposits do not bear the same risks as funds from common shareholders or holders of long-term bonds, whose principal may be at substantial risk from either internal company circumstances or external market forces for up to 0 years or longer. In the capital markets, equity investors and long-term bondholders are compensated for this additional risk with higher rates of return compared to short-term lenders. However, the rate base credit means customers as a class receive the same rate of return as these long-term investors, despite the fact that they bear limited risk. Moreover, investors bear the negative consequences of higher debt and reduced cash flow from the rate base offset, as described in section IV.C. above. The Rate Base Offset for Customer Deposits is Inconsistent with Treatment of Fuel Inventory In its 00 GRC SCE recommended that customer deposits be deemed to finance fuel inventories. The Commission currently provides cost recovery for fuel inventory financing at the short-term commercial paper rate. As SCE explained in its testimony at that time, although fuel inventories turn over like other inventories, a permanent balance remains in place requiring financing on a long-term basis. 1 Although SCE is not recommending any changes to the treatment of fuel inventories in this proceeding, it must point out the inconsistency in the treatment of fuel inventories and In general, customer deposits are returned as soon as a customer makes on-time payments for 1 months or when an account closes. See A.0--0, Exhibit SCE-B. Refer to WP SCE-0 Vol. 0, Chapter IV, pp Despite their permanent nature, the Commission deems these inventories low risk and excludes them from rate base. 1

90 customer deposits. The Commission offsets rate base with customer deposits based on the view that while there is continuous turnover, the average daily and monthly balances stay relatively constant. 1 Yet, the Commission apparently overlooks that there is a constant need to finance fuel inventories and excludes this asset from rate base. In combination, these two policies compound the amount of hidden debt on SCE s ratemaking balance sheet. Both the debt from customer deposits and the debt associated with fuel inventories are excluded from the ratemaking capital structure determined in cost of capital proceedings. As a result, the ratemaking capital structure substantially understates the amount of permanent debt SCE carries on its balance sheet. In combination, the Commission s policies on customer deposits and fuel inventories reduce the ratemaking common equity ratio by 0. percentage points. Total debt increases by 0. percentage points. 1. Balancing Account Considerations In the Commission s decision on SCE s 01 test year General Rate Case, the Commission distinguished SCE from PG&E by the fact that SCE tended to be overcollected in balance accounts and PG&E tended to be undercollected. 1 However, the status of utility balancing accounts does not change the nature of the utility s customer deposits, which are still debt owed to customers.. A Change in Policy is Warranted As described above, SCE s rate base offset has resulted in a material impact on its equity ratio, to the detriment of its financial strength. In addition, the inconsistent application of the offset means that SCE s true debt and equity position is not comparable to that of the other California energy utilities, which can only create confusion in the generic cost of capital proceedings. The Commission should eliminate the customer deposit offset to rate base, consistent with the Commission s Standard Practice U-1 and the practice adopted for the other California utilities. In its place, the Commission should treat customer deposits as debt that is available to finance rate base and, consistent with the treatment for PG&E established in D and adopted in the recent GRC settlements for the SDG&E and SoCalGas. It should reduce SCE s embedded cost of 1 D.0-0-0, Section.. Available at 1 The difference between the reduction in common equity and the increase in debt is the reduction in preferred equity of 0. percentage points. Refer to WP SCE-0 Vol. 0, Chapter IV, p.. 1 D (mimeo), p.. Available at

91 debt by the difference between SCE s current authorized cost of long-term debt and the projected interest rate on 0-day commercial paper for the 01 test year, applied to 0 percent of SCE s customer deposit level recorded for 01. This results in a $. million reduction to SCE s overall revenue requirement. 1 SCE recognizes that it may be difficult for the Commission to make a determination on the financial consequences of the rate base offset without the broader financial context provided in a cost of capital proceeding. However, if such a context is needed, the Commission should eliminate the customer deposits offset here and take up the matter in the next cost of capital proceeding. It should not continue to reduce SCE s equity without considering the true nature of customer deposits and the financial consequences of the rate base offset.. Role for Customer Deposits in Outreach to Minority Suppliers and Communities In its 01 GRC, the Commission granted SCE permission to use a portion of its customer deposits to promote the Company s use of minority and community banks. 1 This policy was renewed in SCE s 01 GRC. 1 As SCE s 01 GRC testimony described, 1 it is particularly challenging to expand the use of Women, Minority, and Disabled Veteran Business Enterprise (WMDVBE) suppliers in banking, where large, publicly-traded commercial banks dominate. In addition, SCE minimizes its short term borrowing costs by accessing short-term capital in the commercial paper and short-term money markets rather than through bank deposits typically available from WMDVBE banks. Finally, SCE s cash flow variability and uncertainty means it cannot be assured that it will be cost effective to maintain deposits in fixed-term certificates of deposit (CDs) available from minority banks. SCE s minority and community bank program contracts directly with minority banks and banks doing business in minority communities. Thus, in addition to increasing contracts with minority owned suppliers, the program supports lending to other community businesses who could be potential 1 This reduction is implemented in the Results of Operations model as an eight basis-point reduction to the cost of long-term debt. Refer to WP SCE-0 Vol. 0, Chapter IV, pp D (mimeo), pp. -0, Conclusion of Law, p.. Available at 1 D (mimeo), p., Finding of Fact, p., Conclusion of Law 1, p A.--01, Exhibit SCE-, Volume, pp. -. Refer to WP SCE-0 Vol. 0, Chapter IV, pp. -1. SCE s cash position is highly dependent on electricity sales and on market energy prices. The unpredictability and volatility of these factors means the investment horizon for deposits is uncertain. The deposit program is not limited solely to minority banks or to local communities made up of minorities.

92 minority suppliers. The program maintains FDIC insurance on the deposits through a certificate of deposit placement service that flows the funds into numerous accounts whose dollar balances remain below the maximum FDIC insurance limit. At a national level, average CD rates are comparable to the commercial paper rate customers currently earn on their deposits. However, rates received from banks in the program may differ from the national average. Thus, although the Commission agreed that placement of a portion of customer deposits into minority and community banks would enhance SCE s efforts in this area, it deemed SCE s program to be voluntary. 1 The Commission authorized placement of up to percent of customer deposits through SCE s minority and community bank program. If any earnings differences occur they are to be shared 0/0 by shareholders and customers. 1 D. Deductions for Reserves 1. Accumulated Depreciation Reserve Accumulated Depreciation Reserves is the sum total of all activity affecting this account, including, depreciation expense, retirements, net salvage, adjustments and transfers as required by the FERC Uniform System of Accounts. The depreciation reserve used in Rate Base calculation is provided on Line 1 of Table IV-1 in the beginning of this chapter.. Accumulated Amortization Accumulated amortization of intangibles is the total annual amortization amounts from inception for Intangible Plant-In-Service. The annual accumulated amortization is shown in Line 1 of Table IV-1 in the beginning of this chapter.. Accumulated Deferred Taxes Plant Rate base is adjusted by the accumulated deferred income tax balance associated with differences in book treatment and tax treatment of property-related items that are subject to the normalization requirements of the Internal Revenue Code Section 1(f)() or allowed by this Commission to be included in normalized accumulated deferred income taxes. Details of these deferred taxes can be found in Chapter III of this Exhibit. Forecast information extracted from the analysis presented in that chapter is accumulated by years and used to develop the weighted average balances as shown in Line 1 of Table IV-1 in the beginning of this 1 D.1--01(mimeo), pp. -0, Conclusion of Law, p.. D (mimeo), p., Finding of Fact, p., Conclusion of Law 1, p Id.

93 chapter. Accumulated deferred income taxes for the test year 01 are developed on a monthly basis and prorated consistent with the normalization rules set forth by the related Treasury Regulations.. Accumulated Deferred Taxes Uniform Capitalization Accumulated Uniform Capitalization is a reserve component calculated in accordance with IRC Section A to capitalize indirect costs attributable to self-constructed assets. A detailed explanation of this deferred tax can be found within Chapter III of this exhibit. Forecast information is extracted from the analysis presented in that chapter, accumulated by year, and used to develop the weighted average balances as shown in Line 1 and incorporated with Accumulated Deferred Taxes - Plant of Table IV-1 at the beginning of this chapter.. Accumulated Deferred Taxes CIAC Accumulated Deferred Taxes-CIAC is a reserve component based on the Federal income tax law, specifically, IRC code section (b) as amended after the TRA, and the ratemaking treatment known as Method set forth in D Details can be found in Chapter III of this Exhibit. Forecast information is extracted from the analysis presented in that chapter, accumulated by year and month, and is used to develop the weighted average balances as shown in Line 1 of Table IV-1 at the beginning of this chapter.. Accumulated Deferred Taxes Vacation Accrual Accumulated Deferred Taxes Vacation Accrual reflects the accumulated deferred tax on the difference between year-end accrued vacation amounts expensed for generally accepted accounting principles and year-end accrued amounts deducted for tax purposes. 1 Forecast information is extracted from the analysis presented in that chapter, accumulated by year and month, and is used to develop the weighted average balances shown in Line 1 of Table IV-1 at the beginning of this chapter.. Unfunded Pension Reserve 1 SCE does not have access to most of SCE s pension reserves because they are held in external trust funds. The Unfunded Pension Reserve represents the unfunded portion of accumulated provision for employee retirement benefits. The balance is a liability to SCE until paid out. It consists of several accounts representing ongoing pension reserves. The forecast for is based upon actuarial determinations of pension accruals and payouts. 1 HR Rep No, 0 th Cong, 1 st Sess. 0-1 (1). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, pp. 1 1 (Unfunded Pension Reserve).

94 A portion of these pension reserves are for shared EIX officers. In the case of the shared officers, utility customers are responsible for about percent of the pension accruals, with the balance being recorded to non-utility operations. Removing those portions of the reserve not recovered from customers leaves approximately. percent of the total unfunded pension reserves as a rate base offset. However, because for tax purposes the revenues for Unfunded Pension Reserve accruals are taxed immediately upon receipt, whereas a tax deduction is taken only when payment is made, the full amount is unavailable to the company. 1 As a result of this timing difference, SCE only holds about 0 percent of the accrual reserve amount (i.e., it has been reduced for taxes paid). The after-tax rate base offset for Unfunded Pension Reserve is shown in Table IV-1. Table IV-1 1 Average Unfunded Pension Reserve (Nominal $000) Line Recorded Forecasted No Item Pre-Tax 1,0,0 1, 1, 1, 1,00 Less: Taxes (,0) (,) (,) (1,) (,0) (,) After-Tax,,,0,01 0,0 1,1 1 I.R.C., Sec. 1(h)()(C). 1 Refer to WP SCE-0 Vol. 0, Chapter IV, p. 1 (Average Unfunded Pension Reserve).

95 Appendix A AFUDC Rate Formula

96 AFUDC RATE FORMULA The AFUDC rate is defined by the Federal Energy Regulatory Commission and is part of the Uniform System of Accounts. 1 The total AFUDC rate is the sum of Ai, the gross allowance for borrowed funds used during construction rate and Ae, the allowance for other funds used during construction rate. Ai accounts for the cost of debt, both short-term and long-term, used to finance construction work in progress ( CWIP ), while Ae accounts for the cost of preferred equity and common equity used to finance construction work in progress. They are given by the following formulas: S D S A i = s + d 1 (1) W D + P + C W where S P C A = e 1 p + c W D + P + C D + P + C () S = average general purpose short-term debt, s = short-term debt interest rate, D = long-term debt, d = long-term debt interest rate, P = Preferred stock, p = preferred stock cost rate, C = common equity, c = common equity cost rate, and W = average balance in construction work in progress plus nuclear fuel in process of refinement, conversion, enrichment and fabrication, less asset retirement costs related to plant under construction. Equations (1) and () can be combined to yield the following: 1 Title 1, Code of Federal Regulations, Subchapter C, Part 1, Uniform System of Accounts Prescribed for Public Utilities and Licensees Subject to the Provisions of the Federal Power Act, Electric Plant Instructions, Section.A.1. This can be found on the Internet at dno=1. The Commission adopted this section of the Uniform System of Accounts in D., dated October 1, 1. The Uniform System of Accounts does not reference general purpose short-term debt, but only short-term debt. However, SCE is permitted to exclude short-term debt associated with financing balancing accounts and fuel inventories from the AFUDC calculation. Letters from FERC Chief Accountant to SCE, dated February 1, 1 and February, 1. A-1

97 A = + = W S C P D C c C P D P p C P D D d W S s A A AFUDC e i 1 () or + = W S WACC W S s AFUDC 1 () where () WACC is the weighted average cost of permanent capital: long-term debt, preferred equity, and common equity = C P D C c C P D P p C P D D d WACC

98 Appendix B Confidentiality Declaration of Connie J. Erickson

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