Michael Martin, who was accepted as an expert witness in the field of accounting. Exhibits 1 through 7 were received into evidence on behalf of the intervenor Ruchlis. The parties' prehearing stipulations were received into evidence as Hearing Officer's Exhibit 1.
Subsequent to the hearing, the petitioner, the respondent and the intervenor Office of Public Counsel filed proposed findings of fact and proposed conclusions of law, and the intervenor Ruchlis filed a brief. To the extent that the parties' proposed findings of fact are not included in this Recommended Order, they are rejected as being either not supported by competent substantial evidence adduced at the hearing, irrelevant or immaterial to the issues presented for decision or as constituting conclusions of law as opposed to findings of fact.
Upon consideration of the oral and documentary evidence adduced at the hearing, the following facts relevant to the issues in dispute are found:
On March 8, 1981, the petitioner provided notice of the administrative hearing which commenced on March 25, 1981, by placing a notice on the doorknob of each resident of Century Village. Customers not residing within Century Village and commercial customers were mailed notice of the hearing on the same date. A newspaper notice of the March 25, 1981 hearing appeared on March 18, 1981.
Quality of Service
There are approximately 7,700 utility meters in Century Village and there has been minimal growth within the utility since the 1979 test year. Sixteen customers of the petitioner testified at the hearing. Their testimony included objections to the sufficiency of the notice they received of this rate case proceeding, the requested rate increases, the taste and smell of the water, the mineral deposits in the water, the odor from the sewage treatment plant, the billing procedures employed by the petitioner and the manner of petitioner's responses to customer inquiries and complaints.
The petitioner's billing cycle is not constant. On some occasions, the bill covers a period of twenty-eight days and, on other occasions, a billing cycle of thirty-five days is used.
Many customers have installed, at their own cost, water filters to alleviate the objectionable smell, taste and mineral deposits in their water. Some customers testified that their cooking pots and pans had become blackened and pitted from the mineral deposits and sediments in the water. Several customers also complained of low water pressure in their homes. None of the testifying witnesses had consulted the local health department as to the quality of the water received from petitioner. At the time of the hearing, there were no outstanding complaints against petitioner filed with the Public Service Commission's Consumer Affairs Department. Previous complaints had been resolved in a timely fashion.
The petitioner's water and sewer operations presently comply with all applicable State regulatory standards for water and sewer service. There are no citations or corrective orders pending against the petitioner's water and sewer systems. Petitioner is operating under a negotiated consent order which requires it to connect its sewer system to the regional system when said system becomes available. There was evidence that this connection to the County system will result in an increased sewer charge. The County will send one monthly bill to the petitioner and the petitioner will then bill the individual customers. The bulk rate charge was speculative at the time of the hearing. Pursuant to an agreement between the County and the petitioner, the petitioner will be required to maintain its sewage treatment plant on a standby basis after it connects to the County system.
Rate Base. I. Gross Plant in Service
This being the petitioner's first rate increase application, no prior amount of utility plant in service for either the petitioner's water or sewer system has been established or approved by the PSC. The petitioner alleges that its utility plant in service is $2,401,436 for water and $2,711,697 for sewer, for a total gross plant in service of $5,113,133. An officer of petitioner who is a certified public accountant testified that this figure is supported by the books and records of the petitioner.
The PSC staff engineer, Jim Shoptaw, attempted to verify the petitioner's alleged original cost of plant. Several methods of determining original cost are utilized by the PSC. Though not formalized by rule, the methods used to substantiate the original cost of a utility system, in order of PSC preference, are as follows: an engineer's original cost study, a review of the contracts let for individual utility construction projects and a review of invoices for materials purchased. The invoicing method of establishing original costs is considered least effective because there is no way to verify that the materials purchased were actually placed or used for the water and sewer systems. When these three methods are not available, as built drawings or plans can be utilized to determine the amount and type of materials in the ground and a unit cost study can then be performed.
In this case, the petitioner did not have either an engineer's original cost study or copies of the construction contracts. The maps or prints submitted by petitioner to the PSC staff were not accurate or complete. Mr. Shoptaw thus made an on-site inspection, with advanced notice, and was provided several boxes of invoices which were not organized in a systematic manner. A review of invoices allowed Mr. Shoptaw to verify only 39 percent of what petitioner claimed in its application as the amount of plant in service.
Petitioner was then requested to supply respondent with a unit cost breakdown and the amount of pipe placed in service each year. A given year was not provided by the petitioner. After calculating the length and cost of pipe utilized, Mr. Shoptaw "trended" the costs and eventually determined that the petitioner's application had overstated the water system plant by approximately
$107,000 and the sewer system plant by some $147,000.
The unit cost information supplied to Mr. Shoptaw by the petitioner was based upon data collected from water and sewer installations in single- family residential communities. This was a result of a misunderstanding by petitioner's employees as to what information Mr. Shoptaw desired. The "trending" and reasonableness study performed by Mr. Shoptaw was also based primarily upon a comparison with utilities serving single-family areas. There are major differences between the costs of constructing multiple-family and single-family utility distribution systems. High density housing requires larger pipes run for shorter distances and a greater number of valves, manholes, connections and other materials due to the greater number of connections per mile. There are also road and construction problems and expenses in a multifamily complex not found in an area with single-family dwellings. It is considerably more expensive per linear foot to build in a high density area such as Century Village than in an area containing single-family dwellings.
Approximately three weeks prior to the commencement of the hearing in this case, the staff of the PSC was provided with additional boxes of invoices to further document the petitioner's gross plant in service. When combined with those already submitted, the additional invoices substantiated 58 percent of the claimed plant in service. Mr. Shoptaw felt that use of the invoices was not compatible with his then completed trending methodology, that the additional invoices arrived too close in time to the hearing to be of assistance and that
58 percent of documented costs was not a large enough sample from which to determine the original cost of the entire system.
Mr. Shoptaw expended approximately 500 hours preparing his report in this proceeding. A reasonable amount of time to be spent on a utility of this size with good record-keeping practices would be approximately 200 hours.
There is some confusion in the record as to whether the PSC staff twice removed the same items from the petitioner's claimed gross plant in service as a result of the different surveys performed by Mr. Shoptaw and the PSC's accounting staff. (T. 998-1000). This issue was never clarified during the hearing.
Rate Base. II. Accumulated Depreciation.
Through the end of the 1979 test year, the petitioner utilized an annual depreciation rate of approximately 6 percent on its gross water and sewer plants. During the course of preliminary discussions with the PSC staff, petitioner agreed to adopt a depreciation rate of 2.5 percent per annum for these assets. The 2.5 percent annual depreciation rate is based upon the premise that petitioner's water and sewer facilities have a service life of 40 years rather than the 16.7 year life originally applied. The issue in dispute regarding this stipulated change in the annual rate of depreciation is whether the 2.5 percent rate should be applied retroactively to the year of inception or whether it should be applied to the future only.
The construction of the petitioner's water and sewer systems began in 1969. Neither the petitioner's original decision to fix the useful life of the water and sewer systems at 16.7 years nor the PSC staff's decision to fix their lives at 40 years was based upon an engineer's expert opinion after a physical inspection of the assets. There have been no significant physical changes in the assets since their installation.
Under generally accepted accounting principles, different treatment is prescribed for the "correction of an error in previously issued financial statements" and a "change in accounting estimate." The "correction of an error" treatment requires a restatement or a retroactive application. This treatment is accorded errors resulting from
"mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that
existed at the time the financial state- ments were prepared."
A "change in accounting estimate" does not require a restatement or retroactive treatment and results from "new information or subsequent developments and accordingly from better insight or improved judgment." APB Opinion No. 20, paragraph .13. The service life or salvage value of a depreciable asset is an example of the estimate required in the preparation of a financial statement.
APB Opinion No. 20, paragraph .10.
Were petitioner permitted to retroactively apply the new 2.5 percent depreciation rate to 1969, the date construction of the water and sewer systems began, a possible result would be the utility's double recovery of depreciation expense through its rates. The impact upon the utility of not making a retroactive adjustment of the 2.5 percent depreciation rate would be to reduce rate base by some one million dollars per year and thus substantially reduce the petitioner's cash flow.
Rate Base. III. Contributions-in-aid-of-construction (CIAC)
Petitioner's water and sewer tariffs on file with and approved by the PSC in 1970 include copies of a schedule of tapping fees and three developer agreements. The developer agreement between petitioner and Century Village, Inc. entered into on November 1, 1968, defines CIAC and denotes the developer's responsibility to pay CIAC for the petitioner's water and sewer systems. Other developer agreements between Century Village, Inc. and secondary developers were also discovered which make reference to the agreement between petitioner and Century Village, Inc. The PSC staff seeks to impute as CIAC over two million dollars as a result of the developer agreements and the tapping fee schedule.
If this amount were imputed as CIAC, the petitioner would have a zero rate base and recover through its rates only operation and maintenance expenses and taxes.
According to petitioner's president, neither the tapping fees on file with the PSC nor CIAC pursuant to the developer agreements were collected by the petitioner since he assumed the presidency in 1970. The amounts which are claimed as CIAC by the petitioner were collected prior to the time Mr. Christopher became the petitioner's president. Those portions of the developer agreements regarding CIAC were not carried out because petitioner desired to build a rate base. The petitioner's overall policy of not accepting CIAC was reflected in a letter dated May 8, 1972 by petitioner to the PSC in response to PSC Order No. 5403 which required petitioner and other regulated utilities to
file a service availability policy with the PSC. Other than this May 8, 1972 letter, petitioner has made no other attempt to revise the tariffs filed with the PSC with respect to the developer agreements or the tapping fees.
Auditors from the PSC staff were unable to find any evidence from the books, records or tax returns of the petitioner that tapping fees or other CIAC were ever collected by petitioner other than as reported by petitioner in this case. No significant investments were written off as cost of goods sold for tax purposes.
Capital Structure and Rate of Return
During the test year, petitioner's actual capital structure was comprised of 85 percent debt due to outstanding loans held by affiliated companies. The capital structure of the parent company, Cenvill Communities, Inc., during the test year was approximately 41 percent common equity, 55 percent long-term debt and 4 percent deferred taxes. For this rate application, the respondent PSC used the capital structure of the parent company in its cost of capital calculations. Subsequent to filing the rate increase application, the petitioner recapitalized its capital structure so that its debt-equity ratio approximately matched the debt-equity ratio of the parent company.
Utilizing various methodologies, including an analysis of average bond yields, a discounted cash flow study, a trend line analysis and an added risk premium, petitioner has computed a range of fair return on equity at between
18.96 percent and 21.13 percent, for an average fair return of 20 percent. Using a ten-year time period, a discounted cash flow methodology and a regression analysis, the PSC staff computed a cost of equity of 16.25 percent, with a range of between 15.25 percent and 17.25 percent.
Petitioner originally requested an overall rate of return of 12.83 percent. This figure was changed during the hearing to 10.38 percent. The PSC staff has computed an overall rate of return of 12.11 percent.
Income Taxes
Petitioner has elected to participate in the consolidated income tax return filed by its parent, Cenvill Communities, Inc. The parent routinely assesses a 46 percent rate on all its subsidiaries having a positive taxable income for the tax year. The petitioner and the PSC staff are in agreement that an appropriate federal income tax rate for petitioner is 46 percent, and an appropriate state income tax rate is 2.7 percent.
The Office of Public Counsel presented testimony to the effect that a
46 percent federal income tax rate is excessive because it reflects a greater percentage tax rate than the actual consolidated tax rate. It was argued that the effective tax rate for petitioner during the 1979 test year was 21.06 percent. Unusual capital gain transactions did occur during the test year.
Other Operating Expenses and Undisputed Items
Petitioner had a contract which called for a meter-reading payment of
25 or 30 cents per meter. The average meter reading expense, including transportation, for the South Florida area is 17 cents per meter. Meters may be read very quickly in Century Village because of its high population density. With each building having approximately 25 meters, one could easily read 75 to
100 meters an hour.
A witness presented by the intervenor Ruchlis examined petitioner's books and concluded that there was insufficient data and supporting documents to validate some of the salary and operating expenses claimed by the petitioner. The PSC staff apparently recognized this deficiency and interviewed some of the employees to determine how much of their time was actually allocated to the petitioner. It was agreed between petitioner and the PSC staff that $25,000 should be deducted from petitioner's claimed salary expenses.
For the purposes of this proceeding, petitioner's working capital needs are zero.
The total amount of rate case expenses for this proceeding is $35,000, to be amortized over a five year period and allocated on a 50-50 basis between the water and sewer operations.
The base facility charge concept is fair to all customers and should be employed as petitioner's rate structure.
CONCLUSIONS OF LAW
The Florida Public Service Commission is empowered to fix and approve rates which are just, reasonable, compensatory and not unfairly discriminatory. Section 367.081, Florida Statutes (1980). In rate making proceedings, the utility bears the burden of establishing entitlement to the requested rate relief by competent, substantial evidence. Rule 25-10.175(1), Florida Administrative Code.
While the evidence submitted at the hearing did not establish that the petitioner provided the complete newspaper notice required by Rule 25-2.981, Florida Administrative Code, it is concluded that all interested persons were, in fact, given adequate notice of the administrative hearings which were conducted in this proceeding. The petitioner provided doorknob notice to each resident of Century Village, and mailed notice to its customers who did not reside in the Village. Due to the length of time over which this seven-day hearing spanned--from March 25 through July 1, 1981, it cannot be legitimately claimed that interested customers did not have the opportunity to participate in the hearing process.
Quality of Service
The evidence adduced at the hearing establishes that the water provided and the sewage treated by the petitioner meets all state regulatory standards, that the petitioner has expeditiously handled its consumer complaints and that it has no outstanding complaints from customers on file with the PSC. While there were customer complaints at the hearing regarding the taste, smell and quality of the water and the odor from the sewage treatment plant, the witnesses who testified did not establish any expertise or competency to provide testimony on the subject of water quality. The petitioner having illustrated that its water and sewer service is satisfactory, no adverse consequences should be imposed upon the petitioner as a result of the quality of its service. Petitioner should be cautioned, however, to utilize a more consistent billing cycle.
Rate Base
Gross Plant in Service
At the outset, it should be noted that when and if the petitioner's sewer operations are connected to the regional or county system, the amount of petitioner's sewer plant used and useful in the public service may be greatly affected, thus affecting the computation of petitioner's sewer rate base. However, there was insufficient evidence adduced at the hearing regarding the dates of completion of the regional pumping station and the petitioner's connection with the regional system to justify a consideration of that issue in computing petitioner's present sewer rate base.
In establishing rates, the PSC must consider the cost of the service provided. Section 367.081(2), Florida Statutes. The rules and regulations of the PSC place the burden upon the utility to maintain and provide accurate records in support of the costs of the services it provides. See Rules 25- 10.27, 25-10.176(4)(b) and 25-10.177, Florida Administrative Code. 1/
Petitioner contends that its total gross plant in service is
$5,113,133. Other than the statement by petitioner's officer that this figure is supported by petitioner's books and records, petitioner has not documented its position in this regard.
The trending approach utilized by the PSC staff was based upon items which relate to utility systems within single-family dwelling areas. Thus the computations derived from this method of establishing original costs of gross plant in service are understated. However, the use of such a methodology was the result of the petitioner's failure to maintain and provide adequate records and documentation of the original cost of its water and sewer systems, as well as the provision by the petitioner to the PSC staff of data which utilized single-family area figures.
Thus, the problem becomes one of choosing between the undocumented and unsupported allegation of petitioner as to the total original cost of gross plant in service to be utilized in establishing rate base and the understated result obtained by the trending method utilized by the PSC staff. A utility should not be rewarded for its failure to maintain and produce competent documentation of the original cost of its system. An applicant for a rate increase carries the burden of proving by competent, substantial evidence that the investment upon which it seeks a return is accurate and verifiable. Given this burden and the fact that the testimony concerning the methodology employed by the PSC staff to establish original cost, even though understated, results in the only documentation of such costs provided during the hearing, it is concluded that the staff's recommended reductions to gross plant in service should be adopted. This conclusion is conditioned upon a further review and determination of whether certain items were deleted twice from petitioner's plant account by the PSC staff.
Accumulated Depreciation
The petitioner contends that the 2.5 percent annual depreciation rate should be retroactively applied because the change is the result of a "correction of an error" rather than a "change in accounting estimate" and because the 40 year lifespan of the system runs from the date of its inception and not from today or next year. The respondent and the Office of Public Counsel contend for a prospective application of the new depreciation rate,
terming it a "change in accounting estimate," because prospective application would preclude the possibility of a partial double recovery of depreciation expense. Both sides rely upon the language contained in Accounting Principles Board Opinion No. 20 as supporting their respective positions.
While the petitioner is correct in its contention that the projected
40 year lifespan of its water and sewer systems begins with the year of inception of the systems, the consumer should not have to twice pay depreciation expenses because of an erroneous original estimate of lifespan by the utility. The examples given in APB Opinion No. 20, paragraphs .10 and .13, to distinguish an error from a change in estimate lead the undersigned to conclude that a change in projected lifespan of an asset, for depreciation purposes, is a change in estimate requiring prospective application only. This conclusion is supported by the PSC's past practice of disallowing the recalculation of depreciation reserve. See In re S. E. Morris and Sons, Inc., PSC Order No. 10042 (June 3, 1981, sheets 4-5). It is concluded that the 6 percent depreciation rate should apply from 1969 through the 1979 test year and that the
2.5 percent rate should apply from that date forward.
Contributions-in-aid-of-construction (CIAC)
A utility is entitled to a fair rate of return on its investment in property used and useful in the public service. CIAC include moneys received by a utility which represent a donation or contribution to capital and are utilized by the utility to offset the acquisition, improvement or construction costs of property, facilities or equipment. Since such funds are not invested by the utility, CIAC are not to be included in rate base.
In this case, it is apparent from the developer agreements that petitioner had contractually agreed to receive CIAC from the various developers of Century Village. However, it is also apparent from the testimony of petitioner's president and the petitioner's books, records and tax returns that neither CIAC from the developers nor tapping fees were ever collected, received or utilized by the petitioner. It thus appears that petitioner waived its rights to receive CIAC and did not, in fact, receive CIAC.
It is true, as asserted by the respondent and the intervenor Office of Public Counsel, that utilities are not permitted by statute or by rule to change their filed and approved tariffs without an application for a change or withdrawal of the tariffs. Section 367.081(1), Florida Statutes, Rules 25-9.01, 25-9.45, 25-10.14 and 25-10.41(2), Florida Administrative Code. However, these regulatory provisions, even if they were in effect during 1970 when the petitioner filed the developer agreements and tariffs with the PSC, should only create a presumption that CIAC was being collected, received and utilized by the petitioner. It is concluded that petitioner has adequately rebutted that presumption in this proceeding through the testimony of its president, the letter dated May 2, 1972 on file with the Public Service Commission and the testimony of the PSC staff's auditors that they could find no evidence in the books, records or tax filings of the petitioner that any moneys were collected pursuant to the developer agreements or the tapping schedules. The appropriate amount of CIAC to be included in petitioner's rate bases should be as claimed by petitioner; to wit: $111,612 for the water system and $554,813 for the sewer system.
CAPITAL STRUCTURE AND RATE OF RETURN
The prime areas of dispute between the parties concerned the appropriate capital structure to be utilized for the petitioner and the appropriate cost of equity to be utilized in determining the utility's overall cost of capital. A review of the testimony concerning capital structure leads the undersigned to conclude that the 40 percent equity ratio, which approximates the parent company's debt-equity ratio, is appropriate.
The petitioner's method of computing cost of equity results in an overall fair rate of return of 12.83 percent, as was originally requested. The PSC's method results in an overall fair rate of return of 12.11 percent. The petitioner is presently requesting rates which will provide an overall rate of return of 10.38 percent. In the case of Utilities Operating Co. v. King, 143 So.2d 854 (Fla. 1962), the court held that, absent a showing that service rendered the public would suffer, the PSC must approve rates requested by a utility which are less than those which would provide a fair rate of return. Thus, if the ultimate refinement of the issues in this proceeding in terms of operating earnings and rate bases produces an overall rate of return less than the lowest fair rate of return adduced by the evidence in this proceeding; to wit: the 12.11 percent suggested by the PSC staff, the revenues or rates requested by the utility should be approved. In the alternative, the undersigned concludes that the discounted cash flow method utilized by the PSC staff in determining equity cost is supported by logic and the greater weight of the evidence.
INCOME TAXES
It is undisputed that not all of the dollars paid by petitioner to its parent as its share of the consolidated tax liability are, in fact, then paid to the Internal Revenue Service. The Office of Public Counsel argues that petitioner's actual income tax expense is its proportionate share of the parent's consolidated tax liability. This argument ignores the fact that the utility actually pays, as an income tax expense, an effective rate of 48.7 percent into the consolidated pool. Petitioner has met its burden of proof with regard to its claimed tax expense of 48.7 percent.
OTHER OPERATING EXPENSES AND UNDISPUTED ITEMS
In the Century Village complex, a meter reading expense of over 17 cents per meter is not reasonable. Petitioner's proposed meter reading expense of $21,296 should be reduced by an amount which equals the excess of the amount obtained by multiplying the average number of meters by the 17 cent figure.
There being no evidence presented showing that the petitioner's salary expenses, after the $25,000 adjustment, were inappropriate, the salary expenses claimed by petitioner should be approved.
There being no dispute concerning the amount of petitioner's working capital needs, the amount of rate case expenses or the use of the base facility charge concept, findings of fact numbers 28, 29 and 30 above should be approved.
