| November, 2011 A summary of the British Columbia Auditor General’s Report entitled
In 2010, British Columbia's Auditor General determined that BC Hydro's accounting practices, particularly those related to the use of rate-regulated accounts (also called deferral or regulatory accounts), needed to be reviewed. Regulated utilities, like BC Hydro, use deferral accounts to defer expenses or revenues to future years instead of recording them in the year they were made or received. Used in this manner, deferral accounts can ‘smooth out’ the effects of a utilities unexpected costs or revenues, and provide rate stability to customers. The Auditor General was concerned that BC Hydro's use of deferral accounts was going well beyond simply smoothing out rates. The Auditor General’s has two significant concerns about how BC Hydro is using deferral accounts. First, BC Hydro does not appear to have a plan to recover the deferred expenses held in its deferral accounts, nor does it have a plan to halt their growth in number (as of March 31, 2011, BC Hydro had 27 separate deferral accounts). The Auditor General argues that if a company overuses or does not carefully manage deferral accounts, they can hide the consequences of financial management decisions and distort the company’s financial condition. Second, although Canada is moving towards adopting a set of accounting rules that would prohibit the use of deferral accounting in the future, the Government of British Columbia has amended its own legislation to require that BC Hydro adopt part of an American accounting standard that allows deferral accounting, thus avoiding the transparency sought by the new Canadian accounting standards. The Auditor General’s report notes that BC Hydro began using deferral accounts in 2005. Prior to that time BC Hydro used its Rate Stabilization Account to smooth out the impact of short-term volatility of expenses and revenues on ratepayers. Since 2005, the balances held in BC Hydro’s deferral accounts have grown from $182 million to $2.2 billion (as of March 31, 2011). BC Hydro forecasts that the balances in its deferral accounts will more than double to almost $5 billion by 2014. The Auditor General’s report notes that the purpose of public financial reporting is to ensure that the implications of a company’s financial management decisions are transparent, and that the company’s management is held publicly accountable. The report states, however, that deferral accounting, as practiced by BC Hydro, and sanctioned by the BC Utilities Commission, is not consistent with these objectives; that BC Hydro uses deferral accounting to obscure its financial management decisions and their implications. The report states that by deferring to future years costs or expenses that companies would normally count in calculating net income for the current year, BC Hydro has created an appearance of profitability where none actually exists. The Auditor General uses BC Hydro's fiscal 2010 to illustrate this. For the fiscal year ending March 31, 2010, BC Hydro’s actual expenses exceeded actual revenues to create a loss of $249 million; however, BC Hydro transferred $696 million of expenses to its various deferral accounts and reported a final net income for the year of $447 million. Instead of reporting a loss for the year of a quarter of a billion dollars, BC Hydro used deferral accounts to report a profit of almost half a billion dollars. What are the implications of this using deferral accounts in this manner? By law, BC Hydro is required to pay up to 85% of its net income for each year to the provincial government as a dividend payment. The Auditor General states that over the last decade, the impact of BC Hydro's use of deferral accounts has been to consistently increase BC Hydro's reported net income. Higher reported income has required BC Hydro to pay higher dividends to the provincial government. In six of the past 10 years, BC Hydro has paid the provincial government a dividend that was greater than the company’s net income would have been if it had not deferred some of its expenses to future years. Since 2000, BC Hydro has paid to the provincial government almost $3.2 billion in dividends. The Auditor General’s report also notes that BC Hydro's use of deferral accounts has had an impact on retained earnings, which are the financial resources a company retains to reinvest in the business or to pay down debt. Although BC Hydro's reported retained earnings have increased over the past decade, when the effect of expense deferrals are taken into account, the opposite is true – retained earnings have actually declined. The Auditor General cautions that if this declining trend continues, Canadian accounting rules may force BC Hydro to eventually report a negative equity, which could potentially challenge the going concern assumption underlying BC Hydro's financial reporting. (Note: in accounting, going concern refers to a company's ability to continue functioning as a business entity. The going concern assumption is an accounting guideline that allows readers of financial statements to assume that the company will continue to operate long enough to carry out its objectives and commitments.) The Auditor General says that over the same period, BC Hydro's debt has been growing. BC Hydro’s debt increased from $7.5 billion in 2006 to $11.6 billion as of March 31, 2011. (Note: BC Hydro forecasts that its debt will continue to climb as the company implements its program to upgrade and expand its infrastructure within the province.) The Auditor General concludes his report with two recommendations. First, that the government of British Columbia determine, at the earliest opportunity, how BC Hydro will recover the deferred costs in its regulatory accounts. He suggests three options that could be used individually or in combination: 1) rate adjustments, i.e., allow BC Hydro to increase its rates to recover the deferred costs over a set period; 2) operating efficiencies, i.e., apply any cost savings or increased revenues that arise from efficiencies suggested in the recent government review to deferral account balances; 3) infusions of cash. The Auditor General’s second recommendation is that the government require that BC Hydro prepare its financial statements in full accordance with Canadian generally accepted accounting principles, i.e., that the government of British Columbia reconsider its decision to allow BC Hydro to continue using deferral accounting. The Auditor General’s full report is available on the Auditor General of British Columbia’s website at www.bcauditor.com |
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Copyright © 2011. All Rights Reserved. Local 258, International Brotherhood of Electrical Workers, British Columbia, CANADA This website created and maintained by Leopard Print Communications. Member CEP 525-G.
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