Energy Sector: Cost Allocation Methodologies
In this article we will see how cost allocations are done in a Energy sector.
Primal Energy is an energy corporation with its chief operations – retailing and bulk distribution of electrical energy with provision of metering and data services. They cater to nearly one million electricity consumers spread across a network franchise spanning over several hundred miles. Primal Energy is essentially in a “Network and Retail business” that is structured into a number of separate business units/segments that facilitate the control of its organizational resources and processes.
1. Business Units/LOB:
(a) Office of CEO: provides support to the Board of Directors through review and helping in the process of improvement to the company’s framework of corporate governance.
(b) Finance: takes responsibility for setting financial and procurement strategies for the organization.
(c) Regulatory and Corporate Affairs – is assigned the responsibility for managing the organization’s regulatory affairs.
(d) Human Resources – to ensure a healthy and safe physical environment for the employees while creating the culture to develop, attract and retain high quality staff.
(e) Retail and Customer Services – is assigned the responsibility of developing, marketing and selling its products designed to meet consumer preferences and thereby expand its customer base.
(f) Network Development and Control – is assigned the responsibility for planning, operating and monitoring the network. This includes the delivery of its capital program to ensure capacity utilization, sustained integrity and long-term value.
(g) Network Asset Operations – is assigned the responsibility of ensuring a safe and reliable network by building and maintaining the network assets in good order. This division is also responsible for the provision of metering and data management services in addition to managing network connections undertaken by external providers.
Rollups are created based on service categories, shown below.
|
Service Classification |
Service Categories |
| Standard Control Services | Standard Network Services ;Standard Connection ServicesConnections necessitating augmentation – Revenue Component |
| Alternative Control Services | Type A Metering Services ;Non Standard Metering ServicesPublic Lighting ServicesFee based servicesQuoted Services
Relocations & Alterations to Assets for Public lighting |
| Unregulated Services | Type B /Type C Metering ServicesConnections necessitating augmentation – Capital Component |
| Negotiated Distribution Services | New Public Lighting Schemes |
2. Cost Allocation Methodology
It is the Company policy to automatically attribute Direct Costs to an appropriate Work Category in its Distribution Service. Methodology adopted by Primal Energy in this regard for some key Direct Attributions are tabulated below for (a) Operating Expenses (OPEX) and (b) Capital Expenditure (CAPEX) separately:
3. Automatic Attribution of Some Key Direct Costs
Direct Cost Attributions of Primal Energy for some of its key Operating Expenses (opex)
|
Main Work Category |
Description of Expense |
| Operating Costs | Opex for -guaranteed service level payments,Maintaining electrical safety, National Electricity Market levy,Real time management of distribution network and dynamic system supervision. |
| Maintenance Costs | Opex for –Planned/Unplanne maintenance costs for fault, connection asset repairs and inspections, planned network system assets, |
| Demand Management | Opex associated with –Demand side management initiatives including capex deferrals. |
| Alternative Control | Opex associated with the provision of –marketing services, public lighting services, Alternative Control Services where their prices are already fixed and allocated on the basis of a fixed fee, quoted services (on a case by case basis). |
| Unregulated | Opex associated with the provision of –Contestable Marketing Services, Unregulated Distribution Business Services. |
However, I have listed below some of the cost drivers used on some cost items, as these cost items can be directly traced to the Company’s Profit and Loss Account:
4. Cost Drivers Used that directly affect some Key Items in the Company’s Profit and Loss Statement:
|
Cost Type |
Cost Driver Employed |
|
Non Operating & Maintenance Costs |
|
| Electricity Purchases | Direct Cost incurred |
| Line Cost – Retail | Direct Cost incurred |
| Net Energy Metering (NEM) Fees | Volume of Electricity Purchased |
| Depreciation (System Assets) | Direct Cost incurred |
| Depreciation (Non System Assets) | Share of Financial Position (PPE – Personal Protective Equipment) allocation for each particular class |
| Interest | Direct Cost incurred |
| Tax | Direct Cost incurred |
|
Operating and Maintenance |
|
| Network Asset Operations – Direct | Direct Cost incurred |
| Network Development & Control – Direct | Direct Cost incurred |
| Network Asset Operations – Indirect | Based on the percentage allocationof Network Development & Control – Direct Costs to distribution services |
| Network Development & Control – Indirect | Based on the percentage allocationof Network Development & Control – Direct Costs to distribution services |
| Customer Care | (FTEs)/Contractors |
| Customer Creation and Transfers | (FTEs)/Contractors |
| Billing | (FTEs)/Contractors |
| Revenue Management Services | (FTEs)/Contractors |
| Customer Interaction Centre | (FTEs)/Contractors |
| Business Systems | Direct Cost Incurred |
| New Contract Operations Sales | Direct Cost Incurred |
| Sales | Direct Cost Incurred |
| Marketing | Direct Cost Incurred |
| Business Performance | Direct Cost Incurred |
| Trading | Direct Cost Incurred |
5. Financial Position Statements
6.1 Assets
6.1.1 Receivables
Receivables are allocated to the Regulated Distribution business segment on a direct basis. Receivables from Retail operations are allocated on the basis of sales revenue to either the Regulated Retail or Other Business segment. Receivables associated with non distribution services are classified in the Other business segment.
6.1.2 Accrued Revenue
Accrued revenues are allocated on a direct basis to the Regulated Distribution business segment. Accrued revenue (estimated revenue from unread meters) relating to the Retail operations is allocated on the basis of sales revenue to either the Regulated Retail or Other business segment.
6.1.3 Inventory
Inventory is deemed to be only required for prescribed and excluded services; and is allocated to the Regulated Distribution business segment.
6.1.4 Prepayments
Prepayments are allocated on a case by case basis based on a review of the individual items involved. Prepayment has been consistently found to consist to a large extent of surpluses.
These surpluses are allocated to the business segments based on the contributions for the respective business units as a proportion of total, and then reallocated to the relevant regulatory segments based on the respective business unit’s operating expense splits. Other prepayments are allocated based on the nature of the drivers.
6.1.5 Future Income Tax Benefit
An analysis is made of the composition of the balance in the Future Income Tax Benefit before any decision are taken with regard to its allocation r final disposal.
Individual items making up the balance are then allocated based on the nature of the drivers.
For example, provisions are allocated so as to be consistent with the liability allocation.
Deferred profit on finance swaps is allocated at 100% to Regulated Distribution on the basis of investment income.
Deferred profit on wholesale energy swaps is also allocated at 100% to the Other business segment, while non-deductible accruals are allocated based on the weighted average operating cost allocation.
6.1.6 Property, Plant & Equipment
System asset balances are allocated directly to the Regulated Distribution Business segment.
Property, plant and equipment balances in Retail are also allocated directly to the relevant regulatory segment.
Non system assets such as land and buildings, motor vehicles, computer equipment, software, furniture and fittings, etc. are allocated to business segments based on usage; (for example depots, and heavy plant and vehicles are allocated to Network).
Where a specific asset is not directly attributable to a particular segment, a relevant cost driver (for example labor) is used.
6.2 Other Assets
Other assets include derivatives, non-current assets held for sale, and Renewable Energy Certificates. These assets are allocated to the respective business segments to which they relate.
6.3 Liabilities
6.3.1 Bank Overdraft
Bank overdraft is allocated to the Regulated Distribution business segment.
6.3.2 Trade Creditors
Trade creditors relating to the Retail operations are allocated on the basis of operating expense splits, to the Regulated Retail or Other business segment. The corporate trade creditor balance is allocated based on operating expense splits to the regulatory segments, with the exception of inventory related creditors which are directly allocated to the Regulated Distribution segment.
6.3.4 Accrued Expenses
Based on a review of the individual items comprising the balance to the regulatory business segments, Accrued expenses are allocated. When it is not possible to directly allocate an item to a segment, items are allocated based on the nature of the most relevant driver, including operating expense splits, customer numbers and volume.
Accrued interest payable is allocated directly to the Regulatory Distribution business segment on a consistent basis with the treatment of borrowings. Accruals in respect of Renewable Energy Certificate Costs are allocated to the Regulated Retail or Other business segment on a volume basis.
6.3.5 Customer Deposits
Allocation of Customer deposits attributed to the Retail operations to the Regulated Retail or Other business segments is done on the basis of number of customers. Contractor deposits are allocated directly based on the nature of the deposits to the Regulated Distribution business segment.
6.3.6 Provision for Income Tax
Provision for income tax based on the proportion of provision for income tax required to reconcile the income tax expense and deferred tax balances, is allocated between regulatory business segments.
6.3.7 Provision for Deferred Income Tax
Provision for deferred income tax balance is allocated based on a review of the individual items comprising the balance. Individual items are allocated based on the nature of the drivers. For example, unread meters are allocated on a consistent basis with the asset allocation. Capitalized labor is allocated at 100% to Regulated Distribution, and variations between tax and book depreciation are allocated based on the overall depreciation expense allocation.
6.3.8 Provision for Dividend
Provision for dividend based on the proportion of operating profit earned by each regulatory segment is allocated between those business segments. Balances are made to be consistent with the Statement of Financial Performance.
6.3.9 Other provisions (employees etc.)
Provisions in respect of Employee Entitlements based on the employee leave entitlements for the respective business units as a proportion of the total are allocated to the regulatory business segments. Residual balances then remaining are reallocated to the relevant regulatory segments based on the respective business units labor expense splits. General provisions based on a review of the individual items comprising the balance are allocated to business segments. Where an item cannot be directly allocated to a segment, items are allocated based on the nature of the most relevant driver.
6.4 Other Liabilities
Allocation of other liabilities is made based on the nature of the liability. Allocation of Deferred Finance Swap and Treasury Derivatives are to the Regulated Distribution business to keep in line with investment income. Due to the direct relationship with contestable customers, Electricity derivatives are allocated to the Other business segment. Keeping in line with non-distribution activities, unearned income associated with pole rental and rental income of land and buildings too are allocated to the Other business segment
7 Shareholders Funds
7.1 Share Capital
Share Capital is the balancing item for the Statement of Financial Position.
7.2 Asset Revaluation Reserve
The balance of the asset revaluation reserve relating to system assets is directly allocated to the Regulated Distribution business segment. The non-system asset revaluation reserve balance is allocated between the Regulated Retail, Regulated Distribution and Other business segments on the basis of the Financial Position Statement’s property, plant and equipment split, for the relevant asset class to which they relate.
7.3 Accumulated profits/losses
Accumulated profits/losses comprise of prior year profits/losses, plus the profit/loss in relation to the current year.
7.4 Capitalized Overheads
It should be noted that this paper does not discuss the calculation of capitalized overheads as the cost allocation methodology is centered on allocation of costs between Network and Retail, and then the various business categories that sit under each of these broad business segments.