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ARCHIVED - Decision CRTC 2000-212

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Decision CRTC 2000-212
Ottawa, 30 June 2000
New depreciation directives established for most independent telephone companies
Reference: 8630-C12-01/99
After consultation with industry players, the Commission has developed new depreciation directives for most independent telephone companies.
Effective immediately, the majority of independent telephone companies will benefit from new streamlined and standardized depreciation filing procedures. Current depreciation directives will continue to be used by Québec-Téléphone, Télébec ltée, The Corporation of the City of Thunder Bay - Telephone Division and Northern Telephone Limited.
Commission seeking simplified depreciation methodology

1.

In Depreciation methodology for the independent telephone companies (except Québec-Téléphone and Télébec ltée), Telecom Public Notice (PN) CRTC 99-26, dated 21 December 1999, the Commission initiated a public process to develop a more simplified and uniform approach to depreciation for the independent telephone companies (independent telcos). The approach should be easy to implement while satisfying the objectives of the Commission's Phase I depreciation directives and the Telecommunications Act.

2.

As part of that process, the Commission hired consultant Elie J. Thimot to hold discussions with a representative number of the independent telcos in Ontario and Quebec and prepare a report of his findings. The consultant's report:
a) identified the limitations currently facing the independent telcos in the preparation of depreciation filings and their ability to meet the Commission's Phase I depreciation directives; and
b) suggested alternatives that could be implemented in order to streamline the independent telcos' approach to depreciation filings.
Consultant met with industry representatives

3.

As an important part of his mandate, the consultant held a series of meetings with a representative number of the independent telcos, as well as staff members from the Ontario Telephone Association (OTA), l'Association des compagnies de téléphone du Québec inc. (ACTQ), and Société d'administration des tarifs d'accès des télécommunicateurs (SATAT). Discussions were held at a total of 13 individual company locations in Ontario and Quebec. Telephone interviews were conducted with representatives from O.N. Tel, Northern Telephone Limited and The Corporation of the City of Thunder Bay - Telephone Division (Thunder Bay). These consultations were aimed at obtaining a good understanding of the independent telcos' current depreciation processes and procedures. It was also intended to obtain information on the availability of detailed asset accounting records and the limitations faced by the independent telcos relative to regulatory filing requirements.

4.

The two larger independent telcos, Thunder Bay and Northern are familiar with, and generally follow, the Phase I depreciation directives. Both companies indicated that, in their respective opinion, it would be appropriate for them to continue with the current Phase I depreciation directives as they already have the tools in place. In their view, it would be counter-productive to introduce another methodology at this time. The consultant recommended that these companies continue to apply the Phase I directives in their depreciation filings with the Commission.
Consultant provides three possible options

5.

As set out below, the consultant's report outlined, among other things, three possible options on how to implement a more streamlined approach to the depreciation filings of the remaining independent telcos. The consultant recommended adoption of Option 1.
Option 1
Modify and simplify the Phase I depreciation directives in order to recognize the particular operating environment of the smaller independent telcos while continuing to satisfy the main objectives of the Commission's directives.
Option 2
For each major asset class, establish a range of depreciation life characteristics considered to be generally representative of the North American telecommunications industry. Independent telcos that use lives which fall within these ranges would be exempt from requiring Commission approval. An independent telco could, based on its particular situation, require lives which fall outside of the established ranges. When lives fall outside of the established ranges, the independent telco would be required to provide detailed support to justify its lives and seek approval from the Commission.
Option 3
Eliminate the requirement that smaller independent telcos file depreciation life characteristics for approval by the Commission. The Commission would continue to be in a position to assess trends in the depreciation expense levels of the companies through the annual Phase III information which is provided in association with Carrier Access Tariff (CAT) filings. In the event of a revenue requirement proceeding, the Commission would have the opportunity to undertake a detailed review of asset lives, depreciation expenses and depreciation methodology.
Some Phase I directives apply to both large and small telephone companies

6.

The consultant's analysis of the 11 Phase I depreciation directives showed that a number of them are just as applicable to small telephone companies as they are to the larger companies. Some others, however, are clearly intended for much larger companies and do not reflect the practical operating environment of the smaller independent telcos (e.g. most only have one or few buildings, switches, vehicles, etc.).

7.

The following summarizes the analysis that was carried out by the consultant as to the applicability of each Phase I directive to the independent telcos.
Directives 1, 2 and 3

8.

The first three directives address the issue of depreciation/asset records. Directives 1 and 2 are considered appropriate for all companies regardless of size as they provide valuable information for the day-to-day management of a company. However, some companies have not kept addition and retirement records by vintage (i.e. year of placement). Companies that do not currently have vintage records should be required to develop them over a two-year period. It is recognized that the further back in time one goes, the more difficult it will be to accurately obtain the information required to establish historical vintage records. One possible simplified approach is to develop the historical information as accurately as possible for a set number of years (e.g. 10 to 15 years), and lump all the older assets into a single vintage. Alternatively, the residual amount, beyond a certain age, could be spread equally over several years. This approach is currently being used by some of the independent telcos.

9.

Directive 3 requires the documentation of the structure of a company's asset records. It is unlikely that sufficient significant changes would occur for a small company over a short period of time to require annual filings with the Commission. The consultant recommended that the independent telcos only be required to advise the Commission on an exception basis whenever a significant change is introduced in a company's record content or structure.
Directives 4 and 5

10.

These directives relate to life studies and identify the methodology to be used to determine the expected service life of a particular asset class. Directive 4 directs the companies to use statistical analysis and standard survivor curves to forecast mortality dispersion patterns in determining average service lives. This approach is not considered applicable for the majority of asset classes in the case of small independent telcos. The number of units of property in each asset class is generally insufficient to provide statistically valid results. In some cases (e.g. switching), a number of companies only have a single unit. Directive 4 also calls for each carrier to provide to the Commission depreciation study reports for the specific asset categories at least annually.

11.

The independent telcos, like any other telephone company, would be expected to review the appropriateness of selected service life estimates on an ongoing basis. By virtue of their size, however, and the relatively small number of plant units contained in each asset class, it is unlikely that changes in asset lives would be required as frequently as annually. Consequently, there would be no reason to require them to be subject to this part of the directive. Study reports need only be filed in those years when changes to depreciation life characteristics are proposed.

12.

Directive 5, on the other hand, requires that the maximum interval between the life study for any asset category is five years. In the consultant's view, this requirement should continue to apply to the independent telcos. Among other things, it imposes a discipline on all companies to do a minimum review of asset lives in order to ensure that undue risk of undepreciated stranded investment is minimized.
Directive 6

13.

This directive requires the use of the Equal Life Group (ELG) method of depreciation for all depreciation categories. Due to the small number of units of plant in each depreciation category for the smaller independent telcos, this methodology cannot be effectively applied. The exceptions, because of their relatively larger size, are Northern and Thunder Bay. Depending on the type of asset to be depreciated, Unit Amortization, Straight-Line Vintage Group and Life Span methodologies are considered to be more appropriate approaches for the small independent telcos and are consistent with regulatory depreciation as applied throughout the North American telecommunications industry. The consultant recommended that these replace the ELG method of depreciation for these companies.
Directive 7

14.

As indicated above, the ELG method of depreciation is not an appropriate methodology for the small independent telcos. The intent, however, of Directive 7 is to ensure that a process is in place, regardless of depreciation methodology, to ensure the exact recovery of the original capital during the life of the assets. It requires that any shortfall (or surplus) in the accumulated reserve created by a change in asset life be recovered by adjusting the depreciation rate during the remaining life of the asset. This approach provides the advantage of minimizing large fluctuations in depreciation expense levels from year to year. Although the specific words of this directive may not be applicable to small independent telcos, the intent of the directive is applicable and appropriate.

15.

Given the operation of the small independent telcos, there is no significant benefit to be gained by requiring the independent telcos to file reserve variance reports annually with the Commission. The consultant recommended that reserve variances be addressed by each company at the time of filing a depreciation study.
Directive 8

16.

The independent telcos generally do not have a formal schedule for introducing major changes in depreciation rates, so this directive would not appear to be applicable to them as currently written. The Commission, however, would still need to obtain evidence that any planned changes in depreciation rates do not create an undue burden on subscribers or have a significant impact on a company's revenue/contribution requirements. The Commission has the opportunity to oversee depreciation expense trends through the annual Phase III filings associated with the contribution review process and can, if required, request justifications for major changes.
Directive 9

17.

The independent telcos almost exclusively recognize net salvage proceeds or expense during the year in which the disposition of the assets takes place. Given the relatively small number of individual assets, the net salvage issue has provided little impact on the financial results of the independent telcos and has not required special courses of action to date.
Directives 10 and 11

18.

These two directives would appear to be just as appropriate for small independent telcos as they are for the much larger companies. The consultant indicated that these directives require a minimum of effort to follow and should continue to apply. Many of the small independent telcos already follow this approach.
Parties generally agree with the consultant's report

19

In response to PN 99-26, including the consultant's report, the following parties provided written and/or reply comments: Bell Canada, Thunder Bay, Northern, O.N. Tel, OTA, SATAT, Prince Rupert City Telephones (CityTel) and the Public Interest Advocacy Centre (PIAC).

20.

Each party generally agreed with the recommendations in the consultant's report. However, as outlined below, some parties made comments with respect to alternative approaches or possible modifications to the consultant's recommendations.

21.

SATAT agreed with the recommendations provided that:
a) Continuing Property Records (CPRs) should only be undertaken if: i) it is possible with reasonable effort; ii) it is meaningful; iii) the cost is recognized in the contribution calculation; and iv) no sanctions are imposed on the companies that find it impossible to track down documents they have no legal obligation to keep; and
b) the companies need only file for Commission approval of depreciation if there is a change in lives and the change results in a company exceeding the contribution requirement cap.

22.

Bell Canada indicated a preference for a price cap regime which would then eliminate the need for Commission review of depreciation after the initial going-in rates are established. Without a price cap regime, Bell Canada agreed with the report's recommendations (i.e. adoption of the consultant's Option 1 for the smaller independent telcos, with Northern and Thunder Bay continuing to follow Phase I depreciation directives). Bell Canada expressed its opposition to the SATAT proposal to only file for Commission approval of depreciation expense if the contribution requirement cap is exceeded. Bell Canada contended that this would be contrary to the Commission's intent in introducing the contribution requirement cap and submitted that SATAT's proposal in this regard should be rejected.

23.

CityTel requested flexibility in establishing a Continuing Property Record and direction from the Commission on the content of a life study. CityTel also indicated that the proposed Life Span methodology is not applicable to it (although it may be for some others).

24.

O.N. Tel sought Commission clarification and direction on specifically how life expectations are to be established, and also, how to define "significant" for a reserve shortfall which may occur at the time of the retirement of an asset.

25.

PIAC suggested that instead of advising the Commission on an exception basis, whenever significant changes are introduced in a company's content and structure of its records, companies be required to submit reports at a minimum of five-year intervals.
Commission's determinations

26.

The Commission agrees with Thunder Bay and Northern that the current Phase I depreciation directives should continue to apply to them, as outlined in Inquiry into telecommunications carriers' costing and accounting procedures - Phase I: Accounting and financial matters, Telecom Decision CRTC 78-1, dated 13 January 1978, Inquiry into telecommunications carriers' costing and accounting procedures - Phase I: Accounting and financial matters - Revision to certain directives contained in Telecom Decision CRTC 78-1, Telecom Decision CRTC 79-9, dated 8 May 1979 and Revisions to certain Phase I directives concerning depreciation, Telecom Decision CRTC 89-11, dated 24 August 1989.

27.

The Commission notes that the consultant found that the depreciation processes currently in place for most independent telcos generally respect the intent of the Commission's depreciation directives as established in Phase I. The Commission is of the view that little would be gained by the introduction of major changes to the existing practices of many of the independent telcos.

28.

The Commission is also of the view that Option 1 in the consultant's report provides a rational and systematic methodology which is not much different from the approaches adopted by most of the independent telcos for their own internal management requirements. It is not expected that the proposed process will be onerous for the independent telcos or that it will cause them a significant increase in regulatory burden.

29.

Option 1 establishes a clear direction on depreciation methodology and filing requirements which can be applied by these independent telcos. It addresses the limitations of small independent telcos, streamlines and standardizes the independent telcos' approach to depreciation filings and satisfies the objectives underlying the Commission's Phase I depreciation directives. (See Appendix 1 for the regulatory depreciation process to be followed by the majority of the independent telcos.)

30.

Partial or complete elimination of depreciation filings with the Commission (Options 2 and 3, respectively), can be seen to offer the benefits of a reduction in regulatory burden for the independent telcos. However, for sound internal management purposes and for annual audit requirements, the independent telcos will need to continue doing analysis of asset lives in order to ensure that total recovery of capital is to be achieved during the useful lives of the assets. Since the independent telcos are expected to continue annual reviews of depreciation, requiring them to file proposed life changes for Commission approval is not considered onerous.

31.

Furthermore, under the current rate of return regime, it is the Commission's responsibility to ensure that the independent telcos' operations are such that rates to subscribers are just and reasonable and that revenue/contribution requirements and the rate base are appropriate. The level of depreciation expense traditionally has a significant impact on the revenue requirement of a telecommunications company (approximately 30 percent of total operating expenses excluding income tax).
32. In addition, adoption of Option 2 would require the Commission, with participation from interested parties, to undertake a public process in order to develop appropriate ranges for each major class of assets. In the short term, a public process would increase the regulatory burden for everyone and, consequently, negate any potential benefits. Also, given that the industry is undergoing rapid changes, it would likely become necessary, from time to time, to undertake reviews of the continued appropriateness of established ranges.

33.

With respect to SATAT's proposal to only file depreciation studies for Commission approval if the contribution requirement cap is exceeded, the Commission finds that this would be contrary to its intent in introducing the contribution requirement cap. Therefore, SATAT's proposal in this regard is denied.

34.

With respect to the modification proposed by SATAT concerning the cost associated with preparing CPRs, the Commission is of the view that it can be considered as an expense for inclusion in the annual contribution calculation process. It should, however, fall within the limitations imposed by the contribution requirement cap elaborated on in Review of contribution regime of independent telephone companies in Ontario and Quebec, Telecom Decision CRTC 99-5, dated 21 April 1999.

35.

It is clear that if records have not been kept, or are not available, it would not be appropriate for the Commission to impose sanctions on a company. The intent is for each independent telco to build asset records that are as accurate as possible, given the information that is readily available or can be reasonably estimated. Keeping continuing property records on a going-forward basis also ensures that the records eventually become more accurate.

36.

The Commission is of the view that the flexibility sought by CityTel in the establishment of CPRs can be met by giving the companies that do not have accurate historical information sufficient time to build accurate CPRs (i.e. two years). With respect to CityTel's request for directions as to the contents of life studies, the Commission notes that Directive 4 has been modified to outline the minimum contents of a life study. With regards to the applicability of either of the three depreciation methodologies, the Commission notes that Directive 6 has been modified to ensure that the independent telcos can choose any one of them depending on each company's individual situation and capability.

37.

The Commission also notes that Directive 4 has been modified to include broad guidelines as to how life characteristics are to be established. With respect to the definition of what is "significant" for a reserve shortfall, the Commission believes that a 10 percent threshold, which is currently defined in Directive 7, should be applied also to the independent telcos.

38.

Based on the foregoing, the Commission hereby directs the independent telcos (with the exception of Thunder Bay and Northern) to implement, effective immediately, the set of 11 depreciation directives set out in Appendix 2 to this decision. For Thunder Bay and Northern, the current Phase I depreciation directives continue to apply.
Secretary General
This document is available in alternative format upon request and may also be examined at the following Internet site: http://www.crtc.gc.ca

 

Regulatory depreciation process for the majority of the independent telephone companies
The following provides a description of the regulatory depreciation process to be followed by the independent telcos, with the exception of Thunder Bay and Northern (for these two companies, the current Phase I depreciation directives will continue to apply).
Continuing Property Records (CPRs)
Companies are directed to maintain detailed CPRs which would identify additions, retirements, depreciation expense and accumulated depreciation by vintage. For companies that do not currently have these records in place, they are to be established over a period of time (i.e. two years). CPRs will facilitate the control over depreciation so that exact recovery of investments (no more or less) can be achieved in a timely manner (see Directives 1 and 2).
Depreciation methodology
Any combination of three methods can be used to depreciate the various assets of an independent telco. Each of the three methods uses the straight-line approach which is consistent with regulatory depreciation as applied throughout the North American telecommunications industry (see Directive 6).
Exact recovery adjustments
Whenever a forecast retirement date for a depreciation category is modified, thus creating an accumulated reserve deficiency (or surplus), the new depreciation rate will also be adjusted so that the deficiency (or surplus) will be recovered over the remaining life of the asset (see Directive 7).
End of life treatment
When an asset is retired before it has been fully depreciated, the depreciation reserve shortfall which results is to be accounted for as a loss on the disposition of the asset. In the event that the amount of the loss is significant, the company is to advise the Commission and obtain approval for the appropriate course of action. When an asset or a vintage group of assets has been fully depreciated, no additional depreciation is to be charged against the asset or the vintage group.
Removal of the investment from the books of the company is to coincide with the physical retirement or removal from service of the asset. When an asset is retired, the cost of removing the asset from service is to be accounted for as a loss on disposition. Any residual or salvage value obtained for the asset would be accounted for as a gain on disposition. In the event that the amount of the gain is significant, the company is to advise the Commission and obtain approval for the appropriate course of action (see Directive 9).
Location life
Accounting for capital assets is to be consistent with Directives 10 and 11 of Phase I: "The original installed cost of all depreciable plant shall be depreciated over its entire useful life, regardless of any relocation. When an asset is relocated, the labour and material cost of interim removal and reinstallation shall be expensed."
Competitive services
The depreciation life characteristics for those assets which are deployed specifically to provide competitive services such as Internet and Station Apparatus need not require Commission approval.
Filing for Commission approval
The independent telcos are required to file depreciation life studies, except for those assets indicated in "Competitive services" above, for Commission approval whenever changes to existing lives are introduced. As a minimum, each independent telco is required to file life characteristics for all depreciation categories once every five years (see Directive 5).

 

Depreciation directives for independent telephone companies
Directive 1
All independent telcos shall identify plant additions and retirements by depreciation categories which shall be established in sufficient detail to reflect life characteristics within the respective categories. When the Commission finds it is economically practicable to do so, the independent telcos shall record and maintain additions, retirements, transfers, and adjustments by vintage.
Directive 2
Each independent telco shall maintain continuous records that will permit the identification of accumulated depreciation, exclusive of salvage accruals, for each main asset account where feasible, for each depreciation category. Each independent telco shall also maintain sufficient data so that the accumulated depreciation can be appropriately allocated to vintages of plant.
Directive 3
All independent telcos shall submit a document detailing the content and structure of the records identified in Directives 1 and 2 at the time of submitting their depreciation life characteristics for Commission approval. All independent telcos shall notify the Commission when substantial changes are made to the content and structure of the identified records.
Directive 4
In determining the life characteristics, the independent telcos shall consider current industry trends in asset lives, and their own particular operating characteristics together with the potential impact of the introduction of new technologies and competition. Life characteristics shall be specified in terms of either average service life (ASL), average year of final retirement (AYFR) or amortization rate (e.g. software). The proposed asset life characteristics shall be supported with appropriate rationale.
The independent telcos shall review the appropriateness of selected asset life characteristics on an ongoing basis. As a minimum, study reports shall include, on an account basis, the current and proposed life characteristics, the financial impact for any proposed changes, the estimated average depreciable plant, the current and proposed depreciation rate, and the annual accrual.
Directive 5
The maximum interval between life studies shall be five years. These studies shall be submitted for Commission approval.
Directive 6
A combination of one or more of the following three methods shall be used to depreciate the various assets of an independent telco. These methods are:
  • A straight-line amortization approach for individual units of investment based on the company's best estimate of the expected life of the unit.
  • For Life Span accounts, a straight-line amortization based on the expected retirement date of all of the elements of an asset, regardless of the date of placement. A Life Span account is one in which both a unit of property and a group of property will all retire as a unit. Examples include Buildings and Switches.
  • Straight-line vintage group based on the expected average life of the group within the vintage. This approach would apply to Outside Plant accounts (cables and poles) and to Station Equipment (telephone sets). With this process, each member of the group is treated as if it will have a life equal to the average of the group.
Directive 7
Each independent telco shall adjust the depreciation rates to ensure that future depreciation expenses together with the accumulated depreciation to date will result in the exact recovery of the original capital. These rates shall reflect the principle of remaining life recognizing changes in the estimates of service lives and the retirement of assets.
All independent telcos shall submit, with their depreciation studies, a report containing the following information for each asset account: reserve variance as a percent of actual depreciation reserve, amount of any adjustments to the depreciation accrual, the final depreciation rate, and the effect of the total adjustment on the final depreciation rate.
In the event that the reserve variance for an account exceeds 10 percent of the actual reserve and the independent telco does not propose to make an adjustment, the independent telco shall immediately upon such determination advise the Commission and obtain its approval of the appropriate course of action.
Directive 8
The introduction of major changes in depreciation rates shall be accompanied by suitable evidence to demonstrate that they do not create an undue burden on subscribers or do not have a significant impact on an independent telco's revenue/contribution requirements.
Directive 9
For the purpose of accounting for salvage, eachindependent telco shall recognize net salvage proceeds or net retirement expenses as realized. If in a given year, an independent telco should experience extraordinary retirement expenses, or salvage proceeds, the independent telco shall immediately advise the Commission which, after consulting the independent telco, will determine an appropriate course of action.
Directive 10
The original installed cost of all depreciable plant shall be depreciated over its entire useful life, regardless of any relocation.
Directive 11
When an asset is relocated, the labour and material costs of interim removal and reinstallation shall be expensed.

 

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