Sce-23: Results of Examination

1 Application No.: A.04-12-014 Exhibit No.: SCE-22 Witnesses: R. Lisbin S. Peters R. Worden D. Avila C. Silsbee

4 (U 338-E)

6 2006 General Rate Case

7 Rebuttal Testimony

9 SCE-22 – Results Of Examination

13 Before the

14 Public Utilities Commission of the State of California

15 Rosemead, California Public Version May 2005

2 SCE-22: Results Of Examination

1 Table Of Contents Section Page Witness 2

I. INTRODUCTION...... 1 ...... R. Lisbin

II. ORA'S RECOMMENDATIONS FOR REIMBURSABLE EXPENSES ARE INCORRECT AND INAPPROPRIATE...... 3 ...... S. Peters

A. Introduction...... 3

B. SCE’s Statistical Methodology Is Correct...... 4

C. ORA Does Not Provide Any Rationale For The Disallowance Of Employee Recognition And Other Miscellaneous Expenses...... 8 ...... R. Worden

III. ORA'S COMPENSATION EXPENSE RELATED ADJUSTMENTS ARE INAPPROPRIATE...... 11 ...... R. Lisbin

IV. ORA INAPPROPRIATELY EXCLUDED DISTRIBUTION PLANT IN SERVICE COSTS...... 12 ...... D. Avila

A. Introduction...... 12

B. The Contracts. As Well As The Parties’ Past Practice, Does Not Provide For Retroactive Adjustment Of Rates...... 12

C. ORA’s Proposed Adjustment To Plant In-Service Constitutes Retroactive Ratemaking...... 16 ...... R. Worden

V. SCE'S ACCOUNTING PROCEDURES ALREADY TRACK INFORMATION THE ORA REQUESTS...... 18 ...... R. Worden

A. SCE Accounting Procedures Currently Track Reimbursable Expenses Showing The Split Between Ratepayer And Shareholder Funding...... 18

3 -i- SCE-23: Results Of Examination

1 Table Of Contents (Continued) Section Page Witness 2 B. ORA’s Recommendation That SCE Redesign Its Expense Reimbursement Process And Forms For Easier ORA Review Is Unnecessary And Would Be An Unwise Diversion Of Scarce Resources...... 18

VI. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION...... 21 ...... C. Silsbee

Appendix A Witness Qualifications

3 -ii- SCE-23: Results Of Examination

1 List Of Tables Table Page 2

Table IV-1 Updated Billing Factors for Payroll Burden and Indirect/Overhead Costs - Arizona Pipeline Company...... 15

3 -iii- 1

2 INTRODUCTION

3 In ORA’s Report on the Results of Examination for Southern California Edison Company’s

4General Rate Case Test Year 2006 (Audit Report), ORA makes nine recommendations. In further

5review and discussions with SCE regarding recommendations contained in the Audit Report, ORA

6agrees that the following two recommendations should be deleted because the expenses were

7appropriately excluded from 2003 expenses before 2006 expenses were forecasted.1

8  $3,161,928 - one-time expense for Receivables Reconciliation Project, Account 920

9 (Administrative and General Services),

10  $532,781 - ORA’s extrapolated error for one-time expense for the sale of Edison Pipeline

11 and Terminal Company (EPTC), Account 923 (Outside Services)

12 SCE agrees that the following ORA recommendation is appropriate:

13  The one time expense of $100,000 for Account 920, Administrative and General Salaries,

14 should not be included in the forecast methodology for the 2006 test year.2

15 In addition, as discussed further in Chapter II, SCE will agree to ORA’s recommendation to

16perform a review of all reimbursable expense reports for the three year period (2004 – 2006) for each

17employee, included in SCE’s General Order 77-L submittal, whose annual total reimbursable expenses

18are $25,000 or more.

19 Throughout its Audit Report, ORA recommends that certain costs be “disallowed”. While it is

20appropriate for costs that are recorded in either a balancing account or a memorandum account to be

21“disallowed” through a reasonableness review proceeding, the ORA Audit in the General Rate Case is

22not such a proceeding. Thus, it is not appropriate for ORA to use the term “disallowed” in the context of

23recorded expenses they have determined should be excluded from recorded costs for purposes of

24developing the test year forecasted costs. For many of the accounts reflected in the GRC, the forecasted

21 Per a telephone discussion with the lead ORA Auditor on May 18, 2005 the ORA will be issuing an errata that will 3 delete these two recommendations. Therefore SCE has not included any rebuttal to these two items.

42 Please refer to Exhibit SCE - 19.

1expenses are estimated by trending the costs for a historic period of time. For other accounts, the test

2year forecast is not based upon the recorded costs, but a budget based estimate. Given this, there is not a

3one-for-one reduction to the test year revenue requirement for the costs ORA recommends in their Audit

4Report should be “disallowed”.

5 The following testimony discusses the remaining ORA recommendations that are not appropriate

6and should not be adopted.

2 ORA'S RECOMMENDATIONS FOR REIMBURSABLE EXPENSES ARE INCORRECT AND

3 INAPPROPRIATE

4A. Introduction

5 Pursuant to D. 04-07-0223, SCE conducted a review of recorded 2003 reimbursable expenses to

6verify that reimbursable expenses charged to ratepayer accounts (and thus reflected in the General Rate

7Case) were appropriate ratepayer expenses and not expenses that should be charged to shareholder

8accounts or below-the-line.4 In its review, SCE determined by use of a statistically valid sampling

9methodology that there were some reimbursable expenses that were inadvertently charged to ratepayer

10accounts. Based on this sample, SCE determined that the most likely error was $374,489, or 2.56%.

11Thus, $374,489 of the $14,615,079 recorded 2003 reimbursable expenses (“The Population”), should

12have been charged to shareholder funded accounts instead of ratepayer funded accounts.5 Since the

13reimbursable expense study was completed after the submission of SCE’s 2006 GRC application,

14appropriate adjustments to SCE’s 2006 revenue requirement have not yet been made.

15 In its Audit Report, ORA recommends that $1,133,3846 of 2003 reimbursable expenses should be

16shareholder funded and that this amount should be disallowed from Accounts 920 and 921.7 The

17difference between SCE’s $374,489 adjustment and ORA’s $1,133,384 adjustment result primarily from

18(1) ORA assuming that if an expense account could not be found, 100% of those expenses should be

19disallowed, and (2) ORA assumed that recognition and other expenses should be shareholder funded,

23 Decision 04-07-022, page 237.

34 SCE’s review did not look at those expenses charged to shareholder accounts to determine if any should have been 4 charged to ratepayers.

55 SCE’s original reimbursable expense review determined a most likely error of $354,647, or 2.43%. However, SCE 6 agrees with ORA that an additional expense of $424.08 for Charitable Contributions should have been charged to 7 shareholders and excluded. (Response to ORA Audit Data Request DFB-33, Question 26) Including this amount in the 8 calculation results in a most likely error of $374,489, or 2.56% for The Population.

96 ORA included an expense of $2,235.83, relating to Mountain View evidentiary hearings which has already been 10 removed from SCE’s forecast (SCE-7, Volume 3, Chapters 2-3, Workpapers p. 81), in its recommended adjustment. 11 ORA agreed that this expense had been removed from SCE’s 2006 GRC forecast, and therefore ORA’s proposed 12 adjustment would be reduced. ORA’s proposed adjustment is $1,090,051 (see DFB-50 Revised, Questions 1 & 2).

137 ORA’s Report on the Results of Examination, pp. 4-2 through 4-8.

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1even though they provided no rationale for their recommendation. 8 ORA also asserts that SCE’s review

2was in error because SCE should have reviewed all expense reports for employees whose expense

3reports contained errors.

4B. SCE’s Statistical Methodology Is Correct

5 In its Audit Report, ORA challenged the methodology SCE used to conduct its review of 2003

6recorded reimbursable expenses by (1) asserting that SCE erred by not reviewing all of the expense

7reports for the year associated with the 24 employees who had errors in their expense report included in

8the sample, (2) that SCE should have assumed that 100% of the expenses on eight expense reports that

9could not be located should have been shareholder funded, and (3) that SCE should have reviewed all of

10the expense reports associated with those employees whose reimbursable expenses were $25,000 or

11more. As will be shown in this section, SCE’s review methodology is appropriate and ORA’s

12challenges would violate basic sampling principles and invalidate the most likely error of The

13Population.

14 In order to comply with the Decision 04-07-022, SCE performed a review of 2003 recorded

15reimbursable expenses to determine if shareholder expenses were inadvertently recorded to ratepayer

16accounts. Since it is impractical to review all of the expense reports for a given year, SCE used a

17Monetary Unit Sampling (MUS) statistical methodology which selects a statistically representative

18sample of expense reports to make inferences about the entire Population. SCE used ACL for Windows,

19a statistical software application to select a statistically valid sample of expense reports to review. The

20$14,615,079 population9 was not stratified because there was no reasonable basis to conclude that one

21group of expense reports had a greater likelihood of including shareholder expenses.

28 In ORA’s Report on the Results of Examination, p. 4-4, ORA takes exception to an additional $25,791 of reimbursable 3 expenses. ORA incorrectly calculated the additional exceptions which actually total $21,093, which consists of $23.00 4 relating to Toastmaster dues, $549.86 for a management offsite related to leadership training for management employees, 5 $2,235.83 relating to Mountain View evidentiary hearings which has already been removed from SCE’s forecast (SCE-7, 6 Volume 3, Chapters 2-3, Workpapers p. 81), $7,857.24 relating to employee recognition events 7 (celebrations/recognition, company picnic, movie tickets, gift cards/certificates, floral supplies), an additional $10,002.73 8 relating to Lineman Rodeo expenses, and $424.08 relating to Employee Contributions which SCE agreed to remove 9 from its GRC request in ORA Audit data request DFB-33, Question 26.

109 The $14,615,079 sample population refers to total reimbursable expenses recorded in 2003.

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1 The ACL software, using a 95% confidence interval, selected a sample size of 338 expense

2reports, with reimbursable expenses totaling $348,699.10 In its testimony, ORA incorrectly indicated that

3“SCE’s internal auditor did not allow for duplicates, either dollar amount or employee name, in the

4sample selection.”11 SCE’s review did, in fact, allow for more than one expense report to be selected for

5any given employee and the same dollar amount to be selected for various employees. However, ACL

6did not allow for the same expense report (duplicate record) to be selected twice.

7 Furthermore, being that the review was statistically significant, SCE did not have to review all

8expense reports for a given employee to determine the most likely error of The Population. “Statistics is

9an area of science concerned with the extraction of information from numerical data and its use in

10making inferences about a population from which the data are obtained.”12 The detailed review of this

11sample determined that of the 338 expense reports reviewed: 306 expense reports (totaling $297,932)

12correctly classified either ratepayer or shareholder reimbursable expenses, 8 expense reports (totaling

13$10,019) could not be located, and 24 expense reports (totaling $40,748) had charged reimbursable

14expenses incorrectly to ratepayers totaling $14,104 or 4.04% of the $348,699 sample. ORA stated that

15“it is conceivable that the employees associated with these 24 expense reports, could have had errors on

16all of their reimbursable expense reports for the year. ORA believes that there is a likelihood that these

1724 employees made similar errors on all of their reimbursable expense reports during the year.”13 SCE

18believes that although this may be conceivable, it is irrelevant because under the MUS methodology, the

19most likely error is statistically extrapolated to The Population. To look at all of the expense reports

20associated with the 24 employees that had errors in the sample would violate basic sampling principles

21and make it so that the most likely error could no longer be applied to The Population. What the MUS

22methodology assumes is that the error in the sample is typical of the error in The Population. Thus, the

23methodology assumes that these employees had a consistent error rate in their other expense reports as

210 See Workpapers to SCE-11 (Compliance).

311 ORA’s Report on the Results of Examination , p. 4-4.

412 Source: Mendenhall, William and Beaver, Robert J., A Course in Business Statistics, (Belmont: Duxbury Press, 5 1992), p. 7.

613 ORA’s Report on the Results of Examination, p. 4-5.

1the sample overall. “The objective of inferential statistics is to make inferences (predictions, decisions)

2about a population based on information contained in a sample.”14

3 For the eight expense reports that could not be located, SCE assumed an error rate of 4.29%,

4which is consistent with the error found in the remainder of the sample. 15 This is a reasonable

5assumption since there is nothing that indicates that these eight expense reports had any greater

6likelihood of (1) having shareholder funded expenses included in them, and (2) that those expenses

7would have inadvertently been charged to ratepayers in error. ORA’s proposal to apply a 100% error

8rate for the missing expense reports is inappropriate and significantly overstates the potential error.

9ORA has not demonstrated that these eight expense reports have a greater likelihood of containing errors

10than the rest of the sample overall.

11 Using a 95% confidence interval, the MUS statistical results extrapolated the sample error into

12the most likely error for The Population of $374,489, or 2.56%. SCE agrees to make the appropriate

13adjustment to exclude $374,489 of 2003 recorded reimbursable expenses from its 2006 GRC forecast.

14 Furthermore, ORA indicated it does not believe that “reviewing only one reimbursable expense

15report is reasonable. SCE in the 2003 General Rate Case reviewed all reimbursable expense reports for

16its employees who had total reimbursable expenses $25,000 or greater during 2000.”16 The review that

17SCE performed for its 2003 GRC was not based upon a statistically significant sample, instead it was

18based upon a judgmentally selected sample. Therefore, the error found in the sample cannot be

19extrapolated to the entire population.17 Contrary to the study performed for the 2003 GRC, the study

214 Source: Mendenhall, William and Beaver, Robert J., A Course in Business Statistics, (Belmont: Duxbury Press, 3 1992), p. 5.

415 SCE agrees with ORA that an additional expense of $424.08 for Charitable Contributions should have been charged 5 to shareholders and excluded (Response to ORA Audit Data Request DFB-33, Question 26). Therefore, SCE calculated 6 a new error rate by taking the new error dollar amount of $14,528 and dividing by $338,680 ($348,699-$10,019), which 7 is the total dollar amount of the sample excluding the total dollar amount for the eight missing expense reports. This 8 resulted in a 4.29% error rate. ORA miscalculated the error rate in its testimony by reducing the sample size by $50,767, 9 which is the total dollar amount of expense reports with exceptions noted instead of only including the dollar amount of 10 $10,019 which is the total dollar amount of expense reports that cannot be located.

1217 “…if an auditor decides to test only high-value items since they comprise the bulk of the dollar values involved and 13 these are most important in their impact on the financial statements, there is no basic objection to such an approach, but 14 it means that conclusions reached on the basis of such a test relating to the frequency of certain types of errors or their

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1performed for the current GRC used a statistically significant sample selected at random. Thus, every

2expense report in the population had the same likelihood to be selected, without regard to personal

3biases that might be present when selecting a sample by judgment.

4 In its Audit Report, the ORA has recommended that SCE perform a review of all reimbursable

5expense reports for each employee, included in SCE’s General Order 77-K submittal18, whose annual

6total reimbursable expenses are $25,000 or more.19 ORA further recommends that the review be

7performed for each of the three years (2004, 2005, & 2006) leading up to SCE’s next GRC. While SCE

8agrees to perform the review as ORA has recommended, it is important to note that since the sample will

9not be statistically significant (selected at random), any error found in the judgmentally selected sample

10cannot be extrapolated to the entire population. Therefore, SCE will correct any errors found during the

11review and exclude the expenses for forecasting purposes in its next GRC, but SCE will not extrapolate

12those errors to the entire population of reimbursable expenses.

13C. ORA Does Not Provide Any Rationale For The Disallowance Of Employee Recognition

14 And Other Miscellaneous Expenses

15 ORA takes exception to an additional $25,791 of reimbursable expenses which relate to

16employee recognition and other miscellaneous expenses.20 ORA’s report provides no rationale as to why

17these costs should not be included in SCE’s GRC request. The extent of ORA’s testimony on this issue

18is as follows: 19 20 “ORA reviewed SCE’s sample of 338 reimbursable expense reports and takes exception to an 21 additional $25,791 of reimbursable expenses. This additional $25,791 in reimbursable expenses 22 relates to Toastmaster dues, celebrations/recognition, company picnic, movie tickets, gift 23 cards/certificates, floral supplies, and Lineman Rodeo expenses.”

2 magnitude apply only to these high-value items. No conclusion may be drawn as to the frequency or magnitude of errors 3 among the small-value items not made available for inclusion in the sample.” Source: Arkin, Herbert, Handbook of 4 Sampling for Auditing and Accounting, (New York: McGraw-Hill, 1984), p. 21.

518 ORA’s analysis of reimbursable expenses was based on employees included in SCE’s submittal pursuant to General 6 Order 77-K. Effective August 19, 2004, General Order 77-K was superseded by General Order 77-L per CPUC 7 Decision 04-08-055. Thus, SCE will use its annual submittal pursuant to General Order 77-L as its basis for its 8 reimbursable expense reviews.

1020 See Footnote 8.

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1 ORA has not even attempted to meet the most basic burden of proof in recommending that these

2expenses be disallowed. ORA has not provided any Commission precedent that supports the charging of

3these types of employee recognition and other miscellaneous expenses to shareholders instead of

4ratepayers. Further, ORA has not demonstrated these expenses fail to benefit ratepayers. Indeed, SCE

5understands that the ORA also recognizes employees with recognition awards.

6 Of these expenses, $7,857 are associated with various recognition events, company picnic, movie

7tickets, giftcards/certificates, etc. used to recognize employees for exceptional performance and increase

8employee morale. Events like breakfasts or lunches are used throughout the company to recognize

9exceptional group performance. Movie tickets, gift cards/certificates or flowers are a very nominal way

10of recognizing an employee or employees that have performed exceptionally well. Like other forms of

11employee recognition, these types of rewards benefit ratepayers by encouraging employees to put in the

12extra effort at their jobs.

13 SCE believes the Commission already considered, and rejected, such adjustments in our 2003

14general rate case. ORA has proposed similar cuts to SCE’s request for SONGS O&M expense and

15decision D. 04-07-022, at section 3.4.2.4, states: 16 17 “The SONGS 2 & 3 awards and recognition program provides employees with incentives to 18 perform above and beyond already high performance standards. Such a program is consistent 19 with current human performance theories and is utilized at many corporations. ORA has not 20 shown why ratepayer input is a necessary condition for ratepayer funding for the program. Even 21 though ratepayer dollars may be involved, SCE management is entitled to a reasonable degree of 22 discretion in determining how to motivate employee performance. Moreover, the costs at issue 23 are not so large as to warrant a cost-benefit analysis to determine the program’s effectiveness….”

24 The remaining $14,683 is associated with what is called the Lineman’s Rodeo. Of the expenses

25associated with the Lineman’s Rodeo, SCE adjusted $4,681 as shareholder-related expenses because

26they were related to entertainment (e.g., clowns, bounce-houses, music, etc.) provided to attendees of

27SCE’s Lineman’s Rodeo event.21 The remaining $10,002 of costs associated with the Lineman’s Rodeo

28are associated with employee participation in the Lineman’s Rodeo and appropriately charged to

29ratepayers as discussed below.

221 See page 3 of workpapers to SCE-11 (Compliance).

1 The Lineman’s Rodeo is an annual national event where SCE employees enhance their skills

2performing line construction and develop new and efficient ways of building and maintaining the

3transmission and distribution system. They also learn about new tools and equipment that are available

4to construct the electrical system. Our field employees, such as apprentice lineman, journeyman

5lineman and electrical crew foreman, perform rigorous tasks while working on the electric system, and

6our ratepayers benefit from having well-trained linemen in the field. The Lineman’s Rodeo is an annual

7event where SCE’s line crews compete in various competitions related to their daily activities. The top

8linemen from SCE’s internal competition then go on to compete at the national competition.

9 SCE employees learn new, safer and efficient ways to construct electrical lines. The ideas and

10new tools we see at the competition are shared with the appropriate SCE organizations that evaluate

11them for potential implementation on SCE’s system. For example, a couple of years ago, an SCE

12employee saw the use of primary covers at the competition. The cover was flexible, easier to use and

13covered more of the wire than the tool SCE uses. The Lineman inquired where to find this new tool

14with the utility that was using this protective cover. This SCE employee shared this information with

15the organization that evaluates new tools for proper use and SCE standards. The tool was approved and

16is now used thoughout the SCE system.

17 The Lineman’s Rodeo provides benefits to SCE’s ratepayers and thus, ORA’s recommendation

18to disallow Lineman’s Rodeo expenses should not be adopted.

1 III.

2 ORA'S COMPENSATION EXPENSE RELATED ADJUSTMENTS ARE INAPPROPRIATE

3 In ORA’s Audit Report, ORA made several recommendations related to compensation issues.

4ORA proposes that spot bonuses be disallowed from various accounts before forecasting our 2006 Test

5Year. The impact of ORA’s recommendation is a reduction of $4.7 million in 2001, $4.4 million in

62002, and $5.0 million in 2003 for a total disallowance of $14.1 million. SCE will comment in detail to

7ORA’s recommendations pertaining to spot bonuses in SCE -17, Human Resources and Pensions &

8Benefits.

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2 ORA INAPPROPRIATELY EXCLUDED DISTRIBUTION PLANT IN SERVICE COSTS

3A. Introduction

4 In its Report on the Results of Examination, the Office of Ratepayer Advocates (“ORA”)

5proposes to retroactively reduce SCE Distribution Plant by $2.0 million22 for each of the years 2001,

62002, 2003, for a collective total adjustment of $6.0 million.23 ORA’s recommendation is based solely

7on its review of SCE preliminary, internal audit findings relating to three purchase orders between SCE

8and Arizona Pipeline Company (“Arizona”), Herman Weissker (“Weissker”), and Tidwell Excavation

9Acquisition Co. (“Tidwell”), respectively, for underground construction work. ORA concludes that

10SCE paid $2.0 million too much in 2003 on the three purchase orders, even though SCE never

11implemented the updated billing factors recommended in the audit. Since 2003 is a representative year,

12ORA then assumes SCE was also overpaid $2 million in both 2001 and 2002.24 As discussed below,

13ORA is mistaken, and its proposal unwarranted.

14B. The Contracts. As Well As The Parties’ Past Practice, Does Not Provide For Retroactive

15 Adjustment Of Rates

16 By way of background, SCE executed three separate purchase orders with Arizona, Weissker,

17and Tidwell on October 18, 1995,25 November 26, 1996,26 and December 16, 1996,27 respectively. Under

18the purchase orders, most underground construction work and related services are performed under cost

19reimbursable rate terms. The three contractors (Arizona, Weissker, and Tidwell) billed SCE for, among

20other things: (1) labor costs (gross salary, excluding benefits, of employees that actually performed the

222 Pursuant to SCE’s confidential and preliminary internal audit report dated July 19, 2004, Arizona overcharged SCE by 3 $XXXXXX, Weissker overcharged SCE by $XXXXXX, and Tidwell overcharged SCE by $XXXXXX, for a collective 4 total of $XXXXXXX.

523 ORA’s Report on the Results of Examination, p. 5-4. Specifically, ORA would reduce FERC Accounts 336 and 367 by 6 $5.1 million and FERC Accounts 364, 365, 368, 369, and 373 by $900,000.

724 ORA’s Report on the Results of Examination, pp. 5-3 through 5-4.

825 Purchase Order U1105905 (dated October 18, 1995) was superseded by Purchase Order K116901 issued on November 9 29, 1996.

1026 Purchase Order K1116902.

1127 Purchase order K1116903.

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1work, referred to as “bare labor”); (2) a percentage of bare labor for payroll burden (e.g., payroll tax,

2unemployment tax, workers’ compensation, general liability insurance); and, (3) indirect/overhead costs.

3 During the duration of the purchase orders, SCE and the contractors updated the billing factors

4for payroll and overhead costs. These updated billing factors were usually the result of SCE internal

5audits and were applied on a prospective basis.

6 SCE’s preliminary, internal audit report dated July 19, 2004 (for calendar year 2003) suggested

7that the billing factors were too high. At that point, SCE attempted to break with our past practice and

8apply the lower billing factor retroactively. But the contractors disputed the audit findings, and we

9entered into negotiations. During the negotiations, SCE agreed that it would be inappropriate to

10retroactively apply the billing factors, so SCE never implemented the audit findings.28 Now, ORA seeks

11to retroactively reduce our rate base by $2 million29 in 2003 and extend that same adjustment to 2002 and

122001 for a total of $6 million.30

13 ORA’s proposal should be rejected. First, neither the purchase orders nor the parties’ past

14practices support retroactively applying different billing factors. Using the Arizona purchase order as an

15example,31 over the course of the purchase order (including change orders), numerous updates to the

228 Rather, after negotiations with Arizona, SCE implemented new billing factors which are reflected in Change Order 23 3 dated March 29, 2005.

429 Under SCE’s confidential and preliminary internal audit report dated July 19, 2004, Arizona overcharged SCE by 5 $XXXXXX, Weissker overcharged SCE by $XXXXXX, and Tidwell overcharged SCE by $XXXXXX, for a collective 6 total of $XXXXXX. With regard to the $XXXXXXX audit finding regarding the Arizona purchase order, the bulk 7 ($XXXXXX) relates to the billing factors for the payroll burden and indirect/overhead costs. The balance ($XXXXX) 8 relates to the audit finding on the contractor’s fee.

1031 As indicated in an earlier footnote, under SCE’s confidential and preliminary internal audit report dated July 19, 2004, 11 Arizona overcharged SCE by $XXXXXX, Weissker overcharged SCE by $XXXXXX, and Tidwell overcharged SCE by 12 $XXXXXX, for a collective total of $XXXXXX. SCE selected Arizona to use as an example in this testimony because 13 ORA’s recommendation with respect to Arizona is represents approximately XX% of the costs. There were also updated 14 billing factors for the Weissker and Tidwell purchase orders. For the Weissker Purchase Order 1116902 dated 15 November 26, 1996, the payroll burden was initially 24.5%, but was then updated to 22% (Change Order No. 8 on 16 October 26, 2000). The indirect/overhead billing factor was initially 35.6% but was updated to 28% (Change Order No. 17 8 on October 26, 2000). In Change Order No. 19 (December 22, 2003), there was a combined billing factor of 53% for 18 payroll burden and indirect/overhead costs. For the Tidwell Purchase Order 1116903 dated December 16, 1996, the 19 payroll burden was initially 19.83%. This was updated to 18.23% (Change Order No. 2 dated July 28, 1997), 17.18% 20 (Change Order No. 8 dated August 16, 2000), and 18.23% (Change Order No. 19 dated March 28, 2003). The 21 indirect/overhead billing factor was initially 58.23% (Purchase Order K1116903 dated December 16, 1996), which was 22 updated to 51.54% (Change Order No. 2 dated July 28, 1997), 54.16% (Change Order No. 8, dated August 16, 2000),

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1billing factors for payroll burden and indirect/overhead costs were made, yet throughout the

2performance period, neither Arizona nor SCE retroactively adjusted the contract even though such

3adjustment went both ways. Our past practice has always been (since 1995) that audit findings would be

4used only to negotiate revised rates from the date of the completed negotiations, and never retroactively.

5It would be contrary to the purchase order and the parties’ past practice to seek retroactive adjustments

6of the billing factors based on the July 2004 preliminary, internal audit report. Table IV-1, below,

7summarizes the numerous times that the billing factors for payroll burden and indirect/overhead costs

8for the Arizona purchase order were updated, and at no time were the updated billing factors applied

9retroactively:

2 and 51.54% (Change Order No. 19 dated March 28, 2003). In Change Order No. 23 (December 22, 2003), there was a 3 combined billing factor of 53% for payroll burden and indirect/overhead costs.

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Table IV-1 Updated Billing Factors for Payroll Burden and Indirect/Overhead Costs - Arizona Pipeline Company DATE DESCRIPTION PAYROLL INDIRECT BURDEN OVERHEAD 10/18/95 SCE Purchase Order U1105905 41% 21%

12/12/95 Change Order No. 1 41% 21%

7/1996 SCE internal audit (for 1995) 32.6% 35.8%

11/29/96 Purchase Order K1116901 32.6% 36% (This purchase order superseded Purchase Order U1105905.) 7/2000 SCE internal audit (for 1998) 36% 37%

3/28/03 Change Order No. 16 36%32 32%

12/22/03 Change Order No. 18 34% 32%

7/19/04 SCE internal audit (for 2003) 9%33 33%34

9/15/04 Arizona sends notice that it disputes the July 19, 2004 SCE internal audit and proposes different billing factors. 37%35 37%36 3/29/05 Change Order No. 23 36% 37%

1 Second, if ORA’s proposal were adopted (which it should not be), the Commission would be

2applying billing factors that were based on preliminary audit findings. As discussed above, the July 19,

32004 preliminary, internal audit report led to in negotiations with Arizona that eventually resulted in the

4use of billing factors agreed to by both Arizona and SCE.37 It does not make sense to reduce SCE’s

5Distribution Plant based on billing factors that were never implemented or agreed to by the parties.

232 After $20 million in cumulative billings in 2003, the 35% for payroll burden would change to 34%.

333 This rate was disputed by Arizona and has never been applied.

434 This rate was disputed by Arizona and has never been applied.

535 This rate was disputed by SCE and has never been applied.

636 This rate was disputed by SCE. As a result of the negotiations between SCE and Arizona, the parties agreed in Change 7 Order No. 23 dated March 29, 2005, to apply a 36% billing factor for payroll burden and a 37% billing factor for 8 indirect/overhead costs.

937 The new billing factors were reflected in Change Order No. 23.

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1C. ORA’s Proposed Adjustment To Plant In-Service Constitutes Retroactive Ratemaking

2 As discussed above, ORA has concluded that there were alleged overcharges which occurred in

32003 for the Arizona, Weissker, and Tidwell purchase orders. ORA then seizes upon that conclusion

4and projects an adjustment backward to 2001 and 2002. As the testimony above demonstrates, ORA has

5not accurately represented the terms of the contracts and its adjustment should be dismissed on the

6merits. However, ORA also over reaches by suggesting that the Commission use an adjustment to 2003

7plant-in-service as a proxy for reducing 2001 and 2002 plant-in-service balances.38

8 In SCE’s test year 2003 general rate case decision, D.04-07-022, the Commission authorized a

9revenue requirement for SCE, including a rate base level beginning in 2003. The Commission stated its

10intent to review capital investments for years 2004 and 2005, as a part of SCE’s next general rate case,

11but not to adjust rate base in prior periods. SCE is currently operating under rates authorized in this test

12year 2003 general rate case. It is inappropriate for the ORA to propose adjustments prior to 2004 in this

13currently pending GRC particularly when no evidence of misrepresentation or wrongdoing exists.

14 The California has long-held prohibitions against retroactive ratemaking. For example, in City

15of Los Angeles et. al v. Public Utilities Commission et al, dated June 9, 1972, the Supreme Court of

16California interpreted Section 734 of the Public Utilities Code when it said, “That section provides that

17when a rate has been formally found reasonable by the commission, the commission shall not order the

18payment of reparation upon the ground of unreasonableness. Of course, the rates existing prior to the

19present proceeding have been found reasonable by a final commission decision.”39 Through its

20adjustment in this matter, the ORA seeks the “reparation” dismissed by the court in the example above

21because SCE’s revenue requirement was found reasonable by the Commission in the 2003 GRC, as it

22established authorized general rate levels.

238 Even if ORA’s proposal to apply the billing factors retroactively were adopted (which it should not), the general 3 application of $2 million to years 2001 and 2002 is incorrect. Contrary to the statement by ORA on page 5-3 of the 4 Report on the Results of Examination, SCE did not indicate that the company apply the 2003 overcharge amount to 2001 5 and 2002. Rather, SCE indicated that the same methodology could be used in those years. Using the same 6 methodology, SCE has determined that the amount “overcharged” for 2002 would be $XXXXX and the net amount for 7 2001 would be $XXXXX. Therefore, to date, the total amount of the “overcharge” for the years 2001-2003 would be 8 $XXXXXXX, and not $6 million.

9 39 City of Los Angeles et. al. v. Public Utilities Commission et. al., 7 Cal. 3d 331, 356 (1972).

10 15 1

2 SCE'S ACCOUNTING PROCEDURES ALREADY TRACK INFORMATION THE ORA

3 REQUESTS

4A. SCE Accounting Procedures Currently Track Reimbursable Expenses Showing The Split

5 Between Ratepayer And Shareholder Funding

6 SCE currently uses the Trial Balance Account to track ratepayer v. shareholder costs. Trial

7Balance Accounts with a sub account of 999, and the function budget items that translate to them,

8provide visibility of all shareholder only costs. When an employee is reimbursed for costs that should

9be shareholder only, they enter the function budget item (i.e. location-function-account) that translates to

10a shareholder only Trial Balance Account on the Employee Expense Report form. This accounting is

11reviewed and approved by the manager/supervisor authorizing the reimbursement.

12B. ORA’s Recommendation That SCE Redesign Its Expense Reimbursement Process And

13 Forms For Easier ORA Review Is Unnecessary And Would Be An Unwise Diversion Of

14 Scarce Resources

15 SCE’s current process for employee reimbursements works well, meeting all current business

16needs and provides the company with more than adequate detail to make proper allocations of costs.

17While the employee is not required to enter a Trial Balance Account (i.e. FERC account) on any

18accounting document, including their reimbursement forms, they are required to record an accounting

19function or work order on the form, which translates to a FERC account and are readily visible and

20available. This translation can be readily identified. For example, if the sub- account of the Trial

21Balance Account is 999, then any recorded costs are shareholder only.

22 The Employee Expense Report form used to request reimbursement requires substantiation and

23explanation for all expenses entered. The employee enters the "Business Purpose" for mileage;

24provides an explanation of "Business Purpose and City including the name of the restaurant or

25entertainment facility when reporting business meals/entertainment or while on travel status" for meals,

26lodging and other; they are required to "List names, titles and affiliations for expenses incurred for

27employees and non-employees" in support of business meals and entertainment.

2 16 1

1 The accounting distribution entered on the form records to the appropriate FERC account

2designation for the costs, including whether the costs are ratepayer or shareholder funded. The

3segregation is readily visible on the individual accounting records as well as the General Ledger Trial

4Balance reports. SCE, like any large organization, is comprised of people who may not always

5accurately record the expenses on the reimbursement forms, and errors sometimes occur in the

6accounting. SCE conducted an error rate study and removed the statistically-correct amount from its

7GRC request. The ORA Auditors issued a number of data requests, which is their right. What the

8ORA’s Results of Examination omits, is the fact that SCE’s responses to these reimbursable expenses

9data requests confirmed the company’s accounting.

10 The Commission should also keep in mind that if SCE were to be held to a standard of

11perfection, the costs to implement such controls would far outweigh any benefit. General rate cases are

12prepared with a forecast of the cost to serve our customers, not the cost to serve the ORA. While it

13might be more convenient for the ORA to have a new reimbursement process and a new form, such an

14additional expense adds no value to SCE customers.

15 If the Commission adopts the ORA’s proposed adjustments such a new expense would be

16impossible. For example, the ORA has proposed to eliminate additional resources in our Controllers’

17department for Sarbanes-Oxley compliance requirements. Failure to continue meeting these new

18regulatory requirements would subject SCE to sanctions from the SEC. Also, the ORA has proposed

19deep reductions in capital expenditures that would force SCE to engage in capital-investment triage.

20The ORA’s proposals, taken together, simply would not allow for any new initiatives designed for their

21convenience. The Commission should reject the reimbursable adjustments identified in the Results of

22Examination.

2 17 1

2 ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION

3 ORA alleges that the amount of short term debt cost included in calculating the financing cost of

4in-progress construction projects (the allowance for funds used during construction or AFUDC) is

5understated and does not appear to have been calculated in accordance with FERC requirements. As a

6result, ORA recommends that a short term debt component equal to 2.61 percent of SCE’s total

7capitalization be included in forecasting the AFUDC rate for 2005 through 2008. This would result in

8including roughly $300 million of short term debt in the AFUDC rate calculation. (The amount varies

9by year). This would lower the amount of financing cost which is forecast to accrue on projects that

10have not yet entered service (construction work in progress or CWIP). The result would be to lower the

11forecast of capital additions to rate base associated with a given level of annual construction

12expenditures.

13 ORA’s testimony reflects a misunderstanding of FERC’s regulations on AFUDC calculations.

14In addition, ORA appears to be unfamiliar with prior Commission decisions related to SCE’s uses of

15short-term debt. While ORA is generally correct in observing that the AFUDC calculation applies short

16term debt towards construction financing before relying on other sources of capital, ORA is wrong to

17conclude that all of SCE’s short term debt is available for this purpose when calculating the AFUDC

18rate. FERC regulations describe the calculation as follows (emphasis added):

19 [AFUDC]…includes the net cost for the period of construction of borrowed funds 20 used for construction purposes and a reasonable rate on other funds when so used… 21 (18 CFR, Part 101, Chapter I, Electric Plant Instruction 17, 4-1-03 Edition)

22 Thus, only short-term debt available to finance construction activities is included in calculating

23AFUDC. In D.91269, the Commission authorized SCE to use a short term debt rate for balancing

24account balances.40 In D.85-12-107, the Commission included fuel inventory as an obligation financed

25with short-term debt.41 Obviously, short-term debt which is being used to finance fuel inventory or a

240 3 CPUC 2nd 200 (January 29, 1980).

341 20 CPUC 2nd 114 (December 20, 1985). Previously the Commission had extended the use of short term debt to 4 finance charges in fuel inventory from the amounts included in base rates (see 4 CPUC 2nd 714, December 5, 1980).

5 18 1

1balancing account undercollection is not available to finance construction activities. Thus, ORA is

2wrong to propose that the entire amount of short-term debt be used in the AFUDC rate calculation.

3 In general, the amount of short-term debt which SCE incurs in excess of balancing account and

4fuel inventory needs is small. The average amount of short-term debt available for construction

5activities in recent years is as follows:

6 Available Short-Term 7 Debt ($ millions) 8 9 2002 $4.6 10 2003 $1.6 11 2004 $43.4

12 Average $17.1

13 For the purpose of forecasting capital additions in 2005 through 2008 in this proceeding, SCE

14assumed that there would be no short term debt available for construction activities when making its

152005 through 2008 forecast of AFUDC rates. SCE would not oppose using the average of the 2002-

162004 short-term debt available for construction as shown above ($17.1 million), rather than assuming

17there will be no such amounts available. It would be wrong, however, to calculate short-term debt as a

18percentage of SCE’s total capitalization, since short-term debt is more closely related to the variations in

19“cash flow” requirements during the course of a year than to SCE’s overall capitalization.

2 19 1

Appendix A Witness Qualificatio ns

2 SOUTHERN CALIFORNIA EDISON COMPANY

3 QUALIFICATIONS AND PREPARED TESTIMONY

4 OF SUSAN P. PETERS

5Q. Please state your name and business address for the record.

6A. My name is Susan P. Peters, and my business address is 2244 Walnut Grove Avenue, Rosemead,

7 California 91770.

8Q. Briefly describe your present responsibilities at the Southern California Edison Company.

9A. I am an auditor in the Operational Audits & Consulting Group within the Audit Services

10 Department. My responsibilities include audit and advisory services for business units in the

11 areas of Transmission & Distribution, Generation, Shared Services, and Regulatory Policy &

12 Affairs, and others as required. Audit services include the assessment of corporate risk areas,

13 adequacy of internal controls, special investigations, and the evaluation of SCE compliance with

14 regulatory requirements/directives.

15Q. Briefly describe your educational and professional background.

16A. I graduated from the University of Southern California with a Bachelor of Arts degree in

17 psychology and also attended numerous business courses. In addition, I earned a Master’s

18 Degree in Business Administration from the University of Nevada, Reno. Since 2000, I have

19 been in the Audit Services Department at Southern California Edison performing the duties as

20 described above.

21Q. What is the purpose of your testimony in this proceeding?

22A. The purpose of my testimony in this proceeding is to sponsor the portions of Exhibit SCE-22,

23 entitled Results of Examination, as identified in the Table of Contents thereto.

24Q. Was this material prepared by you or under your supervision?

25A. Yes, it was.

26Q. Insofar as this material is factual in nature, do you believe it to be correct?

27A. Yes, I do.

2 A-21 1

1Q. Insofar as this material is in the nature of opinion or judgment, does it represent your best

2 judgment?

3A. Yes, it does.

4Q. Does this conclude your qualifications and prepared testimony?

5A. Yes, it does.

2 A-22 1

3 OF RUSSELL G. WORDEN

5A. My name is Russell G. Worden, and my business address is 2244 Walnut Grove Avenue,

6 Rosemead, California 91770.

8A. I am presently a Manager of Regulatory Affairs in Edison’s Regulatory Policy & Affairs

9 Department, and the 2003 General Rate Case Project Manager. My responsibilities have

10 previously included preparation of the Company’s filings before the California Public Utilities

11 Commission in matters pertaining to Edison’s nuclear power plants, and Qualifying Facilities

12 (QF’s). I was responsible for negotiating the phase of Edison’s Test Year 1995 General Rate

13 Case Settlement relating to the rate recovery of SONGS Units 2&3. Also, I was responsible for

14 negotiating the settlement that modified Edison’s ratemaking for the Palo Verde Nuclear

15 Generating Station.

17A. I received an Associate of Arts degree from Cabrillo College, in Aptos, California in 1974. I

18 graduated from San Francisco State University in 1977 with a Bachelor of Arts degree in

19 Political Science, cum laude. After college, I joined the Washington, D.C. staff of U.S. Senator

20 Richard Stone (D-FL) where I served as a Legislative Aide until December 1980. From

21 January 1981 until March 1985, I served as a Legislative Assistant to then Congressman Ron

22 Wyden (D-OR). In March 1985, I joined the Washington, D.C. office of Southern California

23 Edison as a Governmental Affairs Assistant, and in May 1988, I transferred to Edison’s Revenue

24 Requirements Department. I was promoted to my current position in July 1992.

2 A-23 1

1A. The purpose of my testimony in this proceeding is to sponsor Exhibit SCE-13, entitled

2 Overview, and the portions of Exhibit SCE-22, entitled Results of Examination, as identified in

3 the Table of Contents thereto.

5A. Yes, it was.

7A. Yes, I do.

9 judgment?

10A. Yes, it does.

12A. Yes, it does.

2 A-24 1

3 OF DEBRA R. AVILA

5A. My name is Debra R Avila, and my business address is 2244 Walnut Grove Avenue, Rosemead,

6 California 91770.

8A. I am a Manager of Supply Chain in the Procurement and Material Management Department. I

9 am responsible for developing and implementing supply chain strategies to meet internal

10 company and business unit demand.

12A. I received a Bachelor of Science in Business Administration from Cal State University, Los

13 Angeles. I also received a Certificate of Completion in Project Management from the University

14 of Irvine.

16A. The purpose of my testimony in this proceeding is to sponsor the portions of Exhibit SCE-22,

17 entitled Results of Examination, as identified in the Table of Contents thereto.

19A. Yes, it was.

21A. Yes, I do.

23 judgment?

24A. Yes, it does.

26A. Yes, it does.

2 A-25