r Aprovcd for Republic of the ENERGY REGULATORY COMMIS f144L .J San Miguel Avenue, Pasig City

IN THE MATTER OF THE APPLICATION FOR THE APPROVAL OF THE BUSINESS SEPARATION AND UNBUNDLING PLAN (BSUP), PURSUANT TO THE PROVISION OF SECTION:36 OF R.A. 9136, AND RULE 10 OF ITS IMPLEMENTING RULES AND REGULATIONS

ERC CASE NO. 201 2-047 MC

ILOCOS NORTE ELECTRIC COOPERATIVE, INC. (INEC), D 0 i3 1' E I) Applicant. CLTJ

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DECISION

Before this Commission for resolution is the application filed on July 31, 2012 by Ilocos Node Electrib Cooperative, Inc. (INEC) for approval of it& Business Separation and Unbundling Plan (BSUP) in accordance with Section 36 of Republic Act No. 9136 (the Electric Power Industry Reform Act of 2001 or the EPIRA) and Rule 10 of its Implementing Rules and Regulations (IRR).

In the said application, INEC alleged, among others, that:

1. It is a non-stock, non-profit Electric Cooperative (EC) duly organized and existing under and by virtue of the laws of the Republic of the Philippines, with principal office at Brgy. Suyo, , Ilocos Node.

2. It holds an excIu(C franchise issued by the National Electrification ComrjiiAsion (NEC), to operate an electric light 0/ and power distribççtiy 1,service in the two (2) Cities of -t ERC Case No. 2012-047 MC DECISION/May 14, 2013 Paae 2 of 17

and , and the twenty one (21) Municipalities of the Province of namely: AdE ims, , , Bangui, Banna, Burgos, , , Dingras, , Marcos, Nueva Era, , , , , , San Nicolas, , Solsona and .

3. Section 36 of Republic Act No. 9136 (R.A. 9136), otherwise known as the Electric Power Industry Reform Act of 2001 or "EPIRA", provides in part that 'Any electric power industry participant shall functionally and structurally unbundle its business activities and rates in accordance with the sectors as identified in Section 5 hereof The ERC shall ensure full compliance with this pro vision '1

4. Pursuant to the said mandate of the EPIRA as well as Rule 10 of its Implementing Rules and Regulations (IRR), the Commission promulgated Resolution No. 49, Series of 2006, otherwise known as the "Business Separation Guidelines, as Amended' as well as Resolution No. 07, Series of 2012, adopting the Accounting and Cost Allocation Manual (ACAM) for EC.

5. In compliance with the requirements of the foregoing law, rules and resolutions, it is submitting herewith for the Commission's evaluation and approval, its proposed Business Separation and Unbundling Plan (BSUP) for the business separation and structural and functional unbundling of its business activities, with the end in view of separating its distribution activities into appropriate business segments and to have a clear separation of operations and accounts between its regulated and non-regulated activities.

6. It is, likewise, submitting together with its BSUP, its Accounting Separation Statements for Year 2011 based on its 2011 Audited Financial Statements (AFS).

7. It prays that after due notice and hearing, its BSUP be approved accordingly. ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Paae 3 of 17

On September 3, 2012, the Commission issued an Order directing INEC to submit the following: a) Confidentiality Policies and Guidelines; and b) Board Resolution/s on the Statement of Compliance with the applicable provisions of Article 5 of the BSG.

On September 20, 2012, INEC filed its "Compliance".

Having found said application sufficient in form and in substance with the required fees having been paid, an Order and a Notice of Public Hearing, both dated November 12, 2012, were issued setting the case for jurisdictional hearing, expository presentation, pre-trial conference and evidentiary hearing on November 28, 2012.

In the same Order, INEC was directed to caUse the publication of the Notice of Public Hearing, at its own expense, once (lx) in a newspaper of general circulation in the Philippines, at least ten (10) days before the scheduled date of initial hearing.

The Office of the Solicitor General (OSG), the Commission on Audit (COA) and the Committees on Energy of both Houses of Congress were furnished with copies of the Order and Notice of Public Hearing and were requested to have their respective duly authorized representatives present at the initial hearing.

On November 19, 2012, INEC filed an "Urgent Motion to Reset Hearing" praying for the resetting of the hearing and citing that the members of the Technical Working Group (TWG) are scheduled to attend the convention for the Philippine Institute of Certified Public Accountants (PICPA) on the same date of hearing. Said urgent motion was granted. Thus, the Commission issued another Order dated January 28, 2013 resetting the hearing to March 1, 2013.

On February 21, 2013, INEC filed its "Pm-Trial Brief'.

During the March 1, 2013 initial hearing, only INEC appeared. No intervenor/oppositor appeared nor was there any intervention/opposition registered.

ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Pacje 4 of 17

At the said hearing, INEC presented its proofs of compliance with the Commission's posting and publication of notice requirements which were duly marked as Exhibits "B" to "E-2", inclusive. Thereafter, it conducted an expository presentation of its application and presented Ms. Rosita A. Bumanglag, its Finance Manager who testified in support of the application. In the course of her direct examination, additional documents were presented and duly marked as exhibits.

The direct examination having been terminated, the Commission propounded clarificatory questions on the said witness.

On March 26, 2013, INEC filed its "Compliance with Directive" and "Formal Offer of Evidence".

On May 7, 2013, the Commission issued an Order admitting INEC's "Formal Offer of Evidence" and declaring the case submitted for resolution.

DISCUSSION

INEC's BSUP consists of six (6) sections as prescribed in the BSUP Filing Package, as follows:

1) Details of Current Structure

INEC submitted its profile, the diagrammatic representation of its existing corporate structure, the description of the activities and functions undertaken by each of the different departments or juridical entities, as well as the description of the current process enumerated as follows:

1.1 Meter Reading/Billing and Collection 1.2 Issuance of Notice of Disconnection "Abiso" and Collection 1.3 Disconnection, Reconnection, Collection-Remittance- Deposit 1.4 Bank Collection, Check Voucher Preparation, Cahs Advance, Payroll, Journal Voucher Preparation, Petty Cash Fund 1.5 AccourPq for Construction Costs, Preparation of FinancfialReporting, Bank Reconciliation

ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Paae 5 of 17

1.6 Processing and Remittance of Social Security System (SSS), Philippine Health Insurance Corporation (PHIC) and Home Development and Mutual Fund (HDMF) Premiums and Loan Payment 1.7 Budget Rate Computation 1.8 Technical Services-Planning, Planning and Engineering Design 1.9 Transmission and Distribution Pilferage Apprehension 1.10 Big Loads Consumer Tapping and Maintenance 1.11 Kilowatthour (kWh) Meter and Sealing 1.12 Substation Maintenance, Repairs and Maintenance of Equipment, Transformers 1.13 Pole and Transformer Rental 1.14 Employment, Disciplinary Action, Audit 1.15 II System Development and Deployment 1.16 Infrastructure Project Management, Total Work Management System (TWMS) 1.17 Total Customer and Management System (TCMS) 1.18 Meter Testing, Sealing and Rehabilitation Process 1.19 Energy Trading and Construction 1.20 Operations and Maintenance Process

2) Details of Business Segments

In compliance with the BSUP Filing Package, I NEC had adequately complied with this requirement and provided the details of its business segments including the allocation of costs for each segment, as follows:

2.1 Generation Business Segments

It adopted the Generation of Electricity and Provision of Ancillary Service Business Segment. This segment comprises the generation facility of electricity (i.e., the production of electricity including the use of a co- generation facility and embedded generators) and the provision of Ancillary Services (using generation assets).

2.2 Distribution and Related Activities Business Segments

Its businfrSs segments are classified and defined according' t the BSG. These are grouped into six (6) busines&gme,nts, namely: a) Distribution Services ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Paqe 6 of 17

(DS); b) Distribution Connection Services (DCS); c) Non- Regulated Retail Services (NRRS); d) Regulated Retail Services (RRS); e) Related Businesses (RB); and f) Supplier of Last Resort (SOLR).

a. Distribution Services (DS) - This segment includes the following: 1) Conveyance of electricity through a Distribution System and the control and monitoring of electricity as it is conveyed through the Distribution System (including any services that support such conveyance, control or monitoring or the safe operation of the Distribution System); 2) Provision for Ancillary Services (if any) that are provided using assets which form part of a Distribution System; 3) Planning, maintenance, augmentation and operation of the Distribution System; 4) Provision, installation, commission, testing, repair, maintenance and reading of the Wholesale Electricity Spot Market (WESM) related meters that are not also used to measure the delivery of electricity to end-users or other customers; and 5) Billing, collection and the provision of customer services that are directly related to the delivery of electricity to end-users or to the connection of such persons to a Distribution System.

b. Distribution Connection Services (DCS) - This segment includes the following: 1) Provision of capability at each Connection Point to a Distribution System to deliver electricity or to take electricity from the Connection Point and the conveyance of electricity from the facilities of persons which are directly connected to the Distribution System and from the Connection to the facilities of persons which are directly connected to the Distribution System; 2) Planning, installation, maintenance, augmentation, testing and operation of distribution connection assets; and 3) Provision of other services that supports any of the above services.

c. Regulated Retail Services (RRS) - This segment comprises the provision of regulated retails services such as: 1) Services pertaining to the sale of electricity to end-users who are included in the Captive 'rket; 2) Billing, collection and the provision of cu t er services to such end-users in their ERC Case No. 2012-047 MC DECISION/May 14, 2013 Paae 7 of 17

capacity as electricity consumers; Energy trading (including the purchase of electricity and hedging activities) undertaken in connection with the sale of electricity to end-users who are included in the Captive Market; and sales of electricity to end-users who are included on the Captive Market; 3) Regulated retail services also comprise the provision, installation, commissioning, testing, repair, maintenance and reading of meters that are used to measure the delivery of electricity to end-users who are included in the Captive Market.

d. Last Resort Supply Services (LRSS) - This segment comprises the provision of LRSS services pertaining to the sale of electricity to SOLR customers, including billing, collection and the provision of basic customer service.

On August 11, 2011, the Commission designated INEC to act as SOLR for the contestable market in its franchise area connected to its distribution network.

e. Non-Regulated Retail Services (NRSS) - This segment comprises the provision of non-regulated retail services to end-users who are included in the contestable market or to other customers who are not end-users and includes: 1) Billing, collection and the provision of customer services to such end-users in their capacity as electricity consumers or to such other customers in their capacity as purchasers of electricity: 2) Energy trading undertaken in connection with the sale of electricity to end-users who are included in the contestable market or to other customers who are not end-users; 3) Sale of electricity to end-users who are included in the contestable market or to other customers who are not end-users; and 4) Provisions, installation, commissioning, testing, repair, maintenance and reading of meters that are used to measure the delivery of electricity to end-users who are included in the contestable market or to other customers who are ERC Case No. 2012-047 MC DECISION/May 14, 2013 Paae 8 of 17

f. Related Business Services (RB) - This segment comprises the provision of all other services and the carrying out of all other activities that utilize distribution assets, facilities, or staff including the following: 1) Electricity related services such as construction and maintenance of customer installation; and 2) Non-electricity related services such as telecommunications services.

2.3 Segregation of Employees to Business Segment

The BSUP Filing Package requires the details of the business segments, such as the number of individuals who are engaged in the activities of the business segment or other business activities of the utility.

In compliance with the aforesaid requirement, INEC submitted its segregation table of the number of employees who will be engaged in the activities of each business segment. It was noted that common employees will do multi-tasking across three (3) or more businesses. However, in its payroll allocation, it did not allocate salaries of employees who will be assigned to DCS, NRRS, LRSS and RB business segments.

2.4 Description of Assets

INEC's assets will be separated based on the same business segments as •defined in the BSG. Separation will be made based on the purpose to which such assets were acquired and being used. Assets that are being used by all business segments are defined accordingly. Based on the Calendar Year (CY) 2011 Audited Financial Statements (AFS), it has segregated its assets only to three (3) of its six (6) business segments. In the event that INEC has customers for its NRRS, SOLR and RB business segments, the necessary asset allocation will be made accordingly.

a es on the payroll and asset allocation related j,,,#ve mentioned segments become / ERC Case No. 2012-047 MC DECISION/May 14, 2013 Pacie 9 of 17

necessary, it shall inform the Commission of the consequent modification of its BSUP.

3) Accounting Separation

The Accounting Separation Statements and the corresponding accounting principles, policies and procedures used by INEC are in accordance with the BSG. The accounts maintained in the three (3) segments are reflected in such a way that these are separately being carried out by separate companies. As such, the revenues, costs, assets, liabilities, reserves and provisions of said accounts are reasonably allocable to each business segment and are separately identifiable in the books.

[NEC submitted its Statement of Income, Statement of Assets and Liabilities together with the revenue schedule, cost schedule, Inter-segment Transactions and Cash Flow Statements for the year ended December 31, 2011 for its Generation and Distribution business in accordance with its AFS for the year ended December 31, 2011. However, it was noted that its Cash Flow Statement for CY 2011 in the BSUP model does not tally with the Statement of Cash Flows in the AFS in the same period. Thus, INEC should be required to reconcile the two (2) documents.

It submitted an express statement manifesting the incorporation of Articles II (General Principles for Accounting Separation), I II (Information Requirements for Accounting Separation) and IV (Business Segments) of the BSG for the said accounting separation statement. This undertaking will ensure the clear separation of the accounts of its regulated and non-regulated business activities.

3.1 Principles to Achieve Accounting Separation

In accordance with the Commission's approved ACAM, INEC undertakes to adopt the said manual in its operation.

3.2 Allocation Principles

ie allocation methods and principles with Article Ill (Information •1 ERC Case No. 2012-047 MC DECISION/May 14, 2013 Pacie 10 of 17

Requirements for Accounting Separation) of the BSG. Direct Allocation approach was used in allocation of accounts, revenues and expenses that directly relate to a certain activity or section. The accounts revenue and expenses that cannot be directly attributed to an activity/section will be allocated on a fair and reasonable basis as documented in the approved ACAM for ECs. After the amounts have been allocated to different activities/sections, the amount will be further apportioned to different segments using the following principles: a) items/activities/sections directly attributable to a segment; b) items/activities/sections not directly attributable to a certain segment will be allocated using an appropriate factor; and c) items/activities/sections that are un-attributable to a Business Segment are allocated using a fair and reasonable method.

In general, the overall revenue, costs, assets, liabilities and capital obtained from the income statement and balance sheet shall be directly assigned to the segment that caused the revenue, costs, assets, liabilities and capital. However, for those accounts that cannot be directly assigned, the allocation factor is used.

INEC, in general, adopted the allocation factors based on the principles set forth in the approved ACAM and the BSG.

However, the Commission observed that INEC did not follow the proper linking of the allocation factors sheet with the Trial Balance sheet and the factors used for each accounts. In addition, there are factors used for some accounts with no allocation of costs to its respective business segments. Some of the inconsistencies observed are the following: 1) In Payroll Allocation for Maintenance-Street Lighting and Signal System Account (512-513-00-000), it used the factor RRS but cost was allocated to DS; and 2) In Payroll Allocation for Service Installation Expseqç Account (514-504-00-000), it used the factthr't DCS but cost was allocated to RRS. •1 ERC Case No. 2012-047 MC DECISION/May 14, 2013 Page 11 of 17

INEC should be directed to make the necessary adjustment in linking the allocation factors with the appropriate factors in the Trial Balance accounts in order to properly allocate the cost/revenue to its corresponding business segments.

3.3 Chart of Account

INEC complied with the Chart of Accounts as provided by the approved ACAM. The chart of accounts establishes the general ledger and subsidiary ledger accounts to be used by it. It has incorporated the requirements under the EPIRA following the BSG, as amended.

3.4 Basic Accounting Principles

INEC defined its basic accounting principles that are compliant with the BSG in order to properly process its transactions. These principles were observed in the preparation of its financial statements as a whole as well as in the individual business segments.

It intends to present financial statements with the following frameworks, concepts, characteristics, and assumptions such as understandability, relevance, reliability, comparability, materiality, consistency, going concerns and accruals. The calendar year was used as its accounting period in the preparation of financial reports.

It shall comply with the required Accounting Separation Statements prepared for the purposes of the Business Separation Guideline (BSG) which will be accompanied by a report prepared, signed and dated by an Auditor (Auditor's Report) that contains the Auditor's opinion on whether the Accounting Separation Statements are presented fairly in accordance with the requirements of the BSG, clearlyidentifying any exceptions and the effect of each (skich exception on the Accounting Separation Statehibnts. ERC Case No. 2012-047 MC DECISION/May 14, 2013 Pane 12 of 17

3.5 Other Requirements Related to Business Separation

INEC submifted its undertaking stating that it will comply with the other requirements related to business separation as provided under Article V of the BSG, particularly, on the provisions related to Prohibition on Discrimination, Disclosure of Information and Prohibition on Cross-subsidies.

4) Description of Separation

INEC intends to separate the business segment by the creation of separate divisions or departments within the same juridical entity that undertakes the activities. All directly attributable employees, assets and cost will be grouped into their corresponding "business segment". Employees, assets and their corresponding costs common to all segments will be segregated by function forming different departments within the same juridical entity. The assets of INEC and corresponding costs will be allocated based on logical and acceptable method. The method chosen should not in any way increase the cost of INEC.

It will maintain separate books for the Generation Segment and Distribution Segments. It shall be maintained for each Business Segment as if that Business Segment were carried on by a separate company so that the revenues, costs, assets, liabilities, are separately identifiable in the books.

It presented a general and detailed structure per business segment and department, identifying which segment performs the activity.

5) Milestones and Highlights

INEC manifested that it will require all of its employees to attend seminars, competency trainings and workshops to enhance their knowledge of the activity of each business segment. ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Paae 13 of 17

In addition, INEC submitted an undertaking involving the implementation of the separation of business segments to ensure that it is compliant with the requirements of the BSG.

6) Programs for Code of Conduct

On June 21, 2006, the Commission promulgated Resolution No. 49, Series of 2006, entitled "A Resolution Amending the Business Separation Guidelines (BSG)" to incorporate additional business segments and activities as well as to make it consistent with the "Code of Conduct for Competitive Retail Market Participants" which prescribes the operational separation between a distribution utility's regulated and non- regulated business activities.

INEC undertakes to develop a plan to comply with the Code of Conduct for Competitive Retail Market Participants promulgated by the Commission.

In the preparation of the Accounting Separation Statement, the BSG requires that transfer pricing policies shall be used for transactions between business segments. Since INEC did not propose a methodology for such, calculation of transfer prices based on fully allocated costs using the cost allocation standards without any mark-up is recommended for its services, products and assets transferred between related entities/business segments.

WHEREFORE, the foregoing premises considered, the application filed by Ilocos Norte Electric Cooperative, Inc. (INEC) for approval of its Business Separation and Unbundling Plan (BSUP) in accordance with Section 36 of Republic Act No. 9136 (the Electric Power Industry Reform Act of 2001 or the EPIRA) and Rule 10 of its !mplementing Rules and Regulations (IRR) is hereby APPROVED with modification subject to certain conditions and its full compliance with the requirements of the BSG, as amended.

INEC is directed to modify its BSUP relative to the following:

1) For its Trial Balance. It should segregate portion of revenues to be assigned t, DCS, NRRS, LRSS and RB business segments: ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Pacje 14 of 17

2) For Account Nos. 512-513-00-000 and 514-504-00-000. It should properly link to allocation factor RRS instead of DS and factor DCS instead of RRS, respectively;

3) Under Payroll Allocation Sheet. It should segregate portion of salaries of employees to be assigned to DCS, NRRS, LRSS and RB business segments; and

4) Cash Flow Statement as of December 31, 2011. It has to reconcile the amount as stated in the AFS for December 31, 2011.

Finally, [NEC is directed to submit the following documents, within five (5) months from the end of the financial year, as provided in Article II, Section 2.12 of the BSG, as amended:

1) The Accounting Separation Statements prepared by it for the relevant period, in accordance with the approved BSG as amended and the Commission approved ACAM;

2) The Management Responsibility Statement required to accompany the Accounting Separation Statements in accordance with Section 2.6 of the BSG;

3) The Auditor's Report on the Accounting Separation Statements prepared in accordance with Section 2.8 of the BSG;

4) The General Information Sheet required to accompany the Accounting Separation Statement in accordance with Section 2.10 of the BSG;

5) The Compliance Report required to accompany the Accounting Separation Statements in accordance with Section 2.11 of the BSG; and ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Page 15 of 17

6) A consolidated copy of the relevant Electric Power Industry Participant's ACAM, where such ACAM has been amended, so that it does not correspond with the consolidated copy of the ACAM that has been previously approved by the Commission.

SO ORDERED.

Pasig City, May 14, 2013.

. J,ENA G. CRUZ-DUC" Chairperson

MARIA JJC.REVES *Coissionerl sioner

(On Leave) ALFREDO J. NON GLOFIA VICTROIA YAP-TARUC Commissioner Commissioner

f/IJINEC BSUP/ERC CASE NO. 2012-047 Mc-oEclsioN ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Pane 16 of 17

Copy Furnished:

1. LERIOS-AMBOY AND DELOS REYES LAW OFFICES Counsels for [NEC Units 1609-1610, Tycoon Centre Pearl Drive, Ortigas Avenue, Pasig City

2. ILOCOS NORTE ELECTRIC COOPERATIVE, INC. (INEC) Brgy. Suyo, Dingras, Ilocos Norte

3. The Office of the Solicitor General 134 Amorsolo Street, Legaspi Village Makati City

4. The Commission on Audit Commonwealth Avenue Quezon City

5. The Senate Committee on Energy GSIS Building, Roxas Boulevard Pasay City

6. The House Committee on Energy Batasan Hills, Quezon City

7. Office of the President of PCCI Philippine Chamber of Commerce and Industry (PCCI) 3rd Floor, ECC Building, Sen. Gil Puyat Avenue Makati City

8. Office of the City Mayor Batac City, liocos Norte

9. Office of the City Mayor Laoag City, Ilocos Norte

10. Office of the Municipal Mayor Adams, Ilocos Norte

11. Office of the Municipal Mayor Bacarra, Ilocos Norte

12. Office of the Municipal Mayor Badoc, Ilocos Norte

13. Office of the Municipal Mayor Bangui, Ilocos Norte

14. Office of the Municipal Mayor Banna, Ilocos Norte

15. Office of the Municipal Mayor Burgos, Ilocos Norte j r ERC Case No. 20 12-047 MC DECISION/May 14, 2013 Pane 17 of 17

16. Office of the Municipal Mayor Carasi, Ilocos Norte

17. Office of the Municipal Mayor Currimao, Ilocos Node

18. Office of the Municipal Mayor Dingras, Ilocos Node

19. Office of the Municipal Mayor Dumalneg, Ilocos Node

20. Office of the Municipal Mayor Marcos, Ilocos Node

21. Office of the Municipal Mayor Nueva Era, Ilocos Node

22. Office of the Municipal Mayor Pagudpud, Ilocos Node

23. Office of the Municipal Mayor Paoay, Ilocos Node

24. Office of the Municipal Mayor Pasuquin, Ilocos Node

25. Office of the Municipal Mayor Piddig, Ilocos Node

26. Office of the Municipal Mayor Pinili, Ilocos Node

27. Office of the Municipal Mayor San Nicolas, Ilocos Node

28. Office of the Municipal Mayor Sarrat, Ilocos Node

29. Office of the Municipal Mayor Solsona, Ilocos Node

30. Office of the Municipal Mayor Vintar. llocbs Node