Calculation of Reasonable Return, Disposal of Surplus and Replacement of an Asset

Calculation of Reasonable Return

Control Reserve fall short of reasonable return, the appropriations to this reserve can be reduced by the amount of shortfall. The amount of such reserve is to be invested in the same electricity undertaking and is to be handed over to purchaser of the business in case the business is sold away.

The Electricity (Supply) Act, 1948, imposes restrictions on electricity undertakings on earning too high a profit, by means of the concept of reasonable return, which stipulates the following:

1. A yield at the standard rate which is the Bank Rate stipulated by the Reserve Bank of India from time to time, plus 2% on the Capital Base.
2. Income derived from investments excluding investments made against the Contingencies Reserve.
3. An amount equal to ½% on any loans advanced by the Board.
4. An amount equal to ½% on the amounts borrowed from organisations or institutions approved by the State Government.
5. An amount equal to ½% on the amounts realised by the issue of debentures.
6. An amount equal to ½% on the accumulations in the Development Reserve.
7. Any other amount as may be allowed by the Central Government, having regard to the prevailing tax structure in the country.

An electricity company must adjust the rates so that the clear profit in any year does not exceed the reasonable return by more than 20 per cent of the reasonable return. In case it exceeds, it should be credited to Customers Rebate (or Benefit) Reserve.

Moreover, even the surplus within 20 per cent of the reasonable return has to be disposed of as follows:

(i) 1/3 of the surplus not exceeding 5 per cent of the reasonable return will be at the disposal of the undertaking.

(ii) Of the balance, 1/2 will be transferred to the Tariffs and Dividend Control Reserve.

(iii) The balance left will be distributed among consumers by way of reduction of rates or by way of special rebate.

Calculation of Disposal of Surplus

Should the clear profit exceed the reasonable return, the surplus has to be disposed of as under:

(a) One-third of the surplus not exceeding 5% of the reasonable return will be at the disposal of the undertaking;

(b) Of the balance, one-half will be transferred to “Tariffs and Dividends Control Reserve”; and

(c) The balance will be distributed among consumers by way of reduction of rates or by way of special rebate.

An electricity undertaking must so adjust rates that the amount of clear profit in any year does not exceed the reasonable return by more than 20% of the reasonable return.

Replacement of an Asset

In an Electricity company an asset once appeared in a Capital account cannot be reduced even after its replacement or disposal. So, when no extension or improvement is involved the entire replacement cost is charged to revenue and if some extension is involved, the difference is to be capitalised. i.e. the difference between the actual amount spent and the amount that would have been spent had the old asset been constructed now. For this the following calculations and journal are necessary.

Three procedures for replacement of an asset.

(i) The original cost of the asset will remain intact.

(ii) The estimated cost of replacement of the old asset is ascertained. At the same time, the estimated cost is reduced by the sale proceeds of old materials, if any, or by the value of materials re-used in the new construction. The balance is charged to Revenue Account.

(iii) The difference between the total cost of the entire work and the estimated replacement cost of the old asset in original manner is charged to Capital Account, i.e., capitalized.

In addition to above, the additions and improvements are capitalized. Moreover, the auxiliary mains, subsidiary, subsidiary permanent ways, etc. are also to be capitalized. Improvement is the excess amount spent over the cost of replacement with asset of equal efficiency.

It may be mentioned, however, in this respect that current cost of the old assets may be determined either from the market or from the price index. That is, price index which is applicable to the type of asset with same efficiency after 20-30 years may be practically obsolete now.

It may be applied simply to get the estimated current cost. If the asset is in the nature of Construction Works, separate indices have to be applied to different elements of cost. But if the estimate differs (between engineering data and price indices) the lesser amount may be capitalized just on the basis of conservatism.