Accounting Question

T H E GE OR GE W AS HIN GT ON U N IVER S IT Y
F IN AL E XA M 2 0 2 4
MARCH 2024
Montgomery Energy, Inc.
Electricity prices are going through the roof in southern Maryland these days, thanks to Montgomery Energy’s
monopoly in the region. It is unacceptable that a rate-regulated entity such as Montgomery Energy can generate
record profits while local businesses and residents face challenging economic conditions. One must wonder whether
this has something to do with the fact that Montgomery’s CEO is politically well-connected and has doled out
thousands of dollars in contributions to local politicians.
Excerpts from the December 16, 2023, issue of Bethesda Gazette
Montgomery Energy, Inc., headquartered in Silver Spring, MD, is a US-based power company. It was
founded in 1972 by Dr. Bill Moersen, an engineering professor at the George Washington University.
Over the years, it has expanded its operations; as of 2023, Montgomery Energy is the sole electricity
provider in the Maryland suburb of Washington, DC, serving over 1 million households and 500,000
businesses. Montgomery Energy consists of three departments: Commercial and Residential Operations
(CRO), Charging Station Operations (CSO), and Power Generation and Delivery (PGD).
CRO serves retail residential and business customers. It is regulated by the Maryland Public Service
Commission (MPSC), which approves the rate per megawatt annually. While the formula MPSC uses to
calculate electricity rates is quite complex, MPSC typically allows Montgomery Energy to charge a fixed
percentage markup on CRO’s total cost. CRO’s customers are geographically concentrated within a 50mile radius of Washington, D.C.
CSO was recently founded in response to the rapid growth of the electric automobile market. CSO
operates charging stations for electric vehicles. Unlike CRO, which is essentially a monopoly, CSO faces
intense market competition and doesn’t have much pricing power. In addition, CSO service locations are
quite dispersed geographically: it has charging stations all over the state, especially along the I-95
corridor.
Finally, PGD operates four natural gas-fired power plants; it delivers electricity to customers and
maintains transformers that reduce electricity voltage to 110V. Specifically, PGD’s services include
electricity generation, natural gas inventory management, electricity transmission, and transformer
maintenance. PGD solely serves the internal demands of CSO and CRO.
Montgomery Energy is currently mired in a public relations nightmare. In December 2023, Bethesda
Gazette, a widely read and respected local newspaper, ran a scathing article accusing Montgomery
Energy, particularly CRO, of excessively charging its customers. The company has been working to
restore its image and is worried that the public will continue scrutinizing its finances.
1
T H E GE OR GE W AS HIN GT ON U N IVER S IT Y
F IN AL E XA M 2 0 2 4
MARCH 2024
Existing Cost System at Montgomery
The existing cost system at Montgomery Energy calculates costs for CRO and CSO per megawatt. Costs at
CRO and CSO include direct labor and direct materials. The direct labor and direct materials costs are
variable costs that vary with the number of megawatts. Costs at PGD are treated as overhead and
allocated to CRO and CSO based on the number of megawatts. The budgeted operating income statement
for Montgomery Energy in 2024 is provided in Exhibit 1. The expected number of megawatts sold by
CRO and CSO are 2,000,000 and 800,000, respectively.
A New Cost Study
Angela Moon, a Senior Vice President of Montgomery Energy, is concerned with the high budgeted cost
at CRO in 2024. In January 2024, she hired an outside consultant to conduct a new cost study to assess
each department’s performance more precisely. The study reveals the following information about the
use of PGD’s resources.
1.
Electricity generation costs generally vary with the number of megawatts sold.
2.
Electricity transmission costs refer to the costs incurred in delivering electricity from power
plants to end users. The costs seem to be caused by the distance electricity travels.
3.
Transformer maintenance costs appear to be driven by the number of transformers. Due to the
geographical dispersion in CSO locations, significantly more transformers are dedicated to CSO
operations than CRO operations.
4.
Natural gas inventory management costs seem to vary with weight-time. Weight-time is the
liquid gas’ weight (by tons) multiplied by the length of time (by number of days) gas stays in
storage. Both the length of time that gas is stored and its weight impact the inventory cost
incurred by Montgomery Energy.
5.
The direct labor and direct materials costs at CRO and CSO are evaluated the same as in the
existing system; these are variable costs varying with the number of megawatts.
Exhibit 2 contains some of the operating data the consultant projected for 2024. Angela Moon understood
that the pricing for CRO would be affected by any change in Montgomery Energy’s cost system during
2024 (while the percentage markup allowed by MPSC would remain the same).
Recent Development
Montgomery Energy is considering leasing a small power plant near Baltimore for a year to explore the
possibility of expanding CRO’s operation. This power plant’s capacity is 300,000 megawatts, its fixed cost
(including annual lease) is $20,000,000, and its variable cost is $1,000 per megawatt. The company
estimates that it can charge $2,000 per megawatt in Baltimore.
2
T H E GE OR GE W AS HIN GT ON U N IVER S IT Y
F IN AL E XA M 2 0 2 4
MARCH 2024
The actual number of megawatts sold in 2024 is 2,500,000 and 720,000 for CRO and CSO, respectively.
Exhibit 3 provides data on budgeted and actual direct labor costs in 2024.
Montgomery Energy is currently compiling its budget for 2025. 80% of transmission costs and 50% of
transformer maintenance costs are variable; all other PGD costs are fixed. Fixed costs are expected to
remain unchanged from 2024. Exhibit 4 contains some of its projections for 2025.
3
T H E GE OR GE W AS HIN GT ON U N IVER S IT Y
F IN AL E XA M 2 0 2 4
MARCH 2024
Exhibit 1: 2024 Budgeted Operating Income Statement
Revenues
3,500,000,000
Costs
Direct Labor
560,000,000
Direct Materials
420,000,000
Electricity Generation
Natural Gas Inventory
Management
840,000,000
Electricity Transmission
500,000,000
Transformer Maintenance
240,000,000
Operating Profit
700,000,000
240,000,000
Exhibit 2: Operating Data for 2024
Transmission Distance (in miles)
CRO
20,000
CSO
60,000
Natural Gas by Tons
2,000,000
800,000
Days in Inventory
10
50
Number of Transformers
200
800
4
T H E GE OR GE W AS HIN GT ON U N IVER S IT Y
F IN AL E XA M 2 0 2 4
MARCH 2024
Exhibit 3: Budgeted and Actual Direct Labor Usage in 2024
Budgeted
Actual
Wage per Hour
DL Dollars
Wage per Hour
DL Dollars
CRO
400
400,000,000
300
750,000,000
CSO
800
160,000,000
560,000,000
1,000
360,000,000
1,110,000,000
Total
Exhibit 4: 2025 Budget Assumptions
Revenues
3,800,000,000
Direct Labor Cost
650,000,000
Direct Material Cost
450,000,000
Number of Transformers
1,200
Transmission Distance
100,000
5