As a regulated entity, the Utility's rates are designed to recover the costs of providing service. The Utility capitalizes and records, as regulatory assets, costs that would otherwise be charged to expense if it is probable that the incurred costs will be recovered in future rates. Regulatory assets are amortized over the future periods that the costs are recovered. If costs expected to be incurred in the future are currently being recovered through rates, the Utility records those expected future costs as regulatory liabilities. In addition, amounts that are probable of being credited or refunded to customers in the future are recorded as regulatory liabilities.

The Utility tracks differences between customer billings and the Utility's authorized revenue requirements for revenue that is independent, or “decoupled,” from the volume of electricity and natural gas sales. The Utility also tracks differences between incurred costs and customer billings or authorized revenue requirements meant to recover those costs. These differences are recorded to regulatory balancing accounts that represent amounts expected to be collected from or refunded to customers. Regulatory balancing accounts that are not expected to be collected from or refunded to customers over the next 12 months are included in other noncurrent assets - regulatory assets or noncurrent liabilities - regulatory liabilities, respectively, in the Condensed Consolidated Balance Sheets.

To the extent that portions of the Utility's operations cease to be subject to cost-of-service rate regulation, or recovery or refund is no longer probable as a result of changes in regulations or other reasons, the related regulatory assets, liabilities, and balancing accounts are written-off.

At September 30, 2012 and December 31, 2011, the Utility had current regulatory assets of $567 million and $1,090 million, respectively, primarily consisting of the price risk management regulatory asset, the Utility's retained generation regulatory assets, and the electromechanical meters regulatory asset. At December 31, 2011, current regulatory assets also included regulatory assets related to ERBs.

The regulatory asset for pension benefits represents the cumulative differences between amounts recognized for ratemaking purposes and amounts recognized in accordance with GAAP and also includes amounts that otherwise would be recorded to accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets. (See Note 12 of the Notes to the Consolidated Financial Statements in the 2011 Annual Report.)

The regulatory asset for deferred income taxes represents deferred income tax benefits previously passed through to customers. The CPUC requires the Utility to pass through certain tax benefits to customers by reducing rates, thereby ignoring the effect of deferred taxes. Based on current regulatory ratemaking and income tax laws, the Utility expects to recover the regulatory asset over the average plant depreciation lives of one to 45 years.

In connection with the Chapter 11 Settlement Agreement, the CPUC authorized the Utility to recover $1.2 billion of costs related to the Utility's retained generation assets. The individual components of these regulatory assets are being amortized over the respective lives of the underlying generation facilities, consistent with the period over which the related revenues are recognized. The weighted average remaining life of the assets is 13 years.

The regulatory asset for environmental compliance costs represents the cumulative differences between amounts recognized for ratemaking purposes and amounts recognized in accordance with GAAP. The Utility expects to recover these costs over the next 32 years, as the environmental compliance work is performed. (See Note 10 below.)

The regulatory asset for price risk management represents the unrealized losses related to price risk management derivative instruments expected to be recovered as they are realized over the next 10 years as part of the Utility's energy procurement costs. (See Note 7 below.)

The regulatory asset for electromechanical meters represents the expected future recovery of the net book value of electromechanical meters that were replaced with SmartMeter™ devices. The Utility expects to recover the regulatory asset over the next four years.

The regulatory asset for unamortized loss, net of gain, on reacquired debt represents the expected future recovery of costs related to debt reacquired or redeemed prior to maturity with associated discount and debt issuance costs. These costs are expected to be recovered over the next 14 years, which is the remaining amortization period of the reacquired debt.

At September 30, 2012 and December 31, 2011, “other” primarily consisted of regulatory assets related to ARO expenses for the decommissioning of the Utility's fossil fuel-fired generation facilities that are probable of future recovery through rates and costs incurred related to the Utility's plan of reorganization under Chapter 11 that became effective in April 2004, which are being amortized and collected in rates through April 2034.

In general, the Utility does not earn a return on regulatory assets if the related costs do not accrue interest. Accordingly, the Utility earns a return only on its regulatory assets for retained generation, regulatory assets for electromechanical meters, and regulatory assets for unamortized loss, net of gain, on reacquired debt.

At September 30, 2012 and December 31, 2011, the Utility had current regulatory liabilities of $379 million and $161 million, respectively, consisting of amounts that it expects to refund to customers over the next 12 months, primarily including electricity supplier settlement agreements. (See Note 9 below.) At September 30, 2012, current regulatory liabilities also included a U.S. Department of Energy (“DOE”) settlement agreement. Current regulatory liabilities are included within current liabilities - other in the Condensed Consolidated Balance Sheets.

The regulatory liability for recoveries in excess of AROs represents the cumulative differences between ARO expenses and amounts collected in rates primarily for the decommissioning of the Utility's nuclear power facilities. Decommissioning costs recovered through rates are primarily placed in nuclear decommissioning trusts. The regulatory liability also represents the deferral of realized and unrealized gains and losses on the nuclear decommissioning trust investments. (See Note 8 below.)

The regulatory liability for public purpose programs represents amounts received from customers designated for public purpose program costs expected to be incurred beyond the next 12 months, primarily related to energy efficiency programs designed to encourage the manufacture, design, distribution, and customer use of energy efficient appliances and other energy-using products, the California Solar Initiative program to promote the use of solar energy in residential homes and commercial, industrial, and agricultural properties, and the Self-Generation Incentive program to promote distributed generation technologies installed on the customer's side of the utility meter.

At September 30, 2012 and December 31, 2011, “other” primarily consisted of the regulatory liability related to the gain associated with the Utility's acquisition of the permits and other assets of the Gateway Generating Station as part of the settlement that the Utility entered into with Mirant Corporation, the price risk management regulatory liability representing the unrealized gains associated with price risk management derivative instruments expected to be refunded to customers as they are realized beyond the next 12 months as part of the Utility's energy procurement costs (see Note 7 below), and the regulatory liability related to the tax benefit associated with SmartMeters.^TM

The Utility's current regulatory balancing accounts represent the amounts expected to be collected from or refunded to customers through authorized rate adjustments over the next 12 months. Regulatory balancing accounts that the Utility does not expect to collect or refund over the next 12 months are included in other noncurrent assets - regulatory assets or noncurrent liabilities - regulatory liabilities, respectively, in the Condensed Consolidated Balance Sheets.

The distribution revenue adjustment mechanism balancing account is used to record and recover the authorized electric distribution revenue requirements and certain other electric distribution-related authorized costs. The utility generation balancing account is used to record and recover the authorized revenue requirements associated with Utility-owned electric generation, including capital and related non-fuel operating and maintenance expenses. The recovery of these revenue requirements is decoupled from the volume of sales; therefore, the Utility recognizes revenue evenly over the year, even though the level of cash collected from customers fluctuates depending on the volume of electricity sales. During the colder months of winter, there is generally an under-collection in these balancing accounts due to a lower volume of electricity sales and lower rates. During the warmer months of summer, there is generally an over-collection due to a higher volume of electricity sales and higher rates.

The hazardous substance balancing accounts are used to record and recover hazardous substance remediation costs that are eligible for recovery through a CPUC-approved ratemaking mechanism. (See Note 10 below.)

The public purpose programs balancing accounts are primarily used to record and recover the authorized revenue requirements associated with administering public purpose programs as well as incentive awards earned by the Utility for achieving regulatory targets in the customer energy efficiency programs. The public purpose programs primarily consist of energy efficiency programs, low-income energy efficiency programs, demand response programs, research, development, and demonstration programs, and renewable energy programs.

The gas fixed-cost balancing account is used to record and recover authorized gas distribution revenue requirements and certain other authorized gas distribution-related costs. Similar to the utility generation and the distribution revenue adjustment mechanism balancing accounts discussed above, the recovery of these revenue requirements is decoupled from the volume of sales; therefore, the Utility recognizes revenue evenly over the year, even though the level of cash collected from customers fluctuates depending on the volume of gas sales. During the colder months of winter, there is generally an over-collection in this balancing account primarily due to higher natural gas sales. During the warmer months of summer, there is generally an under-collection primarily due to lower natural gas sales.

The ERBs balancing account is used to record and refund to customers the net refunds, claim offsets, and other credits received by the Utility from electricity suppliers related to Chapter 11 disputed claims and to record and recover authorized ERB servicing costs. (See Note 9 below.)

The Utility is generally authorized to recover 100% of its prudently incurred energy procurement costs. The Utility tracks energy procurement costs in balancing accounts and files annual forecasts of energy procurement costs that it expects to incur over the following year. The Utility's energy rates are set to recover such expected costs.

At September 30, 2012 and December 31, 2011, “other” consisted of various balancing accounts, such as the SmartMeter^TM advanced metering project balancing account, which tracks the recovery of the related authorized revenue requirements and costs, and balancing accounts that track the recovery of authorized meter reading costs.