Rate relief and the construction funds allowance: a big dollar question

Recently, the size and cost of utility construction programs have risen dramatically in order to keep pace with growing customer requirements. For many utilities, this situation has had the disturbing effect of pushing capitalized interest, or the allowance for funds used during construction (AFDC), to new heights while internal funds generation and cash-flow percentages decline. Briefly stated, when a utility accrues AFDC, current capital costs associated with construction are added to the cost of construction via a credit to the income statement and a debit to the construction account. In effect, this AFDC credit offsets some portion of current capital costs thereby raising reported net income. The author uses as an example a company raising $200 million of capital from various sources at a composite cost of 9% which it uses to finance a like amount of construction. He concludes that it appears that discontinuing AFDC on some portion of construction work in progress in favor of a current return is advantageous. It improves the financial health of utilities by improving cash flow and lessening the need for outside financing. The opportunity to achieve significant reductions in revenue requirements in future years is dependent upon regulatory action now, the authormore » concludes. (MCW)« less