The allowance for funds used during construction (“AFUDC”) rate calculation is the Federal Energy Regulatory Commission’s (“FERC” or “Commission”) long-standing regulation that permits a regulated electric or gas utility to earn a return on the construction costs of utility plant during the period of construction. AFUDC is not an innocuous accounting provision to ignore as it can represent a material percentage of capitalized construction costs that will ultimately impact rate base and depreciation in the cost of service rate for electric and gas utility companies. As such, we briefly discuss certain provisions of AFUDC, the importance of compliance, and practical advice to ensure compliance as an electric or gas utility company or a stakeholder to cost of service rates. The AFUDC rate is determined annually and applied on a monthly basis to eligible construction costs to determine the amount of AFUDC that is a capitalized as a cost of construction and recovered through rates once the utility plant is placed in service. While the Commission’s AFUDC rules are numerous, they are not complex and have been in place for more than 40 years without any significant modification. Yet there has historically been repeated noncompliance on the accounting for AFUDC. Generally, noncompliance comes from failure to properly capture all sources of financing in computing the AFUDC rate, which includes all amounts of short-term debt, long-term debt, and equity financing. AFUDC noncompliance also frequently comes from failure to appropriately utilize or compute the cost rates associated with debt and equity financing and failure to seek Commission waiver to depart from Commission’s AFUDC rules. AFUDC compliance has been an area of emphasis to the Commission for decades as the Commission’s Office of Enforcement has publicly noted an AFUDC compliance focus through its public audit reports and Annual Report on Enforcement. An example of AFUDC noncompliance and the material impact of it became evident in the Commission’s November 8, 2017 delegated audit report in Docket No. FA15-16-000 and the related December 17, 2020 Order on Paper Hearing affirming the contested audit finding on AFUDC, which resulted in approximately $50 million overstatement of AFUDC. In terms of impact, noncompliance with AFUDC may result in corrections to prior periods and could result in material reductions to plant balances, reductions to current period earnings, and potential refunds. Accordingly, it is paramount that regulated electric and gas utility companies and the stakeholders subject to utility cost-of-service rates thoroughly understand and evaluate compliance with AFUDC to ensure FERC-jurisdictional rates are just and reasonable. Fundamental aspects to the Commission’s AFUDC regulations include the following:
For regulated electric or gas utility companies, how sure are you that your company is compliant? Are you following a “historical” accounting practice for AFUDC but not sure if it is fully compliant? As noted above, the AFUDC rules are numerous and at times can be complex if there are different AFUDC requirements for retail rate regulation. Here are some tips to help navigate through the Commission’s AFUDC regulatory requirements:
For stakeholders that are currently under cost of service rates with electric and gas utility companies, it is important not to overlook risks of material overstatements of capitalized AFUDC. Prior period errors in AFUDC could result in refunds, decrease rate base, and decrease depreciation expenses. Additionally, ensuring AFUDC is properly computed will ensure future rates are not overstated. A full review of AFUDC compliance typically requires more resources than practical for most stakeholders. However, there are some helpful tips to identify potential material errors without a strain on resources.
Know the factors that have the greatest impact on capitalized AFUDC. For example, the failure to use all short-term debt in the AFUDC rate computation and failure to identify material deviations in excess of 25 basis points could result in significant AFUDC errors.
Engage in established tariff and ratemaking processes to evaluate AFUDC compliance. For example, engage in the annual information exchange process required in the tariff protocols of wholesale electric formula rates. Additionally, consider intervening in accounting filings seeking Commission waiver of select AFUDC requirements by electric and gas utility companies to ensure your concerns are heard and interests are protected
Utilize industry experts in the Commission’s AFUDC accounting and ratemaking requirements to help you assess the risk of material noncompliance, engage in discovery, and communicate any AFUDC concerns identified with the utility and Commission, as appropriate.
When noncompliance is discovered, seek refunds and take appropriate measures to ensure that the noncompliance ceases.
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