Opinion ID: 376668
Heading Depth: 1
Heading Rank: 1

Heading: the afdc concept

Text: 2 Located in southeastern Michigan, Detroit Edison is a major public utility engaged principally in the generation, transmission, distribution and sale of electricity. As a Class A utility within the meaning of applicable federal regulations, 1 it is required to maintain its books and records in the manner prescribed by the Uniform System of Accounts promulgated by the Federal Power Commission under the authority of Section 301 of the Federal Power Act, 16 U.S.C. § 825. 3 Recognizing that utilities must often expend large amounts of money in order to amass the staggering sums necessary for new plant construction, the Uniform System of Accounts provides explicit, mandatory instructions for the accounting treatment of this cost. Under 18 C.F.R., Part 101, Electric Plant Instructions § 3(17) (1972), 2 the (a)llowance for funds used during construction (AFDC) is defined as including both a debt component, that is, ordinary interest paid on borrowed funds, and an equity component, that is, the imputed cost to the utility of the diversion of its own capital to the construction project. This definition is reiterated at 18 C.F.R., Part 101, Income Accounts § 419.1 (1972), 3 which further dictates that this amount, although a capital expenditure, must be carried as an item of other income. 4 This seeming mischaracterization is compelled by other provisions of the accounting system, which require that all debt charges be recorded as current expenses regardless of whether they are incurred pursuant to capital formation or as ordinary interest payments, 18 C.F.R., Part 101, Income Accounts §§ 427, 431 (1972). 5 4 Since AFDC is in reality a contribution to capital, unrelated to current operations, its entry as a debit must be offset, and hence, it is entered as an item of other income. Depicted as an asset, AFDC is, in essence, merely a balancing entry necessary to prevent its debit counterpart from causing an unwarranted diminishment of the utility's current net income figure. Plainly then, this treatment of AFDC does not tend to distort a utility's reported net income but rather acts to preserve its accuracy. Its entire purpose and effect is to defer the cost of capital accumulation to a future time when the physical asset being financed is in operation and the utility is able to commence the recovery of its investment, including AFDC, through rate increases granted to offset the depressing effect on net income of increased depreciation. 6 5 Failure to make this adjustment would result in a mismatching of costs and revenues with prejudice to the utility's current customers. Were AFDC treated as an item of ordinary expense, the utility's earnings would be substantially depressed during periods of construction and consumers would pay higher rates. Subsequently, when construction was completed, earnings would be artificially inflated, and rates would be maintained or reduced. The AFDC mechanism, by delaying the recognition of the capital expenditure until the new plant is functional, implements the sound policy of charging utility customers for the services which they are currently receiving, rather than burdening present users for the cost of facilities which will serve future generations. 6 This allocation of the cost of capital to a future period has not always been achieved in precisely this manner. Prior to 1969, the Uniform System of Accounts directed that the interest charged to construction be entered in a non-income account which was used to offset ordinary interest expenses. Aiming for  a more realistic and revealing income statement, the AFPC in 1969 amended its accounting regulations to require that this cost, later redesignated AFDC in recognition of the fact that it included an equity as well as a debt component, be entered as an item of non -operating income. FPC Order No. 389 (October 9, 1969). In 1977, long after the registration statement and prospectus challenged in this action had been issued, the FPC again revised the treatment of AFDC, this time separating the debt and equity components returning the former to its pre-1969 position as a credit against ordinary interest charges, and retaining its equity analog as other income. FPC Order No. 561 (Feb. 2, 1977). Thus, while the implementation of the FDC concept has been fine-tuned on occasion, its use has long been mandated by the FPC. Additionally, it has been specifically approved by the Accounting Principles Board, see Addendum to Accounting Principles Board Opinion No. 2 (December, 1962) 7 , and recognized as appropriate for regulated industries by other governmental agencies including the Securities and Exchange Commission. See Accounting Series Release No. 163 (November 14, 1974), 6 CCH Fed.Sec.L.Rep. P 72,185.