AFUDC

A non-cash regulatory accounting credit representing the estimated cost of debt and equity funds used to finance utility construction.

Allowance for Funds Used During Construction (AFUDC) is an accounting method used by regulated utilities to capitalize the financing costs of major, long-term infrastructure projects. Because utilities must invest massive amounts of capital to build power plants, transmission lines, and pipelines before they can charge customers for them, regulators allow them to add the cost of financing—both debt interest and an implied return on equity—directly to the carrying value of the asset under construction. Instead of expensing these financing costs immediately on the income statement, the utility records AFUDC as a non-cash credit. This credit simultaneously increases reported net income and increases the book value of the property, plant, and equipment on the balance sheet. Once the construction is complete and the asset is placed into service, the capitalized AFUDC becomes part of the utility's official rate base, allowing the company to earn a cash return on those capitalized costs and recover them over time through customer rates. For investors, AFUDC is a double-edged sword that requires careful analysis. While it boosts reported earnings per share during heavy construction cycles, it does not generate immediate cash. Consequently, a utility with high AFUDC relative to its total net income has lower earnings quality and may experience temporary cash flow strain. Analysts often subtract AFUDC from net income to evaluate the underlying cash-generating strength of the utility before the new assets begin generating regulatory revenues.

A utility is building a new power plant with a total construction budget of $100,000,000. During the year, it incurs $4,000,000 in interest on debt and calculates an implied equity financing cost of $3,000,000 to fund the project. Instead of expensing these, the utility records $7,000,000 ($4,000,000 + $3,000,000) as an AFUDC credit. This increases its reported net income by $7,000,000 and increases the capitalized asset value on the balance sheet to $107,000,000, despite no cash being collected from customers yet.