Rate base is the value of property on which a
public utility is permitted to earn a specified
rate of return, in accordance with rules set by a
regulatory agency
A regulatory agency (regulatory body, regulator) or independent agency (independent regulatory agency) is a government authority that is responsible for exercising autonomous dominion over some area of human activity in a licensing and regulatin ...
. In general, the rate base consists of the value of property as used by the utility in providing service. It may be calculated by any one or a combination of accounting methods, such as
fair value, prudent investment, reproduction cost, or original cost.
The rate base can include: cash,
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
, materials and supplies, deductions for accumulated provisions for
depreciation
In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the a ...
, contributions in aid of construction, customer advances for construction, accumulated deferred
income taxes, and accumulated deferred
investment tax credits, all dependent on the method that is used in the calculation.
An emerging question facing utility regulators in some states is whether
cloud computing
Cloud computing is the on-demand availability of computer system resources, especially data storage ( cloud storage) and computing power, without direct active management by the user. Large clouds often have functions distributed over mul ...
software should be included in rate bases. Conventional
software
Software is a set of computer programs and associated documentation and data. This is in contrast to hardware, from which the system is built and which actually performs the work.
At the lowest programming level, executable code consists ...
, in which a company purchases and installs the program on hardware that it own, generally is included, but most regulators do not allow a rate of return on cloud software.
Depreciation
In a period of static costs or no inflation, an original cost valuation may be sufficient. With a period of inflation, a rate base which values plant and equipment at original cost substantially undervalues the plant. In these circumstances, utilities argue in favor of reproduction-cost valuations. In either case, depreciation on plant and equipment is subtracted from the rate base and carried as an operating expense. The theory behind including depreciation as an expense is that capital may be accumulated for further expansion and growth.
The utility's
rate of return (a ratio of net
operating income earned) is calculated as a percentage of its rate base.
References
{{Reflist, 2
Public utilities of the United States
Real estate valuation