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HomeMy WebLinkAbout12. Adopt new Board Policy BP 046 - Regularoty Accounting Page 1 of 13 Item 12. Algi CENTRAL SAN BOARD OF DIRECTORS WE VS.101 M POSITION PAPER MEETING DATE: APRIL 15, 2021 SUBJECT: ADOPT NEW BOARD POLICY BP 046 — REGULATORYACCOUNTING SUBMITTED BY: INITIATING DEPARTMENT: KEVIN MIZUNO, FINANCE MANAGER ADMINISTRATION-FINANCE PHILIP LEIBER, DIRECTOR OF FINANCEAND ADMINISTRATION REVIEWED BY: ROGER S. BAILEY, GENERAL MANAGER Roger S. Bailey General Manager ISSUE Adoption of new Board policies requires approval of the Board of Directors. Staff is proposing adoption of a new Board policy addressing the establishment of regulatory accounting treatment for certain costs or revenues, in limited circumstances approved by the Board of Directors. BACKGROUND Introduction Central San prepares an annual budget that, among other sub-funds, includes Operating & Maintenance ("O&M") expenditures and capital (Sewer Construction) expenditures. O&M expenditures are those that provide a benefit to or relate to one fiscal year, while capital expenditures provide a benefit beyond one year. Various accounting pronouncements issued by the Governmental Accounting Standards Board (GASB), provide guidance on the classification of expenditures as either O&M or capital. Similar guidance is provided for the recognition of revenue in either a single period, or over a number of years. Issue Certain expenditures or revenues would be recognized in a single accounting period or treating them as an O&M item, while nonetheless, a significant rationale may exist for recognizing them over multiple years, or treating them as capital expenditures. GASB 62 provides that a regulator or governing board with ratemaking authority may elect to adopt regulatory accounting treatment for specified items, and thereby April 15, 2021 Regular Board Meeting Agenda Packet- Page 134 of 185 Page 2 of 13 accomplishment this. A policy and associated administrative procedure document have been developed to specify the situations in which this would be allowable, and the process for authorizing such items. Benefits ofAdopting a Regulato1yAccounting Policy The primary purpose foreseen for this policy addresses the situation where certain expenditures are connected with programs that will provide benefits to Central San customers over a multi-year period, but which absent treatment under GASB 62, would be treated as O&M expenditures/recognized in a single period. Treating the amounts as capital expenditures/recognizing the expenditures over multiple years allows for: 1. Budgeting such expenditures in the Sewer Construction Budget; 2. Paying for the expenditures from funding sources in the Sewer Construction budget, which may include revenues or debt proceeds; 3. Including such expenditures as an asset on the balance sheet, and amortizing the expenditure over the anticipated life of the asset. The benefits of this treatment include: 1. Recognizing that such expenditures provide a benefit over a more than a one-year timeframe. 2. Appropriate cost recovery over a multi-year period; providing the opportunity to better match revenues with expenditures. 3. Avoiding volatility in the O&M budget with the inclusion of expenditures that benefit more than one fiscal year and can accordingly be included in the capital budget. 4. Presentation of related programmatic expenditures in a single budget category for improved tracking and oversight. The proposed policy also provides for the possibility of deferral of revenues, which could be treated as a regulatory liability, and recognized as revenue over a period of time. While situations for which this would be necessary are not currently envisioned, this flexibility could be useful in the future. Providing for Fiscal Constraint Around Such Arrangements GASB 62 provides some parameters around which which items may be allowable for regulatory accounting treatment, but provides generally broad latitude. The proposed policy and accompanying administrative procedure provides further limitations by specifying the a framework for consideration of these matters. The policy also provides for transparency in requiring that the items be disclosed to the Board, with an assessment of the rate impact of the proposed regulatory accounting treatment. Accordingly, the policy and associated procedures provides necessary discipline and transparency around this process, and would discourage/prevent the deferral of recognition of routine expenditures that should be recognized in one accounting period. Proposed Policy/Administrative Procedures The attached policy(Attachment 1) establishes the framework for regulatory accounting treatment of items April 15, 2021 Regular Board Meeting Agenda Packet- Page 135 of 185 Page 3 of 13 consistent with GASB 62. The associated administrative procedure (Attachment 2) is provided for informational purposes. Due Diligence Conducted in Preplicy aration of the Po The starting point for the proposed Central San policy was a similar policy adopted by a federal agency. The Director of Finance &Administration also had experience with the development a similar policy at another utility, where regulatory accounting was adopted. Staff also discussed with representatives of the Governmental Accounting Standards Board the applicability of GASB 62 to agencies like Central San, and the particular uses for the regulatory accounting treatment for items in Fiscal Year(FY) 2021-22. Further, staff have discussed the proposed policy with the auditor partner of Central San's independent auditor, Maze &Associates. He indicated that it appeared staff had done the appropriate research and that adopting and applying the policy for the contemplated matters did not raise any red flags based on the discussion we had. It should be noted that an independent auditor will not provide a separate opinion on an accounting position taken by a client, apart from the audit opinion on the financial statements, due to "independence" concerns. But staff would not be recommending the policy to move forward if there were concerns expressed, as this would be inviting problems at the time of the audit. Concluding Remarks Regulatory accounting treatment is widely used in the utility world. Having this tool available for Central San would provide benefits of the nature described above, and would be subject to Board oversight and approval for any items (expenditures or revenues)that would be covered. Staff recommend adoption of the policy, and have certain expenditures in mind for proposed regulatory accounting treatment that would be put forward in the proposed FY 2021-22 budget. These include: • Extraordinary waste hauling costs during the construction of the Solids Handling Facility Improvements Project (District Project (DP) 7348) • Development of a five-year Information Technology (IT) Master Plan (DP 8240, part of IT Development) • Enhanced security staffing while significant Capital Projects are underway (DP 7348 and others) ALTERNATIVES/CONSIDERATIONS The Board of Directors may choose not to adopt a policy to provide for treatment of regulatory expenditures as capital, consistent with GASB 62, or may choose to revise the proposed policy. FINANCIAL IMPACTS There are no direct costs to adopting the policy. If the policy is adopted, staff may from time to time propose that certain items be treated in accordance with regulatory accounting standards, and recognized over a period of time rather than in one accounting period (or vice-versa). The fiscal impact of that treatment would generally be to spread the recognition and potentially cost recovery over more than one fiscal period. The proposed rate impact of the items proposed for regulatory accounting treatment (if any), would be disclosed to the Board for each such proposed item. April 15, 2021 Regular Board Meeting Agenda Packet- Page 136 of 185 Page 4 of 13 COMMITTEE RECOMMENDATION This matter was reviewed by the Administration Committee on April 6, 2021. The Committee recommended submission of the policy to the Board for consideration once staff has discussed the policy with Maze &Associates, which has been done. RECOMMENDED BOARD ACTION Adopt Board Policy BP No. 046 — Regulatory Accounting. Strategic Plan Tie-In GOAL THREE:Fiscal Responsibility Strategy 1—Maintain financial stability and sustainability ATTACHMENTS: 1. Proposed BP 046 - Regulatory Accounting 2. Proposed AP 046 - Regulatory Accounting April 15, 2021 Regular Board Meeting Agenda Packet- Page 137 of 185 Page 5 of 13 ATTACHMENT 1 Number: BP 046 Authority: Board of Directors Adopted: April 15, 2021 Revised: Reviewed: Initiating Dept./Div.: Administration/Finance CENTRALSAN BOARD POLICY REGULATORY ACCOUNTING PURPOSE The maintenance, replacement and expansion of Central San's wastewater collection and treatment infrastructure assets is critical to achieving its mission to protect public health and the environment. Funding for such capital investments is provided for substantially through annual budgets, and rates established in periodic rate cases. Rate stability is a key goal of Central San's rate making, which has become a more challenging goal in light of increasing capital infrastructure investment needs. Regulatory accounting provides the opportunity to account for revenues, expenditures, assets and liabilities in a manner consistent with ratemaking goals. Accordingly, the purpose of this policy is to provide a framework for the creation of regulatory assets, liabilities, revenues and expenditures, and establish the process for approval of individual items to be subject to regulatory accounting treatment. BACKGROUND As a municipal business-type utility reporting as an enterprise fund, Central San is subject to accounting pronouncements issued by the Governmental Accounting Standards Board (GASB). In 2010, GASB adopted Statement No. 62 Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements. One section of GASB 62 addresses "Regulated Operations"and provides that certain costs or credits may be included in rates for recovery or refund over a future period and consequentially are recorded as regulatory assets or liabilities in the financial statements. As long as Central San continues to meet the following criteria, the Board, in their role as rate regulator, has the ability to create regulatory assets or liabilities through the budgeting and rate setting process: • Rates are subject to approval by an independent, third-party regulator or by a governing board empowered by statute to establish rates that bind customers. • The rates are designed to recover the costs of regulated services. April 15, 2021 Regular Board Meeting Agenda Packet- Page 138 of 185 Page 6 of 13 Number: BP 046 REGULATORY ACCOUNTING Page 2 of 3 • It is reasonable to assume that the rates are set at levels that can be charged to and collected from customers. Title 6 of the Central San District Code contains the provisions permitting the Board of Directors to set rates, including capacity fees, sewer service charges and other fees. POLICY 1.1 Overall Framework Expenditures or revenues to be subject to regulatory accounting will typically be identified by staff through the formal budgeting or ratemaking process, although provision for such treatment may occur outside such processes. In either case, the Board shall be provided with a listing of items for proposed regulatory accounting treatment for adoption, along with analysis of the rate impact of such treatment. Upon adoption of regulatory accounting for such items, appropriate regulatory accounting through the establishment of regulatory assets and liabilities shall be effectuated, with appropriate amortization over time recorded. Staff will assess whether the agency is continuing to meet the requirements to apply the "Regulated Operations" provisions of GASB 62 and report regulatory assets and liabilities. If the District no longer meets the requirements to apply regulatory accounting, all such regulatory assets and liabilities will be written off to expense or revenue. 1.2 Applicability This policy is applicable to District Financial Statements prepared annually as part of the Comprehensive Annual Financial Report, the annual budget, financial plan and development of fees, rates and charges in accordance with the District Code. 1.3 Terms & Definitions 1. Regulatory asset: A regulatory asset is an incurred expense that the Board, in their role as rate regulator, intends to recover from customers through rates in a future period and/or through the capital budget. 2. Regulatory liability: A regulatory liability is an obligation resulting from the Board's decision, in their role as rate regulator, to return current receipts or revenues to customers through rates in a future period. 3. Amortization: The process of systematically allocating a regulatory asset to expense or a regulatory liability to revenue over time. 1.4 Responsibilities The authority for making policy is vested in the Board, and implementation and ongoing compliance with such policy is delegated to the General Manager. April 15, 2021 Regular Board Meeting Agenda Packet- Page 139 of 185 Page 7 of 13 Number: BP 046 REGULATORY ACCOUNTING Page 3 of 3 1.5 Standards & Procedures Prior to pursuing a new regulatory asset or liability in either a budget or rate case proceeding or between such events, relevant staff will assess whether the costs or revenues are eligible, and communicate such items to the Board regarding proposed regulatory accounting treatment. An Administrative Procedure will outline categories of Eligible Costs or Revenues, Ineligible Costs, and provide for consideration of appropriate Amortization/Recovery Periods. 1.6 Performance & Monitoring Compliance with this policy may be monitored by the District's external financial auditor, and the Internal Auditor. [Original retained by the Secretary of the District] April 15, 2021 Regular Board Meeting Agenda Packet- Page 140 of 185 Page 8 of 13 DRAFT ATTACHMENT 2 Number: AP 046 Related Board Policies: BP 046 Authority: General Manager ZNih Effective: Revised: Reviewed: CENTRALSAN Initiating Dept./Div.: Administration/Finance Date Signed: ADMINISTRATIVE PROCEDURE REGULATORY ACCOUNTING This administrative procedure provides additional staff guidance related to the implementation and administration of BP 046, Regulatory Accounting. The underlying basis for BP 046 is GASB Statement No. 62 Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements, specifically section "Regulated Operations", which provides that certain costs or credits may be included in rates for recovery or refund over a future period and consequentially are recorded as regulatory assets or liabilities in the financial statements. RESTATEMENT OF POLICY AND ADDITIONAL ADMINISTRATIVE GUIDANCE 1.1 Overall Framework Involved staff shall coordinate on the establishment and treatment of items to be subject to regulatory accounting treatment, and associated establishment of regulatory assets, liabilities, and related amortization. Expenditures or revenues to be subject to regulatory accounting will typically be identified by staff through the formal budgeting or ratemaking process, although provision for such treatment may occur outside such processes. In communication with the Board on such matters, staff shall coordinate to provide for a discussion of the rate impact of proposed regulatory accounting treatment items. A. Approved Through Budget or Rate Case Process Staff will provide a listing of items for Board approval of regulatory accounting treatment in the relevant budget or rate case proceeding. If the Board, through adoption of a budget, or through a rate action, acknowledges their intent to recover a current period expense through rates in a future period, a regulatory asset will be established. Likewise, if the Board, April 15, 2021 Regular Board Meeting Agenda Packet- Page 141 of 185 Page 9 of 13 Number: AP 046 REGULATORY ACCOUNTING Page 2 of 6 through a budget adoption or a rate action, acknowledges their intent to return current receipts or revenues to customers in a future period, a regulatory liability will be established. The basis for a regulatory asset or liability is the budget or rate action. Accounting treatment will follow the treatment in the budget or rate case proposal. B. Cost Deferral Between Budget or Rate Cases In order for a cost to be considered for regulatory accounting treatment between budget adoptions, or rate cases, it must be an eligible cost as described within this policy and must be approved by the Board with a statement of their intent to recover the costs through rates in a future period. Typically, anticipation of the expenditure would not have been reasonably forecast in a budget or rate case. C. Additional considerations include: 1. Materiality of the expenditure; Central San generally considers expenditures of $1 million or higher as material for purposes of this policy. Items less than $1 million would not normally be considered for deferral. However, smaller items which cumulatively in a year are expected to exceed $1 million, may be considered for regulatory assets / liability treatment under this policy. 2. Prudency of the deferral and the related use of debt financing, if applicable. 3. Common industry practice for regulated utilities. 4. See Appendix A to this policy for additional decision criteria. D. Evaluation of Continued Applicability of the Regulatory Accounting. Discontinuance of Policy Central San staff will assess whether the agency is continuing to meet the requirements to apply the "Regulated Operations" provisions of GASB 62. If the District no longer meets the requirements to apply regulatory accounting, all regulatory assets and liabilities established as the result of the Board's budget or rate action, that would not have been established by a non-regulated entity, will be written off to expense or revenue. Communication of such matters internally shall be coordinated by responsible staff and reported to the Board. 1.2 Applicability BP 046 and this related guidance is applicable to District Financial Statements prepared annually as part of the Comprehensive Annual Financial Report, the annual budget, financial plan and development of fees, rates and charges in accordance with the District Code. Staff responsible for these documents will coordinate to ensure consistent treatment of specific items, and appropriate disclosure to the Board for items subject to proposed Regulatory Accounting treatment. April 15, 2021 Regular Board Meeting Agenda Packet- Page 142 of 185 Page 10 of 13 Number: AP 046 REGULATORY ACCOUNTING Page 3 of 6 1.3 Terms & Definitions 1. Regulatory asset: A regulatory asset is an incurred expense that the Board, in their role as rate regulator, intends to recover from customers through rates in a future period and/or through the capital budget. 2. Regulatory liability: A regulatory liability is an obligation resulting from the Board's decision, in their role as rate regulator, to return current receipts or revenues to customers through rates in a future period. 3. Amortization: The process of systematically allocating a regulatory asset to expense or a regulatory liability to revenue over time. 1.4 Responsibilities A. Central San's General Manager has overall responsibility for BP 046, and establishes this AP 046 to provide guidance in its implementation, which stall be the responsibility of the Director of Finance & Administration. B. The Director of Finance & Administration is delegated the authority by the General Manager to provide, on a District-wide basis, those financial management systems, policies, and procedures deemed necessary to keep complete and accurate accounts of operations, including all funds expended and received in connection with the provision of District services. C. The Director of Finance & Administration is responsible for establishing operational procedures and practices that implement reporting and accounting guidance and relevant training, ensuring that the work results conform to the established policies. D. The Director of Finance & Administration shall coordinate with the Engineering Department on matters of ratemaking and financial planning to ensure regulatory accounting treatment consistent with BP 046 is effectuated on a consistent basis. E. The Manager of Planning & Development Services shall coordinate with the Finance organization on matters of ratemaking and financial planning to ensure regulatory accounting treatment consistent with BP 046 is effectuated on a consistent basis in budgeting and financial reporting. F. The Finance Manager provides functional guidance and oversight to District's financial management systems and establish District requirements and reporting mechanisms, ensuring adequacy of internal controls and compliance with applicable laws, regulations, and internal directives. G. District Staff and Subject Matter Experts are responsible for following BP 046 and this associated administrative procedure. 1.5 Standards & Procedures Prior to pursuing a new regulatory asset or liability in either a budget or rate case proceeding or between such events, relevant staff (the Finance organization) will assess whether the costs or revenues are eligible, and communicate such items to the Board regarding proposed regulatory accounting treatment. April 15, 2021 Regular Board Meeting Agenda Packet- Page 143 of 185 Page 11 of 13 Number: AP 046 REGULATORY ACCOUNTING Page 4 of 6 Information related to the assessment of individual items for eligibility, and appropriate amortization periods follows: Eligible Costs or Revenues Non-recurring material costs or revenues specifically identified and recovered in excess of one year should be deferred and treated in financial reporting in the same manner as identified in budget or rate case proceedings. Examples of qualifying costs or revenues include: A. Extraordinary operational costs related to the implementation of Capital projects. B. Certain settlement and litigation costs. C. Certain extraordinary environmental compliance measures D. Impaired / discontinued capital asset projects E. Significant anticipated one-time/non-recurring revenues Ineligible Costs Normal recurring costs and overheads; are not eligible for regulatory asset treatment, unless related to an eligible cost category above. The District's normal recurring operating and maintenance expenses include items such as routine ongoing collection and treatment expenditures, depreciation and amortization, infrastructure maintenance, interest, and general and administrative costs. Amortization/Recovery Period Regulatory assets or liabilities will be amortized in the financial accounting records over the recovery period as anticipated in approved budgets and rates or in the case of capital assets, as described in the asset lives described in the comprehensive annual financial report, or as otherwise determined and approved by the Board. 1.6 Performance & Monitoring Compliance with this policy may be monitored by the District's external financial auditor, and the Internal Auditor. The Finance Organization will provide the Internal Auditor with such information as is necessary for the Internal Auditor to provide such oversight, and as requested by the external financial statement auditor. 1.7 Authorities & References A. District Code Topic 6 regarding rates, fees and charges. 6.12.080 - Schedule of capacity fees, rates and charges. "The Board of Directors has set capacity fees, rates, and charges by ordinance, pursuant to the provisions of this chapter...." April 15, 2021 Regular Board Meeting Agenda Packet- Page 144 of 185 Page 12 of 13 Number: AP 046 REGULATORY ACCOUNTING Page 5 of 6 6.24.010 - Findings and purposes. "... the Board finds and determines that it is necessary to establish a sewer service charge in the manner set forth in this chapter." B. GASB 62 "Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements", paragraphs 476-500: "Regulated Operations". April 15, 2021 Regular Board Meeting Agenda Packet- Page 145 of 185 Page 13 of 13 Number: AP 046 REGULATORY ACCOUNTING Page 6 of 6 Appendix A Decision analysis criteria: used for determining if a cost should be capitalized or expensed. These factors are considered in determining whether GASB 62 "Regulated Operations" treatment should be pursued for costs occurring between rate periods that would otherwise be expensed. Each decision should be decided on a case-by-case basis; however, these factors provide guidelines to use in the decision-making process. FACTORS ANALYSIS Is the cost unusual, or non- If the cost is unusual and non-recurring, greater consideration recurring? should be given to pursuing regulatory asset treatment. Is the cost associated with the If yes, greater consideration should be given to pursuing regulatory implementation of a significant asset treatment. capital project for which the Board is interested in an overall program cost? Is the cost material? If the cost is material, greater consideration should be given to pursuing regulatory asset treatment for the cost. If the cost is a settlement, does it The more the settlement relates to a past event, the more relate to a past event? consideration should be given to expensing the cost so that future ratepayers do not have to bear the burden of prior year costs. The more an accounting treatment matches costs borne by and benefits received by ratepayers, the more it should be considered for regulatory accounting treatment. If the cost is a settlement, what is If the payout period is extended, more consideration should be given the timeline for settlement to deferring the costs. If the payout is immediate, more consideration payout? should be given to expensing the cost. Does the contract/settlement The contract/settlement should be reviewed to see if it provides agreement provide information on insight on whether the costs should be expensed or deferred. whether it should be expensed or capitalized? Rate payer equity considerations. Need to consider how the accounting treatment of the cost would impact rate payer equity as an objective is to strive for rate payer equity. Rate level and stability in terms of Need to consider how the accounting treatment would impact rate rate impact. levels and stability in terms of rate impact. One of the District's objectives is to strive for stable rates given the District's fixed cost and debt structure. The more an accounting treatment minimizes the frequency of rate changes or the fluctuation of rate levels, the more it should be considered. Does the cost provide multi-year The more that a cost provided multi-year benefits, the more it should benefits? be considered for regulatory asset treatment because it is more likely to provide a matching of costs with benefits. [Original retained by the Secretary of the District] April 15, 2021 Regular Board Meeting Agenda Packet- Page 146 of 185