HomeMy WebLinkAboutStaff Report 3465
CITY OF PALO ALTO OFFICE OF THE CITY AUDITOR
January 22, 2013
The Honorable City Council
Palo Alto, California
Finance Committee Recommendation to Accept the Utilities Reserves
Audit
The Office of the City Auditor recommends acceptance of the Utilities Reserves Audit. At its
meeting on December 4, 2012, the Finance Committee approved and unanimously
recommended the City Council accept the report. The Finance Committee minutes are included
in this packet.
Recommended Action: Accept the Utilities Reserves Audit.
Respectfully submitted,
Jim Pelletier
City Auditor
ATTACHMENTS:
: Attachment A: Utilities Reserves Audit (PDF)
: Attachment B: Finance Committee Meeting Minutes Excerpt (December 4, 2012) (PDF)
Department Head: Jim Pelletier, City Auditor
Page 2
CITY OF PALO ALTO OFFICE OF THE CITY AUDITOR
December 4, 2012
The Honorable City Council
Attention: Finance Committee
Palo Alto, California
Utilities Reserves Audit
In accordance with the Fiscal Year (FY) 2012 Annual Audit Work Plan, the Office of the City
Auditor has completed the Utilities Reserves Audit. The audit contains two findings with a total
of five recommendations. The Office of the City Auditor recommends the Finance Committee
review and recommend to the City Council acceptance of the Utilities Reserves Audit.
We thank the staff of the Utilities Department and Administrative Services Department for their
time, information, and cooperation during the audit process.
Respectfully submitted,
Jim Pelletier
City Auditor
ATTACHMENTS:
Attachment A - Utilities Reserves Audit (PDF)
Department Head: Jim Pelletier, City Auditor
Attachment A
Page 2
Attachment A
UTILITIES RESERVES AUDIT
DECEMBER 2012
Office of the City Auditor
Jim Pelletier, City Auditor
Mimi Nguyen, Senior Performance Auditor
Attachment A
1
December 2012
SUMMARY OF RESULTS
REPORT HIGHLIGHTS
Opportunities for improving and strengthening of internal
controls are provided in the following findings:
RECOMMENDATIONS
The Office of the City Auditor (OCA) recommends
the following actions:
FINDING 1: Rate Stabilization Reserves are not consistently
maintained within Council‐approved guidelines. The City
does not currently have a formal, comprehensive reserve
policy for its utility funds. Key City documents show
inconsistency in communication of the City’s reserve policy
decisions. Rate Stabilization Reserve balances were often
outside of Council‐approved guideline ranges. Reserve
balances are inconsistently reported and do not always
reconcile, primarily due to the exclusion of Capital
Improvement Program (CIP) carryforward reserves.
Establishing a more comprehensive reserve policy, with
effective supporting procedures, the City Council and the
Utilities Department could benefit from having clear criteria
to communicate, manage, and monitor utility reserves.
FINDING 2: Capital Improvement Program reserves are not
consistently and clearly reported to Council. The reports
issued regarding CIP are not sufficient to adequately
support effective financial and project planning.
Improvements to the consistency and completeness of
reporting CIP carryforward reserve balances could better
support the City Council’s operating budget, capital budget,
and reserves processes.
The Utilities Department should establish formal
and comprehensive policies and procedures for
its Utility Reserves.
The Utilities Department should re‐evaluate and
determine the use of reserve balance guidelines,
updating the City’s resolution and the language
in key City documents accordingly.
The Utilities Department should revisit its annual
risk assessment model to determine, establish,
and document appropriate levels of utility fund
working capital held in unrestricted reserves.
The Utilities Department should revisit and
update the 5‐year financial projection rate
making worksheets to completely state all
reserve balances consistent with the City’s key
financial documents and improve visibility over
all unrestricted reserves.
The Utilities Department should develop a
mechanism to consistently and clearly report
Capital Improvement Program carryforward
reserves to the oversight bodies.
This document represents a limited summary of the audit report and does not include all of the information available in the full report.
The full report can be found on the Office of the City Auditor website at: http://www.cityofpaloalto.org/depts/aud/audit_reports.asp
Office of the City Auditor
EXECUTIVE SUMMARY–UTILITIES RESERVES AUDIT
Summary of Audit Objectives: To assess the appropriateness and adequacy of utilities reserves,
reserve policies, reserve guidelines, and usage of reserves.
Attachment A
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December 2012
TABLE OF CONTENTS
EXECUTIVE SUMMARY ..................................................................................................................................................... 1
INTRODUCTION ............................................................................................................................................................... 3
AUDIT OBJECTIVES ........................................................................................................................................................................ 3
BACKGROUND.............................................................................................................................................................................. 3
AUDIT SCOPE AND LIMITATIONS ...................................................................................................................................................... 4
AUDIT METHODOLOGY .................................................................................................................................................................. 5
CITY AUDITOR’S CONCLUSION ......................................................................................................................................................... 5
AUDIT RESULTS ................................................................................................................................................................ 6
FINDING 1: RATE STABILIZATION RESERVES ARE NOT CONSISTENTLY MAINTAINED WITHIN COUNCIL‐APPROVED GUIDELINES .............................. 6
FINDING 2: CAPITAL IMPROVEMENT PROGRAM RESERVES ARE NOT CONSISTENTLY AND CLEARLY REPORTED TO COUNCIL ................................ 12
GLOSSARY OF ACRONYMS AND TERMS .......................................................................................................................... 14
ATTACHMENT 1: UTILITY FUND CAPITAL PROJECTS ‐ FY 2012 APPROPRIATION DETAIL ................................................... 16
ATTACHMENT 2: CITY MANAGER’S ACTION SUMMARY .................................................................................................. 19
In accordance with the Fiscal Year 2012 Annual Audit Work Plan, the Office of the City Auditor has
completed this Audit of Utilities Reserves. We conducted this performance audit in accordance with
generally accepted government auditing standards. Those standards require that we plan and perform
the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and
conclusions based on our audit objectives. We believe that the evidence obtained provides a
reasonable basis for our findings and conclusions based on our audit objectives.
We would like to thank the staff of the Utilities Department and Administrative Services Department
for their time, information, and cooperation during the audit process.
Attachment A
3
December 2012
INTRODUCTION
Audit Objectives
The objectives of this audit were to assess the adequacy and appropriateness of the utility financial reserves,
which included:
1) Determining if established utilities reserves policies are reasonable and appropriate for all Utilities
Funds, including Electric, Gas, Water, Wastewater Collection (WWC), and Fiber Optics.
2) Determining if the City maintains adequate reserves within the Utilities Funds.
3) Determining if the City’s utilities reserve balances conform to City Council‐approved utilities reserve
guidelines.
4) Determining if reserve funds maintained in utilities reserves are used appropriately in accordance with
established policy.
Background
Palo Alto is the only city in California that offers a full array of utility services to its citizens and businesses. The
utility services are managed by the Palo Alto Utilities Department with a mission to provide safe, reliable,
environmentally sustainable and cost effective services. The department is comprised of the following five
divisions:
1) Administration ‐ responsible for the overall management of the Utilities Department, including
communication, regulatory compliance, budget coordination, and personnel and administrative support.
2) Customer Support Services ‐ responsible for customer services of the electric, fiber, water, gas, and
wastewater systems, including the Utilities Department’s call center, meter reading, utility billing, credit
and collections, energy efficiency and renewable energy programs, and liaison with key accounts.
3) Engineering ‐ responsible for managing all phases of the Utilities Department’s capital improvement
projects, including replacement and rehabilitation of the City's electric, fiber, water, gas, and
wastewater distribution systems.
4) Operations ‐ responsible for operations, maintenance, and emergency response for the electric, fiber,
water, gas and wastewater distribution systems.
5) Resource Management ‐ responsible for the long‐term acquisition plan of resources, including
electricity, natural gas, and water; contract negotiations to acquire renewable resources; rate
development; and legislation and regulatory policy analysis.
The Utilities Department controls an operating budget of $222.8 million and a capital budget of $25.7 million
summarized by fund in Exhibit 1:
Exhibit 1: Utilities Department Operating Budget (FY 2012) and Reserve Actuals (FY 2011)
(in millions) Budget FY 2012 Actual FY 2011
Fund Operating
Revenue
Operating
Expense
Capital
Expense
Reserve
Electric $125.2 $132.0 $8.7 $142.7
Gas $44.8 $49.5 $7.8 $34.4
Water $33.2 $36.6 $4.4 $25.5
Wastewater Collection $15.9 $17.2 $4.3 $17.1
Fiber Optic $3.7 $2.1 $0.5 $11.9
TOTAL $222.8 $237.4 $25.7 $231.6
Source: FY 2012 Adopted Operating Budget and FY 2011 Comprehensive Annual Financial Report (CAFR)
Attachment A
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December 2012
The charter of the City of Palo Alto, Article VII, Section 2: Public utilities revenue states, “The revenue of each
public utility shall be kept in a separate fund from all other receipts and shall be used for the purposes and in the
order as follows…:
a) The payment of the operating and maintenance expenses of such utility…
b) The payment of interest on the bonded debt incurred for the construction or acquisition of such utility.
c) The payment of the principal of said debt, as it may become due.
d) The capital expenditures of such utility.
e) The replacements or emergency repairs and after special appropriation by the council.
f) The remainder shall be paid into the general fund by quarterly allotments.”
Specific to the utilities funds and by resolution, the City Council set aside unrestricted net assets (in the form of
reserves) and established reserve guidelines for:
General contingencies
Future capital and debt service expenditures
Operating and capital contingencies for unusual or emergency expenditures.
Listed below are current utility fund reserves, including rate stabilization reserves (which have Council‐approved
minimum and maximum balance guidelines) and other reserves.
Exhibit 2: List of Utilities Department Reserves
Reserve Name Minimum
Guideline
Methodology
Maximum
Guideline
Methodology
Reserves with Council‐approved balance guidelines:
1. Rate Stabilization Reserves (RSR)
a) Electric Distribution Rate Stabilization Reserve (D‐RSR)15% sales revenue 30% sales revenue
b) Electric Supply Rate Stabilization Reserve (S‐RSR)50% purchase cost 100% purchase
c) Gas Distribution Rate Stabilization Reserve (D‐RSR)15% sales revenue 30% sales revenue
d) Gas Supply Rate Stabilization Reserve (S‐RSR)25% purchase cost 50% purchase cost
e) Water Rate Stabilization Reserve (RSR) 15% sales revenue 30% sales revenue
f) Wastewater Rate Stabilization Reserve (RSR)15% sales revenue 30% sales revenue
g) Fiber Optics Stabilization Reserve (RSR) 20% sales revenue 50% sales revenue
2. Emergency Plant Replacement Reserves (EPR)Insurance Deductible
Other Reserves:
3. Reappropriations
4. Commitments
5. Electric Special Projects (formerly Calaveras)
6. Public Benefit Program
7. Central Valley Project
8. Underground Loan
Audit Scope and Limitations
We reviewed and evaluated Council‐approved resolutions and policies addressing Utilities operating and capital
reserves. We reviewed the City’s utility reserve balances and considered guidance on the establishment and
maintenance of municipal reserves. We reviewed other related City documents including Adopted Operating
and Capital Budgets, Comprehensive Annual Financial Reports, Rate Making Financial Forecasts, Energy Risk
Management Policy and Procedures, and the Debt Policy. We also reviewed and analyzed activity pertaining to
the sources and uses of utility reserves, reserve levels, and appropriate levels of reserve over an 8‐year period.
Attachment A
5
December 2012
Audit Methodology
To conduct this audit, we analyzed reports from the City’s SAP Enterprise Resource Planning system on reserve
balances, operating and capital budgets, and capital project financial information. We interviewed Utilities
Department staff and Administrative Services Department (ASD) staff to assess the City’s overall reserve and
financial policies and procedures, to determine roles and responsibilities, and to assess the adequacy and
reasonableness of established policies and procedures related to reserves. We reviewed applicable federal,
state, and local laws and regulations, and consulted with the City Attorney’s Office. We also reviewed financial
documents from other jurisdictions for benchmarking.
City Auditor’s Conclusion
Government auditing standards require us to report our conclusion based on the sufficiency and
appropriateness of the evidence supporting the findings in this report. Based on our assessment of Utilities
Reserves, we found that the City generally maintains adequate reserves within the utility funds. We also found
that reserves are generally used appropriately in accordance with established policy. However, we found that by
establishing a more comprehensive reserve policy, with effective supporting procedures, the City Council and
the Utilities Department could benefit from having clear criteria to communicate, manage, and monitor utility
reserves. Additionally, improvements to the consistency and completeness of reporting reserve balances could
better support the City Council’s operating budget, capital budget, and reserves processes.
In this report, the Office of the City Auditor provides five recommendations to improve the management and
monitoring of utility reserves. The audit recommendations in the report are addressed to the Utilities
Department; however, to effectively implement the recommendations, the Utilities Department should work
with the Administrative Services Department to ensure City policies are in alignment.
Attachment A
6
December 2012
AUDIT RESULTS
Rate Stabilization Reserves are not consistently maintained within
Council‐approved guidelines
Reserve level guidelines for utility reserve balances were introduced in 1993 with the establishment of the Rate
Stabilization Reserves. The following are guidelines and objectives for the Rate Stabilization Reserves:
1. To finance extraordinary one‐time contingencies and to finance increased operating cost in the short‐
term.
2. Not to be used to solve long‐term financial problems or to cover major catastrophic disasters.
3. Reserve guidelines to be set to allow reserves to float up or down, with target reserves set based on
assessment of uncertainties and financial risk facing the utilities.
4. Adequacy and prudency of the guidelines to be reviewed internally each year, and if appropriate,
revisions be recommended.
A 1993 Council‐approved resolution states, “The levels of the Rate Stabilization Reserves shall conform to the
reserve level guidelines and other criteria set forth in the Utilities Reserve Policy, as such may be amended from
time to time, and shall be accounted for or disposed of by action of the Council during the fiscal year in which
revenues are placed therein or in the budget of the next succeeding fiscal year.”
Since 1993, some reserve accounts, the methodology for calculating reserve levels, and reserve level guidelines
have changed; however, the requirement to maintain reserve levels within Council‐approved guidelines has
remained unchanged.
Establishing a comprehensive reserve policy could clarify reserve requirements.
The City does not currently have a formal, comprehensive reserve policy. However, we saw elements of policy
language within City staff reports, strategic and operational plans, and other financial documents.
Financial policies are fundamental financial management tools that serve as guidelines for operational and
strategic decision making. Financial policies focus primarily on a government’s
general fund; however, the same emphasis should be placed on other funds,
such as utility enterprise funds, where service is provided which requires a
stable rate and revenue structure, orderly provision of services to ratepayers,
adherence to legislation and regulatory requirements, and sound
management of fiscal financial processes. Due to the close relationships
between rate making, operational and capital budgeting, and debt financing,
it is important that these related policies and procedures are in alignment and
support each other.
FINDING 1:
Recommendation 1: The
Utilities Department should
establish formal and
comprehensive policies and
procedures for its Utility
Reserves.
Attachment A
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December 2012
Exhibit 3 includes portions of reserve guideline language in various City documents that communicate reserve
information.
Exhibit 3: Communication of reserve information in various City documents
City Document
Reserve statement
City of Palo Alto, Council
Resolution Numbers 7207, 7769,
and 8386
The levels of the Rate Stabilization Reserves shall conform to the reserve level guidelines and
other criteria set forth in the Utilities Reserve Policy, as such may be amended from time to time,
and shall be accounted for or disposed of by action of the Council during the fiscal year in which
revenues are placed therein or in the budget of the next succeeding fiscal year.
... the City conformed the levels of the rate stabilization reserves to the reserve level guidelines,
as amended from time to time.
FY 2012 Adopted Operating
Budget, under electric fund
narrative
Reserves may be above the maximum guideline level or below the minimum guideline level for a
particular year as long as the levels are projected to move back to between the minimum and
maximum over the five‐year financial forecast planning horizon.
FY 2012 Adopted Operating
Budget, under enterprise fund
overview section
Reserve levels that are above guidelines are returned to customers in the form of lower future
rates, or used to pay for expenses, which also result in lower future rates.
FY 2013 Adopted Operating
Budget, under City overview
section and under enterprise
funds overview, respectively
Council has adopted a policy specifying the appropriate levels of reserves in each Enterprise
Fund. Typically, the budget will reflect either increasing or decreasing the reserves to within
Council‐approved ranges.
…Reserve levels that are above guidelines are returned to customers in the form of lower future
rates, or used to pay for expenses, which also result in lower future rates.
Utilities Strategic Plan FY 2011 Maintaining adequate cash reserves contributes to maintaining our overall financial health and
retaining our current favorable bond rating. We will maintain Rate Stabilization Reserves levels
within Council‐approved guidelines and sufficient to provide rate stability as desired by
ratepayers. During the annual budget and rate setting process, the risks that each Utilities fund is
exposed to will be identified along with the trajectory of costs and revenues to allow Council to
determine appropriate reserve levels and rate adjustments.
Electric Utility 5‐year Financial
Projections report to Council
(4/19/11)
The projected rate adjustments achieve the goals of ensuring that the balances of the Electric
Supply and Distribution Rate Stabilization Reserves (E‐SRSR and E‐DRSR, respectively) are
adequate and within the Council‐approved reserve guideline levels for the long‐term forecast
horizon.
…These minimum and maximum guidelines represent long term assessments of reserve level
requirements based on long term expected changes in commodity costs, hydro risk and credit
risk. In addition to the long term reserve guidelines, staff performs an annual assessment of
short term uncertainties and risks for each of the supply and distribution funds.
…Rate Stabilization Reserve Adequacy
Table 4 summarizes electric supply and distribution reserve requirement guidelines, short term
assessment of risks and estimated end of year reserve balances for E‐SRSR and E‐DRSR for the
current plus next two fiscal years.
…With no rate increase for the next two years, it is estimated that the end of year balance for
both E‐SRSR and E‐DRSR are expected to be within the long term reserve guideline levels as well
as above the short term risk assessment levels for the current and next two fiscal years.
Energy Risk Management Policy Maintaining the adequacy of these reserve funds in accordance with Council approved reserve
policies and guidelines is a matter of the highest priority for City of Palo Alto Utilities and the
City.
Attachment A
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December 2012
Water Revenue Bond
Official Bond Statement ‐ City of
Palo Alto, Utility Revenue
Refunding Bonds, 2011 Series A
The projected adjustments achieve the goals of ensuring that the balance of the water rate
stabilization reserves is adequate and within the Council‐approved reserve guidelines in the long‐
term horizon.
…Based upon a City Council‐approved methodology, reserve level guidelines (minimum and
maximum) are set annually to allow reserves to adjust up or down without unduly falling below
the minimum or above the maximum. On occasion, reserves have exceeded the maximum level
for a short time. Reserve levels are then adjusted in subsequent years, usually through rate
changes. The decision to set aside more or less than the minimum or maximum is based upon an
assessment of the uncertainties and financial risk facing the utilities. The City notes that reserve
levels in excess of “maximum” levels are considered to be consistent with its reserve guidelines.
The various documents show inconsistency in communication of
the City’s reserve policy decisions. By establishing a
comprehensive reserve policy, the Utilities Department will be
able to more effectively monitor, manage, and report reserves
within the defined parameters.
Upon testing Rate Stabilization Reserve balances for compliance
with reserve guidelines1 approved by Council, we found the
balances were often outside of these Council‐approved guideline ranges, as illustrated in Exhibit 4. These
minimum and maximum ranges for each of the Rate Stabilization Reserves can be found in the Adopted
Operating Budgets.
According to the Utilities Department, the
Council‐approved rate stabilization
guideline ranges are used for long‐term
financial planning purposes, and the reserve
balances may be above the maximum or
below the minimum guidelines. In addition,
the Utilities Department states November
2001 was the first report in which Rate
Stabilization Reserve (RSR) levels and
guidelines were issued to the Utilities
Advisory Commission (UAC) in quarterly
staff reports. The Utilities Department also
issues a 5‐year financial projection report
showing changes in RSR balances as a result
of changes in rate adjustments for the next
five years. This report is issued to the UAC,
Finance Committee, and City Council.
1 Guidelines used for testing were based on the methodologies in Exhibit 2 as approved by Council in various City Manager’s
Reports (CMR).
Recommendation 2: The Utilities
Department should re‐evaluate and
determine the use of reserve balance
guidelines, updating the City’s resolution
and the language in key City documents
accordingly.
Exhibit 4: Rate Stabilization Reserves balance to Council‐approved
guideline ranges (FY 2008 – FY 2012)
Legend: within range of Council‐approved guidelines
% above maximum range or % below minimum range
Source: Comprehensive Annual Financial Report (FY 2008‐FY 2011), Administrative
Services Department‐Enterprise Account (FY 2012), and Adopted Operating Budget
(FY 2008‐FY 2012)
Attachment A
9
December 2012
During the course of this audit, the Utilities Department reported that the FY 2012, Q4 report to the UAC
included a summary table that shows all Utilities Reserves. Additionally, for the last two quarters, the
Department has specifically included the UAC Quarterly reports as part of the informational reports provided to
the Council.
We were not able to adequately assess the reasonableness of the City’s other utility reserves in relation to
Council‐approved guidelines since a comprehensive reserve policy does not exist to provide the criteria
required.
On average, the City maintains between 13 and 18 months of total unrestricted reserves.
From a broader perspective, we reviewed the City’s total unrestricted reserve balances, in addition to the Rate
Stabilization Reserves as discussed previously. The City’s FY 2011 Comprehensive Annual Financial Report
indicates the level of working capital, within the Utilities reserve funds listed below, could cover between 13 and
18 months of operating expenses:
Electric ‐ 18.4 months Gas – 13.0 months
Water ‐ 13.2 months Wastewater Collection ‐ 16.7 months
The Government Finance Officers Association (GFOA) recommends a reserve baseline of three months of
working capital as a starting point and states that the appropriate level depends on the particular characteristics
of each enterprise fund. While the level of unrestricted reserves for the City may be appropriate, the Utilities
Department could not provide documentation to support the current level of working capital currently held in
reserves.
We selected seven local jurisdictions to benchmark the City’s Electric Fund unrestricted reserve balance. We
found the average number of months of operating capital to be 10.3 months, with the City of Palo Alto currently
at 18.4 months, as shown in Exhibit 5. Exhibit 5 compares the City of Palo Alto’s FY 2011 Electric Fund
unrestricted reserve balance, including the Electric Special Projects reserve, to other local jurisdictions providing
similar services. The City of Palo Alto’s Electric Fund reserve represents approximately 62 percent, or $142.7
million, of total reserves in FY 2011.
Exhibit 5: Comparison of FY 2011 Electric Fund Unrestricted Reserve Balances for selected jurisdictions
Source: Comprehensive Annual Financial Reports
Attachment A
10
December 2012
The level of unrestricted fund balance may differ from one jurisdiction to another based on each jurisdiction’s
particular financial and economic characteristics, and local conditions. According to the Utilities Department,
the higher reserve requirement is a result of a higher share of hydro resources in the City’s Electric portfolio,
which could result in unexpected shortfalls in generation as well as higher exposure to market price risk.
The GFOA’s guidance states that local governments should adopt a target amount of working capital to maintain
in each of their enterprise funds that best fits local conditions for each fund. Ideally, targets would be formally
described in a financial policy and/or financial plan. The guidance recommends consideration of the following
areas while customizing a working capital target:
Support from general government Transfers out
Cash cycles Customer concentration
Demand for services Control over rates and revenues
Asset age and condition Volatility of expenses
Control over expenses Management plans for working capital
Separate targets for operating and
capital needs
Debt position
Currently, the Utilities Department performs an annual
risk assessment to determine the adequacy of Rate
Stabilization Reserves; however there is no explicit
criteria or a specified target to indicate appropriate levels
of working capital.
Reserve balances are inconsistently reported and do not always reconcile.
In reviewing the various reports related to
reserve levels and guidelines, we found that
the Utilities Department’s financial forecasting
reports have underreported reserve balances,
as shown in Exhibit 6. The reports include
some utility reserves, and specifically exclude
CIP reserves (known as reappropriation and
commitments). As a result, the financial
forecasting understated actuals of all utility
reserves by $51 million, $72 million, and $54
million in FY 2009, FY 2010, and FY 2011,
respectively.
The projections include balances for reserves
that are attributed to the City’s audited
Comprehensive Annual Financial Report
(CAFR); however, the reserve balances in the
financial projection do not reconcile in total to
the CAFR or to quarterly reports of actual
Exhibit 6: 3‐year historical understatement of financials
Recommendation 3: The Utilities Department
should revisit its annual risk assessment model
to determine, establish, and document
appropriate levels of utility fund working capital
held in unrestricted reserves.
Attachment A
11
December 2012
reserve balances provided by the Administrative Services Department. This is primarily due to the exclusion of
CIP reserves (reappropriations and commitments).
Our review showed the following causes for inconsistencies in the “Actual” column of the Utilities Department’s
financial forecasting report:
All funds excluded the CIP reserves (reappropriation and commitment).
Water and Gas Funds, in addition to excluding the CIP reserves (reappropriation and commitment),
included debt service reserves. Debt service reserves are unique when compared to other reserves
included in this report as they are considered restricted. In the CAFR, Debt Service reserves are
segregated from other reserves because of their restricted status. Additionally, other restricted reserves
that are included in the CAFR are not included in this report.
Electric Fund, in addition to excluding the CIP reserves (reappropriation and commitment), also
excluded two other reserves (Underground Loan and Central Valley Project).
FY 2010 Gas Fund stated the Rate Stabilization reserve figure twice, once each for pre‐transfer and
post‐transfer; however the total reserve balance is correct in that it does not reflect the duplicate
figures.
We also found instances where the Utilities Department financial
forecast figures do not reconcile to the City’s key documents, such as
the Adopted Budgets.
According to the Utilities Department, the financial forecasting
report is adequate for the purpose of its intended use in rate
planning, not reserves management. The Department explains that
the report only shows a reserve if the balance is expected to change
during the forecast horizon as a result of policy change or Council
action. However, we found this report to be the Departments’
primary mechanism for reporting reserves from a financial planning
perspective. Based on our assessment, the report alone does not provide a complete view of the City’s utility
reserves.
Recommendation 4:
The Utilities Department should
revisit and update the 5‐year
financial projection rate making
worksheets to consistently state
reserve balances consistent with the
City’s key financial documents and
improve visibility over all
unrestricted reserves.
Attachment A
12
December 2012
Capital Improvement Program reserves are not consistently and clearly
reported to Council
The Utilities Department does not consistently and clearly report Capital Improvement Program (CIP)
carryforward appropriations, a reserve which holds unexpended CIP funds from prior fiscal years. Utility
carryforward reserve balances are significant, totaling a high of $82.8 million in FY 2012 and an estimated $75.9
million in FY 2013. The reporting of this information may assist with financial and project planning.
Carryforwards are unexpended appropriations at the end of a fiscal year which are automatically carried over to
the following year for open projects. Exhibit 7 shows each of the utility CIP carryforward balances from the prior
fiscal year, over an 8‐year period, including both reappropriations and commitments.
There are four key reports used for communicating CIP reserves: the Comprehensive Annual Financial Report
(CAFR), the Adopted Budget (Budget), the Financial Forecast (Forecast), and the CIP Status report. The CAFR
represents the most formal reporting of carryforward balances, reflected as a consolidated number and
reported at the end of the calendar year for the fiscal year ending June 30. The Forecast and the Budget exclude
prior year carryforward and report only on projects with
planned appropriations looking forward five years. Lastly, the
CIP Status Report does include carryforward information;
however, carryforward balances are not reported separately,
and the report is not available until three to six months after
the close of the mid‐year and year‐end periods.
The Government Finance Officers Association (GFOA) guidance on Capital Project Monitoring and Reporting
states, “Producing project status reports will help officials make informed decisions regarding scheduling and
cost. It is important to be consistent and use plain language when compiling information from various sources
and reporting it to multiple stakeholders. Meaningful reports should provide straightforward project
information for executive leadership and internal staff as well as citizens and the media, and, at minimum:
1. Provide a comparison of actual results to the project plan, including:
• Percent of project completed
• Percent of project budget expended
• Progress on key project milestones
• Contract status information
• Revenue and expenditure activity
• Cash flow and investment maturities
FINDING 2:
Exhibit 7: CIP Carryforward Balances of all Utility Funds (FY 2005 – FY 2013)
Recommendation 5: The Utilities
Department should develop a mechanism to
consistently and clearly report Capital
Improvement Program (CIP) carryforward
reserves to the oversight bodies.
Attachment A
13
December 2012
• Funding commitments
• Available appropriation
• Comparison of results in relation to established performance measures
2. Highlight significant changes to project scope or costs.”
As an example, Exhibit 8 details the CIP projects for Electric Fund Capital projects for FY 2012. The table includes
columns for the FY 2012 Budget, Carryforwards from the prior year, and Net Additional Appropriations/Returns.
The last four columns indicate which projects are included or excluded from each of the key reports. Detailed
CIP projects in FY 2012 for all utility funds are provided in Appendix 1.
In this example, 25 of 39 projects, which represent $6,672,273 or 30% of the total Electric Fund CIP budget, are
not included in the Forecast or the Budget. Additionally, the carryforward total of $13,790,931 is not reported in
detail.
Exhibit 8: Electric Fund Capital projects available appropriations detail (FY 2012)
Overall, we found the reports issued to Council regarding CIP are not sufficient to adequately support effective
financial and project planning. The Utilities Department should have a reporting mechanism that provides
transparency of CIP reserves, specifically carryforward balances, to the oversight bodies.
Attachment A
14
December 2012
Glossary of Acronyms and Terms
Adopted Budget: The annual City budget approved by the City Council on or before June 30.
Administrative Services Department (ASD): City department that strives to provide proactive administrative
support to City departments and decision makers, and to safeguard and facilitate the optimal use of City
resources. ASD is comprised of six divisions, including Administration, Accounting, Purchasing and Contracts,
Office of Management and Budget, Property Management and Acquisition, and Treasury.
Appropriation: The allocation of an expense budget for a particular project or program usually for a specific
period of time.
Capital Budget: A plan of proposed capital outlays and the means of financing them for the current fiscal
period. In a two‐year budget, the second year of the Capital Improvement Program is adopted‐in‐concept.
Capital Improvement Program (CIP): The Capital Improvement Fund accounts for projects related to the
acquisition, expansion, or rehabilitation of the City’s infrastructure.
Carryforward: Unexpended appropriations at the end of the fiscal year that are automatically carried over
to the following year for open projects.
Committed Fund Balance: Amounts that can only be used for the specific purposes determined by a formal
action of the City’s highest level of decision‐making authority, the City Council. Commitments may be
changed or lifted only by the City taking the same formal action that imposed the constraint originally (for
example: resolution and ordinance).
Comprehensive Annual Financial Report (CAFR): The CAFR is presented annually to provide City Council,
citizens, representatives of financial institutions and others with detailed information concerning the
financial condition and performance of the City of Palo Alto.
Electric Services Fund: This fund accounts for all financial transactions relating to the City’s Electric service.
Services are on a user charge basis to residents and business owners located in Palo Alto.
Enterprise Funds: These funds account for City operations that are financed and operated in a manner
similar to private enterprise. Costs of providing service to the public are covered by user charges, grant
funds, and impact fees. The City of Palo Alto owns and operates its own utilities, comprised of the Electric,
Fiber Optics, Gas, Water, and Wastewater Collection Funds.
Fiber Optics Fund: This fund accounts for all financial transactions relating to the City’s Fiber Optics service.
Services are on a user charge basis to licensees located in Palo Alto.
Fiscal Year: A 12‐month period of time to which the annual budget applies and at the end of which a
governmental unit determines its financial position and the results of operations.
Funds: Local government budgets are made up of funds, which help to organize and account for restricted
resources. Each fund is considered a separate accounting entity.
Gas Services Fund: This fund accounts for all financial transactions relating to the City’s Gas service. Services
are on a user charge basis to residents and business owners located in Palo Alto.
Attachment A
15
December 2012
Government Finance Officers Association (GFOA): Organization with the purpose to enhance and promote
the professional management of governments for the public benefit by identifying and developing financial
policies and best practices and promoting their use through education, training, facilitation of member
networking, and leadership.
Invested in Capital Assets, Net of Related Debt: The portion of net assets, which is represented by the
current net book value of the City’s capital assets, less the outstanding balance of any debt issued to finance
these assets.
Net Assets: The excess of all the City’s assets over all its liabilities, regardless of fund. Net assets are divided
into three categories, 1) Invested in Capital Assets, Net of Related Debt, 2) Restricted, and 3) Unrestricted.
Reappropriations and Commitments: Listed in the City of Palo Alto’s Comprehensive Annual Financial
Report (CAFR) as Unrestricted Reserves in the notes to the basic financial statements.
Reserve: The portion of fund balance set aside for financing future capital improvements or the outlay of
capital projects in any given year, and addressing one‐time emergency needs.
Restricted: The portion of net assets, which is restricted as to use by the terms and conditions of
agreements with outside parties, governmental regulations, laws, or other restrictions which the City cannot
unilaterally alter. These principally include bond proceeds received for use on capital projects, debt service
requirements, and special revenue programs subject to limitations, defined regulations, and laws underlying
such programs.
Restricted Fund Balance: Comprised of amounts that can be spent only for the specific purposes stipulated
by external resource providers, constitutionally or through enabling legislation. Restrictions may effectively
be changed or lifted only with the consent of resource providers.
Unrestricted: Describes the portion of net assets which is not restricted as to use.
Unrestricted Net Assets (for Enterprise Funds): The City Council has set aside unrestricted net assets for
general contingencies, future capital and debt service expenditures including operating and capital
contingencies for unusual or emergency expenditures.
Wastewater Collection Fund: This fund accounts for all financial transactions relating to the City’s
Wastewater Collection service. Collections are on a user charge basis to residents and business owners
located in Palo Alto.
Water Services Fund: This fund accounts for all financial transactions relating to the City’s Water service.
Services are on a user charge basis to residents and business owners located in Palo Alto.
Attachment A
16
December 2012
Attachment 1: Utility Fund Capital Projects ‐ FY 2012 Appropriation Detail
Attachment A
17
December 2012
Attachment A
18
December 2012
Attachment A
19
ATTACHMENT 2: City Manager’s Action Summary
In response to the Audit Recommendations in this report, the City Manager has agreed to take the following actions.
Finding
#
Summary of Finding Recommendation City Manager’s Action Plan Target
Date
1 The City does not currently have a
formal, comprehensive reserve
policy for its utility funds.
1. The Utilities Department should
establish formal and
comprehensive policies and
procedures for its Utility Reserves.
Utilities Department will establish formal and
comprehensive policies and procedures for its Utility
reserves
June 2013
1 Key City documents show
inconsistency in communication of
the City’s reserve policy decisions.
Rate Stabilization Reserve balances
were often outside of Council‐
approved guideline ranges.
2. The Utilities Department should
re‐evaluate and determine the use
of reserve balance guidelines,
updating the City’s resolution and
the language in key City
documents accordingly.
Utilities Department will re‐evaluate and determine
the use of reserve balance guidelines, updating the
City’s resolution and the language to key City
documents accordingly.
June 2013
1 Although the Utilities Department
performs an annual risk
assessment to determine the
adequacy of Rate Stabilization
Reserves; however there are no
explicit criteria or a specified target
to indicate appropriate levels of
working capital.
3. The Utilities Department should
revisit its annual risk assessment
model to determine, establish, and
document appropriate levels of
utility fund working capital held in
unrestricted reserves.
The Utilities Department will revisit its annual risk
assessment model to determine, establish and
document appropriate levels of utility fund working
capital held in unrestricted reserves.
June 2013
1 Reserve balances are inconsistently
reported and do not always
reconcile, specifically excluding
Capital Improvement Program
(CIP) carryforward reserves.
4. The Utilities Department should
revisit and update the 5‐year
financial projection rate making
worksheets to completely state all
reserve balances consistent with
the City’s key financial documents
The Utilities Department will revisit and update the
5‐year financial projection rate making worksheets
to completely state all reserve balances consistent
with the City’s key financial documents and improve
visibility over all unrestricted reserves.
June 2013
Attachment A
20
Finding
#
Summary of Finding Recommendation City Manager’s Action Plan Target
Date
and improve visibility over all
unrestricted reserves.
2 The reports issued regarding CIP
are not sufficient to adequately
support effective financial and
project planning. Improvements to
the consistency and completeness
of reporting CIP carryforward
reserve balances could better
support the City Council’s
operating budget, capital budget,
and reserves processes
5. The Utilities Department should
develop a mechanism to
consistently and clearly report
Capital Improvement Program
(CIP) carryforward reserves to the
oversight bodies.
The Utilities Department will develop a mechanism
to consistently and clearly report Capital
Improvement Program (CIP) carryforward reserves
to the oversight bodies.
June 2013
Attachment A
FINANCE COMMITTEE
EXCERPT
Page 1 of 6
Special Meeting
December 4, 2012
Utilities Reserves Audit
Jim Pelletier, City Auditor said the objective of the Utilities Reserves Audit
was to review the Utilities Reserves, reserve policies, reserve guidelines and
the usage of those reserves. There were two main findings, five
recommendations, and the City Manager’s Action Summary in response to
the findings of the report. The conclusion was that the City maintained
adequate reserves in the Utility Fund and that reserves were used
appropriately within the established policy. Council and the Utilities
Department can benefit from establishing a more comprehensive reserve
policy to manage and monitor their reserves. Staff recommended
improvements towards the consistency of reporting reserves and said it
would better support the Council’s Operating Budget, Capital Budget, and
reserve processes.
Mimi Nguyen, Senior Performance Auditor said the first finding was that Rate
Stabilization Reserves were not consistently maintained within Council
approved guidelines. There were two parts within this finding: the Rate
Stabilization Reserves and all reserves. Staff found that the City did not
have a formal comprehensive reserve policy for its Utility Funds and found
elements of policy language within strategic and operational plans and Staff
reports; however, there were inconsistencies with the communication of
reserve policy decisions. One example in a Staff report was that a Council
resolution stated that Staff conformed to the reserve level guidelines, but
the 2012 Adopted Operating Budget said that it was above the maximum
guideline or below the minimum for any particular year. Then a five year
financial production report said that it was within the Council approved
guidelines, but over a long term period. Based on the Council approved
resolution, Staff looked at Rate Stabilization Reserves and tested the
balances for compliance. They found that many of the reserves were
outside the guideline ranges.
Mr. Pelletier said Staff was not suggesting that Council fall between the
minimum and maximum guideline, but wanted to provide Council with the
data for them to see and determine what was intended.
Attachment B
EXCERPT
Page 2 of 6
Finance Committee Regular/Special Meeting
Excerpt 12/4/12
Ms. Nguyen said, regarding reserves in a broader perspective, Staff found
that on average, the City maintained between 13 and 18 months of
operating expenses in total unrestricted reserves. In reviewing the Fiscal
2011 Comprehensive Annual Financial Report (CAFR), the City’s unrestricted
reserves covered 18.4 months in the Electric Fund, 13 months in the Gas
Fund, 13.2 months in the Water Fund, and 16.7 months in Wastewater
Collection Fund. All of the reserves were Council approved for specific
spending, including the Electric Special Project Reserve; however, these
reserves could be repurposed and returned to Rate Stabilization Reserves if
they were not spent the way they were anticipated. She said Staff
benchmarked the CAFR with seven other jurisdictions against Palo Alto’s
reserves and said the levels might be appropriate but they did not find
documentation to justify these funds. That did not mean that the
justification for these funds were inappropriate; policy and documentation of
policy is needs to be established.
Mr. Pelletier said Government Finance Officers Association (GFOA), a
government agency that offers general financial criteria suggested starting
with two to three months of operating reserves, and building from there. He
explained he was emphasizing justification for the City’s funds. For
example, a hydro project presented a different type of risk and it was good
to have enough of a reserve for that type of risk; it was good to see the
justification for the level that the City was at.
Vice Mayor Scharff said if Staff did not account for the special projects then
Palo Alto was right there with other agencies.
Mr. Pelletier said the problem was not being at a certain level, but to have
two to three months of reserves in place, build from there, then justify why
the reserves were in place.
Vice Mayor Scharff said that most agencies did not have two to three months
of reserves.
Mr. Pelletier said every agency was different, with regard to their risk profile.
Some cities set aside more or less funds, depending on their perceived risk.
He emphasized the recommended documentation for the justification of the
City’s reserves and clarifying why the City retained the amount of reserves
they had.
Vice Mayor Scharff asked what the justification looked like.
Mr. Pelletier said it was an analysis of the risks that Utilities had; they
considered all of the risks, gave Staff examples, and documented in their
Attachment B
EXCERPT
Page 3 of 6
Finance Committee Regular/Special Meeting
Excerpt 12/4/12
profile as to why they wanted to set aside additional funds. Staff did not
want a large sum of money being unaccounted for. He said it was better to
see good justification as to why funds might be in a certain account.
James Keene, City Manager confirmed that regardless of what the reserve
results were in the Staff report, Staff would have made this request to justify
funds.
Mr. Pelletier said this information showed where the City was at today and
which cities Palo Alto compared to; the issue was justifying where the City
was at today, regardless of the amount of reserves the City was carrying.
Val Fong, Utilities Director said that there was a risk assessment that was
done annually that explained what the accounts were at. It quantified what
the risks were at, the market price risk, and variability.
Council Member Price asked for explanation of the vertical axis percentages.
Ms. Nguyen said it was the percentage of Electric Unrestricted Reserves to
operating expense.
Council Member Burt said the City had a reserve of 153 percent of operating
expense.
Chair Shepherd said in the former Calaveras Reserves, now called the
Electric Special Projects, there was a three year time period to spend the
reserves; the money was being called reserves because an isolation of the
reserves was not happening.
Ms. Nguyen said within the CAFR document the reserves listed under
“unrestricted” were the types of reserves that are not restricted, including
Electric Special Project Reserve.
Chair Shepherd said it was a matter of using a policy to separate the funds
out.
Council Member Burt wanted clarification on what Staff was looking for from
the City Auditor that was different from what Council received every year
regarding the report on Reserve Justification.
Ms. Nguyen said the Risk Analysis was very specific to the Rate Stabilization
Reserve. Within the unrestricted reserves, there were more reserves than
just the Rate Stabilization Reserves; Staff suggested identifying and
justifying the reserves.
Attachment B
EXCERPT
Page 4 of 6
Finance Committee Regular/Special Meeting
Excerpt 12/4/12
Council Member Burt confirmed that the focus was on reserves other than
the Rate Stabilization reserves.
Ms. Nguyen said the risk assessment portion was out of scope.
Council Member Burt clarified whether it was possible to see the reasoning
for the non-rate stabilization reserve that was on the General Rate
Stabilization.
Ms. Nguyen said the justification was made, but confirmed that she was
talking about the General Rate Stabilization.
Mr. Pelletier said Staff wanted to make sure that when the presentation was
made that Council had a full understanding and that Rate Stabilization was
an important part of the picture.
Vice Mayor Scharff wanted clarification on why Staff chose this portion of the
Audit because it did not seem to be a big risk.
Mr. Pelletier said the Audit was requested a few years ago and Staff wanted
to answer the request. It was important for Staff to present Council with the
correct information and for them to be able to support their decisions.
Additionally the Audit revealed other items that needed to be addressed.
Council Member Burt said the reason the Audit was requested was Staff
wanted Council to have good policy making tools. If the reserves were too
big or small, it affected the City’s money and Council wanted to have the
information to be able to make informed decisions.
Ms. Nguyen said reserve balances were not always reported and did not
always reconcile with the City’s CAFR due to the exclusion of the Capital
Improvement Program (CIP), carry forward Reserves, and the Utility Funds;
there were understated reserves. Staff found that CIP reserves were not
consistently or clearly reported to Council and the reports submitted to
Council regarding Utility CIP were not adequately supporting financial project
planning. Of the four key financial reporting projects, there were problems
with the oversight reporting.
Ms. Fong said there were certain things that could be clearer and more
consistent.
Chair Shepherd said looking at all CIP’s and going forward, there were
projects that were finished and some of the funds did not zero out; the funds
Attachment B
EXCERPT
Page 5 of 6
Finance Committee Regular/Special Meeting
Excerpt 12/4/12
needed to be accounted for in order to move forward. If there were items
that were finished then discussion could take place about those funds, taking
them out of being held, and making the funds available for something else.
Mr. Pelletier said when the City Auditor’s Office reviewed all of the reports,
there was a gap in the projects that were carried forward from year to year.
Ms. Nguyen said the CIP Status Report was meant to accompany the CAFR
report, it was not meant to give Council a project status up-date, and it did
not lay out the details of all the projects. The only reporting document that
captured all of the details of all of the reports was the Matrix report. For
example, fiscal year 2011, for the Electric Fund, there was a carry forward of
funds. The Utilities Department reported out projects, it was still not all
encompassing. This other report showed Council a different perspective on
the budget.
Council Member Price asked how the Rate Stabilization Reserves, outside
Council approved guidelines, with regard to Fiber Optics was at 50 percent
for fiscal year 2011 and wanted to know why these numbers were so
extreme.
Ms. Fong said there were set rates that were increased by the CPI and
making significant profits annually. The City did not spend the monies that
were collected because they were still debating how to extend the network
right now.
Council Member Burt said there was a lot of discussion on what the best
utilization of these extra funds should be.
Chair Shepherd said the Utilities Department just looked at the report.
Mr. Keene said part of the challenge was that the reserve amount was
growing. The ultimate objective was so large was that incremental spending
did not go too far.
Molly Stump, City Attorney said the Fiber Fund was not a municipal
monopoly and the people of Palo Alto were not required to use that service.
That put the fund in a different category and gave Council greater flexibility
to be able to use the funds.
Council Member Burt said the fund was banking the dollars for a future
major project. There was not a decision on what the money would be
allocated for.
Attachment B
EXCERPT
Page 6 of 6
Finance Committee Regular/Special Meeting
Excerpt 12/4/12
Chair Shepherd Palo Alto Unified School District (PAUSD) was getting
connected to the funds.
Council Member Burt asked if it was permissible to bank funds for a future
major capital need, to have a reserve that was defined differently, and did
these extra dollars help explain the Wastewater Connection Fund.
Lalo Perez, Director of Administrative Services said it was permissible to
have a Replacement Fund but the key was to outline and document funds.
The funds that the City were legally required to have were the ones that had
binding obligations with restrictions.
Council Member Burt said there were two categories: projects below budget
and projects completed at a slower rate than projected. He asked if that
was the reason that funds were not expended, budgeted, or part of the
understated reserves.
Mr. Pelletier said one of the concerns the City Auditor’s Office had was
project management, budgeting for projects, and the use of funds. He said
they did not go to that level of detail in this Audit.
Council Member Burt said there had been a general discussion around the
CIP rollovers, what the numbers were and how to see the difference. He
asked if, through the City Auditor’s report, there was a clearer frame work
and better policies and procedures that applied to the General Fund.
Mr. Perez said in terms of the reserves, not as much, but the reasoning was
sound.
Council Member Burt said the reasoning for the reserves was as well as the
explanation for Understated Reserves, how Staff might make them more
visible, and how they might be stated in a timelier manner.
Mr. Perez said it could be incorporated in both but there may be different
views and needs.
MOTION: Chair Shepherd moved, seconded by Vice Mayor Scharff to
recommend City Council accept the Utilities Reserve Audit.
MOTION PASSED: 4-0
Attachment B