A Briefing on the Differences between Ratemaking Analysis and Financial Statement Reporting

A Briefing on the Differences between Ratemaking Analysis and

Financial Statement Reporting

Pine Strawberry Water Improvement District

May 5 2010

IntroductionPurpose of Presentation

Discussion of how the objectives and goals of public utility accounting differs from private company accounting

Analysis of District performance – actual vs. forecast

Background on District’s current and forecast rate plan

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Accounting for Public Utilities

Publicly-owned utilities are fundamentally different from private companies

Non-profit

Do not have owners/shareholders

Not subject to income taxes

To account for these differences, there is a separate and distinct method of bookkeeping for publicly owned utilities – it is centered around Cash Flow as opposed to Net Income

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Objectives and Goals of Ratemaking

Utility ratemaking accounting is based on the American Water Works Association Cash Basis of Accounting and focuses on Cash Flow

Private company financial statement accounting is based on the use of Generally Accepted Accounting Principals (“GAAP”) Accrual Basis of Accounting and focuses on Net Income

Attempts to directly compare these different approaches often lead to invalid conclusions (i.e. double counting of capital expenses)

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AWWA Cash Basis Methodology

Cash Basis has been historically used by publicly-owned utilities throughout the USA

Fundamental goal of Cash Basis: to enable the utility to recover the cash it needs to pay its operating expenses, debt service and meet bondholders’ debt coverage requirements

Under Cash Basis methodology, cash expenses (operating, debt principal, capital outlays) are included but non-cash expenses such as depreciation are excluded

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Types of Expenses RecoveredCash Basis vs. Accrual Basis

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AWWA GAAP Cash Basis Accural Basis

Operating Operating

Debt Interest Debt Interest

Debt Principal Depreciation

Capital Outlays Amortization

AWWA Cash Basis Methodology

Summary: when examining public utility financial statements it is important to concentrate on Cash Flow

Cash flow is the standard set by bond authorities, public sector accountants, ratemaking principles and industry experts to judge the financial health of publicly-owned utilities

AWWA rules (and ACC annual report rules) direct that privately-owned utilities (like Brooke) do not use the Cash Basis, because they are subject to taxation and therefore must take the depreciation deduction

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PSWID Year To Date FinancialsActual vs. Forecast

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It is inappropriate to compare partial year actual performance to Economists.com’s forecast because rate model is based on annual, not monthly, projections

Revenues and expenses vary widely by month

District’s year to date revenues are for lower sales volume months of October through March

District has incurred many one-time start-up costs

Actual Water Volumes (Gallons)Last 12 Months of Brooke Operations

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000 Percent of Annual Volume Oct – Mar = 43%

PSWIDLong Term Financial Plan

To minimize impact of acquisition and capital improvement costs on ratepayers, District chose to phase in annual debt service

Debt service is interest-only for first two years; principal payments begin in 2012

District’s plan always has been to adjust rates when principal payments came due – only issue was how much and when

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Advantages ofDistrict Financial Plan

Plan ensures that District will have sufficient cash to fund all unexpected expenses (common for a “start up” business)

Allows District to defer rate increases until 2012, to minimize impact of acquisition on ratepayers’ household budgets

Enables District to base future rate adjustments on better and more reliable volume and customer data

Will provide District Board and ratepayers time to reach consensus on most appropriate rate plan -- straight percentage increases, uniform rates for all ratepayers, etc.

Only disadvantage: depreciation (non-cash expense) is not fully funded in FY 2010 and FY 2011

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District Actual YTD PerformanceOctober 2009 – March 2010

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Actual Oct 09 -- Mar 10

Revenues $709,896

Cash Basis Expenses Operating 512,011 Debt Interest 105,577 Debt Principal/Cap Outlays - Total 617,588

Net Cash Flow 92,308

Reconciliation to Net Income Add Debt Prin/Cap Outlays - Subtract Depreciation (196,802)

Net Income (104,494)

District Actual YTD FY 2010 PerformanceEconomists.com 2012 Rate Model Forecast

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Economists.com District Actual Cash Basis Accrual Basis Forecast

Oct 09 -- Mar 10 FY 2012

Revenues $709,896 $1,462,232 **

Cash Basis Expenses Operating 512,011 * 870,741

Debt Interest 105,577 288,582 Debt Principal/Cap Outlays - 174,935

Total Expenses 617,588 1,334,258

Net Cash Flow 92,308 127,974

Reconciliation to Net Income Add Debt Prin/Cap Outlays - 174,935

Subtract Depreciation (196,802) (196,802)

Net Income (104,494) 106,107

* Includes $132,378 in start up costs ** Requires rate adjustment

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PSWIDForecast Cost of Service 2010-2019

10/0

9-6/

10

2011

2012

2013

2014

2015

2016

2017

2018

2019

$-

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

Operating Debt Service

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PSWIDCurrent Rate Schedule

PINE RATEPAYERS     STRAWBERRY RATEPAYERS   Williamson   Base 5/8" $ 20.35

Base Charge 5/8" $ 18.45   Cost/1,000 Gal - 2,000 3.50   2,001 4,000 3.50

Usage--Summer - 2,000 6.00   4,001 6,000 3.50 Cost/1,000 Gal 2,001 4,000 7.00   6,001 Above 3.50 May-September 4,001 6,000 7.00  

6,001 Above 8.00   United   Base 5/8" 16.00   Cost/1,000 Gal - 2,000 2.20

Usage-- Winter - 2,000 3.95   2,001 4,000 2.20 Cost/1,000 Gal 2,001 4,000 4.96   4,001 6,000 3.85 October-April 4,001 6,000 4.96   6,001 Above 3.85

6,001 Above 6.00    E&R   Base 5/8" 18.45   Cost/1,000 Gal - 2,000 3.40   2,001 4,000 3.40

  4,001 6,000 5.95   6,001 Above 5.95  

Alternative 1 from Sep 29 2010 Rate Analysis Consolidated Long-Term Rate Plan

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Current Pine All PSWID Ratepayers

Summer Effective Effective Effective EffectiveRate Oct-11 Oct-12 Oct-13 Oct-14

Base Chg 5/8" $18.45 $18.45 $21.22 $22.28 $23.39

Usage Chg per 1,000 Gal: - 2,000 6.00 6.00 6.90 7.25 7.61

2,001 4,000 7.00 7.00 8.05 8.45 8.88

4,001 6,000 7.00 7.00 8.05 8.45 8.88

6,001 Above 8.00 8.00 9.20 9.66 10.14

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Monthly Charges UnderSep 29 2010 Rate Plan (Alternative 1)

2004-2009 Brooke Effective Effective Effective EffectiveRates Oct-11 Oct-12 Oct-13 Oct-14

3,000 Gallons

Pine Total $37.45 $37.45 $43.07 $45.22 $47.48 (summer) Increase - 5.62 2.15 2.26

Strawberry -- WilliamsonTotal 30.85 37.45 43.07 45.22 47.48 Increase 6.60 5.62 2.15 2.26

Strawberry -- UnitedTotal 22.60 37.45 43.07 45.22 47.48 Increase 14.85 5.62 2.15 2.26

Strawberry -- E&RTotal 28.65 37.45 43.07 45.22 47.48 Increase 8.80 5.62 2.15 2.26

Presentation Summary

2009 rate study and financial plan was estimated on the Cash Basis, which is used by public utilities throughout the USA

The Cash Basis assumptions for ratemaking differ fundamentally from the GAAP Accrual Basis used for financial reporting purposes. Both methods are correct for their specific applications, but should not be mixed in their use

District is generating positive cash flow; and is able to fund all operating expenses

It is not valid to try to compare partial year performance with rate model, which forecasts on an annual basis

Rate adjustments will be necessary in 2011 when debt principal becomes due

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