At a recent town meeting, the Council talked about an Enterprise Fund and how it affects water and sewer fees charged and collected. We would like to take a moment to review what an Enterprise Fund is to help clarify how this affects our residents.
Enterprise funds are for services which charge a fee, and the fund should be treated like a business organization. Examples of enterprise funds include municipal utilities such as power, water, and sewer.
Fees collected from enterprises should cover the cost of the enterprise. If fees greatly exceed the amount that it costs to operate the enterprise, municipal officials should leverage the fees to cover the costs of the enterprise.
At their core, enterprise funds provide services based upon the use of user fees. User fees are instituted to charge users based upon their specific utilization of services.
The following information will help you understand:
- The definition of “Enterprise Fund”.
- Why enterprise funds are important to your utility.
- How to implement enterprise funds.
An enterprise fund is considered the best practice to promote and maintain long-term financial sustainability for water sewer, and stormwater activities. An enterprise fund is a separate accounting and financial reporting mechanism for which revenues and expenditures are segregated in a fund with financial statement separate from all other governmental activities. An enterprise fund identifies the total direct and indirect costs to provide the service and the sources and amounts of revenues that support the service for which a fee is charged in exchange for service. Direct costs generally consist of personnel services, expenses and capital outlay, which are budgeted and accounted for in the enterprise fund. Indirect costs are expenditures budgeted and accounted for in the general fund on behalf of the enterprise fund, which area allocated to the enterprise fund for funding. Examples of indirect costs are central service department costs (accounting, treasury, collections, law, and the like), insurances and fringe benefits that are not budgeted and accounted for in the enterprise fund.
The benefit of an Enterprise Fund:
- Identifies a total cost of service and related revenues for a service.
- Provides management information to analyze the extent to which revenues are covering expenditures.
- Retains and maintains investment income and surplus.
- Provides useful information to make decisions on used charges and other financing items.
- Provides the value of the enterprise fixed assets and infrastructure and recognizes the cost of the annual depreciation of these assets.
- Provides long-term liabilities in the financial statements thus provides both sort and long-term financial perspectives.
One of the steps in establishing an enterprise fund is to develop an accounting system. Once adopted, the process of establishing the enterprise fund should begin using accounting records and identifying the assets (capital items and infrastructure), liabilities and equity. Related funds in other derestricted funds should be identified and transferred to the enterprise fund if voted by the legislative body.
You should work with the finance department to:
- Ensure that revenues include user charges, utility liens added to taxes, connection fees, betterment assessments, miscellaneous fees, interest earnings, and other financing sources.
- Ensure that expenditures are known.
Another step in establishing an enterprise fund is to analyze the data provided to (a) monitor that actual revenue is on target to estimated revenue and (b) that your expenditures are on track to appropriations. This is an important step to ensure that the budget, both revenues and expenditures, are realized based on the annual budget.
The bulk of the revenue for enterprises comes primarily from user fees.
Enterprises have bonding authority, meaning they can take out debt based upon the projected revenue from their user fees.
Are you reporting your activities in the correct fund type? Local governments should analyze the services they are providing and determine if the fund types used are appropriate.
An enterprise fund is a fund that may be used to report any activity for which a fee is charged to external users for goods or services. We have observed that local governments sometimes are not reporting enterprise activities in the correct fund type, and noted the following areas of concern:
- Activities financed almost exclusively by user fees (utilities) are reported in the general or special revenue funds, when an enterprise fund should be used
- Enterprise funds are incorrectly used for activities when the only revenue sources are taxes, grants and transfers (these activities should be reported in governmental funds)
- Separate enterprise funds reporting construction, capital improvements and debt servicing related to enterprise funds (must be in the same fund as operations)
- Separate enterprise funds reporting customer deposits or equipment reserves (must be in the same fund as operations)
Because the purpose of financial reporting is to provide information needed to make financial decisions and assess financial stewardship, it is vital to make sure that the reporting meets the established governmental reporting standards. We encourage you to analyze whether your government appropriately classifies and reports its activities, and to make appropriate revisions if necessary.
GASB has issued several pronouncements addressing various fund types, which is indicative of the importance of proper classification of activities. Specifically, GASB Statement 34 provides guidance on the use of proprietary funds, of which enterprise funds are one type. Paragraph 67 of that Statement states that if an activity meets any of the following three criteria, it must be reported in an enterprise fund. These criteria are:
- The activity is financed with debt that is secured solely by a pledge of the net revenues from fees and charges of the activity
- Laws or regulations require that fees and charges be set to recover costs including capital costs (depreciation or debt service)
- There is a pricing policy that fees and charges be set to recover cost, including capital costs (depreciation and debt service)
These criteria should be applied in the context of the activity’s principal revenue source.
The term activity generally refers to programs and services. This term is not synonymous with “fund.” As a practical consequence, if an activity reported as a separate fund meets any of the three criteria, it should be an enterprise fund. Also, if a “multiple activity” fund (e.g., general fund) includes a significant activity whose principal revenue source meets any of these three criteria, the activity should be reclassified as an enterprise fund.
The determination of an activity’s principal revenue source is a matter of professional judgment. A good indicator of the activity’s significance might be comparing pledged revenues or fees and charges to total revenue. For example, consider a county auditor’s office that charges fees to provide a payroll service to various taxing districts. Even if the fee is meant to cover the cost of the service, the county auditor function as a whole is primarily supported with tax dollars from the general fund. It would be allowable in this case to leave the activity all within the general fund.
Finding an appropriate fund type requires a careful analysis because there is not always a clear choice. For example, building permit fees may be accounted for in the general fund or a special revenue fund in certain circumstances, such as when they are partially supported by taxes. However, if there is a pricing policy to recover the cost of issuing those individual building permits, they should be reported in an enterprise fund.