Here is a memo describing the difference between cash and utility basis. Having sat through the presentations it is pretty clear to me that the Utility Basis is the way to go. I do find it funny that the primary reason for the cash basis is to dumb it down for council members…
This seems like a smart policy that better aligns long term income and investments.
DATE: February 28, 2014
TO: Board Members
FROM: Susan Parker, Director of Corporate Services
SUBJECT: Differences between Utility Basis and Cash Basis Rate making
At the February 26, 2014, board meeting Jerry Williams asked for a brief description of the two methods of rate making and how the methods are different.
Under the cash basis the revenue requirements include operations & maintenance expense, debt service, and normalized capital improvements.
The advantages of cash basis is it is understood by City Councils since it is the method that general fund budgeting typically uses. Cash basis attempts to match cash inflows and outflows on a yearly basis and it does meet the bond obligations.
The disadvantages are the cash basis tends to conceal any major rate problems and revenue deficiencies since this method does not take into consideration the future replacements of assets. The cash method tends to result in unexpected and large rate adjustments and is not generally accepted by courts if rates are challenged.
Under the utility basis the revenue requirements include operations and maintenance expense, depreciation expense, and rate of return on assets. The rate of return is determined by including an inflationary increase in asset replacement costs plus interest expense.
The advantages of utility basis is it leads to more stable and consistent rate adjustments and typically leads to a more financially stable and healthy Utility.
The disadvantages are cash reserves will build more quickly for future asset replacements and the cash reserves level may need to be justified. Most governments operate on a cash basis, the Utility may need to explain the use of depreciation since it is a non-cash expense and may need to explain the importance of rate of return.
With the retirement of the Silver Lake Plant for electrical generation in 2015, the timing is good to develop the financial plan on the utility basis. In order to balance the advantages and disadvantages in the event the financial plan indicates large adjustments are needed, which staff does not believe will occur, a minimum rate adjustment to meet debt service would be defined and a plan to phase-in from cash basis to utility would be developed.
Please let me know if you have further questions or concerns.