United States
Environmental Protection
Agency
Setting Small Drinking Water
System Rates for a Sustainable
Future
One of the Simple Tools for Effective
Performance (STEP) Guide Series
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Office of Water (4606M)
EPA816-R-05-006
January 2006
www.epa.gov/safewater
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Contents
Key Terms 4
Is This Guide for Me? 7
What Will I Learn? 8
What is Full-Cost Pricing? 9
What are the Benefits of Recovering Your Costs Through Revenues? 10
Step 1 - Determining Your Costs 11
Annual Costs Worksheet 11
Step 2- Determining Your Current Revenues 17
Annual Revenue Worksheet 17
Step 3 - Setting Aside a Reserve 22
Step 4- Determining Actual Revenue Required from Your Customers 24
Short-term Revenue Required from Your Customers Worksheet 25
Step 5- Designing a Rate to Cover Your Costs 31
Average Monthly Usage Worksheet 37
Step 6- Implementing the Rate 44
Step 7- Reviewing the Rate 45
Appendix A-Sources for More Information on Rate Setting 47
Appendix B-State Drinking Water Primacy Agencies 49
Appendix C-Tribal Drinking Water Contacts 54
Appendix D-State Public Service Agencies 55
Appendix E - Other STEP Documents 60
Appendix F- Depreciation Accounting 61
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Key Terms
Affordability
Amortization
Asset Management
Capacity Development
Capital Expenditure
Capital Improvement
Plan (CIP)
Community Water
System (CWS)
Debt Service
Decreasing Block Rate
Depreciation
Fixed Costs
The ability to pay a water bill without affecting your ability to pay for other essential goods and services.
The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of
time. These payments must cover both principal and interest. Or, writing off the cost of an intangible asset
investment over the projected life of the asset.
A planning process for maintaining and replacing your system's infrastructure in the most efficient
manner. Data on infrastructure (criticality and condition) are used to prioritize capital investments.
A process through which your water system can acquire and maintain technical, managerial, and financial
capabilities to consistently provide a safe and reliable source of drinking water.
The amount your system spends to acquire or upgrade your system's assets.
A budgeting and financial tool that a system can use to establish asset rehabilitation and maintenance
priorities and to establish funding for repairs and improvements.
A public water system that serves at least 15 service connections used by year-round residents or regu-
larly serves at least 25 year-round residents.
Principal or interest payments on an outstanding debt (e.g., a mortgage or loan).
A rate structure under which the price of water per unit (block) decreases as the amount used increases.
Blocks are set according to consumption (e.g., up to 2,000 gallons used, 2,000 to 6,000 gallons, etc.).
An estimate of the reduction in the value of an asset due to wear and tear, obsolescence, or impairment.
Also, the allocation of the cost of an asset over time for accounting and tax purposes—an annual depre-
ciation charge in accounts represents the amount of capital assets used up in the accounting period.
Costs that remain the same regardless of variations in how much water your system pumps, treats, and
delivers (e.g., debt service on loans, rent, etc.).
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Flat Rate/Fixed Fee
Increasing Block Rate
Net Revenue
Public Water System
(PWS)
Rate
Rate Structure
Reserve Account
Revenue
Seasonal Rate
Single Tariff Rates
Strategic Planning
Rate structure under which all customers pay a set fee (monthly, quarterly, etc.) for water service that is
not tied to the amount of water used.
Rate structure under which the price of water per unit (block) increases as the amount used increases.
Blocks are set according to consumption (e.g., up to 2,000 gallons used, 2,000 to 6,000 gallons, etc.).
This type of rate structure encourages water conservation.
The difference between total revenue and costs.
A system that provides water for human consumption to the public through pipes or other constructed
conveyances. These systems have at least 15 service connections or regularly serve an average of at
least 25 individuals daily at least 60 days out of the year.
The charge a system assesses its customers for use of the system's services, usually billed monthly.
A set of fees and rates that a water system uses to charge its customers for water.
An account used to hold funds set aside to finance future system expenses such as infrastructure reha-
bilitation or replacement, or to address system emergencies.
Funds earned by the system through the sale of water or by other means.
A rate that varies depending on the time of the year. Seasonal rates can be used in conjunction with any
rate structure, including flat rates and uniform, decreasing, or increasing block rates.
A unified rate structure for multiple water systems (or other utilities) that are owned and operated by a
single utility but that may or may not be contiguous systems or physically interconnected. Under single-
tariff pricing, all customers of the utility pay the same rate for service, even though the individual systems
providing service may vary in terms of the number of customers served, operating characteristics, and
stand-alone costs.
A process through which an organization defines what it does and why. A strategic plan defines an organi-
zation's long-term goals and objectives and provides a framework through which to meet these goals.
Strategic plans should be flexible to make them adaptable in response to unexpected changes.
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Transfer Payment Payment made by a government as a gift or aid, not as payment for any good or service nor as an obliga-
tion.
Uniform Rate A rate structure under which customers pay a single charge per unit of water. For example, customers
may pay $2 per thousand gallons. The cost per thousand gallons remains constant even if usage
changes. A uniform rate may be combined with a fixed fee so customers would pay a fixed monthly fee
plus a charge per unit of water purchased.
Variable Costs The costs of operating your system that change as the amount of water that you pump, treat, and sell
increases or decreases. Examples include chemicals and maintenance.
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Is This Guide for
As a water system owner or manager, one of your most important jobs is making sure that your system brings in enough money to
cover the full costs of doing business now and in the future. This guide is designed to help owners, operators, and managers of
community water systems (CWSs) serving 3,300 or fewer persons understand the full costs of providing a safe and adequate
supply of drinking water to their customers and how to set water rates that reflect those costs. Systems that will find this guide
useful are small publicly or privately owned entities whose primary business is providing drinking water.
Many states have rate setting requirements and restrictions. Check with your state for specific requirements. Contact information
can be found in Appendix B (State Drinking Water Primacy Agencies), Appendix C (Tribal Drinking Water Contacts), and Appendix D
(State Public Service Agencies).
Why is the Rate Setting Process Important?
This guide will help you determine how much money you need to collect annually from customers through rates to fully cover your
expenses and help you think through how to determine an appropriate rate structure. Doing so involves taking a detailed look at your
current and future costs and expenses, your rate structure options, and the amount of water your customers use. Although the
process takes time, the benefits are significant—you will gain the tools you need to:
• Maintain your system's financial stability by ensuring a sufficient revenue stream.
• Collect and reserve the funds needed to cover the costs of future asset rehabilitation and repair projects, security upgrades, and
compliance with future regulations, among other things.
• Plan ahead for reasonable, gradual rate increases when necessary.
• Deliver fairly priced, high-quality drinking water to your customers now and in the future.
Additional copies of this guide may be obtained by calling the Safe Drinking Water
Hotline at (800) 426-4791. You may also download the guide from EPA's Safe
Drinking Water Act Web site at http://www.epa.gov/safewater/smallsys/ssinfo.htm.
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What Will I Learn?
As the manager or operator of a drinking water system, your most important job is delivering safe drinking water to your customers.
If your system does not have the resources to cover the full cost of producing and delivering water, your job will be all the more
difficult. (The full cost of water service includes the costs of production, treatment, storage, distribution, debt service, capital expen-
ditures, regulatory compliance, and other operation and maintenance costs.)
This guide's information and worksheets will help you understand the importance of recovering the full
cost of running your system through customer charges and how to structure your rates to achieve full
recovery. Structuring your rates in this way will ensure that you have the financial resources to operate
effectively and efficiently now and in the future. This process has seven steps:
Step 1: Determine the full cost of doing business by calculating your costs.
Step 2: Determine your current revenues.
Step 3: Consider your reserve requirements to ensure you have enough funds to cover your asset rehabilitation
and repair costs as well as unexpected costs during the next 5 years.
Step 4: Calculate how much money you need to collect from customer charges to cover your costs and fully fund your reserve
account.
Step 5: Evaluate appropriate rate structures and design an appropriate rate.
Step 6: Implement the rates.
Step 7: Review your rates and make changes when appropriate.
This guide is designed to help you plan financially for the next 5 years. However, once you have a better understanding of your
system's finances and future needs, it will be to your advantage to plan even further ahead—at least 20 years in advance, if pos-
sible. EPA's Strategic Planning: A Handbook for Small Water Systems (EPA 816-R-03-015) will give you the information and tools
you need to develop long-term plans for managing and operating your system.
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What is Full-Cost Pricing?
Charging customers for the actual cost of water service will guarantee you the revenue needed to cover the costs of operation,
treatment, storage, and distribution and will provide funds for future investments. This concept of recovering the costs of running
your system through user charges is called "full-cost pricing" and is discussed throughout this guide.
Ideally, full-cost pricing:
• Ensures rates are a sufficient and stable source of funds. Charging for the full cost of delivering water will ensure your system's
financial health, enabling you to provide safe water now and in the future.
• Provides information on costs to customers. How much you ask your customers to pay sends a signal to them about the value
of the product they are purchasing. Charging for the full cost of the service your system provides will help customers recognize
the value of the service and be more mindful of their water use.
Planning for the Future
EPA encourages water systems to plan for the future. Strategic planning helps you
address and prepare for anticipated and unexpected problems by evaluating your
system's current physical, managerial, and financial condition. It also requires you to
make important decisions about your water system's purpose, structure, and func-
tion.
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What are the Benefits of Recovering
Your Costs Through Revenues?
Evaluating your costs annually and adjusting customer charges to cover your costs does take time
and may sometimes result in a rate increase for your customers. The benefits to your system
and your customers, however, will be worth the effort. The most important benefit will be finan-
cial stability and security, which will ensure that your system has adequate capacity and long-
term sustainability.
Water system capacity is the ability to plan for, achieve, and maintain compliance with drinking
water standards, thereby ensuring the quality and adequacy of the water supply. Capacity has
three components:
1. Financial capacity - the ability to acquire and manage sufficient financial resources.
Recovering costs through revenues increases your financial capacity by increasing your
available resources and improving your credit worthiness. Some loan and grant programs,
including the Drinking Water State Revolving Fund (DWSRF), assess capacity during the loan application process. You might
not qualify for a loan if you do not have adequate capacity.
2. Technical capacity - a system's physical infrastructure and operational abilities. Recovering costs through revenues in-
creases your technical capacity by giving you the means to invest in your system's physical infrastructure and to make
necessary repairs.
3. Managerial capacity - a system's management and administrative capabilities. Recovering all costs through revenues will
increase your managerial capacity by enabling you to attract, retain, and continually train certified operators and other work-
ing staff.
The following pages describe the seven steps to recovering the full cost of running your system through water rates and ensuring
that your system has the capacity to operate effectively and efficiently now and in the future.
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Step 1 - Determining Your Costs
It may sound obvious, but the first step in setting rates that reflect the true cost of delivering safe drinking water is determining how
much it costs to operate your system every year (your annual costs).
In determining your costs, you need to consider all aspects of your system, such as physical equipment, staff, outstanding loans,
and mortgage payments. Knowing what your costs are and understanding how they have changed in the past and can change in
the future is key to knowing how much money you will need to collect from your customers every year.
Annual Costs Worksheet
The Annual Costs Worksheet helps you determine the annual costs of running your water system. To make sure that you collect
enough revenue to cover the full cost of delivering water to your customers, you need to know your full annual operating costs.
There are many ways to account for your system's costs. You should pick one that works well with your current accounting system
and that supports the rates you plan to use. Any approach you use must fully account for your costs. To estimate these costs, review
records of last year's expenditures and take into account anything that might change over the next 5 years (e.g., increased energy
costs). Remember to include only costs related to the provision of water.
You should complete the Annual Costs Worksheet every year.
Two copies of the worksheet are provided. The first worksheet is a completed example. The second copy includes instructions on
how to complete the worksheet.
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Explanation of Example Annual Costs Worksheet
To better understand this system's financial condition, the water system's manager has completed an annual cost worksheet that
estimates costs for the upcoming year. To develop the estimates, the manager reviewed records of the system's costs from the past
year. In doing so, the manager included:
• personnel costs such as salaries, wages, and benefits;
• non-personnel costs for things like equipment, supplies, utilities, the purchase of water, waste disposal, laboratory costs, and
taxes and franchise fees; and,
• costs for debt service and other interest owed by the system.
Note that most costs are for maintenance, salaries and benefits, and chemicals.
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Example Annual Costs Worksheet
Date Worksheet completed/Updated: 6/19/05
Personnel Costs $126,627
Non-Personnel Costs (excluding debt service)
$84,857
Debt Service
£25,570
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Using the Annual Costs Worksheet
This section presents instructions for completing the Annual Costs Worksheet. Each step presented here corresponds to a num-
bered section of the sample worksheet on page 15.
Step 1: Enter the date. Circle whether you are completing or updating the worksheet and fill in the date. You should update this
worksheet once a year. You can either make minor adjustments to the worksheet or start a new worksheet each year.
Step 2: List your annual costs. Fill in your costs on the lines provided. Divide your costs into three categories:
Personnel costs for costs such as salaries and wages for administrative staff and functions, for operations and mainte-
nance staff and functions including labor costs for treatment, monitoring, maintenance, and testing; and benefits paid on
their behalf, including medical insurance, retirement, vacation, etc. Also include billing operations, including meter
reading, mailing of bills, and processing of returns. Note that costs for billing operations, meter reading, and processing
of returns can be contracted to a third party. If your system contracts these services, include them as non-personnel
costs (excluding debt service).
Non-personnel costs (excluding debt service) for costs of operating the office, including rent and utilities; property,
general, and liability insurance, workers' compensation, insurance on vehicles; accounting, legal, engineering, and other
professional services; annual principal and interest payments on mortgages; office supplies, computer software, etc.;
utilities for the operation of the system, including electricity and telephone charges; supplies used in the day-to-day
operations of the system and maintenance of the system (not including major capital purchases); purchase of treated
and untreated water that is resold to customers; chemicals; annual expenses on equipment leased to operate the sys-
tem; cost of regular maintenance and repair of equipment (not including major repairs); cars, trucks, etc. used in daily
operations; certification and training of operations staff; removal or disposal of waste residuals from water treatment;
testing associated with water quality monitoring; equipment used for security, like locks and video tapes; other miscella-
neous costs, taxes paid on annual profits, and franchise fees. (Public systems may include payments made in lieu of
taxes not including indirect taxes like sales taxes charged by the utility, amounts withheld from employees for federal or
state income tax liability, or amounts withheld from employees for their social insurance contributions).
Debt service for cost of annual principal and interest payments on debt of the system incurred to finance investment,
other than mortgages. Also,include any other interest owed by the system.
Step 3: Calculate total annual costs. Calculate your total costs by adding the annual costs you listed in Step 2. Enter this
number in the box marked "Total Costs."
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Annual Costs Worksheet
Date Worksheet Completed/Updated:
Personnel Costs
Non-Personnel Costs (excluding debt service)
Debt Service
15
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Preceeding Page Blank
Step 2 - Determining Your Current Revenue
After determining your costs, you need to calculate how much money you collect every year (your annual revenue).
Annual Revenue Worksheet
The Annual Revenue Worksheet will help you account for your annual revenue and includes de-
tailed instructions for determining:
1. Your system's annual revenues from current rates, interest, and other sources of
revenue.
2. Any additional revenue including how much money you save every year as a result of
subsidy and transfer payments (e.g., the portion of your town's property tax revenue that is
allocated to your system).
Two copies of the worksheet are provided. The first worksheet is a completed example. The second copy includes instructions on
how to complete the worksheet.
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Explanation of Example Annual Revenue Worksheet
After completing the Annual Costs Worksheet, the water system manager completes the Annual Revenue Worksheet to get an
accurate picture of the money the system will likely spend in the upcoming year versus the amount of money it will take in. When
accounting for annual revenue, the manager includes the additional revenue, including revenue from a grant and transfer payment
the system expects to receive to complete a capital improvement project. Note that in the example worksheet almost all revenue (97
percent) comes from water sales.
Looking at the total costs identified in the Annual Costs Worksheet ($235,054) and subtotal of operating revenue and interest listed
in the Annual Revenue Worksheet ($228,024), it appears that this water system's costs and revenues are fairly even (taking into
account the total additional revenues). However, this worksheet does not account for the money that the system will need to set
aside every year to cover the infrastructure rehabilitation and replacement costs that most likely will arise. By calculating how much
money the system should contribute annually to a reserve fund in Step 3, the system manager will have a much better picture of the
system's financial situation.
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Example Annual Revenue Worksheet
Date WorksheeVCompletedJllpdated: 6/19/05
Operating Revenue and Interest
Water Sales
Fees and Service Charges
(include late fee, connection fee, fire fee, system development fee, etc).
Interest
Other
Subtotal Operating Revenue and Interest
Additional Revenue (Subsidies)
Grants
Transfer Payments
Other
Subtotal Additional Revenue (Subsidies)
Total Annual Revenue
$221,465
$4,881
$967
$711
$228,024
$1,824
$4,000
$432
$6,256
$234,280
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Using the Annual Revenue Worksheet
This section presents instructions for completing the Annual Revenue Worksheet. Each step presented here corresponds to a num-
bered section of the sample worksheet on page 21.
Step 1: Enter the date. Circle whether you are completing or updating the worksheet and fill in the date. You should update this
worksheet once a year. You can either make minor adjustments to the worksheet or start a new worksheet each year.
Step 2: List your operating revenue and interest. Fill in your revenue in the lines provided. If your system has other sources of
revenue not listed on the worksheet, enter them on the "Other" line provided. Do not include funding you expect but have
not yet secured.
Step 3: Calculate total operating revenue and interest. Calculate your total operating revenue and interest by adding all the
operating revenue and interest you listed in the previous step. Enter this number in the box marked "Subtotal Operating
Revenue and Interest."
Step 4: List any additional revenue (subsidies). Fill in additional revenues on the lines provided. This category should include
subsidies such as any grants to support day-to-day operations of the system, transfer payments, or other subsidies you
receive that are used to support day-to-day operations of the system.
Step 5: Calculate the subtotal of additional revenue (subsidies). Calculate your total additional revenue by adding all the
additional revenue (subsidies) you listed in the previous step. Enter this number in the box marked "Subtotal Additional
Revenue (Subsidies)."
Step 6: Calculate the total annual revenue. Calculate your total annual revenue by adding the operating revenue and interest
you listed in Step 3 to the additional revenue (subsidies) you listed in Step 5. Enter this number in the box marked "Total
Annual Revenue."
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Annual Revenue Worksheet
Date Worksheet Completed/Updated:
Operating Revenue and Interest
Water Sales
Fees and Service Charges
(include late fee, connection fee, fire fee, system development fee, etc).
Interest
Other
ubtotal Operating Revenue and Interest
Additional Revenue (Subsidies)
Grants
Transfer Payments
Other
Subtotal Additional Revenue (Subsidies)
Total Annual Revenue
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Step 3 - Setting Aside a Reserve
Having enough revenue to cover your costs is the first step in ensuring that you can
consistently provide high-quality drinking water. Two more critical components to pro-
viding safe drinking water are taking care of your facilities and equipment and planning
for any needed repairs and replacements.
You should set aside money every year in a reserve account to help fund asset replace-
ment and rehabilitation. The amount that you need to save must be factored into your
system's rates because rehabilitation and repair costs are part of the overall cost of
providing service. If you do not already have a reserve account, consider establishing
one as soon as possible; having a reserve account is critical to developing financial
capacity.
To establish and properly fund a reserve account you will need to rely on your capital
improvement plan, in which you establish your asset rehabilitation and maintenance
priorities and determine the funding required for these improvements. Asset manage-
ment will be an important tool to help you do this. Asset management can be a lengthy
process, but it involves five basic steps that will help you determine how much you
should set aside in a reserve fund each year:
Asset Depreciation
Dn
;e of
Each time you operate a piece
equipment, you subject it to wear and
tear, thereby reducing its value. This
loss in value is called depreciation.
Some water systems include depre-
ciation in their budget as a cost of
operation. Depreciation can be a
useful guide for determining the
annual contribution to your reserve
fund. Additional information is avail-
able in Appendix F.
1. Develop an inventory of all of your assets by listing them and collecting information on the condition, age, service history,
and useful life of each one.
2. Prioritize your assets to help you decide how best to allocate your limited resources. Priority should be based on the asset's
importance to the operation of your system and the protection of public health. Other factors to consider include how soon
you will have to replace the asset (its remaining useful life) and whether other pieces of equipment can do the same job (its
redundancy).
3. Determine the costs of asset rehabilitation and replacement.
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4. Decide what percentage of these costs you will cover with cash (i.e., money you set aside in the reserve account), and how
much you will cover through grants or loans. (In some cases, it may make more financial sense to borrow money to cover the
cost of the project.)
5. Review and revise your plan. Your asset management plan should be used to help you shape your system's operations. It
should evolve as you gain more information and as your priorities change.
This process will help you determine how much money you need to raise every year through rates to generate the cash necessary to
implement your capital improvement plan. While this is a very brief description of how to determine how much you need to save in
your reserve fund every year, if you do not already have a reserve account in place, it is a good first step towards thinking about how
you will prepare your system to cover the costs of expensive repair and replacement projects.
There are other resources available to help you develop an asset management plan. EPA's Asset Management: A Handbook for
Small Water Systems (EPA 816-R-03-016) will guide you through inventorying and prioritizing your assets using a series of
worksheets and examples. For more information on long-term planning, you also can consult EPA's Strategic Planning: A Handbook
for Small Water Systems (EPA 816-R-03-015).
Determining Your Required Reserve: An Example
Using Asset Management: A Handbook for Small Water Systems, the water system manager completes an asset management plan
that prioritizes the system's assets and determines what rehabilitation and replacement projects will be necessary during the next
five years. The manager also determines what large longer-term capital improvement projects the system needs to start saving for
now. Using engineering reports and historical cost data, the manager estimates the total cost of the capital improvements required.
The manager then determines how much cash the system will use to make these improvements and the amount it will need to
borrow. For this example, the manager determines the system must contribute $87,400 to a reserve fund in the first year to imple-
ment its plan. The water system manager completes his asset management plan each additional year and adjusts the annual re-
serve contribution to account for changing priorities and water system needs. The system manager will use the first year's reserve
contribution in the calculation of the annual revenue that must be recovered from customers in Step 4: Determining Actual Revenue
Required from Your Customers.
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Step 4 - Determining Actual Revenue Required from
Your Customers
Now that you have a better sense of what your costs and revenues will be and how much
money you will need to put in your reserve account over the next few years, you are ready to
determine the total revenue that you will need to collect from customers each year. To cover
the full cost of doing business (i.e., to meet the goals of full-cost pricing), the amount of
revenue that you receive from your customers should equal your total annual costs including
your annual reserve contribution minus any subsidies or transfer payments you receive.
You will need to calculate your required revenue annually, taking into account your budget for
the upcoming year. In addition, you will need to think beyond your needs for the next year.
Variable costs, changes in subsidies, debt service costs, and other factors can affect your
required revenue from year to year. Estimating costs for the next several years based on
your fixed costs, operating expenses, asset rehabilitation and repair needs, and existing
grants or loans can help avoid a significant gap between revenue and costs. Once you have
a better idea of actual costs for future years, you can revise your estimates accordingly.
The next worksheet will help you with short-term planning. Use the worksheet to calculate your revenue requirements for the
upcoming year and to estimate how much revenue you need to generate over the next 5 years.
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Short-term Revenue Required from Your Customers Worksheet
The Short-term Revenue Required from Your Customers Worksheet will help you calculate how much revenue you need to generate
every year from customer charges. This activity will take into account the annual costs and revenues that you calculated in the
Annual Costs Worksheet on and the Annual Revenue Worksheet and the amount you need to reserve every year to replace and
rehabilitate assets, as determined in Step 3.
Financial planning is an important step in avoiding large revenue shortfalls. Knowing what your costs and revenues will be over the
next several years will help you decide now whether you will be able to recover your costs through customer charges, whether rate
increases will be necessary to cover costs over the next few years, how your surplus or deficit will change over time, and whether
you will need to consider restructuring your system, as described later in this guide.
The Short-term Revenue Required from Your Customers Worksheet will help you develop a detailed estimate of your costs and
revenue for the next 5 years. This, in turn, will help you understand the need for and impact of rate increases over the next few years
as you work towards recovering costs through water rates. This worksheet displays information for the current year and can be used
to develop long-term estimates as well.
Long-term planning is another important step to ensuring the financial health of your system. Estimating your costs for the next 15 to
20 years will help you identify future large capital improvement projects that you should start saving for now. You may want to use a
worksheet similar to the Short-term Revenue Required from Your Customers Worksheet to evaluate your long-term revenue needs.
You can estimate your operating costs, reserve contribution requirements, revenue needs, and surplus or shortfall for five-year
increments rather than each year.
EPA's Strategic Planning: A Handbook for Small Water Systems (EPA 816-R-03-015) is a good source of information that will guide
you through the long-term planning process using worksheets and examples.
Two copies of the worksheet are provided. The first worksheet is a completed example. The second copy includes instructions on
how to complete the worksheet.
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Explanation of Example Short-term Revenue Required
from Your Customers Worksheet
After factoring in the amount the system needs to put into its reserve account in the first year ($87,400), the system manager deter-
mines that the system's actual revenue will not be enough to cover its costs. The manager has to decide how the system will begin
to cover those costs. The manager also needs to estimate costs and revenue for the upcoming years to determine whether this
problem will continue and to determine whether it is possible to increase customer charges at a reasonable rate to eliminate this
shortfall. To do this the system manager:
• Estimated the system's annual cost are $235,054 (page 13).
• Adds the estimated annual costs to the system's reserve fund contribution ($87,400) determined on page 23.
• Subtracts the total additional revenue (subsidies) calculated on page 19 from the sum of the system's total costs and total
reserve fund contribution.
• Estimates the amount of money the system needs to cover its costs in the first year is $316,198. The manager will use this
amount to determine its rates.
Looking out a few years the manager realizes that despite a fairly small deficit in the first year, the system's failure to recover costs
could become a much bigger problem as early as five years from now. The system's operating costs are expected to increase every
year, and the amount the system needs to contribute to the reserve fund may change because the system manager completes Step
3 annually and realizes repair and replacement needs and priorities change. The manager realizes that, to make a dent in the grow-
ing deficit while avoiding customer rate shock, the system must seriously consider cutting operating costs, rethink how often and
how much water rates should be increased, and consider changing the way customers are charged.
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^^ ^Fxample Short-term Revenue Required from Your Customers Worksheet
Date Worksheel(Completed)jpdated: 6/29/O5
^ ^
Annual Operating Costs:
Annual Reserve Fund Contribution:
Total Annual Cost of Business:
Total Additional Revenue (subsidies):
Total Annual Revenue Needed:
(Total Annual Cost of Business - Total
Additional Revenue)
Projected Revenue:
Revenue Surplus or Deficit:
Cumulative Surplus/Deficit:
Year: ZOO 6
$235,054-
$87,4-00
$322,4-54-
$6,256
$316,198
$228,024-
($88,174-)
($88,174-)
Year: 2OO7
$258,555
$89,350
$34-7,905
$8,100
$339,805
$230,500
($109,305)
($197,4-79)
Year: ZOO 8
$284-,250
$83,300
$367,550
$7,900
$359,650
$235,820
($123,830)
($321,309)
Year: 2OO9
$312,000
$85,670
$397,670
$8,000
$389,670
$239,600
($150,070)
($4-71,379)
Year: 2O10
$34-2,850
$82,670
$4-25,520
$8,600
$4-16,920
$24-5,200
($171,720)
($64-3,099)
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Using the Short-term Revenue Required from Your Customers Worksheet
This section presents instructions for completing the Revenue Required from Your Customers Worksheet. Each step presented here
corresponds to a numbered section of the sample worksheet on page 29.
Step 1: Enter the date. Circle whether you are completing or updating the worksheet and fill in the date. You should update this
worksheet once a year. You can either make minor adjustments to the worksheet or start a new one each year.
Step 2: Enter the year(s). Enter the year(s) for which you are calculating your estimates.
Step 3: List total annual operating costs. Enter your estimated total costs per year for the first 5 years starting with the total
costs you determined in the Total Annual Costs Worksheet. For the next four years consider total annual costs from
previous years and adjust them, taking into account any information you have on debt payments.
Step 4: List total annual reserve fund contribution. Enter the total annual required reserve amount as discussed in Step 3.
(Use the Asset Management Step Guide to calculate your reserve fund needs.)
Step 5: Sum costs and reserve fund contribution. Add the amount entered in Step 3 (total annual costs) to the amount entered
in Step 4 (required annual reserves) and enter the total in the box provided.
Step 6: List total additional revenue (subsidies). Enter the total additional revenue (subsidies) amount calculated on the
Annual Revenue Worksheet (grants plus transfer payments).
Step 7: Calculate total revenue needed. Subtract the total additional revenue entered in Step 6 from the sum of your costs and
reserve fund contribution calculated in Step 5. This is the estimated amount of money that your system must generate to
cover its costs for each year.
Step 8: Enter projected revenue. Enter the amount you anticipate your system actually will take in from customer charges each
year based on the operating and interest subtotal amount calculated on the Annual Revenue Worksheet.
Step 9: Enter funding deficit or surplus. Subtract the number in Step 7 from the number in Step 8 and enter the result. If the
result is zero or greater, you are taking in enough money to fully recover your costs (and possibly more). If the result is a
negative number, you will not recover all your costs and should re-evaluate your rates based on this figure.
Step 10: Enter cumulative surplus/deficit. Sum the surplus or deficit from each of the previous years.
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Short-term Revenue Required from Your Customers Worksheet
Date Worksheet Completed/Updated:
Annual Operating Costs:
Annual Reserve Fund Contribution:
Total Annual Cost of Business:
Total Additional Revenue
(subsidies):
Total Annual Revenue Needed:
(Total Annual Cost of Business -
Total Additional Revenue)
Projected Revenue:
Revenue Surplus or Deficit:
Cumulative Surplus/Deficit:
Year:
Year:
Year:
Year:
Year:
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What if My System's Costs Exceed Its Revenue?
After determining whether you have a deficit or a surplus, you may need to re-evaluate how your system is operated and how you
are generating revenue. If the actual revenue exceeds the amount needed to cover all costs, you are in good financial shape. This
surplus may be due to fluctuations in demand and may disappear in future years. While your system may face a shortfall or surplus
in any given year, your revenue requirement should be met over the longer-term. If your actual revenue is consistently below the
amount required to cover all costs, you may need to consider options for reducing the gap between actual and required revenue.
Some options are:
• Reducing operating costs.
• Finding additional sources of revenue.
• Restructuring, which includes such options as purchasing water from another system rather than pumping and treating from
your own source, consolidating your operations with a nearby water system, or contracting the operation and maintenance of
your water system to another party in order to obtain increased operational efficiency and possibly reduce costs.
If the gap between your actual revenue and the revenue needed to cover your costs is as high as 50 percent, you should contact
your state (see Appendix B) to discuss your restructuring options; it is unlikely that you could eliminate the deficit through customer
charges alone.
Accounting for Subsidies
Many systems receive subsidies that lower the costs faced by their customers. For example, your system may receive an explicit
transfer from your local municipality or a grant from the federal, state, or local government to help finance your operations. Or, your
system may not pay the full cost of some of the goods and services it uses or may pay interest rates on loans that are less than the
rates charged in private markets. These subsidies will reduce the amount of revenue you must generate through rates and fees.
Your annual deficit would be larger (or your annual surplus would be smaller) if you did not receive these subsidies. However, keep
in mind that these subsidies should be used as a way to achieve financial stability, not as a permanent solution for revenue short-
falls.
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Step 5 - Designing a Rate to Cover Your Costs
Now that you know your costs and the amount of money you need to collect from your customers to fully cover those costs, Steps 5
through 7 will help you start thinking about how you're going to collect this money. One
way is through water rates.
Considerations for Choosing a Rate Structure
Water rates can be structured in several different ways and there are a number of things
to consider, in addition to recovering costs, when selecting the best rate structure for
your system and your customers.
To determine which structure is best for your water system, you should evaluate the
characteristics of your system, its customer base, and your options for maintaining the
predictability of rates and any rate increases. In addition to recovering all your costs, you
should consider:
1. Rate Stability. Customers are more likely to pay for rate increases if their rates are generally stable. Most systems know
that the worst thing they can do is maintain a stable rate for many years, then increase it by 10 percent or more. A single,
large increase can lead to "rate shock" and opposition to the increase. It is far better to increase rates by 2 percent per year
for 5 years than 10 percent once every 5 years.
2. Rate Predictability. As the manager of a small water system, you need to know how much revenue you expect to take in
next year and in the years to come. However, predicting revenue can be difficult, as water use can vary from year to year.
Water use can increase significantly during a dry year and decrease during a wet year. If you promote conservation, you
may see a reduction in water use, requiring a rate increase. This lack of predictability should not discourage you from experi-
menting with rate structures that promote a valuable public program (like conservation). Instead, you should aim to generate
and keep sufficient reserves so that your system can survive a significant decrease in water use.
3. Number of Customers. If your system serves fewer than 500 persons, the simplest approach to rate setting might be to
take the revenue you need to raise and divide it more or less equally among your customers. If you serve more customers,
you might choose an alternative rate structure, e.g., increasing block rates (discussed in more detail on page 43).
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4. Customer Classes. Some systems may serve only residential customers while others also serve industrial, commercial, or
agricultural customers. Residential, industrial, commercial, and agricultural customers may have very different patterns of
water use. The cost of servicing these customers may be different as well. You may want to use different rates and rate
structures for different classes of customers in order to meet their specific needs.
5. Water Use. Examine your customers' water use habits during peak and off-peak seasons. If most of your customers use
roughly the same amount of water, a flat fee might make the most sense for your system. If your customers use significantly
different volumes of water, you should consider charging for the amount of water used. A family of four should not expect to
receive the same water bill as a car wash or laundromat.
Water is a scarce commodity. You can structure rates so that they send a "price signal" to customers and encourage conser-
vation. Customers who recognize the value of the service you are providing will be more likely to use that product in a way
that reflects its true value.
6. Customer Needs. There may be differences among customers within a class that affect the cost of providing water service
to them, or their ability to pay for that service. For example, some residential customers may have low fixed incomes and
therefore may have difficulty paying their water bills. Faced with these types of issues, you may want to consider rate struc-
tures that allow for different rates for customers with different needs within a single customer class.
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Common Rate Structures
There are six common types of rate structures, described in more detail below: flat rate or fixed fee, uniform rate, decreasing
block rate, increasing block rate, seasonal rate, and single tariff.1 Under each of these rate structures, systems have the flexibil-
ity to set different rates for different categories of customers (for example, different rates for residential users and agricultural users).
Flat Rate/Fixed Fee f?afe Structure
Under this rate structure, your customers pay the same amount regardless of how much water they use. A flat rate/fixed fee structure
may make sense for very small water systems whose customers all use about the same amount of water. It can save your system
the cost of installing meters, which are necessary when implementing a rate structure that is based on water consumption. If the cost
of installing meters will far outweigh the benefits of having them in place, this may be the best option for your system, for the time
being.
However, in times where water use is higher than average, your system will not be generating the additional revenue needed to keep
up with higher demand (e.g., additional treatment costs). In addition, this rate structure offers no incentive for customers to conserve
water. Also, keep in mind that some states award additional DWSRF priority points to applicants that have meters in place. Despite
the cost, meters are a worthwhile long-term investment.
Uniform Rate Structure
The uniform rate structure is similar to the flat rate/fixed fee structure, but it is based on customers' water consumption and requires
meters. Under this structure, customers are charged a uniform rate per unit of water (e.g., gallon, hundred cubic feet) regardless of
the amount of water used. This rate structure can also include a fixed service charge. Uniform rate structures are most appropriate
for systems whose customers have similar water use patterns.
This rate structure can guarantee a stable revenue stream for your system and can help encourage conservation because the
average cost of water does not decline as use increases as it does with fixed fees or decreasing block rates, discussed below. It is
fairly easy to implement and easy for customers to understand.
Information provided on the rate structures below draws from: Janice A. Beecher, Ph.D. and Patrick C. Mann, Ph.D., with John D.
Stanford, J.D., Meeting Water Utility Revenue Requirements: Financing and Ratemaking Alternatives, The National Regulatory
Research Institute, Columbus, OH, November 1993.
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Decreasing Block Rate Structure
Under this rate structure, customers are charged lower rates per unit of water for successive blocks (fixed quantities). As with uni-
form rates, systems may charge a fixed fee in addition to the decreasing block rates. This rate structure is especially beneficial for
industrial or commercial customers who use large amounts of water.
However, this rate structure can be difficult to implement and offers little incentive for customers to conserve water. In addition, it
may result in insufficient revenue for the system if demand is unexpectedly high or an unanticipated future need arises. A system
must also have meters in place in order to implement this rate structure.
Increasing Block Rate Structure
Under this rate structure, customers are charged higher rates per unit of water for successive
blocks (fixed quantities). Systems may charge a fixed fee in addition to the increasing block rates.
This rate structure sends a strong signal to customers about the value of the service you are
providing and offers the most incentive for customers to conserve water. The reduction in water
use that conservation brings can ease any potential strains on system infrastructure, potentially
postponing or eliminating the need for expensive upgrades or new equipment. This rate structure's
emphasis on conservation is also beneficial for systems with a limited water source or high treat-
ment costs. The increasing block rate structure does require meters.
Seasonal Rate Structure
Changes in water use patterns from season to season due to changes in weather occur at most systems. In a smaller subset of
systems, these fluctuations can be more extreme, for example, if a system serves a significant number of seasonal customers.
These systems may want to consider implementing a seasonal rate structure. Under this rate structure, you would charge higher
rates to customers during peak season.
A seasonal rate structure is not appropriate for all systems that experience seasonal fluctuations in water use. Consider this rate
structure if: increases in usage occur over the same time period every year, the variation in usage between seasons is significant,
and your system's capacity is determined by demand during peak season.
Systems can apply one of two forms of seasonal rate structure. The first option is to set one rate for the off-peak season and one for
the peak season (these rates can be uniform or increasing or decreasing block rates). The second option is to set one rate (uniform
or increasing block rate) and apply excess usage charges (i.e., charge for water use in excess of that used on average during off-
34
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peak times) during peak season. In this second option, customers' rates increase in the peak season only if their use is higher than
during the off-peak season.
Seasonal rates can encourage conservation, reducing peak use and therefore limiting the need to
expand system capacity (as maximum capacity is determined by peak use rates). In addition, for
systems in areas with a significant seasonal population, customers using water during off-peak
months would not be required to shoulder the full burden of recovering system costs incurred
primarily during peak season.
Setting seasonal rates may require you to increase the frequency with which meters are read, as
you will need to assess average usage at the beginning and end of peak and off-peak periods and
intermittently throughout each period to fairly distribute costs among peak and off-peak season
customers.
Single-Tariff Rate Structure
Some small systems are consolidated into larger systems that have a single owner. This does not mean that the systems are con-
tiguous to one another or physically interconnected, just that one utility owns all of the small utilities. In such a situation, one ap-
proach to rate design would be to allow each of the small systems to establish its own rate structure. Since systems vary in terms of
their operating characteristics and their costs of operation, each would design rates to recover its own costs.
This, however, is not the only option. Under the concept of "single-tariff pricing," the larger utility that owns all of the small utilities can
use a single tariff (or single rate structure) for all of the customers it serves, regardless of the specific costs of each small system that
it owns. This approach is particularly useful for large systems when they are acquiring systems, many of which may need substantial
investment. Making that investment in each very small system acquired, and charging the full cost of that investment to the custom-
ers of that system, would be a burden to those customers. Spreading the costs over the entire customer base of the larger utility can
make rates more stable and affordable for all customers.
Single-tariff pricing removes the direct link between a small system's cost structure and its rates, and it therefore may be less effi-
cient than other options. It may fail to send the proper price signals to customers. On the other hand, it will stabilize rates and rev-
enues and mitigate rate shock. It also will make rates more affordable for customers of the smallest and most expensive systems. If
you are considering a single-tariff rate structure, see http://www.epa.gov/safewater/utilities/stptitle.pdffor more information.
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Estimating the Amount of Water Used by Customers
Now that you have reviewed some of the other rate considerations and common rate
structures, you need one final piece of information to set your rates. Most water rates are a
charge per unit of water (except a flat rate/fixed fee). To ensure that you meet your revenue
requirement, your rates must equal the amount of money you need to collect from customers
based on the amount of water delivered to your customers. Therefore, unless you use a flat
rate or fixed fee, information on water usage is necessary to set rates.
This information will also help you allocate costs, which will be important if you plan to use a
different set of rates for each customer class. For example, if residential customers use
three-quarters of the water sold by your system, you may want to collect three-quarters of your
revenue from residential customers. Or if you have seasonal variation in use, you may want to
allocate costs between peak and off-peak seasons.
All of the water your system draws from its sources may not be delivered to paying customers.
For example, your system may not charge customers for all of the water it delivers. A common
example of uncompensated usage is water provided to municipalities for firefighting. Your
system also may consume some of its water during treatment. A system that filters its water, for example, may use some water to
backwash its filters. Finally, your system may have water losses, due to leaks in the distribution network or elsewhere. Water meters
that monitor withdrawals from the source and meters that monitor water delivered to the customer can help you identify and address
that water loss. Remember that rates are calculated using the full cost of producing, treating and storing water. Therefore, it is
important to have good estimates of the amount of water used by your customers in order to ensure that all of these costs are
divided fairly among customers.
The best source of information to determine the amount of water used by your customers is your billing data. On average, most
water systems measure the amount of water used each month. If your system does not have meters in place, you may need to
estimate the amount of water used by your customers. If you have more than one class of customer, you should determine the
amount of water used by each class. (If the volume of water used by customers in each customer class is similar, you may want to
determine the total water use for all customers.)
In addition, you may choose to divide your customer classes into blocks based on the amount of water they use. For example, you
may want to determine the number of customers and volume of water delivered to residential customers using up to 1,000 gallons
36
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each month, 1,001-2,000 gallons, 2,001-3,000 gallons, and so on. But if you find that average usage does
not vary across customers, you may not need to make these distinctions.
Average Monthly Usage Worksheet
The Average Monthly Usage Worksheet will help you summarize usage by having you determine the number
of service connections served by your system in each customer class and the total amount of water used by
these connections in a typical month. If you have seasonal variation in usage, you may want to divide use into
peak and off-peak seasons. You can fill out a separate worksheet for each customer class if use varies by
class. If usage is similar across customer classes, you can fill out one worksheet for all your customers.
The worksheet lets you divide your customers into blocks based on the amount of water they use. The num-
ber of blocks you use and the cut-offs for each block is up to you and will depend on the type of rate structure
you wish to implement and the objectives you hope to achieve with your rates. If you choose to divide your
customer classes into more than one block, use billing records or meter books to determine the number of
customer service connections that fall into each block and the total volume used by customers in each block.
If you do not have exact information on water usage, use estimates.
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Explanation of Example Average Monthly Usage
Worksheet
To better understand this system's customer base, the water system's manager uses information from billing records covering the
past 2 years and categorizes residential customers according to their average usage habits. The manager divides the system's
residential customers into usage blocks. The manager considers implementing an increasing block rate with 2 blocks. To divide the
residential customers into 2 blocks, the manager sets the first block of usage between 0 and 7,000 gallons per month, and the
second block at more than 7,000 gallons per month. The manager determines the total number of residential customer service
connections that use no more than 7,000 gallons of water each month and the total amount of water used by these customers. The
manager then determines the number of customer service connections that use more than 7,000 gallons per month and the total
amount of water used by these customers. If the manager wants to use more than 4 blocks, additional rows can be added to the
worksheet. The manager fills out a similar worksheet for the system's non-residential customers.
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Example Average Monthly Usage Worksheet
Date WorksheeiVCompleted/'Jpdated:
Customer Class:
Unit of measure of monthly usage:
6/17/05
Water Usage per Month per
Customer
0-7,OOO
> 7,OOO
Number of Service
Connections
520
610
Subtotal Usage per Month
4,9O2,OOO
1,130
7,692,000
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Using the Average Monthly Usage Worksheet
This section presents instructions for completing the Average Monthly Usage Worksheet. Each step presented here corresponds to a
numbered section of the sample worksheet on page 41.
Step 1: Enter the date. Circle whether you are completing or updating the worksheet and fill in the date. You should update this
worksheet once a year. You can either make minor adjustments to the worksheet or start a new one each year.
Step 2: Enter the customer class. If you have a single customer class, enter the customer class on the line. If you have more
than one customer class, you may want to complete one worksheet for each customer class. If you plan to charge all
customers the same rate, you can enter the total number of customers and their water usage in one table.
Step 3: Enter the unit of measure of monthly usage. Enter the units in which you measure water volume (e.g., gallons, cubic
feet, acre feet).
Step 4: Determine a water usage block. Divide the number of customers and the amount of water used into blocks. If you plan
to use a uniform rate, you can use only one block-i.e., put the total number of customer connections and the total amount
of water used by these customers on a single line. If you plan to use an increasing or decreasing block rate, you will need
several blocks. Enter the cut-offs for the blocks on the lines provided. You should add rows to the table if you want to use
more than four blocks.
Step 5: Estimate the total number of service connections. Enter the total number of service connections that your water
system serves for each block of water.
Step 6: Enter the total volume of water used each month. Using billing records, meter records, or your estimates, enter the
total usage for each block. If you plan to use seasonal rates, you should distinguish between peak and off-peak usage.
Step 7: Enter the total number of service connections for all blocks. Add the total number of service connections for each
block of customers you listed in Step 5. Enter the total on this line.
Step 8: Enter the total amount of water used for all blocks. Add the total amount of water used for each block of customers
you listed in Step 6. Enter the total on this line.
40
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Average Monthly Usage Worksheet
Date Worksheet Completed/Updated:
Customer Class:
Unit of measure of monthly usage:
Water Usage per Month per
Customer
Number of Service
Connections
Subtotal Usage per Month
456
7 8
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Fixed and Variable Rates
Just as your water system has fixed and variable costs, you can set fixed and variable rates. A fixed rate is an amount that your
system charges each customer every month, regardless of how much water the customer uses. Fixed rates guarantee stable,
predictable revenue, regardless of how much water your customers use; they also can be used to cover your system's fixed costs. A
variable rate can be based on customer usage, which is determined by routine meter readings. The more water a customer uses, the
more the customer has to pay (in addition to the fixed rate). Variable rates are a good way to encourage water conservation.
If your revenue becomes too unpredictable because of aggressive conservation programs, one could place somewhat more reliance
on fixed rates. You would still be sending a price signal to customers through variable rates, but fixed rates could help preserve
some predictability in revenue from year to year.
Using fixed and variable rates works best in combination with a block rate or seasonal rate structure and the use of meters. Although
installing meters can be expensive, the expense can be well worth it in the long run. Meters will give you a much more accurate
picture of how usage varies among customers, how usage varies seasonally, and whether your efforts to encourage conservation
have been successful. Meters can also help you identify any structural problems within the system. This information can help you
more accurately predict future costs and, therefore, set rates that are designed to recover your costs.
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Now that you have organized your usage data, you may want to consider using the data to set rates. There are many ways to set
rates; the option you choose should reflect the considerations discussed at the beginning of this step. The basic steps are the same
for each approach: the revenue requirement is allocated to customers and then divided by the volume of water used by those cus-
tomers. In practice, the calculations can involve many steps and can be complex. Fortunately, there are many resources available to
help systems calculate rates for many different rate designs. (Appendix A provides information about some of these resources.)
The following example demonstrates how to set a uniform rate. It uses data from the previous example worksheets and assumes
that the system serves only residential customers.
• Using data from the Average Monthly Usage Example worksheet (page 39), we see the system serves 1,130 single-family
residential customer connections.
• The Average Monthly Usage Example worksheet (page 39) shows that total consumption is 7,692,000 gallons per month. Over
the full 12 months of the year, consumption is 92,304,000 gallons.
• In the Short-term Revenue Required from Your Customers Example worksheet (page 27), we see the annual revenue the
system must recover from customers is $316,198 in 2006.
• The system chooses to recover its costs through a uniform rate. The water rate will be set per thousand gallons of water used.
Water usage is reported in gallons and must therefore be divided by 1,000 to convert from gallons to thousands of gallons.
To meet its annual revenue requirement with a uniform rate, the
system must divide the revenue it will need by the volume of water $3-16,198 $3.43 per
it will sell during the year. Therefore, the uniform rate per thou- "' °rm = = thousand
sand gallons that meets its revenue requirement is: 92,304 (thousands of gallons
gallons)
Each customer would be charged $3.43 per thousand gallons of
water delivered. Appendix A lists additional sources of information on rate setting, including electronic rate-setting tools. Now you are
ready to consider how to implement this rate; Step 6 will help you with this process.
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Step 6 - Implementing the Rate
Once you have decided on a rate structure and appropriate rates, it is important to consider a
number of other factors before charging your customers. Your rates may need to be adjusted
because of the particular circumstances of your system. Factors to consider include:
1. Public Perception. Customers should know what the rates are and should understand
that they will be paying a fair and equitable share of the cost of providing safe drinking
water. If, after calculating the amount you need to receive from customers every year, you
determine that a substantial rate increase is necessary, consider preparing outreach
materials (e.g., mailings, announcements in local newspapers, fliers) to explain the
reason for the rate increase. Make sure your customers understand that your ability to
provide safe drinking water depends greatly on having sufficient revenue, most of which
comes from customer charges. Keep your customers informed throughout the rate setting
process; informed customers are more likely to understand and tolerate rate increases.
You might also consider increasing your rates over a number of years or when water use
is low to make the rate increase easier on your customers.
2. Regulatory Requirements. Ensuring your water system has the resources to meet all current and
future state and federal drinking water requirements should be considered when setting rates.
3. Public Service Agency Requirements. The state may require formal approval to institute a rate or to change rates or rate
structures. See Appendix D for a list of Public Service Agencies.
4. Administration. The rate structure should be easy to administer. Complex structures may increase administrative costs and
confuse customers.
5. Security Planning. If financial considerations have prevented you from addressing security in the past, you should use the
rate setting process as an opportunity to fund those projects.
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Step 7 -
the Rate
Ideally, you should review your rates, rate structure, and rate setting procedures
at least once every year. Annual reviews ensure that your rate is appropriate
even if circumstances have changed (e.g., new regulatory requirements, in-
creasing customer base) and that you will continue to generate sufficient rev-
enue to cover costs.
You might also want to submit your rate structure for an independent review.
Your state or a technical assistance provider might offer programs to help you
evaluate your rate structure and set rates. Consider assembling a special
review committee, since a review performed by an external party can be more
transparent and impartial. Determining who should review the rate is an impor-
tant part of the process. Persons with management and budget experience are
good candidates for the review committee. Depending on your system, a review
committee could include:
1. Your water system's operator
2. The town clerk
3. A professional from the community (e.g., accountant, lawyer, water
system engineer)
4. A member of the town council
5. Customers
6. The manager of a neighboring system
Many states may require systems to receive formal approval to change rates or
rate structures. See the box on the right for more information.
Public Service Agencies
Every state has a Public Service Agency
(e.g., a Public Utility or Public Service Com-
mission). In some states, these agencies
evaluate water system proposals for rate
increases. During this process, the agencies
can also evaluate the system's financial
capacity.
Agencies primarily regulate privately owned
systems (particularly investor-owned sys-
tems). But some states also regulate publicly
owned small systems.
If you are regulated by a Public Service
Agency, you may receive special assistance
during the rate increase evaluation process.
Most agencies have established expedited
rate review procedures for small systems
and understand that you may not have the
resources to prepare the type of proposal
required of large systems. During the expe-
dited process, agency staff members often
meet with the system before a formal hearing
to discuss the proposal. Some agencies also
have simplified forms that can be used by
small systems.
To find out if you are regulated by a Public
Service Agency or if there are expedited
procedures for rate increase approvals,
check with your state. A list of state Public
Service Agencies is included in Appendix D.
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You Are on Your Way to a Financially Sound Future!
As you have learned, setting sustainable rates is an important part of ensuring your system's financial health. Accounting for all of
your system's costs including reserve contributions, and revenues including grants and subsidies will help you establish a full-cost
pricing structure so you can recover the funds necessary to provide safe drinking water now and in the future. This guide has helped
you:
• Determine the full cost of doing business.
• Determine your current revenues.
• Consider your reserve requirements to ensure you have enough funds to cover costs during the next 5 years.
• Calculate how much money you need to cover your costs and fully fund your reserve account using customer charges.
• Evaluate your options and design an appropriate rate.
• Implement the rate.
• Review your rates and make changes when necessary.
Ideally, you should review your system's rates each year using this guide to help you through the process. Although it takes time, an
annual rate review will ensure that you are maintaining a balance between your costs and revenues; maintaining adequate technical,
managerial and financial capacity; and, most important, delivering high-quality drinking water to your customers at a fair price. In
addition, communicating effectively with your customers about the full cost of doing business will have a positive impact on your
relationship with your customers and will help alleviate rate shock when a rate adjustment is necessary.
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Appendix A - Sources for More Information on Rate
Setting
Electronic Programs
1. The Environmental Finance Center at Boise State
University has developed several easy-to-use computer
programs to help water systems evaluate their financial
capacity and rate structure:
• CapFinance helps systems develop an inventory of
their assets and analyze funding options for rehabilita-
tion and replacement of assets.
• Ratios is a financial assessment tool that can help
systems identify potential problems and monitor their
financial situation. It analyzes data from eight areas:
operations, revenue, liability, sales, expenses, assets,
debts, and accounts receivable.
• RateCheckup is a rate setting program that generates
rate schedules and provides budgets and financial
forecasts.
For more information on these products, visit the Environ-
mental Finance Center online at http://
sspa.boisestate.edu/efc/services.htm or call (208) 426-
1567.
Show-me Water Ratemaker. The Missouri Department
of Natural Resources has developed analysis software to
help water systems set rates. To obtain a free copy visit
http://www.dnr.mo.gov/services/emi-suite/
Showme41Water.xls or call (800) 361-4827.
Safety/Setting Water Rates - Small Water Systems
Operation and Maintenance. The Office of Water Pro-
grams at California State University Sacramento devel-
oped a series of CD-ROMs. CD: 702E contains informa-
tion on setting water rates from the Small Water System
Operation and Maintenance manual. The CD is the
companion material for the 15-contact hour course on
safety and setting water rates but can be purchased
separately online at http://www.owp.csus.edu/
ordering.htm.
47
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Documents
1 A Guidebook of Financial Tools. This document is avail-
able by e-mail from: efin@epa.gov or by calling (800)
490-9198.
2. Financial Accounting Guide for Small Water Utilities,
Michael D. Peroo (Kansas Rural Water Association). This
document is available by calling the National Drinking
Water Clearinghouse, West Virginia University, 800-624-
8300.
3. Small System Guide to Developing and Setting Water
Rates, Rural Community Assistance Partnership, Inc. The
document is available by mailing or faxing a request to
RCAP at Rural Community Assistance Partnership, Inc.,
1522 K Street NW, Suite 400, Washington, DC 20005.
Fax: (202)408-8165.
4. Rate Setting and Capacity Development, the Environ-
mental Finance Center at the University of Maryland. The
document is available online at http://www.efc.umd.edu/
issues/Rate_Setting.cfm or by calling (301) 403-4220 ext.
26.
5. North Dakota's Small Community Water System's Hand-
book on Developing and Setting Water Rates, the Mid-
west Assistance Program, the Midwestern RCAP, under a
contract with the North Dakota Department of Health.
This document is available online at http://www.map-
inc.org/
Publications/Publications/WatrRate.pdf.
6. A Guide for Financing and Rate Setting Options for Small
Water Systems, Andrea L. Williams/Virginia Water Re-
sources Research Center, Virginia Polytechnic Institute
and State University. The document is available online at
http://www.vwrrc.vt.edu/pdf/sr-17.pdf.
Technical Assistance
1. EPA's Environmental Finance Program provides financial
and technical assistance to water systems and other
regulated entities. Visitwww.epa.gov/efinpage/ or call
(202) 564-4994 for more information about the program,
for access to the program's publications, and to reach the
Environmental Finance Center network.
Organizations
1. Governmental Accounting Standards Board:
www.gasb.org, (203) 847-0700.
2. National Association of Regulatory Utility Commissioners:
www.naruc.org, (202) 898-2200.
3. American Water Works Association: www.awwa.org,
(303)794-7711.
4. Association of State Drinking Water Administrators:
www.asdwa.org, (202) 293-7655.
5. Government Finance Officers Association: www.gfoa.org,
(202) 393-8020.
6. National Association of Water Companies:
www.nawc.org, (202) 833-8383.
7. National Drinking Water Clearinghouse:
www.nesc.wvu.edu/ndwc/, (800) 624-8301.
8. National Rural Water Association: www.nrwa.org,
(580) 252-0629.
9. Rural Community Assistance Partnership: www.rcap.org,
(888) 321-7227.
10. US Department of Agriculture Rural Development:
www.rurdev.usda.gov/rus, (202) 720-9540.
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Appendix B - State Drinking Water Primacy Agencies
For additional information or to learn more about the laws in your state please contact your Regional Coordinator or State Drinking
Water Agency.
State Contact Information
Alabama
Department of Environmental Management: Water Supply Branch
Alaska
Department of Environmental Conservation: Drinking Water Program
American Samoa
Environmental Protection Agency
Arizona
Department of Environmental Quality: Safe Drinking Water Program
Arkansas
Department of Health: Division of Engineering
California
Department of Health Services: Division of Drinking Water and Environmental
Management
Colorado
Department of Public Health and Environment: Drinking Water Program
Connecticut
Department of Public Health: Drinking Water Division
Delaware
Health and Social Services: Division of Public Health
Web site
wvwv.adem.state.al.us/WaterDivision/Drinking/D WMainlnfo.htm
www.state.ak.us/dec/eh/dw
wvwv.asg-gov.com/agencies/epa.asg.htm
www.azdeq.gov/environ/water/dw/indexhtml
www.healthyarkansas.com/eng/
www.dhs.ca.gov/ps/ddwemAechnical/dwp/dwpindex.htm
www.cdphe.state.co. us/wq/drinking_water/drinking_water_
program_home.htm
www.dph.state.ct. us/BRS/water/dwd. htm
www.state.de. us/dhss/dph/about.html
Phone Number
(334)271-7700
(907) 269-7647
(684) 633-2304
(602)771-2300
(501)661-2623
(916)449-5577
(303) 692-3500
(860) 509-7333
(302) 744-4700
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State Contact Information
District of Columbia
Environmental Protection Agency Region 3
Florida
Department of Environmental Protection: Drinking Water Program
Georgia
Department of Natural Resources: Water Resources Branch
Guam
Environmental Protection Agency: Water Programs Division
Hawaii
Department of Health: Environmental Health Division
Idaho
Department of Environmental Quality: Water Quality Division
Illinois
Environmental Protection Agency: Bureau of Water
Indiana
Department of Environmental Management: Drinking Water Branch
Iowa
Department of Natural Resources: Water Supply Program
Kansas
Department of Health and Environment: Bureau of Water
Kentucky
Department for Environmental Protection: Division of Water
Louisiana
Office of Public Health: Safe Drinking Water Program
Maine
Maine Department of Health and Human Services: Drinking Water Program
Web site
www.epa.gov/reg3wapd/drinkingwater
www.dep.state.fl.us/water/drinkingwater/indexhtm
www.gaepd.org/
www.guamepa.govguam.net/programs/water
www.hawaii.gov/health/environmental/water/sdwb/index.html
www.deq.state.id.us/water/
www.epa.state.il.us/water/index-pws.html
www.in.gov/idem/water/dwb/
www.iowadnr.com/water/drinking/indexhtml
www. kd he .state . ks . us/pws/
www.water.ky.gov/dw
www.oph.dhh.louisiana.gov/engineerservice/safewater/
www.state . me . us/d hs/e ng/wate r/
Phone Number
(215)814-2300
(850) 245-8335
(404) 657-5947
(671)475-1658
(808) 586-4258
(208)373-0194
(217)785-8653
(317)232-8603
(515)725-0275
(785) 296-5503
(502)564-3410
(225) 765-5038
(207) 287-2070
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State Contact Information
Maryland
Department of the Environment: Water Supply Program
Massachusetts
Department of Environmental Protection: Drinking Water Program
Michigan
Department of Environmental Quality: Water Bureau
Minnesota
Department of Health: Drinking Water Protection Section
Mississippi
Department of Health: Water Supply Division
Missouri
Department of Natural Resources: Water Protection and Soil Conservation
Division
Montana
Department of Environmental Quality: Public Water Supply Program
Nebraska
Department of Health and Human Services: Public Water Supply Program
Nevada
State Health Division: Safe Drinking Water Program
New Hampshire
Department of Environmental Services: Water Division
New Jersey
Department of Environmental Protection: Water Supply Administration
New Mexico
Environment Department: Drinking Water Bureau
Web site
www. md e .state . md . us/p rog ra ms/Wate rP rog ra ms/Wate r_
Supply/indexasp
www.mass.gov/dep/brp/dws/dwshome.htm
www.michigan.gov/deq
www.health.state.mn. us/divs/eh/water/indexhtml
www.msdh.state.ms.us/msdhsite/indexcfm/44,0,76,html
www.d nr.state .mo . us/wpscd/wpcp/i nd ex html
www.deq.state.mt. us/wqinfo/pws/indexasp
www.hhs.state.ne. us/enh/pwsindexhtm
http://ndep.nv.gov/bsdw/indexhtm
www.des.state.nh.us/wseb/
www.state.nj.us/dep/watersupply/
www.nmenv.state.nm.us/dwb/dwbtop.html
Phone Number
(410)537-3000
(617)292-5770
(517)373-7917
(651)215-0770
(601)576-7518
(573)751-1300
(406) 444-4071
(402)471-0521
(775) 687-6353
(603)271-2153
(609) 292-5550
(505)827-1400
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State Contact Information
New York
New York State Department of Health: Bureau of Water Supply Protection
North Carolina
Department of Environment and Natural Resources: Public Water Supply
Section
North Dakota
Department of Health: Division of Water Quality
Ohio
Environmental Protection Agency: Division of Drinking and Ground Water
Oklahoma
Department of Environmental Quality: Water Quality Division
Oregon
Department of Human Services: Drinking Water Program
Pennsylvania
Department of Environmental Protection: Office of Water Management
Puerto Rico
Department of Health: Public Water Supply Supervision Program
Rhode Island
Department of Health: Office of Drinking Water Quality
South Carolina
Department of Health and Environmental Control: Drinking Water Program
South Dakota
Department of Environment and Natural Resources: Drinking Water Program
Web site
www. hea Ith .state . ny. us/nysd o h/wate r/ma i n . htm
www.deh.enr.state.nc.us/pws/
www.health.state.nd.us/mf/
www.epa.state.oh.us/ddagw/
www.deq.state.ok.us/WQDnew/indexhtm
http://oregon.gov/DHS/ph/dwp/indexshtml
www.dep.state.pa.us/dep/deputate/watermgt/wsm/
WSM.htm
www.epa.gov/region02/cepd/prlink.htm
www.health.ri.gov/environment/dwq/indexphp
www.scdhec.net/eqc/water/html/dwater.html
www.state.sd. us/denr/des/drinking/dwprg. htm
Phone Number
(518)402-7650
(919)733-2321
(701)328-5211
(614)644-2752
(405)702-8100
(971)673-0405
(717)772-4018
(787) 977-5870
(401)222-6867
(803) 898-4300
(605) 773-3754
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State Contact Information
Tennessee
Department of Environment and Conservation: Division of Water Supply
Texas
Texas Commission on Environmental Quality
Utah
Department of Environmental Quality: Division of Drinking Water
Vermont
Vermont Agency of Natural Resources
Virgin Islands
Department of Planning and Natural Resources: Division of Environmental
Protection
Virginia
Department of Health: Office of Drinking Water
Washington
Division of Environmental Health: Office of Drinking Water
West Virginia
Bureau for Public Health: Department of Health and Human Resources
Wisconsin
Department of Natural Resources: Bureau of Drinking Water and Ground
Water
Wyoming
EPA Region 8: Wyoming Drinking Water Program
Web site
wvwv.state.tn.us/environment/dws/indexhtml
www.tceq .state .tx us/nav/uti l_wate r/
wvwv.drinkingwater.utah.gov
www.anr.state.vt.us/dec/watersup/wsd.htm
http://dpnr.gov.vi/dep/home.htm
www.vdh.state.va. us/dw/indexasp
www.doh.wa.gov/ehp/dw/
www.wvdhhr.org/oehs/eed/
www.dnr.state.wi.us/org/water/dwg/
www.epa.gov/region08/water/dwhome/wycon/wycon.html
Phone Number
(615)532-0191
(512)239-4691
(801)536-4200
(802)241-3400
(340)773-1082
(804) 864-7500
(360)236-3100
(304)558-6715
(608) 266-0821
(303)312-6812
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Appendix C - Tribal Drinking Water Contacts
For additional information or to learn more about the laws governing your tribe use the contact information provided in this Appendix.
US EPA Headquarters
American Indian Environmental Office
Web site
www.epa.gov/indian
Phone Number
(202) 564-0303
US EPA Tribal Coordinators
EPA Region 1
EPA Region 2
EPA Region 4
EPA Region 5
EPA Region 6
EPA Region 7
EPA Region 8
EPA Region 9
EPA Region 10
Web site
www.epa.gov/region01/govt/tribes/index.html
www.epa.gov/region02/nations/index.html
www.epa.gov/region04/ead/indian/index.htm
www.epa.gov/region5/water/stpb
www.epa.gov/region06/6xa/tribal.htm
www.epa.gov/region07/government_tribal/index.htm
www.epa.gov/region08/tribes
www.epa.gov/region09/cross_pr/indian/index.html
yosemite.epa.gov/r10Aribal.NSF
Phone Number
(888) 372-7341
(212)637-3000
(404) 562-6939
(312)353-2123
(800) 887-6063
(913)551-7003
(303)312-6312
(415)947-8704
(206)553-4011
Other Contacts
Administration for Native Americans
Bureau of Indian Affairs
Indian Health Service
Native American Water Association
Web site
www.acf.dhhs.gov/programs/ana/
www.doi.gov/bureau-indian-affairs.html
www.ihs.gov
www.nawainc.org
Phone Number
(877) 922-9262
(202)208-3710
(301)443-3024
(775) 782-6636
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Appendix D - State Public Service Agencies
Some states have more than one Public Service Agency, not all Public Service Agencies regulate water rates, and some Public
Service Agencies regulate rates for particular water systems (e.g., those serving more than 10,000 customers). Check with your
State Public Service Agency or State Drinking Water Primacy Agency for more information.
State Contact Information
Alabama
Alabama Public Service Commission
Alaska
Regulatory Commission of Alaska
Arizona
Arizona Corporation Commission
Arkansas
Arkansas Public Service Commission
California
California Public Utilities Commission
Colorado
Colorado Public Utilities Commission
Connecticut
Connecticut Department of Public Utility Control
Delaware
Delaware Public Service Commission
District of Columbia
District of Columbia Public Service Commission
Florida
Florida Public Service Commission
Web site
http://vwvw.psc.state.al.us/
http ://www.state . a k. us/rca/
http://www.cc.state.az.us/
http://www.accessarkansas.org/psc/
http://www.cpuc.ca.gov/
http://www.dora.state.co.us/puc/
http://www.state.ct.us/dpuc/
http://www.state.de.us/delpsc/
http://www.dcpsc.org/
http://www.psc.state.fl.us/
Phone Number
(334) 242-2946
(907) 276-6222
(602) 542-4251
(501)682-2051
(415)703-2782
(303) 894-2000
(860)827-1553
(302) 739-4247
(202)626-5100
(850)413-6100
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State Contact Information
Georgia
Georgia Public Service Commission
Guam
Guam Public Utilities Commission
Hawaii
Hawaii Public Utilities Commission
Idaho
Idaho Public Utilities Commission
Illinois
Illinois Commerce Commission
Indiana
Indiana Utility Regulatory Commission
Iowa
Iowa Utilities Board
Kansas
Kansas Corporation Commission
Kentucky
Kentucky Public Service Commission
Louisiana
Louisiana Public Service Commission
Maine
Maine Public Utilities Commission
Maryland
Maryland Public Service Commission
Massachusetts
Massachusetts Department of Communications and Energy
Web site
http://www.psc.state.ga.us/
http://guampuc.com/main/
http://www.hawaii.gov/budget/puc/
http://www.puc.state.id.us/
http://www.icc.illinois.gov/home.aspx
http://www.ai.org/iurc/indexhtml
http ://www.state . i a . us/g o ve rnme nt/co m/uti l/uti 1 . html
http ://www. kcc.state . ks . us/
http://psc.ky.gov/
http://www.lpsc.org/
http://www.state.me.us/mpuc/
http://www.psc.state.md.us/psc/
http://www.mass.gov/dte/
Phone Number
(404) 656-4501
(671)472-1907
(808) 586-2020
(208) 334-0300
(217)782-7295
(312)232-2700
(515)281-5979
(785)271-3354
(502) 564-3460
(225) 342-4404
(207) 287-3831
(410)767-8000
(617)305-3500
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State Contact Information
Michigan
Michigan Public Service Commission
Minnesota
Minnesota Public Utilities Commission
Mississippi
Mississippi Public Service Commission
Missouri
Missouri Public Service Commission
Montana
Montana Public Service Commission
Nebraska
Nebraska Public Service Commission
Nevada
Public Utilities Commission of Nevada
New Hampshire
New Hampshire Public Utilities Commission
New Jersey
New Jersey Board of Public Utilities
New Mexico
New Mexico Public Regulation Commission
New York
New York Public Service Commission
North Carolina
North Carolina Utilities Commission
North Dakota
North Dakota Public Service Commission
Web site
http://www.michigan.gov/mpsc
http://www.puc.state.mn.us/
http ://www. psc.state . ms. us/
http ://www. psc.state . mo . us/
http ://www. psc.state . mt.us/
http ://www. psc.state . ne . us/
http ://puc.state . nv. us/
http://www.puc.state.nh.us/
http://www.bpu.state.nj.us/home/home.shtml
http://www.nmprc.state.nm.us/
http ://www.d ps .state . ny us/
http://www.ncuc.commerce.state.nc.us/
http://pc6.psc.state.nd.us/
Phone Number
(517)241-6180
(651)296-7124
(601)961-5434
(573)751-3234
(406)444-6199
(402)471-3101
(775)684-6101
(603)271-2431
(973) 648-2026
(505) 827-6940
(518)474-7080
(919)733-7328
(701)328-2400
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State Contact Information
Ohio
Public Utilities Commission of Ohio
Oklahoma
Oklahoma Corporation Commission
Oregon
Public Utility Commission of Oregon
Pennsylvania
Pennsylvania Public Utility Commission
Puerto Rico
Junta Reglamentadora de Telecomunicaciones
Rhode Island
Rhode Island Public Utilities Commission
South Carolina
Public Service Commission of South Carolina
South Dakota
South Dakota Public Utilities Commission
Tennessee
Tennessee Regulatory Authority
Texas
Public Utility Commission of Texas
Utah
Public Service Commission of Utah
Vermont
Vermont Public Service Board
Virgin Islands
Virgin Islands Public Services Commission
Web site
http://www.puco.ohio.gov/puco.cfm
http://www.occ.state.ok.us/
http://www.puc.state.or.us/
http://www.puc.state.pa.us/home.aspx
http://www.jrtpr.gobierno.pr/
http://www.ripuc.state.ri.us/
http://www.psc.sc.gov/
http ://www.state .sd . us/puc/i ndex htm
http ://www. state .tn . us/tra/
http ://www. puc.state .tx. us/
http ://www. psc.state . ut.us/
http://www.state.vt.us/psb/
Phone Number
(800) 686-7826
(405)521-2211
(800) 522-2404
(717)783-1740
(787) 756-0804
(401)941-4500
(803)896-5100
(605) 773-3201
(800) 342-8359
(512)936-7000
(801)530-6716
(802) 828-2358
(340) 776-1291
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State Contact Information
Virginia
State Corporation Commission of Virginia
Washington
Washington Utilities and Transportation Commission
West Virginia
Public Service Commission of West Virginia
Wisconsin
Public Service Commission of Wisconsin
Wyoming
Wyoming Public Service Commission
Web site
http://wvwv.scc.virginia.gov/
http://www.wutc.wa.gov/
http ://www. psc.state .vw.us/
http://psc.wi.gov/
http ://psc.state .wy us/
Phone Number
(804)371-9967
(360)664-1160
(304) 340-0300
(608) 266-5481
(307) 777-7427
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Appendix E - Other STEP Documents
This guide is one in a series of Simple Tools for Effective Performance (STEP) documents for small drinking water systems that can
help them through the rate setting process. Currently available STEP documents can be obtained from EPA by calling the Safe
Drinking Water Hotline at (800) 426-4791 and requesting the document by its publication number.
Asset Management: A Handbook for Small Water Systems
This workbook guides small systems through a four-step pro-
cess of developing an asset management plan and includes
worksheets on completing a thorough asset inventory; prioritiz-
ing the maintenance, rehabilitation, and replacement of your
assets; developing a simple asset management plan; and
carrying out the plan. The workbook also provides information
about how asset management can help improve your system's
financial health and ability to provide safe drinking water.
Publication number EPA 816-K-03-016
Strategic Planning: A Handbook for Small Water Systems
This workbook is designed to help systems understand the
concept of strategic planning and how it can help them prepare
to meet public expectations and regulatory requirements while
maintaining organizational and financial stability in the future.
The workbook provides worksheets to help systems create a
vision statement and mission, assess their capacity, define their
area of service, identify challenges, and develop a strategic plan
for their system.
Publication number EPA 816-R-03-015
Taking Stock of Your Water System: A Simple Asset Inventory
for Very Small Drinking Water Systems
This workbook will guide very small systems through a simple
asset inventory of their drinking water system and the first steps
of an asset management plan. The workbook includes work-
sheets on asset condition and prioritization.
Publication number EPA 816-K-03-002
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Appendix F - Depreciation Accounting
If your water system has financial statements (revenue statements and balance sheets) that are prepared in a manner consistent
with generally accepted accounting principles (GAAP), you will use the concept of "depreciation." Depreciation accomplishes two
objectives:
• It ensures that the asset values in your balance sheet are not overestimated. Since an asset is unlikely to be as valuable in year
2 as it was in year 1, depreciation provides a method for proper estimation.
• Accounting for depreciation on your revenue statement is another way of estimating your reserve fund requirements. If your
accounts currently show depreciation, you may be able to skip the exercise in Step 3, where you learned how to calculate
annual reserve fund requirements.
From an (over-simplified) accounting perspective, the amount of each year's addition to "accumulated depreciation" on the balance
sheet should create an expense (of the same amount) on the revenue statement. Note, however, that unlike many costs, this does
not involve the outlay of cash.
What, therefore, should one do with the revenue associated with this expense? It is recommended that the expense be moved into
a reserve account where it can accumulate and be available for the rehabilitation and replacement of assets.
If you fail to contribute to a reserve fund, regardless of how you calculate your annual contribution, you will not create a reserve fund
large enough for your future capital needs.
Depreciation and GASB 34
You may have heard discussions of the term "GASB 34." GASB stands for the Government Accounting Standards Board, an organi-
zation that establishes accounting and financial reporting standards for government organizations. If your system is part of a munici-
pal government, its accounting standards are established by GASB.1 GASB 34 is "Statement Number 34, Basic Financial State-
ments and Management's Discussion and Analysis for State and Local Governments."
1lf you are a privately owned system, your accounting standards are established by a similar organization for the private sector, the
Financial Accounting Standards Board (FASB).
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The most important change made by GASB 34 is the requirement that state and local governments report all current and long-term
assets and liabilities, including infrastructure, on the balance sheet of the government-wide financial statement. GASB allows gov-
ernment agencies to comply with this requirement in one of two ways:
• By depreciating those assets.
• By using a "modified approach," which allows state and local government agencies to report the current costs of preserving
infrastructure to be reported, in lieu of depreciation.2
Therefore, an organization may comply with GASB 34 by adopting depreciation in balance sheets and revenue statements, but that
is not the only way to comply. In fact, organizations that are concerned about public works3 are concerned that the mere addition of
depreciation to financial statements might be an inadequate approach to accumulating sufficient funds to adequately preserve vital
infrastructure. An agency that uses the "modified approach" to comply with GASB 34 would need to report what it spent on mainte-
nance and replacement and then it would need to show—based on the change in asset condition from year to year—whether it had
spent enough. An agency that simply reports depreciation, but does not set that revenue aside in a reserve account, does nothing to
improve its long-term financial ability to pay for the preservation of asset value. It creates an increase in revenue that is simply rolled
over in the following year, creating no long-term reserves.
Conclusion: Build a Reserve Fund
The lesson from this discussion of GASB 34 is that full accounting for the cost of doing business must include an annual contribu-
tion to a reserve fund. Whether the amount of that contribution is determined by a worksheet (as shown in Step 3) or by a deprecia-
tion expense on a revenue statement, it still must go into the reserve fund. Failure to contribute to that reserve fund each year is a
failure to properly calculate the cost of doing business.
2See GASB 34, para. 20.
3See, e.g., the position statement of the American Public Works Association, 2003.
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