Cost Accounting and Budgeting
for Improved Wastewater Treatment

         Office of Policy, Planning and Evaluation
                and Office of Water
          U.S. Environmental Protection Agency
                 401 M Street, SW
               Washington, DC 20460

                  Prepared by.

           Industrial Economics, Incorporated
             2067 Massachusetts Avenue
               Cambridge, MA 02140
                  February 1998
                FINAL REPORT
                             Common Sense Initiative
                              Metal Finishing Sector


       This report was written by Doug Koplow with research assistance from Alexi Lownie.
Both are with Industrial Economics, Incorporated in Cambridge, MA.  The report was prepared
for Robert Benson of the U.S. Environmental Protection Agency's Office of Policy Planning and
Evaluation and Pat Bradley of EPA's Office of Water.   Research was  supported by the the
Environmental Protection Agency's Common Sense Initiative for the Metal Finishing Sector.

       The report would not have been possible without the cooperation and input of scores of
people,  especially  those  in Escondido, California and  the Massachusetts Water  Resources
Authority who provided  us with so much of their time. We  would especially like to  thank Dan
Gushing, Smokey Lohnes,  Kevin  McManus, and Fred Rowlen for their work in assembling the
data we needed and arranging for us the opportunity  to speak with personnel throughout their
respective sewerage agencies.  Finally, we would like to thank the peer review panel for their
useful feedback on the draft version of this report.

                               TABLE OF CONTENTS

      Budgeting Systems	1-2
      Linking Budgeting With Cost Accounting                                         1-4
      Steps Towards Improved Budgeting and Cost Accounting	1-7

             Strategic Components	1-7
             Implementation                                                       1-8
             Evaluation                                                           1-9

      Capital Budgeting	2-1

             Calculating a Charge for Capital Equipment	2-2
             Protecting Capital Recovery	2-3

      Activity-Based Costing and Wastewater Treatment	2-6

             Mechanics of Activity-Based Costing	2-7
             Implementing an ABC System at a WWTP                                 2-8
             Caveats	2-16

      Resource Pricing and Debottlenecking                                          2-17
      Process Mapping	2-20
      Benchmarking                                                              2-22


      Cross-Subsidies In General	3-2
      Specific Types of Discharges May Force POTW
        to Incur Higher Costs	3-4

             Biosolids Management                                                 3-4
             Effluent Reuse                                                         3-6
             Fats, Oil and Grease (FOG) Discharges and
               System Maintenance Costs	3-8

                                TABLE OF CONTENTS

       Specific Types of Customers May Cost More to Service than Others	3-9

             Permitting Costs                                                       3-10
             Serving Industrial, Commercial, and
               Residential Customers	3-11
             Discharger Location and Multi-Plant Systems	3-15

       Capacity Limits to Existing Plant May Drive Up System Costs	3-16

             Inflow and Infiltration (I/I)	3-19
             Large Dischargers and Seasonal Peaks	3-22
             System Expansions May Create New Challenges	3-23
             System Expansion to New Areas/Customers	3-24
             Differential Impacts of System
               Expansion by Customer Class	3-25

       Interjurisdictional Agreements                                                  3-26

       The City of Escondido, CA	4-1

             General Approach Towards Cost Accounting and Budgeting	4-3
             Managing and Optimizing Key Shared Assets	4-6
             Controlling Constituents of
               Concern with Fragmented Control                                       4-7
             Full Cost Recovery	4-11

       Massachusetts Water Resources Authority (MWRA), Boston, MA	4-12

             General Approach to Cost Accounting and Budgeting	4-13
             Dilution of Price Signals                                                 4-16
             Wholesale Rate Methodology                                            4-17
             Centralization of Industrial Pretreatment                                   4-22
             Outsourcing of Biosolids Management                                    4-24

       Summary                                                                    4-26

5.      SUMMARY	5-1




                                   LIST OF EXHIBITS
Exhibit 1-1: Wastewater Treatment Process Overview

Exhibit 2-1: Hypothetical Example of Activity Based Costing	
Exhibit 2-2: Allocation of Key POTW Costs	
Exhibit 2-3: Boundaries of Activity-Based Costing Assessments
Exhibit 2-4: Sample Process Map
Exhibit 2-5: Interrelationship of Metric and Process Benchmarking
Exhibit 2-6a: Key Outcome Performance Measures
                     Identified by Focus Group	
Exhibit 2-6b: Key Efficiency Performance Measures
                     Identified by Focus Group	
Exhibit 2-6c: Key Effectiveness Performance Measures
                     Identified by Focus Group	

Exhibit 3-1: Possible Cross-Subsidies in POTW Pricing and
                     Resulting Distortions	
Exhibit 3-2: Biosolids Management
Exhibit 3-3: Effluent Reuse
Exhibit 3-4: Effluent Reuse Options
Exhibit 3-5: Management of Fats, Oil, and Grease	
Exhibit 3-6: Permitting Costs
Exhibit 3-7: Sampling and Laboratory Fees	
Exhibit 3-8: Enforcement Activities
Exhibit 3 -9: Wastewater Treatment and Water Treatment/Delivery
Exhibit 3-10: Distance from Plant/Multi-Plant Systems
Exhibit 3-11: Hypothetical Impact of Peaks on Plant Sizing
Exhibit 3-12: Differential Rates for Peak Leveling
Exhibit 3-13: Aggregate Flows of 107 POTWs	
Exhibit 3-14: Inflow and Infiltration Control in Lower Paxton
                     Township Authority, PA
Exhibit 3-15: Inflow and Infiltration
Exhibit 3-16: Large Dischargers/Seasonal Peaks	
Exhibit 3-17: System Expansion/Centralized Versus
                     Decentralized Treatment	

Exhibit 4-1: Sample Program Areas Tracked by Escondido WWT Program
Exhibit 4-2: Program Areas in MWRA Sewerage Division
Exhibit 4-3: MWRA Rate Factors as a Percent of Total Charges (FY 1998).









       Publicly-owned treatment works (POTWs) face a challenging task.   They  must take
polluted discharges from a variety of customers and treat it to a level that will not harm human
health or the environment.  They are regulated both at the state and federal  level, and directly
regulate  discharging industries.   POTW  managers do not  always have accurate or timely
information on the economic performance of the treatment system. Pretreatment managers, often
somewhat isolated in their own section of the POTW, may have even less information on which to
base decisions.

       This  guidance manual  aims to show POTW managers  how effective budgeting and cost
accounting systems  can help  them do a better job running their plants  with  limited resources.
Although POTWs are commonly divided into different  operating departments, activities of one
group often  have  substantial impacts on others. For example, effective pretreatment plays a vital
role in preventing plant upsets, thereby keeping plant operating costs low.  Because decisions in
one part of the POTW affect  other departments, we have chosen to analyze budgeting and cost
accounting systems holistically rather than within pretreatment alone.

       The  impetus for this project  came out of the  Common  Sense Initiative for the Metal
Finishing  Sector.   A number of industry  participants  in  the initiative noted  that  POTW
pretreatment programs had an extremely large impact on their business, but that the efficacy with
which POTWs were operated varied considerably across  geographic regions. During the first part
of 1996, the Agency visited  fourteen  POTWs  in  three states to identify what factors made
pretreatment programs  successful,  and what barriers prevented   struggling  programs from
improving.   Nearly every program, including  those  widely  recognized as  having top-tier
pretreatment, had important weaknesses in  their cost  accounting and budgeting  systems  that
impeded  their ability  to  make optimal decisions.   Our goal  in preparing  this  report is to
demonstrate how  poor cost accounting and budgeting systems can lead to sub-optimal outcomes,
to educate POTW staff about  common problem areas to evaluate in their own programs, and to
provide guidance on how to implement improved cost accounting and budgeting systems.

       The report contains five chapters. Chapter one explains cost accounting and budgeting in
more detail,  including what it is, how it works,  and why it is important. Chapter two provides
background  information on important tools that program managers can use in their utilities to help
them prioritize their activities. Chapter three discusses  common issues associated with  POTW
cost  accounting  and budgeting.  Chapter four examines two  plants in detail,  illustrating the
multiple issues that arise at real facilities.  Chapter  five contains the summary.


       Much of the historic emphasis at Publicly-Owned Treatment Works (POTWs) has
been on the engineering:  building new capacity, preventing plant upsets, and ensuring that
treated effluents and biosolids meet permit requirements.  Less attention has been paid to
budgeting and cost accounting, which involve the financial side of wastewater treatment:
what are the utility's available resources (budgeting) and how do costs vary with different
activities (cost  accounting).  The engineering and the financial aspects of the enterprise
are, not surprisingly, closely linked.   Different engineering approaches  will have  very
different impacts on the cost of running the plant.

       Budgeting and cost accounting themselves should also be closely linked.  Budgets
report the  allocation of POTW resources to particular expenses.   A budget document
serves as a written expression of  management's resource allocation decisions and  as a
benchmark against which on-going operations can be measured.  Cost accounting is the
process by which these expenses are allocated to particular activities.  Whereas a budget
line item might simply  be "pretreatment  inspector  salaries," cost accounting defines
activities of the POTW more broadly.  Under the pretreatment activity,  pretreatment
salaries would be included along with a host of other costs that are  sometimes overlooked,
such as computer programming provided by the town's information systems  department
or laboratory tests required for particular industrial users.  By  reworking  existing budget
categories  to better  reflect the core activities the enterprise provides (even if they cut
across existing  budget accounts or departments), insights from cost accounting can be
integrated into the budget planning  process.

       Neither  budgeting nor cost  accounting tend to rank among most people's favorite
activities. Budget time in any organization can be hectic and stressful, with staff having to
justify every dollar of their budget request before their managers,  sometimes a year or
more  ahead of time.  Cost accounting may be  less  visible within  the utility.  When it is
encountered,  it may be viewed somewhat  perjoratively,  using  terms  such as "bean
counting."  Stepping back from their implementation, both budgeting and cost accounting
are critically important to the effective operation of the treatment plant.  They are simply
tools that help  managers and their  staff decide how to prioritize limited funds across the
many competing options for those funds.  When implemented creatively, these systems
provide important and timely information to decision-makers. For example:

       •      What  are  our  short-  and long-term financial  constraints on
              activities?  These constraints need to be recognized not only at the
              utility-level, but at the program-level as well.

       •      Including all inputs, what is the annualized cost of our services,
              and how do we expect this to change  over time?  To  remain a
              healthy enterprise, the POTW needs to understand its total cost of
              treating wastewater.  Evaluating how the costs will change  over
              time  enables the staff to plan for required upgrades over a longer
              horizon, avoiding sudden spikes in the rates or large revenue short-

       •      Are there differences in our cost of service across regions of the
              utility district,  or across different customers?   Unless managers
              understand how their costs of service vary based on the location or
              characteristics of a  discharger they will not be able to  prioritize
              what areas deserve their focus first. It is important for managers to
              separate the economic from the political here.   For example, the
              economic cost of handling the same type of discharge  in different
              parts of a complex,  multi-plant treatment system may vary widely.
              Nonetheless,  managers  may  still  decide, for  political or  equity
              reasons, to have uniform charges for customers in different parts of
              the system.   However, they may  focus inspection  and  outreach
              activities in the portion of their district where cost impacts are the

       •      How do  current or proposed actions by dischargers affect our
              costs  and performance? Prioritizing  management  attention  also
              requires understanding how certain types of discharges affect the
              treatment system,   and estimating  how  particular  changes  in
              discharge levels or types will affect system operation and costs.

       Our focus in this report is on powerful applications of cost accounting within the
POTW, and on ways to change the structure of the budget and the  budgeting rules to
allow greater flexibility for program managers to run their programs.
Budgeting Systems

       Budgets  serve  a variety of purposes  within an  organization.1   They  help  the
organization to plan for the future by estimating the resource requirements of different
portions of the enterprise. They help managers communicate priorities and constraints to
staff,  as  well as illustrate what items fall under the control/responsibility  of which
departments.   Budgets can also be used to help evaluate performance,  for example, by
comparing budgeted and actual performance.  Variances between budgeted  and actual
performance  can also  help  the organization  to  identify  areas  where  their  market  or
       1 Robert Anthony and James Reece, Accounting Principles, (Irwin: Homewood,
IL, 1989), pp. 603, 604.

performance  is changing.   These  purposes can sometimes  work  in  conflict,  so it  is
important to consider the most important goals for a particular POTW when designing a
new budgeting system.

       Our visits to POTW pretreatment programs found an extremely wide range of
budgeting systems currently in use.  Some pretreatment program managers never even saw
their budget.  Rather, operating as a small part of a larger utility district, pretreatment staff
would simply put in budget requests until an "invisible  line" of spending was passed and
their  requests were  denied.   This  line varied year-by-year, and  applied not only to
aggregate spending  but to individual  purchases as well.   The  larger  the individual
purchase, the more likely it was to be  denied.  This type of budgeting approach meets
none  of the goals of effective budgeting.  Department level managers were not educated
by the information; nor could they be  reasonably evaluated based on their budgetary
performance  since they had  little idea about  what their budget  was.  The lack of
information made planning for longer-term changes extremely difficult.

       At the other end of the spectrum were POTWs with finance or budget departments
that carefully tracked spending by many different areas.  Managers in these programs did
know how much funding they had, and the budget information generally allowed them to
plan much more effectively.  Nonetheless, even the more sophisticated budget  systems had
room for improvement. Four central goals of a budget system  should be to:

       •      Help  programs balance repairs against capital  replacement.
              Some POTWs pay  for  large investments that will  be  used  for
              multiple years out of a single year's budget.   This makes budget
              outlays  "volatile,"   fluctuating   widely  from   year   to year.
              Alternatively, private corporations (as well as  some  POTWs) use
              accrual accounting,  where the  cost of  multi-year  purchases  is
              spread over the useful life of the asset.  This approach is used for
              tangible assets, such as new digesters, as  well as  intangible assets
              such as a headworks analysis used to set local limits.  When capital
              costs are annualized, managers can make better trade-offs between
              the  cost of  new  equipment and the cost  of repairing  existing

       •      Provide program managers with spending flexibility  across
              budget accounts  and budgeting years.  Traditional budgets are
              "use or lose" affairs; any money left at the end of the year reverts
              back from the  department to  the utility or town.   Use-or-lose
              systems provide little incentive for managers to save money one
              year to apply towards something  more  useful next year.  Similar
              dynamics apply when budget  line items are adhered to rigidly.   By
       2 For a detailed description of this problem, see U.S. General Accounting Office,
Budget Issues: Budgeting for Federal Capital, November 1996.

              focusing  managers  on the  results of  their  enterprise, budget
              flexibility can help  managers spend available  funds  much  more
              efficiently. Managers may be allowed to use saved funds in the next
              fiscal year, set up contingency accounts to fund unexpected needs,
              or apply funds more broadly to their needs than can be reflected in
              standard line item budgets.

              Improve long-term planning and expansion   Effective budgets
              should also allow managers to examine trends in spending patterns
              and to estimate spending in the future.  Though estimates of future
              spending are rarely perfect, they can identify large changes on the
              horizon  for which the POTW should begin  planning immediately.
              For example, one  Indiana POTW had been operating under an
              expired NPDES permit for over five years.   Staff knew that  their
              new permit would require  substantial changes to their operations,
              but had never examined in detail what those changes were likely to
              be, how much they would cost, and whether there were alternative
              ways to achieve compliance that were less expensive.

              Illustrate how  changes  in  spending  in  one  department will
              affect resource requirements in other departments.  A budget
              document solely for pretreatment might encourage pretreatment
              managers to  cut back on  inspections in order to meet the budget
              targets they've been given. Without an understanding of how such a
              cutback might affect the influent contamination levels, and therefore
              the  costs of operating the  POTW and disposing  of residuals,
              department-level efficiency might lead to utility-level inefficiencies.
              This  link  between  departmental  action and implications  across
              departments should be reflected in departmental budgets.
Linking Budgeting With Cost Accounting

       Like budgets, cost accounting systems are designed to provide critical information
to decision makers.  Therefore, an  important first step in setting up a cost  accounting
system is to compile a list of the types of management decisions the organization expects
to make. Examples might include: when to expand plant capacity; what user  fees to set;
where to allocate limited inspection budgets; and what activities will most improve the
quality of effluent.

       For organizations long accustomed to  fairly rigid  lines between  departments,
implementing a holistic cost accounting system may require a bit of work.  Rather than
grouping costs by topic (e.g., information systems, legal, laboratory) as many budgets do,
cost accounting systems  should delineate  the core activities  of the organization.  The
primary function of a wastewater treatment plant (WWTP) is to protect human health and
the environment by treating wastewater to safe standards  (as defined by each  plant's

National Pollutant Discharge Elimination System, or NPDES, permit).  To support this
primary  function, WWTP  core activities  might include supply-side functions such  as
collecting wastewater from discharge points and treating it to meet permitted discharge
levels. On the demand-side, the plant could work to manage influent quality, quantity, and
timing through its pretreatment, conservation, and inflow and infiltration programs.  Each
of these areas would, in turn,  have subactivities associated with the broader function. For
example, collecting wastewater would involve broader issues of managing the collection
system, including sewer lines, seepage, oil and grease, and metering. Exhibit 1-1 outlines
these major and sub-functions.
       Detailed activities of the POTW are not shown in the chart, but are important in
assessing the full cost of a particular activity.   In fact, completing a task within any of

                                      Exhibit 1-1

y Function: Ensure wastewater treated to
> standards

(Treat incoming
	 Demand Side 	 Con
deduce quantity of influent,
mprove quality of influent)



Storm Water

Other (Air, Methane,)
	 Local Limits/Effluent Trading

cpn/atinn j?
)w/Infiltration, SSOs

	 Review of past reports

           Cross-cutting functions: Management and Information Systems, Legal, Laboratory, Billing, Human Resources,
           Management/ A dmini strati on, Finance (raising debt, budgeting, managing accounts payable and receivable).
these areas could require the use of resources from a variety of POTW departments, for
example, billing or finance.  Cost accounting will help managers track what resources are
required to complete a particular task, such as permitting a large industrial user, and how
much those  resources cost the POTW.   Linking the  details of how much time and
resources are required from all parts of the  organization in order to, for example, permit
an industrial  user or expand a lateral collection line, is called process mapping. Creating
process maps can be time consuming and expensive.  Thus,  gathering this information is

only cost effective if it helps the POTW operate more efficiently and effectively.  Whereas
cost accounting answers the question "How much does it cost us to do activity x or to
make product y?" process mapping can be used to determine why certain products or
processes are expensive, where there are inefficiencies (e.g., data needs to be manually
transferred multiple times),  and how the activity might be streamlined to make it more
efficient. The goals of a cost accounting system should be to:

       •      Inform managers and staff. This is the primary function of a cost
              accounting approach. The system should give managers and staff
              information on the  cost  of performing  core activities  and help
              managers   evaluate   the   tradeoffs  associated  with  different
              management strategies.

       •      Illustrate the basic  activities of the organization.   The process
              of shifting from budget line items to activity-based measures should
              help  managers define the core functions of the organization in a
              consistent way and communicate these core functions to other staff.

       •      Link activities with costs.  By linking  specific  activities with the
              resources  required to complete them, the POTW can get a much
              clearer picture  of the  costs  and  benefits  of  particular  service
              delivery approaches.

       •      Reduce the  magnitude  of "overhead"  expenditures.    Many
              organizations have a  substantial percentage of their operating costs
              lumped  into a  general budget  category called  "overhead"  or
              "administration." In  reality, many of the activities allocated to these
              accounts support services to POTW staff and operations.  A central
              goal  of activity based costing,  discussed in more detail in the next
              chapter of the report, is to link overhead costs with the activities
              they  support so that managers can  see the total cost of specific
              goods and services provided.

       •      Illustrate  cross-departmental   links   in  service   delivery.
              Departmental lines often group similar functions in an organization
              (legal, personnel, laboratory, etc.)  Day-to-day activities,  however,
              regularly draw on resources from a variety of departments.  Cost
              accounting systems  need  to reveal these links to help managers
              make sound decisions for the enterprise as a whole.

Once in place, a cost accounting system can:

       •     Demonstrate cost effective ways to reduce system costs, optimize
             resource allocation,  and prioritize  activities  towards achieving  a
             particular  goal  (e.g.,  environmental   improvement   or  cost

       •     Illustrate the economic value of pretreatment; evaluate spending on
             pretreatment versus  treatment at the POTW and on supply-side
             management versus demand-side management.

       •     Justify increases in charges to particular customers or municipalities
             and decreased charges to others.

       •     Provide   the  information   needed  to   negotiate  terms   for
             interjurisdictional agreements, network expansion, or industrial user
             (IU) permits.

       •     Identify areas of poor resource utilization within the utility and help
             to rationalize system capacity.

       •     Help managers evaluate alternative mechanisms of service provision
             (e.g., in-sourcing, outsourcing).

Steps Towards Improved Budgeting and Cost Accounting

       While the  basic tools for improved budgeting and cost accounting are consistent
across organizations, the goals of implementing improved systems must be tailored to the
specific needs and circumstances of each POTW.  Managers need  to invest adequate time
up-front to ensure that the questions a new budgeting and cost accounting system answers
are the questions  that are most important to them  and their organizational health.  Some
general steps one  can take towards improving these systems are presented below.  These
steps include both strategic, implementation, and evaluative components.
Strategic Components

       •      Determine key measures of success. As stated above, it is critical
              to focus measurement on items that are central to the organization's
              mission.  These measures can be both financial and non-financial.
              However,  even non-financial  measures,  such as "reduce  copper
              loadings by  50 percent" can be  more  saleable  if an economic
              component is added.  For example,  "reducing copper loadings by
              50 percent will improve recreational fishing in our discharge river,
              boosting tourism."

              Determine key  decisions  needed  to  achieve success.    What
              milestones  are necessary  in  order  to  achieve goals?   Do  key
              strategic decisions need to be made now to facilitate reaching these
              goals?  For example, if reducing metals loadings is a central goal,
              improved data on loadings might be a milestone, with this improved
              data  integrated into  a  cost accounting system that  allocates the
              excess  costs  of  these loadings back to  the  sources of  problem

              Develop a list of core activities of  the organization.  If budgets
              are to be activity based, and new cost  accounting systems  are to
              allocate costs onto specific activities, work needs to be  done up
              front to insure that all  managers define the core  activities  of the
              POTW in roughly the same way.

              Determine ground rules.  The very  purpose of improved  cost
              accounting  is to  identify areas  of inefficiency within the POTW.
              There are winners and losers with these discoveries.   For example,
              the importance of pretreatment in reducing total POTW costs  may
              be highlighted.    Alternatively,  some  departments  may appear
              inefficient or redundant under the new  method  of assessment.  If
              people are afraid  they will be demoted or fired based on the results
              of the system, they will not participate in the implementation  phase,
              and their knowledge of POTW processes will  not  be  shared.  One
              possible ground  rule to address these  concerns is  a "no layoff'

       Strategic issues help  to  determine what the  improved  budgeting  and cost
accounting system  should accomplish,  and to  obtain  initial  buy-in from  plant  staff.
Implementation is where these decisions get translated into organizational changes:

       •      Accrual accounting.  Annual costs for capital spending is a very
              important input into a cost accounting system.  Organizations that
              now pay for multi-year purchases  out of their current budget need
              to implement techniques used in the  private  sector  to  measure
              capital  services, as described below  in the  section  on capital

       •      Cost  accounting.   Using  annualized  capital  costs  and  other
              spending information,  the POTW will  need  to implement an
              activity-based costing system (also explained in the next chapter) to
              better allocate costs to the  activities/customer classes that drive
              those costs.

       •      Changes to budgeting rules.  Where rigid budgeting rules restrict
              saving funds from one year to the next or applying unused funds
              from  one line  item  to  another  (where  it is more  needed),
              modifications are in order.   Changing budgeting rules  provides
              additional flexibility to department managers, but requires utility
              managers to be able to evaluate the results of departmental efforts.
              Performance benchmarking may be useful in  this regard, enabling
              managers to track trends over time and compare  performance with
              external organizations.

       •      Changes in budget  presentation.  Once costs are tracked by
              activity, it may make  sense to present budget data by activity as
              well. This presentation will provide a more useful picture of where
              resources  are  being  used than  do  current topically-organized

       When implementing any of these  tools, managers should consider the costs and
benefits of doing so.  Substantial increases in administrative complexity and costs make
little sense if gains in efficiency and understanding are small.   On the other hand, care
should be taken to evaluate the costs and benefits of the transition over a relatively long
period.  Difficult changes may increase complexity in the short term but greatly enhance
POTW operations once they are in place.


       Cost accounting and budgeting are tools for better decision making.  How well are
they working?  Are  decisions improving  over time?  How  are managers using the
information these systems give them to do their jobs better?  Periodic evaluation of both
these  tools   and  the  POTW's  operations   is   important  to   build  into  the
accounting/budgeting system from the outset.  Performance benchmarking can be useful in
measuring improvement over  time. Annual reviews of improvements, as well as periodic
interviews with staff at various levels of the organization, is important  for garnering the
type of feedback that will enable managers to improve the systems over time.

       To facilitate the implementation process, the next chapter provides a more in-depth
introduction to the analytical tools needed for improved cost accounting and budgeting.


       This chapter provides an overview of a number of tools that POTWs can use to implement
improved  budgeting and  cost  accounting.   Books  are  written on each of these tools;  the
information here  should be viewed as a general  introduction.  The tools fall into three main
categories: determining the cost of service, evaluating cost impacts  of changes in the operating
environment or service mix offered, and evaluating program efficiency.

       •      Determining the cost of service.  The basic element in making  sound
              decisions within the POTW is having accurate information on how much it
              costs to provide particular services to particular customers. Two tools for
              this purpose are discussed below:  capital budgeting and activity-based
              costing (ABC).  Cost data must be supported by solid underlying scientific
              data as well, such as that on headworks loadings.

       •      Evaluating cost impacts of changes.  Measuring the  cost of service helps
              managers see which activities are more or less costly.  One additional tool,
              resource  pricing (also  referred to as  shadow pricing) can  help  the
              organization identify parts of existing operations that have extremely large
              cost  impacts and estimate savings associated  with  operational changes.
              Often, these areas are bottlenecks in  the  system: a  single resource that
              impedes efficient use of much of the rest of the plant.  Resource pricing, in
              conjunction with the  cost accounting system, can be used to evaluate
              competing options,  such as  increasing system capacity  versus trying  to
              reduce demand for existing capacity.

       •      Evaluating program efficiency.   How well is your program providing
              wastewater treatment services? Two  useful tools are Process Mapping
              and Benchmarking.  Process mapping helps illustrate the complexity  of
              seemingly  simple functions within  the organization  and  provides  useful
              insights on how those processes might be simplified. Benchmarking, in
              which aspects of operations are compared to those conducted within other
              organizations, can be a useful tool in identifying areas for improvement
              within the utility.
Capital Budgeting

       A fundamental concept of accounting is the matching of costs to the period over which
benefits associated with those costs are received. When this is not done, managers are unable to
assess their cost of providing goods and services (vital in order to decide what goods and services
make sense to produce).  From this need, costs have been divided into operating expenses  and
capital expenses.  Operating expenses encompass costs that generate benefits in the current year.

Capital  costs, such as new equipment or plants, create a stream of benefits that span multiple
years. These multi-year benefits need to be annualized so that the portion of the benefit stream in
any one year can be estimated.

       Capital  budgeting accomplishes  two important functions.   First it, annualizes capital
spending, allowing capital to be compared to single-year purchases and to be included in a cost
accounting system.  This process is fairly mechanical, incorporating the cost of the purchase and
the expected  service life into an annual expense. In reality, however,  capital purchases lock an
organization's resources into a particular purchase for many years.  Although annualized capital
costs are useful indicators of the annual cost of capital services, the  decision in year one to  make
the purchase  is thereafter, for the most part, irreversible. For example, expanding the collection
system to a new industrial park is a sunk cost.  The money is gone even if no industries decide to
move in, as one mid-Western POTW found out.  The long-term nature and large expense of these
investments requires that the decisions be made carefully.  This is the second strength of capital
budgeting: it  provides a standard basis of comparison for alternative capital purchases.  For this
reason,  many organizations have a separate capital budget that shows only  capital purchases to
help managers choose among many suggested options.
Calculating a Charge for Capital Equipment

       To  calculate  an annual charge for a capital purchase (let's assume a new digester), the
plant first groups all expenses associated with the design, purchase, and installation of the digester
into a single  account.  Expenses that support this capital asset, even labor, are capitalized.  If
particular items are  improperly  excluded from the cost of an asset, the capital will seem less
expensive than it really is.  Consider the following common issues:

       •      Financing Costs.   The asset cost should also include the cost of financing
              the  capital, as this is often a large  portion of the total cost of the asset.
              This cost may be visible and easily included if the city issued a bond to pay
              for the new investment.  However, even if the town decided to pay for the
              asset outright, out of a single year's tax  collection, it still makes sense to
              impute a financing cost to reflect the lost opportunity to use this money in
              an alternative way.  In private firms, this  imputed interest is referred to as
              "hurdle rate," the return below which a capital purchase can't be justified
              because it diverts  funds from more productive uses.1

       •      Incorporate life-cycle costing.   If current activities  create future costs,
              such as decommissioning or remediation, these  need to be allocated to the
              current product/process and accrued over its operating life.
       1 Note that a hurdle rate will generally include not only the break-even return necessary for
the firm to pay for the capital it is investing, but a profit margin above that  level as  well. Since
most POTWs are publicly-owned and do not earn profits, the imputed interest rate will likely be
somewhat lower than if it would be for privately-owned plants.

       •      Replacement Costs versus Historical Costs.  The use of replacement cost
              pricing violates the cost of service principles normally used in rate setting
              at POTWs.  However, if replacing a capital asset is much more expensive
              than it was to install it in the past, the use of historical costs in estimating
              the  rates will encourage overuse of the  capital.  Capital charges based on
              replacement cost will encourage all current users to constrain  their use of
              the  capital, delaying the time when capital expansion — at the much higher
              price — will be necessary.2 Note that replacement costs can be higher for a
              number  of reasons, including inflation, the loss  of government-subsidized
              financing options, or new technical requirements.

       The  sum of these costs becomes the  cost basis of the asset that  is depreciated.   The
purpose of depreciation is to reduce the value of the capital asset over time, as its useful service
life is exhausted.  Thus, the depreciation period should  be set equal to the estimated service life.3
For simplicity, let  us assume that the asset wears out  evenly over time (known as straight line
depreciation).4  If  the digester was expected to last 20 years, than l/20th of the total cost basis
would be recovered from users in  each year. Annual costs (or revenues)  associated with the asset
would be added to the  capital charge in order to obtain a total cost of a capital asset that should
be recovered from customers.  Annual costs, often referred to as operations  and  maintenance
costs, include such items as energy and repairs. Revenues might include by-product sales or reuse
(for example, methane recovery and reuse from a digester) that should be deducted from the total
annual cost.
Protecting Capital Recovery

       The purpose of capital budgeting is to accurately estimate the cost of capital  services to
managers and customers.  In this way, rational decisions can be made about when to replace old
equipment with new, and what the proper mix between capital and operating costs is.  Users can
       2 This occurs naturally in competitive markets, where the market  price is  equal to the
marginal cost of the least-efficient  producer still able  to stay in business.  Since POTWs don't
compete with  each other to  treat wastewater, marginal  cost  rationing needs  to be  added

       3 Private firms depreciate assets as quickly as allowed under the  tax code in order to
reduce their  effective tax rates.  For pricing  capital  services,  however,  the assets should be
depreciated over the service rather than the tax lives, as this is the best  approximation of the
annual cost of using the capital.

       4 There are a variety of other depreciation methods, all of which generally depreciate a
higher percentage of the asset value  in the early years.   The actual pattern by which an asset
depreciates in value will vary by asset type.

charged the true cost of the capital they use, giving them an incentive to use the capital efficiently.
POTWs will be able to accrue funds steadily so they can finance replacement capital at the end of
the old capital's service life.

       Unfortunately, this  system  begins to break down  in the real world politics  of sewage
treatment.  No matter how "perfect" the capital charges  are, if the funds collected  for capital
replacement are diverted  for  other  uses, the plant  will  not make efficient capital allocation
decisions. While this problem is relatively common in WWTPs, our limited sample of site  visits
suggests it is more acute in municipal systems than in special sewer districts.   Funds collected
from within the POTW for capital replacement are diverted  to the general fund of the municipality
to meet some immediate need in another part of the  budget.

       Linking collections to  specific uses is  important  if the  system is to  provide proper
incentives.   For example, if plant managers  know that capital replacement funds will not be
available when they need them, they begin to "game" the budget system to buy capital equipment
whenever they can obtain funds,  rather than when they  really need  it.   The type of capital
equipment they buy may be driven as much by the amount of funds they can obtain in a given year
as by the problem they are trying to address.

       Municipalities have adopted a number of techniques to minimize the problem  of  funds
diversion. All of these techniques  restrict how capital recovery funds may be used, reducing or
eliminating the latitude for town officials to divert the monies for other uses.  Some examples:

       •      Lease  or outsource.   For  utilities where the  political process  makes
              accruing for capital purchases  and replacement nearly impossible, leasing
              equipment or outsourcing functions can bypass some  of the problems.5
              Once in place, funds for wastewater treatment no  longer go to  the city,
              where they could be diverted, but rather to  the lessor or private provider.
              This type of decision (outsourcing more so than leasing) has implications
       5  We encountered  a number of smaller  POTWs where strategic decisions  with any
financial  implications  had to be approved by a utility board, comprised of many members of
Significant Industrial User  (SIU) companies.  These members sometimes use their leverage to
impede effective POTW enforcement of discharge violations or to block improvements in staffing
or equipment that would  have increased the POTW's  enforcement capabilities.   Leasing or
outsourcing specific functions is unlikely to solve these conflict of interest problems, as the utility
boards can still intervene to block the initial leasing or outsourcing decision.

              on other aspects of POTW operation, so should not be undertaken lightly.6
              In addition, unless outsourcing contracts are written carefully, the private
              provider may have disincentives to long-term capital investment as well.7

              Bond financing.  By issuing bonds for capital projects, the POTW creates
              a legal obligation  that funds from users support bond  repayment to an
              external agent.  Bond financing  is commonly used by POTWs for large
              capital expansion.   Ideally, the bond life is matched to the service life of the
              asset being financed.  In this circumstance,  annual bond  repayments are  a
              fairly good indicator of the cost of capital services.  In reality, bond life is
              generally driven by interest rate conditions rather than service life, so may
              be a weak proxy for the cost of specific capital services.

              Revolving Funds. Revolving funds are often run  by external agents,
              although they can also be run by the utility.  A loan is  made to the POTW
              for a specific project,  then repaid over time from user fees.  The up-front
              costs  of bond  issuance, however, make  bonds a more  effective  tool for
              large scale capital projects; revolving funds are economic at a lower level
              of funding.

              Internal Accounts. Some utilities have set up internal accounts for asset
              replacement funds.  Collections go into these accounts and are somewhat
              protected  from  being  "raided" by other parts  of  the municipality.  Funds
              are earmarked for specific purchases, and do not revert back to the general
              fund at the  end of each budget cycle as do most  unspent departmental

              Working  Capital Funds. Also an internal account, working capital funds
              operate as a savings account for  new capital purchases.  Contributions by
              managers  are voluntary, rather than based on mandatory capital charges.
              However,  the approach provides managers with flexibility to do multi-year
       6 For an in-depth discussion of issues associated with POTW privatization,  see AMSA,
Evaluating Privatization: An AMSA Checklist.,  1996.

       7 The payback on major capital investments can be five to ten years or more.  If a private
operator has only a five year operating lease, it will choose not to invest in assets with long-term
paybacks unless absolutely necessary.

       8 U.S.  General Accounting  Office, Budget  Issues:   Budgeting for Federal Capital,
November 1996, p. 52.

       To be effective,  internal accounts and revolving funds must allow managers to purchase
and sell assets as need dictates.  Positive balances should earn interest if these funds are used in
the interim for any other purposes. Managers also need to be free to implement replacement cost
pricing in order to send the proper price signals.9  Because these  systems  reduce the power of
central utility boards to control successive spending (i.e., after the initial capitalization of the fund
or account), the central boards sometimes resist the implementation  of these approaches.
Activity-Based Costing and Wastewater Treatment

       Activity-based costing (ABC) is a simple but powerful idea: allocate costs to processes,
products, or projects on the basis of the activities that generate these costs. To do so, one must
group  spending by  activity  rather than  by department,  as is  often  done.    When ABC is
successfully implemented, many costs  now termed "overhead" are linked to the activities that
generate them, and are allocated accordingly to products, customers, or other cost "objects." The
end result is cost information that provides accurate and complete costs for a particular area of
business activity.  The full costs of generating particular products or  services  can be quite
surprising.  Many private sector firms have discovered they were selling products for less than it
cost them to make, once support services and capital requirements are included.

       This type of an outcome is possible because the intensity of demand for support services
and infrastructure varies  widely by customer and time period. Wastewater treatment abounds
with examples of this type of behavior.  Additional capacity may be needed at the plant to handle
seasonal dischargers, either due to industry cycles or tourist peaks.  Where  infrastructure is  old or
poorly built,  large inflow and  infiltration during rainstorms  can  dramatically increase capacity
requirements at the treatment plant. In terms of differing demands on support functions, certain
industries — such as those in non-compliance —  will require a much higher level  of laboratory
support and inspector time.  Large industries may require more time to permit than smaller, less
complicated ones.   These are but a few examples.  Overhead costs, and costs in general, are
driven by variety, complexity, and activities.10  Variety  reduces opportunities for achieving
economies  of scale and adds complexity.  Complexity increases opportunities for mistakes and
increases the time spent trying to prevent mistakes.  The more activities that need to be done to
create a saleable product, the higher the costs are likely to be.

       Cost distortions are more likely when:

       •      An enterprise provides both high- and low-volume  services  from the  same
       9 Ibid., pp. 44-50.

       10 Michael Ostrenga, et al, The Ernst & Young Guide to Total Cost Management, (NY:
John Wiley & Sons, 1992), p. 38.

       •      A  single  plant  provides  services to  different  customers  of  varying

       •      Some  dischargers  require  higher standards  of treatment,  or  higher
              treatment capacity, than others.
Mechanics of Activity-Based Costing

       ABC involves linking resources to activities to cost objects.  Resources include the basic
inputs to production: time, labor, capital, and energy, all of which cost money.  These resources
are allocated within an organization to  support particular activities:  inspecting a discharger,
testing an effluent sample, preparing and mailing a customer's bill.  These activities, in turn,  are
conducted for the benefit of the "cost object."  A cost object is a rather bland term that describes
the goal for which resources  are being  used.  Most commonly, cost objects  are products or
services. Service to a particular type of customer (a customer class) can be a useful cost object as

       Unlike a factory, which might produce seven varieties of blue jeans, WWTP output is
more difficult to define. At a most basic level, the plants produce clean water and safe biosolids.
However, the plants provide a host of services to support this output, and these services are not at
all uniform.   For example, treatment of wastewater is  a different service for different  types of
customers.   The service  required by a  significant industrial user is quite  different from that
required by a small residential  customer.  Even within the  SIU,  a range of services are provided
depending on the type  of industry and the nature and timing of the discharge. By tracking these
distinctions, ABC provides managers with new insights into their operations.

       The overall process of ABC is presented in the  event-chain shown below.  Each element
of the chain is described in turn.

       Cost Measurement

       Allocating resources to activities requires that the organization accurately measure costs.
For many expenditures, this data can be obtained from WWTP's general ledger, which lists each
purchase or payment.  Capital costs must be adjusted to reflect the real cost of using scarce
capital resources, as described under the  capital budgeting  section above.  Labor costs,  often
grouped into a single expenditure, need to be tracked based on what activity the time was spent
on. For some organizations, implementing a system of tracking time (such as by using timesheets)
can be a big change.

       Cost Allocation

       Costs are  grouped into activity cost pools., which are simply the summation  of all
expenditures related to a particular organizational activity.  The  allocation of costs involves two
important decisions:  what the activity cost pools should be, and how general costs should be
allocated among cost pools.

       •      Defining Activity Cost Pools.  There is a trade-off between more refined
              activity cost pools (which allow costs to be allocated more precisely) and
              the cost and complexity this proliferation adds to the organization.  General
              categories are  usually best unless  compelling information indicates  costing
              would be much improved through additional categories.

       •      Assigning Costs. Costs must be  assigned from activity cost pools to cost
              objects in a manner that reflects the behaviors that actually drive the costs
              (referred to as cost drivers). Thus, costs should be charged to a customer
              or product directly whenever possible — for example, if a specific person
              was hired only to service a particular customer. When this is not possible,
              costs should be allocated based on the level of service provided, such as the
              use of labor or machine hours.   Only when data exist with which to
              estimate  the  degree  of workload  created by a particular  product  or
              customer should costs be allocated based on a general volume measure
              (e.g., share of revenues or production volume).
       "True" Costs of Products/Services

       The full cost of a cost object is equal to the sum of its direct  costs plus a fair share of
applicable indirect costs.  Direct costs include materials,  labor, energy, and  capital that can be
directly attributed to creating or servicing a particular cost object, such as an industrial discharger.
While all POTWs must have their rates approved, for which they conduct a cost-of-service study,
the resultant rates rarely represent the true costs of providing services to particular customers.
Much of the problem lies in how costs are  assigned to particular cost object.   Activity-based
costing  can greatly improve the accuracy of costing. While the results will not be the "true" costs
(as judgments are always required in assigning indirect costs), they will provide customers and
managers with substantially better cost information on costs with which they can make decisions.
Implementing an ABC System at a WWTP

       Implementing an ABC system can be an extensive undertaking.  An important first step is
to think critically about  the  desired outcomes of the endeavor.  Is the  goal to track specific
services more closely?  Specific service families?  Specific customers? What types of decisions do
you hope to make with the output from the system?

       An activity-based costing system for a publicly-owned treatment work can focus less on
product line profitability than would be required in such a system for a private firm.  However,
tracking the costs to serve particular types of customers is quite valuable.  This information can
help managers evaluate their current charges, focus their outreach and enforcement, and identify
high cost activities within the POTW for streamlining.

       Exhibit 2-1 below provides a hypothetical example of the cost  of conducting a routine
inspection  at an IU.  Activities required to conduct  the inspection are broken down into the
resources they use.  The  cost of these resources is then used to estimate the full  cost of the
inspection.  The value of ABC is that it can demonstrate the often large impact that "support"
functions have on the service provided. In this example, laboratory costs are particularly high.

       The first step  in most POTW cost of service assessments is to allocate costs to rather
broad functional area  cost pools.  There is some variation across  POTWs in terms of what cost
pools are chosen.  The functional  areas outlined in Exhibit 1-1 could be used.  Managers may
decide initially to use fewer  allocation pools, including such items  as  treatment, transmission,
collection,  disposal, billing, customer service, accounting and finance, and administration.11 The
Massachusetts Water Resources Authority (MWRA), a very large integrated utility, has additional
categories such as public affairs, procurement, and human resources. These activities would likely
be accomplished by a single person (or fractional FTE) at a small POTW.

       Regardless of their exact categories,  cost pools need to provide managers with their
desired level of information without creating an undue information collection burden on their
staff. It is important  to note that  not all functional areas are the  same with regard to their
contribution to direct and indirect costs.  For example,  most costs associated with  wastewater
collection and treatment are directly related to services provided to dischargers.  Functions such
as human resources or public information have a more indirect  link.  In terms of prioritizing
implementation of activity-based costing, it is best to begin with large costs linked more closely to
customers, as these are the areas where costing problems are most likely to distort discharger

       Assigning costs to functional areas has traditionally been done within customer classes  —
for example, residential,  commercial,  industrial, institutional, other government utilities,  and
customers outside the city.12 In many situations, customer class is not the best allocation base, as
important cross-subsidies may remain.  POTW managers should think carefully about  cost drivers
in determining how to allocate particular costs.  To the extent costs can be allocated to particular
dischargers rather than to customer classes, this should be done.
       11 George Raftelis, Comprehensive Guide to Water and Wastewater Finance and Pricing,
Second Edition, (Ann Arbor, MI:  Lewis Publishers, 1993), p. 178.

       12 Ibid.

                                                Exhibit 2-1
                          Hypothetical Example of Activity Based Costing
Cost Object: Routine Inspection at ACME Eraser Company
Pre-lnspection Data
       Resources Required
-Clerical time to pull files
Possible Costing Basis
Labor time
                       -MIS Resources for data storage and Computer time
                       access; and for scheduling
                       -Review by inspector               Labor time
                       -Phone contact to schedule inspection Labor time (clerical) +
                                                        telephone time
      Cost Allocation
  Units     Rate    Cost

0.2 hours    $12.00   $2.40

0.5 hours     $4.93   $2.47
                                                       0.5 hours     $17.00    $8.50
                                                       0.2 hours              $3.00
Travel to and from Site
-POTW vehicle, gas, repairs,
-Inspector travel time
-Sampler travel time
Average charge per mile 13 miles
Labor time
Labor time
             $0.31   $4.03
                                                                              0.4 hours     $17.00    $6.80
                                                                              0.4 hours     $12.00    $4.80
Inspection of Site
-Inspector time                    Labor time
-Assistant time                    Labor time
-MIS costs for expert system used on Number of inspections
                      1.5 hours    $17.00  $25.50
                      0 hours                $0.00
                               1   $22.50  $22.50

Analyzing Samples
Post-Inspection Write-
-Chemicals and supplies
-Sampler Time

-Lab technician time
-Machine time (includes all costs
related to purchase and upkeep of
machine and rental of space to house
-Chemicals and supplies
-Residual management and disposal
-MIS costs for Laboratory Information
Management System

-Inspector time

-Manager review

-Data verification and entry
-Follow-up communication with
-MIS costs
Total Cost to Inspect ACME
Direct costs
Labor time

Labor time
Pro-rated share of total
cost of particular
equipment used

Direct costs
Direct costs
0.4 hours

1.2 hours
1.0 hours
                                                        Transactions processed  3 samples
Labor time (inspector)

Labor time (manager)

Labor time (clerical)
Labor time (inspector)

Computer time
                                                                               1.0 hour
$35.00  $35.00
$12.00   $4.80

$17.00  $20.40
345.00 $345.00
             43.00  $43.00
             17.00  $17.00

               5.81  $17.43
0.5 hours    $17.00   $8.50

0.25 hours   $23.00   $5.75

0.4 hours    $12.00   $4.80
0.3 hours    $17.00   $5.10
             $4.93   $4.93

                             Exhibit 2-1 (continued)
                         Summary of Cost Factors

Labor Rates ($/hour, including fringe benefits)

               Inspector                                                    $17
               Sampler                                                    $12
               Manager                                                    $23
                Clerical                                                    $12
         Lab Technician                                                    $17

Computer Time

Laboratory Information Management System (Hardware and software)
 Total Cost/Year                                                         $25,000
 Transactions Processed/yr                                                 4,300
        Cost/transaction                                                    $5.81

General MIS Support (other than LIMS and project-related support)
 Total Cost/Year                                                         $74,000
 Number of staff-hours used                                                15,000
  A verage cost/MIS hour                                                   $4.93

Expert System for Inspectors
 Total annualized cost                                                      $9,000
 Number of inspections/year                                                  400
         Cost/inspection                                                   $22.50

Telephone System

 Long-distance                                              direct billed to projects
 Local calls
  Total costs/year                                                           $950
  Total minutes of calling                                                   19,000
        Avg. cost/minute                                                    $0.05

       Exhibit 2-2  illustrates the cost drivers for key functional areas of the POTW.  Similar
services can have very different cost drivers, depending on whether they are baseline versus peak
capacity, or capital versus operating costs.  Some general rules have been used in developing the

       •      Minimum size rule. The minimum scale of operations required to service
              an average customer is defined as the "baseline" system, for which  the
              costs are spread equally across customers. This minimum size needs to be
              determined  by  each  POTW,  but  should  incorporate  two important
              considerations.   First, variability in the "average" discharge suggests that
              the minimum size should be slightly higher than the average to handle
              standard deviations  in  discharges.  Second,  given the  large costs  and
              difficulty of retrofitting POTW infrastructure if it is undersized, a prudent
              baseline system  should also include some level of oversizing  to provide
              flexibility, the cost of which would be shared among all customers.  These
              caveats aside, the additional capacity required should then be allocated
              among specific customers  (or customer classes) based on their demand for
              the incremental services.

       •      Disaggregation of service provided.  By breaking services into smaller
              units, it  becomes easier  to differentiate  the cost  of servicing  different
              customers (this process is  often called "unbundling").  Collection costs are
              a good example.  In very large POTW systems, the sewer line distance  and
              the pumping costs can vary widely across customers.   Unit costs can be
              higher not only due to distance, but due to utilization of particular portions
              of the network as well. With disaggregated costs, the POTW can calculate
              the carrying charge from any particular location fairly  easily, and use  this
              information in rate setting, to identify areas for decentralized treatment, or
              to promote growth in order to increase utilization of infrastructure within
              particular regions.

       •      Polluter  pays  principle.    Wherever  possible,  the  dischargers   of
              constituents that reduce the quality  of residuals (and  hence their market
              value) should bear the financial burden of those lost revenues.

Support functions, such as administration or finance, will generally require some use of process
mapping in order to estimate the costs associated  with  particular services to  customers or
customer classes. Process mapping  is described in more detail at the end of this chapter.

Exhibit 2-2
Collection System
Baseline collection system
Incremental sizing: laterals
Incremental sizing: trunklines and
New collection lines
Pumping: operating costs
Fats, oils and grease (FOG)
collection: baseline program
FOG: enforcement and clean-out
Treatment Works
Baseline capacity construction and
Peaking capacity construction and
- Large dischargers
- Inflow and infiltration
Allocation Base

Flow: non-coincident
demand method
Flow: coincident demand
New customers
Discharge quantity
Customer class
Customer class

Flow: coincident demand
method, with surcharges
for strength
Size of pipes and installation cost of collection system for average sized user is
driven by number of users.
Lateral sizing determined by individual peaks of each customer.
Trunklines can average differing peaks by discharges. Thus, best allocation is
based on peak flow level for the POTW.
The full cost of extending the collection system should be borne by the beneficiary
industries or neighborhoods. POTW can set up a longer-term payment so that
future users in the new zone also pay a portion of the cost.
Each pumping station can have a charge that is a function of influent pumped.
Dischargers farther from the plant may go through a sequence of pump stations,
and thus will pay a higher total pumping fee.
Base fees for setting up and operating an oil and grease program should be spread
among all oil and grease dischargers equally.
Any incremental costs for inspection, enforcement, or damages (e.g., system clean-
out) should be direct-charged to the facility. If facility can't be identified, charge
should be borne by all FOG permittees.
Base fees to set up a basic program should be reflected in permit fees to haulers.
Incremental costs of handling specific loads should be charged directly to the
hauler through a tipping fee (price per gallon or pound) and/or strength surcharge.
In districts with multiple drop-off sites, the incremental costs might include
location-specific surcharges for pumping costs.

Using the minimal size rule, the baseline cost of providing the treatment plant
should be borne equally by all dischargers.
Additional capital requirements driven by large dischargers, high strength wastes,
and inflow/infiltration. Incremental costs of building and operating a larger facility
should be borne by these causal agents, in proportion to their contribution to the
problem. I/I charges may need to be prorated to certain zones of the system (e.g.,
specific towns) based on their contribution.

Exhibit 2-2
System operating costs
System Expansion
Discharge Management
Biosolids and effluent: baseline
Biosolids and effluent: incremental
management costs
Compliance testing
Local limits setting
Permitting and Inspection
Conservation Programs
Allocation Base
Flow: quantity and
Flow: coincident demand

Discharge quantities
Dischargers of
constituent(s) of concern
Discharge quantities

Flow quantity
Time and materials
Time and materials
All lUs
Time and materials by
customer class
Variable costs driven by the amount and strength of wastewater treated.
So long as treatment costs are appropriately allocated among peak and non-peak
users, system expansion costs should be borne by all users, not just new ones. Only
in this way will demand for total capacity be properly rationed.

All dischargers contribute to residuals requiring management. Baseline cost of
management, assuming highest grade biosolids and effluent, should be borne by all
If there are incremental costs of having to landfill or incinerate biosolids, or of not
being able to resell effluent, they should be borne by the dischargers that created
that need, based on their contributory share of that constituent.
While some dischargers may contribute to the need for compliance testing of
influent and effluent more than others, most of the testing is done to comply with
the Clean Water Act. Thus, allocating costs to all customers based on quantities of
discharge requiring treatment is a simply and fairly accurate method.

Baseline requirement of the POTW. While contributions of constituents of concern
may vary by discharger, all customers (including residential) contribute to loadings.
Effort to permit and inspect lUs various by facility. Costs, including associated
support functions, should be allocated based on effort.
All enforcement costs should be allocated to the enforcement target for recovery
during the case. Enforcement costs for cases that are not pursued or lost should be
allocated across lUs.
Since topics are likely to change year-to-year and many of the targets are likely to
be smaller businesses, it probably makes sense to spread this cost across all lUs
based on flow.
Efforts to reduce discharge levels through conservation programs are similar to
education and outreach expenses, although costs and approaches are likely to vary
substantially across customer class.

Exhibit 2-2

Inflow and infiltration/sanitary sewer
Cross-cutting Functions
Laboratory support, human
resources, administration, legal,
Billing and metering
Debt Service
Discharger or zones of

Time and materials
Customer class - fixed
Pro-rated to purpose of
Allocation Base
Charges for peaking capacity due to I/I were already allocated above to zones of
contribution. Efforts to remediate I/I through special maintenance or upgrade
programs to collection systems should also be borne by customers in the particular
part of the system that is causing the problem and benefiting from the upgrade.

Costs should all be allocated to the various departments based on the actual time
and materials spent providing services to them whenever possible. If links can be
made to specific dischargers (as is often possible with laboratory tests), charges
should be pro-rated to them.
Billing and metering costs are fairly fixed for a given size customer. Thus, the
costs for each customer class should be estimated and then included in a monthly
service charge that is independent of quantity discharged.
Recovery all capital related to collection and treatment infrastructure would include
the financing costs.
Sources: Raftelis, 1993; National Association of Regulatory Utility Commissioners, 1989; MWRA, 1994; MWRA, 1997.


       This guidance provides a general overview of ABC applied  to WWTPs.  We draw on
work done for electric and gas utilities on cost allocation, and encourage readers seeking more
detailed information to examine that literature as well. Application of even relatively simple ABC
systems can  greatly improve the  cost  information that managers within the plant, as well as
customers relying on the plant, use to make decisions. It is important to remember that ABC is a
tool for decision making, not the determinant of a decision; interpretation of the results is always
necessary to use this  information  most effectively.  The following caveats help to place the
information in context:

       •      Externalities  excluded.   Activity-based costing generally stops at the
              enterprise walls; external costs are not rolled  into the calculation as is done
              with environmental  accounting or lifecycle  costing.   As  a result, the
              environmental  costs  of particular industrial discharges — for  example
              declining fish populations — will not be picked up as a cost to be allocated
              to particular dischargers unless program managers expressly decide to do

                                           Exhibit 2-3

                             Less Tangible, Hidden,
                             Indirect Company Costs
                                        Conventional Company Costs
                    Internal Cost Domain
                   External Cost Domain
                                                             Total Company Costs
                                                             (Captured by ABC)
                                          Full Life-Cycle Costs
                     Source: Based on White et aL, 1995, p. 21.

       •      Cost Rigidity.  Not all cost components are easy to reduce, even with the
              proper price signals.   In  the  longer-term,  more  of the costs  can  be
              influenced than in the shorter-term.  Thus,  ABC signals are likely to  be
              more valuable in rationing constrained capacity or sizing new capacity than
              in  changing use patterns for infrastructure that is already in place but

       •      ABC  measures average costs, not marginal  costs or  market value.
              Although ABC allocates costs based on which customers/services drive the
              demand for extra resources, the resulting cost allocation is an averaging of
              the incremental cost among  users. For example, if handling peak flows in a
              collection system increases  costs by 50 percent over the baseline, this  50
              percent would be  allocated across the users of  that peak capacity.  For
              existing capital infrastructure that is underutilized, ABC  may suggest a
              higher-than-rational allocation of costs to particular users. In the collection
              system example,  if there is  spare capacity in  both the collection and
              treatment system, charging a new user full ABC value would signal scarcity
              when in fact none is present. Resource pricing, which is a marginal analysis
              (and is described below), can be a useful supplement to ABC in situations
              such as this.

       •      Cost of flexibility. As noted above, flexibility, in the form of some surplus
              capacity at the time of construction, is generally a prudent  strategy with
              large, difficult to modify,  capital infrastructure.  Managers need to interpret
              ABC information in such a way as to recognize the value of this flexibility.
Resource Pricing and Debottlenecking

       Soda bottles have narrow necks that slow the flow of liquid. The narrower the neck, the
slower the flow from the container.  This analogy has been applied to factories where the output
of the entire system is limited by the speed  of the slowest part.  If a  POTW has a treatment
capacity of 16 mgd, but the trunkline system pipes are so narrow that they can deliver only 5 mgd
for treatment,  much of the expensively built treatment capacity will sit unused.  (In all likelihood,
sewage will also be flowing out onto the streets or back into people's houses due to the lack of
collection as well).

       "Debottlenecking" expands the limited constraint, allowing the system to operate with a
higher throughput. A logical solution to the above example would be to  expand the trunklines to
carry greater flow.  This adaptation might solve the problem for some  POTWs; for others, the
bottleneck might simply shift from the trunkline to the laterals in certain parts of the service area.
The  laterals that are constrained may  shift  as well,  depending  on the production cycles of
discharging industries, rainfall (due to I/I), or other factors.

       This simple example illustrates two important points about the POTW system:

              Bottlenecks can  "float"  from  one area to another  depending on what
              problem is corrected and the current activity of the system.

              To  eliminate  all bottlenecks  at  once,  one  must  examine  the   system
              holistically and model capacity constraints under various conditions.
       Unused capacity in the treatment system can drive costs of treatment up substantially. For
example, according to a recent  survey by the  Association of Metropolitan Sewerage Agencies
(AMSA), the average POTW needed to pay $23.2 million in principal and  interest per year,  or
more than $63,000 per day.  The revenue requirements are substantial.  In  a 20 mgd plant, this
translates to roughly 0.3 cents of debt service per gallon treated if the plant were running at full
capacity, funds that are lost if constraints in the process  prevent this capacity from being used.  If
the plant was oversized to handle storm surges, the cost per gallon could be substantially higher,
affecting all users.  Thus,  it  is important to eliminate bottlenecks to ensure that the expensive
infrastructure put  in place can  be used effectively.13  However, the desire to reduce wasted
capacity must be balanced against the ease with which capacity can be expanded later.  Thus, it is
more important to have spare capacity in collection systems  (which require digging up  roads to
replace) than in digester capacity, since digesters can be added one-by-one  as demand for them

       Not all  bottlenecks are as obvious as below-size trunklines.  Any resource  used in the
plant can be constrained. If this constraint impedes the  use of other  assets, the constraint can be
expensive indeed.  Consider the case of skilled engineering labor.  If the POTW is using all its
skilled engineers  to  design the collection system in a new industrial park,  staff may not be
available to retrofit the aeration unit with more energy efficient fine bubble diffusers.  Should the
POTW managers pull  engineers from the  industrial park design and get them  to work on the
diffuser?  The  answer is not always  obvious.  In fact, it is  in situations where the same asset
(including skilled labor) can be deployed in many ways, or the expansion of a very expensive asset
can be delayed via many alternative strategies, that resource pricing becomes most valuable.

       Accurate resource pricing gives managers price signals that help them to decide the most
effective manner to deploy scarce internal resources.   Just as  an expensive price for biosolids
landfilling tells managers to look for less expensive options, so too do expensive internal prices on
key  resources, such  as treatment capacity,  help focus attention  on ways  to conserve  that
commodity.  Resource prices determine  the opportunity cost of using resources in one area as
opposed to another.   If we change one  scarce resource to project  2 (installing the fine bubble
       13 For new construction or plant expansions, this means be sure that the capacity of the
equipment  installed is proportionate to what is needed in the other,  connected, parts  of the
treatment process.

diffuser) from project  1  (designing the industrial park collection system), what will happen to
POTW margins (revenues minus costs)? Will accelerated implementation of project 2 make the
overall POTW system better or worse off than rapid completion of project I?14

       An undersized trunkline in the 10 mgd plant can illustrate how resource pricing works.
The pipe sizing prevents 50  percent of the treatment capacity from working.  This lack of
trunkline capacity is the constraint. If the daily debt service on the plant is $63,000, the cost of
leaving 50 percent of it unused is  $31,500 per  day  (0.3 cents  per gallon per day), or more than
$11 million per year.15 In industries with large  fixed investments and linear processes (where all
material flows through the same equipment),  costs of bottlenecks can be enormous.  The value of
increasing  trunkline capacity  in this example would be roughly  $1.10 per annual  gallon of
capacity.16 That is, in this highly simplified example the resource price for expanding capacity in
the trunkline is $1.10 per annual gallon. (The resource price for any input which is not constrained
— for example treatment capacity — is always zero.  This is because  increasing the amount of this
resource available will do nothing to increase plant output).

       This cost information can be used in a variety of ways:

       •      If expanding the trunkline costs substantially less than $1.10 per annual
              gallon of capacity,  and the lack of additional capacity  is preventing  flow
              from reaching the plant, expanding the line makes sense.

       •      If the plant has  not yet been built and the cost information was gathered to
              help properly size the plant, the information helps managers see the cost of
              over sizing the  treatment plant (or the cost  of under sizing collection
              systems) and to plan accordingly. For example,  if projected peak flows can
              be reduced  for less than $1.10 per annual  gallon  (such as through I/I
              control), resource  pricing helps to demonstrate that  these  alternative
              strategies are cost-effective.
       14 Resource pricing evaluates technical constraints.  There may be  strategic reasons to
continue with project 1  even if doing project 2 sooner would increase POTW margins.  As with
all of the  tools described here, management insight is  still required in order to make a sound

       15 This is a rough approximation.  In reality, not all of the capacity will be used even in
well-balanced plants, and the annualized cost of capacity may not be equal to the debt service. In
addition, costs other than debt service would also be spread over the new capacity, increasing the
value of removing the constraint.  Finally, were the POTW a private entity, the cost of unused
capacity would not be higher costs, but rather forgone profits, usually a higher figure.

       16 Equal to 0.3 cents per gallon per day multiplied by 365 days/year.

       Implementing a comprehensive resource pricing system is much more complicated than
this simple example.  Linear algebra programming is used to map out the many constraints in the
POTW systems and the goal to be maximized (known as the objective function).  Equations are
set up  to describe  the various  outputs,  their  contribution  margins,  and their  production
constraints.  However, unlike industrial processes such as petrochemical plants and oil refineries
that have scores of product output options, POTWs provide a much smaller diversity of services.
Therefore, applying the concept of resource pricing to key assets (especially those shared by
multiple municipalities), even in a simplified way, can help to greatly improve system efficiency.

Process Mapping

       Process mapping is  a  systematic  tracking of physical  processes, key task  flows, and
information flows within an organization.  The purpose is to step back from day-to-day activities
and try to track what resources are actually used in providing a certain type of service or product.
A process map is a picture of the variety, complexity, and activities that commonly drive up costs.
Each  step of the map is a resource input, to which units (labor hours, machine hours, material
inputs) can be attached.  By monetizing these inputs using information on the cost of these inputs,
the total cost of providing the cost object can be estimated.

       An example of a POTW process map is included as Exhibit 2-4.  This map is one of more
than 50 that the Louisville and Jefferson County Metropolitan Sewer District (LMSD) created as
part of their current cost accounting initiative.  Each of the maps takes a specific activity that is
often  lumped into general overhead accounts or, in this case, general capital and general operating
expenditure  line items, and analyzes work flow in detail. Examples of other processes mapped
out include  the bidding process, callbacks and  agency  letters, the construction change order
process, and reviewing a plan of the sanitary sewer to answer a particular question.

       The left side  of the map illustrates the various departments within the plant utilized to
complete  the  task in question.  The  steps in completing  the task begin on the left and are
completed on the right.  This picture is one part of a complete process costing.  To estimate the
cost of corrective and preventive maintenance planning, for example, POTW staff would track the
staff,  machine, or other resources at each step to evaluate the total overhead cost generated each
time an equipment defect report (see chart) is filed. Accurate costs for these general activities can
be used to generate  more  accurate costing estimates for higher-level  activities requiring these

       Process mapping is  also an invaluable tool in identifying  how to improve operations.
Perhaps the map is  extremely  complex, with many areas of duplication.  Perhaps  the  costed
activity is extremely expensive,  suggesting that investments in improved information technology,
for example, might help reduce costs. In both these situations, a  careful process map can illustrate
fruitful areas in which to  begin improving operations.  LMSD has shaded the  portion  of this
particular process that they felt offered the most room for improvement.  Process maps are also
useful supports to process  benchmarking  (described below),  where specific portions  of plant
operations are compared to other entities using a similar process.




 x  *
W  W





       Benchmarking can be used to identify weaknesses in the POTW's products or production
processes,  and  ways  to  improve on these  weaknesses.  Metric  benchmarking  compares
performance quantitatively: inputs, outputs, outcomes, and the relationships among them.  Basic
comparisons between prices or financial ratios are commonly used metrics.  Metric benchmarking
can be a quick way to identify if there are problems. For example, if Manufacturer A spends more
on  manufacturing  his product than Manufacturer  B sells it for,  simple price  benchmarking
demonstrates very clearly that Manufacturer A has a serious problem.  Identifying what that
serious problem is, a critical  step in being able to solve it, requires more refined metrics and the
use of process benchmarking.  Process benchmarking maps ones own process against competitors
that have the best performance using a  similar process in order to identify where and why there
are differences.17 Exhibit 2-5 illustrates the connection between the two approaches.

       Whether using metric or process benchmarking, great  care needs to be taken to be sure
that you are comparing the same thing.  Thus, when comparing costs, you need  to  be sure
everybody has proper costing data.  If one POTW benchmarks its costs for basic service against
similar utilities and finds it is far less expensive, managers need to take their analysis to a second
stage.  Are there problems  with how  these costs  are calculated (e.g., water revenues cross-
subsidize wastewater treatment costs) that account for the discrepancy?  Other factors may also
be relevant.  Is capital infrastructure older?  Does your town  have a better bond rating than the
competitors (and thus a lower cost of financing debt)?  Some of these factors may be used to
adjust the comparison so that operating efficiencies can better be compared.  Other factors may be
used to describe why performance  is  worse than expected, perhaps to justify improvements or
upgrades to these factors.18
       17  WERF  (Water  Environment  Research  Foundation),  Benchmarking  Wastewater
Treatment Plants Operations: Interim Report, 1996, p. 1-5.

       18 The WERF study has attempted to normalize benchmarking for these factors by creating
models for various portions of POTW operations.  This approach can help identify how portions
of the operation within managerial control compare across utilities.  It is important not to rely
solely on normalized comparisons, however, as inefficient operations whether due to  "embedded"
conditions such as the age of equipment or not, need to be improved over the longer term.

                                    Exhibit 2-5
                           BENCHMARKING PROCESS
       • HOW MUCH
       • WHERE
       • WHEN
                        MANAGEMENT COMMITMENT
                         EMPLOYEE PARTICIPATION
                          SUPERIOR PERFORMANCE
     Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996.

       The benchmarking process is often creative in what  is used as a comparable: the central
goal is to identify who  does the process/product of interest best, and how their approach be
copied  and used to improve your own operations. Comparisons can be internal (across divisions
or within the same unit over time), with direct competitors (function or entire organization), with
the industry functional leader (specific function against leaders in that function, even if not a direct
competitor), and finally based on a generic process (against process leader, even from a different
        WERF, p. 2-6.

       Process mapping often pulls best practices for particular operations from a wide range of
other industries, some fairly far  afield  from their  direct line  of business.   For  example,  a
comparison of billing operations might compare POTW billing to that used by major telephone
companies  or package delivery  services.   Peak leveling  efforts  or management  information
systems would likely use a cutting-edge electric utility, where demand-side management efforts
and geographic information systems have been established  for longer than in the POTW arena.
For other areas,  such as pretreatment, benchmarking efforts would likely focus on cutting-edge
POTWs, such as recent EPA pretreatment award winners.  Benchmarking is normally done as a
continuous process in order to ensure that the POTW operations also continuously improve.20

       Most  POTWs undertake some form of benchmarking. For example, tracking trends in
metals loadings over time is almost universally done.  A study now underway by the Water
Environment  Research Foundation explores the many additional uses of benchmarking within
POTWs and  is an extremely good  reference  for utilities who plan to undertake an extensive
benchmarking exercise. Exhibits 2-6a - 2-6c below, developed by WERF, illustrate  a variety of
metrics managers can use to track their performance.  These metrics include outcome measures,
efficiency measures, and effectiveness measures. Outcome  measures focus for  the most part on
how external  agents evaluate POTW performance, such as through complaints or bond ratings.
Efficiency performance measures are cost ratios per unit of service provided,  and help identify
higher cost parts of the POTW's operations. Finally, effectiveness performance  measures include
measures of  labor input  per unit output,  or  the technical effectiveness of existing plant  and
equipment.    The sheer number  of metrics identified by  WERF  focus  groups illustrates the
importance of choosing the most important metrics for a particular utility.
       20 WERF, p. 2-4.

Exhibit 2-6a:
Functional Area
Collection Systems
Customer Service
Biosolids Management
Finance, Administration, & Planning
Labor and Staffing
Wet Operations
Outcome Measures
Degree of Automation
Effectiveness of automation
Number of collection system complaints
Number of claims per year
Number of overflows per year
Moratorium due to collection system
Time to repair collapse (in hours)
Percent of system inspected per year
Time per call
Abandonment rate
Average agent availability
Average time to clear:
- complaint
- service call, etc.
New account cycle time
Walk-in average time to serve
Plan review/turnaround time
Time to billing adjustment
Customer satisfaction (survey/focus group, etc.)
Number of odor complaints
Number of citizen complaints (related to dry process)
Quality of biosolids (Class A orB)
Dry tons produced/strength factor
Permit violations
Redundancy in land applications
Forecasted life of biosolids arrangements
Residential flow per capita at plant (over time)
Audit exceptions and comments
Bond rating
Operating reserves
On time payments
Injury days lost per full time employee
Number of grievances processed
Number of exceedences
Number of complaints
Number of odor complaints
Total hours lost to injury
Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996

Exhibit 2-6b:
Functional Area
Collection Systems
Customer Service
Biosolids Management
Finance, Administration, & Planning
Labor and Staffing
Wet Operations
Efficiency Measures
Cost of automation projects (one time/annual)
Maintenance cost per mile
Maintenance cost per Mgal/day
Maintenance cost per kWh installed
Training expenditure ($) per agent
Customer service costs per day
Customer service costs per customer
Customer service costs per total overhead and
maintenance (O&M) cost
Dollars per dry ton
Dollars per ton mile
Chemical costs per dry ton
Power costs per dry ton
Maintenance costs per process
Fuel cost per dry ton (incineration)
Revenues from product sales
Gas utilization credit (dollars)
Overhead costs per total O&M costs
Labor cost per total O&M costs
Contract services O&M costs per total O&M costs
Debt service per total budget
Annual materials cost per inventory
Training cost per capita
Fleet costs per total O&M (by function)
Return on assets
Value of main replaced per total value of main
Value of capital additions/net asset value
Replacement value of plant (annual)
Overtime cost per total labor costs
Training costs per employee
Total benefits costs per total labor (by type)
Cost per Mgal
Cost per lab analysis
Cost per customer account
Maintenance costs per Mgal
Overtime costs
Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996

                                             Exhibit 2-6c

                                           FOCUS GROUP
                 Functional Area
              Effectiveness Measure
Instrument per Mgal/day
Instrument engineers per Mgal/day
Number of operats per shift
Number of shifts per week
Number of operations automated
Number of administration operations automated
Number of information operations automated
Number of processes that run automatically per total
number of processes	
Collection systems
Full-time employees per mile
Full-time employees per MG
Level of infiltration/inflow (I/T)
Number of blockages per year per mile
Number of collapses per year per mile
Percentage of work orders completed in	days
Customer Service
Complaint calls per 1,000 customers
Percentage of calls that are repeats
Percentage of problems cleared in	days
Percentage of billings collected in	days
Biosolids Management
Full-time employees cost per dry ton (each unit process)
Operations cost
Maintenance cost
Percent  volatile suspended  solids  (VSS)  reduction
Cubic feet gas per pound VSS (anaerobic digestion)
Percent moisture reduction (after dewatering)
Tons product sold per total tons solids
Percent planned per total maintenance
Equipment availability (breakout by process)	
        Source:  WERF, Benchmarking Wastewater Treatment Plant Operations, 1996

                                            Exhibit 2-6c

                                     FOCUS GROUP (continued)
                 Functional Area
              Effectiveness Measure
Finance, Administration, & Planning
Budget to actual:
  - Total expenses
  - Capital improvement program (CIP)
Major project costs per encumbered amounts
Forecasted per actual demand
Debt to equity ratio
Quick ratio
Coverage (debt service ratio)
Billable flow per actual flows at plant
Revenue distribution (fixed charge/variable)
Percent reuse as reclaim (growth over time)
Projected demand per projected capacity at end of
planning horizon
Ratio influent/capacity	
Labor and Staffing
Definable work rates (over time)
Number of operators per shift
Full time  employees per  Mgal/day
time, contract)
Number of labor classifications
                                                                                    (Permanent,  part-
Wet Operations
Percent removal
Full-time employees per Mgal
Full-time employees per customer account
Number of analyses per technician
Cubic feet of air treated per Mgal
Connected HP/gal	
        Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996


       This Chapter discusses a number of areas of common concern for POTWs, though it is
not intended to be an exhaustive listing.  In addition, not every issue will apply to every plant.
Nonetheless, we  hope that  these  examples provide useful illustrations of the value of  cost
accounting and budgeting tools in achieving tangible gains in program performance.

       The underlying theme for both budgeting and cost accounting modifications is getting the
price signals right.  Cost accounting essentially creates price signals within the organization that
help managers rationalize their use of scarce resources. Budgeting organizes this information to
set constraints on the resources available to these managers and groundrules on how the resources
can be used.  Often, this internal pricing information supports changes to external prices (through
rate changes), sending the proper price signals to customers of the POTW.

       Given the importance of this signaling in modifying behavior to conserve resources and
better protect the environment, it is important to briefly mention a couple of general steps the
POTW can take to improve the impact of price signals:

       •      Timing and Frequency of Measurement. Many discharge fees are based
              on periodic measurements of influent and effluent.  The Clean Water Act
              sets statutory minimums for the type and frequency of testing.  However,
              these minimums are unlikely to be frequent enough to (1) rapidly track
              changes in effluent  characteristics; and (2) create certainty that all of these
              changes will  lead to adjustments  in the surcharge levels.  Thus, more
              frequent  measurement  can be expected  to provide better signaling to
              dischargers about  what part of their operations  is most important to
              address quickly.1

       •      Frequency of Billing.   As  with the  frequency of  measurement,  if
              customers receive large bills infrequently (e.g., quarterly or annually), they
              are unable to  react quickly to changes in rates  and unable to associate
              specific behavior with increases in their discharge levels.   This situation
              also applies in communities that commingle wastewater charges with their
              overall property taxes.   All of  these  circumstances  tend  to  reduce
              discharger responsiveness to price signals.

Cross-Subsidies In General

       As  noted  above, poor  cost accounting  matters because it  sends both  managers and
customers the wrong signals about the financial impact of decisions.  These signals can lead the
       1  One POTW with large industrial user flows allocated much of the plant's fixed capital
based on the strength  of contributed  wastewater.   Since the  financial  implications  of this
measurement were so substantial, the lUs tested their wastewater strength on a daily basis.

POTW to invest in the wrong parts of its treatment system and for dischargers to underinvest in
pretreatment or conservation. Normally, POTW rates are set to recover the cost of providing
WWT services. Thus, in the aggregate,  revenues may equal expenditures.  However, quite often
certain customers, types of customers, or geographic regions are paying too little, while others are
making  up the difference by paying too much.  The existing  discharge fees therefore include
cross-subsidies.  Exhibit 3-1 below presents a  range of possible cross-subsidies within POTWs
that we visited. Important issues to consider when evaluating cross-subsidies include:

       •      Magnitude.  If the price signals aren't perfect, but are fairly close, the cost
              and disruption associated with  eliminating  them may not be worth the
              gains.  Magnitude should be evaluated in an  absolute sense, however.  For
              example, if every residential and commercial customer is  paying only 2
              percent more  each  month to  subsidize  the oversight  of industrial
              dischargers, this may not seem  significant.  However, since there are so
              many customers,  this  2  percent could constitute a 50 or 100 percent
              subsidy to particular Ills, which  would likely have a  substantial impact on
              the level of pretreatment investment.

       •      Distortions.   How important are the distortions created by the existing
              cross-subsidies in impeding strategic goals of the POTW?  For example, if
              water  is scarce in your region but  you can't reuse your effluent for
              irrigation due to  discharges of one or two constituents by a handful of
              industries, the resulting  distortions are likely large both financially  and
              environmentally.  In contrast, if rates to one IU are slightly higher than they
              otherwise would  be, but wastewater fees  are an  insignificant  cost of
              business for that discharger, large investments by the POTW to correct the
              problem are clearly unwarranted.

       •      Impact. Correcting cross-subsidies will  change the cost  of  wastewater
              treatment to dischargers,  encouraging them to modify behaviors that cause
              the  POTW to incur the highest  costs.  The impact of these changes can
              reduce  or  delay  the need  to  expand expensive  capital  infrastructure.
              However, for POTWs that  have already built capacity  large enough to
              handle discharges under  the distorted pricing, eliminating cross-subsidies
              will not be quite as efficacious. The capital costs must still be paid whether
              or not the capital is being used by dischargers.   Thus, cross-subsidies are
              most important to eliminate when capacity is constrained.

       •      System Boundaries.  The boundaries of analysis can affect which cross-
              subsidies appear the largest and most in need of correction. For example, a
              cost accounting analysis of POTW dischargers may illustrate that Ills are

                                                    Exhibit 3-1

           Resulting Distortion(s)
Among Industrial Users
Costs of pre-treatment may be
allocated equally across lUs, rather
than based on which specific firms
create costs for the POTW.
-Industries discharging effluent that is most
costly for the POTW to handle will pay less than
they should and underinvest in pretreatment.
-Relatively clean lUs will pay more, serving as a
barrier to new industries locating in the region.
Among different parts of the POTW
service area
Fees for service may be equalized
for all dischargers (industrial,
commercial, and residential)
within the Sewerage District,
despite large differences in the
cost of providing this service.
Examples include multi-plant
systems where one treatment plant
is at capacity and others are not; or
collection areas with particularly
high pumping costs.	
-New dischargers will not receive price signals
to locate in the less expensive portion of the
service area.
-POTW managers will not see which parts of
their systems are most costly to run and factor
that into future expansion decisions.  For
example, peripheral areas may be better served
through decentralized modular WWT rather
than collection system expansion.
Among lUs and other wastewater
treatment (WWT) customers
Charges on industrial users may be
too low to cover (a) the costs of
permitting and overseeing them;
and (b) the cost impacts they have
on the system.
-Industries don't receive the proper price signals
about how their discharges affect the treatment
system and will underinvest in conservation and
Between different municipalities
-Agreements with surrounding
municipalities may not allow
POTW to set fees at levels that
adequately cover the cost impacts
of the imported discharge.
-Customers in the periphery of a
service area may be charged more
because they are in a different
political jurisdiction.  This
surcharge may have nothing to do
with the cost of service.
-Dischargers in the surrounding area will
underinvest in conservation and/or pretreatment.
-Dischargers in the periphery may be hesitant to
hook into the central system even if it is
economically efficient.  Dischargers in the
center may receive artificially low rates and
underinvest in conservation and/or pretreatment.
Between water consumers and
waste water treatment customers
Integrated water and wastewater
utilities sometimes subsidize new
WWT expansion or construction
with surplus revenues from water
-Dischargers may underinvest in conservation
and/or pretreatment.
-POTW may be under less pressure to improve
the efficiency of their operations.
Between the general taxpayer and
the industrial users; between the
general taxpayer and WWT
The POTW may receive general
taxpayer support (e.g., state or
federal grants, general taxpayer
funds) to finance WWT or
pretreatment. Construction grants
or subsidized revolving fund loans
for plants with a high ratio of IU
flow to total flow essentially
subsidize industrial WWT.
-Dischargers may underinvest in conservation
and/or pretreatment.
-Polluting industries, through reduced WWT
costs, improve their relative competitive
position vis-a-vis industries that pollute less.
Between agricultural consumers of
fresh water and WWT
In water scarce regions, federal
policies often subsidize the
extraction and delivery of fresh
water to agriculture. As a result,
treated effluent from POTWs
becomes less competitive.	
-Effluent management is more expensive.
-Market incentive for farms to seek out and
exploit treated effluent is weakened or
-Efficiency of water utilization in the region

              moderately  subsidized  through   higher  charges  on  residential  and
              commercial dischargers.  However, if a watershed perspective were used, it
              may become evident that the largest cross-subsidies are actually going to
              industrial direct dischargers.  Managers should keep this boundary issue in
              mind as they consider where to focus their resources.

       Below we have  classified  the  types of  situations where distortions in costing are
particularly likely.  Included are  differences in the cost of treating  discharges or dischargers,
difficulties associated with peak discharges  and system expansions, and problems from rigidities
inherent in political agreements between municipalities such as interjurisdictional agreements.

Specific Types of Discharges May Force POTW to Incur Higher Costs

       Where specific types of discharges contaminate either the plant's collection system or its
residuals, treatment costs can rise substantially.   The incremental management costs should be
tracked and allocated back to the source that is driving the cost increases. Biosolids management,
effluent reuse, and oil and grease discharges  provide three useful illustrations of this point.

Biosolids Management

       Solid  residuals (biosolids) from wastewater treatment can be managed in a number of
different ways ranging from beneficial reuse  as soil amendments to incineration and landfilling of
ash.   The  cost implications of  these practices differ widely.   Since biosolids management
comprises between 25 and 30% of WWT operating costs,2 contaminants that  force higher-cost
management of the material can have large dollar impacts on the cost of running  a POTW.

       EPA  sludge  regulations  stipulate the maximum allowable concentration of numerous
contaminants (metals, pathogens) in biosolids that are land applied.  Restrictions  on contamination
levels are even more stringent to  meet EPA's highest grade ranking, and may be higher still to
meet  the  demands of   particular customers willing to  accept the  residuals.  As soon as
contamination levels  in any one area exceed  the allowable threshold, the POTW must dispose of
the biosolids as a lower grade product, or, in some cases, pay to incinerate it or dispose of it in a
permitted landfill.

       Consider the example at  Massachusetts'  Water Resources Authority (MWRA).   The
facility invested in a sophisticated sludge pelletization facility that normally produces a product
sold as fertilizer.  Yet,  during the summer months molybdenum (Mo) from air conditioning
cooling towers drives Mo concentrations high enough that the pellets cannot be distributed in the
state, preventing  the POTW  from utilizing its biosolids in an optimal manner.   POTW
management can rectify this constraint by increasing the amount of biosolids over which the same
amount of Mo is distributed  (not a real option) or by reducing the amount of Mo that remains in
the residuals through source reduction.
       2 "Biosolids:  A Business by Any Other Name Would  Smell  as  Sweet," Environmental
Business Journal., February/March 1996, p. 9.


Exhibit 3-2
Common Practice
Cost A ccounting
-Costs of biosolids management recovered through
general user fees on all dischargers.
-Where biosolids quality is poor, more expensive
management options are pursued. Cost of these are
spread among all dischargers. Voluntary reduction
plans or new local limits are implemented to bring
contaminant levels down.
-Biosolids management costs are listed as a line item.
-Residuals testing costs may be listed under general
laboratory costs.
Improved Cost Accounting/Budgeting
-Cost for highest quality sludge allocated to all
dischargers based on quantities discharged.
-Incremental costs associated with poor sludge quality
allocated to dischargers of constituent(s) for which the
biosolids don't meet the highest standards.
-If POTW unable to allocate full charges to these
dischargers, they can evaluate outreach or financing
pretreatment upgrades that reduce overall WWTP costs.
-All related biosolids costs would be grouped together.
       Proper cost accounting should allocate the entire extra cost of biosolids management to
the activity that created that cost:  Mo dischargers.  Mo emissions are but one example; other
POTWs may have exceedances in a variety of metals.  These emissions can often be linked to
specific industrial users, or to Ills as a group.  For example, one plant  on the East Coast receives
a very high proportion of its flow from industries.  The level of contaminants in this flow is such
that they need to incinerate biosolids prior to disposal to destroy any remaining organics.  The full
extra cost of the treatment is properly borne by the Ills rather than spread among all customers.3

       What POTW  managers  choose  to do with this  information is up to  them; the cost
accounting system merely tells them how much a particular occurrence costs them.  Traditionally,
exceedences were met with regulatory reductions in allowable  discharge  levels. Many alternative
options are available:

       •      The POTW could increase discharge fees for the constituents of concern,
              encouraging dischargers to implement better controls.  This could be done
              through direct fees, or through some type of effluent trading system.

       •      If the costs to the  system from particular discharges are  extremely high, but
              delays associated  with modifying permits or increasing discharge  fees too
              long, the POTW might actually find it economic to pay to install treatment
              equipment on the  sites of large dischargers.  This approach is analogous to
              demand-side management programs used for years by electric utilities.
       3  This statement assumes that land  application is less expensive than incineration.   For
POTWs that already have incineration equipment, the variable costs of burning biosolids could
well be less than the total costs of land application - at least until the burner needs to be replaced.

               If the costs of controlling the discharge are extremely large in comparison
               to the cost of incinerating rather than land applying biosolids, the POTW
               may decide that its current practice makes the most sense economically
               (though not necessarily environmentally).
Effluent Reuse

       The issues related to effluent reuse are quite similar to those associated with biosolids.  A
well-functioning POTW will generally produce an effluent that is of sufficient quality that it can be
reused for some beneficial purposes.  However, contaminants in effluent such as metals, salt, or
microbes,  may prevent  reuse  of effluent for irrigation.  Where are these  contaminants coming
from? A detailed study of sources of salinity in Escondido, CA found that water softening plants
were among the largest  sources of salinity in the  discharge area.  The salts introduced by these
plants were  increasing the salinity  of effluent  to the point that the water was unattractive to
                                           Exhibit 3-3
                                       EFFLUENT REUSE
                Common Practice
                        Improved Cost Accounting/Budgeting
Cost A ccounting
-Effluent  is  often  discharged  in
NPDES permit and forgotten about.
-Foregone  opportunities to  resell
compliance  with

the  effluent not
-In water scarce regions,  the cost of managing clean
effluent  is allocated among  all customers  based  on
volume of discharge.
-Lost cost savings from reselling the treated water to
farmers or other bulk users is allocated directly to the
dischargers responsible for discharging the constituents
that make the water unattractive to  these alternative
-If interest in reusing the treated effluent is low, POTW
needs  to evaluate whether existing subsidies to clean
water (e.g., due to federal water projects) is artificially
depressing the value of reclaimed water for non-potable
-Effluent testing (e.g., Whole Effluent
grouped under the laboratory costs.
-Revenues from effluent resale go into
 Toxicity) is often

general fund.
-All costs  associated with monitoring and marketing
effluent  should  be  grouped  under  an  effluent
management category.
-Revenues  from effluent  sales  should be credited to
effluent management.	
       Escondido is a useful illustration because the plant is located in a water-scarce region of
the country (near San Diego, CA), where demand for fresh water is extremely  high.   Logic
suggests that there  would be many users interested in the region's effluent,  especially for non-
potable but higher value uses such as irrigation (see Exhibit 3-4).  Yet this is not the case.  The
quality of Escondido's effluent is not yet high enough for agricultural usage, due to  the discharge
of  constituents  such  as  total  salts,  chloride,  boron,  nitrogen,  bicarbonate,  manganese,  and

fluoride.4 Boron and  chloride are of particular concern to avocado growers, a large potential
irrigation customer.5    These  discharges  are predominantly  from  industrial  and  municipal
dischargers; the rates charged to these dischargers do not reflect the lost opportunity to resell the
                                           Exhibit 3-4

                                EFFLUENT REUSE OPTIONS
                                      Potable Uses


                                      Recharge Surface or Groundwater

                                      Artificial Wetlands

                                      Saline Buffer Flows

                                      Ocean Discharge

                                      Geothermal Field Recharge
       Despite these contaminants, side agreements between farmers and dischargers would likely
work to reduce the loadings of these constituents if the reclaimed water were sufficiently valuable.
Despite widespread shortages,  Escondido's effluent is not  sufficiently valuable  to  farmers to
induce these types of arrangements.  This is an arena where price distortions within  the POTW
combine with price distortions outside to encourage wasteful use of natural resources.

       Reclaimed water is most applicable for re-use  in irrigation.  Yet, it must compete with
irrigation flows from other sources.  In most of the southwestern United States, this water comes
through heavily subsidized federal irrigation projects. Many of the federal water projects do not
charge irrigation users the interest on the debts incurred to construct the facilities.  Many do not
even  recover the  full costs before interest.6  Historically,  irrigators have repaid only about 47
         HYA Consulting Engineers,  City of Escondido Brine Management Feasibility Study,
August 1995. Prepared for the San Diego County Water Authority, pp.3-5.
       5 Ibid., p. 3-5.
       6 U.S. General Accounting Office,  Water Transfers: More Efficient Water Use Possible,
If Problems are Addressed., May 1994, p. 23.

percent of the total costs allocated to them.7 This percentage would be much lower if interest
were compounded on the capital costs of water projects (which the farmers do not have to pay),
as is normally done with capital investments.

       Thus, farmers  have received water rights well below the cost of delivering that water.  If
the  farmers could then turn around and sell their water rights to other users, they would receive a
windfall, but water would be priced efficiently.  However, historically, farmers have not been able
to sell their water rights in federal projects to other users, and thus faced  a cost of using it on their
crops far below what others were willing to pay for those rights. With artificially  cheap fresh
water to use on their  farms,  farmers have little incentive to invest in creative strategies  to reuse
treated sewage.  With artificially low discharge fees, the  dischargers of the constituents of concern
face little incentive to reduce their discharges.
Fats, Oil And Grease (FOG) Discharges And System Maintenance Costs

       FOG discharges  affect the collection system by clogging up pipes and pumping stations.
Sources include restaurants,  auto  shops, and food processing plants.  As  with biosolids and
effluent quality, discharges from a  subset of system users can create large costs for the POTW.
Unless these costs are measured, utility staff may not invest the adequate resources to deal with
the problem.  For example, one POTW in the Washington, DC area had numerous restaurants as
Ills.  Despite efforts by the  pretreatment program to control FOG discharges, main pumping
stations required expensive degreasing on a regular basis.

       No tracking of how much materials, labor, and downtime associated with these clogs cost
the POTW per year was done. In fact, the pretreatment coordinator expressed frustration that the
maintenance staff assumed the work was costless, since they were salaried employees.  This
inability to recognize the opportunity cost of time is often at the root of poor  allocation decisions
within  a POTW.   While the  maintenance staff were salaried, and thus did have to be at work
anyway, they could have been usefully employed on other tasks.

       Once the  cost is recognized, POTW staff can determine the most  effective follow-up
strategy. In many cases, allocating the full cost of dealing with a problem such as oil and grease
clogs back to the  contributory restaurant provides an extremely  effective deterrent to improper
management. In the case of this particular POTW, however, political pressures made it difficult
to pass any substantial  charges  back onto restaurants due to a strong local  restaurant lobby.
However, properly accounting for the  costs might have shown POTW managers  that more
outreach and education in this area was likely to pay off.
       7 U.S.  General Accounting Office,  Bureau of Reclamation: Information on Allocation
and Repayment of Costs of Constructing Water Projects., July 1996.

       For example, the POTW  could have educated the  restaurants  about the  growth in
biodiesel, a blend of diesel and bio-derived diesel originating, in part from waste cooking oil.8
Biodiesel blends, in conjunction with a catalytic converter, can reduce emissions of existing diesel
vehicles  so they meet  CAA standards  and reduce air pollution in non-attainment zones.9  This
growing outlet for FOG creates a lower cost disposal option than previously existed, potentially
reducing illegal discharges.
                                           Exhibit 3-5
                          MANAGEMENT OF FATS, OIL, AND GREASE
               Common Practice
       Improved Cost Accounting/Budgeting
Cost A ccounting
-FOG dischargers are forbidden from discharging these
constituents to the collection system.
-They pay a permit fee which may or may not reflect the
full cost to permit and oversee them.
-They may or may not be charged substantial penalties
for failure to empty their grease traps or when they clog
a collection pipe. When costs are charged back, they
often exclude indirect costs  such  as staff time, travel
costs, etc.	
-Permit fees should cover the full cost of permitting
FOG dischargers and the full costs of any uncovered
FOG-related cleaning of the collection system.
-Full costs of addressing  clogs should be charged back
to the firm causing the problem.
-If unrecoverable FOG costs are large, POTW should
increase outreach to explain  new options  for FOG
-Cost associated with oil and grease are often lumped
under  the  general  collection   system  line  item.
Permitting  for  oil  and  grease  is  often  in  the
pretreatment line item.
-A line item for the entire FOG management program
should be included in the budget, and contain all costs
related  to  permitting,  outreach,  and  FOG-related
-Any costs related to system downtime during a grease
clog should also be charged to the FOG program.	
Specific Types of Customers May Cost More to Service than Others

       Not all customers are created  equal.   POTWs need to recognize differences  in the
demands that these different types of customers put on their staff and on their system.  This is
generally done to some degree by all POTWs.  For example, monthly  service fees are higher for
larger sewer mains,  and surcharges are usually levied  on high strength wastewater.  However,
there are many other ways that the costs associated with particular customers are not reflected in
rates.  When POTWs do  not recognize  all of the  important differences across customer classes,
their fee structures will contain a variety of behavior-distorting cross-subsidies.  It is common that
       8 Waste oil fractions of bio-derived fraction are currently about 50 percent, with the other
half from virgin soybeans.

       9 U.S. Department of Energy, Biofuels Update, Winter 1997, p. 3; Fall 1996, p.l.

residential users end up subsidizing industrial dischargers.    Since it is the industries that generally
discharge most of the  difficult or impossible to treat contaminants (e.g., metals),  cross-subsidies
often end up subsidizing polluters, violating the polluter pays principle.
Permitting Costs

       At least every five years, each industrial discharger must receive a new discharge permit.
The cost to provide this permit can vary widely. Small, standardized industries, such as one-hour
photo shops, have the same processes  and the same issues in every shop.   In  addition, the
emissions  from  any single facility are unlikely to be large enough  to cause  operational  or
compliance problems for the treatment plant. Permits  can be standardized, and site  visits are not
always needed.   MWRA, for example, has adopted a group  permit for all small photo shops and
printers, that applies automatically. This "group permit" approach saves substantial staff time.
                                           Exhibit 3-6
                                     PERMITTING COSTS
                Common Practice
       Improved Cost Accounting/Budgeting
Cost A ccounting
-Permit fees cover a portion of total permitting costs.
-Where fees do cover the full cost of the program, the
fees for any specific permittee may be substantially
different from the time required to permit them.
-Residential and  commercial customers  should  not
cross-subsidize ITJs.
-IU permit fees should be grouped by class of facility,
should  include  administrative support costs (such as
computer systems).
-Labor  costs, including those to write the permit  and
those required  for  inspecting the  plant,  should  be
charged directly to the customer.  Thus, complex firms
would pay higher permit fees.	
-Permitting  costs are  often lumped into  the general
pretreatment budget, if pretreatment has its own budget
section at all.
-Permitting,  regular  inspections,  and  enforcement
inspections are sometimes lumped together, or simply
included in the overall labor line item.
-Permitting,  regular  inspections,  and  enforcement
inspections should all be separate line items in the
pretreatment budget.
       In  contrast, consider  a large automotive manufacturer.   This  manufacturer  will  have
multiple processes,  and  sometimes multiple  discharge points.    The  impact of  this  plant's
discharges on the POTW system can be substantial, but there are no  other  similar plants in the
service area. It is obvious that developing a permit for this type of company will require far more
time for staff, inspectors, and administrators than the  small, simple plant.   A cost accounting
system that properly measures how staff time is used and the costs associated with various steps
          In terms of total charges,  residential  users  often subsidize industrial users.  In some
cases, as noted below, infixed service charges on residential customers are subsidized as well.

of the permitting process, can give POTW managers a much better feel for the incremental cost of
this type of discharger. This information can then be used to justify charging such a firm for these
permitting costs, reducing the burden on residential customers and small businesses.
Serving Industrial, Commercial, and Residential Customers

       Providing metering and billing  services, and operating and maintaining lateral collection
lines, are fairly fixed costs. For larger  customers, meters might be a bit more expensive, and the
collection lines might be larger.  However, many of these basic service costs are the same whether
one  discharges five gallons of water per month or fifty thousand.  In their basic rates, many
POTWs  have tried to recognize this  fact by charging fixed  monthly service  fees.  A more
sophisticated cost accounting system will allow  the utility to understand these differential rates
more clearly, perhaps refining their  charges.    Cross-subsidies with  basic  service tend  to
undercharge  small residential customers.  This practice is dictated by a desire to make at least
basic wastewater treatment service available to all homes.  By targeting universal service based on
consumption rather than  income, this approach also unnecessarily  subsidizes small residential
customers who have more than  adequate income to pay the full charge.

       Residential customers, however, require very little in the form of additional services from
POTW staff than hookups, metering,  and billing. In contrast, industrial customers require  an
entire pretreatment  program.   Aside from permitting costs already mentioned,  a pretreatment
program  expends substantial resources to inspect, enforce against, and educate industrial users.
In providing these functions, the POTW incurs substantial support costs related to litigation,
information management, and laboratory testing.  Many plants track only very basic pretreatment
costs such as direct pretreatment staff. The substantial costs associated with the infrastructure
that  is  used to support the pretreatment program (e.g.,  staff training, legal, space rental, even
sometimes laboratory fees) are often lumped in  the general overhead of the POTW rather than
allocated back to specific industrial dischargers.

       The result can be a complicated mix of cross-subsidies among customer classes. In some
cases, the  costs of running the pretreatment program exceed  collections from  industries from
permitting  fees,  other fees, and surcharges on discharge.  In other cases, while industrial users
overall do cover the  costs of  pretreatment  in total,  payments by specific industries bear little
relationship to the costs they place on the POTW infrastructure.  Subsidies tend to flow to large,
complex  industries (who are charged the  same flat rate as smaller firms) and to small categorical
industries (who require substantial regulatory oversight but are too small  to afford a large user
       Insights on Regulatory Efficiency

       Cost  accounting  systems can  help the POTW evaluate  the efficiency of regulatory
requirements and the efficiency  of its  own implementation  of pretreatment requirements.
Consider the following two examples:

       •      Small Categorical Industries.   Small  categorical  industries provide  an
              instructive  example for evaluating environmental cost/benefit  tradeoffs.
              EPA currently  requires that all categorical industries be  permitted and
              monitored,  simply  because of the industrial processes they use.  In some
              cases, however, the firms are so  small relative to the POTW's flow that
              their operations are irrelevant to wastewater quality in the region.  Yet the
              staff time required  to permit  and inspect these firms  can be substantial.  In
              this situation,  allocating these  costs  directly  to  the  small  firm  may  be
              unworkable, as the charges  would be excessive.  However, tracking the
              costs can help the POTW illustrate the relatively poor cost/benefit trade-off
              associated with the current regulatory regime for small CIUs, and provide
              useful input to EPA's current streamlining effort that may change  some of
              these requirements.

       •      Cost of Pretreatment Program.  A well respected POTW on the west
              coast wanted to better allocate the cost of its pretreatment program to the
              industrial dischargers.  It undertook a fairly  extensive effort to  assess the
              differential  workload to implement its pretreatment  program for different
              classes of  customers (e.g.,  large  industrial dischargers, small industrial
              dischargers). Included was time spent on permitting,  sampling, inspections,
              report   reviews,   enforcement   activities,   laboratory   analysis,   and
              administration.  The resulting numbers showed increases in allocated fees
              for most industries  of between 27 and over 10,000 percent. The upper end
              of this range  was for  categorical industries  with  extremely low  flow.
              However, even relatively large firms would have received substantial rate
              increases.   Faced  with these figures,  the  POTW decided  to retain  a
              substantial  portion of the cross-subsidy between residential/commercial
              customers and Ills, increasing IU charges only slightly. Managers did not
              seem to  consider  the extremely high  fixed  costs  of the  program  per
              discharger  as an indication that (1) some of the  regulatory requirements
              were inefficient; or (2) that their implementation of the requirements could
              be streamlined.  Retaining the cross-subsidy removed the financial pressure
              to address these other factors.
       Improving Charge Backs for Cost of Service

       Even if industrial users do pay the entire cost of the pretreatment program, there may be
distortions within this group of users.  This occurs because the oversight requirements can vary
widely across different industries  due to the size, type, or complexity of a  particular  plant.
Improving the tracking and charge backs for these types of services can greatly reduce cross-
subsidies.  Below, we present a number of activities that could benefit from this approach.

       Sampling and Laboratory Support

       Federal law requires sampling IU discharges a minimum number of times per year.  These
samples must then be analyzed.  Many POTWs add up their laboratory fees,  divide by the number
of Ills, and recover these costs in fees.  This approach is relatively simple, but does not accurately
reflect the costs to  the POTW associated  with sampling  and testing.   First of all, not all
procedures are the same complexity (or cost). For example, testing for pH is straightforward and
inexpensive;  certain metals analyses are not.  Tracking costs more carefully provides important
information to the POTW:

       •      Are there certain analytical tests that we do too few of to justify the capital
              equipment needed to do them and should be outsourced?   This  decision
              must be viewed not only in terms of dollar savings, but in terms of how the
              speed and quality of results on outsourced testing compares to doing it in-
              house and affects the POTW's basic mission. Many POTWs  have reduced
              costs substantially by sending some specialized analyses to outside labs, or
              by increasing their  analytical  volume by  accepting samples  from  other
              municipal agencies (in-sourcing).

       •      Are there certain Ills that create a substantial cost burden on  us because of
              the types of materials  they discharge?  Are there ways to  help  them
              substitute less-problematic materials or switch to zero discharge?
                                          Exhibit 3-7
                            SAMPLING AND LABORATORY FEES
               Common Practice
       Improved Cost Accounting/Budgeting
Cost A ccounting
-Lab and sampling fees absorbed by utility; or
-Lab and sampling fees divided evenly among ITJs.
-Costs of actual sampling and analytics required tracked
and charged back to specific ITJs.
-Costs include labor of sampling or lab technician.
-Costs include overhead  related to equipment used:
depreciation, rent on laboratory space, etc.	
-Laboratory budget listed as a separate line item.
- Sampling costs hidden in overall pretreatment budget.
-Laboratory costs related to pretreatment shown as a
line item in the pretreatment budget; laboratory costs
associated with other  activities grouped with those
-Sampling costs listed  as a separate line item under
pretreatment and enforcement, depending on reason for
taking samples.	
       Because Ills often send their own samples to private labs for analysis, they will be familiar
with the prevailing charges for particular types of analytical work.  This makes benchmarking
laboratory performance both easy to do and quite important.  If full costing of laboratory tests
inside the POTW suggests the tests are substantially more expensive than external ones, POTW
managers will need to proceed cautiously in terms of what they charge Ills.  They should also

identify the reason(s) that internal services are more expensive and use this information to guide
their next steps.
       Enforcement Activities

       As soon as  a violation is suspected,  pretreatment activity for a  specific IU tends to
increase.  Inspection visits are likely to rise, including some surreptitious sampling.  The number
of samples being taken and analyzed will also rise.  If litigation begins, legal costs for the POTW
will also increase substantially.  The polluter pays principle suggests that all of these costs should
be passed on to the  violator.  Where  a violation is suspected, but  not found,  enforcement  costs
should be borne by the pretreatment program overall,  but not charged to the specific facility.
                                           Exhibit 3-8
                                 ENFORCEMENT ACTIVITIES
                Common Practice
       Improved Cost Accounting/Budgeting
Cost A ccounting
-Increased  inspection  costs  absorbed  in   general
pretreatment program costs.
-Increased laboratory analysis often included in general
laboratory spending rather than charged to the IU.
-A cost object should be  set up for  each  IU under
enforcement   suspicion,   with   all  related  work
(inspection, sampling, litigation) tracked and recovered
from the IU.
-If a suspected violation turns out not to be real, costs
should be borne by all lUs in general.	
-Costs for inspection, laboratory analysis, and litigation
are generally  spread  into  three  functional  areas
(pretreatment, laboratory, and legal).   This makes  it
difficult to track spending per case, an important figure
when setting penalties.	
-Managers should have the ability to track spending by
case.   An  enforcement line  item  that contains  all
supporting sub-activities might be a way to accomplish
       Costing Wastewater Treatment Separately from Water Delivery

       Across the country, many districts  are served by  integrated utilities  that  provide both
water and  wastewater services.   Integration of the services can  offer  efficiencies,  such  as
coordinated billing.  However, many integrated utilities do not make a clear distinction between
the costs of the water and those of the wastewater system.  As a result, the fees set by the utility
may send the wrong  signals to customers. If water is underpriced, customers may not adequately
conserve water.  If wastewater is underpriced, large dischargers will have a reduced incentive to
improve their in-plant reuse of water.

                                          Exhibit 3-9
               Common Practice
       Improved Cost Accounting/Budgeting
Cost A ccounting
-Functional  services  provided  to  both  water  and
wastewater  customers  are  not  tracked  separately.
Examples  include  administration,  laboratory,  and
information systems.
-Activity drivers are used to allocate all joint costs to the
respective services provided.
-Costs are then further allocated to specific lUs based on
demand for those services whenever possible.	
-Wastewater and Water services are generally broken
out in budgets. However, each of these budget areas
will  often  exclude  costs  associated  with  support
functions.   As a  result, there  may  be  substantial
overhead costs that have not been linked to either
business service provided.	
-Budget breakouts  for wastewater and water should
include administrative support services.
Discharger Location and Multi-Plant Systems

       Discharger location within a treatment plant service area can affect the cost of treatment in
three main ways.  First, the distance from treatment may generate higher unit costs for collection
systems  (more miles of pipe travelled) and may require  additional pumping.   Second,  a large
system, especially those with multiple treatment plants, may have a mix of newer and older assets
that have very different technical constraints and cost structures in different parts of their districts.
Large differences are common in industry.  For example, the cost difference between the best and
worst performing plant  within a single firm can vary by a ratio of three to  one.  Even once
technical parameters such as plant age, technology, and location are controlled for, this variation
can  still be as high as  two to  one,  indicating  the importance  of good management  in plant
efficiency.11 Finally, since a  substantial portion of the cost  of wastewater collection and treatment
is fixed,  differences in capacity utilization can have large impacts on unit costs.

       Understanding and tracking this variation is important in rationalizing  existing capacity.
Where capacity is tight, differential wastewater fees can encourage new development to occur in a
lower-utilized portion of the system.12 These fees can also encourage discharges to conserve the
scarce resources, allowing the  infrastructure  to  last  longer.   Where a utility wishes  to have
uniform  rates  across  the service  district  despite substantial variations  in the cost of service,
improved  cost accounting  can enable POTW  staff to  better  target their  pretreatment  or
conservation                                                                       resources.
       11 Chew, W. Bruce,  Timothy Bresnahan, and Kim Clark.  "Measurement, Coordination,
and Learning in a Multiplant Network," in Robert Kaplan, editor, Measures for Manufacturing
Excellence, (Boston: Harvard Business School Press, 1990), p. 129.
          Obviously, water treatment fees are but one of many variables evaluated by a company
when deciding where to locate a plant.

The  information can be used by managers to plan infrastructure improvements, as well.  For
example, one Virginia POTW linked its plants together, enabling them to average demand across
the network by diverting streams whenever necessary.13
Exhibit 3-10
Common Practice
Cost A ccounting
-Discharger fees often based on the average cost of
servicing all zones. POTW management may not have
a good handle of differential costs of service due to asset
type, distance from treatment, or utilization levels.
-Although many districts have higher fees for ITJs
outside of the city, these rates often have more to do
with political power than with differential costs of
-While some POTWs have separate budget information
for different treatment plants, even these may not
include the associated overhead costs.
-Often, infrastructure costs are lumped together.
Improved Cost Accounting/Budgeting
-POTW should track differential costs of service based
on distance or zone of the district to use either in rates
or in planning.
-Cost surcharges for differential service costs (such as
collection and pumping) may be in order.
-Budget line items for specific assets to support
peripheral service may be helpful.
-Budget line items for specific key assets with very
different costs may be helpful.
Capacity Limits to Existing Plant May Drive Up System Costs

       Wastewater treatment systems are complex  processes with numerous constraints.  For
example, collection systems can be too small to  allow a district to utilize its entire treatment
capacity. Treatment capacity may be too small to handle the current flow. In both of these cases,
the utility can invest in expansions to solve the problem.  Alternatively, cost accounting can give
program managers  information on  which dischargers are utilizing the largest portions of the
constrained item so they work with these dischargers to reduce their loadings.  This is analogous
to demand side management programs in electric utilities, and may be substantially less expensive
than expanding supply.

       Physical flow constraints are but one of many possible parameters that may limit system
capacity. For example:

       •      Very high strength wastes may require longer residence times than standard
              discharges.   Since throughput is  equal to technical capacity multiplied by
              average residence time, longer residence time can use up plant capacity in
              the same way that large flow can.
       13 This increased flexibility comes at a cost, however.   The cost of the flow diversion
infrastructure is similar to  capacity expansions to handle peak flows, and should be allocated to
the customers causing the peaks.

       •      Peak loadings in flow, strength, or other parameters,  may require larger
              scale or more complex treatment plants, driving up costs as well.  Cost
              accounting can  help identify what customers  or practices drive  up peak
              loadings and identify ways that peaks can be reduced.

       Pricing capacity is very important if the WWTP wants to send the proper signals to
dischargers, encouraging them  to reduce their demand during peak periods.  A variety of pricing
schedules have been developed in the  electric and natural gas utility industries for this very reason.
For example, peak prices tend to be higher than off-peak prices.  Industries that are willing to be
"shut off' during peaks are given discounts.   Finally, the allocation of peak  system costs among
customers is done to try to reflect which customers drive the peak demand.

       Gas utilities allocate infrastructure costs,  such as distribution  systems (analogous to
collection systems in WWT), using the minimum size theory.  The smallest scale system required
to serve a standard customer is allocated to each customer. The difference between the smallest
scale system and what is actually in place  is allocated based on demand.  Thus, larger dischargers
pay a higher share of the infrastructure costs.
                                         Exhibit 3-11

                             HYPOTHETICAL IMPACT OF PEAKS
                                     ON PLANT SIZING
                       0.3x mgd safety margin
                           x mgd capacity
Capacity required to treat peak
flows, including inflow and

Variation in dry weather flow plus
allowance for near-term growth
Average Daily Dry Weather Flow
       But on top of the larger dischargers is the issue of peak capacity.  The additional cost of
handling peak discharges can be substantial.   Exhibit  3-11 above suggests that  the  required
treatment capacity can rise substantially to handle peak flows. Additional collection capacity and
storage facilities need to be built as well.  Allocating these costs appropriately  can be quite a
challenge. Some rules of thumb:

       •      Basic capacity,  plus a safety margin for normal variance in dry weather
              flow, should be allocated equally to all customers.

       •      Incremental capacity required for above-average dischargers  should  be
              allocated to customers using that  capacity based on flow.   There are a
              couple of common methods to allocate these demand charges among users
              to encourage peak reductions.14

              -  Coincident Demand Method  Also known as the peak responsibility
                 method, costs are allocated to customers based on their demand during
                 the time of system peak.15 The rationale is that demand patterns at this
                 point in time are what drive the utility to build the scale plant it did.

              -  Noncoincident Demand  Method   Allocates  costs based  on  the
                 individual  peak  for each customer,  regardless  of when  this  peak
                 demand occurs relative to the  peak demand  on the treatment system
                 overall.  The noncoincident  demand  method makes  sense when the
                 sizing of capital is driven more  by the individual  peak than by the
                 aggregate peak, such as may be the case with the size of portions of the
                 collection system.

              -  Average and Peak Demand Method.  Under  this method, the average
                 load rate multiplied by the total demand charges to yield the costs
                 associated  with  average use.   These costs  are  allocated  among
                 dischargers based on share of annual loadings. The residual costs are
                 assumed to be associated with peak demand and allocated based on the
                 coincident peak method.

       Electric and gas utilities have long worked  to manage  peak demand through their rate
structures.  Some of these approaches have been adapted by wastewater treatment plants; others
may be valuable peak management tools going forward.  These are summarized below in Exhibit
3-12.   A number of peak-related issues for POTWs  are then  presented  in greater detail.
       14 National Association of Regulatory Utility Commissioners (NARUC), Gas Distribution
Rate Design Manual, (Washington, DC: NARUC), June 1989, p.27.

       15 To reduce the cost  impact  of measuring  the  single annual peak imprecisely,  many
utilities  average the contributions to the  top five or ten peak periods throughout the year to
calculate the cost allocations.

Exhibit 3-12
Peak demands create need for
expensive, larger scale capacity,
though this capacity is infrequently
Seasonal populations or production
drive demand far above "normal"
IU has internal treatment, but
wishes to rely on POTW as a backup
in case of problems with in-house
Cost Impacts
POTW must build expensive
collection and treatment capacity to
meet those peaks.
POTW must build expensive
collection and treatment capacity to
meet those peaks.
POTW needs to provide collection
system infrastructure and capacity
for an infrequent user.
Rate Solution
-Interruptible rates provide
reduced charges to customers
willing to forgo services during peak
events. For POTWs, lUs might
have storage capacity on-site
enabling them to delay discharge for
a week or so.
-Demand charges based on peak
consumption patterns forces
consumers of peak capacity to bear
most of the cost of providing it.
Seasonal rates charge higher rates
for users during the peak season to
encourage peak leveling. The
coincident demand method of peak
allocation accomplishes this same
Standby rates recover these
incremental costs through fixed
charges rather than through fees on
Source: National Association of Regulatory Utility Commissioners, Gas Distribution Rate Design Manual, June
1989, pp. 51-53.
Inflow and Infiltration (I/I)

       Wastewater treatment capacity is very expensive.  While there are economies of scale in
bigger collection pipes and  bigger treatment plants, the  absolute cost per  unit treated  remains
high.  Given these costs, the size of the entire treatment  system should be built only to  the size
needed for the population to be served.  Perhaps more than any other source, I/I drives up the
capital infrastructure of wastewater treatment. I/I is comprised of a variety of sources of street
runoff, combined sewer overflows,  and leaks that let rainwater into  the sewage system.  Once
these  sources enter the sewer system, they require pipe capacity to be transported to the treatment
plant, storage areas for when the treatment plant is at capacity, and  treatment capacity  to treat
what used to be relatively clean water.

       Storm surges can be managed through retainment basins that store peak flows, allowing it
to work it's way through the POTW during the weeks following the storm event.  This peak
leveling technique is less expensive than building treatment capacity large enough to treat the
storm peaks.  However, it still requires larger sizing of collection systems and pumps, as well as
the cost of building and maintaining large storage basins.16

       I/I is a big problem.  According to a recent AMSA  survey, inflow and infiltration (along
with stormwater that goes to the plant) comprised almost 25 percent of total flows, increasing the
treatment  capacity required by the same amount.  This figure represents an average; values for
specific plants are substantially higher.
Exhibit 3-13
Flow Type
Combined Stormwater
Total Wet Weather to Plant
Total to Plants
Flow (MGD)
Percent of Total
Source: Association of Metropolitan Sewerage Agencies (AMSA), The AMSA
Financial Survey, 1996, p. A-17
              The costs of extra capacity to handle wet weather peaks associated with I/I should
be allocated as closely to their sources as is possible. Often, the closest one can come to such an
allocation is apply the costs to a particular zone of the collection system, and then allocate within
that zone to each customer. However, careful costing of the I/I events can provide extremely
strong inducements to correct common sources of I/I, such as manhole or sewer leakage,  sump
pumps, or faulty sewer connections.  A detailed study of I/I control options in the Lower Paxton
Township Authority in Pennsylvania is instructive, shown in Exhibit 3-14.
       16 The placement of storage basins is also important.  Placing the basins away from the
plant  allows  a  reduction  in the peaking  capacity required on the trunklines as  well, saving
additional funds.

Exhibit 3-14
Remove Sump Pumps
Grout Manholes
Grout Sewers
Mainline Replacement
Lateral Repairs
Equalization Basins
-Above ground tank
-Below ground tank
Convey and Treat
-Additional capacity at
existing plant
- Construct new plant
I/I Contribution


I/I Control Costs
($/gallon removed)
$0.04 - $0.27
$0.04 - $0.30
$0.05 - $0.36
$0.16 -$2.22
$0.20 - $3.72

$1.32 -$4.80

$3. 81 -$18.80
Source: James Elliott et al., "Removing Private Sources of Infiltration and Inflow," Water
Environment & Technology, August 1997, pp. 55-60.
       The implications of this specific analysis are clear.  For POTWs facing capacity constraints
due to I/I problems,  supply-side options exceed the cost of demand-side options to reduce the
inflow by a wide margin.  Proper cost accounting for the  cost of handling the peak flows can
provide POTW managers with very clear signals in this regard, giving them leverage to implement
control strategies quickly:

       •       Increase Rates.  Charging I/I sources the incremental costs of having to
              increase POTW capacity to handle the flows would induce rapid control of
              the many private sources of I/I.

       •       Defer Acceptance of Developer-Constructed Collection Systems.  The
              Pennsylvania study estimated that over 40 percent of the I/I entering the
              plant came  from defective lateral lines.   These lines are often built by
              developers as a condition of allowing the development to go forward.  The
              incentive of these developers is to put in the lateral  lines  as  cheaply as
              possible so that the POTW will accept the new dischargers and  people will
              buy the new property.   Often these laterals are poorly built  and leak from
              the beginning. Armed with information on the real cost of I/I, POTW staff
              can  refuse to accept the new laterals until they have proven to be of sound
              quality.  The POTW can also require bonding that allows  the I/I to be
              corrected if the laterals are problematic.

              POTW-initiated  Remediation.    Where  charging  I/I  sources  their
              contribution is impossible due to measurement problems or political issues,
              the POTW may still find it less expensive to pay for retrofits directly in
              order to avoid the need for new plant capacity.
Exhibit 3-15
Common Practice
Cost A ccounting
-Costs of I/I embedded in the baseline capital costs of
the facility through increased scale requirements.
-POTWs may have I/I or stormwater divisions that deal
with I/I issues. However, these costs may not include
administrative support needed or the costs of increased
capital sizing.
Improved Cost Accounting/Budgeting
-As facility nears its existing capacity for wet weather
flow, storage, or treatment, I/I issues become far more
-In plants with excess capacity, incremental costs of
handling I/I should be charged back to sources of I/I ~
at least to zones of the system. In plants with dwindling
capacity, costs of capital expansion to alleviate the
shortage should be charged back to I/I sources to
encourage comprehensive I/I controls.
-Exceedances associated with SSOs from I/I should be
charged back to I/I sources.
-New capacity required for I/I related peaks should be
budgeted and include all financing costs.
-I/I operations should include supporting administrative
and analytical functions.
Large Dischargers and Seasonal Peaks

       The minimum size theory allocates baseline costs of treatment across all customers. Large
dischargers  create  additional  demands on  the  system by  the  sheer quantity  of wastewater
discharged.  Collection pipes, pumps, and treatment infrastructure must all be made substantially
larger to handle the additional flows. To encourage efficient decisions regarding on-site reuse or
treatment versus discharge, the  incremental  costs of the  additional equipment  needs to  be
allocated back to its sources.   Most POTWs  do this  in the form of a discharge fee.  Peak rate
pricing will spread the incremental costs of facility size across a smaller portion of the discharging
universe, as a large number of customers (e.g., residential) will not exceed the level of discharge
used in the minimum sizing of the system. As a result, the rates per unit discharged  on these high
quantity dischargers could well be higher than the rates charged for the baseline system.

       The more variable these large discharges, the larger  the incremental units charges are
likely to be.  This is because the same fixed capital must be put in place to handle a smaller annual
flow.  In resort areas, for example, populations can double or triple during peak months, creating
demand spikes for support functions such as wastewater treatment.  (Once again, the spikes for
WWT are more difficult to handle than, for example, those from electrical demand, since services
are difficult  to  import.  Networking plants is  one way to better absorb the peaks).   Seasonal
surcharges reflecting demand patterns during this peak period can help send the proper signals to
dischargers to conserve capacity more during the peak months. Many POTWs increase rates only
to seasonal customers.   This approach, while seemingly more equitable to year-round residents,
will not encourage capacity  conservation by all dischargers.  This may reduce the opportunities
for minimizing the costs of demand reductions.17
Exhibit 3-16
Common Practice
Cost A ccounting
-Large dischargers are normally charged a fee per unit
discharged requiring treatment (excluding surcharges
for strength).
-Fees for larger users vary from lower than average (a
form of a volume discount) to higher than average
(increasing block rates). It is difficult to ascertain how
closely increasing block rates are linked to cost impacts
of large discharges.
-Many POTWs do not increase rates during peak
-No differentiation of peak and baseline costs or
Improved Cost Accounting/Budgeting
-Unit fee should be based on incremental capacity
required to handle the larger flows.
-Discharge fees should be higher during seasonal peaks.
These surcharges should be borne by all dischargers
requiring services during the peak months and not
exclude year-round residents.
-Differentiation of peak and baseline costs would help
illustrate the incremental costs of peak-increasing
demand patterns.
System Expansions May Create New Challenges

       System expansions create challenges for POTWs for two reasons: the large scale of most
new capital equipment (capital "lumpiness"), and a pricing model that charges users the average
cost of existing  capacity even when adding to  that capacity would be  substantially  more
expensive. Each of these items is explained in greater detail below:
         Seasonal pricing is a good example of how important the timing of pricing signals is.
Unless  dischargers during the  peak months know  ahead of time that  their rates will  be
substantially higher than normal, they will have  little incentive  to reduce their discharge levels
through increased recycling or water conservation.

       •      Capital "Lumpiness. "  Wastewater treatment is a capital intensive industry
              with substantial economies of scale. Thus, new capacity is brought on line
              slowly, and in fairly large capacity "lumps."  Right before new capacity
              comes on line, the old capacity is  likely to be fully utilized, with capacity
              shortages.  Right after the new capacity comes on-line, utilization will drop
              substantially, and unit  costs (i.e.,  the capital  costs per unit treated) rise
              significantly.  While all capital intensive markets experience this dynamic to
              some degree, it is worse in wastewater treatment.   In the paper industry,
              for example, a new plant can export its production over a wide area.  Thus,
              the new capacity surplus is shared by multiple plants rather than just one.
              POTWs provide services in a fixed area; it is quite difficult to "import"
              more wastestreams to treat. Thus, the  plants' operate with  substantial
              excess capacity until new  growth increases  the wastestreams requiring
                       1 &

       •      Average Cost Pricing.  Because POTWs are regulated industries with rates
              based on their cost of service, the rates  charged to customers are, in effect,
              the average cost of service.  If changes in regulations, financial conditions,
              or construction costs make plant additions (which are the  marginal  costs
              for the utility) more expensive than the average cost of existing plants,  the
              average cost price could be substantially lower than what  the  utility will
              need to charge once the new plant  comes on line. As a result, dischargers
              will not get the price signals that would exist in a competitive market that
              capacity is becoming tight and they should do what they can to reduce their
System Expansion to New Areas/Customers

       POTW expansion can bring many capacity issues to the surface.  The cost of new lateral
lines to service these customers should generally be borne in full by the new customers.  More
complicated are issues  associated with how the new discharges will affect capacity requirements
in trunk lines,  pumping stations,  and treatment plants.  These impacts  may be from normal
discharge rates, or from new peaking demands (including I/I) from the additional load.  New
discharges may also affect the quality, and hence the marketability, of residuals.

       A common tendency is to want the new dischargers to pay the full costs of extra capacity
associated with their discharges. As noted above, unless the  cost of scarce capacity is charged to
all dischargers rather than just new ones, the proper price signals to reduce consumption of the
scarce capacity will not be sent.  This being said, proper accounting of the full cost of the
       18 Problems associated with capital lumpiness can be mitigated somewhat by coordinating
collection system expansion with new treatment capacity construction, and by installing a series of
smaller scale treatment units as demand rises.

expansion is needed  to compare against alternatives.   As in the I/I example  above, many
alternatives could be less expensive than simply expanding conveyance and treatment capacity to
handle the new volume.

       One  key issue to be grappled with is the issue of centralization versus decentralization.
For dense, urban populations, centralized treatment of wastewater is generally the  most efficient
approach.  At some  point, as collection systems  are expanded into  more sparsely-populated
districts and centralized treatment capacity it used up,  the  full  cost of expanding centralized
treatment could well exceed that of using a  smaller-scale,  decentralized approach.19  One
outspoken critic of the centralized treatment model argues that many viable decentralized methods
are overlooked,  and that packet plants under the control of a sewerage authority, could often be
used.20  New technologies, such as artificial wetlands, are also  more viable  in rural areas where
land is more plentiful and retention  times can be increased.   Technologically, unless  sewerage
authorities  recognize the niche,  off-grid  opportunities for  these  evolving techniques,  the
approaches will not benefit from the trials and incremental improvements  that allow  them to move
into the mainstream over a period of a decade or so.

       Without proper cost accounting, the break-point for alternative treatment is not visible to
plant decision makers.  Any costs  associated with extensions, including  new treatment capacity,
new debt issuance, and  increased pumping or collection system capacity need to be compared to
the cost of decentralized alternatives.
Differential Impacts of System Expansion by Customer Class

       The available options for addressing new service needs can be constrained by particular
types of dischargers in the new areas to be served.   Unless the full costs of these special
requirements are properly tracked and allocated  to their causal factors, the utility may decide to
pursue a less cost-effective option.

       Consider the example of a large industry looking to locate in a rural area, and wanting the
POTW to provide  service to them.  Many residential and commercial customers will receive
service as well, reducing the unit  costs  of the extension.  However, this  particular  industry
discharges constituents that interfere with the effectiveness of the decentralized options or which
contaminates residuals, precluding their local reuse.  In the absence of this discharge, the entire
region could be serviced  at a  substantially lower cost using  decentralized treatment and local
reuse of biosolids and effluent. In this example, the entire incremental cost of extending the
       19 For example, two  small towns,  one in West Virginia and  one in Virginia, realized
substantial  savings (42  to  65 percent)  using  alternative  systems  rather  than installing  a
conventional WWTP.  See U.S. General Accounting Office, Water Pollution: Information on the
Use of Alternative Wastewater Treatment Systems, September 1994, pp. 3-4.

       20 See David Venhiuzen, "Paradigm Shift:  Decentralized wastewater systems may provide
better management at less cost," Water Environment & Technology., August 1997, p. 49.

centralized system over  building a smaller,  less complex decentralized system  (plus the lost
revenues on residuals reuse), should be allocated to the industry. Town development authorities
may decide to go forward anyway,  arguing that many  other  industries would  soon follow;
however, at least the decision would be made with an understanding of how much servicing the
industry was really costing the municipality in the short-term.21
Exhibit 3-17
Common Practice
Cost A ccounting
-Costs of infrastructure assets are not generally
disaggregated in such a way to be able to assess the full
costs of line extensions.
-Incremental costs of capacity expansions may not be
linked to the factors driving that need (e.g., expanding
service to a new area). As a result, system expansion
can't be compared to decentralized alternatives or
demand-side management.
-Costs associated with system expansions not always
linked to specific customers or customer classes.
-Costs of extensions are hidden in very general capital
acquisition line items.
Improved Cost Accounting/Budgeting
-Costs of scarce capacity should be borne by all
dischargers contributing to that scarcity, not just to new
-The total cost of system expansion, including all
impacts on conveyance and treatment, needs to be
compared to alternative methods to provide service.
-Where these expansion costs are due to specific types
of discharges or dischargers, costs should be borne by
those particular entities.
-Budget line items should provide managers with
information on the full incremental costs of system
Interjurisdictional Agreements

       Many POTWs receive  flows from  dischargers located outside of their  jurisdictional
boundaries.  In these circumstances, POTWs face a difficult situation:  the discharges force them
to incur costs and  affect plant  performance,  yet  they have  no political  authority over  the
dischargers.   This issue is resolved  using a contractual agreement called an Interjurisdictional
Agreement (IJA).  IJAs outline the rights and responsibilities of the various municipalities in the
agreement (there are sometimes more than two), but often do so in a fairly legalistic  and unwieldy
way.   IJAs do  not inherently increase  the  distortions  associated with POTW  management;
however,  in  practice  they  often constrain the  ability  of the receiving  POTW to regulate
dischargers or adequately  recover costs.  The case study of Escondido, CA in the next chapter
provides additional illustration of the challenges IJAs can create.
       21 A General Accounting Office study of alternative treatment technologies found that
some state and local codes actually required conventional treatment, creating a substantial barrier
to the use  of alternatives.  Codes such as these make it hard to attract investment for system
construction because not always clear if the plant will, in the end, be permitted.  See U.S. General
Accounting Office, September 1994, op. cit, pp. 40-43.

       While IJAs can be changed, doing so requires a fairly complicated political process and is
generally difficult to do.  As a result, IJAs are often left in place despite their problems.  Costs on
a system from dischargers in another municipality may be borne in part by in-system dischargers,
artificially increasing the cost of wastewater treatment to local industries.

       Cost accounting  can be a useful  tool to highlight the cross-subsidies that an IJA may
entail.  By tracking the cost impacts of discharges, as described in the various sections above, and
then grouping these costs for  all dischargers in another municipality, POTW management can
assess  if  cross-subsidies exist  and how  large  they are.  This  evaluation will help managers
determine when  cross-subsidies  are  so  large that the IJA must  be  renegotiated,  and when
improved outreach or even in-plant investment in discharger  plants can have a positive return to
the utility.


       To augment the topical summaries, we have conducted case studies of budgeting
and cost accounting systems in place at two actual POTWs.*  The complexity associated
with running a POTW is not quite  as apparent in the topical summaries as when the
multiple functions  and systems are evaluated together.  The case studies illustrate how
small distortions, when combined with others in a POTW, can have a large impact on
facility sizing  and  operations.  The  case studies  also illustrate how the needs of,  and
constraints on, various groups involved with the  POTW make compromises in costing
(relative to the theoretical optimum) necessary. POTW managers can use the  information
contained  here to  help them strike their own balance regarding what  information they
collect and how this information is used relative to budgeting and rate setting. As noted
throughout the report, the purpose  of improved  information is to enhance  managerial
decisions whether or not there are any changes made to rates.

       We are  very  appreciative of the many  people  associated  with the  City of
Escondido, the Massachusetts Water Resources  Authority (MWRA),  the City  of San
Diego, and the San Elijo Joint Powers Authority who were willing to give us their time
and insights to make these case write-ups possible. The City of Escondido is a relatively
small treatment plant  with important treatment assets shared with its surrounding cities,
including San Diego. MWRA is a large municipal system servicing scores of communities.
It acts as  a wholesaler,  charging towns  rather then dischargers for their services  (other
than pretreatment  which is billed directly to  Ills).   This  mix of facilities allows us to
present a wider range of issues than would be possible with very similar POTWs.

The City of Escondido, CA

       Escondido,  CA is a medium-sized town located outside of San Diego.  The city
operates its own wastewater treatment plant, the Hale Avenue Resource Recovery Facility
(HARRF).  Escondido participated in EPA's evaluation of pretreatment program success
factors and challenges last year, and agreed to participate in this effort as well. The city
was  targeted as a case  study due to a number of interesting characteristics identified
during last year's site visit.

       •      Capacity  Shortages.  The city is at or near capacity for both its
              treatment plant and its outfall.  Careful allocation of costs, in order
              to  encourage  capacity-conserving  behavior   on  the   part  of
              dischargers, becomes increasingly important as existing capacity is
              used up.
       1  Case  studies are based  on a contribution  of written  documents, telephone
interviews, and personal interviews.  To  protect the candor of  interview participants,
specific comments have not been cited to individuals.  Citations  within the chapter are
limited to written materials.

              Sharing of Key Assets.  The city shares key program assets with
              surrounding  communities, including  the  both the outfall and  its
              treatment  plant.   Sharing of  these  resources  is  governed via
              interjurisdictional agreements,  instruments  that  are  difficult  to
              modify and  do  not always  send the proper pricing signals  to

              Informal  Conditions  Associated with  Municipal  Discharges.
              The  city  receives  discharge  from  a municipally-owned  water
              treatment  plant  (WTP).    Although  the WTP   discharges  have
              significant impacts on plant operations, the relationship between the
              water and wastewater plants  is  informal and not  based on the
              economic  value  of services   being  provided.    This  type  of
              arrangement is not uncommon in municipalities, but can  make
              efficient plant operation more difficult.

              Sale of Valuable Residuals Constrained by Contaminant Levels
              and  External Government Subsidies.  Located in water-scarce
              Southern California, Escondido should have ready resale  markets
              for its effluent.  However, a combination of high contaminant levels
              (salts and metals) and artificially cheap alternative sources of fresh
              water for irrigation impede  HARRFs  ability  to  remarket  its
       While the discussion below is organized by topic areas, there are a few underlying
issues that bear mentioning.   The first, fragmentation of control, impedes Escondido's
ability to rationalize its limited resources. Fragmentation of control dilutes management's
power to regulate and control practices that affect the operation of its plant.  In the city of
Escondido, fragmentation issues affect its pretreatment program, its optimization of key
assets (such as the treatment  plant and the outfall),  and the resale of effluent.  Although
cost accounting approaches can help the POTW to identify the costs of existing practices
as well as more efficient solutions, the fragmented control will require political action to
rectify.  Staff were well aware of the rigidities that this  fragmentation created for  their
program; on more than one occasion,  interviewees remarked that long-term planning and
expansion would be much easier if the region were  organized as a  special utility district
rather than governed through interjurisdictional agreements.

       The second common theme in many of the Escondido areas examined is that of full
cost recovery.  This includes  not only the recovery  of aggregate costs from dischargers,
but the use of peak pricing to  allocate these costs more directly to specific dischargers.  In
some cases, the POTW did not know the full costs of particular activities.   Even where
they did have a rough idea of the full costs, however, managers knew that political realities
prevented them from passing  these costs back to the parties responsible.  In an effort to
create a "business-friendly" environment in the town, managers were under great pressure
to keep  rates to industry low.   Escondido has relatively small  flows from industry.

However, their concerns about being business friendly echo those we have heard from
many other programs where Ills flows  are much more significant. Without sending the
proper price  signals to industry, water pollution will continue  to  be subsidized, and
industries will underinvest in pretreatment.
General Approach Towards Cost Accounting and Budgeting

       Escondido's focus in the cost accounting arena has been on separating water and
wastewater costs, and on ensuring that existing users don't bear the costs of new capital
expansion triggered by new users. With these goals in mind, the city set up separate water
and wastewater enterprise funds, with a statutorily-defmed separation of accounts. Funds
can not be transferred from one account to another without utility board approval and the
creation of a formal loan agreement.  This arrangement prevents cross-subsidies between
water and wastewater operations, as well as protects any wastewater surpluses from being
raided by other municipal functions, a frequent complaint in other cities.

       The POTW relies on the city government for many of its support functions, such
as administration, finance, engineering, legal, management and information systems (MIS),
and human resources.  Costs for these functions are allocated to wastewater operations
based on the number of staff-hours spent on wastewater activities.   Such  an approach,
while a reasonable approximation of costs, may be inaccurate for activities where  capital is
a large cost component, such as MIS.

       The separation of funding sources into existing customers and new connections for
capital expansions helps to ensure that the existing customer base does not bear the cost of
new growth in the community.   New construction is funded through a  flat  capacity
(currently $4,403)  charge  per equivalent dwelling unit or "EDU".  One EDU  allows a
customer to hook into the sewer system and discharge up to 250  gallons per day.  The
rationale for this  approach  is that the  older  customers  have  already  financed the
infrastructure in place and should not have to pay for the upgrades as well.

       The EDU approach has proven extremely useful in allowing Escondido to expand
during times when it could not easily borrow on capital markets.  As implemented, the
new connections fee also ensures that older customers  do not bear the cost of extending
the collection system to new users, which makes sense.  However, some of the other price
signals that  the EDU approach,  and  the  new connections fund in general, send  have a
couple of weaknesses.  First, all projects related to  new  connections are lumped into a
single pool, creating the possibility of cross-subsidies within this group.   Such cross-
subsidies can hide important break-points, such as where decentralized treatment  becomes
more economic  than sewer line extensions.   Second, where common assets  (e.g., a
trunkline) becomes constrained due to system expansion, increasing the rates only to new
customers will not  send the proper price  signals to all users of that scarce capacity, some
of whom may be older customers who are able to cut their discharge  at a lower per unit
cost than new users.  Third, dischargers are not able to  sell their EDUs back to the system

or to other users if they cut their discharge. As a result, they have somewhat less of an
incentive to invest in technologies that reduce their need to discharge to the sewer system.

       Escondido has experimented with a number of budgeting techniques.  Zero-based
budgeting,  where every program must justify its entire  allotment annually, proved too
disruptive to staff.   Two-year budgeting, predicated to  shift the  annual budget-period
crunch into a two-year affair,  was  also  problematic.  They had a very difficult time
projecting needs one year in advance; two years was even worse.  Finally, the city tried
program-based budgeting, which is similar to activity-based costing.  With over sixty cost
pools to project, they found the process too unwieldy.   Managers also felt that their
projections were simply guesses that did not provide them with additional decision-making

       As a result, they have continued to use an annual budget process with expenses
grouped into very general categories.  Programmatic data continues to be collected even
though  it is  not used in  budget development.  Rather,  spending is  tracked  by the
program/project areas,  some of which are shown in Exhibit 4-1, and given to managers in
monthly reports.  Exhibit  4-1 shows only the program area name;  the city  also assigns
each a tracking number.  This system has enabled the city to  provide key information to
managers without  making  their  budgeting process unduly  complex.  The city recently
integrated labor-hour tracking by project as well, vastly improving its ability to cost out
the resources used on particular activities.  Managers have found this  addition extremely
useful in understanding the dynamics of their programs.

       While the project-based  tracking greatly  improves  the information  available to
managers, there are many gaps in the data.  For example,  it remains somewhat difficult to
aggregate spending by program aspect.   Some program areas, such as oil and  grease
management, are not broken out separately.  In addition, capital infrastructure or O&M
costs have  not been allocated to their causal  areas.   Thus,  all capital projects required
handle I/I systems are not easily tracked back to I/I using the existing budgeting accounts.
Similarly,  O&M due  to  grease blockages  would likely  show up   under "Lateral
Maint/Repair" or "Jet Rodding/Vacuum" without being linked specifically to oil and
grease dischargers.

Exhibit 4-1
Program Area
Liquid Processing Maint.
Solids Handling Maint.
Reclaimed System Maint.
Co -Generation Maint.
HARRF Grounds Maint.
Building Custodial Maint.
Safety Equipment Maint.
Equipment/Shop Maint.
Influent Pump Station
Lift Station Maint.
Lift Station Grounds Maint.
Land Outfall Maintenance
Jet Rodding/Vacuum
Manhole Maint. /Repair
Lateral Maint./Repair
Mainline Maint./Repair
Program Area
Equipment/Shop Maint.
Force Main Maint./Repair
Lift Station Maintenance
Lift Station #7
Over Flows & Emergencies
Service Requests
Large Sectional Twister
Manhole Inspection
Easement Maintenance
Confined Space Maintenance
Trench Compaction
Pretreatment Reporting
Bernado/Ham. Assess. Dist.
Liquid Process Operations
Solids Handling
Industrial Waste Adm. & Test.
Storm Water Testing
Laboratory Services
Wastewater Testing
Ind Waste Test - Escon.
Ind Waste Test - Rancho Bern.
Program Area
Ind Waste Comp Mon - Escon.
Ind Waste Comp Mon Ran Bern.
Reclaimed Water Testing
Water Reclamation
Solid Sampling/Testing
Well Water
Misc. Sampling and Testing
QC-QA Testing
Laboratory Administration
Water Connection Rights
Water Reclamation Admin.
Environmental and Safety

Source: City of Escondido Program Chartfield Definitions, 1997.
       POTW managers have established some flexibility in their budgeting process. For
example, although all wastewater revenues go back into the general wastewater fund,
within wastewater operations, there is some flexibility to shift funds among accounting line
items as needs arise.  There is also a multi-year contingency fund used for emergency and
surprise expenses.  Capital budgeting is done annually, although the POTW also utilizes a
five year planning cycle for major capital upgrades.  The POTW does not have a formal
process of depreciating capital  equipment and accruing for replacement  during its life.
Rather,  most  of the capital replacement  is funded through a somewhat undersized
"miscellaneous  major maintenance" line item  (that allows  for replacement as  well  as
maintenance).   As a result, a number of staff felt that  they never had enough funds  to
replace their aging plant (though the POTW works hard to ensure that staff have updated
analytical tools).

Managing and Optimizing Key Shared Assets

       More than  many  POTWs,  Escondido  shares key  assets  with  surrounding
communities.  Substantial flow comes from the Rancho Bernardo  district of San Diego,
and San Diego contracts with HARRF for capacity.  The outfall pipe used by the city to
discharge its treated effluent is comprised of a land portion, owned by Escondido,  and a
water portion, owned by the San Elijo Joint Powers Authority.  The city has an agreement
with San Elijo for 79 percent of the water outfall capacity.  The land outfall is implicitly
shared with  San Diego, as  Rancho Bernardo flows  to  HARRF must the be discharged
through the outfall.

       Capacity in the outfall is  already constrained, and is insufficient to meet demand
during storm events.  Some, though not  much, spare capacity remains at the treatment
plant. The city relies on equalization basins, used nearly to capacity, to allow the existing
dry weather flows to be treated within the existing capacity at HARRF.

       Current  arrangements for  sharing  capacity  are  through   interjurisdictional
agreements among the participating parties.  These specific agreements have three main

       •       Difficult to Modify. IJAs  are negotiated among municipalities and
              rarely modified. Changes in the peak  or average discharge profiles
              of participants  are  difficult  to  integrate into the  contracted
              discharge allowances.

       •       Financial  Arrangements  Do Not   Reflect  Actual  Costs  of
              Capacity  Used.   Payments for both the  treatment and outfall
              capacity are  based on the proportion of average flows from the
              participating  parties that are  sent through HARRF and  the outfall.
              In fact, it is peak flows that drive much of the capital requirements
              for the infrastructure.   While  there are restrictions on the  peak
              flows that may be discharged, these restrictions are  difficult  to
              enforce and do not have associated financial penalties.

       •       No Surcharges for Constituents  of Concern.  Flows received
              from other  municipalities  are not  surcharged.   For  example,
              Escondido receives waste  flows from a San Diego experimental
              treatment plant that uses water hyacinths.  When these plants are
              compressed at the end of the treatment  process, the compression
              releases salts and metals,  and the discharge  has  a higher  than
              average BOD.  The constituents of the discharge can affect the cost
              to process and/or the value of residuals;  charges  should reflect
              these impacts.

       The impacts of some of these limitations on the incentives of particular dischargers
are not as perverse within Escondido as they could be in other municipalities operating
under legalistic IJAs.  For example, a central problem  with a lack of peak pricing is the
reduced incentive to curb I/I, often a major component of peak flows.  Yet, recent I/I
studies  in Escondido,  San Diego,  and San Elijo service areas  suggest that no  single
community is responsible for a disproportionate share of I/I.  The implication is that the
use of average rather than peak flows is unlikely to substantially distort relative  charges.
In other regions, this may not be the case, and substantial sums may be spent to  increase
plant capacity due to improper pricing of capacity.

       Nonetheless, some of the tools discussed earlier in this report can be  usefully
applied to make IJAs more flexible.  For example, resource pricing techniques could be
used to quantify the value of the scarce  outfall or  plant capacity, allowing  capacity
allocations to be done via pricing rather than contractual fiat. This approach would ration
the scarce capacity to the parties that need it  most.  The fact that each party would have to
pay for the capacity it used would encourage each to implement steps that reduced flows
during  peak periods —  whether  through  better I/I control,  improved  equalization
capability, or other means.
Controlling Constituents of Concern with Fragmented Control

       POTWs  are  biological  processes,  designed  to break down  organic matter in
sewage into non-hazardous, reusable by-products. The plants are unable to treat inorganic
constituents such as  metals or salts; these pass through the plant or are entrained in the
biosolids.   At high  enough concentrations, these contaminants can  interfere with the
plant's biological process and/or render by-products unusable.

       To ensure that influent concentrations of these constituents do  not harm the plant
or contaminate residuals, EPA  required pretreatment to remove these constituents from
industrial discharges. The focus has been on industrial dischargers, as these are the largest
sources of most  elements of concern.  Pretreatment programs set limits on allowable
concentrations and enforce these limits  through plant inspections, analytical monitoring,
and litigation where  necessary.  The specific limits set by a plant vary depending on the
specifics of the treatment plant, the receiving water, and the NPDES permit.  Fragmented
control in Escondido's program makes it more difficult for them to curb constituents of
concern and to send the proper price signals to  dischargers. Areas where this is a problem
include oversight of dischargers in the  Rancho Bernardo service area,  effluent  from a
municipally-owned water treatment plant in Escondido, and increasing concerns over brine
loadings from non-industrial dischargers.  Fragmentation of control and distorted price
signals are also central factors in impeding the sale of treated effluent in the region.


       The Rancho Bernardo district of San Diego has rights to discharge 5.3 mgd of a
total  16.5 mgd  of capacity at HARRF, nearly one-third of the entire plant capacity.
Industrial discharge from Rancho Bernardo  is over 500,000 gpd, more than twice that
from industries within Escondido. In addition to the general issues regarding peak flows
from  Rancho Bernardo overall,  discharges from industries located there  are  important
sources of contaminants such as chloride, sodium, flouride, and boron.2

       All of these contaminants  from Rancho Bernardo impede effluent reuse and require
treatment by HARRF. Nonetheless, it is the city of San Diego that oversees the industrial
dischargers in that  region, including permitting, inspections,  and charges.  To address
HARRF compliance with its NPDES permit, the San Diego pretreatment staff incorporate
Escondido's local limits into  the permits they  write for Rancho Bernardo industries.
However, fees  levied on  IU discharges reflect the  standard rates  charged to Ills
throughout San Diego, and bear  no relation to the costs that these discharges  create for
the recipient treatment plant in Escondido.  Escondido  has extremely  limited ability to
independently  verify  reported discharge levels through  surreptitious monitoring or
independent inspections.

       While both  Escondido and  San Diego expressed an interest in transferring the
pretreatment  program to  Escondido,  San Diego pretreatment  staff felt  that political
concerns would  prevent such  a  transfer.  Nonetheless,  some improved tracking of the
impact of Rancho Bernardo discharges on Escondido collection and treatment costs would
be a powerful weapon in renegotiating the IJA or altering the charges for service.
       Municipal Dischargers

       Government entities often have a very difficult time regulating or charging other
government entities.  This issue arose during our site visits last year, where one POTW
had spent years figuring out an effective way to oversee a large military discharger in their
district. In Escondido, it is not the military but a water treatment plant (WTP) that creates
the challenges.  Since both HARRF and the water treatment plant are owned by the city,
their relationship has historically been governed by informal negotiation rather than more
formal assessments of the  impact that  one has  on the other.   This  approach can be
effective for relatively small,  lower cost  adjustments. However,  where the impacts are
larger  (or  not  well  quantified)  the resistance to  changes  that  disrupt operations or
substantially increase costs to one  party increase.
       2 Rancho Bernardo percentage loadings are  18  percent for chlorides, 38 percent
for sodium,  90 percent for fluoride,  and  74 percent for boron.   HYA Consulting
Engineers, City of Escondido Brine Management Feasibility Study, August 1995, p. 48.

       Consider the specific case in Escondido.   The WTP  discharges about  50,000
gallons per day to the WWTP for which it is directly charged nothing. Rather, an imputed
value of services is charged using allocations between municipal accounts.  This allocated
charge does not incorporate the real cost of the  WTP discharges,  and hence may not
encourage them to install processes that minimize the constituents of concern.  At 50,000
gpd, WTP flow is not a major issue. Rather, it is manganese and solids loadings that are a
problem.  The WTP is the source of 85 percent of manganese loadings at the WWTP, a
result of the use of a manganese-based settling compound in the water plant.  These levels
may impede the ability of HARRF to resell its effluent.  The high solids  content of the
effluent is  considered by  many  wastewater staff as a significant factor in  the need to
purchase a new digester at their plant.  In neither case has a careful cost accounting been
done to evaluate how much treating the  effluent  from the WTP plant really costs the

       Were such a study to be done, a more formal financial arrangement for discharges
from the WTP might spur behavior change.  Although the WTP is  currently evaluating
ways to reduce  Mn loadings,  this transition  might  occur  more  quickly  if financial
incentives were in place.  Similarly, alternative management of solids in the face of high
surcharges might, in conjunction with reductions elsewhere in the system, have enabled
the city to avoid the purchase of the new digester.  Even if no behavior change  were
possible, modified charges to reflect the real cost of treating WTP residues would be
passed onto WTP customers, such as  irrigators.  These  additional  costs would then be
borne by the commercial beneficiaries of the service, rather than by WWTP customers as
is  now the  case.   By  increasing the  cost  of fresh water  to better  reflect the costs of
providing it, the surcharges would also help to spur demand for the use of reclaimed water
in irrigation.
       Resale of Treated Effluent

       Fragmentation of control becomes an even more  serious problem when it occurs
on a large scale across various levels of government, as  is the  case in the interaction of
fresh  water delivery and  effluent  reuse.  Located in water-scarce Southern  California,
Escondido would seem to be in an ideal location to market its treated effluent. Demand
for irrigation water, not only for agriculture but for parks and golf courses as well, is high.
Yet, the city has discovered that their apparently ideal market is  not entirely ideal.  This is
partly because the city needs to reduce certain contaminants in their effluent (e.g., flouride,
boron, salt). However, much of the problem has to do with the poor functioning of fresh
water markets in the region.  There are pervasive subsidies to agricultural use of fresh
water which, as noted by a number of Escondido personnel, greatly reduce the interest of
farmers in trying to use reclaimed water.

       Consider the case within Escondido itself. According to utility officials, the cost to
purchase water for local consumption is close to  $429 per acre foot.  Although the quality
of this water  differs substantially in salt content  (depending  on whether its source is
Northern California or the Colorado River), there is no difference in the price that the city

must pay for it.  This lack of differentiation provides little incentive to try to reduce the
salt content of water flowing in the Colorado.

       The base rate for sales to regular customers is $524 per  acre foot.  With water
treatment costs of $40 per acre foot, this leaves little room for the cost of constructing and
maintaining the water delivery infrastructure.  In comparison, agricultural users pay the
city only $371  per  acre foot, less than it costs the  city to  buy the water.  Part of this
subsidy is provided by  the city;  most is provided by the  Metropolitan Water  District,
ostensibly because the farmers' water supply can be  interrupted in a drought.  However,
unlike  private  utilities  which actually do  cut off interruptible  supplies immediately,
municipal supplies to farmers have not been cut off entirely, even in deep drought.

       The  purpose  of this example  is to  provide  a  clear  demonstration  of the
environmental distortions  that cross-subsidies can create.  Rather than farmers pooling
together to buy reclaimed water from POTWs  in Escondido or similar cities,  helping to
pay to  reduce constituents of concern if necessary,  the POTW finds little interest from its
largest potential customers.  Repeated throughout Southern California, or through the
Southwest overall,  these cross-subsidies  lead to overconsumption of fresh water and a
suppression  of what  should  be  strong economic  drivers to recover  and resell WWTP
effluent, using pretreatment or other methods to control concentrations of salts and metals
entering the plant.  The same tools that help a single POTW identify its true  costs to
provide wastewater services  can be used by water treatment plants and water  delivery
systems to price their products, a process that would encourage more rationale use of
fresh and reclaimed water in the region.
       Non-Commercial Dischargers of Constituents of Concern

       Interestingly, Escondido faces increasing challenges  in controlling even the salts
that are added to its effluent by local water softening.  The pretreatment program was set
up to curb industrial discharges.  Controlling constituents  of concern from residential
discharges is much more difficult, given their decentralized origin and the focus of existing
statutes on the industrial sector.

       There are two major types of water softening services.  Automatic softeners are
installed in residential or commercial properties, with salts added by the property  owner.
Brine discharges are  flushed  into the sewer system,  increasing salt  loadings into the
POTW.  Tank exchange systems  are brine tanks supplied by a third party, and replaced
periodically with a new one.  The tanks are recharged at a central location.  Although tank
exchange  firms  also discharge brines to the  sewer system, they can reclaim a higher
proportion for reuse and are regulated as Ills by the POTW  while the homeowner is not.
As a  result, salt loadings can be more  easily controlled.  For example,  Escondido  is
planning to build a brine diversion line that would avoid contaminating POTW effluent

with salts.  Such a diversion line is relatively easy to install for a small number of industrial
brine dischargers, but prohibitively expensive if it must connect to every home or business
with an automatic water softener.

       To prevent problems with salt loadings from residential and commercial customers
using automatic water softeners, Escondido banned these machines.  A similar  ban was
implemented by many communities in Southern California.  Recently, a trade association
representing the automatic water softener manufacturers successfully struck down the ban
in a law suit.  Led by Culligan,  a major manufacturer of this equipment, the association
declared that their victory invalidated all of the  other rulings (though this  was not clear
from the judgment), and began selling automatic softeners to residential customers in all of
the previously banned  areas.   A  copy of a memo distributed by the Water Quality
Association explains their marketing strategy in detail.  As the memorandum  provides
interesting insights into the evolution of what is likely to be a substantial barrier  to water
reclamation in the future, we have included it as Appendix A.

       Legally, the city  of Escondido is fairly limited in the actions that it can take to
control the  discharges.   The longer the period  of time for a  residential  user  base of
automatic water softeners to grow, the  more  difficult controlling  the brine  levels in
effluent will be.  Yet the financial implications of this trend  are significant.  In addition to
the planned industrial brine diversion line (costing over $1 million), Escondido is building
a water reclamation plant at a cost of $46 million.  Unless non-IU brine discharges can be
controlled,  these large capital projects will not be able to deliver the low-salt effluent
needed for resale.  Better cost accounting for the cost impacts of brine dischargers on
system economics would certainly  help the city to make the case against  the automatic
softeners or brine discharge into the treatment plant in general.
Full Cost Recovery

       Escondido managers stated that they try to set rates that will recover the full costs
of their programs, and have been successful in ensuring that overall wastewater costs are
not  subsidized from  general tax  revenues.  However, they acknowledged that going
beyond this to full cost recovery from  particular types of customers was much more
difficult due primarily to a  "business friendly" environment.  This pressure  is faced by
many programs around the country. Yet, these same businesses must pay market rates for
all of their other production inputs; it is unclear  why wastewater treatment should be

       Within Escondido, industrial dischargers pay a flat fee per 1,000 gallons.  There is
no  surcharge  for constituents  such as TSS  or  BOD because the flow  from  these
dischargers (less than 2 percent of the total)  is too small to be worth the extra effort to
surcharge.  There is no attempt to recover the cost of permitting the facilities either.  Oil
and grease dischargers,  such as restaurants, pay a flat fee of $160 per year, plus a fee per
1,000 gallons of wastewater sent to the sewer. This fee covers less than 2/3 of the cost of
the direct time spent monitoring and inspecting oil and grease permittees.  The efforts of

program staff have cut the number of overflows and stoppages due to oil and grease in
half over the past  ten years.  However, staff did note that if the costs of addressing the
clogs were allocated to oil and grease  dischargers (a calculation they did not have the
information to make), the permit fees would cover an  insignificant portion of the total
program costs.3  Finally, as noted above, the  POTW does not attempt to recover the full
costs of servicing peak demand from the dischargers responsible for creating these peaks.

       These existing charges reflect a host of factors.  Some represent estimates of full
cost recovery fifteen years ago, but have not been updated.  Others reflect an estimate of
reasonable charges in the face of incomplete information on the real  cost of particular
types of discharges or activities.  Many others simply reflect a political agreement about
what is fair or acceptable by particular constituent groups within the community.  While
these reasons  do  not correspond to  economically-efficient  pricing,  they do  reflect the
political and organizational realities faced  by hundreds of POTWs  across the country.
Given these realities, changing the  rates overnight is not a  possibility.  However, if the
POTW itself can better understand  the magnitude of subsidies and cross-subsidies within
its operations, it will be well  positioned to prioritize  its outreach  and utility-financed
upgrades. It will also be in a better position to gradually  adjust rates over time.
Massachusetts Water Resources Authority (MWRA), Boston, MA

       MWRA provides wholesale water and wastewater services to a large network of
communities  in  the Boston area.   Forty-five  communities,  comprising an aggregate
population of 2.5 million people,  purchase MWRA's wastewater transport and treatment
services.  MWRA  owns three treatment plants:  the recently constructed  Deer Island
treatment plant, which provides primary and secondary treatment with enough capacity to
replace two older primary treatment facilities; the Nut Island treatment plant (scheduled to
be taken out of service in  1998); and a smaller, decentralized facility in Clinton, MA
providing service to two communities.  MWRA's capital upgrade has been ongoing for
the past  several years.  Once  complete, this new plant will have a primary peak hourly
capacity of 1.27 billion gallons per day (mgd) and a peak secondary hourly capacity of 788
mgd.4    Several  characteristics  of MWRA's  system and  operations  related  to  cost
accounting and budgeting contributed to the selection of MWRA as a case study:

       •      Role  as a Wholesaler.  MWRA  establishes  a wholesale  rate
              structure used to bill the communities within its service area.   The
              incentives within MWRA's rate structures  may not necessarily pass
       3  Aside from grease removal, the city  flushes portions  of its  collection system
known to clog frequently every three months rather than their norm of every 18 to 36

       4  MWRA, Fiscal Year Proposed Current Expense Budget,  February 24,  1997, p.

              through to individual users, as it is up to individual communities to
              set  local user  charges.   MWRA centralizes controls in some
              operational areas (such as pretreatment) to ensure better  control
              over its treatment system.
       •      Challenges of Managing a Large and Spread Out System. The
              size of MWRA's service area and the variation among communities
              within the  service area create a complex series  of factors for
              MWRA to consider in decision making, including variations in the
              cost of service and the ability to pay for service.
       •      Reliance on an Old Collection System   The collection systems
              within many of the service area communities, as well as many of the
              interceptor  mains  owned by MWRA,  are predominantly very old
              and in need of repair or replacement. Cost accounting systems that
              help  to  prioritize system  maintenance and  replacement become
              extremely important.

       Themes underlying  many of the issues we highlight here  are  the management
challenges that increase with  the  size and  reach of the POTW,  and the difficulty in
establishing  the proper  price signals for  optimizing plant  efficiency and  protecting the
environment. These issues are  discussed in greater detail below.
General Approach to Cost Accounting and Budgeting

       With an  annual  budget of $900  million (capital  and operating combined)  and
capital upgrades with a total cost measured in the billions,5 sophisticated financial control
systems are imperative in order for MWRA to function.   Although the Authority does
receive some  financial assistance through state and federal  grants or  loans, the vast
majority of its capital funds must be borrowed on capital markets.  Without accurate and
transparent financial reporting, the Authority would never be able to borrow funds.  To
ensure accurate  budgeting  and financial reporting,  MWRA has its own internal finance
department with a budget of nearly $4 million per year.  The administrative function of the
sewerage division, with a budget of $2.6 million in  FY95  and which is separate from the
MWRA-level finance group, has its  own finance unit as well, responsible for budgeting,
financial control, and long-range planning.

       MWRA  prepares its accounts in compliance  with Governmental Accounting
Standards Board (GASB) procedures for an enterprise fund.  GASB procedures provide
       5 Although the construction of the Deer Island project is nearing completion, the
Authority is projecting total capital improvements worth $3.0 billion between FY 1998
and FY 2007.  Capital improvements over the next three years for the wastewater system
alone are estimated at $680 million.   (See  MWRA, FY98 Proposed Current Expense
Budget, pp. 1-23 -1-26).

outsiders (primarily investors) with the information they need to assess the financial health
of the Authority. Key elements of MWRA's reporting include:6

       •      Accrual Accounting.  The Authority recognizes revenues at the
              point in time they provide services,  and expenses at the point in
              time they  receive  services.   As noted in Chapter 2,  accrual
              accounting is especially important in  the area of capital budgeting.
              MWRA depreciates its  capital purchases  over their  estimated
              service life, allowing them to better reflect the annual cost of capital
              services used.

       •      Recognition  of Liabilities Incurred.   MWRA recognizes  and
              reveals liabilities or potential liabilities they have incurred in the
              course of their current operations if they could affect their financial
              health  or  cost of operations.  Some examples include  long-term
              lease obligations, law suits, environmental liabilities, or exposure to
              losses on risks that they have self-insured for.
       •      Audited   Financial Statements.    MWRA  prepares  financial
              statements that are audited by an independent auditor.

       Although much larger than Escondido, there are some similarities in their approach
to budgeting.   For example, an important concern within MWRA has  been to create
separate sewer and water accounts, as required by its Enabling Act. Transferring funds
between the sewerage division account and the water division  account  requires approval
of the Board of Directors. This separation is particularly important in those municipalities
and joint authorities, such as MWRA, that do not provide sewer and water services to the
same universe of customers.   In MWRA's service  area, some communities receive one
service, others receive both.  MWRA's budget documents reflect this separation.

       The Authority prepares both a detailed current expense and capital budget on  an
annual basis for the sewerage division.  The current expense budget provides information
in two  ways.   First, data are broken  out by line item,  such  as wages  and  salaries;
maintenance; professional services; etc.  Second, this same budget  information is broken
out by program area.  These program areas are shown below in Exhibit 4-2.
       6 See Ibid., Appendix D, "Massachusetts Water Resources  Authority  Financial
Statements and Supplemental Schedule, June 30,  1996 and 1995."

                                     Exhibit 4-2
        -Facilities Development
        -Toxic Reduction & Control
        -Environmental Quality
        -Wastewater Engineering
        -Wastewater Construction
        -North/South Wastewater  Treatment Processes (main treatment plant and pump
        -Clinton Wastewater Treatment Plant
        Source: MWRA, FY98 Proposed Current Expense Budget, p. II-5.
       The capital budget provides a three-year, detailed assessment of anticipated capital
improvements,  and a less detailed projection going  out ten years.  Projects within the
overall Authority  are grouped by program area (Boston  Harbor Project,  wastewater,
water, business and operations support).  There is one additional category, contingency,
which makes allowances  for unanticipated costs  for the  proposed  projects.   The
contingency is estimated at roughly  9.5 percent of the budgeted projects.7   Within the
Sewerage Division, projects are further grouped by category, including  interception and
pumping,  treatment, Deer Island on-going capital improvements, residuals management,
combined sewer overflows (CSOs), and other.  The budget  then provides project-specific
information on each planned capital improvement.

       With a much bigger service base than Escondido, many of the support functions
(such as  engineering, legal,  etc.) which Escondido relied on  the city to  provide are
separate divisions within MWRA.  This includes departments such as Human Resources
and Public Affairs. Staff in these functional areas are also sometimes included  within some
of the operating divisions.  Despite the assumption of these functions within the utility,
cost accounting issues regarding how to  allocate support function  costs to water and
wastewater customers remain.  This allocation is important.   In the proposed FY1998
budget,  for  example, allocated support division and other indirect  expenses total $42
million, 27 percent of the sewer division's $154 million in total O&M spending.8

       The massive investment into new plant and equipment by MWRA has resulted in
more than a 500  percent increase in  combined water and sewer charges  for MWRA
customers between 1986 and  1993, increasing water and sewer  charges to some of the
highest in the country.9 Who would pay for the upgrade became a hot  political question in
       7 MWRA, Proposed FY98-00 Capital Improvement Program,  December  30,
1996, p. 3.
       8 MWRA, February 1997, op. cit, p. 1-40.
       9 Ibid., p. 1-34.

the Boston area, and forced MWRA to revise its rate methodology (discussed in greater
detail below) very  carefully.  The rate  methodology  finally approved resulted  from a
detailed  evaluation  of options given  political  and technical  constraints,  and much
consensus building.  The data to support this rate structure relies on the allocation of costs
to specific functional areas and then to customer classes.  However, the allocations involve
numerous approximations and averaging of costs; significant cross-subsidies remain that
reduce the incentives for important dischargers to invest in pollution prevention and flow
reduction technologies.

Dilution of Price Signals

       A central focus of this report has been on accurately tracking the cost of providing
wastewater treatment services in order to  send the  proper  price signals to staff and to
dischargers.  In a private market, price signals pass relatively unhampered through multiple
layers  of intermediaries.   This is because  competition constrains passing through  too
much,  and the requirement to earn a profit in order  to stay  in business  prevents passing
through too little.  Wastewater treatment is different.

       If communities made rate structure decisions purely on economic terms, price
signals  from MWRA's  wholesale rates would  reach  individual dischargers.   Higher
charges to the town due  to  TSS, BOD, or high peak flows would be passed back to the
sources of these  problems,  encouraging future  investment to  reduce  the factor(s) of
concern.  However, once political considerations influence the process by which local
rates are established, the  impact of MWRA's rate methodology is often  distorted.  Thus,
even if MWRA  could perfectly  track  its costs and  translate them  into  charges  to
communities, there  is no guarantee that the communities would set  rates that  sent the
same signals to the key dischargers. Some of the problems that arise are presented below.

       Using its wholesale rate methodology, MWRA recovers the funds it needs to cover
expenses from its  member communities.  Charges on  water and wastewater are calculated
separately. They  are calculated annually and paid to  MWRA in quarterly installments. It
is then up to the member community to levy charges  on its citizens. In most cases, cities
must add their internal cost  of wastewater services, in terms of installing and maintaining
local sewer collection  systems, to MWRA's charges.  These  two elements become the
basis of charges ultimately paid by local dischargers. A number of distortions in residential
rates are common, though not all apply to every community:

       •      Infrequent billing. Retail customers receive bills as infrequently as
              twice a year, unlike most other utilities (oil, gas, telephone, electric)
              where bills are sent monthly.  This reduces  the  ability to reflect
              seasonal variation  in fees or to  quickly rectify hidden changes in
              consumption patterns (e.g., leaks).

              Payments by  landlord rather than service consumer.  Both
              water and wastewater bills are sent to the property owner not to the
              party consuming the water and wastewater services.  While this
              system enables  unpaid  sewer bills to become a lien against  the
              property, it also dramatically reduces the incentive of those living in
              rental properties to reduce their consumption of water (and hence
              di scharge of wastewater).

              Average of peak  and strength  surcharges.  Retail customers
              generally pay an average amount per  hundred  cubic feet  (equal to
              748 gallons) discharged. This amount reflects an averaging of all
              peak and  strength  surcharges levied on the  city,  reducing  the
              incentive of any  particular  user contributing  to  these peaks
              (including industrial users) to reduce them.

              Hidden charges for wastewater treatment.  Although much less
              common than it once was, some towns include the capital portion
              of water and wastewater charges with the property tax bill levied on
              homeowners.   This approach  can make the actual charges  for
              wastewater services more difficult  to see if the water/ wastewater
              element is not  listed separately, and hence weakens the  ability of
              prices to trigger desired behavior  changes,  such as reduced water

              Derived consumption.  In most cases, retail  wastewater charges
              are calculated based on a fixed percentage of water consumption,
              since it is not  directly  metered at the point  of discharge.   This
              system penalizes customers who use  large amounts of water for
              non-sanitary purposes (e.g., irrigation).  Many towns do not allow
              separate metering for irrigation water.
Wholesale Rate Methodology

       The translation between MWRA's costs and its wholesale charges, in and of itself,
involves a number of trade-offs and potential distortions in the  rates charged to towns.
This level of price distortion is in addition to the dilution in price signals described above.
We first  provide an  overview of this rate methodology,  and then discuss some of the
potential issues with it.

       Reflecting the fact that the cost drivers for capital equipment are not necessarily
the same  as those for  operating expenses  and maintenance (O&M), MWRA uses a
       10   Including the capital charges with town property  taxes  enables residential
consumers to deduct the payments from their federal income taxes.

different method to calculate the rates for each. MWRA's "Sewer Cost  of Service
Methodology"   identifies  "functional  areas"   (e.g.,   pumping,  treatment,   residuals
management)  which cause  MWRA to  incur  operating  costs  and/or  capital costs in
wastewater collection and treatment.  The costs associated with these functional areas are
then allocated to "Cost Causative Factors" (e.g. wastewater volume, TSS, and BOD) to
develop average O&M and capital costs of wastewater service. MWRA costs of service
are updated annually as part of the Current Expense Budget development process.

       O&M costs are allocated using total annual metered wastewater flow, total annual
average strength, septage, and high strength flow loads.  As shown in Exhibit 4-3, flow is
the largest determinant of O&M charges, comprising nearly 60 percent of the total.  This
reflects the importance  of the quantity of wastewater in driving operating costs.  Measures
of strength  such as TSS and BOD increase  solids loadings and residence  times for
treatment, and thus comprise the remainder of O&M charges. MWRA's wholesale rate
methodology also allocates costs to municipalities  that have  high strength users. A high
strength user is  a permitted industry discharging 25,000 gallons per day and  having an
average TSS and/or BOD  strength of 400 mg/1 or greater.  For FY98, seventeen high
strength users were allocated wholesale sewer  charges as part of the annual sewer rate
setting process.  The surcharge rate  above 400  mg/1 for either TSS or BOD is constant,
however, for all levels of discharge.

       Capital costs are allocated using metered wastewater flow and loadings, along with
population.  Capital costs are, by their nature, fixed whether  or not the capital capacity is
being used.  For this reason, MWRA has incorporated two other elements in its capital
rate structure. Monthly peak flow is an attempt to reflect the additional capital demands
required by peak surges,  and comprises about 15 percent of total charges. Population is
used to allocate the vast majority of capital costs, 75  percent of the total.   Population
served drives both the collection system required and the provision of surplus capacity to
address future growth.

       The wholesale rate structure includes two important potential distortions. The first
involves peak flow surcharges.  While MWRA has implemented  some degree of peak
pricing, peak dischargers may still be  cross-subsidized by other users. The second involves
the allocation of such  a  substantial portion of capital costs  on  the basis of population.
Allocating the bulk of capital  costs based on the number of people may overlook other
sources of high cost infrastructure such as peak flows or length of trunklines.

       While we analyze these distortions in greater detail below,  it is important to draw a
distinction between cost allocation in  situations of scarcity versus situations of adequate or
excess capacity.   Consider the case of I/I.  MWRA  has  already built  the  necessary
treatment  capacity to handle high I/I  levels.  This infrastructure must be paid for whether
or not it is used.  Thus,  eliminating  pricing distortions, if it led  to  large investments by

                                        Exhibit 4-3
            MWRA Rate Factors as a Percent of Total Charges (FY 1998)
Annual Flow
Total Suspended Solids
Biochemical Oxygen Demand
 High Strength Component*
Monthly Peak Flow
 O&M Costs
Capital (Debt Service) Charges
       ($OOOs)             (%)
MWRA Inflow and Infiltration as a Percent of Total Flows
                                            60%    (2)
 *Reflects high strength surcharges for flow, TSS, and BOD. Amounts already included in category totals.

(1)  MWRA, "MWRA's Sewer Service Cost Allocation Methodology," July 15, 1997.
(2)  MWRA, "1997 Update on Infiltration/Inflow Reduction Strategy," Draft, August 6, 1997, p. 2.

communities to curb I/I, would simply shift the costs of the plant to the remaining users.
In contrast, had MWRA (or its predecessor  the Metropolitan District Commission) sent
proper price signals about I/I beginning 20 years ago, investments by communities may
have enabled the current Deer Island plant to be smaller, saving substantial costs.
       Peak Flows

       Under the current wholesale rate structure, peak flows pay only fifteen percent of
capital charges.  In fact,  however, inflow and infiltration, a large source of peak flows,
comprises approximately 60 percent of average daily flows (the average value in a survey
of 107 POTWs nationally was 25 percent).11 A year-round average understates the impact
of the problem because peaking capacity requirements are driven by annual peak flows.
MWRA estimates that I/I accounts for roughly 72 to 75 percent of maximum monthly
wastewater  flows, a better  measure  of the impact  on capacity.12  Thus, the current
allocation of capital costs likely subsidizes the sources of large peak flows, and reduces
the incentives for communities with particularly high I/I to invest in sewer upgrades.13

       While quantification of the environmental benefits of I/I reduction is difficult, I/I
reduction will  reduce the  quantity and frequency of raw sewage overflows upstream of
MWRA facilities resulting in reduced pollution of local wetlands, rivers, and Boston
Harbor, as well as reduced incidences of raw sewage backups into homes.  Staff felt  that
the elimination of collection system overflows during severe storm conditions would be
virtually impossible but that the reduction of overflow events during marginal storms  was

       When we analyzed MWRA's community-by-community data on peak flows, we
found that communities with the highest I/I percentage of peak month flows are likely to
be  the ones  receiving the  largest cross-subsidies  from  the  current  rate structure.
Interestingly, these communities include some of the wealthier suburbs, most of which can
afford to invest in sewer upgrades to reduce the problem more easily than the less affluent
communities now bearing a disproportionate share  of the higher costs of waste  water
       11  MWRA data from MWRA, "1997 Update  on Infiltration/Inflow  Reduction
Strategy," Draft, August 6, 1997, p. 2.  National survey data from AMSA, The AMSA
Financial Survey, 1996, p. A-17.

       12  MWRA, Ibid.

       13 Although the recovery rate on peak flows is perhaps too low in the current rate
structure,  it is important to recognize that the surcharging for peaks at all is a  substantial
improvement, and is only possible within MWRA as a result of a substantial investment in
monitoring equipment installed throughout the collection system.

treatment capital infrastructure.14  Converting raw data on peak flows to cost accounting
estimates of how much these additional flows have cost the system might enable the
Authority to eliminate cross-subsidies from less-wealthy to wealthier communities.

       Whether or not the political environment will allow higher charges for peak flows
to some of these communities is an open question.  In  addition, MWRA  would need to
carefully evaluate how  customer reactions to higher charges would affect the Authority's
allocation of capital infrastructure charges. However, improved accounting for the cost of
peak flows  could  help the  authority  to prioritize its  own financial  assistance  for  I/I
controls.  Currently,  their Local  Financial Assistance Program  distributes money  to
communities to use towards reducing I/I, of which  75  percent is used for construction
costs. MWRA has chosen to aggressively address this problem through zero-interest loans
and grants to communities as incentives to repair and replace old wastewater mains.  The
funding is substantial — $64 million over a ten-year period.15 However, the grant program
funds are allocated among all sewer communities based on respective share of overall
MWRA sewerage system charges rather than based on I/I rates or CSOs. Again, there is a
trade-off:  each community wants its  "fair  share" of the grant program,  yet a different
allocation mechanism might well do more to reduce MWRA's aggregate costs.16
       Allocation by Population

       As noted  above in  Exhibit 4-3,  the  largest factor in allocating capital  costs is
population.  Half of this charge is based on the sewered population within a particular
town, reflecting their use of current capacity. The other half of the population charge is
based on the census population, including those not currently discharging to the system.
This allocation reflects the  implicit standby capacity that MWRA provides as more and
more of the people in these communities shift from septic systems to sewers.

       The  use of population  for allocating overall capital does have  its weaknesses,
however.   First of all, much of the demand for the current  scale of trunklines  and
       14 See MWRA, "CY 1996 Community Wastewater Flow Estimates Ranked Flow
Components," August 5, 1997. We compared peak I/I levels to average per capita income
levels and found that many communities with below average incomes were  paying more
than their share of peak flows, while many communities with above average incomes were
paying more.

       15  MWRA,  "MWRA Infiltration/Inflow Reduction  Strategy:  Discussion  with
WAC, " August 8, 1997, p. 3.

       16  MWRA staff also noted that communities that had already invested substantial
sums in reducing their own I/I resented subsidizing communities that had done little in this

treatment capacity  is due to peak  flows  rather than  population.17   Secondly, while
collection system infrastructure is logically allocated based on census population (since it
has to be installed  even if few  people in  a  town are currently using it), most of the
collection systems within  the towns  are  owned by  the towns themselves, not MWRA.
Other factors that would be likely to  drive up collection costs, such as distance from the
treatment plant (requiring more miles of trunklines and more pumping stations)  are not
reflected at all in rates.

       The allocation of the bulk of the capital costs based on population is useful in that
it minimizes the cost of wastewater  treatment per capita, a possible strategy to ensure
universal service.  It also ensures a  fairly stable rate base, since flow reduction efforts
within a community do not reduce MWRA's recovery of already-spent capital. However,
as noted above, the cost  driver in much of the capital needed is peak flows. Peak flows,  in
turn, are driven by I/I, not by sanitary flows (which are linked to population). Because it
reduces the incentive to  curb peak flows, a population-based charge may not ration scarce
capital capacity in an optimal way. In addition, the lack of surcharges based on distance
from  the treatment plant may  hide  break-points  at  which  decentralized treatment
alternatives become economic.
Centralization of Industrial Pretreatment

       Cross-subsidies between  communities and user groups can dilute the signals to
curb wastewater discharges, driving up capital requirements and system costs; however,
they do not threaten the functioning of the wastewater treatment system. Discharges from
industrial users can cause plant upsets or trigger non-compliance with MWRA's NPDES
permit.  Thus,  despite being a wholesaler, MWRA has maintained (and EPA generally
requires) centralized  control of its industrial pretreatment program,  known as Toxic
Reduction and  Control (TRAC).  Through centralized analysis and control not  only of
industrial discharges, but of non-industrial discharges of constituents of concern, TRAC
has successfully reduced toxics loadings to the system.  For example, levels of industrial
metals released to the  system were reduced by more than 50 percent between 1993 and
1996.18  Direct oversight  of industrial dischargers  has  eliminated the  large potential
problems that decentralizing oversight to the 45 sewer service communities would have
caused to treatment plant operations and influent loadings of metals and toxics.
       Much of this oversight has relied  on regulatory approaches such as permitting,
inspection, monitoring, enforcement, and penalties. Increased fees have not been used as a
tool to modify discharger behavior to the extent they could be.  For example, surcharges
       17 As noted above,  I/I comprises 72 to 75 percent of maximum monthly flows.
Since peak flows in nearly all MWRA communities occur in December, these peaks drive
the demand for system capacity.
         Industrial metals include copper, nickel, silver, zinc, chromium, cadmium, lead
and mercury. See MWRA, Industrial Waste Report, October 1996, pp. 5-6.

on industrial users for TSS and BOD, often an important component of the price signals
that  POTW's send to industrial dischargers,  are levied on the city  within the MWRA
service area.19 It is then up to the city to decide what proportion of the fees to pass on to
industry in general, or to particular Ills.  The greater the pressure  within a city  to  be
"business  friendly," the  more likely that  other,  non-industrial,  users  bear  part of the
charges for TSS and BOD.

       MWRA  also  charges  industrial  dischargers  a  fee  both  for permitting and
monitoring,  and  staff state  that this fee has encouraged  some  Ills to reduce  their
discharges. Unlike strength surcharges, permit and monitoring fees are  levied directly  on
the company, and do  not go through the respective city sewer authorities.  These charges
use a sliding scale (based, in part, on a point system) to more accurately  reflect the burden
to TRAC  of resource-intensive permits.  This point  system is rather innovative  in that it
reflects the  relative importance of certain  constituents to MWRA's NPDES and sludge
disposal compliance.   Those constituents which appear in concentrations  nearest  to
MWRA's  effluent and disposal  limits (including  copper,  lead and mercury), and which
could subsequently force MWRA  into more expensive  treatment or  disposal options,
receive a greater weight in determining a facility's monitoring charge.

       The  point system aside, industrial users are subsidized by non-industrial users.  In
fact,  MWRA made  a conscious  decision not  to create a pretreatment program fee
structure that recovered the full costs of their program as it would have resulted in  much
larger industrial fees.   The current  fee structure (which was only implemented  in  1993)
aims to reduce total loadings, but is less concerned with full cost recovery.20  As a result,
permitting and monitoring charges are only meant to capture the full cost of labor time for
each activity (inspecting, permit writing, permit review, and monitoring) as well as most of
the laboratory  costs.   Users  are not charged the costs of litigation  and/or additional
monitoring unless it is associated with a significant enforcement action.  Nor is TRAC's
share of MWRA administrative and overhead costs included in TRAC's fee  structure.

       The  point system is an approximation even of the direct costs that TRAC  incurs to
monitor lUs. The amount charged for each permit was determined by  dividing the total
direct labor, materials, and services costs  associated with permitting and  inspecting the
regulated  facilities by the number of permits issued per  year.   Currently, this  averages
$2,860 per permit.  Permit length (2-5 years) is dependent on the level of attention and
resources  determined  appropriate for the category of facility.  In general,  more complex
facilities or those discharging higher levels  of pollutants of concern will pay higher permit
fees ($1,430 versus $575 per year) and be issued a shorter permit. While this  system does
generally  allocate costs back to  appropriate classes of permittees, cross-subsidies within
       19 Within MWRA, these charges are levied by the Authority's Budget Department
rather than TRAC. MWRA has  no authority to force member communities to pass the
strength surcharges back to the appropriate discharging industries.
         All else being equal, higher fees on loadings will generally encourage additional


Ills  certainly  remain.   Only  recently has  TRAC  actually tracked (on  a pilot basis)
employee time by activity.  This would enable them to more accurately assess how their
resources are being used.  Whether or not the Authority decides to modify its fees based
on this new cost information will depend on whether key decision makers within MWRA
believe the new fees justify the potential increase in administrative burden to track costs
and justify the change in fees to Ills.

       TRAC is funded by MWRA's General Fund,  and all permit fees and penalties
collected by TRAC go to the General Fund.  Annual budget appropriations to TRAC  from
the General Fund  have no explicit linkage to fees and  penalties collected from users.
There is  also no roll-over from year-to-year of surpluses within TRAC (surpluses revert
back to MWRA's Rate  Stabilization Fund), reducing  the incentive  to optimize budget
allocations across budget years.

       While  fees  on Ills may be artificially low (both due to TRAC fees that do not
recover the full cost of oversight and to strength surcharges that towns do not pass  back
onto their Ills), TRAC does  try to focus its outreach based  on the  overall  impact of
particular discharges on the treatment system.  Two examples  of this targeting are  their
current outreach to  hospitals  and dental offices  to  reduce  mercury, and to owners of
industrial cooling towers to reduce molybdenum loadings.  Although there is no plan to
increase  fees on these  dischargers to reflect the  costs they force MWRA to  incur, the
Authority is   essentially  using  a  demand-side  management  approach to control the
constituents of concern.
Outsourcing of Biosolids Management

       MWRA has contracted with the New England Fertilizer Company (NEFCo) to
barge its digested and thickened  sludge from the Deer Island and Nut Island treatment
plants.  NEFCo  then de-waters,  pelletizes, and  arranges  for  use  or disposal  of the
biosolids.  MWRA's contract with NEFCo, which is valid through 1999, stipulates that
the contractor will be paid per unit of material handled,  regardless of the quality of the
resulting  pelletized  biosolids.    Generally,  MWRA biosolids meet  EPA  Table  3
("exceptional quality") standards for land application, thereby allowing the product to be
marketed, distributed, and disposed of nationally.  NEFCo ships these pellets by rail to
several  different  sites for land application or use in blended fertilizers.   Occasionally,
MWRA pellets do not meet the federal lead limit for unrestricted use.  When this occurs,
the biosolids are used only at designated land application sites or are landfilled.

       NEFCo has historically spent between $16/ton and $72/ton  (or an  average of
about $50/ton) for land  application  or  fertilizer blending, depending on sludge quality,
physical properties, and the distance to the consumer (pellets are shipped by rail as far as
Colorado). According to MWRA, the current market price to landfill biosolids is $76/ton.
Additionally,  during 1993 MWRA signed a 30-year contract with a  landfill  in Utah to
guarantee back up disposal capacity.  This contract helped MWRA to reach an agreement

with the Commonwealth of Massachusetts, EPA, and the Court to avoid constructing its
own landfill, as previously required as backup for  its beneficial use plans.  The contract
contains a guaranteed transport and tipping fee that is  somewhat above current market
rates. MWRA is not obliged to use this landfill if it  has other disposal options.  In fact, the
landfill has offered lower spot rates to compete with less expensive alternatives that have
been available.

       This combination  of factors provides  an interesting example.   It is  cheaper to
beneficially use the pelletized biosolids through land application or fertilizer blending than
it is to landfill biosolids.  It is therefore in NEFCo's interest to produce pellets that meet
all federal guidelines for unrestricted use.  However, the terms of the current contract do
not vary  the  cost  to  MWRA based on  biosolids  contamination levels, even though
reducing this contamination is much more in the control of MWRA than NEFCo.   In the
same way that residential pricing  for wastewater services  diluted  the incentive for
residential customers to reduce water consumption, the NEFCo  contract terms have the
potential to reduce MWRA's incentive to implement source reduction for contaminants in
their solid residuals.

       In  this specific example, a number of factors do induce MWRA to act despite a
lack of short-term financial penalty for contamination levels.   First, there are  regulatory
pressures  to bring down metals contamination in biosolids (in this case, Pb and Mo).  In
addition, the NEFCo contract is relatively short  (five years).  Thus,  any new contract
would likely penalize  the Authority for  contamination  levels  either  directly through
specific provisions,  or indirectly through higher bid prices overall, and preparing for that
contract rebid requires that MWRA start trying to reduce metals loadings now.

       However, the general issue of a  disparity  between  short-term  and  long-term
pressures  is common in many POTWs, which is why it is worth mentioning here.   In the
NEFCo example, MWRA staff noted that the need to obtain a new residuals management
contract within only a few years was an important additional impetus to  ensure that metals
loadings were reduced so that all biosolids met EPA "exceptional quality" standards year-
round.  Many other utilities face a disparity between short- and long-term pressures from
out-of-date NPDES permits or capital infrastructure that is nearing capacity but that is far
more expensive to expand or replace than it was to build in the first place.  It is important
that POTW staff recognize how the current situation is likely to change over time so they
can plan accordingly.  As noted above, changes  in user  discharges can take years to
achieve, so adjustments to rate structures, outreach, and monitoring/enforcement need to
occur well in advance of the new requirements if they are to be effective.

       Escondido and  MWRA differ tremendously in size  and scope.  While  local
conditions dictate some of their issues of importance (such as effluent reuse in California),
both face  a number of  similar challenges in trying to balance political and economic
objectives. Both case studies illustrate how improper price signals can distort the behavior
of dischargers in detrimental ways, driving up total POTW costs  and potentially reducing
environmental quality as well.  Similarly, both illustrate  the difficulties that program

managers  face in trying to maintain both proper price signals and a business friendly

       The exact issues in your POTW will likely differ from these two case examples.
However,  being aware of the types of cost accounting and budgeting issues that can arise
and using information on the costs of existing distortions, can help you prioritize areas for
immediate, medium-term, and long-term improvement.

5.     SUMMARY

       Improved budgeting and cost accounting can be an extremely powerful tool for POTW
managers.  Across nearly every aspect of the POTW, understanding how particular dischargers
and discharges drive treatment costs can improve internal planning, rate setting, and the incentives
to reduce pollution and peak flows. This report has provided an overview of a number of useful
tools to  support the transition to improved budgeting and cost accounting as well as detailed
examples of what parts of your operations could likely benefit.  We hope you will customize these
examples to your own plants.

       Implementing improved budgeting and cost accounting will not be easy.  The points below
will hopefully help to keep the process in perspective:

       •      Focus  on the Long-term.   Any single issue  area, once you begin to
              address it, will uncover  (or create) others in need  of attention.   The
              implementation process will not always be smooth.  Thus, it is important
              not  to expect immediate benefits  but  to  look for systematic  gains  in
              understanding and control over a 2-3 year period.  Implementing changes
              (in rates for  example) after the new system has identified problem areas
              may also take some years.  Patience is important, but the new approaches
              will make many changes  possible that would be inconceivable without the
              improved ability to identify and quantify cost drivers.

       •      Focus on the Utility-Level.  Systematic changes in the method used for
              cost accounting and budgeting cannot be done within a single division, as it
              is affected by, and affects, most of the other divisions in the enterprise.
              Changes need to be implemented across the POTW, and with the active
              support of top management.

       •      Spend Adequate Time Focusing the Effort.  New cost accounting and
              budgeting systems will alter the information that managers have to make
              critical decisions for the organization. The information that these systems
              provide, and the format that  they provide them in, will greatly influence the
              management of the utility for many years.  Spend sufficient time early in the
              process to  be sure  the  systems  answer  the  questions  that  are most
              important to you, and provide data in a useful format.  Be sure  to get
              feedback on these important questions from all divisions and from all levels
              of the organization; the view from the utility director's office is unlikely to
              convey all that is important.

       •      Treat the Systems as an Input to the Answer, Not the Answer Itself.
              There is a temptation to take quantified data as the key input in a decision.
              Analytical tools help  managers to structure a problem; they still require
              interpretation.  Economically-optimal outcomes may need to be balanced
              against technical  or  political constraints.   Work with  key  staff to
              understand how  to interpret the  new cost accounting  and budgeting

information so that they can use it to make better decisions without using it

Share Lessons Learned.  Many  firms  have implemented the types of
budgeting and  cost  accounting  systems  described here.  However, the
specific challenges and hurdles faced by POTWs that try to do so will likely
be quite different. Be willing  to ask questions of utilities who have moved
in this arena  sooner than you; you can  learn  much from  them.   A
centralized forum (perhaps a  special area of EPA's Office of Water Web
site or its PIPES bulletin board for water-related issues)  in which to share
questions and  advice  on  implementing  improved budgeting  and  cost
accounting might be extremely useful.

Be Flexible in How to Use  the New Information.   If political  realities
prevent you from increasing  fees on the  large Ills driving your elevated
biosolids costs, the  new information  on costs can nonetheless be very
useful in  prioritizing the use of internal resources.   The net result will still
be less pollution at lower cost.

                        GLOSSARY AND ACRONYM DIRECTORY

activity  cost  pools - Accounting groupings  that  sum  all expenditures related  to  a particular
       organizational activity, used in an activity-based costing approach.
activity-based costing (ABC) - Cost accounting approach  that  allocates all  costs  within  an
       organization to processes, products, or projects on the basis of the activities that generate those
       costs.  Spending is grouped by activity, rather than department as is often done.
AMSA - Association of Metropolitan  Sewerage Agencies, the trade association of large, municipal
       sewerage agencies.
average and peak demand method - Method of allocating capital infrastructure costs to system users
       by assigning the baseline costs based on average demand for  services  and allocating residual
       costs, assumed to be associated with peak demand, based on peak demand patterns.
benchmarking  - A detailed comparison of ones  own products or processes to those of other
       competitors or service providers to identify avenues for improvement.
capital budgeting - Process by which the POTW assesses long-term  capital needs, and estimates the
       costs and benefits of particular capital acquisitions. An important aspect of capital budgeting is
       the assessment of the full annualized costs of capital services from particular plant or equipment
coincident demand method - Approach used to allocate capital costs to users  based on their demand
       for system capacity during the system's peak period.
cost accounting - Process by  which costs are allocated to specific products or services so that
       managers can better assess how their costs vary based on different activities.
cross-subsidies - Pricing or fee systems that charge one class of users or certain activities less than the
       real cost of providing service.  Generally, cross-subsidies are financed through higher charges
       on other consumers.  Cross-subsidies are  independent of whether  a utility  meets its overall
       revenue requirement, and tend to exist in  regulated markets more  often than in competitive
debottlenecking - Bottlenecks in a plant are the "weak links" in production (or waste water treatment)
       where  capacity is constrained,  preventing an increased  production or treatment capacity.
       Debottlenecking is the process of identifying and rectifying these constraints.
direct discharger - Industry with an EPA NPDES  permit allowing it to discharge waste water directly
       to a river or stream rather than having to send it to a sewage treatment plant.
FOG - Fats, Oil, and Grease discharges into the sewer system. Term is applied to both cooking oil and
       petroleum-based products.
HARRF - Hale Avenue  Resource Recovery Facility, the wastewater treatment plant in Escondido,
historical costs - Measurement of the actual cost to install infrastructure. Flistorical costs, as opposed
       to replacement costs, are  often used as a basis  for pricing wastewater services and setting
       revenue requirements.

I/I - Inflow and Infiltration.  Infiltration includes ground or surface waters entering the  collection
       system through physical defects in collection system such as cracked pipes, deteriorated joints,
       or poor construction.  Inflow includes flow entering the collection system from sump pumps,
       cross-connections, leaking tide gates, manhole covers or other non-wastewater source.
IJAs - Interjurisdictional agreements, the legally-binding contracts municipalities sign with each other
       governing shared services, such as wastewater treatment.
indirect discharger - Firms discharging waste water to a sewage treatment plant rather than directly
       to a river or stream. Indirect dischargers are regulated by the receiving POTW.
IU - Industrial Users.  Refers to industries discharging to the municipal sewerage system.
lateral lines - Smaller, peripheral sewer lines in waste water collection system.
LMSD - Louisville and Jefferson County Metropolitan Sewer District.
life-cycle costing - Process of evaluating not  only the direct costs of providing a product or service,
       but costs  throughout  the life-cycle.   This would include such factors  as the environmental
       impacts of producing the product and the cost of disposal.
minimum size rule - Used to  allocate infrastructure shared by many users, the minimum cost rule
       assumes that the minimum capacity (plus a safety margin)  needed to serve a standard user is a
       joint cost, and the incremental costs beyond that level should be borne by the subset of users
       requiring the larger capacity.
MWRA - Massachusetts Water Resource  Authority, the oversight body for water and wastewater
       services for 45 communities in the Boston area.
noncoincident demand method - Approach used to allocate the costs of capital infrastructure among
       users based  on the peak demand for the system for each individual large system user. Often
       used when infrastructure sizing is driven by customer rather than  system peaks, such as in the
       size of lateral collection lines.
NPDES -  National Pollutant Discharge Elimination System, used by the Environmental Protection
       Agency to track discharges to the nation's water bodies.
peak leveling - The need for wastewater collection,  storage, and treatment capacity is driven by peak
       demand. Peak leveling uses a variety  of market and outreach approaches to reduce the peak
       surges, thereby deferring the need for additional capacity.
POTW - Publicly Owned Treatment Work,  wastewater treatment plants owned by the public sector.
process mapping - Systems  tracking of physical processes, key task flows, and information  flows
       within  an  organization.  Process mapping is used to improve estimates  of the real  cost of a
       particular organizational function and to identify ways to streamline organizational processes.
replacement costs - Cost to replace existing capital infrastructure at  today's prices. Replacement costs
       can be lower than historical costs (e.g., if technical improvements have  reduced the costs  of
       new equipment) or higher than historical costs (e.g., if labor costs, interest rates, or siting costs
       have risen).
resource  or shadow pricing  -  Linear algebraic analytic approach that estimates the cost to a
       production objective (generally profit) from a scarcity of a particular input or resource.

TRAC - Toxic Reduction and Control Department, the  division administering MWRA's industrial
       pretreatment program.
trunk lines - Large, central sewer lines in a waste water collection system.
unbundling  - Process of disaggregating the various services provided by a utility such as wastewater
       collection,  billing,  stormwater control, to be  sure that the price of each service accurately
       reflects the cost of providing it.  Unbundling tends to remove many cross-subsidies that exist
       within the current pricing structure.
WWTP - Wastewater Treatment Plant.

      Memo From Water Quality Association Regarding Automatic Water Softeners

To:      WQA Manufacturers
         California Retailer Members
         Interested Parties
From;   Cartyn Meyer
         Director Public Affairs
Date:    May27,19S7
Re:      Recent Court Decisions

This fact sheet is intended to answer the questions most commonly asked of WQA about recent court decisions in
Status of California Lawsuits:

As most of you know, the 4"1 appellate district court in San Diego recently decided in favor of WQA regarding local
water softener bans. The appeal court agreed with a lower court ruling that overturned the Escondido softener ban
imposed in 1991,

We now have two published and certified court decisions, one from the 2nd appellate district court, the other from the
4th appellate district court The California Supreme Court refused to hear the case, thereby letting the appellate
decisions stand. These decisions are, therefore, precedents that all California lower courts are obliged to follow.

The appeal court's decision ends six years of WQA litigation over softener bans.

Scope of Court Rulings:

When WQA first Sled in Escondido, we had anticipated that aft bans before 1978 were "grand-fathered" into the
California Health and Safety Code. The courts ruied that they are not.  Therefore, these old bans are subject to the
same interpretation of the law as Escondido and Santa Maria. This means a!S California residential softener bans are

According to WQA attorney Ladd Bedford of McQuaid, Metzler, McCormick and Van Zartdt

         "With respect to those local ordinances stii! on the books in California, these two published appellate
         decisions create binding iegal precedent As a consequence, §ny trial court considering these local
         ordinances would be bound to follow these appellate decisions and conclude that ioca! ordinances banning
         or unduly restricting residential automatic water softeners which comply wiih state standards, are void and

Can Automatic Water Softeners Now B» Sold in PiwtoatLtostrieM Anas throughout Ca/ifornfa?

The courts have said yes, as long as itiey meet a 2850 grains of hardness:removed/pound of salt used efficiency rating
and provided other requirements of the State Health and Safety Code Section 11678.5 are met  Be sure you also
observe the laws of your local jurisdiction, including pulling permits.

A significant number of California cities experience above-average levels of salts in their source and wastewaters.
Especially when they are pressured by the Regional Water Quality Control Boards to achieve waste discharge
standards,'this is a difficult problem for them, "Aeconingly, to help address this problem, WQA recommends selling
only high efficiency DIR equipment in CalBbmia.    .

We should work with tocal officials and ofher industries to help mitigate ihese problems. We can help by selling only
high efficiency equipment and educating consumers to properly maintain their water softeners so Ifiat units remain
efficient throughout their useful lives.   .•:.-•,-.•,••.

Page 2—Court Decisions

How will local officials respond to salts of softeners fn areas that warn ones restricted?

This depends on the situation, but few will welcome the court decision with open arms. Some officials will accept the
ruling as state law.  A couple of cities are already moving to reverse bans. However, even if a city does not olciaily lift
a ban, the court decisions say those bans cannot be enforced.

Some agencies will understand that salinity problems are larger Bian water softeners and require much more
comprehensive water and wastewater management programs to resolve.  Others wi be skeptical and challenge
companies  selling in their area. Still others will want legal proof or to consult with their respective city attorney. A lot
depends on how much local officials have followed the court case or how big the salinity problem is in their source

It is extremeiy important that you educate your local officials.  Explain the softening process, especially advances in
technology  since Uie bans were first imposed in (he 1960s and 1970s. It can go a long way towards building an
understanding with agencies with which you have contact day in and day out

Remember that the reaction of a local inspector or lower level staff person does not necessarily reflect the official
position of a city. Be advised ihat - in dealing wifh this issue - you should talk directly with the Director of Public
Works, the  City Attorney or other responsible local official.  They should know about the lawsuit decisions. If not
provide them  with a copy of (he Health and Safety Code and the appellate court decision itself.

Expect strict enforcement of rales regarding permits, installation specifications, advertising, the "3-day* cooling off
period, etc.  And be prepared to respond to any negative consumer information campaign on the part of a city or water
district  There is nothing in the law that prohibits a local agency from "educating" consumers about softener brine and
the local agency's position on softeners, (They cannot, of course, lie and mislead or say softeners are iegal.)

How will state agendas react to the court decisions?

Several state agency associations have already sponsored a "spot bill" (or "sheii biii") in the California Senate (SB
360).  These indude the Association of California Water Agencies, the Association of California Sanitation Agencies,
the League of Cities, and the Water Reuse Association. The bill's language is harmless at this time; however, it was
introduced  as a way to reserve space on the legislative calendar for a future amendment to include language that could
be detrimental to the industry.  Although we have assurances from the bill's author that he would not add such
language, we can't rest on that promise alone.

WQA is poised to respond to any legislation that may be introduced by opponents to our lawsuit wins. We hive kept
key legislators abreast of developments in the lawsuit and have alerted them to our interests in the issue. WQA's
position also has support from many sizable end-user groups, such as those representing hotels, restaurants,
laundries and hospitals.

We have made it dear that the industry could support legislation containing tougher standards than what presently
exists in state law but which meet current industry capabilities {DIR, 3350 grains removed), provided local jurisdictions
are not given the authority to ban products.

The water and sanitation agencies will continue to portray their position as serving Jhe public good. However, many
legislators have tax-paying constituencies who would suffer if they were prohibited from using softeners.

Page 3—Court Decisions

Other issues that mav be raised

Q;  Can a private homeowners association ban water softeners as part of Ms covenant?

A: They may be able to, depending upon how the covenant is wriSen. Condominium associition agreements are
more or less contracts entered into voluntarily by private citizens.

0:  What if my local officials say they are banning brine discharge under the sewer laws, not water softeners

k Several districts have brought this up.  It may be a way to circumvent the court decisions.  However, a district
cannot single out water softeners. It would be in violation of state law.

Q:  My city says that the  Regional Water Quality Control Board bans water softeners.

A: This is nonsense. The  Regional Water Quality Control Board sets standards for municipal sewage treatment
plants. Some cities believe that if they are in violation of those discharge standards setting TDS limits, it gives them
the right to ban water softeners, it does not. Plus, the Regional Water Quality Control Board does not have the power
itself to ban water softeners or even to tett cities what specific actions to take to comply with board-issued standards.
Neither do the State Water Resources Control Board or the EPA.

To receive a copy of the appellate court decision or the California Health and Safety Code, fax your request to WQA at


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