Rate of Return for Municipal Enterprise Funds: The Case of Rock Hill, SC

By Grigsby, William W.; Parker, Darrell | Journal of the International Academy for Case Studies, January 2000 | Go to article overview

Rate of Return for Municipal Enterprise Funds: The Case of Rock Hill, SC


Grigsby, William W., Parker, Darrell, Journal of the International Academy for Case Studies


MUNICIPAL SERVICES AND ENTERPRISE FUNDS

Local Governments often undertake the delivery of utility services through the operation of publicly owned utilities within the framework of an enterprise fund. Among the most common type of enterprise is the municipally owned electric company. Other common utilities provided include water and sewer services. The revenues, expenditures, and debt associated with owning and operating these enterprises pose a significant public finance concern for municipalities. The activities of a municipality that are intended to operate in a manner similar to a private business are accounted for in a separate fund known as an "enterprise fund." It is the intent of this separate fund to permit the treatment and operation of publicly owned enterprises to obtain accounting information similar to that available for their private counterparts.

For a municipal utility, surplus revenues can be transferred from the enterprise fund to the general fund to subsidize other operations. The extent to which the municipality is free to generate profits and transfer them to other uses will vary depending on the state regulatory environment. In South Carolina, municipal utility rates are not governed by statewide regulatory rules. Municipalities can set and change rates without regard for the regulatory bodies governing investor owned utilities. Unfortunately, this encourages the practice of adopting transfer policies to be heavily influenced by political concerns, rather than the underlying foundations of economics and governmental accounting.

One alternative that provides discipline for local government is the adoption of a policy determining the level of transfers. If a private utility were operating within the City limits, it would be required to pay franchise fees and taxes. In addition, the utility owners would have earned a rate of return on their investment. Rate of return policies when adopted would typically claim to base rates and generate transfers to achieve a fair rate of return. This case highlights the rate of return and transfer policies adopted in Rock Hill, SC. The diverse pressures facing the city operated electric, water, and sewer systems provide insight into the managerial accounting issues for municipalities.

When a governmental unit engages in activities that sell services to the general public, the unit reports on such activities with a "proprietary fund type," specifically an enterprise fund. As the name suggests, this type of fund or activity is accounted for in the same manner as a privately owned business. Such funds use full accrual accounting and account for all assets, current and long lived, used in the generation of the revenue of the fund. The standard setting body for governmental accounting in the United States is the Governmental Accounting Standards Board (GASB). This board's statement on enterprise fund accounting can be summarized simply: "In order to take advantage of the work done by regulatory agencies and trade associations to develop useful accounting information systems for investor owned enterprises, it is recommended that governmentally owned enterprises use the accounting structures developed for investor-owned enterprises of the same nature." [2, Statement No. 20]

Investor owned utilities are normally regulated by the states in which they operate. The rates for charges for services are approved by the individual state's regulatory agency. The normal process is for the regulatory agency to allow charges that will provide a given rate of return on the utility's investment. The approach to the analysis is to compare the income for a certain period, six months to a year, prior to the rate setting hearing with the costs of the property used and to be used within a reasonable time. Usually adjustment are made to the reported income for interest, or rate of return, on equity; for refunds to consumers as a result of rate hearings; the cost of legislative-advocacy expenses; business gifts and some entertainment expenses; and other expenses that such regulatory agencies determine not to have been prudently incurred or not incurred in the interest of the public. …

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Rate of Return for Municipal Enterprise Funds: The Case of Rock Hill, SC
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