02-05-2019 - AGENDA ITEM 13 GENERAL FUND BALANCE RESERVE POLICYAGENDA ITEM NO. 13
AGENDA STAFF REPORT
City of West Covina I Office of the City Manager
DATE:
February 5, 2019
TO:
Mayor and City Council
FROM:
Chris Freeland
City Manager
SUBJECT:
GENERAL FUND BALANCE RESERVE POLICY
RECOMMENDATION:
It is recommended that the City Council receive and file this informational report.
BACKGROUND:
At the June 5, 2018 City Council Meeting, City Council adopted Resolution 2018-64 (Attachment No. 1),
amending the Fund Balance Reserve Policy for the General Fund. The amended General Fund Balance
Reserve Policy changed the minimum unassigned fund balance requirement by reducing it from 20% to 17% of
operating expenditures.
DISCUSSION:
Cities maintain a Fund Balance to provide the City with the financial ability to respond to an economic
downturn, provide sufficient cash flow to avoid the need for short-term borrowing, make unexpected purchases
of equipment and supplies, and much more. The amount of a City's Fund Balance is also an indicator of a
City's financial condition, and those cities with a greater Fund Balance are typically more financially secure
than other communities. This is also a significant measurement used by bond agencies when determining a
City's credit raring. Those cities that maintain their Fund Balance at or above recommended levels, without
dipping into them, earn a greater credit rating. The greater the credit rating, the better the interest rate a City
earns if it needs to borrow money for projects and programs. In October 2018, Standard & Poor's provided the
City of West Covina a credit rating of A+.
Currently, the Fund Balance Reserve Policy states that the City shall maintain a minimum unassigned fund
balance of at least 17% of the General Fund operating expenditures. Unassigned fund balance (residual net
resources) is the difference between total fund balance and its nonspendable, restricted, committed, and
assigned components. If the reserve level falls below 17%, the City must amend this policy by including a plan
to rebuild the fund within three years. At the fiscal year end close, the annual excess revenue over expenditures
in the City's General Fund will be automatically allocated as follows, unless the transfer is overridden by an
action of the City Council: 25% stays in the General Fund Balance reserves, 50% is transferred to the City's
Capital Projects Fund, and 25% goes to pay down the City's Other Post Employment Benefit (OPEB) liability.
The unassigned fund balance of at least 17% of General Fund operating expenditures meets the reserve level at
a minimum of no less than two months of regular General Fund operating expenditures, which is consistent
with the Government Finance Officers Association (GFOA) minimum recommended fund balance reserve
GFOA recommends that governments establish a formal policy on the level of unrestricted fund
balance that should be maintained in the general fund for GAAP and budgetary purposes.3 Such a
guideline should be set by the appropriate policy body and articulate a framework and process for
how the government would increase or decrease the level of unrestricted fund balance over a
specific time period 4 In particular, governments should provide broad guidance in the policy for
how resources will be directed to replenish fund balance should the balance fall below the level
prescribed.
Appropriate Level. The adequacy of unrestricted fund balance in the general fund should take into
account each government's own unique circumstances. For example, governments that may be
vulnerable to natural disasters, more dependent on a volatile revenue source, or potentially subject
to cuts in state aid and/or federal grants may need to maintain a higher level in the unrestricted fund
balance. Articulating these risks in a fund balance policy makes it easier to explain to stakeholders
the rationale for a seemingly higher than normal level of fund balance that protects taxpayers and
employees from unexpected changes in financial condition. Nevertheless, GFOA recommends, at a
minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary
fund balance in their general fund of no less than two months of regular general fund operating
revenues or regular general fund operating expenditures.5 The choice of revenues or expenditures
as a basis of comparison may be dictated by what is more predictable in a government's particular
circumstances 6 Furthermore, a government's particular situation often may require a level of
unrestricted fund balance in the general fund significantly in excess of this recommended minimum
level. In any case, such measures should be applied within the context of long-term forecasting,
thereby avoiding the risk of placing too much emphasis upon the level of unrestricted fund balance in
the general fund at any one time. In establishing a policy governing the level of unrestricted fund
balance in the general fund, a government should consider a variety of factors, including:
1. The predictability of its revenues and the volatility of its expenditures (i.e., higher levels of
unrestricted fund balance may be needed if significant revenue sources are subject to
unpredictable fluctuations or if operating expenditures are highly volatile);
2. Its perceived exposure to significant one-time outlays (e.g., disasters, immediate capital
needs, state budget cuts);
3. The potential drain upon general fund resources from other funds, as well as, the availability
of resources in other funds;
4. The potential impact on the entity's bond ratings and the corresponding increased cost of
borrowed funds;
5. Commitments and assignments (i.e., governments may wish to maintain higher levels of
unrestricted fund balance to compensate for any portion of unrestricted fund balance already
committed or assigned by the government for a specific purpose). Governments may deem it
appropriate to exclude from consideration resources that have been committed or assigned to
some other purpose and focus on unassigned fund balance, rather than on unrestricted fund
balance.
Use and Replenishment.
The fund balance policy should define conditions warranting its use, and if a fund balance falls below
the government's policy level, a solid plan to replenish it. In that context, the fund balance policy
should:
1. Define the time period within which and contingencies for which fund balances will be used;
2. Describe how the government's expenditure and/or revenue levels will be adjusted to match
any new economic realities that are behind the use of fund balance as a financing bridge;
3. Describe the time period over which the components of fund balance will be replenished and
the means by which they will be replenished.
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Generally, governments should seek to replenish their fund balances within one to three years of
use. Specifically, factors influencing the replenishment time horizon include:
1. The budgetary reasons behind the fund balance targets;
2. Recovering from an extreme event;
3. Political continuity;
4. Financial planning time horizons;
5. Long-term forecasts and economic conditions;
6. External financing expectations.
Revenue sources that would typically be looked to for replenishment of a fund balance include
nonrecurring revenues, budget surpluses, and excess resources in other funds (if legally permissible
and there is a defensible rationale). Year-end surpluses are an appropriate source for replenishing
fund balance.
Unrestricted Fund Balance Above Formal Policy Requirement. In some cases, governments can
find themselves in a position with an amount of unrestricted fund balance in the general fund over
their formal policy reserve requirement even after taking into account potential financial risks in the
foreseeable future. Amounts over the formal policy may reflect a structural trend, in which case
governments should consider a policy as to how this would be addressed. Additionally, an education
or communication strategy, or at a minimum, explanation of large changes in fund balance is
encouraged. In all cases, use of those funds should be prohibited as a funding source for ongoing
recurring expenditures.
Notes:
1. For the sake of clarity, this recommended practice uses the terms GAAP fund balance and
budgetary fund balance to distinguish these two different uses of the same term.
2. These categories are set forth in Governmental Accounting Standards Board (GASB)
Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions.
3. Sometimes restricted fund balance includes resources available to finance items that typically
would require the use of unrestricted fund balance (e.g., a contingency reserve). In that case,
such amounts should be included as part of unrestricted fund balance for purposes of
analysis.
4. See Recommended Practice 4.1 of the National Advisory Council on State and Local
Budgeting governments on the need to "maintain a prudent level of financial resources to
protect against reducing service levels or raising taxes and fees because of temporary
revenue shortfalls or unpredicted one-time expenditures" (Recommended Practice 4.1).
5. In practice, a level of unrestricted fund balance significantly lower than the recommended
minimum may be appropriate for states and America's largest governments (e.g., cities,
counties, and school districts) because they often are in a better position to predict
contingencies (for the same reason that an insurance company can more readily predict the
number of accidents for a pool of 500,000 drivers than for a pool of fifty), and because their
revenues and expenditures often are more diversified and thus potentially less subject to
volatility.
6. In either case, unusual items that would distort trends (e.g., one-time revenues and
expenditures) should be excluded, whereas recurring transfers should be included. Once the
decision has been made to compare unrestricted fund balance to either revenues and/or
expenditures, that decision should be followed consistently from period to period.
The County of San Diego, CA was awarded the GFOA Award for Excellence for outsanding use of
GFOA's Best Practice on Fund Balance Guidelines for the General Funds. To learn more about the
County's implementation process, please visit their award page.
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This best practice was previously titled Appropriate Level of Unrestricted Fund Balance in the
General Fund.
203 N. LaSalle Street - Suite 2700 1 Chicago, IL 60601-1210 1 Phone: (312) 977-9700 - Fax: (312) 977-4806
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level. The GFOA provides cities with "Best Practices" in the area of municipal finances throughout the United
States.
Prepared by: Marcie Medina, Finance Director
Fiscal Impact
FISCAL IMPACT:
The unassigned fund balance of at least 17% of General Fund operating expenditures provides for two months
of regular General Fund operating expenditures. Any reduction in the minimum unassigned fund balance could
result in cashflow issues, and the City needing to borrow for ongoing operations. Also, it would most likely
result in downgrading of the City's credit rating and further scrutiny by the State and other agencies.
Attachments
Resolution No. 2018-64 Including Exhibit A
GFOA Fund Balance Guidelines
ATTACHMENT NO. 1
RESOLUTION NO.2018-64
A RESOLUTION OF THE CITY COUNCIL OF THE CITY
OF WEST COVINA, CALIFORNIA, AMENDING THE FUND
BALANCE RESERVE POLICY FOR THE GENERAL FUND
WHEREAS, in an effort to become more financially secure, the City Council adopted a
Fund Balance Reserve Policy for the General Fund on July 7, 2015, with the adoption of
Resolution No. 2015-52; and
WHEREAS, the City Council amended the Fund Balance Reserve Policy for the General
Fund on March 1, 2016, with the adoption of Resolution No. 2016-18; and
WHEREAS, the City Council amended the Fund Balance Reserve Policy for the General
Fund on June 21, 2016 with the adoption of Resolution No. 2016-60; and
WHEREAS, the City Council had previously adopted a fund balance reserve policy of
maintaining a minimum unassigned fund balance of at least 20% of General Fund operating
expenditures. At the end of the fiscal yearend close, the annual excess revenue over expenditures
in the City's General Fund will be automatically allocated as follows, unless the transfer is
overridden by an action of the City Council: 25% stays in the General Fund Balance reserves,
50% is transferred to the City's Capital Projects Fund, and 25% goes to pay down the City's
Other Post Employment Benefit (OPEB) liability; and
WHEREAS, the City Council has determined that the City shall maintain a minimum
unassigned fund balance of at least 17% of the General Fund operating expenditures. If the
reserve level falls below 17%, the City must amend this policy, including a plan to rebuild the
fund within three years. At the end of the fiscal year end close, the annual excess revenue over
expenditures in the City's General Fund will be automatically allocated as follows, unless the
transfer is overridden by an action of the City Council: 25% stays in the General Fund Balance
reserves, 50% is transferred to the City's Capital Projects Fund, and 25% goes to pay down the
City's Other Post Employment Benefit (OPEB) liability.
WHEREAS, the City Council has determined that the City has met the reserve level at a
minimum of no less than two months of regular General Fund operating expenditures which is
consistent with the Government Finance Officers Association (GFOA) recommended fund
balance reserve level; and
NOW, THEREFORE, the City Council of the City of West Covina does resolve as
follows:
Section 1. This resolution supersedes Resolution No. 2016-60 and adopts the
Amended Fund Balance Policy for the General Fund as reflected in Exhibit A to this resolution.
Section 2. That the City Clerk shall certify to the adoption of this resolution and the
same shall be in full force in effect immediately upon adoption.
PASSED, APPROVED AND ADOPTED this 5th day of June, 2018.
tl—oyd Johns n
Mayor Pro Tern
APPROVED AS TO FORM: ATTEST:
Kimberly Hal arlow ckolas S. Lew
City Attorney City Clerk
1, HEREBY CERTIFY that the foregoing resolution was duly adopted by the City Council
of the City of West Covina, California, at a regular meeting thereof on the 51h day of June 2018,
by the following vote of the City Council:
AYES: Toma, Warshaw, Wu, Johnson
NOES: None
ABSENT: Spence
ABSTAIN: None
_ickolass S. Le'
City Clerk
CITY OF WEST COVINA
FUND BALANCE
POLICY
POLICY
EXHIBIT A
In February 2009, the Governmental Accounting Standards Board (GASB) issued Statement No.
54, Fund Balance Reporting and Governmental Fund Type Definitions. This new standard has not
changed the total amount of reported fund balance, but has substantially altered the categories and
terminology used to describe its components. The new- categories and terminology reflect an
approach that will focus; not on financial resources available for appropriation within a fund, but
on the extent to which the City is bound to honor constraints on the specific purposes for which
amounts in the fund can be spent.
This Fund Balance Policy establishes the procedures for reporting unrestricted fund balance in the
City's financial statements. Certain commitments and assignments of fund balance will help ensure
that there will be adequate financial resources to protect the City against unforeseen circumstances
and events such as revenue shortfalls and unanticipated expenditures. The policy also authorizes
And directs the Finance Director to prepare financial. reports which, accurately categorize fund
balance as per Governmental Accounting Standards Board (GASB) Statement No. 54, Fund
Balance Reporting and Governmental Fund Type Definitions.
PROCEDURES
The term "Fund Balance" is used to describe the difference between assets (what .is owned) and
liabilities (what is owed) reported within a fund. In the. past,. Rind balance has been classified into
basically three separate components: Reserved, Designated, and Undesignated. There are almost
always important limitations on the purpose for which.all or a portion of the resources of a fund
can be used. The force of these limitations can vary significantly, depending on their, source. The
various components of the "new" fund balance are designed to indicate the extent to which the
City is bound by these limitations placed upon the.resources.
GASB Statement No. 54 defines five separate components of fund balance, each of which
identifies the extent to which the City is bound to honor. constraints on the specific purposes for
which amounts can be spent. These new components of fund. balance will replace the current
existing three components. The five components are:
• Nonspendable fund balance (inherently nonspendable)
• Restricted fund balance (externally enforceable limitations on use)
• Committed fund balance (self-imposed limitations on use)
• Assigned fund balance (limitation resulting from intended use)
• Unassigned fund balance (residual net resources)
The first two components listed above are not addressed in this policy due to the nature of their
restrictions. Some examples of nonspendable fund balance are prepaid expenses, notes receivable;
inventory and land held for resale. Restricted fund balance is either imposed by law or constrained
by grantors, contributors, or laws or regulations of other governments. This policy is focused on
financial reporting of unrestricted fund balance, or the last"three components listed above. These
three components are further defined below.
COMMITTED FUND BALANCE
The City Council, as the City's highest level of decision -making authority, may commit fund
balance for specific purposes pursuant to constraints imposed by formal actions taken, such as an
ordinance or resolution. These committed amounts cannot be used for any other purpose unless
the City Council removes or changes the specified use through the same type of formal action
taken to establish the commitment. City Council, action to commit fund balance needs to occur
within the fiscal reporting period; however, the amount can be determined subsequently.
ASSIGNED FUND BALANCE
Amounts that are constrained by the City's intent to be used for specific purposes, but are neither
restricted nor committed, should be reported as assigned fund balance: Such intent needs to be
established at either the highest level of decision making, or by an official designated for that
purpose.
This policy hereby delegates the authority to assign amounts to be used for specific purposes to
the City Manager for the purpose of reporting these amounts in the annual financial statements.
UNASSIGNED FUND BALANCE
These are residual positive net resource of the general fund in excess of what can properly be
classified in one of the other four categories.
RESERVE POLICIES
The City shall maintain a minimum unassigned fund balance of at least 17% of the General Fund
operating expenditures. If the reserve level falls below 17%, the City must amend this policy,
including a plan to rebuild the fiend within three years; This is considered the minimum level
necessary to maintain the City's credit worthiness and to adequately provide for:
• Economic uncertainties,, local, disasters and other hardships or downturns in the local
economy
• Contingencies for unforeseen operating or capital needs
• Cash flow requirements
At the end of the fiscal year, the annual excess revenue over expenditures in the City's General
Fund will be automatically allocated as follows, unlessthe transfer is overridden by an action of
City Council: 25% stays in the General Fund Balance reserves, 50% is transferred to the. City's
Capital, Projects Fund, and 25% goes to pay down the City's Other Post Einpioyment Benefit
(OPBB) liability.
FUND BALANCE CLASSIFICATION
When -an expenditure.is incurred for purposes for which both restricted and unrestricted fund
balance is,ay.ailable the poIicy shall be to expend the restricted fund balance first before expending
the unrestricted fund balance. Similarly, when an expenditure is incurred.for purposes for which.
amounts in any of the unrestricted classification of fund balance could.be used, the City considers
committed amounts to be reduced 'first, followed by assigned amounts and. then unassigned
amounts.
This policy is in place to provide a measure of protection for the City against unforeseen
circumstances. and to comply with GASB Statement No.. 54. No other policy or procedure
supersedes the authority and provisions of this policy.
ATTACHMENT NO.2
Government Finance Officers Association
BEST PRACTICE
Fund Balance Guidelines for the
General Fund
BACKGROUND:
In the context of financial reporting, the term fund balance is used to describe the net position of
governmental funds calculated in accordance with generally accepted accounting principles (GAAP).
Budget professionals commonly use this same term to describe the net position of governmental
funds calculated on a government's budgetary basis.' While in both cases fund balance is intended
to serve as a measure of the financial resources available in a governmental fund; it is essential that
differences between GAAP fund balance and budgetary fund balance be fully appreciated.
1. GAAP financial statements report up to five separate categories of fund balance based on the
type and source of constraints placed on how resources can be spent (presented in
descending order from most constraining to least constraining): nonspendable fund balance,
restricted fund balance, committed fund balance, assigned fund balance, and unassigned
fund balance? The total of the amounts in these last three categories (where the only
constraint on spending, if any, is imposed by the government itself) is termed unrestricted
fund balance. In contrast, budgetary fund balance, while it is subject to the same constraints
on spending as GAAP fund balance, typically represents simply the total amount accumulated
from prior years at a point in time.
2. The calculation of GAAP fund balance and budgetary fund balance sometimes is complicated
by the use of sub -funds within the general fund. In such cases, GAAP fund balance includes
amounts from all of the subfunds, whereas budgetary fund balance typically does not.
3.Often the timing of the recognition of revenues and expenditures is different for purposes of
GAAP financial reporting and budgeting. For example, encumbrances arising from purchase
orders often are recognized as expenditures for budgetary purposes, but never for the
preparation of GAAP financial statements.
The effect of these and other differences on the amounts reported as GAAP fund balance and
budgetary fund balance in the general fund should be clarified, understood, and documented.
It is essential that governments maintain adequate levels of fund balance to mitigate current and
future risks (e.g., revenue shortfalls and unanticipated expenditures) and to ensure stable tax rates.
In most cases, discussions of fund balance will properly focus on a government's general fund.
Nonetheless, financial resources available in other funds should also be considered in assessing the
adequacy of unrestricted fund balance in the general fund.
RECOMMENDATION:
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