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CC 2024-04-09_09c Resolution Updating Fund Balance_Reserve PolicyItem 9.c. MEMORANDUM TO: City Council FROM: Nicole Valentine, Administrative Services Director SUBJECT: Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy DATE: April 9, 2024 SUMMARY OF ACTION: Updating the Fund Balance and Reserve Policy will be used as a guide for future City Council and staff actions regarding the financial health of the City. IMPACT ON FINANCIAL AND PERSONNEL RESOURCES: There is no fiscal impact resulting from updating the Fund Balance and Reserve Policy. The total fund balance amounts reported in any given fund will not be altered. Only the consideration of reporting of the individual components that make up the total fu nd balance are being discussed. RECOMMENDATION: Adopt a Resolution updating the Fund Balance and Reserve Policy. BACKGROUND: The City Council first adopted the Fiscal Policy on September 5, 1995, and has revised the policy on November 12, 1996; February 10, 1998; May 29, 2003; May 24, 2005; and most recently June 28, 2011. Many of these updates were included with a review of the budget adoption. The current reserve policy states the following:  Establish and maintain a Fund Balance reserve goal of 20% of expenditures with a minimum of 15% in the General Fund.  Maintain a minimum of 5% of the General Fund budget as a Contingency Reserve.  Contribute 10% of annual appropriations to the improvement of Infrastructure. Over many years, the City has established a comprehensive and extensive budget and financial policy framework. This framework is reviewed with each Biennial Budget and periodically amended based on the need of the organization as well as changes in mandates and best practices. Item 9.c. City Council Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy April 9, 2024 Page 2 In 2009, the Governmental Accounting Standard Board (GASB) introduced GASB Statement No. 54 – Fund Balance Reporting and Governmental Fund Type Definitions. The statement’s objective is to enhance the usefulness of fund balance information by providing clearer fund balance classifications that can be applied consistently. The classifications comprise a hierarchy based primarily on the extent to which a government is bound to observe constraints imposed upon the use of the resources reported in its governmental funds. In order to apply GASB 54, staff amended the established policies and combined them into a stand-alone comprehensive policy document for easy access and reference. The City’s Biennial Budget will continue to incorporate this information in the financial policy section and reference the adopting resolution. Additionally, the Fund Balance and Reserve Policy will be posted on the City website. The City’s independent auditor will use the definitions of fund balance when providing the City’s annual audit and annual f inancial statements. On June 27, 2023, the City Council adopted FY 2023-25 Biennial Budget which included an overview of the Consolidated General Fund to provide the City Council and the community the full picture of the City revenues, expenditures, ending fund balance s, and the updated Consolidated General Fund is shown in Table 1: Item 9.c. City Council Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy April 9, 2024 Page 3 Table 1 – FY 2023-25 Consolidated General Fund Budget & Available Fund Balance in Thousands The City’s Annual Comprehensive Financial Report (ACFR ) was presented on January 23, 2024, and a request to review the reserve policy was discussed. The Beginning Fund Balances for the funds have been updated upon completion of the ACFR and are shown in Table 2: General General Fund Fund Beginning Fund Balance $8,993 $3,093 $12,086 $8,462 $2,904 $11,366 Revenues: Revenues 18,544 2,962 21,506 19,000 3,033 22,033 Transfers In 3,114 - 3,114 3,185 - 3,185 Total Revenues 21,658 2,962 24,620 22,185 3,033 25,218 Expenditures: Salaries and Benefits 12,089 - 12,089 12,437 - 12,437 Services and Supplies 9,435 1,042 10,477 9,775 1,087 10,862 Debt Service 310 - 310 294 - 294 Capital Outlay 240 - 240 150 - 150 Transfers Out 115 2,109 2,224 2,475 3,858 6,333 Total Expenditures 22,189 3,151 25,340 25,131 4,945 30,076 Total Operating Incr/(Decr)(531) (189) (720) (2,946) (1,912) (4,858) Available Fund Balance $8,462 $2,904 $11,366 $5,516 $992 $6,508 Reserve %38.1%92.2%44.9%22.0%20.1%21.6% $ Above Reserve Policy 4,025 2,274 6,299 491 3 494 Funds Available to Allocate 3,500 1,695 5,195 400 - 400 FY 2023-24 FY 2024-25 Local Sales Consolidat ed Total Local Sales Consolidat ed Total Item 9.c. City Council Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy April 9, 2024 Page 4 Table 2 – Updated Fund Balances FY 2023-25 Consolidated General Fund Budget & Available Fund Balance in Thousands The estimated Consolidated General Fund available fund balance at the end of FY 2024 - 25 is $13,909,000. ANALYSIS OF ISSUES: Healthy reserves are a mark of fiscal stability and a cornerstone of financial flexibility. The Government Finance Officers Association (GFOA) best practice 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 (16.67%) of regular general fund operating revenues or operating expenditures. The updated Fund Balance and Reserve Policy included in Attachment 1, as Exhibit A, does not change the current Operating Reserve policy that is equal to 15%, with a goal of 20% of the City’s annual operating expenditures. The updated Fund Balance and Reserve Policy establishes a Budget Stabilization Reserve that will maintain a $1,000,000 balance of annual Consolidated General Fund operating expenditures. The Budget Stabilization Reserve is meant to be used to address financial impacts resulting from changes in the economic environment. If revenues are insufficient to meet the normal operating requirements of essential services in times of General General Fund Fund Beginning Fund Balance $11,862 $7,625 $19,487 $11,331 $7,436 $18,767 Revenues: Revenues 18,544 2,962 21,506 19,000 3,033 22,033 Transfers In 3,114 - 3,114 3,185 - 3,185 Total Revenues 21,658 2,962 24,620 22,185 3,033 25,218 Expenditures: Salaries and Benefits 12,089 - 12,089 12,437 - 12,437 Services and Supplies 9,435 1,042 10,477 9,775 1,087 10,862 Debt Service 310 - 310 294 - 294 Capital Outlay 240 - 240 150 - 150 Transfers Out 115 2,109 2,224 2,475 3,858 6,333 Total Expenditures 22,189 3,151 25,340 25,131 4,945 30,076 Total Operating Incr/(Decr)(531) (189) (720) (2,946) (1,912) (4,858) Available Fund Balance $11,331 $7,436 $18,767 $8,385 $5,524 $13,909 Reserve %51.1%236.0%74.1%33.4%111.7%46.3% $ Above Reserve Policy 6,895 6,806 13,701 3,360 4,536 7,896 Funds Available to Allocate 3,300 4,520 7,820 2,800 3,780 6,580 FY 2023-24 FY 2024-25 Local Sales Consolidated Total Local Sales Consolidated Total Item 9.c. City Council Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy April 9, 2024 Page 5 economic downturn, funds contained in the Budget Stabilization Reserve may be used if approved by City Council action. The updated Fund Balance and Reserve Policy also establishes a Pension and Other Post-Employment Benefits Reserve. Funds set aside under this reserve shall be used to further mitigate costs associated with pensions and other post -employment benefits. These funds will be used as a funding source for potential additional discretionary payments to pay down unfunded liability, held in the reserve account, or placed in a City Council approved trust instrument. Funds may be used for such purposes as a supplemental funding source for unanticipated increases to the annual pension and/or other post-employment benefit costs resulting from future actuarial assumptions and investment market volatility, or to make the City’s annual payments during times of economic uncertainty as brought on by such circumstances as a recession resulting in funding gaps. Additionally, the updated Fund Balance and Reserve Policy establishes three replacement/repairs reserves:  Information Technology Reserve – Funds set aside under this reserve shall be used for information system and technology projects including communications systems, hardware, and software, which are capital in nature. Technology can change rapidly within the information systems sphere and often comes at a large cost. This reserve helps the City keep pace with changes in information technology and take advantage of improvement/efficiency opportunities in this area. While this will not eliminate the need to utilize the General Fund to support technology, it will help defray costs associated with unforeseen impacts to the City’s Information Technology system.  Fleet Replacement Reserve – Funds set aside under this reserve shall be used to maintain a Fleet Replacement Reserve in the Consolidated General Fund to provide for the timely replacement of existing vehicles should they come to the end of their useful life or become inoperable. The intent of this fund is to help self- finance the City’s fleet needs into the future.  Facility Repairs Reserve – Funds set aside under this reserve shall be to address any unforeseen maintenance and repairs or planned replacement s within City owned facilities. This fund is not intended to support planned facility maintenance and repairs. Item 9.c. City Council Consider Adoption of a Resolution Updating the Fund Balance and Reserve Policy April 9, 2024 Page 6 There is no set required balances for the Pensions, Information Technology, Fleet Replacement, and Facility Repairs reserves but it is recommended that these reserves be funded at levels adequate to fund the City’s schedules for equipment replacement, facility repairs, and future pension obligations. The City’s future budgets will incorporate a line item to increase these fund balances each year. The updated Fund Balance and Reserve Policy incorporates the Reserves for Enterprise Funds that have been approved and incorporated in the City Rate setting but not adopted with the formal policy. Funds contained in the Reserves for Enterprise Funds are restricted revenues and may only be used for authorized purposes related to the water and wastewater systems. The City will incorporate this update Fund Balance and Reserve Policy in the FY 2024 - 25 Mid-Cycle Budget Update and provided balances with that rep ort. ALTERNATIVES: The following alternatives are provided for the Council’s consideration: 1. Adopt a Resolution updating the Fund Balance and Reserve Policy; 2. Modify as appropriate the Fund Balance and Reserve Policy; or 3. Provide other direction to staff. ADVANTAGES: The last update to the Fund Balance and Reserve Policy was more than thirteen years ago. The proposed changes align the GFOA best practices and continue to improve the City’s ongoing commitment to responsible stewardship and transparency of public funds. DISADVANTAGES: There are no disadvantages in relation to the recommended action. ENVIRONMENTAL REVIEW: Adopting a resolution updating the Fund Balance and Reserve Policy is not subject to the California Environmental Quality Act (“CEQA”) because it has no potential to result in either a direct, or reasonably foreseeable indirect, physical change in the environment. (State CEQA Guidelines, Cal. Code Regs., tit. 14, §§ 15060, subd. (c)(2)- (3), 15378.) PUBLIC NOTIFICATION AND COMMENTS: The Agenda was posted at City Hall and on the City’s website in accordance with Government Code Section 54954.2. ATTACHMENTS: 1. Proposed Resolution ATTACHMENT 1 RESOLUTION NO. A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF ARROYO GRANDE UPDATING THE FUND BALANCE AND RESERVE POLICY WHEREAS, the Governmental Accounting Standards Board (“GASB”) released Statement No. 54 - “Fund Balance Reporting and Governmental Fund Type Definitions” on March 11, 2009. The objective of the Statement is to enhance the usefulness of fund balance information by providing clearer fund balance classifications and by clarifying governmental fund type definitions; and WHEREAS, the City Council has expressed a desire to update the established Fund Balance and Reserve Policy for the General Fund that promotes responsible financial management by adhering to best budget practices and Generally Accepted Accounting Principles (GAAP); and WHEREAS, by maintaining sufficient fund balances and reserves, the City will be well positioned to provide financial security and continued delivery of services, withstand economic downturns and other financial stressors such as a natural disaster or emergency, promote stable tax rates and fees, protect the city’s credit worthiness and bond rating, respond to opportunities, and consider long-term financial needs; and WHEREAS, adopting a resolution updating the Fund Balance and Reserve Policy is not subject to the California Environmental Quality Act (“CEQA”) because it has no potential to result in either a direct, or reasonably foreseeable indirect, physical change in the environment. (State CEQA Guidelines, Cal. Code Regs., tit. 14, §§ 15060, subd. (c)(2)- (3), 15378.); and WHEREAS, the policy will establish a target threshold for the unassigned General Fund balance, provide requirements to replenish the depleted reserves, and guidelines by which surpluses may be spent; and WHEREAS, the City Council desires to update the Fund Balance and Reserve Policy at this time. NOW, THEREFORE, BE IT RESOLVED by the City Council of the City of Arroyo Grande, that: 1. The recitals set forth herein are true, correct and incorporated herein by this reference. 2. The Fund Balance and Reserve Policy attached to this Resolution and marked as Exhibit A, is hereby incorporated herein by this reference. The Fund Balance and Reserve Policy shall become effective concurrently with the adoption of this RESOLUTION NO. PAGE 2 Resolution. 3. The City Council finds that the Fund Balance and Reserve Policy is reasonable and necessary to ensure the City is prepared in times of financial difficulties to continue to provide vital services to its residents. 4. The City Council further finds the types of reserve funds and the amounts to be funded within each fund described in the Fund Balance and Reserve Policy are reasonable and necessary to meet the City’s financial planning needs. 5. The City Council may amend the Fund Balance and Reserve Policy from t ime to time as may be necessary. On motion of Council Member___________, seconded by Council Member ________, and by the following roll call vote, to wit: AYES: NOES: ABSENT: the foregoing Resolution was passed and adopted this 9th day of April, 2024. RESOLUTION NO. PAGE 3 CAREN RAY RUSSOM, MAYOR ATTEST: JESSICA MATSON, CITY CLERK APPROVED AS TO CONTENT: MATTHEW DOWNING, CITY MANAGER APPROVED AS TO FORM: ISAAC ROSEN, CITY ATTORNEY RESOLUTION NO. PAGE 4 EXHIBIT A Fund Balance and Reserve Policy INTRODUCTION The purpose of this document is to state the policy goals of the City of Arroyo Grandes’ General Fund reserves, and the budgeting practices that maintain such reserves. Although there is no formula that defines a completely adequate Fund Balance, a conservative approach should enable the City to finance its operations and meet unplanned expenditures without having to incur short-term debt or raise new revenues. These policies are intended to provide guidelines for budget decisions as to the appropriate use of General Fund resources and the maintenance of adequate reserves for contingencies, emergencies, capital improvements, and other such uses as determined by the City Council. After amounts projected to be available from the year-end fund balance of the General Fund are allocated to Assigned categories, the remaining amount, referred to as the Unassigned Fund Balance, will be reserved for contingencies as further set forth below. PURPOSE The purpose of the Fund Balance and Reserve Policy is to ensure strong fiscal management to guide the City of Arroyo Grande’s financial planning, while continuing to provide services to the residents of the City. Additionally, the policy will: aide in reducing financial impacts of temporary revenue short falls and unpredicted one-time expenditures, such as disasters or catastrophic events; assist the City in responding to challenges of a changing economic environment; and preserve adequate reserve levels to improve or maintain the City’s credit worthiness. The Fund Balance and Reserve Policy establishes the appropriate level of reserves in the Consolidated General Fund. The policy sets conditions warranting the use of reserves and outlines the plan to replenish them if the balances fall below the levels established in this policy. BACKGROUND Governmental Accounting Standards Board (GASB) Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions, was implemented in FY 2010-11 with the intent of improving financial reporting by providing fund balance categories that will be more easily understood. The categories are more clearly defined to make the nature and extent of the constraints placed on a government’s fund balance more transparent. This Fund Balance and Reserve Policy establishes the procedures for reporting unrestricted fund balance in the financial statements. The policy also authorizes and directs the Administrative Services Director to prepare financial reports which accurately categorize fund balance as per GASB Statement No. 54. RESOLUTION NO. PAGE 5 Fund Balance and Reserve Policy POLICY Fund balance is essentially the difference between the assets and liabilities reported in a governmental fund. There are 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.  Non-spendable fund balance: Amounts that cannot be spent because they are either (a) not in spendable form or (b) legally or contractually required to be maintained intact.  Restricted fund balance: To be used for specific purposes stipulated by external resource providers, constitution, or through enabling legislation.  Committed fund balance: To be used for specific purposes as established by City Council.  Assigned fund balance: Amounts intended for a specific purpose as authorized by the City Manager, but are neither restricted nor committed.  Unassigned fund balance: The residual amount not contained in the other classifications. The first two components listed above, non-spendable and restricted fund balances, are not addressed in this policy due to the nature of the restrictions. Examples of non-spendable fund balance include prepaid expenses, loan receivables, and inventory. Restricted fund balance is either imposed by laws or constrained by grantors, contributors, or laws or regulations of other governments. This policy is focused on financial reporting of unrestricted fund balance, which is the last three components listed above. These three components are further defined below. These funds may be pooled for investment earning purposes only and interest earned shall be credited to each individual fund based upon the proportionate share of the revenues invested. 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. Six types of committed reserves are set aside by the City including Operating Reserve, Budget Stabilization Reserve, Pension and Other Post-Employment Benefits Reserve, Information Technology Reserve, Fleet Replacement Reserve, and Facility Repairs Reserve. The intended use of each reserve and the Fund(s) in which they are held is outlined below. To develop the appropriate amount of reserves, the City considered guidance from the Government Finance Officers Association (GFOA), as well as the current economic conditions and needs of the City. Reserve balances will be reviewed at mid- year and at the end of each fiscal year to ensure compliance with this Policy. RESOLUTION NO. PAGE 6 Fund Balance and Reserve Policy  Operating Reserve – The GFOA recommends that general-purpose governments maintain reserves in the general fund of no less than two months (16.67%) of annual general fund operating revenues or annual general fund operating expenditures. The City has established an Operating Reserve in the Consolidated General Fund to mitigate financial and service delivery risk due to unexpected revenue shortfalls or unanticipated critical expenditures. The purpose of this reserve is to provide budgetary stabilization and not to serve as an alternative funding source for new programs and ongoing operating expenditures. It is for one-time needs and expenditures identified in the budget and not ongoing structural challenges. The City will aim to maintain a minimum balance in the Operating Reserves equal to approximately 15%, with a goal of 20% of the City’s annual operating expenditures.  Budget Stabilization Reserve – The Budget Stabilization Reserve shall be maintained in the Consolidated General Fund to address financial impacts resulting from changes in the economic environment. If revenues are insufficient to meet the normal operating requirements of essential services in times of economic downturn, funds contained in the Budget Stabilization Reserve may be used if approved by City Council action. This reserve will maintain a $1,000,000 balance, or approximately 3.0% of annual Consolidated General Fund operating expenditures.  Pension and Other Post-Employment Benefits Reserve – Funds set aside under this reserve in the Consolidated General Fund to be used to further mitigate costs associated with pensions and other post-employment benefits. These funds will be used: as a funding source for potential additional discretionary payments to pay down unfunded liability; or held in the reserve account; or placed in a City Council approved trust instrument. Funds may be used for such purposes as a supplemental funding source for unanticipated increases to the annual pension and/or other post-employment benefit costs resulting from future actuarial assumptions and investment market volatility, or to make the City’s annual payments during times of economic uncertainty as brought on by such circumstances as a recession resulting in funding gaps.  Information Technology Reserve – This fund, established in the Consolidated General Fund, provides for information system and technology projects including communications systems, hardware, and software, which are capital in nature. Technology can change rapidly within the information systems sphere and often comes at a large cost. This reserve helps the City keep pace with changes in information technology and take advantage of improvement/efficiency opportunities in this area. RESOLUTION NO. PAGE 7 Fund Balance and Reserve Policy  Fleet Replacement Reserve – The City will maintain a Fleet Replacement Reserve in the Consolidated General Fund to provide for the timely replacement of existing vehicles should they come to the end of their useful life or become inoperable. The annual contribution to this reserve will generally be based on the annual use allowance, which is determined based on the estimated life of the vehicle, or equipment, and its original purchase cost.  Facility Repairs Reserve – This reserve is set up in the Consolidated General Fund to address any unforeseen maintenance and repairs or planned replacements within City owned facilities. There is no set required balances for the last four reserves but it is recommended that these reserves be funded at levels adequate to fund the City’s schedules for equipment replacement, facility repairs, and future pension obligations.  Reserves for Enterprise Funds – Water and Wastewater (Sewer): Revenues contained in these funds are restricted and may only be used for their described purposes below. In no event will these funds be used to fund general fund services. o Operating Reserve – The purpose of the Enterprise Fund Operating Reserve is to provide working capital to meet cash flow needs during normal operations and support the operation, maintenance and administration of the utility. This reserve ensures that operations can continue should there be significant events that impact cash flows. The target balance to be maintained is 90 days (25 percent) of the current annual operating expense budget. o Capital Reserve – The purpose of the Enterprise Fund Capital Reserve is to fund future replacement of assets and CIP projects. The Capital reserves are used to fund the construction of the projects as the projects progress and the funds are expended. The reserve target has been established at $500,000 each for the water and wastewater systems through prior cost of service studies. o Lopez Fund Reserve – The Enterprise Fund Lopez Fund accounts for the revenue and expenditures of the surface water purchases from the County. Revenues are collected through the water rates in sufficient amounts to provide for a transfer of revenue to meet the expenses in the Lopez Fund. A reserve is maintained in the fund at least equal to annual Lopez debt service. RESOLUTION NO. PAGE 8 Fund Balance and Reserve Policy 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. This policy herby delegates the authority to assign amounts to be used for specific purposes to the City Manager or designee for the purpose of reporting these amounts in the annual financial statements. Examples of assigned fund balance include:  Encumbered Fund balance levels must be sufficient to meet funding requirements for materials or services ordered, but not received, before the end of the fiscal year.  Continuing Appropriations Fund balance levels must be sufficient to meet funding requirements for projects approved in prior years and which must be carried forward into the new fiscal year.  Other Designations Assigned fund balance can also include amounts designated for certain programs, additional reduction of debt, special events, or other non-recurring expenditure needs of the City. Unassigned Fund Balance Unassigned fund balance is the residual positive net resources in excess of what can properly be classified in one of the other four categories. The Consolidated General Fund is the only fund that may report a positive (surplus) unassigned balance. Conversely, any governmental fund in a negative (deficit) position could report a negative amount of unassigned fund balance. Fund Balance Classification The accounting policies of the City consider restricted fund balance to have been spent first when the expenditure is incurred for purposes for which both restricted and unrestricted fund balance is available. Similarly, when the expenditure is incurred for purposes for which amounts in any of the unrestricted classifications of fund balance could be used, the City considers committed amounts to be reduced first, followed by assigned amounts and the unassigned amounts. Surplus Since a surplus of unassigned fund balance does not represent a recurring source of revenue, it shall not be used to fund a recurring expense; however, the surplus may be appropriated for use to fund a one- time expenditure or use not already funded through an appropriation. If it is determined there is an operating surplus, the City Council may appropriate funds for the following nonrecurring purposes, listed in order of priority: RESOLUTION NO. PAGE 9 Fund Balance and Reserve Policy  Surplus funds may be used to meet the minimum Operating Reserve requirement;  Any surplus may be transferred to reduce the unfunded pension liability and/or any other unfunded postemployment benefit liabilities;  If there is short-term debt within the General Fund, the surplus may be applied to reduce, or eliminate, the debt if determined to be advantageous for the City. If a borrowing is scheduled, the surplus may be used to reduce the principal amount the City needs to obtain if determined to be advantageous for the City; and  Surplus funds may be used for capital improvements and equipment purchases that are not financed with borrowings or other contributions. Replenishment of Reserves If any balance established in this policy falls below the minimum required level, the City shall strive to restore it to the minimum required balance by any feasible means, including, but not limited to, adopting a budgetary surplus; applying any cost savings, over-realized revenues, and/or surpluses realized within the applicable fund; or transferring a portion of the Consolidated General Fund Budget Stabilization Reserve. These guidelines may be suspended, in whole or part, if financial or economic circumstances prevent meeting any or all of the timelines. These policy guidelines may also be amended by action of the City Council from time to time. This policy is instituted 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.