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CC 2024-06-11_09d Reso Updating Fund Balance and Reserve Policy MEMORANDUM TO: City Council FROM: Matthew Downing, City Manager BY: Nicole Valentine, Administrative Services Director SUBJECT: Adoption of a Resolution Updating the Fund Balance and Reserve Policy DATE: June 11, 2024 RECOMMENDATION: 1) Adopt a Resolution Updating the Fund Balance and Reserve Policy; and 2) Determine that adopting a resolution updating the Fund Balance and Reserve Policy is not subject to the 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.) 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 fund balance are being discussed. BACKGROUND: The City Council first adopted the Fiscal Policy on September 5, 1995, and has revised the policy several times, most recently on June 28, 2011. Many of these updates were included with a review of the budget adoption. The current Fiscal Policy states the City will: 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. Item 9.d. City Council Adoption of a Resolution Updating the Fund Balance and Reserve Policy June 11, 2024 Page 2 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. In 2009, the Governmental Accounting Standard Board (GASB) introduced GASB Statement No. 54 Fund Balance Reporting and Governmental Fund Type Definitions. 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 section and reference the adopting resolution. Additionally, the Fund Balance and Reserve Policy al statements. On June 27, 2023, the City Council adopted the 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 City revenues, expenditures, ending fund balances, and the updated Consolidated General Fund as shown in Table 1. Item 9.d. City Council Adoption of a Resolution Updating the Fund Balance and Reserve Policy June 11, 2024 Page 3 Table 1: FY 2023-25 Consolidated General Fund Budget & Available Fund Balance in Thousands 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. Item 9.d. City Council Adoption of a Resolution Updating the Fund Balance and Reserve Policy June 11, 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. Staff brought forward a Fund Balance and Reserve Policy during the April 9, 2024,City Council meetingto update the existing policy and consider updating the policy to incorporate a Budget Stabilization Reserve, as well as, three replacement/repairs reserves. This item was continued andstaff incorporated this discussion in the preliminary budget item presented to the City Council onMay 28, 2024. The City Council reviewed thepreliminary budgetandprovided direction to appropriate $560,000 of Excess Available Consolidated General Fund Balance tothe three replacement/repairs reserves: Information Technology Reserve Fleet Replacement Reserve Facility Repairs Reserve The Fund Balance and Reserve Policyhas been updated to incorporate this direction. ANALYSIS OF ISSUES: Healthy reserves are a mark of fiscal stability and a cornerstone of financial flexibility. The Government Finance Officers Associationbest practice recommends, at a minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary fund Item 9.d. City Council Adoption of a Resolution Updating the Fund Balance and Reserve Policy June 11, 2024 Page 5 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 as Exhibit A to Attachment 1 does not change the current Operating Reserve policy that is equal to 15%, with a goal The updated Fund Balance and Reserve Policy also maintains 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 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 u 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- Facility Repairs Reserve Funds set aside under this reserve shall be to address any unforeseen maintenance and repairs or planned replacements within City Item 9.d. City Council Adoption of a Resolution Updating the Fund Balance and Reserve Policy June 11, 2024 Page 6 owned facilities. This fund is not intended to support planned facility maintenance and repairs. The three replacement/repairs reserves would have a maximum fund balance of 1% each, bringing the full Reserve Policy to a total of 23% expenditures. Any Excess Available General Fund Balance above 23% would be brought back to the City Council each year for consideration and options of how to appropriate funds. ALTERNATIVES: 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 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 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 Government Code Section 54954.2. ATTACHMENTS: 1. Proposed Resolution Item 9.d. ATTACHMENT 1 RESOLUTION NO. A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF ARROYO GRANDE UPDATING THE FUND BALANCE AND RESERVE POLICY WHEREAS, Statement No. 54 - 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 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 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 5. The City Council may amend the Fund Balance and Reserve Policy from time to time as may be necessary. 6. This Resolution shall become effective immediately upon its adoption. On motion of Council Member___________, seconded by Council Member ________, and by the following roll call vote, to wit: AYES: NOES: ABSENT: th the foregoing Resolution was passed and adopted this 11 day of June, 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 Gvoe!Cbmbodf!boe!Sftfswf!Qpmjdz! JOUSPEVDUJPO! 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. QVSQPTF! The purpose of the Fund Balance and Reserve Policy is to ensure strong fiscal management to guide 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 und 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. CBDLHSPVOE! 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 und 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 Gvoe!Cbmbodf!boe!Sftfswf!Qpmjdz! QPMJDZ! 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 -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. Five types of committed reserves are set aside by the City including Operating 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 the end of each fiscal year to ensure compliance with this Policy. RESOLUTION NO. PAGE 6 Gvoe!Cbmbodf!boe!Sftfswf!Qpmjdz! 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 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 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. This reserve will not exceed 1.0% of annual Consolidated General Fund operating expenditures. 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. This reserve will not exceed 1.0% of annual Consolidated General Fund operating expenditures. 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. This reserve will not exceed 1.0% of annual Consolidated General Fund operating expenditures. RESOLUTION NO. PAGE 7 Gvoe!Cbmbodf!boe!Sftfswf!Qpmjdz! Assigned Fund Balance Amounts that are const 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 8 Gvoe!Cbmbodf!boe!Sftfswf!Qpmjdz! 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 the Operating Reserve 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. If the Information Technology Reserve, Fleet Replacement Reserve, or Facility Repairs Reserve fall below the 1.0% of annual Consolidated General Fund operating expenditures, the levels will be replenished when surplus funds become available. 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. Enterprise Fund Reserves 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. 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 RESOLUTION NO. PAGE 9 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. 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. 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.