Exhibit A. FUND BALANCE POLICY General Fund & Other Governmental Funds

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1 FUND BALANCE POLICY General Fund & Other Governmental Funds POLICY PURPOSE This Fund Balance Policy establishes the procedures for reporting unrestricted fund balance in the General Fund 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. Unless otherwise stated, no other policy or procedure supersedes the authority and provisions of this policy regarding fund balance of the General Fund. PROCEDURES 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. The 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 subject to this policy due to the nature of their restrictions; however, they are described for informational purposes. Attachment 1 identifies the components of fund balance as reported on the City s annual financial statements. Non-Spendable Fund Balance As the title implies, this classification includes amounts that cannot be spent because they are not in a spendable form. An example of non-spendable fund balance is inventory or prepaid amounts. In addition to items that are in a non-spendable form, this category includes those items that are legally or contractually required to be maintained intact, such as the capital portion of a revolving loan fund. Another example of items in this category is the long term portion of loans or notes receivable. Restricted Fund Balance The restricted fund balance classification includes amounts that reflect constraints placed on the use of resources (other than non-spendable items) through legal restrictions. The constraints are either: Externally enforceable restrictions imposed by grantors, contributors, or other governmental entities (through laws and regulations) Fund Balance Policy General Fund Page 1 of 17

2 Imposed by law through the governments own constitutional or charter provisions or enabling legislation. Stabilization arrangements, such as the City s Economic Uncertainty Fund, are sometimes reported in the restricted fund balance category, depending on how the arrangement was initially approved (legislation or simply a policy). The Economic Uncertainty Fund is not specifically identified in the Lompoc Municipal Code Section 3.20 regarding Funds and would, therefore, not be considered as a restricted fund balance. Under Statement 54, the Economic Uncertainty Fund will be considered a part of the General Fund and would be accounted for in one of the following categories of fund balance, as defined by this policy. Statement 54 provides guidance for revenue stabilization funds, prudent reserves, working capital requirements, emergency reserves, contingencies, encumbrances or similarly titled rainy day amounts and the City s Economic Uncertainty Fund falls into this category. Part of the guidance includes the level of approval necessary to place these funds in restricted, committed or assigned fund balance categories. This policy is focused on financial reporting of unrestricted fund balance while an attachment outlines the proposed new stabilization arrangement that will replace the City s Economic Uncertainty Fund and unrestricted General Fund reserve classifications. Unrestricted fund balance categories, under Statement 54 include: Committed fund balance (self-imposed limitations on use) Assigned fund balance (limitation resulting from intended use) Unassigned fund balance (residual net resources) 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. To be categorized as a committed fund balance, the constraint must be imposed by formal action of the City Council, 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 (ordinance or resolution). City Council action to commit fund balance is required to occur before the end of the fiscal reporting period; however, the specific amount can be determined subsequently. Contractual obligations should also be incorporated into the reported committed fund balance category to the extent that existing resources in the fund have been specifically committed for use in satisfying those contractual obligations. An example of such an obligation is the portion of a maintenance contract approved as part of the current budget that applies to a period of time beyond the end of the current budget cycle for instance, December 31 of the following budget cycle. Fund Balance Policy General Fund Page 2 of 17

3 Assigned Fund Balance The assigned fund balance classification includes amounts that are constrained by the City's intent to use the amounts for specific purposes, but are neither restricted nor committed. This policy hereby delegates the authority to assign amounts to be used for specific purposes to the City Administrator or their designee. The policy further designates the Finance Director to allocate assigned fund balances for the purpose of reporting these amounts in the annual financial statements. A few examples of categories of assigned fund balance include: Continuing Appropriations Fund balance levels must be sufficient to meet funding requirements for projects approved in prior years but are incomplete at the end of the fiscal year and which must be carried forward into the new fiscal year for completion. Debt Service Established to provide for future debt service obligations. Budget Balancing Measures Funds set aside for the purpose of stabilizing the delivery of City services during periods of operational budget deficits and to mitigate the effects of major economic uncertainties resulting from unforeseen changes in revenues and/or expenditures. The City Council has previously identified fund balance reserves to be preserved for this purpose. The Economic Uncertainty Fund is one component of this while the General Fund s unrestricted fund balance has been another component. The implementation of this Fund Balance policy could identify a portion of these previously characterized General Fund reserves in both the committed fund balance section and in this assigned fund balance section for flexibility. Previous to the implementation of this Fund Balance Policy, designations of reserves have not been implemented by resolution or ordinance (except for the Reserve Policy for the Electric Fund which, as an enterprise fund, is not affected by this Fund Balance Policy). As such, for the initial reporting period (the Fiscal Year ending June 30, 2011), no amounts are reported as committed fund balances for a stabilization component but amounts can be reported in the assigned fund balance section for stabilization or budget balancing measures. For governmental funds other than the General Fund (and funds consolidated with the General Fund for financial statement reporting purposes), amounts in excess of nonspendable, restricted, and committed fund balances are automatically reported as assigned fund balance. The City provides for the creation of funds per the Lompoc Fund Balance Policy General Fund Page 3 of 17

4 Municipal Code Section If it is determined that a governmental fund has residual unassigned fund balances at the end of any given fiscal year, per Statement 54, that fund would be consolidated with the General Fund for financial statement reporting purposes. This does not imply that the purpose of the governmental fund is not required for budgeting, reporting, or other reasons. Statement 54 does not dictate the number or make up of a governmental entity s accounting structure. What Statement 54 does do is to provide for a more consistent basis for reporting of resources across all governmental entities. The fund structure in existence today that provides for the day to day framework for operations does not need to be modified due to the implementation of Statement 54. Unassigned Fund Balance These are residual positive net resources of the General Fund in excess of what can properly be classified in one of the other four categories of fund balances. Other governmental funds should have a restriction of the use of the amounts in the funds; otherwise the fund would be general in nature and would be consolidated with the General Fund for financial statement reporting purposes. As such, other governmental funds should reflect all fund balances in one or more of the four classifications there should not be any unassigned fund balances in governmental funds except for the General Fund (or funds that are consolidated with the General Fund for financial statement reporting purposes). HIERARCHY OF FUND BALANCE CLASSIFICATIONS As funds are expended by the City, in order to track the individual components of fund balance, there needs to be an order of precedence established to accurately report ending fund balance components. To accomplish this, when an expenditure is incurred that could draw upon either a restricted or unrestricted fund balance, the accounting policies of the City is to consider restricted fund balance to have been spent first and then the unrestricted amount once the restricted amount is extinguished. Similarly, when an 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 then unassigned amounts. This policy is in place to provide a measure of protection for the City against unforeseen circumstances and to comply with Statement 54. As stated in the Policy Purpose section, no other policy or procedure supersedes the authority and provisions of this policy. Fund Balance Policy General Fund Page 4 of 17

5 Attachment 1 Components of Fund Balance for the City of Lompoc as defined by GASB Statement 54 Non-Spendable Fund Balance Petty Cash: The portion of fund balance that represents the asset amount of petty cash, held by a given fund. Inventories: The portion of fund balance that represents the asset amount of supply inventories, held by a given fund. Prepaid Expenditures: The portion of fund balance that represents the asset amount of prepaid expenditures, held by a given fund. Notes Receivable: The portion of fund balance that represents the asset amount of notes receivable, held by a given fund. Advances to Other Funds: The portion of fund balance that represents the asset amount of cash advanced to other funds, held by a given fund. Loans Receivable: The portion of fund balance that represents the asset amount of loans receivable, held by a given fund. Redevelopment Loans Receivable: The portion of fund balance that represents the asset amount of loans receivable made to the Lompoc Redevelopment Agency, held by a given fund. Restricted Fund Balance Traffic Signal Mitigation: The portion of fund balance derived from fees collected to be used for future traffic signal mitigation. Traffic Mitigation: The portion of fund balance derived from fees collected to be used for future traffic mitigation. Fire Equipment: The portion of fund balance derived from fees collected to be used for future purchase of fire equipment and apparatus. Park Land & Improvements: The portion of fund balance derived from fees collected to be used for funding park acquisition and park improvements including planning, design and construction of projects. Recreation Facilities: The portion of fund balance derived from fees collected to be used for funding recreation facility improvements including planning, design and construction of projects. Fund Balance Policy General Fund Page 5 of 17

6 Public Facilities: The portion of fund balance derived from fees collected to be used for funding future public facilities including planning, design and construction of projects, not otherwise defined as specific public facilities. Traffic Signal Impact: The portion of fund balance derived from fees collected to be used for future traffic signals including planning, design and construction of projects. Traffic Impact: The portion of fund balance derived from fees collected to be used for future street improvements including planning, design and construction of projects. Housing In-Lieu: The portion of fund balance derived from fees collected to be used for future development and provision of low and moderate income housing. Cable Franchise PEG: The portion of fund balance derived from fees collected from cable television operators and restricted for the purpose of providing Public, Educational, and Governmental cable program access. Debt Redemption: The portion of fund balance within a given fund that has been set aside for debt redemption. Bond Reserve Requirement: The portion of fund balance within a given fund that has been set aside from debt proceeds and is maintained as security for holders of the debt. Financing Proceeds: The portion of fund balance that is derived from lease, bond or other financing proceeds for specified incomplete capital projects and remains unspent. Fund Balance Restricted: The portion of fund balance that is in any non-general Fund governmental fund that is restricted under the Restricted Fund Balance definition as prescribed by GASB Statement 54 and not otherwise defined in this category above. Committed Fund Balance Capital Projects: The portion of fund balance that has been appropriated for specified incomplete capital projects and remains unspent. Measure A: That portion of fund balance that is derived from Measure A sales tax revenues and used to fund specified street improvement, operating and maintenance costs. Measure D: That portion of fund balance that is derived from Measure D sales tax revenues and used to fund specified street improvement, operating and maintenance costs. Beautification Contributions: That portion of fund balance that is derived from community donations for the improvement of parks and open space. Fund Balance Committed: The portion of fund balance that is in any non-general Fund Balance Policy General Fund Page 6 of 17

7 Fund governmental fund that is committed under the Committed Fund Balance definition as prescribed by GASB Statement 54 and not otherwise defined in this category above. Assigned Fund Balance GASB 31 Adjustment: Used to account for that portion of fund balance that is the result of unrealized investment gains that have been recorded in accordance with GASB Statement No. 31. Encumbrances: Used to account for that portion of fund balance that is being used to fund appropriations being carried over from the prior fiscal year into the current fiscal year. Accrued Benefits: Used to account for that portion of fund balance that is the result of accrued benefit costs that have been recorded for previously earned salary and benefits. Human Service Contributions Reserve: Used to account for that portion of fund balance that is the set aside for distribution to not-for-profit agencies on a competitive basis to promote human welfare and to provide for necessary support services for disadvantaged groups in the community. Parking Reserve: The portion of fund balance that represents the amount set aside for acquisition, preservation, development, improvement or maintenance of property for use or addition of parking lots. Economic Uncertainty: The portion of fund balance that has been assigned as the City s emergency or rainy day fund. Fund Balance Assigned: The portion of fund balance that is in any non-general Fund governmental fund that is assigned under the Assigned Fund Balance definition as prescribed by GASB Statement 54 and not otherwise defined in this category above. Unassigned Fund Balance (General Fund Only) Prior Year Available Fund Balance: The portion of fund balance that is brought forward from the prior fiscal year and is available for appropriation to fund current fiscal year activities. Emergency Shortfall Reserve: The portion of fund balance that has been set aside as the City s emergency or rainy day fund. Fund Balance Unassigned: Any portion of the General Fund fund balance that does not fall under any of the fund balance definitions presented above. Fund Balance Policy General Fund Page 7 of 17

8 Attachment 2 Stabilization Reserve of Committed and Assigned Fund Balance for the City of Lompoc in accordance with guidelines from GASB Statement 54 PURPOSE The City has diverse and extensive operations. To account for these operations, the City has set up various funds to segregate financial, if not operational, results. In many cases, this segregation is statutory or legal in nature. In some cases, the statutory requirements are from governmental entities larger than the City (County, State or Federal) while other statutory requirements come from the enabling legislation of the City itself. The General Fund represents the revenues and expenditures of all the City activities that are NOT segregated for legal, statutory or other reasons. However, the General Fund receives substantial unrestricted revenues and is the primary source of fund to pay for public safety services of the City. As such, the City Council has considerable discretion over the use of funds received in the General Fund. Proposition 218 was passed by the voters and provides guidelines regarding the implementation of any new taxes. Simply put, the City cannot implement any new or expanded tax unless it is approved by a majority of the voters. Because of this, it is reasonable that the City cautiously guard the General Fund and monitor activity in it such that expenses do not exceed revenues in an uncontrolled manner. Statement 54 identifies the categories assigned to fund balance amounts (nonspendable, restricted, committed, assigned and unassigned) for financial statement purposes. However, it also states that the policy should address the following important criteria for fund balance (excerpts from What Everyone Needs to Know about the New Fund Balance by Stephen J. Gauthier as published by the Government Finance Officers Association (GFOA) in conformance with Statement 54): The appropriate level of unrestricted fund balance to be maintained in the General Fund The desired level of unrestricted fund balance can be expressed either as a minimum amount or as a range between a minimum and maximum amount. The range approach might help allay concerns from taxpayer groups and others about excessive unrestricted fund balances. The circumstances in which unrestricted fund balance can be spent down A sound fund balance policy should describe the specific circumstances in which the resources accumulated for contingencies may be spent. Circumstances that are vague (e.g., emergencies) or routine (e.g., unanticipated budgetary shortfalls) normally are impractical, although specifying the degree of magnitude may remedy the problem (e.g., an unanticipated budgetary shortfall in excess of ). Fund Balance Policy General Fund Page 8 of 17

9 The policy for replenishing deficiencies If spending in designated circumstances has reduced unrestricted fund balance to a point below the targeted minimum level, it must be replenished. A sound fund balance policy will describe both how such replenishment is to be funded (i.e., source of funding), and the period over which replenishment is to occur. The GFOA publication gives additional guidance regarding the minimum amount to be maintained in the General Fund. For some governments operating revenues are more predictable than operating expenditures (e.g., local governments that rely primarily on a property tax). For others, expenditures may be less volatile than revenues (e.g., a government that relies primarily on a sales tax). As a rule, governments express their desired level of unrestricted fund balance as a function of the more predictable amount (i.e., revenues v. expenditures). For the City of Lompoc, the more predictable amount (or more practically, the more controllable amount) would be our expenditures. As a general rule, unrestricted fund balance in the general fund should represent no less than two months of operating revenues or operating expenditures (whichever is less volatile). A minimum of as little as 5 percent, however, may be appropriate for larger governments for two reasons. First, larger governments normally find it easier to predict contingencies than do smaller ones (for the same reason that an insurance company can more readily predict the number of car accidents for a pool of 500,000 drivers than for a pool of fifty). Second, operating revenues and operating expenditures of larger governments often are more diversified and less volatile than those of their smaller counterparts. While the City of Lompoc is more diversified than most cities (in California) in our population range, which would point to the need for a lower level of unrestricted fund balance, the City cannot be confused with a larger government (e.g., Los Angeles, San Francisco, Sacramento, Fresno, etc). As a benchmark, using the budgeted expenditures, the amount of the General Fund s unrestricted fund balance simply would be $4,189,724 (2/12 th of our expenditure budget) at June 30, Statement 54 provides for accumulation of resources pursuant to Stabilization Arrangements (rainy day funds, contingency funds, economic uncertainty funds, etc, which can be reported as restricted but usually as unrestricted (committed or assigned) fund balances) that would supplement the unrestricted fund balances of the General Fund in determining the appropriate level of unrestricted fund balance needed by the City. Fund Balance Policy General Fund Page 9 of 17

10 PROCEDURES What is the correct level of unrestricted fund balance (including a Stabilization component)? There is no easy answer to this question. What is correct for one city may not be for another. The amount may even change over time for an individual city as it grows or shrinks, as revenue resource mixes change or for other changes in long-term circumstances. Although finance professionals may disagree on the levels needed, the determinants for each government are very similar. The degree of risk associated with revenues streams and sources is a common factor. The likelihood of major contingencies and the amount of funds required to respond to them is another common factor. Some questions to consider in formulating a reasonable level of unrestricted fund balance (reserves) are: How stable is the tax base and all revenues of the General Fund in the face of adverse economic conditions? How broad is the City s General Fund revenue base? To what extent is any City revenue source at risk to State or Federal political action? What are the cash flow needs of the City and, specifically, the City s General Fund? Does the City have any unfunded liabilities? The above can be used in determining a correct unrestricted fund balance amount and stabilization reserve. In the past, the City has had a $2,000,000 Economic Uncertainty Fund. The expectation with Statement 54 is that a Stabilization Reserve be based on specific factors. The $2,000,000 amount, while advantageous to have, is not based on any specific factors. The answers to the above five questions will help identify a prudent level of reserves based on the methodology presented. How stable is the tax base and all revenues of the General Fund in the face of adverse economic conditions? One measure to be used for evaluating a proper level of stabilization reserves is the stability of the tax base. In reviewing the prior seven years and comparing them to the fiscal year, there have been fluctuations in various tax revenues over the years. Sales tax has, for instance, dropped from a high of 17% of operating expenditures in , and to 13% in However, as a whole, the tax base was 46% of operating expenditures in and again in For the last seven years, the percentage hit a high of 49% in , the height of the property tax bubble and reached a low of 42% in the last year of the City s budget when both sales tax and property tax dropped from budget estimates and prior year actual results before adjustments could be made to expenditures to reflect the changes. The fact that the average (in percentage terms) of the past seven years is the same as results from speaks to the stability of the tax base overall even though there have been changes in the components of the tax base (property tax, sales tax and TOT are considered the tax base). This stability would indicate a smaller than average reserve would need to be retained for the stabilization Fund Balance Policy General Fund Page 10 of 17

11 reserve. It also suggests that, for budgetary purposes, any expected revenue growth above 45% of operating expenditures might best be evaluated carefully. One suggested resolution for revenue growth, in these tax revenue categories, above 45% would be to place such revenue in reserve so that it is available for the inevitable times when the revenue growth dips below 45% - to treat such revenue similarly to one-time revenues and refrain from dedicating that revenue stream to ongoing operating expenditures. The City experienced unprecedented declines in the property tax base between and Secured property taxes (our largest source) dropped 6% in from However, our supplemental property taxes (those from changes in assessments during the year from sales or improvements) dropped from a high of $393,000 in to $68,500 in , a drop of $324,000. Further analysis of this revenue source identifies a significant bubble from 2001 to 2009 with the average revenue over $210,000 in this period compared to an average of $53,000 for the fifteen (15) years previous to Property tax revenues will likely be relatively stable over the next few years as the housing market stabilizes. However, the supplemental property taxes may not be as stable as foreclosures and unsold housing stock get resolved. Because of this, it is prudent to reserve future revenues that exceed the following guidelines: Secured Property Taxes budget no more than twice the Proposition 13 annual inflation limit of 2% (or 4%). If actual or projected increases in secured property taxes exceed 4%, the difference between the budget and actual revenues would be set aside in the stabilization reserve. Supplementary Property Taxes budget no more than 1.5 times the average of $53,000. If actual supplementary secured property taxes exceed 3 times the average, the difference is to be set aside in the stabilization reserve. In the year, the Proposition 13 annual inflation factor was a negative 0.237%. Since the implementation of Proposition 13 in 1978, the inflation factor for secured property taxes has never been negative. In the future, a negative growth in this factor would likely indicate a significant trend such as we had leading up to the negative assessment. This leads into the next section of how to access reserves. An effective Stabilization Arrangement (reserve) also identifies the circumstances in which it is allowable to utilize reserves. In this instance, it is reasonable to utilize previously set aside property tax based reserves in the following cases: Projected secured property taxes growth for a budget period is more than negative 2% than the previous projected secured property taxes (the percentage change used would be provided by the Santa Barbara County Assessor s office). If the projected drop in secured property taxes would zero out the accumulated reserve in this category, only 50% of the reserve, or $500,000, whichever is less, can be used to supplement secured property tax revenues, otherwise, the reserve Fund Balance Policy General Fund Page 11 of 17

12 could be utilized to bring secured property tax revenues up to the previous year s level. The $500,000 shall be indexed to the annual December to December LA/Riverside/Orange County All Urban Consumers CPI (Not seasonally adjusted but including all items) available in the year prior to the budget cycle. The first adjustment would be made based on the December 2012 CPI for the budget). As supplemental property taxes are extremely hard to budget with any accuracy, it is recommended that any adjustments to the reserve would be after the fact based on actual results from year to year. If supplemental property tax revenues falls below the average of $53,000, property tax reserves would be utilized to supplement the revenue amount for that year so that overall supplemental property tax revenue would be $53,000 for that year. As with the Secured Property Tax utilization, the $53,000 would be indexed using the same methodology as for secured property taxes above. There needs to be a beginning amount for each of these measures. Had this policy been in place in 2000, the following amounts would have been added to reserves or taken from reserves: Added Taken Balance Secured Property Taxes $655,675 $61,998 $593,677 Supplemental Taxes $544, $544,994 Recommended beginning reserve for property taxes: $1,138,671 Another revenue stream that is extremely volatile, yet relatively small in comparison to overall general fund revenues, is generated from construction activity. The City has modified the Building Inspection Division to reflect the current economics of construction activities. However, over the past decade, there have been years that the division added to overall reserves of the General Fund by taking in more permit fees than it cost to provide the services of the division. As with the supplemental property taxes, it would be appropriate to set aside funds over the cost of providing the services when available and utilize these reserves when costs exceed revenues. Since the City now has a contract for services, the difference (either positive or negative) can be easily determined. Using the pre-contract experience for the division, had this policy been in place in 2000, the following amounts would have been added to reserves or taken from reserves: Added Taken Balance Building Inspection Fees $973,465 $1,359,693 ($386,228) As with community services with no fee component such as police and fire protection (public safety), a certain aspect of building inspection services also include a no fee component. It has only been in the active years between 2001 and 2005 that revenues exceeded expenditures for building inspection activities. As we have come to understand, this timeframe was a financial bubble for real estate and will likely not be Fund Balance Policy General Fund Page 12 of 17

13 repeated in the near future. Considering the direction taken with building inspection in contracting out services and moving the administration of the activity to a new department, it would be prudent to place any future revenues in excess of division expenses into a reserve to facilitate any changes that may occur in the future in relation to the method the City provides building inspection services. This analysis will be based on actual financial information upon the conclusion of the fiscal year rather than budgeted information. The goal would be to accumulate one year s minimum contract costs in a reserve, or approximately $126,000 (modified annually by the contact terms based on the CPI). This reserve will likely be unfunded for a number of years due to the economic condition of real estate in the City. Once this reserve component is funded, it would be used in the next eventual downturn to supplement building permit revenues to the extent that the revenues do not support the minimum contract obligations in any one fiscal year. In the event the City moves away from contracting this service, the use of the reserves would supplement building permit revenues to the extent that they are exceeded by division expenditures. Recommended reserve for building inspection contract: $126,000 Sales tax has normal annual cycles. Annual revenues are typically highest during the holiday shopping season (October to December). Sales tax receipts are also directly related to the economic condition in the country. Sales will be down in a recession and up in an expansion. There are some circumstances that are specific to the City of Lompoc s position. As a commuter community, we have the advantage of gasoline sales to commuters. In fact, fuel sales are the number one generator of sales tax for the City with a 20% share. Due to the volatility in gas prices, the sales tax revenues generated from fuel sales has been as high as $182,000 in a quarter (Q and Q2 2011) and as low as $98,000 in the first quarter of As you may recall, gas prices spiked in the summer of 2008 at around $4 per gallon. The economic recession was the primary reason for prices to drop to the $2.50 per gallon range in the first quarter of Prices again were close to $4 per gallon in the summer of Eight of the last eleven quarters have had revenues near $130,000 per quarter. For the purposes of this revenue stream, it would be appropriate set a reserve that would protect the sales tax revenue stream from the fluctuations due to gas prices in the fuel and service stations category in a similar manner as with the supplemental property tax reserve. The timeframe for the analysis of this revenue stream is from April 1, 2008 to June 30, Added Taken Balance Sales taxes - fuel $182,000 $42,000 $140,000 Recommended reserve for sales tax: $140,000 How broad is the City s General Fund revenue base? Another measure to be used for evaluating a proper level of stabilization reserves is the extent that General Fund revenues are concentrated in a few narrow categories or are Fund Balance Policy General Fund Page 13 of 17

14 derived from a broad range of revenue categories. Cities with a broad base will likely require a smaller reserve than cities that have narrow or few categories of revenues. Does the City of Lompoc have a narrow base or wide base? A benchmark from other agencies gives a general guideline for the amount of reserves needed based on the number of revenue sources a city has. This is illustrated in the following table: Number of Reserve Revenue Sources Amount 1 25% 2 20% 3 15% 4 10% 5+ 5% In looking at the City s major revenue categories over the period, the following revenue sources comprise more than 5% of the average total revenue stream for the general fund: Property Taxes 26% Sales Taxes 15% Transient Occupancy Taxes 5% Administrative service charges 19% Operational transfers 19% All other revenues 17% The City has at least 4 and possibly 5 major sources of revenues over the past seven years. This would suggest that the City reserve from 5% to 10% of revenues. Since the 5 th category is exactly 5%, to be conservative, the City should consider a 10% stabilization reserve based on this measurement. Recommended reserve for revenue base: $2,628,589 To what extent is any City revenue source at risk to State or Federal political action? A measure that is still required to be addressed, in spite of the Proposition 22 prohibition on the theft of city revenue sources, the State continues to enact illegal legislation to do just that. Cities have experienced this trend since the implementation of Proposition 13 in In the 1990 s, the shift known as ERAF began and continues to drain property tax funds that had once been an unrestricted source of revenue to the City. The City has lost several million due to these ERAF shifts. Continuing in the fiscal period, the State has attempted to siphon off additional property tax receipts by dissolving the City s redevelopment agency. This action has the potential to remove $1,400,000 from local control and transfer property taxes to the State to help fix their budget deficit. In addition to the redevelopment action, the State enacted illegal legislation at the end of the 2011 session which diverted remaining vehicle license fee revenues and the annual COPS block grant from local to state control. This was a loss Fund Balance Policy General Fund Page 14 of 17

15 of approximately $230,000 annually. Recommended reserve for State raid risks: $230,000 Does the City have unfunded liabilities in the General Fund and if so, to what extent? In 2004, GASB issued Statement 16 in 1992 and Statement 45 in Both account for benefits earned by employees but unpaid at the time of the financial statements. Statement 16 provides guidance on the reporting of time earned by employees while actively employed. The common term for this is compensated absences or accrued leave. An excellent example is vacation time earned but unused. Statement 45 provides guidance on the reporting of retirement benefits earned by employees while actively employed. An example of this is, for eligible employees, health care that is partially paid for by the City once the employee retires. The City has calculated compensated absences since Statement 16 was implemented in Several government entities fund compensated absences from reserves in the applicable governmental funds or as a liability of enterprise funds. Some governments charge departments as part of the payroll process and fund compensated absences in an Internal Services Fund. Until 2011, the City of Lompoc accounted for compensated absences in proprietary funds as either short term or long term liabilities and in the notes to the financial statements for governmental funds. Statement 16 provides guidance regarding recording short term liabilities (defined as those liabilities expected to be liquidated in one year or less) in governmental fund s financial statements. In 2011, the City of Lompoc initiated the recording of short term liabilities in the financial statements of the General Fund and in other governmental funds as appropriate. As the financial statements show a portion of total compensated absences as a liability, there is no need to also dedicate a reserve for the same compensated absences. However, there is no provision in the General Fund for long term compensated absences. While the expectation is that the amount of long term compensated absences will be liquidated sometime later than one year from the date of the financial statements, the City is aware of the longevity of a majority of employees. As has been stated in budget hearings for the budget, by the end of the budget, well over half of the employees of the City will be eligible for retirement or may have already retired by then. Due to this fact of life, it is reasonable to evaluate the long term portion of compensated absences and reserve a portion of fund balance in increasing but measured annual amounts until the full balance of compensated absences (both short term and long term) is either reserved or is recorded as a short term liability. At June 30, 2011, total general fund compensated absences was $2,292,308. An additional $105,457 is in special revenue accounts that will likely be combined with the General Fund in 2011 for reporting purposes. The amount of compensated absences considered short term at June 30, 2011 is $1,999,493 and is recorded in the general fund as an existing liability. An additional $292,815 is considered long term and is reported in the financial statements notes at June 30, This second amount should be recorded as a component of the stabilization reserve at June 30, Fund Balance Policy General Fund Page 15 of 17

16 Recommended reserve for long term compensated absences: $292,815 In June 2009, the City Council authorized the use of the CalPERS CERBT program to prefund our Statement 45 OPEB obligation. The CERBT, or the CalPERS California Employers Retiree Benefit Trust is a qualifying trust account that the City contributes to so that the OPEB or Other Post Employee Benefit obligation can be prefunded much like the CalPERS retirement programs are prefunded. As the City has a CERBT and funds the annual minimum obligation (the account has been slightly overfunded during the first two years of the account history) there is no reserve amount needed for the General Fund for this post retirement benefit. SUMMARY OF STABILIZATION RESERVE LEVELS The above five criteria have been presented to provide a frame of reference for the amount that should be considered a committed stabilization reserve for the City s general fund. Additional reserves exist today that exceed these specific reserves and would be available to allocate to assigned reserves or to leave as unassigned reserves. In summary, the reserves are as follows: Measure: Amount Property taxes: $1,138,671 Building inspection contract: 126,000 Sales tax: 140,000 Revenue base: 2,628,589 State raid risks 230,000 Long term compensated absences 292,815 Total committed reserves if implemented at $4,556,075 At June 30, 2011, the City s General Fund had $4,125,483 of fund balances, which includes $2,000,000 of unrestricted fund balances held in the Economic Uncertainty Fund. Based on the recommended committed reserves, total fund balance would be short by $600,132 in total fund balances at June 30, 2011 to completely fund each of the restricted reserve components as well as the committed and assigned unrestricted fund balances. When total reserves are inadequate to fund all the component parts of fund balance, Statement 54 provides for the creation of a goal to plan for and to implement practices so that the components can be fully funded. The above summary of reserve components is the initial recommendation for the City s stabilization reserve. The total recommended committed reserve amount constitutes 17% of actual expenditures in and as of June 30, At June 30, 2011, preliminary results indicate that $4,125,483 is available for all fund balance components. It is expected that the supplemental property tax and the building inspection reserves will only be able to be funded upon a significant improvement in the local economy, which could occur as late as the budgetary cycle. Once the economy recovers, it is the intent to fund these two cyclic reserves within two budget cycles. Fund Balance Policy General Fund Page 16 of 17

17 CONCLUSION It is important to note that the Fund Balance Policy is a requirement for the presentation of financial information in the City s annual financial statements. This supplement to the policy that outlines the components and methodology for a Stabilization Reserve provides a framework that allows the Council to itemize the reserves into measurable amounts. Neither the Policy nor the methodology of the Stabilization Reserve supersede the City Council s authority over the budgeting process or authority to use (or not) available reserves by Council action. Having said that, it is prudent for the City to maintain adequate levels of reserves. This Stabilization Reserve supplement to the Fund Balance Policy provides measurable tools and a methodology to determine an adequate level of reserves, what criteria is used to draw upon those reserves and how to fund the reserves when resources are available. Also of note, fund balance is generally the offset to cash or other marketable investments. The existing Economic Uncertainty Fund generates interest income that is a General Fund source of revenues. Once interest rates return to a reasonable amount (say 3%), this fund can generate $60,000 in interest income annually. Cash on hand in the General Fund (again at 3%) can generate an additional $110,000 annually. A prudent reserve has the ability to generate measurable additional resources for the General Fund that can be used for discretionary activities. Finally, Stabilization Reserves have another name a Rainy Day fund. The period, specifically, as well as 2009 to present, have been very difficult periods for the City. However, these have been economical in nature and the economy will improve. Rainy Day funds have been created over time for economic as well as non economic events. The City needs to plan for unanticipated events such as the taking of a revenue source by another governmental entity (such as the State has attempted time and time again). It is inevitable that City reserves will some day be needed for a major event such as a catastrophic disaster. Having a Stabilization Reserve will allow the City to have the resources necessary to confront many of the potential, but less likely, events that would otherwise devastate a municipal government that isn t as prepared financially. Fund Balance Policy General Fund Page 17 of 17