Although the Water Replenishment District of Southern California (district) has lowered its accumulated reserve funds and assessment rate, it lacks a long-term vision of its financing needs.
In addition, the district lacks adequate planning for its capital improvement projects and adequate accounting and administrative controls over its operating expenses.
Specifically, our review revealed that the district:
RESULTS IN BRIEF
The Water Replenishment District of Southern California (district) was established in 1959 to counteract the effects of overpumping the groundwater in the West Coast and Central basins (basins). The California Water Code (water code) grants the district broad powers to do what is necessary to replenish and maintain the integrity of the basins. In December 1999 the Bureau of State Audits (bureau) issued a report concluding that the district's poor management had led to its charging those who pump groundwater an excessively high replenishment assessment (assessment rate). Because that report raised significant issues, the Legislature amended the water code to ensure that the district implemented the bureau's recommendations. The amendments also required the bureau to perform this follow-up audit of the district's operations and management.
One of the bureau's 1999 recommendations was that the district should reduce its reserve funds, which totaled $67 million in 1998. The district responded by lowering its reserve funds to a projected balance of slightly more than $6 million by June 30, 2002. We believe that this significant depletion may pose a threat to the district's ability to maintain the current quantity of groundwater in the basins. The district uses its reserve funds to ensure an adequate supply of groundwater, to stabilize its assessment rate, and to develop capital improvement projects that increase the reliable supply of clean groundwater in the basins. In spite of the current low level of reserve funds, the district has not established a minimum level of funds necessary for it to meet its responsibilities. Compounding the situation, the quantity of groundwater stored in the basins has dropped. During the past three years, the progress that the district has made in restoring groundwater to the basins has eroded by about 30 percent. The district has not established an optimum quantity for groundwater it should store or a minimum quantity it needs to assure an adequate supply of water to the basins' users. Without establishing targeted groundwater quantities, the district cannot fully justify its water purchase expenditures.
The district's current weakened financial condition was caused in part by the lack of a long-term vision for its finances. This lack of vision has in turn led to its failure to better manage its assessment rate and its reserve funds. After years of increases, its assessment rate reached a historical high of $162 per acre-foot in the mid-1990s. The district then began lowering the rate, reducing it to $112 per acre-foot by fiscal year 2000-01. The $112 rate is problematic for two reasons. First, amendments to the water code currently limit the amount the district can increase the rate, even if its costs increase. Second, the district continued the $112 assessment rate in fiscal year 2001-02 in spite of the fact that its annual Engineering Survey and Report and budget efforts indicated that it should have been charging $116 per acre-foot, the maximum rate that restrictions in the water code related to annual increases in the assessment rate allowed for that year. Furthermore, the district's decision to return nearly $30 million to the assessment ratepayers in the basins through its Clean Water Grant program in fiscal year 1998-99 helped deplete the district's reserve funds. Although the district had significant surplus funds when it initiated the grant program, these funds were created in part because it made extremely low water replenishment purchases during fiscal year 1997-98, when construction limited its ability to percolate the water into the ground, and because it accumulated funds to pay for capital improvement projects.
Although the legal constraints on the district's ability to raise its assessment rate are scheduled to expire on December 31, 2002, the constraints will still be in effect for fiscal year 2002-03, and the district projects that it will not be able purchase all of the water it determined it needs to adequately replenish the basins as well as pay for its operations and planned capital projects. Even though it plans to implement the maximum assessment rate increase allowed for fiscal year 2002-03, the district believes that in all likelihood it will have to delay water replenishment purchases to pay its operating costs and complete the projects it has already begun or to which it has made binding commitments. Because groundwater levels are declining as total water usage is rising and because the district has not identified desirable quantities of groundwater for the basins, the district may not be able to continue delaying water replenishment purchases in order to pay for its operating costs and capital improvement projects and still meet its statutory responsibilities.
The district's lack of financial vision extends to its preparation of its annual budgets. An accurate budget is important in part because inaccuracies can result in over- or undercharging ratepayers. However, the district's process for preparing its spending plans is weak. Its budget documents have not contained adequate support of its estimates or clear and complete explanations of its calculations of the assessment rate. In our review of its fiscal year 2001-02 budgeting process, we found that the district did not provide the staff who prepared the budget with adequate managerial oversight or written guidelines offering appropriate direction. The staff therefore included different levels and types of support for their estimates, prepared some elements of the budget inaccurately, and inconsistently allocated administrative costs to the district's programs. Beginning with its fiscal year 2002-03 budget, the district has reassigned responsibility for preparing the budget to the district's recently hired controller, who has begun implementing improvements in the budgeting process.
The district also does not have current strategic and capital improvement plans that identify and prioritize the implementation of its capital improvement projects. These plans can be important for giving the district's ratepayers a clear view of the long-term direction of the district and a better understanding of its ongoing needs for revenue to fund capital improvement projects. The district is creating a strategic plan to replace the plan that it prepared in 1998. Although its ability to begin new projects is limited by its low reserve funds and legal restrictions that prohibit it from incurring debt, the district has $12 million currently earmarked for projects. Moreover, the legal constraints are scheduled to expire on December 31, 2002, unless the Legislature extends them. Current strategic and capital improvement plans are therefore crucial to the district's ability to effectively and efficiently meet its statutory responsibilities. We believe that the most effective process for developing these plans would include the participation of those whom the district's programs and projects most affect, the district's ratepayers.
In order to ensure that it invests its funds in ways that will most benefit it, the district needs to establish a standardized approach for evaluating the risks involved in proposed capital improvement projects. In the past, it has invested in projects without understanding their full costs or ensuring that it would receive the benefits it anticipated. For example, the district's $10.3 million Goldsworthy Desalter facility (desalter), a large capital improvement for cleaning up saline pollution in the West Coast Basin, is complete but the district's operating costs for the desalter are still uncertain. Prior to construction, the district failed to clarify its need for legal water rights to pump the brackish water from the basin. The need for those rights is determined by the level of salinity in the water the desalter pumps and would affect the district's costs to operate the desalter. When the district filed an action to clarify the issue, the court instructed that the extracted water had to meet the statutory definition of saline water to exempt the district from obtaining pumping rights, an amount higher than the district had originally anticipated. As a result, the district's operating costs for the desalter may increase or it may have to invest up to an additional $2.3 million to meet the requirements for a subsidy to offset the desalter's operating costs.
Further, the district continues to need improvement in its controls over its administrative costs. Although it has expanded its contracting policies, its practices are inconsistent and do not always comply with the requirements of the law. In some cases, the district has paid for services without first signing contracts and continues to maintain contracts that do not specify duration. In addition, the district could not provide evidence that it has evaluated its contracts involving fixed monthly fees to determine whether it has received services of relative value, even though it paid legislative advocacy and public relations consultants more than $442,000 under fixed-fee schedules in 2001. In addition, at the time of our review, the district lacked proper accounting procedures for paying vendors or reimbursing employees and consultants for travel. As a result, it made payments to vendors that were not authorized by management and reimbursed certain unallowable travel costs. The district's Administrative Code does not yet provide adequate guidance on which costs it will and will not allow.
Finally, the district has not ensured that its financial statements contain elements required by the water code. Its financial statements for fiscal year 2000-01 did not identify the sources of funds for its capital improvement projects and did not contain a report on the propriety of the district's operating expenses, although the law requires that the statements contain both of these pieces of information. In addition, the district's list of planned and ongoing capital improvement projects contained inaccuracies, and its calculation of its reserve funds incorrectly used ending cash balances rather than net unrestricted assets (the value of its assets minus its liabilities and its investments in facilities and equipment).
The district should adopt a policy concerning the minimum reserve funds necessary to ensure it has sufficient funds to meet its statutory responsibilities. In addition, the district should ensure that it sets its assessment rate in accordance with its needs for funds as determined through its annual budget process and Engineering Survey and Report. The rate should enable the district to maintain an adequate balance of reserve funds.
To ensure it provides for an adequate quantity of groundwater in the basins and better justifies its expenditures, the district should identify optimum and minimum quantities of groundwater at which to target its operations.
If the Legislature extends restrictions on the district's ability to raise funds for its operations and capital improvement projects beyond December 31, 2002, the district should seek changes in the water code that would allow it more flexibility to adjust its assessment rate to match its needs.
The district should implement a comprehensive process to produce a budget that supports its assessment rate. District staff should prepare a clear and complete explanation of the elements that make up the calculation of the rate that it can share with the board and present in public hearings.
To identify the programs and capital improvement projects that will aid it in fulfilling its mission, the district should continue to update its strategic and capital improvement plans. The district should implement a procedure to periodically update its capital improvement plan to ensure it bases future financing decisions on current information.
The district should adopt a standardized approach to identify all technical, legal, and financial risks related to proposed capital improvement projects. This approach should accurately present the costs and benefits of the projects, using reasonable assumptions.
The district should further strengthen its contract management procedures to ensure that it has contracts for all services for which it pays and that it receives value from those services that is comparable to the fees it pays.
To better control its administrative costs, the district should continue the development and implementation of written accounting procedures. It should also adequately document how payments for public relations and conferences benefit the public purpose of the district and ensure that services performed by contractors are within the scope of written contracts.
The district should further amend its Administrative Code to ensure that it is consistent with the requirements of the water code; that it provides guidance to its staff on allowable and unallowable expenses; that it adequately defines what constitutes appropriate reimbursable lodging expenses, including dollar thresholds; and that it holds contractors to the same reimbursement policies as district staff for meals and lodging.
The district should take steps to ensure that it complies with the water code's requirements that its audited annual financial statements contain accurate reports concerning its capital improvement projects and the propriety of its operating expenses.
The district agreed with the audit report's recommendations. It also states that it has taken steps to implement many of the recommendations and will seek to implement the balance of them in the upcoming fiscal year.