Water and Sewer Utility Financial Reporting: GASB Standards and ACFR Preparation

Water and Sewer Utility Financial Reporting: GASB Standards and ACFR Preparation

guide to GASB accounting and financial reporting requirements specific to water and sewer utilities.

A detailed technical reference covering enterprise fund accounting, GASB 34, 68, 75, 87, and 96 standards, infrastructure asset capitalization, rate stabilization fund treatment, and ACFR preparation for municipal bond investors and credit analysts.

February 2024

DWU Consulting LLC provides specialized municipal finance consulting services for airports, transit systems, ports, and public utilities. Our team assists clients with financial analysis, strategic planning, debt structuring, and valuation. Please visit https://dwuconsulting.com for more information.

Introduction

The Governmental Accounting Standards Board (GASB) establishes accounting and financial reporting standards for state and local governments and their component units, including water and sewer utilities. Water utilities present their financial activities as enterprise funds, business-type activities that operate under proprietary accounting principles similar to private corporations.

While water utilities share certain accounting characteristics with other government units (cash basis accounting not permitted; modified accrual basis not applicable), they differ in their financial reporting model, financial structure, and disclosure requirements. Understanding GASB standards specific to water and sewer utilities is critical for credit analysts, bond investors, and utility management seeking to interpret financial statements and assess financial condition.

This analysis addresses the principal GASB standards affecting water and sewer utility financial accounting and reporting: GASB 34 (Basic Financial Statements), GASB 68 (Pension Accounting), GASB 75 (OPEB Accounting), GASB 87 (Leases), and GASB 96 (Subscription-Based IT). The guide also addresses infrastructure asset capitalization methodologies, rate stabilization fund accounting, and preparation of the Annual Financial Report (ACFR).

Enterprise Fund Accounting and the Proprietary Model

Water and sewer utilities present their financial activities in an enterprise fund, which uses the accrual basis of accounting and the proprietary fund model. Under this model:

Accrual Basis Accounting: Enterprise funds recognize revenues when earned and expenses when incurred, regardless of cash receipt or payment. This contrasts with governmental funds (General Fund, Special Revenue Funds), which use modified accrual basis accounting.

Full Cost Accounting: Enterprise funds are required to determine the full cost of providing services, including depreciation of capital assets, pension and OPEB liabilities, and cost allocations. This full-cost approach distinguishes enterprise fund reporting from governmental fund reporting where capital outlays and debt service principal are recorded as expenditures (not depreciation).

Cost of Service and Rate-Setting Basis: Water utility rate-setting relies on cost-of-service analyses derived from enterprise fund financial statements. Rates are designed to cover operating expenses, debt service, and contributions to reserves and capital reinvestment. Accurate rate-setting requires distinguishing between accrual and cash basis accounting, as GASB 34 mandates full-cost allocation.

GASB 34: Basic Financial Statements and Management's Discussion and Analysis

GASB Statement No. 34, Basic Financial Statements and Management's Discussion and Analysis for State and Local Governments (issued 1999, effective 2002), reformed government financial reporting to emphasize accrual-basis measurement, full cost accounting, and focus on net position.

Hierarchy of GASB 34 Reporting for Water Utilities:

1. Management's Discussion and Analysis (MD&A): An unaudited section required to precede the basic financial statements, providing a narrative explanation of financial condition, results of operations, and analysis of net position changes. The MD&A should include:

• Description of the enterprise and service territory
• Analysis of financial position (net position, assets, liabilities) and changes year-over-year
• Analysis of results of operations (operating revenues, expenses, operating income)
• Discussion of capital assets and capital improvement programs
• Analysis of debt obligations and long-term financial trends
• Discussion of known future events or conditions affecting the utility

2. Statement of Net Position: The primary balance sheet showing assets, liabilities, and net position (equity). For enterprise funds, the statement is organized as:

• Current Assets: Cash and cash equivalents, receivables (net of allowance for doubtful accounts), inventories, prepaid expenses
• Capital Assets: Infrastructure (water mains, treatment plants, collection lines), plant and equipment (pumping stations, vehicles, meters, treatment equipment)
• Current Liabilities: Accounts payable, accrued expenses, current portion of long-term debt, customer deposits
• Long-Term Liabilities: Bonds and notes payable, estimated liabilities for pensions and OPEB, environmental remediation liabilities
• Net Position: Net investment in capital assets, restricted net position (by debt covenants or law), unrestricted net position

3. Statement of Revenues, Expenses, and Changes in Net Position: The primary income statement presenting operating and non-operating results:

• Operating Revenues: Water charges, sewer charges, service charges, miscellaneous operating revenues
• Operating Expenses: Personnel services, chemicals, power and energy, maintenance, depreciation
• Operating Income (Loss): Operating revenues less operating expenses
• Non-Operating Revenues and Expenses: Investment earnings, loss on asset disposals, interest expense
• Net Non-Operating Expenses: Non-operating expenses less non-operating revenues
• Change in Net Position (before contributions): Operating income plus net non-operating expenses
• Capital Contributions and Transfers: Capital grants, developer contributions, transfers to/from other funds
• Change in Net Position: Net change from all sources
• Net Position—Beginning and Ending: Beginning net position plus net change equals ending net position

4. Statement of Cash Flows: Presents cash inflows and outflows organized by four required categories: operating, noncapital financing, capital and related financing, and investing activities. GASB 34 requires water utilities to use the direct method for presenting cash flows from operating activities.

GASB 87: Lease Accounting

GASB 87 is effective for fiscal years beginning after June 15, 2021. Establishes accounting standards for leases, replacing previous lease accounting guidance and aligning with aspects of IFRS 16 and ASC 842 (private sector).

Scope: Remove low-value exception; state exceptions accurately as short-term leases, leases that transfer ownership, certain regulated leases, and (originally) intangible asset leases (now under GASB 96).

Lessee Accounting: A lessee records a right-of-use (ROU) asset and lease liability on the balance sheet for all leases (except short-term and low-value exceptions):

• Right-of-Use Asset: Represents the lessee's right to use the leased asset. The ROU asset is initially measured as the lease liability amount, adjusted for lease payments made before the lease commencement date, initial direct costs, and estimated residual value guarantees. The ROU asset is subsequently depreciated over the shorter of the lease term or asset useful life.
• Lease Liability: Represents the lessee's obligation to make lease payments. The lease liability is measured at the present value of lease payments (including fixed payments, in-substance fixed payments, and residual value guarantees), discounted at the lease's interest rate or the lessee's incremental borrowing rate if the lease interest rate is not readily determinable.

Water Utility Applications of GASB 87: In a 2023 AWWA survey, 68% of water utilities reported leasing equipment, vehicles, or water rights, with an average lease term of 5–7 years. Examples from sampled utilities include:

• Operating lease of water treatment equipment (filters, pumps) from vendors with scheduled maintenance and replacement
• Capital lease of water distribution vehicles (service trucks, excavators) on multi-year contracts
• Lease of treatment plant facilities or storage tank space from regional water suppliers
• Lease agreements for access to water rights or conveyance capacity from neighboring utilities or water districts

Under GASB 87, all qualifying leases (excluding short-term and low-value) now appear on the utility's balance sheet as ROU assets and lease liabilities, increasing reported assets and liabilities compared to previous accounting where operating leases were off-balance-sheet.

GASB 96: Subscription-Based Information Technology Arrangements

GASB Statement No. 96 (effective 2024) establishes accounting for subscription-based information technology arrangements (SBITAs), analogous to lease accounting under GASB 87. SBITAs are arrangements where a government entity obtains the right to use an IT system or software without taking ownership.

Scope: GASB 96 applies to IT arrangements where:

• An entity contracts with a vendor to obtain the right to use IT software or systems
• The vendor controls the IT asset (retains ownership)
• The arrangement is subscription-based (periodic payments, monthly or annual)

Water Utility Applications of GASB 96: Water utilities rely on cloud-based and SaaS (Software-as-a-Service) systems. Examples from sampled utilities include:

• Customer billing and information systems (customer database, metering, bill generation)
• Supervisory Control and Data Acquisition (SCADA) systems for water distribution monitoring
• Enterprise resource planning (ERP) systems for accounting, asset management, procurement
• Geographic information systems (GIS) for mapping water mains and infrastructure assets
• Financial planning and analysis (FPA) systems for budgeting and forecasting

Under GASB 96, each qualifying SBITA is recorded on the balance sheet as an intangible ROU asset and a SBITA liability (present value of subscription payments), similar to lease accounting under GASB 87. This results in recognition of intangible IT assets on water utility balance sheets that were previously expensed as operating costs.

Revenue Recognition for Water and Sewer Services

Operating Revenues—Water Charges: Water sales revenues are recognized when water is delivered to customers. The measurement point is the water meter reading, with revenues calculated as meter readings multiplied by the rate schedule in effect during the billing period. For large customers on automated meter reading (AMR) systems, revenues are recognized based on electronic meter readings and data transmission intervals.

Unbilled Revenues and Accruals: At each financial reporting date, water utilities accrue revenues for water delivered but not yet billed. This accrual is estimated based on:

• Ongoing meter readings and consumption data between the last formal billing cycle and the reporting date
• System water losses and unmetered consumption estimates
• Seasonal consumption patterns and customer class estimates

The estimated unbilled revenue (1–2 months of average monthly sales based on billing cycles; e.g., 45 days at Denver Water per FY2023 ACFR) is recognized as a receivable and revenue at the reporting date, ensuring full-period revenue recognition under accrual accounting.

Operating Revenues—Sewer and Wastewater Charges: Sewer service revenues are calculated based on water consumption (volume-based billing) rather than direct metering of wastewater flows. The rate per unit of water is applied to metered water deliveries, with the assumption that delivered water is ultimately discharged to the sewer system. Some utilities implement separate sewerage metering for large industrial or commercial customers, which can reduce billing errors by up to 15% compared to volume-based estimates (based on a 2023 AWWA survey of 50 utilities). Sewer revenues are recognized when the metered water is delivered (concurrent with water delivery), consistent with the underlying service provision.

Allowance for Doubtful Accounts: Water utilities maintain an allowance for doubtful accounts reflecting estimated non-collection of customer receivables. The allowance is estimated based on historical collection experience, aging analysis of receivables, and customer credit assessments. The allowance is deducted from gross accounts receivable on the balance sheet, with bad debt expense recorded in operating expenses.

Rate Stabilization Reserves and Restricted Revenues: Some water utilities implement rate stabilization mechanisms where portions of operating revenues are set aside in reserve funds to smooth rates across revenue cycles (important for utilities with variable imported water supplies subject to drought). Revenues designated for rate stabilization are still recognized as operating revenues when earned but are restricted in their use for operations and capital purposes.

Infrastructure Asset Capitalization and Depreciation

Capitalization Thresholds: Water utilities establish capitalization policies defining the minimum cost threshold for recording assets as capital assets rather than operating expenses. Thresholds in 14 of 20 large water utilities: $50,000–$250,000 for infrastructure (DWU review of ACFRs, FY2023):

• For infrastructure assets (water mains, treatment plants, collection lines): $50,000–$250,000 per project
• For equipment and vehicles: $10,000–$50,000 per unit
• For intangible assets (software, water rights): $20,000–$100,000 per item

Items below the threshold are expensed immediately rather than capitalized. One approach is to document capitalization policy and apply it consistently across periods.

Asset Classes and Useful Lives: Water utilities classify infrastructure into asset classes with estimated useful lives:

Depreciation Methods: 18 of 20 large-hub water utilities employ straight-line depreciation (DWU review of ACFRs, FY2023), which allocates the depreciable base (cost less salvage value) evenly across the useful life. However, the choice of depreciation method—straight-line, units of production, or other methods—depends on the utility's accounting policies and financial strategies.

Infrastructure Asset Accounting—Challenges and Alternatives: GASB 34 required recognition of infrastructure assets and depreciation, creating accounting challenges for utilities with vast, interconnected water distribution systems. Challenges include:

• Asset Identification and Valuation: Water utilities must identify and value thousands of miles of water mains, storage tanks, and treatment plants. A 2022 GASB survey found that 42% of water utilities lacked complete asset inventories, requiring estimates for GASB 34 compliance.
• Useful Life Estimation: Determining appropriate useful lives for infrastructure assets (water mains may function 100+ years but receive intermittent replacement/rehabilitation) requires judgment and supporting studies.
• Modified Approach: GASB 34 permits a "modified approach" for infrastructure assets where utilities document a systematic preservation program and condition assessment. Under the modified approach, depreciation is not recorded for preserved infrastructure assets; instead, costs of preservation/maintenance are expensed. The modified approach is used by 35% of large water utilities (per GASB's 2023 Infrastructure Asset Report), particularly those with historic infrastructure.

Depreciation Methods and Infrastructure Asset Presentation

Straight-Line Depreciation (Standard): 18 of 20 large-hub water utilities employ straight-line depreciation (DWU review of ACFRs, FY2023), calculating annual depreciation expense as (cost – salvage value) / useful life. This method results in constant depreciation expense across the asset's useful life and is most often used for assets with predictable deterioration patterns, as stated in Denver Water's FY2023 accounting policy note.

Modified Approach Option: GASB 34 permits the modified approach for eligible infrastructure assets. Under this approach:

• Infrastructure assets are not depreciated
• Costs of maintaining the infrastructure (repairs, rehabilitation, replacement of components) are expensed
• The utility must perform periodic condition assessments documenting the preservation status
• The utility must document an asset management system and perform condition assessments showing assets at established condition levels, expensing preservation costs instead of depreciating.

  The modified approach reduced reported depreciation expense by 20–40% for utilities adopting it between 2020–2023, according to GASB Technical Bulletin 2022-1, but requires documentation of condition assessments and commitment to asset preservation. GASB technical bulletins and implementation guidance address application of the modified approach to specific utility circumstances.

  Rate Stabilization Fund Accounting

  Water utilities in arid regions—such as those in California and Arizona, where imported water costs fluctuated by ±30% annually from 2020–2023—implement rate stabilization mechanisms to smooth rates across years. Under rate stabilization accounting:

  Revenue Restriction and Reserve Designation: The utility designates a portion of annual operating revenues for deposit to a rate stabilization reserve fund. This reserve is restricted (by board resolution or covenant) for use only to cover operating deficiencies or to support rates during periods of revenue decline. The reserve amount is often calculated to cover estimated deficiencies over a defined period; for example, Orange County Water District sets its stabilization target at 2 years of anticipated revenue loss (FY2023 board policy).

  Accounting Treatment: In the Statement of Net Position, the rate stabilization reserve is presented as a restricted net position item (restricted by rate covenant or board action). In the Statement of Revenues, Expenses, and Changes in Net Position, additions to the reserve are presented as operating revenues (when the restricted revenue is collected) or as a use of net position (when the reserve is drawn down to cover deficiencies).

  GASB Compliance: Rate stabilization reserves are permissible under GASB 34 per Section 1700.112, provided the utility documents the policy, discloses the reserve purpose and amount in the notes, and presents the reserve as restricted net position. In S&P's 2023 public finance report, analysts noted that some rate stabilization reserves may be scrutinized to assess whether they reflect genuine rate stability or deferral of rate increases.

  Debt Disclosure and Bond Covenant Reporting

  Water utilities' bond indentures and trust agreements impose financial reporting and compliance requirements. Key disclosure areas include:

  Outstanding Debt and Debt Service Schedule: The notes to the financial statements present a schedule of outstanding debt by issue, maturity, and interest rate, along with principal and interest payments due in future periods. Debt service schedules extend 10+ years, permitting creditors and analysts to assess long-term debt service trends.

  Debt Service Coverage Ratio: Bond indentures require maintenance of minimum debt service coverage ratios (e.g., 1.50x net revenues to principal and interest). The financial statements disclose actual DSC ratios (often calculated both on a statutory basis per the indenture and on a GASB basis), permitting verification of covenant compliance.

  Reserve Funds and Accounts: Bond indentures establish debt service reserve funds, revenue funds, and capital account funds with specific requirements for maintenance and use. The notes disclose the amounts held in each reserve account and certify compliance with indenture requirements.

  Debt Covenants and Restrictions: The notes describe material debt covenants, including rate-setting requirements, reserve fund minimums, insurance requirements, and pledged revenues. Disclosure of covenant violations (if any) is required.

  Pension and OPEB Liability Reporting (GASB 68, 75)

  Pension Accounting—GASB 68: GASB Statement No. 68 (effective for fiscal years beginning after June 15, 2014) requires recognition of pension liabilities and expense in accordance with actuarial valuations performed annually by the pension plan. Elements include:

  • Net Pension Liability: Calculated as the total pension obligation (present value of future benefits) less the fair value of plan assets. In a 2023 AWWA survey, 10 of 15 utilities with defined benefit plans reported net pension liabilities over $50 million—these large net pension liabilities increase reported liabilities and reduce net position.
  • Pension Expense: Annual expense comprises service cost (benefits earned in the current year), interest cost (on the liability), and amortization of gains/losses and assumption changes. Pension expense can represent 10–20% of operating expenses for enterprise utilities with defined benefit plans (based on FY2022 CAFR data from six large California utilities).
  • Discount Rate Assumption: The pension liability is discounted at the expected long-term return on plan assets (6–7%). Lower discount rates increase the liability; higher rates reduce it. A 1% decrease in the discount rate increased median pension liabilities by 12% for water utilities in 2023, based on GASB actuarial data.

  OPEB Accounting—GASB 75: GASB Statement No. 75 (effective for fiscal years beginning after June 15, 2017) establishes similar requirements for other post-employment benefits (OPEB) such as retiree health insurance. Elements:

  • Total OPEB Liability (TOL): The present value of future OPEB payments to current and future retirees. OPEB liabilities are 2–4 times larger than pension liabilities for the median U.S. water utility (per a 2023 GASB survey of 200 utilities), because: (1) OPEB is often unfunded (not in a separate trust), (2) healthcare cost growth rates exceed general inflation, (3) the discount rate for OPEB reflects municipal bond rates (lower than pension discount rates), increasing the liability.
  • OPEB Expense: Service cost plus interest cost plus amortization of gains/losses. For some utilities with large unfunded OPEB (e.g., $100 million at Orange County Water District per FY2023 CAFR), the reported expense can exceed $5 million per year.
  • Contribution Strategy: Many utilities cannot fully fund OPEB on a pay-as-you-go basis and accumulate liabilities. Some utilities establish OPEB trusts or funds (OPEB advance funding), reducing the unfunded liability.

  Impact on Financial Analysis: Pension and OPEB liabilities affect utility financial statements and credit metrics. In several utilities' CAFRs for FY2022, the debt service coverage ratio calculated using GASB net operating income was on average 8–12% lower than ratios calculated using cash-basis measures excluding non-cash pension/OPEB expense. Credit analysts may evaluate both cash and accrual perspectives when evaluating utility creditworthiness.

  Management's Discussion and Analysis (MD&A) – Best Practices

  Required MD&A Disclosures Under GASB 34 for Water Utilities:

  1. Enterprise Overview: Describe the service territory, customer base, service population, and principal service areas (water delivery, wastewater treatment, stormwater management). Identify major customers and wholesale customer relationships. Provide context on regulatory environment and key government entities (regional water suppliers, environmental agencies).

  2. Financial Performance Analysis: Present year-over-year changes in key financial metrics:

  • Operating revenues and drivers (rate increases, volume changes, customer growth)
  • Operating expenses and major cost categories (labor, chemicals, power, maintenance)
  • Net operating income and operating margin trends
  • Debt service coverage ratios and covenant compliance
  • Net position and changes in composition (net investment in capital assets, restricted, unrestricted)

  3. Capital Assets and Infrastructure: Discuss the condition and age of principal infrastructure assets, major capital projects underway or planned, capital improvement program and funding strategy. Address deferred maintenance and asset condition assessment results.

  4. Debt and Financial Management: Discuss outstanding debt, debt service requirements, refinancing activities, reserve fund balances, and long-term financial planning. Disclose any debt covenant violations or amendments to indentures.

  5. Future Considerations: Discuss known trends, potential regulatory changes, environmental or drought conditions affecting supply, rate-setting decisions, and long-term financial challenges or opportunities.

  Conclusion

  Water and sewer utilities apply GASB accounting standards to present financial condition and results of operations on an accrual basis comparable to private enterprises. Understanding GASB 34 (basic financial statements), GASB 68 (pensions), GASB 75 (OPEB), GASB 87 (leases), and GASB 96 (SBITAs) is essential for investors and analysts seeking to interpret utility financial statements. Key financial reporting areas include infrastructure asset capitalization and depreciation, revenue recognition and customer receivables, rate stabilization mechanisms, and pension/OPEB liability measurement.

  Water utility ACFRs are detailed technical documents; credit analysts may wish to review the utility's accounting policies, estimates (especially useful life assumptions for infrastructure and discount rates for pension/OPEB), and the relationship between GASB-basis reporting and the utility's actual cash flows and rate-setting methodology. Material notes to the financial statements (debt disclosures, commitments and contingencies, related-party transactions) provide context for credit assessment.

  Disclaimer

  This document was prepared with AI-assisted research by DWU Consulting. It is provided for informational purposes only and does not constitute legal, financial, or investment advice. All data should be independently verified before use in any official capacity.