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II. THE FULL COST ACCOUNTING METHODOLOGY A. Full Cost Accounting Defined Full cost accounting is defined as the identification and inclusion of all direct and indirect costs associated with the providing of a particular service or program. For purposes of this workbook, full cost accounting will be discussed from a ratemaking perspective, which emphasizes a mod'rfied cash basis. Many of the recent articles and presentations on full cost accounting have focused on the topic from a financial reporting and enterprise fund accounting perspective, which utilizes an accrual basis. If a ciry establishes customer charges utilizing an accrual basis it runs the risk of incurring a cash shortfall. If a municipality wants to ensure the full recovery of all cash costs associated with providing solid waste services, full cost accounting should be based on what is called a"modified cash basis." The difference between the modified cash basis and accrual basis is that principal payments and cash capital outlays are used instead of depreciation expense to recover capital costs. A comparison of the two methods is detailed below: Modified Cash Basis: Salaries, Wages & Benefits General O&M Costs Vehicle Expense Capital Costs - Principal Payments - Interest Expense - Cash Capital Outlays Predevelopment Costs Closure & Post-Closure Care Costs Accrual Basis: Salaries, Wages & Benefits General 0&M Costs Vehicle Expense Capital Costs - Depreciation Expense - Interest Expense Predevelopment Costs Closure & Post-Closure Care Costs Because most cities budget and operate their solid waste utility on a cash basis, it is important that rates be established on a cash basis to ensure the recovery of the cash costs associated with these services. Use of the accrual basis in establishing solid waste rates could resuft in a potential under recovery of solid waste revenues. For instance, ff a ciry has a transfer station which is being depreciated over 30 years but is financed with a 20 year revenue bond, the bond's annual principal payments will be greater than the annual depreciation expense. This will result in a cash shortfall for the city in the early years and a surplus in the later years. In addition, 'rf the city's solid waste facilities are financed with revenue bonds, there are typically coverage and reserve requirements. If these coverage and reserve requirements are not incorporated into the revenue requirement, the city risks not only a revenue shortfall, but the potential violation of loan covenants. The violation of these covenants could result in the city either defaulting on its debt or at the very least, restricting the city from issuing any new revenue bonds. The use of the accrual basis to set rates also enters a level of uncertainry for the investment community which is familiar with the establishment of municipal utility rates on a cash basis. This uncertainty could adversely impact the city's debt ratings. The modified cash basis should aid the city in avoiding any potential cash shortfalls while maintaining the financial integrity of the citys solid waste utility. . 000195