On August 21, 2014, we received two similar inquiries regarding the City’s accounting practices associated with its pooled investment portfolio and cash. The questions can be summarized as follows:
- When cash is withdrawn from the city’s pooled investment portfolio, how are the expenditures accounted for?
- How does the City track the allocation of cash held in the pooled investment portfolio to the City’s various funds (General Fund, Electric Fund, Sewer Fund, etc.)?
- When cash enters or leaves the pooled investment portfolio, where did it come from and where does it go?
- When revenues are collected that belong to a specific fund (Electric Fund, Parking Fund, etc.), are they all received by the General Fund, and if not, how does the receipt of funds work?
First, it makes sense to discuss the basic concept of a pooled investment portfolio. The City typically has over $400 million of cash on hand. This cash belongs to a variety of funds, primarily the City’s enterprise funds (Electric, Water, and Sewer, among others) and the General Fund. Managing cash in this way is a common practice for large organizations, which allows all of the cash to be combined and invested as a “pool” of funds to increase earnings and enhance flexibility. The City never needs all $400 million of cash at any one time. Therefore, the cash is invested in various types of investments as authorized by the City’s investment policy. The primary investments are in government agency securities, US Treasury notes and bonds, medium term corporate bonds, the State’s Local Agency Investment Fund (LAIF), and money market accounts. The longer term investments represent cash that is not likely to be needed during the next 12-month period, while the funds held in LAIF and money market accounts are intentionally kept liquid to be available for any immediate cash needs. The decision as to how much cash to invest in the various investments changes over time as interest rates change. Due to the current low interest rate environment, the City has a larger percentage of its cash held in shorter term investments than is usually the case. It is also important to mention that the City is advised by a professional external investment advisor who makes recommendations for optimizing earnings in the portfolio on a regular basis. The City consistently outperforms market benchmarks for comparable portfolios, though the difference is small, as appropriate, given the low-risk, low-yield nature of the investments permitted by the City’s investment policy.
The City has a single banking relationship with Bank of America to address its depository and disbursement requirements – it pays all payroll and accounts payable disbursements through its bank accounts with the bank. The City’s Treasury Office manages the amount of cash needed for these payments daily as well as processes all cash receipts, which includes recording each receipt to the appropriate revenue account (Electric, Sewer, Water, Business License, etc.). In this way, the amount of funds not immediately needed is identified and can be invested to earn a higher rate of return. The City undertakes extensive cash flow analysis to anticipate its need for cash and is therefore able to maximize its investment earnings by not sitting on too much cash at the bank, or by investing too much in longer term securities and possibly having to sell an investment before maturity losing out on a portion of interest it would otherwise have earned.
From an accounting perspective, without getting into too much detail, each fund of the City keeps track of its share of the large cash pool in the City’s accounting system. Revenues come in and payments go out, and each of these changes causes an increase or a decrease in the related fund’s cash. Cash is reconciled daily to ensure that all transactions recorded in the accounting records are accurately reflected in the bank’s record of cash activity. Contrary to the assumption made in one of the inquiries, cash is not “first received” into the General Fund before being recorded into its correct City fund; rather, it is immediately recorded in the appropriate fund based on the accounting provided by the Treasury office at the point of deposit. It is important to understand that the movement of cash between various investment options does not increase or decrease cash balances in total. Also, accounting transactions (payments and receipts) do not immediately impact the City’s portfolio of investments/securities – only the cash balance at the bank is affected. Over time, decrease or increases in the balance of cash at the bank will affect the investment portfolio, as surplus cash will be pulled from the bank and higher yielding securities purchased, or if cash declines, as existing securities mature, that cash may be required to secure the bank balance at that time. The daily reconciliation and monitoring processes ensure that the two are in sync.
Once one understands these pieces of the puzzle, the natural next question is “What happens to the interest earned on investments and how is it allocated amongst the various City funds?” Good question! The City employs a monthly process by which interest is allocated to each of the City’s funds based on the fund’s average cash balance for the month. For example, if the General Fund held $10 and the Electric Fund held $20 in average balances over the month, and if $3 of interest was earned, $1 would go to the General Fund and $2 would go to the Electric Fund.
Complicating the matter are instances where funds have a “negative cash” balance recorded in the City’s accounting system. Grant funds are like this – monies are expended up front for a grant-funded project and the City is made whole on a reimbursement basis at a later date. In these situations, the cash pool “fronts” the money to cover the required project payments and is reimbursed when the grant revenue is received. The cash pool is made whole because during the period of negative cash the interest allocation process charges interest to the funds with a deficit cash balance rather than paying them interest. In the previous example, the General Fund had $10 and the Electric Fund had $20. If instead the General Fund had $50 and the Electric Fund had negative $20, then the Electric Fund would pay interest to the General Fund to compensate for the fact that the pool really only held $30 ($50 – $20). If the interest earnings should have been $5, then the General Fund would still receive the $5 due, but $3 would come from investment earnings and $2 would come from the Electric Fund. The fund with a negative cash balance would record interest expense for the amount “borrowed’ from the cash pool temporarily and the other funds in the pool would record additional interest income. In this way, all funds are made whole each month whether they have positive or negative cash. This is a common practice in agencies with pooled investment portfolios. Both cash activity and the monthly interest allocation process are areas of focus by the City’s independent external auditors each year to ensure that all cash balances and interest income are properly recorded in the City’s financial statements. The City’s annual financial statements specifically call out any of these negative cash conditions that exist as of June 30 each year as described in Note 12 to the financial statements. At June 30, 2013, these transactions (referred to as “Due To” or “Due From” transactions) amounted to approximately $22 million due to the General Fund, primarily related to pending grant receipts, and a small amount due to the Electric and Water Funds related to Central Stores inventory.