Capital Project Funds
Ah, capital projects. The backlogged list of needs in communities makes many local officials shutter. Nonetheless, each year communities across the state adopt budgets that include the completion of one or several projects. While many of the projects are similar from community to community — reconstructing a local road; enhancing or creating a park; or building a new facility, for instance — there are many different methods selected to budget and account for such improvements.
As I have traveled to different communities and fielded phone calls from local officials, one common budget question regarding capital projects arises. Specifically, many small communities seek assistance regarding methods to accumulate monies in the general fund over a two or three year period so that a major capital project can be completed. Due to the number of times such questions have been posed, I thought it a good time to address this issue.
There are several ways a community can accumulate funds for capital projects. The sock-in-the-drawer style aside, the most common approach used by many small communities is to simply budget money in the general fund over the requisite period of time; allow excess funds to revert to the General Fund’s balance at year end; and finally, budget the appropriate amount from fund balance when the monies required to complete the project have been accumulated. While this approach works, it may not necessarily be the easiest and most efficient, especially if the “saving cycle” spans more than two years and new elected officials come on board.
To illustrate the difficulties inherent in what we will refer to as the “fund-balance-as-the-savings-plan” technique, let’s assume that a community wants to accumulate two years’ of Class C road revenue to finance a major street project. Based on my experience, the community will likely budget the first year’s Class C allotment in the General Fund. To balance the budget, an expense equal to the amount of the projected revenue may be created. If the expense is created, however, city leaders know that real expenses associated with the project will exceed one year’s allotment so the funds aren’t spent in the first year budgeted. Thus, at year-end, the Class C revenue reverts to the General Fund’s fund balance because expenditures weren’t made against it.
For the subsequent budget year, the community budgets the second year’s Class C allotment; creates the total project expense; and records a transfer from prior year fund balance as a revenue source in the general fund (thereby transferring back the first year’s Class C total), so that revenue is sufficient to cover expenses associated with the total project. (It should be noted that some communities bypass the expense side of this technique and simply record as an expense “transfer to fund balance” thus making expenses equal revenue.) Again, while this method certainly works, it may create confusion for the public and newly elected officials. First, the public or officials may question why the project was included in the first year’s budget but wasn’t completed (it isn’t unusual for such a question to be posed during the political campaign season). Second, oftentimes the public views fund balance as “rainy day money.” As a result, the public may question why the City is spending “rainy day money” for a capital project. While the explanation that the money was earmarked for the capital project, but wasn’t spent and therefore reverted to fund balance is logical, it often isn’t easy for the public to understand especially during the heat of a political campaign. Believe me, I’ve tried to explain such things to the public in the past, all to no avail!
When I have worked with communities that desire to accumulate multiple years’ monies for a capital project, I typically suggest that they create a Capital Project Fund. Many of the larger communities use this type of fund with ease, but often, smaller communities are reluctant to create a new fund within the city. However, a Capital Project Fund has several advantages. First, monies allocated to projects in a Capital Project Fund do not expire. In other words, they stay with the project until the project is completed. The monies do not revert to the Capital Project Fund balance or the General Fund balance at year-end. A community can, as a result, create a project in the Capital Project Fund and apply multiple years’ funding to it until it is fully financed. Second, because money dedicated to a project in a Capital Project Fund stays with the project, it does not impact the General Fund’s balance. Some of you may find this hard to believe, but some of our communities must actually keep a close watch on the balance of the General Fund to ensure compliance with State Law. (Remember, cities can accumulate up to 18% of a fiscal year’s projected revenue in fund balance,while towns may accumulate up to 75%. If the General Fund’s balance exceeds these limits, a property tax reduction can be ordered.) Using the Capital Project Fund method of funding multiple year projects helps communities to not artificially inflate the General Fund’s balance at year-end. (i.e. instead of revenue reverting to the Fund balance just to be transferred out again in the following fiscal year’s budget, the revenue stays with the project in the Capital Project Fund.)
Using a Capital Project Fund as a savings reservoir for pending projects eliminates the need to explain transfers from the General Fund’s balance to the public. It creates a clear picture of planned projects and funding received as well as funding needed to complete the project.