The Smithfield Town Council has a better understanding of the accounting mistakes that created a paper loss in the electric department.
In a special meeting on Tuesday, the council sat down with the town’s auditor, accountant Phyllis Pearson. Councilmen had received her audit of Smithfield’s 2012-13 finances earlier in the month. But the council received the report at the last minute and had no time to review it before hearing Pearson’s critical comments.
At that meeting, Pearson spoke about her two main findings: Smithfield had not properly accounted for depreciation in the electric department, and when Pearson corrected the bad accounting, it created a paper loss in the electric fund. Also, a drop in electric department revenue last year meant the town was technically on its way to defaulting on bonds issued to build a substation.
Pearson laid the blame for the accounting mistakes on turnover in Smithfield’s town hall. In just the finance department, four people held the job of finance director in two years. The new director, Greg Siler, started last October.
What went wrong
In 2007, Smithfield built a new electric substation for about $7 million. In accounting, large purchases are depreciated over time, but in an apparent oversight, Smithfield didn’t depreciate the substation.
To understand depreciation in town finances, think of how a car loses value over time. A person might buy a new car for $20,000, but the car starts losing value as soon as it’s driven off the lot. Each year, the value of the car drops even more, to $18,000, then to $16,000 the next year and so on. Electrcic substations lose their value too, but in accounting, that loss of value is counted as an actual loss of money.
But Smithfield hadn’t been counting this loss on its books. The auditor caught the mistake this year and corrected it, lowering the value of electric department assets by an extra $300,000. When the auditor then tallied the department’s assets and liabilities, it was suddenly in a hole.
This was a paper loss though, and the electric department still had enough cash to pay all of its bills.
In another problem, Smithfield made less money in the electric department last year than it had budgeted. That put Smithfield in violation of rules it agreed to when it issued bonds for the substation. Those rules require a certain ratio of revenue to expenses in the electric fund.
Smithfield has enough money in its other funds to get the ratio to where it needs to be, but the bond-financing rules say money to repay the substation debt must come entirely from electric department operating revenue.
Pearson suggested raising electric rates to increase revenue or refinancing the debt with a different type of loan without the ratio requirement.
Pearson said electric revenue could have fallen for any number of reasons, including calmer weather and people using less electricity because of the economy.
The council isn’t sure what it will do about the substation bonds. They prefer refinancing over raising rates, but Mayor John Lampe said, “I’m not sure it’s going to be so easy to refinance.”
The town manager’s staff will look into refinancing the bonds and will report back to the council later.
Tuesday’s meeting was a chance for the council to ask a number of questions of Pearson, Siler and Town Manager Paul Sabiston.
Since the recession, the town has been trying to build back up its cash reserves. And even with the problems in the electric fund, the town ended last fiscal year with a $1.6 million surplus. That figure brought reserves to 23 percent of spending, within reach of the council’s goal of 25 percent.
“Whatever happened, happened; $1.6 million is a nice way to end this year,” Sabiston said.
During the meeting, Councilman Perry Harris suggested raising the cash-reserve goal to the state’s average, which is more than 30 percent. The council will likely discuss Harris’ recommendation later.
Councilmen Charles Williams and Marlon Lee did not attend the meeting.