UMC Financial Management & Rate Structures 3 — Questions and Answers
Question 1: The 'test year' in a utility rate study refers to:
- The year in which new rates will first take effect
- A historical or projected 12-month period used to determine revenue requirements (Correct answer)
- The year the utility's last bond covenant was tested
- A fiscal year chosen by auditors for financial review
Correct answer: A historical or projected 12-month period used to determine revenue requirements
The test year establishes the revenue requirement baseline by capturing representative operating costs and capital needs for a defined 12-month window.
Question 2: Which depreciation method allocates an equal expense amount each year over the asset's useful life?
- Sum-of-years-digits
- Double-declining balance
- Straight-line depreciation (Correct answer)
- Units-of-production
Correct answer: Straight-line depreciation
Straight-line depreciation divides the asset's depreciable cost evenly across its estimated useful life, producing a constant annual expense.
Question 3: A utility's 'rate stabilization fund' is PRIMARILY used to:
- Finance emergency capital projects without council approval
- Smooth rate increases by accumulating reserves in low-cost years (Correct answer)
- Satisfy bond covenant coverage requirements each year
- Fund employee pension obligations
Correct answer: Smooth rate increases by accumulating reserves in low-cost years
Rate stabilization funds allow utilities to set aside surplus revenues during favorable periods and draw them down to avoid sharp rate spikes in difficult years.
Question 4: In utility cost-of-service analysis, 'peaking costs' are typically allocated to customers based on:
- Average annual consumption only
- Their contribution to maximum demand (peak usage) (Correct answer)
- The number of meters served
- Geographic location within the service area
Correct answer: Their contribution to maximum demand (peak usage)
Peaking costs are driven by the need to build capacity for maximum demand periods, so they are allocated proportionally to each customer class's peak demand contribution.
Question 5: Which of the following is an example of a non-operating revenue for a water utility?
- Monthly service charges collected from residential customers
- Interest earned on invested reserve funds (Correct answer)
- Connection fees paid by new customers
- Hydrant rental fees paid by the fire department
Correct answer: Interest earned on invested reserve funds
Interest income from invested reserves is classified as non-operating revenue because it does not arise from the primary service delivery function.
Question 6: A utility calculates its 'days cash on hand' as 45 days. This metric primarily measures:
- How quickly the utility collects accounts receivable
- The number of days the utility could operate using only available cash reserves (Correct answer)
- The average lag between billing and payment
- How many days until the next bond payment is due
Correct answer: The number of days the utility could operate using only available cash reserves
Days cash on hand shows liquidity resilience by expressing unrestricted cash as a fraction of daily operating expenses.
Question 7: Impact fees charged to new development must legally be:
- Deposited into the general operating fund
- Spent on capital improvements that benefit the fee-paying development (Correct answer)
- Used to subsidize low-income customer assistance programs
- Refunded if not spent within 30 days
Correct answer: Spent on capital improvements that benefit the fee-paying development
Nexus requirements and state law typically mandate that impact fees be used only for capacity-expanding capital projects that provide benefit to the new development paying the fee.
UMC Financial Management & Rate Structures 3
The 'test year' in a utility rate study refers to: