Cost Accounting and Budgeting

for Improved Wastewater Treatment

Prepared for:

Office of Policy, Planning and Evaluation

and Office of Water

U.S. Environmental Protection Agency

401 M Street, SW

Washington, DC 20460

Prepared by:

Industrial Economics, Incorporated

2067 Massachusetts Avenue

Cambridge, MA 02140

February 1998

FINAL REPORT

Common Sense Initiative

Metal Finishing Sector
ACKNOWLEDGMENTS

This report was written by Doug Koplow with research assistance from Alexi Lownie.

Both are with Industrial Economics, Incorporated in Cambridge, MA. The report was prepared

for Robert Benson of the U.S. Environmental Protection Agency's Office of Policy Planning and

Evaluation and Pat Bradley of EPA's Office of Water. Research was supported by the the

Environmental Protection Agency's Common Sense Initiative for the Metal Finishing Sector.

The report would not have been possible without the cooperation and input of scores of

people, especially those in Escondido, California and the Massachusetts Water Resources

Authority who provided us with so much of their time. We would especially like to thank Dan

Cushing, Smokey Lohnes, Kevin McManus, and Fred Rowlen for their work in assembling the

data we needed and arranging for us the opportunity to speak with personnel throughout their

respective sewerage agencies. Finally, we would like to thank the peer review panel for their

useful feedback on the draft version of this report.
TABLE OF CONTENTS

INTRODUCTION................................................................................................................................ i

1. OVERVIEW OF BUDGETING AND COST ACCOUNTING

FOR WASTEWATER TREATMENT............................................................................. 1-1

Budgeting Systems................................................................................................................. 1-2

Linking Budgeting With Cost Accounting.............................................................................. 1-4

Steps Towards Improved Budgeting and Cost Accounting.................................................... 1-7

Strategic Components................................................................................................ 1-7

Implementation .......................................................................................................... 1-8

Evaluation.................................................................................................................. 1-9

2. OVERVIEW OF TOOLS ................................................................................................... 2-1

Capital Budgeting................................................................................................................... 2-1

Calculating a Charge for Capital Equipment .............................................................. 2-2

Protecting Capital Recovery....................................................................................... 2-3

Activity-Based Costing and Wastewater Treatment............................................................... 2-6

Mechanics of Activity-Based Costing ........................................................................ 2-7

Implementing an ABC System at a WWTP ............................................................... 2-8

Caveats..................................................................................................................... 2-16

Resource Pricing and Debottlenecking................................................................................. 2-17

Process Mapping .................................................................................................................. 2-20

Benchmarking....................................................................................................................... 2-22

3. TOPICAL DISCUSSIONS OF COMMON PROBLEM AREAS.................................. 3-1

Cross-Subsidies In General..................................................................................................... 3-2

Specific Types of Discharges May Force POTW

 to Incur Higher Costs.......................................................................................................... 3-4

Biosolids Management............................................................................................... 3-4

Effluent Reuse............................................................................................................ 3-6

Fats, Oil and Grease (FOG) Discharges and

 System Maintenance Costs...................................................................................... 3-8
TABLE OF CONTENTS

(continued)

Specific Types of Customers May Cost More to Service than Others.................................... 3-9

Permitting Costs....................................................................................................... 3-10

Serving Industrial, Commercial, and

 Residential Customers........................................................................................... 3-11

Discharger Location and Multi-Plant Systems......................................................... 3-15

Capacity Limits to Existing Plant May Drive Up System Costs........................................... 3-16

Inflow and Infiltration (I/I)....................................................................................... 3-19

Large Dischargers and Seasonal Peaks.................................................................... 3-22

System Expansions May Create New Challenges.................................................... 3-23

System Expansion to New Areas/Customers........................................................... 3-24

Differential Impacts of System

 Expansion by Customer Class............................................................................... 3-25

Interjurisdictional Agreements.............................................................................................. 3-26

4. DETAILED CASE STUDIES............................................................................................. 4-1

The City of Escondido, CA .................................................................................................... 4-1

General Approach Towards Cost Accounting and Budgeting ................................... 4-3

Managing and Optimizing Key Shared Assets........................................................... 4-6

Controlling Constituents of

 Concern with Fragmented Control.......................................................................... 4-7

Full Cost Recovery................................................................................................... 4-11

Massachusetts Water Resources Authority (MWRA), Boston, MA.................................... 4-12

General Approach to Cost Accounting and Budgeting............................................ 4-13

Dilution of Price Signals........................................................................................... 4-16

Wholesale Rate Methodology.................................................................................. 4-17

Centralization of Industrial Pretreatment.................................................................. 4-22

Outsourcing of Biosolids Management .................................................................... 4-24

Summary .............................................................................................................................. 4-26

5. SUMMARY.......................................................................................................................... 5-1

GLOSSARY

APPENDIX : MEMO FROM THE WATER QUALITY ASSOCIATION

REFERENCES
LIST OF EXHIBITS

Exhibit 1-1: Wastewater Treatment Process Overview...................................................................... 1-5

Exhibit 2-1: Hypothetical Example of Activity Based Costing......................................................... 2-10

Exhibit 2-2: Allocation of Key POTW Costs................................................................................... 2-13

Exhibit 2-3: Boundaries of Activity-Based Costing Assessments..................................................... 2-16

Exhibit 2-4: Sample Process Map .................................................................................................... 2-21

Exhibit 2-5: Interrelationship of Metric and Process Benchmarking ................................................ 2-23

Exhibit 2-6a: Key Outcome Performance Measures

Identified by Focus Group........................................................................... 2-25

Exhibit 2-6b: Key Efficiency Performance Measures

Identified by Focus Group........................................................................... 2-26

Exhibit 2-6c: Key Effectiveness Performance Measures

Identified by Focus Group ........................................................................... 2-27

Exhibit 3-1: Possible Cross-Subsidies in POTW Pricing and

Resulting Distortions..................................................................................... 3-3

Exhibit 3-2: Biosolids Management ................................................................................................... 3-5

Exhibit 3-3: Effluent Reuse ................................................................................................................ 3-6

Exhibit 3-4: Effluent Reuse Options................................................................................................... 3-7

Exhibit 3-5: Management of Fats, Oil, and Grease............................................................................. 3-9

Exhibit 3-6: Permitting Costs........................................................................................................... 3-10

Exhibit 3-7: Sampling and Laboratory Fees..................................................................................... 3-13

Exhibit 3-8: Enforcement Activities................................................................................................. 3-14

Exhibit 3-9: Wastewater Treatment and Water Treatment/Delivery................................................ 3-15

Exhibit 3-10: Distance from Plant/Multi-Plant Systems................................................................... 3-16

Exhibit 3-11: Hypothetical Impact of Peaks on Plant Sizing............................................................ 3-17

Exhibit 3-12: Differential Rates for Peak Leveling........................................................................... 3-19

Exhibit 3-13: Aggregate Flows of 107 POTWs............................................................................... 3-20

Exhibit 3-14: Inflow and Infiltration Control in Lower Paxton

Township Authority, PA.............................................................................. 3-21

Exhibit 3-15: Inflow and Infiltration................................................................................................. 3-22

Exhibit 3-16: Large Dischargers/Seasonal Peaks............................................................................. 3-23

Exhibit 3-17: System Expansion/Centralized Versus

Decentralized Treatment.............................................................................. 3-26

Exhibit 4-1: Sample Program Areas Tracked by Escondido WWT Program..................................... 4-5

Exhibit 4-2: Program Areas in MWRA Sewerage Division ............................................................. 4-15

Exhibit 4-3: MWRA Rate Factors as a Percent of Total Charges (FY 1998) .................................. 4-19
i

INTRODUCTION

Publicly-owned treatment works (POTWs) face a challenging task. They must take

polluted discharges from a variety of customers and treat it to a level that will not harm human

health or the environment. They are regulated both at the state and federal level, and directly

regulate discharging industries. POTW managers do not always have accurate or timely

information on the economic performance of the treatment system. Pretreatment managers, often

somewhat isolated in their own section of the POTW, may have even less information on which to

base decisions.

This guidance manual aims to show POTW managers how effective budgeting and cost

accounting systems can help them do a better job running their plants with limited resources.

Although POTWs are commonly divided into different operating departments, activities of one

group often have substantial impacts on others. For example, effective pretreatment plays a vital

role in preventing plant upsets, thereby keeping plant operating costs low. Because decisions in

one part of the POTW affect other departments, we have chosen to analyze budgeting and cost

accounting systems holistically rather than within pretreatment alone.

The impetus for this project came out of the Common Sense Initiative for the Metal

Finishing Sector. A number of industry participants in the initiative noted that POTW

pretreatment programs had an extremely large impact on their business, but that the efficacy with

which POTWs were operated varied considerably across geographic regions. During the first part

of 1996, the Agency visited fourteen POTWs in three states to identify what factors made

pretreatment programs successful, and what barriers prevented struggling programs from

improving. Nearly every program, including those widely recognized as having top-tier

pretreatment, had important weaknesses in their cost accounting and budgeting systems that

impeded their ability to make optimal decisions. Our goal in preparing this report is to

demonstrate how poor cost accounting and budgeting systems can lead to sub-optimal outcomes,

to educate POTW staff about common problem areas to evaluate in their own programs, and to

provide guidance on how to implement improved cost accounting and budgeting systems.

The report contains five chapters. Chapter one explains cost accounting and budgeting in

more detail, including what it is, how it works, and why it is important. Chapter two provides

background information on important tools that program managers can use in their utilities to help

them prioritize their activities. Chapter three discusses common issues associated with POTW

cost accounting and budgeting. Chapter four examines two plants in detail, illustrating the

multiple issues that arise at real facilities. Chapter five contains the summary.
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1. OVERVIEW OF BUDGETING AND COST ACCOUNTING

FOR WASTEWATER TREATMENT

Much of the historic emphasis at Publicly-Owned Treatment Works (POTWs) has

been on the engineering: building new capacity, preventing plant upsets, and ensuring that

treated effluents and biosolids meet permit requirements. Less attention has been paid to

budgeting and cost accounting, which involve the financial side of wastewater treatment:

what are the utility’s available resources (budgeting) and how do costs vary with different

activities (cost accounting). The engineering and the financial aspects of the enterprise

are, not surprisingly, closely linked. Different engineering approaches will have very

different impacts on the cost of running the plant.

Budgeting and cost accounting themselves should also be closely linked. Budgets

report the allocation of POTW resources to particular expenses. A budget document

serves as a written expression of management’s resource allocation decisions and as a

benchmark against which on-going operations can be measured. Cost accounting is the

process by which these expenses are allocated to particular activities. Whereas a budget

line item might simply be “pretreatment inspector salaries,” cost accounting defines

activities of the POTW more broadly. Under the pretreatment activity, pretreatment

salaries would be included along with a host of other costs that are sometimes overlooked,

such as computer programming provided by the town’s information systems department

or laboratory tests required for particular industrial users. By reworking existing budget

categories to better reflect the core activities the enterprise provides (even if they cut

across existing budget accounts or departments), insights from cost accounting can be

integrated into the budget planning process.

Neither budgeting nor cost accounting tend to rank among most people’s favorite

activities. Budget time in any organization can be hectic and stressful, with staff having to

justify every dollar of their budget request before their managers, sometimes a year or

more ahead of time. Cost accounting may be less visible within the utility. When it is

encountered, it may be viewed somewhat perjoratively, using terms such as “bean

counting.” Stepping back from their implementation, both budgeting and cost accounting

are critically important to the effective operation of the treatment plant. They are simply

tools that help managers and their staff decide how to prioritize limited funds across the

many competing options for those funds. When implemented creatively, these systems

provide important and timely information to decision-makers. For example:

• What are our short- and long-term financial constraints on

activities? These constraints need to be recognized not only at the

utility-level, but at the program-level as well.
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• Including all inputs, what is the annualized cost of our services,

and how do we expect this to change over time? To remain a

healthy enterprise, the POTW needs to understand its total cost of

treating wastewater. Evaluating how the costs will change over

time enables the staff to plan for required upgrades over a longer

horizon, avoiding sudden spikes in the rates or large revenue shortfalls.

• Are there differences in our cost of service across regions of the

utility district, or across different customers? Unless managers

understand how their costs of service vary based on the location or

characteristics of a discharger they will not be able to prioritize

what areas deserve their focus first. It is important for managers to

separate the economic from the political here. For example, the

economic cost of handling the same type of discharge in different

parts of a complex, multi-plant treatment system may vary widely.

Nonetheless, managers may still decide, for political or equity

reasons, to have uniform charges for customers in different parts of

the system. However, they may focus inspection and outreach

activities in the portion of their district where cost impacts are the

highest.

• How do current or proposed actions by dischargers affect our

costs and performance? Prioritizing management attention also

requires understanding how certain types of discharges affect the

treatment system, and estimating how particular changes in

discharge levels or types will affect system operation and costs.

Our focus in this report is on powerful applications of cost accounting within the

POTW, and on ways to change the structure of the budget and the budgeting rules to

allow greater flexibility for program managers to run their programs.

Budgeting Systems

Budgets serve a variety of purposes within an organization.1 They help the

organization to plan for the future by estimating the resource requirements of different

portions of the enterprise. They help managers communicate priorities and constraints to

staff, as well as illustrate what items fall under the control/responsibility of which

departments. Budgets can also be used to help evaluate performance, for example, by

comparing budgeted and actual performance. Variances between budgeted and actual

performance can also help the organization to identify areas where their market or

 1

 Robert Anthony and James Reece, Accounting Principles, (Irwin: Homewood,

IL, 1989), pp. 603, 604.
1-3

performance is changing. These purposes can sometimes work in conflict, so it is

important to consider the most important goals for a particular POTW when designing a

new budgeting system.

Our visits to POTW pretreatment programs found an extremely wide range of

budgeting systems currently in use. Some pretreatment program managers never even saw

their budget. Rather, operating as a small part of a larger utility district, pretreatment staff

would simply put in budget requests until an “invisible line” of spending was passed and

their requests were denied. This line varied year-by-year, and applied not only to

aggregate spending but to individual purchases as well. The larger the individual

purchase, the more likely it was to be denied. This type of budgeting approach meets

none of the goals of effective budgeting. Department level managers were not educated

by the information; nor could they be reasonably evaluated based on their budgetary

performance since they had little idea about what their budget was. The lack of

information made planning for longer-term changes extremely difficult.

At the other end of the spectrum were POTWs with finance or budget departments

that carefully tracked spending by many different areas. Managers in these programs did

know how much funding they had, and the budget information generally allowed them to

plan much more effectively. Nonetheless, even the more sophisticated budget systems had

room for improvement. Four central goals of a budget system should be to:

• Help programs balance repairs against capital replacement.

Some POTWs pay for large investments that will be used for

multiple years out of a single year’s budget. This makes budget

outlays “volatile,” fluctuating widely from year to year.

Alternatively, private corporations (as well as some POTWs) use

accrual accounting, where the cost of multi-year purchases is

spread over the useful life of the asset. This approach is used for

tangible assets, such as new digesters, as well as intangible assets

such as a headworks analysis used to set local limits. When capital

costs are annualized, managers can make better trade-offs between

the cost of new equipment and the cost of repairing existing

equipment.2

• Provide program managers with spending flexibility across

budget accounts and budgeting years. Traditional budgets are

“use or lose” affairs; any money left at the end of the year reverts

back from the department to the utility or town. Use-or-lose

systems provide little incentive for managers to save money one

year to apply towards something more useful next year. Similar

dynamics apply when budget line items are adhered to rigidly. By

 2

 For a detailed description of this problem, see U.S. General Accounting Office,

Budget Issues: Budgeting for Federal Capital, November 1996.
1-4

focusing managers on the results of their enterprise, budget

flexibility can help managers spend available funds much more

efficiently. Managers may be allowed to use saved funds in the next

fiscal year, set up contingency accounts to fund unexpected needs,

or apply funds more broadly to their needs than can be reflected in

standard line item budgets.

• Improve long-term planning and expansion. Effective budgets

should also allow managers to examine trends in spending patterns

and to estimate spending in the future. Though estimates of future

spending are rarely perfect, they can identify large changes on the

horizon for which the POTW should begin planning immediately.

For example, one Indiana POTW had been operating under an

expired NPDES permit for over five years. Staff knew that their

new permit would require substantial changes to their operations,

but had never examined in detail what those changes were likely to

be, how much they would cost, and whether there were alternative

ways to achieve compliance that were less expensive.

• Illustrate how changes in spending in one department will

affect resource requirements in other departments. A budget

document solely for pretreatment might encourage pretreatment

managers to cut back on inspections in order to meet the budget

targets they’ve been given. Without an understanding of how such a

cutback might affect the influent contamination levels, and therefore

the costs of operating the POTW and disposing of residuals,

department-level efficiency might lead to utility-level inefficiencies.

This link between departmental action and implications across

departments should be reflected in departmental budgets.

Linking Budgeting With Cost Accounting

Like budgets, cost accounting systems are designed to provide critical information

to decision makers. Therefore, an important first step in setting up a cost accounting

system is to compile a list of the types of management decisions the organization expects

to make. Examples might include: when to expand plant capacity; what user fees to set;

where to allocate limited inspection budgets; and what activities will most improve the

quality of effluent.

For organizations long accustomed to fairly rigid lines between departments,

implementing a holistic cost accounting system may require a bit of work. Rather than

grouping costs by topic (e.g., information systems, legal, laboratory) as many budgets do,

cost accounting systems should delineate the core activities of the organization. The

primary function of a wastewater treatment plant (WWTP) is to protect human health and

the environment by treating wastewater to safe standards (as defined by each plant’s
1-5

National Pollutant Discharge Elimination System, or NPDES, permit). To support this

primary function, WWTP core activities might include supply-side functions such as

collecting wastewater from discharge points and treating it to meet permitted discharge

levels. On the demand-side, the plant could work to manage influent quality, quantity, and

timing through its pretreatment, conservation, and inflow and infiltration programs. Each

of these areas would, in turn, have subactivities associated with the broader function. For

example, collecting wastewater would involve broader issues of managing the collection

system, including sewer lines, seepage, oil and grease, and metering. Exhibit 1-1 outlines

these major and sub-functions.

Detailed activities of the POTW are not shown in the chart, but are important in

assessing the full cost of a particular activity. In fact, completing a task within any of

these areas could require the use of resources from a variety of POTW departments, for

example, billing or finance. Cost accounting will help managers track what resources are

required to complete a particular task, such as permitting a large industrial user, and how

much those resources cost the POTW. Linking the details of how much time and

resources are required from all parts of the organization in order to, for example, permit

an industrial user or expand a lateral collection line, is called process mapping. Creating

process maps can be time consuming and expensive. Thus, gathering this information is

Exhibit 1-1

WASTEWATER TREATMENT PROCESS OVERVIEW

Cross-cutting functions: Management and Information Systems, Legal, Laboratory, Billing, Human Resources,

Management/Administration, Finance (raising debt, budgeting, managing accounts payable and receivable).

Expansion

Supply Side

(Treat incoming

wastewater)

Demand Side

(Reduce quantity of influent,

improve quality of influent)

Collection System

Treatment Works

Discharge

System Expansion

System Management

Residuals Management

Testing

Whole Effluent

Toxicity

Other

Sewer Lines

Septage

Oil and Grease

Metering

Maintenance

Storm Water

Wet Weather/Peaks

Dry Weather

Maintenance

Biosolids

Effluent

Other (Air, Methane recovery)

Pretreatment

Conservation

Inflow/Infiltration, SSOs

Permitting

Inspection

Enforcement

Education

Site Visits

Sampling/testing

Review of past reports

Sampling/testing

Litigation/Other Enforcement Activity

Primary Function: Ensure wastewater treated to

NPDES standards

Local Limits/Effluent Trading
1-6

only cost effective if it helps the POTW operate more efficiently and effectively. Whereas

cost accounting answers the question “How much does it cost us to do activity x or to

make product y?” process mapping can be used to determine why certain products or

processes are expensive, where there are inefficiencies (e.g., data needs to be manually

transferred multiple times), and how the activity might be streamlined to make it more

efficient. The goals of a cost accounting system should be to:

• Inform managers and staff. This is the primary function of a cost

accounting approach. The system should give managers and staff

information on the cost of performing core activities and help

managers evaluate the tradeoffs associated with different

management strategies.

• Illustrate the basic activities of the organization. The process

of shifting from budget line items to activity-based measures should

help managers define the core functions of the organization in a

consistent way and communicate these core functions to other staff.

• Link activities with costs. By linking specific activities with the

resources required to complete them, the POTW can get a much

clearer picture of the costs and benefits of particular service

delivery approaches.

• Reduce the magnitude of “overhead” expenditures. Many

organizations have a substantial percentage of their operating costs

lumped into a general budget category called “overhead” or

“administration.” In reality, many of the activities allocated to these

accounts support services to POTW staff and operations. A central

goal of activity based costing, discussed in more detail in the next

chapter of the report, is to link overhead costs with the activities

they support so that managers can see the total cost of specific

goods and services provided.

• Illustrate cross-departmental links in service delivery.

Departmental lines often group similar functions in an organization

(legal, personnel, laboratory, etc.) Day-to-day activities, however,

regularly draw on resources from a variety of departments. Cost

accounting systems need to reveal these links to help managers

make sound decisions for the enterprise as a whole.
1-7

Once in place, a cost accounting system can:

• Demonstrate cost effective ways to reduce system costs, optimize

resource allocation, and prioritize activities towards achieving a

particular goal (e.g., environmental improvement or cost

reduction).

• Illustrate the economic value of pretreatment; evaluate spending on

pretreatment versus treatment at the POTW and on supply-side

management versus demand-side management.

• Justify increases in charges to particular customers or municipalities

and decreased charges to others.

• Provide the information needed to negotiate terms for

interjurisdictional agreements, network expansion, or industrial user

(IU) permits.

• Identify areas of poor resource utilization within the utility and help

to rationalize system capacity.

• Help managers evaluate alternative mechanisms of service provision

(e.g., in-sourcing, outsourcing).

Steps Towards Improved Budgeting and Cost Accounting

While the basic tools for improved budgeting and cost accounting are consistent

across organizations, the goals of implementing improved systems must be tailored to the

specific needs and circumstances of each POTW. Managers need to invest adequate time

up-front to ensure that the questions a new budgeting and cost accounting system answers

are the questions that are most important to them and their organizational health. Some

general steps one can take towards improving these systems are presented below. These

steps include both strategic, implementation, and evaluative components.

Strategic Components

• Determine key measures of success. As stated above, it is critical

to focus measurement on items that are central to the organization’s

mission. These measures can be both financial and non-financial.

However, even non-financial measures, such as “reduce copper

loadings by 50 percent” can be more saleable if an economic

component is added. For example, “reducing copper loadings by

50 percent will improve recreational fishing in our discharge river,

boosting tourism.”
1-8

• Determine key decisions needed to achieve success. What

milestones are necessary in order to achieve goals? Do key

strategic decisions need to be made now to facilitate reaching these

goals? For example, if reducing metals loadings is a central goal,

improved data on loadings might be a milestone, with this improved

data integrated into a cost accounting system that allocates the

excess costs of these loadings back to the sources of problem

metals.

• Develop a list of core activities of the organization. If budgets

are to be activity based, and new cost accounting systems are to

allocate costs onto specific activities, work needs to be done up

front to insure that all managers define the core activities of the

POTW in roughly the same way.

• Determine ground rules. The very purpose of improved cost

accounting is to identify areas of inefficiency within the POTW.

There are winners and losers with these discoveries. For example,

the importance of pretreatment in reducing total POTW costs may

be highlighted. Alternatively, some departments may appear

inefficient or redundant under the new method of assessment. If

people are afraid they will be demoted or fired based on the results

of the system, they will not participate in the implementation phase,

and their knowledge of POTW processes will not be shared. One

possible ground rule to address these concerns is a “no layoff”

policy.

Implementation

Strategic issues help to determine what the improved budgeting and cost

accounting system should accomplish, and to obtain initial buy-in from plant staff.

Implementation is where these decisions get translated into organizational changes:

• Accrual accounting. Annual costs for capital spending is a very

important input into a cost accounting system. Organizations that

now pay for multi-year purchases out of their current budget need

to implement techniques used in the private sector to measure

capital services, as described below in the section on capital

budgeting.
1-9

• Cost accounting. Using annualized capital costs and other

spending information, the POTW will need to implement an

activity-based costing system (also explained in the next chapter) to

better allocate costs to the activities/customer classes that drive

those costs.

• Changes to budgeting rules. Where rigid budgeting rules restrict

saving funds from one year to the next or applying unused funds

from one line item to another (where it is more needed),

modifications are in order. Changing budgeting rules provides

additional flexibility to department managers, but requires utility

managers to be able to evaluate the results of departmental efforts.

Performance benchmarking may be useful in this regard, enabling

managers to track trends over time and compare performance with

external organizations.

• Changes in budget presentation. Once costs are tracked by

activity, it may make sense to present budget data by activity as

well. This presentation will provide a more useful picture of where

resources are being used than do current topically-organized

budgets.

When implementing any of these tools, managers should consider the costs and

benefits of doing so. Substantial increases in administrative complexity and costs make

little sense if gains in efficiency and understanding are small. On the other hand, care

should be taken to evaluate the costs and benefits of the transition over a relatively long

period. Difficult changes may increase complexity in the short term but greatly enhance

POTW operations once they are in place.

Evaluation

Cost accounting and budgeting are tools for better decision making. How well are

they working? Are decisions improving over time? How are managers using the

information these systems give them to do their jobs better? Periodic evaluation of both

these tools and the POTW’s operations is important to build into the

accounting/budgeting system from the outset. Performance benchmarking can be useful in

measuring improvement over time. Annual reviews of improvements, as well as periodic

interviews with staff at various levels of the organization, is important for garnering the

type of feedback that will enable managers to improve the systems over time.

To facilitate the implementation process, the next chapter provides a more in-depth

introduction to the analytical tools needed for improved cost accounting and budgeting.
2-1

2. OVERVIEW OF TOOLS

This chapter provides an overview of a number of tools that POTWs can use to implement

improved budgeting and cost accounting. Books are written on each of these tools; the

information here should be viewed as a general introduction. The tools fall into three main

categories: determining the cost of service, evaluating cost impacts of changes in the operating

environment or service mix offered, and evaluating program efficiency.

• Determining the cost of service. The basic element in making sound

decisions within the POTW is having accurate information on how much it

costs to provide particular services to particular customers. Two tools for

this purpose are discussed below: capital budgeting and activity-based

costing (ABC). Cost data must be supported by solid underlying scientific

data as well, such as that on headworks loadings.

• Evaluating cost impacts of changes. Measuring the cost of service helps

managers see which activities are more or less costly. One additional tool,

resource pricing (also referred to as shadow pricing) can help the

organization identify parts of existing operations that have extremely large

cost impacts and estimate savings associated with operational changes.

Often, these areas are bottlenecks in the system: a single resource that

impedes efficient use of much of the rest of the plant. Resource pricing, in

conjunction with the cost accounting system, can be used to evaluate

competing options, such as increasing system capacity versus trying to

reduce demand for existing capacity.

• Evaluating program efficiency. How well is your program providing

wastewater treatment services? Two useful tools are Process Mapping

and Benchmarking. Process mapping helps illustrate the complexity of

seemingly simple functions within the organization and provides useful

insights on how those processes might be simplified. Benchmarking, in

which aspects of operations are compared to those conducted within other

organizations, can be a useful tool in identifying areas for improvement

within the utility.

Capital Budgeting

A fundamental concept of accounting is the matching of costs to the period over which

benefits associated with those costs are received. When this is not done, managers are unable to

assess their cost of providing goods and services (vital in order to decide what goods and services

make sense to produce). From this need, costs have been divided into operating expenses and

capital expenses. Operating expenses encompass costs that generate benefits in the current year.
2-2

Capital costs, such as new equipment or plants, create a stream of benefits that span multiple

years. These multi-year benefits need to be annualized so that the portion of the benefit stream in

any one year can be estimated.

Capital budgeting accomplishes two important functions. First it, annualizes capital

spending, allowing capital to be compared to single-year purchases and to be included in a cost

accounting system. This process is fairly mechanical, incorporating the cost of the purchase and

the expected service life into an annual expense. In reality, however, capital purchases lock an

organization’s resources into a particular purchase for many years. Although annualized capital

costs are useful indicators of the annual cost of capital services, the decision in year one to make

the purchase is thereafter, for the most part, irreversible. For example, expanding the collection

system to a new industrial park is a sunk cost. The money is gone even if no industries decide to

move in, as one mid-Western POTW found out. The long-term nature and large expense of these

investments requires that the decisions be made carefully. This is the second strength of capital

budgeting: it provides a standard basis of comparison for alternative capital purchases. For this

reason, many organizations have a separate capital budget that shows only capital purchases to

help managers choose among many suggested options.

Calculating a Charge for Capital Equipment

To calculate an annual charge for a capital purchase (let’s assume a new digester), the

plant first groups all expenses associated with the design, purchase, and installation of the digester

into a single account. Expenses that support this capital asset, even labor, are capitalized. If

particular items are improperly excluded from the cost of an asset, the capital will seem less

expensive than it really is. Consider the following common issues:

• Financing Costs. The asset cost should also include the cost of financing

the capital, as this is often a large portion of the total cost of the asset.

This cost may be visible and easily included if the city issued a bond to pay

for the new investment. However, even if the town decided to pay for the

asset outright, out of a single year’s tax collection, it still makes sense to

impute a financing cost to reflect the lost opportunity to use this money in

an alternative way. In private firms, this imputed interest is referred to as

“hurdle rate,” the return below which a capital purchase can’t be justified

because it diverts funds from more productive uses.1

• Incorporate life-cycle costing. If current activities create future costs,

such as decommissioning or remediation, these need to be allocated to the

current product/process and accrued over its operating life.

 1

 Note that a hurdle rate will generally include not only the break-even return necessary for

the firm to pay for the capital it is investing, but a profit margin above that level as well. Since

most POTWs are publicly-owned and do not earn profits, the imputed interest rate will likely be

somewhat lower than if it would be for privately-owned plants.
2-3

• Replacement Costs versus Historical Costs. The use of replacement cost

pricing violates the cost of service principles normally used in rate setting

at POTWs. However, if replacing a capital asset is much more expensive

than it was to install it in the past, the use of historical costs in estimating

the rates will encourage overuse of the capital. Capital charges based on

replacement cost will encourage all current users to constrain their use of

the capital, delaying the time when capital expansion -- at the much higher

price -- will be necessary.

2

 Note that replacement costs can be higher for a

number of reasons, including inflation, the loss of government-subsidized

financing options, or new technical requirements.

The sum of these costs becomes the cost basis of the asset that is depreciated. The

purpose of depreciation is to reduce the value of the capital asset over time, as its useful service

life is exhausted. Thus, the depreciation period should be set equal to the estimated service life.3

For simplicity, let us assume that the asset wears out evenly over time (known as straight line

depreciation).4 If the digester was expected to last 20 years, than 1/20th of the total cost basis

would be recovered from users in each year. Annual costs (or revenues) associated with the asset

would be added to the capital charge in order to obtain a total cost of a capital asset that should

be recovered from customers. Annual costs, often referred to as operations and maintenance

costs, include such items as energy and repairs. Revenues might include by-product sales or reuse

(for example, methane recovery and reuse from a digester) that should be deducted from the total

annual cost.

Protecting Capital Recovery

The purpose of capital budgeting is to accurately estimate the cost of capital services to

managers and customers. In this way, rational decisions can be made about when to replace old

equipment with new, and what the proper mix between capital and operating costs is. Users can

be

 2

 This occurs naturally in competitive markets, where the market price is equal to the

marginal cost of the least-efficient producer still able to stay in business. Since POTWs don’t

compete with each other to treat wastewater, marginal cost rationing needs to be added

artificially.

3

 Private firms depreciate assets as quickly as allowed under the tax code in order to

reduce their effective tax rates. For pricing capital services, however, the assets should be

depreciated over the service rather than the tax lives, as this is the best approximation of the

annual cost of using the capital.

4

 There are a variety of other depreciation methods, all of which generally depreciate a

higher percentage of the asset value in the early years. The actual pattern by which an asset

depreciates in value will vary by asset type.
2-4

charged the true cost of the capital they use, giving them an incentive to use the capital efficiently.

POTWs will be able to accrue funds steadily so they can finance replacement capital at the end of

the old capital’s service life.

Unfortunately, this system begins to break down in the real world politics of sewage

treatment. No matter how “perfect” the capital charges are, if the funds collected for capital

replacement are diverted for other uses, the plant will not make efficient capital allocation

decisions. While this problem is relatively common in WWTPs, our limited sample of site visits

suggests it is more acute in municipal systems than in special sewer districts. Funds collected

from within the POTW for capital replacement are diverted to the general fund of the municipality

to meet some immediate need in another part of the budget.

Linking collections to specific uses is important if the system is to provide proper

incentives. For example, if plant managers know that capital replacement funds will not be

available when they need them, they begin to “game” the budget system to buy capital equipment

whenever they can obtain funds, rather than when they really need it. The type of capital

equipment they buy may be driven as much by the amount of funds they can obtain in a given year

as by the problem they are trying to address.

Municipalities have adopted a number of techniques to minimize the problem of funds

diversion. All of these techniques restrict how capital recovery funds may be used, reducing or

eliminating the latitude for town officials to divert the monies for other uses. Some examples:

• Lease or outsource. For utilities where the political process makes

accruing for capital purchases and replacement nearly impossible, leasing

equipment or outsourcing functions can bypass some of the problems.5

Once in place, funds for wastewater treatment no longer go to the city,

where they could be diverted, but rather to the lessor or private provider.

This type of decision (outsourcing more so than leasing) has implications

 5

 We encountered a number of smaller POTWs where strategic decisions with any

financial implications had to be approved by a utility board, comprised of many members of

Significant Industrial User (SIU) companies. These members sometimes use their leverage to

impede effective POTW enforcement of discharge violations or to block improvements in staffing

or equipment that would have increased the POTW’s enforcement capabilities. Leasing or

outsourcing specific functions is unlikely to solve these conflict of interest problems, as the utility

boards can still intervene to block the initial leasing or outsourcing decision.
2-5

on other aspects of POTW operation, so should not be undertaken lightly.6

In addition, unless outsourcing contracts are written carefully, the private

provider may have disincentives to long-term capital investment as well.7

• Bond financing. By issuing bonds for capital projects, the POTW creates

a legal obligation that funds from users support bond repayment to an

external agent. Bond financing is commonly used by POTWs for large

capital expansion. Ideally, the bond life is matched to the service life of the

asset being financed. In this circumstance, annual bond repayments are a

fairly good indicator of the cost of capital services. In reality, bond life is

generally driven by interest rate conditions rather than service life, so may

be a weak proxy for the cost of specific capital services.

• Revolving Funds. Revolving funds are often run by external agents,

although they can also be run by the utility. A loan is made to the POTW

for a specific project, then repaid over time from user fees. The up-front

costs of bond issuance, however, make bonds a more effective tool for

large scale capital projects; revolving funds are economic at a lower level

of funding.

• Internal Accounts. Some utilities have set up internal accounts for asset

replacement funds. Collections go into these accounts and are somewhat

protected from being “raided” by other parts of the municipality. Funds

are earmarked for specific purchases, and do not revert back to the general

fund at the end of each budget cycle as do most unspent departmental

funds.

• Working Capital Funds. Also an internal account, working capital funds

operate as a savings account for new capital purchases. Contributions by

managers are voluntary, rather than based on mandatory capital charges.

However, the approach provides managers with flexibility to do multi-year

planning.8

 6 For an in-depth discussion of issues associated with POTW privatization, see AMSA,

Evaluating Privatization: An AMSA Checklist, 1996.

7

 The payback on major capital investments can be five to ten years or more. If a private

operator has only a five year operating lease, it will choose not to invest in assets with long-term

paybacks unless absolutely necessary.

8

 U.S. General Accounting Office, Budget Issues: Budgeting for Federal Capital,

November 1996, p. 52.
2-6

To be effective, internal accounts and revolving funds must allow managers to purchase

and sell assets as need dictates. Positive balances should earn interest if these funds are used in

the interim for any other purposes. Managers also need to be free to implement replacement cost

pricing in order to send the proper price signals.9

 Because these systems reduce the power of

central utility boards to control successive spending (i.e., after the initial capitalization of the fund

or account), the central boards sometimes resist the implementation of these approaches.

Activity-Based Costing and Wastewater Treatment

Activity-based costing (ABC) is a simple but powerful idea: allocate costs to processes,

products, or projects on the basis of the activities that generate these costs. To do so, one must

group spending by activity rather than by department, as is often done. When ABC is

successfully implemented, many costs now termed “overhead” are linked to the activities that

generate them, and are allocated accordingly to products, customers, or other cost “objects.” The

end result is cost information that provides accurate and complete costs for a particular area of

business activity. The full costs of generating particular products or services can be quite

surprising. Many private sector firms have discovered they were selling products for less than it

cost them to make, once support services and capital requirements are included.

This type of an outcome is possible because the intensity of demand for support services

and infrastructure varies widely by customer and time period. Wastewater treatment abounds

with examples of this type of behavior. Additional capacity may be needed at the plant to handle

seasonal dischargers, either due to industry cycles or tourist peaks. Where infrastructure is old or

poorly built, large inflow and infiltration during rainstorms can dramatically increase capacity

requirements at the treatment plant. In terms of differing demands on support functions, certain

industries -- such as those in non-compliance -- will require a much higher level of laboratory

support and inspector time. Large industries may require more time to permit than smaller, less

complicated ones. These are but a few examples. Overhead costs, and costs in general, are

driven by variety, complexity, and activities.10 Variety reduces opportunities for achieving

economies of scale and adds complexity. Complexity increases opportunities for mistakes and

increases the time spent trying to prevent mistakes. The more activities that need to be done to

create a saleable product, the higher the costs are likely to be.

Cost distortions are more likely when:

• An enterprise provides both high- and low-volume services from the same

facility.

 9

 Ibid., pp. 44-50.

10 Michael Ostrenga, et al., The Ernst & Young Guide to Total Cost Management, (NY:

John Wiley & Sons, 1992), p. 38.
2-7

• A single plant provides services to different customers of varying

complexity.

• Some dischargers require higher standards of treatment, or higher

treatment capacity, than others.

Mechanics of Activity-Based Costing

ABC involves linking resources to activities to cost objects. Resources include the basic

inputs to production: time, labor, capital, and energy, all of which cost money. These resources

are allocated within an organization to support particular activities: inspecting a discharger,

testing an effluent sample, preparing and mailing a customer’s bill. These activities, in turn, are

conducted for the benefit of the “cost object.” A cost object is a rather bland term that describes

the goal for which resources are being used. Most commonly, cost objects are products or

services. Service to a particular type of customer (a customer class) can be a useful cost object as

well.

Unlike a factory, which might produce seven varieties of blue jeans, WWTP output is

more difficult to define. At a most basic level, the plants produce clean water and safe biosolids.

However, the plants provide a host of services to support this output, and these services are not at

all uniform. For example, treatment of wastewater is a different service for different types of

customers. The service required by a significant industrial user is quite different from that

required by a small residential customer. Even within the SIU, a range of services are provided

depending on the type of industry and the nature and timing of the discharge. By tracking these

distinctions, ABC provides managers with new insights into their operations.

The overall process of ABC is presented in the event-chain shown below. Each element

of the chain is described in turn.

COST MEASUREMENT Æ COST ALLOCATION Æ TRUE COSTS OF

PRODUCTS/SERVICES Æ BETTER DECISIONS

Cost Measurement

Allocating resources to activities requires that the organization accurately measure costs.

For many expenditures, this data can be obtained from WWTP’s general ledger, which lists each

purchase or payment. Capital costs must be adjusted to reflect the real cost of using scarce

capital resources, as described under the capital budgeting section above. Labor costs, often

grouped into a single expenditure, need to be tracked based on what activity the time was spent

on. For some organizations, implementing a system of tracking time (such as by using timesheets)

can be a big change.
2-8

Cost Allocation

Costs are grouped into activity cost pools, which are simply the summation of all

expenditures related to a particular organizational activity. The allocation of costs involves two

important decisions: what the activity cost pools should be, and how general costs should be

allocated among cost pools.

• Defining Activity Cost Pools. There is a trade-off between more refined

activity cost pools (which allow costs to be allocated more precisely) and

the cost and complexity this proliferation adds to the organization. General

categories are usually best unless compelling information indicates costing

would be much improved through additional categories.

• Assigning Costs. Costs must be assigned from activity cost pools to cost

objects in a manner that reflects the behaviors that actually drive the costs

(referred to as cost drivers). Thus, costs should be charged to a customer

or product directly whenever possible -- for example, if a specific person

was hired only to service a particular customer. When this is not possible,

costs should be allocated based on the level of service provided, such as the

use of labor or machine hours. Only when data exist with which to

estimate the degree of workload created by a particular product or

customer should costs be allocated based on a general volume measure

(e.g., share of revenues or production volume).

“True” Costs of Products/Services

The full cost of a cost object is equal to the sum of its direct costs plus a fair share of

applicable indirect costs. Direct costs include materials, labor, energy, and capital that can be

directly attributed to creating or servicing a particular cost object, such as an industrial discharger.

While all POTWs must have their rates approved, for which they conduct a cost-of-service study,

the resultant rates rarely represent the true costs of providing services to particular customers.

Much of the problem lies in how costs are assigned to particular cost object. Activity-based

costing can greatly improve the accuracy of costing. While the results will not be the “true” costs

(as judgments are always required in assigning indirect costs), they will provide customers and

managers with substantially better cost information on costs with which they can make decisions.

Implementing an ABC System at a WWTP

Implementing an ABC system can be an extensive undertaking. An important first step is

to think critically about the desired outcomes of the endeavor. Is the goal to track specific

services more closely? Specific service families? Specific customers? What types of decisions do

you hope to make with the output from the system?
2-9

An activity-based costing system for a publicly-owned treatment work can focus less on

product line profitability than would be required in such a system for a private firm. However,

tracking the costs to serve particular types of customers is quite valuable. This information can

help managers evaluate their current charges, focus their outreach and enforcement, and identify

high cost activities within the POTW for streamlining.

Exhibit 2-1 below provides a hypothetical example of the cost of conducting a routine

inspection at an IU. Activities required to conduct the inspection are broken down into the

resources they use. The cost of these resources is then used to estimate the full cost of the

inspection. The value of ABC is that it can demonstrate the often large impact that “support”

functions have on the service provided. In this example, laboratory costs are particularly high.

The first step in most POTW cost of service assessments is to allocate costs to rather

broad functional area cost pools. There is some variation across POTWs in terms of what cost

pools are chosen. The functional areas outlined in Exhibit 1-1 could be used. Managers may

decide initially to use fewer allocation pools, including such items as treatment, transmission,

collection, disposal, billing, customer service, accounting and finance, and administration.11 The

Massachusetts Water Resources Authority (MWRA), a very large integrated utility, has additional

categories such as public affairs, procurement, and human resources. These activities would likely

be accomplished by a single person (or fractional FTE) at a small POTW.

Regardless of their exact categories, cost pools need to provide managers with their

desired level of information without creating an undue information collection burden on their

staff. It is important to note that not all functional areas are the same with regard to their

contribution to direct and indirect costs. For example, most costs associated with wastewater

collection and treatment are directly related to services provided to dischargers. Functions such

as human resources or public information have a more indirect link. In terms of prioritizing

implementation of activity-based costing, it is best to begin with large costs linked more closely to

customers, as these are the areas where costing problems are most likely to distort discharger

behavior.

Assigning costs to functional areas has traditionally been done within customer classes --

for example, residential, commercial, industrial, institutional, other government utilities, and

customers outside the city.12 In many situations, customer class is not the best allocation base, as

important cross-subsidies may remain. POTW managers should think carefully about cost drivers

in determining how to allocate particular costs. To the extent costs can be allocated to particular

dischargers rather than to customer classes, this should be done.

 11 George Raftelis, Comprehensive Guide to Water and Wastewater Finance and Pricing,

Second Edition, (Ann Arbor, MI: Lewis Publishers, 1993), p. 178.

12 Ibid.
Exhibit 2-1

Hypothetical Example of Activity Based Costing

Cost Object: Routine Inspection at ACME Eraser Company

Activities Resources Required Possible Costing Basis Cost Allocation

Units Rate Cost

Pre-Inspection Data 

Review

-Clerical time to pull files Labor time 0.2 hours $12.00 $2.40

-MIS Resources for data storage and 

access; and for scheduling

inspections

Computer time 0.5 hours $4.93 $2.47

-Review by inspector Labor time 0.5 hours $17.00 $8.50

-Phone contact to schedule inspection Labor time (clerical) + 

telephone time

0.2 hours $3.00

Travel to and from Site -POTW vehicle, gas, repairs, 

insurance

Average charge per mile 

traveled

13 miles $0.31 $4.03

-Inspector travel time Labor time 0.4 hours $17.00 $6.80

-Sampler travel time Labor time 0.4 hours $12.00 $4.80

Inspection of Site -Inspector time Labor time 1.5 hours $17.00 $25.50

-Assistant time Labor time 0 hours $0.00

-MIS costs for expert system used on 

inspections

Number of inspections 1 $22.50 $22.50

Sampling -Chemicals and supplies Direct costs $35.00 $35.00

-Sampler Time Labor time 0.4 hours $12.00 $4.80

Analyzing Samples -Lab technician time Labor time 1.2 hours $17.00 $20.40

-Machine time (includes all costs 

related to purchase and upkeep of 

machine and rental of space to house 

it)

Pro-rated share of total 

cost of particular 

equipment used

1.0 hours 345.00 $345.00

-Chemicals and supplies Direct costs 43.00 $43.00

-Residual management and disposal 

costs

Direct costs 17.00 $17.00

-MIS costs for Laboratory Information 

Management System

Transactions processed 3 samples 5.81 $17.43

Post-Inspection Writeup

-Inspector time Labor time (inspector) 0.5 hours $17.00 $8.50

-Manager review Labor time (manager) 0.25 hours $23.00 $5.75

-Data verification and entry Labor time (clerical) 0.4 hours $12.00 $4.80

-Follow-up communication with 

industry

Labor time (inspector) 0.3 hours $17.00 $5.10

-MIS costs Computer time 1.0 hour $4.93 $4.93

Total Cost to Inspect ACME $591.71

 2-10
Exhibit 2-1 (continued)

Summary of Cost Factors

Rate

Labor Rates ($/hour, including fringe benefits)

Inspector $17

Sampler $12

Manager $23

Clerical $12

Lab Technician $17

Computer Time

Laboratory Information Management System (Hardware and software)

 Total Cost/Year $25,000

 Transactions Processed/yr 4,300 

 Cost/transaction $5.81

General MIS Support (other than LIMS and project-related support)

 Total Cost/Year $74,000

 Number of staff-hours used 15,000 

 Average cost/MIS hour $4.93

Expert System for Inspectors

 Total annualized cost $9,000

 Number of inspections/year 400

 Cost/inspection $22.50

Telephone System

 Long-distance direct billed to projects

 Local calls

 Total costs/year $950

 Total minutes of calling 19,000 

 Avg. cost/minute $0.05

 2-11
2-12

Exhibit 2-2 illustrates the cost drivers for key functional areas of the POTW. Similar

services can have very different cost drivers, depending on whether they are baseline versus peak

capacity, or capital versus operating costs. Some general rules have been used in developing the

exhibit:

• Minimum size rule. The minimum scale of operations required to service

an average customer is defined as the “baseline” system, for which the

costs are spread equally across customers. This minimum size needs to be

determined by each POTW, but should incorporate two important

considerations. First, variability in the “average” discharge suggests that

the minimum size should be slightly higher than the average to handle

standard deviations in discharges. Second, given the large costs and

difficulty of retrofitting POTW infrastructure if it is undersized, a prudent

baseline system should also include some level of oversizing to provide

flexibility, the cost of which would be shared among all customers. These

caveats aside, the additional capacity required should then be allocated

among specific customers (or customer classes) based on their demand for

the incremental services.

• Disaggregation of service provided. By breaking services into smaller

units, it becomes easier to differentiate the cost of servicing different

customers (this process is often called “unbundling”). Collection costs are

a good example. In very large POTW systems, the sewer line distance and

the pumping costs can vary widely across customers. Unit costs can be

higher not only due to distance, but due to utilization of particular portions

of the network as well. With disaggregated costs, the POTW can calculate

the carrying charge from any particular location fairly easily, and use this

information in rate setting, to identify areas for decentralized treatment, or

to promote growth in order to increase utilization of infrastructure within

particular regions.

• Polluter pays principle. Wherever possible, the dischargers of

constituents that reduce the quality of residuals (and hence their market

value) should bear the financial burden of those lost revenues.

Support functions, such as administration or finance, will generally require some use of process

mapping in order to estimate the costs associated with particular services to customers or

customer classes. Process mapping is described in more detail at the end of this chapter.
2-13

Exhibit 2-2

ALLOCATION OF KEY POTW COSTS

Cost Allocation Base Rationale

Collection System

Baseline collection system Customer Size of pipes and installation cost of collection system for 

driven by number of users.

Incremental sizing: laterals Flow: non-coincident

demand method

Lateral sizing determined by individual peaks of each cus

Incremental sizing: trunklines andpumps

Flow: coincident demandmethod

Trunklines can average differing peaks by discharges. Thbased on peak flow level for the POTW.

New collection lines New customers The full cost of extending the collection system should be 

industries or neighborhoods. POTW can set up a longer-future users in the new zone also pay a portion of the cost

Pumping: operating costs Discharge quantity Each pumping station can have a charge that is a function 

Dischargers farther from the plant may go through a sequand thus will pay a higher total pumping fee.

Fats, oils and grease (FOG)collection: baseline program

Customer class Base fees for setting up and operating an oil and grease p

among all oil and grease dischargers equally.

FOG: enforcement and clean-out Facility Any incremental costs for inspection, enforcement, or dam

out) should be direct-charged to the facility. If facility cashould be borne by all FOG permittees.

Septage Customer class Base fees to set up a basic program should be reflected in 

Incremental costs of handling specific loads should be chhauler through a tipping fee (price per gallon or pound) aIn districts with multiple drop-off sites, the incremental clocation-specific surcharges for pumping costs.

Treatment Works

Baseline capacity construction andmaintenance

Customers Using the minimal size rule, the baseline cost of providin

should be borne equally by all dischargers.

Peaking capacity construction andmaintenance

- Large dischargers- Inflow and infiltration

Flow: coincident demandmethod, with surchargesfor strength

Additional capital requirements driven by large dischargeand inflow/infiltration. Incremental costs of building and should be borne by these causal agents, in proportion to tproblem. I/I charges may need to be prorated to certain zspecific towns) based on their contribution.
2-14

Exhibit 2-2

ALLOCATION OF KEY POTW COSTS (continued)

Cost Allocation Base Rationale

System operating costs Flow: quantity and

strength

Variable costs driven by the amount and strength of waste

System Expansion Flow: coincident demand So long as treatment costs are appropriately allocated amo

users, system expansion costs should be borne by all usersin this way will demand for total capacity be properly rati

Discharge Management

Biosolids and effluent: baselineprogram

Discharge quantities All dischargers contribute to residuals requiring managem

management, assuming highest grade biosolids and effluedischargers.

Biosolids and effluent: incrementalmanagement costs

Dischargers ofconstituent(s) of concern

If there are incremental costs of having to landfill or incinbeing able to resell effluent, they should be borne by the dthat need, based on their contributory share of that constit

Compliance testing Discharge quantities While some dischargers may contribute to the need for co

influent and effluent more than others, most of the testing the Clean Water Act. Thus, allocating costs to all customdischarge requiring treatment is a simply and fairly accur

Pretreatment

Local limits setting Flow quantity Baseline requirement of the POTW. While contributions 

may vary by discharger, all customers (including resident

Permitting and Inspection Time and materials Effort to permit and inspect IUs various by facility. Cost

support functions, should be allocated based on effort.

Enforcement Time and materials All enforcement costs should be allocated to the enforcem

during the case. Enforcement costs for cases that are not allocated across IUs.

Education/Outreach All IUs Since topics are likely to change year-to-year and many o

be smaller businesses, it probably makes sense to spread tbased on flow.

Conservation Programs Time and materials by

customer class

Efforts to reduce discharge levels through conservation peducation and outreach expenses, although costs and apprsubstantially across customer class.
2-15

Exhibit 2-2

ALLOCATION OF KEY POTW COSTS (continued)

Cost Allocation Base

Inflow and infiltration/sanitary seweroverflows

Discharger or zones ofcontribution

Charges for peaking capacity due to I/I were already alloccontribution. Efforts to remediate I/I through special maiprograms to collection systems should also be borne by cupart of the system that is causing the problem and benefit

Cross-cutting Functions

Laboratory support, humanresources, administration, legal,finance

Time and materials Costs should all be allocated to the various departments b

and materials spent providing services to them whenever made to specific dischargers (as is often possible with labshould be pro-rated to them.

Billing and metering Customer class - fixed

charge

Billing and metering costs are fairly fixed for a given size costs for each customer class should be estimated and theservice charge that is independent of quantity discharged.

Debt Service Pro-rated to purpose of

debt

Recovery all capital related to collection and treatment inthe financing costs.

Sources: Raftelis, 1993; National Association of Regulatory Utility Commissioners, 1989; MWRA, 1994; MWRA, 1997.
2-16

Caveats

This guidance provides a general overview of ABC applied to WWTPs. We draw on

work done for electric and gas utilities on cost allocation, and encourage readers seeking more

detailed information to examine that literature as well. Application of even relatively simple ABC

systems can greatly improve the cost information that managers within the plant, as well as

customers relying on the plant, use to make decisions. It is important to remember that ABC is a

tool for decision making, not the determinant of a decision; interpretation of the results is always

necessary to use this information most effectively. The following caveats help to place the

information in context:

• Externalities excluded. Activity-based costing generally stops at the

enterprise walls; external costs are not rolled into the calculation as is done

with environmental accounting or lifecycle costing. As a result, the

environmental costs of particular industrial discharges -- for example

declining fish populations -- will not be picked up as a cost to be allocated

to particular dischargers unless program managers expressly decide to do

so.

Exhibit 2-3

BOUNDARIES OF ACTIVITY-BASED COSTING ASSESSMENTS

Less Tangible, Hidden,

Indirect Company Costs

Conventional Company Costs

A

B

C

Full Life-Cycle Costs

Total Company Costs

(Captured by ABC) Internal Cost Domain

External Cost Domain

External Costs

Source: Based on White et al., 1995, p. 21.
2-17

• Cost Rigidity. Not all cost components are easy to reduce, even with the

proper price signals. In the longer-term, more of the costs can be

influenced than in the shorter-term. Thus, ABC signals are likely to be

more valuable in rationing constrained capacity or sizing new capacity than

in changing use patterns for infrastructure that is already in place but

oversized.

• ABC measures average costs, not marginal costs or market value.

Although ABC allocates costs based on which customers/services drive the

demand for extra resources, the resulting cost allocation is an averaging of

the incremental cost among users. For example, if handling peak flows in a

collection system increases costs by 50 percent over the baseline, this 50

percent would be allocated across the users of that peak capacity. For

existing capital infrastructure that is underutilized, ABC may suggest a

higher-than-rational allocation of costs to particular users. In the collection

system example, if there is spare capacity in both the collection and

treatment system, charging a new user full ABC value would signal scarcity

when in fact none is present. Resource pricing, which is a marginal analysis

(and is described below), can be a useful supplement to ABC in situations

such as this.

• Cost of flexibility. As noted above, flexibility, in the form of some surplus

capacity at the time of construction, is generally a prudent strategy with

large, difficult to modify, capital infrastructure. Managers need to interpret

ABC information in such a way as to recognize the value of this flexibility.

Resource Pricing and Debottlenecking

Soda bottles have narrow necks that slow the flow of liquid. The narrower the neck, the

slower the flow from the container. This analogy has been applied to factories where the output

of the entire system is limited by the speed of the slowest part. If a POTW has a treatment

capacity of 16 mgd, but the trunkline system pipes are so narrow that they can deliver only 5 mgd

for treatment, much of the expensively built treatment capacity will sit unused. (In all likelihood,

sewage will also be flowing out onto the streets or back into people’s houses due to the lack of

collection as well).

“Debottlenecking” expands the limited constraint, allowing the system to operate with a

higher throughput. A logical solution to the above example would be to expand the trunklines to

carry greater flow. This adaptation might solve the problem for some POTWs; for others, the

bottleneck might simply shift from the trunkline to the laterals in certain parts of the service area.

The laterals that are constrained may shift as well, depending on the production cycles of

discharging industries, rainfall (due to I/I), or other factors.

This simple example illustrates two important points about the POTW system:
2-18

• Bottlenecks can “float” from one area to another depending on what

problem is corrected and the current activity of the system.

• To eliminate all bottlenecks at once, one must examine the system

holistically and model capacity constraints under various conditions.

Unused capacity in the treatment system can drive costs of treatment up substantially. For

example, according to a recent survey by the Association of Metropolitan Sewerage Agencies

(AMSA), the average POTW needed to pay $23.2 million in principal and interest per year, or

more than $63,000 per day. The revenue requirements are substantial. In a 20 mgd plant, this

translates to roughly 0.3 cents of debt service per gallon treated if the plant were running at full

capacity, funds that are lost if constraints in the process prevent this capacity from being used. If

the plant was oversized to handle storm surges, the cost per gallon could be substantially higher,

affecting all users. Thus, it is important to eliminate bottlenecks to ensure that the expensive

infrastructure put in place can be used effectively.13 However, the desire to reduce wasted

capacity must be balanced against the ease with which capacity can be expanded later. Thus, it is

more important to have spare capacity in collection systems (which require digging up roads to

replace) than in digester capacity, since digesters can be added one-by-one as demand for them

rises.

Not all bottlenecks are as obvious as below-size trunklines. Any resource used in the

plant can be constrained. If this constraint impedes the use of other assets, the constraint can be

expensive indeed. Consider the case of skilled engineering labor. If the POTW is using all its

skilled engineers to design the collection system in a new industrial park, staff may not be

available to retrofit the aeration unit with more energy efficient fine bubble diffusers. Should the

POTW managers pull engineers from the industrial park design and get them to work on the

diffuser? The answer is not always obvious. In fact, it is in situations where the same asset

(including skilled labor) can be deployed in many ways, or the expansion of a very expensive asset

can be delayed via many alternative strategies, that resource pricing becomes most valuable.

Accurate resource pricing gives managers price signals that help them to decide the most

effective manner to deploy scarce internal resources. Just as an expensive price for biosolids

landfilling tells managers to look for less expensive options, so too do expensive internal prices on

key resources, such as treatment capacity, help focus attention on ways to conserve that

commodity. Resource prices determine the opportunity cost of using resources in one area as

opposed to another. If we change one scarce resource to project 2 (installing the fine bubble

 13 For new construction or plant expansions, this means be sure that the capacity of the

equipment installed is proportionate to what is needed in the other, connected, parts of the

treatment process.
2-19

diffuser) from project 1 (designing the industrial park collection system), what will happen to

POTW margins (revenues minus costs)? Will accelerated implementation of project 2 make the

overall POTW system better or worse off than rapid completion of project 1?14

An undersized trunkline in the 10 mgd plant can illustrate how resource pricing works.

The pipe sizing prevents 50 percent of the treatment capacity from working. This lack of

trunkline capacity is the constraint. If the daily debt service on the plant is $63,000, the cost of

leaving 50 percent of it unused is $31,500 per day (0.3 cents per gallon per day), or more than

$11 million per year.15 In industries with large fixed investments and linear processes (where all

material flows through the same equipment), costs of bottlenecks can be enormous. The value of

increasing trunkline capacity in this example would be roughly $1.10 per annual gallon of

capacity.16 That is, in this highly simplified example the resource price for expanding capacity in

the trunkline is $1.10 per annual gallon. (The resource price for any input which is not constrained

-- for example treatment capacity -- is always zero. This is because increasing the amount of this

resource available will do nothing to increase plant output).

This cost information can be used in a variety of ways:

• If expanding the trunkline costs substantially less than $1.10 per annual

gallon of capacity, and the lack of additional capacity is preventing flow

from reaching the plant, expanding the line makes sense.

• If the plant has not yet been built and the cost information was gathered to

help properly size the plant, the information helps managers see the cost of

oversizing the treatment plant (or the cost of undersizing collection

systems) and to plan accordingly. For example, if projected peak flows can

be reduced for less than $1.10 per annual gallon (such as through I/I

control), resource pricing helps to demonstrate that these alternative

strategies are cost-effective.

 14 Resource pricing evaluates technical constraints. There may be strategic reasons to

continue with project 1 even if doing project 2 sooner would increase POTW margins. As with

all of the tools described here, management insight is still required in order to make a sound

decision.

15 This is a rough approximation. In reality, not all of the capacity will be used even in

well-balanced plants, and the annualized cost of capacity may not be equal to the debt service. In

addition, costs other than debt service would also be spread over the new capacity, increasing the

value of removing the constraint. Finally, were the POTW a private entity, the cost of unused

capacity would not be higher costs, but rather forgone profits, usually a higher figure.

16 Equal to 0.3 cents per gallon per day multiplied by 365 days/year.
2-20

Implementing a comprehensive resource pricing system is much more complicated than

this simple example. Linear algebra programming is used to map out the many constraints in the

POTW systems and the goal to be maximized (known as the objective function). Equations are

set up to describe the various outputs, their contribution margins, and their production

constraints. However, unlike industrial processes such as petrochemical plants and oil refineries

that have scores of product output options, POTWs provide a much smaller diversity of services.

Therefore, applying the concept of resource pricing to key assets (especially those shared by

multiple municipalities), even in a simplified way, can help to greatly improve system efficiency.

Process Mapping

Process mapping is a systematic tracking of physical processes, key task flows, and

information flows within an organization. The purpose is to step back from day-to-day activities

and try to track what resources are actually used in providing a certain type of service or product.

A process map is a picture of the variety, complexity, and activities that commonly drive up costs.

Each step of the map is a resource input, to which units (labor hours, machine hours, material

inputs) can be attached. By monetizing these inputs using information on the cost of these inputs,

the total cost of providing the cost object can be estimated.

An example of a POTW process map is included as Exhibit 2-4. This map is one of more

than 50 that the Louisville and Jefferson County Metropolitan Sewer District (LMSD) created as

part of their current cost accounting initiative. Each of the maps takes a specific activity that is

often lumped into general overhead accounts or, in this case, general capital and general operating

expenditure line items, and analyzes work flow in detail. Examples of other processes mapped

out include the bidding process, callbacks and agency letters, the construction change order

process, and reviewing a plan of the sanitary sewer to answer a particular question.

The left side of the map illustrates the various departments within the plant utilized to

complete the task in question. The steps in completing the task begin on the left and are

completed on the right. This picture is one part of a complete process costing. To estimate the

cost of corrective and preventive maintenance planning, for example, POTW staff would track the

staff, machine, or other resources at each step to evaluate the total overhead cost generated each

time an equipment defect report (see chart) is filed. Accurate costs for these general activities can

be used to generate more accurate costing estimates for higher-level activities requiring these

tasks.

Process mapping is also an invaluable tool in identifying how to improve operations.

Perhaps the map is extremely complex, with many areas of duplication. Perhaps the costed

activity is extremely expensive, suggesting that investments in improved information technology,

for example, might help reduce costs. In both these situations, a careful process map can illustrate

fruitful areas in which to begin improving operations. LMSD has shaded the portion of this

particular process that they felt offered the most room for improvement. Process maps are also

useful supports to process benchmarking (described below), where specific portions of plant

operations are compared to other entities using a similar process.

2-22

Benchmarking

Benchmarking can be used to identify weaknesses in the POTW’s products or production

processes, and ways to improve on these weaknesses. Metric benchmarking compares

performance quantitatively: inputs, outputs, outcomes, and the relationships among them. Basic

comparisons between prices or financial ratios are commonly used metrics. Metric benchmarking

can be a quick way to identify if there are problems. For example, if Manufacturer A spends more

on manufacturing his product than Manufacturer B sells it for, simple price benchmarking

demonstrates very clearly that Manufacturer A has a serious problem. Identifying what that

serious problem is, a critical step in being able to solve it, requires more refined metrics and the

use of process benchmarking. Process benchmarking maps ones own process against competitors

that have the best performance using a similar process in order to identify where and why there

are differences.17 Exhibit 2-5 illustrates the connection between the two approaches.

Whether using metric or process benchmarking, great care needs to be taken to be sure

that you are comparing the same thing. Thus, when comparing costs, you need to be sure

everybody has proper costing data. If one POTW benchmarks its costs for basic service against

similar utilities and finds it is far less expensive, managers need to take their analysis to a second

stage. Are there problems with how these costs are calculated (e.g., water revenues crosssubsidize wastewater treatment costs) that account for the discrepancy? Other factors may also

be relevant. Is capital infrastructure older? Does your town have a better bond rating than the

competitors (and thus a lower cost of financing debt)? Some of these factors may be used to

adjust the comparison so that operating efficiencies can better be compared. Other factors may be

used to describe why performance is worse than expected, perhaps to justify improvements or

upgrades to these factors.18

 17 WERF (Water Environment Research Foundation), Benchmarking Wastewater

Treatment Plants Operations: Interim Report, 1996, p. 1-5.

18 The WERF study has attempted to normalize benchmarking for these factors by creating

models for various portions of POTW operations. This approach can help identify how portions

of the operation within managerial control compare across utilities. It is important not to rely

solely on normalized comparisons, however, as inefficient operations whether due to “embedded”

conditions such as the age of equipment or not, need to be improved over the longer term.
2-23

Exhibit 2-5

INTERRELATIONSHIP OF METRIC AND PROCESS BENCHMARKING

BENCHMARKING PROCESS

BENCHMARK

METRICS

BENCHMARK GAP

• HOW MUCH

• WHERE

• WHEN

BENCHMARK

PRACTICES

HOW CLOSE TO THE GAP

• IMPROVED KNOWLEDGE

• IMPROVED PRACTICES

• IMPROVED PROCESSES

MANAGEMENT COMMITMENT

ORGANIZATIONAL COMMUNICATION

EMPLOYEE PARTICIPATION

SUPERIOR PERFORMANCE

Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996.

The benchmarking process is often creative in what is used as a comparable: the central

goal is to identify who does the process/product of interest best, and how their approach be

copied and used to improve your own operations. Comparisons can be internal (across divisions

or within the same unit over time), with direct competitors (function or entire organization), with

the industry functional leader (specific function against leaders in that function, even if not a direct

competitor), and finally based on a generic process (against process leader, even from a different

industry).19

 19 WERF, p. 2-6.
2-24

Process mapping often pulls best practices for particular operations from a wide range of

other industries, some fairly far afield from their direct line of business. For example, a

comparison of billing operations might compare POTW billing to that used by major telephone

companies or package delivery services. Peak leveling efforts or management information

systems would likely use a cutting-edge electric utility, where demand-side management efforts

and geographic information systems have been established for longer than in the POTW arena.

For other areas, such as pretreatment, benchmarking efforts would likely focus on cutting-edge

POTWs, such as recent EPA pretreatment award winners. Benchmarking is normally done as a

continuous process in order to ensure that the POTW operations also continuously improve.20

Most POTWs undertake some form of benchmarking. For example, tracking trends in

metals loadings over time is almost universally done. A study now underway by the Water

Environment Research Foundation explores the many additional uses of benchmarking within

POTWs and is an extremely good reference for utilities who plan to undertake an extensive

benchmarking exercise. Exhibits 2-6a - 2-6c below, developed by WERF, illustrate a variety of

metrics managers can use to track their performance. These metrics include outcome measures,

efficiency measures, and effectiveness measures. Outcome measures focus for the most part on

how external agents evaluate POTW performance, such as through complaints or bond ratings.

Efficiency performance measures are cost ratios per unit of service provided, and help identify

higher cost parts of the POTW’s operations. Finally, effectiveness performance measures include

measures of labor input per unit output, or the technical effectiveness of existing plant and

equipment. The sheer number of metrics identified by WERF focus groups illustrates the

importance of choosing the most important metrics for a particular utility.

 20 WERF, p. 2-4.
2-25

Exhibit 2-6a:

KEY OUTCOME PERFORMANCE MEASURES IDENTIFIED BY FOCUS GROUP

Functional Area Outcome Measures

Automation Degree of Automation

Effectiveness of automation

Collection Systems Number of collection system complaints

Number of claims per year

Number of overflows per year

Moratorium due to collection system

Time to repair collapse (in hours)

Percent of system inspected per year

Customer Service Time per call

Abandonment rate

Average agent availability

Average time to clear:

 - complaint

 - service call, etc.

New account cycle time

Walk-in average time to serve

Plan review/turnaround time

Time to billing adjustment

Customer satisfaction (survey/focus group, etc.)

Biosolids Management Number of odor complaints

Number of citizen complaints (related to dry process)

Quality of biosolids (Class A or B)

Dry tons produced/strength factor

Permit violations

Redundancy in land applications

Forecasted life of biosolids arrangements

Finance, Administration, & Planning Residential flow per capita at plant (over time)

Audit exceptions and comments

Bond rating

Operating reserves

On time payments

Labor and Staffing Injury days lost per full time employee

Number of grievances processed

Wet Operations Number of exceedences

Number of complaints

Number of odor complaints

Total hours lost to injury

Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996
2-26

Exhibit 2-6b:

KEY EFFICIENCY PERFORMANCE MEASURES IDENTIFIED BY FOCUS GROUP

Functional Area Efficiency Measures

Automation Cost of automation projects (one time/annual)

Collection Systems Maintenance cost per mile

Maintenance cost per Mgal/day

Maintenance cost per kWh installed

Customer Service Training expenditure ($) per agent

Customer service costs per day

Customer service costs per customer

Customer service costs per total overhead and

maintenance (O&M) cost

Biosolids Management Dollars per dry ton

Dollars per ton mile

Chemical costs per dry ton

Power costs per dry ton

Maintenance costs per process

Fuel cost per dry ton (incineration)

Revenues from product sales

Gas utilization credit (dollars)

Finance, Administration, & Planning Overhead costs per total O&M costs

Labor cost per total O&M costs

Contract services O&M costs per total O&M costs

Debt service per total budget

Annual materials cost per inventory

Training cost per capita

Fleet costs per total O&M (by function)

Return on assets

Value of main replaced per total value of main

Value of capital additions/net asset value

Replacement value of plant (annual)

Labor and Staffing Overtime cost per total labor costs

Training costs per employee

Total benefits costs per total labor (by type)

Wet Operations Cost per Mgal

Cost per lab analysis

Cost per customer account

Maintenance costs per Mgal

Overtime costs

Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996
2-27

Exhibit 2-6c

KEY EFFECTIVENESS PERFORMANCE MEASURES IDENTIFIED BY

 FOCUS GROUP

Functional Area Effectiveness Measure

Automation Instrument per Mgal/day

Instrument engineers per Mgal/day

Number of operats per shift

Number of shifts per week

Number of operations automated

Number of administration operations automated

Number of information operations automated

Number of processes that run automatically per total

number of processes

Collection systems Full-time employees per mile

Full-time employees per MG

Level of infiltration/inflow (I/T)

Number of blockages per year per mile

Number of collapses per year per mile

Percentage of work orders completed in __ days

Customer Service Complaint calls per 1,000 customers

Percentage of calls that are repeats

Percentage of problems cleared in __ days

Percentage of billings collected in __ days

Biosolids Management Full-time employees cost per dry ton (each unit process)

Operations cost

Maintenance cost

Percent volatile suspended solids (VSS) reduction

(digestion)

Cubic feet gas per pound VSS (anaerobic digestion)

Percent moisture reduction (after dewatering)

Tons product sold per total tons solids

Percent planned per total maintenance

Equipment availability (breakout by process)

Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996
2-28

Exhibit 2-6c

KEY EFFECTIVENESS PERFORMANCE MEASURES IDENTIFIED BY

 FOCUS GROUP (continued)

Functional Area Effectiveness Measure

Finance, Administration, & Planning Budget to actual :

 - Total expenses

 - Capital improvement program (CIP)

 expenditures

Major project costs per encumbered amounts

Forecasted per actual demand

Debt to equity ratio

Quick ratio

Coverage (debt service ratio)

Billable flow per actual flows at plant

Revenue distribution (fixed charge/variable)

Percent reuse as reclaim (growth over time)

Projected demand per projected capacity at end of

planning horizon

Ratio influent/capacity

Labor and Staffing Definable work rates (over time)

Number of operators per shift

Full time employees per Mgal/day (Permanent, parttime, contract)

Number of labor classifications

Wet Operations Percent removal

Full-time employees per Mgal

Full-time employees per customer account

kWh/Mgal

Number of analyses per technician

Cubic feet of air treated per Mgal

Connected HP/gal

Source: WERF, Benchmarking Wastewater Treatment Plant Operations, 1996
3-1

3. TOPICAL DISCUSSIONS OF COMMON PROBLEM AREAS

This Chapter discusses a number of areas of common concern for POTWs, though it is

not intended to be an exhaustive listing. In addition, not every issue will apply to every plant.

Nonetheless, we hope that these examples provide useful illustrations of the value of cost

accounting and budgeting tools in achieving tangible gains in program performance.

The underlying theme for both budgeting and cost accounting modifications is getting the

price signals right. Cost accounting essentially creates price signals within the organization that

help managers rationalize their use of scarce resources. Budgeting organizes this information to

set constraints on the resources available to these managers and groundrules on how the resources

can be used. Often, this internal pricing information supports changes to external prices (through

rate changes), sending the proper price signals to customers of the POTW.

Given the importance of this signaling in modifying behavior to conserve resources and

better protect the environment, it is important to briefly mention a couple of general steps the

POTW can take to improve the impact of price signals:

• Timing and Frequency of Measurement. Many discharge fees are based

on periodic measurements of influent and effluent. The Clean Water Act

sets statutory minimums for the type and frequency of testing. However,

these minimums are unlikely to be frequent enough to (1) rapidly track

changes in effluent characteristics; and (2) create certainty that all of these

changes will lead to adjustments in the surcharge levels. Thus, more

frequent measurement can be expected to provide better signaling to

dischargers about what part of their operations is most important to

address quickly.1

• Frequency of Billing. As with the frequency of measurement, if

customers receive large bills infrequently (e.g., quarterly or annually), they

are unable to react quickly to changes in rates and unable to associate

specific behavior with increases in their discharge levels. This situation

also applies in communities that commingle wastewater charges with their

overall property taxes. All of these circumstances tend to reduce

discharger responsiveness to price signals.

Cross-Subsidies In General

As noted above, poor cost accounting matters because it sends both managers and

customers the wrong signals about the financial impact of decisions. These signals can lead the

 1

 One POTW with large industrial user flows allocated much of the plant’s fixed capital

based on the strength of contributed wastewater. Since the financial implications of this

measurement were so substantial, the IUs tested their wastewater strength on a daily basis.
3-2

POTW to invest in the wrong parts of its treatment system and for dischargers to underinvest in

pretreatment or conservation. Normally, POTW rates are set to recover the cost of providing

WWT services. Thus, in the aggregate, revenues may equal expenditures. However, quite often

certain customers, types of customers, or geographic regions are paying too little, while others are

making up the difference by paying too much. The existing discharge fees therefore include

cross-subsidies. Exhibit 3-1 below presents a range of possible cross-subsidies within POTWs

that we visited. Important issues to consider when evaluating cross-subsidies include:

• Magnitude. If the price signals aren’t perfect, but are fairly close, the cost

and disruption associated with eliminating them may not be worth the

gains. Magnitude should be evaluated in an absolute sense, however. For

example, if every residential and commercial customer is paying only 2

percent more each month to subsidize the oversight of industrial

dischargers, this may not seem significant. However, since there are so

many customers, this 2 percent could constitute a 50 or 100 percent

subsidy to particular IUs, which would likely have a substantial impact on

the level of pretreatment investment.

• Distortions. How important are the distortions created by the existing

cross-subsidies in impeding strategic goals of the POTW? For example, if

water is scarce in your region but you can’t reuse your effluent for

irrigation due to discharges of one or two constituents by a handful of

industries, the resulting distortions are likely large both financially and

environmentally. In contrast, if rates to one IU are slightly higher than they

otherwise would be, but wastewater fees are an insignificant cost of

business for that discharger, large investments by the POTW to correct the

problem are clearly unwarranted.

• Impact. Correcting cross-subsidies will change the cost of wastewater

treatment to dischargers, encouraging them to modify behaviors that cause

the POTW to incur the highest costs. The impact of these changes can

reduce or delay the need to expand expensive capital infrastructure.

However, for POTWs that have already built capacity large enough to

handle discharges under the distorted pricing, eliminating cross-subsidies

will not be quite as efficacious. The capital costs must still be paid whether

or not the capital is being used by dischargers. Thus, cross-subsidies are

most important to eliminate when capacity is constrained.

• System Boundaries. The boundaries of analysis can affect which crosssubsidies appear the largest and most in need of correction. For example, a

cost accounting analysis of POTW dischargers may illustrate that IUs are
3-3

Exhibit 3-1

POSSIBLE CROSS-SUBSIDIES IN POTW PRICING AND RESULTING DISTORTIONS

Cross-Subsidies Explanation Resulting Distortion(s)

Among Industrial Users Costs of pre-treatment may be

allocated equally across IUs, rather

than based on which specific firms

create costs for the POTW.

-Industries discharging effluent that is most

costly for the POTW to handle will pay less than

they should and underinvest in pretreatment.

-Relatively clean IUs will pay more, serving as a

barrier to new industries locating in the region.

Among different parts of the POTW

service area

Fees for service may be equalized

for all dischargers (industrial,

commercial, and residential)

within the Sewerage District,

despite large differences in the

cost of providing this service.

Examples include multi-plant

systems where one treatment plant

is at capacity and others are not; or

collection areas with particularly

high pumping costs.

-New dischargers will not receive price signals

to locate in the less expensive portion of the

service area.

-POTW managers will not see which parts of

their systems are most costly to run and factor

that into future expansion decisions. For

example, peripheral areas may be better served

through decentralized modular WWT rather

than collection system expansion.

Among IUs and other wastewater

treatment (WWT) customers

Charges on industrial users may be

too low to cover (a) the costs of

permitting and overseeing them;

and (b) the cost impacts they have

on the system.

-Industries don’t receive the proper price signals

about how their discharges affect the treatment

system and will underinvest in conservation and

pretreatment.

Between different municipalities -Agreements with surrounding

municipalities may not allow

POTW to set fees at levels that

adequately cover the cost impacts

of the imported discharge.

-Customers in the periphery of a

service area may be charged more

because they are in a different

political jurisdiction. This

surcharge may have nothing to do

with the cost of service.

-Dischargers in the surrounding area will

underinvest in conservation and/or pretreatment.

-Dischargers in the periphery may be hesitant to

hook into the central system even if it is

economically efficient. Dischargers in the

center may receive artificially low rates and

underinvest in conservation and/or pretreatment.

Between water consumers and

waste water treatment customers

Integrated water and wastewater

utilities sometimes subsidize new

WWT expansion or construction

with surplus revenues from water

sales.

-Dischargers may underinvest in conservation

and/or pretreatment.

-POTW may be under less pressure to improve

the efficiency of their operations.

Between the general taxpayer and

the industrial users; between the

general taxpayer and WWT

The POTW may receive general

taxpayer support (e.g., state or

federal grants, general taxpayer

funds) to finance WWT or

pretreatment. Construction grants

or subsidized revolving fund loans

for plants with a high ratio of IU

flow to total flow essentially

subsidize industrial WWT.

-Dischargers may underinvest in conservation

and/or pretreatment.

-Polluting industries, through reduced WWT

costs, improve their relative competitive

position vis-a-vis industries that pollute less.

Between agricultural consumers of

fresh water and WWT

In water scarce regions, federal

policies often subsidize the

extraction and delivery of fresh

water to agriculture. As a result,

treated effluent from POTWs

becomes less competitive.

-Effluent management is more expensive.

-Market incentive for farms to seek out and

exploit treated effluent is weakened or

destroyed.

-Efficiency of water utilization in the region

declines.
3-4

moderately subsidized through higher charges on residential and

commercial dischargers. However, if a watershed perspective were used, it

may become evident that the largest cross-subsidies are actually going to

industrial direct dischargers. Managers should keep this boundary issue in

mind as they consider where to focus their resources.

Below we have classified the types of situations where distortions in costing are

particularly likely. Included are differences in the cost of treating discharges or dischargers,

difficulties associated with peak discharges and system expansions, and problems from rigidities

inherent in political agreements between municipalities such as interjurisdictional agreements.

Specific Types of Discharges May Force POTW to Incur Higher Costs

Where specific types of discharges contaminate either the plant’s collection system or its

residuals, treatment costs can rise substantially. The incremental management costs should be

tracked and allocated back to the source that is driving the cost increases. Biosolids management,

effluent reuse, and oil and grease discharges provide three useful illustrations of this point.

Biosolids Management

Solid residuals (biosolids) from wastewater treatment can be managed in a number of

different ways ranging from beneficial reuse as soil amendments to incineration and landfilling of

ash. The cost implications of these practices differ widely. Since biosolids management

comprises between 25 and 30% of WWT operating costs,2

 contaminants that force higher-cost

management of the material can have large dollar impacts on the cost of running a POTW.

EPA sludge regulations stipulate the maximum allowable concentration of numerous

contaminants (metals, pathogens) in biosolids that are land applied. Restrictions on contamination

levels are even more stringent to meet EPA’s highest grade ranking, and may be higher still to

meet the demands of particular customers willing to accept the residuals. As soon as

contamination levels in any one area exceed the allowable threshold, the POTW must dispose of

the biosolids as a lower grade product, or, in some cases, pay to incinerate it or dispose of it in a

permitted landfill.

Consider the example at Massachusetts’ Water Resources Authority (MWRA). The

facility invested in a sophisticated sludge pelletization facility that normally produces a product

sold as fertilizer. Yet, during the summer months molybdenum (Mo) from air conditioning

cooling towers drives Mo concentrations high enough that the pellets cannot be distributed in the

state, preventing the POTW from utilizing its biosolids in an optimal manner. POTW

management can rectify this constraint by increasing the amount of biosolids over which the same

amount of Mo is distributed (not a real option) or by reducing the amount of Mo that remains in

the residuals through source reduction.

 2

 “Biosolids: A Business by Any Other Name Would Smell as Sweet,” Environmental

Business Journal, February/March 1996, p. 9.
3-5

Exhibit 3-2

BIOSOLIDS MANAGEMENT

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Costs of biosolids management recovered through

general user fees on all dischargers.

-Where biosolids quality is poor, more expensive

management options are pursued. Cost of these are

spread among all dischargers. Voluntary reduction

plans or new local limits are implemented to bring

contaminant levels down.

-Cost for highest quality sludge allocated to all

dischargers based on quantities discharged.

-Incremental costs associated with poor sludge quality

allocated to dischargers of constituent(s) for which the

biosolids don’t meet the highest standards.

-If POTW unable to allocate full charges to these

dischargers, they can evaluate outreach or financing

pretreatment upgrades that reduce overall WWTP costs.

Budgeting

-Biosolids management costs are listed as a line item.

-Residuals testing costs may be listed under general

laboratory costs.

-All related biosolids costs would be grouped together.

Proper cost accounting should allocate the entire extra cost of biosolids management to

the activity that created that cost: Mo dischargers. Mo emissions are but one example; other

POTWs may have exceedances in a variety of metals. These emissions can often be linked to

specific industrial users, or to IUs as a group. For example, one plant on the East Coast receives

a very high proportion of its flow from industries. The level of contaminants in this flow is such

that they need to incinerate biosolids prior to disposal to destroy any remaining organics. The full

extra cost of the treatment is properly borne by the IUs rather than spread among all customers.3

What POTW managers choose to do with this information is up to them; the cost

accounting system merely tells them how much a particular occurrence costs them. Traditionally,

exceedences were met with regulatory reductions in allowable discharge levels. Many alternative

options are available:

• The POTW could increase discharge fees for the constituents of concern,

encouraging dischargers to implement better controls. This could be done

through direct fees, or through some type of effluent trading system.

• If the costs to the system from particular discharges are extremely high, but

delays associated with modifying permits or increasing discharge fees too

long, the POTW might actually find it economic to pay to install treatment

equipment on the sites of large dischargers. This approach is analogous to

demand-side management programs used for years by electric utilities.

 3

 This statement assumes that land application is less expensive than incineration. For

POTWs that already have incineration equipment, the variable costs of burning biosolids could

well be less than the total costs of land application -- at least until the burner needs to be replaced.
3-6

• If the costs of controlling the discharge are extremely large in comparison

to the cost of incinerating rather than land applying biosolids, the POTW

may decide that its current practice makes the most sense economically

(though not necessarily environmentally).

Effluent Reuse

The issues related to effluent reuse are quite similar to those associated with biosolids. A

well-functioning POTW will generally produce an effluent that is of sufficient quality that it can be

reused for some beneficial purposes. However, contaminants in effluent such as metals, salt, or

microbes, may prevent reuse of effluent for irrigation. Where are these contaminants coming

from? A detailed study of sources of salinity in Escondido, CA found that water softening plants

were among the largest sources of salinity in the discharge area. The salts introduced by these

plants were increasing the salinity of effluent to the point that the water was unattractive to

farmers.

Exhibit 3-3

EFFLUENT REUSE

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Effluent is often discharged in compliance with

NPDES permit and forgotten about.

-Foregone opportunities to resell the effluent not

evaluated.

-In water scarce regions, the cost of managing clean

effluent is allocated among all customers based on

volume of discharge.

-Lost cost savings from reselling the treated water to

farmers or other bulk users is allocated directly to the

dischargers responsible for discharging the constituents

that make the water unattractive to these alternative

outlets.

-If interest in reusing the treated effluent is low, POTW

needs to evaluate whether existing subsidies to clean

water (e.g., due to federal water projects) is artificially

depressing the value of reclaimed water for non-potable

uses.

Budgeting

-Effluent testing (e.g., Whole Effluent Toxicity) is often

grouped under the laboratory costs.

-Revenues from effluent resale go into general fund.

-All costs associated with monitoring and marketing

effluent should be grouped under an effluent

management category.

-Revenues from effluent sales should be credited to

effluent management.

Escondido is a useful illustration because the plant is located in a water-scarce region of

the country (near San Diego, CA), where demand for fresh water is extremely high. Logic

suggests that there would be many users interested in the region’s effluent, especially for nonpotable but higher value uses such as irrigation (see Exhibit 3-4). Yet this is not the case. The

quality of Escondido’s effluent is not yet high enough for agricultural usage, due to the discharge

of constituents such as total salts, chloride, boron, nitrogen, bicarbonate, manganese, and
3-7

fluoride.4 Boron and chloride are of particular concern to avocado growers, a large potential

irrigation customer.5

 These discharges are predominantly from industrial and municipal

dischargers; the rates charged to these dischargers do not reflect the lost opportunity to resell the

water.

Exhibit 3-4

EFFLUENT REUSE OPTIONS

Higher 

Quality

Lower 

Quality

Potable Uses

Irrigation

Recharge Surface or Groundwater

Artificial Wetlands

Saline Buffer Flows

Ocean Discharge

Geothermal Field Recharge

Despite these contaminants, side agreements between farmers and dischargers would likely

work to reduce the loadings of these constituents if the reclaimed water were sufficiently valuable.

Despite widespread shortages, Escondido’s effluent is not sufficiently valuable to farmers to

induce these types of arrangements. This is an arena where price distortions within the POTW

combine with price distortions outside to encourage wasteful use of natural resources.

Reclaimed water is most applicable for re-use in irrigation. Yet, it must compete with

irrigation flows from other sources. In most of the southwestern United States, this water comes

through heavily subsidized federal irrigation projects. Many of the federal water projects do not

charge irrigation users the interest on the debts incurred to construct the facilities. Many do not

even recover the full costs before interest.6

 Historically, irrigators have repaid only about 47

 4

 HYA Consulting Engineers, City of Escondido Brine Management Feasibility Study,

August 1995. Prepared for the San Diego County Water Authority, pp.3-5.

5

 Ibid., p. 3-5.

6

 U.S. General Accounting Office, Water Transfers: More Efficient Water Use Possible,

If Problems are Addressed, May 1994, p. 23.
3-8

percent of the total costs allocated to them.7 This percentage would be much lower if interest

were compounded on the capital costs of water projects (which the farmers do not have to pay),

as is normally done with capital investments.

Thus, farmers have received water rights well below the cost of delivering that water. If

the farmers could then turn around and sell their water rights to other users, they would receive a

windfall, but water would be priced efficiently. However, historically, farmers have not been able

to sell their water rights in federal projects to other users, and thus faced a cost of using it on their

crops far below what others were willing to pay for those rights. With artificially cheap fresh

water to use on their farms, farmers have little incentive to invest in creative strategies to reuse

treated sewage. With artificially low discharge fees, the dischargers of the constituents of concern

face little incentive to reduce their discharges.

Fats, Oil And Grease (FOG) Discharges And System Maintenance Costs

FOG discharges affect the collection system by clogging up pipes and pumping stations.

Sources include restaurants, auto shops, and food processing plants. As with biosolids and

effluent quality, discharges from a subset of system users can create large costs for the POTW.

Unless these costs are measured, utility staff may not invest the adequate resources to deal with

the problem. For example, one POTW in the Washington, DC area had numerous restaurants as

IUs. Despite efforts by the pretreatment program to control FOG discharges, main pumping

stations required expensive degreasing on a regular basis.

No tracking of how much materials, labor, and downtime associated with these clogs cost

the POTW per year was done. In fact, the pretreatment coordinator expressed frustration that the

maintenance staff assumed the work was costless, since they were salaried employees. This

inability to recognize the opportunity cost of time is often at the root of poor allocation decisions

within a POTW. While the maintenance staff were salaried, and thus did have to be at work

anyway, they could have been usefully employed on other tasks.

Once the cost is recognized, POTW staff can determine the most effective follow-up

strategy. In many cases, allocating the full cost of dealing with a problem such as oil and grease

clogs back to the contributory restaurant provides an extremely effective deterrent to improper

management. In the case of this particular POTW, however, political pressures made it difficult

to pass any substantial charges back onto restaurants due to a strong local restaurant lobby.

However, properly accounting for the costs might have shown POTW managers that more

outreach and education in this area was likely to pay off.

 7

 U.S. General Accounting Office, Bureau of Reclamation: Information on Allocation

and Repayment of Costs of Constructing Water Projects, July 1996.
3-9

For example, the POTW could have educated the restaurants about the growth in

biodiesel, a blend of diesel and bio-derived diesel originating, in part from waste cooking oil.8

Biodiesel blends, in conjunction with a catalytic converter, can reduce emissions of existing diesel

vehicles so they meet CAA standards and reduce air pollution in non-attainment zones.9

 This

growing outlet for FOG creates a lower cost disposal option than previously existed, potentially

reducing illegal discharges.

Exhibit 3-5

MANAGEMENT OF FATS, OIL, AND GREASE

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-FOG dischargers are forbidden from discharging these

constituents to the collection system.

-They pay a permit fee which may or may not reflect the

full cost to permit and oversee them.

-They may or may not be charged substantial penalties

for failure to empty their grease traps or when they clog

a collection pipe. When costs are charged back, they

often exclude indirect costs such as staff time, travel

costs, etc.

-Permit fees should cover the full cost of permitting

FOG dischargers and the full costs of any uncovered

FOG-related cleaning of the collection system.

-Full costs of addressing clogs should be charged back

to the firm causing the problem.

-If unrecoverable FOG costs are large, POTW should

increase outreach to explain new options for FOG

management.

Budgeting

-Cost associated with oil and grease are often lumped

under the general collection system line item.

Permitting for oil and grease is often in the

pretreatment line item.

-A line item for the entire FOG management program

should be included in the budget, and contain all costs

related to permitting, outreach, and FOG-related

maintenance.

-Any costs related to system downtime during a grease

clog should also be charged to the FOG program.

Specific Types of Customers May Cost More to Service than Others

Not all customers are created equal. POTWs need to recognize differences in the

demands that these different types of customers put on their staff and on their system. This is

generally done to some degree by all POTWs. For example, monthly service fees are higher for

larger sewer mains, and surcharges are usually levied on high strength wastewater. However,

there are many other ways that the costs associated with particular customers are not reflected in

rates. When POTWs do not recognize all of the important differences across customer classes,

their fee structures will contain a variety of behavior-distorting cross-subsidies. It is common that

 8

 Waste oil fractions of bio-derived fraction are currently about 50 percent, with the other

half from virgin soybeans.

9

 U.S. Department of Energy, Biofuels Update, Winter 1997, p. 3; Fall 1996, p.1.
3-10

residential users end up subsidizing industrial dischargers.10 Since it is the industries that generally

discharge most of the difficult or impossible to treat contaminants (e.g., metals), cross-subsidies

often end up subsidizing polluters, violating the polluter pays principle.

Permitting Costs

At least every five years, each industrial discharger must receive a new discharge permit.

The cost to provide this permit can vary widely. Small, standardized industries, such as one-hour

photo shops, have the same processes and the same issues in every shop. In addition, the

emissions from any single facility are unlikely to be large enough to cause operational or

compliance problems for the treatment plant. Permits can be standardized, and site visits are not

always needed. MWRA, for example, has adopted a group permit for all small photo shops and

printers, that applies automatically. This "group permit" approach saves substantial staff time.

Exhibit 3-6

PERMITTING COSTS

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Permit fees cover a portion of total permitting costs.

-Where fees do cover the full cost of the program, the

fees for any specific permittee may be substantially

different from the time required to permit them.

-Residential and commercial customers should not

cross-subsidize IUs.

-IU permit fees should be grouped by class of facility,

should include administrative support costs (such as

computer systems).

-Labor costs, including those to write the permit and

those required for inspecting the plant, should be

charged directly to the customer. Thus, complex firms

would pay higher permit fees.

Budgeting

-Permitting costs are often lumped into the general

pretreatment budget, if pretreatment has its own budget

section at all.

-Permitting, regular inspections, and enforcement

inspections are sometimes lumped together, or simply

included in the overall labor line item.

-Permitting, regular inspections, and enforcement

inspections should all be separate line items in the

pretreatment budget.

In contrast, consider a large automotive manufacturer. This manufacturer will have

multiple processes, and sometimes multiple discharge points. The impact of this plant’s

discharges on the POTW system can be substantial, but there are no other similar plants in the

service area. It is obvious that developing a permit for this type of company will require far more

time for staff, inspectors, and administrators than the small, simple plant. A cost accounting

system that properly measures how staff time is used and the costs associated with various steps

 10 In terms of total charges, residential users often subsidize industrial users. In some

cases, as noted below, the fixed service charges on residential customers are subsidized as well.
3-11

of the permitting process, can give POTW managers a much better feel for the incremental cost of

this type of discharger. This information can then be used to justify charging such a firm for these

permitting costs, reducing the burden on residential customers and small businesses.

Serving Industrial, Commercial, and Residential Customers

Providing metering and billing services, and operating and maintaining lateral collection

lines, are fairly fixed costs. For larger customers, meters might be a bit more expensive, and the

collection lines might be larger. However, many of these basic service costs are the same whether

one discharges five gallons of water per month or fifty thousand. In their basic rates, many

POTWs have tried to recognize this fact by charging fixed monthly service fees. A more

sophisticated cost accounting system will allow the utility to understand these differential rates

more clearly, perhaps refining their charges. Cross-subsidies with basic service tend to

undercharge small residential customers. This practice is dictated by a desire to make at least

basic wastewater treatment service available to all homes. By targeting universal service based on

consumption rather than income, this approach also unnecessarily subsidizes small residential

customers who have more than adequate income to pay the full charge.

Residential customers, however, require very little in the form of additional services from

POTW staff than hookups, metering, and billing. In contrast, industrial customers require an

entire pretreatment program. Aside from permitting costs already mentioned, a pretreatment

program expends substantial resources to inspect, enforce against, and educate industrial users.

In providing these functions, the POTW incurs substantial support costs related to litigation,

information management, and laboratory testing. Many plants track only very basic pretreatment

costs such as direct pretreatment staff. The substantial costs associated with the infrastructure

that is used to support the pretreatment program (e.g., staff training, legal, space rental, even

sometimes laboratory fees) are often lumped in the general overhead of the POTW rather than

allocated back to specific industrial dischargers.

The result can be a complicated mix of cross-subsidies among customer classes. In some

cases, the costs of running the pretreatment program exceed collections from industries from

permitting fees, other fees, and surcharges on discharge. In other cases, while industrial users

overall do cover the costs of pretreatment in total, payments by specific industries bear little

relationship to the costs they place on the POTW infrastructure. Subsidies tend to flow to large,

complex industries (who are charged the same flat rate as smaller firms) and to small categorical

industries (who require substantial regulatory oversight but are too small to afford a large user

fee).

Insights on Regulatory Efficiency

Cost accounting systems can help the POTW evaluate the efficiency of regulatory

requirements and the efficiency of its own implementation of pretreatment requirements.

Consider the following two examples:
3-12

• Small Categorical Industries. Small categorical industries provide an

instructive example for evaluating environmental cost/benefit tradeoffs.

EPA currently requires that all categorical industries be permitted and

monitored, simply because of the industrial processes they use. In some

cases, however, the firms are so small relative to the POTW’s flow that

their operations are irrelevant to wastewater quality in the region. Yet the

staff time required to permit and inspect these firms can be substantial. In

this situation, allocating these costs directly to the small firm may be

unworkable, as the charges would be excessive. However, tracking the

costs can help the POTW illustrate the relatively poor cost/benefit trade-off

associated with the current regulatory regime for small CIUs, and provide

useful input to EPA’s current streamlining effort that may change some of

these requirements.

• Cost of Pretreatment Program. A well respected POTW on the west

coast wanted to better allocate the cost of its pretreatment program to the

industrial dischargers. It undertook a fairly extensive effort to assess the

differential workload to implement its pretreatment program for different

classes of customers (e.g., large industrial dischargers, small industrial

dischargers). Included was time spent on permitting, sampling, inspections,

report reviews, enforcement activities, laboratory analysis, and

administration. The resulting numbers showed increases in allocated fees

for most industries of between 27 and over 10,000 percent. The upper end

of this range was for categorical industries with extremely low flow.

However, even relatively large firms would have received substantial rate

increases. Faced with these figures, the POTW decided to retain a

substantial portion of the cross-subsidy between residential/commercial

customers and IUs, increasing IU charges only slightly. Managers did not

seem to consider the extremely high fixed costs of the program per

discharger as an indication that (1) some of the regulatory requirements

were inefficient; or (2) that their implementation of the requirements could

be streamlined. Retaining the cross-subsidy removed the financial pressure

to address these other factors.

Improving Charge Backs for Cost of Service

Even if industrial users do pay the entire cost of the pretreatment program, there may be

distortions within this group of users. This occurs because the oversight requirements can vary

widely across different industries due to the size, type, or complexity of a particular plant.

Improving the tracking and charge backs for these types of services can greatly reduce crosssubsidies. Below, we present a number of activities that could benefit from this approach.
3-13

Sampling and Laboratory Support

Federal law requires sampling IU discharges a minimum number of times per year. These

samples must then be analyzed. Many POTWs add up their laboratory fees, divide by the number

of IUs, and recover these costs in fees. This approach is relatively simple, but does not accurately

reflect the costs to the POTW associated with sampling and testing. First of all, not all

procedures are the same complexity (or cost). For example, testing for pH is straightforward and

inexpensive; certain metals analyses are not. Tracking costs more carefully provides important

information to the POTW:

• Are there certain analytical tests that we do too few of to justify the capital

equipment needed to do them and should be outsourced? This decision

must be viewed not only in terms of dollar savings, but in terms of how the

speed and quality of results on outsourced testing compares to doing it inhouse and affects the POTW’s basic mission. Many POTWs have reduced

costs substantially by sending some specialized analyses to outside labs, or

by increasing their analytical volume by accepting samples from other

municipal agencies (in-sourcing).

• Are there certain IUs that create a substantial cost burden on us because of

the types of materials they discharge? Are there ways to help them

substitute less-problematic materials or switch to zero discharge?

Exhibit 3-7

SAMPLING AND LABORATORY FEES

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Lab and sampling fees absorbed by utility; or

-Lab and sampling fees divided evenly among IUs.

-Costs of actual sampling and analytics required tracked

and charged back to specific IUs.

-Costs include labor of sampling or lab technician.

-Costs include overhead related to equipment used:

depreciation, rent on laboratory space, etc.

Budgeting

-Laboratory budget listed as a separate line item.

- Sampling costs hidden in overall pretreatment budget.

-Laboratory costs related to pretreatment shown as a

line item in the pretreatment budget; laboratory costs

associated with other activities grouped with those

activities.

-Sampling costs listed as a separate line item under

pretreatment and enforcement, depending on reason for

taking samples.

Because IUs often send their own samples to private labs for analysis, they will be familiar

with the prevailing charges for particular types of analytical work. This makes benchmarking

laboratory performance both easy to do and quite important. If full costing of laboratory tests

inside the POTW suggests the tests are substantially more expensive than external ones, POTW

managers will need to proceed cautiously in terms of what they charge IUs. They should also
3-14

identify the reason(s) that internal services are more expensive and use this information to guide

their next steps.

Enforcement Activities

As soon as a violation is suspected, pretreatment activity for a specific IU tends to

increase. Inspection visits are likely to rise, including some surreptitious sampling. The number

of samples being taken and analyzed will also rise. If litigation begins, legal costs for the POTW

will also increase substantially. The polluter pays principle suggests that all of these costs should

be passed on to the violator. Where a violation is suspected, but not found, enforcement costs

should be borne by the pretreatment program overall, but not charged to the specific facility.

Exhibit 3-8

ENFORCEMENT ACTIVITIES

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Increased inspection costs absorbed in general

pretreatment program costs.

-Increased laboratory analysis often included in general

laboratory spending rather than charged to the IU.

-A cost object should be set up for each IU under

enforcement suspicion, with all related work

(inspection, sampling, litigation) tracked and recovered

from the IU.

-If a suspected violation turns out not to be real, costs

should be borne by all IUs in general.

Budgeting

-Costs for inspection, laboratory analysis, and litigation

are generally spread into three functional areas

(pretreatment, laboratory, and legal). This makes it

difficult to track spending per case, an important figure

when setting penalties.

-Managers should have the ability to track spending by

case. An enforcement line item that contains all

supporting sub-activities might be a way to accomplish

this.

Costing Wastewater Treatment Separately from Water Delivery

Across the country, many districts are served by integrated utilities that provide both

water and wastewater services. Integration of the services can offer efficiencies, such as

coordinated billing. However, many integrated utilities do not make a clear distinction between

the costs of the water and those of the wastewater system. As a result, the fees set by the utility

may send the wrong signals to customers. If water is underpriced, customers may not adequately

conserve water. If wastewater is underpriced, large dischargers will have a reduced incentive to

improve their in-plant reuse of water.
3-15

Exhibit 3-9

WASTEWATER TREATMENT AND WATER TREATMENT/DELIVERY

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Functional services provided to both water and

wastewater customers are not tracked separately.

Examples include administration, laboratory, and

information systems.

-Activity drivers are used to allocate all joint costs to the

respective services provided.

-Costs are then further allocated to specific IUs based on

demand for those services whenever possible.

Budgeting

-Wastewater and Water services are generally broken

out in budgets. However, each of these budget areas

will often exclude costs associated with support

functions. As a result, there may be substantial

overhead costs that have not been linked to either

business service provided.

-Budget breakouts for wastewater and water should

include administrative support services.

Discharger Location and Multi-Plant Systems

Discharger location within a treatment plant service area can affect the cost of treatment in

three main ways. First, the distance from treatment may generate higher unit costs for collection

systems (more miles of pipe travelled) and may require additional pumping. Second, a large

system, especially those with multiple treatment plants, may have a mix of newer and older assets

that have very different technical constraints and cost structures in different parts of their districts.

Large differences are common in industry. For example, the cost difference between the best and

worst performing plant within a single firm can vary by a ratio of three to one. Even once

technical parameters such as plant age, technology, and location are controlled for, this variation

can still be as high as two to one, indicating the importance of good management in plant

efficiency.11 Finally, since a substantial portion of the cost of wastewater collection and treatment

is fixed, differences in capacity utilization can have large impacts on unit costs.

Understanding and tracking this variation is important in rationalizing existing capacity.

Where capacity is tight, differential wastewater fees can encourage new development to occur in a

lower-utilized portion of the system.12 These fees can also encourage discharges to conserve the

scarce resources, allowing the infrastructure to last longer. Where a utility wishes to have

uniform rates across the service district despite substantial variations in the cost of service,

improved cost accounting can enable POTW staff to better target their pretreatment or

conservation resources.

 11 Chew, W. Bruce, Timothy Bresnahan, and Kim Clark. “Measurement, Coordination,

and Learning in a Multiplant Network,” in Robert Kaplan, editor, Measures for Manufacturing

Excellence, (Boston: Harvard Business School Press, 1990), p.129.

12 Obviously, water treatment fees are but one of many variables evaluated by a company

when deciding where to locate a plant.
3-16

The information can be used by managers to plan infrastructure improvements, as well. For

example, one Virginia POTW linked its plants together, enabling them to average demand across

the network by diverting streams whenever necessary.13

Exhibit 3-10

DISTANCE FROM PLANT/MULTI-PLANT SYSTEMS

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Discharger fees often based on the average cost of

servicing all zones. POTW management may not have

a good handle of differential costs of service due to asset

type, distance from treatment, or utilization levels.

-Although many districts have higher fees for IUs

outside of the city, these rates often have more to do

with political power than with differential costs of

service.

-POTW should track differential costs of service based

on distance or zone of the district to use either in rates

or in planning.

-Cost surcharges for differential service costs (such as

collection and pumping) may be in order.

Budgeting

-While some POTWs have separate budget information

for different treatment plants, even these may not

include the associated overhead costs.

-Often, infrastructure costs are lumped together.

-Budget line items for specific assets to support

peripheral service may be helpful.

-Budget line items for specific key assets with very

different costs may be helpful.

Capacity Limits to Existing Plant May Drive Up System Costs

Wastewater treatment systems are complex processes with numerous constraints. For

example, collection systems can be too small to allow a district to utilize its entire treatment

capacity. Treatment capacity may be too small to handle the current flow. In both of these cases,

the utility can invest in expansions to solve the problem. Alternatively, cost accounting can give

program managers information on which dischargers are utilizing the largest portions of the

constrained item so they work with these dischargers to reduce their loadings. This is analogous

to demand side management programs in electric utilities, and may be substantially less expensive

than expanding supply.

Physical flow constraints are but one of many possible parameters that may limit system

capacity. For example:

• Very high strength wastes may require longer residence times than standard

discharges. Since throughput is equal to technical capacity multiplied by

average residence time, longer residence time can use up plant capacity in

the same way that large flow can.

 13 This increased flexibility comes at a cost, however. The cost of the flow diversion

infrastructure is similar to capacity expansions to handle peak flows, and should be allocated to

the customers causing the peaks.
3-17

• Peak loadings in flow, strength, or other parameters, may require larger

scale or more complex treatment plants, driving up costs as well. Cost

accounting can help identify what customers or practices drive up peak

loadings and identify ways that peaks can be reduced.

Pricing capacity is very important if the WWTP wants to send the proper signals to

dischargers, encouraging them to reduce their demand during peak periods. A variety of pricing

schedules have been developed in the electric and natural gas utility industries for this very reason.

For example, peak prices tend to be higher than off-peak prices. Industries that are willing to be

“shut off” during peaks are given discounts. Finally, the allocation of peak system costs among

customers is done to try to reflect which customers drive the peak demand.

Gas utilities allocate infrastructure costs, such as distribution systems (analogous to

collection systems in WWT), using the minimum size theory. The smallest scale system required

to serve a standard customer is allocated to each customer. The difference between the smallest

scale system and what is actually in place is allocated based on demand. Thus, larger dischargers

pay a higher share of the infrastructure costs.

Exhibit 3-11

HYPOTHETICAL IMPACT OF PEAKS

ON PLANT SIZING

0.8x mgd

0.3x mgd safety margin

x mgd capacity

Capacity required to treat peak 

flows, including inflow and

infiltration

Variation in dry weather flow plus 

allowance for near-term growth

Average Daily Dry Weather Flow

But on top of the larger dischargers is the issue of peak capacity. The additional cost of

handling peak discharges can be substantial. Exhibit 3-11 above suggests that the required

treatment capacity can rise substantially to handle peak flows. Additional collection capacity and

storage facilities need to be built as well. Allocating these costs appropriately can be quite a

challenge. Some rules of thumb:

• Basic capacity, plus a safety margin for normal variance in dry weather

flow, should be allocated equally to all customers.
3-18

• Incremental capacity required for above-average dischargers should be

allocated to customers using that capacity based on flow. There are a

couple of common methods to allocate these demand charges among users

to encourage peak reductions.14

− Coincident Demand Method Also known as the peak responsibility

method, costs are allocated to customers based on their demand during

the time of system peak.15 The rationale is that demand patterns at this

point in time are what drive the utility to build the scale plant it did.

− Noncoincident Demand Method Allocates costs based on the

individual peak for each customer, regardless of when this peak

demand occurs relative to the peak demand on the treatment system

overall. The noncoincident demand method makes sense when the

sizing of capital is driven more by the individual peak than by the

aggregate peak, such as may be the case with the size of portions of the

collection system.

− Average and Peak Demand Method. Under this method, the average

load rate multiplied by the total demand charges to yield the costs

associated with average use. These costs are allocated among

dischargers based on share of annual loadings. The residual costs are

assumed to be associated with peak demand and allocated based on the

coincident peak method.

Electric and gas utilities have long worked to manage peak demand through their rate

structures. Some of these approaches have been adapted by wastewater treatment plants; others

may be valuable peak management tools going forward. These are summarized below in Exhibit

3-12. A number of peak-related issues for POTWs are then presented in greater detail.

 14 National Association of Regulatory Utility Commissioners (NARUC), Gas Distribution

Rate Design Manual, (Washington, DC: NARUC), June 1989, p.27.

15 To reduce the cost impact of measuring the single annual peak imprecisely, many

utilities average the contributions to the top five or ten peak periods throughout the year to

calculate the cost allocations.
3-19

Exhibit 3-12

DIFFERENTIAL RATES FOR PEAK LEVELING

Issue Cost Impacts Rate Solution

Peak demands create need for

expensive, larger scale capacity,

though this capacity is infrequently

used.

POTW must build expensive

collection and treatment capacity to

meet those peaks.

-Interruptible rates provide

reduced charges to customers

willing to forgo services during peak

events. For POTWs, IUs might

have storage capacity on-site

enabling them to delay discharge for

a week or so.

-Demand charges based on peak

consumption patterns forces

consumers of peak capacity to bear

most of the cost of providing it.

Seasonal populations or production

drive demand far above “normal”

level.

POTW must build expensive

collection and treatment capacity to

meet those peaks.

Seasonal rates charge higher rates

for users during the peak season to

encourage peak leveling. The

coincident demand method of peak

allocation accomplishes this same

goal.

IU has internal treatment, but

wishes to rely on POTW as a backup

in case of problems with in-house

system.

POTW needs to provide collection

system infrastructure and capacity

for an infrequent user.

Standby rates recover these

incremental costs through fixed

charges rather than through fees on

discharges.

Source: National Association of Regulatory Utility Commissioners, Gas Distribution Rate Design Manual, June

1989, pp. 51-53.

Inflow and Infiltration (I/I)

Wastewater treatment capacity is very expensive. While there are economies of scale in

bigger collection pipes and bigger treatment plants, the absolute cost per unit treated remains

high. Given these costs, the size of the entire treatment system should be built only to the size

needed for the population to be served. Perhaps more than any other source, I/I drives up the

capital infrastructure of wastewater treatment. I/I is comprised of a variety of sources of street

runoff, combined sewer overflows, and leaks that let rainwater into the sewage system. Once

these sources enter the sewer system, they require pipe capacity to be transported to the treatment

plant, storage areas for when the treatment plant is at capacity, and treatment capacity to treat

what used to be relatively clean water.
3-20

Storm surges can be managed through retainment basins that store peak flows, allowing it

to work it’s way through the POTW during the weeks following the storm event. This peak

leveling technique is less expensive than building treatment capacity large enough to treat the

storm peaks. However, it still requires larger sizing of collection systems and pumps, as well as

the cost of building and maintaining large storage basins.16

I/I is a big problem. According to a recent AMSA survey, inflow and infiltration (along

with stormwater that goes to the plant) comprised almost 25 percent of total flows, increasing the

treatment capacity required by the same amount. This figure represents an average; values for

specific plants are substantially higher.

Exhibit 3-13

AGGREGATE FLOWS OF 107 POTWS

Flow Type Flow (MGD) Percent of Total

Infiltration/Inflow 2,423 20.2%

Combined Stormwater 502 4.2%

Total Wet Weather to Plant 2,925 24.4%

Residential 6,826 56.7%

C&I 2,253 18.8%

Total to Plants 12,005 100.0%

Source: Association of Metropolitan Sewerage Agencies (AMSA), The AMSA

Financial Survey, 1996, p. A-17

The costs of extra capacity to handle wet weather peaks associated with I/I should

be allocated as closely to their sources as is possible. Often, the closest one can come to such an

allocation is apply the costs to a particular zone of the collection system, and then allocate within

that zone to each customer. However, careful costing of the I/I events can provide extremely

strong inducements to correct common sources of I/I, such as manhole or sewer leakage, sump

pumps, or faulty sewer connections. A detailed study of I/I control options in the Lower Paxton

Township Authority in Pennsylvania is instructive, shown in Exhibit 3-14.

 16 The placement of storage basins is also important. Placing the basins away from the

plant allows a reduction in the peaking capacity required on the trunklines as well, saving

additional funds.
3-21

Exhibit 3-14

INFLOW AND INFILTRATION CONTROL IN LOWER PAXTON TOWNSHIP

AUTHORITY, PA

Control

Approach

I/I Contribution

(%)

I/I Control Costs

($/gallon removed)

Remove Sump Pumps 19 $0.04 - $0.27

Grout Manholes 25 $0.04 - $0.30

Grout Sewers 15 $0.05 - $0.36

Mainline Replacement <1 $0.16 - $2.22

Lateral Repairs 42 $0.20 - $3.72

Equalization Basins N/A

-Above ground tank $0.98

-Below ground tank $1.32 - $4.80

Convey and Treat N/A

-Additional capacity at

existing plant

$6.16

- Construct new plant $3.81 - $18.80

Source: James Elliott et al., “Removing Private Sources of Infiltration and Inflow,” Water

Environment & Technology, August 1997, pp. 55-60.

The implications of this specific analysis are clear. For POTWs facing capacity constraints

due to I/I problems, supply-side options exceed the cost of demand-side options to reduce the

inflow by a wide margin. Proper cost accounting for the cost of handling the peak flows can

provide POTW managers with very clear signals in this regard, giving them leverage to implement

control strategies quickly:

• Increase Rates. Charging I/I sources the incremental costs of having to

increase POTW capacity to handle the flows would induce rapid control of

the many private sources of I/I.

• Defer Acceptance of Developer-Constructed Collection Systems. The

Pennsylvania study estimated that over 40 percent of the I/I entering the

plant came from defective lateral lines. These lines are often built by

developers as a condition of allowing the development to go forward. The

incentive of these developers is to put in the lateral lines as cheaply as

possible so that the POTW will accept the new dischargers and people will

buy the new property. Often these laterals are poorly built and leak from

the beginning. Armed with information on the real cost of I/I, POTW staff

can refuse to accept the new laterals until they have proven to be of sound

quality. The POTW can also require bonding that allows the I/I to be

corrected if the laterals are problematic.
3-22

• POTW-initiated Remediation. Where charging I/I sources their

contribution is impossible due to measurement problems or political issues,

the POTW may still find it less expensive to pay for retrofits directly in

order to avoid the need for new plant capacity.

Exhibit 3-15

INFLOW AND INFILTRATION

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Costs of I/I embedded in the baseline capital costs of

the facility through increased scale requirements.

-As facility nears its existing capacity for wet weather

flow, storage, or treatment, I/I issues become far more

important.

-In plants with excess capacity, incremental costs of

handling I/I should be charged back to sources of I/I --

at least to zones of the system. In plants with dwindling

capacity, costs of capital expansion to alleviate the

shortage should be charged back to I/I sources to

encourage comprehensive I/I controls.

-Exceedances associated with SSOs from I/I should be

charged back to I/I sources.

Budgeting

-POTWs may have I/I or stormwater divisions that deal

with I/I issues. However, these costs may not include

administrative support needed or the costs of increased

capital sizing.

-New capacity required for I/I related peaks should be

budgeted and include all financing costs.

-I/I operations should include supporting administrative

and analytical functions.

Large Dischargers and Seasonal Peaks

The minimum size theory allocates baseline costs of treatment across all customers. Large

dischargers create additional demands on the system by the sheer quantity of wastewater

discharged. Collection pipes, pumps, and treatment infrastructure must all be made substantially

larger to handle the additional flows. To encourage efficient decisions regarding on-site reuse or

treatment versus discharge, the incremental costs of the additional equipment needs to be

allocated back to its sources. Most POTWs do this in the form of a discharge fee. Peak rate

pricing will spread the incremental costs of facility size across a smaller portion of the discharging

universe, as a large number of customers (e.g., residential) will not exceed the level of discharge

used in the minimum sizing of the system. As a result, the rates per unit discharged on these high

quantity dischargers could well be higher than the rates charged for the baseline system.
3-23

The more variable these large discharges, the larger the incremental units charges are

likely to be. This is because the same fixed capital must be put in place to handle a smaller annual

flow. In resort areas, for example, populations can double or triple during peak months, creating

demand spikes for support functions such as wastewater treatment. (Once again, the spikes for

WWT are more difficult to handle than, for example, those from electrical demand, since services

are difficult to import. Networking plants is one way to better absorb the peaks). Seasonal

surcharges reflecting demand patterns during this peak period can help send the proper signals to

dischargers to conserve capacity more during the peak months. Many POTWs increase rates only

to seasonal customers. This approach, while seemingly more equitable to year-round residents,

will not encourage capacity conservation by all dischargers. This may reduce the opportunities

for minimizing the costs of demand reductions.17

Exhibit 3-16

LARGE DISCHARGERS/SEASONAL PEAKS

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Large dischargers are normally charged a fee per unit

discharged requiring treatment (excluding surcharges

for strength).

-Fees for larger users vary from lower than average (a

form of a volume discount) to higher than average

(increasing block rates). It is difficult to ascertain how

closely increasing block rates are linked to cost impacts

of large discharges.

-Many POTWs do not increase rates during peak

seasons.

-Unit fee should be based on incremental capacity

required to handle the larger flows.

-Discharge fees should be higher during seasonal peaks.

These surcharges should be borne by all dischargers

requiring services during the peak months and not

exclude year-round residents.

Budgeting

-No differentiation of peak and baseline costs or

revenues.

-Differentiation of peak and baseline costs would help

illustrate the incremental costs of peak-increasing

demand patterns.

System Expansions May Create New Challenges

System expansions create challenges for POTWs for two reasons: the large scale of most

new capital equipment (capital “lumpiness”), and a pricing model that charges users the average

cost of existing capacity even when adding to that capacity would be substantially more

expensive. Each of these items is explained in greater detail below:

 17 Seasonal pricing is a good example of how important the timing of pricing signals is.

Unless dischargers during the peak months know ahead of time that their rates will be

substantially higher than normal, they will have little incentive to reduce their discharge levels

through increased recycling or water conservation.
3-24

• Capital “Lumpiness.” Wastewater treatment is a capital intensive industry

with substantial economies of scale. Thus, new capacity is brought on line

slowly, and in fairly large capacity “lumps.” Right before new capacity

comes on line, the old capacity is likely to be fully utilized, with capacity

shortages. Right after the new capacity comes on-line, utilization will drop

substantially, and unit costs (i.e., the capital costs per unit treated) rise

significantly. While all capital intensive markets experience this dynamic to

some degree, it is worse in wastewater treatment. In the paper industry,

for example, a new plant can export its production over a wide area. Thus,

the new capacity surplus is shared by multiple plants rather than just one.

POTWs provide services in a fixed area; it is quite difficult to “import”

more wastestreams to treat. Thus, the plants’ operate with substantial

excess capacity until new growth increases the wastestreams requiring

treatment.18

• Average Cost Pricing. Because POTWs are regulated industries with rates

based on their cost of service, the rates charged to customers are, in effect,

the average cost of service. If changes in regulations, financial conditions,

or construction costs make plant additions (which are the marginal costs

for the utility) more expensive than the average cost of existing plants, the

average cost price could be substantially lower than what the utility will

need to charge once the new plant comes on line. As a result, dischargers

will not get the price signals that would exist in a competitive market that

capacity is becoming tight and they should do what they can to reduce their

discharges.

System Expansion to New Areas/Customers

POTW expansion can bring many capacity issues to the surface. The cost of new lateral

lines to service these customers should generally be borne in full by the new customers. More

complicated are issues associated with how the new discharges will affect capacity requirements

in trunk lines, pumping stations, and treatment plants. These impacts may be from normal

discharge rates, or from new peaking demands (including I/I) from the additional load. New

discharges may also affect the quality, and hence the marketability, of residuals.

A common tendency is to want the new dischargers to pay the full costs of extra capacity

associated with their discharges. As noted above, unless the cost of scarce capacity is charged to

all dischargers rather than just new ones, the proper price signals to reduce consumption of the

scarce capacity will not be sent. This being said, proper accounting of the full cost of the

 18 Problems associated with capital lumpiness can be mitigated somewhat by coordinating

collection system expansion with new treatment capacity construction, and by installing a series of

smaller scale treatment units as demand rises.
3-25

expansion is needed to compare against alternatives. As in the I/I example above, many

alternatives could be less expensive than simply expanding conveyance and treatment capacity to

handle the new volume.

One key issue to be grappled with is the issue of centralization versus decentralization.

For dense, urban populations, centralized treatment of wastewater is generally the most efficient

approach. At some point, as collection systems are expanded into more sparsely-populated

districts and centralized treatment capacity it used up, the full cost of expanding centralized

treatment could well exceed that of using a smaller-scale, decentralized approach.19 One

outspoken critic of the centralized treatment model argues that many viable decentralized methods

are overlooked, and that packet plants under the control of a sewerage authority, could often be

used.20 New technologies, such as artificial wetlands, are also more viable in rural areas where

land is more plentiful and retention times can be increased. Technologically, unless sewerage

authorities recognize the niche, off-grid opportunities for these evolving techniques, the

approaches will not benefit from the trials and incremental improvements that allow them to move

into the mainstream over a period of a decade or so.

Without proper cost accounting, the break-point for alternative treatment is not visible to

plant decision makers. Any costs associated with extensions, including new treatment capacity,

new debt issuance, and increased pumping or collection system capacity need to be compared to

the cost of decentralized alternatives.

Differential Impacts of System Expansion by Customer Class

The available options for addressing new service needs can be constrained by particular

types of dischargers in the new areas to be served. Unless the full costs of these special

requirements are properly tracked and allocated to their causal factors, the utility may decide to

pursue a less cost-effective option.

Consider the example of a large industry looking to locate in a rural area, and wanting the

POTW to provide service to them. Many residential and commercial customers will receive

service as well, reducing the unit costs of the extension. However, this particular industry

discharges constituents that interfere with the effectiveness of the decentralized options or which

contaminates residuals, precluding their local reuse. In the absence of this discharge, the entire

region could be serviced at a substantially lower cost using decentralized treatment and local

reuse of biosolids and effluent. In this example, the entire incremental cost of extending the

 19 For example, two small towns, one in West Virginia and one in Virginia, realized

substantial savings (42 to 65 percent) using alternative systems rather than installing a

conventional WWTP. See U.S. General Accounting Office, Water Pollution: Information on the

Use of Alternative Wastewater Treatment Systems, September 1994, pp. 3-4.

20 See David Venhiuzen, “Paradigm Shift: Decentralized wastewater systems may provide

better management at less cost,” Water Environment & Technology, August 1997, p. 49.
3-26

centralized system over building a smaller, less complex decentralized system (plus the lost

revenues on residuals reuse), should be allocated to the industry. Town development authorities

may decide to go forward anyway, arguing that many other industries would soon follow;

however, at least the decision would be made with an understanding of how much servicing the

industry was really costing the municipality in the short-term.21

Exhibit 3-17

SYSTEM EXPANSION/CENTRALIZED VERSUS DECENTRALIZED TREATMENT

Common Practice Improved Cost Accounting/Budgeting

Cost Accounting

-Costs of infrastructure assets are not generally

disaggregated in such a way to be able to assess the full

costs of line extensions.

-Incremental costs of capacity expansions may not be

linked to the factors driving that need (e.g., expanding

service to a new area). As a result, system expansion

can’t be compared to decentralized alternatives or

demand-side management.

-Costs associated with system expansions not always

linked to specific customers or customer classes.

-Costs of scarce capacity should be borne by all

dischargers contributing to that scarcity, not just to new

entrants.

-The total cost of system expansion, including all

impacts on conveyance and treatment, needs to be

compared to alternative methods to provide service.

-Where these expansion costs are due to specific types

of discharges or dischargers, costs should be borne by

those particular entities.

Budgeting

-Costs of extensions are hidden in very general capital

acquisition line items.

-Budget line items should provide managers with

information on the full incremental costs of system

expansion.

Interjurisdictional Agreements

Many POTWs receive flows from dischargers located outside of their jurisdictional

boundaries. In these circumstances, POTWs face a difficult situation: the discharges force them

to incur costs and affect plant performance, yet they have no political authority over the

dischargers. This issue is resolved using a contractual agreement called an Interjurisdictional

Agreement (IJA). IJAs outline the rights and responsibilities of the various municipalities in the

agreement (there are sometimes more than two), but often do so in a fairly legalistic and unwieldy

way. IJAs do not inherently increase the distortions associated with POTW management;

however, in practice they often constrain the ability of the receiving POTW to regulate

dischargers or adequately recover costs. The case study of Escondido, CA in the next chapter

provides additional illustration of the challenges IJAs can create.

 21 A General Accounting Office study of alternative treatment technologies found that

some state and local codes actually required conventional treatment, creating a substantial barrier

to the use of alternatives. Codes such as these make it hard to attract investment for system

construction because not always clear if the plant will, in the end, be permitted. See U.S. General

Accounting Office, September 1994, op. cit., pp. 40-43.
3-27

While IJAs can be changed, doing so requires a fairly complicated political process and is

generally difficult to do. As a result, IJAs are often left in place despite their problems. Costs on

a system from dischargers in another municipality may be borne in part by in-system dischargers,

artificially increasing the cost of wastewater treatment to local industries.

Cost accounting can be a useful tool to highlight the cross-subsidies that an IJA may

entail. By tracking the cost impacts of discharges, as described in the various sections above, and

then grouping these costs for all dischargers in another municipality, POTW management can

assess if cross-subsidies exist and how large they are. This evaluation will help managers

determine when cross-subsidies are so large that the IJA must be renegotiated, and when

improved outreach or even in-plant investment in discharger plants can have a positive return to

the utility.
4-1

4. DETAILED CASE STUDIES

To augment the topical summaries, we have conducted case studies of budgeting

and cost accounting systems in place at two actual POTWs.1 The complexity associated

with running a POTW is not quite as apparent in the topical summaries as when the

multiple functions and systems are evaluated together. The case studies illustrate how

small distortions, when combined with others in a POTW, can have a large impact on

facility sizing and operations. The case studies also illustrate how the needs of, and

constraints on, various groups involved with the POTW make compromises in costing

(relative to the theoretical optimum) necessary. POTW managers can use the information

contained here to help them strike their own balance regarding what information they

collect and how this information is used relative to budgeting and rate setting. As noted

throughout the report, the purpose of improved information is to enhance managerial

decisions whether or not there are any changes made to rates.

We are very appreciative of the many people associated with the City of

Escondido, the Massachusetts Water Resources Authority (MWRA), the City of San

Diego, and the San Elijo Joint Powers Authority who were willing to give us their time

and insights to make these case write-ups possible. The City of Escondido is a relatively

small treatment plant with important treatment assets shared with its surrounding cities,

including San Diego. MWRA is a large municipal system servicing scores of communities.

It acts as a wholesaler, charging towns rather then dischargers for their services (other

than pretreatment which is billed directly to IUs). This mix of facilities allows us to

present a wider range of issues than would be possible with very similar POTWs.

The City of Escondido, CA

Escondido, CA is a medium-sized town located outside of San Diego. The city

operates its own wastewater treatment plant, the Hale Avenue Resource Recovery Facility

(HARRF). Escondido participated in EPA’s evaluation of pretreatment program success

factors and challenges last year, and agreed to participate in this effort as well. The city

was targeted as a case study due to a number of interesting characteristics identified

during last year’s site visit.

• Capacity Shortages. The city is at or near capacity for both its

treatment plant and its outfall. Careful allocation of costs, in order

to encourage capacity-conserving behavior on the part of

dischargers, becomes increasingly important as existing capacity is

used up.

 1

 Case studies are based on a contribution of written documents, telephone

interviews, and personal interviews. To protect the candor of interview participants,

specific comments have not been cited to individuals. Citations within the chapter are

limited to written materials.
4-2

• Sharing of Key Assets. The city shares key program assets with

surrounding communities, including the both the outfall and its

treatment plant. Sharing of these resources is governed via

interjurisdictional agreements, instruments that are difficult to

modify and do not always send the proper pricing signals to

participants.

• Informal Conditions Associated with Municipal Discharges.

The city receives discharge from a municipally-owned water

treatment plant (WTP). Although the WTP discharges have

significant impacts on plant operations, the relationship between the

water and wastewater plants is informal and not based on the

economic value of services being provided. This type of

arrangement is not uncommon in municipalities, but can make

efficient plant operation more difficult.

• Sale of Valuable Residuals Constrained by Contaminant Levels

and External Government Subsidies. Located in water-scarce

Southern California, Escondido should have ready resale markets

for its effluent. However, a combination of high contaminant levels

(salts and metals) and artificially cheap alternative sources of fresh

water for irrigation impede HARRF’s ability to remarket its

effluent.

While the discussion below is organized by topic areas, there are a few underlying

issues that bear mentioning. The first, fragmentation of control, impedes Escondido’s

ability to rationalize its limited resources. Fragmentation of control dilutes management’s

power to regulate and control practices that affect the operation of its plant. In the city of

Escondido, fragmentation issues affect its pretreatment program, its optimization of key

assets (such as the treatment plant and the outfall), and the resale of effluent. Although

cost accounting approaches can help the POTW to identify the costs of existing practices

as well as more efficient solutions, the fragmented control will require political action to

rectify. Staff were well aware of the rigidities that this fragmentation created for their

program; on more than one occasion, interviewees remarked that long-term planning and

expansion would be much easier if the region were organized as a special utility district

rather than governed through interjurisdictional agreements.

The second common theme in many of the Escondido areas examined is that of full

cost recovery. This includes not only the recovery of aggregate costs from dischargers,

but the use of peak pricing to allocate these costs more directly to specific dischargers. In

some cases, the POTW did not know the full costs of particular activities. Even where

they did have a rough idea of the full costs, however, managers knew that political realities

prevented them from passing these costs back to the parties responsible. In an effort to

create a “business-friendly” environment in the town, managers were under great pressure

to keep rates to industry low. Escondido has relatively small flows from industry.
4-3

However, their concerns about being business friendly echo those we have heard from

many other programs where IUs flows are much more significant. Without sending the

proper price signals to industry, water pollution will continue to be subsidized, and

industries will underinvest in pretreatment.

General Approach Towards Cost Accounting and Budgeting

Escondido’s focus in the cost accounting arena has been on separating water and

wastewater costs, and on ensuring that existing users don’t bear the costs of new capital

expansion triggered by new users. With these goals in mind, the city set up separate water

and wastewater enterprise funds, with a statutorily-defined separation of accounts. Funds

can not be transferred from one account to another without utility board approval and the

creation of a formal loan agreement. This arrangement prevents cross-subsidies between

water and wastewater operations, as well as protects any wastewater surpluses from being

raided by other municipal functions, a frequent complaint in other cities.

The POTW relies on the city government for many of its support functions, such

as administration, finance, engineering, legal, management and information systems (MIS),

and human resources. Costs for these functions are allocated to wastewater operations

based on the number of staff-hours spent on wastewater activities. Such an approach,

while a reasonable approximation of costs, may be inaccurate for activities where capital is

a large cost component, such as MIS.

The separation of funding sources into existing customers and new connections for

capital expansions helps to ensure that the existing customer base does not bear the cost of

new growth in the community. New construction is funded through a flat capacity

(currently $4,403) charge per equivalent dwelling unit or “EDU”. One EDU allows a

customer to hook into the sewer system and discharge up to 250 gallons per day. The

rationale for this approach is that the older customers have already financed the

infrastructure in place and should not have to pay for the upgrades as well.

The EDU approach has proven extremely useful in allowing Escondido to expand

during times when it could not easily borrow on capital markets. As implemented, the

new connections fee also ensures that older customers do not bear the cost of extending

the collection system to new users, which makes sense. However, some of the other price

signals that the EDU approach, and the new connections fund in general, send have a

couple of weaknesses. First, all projects related to new connections are lumped into a

single pool, creating the possibility of cross-subsidies within this group. Such crosssubsidies can hide important break-points, such as where decentralized treatment becomes

more economic than sewer line extensions. Second, where common assets (e.g., a

trunkline) becomes constrained due to system expansion, increasing the rates only to new

customers will not send the proper price signals to all users of that scarce capacity, some

of whom may be older customers who are able to cut their discharge at a lower per unit

cost than new users. Third, dischargers are not able to sell their EDUs back to the system
4-4

or to other users if they cut their discharge. As a result, they have somewhat less of an

incentive to invest in technologies that reduce their need to discharge to the sewer system.

Escondido has experimented with a number of budgeting techniques. Zero-based

budgeting, where every program must justify its entire allotment annually, proved too

disruptive to staff. Two-year budgeting, predicated to shift the annual budget-period

crunch into a two-year affair, was also problematic. They had a very difficult time

projecting needs one year in advance; two years was even worse. Finally, the city tried

program-based budgeting, which is similar to activity-based costing. With over sixty cost

pools to project, they found the process too unwieldy. Managers also felt that their

projections were simply guesses that did not provide them with additional decision-making

data.

As a result, they have continued to use an annual budget process with expenses

grouped into very general categories. Programmatic data continues to be collected even

though it is not used in budget development. Rather, spending is tracked by the

program/project areas, some of which are shown in Exhibit 4-1, and given to managers in

monthly reports. Exhibit 4-1 shows only the program area name; the city also assigns

each a tracking number. This system has enabled the city to provide key information to

managers without making their budgeting process unduly complex. The city recently

integrated labor-hour tracking by project as well, vastly improving its ability to cost out

the resources used on particular activities. Managers have found this addition extremely

useful in understanding the dynamics of their programs.

While the project-based tracking greatly improves the information available to

managers, there are many gaps in the data. For example, it remains somewhat difficult to

aggregate spending by program aspect. Some program areas, such as oil and grease

management, are not broken out separately. In addition, capital infrastructure or O&M

costs have not been allocated to their causal areas. Thus, all capital projects required

handle I/I systems are not easily tracked back to I/I using the existing budgeting accounts.

Similarly, O&M due to grease blockages would likely show up under “Lateral

Maint/Repair” or “Jet Rodding/Vacuum” without being linked specifically to oil and

grease dischargers.
4-5

Exhibit 4-1

SAMPLE PROGRAM AREAS TRACKED BY

ESCONDIDO WWT PROGRAM

Program Area Program Area Program Area

Liquid Processing Maint. Equipment/Shop Maint. Ind Waste Comp Mon - Escon.

Solids Handling Maint. Force Main Maint./Repair Ind Waste Comp Mon Ran Bern.

Reclaimed System Maint. Lift Station Maintenance Reclaimed Water Testing

Electrical Lift Station #7 Water Reclamation

Instrumentation Over Flows & Emergencies Solid Sampling/Testing

Co-Generation Maint. Service Requests Copper/Lead

HARRF Grounds Maint. Large Sectional Twister Well Water

Building Custodial Maint. Manhole Inspection Misc. Sampling and Testing

Safety Equipment Maint. Easement Maintenance QC-QA Testing

Equipment/Shop Maint. Confined Space Maintenance Laboratory Administration

Influent Pump Station Trench Compaction Water Connection Rights

Lift Station Maint. Pretreatment Reporting Water Reclamation Admin.

Lift Station Grounds Maint. Bernado/Ham. Assess. Dist. Environmental and Safety

Land Outfall Maintenance Liquid Process Operations

Jet Rodding/Vacuum Solids Handling

Twisting Industrial Waste Adm. & Test.

Televising Storm Water Testing

Locates Laboratory Services

Manhole Maint./Repair Wastewater Testing

Lateral Maint./Repair Ind Waste Test - Escon.

Mainline Maint./Repair Ind Waste Test - Rancho Bern.

Source: City of Escondido Program Chartfield Definitions, 1997.

POTW managers have established some flexibility in their budgeting process. For

example, although all wastewater revenues go back into the general wastewater fund,

within wastewater operations, there is some flexibility to shift funds among accounting line

items as needs arise. There is also a multi-year contingency fund used for emergency and

surprise expenses. Capital budgeting is done annually, although the POTW also utilizes a

five year planning cycle for major capital upgrades. The POTW does not have a formal

process of depreciating capital equipment and accruing for replacement during its life.

Rather, most of the capital replacement is funded through a somewhat undersized

“miscellaneous major maintenance” line item (that allows for replacement as well as

maintenance). As a result, a number of staff felt that they never had enough funds to

replace their aging plant (though the POTW works hard to ensure that staff have updated

analytical tools).
4-6

Managing and Optimizing Key Shared Assets

More than many POTWs, Escondido shares key assets with surrounding

communities. Substantial flow comes from the Rancho Bernardo district of San Diego,

and San Diego contracts with HARRF for capacity. The outfall pipe used by the city to

discharge its treated effluent is comprised of a land portion, owned by Escondido, and a

water portion, owned by the San Elijo Joint Powers Authority. The city has an agreement

with San Elijo for 79 percent of the water outfall capacity. The land outfall is implicitly

shared with San Diego, as Rancho Bernardo flows to HARRF must the be discharged

through the outfall.

Capacity in the outfall is already constrained, and is insufficient to meet demand

during storm events. Some, though not much, spare capacity remains at the treatment

plant. The city relies on equalization basins, used nearly to capacity, to allow the existing

dry weather flows to be treated within the existing capacity at HARRF.

Current arrangements for sharing capacity are through interjurisdictional

agreements among the participating parties. These specific agreements have three main

problems:

• Difficult to Modify. IJAs are negotiated among municipalities and

rarely modified. Changes in the peak or average discharge profiles

of participants are difficult to integrate into the contracted

discharge allowances.

• Financial Arrangements Do Not Reflect Actual Costs of

Capacity Used. Payments for both the treatment and outfall

capacity are based on the proportion of average flows from the

participating parties that are sent through HARRF and the outfall.

In fact, it is peak flows that drive much of the capital requirements

for the infrastructure. While there are restrictions on the peak

flows that may be discharged, these restrictions are difficult to

enforce and do not have associated financial penalties.

• No Surcharges for Constituents of Concern. Flows received

from other municipalities are not surcharged. For example,

Escondido receives waste flows from a San Diego experimental

treatment plant that uses water hyacinths. When these plants are

compressed at the end of the treatment process, the compression

releases salts and metals, and the discharge has a higher than

average BOD. The constituents of the discharge can affect the cost

to process and/or the value of residuals; charges should reflect

these impacts.
4-7

The impacts of some of these limitations on the incentives of particular dischargers

are not as perverse within Escondido as they could be in other municipalities operating

under legalistic IJAs. For example, a central problem with a lack of peak pricing is the

reduced incentive to curb I/I, often a major component of peak flows. Yet, recent I/I

studies in Escondido, San Diego, and San Elijo service areas suggest that no single

community is responsible for a disproportionate share of I/I. The implication is that the

use of average rather than peak flows is unlikely to substantially distort relative charges.

In other regions, this may not be the case, and substantial sums may be spent to increase

plant capacity due to improper pricing of capacity.

Nonetheless, some of the tools discussed earlier in this report can be usefully

applied to make IJAs more flexible. For example, resource pricing techniques could be

used to quantify the value of the scarce outfall or plant capacity, allowing capacity

allocations to be done via pricing rather than contractual fiat. This approach would ration

the scarce capacity to the parties that need it most. The fact that each party would have to

pay for the capacity it used would encourage each to implement steps that reduced flows

during peak periods -- whether through better I/I control, improved equalization

capability, or other means.

Controlling Constituents of Concern with Fragmented Control

POTWs are biological processes, designed to break down organic matter in

sewage into non-hazardous, reusable by-products. The plants are unable to treat inorganic

constituents such as metals or salts; these pass through the plant or are entrained in the

biosolids. At high enough concentrations, these contaminants can interfere with the

plant’s biological process and/or render by-products unusable.

To ensure that influent concentrations of these constituents do not harm the plant

or contaminate residuals, EPA required pretreatment to remove these constituents from

industrial discharges. The focus has been on industrial dischargers, as these are the largest

sources of most elements of concern. Pretreatment programs set limits on allowable

concentrations and enforce these limits through plant inspections, analytical monitoring,

and litigation where necessary. The specific limits set by a plant vary depending on the

specifics of the treatment plant, the receiving water, and the NPDES permit. Fragmented

control in Escondido’s program makes it more difficult for them to curb constituents of

concern and to send the proper price signals to dischargers. Areas where this is a problem

include oversight of dischargers in the Rancho Bernardo service area, effluent from a

municipally-owned water treatment plant in Escondido, and increasing concerns over brine

loadings from non-industrial dischargers. Fragmentation of control and distorted price

signals are also central factors in impeding the sale of treated effluent in the region.
4-8

Pretreatment

The Rancho Bernardo district of San Diego has rights to discharge 5.3 mgd of a

total 16.5 mgd of capacity at HARRF, nearly one-third of the entire plant capacity.

Industrial discharge from Rancho Bernardo is over 500,000 gpd, more than twice that

from industries within Escondido. In addition to the general issues regarding peak flows

from Rancho Bernardo overall, discharges from industries located there are important

sources of contaminants such as chloride, sodium, flouride, and boron.2

All of these contaminants from Rancho Bernardo impede effluent reuse and require

treatment by HARRF. Nonetheless, it is the city of San Diego that oversees the industrial

dischargers in that region, including permitting, inspections, and charges. To address

HARRF compliance with its NPDES permit, the San Diego pretreatment staff incorporate

Escondido’s local limits into the permits they write for Rancho Bernardo industries.

However, fees levied on IU discharges reflect the standard rates charged to IUs

throughout San Diego, and bear no relation to the costs that these discharges create for

the recipient treatment plant in Escondido. Escondido has extremely limited ability to

independently verify reported discharge levels through surreptitious monitoring or

independent inspections.

While both Escondido and San Diego expressed an interest in transferring the

pretreatment program to Escondido, San Diego pretreatment staff felt that political

concerns would prevent such a transfer. Nonetheless, some improved tracking of the

impact of Rancho Bernardo discharges on Escondido collection and treatment costs would

be a powerful weapon in renegotiating the IJA or altering the charges for service.

Municipal Dischargers

Government entities often have a very difficult time regulating or charging other

government entities. This issue arose during our site visits last year, where one POTW

had spent years figuring out an effective way to oversee a large military discharger in their

district. In Escondido, it is not the military but a water treatment plant (WTP) that creates

the challenges. Since both HARRF and the water treatment plant are owned by the city,

their relationship has historically been governed by informal negotiation rather than more

formal assessments of the impact that one has on the other. This approach can be

effective for relatively small, lower cost adjustments. However, where the impacts are

larger (or not well quantified) the resistance to changes that disrupt operations or

substantially increase costs to one party increase.

 2

 Rancho Bernardo percentage loadings are 18 percent for chlorides, 38 percent

for sodium, 90 percent for fluoride, and 74 percent for boron. HYA Consulting

Engineers, City of Escondido Brine Management Feasibility Study, August 1995, p. 48.
4-9

Consider the specific case in Escondido. The WTP discharges about 50,000

gallons per day to the WWTP for which it is directly charged nothing. Rather, an imputed

value of services is charged using allocations between municipal accounts. This allocated

charge does not incorporate the real cost of the WTP discharges, and hence may not

encourage them to install processes that minimize the constituents of concern. At 50,000

gpd, WTP flow is not a major issue. Rather, it is manganese and solids loadings that are a

problem. The WTP is the source of 85 percent of manganese loadings at the WWTP, a

result of the use of a manganese-based settling compound in the water plant. These levels

may impede the ability of HARRF to resell its effluent. The high solids content of the

effluent is considered by many wastewater staff as a significant factor in the need to

purchase a new digester at their plant. In neither case has a careful cost accounting been

done to evaluate how much treating the effluent from the WTP plant really costs the

WWTP.

Were such a study to be done, a more formal financial arrangement for discharges

from the WTP might spur behavior change. Although the WTP is currently evaluating

ways to reduce Mn loadings, this transition might occur more quickly if financial

incentives were in place. Similarly, alternative management of solids in the face of high

surcharges might, in conjunction with reductions elsewhere in the system, have enabled

the city to avoid the purchase of the new digester. Even if no behavior change were

possible, modified charges to reflect the real cost of treating WTP residues would be

passed onto WTP customers, such as irrigators. These additional costs would then be

borne by the commercial beneficiaries of the service, rather than by WWTP customers as

is now the case. By increasing the cost of fresh water to better reflect the costs of

providing it, the surcharges would also help to spur demand for the use of reclaimed water

in irrigation.

Resale of Treated Effluent

Fragmentation of control becomes an even more serious problem when it occurs

on a large scale across various levels of government, as is the case in the interaction of

fresh water delivery and effluent reuse. Located in water-scarce Southern California,

Escondido would seem to be in an ideal location to market its treated effluent. Demand

for irrigation water, not only for agriculture but for parks and golf courses as well, is high.

Yet, the city has discovered that their apparently ideal market is not entirely ideal. This is

partly because the city needs to reduce certain contaminants in their effluent (e.g., flouride,

boron, salt). However, much of the problem has to do with the poor functioning of fresh

water markets in the region. There are pervasive subsidies to agricultural use of fresh

water which, as noted by a number of Escondido personnel, greatly reduce the interest of

farmers in trying to use reclaimed water.

Consider the case within Escondido itself. According to utility officials, the cost to

purchase water for local consumption is close to $429 per acre foot. Although the quality

of this water differs substantially in salt content (depending on whether its source is

Northern California or the Colorado River), there is no difference in the price that the city
4-10

must pay for it. This lack of differentiation provides little incentive to try to reduce the

salt content of water flowing in the Colorado.

The base rate for sales to regular customers is $524 per acre foot. With water

treatment costs of $40 per acre foot, this leaves little room for the cost of constructing and

maintaining the water delivery infrastructure. In comparison, agricultural users pay the

city only $371 per acre foot, less than it costs the city to buy the water. Part of this

subsidy is provided by the city; most is provided by the Metropolitan Water District,

ostensibly because the farmers’ water supply can be interrupted in a drought. However,

unlike private utilities which actually do cut off interruptible supplies immediately,

municipal supplies to farmers have not been cut off entirely, even in deep drought.

The purpose of this example is to provide a clear demonstration of the

environmental distortions that cross-subsidies can create. Rather than farmers pooling

together to buy reclaimed water from POTWs in Escondido or similar cities, helping to

pay to reduce constituents of concern if necessary, the POTW finds little interest from its

largest potential customers. Repeated throughout Southern California, or through the

Southwest overall, these cross-subsidies lead to overconsumption of fresh water and a

suppression of what should be strong economic drivers to recover and resell WWTP

effluent, using pretreatment or other methods to control concentrations of salts and metals

entering the plant. The same tools that help a single POTW identify its true costs to

provide wastewater services can be used by water treatment plants and water delivery

systems to price their products, a process that would encourage more rationale use of

fresh and reclaimed water in the region.

Non-Commercial Dischargers of Constituents of Concern

Interestingly, Escondido faces increasing challenges in controlling even the salts

that are added to its effluent by local water softening. The pretreatment program was set

up to curb industrial discharges. Controlling constituents of concern from residential

discharges is much more difficult, given their decentralized origin and the focus of existing

statutes on the industrial sector.

There are two major types of water softening services. Automatic softeners are

installed in residential or commercial properties, with salts added by the property owner.

Brine discharges are flushed into the sewer system, increasing salt loadings into the

POTW. Tank exchange systems are brine tanks supplied by a third party, and replaced

periodically with a new one. The tanks are recharged at a central location. Although tank

exchange firms also discharge brines to the sewer system, they can reclaim a higher

proportion for reuse and are regulated as IUs by the POTW while the homeowner is not.

As a result, salt loadings can be more easily controlled. For example, Escondido is

planning to build a brine diversion line that would avoid contaminating POTW effluent
4-11

with salts. Such a diversion line is relatively easy to install for a small number of industrial

brine dischargers, but prohibitively expensive if it must connect to every home or business

with an automatic water softener.

To prevent problems with salt loadings from residential and commercial customers

using automatic water softeners, Escondido banned these machines. A similar ban was

implemented by many communities in Southern California. Recently, a trade association

representing the automatic water softener manufacturers successfully struck down the ban

in a law suit. Led by Culligan, a major manufacturer of this equipment, the association

declared that their victory invalidated all of the other rulings (though this was not clear

from the judgment), and began selling automatic softeners to residential customers in all of

the previously banned areas. A copy of a memo distributed by the Water Quality

Association explains their marketing strategy in detail. As the memorandum provides

interesting insights into the evolution of what is likely to be a substantial barrier to water

reclamation in the future, we have included it as Appendix A.

Legally, the city of Escondido is fairly limited in the actions that it can take to

control the discharges. The longer the period of time for a residential user base of

automatic water softeners to grow, the more difficult controlling the brine levels in

effluent will be. Yet the financial implications of this trend are significant. In addition to

the planned industrial brine diversion line (costing over $1 million), Escondido is building

a water reclamation plant at a cost of $46 million. Unless non-IU brine discharges can be

controlled, these large capital projects will not be able to deliver the low-salt effluent

needed for resale. Better cost accounting for the cost impacts of brine dischargers on

system economics would certainly help the city to make the case against the automatic

softeners or brine discharge into the treatment plant in general.

Full Cost Recovery

Escondido managers stated that they try to set rates that will recover the full costs

of their programs, and have been successful in ensuring that overall wastewater costs are

not subsidized from general tax revenues. However, they acknowledged that going

beyond this to full cost recovery from particular types of customers was much more

difficult due primarily to a “business friendly” environment. This pressure is faced by

many programs around the country. Yet, these same businesses must pay market rates for

all of their other production inputs; it is unclear why wastewater treatment should be

different.

Within Escondido, industrial dischargers pay a flat fee per 1,000 gallons. There is

no surcharge for constituents such as TSS or BOD because the flow from these

dischargers (less than 2 percent of the total) is too small to be worth the extra effort to

surcharge. There is no attempt to recover the cost of permitting the facilities either. Oil

and grease dischargers, such as restaurants, pay a flat fee of $160 per year, plus a fee per

1,000 gallons of wastewater sent to the sewer. This fee covers less than 2/3 of the cost of

the direct time spent monitoring and inspecting oil and grease permittees. The efforts of
4-12

program staff have cut the number of overflows and stoppages due to oil and grease in

half over the past ten years. However, staff did note that if the costs of addressing the

clogs were allocated to oil and grease dischargers (a calculation they did not have the

information to make), the permit fees would cover an insignificant portion of the total

program costs.3

 Finally, as noted above, the POTW does not attempt to recover the full

costs of servicing peak demand from the dischargers responsible for creating these peaks.

These existing charges reflect a host of factors. Some represent estimates of full

cost recovery fifteen years ago, but have not been updated. Others reflect an estimate of

reasonable charges in the face of incomplete information on the real cost of particular

types of discharges or activities. Many others simply reflect a political agreement about

what is fair or acceptable by particular constituent groups within the community. While

these reasons do not correspond to economically-efficient pricing, they do reflect the

political and organizational realities faced by hundreds of POTWs across the country.

Given these realities, changing the rates overnight is not a possibility. However, if the

POTW itself can better understand the magnitude of subsidies and cross-subsidies within

its operations, it will be well positioned to prioritize its outreach and utility-financed

upgrades. It will also be in a better position to gradually adjust rates over time.

Massachusetts Water Resources Authority (MWRA), Boston, MA

MWRA provides wholesale water and wastewater services to a large network of

communities in the Boston area. Forty-five communities, comprising an aggregate

population of 2.5 million people, purchase MWRA’s wastewater transport and treatment

services. MWRA owns three treatment plants: the recently constructed Deer Island

treatment plant, which provides primary and secondary treatment with enough capacity to

replace two older primary treatment facilities; the Nut Island treatment plant (scheduled to

be taken out of service in 1998); and a smaller, decentralized facility in Clinton, MA

providing service to two communities. MWRA’s capital upgrade has been ongoing for

the past several years. Once complete, this new plant will have a primary peak hourly

capacity of 1.27 billion gallons per day (mgd) and a peak secondary hourly capacity of 788

mgd.4

 Several characteristics of MWRA’s system and operations related to cost

accounting and budgeting contributed to the selection of MWRA as a case study:

• Role as a Wholesaler. MWRA establishes a wholesale rate

structure used to bill the communities within its service area. The

incentives within MWRA’s rate structures may not necessarily pass

 3

 Aside from grease removal, the city flushes portions of its collection system

known to clog frequently every three months rather than their norm of every 18 to 36

months.

4

 MWRA, Fiscal Year Proposed Current Expense Budget, February 24, 1997, p.

III-38.
4-13

through to individual users, as it is up to individual communities to

set local user charges. MWRA centralizes controls in some

operational areas (such as pretreatment) to ensure better control

over its treatment system.

• Challenges of Managing a Large and Spread Out System. The

size of MWRA’s service area and the variation among communities

within the service area create a complex series of factors for

MWRA to consider in decision making, including variations in the

cost of service and the ability to pay for service.

• Reliance on an Old Collection System. The collection systems

within many of the service area communities, as well as many of the

interceptor mains owned by MWRA, are predominantly very old

and in need of repair or replacement. Cost accounting systems that

help to prioritize system maintenance and replacement become

extremely important.

Themes underlying many of the issues we highlight here are the management

challenges that increase with the size and reach of the POTW, and the difficulty in

establishing the proper price signals for optimizing plant efficiency and protecting the

environment. These issues are discussed in greater detail below.

General Approach to Cost Accounting and Budgeting

With an annual budget of $900 million (capital and operating combined) and

capital upgrades with a total cost measured in the billions,5

 sophisticated financial control

systems are imperative in order for MWRA to function. Although the Authority does

receive some financial assistance through state and federal grants or loans, the vast

majority of its capital funds must be borrowed on capital markets. Without accurate and

transparent financial reporting, the Authority would never be able to borrow funds. To

ensure accurate budgeting and financial reporting, MWRA has its own internal finance

department with a budget of nearly $4 million per year. The administrative function of the

sewerage division, with a budget of $2.6 million in FY95 and which is separate from the

MWRA-level finance group, has its own finance unit as well, responsible for budgeting,

financial control, and long-range planning.

MWRA prepares its accounts in compliance with Governmental Accounting

Standards Board (GASB) procedures for an enterprise fund. GASB procedures provide

 5

 Although the construction of the Deer Island project is nearing completion, the

Authority is projecting total capital improvements worth $3.0 billion between FY 1998

and FY 2007. Capital improvements over the next three years for the wastewater system

alone are estimated at $680 million. (See MWRA, FY98 Proposed Current Expense

Budget, pp. I-23 - I-26).
4-14

outsiders (primarily investors) with the information they need to assess the financial health

of the Authority. Key elements of MWRA’s reporting include:6

• Accrual Accounting. The Authority recognizes revenues at the

point in time they provide services, and expenses at the point in

time they receive services. As noted in Chapter 2, accrual

accounting is especially important in the area of capital budgeting.

MWRA depreciates its capital purchases over their estimated

service life, allowing them to better reflect the annual cost of capital

services used.

• Recognition of Liabilities Incurred. MWRA recognizes and

reveals liabilities or potential liabilities they have incurred in the

course of their current operations if they could affect their financial

health or cost of operations. Some examples include long-term

lease obligations, law suits, environmental liabilities, or exposure to

losses on risks that they have self-insured for.

• Audited Financial Statements. MWRA prepares financial

statements that are audited by an independent auditor.

Although much larger than Escondido, there are some similarities in their approach

to budgeting. For example, an important concern within MWRA has been to create

separate sewer and water accounts, as required by its Enabling Act. Transferring funds

between the sewerage division account and the water division account requires approval

of the Board of Directors. This separation is particularly important in those municipalities

and joint authorities, such as MWRA, that do not provide sewer and water services to the

same universe of customers. In MWRA’s service area, some communities receive one

service, others receive both. MWRA’s budget documents reflect this separation.

The Authority prepares both a detailed current expense and capital budget on an

annual basis for the sewerage division. The current expense budget provides information

in two ways. First, data are broken out by line item, such as wages and salaries;

maintenance; professional services; etc. Second, this same budget information is broken

out by program area. These program areas are shown below in Exhibit 4-2.

 6

 See Ibid., Appendix D, “Massachusetts Water Resources Authority Financial

Statements and Supplemental Schedule, June 30, 1996 and 1995.”
4-15

Exhibit 4-2

PROGRAM AREAS IN MWRA SEWERAGE DIVISION

-Administration

-Facilities Development

-Residuals

-Toxic Reduction & Control

-Environmental Quality

-Wastewater Engineering

-Wastewater Construction

-Transport

-North/South Wastewater Treatment Processes (main treatment plant and pump

stations)

-Clinton Wastewater Treatment Plant

Source: MWRA, FY98 Proposed Current Expense Budget, p. II-5.

The capital budget provides a three-year, detailed assessment of anticipated capital

improvements, and a less detailed projection going out ten years. Projects within the

overall Authority are grouped by program area (Boston Harbor Project, wastewater,

water, business and operations support). There is one additional category, contingency,

which makes allowances for unanticipated costs for the proposed projects. The

contingency is estimated at roughly 9.5 percent of the budgeted projects.7 Within the

Sewerage Division, projects are further grouped by category, including interception and

pumping, treatment, Deer Island on-going capital improvements, residuals management,

combined sewer overflows (CSOs), and other. The budget then provides project-specific

information on each planned capital improvement.

With a much bigger service base than Escondido, many of the support functions

(such as engineering, legal, etc.) which Escondido relied on the city to provide are

separate divisions within MWRA. This includes departments such as Human Resources

and Public Affairs. Staff in these functional areas are also sometimes included within some

of the operating divisions. Despite the assumption of these functions within the utility,

cost accounting issues regarding how to allocate support function costs to water and

wastewater customers remain. This allocation is important. In the proposed FY1998

budget, for example, allocated support division and other indirect expenses total $42

million, 27 percent of the sewer division’s $154 million in total O&M spending.8

The massive investment into new plant and equipment by MWRA has resulted in

more than a 500 percent increase in combined water and sewer charges for MWRA

customers between 1986 and 1993, increasing water and sewer charges to some of the

highest in the country.9

 Who would pay for the upgrade became a hot political question in

 7

 MWRA, Proposed FY98-00 Capital Improvement Program, December 30,

1996, p. 3.

8

 MWRA, February 1997, op. cit., p. I-40.

9

 Ibid., p. I-34.
4-16

the Boston area, and forced MWRA to revise its rate methodology (discussed in greater

detail below) very carefully. The rate methodology finally approved resulted from a

detailed evaluation of options given political and technical constraints, and much

consensus building. The data to support this rate structure relies on the allocation of costs

to specific functional areas and then to customer classes. However, the allocations involve

numerous approximations and averaging of costs; significant cross-subsidies remain that

reduce the incentives for important dischargers to invest in pollution prevention and flow

reduction technologies.

Dilution of Price Signals

A central focus of this report has been on accurately tracking the cost of providing

wastewater treatment services in order to send the proper price signals to staff and to

dischargers. In a private market, price signals pass relatively unhampered through multiple

layers of intermediaries. This is because competition constrains passing through too

much, and the requirement to earn a profit in order to stay in business prevents passing

through too little. Wastewater treatment is different.

If communities made rate structure decisions purely on economic terms, price

signals from MWRA’s wholesale rates would reach individual dischargers. Higher

charges to the town due to TSS, BOD, or high peak flows would be passed back to the

sources of these problems, encouraging future investment to reduce the factor(s) of

concern. However, once political considerations influence the process by which local

rates are established, the impact of MWRA’s rate methodology is often distorted. Thus,

even if MWRA could perfectly track its costs and translate them into charges to

communities, there is no guarantee that the communities would set rates that sent the

same signals to the key dischargers. Some of the problems that arise are presented below.

Using its wholesale rate methodology, MWRA recovers the funds it needs to cover

expenses from its member communities. Charges on water and wastewater are calculated

separately. They are calculated annually and paid to MWRA in quarterly installments. It

is then up to the member community to levy charges on its citizens. In most cases, cities

must add their internal cost of wastewater services, in terms of installing and maintaining

local sewer collection systems, to MWRA’s charges. These two elements become the

basis of charges ultimately paid by local dischargers. A number of distortions in residential

rates are common, though not all apply to every community:

• Infrequent billing. Retail customers receive bills as infrequently as

twice a year, unlike most other utilities (oil, gas, telephone, electric)

where bills are sent monthly. This reduces the ability to reflect

seasonal variation in fees or to quickly rectify hidden changes in

consumption patterns (e.g., leaks).
4-17

• Payments by landlord rather than service consumer. Both

water and wastewater bills are sent to the property owner not to the

party consuming the water and wastewater services. While this

system enables unpaid sewer bills to become a lien against the

property, it also dramatically reduces the incentive of those living in

rental properties to reduce their consumption of water (and hence

discharge of wastewater).

• Average of peak and strength surcharges. Retail customers

generally pay an average amount per hundred cubic feet (equal to

748 gallons) discharged. This amount reflects an averaging of all

peak and strength surcharges levied on the city, reducing the

incentive of any particular user contributing to these peaks

(including industrial users) to reduce them.

• Hidden charges for wastewater treatment. Although much less

common than it once was, some towns include the capital portion

of water and wastewater charges with the property tax bill levied on

homeowners. This approach can make the actual charges for

wastewater services more difficult to see if the water/ wastewater

element is not listed separately, and hence weakens the ability of

prices to trigger desired behavior changes, such as reduced water

consumption.10

• Derived consumption. In most cases, retail wastewater charges

are calculated based on a fixed percentage of water consumption,

since it is not directly metered at the point of discharge. This

system penalizes customers who use large amounts of water for

non-sanitary purposes (e.g., irrigation). Many towns do not allow

separate metering for irrigation water.

Wholesale Rate Methodology

The translation between MWRA’s costs and its wholesale charges, in and of itself,

involves a number of trade-offs and potential distortions in the rates charged to towns.

This level of price distortion is in addition to the dilution in price signals described above.

We first provide an overview of this rate methodology, and then discuss some of the

potential issues with it.

Reflecting the fact that the cost drivers for capital equipment are not necessarily

the same as those for operating expenses and maintenance (O&M), MWRA uses a

 10 Including the capital charges with town property taxes enables residential

consumers to deduct the payments from their federal income taxes.
4-18

different method to calculate the rates for each. MWRA’s “Sewer Cost of Service

Methodology” identifies “functional areas” (e.g., pumping, treatment, residuals

management) which cause MWRA to incur operating costs and/or capital costs in

wastewater collection and treatment. The costs associated with these functional areas are

then allocated to “Cost Causative Factors” (e.g. wastewater volume, TSS, and BOD) to

develop average O&M and capital costs of wastewater service. MWRA costs of service

are updated annually as part of the Current Expense Budget development process.

O&M costs are allocated using total annual metered wastewater flow, total annual

average strength, septage, and high strength flow loads. As shown in Exhibit 4-3, flow is

the largest determinant of O&M charges, comprising nearly 60 percent of the total. This

reflects the importance of the quantity of wastewater in driving operating costs. Measures

of strength such as TSS and BOD increase solids loadings and residence times for

treatment, and thus comprise the remainder of O&M charges. MWRA’s wholesale rate

methodology also allocates costs to municipalities that have high strength users. A high

strength user is a permitted industry discharging 25,000 gallons per day and having an

average TSS and/or BOD strength of 400 mg/l or greater. For FY98, seventeen high

strength users were allocated wholesale sewer charges as part of the annual sewer rate

setting process. The surcharge rate above 400 mg/l for either TSS or BOD is constant,

however, for all levels of discharge.

Capital costs are allocated using metered wastewater flow and loadings, along with

population. Capital costs are, by their nature, fixed whether or not the capital capacity is

being used. For this reason, MWRA has incorporated two other elements in its capital

rate structure. Monthly peak flow is an attempt to reflect the additional capital demands

required by peak surges, and comprises about 15 percent of total charges. Population is

used to allocate the vast majority of capital costs, 75 percent of the total. Population

served drives both the collection system required and the provision of surplus capacity to

address future growth.

The wholesale rate structure includes two important potential distortions. The first

involves peak flow surcharges. While MWRA has implemented some degree of peak

pricing, peak dischargers may still be cross-subsidized by other users. The second involves

the allocation of such a substantial portion of capital costs on the basis of population.

Allocating the bulk of capital costs based on the number of people may overlook other

sources of high cost infrastructure such as peak flows or length of trunklines.

While we analyze these distortions in greater detail below, it is important to draw a

distinction between cost allocation in situations of scarcity versus situations of adequate or

excess capacity. Consider the case of I/I. MWRA has already built the necessary

treatment capacity to handle high I/I levels. This infrastructure must be paid for whether

or not it is used. Thus, eliminating pricing distortions, if it led to large investments by
4-19

Exhibit 4-3

MWRA Rate Factors as a Percent of Total Charges (FY 1998)

Factor O&M Costs Capital (Debt Service) Charges Source

($000s) (%) ($000s) (%)

Annual Flow 83,048 58.2% - 0.0%

Total Suspended Solids 35,112 24.6% 6,124 5.0%

Biochemical Oxygen Demand 24,498 17.2% 6,129 5.0%

 High Strength Component* 2,770 1.9% 513 0.4%

Monthly Peak Flow - 0.0% 18,335 15.0%

Population - 0.0% 91,765 75.0%

Total 100.0% 122,353 142,660 100.0% (1)

MWRA Inflow and Infiltration as a Percent of Total Flows 60% (2)

Notes:

 *Reflects high strength surcharges for flow, TSS, and BOD. Amounts already included in category totals.

Sources:

(1) MWRA, "MWRA's Sewer Service Cost Allocation Methodology," July 15, 1997.

(2) MWRA, "1997 Update on Infiltration/Inflow Reduction Strategy," Draft, August 6, 1997, p. 2.
4-20

communities to curb I/I, would simply shift the costs of the plant to the remaining users.

In contrast, had MWRA (or its predecessor the Metropolitan District Commission) sent

proper price signals about I/I beginning 20 years ago, investments by communities may

have enabled the current Deer Island plant to be smaller, saving substantial costs.

Peak Flows

Under the current wholesale rate structure, peak flows pay only fifteen percent of

capital charges. In fact, however, inflow and infiltration, a large source of peak flows,

comprises approximately 60 percent of average daily flows (the average value in a survey

of 107 POTWs nationally was 25 percent).11 A year-round average understates the impact

of the problem because peaking capacity requirements are driven by annual peak flows.

MWRA estimates that I/I accounts for roughly 72 to 75 percent of maximum monthly

wastewater flows, a better measure of the impact on capacity.12 Thus, the current

allocation of capital costs likely subsidizes the sources of large peak flows, and reduces

the incentives for communities with particularly high I/I to invest in sewer upgrades.13

While quantification of the environmental benefits of I/I reduction is difficult, I/I

reduction will reduce the quantity and frequency of raw sewage overflows upstream of

MWRA facilities resulting in reduced pollution of local wetlands, rivers, and Boston

Harbor, as well as reduced incidences of raw sewage backups into homes. Staff felt that

the elimination of collection system overflows during severe storm conditions would be

virtually impossible but that the reduction of overflow events during marginal storms was

achievable.

When we analyzed MWRA’s community-by-community data on peak flows, we

found that communities with the highest I/I percentage of peak month flows are likely to

be the ones receiving the largest cross-subsidies from the current rate structure.

Interestingly, these communities include some of the wealthier suburbs, most of which can

afford to invest in sewer upgrades to reduce the problem more easily than the less affluent

communities now bearing a disproportionate share of the higher costs of waste water

 11 MWRA data from MWRA, “1997 Update on Infiltration/Inflow Reduction

Strategy,” Draft, August 6, 1997, p. 2. National survey data from AMSA, The AMSA

Financial Survey, 1996, p. A-17.

12 MWRA, Ibid.

13 Although the recovery rate on peak flows is perhaps too low in the current rate

structure, it is important to recognize that the surcharging for peaks at all is a substantial

improvement, and is only possible within MWRA as a result of a substantial investment in

monitoring equipment installed throughout the collection system.
4-21

treatment capital infrastructure.14 Converting raw data on peak flows to cost accounting

estimates of how much these additional flows have cost the system might enable the

Authority to eliminate cross-subsidies from less-wealthy to wealthier communities.

Whether or not the political environment will allow higher charges for peak flows

to some of these communities is an open question. In addition, MWRA would need to

carefully evaluate how customer reactions to higher charges would affect the Authority’s

allocation of capital infrastructure charges. However, improved accounting for the cost of

peak flows could help the authority to prioritize its own financial assistance for I/I

controls. Currently, their Local Financial Assistance Program distributes money to

communities to use towards reducing I/I, of which 75 percent is used for construction

costs. MWRA has chosen to aggressively address this problem through zero-interest loans

and grants to communities as incentives to repair and replace old wastewater mains. The

funding is substantial -- $64 million over a ten-year period.15 However, the grant program

funds are allocated among all sewer communities based on respective share of overall

MWRA sewerage system charges rather than based on I/I rates or CSOs. Again, there is a

trade-off: each community wants its “fair share” of the grant program, yet a different

allocation mechanism might well do more to reduce MWRA’s aggregate costs.16

Allocation by Population

As noted above in Exhibit 4-3, the largest factor in allocating capital costs is

population. Half of this charge is based on the sewered population within a particular

town, reflecting their use of current capacity. The other half of the population charge is

based on the census population, including those not currently discharging to the system.

This allocation reflects the implicit standby capacity that MWRA provides as more and

more of the people in these communities shift from septic systems to sewers.

The use of population for allocating overall capital does have its weaknesses,

however. First of all, much of the demand for the current scale of trunklines and

 14 See MWRA, “CY 1996 Community Wastewater Flow Estimates Ranked Flow

Components,” August 5, 1997. We compared peak I/I levels to average per capita income

levels and found that many communities with below average incomes were paying more

than their share of peak flows, while many communities with above average incomes were

paying more.

15 MWRA, “MWRA Infiltration/Inflow Reduction Strategy: Discussion with

WAC, “ August 8, 1997, p. 3.

16 MWRA staff also noted that communities that had already invested substantial

sums in reducing their own I/I resented subsidizing communities that had done little in this

regard.
4-22

treatment capacity is due to peak flows rather than population.17 Secondly, while

collection system infrastructure is logically allocated based on census population (since it

has to be installed even if few people in a town are currently using it), most of the

collection systems within the towns are owned by the towns themselves, not MWRA.

Other factors that would be likely to drive up collection costs, such as distance from the

treatment plant (requiring more miles of trunklines and more pumping stations) are not

reflected at all in rates.

The allocation of the bulk of the capital costs based on population is useful in that

it minimizes the cost of wastewater treatment per capita, a possible strategy to ensure

universal service. It also ensures a fairly stable rate base, since flow reduction efforts

within a community do not reduce MWRA’s recovery of already-spent capital. However,

as noted above, the cost driver in much of the capital needed is peak flows. Peak flows, in

turn, are driven by I/I, not by sanitary flows (which are linked to population). Because it

reduces the incentive to curb peak flows, a population-based charge may not ration scarce

capital capacity in an optimal way. In addition, the lack of surcharges based on distance

from the treatment plant may hide break-points at which decentralized treatment

alternatives become economic.

Centralization of Industrial Pretreatment

Cross-subsidies between communities and user groups can dilute the signals to

curb wastewater discharges, driving up capital requirements and system costs; however,

they do not threaten the functioning of the wastewater treatment system. Discharges from

industrial users can cause plant upsets or trigger non-compliance with MWRA’s NPDES

permit. Thus, despite being a wholesaler, MWRA has maintained (and EPA generally

requires) centralized control of its industrial pretreatment program, known as Toxic

Reduction and Control (TRAC). Through centralized analysis and control not only of

industrial discharges, but of non-industrial discharges of constituents of concern, TRAC

has successfully reduced toxics loadings to the system. For example, levels of industrial

metals released to the system were reduced by more than 50 percent between 1993 and

1996.18 Direct oversight of industrial dischargers has eliminated the large potential

problems that decentralizing oversight to the 45 sewer service communities would have

caused to treatment plant operations and influent loadings of metals and toxics.

Much of this oversight has relied on regulatory approaches such as permitting,

inspection, monitoring, enforcement, and penalties. Increased fees have not been used as a

tool to modify discharger behavior to the extent they could be. For example, surcharges

 17 As noted above, I/I comprises 72 to 75 percent of maximum monthly flows.

Since peak flows in nearly all MWRA communities occur in December, these peaks drive

the demand for system capacity.

18 Industrial metals include copper, nickel, silver, zinc, chromium, cadmium, lead

and mercury. See MWRA, Industrial Waste Report, October 1996, pp. 5-6.
4-23

on industrial users for TSS and BOD, often an important component of the price signals

that POTW’s send to industrial dischargers, are levied on the city within the MWRA

service area.19 It is then up to the city to decide what proportion of the fees to pass on to

industry in general, or to particular IUs. The greater the pressure within a city to be

“business friendly,” the more likely that other, non-industrial, users bear part of the

charges for TSS and BOD.

MWRA also charges industrial dischargers a fee both for permitting and

monitoring, and staff state that this fee has encouraged some IUs to reduce their

discharges. Unlike strength surcharges, permit and monitoring fees are levied directly on

the company, and do not go through the respective city sewer authorities. These charges

use a sliding scale (based, in part, on a point system) to more accurately reflect the burden

to TRAC of resource-intensive permits. This point system is rather innovative in that it

reflects the relative importance of certain constituents to MWRA’s NPDES and sludge

disposal compliance. Those constituents which appear in concentrations nearest to

MWRA’s effluent and disposal limits (including copper, lead and mercury), and which

could subsequently force MWRA into more expensive treatment or disposal options,

receive a greater weight in determining a facility’s monitoring charge.

The point system aside, industrial users are subsidized by non-industrial users. In

fact, MWRA made a conscious decision not to create a pretreatment program fee

structure that recovered the full costs of their program as it would have resulted in much

larger industrial fees. The current fee structure (which was only implemented in 1993)

aims to reduce total loadings, but is less concerned with full cost recovery.20 As a result,

permitting and monitoring charges are only meant to capture the full cost of labor time for

each activity (inspecting, permit writing, permit review, and monitoring) as well as most of

the laboratory costs. Users are not charged the costs of litigation and/or additional

monitoring unless it is associated with a significant enforcement action. Nor is TRAC’s

share of MWRA administrative and overhead costs included in TRAC’s fee structure.

The point system is an approximation even of the direct costs that TRAC incurs to

monitor IUs. The amount charged for each permit was determined by dividing the total

direct labor, materials, and services costs associated with permitting and inspecting the

regulated facilities by the number of permits issued per year. Currently, this averages

$2,860 per permit. Permit length (2-5 years) is dependent on the level of attention and

resources determined appropriate for the category of facility. In general, more complex

facilities or those discharging higher levels of pollutants of concern will pay higher permit

fees ($1,430 versus $575 per year) and be issued a shorter permit. While this system does

generally allocate costs back to appropriate classes of permittees, cross-subsidies within

 19 Within MWRA, these charges are levied by the Authority's Budget Department

rather than TRAC. MWRA has no authority to force member communities to pass the

strength surcharges back to the appropriate discharging industries.

20 All else being equal, higher fees on loadings will generally encourage additional

reductions.
4-24

IUs certainly remain. Only recently has TRAC actually tracked (on a pilot basis)

employee time by activity. This would enable them to more accurately assess how their

resources are being used. Whether or not the Authority decides to modify its fees based

on this new cost information will depend on whether key decision makers within MWRA

believe the new fees justify the potential increase in administrative burden to track costs

and justify the change in fees to IUs.

TRAC is funded by MWRA’s General Fund, and all permit fees and penalties

collected by TRAC go to the General Fund. Annual budget appropriations to TRAC from

the General Fund have no explicit linkage to fees and penalties collected from users.

There is also no roll-over from year-to-year of surpluses within TRAC (surpluses revert

back to MWRA’s Rate Stabilization Fund), reducing the incentive to optimize budget

allocations across budget years.

While fees on IUs may be artificially low (both due to TRAC fees that do not

recover the full cost of oversight and to strength surcharges that towns do not pass back

onto their IUs), TRAC does try to focus its outreach based on the overall impact of

particular discharges on the treatment system. Two examples of this targeting are their

current outreach to hospitals and dental offices to reduce mercury, and to owners of

industrial cooling towers to reduce molybdenum loadings. Although there is no plan to

increase fees on these dischargers to reflect the costs they force MWRA to incur, the

Authority is essentially using a demand-side management approach to control the

constituents of concern.

Outsourcing of Biosolids Management

MWRA has contracted with the New England Fertilizer Company (NEFCo) to

barge its digested and thickened sludge from the Deer Island and Nut Island treatment

plants. NEFCo then de-waters, pelletizes, and arranges for use or disposal of the

biosolids. MWRA’s contract with NEFCo, which is valid through 1999, stipulates that

the contractor will be paid per unit of material handled, regardless of the quality of the

resulting pelletized biosolids. Generally, MWRA biosolids meet EPA Table 3

(“exceptional quality”) standards for land application, thereby allowing the product to be

marketed, distributed, and disposed of nationally. NEFCo ships these pellets by rail to

several different sites for land application or use in blended fertilizers. Occasionally,

MWRA pellets do not meet the federal lead limit for unrestricted use. When this occurs,

the biosolids are used only at designated land application sites or are landfilled.

NEFCo has historically spent between $16/ton and $72/ton (or an average of

about $50/ton) for land application or fertilizer blending, depending on sludge quality,

physical properties, and the distance to the consumer (pellets are shipped by rail as far as

Colorado). According to MWRA, the current market price to landfill biosolids is $76/ton.

Additionally, during 1993 MWRA signed a 30-year contract with a landfill in Utah to

guarantee back up disposal capacity. This contract helped MWRA to reach an agreement
4-25

with the Commonwealth of Massachusetts, EPA, and the Court to avoid constructing its

own landfill, as previously required as backup for its beneficial use plans. The contract

contains a guaranteed transport and tipping fee that is somewhat above current market

rates. MWRA is not obliged to use this landfill if it has other disposal options. In fact, the

landfill has offered lower spot rates to compete with less expensive alternatives that have

been available.

This combination of factors provides an interesting example. It is cheaper to

beneficially use the pelletized biosolids through land application or fertilizer blending than

it is to landfill biosolids. It is therefore in NEFCo’s interest to produce pellets that meet

all federal guidelines for unrestricted use. However, the terms of the current contract do

not vary the cost to MWRA based on biosolids contamination levels, even though

reducing this contamination is much more in the control of MWRA than NEFCo. In the

same way that residential pricing for wastewater services diluted the incentive for

residential customers to reduce water consumption, the NEFCo contract terms have the

potential to reduce MWRA’s incentive to implement source reduction for contaminants in

their solid residuals.

In this specific example, a number of factors do induce MWRA to act despite a

lack of short-term financial penalty for contamination levels. First, there are regulatory

pressures to bring down metals contamination in biosolids (in this case, Pb and Mo). In

addition, the NEFCo contract is relatively short (five years). Thus, any new contract

would likely penalize the Authority for contamination levels either directly through

specific provisions, or indirectly through higher bid prices overall, and preparing for that

contract rebid requires that MWRA start trying to reduce metals loadings now.

However, the general issue of a disparity between short-term and long-term

pressures is common in many POTWs, which is why it is worth mentioning here. In the

NEFCo example, MWRA staff noted that the need to obtain a new residuals management

contract within only a few years was an important additional impetus to ensure that metals

loadings were reduced so that all biosolids met EPA "exceptional quality" standards yearround. Many other utilities face a disparity between short- and long-term pressures from

out-of-date NPDES permits or capital infrastructure that is nearing capacity but that is far

more expensive to expand or replace than it was to build in the first place. It is important

that POTW staff recognize how the current situation is likely to change over time so they

can plan accordingly. As noted above, changes in user discharges can take years to

achieve, so adjustments to rate structures, outreach, and monitoring/enforcement need to

occur well in advance of the new requirements if they are to be effective.

Summary

Escondido and MWRA differ tremendously in size and scope. While local

conditions dictate some of their issues of importance (such as effluent reuse in California),

both face a number of similar challenges in trying to balance political and economic

objectives. Both case studies illustrate how improper price signals can distort the behavior

of dischargers in detrimental ways, driving up total POTW costs and potentially reducing

environmental quality as well. Similarly, both illustrate the difficulties that program
4-26

managers face in trying to maintain both proper price signals and a business friendly

environment.

The exact issues in your POTW will likely differ from these two case examples.

However, being aware of the types of cost accounting and budgeting issues that can arise

and using information on the costs of existing distortions, can help you prioritize areas for

immediate, medium-term, and long-term improvement.
5-1

5. SUMMARY

Improved budgeting and cost accounting can be an extremely powerful tool for POTW

managers. Across nearly every aspect of the POTW, understanding how particular dischargers

and discharges drive treatment costs can improve internal planning, rate setting, and the incentives

to reduce pollution and peak flows. This report has provided an overview of a number of useful

tools to support the transition to improved budgeting and cost accounting as well as detailed

examples of what parts of your operations could likely benefit. We hope you will customize these

examples to your own plants.

Implementing improved budgeting and cost accounting will not be easy. The points below

will hopefully help to keep the process in perspective:

• Focus on the Long-term. Any single issue area, once you begin to

address it, will uncover (or create) others in need of attention. The

implementation process will not always be smooth. Thus, it is important

not to expect immediate benefits but to look for systematic gains in

understanding and control over a 2-3 year period. Implementing changes

(in rates for example) after the new system has identified problem areas

may also take some years. Patience is important, but the new approaches

will make many changes possible that would be inconceivable without the

improved ability to identify and quantify cost drivers.

• Focus on the Utility-Level. Systematic changes in the method used for

cost accounting and budgeting cannot be done within a single division, as it

is affected by, and affects, most of the other divisions in the enterprise.

Changes need to be implemented across the POTW, and with the active

support of top management.

• Spend Adequate Time Focusing the Effort. New cost accounting and

budgeting systems will alter the information that managers have to make

critical decisions for the organization. The information that these systems

provide, and the format that they provide them in, will greatly influence the

management of the utility for many years. Spend sufficient time early in the

process to be sure the systems answer the questions that are most

important to you, and provide data in a useful format. Be sure to get

feedback on these important questions from all divisions and from all levels

of the organization; the view from the utility director’s office is unlikely to

convey all that is important.

• Treat the Systems as an Input to the Answer, Not the Answer Itself.

There is a temptation to take quantified data as the key input in a decision.

Analytical tools help managers to structure a problem; they still require

interpretation. Economically-optimal outcomes may need to be balanced

against technical or political constraints. Work with key staff to

understand how to interpret the new cost accounting and budgeting
5-2

information so that they can use it to make better decisions without using it

unquestioningly.

• Share Lessons Learned. Many firms have implemented the types of

budgeting and cost accounting systems described here. However, the

specific challenges and hurdles faced by POTWs that try to do so will likely

be quite different. Be willing to ask questions of utilities who have moved

in this arena sooner than you; you can learn much from them. A

centralized forum (perhaps a special area of EPA’s Office of Water Web

site or its PIPES bulletin board for water-related issues) in which to share

questions and advice on implementing improved budgeting and cost

accounting might be extremely useful.

• Be Flexible in How to Use the New Information. If political realities

prevent you from increasing fees on the large IUs driving your elevated

biosolids costs, the new information on costs can nonetheless be very

useful in prioritizing the use of internal resources. The net result will still

be less pollution at lower cost.
GLOSSARY AND ACRONYM DIRECTORY

activity cost pools - Accounting groupings that sum all expenditures related to a particular

organizational activity, used in an activity-based costing approach.

activity-based costing (ABC) - Cost accounting approach that allocates all costs within an

organization to processes, products, or projects on the basis of the activities that generate those

costs. Spending is grouped by activity, rather than department as is often done.

AMSA - Association of Metropolitan Sewerage Agencies, the trade association of large, municipal

sewerage agencies.

average and peak demand method - Method of allocating capital infrastructure costs to system users

by assigning the baseline costs based on average demand for services and allocating residual

costs, assumed to be associated with peak demand, based on peak demand patterns.

benchmarking - A detailed comparison of ones own products or processes to those of other

competitors or service providers to identify avenues for improvement.

capital budgeting - Process by which the POTW assesses long-term capital needs, and estimates the

costs and benefits of particular capital acquisitions. An important aspect of capital budgeting is

the assessment of the full annualized costs of capital services from particular plant or equipment

investments.

coincident demand method - Approach used to allocate capital costs to users based on their demand

for system capacity during the system's peak period.

cost accounting - Process by which costs are allocated to specific products or services so that

managers can better assess how their costs vary based on different activities.

cross-subsidies - Pricing or fee systems that charge one class of users or certain activities less than the

real cost of providing service. Generally, cross-subsidies are financed through higher charges

on other consumers. Cross-subsidies are independent of whether a utility meets its overall

revenue requirement, and tend to exist in regulated markets more often than in competitive

ones.

debottlenecking - Bottlenecks in a plant are the "weak links" in production (or waste water treatment)

where capacity is constrained, preventing an increased production or treatment capacity.

Debottlenecking is the process of identifying and rectifying these constraints.

direct discharger - Industry with an EPA NPDES permit allowing it to discharge waste water directly

to a river or stream rather than having to send it to a sewage treatment plant.

FOG - Fats, Oil, and Grease discharges into the sewer system. Term is applied to both cooking oil and

petroleum-based products.

HARRF - Hale Avenue Resource Recovery Facility, the wastewater treatment plant in Escondido,

CA.

historical costs - Measurement of the actual cost to install infrastructure. Historical costs, as opposed

to replacement costs, are often used as a basis for pricing wastewater services and setting

revenue requirements.
I/I - Inflow and Infiltration. Infiltration includes ground or surface waters entering the collection

system through physical defects in collection system such as cracked pipes, deteriorated joints,

or poor construction. Inflow includes flow entering the collection system from sump pumps,

cross-connections, leaking tide gates, manhole covers or other non-wastewater source.

IJAs - Interjurisdictional agreements, the legally-binding contracts municipalities sign with each other

governing shared services, such as wastewater treatment.

indirect discharger - Firms discharging waste water to a sewage treatment plant rather than directly

to a river or stream. Indirect dischargers are regulated by the receiving POTW.

IU - Industrial Users. Refers to industries discharging to the municipal sewerage system.

lateral lines - Smaller, peripheral sewer lines in waste water collection system.

LMSD - Louisville and Jefferson County Metropolitan Sewer District.

life-cycle costing - Process of evaluating not only the direct costs of providing a product or service,

but costs throughout the life-cycle. This would include such factors as the environmental

impacts of producing the product and the cost of disposal.

minimum size rule - Used to allocate infrastructure shared by many users, the minimum cost rule

assumes that the minimum capacity (plus a safety margin) needed to serve a standard user is a

joint cost, and the incremental costs beyond that level should be borne by the subset of users

requiring the larger capacity.

MWRA - Massachusetts Water Resource Authority, the oversight body for water and wastewater

services for 45 communities in the Boston area.

noncoincident demand method - Approach used to allocate the costs of capital infrastructure among

users based on the peak demand for the system for each individual large system user. Often

used when infrastructure sizing is driven by customer rather than system peaks, such as in the

size of lateral collection lines.

NPDES - National Pollutant Discharge Elimination System, used by the Environmental Protection

Agency to track discharges to the nation's water bodies.

peak leveling - The need for wastewater collection, storage, and treatment capacity is driven by peak

demand. Peak leveling uses a variety of market and outreach approaches to reduce the peak

surges, thereby deferring the need for additional capacity.

POTW - Publicly Owned Treatment Work, wastewater treatment plants owned by the public sector.

process mapping - Systems tracking of physical processes, key task flows, and information flows

within an organization. Process mapping is used to improve estimates of the real cost of a

particular organizational function and to identify ways to streamline organizational processes.

replacement costs - Cost to replace existing capital infrastructure at today's prices. Replacement costs

can be lower than historical costs (e.g., if technical improvements have reduced the costs of

new equipment) or higher than historical costs (e.g., if labor costs, interest rates, or siting costs

have risen).

resource or shadow pricing - Linear algebraic analytic approach that estimates the cost to a

production objective (generally profit) from a scarcity of a particular input or resource.
TRAC - Toxic Reduction and Control Department, the division administering MWRA's industrial

pretreatment program.

trunk lines - Large, central sewer lines in a waste water collection system.

unbundling - Process of disaggregating the various services provided by a utility such as wastewater

collection, billing, stormwater control, to be sure that the price of each service accurately

reflects the cost of providing it. Unbundling tends to remove many cross-subsidies that exist

within the current pricing structure.

WWTP - Wastewater Treatment Plant.



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Business Journal, February/March 1996, p. 9.

"One Stream Solves Two Problems for Rural California County," ENR,April 7, 1997, p.

20.

AMSA (Association of Metropolitan Sewerage Agencies). Evaluating Privatization: An

AMSA Checklist, 1996.

Chew, W. Bruce, Timothy Bresnahan, and Kim Clark. "Measurement, Coordination, and

Learning in a Multiplant Network," in Robert Kaplan, editor, Measures for

Manufacturing Excellence, (Boston: Harvard Business School Press, 1990).

Elliot, James, et al. "Removing Private Sources of Infiltration and Inflow," Water

Environment & Technology, August 1997, pp. 55-60.

Ernst & Young LLP. 1994 National Water and Wastewater Rate Survey, Ernst & Young

National Environmental Consulting Practice, August 1994.

Godlewska, Anna, Antonio Mello, and John Parsons. "Price Behavior in Electricity

Futures: The Story So Far," Public Utilities Fortnightly, January 1, 1997, pp. 32-

35.

HYA Consulting Engineers. City of Escondido Brine Management Feasibility Study,

August 1995. Prepared for the San Diego County Water Authority.

Kimmel, Liz, Alan Saylor, and David Reardon. "Research Groups Help POTWs Cut

Energy Cost," Water Environment & Technology, pp. 26, 28.

Koplow, Doug, et al. Improving Industrial Pretreatment: Success Factors, Challenges,

and Project Ideas. Prepared for the U.S. Environmental Protection Agency's

Office of Policy, Planning and Evaluation by Industrial Economics, Inc., October

1996.

MWRA. Final Billable FY 1998 Water and Sewer Charges, June 30, 1997.

MWRA. FY98 Proposed Current Expense Budget, February 24, 1997.

MWRA. "MWRA's Sewer Service Cost Allocation Methodology," July 15, 1997.

MWRA. "Massachusetts Water Resources Authority Incentive and Other Charges

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