1.1 INTRODUCTION
As of mid-1999, there were 586 municipalities in Ontario that spend approximately $4 billion annually on capital projects. It is anticipated that this spending amount will grow as municipalities take on their new responsibilities under the Provincial Local Services Realignment (LSR) initiatives and other transfers such as highways. LSR has highlighted the need for municipalities to plan and budget for their capital works programs in a strategic manner.
Capital budgeting is a very important planning tool for municipalities as it allows them to provide for the necessary infrastructure to maintain or enhance future service levels. Through capital budgeting, municipalities can plan future operating budget expenditure, debt repayment and potential reserve fund needs in order to manage the financial position of a municipality over a five to ten-year period. Capital budgets provide the basis for the implementation of official plans, master plans and strategic plans and also provide the financial mechanism to implement Council's planning and fiscal policies.
The purpose of this manual is to assist municipalities in the development of their capital infrastructure planning and budgeting processes. The manual recognizes the increasing need on the part of municipalities to prioritize various competing capital requirements and the application of scarce financial resources to those needs. It is important that municipalities have the tools available to them in order to project the financial impacts of their decisions over a number of fiscal periods.
This manual is specifically targeted to small and medium-sized municipalities. Larger municipalities will find that the principles and approach are similar to those applicable to them, although the process for review and implementation may differ. It is recognized that each municipal organization has unique characteristics, organizational structures, physical environments and financial resources, hence the principles and processes provided herein should be reviewed and adjusted to individualize them to each municipality.
Recently there have been many changes to municipal legislation and financial reporting procedures. Further changes may be made in the future which could affect aspects of this document. It is, therefore, recommended that provincial legislation and reporting requirements continue to be monitored as part of the municipality's ongoing capital budgeting process.
1.2 OVERVIEW OF THE MUNICIPAL FINANCIAL SYSTEM
Municipalities in Ontario use Fund Accounting as the basis for recording and reporting of all financial transactions. Fund Accounting can be defined as an "accounting system in which a self-balancing group of accounts is provided for each accounting entity established by legal, contractual, or voluntary action, especially in government units". In more simple terms, Ontario municipalities practice a form of accounting which uses three funds: a revenue (or operating) fund, a capital fund and a reserve fund. Each of these funds has a specific defined use; within that use, expenditures are financed by various sources. The three funds are described as follows:
Revenue Fund
The revenue fund or the "operating" or "general fund" as it is often called, is the principal fund found in all municipalities. This is the fund into which the main sources of financing available to the municipality flow. Taxation revenue, grants, interest earned on investments, service charges, licenses and permits are all recorded in this fund. This fund also records the everyday operating expenditures of the municipality. The revenue fund initially records most of the sources of financing that are eventually transferred to the capital fund and the reserve funds.
Capital Fund
The capital fund is used to record the financing sources and expenditures for the acquisition, rehabilitation or replacement of the capital assets of the municipality. In general, capital assets refer to buildings, equipment and infrastructure of the municipality. Included here are municipal buildings, arenas, trucks, graders, roads, water/sewerage systems and the like.
Reserve Funds
Reserve funds are those funds that have been set aside either by a by-law of the council or by a requirement of provincial legislation to meet a future event. As a result, reserve funds could be called either "permissive", those set up by Council or "regulatory" (or obligatory), those set up by virtue of a requirement of a provincial statute. As a general principle, municipal Councils may set up reserve funds for any purpose for which they have the authority to spend money.
An overview of these three funds, how they inter-relate and the more common expenditures and revenues associated with each fund is provided in Figure 1-1. This document will focus on the capital fund. References to how this fund interacts with the other funds will also be addressed.
1.3 WHAT IS A CAPITAL BUDGET?
A capital budget is a multi-year financial plan, usually five or ten years, for the construction or acquisition of capital works. The plan, once complete, should provide for the planning of future financial resources required to finance the project, identify the future financial resources to be allocated from the operating (revenue fund) budget to operate and maintain the capital asset once it is acquired, and integrate with the municipality's ongoing management control system.
The capital budget is distinguished from an operating budget. An operating budget normally provides for the day to day expenditures of a municipality for items such as salaries, wages, benefits, heat, hydro, maintenance of buildings and infrastructure, etc., whereas the capital budget plans for the acquisition or rehabilitation of capital assets.
1.4 DEFINITION OF CAPITAL EXPENDITURE
The manner in which the term capital is interpreted and applied for municipal purposes tends to vary from municipality to municipality. Many expenditures cannot be easily classified as capital or operating as they may display characteristics of both. Deciding what is capital is a matter of judgement and may be difficult in some cases. Accordingly, where appropriate a municipality may wish to seek professional advice. However, for general reference purposes, a number of definitions of capital found from several sources are provided below.
The Province is presently reviewing the definition of capital and may provide further instructions to municipalities with the 2000 Financial Information Return packages. This new definition would take into account the Public Sector Accounting Board (PSAB) rules respecting capital.
In the document, "Instructions for Completing the 1998 Financial Information Return", the following definition of capital expenditure is provided:
"A capital expenditure is any significant expenditure incurred to acquire or improve land, buildings, engineering structures, machinery and equipment. It normally confers a benefit lasting beyond one year and results in the acquisition or extension of the life of a fixed asset. It includes vehicles, office furniture and equipment. An expenditure on repair or maintenance designed to maintain an asset in its original state is not a capital expenditure. A capital expenditure may include the costs of studies, etc., undertaken in connection with acquiring land or constructing buildings. It may also include interest on temporary borrowings for capital purposes and transfers for capital purposes to unconsolidated local entities, hospitals, universities and similar organizations."
The Development Charges Act, 1997 (section 5(3)) provides a similar definition:
"The following are capital costs .... if they are incurred or proposed to be incurred by a municipality or a local board directly or by others on behalf of, and as authorized by, a municipality or local board:
1. Costs to acquire land or an interest in land, including a leasehold interest.
2. Costs to improve land.
3. Costs to acquire, lease, construct or improve buildings and structures.
4. Costs to acquire, lease, construct or improve facilities including,
i. rolling stock with an estimated useful life of seven years or more,
ii. furniture and equipment, other than computer equipment, and
iii. materials acquired for circulation, reference or information purposes by a library board as defined in the Public Libraries Act.
5. Costs to undertake studies in connection with any of the matters referred to in paragraphs 1 to 4.
6. Costs of the development charge background study ...
7. Interest on money borrowed to pay for costs described in paragraphs 1 to 4."
The Public Sector Accounting Board (PSAB) may provide an authoritative guide for Municipal Reporting requirements at some time in the future. The Canadian Institute of Chartered Accountants (CICA) "Public Sector Accounting Recommendations -September,1997" document provides the following definitions:
"Tangible capital assets are non-financial assets having physical substance that are acquired, constructed or developed and:
(i) are held for use in the production or supply of goods and services; (ii) have useful lives extending beyond an accounting period and are intended to be used on a continuing basis; and (iii) are not intended for sale in the ordinary course of operations.
Cost is the amount of consideration given up to acquire, construct, develop or better a tangible capital asset, and includes all costs directly attributable to acquisition, construction, development, or betterment of the tangible capital asset, including installing the asset at the location and in the condition necessary for its intended use. The cost of a contributed tangible capital asset is considered to be equal to its fair value at the date of contribution."
In summary, from the above, capital works may be defined to include the following elements:
acquisition and construction of new buildings, structures, facilities, equipment, rolling stock, furnishings, studies, development and purchase of land, and all associated items to bring the foregoing into function operation; or
major rehabilitation of the above;
normally has a useful life of more than one year.
For ease of administration, capital expenditures may have a minimum dollar amount associated with them (e.g. some municipalities define items in excess of $5,000 or $10,000 as a capital item). Figure 1-2 provides an informal comparison of capital asset expenditures versus expenditures which would typically be included in a municipality's operating budget.
1.5 Purpose and Who Uses the Capital Budget
Municipal multi-year capital forecasts can have widespread purposes and benefits. Many public and private sector groups may have an interest in reviewing these forecasts. An overview of various groups and potential use of the forecast is provided below:
Municipal Council:
To a municipal council, a capital budget represents a statement of intention to proceed with a certain program of capital works and services. Within specific programs, council establishes priorities for servicing and spending while controlling the ultimate impact on the tax/ratepayer over a five year (or longer) planning horizon. The budget also provides a control mechanism for future debt levels.
Council's input to the process is imperative as it will establish the direction the municipality will take over the short to medium term. Since the capital budget affects future operating expenditures, appropriate guidance should be provided during the capital budgeting process to ensure that desired service levels and tax levels are managed and planned.
In Ontario, the degree of council's involvement in the capital budgeting process varies from municipality to municipality. For example, councils may participate directly in the capital budgeting process, or they may establish policy direction and provide key input at various stages of the process. In each case, the council remains legally responsible for all budget decisions. Individual municipalities establish individualized processes to achieve local objectives. Council's involvement, in whatever form it may take, is important to the future financial health of the municipality.
Municipal Administration:
The capital budget represents an integrated and co-ordinated effort of the municipality and relies on inputs from several areas of municipal responsibility:
1. PUBLIC WORKS
Provides the analysis of needs, pre-planning and prioritization of services to be constructed in the future. With respect to ongoing construction of works, Public Works monitors quality control of the construction and expenditures within council-established spending limits.
2. FINANCE/TREASURY
To the Finance/Treasury department, the capital budget is a key financial planning document. From this document, Finance monitors existing and future debt levels, present and future impacts (debt charges and operating costs) on the operating budget and taxpayer rates, future grant applications, project monitoring, and budget control.
3. PLANNING
The capital budget represents a translation of planning policies and objectives into physical development plan. The Planning department reviews the projects in the capital budget to ascertain whether their implementation is in conformity with the Official Plan.
4. OTHER DEPARTMENTS
Other departments within the municipality (Fire, Police, Parks, Recreation, Library, Day Care, Homes for the Aged, etc.) also provide input into this document for the phased planning of their major works.
Upper/Lower Tier Government:
Both the upper tiers (regions, counties, and district) and lower tiers (City, Town, Township, Village, etc.) review each others' budget documents to ensure that certain works (eg. roads, water mains, sewer mains, etc.) can be co-ordinated with works planned by the other tier government. Cost savings can be achieved by undertaking certain works in a co-ordinated manner.
Provincial Government:
The Ministry of Municipal Affairs and Housing (MMAH) is the provincial ministry responsible for municipal issues. MMAH's vision for the municipal sector is that the sector should be more efficient, accountable and effective in addressing local needs. One of MMAH's key strategies is to work toward providing the Ministry and municipalities with opportunities to improve skills and tools to implement new responsibilities and directions, and to manage change. Also, the legislation administered by MMAH provides the primary governance and financial framework for local government.
MMAH's primary interest in developing a structured approach to capital budgeting is to facilitate informed decision making at the local level to meet capital needs. A sound capital budgeting system is part of an overall prudent and efficient financial management system that produces useful data and information.
MMAH often relies on the Financial Information Returns (FIR's) to obtain information and financial data for developing policies, programs or satisfying regulatory or statistical needs. The availability of information from capital budgets may provide useful and timely information on municipal capital needs.
Business Community:
The business community looks to the capital budget for an indication of the timing, location and types of services the municipality is planning to construct. Developers, or existing businesses, review this information to assist in their planning for development or potential expansion.
Financial Community:
The financial community reviews the capital budget to assess forward planning and future anticipated debt levels. Potential purchasers of municipal debentures are most concerned with the credit worthiness or risk involved in their purchase. More specifically, they are concerned with the municipality's future ability to pay their debt obligations.