Water Rates

AWWA MANUAL M1

Fourth Edition

FOUNDED 1881

American Water Works Association

Copyright (C) 1999 American Water Works Association All Rights Reserved

Copyright © 1954, 1972, 1983, 1991 American Water Works Association 6666 West Quincy Ave. Denver, CO 80235 Printed in USA ISBN 0-89867-574-X
Printed on recycled paper.

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Copyright (C) 1999 American Water Works Association All Rights Reserved

Contents
Foreword, iv Acknowledgments, vi Introduction, vii Chapter 1 Revenue Requirements . . . . . . . . . . . . . . . . . 1

Cash-Needs Approach, 1 Utility Approach, 3 Revenue-Requirement Projections, 4 Chapter 2 Allocation of Costs of Service to Cost Components . . . . . Base–Extra Capacity Method, 11 Commodity–Demand Method, 16 Special Considerations, 19 Chapter 3 Distribution of Costs to Customer Classes . . . . . . . . . Customer Classes, 20 Units of Service, 23 Unit Costs, 26 Distribution of Costs to Customer Classes, 28 Chapter 4 Development and Design of Rate Schedules . . . . . . . . Basic Cost-of-Service Rate Philosophy, 32 Rate-Design Example, 38 Other Rate-Design Considerations, 46 Chapter 5 Rate Design for Small Water Utilities . . . . . . . . . . . Information and Data Requirements, 54 Revenue Requirements, 54 Rate Design, 59 Appendix A Bill Tabulation Methodology . . . . . . . . . . . . . . Introduction, 63 Bill Tabulation, 64 Glossary, 73 Index, 79 63 53 32 20 9

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Copyright (C) 1999 American Water Works Association All Rights Reserved

Foreword

In 1954, the American Water Works Association (AWWA) prepared and published a report titled “Determination of Water Rate Schedules,” which later was issued as the first AWWA manual on water rates. The most recent edition of the manual (third ed.) was published in 1983 to update the 1972 edition (second) and to better reflect the current water rate-making philosophy. Dramatic changes in economic conditions that have taken place in the years since the 1972 edition was published have had a continuing and far-reaching influence on water utility operational and financial management during that period. Inflation and resulting cost impacts on water utility customers, as well as increased public awareness of the need for conservation and more effective use of natural resources, together with the need to provide proper price signals, have challenged utility managers to continue providing high-quality service to water utility customers on an equitable and fair cost basis. While the rate of inflation has somewhat declined in magnitude in recent years from the previous decade, pressures to maintain low rates and provide better use of water resources have continued to present challenges to utility management. It is also important to note that none of these forces and pressures have presented any reasons to modify the traditional cost-ofservice principles outlined in this manual as a policy of AWWA. In view of these factors, it is essential that water utility management have a basic understanding of the fundamental cost-of-service principles involved in the evaluation and allocation of water system revenue requirements, the importance of short- and long-term revenue adequacy and stability, and the measuring of revenue requirements and design of water rates to achieve the utility’s objectives while reflecting cost-of-service principles. Current economic conditions and continuing pressures on infrastructures of municipalities and private companies emphasize the obvious fact that a water utility, whether government-owned or investor-owned, must consistently provide adequate income to successfully meet its obligations to the public it serves. The basis for the rates, including rate of return, must reflect anticipated future conditions as well as historical costs. It follows that the financial health of the utility as well as equitability among customers should be primary objectives of the cost allocation and design of rates to meet revenue requirements. Cost-of-service-based rates achieve both of these goals in the most efficient way possible. Development of an adequate revenue requirement to meet both current and expected future cost is essential. Establishment of revenue requirements based solely on current costs without considering elements of expected future expenditures may result in inadequate revenue to meet the utility’s needs. This fourth edition of AWWA Manual M1, Water Rates, contains the traditional and proven rate-making concepts and methodologies endorsed by AWWA in previous editions; discussion of topics relevant to the evaluation and design of equitable rates; and editorial changes, clarifications, and updates to reflect current thinking and to conform to the recent publication of new rate-related manuals, including AWWA Manual M35, Revenue Requirements, and AWWA Manual M26, Water Rates and

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Copyright (C) 1999 American Water Works Association All Rights Reserved

which present methodologies for allocation of total costs of service to various classes of customers served. this chapter includes some discussion of alternative rate forms that have been proposed during past decades as a result of inflationary. Chapter 1 presents a condensed description of the development of revenue requirements based on M35. Revenue Requirements. and social concerns. A glossary of terms is included in this edition of the manual. An appendix is attached that briefly sets forth a bill tabulation methodology. conservation. In addition. Chapter 5 addresses the simplified development of water rates for small utilities. Chapters 2 and 3. present the primary considerations in determining the cost of serving customers. Chapter 4 discusses and illustrates the design of a schedule of water rates to derive the allocated costs of service. v Copyright (C) 1999 American Water Works Association All Rights Reserved .Related Charges.

R. R. Guastella Associates.. Jackson. Va. Issues involving final changes in organization and content were mutually resolved by an editorial committee. J. Moorestown. Conn.. Vann. N. Editorial Subcommittee). Moriarty. Charlotte. Editorial Subcommittee vi Copyright (C) 1999 American Water Works Association All Rights Reserved . C. Ont. St. Louis County Water Company. Mass. Waterloo.O. Pa. AWWA Management Division Liaison Representative G. All members of the committee reviewed the manuscript and made constructive recommendations for revision. American Water Works Service Company. Wash. V. G. Voorhees.D. N.. McKinley. Birmingham. Northern Illinois Water Corporation.J. Clackamas. Ill. Stack* (Vice Chair). Mich.N.J. Pennacchio. Woodcock. Griffith Jr.R.Acknowledgments The AWWA Management Division Board of Trustees gratefully acknowledges the contribution made by members of the Rates and Charges Subcommittee in preparing this edition of the water rates manual. Inc. New Haven. Associated Utility Services. Dallas.R. Texas F. Inc.E. City of Pasadena.F. Bellevue. Fairfax County Water Authority..A. Ala. Merrifield. D.C. Kansas City.* General Motors Corp. Loen.E. M. Weymouth..J. F. J. Dallas Water Utilities.. Schierry. Springfield. University of Waterloo.. City of Kalamazoo. Mass. Champaign. Ore. Illinois Commerce Commission. Gannett Fleming Valuation & Rate Consultants. Calif. Boston.J. Palko. Robinson.W. Harrison. O. Ernst & Young. South Central Connecticut Regional Water Authority.* Clackamas Water District. Voorhees. Saleba. Kalamazoo. T. Day. C. Texas J. Raftelis. Tolan. Clark. M.K. Mich. Mo. Detroit.A. G.S. Louis. Inc.G. Simpson.F.S. Dallas. Economic & Engineering Services. N. Public Utilities Division. McKitrick. Smith. Inc.R. D.P. *Member. Pasadena. T. St. Potochney* (Chair).M. R. Mo. Pittsburgh. Mo. J. Camp Dresser & McKee. Rates and Charges Subcommittee A. Kansas City. Johnstone. Banker* (Chair.R. Samson & Associates. Water Works and Sewer Board. Black & Veatch. Appreciation is extended to those members of the subcommittee who updated and drafted the manuscript. Ill.P. Black & Veatch. American Water Works Service Company. Inc. N.

25. or costs of service. must reflect the utility’s need to maintain and meet future customer needs. Revenue Requirements. Determination of the total annual revenue requirements for the period for which the rates are to be effective. Revenue Requirements. The allocation of annual revenue requirements. 1982. A methodology that properly allocates costs to various classes of customers and then recovers these costs through a rate structure to maintain a self-sustaining enterprise and that is not unduly discriminatory to any class of customer is the objective of AWWA. 2. which are briefly summarized in the following paragraphs. 3. the cost to serve that class of customer. Allocation of Costs of Service to Cost Components. as well as the development of rates to equitably recover the costs of service from each class of customer. 1987. The reader of this manual is referred to AWWA Manual M35. 4. Design of water rates that will recover from each class of customer. The amount of revenue required may be determined by either the cash-needs approach or the utility approach.” adopted by the AWWA Board of Directors on Jan. whether it be the net book value or an established fair market value. 1965. to functional cost components is vii Copyright (C) 1999 American Water Works Association All Rights Reserved . The applicability of each approach is discussed. The subject matter is presented in five chapters. Generally. Chapter 2. A simplified diagram of these procedures is presented in Figure I-1 to which reference can be made as the manual is read and used.Introduction The American Water Works Association (AWWA) statement of policy regarding “Financing and Rates. This manual describes in detail two methods for preparing cost-allocation studies and presents a variety of generally accepted forms for rate structures. for a more comprehensive discussion of revenue requirements. The identification of the value of the rate base. 25.” This manual outlines the basic elements involved in the determination and allocation of the costs of service to the various classes of customers. Distribution of the component costs to the various customer classes in accordance with their requirements for service. Scope. The reference to rate-base “value” is intended to recognize that either net book value or an established fair market value may be used in determining the revenue requirements. The value must reflect the financial needs of the utility. within practical limits. Allocation of the total annual revenue requirements to the basic functional cost components. states in part: “The AWWA believes the public can be served best by self-sustained enterprises adequately financed with rates based on sound engineering and economic principles. The concepts and procedures described in this manual are based on principles that are generally accepted and widely followed throughout the industry. 31. The acceptability of variations in allocation methods or rate designs that are cost-based and nondiscriminatory is recognized. and reaffirmed on Jan. revised on Jan. Chapter 1. the development of water rates involves the following procedures: 1. and illustrative applications are presented.

viii Copyright (C) 1999 American Water Works Association All Rights Reserved .

nor should it be considered. as a complete text of specific rate making. based on sound engineering and economic principles. Record-keeping practices are. steps should be taken to minimize any discriminatory effect. An outside independent study also provides the advantage of different judgments and additional credibility where public support of the resulting level and structure of rates is important. Those persons responsible for conducting rate studies must continually communicate their information requirements to engineering. Development and Design of Rate Schedules. It should be recognized that rates may be adjusted to recognize past practices. and accounting staffs to ensure that the necessary information is available on a timely basis. For investor-owned utilities. Chapter 3. ix Copyright (C) 1999 American Water Works Association All Rights Reserved . and other special circumstances. Chapter 4. Larger utilities with complex system configurations will require more detailed analysis than illustrated in this manual. local policy. this manual may suffice with minimum supplemental expertise. political. may require the services of consultants experienced in rate matters. If the utility does not have necessary in-house expertise to cope with the added complexities. Rate Design for Small Water Utilities.presented using both the base–extra capacity and commodity—demand methods. Specific rate making for any particular water utility. When special situations require that factors other than the cost of providing service be considered in the final determination of water rates. The AWWA Rates and Charges Subcommittee does not endorse any substantial departure from cost-of-service-based rates to achieve social objectives. operating. critical to the credibility of the rate study. This manual provides a basic outline of the rate-making process and serves as a resource that the policymaker or manager may draw on to guide the analysis of the validity of rates and the basis on which they are founded. Chapter 5. This chapter discusses the design of water rates that will recover the allocated costs of serving each customer class. Distribution of Costs to Customer Classes. The application of the general theory involved in making each type of allocation is presented with illustrative examples. Purpose. whereas for government-owned systems. Simplified procedures for developing rates for small water utilities are presented to assist the smaller water utilities in preparing rate schedules without the need for relatively complex engineering and economic analysis. outside independent experts should be called in to ensure that the rates developed are truly cost-based. Rate design for a water utility is a process of matching the costs of service to be recovered to the unique economic. For small water systems. The distribution to customer classes of component costs is shown for both the base–extra capacity and commodity–demand methods. many bond agreements require such outside examination and certification. Even where in-house expertise is available. It should be recognized that the results of a cost-of-service study are highly dependent on the accuracy and reliability of the record-keeping systems that furnish the basic information for the study. and social environments in which the utility provides service. local regulatory agencies frequently require such independent review. This manual is not intended. Illustrative examples are offered for both cost-distribution methods. The complexities of any system require consideration of many factors not included in this simplified presentation. and a discussion of the theory and means of distributing costs is presented. an independent review may provide insights not perceived by personnel with limited exposure related to a single system. therefore.

generally more easily understood by the governing bodies than studies using the utility approach. The two generally accepted and practiced approaches to projecting total revenue requirements of a water utility are the “cash-needs” approach and the “utility” approach. can provide for sound utility financing. The reader is referred to that manual. for a more complete discussion of revenue requirements. presents an extensive discussion of considerations and illustrative tables regarding revenue requirements and their projections as they relate to water utilities. every water utility must receive sufficient total revenue to ensure proper operation and maintenance (O&M). Numerical examples in this manual are derived from the examples developed in M35 to provide continuity from one manual to the other. Another factor encouraging the use of the cash-needs approach by government-owned utilities is the use of bond financing. development and perpetuation of the system. The first step in utility rate making is to determine the total annual operating revenue requirements for the period in which the rates are to be effective. and maintenance of the utility’s financial integrity. in condensed form. Revenue-requirement studies prepared using the cash-needs approach are. The cash-needs approach of determining revenue requirements has been generally used by government-owned utilities and is basically an extension of the cash-oriented budgeting and accounting system traditionally used by government entities.AWWA MANUAL M1 Chapter 1 Revenue Requirements In providing adequate water service to its customers. which requires periodic payment toward liquidation of the debt. therefore. 1 Copyright (C) 1999 American Water Works Association All Rights Reserved . which was published in 1990. for the period over which the rates are intended to be adequate. CASH-NEEDS APPROACH __________________________________ The essence of the cash-needs approach is that the revenues of the utility must be sufficient to cover all cash needs. Each has a proper place in utility practice and each. Revenue Requirements. The revenue requirements are the costs of service to be derived from rates. elements of M35. AWWA Manual M35. the discussion of revenue requirements in this chapter parallels. including debt obligations as they come due. when properly used.

an additional element of O&M expense might also include payment to a city’s general fund for support services rendered. The debt-service components of the revenue requirements in the cash-needs approach consist of principal and interest requirements on bonds outstanding during the period that rates are effective. they constitute another component of revenue requirements under the cash-needs approach. However. In addition. Other cash revenue requirements that may be required to be financed from water system revenues might include payment to the general fund for items such as Copyright (C) 1999 American Water Works Association All Rights Reserved . and capital expenditures not debt-financed. e. The amount of cash required to pay principal and interest on outstanding debt is obtained from established debt-service schedules. As such. use of the city’s computer facilities. In a government-owned utility.e. and the like. Capital expenditures are generally classified into three broad categories: replacement of existing facilities. assistance in collecting water bills. other materials and supplies. rent on office space provided for water utility operations. Pro forma adjustments to historical O&M expenses are determined by incorporating all known and measurable changes into expense levels or by using well-considered estimates of future expenses. but some utilities also use current revenue to finance a portion of major capital improvements and replacements. and major capital improvements and replacements. and general overheads. to equal or exceed by a stated percentage annual debt principal and interest payments. some utilities may also be required to generate sufficient revenues to provide coverage on bonded debt. over the useful life of the facility. it is also appropriate when the services are furnished by an associated government entity. coverage requirements must also be evaluated in determining total annual revenue requirements to prevent the utility from failing to meet its bond covenant agreements. most major capital projects are financed from serially funded debt because the repayment of the debt over a number of years distributes the capital costs. smaller items of equipment that do not extend the useful life of major facilities. It is a generally accepted practice to finance normal replacements and extensions and minor improvements from current revenue. purchased power. rent. in order to provide a measure of security to bond holders. The O&M expense component of revenue requirements is based on actual expenditures derived from accounting records with adjustments to reflect the level of expenditure anticipated to be incurred during the period that rates are to be effective.2 WATER RATES Basic revenue-requirement components considered under the cash-needs approach generally include O&M expense. as a minimum. other purchased services. Those revenue requirements of the utility that are generally classified as O&M expenses include salaries and wages. Coverage requirements typically specify that utility revenues in excess of O&M expense be sufficient. To the extent that capital expenditures are financed from current revenues. debt-service requirements. Since inclusion of expenses for such services in the total revenue requirements would be proper if the utility were operating independently. chemicals. In addition to debt principal and interest expense and payments to reserve accounts established by bond covenants. employee fringe benefits. to some extent. normal extensions and improvements.g. there may be obligations to debt-service reserves. existing customers will not be paying 100 percent of the initial cost of facilities to be used by future customers). The establishment of the cash requirement for future plant improvements or additions is a decision generally affected by the nature of investment and utility financing policies. This debt-financing approach results in a better matching of the customers’ charges from year to year with the use of the facilities (i...

the government-owned utility. the situation is similar to the relationship of an investor-owned utility to its customers since the owner (municipality) provides service to non-owner customers (customers outside corporate limits). It is often used in the allocation of costs among customer classes within the corporate limits. or expansion of its system or for repayment of debt. whether governmentor investor-owned. not restored by current maintenance. like an investor-owned utility. should be sufficient to assure confidence in the financial integrity of the enterprise so as to maintain its credit and to attract and hold capital. When a government-owned utility provides service to customers outside the corporate limits. The utility approach of determining revenue requirements requires the establishment of a rate base. The annual cost of outstanding debt can be determined from the accounting records of the utility. and the fixing of a fair rate of return on the rate base. The O&M expense component of total revenue requirements is usually identical under both approaches. moreover. defined to be the value of the assets on which the utility is entitled to earn a return. decay. The annual cash requirement for capital-related costs under the utility approach of revenue-requirement determination consists of two components: depreciation expense and return on rate base. and obsolescence. that occurs due to wear and tear. For a government-owned utility. The Copyright (C) 1999 American Water Works Association All Rights Reserved . UTILITY APPROACH ________________________________________ The utility approach to determining revenue requirements is mandated for all investor-owned water utilities and for most government-owned (municipal) systems under the jurisdiction of state commissions or other regulatory bodies. The return to the equity owner should be commensurate with the return from other enterprises having corresponding risks. The funds resulting from the inclusion of depreciation expense in the annual revenue requirements are the property of the utility and are available for use as a source of capital for replacement. inadequacy. gross-receipts taxes. The annual depreciation expense component of revenue requirements provides for the recovery of the utility’s capital investment over the anticipated useful life of the depreciable assets. Such additional requirements depend on each local situation and should be considered where applicable. It is. therefore. The return component is intended to pay the annual interest cost of debt capital and provide a fair rate of return for the total equity capital employed to finance physical facilities used to provide water service. improvement. The proper level of depreciation expense to be included in the total revenue requirement should be based on the cost of the depreciable plant in service during the period for which rates are being established. which are not so immediately affected by the level of system capital expenditures as are rates developed under the cash-needs approach. is entitled to a reasonable return from non-owner customers based on the value of its plant required to serve those customers. the total level of annual revenue required is the same under either the cash-needs or the utility approach. In this situation. Depreciation is the loss in value of facilities. proper that this expense be borne by the customers benefiting from the use of these assets.REVENUE REQUIREMENTS 3 payment in lieu of taxes. The use of the utility approach can reduce controversy since it generally results in more stable rates. The cost of equity capital is more difficult to determine. Depreciation is a real part of the cost of operating a utility. It is also an appropriate method for determining the costs of service applicable to customers served outside of the corporate limits by a government-owned water utility. or a dividend payment. The return. whether at retail or wholesale.

The total annual revenue requirements of an investor-owned utility include O&M expenses. Federal and state income taxes must be paid by an investor-owned water utility and are. Other taxes. The prospective procedure develops the revenue requirement for costs. it has been the general practice of regulatory commissions to establish rates based on an actual historical test year. income taxes. This procedure has been used frequently by government-owned utilities. it is essential that the procedures and policies of the regulatory body be determined and that the utility be guided by them in the determination of its revenue requirements. On the other hand. regulations. contributions in aid of construction and customer advances for construction are generally deducted from utility plant in service for rate-base determination. whether determined using the cash-needs approach or the utility approach. In preparing for any rate matter within a specific jurisdiction. working capital. Frequent rate adjustments are likely to be needed when a historical year is used as the basis for establishing revenue requirements. REVENUE-REQUIREMENT PROJECTIONS_______________________ Among the more significant financial problems confronting government-owned and investor-owned utilities in recent years has been the impact of inflation. depreciation expense. such adjustments might include increases in salary and wage expenses resulting from a negotiated labor agreement. and construction work in progress. Although the use of a prospective basis for determining revenue requirements for rate making may be desirable from the utility’s viewpoint. Each state commission and regulatory body has its own rules.4 WATER RATES rate base is primarily composed of the value of the utility’s plant and property useful in serving the public. it is proper to include an allowance in the rate base for materials and supplies. Rapidly escalating costs have affected every component of revenue requirements. Historical data also provide the basis for the bridge between the actual costs of the past and the projected costs of the future. and a return on rate base. such as general property taxes and gross receipts taxes. In the past.” or prospective. For purposes of illustrating the various principles and techniques of rate making discussed in this and the following chapters. In addition. and return on rate base for an investor-owned utility involve the same considerations discussed above for a government-owned utility using the utility approach. because future cost levels will most certainly exceed those incurred in the past. whereby rates are established to meet projected revenue requirements for a specified future period. other taxes. it has not always been accepted in certain jurisdictions subject to regulatory review. and policies for determining total revenue requirements. Operation-and-maintenance expense. an elementary example for a Copyright (C) 1999 American Water Works Association All Rights Reserved . and it is gaining increasing acceptance by state commissions regulating investor-owned utilities. depreciation expense. One of the most effective methods used to cope with the problem of rapidly increasing costs is the use of a “forward-looking. that are anticipated for the period the rates will be in effect. particularly in periods of rapid inflation. therefore. Typically. both capital and operating. rate period. with certain adjustments to historical costs being allowed for known and measurable changes. It is essential to first develop adequate historical data to serve as a basis for projecting future requirements. properly included in the determination of total revenue requirements. must also be included. and the like. known increases in costs for purchased water and electric power. fringe benefit adjustments.

000 224.000 146.000 __________ 2.000 286.053.000 43.000 149.000 13.000 70.000 $3.000 $3.000 46.000 211.000 (75.000 12.000 242.000 27.000 385.000 186.000 25.000 860.000 860. the concepts and tables presented throughout the manual are equally applicable to investor-owned utilities.000 266.000 __________ 2.000 45.000 141.000 3 $93.000 13.000 710.000 130.000 272.000 5 $101.000 202.830.932.040.000 4 $97.000 201. debt-service reserve requirements.000 130.000 __________ 1.000 $4.000 15.000 259.000 14.000 135.000 218.000 60.000 __________ 2.000 299.000) __________ 1.000 375.000 60.000 O&M Expense: Source of supply Pumping: Purchased power Other Water Treatment: Chemicals Other Transmission and Distribution: Mains Storage Meters and services Hydrants Other Customer Accounting: Meter reading and collection Uncollectible accounts Administrative and General: Salaries Employee benefits Insurance Other 17 Total O&M expense 18 19 20 Capital Requirements: Debt service Debt-service reserve Capital improvements 21 Total capital requirements 22 Less: other revenue 23 Net capital requirements 24 Total revenue requirements from rates hypothetical utility has been developed.184.224.000 200.000 60.000 306.000 $3.000 121.279.000) __________ 1. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Expenditure Component 1 $86.500.000 30.310.000 __________ 1.000 390.000 259.000 256. The example is oriented toward governmentowned utilities.000 161.000 167.000 __________ 1.000 2 $90.000 82.000 375. are derived from AWWA Manual M35.222. *Table 6-1.000 217. debt-service requirements.000 399.000) __________ 1.223.000 (91.000 28.000 193. 42.000 395.000 276.000 243.” pg.000 (87.000 425. however.000 $4.000 208.000 72.000 (79.000 155.000) __________ 1.000 177.000 29.000 235.000 __________ 2.000 194.000 209.* They reflect prospective projection of the cash revenue requirements of the utility for a future five-year period and include O&M expense.000 26.000 294. The revenue requirements for the utility in the example.000 380.000 860.000 171.000 247. “Flow of Funds. as shown in Table 1-1.223.000 75. Copyright (C) 1999 American Water Works Association All Rights Reserved .000 78.000 860.000 174.000 __________ 1.710.000 152.000 (83.221.REVENUE REQUIREMENTS 5 Table 1-1 Projected Revenue Requirements—Government-Owned Utility Projected Years Line No.305.000 125. with the exception of the development of revenue requirements shown in Table 1-1.000 __________ 1.000 44.315.000 221.115.000 135.000 __________ 2.960.000 47.000 116.300.000 185.000 151.000 283.000 157.000 140.000 146. and capital improvements not debt-financed.000 60.000) __________ 1.183.000 233.000 288.

the estimates of such other revenue is shown on line 22. In allocation of costs to customer classes and design of rates. Second. it is assumed that rates are to be designed for a one-year period. The total test-year cash requirement for the government-owned utility in the example amounts to $3.000 on existing revenue bond debt and $300. An estimate of $380. Prior to years of relatively high inflation. Such an illustration reflects prudent planning in that Year 1 could well be the current year. the latter being a $3. total $860. This total consists of $560.6 WATER RATES The example in M35 illustrates that revenues under existing rates are adequate to meet cash requirements in Year 1 but that revenues under existing rates are insufficient in subsequent years.000. The accounting system format maintained by utilities varies considerably. The projections of O&M expense shown on lines 1–17 in Table 1-1 are separated into various expenditure components. In the example. and 5. is $79.000. While most revenue requirements usually need to be met from rates applicable to water service. for which projections show that revenues will be adequate to meet revenue requirements but that projections for next year. For this example. Year 2. and improvements not debt-financed. The debt-service requirements on outstanding debt during the rate period. it provides for small elements of expense to be more accurately analyzed and projected. with subsequent rate changes possibly necessary to meet the requirements in Years 3. if marked cost increases are experienced. 4. Because such expenditures are generally of a recurring nature.000 for normal annual capital improvements is used for the utility in the example and is shown on line 20 of Table 1-1. Year 2. some other revenue is derived from miscellaneous income items such as rentals and interest on invested capital. Projection of expense in the detail shown in Table 1-1 is important for two reasons. it is proper that they be financed directly from annual revenues rather than through debt-financing. First.000 in the test year.000 issue with approximately equal annual principal and interest payments over 20 years at an average annual interest rate of nearly 8 percent.500. extensions. a general rule of thumb for projecting an adequate allowance for such costs is that they should amount to between 1 and 2 percent of total depreciable gross plant investment. an allowance in excess of 2 percent may be justified. shown in Table 1-1. however. the total requirement for O&M expense is separated into cost elements that are readily assignable to appropriate functional cost components in the cost-of-service allocation phase of the rate study analysis. as shown on line 24 in the second column in Table 1-1. Another item of revenue requirements included in the example is the expenditure for capital improvements consisting of replacements. the categories of O&M expense shown in Table 1-1 are considered to be representative of the type of accounting detail available in most utilities. In the example. and the level of expenditures established based on careful examination of historical trends and anticipated future conditions. It is reflected as a deduction from total capital requirements in deriving the total revenue requirements of the utility. necessary contributions to debt-service reserve are estimated to be $60.000 on proposed new debt. However. and for the test year. This represents the total annual cost of service to be derived from rates Copyright (C) 1999 American Water Works Association All Rights Reserved .000. show a need for additional revenues.000 per year as shown on line 19. The appropriate level of normal annual improvements certainly varies with the size and average age of a particular utility. Year 2. a period for which the initial rate change is to be adequate is usually considered to be the test year.

Table 1-2 also shows the revenue requirements for a similar investor-owned utility. Only the greater of the two amounts should be included in the determination of total revenue requirements.000 1.000 469.000 60.000) ___________ $3. this same level of total annual revenue requirements is shown for a government-owned utility on both the cash-needs and the utility approach. Assuming a rate base of $16.000).942.000 *Annual cash requirements for this item are met from depreciation expense and return. Under the utility approach.000 380. the level of return to be derived from rates in the example is required to be $807. indicating the relationship of the two methodologies.279. In any particular Table 1-2 Summary of Test-Year Revenue Requirements Investor-Owned Utility Utility Approach $2. This is determined by applying a proper schedule of depreciation rates to the total depreciable plant investment in service.89 percent of the total depreciable plant investment of $21. As shown in Table 1-2.REVENUE REQUIREMENTS 7 anticipated to be incurred by the utility in the test year for providing service during the period for which rates are being designed. is $414. shown on line 5 in Table 1-2.000 * 414.000 ($886.000 – $79. In the example.000.000 360.500. revenue-bond covenants prescribe a minimum coverage level with the frequent provision that revenue amounts in excess of that required for operating expenses and debt service can be spent only for capital improvements or early debt retirement. as shown on lines 8 and 9 of Table 1-2. the composite depreciation rate is about 1.000.904.000 Utility Approach $2.279.279. a comparison needs to be made between these provisions and planned capital expenditures to be financed from current revenues. the overall rate of return for the hypothetical government-owned utility is about 4. 1 2 3 4 5 6 7 8 9 O&M expense Debt service Debt-service reserve Capital improvements Depreciation expense Taxes other than income tax Income taxes Return (operating income) Other revenue Cash-Needs Approach $2. the O&M expense component of the total test-year revenue requirement is the same for the investor-owned utility as for the government-owned utility using either the cash-needs or the utility approach.000 860. the annual depreciation expense component of total revenue requirements.000) ___________ $4.000 Government-Owned Utility Line No. In Table 1-2. Generally. Copyright (C) 1999 American Water Works Association All Rights Reserved . Using the utility approach.000† (79. †Includes interest on debt.186. For a government-owned utility to meet the total cash-revenue requirements under the utility approach.451.99 percent.000 10 Total revenue requirements from rates (79.000 886.500.000. The projected revenue requirements shown in Table 1-1 reflect the cash-needs determination of revenue requirements referred to at the beginning of this chapter.000 * 414.000† (31.000) ___________ $3. the annual depreciation expense allowance is the same for either an investor-owned or a government-owned utility. If provisions for coverage on bonded debt are applicable to determining revenue requirements.

For the investor-owned utility.451. For a government-owned utility providing service to non-owners. the applicable rates of return may properly reflect a differential between owners and non-owners.942.000.99 percent rate of return shown for the government-owned utility in the example. In the example. and interest expense.000. Income tax is shown on line 7 to be $469. financed with tax-free bonds. The higher return for the investor-owned utility assumed in the example shown in Table 1-2 results from the weighted cost of debt and equity capital. The income tax element of the investor-owned utility’s cost of service is based on the application of a composite tax-rate allowance for both federal and state income taxes to total taxable income. An overall rate of return of 10. From the example shown in Table 1-2. and having to pay a fair and reasonable return to equity investors who provided a portion of the investment requirements. resulting in a requirement for return (operating income) of $1. This return would be expected to be greater than the resulting overall 4. depreciation expense. Copyright (C) 1999 American Water Works Association All Rights Reserved . having no tax-free financing available. the latter of which in this example is adequate only to provide for cash needs beyond O&M expense and capital requirements covered by depreciation expense. the rate base is less than that for the government-owned utility by the amount of accumulated deferred income taxes. development of an appropriate rate of return may reflect imbedded interest cost and return on system equity. For the same example utility on an investor-owned basis.000 and could include business. shown on line 6 of Table 1-2. amounts to $360. income taxes and other taxes must be recognized in the determination of annual revenue requirements. and in which the customers have made the equity investment for which no return is required.000 for an investor-owned utility paying all taxes.820.000 was assumed.5 percent on the rate base of $13.000 for the government-owned utility paying no income taxes. Once established. the magnitude of existing debt service and policy regarding the amount of revenue financing of capital improvements will influence the required level of return and may result in an indicated need for an overall rate of return markedly different from the example. Where a government-owned utility is serving customers who are outside its jurisdictional boundaries and who are considered to be non-owners. to $4. the rate of return assigned to system owners would be developed to recognize remaining cash needs.500. taxable income is equivalent to total revenue less O&M expense. The element of other taxes. other taxes. occupational. gross receipts. In this example. it is apparent that the overall revenue requirement to be obtained from water rates varies with the type of ownership and other requirements of the system. the overall level of revenue requirements varies from $3.8 WATER RATES government-owned utility. and other types of taxes. Consideration of differential rates of return is addressed in a subsequent chapter of this manual.

A utility incurs costs in relationship to the various expenditure requirements caused by meeting those customer needs. In seeking equitability in charges to the different customers. peak rates of use. cost-allocation procedures should recognize the particular service requirements of the customers for total volume of water. and other factors. For 9 Copyright (C) 1999 American Water Works Association All Rights Reserved . as discussed in chapter 1 of this manual and more extensively in AWWA Manual M35. the basic premise in the establishment of adequate rate schedules is that they should reflect the cost of providing water service. a water utility is required to supply water in total amounts and at such rates of use as desired by the customer.AWWA MANUAL M1 Chapter 2 Allocation of Costs of Service to Cost Components The total annual cost of providing water service is the annual revenue requirements applicable to the particular utility. Accordingly. For example. Since the needs for total volume of supply and peak rates of use vary among customers. Revenue Requirements. A sound analysis of the adequacy of charges requires allocation of costs among the customers commensurate with their service requirements in order to recognize differences in costs of furnishing service to different types of customers. a customer with a high peak rate of use as compared with an average rate of use requires larger capacity pumps. and certain other system facilities than a customer who has an equal total volume of use but takes water at a uniform rate. pipes. the costs to the utility of providing service also vary among customers or classes of customers. The total annual revenue requirements discussed in chapter 1 are the total costs of service to be derived from water rates and may be considered in the two broad categories of operation-and-maintenance (O&M) expenses and capital costs. Consistent with the exercise of appropriate conservation considerations in providing service.

transmission and distribution. Copyright (C) 1999 American Water Works Association All Rights Reserved . or assigned. Those costs by functions. both of these methods of cost allocation recognize the fact that costs of serving customers are dependent not only on the total volume of water used but also on the rate of use. (2) costs related to customer meters. depreciation expense. In most cases. they apply only in special situations. Under the utility approach. depending on the basis of allocation used. Other methods of cost allocation. and. are further distributable to customer classes on the basis of their particular requirements for service. or peaking requirements. The cost components vary. or special-use service. then to customers. involving incremental. and (3) direct costs incurred to provide for fire protection. billing and collection. capital requirements not debt-financed. and customer costs in the commodity–demand method. in terms of O&M expense. has been used in the past but is little used today because of its limitations relative to the two previously mentioned factors. the methods each recognize customer-related costs as a valid cost function. For a government-owned utility such as the one illustrated in Table 1-2. In allocating costs of service to customer classes. Cost allocation under the base–extra capacity and commodity–demand methods includes: • Allocation of costs applicable to the functional cost components of base. In addition. Under the cash-needs approach. extra capacity. The two most widely used methods of cost allocation are the base–extra capacity method and the commodity–demand method. depreciation expense. the total depreciation expense and return are equal to the total cash requirements. demand. in turn. Such cost breakdowns also usually show separation of salaries and wages. volume and rate of use. and to commodity. return on rate base. Such expenses are of a similar nature. whether for a governmentowned utility or an investor-owned utility. treatment. In their respective ways. pumping. and return. The allocation of water utility costs have. taxes. and accounts. and customer costs in the base–extra capacity method. capital costs would include depreciation expense and return on rate base. services. in some cases. and administrative and general. Utility records generally show these expenses broken down into costs related to supply. materials and supplies (including power and chemicals). are of limited application—that is. payments in lieu of taxes may also be a part of revenue requirements. revenue requirements may be apportioned among customer classes on a utility basis—that is. and income taxes and other taxes if applicable. customer meter reading. and other categories of expense. contributions to debt-service reserve. where appropriate. payments in lieu of taxes. marginal. the functional-cost method. and. including O&M expense. whether the utility is government-owned or investor-owned. Another method of cost allocation. these costs would include such investment-related cash requirements as debt service. Operation-and-maintenance expenses include both the costs of operating the system and the costs of maintaining system facilities and equipment. in two steps: first to appropriate cost components. gone through an evolution in the application of a variety of bases or methods. over the years. beyond O&M expense and other revenues.10 WATER RATES government-owned utilities. The purpose of cost allocation is to express the total utility cost of service. in terms of costs associated with supplying: (1) both the customer’s average and peak rates of use or demands. Capital costs may be expressed as annual costs associated with plant investment. to be recovered from rate-related revenues to meet capital-related costs. the costs are allocated.

budgeting. In detailed rate studies. annual rate of use. the evaluation process itself provides a useful consideration of a utility’s revenue requirements. Base costs include O&M expenses of supply. Moreover. as well as maintenance and capital costs related to meters and services. and customer accounting and collecting expense. such as a year. minimum required revenue levels. The allocations of costs to cost components by the base–extra capacity method and the commodity–demand method are discussed and illustrated in the remainder of this chapter. some of these elements may be broken down further into two or more subcomponents. Variable costs are those costs that tend to vary directly with the volume of water produced. They include meter reading. Examples of variable costs include chemicals used in treatment and the energy portion of the costs of power used in pumping. (2) extra capacity costs. irrespective of the amount or rate of water use. BASE–EXTRA CAPACITY METHOD ___________________________ In the base–extra capacity method. as well as capital costs related to water plant investment associated with serving customers to the extent required for a constant. without the elements of cost incurred to meet water use variations and resulting peaks in demand. pumping. (3) customer costs. or other extra-demand criteria appropriate for a particular utility.ALLOCATION OF COSTS OF SERVICE 11 • Distribution of costs by the various cost components to respective classes of customers in accordance with the respective responsibility of the customer classes for each of the component costs. as well as costs of O&M for system facilities. the costs for meter reading and billing and for customer accounting and collecting may be considered as one Copyright (C) 1999 American Water Works Association All Rights Reserved . costs of service are usually separated into four primary cost components: (1) base costs. Base costs are costs that tend to vary with the total quantity of water used plus those O&M expenses and capital costs associated with service to customers under average load conditions. Water purchased on a charge per unit of volume basis is also considered to be a variable cost. Extra capacity costs are costs associated with meeting rate-of-use requirements in excess of average and include O&M expenses and capital costs for system capacity beyond that required for average rate of use. and distribution facilities. maximum-hour demand in excess of maximum-day demand. can be appropriately evaluated. potentially leading to improved record keeping. It is useful to consider the distinctions between variable and fixed cost categories in performing base–extra capacity or commodity–demand cost allocations. and (4) direct fire-protection costs. Examples of fixed costs would include virtually all capital costs such as debt service or depreciation expense and return. can be evaluated with respect to each customer class. and recognition of the nature of the utility’s costs. Distribution of component costs to customer classes is discussed in chapter 3. billing. Fixed costs are those capital and operating costs that remain relatively unchanged over a given operating period. Customer costs comprise those costs associated with serving customers. These costs may be subdivided into costs necessary to meet maximum-day extra demand. Finally. Contractual charges to large customers. which include a fixed-cost component. or average. based on fixed-cost needs. In detailed studies. treatment. Such a categorization provides a useful understanding and insight into the way costs are incurred by the utility. The impact on revenues of significantly changing volumes of production and the potential resultant revenue instability can be more easily recognized with this data available.

For purposes of this illustration. such as distribution mains. Direct fire-protection costs are those costs that are applicable solely to the fire-protection function. a significant portion of extra capacity costs is also allocable to fire protection in the distribution of costs to customer classes.55 mgd. As previously discussed.54/1. based on the accounting records of the utility as projected for the test period.54/2. land.22). Facilities designed to meet maximum-hour requirements. Facilities designed to meet maximum-day requirements. such costs are simply those directly related to public fire hydrants and related branch mains and valves. may be allocated 65 percent (1/1. if a system has an annual average-day use of 7. Evaluation of each particular local situation will indicate if some portion of the impounded reservoir-related costs should be allocated to the extra capacity cost function. care must be taken in separating costs between base costs and extra capacity costs. Thus. (2) depreciation expense. In some instances. land rights. The base cost component would be allocated 45 percent (1/2. Return is the balance of annual capital costs not derived through depreciation expense and is expressed as a percentage of rate base. the maximum-day to average ratio would be 1:1. payment in lieu of taxes must be included as an element in cost of service.22.54) to the maximum-day extra capacity cost component. and maintenance and capital costs on customer meters and services may be considered as another subcomponent. In some cases. and sound judgment must be exercised in their development. and the maximum-hour extra capacity component would be allocated approximately 30 percent (0. inherently meet both maximum-day and maximum-hour requirements and may appropriately be allocated to the base maximum-day extra capacity and maximum-hour (in excess of maximum-day) extra capacity cost components. As more fully described and illustrated in chapter 3. Payment in lieu of taxes may be allocated similarly. reservoirs may function to provide not only total annual supply requirements but also to provide for fluctuations in use on a seasonal or daily basis. The appropriate allocation factors between base and extra capacity usually vary among systems and should be determined on the basis of the actual operating history or design criteria for each system. the maximum-day extra capacity cost component would be allocated approximately 25 percent (0. and (3) return. For example. Usually. It is cautioned that ratios must be developed with care. and impounded reservoir structures in this example is allocated 100 percent to the base cost component in recognition of the fact that such facilities are sized principally to meet annual supply requirements in total. In the base–extra capacity method.65 mgd.22).68/2. such as a treatment plant. Investment in source of supply. the maximum-hour to average ratio would be 1:2. the various elements of rate base shown in the table are the net book value (original cost less accrued depreciation) of the water system.54) to the base cost component and 35 percent (0.22). total costs of service are represented by three principal elements: (1) O&M expense. return is allocated on the basis of the distribution of rate base to appropriate cost components as a basis for subsequent distribution of responsibility for return to the various customer classes. whether or not variations in daily needs are experienced. Table 2-1 presents an example of the allocation of rate base to cost components under the base–extra capacity cost-allocation method.54.12 WATER RATES subcomponent. It should be noted that the costs allocated to the direct fire-protection cost component are usually only a small part of the total cost of fire protection. The source of supply for many utilities may also Copyright (C) 1999 American Water Works Association All Rights Reserved . Operation-and-maintenance expense and depreciation expense are annual amounts directly allocable to cost components as subsequently illustrated. If the system also has a maximum-hour use of 16.5 mgd and a maximum-day use of 11.

serve principally to assist in meeting maximum-hour extra capacity requirements of the system.000 3.000 Plus: Materials and supplies 291.000 2.000 Source of Supply Plant: Land 423.000 129.000 55. include well supply.753.000 55.000 5.000 132.000 47.000 8.000 1. Treated-water transmission and distribution mains are allocated 45 percent to base.000 102.000 Structures 369.000 Transmission and Distribution Plant: Land 35.000 Meters 996.000 15.000 43.000 37.000 21. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Maximum Day $1.799.000 (1.000 ________ $426.000 __________ $3.000 __________ 7.925.000 149.000 __________ $2.000 244.000 102.000 Less: Contributions and advances (1. such as elevated storage tanks. in this example.000 1.628.000 240.339.000 31.000 918.000 *Maximum-hour demand in excess of maximum-day demand.000 __________ 3.077. It is noted that if the example were to separately identify reservoir intake facilities and/or raw-water transmission mains.000 1.000 47.000 1.000 407.000 Cash working capital 285.491.000 Other pumping equipment 157.000 56.000 56.000 Construction work in progress 104.264. 25 percent to maximum-day extra capacity.000 Electric pumping equipment 376. Raw.000 Direct FireProtection Service Item Total Base $3.000 7.000 Services 2.000 5.478.000 277.000 423. a portion of the rate base for source of supply may be allocated to maximum-day and/or maximum-hour extra capacity.000 Pumping Plant: Land 23.000 31. Distribution-storage-related facilities. depending on the basis of design or usage characteristics associated with the well supply.000 Water treatment equipment 3.000 ________ 412.020. and are.000 Hydrants 404.000) __________ $1.000 Customer Meters and Services $1.832.000 80.000 1.000 122.000 1.365.324.264.000 7.000 Water Treatment Plant: Structures 426.000 996.000 26.000) ___________ Test-year rate base $16.000 Other 129.ALLOCATION OF COSTS OF SERVICE 13 Table 2-1 Allocation of Rate Base—Base–Extra Capacity Method (Test Year) Extra Capacity Line No. therefore.341.186. In these instances.992.445.000 2.000 Mains 5.000 1.000 Maximum Hour* $1.000 __________ 3.000 __________ $7.951.445.000 Structures 48.000 General Plant: Land 4.000 Reservoir 407. allocated Copyright (C) 1999 American Water Works Association All Rights Reserved .842.000 57.000 48.000 25.000 37.000 4.461.000 __________ 2.000 119. and 30 percent to the maximum-hour extra capacity cost components in recognition of the fact that mains provide maximum-day and maximum-hour service to all customers.000 Distribution storage 1.000 2.000 Structures 190.and treated-water pumping and treatment facilities are allocated 65 percent to base and 35 percent to the maximum-day extra capacity cost components since these facilities are designed to meet maximum-day demands.000 31. these facilities also would be allocated 65 percent to base and 35 percent to the maximum-day extra capacity cost components.000 25.000 ___________ Net plant in service 16.000 Intangible Plant: Organization $6.000 $404.000 57.

14 WATER RATES 90 percent to the maximum-hour extra capacity cost component. In many water utility systems. The demand portion of power costs should be allocated to extra capacity to the degree that it varies with demand pumping requirements. The allocation to base and extra capacity components depends on conditions controlling the design of any given system and facilities within the system. 25 percent to maximum-day extra capacity cost. pumping power is allocated 10 percent to the maximum-day extra capacity cost component in recognition of this factor. Construction work in progress is allocated to cost components on the same basis as similar elements of plant in service. Expenses related to facilities designed to meet maximum-hour requirements are allocable 45 percent to base cost. being allocated to base cost. Contributions should be deducted from plant value in accordance with the purposes for which the contributions were made. vehicles. furniture and equipment. the base cost component is assigned 10 percent of such facilities. Fire hydrants are allocated to the direct fire-service cost component. Meters and services are allocated to the customer cost component. provide a basis for subsequent distribution of capital costs to these components and then to the customer classes. the accounting records will show contributions in aid of construction that ordinarily are deducted from the rate base before applying rate-of-return percentages. as illustrated in Table 2-1. Expenses that tend to vary directly with water usage are assigned directly to the base cost component. and 30 percent to maximum-hour extra capacity cost. if designed to meet maximum-day requirements. Table 2-2 illustrates the allocation of annual depreciation expense to cost components. Such expenses. chemical. O&M expense for each facility is allocated to cost components in a manner similar to that for rate base. The categories of items of depreciation expense are allocated to cost components in the same manner described in the allocation of rate base. In recognition that distribution storage provides some element of system reliability. it is assumed that all construction work in progress is transmission and distribution mains. as further explained in chapter 3. are allocated 65 percent to base cost and 35 percent to maximum-day extra capacity cost. In the example. The results of the allocation of rate base to the various cost components. Power costs are allocated principally to the base cost component. The value of office buildings. The extent to which power costs are allocated to the extra capacity cost component depends on the variations in electric demands incurred in pumping and the energy/demand electric rate structure applicable to pumping. or 90 percent. 10 percent to base cost and 90 percent to maximum-hour extra capacity costs. with the balance of power costs. It must be recognized that each system requires separate analysis for proper allocation to cost components. and customer-related costs are allocable to cost components on the basis of the design capacity requirements of each facility. Expenses other than power. Table 2-3 presents an example of the allocation of O&M expense to cost components under the base–extra capacity method. In the illustration. Expenses related to distribution storage are allocated in the same manner as for rate base—that is. Copyright (C) 1999 American Water Works Association All Rights Reserved . Chemical costs are an example of such an expense. In general. The example illustrated in Table 2-1 assumes that all contributions in this instance are related to customer meters and services. and other general plant is allocated to cost components on the basis of the resulting allocation of other plant facilities. The percentage factor used in the allocation of distribution storage is largely dependent on engineering judgment as well as the operating and design characteristics of the reservoirs in each particular system.

ALLOCATION OF COSTS OF SERVICE

15

Table 2-2 Allocation of Depreciation Expense—Base–Extra Capacity Method (Test Year)
Extra Capacity Line No. 1 Maximum Day Maximum Hour* Customer Meters and Services Direct FireProtection Service

Item

Total

Base $11,800 6,200 6,900 2,700 7,100 54,500 100 2,900 72,500

2 3 4 5 6 7 8 9 10 11 12 13 14 15

Source of Supply Plant: Reservoir $11,800 Pumping Plant: Structures 9,600 Electric pumping equipment 10,600 Other pumping equipment 4,200 Water Treatment Plant: Structures 11,000 Water treatment equipment 83,800 Transmission and Distribution Plant: Structures 1,200 Distribution storage 28,500 Mains 161,100 Services 48,900 Meters 21,500 Hydrants 12,300 General Plant: Structures 4,900 Other 4,600 _________ Total depreciation expense $414,000

$3,400 3,700 1,500 3,900 29,300 $1,100 25,600 48,300 $48,900 21,500 $12,300

40,300

2,000 1,900 _________ $168,600

1,000 900 ________ $84,000

800 800 ________ $76,600

1,000 900 ________ $72,300

100 100 ________ $12,500

*Maximum-hour demand in excess of maximum-day demand.

Table 2-3 Allocation of O&M Expense—Base–Extra Capacity Method (Test Year)
Customer Costs Extra Capacity Line No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Maximum Day Maximum Hour* Meters and Services Direct Billing Fireand Protection Collecting Service

Item

Total

Base $90,000 233,100 125,400 121,000 102,000 58,500 2,600

Source of Supply $90,000 Pumping: Purchased power 259,000 Other 193,000 Water Treatment: Chemicals 121,000 Other 157,000 Transmission and Distribution: Mains 130,000 Storage 26,000 Meters and services 155,000 Hydrants 13,000 Other 72,000 Customer Accounting: Meter reading and collection 247,000 Uncollectible accounts 44,000 Administrative and General: Salaries 194,000 Employee benefits 177,000 Insurance 135,000 Other 266,000 ___________ Total O&M expense $2,279,000

$25,900 67,600

55,000 32,500 $39,000 23,400 $155,000 $13,000 2,900 $247,000 7,700 44,200 40,400 200 60,700 _________ $400,200

13,600

7,200

13,900

34,400

20,800 70,300 64,000 77,600 96,300 __________ $1,075,200

6,300 29,100 26,500 36,300 39,900 _________ $326,300

2,800 13,700 12,500 19,700 18,700 _________ $143,700

5,900 33,900 31,000 1,200 46,500 _________ $307,900

500 2,800 2,600 3,900 ________ $25,700

*Maximum-hour demand in excess of maximum-day demand.

Copyright (C) 1999 American Water Works Association All Rights Reserved

16

WATER RATES

Expenses for meters and services and for customer billing and collecting are allocated directly to the customer cost components. Administration and general expense, in the example, is allocated to cost components in three parts. Salaries and employee benefits are allocated on the basis of the allocation of salaries and wages. Insurance is allocated on the basis of test-year rate base in Table 2-1. Other administration and general expense is allocated on the basis of the allocation of all other expenses, exclusive of power and chemical costs.

COMMODITY–DEMAND METHOD __________________________
In the commodity–demand method, costs of service are separated into four primary cost components: (1) commodity costs, (2) demand costs, (3) customer costs, and (4) direct fire-protection costs. In detailed rate studies, some of these elements may also be broken down further into two or more subcomponents. Commodity costs are costs that tend to vary with the quantity of water produced. They usually include costs of chemicals, a large part of power costs, and other elements that increase or decrease almost directly with the amount of water supplied. Costs related to impounded reservoir source of supply or other costs that vary with average daily demands, such as raw-water transfer pumping costs, may also be considered as commodity costs. Purchased-water costs, if water is bought on a unit volume basis, would also be considered as commodity costs. However, recognition of recent practices to include a demand charge in addition to commodity charge in purchased-water agreements may dictate that demand portions of purchased-water costs be allocated to demand components. Demand costs are associated with providing facilities to meet the peak rates of use, or demands, placed on the system by the customers. They include capital-related costs on plant designed to meet peak requirements plus the associated O&M expenses. This cost component may be broken down into costs associated with meeting specific demands, such as maximum-day, excess maximum-hour, or other periods of time that may be appropriate to the utility that has to meet these demands. The definition of customer costs for this method is the same as for the base–extra capacity method. Direct fire-protection costs are also the same as under the base–extra capacity cost method. Table 2-4 presents an example of allocation of rate base under the commodity– demand method. In this example, rate base for each facility is the same as in the base–extra capacity method presented in Table 2-1. Each element of utility plant is assigned to commodity, demand, customer, or direct fire-service functions. Pumping plant and treatment plant, which meet maximum-day demands, are allocated 100 percent to the maximum-day demand component. Treated-water mains, which serve maximum-hour demands, are allocated 70 percent to the maximum-day demand component and 30 percent to the maximum-hour demand cost component. Rate base for distribution storage is allocated 100 percent to the maximum-hour demand component. The results of the allocation of rate base to the various cost components, as illustrated in Table 2-4, provide a basis for subsequent distribution of rate base, and capital costs related thereto, to customer classes, as further explained in chapter 3. Table 2-5 presents an example of the allocation of depreciation expense to cost components under the commodity–demand method. The categories of items of depreciation expense are allocated to cost components in the same manner as described in the allocation of rate base. Table 2-6 presents an example of allocation of O&M expense under the commodity–demand method. In general, O&M expense for each facility is allocated to

Copyright (C) 1999 American Water Works Association All Rights Reserved

ALLOCATION OF COSTS OF SERVICE

17

Table 2-4 Allocation of Rate Base—Commodity–Demand Method (Test Year)
Demand Line No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Maximum Day $4,000 $423,000 407,000 23,000 369,000 376,000 157,000 426,000 3,832,000 35,000 48,000 1,020,000 1,753,000 2,264,000 996,000 $404,000 2,000 106,000 73,000 __________ 9,457,000 162,000 159,000 73,000 __________ $9,851,000 1,000 33,000 22,000 __________ 2,913,000 50,000 49,000 31,000 __________ $3,043,000 1,000 37,000 25,000 __________ 3,324,000 57,000 56,000 Maximum Hour* $1,000 Customer Meters and Services $1,000 Direct FireProtection Service

Item

Total

Commodity

Intangible Plant: Organization $6,000 Source of Supply Plant: Land 423,000 Reservoir 407,000 Pumping Plant: Land 23,000 Structures 369,000 Electric pumping equipment 376,000 Other pumping equipment 157,000 Water Treatment Plant: Structures 426,000 Water treatment equipment 3,832,000 Transmission and Distribution Plant: Land 35,000 Structures 48,000 Distribution storage 1,020,000 Mains 5,842,000 Services 2,264,000 Meters 996,000 Hydrants 404,000 General Plant: Land 4,000 Structures 190,000 Other 129,000 ___________ Net plant in service 16,951,000 Plus: Materials and supplies 291,000 Cash working capital 285,000 Construction work in progress 104,000 Less: Contributions and advances (1,445,000) ____________ Test-year rate base $16,186,000

4,089,000

9,000 6,000 _________ 845,000 15,000 14,000

5,000 3,000 ________ 412,000 7,000 7,000

_________ $874,000

(1,445,000) __________ $1,992,000

_________ $426,000

*Maximum-hour demand in excess of maximum-day demand.

cost components in a manner similar to that for rate base. However, chemical costs, which tend to vary with the amount of water produced, are assigned 100 percent to the commodity cost function. Pumping power costs are allocated 71 percent to commodity cost and 29 percent to maximum-day demand cost in recognition of the fact that power costs vary with demand. Administration and general expense is allocated to cost components in a manner similar to that described for the base–extra capacity method—that is, in three parts in the example. Employee benefits are allocated on the basis of the allocation of salaries and wages. Insurance is allocated on the basis of test-year rate base in Table 2-4. Other administration and general expense is allocated on the basis of all other expenses, exclusive of power and chemicals. In comparing allocations under the base–extra capacity and commodity–demand methods, base costs in the base–extra capacity method include commodity costs plus that portion of demand costs in the commodity–demand method related to providing services at average annual rates of water use. In the example, base cost includes all

Copyright (C) 1999 American Water Works Association All Rights Reserved

18

WATER RATES

Table 2-5 Allocation of Depreciation Expense—Commodity–Demand Method (Test Year)
Demand Line No. 1 Maximum Day Maximum Hour* Customer Meters and Services Direct FireProtection Service

Item

Total

Commodity $11,800

2 3 4 5 6 7 8 9 10 11 12 13 14 15

Source of Supply Plant: Reservoir $11,800 Pumping Plant: Structures 9,600 Electric pumping equipment 10,600 Other pumping equipment 4,200 Water Treatment Plant: Structures 11,000 Water treatment equipment 83,800 Transmission and Distribution Plant: Structures 1,200 Distribution storage 28,500 Mains 161,100 Services 48,900 Meters 21,500 Hydrants 12,300 General Plant: Structures 4,900 Other 4,600 _________ Total depreciation expense $414,000

$9,600 10,600 4,200 11,000 83,800 $1,200 28,500 48,300 $48,900 21,500 $12,300 200 200 ________ $12,200 2,800 2,600 _________ $237,400 800 800 ________ $79,600 1,000 900 ________ $72,300 100 100 ________ $12,500

112,800

* Maximum-hour demand in excess of maximum-day demand.

Table 2-6 Allocation of O&M Expense—Commodity–Demand Method (Test Year)
Customer Costs Demand Line No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Maximum Day Maximum Hour* Meters and Services Direct Billing Fireand Protection Collecting Service

Item

Total

Commodity $90,000 183,900

Source of Supply $90,000 Pumping: Purchased power 259,000 Other 193,000 Water Treatment: Chemicals 121,000 Other 157,000 Transmission and Distribution: Mains 130,000 Storage 26,000 Meters and services 155,000 Hydrants 13,000 Other 72,000 Customer Accounting: Meter reading and collection 247,000 Uncollectible accounts 44,000 Administrative and General: Salaries 194,000 Employee benefits 177,000 Insurance 135,000 Other 266,000 ___________ Total O&M expense $2,279,000

$75,100 193,000

121,000 157,000 91,000 $39,000 26,000 $155,000 20,300 14,400 34,400 $247,000 7,700 44,200 40,400 200 60,700 _________ $400,200 $13,000 2,900

9,000 16,100 14,700 8,200 22,100 _________ $465,000

18,000 82,800 75,300 103,600 113,300 _________ $929,400

2,900 14,200 13,000 21,800 19,500 _________ $150,800

5,900 33,900 31,000 1,200 46,500 _________ $307,900

500 2,800 2,600 3,900 ________ $25,700

*Maximum-hour demand in excess of maximum-day demand.

Copyright (C) 1999 American Water Works Association All Rights Reserved

consideration should be given to the responsibility for reserve capacity in the system.ALLOCATION OF COSTS OF SERVICE 19 commodity costs plus 65 percent of the maximum-day demand costs. Means of recognizing this factor vary from one situation to another but. it may be desirable to assign the costs related to specific facilities to each pressure district in order to determine the cost responsibility of each section of the system. there are customers with certain water-use characteristics that require special consideration in allocating costs. A general approach to this situation is the use of the utility basis for assigning cost responsibility to outside customers. Customers provided with firm water service. in addition to purely incremental costs. In some instances. Consideration of the merits of the base–extra capacity method relative to the commodity–demand method of allocation is presented in chapter 4 of this manual. that is. SPECIAL CONSIDERATIONS _________________________________ In some water utility systems. where warranted. charges should reflect a recognition of capacity-related and other costs. such as for power and chemicals. Under these conditions. the maximum-day extra capacity costs are 35 percent of the maximum-day demand costs for such facilities. such as for a metropolitan service approach. This method is presented in more detail in chapter 3 of this manual. Copyright (C) 1999 American Water Works Association All Rights Reserved . and other special items. The maximumday extra capacity costs include the balance of the costs allocated to the maximumday demand component. such as off-peak or interruptible service. or in the example. The results of such detailed studies will indicate whether there are significant differences in the costs of providing service to each pressure district. unlimited service in the amounts and at such times as desired. Such rates might consist of those direct additional costs. consideration should be given to charging special rates that are less than the rates for firm service. ownership. Except in specific instances. the service area may be subdivided into pressure zones or districts due to the geophysical characteristics of the area. it is reasonable to establish separate inside-city and outside-city cost factors in order to properly allocate costs related to serving a particular group of customers. however. discussed in chapter 3. are vital to an equitable allocation of costs. Costs associated with seasonal use might be recovered through rates applied to separate metering for such services or through surcharges applied to consumption over and above an established normal use. associated with providing water from existing facilities. In certain utility systems. extent and nature of service. The allocation of the costs of service between inside-city and outside-city customers of a government-owned utility system should include special consideration of factors such as facilities required. should be charged rates adequate to recover the full cost to the utility of providing such service. In some areas where irrigation or other seasonal uses impose significant demands on the system. risk. In establishing charges for nonfirm service. A typical example would be where a significant portion of the system is being held for the future growth needs of a specific customer or class of customers. consideration may be given to separate charges for such use.

and other large users tend to be served directly from major treated-water transmission mains. wholesale customers. the cost of providing service can reasonably be determined for groups or classes of customers that have similar water-use characteristics and for special customers having unusual water-use or service requirements. consideration is given to service characteristics. depending on their peak-day and peak-hour rates of demand relative to average demands. warrant recognition in establishing customer classes and their costs of service. The theoretically ideal solution to developing rates for water utility customers would be to assign cost responsibility to each individual customer served and develop rates to derive that cost. It is not economically practical nor often possible to determine the cost responsibility and applicable rates for each individual customer served. demand patterns. and whether service is provided both inside and outside the city (jurisdiction) limits. large-volume industrial customers. However. the residential 20 Copyright (C) 1999 American Water Works Association All Rights Reserved . Demand patterns of various customers differ. This chapter presents the third element in the rate-making process—distribution of component costs to customer classes. Service-characteristic differences may be illustrated by recognizing that customers using treated water require facilities not needed by raw-water customers. whereas smaller users are served by both large and small mains. It is an objective of rate making to assign costs to classes of customers in such a manner that rates can be designed that are nondiscriminatory and meet as nearly as possible the cost of providing service to such customer classes.and capital-related costs to the functional components of cost of service.AWWA MANUAL M1 Chapter 3 Distribution of Costs to Customer Classes Preceding chapters of this manual have dealt with the determination of revenue requirements and the allocation of both operating. CUSTOMER CLASSES _____________________________________ In establishing customer classes for a water utility. in some cases. Similarly. For example. This factor will.

but on occasion raw water is provided to wholesale customers. this factor is of major importance to governmentowned utilities and may. Industrial—Manufacturing and processing establishments. in some instances. but it may be in an area within the jurisdiction of the supplying utility. Usually. military establishments. there may be a breakdown of these general classes into more specific groups. Such classes may include large hospitals. have a separate class designation. Legal requirements or customs may require recognition of certain customer classifications from an accounting standpoint. (2) commercial. Four of those considered here are (1) wholesale service. universities. large industry. The classification of water customers as to whether they are inside or outside the city limits is related to each major group’s responsibility for overall costs. but in very broad terms. (2) fire-protection service. therefore. service requirements. In many systems. and such requirements can be accommodated in rate studies. the wholesale customer is a separate municipality or water district adjacent to the supplying utility.DISTRIBUTION OF COSTS 21 customer class that places summertime lawn irrigation loads on the system typically has a much higher peak-demand requirement. the following definitions are common: Residential—One. and other such categories. frequently there are customers having individual water-use characteristics. These customers should. readiness to deliver relatively large quantities of water for short periods of time at any of a large number of points in the Copyright (C) 1999 American Water Works Association All Rights Reserved . than does a petroleum refinery. and (3) industrial. For example. particularly larger ones. demand patterns. water utilities often provide service to certain special classes of customers. or other reasons that set them apart from other customers with regard to cost responsibility. Treatedwater service is provided in most cases. The service provided is principally of a standby nature—that is. Wholesale service is usually defined as a situation in which water is sold to a customer at one or more major points of delivery for resale to individual retail customers within the wholesale customer’s service area. general service characteristics. which may require water on a relatively uniform basis throughout the year. General Classes The three principal customer classes typical of most water utilities are (1) residential. and (4) air conditioning and refrigeration. nonindustrial business enterprises. However.and two-family dwellings. and location with regard to city limits are generally the principal considerations in customer classification. relative to the average demand. Fire-protection service. Special Classes In addition to the general classes of service previously described. Definition of these general customer classes differs among utilities. Wholesale service. have a bearing on investor-owned utilities. For specific utilities. (3) lawn irrigation. Commercial—Multifamily apartment buildings and nonresidential. and special. As explained later in this manual. the industrial customer group may be subdivided into small industry. usually physically separate. Fire-protection service has characteristics that are markedly different from other types of water service. the latter typified by a petroleum refinery.

A second approach proposes that fire-protection-service costs be allocated as an incremental cost to the costs of general water service. Lawn irrigation. Water Rates and Related Charges. but a common rule of thumb for make-up water due to evaporation. usually during the late afternoon and early evening hours. city codes prohibit the use of “water-wasting” units. One approach proposes that the costs of fire-protection service. A survey of the magnitude of water-cooled air conditioning and refrigeration service provided or expected could determine the need or advisability of recognition of such service as a separate class. In the 1950s and 1960s. where separate metering for lawn irrigation is provided. Customers within the city are owner customers. being most pronounced during the summer months and virtually nonexistent during the winter months. However. In some cases.22 WATER RATES water distribution system while the total annual quantity of water delivered is relatively small. Costs allocated to fire-protection service as a class can be subdivided into those related to public fire-protection service and private fire-protection service. Residential lawn irrigation is characterized by the relatively high demands it places on the water system. who must bear the risks and Copyright (C) 1999 American Water Works Association All Rights Reserved . Subsequent to the rapid increase in electric-power and natural-gas costs in the 1970s. For the purposes of illustration in this manual. a separate class designation is warranted. A government-owned utility may be considered to be the property of the citizens within the city. the high-peaking characteristics of lawn irrigation need to be recognized as a part of residential-class water-use characteristics. and other causes is estimated as 20 gpd/ton of air conditioning. There are two principal approaches to the determination of fire-protection service costs that differ widely in both theory and application. Each approach has advocates among water utility professionals. lawn irrigation service is not separate from other service. and where such loads are significant in the system. Service Outside City Limits Many government-owned utilities recognize in their rate structures the differences in costs of serving water users located outside the corporate limits of the supplying city or jurisdiction compared with those located within the corporate limits. it has been found that higher initial outlays for water-cooled units can be more than offset by the operating economies of water costs versus power requirements. there was a trend away from water-cooled air conditioning and refrigeration. In most of the United States. This second approach is based on the premise that the prime function of the water utility is to supply general water service and that fire-protection service is a supplementary service. as is sometimes the case for automatic lawn sprinkling systems. other than those of the direct cost related to the hydrants themselves. In most instances. be determined on the basis of the potential demand for water for fire-fighting purposes in relationship to the total of all potential demands for water. however. lawn irrigation is very seasonal in nature. The reader of this manual is referred to chapter 2 of AWWA Manual M26. In many communities. quality control. therefore. The specific methodology for such subdivision is presented in chapter 4. the first approach discussed above is used. Make-up water requirements will vary. parks. and golf courses. for further discussion of fire-protection rates and charges. Air conditioning and refrigeration. commercial and industrial customers have reconsidered the economics of alternative cooling methods. The use of recirculating units needing only make-up water is a proposed alternative.

The reverse situation could also occur. The sum of all component costs attributable to a customer class is the total cost of service to be recovered from it. if total utility revenue requirements are relatively low. as a matter of policy. and possibly other cash requirements as described in chapter 1. depreciation expense. non-owner customers. As a basis for distributing component costs to customer classes. that is. A government-owned utility. Outside-city customers are non-owner customers and. such as base cost. as such. Those who are responsible for designing or reviewing water rates do not always have a clear understanding of the relationship of the cash-needs approach to measuring total revenue requirements to the utility basis of cost allocation with regard to government-owned water systems. assign costs to outside-city customers for O&M expense. bear a different responsibility for costs than do owner customers. The unit costs of each component serve as a basis for designing rates. and an appropriate return on the value of property devoted to serving the outside-city customers. perhaps due to a major part of the bonded indebtedness having been retired which resulted in a large amount of paid-up equity.DISTRIBUTION OF COSTS 23 responsibilities of utility ownership. a government-owned utility might choose to waive the distinction between owner and non-owner customers. may be divided by appropriate total customer requirements or units of service to express a unit cost for each component. This involves determining or estimating the total quantity of water to be used by each class in the test year and the peak rates of use by the class. debt-service requirements. where not regulated by a state public utility commission. where differences in costs between owners and non-owners are not recognized in cost allocation and rate making. UNITS OF SERVICE_________________________________________ As a step toward rate design. considering the utility to be metropolitan in nature. in most cases. The costs to be borne by outside-city (non-owner) customers are similar to those attributable to the customers (non-owners) of an investor-owned utility. component costs may be distributed among customer classes in the proportion that the respective class responsibility for those costs bears to the total cost responsibility of all customer classes served by the system. depreciation expense. determines its total revenue requirements. and an appropriate return on the value of property devoted to serving them. the utility basis of allocating cost of service is fair to both the supplier and the outside-city customer. If the rate of return is properly set. capital expenditures not debt-financed. and why both elements are used in many rate studies. Thus. the inside-city customers have relatively low rates. However. that is. usually for Copyright (C) 1999 American Water Works Association All Rights Reserved . Such a policy is a choice to be made by the governing body of the utility. It is then the responsibility of the inside-city customers to meet all remaining cash requirements not derived from outside-city customers. benefiting from having invested in and owning paid-up equity in the system. Responsibility for each component may be expressed in terms of the number of units of service required by each class of customer. on a cash-needs basis. or costs of service. it must develop sufficient revenue to meet cash needs for O&M expense. In some instances. Such costs include operation-and-maintenance (O&M) expense. it is essential that the units of service attributable to the respective classes be established for the test year. when that utility serves outside-city. This applies for each of the component costs of service. it is most appropriate to measure the costs of such service on a utility basis. Such cash needs must be met by the utility as a whole. This generally would require the owner customers to subsidize the non-owner customers to some degree. The total cost of each component.

are a very good source of maximum-capacity requirements for fire service. a percentage relationship of the class maximum rate of use to average annual rate of use.0 1 1 1⁄2 2 3 4 6 8 Customer meter-and-service costs are sometimes distributed among customer classes based on factors other than investment. it is said to have a maximum-day capacity factor of 250 percent.5 times its average rate. maximumweek or other periods may be appropriate.. Such data should include daily and hourly pumpage records. The periodic reports of the Insurance Services Office. materials used. in which desired rates of flow for fire service are defined.0 29. a method for distributing meter-and-service costs to customer classes is in proportion to the investment in meters and services installed for each customer class. Distribution of customer costs by equivalent meter-and-service ratios recognizes that meter-and-service costs vary. New York. Selection of appropriate measures for distributing such costs should be considered on an individual utility basis. Equivalent ratios based on meter capacity or other measures may be appropriate in some circumstances.0 14. special-demand metering programs. Thus.Y. typical customer meter-and-service equivalent ratios based on investment are as follows: Meter Size in. However.1 1.) In addition. based on the number of equivalent meters. Sound and logical inferences can be drawn from customer metering information. For purposes of this example. recorded rates of flow in specific areas of the system. Such data must be applied with judgment and care to achieve practical cost allocations.0 1. studies and interviews of large users regarding individual and group characteristics of use. As an example. Customer-related costs for meters and services may be properly distributed among customer classes by recognizing factors that are generally responsible for those costs being incurred. if a customer class maximum-day rate of use is 2. 5⁄8 3⁄4 Equivalent Meterand-Service Ratio 1. and other local characteristics for various-sized meters as compared to 5⁄8-in. as well as the number of bills by class. a determination needs to be made of the number of equivalent meters and services by class. (In some systems. usually not to exceed three-month periods. peak requirements for fire service can be quite significant.9 11. Maximum rates of use may be expressed in terms of capacity factor—that is. and experience in studies of other utilities exhibiting like characteristics. provided billing periods are sufficiently short to reflect seasonal differences. All pertinent sources of information need to be investigated and studied in estimating customer-class capacity factors.4 1.24 WATER RATES both maximum-day and maximum-hour rates of use.8 2. at least in relation to that of other classes. locations of meters. N. Copyright (C) 1999 American Water Works Association All Rights Reserved . depending on considerations such as size of service pipe.0 21. meters and services. The total annual quantity of water attributable to fire service is usually considered to be negligible.

gpd on a maximum daily basis.100 3.592 4. thou.978 1. using the base–extra capacity method of cost allocation and distribution. Maximum-hour fireprotection service reflects the assumption that flow for fires is concentrated in a four-hour period.095.760 _______ 26.000 2.536. through billing ratios. It differs from Table 3-1 only by the fact that the maximum-day extra capacity column is excluded. For each customer class.418 _______ 16.943 3.820 34 48 _______ ________ 17. and gal gpd % gpd gpd % gpd gpd Services Bills Inside-City: Retail service Residential 968. thou.000 Fire-protection service __________ ______ Total inside-city 2.948 Outside-City: Wholesale service Total system 230. Extra capacity is the difference between total capacity and average rate of use.978 1. the total annual water use in thousand gallons is shown. Fire-protection service is considered to require negligible flow on an average basis but 960 thou.652 Commercial 473.760 14.652 1.630 2.296 1.758 251 185. Maximum-day capacity factors are applied to average-day rates of flow to develop total capacity by class.608 4. regardless of the day or hour in which such Table 3-1 Units of Service—Base–Extra Capacity Method (Test Year) Base Maximum Day Maximum Hour Customer Class Annual Average Total Extra Total Extra Equivalent Use Rate Capacity Capacity Capacity Capacity Capacity Capacity* Meters thou. For the example.212 6.868 225 375 *Maximum-hour demand in excess of maximum-day demand.296 Industrial 1. In some instances. Factor thou. Outsidecity service is provided on a wholesale basis.766.640 420 _______ ________ 17. Equivalent meters and services are derived by applying equivalent ratios to the number of meters of each size by class. Test-year units of service reflect the prospective average annual customer water-use requirements during the test-year study period considered in this example.898 945 _______ 12.695 200.000 7. as well as the average rate in thousand gallons per day. it is appropriate to recognize. it is assumed that retail service and fire-protection service are provided inside the city to residential.661 200.843 15.500 960 ______ 7. It should be recognized that the maximum total capacity on both a maximumday and maximum-hour basis for the total system (shown in Tables 3-1 and 3-2) is the estimate of the sum of noncoincidental peaking requirements on the system.DISTRIBUTION OF COSTS 25 Costs related to billing and collecting may be distributed among customer classes based on the total number of bills rendered to the respective classes in a test year.682 1.800 ______ 11.578 250 200 150 6.500 960 ______ 14.000 630 __________ ______ 2.620 1.580 2.522 400 325 200 10. is presented in Table 3-1. commercial. An illustration of the development of the test-year units of service for the hypothetical utility. Factor thou. Table 3-2 shows the development of the units of service applicable to the commodity–demand method of cost allocation. and industrial classes. that is. Maximum-hour extra capacity is developed similarly. it is the sum of the peaks for each class.363 _______ 28.500 4.000 5. The number of bills is simply the total number of bills rendered annually for each class. that billing and collecting for larger services may incur more cost than for smaller services.000 6.000 1. Copyright (C) 1999 American Water Works Association All Rights Reserved . thou.000 3. under the heading of Base in Table 3-1.734 788 ______ 8.

000 __________ 2.000 ______ 6.500 4. costs of service are distributed among customer classes by application of unit costs of service to respective service requirements.630 2.800 _______ 11.580 2.296 3.760 14. the resulting average unit costs for O&M expense and depreciation expense are applicable to all customers.843 15.608 4.418 ______ 16. the level of return in the example would be $807.760 _______ 26. peaks may occur.000 5.978 1. As discussed in chapter 1. The development of unit costs of service for the base–extra capacity method is presented in Table 3-3.000 230. For example.000 __________ 2.000 2. gpd Maximum Day Total Capacity Capacity thou.592 4.948 630 ______ 7.3887/thou. for the government-owned utility to meet total cash revenue requirements under the utility approach.075.186.943 3.536.000. Subsequently. Similar computations are made to determine unit costs for all other O&M expense and depreciation expense.652 1.and outside-city rates of return to the unit rate base. Unit costs of service are based on total costs previously allocated to functional components and the total number of applicable units of service for the test year. Factor % gpd Maximum Hour Total Extra Equivalent Capacity Capacity Capacity* Meters thou. unit return on rate base is derived by applying appropriate inside.868 225 375 *Maximum-hour demand in excess of maximum-day demand. as related to the average rate.000 473. Factor and % gpd gpd Services Customer Class Inside-City: Retail service Residential Commercial Industrial Fire-protection service Total inside-city Outside-City: Wholesale service Total system Bills 968.898 945 _______ 12.000 1.640 420 ________ 200.363 _______ 28. thou.000.766. UNIT COSTS______________________________________________ Component costs can be directly distributed to respective customer classes in proportion to the respective units of service applicable to each class. gal Average Rate thou. For instance. The determination of unit return on rate base is made by first calculating unit rate base.766. Based on a total rate base of $16. is not to be confused with the coincidental maximum-to-average ratio used in system design. Thus.500 960 ______ 14.695 185.212 6.620 1.661 34 _______ 17. Allocation of O&M expense and depreciation expense to functional cost components is presented in chapter 2. the overall rate of Copyright (C) 1999 American Water Works Association All Rights Reserved .000 thou. Under the utility-basis method of cost allocation.652 1. gal. under the base–extra capacity method.26 WATER RATES Table 3-2 Units of Service—Commodity–Demand Method (Test Year) Commodity Annual Use thou.578 250 200 150 6. gal may be derived by dividing the allocated base O&M expense of $1. the total system capacity shown.100 400 325 200 10. the base unit cost for O&M expense of $0.095.200 by the total base-component units of service of 2. Unit costs are determined simply by dividing the test-year functionally allocated O&M and capital costs by the respective total system units-of-service requirements in the test year. both inside and outside the city. The functionally allocated total rate base is divided by respective total system units of service to yield unit rate base.758 251 _______ 17.820 48 ________ 200.682 1.

†At 4.000 227.6534 20. Although it is not presented in Table 3-3.2394 84.200 by the inside-city rate base. $807. In this example.800. meters $307. where inside-city owners provide service to outside-city non-owners.6893 $326.7323 67.9924 $25.075.522 thou.500 $426.200. total outside-city rate base is derived by applying the unit rate base from Table 3-3 to the respective outside-city units of service presented in Table 3-1. the inside-city rate of return is established at a level sufficient to derive the balance of total return—that is.153.153.000 rate base.000 9. Total inside-city rate of return is determined to be 4. The differential in inside.868 bills Item Total System Units of Service: Number Units Base 2.8573 $3.279.800.2907 $84.0 percent is assumed and applied to component unit rate base in order to determine the outside-city unit return on rate base.DISTRIBUTION OF COSTS 27 Table 3-3 Unit Costs of Service—Base–Extra Capacity Method (Test Year) Customer Costs Extra Capacity Line No. inside-city unit return on rate base is developed by applying the 4. 1 2 Total Cost Maximum Day 8.000 less the outside-city return of $103. gpd Maximum Hour* 12.700 $12.0 percent rate of return to outside-city rate base of about $1. a rate of return of 9.925. The inside-city rate base is calculated in a manner similar to that described for developing the outside-city rate base and totals $15. return is equivalent to about 4. ‡At 9.6180 1.000 Unit rate base ($/unit) Unit Return on Rate Base: Inside-city ($/unit)† Outside-city ($/unit)‡ Total Unit Costs of Service: Inside-city ($/unit) Outside-city ($/unit) $1.992.000 rate base. gpd Meters and Services 17.000 results in an outside-city return of approximately $103.000. Application of the 9.1317 26. Once outside-city return is determined. total outside-city return may be calculated by determining total outside-city rate base and applying the 9.8065 37. the municipality’s risk in the ownership of facilities constructed to serve Copyright (C) 1999 American Water Works Association All Rights Reserved . in part.000 112.000 thou.033. it is assumed that the utility provides service to both inside.000 2.6504 $400.99 percent. or $703.0859 $1. For the base–extra capacity method.200 1.600 5.365.900 *Maximum-hour demand in excess of maximum-day demand.6627 0.0 percent return on $1.2659 10. a differential rate of return is appropriate.600 0.1888 $76.478. In this example.and outside-city customers.000 19. Returning to the unit-cost approach presented in Table 3-3.1246 0.1372 19.4004 $72.843 thou.200 0.9643 $2.0915 36.300 4.0 percent rate of return to it.4973 27.5742 0.186.68 percent rate of return to the unit rate base.7479 10.900 17. gal 3 4 5 6 7 8 9 10 11 12 O&M Expense: Total $2. Generally.0610 $7.2396 0.9924 1.7522 31.9924 Direct Billing Fireand Protection Collecting Service 200.000 Unit cost ($/unit) Depreciation Expense: Total $414.000 408.5742 5.695 equiv.68 percent return on $15.300 38. Determination of the inside-city rate of return is made by dividing the balance of total return of $703.033.8803 $143.766.versus outside-city rates of return reflects.700 11.3887 $168.000 Unit cost ($/unit) Rate Base: Total rate base $16. which is not derived from the outside-city customers.68 percent.

695 equiv.5742 5. from Tables 3-1 and 3-3. Copyright (C) 1999 American Water Works Association All Rights Reserved . The resulting distribution of cost responsibility for base costs is simply a function of the volume of water used by each class.5419 $150.900 17.900 *Maximum-hour demand in excess of maximum-day demand.3245 29.868 bills Item Total System Units of Service: Number Units Commodity 2. as discussed previously.0284 0.2010 $929.3160 0.000 rate base. are summarized in Table 3-5. meters $307. Total unit costs of service for inside.800 11.000 611.300 4. gal 3 4 5 6 7 8 9 10 11 12 O&M Expense: Total $2. gpd Maximum Hour* 12.6180 1.0686 101.018.000 236.1873 0. Total unit costs of service are comprised of the O&M. ‡At 9.9924 $25.000 19.7277 $237.0887 21.100 thou. and return on rate base unit costs of service and are shown at the bottom of Table 3-3 for inside.and outside-city customers.000 Unit cost ($/unit) Depreciation Expense: Total $414. base costs are costs that would be incurred in supplying water at perfect load factor (that is.4004 $72.2685 10. outside-city customers.851.9384 11.28 WATER RATES Table 3-4 Unit Costs of Service—Commodity–Demand Method (Test Year) Customer Costs Demand Line No.0859 $1.0148 0. at a continuous.000 112.766. 1 2 Total Cost Maximum Day 16. The total units of service and the unit costs of service for the test year.0044 $874.0 percent return on $1. DISTRIBUTION OF COSTS TO CUSTOMER CLASSES__________ Base–Extra Capacity Method The distribution of the costs of service to the utility’s customer classes is accomplished by applying unit costs of service to individual customer-class units of water service.1090 127.400 57.279.843 thou. †At 4.200 0.2642 $400.7456 $9.9924 Direct Billing Fireand Protection Collecting Service 200.1979 $3.9924 1.7418 $79.186.000 Unit cost ($/unit) Rate Base: Total rate base $16.7548 31.000 Unit rate base ($/unit) Unit Return on Rate Base: Inside-city ($/unit)† Outside-city ($/unit)‡ Total Unit Costs of Service: Inside-city ($/unit) Outside-city ($/unit) $465.000 0.0285 39. depreciation.168.000 thou.1317 26.043.68 percent return on $15.1681 $12.and outside-city customers under the commodity–demand method are summarized at the bottom of Table 3-4. without costs incurred in providing extra plant capacity for variation in the rate of use beyond a uniform rate.400 14. The development of unit costs of service for the commodity–demand method is made similarly to that used for the base–extra capacity method. respectively. uniform rate). As discussed previously. as well as a return on paid-up equity in system facilities to inside-city customers.000 0.6357 55.600 6.8738 28.500 $426. gpd Meters and Services 17.000 rate base.700 $12.200 1. Also included in the table are the costs of service that are directly allocated to fire-protection service.992.

500 15.722. gal of water in the test year.6893 Wholesale: Units of service 230.000 $58.000 $555. Customer-class responsibility for extra capacity costs is determined by applying the unit costs of service to the individual customer-class units of service in a manner similar to that used for determining customer-class base costs.900 960 $64. gal 2 3 4 5 6 7 8 9 10 Retail Service: Residential: Units of service Allocated cost of service Commercial: Units of service Allocated cost of service Industrial: Units of service Allocated cost of service Fire-Protection Service: Units of service Allocated cost of service 968.000 thou.000 Allocated cost of service $158.700 4.652 $418.758 $47.000 thou.500 1.900 37.100 $100 _________ _________ $473. gal.6504 945 $35. gal.095.700 185.000 thou.100 ___________ $256. gal to the respective units of service yields the distributed customer-class base cost of service.620 $45.800 11 12 13 14 Total inside-city allocated cost of service Outside-City: Unit costs of service ($/unit) 0.500 __________ Total system allocated cost of service $1.500.9924 per bill Total Cost of Service Item Inside-City: Unit costs of service ($/unit) Base 0. Units based on equivalent 5⁄8-in.900 473. the unit base cost is the minimum rate at which water could be sold (if perfect load-factor use could be achieved) after customer costs are recovered.760 $370. Outside-city distributed base costs are derived from the application of the unit base cost of $0.8065 per thou. Extra capacity costs for maximum-day and maximum-hour service are incurred in providing facilities to furnish water at varying rates above the average.500 $41. meters Copyright (C) 1999 American Water Works Association All Rights Reserved . meters and are applied to customer-class equivalent meter units of service in order to determine allocated cost of service. Customer costs.9924 34 48 $1.900 84.DISTRIBUTION OF COSTS 29 Table 3-5 Cost Distribution to Customer Classes—Base–Extra Capacity Method (Test Year) Customer Costs Extra Capacity Line No.500 3.500 $100. commercial customers.100 14.100 $3.900 $779. gpd 27. The higher unit base cost reflects the rate-of-return differential discussed previously.000 1.600 1. Customer costs associated with meters and services (both capital and O&M costs) may be distributed to customer classes on the basis of equivalent meter-and-service cost factors. Meter-and-service costs are based on the total number of equivalent 5⁄8-in.900 _________ $586. Applying the inside-city unit base cost of $0.978 $110.8803 788 $66.640 $29.100 1. which include the category of meters and services and the category of billing and collecting.5742 per thou.700 1.000 $271.400 31.800 $133.200 $262. By definition. residential customers are projected to use 968.6893/thou.5742/thou.000 $628.200 ________ ___________ $58.500 $400. 473.600 _________ $366. gal to the outside-city base unit-of-service requirements.7522 per equiv. meter Direct Billing Fireand Protection Collecting Service 1.900 3.000 251 $6.800 $479.614. gpd Meters and Services 26.6180 1.296 $87.978 $267.2394 per thou. and industrial customers 1.000 As shown in Table 3-5. 1 Maximum Maximum Day Hour 67.100 $3.200 420 $800 $1. are generally treated separately in rate studies.600 1.095.237.

Commodity–Demand Method The distribution of costs to customer classes under the commodity–demand method is accomplished in the same manner used for distributing base–extra capacity costs. For the example.000 4.592 $262.234.100 14.500 1.900 960 $97.000 1.5419 1. summarized by customer classes.500 4.7548 per equiv.400 1.665.300 15. Billing and collecting costs may be related to the number of bills issued and.30 WATER RATES are used to allow for the fact that customer costs will vary and tend to increase with the size of the customer meter and service.100 $294.630 $670.000 $88.000 3. gal 2 3 4 5 6 7 8 9 10 Retail Service: Residential: Units of service Allocated cost of service Commercial: Units of service Allocated cost of service Industrial: Units of service Allocated cost of service Fire-Protection Service: Units of service Allocated cost of service Total inside-city allocated cost of service Outside-City: Unit costs of service ($/unit) Wholesale: Units of service Allocated cost of service Total system allocated cost of service 968.095. gpd 29.1873 per thou.600 $711. extra capacity.000 $46. in turn.300 473. distributed to customer classes on the basis of the number of bills rendered to customers within each class.000 251 $6. Table 3-6 Cost Distribution to Customer Classes—Commodity–Demand Method (Test Year) Customer Costs Demand Line No.700 1.400 1.6180 34 $1.300 2.000 $473. gpd Meters and Services 26.100 $382. The base.200 $521. and customer costs.9924 per bill Total Cost of Service Item Inside-City: Unit costs of service ($/unit) Commodity 0.000 $205.000 $181. commodity costs are distributed to customer classes on the basis of total annual use.100 $58.400 $3.200 $3. Table 3-6 summarizes the application of units of service to unit costs of service.000 39.760 $370.620 $47. constitute the costs of service to be recovered from the respective classes of customers involved.500 $454. as developed in Tables 3-2 and 3-4 for the commodity–demand method.700 185. 1 Maximum Maximum Day Hour 101.300 31.000 Copyright (C) 1999 American Water Works Association All Rights Reserved .755.500 $43. Demand-related costs are distributed to the various classes in proportion to the class total demand responsibility.2642 945 $37.418 $180.800 11 12 13 14 0.100 $265.100 420 $800 $1. In the commodity–demand method.100 6.800 $1.100 127.2010 230.0285 per thou.1090 per thou. This summation also provides identification of the responsibility of each class for the functional costs.800 $473. and customer costs are distributed based on equivalent meter and billing requirements.758 $47.640 $29.800 $139.9924 48 $100 $400. meter Direct Billing Fireand Protection Collecting Service 1.652 $418.500. customer-class responsibility is determined by applying the billing and collecting unit cost to the total estimated number of bills in each customer class rendered for the average rate year.000 $58.978 $115.

demand or capacity costs must be added. Meter-and-service costs are distributed to classes in proportion to the number of equivalent 5⁄8-in. Likewise. meters.1873/thou. whereas billing and collecting costs are distributed on the basis of the number of bills rendered. gal to the respective inside-city class units of service. Customer costs to be distributed for meters and services and for billing and collecting are the same under both the base–extra capacity and commodity–demand methods and are distributed similarly in both methods. Cost of service for outside-city wholesale service may also be derived by applying the outside-city unit costs of service to outside units of service. gal. demand-related costs for maximum-day and maximum-hour service requirements are distributed to the classes based on the application of total estimated class service demands and the unit costs of demand. A summation of the distributed costs for each component of cost for inside.and outside-city customers yields the total distributed customer class cost-of-service responsibility and appears in the right-hand column of Table 3-6.1873/thou.DISTRIBUTION OF COSTS 31 Commodity costs. Copyright (C) 1999 American Water Works Association All Rights Reserved . Even with perfectly uniform use. A word of caution should be added that may prevent misinterpretation of the commodity cost of $0. Under no circumstances is this the cost of water. The base–extra capacity method avoids the possibility of such a misconception. are distributed to inside-city customer classes by applying the inside-city commodity unit cost of $0. which tend to vary with the annual quantity of water produced.

or other requirements are also discussed. the development of a schedule of rates to recover. The circumstances under which such alternatives may find acceptance for meeting social. the allocated costs of service from customers. the only method of assessing entirely equitable 32 Copyright (C) 1999 American Water Works Association All Rights Reserved . When a deviation from cost-related rates is made. special service. and the public is not misled into believing that the resulting rates are fully cost-related when they are not. As previously discussed. the reason for such modification should be explicitly understood so that the responsibility for such deviation is placed on legal and policy-making factors. This chapter presents the final step in a cost-of-service rate study—namely. The final portion of this chapter is devoted to a review and general discussion of alternative rate considerations. The initial portion of this chapter discusses several considerations to be addressed during the rate-design process and is followed by an illustration of the development of a cost-of-service schedule of rates based on costs identified and allocated in chapters 1 through 3. BASIC COST-OF-SERVICE RATE PHILOSOPHY ________________ General Considerations A primary consideration in the derivation of water-rate schedules is the establishment of equitable charges to customers commensurate with the costs of providing that service. as nearly as possible. some of which may deviate from cost-of-service principles.AWWA MANUAL M1 Chapter 4 Development and Design of Rate Schedules The preceding chapters have discussed general procedures for determining total costs of service and assigning these costs to classes of utility customers in accordance with their respective service requirements.

will be consistent with local practice and conditions. gas. often presents administrative and logistical problems. Thus. However. the basic objective of a rate study should be the development of a rate structure that will attain the maximum degree of equitability among customers. several policy considerations. characteristics of the rate-schedule format may be analyzed for their adequacy in recovering costs of service. Once costs of service by class are established. This is quite different from the practice of other utility services (such as electricity. Such factors can seriously affect the practicality of seasonal types of rates. These are discussed below. it is common practice in the water industry to provide water service to all general service customers within a given jurisdiction through a single rate schedule comprised of a two-part rate. is made by politicians. based on his or her particular service requirements. for Copyright (C) 1999 American Water Works Association All Rights Reserved . pressure of special interest groups. This two-part rate includes an initial charge to generally recover customer-related and possibly some volume-related costs. administration. legal. not the rate designer. Chapter 3 developed a basis for categorizing customers into classes having similar service requirements and presented a methodology for identifying the costs of serving each customer group. reluctance to depart from rate forms that have existed for so long that they have almost become traditional despite inequities. consideration of the impact of shifts in the cost burden from a group of customers that has been overcharged to a group that has been subsidized under existing rates. together with a volumetric charge to recover remaining volume costs. Factors such as general public reaction to changes in rates. when dealing with thousands of customers. if not impossible.DEVELOPMENT/DESIGN OF RATE SCHEDULES 33 rates would be the determination of each customer’s water bill. Therefore. Routine reading of water meters. rates are normally designed to fit average conditions for groups of customers having similar service requirements. While rates designed on the basis of cost of service should be the principal consideration in rate making. Consideration of rates deviating from cost of service. or other reasons. judgment must be exercised in the final decision as to revisions to be made in the existing rate structure. and customer acceptance. which may ultimately affect the actual development of rates. Since this obviously is impractical. water rates should be designed with metering practicalities in mind and with the thought that they may be revised if and when future technology and costs permit. There are certain limitations in designing water rates that relate to existing and economically available water meters. Various factors may affect the decision as to recommended rate modifications. and similar factors may require consideration as revisions in existing rate structures are made. For instance. Departure from rates based on cost of service is generally a decision made for political. Often water meters are only read quarterly or semiannually. therefore. water rates having both demand and volume elements are practicable only for very large users because demand-metering equipment is generally too expensive for most customers. and telephone). based on the overall level of needed revenue requirements. before cost-of-service rates can be designed. General Service Rates For reasons of practicality of application. A factor that may have some bearing on the rate-design process is consideration of metering requirements associated with various rate formats. should be addressed. Adherence to the results of the cost-of-service determinations presents a practical basis for determining equitable water rates. many of which are located indoors. and will be in the best interest of both the community and the utility.

or it may be graduated. industrial. consequently. the regular rate schedule prevails. if any. should reflect factors such as different frequencies of meter reading and billing among customers. The method of recovering customer costs. irrespective of the volume of use. Under this type of rate. Recovering customer costs. the rates for subsequent blocks generally decline for larger rates of use. based on an analysis of metering. billing. In some instances. Another criterion that might be considered is to base the water allowance included in the minimum charge on the winter time (nonirrigation) use of very small households. or readiness-to-serve charge. The amount of water allowed is simply determined by the quantity that the customer could buy under the applicable volume rates. based on meter size. that is used. As with the minimum charge. The percentage selected for this purpose should not be so high. and other classes of customers. The minimumcharge format is usually designed to recover all customer-cost elements and both the volume and extra-capacity-related costs associated with an allowance for a specified quantity of water usage.34 WATER RATES which separate rate schedules are used for residential. Another form of minimum charge is a “disappearing” charge. The water allowance under the schedule of minimum charges may be uniform for all customers. The service charge is designed to recover customer-related costs and possibly some capacity-related costs associated with readiness to serve. From the standpoint of cost recovery. perhaps on the order of 5 to 15 percent. and. and other associated costs for customer services of varying sizes. all water use would be billed under subsequent rate blocks. Rather than preparing a minimum bill that includes an allowance for some water use. the service charge may be graduated by meter size. the minimum charge is “disappearing” in that when use exceeds the amount allowed under the minimum charge. or (2) two or more rate blocks. Such a schedule is often referred to as a declining-block schedule. there may be an inverted rate structure. The design of a water-rate schedule that requires each customer class to pay its full cost of service takes into consideration unit costs applicable to the level of service rendered. and the water allowance so great. that it effectively approaches a flat rate for a large number of customers. if properly designed. Recognition of the degree to which each component is involved in providing the level of service rendered provides a basis for design of a schedule of rates. Copyright (C) 1999 American Water Works Association All Rights Reserved . Customer costs related to meter reading and billing-and-collecting are incurred regardless of the amount of water. commercial. An important issue to be determined in rate design is whether the water rate schedule will consist of (1) a single rate per unit of volume. These costs are generally recovered through either a minimum charge or a service charge. the rate schedule can be designed to provide for a service charge. such as meter reading and billing-and-collecting. The water use included in the minimum charge can be established at a level such that some nominal percentage of all the residential bills will be rendered under this charge. Unit costs for each major component of service have been described and illustrated in chapter 3. either a minimum bill or a service charge can be used. Recovering costs related to volume and extra capacity. Because of load-factor effects. and it may consider the greater cost of billing for large meters and other factors. which fixes the minimum amount of dollars to be collected from the customer and incidentally allows the customer a given amount of water under the minimum charge. which would be an initial charge that provides no water-use allowance. This would encourage waste of water by those customers who normally would use a smaller quantity of water than that included under the minimum charge.

an additional block may be warranted for an extremely large industry having nearly uniform demand requirements.000 gal/month. a declining-block water-rate schedule may be designed to recover the costs of serving different classes of customers while maintaining reasonable equitability between the customer classes. The cumulative percentage of total water use by class is shown on the vertical scale. a properly designed block-rate schedule having a decreasing level of unit charges will ordinarily recover revenue for each class in accordance with the cost of providing service to the respective classes. characteristically have a much lower peak-to-average demand factor with correspondingly lower extra capacity requirements and related costs than do the smaller users. In special cases. This block is normally associated with the allowance included in the minimum charge. This information can then be depicted graphically by means of curves showing the relative percentage of total use by meter size or customer class at various levels of usage per month. by meter size and customer classification at each level of use. as well as the cumulative use and bills rendered at each of the various levels of use. Copyright (C) 1999 American Water Works Association All Rights Reserved . beyond those of the smallest users. Figure 4-1 shows examples of curves prepared to express the various levels of monthly water use per customer in a class as a percentage of the total water use by that class.DEVELOPMENT/DESIGN OF RATE SCHEDULES 35 whereby the charge for use beyond the first block would be priced at higher rates rather than at declining rates. provides a basis for the selection of usage blocks and the development of rates for respective blocks. in general. together with the first 10. Where all customer classes are served under a single water-rate schedule. The 88 percent figure for residential customers represents total water used by those customers using a total of less than 10. The blocks that ultimately control the charges for any particular system should be designed on the basis of customer-class water usage information derived from billing records of that system. It has been found that the larger users. In order to design rate blocks and to estimate revenues to be obtained through the designed rates. An initial block may be designed to recover customer and other costs associated with use of the smallest users.000 gal total monthly use. Accordingly. Appendix A presents procedures for tabulating bills and usage based on hypothetical water billing records. and industrial users based on the differing water-use and demand characteristics associated with providing their service. Such rates do provide a mechanism for recovering costs from residential. it is necessary that several rate blocks be used. For residential customers. recognition of costs associated with various levels of customer usage. an analysis of the number of bills rendered to various customer classes at various use levels is necessary. commercial. declining blocks do not reflect quantity discounts or lower rates simply because water is sold in large amounts. Contrary to usual lay opinion. as a class.000 gal or less monthly usage range. Subsequent rate blocks may be designed to recover costs. As an approach to the design of a schedule of rates. Each subsequent block should be designed to recover that part of the total cost of service that has not been recovered through rates for water use in prior blocks. the curves indicate that only 12 percent of commercial use and only a very small percentage of industrial use occurs in the 0–10. the number of bills rendered and the use. as a class. In the design of rates. a usage of 10.000 gal/month intersects the curve at 88 percent. associated with use and capacity requirements of residential and small commercial customers. Such information can be provided in the form of a bill tabulation showing. and monthly water use per customer is shown on the horizontal scale.000 gal used by customers with greater than 10. Similarly.

.36 WATER RATES Copyright (C) 1999 American Water Works Association All Rights Reserved Figure 4-1 Metered water-use condition (example).

storage facilities. While there are often legal or other reasons for such a practice. For instance. In some cases. and an additional charge is made per hydrant. a separate charge is made for the water mains and backup facilities on an inch–foot (in. In some instances. Copyright (C) 1999 American Water Works Association All Rights Reserved . and governmental buildings and facilities. Equivalent 6-in. Private fire-protection service would consist generally of the costs for backup facilities and separate connections to the water system for the purpose of providing water to fire sprinkler systems. often of an ogee type. such as public hydrants and fire-service connections. the footage of main multiplied by the inches in diameter. By this method. whereas for a smaller town. The commercial class curve for a large city would represent a composite usage pattern of numerous stores. the preferred method is to charge the municipality directly for fire-protection service. public fire-protection allocated cost of service must be distributed to customer classes benefited by public fire protection. pumps. and other commercial establishments. private fire connections. Charges for fire-protection service are based on costs not only of direct facilities. the pattern may be more subject to the possible influence of one particular business or customer. In this case. The division of fire-protection-service costs that are common to both public and private fire-protection service may be accomplished in several ways. Both unit charge methods are founded on sound principles and have the merit that the total annual charge for fire-protection service increases with the amount of fire-protection facilities installed. A relatively simple method is to base the division of costs related to common facilities between public and private fire protection on the number of equivalent 6-in. The development of rates to recover the costs of service are often separated into public and private fire-protection categories. The backup facilities normally constitute a much larger share of the cost of providing fire-protection service than the costs directly related to fire-service connections. the curves are usually similar in configuration. public fire hydrant branches and the number of equivalent 6-in. rather than through a separate charge to the municipality or fire-protection district served. the cost of public fire-protection service is collected as part of the basic water rates applicable to retail customers. commercial. an annual charge is made in cents per inch–foot of main. but the slope and relative locations of the curves for any particular utility will depend on the type and mixture of customers served by the utility. but also the allocated share of costs for backup facilities in the water system.DEVELOPMENT/DESIGN OF RATE SCHEDULES 37 Such curves provide a basis for selection of usage blocks in rate design and a means of estimating total annual revenues by customer class that would be derived from rate schedule designs. the amount of lawn sprinkling that occurs significantly affects the location and shape of the residential curve. For various water systems. Customers with private fire-protection-service connections are generally large industrial. hotels. Public fire-protection service would consist of the costs for fire hydrants and the backup facilities required to provide an adequate water supply in the event of fire. connections can be determined on the basis of cross-sectional area. and other facilities.–ft) basis—that is. and private fire hydrants located on customer premises. Fire-Protection Service Consideration of the costs of service related to fire protection should normally be included in a cost-of-service study. including transmission and distribution mains. fire standpipes. office buildings. Rates for public fire protection are generally expressed as a total annual charge and may be expressed as an annual charge per hydrant. or it may be appropriate to consider relative potential fire flows.

particularly in the initial year of an increase. Another factor sometimes overlooked in considering a rate adjustment is a possible lag between the date of rate increase and actual receipt of additional funds. residential customers will take action to conserve on their usage. It is noted that if all Copyright (C) 1999 American Water Works Association All Rights Reserved . Development of rates in the example is prepared from cost information determined under the base–extra capacity method. accounting procedures. Failure to recognize lag in receipt of additional funds can create a revenue cash-flow problem. In general. The extent of potential customer water conservation with increased charges warrants careful consideration in rate design if the utility is to actually realize the required additional revenues. For service to large-use customers. business and industry will initiate more stringent reuse practices with resulting permanent reductions in water requirements. where wholesale customers are served directly from major transmission facilities. an allocation of small distribution mains may not be appropriate since they provide little service to such customers. for further discussion of fire-protection rates and charges. with the result being a shortfall in revenues due to the timing of water revenue receipts. It is important to carefully define and evaluate the cost of providing water on a wholesale basis and to design the rates accordingly. Similarly. it may benefit both the utility and the customer to have such a demand rate since it is directly responsive to the service requirements of the wholesale customer. particularly with modest increases. reduction in customer water usage following a rate increase is usually temporary in nature. Such incentives benefit the customer and the water utility in terms of reducing peak water demands and costs. a careful analysis should be made of the cost-of-service elements entering into such service. however. However. Water Rates and Related Charges. or other factors. For example. when rates reach such a level that once-through use is not economical. A demand-type rate will encourage the wholesale customer to either install storage on the system or to adjust operations so as to minimize peak demands to the fullest extent practicable. it is wise to consider in the design of the rates possible customer conservation of water use as a resistance to increased charges. it may be desirable to design a two-part volume–demand rate with one part applicable to the volume of water used and the other to measured demands imposed on the system by the customer. When a substantial increase in rates is indicated or when the differential increase among classes of service is somewhat drastic. The degree of lag can depend on billing frequency. when water is no longer considered an inexpensive service. This type of rate requires demand-metering equipment. a more costly installation than straight volume metering. RATE-DESIGN EXAMPLE ____________________________________ The development of a schedule of rates to recover costs of service allocated to customer classes in chapters 2 and 3 is presented to illustrate rate-design procedures discussed previously. Customer Resistance and Lag Two additional considerations that can be incorporated into the rate-design process are recognition of customer water-use resistance and lag. the reader is referred to chapter 2 of AWWA Manual M26.38 WATER RATES As previously noted. Wholesale Service Rates Where wholesale or sale-for-resale service is provided.

it is divided by 12 to derive the monthly unit cost of $2. a portion of distribution-main costs as well as a portion of demand-related costs are sometimes included in the determination of service charges. however. meter and related service per chapter 3. Service Charge: Meter-and-service-related costs Billing-and-collecting-related costs Total Total (rounded) $2. no allowance for water usage is included in the development of the service charge. the design of a rate form having a service charge with block rates is illustrated. One particular advantage in using the base–extra capacity method is that it identifies in the base cost element the minimum unit volume cost of service. For purposes of this example.7522 annually/equivalent meter / 12 bills/year = $2. may be recovered from customers through a service charge. In this example. In addition. a minimum charge is also designed to illustrate an alternative type of initial charge.20 1 2 3 4 5 6 7 8 Total Total (rounded) 2-in.9 6. Unit Cost Service Charge: Meter-and-service-related costs Billing-and-collecting-related costs $2.46 $8. Such a unit cost would be applicable as a rate only if perfect load factor or constant rate of use could be achieved. which are comprised of meter-and-service and billing-and-collecting related costs.2294/month/equivalent meter per chapter 3.9924/bill 2. and. Copyright (C) 1999 American Water Works Association All Rights Reserved . Examples of unit costs are as developed in Table 3-3.2294/meter† $1.47 1.DEVELOPMENT/DESIGN OF RATE SCHEDULES 39 elements of cost are properly allocated. As discussed.45 *Ratio of investment in this size meter and related service relative to investment in a 5/8-in. †$26. the unit base cost establishes an important guide in preventing the potential for establishing a charge that could result in the sale of water below cost. Therefore. The unit billing-and-collecting cost of $1. therefore. 5⁄8-in. use of either the base–extra capacity or the commodity–demand method will result in comparable charges.7522/equivalent meter is an annual cost.2294/equivalent meter/month. In addition. As such.2294/meter† $1. the unit base cost provides a measure of the lowest potential charge in a schedule of rates for delivery of uniform service.0 (3) Cost $2. only customer-related costs of meter-and-service and billing-and-collecting related costs are included in the determination of service charges. Since the meter-and-service unit cost of $26.9924/bill is based on the total number of bills projected to be issued annually during the rate Table 4-1 Design of Inside-City Monthly Service Charges (Test Year) (1) Line No.9924/bill* (2) Equivalent Meter-andService Ratio* 1. Table 4-1 presents the development of a monthly service charge for inside-city retail service customers.99 ______ 8.23 1. the base and extra capacity costs are recovered in the volume portion of the rate illustrated subsequently. Unit customer costs for meter-and-service and billing-andcollecting related costs are presented in column 1. Service-Charge Design Customer costs.99 ______ 4.22 4.

Service charges for outside-city retail service would be developed in a manner similar to that used for inside-city retail service.46. and industrial users under a single rate schedule by recognizing the differing water-use and associated cost characteristics for each class of service. Total service-charge revenue by class is considered subsequently in conjunction with customer-class revenues from volume-related charges to verify that total water charges generally recover allocated costs of service from each customer class.47 to derive the total 2-in. a 2-in. beyond 15 and up to and including 1500 thou. Application of the equivalent meter-and-service ratio to the unit meter-and-service cost results in the total meter-and-service cost portion of the service charge. An example of rate-block selection is indicated at the top of Figure 4-1.45. gal.9 is applied to the unit cost of $2. In the case of the 2-in. except that outside-city unit costs would be substituted for inside-city unit costs. Block-Rate Design Block rates provide a means of recovering costs for general service classes of residential. For purposes of this example. service charge of $8. Similar determinations would be made for each meter size to determine the total service charge. As previously discussed. billing information is tabulated by customer class to establish quantity of usage and number of bills rendered at various usage levels. a ratio of 2. Column 2 presents the equivalent meter-and-service ratio. it is assumed that billing-and-collecting costs do not vary substantially from smaller to larger customer accounts. would include a major part of the total commercial water use and only a small portion of industrial water use. The next 1485 thou. meter.9.2294. The blocks that ultimately control the charges for any particular system should be designed on the basis of customer-class water-use information derived from historical billing records for that system.40 WATER RATES year. and service this meter as compared to a 5⁄8-in. Comparison of individual customer-class curves reveals the distinct differences in the use patterns of the classes of customers. The curves depicted in Figure 4-1 are used in this example of rate design and express levels of monthly water use by retail customer classes. Water-use and related Copyright (C) 1999 American Water Works Association All Rights Reserved . which reflects the relative ratio of meter-and-service investment as compared to a 5⁄8-in. gal would include a large portion of the total residential use but relatively little commercial or industrial water use. As shown in column 2. commercial. A billing-and-collecting cost of $1. install. Accordingly. meter.9924/bill/month. The results of the bill tabulation are then graphically depicted for each customer class in the form of curves to allow selection of appropriate usage blocks. through proper selection of usage blocks. gal. These patterns afford a basis for design of a rate structure. The rate for this block would need to be adequate to recover a large part of the costs of providing commercial service.99 is added to the meter-and-service cost of $6. the charge can be applied to the total number of customer-class bills to determine total service-charge revenue for each customer class. and water-use and cost characteristics of this type of service would serve as the predominant basis for the design of rates for the initial block. which is rounded to $8. meter is assigned a factor of 2. Once the service charge is established for each meter size. most residential costs of service would need to be recovered in this first block. meter. and all accounts are billed at a uniform rate of $1.47 is determined. indicating the relative difference in cost incurred by the utility to buy. as shown in column 3. Examination of the figure indicates that an initial block of 15 thou. under which revenues can be derived in accordance with the cost responsibility of each class. and a total cost of $6.

The base cost per thousand gallons by water-usage block is shown in column 2. and the unit cost is the same for all levels of use or classes of inside-city service.5742 150 100 50 0. 15 percent of the total commercial use. is the cost for constant.5742 0. including the elements of base cost and maximum-day and maximum-hour extra capacity costs. Table 4-2 shows the derivation of the typical costs per thousand gallons for inside-city service. Accordingly. Such curves provide a basic tool for use in testing whether or not proposed rates derive revenues from the various customer classes in accordance with the respective class costs of providing service. Accordingly. The first 15-thou. In addition to providing a basis for the initial selection of appropriate limits for block rates.2394 /year/thou. gal 0.1842 0. Figure 4-1 indicates that a final block. would encompass essentially all the industrial service and the use by commercial customers not covered in earlier blocks. gal 150 125 50 0. Base cost. the maximum-day and maximum-hour capacity factors in excess of average-day use Table 4-2 Derivation of Typical Inside-City Cost per Thousand Gallons by Water-Use Blocks (Test Year) (1) Water-Use Block Line thou. uniform. gal/month 1 2 3 First 15 Next 1485 Over 1500 (3) (4) Extra Capacity Factor Extra in Excess of Capacity Base Cost Average Day Cost* $/thou. gal) applied to the extra capacity factor shown in column 3. Accordingly. 4. The design of a water-rate schedule that requires each customer class to pay its full cost of service takes into consideration unit costs applicable to the level of service rendered. Copyright (C) 1999 American Water Works Association All Rights Reserved .0381 (7) Total Cost‡ $/thou. No.DEVELOPMENT/DESIGN OF RATE SCHEDULES 41 demand cost characteristics of commercial customer service would be included in the basis of design of the rate.2763 0. Recognition of the degree to which each component is involved in providing the level of service rendered provides a basis for design of a schedule of rates.0952 0. by definition. gal % $/thou. the next step becomes one of designing an appropriate schedule of block rates. rates for this block would be designed to recover primarily the industrial-class costs of service. gal is equal to sum of values shown in columns 2.8065/year/thou. information in Figure 4-1 also affords a means of estimating revenues that would be derived from each class of service for any particular schedule of blocks and rates. including water use over 1500 thou. The total cost for each block reflects the cost characteristics of the predominant class of water use that occurs within the respective blocks. or perfect load-factor use.5742 0. †Based on a maximum-hour extra capacity unit cost of $27. and 6. the variation in the total cost per thousand gallons between levels of usage reflects solely the difference in extra capacity requirements for classes of service representative of the various levels of use.0762/thou. gal/month.9648 0.1842/thou. gal 0. gal) applied to the extra capacity factor shown in column 5. and practically no industrial use. Unit costs for each major component of service associated with water usage of base cost and maximum-day and maximumhour extra capacity costs are developed in Table 3-3. After selection of the usage blocks. ‡Total cost per thou.0921 (2) (5) (6) Extra Capacity Factor Extra in Excess of Capacity Maximum Day Cost† % $/thou.8536 0.1143 0. gpd divided by 365 days/year (or $0.7044 *Based on maximum-day extra capacity unit cost of $67.-gal-per-month block includes 94 percent of the residential use. based principally on the cost characteristics associated with industrial service. gpd divided by 365 days/year (or $0.

Therefore. and $0. Costs for outside-city service would be developed in a similar manner. Detailed design studies would involve examination of the costs for a range in both amount and characteristics of water use for various potential users within each block and might indicate the selection of extra capacity factors that reflect a combination of factors from more than one class. quantity of use is no indication of load characteristics for this type of customer.000 thou. the amount and characteristics of use will vary among customers within each block. The resulting total costs per thousand gallons are derived in column 7 by adding costs developed in columns 2. Normally. For the purpose of simplicity in illustration. comparison of revenue using designed rates with costs of service by customer class may indicate that designed rates may not adequately recover costs of service from one or more customer classes while recovering more than cost from other classes. Actual rate-design practice would also recognize that because of the relatively high capacity factors associated with water use in the initial rate blocks.42 WATER RATES for the block are shown on line 1 in columns 3 and 5 and are representative of residential service. respectively. In this example. resulting in a uniform volume rate of $1. 4. The calculated charges for subsequent rate blocks may need to be adjusted downward to recognize costs recovered in prior blocks. gal/month includes primarily industrial water use. Declining-block rates are usually not appropriate for wholesale service because large-use wholesale customers do not necessarily have more favorable peaking factors than do small wholesale users. the extra capacity factors on line 2 of Table 4-2 used in development of the average cost for water use in this block principally reflect commercial-service characteristics. Copyright (C) 1999 American Water Works Association All Rights Reserved . the extra capacity factors listed on line 3 in the derivation of the average costs for the last block of the rate schedule are considered representative of large-volume customer water-use characteristics. if designed rates recover total system costs of service and individual customer-class costs of service to within 2 to 3 percent. However. the rate applicable to wholesale service is derived simply by dividing the total allocated cost of service of $262.70 per thousand gallons. The next 1485-thou. the rates may be considered adequate.-gal-per-month block is predominantly a commercial-class block. gal. gal. The calculated rates should be tested by application to customer-class water usage to determine if revenues will be derived from each class in accordance with the cost of service.14/thou. using customer-class characteristics and unit costs appropriate for those customer classes. At this point in the development of the rate schedule.85. The last block of over 1500 thou. for each of the three blocks might be proposed. and 6 and provide an initial basis for selection of potential rates. Actually. Selection of slightly different rate blocks or redesign of rates for selected blocks using modified excess capacity factors may be warranted in order to more closely recover total allocated costs of service. Accordingly. the development of total costs per thousand gallons developed in Table 4-2 is based on a single set of water-use characteristics selected as a representative composite of all customer use within each block. In other words. The costs indicate that for monthly water use a schedule of rates for inside-city service of $0.96. $0. charges in these blocks may recover costs in excess of the requirements representative of usually better load-factor users in subsequent rate blocks. the designed rates are subject to further testing to determine if revenues of each class meet costs of service.200 from Table 3-5 by the total annual use of 230.

Indicated deviations from allocated costs for all classes are less than 2 percent and are well within practical design allowances. It is noted that final block rates designed for inside-city service are slightly different than reflected in the initial schedule of rates developed in Table 4-2 in order to more closely recover total customer-class costs of service.800 99.0 79.2 13.0 6. The revenues.100 2. Customer Class 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Industrial Commercial Inside-City: Residential Monthly Usage Block thou.0 ______ 100.100 129.DEVELOPMENT/DESIGN OF RATE SCHEDULES 43 Table 4-3 shows a test for the rate schedule developed for all classes of service.400 _________ 779.000 0.900 321.0 0.1 17 18 100.97 0. also shown in the table.100 _________ 968.500 2. gal Service charge First 15 Next 1485 Over 1500 Total Service charge First 15 Next 1485 Over 1500 Total Service charge First 15 Next 1485 Over 1500 Percent of Use % Annual Water Use thou. expressed as a percentage of costs and shown in column 7.900 101.7 0.000 1. The resulting revenues under proposed rates after application of the proposed schedule of charges to water usage in each block is shown in column 5.97 0. Application of these percentages to the total average annual class for the rate year results in the projected water use by block shown in column 3.200 __________ 3.0 230.86 0.8 86.86 0.500. gal 94.1 100.700 28.200 _________ 263.722.300 882.0 ______ 100.000 373.300 _________ 485.900 58. Service charge revenues.2 0.095. indicate that the proposed schedule of rates derives revenues from all customer classes in accordance with the costs of providing service.000 71. The costs of service by customer class developed in Table 3-5 appear in column 6.400 19.5 ______ 100.68 1.100 941.0 6. are derived by applying designed service charges by meter size to the total projected average test-year number of bills rendered by meter size to each customer class.400 _________ 473. The percent of use by rate blocks shown in column 2 is derived from the customer-class curves presented in Figure 4-1.900 76.000 0 _________ 1.14 19 Total 262.503.97 0.000 100.600 50.200 100.300 (6) Allocated Cost of Service $ (7) Revenue as a Percent of Cost of Service % Line No. Columns 1 through 3 present the development of the total annual water use by rate blocks for each class of service.68 479.0 909.900 256.100 68.1 Copyright (C) 1999 American Water Works Association All Rights Reserved .717.700 _________ 1.400 _________ 3.900 256.900 640.200 151.700 7.0 15. Table 4-3 Summary of Customer Water Use by Rate Block and Application of Proposed Rates (Test Year) (1) (2) (3) (4) (5) Revenue Under Proposed Rates $ 785. gal Proposed Rates $/thou.86 0.200 262.400 1.68 Total Public fire-protection-service annual charge —1155 hydrants @ $222 per hydrant Outside-City: Wholesale Service charge All usage 778.

represent a total cost of $9.11. Application of the base and extra capacity unit costs of service to the assumed minimum-user conditions is shown in lines 4 through 6 of Table 4-4. and only a very small percentage of industrial use. maximum-day extra capacity costs of $0. an alternative minimum charge that provides a customer with some volume of water for the charge may be designed as a part of the rate schedule. are assumed to be representative of residential customers and are used to design the minimum charge.42 for the minimum allowed usage of 1 thou. public fire hydrants. Rate Design for Fire-Protection Service In the cost-of-service allocations. It should be recognized that satisfactory results on a first-try basis would be a marked oversimplification of the problems usually involved in the development of an appropriate schedule of rates. and it is assumed the minimum bill would allow 1 thou. Minimum-Bill Design Rather than utilizing a service charge that allows no water use. imposes on the utility certain demands and facility requirements with associated costs. an annual hydrant charge of $222 would be assessed to the proper authority. Revenue under proposed rates for public fire protection is summarized in Table 4-3.28. For the example. public fire-protection-service charges are stated simply as a cost per hydrant.57. The initial block may be designed to recover customer costs and costs associated with use and capacity requirements of the smallest users. Based on an allocated cost of service of $256. The total customer-cost component of the minimum charge is derived in the same manner presented for the development of service charges shown in Table 4-1 and is shown in lines 1 and 2 of Table 4-4. together with customer costs. This may reasonably be rounded to $9. Examination of the customer-class usage curves presented in Figure 4-1 indicates that this block encompasses approximately 10 percent of the total residential use. and maximum-hour extra capacity costs of $0. The remaining blocks are designed in the same manner shown previously to recover costs beyond those of the smallest users. The design of rates for water use in blocks beyond the minimum would include recovery of costs associated with the requirements of the larger residential.200 and 1155 fire hydrants. the development of rates that result in revenue meeting costs within limits indicated in the illustration may involve adjustments to the number of rate blocks.40. gal of water usage per month. Fire protection. and industrial customers. Costs for quantity of water use and capacity requirements are also recognized. commercial. In this example. like any other class of service. and the individual block rates within the schedule. Table 4-4 presents the design of the minimum monthly charge for an inside-city retail customer with a 2-in. The resulting total base costs of $0. the maximum-day and maximum-hour extra capacity factors in excess of average day of 150 and 150. fire-protection service has been included as a class of service separate from regular retail service customers. and charges can be designed to recover costs for this service. Copyright (C) 1999 American Water Works Association All Rights Reserved . gal. usage allowances in each of the various blocks. and maintenance of.44 WATER RATES In practice. The design of a rate for each block would be made in the same general manner discussed previously. The costs distributed to fire-protection service in Table 3-5 include extra capacity costs associated with potential demands on the system by public fire-protection requirements and direct costs related to investment in. less than 3 percent of the total commercial use. respectively. meter.

1842 per thou. thus receiving the benefits of system diversity of peak-demand requirements.8065/year/thou. The unit base cost provides a measure of the lowest potential rate in a schedule of rates for firm service.42 $9.5742/thou.0762/thou. gal Maximum hour @ 27. The use of costs derived by either the commodity–demand or the base–extra capacity method as a basis for rate design will result in comparable charges if all elements of cost are properly treated.5 extra capacity factor × 1. gal $0.5 extra capacity factor × 1.11 _____ 9. load-factor customer.DEVELOPMENT/DESIGN OF RATE SCHEDULES 45 Table 4-4 Design of Inside-City Minimum Monthly Bill for 2-in. does not contribute to diversity in peak-demand requirements and should not receive benefits in cost that result from such diversity. the perfect load-factor customer is assigned only base cost. gal $0. gal × 1. the demand costs are allocated among users on the basis of their total diversified peak demands. 150% maximum-day extra capacity factor. In the commodity–demand cost method. the perfect load-factor customer is assigned a portion of the diverse peak-demand costs.2294/meter) × 2. Meter (Test Year) Line No.5742/thou. gpd = $0.47 1. In the base–extra capacity cost method.1842/thou. gal monthly allowance. gpd = $0.40 Base–Extra Capacity Versus Commodity–Demand Rate Design The design of rates in the foregoing example is based on cost allocations made in accordance with the base–extra capacity method.99 4 5 6 7 8 0.0 thou. Meter $6.0 thou. 1 2 3 Customer Costs: Meter-and-service-related costs ($2. gal Extra Capacity Costs: Maximum day @ 67. and 150% maximum-hour extra capacity in excess of maximum day Base Costs: @ $0.57 Monthly Cost 2-in. Accordingly.0 thou. gal $0. The principal difference between the commodity–demand method and the base–extra capacity method of cost allocation is in the effect of system diversity on cost. gal Total minimum charge for 1. an important guide in preventing possible establishment of rates that could result in the sale of water by the utility at below cost. and this would ordinarily be applicable only if perfect load-factor use could be achieved.0 thou.2394/year/thou.9 equivalent meter-and-service ratio Billing-and-collecting-related costs Assume 1. or uniform. gal allowance Rounded 0. gal × 1. Such a customer. the base–extra capacity method directly identifies through the base-cost element the minimum unit cost of service after recovery of customer cost.0762 per thou.28 0. exercising a constant demand 100 percent of the time. Similar computations would also be made in designing rates using allocations based on the commodity–demand method. This difference may be illustrated by considering the allocation of costs to a perfect. gal × 1. which is allocated among customers on an average. Copyright (C) 1999 American Water Works Association All Rights Reserved .0 thou. As previously discussed.

that when the average costs of serving customers are relatively low. which is allocated among customers on the basis of the diversified extra demands created by only those customers contributing to the system diversity of peak water use. rate making must be based on reasonableness under specific conditions prevailing in the affected utility. In instances where the disparity between the existing level of charges and cost-based rates is great. Consequently. The base–extra capacity method provides a better means of cost allocation by recognizing the customer contribution to diversity in system peak water use. the totally standby customers would only be assigned extra capacity cost. environmental. who does not contribute to diversity of peaking water use. Such a customer is then assigned the full cost incurred in providing his or her share of the nondiversified system load. Considerations in specific situations may dictate procedures and influences quite different from those described herein. It is emphasized that these discussions are meant to be quite general. In the commodity–demand method. and included an example illustrating the derivation of cost-of-service rates in the form of a service charge and block-rate schedule.46 WATER RATES nondiversified-use basis. departure from full cost-of-service approaches may be required in order to address special social. therefore. The totally standby customer would share in the benefits in cost that result from diverse use only to the same extent as the perfect load-factor customer. It is. the potential demand of such a customer would be a part of the total diversified-system peak demand. The conditions of a perfect load-factor customer and a totally standby customer illustrate the maximum differences in the two cost-allocation methods. the same as the demand of the perfect load-factor customer. The remainder of this chapter describes other water-pricing practices through discussions of alternative water-rate forms. American Water Works Association policy provides that water rates be developed in accordance with sound economic and engineering judgment and cost-of-service principles. In the base–extra capacity method. systems of charges are Copyright (C) 1999 American Water Works Association All Rights Reserved . The degree of difference in the cost allocations reduces progressively as requirements of the customer approach the total-system average requirements. suggested that if deviation from cost-of-service concepts is to be considered. In addition. recognizing traditional factors and rate forms. OTHER RATE-DESIGN CONSIDERATIONS _____________________ Preceding portions of this chapter presented general considerations regarding the design of rates. a gradual movement toward cost-based rates is acceptable to moderate the impact of the change in rates on affected customers. Discussion of both cost-based and non-cost-based rate forms is included in this section. including water rates. for many utilities the degree of difference will not be large by using either the commodity–demand or the base–extra capacity cost method. General Information It is characteristic of the development of utility rates. Departure from rates based on cost of service is not recommended by the AWWA Water Rates and Charges Subcommittee. The effect of the difference in the handling of system diversity in the two methods of cost allocation may be further illustrated by examining the allocation of costs to the opposite type of use by the totally standby customer. In every case. the consequences of such approaches should be brought out so that there is full knowledge and understanding of the effects of such a decision. or other considerations as dictated by legal or policy-making bodies.

and other special rate forms. The remainder of this section discusses. industrial. Rapidly increasing costs have generally prompted additional attention to equitability in the development of utility charges. are theoretically better than others in recognizing individual customer requirements that deviate from the customer-class average requirements. In some instances. such as uniform rates for all customers. Many public water systems have separate rates for retail customers residing outside the jurisdictional limits. the same customer classifications might be used for retail service both inside and outside of the city. flat-rate (unmetered) charges that gave little recognition to the amount of service provided a given customer were utilized for most water customers. water utilities have been considering other rate structures. At the turn of the century. and resale or wholesale. It is noted that the AWWA Rates and Charges Subcommittee is developing a separate manual to provide a more complete discussion of alternative rate methodologies and forms than is provided in this manual. lifeline rates. and other considerations in the development of rates. multifamily residential. which often provide service to different customer classes under separate rate schedules. and other characteristics of the customer class using a single rate for all customers in the class. there has been recent emphasis by certain groups for recognition of socioeconomic. although not necessarily consistent with the cost-of-service concept. environmental. This practice is quite distinct from electric and gas utilities. More recently. Some rate forms. Uniform Rate by Customer Class The majority of investor-owned and government-owned water systems in the United States today provide water service to all general-service customers under a single declining-block rate schedule. inverted block rates. A list of such rate classes might include single-family residential. Separate rates for each class may complicate rate administration and cost and perhaps enhance the chances of controversy. public authority. One advantage of providing for separate rate schedules by customer class is that each schedule can be designed based on the demand. these rate forms and other considerations that generally affect the selection and development of rates designed to recover total costs. and uniform volume charges by customer class. seasonal excess-use charges. Such schedules require up-to-date identification and classification of individual customers into rate classes having common characteristics. considerations that may not be directly related to the utility’s cost of providing service. such as commodity–demand rates. such as commodity–demand rates. The philosophy of water utility rate determination has undergone dramatic changes over the past century. to a limited extent. several alternative rate forms can be utilized. An initial step in Copyright (C) 1999 American Water Works Association All Rights Reserved . At the same time that utilities are facing higher costs. To recover water utility costs of service from customer classes. many water utilities adopted volume-related block-rate structures to better recognize customer-service requirements and the associated responsibility for costs. including those that try to recognize peak responsibilities in a more sophisticated manner. other forms of seasonal rates. commercial. With the development of the water meter in the early 1900s. Rates designed to charge customers for the peak or seasonal demand that they place on a system may be viewed as simply a normal evolution in the increased sophistication in structuring rates to more equitably recover costs from those individual customers creating them. still may need to be considered for particular legal or policy reasons. use.DEVELOPMENT/DESIGN OF RATE SCHEDULES 47 justifiably simple. but these rate forms have their practical drawbacks. Other rate forms.

whereby higher rates are charged for water used in the summer. excess use is that volume of use over a given period of time that exceeds some base figure.000 gal. identification. Further experience and study are needed to determine whether or not and to what extent such rates do. For example. Where uniform rates by customer class are to be designed. This fact has given rise to consideration of seasonal rates. even though it is a more sophisticated form of charge. There are a number of unknowns regarding the effect of seasonal rates on peak system demands. Excess-use charges are characterized by having one schedule of charges for winter-season level of use. while customers exerting relatively uniform requirements on the system bear only the costs related to such service. than for the non-peaking portion of the year. billing. and potential administrative constraints and added costs related to metering. is that it does tend to result in a more equitable bearing of costs by individual customers of the system. to localized water shortages. and data processing. Particular emphasis should be placed on practicality of application. The definition of excess use selected will affect the magnitude of both the rate of charge for excess use and the base rate of charge (that is. Each water system should consider seasonal rates on their individual merits after first determining the objectives to be accomplished through such rates. by projected class water use.000 gal. The costs incurred in meeting peaking requirements can be derived from among those customers using the extra capacity.000 gal and usage during a given month during the summer period is 25. in part. excess use must be related to the period of time in which the volume of use can be measured in order to establish a sound basis for establishing excess usage. Copyright (C) 1999 American Water Works Association All Rights Reserved . The added charge is developed from an analysis of costs during peak and off-peak periods. One consideration in developing excess-use charges is the determination of a suitable definition for excess use. The simplest type is merely to charge a higher unit price for water used in the summer than for water used the rest of the year.48 WATER RATES considering separate rate schedules for outside-city customers is the practicability. One beneficial aspect of an excess-use charge. which would be at the lower winter rate. moderate peak demands. In the broadest sense. in fact. Excess use is usually determined from the usage patterns of individual customers. with an additional charge for use in excess of the base amount during a peak water-using period. As a practical matter. Before adopting any one definition of excess use. In addition. the potential quantitative and subjective impacts should be carefully considered.000 gal would be charged at a higher rate than the rate for the first 10. less customer costs. if a customer’s average monthly usage during the winter period is 10. they may basically be developed by dividing allocated class costs of service. the peak demand for water service occurs in the summertime. and classification of customers by customer classes. or peak season. Seasonal rates have received greater attention the last several years due. the charge for off-peak usage). A more sophisticated method is to develop a system of excess-use charges. when lawn irrigation and other outdoor water uses are more prevalent. There are several types of seasonal water rates. then the excess above-average winter-period monthly use of 15. customer understanding. Seasonal Rates In most water systems. the recognition of peaking requirements as a significant element of cost has opened the way to seasonal rates.

DEVELOPMENT/DESIGN OF RATE SCHEDULES 49 Commodity–Demand Type Rates Commodity–demand rates. to the limited extent to which they are available. commodity–demand rates are not commonly used in the water industry today. Peak-load pricing and commodity–demand pricing are similar in that each method consists of a multiple-part rate structure in which charges are based on both the quantity of water used and the maximum rate at which it is used. As a practical matter. if a water utility needed to develop a new source of supply at considerable expense. outside of possible industrial application. The demand charge is based on a customer’s peak load imposed on the water system. and (2) customer’s noncoincidental demands (each of these demands are priced separately). However. Some economists assert that the price of water should reflect the marginal cost. As a result. are relatively expensive to install and maintain. separate rates or rates lower than average are applied to water delivered during off-peak periods. Such deliveries may be advantageous to a water utility whereby the overall system load factor is improved. Thus. Generally. it would be a relatively simple matter to apply the cost-of-service unit costs to customer-service requirements to determine each customer’s cost responsibility. If it were possible to meter and measure each customer’s volume-use and maximum-demand units of water service. a recording metering device must be installed to record both volume of use and the maximum rate of flow. and a demand charge based on the maximum rate of water use. it has been found that few customers consider worthwhile the potential savings that may result from limiting their use to the off-peak service and the potentially lower rates related thereto. and benefits generally do not justify the added costs. Although the commodity–demand form of rate is. and its administration is apt to be complex and costly. Peak-load pricing rates. the charge for all water sold should reflect that cost even though the average could be less. where demand rates are used. they are applicable only for large wholesale and industrial users where it is cost-effective to meter both total use and rate of demand. a commodity charge based on the total volume of water used. Where used. more equitable for all concerned. The contention is that only through such pricing is the customer given the proper signal as to the true price of Copyright (C) 1999 American Water Works Association All Rights Reserved . Commodity–demand rates offer a sound means of recovering the costs of providing service to those customers with water-use characteristics that vary significantly from the class average. A commodity–demand rate can be developed for water service whereby the total charge consists of a customer charge to generally recover metering. and collection costs. Off-peak rates for delivery of utility service are common in the electric utility industry and are occasionally considered in the water utility industry. billing. in many respects. peak-load pricing may recognize two types of demand: (1) customer’s demand that is coincidental with the system peak demand. it still requires the installation of expensive demand meters. However. Marginal Cost Rates Marginal cost is usually defined as the cost of water from the most recent or next increment of plant capacity and supply. The commodity-charge portion of the rate usually takes the form of a uniform rate. Off-peak rates. Although this method of pricing for variations in the load factor overcomes some of the objection to demand pricing based on maximum noncoincidental demand only. its application is not practical because demand meters.

due to improved peaking factors. amount of water use. which charge a higher price for water as usage increases. and is applicable to all customers served. In the traditional cost-of-service study. It has been suggested by some that such excess revenues should be utilized to lower rates to customers whose use is relatively inelastic. A uniform rate for all customers implies that each unit of water costs the same. there is little Copyright (C) 1999 American Water Works Association All Rights Reserved . Under such rates. This type of rate may be appropriate where the predominance of water customers have similar water-use characteristics and. for the residential class. it is easy to understand and administer. A very practical objection to inverted rates is that higher use per customer does not necessarily indicate a higher cost per unit of use. but their practical applicability needs to be thoroughly studied before adoption. It is possible to use some elements of a cost-of-service study as a guide in the design of inverted rates. do not recognize the generally better load factors of the large-use customers.or increasing-block rate structure is the counterpart to declining-block rates. Declining-block rates are used to recognize that the average cost of water decreases with the volume used. For example. regardless of the amount used. Inverted rate schedules would not likely be appropriate for all customer classes. on their demand for extra capacity. Increased concern for conservation of resources has led to limited acceptance of inverted rates in several areas.50 WATER RATES water and the opportunity to make an economic decision concerning his or her desire for additional service. Some large-volume commercial and industrial customers have very uniform wateruse patterns with a resultant lower unit cost of service than residential customers. Thus. only in special circumstances could inverted rates be considered as cost-of-service related. Marginal cost rates have some value in theory. high irrigation use during the summer season is generally a cause indicative of a poor load factor. It is not possible to design each rate step in an inverted rate schedule based on the results of a traditional cost-of-service study. such as low-use customers. Such circumstances should be documented and carefully evaluated before inverted rates are proposed. The same rate is paid by all users. Since the rate is generally established by dividing total anticipated costs by total anticipated water sales. particularly those facing immediate and recognizable water supply problems. The concept of an increasing price per unit of use frequently arises from the desire for conservation in total water use. irrespective of user class. consequently. patterns of water use. or size of meter and service. Pricing all water at the marginal cost could result in the collection of revenue from customers considerably in excess of current needs. The use of inverted rates is a relatively recent development in water pricing. resulting in both the incremental and average cost of water increasing with increased customer usage. Although the economic theory behind marginal cost pricing is sound. the application of the theory to water rates lacks considerable practicality. Invertedblock rates. customers are allocated cost responsibility based. in part. the unit price rises with each successive block. Inverted-Block Rates The inverted. Uniform Rate The uniform rate is a constant unit price for water. A peak-use-period inverted-block rate schedule could function to charge for such peak use.

Consequently. lifeline rates may. The lifeline concept of rate design is frequently proposed as an aid to economically disadvantaged and elderly residential customers who might not be able to pay their bills. and other such elements. such as general tax revenues. Lifeline Rates Consumer-advocate groups sometimes propose programs to reduce utility charges for residential customers who are senior citizens. but they may contribute to excessive use of water with attendant higher total costs. a uniform rate might be appropriate in a suburban community with generally similar residential use only. Such assistance is often described by the single category of lifeline rates. should not be advocated by those responsible for rate design. Such rates are applied to certain measures of customer service. which are not based on cost-of-service principles.DEVELOPMENT/DESIGN OF RATE SCHEDULES 51 need for more than a single charge. The water connection charge is frequently based on a capital contribution by the customer for the purpose of financing initial capital investment attributable to the Copyright (C) 1999 American Water Works Association All Rights Reserved . Such rates have been common in the past and continue to be used in some water utilities. Unmetered or Flat Rates Flat rates refer to charges utilized where customer use is not metered. The first problem is that providing reduced rates to low-volume residential users can discriminate unfairly within a class of customers being provided essentially similar service. the size of irrigated areas. and (3) the poor and elderly. or relying on revenue from other sources. increasing the rates charged to other customers. Opponents of lifeline rates argue that the concept is essentially similar to a single schedule of inverted rates and has serious drawbacks. For example. In addition. except where legislative authority mandates such a policy. since lifeline rates provide favorable rates for minimal “conservative” use and increasing rates for greater use. or on fixed incomes. a correlation between water use and income level generally has not been proven to exist. poor. (2) the inverted form of rate will encourage conservation. such rates can be designed to generally recover estimated costs of service. Extensive discussion of the theory and practice of lifeline rates is beyond the scope of this manual. The subsidizing of one part of a class of customers by other classes of customers may be ruled unlawful discrimination except in those states that have enacted laws supporting the lifeline concept. The institution of lifeline rates. such as the number of rooms. Lifeline rates seek to assure that each qualifying customer may obtain his or her theoretically minimum requirements for service at a lower-than-cost rate. In specific instances where water conservation is not a significant consideration and the installation of meters is impractical. in fact. Water Connection Charges Many water systems require a connection charge for a new customer joining the system. rates should be based on nondiscriminatory cost-of-service principles. will be the chief beneficiaries. the number of plumbing fixtures. Revenues not recovered from this minimum-usage allowance would need to be recovered by increasing the rates charged for use above the minimum. who are thought to be the low-use customers. unduly benefit customers who have low water-use requirements but who have the ability to pay for their full cost of service. In the absence of such direction. Proponents of lifeline rates argue that (1) such rates are easy to understand and to implement and require no additional tax revenues.

To the extent that such charges are used. In addition. Such records provide information as to the quantity of water sold at various levels of use and are used for rate-block design. development of appropriate charges should proportionately recover the costs incurred by the utility in providing the water service connection.and treated-water produced as well as maximum-day and maximum-hour production at water treatment and major booster pumping facilities should be maintained so that they can be used to develop a bill-frequency tabulation (an example of which is shown in the appendix). which addresses general water-service rates. Such charges can be valid. Water Rates and Related Charges.. 1980). These include individual customer billing records for which a history of at least one fiscal year should be maintained. Therefore. Other Considerations The reader is referred to AWWA Manual M26. The information in this publication is not only vital for a rate-design study but is useful as a management tool. for further discussion of the rate and charge matters set forth in this manual. but are not considered as water rates in the ordinary sense of the term. Each utility should also maintain a careful record of all expenditures. the concept is beyond the scope of this manual.52 WATER RATES new service. The billing records should be maintained so that they can be used to develop a bill-frequency tabulation (an example of which is shown in the appendix). Each water utility should maintain adequate records to provide for periodic rate design. including classified cost data regarding investment in the physical plant and equipment. Suggested accounting practices are set forth in the AWWA publication Water Utility Accounting (2nd ed. Copyright (C) 1999 American Water Works Association All Rights Reserved . Such records provide information as to the quantity of water sold at various levels of use and are used for rate-block design. accurate records of total daily raw.

Also.AWWA MANUAL Chapter 5 Rate Design for Small Water Utilities The allocation of the total cost of service to cost functions and the design of water rates to recover these costs using the somewhat complex techniques described in earlier chapters of this manual requires information not always available to small water utilities. Generally. a small utility may generally be defined as one having fewer than about 5000 customers. and who have no significant industrial or other special-use customers. even if the cost exceeds 5 percent of the revenue or if the utility is facing significant changes in costs. or simplified method. it may be prudent to conduct a full study. the simplified method is most appropriate for small water utilities with customers who are either mostly or entirely residential with a few commercial users. the cost of preparing relatively detailed studies may not be justified for a small utility. if a utility has substantial industrial or other special sales. of rate design described in this chapter may be considered when the estimated cost of preparing a full rate-design study exceeds approximately 5 percent of the utility’s annual revenue. 53 Copyright (C) 1999 American Water Works Association All Rights Reserved . It should be noted that many of the elements of a rate study presented in chapters 1 through 4 provide the background for suggested rate-making procedures presented in this chapter and should be reviewed and used as appropriate. The purpose of this chapter is to provide a simplified cost-based method for the preparation of rates for a small utility. Such a study can demonstrate the changes in costs and how those costs can be reflected in rates. Use of the small-utility method. However. As the term is used in this chapter.

A bill-frequency analysis of metered water use by customer class and meter size. is required to develop the simplified rate design described in this chapter: 1. As mentioned previously. pumping. depreciation expense. and return on rate base. debt service on borrowed funds. The objective of developing revenue requirements is to determine the cash needs and general timing of utility expenditures in order that adequate funds may be made available as requirements come due. a “forward-looking. based on operational areas. 2. This procedure has been used frequently by government-owned utilities. The following information. and labor would be made for one or more years in the future.” or prospective. Projections of anticipated expenditures based on historical expense trends of anticipated growth in sales of water and of potential increases in costs of materials. separate identification of power-related expense for treatment and distribution pumping as well as treatment-related chemical expense is recommended. The number and size of meters by customer class. Basic revenue requirements of a small government-owned utility would normally include operation-and-maintenance (O&M) expense. possibly some small capital additions to the system. to the extent available. treatment. Recognition of factors such as the effect of inflation and growth on expenses will reduce the need for frequent rate adjustments likely to be needed if a historical test year is used as the sole basis for establishing revenue requirements. and costs of general administration. Chapter 1 presents a more comprehensive presentation of the development of revenue requirements on the cash-needs basis. Investment in utility plant and equipment should also be separated. revenue requirements must be identified in sufficient detail to permit development of cost-of-service rates. REVENUE REQUIREMENTS Development of revenue requirements to reflect annual cash needs of the utility is the first step in the development of rates and maybe incorporated as an extension of cash budgeting and accounting techniques practiced by most utilities. billing. costs of customer metering. transmission and distribution. Copyright (C) 1999 American Water Works Association All Rights Reserved . rate year should be used in developing revenue requirements. and it is gaining increasing acceptance by state commissions regulating investor-owned utilities. as a minimum. Revenue requirements for investor-owned utilities would include provisions for O&M expense. The revenue requirements of the water utility for the projected rate period in sufficient detail to permit allocation to cost categories. Generally. including provisions for recognizing cost escalation. In addition. In order to minimize potential cash-flow shortages during the period rates are to be effective. allowances for normal annual repairs and replacement of existing facilities. Costs might be separated to include costs of O&M for source of supply. utility costs for O&M would be identified in accordance with specific operational areas or cost centers of the utility. and other cash requirements for items such as payment in lieu of taxes and payments for services provided to the utility by other municipal departments. income and property taxes. This is particularly true in periods of rapid inflation since the current and projected costs being incurred by the utility will generally exceed those incurred in the past.54 WATER RATES INFORMATION AND DATA REQUIREMENTS Small water utility data requirements for determining cost-of-service rates are quite similar to those required for larger water utilities. 3. supplies. and collecting.

In order to properly distribute revenue requirements. chemical and power costs are allocated to the commodity cost component. related costs are allocated to the demand component. Customer costs include meter and service maintenance. transmission. Other costs that may be allocated to the commodity cost component include costs related to impounded reservoir source of supply and purchased water since these costs tend to vary with average daily usage requirements. Customer costs include costs incurred to serve customers. billing. Costs allocated to the commodity cost component include those costs that tend to vary with the quantity of water produced. customer. Consequently. Maine. the curve indicates the amount of the fire-service cost as a percentage of the total revenue. supply is assumed to be from groundwater sources. In the example presented in this chapter. meter reading. associated costs would be allocated to the demand component. In the absence of other data. an estimate can be developed using Figure 5-1. Even though a utility may not charge its customers for public fire-protection service separately. and customer accounting and collection costs. Maine. a fire-protection-service cost allocation is desirable. The results obtained from Figure 5-1 can be modified to reflect the results of other studies for other pertinent considerations as may be known. Demand costs are associated with providing facilities to meet peak rates of use by system customers. service provided to customers must include provision for meeting average water-use or volume needs as well as peak-demand requirements. Allocation of Public Fire-Protection Costs Public fire-protection costs are related to provision of public fire-protection services and are directly allocated to the public fire-protection component. This curve is an adaptation of a curve developed by the Maine Water Utilities Association. Copyright (C) 1999 American Water Works Association All Rights Reserved .RATE DESIGN FOR SMALL UTILITIES 55 Functional Cost-Allocation Components In any utility. utility costs must be identified as being related to particular levels of service. as a basis for estimating the required fire-service cost when a detailed fire-service allocation study is not feasible. Consequently. Therefore. amount of water supplied. Costs related to levels of service provided may be categorized as either commodity–demand. Fire-service costs derived from the figure may be considered to be the cost of service for public fire protection. to customers in accordance with water-service requirements. and has been used by the Maine Public Utilities Commission. Based on the number of customers served. all transmission and distribution system pumping and all treatment. Public fire-service costs are primarily demand-related. Augusta. or costs of service. An estimate of the cost to provide fire service can be based on the results of cost-allocation studies made for other larger utilities where such information is available. irrespective of the amount or rate of water use. It may be difficult for small utilities to determine the full cost of public fire-protection service without performing comprehensive studies. Gorham. Generally. Commodity costs usually include costs of chemicals and power and other costs that increase directly with the. and distribution mains and storage facilities are sized to meet peak demands. For purposes of this example. or public fire-protection costs. costs associated with these facilities are allocated to the demand cost component. Source of supply costs related to groundwater sources are generally sized to meet maximum-day demand.

56 WATER RATES Figure 5-1 Percentage of total revenue allocated as fire-protection-service cost. Copyright (C) 1999 American Water Works Association All Rights Reserved .

RATE DESIGN FOR SMALL UTILITIES 57 Allocation of Revenue Requirements Table 5-1 shows the allocation of plant value to cost functions using a simplified version of the commodity–demand method described in chapter 2. capital expense is assumed to include debt service as well as normal annual repairs and replacement expenditures. Total costs of service for the test year to be recovered from general service rates are presented in Table 5-3. excluding power and chemicals. †Allocated based on overall weighted allocation of all other plant. Total allocated O&M expense developed in Table 5-2 is restated in line 2 of Table 5-3. since relatively little general administration is required to monitor consumption of power and chemicals. Customer costs include expense related to services. In line 5. based on the subtotal allocation of all other O&M expense. fire-protection service revenues are deducted to entirely offset costs allocated to the direct fire-protection cost component. meters. capital-related costs would include depreciation expense. is predominantly Table 5-1 Small Utilities—Allocation of Plant Value Using the Commodity–Demand Method *Assumes groundwater source of supply. other than hydrant expense. For an investor-owned utility. Capital-related expenses are allocated to cost components. with remaining revenues deducted from costs allocated to the demand cost component in recognition of the fact that fire service. is allocated to fire-protection service based on the system having 2500 customers. based on total allocated plant value and are shown in line 3. Hydrant maintenance expense is allocated to the public fire-protection cost component. and customer accounting and collecting. and transmission and distribution expense for mains and storage facilities. pumping. Total utility costs of service are summarized in line 4 and are offset by revenue from public fire-protection service shown in line 5. income and property taxes. Cost allocations to the commodity component include pumping power and treatmentrelated chemical expenses.500. The revenue to be obtained from public fire-protection service is estimated from the curve shown in Figure 5-1. and return on rate base. treatment. In the example. Costs allocated to the demand component include labor. Copyright (C) 1999 American Water Works Association All Rights Reserved . Table 5-2 presents the allocation of O&M expense to functional cost components.5 percent of the total revenue requirement. Administrative and general expenses are generally allocated to all cost components. 22. or $67. materials and supplies. In the case of a government-owned utility. and other expense for O&M of source of supply.

excluding purchased power and chemicals. ‡Allocated based on overall weighted allocation of all other expenses. Copyright (C) 1999 American Water Works Association All Rights Reserved . †Chemicals only.58 WATER RATES Table 5-2 Small Utilities—Allocation of O&M Expense Using the Commodity-Demand Method *Power for pumping only. line 1. Table 5-3 Small Utilities—Allocation of Costs of Service Using the Commodity-Demand Method (Test Year) *Allocation on basis of allocated plant value. †Line 2 plus line 3. ‡Line 4 less line 5.

Copyright (C) 1999 American Water Works Association All Rights Reserved . and a two-block rate structure may be unduly discriminatory. Single-Block Rate Design If a single-block rate structure is to be used. Table 5-4 demonstrates how to calculate the number of equivalent 5/8-in. by perhaps three times or more.46/month equivalent 5/8-in. It should be noted.RATE DESIGN FOR SMALL UTILITIES 59 related to peak rates of use. meter service charge. meters. Total costs of service to be recovered from general water service rates are summarized in line 6 of Table 5-3. no cost is allocated to the commodity component. Generally speaking.46. the entire revenue requirement less customer costs will be recovered through a volumetric charge. The small amount of commodity cost that might be allocable to fire service is negligible in comparison to total system water use. a two-block structure may be needed to provide equitability between the classes. If the average commercial use is substantially higher than the average residential use. whereas utilities serving from 500 to 5000 customers should probably use a two-block rate structure. a service charge with no water allowance can be developed. however.57. Development of a suitable monthly service charge for any size meter is accomplished by multiplying the appropriate equivalent meter and service ratio shown in Table 5-4 by the $2. the monthly service charge for a 1½-in. RATE DESIGN General Two types of rate structures are recommended for consideration by small water utilities.43. Fire-service charges should also be considered and are discussed subsequently. charge. Utilities with significant commercial use should use an initial customer service charge and a two-block rate structure. or a monthly charge of $2. the preparation of the detailed studies described in earlier chapters should be considered. water utilities serving fewer than 500 customers are likely candidates for a single-block rate structure. meters calculated in Table 5-4 are to recover the $76. is indicated for an equivalent 5/8-in. A schedule consisting of an initial charge related to customer costs and a single-block rate structure is best suited for water utilities with primarily residential use and little commercial use. meter would be 1. If the average use of residential and commercial customers is close. and therefore. A comparison of average water use for residential and commercial customers can serve as a guide to the number of rate blocks to be used. meter.500 of customer costs calculated in Table 5-3. This is calculated by dividing the revenues to be recovered by the total water sales. that many water utilities at the upper end of this range could have significant industrial users. a one-block structure can be adequate. an annual charge of $29. In such a case. For example. or $4.8 times the 5/8-in. as shown in the following example: To recover customer costs. If the 2587 equivalent 5/8-in.

Meters A minimum charge consisting of the service charge plus the volume cost of an amount of water allowed under the minimum is also acceptable. This assumes that water sales in the second block have a peaking factor of one half that of water sales in the first block. The next step is the allocation of the commodity and demand costs between the two rate blocks. If less than a full year’s bills are analyzed. Copyright (C) 1999 American Water Works Association All Rights Reserved . This limit is needed in order to determine the total volume of water use in each rate block and to allocate the commodity and demand costs between the first and second rate blocks. a generally accepted practice is to set the water usage limit of the first rate block so that it will include almost all of the residential use. i. Commodity and demand costs allocated to each rate block are then divided by total estimated water sales in each block to produce the block rate for each block. In the absence of a bill-frequency analysis. Generally. The second usage block would include all usage beyond the first block. an all-winter period or an all-summer period.. Once established. Allocate the demand costs between the first and second blocks based on the volume of water sold in each block but giving twice the weight to water sales in the first block. Once the curves are prepared. a first-block water usage limit of two to three times the average residential customer’s use is reasonable.60 WATER RATES Table 5-4 Small Utilities—Equivalent 5/8-in. a check of the customer bills for several months to determine the total use within the first block would be made in order to evaluate the percentage of annual water use that would be billed at the first-block rate. indicating a more uniform usage of water at higher use levels. selection of bills should be for periods when a customer’s average water usage is not abnormally high or low. The appendix to this manual illustrates procedures for developing a bill-frequency analysis and curves. 2. Two-Block Rate Design If a two-block rate schedule is considered appropriate. One method for selecting rate blocks is to develop a bill-frequency analysis and prepare curves depicting the percentage of total water use by customer class and the total water use by the class. This calculation is illustrated in Table 5-5. Details for calculating minimum charges are shown in chapter 4. it is necessary to establish the first-block water usage limit. A simple approach suitable for small water utilities is as follows: 1. Allocate the commodity costs between the first and second blocks based on the percentage of the volume of water sold in each block. the initial usage block would be selected to include about 80 to 90 percent of residential usage.e. All other water would then be billed at the second-block rate.

capability. Thus.RATE DESIGN FOR SMALL UTILITIES 61 Table 5-5 Small Utilities—Allocation of Costs of Service to Rate Blocks and Calculation of Water Rates (Test Year) If a study of the usage patterns in a particular utility indicates that a peaking-factor ratio different from that used in Table 5-5 is appropriate. A commonly used basis for establishing rates of charge is the number of water-using fixtures in the structure served. then such a ratio should be used in the allocation of demand costs. which should be related to their rated capacity use. but it must be remembered that as the number of fixtures increases. the probability of using all fixtures coincidentally diminishes. For a small utility. Unmetered Rates Procedures for designing water rates for unmetered customers are included because many small water systems serve unmetered customers. Therefore. After determining the revenue requirements for unmetered customers. a customer’s first faucet is given substantially more weight and a higher charge than the balance of the customer’s fixtures. it is an acceptable procedure to design metered rates and unmetered rates to produce about the same average revenue per customer from similar classes of customers. Unmetered rates should potentially reflect the greater costs required to serve these customers because they generally exhibit higher water use. Because the water use is unknown. Additional fixtures owned by the same customers are generally assigned a lower charge. The first-faucet or minimum charge should produce a substantial (25 to 50) percent of the total revenue requirements from these customers. the first-faucet charge can become the minimum charge. the rates must be based on estimates of such customers’ demand for water. it is necessary to design rates to produce this revenue. the rates should also reflect lower customer costs resulting from the fact that the unmetered customers do not incur costs related to the increment of meter ownership and maintenance and meter reading expense. However. This requires an inventory or count of all the fixtures and an estimation of their demand . In cases where the water utility has both metered and unmetered customers. Copyright (C) 1999 American Water Works Association All Rights Reserved . The demand characteristics of various water-using fixtures is published information. an allocation of the revenue requirement between these types of customers must be made.

20/year 2500 first faucets Assuming an average of 12 fixture units per customer in excess of the first faucet. the first-faucet annual rate will be: $232. Assuming that 40 percent of the revenue requirement is to come from the first faucet.500 × 60% = $4.500 × 40% = $37.65 × 3. The direct per-hydrant charge would then be billed to a fire district or other governmental agency. Copyright (C) 1999 American Water Works Association All Rights Reserved . In some instances.95/year. the cost of public fire-protection service is collected as part of the basic water rates rather than through a separate charge. It is the general policy of the American Water Works Association that all customers be metered. and this simplified discussion of flat rates should not be considered as a waiver of the advisability of this policy. the rate per fixture unit would be: $232. eliminating the need for a large number of fixture rates. which indicates the relative water-demand potential of all water-using devices installed per customer. Alternative rate-setting methods should be explored. Fixture rates are difficult to establish and administer because they require frequent fixture counts for all customers. the preferred method is to charge separately for fire-protection service. This is accomplished by dividing total fire-protection costs by the total number of hydrants. public fire-protection costs of service maybe distributed to all customers benefitted by public fire protection as an addition to the customer service charge. or $13. While there are occasional reasons for such practice.62 WATER RATES The following example demonstrates a method used to calculate unmetered or flat rates: Assume the total test-year annual revenue requirements from 2500 flat-rate residential customers is $232. Public Fire-Protection Rates Perhaps the simplest method for recovering fire-protection costs is on a per-hydrant basis. Nonresidential customers can be billed on the basis of equivalent family units.500. In this case.65/year per fixture unit 2500 × 12 If a fixture has a weighting of 3 due to its rate of water use. Family units or equivalent family units are often used as a basis for charges. the fixture rates for this type of fixture would be $4.

If the utility billing system is computerized. if a summer–winter seasonal rate were to be developed with one rate applicable for usage during the 6-month summer period and another for the 6-month winter period. the results should be available to avoid delay both in the design of rates and in the evaluation of the adequacy of proposed rates to recover allocated costs of service from customer classes. and determining utility billing revenue under any rate schedule. commonly referred to as a bill-frequency distribution analysis or simply a bill tabulation. By beginning the bill tabulation early in the cost-of-service study. For instance. may be accomplished either manually or by data processing. Normally. Tabulation of customer bills and usage. the time required for the preparation of the bill tabulation may be relatively short. selecting water-usage rate blocks. On the other hand. This permits recognition of customer usage patterns and variations in use between seasons. The tabulation of bills for a historical period provides the basis for identifying typical customer-class usage patterns and aids in the development of rates recognizing such usage patterns. if a seasonal rate schedule is to be developed. and delays are often encountered because computer time is not readily available when needed. In the example presented here. be required to develop specific programs to extract and summarize data in the form required. the selection of the 12-month period 63 Copyright (C) 1999 American Water Works Association All Rights Reserved . perhaps only one or two weeks. however. separate bill tabulations would need to be made to coincide with the periods for which each part of the seasonal rates are to be effective. the bill tabulation would need to be made in two parts so as to coincide with the summer and winter periods as defined. Rate schedules that are intended to be applicable throughout an entire year generally require a bill tabulation for a historical 12-month period in order that annual usage patterns are properly identified. A bill tabulation shows the number of customer bills rendered at various levels of water usage during a specified period of time for each customer class served by the utility. it is best to initiate bill tabulation procedures during the early stages of a cost-of-service rate study due to the potentially time-consuming work involved in summarizing billing data and in testing the completeness and accuracy of the results of the bill tabulation. In addition.AWWA MANUAL Appendix A Bill Tabulation Methodology INTRODUCTION The summarization or tabulation of customer bills provides a useful basis for identifying and analyzing customer usage patterns. The computer staff may. bills are tabulated for one customer class for a continuous 12-month period. Tabulating bills for a continuous 12-month period is strongly recommended in order to properly account for seasonal variations in customer water-usage patterns.

particularly for large customers. the usage for inside-city residential customers with 5/8-in. This procedure is continued for each meter size until all customer bills in the class have been summarized. for larger utilities. and into meter sizes. To illustrate the bill summarization procedure. BILL TABULATION Bill Summarization The first step in tabulating customer bills is to separate billing records into customer classes. Figure A-2 shows an example of the type of sheet on which the usage for each monthly bill is tabulated when a manual bill tabulation is necessary. because the use per customer in other classes is likely to be much more variable than for the residential class. due to climatic or other conditions. on the order of 10 to 20 percent of the total number of customers in the class. hypothetical customer-billing account records and a bill tabulation sheet are shown in Figures A-1 and A-2. in the example in Figure A-2. the selection of bills for tabulation should reflect a year in which average conditions prevail. a sample tabulation of the residential class. The possibility that the period selected for study may represent a year in which water usage was abnormally high or low. presenting each customer’s monthly water use and the amount billed. random sampling procedures should be used. has been selected. Thus. If a sample of customers is to be made. Several summary sheets may be required for a given customer class and meter size in order to accommodate the range of monthly usage by customers in the class. meters is to be summarized on this sheet. a manual bill-tabulation process involves entering individual customer usage for each billing period on summary sheets that are separated into various levels of usage. if available. It is noted that usage levels or use blocks should be established to cover the largest monthly usage in each class. should be considered when utilizing the bill tabulation for rate-design purposes. In the left-hand margin of the tabulation sheet appear the various possible levels of customer usage for each billing period in terms of hundred cubic feet (Ccf). It is suggested that a 100 percent tabulation be made for other customer classes. Copyright (C) 1999 American Water Works Association All Rights Reserved . as indicated on the billing record.64 WATER RATES should coincide as closely as possible with the utility’s fiscal accounting period so that the accuracy of the bill tabulation in generating revenue can be more easily ascertained. each customer’s usage may be tabulated for the 12-month period. Bills issued to active customer accounts with zero usage during any billing period should be included as “zero-usage” bills. However. If possible. as previously discussed. may be adequate to establish usage patterns for that class. The same process would be repeated for every other customer class. For small utilities. may not provide a representative distribution of water-usage patterns. Next. The bill-tabulation process is initiated by selecting the smallest meter size for a particular customer class and tabulating identified individual customer usage onto the summary sheet for that meter size and class. the manual process described herein would be simulated on the computer. If a computer is utilized for the summarization of bills. respectively. Both customers are inside-city residential customers with 5/8-in. It is important to summarize bills for each identified customer in all customer classes unless a sample for the class. A less than 100 percent sample. the number “2” is equal to a monthly usage of 200 ft3. meters. Figure A-1 shows two customer billing accounts. Bills issued to inactive accounts should be excluded. As indicated at the top of the sheet.

Copyright (C) 1999 American Water Works Association All Rights Reserved .APPENDIX A 65 Figure A-1 Hypothetical customer-account billing records.

Copyright (C) 1999 American Water Works Association All Rights Reserved .66 WATER RATES Figure A-2 Example of a water-bill tabulation sheet.

residential inside-city accounts billed during the 12-month period. Selection of usage blocks for summarizing cumulative billing data does not need to set forth all usage blocks used in the bill-tabulation sheet described earlier. a tick mark is made on the line in Figure A-2 that corresponds to the usage billed in a given month. shown in Figure A-1. residential inside-city customers. total water sales. Column 1 shows the usage blocks for which water-usage and bill data are summarized. This will result in a readily identifiable cumulative level of usage in each rate block against which existing rates may be applied for purposes of checking the Copyright (C) 1999 American Water Works Association All Rights Reserved . Similarly. a tick mark is made on the usage-block line marked “5” on Figure A-2. Usage associated with the bills tabulated in each usage block is determined by multiplying the number of bills by the usage amount—shown in the left-hand column of each line. total customer-class usage and bills would be determined by adding the bills and usage for all meter sizes for a given customer class. Therefore. As shown in Figure A-3. The data summarized in Figure A-3 are for a hypothetical residential customer class. Development of Cumulative Billed Usage After tabulating the number of bills and usage for each customer class by meter size.APPENDIX A 67 Beginning with customer account number 115147. of Figure A-3 and would be recorded on the line opposite the usage-block category marked “11–15” in columns 2 and 4. the next step is to determine the cumulative billed water usage by various usage blocks or increments for each customer class and meter size. the number of tick marks or bills is totaled for each usage block and summarized at the bottom of the appropriate column on each sheet. a separate tabulation sheet or sheets for each meter size by customer class would be completed. respectively. A tick mark is made for each monthly usage quantity on the appropriate line on Figure A-2 for both customers’ monthly usage quantities. for the January billing period. For example. and revenue for that period would be readily available. Each tick mark is equivalent to one bill. the total number of bills and usage would be those shown in Figure A-2 at the bottom of the two right-hand columns. The numbers entered on this line would represent the total number of bills and associated usage for customer usage of 11 through 15 Ccf per billing period. The selection of the period for which bills are to be summarized to coincide with the utility’s fiscal accounting period greatly enhances the ability to check the accuracy of the bill tabulation since cumulative data as to the number of bills. Once the bill tabulation is complete for each meter size by class. The final check as to the accuracy of the bill tabulation is based on the revenue that the tabulation generates when applied to the existing schedule of rates. This procedure would be repeated for all 5/8-in. and larger increments are utilized thereafter. increments of usage from 1 Ccf up to 10 Ccf are used. After all bills and associated usage have been summarized for each meter size and class. The procedure includes several steps and is best accomplished by using a computation table similar to the one shown in Figure A-3. Usage blocks summarized should be selected in part to coincide with the existing rate blocks. the usage for customer account 115147 is indicated to be 5 Ccf. the bills and usage recorded for the unit increments of 11 through 15 Ccf from the bill tabulation sheet (see Figure A-2) would be combined for the purposes. The usage blocks used in summarizing cumulative billed usage are generally established to include single-unit increments at the lower usage levels to coincide with the use of smaller users and larger increments or groupings of several unit increments at the higher usage levels. If the two hypothetical customers shown in Figure A-1 were the only 5/8-in. as shown. From Figure A-1.

.Copyright (C) 1999 American Water Works Association All Rights Reserved Figure A-3 Development of cumulative billed usage residential class—annual number of bills and usage—5/8-in. meters.

In this example. residential customers maybe developed at this point by adding the values shown in columns 5 and 6 for each usage block. This quantity does not include water used by customers who use more than 3 Ccf. 5/8-in. during the 12-month period represented by the bill tabulation. The cumulative billed usage of all 5/8-in. While the accumulated usage shown in column 5 provides a measure of total customer-class water use.254. Bills for each usage block are summarized in this manner for each customer class and each meter size individually. at the 3 Ccf usage block. That is. 154. including the usage in the block by customers whose usage exceeds the block.508 Ccf of water was used by those customers billed for 0. the column 6 value for the 31–50 Ccf usage block is calculated by multiplying 50 Ccf by the number of cumulative bills for the 51–100 Ccf block of 645 and totals 32. beginning with the “251 and over” Ccf usage block and summing up the number of bills. it does not indicate the quantity of water used in a given usage block by bills that exceed that usage level. Column 4 represents the total use of bills stopping in each usage block and corresponds to the number of bills listed in column 2. For example. Other usage blocks should be summarized in sufficient detail to prepare a representative graphical curve. residential-class customers used 1.836 bills issued to the residential class is represented in the figure. For rate-design purposes. In the example in Figure A-3. As shown in Figure A-3. The values shown in column 6 are calculated for each usage block by multiplying the usage block value in column 1 by the number of cumulative bills through block corresponding to the next larger usage block. These numbers are taken from the far right-hand column of each bill-tabulation sheet (an example of which is shown in Figure A-2).317 bills are issued for the 3 Ccf usage block for a total of 72. The number of cumulative bills in any particular usage block represents the number of bills issued for the amount of water use shown in that block or more. a total of 187. the next step is to determine the total use in the block of all billed usage passing beyond each block. Therefore. the summarization of usage for all usage blocks yields the total use of the customer class for the meter size during the bill tabulation period. at the 3 Ccf consumption block. The total water use of bills stopping in each usage block shown in column 4 is accumulated. beginning with the 0 Ccf usage block.308 Ccf during the 12-month bill tabulation period. The 32.250 Ccf of water use is the quantity of usage in the 31–50 Ccf block of monthly use for the 645 bills whose usage exceeds this block. column 5 indicates that a total of 120. 1. as shown in column 3. Consequently. 2. as shown in the last line of column 5. For instance.158 bills have been issued for usage of 3 Ccf or more. Once the number of bills is summarized by usage block. as shown in column 5. meters. Copyright (C) 1999 American Water Works Association All Rights Reserved . The number of bills issued for each usage block would be taken directly from bill tabulation sheets similar to the one shown in Figure A-2. the bills are accumulated up in column 3 of Figure A-3 by starting with the bills in the largest usage block and adding the next above usage block’s number of bills to it.250 Ccf. 24. This quantity may be determined from data in columns 1 and 3 and is summarized in column 6. and 3 Ccf. In the example. The value in column 5 for a given usage block represents the cumulative billed usage of all bills with monthly usage less than or equal to the usage represented by the usage block. the total quantity of water used at a particular usage block needs to be determined. total bills represent the summation of bills issued to residential-class customers with 5/8-in.951 Ccf in total water use.APPENDIX A 69 accuracy of revenue generated by the bill tabulation. The number of bills issued for water usage corresponding to the various consumption blocks is shown in column 2. 24. For example.317 bills were issued to the group of customers having a monthly usage of 3 Ccf.

050. Application of existing rates to the cumulative usage in each rate block as determined from the bill tabulation would result in the indicated “bill-tabulation” revenue under existing rates.229 Ccf less 510. A correlation of bill-tabulation revenue to actual billed revenue of 3 percent or less generally indicates that the bill tabulation is sufficiently accurate for rate-design purposes. precaution must be taken to avoid multiple counting of minimum usage in computing revenues. Once the bill tabulation has been completed for all customer classes. To construct the curve representing cumulative usage for the hypothetical residential class shown in Figure A-3. or 540. as determined from bill tabulation. In designing rates for future study periods. Construction of a curve for the hypothetical residential customer class is shown in Figure A-4. which is related to existing volumerelated charges. cumulative usage curves may be derived from the bill analysis. the usage between 3 Ccf and 10 Ccf). the cumulative usage corresponding to the smaller block would be subtracted from the cumulative usage of the larger block. the usage pattern from the bill tabulation may be applied to projected water usage of various classes to determine estimated water usage applicable to each rate block. the cumulative usage (shown in column 7 of Figure A-3) for each existing rate block would be determined. Application of Bill Tabulation for Rate Design The bill analysis. Applying existing service charges to the number of bills by meter size and adding the volume-charge revenue produced from the bill tabulation would yield the total bill-tabulation revenue under existing rates.198 Ccf. is generally considered to remain relatively stable over a period of several years. provides a useful tool for rate design. and a line is drawn through all plotted points. if a proposed rate block is chosen at a monthly usage of 3 Ccf. To aid in the selection of the proposed rate blocks. from the curve it is determined that approximately 40 percent of the total water use of customers in this class for this meter size would be expected to be billed in the 0–3 Ccf block.70 WATER RATES Total cumulative usage for the 5/8-in. The resulting curve may then be used to determine an estimate of the cumulative percent of future water usage that will occur at a given usage level. This revenue figure can then be compared with the billed revenue recorded by the utility to test the accuracy of the bill tabulation. Where initial charges in the form of a minimum bill are utilized. 1. once verified for accuracy. the cumulative billed percent usage figures from column 8 are plotted for each level of usage.031 Ccf. residential class is shown in column 7. To determine the usage at interim blocks (for example. the bill tabulation provides a means for selecting alternative rate blocks and the associated amount of water usage with the new blocks. the percentage of cumulative billed usage must be determined. Copyright (C) 1999 American Water Works Association All Rights Reserved . The cumulative usage figures in column 7 indicate the total usage that would be billed at any given usage block. For example. would be the use in a rate block of 4–10 Ccf. The curve is constructed on semilogarithmic graph paper with cumulative billed percent usage shown on the vertical linear axis and monthly usage levels shown on the horizontal logarithmic axis. The usage pattern of each class of customers. Column 8 of Figure A-3 presents the percent of cumulative billed usage for each usage block and is determined by dividing the cumulative billed usage for each block in column 7 by the total cumulative usage times 100. If it becomes necessary to change existing blocks in order to more equitably recover allocated costs of service from the various customer classes. To construct the necessary curves. In this example.

APPENDIX A 71 Copyright (C) 1999 American Water Works Association All Rights Reserved .

Copyright (C) 1999 American Water Works Association All Rights Reserved . In order to add cumulative billed usages for each meter size. A more complete discussion of the use of curves in rate design is included in chapter 4. In some instances. It is generally useful to plot all customer-class curves on the same graph as an aid in the selection of proposed rate blocks for rate design. it may be more desirable to determine the cumulative billed usage and graph the curve for the combination of all meter sizes in each class. Trial rate blocks may be chosen that effectively separate the majority of the usage for each class into one or more rate blocks simply by visual inspection of the family of customer-class curves. The value determined from the summation would represent the cumulative billed usage of all customers in the class and would be used to calculate cumulative billed usage percentages and. This may be accomplished simply by adding together the cumulative billed usages (similar to those shown in column 7 of Figure A-3) determined for each meter size in a class for each respective usage block. to graph the customer-class curve.72 WATER RATES Similar curves can be developed for each customer class and meter size. subsequently. the usage blocks established for each meter size must be exactly the same.

and customer costs. cash-needs approach The method of determining annual operating revenue requirements based on all cash needs. class. bill frequency analysis A tabulation and summarization of customer bills and usages showing the number of bills rendered at various levels of water usage during a specified period of time. commodity–demand rate A multiple-part rate containing both fixed and variable components. The fixed portion is generally based on the customer’s peak demand requirements. and transmission and distribution facilities. and capital expenditures from current revenues. bond covenants Terms of obligations incurred as conditions of the issuance of bonds. capital expenditures Expenditures that result in the acquisition of or addition of fixed assets. 73 Copyright (C) 1999 American Water Works Association All Rights Reserved . base costs Costs that tend to vary with the total quantity of water used and operation under average load conditions. Purchased water costs. it may also include customer charges (billing. bonded debt Indebtedness represented by outstanding bonds. the amount of water produced. quality.) for a customer. and capital costs related to plant investment associated with serving customers at a constant. day. commodity costs (variable costs) Costs that tend to vary with the quantity of water produced. extra capacity. including but not limited to. pumping. if the water is purchased on a unit volume basis without minimum charges or any associated demand charges. etc. and other service needs of the various customers or classes of customers served by the utility. annual rate of use (100 percent load factor). generally requiring the fixed portion (or a percentage of it) to be paid independent of volume of water usage. base–extra capacity The method of cost allocation in which the costs of service are classified to the functional cost components of base. etc. capacity factor Ratio of peak rate of demand to the average rate of demand over a specified period of time (hour. debt service. operation and maintenance expense. while the variable portion is based on the volume of water usage. may also be considered as commodity costs. including the costs of chemicals. It is generally greater than 1. capacity The ability of available water utility resources to meet the quantity. and other elements that follow.Glossary annual operating revenue requirement The total revenues required on an annual basis adequate to meet all expenses and capital requirements of the utility. or average. demand. Variable costs are allocated to the commodity component. with the balance of costs being allocated to the demand and customer components. Costs included are operation and maintenance expenses of supply. treatment. commodity–demand The method of cost allocation in which the cost of service is allocated to the functional cost components of commodity. a large part of power costs. peak loads. or system.). metering. or change almost directly with. and customer cost.

or equipment used to provide utility services to the public. and industrial for rate-making and other purposes. but not yet dedicated to service. facilities. irrespective of the amount of water use. Coverage may be expressed as a ratio or as a percentage. reflecting the ratio of the actual or projected net revenue available for debt service to debt service or other costs. improvement. and other such categories. and variable costs. or other factors that set them apart from other general customer classes and thus may require a separate class designation. debt An obligation resulting from the borrowing of money or from the purchase of goods and services. and maintenance and capital costs related to meters and associated services. and collecting expense. For specific utilities. universities. large industry. construction work in progress (CWIP) The utility’s investment in facilities under construction. It represents an addition or transfer to the capital of the utility. cost allocation The procedure for classifying or assigning the costs of service to functional cost components for subsequent distribution to respective customer classes. water utility customers may be classified as residential. and is used to offset the acquisition. Some water systems have individual customers (large users) with unique water-use characteristics. demandrelated costs. Copyright (C) 1999 American Water Works Association All Rights Reserved . contribution in aid of construction (CIAC) Any amount of money. Contributions are generally carried as equity capital on the balance sheets of government-owned utilities. the industrial class may be subdivided into small industry. This may include large hospitals. or construction costs of the utility’s property. including preferred stock dividends and lease payments. military establishments. The inclusion of CWIP in rate base varies from one agency to another. commercial. customer costs Costs directly associated with serving customers. customer classification The grouping of customers into homogeneous classes. to interest only. billing. This charge is often considered as a contribution of capital by the customer or other agency receiving the service. Typically. service requirements. there may be a breakdown of these general classes into more specific groups. such as customer billing costs. For example.74 WATER RATES connection charge The charge made by the utility to recover the cost of connecting the customer’s service line to the utility’s facilities. It includes amounts transferred from advances for construction representing any unrefunded balances of expired refund contracts or discounts resulting from termination of refund contracts. Such costs generally include meter reading. and special. debt-service requirement The amounts of money necessary to pay interest and principal requirements for a given series of years. coverage ratios The margin of safety ratios associated with bonded indebtedness and preferred stocks. or property received by a water utility from any person or governmental agency that is provided at no cost to the utility. These ratios range from debt-service coverage of principal and interest. costs of service The operating and capital costs incurred in meeting various aspects of providing water service. Contributions received from governmental agencies and others for relocation of water mains or other plant facilities are also included. wholesale service districts. to all fixed charges. accounting. services.

It provides for the recovery of a utility’s capital investment over the anticipated useful life of the depreciable assets. that occurs in the property due to wear and tear. and obsolescence. Depreciation is incurred in connection with the consumption or prospective retirement of plant facilities in the course of providing service. or an individual customer. and. based on the estimated loss in value of the facilities. expenditures Amounts paid or incurred for all purposes. earned surplus (or retained earnings). fire-protection charges Charges made to recover the cost of providing fireprotection service to the area served by the utility. expansion of the system. dividend payment Payment made by an investor-owned water utility to its shareholders. specific customer class or classes. action of the elements. consisting of capital stock. Copyright (C) 1999 American Water Works Association All Rights Reserved . Among the causes are wear and tear. firm service Dependable service in the amounts and at times as desired by the customer. including expenses. each successive block rate is applicable to a greater volume of water delivery than the preceding block(s). based on its earnings. equivalent meter-and-service ratio The ratio of the cost of investment in larger meters and services to those of a base meter size. equity The net worth of a business. demand patterns Profiles and characteristics of the demand requirements of the system. such as the 5⁄8-in. certain net worth reserves. duration. improvements. inadequacy. capital (or paid in) surplus. demand costs Costs associated with providing facilities to meet demands placed on the system by customers. Meter capacities may be used rather than investments. obsolescence. and amount of demand placed on the water production and delivery system. changes in technology. depreciation The loss in service value not restored by current maintenance as applied to depreciable plant facilities. indicating the frequency. and capital outlays. decay. not restored by current maintenance. inadequacy. occasionally. The funds resulting from depreciation are available for replacements. This depreciation is the result of causes known to be in current operation and against which the utility is not protected by insurance. The proper level of depreciation expense at any given time should be based on the costs of depreciable plant in service. depreciation rate The annual rate at which capital facilities are depreciated. Generally. provision for retirement of debt. meter typically used for residential customers. changes in demand. and requirements of public authorities. decay.GLOSSARY 75 declining-block rates A schedule of rates applicable to blocks of increasing usage in which the usage in each succeeding block is charged at a lower unit rate than in the previous blocks. or for repayment of the principal portion of outstanding debt. extra capacity costs Costs of capital and operation and maintenance associated with meeting rate-of-use requirements in excess of average rate-of-use requirements. They include capital-related costs associated with those facilities plus related operation and maintenance expenses.

these are usually the components of base. each successive block rate may be applicable to a greater volume of water delivery than the preceding block(s). payment in lieu of taxes A payment made to a governmental entity by the government-owned utility instead of taxes. they are the components of commodity. rate base The value of a water utility’s property used in computing an authorized return under the applicable laws and/or regulatory policies of the agency setting rates for the utility. and welfare. (2) allocation of costs to the functional components of the cost of service. Regulation may take the form of local or state jurisdiction. investor-owned water utility A utility owned by an individual. rate-making process The process of developing and establishing rates and charges. and (4) development and design of a schedule of rates and charges to recover the revenue requirements. lifeline rates Rates applicable to usage up to a specified level that are below the cost of service for the purpose of meeting the social goal of providing so-called minimum annual water requirements to qualified customers at a below-cost price. minimum bill A minimum charge to a customer that includes a fixed volume of water delivered to the customer during the applicable period of time. Copyright (C) 1999 American Water Works Association All Rights Reserved . and direct fire-protection costs. A government-owned water utility may be part of a municipal government operation. demand. extra capacity. customer. and direct fire-protection costs. off-peak rates Rates charged for usage during certain designated off-peak periods. safety. rate blocks Elements of a schedule of charges for specific usages within certain defined volume and/or demand boundaries.76 WATER RATES functional cost components The distinct operational components of a water utility to which separate cost groupings are typically assigned. The process is comprised of four phases: (1) determination of revenue requirements. In the commodity–demand method. or take such other form as is appropriate for its service area. Its primary purpose is to provide its designated service area with potable water in an adequate supply at reasonable costs so that people of the area may promote their health. marginal cost rates Rates based on the cost of providing the next unit of production. gross receipts tax Payments made to a government entity based on the gross revenues received by the water utility from its revenues. inverted block rates A schedule of rates applicable to blocks of increasing usage in which the usage in each succeeding block is charged at a higher unit rate than in the previous blocks. customer. (3) distribution of the function costs of service to customer classes. peak-load pricing rates A multiple-part rate structure in which charges vary and are based on the higher costs of providing water during the system peak periods of use and on the lower cost of providing water during the system off-peak periods. government-owned water utility A water utility created by state or other government-agency legislative action. In the base–extra capacity method of cost allocation. partnership. a county agency. a regional authority. corporation. or other qualified entity with the equity provided by shareholders. with the mandate that the purposes of the utility are public purposes and that its functions are essential governmental proprietary functions. Generally.

such as wells. supplies. test year The annualized period for which costs are to be analyzed and rates established. or sometimes as a percentage of annual operation and maintenance expense levels. reservoirs. higher rates may be charged during the summer months when a system peak occurs. standby service Service provided occasionally under certain defined conditions. Fire protection is another form of standby service. typically used during periods of peak use relative to use during off-peak periods.GLOSSARY 77 rate schedule Schedule of the rates and charges to the various customer classes and customers. unmetered or flat rate A fixed charge for unmetered service. etc. often simply based on the number of fixtures and water-using devices of the customer. uniform volume charge A single charge per unit of volume for all water used. return on rate base The percentage of earnings on the rate base. It is usually measured by the excess of current assets over the current liabilities. and other similar current assets necessary in the operation of the enterprise. materials. For example. that has not been treated to produce potable water. unit cost The cost of producing a unit of a product or service. such as thousand gallons. seasonal rates Rates based on the cost of service variations with respect to system seasonal requirements. depreciation expense.. such as in the event of failure of the customer’s normal water supply system. utility approach The method of determining annual operating revenue requirements. wholesale service customers Service in which water is sold to a customer at one or more major points of delivery for resale within the wholesale customer’s service area. working capital Cash. monthly bill. seasonal excess-use charges Charges for usage above pre-established levels. hundred cubic feet. treated water Water that has been obtained from supply sources and treated to produce potable water. and return on rate base. raw water Water that is obtained directly from the supply sources. rivers. etc. Copyright (C) 1999 American Water Works Association All Rights Reserved . An example would be the cost of treating a thousand gallons of potable water for use by the water utility’s customers. million gallons per day. which requires facilities not needed to meet lower winter loads. unit of service An element of service for which a cost can be ascertained. self-sustaining water enterprise A water utility operating without subsidies given to or received from non-water utility operations. service charge A fixed charge usually designed to recover customer costs. which includes operation and maintenance expense.

30–31. refers to a table. 12 extra capacity costs. 71f. 15t. 55 special considerations. Air conditioning and refrigeration. 11 O&M allocation. 9 firm water service. 30–31. 64. 10–11. 68f. 28–30. 65f. 10–11. 23–26 Cost distribution to customer classes base–extra capacity method. 40–44. 2 Cash-needs approach debt-service requirements. Commodity–demand rates. 67 and rate design. 2 City limits service outside. 26–28 Cumulative billed usage. 17t. 1 Cash-needs approach O&M expense. 19 pressure zones. direct fire-protection costs. customer costs. 19 nonfirm service. Block-rate design. 14 Base costs. rate design for. 10–11 base costs. 64. 64–67 billing records. 45–46 cost components. 16. 57t. 11–16 commodity–demand method. 45–46 unit costs of service. 45–46 commodity costs. 30t. 71f. 19 inside-city and outside-city users. 16 in small utilities. 16–19. 18t. 67–70. 11–12 depreciation allocation. See Bill tabulation Billing records. and meter size. Bill-frequency distribution analysis. 13. 12–14. 11 and commodity–demand method. 22 AWWA Water Rates and Charges Subcommittee. 51–52 Construction work costs. 64. 16. units of service. 67–70. 11 Base–extra capacity method. 10 Capital expenditures and cash-needs approach. 16 Commodity–demand method. 10 functional-cost method. 12 and rate design. 11–12. 57–59. Customer costs. 27t. customer costs. 23–26 79 Copyright (C) 1999 American Water Works Association All Rights Reserved . 10 and customer needs. 14 Cost allocation base–extra capacity method. 45–46 unit costs of service. 30t. 14. 16 demand costs. See also Rate blocks Capital costs. 22–23 Commercial customers. 66f. O&M allocation. 28–30. 25. 10–11 Cost components related to customer classes. 16 depreciation allocation. 63–64 bill summarization. rate base. rate base. 16. units of service. 19 unit costs. 26t. 9 reserve capacity. following a page number refers to a figure. 14. 16–19 and costs of service. cumulative billed usage. 18t. See also Service charges Customers air conditioning and refrigeration. 29t. 16 cost components. 46 Base cost component. 65f. 70. 29t. 49 Connection charges. 65f. 25. 13t. Bill tabulation. Costs of service components in base–extra capacity method. 64... 22 classes of related to cost components. direct fire-protection costs. 25t. 68f. 19 principal elements. 2 Cash-needs approach capital expenditures. 21 Commodity costs. 28t. 11 and extra capacity costs. 2 Cash-needs approach described. 10–11 and base–extra capacity method. 19 seasonal uses.. 11 and cost of allocation. 16 cost distribution to customer classes. 19 small utilities. 70–72 tabulation sheet. 32–33 and rates. 70. 58t. 34. 11 cost distribution to customer classes..Index NOTE: An f. commodity–demand method. 15t. a t. rate design for.

21 special classes. 35 Rates and costs of service. 49–50 minimum charge. 44. 36f. 41t. 34. 62 flat rates. allocation in commodity–demand method. 39t. 6 debt-service requirements. 18t. 51–52 and costs of service. 52 recovering costs related to volume and extra capacity. 25t. 55 Depreciation. 2 Declining-block rate schedules. 3. Copyright (C) 1999 American Water Works Association All Rights Reserved . 37–38. wholesale. Utility approach government-owned utilities. 34–35. 24 residential. 49 connection charges. See also Block-rate design and use costs. 21 differences among.. 38 Rate schedules declining-block. 12 allocation in base–extra capacity method. 14 General service rates. 33–34 Government-owned utilities capital improvements. See Small utilities uniform rate by customer class.80 WATER RATES commercial. 21 lawn irrigation. 16. 33–34 and income lag. 14 Extra capacity costs. 47 Rate design. 52 Residential customers. 23 projected revenue requirements.. 12. 8 taxes. 40–44 commodity–demand rates. 34 seasonal rates. 44. 1. 49 Operation and maintenance expense. 49 and record keeping. 20–21 distribution of costs to. 34–35. 21 industrial. 5t. 28–31 fire-protection. for small utilities. 51 marginal cost rates. 11 and base costs. 3 Lawn irrigation. 13t. 12–14. 5t. 21–22. 3–4 base–extra capacity method. 46–47 base–extra capacity and commodity– demand methods compared. 10–11 General plant costs. 24 general classes. 51 Marginal cost rates. 24 Minimum charge. See O&M expense Peak-load pricing. allocation in commodity–demand method. 43t. 43. 16 “Disappearing” charge. 48 service charges. 2 Off-peak rates. 4 Pumping facilities. 9 Record keeping and rate design. 11 Fire-protection costs small utilities. 34. 13. 47 single-rate. 47–48 units of service. Industrial customers. 33 for fire-protection service. 44. 44. O&M expense.. 15t. 14. 39–40. 10. 35–37. See also Cash-needs approach. 21 Inverted-block rates. water use by classes. 4 utility approach to revenue requirements. 51 general service rates. 38 inverted-block rates. and cash-needs approach. Rate blocks. 34–37 recovering customer costs. 37–38. 21 Debt-service requirements and cash-needs approach. 49 peak-load pricing. 62 Flat rates. 21–22. 12 Revenue requirements. 12 allocation in base–extra capacity method. 49 Prospective rates. 47–48 uniform rates. 3. 22 meter-and-service costs. 34 Excess use. 16–19. 47 Demand costs. 8. 21 Return. 51 and user conservation. 56f. and water meters. 17t. 55. 6 O&M expense.. 18t. Direct fire-protection costs. 45–46 block rates. 48 Extra capacity component. 32–33 “disappearing” charge. 57–59 Fire-protection service. 15t. 24 rate design for. 13 Rate base. 45t. 38 for wholesale service. commodity–demand method. 50 Investor-owned utilities projected revenue requirements. 16. 26t. 41–42. 51 Functional-cost method. 14. off-peak rates. 6 and outside-city customers. 16 small utilities. 50 lifeline rates. 21–22 uniform rates by class. 45t. 49–50 Meter-and-service costs. 34 factors affecting. 22 Lifeline rates. ixf. 50–51 unmetered rates.

57t. rate design. Treatment facilities Uniform rates. 54 Revenues from nonrate sources. 27t. 59–60. Small utilities and commodity–demand method. 35–37. 60t. 39–40. 57t. 3 taxes. 3 rate base. 60. 54 service charges. 53–54. 51 Utility approach depreciation. 28t. commodity–demand method. 61t. 54 meter equivalents. Water use by customer classes. 36f. 59–60. 55 fire-protection costs. 62 information needed for rate design. 38 Copyright (C) 1999 American Water Works Association All Rights Reserved . unmetered rates. 57. 57–59. 59–60.. 58t. 6 revenue requirements. 58t. 3–4 return. 22–23 Service-charge design. 55 costs-of-service allocation. 60t. 55 demand costs. 5t. O&M allocation.. 56f. 61t. Units of service base–extra capacity method. prospective basis. 60–61. costs of service. 3 and investor-owned utilities. 47 in small utilities. 59–62 revenue requirements. customer costs. 25. plant value allocation. 6 Seasonal rates. 57–59 fire-protection rates. 57. 7t. 4 Water meters and rate design. 50–51 by customer class. Unmetered rates. 25. Wholesale service. 21 rates. 25t. 39t. 59–60 two-block rate design.INDEX 81 projected. 48 Service outside city limits. commodity–demand method. 60t. 47–48 Unit costs of service. 26–28 base–extra capacity method. single-block rate design. 4 small utilities. 57. 61–62 Test year. 26t.. 58t. 55.