I have received enquiries from several readers about the language in AB 240 (2013) regarding annual budgeting and review of financial records for mutual water companies in California. This post summarizes what we currently know about the topic, although some uncertainties remain.
AB 240 adopted new Corporations Code section 14306, which provides in part:
(a) The board of a mutual water company that operates a public water system shall adopt, in an open meeting, an annual budget on or before the start of each fiscal year of the mutual water company.
(b) The board of a mutual water company that operates a public water system shall contract with a certified public accountant or public accountant to conduct an annual review of the financial records and reports of the mutual water company. The review shall be subject to generally accepted accounting standards.
As a threshold matter, the accounting rules of section 14306 only apply to a mutual water company that operates a public water system, which is defined as “a system for the provision of water for human consumption through pipes or other constructed conveyances that has 15 or more service connections or regularly serves at least 25 individuals daily at least 60 days out of the year.” (Cal. Health & Safety Code § 116275(h).)
Section 14306 requires a mutual water company board to take two affirmative actions: the adoption of an annual budget; and the hiring of a certified public accountant or public accountant to conduct an annual review of the company’s financial records and reports. In addition, sections 14306(c) and 14307(a)(1)(B) and (C) require a company to provide copies of the annual budget and accounting report to any eligible person, subject to reimbursement of copying costs. (For the definition of who is an eligible person, see my earlier post on AB 240.)
We quickly encounter several uncertainties about the requirements of AB 240. First, while section 14306(b) expressly applies generally accepted accounting standards only to the annual review, it may be easier for the reviewing accountant to give a positive review if all financial records and reports, including the annual budget, are prepared according to the same standards. There would undoubtedly be additional expense associated with accounting in accordance with those standards, when compared to the more informal accounting followed by many small water companies, and some companies may prefer to follow their historical accounting practices as much as possible for that reason. How a company proceeds on this question likely depends on the advice of its accountant.
Second, while AB 240 refers to “generally accepted accounting standards,” that term is likely to be conflated with generally accepted accounting principles (GAAP). GAAP is a set of accounting standards adopted by the Financial Accounting Standards Board (FASB) for entities based in the US. GAAP are generally used as the standard for correct accounting practices in the US. They are required of publicly traded corporations according to regulations of the federal Securities and Exchange Commission (SEC). They can be relatively onerous for smaller business and nonprofit enterprises, however, and many organizations do not follow GAAP fully. Starting in 2009, GAAP has been codified in the FASB Accounting Standards Codification, a free version of which is available online (although for most of us, we would be better off not even attempting to interpret the standards).
It should be noted that GAAP itself is not a permanent standard. In 2008, the SEC issued a proposed rule that would lead to the use by US companies of financial statements prepared in accordance with the International Financial Reporting Standards as issued by the International Accounting Standards Board in London, rather than GAAP. That transition is still pending, and is expected to take a number of years to trickle down from publicly traded corporations to smaller corporations and governmental entities.
Third, there is some uncertainty regarding the meaning of the term “annual review.” That term has a specific meaning within the accounting profession, but it is unknown whether the California Legislature intended to use the term in that manner. In the absence of any information to the contrary, however, it is likely that the term would be interpreted according to its normal usage by a certified public accountant or public accountant, since those are the professionals who would carry out the annual review. Some information on what constitutes an accounting review, when compared to a compilation or an audit, may be found on this brochure prepared by the American Institute of Certified Public Accountants or by consulting your accountant.
If you or your mutual water company has a question about AB 240, please contact me below or by email.
Hello we are a Mutual Water Company originally established as for profit.
How do we change our status to a non profit?
There are two separate issues. First, there is the type of corporation organized under California law. A mutual may be organized as either a general corporation or a nonprofit mutual benefit corporation. To make the conversion is a relatively straightforward process with the California Secretary of State, and I have done that for several clients.
Second, there is the tax exemption under both federal and state laws. The exemption is not necessarily tied to the type of organization of the mutual, i.e., a general corporation may be tax-exempt, and a nonprofit mutual benefit corporation may not quality as tax-exempt. There are a number of rules regarding the exemption for mutual water companies, based on their organization and operations. I am not a tax attorney, but have worked with other attorneys in my firm to secure that exemption in the past.
Feel free to reach out directly with any specific questions.
Can an Enrolled Agent who has reviewed and used the water company financial records to prepare and file income tax returns also perform the annual financial review?
California Corporations Code section 14306(b), adopted as part of AB 240 (2013), requires that the annual financial review be performed by a certified public accountant or public accountant. CPAs and PAs are licensed by the California Board of Accountancy under state laws contained in the California Business and Professions Code sections 5000 et seq. Enrolled agents are credentialed by the US Internal Revenue Service for the sole purpose of representing taxpayers before that agency. Thus, a person may be an enrolled agent without being a CPA or PA under California law, and vice versa. A single person may have both credentials, but you should check with the individual professional.
If your mutual water company secretary/accountant is refusing to allow anyone to look at the financial records, is there a recourse, besides a lawyer, the share holders can take?
The short answer is no, there is no authority who can enforce shareholder inspection rights other than a court. Under the new Mutual Water Company Open Meeting Act, a shareholder may send a demand letter to the company board of directors, which then has 30 days to respond. If the shareholder is not satisfied with the response, he or she may file a civil action seeking an injunction requiring the company to comply with the Act. If the shareholder is deemed to have prevailed in the civil action, the court may award attorney fees and costs to the shareholder, but a mutual water company will not recover any costs unless the court finds that the lawsuit was frivolous, unreasonable or without foundation. Thus, there is some assistance for a shareholder who believes a company is not complying with the law, but does not have the funds to pay for litigation.
There would undoubtedly be additional expense associated with accounting in accordance with those standards, when compared to the more informal accounting followed by many small water companies, and some companies may prefer to follow their historical accounting practices as much as possible for that reason. How a company proceeds on this question likely depends on the advice of its accountant.