Guidelines for Ring-Fencing in MPCs with Water Operations

Legal basis and related authorities

Republic Act No. 9520 (Philippine Cooperative Code of 2008) requires a monitoring and evaluation tool for cooperatives to conduct self-assessments of managerial, financial, and social objectives.
Republic Act No. 9520 and its Implementing Rules and Regulations (IRR) require that new and existing cooperatives transformed into multi-purpose cooperatives (MPCs) maintain separate books of accounts for each business activity.
Memorandum Circular (MC) No. 2009-04 prescribes the Standard Chart of Accounts (SCA) for all cooperatives.
MC No. 2009-04 further requires that for cooperatives with multi-business activities, separate financial reports be prepared for each type of activity.
The ring-fencing approach is adopted as a tool to segregate the operations of a specific business activity—such as the Water Service Unit—from the MPC’s general accounts.
The CDA’s preparation activities and earlier adoption efforts are anchored on orientation and training conducted in 2008 and pilot-testing in 2008-2009 with three MPCs, with outputs used to develop ring-fencing guidance.

Policy intent and purpose

The Guidelines promote ring-fencing as an essential step to improve the performance of water service operations and to pursue utility reform.
The Guidelines aim to segregate water utility operations from the MPC’s general system of accounts for improved accounting accuracy.
The Guidelines establish a basis for monitoring and supervision of water service operations using ring-fenced accounts and reports.
The ultimate goal is to enable the water utility unit to operate as a self-sustaining unit within the MPC or as a subsidiary cooperative with a separate legal entity or charter.

Definitions and core concept

Ring-fencing is the segregation of:
- activities,
- assets and liabilities, and
- revenues and costs
  generated by a specific economic undertaking from the general business of the MPC.
Ring-fencing isolates water supply operations as an autonomous enterprise from other MPC business activities.
Ring-fencing requires that funds set aside for the water supply enterprise are not spent on anything else, and that revenues generated from it are invested back for its operations.
Ring-fencing requires separation of financial accounts through the use of a subsidiary accounting system.
The ultimate objective is autonomy of operations without changing the MPC’s legal personality, or through a spin-off into a subsidiary cooperative with separate legal entity or charter.

Scope and coverage of application

The Guidelines apply to the segregation (ring-fencing), accounting, and financial reporting of water service operations of multi-purpose cooperatives duly registered with the CDA.
The Guidelines target the separation of water utility operations from the MPC’s general system of accounts.
The segregation approach is used to create uniformity and common understanding of water utility accounts.
The Guidelines facilitate analysis and evaluation of financial management performance and support monitoring and supervision of water service operations.

Objectives and benefits of ring-fencing

The Guidelines provide information on ring-fencing and guidelines for adoption in separating water utility operations from general accounts.
The Guidelines introduce new accounts for MPCs with water supply operations to ensure uniformity and common understanding of water utility accounts.
The Guidelines enable generation of financial information that can be used for:
- resource allocation,
- management and operational changes and improvements, and
- setting tariffs.
Ring-fencing results in more accurate financial information and supports more sustainable water supply services for cooperative members and the served community.
Ring-fencing enables generation of reliable financial reports showing the true performance of the water utility.
Ring-fencing provides a mechanism to capture all expenses related to water supply provision, including expenses currently not included in water service financial reports because of centralized operations.
Ring-fencing supports engagement in private sector participation and/or public private partnerships to operate and manage part or all of the water utility operations.
Ring-fencing can support conversion of the water utility into a subsidiary cooperative.
Ring-fenced financial statements provide accurate inputs in reviewing the adequacy of tariff.
Ring-fencing facilitates better monitoring/tracking of the financial performance of water service operations, including:
- more efficient control of water service expenses,
- gauging and monitoring staff performance and improving accountability,
- increasing collection efficiency through greater transparency, and
- determining investment needs with more precision.

Adoption framework and operational phases

The ring-fencing framework and process are elaborated in the “Ring-fencing Manual Guide for Multi-Purpose Cooperatives with Water Services Operations.”
The ring-fencing system must conform with:
- Republic Act No. 9520 and CDA rules and regulations,
- Philippine Financial Reporting Standards (PFRS),
- and other government policies and guidelines.
The development of the financial system for ring-fencing is divided into two phases:
- Phase 1: preparatory activities and reconstruction of water utility accounts still forming part of the MPC’s general accounting records.
- Phase 2: operations are viable and sustainable with its own budget, separate financial accounting and reporting system, and even a separate bank account.
When financial reporting becomes autonomous, ring-fencing becomes automatically effective (i.e., no longer requires separate ring-fencing workarounds because it becomes part of autonomous reporting).

Step-by-step ring-fencing process

Step 1: Affirmation of commitment
- The MPC’s ring-fencing implementation starts with a Board Resolution of the Board of Directors (BOD) to effect separation.
Step 2: Account reconstruction
- Beginning balances for the water service unit financial statements must be established using the full cost method.
Step 3: Interim accounting procedures
- Revenues must be based on the total amount of bills issued using an accrual method.
- All costs and expenses incurred by other operating units of the MPC related to water service provision must be captured through interim accounting procedures.
- A system for obtaining the cost of services from related operating units must be implemented.
- A separate set of books of accounts must be maintained.
- Ring-fenced financial statements of the water utility must be prepared.
Step 4: Bank account and other activities
- A separate bank account must be established for the water utility for depositing collections and paying disbursements.
- A full budget for the following year for ring-fenced operations must be prepared adopting full cost accounting.
Step 5: Preparation, adoption, and implementation of ring-fencing financial management guidelines
- The adoption institutionalizes the ring-fencing system and enforces maintenance of separate books of accounts and periodic preparation of ring-fenced financial reports.
- The utility business plan must then be prepared based on ring-fenced financial statements.
Step 6: Shift to a fully self-sustaining entity
- The MPC may spin-off its water operations into a separate legal entity through General Assembly approval, subject to pertinent incorporation laws, when the water operation has:
  - dedicated staff members or assigned shared staff,
  - a separate financial and accounting system,
  - a full cost budget considering all costs of operating and running the water utility, and
  - fiscal autonomy to utilize funds for system expansion and improvement.
Once financial reporting of the water utility’s operations is autonomous, the operations are treated as automatically ring-fenced.

Ring-fencing chart of accounts for water operations

The ring-fenced financial management system generally follows the CDA Standard Chart of Accounts (SCA) for all cooperatives.
For accounts peculiar and exclusive to water service cooperatives, account titles and descriptions may be customized to fit water supply services.
The following water-specific/customized accounts are used:
- 14150 — Water Utility Plant
  - Records the cost of property and equipment used for generating water utilities for operation and/or distribution to consumers.
- 14151 — Accumulated Depreciation-Water Utility Plant
  - Records total depreciation cost for utility plant set up periodically and charged against current operations.
- 17600 — Due from Branch/ Subsidiary
  - Records receivables from head office/branches/subsidiary.
- 24830 — Due to Head Office
  - Records inter-office transactions in the books of head office/branch/subsidiary and must be closed at the end of the accounting period.
- 24850 — Depreciation Reserve
  - Records funds provided by Public Fund Service Law, Section 16, set aside as depreciation reserve fund used only for improvements, new constructions, extensions, or additions to the water utility property.
- 24860 — Water Maintenance Fund
  - Records advance collections from customers to cover maintenance of water facilities from distribution lines up to the water meters.
- 40210 — Water Service Income
  - Records amounts collected for various services rendered.
- 40211 — Other Service Income
  - Records revenues arising from water service provision other than regular water consumption.
  - Requires a subsidiary ledger for each sub-account.

Capacity building, advocacy, and monitoring

Interested MPCs must signify commitment to adopt the approach with the CDA.
The CDA and the Polytechnic University of the Philippines College of Cooperatives can mobilize trainors/facilitators and ring-fencing teams of pilot cooperatives to provide assistance to MPCs adopting ring-fencing for water service operations.
The use of the “Guide to Ring-Fencing (Manual) for Multipurpose Cooperatives with Water Services” developed by the Philippine Water Revolving Fund–Support Program (PWRF-SP) is encouraged to guide adoption.
Templates of the BOD resolution developed under the program are available to facilitate institutionalization at the ground level.
The CDA, through its Extension Offices, must lead advocacy on ring-fencing, including promotion to MPCs.
The CDA must also monitor adoption of ring-fencing at the cooperative level.
All CDA Regional Directors must disseminate the Memorandum Circular to field personnel and partners—the Local Cooperative Development Officers (LCDOs) from LGUs within their areas of jurisdiction—and provide administrative and technical guidance as needed.

Sanctioning and enforcement

The Memorandum Circular establishes procedural and operational requirements for adoption through board resolution, accounting reconstruction, interim accounting procedures, bank account separation, budget preparation, and institutionalization through financial management guidelines, supported by CDA advocacy and monitoring.
The Memorandum Circular does not state specific monetary penalties, fines, or administrative sanctions for non-adoption or non-compliance.