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INTERNAL SERVICE FUNDS Internal charges (accruals) are costs reflected in the operating budgets that represent liabilities we are accumulating over time. These liabilities may not result in actual expenditures in the short term, but will result in future expenditures for the future replacement of equipment we are now using (similar to charges for depreciation). They also include accruals for renovations of parks and facilities that are aging as we use them and employee costs that are accruing now but will be paid out later, such as unused vacation and benefits. In accordance with the City's adopted financial policies and the City's General Plan, the City recognizes costs as they accrue, and sets money aside to fund the future expenditures, rather than allowing these costs to accumulate and become a burden on future generations. An adjustment was necessary in the LPFD Retiree Medical Reserve Fund because certain Fire Management and Fire Miscellaneous retirees had their medical premiums paid from the Retiree Medical Reserve Fund rather than the LPFD Retiree Medical Reserve Fund. To correct this for 2006-07 expenditures of $110,657 were transferred into the LPFD Retiree Medical Reserve Fund from the Retiree Medical Reserve Fund. Consequently, the LPFD Medical Reserve Fund exceeded the budget by $101,710. By accepting the staff recommendation Council will be increasing the budget to match the expenditures. Replacement/Renovation Funds In accordance with its financial policies and the General Plan, the City maintains various Replacement/Renovation Funds. The purpose of these Funds is to provide ongoing replacement of City equipment, vehicles, traffic signals, and streetlights, and to make major repairs/ renovations to City facilities, parks, and medians, in order to extend their lives. Historically, the City has been able to use the Replacement Funds to help smooth out challenging budget periods that resulted primarily from economic factors and State impacts. This smoothing was accomplished by temporarily reducing annual contributions to the Funds in very lean years, and then making additional contributions in better years. Should the City again be impacted by a weak economy or State budget impacts, these Funds could be used as a temporary source to help maintain service levels until appropriate budget adjustments could be made. Obviously, these Funds are not adequate to sustain prolonged budgetary problems, but as part of the City's focus on long term financial sustainability, the Funds are a valuable tool in helping smooth the highs and lows of economic cycles over time. As of June 30, 2007, actual revenue to these Funds exceeded the budget in all cases due to interest earnings exceeding budget. Expenditures, on the other hand, continue to occur slower than expected. Therefore, staff is recommending that the budget for many of the expenditures planned for FY 2006-07 be carried over to FY 2007-08. Page 8 of 10