City of Mercer Island

Washington State Auditor’s Office

Financial Statements Audit Report

City of Mercer Island King County

Audit Period January 1, 2006 through December 31, 2006

Report No. 73721

Issue Date December 24, 2007

Washington State Auditor Brian Sonntag

December 24, 2007 Council City of Mercer Island Mercer Island, Washington Report on Financial Statements Please find attached our report on the City of Mercer Island’s financial statements. We are issuing this report in order to provide information on the City’s financial condition. In addition to this work, we look at other areas of our audit client’s operations for compliance with state laws and regulations. The results of that audit will be included in a separately issued accountability report. Sincerely,

BRIAN SONNTAG, CGFM STATE AUDITOR

Insurance Building, P.O. Box 40021 Olympia, Washington 98504-0021 (360) 902-0370 (866) 902-3900 TDD Relay (800) 833-6388 FAX (360) 753-0646 http://www.sao.wa.gov

Insurance Building, P.O. Box 40021 Olympia, Washington 98504-0021 (360) 902-0370 TDD Relay (800) 833-6388 FAX (360) 753-0646 http://www.sao.wa.gov

Table of Contents


January 1, 2006 through December 31, 2006

Independent Auditor’s Report on Internal Control over Financial Reporting and on Compliance and Other Matters in Accordance with Government Auditing Standards ........................................ 1

Independent Auditor’s Report on Financial Statements ............................................................................... 3 Financial Section........................................................................................................................................... 5

Independent Auditor’s Report on Internal Control over Financial Reporting and on

Compliance and Other Matters in Accordance with Government Auditing Standards

City of Mercer Island

King County January 1, 2006 through December 31, 2006

Council City of Mercer Island Mercer Island, Washington We have audited the financial statements of the governmental activities, the business-type activities, each major fund and the aggregate remaining fund information of the City of Mercer Island, King County, Washington, as of and for the year ended December 31, 2006, which collectively comprise the City‘s basic financial statements, and have issued our report thereon dated October 16, 2007. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to the financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. INTERNAL CONTROL OVER FINANCIAL REPORTING In planning and performing our audit, we considered the City’s internal control over financial reporting as a basis for designing our auditing procedures for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the City’s internal control over financial reporting. Accordingly, we do not express an opinion on the effectiveness of the City’s internal control over financial reporting. A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the City's ability to initiate, authorize, record, process or report financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the City's financial statements that is more than inconsequential will not be prevented or detected by the City's internal control. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected by the entity’s internal control. Our consideration of internal control over financial reporting was for the limited purpose described in the first paragraph of this section and would not necessarily identify all deficiencies in internal control that might be significant deficiencies or material weaknesses. We did not identify any deficiencies in internal control over financial reporting that we consider to be material weaknesses, as defined above.

____________________________________________________________________________________________________________Washington State Auditor's Office

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COMPLIANCE AND OTHER MATTERS As part of obtaining reasonable assurance about whether the City’s financial statements are free of material misstatement, we performed tests of the City’s compliance with certain provisions of laws, regulations, contracts and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. This report is intended for the information and use of management and the Council. However, this report is a matter of public record and its distribution is not limited. It also serves to disseminate information to the public as a reporting tool to help citizens assess government operations.

BRIAN SONNTAG, CGFM STATE AUDITOR October 16, 2007


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Independent Auditor’s Report on Financial Statements

City of Mercer Island

King County January 1, 2006 through December 31, 2006

Council City of Mercer Island Mercer Island, Washington We have audited the accompanying financial statements of the governmental activities, the business-type activities, each major fund and the aggregate remaining fund information of the City of Mercer Island, King County, Washington, as of and for the year ended December 31, 2006, which collectively comprise the City’s basic financial statements as listed on page 5. These financial statements are the responsibility of the City’s management. Our responsibility is to express opinions on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinions. In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities, the business-type activities, each major fund and the aggregate remaining fund information of the City of Mercer Island, as of December 31, 2006, and the respective changes in financial position and, where applicable, cash flows thereof for the year then ended in conformity with accounting principles generally accepted in the United States of America. In accordance with Government Auditing Standards, we have also issued our report on our consideration of the City’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit. The management’s discussion and analysis on pages 6 through 14 and the budgetary comparison information on pages 48 through 49 are not a required part of the basic financial statements but are supplementary information required by the Governmental Accounting Standards Board. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods


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of measurement and presentation of the required supplementary information. However, we did not audit the information and express no opinion on it.

BRIAN SONNTAG, CGFM STATE AUDITOR October 16, 2007


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Financial Section


January 1, 2006 through December 31, 2006 REQUIRED SUPPLEMENTAL INFORMATION Management’s Discussion and Analysis – 2006

BASIC FINANCIAL STATEMENTS

Statement of Net Assets – 2006 Statement of Activities – 2006 Balance Sheet – Governmental Funds – 2006 Statement of Revenues, Expenditures and Changes in Fund Balance – Governmental Funds –

2006 Reconciliation of Governmental Funds Statement of Revenues, Expenditures and Changes in

Fund Balance to the Statement of Activities – 2006 Statement of Net Assets – Proprietary Funds – 2006 Statement of Revenues, Expenses and Changes in Net Assets – Proprietary Funds – 2006 Statement of Cash Flows – Proprietary Funds – 2006 Statement of Net Assets – Fiduciary Funds – 2006 Statement of Changes in Fiduciary Net Assets – Fiduciary Funds – 2006 Notes to Financial Statements – 2006

REQUIRED SUPPLEMENTAL INFORMATION

Schedule of Revenues, Expenditures, and Changes in Fund Balances – Budget and Actual – General Fund – 2006

Schedule of Revenues, Expenditures, and Changes in Fund Balances – Budget and Actual Street Fund – 2006


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City of Mercer Island Management’s Discussion qnd Analysis For the Year Ended December 31, 2006

The discussion and analysis of the City of Mercer Island’s financial performance provides an overall review of the City’s financial activities for the year ended December 31, 2006. The intent of this discussion and analysis is to look at the City’s financial performance as a whole. We encourage readers to consider the information presented here in conjunction with the basic financial statements to enhance their understanding of the City’s financial performance. For comparison purposes year 2005 data is also included in the discussion. FINANCIAL HIGHLIGHTS Key financial highlights for 2006 are as follows:

• Overall, the City’s financial position improved in 2006.

• In total, net assets, the amount by which total assets exceed total liabilities, increased about $5.2 million. Most of that increase can be attributed to net income from operations in both the governmental and business type activities.

• Entity wide governmental fund balances at year end were $137,748,207, an increase of $2.6 million from

2005. Over half of the fund balances were in the capital projects funds, such as the Street Fund, for planned capital expenditures in future years.

• During 2006, the City redeemed $955,000 of General Obligation bonds and $171,749 of loans.

Outstanding General Obligation debt at year end was $5,205,000. OVERVIEW OF THE FINANCIAL STATEMENTS The city’s basic financial statements are presented in three parts: 1) government-wide financial statements, 2) fund financial statements, and 3) notes to the financial statements. These statements are organized so the reader can understand the City of Mercer Island as a financial whole or as an entire operating entity. The statements then proceed to provide an increasingly detailed look at specific financial conditions. This section of the management’s discussion and analysis is intended to introduce and explain the basic financial statements. The statement of Net Assets and Statement of Activities provide information about the activities of the whole City presenting both an aggregate view of the City’s finances and a longer-term view of those assets. Major fund financial statements provide the next level of detail. For governmental funds, these statements tell how services were financed in the short-term as well as what dollars remain for future spending. The fund financial statements also look at the City’s most significant funds with all other non-major funds presented in total in one column. Reporting the City of Mercer Island as a Whole – The Statement of Net Assets and the Statement of Activities. The view of the City as a whole looks at all financial transactions and asks the question, “How did we do financially during 2006?” The Statement of Net Assets and the Statement of Activities answer this question. These statements include all assets and liabilities using the accrual basis of accounting similar to the accounting used by the private sector companies. The accrual basis takes into account all of the current year’s revenues and expenses regardless of when the cash is received or paid. These two statements report the City’s net assets and changes in those assets. This change in assets is important because it tells the reader whether, for the City as a whole, the financial position of the City has improved or diminished. However, in evaluating the overall position of the City, non-financial information such as changes in the City’s tax base and the condition of the City’s capital assets will also need to be evaluated. In the Statement of Net Assets and the Statement of Activities, we divide the City into two kinds of activities:

• Governmental Activities—Most of the City’s basic services are reported here, including police, fire, facilities, parks, planning, engineering and general administration. Taxes (Property, Sales, and Utility) and charges for services finance most of these activities.

• Business-type activities—The City charges a fee to customers to help it cover all or most of the costs of

certain services it provides. The City charges fees to recoup the cost of the operations of our Water, Sewer, and Storm Water utilities as well as all capital expenses associated with each utility.


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Reporting the City of Mercer Island’s Most Significant Funds - Fund Financial Statements The City has established many funds which account for the multitude of services provided to our residents. The Fund Financial Statements focus on the city’s most significant funds and provide detail on each of these major funds. In the case of the City of Mercer Island, our major funds are the General Fund, Street Fund, Capital Improvement Fund, Capital Reserve Fund, and the Community Center Construction Fund. All other funds are summarized together and included as only one column in the statements.

• Governmental funds—Most of the City’s basic services are reported in governmental funds. The primary focus of governmental funds is how money flows into and out of the fund and the balances left at year-end that are available for spending in future periods. Governmental funds are reported using an accounting method called modified accrual accounting, which measures cash and all other financial assets that can readily be converted to cash. The governmental fund statements provide a detailed short-term view of the City’s general government operations and the basic services it provides. Governmental fund information helps you determine whether there are more or less financial resources that can be spent in the near future on services to our residents. The relationship (or differences) between governmental activities (reported in the Statement of Net Assets and the Statement of Activities) and governmental funds is reconciled in the fund financial statements.

• Proprietary funds—When the City charges customers for the services it provides, these services are

generally reported in proprietary funds. Proprietary funds use the same basis of accounting as business type activities; therefore, the entity wide statements and the fund statements will essentially match. We use internal service funds (the other component of proprietary funds) to report activities that provide supplies and services internally for the City’s other programs and activities. The Equipment Rental and Computer Equipment Funds are both Internal Service Funds of the City. Both Internal Service Funds predominantly benefit governmental rather than business type functions and are thus included within governmental activities in the government-wide financial statements.

• Fiduciary Funds – Assets held by the City in a trustee capacity are accounted for in fiduciary funds.

Fiduciary funds are not included in the government wide financial statements because their assets are not available to support City activities. The City has two types of fiduciary funds, a pension trust fund and an agency fund. All of the City’s fiduciary activities are reported in separate Statements of Fiduciary Net Assets.

Notes to the Financial Statements The notes to the financial statements provide additional information that is essential to a full understanding of the data in the government-wide and fund financial statements. The notes are located immediately following the Basic Financial statements.


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THE CITY OF MERCER ISLAND GOVERNMENT-WIDE FINANCIAL ANALYSIS Net Assets of the City as of Dec. 31, 2005 and Dec.31, 2006 are summarized and analyzed below.

Change2006 2005 2006 2005 2006 2005

Assets

Current and Other Assets $23,274,587 $23,437,929 $11,661,308 $8,777,657 $34,935,895 $32,215,586 $2,720,309Capital Assets, Net of Accumulated Depreciation 123,422,014 121,468,605 24,727,716 24,476,402 148,149,730 145,945,007 2,204,723 Total Assets 146,696,601 144,906,534 36,389,024 33,254,059 183,085,625 178,160,593 4,925,032

Liabilities

Long-Term Debt 6,352,736 7,297,952 1,011,624 663,448 7,364,360 7,961,400 (597,040) Other Liabilities 2,595,658 2,466,461 725,639 508,078 3,321,297 2,974,539 346,758 Total Liabilities 8,948,394 9,764,413 1,737,263 1,171,526 10,685,657 10,935,939 (250,282)

Net assets:

Invested in Capital 118,253,266 115,347,282 23,813,311 24,476,402 142,066,577 139,823,684 2,242,893 Assets Net of Debt Restricted 6,615,350 7,603,669 0 0 6,615,350 7,603,669 (988,319) Unrestricted (deficit) 12,879,591 12,191,171 10,838,450 7,606,131 23,718,041 19,797,302 3,920,739 Total Net Assets $137,748,207 $135,142,122 $34,651,761 $32,082,533 $172,399,968 $167,224,655 $5,175,313

Table 1 - Net Assets

Governmental Activities Business-Type Activities Total

The largest component of the City’s total net assets at $142,066,577, or 82%, is its investment in capital assets less any related outstanding debt. This is an increase of 10% from 2005. These capital assets, such as streets, trails, parks, buildings, and utility infrastructure, are used to provide services to the citizens. Consequently, these assets are not available to sell and convert to cash for future spending. Approximately 4% of the governmental net assets are shown as restricted – meaning they have been set aside for specific purposes including payment of debt service, capital improvements, and construction. These restricted assets decreased from 2005, reflecting the use of funds previously restricted for the construction of a new Community Center. The remaining category of net assets is unrestricted funds at approximately 14% of total net assets. These assets are divided between governmental and business type activities and also represent funds available for capital projects planned for the future. The total unrestricted net assets amount to $23,718,041, an increase of 17% from 2005. The majority of that increase was in the Business Type Funds. City of Mercer Island Change in Net Assets The changes in net assets table on the following page illustrates the increases or decreases in net assets of the City resulting from its operating activities. Overall, the City of Mercer Island’s net assets increased about $5.2 million in 2006 resulting in an improvement of financial position. A breakdown of this increase by governmental and business-type activities follows along with a description of some of the major revenue sources and expense categories.


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Revenues: 2006 2005 2006 2005 2006 2005 Program Revenues Charges for services $5,070,008 $4,318,154 $9,904,863 $9,559,954 $14,974,871 $13,878,108 Operating grants and contributions 932,694 878,514 932,694 878,514 Capital grants and contributions 100,977 727,955 100,977 727,955 General Revenues Property taxes 9,476,037 9,219,222 9,476,037 9,219,222 Sales taxes 3,133,199 3,113,670 3,133,199 3,113,670 B&O taxes 3,210,074 3,198,748 3,210,074 3,198,748 Real estate excise taxes 2,776,372 3,708,656 2,776,372 3,708,656 Other taxes 867,748 835,144 867,748 835,144 Investment earnings 1,029,971 708,772 431,297 264,170 1,461,268 972,942 Total revenues 26,597,080 26,708,835 10,336,160 9,824,124 36,933,240 36,532,959

Expenses: General Government 1,257,250 2,133,108 1,257,250 2,133,108 Judicial 268,617 286,145 268,617 286,145 Public Safety 10,768,344 10,012,825 10,768,344 10,012,825 Physical Environment 95,483 80,534 95,483 80,534 Transportation 1,486,161 1,189,390 1,486,161 1,189,390 Human Services 2,123,132 1,389,256 2,123,132 1,389,256 Economic Environment 3,348,069 1,942,421 3,348,069 1,942,421 Culture and Recreation 3,510,031 3,907,603 3,510,031 3,907,603 Interest on Long Term Debt 201,256 241,446 3,987 3,211 205,243 244,657 Water 0 0 4,147,074 3,796,351 4,147,074 3,796,351 Sewer 0 0 4,330,838 4,060,449 4,330,838 4,060,449 Stormwater 0 0 1,062,975 1,002,888 1,062,975 1,002,888 Total expenses 23,058,343 21,182,728 9,544,874 8,862,899 32,603,217 30,045,627

Increase in net assets before transfers,special and extraordinary items 3,538,737 5,526,107 791,286 961,225 4,330,023 6,487,332

Other General Financing Sources 206,576 0 0 0 206,576 Disposition of capital assets (2,603) 6,000 0 0 (2,603) 6,000 Permanent fund contributions 25,000 0 0 0 25,000 Transfers (1,777,939) 2,260 1,777,939 (2,260) 0 0 Extraordinary - Capital asset donation 847,890 0 0 0 847,890 0

Increase in net assets 2,606,085 5,765,941 2,569,227 958,965 5,175,312 6,724,908Net assets - beginning 135,142,122 129,376,182 32,082,533 31,109,619 167,224,655 160,485,801Prior Period Adjustments 0 0 0 13,948 0 13,948Net assets - ending $137,748,207 $135,142,122 $34,651,761 $32,082,533 $172,399,968 $167,224,657

Table 2 - Changes in Net Assets


CITY OF MERCER ISLAND’S GOVERNMENTAL FUND ACTIVITIES Revenues Taxes account for the largest revenue category in the governmental funds, generating more than 73% of the total revenue. This category includes the sales, property, utility, criminal justice and real estate excise taxes and totaled $19,463,430 in 2006. This is a decrease of $612,010 from 2005. The decrease is primarily attributed to extraordinary real estate excise taxes received in 2005. Property tax receipts increased approximately 3% from 2005, with a total dollar increase of $256,815. The increase in property tax collected was primarily the result of new development and construction on the island.


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Sales and Use tax revenue, in contrast to property tax, is an economically sensitive tax source. The City has experienced a continual increase in sales tax, producing the largest single source of revenue after property tax. The City’s sales tax rate is 1% on all retail sales taking place within the City limits. The sales tax collected on sales taking place within the City is distributed as follows:

State 6.5% City 1.0% (0.15% to County) RTA 0.4% Criminal Justice 0.1%* KC Metro 0.8% Total 8.8%

* The County keeps 10% of this revenue; the remaining 90% is distributed back to the cities located within the county based on population. The City of Mercer Island accounts for the Criminal Justice portion of the sales tax in the Criminal Justice Fund. In 2006, Sales tax collected in the City’s Governmental Funds totaled $3,133,199, an increase if 1% from 2005 receipts. The majority of the growth can be attributed to the construction sector as a result of extensive commercial redevelopment in the city’s town center. Business and Occupation Taxes are collected from all companies conducting business on Mercer Island, including private utilities that provide phone, electricity, gas, garbage, and cable TV services in the City. In 2006, $3,210,074 was collected from these utilities. Continuing growth in this revenue category is attributed to the electricity/natural gas and cable television utilities. Real estate excise taxes are paid on sales of property within the City. The tax is .005% and is allocated to the Street Fund and the Capital Improvement Fund for construction activities related to street, roads, trails, and parks. Expenses Expenses are classified into the general categories or purposes for which they were spent. In total, expenses were $23.0 million in 2006. Judicial - The City began operations of its own Municipal Court in 2005. In prior years the court function was contracted with King Count District Court. Current year expenditure for operations of the court totaled $268,617. General Government Expenses – This category encompasses a variety of services including legislative, executive, finance, legal, personnel, and building maintenance. Public Safety - The Police Department works to provide professional law enforcement services to keep our citizens and their property safe. The Fire Department combats fires and provides first response medical aid for 911 calls. The expenses for Public Safety are the largest part of the Governmental activities at $10 million (46%) of the total governmental expenses. Physical Environment - Creating a satisfactory living environment for the City’s residents is the purpose of expenditures made in the Utility and Environment category. Inspection of private construction projects and coordinating the design of city projects are two examples of physical environment activities. Transportation - Maintenance of the city’s streets, sidewalks, paths and traffic control signs/signals are all included in the transportation category which totaled $1.5 million in 2006. Human Services - This category includes services provided to youth, adults, and seniors to promote and aid mental health. In 2006, it amounted to $2.1 million in expenditures. Economic Environment - Planning, zoning and community development are the key functions of the economic environment category. Expenditures in this category totaled $3.4 million. Culture and Recreation - Culture and recreation includes expenses for participant recreation programs and the maintenance of park facilities including the I-90 corridor. Expenditures in this category totaled $3.5 million.


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CITY OF MERCER ISLAND’S BUSINESS-TYPE ACTIVITY The City of Mercer Island owns and fully operates three utility operations - Water, Sewer, and Storm Water. These utilities operate like a private business and charge fees to support ongoing operations and maintenance as well as capital costs. Water Utility Water revenue is derived from three sources: 1) monthly service charges, 2) system connection fees, and 3) miscellaneous work orders. The majority comes from monthly service charges. The City uses consumption based rates for water. Ratepayers pay a base fee plus a consumption charge according to the number of cubic feet of water used. A ramped rate for usage was built into the rate structure to encourage conservation; whereby the less water used, the lower the consumption rate. This type of rate encourages conservation. Sewer Utility Sewer revenue is derived from three sources: 1) monthly service charges, 2) system connection fees, and 3) investment interest. The majority of the revenue comes from the monthly service charges. Residential sewer rates are charged on a consumption basis. The utility uses the four most recent winter months to determine the average consumption for each residence. Commercial accounts are charged based on the actual consumption of water. The City contracts with King County to process and treat all sewage. In addition to the rate that the City charges for the transmission of the sewage to the treatment plant, there is an additional rate that King County charges for the treatment for all customers. That rate is charged as a direct pass through to the customer and is the largest part of the total sewer rate. The Sewer Utility is in the process of requesting permits and designing a replacement for the sewer transmission line that is around the north end of the island. This is a very large, complex, and expensive project but is deemed crucial since the line is failing. The funds for this project will be borrowed and rates are being increased each year by about 9% in order to be able to pay the debt service on the borrowing. Storm Water Utility The storm water utility charges customers based on the amount of impervious surface on the customers property. A sample of residences was taken and the average impervious surface for a residence was determined to be 3419 sq ft. That is considered one (1) ERU (equivalent residential unit). All residences are charged one ERU at $11.10 per month. All other property is measured for impervious surface and charged based on the actual impervious surface. The Storm Water Utility, like the other utilities receives the majority of its revenues from the monthly service charge. CITY OF MERCER ISLAND’S BUSINESS-TYPE ACTIVITY Internal Service Funds are a type of proprietary fund which account for the goods and services provided to other units of the entity. Payment by the benefiting units is intended to cover the costs of providing service. The City of Mercer Island has two funds that fall into this category: the Equipment Rental Fund and the Computer Equipment Fund. Equipment Rental Fund The Equipment Rental Fund accounts for the cost of maintaining all City owned vehicles and heavy equipment used by City staff. The equipment rental mechanic is responsible for minor repairs to the fleet. Major repairs and body work are contracted out. All costs related to the operation, maintenance, and replacement of the fleet are charged back to the user departments via the rate calculation. Computer Equipment Fund The Computer Equipment Fund was created to protect the City’s current and future investment in computer equipment. The City owns over $400,000 in personal computers, printers, and servers. The fund operates in a manner similar to the Equipment Rental Fund. It funds scheduled computer equipment replacements, equipment maintenance, and network administration through user charges. Each department is assessed an amount to cover the maintenance and replacement costs associated with the computers and printers located in the department.


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THE CITY’S FUNDS Information about the City’s major governmental funds begins with the Statement of Revenues, Expenditures, and Changes in Fund Balance. The City, in performing the major fund calculation, determined that the Street Fund, the Capital Improvement Fund, the Capital Reserve, and the CCMV Construction Funds, along with the General Fund, met GASB 34 requirements for major funds. These funds are accounted for using the modified accrual basis of accounting. All Governmental funds had total operating revenues of $26.6 million and operating expenditures of $25.3 million. CITY OF MERCER ISLAND’S GENERAL FUND BUDGETARY HIGHLIGHTS The City of Mercer Island budgets on a biennial basis with each biennial budget beginning in an odd numbered year by state law. There were increases in both the revenue and expenditure appropriations from the original 2005/2006 budget passed in 2004 and the final 2005/2006 biennial budget. Following are explanations of the major budget changes during the 2005/2006 biennium:

• An increase in Voice program expenditures, Middle School Girls Empowerment, and summer camp scholarships all funded by MIYFS foundation donation revenues.

• An increase in salaries expense for additional staff at the Thrift Shop funded by sales revenue.

• A cost reimbursement grant was awarded to YFS for drug and alcohol abuse prevention.

• Carryover of CIP Budget Appropriations from 2003/2004 biennium and additional CIP related expenditures

including Fiber and TV Broadcast equipment at CCMV, emergency slide repairs, street corridor study and the drilling of a test well for emergency water supply.

• The category of Transfers Out includes the transfers to other funds of any General Fund cash carryover

that is generated by an excess of revenues over expenditures. The City does not budget for such cash carryovers, but recognizes such additional revenue at the end of each calendar year.

• Grants received for CCMV Landscaping, Park improvements, NRPA fishing opportunities, and a Veterans

memorial increased both revenue and expenditure appropriations.

• General fund increase to offset unforeseen increase in the cost of employee benefits.

• Increase in General fund to increase expenditures for cost of additional plan review and inspection services needed for town center redevelopment offset by increase in permit revenue.

• Fire Department purchase of defibrillators using donations received and reserved in prior years.

• Increase to water fund expenditures to reflect higher cost of purchased water.

• Additional expenditure in the Firemens Pension fund for higher than projected retiree costs.

• Authorized additional expenditures related to the sewer lake line construction project.

• Authorized use of unappropriated fund balance the purchase of Quarles property open space.

• Increase in capital expenditure budget for NORCOMM startup costs.

CITY OF MERCER ISLAND’S DEBT ADMINISTRATION At the end of 2006, the City of Mercer Island had total bonded debt outstanding of $5,205,000. Of this amount, $1,550,000 is for voted General Obligation bonds, while the remaining $3,655,000 is for Councilmanic (non-voted) debt and is paid for from revenue received from real estate excise taxes. The Councilmanic debt consists of two bond issues, both for the community center that began in 2004. The first issue, in 2003, was for $2.29 million and was for the land that the community center occupies. The second issue, in 2004, was for construction funds for the center. The City of Mercer Island maintains ratings with Moody’s investment service. Moody’s raised the City rating with the issuance of the bonds in 2003. Our Unlimited General Obligation bond rating is Aa1, while the limited General Obligation bond rating was upgraded to Aa2.


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2006 2005 2006 2005

General obligation bonds $5,205,000 $6,160,000 $0 $0

Installment and public works notes 0 0 914,410 586,159

TOTAL $5,205,000 $6,160,000 $914,410 $586,159

Governmental Activities Business-Type Activities

Table 3 - Long-Term Debt

The City also has four Public Works Trust Fund loans from the State of Washington, all with interest rates of 1%. One of the loans is for a Water Booster Pump station project. The other three loans are all for sewer work. All are paid for by utility rates. The City has no revenue bonds. Washington State statutes limit the amount of general obligation debt a governmental entity may issue to 7.5% of its total assessed valuation, subject to a 60% majority vote of qualified electors. Of the 7.5% limit, 2.5% is for general purposes, 2.5% for open space/park facilities, and 2.5% for utilities. Non-voted (limited tax) general obligation indebtedness is limited to 1.5% of assessed valuation. The combination of all debt cannot exceed 7.5% of assessed valuation. The City of Mercer Island’s debt obligations are substantially below the statutory limits for debt capacity. The City’s actual debt outstanding is only 1% of its total assessed valuation. For more detailed information about the City’s long term debt, see Long Term Debt, in the notes to the Financial Statements. CAPITAL ASSETS The City of Mercer Island’s investment in capital assets for its governmental and business-type activities as of December 31, 2006 amounts to $148,149,729 (net of accumulated depreciation). This investment includes land, building, improvements, machinery and equipment, intangibles and infrastructure.

2006 2005 2006 2005 2006 2005Land $90,407,073 $89,233,993 $203,992 $203,992 $90,611,065 $89,437,985Buildings 19,535,171 19,166,288 325,759 222,293 19,860,930 19,388,581 Improvements 5,683,680 5,805,999 22,503,319 22,355,472 28,186,999 28,161,471 Machinery & Equipment 724,199 826,410 1,675,842 1,675,842 2,400,041 2,502,252 Machinery & Equipment - IS 1,385,176 1,640,743 1,385,176 1,640,743 Infrastructure 5,426,074 4,465,448 5,426,074 4,465,448 Intangibles 260,640 329,722 18,804 18,804 279,444 348,526

$123,422,014 $121,468,603 $24,727,716 $24,476,403 $148,149,729 $145,945,006

Table 4 - Capital Assets at Year End(Net of Depreciation)


For more information about the City’s capital assets, refer to Capital Assets in the notes to the financial statements. ECONOMIC FACTORS AND MERCER ISLAND IN THE FUTURE A number of factors that affect the economic climate of Mercer Island were considered when preparing the City’s 2005-2006 biennial budget and in considering the future of Mercer Island. The Island is primarily single-family residential community supporting an affluent population as reflected by per capita income levels well over two times the average state figure. The City relies on the Property Tax as one of its major revenue sources, which lends stability to the City’s finances. In addition to property taxes, the City receives sales taxes, business and utility taxes, and licenses and permit fees. The sales taxes received by the City have been strong in the past few years, due to continued single family construction and reconstruction and redevelopment of the central business district. The downtown redevelopment activity will continue for the next several years and will significantly add to the tax base of the Island. The rebounding economy as well as low interest rates has continued to fuel both residential and commercial building on the Island. As interest rates rise, the construction activity will likely subside, however, the location and excellent schools of Mercer Island will continue make it a desirable place to live.


13

The City of Mercer Island has a history of excellent financial management and prudent fiscal policies. Adherence to conservative financial management practices has served the City well in the past and should help the City continue to remain in good financial condition. The City is primarily residential, it receives almost half of its General Fund revenue from property taxes, which are limited by State law to an increase of 1% per year plus any additions due to new construction. With salaries, wages, and benefits, which compromise two-thirds of the General fund budget, growing faster than inflation, the City has become increasingly reliant on sales tax and business and occupation tax growth in order to balance its budget. Beginning in July 2008, the City will receive substantially more sales tax revenue as a result of the State Legislatures passage of the Streamlined Sales Tax (SST) legislation. REQUEST FOR FINANCIAL INFORMATION This financial report is designed to provide our citizens, taxpayers, creditors and investors with a general overview of the City’s finances and to show the City’s accountability for the money it receives. If you have any questions about this report or need additional financial information, contact the Finance Director, City of Mercer Island, Washington, 9611 SE 36th Street, Mercer Island, Washington 98040.


14

City of Mercer IslandStatement of Net Assets

December 31, 2006

Governmental Activities

Business-type Activities Total

ASSETSCash & cash equivalents 20,169,360$ 10,963,687$ 31,133,047$ Receivables (net) 2,294,165 573,328 2,867,493 Internal Balances 19,789 (19,789) - Inventories 126,753 144,082 270,835

Deferred charges & other assetsDeferred charges 44,789 - 44,789

Noncurrent receivables Due from other Govt 619,730 - 619,730

Capital Assets:Land 90,407,073 203,992 90,611,065

Depreciable assets (net of accumulated

depreciation) 27,588,867 24,523,724 52,112,591 Infrastructure 5,426,074 - 5,426,074

Total Assets 146,696,601 36,389,024 183,085,624

LIABILITIESAccounts payable and accrued exp. 1,406,976 723,423 2,130,399 Unearned revenue 1,129,745 - 1,129,745 Other current liabilities 58,937 2,215 61,152 Due within one year 990,000 171,750 1,161,750 Due in more than one year 5,362,736 839,874 6,202,610

Total Liabilities 8,948,394 1,737,263 10,685,657

NET ASSETS Invested in capital assets, net of related debt 118,253,266 23,813,311 142,066,577 Restricted for:

Debt service 201,058 - 201,058 Capital projects 6,105,473 6,105,473 Non Expendable Permanent Fund 308,819 308,819

Unrestricted 12,879,591 10,838,450 23,718,041 Total Net Assets 137,748,207$ 34,651,761$ 172,399,968$

The Notes to the Financial Statements are and integral part of this statement.


15

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16

City of Mercer IslandBalance Sheet

Governmental FundsFor the Year Ended 12/31/2006

General Fund Street Capital Improve

Capital Reserve

CCMV Const

Other Governmental

Funds

Total Governmental

Funds ASSETSCash & cash equivalents 3,771,923$ 3,127,698$ 3,125,560$ 1,093,239$ 442,981$ 5,346,759$ 16,908,160$ Receivables (net) 1,489,688 92,871 112,875 598,731 2,294,165 Inventories 126,753 - 126,753

Total assets 5,388,365 3,220,569 3,238,435 1,093,239 442,981 5,945,490 19,329,078

LIABILITIES AND FUND BALANCESAccounts payable and accrued exp. 581,190 87,174 256,246 76 29,735 109,382 1,063,803 Deferred revenue 508,272 1,743 510,015 Other current liabilities 58,937 - 58,937 Compensated absences 895,467 - 895,467 Salaries & Wages Payable 227,193 - 227,193 Other noncurrent liabilities - -

Total liabilities 2,271,059 87,174 256,246 76 29,735 111,125 2,755,415

FUND BALANCE - Reserved for: -

Encumbrances, petty cash, inventory 130,523 - 130,523 Debt service 201,058 201,058 Capital improvements 250,000 250,000 Other - -

Unreserved, reported in - - General Fund 2,986,784 - 2,986,784

Special revenue funds 3,133,395 3,707,611 6,841,005 Capital project funds 2,982,189 1,093,163 413,246 1,366,875 5,855,473 Permanent funds 308,819 308,819

Total fund balance 3,117,307 3,133,395 2,982,189 1,093,163 413,246 5,834,363 16,573,662 Total liabilities and fund balance 5,388,365$ 3,220,569$ 3,238,435$ 1,093,239$ 442,981$ 5,945,488$ 19,329,078$

Amounts reported for governmental activities in the statement of net assets are different because:

Capital assets used in governmental activities are not financial resources and are not reported in the funds 122,036,835$

The Defferd Charge for Bond Issuance costs are not included in the Fund Statements 44,789

Long-term liabilities are not due and payable in the current period and therefore are not reported in the funds (5,428,362)

Internal service funds are used by management to charge the costs of certain activities to individual funds.

These assets and liabilities are included in governmental activities in the statement of net assets. 4,521,282

Net assets of governmental activities 137,748,207$

The Notes to the Financial Statements are an integral part of this Statement


17

City of Mercer IslandStatement of Revenues, Expenditures, and Change in Fund Balance


General Fund Street Capital Imp

Capital Reserve

CCMV Construction

Other Governmental

Funds

Total Governmental

Funds REVENUES Taxes:

Property 8,855,286$ 99,263$ 0$ 0$ 521,488$ 9,476,037$ Sales 2,638,885 494,314 3,133,199 B&O 2,911,188 298,886 3,210,074 Other 337,500 1,332,238 1,950,189 24,193 3,644,120

Licenses & Permits 1,942,148 3,735 1,945,883 Intergovernmental 373,646 900 314,151 688,697 Charges for Services 1,174,257 (201) 459,640 1,633,696 Fines & Forfeitures 335,151 - 335,151 Investment Earnings 584,688 158,033 175,676 110,740 1,029,137 Other Revenues 456,121 2,741 1,054,859 1,513,721

Total revenues 19,608,872 1,490,070 2,228,769 0 0 3,282,006 26,609,717

EXPENDITURES Current:

Judicial 268,153 - 268,153 General Government 2,632,636 46,601 116,301 2,795,538 Public Safety 8,245,652 505,817 8,751,469 Physical Environ 51,908 2,943 - 54,851 Transportation 1,059,396 310,543 7,380 100,721 1,478,040 Health & Human Services 2,091,055 2,091,055 Economic Environment 2,107,971 14,400 2,122,371 Culture & Recreation 3,076,629 464,996 25,054 583,178 4,149,857

Debt Service:Principal 955,000 955,000 Interest 241,442 241,442

Capital Outlay:General government 106,811 127,231 234,043 Public safety 5,373 10,125 9,591 25,089 Transportation 944,020 16,606 960,626 Health & Human services 10,575 - 10,575 Culture & Recreation 5,091 470,336 693,555 - 1,168,982

Total expenditures 17,452,809 1,254,563 1,073,167 46,601 718,609 4,761,342 25,307,090

Excess (deficiency) of

revenues over (under) 2,156,063 235,508 1,155,601 (46,601) (718,609) (1,479,335) 1,302,626

OTHER FINANCING SOURCES (USES)Transfers in 700,000 164,339 1,616,789 2,481,128 Transfers out (2,035,534) (11,230) (1,372,839) (874,389) (4,293,992) Sale of Capital Assets 270 - 270

Total other financing sources

(uses) (1,335,264) (11,230) (1,208,501) 0 0 742,401 (1,812,594)

Net change in fund balances 820,799 224,278 (52,899) (46,601) (718,609) (736,935) (509,968) Fund balances - Beginning 2,296,508 2,909,117 3,035,089 1,139,764 1,131,855 6,571,297 17,083,630

Fund balances - Ending 3,117,307$ 3,133,395$ 2,982,189$ 1,093,163$ 413,246$ 5,834,362$ 16,573,662$

The Notes to the Financial Statements are an integral part of this statement.


18

City of Mercer IslandStatement of Revenues, Expenditures, and Change in Fund Balance


Net changes in fund balances for governmental funds (509,968)

Amounts reported for governmental activities in the statement of activities are different because:

Governmental funds report capital outlays as expenditures. However, in the statement of activities, the cost

of those assets is depreciated over their estimated useful lives and reported as depreciation expense.

The net effect of transactions involving Capital Assets 1,361,087

Governmental Funds record the receipt of Capital Asset donations in the General Fixed Asset Account Group.

In the Statement of Activities the value of the donated assets are recorded as a donation revenue. 847,890

The issuance of long-term debt (e.g., bonds, leases) provides current financial

resources to governmental funds, while the repayment of the principal of long-term

debt consumes the current financial resources of governmental funds. Neither

transaction, however, has any effect on net assets. Governmental funds

report the effect of issuance cost, premiums, discounts, and similar items when

debt is first issued, whereas these amounts are deferred and amortized in the

statement of activities. This amount is the net effect of these differences in the

treatment of long-term debt and related items 979,197

Internal service funds are used by management to charge the costs of certain activities to individual (72,119)

funds. The net revenue of most of these activities is reported with governmental activities.

Change in net assets of governmental activities 2,606,085$

See also NOTE 3 for detailed reconciliation.



19

City of Mercer IslandStatement of Net Assets

Proprietary FundsFor the Year Ended December 31, 2006

Business-type Activities--Enterprise Funds

Water Fund Sewer Fund Storm Drain

Fund

Total Enterprise

Funds

Governmental Activities-

Internal Service Funds

ASSETS Current assets:

Cash & cash equivalents 1,554,401 7,513,996 1,895,290 10,963,687$ 3,261,200$ Receivables (net) 168,174 310,541 94,613 573,328 - Inventories 135,527 8,555 144,082 -

Capital assets:Land 106,125 97,866 203,992 -

Depreciable assets (net of accumulated depreciation) 12,114,364 7,891,879 4,517,481 24,523,723 1,385,179

Total assets 14,078,591 15,822,837 6,507,384 36,408,812 4,646,379

LIABILITIES Current liabilities:

Accounts payable and accrued exp. 160,107 505,324 57,992 723,423 141,913 Bonds, notes, loans payable 13,732 158,018 171,750 - Deposits payable 2,215 2,215 -

Noncurrent liabilities:Compensated absences 70,159 19,392 7,669 97,220 2,974 Bonds, notes, loans payable 13,731 728,923 742,654 -

Total liabilities 259,944 1,411,658 65,661 1,737,263 144,887

NET ASSETS Invested in capital assets, net of related debt 12,193,026 7,102,804 4,517,481 23,813,311 1,385,179 Unrestricted 1,625,621 7,308,376 1,924,242 10,858,239 3,116,313 Total net assets 13,818,647$ 14,411,179$ 6,441,723$ 34,671,549$ 4,501,492$

Adjustment to reflect the consolidation of internal service fund activities related to

enterprise funds: (19,789)

Net assets of business-type activities 34,651,761$

The Notes to the Financial Statements are an integral part of this statement


20

City of Mercer IslandStatement of Revenues, Expenses, and Changes in Net Assets


Water Fund Sewer Fund Storm Drain

Fund

Total Enterprise

Funds

Governmental Activities-Internal

Service Funds

OPERATING REVENUES Charges for Services:

Utility Services 3,826,035$ 4,478,995$ 1,586,363$ 9,891,393$ -$ Other services 1,110,480

Total operating revenues 3,826,035 4,478,995 1,586,363 9,891,393 1,110,480

OPERATING EXPENSESMaintenance & operations 914,168 833,428 566,484 2,314,080 603,609 Water Purchased for Resale 1,577,732 1,577,732 - Metro Sewer Charges 2,594,918 2,594,918 - Administrative & general 732,705 373,187 346,838 1,452,730 120,202 Insurance 43,000 43,000 40,000 126,000 20,690 State Utility Taxes 175,991 70,061 246,052 Depreciation 694,616 411,725 103,245 1,209,586 476,468

Total operating expenses 4,138,213 4,326,319 1,056,567 9,521,098 1,220,969 Operating income (loss) (312,178) 152,676 529,796 370,295 (110,489)

NONOPERATING REVENUES (EXPENSES)Investment earnings 75,444 264,635 91,218 431,297 - Interest expense (412) (3,575) (3,987) - Other non-operating revenue (2,873) Gain (loss) on disposition of assets - -

Total non-operating income (expense) 75,032 261,060 91,218 427,310 (2,873) Income before contributions & transfers (237,146) 413,736 621,014 797,605 (113,362)

Capital grantsCapital contributions - - Transfers in 1,250 1,801,250 2,500 1,805,000 34,925 (Transfers out) (10,153) (7,569) (9,339) (27,061) -

Change in net assets (246,049) 2,207,417 614,175 2,575,544 (78,437) Net assets--beginning 14,064,696 12,203,761 5,827,547 32,096,004 4,579,930 Prior Period AdjustmentsNet assets--ending 13,818,647$ 14,411,179$ 6,441,723$ 34,671,549$ 4,501,493$

NET Adjustment to reflect the consolidation of internal service fund

activities related to enterprise funds: (6,317)

Change in Net assets of business-type activities 2,569,227$



21

City of Mercer IslandStatement of Cash Flows


Total InternalWater Sewer Storm Drain Totals Service Funds

CASH FLOWS FROM OPERATING ACTIVITIESReceipts from Customers and Users 3,736,493$ 4,356,612$ 1,547,519$ 9,640,624$ 1,110,480$ Payments to Employees (854,254) (499,965) (417,579) (1,771,798) (252,297)Payments to Suppliers (989,485) (319,497) (589,442) (1,898,424) (390,419)Payments to Other Governments (1,753,723) (2,664,979) 0 (4,418,702) 0Other Operating Revenues 0 0 0 0 0

NET CASH PROVIDED BY OPERATING ACTIVITIES 139,031 872,170 540,499 1,551,700 467,764

CASH FLOWS FROM NONCAPITAL FINANCING ACTIVITIES

Miscellaneous Cash Received (Paid) 0 0 0 0 0NET CASH PROVIDED BY NONCAPITAL FINANCING ACTIVITIES 0 0 0 0 0

CASH FLOWS FROM CAPITAL AND RELATED FINANCING ACTIVITIES

Cash contributions in aid of construction (8,903) 1,793,681 (6,839) 1,777,939 34,925Purchase of Capital Assets (316,896) (706,464) (437,539) (1,460,899) (232,368)Proceeds of Capital Debt 0 500,000 0 500,000 0Principal Paid on Capital Debt (13,731) (158,018) 0 (171,749) 0Interest Paid on Capital Debt (412) (3,575) 0 (3,987) 0Proceeds from Sales of Capital Assets 0 0 0 0 8,591

NET CASH PROVIDED BY CAPITAL FINANCING ACTIVITIES (339,942) 1,425,624 (444,378) 641,304 (188,852)

CASH FLOWS FROM INVESTING ACTIVITIES

Interest Received on Investments 75,444 264,635 91,218 431,297 0Purchase of Investments 0 0 0 0 0Proceeds from Sale of Investments 0 0 0 0 0

NET CASH PROVIDED BY INVESTING ACTIVITIES 75,444 264,635 91,218 431,297 0

Net Increase(decrease)in cash (125,467) 2,562,429 187,339 2,624,301 278,912

Cash January 1, 2006 1,679,868 4,951,567 1,707,951 8,339,386 2,982,288

Cash December 31, 2006 1,554,401 7,513,996 1,895,290 10,963,687 3,261,200

Cash at the End of the Year Consists of: Operating Fund Cash 1,554,401 7,513,996 1,895,290 10,963,687 3,261,200 Bond Reserve Cash 0 0 0 0 0Total Cash at the End of the Year 1,554,401 7,513,996 1,895,290 10,963,687 3,261,200

RECONCILLIATION OF OPERATING INCOME TO NET CASH PROVEDED BY OPERATING ACTIVITIES Operating income (loss) (312,178)$ 152,676$ 529,796$ 370,294$ (110,489)$

Adjustments to reconcile operating income to net cash provided by operating activities 0 0 0 0 0 Depreciation 694,616 411,725 103,245 1,209,586 476,468 Change in assets and liabilities 0 0 0 0 0

(Increase)decrease in due from other funds 0 0 0 0 0(Increase)decrease in accounts receivable (89,542) (122,383) (38,844) (250,769) 0Increase(decrease) in accounts payable (169,001) 423,975 (52,310) 202,664 104,730Increase (decrease) in loans payable 0 0 0 0 0(Increase)decrease in inventory 0 0 0 0 0Increase (decrease) in Compensated Absences payable 15,136 6,177 (1,388) 19,925 -2945Increase (decrease) in current liabilities 0 0 0 0 0Other Adjustments 0 0 0 0 0

Total adjustments 451,209 719,494 10,703 1,181,406 578,253Net cash provided by operating activities 139,031$ 872,170$ 540,499$ 1,551,700$ 467,764$

Noncash Capital and Related Financing ActivitiesCapital Contributions From YFS Fund - 2,016Capital Contributions From Capital Imp Fund - 18,375Retirement of Internal Service Fund Capital Assets - 0

Total Noncash Investing, Capital and Financing. -$ -$ -$ -$ 34,925$

The notes to the financial statements are an integral part of this statement.


22

City of Mercer IslandStatement of Fiduciary Net Assets

Fiduciary FundsFor Year Ended December 31, 2006

Firemens Pension

Trust Fund Agency Funds

ASSETS Cash & cash equivalents 1,091,186$ 17,328$

Receivables: 6,418

Total assets 1,091,186 23,746

LIABILITIESAccounts payable and accrued expenses 1,245 23,746

Total liabilities 1,245$ 23,746

NET ASSETSHeld in Trust for Pension and Other Benefits 1,089,941$ 0$



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City of Mercer IslandStatement of Changes in Fiduciary Net Assets

Fiducary FundsFor the Year Ended December 31, 2006

Firemens Pension

Trust Fund

ADDITIONS:

Contributions:

Taxes 21,493$

Other

Total Other Contributions 21,493

Investment earnings:

Interest & dividends 52,204

Total net investment income (loss) 52,204

Total additions 73,697

DEDUCTIONS:Benefits 52,998

Total deductions 52,998

Change in net assets 20,699

Net assets - Beginning 1,069,242

Net assets - Ending 1,089,941$



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Notes to Financial Statements City of Mercer Island, Washington

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of the City of Mercer Island, which conform to generally accepted accounting principles for governments as prescribed by the Governmental Accounting Standards Board, are regulated by the Washington State Auditors Office. The City’s significant accounting policies are described below. Organization The City of Mercer Island was incorporated on July 18, 1960. It remained separate from the Town of Mercer Island (which occupied the area now in the central business district) until July of 1970. The City has a council-manager form of government and operates under Title 35A of the Revised Code of Washington (RCW). The City Council is composed of seven non-partisan members elected at large for 4 year terms. From among the council members a mayor is elected for a term of two years. Day-to-day City operations are under the direction of a city manager, who is appointed by the council. The City provides general government services including public safety, streets and trails, parks and recreation, planning and zoning, permits and inspection, general administrative and water and sewer services. Reporting Entity The City's Basic Financial Statements include all funds, account groups, agencies and boards controlled by or dependent on the City. Control by or dependence on the City was determined on the basis of budget adoption, taxing authority, outstanding debt secured by revenues or general obligation of the City, obligation of the City to finance any deficits that may occur or receipt of significant subsidies from the City. New Accounting Standards In June 1999 the Governmental Accounting Standards Board (GASB) issued Statement 34, Basic Financial Statements and Management Discussion and Analysis for State and Local Governments. This statement includes significant financial reporting changes and allows for a phased implementation based on the size of the government. The statement established new accounting and financial reporting standards for general purpose external financial reporting by governments. It establishes specific standards for basic financial statements, management’s discussion and analysis, and other required supplementary information. The basic financial statements now include government wide financial statements, fund financial statements, and notes to the financial statements. GASB 34 also mandated the inclusion of the government's general infrastructure (roads, bridges, traffic signals, etc.) as governmental assets in the financial statements. GASB 34 permits an optional four year delay in full reporting of the city's infrastructure. The city has elected to implement financial reporting under GASB 34 for the fiscal year ended December 31, 2003, with the exception of infrastructure. Full reporting of Infrastructure assets will be added within the delayed timeline allowed under GASB 34. In April 2000 the GASB issued Statement Number 36 – Certain Shared Revenues, which supersedes GASB Statement Number 33 paragraph 28 – Accounting and reporting for Non-Exchange Transactions. In June 2001 the GASB issued Statement Number 37, Basic Financial Statements – Management’s Discussion and Analysis for State and Local Governments: Omnibus. This statement was issued to amend certain provisions in GASB Statements Number 21 and 34. The City implemented GASB Statement 34 and the applicable amendments for fiscal year end December 31, 2003. Also in June 2001 the GASB issued Statement Number 38 – Certain Financial Statement Note Disclosures. This statement was issued to establish and modify disclosure requirements related to the summary of significant accounting policies, actions taken to address violations of significant finance related legal and contractual provisions, debt and lease obligations, short term debt, desegregation of receivable and payable balances, and inter-fund balances and transfers.


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Basic Financial Statements The city's basic financial statements consist of government-wide statements, including a statement of net assets and a statement of activities, and fund financial statements which provide a more detailed level of financial information

The government-wide financial statements report information on all of the non-fiduciary activities of the primary government and its component units. For the most part, the effect of inter-fund activity has been removed from these statements. Governmental activities, which normally are supported by taxes and intergovernmental revenues, are reported separately from business-type activities, which rely on user fees and charges for support.

The statement of activities demonstrates the degree to which the direct expenses of a given function are paid for by program revenues. Direct expenses are those that are clearly identifiable with a specific function. Program revenues include 1) charges to customers or applicants who purchase, use, or directly benefit from goods, services, or privileges provided by a given function and 2) grants and contributions that are restricted to meeting the operational or capital requirements of a particular function. Taxes and other items not properly included as program revenues are reported instead as general revenues. Separate fund financial statements are provided for governmental funds, proprietary funds, and fiduciary funds, even though the latter are excluded from the government-wide financial statements. Major individual governmental funds and major individual enterprise funds are reported as separate columns in the fund financial statements. Measurement Focus and Basis of Accounting The government-wide financial statements are reported using the economic resources measurement focus and the accrual basis of accounting, as are the proprietary fund and fiduciary fund financial statements. Revenues are recorded when earned and expenses are recorded when a liability is incurred, regardless of the timing of related cash flows. Property taxes are recognized as revenues in the year for which they are levied. Grants and similar items are recognized as revenue as soon as all eligibility requirements imposed by the provider have been met. Governmental fund financial statements are reported using the current financial resources measurement focus and the modified accrual basis of accounting. Revenues are recognized as soon as they are both measurable and available. Revenues are considered to be available when they are collectible within the current period or soon enough thereafter to pay liabilities of the current period. For this purpose, the City considers revenues to be available if they are collected within 45 days of the end of the current fiscal period. Expenditures generally are recorded when a liability is incurred, as under accrual accounting. However, debt service expenditures, as well as expenditures related to compensated absences and claims and judgments, are recorded only when payment is due. Proprietary fund financial statements are reported using the economic resources measurement focus and the accrual basis of accounting. This means that all assets and all liabilities (whether current or non-current) associated with their activity are included on their statement of net assets. The proprietary fund measurement focus is based upon determination of net income, financial position and cash flows. Proprietary funds distinguish operating revenues and expenses from non-operating items. Operating revenues and expenses result from providing services and delivering goods in connection with the funds principal ongoing operations. All revenues and expenses not meeting this definition are reported as non-operating. Proprietary Funds have the option of consistently following or not following FASB pronouncements issued subsequent to November 30, 1989. The option selected by the City for all of its Proprietary Fund activities, as policy, is to apply all applicable GASB pronouncements and all FASB Statements and Interpretations, Accounting Principles Board (APB) Opinions and Accounting Research Bulletins (ARB) issued on or before November 30, 1989, unless they conflict with or contradict GASB pronouncements. When both restricted and unrestricted resources are available for use, it is the city’s policy to use restricted resources first, then unrestricted resources as they are needed. Financial Statement Presentation The City of Mercer Island reports the following major governmental funds:

The General Fund is the general operating fund of the City. It accounts for all financial resources and transactions of the City except those required to be accounted for in another fund.


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The Street Fund is a special revenue fund that accounts for the financial resources dedicated to street maintenance and construction. The Capital Improvement Fund accounts financial resources to be used for the acquisition, construction and preservation of the City’s general government capital assets and facilities. The Community Center Construction Fund is a capital project fund which accounts for the financial resources dedicated to the construction of a new community center. The Capital Reserve Fund accounts for financial resources that the City Council has set aside for future large scale capital facility improvements.

The City reports the following major Proprietary Funds:

The Water Fund accounts for all activities necessary for the operation, maintenance, and capital reinvestment required to provide water services to Mercer Island residents. The Sewer Fund accounts for all activities necessary for the operation, maintenance, and capital reinvestment required to provide waste water services to Mercer Island residents. The Storm and Surface Water Fund accounts for all activities necessary for the operation, maintenance, and capital reinvestment required to provide storm water services to Mercer Island residents

Additionally the City reports the following fund types: Permanent Funds account for principle restricted donation earnings. The City has one permanent fund, the Youth Service Endowment, which was created as long term funding mechanism to support ongoing YFS programs. Special Revenue Funds account for revenues derived from specific taxes, grants, or other sources which are restricted to expenditures for specified purposes. The City has seven special revenue funds: Streets, Criminal Justice, Beautification, I-90 Landscape Maintenance, Municipal Arts, Youth and Family Services, and a Contingency Fund. Internal service funds account for fleet maintenance and information technology services provided to other departments of the city. Agency funds account for assets held by the city as an agent for private individuals or other governments. Agency funds are custodial in nature (assets equal liabilities) and do not involve the measurement of the results of operations. The Pension Trust Fund accounts for the activities of the Firemen’s Pension Fund, which accumulates resources for excess pension benefit payments to qualified firefighters.

Budgetary Information The City of Mercer Island budgets its funds in accordance with the Revised Code of Washington (RCW) Chapter 35A.34. The City of Mercer Island biennial budget is adopted by appropriation ordinance of the Mercer Island City Council and may be amended by subsequent ordinances. Budgets are legally adopted for all general and special revenue fund types on the modified accrual basis, in accordance with GAAP (Generally Accepted Accounting Principles). The City also establishes budgets for the following other fund types: debt service, capital projects, internal service, proprietary, and fiduciary funds. Biennial budgets for debt service and capital project funds are determined by debt issue ordinances and capital spending plans, respectively, therefore, budgetary comparisons, are not reported in the basic financial statements. Nor are budgetary comparisons presented for proprietary fund types, as they are "management budgets", determined on the working capital basis. Washington State law requires that a mid-biennial review and modification be conducted between September 1st and December 31st of the first year of the biennium. The budget, as adopted, constitutes the legal authority for expenditures. The City’s budget is adopted at the fund level, so that expenditures may not legally exceed appropriations at that level of detail. Transfers or revisions within funds are allowed, however, any revisions that alter the total expenditures must be approved by the City


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Council. When the City Council determines that it is in the best interest of the City to amend the budget appropriations it may do so by ordinance approved by one more than the majority after holding a public meeting. The City’s 2005-2006 biennial budget was amended 8 times during the 2005-2006 biennium. The financial statements present the original and final budgetary information as approved. The original budget is the first complete adopted budget. The final budget is the original budget adjusted by all revisions, transfers and supplemental appropriations legally authorized. All appropriations, except for budgeted capital projects and appropriations for federal and state grant projects, lapse at the end of the biennium. Unexpended resources must be re-appropriated in the subsequent biennial period. The City does not use encumbrances. The steps taken in the budget process are as follows: City departments begin budget preparation in late spring, incorporating policies, goals, and priorities set by City Council in their Management and Budget Policies, during their annual retreat, and during regular Council meetings throughout the year. By November 1st of even years, in compliance with the law, the City Manager submits a balanced proposed budget to the City Council for the two fiscal years commencing the following January 1. The operating budget includes proposed expenditures and the means of financing them. Public budget hearings are conducted by the City Council in November and December, in accordance with State Law, to obtain taxpayer comments. Should the Council decide to make changes in the preliminary budget, the changes are made after the public hearings and before the adoption of the budget ordinance in December. Washington State law requires that the City Council adopt a balanced budget, which is legally enacted through passage of an ordinance, on or before December 31st. The City Council biennially adopts a budget by ordinance establishing appropriations for City funds, and may during the year authorize supplemental appropriations. Amounts shown in the accompanying financial statements represent the original budgeted amounts plus all supplemental appropriations. Revisions made to the original budget are shown below:

Fund

Original Biennial Budget

Biennium Adjustments

Final Biennial Budget

General Government

General 35,339,809 3,960,048 39,299,857

Self Insurance 60,000 60,000

YFS Endowment 6,000 6,000

MIYFS Foundtn Endow 443,237 443,237

Total General Govt 35,405,809 4,403,285 39,809,094

Special Revenue Funds

Street 3,038,000 1,137,196 4,175,196

Criminal Justice 1,661,458 1,661,458

Beautification 707,495 60,000 767,495

I-90 Landscape 903,732 903,732

Contingency - 787,186 787,186

Municipal Arts 6,000 37,600 43,600

YFS Fund 2,584,268 278,064 2,862,332

MIYFS Foundation 166,450 247,780 414,230

Total Special Revenue 9,067,403 2,547,826 11,615,229

Total General & Spec Rev 44,473,212 6,951,111 51,424,323 Cash and Investments It is the City's policy to invest all temporary (residual) cash surpluses. These investments are reported on the Statement of Net Assets as cash and cash equivalents or investments. Included in cash and cash equivalents are currency on hand, investments with the State Investment Pool and investments with original maturities of three months or less. Residual cash from all funds is pooled and the interest earned on the investments is allocated back to the various funds on a pro-rata basis. See also Note 4. The City, by State law is authorized to purchase Certificates of Deposit issued by Washington State depositories that participate in a State Insurance Pool; U.S. Treasury and Agency Securities and banker's acceptances. All security transactions, entered into by the City of Mercer Island, are conducted on a delivery versus payment


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(DVP) basis. Securities are held by a third party custodian designated by the Finance Director. Investments are reported at Fair market value in accordance with GASB Statement 31. Receivables The City of Mercer Island recognizes receivables in its financial statements based on the accounting requirements for each statement. Receivables are as follows:

Taxes: Uncollected property taxes levied for the current year are reported as receivable at year-end. The City's property tax collection records show that approximately 98% of the property taxes due are collected in the year of the levy and delinquent taxes are collected in the next few years. Historically, all taxes have been collected; therefore no allowance for uncollectible taxes is recorded.

Interest: Interest receivable consists of interest earned on investments, notes or contracts at the end of the year.

Special Assessments: Special assessments are levied against certain property owners and become liens against the property benefited by the improvement. Special assessments receivable consist of current assessments which are due within one year, delinquent assessments remaining unpaid after the due date, and deferred, uncollected assessments which have been levied but are not due within one year.

Accounts Receivable: Customer accounts receivable consists of amounts owed by private individuals or organizations for City goods and services provided. Uncollectible amounts are considered immaterial and the direct write-off method is used when necessary. Due From Other Governments: Included in the entity-wide statements only, this receivable represents a long term capital lease agreement between the City of Mercer Island and King County Library District for the purchase of the Library building. The building was constructed by the City and subsequently annexed by the County. The total receivable is offset by deferred revenue. Annual payments are recognized as revenue in the fund statements.

Inter-fund Transactions During the course of normal operations, the City has numerous transactions between City funds. Quasi-external transactions such as buying goods and services are recorded as revenues and expenditures/expenses. Reimbursements to a fund for expenditures previously paid that are more properly applicable to another fund are recorded as an expenditure in the reimbursing fund and a reduction of expenditure/expense in the fund receiving reimbursement. All other inter-fund transactions are reported as transfers. As a general rule the effect of inter-fund activity has been eliminated from the government-wide financial statements. Direct expenses of the functional categories are included in the government-wide statement of activities while indirect expense allocations are eliminated. Indirect expenses are primarily charged to the various functions through the use of internal service funds for fleet maintenance and information technology. Elimination of payments to internal service funds are treated as expense reductions. No other indirect expenses are allocated to the various governmental functions. Exceptions to this general rule are charges between the government’s utility functions and various other functions of the government. Elimination of these charges would distort the direct costs and program revenues reported for the various functions concerned. Activities between funds that are lending/borrowing arrangements outstanding at the end of the reporting period are referred to as “inter-fund loans receivable/payable”. All other outstanding balances between funds are reported as “due to/from other funds.” Any residual balances outstanding between the governmental activities and business-type activities are reported in the government wide financial statements as “internal balances.” Inventories Inventories in governmental funds consist of expendable supplies held for consumption. The reserve for inventory is equal to the reported amount of inventory to indicate that a portion of the fund balance does not constitute "available spendable resources" even though it is included in net current assets. The purchases method is used in which the cost is recorded as an expenditure when individual items are purchased. Inventories in proprietary funds are valued at cost, which approximates the market value.


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Restricted Assets These accounts represent cash and/or investments in the enterprise funds for debt service on revenue bonds. Deferred Charges Deferred charges in the governmental activities consist of issuance costs for 2003 and 2004 G.O. Bonds that were issued for the purchase of the land and the construction of a new community center. These issuance costs will be amortized over the life of the bonds for 15 and 20 years respectively. Long Term Obligations In the government-wide financial statements and proprietary fund types in the fund financial statements, long-term debt and other long-term obligations are reported as liabilities in the applicable governmental activities, business-type activities, or proprietary fund type statement of net assets. Bond premiums and discounts, as well as issuance costs, are deferred and amortized over the life of the bonds using the straight line method. Bonds payable are reported net of the applicable bond premium or discount. Bond issuance costs are reported as deferred charges and amortized over the term of the related debt. In the fund financial statements, governmental fund types recognize bond premiums and discounts, as well as bond issuance costs, during the current period. The face amount of debt issued is reported as other financing sources. Premiums received on debt issuances are reported as other financing sources while discounts on debt issuances are reported as other financing uses. Issuance costs, whether or not withheld from the actual debt proceeds received, are reported as debt service expenditures. Capital Assets General capital assets are those assets not specifically related to activities reported in the proprietary funds. These assets generally result from expenditures in the governmental funds. These assets are reported in the governmental activities column of the government-wide statement of net assets but are not reported in the fund financial statements. Capital assets utilized by the proprietary funds are reported both in the business-type activities column of the government-wide statement of net assets and in the respective funds. Capital assets are defined by the city as land, buildings, improvements, and equipment with an original cost of $5,000 or more each. All vehicles, computers, printers and projection equipment are capitalized regardless of the initial cost. Such assets are recorded at historical cost or estimated historical cost if purchased or constructed. Donated capital assets are recorded at estimated fair value at the date of donation. See also Note 8. The costs of normal maintenance and repairs that do not add to the value of the asset or materially extend assets’ lives are not capitalized. Major outlays for capital assets and improvements are capitalized as projects are constructed. Land, construction in progress, and works of art are not depreciated. Property, plant, and equipment of the city are depreciated using the straight line method over the following estimated useful lives:

ASSET YEARSBuildings\Bldg Improvements 30-50

Other Improvements 10-50

Equipment 5-10

Intangibles 5-10 Compensated Absences - Vacation and Sick Leave Vacation leave for permanent full-time employees accumulates monthly at annual rates ranging from 12 to 21 days unless otherwise provided for in a collective bargaining agreement. Permanent part-time employees who work at least 8 hours per week earn vacation leave on a pro-rata basis. Employees with at least 5 years and 10 years of service may convert respectively 3 and 5 days of accrued vacation leave to cash, paid through the regular payroll. At termination of employment, employees with the required length of service may receive cash payment for accumulated vacation leave up to a maximum of 30 days. The payment is based on current wages at termination. In accordance with GASB Statement 16, the City accrues a liability for vacation pay. Sick leave for permanent full-time employees accumulates monthly at the rate of one day for each full month of service unless otherwise provided in a collective bargaining agreement. Permanent part-time employees who work at least 8 hours per week earn sick leave on a pro-rata basis. Sick leave can be accrued to a maximum of 90 days; however; no compensation for accrued sick leave is paid on termination. Accordingly, no liability is recorded for accrued sick leave.


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Salaries Payable In a given fiscal year there are 26 pay dates. Approximately once every 10 years an additional, or 27th pay date, falls within the fiscal year. In order to remain consistent in the budgeting for Salaries and Benefits the decision was made to begin accruing a long term liability to fund the extra pay date. Beginning with fiscal year end 2000 the City began accruing the cost equivalent of one extra day of salary expense per year. The liability will continue to increase each year until the 10th year when the 27th payroll will be paid. Deferred Revenue Deferred revenues are those which are measurable but not yet available under the modified accrual basis of accounting. Accordingly, they are not recorded as revenue in the fund financial statements. The City has recognized four deferred revenue items in 2006:

• Uncollected property taxes levied • Rental charges for future scheduled use of City Community Center and Park facilities. • Unearned Permit Revenue related to large CBD development projects. • Due from other Governments for total of lease purchase agreement with King County Library

District. Fund Equity Reserves and Designations In the fund financial statements, governmental funds report reservations of fund balance for amounts that are not available for appropriation or are legally restricted by outside parties for use for a specific purpose. Designations of fund balance represent tentative management plans that are subject to change. NOTE 2 - STEWARDSHIP, COMPLIANCE AND ACCOUNTABILITY There have been no material violations of finance-related legal or contractual provisions, and there have been no expenditures exceeding legal appropriations in any of the funds of the City of Mercer Island. NOTE 3 – RECONCILIATION OF GOVERNMENT WIDE AND FUND FINANCIAL STATEMENTS

Explanation of aggregated differences between the governmental fund balance sheet and the government--wide statement of net assets The governmental fund balance sheet includes a reconciliation between total fund balance and total net assets as reported in the government-wide statement of net assets. The details of the aggregated differences are presented below: Other long term and capital assets are not available to pay for current period expenditures and therefore are not reported in the funds:

Capital assets used in governmental activities are not financial

resources and are not reported in the funds

Land 90,407,073$

Infrastructure 5,426,074

Depreciable Assets (net) 26,203,688

Deferred charge for Bond Issuance Costs 44,789

Net Assets and Liabilities of Internal Service Funds are

included as governmental activites in the statement of net

assets 4,521,282 Net Adjustment to increase fund balance for total

governmental funds to arrive at net assets for governmental

activities 126,602,905$

Some long term liabilities are not due and payable in the current period and therefore are not reported in the fund financial statements:


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Long term liabilities not reported in the fund statements

G.O. Bonds Payable 5,205,000$

Plus Un-amortized Premium/Discount (net) 8,538

Interest Payable on Long Term Debt 201,260

Unfunded portion of Compensated Absence Payable 13,564 Net adjustment to reduce fund balance for total

governmental funds to arrive at net assets for governmental

activities 5,428,362$

Explanation of aggregated differences between the governmental fund statement of revenues, expenditures, and changes in fund balances and the government-wide statement of activities The governmental fund statement of revenues, expenditures, and changes in fund balances includes a reconciliation between net changes in fund balances for total governmental funds and changes in net assets of governmental activities as reported in the government wide statement of activities. The details of the aggregated differences are presented below: Revenues in the statement of activities that do not provide current financial resources are not reported as revenues in the funds:

The value of donated assets is not included as revenue in the

fund statements 847,890

Governmental Activities Portion of Internal Service Fund net

revenue (72,118) Net adjustment to decrease change in fund balances of

governmental funds to arrive at change in net assets for

governmental activites 775,772$

Repayment of the principal of long-term debt consumes the current financial resources of governmental funds but has no effect on net assets:

Principal Payment G.O. Bonds 955,000$

Net Change in Interest Payable on Long Term Debt 40,186

Amortization of Premium/Discount (net) 834

Unfunded change in Liability for Compensated Absences (13,564)

Amortization of Bond Issuance Costs (3,259) Net adjustment to increase change in fund balances of


governmental activities 979,197$

Some expenses reported in the statement of activities do not require the use of current financial resources and therefore are not reported as expenditures in governmental funds:

Capital outlays reported as expenditures in the

governmental funds 2,399,315$

Depreciation expense not reported in fund statements (1,027,351)

Disposal of Capital Assets not reported in fund statements (10,878) Net adjustment to decrease change in fund balances of


governmental activites 1,361,087$


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NOTE 4 - DEPOSITS AND INVESTMENTS Deposits The Federal Deposit Insurance Commission (FDIC) insures the City’s deposits up to $100,000 and the Washington Public Deposit Protection Commission (PDPC) insures amounts over $100,000. The PDPC is a multiple financial institution collateral arrangement providing for additional assessments against members of the pool on a pro rata basis. Accordingly, the deposits covered by the PDPC are considered to be insured. Year-end deposits are included in Cash and Cash Equivalents on the Combined Balance Sheet. At December 31, 2006 the book carrying amount of the City's cash demand deposits with Key Bank was $509,015.72. On December 31, 2006 the City’s claims warrant account had a balance of (14,965.95) and the manual payroll warrant account balance was ($1,094.04). All other bank accounts had a positive balance. The book value of deposits does not differ materially from the bank balance of deposits and any differences have been accounted for as deposits in transit at the balance sheet date. Petty cash on hand totaled $3,770.00. Investments Washington State law authorizes investments in obligations of the U.S. Treasury, U.S. government agencies and instrumentality’s, bankers’ acceptances, primary certificates of deposit issued by qualified public depositories, the State Treasurer’s Local Government Investment Pool (a 2a7 like pool) and repurchase agreements collateralized by the previously authorized investments. At December 31, 2006, the City’s investments were held with government agencies and with the State Treasurer’s Local Government Investment Pool. Investments are carried at fair market value in accordance with GASB 31. Investments are categorized to give an indication of the risk assumed at year-end. The following summary shows the City's investments at year-end categorized by risk. Category 1 includes investments that are either insured, registered, or held by the City or its agent in the City's name. Category 2 includes uninsured and unregistered investments, which are held by the counterparty's trust department or agent in the City's name. Category 3 includes uninsured and unregistered investments for which the securities are held by the counterparty, or its trust department or agent, but not in the City's name. All investments of the City of Mercer Island are Category 1. Investments in the State Treasurer’s Local Government Investment Pool are not normally subject to risk categorization pursuant to GASB Statement 3. The City adopted GASB statement 40 for the year ending December 31, 2006, but does not currently have its own policy guiding custodial credit risk for investment securities. Investment in this pool is not evidenced by securities that exist in physical or book entry form in the name of the City. Therefore, this investment is treated as a type of investment with a market value equal to net realizable value of the City’s share of the pool based on the pool’s valuation method. Year-end investments in the pool are included in Cash and Investments on the Statement of Net Assets. Investment Type Category 1 Carrying Amount Market Value

Other Securities -$ -$ -$

Subtotal - - -

Non-Category InvestmentsState Investment Pool 31,732,712$ 31,732,712$

NOTE 5 – PROPERTY TAXES The King County Treasurer acts as an agent to collect property taxes levied in the County for all taxing authorities. Taxes are levied annually on January 1 on property value listed as of the prior May 31. Assessed values are established by the County Assessor at 100 percent of fair market value. A reevaluation of all property is required every two years. Taxes are due in two equal installments on April 30 and October 3l. Collections are distributed on a daily basis. The amount of taxes receivable at year end are recorded as receivables and offset by deferred revenue. Since state law allows for sale of property for failure to pay taxes, no estimate of uncollectible taxes is made. The City is permitted by law to levy up to $3.10000 per $1,000 of assessed valuation for general governmental services. This amount may be reduced for any of the following three reasons:

1. The Washington State Constitution limits the total regular property taxes to 1 percent of assessed valuation or $10 per $1,000 of value. If the taxes of all districts (except for ports and utility districts) exceed this amount, each is proportionately reduced until the total is at or below the l percent limit.


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2. Washington State law in RCW 84.55.010 limits the growth of regular property taxes to the lesser of inflation (as measured by the Implicit Price Deflator) or 101%, after adjustments. Inflation can be expected to exceed one percent; consequently, the levy lid will normally be 101%.

3. The City is allowed by law in RCW 84.55.050 to ask the voters to approve increases in excess of the

101% limit. A simple majority of voters can approve a “levy lid lift” that would increase the base for the following year. That base can be increased either forever, for a limited period of time, or for a particular purpose

Special levies approved by the voters are not subject to the above limitations. For 2006 the City's tax levy was $1.35283 per $1,000 on a total assessed valuation of $7,059,706,779 for a total levy of $9,550,023. The total property tax levy includes the regular statutory levy and special levies as detailed below:

General Levy 8,589,864$

1987 Lid Lift 460,000

2003 Lid Lift 435,159

GO Bonds 65,000

Total Levy 9,550,023$

NOTE 6 - INTERFUND TRANSFERS Transfers In and Transfers Out During the course of normal operations, the City has numerous transactions between City funds. Quasi-external transactions such as buying goods and services are recorded as revenues and expenditures/expenses. Reimbursements to a fund for expenditures previously paid that are more properly applicable to another fund are recorded as an expenditure in the reimbursing fund and a reduction of expenditure/expense in the fund receiving reimbursement. Significant transfers include; $1,000,000.00 from the Capital Improvement and $800,000 from the General fund to the Sewer fund for sewer lake line construction costs, $700,000 from the Contingency fund to the General fund to establish a LEOFF I long term care reserve, $232,000 from the General fund to the Technology fund for NORCOMM startup costs, and $69,000 from the General Fund to the Voted Debt Fund as a net property tax reduction. As a general rule the effect of interfund activity has been eliminated from the government-wide financial statements.


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The following is a Summary of Inter-fund Transfers:

Fund Transfer In Transfer Out Transfer In Transfer Out

General 700,000 (2,035,534)

Youth Services Endowment (3,000)

Street (11,230)

Beautification (119,366)

I-90 Landscape 64,366

Contingency 150,000 (700,000)

Municipal Arts 10,584

Youth & Family Services 468,000 (33,648)

Bond Redemption-Voted 69,000

Bond Redemption-NonVoted 372,839

Capital Improvement 164,339 (1,372,839)

Technology & Equipment 482,000 (18,375)

Subtotal Governmental Activities: 2,481,128 (4,293,991) Water 1,250 (10,153)

Sewer 1,801,250 (7,569)

Storm Drainage 2,500 (9,339)

Subtotal Business Type Activities: 1,805,000 (27,061) Computer Replacement 34,925

Equipment Rental

Subtotal Internal Service 34,925 0 Total Interfund Transfers 2,516,052 (4,293,991) 1,805,000 (27,061)

CONSOLIDATING ENTRYTRANSFERS IN 4,293,991 27,061

TRANSFERS OUT (4,293,991) (27,061)

NET TRANSFERS (1,777,939) 0 1,777,939 0

GOVERNMENTAL BUSINESS TYPE

NOTE 7 - LONG-TERM DEBT General obligation (G.O.) bonds are a direct obligation of the City, which pledges its full faith and credit for repayment. Payment of principal and interest is made from Debt Service Funds. There are two kinds of G.O. bonds: (1) non-voted or councilmanic, which the City can issue up to a specified limit without a vote of the people. These are funded from regular property tax revenues; and (2) voter-approved bonds, which require a vote of the people because a special (excess) property tax levy is required for bond repayment. The City presently has three Councilmanic bonds and two voter approved bonds. At December 31, 2006, the City had $96,281 available in debt service funds to service the general obligation bonds.


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General Obligation Bonds, Issuances, Redemptions, and Balances Outstanding

Date of Date of Interest Amount Beginning Amount Current Ending

Issue Final Rates Originally Unmatured Issued Period Unmatured

Maturity Issued Debt 1/1/2006 Reductions Debt 12/31/2006

*1996 Mida Refundi 8/26/96 12/1/08 3.5/5.15 3,680,000 1,255,000 0 400,000 855,000

1996 Refunding 8/26/96 12/1/08 4.4/5.2 2,680,000 1,005,000 0 310,000 695,000

*CCMV Property 5/18/03 6/1/17 2.0/3.6 2,290,000 1,960,000 0 165,000 1,795,000

*CCMV Constructio 10/1/04 12/1/23 2.5/4.4 2,040,000 1,940,000 0 80,000 1,860,000

Total GO Bonds 10,690,000$ 6,160,000$ -$ 955,000$ 5,205,000$

*Councilmanic Bonds The 2003 CCMV Property Bond issuance is presented in the Statement of Net Assets net of the related Premium. The total bonds payable plus premiums net of amortization are as follows:

Bonds Outstanding 1,795,000$

Plus Un-Amortized Bond Premium 10,331

Bonds Outstanding Net 1,805,331$

The 2004 CCMV Property Bond issuance is presented in the Statement of Net Assets net of the related discount. The total bonds payable minus unamortized discount is as follows:

Bonds Outstanding 1,860,000$

Less Un-Amortized Bond Discount 1,793

Bonds Outstanding Net 1,861,793$ Public Works Trust Fund Debt, Issuances, Redemptions and Balances Outstanding

Date of Date of Interest Amount Beginning Amount Current Ending

Issue Final Rate Originally Unmatured Issued Period Unmatured

Maturity Issued Debt 1/1/2006 Reductions 12/31/2006

Water Booster Pump 5/1/88 7/1/08 1.0% 248,906 41,196 0 13,731 27,465

Sewer Emer Generator 5/1/88 7/1/08 1.0% 290,551 45,878 0 15,292 30,586

Sewer Pump Rehab. II 11/6/92 7/1/11 1.0% 368,625 124,085 0 17,726 106,359

Sewer Lake Line 1/31/05 7/1/08 1.5% 500,000 375,000 500,000 125,000 750,000

Total PWTF Debt 586,159$ 500,000$ 171,749$ 914,410$ In 2005 the City of Mercer Island entered into a new agreement with Washing State Public Works Board to partially fund the preconstruction phase of a sewer lake line replacement project. The Pre-Construction Public Works Trust Fund (PWTF) Loan agreement totals $1,000,000. The first loan draw, in the amount of $500,000, was taken in 2005 with the remaining balance drawn in 2006. The principal and interest payments will be made from the Sewer Fund. There are a number of other limitations and restrictions contained in the various bond indentures. The City is in compliance with all significant limitations and restrictions.


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Annual Debt Service Requirements to Maturity

YEAR PRINCIPAL INTEREST PRINCIPAL INTEREST

2007 990,000 201,260 171,750 5,394

2008 865,000 157,959 171,750 3,052

2009 440,000 119,701 142,726 2,584

2010 255,000 102,651 142,726 2,407

2011 255,000 94,694 142,726 2,230

2012 260,000 86,305 142,731 2,052

2013 265,000 77,514 0 0

2014-2023 1,875,000 344,536 0 0

TOTAL 5,205,000 1,184,620 914,410 17,718

GOVERNMENTAL ACTIVITES BUSINESS TYPE ACTIVITES

Changes in Long Term Liabilities Long term liability activity for the year ended December 31, 2006 was as follows:

Beginning Balance Additions Reductions

Ending Balance

Due Within One Year

Governmental ActivitiesBonds Payable:

General Obligation Bonds 6,160,000 0 (955,000) 5,205,000 990,000

Deferred Amounts:

Issuance Discounts (1,898) 105 (1,793)

For Issuance Premiums 11,270 (939) 10,331

Total Bonds Payable 6,169,372 0 (955,834) 5,213,538 990,000

Salaries Payable 227,194 227,194

Compensated Absences 901,386 10,617 912,003 0 Total Governmental Activity

Long Term Liabilities 7,297,951 10,617 (955,834) 6,352,735 990,000

Business Type ActivitiesPWTF Loans 586,160 500,000 (171,750) 914,410 171,750

Compensated Absences 77,294 19,920 0 97,214 Total Business Type Activity

Long term Liabilities 663,454 519,920 (171,749) 1,011,624 171,750 Internal service funds predominantly serve the governmental funds. Accordingly, long-term liabilities for them are included as part of the above totals for governmental activities. At year end $2,164 of internal service funds compensated absences are included in the above amounts. Compensated absences for governmental activities are liquidated in the governmental fund from which the employee's salary is paid.


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NOTE 8 – CAPITAL ASSETS Changes in Capital Assets – Governmental Activities

Balance BalanceAsset C lass 12/31/2006 Add itions Deletions 12/31/2006

Cap ita l A ssets Not Bein g D epreica ted

Land 89 ,233 ,993$ 1 ,173 ,080$ 90 ,407 ,073$

In frastructu re 4 ,465 ,448 960 ,626 5 ,426 ,074$

D eprec iated 93 ,699 ,441 2 ,133 ,706 - 95 ,833 ,147

Cap ita l A ssets Bein g D epreica ted

Bu ild in gs 22 ,224 ,273 861 ,406 23 ,085 ,679

Improvemen ts 7 ,872 ,367 95 ,196 (13 ,597 ) 7 ,953 ,966

Mach inery & Equ ipmen t 2 ,710 ,291 156 ,896 2 ,867 ,187

Mach inery & Equ ipmen t - IS 6 ,039 ,465 232 ,368 (137 ,127 ) 6 ,134 ,706

In tang ib les 681 ,579 681 ,579

Tota l Cap ita l A ssets Bein g D eprec ia ted 39 ,527 ,975 1 ,345 ,867 (150 ,724 ) 40 ,723 ,118

Less A ccum D eprec ia tion For:

Bu ild in gs (3 ,057 ,982 ) (492 ,526 ) (3 ,550 ,508 )

Improvemen ts (2 ,066 ,369 ) (206 ,636 ) 2 ,719 (2 ,270 ,286 )

Mach inery & Equ ipmen t (1 ,883 ,881 ) (259 ,107 ) (2 ,142 ,988 )

Mach inery & Equ ipmen t - IS (4 ,398 ,725 ) (476 ,468 ) 125 ,663 (4 ,749 ,530 )

In tang ib les (351 ,857 ) (69 ,082 ) (420 ,939 )

Tota l A ccum D eprec ia tion (11 ,758 ,814 ) (1 ,503 ,819 ) 128 ,383 (13 ,134 ,251 )

Tota l Net D eprec iab le Cap ita l A ssets 27 ,769 ,161 (157 ,952 ) (22 ,341 ) 27 ,588 ,867

Total G overnmental Cap ital Assets - N ET 121,468,602$ 1,975,754 (22,341) 123,422,014$ Asset Useful Lives Estimated Service Life Buildings 30-50 years Improvements Other Than Buildings 10-50 years Equipment 5-10 years


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Changes in Capital Assets - Business Type Activities

Asset Class

En terprise

Funds Add itions Tota l

Cap ita l A sset Not Being Deprecia ted

Land 203 ,992$ 203 ,992$

Tota l Cap ita l A sset Not Being Deprecia ted 203 ,992 0 203 ,992

Cap ita l A ssets Being D epreciated

In tang ib les 18 ,804 18 ,804

Bu ild ings 222 ,293 103 ,466 325 ,759

Improvements O .T.B. 43 ,604 ,775 1 ,357 ,433 44 ,962 ,208

Mach inery & Equ ipment 1 ,675 ,842 1 ,675 ,842

Accumulated Depreciation (21 ,249 ,303 ) (1 ,209 ,586 ) (22 ,458 ,889 )

Tota l Net D epreciab le Cap ita l A ssets 24 ,272 ,411 251 ,313 24 ,523 ,724

Tota l Business Type Cap ita l A ssets-NET 24 ,476 ,403$ 251 ,313$ 24 ,727 ,716$

Depreciation expense was charged to functions/programs of the primary government as follows: Governmental Activities

General Government 211,473$

Public Safety 212,220

Physical Environment 33,483

Transportation 0

Economic Environment 50,363

Mental Health 24,275

Culture and Recreation 495,537

Capital Assets held by Internal Service Funds are charged to the

various functions based on their usage of the assets 476,468

Total Depreciation Expense - Governmental Activities 1,503,819$

Business Type ActivitiesWater 694,616$

Sewer 411,725

Stormwater 103,245

Total Depreciation Expense - Business Type Activities 1,209,586$ NOTE 9 - RISK MANAGEMENT The City maintains insurance against most normal hazards, but has elected to become self-insured for property damage up to $5,000. At December 31, 2006 the total reserved for self insurance claims was $107,851.00. The City of Mercer Island is a member of the Washington Cities Insurance Authority (WCIA). Utilizing Chapter 48.62 RCW (self-insurance regulation) and Chapter 39.34 RCW (Interlocal Cooperation Act), nine cities originally formed WCIA on January 1, 1981. WCIA was created for the purpose of providing a pooling mechanism for jointly purchasing insurance, jointly self-insuring, and/or jointly contracting for risk management services. To date, WCIA has a total of 115 members.


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New members initially contract for a three year term, and thereafter automatically renew on an annual basis. A one year withdrawal notice is required before membership can be terminated. Termination does not relieve a former member from its unresolved loss history incurred during membership. Liability coverage is written on an occurrence basis, without deductibles. Coverage includes general, automobile, police professional, public officials’ errors or omissions, stop gap, and employee benefits liability. Limits are $3 million per occurrence in the self insured layer, and $11 million per occurrence in the re-insured excess layer with no annual aggregate except $10 million per member for public officials’ errors and omissions. The excess layer is insured by the purchase of reinsurance and insurance. Total limits are $14 million per occurrence. The Board of Directors determines the limits and terms of coverage annually. Insurance coverage for property, automobile physical damage, fidelity, inland marine, and boiler and machinery are purchased on a group basis. Various deductibles apply by type of coverage. Property insurance and auto physical damage are self-funded from the members’ deductible to $500,000, for all perils other than flood and earthquake, and insured above that amount by the purchase of reinsurance. In-house services include risk management consultation, loss control field services, claims and litigation administration, and loss analysis. WICA contracts for the claims investigation consultants for personnel issues and land use problems, insurance brokerage and lobbyist services. WCIA is fully funded by its members, who make annual assessments on a prospectively rated basis, as determined by an outside, independent actuary. The assessment covers loss, loss adjustment, and administrative expenses. As outlined in the interlocal, WCIA retains the right to additionally assess the membership for any funding shortfall. WCIA made no additional assessments to members in the current period or the prior three years. An investment committee, using investment brokers, produces additional revenue by investment of WCIA's assets in financial instruments which comply with all State guidelines. These revenues directly offset portions of the membership's annual assessment. A Board of Directors governs WCIA, which is comprised of one designated representative from each member. The Board elects an Executive Committee and appoints a Treasurer to provide general policy direction for the organization. The WCIA Executive Director reports to the Executive Committee and is responsible for conducting the day to day operations of WCIA. NOTE 10 - PENSION PLANS Substantially all of the City's full-time and qualifying part-time employees participate in one of the following statewide local government retirement systems administered by the Washington State Department of Retirement Systems, under cost-sharing multiple-employer public employee defined benefit and defined contribution retirement plans. The Department of Retirement Systems, a department within the primary government of the State of Washington, issues a publicly available comprehensive annual financial report that includes financial statements and required supplementary information for each plan. A copy of this report may be obtained at:

Department of Retirement Systems Communications Unit PO Box 48380 Olympia, WA 98504-8380

Public Employees’ Retirement System (PERS) The state legislature established PERS in 1947 under Chapter 41.40 RCW. PERS is a cost-sharing multiple-employer retirement system comprised of three separate plans for membership purposes. Plans 1 and 2 are defined benefit plans and Plan 3 is a combination defined benefit/defined contribution plan. Membership in the plan includes elected officials, state employees, employees of the Supreme, Appeals, and Superior courts (other than judges), employees of legislative committees, college and university employees not in national higher education retirement programs, judges of district and municipal courts, non-certificated employees of school districts, and employees of local government. PERS participants who joined the system by September 30, 1977, are Plan 1 members. Those who joined on or after October 1, 1977 and by either, February 28, 2002 for state and higher education employees, or August 31, 2002 for local government employees, are Plan 2 members unless they exercise an option to transfer their membership to Plan 3. PERS participants joining the system on or after March 1, 2002 for state and higher


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education employees, or September 1, 2002 for local government employees have the option of choosing membership in either PERS Plan 2 or PERS Plan 3. The option must be exercised within 90 days of employment, those who fail to choose will default to PERS Plan 3. Retirement benefits are financed from employee and employer contributions and investment earnings. Retirement benefit provisions are established in state statute and may be amended only by the state legislature. PERS Plan 1 retirement benefits are vested after an employee completes five years of eligible service. Plan 1 members are eligible for retirement at any age after 30 years of service, or at age 60 with 5 years of service, or at age 55 with 25 years of service. The annual pension is 2 percent of the average final compensation per year of service, capped at 60 percent. The average final compensation is based on the greatest compensation during any 24 eligible consecutive compensation months. If qualified, after reaching age 66, a cost of living allowance is granted based on years of service credit and is capped at 3 percent annually. PERS Plan 2 retirement benefits are vested after an employee completes five years of eligible service. Plan 2 members may retire at age 65 with 5 years of service, or at age 55 with 20 years of service, with an allowance of 2 percent per year of service of the average final compensation. The average final compensation is based on the greatest compensation during any 60 eligible consecutive compensation months. Plan 2 retirements prior to age 65 are actuarially reduced. There is no cap on years of service credit and a cost-of-living allowance is granted, capped at 3 percent annually. PERS Plan 3 has a dual benefit structure. Employer contributions finance a defined benefit component, and member contributions finance a defined contribution component. The defined benefit portion provides a benefit calculated at 1 percent of the average final compensation per year of service. The average final compensation is based on the greatest compensation during any eligible consecutive 60 month period. Plan 3 members become eligible for retirement if they have: at least ten years of service; or five years including twelve months that were earned after age 54; or five service credit years earned in PERS Plan 2 prior to June 1, 2003. Plan 3 retirements prior to the age of 65 receive reduced benefits. If retirement is at age 55 or older with at least 30 years of service, a 3 percent per year reduction applies; otherwise an actuarial reduction will apply. There is no cap on years of service credit; Plan 3 provides the same cost of living allowance as Plan 2. The defined contribution portion can be distributed in accordance with an option selected by the member, either as a lump sum or pursuant to other options authorized by the Employee Retirements Benefit Board. Each biennium, the state Pension Funding Council adopts Plan1 employer contribution rates, Plan 2 employer and employee contribution rates, and Plan 3 employer contribution rates. Employee contribution rates for Plan 1 are established by statute at six percent and do not vary from year to year. The employer and employee contribution rates for Plan 2 and the employer contribution rates for Plan 3 are developed by the Office of the State Actuary to continue to fully fund Plan 2 and the defined benefit portion of Plan3. All employers are required to contribute at the level established by state law. The methods used to determine the contribution requirements are established under state statute in accordance with Chapters 41.40 and 41.45 RCW. The required contribution rates expressed as a percentage of current year covered payroll, as of December 31, 2006 were:

PERS Plan 1 PERS Plan 2 PERS Plan 3 Employer* 3.69% 3.69% 3.69%

Employee 6.00% 3.50% The City of Mercer Island's current-year covered payroll for the fiscal year ended December 31, 2006 was $6,876,572 ($349,685 for PERS 1, $5,857,665 for PERS 2 and $669,222 for PERS 3). The City's total current-year covered payroll for all employees was $11,907,343. Both the City of Mercer Island and the employees made the required contributions. The City of Mercer Island’s required contributions for the years ended December 31, 2006 were:

PERS Plan 1 PERS Plan 2 PERS Plan 32006 10,837 181 ,875 20 ,405

2005 5,940 103 ,071 13 ,306

2004 4,229 70 ,852 10 ,004


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Law Enforcement Officers' and Fire Fighters' Retirement System (LEOFF) LEOFF was established in 1970 by the Legislature under Chapter 41.26 RCW. LEOFF is a cost-sharing multiple-employer defined benefit retirement system. Membership includes all full-time, fully compensated, local law enforcement officers and fire fighters. LEOFF is comprised primarily of non-state employees. The LEOFF system includes two defined benefit pension plans. Participants who joined the system by September 30, 1977, are Plan 1 members. Those who joined thereafter are enrolled in Plan 2. Retirement benefits are financed from employee and employer contributions, investment earnings and legislative appropriations. Retirement benefits for both plans are vested after completion of 5 years of eligible service. Retirement provisions are established in state statute and may be amended only by the state legislature. Plan 1 participants are eligible to retire with five years of service at age 50. The benefit per year of service is as follows, with a cost of living allowance granted, capped at 3 percent annually:

T e rm O f Se rv ic e P e rc e nt o f F inal A v e rag e Salary20 or m ore ye a rs 2.0%10 but le ss tha n 20 ye a rs 1.5%5 but le ss tha n 10 ye a rs 1.0%

The final average salary is based on salary received during the last two years of service. Substantial disability and death benefits are provided by the plan. Retirement benefits are indexed to the Seattle area consumer price index. Plan 2 participants are eligible to retire at age 50 with 20 years of service or at age 53 with 5 years of service. Retirement benefits prior to age 53 are actuarially reduced. The benefit is 2 percent of average salary per year of service. The average salary is based on the highest consecutive 60 months. There is no cap on years of service credit and a colt of living allowance is granted, capped at 3 percent annually. Death and disability benefits are also provided. These benefit provisions were established under the authority of legislative statute. Plan 1 employer and employee contribution rates are established by statute, and the state is responsible for the balance of the funding at rates set by the Pension Funding Council to fully amortize the total costs of the plan. Employer and employee rates for Plan 2 are set by the director of the Department of Retirement Systems based on recommendations by the Office of the State Actuary to continue to fully fund the plan. Plan 2 employees are required to contribute at the level required by state law. The methods used to determine the contribution rates are established under state statute in accordance with Chapters 41.26 and 41.45 RCW. During the 1997 legislative session a portability benefit was provided for members of LEOFF I who later established membership in another system. The portability benefit will increase state contribution rates .01 percent of salary. The required contribution rates expressed as a percentage of covered payrolls, as of December 31, 2006 were:

LEOFF P lan 1 LEOFF P lan 2Emp loyer 0 .18% 4 .90%

Emp loyee 0 .00% 7 .85%

State 3 .13% The City of Mercer Island's current-year covered payroll for the fiscal year ended December 31, 2006 was $5,030,771. ($153,581 for LEOFF 1 and $4,877,190 for LEOFF 2). The City's total current-year covered payroll for all employees was $11,907,343. Both the City of Mercer Island and the employees made the required contributions. The City of Mercer Island’s required contributions for the years ended December 31, 2006 were:

LEOFF P lan 1 LEO FF P lan 22006 2 8 7 2 2 7 ,3 1 3

2005 4 3 7 1 6 8 ,0 5 4

2004 6 6 1 1 3 5 ,6 6 8 Other Retirement Systems - Volunteer Fire Fighters' Relief and Pension Fund The Volunteer Fire Fighters' Relief and Pension Fund System is a cost-sharing multiple-employer retirement system which was created by the Legislature in 1945 under Chapter 41.24 RCW. It provides pension, disability


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and survivor benefits. Membership in the system requires service with a fire department of an electing municipality of Washington State except those covered by LEOFF. The system is funded through member contributions of $30 per year; employer contributions of $30 per year; and 40 percent of the Fire Insurance Premium Tax and earnings from the investment of moneys by the Washington State Investment Board. Members do not earn interest on their contributions, however, they may elect to withdraw their contribution upon termination. Local Government Pension Trust Funds - Firemen's Pension Fund In addition to the two statewide retirement systems, the City is itself the administrator of a Firemen's Pension System, which is shown as a pension trust fund in the financial reports of the City. As of December 31, 2006, there were a total of nine individuals covered by this system, nine of whom are retired and six of whom qualified to receive benefits during 2006 The Firemen’s Pension Plan (FPP), is a closed, single-employer defined benefit pension plan established in conformance with Revised Code of Washington (RCW) 41.18. The Plan provided retirement and disability benefits, annual cost of living adjustments, and death benefits to Plan members and beneficiaries. Retirement benefit provisions are established in state statute and may be amended only by the State Legislature. Membership is limited to firefighters employed prior to March 1, 1970 when the LEOFF retirement system was established. The City’s obligation under the Plan consists of paying the difference between pension and medical benefits provided by LEOFF and those provided by the FPP for covered firefighters who retire after March 1, 1970. No separate financial report is issued for the plan. Accordingly, the required supplemental information is included in this note. Under State law, the FPP is provided an allocation of 25% of all moneys received by the State from taxes on fire insurance premiums. Other funding sources include interest earnings, member contributions made prior to the inception of LEOFF, and City contributions required to meet projected future pensions obligations. The most recent actuarial study of the system was done by Milliman & Robertson, Inc. to determine the funding requirements as of January 1, 2004. As of that date, the market value of the net plan assets (current assets plus present value of future fire insurance premium taxes) was $405,000 and the total pension benefit obligation was $1,234,000, leaving an unfunded pension benefit obligation of $829,000. Since no new members have entered this pension plan since October 1, 1977, the City had not adopted a plan to fund the actuarial liability, but was paying benefits as they came due. As of December 31, 2004, there had been only small payments made to any members. However, subsequent to the end of fiscal year 2004, the City Council allocated the entire unfunded actuarial liability of $829,000 to the Firemen’s Pension Fund to totally fund the liability.

Valuation Date January 1, 1997 January 1, 2004

Actuarial Value of Assets 196 250

Present Value of Future Fire Insurance Premiums

Actuarial Liabilities - Entry Age 1023 1234

Unfunded Actuarial Liabilities (UAL) 827 984

Funded Ratio 19% 20%

Covered Payroll 127 0

UAL as a Percentage of Covered Payroll 649 N/A

Firemens Pension Fund - Schedule of Funding Progress(in thousands)

Fiscal Year Ending 12/31 1997 1998 1999 2000 2001 2002 2003 2004

Actual Employer Contributions 0 0 0 0 0 0 0 0

Fire Insurance Premiums 19,291 16,558 20,342 12,003 15,410 15,392 17,424 19,402

Disbursements 8,020 0 0 0 0 0 0 0

Total Employer Contributions 11,271 16,558 20,342 12,003 15,410 15,392 17,424 19,402

Annual Required Contribution (ARC) 70,048 70,048 70,048 70,048 70,048 66,616 66,616 75,385

Percentage of ARC Contributed 16% 24% 29% 17% 22% 23% 26% 26%

Firemens Pension Fund - Schedule of Employer Contributions


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Other Post-employment Benefits The only post-employment benefit provided to City employees is post-retirement health care benefits, to LEOFF 1 retirees (in accordance with State statutes). Currently, 36 retirees meet those eligibility requirements. The City provides medical insurance and reimburses for all validated claims for medical, dental, and hospitalization costs incurred by these retirees. Expenditures for post-retirement health care benefits are recognized as retirees report claims. During the year, expenditures of $412,407 were recognized for post-retirement health care. The city will meet its future liability for extended medical care costs for these LEOFF 1 retirees through a combination of third party insurance and direct payment of excess medical costs. NOTE 11 - FUND EQUITIES Governmental Fund Types Reservations of Fund Balance. The City recognizes that some of the assets occasionally carried in governmental funds are not available resources and thus are not legally available for appropriation. Current examples are inventory and petty cash or change funds. In addition, City management may reserve “rainy day” funds. Current examples are the Sales Tax Revenue Reserve and the Emergency Reserve. When this is the case, fund balance is "reserved" for the amounts not available.

Proprietary Fund Type Contributed capital in proprietary funds (Water Revenue, Sewer Revenue, Storm Water Management, Computer Replacement and Equipment Rental) represents contributed capital assets, or contributions for capital asset acquisition, from other funds, governments, customers and developers. Operating reserves are maintained in each of the utility funds in accordance with the City’s Management and Budget Policies. In addition, a capital reserve has been created in the Sewer Fund to set aside funds for the future replacement of the City’s sewer lake line NOTE 12 – OTHER DISCLOSURES Close Out of Funds 165 and 065 – MIYFS Foundation The MIYFS Foundation was established as an IRS designated 501(c)3 tax exempt organization. The primary purpose of the Foundation is fund raising efforts to support the programs of the City’s Youth and Family Services Department. As a 501(c)3, the Foundation has a Board of Directors which is responsible for its financial oversight, including fundraising efforts and budget spending decisions. The Foundation supports only City of Mercer Island Youth and Family Services programs, as such, it was historically included as a fund of the City under the definitions of a blended component unit as directed by the Governmental Accounting Standards Boards Statement 34. The Foundation was divided into two City funds, Fund 165 MIYFS Foundation Special Revenue Operating Fund and Fund 065 the MIYFS Permanent Endowment Fund. At the beginning of 2006 the MIYFS Foundation Board of Directors made the decision to end their agreement with the City of Mercer Island for the management of cash and accounting functions. As a result, the entire balance of both the MIYFS Foundation Fund and the MIYFS Permanent Endowment Fund was remitted to the Foundation Board of Directors whose designated Treasurer now performs all cash control and accounting functions. NOTE 13 – SUBSEQUENT EVENTS

1. The City of Mercer Island has committed to constructing replacement sections of its Sewer Lake Line located just off the shoreline in two separate areas: between SE 32nd Street to Roanake Way, and between 76TH Ave and 80TH Ave SE. These sections of sewer line were originally constructed in the mid-1950’s with asbestos-cement pipe in Lake Washington along the near shore area at the north end of the Island. The pipe is currently in a deteriorated state and is subject to recurring leaks and breaks. Partial financing for this extensive project will come from loan agreements with the state Public Works Board in the form of Public Works Trust Fund Loans (PWTF). The PWTF loans are in two separate agreements, one for Preconstruction and an additional loan for the construction phase.

The Preconstruction loan, in the amount of $1 Million was approved in May of 2005. The preconstruction phase of the project included design and engineering estimates. An initial draw of $500,000 was taken in 2005. The second half of the preconstruction loan was drawn in July of 2006. The preconstruction phase of the project will be substantially complete at year end 2006.


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The Construction phase of the Sewer Lake Line Project will be partially funded by a $7 Million PWTF loan. A loan agreement with the Public Works Board was entered into by the City on July 18, 2006. Construction of the Sewer Lake Line replacement is scheduled to begin in 2008.

2. At its regular business meeting on September 17, 2007 the Mercer Island City Council authorized the

execution of an Inter-local Agreement to form the North East King County Regional Public Safety Communications Agency (NORCOMM), and to authorize Mercer Island to participate as a Principal. As a Principal participant, Mercer Island will be making a significant investment in capital equipment as well as incurring ongoing operational expenses.

3. At its regular business meeting on September 17, 2007 the Mercer Island City Council authorized the

contract with Pierce Manufacturing to purchase one Mini Pumper Fire Truck through a Lease Purchase financing agreement with Municipal Asset Management Inc. in the amount of $251,982

4. At its regular business meeting on June 18, 2007 the Mercer Island City Council authorized the contract

with Pierce Manufacturing to purchase two Velocity Pumper Fire Trucks through a Lease Purchase financing agreement with Municipal Asset Management Inc. in the amount of $1,035,026.00.

NOTE 14 - CONTINGENT LIABILITIES AND LITIGATION There are various contingent liabilities and pending legal actions which City officials consider routine and part of the ordinary course of business. In the opinion of City officials, adequate provision has been made for any losses which may reasonably be foreseen. In the opinion of the City's legal advisor, there are no claims or actions pending against the City whose adverse outcome would pose a threat to continued City operations, or materially alter the financial condition of the City. NOTE 15 - JOINT VENTURE/RELATED PARTY Eastside Public Safety Communications Agency The Eastside Public Safety Communications Agency (EPSCA), an emergency regional radio access service, was established on May 26, 1992, by an Interlocal Agreement (Agreement 1), pursuant to the Interlocal Cooperation Act, Chapter 39.34 RCW, among the Cities of Bellevue, Redmond, Kirkland and Mercer Island (Principals), municipal corporations organized under the laws of the State of Washington. Agreement 1 was amended June 10, 1993, to include the City of Issaquah as an additional principal in EPSCA's governance. The duration of this agreement was for ten years, and under the terms set forth in Resolution R-18 as approved by majority vote of the Executive Board in regular open meeting on April 11, 2002 it was extended for a subsequent five year period until May 18, 2007. EPSCA began principal operations in December 1995. EPSCA is governed by an Executive Board (Board), which is composed of the Chief Executive officers of the Principals. The Executive Board is responsible for review and approval of all budgetary, financial and contractual matters. An Operations Committee (Committee) composed of the Chief of Police and Fire Chief of each principal, reports to the board and oversees budget preparation, rates, revenues, expenditures, policies and other operational issues. The Committee also includes representation from non-principal EPSCA user agencies. EPSCA has developed an Eastside radio communications system which is integrated with a regional radio communications network. Its capital funding derives from a September 15, 1992, voter-approved King County excess property tax levy of $57,016,764. EPSCA's portion of the levy was $10,004,469. Operating revenues derive from fees charged to the Principals for communications services and from subscriber fees for communications services. Agreement 1 provides for a weighted vote according to the proportion of each Principal's system radios in relation to the total number of system radios used by all Principals. As of December 31, 2006, the weighted vote was as follows: Bellevue 51.930 % Kirkland 17.790 % Redmond 18.140 % Mercer Island 6.510 % Issaquah 5.640 % 100.000 %


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These percentages are reviewed and adjusted annually at January 1 based on the number of radios on the system in use by current principals as of December 31 of the preceding year. Upon dissolution, Agreement 1 provides for distribution of retained earnings among the Principals based on the weighted voting percentages in force at the time of dissolution. Any property contributed without charge would revert to the contributing Principal. In August of 1993, EPSCA entered into an Interlocal Cooperation Agreement (Agreement 2), pursuant to Chapter 39.34 RCW, with King County, Seattle, and Valley Communications (Sub regions), municipal corporations organized under the laws of the State of Washington. Agreement 2 governs the development, acquisition and installation of the emergency radio communication system (System). Agreement 2 provides that upon voluntarily termination of any Sub region’s participation in the System, it surrenders its radio frequencies, relinquishes its equipment and transfers any unexpended levy proceeds and equipment replacement reserves to another Sub region or a consortium of Sub regions. Thus, in accordance with Agreement 2, the Principals of EPSCA have no equity interest in EPSCA's contributed capital ($10,502,938 from King County levy proceeds) as of December 31, 2004. Capital contributed to Mercer Island as of December 31, 2004 amounted to $344,692. While Agreement 1 provides that EPSCA's retained earnings of $501,725, as of December 31, 2006, are to be apportioned among the Principals, Mercer Island's prorata share ($32,663) is deemed immaterial and thus is not reflected in its financial statements. Complete audited financial statements for EPSCA can be obtained from EPSCA c/o Jessie Morgan, 16100 N.E. 8th Street, Bellevue, Washington 98004. ARCH – Housing Coalition In November 1992, the cities of Bellevue, Kirkland, Redmond, and King County joined to establish A Regional Coalition for Housing (ARCH). The agreement was amended in January 1993 to add clarifying language regarding responsibility and disillusionment. Subsequently, the cities of Bothell, Issaquah, and Woodinville joined ARCH. Mercer Island joined ARCH in March, 1994. The purpose of ARCH is to cooperatively formulate affordable housing goals and policies and to foster efforts to provide affordable housing by combining public funding with private-sector resources. Operating funding is provided by the member cities. ARCH identifies and prioritizes projects which the member cities fund directly through their own grants, Community Development Block Grants, and HUD grants. ARCH is governed by an Executive Board composed of the chief executive officer from each member agency. The Executive Board is responsible for review and approval of all budgetary, financial, policy, and contractual matters. The Board is assisted by an administrative staff and a Citizen Advisory Board. Each member city is responsible for contributing operating revenues as determined from the ARCH annual budget. Contributions from the member cities are based on each member’s population. Members withdrawing from the agreement relinquish all rights to any reserve funds, equipment, or material purchased. Upon dissolution, the agreement, as amended, provides for distribution of net assets among the members based on the percentage of the total annual contributions during the period of the Agreement paid by each member. The City’s share of net assets is deemed immaterial and thus is not reflected in the financial statement. Budget monitoring information can be obtained from ARCH, c/o Art Sullivan, 16625 NE 87th Street, Redmond, WA 98052. Eastside Narcotics Task Force In August 1998, the Cities of Mercer Island, Bellevue, Redmond, Kirkland, and Issaquah (Principals) restructured the Eastside Narcotics Task Force. The purpose of the task force is to provide for the collaborative efforts of participants’ detective staffs and to equitably benefit from asset forfeitures. The task force is governed by an Executive Board consisting of the Police Chiefs and Directors of Public Safety. The Executive Board is responsible for formulating policy, establishing annual budgets, and acquiring, holding, and disposing of real and personal property. The Task Force is managed by a Commander who is responsible for the operation of the task force and the accomplishment of the goals and objectives of the task force.


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Upon termination of the Task Force, equipment and proceeds will be divided equitably as determined by the board. Member agencies share in the costs and proceeds of the operation of the Task Force on a percentage basis. The member agencies shares are:

Mercer Island 14.7% Bellevue 51.0% Redmond 14.7% Kirkland 14.7% Issaquah 4.9%

Total revenues for fiscal year 2006 (ending June 30, 2006) were $418,438. Total Expenditures for fiscal year 2006 were $263,497. Any difference in revenue and expenditures is either added to or taken from the Task Force reserves. The Cities share of the net assets is deemed immaterial and thus is not reflected in the financial statements. Budget monitoring information can be obtained from Eastside Narcotics Task Force, c/o Carl Krikorian, Police Finance Director, Bellevue Police Finance Manager, 11511 Main Street Bellevue, WA 98004. E-Gov Alliance In March 2002 the City of Mercer Island joined the Cities of Bellevue, Bothell, Burien, Issaquah, Kenmore, Kirkland, Sammamish and Woodinville in forming the E-Gov Alliance. The Alliance establishes on-line services through a jointly operated internet portal. Additionally, the Alliance has established a partnership with Microsoft to help define the E-Gov architecture, provide consulting services, offer training, and donated software. The inter-local agreement may be terminated if Principals holding at least sixty percent (60%) of the weighted vote of all of the Principals are in concurrence. Upon termination, all property acquired shall be disposed of as follows: (1) property contributed without charge by any member shall revert to the contributor, (2) all property purchased after the effective date of the inter-local agreement shall be distributed to the Principals based upon each Principals proportional ownership interest at the time of the sale of the property. The Cities share of the net assets is deemed immaterial and thus is not reflected in the financial statements. Budget monitoring information may be obtained from Nina Dennis, City of Bellevue, Information Technology Department, PO Box 90012, Bellevue, WA 98009.


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City of Mercer IslandGeneral Fund

Schedule of Revenues, Expenditures, and Changes in Fund Balances - Budget and ActualFor the Year Ended December 31, 2006

Original Budget

Final Budget Actual for Biennium

Variance From Final

Budget Positive

(Negative) REVENUESTaxes:

Property 17,315,010$ 17,315,010$ 17,374,240$ 59,230$ Sales 4,260,000 4,260,000 5,290,272 1,030,272 B&O 4,877,000 4,877,000 5,606,564 729,564 Other 1,009,080 1,009,080 678,777 (330,303)

Licenses & Permits 3,123,000 3,123,000 3,782,173 659,173 Intergovernmental 1,216,091 1,219,591 753,182 (466,409) Charges for Services 2,819,628 2,819,628 2,257,261 (562,367) Fines & Forfeitures 540,000 540,000 565,169 25,169 Investment Earnings 200,000 200,000 858,339 658,339 Miscellaneous Revenues - 647,742 647,742

Total revenues 35,359,809 35,363,309 37,813,719 2,450,410

EXPENDITURESCurrent:

Judicial 521,839 521,839 527,987 6,148 General Government 5,697,139 6,163,525 3,377,357 (2,786,168) Public Safety 15,279,116 15,326,907 17,584,050 2,257,143 Physical Environ 3,280,100 3,280,100 98,746 (3,181,354) Transportation - 2,092,361 2,092,361 Health & Human Services - 4,375 4,375 Economic Environment 3,628,914 3,918,914 3,981,336 62,422 Culture & Recreation 5,562,701 5,573,701 5,642,254 68,553

Total expenditures 33,969,809 34,784,986 33,308,466 (1,476,520) Excess (deficiency) of revenues over

(under) expenditures 1,390,000 578,323 4,505,254 3,926,931

OTHER FINANCING SOURCES (USES)Transfers in - 700,000 700,000 Transfers out (1,430,000) (4,574,871) (4,596,917) (22,046) Disposition of capital assets - 270 270

Total other financing sources (uses) (1,430,000) (4,574,871) (3,896,647) 678,224

Net change in fund balances (40,000) (3,996,548) 608,607 4,605,155 Fund balances - Beginning 107,853 107,853 2,508,698 (2,400,845) Prior Period Adjustments - -

Fund balances - Ending 67,853$ (3,888,695)$ 3,117,307$ 2,204,310$

Budgeted Amounts

The notes to the Financial Statements are an intregal part of this statement ____________________________________________________________________________________________________________

Washington State Auditor's Office48

City of Mercer IslandStreet Fund

Schedule of Revenues, Expenditures, and Changes in Fund Balance - Budget and ActualFor the Year Ended December 31, 2006

Original Budget

Final Budget

Actual for Biennium

Variance From Final Budget

Positive (Negative)

REVENUESTaxes:

Other 1,850,500$ 2,455,000$ 2,651,916$ 196,916$ Intergovernmental 312,000 312,000 262,889 (49,111) Charges for Services - 30,599 30,599 Investment Earnings 35,000 35,000 257,791 222,791

Total revenues 2,197,500 2,802,000 3,203,195 401,195

EXPENDITURESCurrent:

Transportation 195,000 195,000 361,132 166,132 Capital Outlay:

Transportation 2,833,000 3,970,196 2,872,448 (1,097,748) Total expenditures 3,028,000 4,165,196 3,233,580 (931,617) Excess (deficiency) of revenues

over (under) expenditures (830,500) (1,363,196) (30,385) 1,332,812

OTHER FINANCING SOURCES (USES)Transfers in - 379,500 379,500 Transfers out (10,000) (10,000) (58,640) (48,640)

Total other financing sources (uses) (10,000) (10,000) 320,860 330,860

Net change in fund balances (840,500) (1,373,196) 290,476 1,663,672 Fund balances - Beginning 2,181,120 2,181,120 2,842,919 661,799 Prior Period Adjustments - -

Fund balances - Ending 1,340,620$ 807,924$ 3,133,395$ 2,325,471$

Budgeted Amounts



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(SAO FACTS.DOC - Rev. 07/07)

ABOUT THE STATE AUDITOR'S OFFICE

The State Auditor's Office is established in the state's Constitution and is part of the executive branch of state government. The State Auditor is elected by the citizens of Washington and serves four-year terms. Our mission is to work in cooperation with our audit clients and citizens as an advocate for government accountability. As an elected agency, the State Auditor's Office has the independence necessary to objectively perform audits and investigations. Our audits are designed to comply with professional standards as well as to satisfy the requirements of federal, state, and local laws. The State Auditor's Office has 300 employees who are located around the state to deliver our services effectively and efficiently. Approximately 65 percent of our staff are certified public accountants or hold other certifications and advanced degrees. Our regular audits look at financial information and compliance with state, federal and local laws on the part of all local governments, including schools, and all state agencies, including institutions of higher education. We also perform fraud and whistleblower investigations. In addition, we have the authority to conduct performance audits of state agencies and local governments. The results of our audits are widely distributed through a variety of reports, which are available on our Web site. We continue to refine our reporting efforts to ensure the results of our audits are useful and understandable. We take our role as partners in accountability seriously. We provide training and technical assistance to governments and have an extensive program to coordinate audit efficiency and to ensure high-quality audits. State Auditor Brian Sonntag, CGFM Chief of Staff Ted Rutt Chief Policy Advisor Jerry Pugnetti Director of Administration Doug Cochran Director of Audit Chuck Pfeil, CPA Director of Performance Audit Linda Long, CPA, CGFM Director of Special Investigations Jim Brittain, CPA Director for Legal Affairs Jan Jutte Local Government Liaison Mike Murphy Communications Director Mindy Chambers Public Records Officer Mary Leider Main number (360) 902-0370 Toll-free hotline for government efficiency (866) 902-3900 Web Site www.sao.wa.gov

City of Mercer Island

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