operating expenses and allow the utility to earn a fair and reasonable return on invested capital. Rates for the City of Hawthorne water system are established in accordance with an operating agreement and are subject to ratification by the Hawthorne City Council. Fees for other operating agreements are based on contracts nego- tiated between the parties. Utility Services derives non-regulated income from contracts with other private companies and municipalities to operate water systems and provide meter reading and billing services. It also leases commu- nication antenna sites, operates recycled water systems and conducts real estate sales of surplus properties. The Company maintains its accounting records in accordance with accounting principles  generally accepted in the United States of America and as directed by the regulatory commissions to which the Company’s operations are subject.The process of preparing financial statements requires the use of esti- mates on the part of management.The estimates used by management are based on historic experience and an understanding of current facts and circumstances. Management believes that the following accounting policies are critical because they involve a higher degree of complexity and judgement and can have a material impact on the Company’s results of operations and financial condition. Revenue Recognition. Revenue from metered customers includes billings to customers  based on monthly meter readings plus an estimate for unbilled revenue which represents water used between the last reading of the customer’s meter and the end of the accounting period. The unbilled  revenue amount is recorded as a current asset on the balance sheet under the caption “Unbilled Revenue.” At December 31, 2002, the unbilled revenue amount was $8.0 million and at December 31, 2001, was $7.3 million.The unbilled revenue amount is generally higher during the summer months when water sales are higher.The amount recorded as unbilled revenue varies depending on water usage in the preceding period, the number of days between meter reads for each billing cycle, and the number of days between each cycle’s meter reading and the end of the accounting cycle. Flat-rate customers are billed in advance at the beginning of the service period.The revenue  is prorated so that the portion of revenue applicable to the current accounting period is included in that period’s revenue.The portion related to a subsequent accounting period is recorded as unearned revenue on the balance sheet and recognized as revenue when earned in the subsequent accounting period.The unearned revenue liability was $1.7 million at December 31, 2002 and 2001. It is included in “Other accrued liabilities” on the balance sheet. Expense-balancing and Memorandum Accounts. Expense-balancing accounts and  memorandum accounts represent costs incurred, but not billed to Cal Water customers. The amounts included in these accounts relate to rate increases charged to the Company by suppliers of purchased water and purchased power, and increases in pump taxes. The Company does not record expense-balancing or  memorandum accounts in its financial statements as revenue, nor record a receivable until the CPUC has authorized recovery of the higher costs and customers have been billed. The accounts are only used to track the higher costs. The cost increases, which are beyond the Company’s control, are referred to as “offsetable expenses” because under certain circumstances they are recoverable from customers in future offset rate increases. In October 2001, the CPUC adopted a resolution implementing its staff’s interim recommen- dation concerning practices and policies that enable water utilities to recover cost increases in purchased water, purchased power and pump taxes.The interim recommendation directed that future Company requests  to recover offsetable expenses will be processed only if an operating district has filed a General Rate Case (GRC) application within a three-year period and the district is not earning more than its authorized rate of return on a forward-looking, pro forma basis. Neither of these requirements applied to offset rate increase recovery prior to adoption of the resolution.The CPUC also directed its staff to open a proceeding to evalu- ate offsetable expense recovery practices and policies and to recommend permanent revisions. CALIFORNIA WATER SERVICE GROUP 21 CRITICAL ACCOUNTING POLICIES