A $10.4 million discrepancy in the city’s utility fund has caused the city to fall out of compliance with its own fiscal policy and could affect next year’s water rates.

The inconsistency was discovered during a routine audit, city budget director Anne Seward said. City Manager Selena Cuffee-Glenn said the account was the responsibility of the finance department, where the director recently resigned under pressure.

Apparently, Seward said, the utility fund’s unrestricted cash line item was $10.4 million larger than it should have been. That money should have been in the restricted cash column. The total cash for the fund still was correct.

The discrepancy was present in June 2009, but was not caught by auditors, Seward said. It remained incorrect until June 2010, when the fiscal year ended and the audit began.

“There was just an error in the compilation,” Seward said.

Former finance director Dale Walker said the discrepancy predates his time with the city.

“About three years ago, there was an assistant finance director who made an entry to move some funds from restricted cash to unrestricted,” Walker said by phone Thursday. “Nobody who is there currently knows exactly why that entry was made, but yet we made that entry every year.”

Walker began working for the city in April 2009.

During Wednesday’s City Council meeting, City Manager Selena Cuffee-Glenn said the account “falls under the purview of the finance department” in response to a question from Councilman Charles Parr about who was responsible.

“Why did that happen? I don’t know, and it was way before my time, but I got nailed for it,” Walker said.

Now that the money must be transferred back to restricted funds, it puts the city out of compliance with a policy that states it must maintain a certain amount of cash in the unrestricted fund. It now has only about $850,000 there.

“We have to just be forthright about it,” Seward said.

The city will disclose the discrepancy to the credit rating agencies, Mayor Linda T. Johnson said.

“We don’t want any surprises with them, ever,” Johnson said.

The city’s policy gives it two years to come back into compliance with the minimum balance requirement. Some council members feared that could drive the water rates up slightly.

“The water rate is really predicated upon what it costs to operate the utility system,” Seward said. The young utility system and slowdown in new connections already have caused the water rates to rise in recent years.

“Unfortunately, in the last couple of years, we’ve gone from having 1,000 [new] customers a year to about 250,” Seward said. “What’s driving the rates now is the existing customers are having to carry the burden [of capital investments].”

On a positive note, Seward said, the water and sewer rates are projected to increase by only about half the amount that was expected a year ago.

“Any increase is something nobody wants to have to deal with,” Seward said. “They’ve been able to make a lot of positive changes.”