It’s time for your community to create a municipal audit

The San Diego District Attorney last week charged John Collins with misuse of hundreds of thousands of dollars over several years as superintendent of Poway Unified School District.

The allegations would be shocking if they weren’t so common. In Placentia, Bell, Compton, Pasadena, Beaumont, and elsewhere, California cities have needlessly lost millions, and for a time, nobody knew. Accounting is boring. Until it isn’t. Just as the devil is in the details, the financial fate of public agencies is buried in the numbers.

Whether it’s via corruption or incompetence, without vigilant oversight, millions can be lost. Even in wealthy suburban cities with surplus funds, it’s still necessary to verify that internal controls are in place. In larger cities with limited funds and urgent needs for public services, it’s even more important. No matter what sort of city you live in, things can go terribly wrong.

If you’re a concerned citizen or an elected official charged with responsible management of your city’s finances, the annual audit can be extremely helpful. But instead of bringing in a CPA firm merely to verify the balances on your financial statements, you have an opportunity to do much more. Here are some ideas for getting the most out of your audit.

One recommendation, coming from Linda Lindholm, who served for fourteen years on the city council of Laguna Niguel and was mayor twice, is to change audit firms every five years. Let them know when they’re hired that it will be for a five year engagement. This policy helps ensure against the slight but very real possibility that an overly cozy relationship might develop between members of the city’s permanent staff, and the audit partners. A firm that is on a limited term of engagement will have far less motivation to smooth over bad news to keep the account.

Lindholm also recommended keeping an arms-length relationship with the auditors throughout the audit process. Once they’ve been given their instructions, as a matter of policy, council members should leave them alone until their report is completed. This prevents any elected official from attempting to influence the auditors.

So what more should a city have their auditors do, beyond just checking over the financial reports? To answer this we talked with several public accountants who have audited local agencies. Rich Kikuchi, a managing partner at LSA CPAs, makes the distinction between a “financial audit” and an “internal audit,” where the internal audit, or “watchdog audit,” represents this extra work. Other people we spoke with viewed this process as an extension of the normal audit. Some called it a “secondary audit.” Whatever it is called, here are a few of the specific things an elected official can instruct their auditors to add to their regular annual work:

  • Are funds being spent in compliance with the terms of the grants under which they were awarded?
  • Are what are the terms of capital improvement bonds, interest rate, payout timeline, use of funds?
  • Are there any irregularities in city investments?
  • Are the city’s employee payroll and benefits records consistent with what the city council authorized?
  • Are there always two signatures on all outgoing checks from the city?
  • Are all transfers in and out of the city’s bank accounts consistent with authorized city budgets?

Remember. Not boring. Millions of dollars of taxpayers money can be lost when questions like these aren’t proactively answered. In larger cities, hundreds of millions.

Depending on how much extra work auditors get assigned, the added costs to the CPA firm can add up. But often these additional fees are not significant when the work is performed at the same time as the auditors are on-site anyway to do their conventional audit. And of course if these auditors end up uncovering a significant problem in the course of this extra work, the savings realized by solving the problem could dwarf what it cost to get it discovered.

Another tip: When elected officials meet with the audit firm to identify and assign additional work, sometimes it makes sense to keep the additional assignments confidential. If a cover-up is occurring, there’s no benefit in announcing to staff where the extra scrutiny is going to fall.

California’s cities and counties face unprecedented financial challenges. The obvious one, mandatory payments to the pension systems that increase every year, is not going away. Other budget items that may have been neglected such as maintenance and upgrades of roads and other public works, eventually have to be faced, possibly at great cost. The last thing your city needs is to see money being wasted through misuse of funds. Especially when there is an annual opportunity to dig deep, expose the problem, and save that money.

References:

State Controller’s Office, Internal Control Guidelines for Local Agencies, 2015 (Betty Yee)
http://www.sco.ca.gov/Files-AUD/2015_internal_control_guidelines.pdf

“Watchdog Audit” Checklist – courtesy of LSA CPAs:

Public Safety
– Cash receipting/fee schedule
– Purchasing – ordering/receiving – approval
– Invoice approval
– Credit card use
– Budget monitoring
– Inventory control
– Fuel usage
– Fleet management
– Capital asset controls – purchasing/receiving/observation & inspection
– Payroll – timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking)
– IT & systems analysis
– Revenue and expenditure accrual – period end reporting
– Cost allocations
– Customer complaints
– Other significant revenue sources

Community Development/Planning
– Inspections
– Permitting process and fee determination
– Revenue recognition & accounting for deposits
– Segregation of duties and supervision
– Use of City vehicles & fuel usage
– Cash receipting/fee schedule
– Purchasing – ordering/receiving/ – approval
– Invoice approval
– Credit card use
– Budget monitoring
– Capital asset controls – purchasing/receiving/observation & inspection
– Payroll – timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking)
– IT & systems analysis
– Revenue and expenditure accrual — period end reporting
– Housing compliance and monitoring
– Review of any management companies used including controls, compliance, monitoring
– Child development program
– Cost allocations
– Customer complaints
– Other significant revenue sources

Parks & Recreation
– Cash receipting / fee schedule
– Revenue recognition & deposits accounting Class/event enrollment procedures
– Purchasing – ordering / receiving – approval Invoice approval
– Credit card use
– Credit card procedures & online payments Budget monitoring
– Inventory control
– Capital asset controls — purchasing/receiving/observation & inspection
– Payroll — timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking) IT & systems analysis
– Revenue and expenditure accrual — period end reporting
– Use of City vehicles & fuel usage
– Cost allocations
– Customer complaints
– other significant revenue sources

Public Works
– Capital project controls
– Developer agreements
– Purchasing – ordering / receiving – approval
– Invoice approval Credit card use
– Budget monitoring
– Inventory control
– Land management
– Street management
– Cash flow
– Long-term expenditure planning and capital asset replacement/maintenance on major assets
– Fuel usage
– Fleet management
– Capital asset controls — purchasing/receiving/observation & inspection, fair value assessment/Developer contributed assets
– Payroll — timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking)
– IT & systems analysis
– Revenue and expenditure accrual — period end reporting
– Segregation of duties and supervision
– Revenue recognition & accounting for deposits
– Cost allocations
– Customer complaints
– other significant revenue sources
– Debt compliance

Golf Course, Theatre (other enterprise activities managed by 3rd party)
– Management company compliance, report preparation & management fee verifications
– Fee schedule
– Cash receipting, revenue recognition (all revenue sources)
– Purchasing – ordering / receiving – approval
– Expenditure reporting
– Financial controls over accounting
– Cash & reconciliation procedures
– Financial period close & reporting
– Interim & monthly reporting
– Communication with the City
– City oversight
– Inventory control
– Capital asset controls — purchasing/receiving/observation & inspection
– Segregation of duties and supervision
– IT & systems analysis
– Credit card procedures
– City oversight
– Budget development and monitoring
– Debt/lease management
– Cost allocations Customer complaints
– other significant revenue sources

Water, Sewer, Electric Utilities
– If applicable -Management company compliance, report preparation & management fee
– Billing
– Fee schedule
– Capital project controls
– Long-term expenditure planning and capital asset replacement/maintenance on major assets
– Fuel usage
– Fleet management
– Capital asset controls — purchasing/receiving/observation & inspection, fair value assessment/Developer contributed assets
– Review of accounting operations
– Financial period close & reporting
– Interim & monthly reporting
– Communication with the City
– Inventory control
– Segregation of duties and supervision
– Budget development and monitoring
– Credit card procedures & online payments
– Credit card use
– Cash receipting, revenue recognition (all revenue sources)
– Cash receipting / fee schedule
– Purchasing – ordering / receiving – approval Invoice approval
– Fuel usage
– Fleet management
– Payroll — timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking)
– IT & systems analysis
– Complex accounting — derivatives, swaps, futures, intangibles, etc.
– Cost allocations
– Customer complaints
– Debt compliance

Finance Department
– Payroll
– Purchasing / receiving
– Credit cards
– Travel
– IT & systems analysis — redundancy review
– Grant management
– Capital assets
– Inventories
– Journal entries
– Cash/transfers & bank account activity
– Wire transfers / EFT
– Debt management
– Long-term Cash flow & expenditure forecasting
– Cost allocations
– Customer complaints
– Billing for miscellaneous revenues
– Fraud management
– TOT/UUT/ business license/ other significant revenue sources
– Debt compliance

Governance
– Risk management
– Information & communication
– Credit card use
– Conflicts of interest
– Oversight of financial reporting & management override of controls Fraud hotline and Customer complaints

Transportation
– Management company compliance, report preparation & management fee verifications
– City oversight
– Communication with the City
– Cash receipting / fee schedule
– Purchasing – ordering / receiving – approval
– Invoice approval
– Credit card use
– Budget monitoring
– Inventory control
– Fuel usage
– Fleet management
– Capital asset controls — purchasing/receiving/observation & inspection
– Payroll — timekeeping & review procedures
– Grant management (application, award, reporting, compliance, communication, G/L tracking)
– IT & systems analysis
– Revenue and expenditure accrual — period end reporting
– Customer complaints
– other significant revenue sources

Internal service funds
– Allocation, classification
– Cost analysis