Internal Controls

Recommendations 3

• R1

  Page 17
  A biennial audit covering a two-year period;
• R2

  Page 15
  Accounting and Financial Management NCSD Lacks State-Mandated Financial Audits NCSD has not completed annual financial audits for fiscal years 2009-2010, 2010-2011, and 2011-2012. NCSD is therefore not in compliance with State Government Code Section 26909 for 2009-2010 and 2010-2011, which requires annual audits of financial condition for all special districts of the end of a fiscal year. The State Controller’s Office prescribed minimum auditing requirements for special districts, set out in Title 2, Section 1131.2 of the California Code of Regulations, consist of 17 general statements that county auditors or independent accounting firms should consider in preparing an audit program. These 17 statements include the following important steps, among others:  A proper study and evaluation of the existing internal control and the financial organizational structure;  A review of the district’s report of financial transactions to the State Controller to see that it agrees with official records of the district for the period. The State Controller should be informed of any material difference;  A determination that expenditures were properly documented, authorized and incurred and are proper charges to the fund and appropriation against which they have been charged; and,  A verification of all assets and liabilities in accordance with generally accepted auditing standards. The failure to follow these and the other requirements set out by the State Controller has led to negative consequences for NCSD including: (1) putting NCSD out of compliance with State Code; (2) leaving residents and taxpayers without a reasonable assurance that financial statements are presented fairly and accurately; and, (3) putting the District at greater risk of waste, fraud and abuse due to the absence of any review of internal controls. The lack of audited financial statements is also not consistent with industry best practices, such as those promulgated by the Institute for Local Government, which notes that “audited financial reports alert governing body members if there are irregularities in financial practices and financial reporting.”3 3 The Institute for Local Government is an affiliate of the California State Association of Counties and the League of California Cities. The best practices information can be found online at this address: http://www.ca‐ ilg.org/sites/main/files/file‐attachments/resources__3r_Financial_Reporting_and_Accounting.pdf 7 2012-2013 San Bernardino County Grand Jury Final Report Auditor-Controller Monitoring of Audit Requirements Has Had Limited Effectiveness with NCSD State code places responsibility on the County Auditor-Controller for making sure special districts are audited annually or on a different frequency under certain restrictions. Specifically, Section 26909 of the State Government Code requires county auditors to: Either make or contract with a certified public accountant or public accountant to make an annual audit of the accounts and records of every special district within the county for which an audit by a certified public accountant or public accountant is not otherwise provided. The Internal Audits Section of the County Auditor-Controller, which is responsible for performing operational and financial audits of special districts, has taken steps to monitor special districts’ compliance with State auditing requirements. However, these efforts have not been successful with NCSD. The Auditor-Controller has procedures that call for repeated, increasingly assertive correspondence with general managers and district boards that have not completed a financial audit on time. In the case of NCSD’s FY 2011-12 audit, the Auditor-Controller relied on the District’s general manager’s and its certified public accountant’s assertions that a contract was in place to conduct audit services. However, as noted later in this section, the work performed by the certified public accountant does not comply with State audit requirements. The enforcement of Section 26909 is somewhat complicated by the Code’s requirement that any costs incurred by the county auditor, including any contracts with accountants, be borne by the special district. County Auditor-Controller management staff has asserted to our audit team that there has been some hesitancy to enforce the annual audit requirement on NCSD due to the District’s budgetary constraints. However, there has been no formal steps taken or analysis conducted by the Auditor-Controller to determine the most cost effective method of complying with State audit requirements. NCSD and Auditor-Controller Have Not Pursued Potential Alternatives to Annual Audits Neither NCSD nor the Auditor-Controller have studied or pursued potential alternatives to annual audits allowed for in the State Government Code under certain restrictions. Specifically, Government Code Section 26909 allows for the following three alternatives if requested unanimously by the special district’s governing board and unanimously approved by the Board of Supervisors:
• R3

  Page 17
  An audit conducted at specific intervals, as recommended by the County Auditor, which shall be completed at least once every five years. 8 2012-2013 San Bernardino County Grand Jury Final Report Given the District’s relatively small budget of approximately $250,000 per year, the Auditor- Controller and District Board members should consider these alternatives, which would require fewer resources to be devoted to financial audits, but would still be in compliance with State requirements. 2011-12 Financial Review Did Not Meet Minimum Audit Requirements Financial reports required by State Government Code to be filed with the State Controller’s Office have been submitted by NCSD, but were based upon unaudited and unverified data. Contrary to State code requirements, the District’s FY 2011-12 annual report of financial transactions to the State Controller has not been reviewed by an independent public accountant to ensure that they agree with the official records of the District. In September 2012, NCSD contracted with a certified public accountant for audit services covering financial transactions in FY 2011-12. The Auditor stated the District did not provide adequate or sufficient documentation to complete an audit and express an audit opinion. However, these services did not meet the minimum requirements prescribed by the State Controller’s Office for audits of special districts. Rather, in his transmittal letter to the District’s Board of Directors the certified public accountant stated that his work was limited to putting together the financial report that must be filed annually with the State Controller. Further, the letter states that “I have not audited or reviewed the financial statements referred to above and accordingly do not express an opinion or any other form of assurance on them.” The State Controller’s prescribed minimum audit requirements are contained in the California Code of Regulations (Title 2, Section 1131.2). As previously mentioned, these minimum requirements include the statement that: the district’s report of financial transactions to the State Controller should be reviewed to see that it agrees with the official records of the district for the period. The State Controller should be informed of any material difference. The General Manager should prepare the District’s financial statements on an annual basis before they are reviewed by the Auditor-Controller or a certified public accountant to ensure they are an accurate reflection of the District’s financial condition. Financial Data Reported to State Controller Indicate Financial Instability and Structural Deficits Although the data provided to the State Controller’s Office is unaudited, a review of such data indicates financial instability, which further underlies the need for regular financial audits. As seen in Table 2.1 below, the District appears to have run a deficit in FY 2009-10 of approximately $18,000 or about 8 percent of total revenues. Further, the lighting and lighting maintenance function has run deficits ranging from $41,142 to $5,011 from FY 2008-09 to FY 2010-11 and the Recreation and Park Function has run deficits of approximately $25,000 in FY 2009-10 and about $2,300 FY 2010-11. NCSD management has been unable to identify the cause(s) of these deficits. Additionally, the District’s methodology for assigning district-wide costs such as Director’s fee, office costs, and accounting and legal fees between the three functional departments is not documented, and therefore cannot be verified. 9 2012-2013 San Bernardino County Grand Jury Final Report Table 2.1 NCSD Expenditure Data Reported to State Controller Activity FY 2008-09 FY 2008-09 FY 2009-10 FY 2009-10 FY 2010-11 FY 2010-11 Revenues Expenditures Revenues Expenditures Revenues Expenditures Fire Protection $152,701 $119,179 $124,762 $112,437 $136,411 $109,611 Lighting and Lighting 3,434 44,576 2,141 7,152 2,210 8,698 Maintenance Recreation and Park 155,645 142,136 98,935 124,115 100,563 102,910 Total $311,780 $287,891 $225,838 $243,704 $239,184 $221,219 Source: State Controller’s Office NCSD Lacks Sufficient Accounting Procedures and Controls NCSD lacks sufficient accounting procedures and controls. According to State Government Code 61053, NCSD must: adopt a system of accounting and auditing that shall completely and at all times show the district’s financial condition. The system of accounting and auditing shall adhere to generally accepted accounting principles. However, the District does not have: (1) a hierarchical account numbering system; (2) a financial or accounting manual; or, (3) a consistent system to classify expenditures carried out by the District. Further, although the State Controller requires special districts to use the modified accrual basis of accounting, it is not employed at NCSD. NCSD Lacks Account Numbering System and Financial Manual Beginning in FY 2012-13, the District abandoned utilizing its numerical and hierarchical account structure in favor of an accounting scheme based on account titles. A fundamental objective of accounting is to accurately classify transactions such as expenditures and receipts into proper “buckets” or accounts. Accounts are generally identified utilizing a numeric or alpha-numeric scheme. Accounting identifiers are usually broken down into some type of hierarchical components to accommodate data correlation and reporting activities. The numerical assignment of an accounting identifier also facilitates system to system and intra-system exchanges of data, such as from a Purchase Order system to the General Ledger. The abandonment of account numbers inhibits accurate and efficient hand-offs of accounting data for establishment and performance measurement of budgets and future growth into new and more sophisticated computer system interfaces. NCSD lacks a financial or accounting manual, which would provide guidance to the General Manager and other staff on how to create and maintain District accounts and prepare the District’s income statement, general ledger, and annual financial statement. In addition, a 10 2012-2013 San Bernardino County Grand Jury Final Report financial or accounting manual would assist the staff in using modified accrual based accounting, which is required by the State Controller for non-enterprise funds. The lack of a financial or accounting manual may have led to the following odd general ledger and income statement entries observed by the Grand Jury from FY 2011-12:  On the District’s Income Statement, a revenue line title “Deposits Not Recorded” shows a value of $121,248.76, which is 47 percent of the District’s fiscal year revenue. No explanation was found for the purpose or intended usage of this account.  Account 5100 titled “Directors Stipend” reflects amounts that are not in increments of $50 even though Directors are paid $50 per authorized meeting.  Account 5101 titled “Secretary Salary” reflects payments made to five individuals ranging from $39.67 to $12,640.02. However, the District did not have five secretaries during FY 2011-12. Expenditures Not Consistently Classified to Support Proper Accounting NCSD does not consistently classify or document expenditures to allow for proper accounting of the various functions carried out by the District. For example, approximately $20,000 of purchase card expenditures was placed in a general ledger clearing account because the former General Manager, lacking documentation, could not determine the appropriate cost account. Additionally, a 4,000 gallon Water Tender Truck was acquired via a capital lease, but is being accounted for as an operating lease. This misstates both the District’s assets and liabilities. The failure to properly classify expenditures leaves the District non-compliant with the State Code requirement to adopt a system of accounting and auditing that shall completely and at all times show the District’s financial condition. It also affects the accuracy of the District’s State- mandated financial reporting. District Has Weak Check Reconciliation Process NCSD’s check reconciliation process has been deficient. The District’s FY 2011-2012 account for workers’ compensation insurance was overstated by the value of one extra quarterly payment in the amount of $2,172, which resulted from a voided check not being reversed off the books. This is an indicator of a weak check reconciliation process. Reconciling bank statements to check registers and to General Ledger account balances is a fundamental management practice and a basic internal control process. This process ensures the bank’s records are in-line with the District’s records, and that any voided or un-cashed checks are identified for follow-up and corrective action if needed. A check that has been voided must also have its charged reversed on the accounting ledgers. Failure to reverse an entry in the accounting ledger will overstate expenditures and under-state the District’s actual cash position. The General Manager has indicated that improvements to the check reconciliation process have been implemented. Identifying any additional prior year problems requires the completion of outstanding audit work. 11 2012-2013 San Bernardino County Grand Jury Final Report Conclusions The Newberry Community Services District (NCSD) has not completed annual financial audits for the previous three fiscal years (2009-2010, 2010-2011, and 2011-2012). State Government Code requires public agencies, including special districts, to conduct annual financial audits of the end of each fiscal year. The Board of Directors failure to execute this responsibility is in noncompliance with California Government Code at Section 26909 and 61118 for 2009-2010 and 2010-2011. Further, while State Code requires the County Auditor- Controller to ensure such audits are completed, efforts to monitor and enforce this provision have had limited effectiveness. Financial reports required by State Government Code to be filed with the State Controller’s Office have been submitted by NCSD, but were based upon unaudited and unverified data. Contrary to State code requirements, the District’s FY 2011-12 annual report of financial transactions to the State Controller has not been reviewed by an independent public accountant to ensure that it agrees with the official records of the District. The financial information that has been provided, while unaudited, indicates some financial instability, which further underlies the need for regular financial audits. NCSD lacks basic accounting procedures and controls. Specifically, District does not have: (1) a hierarchical account numbering system; (2) a financial or accounting manual; or, (3) a consistent system to classify expenditures carried out by the District. Further, the District lacks a consistent method for authorizing, classifying, and documenting expenditures from purchase cards. Recommendations The Newberry Community Services District Board of Directors should direct the General Manager to: 4 Re-adopt a numerical and hierarchical account numbering structure for use in the District’s general ledger and income statement. Work with the Board, County Auditor, and utilize resources such as the California Special Districts Association to develop a basic accounting manual. The Auditor Controller should: 6 Revise Outside Audit Report procedures to include corrective actions for special districts that do not comply with State audit requirements for an extended period of time. Such corrective actions could include conducting audits and billing the districts for Auditor- Controller staff time or hiring an outside certified public accountant to conduct the audit and billing the district for the accountant’s work. Work with the Newberry Community Services District General Manager to determine a feasible approach to complying with audit requirements established in State Government Code Section 26909. Such approaches could, with the unanimous request of the Board of Directors and the unanimous approval of the Board of Supervisors, include: 12 2012-2013 San Bernardino County Grand Jury Final Report (a) A biennial audit covering a two-year period; (b) An audit covering a five-year period, if the District’s annual revenues do not exceed an amount specified by the Board of Supervisors; or, (c) An audit conducted at specific intervals, as recommended by the County Auditor- Controller, which shall be completed at least once every five years. Costs and Benefits The costs of implementing with these recommendations would include District staff time to draft and adopt policies and procedures. The benefits of implementing these recommendations would include stronger controls over accounting and management of the District’s finances and greater transparency in the reporting of the District’s financial condition. The benefits would also include compliance with State Government Code audit requirements for special districts. 13 2012-2013 San Bernardino County Grand Jury Final Report