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HomeMy WebLinkAbout1981-12-08; City Council; N/A; Presentation of Audit ReportFrom City Council, 'kieeting of: December 8, 1981 CERTIFIED The Honorable Members of City Council City of Carlsbad, California UNTANTS U/ We have examined the financial statements of the various fund types and account groups of the City of Carlsbad, California, for the year ended June 30, 1981 as listed in the accompanying table of contents, and have issued our report thereon dated September 30, 1981. As part of our examination, we made a study and evaluation of the City's system of internal accounting control to the extent we considered necessary to evaluate the system as required by generally accepted auditing standards. Under these standards, the purposes of such evaluation are to establish a basis for reliance on the system of internal accounting control in determining the nature, timing and extent of other auditing procedures that are necessary for expressing an opinion on the financial statements and to assist the auditor in planning and performing his examination of the financial statements. Also, we have performed tests of compli- ance with the Revenue Sharing and Antirecession Fiscal Assistance Acts and regulations as required by Sections 11.C.3 and III.C.3 of the "Audit Guide and Standards for Revenue Sharing and Antireces- sion Fiscal Assistance Fund Recipients" (Guide) issued by the Office of Revenue Sharing, U.S. Department of the Treasury, and (2) compared the data on Bureau of Census Form F-21A, Part I with the records of the City of Carlsbad, California as required by Sections II.C.4 of the Guide. The objective of internal accounting control is to provide reason- able, but not absolute, assurances as to the safeguarding of assets against loss from unauthorized use or disposition, and the reli- ability of financial records for preparing financial statements and maintaining accountability for assets. We understand that the objective of those administrative control procedures comprehended in Section II of the Guide is to provide similar assurance as to compliance with revenue with revenue sharing acts and regulations. The concept of reasonable assurance recognizes that the cost of a system of internal accounting control should not exceed the bene- fits derived, and also recognizes that the evaluation of these factors necessarily requires estimates and judgments by management. The Honorable Members of City Council _s �,,,.��•, '.;a.L:L Zvi rria Page Two There are inherent limitations that should be recognized in consid- ering the potential effectiveness of any system of internal ac- counting and administrative control. In the performance of most control procedures, errors can result from misunderstanding of instructions, mistakes of judgment, carelessness, or other personal factors. Control procedures whose effectiveness depends upon segregation of duties can be circumvented by collusion. Similarly, control procedures can be circumvented intentionally by management either with respect to the execution and recording of transactions or with respect to the estimates and judgments required in the preparation of financial statements and with respect to compliance with applicable laws and regulations. Further, projection of any evaluatton of internal accounting and administratiave control to future periods is subject to the risk that the procedures may become inadequate because of changes in conditions and that the degree of compliance with the procedures may deteriorate. Our examination of the financial statements made in accordance with generally accepted auditing standards, including the study and evaluaton of the City's system of internal accounting control and comliance with the revenue sharing acts and regulations for the year ended June 30, 1981 that was made for the purposes set forth in the first paragraph of this report, would not necessarily dis- close all weaknesses in the system nor all compliance violations because it was based on selective tests of accounting records and related data. However, such study and evaluation disclosed no conditions that we believe to be material weaknesses or compliance violations. September 30, 1981 ONRAD ,SSOCIA The Honorable City Council City of Carlsbad 1200 Elm Avenue Carlsbad, California 92008 Dear Council Members: CERTIFIED PUBLIC ACCOUNTANTS FOURTEEN CORPORATE PLAZA DRIVE NEWPORT BEACH, CALIFORNIA 92660 7141759.0511 We have examined the combined financial statements of the City of Carlsbad, California for the year ended June 30, 1981, and have issued our report thereon dated September 30, 1981. As part of our examination, we reviewed and tested the City's system of internal accounting control to the extent we consid- ered necessary as required by generally accepted auditing standards. We have not evaluated internal accounting control since September 30, 1981, the date of our accountant's report. Under these standards, the purpose of such evaluation is to establish a basis for reliance thereon in determining the nature, timing and extent of other auditing procedures that are necessary for expressing an opinion on the financial statements. The objective of internal accounting control is to provide reasonable, but not absolute, assurance as to the safeguarding of assets against loss from unauthorized use or disposition, and the reliability of financial records for preparing finan- cial statements and maintaining accountability for assets. The concept of reasonable assurance recognizes that the cost of a system of accounting control should not exceed the benefits derived and also recognizes that the evaluation of these fac- tors necessarily requires estimates and judgments by management. There are inherent limitations that should be recognized in considering the potential effectiveness of any system of inter- nal accounting control. In the performance of most control procedures, errors can result from misunderstanding of instruc- tions, mistakes of judgment, carelessness, or other personal factors. Control procedures whose effectiveness depends upon segregation of duties can be circumvented by collusion. Simi- larly, control procedures can be circumvented with respect either to the execution and recording of transactions or with respect to the estimates and judgments required in the prepara- tion of financial statements. Further, projection of any evaluation of internal accounting control to future periods is subject to the risk that the procedures may become inadequate because of changes in conditions, and that the degree of com- pliance with the procedures may deteriorate. The Honorable City Council City of Carlsbad December 2, 1981 Page 2 Our study and evaluation of the City's system of internal accounting control was made for the purpose set forth in the first paragraph above, and it would not necessarily disclose all weaknesses in the system. However, such study and evalu- ation disclosed the following conditions that we believe war- rant your attention: Purchasing, Accounts Payable and Cash Disbursement Svstem Several concerns were noted during our review of the City's purchasing, accounts payable and cash disbursement system: 1. Bank reconciliations are performed by the same individual who was directly associated with cash disbursements func- tions. This employee who reconciled bank accounts was also responsible for operation of the check signing machine. 2. We noted that there was a lack of documentation on accounts payable invoices evidencing that invoices were checked for ca-:rical accuracy, that prices invoiced were compared to amounts per the purchase order and that goods or services rendered were in fact received (which should be evidenced by a receiving report or packing slip denoting receipt where materials are involved). 3. Blank warrants are not adequately safeguarded. The City does not follow the practice of maintaining blank warrants in a loc:ced storage cabinet. Recommendations 1. We recommend that bank reconciliations for the City's general and other accounts be performed by an individual independent of the cash disbursements and cash receipts functions. In the event that the foregoing cannot be achieved due to a limited number of personnel we would recommend that the Finance Director or Assistant Finance Dire'' ctor closely scrutinize monthly reconciliations and test check reconciling items in the reconciliation. We also recommend that the Finance Director or his designee as a matter of practice initial the monthly bank reconcilia- tions as evidence of approval of the reconciliation process. The Honorable City Council City of Carlsbad December 2, 1981 Page 3 2. We recommend that the individual vested with custody and control of the check signing machine not be directly asso- ciated with cash disbursement transactions. We also recom- mend the present log which is maintained on a steno pad be formalized, to include date, check number, log numbers and operator name. We recommend that this log be maintained under custody of the Assistant Finance Director who should maintain one (1) of the two (2) keys necessary to operate the check signing machine. The second key would be vested with the individual. responsible for preparation of checks for mailing. We recommend that the log be reviewed for accountability after each use by the Assistant Finance Director. . 3. We recommend that the City docu,aent as a matter of practice its verification process of accounts payable invoices. Invoices should be compared to purchase orders and receiv- ing reports (or other evidence of ruz!eipt) prior to pay- ment. Additionally ex`:ensions and footings should be verified prior to submitting invoices for payment. This process could be accomplished by the purchase and use of a simple rubber stamp to indicate the initials of each veri- fication process prior to the invoice being approved for payment. 4. We recommend that the City consider the use of a cen- tralized receiving department or at a minimum a separate function independent of persons who initiate requests or purchase goods or services. Materials or supplies should be inspected for condition, and counted or measured to provide for comparison with the applicable purchase order. Prenumbered, written receiving reports should be used to provide evidence that goods received are evaluated for quality and completeness. S. We recommend that the City improve its accountability over blank warrants. Blank warrants should be maintained in a locked storage cabinet and access thereto should be limited to authorized personnel only. A log of the warrants should be maintained accounting for all blank warrants received from the bank printer and warrants used. All voided war- rants should be accounted for and maintained on file. A responsible individual should be offered responsibility for control and custodianship over blank warrants. IN The honorable City Council City of Carlsbad December 2, 1981 Page 4 EDP Access Controls Our review of the EDP environment disclosed that access to computer hardware, programs, data files, and program docu- mentation is not adequately controlled. The computer hardware and data files are mainly located in a storage area where blank warrants and other accounting records, the mail scale and meter are maintained. Employees enter the room for mail or other purposes with no restrictions. Recommendation We recommend that the City modify its existing computer room environment to restrict access to authorized personnel only. The failure to restrict access creates an environment vulner- able to the accidental or intentional destruction of data. Limited access can be assured through the use of physical security devices and techniques, including the use of door locks and secure storage devices. In addition, machine utili- zation reports and console logs should be reviewed to detect and control unauthorized computer use. At a minimum, the mail activity should be moved from the data processing area. EDP Controls - Protection of Important Files The City's back up plan, for the protection of important master files, documentation, and programs is inadequate. Recommendation Plans for providing backup, that is, providing for the restora- tion of operations after a physical disaster or hardware fail- ure has taken place are of particular importance. We recommend that provisions for adequate backup of files, programs, docu- mentation, supplies, and hardware include the following proce- dures: 1. Off -premises storage of important files, programs, and documentation, as well as a formal plan for record reten- tion. 2. Environmental controls to protect against excess humidity, temperature variations, or other atmospheric conditions. The Honorable City Council City of Carlsbad December 2, 1981 Page 5 3. Protection of computer hardware, programs, and files against fire and other hazards. 4. Special data-processing risk insurance to cover the costs of restoring EDP operations. Cost of Services - Central Stores During 1981 the City established a central stores inventory whereby user departments and funds of the City would be charged for usage of City's supplies. This function was accounted for in the City's general fund. A physical inventory of supplies on hand at June 30, 1981 was not taken. Additionally, discrep- ancies in the method of pricing inventories existed during the year. s e i Recommendation We recommend tha=t central stores cost accounting be accom- plished through the use of a separate internal. service fund rather than the general fund. Usage of supplies by the various departments would be supported by charge tickets or other reasonable means of usage. Charges to other departments and funds should be based upon the actual cost of goods used and provision for the recovery of other expenses (ie the applicable portion of salaries and fringe benefit expense). Costs of the n fund would include inventory usage, payroll charges and other expenses of administering the fund. The fund would be main- tained on the accrual basis of accounting. 'Re also recommend that a physical inventory be taken at least annually and that the inventories be adjusted to reflect book to physical differ- ences. Cost of Services - Sewer and Sanitation The City currently accounts for its sewer and sanitation activ- ities in governmental funds (special revenue and capital proj- ect fund types)-. This method of accounting accounts for only the "flow of resources" rather than the cost of providing sewer and sanitation service. The Honorable City Council City of Carlsbad December 2, 1981 Page 6 Recommendation. We recommend that the City finance department personnel isolate all 'sewer and sanitation related costs (-3nd the fund to which •they are now recording those costs). Once isolated, those costs could be reviewed with the City Manager and other depart- mental personnel for their propriety. We recommend that the chart of accounts for sewer activities be restructured to account for all sewer related activities within one enterprise fund. Additionally, we recommend that all sewer related capi- tal assets be identified and capitalized within the sewer and sanitation enterprise fund. Depreciation would be recorded on those sewer related fixed assets. The objective of accounting for all sewer related activities within one proprietary fund would be to determine the "cost of services" for sewer rate setting by the City Council. Cost of Services - Central Garage/Motor Pool The City currently accounts •cor vehicles and other equipment purchases and the costs of maintenance thereof within the general fund of the City. Vehicles and equipment are capital- ized in the general fixed asset group of accounts of the City. Depreciation is not reflected on those fixed assets. Recommendation We recommend that the City establish a central garage/motor pool internal service fund. This fund would act as an "equip- ment replacement fund". Revenue of the fund would be based upon -charges to user departments and funds of the City. All costs of rendering those central garage/motor pool related expenses would be accounted for within this internal service fund (including payroll and fringe benefits, maintenance sup- plies, depreciation, etc.) The cost of equipment purchases would be capitalized and depreciated over the estimated useful lives of the assets. Retained earnings within this fund would be designated for equipment replacement. The Honorable City Council City of Carlsbad December 2, 1981 Page 7 Construction in Progress In the Water Utility Fund there exist some very old construc- tion in progress work orders, the status of which could not be determined by the Finance Department. Recommendation We recommend that the detailed subsidiary ledger records (by work order) at least annually, be reviewed and updated in accordance with information furnished by the Engineering De- partment. General Fixed Assets During our examination of the City's general fixed assets we noted the following: 1. The finance department has not kept an updated detailed listing of all of the City's general fixed assets. Al- though this is being done for purchases of equipment, the detailed listing of other general fixed assets (structures, other improvements, etc.) has not been kept current and reconciled with the amounts recorded on the City's finan- cial statements. 2. The equipment records of the purchasing department are periodically reconciled to the finance department's expend- iture runs. There is presently no reclassification (out of the "capital outlay" expenditure accounts) of the amounts that are determined at that time to represent expenditures other than capital outlay. The effect of this weakness in accounting control is that the capital outlay expenditures accounts become overstated. (Operating expenditures would be understated by a corresponding amount.) Recommendations 1. We recommend that at least once a year the finance depart- ment reconcile a detailed listing of the City's general fixed assets to the amounts recorded in the City's finan- cial statements. The detailed listing should include .J The Honorable City Council City of Carlsbad 'December. 2, 1981 Page 8 descriptions, cost figures, dates acquired, locations and inventory tag numbers. 2. We also recommend that only additions to the general fixed asset group of accounts be recorded in the "capital outlay" expenditure accounts of the governmental funds. Fixed Assets in the Water Utility Fund The Water Utility Fund, as a proprietary type of fund, is accounted for on a cost of services or "capital maintenance" measurement focus rather than the spending or "financial flow" measurement focus as used in governmental types of funds. This means that fixed asset additions should be capitalized and reported on the funds balance sheet. The related expense associated with the fixed asset acquisitions should be alloca- ted over the estimated useful lives of the fixed assets. This is in contrast to the method used in governmental types of funds wherein the entire amount of the fixed asset addition is recorded as on expenditure of that fund at the time of acquisi- tion. The City has been utilizing a combination of proprietary fund principles and governmental fund principles. There is a dupli- catz recording of fixed asset additions. Each fixed asset ac,dition is recorded once as a capital outlay expenditure and again as depreciation expense, as its cost is allocated over its estimated useful life. At the end of the year the fixed assets are recorded on the balance sheet with an offsetting entry to an equity account called "Investment in Fixed Assets". The effect of the above mentioned practices is that the Water Utility Fund transactions are not recorded in accordance with Statement 1 of the.National Council on Governmental Accounting. Recommendation In accordance with accepted proprietary fund practices, we recommend that fixed asset additions be capitalized rather than recorded as expenditures. This holds true for acqui-siti=> of fixed assets by closing of construction -in -progress work or- ders, as well as for acquisitions by issuance of City 0 The Honorable City Council City of Carlsbad December 2, 1981 Page 9 warrants. The "Investment in Fixed Assets" account and the "Capital -Outlay -Expenditure" accounts should not be used in proprietary funds. Detailed illustrative journal entries have been provided to the Director of Finance. Budgetary control of capital expenditures as authorized by the City Council could be maintained by the purchasing agent having a complete listing of all authorized capital projects and expenditures. The Finance Department could provide to pur- chasing actual expenditure amounts as compared to budget. The actual expenditure figures would come from the additions to capital assets cumulatively for the fiscal year. Installation Fees Through the Water Utility Fund the City charges developers for the installation of meters, services, fire hydrants, etc. The receipt of cash from the developers and the relief of the supplies inventory are recorded through deposits payable with- out recognition of the associated revenue and expense. The effect of this practice is that both revenues and expenses are understated.. _Recommendation We recommend that revenue be recognized and deposits payable reduced upon the closing of the work order for the installation of meters, services, fire hydrants, etc. We also recommend that upon closing of the work order, inventory be relieved and the resultant expense (for the consumption of meters and serv- ices) or increase in fixed assets (fQr fire hydrants) be re- cord`ed. Illustrative journal entries have been provided to the i' Director of Finance. CONCLUSION The foregoing conditions were considered in determining the nature, timing and extent of audit tests applied in our The Honorable City Council City of Carlsbad December 2, 1981 Page 10 examination of the financial statements, and this report of such conditions does not modify our report dated September 30, 1981. We would like to express our appreciation for the courtesy and assistance extended to us during the course of our audit by staff of the City. Should you have any questions or comments concerning the matters presented herein, we will be pleased to discuss them at your convenience. December 2, 1981