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