How red do the flags have to be?

The DeKalb city council recently received and filed its fiscal 2019 Comprehensive Annual Financial Report (CAFR) along with the auditor’s letters and communications to council and management. Although the audit was problematic, the council did not talk about the issues, so we will do it here. First, to summarize:

  • The auditor detected material misstatements in the financial statements.
  • The auditor found deficiencies in internal controls that are supposed to prevent and detect material misstatements.
  • The auditor reported that findings from fiscal 2018 were not corrected in 2019, including mismatches between fee rates charged and the actual rates authorized by ordinance.
  • For the second year in a row, the city has failed to review and properly adjust accounts at year’s end.

Next I’ll get into more detail using the auditor’s own words. To read them in the source material, go here and start on PDF page 243.

Material misstatement

What it is: information in the financial statements that is sufficiently incorrect that it may impact the economic decisions of someone relying on those statements.

From the auditor:

Professional standards require us to accumulate all known and likely misstatements identified during the audit, other than those that are clearly trivial, and communicate them to the appropriate level of management. The attached schedule summarizes the uncorrected misstatements, none of which were material individually or in the aggregate, to the basic financial statements taken as a whole. Several of the misstatements on the separate schedule detected as a result of audit procedures were material. All of these were agreed upon with management and corrected.

Deficiency in internal controls over financial reporting

What it is: a design or operation of a control that does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

From the auditor:

An essential feature of segregation of duties within an organization is that no one employee or group of employees has exclusive control over any transaction or group of transactions. We noted specific lack of segregation of duties listed below. This list would not be considered to be all inclusive as we did not perform a review of all control structures throughout the city.

Utility Billing
Currently the Water Superintendent is the only employee reviewing the unusual highs/lows in the monthly billing register although does provide city staff support of his reviews. We recommend processes are put in place to review the original source billing files to ensure proper entry of data was performed.

Bank Reconciliations
We noted during our audit that bank reconciliations are completed accurately and timely, however, we noticed that there is no documentation of the review of the General Fund bank reconciliation. We recommend that bank reconciliations are reviewed by management and initialed that the review was completed. The review should include tests of mechanical accuracy and tracing of items on the reconciliation to the relevant source documents.

Significant deficiency & material weakness

What it is: a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

From the auditor:

As part of the annual audit, we are required to communicate internal control matters that we classify as significant deficiences and material weaknesses to those charged with governance. A deficiency in internal controls exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, detect and correct, misstatements on a timely basis. A significant deficiency is a deficiency or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.

While the auditor did not report a finding of material weakness, the act of reporting a deficiency tags it as a significant deficiency. Personally, I believe the deficiencies could have seen reduction in severity from material weaknesses to significant deficiencies by the city manager’s sudden hiring of an unbudgeted account manager just before release of these reports.

Still, the auditor has clearly put the city council on notice about its responsibility here.

Fiscal 2018 findings still applicable in fiscal 2019

From the auditor:

While testing the enterprise revenues at the City, we noted that ordinances that contained the authorized rates to be charged were out of date and not clearly defined as to what the current rate should be. We recommend that the city reviews all of their rates being charged and ensure that they have appropriate authorization to charge those rates.

I don’t know whether the city has been over- or undercharging, but the Water Fund is an enterprise fund. If the problem lies with water sales revenues, it affects all of us.

Also:

During our audit we identified and proposed several audit adjustments, which were reviewed and approved by management, to present fairly the city’s basic financial statements. Adjustments that were proposed included correcting personal property replacement tax revenue, recording additional refuse payables and related expenditures, adjusting police and fire pension balances to actual, adjusting governmental capital asset depreciation to actual, increasing claims payable, adjusting allowance for bad debts in the water fund, and reclassifying the gain of disposal of capital assets. We recommend that the city reviews these accounts at year end to ensure they are properly adjusted and agree to subsidiary ledgers.

For the past two fiscal years, the city has retroactively amended its budget to reflect recommended adjustments. Now it looks like it’s because the auditor is finishing work the city should have gotten done at fiscal years’ ends.

These are serious issues. What is our council going to do about them? Will they fix the city’s financial policy to require DeKalb to have a finance director — a finance director who is actually an accountant? Will they call the sidelined Finance Advisory Committee back in? Will they admit that Finance Division has been so severely skeletonized that it cannot function properly?

How many red flags does it take? How big must they be? How red?