By Richard K. Kikuchi, Partner Lance, Soll & Lunghard, LLP

In light of the recent events at the City of Placentia, I would like to use this opportunity to share some of my thoughts regarding the audits of local governments. First of all, my heart aches for all who were closely affected by the recent occurrence: the City Council members, citizens and the hardworking dedicated honest employees of the City.  Secondly, the thoughts in this letter are not just for myself, not just for the firm of LSL, but I believe all the other CPA firms conducting the audits of local governments. Hardworking and dedicated professionals who are passionately dedicated to abiding by professional standards and providing valuable information to the governing boards of governments throughout the country.

Our world is ever changing and local governments are no exception. Over the recent years we have seen a significant strain on local government budgets caused by the overall economic climate and most recently with the tremendous and transparent rising costs of government pensions. Due to financial strains, budgets for local governments have been significantly trimmed. This has, among other things, resulted in reduced personnel for local government (which ultimately reduces internal controls due to lessened segregation of duties) and has required government officials to make difficult decisions on where to spend and how to cut.

Governing Board Members and Administrators……my heart goes out to you!  You are people who have chosen to put great efforts into government. To make a difference and serve the public. To tell you truthfully, that is why I personally have chosen the career of providing financial audits to governments and to give back to the community.

The heart of the matter, in my opinion, is that there is disconnect between the objective of a financial audit and what governing board members are looking for in an audit. If I were to put myself in the shoes of the mayor of a city in 2016, I could tell you that, yes, I would be interested in what the fund balance is in the General Fund and how it compares to the budget. However, I would be much more interested that the City has sound internal controls and that the employees of the City are abiding by those policies.  That would help me sleep at night knowing that the City is in compliance with Rules, Laws and Regulations, and that the chances of fraud are being mitigated to the extent possible.

When the word audit or the term auditor comes to mind, there are a few things that most people think about.  Most are not flattering! The vision of someone looking around at documentation, correcting mistakes, and asking penetrating questions and pointing fingers for not doing things right are certainly common.

In actuality, in the world of accounting and auditing, there are numerous types of audits.  Some examples of these are:

  • Financial Audits
  • Compliance Audits
  • IRS Audits
  • Internal Audits
  • Forensic Audits

CPA firms are often engaged to perform financial audits. The objective of which is to “render an opinion” regarding the material accuracy of the financial statements at the end of each year, in accordance with generally accepted accounting principles.

The financial statements are basically a financial “snapshot” of the financial results at each year end. These financial statements are prepared by summarizing the amounts on the books and records of the City. In order to obtain assurance that the amounts on the accounting records are correct, financial auditors perform various types of test work. Some of these tests are looking at documentation, correcting mistakes, asking penetrating questions, reconciling account balances, etc.

Before we even start testing the account balances, we look at the internal controls in place to obtain an understanding of the system of controls so that we might be able to plan the extent of our procedures on the financial statements.

A financial audit, by its nature:

  • Has the primary goal of issuing an opinion on the financial statements (whether the statements are materially correct or not),
  • Requires the auditor to assess internal controls to determine extent that the financial reporting system can be relied on to correctly summarize the books and records
  • Takes place, the same time every year.  The audit is scheduled months in advance, because the goal is to get a timely financial statement out (that is materially correct) to bond agencies and other outside interested readers.

As stated above, as financial auditors, like all financial auditors, our objective is to render an opinion on the year-end financial statements, and we use our assessment of internal control as a planning mechanism for our own audit. However, sound internal controls (policies and procedures) are only effective if they are being monitored by the local government and there is a culture of accountability. Bottom line, sound controls are essential, but if they are not followed and monitored, they can be rendered ineffective.

I say all this in hopes of helping to create an understanding that what many citizens and governing board members think is an audit, is most certainly not what financial auditors are engaged to perform. I am an auditor, not a council member, but if I were a council member, I would want to know two things regarding finances:

  • Number 1. What the financial status of the organization is at any point in time and particularly year end.
  • Number 2.  And more importantly, are the internal controls and safeguards of the local government working and being followed?

I personally, would be more interested in knowing that controls are in place and being monitored, the auditor being a watch dog and making sure people are doing what they should be doing. A watch dog is more aligned with activities of an internal auditor rather than a financial auditor.

An internal auditor often does…and should:

  • Be independent and work with the audit committee and staff. By creating an audit committee, this will create an opportunity for collaborative communications with the internal auditor or equivalent.
  • Center their focus on policies and procedures of the local government (internal controls and safeguards).  A watch dog is what governing members and citizens are looking for and that is what internal audit type work can focus on.
  • Perform audits throughout the year and on a surprise basis. As financial auditors, we are usually at the local government one week in the spring and another week or two in the fall. So, only two to three weeks out of the entire year! Also, the local government knows months in advance when we are coming, it has been scheduled since there is a tight deadline to issue the financials after each year. To be a watch dog, it should also contain an element of surprise.

So what are some final thoughts?

  • Cities and other local governments require financial audits to make sure their records are accurate and issue financial statements for distribution to certain outside users. However, it is clear that cities and local governments need internal audit type work done throughout the year.  Question, in light of tightened budgets, is this something that local governments can afford?  Absolutely….they can’t afford not to!
  • Many CPA Firms have provided internal audit type work for local governments over the years who have been proactive and have seen the need for this watch dog type work.  One example, which comes to mind, is a City where LSL reported directly to the audit committee. We compiled a listing of a couple of dozen internal audit type procedures that could be performed. Examples:  review of journal entries, bank reconciliations, and wire transfers. The audit committee would randomly select three areas per quarter and we would test these areas and report back to the committee. These types of procedures done on a surprise basis and working directly with the audit committee is what I believe government officials are looking for!
  • The City of Pasadena (a current client), is setting the ideal model for local governments. In light of the recent fraud that took place at the City, the City of Pasadena engaged LSL and has elected to:
    • Spend more time and money with expanded scope audits (LSL has been asked to audit every fund of the City regardless of the dollar amount. The City made the “investment” of almost doubling the audit fees for the peace of mind in knowing all funds are being looked at. This resulted in feed back to the governing board of over 25 material weaknesses in the first year alone which are being addressed by management),
    • Hire a separate firm to conduct internal audits,
    • Hire an internal auditor employed by the City on a full-time basis.

Audits and the term auditor mean different things to different people. With the recent occurrence at the City of Placentia, it is a call for all Local Government Officials to recognize the need for more internal audit type work!

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