Municipal Audits

Some of this is a reposting of archived material.

New stuff: three scanned pdfs of the “General Comments” sections of the Borough’s financial audits for FY 2004, FY 2005 and FY 2006. It’ll be interesting to see if it takes a full 12 months to get the audit of the 2007 books from the auditors, and whether Mr. Morrison will be hired again for the ninth straight year.

FY04 Audit – General Comments

FY05 Audit – General Comments

FY06 Audit – General Comments

From the archives:

December 15, 2007:

The Borough recently received the Financial Audit for FY2006, prepared by Robert Morrison of Holudik and Morrison. Mr. Morrison will be present at the Council Agenda Sesssion at 7 p.m. on Monday, December 17, at the Vermeule Community Center. If you have questions or comments about the Borough’s financial status, come on out to the meeting.

The previous post (reposted below)  covered Oleh Kaniuka’s initial thoughts on reading two previous audits. He is a local resident and CPA.

Most interesting in the 2006 audit is that, three years running, the Borough has failed to implement a fixed asset accounting system, and this year, received an “adverse opinion.”

Mr. Kaniuka’s initial comments on the newest audit:

There are 4 possibilities as far as opinions- Unqualified, Qualified, Disclaimer, or Adverse. This opinion is Adverse (the worst kind), based primarily on the lack of a fixed asset accounting system. The accounting firm of Holudik and Morrison, PA, states, however, that they do not dispute the decision on the part of the borough to remain in noncompliance with the statutory requirements for a fixed asset accounting system based on a cost benefit analysis performed by the Borough. In my opinion, this appears to be an attempt on the part of the firm to water down the seriousness of the finding, and I am not sure why they would do that. If something is required based on an accounting principle or a statute, then it is not ever debatable or justifiable to be noncompliant, unless compliance would cause the financials to be misleading, which is clearly not the case here.

Segregation of duties was also one finding. A proper internal control system ensures that authorization, custodial, and journalization functions never be performed by the same person because of the ease in which fraud may be perpetrated. Verbiage on pp. 153 and 154 suggests that these functions are not appropriately separated.

“An adverse opinion states that the financial statements are not fairly presented. In practice, an adverse opinion is rare, because it would be of little use to the client. If the financial statements are so deficient as to warrant an adverse opinion by the auditors, the situation will be discussed between the auditors and the client’s management. The management will probably agree to make the changes necessary to avoid an adverse opinion or will decide to terminate the audit engagement and thus avoid paying additional audit fees.” (Meigs, Whittington, Pany, & Meigs, (1989), Principles of Auditing, Ninth Edition, Il, Richard D. Irwin, Inc.)

November 30, 2007: Analysis by Oleh Kaniuka, CPA:

A CPA firm that performs any type of attestation service must be independent in fact and appearance. Lack of independence can be as obvious as having a brother-in-law of a company employee working for the CPA firm, or as distant as the CPA owning shares of a mutual fund that holds shares of the audited company.

The question a CPA must ask him/herself is,”Is there any single thing that could make our firm APPEAR to be anything other that independent of the financials we are auditing?” There have even been examples of CPAs having been subpoenaed as witnesses, and being asked questions such as “Have you or anyone in your immediate or distant family ever owned shares of ABC Company,” in an attempt to establish a lack of independence.

If the Firm determines itself to be non-independent, then it must withdraw from the audit and not issue an opinion. Giving an unqualified opinion so as to secure additional work in the future would be considered highly unethical.

Further, it is common practice to rotate CPA firms (not use the same firm more than 3 years in a row) in order to help maintain the appearance of independence.

Bottom line- unless someone knows for a fact that there is an employee of this particular CPA firm [the firm that did the audits for FY 2003, 2004, and 2005] that has some legal relationship with the township, then I am not sure it is feasible to consider the audit invalid due to lack of independence.

CPA firms are required to obtain 40 credit hours per year of continuing professional education, which includes 4 credits of Law and Ethics. CPA firms also undergo a peer review as part of the control process to ensure the highest standards of integrity. These are actually not just pretty words, because there is a section in the AICPA journal that explicitly names CPAs who have been suspended from practice for ethical infractions. The additional governmental oversight of CPAs is in the form of the licensing process.

There are various Governmental agencies and oversight boards that do set accounting standards and principles, in addition to performing audits of governmental agencies, but I don’t know what the rules are regarding who audits what, since I am a CPA in private industry and do not have experience in this area.

I believe Federal agencies must be audited by the GAO, but I am not sure how that filters down to the municipal or state level. There may even be state versions of similar entities. In any event, as long as the audits of NP were prepared by an independent firm according to established financial auditing standards, then I would trust the reports to have integrity.

The caveat is, however, that a financial audit is not designed to specifically detect fraud, should it exist. Certainly if the resulting audit results in the discovery of fraudulent activity, then it must be reported, but the standards of testing and the rules of evidence for a fraud audit are set much higher. Fraud is, by its nature, designed to undermine internal controls and to be undetectable.

I have not compiled a complete list of findings from the audit yet, but one of the most disturbing thing about the findings is the lack of a fixed asset accounting system. This was a repeat finding in the 2 reports I have (It is expected that a finding be addressed before the next audit occurs.)

There were a bunch of other things that were also wrong, but I don’t recall what they were at the moment. I will compile a list of the findings shortly.

I also do not know what recourse there is with respect to the findings. A corporate Internal Audit group would do regular follow ups which it would then report to the Board of Directors.

An external CPA firm’s report is published along with a corporation’s annual report, which would result in a drop in the stock price for reportable conditions or material misstatements that had not been addressed.

I don’t know what happens when a municipality fails to address these items- other than the publishing of the findings and the decision on the part of the voters to not re-elect the incumbent administration. The council’s reluctance to make documentation available to the public certainly is a disturbing twist.

I think what would be in order would be a something along the lines of a fraud audit or, as you suggested, some type of audit performed by the state or Federal agency, but I don’t know how to orchestrate this. I also don’t know what would be the level of probable cause needed to initiate such an audit.