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R2005-0066 04-11-05RESOLUTION NO. R2005-66 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF PEARLAND, TEXAS, ACCEPTING THE CITY'S ANNUAL AUDIT MANAGEMENT LETTER AS PREPARED BY THE ACCOUNTING FIRM OF PATTILLO, BROWN AND HILL. BE IT RESOLVED BY THE CITY COUNCIL OF THE CITY OF PEARLAND, TEXAS: Section 1. That certain financial audit management letter as prepared by Patillio, Brown and Hill, a copy of which is attached hereto as Exhibit "A" and made a part hereof for all purposes, is hereby authorized and approved. Section 2. That the City Council accepts the City's annual financial audit letter. PASSED, APPROVED and ADOPTED this the 11th day of Apri 1 A.D., 2005. ATTEST: APPROVED AS TO FORM: (0 • it( aist DARRIN M. COKER CITY ATTORNEY TOM REID MAYOR City of Pearland Interoffice Memorandum To: Mayor and City Council From: Andrea Gardner Bill Eisen, City Manager Date: March 31, 2005 Subject: Staff Response to Management Letter Comments As you are aware a Management Letter is issued from out external auditors on an annual basis with our Comprehensive Annual Financial Report. A copy of this letter is attached along with the City's staff response to each comment. Current Year Comments ■ Comment: Inter -local Agreement With Pearland ISD o Staff Response: Director of Finance will work with Pearland ISD, Legal, and the Police Department to create a contract suitable for all parties. • Comment: Detail of Construction Projects o Staff Response: We currently identify all projects distinguishing them by generic funding source. Will begin identifying by specific funding source (Bond Issue). o Capital Projects are being tracked in the projects module that was purchased in FY 2003. o Hired Project Analyst in October 2004. o Since July 2004, Finance and Projects have conducted monthly meetings to discuss project related matters. o Over the last 2 months, Projects has evaluated all projects and are coding them as active, inactive or closed (completed). • Comment: Status of Audit Committee o Staff Response: Director of Finance will create an Audit Committee Policy for future adoption by City Council. • Comment: Economic Condition Reporting: The Statistical Section o Staff Response: New Audit Standard issued in May 2004 to establish guidelines for the preparation of statistical section of the CAFR. We will be implementing new standard in FY 2005. • Comment: Electronic Purchase Order Approval o Staff Response: Training documentation was prepared by Finance Department in February 2004 and distributed to all department heads via email. o The Finance Department will provide mandatory follow up training to all department heads and their staff by end of FY 2005. • Comment: Reconciliation of Account Balances o Staff Response: The Director of Finance has determined the areas of concern and is working with the appropriate parties to resolve. o With the hiring of the new Senior Accountant the policies and procedures put in place will be audited to assure compliance. Prior Year Comments ■ Comment: Internal Auditor o Council Action (approval of mid year staff addition; Senior Accountant) was taken on 3/28/05 that satisfied this comment. • Comment: General Capital Asset Reporting o Public Works and GIS personnel are currently working together to complete via Gismo (currently 85% complete). o Bi -annual updates will be completed once all infrastructure have been assigned a value. ■ Comment: Reconciliation of Subsidiary Ledgers to Control Accounts o This matter is included as one of the job responsibilities for the Senior Accountant and Staff Accountant III position. Page 2 Staff Response to Management Letter Comments • Comment: Water and Sewer Sub ledgers o This matter is included as one of the job responsibilities for the Senior Accountant and Staff Accountant III position. Tnks for your time. ! w r r 1 -h'V Andrea Gardner, Director of Finance wll PATTILLO, BROWN & HILL, L.L.P. CERTIFIED PUBLIC ACCOUNTANTS • BUSINESS CONSULTANTS Honorable Mayor and City Council City of Pearland, Texas In planning and performing our audit of the financial statements of the City of Pearland, Texas, for the year ended September 30, 2004, we considered the City's internal control structure to determine our auditing procedures for the purpose of expressing an opinion on the financial statements and not to provide assurance on the internal control structure. However, during our audit we became aware of certain matters that are opportunities for strengthening internal controls and operating efficiency. The memorandum that accompanies this letter summarizes our comments and suggestions regarding those matters. This letter does not affect our report dated January 7, 2005, on the financial statements of the City of Pearland, Texas. We will review the status of these comments during our next audit engagement. We have already discussed many of these comments and suggestions with various City personnel, and we will be pleased to discuss them in further detail at your convenience, to perform any additional study of these matters, or to assist you in implementing the recommendations. Pao; 13itW..4t d %V, L. L. P. January 7, 2005 401 WEST HIGHWAY 6 ■ P. O. BOX 20725 ■ WACO, TX 76702-0725 ■ (254) 772-4901 ■ FAX: (254) 772-4920 • www.pbhcpa.com AFFILIATE OFFICES: BROWNSVILLE, TX (956) 544-7778 ■ HILLSBORO, TX (254) 582-2583 TEMPLE, TX (254) 791-3460 ■ ALBUQUERQUE, NM (505) 266-5904 ■ RIO RANCHO, NM (505) 898-3516 CITY OF PEARLAND, TEXAS COMMENTS AND SUGGESTIONS SEPTEMBER 30, 2004 INTERLOCAL AGREEMENT WITH PEARLAND ISD During our audit, we noted that the City receives a fee for providing security services to the school district as the District uses City law enforcement personnel to patrol the District's campuses during the school year. As part of our audit procedures, we apply tests to see if the amount of revenue that is collected is reasonable compared to the amount stated in the local agreement. We could not find a written agreement that states the yearly fee that is to be charged to the school district. We also noted that the school pays once a year for services that extend over many months. We recommend the City have a signed interlocal agreement with the school district that states a fee for the security services provided by the City's law enforcement personnel. We also recommend the agreement state payment terms that require payment on a more frequent basis than once a year. This will allow the revenue to be tested against a signed and approved contract and will increase the cash flow to the City. DETAIL OF CONSTRUCTION PROJECTS Over the past few years, the City has issued large amounts of debt for various facility improvements and road and drainage projects to coincide with the City's growth. While reviewing additions to fixed assets, we noted that it is very difficult to identify which additions apply to what projects. It is also difficult to determine when a project is complete and should be moved to fixed assets from construction in progress. The City should have a list of construction projects by bond issue, the budget of each project and the expenditures to date on the project. This will be helpful to the City when it comes to the annual budget as well as the amounts that should be in construction in progress and fixed assets. STATUS OF AUDIT COMMITTEE The City has an audit committee that meets once a year to review the annul audit report and management letter. The audit committee does not record minutes of these meetings. There are also no formal requirements as to how many people should comprise the committee or who should be on the committee. The main requirement of the audit committee is to meet periodically and discuss finance and financial information of the City. They should also review and discuss the annual audit and management letter as presented by the outside auditors. The committee should then report back to the City Council about the findings in the report and the management letter. We recommend the City formalize their audit committee or just have an advisory committee that meets informally. The City should also consult with the City Attorney as to the necessity of keeping minutes and requirements of the Open Meetings Act. 2 ECONOMIC CONDITION REPORTING: THE STATISTICAL SECTION Governmental Accounting Standards Board (GASB) Statement No. 44, Economic Condition Reporting: The Statistical Section, issued in May 2004, establishes new guidelines for preparing the statistical section of a Comprehensive Annual Financial Report (CAFR). GASB Statement No. 44 enhances and updates the statistical section that accompanies the City's basic financial statements to reflect the significant changes that have taken place in government finance, including the more comprehensive government -wide financial information required by GASB Statement No. 34. The Statistical Section will be required to contain the following five categories: • Financial Trends — trend information to help readers understand how the City's financial performance and well-being have changed over time. • Revenue Capacity — information to help readers assess the City's most significant "own source" revenue sources. • Debt Capacity — information to help readers assess the affordability of the City's current levels of outstanding debt and the City's ability to issue additional debt in the future. • Demographic and Economic Information — offer demographic and economic indicators to help readers understand the environment within which the City's financial activities take place. • Operating Information — contains service and infrastructure data to help readers understand how the information in the City's financial report relates to the services the City provides and the activities it performs. The Government Finance Officers Association (GFOA) has awarded a Certificate of Achievement for Excellence in Financial Reporting to the City for its Comprehensive Annual Financial Report (CAFR) for many consecutive years. In order to continue to receive this prestigious award, the City will be required to implement the new standard in the fiscal year ending September 30, 2006. We recommend the City become familiar with the new statistical section requirements in order to ensure that all necessary information is available in the year of implementation. ELECTRONIC PURCHASE ORDER APPROVAL The City has implemented the new procedure of using electronic or "Field Purchase Orders" where the purchase order is originated in the individual departments through the computer, and each stage of the process requires a certain level of electronic approval. It came to our attention that certain department heads are not very familiar with the software and have delegated that responsibility to their subordinates. By allowing subordinates access to approving purchases where management approval is required, officials are circumventing the procedures put in place to prevent the misappropriation of City assets and the payment of potentially fraudulent invoices. Although it may be efficient to allow a subordinate to enter the information into the system, it is important that the approval of these items not be delegated. We recommend department heads receive the proper training on the software to ensure that they can be as functional and efficient as possible when using the system. 3 RECONCILIATION OF ACCOUNT BALANCES During our testing of accrued liabilities, we noted that there are some accounts that have negative balances and have not changed during the year. Although these balances are not material to the financial statements, we recommend the City investigate these balances during the year and make the proper adjustments to these accounts. Performing periodic reconciliations during the year will help to find any discrepancies and will help in providing accurate balances at year-end. PRIOR YEAR COMMENTS ANTII+RAUD PROGRAMS AND CONTROLS Prior Year Comment: Antifraud programs and controls are the policies and procedures put in place by an organization to help ensure that management directives are carried out. They are part of the overall system of internal control established to achieve reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations. An organization's management is responsible for designing and implementing effective systems and procedures for preventing, deterring and detecting fraud. With the recently intensified focus on fraudulent financial statement reporting, as well as the ever-present risk of misappropriation of assets, many organizations are now more interested in establishing effective antifraud programs and controls. The risk of fraud can be reduced through a combination of prevention, deterrence and detection measures. However, fraud can be difficult to detect, and the time and expense required for fraud investigation can be very costly. Therefore, it is essential to place a strong emphasis on fraud prevention to reduce opportunities for fraud and fraud deterrence that discourages individuals from committing fraud because of the likelihood of detection and punishment. The AICPA fraud task force of the Auditing Standards Board commissioned a group of organizations and individuals with expertise in the area of fraud prevention, deterrence and detection to develop guidance to help companies improve their antifraud programs and controls. In November 2002, the AICPA and six other professional organizations jointly published a document titled, "Management Antifraud Programs and Controls: Guidance to Help Prevent, Deter and Detect Fraud." This document identifies measures entities can implement to prevent, deter and detect fraud. It discusses these measures in the context of three fundamental elements. Broadly stated, these fundamental elements are: 1) create and maintain a culture of honesty and high ethics; 2) evaluate the risks of fraud and implement the processes, procedures and controls needed to mitigate the risks and reduce the opportunities for fraud; and 3) develop an appropriate oversight process. 4 We recommend the City develop a heightened "fraud awareness" and an appropriate fraud risk - management program with oversight provided by the City Council or audit committee. An effective system of antifraud program and controls should encompass prevention, deterrence and detection techniques and activities. Current Status: The City is aware of the policy and has begun discussions on implementing an antifraud policy. INTERNAL AUDITOR Prior Year Comment: Internal auditors can be of great value to local governments in a variety of ways. In particular, they assist management in monitoring the design and proper functioning of internal control policies and procedures. In this capacity, internal auditors themselves function as an additional level of control and help to improve the City's overall control environment. A City of this size, with many complex transactions and ongoing operations, needs an Internal Auditor. We believe that the Internal Auditor should be independent of as many of the City's functions as possible to provide the proper check and balance system. We recommend the City consider the feasibility of establishing a formal internal audit function which will play an important role in helping management to maintain a comprehensive framework of internal controls. The position of Internal Auditor should be staffed with someone with direct reporting responsibility to the City Manager. Internal audit staff should conduct their work in accordance with the professional standards relevant to internal auditing contained in the U. S. General Accounting Office's publication Government Auditing Standards. We believe that the Internal Auditor should be independent of as many of the City's functions as possible to provide the proper check and balance system. Current Status: Unchanged EVALUATION OF POTENTIAL COMPONENT UNITS Prior Year Comment: Governmental Accounting Standards Board (GASB) Statement No. 14, The Financial Reporting Entity, establishes standards for defining and reporting on the financial reporting entity. Recently, GASB amended Statement No. 14 with GASB Statement No. 39, Determining Whether Certain Organizations Are Components Units. Statement No. 39 establishes additional guidance on the application of existing standards for the assessment of potential component units in determining the financial reporting entity. Generally, it requires reporting as a component unit an organization that raises and holds economic resources for the direct benefit of the City, its component units or its constituents. This additional guidance will require the City to determine whether certain organizations for which the City is not financially accountable should be reported as component units based on their relationship with the City. 5 We recommend the City reevaluate potential component units using the additional criteria. If an organization is identified as a new component unit, the City will need to obtain its financial statements and include the entity as part of the City's financial statements. The City will be required to implement the new standard in the fiscal year ending September 30, 2004. Current Status: This matter has been resolved. INFRASTRUCTURE REPORTING Prior Year Comment: Prior to GASB Statement No. 34, local governments were not required to report general infrastructure assets and most governments chose not to report them. Many governments did not maintain historical cost information for general infrastructure assets and some retained limited records relating to infrastructure assets. In order to ease the implementation of general infrastructure reporting, more liberal rules apply for reporting general infrastructure assets acquired before the adoption of GASB Statement No. 34. These include allowing an extended period of time for retroactively reporting infrastructure assets. Governments must prospectively report general infrastructure assets when they adopt the general provisions of GASB Statement No. 34. Governments are encouraged to retroactively report general infrastructure assets at the same time that they apply the other provisions of GASB Statement No. 34. However, governments may delay the retroactive reporting of their major general infrastructure assets for up to four years. The City will be required to comply with these requirements no later than the fiscal year ending September 30, 2006. Many local governments have encountered difficulty in complying with the general rules for infrastructure asset reporting. Additionally, for governments that do not retroactively report debt- financed infrastructure capital assets, the amount reported as net assets "invested in capital assets, net of related debt" in the statement of net assets is understated until the historical cost of debt-financed infrastructure assets has been estimated and reported. We recommend the City develop a plan for reporting infrastructure assets. Some matters to consider follow: • Required retroactive capitalization is limited to "major" general infrastructure assets, as defined by GASB Statement No. 34. • The required retroactive capitalization period is limited to years ending after June 30, 1980. • Initial capitalization using deflated current replacement cost to represent estimated historical cost is allowed. • Bond documents, engineering documents, and capital projects funds expenditures may be used as source documents when estimating historical cost. 6 • Composite depreciation rates based on groupings of similar assets or classes of dissimilar assets is permitted. Current Status: The City is currently working towards implementing this standard. GENERAL CAPITAL ASSET REPORTING Prior Year Comment: Prior to GASB Statement No. 34, local governments were not required to report gains and losses on disposals of general fixed assets. General capital assets were only reported in account groups, not in governmental funds. Furthermore, because governmental funds only report financial resource flows, the entire amount of the cash received from a sale would be reported as an inflow. After implementation of GASB Statement No. 34, governments are required to report gains and losses on disposals of general fixed assets in the government -wide financial statements. Sales, disposals, or retirements of capital assets should be reported by reducing the specific related accounts (capital assets and accumulated depreciation, if any) to zero and reporting the difference between the sales price, if any, and the carrying amount as a gain or loss in the statement of activities. As a practical matter, however, insignificant gains or losses on the sale of capital assets could be eliminated by adjusting the current period's depreciation expense by the amount of the gain or loss. We recommend the City implement procedures to accumulate the information required to report disposals of general fixed assets in the government -wide financial statements. Current Status: Unchanged COLLATERALIZATION OF INVESTMENTS Prior Year Comment: During our testing, we noted the City's investments were under collateralized. The purpose of collateralization (the pledging of securities by the depository financial institution to the City) is to protect the City in the event of the financial institution's closure or default. The amount of collateralization should be in excess of the City's cash balance less FDIC insurance coverage. The responsibility to maintain adequate collateralization is a joint responsibility between the City and the depository. We recommend the Finance Director monitor collateralization on a monthly basis, and during months of traditionally high daily cash balances, collateralization should be monitored at least weekly. Some governments have also found it helpful to require depositories to collateralize over 100% of the uninsured cash balance to provide for a cushion for error, for example 110%. 7 Current Status: These investments are now being collateralized. GRANT CENTRALIZATION Prior Year Comment: The centralization of grant information, reporting and monitoring of compliance is an important part of streamlining the audit process. It facilitates the ease of obtaining documents and other pertinent information required to perform the audit. It also lightens the load of City personnel performing grant related responsibilities and reduces the chance of duplicating efforts. We recommend the City consolidate all grant -related responsibilities to a Grant Coordinator and that this position be under the direction of a City official, (example, Finance Director). By consolidating these duties, reporting can be monitored, documentation can be easily accessed and controlled, and grants can be readily detected and identified. Current Status: Grants are now centralized within the Finance Department. BANK RECONCILIATIONS Prior Year Comment: During our audit of cash, we determined that bank reconciliations were not performed timely. Bank statements should be reconciled promptly, and any discrepancies should be identified and corrected in order to properly state the City's cash. Any necessary adjustments should be documented and posted to the general ledger. Therefore, we recommend the City perform reconciliations of bank accounts on a monthly basis and any differences should be investigated and corrected in a timely manner. Current Status: Bank reconciliations are now being done on a timely basis. However, we noted reconciling items that are not being posted to the general ledger. RECONCILIATION OF SUBSIDIARY LEDGERS TO CONTROL ACCOUNTS Prior Year Comment: Currently, the reconciliation of subsidiary ledgers to the general ledger control accounts are not being performed in a timely manner. As a result, errors and double postings have occurred and were undetected until the audit. Although the problem was a computer generated error, the possibility of this or other irregularities (intentional or not) could be detected earlier if a reconciliation of subsidiary ledger to control accounts had been performed in a timely manner. 8 We recommend that the City reconcile each subsidiary ledger to the appropriate general ledger control account on a monthly or at least on a quarterly basis to reduce the possibility of errors being undetected for an extended period of time. Current Status: Unchanged JOURNAL ENTRIES Prior Year Comment: It was noted that on several occasions, adequate documentation was unavailable to support transfers of funds between investment accounts. The City should keep a record of all journal entries in order to provide and audit trail that will help detect errors and accurately portray the investment balances in the individual funds. Documenting all journal entries also assists in the effortless preparation of reconciliations in a timely manner. Current Status: This matter has been resolved. WATER AND SEWER SUBLEDGERS Prior Year Comment: A section of our auditing procedures focus' on enterprise revenues and internal controls over those funds. As meters are read and input into the water billing software, the system calculates how much is owed to the City and posts this amount as a receivable. The amount calculated, per the water system, does not agree to the amount listed per the general ledger, as the water system does not directly link to the general ledger system. Returned checks, applying deposits to water bills and billing errors are just some of the reasons that the receivable, per the water system, differs from the receivable per the general ledger. The receivable, per the general ledger, should be reconciled to the amount per the water system on a regular basis. This reconciliation will make sure that changes to the receivable will be posted to the proper general ledger account lines. Current Status: Unchanged 9 GRANT ISSUES Prior Year Comment: While performing test work on the City's grants, we noted two areas where operating efficiency and internal controls could be strengthened. The City had a grant through the United States Department to reduce underage drinking in the City of Pearland. We found that the grant availability period expired and the City lost approximately $19,000 of funds. Another grant the City received requested that reports be filed on a monthly basis. The City did not file some of the expenditure reports within the prescribed timeframe. Failure to comply with requirements of grant contracts can lead to delays in the receipt of grant funding and even cause the loss of grant dollars. We recommend the City review all grant contracts and implement procedures to ensure all requirements of grant contracts are met. This will help prevent any delays in the receipt of funding or possible loss of future funding. Current Status: This matter has been resolved. CUSTOMER DEPOSITS Prior Year Comment: When an application for water service is made, the customer pays a deposit to the City. This deposit is a liability of the City as the customer is refunded the deposit when service is discontinued. If the customer's account becomes delinquent, the City can apply the deposit to the unpaid water bill. A record of water deposits owed to customers is maintained. While auditing this area, we noted that this record did not agree to the balance of customer deposits on the general ledger. A detail listing supporting the amount on the general ledger is an important element in the internal control structure over this account. We recommend the City implement procedures to reconcile the subsidiary ledger for customer deposits to the general ledger balance on a monthly basis. Any differences should be investigated and corrected in a timely manner. This will provide the City with an accurate listing of the items comprising this account during the year and assist in detecting errors in a timely manner. Current Status: The City now has a listing of customer deposits, and the liability on the general ledger matches this listing. 10 WATER DEPARTMENT Prior Year Comment: During our examination of internal controls in the Water Department, we found some areas that could be improved upon. We discovered the Department was late in issuing bills at times throughout the year. We also noted instances in which water service for delinquent customers was not terminated in a timely manner. This was at least partially attributable to turnover in the Department and the lack of personnel to cut off water service. We recommend management increase monitoring of the Department to ensure that bills continue to be issued in a timely manner and service is terminated when necessary. Current Status: The City has a new Water Department supervisor and terminations of service are now being done in an effort to decrease the receivable balance. * * * * * * * * Thank you for the opportunity to be of service to the City of Pearland, Texas. We appreciate the assistance and cooperation shown our personnel during our audit. 11