Spring is the season for planning, whether it focuses on spending time with family or pursuing our professional goals. For government agencies, it’s also the busiest time of the year.  Management must not only prepare the next year’s budget, but also coordinate the audit for the current year.  It can be a difficult balancing act, particularly when you look at what’s on the line – both financially and politically.

The Risk of Routine

Because municipalities are required by state law to be audited, the exercise frequently becomes a routine annual process.  Between April and December, auditors come to your office and perform various audit procedures, obtaining sufficient evidence necessary to express their opinions concerning your financial statements.

As government officials, no matter how much you may like your auditors, you would prefer to have the their work completed in the most efficient way possible, without adding disruption to your day-to-day operations. Thanks to the use of technology, auditors today enjoy an unprecedented ability to streamline the process for increased efficiency. Those advancements notwithstanding, the audit objective is to provide an independent opinion as to whether management’s financial statements are accurate and fairly presented.

Raising Questions

The Pun Group surveyed some 105 cities and 14 counties across California over a 10-year period, examining each jurisdiction’s Comprehensive Annual Financial Report (CAFR) and performing a number of separate analyses on the data provided.  One of the analyses involves reviewing the relationship between prior period adjustments due to correction of error (“restatements”) and the audit opinions issued.

Interestingly, on average, about 65 cities and 8 counties reported restatements, yet received an “unmodified” opinion from their auditors. Experienced practitioners know that any prior period adjustments mean there are material misstatements noted in the financial statements that auditors were not able to identify in their procedures.

Given that outcome, it’s fair to raise the question: By streamlining the audit process, are we substantially increasing the risk of leaving these material misstatements unidentified? That answer then leads one to the ultimate question: Can these financial statements be considered reliable and meet expectations from stakeholders?

Why it Matters

Government serves a broad cross-section of stakeholders, which generally fall into one of three groups:

Taxpayers, citizens, and elected officials – Because government revenues are generated on an involuntary basis rather than a willing exchange of values found in a typical business transaction, taxpayers and citizens have the right to know whether their jurisdictions or agencies are spending their tax dollars wisely. Correspondingly, they require assurance that their elected officials prudently budget and allocate tax money to satisfy expectations regarding public safety, public works, and other community service needs. Taxpayers and citizens fully understand whether services provided by government are supported by tax revenues, thus providing them a basis for which to evaluate any new funding measures that may need to be imposed.

Grantors and other oversight groups – Government programs are often subsidized by federal, state, and other local grant funding.  By providing the necessary financial support, grantors and oversight agencies have the responsibility to ensure that these programs are free of fraud, waste, abuse and other forms of mismanagement.  The financial statements can provide information about the sources and programmatic uses for these funds, and effectively create the audit trail.  Monitoring actual compliance with budgeted public policies can produce performance measures that promote transparency and accountability.

Bondholders and others in the financial community – Governments issue municipal securities to finance a wide variety of projects and generate necessary cash flows.  The debt service payments may come from general revenues of the issuer, specific tax receipts, or even revenues generated from a public project.  These municipal securities may be secured by letter of credit, other government guarantees, or an insurance policy.  Audited financial statements are a required part of continuous disclosures and provide bondholders with comfort and confidence regarding the repayment of the debt as well as the guaranteed return on their investment.

Closing the Trust Gap

Reliable financial statements represent the key to meeting stakeholder expectations.  To ensure reliability and strengthen public trust, both auditors and auditees must pay close attention to detail when preparing for the audit.  I’m a firm believer in the philosophy of “Garbage in, garbage out!”

Even though the process can be streamlined through technology, a good audit still requires a significant level of manual input. Otherwise, the process becomes robotic and the utility of the resulting information suffers.  A good audit always starts with good planning – and that responsibility falls on the auditors, as well as the auditees.  To ensure reliable financial statements, here are few guidelines to follow:

  1. Understand the ordinance or charter and identify any unique requirements outside of those associated with a general-law city.
  2. Evaluate the “Tone at the Top” to ensure that the organization promotes high integrity and retains competent employees for its mission
  3. Evaluate internal controls and perform risk assessment.  By understanding the risk appetite, you can deploy the necessary resources to those high-risk areas and eliminate any waste of resources.
  4. Organizations should embed design, implementation and proper internal control measures to mitigate risk.
  5. People are the key to any organization. However, agencies should ensure that information is transparent and properly communicated to the right audiences.
  6. Organizations should continuously monitor results and make necessary adjustments based on changing conditions
  7. Evaluate the user of the financial statements and put yourself in their shoes.  Ask the question: If things go wrong, what are the major consequences?
  8. Identify any unique transactions that require additional attention. Invest the incremental resources needed to fully address them.

Takeaway

Without auditors and auditees understanding – and, more importantly, embracing – proper process, the audit can become a commodity of questionable value.

Kenneth Pun, CPA, CGMA, is Managing Partner of The Pun Group, a full-service CPA firm headquartered in Orange County, California.