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HomeMy WebLinkAbout2011 Management LetterCITY OF EVANSTON, ILLLINOIS COMMUNICATIONS FROM AUDITOR TO MANAGEMENT AND THE CITY COUNCIL (Including Memorandum on Accounting Procedures, Internal Controls and Other Matters) December 31, 2011 CITY OF EVANSTON INDEX Report on Internal Control Introduction Material Weaknesses Significant Deficiencies Recom m endation/Observation Issued GASB Change Two Way Auditor Communication -STATEMENT ON AUDITING STANDARDS (SAS) No. 114 The Auditor's Communication With Those Charged with Governance Required Communications with Those Charged With Governance Appendix A -Summary of Passed Adjusting Journal Entries Appendix B -Management Representations Page No. 1 3 3 5 6 7 8 10 ~ BAKER TILLY To Honorable Elizabeth B. Tisdahl, Mayor and Members of the City Council Evanston , Illinois Baker Tilly Virchow Krause. LLP 1301 W 22nd St. Ste 400 Oak Brook. IL 60523-3389 t<1630 990 3131 fax 630 990 0039 bakerti lIy.com In planning and performing our audit of the financial statements of City of Evanston as of and for the ten months ended December 31, 2011, in accordance with auditing standards generally accepted in the United States of America, we considered its internal control over financial reporting (internal control) as a basis for designing our auditing procedures for the purpose of expressing our opinions on the financial statements , but not for the purpose of expressing an opinion on the effectiveness of its internal control. Accordingly, we do not express an opinion on the effectiveness of its internal control. Our consideration of internal control was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control that might be significant deficiencies or material weaknesses and , therefore, there can be no assurance that all such deficiencies have been identified . However, as discussed below , we identified certain deficiencies in internal control , which are defined by auditing standards to fall within three categories: > A control deficiency 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 or detect and correct misstatements on a timely basis. > A significant deficiency is a deficiency, or 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 . > A material weakness is a deficiency, or combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented , or detected and corrected on a timely basis. We have noted deficiencies at the City of Evanston and classified them based on the above definitions accordingly . These are described in detail in the pages that follow this report. The City of Evanston's written responses to the material weaknesses, significant deficiencies, and other items identified in our audit has not been subjected to the audit procedures applied in the audit of the financial statements , and accordingly , we express no opinion on it. This communication is intended solely for the information and use of the City Council and management and is not intended to be , and should not be, used by an yo ne other than the specified parties . ~,!~ V~ K~ LLP June 26, 2012 ~ .. ~ctH.ni IIMIl!ltH, w' BAKER TILLY tN T ERNATIONAL Page 1 INTRODUCTION In planning and performing our audit of the financial statements of the City of Evanston, Illinois for the ten months ended December 31, 2011, we considered the City's internal control 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. Below is a list of potential controls that, if in place , would achieve a higher level of reliability that errors or irregularities in your processes would be discovered by your staff. Our procedures identified that these controls do not currently exist, or are not designed or implemented properly, for the City. Keep in mind that some of these controls may not be practical due to your staff size or other reasons . You should also consider the costs of making improvements to the expected benefits. However, current professional standards require us to communicate these to you. In addition, as you make changes within your organization, and we continue to rotate audit procedures, more controls of this kind may be communicated to you . A separate report will contain our report on internal control. This letter does not affect our report on the financial statements of City of Evanston. MATERIAL WEAKNESSES JOURNAL ENTRIES The ability to prepare and initiate journal entries is delegated to various levels of finance employees. These entries do not post to the system until the Accounting Manager reviews and approves them . However, there is no review and approval of journal entries initiated and recorded by the Accounting Manager. An entry could be made or improperly supported without the City's knowledge. CITY RESPONSE: The City believes there are adequate controls in place for journal entry management. It is not common for organizations to have three steps in journal entry review and is much more accepted to have entries done by one staff member and reviewed by the manager . To add another level of management/review would be overly redundant and not cost efficient. The City made changes allowing only the Accounting Manager to approve journal entries based on the auditor's recommendation couple of years back. Department directors periodically review transactions posted to their business units to identify/investigate any material variances from the budget numbers . The Budget Division prepares monthly financials which would serve as yet another tool to discover any material misstatements. Page 2 MATERIAL WEAKNESSES (cont.) EXTERNAL FINANCIAL REPORTING The system of internal controls over financial reporting is addressed by auditing standards . In theory, a good system of internal controls staffed with enough people with enough training would provide your organization with the ability to not only process and record monthly transactions, but also to prepare a complete set of annual financial statements . The current standard makes it clear that the definition of a material weakness in internal control should now include consideration of the year-end financial reporting process. To avoid the auditor reporting a material weakness in internal controls, your system of controls would need to be able to accomplish the following: 1. Present the books and records to the auditor in such a condition that the auditor is not able to identify any material journal entries for the current or prior periods as a result of our audit procedures . This is very rare indeed for most of our clients . 2. Prepare a complete set of year-end financial statements with a very high level of accuracy. The current standard requires that the level of accuracy be such that there is only a remote likelihood that the auditor discovers a material change to the statements or footnotes. While a number of our clients prepare their own statements, it may not be cost beneficial to scrutinize those statements internally to the same degree that the auditor will do later. If the auditor, therefore, discovers a material change to the statements, by definition, the system of internal controls over financial reporting must have a material weakness . To accomplish such a high level of internal control over financial reporting is a difficult task for most governments. During the course of our audit , it was discovered that property tax revenue in the General Fund was materially misstated resulting in audit adjusting entries prepared by the City. The adjustments to the financial statements increased property tax receivable by $291,872, decreased deferred revenue by $526,938 and increased property tax revenue by $818,810. This entry was necessary to ensure that the financial statements are fairly stated and , in our judgment, was material to the financial statements. Management subsequently recorded these amounts. As noted above , the design and implementation of internal controls over financial reporting are the responsibility of the City as emphasized in Statement of Auditing Standards statement No . 115, Communicating Internal Control Related Matters in an Audit . We have observed that the improper design and implementation is normally a constraint of cost containment and lack of staffing available to public entities . CITY RESPONSE: The Property Tax in the amount $291 ,872 for 2010 levy was received during the month of January and February of 2012. The City also received $526,938 for 2011 levy during the month of January and February of 2012 . The City of Evanston has allocated $526,938 to the newly set up Library Fund for their operating expenses . The city staff made appropriate audit adjustments recommended by the Auditors. Page 3 SIGNIFICANT DEFICIENCIES INFORMATION TECHNOLOGY As part of the audit , we were required to identify the processes in place that provide a controlled information technology (IT) environment for the applications, supporting systems and infrastructure determined to be critical to the financial statement audit. We documented the processes in place for each of the three main areas of focus : change management, logical access and IT operations . We then assessed the design effectiveness of each of these processes and noted the following opportunities to strengthen the City's IT controls . The City has some logical restrictions in place, such as requiring a unique user ID and password to access the systems . Through our discussions with the City and related observations, we noted that the Network password login from the active directory requires eight characters and is changed every 90 days; password complexity is required and the system remembers the last five passwords. Some of the City's software systems such as AQUAS and PAL also follow these password criteria . Other of the City's software systems such as CryWolf, JDE and RecTrac require passwords; however they are not in line with recommended password complexity standards. Best practices indicate that other steps could be taken to further ensure the integrity of the data. All passwords should be changed periodically. They should also meet the industry standards for length, expiration, characters, and history (passwords cannot be repeated). However, we understand that purchased software cannot always be modified in order to strengthen password complexity requirements . CITY RESPONSE -Provided by Information Technology (IT): The referenced systems -CryWolf, JDE and RecTrac are purchased packages and the City cannot change the password handling in these systems. JDE could be upgraded to use our Active Directory and then would be in compliance with best practices. The City prevents any issues with the utilization of these software systems by requiring a system software password for the use of any City system. In effect, a user must enter a password that meets or exceeds the above referenced definitions (character length, complexity and history). CASH RECEIPTS CONTROLS In an optimal internal control environment, certain control processes and segregation of duties would exist in order to prevent a misstatement of financial information. This is accomplished when no single person can initiate, record, and control distribution of a single transaction or series of transactions. In some instances, the personnel constraints of many organizations do not always allow for ideal segregation of duties . However, it is our responsibility as auditors to communicate this deficiency. During the course of our audit, we noted that the Operations Coordinator in the Collector's Office is responsible for reconciling daily cash receipts collected by the cashiers, preparing the deposit for pickup by Garda, and posting receipts to the City's accounting system. This presents a risk of the misappropriation of cash receipts to be concealed within the accounting system. We recommend that a second individual review the amount prepared for deposit in comparison to the original cash register reports and amounts posted to the general ledger for accuracy. CITY RESPONSE: During the fiscal year 2011, Accounting Division started posting batches prepared by Operations Coordinator. Page 4 RECOMMENDATION/OBSERVATION DEFICIT FUND NET ASSETS At December 31, 2011 , the City's Insurance Internal Activity Fund, reported deficit fund net assets of $6,124,771. The Insurance Fund began the period with a deficit net asset balance of $4,937,496. As this is an internal service fund, all revenues and transfers of net assets are supported by the City's other funds including the General Fund , Water Fund, and Sewer Fund . These funds are expected to subsidize the Insurance Internal Service Fund 's improvement in future years. CITY RESPONSE: The City agrees to the above deficit fund net asset numbers for the Insurance Fund. The City started making inter-fund transfers from the other funds during the 2010-11 fiscal year to reflect proportionate estimated insurance costs for those funds. It is worth noting that the Insurance Fund has total current assets of approximately $1.4M at the end of the year and the negative fund balance is mainly due to an accrual for short/long-term claims payable recorded for the potential liability In the Fund financial statements for the year ended December 31, 2011. Page 5 ISSUED GASB CHANGE GASB STATEMENT NO. 61: THE FINANCIAL REPORTING ENTITY: OMNIBUS The Governmental Accounting Standards Board (GASB) has issued Statement No.61, which changes governmental financial reporting for component units . These changes will affect your financial statements for the year ended December 31, 2013, primarily the government-wide financial statements, and possibly the fund financial statements. This Statement modifies certain requirements for inclusion of component units in the financial reporting entity . For organizations that previously were required to be included as component units by meeting the fiscal dependency criter ion, a financial benefit or burden relationship also would need to be present between the primary government and that organization for it to be included in the reporting entity as a component unit. Further , for organizations that do not meet the financial accountability criteria for inclus ion as component units but that , nevertheless , should be included because the primary government 's management determines that it would be misleading to exclude them, this Statement clarifies the manner in which that determination should be made and the types of relationships that generally should be considered in making the determination . This Statement also amends the criteria for reporting component units as if they were part of the primary government (that is, blending) in certain circumstances. For component units that currently are blended based on the "substantively the same governing body" criterion , it additionally requires that (1) the primary government and the component unit have a financial benefit or burden relationship or (2) management (below the level of the elected officials) of the pr imary government have operational responsibility (as defined) for the activities of the component unit. New criteria also are added to require blending of component units whose total debt outstanding is expected to be repaid entirely or almost entirely with resources of the primary government. The blending provisions are amended to clarify that funds of a blended component unit have the same financial reporting requirements as a fund of the primary government. Lastly, additional reporting guidance is provided for blending a component unit if the primary government is a business-type activity that uses a single column presentation for financial reporting. This Statement also clarifies the reporting of equity interests in legally separate organizations. It requires a primary government to report its equity interest in a component unit as an asset. You will need to determine how these new requirements will affect your financial statements . Page 6 TWO WAY AUDITOR COMMUNICATION -STATEMENT ON AUDITING STANDARDS (SAS) NO. 114 THE AUDITOR'S COMMUNICA T/ON WITH THOSE CHANGES WITH GOVERNANCE Current auditing standards establish requirements and provide guidance to an auditor's communication with those charged with governance in relation to an audit of financial statements . The standard defines those charged with governance as the person(s) with responsibility for overseeing the strategic direction of the entity and obligations related to accountability of the entity. Most times in local government those charged with governance means the governing body. Among other things, the SAS directs the auditor to communicate with those charged with governance - > The auditor's responsibilities under generally accepted auditing standards > An overview of the planned scope and timing of the audit; and > Significant findings from the audit. > Regarding the last bullet point , significant findings from the audit, the auditor should communicate: > The auditor's view about qualitative aspects of significant accounting practices > Significant difficulties, if any, encountered during the audit > Uncorrected misstatements > Disagreements with management , if any > Other findings or issues > Unless all of those charged with governance are involved in managing the entity, the following should also be communicated: > Material corrected misstatements > Representations the auditor is requesting from management > Managements consultations with other accountants > Significant issues, if any, arising from the audit, or subject of correspondence, with management. How does this impact the City of Evanston? We are providing increased communications to you throughout the audit process. We have previously issued an additional letter to you covering the items noted above. The new requirements provide for two-way communication and are important in assisting the auditor and you with more information relevant to the audit. In addition, as this audit is concluded, we use what we have learned to begin the planning process for next year's audit. It is important that you understand the following points about the scope and timing of our next audit: a . We address the significant risks of material misstatement, whether due to fraud or error, through our detailed audit procedures . Page 7 TWO WAY AUDITOR COMMUNICATION -STATEMENT ON AUDITING STANDARDS (SAS) NO. 114 THE AUDITOR'S COMMUNICATION WITH THOSE CHANGES WITH GOVERNANCE (cont.) b. We will obtain an understanding of the five components of internal control sufficient to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures. We will obtain a sufficient understanding by performing risk assessment procedures to evaluate the design of controls relevant to an audit of financial statements and to determine whether they have been implemented. We will use such knowledge to: > Identify types of potential misstatements . > Consider factors that affect the risks of material misstatement. > Design tests of controls, when applicable, and substantive procedures. c. We will not express an opinion on the effectiveness of internal control over financial reporting or compliance with laws, regulations, and provisions of contracts or grant programs . For audits done in accordance with Government Auditing Standards, our report will contain the following restriction: "This report is intended solely for the information and use of the client's management, others within the City, federal awarding agencies and pass-through entities and is not intended to be, and should not be, used by anyone other than these specified parties." d . The concept of materiality recognizes that some matters , either individually or in the aggregate, are important for fair presentation of financial statements in conformity with generally accepted accounting principles while other matters are not important. In performing the audit, we are concerned with matters that, either individually or in the aggregate, could be material to the financial statements. Our responsibility is to plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, are detected. We are very interested in your views regarding certain matters. Those matters are listed here: a . We typically will communicate with your top level of management unless you tell us otherwise. b. We understand that the City Council has the responsibility to oversee the strategic direction of your organization, as well as the overall accountability of the entity. Management has the responsibility for achieving the objectives of the City. c. We need to know your views about your City's objectives and strategies, and the related business risks that may result in material misstatements . d. Which matters do you consider warrant particular attention during the audit, and are there any areas where you request additional procedures to be undertaken? e . Have you had any significant communications with regulators? f. Are there other matters that you believe are relevant to the audit of the financial statements? Also, is there anything that we need to know about the attitudes, awareness, and actions of the City concerning : a . The City's internal control and its importance in the City, including how those charged with governance oversee the effectiveness of internal control? b . The detection or the possibility of fraud? Page 8 TWO WAY AUDITOR COMMUNICATION -STATEMENT ON AUDITING STANDARDS (SAS) NO. 114 THE AUDITOR'S COMMUNICATION WITH THOSE CHANGES WITH GOVERNANCE (cont.) We also need to know if you have taken actions in response to developments in financial reporting , laws , accounting standards, governance practices, or other related matters, or in response to previous communications with us . With regard to the timing of our audit, here is some general information. We complete preliminary audit work during the month of March . Our final fieldwork is completed in May . After fieldwork , we wrap up our audit procedures at our office. Final copies of our report and other communications are issued after approval by your staff. REQUIRED COMMUNICATIONS WITH THOSE CHARGED WITH GOVERNANCE The following section presents communications required by our professional standards. OUR RESPONSIBILITY UNDER AUDITING STANDARDS GENERALLY ACCEPTED IN THE UNITED STATES OF AMERICA, OMB CIRCULAR A-133 AUDIT GUIDELINES The objective of a financial statement audit is the expression of an opinion on the financial statements. We conducted the audit in accordance with auditing standards generally accepted in the United States of America. These standards require that we plan and perform our audit to obtain reasonable, rather than absolute , assurance about whether the financial statements prepared by management with your oversight are free of material misstatement, whether caused by error or fraud. Our audit included examining , on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit does not relieve management or those charged with governance of their respons ibilities . As part of the audit we obtained an understanding of the entity and its environment, including internal control, sufficient to assess the risks of material misstatement of the financial statements and to design the nature, timing and extent of further audit procedures . The audit was not designed to provide assurance on internal control or to identify deficiencies in internal control. As part of obtaining reasonable assurance about whether the financial statements are free of material misstatement , we performed tests of the City of Evanston's compliance with certain provisions of laws, regulat ions , contracts , and grants , noncompliance with which could have a direct and material effect on the determination of financial statement amounts . However, providing an opinion on compliance with those provisions was not an objective of our audit. Also, in accordance with OMB Circular A-133, Prado & Renteria CPAs will examine , on a test basis, evidence about the City's compliance with the types of compliance requirements described in the U.S. Office of Management and Budget (OMB) Circular A-133 Compliance Supplement applicable to each of the City's major programs for the purpose of expressing an opinion on the City's compliance with those requirements . While the audit provides a reasonable basis for the op inion , it does not provide a legal determination on the City 's compliance with those requirements. Prado & Renteria CPAs will issue a separate document which contains the results of our audit procedures to comply with OMB Circular A-133 . Page 9 REQUIRED COMMUNICATIONS WITH THOSE CHARGED WITH GOVERNANCE (cont.) OTHER INFORMATION IN DOCUMENTS CONTAINING AUDITED FINANCIAL STATEMENTS Our responsibility does not extend beyond the audited financial statements identified in this report. We do not have any obligation to and have not performed any procedures to corroborate other information contained in client prepared documents, such as official statements related to debt issues . PLANNED SCOPE AND TIMING OF THE AUDIT We performed the audit according to the planned scope and timing previously communicated to you in our letter accompanying the February 28 , 2011 audited financial statements. QUALITATIVE ASPECTS OF THE ENTITYS SIGNIFICANT ACCOUNTING PRACTICES Accounting Policies Management has the responsibility for selection and use of appropriate accounting policies. In accordance with the terms of our engagement letter, we will advise management about the appropriateness of accounting policies and their application. The significant accounting policies used by the City of Evanston are described in Note 1 to the financial statements. The City of Evanston has adopted the provisions of GASS Statement No . 54 -Fund Balance Reporting and Governmental Fund Type Definitions effective March 1, 2011. The application of existing policies was not changed during the ten months ending December 31, 2011. We noted no transactions entered into by the City of Evanston during the period that were both significant and unusual, and of which, under professional standards, we are required to inform you , or transactions for which there is a lack of authoritative guidance or consensus. Accounting Estimates Accounting estimates are an integral part of the financial statements prepared by management and are based on management's knowledge and experience about past and current events and assumptions about future events . Certain accounting estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ significantly from those expected. The most sensitive estimates affecting the financial statements were: Depreciation expense Allowance for doubtful accounts Insurance claims payable OPES liability We evaluated the key factors and assumptions used to develop these estimates in determining they are reasonable in relation to the financial statements taken as a whole. Financial Statement Disclosures The disclosures in the financial statements are neutral , consistent, and clear. DIFFICULTIES ENCOUNTERED IN PERFORMING THE AUDIT We encountered no significant difficulties in dealing with management in performing our audit. Page 10 REQUIRED COMMUNICATIONS WITH THOSE CHARGED WITH GOVERNANCE (cont.) AUDIT ADJUSTMENTS For purposes of this letter, professional standards define an audit adjustment as a proposed correction of the financial statements that, in our judgment, may not have been detected except through our aud iting procedures. An audit adjustment mayor may not ind icate matters that could have a significant effect on the C ity of Evanston 's financial reporting process . Matters underlying adjustments proposed by the auditor could potentially cause future financial statements to be materially misstated. The following audit adjustment, in our judgment, indicates matters that could have a significant effect on the C ity of Evanston 's financial reporting process: ~ To properly state General Fund property taxes, adjustments to the financial statements increased property tax receivable by $291,872, decreased deferred revenue by $526,938 and increased property tax revenue by $818,810 . ~ To properly state General Obligation Debt Fund property taxes, adjustments to the financial statements increased property tax receivable and revenue by $119 ,000. ~ To properly state Special Service District NO .5 Fund property taxes, adjustments to the financial statements decreased deferred revenue and increased property tax revenue by $44,740. ~ To properly state Parking Fund capital assets and accounts payable adjustments to the financial statements increased both accounts by $533,162. ~ To properly state Governmental Act ivities capital assets adjustments to the financial statements increased capital assets and decreased depreciation expense by $1 ,140,039 . In addition, the attached schedule in Appendix A of this report summarizes uncorrected misstatements of the financial statements . Management has determined that their effects are immaterial, both individually and in the aggregate , to the financial statements taken as a whole. DISAGREEMENTS WITH MANAGEMENT For purposes of this letter, professional standards define a disagreement with management as a matter , whether or not resolved to our satisfaction , concerning a financial accounting, reporting, or auditing matter that could be significant to the financial statements or the auditor's report. We are pleased to report that no such disagreements arose during the course of our audit. CONSULTATIONS WITH OTHER INDEPENDENT ACCOUNTANTS In some cases, management may decide to consult with other accountants about auditing and accounting matters, similar to obtaining a "second opinion" on certain situations. If a consultation involves application of an accounting principle to the governmental unit's financial statements or a determination of the type of auditors' opinion that may be expressed on those statements, our professional standards require the consulting accountant to check with us to determine that the consultant has all the relevant facts. To our knowledge, there were no such consultations with other accountants. MANAGEMENT REPRESENTATIONS We have requested certain representations from management that are included in the management representation letter, and attached as Appendix B to this report. INDEPENDENCE We are not aware of any relationships between Baker Tilly V irchow Krause, LLP and the City of Evanston that, in our professional judgment , may reasonably be thought to bear on our independence. Page 11 REQUIRED COMMUNICATIONS WITH THOSE CHARGED WITH GOVERNANCE (cont.) Relating to our audit of the financial statements for the ten months ended December 31 , 2011, Baker Tilly Virchow Krause, LLP hereby confirms in accordance with the Code of Professional Conduct issued by the American Institute of Certified Public Accountants, that we are, in our professional judgment, independent with respect to the City of Evanston and provided no services to the City of Evanston other than the audit of the current period 's financial statements. OTHER AUDIT FINDINGS OR ISSUES We generally discuss a variety of matters , including the application of accounting principles and auditing standards, with management each year prior to retention as the City of Evanston's auditors. However , these discussions occurred in the normal course of our professional relationship and our responses were not a condition to our retention . It was a pleasure to work with the City's Accounting and Finance staff again this year. We would like to thank you for allowing us to serve you and we look forward to the opportunity to work with the City in the future. If there are any questions, please contact: Jason Coyle -630-645-6205. This report is intended solely for the information and use of City of Evanston 's management, others within the entity, federal and state awarding agencies and pass-through entities and is not intended to be, and should not be, used by anyone other than the specified parties. Page 12 Governmental Activities Business-Type Activities General Fund Water Fund Noncurrent Assets 80 ,000 80 ,000 City of Evanston SUMMARY OF UNCORRECTED FINANCIAL STATEMENT MISSTATEMENTS Total Assets 1,701 ,334 80 ,000 238,765 80,000 December 31, 2011 Financial Statements Effect - Increase (Decrease) to Financial Statement Total Total Current Total Net Assets! Total Liabilities Liabilities Fund Balances Revenues 1,701,334 238 ,765 80,000 435 ,380 (355 ,380) 238,765 238 ,765 80,000 80 ,000 Total Expenses! Expenditures (475,974) 355,380 Change in Net Assets! Fund Balances 714 ,739 (355 ,380) 238,765