Wednesday, February 6, 2019

Outside Audit Finds Errors In Town's 2018 Reported Financial Result

Town financial internal control procedures in question
According to an audit report of the Town's 2018 financial statements, the internal controls surrounding the recording of economic transactions that occur outside the Town of Oro Valley's finance department have been found to be insufficient.

This finding was part of the annual audit report by independent town auditor, Heinfeld, Meech. The auditor will present these and other results at tonight's town council meeting.

Not material?
The lack of internal control resulted in a restatement of previously reported 2018 financial results.  According to town staff: " It is important to note that these findings did not cause a material misstatement of the Town's financial statements." The term "material" is their judgement that the errors detected were a relatively small portion of total town budget.

The auditors, however, did not provide judgment on that. What they did say is that the deficiency is significant. (source)

Impact fees not properly recorded
There were three errors uncovered by the outside auditors:
  • Street infrastructure contributed to the Town was not captured in capital asset records.
  • Impact fee credits issued to developers were not recorded in the Town’s general ledger
  • A cash contribution received was incorrectly recorded as deposits payable.
Significant amount of error: $3.2 million
The amounts of the misstatement are significant:
  • The Town received $2.5 million in street infrastructure in the current year which was not added to the Town’s capital asset records. 
  • $630,830 in impact fee credits were issued in exchange for the contributed infrastructure. Of these credits, $199,000 were drawn on and used by developers during the fiscal year. The Town did not record transactions related to the impact fee credits, resulting in a misstated general ledger. 
  • Also, a cash contribution of $133,000 was incorrectly recorded as a deposit payable. ​
The auditor recommended that "The Town should implement procedures to ensure that all transactions and pertinent financial information is being communicated to the Finance Department and captured in the Town’s financial records."

Procedures being put in place
According to town staff, "...procedures will be completed by mid-February, and will be followed by training with all key staff involved in collecting, approving, managing and accounting for impact fees and impact fee credit agreements." (source)

Independent party review required
We understand that mistakes happen. Occasionally, a transaction does get incorrectly recorded.

But this is more than a mistake in recording a transaction. It is a mistake in not even knowing that a transaction occurred. That is a situation that is ripe for fraud. It is wrong to shrug off the situation by saying that it does not have a material affect on the financial statements. That is because it is a serious breach of the integrity of the accounting system.

It is not sufficient that the same people, town staff, who failed to recognize the breach in the first place be the same people to design, write and train in the procedures to fix the lack of internal control.  The fix should be one that considers all economic transactions that originate outside of the finance department. The town council should retain a third party unrelated to the town and to the town's auditor to evaluate and opine on the "fix." And then to test the "fix"  thoroughly. That person should be retained by and directly report to town council, not town staff.