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HomeMy WebLinkAboutItem #58 - Discussion Item.04 PEAT. MARWICK, MITCHELL & CO. CERTIFIED PUBLIC ACCOUNTANTS 1000 BRICI[ELL AVENUE MIAM1, FLORIDA 33131 September 27. 1979 .41 The Honorable Maurice Ferre City of Miami, Florida 3500 Pan American Drive Miami. Florida 33133 0 ids Cor • Dear Mayor Ferre: Several months ago we forwarded to you and the members of the City Com- mission a booklet our firm published relating to audit committees for municipalities. Recently, you asked for additional information regarding the use of audit committees and I have ordered additional copies of our booklet to deliver to you. We have orally recommended the implementation of an independent audit committee by the City on previous occasions and we are pleased to hear of your interest in proceeding to establish such a body at this time. For your information I have enclosed a copy of a special bulletin issued by the Municipal Finance Officers Association entitled "Ho to Best Utilize the External Auditor." On page two of this document under the heading The Audit Committee, the role of the audit committee is briefly mentioned. Additionally, I have included an article entitled "How Greenwich Used an Audit Conmmitte." On the fourth page of this article the subject of audit committees is addressed. Our firm has long favored the formation of audit committees in both the public and private sectors. There are a number of benefits to be derived through the use of audit coum►ittees, such as: . - increasing the awareness of Commission Members regard- ing the role and scope of independent auditors; - assisting management explain the company's financial information and financial management processes to the audit committee in greater detail than would be practical before the full Commission; - increasing the independence of the external auditors by providing a forum in which a free exchange'of detailed information can take place; P M.M. 8 CO. The Honorable Maurice Ferre September 27, 1979 Page 2 - increasing the effectiveness of internal auditors by allowing them to report directly to the audit committee; - increasing the confidence of taxpayers, bond under- writers and others who must rely on the financial integrity of the municipality. We appreciate the leadership you.have taken with respect to this important matter and would be pleased to answer any questions you may have. Very truly yours, PEAT, • WICK, ITCHELt & CO. Powell, Managing Partner EWP/ai, Enclosures cc: `Members of the. City Commission" The City Manager •�'.... _R :9►, • • . SPECIAL BULLETIN 1176E • DEC. 16, 1176 • =1.60 HOW TO BEST UTILIZE. THE EXTERNAL AUDITOR BY IRWIN T. OAVID While most elected officials know the impor- tance of fiscal responsibility and accounta- bility for public monies, their awareness has been heightened in the last several years as resources have become increasingly scarce and as the financial stability of local govern- . ments has become a major public issue. Accord- ingly, the role of the external auditor --as an agent of change as well as an attestor --is be- coming a subject of great interest to public administrators. Unfortunately, this role has not been well understood, nor has the work of the external auditor been fully utilized as a management tool in government. By knowing the necessary questions, city and county boards and councils can increase external accounta- bility and internal control and can improve operational efficiency. This article illus- trates ways to achieve effective utilization .of professional audit and audit -related serv- ices. THE AUDIT PROCESS Why An Audit? Although audits are often re- quired by law or regulation, there are several more fundamental reasons why a unit of local government should.have an outside audit: • An audit provides the governing board with an independent professional opinion of the financial condition, health and stability of the governed .unit. • Audited financial statements provide under - Writers and rating agencies with the basic financial information to establish and main- tain credit ratings. Such ratings can have significant impact on the debt carrying cost Irvin '1. David is a partner in the Chicago office of Touche Ross i Co. and a National Services Director for .State and Local Government. Since joining Touche Ross in 1960, he has been active in governmental accounting and counseling at the state and local government lev- els. He has had major responsibility in developing and implementing governmental accounting systems, and has written several articles in the area of governmental operations and financial management. ial bufletin MUNICIPAL FINANCE OFFICERS ASSOCIATION of the government entity and are particularly important now with the financial "crunch" facing so many municipalities and counties. • The statements also provide information for federal government agencies regarding grant requests. • Comments and recommendations to strengthen the management process and to promote effi- ciencies and economies of the governmental unit's operation should be received from the external auditor --usually as a letter of rec- ommendations or a management letter. What Is An Audit? A financial audit is an ex- amination of accounts and records of the gov- ernmental unit, conducted in accordance with generally accepted auditing standards. The audit may, however; extend beyond the finan- cial area. For instance, the auditor may also examine departmental operations to provide an outside professional opinion regarding perform- ance, i.e., efficiency and/or effectiveness, in the specific area examined. The result of the auditor's work in a fi- nancial.audit consists of an independent opin- ion on the fairness of the presentation of the financial statements and recosrmendatibns for increased control or operational improvements. The auditor's opinion is usually in one of the following categories: • Unqualified --The statements present fairly • the financial position and results of opera- tions of the entity on a consistent basis. . Qualified --As above except that.... • Adverse —Statements 'do not fairly present fi- nancial information, with explanation for reasons as can be'determined in the course of the audit. • Disclaimer --The auditor cannot render an opinion. A letter of recommendations relating to the MUNICIPAL FINANCE OFFICERS _.iOCIATION organisation's internal controls and opera- tions usually accompanies the opinion. This letter, intended to assist the governing body in assessing its operations and in implement- ing improvements, is often the most important part of the audit engagement. Of growing interest to government execu- tives are the expanding services which can be performed by the auditor to complement the fi- .nancial•examinations. These services, like the financial audit, can be extremely useful to government officials because they aid in determining whether funds are being spent as intended and whether programs are achieving desired results. s Of Audits. The four basic types of au - its are: • Financial --The auditor reviews financial transactions and, based on his audit pro- cedures, renders an opinion on the fairness of presentation of the governmental unit's financial statements. Until recently, the financial audit was the most common. • Compliance --The auditor reviews operations in terms of compliance with various laws and ordinances regarding fiscal and financial operations, ethical requirements, bond pro- visions and other regulations. While the compliance audit has always been a part of the financial audit, stronger emphasis on the compliance aspect has surfaced recently. • Performance --The auditor reviews the effi- ciency of operations. This review usually addresses issues relating to organization, personnel management, information systems, and cost-effectiveness questions. .Program --The auditor reviews various pro- grams (particularly federally funded pro- grams), to determine if the programs are accomplishing stated objectives. In audits of federally funded programs, in- creased emphasis is being placed on perform- ance and program aspects of the audit. Follow- ing the leadership of the U.S. General Account- ing Office (GAO), this emphasis is expanding through all levels of the government. In the future, audits will encompass more performance .and program requirements; there will be less emphasis on financial and compliance require- ments. This is due to increased recognition of the auditor's role as an agent of change in addition to his or her role as an attestor. RELATIONS WITH THE AUDITOR The successful relationship between a govern- mental organization and its auditor depends on a number of factors, including the extent and the attention paid to the audit relation- ship by the governmental unit. The audit re- lationship begins with the selection of the auditor and is a continuing relationship throughout the year. Some important factors in the audit relationship follow. The Audit Committee. The auditor should be en- gaged by and report to the governing board of the governmental unit. The auditor is the in- dependent representative of the taxpayer (through the governing board) and is accounta- ble for providing sufficient information in a usable form so that the governing board can exercise due control over management. Accord- ingly, it is appropriate for the auditor to be engaged by and report to the governing board. This relationship can be successfully handled through an audit committee, a subcommittee of the governing board. The formation of an audit committee is now almost a uniform practice in the private sec- tor. It is usually considered one of the most important functions of the board and'one which cannot be delegated. The same should be true in the public sector. This does not preclude participation in the committee by management. Most audit committees, in fact, do include the chief executive officer and/or chief financial officer as ex-officio members of the committee. The decision making responsibility, however, clearly must reside with the board, council or commission and is fundamental to the concept. Of course on a day-to-day basis the auditors deal with the governmental unit's management group. However, the audit report must go to the governing board. Likewise, the board must take the appropriate time and interest to get full benefit from the audit relationship. The role of the audit committee should in- clude: • Determining the scope of the audit. • Selecting the auditor. • Reviewing interim and final results of the audit and asking relevant questions of the auditor as necessary to support the decision making process. • Reporting to the entire governing board the committee's recommendations for action in- • dicated by the audit. Audit Scope. The potential value of an audit is only•as broad as its scope. Therefore, the governmental unit, together with the auditor, must define the scope of the audit; that is, what is the auditor expected to do. In addi- tion, the auditor must define the areas he will emphasize and review (e.g., data processing, enterprises, etc.) and how, within that scope. Therefore, the audit committee should discuss the following scope questions, among others. with the prospective or current auditor: • Will the audit program be tailored to our entity or is it •a general nature/checklist approach? What specific procedures (includ- ing statistical sampling) are to be used for the examination and will they remain the same next year? • Will all funds be audited, including the en- terprise funds, federal grant funds, and rev- • MUNICIPAL FINANCE OFFICERS ASi` NATION enue sharing monies or other revenues? /f . not, why? - • Will the a'idit include elements of compliance audit, performance audit, or program audit? If so, why? If not, why not? This is quite often an area in which the board or council might ask the auditor to perform in-depth analyses of the effectiveness and efficien- cies'of various aspects of the operation. • Will the auditor consider a program of rotat- ing in-depth analyses of specific areas of operations? (Quite frequently, the auditor may perform in-depth analyses of functions on a rotating basis. For example, one year an enterprise might be reviewed, another • year the purchasing function, another year revenue collections, etc. Such an approach will hold down costs and provide in-depth analysis.) • To what degree will the auditor review the data processing function? (The auditor should briefly explain to the audit committee the EDP audit procedures and, if none are used, explain why and how computer activities • will be audited.) • Will any limitations be placed upon the audit scope by members of management? What pro- cedures will be used to mitigate such re- strictions? Selecting the Auditor. Although audit stand- ards and practice principles are uniform with- in the auditing profession, one audit is not necessarily the same as another. As with any other professional service, the quality of and the value derived from different audit rela- tionships will differ, depending on the orien- tation of both the auditors and the governmen- tal unit. In selecting.auditors, the audit committee and/or other municipal representa- tives should interview the key partner and staff who will be assigned to the engagement. The committee should be satisfied that the auditors and their firm have a solid under- standing of government programs generally and the operations of their unit in particular. Some of the factors to be considered in select- ing the auditor include: • Understanding of the problem. Does the audi- tor understand the governmental unit, legal requirements concerning the proposed work, current and future needs relating to the gov- ernmental unit, the governmental unit's ob- jectives and the parameters of the work to be accomplished? • Approaoh/hethodoiogy. Is the proposed meth- odology feasible and compatible with the gov- ernmental unit's operations? Is the timing of the final report appropriate? Will in- terim reports be available? Is the approach logical, orderly and consistent with the specified tasks and desired results? • Experience. Has the auditor worked for simi- lar governmental units on similar audits? Does the auditor have capabilities in areas which the governmental unit might require at • later time, such as performance and pro- gram audits, financial systems, or data pro- cessing? The auditor should provide, and the governmental unit should thoroughly check. references from other clients along with spe- cific references on key personnel who will be responsible for the audit. • Staff qualifications. How is the firm going to bring its experience to bear on this pro- ject? Are the staff members who are proposed for the audit experienced in working with similar governmental units and on similar projects? • Cost. Cost must, of course, be a factor in selecting the auditor. In evaluating cost the governmental unit must evaluate the qual- ity of service being provided by the auditor. Cost is generally a function of the effort devoted by the auditor. The effort depends on factors such as the number of funds to be audited, the number of reports to be provided, the extent of use of data processing, the adequacy of the internal controls and the accounting records and the timing of the en- gagement. A major factor affecting cost is the assistance to be provided by the govern- mental unit. For instance, an internal audit staff could perform activities for the out- side auditors which could impact fees. Like- wise,,clerical assistance could reduce the outside audit fees. In evaluating cost, the governmental unit must also evaluate the quality of service being provided. The audit committee must compare "apples to apples" to assure that they are receiving the same ser- vice from different auditors. As with other services, the buyer will.get what he pays for. QUESTIONS TO ASK YOUR AUDITOR Regardless of the auditor's scope, he or she offers significant assistance in the steward- ship and improvement of local government assets and operations. Although local government ad- ministrators deal with the auditor frequently (during the audit and possibly other times dur- ing the year), elected officials often have little contact with the auditor. As a result, they frequently do not understand the impor- tance of the audit relationship. This rela- tionship has begun to change with the practice of establishing audit committees. - The audit committee has a continuing respon- sibility to periodically meet with the auditor and to review interim and final reports. In addition, the auditor should make at least one presentation to the entire governing board, typically at the conclusion of the audit. During meetings with the governing board and/or the audit committee, the auditor should be questioned in six major areas: 1) Scope of the audit; 2) Audit firm personnel; 3) Systems and procedures; 4) Overall findings; 5) Report- ing issues; and 6) Ethics. • Audit Scope. While the audit committee and the auditor have agreed to the audit scope, it is MUNICIPAL FINANCE OFFICERS rib''OCIATION important that the governing body understand what areas.the auditor actually reviewed and the reason why a particular scope has been se- lected. It is particularly important when the auditor performs in-depth analysis of a par- ticular area. Therefore, the audit committee _._should assure itself that the scope defined .was actually covered and should understand 'what special areas were examined. Questions .similar to those indicated previously should be asketat the conclusion of each year's audit. Audit Firm Personnel. If the audit committee does not meet frequently with the auditor, they may wish to ask questions such as: • What personnel are assigned to the engagement and what are their qualifications? What are the qualifications of supervisory personnel? How much time do they spend on the audit? What training enables those individuals to satisfactorily complete the audit? • How often do audit management personnel meet with representatives of the governmental unit? Are they available to answer financial or other questions during the year? Does the auditor visit the agencies throughout the year? Systems and Procedures. Many questions regard- ing a local government's systems and procedures may be addressed in the management letter. In understanding its potential value, the follow- ing questions will be especially useful to elected officials: • Does the letter identify areas for improve- ment in operations as well as exceptions to internal financial controls? Were the ex- ceptions identified due to the inadequacy of the systems or to departures from the pre- scribed systems by government personnel? • Within staff constraints, is there a proper segregation of duties? • Is the internal audit staff being utilized properly? How can the staff be used more effectively? • Is information properly organized and main- tained and are data retention policies ade- quate? Are proper controls in place to as- sure security and confidentiality'of infor- mation? • • Is information reported on a timely and in- terim basis? Are interim reports accurate and is management making use of them? • Are statutes, ordinances, and bond require- • s►ents being complied with? Does current bonding of employees and/or officials appear adequate? Are insurance policies adequate? • Were prior recommendations made by the audi- tor instituted? If not, why not? Are they still valid? • Overall, are personnel competent and are they fulfilling their responsibilities in a con- scientious and professional manner? Overall Findings. Because of the significant financial problems faced by many states, coun- ties and cities, boards and council members are very interested in the overall financial pic- ture of their communities. While the adminis- trator and financial manager of the governmen- tal unit will, most likely be on top of the fi- nancial areas, auditors can often provide ad- ditional comment on the financial operations based on the breadth of their experience in the private and public sectors. In reviewing the auditor's findings the committee should consider asking: • Are all sources of available funds being utilized? Do possibilities exist for addi- tional grants from either the state or fed- eral government? For example, is the unit of local government receiving maximum federal reimbursement for indirect costs allowed un- der Federal Management Circular 74-4? • Does it appear that the local government can provide more effective services to its con- stituency without the burden of excessive taxation and fees? • Are utilities and enterprise funds self-suf- ficient? Are the current rate structures adequate or excessive? Are we in compliance with federal guidelines? • What can be done to improve our credit rat- ing? How can our bonds be made more market- able? For example, are appropriate cash flow techniques being used and is there a formal financial management plan in existence to assure that excess funds are invested properly on a timely basis? • Is our budget definitive enough to properly monitor costs against appropriations? Are our budgeting techniques effective? Do they help preclude the possibility of deficit spending? • How can we maintain effective services and • efficient operations? Can costs be reduced through consolidation of administrative func- tions or implementation of improved manage- ment techniques? Reporting Issues. The financial -statements and audit reports of the local unit of government are the mechanism for communicating findings to the citizens, the federal government, rating agencies, and investors. Quite often, these reports seem confusing, and a governing body properly asks for necessary explanations. Typ- ical areas often explored include: • Can our reports be revised or expanded for better communication to various potential audiences? Is reporting in compliance with established standards? • Do our interim (e.g., monthly) financial and statistical reports provide enough informa- tion, in usable form, for management control and decision making? • �tii3iaitsMv[49ti.�Ih�fL{.=.h:1^iy.�-�!4_'���t1l�P 1.1�11'O�O 0® MUNICIPAL FINANCE OFFICERS A )CIATION rt5 • If any exceptions were taken in the audit report, what were the reasons for such ex- ceptions? What future measures can be tak-• en to remove the exceptions? • Can we receive a Certificate of Conformance from the Municipal Finance Officers Associ- ation? If not, what must be done to put our statements into compliance with Certificate • guidelines? • Do we or should we report on a program bud- get basis in addition to traditional line - item reporting? • What is the difference between accrual, modi- fied•eccrual, and cash basis accounting? What does "full disclosure" mean? Is "cur- rent value (inflation) accounting" of value to us? What is the difference between equity balances and reserves? Ethics. Finally, a matter of great discussion relates to questions of ethics in government. Auditors should be asked: • Did you note any instance where an official. or employee had any direct or indirect in- 'terest in any business serving government? • Were all required statements of economic in- terest properly filed? Did the statements disclose any conflicts or potential con- flicts? • Were salaries of any elected officials changed during their terms of office? Were reimburseable expenses adequately documented? • Were there any transactions by government employees involving real property with land trusts? Were beneficiaries disclosed? Did any potential conflicts exist? • Were competitive bids solicited and received if required by' law? Did the examination dis- close any irregularities or apparent fraud? In summary, an audit can and should do more than simply satisfy a legal requirement or the requirement of an external funding source. An audit is a tool which those responsible to the public should use in assuring that their re- sponsibility is being properly discharged. Whether the audit is financial, compliance, performance or program in scope, it should serve the information needs of the entity be- ing audited. If it does not, management should ask questions. REFERENCES American Institute of Certified Public Accountants. AICPA Professional Standards ---Auditing Management Advisory Services, Tax Practice, as of July, 1, 1976. Chicago: Commerce Clearing House, Inc., 1976. Includes the currently effective Statements on Auditing Standards, Commentaries by the Auditing , Standards Executive Committee, and Auditing Interpretations issued by the AICPA staff. Committee on Governmental Accounting and Auditing, American Institute of Certified Public Ac- countants. Audits of State and Local Governmental Units. New York: American Institute of Certified Public Accountants, Inc., 1974. Industry audit guide prepared to assist the independent auditor in examining and reporting on financial statements of state and local governmental units. Proper use of the guide requires thorough knowledge of Governmental Accounting, Auditing, and Financial Reporting. Comptroller General of the United States. Standards for Audit of Governmental Organisations, • Programs, Activities and Functions. Washington, D.C.: U.S. General Accounting Office, 1972. Audit standards for governmental financial and compliance, economy and efficiency, and program results auditing. National Committee on Governmental Accounting. Governmental Accounting, Auditing, and Financial Reporting. Chicago: Municipal Finance Officers Association of the United States and Canada, 1968. The primary authoritative publication in the field of governmental accounting, this book deals with accounting and reporting principles, procedures, and illustrations as well as auditing. National Council on Governmental Accounting. Interpretation 1, GAAFR and the AICPA Audit Guide. Chicago: Municipal Finance Officers Association of the United States and Canada, 1976. Analyzes the differences between and provides guidance for the use of Governmental Accounting, Auditing, and -Financial Reporting and Audits of State and Local Governmental Units. Sim am am 11 • How Greenwich used an audit committee • by William J. Reynolds The Greenwich Board of Estimate and Taxation faced a ticklish situation this year. Either change the town's method of accounting from a cash basis to a modified accrual basis, and report a $2.5 million surplus, or take a qualified opinion on the town's audit report. A $2.5 million surplus might seem to be a sign of good financial management, but not when a $250,000 deficit had been projected earlier in the year. To the town's taxpayers it would seem to indicate either that planned expenditures had not been made, or that someone had made a serious miscalculation in estimating the financial needs of the town. On the other hand, a qualified opinion on the town's audit report was not particularly desirable either, espe- cially if it is your first year as Comptroller. Ordinarily, such a dilemma in the town's finances would have sent shock waves through the Board —espe- cially aftcr better than a quarter century of sound finan- cial administration under a Comptroller praised as `one of the top men in municipal finance." Now under a new Comptroller with ncw ideas and ncw problems, in less .than one year the town already was faccd with an ac- counting dilemma. 44/World/Spring 1973/PMM&Co. But, the fact is, the Board and the Comptroller didn't even bat an eye. They took the whole thing in stride as part of an orderly transition to accounting for the town's finances on the bitcis of newly revised generally accepted accounting principles for municipal governments. As with any surgery, of course, there is bound to be some trauma in the post -operative period before the recovery is com- plete. For Greenwich, the key to the recovery and the successful transition was a somewhat revolutionary de- velopment for Local government —the audit committee. As in most towns, the Greenwich Board of Estimate and Taxation, a twelve -member, bi-partisan body, is made up of civic -minded, hardworking people who de- vote their time and effort to better government. Among its responsibilities, the Board draws up the annual budget, makes appropriations for capital projects, and determines fiscal policy for the town. As in most towns, the Board members are pretty savvy about local issues and know pretty much what the town wants and needs. But as in most towns, too, when it comes to accounting matters and the annual audit report, the Board members would prefer to leave that laborious task to the Comptroller and the town's independent auditor. The problem is that t i• .00 4 state auditor. State auditors must typically cover three or four or more years at a time. Litc moves too fast now- adays to let undesirable conditions cxist uncorrected for that long. Further, state auditors look mainly for com- pliance with the law, for defalcations and cash shortages, and for statistical data that can be used in thc legislature. This is an important function but other things are im- portant too. Because it isn't thc job they set out to do, state auditors arc far less likely than CPAs to explore ways thtsaudited unit can improve its reporting practices to prodtke better decisionmaking. • This somewhat expanded view of the role of the inde- pendent auditor is fairly recent. A decade ago, most CPAs were likely to limit themselves to only the detail. When they audited a purchasing system, the primary — and usually only concern —was to see that the required number of bids were received, that the purchase orders were filled out precisely, and that the arithmetic in the vendors invoice was correct. Today, his questions are likely to include: Was this purchase necessary? is the total system of internal control functioning as it should? In other words, his scope has broadened beyond verifica- tion —which .is carried out on a test basis —into analysis and the making of recommendations. Where properly employed, the auditor goes beyond being the periodic examiner of a set of financial statements and becomes a partner in the year round financial reporting and man- agement of the government entity. It should be recognized, however, that government auditing is different from corporate auditing and requires auditors with special skills in the field. Not every CPA has these skills. For example, when auditing for compli- ance with the law it takes unusual perception and under- standing of the thrust and purpose of the legislation to know when to expect word-for-word compliance, and when not to. An auditor who is a specialist in governmental audit- ing comes to the engagement prepared so that his work can be of genuine value. He familiarizes himself with the general statutes governing the unit —both state and local. He gets to know the charter or special acts by which the unit acquired its rights of existence and its powers. He has a thorough understanding of the type of organization permitted, the duties imposed by the charter ordinances, and state laws, together with similar understanding of how the unit actually is organized, what activities it is carrying on, and how these activities are administered. Most importantly, he understands the uniqueness of gov- ernmental accounting systems. As a means of enabling its auditors to develop this specialized understanding, PMM&Co. developed an au- dit preparation guide for state and local government au- diting. It advocates the preparation of tailored audit pro- grams through the Systems Evaluation Approach (SEA). Many government officials feel the prima. value of an audit for their type of organization is thc identification of weaknesses and problems in internal controls and ad- ministrative systems. That is why management letters arc so vital in governmental audits. SEA forces an under- standing and critical analysis of thc unit and its systems which can result in comprehensive management letters. It provides precisely the kinds of information that city councils mai community residents are interested in. There arc six basic steps that a governmental auditing specialist, using SEA, would take to prepare himself for an audit: 1) He obtains an overall understanding of the client. This includes an understanding of how thc present state of the economy affects the client, an understanding of the client's industry. i.e., government, and an understand- ing of the client's operations. 2) He identifies major areas of audit concern. The knowledge and perspective gained from the initial SEA step is brought to bear in identifying the possible risk areas from among the common transaction cycles and audit areas. 3) He determines the major audit objectives. While general audit objectives exist for financial accounts such as physical existence and proper ownership, adequacy of recorded liability, proper ,valuation in accordance with generally accepted accounting principles, etc., these general objectives must be expanded into specific audit objectives for a government audit. Examples are timely mailing of tax bills, the budget acting as an effective deterrent against overexpenditure, and encumbrances properly recognized. 4) He obtains an in-depth understanding of the gov- ernmental unit's accounting and internal control system. This is accomplished by identifying the major transaction cycles and -avoiding arms, e.g., tax assessment, levying billing, and receivables; personal services and long-term debt authorization, issuance and servicing, and then flow- charting the system to establish that understanding. 5) He identifies the internal controls strengths and weaknesses that have a bearing on audit objectives. This would be done through a review of the major transaction cycles and audit areas of the governmental unit. 6) He develops a tailored program. Developing a pro- gram that is responsive to the audit concerns and that recognizes the evaluation of the internal control system is the final step before the actual audit begins. This approach provideslthe unit that has been audited with meaningful information that can be used in the management process as well as forming the basis of a good financial audit. Only an understanding of the unique needs and requirements of a governmenial unit can pro- vide a sound auditing framework whi h measures the standards of stewardship and accountability and, at the same time, provides information on which management decisions can be considered. Good accounting can alert governmental officials to potential problems so they can make programs work effectively and correct inefficiencies and uneconomical practices before serious, or irreparable, harm is done. The more effective and efficient govern- ment that results from such auditing not only leads to less expensive government, but can also enhance officials' reputations as good managers and prudent administra- tors. inlay, more than ever before, good accounting is good politics and the independent CPA, skilled in gov- ernmental auditing, can he of invaluable assistance. • • World/Spring 1975/PMM&Co./43 ..:._ ,:.,r *-,., �,,,,,, • -- • _-.. _ . .... ". - "� ...-,.. ,••....._ ter- —•-_ when the Comptroller reports back to the Board, its mem- bers get the information second-hand. Uninvolved in the audit function, they remain unaware of vital information and important decisions that could affect their policy con- siderations as guardians of the town's coffers and over- seers of the taxpapers' investment. Some years ago corporate directors found themselves in a similar situation with regard to corporate audits. • While they had been designated as proxies by the com- pany's shareholders to oversee thcir investment, the direc- tors were sorely out of touch with the company's auditors. •In short, they had been isolated from the auditors by the very people whose performance was being audited —the company's executives. Instead of getting the story straight from the horse's mouth, the findings of the audit were being filtered through the company's executives to the directors who became little more than a rubber stamp an thc final audit report. By the late 1960s, a new concept had begun to take hold in business —the audit committcc. The idea was to have a committee made up of two or thrcc directors who would deal directly with the company's auditors in the conduct of the audit. The result would be that the dircc- tors would be getting a first hand look at the audit func- tion, its findings, the company's performance, and, in addition, they.would be making decisions which they, as shareholders' proxies, should be making to safeguard shareholders' inLestments. For local government, the audit committee concept was slow in coming. Already overburdened with other pressing matters, most local government officials re- mained unaware of the new development in the business sector, and continued to rely on the Comptroller or other financial officers to handle financial matters and take care of the annual audit report. The problem with the municipal audit report waaithat, couched in thc accountant's technical jargon, IF said nothing to the municipal officeholder. For him the report was nothing more than a tedious compilation of figures to be leafed-thipgh and set aside in the facc of more ur- gent concerns.4'hat was needed was for the audit report to be taken apart piece by piece and reassembled in terms that meant something. For thc Greenwich Board the way to do that was to get at least some of its members directly involved in thc audit right from the start. Traditionally it has been thc Comptrollers responsi- World/Spring 1973/PMM&Co./4S bility to work on the town's audit with the independent auditor, to sort out the figures and make heads or tails of the results, and report back to the Board. In thc process, howevert the Comptroller was being forced to go far be- yond his responsibility and assume a decision -making role in matters that he felt rightfully belonged to the Board. Now the Board would have to step in and reverse that trend. The Board's members would have to become involved in the actual audit, itself, and share a good part of th;responsibility that had been placed on the Comp- trollefs shoulders over the years. In some towns, the suggestion of such involvement would have brought sharp protests from conscientious Comptrollers who felt no need to have their bosses look- ing over thcir shoulders, judging what they had done for the past year. Because in fact, that's what the audit covers —the Comptroller's performance over the past year as financial administrator. To many it would seem an un- necessary intrusion which could only mean added pres- sures since the Comptroller's operation would now be bared to those who had the power to hire and fire him. Key to the Board's involvement was the realization that the Comptroller's function in municipal government is basically administrative. The Comptroller has no con- stituency to answer to, no voters to represent. He is essentially an administrator who lends his expertise, at a price, to the policymakers and elected officials of the town —the members of the Board. It is they who have the authority and must make the decisions. It is they who represent the town and must answer to the voters for their actions and, ultimately, the actions of the Comp- troller. With no real model to go by in local government, and no evidence that an audit committee would work, the Board was hesitant about plunging ahead with the idea. They were treading on uncertain ground and they were more than a little anxious about the possible unseen consequences. Too, the individual Board members were concerned about their role in the audit committee. Though well qualified to handle the responsibilities of committee involvement, they were not entirely familiar with what their duties would be as active participants in the town's audit function. The idca had to be sold to them, and it was —by thc Comptroller and by the indepen- dent auditor which the Board subsequently engaged to perform the audit. But assurances alone would not allay their skepticism. It was a new idea for local government. previously untested, and there was only one way to see if it would work, and that was to try it out. With somc trepidation, thc Board appointed two of its membcrs—a local CPA and a financial vice president for a major insurance company —to act as an audit committec. For the audit committee's first and, possibly, only timc around, its responsibilities would be to: • interview potential auditors. • recommend to thc full Board the appointment of a selected auditor. • meet with thc auditor and rcvicw the scope of thc audit to bc conducted. • bc available during the audit to meet with thc auditor 66/Worki/Spring 1975/PMM&Co. and discuss findings or procedural recommendations, and evaluate which recommendations could be adopted and which should not. • review the initial draft of the audit report with the auditor, covering all items contained in thc report and focusing on thosc recommendations that had been made, but whose implementation had been postponed. • present the audit report to the full Board, analyzing the report and discussing its recommendations for the future. Each of these had been a responsibility previously assumed by the Comptroller. Now the Comptroller would have to make his recommendations and comments to the committee and leave the dicisions to them. The value of the audilffrnmittee quickly became ap- parent as the impact of recommended new accounting principles began to be recognized. For some years the town's financial philosophy had been extremely conserva- tive, with revenues not recorded until the actual cash had been received. The town's new independent auditors rec- ommended that instead of cash basis accounting, reve- nues be accounted for on a modified accrual basis. This would be in keeping with generally accepted accounting principles recently adopted for local government units, and would achieve a better matching of revenues with expenditures to be covered. The initial reaction by the committee, however, was "No." But instead of dropping it at that. the two audit committee members sat down face-to-face with the Comptroller and the independent auditor and through a series of meetings thrashed out the reasons for and against the recommended change to accrual accounting. Stick with cash basis accounting and the audit report would get a qualified opinion from the auditor. Make a change for the past year to modified ac- crual accounting and, instead of the estimated $250,000 deficit, the audit report would show a $2.5 million sur- plus. For the first time Board members were directly in- volved in accounting and auditing matters that would have both an 'immediate and a long-range effect on the town's financial position. The ball had been dropped in their lap, and the decision was vp to them. While the audit committee.decided not to make the change for the past year. it did decide to implement a change to modifed accrual accounting for the next year. Because of thg town's conservative approach to local government finances. and its dependence on a sound cash position to finance capital projects, the audit com- mittee felt it was more important that the town have suf- ficient time to assimilate the change. For that reason they were willing to accept thc qualified opinion on this year's statement, wbilc recommending to the Board that a *change be male for the next year's statement. The Corahittce didn't stop there, of course. Other rec- ommended changes were made —changes that would have to be taken into consideration in future policy decisions — changes that, without an Alit committee to explain them, might have gone unnoticed despite thcir import- ance. They came in accounting methods for Special Re- serve Funds, the Debt Service Fund, Parking Fund, Retirement Reserve, and Sewer Improvement Fund. At the audit committee's presentation to the full Board, its two members analyzed and discussed the various sections of the completed audit report. With the Comp- troller and the independent auditor on the side, the two members of the committee made a clear. informative presentation to their colleagues in terms the Board mem- bers could understand. They discussed the implications of changes that had been made, the results of operations for the different funds, the recording of revenues and their use to cover expenditures, and the financial status of the town as a result of the year's operations. The audit committee had achieved what no Comp- troller could ever hope to have achieved on his own. The committee had gotten the town's financial policymakers actively involved and interested in the administration of the town's financial affairs. The committee had partici- pated in updating many of the town's accounting meth- ods and it had transformed meaningless figures into the meaty, dollars and ccnts appropriations that the Board had made. Most importantly, through the committee the Board's members had achieved a better understanding of those accounting matters that would help them to act more effectively on behalf of the town's taxpayers. For the Comptroller's Office, the audit committee had another important effect. Contrary to what wary Comp- trollers might think, the audit committee had strength- ened thc position of thc Comptroller's Office. It had helped the Board to understand thc town's financial op- erations and, in doing so, had helped them to bctter evaluate thc Comptroller's suggestions, actions, and dc- cisions, as well as the outcomes. further, the audit com- mittee had provided a solid source of, supporl in the Comptroller's on -going effort to modify and hopefully improve the town's accounting practices. Even the Comp- troller's internal audit staff had felt the effect and it re- sulted in a boost in morale—thefommittee and the Board were viewing their work and acting upon it. But this is only a beginning. The audit committee, acting as a standing committee, will continue to be in- volved, both with the Comptroller's Office and with the town's auditor. As issues ariss and decisions must be made, the audit committee will be involved. Expanding its operational base, the committee will go further into the Comptroller's Office, setting up direct lines of com- munication with the internal audit staff. In an effort further to improve the town's overall oper- ation, "performance audits" are being considered as a supplement to the standard audit. Unlike the standard audit, which focuses on the town's financial operations, the performance audit assesses the town's overall opera- tion as a local governmental unit and determines whether it is being efficiently and effccti$cly run. As thc town moves toward this new development, again the audit committee will be there, actively involved. Finally, of all thc effects, paps the most important is the least obvious —the audit mmittec's effect on thc taxpaycr's dollar. While it is likely that most taxpayers will never know of its existence, all will benefit from its active role in overseeing their investment, in more con- scientiously administering their tax dollars. ■ World/Spring 1975/PMMd1Co./47 • , • "In the broad sweep of world history, the surprising thing is that man has not long ago come toaccept inflation as normal and a continuing stability of his monetary unit as exceptional." —Bach H... under controls, business and labor leaders begin to pay more attention to the regulatory body than to the dynamics of the marketplace." —Grayson and Neeb Perspective on Inflation and controls by John W. Lee and Robert L. Conn President Ford's WIN or "Whip Inflation Now" is dead as are wage and price controls. Yet inflation and controls are issues that will remain with us for some time and deserve a good deal of study in the business world. There are a number of excellent books on the subjects of infla- tion and controls. The New Inflation, by G. L. Bach suggests that many executives and policy makers should re-examine long held economic beliefs and scrutinize many of the new economic strategies that are being proposed to arrest the inflationary tendencies of our economy. Written for the layman, The New Inflation is an outstanding choice for those wishing a reasoned overview of inflation in the real world environment of economic, political, and social forces. Bach is a professor at Stanford University who has years of experience as a consultant to the Federal Reserve Board and to Secretaries of the Treasury. An excellent text to accompany Professor Bach's book is C. Jackson Grayson's Confessions of A Price Control- ler. Grayson, past chairman of the Price Commission, wrote the book to give the average citizen an insight into the real process of price controls —how they work and what they do for and to our country. Light and easy to read, even humorous. Confessions of a Price Controller provides us outsiders with an insider's view on the Phase II Economic Controls of the 1971-73 Price Commission. The potential problem under price controls arc detailed by Grayson and co-author Louis Necb as is their warning "it is much 'easier to get into controls than to get out." The underlying rationale behind wage and price con- trols and the complexity inherent in attempting to control an economic system through government regulation arc examined in two brief new publications. Professor Abba 41/World/Spring 1971/PMM&Co. B. Lerner, described by one literary critic as "... one of the few economists able to communicate intelligently with the non -economist," has written a clever, thoughtful little paperback called Flation. Lerner's arguments on the ne- cessity for controls, and indeed the inevitability of con- trols, are well -reasoned and persuasive. As a bonus, Lerner has included a crisp and lucid explanation on the relevance of international economic affairs, such as the recurrent dollar crisis and floating exchange rates, to the present inflationary malaise. Jerry E. Pohlman's Economics of Wage and Price Controls presents a well -sustained analysis of the issues surrounding both inflation and efforts to control it. The distinguishing characteristic of this book is its objective attempt to catalog the sources of inflation and evaluate the probable succcss of alternative public policies, in- cluding controls, in alleviating the inflation depression dilemma. The message in each book is similar —the viper of inflation is in the Keynesian Garden of Eden. The opinions vary, however, on the appropriate method to drive the serpent out. The books reviewed may be ordered directly from the publishers: The New Inflation (Prentice -Hall, 1973. 100 pages, $3.50), Confessions of a Price Controller (Dow Jones -Irwin, Inc., 1974, 265 pages, $9.95 ). Flation (Penguin Books, Inc., 1973, 184 pages, $1.45), and Economics of Wage and Price Controls, (Grid, Inc., 1972. 210 pages, $4.95) . ■ Dr. Lee is an Associate Professor of Management at The Florida State University and a consultant to PMM&Co. Education Department. Dr. Conn is an Assistant Pro- fessor of Finance at The Florida State University.