Audit of city finances resulted in more than $60M in changes; auditors found Lawrence lacked proper financial controls

photo by: Mike Yoder

Lawrence City Hall, 6 E. Sixth St., is pictured Thursday, July 7, 2016

The city of Lawrence’s finances have been red-flagged by auditors after they had to adjust more than $60 million worth of transactions in the city’s 2018 financial records.

Among the most serious of findings: Auditors determined that for 12 months, the city was unable to reconcile its various cash accounts. Financial experts said that is analogous to not being able to balance your checkbook for an entire year.

Ultimately, the auditing firm RSM determined the city had a “lack of internal controls over its financial reporting.” That means the city’s processes for tracking its cash, assets and liabilities weren’t strong enough to ensure that the city had accurate financial records in 2018.

The auditors did not make any finding that fraud had occurred, but the flawed finances did open the city up to other kinds of risks, Michele Hammann, an accountant and vice president of the firm SS&C Solutions, said when asked by the Journal-World for insight into the findings.

Hammann said the identified weaknesses create concern because organizations need to be able to rely on their financial statements when making decisions.

“The risk is that every single month they are getting reports, and then waiting for the auditor to come back in and change those reports,” Hammann said. “So if you get a report for December and you make a decision based upon that December report and then the auditors put in 10 adjustments in June of the next year, your financial statement information is stale and you didn’t have good information to make a decision.”

After making more than 200 changes totaling $63.2 million — about $4.5 million were due to midyear accounting rule changes, but the rest were due to errors — the accounting firm ultimately signed off on the city’s 2018 books as being accurate. But in a separate letter to the city’s management, the firm designated the city’s internal controls as a “material weakness,” which is the most severe of the three levels of deficiencies that auditors can assign.

The auditing firm ended up charging the city $15,000 in extra fees for approximately 130 hours of unexpected time the firm had to spend on bringing the city’s books back into order.

Mayor Lisa Larsen said the weaknesses identified by the auditors were of concern, and that the city needs to make sure it follows a corrective action plan created by the auditors.

“I do think that comprehensively that it bodes to our need to go back to some of these internal controls and make sure that we’re hitting our marks that we’re supposed to be hitting,” Larsen said.

Commissioner Stuart Boley, a retired tax auditor, said that a finding of a lack of internal controls is always significant and that he would be taking a closer look at the report. However, Boley emphasized that because the audit adjustments were made, the city finished with a clean audit.

“By having that identified, to get the clean opinion you have to take steps to address those weaknesses,” Boley said. “So if these were ongoing and hadn’t previously been identified, they’d continue into the future. I don’t think this is a sudden lapse, I think this is where past practice wasn’t sufficient.”

The auditor’s findings come in the wake of several other financial errors in City Hall that previously have been reported. In February, the Journal-World reported that the city found as many as 2,000 solid waste customers had been incorrectly taxed, with some of the areas going back to 2012. Also, in 2018, the city discovered that the majority of downtown trash customers had been undercharged for years. In 2017, the city found that it had failed to bill approximately $700,000 in lease payments it was owed.

A lack of internal controls

Regarding its determination on the city’s internal financial controls, auditors stated that the city does not have proper procedures and controls in place to ensure the financial statements are prepared in accordance with generally accepted accounting principles. In addition to the significant number of adjustments, the report states that the lack of internal controls could result in material misstatements of the financial statements and material departures from generally accepted accounting principles. Auditors recommend that the city put in place a timely year-end financial statement close process to ensure the accounting and financial reporting are accurate and in line with accounting standards.

University of Washington Professor of Public Finance and Civic Engagement Justin Marlowe said the designation of a lack of internal controls is not uncommon, but definitely something that deserves attention. Marlowe, who was previously a professor at the University of Kansas, is the author of “The Governing Guide to Financial Literacy.” That guidebook lists a finding of lack of internal controls as one of “10 Financial Health Red Flags.” Marlowe said the designation means the city’s finance team is going to need to take some corrective action and that the governing body should follow up on progress.

“It’s definitely up to the commission to follow up and make sure that there is a good explanation for why those adjustments needed to be made, and to follow up throughout the year and make sure that policies, procedures and training are adjusted accordingly to try to prevent that sort of thing from happening again,” Marlowe said.

This is not the first time auditors have told the city that its internal controls needed some attention. Finance Director Jeremy Willmoth, who began his position at the end of 2018, noted that the city’s last audit, for 2017, noted a significant deficiency in internal controls, but that with staff turnover, the issues were not properly addressed and thus became worse.

“As you can see in the compliance report, the city did acknowledge in 2017 what their plan was and then the people that were here left,” Willmoth said. “The turnover I think is really the driving force.”

Former Finance Director Bryan Kidney resigned his position in September 2018. The city had an interim finance director until Willmoth began his position on Nov. 19, 2018.

A 12-month delay

The audit states that city personnel were approximately 12 months delinquent on reconciling cash and investment accounts during 2018, including the primary operating account. Not reconciling cash and investment accounts is akin to someone not balancing their checking account, except that in the city’s case, there are numerous cash accounts and none of them were being balanced.

Regarding the reconciliation of cash, auditors noted that the city had personnel turnover during 2018, which caused significant delays in performing timely bank reconciliations. Auditors state that the process of timely cash reconciliations are a key control over significant transaction cycles, including cash disbursements and cash receipts, and that not balancing its cash accounts could increase the risk of misstatements on the city’s financial statement or misappropriation of cash. At the end of 2018, the city still had an unreconciled variance of about $113,000.

Marlowe said that auditors are very sensitive about cash because if an organization doesn’t have strong control over its cash, it increases risk, since cash transactions tend to be the source and setting for a lot of fraud.

“More often than not, when something nefarious is going on inside of an organization, it almost always involves cash being moved in ways that it shouldn’t be moved,” Marlowe said.

Though most of the adjustments are more reclassifications, Hammann agreed that not reconciling cash accounts is a key control that when not functioning opens organizations up to risk.

Willmoth said he doesn’t think the finance department has done a good job of communicating with the other departments about what it needs to make sure it can reconcile in a timely matter. However, Willmoth said it’s not that city staff was not attempting to balance the accounts — it’s that at the end of every month, it was not able to get the numbers to line up. Though he wasn’t with the city for most of the year, Willmoth said that some of the reasons the city got so behind is because some interest was not being recorded and that some transactions were being grouped together, making it difficult for staff to match things up.

“All I can say is that when I looked at the documents, I could see that staff was trying to reconcile it as best they could, but there was numerous transactions that didn’t match what staff had entered in the city’s financial system and what the bank showed,” Willmoth said. “And so every transaction had to be researched, and it becomes very time-consuming.”

In total, auditors identified five material weaknesses. In addition to the lack of internal controls and the one-year delay in cash reconciliations, auditors noted that there were errors in the city’s capital assets and tax revenues; errors in the classification of some federal grants; and a missed deadline for a federal grant report.

Corrective action plan

As a result of the audit, the city created a corrective action plan that addresses each of the five weaknesses identified. Regarding the significant number of audit adjustments, the plan establishes a month-end closing process that will assist the city in preparing the annual financial statements. To reconcile its cash accounts for 2018, the city contracted with McBride, Lock & Associates in March 2019 and the plan states that the finance director will ensure that a monthly reconciliation is completed beginning in June.

Willmoth said the city definitely takes the audit results seriously and is taking steps to correct issues. He said that the month-end process will make the audit go a lot smoother next year and that the finance department is trying to better communicate with other departments about steps that need to be taken to balance the cash accounts.

“We are definitely concerned about it and are taking steps to ensure that it’s corrected before the next audit,” Willmoth said.

After receiving the results of the audit, Larsen requested that city staff bring a follow-up report to the commission after six months. Larsen said she is confident in the competency of the city’s current staff and its ability to correct the issues.

“At this point in time, my goal is to make sure we hear back on these, how we’re proceeding with doing these corrective action procedures to make sure we have addressed this issue with the internal controls,” Larsen said.

This was the first year RSM conducted the city’s audit, and Boley said the city now plans to rotate the auditor every three to five years. He said such rotations are good practice, in order to ensure fresh eyes on the city’s books, but that had not been done by the city in years past. He said that so many areas of concern were identified sounds like a bad thing, but that because the city knows about those weaknesses, they’ve been dealt with and won’t be a problem in the future.

“I think it’s probably money well spent because we need to improve, and this is how you improve,” Boley said.

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