Audit of city finances resulted in more than $30M in changes; auditors again find Lawrence lacked proper financial controls
photo by: Nick Krug
After the City of Lawrence’s finances were red-flagged by auditors last year due to millions in adjustments required to get them in good order, city leaders were hoping for a better showing when auditors came to review the city’s books this year.
Instead, outside auditors had to make more than $30 million worth of adjustments to the city’s financial statements before they were comfortable vouching that all the city’s funds were properly accounted for. The auditing firm RSM, for the second year in a row, also found the city had a “lack of internal controls over financial reporting,” meaning that the city’s processes for tracking its cash, assets and liabilities weren’t reliable enough to ensure that the city had accurate financial records in 2019.
Like last year, a problem area for the city was reconciling its cash statements, which is a process similar to how a household would reconcile its checkbook. Auditors had to make an approximately $600,000 adjustment to the cash statements in order to get the city’s books to balance, and also say the city’s process puts it at risk of errors and potential fraud.
City leaders, though, say that the city has made progress in improving its financial reporting, but that it will take more time to address the underlying issues.
Some of the same underlying issues blamed for errors found in the last audit were also cited in the 2019 audit. Finance Director Jeremy Willmoth said that turnover in the city’s finance department and problems with the city’s financial accounting system continued to create issues. Willmoth, who began his position at the end of 2018, said that correcting some of the issues would be a years-long process that the city is committed to.
“We are doing what we can to make the necessary changes to improve that process, but a lot of these things aren’t overnight fixes because they weren’t overnight mistakes,” Willmoth said. “To say there will be no findings in the 2020 audit I think is an unrealistic goal.”
Though auditors gave the city’s financial statements an “unmodified opinion,” or a clean audit, a separate letter to the city’s management identified five significant accounting problems that require corrective action. That includes four “material weaknesses,” which is the most severe of the three levels of deficiencies that auditors can assign. The finding that the city had a lack of internal controls over its financial reporting was due to the “significant” number of adjustments auditors had to make. Specifically, auditors made about 125 changes totaling $32 million. The 2018 audit, which found five material weaknesses, including a lack of internal controls, resulted in more than 200 changes totaling $63 million, as the Journal-World reported at the time.
City Manager Craig Owens, who joined city staff in July of last year, indicated he expects better when it comes to the city’s level of financial management. Owens said that the goal is for auditors to identify no deficiencies and make few if any adjustments. Still, Owens emphasized that the city received a clean audit and recognition for following accounting standards through its annual financial reviews, which he said are two strong baseline signals he always looks for.
“All of our money is accounted for,” Owens said. “The difference is did we report it in compliance with the accounting standards and were we ready to report those when the auditors showed up. That’s a plain language translation.”
For now, the explanations have been enough to satisfy City Commissioner Stuart Boley, a former tax auditor who has been monitoring the financial processes of the city during his term.
He said that having $32 million of adjustments was not where the city wanted to be, but that explanations behind why the errors occurred made sense. He stressed that the city still got an unmodified opinion and he believed the city had improved over the 2018 findings.
“You want no adjustments, but I see this as progress from last year,” Boley said.
The reconciliation of cash statements — making sure the city’s records and the cash transactions that actually occurred line up — is an example of a flaw in the city’s process. In 2018, auditors found the city was a full 12 months behind on reconciling the cash statements, and that issue continued into 2019. Though the city was able to start reconciling its cash — or the process akin to balancing a checkbook — about midway through the year, mistakes were still made and the city’s process flagged by auditors as risky. Auditors found the cash statements were off by about $600,000 in 2019 compared with about $113,000 in 2018.
In a summary of prior audit findings included with the 2019 audit, auditors state that the city contracted with an outside firm to reconcile cash for 2018 and corrected an issue where transactions were being improperly combined and causing variances. Ultimately, the city reconciled cash for every month since July 2019.
However, other serious issues with cash reconciliation persisted in the 2019 audit. At the end of 2019 the city still had an unreconciled variance of about $600,000, and auditors found that the bank reconciliation software used by the city does not capture all necessary transactions. The auditor’s report states that the city was unable to identify the cause of the variance through the bank reconciliation process, and auditors ultimately identified the cause and made an adjustment to correct the error. RSM also warned that a workaround the city has been doing — removing certain transactions and reposting them in a way the software will properly recognize them — requires circumventing controls meant to segregate duties, which helps prevent fraud and errors.
Outside accountants previously have told the Journal-World that the cash reconciliation process is a vital one to ensure financial integrity of an organization. When the 2018 issues came to light, the Journal-World talked to accountants not involved in the city’s audit. They said having accurate and up-to-date knowledge of how much cash an organization has in its accounts is important to prevent fraud and make well-informed financial decisions.
Regarding the $600,000 variance in the 2019 statements, Willmoth said there was a cash receipt that had been inadvertently entered into the system twice. He said that because the finance staff was shorthanded and didn’t finish its reviews, any errors identified after auditors arrived counted as adjustments.
Regarding the workaround, Willmoth said that the city has begun the review process to replace its financial software, but those issues will continue until the new system is implemented, which likely won’t be until 2022. He said that until then, transactions done outside the main system get automatically labeled in such a way that the system doesn’t recognize them, and they must be corrected manually. That involves removing a transaction and then reposting it with a different label, which Willmoth said causes the material weakness because whenever entries can be unposted, there is potential for someone to unpost an entry for fraudulent purposes. However, he said to mitigate the weakness, the city monitors unposted entries to make sure only the label or date is changed.
Currently, Willmoth said the city’s unreconciled balance has remained steady the past several months and is less than $4,000. He said the city continues to refine its reconciliation practices and will make an adjustment before the end of the year so that the city’s cash balance and the banks’ cash balance reconcile with no variance. Willmoth said that previous to doing the workaround, city personnel were completely bypassing the system and doing a manual reconciliation of cash every month.
“The reason the cash hadn’t been reconciled was I don’t think the people who were here at that time understood that you had to manipulate the data to get it to go in,” Willmoth said. “That was the only way we could get the software to work.”
Owens said that addressing staff turnover and the financial system were long-standing issues that the city was working on so that audit findings could improve.
“There are underlying structural and historical challenges that we’ve got to address before we can get to that completely perfect level of reporting,” Owens said.
Regarding the issues with cash reconciliation, Boley emphasized that from July 2019 on the city was able to reconcile monthly. He said he saw that as a significant improvement and that the other issues demonstrate why the city needed a new financial system.
Willmoth said the city has contracted with a firm to issue a Request for Proposals for a new financial management system. He said the RFP is set to be released this fall, and a system will be presented to the City Commission in the summer of 2021. Depending on the selection and the complexity of the conversion, the new finance system will most likely be operational sometime in 2022.
Lack of internal controls
Other problems that led to the finding the city lacked internal financial controls were varied. For instance, auditors found the city’s books included $1.3 million in bond proceeds that were actually duplicate entries. In another instance, it found the city’s beginning balances for some funds were off by about $6 million. In other words, the amount of money the city said it started the year with in those funds was different from what the prior year’s year-end financial statements showed.
The number of adjustments auditors had to make led to extra work on the part of the accounting firm. Like the 2018 audit, the auditing firm ended up charging the city extra money for the 2019 audit due to the additional time needed to correct mistakes in the city’s books. For the 2018 audit, RSM charged 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 into order. For 2019, RSM charged the city $20,000 in extra fees for approximately 115 extra hours, bringing the total cost of the audit to $90,720, according to a city staff memo to the commission.
As part of its 2019 report, auditors did state that the city created a plan to correct many of the issues found in the 2018 audit, but the internal control issues identified in the 2018 audit were only partially corrected.
Despite creating a new month-end closing process, auditors agreed that the finance department suffered from staff turnover just months before the audit began and struggled to keep up with the demands of the daily assignments as well as the added workload of the annual audit.
Willmoth, the city’s finance director, said there is no evidence that funds aren’t being spent as planned, and that the adjustments are mainly a matter of how transactions are classified. He said that there was again turnover in one of the city’s three accountant positions, which led to the city not being able to finish reviews and adjustments it would usually get done before auditors arrive.
“We had staff turnover right before the audit began, which put us behind,” Willmoth said. “And when you don’t have enough people to get the work done, we’re not able to keep up with the schedule of the audit and that was our main problem.”
Willmoth said the city was still in the process of filling the vacant position and that the next person the city hired would be the fourth accountant in three years. He said with adequate staffing he was confident the city wouldn’t have those problems.
Apart from the lack of internal controls and reconciliation of cash, auditors identified material weaknesses regarding restatement of capital assets and a significant deficiency regarding financial data from Lawrence Memorial Hospital. The last material weakness regarded an error regarding the classification of federal grants spent by the city, in which local matches were not properly labeled.
Regarding the classification of capital assets, auditors found that the city should have expensed certain project costs in the year they were incurred but instead labeled them as construction in progress in error, resulting in a $7.5 million adjustment. The error in LMH financial data was because the hospital’s endowment was excluded in error from the city’s statements. LMH, which has its own operating board and doesn’t receive city funding, is included under the city’s financial umbrella, in part because the City Commission appoints the hospital’s operating board.
For both those issues, auditors noted that management did not have an adequate process in place to properly review those aspects, and again said that the finance department suffered from staff turnover and struggled to keep up with demands of daily assignments and the audit.
The auditor’s findings are not the first financial errors to be identified at City Hall. In February 2019, the Journal-World reported that the city found as many as 2,000 solid waste customers had been incorrectly taxed, with some of the errors going back to 2012. In August 2019, a Journal-World review led to the discovery of a bookkeeping error of about $17 million that artificially inflated — for at least two budget years — the amount of money that showed up in the city’s water and sewer utility fund. 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.
This was the second year RSM conducted the city’s audit, and Boley noted that before that the city had used the same firm for about 25 years. He said rotating the auditor is the best practice because getting fresh eyes on the city’s books has helped the city identify errors and improve. He said staff has been responsive and transparent about auditor findings and that while issues need to be addressed he thinks the city is on a good trajectory.
“We’re not doing as well as we need to do; we need to do better,” Boley said. “But if you only focus on what’s wrong, you lose track of what’s good.”