Are Your Municipality’s Audited Financial Statements Accurate?

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Commentary

It was an awkward moment. I served on the Orange County, California, Board of Supervisors and attended the Audit Committee meeting to make an inquiry, as the annual comprehensive financial report (ACFR) had been issued and the managing partner of the Certified Public Accounting firm was making a presentation.

I, too, was a Certified Public Accountant (CPA). I spotted what I thought was an error in the financial statements and wanted to get clarification. I got my answer. It wasn’t what I expected. But I got it. It was an error. But what did the managing partner tell me and the committee? That the financial statements were the presentation of the county’s management. All he did was do the audit. End of discussion.

One would think that if one was the managing partner of a large California accounting firm that he or she would have the professionalism to at least state that the firm failed in its quality control by missing something that should have been caught and corrected.

What was missed? The amount on the statement of net position (balance sheet) for “net investment in capital assets” was incorrect. If the financial statement has this wrong, then the amount for the “unrestricted net position” will be wrong.

Looking at a few school districts in Los Angeles County, this concern has come up for Paramount Unified School District, William S. Hart Union High School District, Azusa Unified School District, Compton Unified School District, and Glendora Unified School District.

It also came up when reviewing Orange County, California’s 34 cities for the year ending June 30, 2024. One of the 75 largest cities in the nation, Irvine, corrected a quarter-billion dollar error made in the previous year to its “Net Investment in Capital Assets” account. Mistakes happen. But, they can be prevented.

In my initial career days, as a junior accountant, I was instructed that if I could substantiate every amount on the balance sheet, then the bottom line would be correct. Expenses may be misclassified, but at least the bottom line is accurate. That’s why auditors seek bank confirmations and other independent sources to verify cash and other balances.

Since I rank municipalities according to their unrestricted net position per capitas, if the “net investment in capital assets” amount is not correct, then its ranking isn’t accurate. Unfortunately, after reviewing hundreds, if not thousands, of annual comprehensive financial reports (ACFRs), I’m finding too many with the same error that occurred with the County of Orange.

CPAs preparing governmental financial statements must follow procedures issued by the Government Accounting Standards Board (GASB). This standard setting organization has a simple worksheet for calculating the “net investment in capitals assets of a reporting unit.”

The formula is very simple. Take the total capital assets, reduced by accumulated depreciation, from the asset section of the balance sheet and reduce it by the related mortgage and bond debt in the liabilities section. But this is not happening more often than not.

Perhaps GASB should require a footnote disclosure that shows how this amount was determined on the balance sheet? In certain instances, I’m seeing negative amounts for this category. How can that be? If it is caused by having more debt than the related collateralized assets, then an entity could borrow its way to a positive unrestricted net position. That’s so wrong.

This reporting category was established with GASB Statement No. 34. It included a hopeful justification: “We developed these new requirements to make annual reports more comprehensive and easier to understand and use.” But if the amount provided for “net investment in capital assets” is incorrect, it’s not easier to use. And it makes the ACFR more difficult to understand.

During my practice days, having regular peer reviews was important. An independent CPA would come to your firm and review work product to make sure the quality met industry standards. Perhaps firms that specialize in governmental audits should expand their peer review scope to focus on this particular concern?

It’s one thing to issue the ACFR late. But to also have its bottom line be inaccurate, that adds insult to injury.

To my colleagues in the CPA profession who have decided to work in the governmental audit space, please remember that some of us actually read the ACFRs and become very disappointed when we see amounts that do not reconcile with the related assets and liabilities. Please do your best at quality control. And put justifying the amount provided for the “net investment in capital assets” on your final review checklist.

Timely and accurate transparency is critical to a municipality’s stakeholders. They invest in the municipality through various taxes and fees and should be respected for their investments in their city, school district, county, and state.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.