Is your local government looking to tighten up its financial processes or improve transparency? As a financial auditor, I review many financial processes in the government sector and some are better than others. Today, I will show you the most frequent recommendations I propose to my clients. Many of these recommendations should not take too long to implement. The recommendations cover more than one audit area. I’ll categorize them by the following:
- Revenues, receivables, and cash receipts
- Expenses, payables, and cash disbursements
- Payroll
- Fixed assets and inventory
- Equity (Fund Balances)
- Financial reporting
- Other
Revenues, Receivables, and Cash Receipts
Recommendation #1: Make sure you segregate the process from order to cash. In other words, make sure the following activities or jobs are performed by different personnel:
- Custody of the cash
- Bookkeeping
- Reconciliation
- Authorization
If you are a small or medium-sized local government and say well that will never work in my organization because we don’t have the personnel, I understand. Consider hiring an outside accountant or bookkeeper to reconcile the account(s) or perform the bookkeeping. The manager should authorize each transaction. The idea behind separating these duties is to reduce the risk of either error or fraud. For example, if somebody is committing fraud and does so by not entering the transaction into the accounting system (but they did write a receipt to the customer), the reconciliation should catch the theft assuming the reconciliation is performed on a monthly basis and entails comparing customer receipts to the deposits found in the bank statement.
This recommendation, although written in the ‘Revenues, Receivables, and Cash Receipts’ section applies to every section in this white paper. Keep this in mind when reading the remaining sections.
Recommendation #2: Create a policy to process the collecting of delinquent customer balances and when to determine the balances are no longer collectible. Assuming your organization has accounts receivable, the customer balances should be reviewed on a periodic basis and you should determine if the balance is collectible or not. You also need to create a process on collecting the balances prior to them being deemed as bad debt. Implementing this recommendation may save you from future embezzlement. There have been cases where customers are conspiring with an employee to either to receive a free product or the customer is actually an employee, but the customer name is hidden in order for management not recognizing the fraud scheme. A routine process to collect and a process to record bad debt will reduce the likelihood of any malpractice of customers or employees.
Recommendation #3: Track deferred revenue and deposits at the customer level. As an organization, you should know how many customers have either prepaid a service like pre-need burial services or overpaid a water/sewer bill. The importance of this recommendation is to know who owes you money and who do you owe. Even though the cash receipt was recorded, you still have a liability to perform the service (burial services, water, sewer, etc) and you need to understand that for these customers, when you perform the service, no money will be transacted because the cash was already deposited into your bank account.
Recommendation #4: Code the revenue accounts in a way that properly records the various services your District or Agency provides. For instance, a cemetery district will charge with for an open/close fee, vault, possibly extra fee for a Saturday service, etc. Your organization should have a separate revenue account for each of these services. Planning and budgeting will become easier because you’ll have the data review how many open/close, vaults, etc were sold in the last 3 years and you can project the future into the next fiscal year.
Recommendation #5: Prepare a schedule of transfers between bank accounts, especially during year-end. You should make sure, each bank account is the property of your local government. Nobody ever wants to tell the Board that a bookkeeper, accountant, or any other personnel embezzled money because either a proper bank reconciliation or schedule of transfers were never performed. There are previous fraud cases, where no internal controls were in place or became ineffective and the transfer of cash went into the fraudster’s personal bank account.
Expenses, Payables, and Cash Disbursements
Recommendation #6: Create a purchasing policy. This policy will give guidance to the District Manager, supervisor, and other staff as to what they can spend in case of an emergency. The amount that the Board should authorize to the District Manager is to the discretion of the Board, but they should consider implementing a purchasing policy. In addition, when an outside emergency occurs, such as the Corona Virus, Board members may not be available to sign checks to vendors. Given the recent past, if your District or Agency doesn’t have a purchasing policy, I suggest you create one sooner than later.
Recommendation #7: Create a travel policy. If anybody in your organization like a board member or manager travels frequently, the board should create a policy. The policy will clarify what the organization will reimburse and how much it will not. For example, a travel policy can say, the District will pay for up to $200 per night for a hotel. If the board member or manager stays at a five star hotel, s/he will need to pay the difference. Travel is also an account that is high risk for fraud, abuse, or wasteful spending. Clarity on what will be reimbursed will help prevent fraud, abuse, or wasteful spending from board members and employees taking advantage of free vacations with family and friends.
Payroll
Recommendation #8: Make sure you reconcile payroll even if a professional third-party is processing payroll. Also, make sure your payroll taxes are submitted to the proper authorities. The state tax collectors will penalize you and charge interest if you are not reconciling and ensure payments are made. Most professional third-parties are competent, but it’s best to review or reconcile their reports.
Recommendation #9: If the sick/vacation accrual is being calculated manually by the general manager (due to a small staff), I recommend either an outside accounting firm or a member of the board review the calculation including the accrued portion and how the sick/vacation was used. Manual ledgers and computations are more easily abused and a second set of eyes prevent abuse or wasteful spending. It also improves accuracy.
Fixed Assets and Inventory
Recommendation #10: Perform an annual inventory on capital assets and inventory. The inventory count is a fraud prevention and detection technique. I once recommended this to a local government, after the count, they realized somebody had stolen a $500 equipment. Furthermore, the inventory provides an overview of which capital assets or inventory should be replaced. It will give you an accurate reading for budgeting purposes. Lastly, the inventory will help you accurately report the capital asset listing schedule other wise known as the depreciation schedule.
Recommendation #11: Retain a depreciation schedule and update it on an annual basis. The depreciation schedule is a report that lists all capital assets, expected life of each capital asset, beginning accumulated depreciation, depreciation expense, ending accumulated depreciation, and net realizable value. The report is used by accountants and auditors to review and test capital assets. It is important to hold on to and update it annually. You can also use this report as a gauge to budget new capital assets. If your Board is usually looking to decrease cost, this report can show them the necessity of purchasing another vehicle or equipment in the following year.
Recommendation #12: Inscribe your local government’s name or initials on the equipment. If, for some reason, your equipment walks away from the property, you can tell the local officials the inscription to locate the equipment. It serves as a fraud prevention/detection technique.
Equity
Recommendation #13: If your local government has an endowment fund or something equivalent, I recommend you create a schedule to reconcile the interest earned compared to the principle balance. I have had to modify the opinion, because some local governments did not have any records nor did they know the interest portion balance. It is important to know the principle balance compared to the interest balance. The interest portion is allowed to be used for maintenance and repairs for cemetery districts. Don’t you want to know what portion of the endowment fund can be used in operations?
Financial Reporting
Recommendation #14: Ensure your accounting system year-end is the same as your local government’s year-end. This mistake although infrequent, distorts your income and expenses. I had a situation a few years ago where the QuickBooks file year-end was December 31 and the year-end of the local government was June 30. When I downloaded the profit and loss statement, the revenues and expenses had already been transferred to the equity account at “year-end” aka Dec 31. The reported revenues and expenses were only reporting 1/2 year due to the mistake. Normally, after you review the year-end date and either verify it’s correct or change it, you won’t have to change it again.
Recommendation #15: If your local government reports enterprise funds, you should record the business transactions on the full accrual basis of accounting. Per GASB 34, enterprise funds should report its accounting transactions on the full accrual basis of accounting. This little feature helps the accountant or auditor when reconciling or auditing the financial statements.
Recommendation #16: Review all the funds of the local government at the Board meetings. You don’t need to do an extensive review, but the Board should be made aware of the activity of each fund. Most local governments are already reviewing each fund at some level or another, but I have found a few local governments that were not aware of the funds until the audit was performed. Insufficient review is a red flag for fraud and a fraud risk.
Recommendation #17: Add classes for each fund in your accounting system. Even if you are using small business accounting software like QuickBooks or Xero accounting software, these accounting systems allow you to review the revenues, expenses, assets, liabilities, and equity per fund by using classes. By adding classes to your QuickBooks instead of having multiple QuickBook files or multiple spreadsheets, you are able to compare the budget to actual results very quickly. You are also able to review the transactions in one central location. It is easier to perform accounting tasks when there is one central location.
Recommendation #18: Create a process to ensure monthly reconciliations of bank accounts and credit cards are performed. Also make sure the person reconciling is not the same person entering the transactions into the accounting software. If due to size of your office staff you cannot segregate these duties, I recommend asking a Board member to review the reconciliations of bank accounts and credit cards. Also make sure to incorporate a process or policy on how to look into any irregularities or outstanding items in the reconciliations.
Recommendation #19: Enter the adjusting journal entries proposed by the auditor into the accounting system. It is a good practice to have your accounting system reconcile to the audited financial statements.
Recommendation #20: Prepare a budget on time according to your County Auditor’s due date. Also communicate and send any authorized changes to the budget. If your local government is not preparing a budget, this is a huge red flag for fraud and in violation of regulations. Each local government (special districts, JPAs, etc) are supposed to prepare a yearly budget on the general fund and special revenue fund.
Other Recommendations
Recommendation 21: Create a plan to reimburse one fund to another fund. For example, if you receive one check and it is to pay for burial services and the endowment fund, many times the check will be deposited into the general fund. The endowment fund portion should be transferred to the endowment cash account or investments. If it is not transferred, the accountant should create a due to endowment fund and due from general fund accounts. The local government should have a plan to reimburse the endowment fund. In this example be sure to be very cautious because the endowment principle balance cannot be spent.
Recommendation 22: Create a fraud risk policy to monitor and assess fraudulent activity. My position is it is better to be safe than sorry. If your local government creates a policy and process to fight against fraud you are proactive rather than reactive. Fraud studies show that local governments that are reactive spend much more money if fraud does occur.
I hope these recommendations will help you on your journey to managing a transparent and fraud resistant organization. Please, feel free to pass along the content you learn to other board members, special districts, JPAs, or any other Agency you believe will benefit and feel free to contact me with any question you may have at (408) 780-2236 or david@dfarnsworthcpa.com.
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