City commission receives state auditor’s report

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By William Carroll

The Kentucky Auditor of public accounts released its special examination of the City of Taylorsville last week, which outlined four separate findings and recommendations to assist the city to improve internal controls.
According to the cover letter submitted with the examination, the APA received concerns “related to specific activities and transactions that could indicate possible mismanagement leading to misuse of public funds.” No details were provided as to who may have initiated this investigation, however Evelyn McKemie provided a copy of a letter she submitted to the APA requesting that the auditors look into the city’s finances.
The examination document provided by the APA goes on to outline that the APA, “reviewed certain activities for the period July 1, 2012 through June 30, 2014.” The auditors office said that the procedures performed, “included reviewing accounting detail for certain accounts, reviewing written policies and procedures and documentation supporting certain transactions or events, and conducting interviews with city management.”
The APA said that the purpose of the review, “was not to provide an opinion on financial statements or activities, but to evaluate whether appropriate processes are in place to provide strong oversight of financial activity and to review specific issues brought to our attention.”
The examination made four findings including: 1. The City of Taylorsville utilizes its water and sewer service to fund city operations, 2. The City of Taylorsville failed to adequately assess the potential consequences of providing funding to assist the former police chief’s retirement, 3. The City of Taylorsville failed to implement adequate policies to assist in administrating the health reimbursement account provided to the mayor and city commission members, 4. The City of Taylorsville failed to maintain updated policy and procedure manuals.
As to the first finding, the APA said that concerns were brought to the attention of the Auditor that indicated the city water and sewer fund is being utilized to fund the general operations of the city.
“Review of supporting documents identified that City water rates were established in accordance with City Ordinance No. 337, enacted and published January 4, 2012, which was based on a February 2011 water rate study,” the report stated. “Although, the City appears to have taken acceptable measures and procedures in setting the utility rates, the 2013 audit report and discussions with City officials identified the City utilizes Water and Sewer Fund revenues to fund General Fund operations.”
The report goes on to state:
“Interviews with a City official identified ‘We are a Water company that just happens to be a City’, suggesting that the utility company sustains the operations of the City. Additionally, City officials commented in relation to City operations ‘The City is 98% Water and 2% General Fund.’ Review of the City’s 2013 audit report identified a qualified opinion was issued for the General Fund identifying that ‘Management elected to not allocate any salaries or wages for administrative staff to the General Fund’, with the administrative staff being paid out of the Water and Sewer Fund. The Schedule of General Fund Activity in the City’s 2013 audit report identified only $677 in salaries and wages within the general government.”
The APA acknowledged however that the city is allowed to use profits from a city owned public utility citing to KRS 96.200 which states:
Except as otherwise provided in KRS 96.550 to 96.900 the legislative body of any city of the third through sixth classes inclusive may, by ordinance, provide in what manner and for what purpose any profits, earnings, or surplus funds arising from the operation of any public utility owned or operated by the city may be used and expended. Until such an ordinance is enacted any surplus earnings shall be paid into the city treasury, to be expended for the general purposes of government in the city.
The APA went on to cite an attorney general opinion dealing with depositing surplus electric utility funds but distinguished that opinion in stating, “a distinguishing factor in the OAG opinion is that although cities have the authority to deposit surplus utility funds into the General Fund, the funds must truly be surplus, meaning operating, maintenance, and any other costs for the utility must first be accounted for before any surplus utility funds are paid into the city treasury.”
In response to questions asked by the Spencer Magnet, APA Communication Director Stephenie Hoelscher said, “The City is allowed to use a surplus that occurs during the normal course of business as long as operating, maintenance, and other costs of the utility are first accounted for before any surplus funds are paid into the city treasury for general government expenditures; however, it should not set rates specifically to earn additional revenue for other city operations. It appears that happened. The finding is that the City administrative personnel were paid out of the Water and Sewer fund even though at least some, if not all, of their time should have been associated with the General Fund and general operations of the City. By default, that means the City was receiving the benefit of surplus funding from the utilities fund. This has occurred for some time in the City, so those general administrative personnel costs are likely part of the cost basis used for setting the utility rates.”
City Clerk Steve Biven responded to the APA’s initial finding by agreeing that the city can expend water funds for the general government purposes but pointed out that the city does not transfer funds to the General Fund, “due to the regulatory provisions of the United States Department of Agriculture’s Rural Development Agency, to which we must adhere.”
Biven went on to state, “The city does not make such transfers due also to the terms of the bond ordinances associated with our loans provided by that agency and the corresponding lien placed upon the city to guarantee repayment of those loans.”
Biven also said KRS 96.440 stipulates that “if a surplus is accumulated in the operating and maintenance funds equal to the cost of maintaining and operating the waterworks during the remainder of the calendar, operating or fiscal year and during the succeeding like year, any excess over such amount may be transferred at any time by the city legislative body to the depreciation account, to be used for improvements, extension or addition to the waterworks.”
“Accordingly, Rural Development requires us to maintain a certain amount of this surplus in a depreciation account as opposed to transferring funds to the General Fund,” Biven added.
The APA recommended that, “the City of Taylorsville should consult its City Attorney and the Office of the Attorney General to determine if it is operating within the requirements of KRS 96.200. Additionally, the City should take adequate measures to address the weaknesses that resulted in a qualified opinion issued on its 2013 audit report.”
According to Biven’s response, and a separate interview conducted by the Spencer Magnet, the Attorney General’s office did review the city’s financial records, ordinances and policies in January 2013 in reference to similar complaints relating to the city’s use of water funds to fund general government activity. According to Biven, no findings or recommendations came forth from that investigation.
Biven told the Spencer Magnet that a representative for the Attorney General’s office came down in January and spent a couple of days with city officials going through the city’s financial paperwork relating to water rates. Biven said that the Attorney General’s office did not have any concerns regarding how the city was conducting business.
Regarding weaknesses in the 2013 audit report prepared by Peercy & Gray, PSC, Biven said that the qualified opinion reached by the auditor, “was based solely on management not allocating any salaries for administrative staff to the General Fund. The City of Taylorsville respectfully disagreed with allocating salaries in this manner.”
Biven further stated that the city allocates salaries to the department where the employee spends the majority of their time, in this case the water department. Biven said that the external auditor was unable to provide the city with an accurate number to calculate the proper allocation of hours.
According to Biven’s response, five previous auditors for the city all reached different conclusions from Peercy and Gray and that the firm was unfairly biased due to contact with critics of the city prior to the audit.
Biven notes that the city has secured the services of a firm to conduct the 2014 audit. Biven told the Spencer Magnet that certified public accountant Paul Maddox has been working closely with the city to ensure the accuracy of their audit. Both Biven and City Comptroller Randy McConnell said that they believe from the scope of their talks with Maddox that the city will receive an unqualified opinion.
“There are a few minor tweaks we may have to make,” Biven said. “But our accounting is sound, we aren’t expecting any problems.”
McConnell said that Maddox’s opinion, he believes, would be in line with previous city auditors, “for the last 15 years all of our auditors have charged expenses to the water department, we never had this problem before.”
City Commissioner Ellen Redmon, who was part of the committee tasked with selecting a new auditor is pleased with Maddox’s work.
“During out last audit, we were never asked any questions by Peercy and Gray,” Redmon said. “Our current auditor is the one we need to take action on these issues, he is even willing to do a response to Peercy and Gray’s audit.”
Commissioner Kathy Spears was more critical of Peercy and Gray, “Peercy and Gray never interviewed me, none of us to my knowledge. They admitted they had talked to individuals about our audit other than us. Also the audit was not done on time.”
Spears compares the previous auditor’s conduct to the current firm, “Maddox is very thorough, he interviewed each of us in detail. We have told the state auditors we will fix any problems.”
In support of Redmon’s comments, Biven said that Maddox had agreed to prepare a response to Peercy and Gray’s audit discussing the issues the former firm had with the city’s finances.
In reply the APA said that the City of Taylorsville’s response neglected to address issues, “whereby the city appears to be setting public utility rates at a level that not only covers the cost of operations for the utility, but also funds operations of the general government.”
The APA response goes on to state that the Auditor’s office did not duplicate the work of Peercy and Gray, however interviews with city officials made it apparent to the Auditor’s office that the possibility exists that water rates are improperly inflated.
When asked whether the APA had any direct evidence of rates being inflated the APA’s response was as follows:
“During the examination, auditors did review the rate setting process but did not recalculate rates. In the rate setting process, it appears that the base expenditures used in establishing a rate was derived from the Utility Fund total expenditures amount. That total included the general administrative personnel expenditures. Therefore, the methodology used appears to use a higher expenditure base than it needed if rates are intended only to cover the cost of utility operations. Auditors did not recalculate rates, so this could not be confirmed with certainty, but logically the methodology likely builds in a surplus to help continue funding the general administrative expenditures.”
City Attorney Dudley Dale said such a conclusion was not supported by the facts.
“Rates are set by the cost of the project,” Dale said. “Rates are then adjusted based upon the payback schedule with the federal government. Rates are always set based upon considerations relating to our bond repayment schedules.”
Dale explained that different costs for differing county residents is due to several factors including when the project was started and the status of the underlying infrastructure relating to a project.
Dale also explained that the federal government sets specific requirements on the city’s depreciation account based upon the outstanding bond amounts.
“The federal government has a lien on all assets,” Dale said. “If we did not have the bonds then the auditors would be correct and we could move money into the general fund.”
The APA also found that the City of Taylorsville failed to adequately assess the potential consequences of providing funding to assist the former police chief’s retirement.
In December of 2013, now retired Police Chief Toby Lewis presented a proposal to the city to purchase service credit by purchasing 59 months of service Lewis had previously withdrawn.
According to the APA, the city of Taylorsville entered into an agreement without analyzing the situation in its entirety.
“This includes the drawbacks associated with the precedent that has been established as noted by KLC (Kentucky League of Cities), and the possibility that additional funding will be necessary, which the City would be responsible for, once the final KRS calculation and determination is made. Additionally, approval of this agreement creates an equity issue until a policy establishing criteria is adopted which is applicable to all personnel.”
The precedent referred to by the APA is in a letter to city officials from KLC Representative Andrea Shindlebower in which she states, “It seems a city could do this if they can demonstrate that this will result in fiscal savings for the city. However, I think it will be difficult to avoid setting a precedent by offering this deal, so the city should be prepared to possibly do the same in the future.”
The APA’s recommendation stated, “We recommend the City acquire adequate information prior to entering into any contractual agreement to ensure the decision is prudent and in the City’s best interest. Policies and procedures should be updated to reflect the conditions necessary to ensure equitable treatment of all employees. Additionally, when requesting advice, all information should be taken into consideration. As pointed out by KLC, the question is not always can, but rather should the City enter into such agreement as precedent has now been set that could become a liability for the City in the future.”
Biven’s response on behalf of the City of Taylorsville said that the city did properly assess all of the information at its disposal. Biven said that the city was advised by KLC and its own legal counsel that any agreement made with Lewis to buy back portions of his retirement would need to be made available to all employees. Biven added that based upon an analysis of current city employees, there was limited liability in that comparable conditions did not exist with other employees.
The Spencer Magnet asked the APA a question regarding what information the city should have considered in making its determination and whether it is the policy of the auditor’s office to second guess decisions made by local entities? Hoelscher responded as follows:
“Basically, the information that was not considered is whether the action taken by the Commission to approve the retirement benefit would establish a precedent, meaning that the decision could impact other employees within the City. The City could have researched to determine the number of employees impacted, and what type of parameters and limitations it would like to implement in a formal written policy. This policy would need to be approved prior to entering into any agreement to ensure equitable treatment for all employees. Additionally, a final determination was not received from Kentucky Retirement prior to approving the retirement on legislation related to pension spiking, for which the City would be responsible for any additional payments that were not part of the original agreement. As a rule, auditors do not question management decisions, but may determine whether decisions made resulted in additional liability, employee equity, or other weaknesses within the government. The APA has no opinion on whether a retirement benefit should be implemented for City employees, only makes recommendations that such decisions should take into consideration the impact they have on City operations.”
Biven, Redmon and Spears all asserted that the city did consider all of the factors suggested by the APA in reaching its decision. Biven in his response to the auditor goes into some detail regarding how city officials worked with the state retirement system on Lewis’ arrangement. According to Biven, the questions raised by auditors still have not been answered by the retirement system.
“It is impractical and impossible to postpone such an agreement that was arranged with the Chief of Police, until 8 months after the retirement date,” Biven said in his letter to the APA.
The state auditor’s third finding is that the City of Taylorsville failed to implement adequate policies to assist in administrating the health reimbursement account provided to the mayor and city commission members.
According to the examination, city commission members received a $450 medical allowance each month to be used to reimburse elected officials and their qualifying family members medical services costs. The auditor took the position that the requirements of the ordinance establishing the allowance are vague and does not effectively, “communicate all information necessary for the city to determine if an expense to be reimbursed is in fact allowable,”
The Spencer Magnet asked the APA if it was aware of any improper disbursements to city officials to which they replied, “The policies and procedures did not clarify the specific allowable services or the specific proof needed for reimbursement, leaving the determination at the discretion of the City. Therefore, it would be difficult for either an auditor or City employee to determine inappropriate disbursements. Therefore, the finding is drawing this risk to the attention of the City officials.”
The APA’s recommendation was simply that the city should strengthen its policies. The APA however offered no suggestions on how that might be accomplished.
According to Biven, the city is working with KLC to develop specific requirements.
The final finding is that the city failed to maintain an updated policy and procedure manual.
Biven said that prior to the APA initiating its examination the city was already in the process of updating its policies and procedure manual. Over the last several months the city has conducted several meetings with KLC representatives to achieve those goals.
City officials said that they were pleased with the audit.
“We think this is a very positive result,” Biven said. “The state auditor’s office is only suggesting minor tweaks, unlike in some places, they found absolutely no evidence of wrongdoing. I would put our results up against any city in the state.”
Dale went one step further, “This is a great audit, with every audit the auditor is going to come back with suggestions, these suggestions are only for very minor issues.”
In response to several questions posed by the Spencer Magnet the APA agreed that no wrongdoing was found. The APA reiterated that the examination results were merely suggestions for the city officials to consider in moving forward with the four issues presented.
When asked if the city was going to do anything different in response to the state’s report, officials said that they would await Maddox’s report later this year to determine if any changes needed to be made.