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1997 Management Letter I I I I I I I I I I I I I I I I I I I ~~ Alvm M Kern Duane N DeWenter Loren M Vlere Gerald A Stover Keith W Julson Dwayne B Dockendorf DaVId H Hmnenkamp Chnstopher P Shorba Kern, DeWenter, Viere, Ltd. Cerllfled Public Accountants March 5, 1998 Honorable Mayor and Members of the CIty CouncIl CIty of AlbertvIlle AlbertvIlle, MInnesota The accompanYIng memorandum Includes suggestIons for Improvement of accountIng procedures and Internal accountIng control measures that came to our attentIon as a result of our audIt of the general purpose fInanCIal statements of the CIty of AlbertvIlle, MInnesota, for the year ended December 31, 1997 The matters dIscussed hereIn were consIdered by us durmg our audIt and they do not modIfy the OpInIOn expressed In our Independent audItors' report dated March 5, 1998, on such statements In planrnng and performIng our audIt of the general purpose finanCIal statements of the CIty of AlbertvIlle, MInnesota, for the year ended December 31, 1997, we conSIdered Its Internal control In order to determme our audItIng procedures for the purpose of expressIng our OpInIOn on the general purpose fInanCIal statements and not to proVIde assurance on the Internal control However, we noted certaIn matters InvolVIng Internal control and Its operatIOn that we conSIder to be reportable condItIons under standards establIshed by the Amencan InstItute of CertIfied PublIc Accountants Reportable condItIons Involve matters comIng to our attentIon relatIng to sIgmficant defiCIenCIes In the deSIgn or operatIon of Internal control that, In our Judgment, could adversely affect the CIty'S abIlIty to record, process, summanze and report on finanCial data consistent With the assertIOns of management In the general purpose finanCIal statements The follOWing pages distIngUIsh between reportable condItIons, finanCIal analYSIS, and management suggestIons A matenal weakness IS a reportable condItIon In WhICh the deSIgn or operatIOn of one or more of the Internal control components does not reduce to a relatIvely low level the nsk that errors or IrregulantIes In amounts that would be matenal In relatIon to the general purpose finanCIal statements beIng audited may occur and not be detected WithIn a tImely penod by employees In the normal course of performIng theIr asSigned functIons Our conSideratIon of Internal control would not necessanly disclose all matters In Internal control that might be reportable conditIons and, accordIngly, would not necessanly disclose all reportable conditIons that are also conSidered to be matenal weaknesses as defined above However, none of the reportable conditIOns descnbed on the followmg pages are believed to be matenal weaknesses 220 Park Avenue South PO Box 1304 St Cloud, MN 56302 320-251-7010 FAX 320.251.1784 I I I I I I I I I I I I I I I I I I I FINANCIAL ANALYSIS General Fund For the year ended December 31, 1997, the CIty expenenced a 9 8% mcrease m revenues The mam reason for thIS mcrease was bU11dmg permtts (mc1uded m lIcenses and permIts on the graphs below) BU11dmg permIts went from $ 62,015 m 1996 to $ 131,833 m 1997 Some of thIs mcrease can be attrIbuted to the Cottages of AlbertvIlle project Smce the CIty collected a large amount of money for bU11dmg permIts, one would expect a large expense for bU11dmg mspectIon ThIs dId not happen m 1997 smce the buIldmg mspectIon bIllIng IS sometImes one to two years behInd The CouncIl needs to be aware of thIs temporary "wmdfall" and realIze thIs money IS not avaIlable to spend Other revenue Items of note mc1ude an mcrease m tax revenue due to an mcrease m the general fund levy, and a decrease m charges for servIces because storm water and connectIon fees are now accounted for m a separate fund In 1996, some of these charges were recorded m the general fund A SynOpSIS of the revenue actIvIty for 1996 and 1997 IS graphed below 1997 General Fund Revenues 1997 Revenues.. $919,458 Intergovemmental 26% Charges for Servoces 4% Locenses and Perrmls 16% Taxes 47% 1996 General Fund Revenues 1996 Revenues.. $ 837,307 Intargovemmental 27% Charges for Servoces 10% Locenses and Permols 9% Taxes 45% 3 I I I I I I I I I I I I I I I I I I I FINANCIAL ANALYSIS (Contmued) General Fund (Contmued) ExpendItures for the general fund m 1997 also portray good news Expendttures declmed 14 4% and were $ 91,589 under budget The most slgmficant declmes occurred m general government and economIc development In general government, there were no electIon expendttures m 1997, legal fees were half of 1996' s amount, engmeer fees were 1/3 of last year's amount, and planmng and zomng decreased 23% EconomIc development declIned because the payment to Fraser Steel on a "Pay-as-you-go" note IS bemg accounted for m a separate fund as approved by the CIty CouncIl m 1997 Other hIghlIghts mclude an mcrease m publIc works expendItures mamly due to streets salanes and benefits and capItal outlay, and an mcrease m mIscellaneous expendttures due to gamblmg donatIons bemg "grossed up" by recordmg the revenue and correspondmg donatIon expendIture 1997 and 1996 general fund expendItures are graphed below 1997 General Fund Expenditures 1997 Expenditures = $573,927 MIscellaneous SanllallOn & Econ Dev 5% 3% Park and Recreellon 3% PublIC Wor1<s 28% Public Safety 20% 1996 General Fund Expenditures 1996 Expenditures = $670,179 SanllallOn & Econ Dev 7% MIscellaneous 1% PublIC Wor1<s 18% General Government 48% Park and RecreatIon 8% 4 I I I I I I I I I I I I I I I I I I ~I FINANCIAL ANALYSIS (ContInued) General Fund (ContInued) SInce revenues Increased and expendItures decreased In 1997, one would expect the fund balance to also Increase As the graph below outlInes, the general fund balance actually decreased In 1997 from $ 552,749 to $ 473,205 GENERAL FUND $1100000 - ------ - - - $1 000 000 919458 $900 000 $800 000 $700 000 $800 000 $500 000 $400 000 S300 000 $200 000 $100 000 $0 1993 1994 1995 1995 1997 Is Revenues. Expenditures 0 Fund Balance I Two transfers can explaIn the decrease In fund balance Frrst, the CIty CouncIl approved the establIshment of a capItal outlay reserve fund to account for capItal outlay Items In the past, thIs has been part of the general fund as reserve fund balance In 1997, a transfer of $276,056 was transferred out of the general fund representIng 1996's reserve fund balance for capItal outlay Then, an addItIonal $ 149,019 was transferred representIng the amount needed to balance WIth the amount of funds carned forward to the 1998 budget The general fund balance decreased as a result of these transfers, but the speCIal revenue fund "CapItal Outlay Reserves" has a balance avaIlable of$ 425,075 for future capItal outlay purchases We recommend capItal outlay Items be coded to therr respectIve funds, and at the end of each fiscal year, an analYSIS of the carryover funds WIll determIne whether a transfer needs to made to or from the general fund The 1997 general fund balance of$ 473,205 IS composed of$ 405,884 deSIgnated for operatIng capItal and $ 67,321 undeslgnated The deSIgnated for operatIng capItal represents SIX months of 1998's budget The undeslgnated portIon of the general fund balance Increased from $ (83,255) to $67,321 In 1997 The CIty should be commended for ItS conservatIve fiscal spendIng and abIlIty to maIntaIn a healthy, but not exceSSIve, general fund balance 5 I I I I I I I I I I I I I I I I I I I FINANCIAL ANALYSIS (Contmued) Sewer Fund The followmg two graphs lnghhght the actIvIty of the sewer fund for the past five years I_User Fees _Operating Expenses _Operating Income With Depr _Operating Income WIO Deprl Sewer Retained Earnings $600 000 - -- ---- $500 000 $400 000 $300 000 $200 000 $100 000 $0 1993 1994 1995 1996 1997 6 I I I I I I I I I I I I I I I I I I I FINANCIAL ANALYSIS (Contmued) Sewer Fund (Contmued) There are two Items to note about the sewer fund FITst, operatmg revenues mcreased 8 6% m 1997, and for the fITst tIme m five years, operatmg revenues are sufficIent to cover operatmg expenses, mc1udmg depreCIatIon However, the sewer retamed earnmgs graph depIcts a dIfferent story Retamed earnmgs has been steadIly decreasmg smce 1994 (The large decrease from 1993 to 1994 was due to the PF A loan bemg recorded m the fund) The reason for the decrease has been the mterest charges on the PF A loan Even though the CIty expenenced operatmg mcome of $9,555 m 1997, net mcome was $ (30,709) The dIfference between operatIng mcome and net mcome IS mterest revenue and mterest charges on the loan Sewer rates should be suffiCIent to cover depreCIatIon and debt on the facIlIty Currently, rates are sufficIent to cover depreCIatIon but not the debt Smce the debt extends to the year 2014, the CIty faces a sItuatIon whereby rates need to be mcreased or operatmg expenses need to decrease by at least 20% ThIs IS mformatIon the CIty CouncIl needs to conSIder when evaluatmg whether to contInue the current contract WIth PSG or operatIng the faCIlIty WIth CIty personnel Cash and Investments. Undesienated Fund Balance and Retained Eamines Dunng our audIt the followmg questIon was asked by the new CIty AdImmstrator "Consldermg all cash and mvestments of the CIty, what IS aVaIlable for project spendmg at the optIon of the CouncIl?" ThIs can be answered by vlewmg the graph below City of Albertville FinanCial Position $3 000 000 $3,037,838 $2 500 000 $2 770 546 $2 795,885 $2 000 000 $1500000 $1000000 $500 000 $579428 $0 1995 1996 1997 - To1ll1 Cash and Investmenls -Unreserved Undesognaled FIB In determmmg what IS avaIlable to spend on proJects, one needs to look at unreserved, undeslgnated fund balance and retamed earrnngs, not cash and mvestments As you can see above, there IS a large dIfference between total cash and mvestments of the CIty and unreserved, 7 I I I I I I I I I I I I I I I I I I I FINANCIAL ANALYSIS (Continued) Cash and Investments and Undesig:nated Fund Balance and Retained Earning:s (Contmued) undeslgnated fund balance and retaIned earmngs The dIfference between the two amounts IS, for the most part, reserve and desIgnated fund balances and retamed earnmgs These are amounts that are deSIgnated or reserved for a specIfic purpose The amount aVaIlable to spend at the end of 1997 IS $ 1,164,773 The maJonty of thIs amount IS found m the SAC fund At the end of 1997, fund balance m the SAC fund IS $1,111,781 ThIs mformatIon should be useful as CIty admmIstratIon makes deCISIons on fundmg of future projects However, m evaluatmg thIS data, the CIty CouncIl should still analyze each fund separately when determrmng fundmg for projects smce there may be other mItigatIng factors affectmg the fund not addressed by thIs narrative MANAGEMENT SUGGESIONS In our Judgement, the followmg comments are matters whIch are not reportable condItions as defmed by standards establIshed by the Amencan Institute of CertIfied PublIc Accountants, however, we feel these observations and suggestions regardmg activIties beyond mtemal control WIll benefit management Balance Cash to General Ledeer 11us IS an unresolved Item for the past two years Dunng the begmnmg of the audIt, cash was off from the general ledger approxunately $69,000. Through our audIt procedures, we found most of the dIfference, and at the end of the audIt there was only an unexplamed dIfference of $ 182 whIch was adjusted through rmscellaneous mcome Most of the dIfference occurred m recordmg the mvestment activIty and a bond mterest payment not posted from the accounts payable system We dId note Improvements from 1996 m that the mvestment activIty for Dam Bosworth was recorded and the cash accounts were separated to facIlItate reconcIlIation, however, the checkmg account cash was not reconcIled Had thIs account been reconcIled to the general ledger, the errors m the mvestment activIty and the problem WIth the check not bemg posted would have been caught ImmedIately and corrected The CIty Clerk-Treasurer currently balances receIpts and dIsbursements WIth the bank We recommend she take the reconcIlIation process one step further and balance WIth the general ledger DIfferences should be ImmedIately mvestIgated We would be able to assIst the Clerk- Treasurer m thIs reconcIlIation process Balance Investments and Allocate Investment Income As mentioned m the prevIous comment, the mvestment activIty for the Dam Bosworth account was recorded, but It appeared It was not always balanced to the general ledger Durmg the last quarter, errors occurred m recordmg thIS actIvIty for a net result of an understatement of mterest eammgs of approxImately $ 40,000 After a detaIled revIew of the mvestment activIty and many adjustments, the mvestment earmngs balanced WIth no dIfferences In addItion, all of the 8 I I I I I I I I I I I I I I I I I I I MANAGEMENT SUGGESTIONS (ContInued) Balance Investments and Allocate Investment Income (ContInued) Investment earmngs were recorded In the general fund and allocated by the audItors as of the end of the year The net result of thIs adjustment was to decrease Investment earmngs In the general fund by approxImately $ 116,000 and "spread" thIs Interest to other funds based upon average cash and Investment balances SInce the Investment Income was not allocated untIl the end of the year, the general fund was overstated and other funds understated durIng the year by the amount of the Investment earmngs To present a more accurate fInanCIal pIcture of the CIty and to aSSIst admInIstratIon In makmg Informed fInanCIal deCISIons, we recommend the CIty Clerk-Treasurer balance the Investment accounts monthly WIth the general ledger and allocate Investment Income on a quarterly basIS AgaIn, we would be able to asSISt the CIty Clerk-Treasurer WIth thIs recommendatIon Consider Chaneine Accountine Software ThIs IS to reIterate and expand on comments from the last two years DIfficultIes were agaIn encountered WIth the software In 1997 A check that was clearly run though the accounts payable system and VISIbly appeared to be posted to the general ledger was never posted ThIs was part of the cash dIfference mentIoned In a preVIOUS comment In addItIon, In reVIeWIng audIt adjustments, there were Instances In whIch the adjustment was entered, posted to the general ledger, but not shown anywhere on the trIal balance In other words, the amount as lIsted on the general ledger actIVIty dId not agree WIth the trIal balance As mentIoned last year, WIth software support commg from personnel In MIchIgan, It IS often dIfficult to determIne the source of these problems We agaIn recommend the CIty conSIder changmg software packages to a company WIth support personnel avaIlable to asSISt the CIty If needed It may be expenSIve and tIme consummg to change software, however, the trme and expense WIll be recovered through less frustratIon and tIme spent In recordIng fInanCIal data and more accurate fInanCIal output that allows CIty admInIstratIon to make Informed deCISIons Chanee Accountine Practices in Reeards to Gambline Donations The CIty receIves many gamblIng donatIons that are "pass-through" donatIons In other words, the CIty SOlICIts the donatIon and pays another orgamzatIon the amount of the solICIted donatIon The current practIce of accountIng for thIs money IS to record the donatIOn as revenue and then code the payment dIrectly agamst revenue In 1997, donatIons paId exceeded receIpts resultIng In negatIve revenue of$ 3,301 The donatIons were "grossed up" on the fInanCIal statements shOWIng donatIon revenue and donatIon expendItures To present a more accurate representatIon of the CIty'S finanCIal status, we recommend the Clerk-Treasurer record the donatIons paId as expendItures and not as negatIve revenue 9 I I I I I I I I I I I I I I I I I I I MANAGEMENT SUGGESTIONS (Contmued) Chanfle Accountinfl Practices in Reflards to Gamblin!! Donations (Contmued) AdmmlstratIon should also consIder thIs when prepanng the next budget so as to facIlItate the preparatIon of an accurate budget Perfection of Collateral In 1992, the Federal Court of Appeals stated three steps are reqwred to perfect a secunty mterest m the pledge of collateral under federal law 1 The assIgnment must be m wntmg 2 The depOSItory's board of dIrectors or loan commIttee must have approved the assIgnment 3 The assIgnment needs to have been contInuously, from the tIme of ItS executIon, an officIal record of the depOSItory WIthOut perfectIon, there IS a possIbIlIty the assIgnment could be defeated If the depOSItory fads Currently, the fIrst perfectIon step IS requIred by Mmnesota State Statutes The second and thrrd steps reqwre a governmental entIty to obtam a certIfIcatIon of adoptIon of the deposItory's loan commIttee or board's resolutIon ThIs resolutIon states the detaIls of pledge as specIfIed m the assIgnment and pledges the resolutIon shall be an officIal record of the mstItutIon ThIs certIfIcatIon IS to be SIgned by the secretary and preSIdent or other offIcer of the depOSItory To ensure the CIty'S collateral IS perfected under federal law, we recommend the CIty obtam mmutes from ItS officIal depOSItory or a board resolutIon from the bank outlmmg the collateral pledged to the CIty Consider Potential Effects of GASH Statement No. 31 Implementation The Government Accountmg Standards Board has Issued Statement No 31, whIch IS effectIve for mumclpalltIes begmnmg WIth the Issuance of theIr December 31, 1998 fmanclal statements ThIs statement reqwres all mvestment mcome, mcludmg changes m faIr value of mvestments, be recognIzed as revenue m the operatmg statement AddItIonally, the carrymg value of mvestments on the balance sheet WIll be equal to the faIr value of mvestments FaIr value IS the amount at whIch an mvestment could be exchanged m a current transactIon between Wlllmg partIes, other than a forced or lIqwdatIon sale Generally, two types of mvestment contracts eXIst, as follows Participatinfl Investment Contracts Partlclpatmg mvestment contracts are mvestments whose value IS affected by market (mterest rate) changes Such contracts are consIdered "partlclpatmg" If they are negotIable or transferable, or If theIr redemptIOn value consIders market mterest rates 10 I I I I I I I I I I I I I I I I I I I MANAGEMENT SUGGESTIONS (Contmued) Consider Potential Effects ofGASB Statement No. 31 Implementation (Contmued) Nonparticipatin~ Investment Contracts Nonpartlclpatmg mvestment contracts are mvestments whose value IS not affected by market (mterest rate) changes Included m this category are nonnegotiable certIficates of deposIt With redemption terms that do not consIder market rates Generally, partlclpatmg mvestment contracts should be reported at farr value usmg quoted market pnces, With offsettmg unreahzed gam or loss mcluded m the operatmg statement Nonpartlclpatmg mvestment contracts should be reported usmg a cost-based measure, provIded that the farr value of these contracts IS not slgmficantly affected by the Imparrment of the credIt standmg of the Issuer One exception eXIsts for nonpartlclpatmg money market mvestment contracts that have a remammg matunty at the tune of purchase of one year or less These mvestment contracts may be reported at amortIzed cost, provIded that the farr value of these contracts IS not slgmficantly affected by the Imparrment of the crewt standmg of the Issuer Examples mclude commercIal paper, banker's acceptances and U S Treasury and agency obhgatIons Asset-backed secuntIes and structured notes (pnmanly debt secuntIes) are not mcluded m this exception DIfferences between carrymg values that eXist at the begmmng of the penod of unplementatIon should be reported as a restatement of begmmng fund balance or retamed earmngs, as appropnate Fmanclal statements should wsclose the nature of this restatement and ItS effects An optional presentation of mvestment mcome m the operatmg statement m the penod of Implementation IS shown as follows Investment Income - Interest Net Increase m the Farr Value of Investments Total Investment Income $ 100 ---2.Q $ 150 RealIzed gams and losses should not be dIsclosed separately from unreahzed gams and losses, although optional footnote dIsclosure IS allowed under certam condItions Those who opposed passage of this statement had several concerns, one of wmch was that the government may become too conservative m therr mvestment strategy so as to aVOid the posslblhty of dlsclosmg certam unreahzed losses wmch would result when partlclpatmg mvestment contracts decrease m value because of upward movement m market mterest rates However, the statement's mtent IS to prOVIde a more accurate measure of the government's finanCial pOSItion 11 I I I I I I I I I I I I I I I I I I I MANAGEMENT SUGGESTIONS (Contmued) Consider Potential Effects ofGASB Statement No. 31 Implementation (Contmued) We recommend admmIstratIon dIscuss GASB Statement No 31 WIth Its CIty CouncIl and educate them on the potentIal Impact ofmvestment deCISIons on the CIty'S fmancIal statements So long as the CIty follows ItS establIshed mvestment polIcy, whIch adequately consIders short- term cash needs, It should not be concerned about pen odIc fluctuatIOns m market mterest rates and theIr effect on the CIty'S fmancIal statements REPORTABLE CONDITIONS Lack of Seere~ation of Accountine Duties DurIng our audIt, we noted a condItIon that IS conSIdered to be a "reportable condItIon" as defmed by standards establIshed by the Amencan InstItute of CertIfied PublIc Accountants Dunng the year ended December 31, 1997, the CIty had a lack of segregatIon of accountIng dutIes due to a IIrmted number of office employees Although thIs meets the defimtIon of a "reportable condItIon," It may not be practIcal to correct smce the costs of obtammg deSIrable segregatIon of accountIng dutIes may exceed benefits that could be denved City Does Not Maintain Historical Cost Fixed Asset Records The CIty does not mamtam hIstoncal cost fixed asset records that prOVIde complete accountmg control over the quantItIes and costs of ItS general fixed assets As a result, we Issued a qualIfied opInIon on the CIty'S general purpose finanCIal statements At thIs tIme, the costs of ImplementIng such a system may exceed potentIal benefits that could be denved AdmInIstratIon WIll contmua1ly momtor the SItuatIon and Implement changes, If necessary Monitor Collateral to Ensure Proper Collateralization MInnesota Statutes Sec 11801 and 118 10 prOVIde that all depOSIts WIth fmancIaI mstItutIons must be collateralIzed m an amount equal to 110% of depOSIts m excess of FDIC msurance The depOSIts of the CIty at December 31, 1997, were unsecured by $ 18,498 at the State Bank of Rogers We recommend the CIty Clerk-Treasurer momtor collateral on a monthly basIS to ensure proper collateralIzatIon 12