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1973CITY OF BANGOR POST AUDIT MANAGEMENT LETTER for the year ended DECEMBER 31, 1973 LeEll-i ?... L9:-3 BROOKS & CARTER Certified Public Accountants 84 HARLOW STREET BANGOR, MAINE 04401 N PRANK M. CARTER, CPA RAYMOND T. ADAMS JR.. CPA VAUGHN L. HERSEY. CPA GEORGE W. CHESBA. CPA KENNETH N. FOSTER. CPA WAYNE C. INGALLS. CPA BROOKS & CARTER Certified Public Accountants 84 'HARLOW STREET BANGOR, MAINE 04401 TELEPHONE 047-0931 May 24, 1974 Honorable Members City of Bangor in Council Bangor, Maine 04401 Gentlemen: EDWIN M. BULLARD JR., CPA 10E ACCESS ROAD CARIBOU. MAINE 04736 We have examined the financial statements of the City of Bangor for the year ended December 31, 1973 and have issued our report thereon dated May 3, 1974. As a part of our examination, we reviewed and tested the City's system of internal account- ing control to the extent we considered necessary to evaluate the system as re- quired by generally accepted auditing standards. Under these standards the purpose of such evaluation is to establish a basis for reliance thereon in determining the nature, timing, and extent of other auditing procedures that are necessary for ex- pressing an opinion on the financial statements.. The objective of internal accounting control is to provide reasonable,' but not absolute, assurance as to the safeguarding of assets against loss from unauthor- ized use or disposition, and the realiability of financial records for preparing financial statements and maintaining accountability for assets. The concept of reasonable assurance recognizes that the cost of a system of internal accounting control should not exceed the benefits derived and also recognizes that the evalua- tion of these factors necessarily requires estimates and judgments by management. There are inherent limitations that should be recognized in considering the potential effectiveness of any system of internal accounting control. In the performance of most control procedures, errors can result from misunderstanding of instructions, mis- takes of judgment, carelessness or other personal factors. Control procedures whose effectiveness depends upon segregation of duties can be circumvented by collusion. Similarly, control procedures can be circumvented intentionally by management with respect either to the execution and recording of transactions or with respect to the estimates and judgments required in the preparation of financial statements. Further, projection of any evaluation of internal accounting control to future periods is subject to the risk that the procedures may become inadequate because of changes in conditions, and that the degree of compliance with the procedures may deteriorate. Our study and evaluation of the City's system of internal accounting control for the year ended December 31, 1973, whicn was made for the purpose set forth in the first paragraph above, was not designed for. the purpose of expressing an opinion on internal accounting control and it would not necessarily disclose all weaknesses in the system. However, such study and evaluation disclosed the following conditions. Honorable Members in Council -2- May 24, 1974 that we believe are worthy of comment. Our examination of the City's financial statements, furthermore, disclosed certain financial matters which we feel should be brought to your attention. Accordingly we submit our comments thereon for your consideration. Certified Public Accountants a INTERNAL AUDIT We noted during our examination that the audit department of the City con- cerned itself primarily with a detail review of cash receipts and disbursements which we understand included field examinations of various City departments. We commend the City on the increased effort in this area, however, we suggest that the internal audit function to be performed by the audit department is more encompassing in scope than the aforementioned procedure., We suggest that the internal audit function should be designed and structured for the purpose of conducting internal examinations of the City's financial statements. Accordingly, such an examination would include (in addition to field audits of cash receipts and disbursements of the various departments) analysis of various revenue, expense, and balance sheet accounts, review of the underlying system of internal control throughout the City's accounting system, and review of the City's financial statements for presentation in accordance with generally accepted accounting principles and compliance with charter and state law. We recommend, therefore, that the audit department expand its audit function to include the aforementioned audit procedures. CASH FLOW In recent years the City has experienced serious cash flow shortages in the "Operating Funds" (General, Airport, Sewer, and Hospital) which has necessitated the borrowing of working capital from the Capital Improvement Fund, the Trust and Agency Fund, and/or the Municipal Debt. Fund. Schedule 1 attached to a certain letter submitted to Management on.May 20, 1974, which is included herein as Exhibit 1, shows that the "Operating Funds" borrowed $540,978 from the Debt Fund at December 31, 1973 while the 1973 Comparative Financial Statements indicate that approximately $2,534,000 was loaned to the "Operating Funds" by the Capital Improvement and Trust and Agency Funds at December 31, 1972. The Capital Improvement Fund is funded prim-arily by bonds and notes and, therefore, any borrowings made from the Capital Improvement Fund for large amounts most likely was funded by debt issues. Since the charter restricts the issue of public debt to permanent public improvements, charter law was undoubtedly violated bythe aforementioned working capital loans. Furthermore, state statutes specifically prohibit the loaning of trust fund monies. It appears, therefore, that state law was also violated in 1972 when the Trust and Agency Fund loaned at least $236,000 of Trust Fund monies to the "Operating Funds". This type of interfund borrowing and more importantly the underlying cause must be eliminated if the City_ is to conduct its operations within the guidelines of the charter. More importantly, .elimination of this kind of interfund borrowing, of necessity, requires that the "Operating Funds" generate sufficient working cash since the former results only when the latter has occured. We offer the following suggestions, therefore, which we believe will help to provide increased cash flow in the future. a) Inventory Budgeting and .Control The City has established a policy of budgeting andrecording inventory usage in the various operating departments. Since the annual budget, however, concerns itself with usage and not inventory purchases it may or may not provide sufficient tax dollars for annual inventory expendi- tures. Provided that inventory carrying values remain on a constant level budgeted usage should approximate actual cash outlay for inventory purchases for the City as a whole. When inventory carrying values show a growth trend, however, it becomes evident .that usage is not on a par with actual inventory purchases and there may be a negative effect on working capital cash. In reviewing the City's inventory accounts from December 31, 1971 to December 31, 1973, we found that inventories had increased by approximately $77,000 which suggests to us that inventory cash requirements during this two-year period have exceeded available tax dollars by approximately this amount. It would appear, therefore,. that growth in inventory values has contributed to the City's shortage of working cash and is a factor to be concerned with in future budgets, especially in light of prospective increases in Airport inventories as a consequence of the proposed purchase of the fixed base operation. We suggest, therefore, that the City consider the following courses of action. First, and foremost, the City should determine whether inventory growth, especially in the General Fund (which growth amounted to $76,000 during the two-year period mentioned above), is necessary. We would seiously question such growth since the inventory consists primarily of expendable supplies held for the City's consumption. If it is determined that such growth is unnecessary then the City should establish tighter control procedures over inventory purchase and usage and attempt to obtain maximum benefit from existing inventory supplies. Secondly, any prospec- tive increases in inventory accounts, which are necessary and warranted, should be budgeted for in the annual budget in order to provide sufficient tax dollars to cover the anticipated cash application in excess of usage. b) Accounts and Taxes Receivable - Collection Policies During the past two years the City has made significant strides toward collection of outstanding taxes receivable. We commend the effort that has been made and point out that continued effort to turn taxes into. cash will serve to improve the City's cash position. Regarding accounts receivable we would point out that although the City is generally holding the line there exist'. some serious problems in the Hospital Fund's accounts receivable. We detected during our examination an apparent lack of communication between City Hall and the Hospital as regards a certain large outstanding balance with a Mr. and Mrs. Hamm. It is our understanding that the Hamims, who had an outstanding bill of $18,662 at December 31, 1973, qualify for state care except for the fact that they own a house. While a debate apparently continues as to how much the house should be sold for the Hamms continue to run up a $1,500 monthly bill. We suggest the case should be settled as expediately as possible in order that the City can take advantage of the available state funding. While the Hamm case deserves attention because of the size of the monthly charge we are more concerned about the collection procedures in general at the Hospital. We question whether sufficient infox mat,iolconcerning the patients. ability to pay is obtained at the time he enters the Hospital. Furthermore, we question whether the information obtaine is subjected to a thorough review for the purpose of projecting the means of payment. It would seem, for instance, that if the above mentioned criteria were satisfied that the City would not be faced with doubtful accounts of $68,548, which amount approximates 460 of the total outstanding Hospital receivables. We strongly suggest, therefore, that the City review the entire collection procedure at the Hospital for the purpose of strengthening credit .policy. c) Capital Expenditure and Related Financing - Sewer Fund During 1973 the Sewer Fund generated cash from operations of $249,334 as re- flected on the City.'s 1973 financial statements (statement of changes in financial position). This cash was in turn applied to retirement of general obligation bond principal in the amount of $162,521 and deposits for construc- tion with the Capital Improvement Fund of approximately $87,000. Since the Sewer Fund has on deposit with the Capital Improvement Fund $235,420 of bond monies reserved for future construction it would seem that 1974 Sewer Fund operations would not be required to fund Capital expenditures. Provided 1974 operations are comparable to 1973 it would then seem fair to expect a net 1974 cash generation in the Sewer Fund in the range of $75,000 to $100,000: We suggest that this excess cash generation could then be used where needed by the other "Operating Funds" via interfund borrowing or used to retire the indebtedness owed the Capital Improvement Fund of $114,600. We emphasize, however, that these funds would only be avail= able if the Sewer Fund operations improved or remained comparable to 1973. We suggest that, in any event, the bond reserves currently on hand in the Capital Improvement Fund should be used for any 1974 Sewer Fund Capital outlay in order to reduce the drain on operating cash. We would also point out to you that the Sewer Fund has, as of December 31, 1973, $148,242 of deferred sewer assessments which represent sewer assess- ments to be recognized in future years. Since it is our understanding that a majority of these assessments relate to projects completed and paid for by the City,these assessments technically represent designated monies for future sewer construction and should be used or such when they are re- ceive e suggest that the City should review the status of these assess- ments and levy those whichare due for"the purpose of providing additional working cash for Sewer Construction. 1974 BUDGET - APPROPRIATION TO SURPLUS Under separate letter to Management dated May 20, 1974, which is included herein as Exhibit 1, we pointed out that in our opinion the City needed an appropria- tion to surplus of approximately $930,000 in 1974. At this time we would like to comment further on the data contained in Schedules 1 and 2 of that letter. Schedule 2 of the aforementioned letter presents three deficiencies in cash which existed at December 31, 1973. Those deficiencies were; loans made by the Debt Fund to the "Operating Funds" of $540,978; customer deposits on the Airport Fund in the amount of $110,000 which are designated for the International Arrivals Building Fund; and designated reserves on the General Fund in the amount of $108,159. In all three cases at year end the "Operating Funds" did not have suffi- cient cash to meet these committments. In addition, Schedule 2 identified two pros- pective cash requirements in 1974, the nature of which has not heretofore been con- sidered in annual budgets. It is our understanding that the sixth element - contracts payable - of $22,077 will be considered in the 1974 budget. We, therefore, will not comment on this element. . The three elements which we have defined as cash deficiencies at year end are in our opinion most critical. Unless the operations of the General, Sewer, Airport, and Hospital Funds are extremely profitable in 1974, it is difficult to see where the cash will be generated to meet these necessary cash committments which total $759,137. It seems essential therefore that the General Fund appro- priate to surplus an amount necessary to meet these requirements. The General Fund could then loan the Airport and Sewer Funds the amounts necessary to meet their cash deficiencies. As explained in the preceding paragraph entitled "Capital Expenditures and Related Financing - Sewer Fund" the Sewer Fund may generate $100,000 of working cash in 1974 which could be used to meet its cash deficiency at December 31, 1973. It seems sound municipal finance, however, to take care of the 1973 cash deficiencies by an appropriation to surplus and thereby place the "Operating Funds" in a position which would allow them to generate some cash to serve as an operating cushion. It is difficult at this time to project how much of an operating cash cushion could be generated. However, if the $759,000 were appropriated to surplus and provided 1974 operations in the Sewer and Airport Funds were at least comparable to 1973, and furthermore, provided 1974 Sewer and Airport Capital projects were financed by contributions or bond monies, it is con- ceivable that the Airport and Sewer Funds could generate in the range of $200,000 to $2501000 of working cash to be used by the "Operating Funds". This estimate is based on the following: (A) The loans payable to the Capital Improvement Fund by the Airport and Sewer Funds would be repaid by tax dollars generated by the appropria- tion to General Fund surplus and loaned to the Airport and Sewer Funds. At December 31-, 1973 these loans amounted to $114,000 and $114,600 for the Airport and Sewer Funds respectively. (B) The cash committed for customer deposits on the Airport Fund of $110,000 would be loaned to that fund by the General Fund from tax dollars generated by the appropriation to General Fund surplus. (C) The loans payable to the General Fund as created by (A) and (B) would not be repaid by the Airport and Sewer Funds during 1974. (D) Capital outlay by the Airport and Sewer Funds would be funded by contri- butions or bond monies. (E) Based upon the above and assuming the following, estimated cash generation would be approximately $250,000. Airport Fund Sewer Fund Estimated cash to be provided from operations based upon 1973 results (see 1973 financial statements - Statement of Changes in Financial Position) $251,000 $ 249,000 Debt retirement (79,000) (168,000) Estimated Net Cash Generated $172,000 $ 81.,000 Estimated Total Cash Generated $253,000 The two prospective cash requirements for 1974 which are identified as estimated increases in inventories and accounts receivable have been dealt with in preceding paragraphs. We would add, however, to our earlier comments on accounts receivable that if management concludes that it cannot hold the line on receivables then it should provide some cushion in its annual budget to cover any projected in- crease's in these accounts. Schedule 2 of our May 20, 1974 letter estimates that these increases might be as high as $65,000, based upon a comparison of 1973 balances to 1972. . We would also reiterate our comments in our earlier paragraph on inventory budgeting; that prospective increases in inventory accounts should be budgeted for in the annual budget. OTHER MATTERS Borrowing From the Capital Improvement Fund We have mentioned in preceding paragraphs that borrowing money from the Capital Improvement Fund for use in the "Operating Funds" generally would be con- sidered a violation of the charter since the Capital Improvement Fund is funded primarily by bond issues. We would point out, however, that the Capital Improve- ment Fund may from time to time have cash on deposit for construction which was generated by an "Operating Fund". We see no reason why this cash could not be loaned to the "Operating Funds" as required. Cash - Control Over Receipts and Unused Checks At the present time, cash received via mail is received directly from the mail room by a cashier in the treasurer's department who also prepares the deposit slip and occasionally takes the deposit to the bank. We feel internal control would be greatly improved if the person opening the mail ran an adding machine tape on these checks and restrictively endorsed all checks before they are forwarded to the treasurer's department., This person would then forward the items to the cashier and the tape to the treasurer who would attach the bank de- posit receipt to the tape and compare for agreement. We also noted that unused checks were left on open shelves in the com- puter room. We feel that access to unused checks should be limited to computer processing personnel and therefore recommend that they be kept in locked cabinets. Tax Acquired Property During our review, we noted that sales of tax acquired properties.for. 1972 and 1973 were not reflected as reductions in the tax acquired property account of the Fixed Asset Fund. We feel that the treasurer's department should give this matter some attention and prepare the necessary journal entries when the cash from the sale is received. Inventories . In a preceding paragraph, we stated that the City should establish tighter control procedures over inventory purchase and usage and attempt to obtain maximum benefit from existing inventory supplies. It was noted during our audit, for example, that a portion of motor pool inventory appeared to be un- usable and/or obsolete and that, for the most part, items needed currently were being ordered currently. Although we feel that any potential write off would be immaterial to the City's financial statements taken as a whole, we believe it is a matter for consideration and that a complete objective review and physical count would be'a worthy project for the internal audit department. This review should also encompass a critical review of the procedures as they relate to maintaining the perpetual inventory cards since we noted that in both the motor pool and electrical stock rooms items were taken from stock and not properly removed from inventory when the stock clerks were off duty or busy with other functions. We feel access to inventories should be limited to as few individuals as possible and that stock requisitions should be utilized for all items leaving the stock rooms. The stock requisitions should then be used as a source of relieving the perpetual inventory cards. Another area where we. noticed deficiencies was in the returning of goods to vendors by the motor pool. When the stock clerk feels that certain parts will not be used, he can, in some instances, return them for credit. At present, no communication is made with the purchasing department informing them that a credit memo should be forthcoming. Thus, if the vendor fails to issue the credit memo to the City, there is no.means of follow up and the general ledger.inventory account is never credited. We suggest that an internal three-part credit memo be utilized which would flow through the system much like a purchase order. Distri- bution might be as follows: Copy 1 - To vendor with goods Copy 2 - Stock room files Copy 3 To purchasing When the vendor's credit memo is received, the purchasing department merely matches it with the open internal credit memo and forwards it to auditing for processing in the general ledger. Workmen's Compensation Receivable The City now has in a Trust and Agency account a receivable for workmen's compensation in the amount of approximately $18,000. This receivable arose as a result of the City paying a few individuals weekly workmen's compensation checks.. No claims have been made against Lloyds of London (the insurance carrier at the time payments began) for several years. We cannot emphasize strongly enough, the need to. take immediate action on this matter particularly since indications are that the City need only submit a claim. Engineering Cost Allocations The engineering department periodically bills the Sewer Fund for services rendered. We noted, however, that these costs were being absorbed by the Sewer Fund in its maintenance accounts even though they were applicable to projects under con- struction in the Capital Improvement Fund. Since engineering costs are a valid cost of construction, we recommend that they be allocated accordingly and charged to the project. Bangor City Nursing and Health Center We recommend that consideration be given to establishing the Hospital as a separate enterprise fund instead of the present practice of including its opera- ting results with the General Fund operations. By identifying this service on a continuing basis, fiscal responsibility could be fixed; the annual losses or gains would accumulate to further identify the fiscal problem instead of the present method of annually closing out the losses to General Fund Surplus and starting fresh each year; and plant assets and accumulated depreciation would become part of the separate fund account with depreciation being recorded monthly consistent with Medicare regulations. Whether or not the Hospital remains part of the General Fund or is set up as a separate enterprise fund, there is amore important area which should be re- viewed to help reduce the perennial and mounting losses. That area concerns the space rented or not used for Hospital care. There are presently some six different agencies using space in the Hospital complex. The Bangor City Health Department presently occupies 3,362 square feet of space at no cost. We suggest that the City Health Department be charged - through.an inter -account transfer voucher - for the reasonable cost of the space it uses. Although this procedure wouldn't. involve any money, it would more accurately reflect the space costs of the respective departments instead of the present policy of the Hospital subsidizing the Health Department. The nominal rate paid by the present tenants also. contributes to the substantial losses experienced by the Hsopital. Some perspective of the magnitude of foregone revenues of which we are spe7aMing can be illustrated by what must be done in order to file .proper Medicare and Medicaid cost reports. For calendar 1973, $77,510 of space costs had to be eliminated from Hsopital costs as they didn't relate to patient a care. There areas were either being used by the Bangor City Health Department at no charge or by the tenants at a greatly reduced charge. The tenants paid $11,678 in 1973. The difference between this figure and the $77,510 of eliminated costs prominently identifies the seriousness of the situation and the magnitude of foregone Hospital revenues.