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California State Auditor · 2004-117 · 2004-01-01

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City of Richmond: Poor Spending Decisions and Weak Monitoring of Its Finances Caused Its Financial Decline and Hinder Its Ability to Recover December 2004 2004-117 rotiduA etatS ainrofilaC S T I D U A E T A T S F O U A E R U B The first five copies of each California State Auditor report are free. Additional copies are $3 each, payable by check or money order. You can obtain reports by contacting the Bureau of State Audits at the following address: California State Auditor Bureau of State Audits 555 Capitol Mall, Suite 300 Sacramento, California 95814 (916) 445-0255 or TTY (916) 445-0033 OR This report is also available on the World Wide Web http://www.bsa.ca.gov/bsa/ The California State Auditor is pleased to announce the availability of an on-line subscription service. For information on how to subscribe, please contact the Information Technology Unit at (916) 445-0255, ext. 456, or visit our Web site at www.bsa.ca.gov/bsa Alternate format reports available upon request. Permission is granted to reproduce reports. � � � �� December 7, 2004 2004-117 The Governor of California President pro Tempore of the Senate Speaker of the Assembly State Capitol Sacramento, California 95814 Dear Governor and Legislative Leaders: As requested by the Joint Legislative Audit Committee, the Bureau of State Audits presents its audit report concerning our review of the city of Richmond (city) with a focus on the factors that contributed to its financial crisis. This report concludes that the city drained its financial assets and jeopardized its financial stability because it failed to control spending while its revenues decreased. Between 1998 and 2003, the city entered into agreements with its six employee unions that significantly increased salaries and improved retirement benefits. Unreasonable budget estimates in fiscal years 2002–03 and 2003–04, some of which were intentional, and ineffective budget monitoring masked Richmond’s overspending and the city did not take timely action to reduce its costs. In March 2004 the city introduced a corrective action plan to rectify the city’s deficit and build long- term financial health. Since that time, the city has taken steps to reduce its costs by renegotiating certain benefits in its labor agreements and increase its revenues by placing a half-cent sales tax increase on the November 2004 ballot that voters approved. Although the city is moving in the right direction, it is too soon to tell whether the actions the city has already taken and plans to take in the future will be sufficient to restore its financial health. Respectfully submitted, ELAINE M. HOWLE State Auditor �� CONTENTS Summary 1 Introduction 5 Chapter 1 The City of Richmond’s Failure to Control Costs Has Damaged Its Financial Health, Reduced Public Services, and Created Challenges for Its Future Fiscal Stability 13 Recommendations 26 Chapter 2 The City of Richmond Made Unreasonable Budget Estimates and Did Not Monitor Its Budget Effectively 29 Recommendations 42 Appendix The City of Richmond’s Progress in Implementing Its Corrective Action Plan 45 Response to the Audit City of Richmond 49 California State Auditor’s Comments on the Response From the City of Richmond 55 SUMMARY RESULTS IN BRIEF In reviewing its midyear progress for fiscal year 2003–04, the city of Richmond (city) announced in March 2004 that during the previous fiscal year, several funds had greater outflows than inflows and some funds had large negative Audit Highlights . . . cash amounts. Most significantly, during fiscal year 2002–03, expenditures exceeded revenues by $14.5 million in the city’s Our review found that the city general fund—its main operating fund—and the fund had an of Richmond’s (city) financial health deteriorated because it: $8.3 million negative cash amount as of June 30, 2003. þ Significantly increased The imbalance between the city’s inflows and outflows was employee salaries and retirement benefits largely caused by its failure to control spending. Although the without ensuring it would city expected to increase revenues to make up for the increased have adequate funds to spending, its expectations for swift revenue increases were overly pay for them. optimistic and did not materialize. Personnel costs represent þ Agreed to increase some the largest portion of the city’s spending and contributed salaries to exceed those significantly to the city’s increased costs, the result of salary of other cities without increases ranging from 16 percent to 27 percent for most knowing what the amounts employees between 2000 and 2003. The city also enhanced its would be and without limiting the increases. employees’ retirement benefits, thereby increasing its obligation to the retirement system; in some cases, retirement benefit þ Underestimated how costs exceed 30 percent of what it pays employees in salaries. much it would spend out of its general fund, The city council believed that the increases were necessary sometimes intentionally, to be competitive with other cities and to attract and retain and delayed making qualified employees. However, it agreed to increase some salaries spending reductions. to exceed those of other cities without knowing what the þ Relied on inaccurate amounts would be and without setting limits on the increases. reports to monitor and Additionally, the city council enhanced retirement benefits, adjust the budget. knowing that the benefits would be a significant expense and Since March 2004 the city without having set aside funds to prepare for the increases. has taken steps to improve its financial health and how it Although the intent of the city council’s decisions was to monitors its finances. improve services to the public, the effect appears to have backfired. In fact, because the city’s costs increased rapidly while its revenues did not, the city has laid off 250 of its staff since March 2003, drastically cut funds to some of its programs, and diminished its reserves. To improve its financial outlook, the city’s revenues must not only align but also exceed its expenditures to make up for past deficits and rebuild its resources, a direction the city has been heading with recent revenue increases and cost reductions. California State Auditor Report 2004-117 11 The city’s budget preparation and monitoring processes were disjointed and therefore did not identify that the city council’s decisions would cause a deficit in fiscal years 2002–03 and 2003–04. Consequently, the city council did not make decisions to reduce spending until after the city had spent more money than it could afford. The city’s budget process failed in part because the city significantly underestimated what it would spend on personnel, bond payments, and insurance during fiscal year 2002–03. Additionally, the city deliberately underbudgeted certain expenditures to balance its fiscal year 2003–04 budget. The finance department’s quarterly and midyear reports, which it provides to the city council to monitor the budget, should have indicated what the budgets did not: that the city’s outflows would exceed its inflows. However, the reports from the finance department for fiscal year 2002–03 did not disclose that information. Instead, the updated spending estimates the finance department reported to the city council incorrectly showed that the city could afford the increases using reserve funds. The department’s calculations of the city’s general-fund reserves were incorrect, mostly because they did not include all outflows, such as transfers from the general fund to other funds. The quarterly and midyear reports also did not show other indicators of the city’s financial troubles, such as the cash position of the city’s individual funds and losses in other funds, including its workers’ compensation and general insurance funds. As a result, the city council was not fully aware of the city’s serious financial predicament until the city released its audited financial statements. The financial statements disclosed losses and negative cash amounts nearly one year after the end of the 2002–03 fiscal year, at which point the city began taking corrective action. Although the city has taken steps to improve its monitoring procedures, to some extent the problems continued throughout fiscal year 2003–04. Since the city discovered its financial deterioration, it has taken steps to improve its financial health and how it monitors the finances of the city. Specifically, in March 2004, the city published a corrective action plan to eliminate negative cash amounts and reduce costs by June 30, 2004, while the city implemented longer term solutions, such as increasing the sales tax and renegotiating certain benefits with its six employee unions. Additionally, in September 2004, the interim city manager issued an assessment that enumerated specific tasks needed to strenghten the city’s fiscal and organizational structure. The tasks in this assessment include having departments submit monthly reviews of their budgets and 22 California State Auditor Report 2004-117 California State Auditor Report 2004-117 33 ensuring the city completes its financial statements by the end of the calendar year. However, it is too soon to tell whether the actions the city has already taken and plans to take in the future will be sufficient to restore its financial health. RECOMMENDATIONS To ensure that the city has sufficient funds to meet its operating costs and does not spend more than it can afford, Richmond should do the following: • When negotiating agreements with its employee unions, consistently analyze salary and benefit increases to determine the long- and short-term effects the increases will have on the city’s budget. • Cease raising salaries based on amounts outside the city’s control. If the city chooses to continue to base its salaries on those of other cities, it should ensure that its agreements with employee unions include limits to the amounts the city will raise the salaries. To reestablish the value of the budget as an essential planning tool, Richmond should budget for all likely expenditures and not knowingly adopt budgets that reflect inaccurate estimates of expenditures or revenues. If the city needs to reduce expenditures to balance the budget, it should promptly take cost-cutting measures. To improve the quality of the financial information that the city council uses to make budget changes during the year, the city’s finance department should take the following steps: • Monitor the amount of reserves the city has during the year, using a method that includes all inflows and outflows. • Include information on the status of other city funds, not just the general fund, in its quarterly and midyear reports. AGENCY COMMENTS The city is in general agreement with the recommendations and facts in the report. n 22 California State Auditor Report 2004-117 California State Auditor Report 2004-117 33 Blank page inserted for reproduction purposes only. 44 California State Auditor Report 2004-117 California State Auditor Report 2004-117 55 INTRODUCTION BACKGROUND Incorporated in 1905, the city of Richmond (city), in western Contra Costa County, had a population of 101,400 as of 2003, according to estimates from the California Department of Finance. Located 16 miles northeast of and directly across the bay from San Francisco, the city boasts 32 total miles of shoreline and a central Bay Area location situated near major metropolitan cities. The California Constitution and the provisions of the city charter charge the city with making and enforcing all regulations and ordinances regarding municipal affairs and to maintain a city police force and fire department, among other duties. The city is authorized to levy and collect taxes and assessments and charge fees for services that it provides to residents and businesses. A nine-member, publicly elected city council governs the city.1 The city council establishes comprehensive goals and objectives for the city, provides leadership in establishing policies for the conduct of city business, and formulates priorities for allocating city resources. To carry out its policies, the city council appoints a city manager who is responsible for directing departments, providing day-to-day leadership in policy development and implementation, and directing administrative functions, including overseeing the annual budget process. Figure 1 on the following page shows Richmond’s organizational structure. The city’s fiscal year runs from July 1 through June 30. For fiscal year 2004–05, the city council adopted a budget that included general-fund operating revenues and expenditures totaling $96.9 million, and the city had 672 employees, including 161 sworn police officers and 83 full-time firefighters. In March 2004, during its midyear review of fiscal year 2003–04, the city announced it had spent $14.5 million more than it took in to the general fund during fiscal year 2002–03 and that if the city did not take corrective action, spending would exceed revenue by $6 million in fiscal year 2003–04. Facing these significant operating deficits, the city also announced it needed $35.2 million in cash to cover negative cash amounts in the general fund and in other funds. The city attributed its financial situation to its inability to 1 As a result of a measure passed in November 2004, beginning with the November 2008 election, the number of council members will be reduced to seven. 44 California State Auditor Report 2004-117 California State Auditor Report 2004-117 55 FIGURE 1 Richmond’s Organizational Structure �� Source: City of Richmond. 66 California State Auditor Report 2004-117 California State Auditor Report 2004-117 77 control personnel costs, a slowdown in the economy, and the loss of certain city revenues to the State, such as the portion of the vehicle license fee that the State promises to repay in 2006. When making those announcements, the city introduced a plan of action to rectify the city’s current deficits and build long-term financial health. The plan contained a number of one-time corrections to infuse the general fund with cash, such as accelerating the repayment of loans it made to the Richmond Redevelopment Agency, as well as more permanent actions, such as laying off city employees. The Appendix shows the components of the city’s corrective action plan and the status of those components as of November 12, 2004. Because of the city’s reduced operating reserves and lack of cash and other liquid assets, in March 2004, the city’s credit rating was downgraded to Ba3, which limits its ability to obtain short- term financing notes to help remedy cash shortfalls. To allow the notes to be adequately secured and marketable at reasonable interest rates, in July 2004, the Legislature authorized the Contra Costa County auditor to transfer a portion of the city’s property tax revenues directly to the notes’ trustees to pay principal and interest on the notes. Part of the Legislature’s intent was for Richmond to continue to explore innovative cost-cutting measures, including a charter amendment to reduce the size of the city council. The city has not yet issued short-term financing notes. According to Richmond’s deputy finance director, the city will likely issue notes before December 31, 2004. ECONOMICS OF RICHMOND Richmond obtains revenue to operate the city from a variety of sources. However, as Figure 2 on the following page shows, Richmond’s revenue mix is largely made up of a utility users’ tax and property taxes. The city imposes the utility users’ tax on consumers and businesses for the use of utilities such as telephone, natural gas, and electricity. Property taxes, a significant source of revenue for any city, are based on the assessed value of properties. Richmond projects that it will collect $27.8 million from the utility users’ tax and $28.4 million from property taxes in fiscal year 2004–05. Like other cities throughout the State, Richmond spends a significant portion of its budget on personnel costs, including salaries and benefits. In addition, the city spends 5 percent of its general fund paying principal and interest on bonds it has issued. As Figure 3 on the following page shows, the city spends its revenues in a variety of areas. As in other California cities, the 66 California State Auditor Report 2004-117 California State Auditor Report 2004-117 77 largest portion of Richmond’s budget (49 percent) goes toward public safety, which includes police services. Because of its crime rate, however, Richmond’s need for public safety spending may be greater than that of other cities in the State. Overall, Richmond’s crime index, which is calculated using several factors such as population and the number of various crimes, is significantly higher than the statewide crime rate. FIGURE 2 Inflows of Richmond’s General Fund Fiscal Year 2002–03 �� Source: City of Richmond’s audited financial statements, fiscal year 2002–03. FIGURE 3 Outflows of Richmond’s General Fund Fiscal Year 2002–03 �� Source: City of Richmond’s audited financial statements, fiscal year 2002–03. 88 California State Auditor Report 2004-117 California State Auditor Report 2004-117 99 Richmond provides some services that have not always been self-supporting. An example of a non-self-supporting service is the city’s employment and training program, which trains unemployed workers in Richmond and helps them find jobs. Although the current interim city manager has set a goal for the employment and training program to be financially independent of the city’s general fund, the program drew from the general fund in fiscal year 2002–03. In fact, the employment and training program spent $400,000 more than it took in during fiscal year 2002–03. Additionally, Richmond’s municipal sewer operated at a loss of almost $2.7 million during fiscal year 2001–02. Although the sewer fund began generating a surplus in fiscal year 2002–03, the city expects it will take two to three years to erase the deficit in the sewer fund. Moreover, because both the sewer fund and the employment and training program fund ended fiscal years 2001–02 and 2002–03 with negative cash amounts, the city looked to the general fund to cover those cash shortages. RICHMOND’S BUDGET PROCESS The city starts preparing its budget five months before the beginning of the new fiscal year, typically in February, with the finance department distributing instructions that the city’s various departments follow when creating their budgets. Once departments submit their budgets, the finance department reviews and compiles the information into a comprehensive draft budget document. After the draft budget document is complete and before the end of April, members of the city management team—the city manager, assistant city manager, finance director, and department directors—review and discuss the draft before they approve it and submit it to the city council in May. At the May city council meeting, the department directors hold a work session to inform the city council about the budget. Based on the city council’s comments, the finance department may subsequently revise the draft budget. Finally, the city council adopts the budget by a formal resolution before the start of the fiscal year on July 1, and the budget then serves as the city’s operational plan for the ensuing fiscal year. The city updates the budget throughout the year as needed but generally makes most adjustments during the quarterly and midyear reviews. 88 California State Auditor Report 2004-117 California State Auditor Report 2004-117 99 STAFF TURNOVER AND LAYOFFS AFFECT THE WORK ENVIRONMENT AT THE CITY In recent years, leadership within the city government has changed in several ways. For example, the city manager retired during fiscal year 2003–04. Since that time, the city has had three interim city managers. Additionally, the finance department has had significant turnover in management staff, and the city has tried to save money by removing directors and managers in other departments, such as the recreation and parks department. When the city council discovered that the city was operating in a deficit, it took steps to lay off 250 city employees. Consequently, city staff are spread more thinly than they were previously, forcing management to prioritize tasks. Moreover, with fewer resources, city leaders are left to strike a balance between vital services, such as police and fire protection, and other services it elects to provide, such as employment and training. Although he is convinced that the personnel cuts were necessary, the current interim city manager concedes they have negatively affected morale because a reduced workforce is expected to keep up with a growing workload. Thus, although the financial situation of the city is precarious, it is not the only challenge the city faces. SCOPE AND METHODOLOGY The Joint Legislative Audit Committee (audit committee) requested that the Bureau of State Audits conduct an audit of the financial records and accounting systems of the city of Richmond, focusing on the factors that contributed to the city’s financial crisis. Specifically, the audit committee asked us to do the following: • Determine the extent to which items such as the city’s accounting and budgeting practices, revenue shortfalls, and increases in expenditures contributed to the deficit. • Determine if the financial statements disclosed the impending financial crisis, and if so, examine any corrective action taken by city officials. • Review the corrective action plan that the city issued in response to its financial crisis, and determine the extent to which the city will correct the problems. 1100 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1111 To understand the extent to which the city’s budget process contributed to the financial crisis, we reviewed the city’s budget preparation procedures and determined whether the city followed its procedures during fiscal year 2002–03. We also calculated variances between the original budget and actual numbers for fiscal year 2002–03. For large variances, we reviewed the original budget estimates and assessed them for reasonableness. We also determined if the finance department accurately input its budget amounts into the accounting system—a procedure that could help prevent departments from spending beyond their budgets—and found that the finance department correctly input original budget amounts. We focused on fiscal year 2002–03 because the city’s financial health significantly deteriorated that year and because year-end financial statements for fiscal year 2003–04 prepared by the finance department were not available. To evaluate if the city council had accurate and timely information, we reviewed the quarterly and midyear reports that the finance department provided to the city council for fiscal years 2001–02 through 2003–04. Our review included determining if the information was complete and accurate and if the finance department submitted the reports promptly. We also interviewed city staff, the mayor, and the former interim city manager to obtain their perspectives on the information that the city’s finance department provided in the past. Finally, we reviewed the audited financial statements for fiscal years 2000–01, 2001–02, and 2002–03 to determine if they disclosed the city’s financial condition and if the city issued the financial statements within a reasonable amount of time after the end of the applicable fiscal year. Because the city had a significant cash deficit at the end of fiscal year 2002–03 that the finance department was not aware of, we evaluated the city’s process for reconciling its pooled cash account and reviewed its monthly reconciliations for fiscal years 2002–03 and 2003–04 to determine if the reconciliation process is adequate to monitor the city’s pooled cash account. To understand how the changes in the city’s revenues affected its fiscal condition, we determined if the city had significant unplanned changes to its revenues during fiscal years 2002–03 and 2003–04 and found it did not. We also examined the extent to which changes to revenues, imposed by the State, affected the city. Because the city informed the public that personnel costs had increased more than any other city expenditure and thus 1100 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1111 had the biggest effect on the city’s financial health, we reviewed the agreements that the city has with its six employee unions. In view of the information available when the city council entered into those agreements, we assessed whether the city council acted appropriately. To determine if the city is following its corrective action plan, we interviewed management staff in the finance department and reviewed documentation that supported their assertions. However, the city’s fiscal year 2003–04 financial statements prepared by the city’s finance department were not available for our review; therefore, we could not evaluate the overall success of the city’s corrective action plan. n 1122 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1133 CHAPTER 1 The City of Richmond’s Failure to Control Costs Has Damaged Its Financial Health, Reduced Public Services, and Created Challenges for Its Future Fiscal Stability CHAPTER SUMMARY The cost of operating the city of Richmond (city) has grown significantly in recent years. Agreements the city made with its six employee unions, some of which took effect as early as 1998, to raise salaries by 16 percent or more between fiscal years 2000–01 and 2002–03 and the city’s July 2002 decision to enhance retirement benefits contributed significantly to the higher operating costs. With 85 percent of the city’s budget composed of personnel costs, salary increases significantly affect the city’s finances. Therefore, we believe the city should have assessed whether it could afford salary increases before it agreed to them. Instead, the city council entered into some of the salary agreements without knowing what they would cost the city. The city council agreed to base its salaries for public safety employees (police officers and firefighters) on the salaries that certain other cities in the Bay Area would be paying at future points in time. However, Richmond did not know the exact amounts the other cities would be paying and did not limit how much it would raise salaries. Although the city council intended to keep Richmond’s salaries competitive, it failed to recognize that some of the other cities can better afford to pay higher salaries than Richmond. The increased salaries have had a significant effect on the city’s current expenditures, and its enhanced retirement benefits drastically increased payments the city must make to the retirement system both now and in the foreseeable future. In some cases, payments to the retirement system exceed 30 percent of its employees’ salaries and will likely increase in the next few years. Although the city council was informed of the impending increases in retirement contribution rates, it did not take steps to set money aside to stabilize its costs when funds were available or require its employees to pay into the retirement system. 1122 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1133 The city planned to increase its revenues to pay for the added costs; however, its expectations of obtaining additional revenue sources in time to meet the increased expenditures were unreasonable. Moreover, the new source of revenue the city acquired in fiscal year 2002–03 did not provide enough funds to cover reductions in other revenue sources, such as the sales tax and funding from the State, much less increase city revenues to cover the 17 percent increase in expenditures since fiscal year 2000–01. With increased spending and decreased revenues, the city had to reduce the services it provides to the public. For example, the city reduced the staff in its police and fire departments and cut funding to public libraries. Even with those reductions, the city’s budget for fiscal year 2004–05 projects that, beginning in fiscal year 2005–06, revenues for the general fund will again be insufficient to cover the cost of operating the city. Richmond is currently working on ways to increase its revenues to reduce the imbalance between inflows and outflows. However, to recover from past years’ deficits, rebuild its reserves, and improve its financial outlook, the city must ensure that its revenues exceed its expenditures. HIGH-COST AGREEMENTS WITH EMPLOYEE UNIONS FORCED PERSONNEL LAYOFFS AND CUTS TO VITAL PUBLIC SERVICES By agreeing to large increases in employee salaries and benefits, Richmond shrank its financial assets and jeopardized its financial stability to the extent that major cuts were required in city services, including fire and police protection. Between 1998 and 2003, the city council agreed to certain employee salary increases with no knowledge of their costs. Moreover, the city council ignored warnings that enhancing retirement benefits would cost more than the city could afford. During 2001, the California Public Employees’ Retirement System (CalPERS) allowed Richmond to use excess retirement plan earnings to pay the employer’s share of benefits. However, the city did not use that one-time source of funds to establish a rate stabilization reserve. With 39 fewer police officers than the city had planned to have and the rotating closure of three of its 11 fire stations, the cost of the city’s agreements with its employee unions is negatively affecting services to the residents of Richmond. 1144 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1155 Richmond Significantly Increased Employee Salaries The city provided a number of salary increases between 1998 and 2003, raising its salary costs for some public safety classifications by more than 20 percent since 2000, as Table 1 shows. Some of the increases occurred during fiscal year 2002–03, when the city’s revenues were not sufficient to cover its expenditures. Currently, Richmond has agreements with six unions—four unions representing public safety employees, one representing general employees, and one representing management employees. The agreements provided for several salary increases. TABLE 1 Sample of Richmond Salary Increases Between 2000 and 2003 2000 Lowest 2003 Lowest Percentage Union Position Base Salary Base Salary Difference Increase Representing public safety employees Richmond Police Officers Association Police Officer $4,513 $5,441 $ 928 21% Richmond Police Management Association Police Captain 7,420 8,571 1,151 16 International Association of Firefighters Firefighter 4,026 5,117 1,091 27 Richmond Fire Management Association Fire Marshal 7,210 8,874 1,664 23 Representing non-public safety employees Richmond General Employees Buyer 3,715 4,391 676 18 Chief of Richmond Management Redevelopment Association Projects 6,185 7,309 1,124 18 Source: City of Richmond’s 2000 and 2003 salary schedules. Richmond entered into salary agreements with four of its employee unions between 1998 and 2002 without knowing what the amounts of some of the increases would be or the impact the increases would have on the city’s budget. Specifically, in 1998, the city agreed to raise salaries for members of its police unions effective July 2000 and July 2001, and for members of its two firefighter unions effective January 2001 and January 2002. Without specifying salary amounts or percentage increases, the city agreed to make the compensation package for each union the fourth highest in a survey of 12 Bay Area cities. (For a sample of cities used in the survey and their 1144 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1155 respective per-capita incomes, see the text box.) The compensation packages included salaries and other compensation the city provides, such Some Cities Richmond Included in Survey of Salaries for Public as the retirement costs it pays on behalf of the Safety Employees employees. In June and July 2002, the city made the compensation packages for public safety Per-Capita Income employees even more competitive with the other City as of 2000 cities surveyed by agreeing to salary increases that Richmond $19,788 placed the compensation packages at the third Palo Alto 56,257 highest as of July 2002 and the second highest Mountain View 39,693 as of January 2003. Thus, the 2003 salary levels San Mateo 36,176 were to be based on the compensation that the second-highest-paying city would decide to pay, Fremont 31,411 an amount that Richmond would not know until Alameda 30,982 the survey was completed, seven months after the Berkeley 30,477 date of the agreement. Although the city council South San Francisco 23,562 had to officially approve each salary increase Vallejo 20,415 after the survey was completed, the agreements Hayward 19,695 it had already entered into with the unions made it unlikely the council would not approve the increase. Therefore, in essence, Richmond’s Source: U.S. Census Bureau. city leaders relinquished control of public safety employees’ salaries to the decisions of leaders in other cities. Because the economies of some of the surveyed cities may be better than Richmond’s, those cities may be able to afford higher salaries than Richmond can pay, a reality that the city must consider when trying to offer competitive salaries. For example, one of the cities to which Richmond compares itself is Berkeley, which not only has a greater per-capita income but also has much larger total revenues than Richmond does. In fact, all the other cities, with the exception of two, have per-capita incomes signifi cantly greater than Richmond. Certain other cities in the Bay Area agreed with their employees to make salary adjustments using salary surveys; however, the agreements we reviewed typically had safety nets to ensure that the cities did not give salary increases they could not afford. For example, one city agreed to increase salaries based on the average salary of 12 comparable cities, but the increase could not exceed 3 percent. Because Richmond did not have a similar provision in its agreements, it gave up the ability to control salary costs. 1166 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1177 Generally, city governments in California spend a large amount of their budgets on personnel costs. According to the city, personnel costs—salaries and benefits—are roughly 85 percent of its budget. Decisions to increase expenditures in this area, if not well thought out, could cause extensive damage to the city’s financial health. In the future, before agreeing to salary increases, the city should know what the full cost of the agreement will be; otherwise, the city risks spending more than it can afford. Improved Retirement Benefits Have Dramatically Increased Richmond’s Current and Long-Term Obligation to the Retirement System To attract and retain employees, the city council approved enhanced retirement benefits for all city employees during 2002. Ironically, the result was exactly the opposite of what the city intended: Steep retirement costs have been partly to blame for Richmond’s major personnel layoffs. To increase what it will pay retirees in the future, the city must pay more into the retirement system now. Moreover, the city will continue to pay at least a portion of the employees’ share of payments into the retirement system for most employees until July 2005. As city staff warned the city council as early as 2001, retirement Retirement costs will costs have strained the city’s resources. Further, those costs will continue to increase in continue to increase in the future, making it more difficult for the the future, making it city to balance its budget and maintain essential public services. more difficult for the city to balance its budget The city contracts with CalPERS to assist it in providing benefits. and maintain essential CalPERS is an institutional investor that invests its assets and public services. those it holds in trust for others, such as a city’s retirement funds. Using actuarial valuations, CalPERS sets Richmond’s contribution rates, expressed as percentages of payroll, to cover the accumulated cost of the plan’s benefits, which were previously earned by active and retired members but not yet collected or paid. The actuarial valuations are based on a set of actuarial assumptions, such as plan earnings, life expectancy, and inflation rates, as well as the employer’s schedule of benefits and membership data. To avoid placing the complete burden of retirement costs on the employers, the plan is structured so that each employee pays a percentage of his or her wages to the retirement system. Known as the employee’s contribution, the percentage is set in law. 1166 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1177 Table 2 shows that in 2001 the city did not have to pay an employer’s contribution. CalPERS attributes this to its excellent investment performance. Throughout that year, the city paid the employees’ contributions but did not adequately prepare for likely future increases to its contribution rates by setting aside funds it normally would have paid to the retirement system. In October 2001, CalPERS notified Richmond that its retirement contribution rates for fiscal year 2002–03 would increase to 2.5 percent of salaries for public safety personnel and remain at zero for its general employees. Additionally, although CalPERS did not provide the specific rates until October 2002, the city received advance warning in June 2002 that it would have a second, more substantial increase in the retirement contribution rates beginning in fiscal year 2003–04. According to the Government Finance Officers Association (GFOA), a professional association of state and local finance officers dedicated to the sound management of government financial resources, city governments should have policies to guide the creation, maintenance, and use of resources for financial stabilization purposes. However, Richmond did not have a policy to set aside funds to respond to CalPERS’ increases, as do some other California cities. Consequently, the city did not have funds to lessen the impact of the rising contribution rates imposed by the retirement system. TABLE 2 Allocation of Contributions to CalPERS 2001 Through 2004 Total Share Paid by Employees’ Share Richmond’s Share Richmond Prior to 2003 to Plan 2003 Current 2001 2002 2003 2004* 2001 2004 Public safety employees 9.0% 9.0% 0.0% 2.5% 21.1% 22.2% 9.0% 31.2% General employees 7.0 8.0 0.0 0.0 8.3 9.5 7.0 17.5 Source: CalPERS. Note: Contribution rates are expressed as percentages of payroll. * Rates for 2004 reflect reductions from restructuring that is described more fully on page 20. 1188 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1199 Between 1998 and 2003, the city’s retirement benefits provided 2 percent of the final year’s salary for each year of service for general employees retiring at age 55; public safety personnel received 2 percent at age 50. Under this plan, for example, a person who served the city for 25 years as a general employee would receive 50 percent (2 percent times 25) of his or her final compensation on retiring at age 55. In June and July 2002, aware that increases in the employer’s contribution were imminent, the city council awarded enhanced retirement benefits of 3 percent at age 55 to members of the four unions representing public safety employees and 2.7 percent at age 55 to members of the unions representing general employees and management. In our example, with the enhanced benefit, the 55-year-old retiree who was a member of the general employees’ union would receive 67.5 percent (2.7 percent times 25) of his or her final compensation. Additionally, the city council agreed to further enhance the retirement benefit to its police force to 3 percent at age 50 effective October 2002, three months after the initial enhanced benefits went into effect. Like other local agencies in California, Richmond sets its retirement benefits for its public safety employees to match the levels that the State gives its firefighters and patrol officers. However, Richmond gives its general and management employees significantly more than the 2 percent at age 55 that the State gives its general and industrial employees. Richmond’s dramatically enhanced retirement benefits, combined with a downturn in CalPERS’ investment earnings, also caused dramatic increases to the city’s contribution rate to CalPERS. Table 2 shows that the city’s rates jumped to 22 percent of salaries for public safety personnel and nearly 10 percent of salaries for general employees in 2004. During this period, although the public safety employees’ share remained at 9 percent, the general employees’ share increased, and the city elected to continue paying those costs, which it estimates at approximately $5 million per year.2 City staff warned the city council in May 2001 that having city employees share in the retirement plan costs was necessary because the city could not afford to pay the increased employer’s contribution as well as the employees’ share. The contribution rate increases ultimately affect the city’s general-fund assets by requiring the city to contribute more money to cover the future retirement costs of its employees. 2 The portion the city pays on behalf of its public safety personnel is included as compensation in the survey it uses to set salaries for those employees. Therefore, if the city continues to set the salaries for public safety employees to be the second highest in the survey of 12 cities, it would have to raise salaries for this group of employees by the amount of any decrease in these payments. 1188 California State Auditor Report 2004-117 California State Auditor Report 2004-117 1199 The city may be limited in its ability to change the benefits offered under its retirement plans. Therefore, reducing the amount the city will pay its current employees at retirement City staff warned the is not a likely option. Richmond’s agreement with each of its city council in May 2001 employee unions to enhance retirement benefits is much like a that the city could contract in that it gives the parties to that agreement enforceable not afford to pay the contract rights. In the context of retirement benefits, the courts increased employer’s have stated that the pension rights of public employees are contributions for an integral portion of “contemplated compensation” and that retirement benefits as well employees have a vested right to pension benefits in effect as the employees’ share. during their employment. Related to that, both the federal and state constitutions prevent a vested contract right from being impaired. The courts have also established that pension rights are not necessarily unchangeable; however, in making any changes to those rights during the time that an employee is working for the city, the city would have to make reasonable modifications, replacing a benefit that is taken away with an equivalent benefit. This requirement would not likely cause the city to save money. Although the city has a limited ability to alter the benefits for existing employees, it may have other options it could explore, such as offering different retirement benefits to employees it hires in the future. These changes would likely require approval from the six employee unions. Because the city is facing financial difficulties, it has been able to take advantage of two restructuring opportunities to defer a portion of its contributions to CalPERS. The retirement system’s policy allows local agencies to request a rate restructuring of the unfunded future retirement liability for a period of up to 30 years. As local agencies began experiencing financial difficulties during fiscal year 2003–04, CalPERS adopted another one-time policy that allowed agencies facing severe budget crises in fiscal year 2004–05 to restructure their contributions by paying less in fiscal year 2004–05 and more in subsequent years beginning in fiscal year 2007–08. Although the city projects that this restructuring will save it a total of $5.7 million over the three-year period from fiscal year 2004–05 through fiscal year 2006–07, the solution is temporary and does not address the effects of increasing salaries and benefits on Richmond’s future retirement liability. Facing Rising Personnel Costs, Richmond Laid Off 250 Employees and Reduced Public Services The city’s decisions to increase salaries and enhance benefits have backfired. The city offered improved compensation packages to make them competitive with those offered by other 2200 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2211 cities and to attract and retain highly qualified candidates, thus improving city services. Instead, the increased salaries and benefits led the city to spend more than it could afford. As a result, the city ended up having to cut its workforce. In March 2003, the city estimated it would spend $3.7 million more than it took in for fiscal year 2002–03. To close the gap, the city implemented a rightsizing plan that resulted in the layoff of 42 employees. In fiscal year 2003–04, the city made additional staff cuts for a total of 250 layoffs and drastically cut funds to some of its programs. For example, according to the interim city manager, the recent budget reductions resulted in 26 percent cuts in library service hours and 60 percent cuts in staffing. Additionally, the budget for library materials was reduced by 90 percent, resulting in spending per child dropping from $3.27 to 34 cents. The city also froze 18 vacant police officer positions to achieve In the middle of fiscal a $1.8 million reduction to the police department’s budget in year 2003–04, the city fiscal year 2003–04; in fiscal year 2004–05, the city froze 21 more cut the fire department’s vacant police officer positions to achieve an additional savings budget by $2.9 million, of $2.1 million. The city made similar reductions to the fire which resulted in department’s budget. In the middle of fiscal year 2003–04, the the elimination of city cut the fire department’s budget by $2.9 million, which 30 positions and the resulted in the elimination of 30 positions and the rotating rotating closure of three closure of three of its 11 fire stations. These disruptions to city of its 11 fire stations. services are potentially harmful to the residents of Richmond. With fewer staff filling crucial public safety positions, the citizens of Richmond may be exposed to longer wait times for nonemergency calls. Moreover, closing fire stations on a rotating basis could increase wait times when mere minutes can be vitally important. RICHMOND’S REVENUE DECREASED WHILE ITS EXPENDITURES INCREASED As the city was increasing its expenditures, its revenues were not increasing at a comparative rate. Consequently, as Figure 4 on the following page shows, Richmond started spending more money out of its general fund than it was receiving in revenue, beginning in fiscal year 2002–03. Although the city increased its revenues in some areas, its expectations for revenue increases were unrealistic, and they proved inadequate to cover the city’s increased spending. Further complicating the situation were reductions in revenues from the sales tax and state funding that the city experienced. 2200 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2211 FIGURE 4 Richmond’s General Fund Revenues and Expenditures Fiscal Years 2000–01 Through 2002–03 �� Source: City of Richmond’s audited financial statements, fiscal years 2000–01, 2001–02, and 2002–03. Between fiscal years 2000–01 and 2002–03, the city’s total revenue decreased by almost 2 percent and total expenditures increased by nearly 17 percent. As discussed earlier in the chapter, the city raised employees’ salaries and enhanced retirement benefits. To pay those increased costs, the city counted on increased revenues. In November 2002, the city tried to increase revenues by introducing a measure to raise the utility users’ tax from 8 percent to 10 percent. Voters approved the tax increase, which was to provide additional funds to help preserve vital city services—including police and fire protection, emergency medical and library services, recreation, and local street maintenance—and for other general governmental purposes. The finance department estimated that the increase in the utility users’ tax would generate $5.4 million annually in additional revenue. In fiscal year 2002–03, for the first six months the city could collect the increased tax, Richmond received $2.3 million more from its utility users’ tax than it did in the prior year; 2222 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2233 however, the city’s overall revenue decreased compared with fiscal year 2000–01. Increases in some revenues, including that gained from the utility users’ tax, were offset by decreases in other revenues, such as a $2 million decrease in the sales tax and a reduction in the vehicle license fee in fiscal year 2002–03. The The city’s expectation that State promises to pay back the reduction in the vehicle license it would achieve adequate fee in August 2006, adding $1.8 million to Richmond’s general revenue increases in time fund, according to the city’s estimates. to pay for its increased costs was unreasonable By the time Richmond adopted its fiscal year 2003–04 budget, because significant the city announced that to operate within the budget and to revenue increases, such maintain current programs required increased revenues. The as an increase to the city’s expectation that it would achieve adequate revenue sales tax, often require increases in time to pay its increased costs was unreasonable voter approval. because, as illustrated later in the chapter, significant revenue increases such as an increase to the sales tax, often require voter approval, making it impossible for the city to collect the new revenue immediately. Richmond also believes that the State’s shifting of property tax revenues to the Educational Revenue Augmentation Fund (ERAF), which began in 1993, has caused the city to lose revenues. In response to its severe budget deficits of the early 1990s, the State set up the ERAF to help pay its obligation to schools from kindergarten through grade 14. In doing so, the State directed each county auditor to establish a fund and annually transfer to the fund property taxes that otherwise would be allocated to cities, counties, and special districts. About half the losses that local governments incurred from the property tax shift were offset in 1993 by a half-cent increase in the sales tax that went to cities and counties for local public safety, but most of the funds from the sales tax increase have gone to the counties. Richmond estimates that it will lose almost $6 million to the State in fiscal year 2004–05 as a result of the ERAF. Although correct, the city’s argument that it lost revenues to the State does not excuse the city for spending more than it can afford because Richmond’s decisions to increase its expenditures in fiscal year 2002–03 came nine years after the revenue reductions began. RICHMOND MUST DECREASE EXPENDITURES OR INCREASE REVENUES TO IMPROVE ITS FINANCIAL HEALTH The city’s budget for fiscal year 2004–05 shows that without $6 million in one-time revenues, the city’s spending would exceed its revenues. Specifically, the Richmond Redevelopment 2222 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2233 Agency (redevelopment agency) is making payments on a loan the city made to it from the general fund more than 20 years ago. In 2003, the redevelopment agency used a portion of its revenue bonds to repay approximately $18 million of prior city obligations, leaving an outstanding balance of about $6.4 million. Originally, the redevelopment agency and the city planned for the remaining balance to be repaid in two $3 million installments (plus interest), one in fiscal year 2004–05 and the other in fiscal year 2005–06. However, because of the city’s difficult financial condition, the redevelopment agency paid the entire balance on October 28, 2004. The city plans to use those funds for the city’s normal operating expenses in fiscal year 2004–05. Because the one-time revenue source will not exist in future years and the city expects certain costs to increase, the city projects that expenditures will exceed revenues in its general fund by $6.6 million in fiscal year 2005–06, assuming that the city receives no new revenues. Therefore, to improve its financial outlook, the city must either decrease its expenditures or find ways to raise its revenues. In fact, the only way Richmond can improve its financial The only way Richmond condition is by ensuring that its revenues not only meet but can improve its financial exceed its expenditures so it can eliminate the negative fund condition is by ensuring balance in its general fund, which was $4.4 million as of its revenues not only June 30, 2003, and then rebuild its reserve funds (reserves). meet but also exceed its Governments often maintain reserves to cover economic expenditures so it can uncertainties or assist with cash flows. Reserves typically act as a rebuild its reserves. holding account to provide resources for periods of uncertainty or to help cover unexpected costs, such as damage from a natural disaster. The GFOA recommends that a government maintain unrestricted reserves—that is, current and available financial resources—of 5 percent to 15 percent of the general- fund budget for annual operations. Richmond has a policy to maintain reserves at 5 percent of the general-fund expenditure budget. However, it has not always enforced this policy and has sometimes used its reserves to pay for ongoing expenses. By not following its policy, the city risks not only being short on funds but also setting a precedent that will make it more difficult to increase its reserves in the future. For example, the city acknowledged that it used its reserves to help support ongoing programs and activities. This is an unsound practice because it leaves no money either to continue the programs or to replenish the reserves. The city is currently working on a plan to accumulate money over time to fund a contingency reserve 2244 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2255 to use for items such as infrastructure failures. Similarly, the city may pursue a benefit stabilization reserve to help absorb major increases in health care and retirement costs. The city recently started researching other sources of revenue. Between April and June 2004, the finance department contracted with outside experts to review the city’s revenues. That prompted various departments to take individual actions to propose new revenues. For instance, the police department has proposed taking full control of the city’s vehicle towing needs rather than using local tow companies. The police department estimates this would generate several million dollars per year in additional revenue for the city. The fire department has also proposed new sources of revenue: a tax on 911 emergency calls and a charge for any 911 emergency calls that are false alarms. In addition, the city contracted with a firm to provide a legal To increase revenues, review of the potential use of special districts, assessments, and the city opted to place tax increases to raise revenues. The city also opted to place a half- a half-cent increase in cent increase in the sales tax on the November 2004 ballot that the sales tax on the voters approved. The city estimates the increased tax will generate November 2004 ballot roughly $6 million in revenues annually. Richmond is also that voters approved. considering other options for future voter initiatives to increase revenues, such as a special library tax, revision of the business license tax, and formation of landscape and lighting districts. The finance department also coordinated a citywide fee review and compiled the city’s master fee schedule, which consisted of increasing many fees based on the employment cost index, increasing selected fees based on the costs of providing the services, and adopting new fees for services the city already provides but for which it is not compensated. On January 13, 2004, in accordance with the municipal code, the city council adopted the resolution to establish a master fee schedule that updates the fees that city departments assess for services to reflect the actual costs associated with providing the services. In fiscal year 2003–04, the city set out a plan that identified areas where expenditures could be reduced, in addition to the significant layoffs the city instituted. For example, the city negotiated with the employee unions to have employees pay their share of pension contributions to CalPERS, which the city currently pays. The city estimates that having employees pay their share of retirement costs could save Richmond $5 million a year. In November 2004 the city reached agreements with five of its six employee unions and is imposing conditions on 2244 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2255 the sixth. As a result, members of all unions will pay the entire amount of the employees’ contribution by July 1, 2005. The city also planned to explore combining utility accounts for all city facilities to qualify for large-user discount rates; however, according to the deputy finance director, the city does not yet have a plan in place to aggregate the accounts. Although the city is making efforts to increase its revenues and reduce its expenditures to eliminate the budget deficits it faces, other changes in state funding will also affect the city’s financial outlook. For instance, beginning in fiscal year 2004–05, the State plans to retain a portion of the city’s sales tax revenues and replace it with property tax revenues, which the state had previously diverted to ERAF. This shift in revenue sources is supposed to have no impact on the amount of money the city receives. However, the frequency with which the city receives revenues will change because cities receive sales taxes monthly and property taxes twice annually. Consequently, at various times throughout a year, the city may have access to less money than it otherwise would have, which could require the city to obtain short-term financing and incur the associated costs. RECOMMENDATIONS To ensure that the city has sufficient funds to meet its operating costs and does not spend more than it can afford, Richmond should do the following: • When negotiating agreements with its employee unions, consistently analyze salary and benefit increases to determine the long- and short-term effects the increases will have on the city’s budget. • Cease raising salaries based on amounts outside the city’s control. If the city chooses to continue to base its salaries on those of other cities, it should ensure that its agreements with employee unions include limits on the amounts the city will raise the salaries. • Evaluate other options the city may have to reduce its retirement costs, such as offering different retirement benefits to employees it hires in the future. 2266 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2277 • Continue exploring ways to reduce the city’s expenditures as outlined in its March 2004 corrective action plan, including having the employees share in the added cost of enhancing retirement benefits. The city should establish a policy to set funds aside for fluctuations in its contributions to the retirement system. This policy should specify the conditions under which the city contributes to the stabilization fund and when it may use the funds. To meet the challenges of a budget deficit, the city should first consider reducing its expenditures, which is more immediate than increasing its revenues. If the city creates a new revenue source to eliminate the deficit, it should match the increases to the period in which they will likely occur. To ensure that the city does not operate outside its means and that it has funds available for contingencies, the city should take the following steps: • Establish a policy that delineates how the city may use one-time revenues and discourages using them to fund ongoing operations. • Reevaluate and reestablish its policy for building and maintaining reserves for specific purposes, such as contingencies and economic uncertainties. The policy should indicate when it is appropriate to use the reserves. Once it has established a reserves policy, the city should follow it and continue with its plans to fund the reserve within five years. n 2266 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2277 Blank page inserted for reproduction purposes only. 2288 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2299 CHAPTER 2 The City of Richmond Made Unreasonable Budget Estimates and Did Not Monitor Its Budget Effectively CHAPTER SUMMARY Unreasonable budget estimates and ineffective budget monitoring by the city of Richmond (city) masked the city’s overspending and the city did not take timely action to reduce costs. In its budgets for fiscal years 2002–03 and 2003–04, the city underestimated certain expenditures, including personnel costs, the costs for workers’ compensation insurance and general liability insurance, and the general fund’s share of debt payments. Because of these inaccuracies, the adopted budgets did not expose the city’s overspending. Although it was aware that some of the estimates were inaccurate in the proposed fiscal year 2003–04 budget, the city council adopted the budget anyway, intending to adjust it later. However, the reports the city’s finance department prepared and the city council relied on to monitor and adjust the budget were fraught with errors and lacked some important information. The reports included overly optimistic revenue projections that did not materialize and indicated erroneously that the city had unspent reserve funds (reserves) from earlier years on which it could draw. In addition, the finance department’s reports did not contain information on the amount of cash in each of the city’s funds. Not fully notified that the city lacked adequate resources to cover its expenses, the city council did not take adequate actions to curb the city’s spending and, in fact, increased spending in some areas. Because the city’s budget-monitoring process failed to disclose the overspending, the city’s bleak financial position was not revealed until the city’s audited financial statements for fiscal year 2002–03 were issued in March 2004. Although the city has taken steps to improve its monitoring procedures, to some extent the problems continued throughout fiscal year 2003–04. Without timely, accurate, and complete reports, the city council remains vulnerable to the same type of spending mistakes that created its present fiscal predicament. 2288 California State Auditor Report 2004-117 California State Auditor Report 2004-117 2299 RICHMOND’S POOR BUDGETING CONTRIBUTED TO UNEXPECTED REDUCTIONS TO SEVERAL FUND BALANCES Although the city adopted seemingly balanced budgets for fiscal years 2002–03 and 2003–04, the budgets were flawed because they contained inaccurate estimates of the city’s personnel costs, costs for workers’ compensation insurance and general liability insurance, and bond payments. The city council was aware of some of the underestimates when it adopted the budget for fiscal year 2003–04. Further, as Table 3 shows, the city used its general fund for expenditures and transfers to other funds that deviated significantly from the city’s original budget estimates for fiscal year 2002–03. Consequently, the city spent more of its general fund than it took in, and the city estimated in the middle of fiscal year 2003–04 that, without corrective action, the city would overspend again. Because the city had not maintained reserves according to its policy, the city’s general fund did not have the assets to pay for its spending deficits. Therefore, at the end of fiscal year 2002–03, the liabilities of the general fund exceeded its unreserved assets by $4.4 million. TABLE 3 Budgeted and Actual Inflows and Outflows of Richmond’s General Fund Fiscal Year 2002–03 Variance From Original Budget Budget Favorable/ Amounts Actual Amounts (Unfavorable) Inflows Revenues $91,102,623 $91,050,944 $ (51,679) Transfers in 3,328,449 1,169,088 (2,159,361) Outflows Expenditures 91,780,405 98,493,953 (6,713,548) Transfers out 4,120,908 8,199,828 (4,078,920) Source: City of Richmond’s audited financial statements, fiscal year 2002–03. According to the Governmental Accounting Standards Board, an organization dedicated to improving the standard of governmental accounting and financial reporting, many believe the budget is the most significant financial document produced by a government unit. Richmond shares this belief, stating in its policies that the budget is an essential component of the city’s financial planning and management. As an expression of the city 3300 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3311 council’s financial intent for the upcoming fiscal year, the budget indicates the amount of revenue the city expects to receive and the expenditures it plans to make with its financial resources. Additionally, the budget is an essential planning tool that reflects the city’s choices among available spending options in providing its citizens with public services, including police and fire protection. Richmond Adopted an Imperfect Budget Without Acting to Reduce Its Costs for Fiscal Year 2003–04 To balance its budget for fiscal year 2003–04, the city intentionally underestimated some of its expenditures and delayed immediate reductions to its costs. Specifically, when the city council adopted the budget for fiscal year 2003–04 on July 1, 2003, the city council and the city manager then in office discussed that the budget’s spending estimates were not adequate to sustain the city’s programs at their current levels and that making significant spending reductions or increasing revenues was necessary. To help balance the budget, the city included only 80 percent of what the fire department expected to spend. However, rather than taking immediate action, such as laying off public safety personnel, the city council passed the imperfect budget and planned to revisit the budget six months later. The city council and the city manager then in office agreed to keep all fire stations and libraries open and to work diligently to control expenses and maximize city revenues. In an effort to control personnel costs, the city began to reduce its spending in December 2003. However, those cost-cutting measures came too late because in fiscal year 2002–03, before the city council adopted the budget, the city had already spent significantly more than it had. As discussed later in the chapter, the city was unaware it had already overspent because it relied on faulty reporting, which showed the city had reserves. Richmond Did Not Budget Enough for Its Personnel Costs As discussed in Chapter 1, the city’s revenues have not increased to the same degree as its expenditures, which rose significantly due to increases in salaries and employee benefit costs. To understand why the city’s expenditures exceeded its budget, we examined how the city’s spending estimates in the original budget for fiscal year 2002–03, the year in which the city first experienced significant spending deficits, compared with its actual spending. We found that although most of the city’s departments spent close to the amounts in the original 3300 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3311 budget during fiscal year 2002–03, some large departments had expenditures that greatly exceeded their original budget allocations. For example, the city originally allocated a total of $45.6 million for its fire and police departments, or In fiscal year 2002–03, approximately 50 percent of the general-fund budget. However, the fire and police those departments spent $52.4 million, exceeding their original departments exceeded budgets by roughly $6.8 million. their original budgets by roughly $6.8 million The imbalance between actual spending and the original because the city did not budget for fiscal year 2002–03 occurred because the city did not adequately budget for adequately budget for certain components of employee costs certain components of for the fire and police departments. When we reviewed the employee costs. salary and benefit costs for units within the fire department, we discovered that personnel costs for its operations and emergency service units accounted for approximately $2.9 million, or 97 percent, of the $3 million difference between the original budget and actual expenditures. Our review of personnel costs for the police department disclosed that two administrative units accounted for approximately $2.3 million, or 59 percent, of the $3.8 million discrepancy. Discoveries the finance department made during fiscal year 2003–04 point to a flaw in the city’s process for estimating its personnel costs and may explain why the budgets for personnel costs were not accurate during fiscal year 2002–03. Like the fire and police departments, other city departments did not budget adequately for personnel costs in fiscal year 2003–04. For example, in the middle of fiscal year 2003–04, the finance department discovered that the city’s public works division did not budget adequately for all its staff positions, and the finance department had not caught the omission before the budget was approved. The oversight illustrates a larger problem with Richmond’s budgeting process. Overall, in fiscal year 2003–04, the city found that it did not budget for at least 24 positions, 12 of which were public works positions totaling nearly $768,000. Although it is likely that the city did not budget for all positions when it prepared the budget for fiscal year 2002–03, we could not verify that conclusion because limited documentation exists. Before the fall of fiscal year 2003–04, the city did not have a fundamental control in place to compare the number of paid employees to the number of budgeted positions. Without adequate controls to assist it in identifying the number of budgeted employees versus actual paid employees, the city may incorrectly calculate its personnel costs. 3322 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3333 The city’s finance department realized it lacked the necessary control function and made changes to its process to ensure that the city adequately budgets for all positions. Specifically, beginning with the development of the fiscal year 2004–05 budget, the finance department centralized the process by taking charge of estimating the city’s personnel costs, rather than giving the departments the responsibility. In fiscal year 2004–05, the department also implemented a position control listing, which was started in concept in fiscal year 2003–04. Using the position control listing on a monthly basis, the finance department compares the actual number of paid employees to the number of budgeted employees. This process should ensure that the city’s budget reflects all approved or filled positions. The interim city manager recognizes the importance of the process and recommends the city use a position control listing as part of its budgeting process. Because the finance department implemented that mechanism in fiscal year 2004–05, it is too early to determine how effective the process is in practice. Richmond Did Not Budget Enough for Workers’ Compensation Insurance and General Liability Insurance The city used a flawed system to budget for its workers’ compensation insurance and general liability insurance funds (insurance funds), which pay for activities ranging from employee claims resulting from industrial injuries to general claims against the city for damages. Consequently, the two funds have liabilities greater than their assets (negative fund balances). Table 4 shows that the city significantly underestimated its expenditures and overestimated its revenues when it budgeted for its insurance funds in fiscal year 2002–03. TABLE 4 Budgeted and Actual Inflows and Outflows of Richmond’s Insurance Funds Fiscal Year 2002–03 Variance From Original Budget Budget Favorable/ Amounts Actual Amounts (Unfavorable) Inflows Revenues $6,924,224 $ 3,588,622 $(3,335,602) Transfers in 1,000,000 3,000,000 2,000,000 Outflows Expenditures 7,924,224 11,027,473 (3,103,249) Source: City of Richmond’s audited financial statements, fiscal year 2002–03. 3322 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3333 Richmond self-insures and self-administers a portion of its workers’ compensation insurance and its general liability insurance. Therefore, the city established the insurance funds to accumulate assets for claim settlements associated with losses, up to a predetermined limit. Additionally, the city purchases excess insurance coverage from various commercial insurance carriers to assist it in meeting its insurance needs. The city centralizes services for workers’ compensation insurance and general liability insurance into its risk management division and uses the insurance funds to accumulate and allocate the cost of providing those services among the city departments on a cost reimbursement basis. It does this by estimating the costs for the year during the budget process. Because the city, in past budgets, did not fully cover expenditures from the insurance funds, the funds’ liabilities have grown. For example, the audited fi nancial statements for fi scal year 2001–02 show negative fund balances totaling $6.4 million, which the city’s audited fi nancial statements show increased to $10.9 million by the end of fi scal year 2002–03. Most of the negative fund balances are related to accrued claims liabilities. Annual actuarial studies, an important tool, consist of a review of the estimated value of claims incurred, asset reserve levels, and payout patterns over the life of prior and current claims. After reviewing and analyzing this data, the actuary projects the city’s estimated total insurance costs Calculation of Total Cost of Claims for Workers’ Compensation based on its actual Insurance and General Liability Insurance claims experience. Total cash payments + Accrued claims According to the manager of the risk (estimated amount in claims to be (estimated amount of paid during the fi scal year) claims that will be paid at management division future dates but are attributable (risk manager), the to the current or prior year) city was budgeting only for the cash expenditures that it expected to make that year, not the total insurance costs, which would include the payments it would likely make in future years. Moreover, during the fi scal year, the city further reduced the already underbudgeted expenditure amounts. Specifi cally, at the beginning of fi scal year 2002–03, the city estimated cash expenditures for risk management at $7.9 million, but in its third- quarter report, the city’s fi nance department reduced that amount to $3.5 million without explaining why. 3344 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3355 Budgeting less than what is needed to pay the total cost of workers’ compensation insurance and general liability insurance may be a way for the city to create the appearance of reduced expenditures in the general fund and the insurance funds. Although accrued liabilities and the related expenses do not have an immediate cash impact, not funding the total amount could result in cash shortages as claims arise and require the city to tap into the general fund to pay some claims. For example, because the city did not adequately fund the total cost of insurance in the past by increasing the amount of revenue it planned to collect from other departments and thus build sufficient assets, the city had to transfer $3 million from the general fund to the insurance funds in fiscal year 2002–03. According to the risk manager, the city has made significant changes to improve how it budgets for its insurance costs. Specifically, the city is now budgeting for the total cost of claims rather than just the cash cost, and it no longer uses a flat-rate approach to allocate its workers’ compensation insurance costs to city departments. The flat-rate approach did not take into account the hazards of specific job classifications. For example, because firefighting is a high-risk occupation, the average cost of claims for firefighters injured on the job is expected to be greater than the average cost of claims for injured clerical staff. However, we were unable to determine the adequacy of the city’s budgeting process for insurance costs because fiscal year 2004–05 does not end until June 30, 2005. To address the existing negative fund balance, the city has developed a plan to increase the insurance funds’ assets to more closely match its liabilities. According to the interim city manager, Richmond plans to adopt a seven-year goal to build sufficient assets to pay for the majority of costs related to its insurance funds. Richmond Did Not Reasonably Budget for Bond Payments Although fully aware of how much its bond payments would For fiscal year 2001–02, be for fiscal years 2001–02 and 2002–03, the city did not the city allocated nothing adequately budget the amounts it would have to transfer from in its adopted budget for the general fund for those payments. If the city had included making bond payments the transfers in its budget, the city council would have noticed from the general fund, earlier that an imbalance existed between the general fund’s yet it actually transferred inflows and outflows and could have corrected the imbalance by more than $2.3 million decreasing spending. Bond payments, which include principal from the general fund to and interest on bonds sold by the city, have set payments that make bond payments. the city tracks on schedules. However, the deputy finance director told us that because he did not work at the city when it 3344 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3355 prepared the budget for fiscal year 2002–03, he was unsure if the city used the payment schedules. Because the budgeted transfers for bond payments were significantly different from the actual payments, it appears that the city did not use its schedules. For example, for fiscal year 2001–02, the city allocated nothing in its adopted budget for making bond payments from the general fund, yet it actually transferred more than $2.3 million from the general fund to make bond payments. Similarly, the budget When the city does not for fiscal year 2002–03 allowed for a transfer of $4.1 million properly reflect in its from the general fund to another fund to help pay bonds, $1 budget the amount million less than the $5.1 million the deputy finance director transferred from the told us was needed to pay general debt. When the city does general fund to other not properly reflect in its budget the amounts transferred from funds, it is not accounting the general fund to other funds, it is not accounting for all its for all its outflows and outflows and may incorrectly report a balanced budget. Based on may incorrectly report a the fiscal year 2004–05 budget, the city used the debt payment balanced budget. schedules when it budgeted for transfers out of the general fund to cover bond payments. RICHMOND’S BUDGET MONITORING WAS INCONSISTENT AND FLAWED Inaccuracies in Richmond’s original budgets highlighted the importance of the city’s process of monitoring and adjusting the budget throughout the year. The primary tools the city uses in this process are the quarterly and midyear reports prepared by the finance department. However, during fiscal year 2002–03, the quarterly and midyear reports that the city council received did not accurately represent the city’s financial position. At times, the city council adjusted its budgeted spending upward, relying on the information it had, when the city could not afford additional costs. Moreover, the reports did not indicate that corrective actions were necessary because they did not disclose cash and operating deficits in the city’s general fund or in the city’s other funds. The city council must have accurate and timely financial information so it can approve the budget and track the progress of the city’s financial position. The Government Finance Officers Association (GFOA) recommends that a government periodically review budget-to-actual revenues, expenditures, cash flows, and fund balances during the budget period. Regular monitoring of budgetary performance provides an early warning of potential problems and gives decision makers time to consider actions that may be needed if major deviations in budget-to-actual results become evident. 3366 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3377 Past Quarterly Reports Did Not Accurately Reflect the City’s Financial Position The finance department’s midyear and quarterly reports for fiscal year 2002–03 stated that the city was spending more from its general fund than it was taking in for the year, indicating that the fund had an operating deficit for the year. However, the The finance department reports misrepresented the amount of the surpluses from prior projected in its July years that the city held in reserve in its general fund. Specifically, 2003 report that the city based on accounting information through May 2003, the finance would have $2.2 million department projected in its July 2003 report that the city would in general-fund reserves have $2.2 million in general-fund reserves as of June 30, 2003. as of June 30; however, Actually, as the city’s audited financial statements for fiscal year the fund actually had a 2002–03 reported, the fund had a $4.4 million deficit. That $4.4 million deficit. difference affected the fiscal year 2003–04 budget because the city made no allowances in the budget for a deficit. The finance department calculated the city’s reserves in most of its quarterly and midyear reports using the same process for fiscal year 2002–03: It began with the estimated ending reserve balance from the prior year, subtracted the budgeted use of reserves, and added or subtracted increases and decreases to its budgeted inflow and outflows. However, the department overestimated the general fund’s inflows and failed to include certain fund outflows. The finance department overestimated the general fund’s inflows because it would increase revenue projections to match the increasing expenses and add any surplus revenues from the projections to the reserve balance. However, in total, the revenue estimates for the general fund shown in the original budget were very close to the actual total revenue; therefore, it may not have been necessary for the city to adjust its estimates for individual sources of revenue. By the end of fiscal year 2002–03, the city lowered its revenue estimates to reflect the amount it actually earned; however, it had already incurred the increases in expenditures. The finance department drastically underestimated the general fund’s outflows because it did not include the more than $8 million that the finance department transferred from the general fund to other funds during fiscal year 2002–03 to pay for insurance costs and bond payments. Because the finance department used an outflows amount that excluded the transfers to calculate its reserves, the department overstated the general fund’s reserves. Management staff in the finance department agreed with us that the previous finance staff did not adequately monitor the reserve balance. 3366 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3377 Not only did the fiscal year 2002–03 midyear and quarterly reports include inaccurate reserve calculations for the general fund, but also the reports did not disclose the losses some individual funds were experiencing. The city’s insurance funds have experienced growing losses over the past few years, as discussed earlier in the chapter, but the reports did not mention the losses. Moreover, the finance department further reduced the insurance funds’ revenues by reducing the amount the general fund would spend for risk management. Thus, the finance department attempted to balance the general fund’s budget by shifting shortfalls of the general fund to the insurance funds that were not monitored. Ultimately, as mentioned earlier in the chapter, the city had to transfer general-fund assets to cover the losses of the insurance funds. If the reports had contained more information regarding the insurance funds’ balances, the city council might have noticed that the insurance funds had a deficit and required money from the general fund. Another indicator of financial troubles that the finance department did not include in its quarterly and midyear reports was the cash position of the city’s individual funds. At the end of fiscal year 2002–03, several of the city’s funds had large cash deficits, as described later in this chapter. The reports that the finance department presented to the city council The quarterly and compared budgeted amounts to actual amounts for revenues midyear reports that and expenditures, which appeared in line with the projections the finance department for a given point in time. However, the reports did not disclose presented to the city the funds that had negative cash amounts. When the finance council did not disclose department provides the city council with budget-to-actual that several funds had comparisons in isolation, it gives the city council members negative cash amounts. an incomplete view of the city’s financial health, which could create false perceptions that the city is operating as intended at various times. Moreover, if the finance department does not include information on negative cash amounts in its reports, it is not providing the members of the city council with details that could affect their decisions or raise questions about the city’s financial health. If the city council members had taken training in public finance, they might have been better prepared to ask questions about inconsistencies in the finance department’s reports. However, city council members are not required to have public finance training. Although training is available through outside sources, such as the League of California Cities, members are not required to participate. This puts city council members at a disadvantage when presented with financial information. If city 3388 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3399 council members do not fully understand information that city management staff present to them in reports or during council sessions, they could fail to recognize discrepancies and make decisions based on inaccurate information. The first-quarter report for fiscal year 2003–04 attempted to address the shortcomings of the flawed budget and the increased costs caused by severance and accumulated vacation payments to employees the city had laid off. However, like its predecessors, the report did not provide a complete picture of the city’s financial problems. It was not until March 2004, when It was not until the audited financial statements were nearing completion, March 2004 that the that the finance department described in the midyear report finance department for fiscal year 2003–04 the full impact of the city’s financial described the full impact problems. Although the midyear report for fiscal year 2003–04 of the city’s financial was more informative than that for the prior year, the finance problems in a report to department’s third-quarter report provided information only the city council. on the general fund. According to the finance department, it did not include information on the city’s other funds because the postings to its accounting system were not up-to-date. Richmond Is Attempting to Improve Its Financial Monitoring The finance department has realized the shortcomings of its reporting process and is taking steps to improve. Richmond’s deputy finance director told us that the city is monitoring its deficits monthly and will calculate its reserves at the end of the fiscal year. Additionally, the finance director told us that future reports to the city council would include information regarding the city’s cash balances, particularly those for funds with deficits. Richmond’s interim city manager has also stressed the importance of the city’s following its budget review policy to achieve and maintain financial stability as part of his September 2004 assessment of the fiscal and organizational stabilization needs of the city. Therefore, he has started to require departments to submit monthly reviews of their budgets. According to the deputy finance director, the finance department suspended the monthly review process during fiscal years 2002–03 and 2003–04 and had switched to using quarterly reports because key finance and budget staff had been laid off. Resuming the monthly review process, as well as improving quarterly and midyear reports, should give the finance department and the city council more timely and accurate information than they have previously received. 3388 California State Auditor Report 2004-117 California State Auditor Report 2004-117 3399 Richmond Did Not Monitor the Cash Position of Its Funds Like many other local governments, the city maintains a large portion of its cash in a pooled cash account. Many of the city’s funds, including the general fund, operate out of the pooled cash account. In March 2004, Richmond announced that at the end of June 2003, several of the city’s funds had negative cash amounts. A fund with a negative cash amount has used its portion of the pooled cash account and has tapped other funds’ portions of the account. As of June 2003, the general fund had an $8.3 million negative cash amount, and 11 other funds had negative cash amounts totaling $21 million. Despite having funds with negative cash amounts, the city was not overdrawn at its banks because, with positive cash balances in 16 funds totaling $41.7 million, the city’s total cash was still positive. The funds with negative cash amounts were using the surplus cash of those 16 funds. Although several of the city’s funds also had negative cash amounts in fiscal year 2001–02, it appears that Richmond did not make an effort, such as formulating a corrective action plan, to ensure that those funds did not continue to have negative cash amounts. Usually, governments account for borrowing between funds. Because all the city’s However, Richmond’s finance director told us that the city’s funds, other than the accounting system allows a fund with a negative cash amount general fund, have to borrow cash from another fund without recording an entry limitations on their use, to identify the other fund or funds from which it borrowed. each fund with a negative Because all the city’s funds, other than the general fund, have cash amount would look limitations on their use, a fund with a negative cash amount to the general fund to would look to the general fund to cover any cash shortage. cover the cash shortage. Therefore, it is important that the city monitor all its funds’ shares of the pooled cash account. However, Richmond did not have an adequate process to monitor each fund’s share of the pooled cash account until May 2004. Prior to that time, the city’s finance department reconciled the total pooled cash on its general ledger to the bank statement for each month. We reviewed the procedures and reconciliations it prepared during fiscal year 2002–03 and found that the reconciliations were not adequate to monitor the cash position of the city’s funds for two reasons: The procedures did not require staff to reconcile each fund’s share of cash to the pooled cash account, and the city did not consistently reconcile its pooled cash account within a reasonable amount of time after the end of the month. The finance department’s procedures require staff to reconcile the total pooled cash to the bank statement. However, by looking at the total pooled cash, which is a combination of 4400 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4411 positive and negative cash amounts, the staff would not see negative cash amounts in individual funds. The finance director told us that most cities usually rely on their accounting software to deal with each fund’s portion of the pooled cash account. While his comments have merit and we agree that the city can use its accounting system to keep track of each fund’s share of the pooled cash, the city did not extract the information from the system until May 2004, when the finance department created reports of cash balances of the individual funds to show each fund’s claim on the pooled cash account. These reports clearly show funds with negative cash amounts. By reviewing this information frequently, the finance department will know when certain funds are low in cash and can notify the city council. The second reason we do not believe that the finance department’s cash reconciliations were adequate to monitor the cash position of the city’s funds is that the city did not consistently reconcile its The city did not pooled cash account within a reasonable amount of time after the consistently reconcile end of the month. By delaying those reconciliations, the finance its pooled cash account department minimized any assurance that its reconciliation within a reasonable process provided. Specifically, during fiscal year 2002–03, it amount of time after the appeared that the city waited until near the end of the fiscal end of the month. year to complete its reconciliations. Moreover, the city did not complete and review its reconciliations promptly during fiscal year 2003–04, with some reconciliations as much as seven months late. Unless the finance department promptly and frequently reviews the cash position of its funds, it will lack a complete picture of the city’s current financial health and may deprive the city of time to react to low cash balances and the necessary information to make appropriate management decisions. LATE AUDITED FINANCIAL STATEMENTS IMPAIRED THE CITY COUNCIL’S ABILITY TO PROTECT RICHMOND’S FINANCIAL HEALTH For fiscal years 2001–02 and 2002–03, the city’s audited financial statements disclosed its weakened financial condition: The cash balances of several funds were declining and deficits existed. However, the city did not have audited financial statements for fiscal year 2001–02 until 10 months into the next fiscal year, and audited financial statements for fiscal year 2002–03 were not completed until more than eight months after the end of the fiscal year. Lacking timely financial statements, neither city staff nor the city council had the information regarding deficits they needed to make the appropriate management decisions to improve Richmond’s financial condition. 4400 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4411 The GFOA recommends that government agencies issue financial statements within 120 days after the end of the fiscal year, but the GFOA also recognizes that under certain circumstances a city might have difficulty meeting the deadline. In fact, cities that complete their financial statements within six months after the end of their fiscal years are still eligible for GFOA’s certificate of achievement for excellence in financial reporting. According to the finance department, the city’s financial statements were delayed in fiscal year 2001–02 because it implemented a change in reporting standards. According to the city’s independent auditor, the city’s financial statements were also delayed for that fiscal year because the city did not provide the information required to perform the audit in a timely manner. For fiscal year 2002–03, the city’s financial statements were delayed because the finance department did not engage an auditor until six months after the fiscal year ended and the city lost several important staff. As noted earlier in the chapter, because the city’s quarterly and midyear reports did not disclose the city’s financial condition, the city council was forced to rely on the late financial statements. If the city does not ensure that its financial statements are promptly completed, it will not be able to make appropriate management and budgeting decisions, and it will not be able to warn the city council of financial difficulties that might lie ahead. According to the finance department, it is taking steps to improve the timeliness of the city’s audited financial statements. For example, the finance department has developed a timeline for its year-end closing that department staff are required to follow. In addition, as laid out in his September 2004 assessment of actions needed to stabilize the city’s fiscal structure, the interim city manager is planning to implement a policy requiring the city to issue its financial statements by the end of the calendar year. Although this policy falls short of the GFOA’s recommended 120 days, it still meets the GFOA’s six-month requirement. RECOMMENDATIONS To reestablish the value of the budget as an essential planning tool, Richmond should take the following steps: • Budget for all likely expenditures and not knowingly adopt budgets that reflect inaccurate estimates of expenditures or revenues. If the city needs to reduce expenditures to balance the budget, it should promptly take cost-cutting measures. 4422 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4433 • Continue using its new centralized process to budget for personnel and periodically comparing the positions on its position control listing to its current staff. • When budgeting for the city’s insurance costs, the city should follow its plan to ensure that it budgets for the total costs of the insurance, rather than just the cash cost. Additionally, the city should follow its plan to rebuild its insurance funds’ assets. • The city should continue using the payment information in its bond payment schedules when budgeting for bond payments. To improve the quality of the financial information that the city council uses to make budget changes during the year, the city’s finance department should take the following steps: • Monitor the amount of reserves that the city has during the year, using a method that includes all inflows and outflows. • Include information on the status of other city funds, not just the general fund, in its quarterly and midyear reports. • Perform prompt reconciliations of its pooled cash account. • Regularly review the report on the cash balances of city funds that the department created in May 2004 and share this information with the city council in its updates. To ensure that the city council is prepared to ask questions related to the information the finance department provides, the city should consider adopting a policy requiring city council members to periodically receive training related to public finance. To ensure that the city council has adequate time to respond to financial information presented in the audited financial statements, it should adopt, as a policy, the interim city manager’s recommendation to issue statements by the end of the calendar year. 4422 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4433 We conducted this review under the authority vested in the California State Auditor by Section 8543 et seq. of the California Government Code and according to generally accepted government auditing standards. We limited our review to those areas specified in the audit scope section of this report. Respectfully submitted, ELAINE M. HOWLE State Auditor Date: December 7, 2004 Staff: Nancy C. Woodward, CPA, Audit Principal Peter A. Foggiato, III Fernando Valenzuela Katrina Williams 4444 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4455 APPENDIX The City of Richmond’s Progress in Implementing Its Corrective Action Plan The city of Richmond (city) recognizes that it faces challenging financial hurdles in both the short term and the long term. The city believes its corrective action plan of March 2004, shown in Table A, addresses these hurdles and provides a framework for the difficult decisions the city council faces. Although it has developed one-time corrections to address the current deficit and cash shortfall, its solvency depends on its ability to make ongoing structural changes involving significant and difficult program cuts and citywide restructuring. TABLE A Richmond’s Progress in Implementing Its Corrective Action Plan as of November 12, 2004 Corrective Action City’s Progress One-Time Corrections Convert $13 million of bond proceeds, which the Implemented. The city converted the bond proceeds to Richmond Redevelopment Agency (redevelopment working capital in May 2004. As discussed in Chapter 1, the agency) paid to the city in the fall of 2003, to working redevelopment agency paid the remaining debt to the general capital to fund normal operations of the general fund on October 28, 2004. fund. Additionally, accelerate the repayment of the redevelopment agency’s remaining $6 million debt to the city so it is repaid in fiscal year 2003–04. Convert approximately $2 million in series 2001A bond Implemented. The city requested nearly $2 million in funds from proceeds to working capital to offset amounts the general the fiscal agent since March 2004. fund previously advanced to pay for capital costs. Reimburse the general fund for eligible pension costs of In progress. According to the city, it hired actuaries to determine $1.2 million that it paid. the amount of pension override funds available to reimburse the general fund for eligible pension costs. Immediately collect $1 million that the Richmond Not implemented. According to the city, the amount owed to the housing authority owes the city in sewer service charges city is $601,000 and will be paid by November 1, 2005. that are past due. Determine if the city used the general fund to pay capital Implemented. According to the city, it has determined that it did expenditures that could be reimbursed using bond not use the general fund to pay capital expenditures. proceeds from the wastewater enterprise fund. Collect $875,000 as cost reimbursement from one Implemented. The city received a payment of $875,000 from the vendor for the city’s wastewater treatment plant by vendor in April 2004. June 30, 2004. continued on next page 4444 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4455 Corrective Action City’s Progress One-Time Corrections cont. Improve the cash position of the general fund with In progress. According to the city, it is currently working to reimbursements from grants and bonds as follows: improve the cash position of the general fund as described in the corrective action plan, and the city plans to keep all • Receive $1.2 million in reimbursements from the reimbursements from grants and bonds current. We asked the U.S. Department of Housing and Urban Development city to tell us how much of the $2.7 million in reimbursements it for the Community Development Block Grant Fund by received; however, the city did not provide us with information to June 30, 2004, thus erasing the deficit in the fund. support the actions it has taken. • Receive about $1.5 million in reimbursements for its employment and training program by June 30, 2004. • Research other expenditures for which grants or bond proceeds are supposed to pay reimbursements, immediately process the reimbursement requests, and pursue payment on an expedited basis. Personnel Cost Reductions Decrease personnel costs by considering the following Implemented. The city has laid off 250 employees since alternatives: March 2003, as discussed in Chapter 1. Also as discussed in Chapter 1 as a result of negotiations with the employees’ unions, • Lay off city employees. employees will pay their entire share of retirement contributions • Have employees pay their share of pension by July 1, 2005. contributions to the California Public Employees’ Retirement System. • Institute unpaid furloughs. • Institute salary reductions. Other Actions Considered Examine whether any of the $4.4 million that the general Implemented. The city determined that none of the $4.4 million fund transferred to other funds to make bond payments of general-fund transfers to other funds to make bond payments could be or should be paid or reimbursed by other funds’ should be paid by the other funds’ bond proceeds or grants. bond proceeds or grants. Evaluate whether grants from state and federal In progress. As part of the city’s preparation for the annual audit governments are likely to be received and in what time for fiscal year 2003-04, the deputy finance director told us that all frame. Additionally, downsize or defer expenditures to state and federal grant receivables will be analyzed to determine match expected dates and amounts of grant receipts. the collectibility as of June 30, 2004. Aggregate utility accounts for all city facilities to qualify Not implemented. According to the city, it currently does not have for large-user discount rates. a plan in place to aggregate utility accounts for city facilities. Examine development and capital projects to determine Not implemented. According to the city, it has not deferred which projects could be deferred. capital projects. Examine fees, charges, rates, and franchises for the Implemented. The city has examined and restructured the fees and Development Services Department to ensure that it is rates it charges, as described in Chapter 1. recovering actual costs from applicants. Also, reduce services to the extent that there are no offsetting revenues, and adjust pricing to recover the actual productive time of staff. Open discussions with major property holders regarding Not implemented. The city does not plan to move forward on possible prepayment of future years’ property taxes in this item. exchange for prompt-payment discount, which would require legislative authorization. Review inventory of surplus properties and evaluate In progress. In May 2004, the city council authorized staff, under whether any small surplus parcels can be sold quickly the direction of the city manager, to pursue disposition and sale for cash. of surplus properties. City staff have identified the city’s surplus properties and prepared criteria for selecting proposals for the sale of surplus properties. 4466 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4477 Corrective Action City’s Progress Other Actions Considered cont. Explore asset transfer financing, which the city describes Not implemented. The city does not plan to move forward on as essentially borrowing on a long-term basis to cover this item. operating deficits. Evaluate whether state or federal grants could be Not implemented. The city does not plan to move forward on redirected for use in capital projects. this item. Identify unspent bond proceeds, evaluate contract In progress. Although the city has identified bond proceeds, it has commitments against those proceeds, and explore (with not explored the redirection of the use of proceeds. We asked the bondholder consent) redirection of the use of proceeds. city if it planned to do so, but the city did not reply. Borrow through what is commonly known as a tax and In progress. The Legislature acted to help Richmond obtain revenue anticipation note to cover the intrayear cash-flow short-term financing as described in the Introduction. According to shortfall of $13.8 million. the deputy finance director, the city will probably issue a note by December 31, 2004. Long-Term Structural Changes Examine liability insurance costs ($5.7 million of the In progress. According to the city, it has taken several steps to fiscal year 2003-04 budget) and workers’ compensation decrease its costs, including outsourcing the administration of its insurance costs ($2.3 million between July 2003 and workers’ compensation claims to a vendor it selected through a March 2004) to evaluate if increased efficiencies and competitive process. Additionally, the risk management division has better pricing are available. Engage an insurance broker- been developing and implementing a major upgrade to the city’s evaluator to work on a contingent basis and earn a fee claims-tracking software to improve the quality of data and allow only if and to the extent the city saves money. for better tracking of the city’s overall cost of risk. Evaluate whether underused assets (such as the port) Not implemented. The city has no plans to implement this action. could be sold, leased, or developed without requiring significant expenditures by the city. Consider private enterprise lease, franchise, or development financing of large parcels that could generate long-term revenues, such as ground rent and increased property taxes. State- enabling legislation might be needed to authorize or speed up this process. Consider debt restructuring by doing the following: Not implemented. The city has no plans to implement this action. • Evaluating 22 bond issues for interest-rate savings, considering capital markets demands. • Consider replacing reserve funds with sureties. • Consider extending maturities to lower annual payments. Explore additional revenue sources, including landscaping In progress. The city has taken steps to increase its revenues, and lighting assessment districts, a library tax, increased as described in Chapter 1, including a half-cent sales and use users’ fees of various types, and increased general or tax increase to provide additional funds for the city’s general special taxes. governmental purposes, such as police and fire protection, emergency medical and library services, recreation, local street maintenance, and other general governmental services. Pursue grants from the Economic Development Not implemented. The city has no plans to implement this action. Administration and elsewhere. 4466 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4477 Blank page inserted for reproduction purposes only. 4488 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4499 Agency’s comments provided as text only. City of Richmond Finance Department 1401 Marina Way South Richmond, CA 94804 November 24, 2004 Elaine M. Howle, State Auditor* Bureau of State Audits 555 Capitol Mall, Suite 300 Sacramento, California 95814 RE: Draft Report 2004-117 City of Richmond We appreciate the opportunity to respond to the draft report. We have the following observations to the draft. Summary (page 1 - page 6) 1 The summary does not acknowledge the accomplishments and corrective actions taken to date. Among the accomplishments are: 2 • The City has gone through a series of three layoffs that have resulted in the reduction in the work force of approximately 250 positions. 3 • The City has entered into a tentative agreement with all six of its employee organizations to reduce the benefits for safety employee by 9% and by 8% for non safety employees. As of November 24, 2004, five of the six agreements have been ratified by the employees. 1 • The City Manager prepared an initial assessment of the fiscal and organizational stabilization needs of the City that contained 170 recommendations to improve the organization, operation and financial well being of the City. Included in this report were 64 recommendations dealing with the fiscal issues of the City, such as the requirement that each department submit monthly financial status reports to the Council and the requirement that the City complete its financial statements by the end of the calendar year. This report was presented at the City Council meeting of September 14, 2004 and was approved without modification by a unanimous vote of the Council. 4 • On November 18, 2004, the City Finance Committee approved a report that was prepared by the City Manager and the Finance Director that recommended the reorganizing of the Finance Department, establishing clear reporting channels that will improve efficiency, accountability, communications and establishing needed internal controls. Other organizational and operational recommendations in this report that will be acted on by the City Council during the November 30, 2004 meeting include: • The establishment and strengthening of a Budget function that reports directly to the Finance Director, * California State Auditor’s comments begin on page 55. 4488 California State Auditor Report 2004-117 California State Auditor Report 2004-117 4499 Page 2 Elaine M. Howle, State Auditor Bureau of State AUdits November 24, 2004 • The transfer of the inactive Auditing function from the Finance Department, • The re-establishment of a Purchasing function, • The establishment of a Cash Management Section, • The review and strengthening of the Accounts Payable function, • The identification of an Accounts Receivable function, • The addition of six staff positions, • The establishment of an independent Internal Audit function that will report directly to the City Council and will perform financial and operations audits. The foundation of the Internal Audit function has four cornerstones: 1) Governmental Auditing Standards, 2) Independence, 3) Peer Review, and 4) a Professional Audit Advisory Committee. The proposal includes staffing the function with four individuals. • The adoption of the Governmental Auditing Standards as recommended by the Government Finance Officers Association that were prepared by the United States General Accounting Office as the basis for the proper functioning of this program. • The establishment of a Professional Audit Advisory Committee, consisting of three (3) professional members, one representative from the City Council and one representative from the City Manager’s Office whose responsibilities would be to: • Advise the City on the selection of the City’s independent auditors and the resolution of audit findings from both the independent and internal auditors. • Monitor the independent audit function of the City of Richmond including the selection of the independent auditor and the resolution of audit findings. • Monitor reports of the Internal Auditors. • Review the annual internal audit work plan. • Review the resolutions of internal audit findings, and • Provide written annual reports to the City Manager and Council on how effectively and efficiently the auditors perform their duties and discharge their responsibilities. 1 • The adoption of a policy that the annual financial audit, for each preceding fiscal year, is to be completed by the end of the calendar year. • A provision for the Internal Audit Unit to review and recast the City’s credit card policy and cancel all unnecessary credit cards. • A provision for the Internal Audit function to perform an audit of the Accounts Payable function to audit the City’s records and identify any discounts that may be due the City. 5500 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5511 Page 3 Elaine M. Howle, State Auditor Bureau of State AUdits November 24, 2004 • A requirement that a cash receipts audit be performed consisting of cash counts, physical control and receipt site record keeping reviews, an examination of the accountability and reconciliation procedures that will ensure that all cash receipts are properly accounted for, deposited and recorded in the finance system on a timely basis. • The adoption of a policy that one-time reserves will not be used as a source of funding for continuing programs and activities. • A requirement that a position control accounting procedure be developed and utilized by all agencies, authorities and departments in the City as part of the budgetary and appropriations process. 5 • It is also important to take into account the significance of the fact that, on November 2, 2004, the voters of the City of Richmond approved a general one-half cent sales tax measure which should provide for additional stability with regards to the City’s finances. 6 • The City Council also approved a Land Disposition Agreement with Upstream to sell City- owned property located at Point Molate to Upstream for $50 million with the potential to generate another $350 million, in the next twenty years. Even if this development proposal cannot move forward, Upstream will pay the City a potential $15 million in non-refundable deposits in the next five years. 1 As noted, the summary is notable for its silence on the progress being made. We have provided by separate cover -- a video tape of the November 18, 2004 Finance Committee meeting in which future revenue efforts are discussed as well as the independent Internal Auditor, summaries of the negotiated and imposed labor agreements, and the Finance Department Reorganization, Accountability and Work Improvement Plan dated November 18, 2004 (Finance Committee) and November 30, 2004 (City Council). Report Title 7 There seems to be a disconnect between the report title and the report. The title does not acknowledge the City is on the road to recovery, or that previous State takeaways also contributed to the City’s financial condition and ability to recover. Draft Report (page 26 and page 27) 8 The State, in efforts to balance past State budget deficiencies, has shifted a cumulative $55,516,514 in City of Richmond property tax revenues through the ERAF shift. The shift has only partially been offset by other sources for a net takeaway of $45,703,733 through fiscal year 2003- 2004. While the City has to accept responsibility for its own actions, actions by the State have contributed to the City’s ability to provide services to the Citizens of Richmond. We request the above information be included in the report. 5500 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5511 Page 4 Elaine M. Howle, State Auditor Bureau of State AUdits November 24, 2004 Overall The City is in general agreement with the recommendations and facts in the report and we thank the State Auditor for the opportunity to respond to the draft. (Signed by: Patrick Samsell) Patrick Samsell Finance Director 5522 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5533 November 22, 2004 Elaine M. Howle, State Auditor Bureau of State Audits 555 Capitol Mall, Suite 300 Sacramento, California 95814 Attn: Tanya Elkins RE: Supplementary Material to City of Richmond Response To Draft Report 2004-117 Enclosed are a video tape of the City of Richmond City Council Finance, Administrative Services and Economic Development Standing Committee meeting of November 18, 2004 which discusses: • future revenue options, • the establishment of an independent internal audit function, • discussion of the finance department reorganization, • monthly and quarterly financial reports, and • cash balances of funds. Resolutions for the labor unions outlining the terms and conditions of the three year labor agreements and the impact on fire union 188 members to not ratifying the negotiated three year agreements is also enclosed. In addition, included is the 390 page Finance Department Reorganization, Accountability and ♦ Work Improvement Plan consisting of: • Recommended actions, discussions of those actions , and draft ordinances breaking out the duties and responsibilities of an independent internal auditor (page 1 through page 43), • Monthly reports of operations summarized (page 45 through page 50) and detailed (page 51 through page 387), and • Quarterly cash balance by fund report (page 388 through page 390). The City Council is scheduled to act on the recommendations on November 30, 2004. Also included is a one page table showing the City’s cumulative ERAF loss through FY 2004 totaling $55,516,514 and netting $45,703,733. While not the immediate cause of the City’s fiscal problems, the State’s takeaway of City property tax revenues do contribute to the City’s ability to respond to fiscal challenges and do support our claims that the total ERAF takeaway and the net should be included in the report. We appreciate the opportunity to respond to the draft report and hope the State Auditor will acknowledge the efforts undertaken by the City which go beyond the recommendations in the draft report. (Signed by: Patrick Samsell) Patrick Samsell, Finance Director ♦ We have not included attachments in the report; however, they are available for review at the California State Auditor’s office. 5522 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5533 Blank page inserted for reproduction purposes only. 5544 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5555 COMMENTS California State Auditor’s Comments on the Response From the City of Richmond To provide clarity and perspective, we are commenting on the response to our audit report from the city of Richmond (city). The numbers below correspond with the numbers we have placed in the margin of the city’s response. 1 The city inaccurately asserts that the Summary does not acknowledge the accomplishments and corrective actions the city has taken to date. Specifically, we note in our Summary that the city has worked to increase revenues and reduce costs and has taken steps to improve its monitoring. Additionally, during the agency response period, we added a paragraph to the Summary that refers to the city’s attempts to improve its financial health with its March 2004 corrective action plan. The paragraph also refers to the city manager’s directive that requires departments to submit monthly reviews of their budgets and that requires the city to complete its financial statements by the end of the calendar year. We provided a draft of this paragraph to the city during the agency response period. Since the Summary is a synopsis of the entire report, certain of the details the city cites are discussed only in the individual chapters. 2 The city may have overlooked the third paragraph of the Summary, in which we mention that the city has laid off 250 of its staff since March 2003. 3 Based on the documentation the city provided, we have updated our report and the Appendix to recognize the ratification of the agreements, which occurred after we sent our draft report to the city. These changes are on page 2 of the Summary, page 25 of the report, and page 46 of the Appendix. 4 We agree that the city’s proposed reorganization of the finance department, its proposed establishment of an internal audit function, and its proposed establishment of a professional audit advisory committee are indications of the city’s attempts to implement a viable operating framework. However, as of the November 24 date of the city’s response, this proposal was to be presented to the city council for action on November 30, 2004. 5544 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5555 Consequently, we did not include this in our report as corrective action that the city has taken. Furthermore, these actions in and of themselves will not necessarily improve the city’s financial health and our recommendations are focused on the information the city needs to generate and the actions it needs to take to improve its financial health. 5 In Chapter 1 we discuss the city’s explorations of additional revenues increases and expenditure reductions. We discuss the November 2004 voter approval of the half-cent sales tax increase on page 25 of the report. 6 Although agreeing to sell property located at Point Molate may be considered progress, the city’s revenue estimates only represent potential revenues. As noted in the city’s response, there is a possibility that the development proposal may not move forward. Therefore, it is premature to assess the effect of this action on the city’s financial position. 7 We disagree with the city’s assessment that the report title is disconnected from the report contents. The city’s suggested inclusions mischaracterize the contents of our report by overstating the city’s progress, which cannot be reliably measured until the fiscal year 2003–04 financial statements are completed. Additionally, the city’s abrupt financial decline is primarily the result of the city’s poor decisions, not takeaways of city revenues by the State, as the city indicates. Therefore, we have not revised our title. 8 We discuss the effects of the State’s diversion of local government property taxes to the Educational Revenue Augmentation Fund on page 23 of the report. However, as we also mention, in light of the fact that this revenue shift is of longstanding, it cannot excuse the city for spending more than it can afford. 5566 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5577 cc: Members of the Legislature Office of the Lieutenant Governor Milton Marks Commission on California State Government Organization and Economy Department of Finance Attorney General State Controller State Treasurer Legislative Analyst Senate Office of Research California Research Bureau Capitol Press 5566 California State Auditor Report 2004-117 California State Auditor Report 2004-117 5577