Humboldt County - Internal Control Over Financial Reporting

HUMBOLDT COUNTY Review Report INTERNAL CONTROL OVER FINANCIAL REPORTING July 1, 2019, through June 30, 2021 BETTY T. YEE California State Controller July 2022 BETTY T. YEE California State Controller July 22, 2022 Cheryl Dillingham, Elishia Hayes, Interim Auditor-Controller County Administrative Officer Humboldt County Humboldt County 825 5th Street, Room 126 825 5th Street, Room 126 Eureka, CA 95501 Eureka, CA 95501 Dear Ms. Dillingham and Ms. Hayes: The State Controller’s Office reviewed Humboldt County’s internal controls over its annual financial reporting process to determine whether the county’s inability to submit timely annual financial reports is due to a lack of internal controls. Our review was for the period of July 1, 2019, through June 30, 2021. We expanded our scope to include prior fiscal years and the current fiscal year when information obtained from county officials, independent auditors, and other audit reports merited further review. Our review found internal control deficiencies that contributed to the county’s inability to complete its annual financial reports promptly. The county should develop a comprehensive plan to address the deficiencies. The plan should identify the tasks to be performed, as well as milestones and timelines for completion. The Board of Supervisors should require periodic updates at public meetings of the progress in implementing this plan. Furthermore, we request that the county provide the State Controller’s Office with a progress update of its plan six months from the issuance date of the final report. We would like to express our thanks to the county staff and management who were helpful throughout the review process. If you have any questions, please contact Efren Loste, Chief, Local Government Audits Bureau, by telephone at (916) 324-7226, or by email at eloste@sco.ca.gov. Sincerely, Original signed by KIMBERLY TARVIN, CPA Chief, Division of Audits KT/ls Cheryl Dillingham, -2- July 22, 2022 Interim Auditor-Controller Elishia Hayes, County Administrative Officer cc: The Honorable Virginia Bass, Chair Humboldt County Board of Supervisors The Honorable Mike Wilson, Vice Chair Humboldt County Board of Supervisors The Honorable Rex Bohn, Member Humboldt County Board of Supervisors The Honorable Michelle Bushnell, Member Humboldt County Board of Supervisors The Honorable Steve Madrone, Member Humboldt County Board of Supervisors Humboldt County Internal Control over Financial Reporting Contents Review Report Summary ............................................................................................................................ 1 Background ........................................................................................................................ 1 Review Authority ............................................................................................................... 3 Objective, Scope, and Methodology ................................................................................. 3 Conclusion .......................................................................................................................... 4 Views of Responsible Officials and SCO Comments ...................................................... 4 Restricted Use .................................................................................................................... 4 Findings and Recommendations ........................................................................................... 5 Attachment A—Humboldt County Auditor-Controller’s Office Response to Draft Review Report Attachment B—Humboldt County Administrative Officer’s Response to Draft Audit Report Humboldt County Internal Control over Financial Reporting Review Report Summary The State Controller’s Office (SCO) completed a review of Humboldt County’s internal controls over its annual financial reporting process for the period of July 1, 2019, through June 30, 2021 (fiscal year [FY] 2019-20 and FY 2020-21). We expanded our scope to include prior fiscal years and the current fiscal year when information obtained from county officials, independent auditors, and other audit reports merited further review. We performed this review because in recent years the county has been unable to complete and/or file required reports to SCO in a timely manner. Our review found internal control deficiencies that contributed to the county’s inability to complete its annual financial reports promptly, as described in the Findings and Recommendations section of this report. Background Humboldt County Humboldt County is a general-law county established in 1853 by the state legislature, and is a political subdivision of the State of California. The county, with a population of 136,463 as of the 2020 census, is located on the far north coast of the state. Seven incorporated cities within Humboldt County, including the county seat of Eureka, provide services to their residents. The county is governed by a five-member Board of Supervisors, which serves as the legislative and executive body of county government and many special districts. As the governing body of the county, the Board of Supervisors enacts legislation and determines policies for county departments and various special districts, adopts the annual budget, and establishes salaries. The county’s organizational structure includes 20 separate departments, six of which are directed by officials elected by residents to serve a four- year term. These include the Assessor, the Auditor-Controller, the Clerk- Recorder, the District Attorney, the Sheriff, and the Treasurer-Tax Collector. The remaining officials and department heads, including the County Administrative Officer, are appointed by either the Board of Supervisors or other agencies as described in state law. Annual Financial Reports In Humboldt County, the Auditor-Controller exercises general supervision over the accounting of all county organizations and administers the county’s major financial, payroll, and property tax apportionment systems; prescribes and exercises general supervision over the accounting forms and the method of keeping the accounts of all offices and institutions under the control of the Board of Supervisors, and for those entities that maintain their funds in the County Treasury, including special districts and school districts. -1- Humboldt County Internal Control over Financial Reporting The county is required to complete and/or file annual financial reports to SCO and the federal government, including the Financial Transactions Report (FTR), the Single Audit Report (SAR), and the Annual Comprehensive Financial Report (ACFR). In recent years, the county has been unable to complete and/or file the following reports promptly:  FTR – Government Code (GC) section 53891 requires that the financial transactions of each local agency be submitted to SCO within seven months after the close of the fiscal year or within the time prescribed by the Controller, whichever is later. The report must contain underlying data from audited financial statements prepared in accordance with generally accepted accounting principles, if this data is available. The county filed its FTRs for FY 2016-17 through FY 2020-21 late, as shown in the following table: FTR for Due Date Filed Number of Fiscal Year Date with SCO Days Late 2020-21 January 31, 2022 Pending Delinquent 2019-20 January 31, 2021 March 16, 2022 409 2018-19 January 31, 2020 May 1, 2020 91 2017-18 January 31, 2019 May 7, 2019 96 2016-17 January 31, 2018 February 13, 2018 13  SAR –The federal Uniform Guidance (Code of Federal Regulations, Title 2, Part 200) mandates that any non-federal entity that expends $750,000 or more in federal awards during a fiscal year complete a SAR within nine months after the fiscal year-end.1, 2 Humboldt County has completed its SARs for FY 2017-18 through FY 2020-21 late, as shown in the following table: SAR for Fiscal Year Due Extended County Number of Ending Date Due Date Completion Date Days Late June 30, 2021 March 31, 2022 September 30, 2022 Pending Pending June 30, 2020 March 31, 2021 September 30, 2021 Pending Delinquent June 30, 2019 March 31, 2020 N/A September 25, 2020 178 June 30, 2018 March 31, 2019 N/A June 6, 2019 67 June 30, 2017 March 31, 2018 N/A March 21, 2018 On time  ACFR – An ACFR is a set of financial statements for a state, municipality, or other governmental entity that comply with the accounting requirements established by the Governmental Accounting Standards Board. 3 Completion of the ACFR satisfies various auditing and reporting requirements, including those in GC sections 25250 and 25253. For the ACFR to be relevant and useful, it should be completed within nine months after the fiscal year-end. The ACFR is usually completed in conjunction with the SAR. Humboldt County has 1 Non-federal entities include states, local governments, Indian tribes, universities, and non-profit organizations. 2 On March 19, 2021, the Office of Management and Budget issued memorandum M-21-20, extending the SAR due date for FY 2019-20 and FY 2020-21 by six months. 3Some entities, including Humboldt County, complete and issue a financial statement report instead of a full ACFR. -2- Humboldt County Internal Control over Financial Reporting completed its financial statements for FY 2017-18 through FY 2020-21 late, as shown in the following table: ACFR for Fiscal Year Due Date SAR Extended County Number of Ending (Best Practice) Due Date Completion Date Days Late June 30, 2021 March 31, 2022 September 30, 2022 Pending Pending June 30, 2020 March 31, 2021 September 30, 2021 Pending Delinquent June 30, 2019 March 31, 2020 N/A September 25, 2020 178 June 30, 2018 March 31, 2019 N/A June 6, 2019 67 June 30, 2017 March 31, 2018 N/A March 21, 2018 On time Prior Financial Reporting Findings Between 2018 and 2020, various accounting and reporting issues have been identified and reported to county management. These include reports by Craig Goodman, CPA, and CPS HR Consulting in 2018; and by the Humboldt County Civil Grand Jury in 2019. CliftonLarsonAllen, LLP also reported internal control findings related to financial reporting in the county’s audited financial statements for the fiscal years ending June 30, 2018, and June 30, 2019, completed on June 6, 2019, and September 25, 2020, respectively. In 2017, after claims that the Auditor-Controller’s Office (ACO) was failing to perform its duties, the Board of Supervisors directed the County Administrative Officer to contract with Craig Goodman, CPA, and CPS HR Consulting to conduct management and accounting reviews of the ACO’s policies and procedures. The firms completed their reviews and reported the results to the county in 2018. These reports included findings and recommendations relevant to financial reporting. Following completion of these reviews, the county’s Civil Grand Jury performed its own investigation to review the county’s responses and to evaluate the progress in resolving the review findings and recommendations. We performed this review of the county’s internal controls over its annual financial reporting process due to the county’s continuing inability to complete its annual financial reports promptly, and ongoing claims of poor financial reporting practices. Review We conducted this review pursuant to GC section 12422.5, which authorizes the State Controller to “audit any local agency for purposes of Authority determining whether the agency’s internal controls are adequate to detect and prevent financial errors and fraud.” Objective, Scope, The objective of our review was to evaluate the county’s internal controls over its annual financial reporting process to determine whether the and Methodology county’s inability to submit timely annual financial reports is due to a lack of internal controls. Our review period was July 1, 2019, through June 30, 2021. We expanded our scope to include prior fiscal years and the current fiscal year when information obtained from county officials, independent auditors, and other audit reports merited further review. -3- Humboldt County Internal Control over Financial Reporting To achieve our objective, we:  Evaluated the county’s formal internal policies and procedures;  Reviewed the Independent Auditor’s Report, and other reports and studies that were relevant to our objective;  Interviewed county employees; and  Evaluated various aspects of the county’s internal control system in accordance with Standards for Internal Control in the Federal Government. Conclusion Our review found internal control deficiencies that contributed to the county’s inability to complete its annual financial reports promptly. These deficiencies, several of which have been identified in various reports, include:  The county amassed a backlog of journal entries;  The county failed to complete its cash reconciliations;  The ACO is insufficiently staffed;  County staff members need additional training; and  The county lacks updated policies and procedures. Views of We issued a draft review report on June 17, 2022. The Office of the Humboldt County Auditor-Controller and the Humboldt County Responsible Administrative Officer responded by separate letters dated June 27, 2022, Officials and agreeing with the review results. The additional details and the SCO Comments perspectives provided in the responses do not change our review conclusions and recommendations. The ACO’s and County Administrative Officer’s complete responses are included in this report as Attachments A and B. Restricted Use This report is solely for the information and use of Humboldt County and SCO; it is not intended to be and should not be used by anyone other than these specified parties. This restriction is not intended to limit distribution of this review report, which is a matter of public record and is available on the SCO website at www.sco.ca.gov. Original signed by KIMBERLY TARVIN, CPA Chief, Division of Audits July 22, 2022 -4- Humboldt County Internal Control over Financial Reporting Findings and Recommendations FINDING 1— The county amassed a backlog of journal entries that were required to be processed prior to finalizing the financial statements. This delay The county significantly contributed to the county’s inability to produce timely year- amassed a backlog end financial statements. The backlog in approving journal entries resulted of journal entries from substantial changes to the county’s journal entry approval processes implemented in 2019 to increase reliability of the submitted journal entries and identify potential errors. Background Journal entries are used to record various financial transactions including accounting adjustments or corrections, allocating revenues and costs between departments, and recording operating transfers. In Humboldt County, journal entries originate from various county departments. The entries are prepared by the department’s fiscal staff and sent to ACO to be processed and entered into the county’s general ledger. Prior to policy changes, ACO placed greater trust and reliance on the various county departments that submitted journal entries. Prior policies and procedures required departments to submit no more than two pages of documentation to support each journal entry. In some cases, this documentation consisted of a cover page and a summary that provided insufficient detail. Receiving only two pages of documentation to support the journal entries likely limited the ACO’s ability to identify errors, misclassifications, improper entries, and fraud. According to the current Auditor-Controller and county staff, the county relied too heavily on the year-end financial statement auditors to catch and identify material errors in the accounting records, which most times led to substantial year-end adjustments. These adjustments were a result of erroneous and improper journal entries. To increase reliability and to minimize year-end adjustments, the current Auditor-Controller implemented new policies requiring substantially more documentation, and requiring ACO to review all submitted documentation prior to approving and entering journal entries in the financial system. Erroneous journal entries According to ACO staff members, many of the journal entries received for processing contain errors, including incorrect object codes for classifying transactions into specific accounting categories; unbalanced debits and credits; insufficient or missing descriptions; and insufficient or missing supporting documentation. Some of these errors existed prior to the requirement to submit additional documentation to ACO; other errors were identified because ACO was receiving additional documentation and conducting a more thorough review. When ACO identifies multiple journal entries with errors from a department, ACO deems that department a higher risk and increases controls as necessary. The additional time necessary to reject an incorrect journal entry, make the necessary corrections, and re-review the entry contributed to the backlog of journal entries. -5- Humboldt County Internal Control over Financial Reporting Implementation of the policy changes According to county staff members, the policy changes were abrupt, and the departments were provided inadequate notice and explanations of the changes. County staff members also complained that the new policies were confusing because they were not formalized and documented countywide and were inconsistently applied. For example, departments were directed to provide to ACO “all” of the documentation that supports every journal entry. The types and extent of documentation required are not standard for all the different departments, business processes, and accounting entry types within the county. The required documentation may be brief or consist of hundreds of pages. A significant amount of time was necessary both for the departments to understand what documentation was required and for ACO to review the documentation. In some cases, the previously submitted documentation was not satisfactory, and ACO had to request additional or alternate documentation. Department staff and ACO stated that the additional documentation requirements were not initially well-received. Department staff also questioned the need for some of the additional documentation. Backlog of Journal Entries A combination of erroneous journal entries, additional review of the journal entries by ACO, and unrealistic expectation of the time needed to implement the new procedures contributed to the backlog of journal entries. Insufficient staffing of ACO (Finding 3) and the need for additional training for departmental staff members (Finding 4) also contributed to the backlog of journal entries. One reason for numerous journal entries is that the county previously relied too heavily on its external auditors to identify financial transaction errors, including journal entry errors and to help the county correct those errors during the annual year-end financial reporting process. As a result, the county has not placed much emphasis on preparing journal entries that are as free from errors as possible. Although external auditors routinely look for errors, the county should have a process in place to ensure that journal entries are prepared correctly and with minimal errors. To eliminate the backlog, the county hired a consultant to help process journal entries and reconcile financial records for FY 2019-20 and FY 2020-21. Timely and correct accounting data are essential for fiscal monitoring; therefore, financial transactions must be recorded promptly and accurately. The substantial backlog and extensive turnaround time to post journal entries made the county’s accounting data unreliable. For instance, in September and October 2021, 15 months after the June 30 fiscal year- end, ACO staff members posted journal entries totaling $106 million to the FY 2019-20 general ledger. As a result, county management may have been using outdated accounting data throughout FY 2019-20 when making fiscal decisions. -6- Humboldt County Internal Control over Financial Reporting Recommendation We recommend that the county:  Develop a plan to process the backlog of journal entries and to ensure that the backlog does not occur in the future;  Formalize and implement policies and procedures to ensure that journal entries recorded in the general ledger are properly reviewed and approved;  Improve communication and working relationships among ACO, the County Administrative Officer, and county departments;  Clarify what documentation is necessary for journal entry approval and streamline journal entry processes and procedures; and  Ensure that journal entries are prepared accurately and in conformance with county requirements, recorded in accordance with accounting principles, and processed promptly. FINDING 2— The county does not reconcile its bank balances and the county treasurer’s accounting records, nor does it reconcile cash and investment accounts The county failed between the county treasurer’s records and the Auditor-Controller’s to complete its cash records pursuant to GC section 26905. The county’s failure to complete reconciliations timely cash reconciliations contributed to the delay of its financial reports. Bank reconciliations Due to a lack of records, it is not clear when the county last performed a bank reconciliation. As part of its efforts to complete its FY 2019-20 financial statements, the county contracted with a consultant to complete the monthly bank reconciliations for that fiscal year. However, as of April 2022, it appears that the consultant will not be able to complete the bank reconciliations before the contract ends, due to the lack of documentation and the abundance of transactions. The county’s cash deposit process is currently completed manually, and individual deposits are grouped into lump-sum amounts before being deposited at the bank. County records do not specify which transactions correlate to a deposit amount in a bank statement. This process makes it difficult for accountants to trace deposit amounts from the bank statements to the county’s records. The county appears to have difficulties preparing bank reconciliations partly because it does not have formal processes and procedures for guidance. Insufficient knowledge and incomplete accounting records also appear to prevent staff members from performing reconciliations efficiently. -7- Humboldt County Internal Control over Financial Reporting Cash and investment account reconciliation The county does not comply with the cash and investment account reconciliation required by GC section 26905, which states: Not later than the last day of each month, the auditor shall reconcile the cash and investment accounts as stated on the auditor’s books with the cash and investment accounts as stated on the treasurer’s books as of the close of business of the preceding month to determine that the amounts in those accounts as stated on the books of the treasurer are in agreement with the amounts in those accounts as stated on the books of the auditor. The cash and investment account reconciliation finding was noted in prior reports (by Craig Goodman, CPA, and CPS HR Consulting in 2018; by the Humboldt County Civil Grand Jury in 2019; and by CliftonLarsonAllen, LLP in 2020), and appears to continue to the present. The bank balance should be reconciled to the county treasurer’s balance, and the cash and investments balance in the county’s general ledger should be reconciled to the total cash and investments balance in the county treasurer’s records. Cash reconciliations with the banks’ records, county treasurer’s records, and the general ledger allow the county to determine whether all cash transactions have been recorded properly and to detect errors and fraud. Cash reconciliations also assist in regular monitoring of a county’s cash flows and assure accuracy and timeliness of withdrawals and deposits. Recommendation We recommend that the county:  On a regular basis, reconcile bank and general ledger balances to the county treasurer’s records, to ensure that the cash balance reported in the general ledger is complete and accurate;  Develop a plan to complete the backlog of cash reconciliations; and  Develop, formalize, and implement procedures to ensure that cash reconciliations are completed, reviewed, and approved in a timely manner. FINDING 3— In the last three years, insufficient staffing has kept ACO from accomplishing its duties and responsibilities. This lack of staffing was Auditor- noted by Craig Goodman, CPA, and CPS Consulting in 2018; and by the Controller’s Office Humboldt County Grand Jury in 2019. ACO continues to lack adequate staffing is staffing. The lack of staffing has resulted in a heavier workload for the insufficient remaining staff members and contributed to the county’s inability to promptly complete its financial reports. Adequate staffing is necessary to maintain accurate and timely accounting records. ACO has had ongoing vacancies caused by separations, promotions, and difficulty recruiting qualified staff to fill vacancies. During FY 2019-20 and FY 2020-21, ACO had a total of 13 full-time positions comprised of the Auditor-Controller, the Assistant Auditor-Controller, and 11 accountant/auditor/fiscal staff. Throughout these two fiscal years, ACO -8- Humboldt County Internal Control over Financial Reporting had an average of three staff vacancies. During this time, ACO also lost two of its most senior staff and had difficulty backfilling the positions. As of April 2022, three accountant/auditor/fiscal positions continue to be vacant. In August 2021, the county approved an operational realignment moving payroll functions from the Human Resources Department to ACO. The realignment increased the ACO’s workload and contributed to the ACO’s staffing problems. Two of the five payroll staff positions are currently vacant, leaving the payroll unit without a full staff. This staffing shortage requires other ACO staff members to work on payroll functions instead of financial functions because payroll must be completed biweekly to ensure that county employees are paid on time. Recommendation We recommend that the county:  Reassess the staffing levels allocated to ACO;  Implement a remedial action plan to address the importance of hiring, developing, and maintaining qualified permanent staff; and  Consider hiring additional consultants or qualified staff to backfill or assist ACO in performing functions. FINDING 4— During our conversations, staff members from various departments expressed their eagerness to accomplish their assigned responsibilities. To County staff make this possible, the county must communicate the requirements it members need wants to implement and provide proper training on how the requirements additional training are to be fulfilled. According to ACO, it provided various communications and training when the county made changes to its journal entry processing. However, staff members claimed that the implementation was abrupt and that additional training would have been helpful. It also appears that many county staff members lack sufficient knowledge about using the county’s financial accounting software. These training issues were identified and reported by Craig Goodman, CPA, and CPS HR Consulting in 2018; and by the Humboldt County Civil Grand Jury in 2019. The county hired consultants to provide training sessions on its accounting software. Our interviews of staff members and management indicate that staff continue to need a better understanding of the software. The county could also improve efficiency by eliminating or minimizing paper transactions and using more of the accounting software’s available functions to process transactions electronically. It is difficult to determine whether the continued need for additional training was due to staff turnover, loss of institutional knowledge, or inadequate training. One of the principles of an effective internal control system is an organization’s commitment to competence. Management should ensure that its personnel possess and maintain a level of competence that allows them to accomplish their assigned responsibilities and understand the importance of effective internal control. -9- Humboldt County Internal Control over Financial Reporting Recommendation We recommend that the county implement a training plan for its staff to increase their understanding of accounting procedures and the county’s accounting software. FINDING 5— The ACO’s Department Policy & Procedure Manual was last updated in 2012 and does not reflect current procedures. The manual also lacks The county needs complete and accurate documentation of current processes. The county has to update policies updated certain policies on an ad hoc basis. However, according to county and procedures staff members, these ad hoc policies are confusing, and sometimes they are conflicting or not communicated properly. A well-designed and properly maintained system of accounting policies and procedures enhances accountability and helps improve business processes and efficiency. The resulting documentation can also serve as a useful training tool for staff. Incomplete and outdated policies and related internal controls result in unclear roles and responsibilities and lead to improper handling of transactions. Formal accounting policies and procedures should be available to staff, back-up staff, and new employees. The lack of policies and procedures has been identified and reported previously, by Craig Goodman, CPA, and CPS HR Consulting in 2018; and by the Humboldt County Civil Grand Jury in 2019. The county has indicated that it is currently working with a consultant to update its accounting policy manual. Recommendation We recommend that the county:  Continue to review, update, and document its accounting policies to ensure consistency with current processes;  Ensure that its accounting policies clearly state the authority and responsibility of appropriate parties; and  Disseminate the accounting policies to all responsible employees and provide training when necessary. -10- Humboldt County Internal Control over Financial Reporting Attachment A— Humboldt County Auditor-Controller’s Office Response to Draft Review Report Humboldt County Internal Control over Financial Reporting Attachment B— Humboldt County Administrative Officer’s Response to Draft Review Report State Controller’s Office Division of Audits Post Office Box 942850 Sacramento, CA 94250 http://www.sco.ca.gov S22-LGO-9000