An Audit Can Be Good for You by James Hogan and Warren Jones’

s many communities are discovering, independent audits of local A governments are a key element in developing sound financial management practices. As professional analyses of how public funds are spent, audits enhance local government effectiveness and, by cementing the credibility of municipal financial statements, help reduce borrowing costs. What’s more, federal revenue sharing rules require every recipient of $25,000 or more of revenue sharing funds to have an independent audit of its annual financial statements at least once every three years.

The audit yields its greatest benefits only if the municipality’s elected, nonfinancial officials are involved in choosing the auditing firm. To promote that involvement, let’s examine the audit process from the perspective of a municipal official with no particular ground- ing in finance.

What is an audit?

An audit is an examination-of systems, procedures, programs and financial data. The product, or result, of an audit is a report such as that rendered by an independent auditor of how appropriately an organization’s financial statements depict its financial condition and results of its operations. An independent audit is one performed by persons not affiliated with the organization being audited, in this case, the independent or “outside” auditor engaged by the munici- pality.

The most common kind of audit is the financial audit. Other types are the compliance audit, designed to determine if the municipality has acted in accordance with applicable laws, regulations, policies and procedures; operational, performance or management audits, which assess municipal resource use; and the program-results audit, which determines whether a program’s planned results were achieved.

‘James Hogan and Warren Jones are partners in the Boston office of Coopers 8 Lybrand. This article IS an adaptation of a manual created jointly by Coopers 8 Lybrand and the Massachusetts Department of Community Affairs’ Office of Local Assistance, under the auspices of the U.S. Civil Service Commission.

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What is the federal revenue sharing audit requirement?

Each recipient of $25,000 or more of revenue sharing funds must have an independent audit of its annual financial statements (includ- ing all funds) at least once every three years. Cities and towns affected by this requirement must have their financial statements audited for one of the three years ending on or before December 31, 1979 (some states also have audit requirements).

Who may perform financial audits? Financial audits may be performed by certified public accountants,

public accountants licensed before 1970 and, in some states, auditors charged with performing such audits. Compliance audits for federal revenue sharing purposes may be performed by any of these groups, provided they conform to formally established professional stan- dards.

Why should elected officials get involved in the audit process? Municipal decision makers should participate in the audit process

because it is a key ingredient in overall management. Their participa- tion is important because:

By participating in the audit process, municipal officials render an important public service and enhance their ability and visibility as public servants.

0 The municipality’s financial operations and internal controls may be substantially improved as a result of an audit. Auditors are re- quired to report in writing any significant control weaknesses they find, and would normally make recommendations for needed im- provements-particularly if municipal officials direct their attention to areas of concern at the outset.

0 Precisely because the public’s demand for understandable fi- nancial information is growing, it is highly desirable for both the public and municipal officials that this information be lent credibility by the professional opinion of an independent auditor, intelligently chosen.

Elected, nonfinancial officials’ participation in the audit process is also important because any in-depth evaluation of a municipality’s activities has political implications. For example, if an independent auditor concluded that the municipality’s financial records were in such disarray that they could not be audited, people might question what had been happening to public funds over the years and be concerned with a possible loss in federal or state aid. Even an audit benefit such as the savings mentioned previously may have political

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implications, because the public might then ask why financial offi- cials hadn't saved money on their own. The auditor should be selected by nonfinancial rather than financial officials because the audit, in focusing on financial systems, is necessarily an evaluation of those financial officials' responsible for the systems' operation.

The auditors should be selected by an audit committee comprising representatives from: Recommended-the mayor and city council, board of aldermen or selectmen, finance committee, school com- mittee, commissioners (if separately elected); Optional-informed citizens and educators.

The audit committee should seek the advice of anyone it believes can help, particularly individuals knowledgeable about audits and auditors.

What is involved in determining the municipality's audit needs? Once the committee has been established, it should determine the

municipality's particular needs. These may include the financial and compliance audit for revenue sharing requirements, any other grant programs that require financial and compliance audits, and any specific evaluations the municipality may require. The committee should also consider other factors, such as:

0 The need for accounting and financial advice; 0 The adequacy of controls exercised by the municipality's comput-

0 The need for technical assistance in planning computer applica- er service bureau; and

tions. What are the auditor selection criteria?

Once the committee has determined the audit requirements, it should establish the procedures it will follow in soliciting and evaluat- ing the proposals. Comprehensive, definitive selection criteria should be established, and their relative importance assigned, by the com- mittee. The criteria are:

0 The skill, experience and time commitments of the specific persons who will be performing the services requested;

0 The auditor's demonstrated understanding of the municipality's requirements and his plan for meeting them;

0 The auditor's prior experience and reputation in auditing munici- palities: and

0 Price. What conrideratlons are important in requesting and evaluating proposals?

Once the municipality's needs+ommonly called the scope of the

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examination-and the selection criteria have been established, the committee should write its request for proposal (RFP) and send it to prospective auditors.

The proposing auditors’ written proposals, oral presentations and references should be judged against the criteria. Checking refer- ences is particularly important. Each committee member’s evaluation of the prospective auditors will necessarily be subjective. This should not be of concern. Once the selection has been made, the reasons should be documented and communicated to the municipal body that has the legal authority to authorize the contract. All the proposing auditors should be notified of who has been selected and why.

Should the committee continue to be involved after an auditor has been selected?

The audit committee should stay involved. It should oversee the preparation and review drafts of the audit reports prior to issuance. A member of the committee should be designated to maintain day-to- day liaison with the auditors. At the conclusion of the audit, the committee should determine if another audit should be performed, and, if so, what type, when and by whom.

What will the auditor expect?

0 An organized, timely and well-documented closing of the munic- ipality’s books, including adequate supporting documentation and reconciliation of accounts;

0 Clerical assistance in typing requests for confirmation and ob- taining documents from the files;

0 Availability of key personnel to obtain an understanding of the municipality’s operations and systems;

0 Professional treatment of the auditing staff; and 0 Adequate working conditions. The auditor is a resource that may be used throughout the year to

provide advice and help solve problems. The presentation of finan- cial statements with an auditor’s report enhances the municipality’s credibility in the investment community. It may increase the number of bidders for municipal securities and affect the interest rate that must be paid.

In conclusion, a municipality can use to advantage the suditors’ independent, objective approach. Their judgment and opinions can and should be used to effect change, resolve issues, meet the public’s demand for information and improve the efficiency of municipal govern men t.