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November 24, 2017

10/31/2017 1:53:00 PM
Local officials worried about auditing change
Daily News

A policy change by the office of the Illinois Comptroller could end up costing local governments thousands of dollars.

The word "audit" is scary. It conjures up thoughts of judgement and consequences, when in reality it is simply a review of how money is received and spent. It is the auditor's job to report the accuracy of management's accounting.

In June, the comptroller's office notified municipalities that it will no longer accept audit statements prepared using the cash basis or modified cash basis accounting method.

This policy shift challenges existing law and decades of precedent. Most local municipalities currently use a modified cash accounting audit. which is acceptable under Generally Accepted Auditing Standards (GAAS), and the Illinois Municipal Code requires audits to be GAAS-compliant. Cash basis accounting is GAAS-compliant.

Requiring that audit statements must be submitted based on the accrual basis method of accounting will add unnecessary complexity and costs to municipalities that use cash-basis accounting for their audits, experts say.

Brian Bradbury of Kemper CPA Group, Robinson, has been conducting audits for local municipalities, school districts, and other government agencies for years. His office was one of the first to bring this policy change to the Illinois CPA Society's attention. The group has organized a protest and responded formally to the comptroller's office about this policy change.

Bradbury believes changing to a modified accrual accounting from modified cash could double the cost of an audit and report, which could have a significant impact on small agencies.

Bradbury explained the agency would have to convert its modified cash accounting to modified accrual, then full accrual to create an acceptable report.

"An auditor can't do that," Bradbury said. "Someone, either another CPA firm or in-house accountant, has to make those conversions."

Based on costs reported by small municipalities and school districts, audits cost around $4,000 to $5,000 or more depending on the size and complexity of the agency. Bradbury believes that cost would double with a conversion, or at least it would cost 30 to 50 percent more if done as a package.

For those unfamiliar with accounting practices, the accrual accounting method records revenues and expenses when they are incurred, regardless of when cash is exchanged. The term "accrual" refers to any individual entry recording revenue or expense in the absence of a cash transaction.

Businesses typically use one of two basic accounting methods in their bookkeeping systems, cash basis or accrual basis. The most appropriate method depends on sales volume, whether or not you sell on credit and business structure.

The cash method is simple. Income is recorded when it's received, and expenses are reported when they're actually paid. The cash method is used by many sole proprietors and businesses with no inventory.

Most local governments use a modified cash accounting system. When the policy change was first suggested in 2014, it was estimated that 75 percent of agencies were using modified cash accounting. The number is now believed to be closer to 40 percent in anticipation of the change.

Bradbury explained a big part of accrual accounting is decided by management of the agency.

"Modified accrual receivables need to be accounted for to pay current obligations." Bradbury said. "That number or value is established by management or the agency, is it 60 or 90 days out. The problem is management needs to make that decision not the auditor."

In the case of a municipality or government agency, receivables include property taxes, which are promised, but not received until later in the year. "Then you have to change to full accrual, and 90 days now included 12 month obligations and receivables," said Bradbury. "It is a receivable in January, a recorded liability, but not in the 60 day category,"

Other challenges come up when you get into pensions and post employment liabilities. Questions of limited equality and disclosure come can arise, Bradbury noted.

"Management has to discuss and analyze the numbers before they can make a statement for the auditors," he added.

"Management" in a municipality or government agency are elected officials who may or may not full understand accrual accounting, but can grasp basic cash accounting. So an agency may end up believing it has more money than it really does.

A prime example of the challenge has been school districts. For the past several year school districts have had to create budgets based on the promise of timely payments from the state, but the state has prorated or been late with those payments.

Through accrual accounting, everything would look fine - promised money is "accrual" - but there is not cash to pay expenses, which have been promised to be paid.

Throughout the summer and early fall, Illinois Municipal League staff has tried to work with the comptroller's office to preserve the use of cash-basis accounting when filing annual municipal audits.

In early October, HB 4104 was filed. It would amend state statute and clarify explicitly that annual municipal audits are allowed using either the accrual or cash-basis method of accounting.

State Sen., Dale Righter, R-Mattoon, is also working on legislation that would make either cost or cash accounting acceptable.

"The simple fact is some communities are small enough not to have to deal with cost accounting," said Righter. "Cash based accounting gives taxpayers an accurate enough view of a city's finances."

What could also come into play if the policy is not changes, are fees and penalties municipalities might face if an audit report is found to be non-compliant. Fees are charged by the day and could add up to thousands of dollars quickly.

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