ORDER-2021-60 : Request for informational session with independent audit firms Powers and Sullivan, CPA and Clifton/Larsen/Allen

Transcript (~25 min @ 13:00)

Speakers identified by voice; unnamed voices are numbered within this recording. Auto-caption text — verify against the video.

▶ 12:34 Jeff McNaught: And yes. Now, before I read off the first order, I just want to make a note for our guests that are here speaking. And that is just to say, please don't pay attention to all of us who may be raising our hands at any time. Counselors may be getting in line to ask questions. You don't need to stop in your statement or your answer. You can continue on. I'll be tracking the hand raisers and you don't need to stop unless I alert you or the clerk alerts you to do so. So that being said, first up on our orders this evening is Order 2021-60. It's a request for an informational session with an independent audit firm, Powers and Sullivan. And I am a co-sponsor of this order, but I'm going to hand it over to President Cinella, who's the maker of the order, to explain what this order means.

▶ 13:40 Christopher Cinella: Thank you, Chair McNaught. You bringing folks into the room? So the thought on this

▶ 13:54 Christopher Cinella: a year ago was that I wanted to bring them in just to simply educate a mostly new council at the time so ahead of our budget season. Of course COVID hit and then everything got kind of put on hold but but nonetheless, I still think it's important to learn about what they do at their firm, what they look for, and then maybe how that may or may not correlate into our credit ratings. But just as a reminder, this is not meant to be a budget hearing, but more about just the process that they conduct. I also understand in the order we have Clifton, and Alan, but they couldn't be with us this evening. So hopefully we'll schedule something with them in the future. So thank you.

▶ 14:45 Jeff McNaught: Thank you, President Cinella. That being said, we have our auditor, Mr. Della Russo in the room, and we have Mr. Powers from Powers and Sullivan. Mr. Della Russo, we'll let you take the floor first to introduce our guest and what we may be hearing a little bit about tonight.

▶ 15:06 Speaker 6: good evening um can you hear me yes thank you yes it's uh i appreciate being here this evening and uh it um to the maker of the order i i thank him um i believe that this is actually perfect timing to bring in the outside auditor um jim powers this is his first year as the partner for the city of melrose um the former partner retired who spent years working with us and we're very fortunate to have him we're just as fortunate and i'll argue even more so having mr palo is here who has a relationship with approximately 80 cities and towns or more and he also has relationship with the department of revenue division of local services and it allows us to really be, in our own way, a partner with the outside auditors. This insight that he can bring to the table for the City of Melrose is invaluable. It's not often you get not only a great audit from him, and I consider them exceptional, but you also have the ability to work with someone that interacts with the Department of Revenue on a regular basis and that makes our job um that more uh important and meaningful um he can provide insight that others just simply can't so without further ado welcome jim i appreciate you having

▶ 16:38 Speaker 7: yeah come here tonight thank you patrick again my name is jim powers from powers and sullivan Audit partner for Powers & Sullivan. I've been working for a long time, let's put it that way, for well over 30 years. This is what our firm does all the time and it's like Patrick said, we audit communities as small as Gosnold, which is the smallest community in the state, as large as the city of Springfield, and everybody in between. We audit, like Patrick said, approximately 80 cities and towns, and probably another 40 or 50 regional school districts, water and sewer districts, special governments, et cetera. That's the focus of our firm, and it ends up being a very nice niche for us as we go through and service Melrose and all of our municipal communities. patrick asked me here tonight to kind of give an overview of the audit process itself what we audit responsibilities etc um and i know constantly that you said um there might be hands being you know uh put up to ask a question etc i don't mind being interrupted all the way through this to me is a an open forum and works best that way with again we we have just a limited number of attendees from the standpoint of who's participating in that so if we get stuck on something and you want to drill down um here as long as you want me or here's little as you want me as we go through this um i uh sent over to kristen a um a powerpoint presentation i have not used webex before how do i get that up if you want me to put that up

▶ 18:34 Speaker 1: i'm going to make you the presenter mr powers yeah you should be able to share your video

▶ 18:43 Speaker 1: screen across the powerpoint you should be able to share that all right i can see myself a little bit

▶ 18:57 Speaker 7: over here yeah all right all right because can everybody see the powerpoint yes yes okay i'm I'm sorry, I just can't see it on my screen. This is just a general presentation. The first 20 pages or so of this presentation is looking at it from 10,000 feet as opposed to drilling down. The last eight or nine pages, it's into a little bit more detail that I just put that in there for everybody to read. If Kristen wants to send the presentation to everyone, that would certainly be helpful. We can discuss the last pages, but there's required communications with those charged with governance that we have to give either management or councilors, mayors, etc., depending on the environment. It just goes over detail of an example of the type of information that we send over at the end of the audit. To stop the process, we just have to discuss what's audited. Objective, review the audit process, discuss roles and responsibilities of the city and the audit firm. What do we audit as we get through this? We're hired to audit the city's annual financial statements presented in accordance with generally accepted accounting principles. I highlighted cities for a specific reason. One of the misconceptions a lot of times is that although we assist the team to put together the financial statements, we have the infrastructure to do that. We do 150 of these per year, so we're pretty good at putting that together. But these are the city's financial statements. They're not the auditor's financial statements. Patrick takes responsibility for 100 percent of what's in the financial statements, including the statements, the notes to financial statements, the adjustments that need to be made to convert from the UMIS basis of accounting all the way through. All we own in the financial statements is our audit opinion. Just wanted to make sure everybody understands that. Similar to, if you're not familiar with governmental financial statements, and I apologize if you do, but some of you may not, so I'm just going to go a little bit basic. Here is that if you're familiar with commercial financial statements, regular business, et cetera, there's a group out there called the Financial Accounting Standards Boards, which sets all the rules and regulations on how the accounting and the financial statements and the presentation of such is conducted for all commercial enterprises. The offshoot to that happened 30 years ago or so that created the Governmental Accounting Standards Board. And the reason for that is they, although many things are similar, there are things that are different in governments and how it's treated. You don't have a profit motivation. In Massachusetts, it's illegal for the city or town to, in effect, go bankrupt or close its doors. and so there's different ways to take a look at things where all of a sudden we see we have seen in the past large companies in effect go bankrupt but you won't see the city of Melrose going out of business you may have financial difficulties but you'll still be able to continue and people will still go to school police and fire protection so with that being said there's different rules on some of the items that are contained in the financial statements and that's why you have a governmental accounting standards board and the acronym is GASB that's part of that and what GASB does is it provides a consistent accounting treatment of a government's activity now Melrose is in Massachusetts and in Massachusetts the department of revenue division of local services establishes the rules for the financial activity and that's different than rhode island it's different than every other state in the union everybody gets to decide how they how the municipalities governed by the particular state uh reports their financial activity in massachusetts from your activity you get free cash etc and so what the governmental accounting standards board that says for all intents and purposes what a city of town does is pretty much similar regardless of the state you're in but they have to set up in effect a consistent accounting treatment so that users of the financial statements stakeholders or say moody's or an investor in your bonds etc can compare the city of melrose to the the city of Peoria and every other city or town throughout the nation, if you didn't have that consistent accounting treatment, you wouldn't know how people were treating, in effect, that particular activity and you think you're making a decision based on one thing, but it's actually different. What happens is that as part of this, the Massachusetts Department of Revenue, through law and regulation, established what's called the Uniform Municipal Accounting System, UMass. Different than UMass College, but UMass is the name of that. That creates a consistent budgetary basis of financial reporting for all our communities. As you know, as you go through, you have a general fund which you go through is looking at the finances that go through and say, we've got free cash, we've got to balance our budget every year. We have a recap, we have a water enterprise, we have a sewer enterprise, we have the Mount Hood golf course, etc. There's a lot of funds that are maintained by Patrick on his ledgers in accordance with the UMass accounting system. They're separated by funds for a reason. Not everything's a general fund operation. you get a lot of grants in for school operations, for other things as you go through. And for statutory compliance, the DOI has established reasons for every one of those particular funds and whether or not they're legally able to be established by any city or town. The foundational ledgers, the UNIS ledgers that you go through, the things that you do day to day, the budget that you passed, we audit that. I consider that the foundation for all of these financial statements when we get to the GAAP-based financial statements that contains 95% of what's audited. It's what you do, it's how you live and breathe, and it's how you account for everything. For all intents and purposes, the UMIS basis of accounting is a cash basis system, Meaning that you recognize, and again, with some minor variations, but you recognize revenue when you receive it. So, even though you might have a receivable for taxes, if it's not paid by June 30th, the recognition of revenue is deferred to the following year when you actually collect it. That's not the same thing that happens on a GAAP basis account. You budgeted expenses for the year and what you paid during the year plus any warrants that were processed in the 1st, 15 days of July is accounted as an expenditure for that particular budgetary period. And if there's anything else that may be carried forward, it's incumbent from a budgetary basis of accounting. And so what happens from there is that we have a cash based financial statement. that when we convert over to the GASB reporting model, there's a series of journal entries that is used to convert to the GASB reporting model that's layered on top of it. What is in the GASB conversion process? The UMass reporting model is the foundation and that doesn't change. We audit that. We go through that in detail and I'll talk about some of audit procedures that we use a little later in this presentation. But what happens is that there's a series of journal entries, as I said, to convert UMass to both the modified accrual basis of accounting and the full accrual basis of accounting. Now, these entries that are completed, the conversion entries, are not completed by the audit firm. They're completed by Patrick and his team to give us as part of that and some of these entries are in the umis basis of accounting they don't really recognize any long-term assets long-term liabilities in the financial reporting model so you have fixed assets capital assets reporting and you need to report that in the gatsby reporting model you know say if you built a new school for 100 million dollars In the UMIS basis, it's not part of your reporting model to figure out free cash, etc., but it's obviously an asset, you know, similar to your house, that has value to that and it's depreciated over the next, say, 50 years, and so there's a net value for those fixed assets. In order to create and buy and build that particular school, you would have had to take out long-term debt. Every year, the UMIS basis and what you budget in the general fund is just the debt service principal and interest on the long-term debt but it doesn't record as a liability in your fund-based financial statements that particular liability second vacation time that's earned by your employees through june 30th that's a long-term liability has to be recorded i think everybody uh and correct me if i'm wrong does everybody kind of realize that the there's a huge unfunded liability for your net pension liability that has to be funded by 2040 and that isn't reported right now on your fund-based statements to umass the same thing we can net other post-employment benefits in effect all of your employees when they retire earn a benefit that the city has agreed to pay a portion of their health insurance for the rest of their lies based on specific decisions from a statutory standpoint and what the city decide to do for that particular liability and then there's other things for landfill liabilities and reporting deferred inflows and outflows oops okay and so what we do is when we audit that each one of those adjustments that are given to us by management we audit those independently and layer that on top of the foundation to develop and create the fund-based statements according to GAP and the accrual-based statements also. The actual basic financial statement, what's included in there, if you had a copy of it, basically what we own is our independent auditor's opinion. It basically states that our responsibility is to express an opinion on the financial statements based on our audit in accordance with auditing standards. What you want and what you have received is what's called the unmodified or clean opinion and basically states that the financial statements present failure in all material respects. The financial position changes in financial position and then cash flows in accordance with accounting principles generally accepted in the United States of America and that's in effect promulgated by the GASB. and uh what it also says kind of repeat what i said earlier that you are responsible meeting management is responsible for the content of these financial statements and not the auditor um a couple of things that are important there's part of the independent auditor's opinion if you read that uh middle bullet uh point it says an unmodified opinion states the financial statements are presented fairly in all material respects that doesn't mean that it's perfect okay You spend well over $100 million a year when you add everything up, $90 million general fund plus your enterprise funds and special revenue funds, etc. Therefore, we go through when we audit and there's a materiality standpoint that we don't look at everything. We're not looking at a department that may collect $12,000 per year in cash receipts. Because if you have a $12 million fund balance, and they misrepresented or misreported the $12,000 they collected in the year, it's not going to change any reader's financial opinion on whether or not your financial statements are fairly presented. If it was a million two, that would be something different. But always take a look at that. We're not hired to find every error in the financial statements. We're taking a look at it with a materiality function as part of the audit. Inside the basic financial statements after that of what you own, there's a statement of net position and statement of activity that present the full accrual basis of accounting. Again, UMass foundation alleges the stock, and then add those full accrual adjustments to these. One of the things you'll notice when you take a look at these financial statements, it's usually going to show a large negative balance in net position due to the pension and OPEB unfunded liabilities. You'll eventually have to fund that. That's one of the differences between what I talked about earlier, Commercial enterprise funds, enterprise activity through the FASB would not allow this. They would go bankrupt because you're not allowed legally to carry these particular unfunded liabilities. But you are in the governments, you have over 200M dollars worth of unfunded liabilities just for these 2 items. And therefore that drives that negative. Financial position 1 of the things I heard someone talk about earlier. How does that affect your rating, your bond rating, et cetera? This is something that pretty much every city and town across the nation has a considerable liability and all the states do too. They take that into account when they're evaluating your credit worthiness and your bond rating. And depending on what you're doing for these particular items, they'll just take that into effect. There's another set of by financial statements, they're called the governmental funds balance sheet. And a statement of revenues, expenses and changes in fund balance. And they use the modified accrual basis of accounting. Inside of government, it may not make any sense to you, but. There's different statements that present 1, a full cruel basis of accounting, which I just discussed. which includes all long-term assets, long-term liabilities, all short-term assets, all short-term liabilities, and obviously the changes in financial position. But that's not how you really operate. You operate through that funds. You go through and you set your tax rate for your general fund based on what you have to pay for say debt service, and you're not raising depreciation. And so they realized, the GASB is that, These statements are very meaningful and sometimes are more important than the other statements we just mentioned to see how well you're doing from a year-to-year financial flexibility and how well your fund balance is being maintained, what type of balances your stabilization funds have. And that uses the modified approval basis of accounting, the flow of financial resources as opposed to the flow of economic resources. Same type of things that happen, but it includes things in your general fund that doesn't, as part of your UMIS fund-based, it's like stabilization funds. If you add up all your stabilization funds, they are included as part of your general fund, even though UMIS doesn't, separates that. But they had to do this to make sure there's consistent application for all communities throughout the nation, and that's evaluated and go through that process. Also, another fund-based is the proprietary fund-based statements. Again, they're full accrual, and these are your enterprise funds. They use the full accrual basis of accounting, and then Melrose is the water, sewer, mountain hood, and the ambulance enterprise funds. Again, these are prepared in the same manner as the entity-wide statements. The UMIS conversion entries are added to make the full accrual financial statements. These are different and you don't see a budget to actual on these. A GAAP doesn't allow it because they are enterprise funds. Enterprise funds, basically, from the GAAP standpoint, the GASB standpoint, they expect that the enterprise fund runs similar to a business where you recover all of your expenses, whether direct or indirect, through rates, that you charge the users, the water users, the sewer users, a fee sufficient to make sure that your budget's balanced and you have a certified retained earnings at the end of the year. .

▶ 37:30 Jeff McNaught: Mr. Powers. Yeah. I'm sorry to interrupt you. We actually have some meetings following this, so we're just going to have to recess and gavel out of this one and then come back. I'm sorry to interrupt you. We will come back to you shortly. But for the moment, I have to entertain a motion for a recess.