Ann Arbor FY 2013 Audit: Clean Report

An Oct. 24, 2013 meeting of the Ann Arbor city council’s audit committee featured just one item – a review of the draft audit report prepared by auditor Mark Kettner of Rehmann Robson, working with city staff. And overall the report on the fiscal year concluding on June 30, 2013 provided $2.4 million of good news for the city’s general fund.

Oct. 24, 2013 Ann Arbor city council audit committee meeting. From left: auditor Mark Kettner (Rehmann Robson), Margie Teall (Ward 4), city chief financial officer Tom Crawford, Sumi Kailasapathy (Ward 1), Sally Petersen (Ward 2) and Stephen Kunselman (Ward 3). Arriving after this photo was taken was Chuck Warpehoski (Ward 5).

Highlights from that draft FY 2013 report, which has now been issued in final form to the city, include an increase to the general fund balance from about $15.4 million to about $16.2 million. The $800,000 increase contrasts to the planned use of roughly $1.6 million from the general fund balance in the FY 2013 budget. About $200,000 of the increase was in the “unassigned” fund balance. The rest of it fell into restricted categories, CFO Tom Crawford explained at the meeting.

The result of the audit, in the new GASB terminology, was an “unmodified” opinion – which corresponds to the older “unqualified” opinion. In sum, that means it was a “clean” audit. The concerns identified last year had been addressed to the auditor’s satisfaction.

Members of the audit committee were enthusiastic about the $2.4 million better-than-budget performance for the city’s general fund, which had expenditures budgeted for $74,548,522 in FY 2013.

However, Crawford cautioned that he is “not crazy about the versus-budget comparison” because actual expenses will generally be less than budget anyway. He also pointed out during the meeting that just $1.3 million of the $2.4 million better performance are recurring items – things that he would expect to continue going forward.

While the year-end audit provided some good news, Crawford said he recommended that the city try to have about $1 million to $1.5 million of “good news” each year, because the city needs fund balance to pay for non-recurring items.

Crawford and Rehmann auditor Mark Kettner walked the committee through some of the highlights that still, on balance, had led to the good news. Revenue for services was almost $400,000 less than budgeted, due in part to lower-than-budgeted fire inspection fee revenue. Fines and forfeitures – including parking tickets – were $300,000 less than budgeted. And investment income was off by $400,000. But state shared revenue came in at $500,000 better than budgeted. [These figures come from page 36 of the final audit report.]

“The general fund had pretty much a year like you’d hope it would,” Crawford said. The year ended with an unassigned fund balance of roughly $14 million, or about 18% of expenditures – and 18-20% of expenditures is where the fund balance should be, he said. “So we’re really in a good spot.”

Challenges facing the city this coming year include the implementation of the new GASB 68 accounting standard starting in FY 2015, which begins July 1, 2014. That standard requires that most changes to the net pension liability will be included immediately on the balance sheet – instead of being amortized over a long time period. The GASB 68 standard must be implemented for an organization’s financial statements for fiscal years beginning after June 15, 2014.

Crawford prepped the committee to see a probable drop in the pension plans funded ratio – from about 82% to 80% – because of the five-year window used to book losses. The last of the losses in 2008-09 will be on the books this year, but after that the city would expect to see improvement every year, Crawford said. This most recent year, the pension fund had an 11% return, which is four points better than the 7% return the fund assumes for planning purposes.

Two of the city’s funds were highlighted by Crawford at the Oct. 24 meeting as having potential difficulties associated with the GASB 68 standard – solid waste and the public market (farmers market). For the public market fund, Crawford floated the idea to the audit committee that it could be folded back into the city’s general fund, on analogy with the golf fund. Starting this year (FY 2014) the golf fund has been returned to general fund accounting.

The consensus on the audit committee was that the full city council should receive a brief presentation on the audit report – either at an upcoming working session or a regular meeting. [.pdf of final audit report released on Nov. 15, 2013]

Prior to new committee assignments to be made by the post-election composition of the city council, the audit committee consists of: Margie Teall (Ward 4), Sumi Kailasapathy (Ward 1), Sally Petersen (Ward 2), Stephen Kunselman (Ward 3), and Chuck Warpehoski (Ward 5).

This report includes additional description of the Oct. 24, 2013 city council audit committee meeting.

Two Sets of Statements

The only item on the audit committee’s agenda was to review the draft audit report. Chief financial officer for the city, Tom Crawford, first reviewed how the city did from an operating perspective last year. He stressed that the document being reviewed by the committee was a draft report.

Crawford reminded committee members that the audit report presents the city’s financial condition in two different sets of statements. One set is the government-wide statements, which use full accrual accounting for everything. Those statements are used for comparability across communities and give you a sense of how the city is doing over time, Crawford explained. The second set of statements is the fund statements, which are used for budgeting.

Government-wide Statements

On a government-wide basis, the equity – or what is now called “net assets” of the city – is about $1.058 billion, Crawford said. That’s an increase of about $28 million from the prior year, according to the final audit report. Most of that equity is tied up in fixed assets, he said, like streets and other assets – $890 million of it, according to the final audit report.

And of the $1.058 billion in net assets, the final audit report shows $81.7 million is “unrestricted.” Even though it’s “unrestricted,” Crawford explained at the committee meeting, that amount is still subject to the requirements of the funds containing the money. The water fund, for example, accounts for some of those unrestricted funds – and the water fund is restricted to water-fund type uses. Of the total amount of “unrestricted” funds, the general fund’s unassigned portion is $14.3 million – which is basically what it was last year. But it reflects a slight increase, from $14 million to $14.3 million, Crawford said.

The government-wide statements show that over time, the city is in a strong financial position and there’s a moderately positive momentum. There’s an increase of 3% in unrestricted net position, he said. “Government-wide statements indicate that Ann Arbor is financially healthy,” Crawford concluded, “and will continue to be so.”

Sally Petersen (Ward 2) asked about the city’s long-term liabilities, which the draft report indicated had increased by $11 million. Crawford explained that the debt for which the city’s general fund is accountable had increased by about $7 million – primarily due to the First & Washington parking structure project. That project had required $9 million of bonding, but the city had also had some “pay downs,” Crawford explained, reducing that $9 million to $7 million. The city had done some debt issuances – but off the top of his head, he thought they were all re-financing of existing debt in water and sewer bonds.

Street Millage Fund: Minimum Fund Balance Requirements

Sumi Kailasapathy (Ward 1) asked if the street millage fund was required to have one year’s worth of millage revenue as fund balance – possibly under the city charter or under an ordinance? Crawford responded to Kailasapathy’s question by noting the street fund showed $18 million in fund balance. He pointed out that $9 million had been spent out of the street fund last year, when it showed a fund balance of $25 million. The minimum requirement for fund balance in the street millage fund is $9 million, Crawford said – as a part of the city’s fund balance policy [that is, it's not a city charter or an ordinance requirement].

From left: CFO Tom Crawford, Sumi Kailasapathy (Ward 1), Sally Petersen (Ward 2).

The logic behind that $9 million figure is that it’s equivalent to about one year’s worth of millage revenue, Crawford said. Because that millage is renewed every five years, maintaining one year’s worth of millage revenues in the fund balance gives the city some flexibility in case the millage isn’t approved by voters when it’s up for renewal. Kailasapathy observed that the $18 million currently in the street millage fund balance equated to two years’ worth of millage revenue, so the city had twice the required amount. Crawford responded by saying, “You do, and you don’t.”

The fiscal year ends in the middle of the construction season, Crawford explained, so there’s fund balance that is shown, but there are ongoing projects that are not yet closed out. It doesn’t get booked until a project gets closed, he continued. So a portion of the street millage fund balance, above the $9 million, is really just a matter of timing, he said.

Kailasapathy wanted a rough estimate of how much in additional, as yet unclosed projects would “hit” this year.

Crawford indicated that he’d need to ask other staff. He based a rough guess on the kind of fund balances the street millage fund typically showed before money was conserved in anticipation of possibly needing to pay for a substantial portion of the East Stadium bridges repair out of that fund. He ventured it could be $3-5 million of projects that would be paid yet. He felt that going forward, the kind of fund balances the council could expect to see in the street millage fund would be in the neighborhood of $10 million to $13 million.

General Fund

Crawford noted that while the city’s general fund balance had increased by around $800,000, that compares with a FY 2013 budget that had planned to use $1.6 million from the fund balance. So that was about “$2.4 million in good news versus budget,” Crawford concluded. He’d reviewed that amount to look at some of the variances, he told the committee. About half of the good news was recurring items, he said. So about $1.3 million of that better performance are things that he would expect to continue going forward.

For example, state shared revenue came in higher than budgeted – by about $500,000. But about $1.1 million of the “good news” was for non-recurring items, he cautioned. “I would say it was a very good year for us; we didn’t use the fund balance we’d planned.” He recommended that the city try to have about $1 million to $1.5 million of good news each year, because the city needs fund balance to pay for non-recurring items, he said.

Responding to positive comments around the table from committee members about the $2.4 million better-than-budget performance, Crawford cautioned that “I’m not crazy about the versus-budget comparison.” That’s because the budget is always going to be higher than actuals, he said.

But Stephen Kunselman (Ward 3) pointed out that in the two-year budget planning, the projection for FY 2015 had been for a shortfall. So Kunselman ventured this year’s outcome would help balance that out. Crawford’s response: “Yep.”

Mark Kettner, the auditor, also pointed out that the value is in having a conversation about it. He ventured that you’d typically estimate low, particularly on items like state shared revenues, but you’d usually be realistic on the property taxes.

Crawford countered Kettner’s remarks by saying that in his view, the city was not budgeting that conservatively any longer. He said he was actually trying to hit the budgeted numbers. There are some council policies that will create good news, he said. The parks fairness resolution, for example, meant that the parks department got extra money this year. The parks department didn’t have plans to spend that, but the parks department might need those resources in the future. In a dry year when less mowing was required, maybe they wouldn’t need it, but that extra amount might be used in a future year, he said.

Kettner pointed out that on revenue items, charges for services were almost $400,000 less than budgeted. Fines and forfeitures were $300,000 less than budgeted. Investments were off by $400,000. So on the revenue side, that was offset by the increase in the state shared revenue increase. All of it had been made up on the expenditure side, he explained. Some of that is likely simply delayed spending.

Crawford offered some detail on the lower-than-budgeted fees for services. Not as much revenue was received as had been budgeted for fire inspection fees, he explained. Parking ticket revenues were down $200,000, he continued. About $700,000 had been budgeted for bond user fees, but those fees wouldn’t be collected because the city was using some state financing tools.

Committee members were interested in knowing why parking ticket revenue was under budget. Crawford indicated that parking ticket revenue had been trending down for the last couple of years but had stabilized. He attributed the lower numbers to some vacancies, saying he thought community standards was down one or two people over the last year, so they’re not writing as many tickets.

On the expenditure side, Crawford continued, the city never knows how many people are going to retire. And when they retire the city has to pay out their leave balances. Fewer people retired than the city forecasted last year, and that amounted to $500,000 just for that item. For some items you use your best guess, and it doesn’t work out, he said.

More General Fund

The golf fund, which had been budgeted for about a $500,000 subsidy, turned out to require $200,000 less subsidy than that, Crawford said.  That won’t be an issue in the future, he noted, because the golf fund has now been folded into the general fund for FY 2014.

The dangerous buildings fund – a $250,000 allocation that the city’s building official Ralph Welton can tap to demolish blighted properties – had not been spent down, Crawford said. That shows up as “good news” versus the budget, he said. Kunselman interjected that the fund is meant to be self-replenishing, as costs are recovered from property owners, and that the council won’t be adding money to that fund.

Crawford allowed that was accurate, but for this year, a certain amount had been planned to be spent and it wasn’t spent – that’s why it showed up as “good news.” Kunselman responded by saying, “The fact that he didn’t spend it is a problem.” He said he knew of some significantly blighted properties that needed to be torn down. Kunselman asked if there were any houses torn down and any liens paid back. Crawford wasn’t sure, but did indicate that the city had finally gotten the Michigan Inn situation settled this year. [That property is located on Jackson Road, on the city's far west side.]

Second floor bathrooms in city hall are being renovated.

There was a delay in the asbestos remediation and handicapped accessibility work in the city hall bathrooms, Crawford reported, so that work had shifted into FY 2014 – about $300,000. There were a number of items like that, he said. A brief discussion ensued about which bathrooms on the second floor were now open and which were under construction.

Summarizing the general fund condition, Crawford said, “The general fund had pretty much a year like you’d hope it would.” The year ended with an unassigned fund balance of $14 million, or about 18% of expenditures – and 18-20% of expenditures is where the fund balance should be, he said. “So we’re really in a good spot.”

Enterprise Funds

Reviewing the enterprise funds, Crawford noted that the water and sewer funds have very large fund balances – $81 million and $111 million. But most of that is tied up in capital assets, he explained. The water fund has about $12 million in unrestricted funds and the sewer fund has about $18 million. For both of those funds, the minimum fund balance is about $4 million, Crawford said.

The amounts are greater due to the rate smoothing that the city uses, where a 3-4% increase is applied each year – so the fund balance will build up and then go back down. In addition, about $20 million in capital projects are planned for each of those funds, Crawford said. Those two funds are pretty much on track, he said. They show an income of $6-7 million.

Turning to the golf course and the airport funds, Crawford noted that both funds showed a slight “deficit” – which was the unassigned deficit. If the assets of the funds were included, then there’s not a deficit, he explained. During the last year, the city was required to create a deficit elimination plan for the airport fund. Now, however, Crawford reported that the state recognized that the state’s definition of “deficit” needed to change to reflect the actual viability of a fund. So the state had issued a new standard back in December 2012, he said.

At this point, it wasn’t clear if a deficit elimination plan would be required for the airport. He described the fund as “holding its own,” saying that it made some money last year. It’s currently showing a deficit because of the way the city books a loan that was made to the fund, he said. “I’m not concerned about it, from that perspective,” Crawford concluded.

However, Crawford cautioned that GASB (Governmental Accounting Standards Board) 68 is coming and that’s going to be something that might challenge the city. GASB 68 will be part of the council’s budget discussion, Crawford said. It’s a new accounting standard for pensions, he said.

Kailasapathy inquired about the municipal service charge that’s applied to the different enterprise funds – water compared to golf, for example. For the water fund, personnel services were about $6.6 million and the fund had about $400,000 in municipal service charges – the “overhead” that’s allocated. She allowed there wasn’t a 1-1 correlation between personnel charges and the municipal service charge, but the amount charged for the golf courses looked disproportionate.

Crawford said that issue had been discussed in connection with the golf task force. The MSC calculation is done by an outside consultant, he said, and it’s based on the best metrics the city can get. The golf fund employs a lot of temps, he said, so there’d be significant allocation for recruiting and human resources – more so than the water fund, which has low turnover. For golf, the MSC will disappear anyway, he said, because the golf fund is being folded into the general fund.

Kailasapathy asked why the solid waste fund showed such a large fund balance – $11 million. Kettner noted that property taxes for an enterprise fund like the solid waste fund are not recorded as operating revenue. Rather, it shows up as non-operating revenue. By its operations alone – its fees as revenues against its expenses – the fund does show a loss. But that’s covered by the property taxes. So it’s “substantially break-even,” Kettner concluded. He described it as an example of the difference between accrual and modified accrual accounting. Crawford noted that the solid waste fund is the only enterprise fund that receives property tax dollars.

Enterprise Funds: Public Market Fund

Crawford also drew the committee’s attention to the public market fund, which has an unrestricted reserve of $485,000. It has lost money, however, he said. That fund is one that needs some attention this next budget year, Crawford said. “It’s borderline, so we need to look at that one in our next budget discussion.”

Kunselman asked if the market fund – which is associated with park activities – could be compared to the golf enterprise fund as far as being general fund activities that are accounted for in an enterprise fund.

Crawford allowed that there were many analogies between the market fund and the golf fund. The market fund is a parks-type activity that is the only enterprise fund that the parks system has, he said. “It’s not quite there in the long term, particularly when GASB 68 comes.” Kunselman observed that the farmers market is in the Ann Arbor Downtown Development Authority district, quipping: “Imagine that!”

The stormwater fund shows about $16 million in fund balance, Crawford. Solid waste has $27 million in its fund balance, he noted. The fund balance policy for the solid waste fund calls for $2 million, but he noted there are a number of issues associated with that fund that had been discussed in connection with last year’s budget. That fund has a significant GASB 68 issue, he added, and there are some liability issues with the city’s closed landfill.

Crawford said he wasn’t concerned about any of the funds, but noted that the market fund was one that deserved some attention.

Later, toward the end of the committee meeting, the conversation came back around to the market fund. That needs to be on our radar, Crawford said. Kunselman asked why it was put into an enterprise fund in the first place. Crawford said he had no idea, because it happened so long ago. 

Crawford said he wanted to discuss that with the public market advisory commission, because he doesn’t want to get out in front of that group. Teall indicated that the park advisory commission also should be kept apprised.

Part of the issue, said Crawford, is parking revenue. The new contract between the city and the Ann Arbor Downtown Development Authority – which transfers to the city 17% of the gross parking revenues of the public parking system – changes the allocation of parking revenue to the public market fund. But the real issue for the market fund, Crawford stressed, is GASB 68.

Petersen worried that putting the market fund into the general fund might mask the need for operational improvements. Crawford noted that the public market advisory commission and park advisory commission would apply scrutiny regardless of the fund.

[The public market advisory commission includes: Aimee Germain, David Santacroce, Jillian Lada, Karlene Goetz, and Lindsay-Jean Hard.]

Pension System, VEBA

The pension system investments had an 11% return last year. The system operates on an assumption of just a 7% return, so that was a “pretty good year for the pension system,” Crawford said. The system is funded at about 82%, he said. Because of the timing for the audit report and when the actuaries are finished with their work, he’d chosen to include the 2012 pension system numbers in the audit report, Crawford said. He was just now receiving the actuarial numbers as of June 2013, and that’s where the 11% will come through.

In general, the investment losses from 2008-09 roll through during a five-year window, and the last year of that will be FY 2015. So Crawford is expecting the percentage funded ratio to drop from 82% to around 80%. He said he thought that would be the low point, and after that the council would see improvement, reflecting the gains that had been realized since the 2008-09 down period. During that period, about 25% of market value had been lost, he explained, and that loss was recognized over a period of five years. The last year of that will be FY 2015.

On average, the city is about ready to hit the positive years that the pension system has enjoyed after that. The VEBA (Voluntary Employees Beneficiary Association) was not as severely impacted back in 2008-09, Crawford explained, because it didn’t have that much money in the market – as it was only funded at about the 35% level. So when the market went down, there wasn’t as much money to lose. The pension system, however, had been previously funded at 100%.

The VEBA funding policy and the actuals are in a really good position, Crawford said. “All you need is time,” he said, and the contribution policy will work so that “you will be funded one day.”

Crawford also mentioned the Ann Arbor housing commission, but noted that the housing commission situation was something that the council had been fairly well briefed on. [For background, see Chronicle coverage: "Work Progresses on Public Housing Overhaul."]

The Future

The audit report reflects an economic firming up of the city, Crawford said. Kettner noted that there’d been a recent management conversation, and he’d suggested that Crawford present the city’s own financial statements. Another thing they’d discussed was whether they’d like a presentation to the full council – from him and the CFO.

Crawford said that the council in the past would have committees dive into things and it would be passed along to the full council. About a possible presentation to the council, Crawford said: “If we did it, I’d liven it up a little bit,” but he quipped that it’d be “no more exciting than today.”

Petersen wanted a presentation from both Kettner and Crawford to the full council. There’d be balance if both presented the information, she felt. She told Crawford: “You’re a city guy and you’re always going to want to tell us good news …” Crawford countered by saying this was the first year he’d been able to deliver good news, quipping that the feeling was unfamiliar to him.

The committee then weighed having a presentation at a work session or a regular meeting. Kunselman said that he didn’t want a lengthy PowerPoint presentation. Crawford indicated that he could do a “one-pager” and be done in 10 minutes. Kunselman felt that would be appropriate. Committee members discussed how the audit report would be provided to all councilmembers.

Crawford noted that he’s focused on GASB 68.

Auditor’s Remarks

GASB 63 and 65 standards modified the terminology used in the audit report, Kettner told the committee. Instead of “net assets” for full accrual statements, “deferred inflows of resources” and “deferred outflows” are now used. And the term “net position” is used for the equity in the full accrual basis statement. In the modified accrual statement, which is the governmental accounting, the term “fund balance” is still used.

From left: Auditor Mark Kettner and Chuck Warpehoski (Ward 5).

Also, there are some new headings and some changes to the order. The opinion is no longer called an “unqualified” opinion. Instead  it’s an “unmodified” opinion. So the city’s audit this year will again be an “unmodified” or a “clean” opinion, Kettner said. That should be the expectation of management each year, he added.

The audit report includes an introduction, plus the basic financial statements and then the notes. Kettner walked the committee through the components of the report, including the Comprehensive Annual Financial Report (CAFR). He noted the statistical section is really interesting. He also pointed committee members to the section with notes: Why did the debt go up $9 million? It’s in the notes, he said.

The good news is that it’s only the end of October, he said. That’s about a month to a month and a half ahead of schedule for the audit. The first year of his firm’s service as auditor (last year) was more time consuming. He figured that in subsequent years, the timing would be similar or even earlier.

The management letter, like last year’s letter, includes three pages about the conduct of the audit. After the “auditor-ese” there’s “nothing there” of concern, Kettner said. The GASB 68 issue is “really really complex,” he said. It’s going to be a challenge for the city as well as for his auditing firm, Kettner said. The good news is that Crawford and accounting services manager Karen Lancaster are up to speed on the issue, he added. That’s a matter of “cake in the oven.”

There’s no attachment B, Kettner said, because there were no findings. No adjustments were made by the auditor that weren’t already identified by the city, he explained.

Management issues from last year had been addressed to the auditor’s satisfaction, Kettner concluded.

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