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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Sumi Kailasapathy (Ward 1) questioned CFO Tom Crawford’s conclusions about the travel and mileage policies at the audit committee’s Jan. 24, 2013 meeting. (Photo by the writer.)

Listed among other relatively minor matters in Rehmann’s report was a note identifying three instances of an employee who had claimed mileage reimbursement despite receiving a vehicle allowance. At a scheduled Dec. 20, 2012 meeting of the audit committee, the dual claims were described by Rehmann’s Mark Kettner as a “double dip.” Those claims were also cited in Kettner’s written report as a violation of city policy.

The Chronicle’s write-up of the auditor’s presentation late last year to the audit committee – which did not achieve a quorum on that occasion – included the result of additional reporting: Mileage claims made by city attorney Stephen Postema caused the auditor to flag the issue in his formal report.

But at the Jan. 24 committee meeting, Kettner revealed that he’d been convinced to change the wording of the note. The new wording will not indicate a “violation” of city policy. At the meeting, however, Kettner indicated that a note about this issue would still be included – with the exact wording yet to be settled. City CFO Tom Crawford’s written response to the auditor’s report includes email messages that show it was Crawford and Postema who made a successful effort to convince Kettner to alter the report’s wording.

The wording of Postema’s employment contract factored into arguments made by Postema and Crawford for a revision to the auditor’s report. When Postema made his reimbursement claims, his contract at that time provided for “travel” expenses in addition to a vehicle allowance. Postema’s vehicle allowance was eliminated late last year, as a result of his annual performance review. Also factoring into the argument for revising the auditor’s note was Crawford’s contention that the city’s written policies don’t provide clear guidance on the question.

However, at the Jan. 24 committee meeting, Sumi Kailasapathy (Ward 1) challenged Crawford on that point. [Kailasapathy was elected to the council in November 2012 – running a campaign that stressed her credentials as a certified public accountant.] She reviewed the logic and specific wording of each of the city’s relevant policies, with particular attention to the meaning of the word “travel” – and reached the conclusion that the mileage reimbursements had not conformed with city policy.

And even though Kettner has agreed to change the wording of the note in his report, Kettner wrote in a Jan. 18 response to Postema and Crawford: “… from a business practices standpoint, our conclusion (with or without the existence of a policy) was it would be illogical and, therefore inappropriate, to make mileage reimbursements to persons having a car allowance.” Kettner’s response also indicates that his conclusion of inappropriateness was not based on a review of Postema’s employment contract.

At the Jan. 24 meeting, Crawford interpreted the fact that he and Kailasapathy reached different conclusions about the appropriateness of the mileage claims as evidence that the written policies didn’t provide clear guidance.

Stephen Kunselman (Ward 3) seemed to reflect the general sentiment of the two other committee members present – Chuck Warpehoski (Ward 5) and Margie Teall (Ward 4) – in concluding that he didn’t think anyone had been trying to “game the system.” Kunselman indicated little enthusiasm for delving into the wording of Postema’s contract or existing city policies. He was more interested in making sure that the relevant policies would be revised and applied in the future – not just for the travel and mileage policies, but for the other issues identified in the auditor’s report.

Kunselman also indicated that he was keen to see the audit committee take a more active, engaged role – throughout the year, not just once a year on the occasion of the auditor’s report. The committee as a group also seemed favorably inclined toward adopting a more proactive approach. The committee’s extended conversation about the relationship of the city’s part-time internal auditor indicated that while the internal auditor would still report to Crawford, the audit committee would be looped into the ongoing issues that emerged throughout the year as they arose – instead of six months after they happened. It could result in meetings of the committee at other times besides the occasion of the annual auditor’s report.

That reflects a transition from the role that the audit committee has played as recently as two years ago. The committee did not meet at all during that year, even to review the FY 2010 auditor’s report – because audit committee chair Stephen Rapundalo declined to call a meeting. Kunselman complained at the time about the lack of a committee meeting. Rapundalo was not re-elected in 2011 – when he had faced Jane Lumm, who received more votes than Rapundalo that November.

Travel versus Mileage

The note in the auditor’s formal letter, previously conveyed to the city last year, reads:

Employee Expense Reports. We reviewed various employee expense reports to ensure reimbursements were properly supported and approved. We noted in three instances, that an employee was requesting and receiving mileage reimbursement while also receiving a car allowance, which violates City policy. After further inquiry, it was determined that the City became aware of this situation during the year and has since implemented procedures to address this issue.

Travel versus Millage: Background

As The Chronicle previously reported, a request of the city made under Michigan’s Freedom of Information Act revealed that city attorney Stephen Postema made three claims for mileage reimbursement, despite having a vehicle allowance. One was for a professional meeting in Grand Rapids, while the other two were for court appearances in Cincinnati and Lansing. [.pdf of city of Ann Arbor response to initial FOIA request] [.pdf of follow-up city of Ann Arbor response with additional, corrected data on vehicle allowance amounts]

Up until his performance review in November 2012, Postema’s employment contract provided for a vehicle allowance:

Section 2.14 Car Allowance. Employee shall receive a car allowance calculated at $330/per month.

The resolution approved by the city council as the result of the city attorney’s performance review – which included a salary adjustment upward that is just slightly less than the value of the car allowance – explained the elimination of the car allowance this way:

Whereas, The City Attorney has offered to eliminate his contractual car allowance of $330/month as of January 1, 2013, as has been done with the City Administrator’s contract;

Even though the “whereas” clause seems to invite the conclusion that city administrator Steve Powers also had a vehicle allowance specified in his contract, and that it was also eliminated in the context of a regular performance evaluation, that’s not the case. Previous city administrator Roger Fraser had such an allowance, but Powers, who took over the city’s top job in the fall of 2011, never had such an allowance in his contract.

The initial discussions of the city attorney’s performance review are handled by the council’s administration committee. It currently consists of Sally Petersen (Ward 2), Margie Teall (Ward 4), Christopher Taylor (Ward 3), mayor pro tem Marcia Higgins and mayor John Hieftje. At the time of Postema’s performance review, former Ward 2 councilmember Tony Derezinski served instead of Petersen. Higgins did not respond to an emailed query from The Chronicle asking if she was aware of the issue with Postema’s mileage claims at the time of Postema’s performance review. Hieftje responded to that same query saying he was not aware Postema had made mileage claims.

In his response, Hieftje also insisted that the current review of travel and mileage policies was not caused by Postema’s mileage reimbursements:

I should note that going forward there will be a clarification of city policy regarding mileage reimbursement. However, this was not triggered by Stephen’s being reimbursed but as an overall response to something that came up as a minor issue in a “clean” audit.

In an interview with The Chronicle on Jan. 11, 2013, Hieftje explained his written assertion in part with the idea that Postema does not report to the city administrator but rather to the city council. [Under the city charter, the city council hires and evaluates two positions – the city attorney and the city administrator.] From that, Hieftje concluded that whatever policy revisions might be undertaken now by city administrator Steve Powers would not affect Postema’s reimbursements, because Postema’s reimbursements would be governed by his employment contract.

However, Postema’s employment contract explicitly states that reimbursement is to be made under standard city procedures:

Section 2.2 Business Expenses. Employee is authorized to incur such reasonable budgeted travel, cell phone expenses, entertainment and other professional expenses as are necessary in the performance of his duties. The City will reimburse Employee for such expenses in accordance with standard City procedures.

Hieftje seemed unaware during the Jan. 11 interview that the city’s response to The Chronicle’s record request had linked Postema’s mileage claims to the auditor’s note. At the conclusion of the interview, after being shown the records, Hieftje conceded the connection between Postema’s mileage claims and the policy review.

Travel versus Mileage: Significance of the Note

Tom Crawford, the city’s chief financial officer, led off the Jan. 24 meeting of the audit committee by establishing some context for the auditor’s note. He referred committee members to a written response he’d provided them. [.pdf of Crawford's response to auditor's letter]

Crawford reviewed how the basic result of the audit, communicated in the SAS (Statement of Auditing Standards) No. 114 letter, had been essentially a clean audit with two deficiencies. This year the letter had included notes on other matters, of a type that Crawford said he wouldn’t normally expect to see: “I don’t usually look for these comments down here.” The letter typically includes things like a material weakness or other deficiencies, but this year the letter included some other matters, that in Crawford’s experience are usually mentioned orally to staff – the CFO or the city administrator.

Crawford’s portrayal of the notes in the letter is consistent with that of auditor Mark Kettner’s remarks about them – when he presented the report to two audit committee members on Dec. 20, 2012. From The Chronicle’s report:

Kettner described a hierarchy of problems that an auditor can find: deficiencies, significant deficiencies, and material weaknesses.

There are also “other matters” that an auditor is not required to put into writing, he said. But they have to be communicated at least orally, and you have to document who was told and what they were told. So Rehmann’s practice is to include other matters in the management letter, because it’s easier to write down the information.

On Jan. 24, Crawford indicated that typically, the staff just deals with the orally-communicated notes in this category. But because this year the notes were in writing, Crawford said, he wanted to respond in writing. He indicated that a response would be sent to the auditor as well. He wanted the committee to understand that “We take this stuff seriously.”

Crawford welcomed any comments the audit committee members had on the written response. He continued by drawing a distinction between “council policies” and “administrative policies.” Crawford was recommending that the policies be reviewed and he indicated that the revisions to the policies were included in the written response that he’d provided to the committee. He invited questions from the audit committee.

Travel versus Mileage: Definitions

Sumi Kailasapathy (Ward 1) led off questions by focusing attention on the second page of Crawford’s written response. It portrays a lack of consensus among city finance staff about the appropriateness of the mileage claims. But Kailasapathy focused on Crawford’s contention that the city’s written policies don’t provide clear guidance. From Crawford’s written response [emphasis added]:

In evaluating this issue, staff first looks to legal contracts as a guiding document and secondly to administrative policies for guidance. The above employee with 3 trips had an employment agreement (see attached) with the city at the time of travel that included two separate provisions for an auto allowance and for reimbursement of travel expenditures. A review of the travel & mileage policy (see attached APP #504 & #505) revealed they do not provide clear guidance on how to handle this situation. Some finance staff reasonably believed a mileage reimbursement appeared like the same expense was being reimbursed for twice and raised the issue to the CFO. Meanwhile some supervisors and administrators operated with the belief that the vehicle allowance was for ordinary and customary travel within the city/county but not for less frequent out-of-town trips necessary for travel, training, etc.

Kailasapathy indicated that she’d reviewed the administrative policy on travel and on employee mileage reimbursement. She quoted from Policy 505:

The City of Ann Arbor shall pay mileage reimbursement for authorized business travel when an employee uses their personal vehicle.

Kailasapathy said that for her, that sentence is unambiguous: If you use your personal car, then you will be provided reimbursement and that is called “mileage reimbursement.” But in Crawford’s description of the issue, he’d used “travel” repeatedly, Kailasapathy pointed out. That, she felt, was incorrect, because you could come to different conclusions depending on whether it’s considered mileage reimbursement or travel.

By way of additional background on the issue of travel versus mileage, in response to an initial request made by The Chronicle under the FOIA, the city of Ann Arbor did not produce any official “City of Ann Arbor Travel Expense Report” forms for the three mileage claims made by Postema. For other claims, however, such forms were produced. Because the wording of the request had been somewhat vague, The Chronicle made an additional request asking specifically for those forms, if they existed.

After additional back-and-forth with the city in connection with that request, The Chronicle was able to establish that “City of Ann Arbor Travel Expense Report” forms were not submitted for Postema’s claims. Instead, an electronic submission was used, consistent with reimbursement for mileage by city employees who use their personal vehicle for city business. In terms of the distinction Kailasapathy was drawing, the claims appear to have been considered mileage reimbursements, as a opposed to travel expenses. [.pdf of records associated with Postema's mileage claims].

Kailasapathy then appealed to the city’s travel policy, which defines travel in a way that she indicated is consistent with IRS rules, which includes the need to stay overnight:

2.2 General Travel Limitations – Subject to budget limitations, all employees are permitted to attend, subject to authorization by the service area administrator or his/her designee, City work-related overnight conferences, seminars, training, certification programs, continuing education, or other similar work-related educational or professional events. The number of employees from a service area allowed to attend the same travel function will be at the service area administrator’s discretion. Overnight travel will be used only for opportunities that cannot be achieved locally.

Kailasapathy said it’s important to be clear about what it means for someone to be using their personal vehicle. She contended that if an employee has a car allowance, then it is for operating that car – and to her that’s clear. She told Crawford she was disappointed that he was saying the city policies don’t provide clear guidance. She felt the guidance is clear – and that travel and mileage reimbursements are very clearly defined. If you have a car allowance and you’re asking for a car allowance, then you’re asking for the reimbursement for “one and the same thing.” Kailasapathy ventured that a car allowance is not “to park the car in front of your house to look pretty.”

Travel versus Mileage: Intent of a Vehicle Allowance

Earlier in the back-and-forth, Crawford had asked if Kailasapathy was drawing a conclusion about any employee who had a vehicle allowance – and whether “the vehicle they acquire” is still their personal vehicle. Crawford seemed to indicate a view that, to him, it’s reasonable to interpret the intended use of a vehicle allowance to be exclusively the acquisition of a vehicle, not including the operation of that vehicle for businesses purposes.

Responding to Kailasapathy’s “to look pretty” comment, Crawford again reiterated his position that a vehicle allowance was intended for acquisition of a vehicle, saying that if an employee uses their vehicle allowance to acquire a vehicle, that doesn’t make it a city vehicle. Because it’s still their personal vehicle, Crawford contended, the employee could be reimbursed for mileage. He then allowed that it’s at least not clear if an employee with a vehicle allowance could be reimbursed for mileage – because the mileage policy doesn’t mention a vehicle allowance.

Kailasapathy compared the situation to receiving a house as part of your compensation but still claiming rent as an expense. Crawford said he thought Kailasapathy was assuming that the purpose of the vehicle allowance is for the acquisition and use of that vehicle. Crawford asked her what she felt the point of the car allowance was. “Using your personal car to do business,” she replied, giving examples like going to court to defend the city in a lawsuit. Crawford responded by saying, “That’s interesting … that’s not written anywhere what the allowance is for.”

At that point Stephen Kunselman (Ward 3) said, “It’s an outright perk, basically – right? Monetary benefit, car allowance, no strings attached.” Margie Teall (Ward 4) seemed to chafe at Kunselman’s characterization of the car allowance as a perk, saying, “It’s a ‘perk’ if you want to call it that …” Crawford indicated that the vehicle allowance has been used in different ways by different city employees. He was trying to point out that Kailasapathy’s assumption – that the vehicle allowance was meant to cover the operation of a personal vehicle when it’s used for city business – is not recorded anywhere in a written city policy.

Crawford stated that the mileage reimbursement that Postema had been seeking was subject to his contract, which has two clauses that mention travel. At that point, Kailasapathy appeared ready to argue about whether the clauses in Postema’s contract on travel would, in fact, justify the mileage reimbursement. However, Teall indicated no enthusiasm for that kind of detailed debate: “You know, I don’t want get into a contract issue. … I don’t think we can have that discussion here.” Kunselman also indicated he didn’t want to entertain that discussion.

Kunselman came back to the auditor’s note that indicated there had been a “violation” of city policy. It wasn’t the role of the audit committee to interpret the city policy, but rather to have management address any unclarities. Kunselman said it sounded like there were a lot of changes being implemented with respect to car allowances. By way of additional background, in an email to The Chronicle published previously, city administrator Steve Powers wrote:

During the past year, I have removed vehicle allowances from the compensation for service area administrators.

The remaining vehicle allowances are for employees, such as property appraisers, where the use of personal vehicles with an allowance is more advantageous to the City than paying mileage or using a city vehicle.

Kunselman indicated he felt this was the right direction to go, but didn’t want to spend a lot of time looking back and getting bogged down.

Travel versus Mileage: Revision of the Letter

Kunselman was, however, interested in having the wording of the auditor’s letter revised, because Kunselman felt that the statement that there had been a “violation” of city policy was inaccurate. Based on the material provided in Crawford’s response to the auditor’s comment, auditor Mark Kettner had already agreed to revise the phrase that referred to a policy violation – as a result of a phone conversation he’d had with Crawford and Postema.

In Kettner’s written response to Crawford and Postema, he agrees that the phrase “violates city policy” is incorrect and acknowledges that he was not given Postema’s employment contract for review in reaching his conclusion that the mileage reimbursement was not appropriate. Kettner explained his conclusion this way:

As I also stated in our conversations, from a business practices standpoint, our conclusion (with or without the existence of a policy) was it would be illogical and, therefore inappropriate, to make mileage reimbursements to persons having a car allowance. This conclusion is in the absence of knowledge of an agreement that would reasonably identify that payment of both mileage reimbursement and car allowance is acceptable and appropriate.

The question the audit committee was disinclined to settle explicitly is whether Postema’s contract is an employment agreement that identifies payment of mileage reimbursement and car allowance as acceptable.

At the Jan. 24 meeting, Kettner indicated that he’d be willing to change the phrase “which violates city policy.” After “all the extra stuff that has occurred,” Kettner said he concluded that “there is not a policy per se that says ‘You shall not get a mileage reimbursement if you have a car allowance.’” But he would keep the note in the letter – because even though it involves a small dollar amount, it’s an issue involving policies, procedures and contracts, and he felt the city needs to address it and figure out what to do about it. That’s the whole purpose of it, he said.

In the context of the overall city audit, Kettner said, the mileage issue was really a tiny issue. Crawford indicated he felt that the city’s approach to identifying problems seemed to be working. Crawford indicated that there were differing views by city staff about how the policies should be interpreted, and the fact that he and Kailasapathy had different views on interpretation supported the idea that the policies weren’t completely clear. He said the issue had come to light during the audit – in a minor way – and whenever those issues come to light, the staff re-visits them. Teall added that the review of the policy had already started.

Travel versus Mileage: Recommendations

Recommendations by Crawford responding to the audit note on travel and mileage reimbursements include:

• Clarify and revise the city’s travel policy to reflect expectations for reimbursement when an employee receives a vehicle allowance.
• Clarify and revise the city’s travel policy to require travel reimbursement requests for the city administrator and city attorney to be approved by the Council Administration Committee Chairperson.
• Establish a vehicle allowance policy to clarify expectations for what a vehicle reimbursement is intended to be used for.
• Communicate these policy updates with staff and have Service Area Administrators responsible for ensuring consistent treatment across the organization.

Responding to a query from Kailasapathy, Crawford indicated he did not necessarily think that travel reimbursements for mileage should be tied in the future more explicitly to an overnight requirement – because it could create a perverse incentive for employees to stay overnight, thus incurring even greater expense to the city. Kailasapathy countered that whether the travel expense was appropriate or not was already subject to a supervisor’s review. In the case of the city administrator and the city attorney, Crawford pointed out, the recommendation is that their travel requests in the future be subject to review by the council’s administration committee.

Role of the Audit Committee

The travel and mileage issue took about 25 minutes of the Jan 24 audit committee meeting, which lasted about an hour.

In the remaining time, the committee discussed some of other items in Crawford’s written response. For example, they discussed the challenge of implementing regular password changes by employees, when they must log on to several different systems – the sheer number of passwords could result in a sticky-note strategy of recording passwords, which is also not desirable.

However, the main focus of the remainder of the meeting could be summarized as dealing with the future role of the audit committee. It was prompted by Rehmann’s observation about the way the city’s internal auditor reports:

We noted through inquiries of various City employees that the Internal Auditor organizationally reports through the Chief Financial Officer. We recommend that the City review this procedure and determine if this function would be more effective if the Internal Auditor reported directly to the Audit Committee.

But the consensus of the audit committee at the Jan. 24 meeting seemed to be that the internal auditor should not report in an organizational sense to the audit committee. That is, the city council would not want to explore adding a third employee – in addition to the city attorney and the city administrator – to the two they already supervise. But committee members felt that the internal auditor should be able to communicate to the audit committee, if the internal auditor didn’t feel comfortable communicating a concern to the chief financial officer or the city administrator.

The audit committee as a group indicated a desire to be kept apprised of information that comes to light in the course of the year. For example, Crawford noted that the city has an anonymous fraud hotline, and when tips come in through the hotline, they’re investigated – but he pointed out that not many tips come in. The audit committee would be kept apprised of those tips and the outcome of the investigation.

The committee also indicated a desire to meet again, well before next fall, to review how the recommendations from this year’s audit are being implemented. Chuck Warpehoski (Ward 5) seemed to reflect a consensus, however, that the committee did not want to distract the financial services staff from their current preparations for the budget.

In the shorter term, the audit committee will be meeting again before the next regularly scheduled city council meeting on Feb. 4, 2013. No date or time for that committee meeting has been announced. Audit committee member Sally Petersen (Ward 2) was not able to attend the Jan. 24 meeting, and according to some other members of the committee, the next meeting will give Petersen an opportunity to make sure her concerns are addressed.

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