Hartzheim Statements – from the Auditing Firm of Moss Levy Hartzheim – on 2012 City Audit

By: Libi Uremovic , November 03, 2013 | Original Article at Patch.com

Craig Hartzheim of the Auditing Firm of Moss Levy Hartzheim attended the October 15, 2013 City of Beaumont Council Meeting to discuss the 2012 GAAP Audit that is dated
September 25, 2013. The 2012 GAAP Audit is on the City website here:
http://www.ci.beaumont.ca.us/DocumentCenter/View/17614

Below is an audit of the statements made by Mr. Hartzheim. The audio transcript referenced can be heard here: http://www.ci.beaumont.ca.us/index.aspx?NID=212.

47:50 Mr. Hartzheim starts speaking about the Auditor’s Report.

CAPITAL ASSETS & DEPRECIATION

48:22 Hartzheim: “First of all; let me start with pages 1-3 of your audit. It’s our Independent Auditor’s Opinion Letter/Report….”

48:45 Hartzheim: “…The one anomaly in this Audit is that it’s qualifying the governmental activities which ya kind of have to break down with your daily perating  funds that you’re operating under the modified accrual basis of accounting and the current resource measurement focus; meaning day to day you’re
basically a cash basis. You’re operating money in/money out; what can you get in/what can you get out on a short term basis. Back in 2003/2004 I believe the City was required under GASB 34 to create some new funds, some new reporting guildelines which make you report under full accrual which is the economic resource measurement focus which means it entails all long term assets and all long term liabilities. The one thing the City did not do was follow through
with that GASB. They did not do an appraisal or give a value to its infrastructure assets. Meaning streets, roads, curbs, gutters, street lights storm drains, things of that nature.”

50:00 Hartzheim: “So our audit
report basically qualifies our opinion saying that your governmental
– only your governmental under the full accrual method is not in
accordance with GAAP. And that’s the one anomaly. Otherwise we give
you a clean opinion on all your other funds.”

Hartzheim is telling Council that
‘only’ the City’s government activities are not in accordance with
GAAP as if it’s a small fraction, but that’s all of the government
activities. The Audit states the City uses the accrual method on
page 23 Note 1c. ‘Accrual’ is a method of accounting and has
nothing to do with the topic – which is that the City falsifies
their Capital Assets.

Page 1 paragraph 3 of the Auditor’s
Report states: “..the City has not recorded capital assets within
its governmental activities, and accordingly, has not recorded
depreciation expense on those assets.”

The statement implies that the City
isn’t recording the assets, but the problem is that the City is
grossly overstating the assets. Page 5 Statement of Assets lists
Capital Assets at $54,337,729 – which is 45% of total assets and
is a material misstatement on the Financial Statements.

83:00 Hartzheim: “As far as
depreciation and net assets; you focused on depreciation, but the
bigger issue is the value of the infrastructure that needs to go on
there. Where depreciation might happen straight line over 50 years
it may only effect $2 million of net assets, but the net assets that
are decreased might be $100 million. If you’re talking right of
ways, streets, curbs, gutters, storm drains though; you’re taking a
look at depreciation as a small part of the annual bottom line, but
you’re neglecting to take the bigger part – the undepreciated
assets – that’s not included on there. I don’t know if that
answers your question. It doesn’t?

Kapanicas: “Mayor/Council – One
of the items the Auditor brought up is the, for lack of better terms,
is the inventory of all our streets. We’ve been working on it for
about a year and we expect next year – year after that to have a
full inventory. One of the issues is that some of our roads were
built around 1923 by WPA. We’re costing those out, we have a
pavement management program that we’ll bring to a future meeting to
show we do not depreciate down past 50% because we keep adding
more money into our roads. The Engineer will tell you a road last 20
years. That means that road that was built in 1923 should have been
gone 7x’s ago. So it’s, we’re going to see we will be able to get
that financial; that will be able to start until mid 2000’s and it
was a boondoggle for engineers and consultants because they’ll charge
you quite a bit of money to come in and do that inventory especially
the old cities, so we’ve done it internally to save funds. It’s just
taking a little bit longer because of that. All the new roads have
been costed and the sewer improvements have been costed because they
are new. It’s the old roads, it’s the old curbs, gutters, sidewalks.
I know some of the sidewalks don’t count, but it’s part of all those
different infrastructures all those lines in the streets. In fact;
one of these will be able to tell how those happen because we’ll know
when the street was dedicated. Some of them were settled over 100
years ago and that’s one of the things the directors will show.
Again, we just have to dig into our accounts, go through old
newspaper articles to figure out when the property was original.

87:00 Kapanicas: “One question to
the Auditor; once we put that in there – that’s going to raise our
Fund Balance up quite a bit more because now we have an asset – is
that correct?”

Hartzheim: “Yes. Not your Fund
Balance, but your Net Assets, yes.”

Kapanicas: “Net Assets. And Net
Assets over Liabilities equals Fund Balance – that’s correct?”

Hartzheim: “No it’s not. Fund
Balance is a term used for your government funds and they’re under
the modified accrual. Net Assets are now going forward it’s called
‘Net Position’ is what’s referred to in your full accrual. So it’s
only going to effect your government-wide savings. So your Net
Position.”

93:00 Hartzheim: “Depreciation is
in the Beaumont Utility Audit because we have the infrastructure, we
have the sewer lines and the sewer plant. I don’t know if you missed
in my presentation that we qualify the governmental activities
because there’s no depreciation, because there’s no infrastructure.
We made a comment in our audit report about that. We do think it’s
material. It is material. We do think it is a factor, but they
don’t have it yet, so we can’t do anything but qualify our opinion
saying: ‘it’s not in accordance with GAAP’. There is a scope
limitation there.”

Alyward: “If I could expand on that
a little. Craig talked about government funds and the measurement
focus being modified accrual. The measurement focus for the
utility funds is full accrual. We account for the sewer plant as a
business basically where we’re charging residences for the costs of
operating that business. Included in that is the depreciation of the
assets. Once those assets go away they have to be replaced and
that’s part of our sewer fees, our monthly sewer charges, and our
connection fees that is used to replace that sewer plant.”

Kapanicas: “That’s per State rules,
right? We have full accrual on business type and modified accrual,
right?”

Alyward: “Yes.”

…we do not depreciate down
past 50%”
is not proper
accounting procedure. The City can not create their own depreciation
schedule and can not keep assets on the books past their useful
lives.

$21.5
MILLION ADVANCE TO RDA SUCCESSOR AGENCY

Also listed as an asset on the
Statement of Net Assets is $21.5 Million with the notation: ‘Advances
to RDA Successor Agency’. When questioned about this amount
Hartzheim replied:

1:35:00 Harztheim: “As far as the
RDA, the $21 Million. It will be collected, hopefully, from the
State of California. The Dept. of Finance, the State Controller.
They’re the ones now in charge of collecting property taxes and
releasing them to the successor agency to pay their debt. That $21
Million is considered a debt of the RDA to the City. No one knows at
this point whether is State going to accept it or not. But
right now it truly is I believe that’s the only debt the RDA has.

Most RDA’s what they used to do; they used to get a couple initial
years of loans from the city to get going then they would issue tax
allocation bonds to do the work. And those were established debt of
the RDA. And as far as the RDA and the Dept. of Finance with the
State says; we recognize those tax allocation bonds, but we’re not
going to recognize all of your advances that the City gave to the
RDA. Beaumont is different in that it never issued tax allocation
bonds, it strictly loaned it to the RDA to do the work, so therefore
you would think that they would recognize all of that as legal debt
of the RDA and pay it over time.”

Hartzheim is incorrect. Because the
city loaned the money directly to itself there is no chance of
recouping the funds from the State.

This is another material misstatement
on the Statement of Net Assets. The combined $21 million plus $54
million from misstated Capital Assets represent 62% of all assets
listed.

LAIF
ACCOUNT

Hartzheim was questioned about the $10
million listed on page 34 Note 4. Hartzheim’s response and the
conversation between him and Alyward is transcribed below:

81:20 Hartzheim: “As far as the
LAIF Account; how many LAIF statements did you look at? I think what
you’re missing is there’s an individual account for PASIS which the
City operates as an Agent for and that’s around $9 million. I don’t
know if you got that LAIF Statement. That’s reported under the
agency funds. So that plus your $1.8 Million I think will be $10
Million. Is that correct? I mean; not looking at what he’s talking
about; that’s hard for me to determine. Bill, would that be
correct?”

Alyward: “I don’t think we’ve ever
provided any LAIF Statements for PASIS. I believe the discrepancy is
period that they’re looking at: 06/30/13 we had close to $10 million
in LAIF. 06/30/12 we had $1.8 million. For 06/30/12 we
had $1.89 (million).”

Hartzheim: “So that does not include
PASIS – what they’re talking about?”

Alyward: “The Financial Statement
does.”

Hartzheim: “The Financial Statement
does.”

  1. Alyward is correct – it was the
    06/30/13 LAIF account that had $10 million in the account because
    the State seized the Bond issued in May, but the 06/30/12 LAIF
    account had $1.8 as of 06/30/12. This is in reference to the
    06/30/12 audit, so the City should have used the $1.8 amount, not
    the $10 million figure.
  2. Hartzheim is incorrect in his
    statement that PASIS is considered part of the City’s investments.
    Those funds belong to the employees, not the City. The City also
    lists $32,932,952 as ‘Money Market Mutual Funds’ and states they are
    available in 12 months or less. This is incorrect. This
    amount is the Bond Reserves. The City has no access to this money
    and it is not considered a short term investment.Also listed under investments is
    $213,953,793 CFD Bonds. This is debt and should not be listed under
    Cash and Investments. Page 33 on the 2012 Audit lists ‘Investments
    Authorized by the California Government Code and the City’s
    Investment Policy’. Issuing Bond Debt is not an investment. An
    investment is when money is deposited to earn interest and can be
    withdrawn as needed. Bond debt is long-term debt that has to be
    repaid with interest.

Hartzheim stated: “But right
now it truly is I believe that’s the only debt the RDA has.”

Hartzheim lists the bond debt on pages 40-54. He is aware of the
debt.

INTERNAL
CONTROLS

50:20 Hartzheim: “One of the things
we also talk about in these letters is Internal Controls. Now I’ve
been sitting throughout the Council Meeting and apparently there’s
some information that people want about internal controls. And just
to give my input on what we do; all we do under a financial audit is
test the effectiveness of the internal controls. And hopefully we
find things, you know, we find everything or don’t find everything
that needs to be found on every transaction because we don’t look,
we’re not here on the day-to-day every day of the year. We can’t
give an opinion nor do we give an opinion on the effectiveness of the
internal controls or on the internal controls themselves.”

80:00 Hartzheim “As far as providing
the Internals Control Report; why wasn’t it released. That was the
1st question and the 2nd question by another
individual was on those same lines; where is the Internal Controls
Report. Our Internal Controls Reports are released to the City. If
you’ve asked them for them they should be giving you what you
request. I don’t why the hold up. I’ve never been requested to
give them to anybody other than the City. My job is to provide those
to the City and that’s it. I don’t do public records request; that
has to come through the City. As far as the current year; we have
finished our Internal Controls Audit Report and what that consists of
is a listing of findings and recommendations and observations and we
don’t release that until we get responses back from the City and
their corrective action plans on our findings. Those have not yet
been established. Some of the items the City is arguing against.
They have documents and trying to provide that for us. Others; they
wanted to know where we got our information from. We were providing
that to them over the last couple weeks. So now we’re just waiting
for Management’s response for this year; the one dated September
25th.

94:40 Hartzheim: “And as far as the
Internal Controls Report; it has not been released yet to anybody.
It’s in draft form with the Finance Department who is asking for
information to us as to how we arrived at certain things and we’re
giving them the documents then we’re asking for their responses, so
that’s where that stands.”

As of November 1, 2013 the City of
Beaumont has not released the the Internal Controls Report for the
2012 GAAP Audit, or the 2011 GAAP Audit that was released August 1,
2012.