BILL ANALYSIS                                                                                                                                                                                                    Ó




                     SENATE GOVERNANCE & FINANCE COMMITTEE
                            Senator Lois Wolk, Chair
          

          BILL NO:  AB 1345                     HEARING:  6/13/12
          AUTHOR:  Lara                         FISCAL:  Yes
          VERSION:  6/6/12                      TAX LEVY:  No
          CONSULTANT:  Weinberger               

                           LOCAL GOVERNMENTS' AUDITS
          

               Imposes additional requirements on audits of local 
                                  governments.


                           Background and Existing Law  

          The federal Single Audit Act of 1984 requires that state 
          and local public agencies, which receive federal funds from 
          a variety of sources, perform a single, jurisdiction-wide 
          specific audit.  The objective is to save time and expense 
          on the part of the state and local entities, while giving 
          the federal agencies involved a more consistent source of 
          information.

          State law requires the State Controller to receive audit 
          reports prepared by any local public agency in compliance 
          with the federal Single Audit Act of 1984.  After the 
          Controller receives these reports, he or she must ascertain 
          the report's compliance with the federal act and transmit 
          the report to the appropriate state agency (AB 4334, 
          Waters, 1988).

          State law prohibits a public accounting firm from providing 
          audit services to a local educational agency if the lead 
          audit partner, or coordinating audit partner, having 
          primary responsibility for the audit, or the audit partner 
          responsible for reviewing the audit, has performed audit 
          services for that local educational agency in each of the 
          six previous fiscal years.  An appeals panel can waive this 
          requirement if the panel finds that no otherwise eligible 
          auditor is available to perform the audit (AB 2834, Migden, 
          2002).

          The State Controller believes that recent misuses of public 
          funds in the Cities of Bell and Montebello and the County 
          of Modoc indicate that the current statutory approach to 




          AB 1345 -- 6/6/12 -- Page 2



          local governments' audits is not working.  To provide 
          additional safeguards against local officials' misuse of 
          public funds, the Controller wants legislators to 
          strengthen the state laws that govern local governments' 
          audits.




           
                                   Proposed Law  

          Assembly Bill 1345 requires an audit for any local agency 
          to be made by a certified public accountant or public 
          accountant, licensed by, and in good standing with, the 
          California Board of Accountancy.

          Beginning in the 2013-14 fiscal year, AB 1345 prohibits a 
          local agency from employing a public accounting firm to 
          provide audit services to the agency if the lead audit 
          partner or coordinating audit partner having primary 
          responsibility for the audit, or the audit partner 
          responsible for reviewing the audit, has performed audit 
          services for that local agency for six consecutive fiscal 
          years.  The Controller can waive this requirement if he or 
          she finds that another eligible public accounting firm is 
          not available to perform the audit.  The bill specifies 
          that, for the purposes of calculating the six consecutive 
          fiscal years, the local agency must not take into account 
          any time that a public accounting firm was employed by that 
          local agency prior to the 2013-14 fiscal year.

          AB 1345 requires that audit reports prepared in compliance 
          with the federal Single Audit Act for any city, county or 
          special district, as defined by state law, must:
                 Be submitted to the State Controller within nine 
               months after the end of the period audited or pursuant 
               to applicable federal or state law, and
                 Comply with the Government Auditing Standards 
               issued by the Comptroller General of the United 
               States.

          If a local agency does not submit an audit report to the 
          Controller by the specified due date, AB 1345 allows the 
          Controller to appoint a qualified certified public 
          accountant or public accountant to complete the report and 





          AB 1345 -- 6/6/12 -- Page 3



          to obtain the information required.  The bill requires the 
          Controller to notify a local agency of its failure to 
          submit the audit report and give the local agency a 
          reasonable amount of time to submit the report before 
          appointing a certified public accountant or public 
          accountant.  The Controller's costs, including a contract 
          with, or the employment of, the certified public accountant 
          or public accountant, in completing the audit must be borne 
          by the local agency and must be a charge against any 
          unencumbered funds of the local agency. 

          AB 1345 requires the Controller to refer any matters of 
          unprofessional conduct, as defined in state law, and 
          multiple and repeated failures to disclose noncompliant 
          acts to the California Board of Accountancy.


                               State Revenue Impact
           
          No estimate.

                                     Comments  

          1.   Purpose of the bill  .  The City of Bell's independent 
          auditor failed to report financial abuses such as excessive 
          salaries, illegal loans, and questionable fees.  In a 
          series of audits of Bell's finances, the Controller found 
          that the independent auditor failed to comply with 13 of 17 
          fieldwork auditing standards and reported no significant 
          deficiencies in any of the city's funds.  These failures 
          suggest a lack of proper checks and balances in the local 
          government audit process.  To ensure that local 
          governments' independent auditors remain independent, AB 
          1345 requires local governments to comply with the same 
          audit partner rotation requirements that the 2002 Migden 
          bill applied to school districts.  The bill also enacts 
          common-sense reforms, including:
                 Requiring local governments' audits to conform to 
               recognized government standards and procedures, and 
                 Establishing deadlines by which local agencies must 
               submit audits to the Controller for review.  
          AB 1345 strengthens local governments' independent audit 
          processes and provides safeguards to protect taxpayers 
          against local agencies' misusing public funds.  

          2.   More independent  ?  AB 1345's requirement that local 





          AB 1345 -- 6/6/12 -- Page 4



          governments must rotate audit partners every six years is 
          identical to current requirements that apply to school 
          districts' audit partners.  This rotation requirement 
          responds to the concern that a long-standing business 
          relationship between a government agency and a particular 
          audit partner diminishes that audit partner's independence. 
           Although having a new audit partner periodically review an 
          agency's books provides some safeguards, it is unclear 
          whether a six year rotation requirement substantially 
          reduces the potential for an audit partner to be influenced 
          by the incentive of continuing to work for a public agency 
          in future years.  Is a local government audit partner who 
          can audit an agency's books in 12 out of every 13 years 
          significantly more independent than an auditor under 
          current law?  To ensure auditors' independence, the 
          Committee may wish to consider amending AB 1345 to require 
          more frequent rotations of audit partners or require audit 
          partners to take more than one year off in between 
          rotations.

          3.   Burdensome  ?  The six year rotation requirement may be 
          burdensome for some small, rural special districts.  These 
          districts often have few auditors available locally and 
          have difficulty finding other audit firms that are willing 
          to cover the costs of travelling to less accessible parts 
          of the state to perform relatively small audits.  AB 1345 
          addresses this concern by allowing the Controller to waive 
          the rotation requirement if he or she finds that another 
          eligible firm is not available to perform an audit.  
          However, this waiver may not provide much relief to small 
          special districts if the Controller determines that other 
          firms are available to perform a district's audit, albeit 
          at significantly higher costs.  The Committee may wish to 
          consider whether the additional independence generated by 
          the bill's auditor rotation requirement justifies the 
          higher costs that it may impose on some small rural local 
          governments.

          4.   Board of Accountancy's concerns  .  The California Board 
          of Accountancy (CBA) is responsible for regulating the 
          accounting profession for the public interest.  It does so 
          by establishing and maintaining entry standards of 
          qualification and conduct within the accounting profession, 
          primarily through its authority to license.  CBA, while 
          supporting AB 1345, also is proposing amendments to address 
          Board members' concerns with the bill.  Specifically, CBA 





          AB 1345 -- 6/6/12 -- Page 5



          suggests amendments to:
                 Require that only the lead audit partner, and not 
               the technical audit partner, comply with the bill's 
               six year rotation requirement.
                 Prohibit the lead audit partner from resuming work 
               with a local agency for two years, which is similar to 
               the federal Securities and Exchange Commission's 
               rules.
                 Require a local agency, as part of an audit, to 
               prepare a payroll schedule that would include all 
               compensation for elected officials and designated 
               employees paid from local agency sources.
          The Board suggests that requiring only the lead audit 
          partner to rotate every six years allows the technical 
          audit partner to act as a repository of institutional 
          knowledge, providing continuity to audits conducted by 
          different lead audit partners.  The Committee may wish to 
          consider whether the need to preserve institutional 
          knowledge outweighs the safeguards and benefits of having a 
          new technical audit partner work with an agency's financial 
          data after six years.  Requiring audit partners to wait for 
          more than one fiscal year before resuming work for an 
          agency is discussed above in Comment 2.  The Committee may 
          wish consider whether requiring a local agency to submit a 
          payroll schedule may duplicate the State Controller's 
          current efforts to compile local government compensation 
          information and could result in significant state costs if 
          the requirement is found to be a reimbursable mandate.

                                 Assembly Actions  

          Assembly Local Government Committee:  9-0
          Assembly Appropriations Committee:17-0
          Assembly Floor:                    74-0


                         Support and Opposition  (6/7/12)

           Support  :  State Controller John Chiang; American Federation 
          of State, County, and Municipal Employees; California Board 
          of Accountancy.

           Opposition  :  Unknown.   








          AB 1345 -- 6/6/12 -- Page 6