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