Audit of SD1 reports unbid work, missing info, incomplete board guidelines | Business

FORT WRIGHT, KY (FOX19)- The State Auditor of Kentucky released an audit Wednesday of Sanitation District #1 that had been requested by Kenton County Judge Executive Steve Arlinghaus. 

SD1 supplies sewage services for virtually all urbanized area of Northern Kentucky, outside Florence and Walton.

The audit says that in several instances the District ignored its own requirements that public bidding be required for purchases or projects over $20,000, made mistaken calculations in budgeting for project labor, made changes to year-end journal entries based on records that could not be found, and lacked some important oversight guidelines for the board of directors.

A statement from SD1 say the state had found them to have an effective structure for oversight and processes, although a response by the District to the Auditor said portions of the audit go beyond what Kentucky law requires in accounting, and that the District has complied with Kentucky law.  That response also attributes some problems cited by the audit to SD1's former controller.

A statement from Arlinghaus says he is pleased the audit is completed, but "I am quite disturbed such a scathing report issued by the State Auditor's Office of SD1." Arlinghaus goes on to cite unbid purchases mentioned on page 58 of the auditor's report.

The Auditor's news release is below.

SD1's news release is here.

SD1's response to the auditor is here.

A copy of the entire audit has been posted by SD1 here.

State Auditor Crit Luallen today released a special audit of Sanitation District No.1 (SD1) of Northern Kentucky which makes 72 recommendations to strengthen accounting controls, procurement, and board governance.

The audit was requested by Kenton County Judge/Executive Steve Arlinghaus to address questions about the financial management of the sewer district and its rate setting process.

SDI is the second largest public sewer utility in Kentucky and has ownership of all sanitary sewer systems in Northern Kentucky, with the exception of systems in Florence and Walton. The utility serves approximately 100,000 customer accounts.

The audit reviewed SD1 policies and procedures, records retention, rate increases, construction in progress projects, and the accounting of financial transactions. The audit covered the period July1, 2008 through December 31, 2010.

“The audit found that overall policies of SD1 generally provide an effective structure for the oversight of the organization,” Luallen said. “However, the audit points out the Board should assume a stronger role in governance and implement stronger policies governing accounting and procurement practices.”

Accounting Controls

During the course of the examination, auditors noted several instances of accounting errors and apparent lax accounting controls and oversight. The specific instances involved errors in a spreadsheet allocating labor costs to projects, significant accounting entries made without proper review or documentation, and errors in the rate setting model.

SD1 calculated the labor costs to be charged to a particular project using an Excel spreadsheet containing a formula which multiplied the hours by the applicable rates. The formula was in error resulting in 151 projects being charged excessive labor costs. SD1’s failure to recognize such a significant error in labor allocation calls into question the quality and frequency of accounting review and oversight.

Auditors recommend that all projects that were overcharged in-house labor be considered for correction through prior period adjustments.

Auditors also found there were instances of entries made to the general ledger with no supporting documentation, approval, or prior period adjustments. The SD1 Director of finance and the current SD1 Controller were unable to produce a copy of fiscal year-end June 30, 2008 adjusting journal entries or provide the details that support the year-end adjusting entries.

Auditors recommend that SD1 assure the integrity and security of the SD1 ledgers by imposing strict controls on general ledger access, by evidencing review and approval of ledger entries, and by maintaining the approved documentation supporting all entries in the SD1 ledger. Finance and accounting staff should ensure that applicable accounting standards are followed in determinations of all capital versus expense decisions.

An initial error in the 2008 “Pro Forma” model used to set rates produced erroneous sewer rate projections of 25 percent for fiscal years ending 2009 and 2010. The error was detected by staff prior to being presented to the Board and the corrected 15 percent rate increase was approved. Again, this error demonstrated the lack of proper accounting controls and the need for broader accounting and operations review and oversight of the model and rate setting process. Though the model used by SD1 to produce and evaluate rate setting scenarios appears to be a reasonable, the amount of manual input and extensive base of knowledge required to effectively maintain and use that model dictates the need for broader financial oversight and review.

The audit recommends SD1 establish a review and oversight process of the rate setting model to include additional financial related expertise as well as operations expertise and document the procedures followed to update the model and produce the various scenarios.

In addition, the examination of specific charges recorded in the Construction in Progress (CIP) account balances raised several questions as to whether treatment of those costs was appropriate and accurate. Certain charges were included in CIP account balances and eventually capitalized as assets rather than expensed in the year they were incurred.

The audit recommends that SD1 review and update its Capitalization policy for Construction in Progress to provide more detailed guidance for properly capitalizing expenditures.

Procurement

The audit found that SD1 purchased materials and supplies and procured services for the construction of a major project without following its own procurement requirements.

One Construction in Progress had over $100,000 in engineering services approved by the Board of Directors with no documentation of formal requests for proposals for those engineering services or of a review by a selection committee as required by the SD1 guidelines.

SD1 purchased $156, 349 worth of drainage pipe couplings and $228,890 of pipe directly from the contractor’s vendor without going through the competitive bidding requirements, which is required by SD1 guidelines for the purchase of materials exceeding $20,000.

The audit recommends that SD1 develop and implement, with board approval, procurement guidelines that fully comply with the Model Procurement Code and that SD1, through its procurement officer, implement procedures to ensure that the utility complies with the provisions of the guidelines.

The audit found that Construction in Progress change orders were not always preapproved by the staff, nor reviewed by the board. Internal controls and procedures related to CIP project change orders did not properly address oversight for increases to project totals.

The audit recommends SD1 management, on a regular basis, provide the board with information on all projects that are approaching the board approved amounts, including the related change orders and reasons for such increases, and that all change orders be approved prior to the work being done.

Board Governance

Auditors found that policies for the Board of Directors did not address several critical responsibilities necessary for proper and effective oversight.

There was no internal audit function that reports directly to the Board, or any independent process to receive information and resolve conflicts. Since the audit, the Board has created an internal audit function.

Auditors recommend the Board strengthen its oversight policies, including a whistleblower policy, to allow employees and customers the option of making the Board directly aware of concerns.

Auditors also recommend that the Board provide annual orientation training for new and returning Board members to ensure the members have, at a minimum, a clear understanding of SD1’s organizational structure and policies, their responsibilities as board members , as well as their legal and fiduciary roles, and the purpose of the board on which they serve.

Auditors found that SD1 had no written policies or procedures regarding the use of credit cards, reimbursements to employees, electronic backup of financial information, and fixed asset inventory.

Auditors recommend SD1 adopt a credit card usage and oversight policy and document the policy in an employee handbook.

Auditors found that ethical policies of board members and employees were not comprehensive and recommend that the board establish a comprehensive code of ethics applicable to both board members and employees and require financial disclosure statements from board members and executive staff.

SD1 has submitted a written response to the audit which is included in the report.

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