Comptroller’s Office Addresses School District Audits

By Suvro C. Banerjee-Lahiri, Quality Assurance Manager, Ethics

New York—State Assistant Comptroller Steven J. Hancox made it clear to members of the Society’s Public Schools Committee that audit reform and a closer scrutiny of the peer review process are in the spotlight. Hancox addressed the committee on Aug. 10 with a presentation entitled “The State Comptroller’s Reform Agenda” that focused on recently passed legislation that governs the auditing of school districts in the wake of the scandal in the Roslyn school district.

State Comptroller Alan Hevesi and a coalition of legislators, officials and organizations, including the NYSSCPA, in January proposed a five-point plan designed to strengthen internal controls in school districts. The plan, which is the basis for the new legislation, calls for, among other things, an internal audit function independent of school officials, increased training of school board members and strong audit committees. Governor George Pataki on July 25 signed the legislation into law (see “School Audit Bills Become Law” in the Aug. 15, 2005, issue of The Trusted Professional).

Hancox noted that the auditing profession in general is undergoing a “bad stretch,” with accounting scandals, like those of Enron, WorldCom and Parmalat, tainting the public’s opinion of all auditors.

“It would have been a great story if Enron was discovered because Arthur Andersen quit the engagement in disgust and went to the SEC,” Hancox said. “That didn’t happen. Enron is not a good story for the profession.”

In the case of the Roslyn school district, the comptroller’s June 2004 audit uncovered extensive fraud, allegedly perpetrated by the school business officials. These improprieties had remained undetected by the district’s audit firm.

“In Roslyn, the first year we looked at under the audit, the school district paid $17,000 for the audit of their $75 million operation,” Hancox said. “If you figure out the total hours, and what work you need to do on the internal controls, computer system and some level of testing, you’ll probably be paying only $6 an hour to do that work … or somehow you’re going to need to cut corners.”

Hancox said that the audit firm circumvented the testing of the internal controls in place at the district by assessing the control risk for the engagement at maximum, while simultaneously failing to increase substantive testing.

“There are two sides of the profession: the standard setters and the practitioners,” Hancox said. “The standard setters talk about things like fraud, internal control, evaluation of internal control. They provide standards and guidance for interpretations of the standards. The practitioners try to meet those standards with a minimum amount of work possible. … So we have to find the balance between these two.”

Noting that the Roslyn audit had been peer reviewed and had received a clean report, Hancox called into question the peer review process to which current school district auditors are subject.

“The question becomes, ‘How effective is the peer review process that occurs?’ There is no question in my mind—no question, I think, for anyone who looked at the audit of Roslyn—that this was an inadequate audit. So how did it pass clean?”

As an example, Hancox pointed out that when the OSC’s auditors inspected the accounting records of the school district, they found that the fraudulent expenditures were charged to general business accounts annually through the booking of journal entries totaling millions of dollars at year-end. The state comptroller’s team found that these journal entries were never checked by the auditors. Hancox also mentioned that his team found that the firm had neglected to review payment documents during its test of transactions. When the OSC looked at some vouchers and the corresponding cancelled checks, the payees on the two did not match. The vouchers listed legitimate payees, but the checks were actually made out to credit card companies to pay for the personal expenses of the district employees.

The Society also has called for changes to the audit peer review process in the form of elevated standards.

“The Society wholeheartedly agrees that peer review needs to be strengthened, made part of a more comprehensive system of quality review and be more accessible to state regulatory agencies,” said Thomas E. Riley, chair of the Society’s Quality Enhancement Policy Committee and the Society’s president-elect.

In closing, the assistant comptroller stressed the importance of the difference in the concept of materiality as it applies to audits of public entities versus audits of corporations.

“In the public arena,” Hancox said, “materiality does not just depend on dollar amounts, because public trust is involved.”