BOARD OF SUPERVISORS

BUDGET ANALYST

1390 Market Street, Suite 1025, San Francisco, CA 94102 (415) 554-7642

FAX (415) 252-0461

September 15, 2003

Honorable Tony Hall, Chair of the Rules Committee
And Members of the Board of Supervisors
City and County of San Francisco
Room 244, City Hall
1 Dr. Carlton B. Goodlett Place
San Francisco, CA 94102-4689

Dear Supervisor Hall and Members of the Board of Supervisors:

The Budget Analyst is pleased to submit this Management Audit Report on the San Francisco Controller's Office. This management audit was authorized by the Board of Supervisors of the City and County of San Francisco on May 13, 2003, pursuant to its powers of inquiry defined in Charter Section 16.114. Motion Number M03-81 directed the Budget Analyst to "conduct a management audit of the Controller's Office on a priority basis." The stated purpose of the management audit was "to ensure that the entity providing advice and counsel to other City departments about efficient management and performance (the Controller) is itself managed efficiently and performs efficiently . . ."

As part of this management audit, the Budget Analyst interviewed the Controller, Deputy Controller and managers from each of the seven divisions in the Department; section managers; and, selected unit managers and staff. The Budget Analyst also interviewed representatives from other City and County Departments, responsible Controller officials from other jurisdictions, and representatives from the State Controller's Office who have certain regulatory responsibility over Controller activities.

In addition to interviews, the Budget Analyst reviewed the City Charter, various State statutes and local codes; examined various documents, reports and work products prepared by the Controller's Office; reviewed the audited financial statements for the City and County of San Francisco, including the management letters prepared by the outside auditors for each of the last three fiscal years; obtained and analyzed various data and financial reports from the City's FAMIS accounting system; and evaluated the effectiveness of the various tools used by the Controller, his managers and staff to oversee the activities of the organization.

The management audit was conducted in accordance with Government Auditing Standards, 1994 Revision, by the Comptroller General of the United States, U.S. General Accounting Office. In accordance with these standards, we have noted a number of the more significant accomplishments of the Controller's Office during the past several years, which are described below:

Expansion of the Controller's Role

During recent years, the current Controller's Office has assumed a greater analytical, management reporting and consulting role in the City. While many of these added functions have stemmed from requests made by the Mayor and the Board of Supervisors, others have resulted from the Controller's professional goals to enhance financial management and the performance of departments within the City. Although these activities are largely non-mandated, the efforts made by the Controller and his staff are commendable.

Implementation of GASB 34

The Controller's Office successfully converted to a new financial reporting model, pursuant to Governmental Accounting Standards Board (GASB) 34 provisions affecting financial reporting, a year before the required deadline. The conversion significantly changed the ways in which financial data is reported within the City's Comprehensive Annual Financial Report (CAFR), given the unique requirements of GASB 34. Further, the Controller's Office successfully implemented alterations to its financial reporting processes to meet the new accounting standards of GASB and provided training to all departments on the GASB 34 model. The Controller's Office received a Government Finance Officers Association Certificate of Achievement for these efforts.

Accountant Intern Program

The 1649 Accountant Intern Program that was devised by the Controller's Office, has been recognized as a successful mechanism for improving the quality of accounting personnel throughout the City. Designed, operated and maintained by the Controller's Office, the program was created to improve accounting staff training and abilities. The program offers beginning accountants extensive training for 18 months, with two 9-month rotations in different departments. Since its inception in 1995, the Intern Program has graduated 59 of 67 participants. Approximately 40 percent of those participants were already City employees when they entered the program.

Payroll and Personnel Services Division

The Payroll and Personnel Services Division has been successful in attaining its goals and meeting performance measures. The division met their 98 percent accuracy target in the disbursement of approximately 29,000 paychecks for each of the 27 pay periods in FY 2002-03. The Payroll and Personnel Services Division also successfully issued all W-2 forms to City employees within 14 days of the calendar year, approximately two weeks ahead of the deadline.

Budget and Financial Analysis

The Controller continues to produce monthly, 6-month and 9-month Budget Status reports that provide useful tools for City policy makers and financial managers. These reports provide reasonable projections of revenue and expenditure trends, and in combination with the three-year budget projection report prepared jointly with the Mayor and the Budget Analyst, provide the basis for assessing the overall financial health of the City and financial planning.

Controller's Response

The Controller states in the cover letter to his response that "The Controller is pleased that there are few or no findings or recommendations regarding most of the core functions of the office, such as budget preparation and monitoring, property tax operations, payroll, vendor payments, and bond and financial statement reporting activities." This management audit includes findings and recommendations on many of the more significant responsibilities of the Controller's Office, including its primary function of overall financial management of the City. Many of the recommendations focus on key activities of the department and the infrastructure that is necessary to ensure that the financial integrity of the City remains strong. It is unfortunate that the Controller's written response does not specifically address each of the 69 recommendations contained in the report, instead of focusing on his reaction to the evidence which the Budget Analyst has used to support the findings and conclusions contained herein.

He also states that, "We apologize in advance if the comments do not exactly match the text of the Analyst's final report due to the rushed nature of this audit and the limited time available for both the Analyst to prepare and the Controller to respond to this audit." The Budget Analyst would like to point out that the management audit was not "rushed." Although the project was expedited at the request of the Board of Supervisors, the Budget Analyst was able to accomplish the required work in accordance with professional standards by dedicating a highly qualified and senior group of auditors. The project team included a manager with over 22 years of experience managing audits in San Francisco and in other jurisdictions throughout the western United States, a CPA with experience working in an Auditor-Controller's Office in another California County, and other senior Budget Analyst staff with considerable experience providing audit services to the San Francisco Board of Supervisors. Because the Budget Analyst was able to dedicate exceptionally well qualified personnel, the management audit was successfully accomplished in the expedited manner requested by the Board of Supervisors.

The Controller also suggested that findings related to increased reimbursement of costs would likely yield insignificant additional revenues for the City. Specifically, the Controller stated that "The Analyst spent a considerable amount of time looking at how we could increase the ability of the City to increase reimbursement for costs from other agencies or within the city structure... The Analyst's report, while not finding any significant items that have been missed, encourages us to focus on this area."

In fact, we believe that "significant items" have been missed by the Controller. For example, although the Controller dismisses the impact from excluding $17 million in general liability settlement costs from the Countywide cost allocation plan, it is clear from discussions with the State Controller, cost allocation plan practices in other jurisdictions, and our review of financial data available from the City Attorney, that significant reimbursement could potentially be received from federal and State grants by including general liability costs in the Countywide cost allocation plan. As discussed in this report, until the Controller goes through the exercise of allocating all allowable costs, the true financial impact of our recommendations related to cost reimbursement will be unknown.

This management audit report includes 13 findings and 69 related recommendations prepared by the Budget Analyst, that encompass major areas of the Controller's operations. Included are findings and recommendations related to the department's organization, financial management, budgetary controls, fund management, indirect costs, mandated cost claiming and internal audit. The report also identifies at least $1.1 million in potential annual savings, including reduced costs and increased revenues, as well as one-time available resources of approximately $2.4 million. Additional resources and revenues could be realized if the recommendations in this report to conduct a full analysis and reconciliation of funds and cost reimbursement opportunities are implemented. Further, the report focuses on methods for improving internal controls, capturing additional revenue for the City and County and accomplishing other systemic improvements to the operations of the Department. The following sections describe our findings. Where appropriate, we have integrated comments into the section descriptions, on statements made by the Controller in his written response.

1. Organization

Over time, the management structure of the Controller's Office has evolved, as new functions and responsibilities have been added and business lines have been redefined. During this evolution, sections have been created to perform non-traditional services and units have been established which provide questionable benefit to the organization. This has had the effect of expanding the number of management positions within the Controller's Office organization. In summary:

· Approximately 17.3% of the Controller's Office personnel perform management or director functions, equating to one manager for every 5.8 employees. These computations exclude four project manager positions in the City Projects Division, since these individuals do not directly manage the activities of other staff but instead may only act as leads on more complex analyses. The computations also exclude five supervisory personnel within the Payroll and Personnel Services Division and the Finance and Administration Division.

· The number of subordinate personnel and number of direct reports to managers vary significantly. For example, the Compliance Manager (a fourth tier manager) directly manages the activities of 21 Fund Accountants who are responsible for ensuring that financial transactions are appropriately processed by the departments. At the other extreme, the Performance Management Director (a second tier manager) directly manages the activities of only one staff person. While the roles and responsibilities of these individuals differ significantly, the contrast is stark and will be discussed further in this report.

While clearly beneficial to the City organization, the major activities of the City Projects Division are not mandated. With the exception of the activities performed to accomplish the mandates included in Charter Section 3.105, the activities of the Division are primarily discretionary. Of the 8,744 productive annual hours of service estimated from Division records, only 1,969, or 22.5 percent were expended providing services that are generally mandated. Approximately 77.5 percent of the Division's services are generally non-mandated. Approximately 30 percent of the Division's paid time is for leave, administration or training. The Board of Supervisors should reconsider whether it wishes to continue non-mandated functions performed by the City Projects Division. If 4.5 FTE positions associated with these non-mandated functions were eliminated, the savings to the City would be over $400,000 per year. The Board could once again fund these functions in the future, if determined to be an appropriate priority for the City.

As with the City Projects Division, the Board of Supervisors should determine whether the non-mandated Citizen Survey and performance measurement support activities conducted by the Performance Management Division should be continued during this period of economic downturn. Annual cost of the unit is approximately $201,732. Assuming that additional consultant resources would be required to perform the triennial survey of parents and youth, net savings to the City would amount to approximately $150,000 per year.

During interviews, the Controller stated that his decision to place the Performance Management functions at the division level stemmed from his perceived need to have a manager available to directly interact with departments, in order to gain departmental cooperation. Accordingly, the Controller's Office established an 0931 Performance Management Director position, with only one subordinate position, to perform these functions. The Performance Management Director supervises only one employee.

We do not agree with the Controller's opinion in this regard. Every employee in the Controller's Office carries the authority of the Controller, whether the employee is a fund accountant in the Accounting Operations Division or an analyst. That authority can be communicated in many ways, without establishing a two-person division. For example, the Controller could (a) directly communicate with department managers in writing, requesting cooperation; (b) place the two-person function under one of his other division managers, who has the same organizational stature as the incumbent manager of the Performance Management Division; or, (c) request the Board of Supervisors to grant authority to the Controller's Office in the Administrative Code. Accordingly, the Controller should restructure the Department organization, by disbanding the Performance Management Division and merging functions under the City Projects Division.

The Controller established a Grants Management Unit in the mid-1990's, in response to a finding of material weakness identified by the City's financial auditors. Grants require a certain degree of specialization to ensure that grants are accurately accounted for and reported. However, much of this responsibility has been divested to the departments with the Controller's Office providing routine approval, audit, and reporting functions.

Additionally, a grants unit should ensure that grant revenues are maximized by verifying all allowable costs are claimed and reimbursed, and by compelling departments to file claims in a timely manner. However, the Grants Management Unit does not fulfill this role. While the Grants Management Unit has attempted to establish procedures for departments to complete a quarterly reconciliation of grant revenues and expenditures, which ensures that all grant costs have been appropriately accounted for, the first attempt in April 2003 has met with limited success. This effort was instigated by a 2001 independent financial audit finding by KPMG that found significant errors in grant data and information reported by departments. In fact, KPMG actually conducted training for City departments in January 2003 on the reconciliation process.

With respect to ensuring all allowable costs are claimed and pursuant to Section 10.170-1 (d) of the Administrative Code, the Grants Management Unit should be reviewing and certifying whether the appropriate indirect cost reimbursement has been included in the grant budget. As noted in Section 10 of this audit report, the Grants Management Unit is not providing this level of review. Finally, the Grants Management Unit does not monitor department claims to verify they are being completed in a timely manner and therefore obtaining reimbursement as quickly as possible. Given that this unit does not perform these functions, the Grant Management Unit in Accounting Operations should be eliminated and current functions merged with those performed by other staff within the organization.

In regards to this latter recommendation, the Controller has stated that "The Analyst's assertion that these duties should be performed in other divisions would not streamline the functions, but rather would increase the workload among fewer employees." In fact, this statement by the Controller distorts our report conclusions and recommendations. As stated above, we have recommended that the staff associated with the core grants management and Countywide cost allocation activities be reassigned to the units which would be assuming the transferred workload. Accordingly, implementation of the recommendations would not "increase the workload among fewer employees." As demonstrated in our report, we believe that functions performed by the current Unit Manager could be absorbed by other management personnel within the Controller's organization with minimal impact on their workload.

At a minimum, these organizational changes would result in $24,576 in annual savings by replacing one 0931 Performance Management Director with an 1805 Associate Performance Auditor. Potentially, an additional $98,032 in annual savings could be achieved by eliminating one 1824 Principal Administrative Analyst position, which is acting as a manager over the Grant Management Unit. Total savings related to these two changes would amount to $122,608 per year. Additional savings potentially could be achieved by discontinuing non-mandated functions currently performed by the City Projects and Performance Management Divisions.

The Controller should:

1.1 Disband the Performance Management Division;

1.2 Reassign responsibilities for producing the Citizen's Survey to the City Projects Division;

1.3 Reassign responsibilities for assisting departments with the development of performance measures to the City Projects Division.

1.4 Disband the Grant Management Unit; and,

1.5 Reassign the Grant Management Unit duties and responsibilities to the staff within the Compliance Unit, the Financial Reporting Unit, and the Budget and Analysis Division.

The Board of Supervisors should:

1.6 Eliminate one 0931 Performance Management Director position;

1.7 Add one 1805 Associate Performance Auditor position;

1.8 Eliminate one 1824 Principal Administrative Analyst position; and,

1.9 Consider funding alternatives which would narrow the mission of the City Projects Division to include only mandated functions.

There would be no cost to implement these recommendations. The management structure of the Controller's Office would be streamlined, functions would be more suitably aligned, and the City and County would achieve estimated annual savings of approximately $122,608 per year. Additional savings of $550,000 could potentially be achieved by discontinuing non-mandated functions currently performed by the City Projects and Performance Management Divisions.

2. Financial Administration

As Chief Financial Officer for the City and County of San Francisco, the Controller is responsible for establishing the necessary framework to facilitate sound financial management and accounting practices. Sound financial and accounting practices are contingent upon authoritative and comprehensive policies and procedures that guide financial processes, and a financial accounting system and structure that can produce useful financial reports for the monitoring and control over the City's finances and operations.

The Controller's Office has made significant strides toward providing departments guidance through financial system on-line access to screen inquiries, help menus, real-time edits and other technological improvements. The Controller also asserts that policies and procedures that guide departments and promote sound financial practices are contained in the City's Administrative Code and the Governmental Accounting, Auditing and Financial Reporting text published by the Government Finance Officers Association and otherwise known as the "Blue Book." However, individually, these resources do not provide a comprehensive overview of the City's financial and accounting policies and procedures to ensure departments are utilizing sound and consistent financial management practices. Written policies and procedures do not exist for several accounting and finance processes, such as the preparation of indirect cost rates and the reconciliation and monitoring of funds and sub-funds. Accordingly, the Controller's Office does not have a document that brings all of the various resources together and expands on areas that may not be addressed anywhere else.

The Controller is critical of the Budget Analyst's assessment of the Controller Office's need for comprehensive policies and procedures. The Controller states "...some of the Analyst's comments come from a lack of familiarity with how the City's financial systems and their inherent controls are designed to work." While, of course, the Budget Analyst does not have the same familiarity with the financial systems that the Controller's Office has, the Budget Analyst is familiar enough to note that the financial systems and the inherent controls designed in the system are transaction based. Such controls are not a substitute for policies and procedures, nor do they provide staff with a comprehensive understanding of the underlying financial and accounting principles and practices. One of the main reasons for comprehensive policies and procedures is so that finance and accounting staff in the City's operating departments, who may have less familiarity with the City's financial system, understand the basis for their activities and are not merely performing their jobs by rote.

A review of the Controller findings with respect to routine audits of financial transactions found a decrease in the adherence by City departments to the City's policies and procedures from calendar year 2001 to the first three months of 2003. A review of the more recent Post-Audit statistics shows that overall the Compliance Unit found an exception for every 4.00 documents, an overall decrease in adherence to City policies and procedures of 13.9 percent from a Post-Audit conducted the previous fall. Excluding exception categories that the Controller believes do not impact financial integrity, the exception ratio for the recent period is one exception for every 8.47 documents, a decrease in adherence to policies and procedures of 15.7 percent from the Post-Audit conducted the previous fall.

The Controller states "The Analyst does not consider that the dollar value of the errors dropped significantly, nor recognizes that the Controller focused its last review solely on those departments with the most exceptions in the prior year." As noted in the report, the focus of the Budget Analyst review was on the practices of departments, and therefore, any exception, whether for $10 or $1.0 million, represents a lapse in internal controls. With respect to the Controller's selection of the departments for its Post-Audit, our analysis of those departments or agencies that were not included in the Controller's last review totaled only 5.5 percent of the review conducted in the previous year, based on total document population. Accordingly, the Budget Analyst states that the results of the Controller's last review are representative.

With respect to reporting issues, departments have created parallel applications, spreadsheets and other duplicative procedures to obtain financial data and information in a format that is useful. For example, the Department of Human Resources (DHR) creates excel spreadsheets to monitor expenditures by index code and sub-objects. Additionally, DHR creates excel spreadsheets for monitoring the Health Service System, for analysis during the budget development process, and for position control. The Department of Children, Youth and Their Families re-enters transaction data into excel spreadsheets to track expenditures by index code and by lower levels of detail, such as purchase order. The Recreation and Park Department has developed their own monthly report by index code to track revenues and expenditures. These efforts by departments require considerable resources to essentially recreate financial data and information in a useable format. The Recreation and Park Department reports that it takes 50 percent of one accountant's time just to produce the monthly financial reports that the Department needs for the Recreation and Park Commission.

The Controller states in his response that "The Controller believes the Analyst misunderstands the reporting needs of the various departments and how they are being met." Further, the Controller states that "The Controller's office has addressed the real need for more flexible use of financial data at the department and other levels on multiple fronts." (Page 3, Paragraph 1) The Controller has developed many tools to meet the City's reporting needs. For example, the Controller reports that it has developed the Executive Information System (EIS) and provided it to 13 departments. However, these tools are not currently available to all departments or readily accessible. Several departments reported to the Budget Analyst that they have created duplicative applications and spreadsheets to meet specific departmental needs. Two of the departments the Budget Analyst interviewed are also on the Controller's list of departments with access to EIS. Accordingly, it appears that either the departments have not fully accessed the functionality of EIS or it does not meet their needs.

Further, the lack of centralized monitoring of the accounting structure by the Controller's Office has led to the existence of unnecessary funds, unreconciled financial activity, the accumulation of resources, and accounting structures that do not necessarily meet the needs of departments. Departmental "recasts" are customary, where a department's accounting structure is significantly revised and prior year financial data must be "recast" to conform with the revised structure. Recasts are an intensive process that requires considerable Controller and departmental resources. Additionally, recasts are generally problematic. Historical information is restated and reported in a way that was never intended, impairing the quality and comparability of financial data and departmental activities over time. There are valid reasons why a recast may be necessary, such as fundamental changes in the operating environment. However, departmental structures should remain relatively stable and not be subject to shifting policies or personalities, such as when changes in department heads and fiscal officers occurs.

Finally, incomplete and untimely reviews of user security allows for unauthorized access to financial systems and weakens the integrity of financial activity. As part of the security review for FY 2002-2003, the Controller's Office distributed a list of staff with FAMIS, ADPICS or FAACS access and instructed department heads or chief financial Officers to respond by July 31, 2003 with updated information on which staff are authorized to access the financial systems to: (a) initiate transactions, (b) approve transactions, or (c) make inquiries on transactions. The Controller's Office stated that "users whose status is not confirmed or updated by July 31, 2003 may then be denied system access." However, of six department user security surveys selected for review, one department's survey was never submitted and a second department's survey was incomplete. There was no indication that any users were denied system access as a result of non-compliance with the security policy.

The Controller correctly states that "It should be noted that in reviewing the Controller's process, the Analyst did not find any cases of inappropriate user access to the system." However, the Budget Analyst reviewed the security review process and did not test for any cases of inappropriate user access to the system. Nonetheless, the Budget Analyst found weaknesses in the Controller's internal control process designed to prevent unauthorized access.

The Controller should strengthen the financial management framework by developing authoritative and comprehensive policies and procedures, addressing departmental financial reporting needs, ensuring consistent and stable departmental accounting structures, and verifying that only appropriate personnel have user access to the financial systems.

The Controller should:

2.1 Develop and make available to departments, physically or electronically, written, authoritative and comprehensive policies and procedures for all aspects of the financial and accounting processes;

2.2 Perform an assessment of departmental financial reporting needs, and develop a strategic plan for meeting those needs, by June 30, 2004;

2.3 Consider the long-term structural stability of departmental accounting structures when developing departmental accounting structures and conducting recasts;

2.4 Designate the following responsibility to oversee the accounting structure to a specific unit in the Financial Systems and Reporting Units or to a consistent working group, including:

i. Being the sole authority for the creation of funds, sub-funds, organization and index codes;

ii. Being the sole authority for the recast of a department's accounting structure; and

iii. Ensuring that the accounting structure is appropriate and is in accordance with sound financial management and accounting practices; and

iv. Being accountable for the monitoring of funds and sub-funds.

2.5 Ensure that annual user security reviews are conducted in a timely manner; and

2.6 Deny system access for users whose status is not confirmed or updated by the deadline in order to enforce compliance with the security policy.

The development of a policies and procedures manual should be achieved through the assignment of existing resources. Oversight of the accounting structure can be achieved through the reallocation and consolidation of the current assignments. An assessment of reporting needs and strategic planning will require additional resources which should be obtained through a reallocation of existing staff as current projects are completed, rather than with new staff. The benefits which are realized from these recommendations include operational efficiencies and enhanced controls at the departments and at the Controller's Office, which will exceed the costs of implementation.

3. System Planning

The City Charter charges the Controller with the responsibility for establishing accounting records, procedures and internal controls necessary to facilitate sound financial management and accounting practices. In order to perform these basic duties, the Controller is responsible for establishing and maintaining a financial accounting system that can provide for the monitoring and control over the City's finances and operations; and, produce accurate, timely and useful financial reports.

The City's current financial accounting system, FAMIS, and supporting financial and reporting systems are inadequate to meet the financial reporting and fiscal management needs of City and County of San Francisco departments. In an effort to compensate for the weaknesses in the financial system, the Controller and departments have implemented an ad hoc system of databases and reporting software. However, many departmental reporting and financial management needs are still left unmet. Further, the current system is inflexible, resulting in delays in meeting basic reporting needs and the duplication of work.

For example, the Department of Human Resources (DHR) creates excel spreadsheets to monitor expenditures by index code and sub-objects. Additionally, DHR creates excel spreadsheets for monitoring the Health Service System, for analysis during the budget development process, and for position control. The Department of Children, Youth and Their Families re-enters transaction data into excel spreadsheets to track expenditures by index code and by lower levels of detail, such as purchase order. The Recreation and Park Department has developed their own monthly report by index code to track revenues and expenditures. These efforts by departments require considerable resources to essentially recreate financial data and information in a useable format. The Recreation and Park Department reports that it takes 50 percent of one accountant's time just to produce the monthly financial reports that the Department needs for the Recreation and Park Commission.

The estimated cost of updating FAMIS is $500,000 to $1.7 million. At least one California jurisdiction, the County of Santa Clara, replaced its general ledger system for $13 million. The significant cost of updating FAMIS, or acquiring a new system, has resulted in a decision by the Controller to continue operating the current system and develop enhancements to the system in the immediate future.

The Controller should perform an assessment of the short-term financial reporting and accounting needs of the departments, and the City and should develop a strategic plan for meeting those needs. In addition, the Controller should assess the impact on the City's financial management resulting from the continued long-term use of the FAMIS financial accounting system and develop a strategic plan for replacing the current system.

The Controller should:

3.1 Perform an assessment of the City's financial systems needs and report back to the Board of Supervisors by June 30, 2004;

3.2 Develop a strategic plan for meeting identified departmental and City needs; and

3.3 Be prepared to move forward with a replacement system when it becomes either necessary or financially feasible.

The estimated cost of updating FAMIS is $500,000 to $1.7 million. The Controller has estimated that the cost to replace the City's general ledger, budget and purchasing systems would be approximately $30 million, not including hardware or in-house implementation costs. As noted above, at least one California jurisdiction, the County of Santa Clara, recently replaced its general ledger system for $13 million. A new accounting system would provide long-term operational efficiencies in the Controller's Office and in the City's operating departments.

4. Internal Control Reporting and Financial Auditor Independence

Although the Sarbanes-Oxley Act, which increases oversight over publicly-held private companies, does not apply to government agencies, the principles underlying the Act do apply to government agencies. The Sarbanes-Oxley Act strengthens the role of audit committees in the financial reporting process and increases the level of auditor independence. The Board of Supervisors Audit Committee, which is known as the Finance and Audits Committee, already has a direct reporting relationship with the City's financial auditors. By adopting policies consistent with the Securities and Exchange Commission's rules under the Sarbanes-Oxley Act (such as requiring pre-approval by the Finance and Audits Committee of all non-audit services to be performed by the contract financial auditor, requiring that the audit partner be rotated every five years, and requiring conflict of interest standards), the Board of Supervisors would increase its oversight over financial statement audits and non-audit services provided by the financial auditor.

In his response, the Controller states that "The Controller wants to make it clear that at no time has the City's external independent auditor been out of compliance with any legal or industry rule or regulation in any work conducted on behalf of the City. The Controller is quite comfortable that the City's independent auditor is selected by the Board and the Board is free to make whatever rules they would like in this area."

"The Controller believes that the City's external auditors have always complied with all legal and industry rules and practices related to their independence. The Analyst lists several projects that the City's current auditor has done for the City. We want to make it completely clear that this work was not and is not out of compliance with any regulation."

The Budget Analyst did not audit the work of the external financial auditor and therefore cannot comment on external financial auditor compliance with legal and industry rules and practices related to independence. However, as stated previously, we recommend that the Board of Supervisors amend the Administrative Code to include provisions of the Federal Sarbanes-Oxley Act of 2002 that would strengthen the role of the Board's Finance and Audits Committee as it pertains to financial reporting processes and increased controls over auditor independence.

The provisions of the Sarbanes-Oxley Act to evaluate and report on internal controls could be costly for the City to implement. However, if the City were able to reduce its risk of loss from inefficient or fraudulent activities through strengthening internal controls, the reduced loss could offset the increased costs of implementing a comprehensive policy to evaluate and report on internal controls.

The Board of Supervisors should:

4.1 Propose an amendment to the Administrative Code, adopting the policies of the Sarbanes-Oxley Act and giving the Audit Committee authority to:

i Pre-approve all non-audit services performed by the City's financial auditor, and

ii Require the City's contract financial auditor to report to the Board of Supervisors' Audit Committee prior to issuing the final audit report on the City's financial statement, in order to apprise the Board of Supervisors on (a) all critical accounting policies and practices used by City management; (b) all alternative accounting treatments of financial information that have been discussed with management, including the ramifications of the use of such alternative treatments and disclosures and the treatment preferred by the accounting firm; and (c) other material written communications between the accounting firm and City management.

The Controller should:

4.2 Develop and present a policy, within 60 days, for Board of Supervisors adoption, on auditor independence, including (a) standards on conflict of interest, and (b) financial auditor partner rotation.

4.3 Develop and present a cost estimate, including expenditure details, within 60 days for Board of Supervisors' consideration, of a feasibility study to assess and report on the City's internal controls.

4.4 If the Board of Supervisors approves the feasibility study, conduct and report on the feasibility of a policy to evaluate and report on the City's internal controls, prior to June 30, 2004, to be implemented for the fiscal year ending June 30, 2005.

The City's costs to implement policies consistent with the Sarbanes-Oxley Act provisions on audit committees and auditor independence would be negligible. The provisions of the Sarbanes-Oxley Act to evaluate and report on internal controls could be costly for the City to implement, but could result in a reduced risk of loss from inefficient or fraudulent activities, offsetting the increased costs.

5. Budgetary Control

The Controller's Office does not always enter appropriation reserves into FAMIS in a manner that will achieve the Board of Supervisors' policy objectives. Departments have been able to expend against reserves because the Controller's Office did not enter the reserve against the work order or subproject for which it was established.

For example, in the past year there have been two instances when Board-authorized appropriation reserves were expended without prior Board of Supervisors approval. In March of 2003, the Department of Administrative Services requested retroactive release of $3,088,926 reserved by the Board of Supervisors in the FY 2002-2003 budget for the maintenance and repair of City-owned vehicles. Because the Department of Administrative Services provides vehicle maintenance services on a work order basis to City departments, the Controller's Office placed the appropriation reserve on the requesting departments. Between July of 2002 and March of 2003, when the Finance and Audits Committee authorized the retroactive release of reserves, the Controller's Office City Projects staff worked with the Department of Administrative Services to address the Board of Supervisors' policy issues. Also, a March 19, 2003 memorandum to the Budget Analyst from the Department of Administrative Services states that the Department had been in regular contact with the office of the sponsoring supervisor "for the last three months in regard to the timing and substance of the release of reserve request".

Although the monies were on reserve, the Administrative Services Central Shops performed the work and charged $836,484 against the $3,088,926 reserve prior to authorization by the Finance and Audits Committee to release the funds. According to the Budget and Fiscal Operations Manager, requesting departments should notify performing departments if insufficient funds are available to pay for the work. According to the Accounting Operations Manager, the reserve was entered into FAMIS at the high work order level for the requesting department and not on the specific work order between the requesting and performing department. Therefore, the Accounting Operations and Systems Division fund accountants could only identify if monies were expended against all the requesting departments' work orders, up to the level of the reserve, and could not identify if monies were expended against the specific work order for which the reserve had been placed.

In April of 2003, the Department of Public Works requested retroactive release of reserves for completed Fire Department capital projects. In 1996, the Board of Supervisors appropriated $14,233,588 in General Obligation Bond Fund monies for 20 Fire Department capital projects and had reserved $7,864,100 of the $14,233,588 appropriation. From 1996 until 2003, the Board of Supervisors released $4,340,872 of the $7,864,100 reserve, with a remaining balance of $3,523,228. The remaining reserves were designated for capital projects at three fire stations. However, the Department of Public Works expended other bond funds for the three fire station projects, even though the Board of Supervisors had designated specific reserves for these projects. According to the Deputy Controller, the capital project appropriation was entered into FAMIS at the higher project level, and the Controller's Office was unable to monitor reserves placed on sub projects.

Regarding reserves established by the Mayor's Office, the Controller's Office procedures for entering Mayor's Office reserves or contingencies into FAMIS is redundant. Both the Budget and Analysis Division and the Accounting Operations and Systems Division enter reserves or contingencies into FAMIS to control departments' expenditures, resulting in a process that is inefficient and could lead to errors in FAMIS entries.

For example, during FY 2002-2003, the Budget and Analysis Division and the Accounting Operations and Systems Division both entered the Mayor's appropriation reductions into FAMIS, either as a reserve or a contingency. In one instance, the Budget and Analysis Division entered a $1.5 million reserve for the Department of Administrative Services into FAMIS on September 16, 2002, as part of the Mayor's "Capital Reserve List". The Accounting Operations and Systems Division entered a $340,943 reserve into FAMIS for the Department of Administrative Services on April 11, 2003 as part of the Mayor's savings initiative. According to a May 11, 2003 FAMIS journal entry, the $340,943 "was part of $1,500,000 reserve placed on JECO03000268-03 on 9/16/02 and recorded again on JECO03018086 on 4/11/03".

The Accounting Operations and Systems Division released the $340,943 on reserve, and entered into the FAMIS notepad that the transaction was to "release portion of reserve that was duplicated". Despite documentation to the contrary, the Controller's Office has stated that the entry was not a duplicated entry and that the monies were released only after discussion with the Mayor's Office.

The Controller's Office does not closely monitor General Fund appropriation reserves for ongoing projects. Our review of the listing of appropriation reserves produced by the Controller's Office at the request of the management audit found that several appropriation reserves on continuing projects had already been released and expended. For example, as of June 30, 2003, there were $18,144,792 in appropriation reserves for continuing projects in City departments (1G AGF ACP). The majority of these projects were multi-year capital or information system projects, although a few of the projects were for other types of programs. More than half of these monies, or $9,728,296, were listed as appropriation reserves for continuing projects established in FY 1999-2000 or earlier. We reviewed the details for the 16 projects that were established in FY 1999-2000 or earlier, and based on our interviews with the respective departments, found that several of these appropriation reserves had been released and expended. For example, of the five Department of Public Works projects, three of the appropriation reserves had been released and expended and the projects closed, one project had been closed and the monies returned to the fund balance, and one project from FY 1993-1994 was still open. Both Recreation and Park Department appropriation reserves had been released and expended.

At least two of the appropriation reserves that we reviewed should be returned to fund balance.

· Documentation showed a $22,063 appropriation reserve, established in FY 1996-1997, for which the Medical Examiner's Office was able to identify the entry into FAMIS in April 1997 and the enabling Ordinance 101-97, but was not able to identify the associated project. Because the revenue source was Jail Overcrowding Fine Revenue, which is not a revenue source for the Medical Examiner's Office, the Medical Examiner's Office thought that this could be an incorrect journal entry.

· Documentation showed a $61,210 appropriation reserve, established in FY 1993-1994, for the Department of Public Works Civic Center Steam System Improvement Project. According to the Department of Public Works, the balance in this account, including the $61,210 reserve, is $177,995. Although the Department of Public Works owns the steam system loop in Civic Center, a private contractor provides the actual steam heat. The Department of Public Works is reviewing the feasibility of transferring the steam system to the private contractor, and therefore, the appropriateness of the $177,995 account, including the $61,210 reserve, needs to be reviewed.

Although we have recommended further review by the Controller, based on our review, we believe these two appropriation reserves should be closed and available revenues returned to the General Fund.

The Controller's Office approves most City department requests to carry forward unexpended appropriations from one fiscal year to the next. Carry forward requests are generally only denied if the department does not have sufficient funds to balance its budget, or if the department has funding for the same purpose in the next fiscal year. The Controller's Office approves departments' requests to carry forward funds although some of these requests exceed the Controller's Office written policy for carry forward approval.

The Controller stated in his response, that "The Analyst reports that the Controller approves most of the Departments' requests to carry forward unexpended funds from one year to the next when they meet the Controller's guidelines implying this indicates inadequate review. However, the Analyst has not substantiated his opinion that in some instances, approvals granted to carry forward funds have exceeded the Controller's policies."

The Controller's Office has three key criteria for approving the carry forward of funds: (a) monies must be for specific non-recurring items or services; (b) the department can not have funds budgeted in the next fiscal year for the specific purpose; and (c) the department must spend the money in the next fiscal year for the same purposes for which it had been appropriated in the prior fiscal year. In our sample of six Departments, we found one instance in which the Controller authorized the Department of Public Health to carry forward funds to purchase bulk medications, although funds for the specific purpose were budgeted in the next fiscal year.

We found another instance in which the Controller's Office approved a request by the Department of Public Health to fund a purpose in FY 2002-2003 that differed from the appropriation in FY 2001-2002. The Department of Public Health used $254,000, appropriated for professional services in FY 2001-2002 and carried forward into FY 2002-2003, to pay off the mortgage balance of the Women's and Children's Family Services facility at 15 Bishop Street. Although the funds were used to pay off the mortgage balance for the non-profit organization, these monies continued to be identified in FAMIS as monies for a professional services contract. According to the City Attorney's Office, the title to the building will be transferred to another non-profit organization, the Mission Neighborhood Development Corporation. Because the transaction involves the transfer of property between two non-profit organizations rather than the purchase or transfer of the property to the City, the proposed transaction has not been submitted to the Board of Supervisors for approval. We believe that this violates the Controller's established policy of approving funds for the same purpose. Although the Board of Supervisors had appropriated funds for a service contract in FY 2001-2002 for the operating expenses of the Women's and Children's Family Services, which included the mortgage payment, we do not believe that the Board of Supervisors intended to appropriate these funds to pay-off the mortgage and transfer title to another non-profit organization.

Further, the Controller made the statement that "The Analyst also implies but has not shown any instance that the carry-forward process circumvented the Board's appropriation authority. In no instance has the Controller allowed Departments to carry-forward funds that were not already approved by the Board of Supervisors, or circumvented the appropriation process of the Mayor and the Board of Supervisors. As noted in the above example, the Controller authorized the Department of Public Health to carry forward funds, which had been budgeted for contractual services, to purchase a building and transfer the title to another non-profit organization. This use of funds does not appear to have been consistent with the Board of Supervisors original intent.

The City needs a clearly stated policy on the carry forward of appropriations from one fiscal year to the next. Currently, the Administrative Code is silent on the process. Although the Controller's Office has a documented policy to carry forward one-time monies if there is no new appropriation in the next fiscal year and if the purpose is unchanged, the Controller's Office approves the carry forward of funds for many reasons not included in the Controller's documented procedures.

The Controller's Office should:

5.1 Work with the Board of Supervisors to ensure that the Board's policy objectives are met in authorizing appropriation reserves, including defining such procedures as (a) placing work order reserves on both the performing and requesting departments, and (b) establishing separate project accounts to account for reserves placed on sub projects.

5.2 Define the policies and procedures for establishing reserves and contingencies and the responsibilities of the Budget and Analysis Division and the Accounting Operations and Systems Division for placing and monitoring reserves and contingencies, including the responsibility for the Budget and Analysis Division in overseeing Board of Supervisors and Controller's reserves, and the responsibility of the Accounting Operations and Systems Division in overseeing the Mayor's reserves to achieve savings targets.

5.3 Work with the Board of Supervisors to (a) define the policy objectives and scope of carrying forward annual appropriations from one year to the next, and propose Administrative Code changes, as needed; and (b) define the policies and procedures for reviewing and approving the carry forward of unexpended annual appropriations into the next fiscal year.

Our recommendation to redefine the responsibilities of the Budget and Analysis and Accounting Operations and Systems Divisions in monitoring reserves and contingencies would increase efficiency by reducing duplicative efforts in establishing and monitoring appropriation reserves.

Our recommendation to increase the Controller's role in monitoring and recommending closure of continuing General Fund projects, including projects with appropriation reserves, would release additional revenues to the General Fund for alternative uses. Closing out the $22,063 Medical Examiner appropriation reserve would clear the books but may not result in additional revenues if no revenues were received from the Jail Overcrowding Fines. However, by working with the Department of Public Works to close out prior year continuing projects, approximately $177,995 could be available for other uses.

Our recommendation to increase oversight over the approval of departments' requests to carry forward unexpended appropriations would ensure that departments' appropriations in the next fiscal year did not exceed the appropriation levels and purposes intended by the Board of Supervisors.

6. Fund Maintenance

Funds are the accounting instruments by which governmental entities record financial activities and resources. A governmental entity may have many funds to separate disparate activities and restricted resources. Sound financial management and governmental accounting practices prescribe that funds be kept to the minimum number necessary to prevent unwarranted complexity and inflexibility. Accordingly, the Controller's Office has structured the financial accounting framework so funds are comprised of numerous sub-funds, which are the level at which the Controller records financial activities and resources that are segregated for specific uses.

Historical records on the creation of sub-funds have not been maintained by the Controller's Office. Accordingly, for any given sub-fund, there is limited documentation on the purpose, source of revenue, authorization, and department(s) responsible for the sub-fund. A review of selected special funds maintained by the Controller's Office has identified sub-funds that are not necessary. Some funds are not legally required. Other funds are required by the City and County of San Francisco Code, but do not appear to otherwise meet the criteria for a separate fund. These activities may be accounted for and separately tracked in the General Fund or other primary operating fund, using special accounts. Further, financial activities are not necessarily monitored at the sub-fund level. For example, a number of sub-funds had inappropriate deficit or residual fund balances. Other sub-funds should be closed due to lack of activity as required by Administrative Code Section 10.100-1 and the Annual Appropriation Ordinance.

The following are examples of the types of issues identified during the review of funds and sub-funds:

· The Public Works, Transportation and Commerce - DPW Personnel Fund is used to account for errors made by DPW employees when billing projects. The year end fund balance for FYs 1999-2000, 2000-2001, and 2001-2002 of this sub-fund was a negative $569,480. According to DPW, this negative balance was created in the conversion to on-line FAMIS in FY 1995-1996. Otherwise, DPW does not know the source of the negative balance. According to DPW, the Controller asked DPW to recover these funds through charging for these costs through DPW's overhead account. However, according to DPW, the Department has forgotten to do this and the negative fund balance remains.

· According to Controller files, the Civil Service Special Revenue Sub-Fund is to record revenues received from the lease of examination material and the provision of consulting services for the purpose of examination research and development. The Civil Service Commission was unaware of this fund and believed that fund management might be the responsibility of the Department of Human Resources (DHR). However, DHR stated that the fund is not in their purview, and noted that the only activity in the sub-fund was posted by the Controller's Office. However, according to Controller staff, this sub-fund is the responsibility of the Civil Service Commission.

· The fund and sub-fund used to account for gifts to the City include approximately $191,075 in insurance settlements for earthquake damaged art, which clearly are not gifts or donations to the City. Further, according to the Fine Arts Museum, the repair and replacement of earthquake damaged art for which these funds were intended, has been completed.

The Controller's Office should review all sub-funds, closing those that have not had activity or those for which activity is not required to be recorded separately. The Controller's Office should also establish comprehensive written policies and procedures for the establishment, maintenance, and monitoring of sub-funds. Internal and external policies and procedures should be developed, clearly defining the roles and responsibilities of the departments as well as of the Controller's Office.

Our management audit identified approximately $2,193,114 in funds that can potentially be transferred to the primary operating funds of the City, including the General Fund. However, some, but not all, of these funds may continue to be restricted for certain activities. The remaining special and fiduciary sub-funds that have not been reviewed would almost certainly have additional monies that could be transferred to the primary operating funds of the City, including the General Fund. A thorough analysis of the remaining 227 special funds is required to address the issues discussed in this review and would likely identify additional fund balances available to support General Fund or other primary operating fund activities. In addition to identifying available resources, operational and financial management efficiencies would be realized.

The Controller notes "However, the Analyst spent most of their time reviewing selected sub-funds and accounts. . . " This is correct. The reason the Budget Analyst reviewed funds at the sub-fund level is because this is the level at which, as noted in our report, the Controller has chosen to record disparate financial activities and resources. The Controller asserts that the City controls its budget at the fund level. However, in any given fund, which is a compilation of any number of sub-funds, there may be numerous departments as well as numerous unrelated and restricted financial activities (some of these explicitly restricted by the City's Codes or State law). To manage these financial activities at the fund level, rather than sub-fund levels, invites the kind of discrepancies identified in our report.

The Controller believes "It is by no means "certain" the process of reconciling all special and fiduciary funds will produce surplus monies - both because there are negative as well as positive balances to be analyzed, and because restrictions attached to fiduciary funds must be honored before the criteria of closing inactive funds is applied." The Budget Analyst's report includes not only positive balances, but negative balances in our assessment of sub-funds and in our estimate of the monies that appear likely to be able to be transferred to the primary operating funds of the City. In fact, negative balances are more troubling than positive in that they are more likely to represent either an over-expenditure of funds or incomplete financial activity. With respect to the restrictions on fiduciary funds, the Budget Analyst's review identified monies that were inappropriately held in fiduciary funds and that were not restricted by fiduciary obligations.

The Controller should:

6.1 Establish formal policies, procedures and criteria for the establishment of special revenue and fiduciary funds and sub-funds, in accordance with Generally Accepted Accounting Principles; and, develop specific criteria for funds that are necessary to meet "sound financial administration" principles;

6.2 Conduct a thorough review and reconciliation of special revenue and fiduciary funds and sub-funds by June 30, 2004, including an analysis of departments' subsidiary financial accounting systems that record detail on special revenue or fiduciary fund activities;

6.3 Conduct a review and reconciliation by June 30, 2004 of all gift and bequest funds, identifying monies where:

i Recording in the gift or bequest fund is not warranted and the resources/activity can be recorded in the primary operating fund; and

ii Gift purpose has been achieved and residual gift balances must be disposed.

6.4 Close and transfer any residual fund balances for those funds and sub-funds that do not meet the criteria established by Recommendation 6.1, above, and for which the activity can be sufficiently tracked and monitored in the primary operating fund;

6.5 Resolve or dispose of any inappropriate residual or deficit fund balances identified by the reviews performed pursuant to Recommendation 6.2 and 6.3 above; and,

6.6 Establish periodic and year-end procedures for the reconciliation and review of all special revenue and fiduciary funds and sub-funds.

The Board of Supervisors should:

6.7 In order to assure departmental activities are monitored while retaining adequate controls, consider the use of special accounts rather than special funds as an acceptable and preferable mechanism by which activities can be segregated, tracked and monitored.

While the recommendations above will require both one-time and limited on-going resources, the costs will be significantly exceeded by the identification of available resources resulting from 1) residual balances identified by the Controller's review which may be returned or escheated to the General Fund and 2) operational and financial management efficiencies. A minimum of approximately $2,193,114 in funds can potentially be transferred to the primary operating funds of the City, including the General Fund. Review of the remaining 227 special and fiduciary sub-funds almost certainly will identify additional funds. While some of these funds may be restricted for certain activities, many of these funds are not restricted or can be used to subvent General Fund subsidies of the specified activity.

7. Cash Revolving Funds

According to the San Francisco Administrative Code Sections 10.100 and 10.125, the Controller is charged with the responsibility to administer, monitor use, and authorize exceptions to Cash Revolving Funds. As part of its responsibility to monitor the use of Cash Revolving Funds, the Controller's Office is responsible for periodically auditing Cash Revolving Funds, assessing the appropriateness of authorized amounts and recommending changes to authorized amounts of such funds.

Currently, there are a total of 58 Cash Revolving Funds with a total authorized amount of $765,950. In FY 2002-03, the Controller's Office approved a total of $3,499,150 in transactions through Cash Revolving Funds. While some Cash Revolving Funds were closed out or reduced following the issuance of Departmental Instructions Numbers 1051 and 1052 and the Controller's review of usage in 1996, the Budget Analyst has identified a total of 19 Cash Revolving Funds that showed no activity for FY 2002-2003 and an additional 37 Cash Revolving Funds that showed transaction activity that did not appear to justify the level of the authorized fund amount.

Because the Controller's Office does not have clear policies and procedures regarding the appropriate number and authorized amount for Cash Revolving Funds some Cash Revolving Funds are replenished as infrequently as once a year (or not at all) and some are replenished multiple times in one day, based entirely on the frequency of requests by departments. The Controller's Office Audits Division periodically audits Cash Revolving Funds. However the Controller's Office considers such audits a lower priority. The Audits Division performed a total of three audits out of a total of 58 Cash Revolving Funds in FY 2001-2002.

There is a $200 limit on how much can be expended for each fund at one time. The Elections Department Cash Revolving Fund is an example of the risk associated with revolving funds. Certain departments and funds have exemptions from the $200 limit on purchases, including the Municipal Transportation Authority, the Department of Public Works, the Airport Commission and the Elections Department. For example, the Administrative Code provides for a $500 Cash Revolving Fund for the Elections Department and states that the Elections fund "may also be used, with the approval of the Controller, to reimburse election judges, inspectors and other poll workers" (Sec. 10.162). In FY 2002-03, the Elections Department's Cash Revolving Fund was replenished for $465,000 with individual replenishments of $450,000, $5,000 and $10,000. The Controller's Office has stated that "due to the volume of details, expenditures are not verified at the time reimbursements are made. The revolving fund is subject to periodic audit by the Controller's Internal Audit."

The City's risk for loss from potential unauthorized expenditures is unnecessarily high due to the proliferation of unnecessary Cash Revolving Funds and Cash Revolving Funds with authorized amounts set higher than necessary. In addition, in the absence of a clear policy regarding frequency and amount of replenishments for Cash Revolving Funds, the workload associated with replenishing the funds is not being kept to a minimum by the Controller's Office.

The Controller's Office should implement standards for the replenishment of Cash Revolving Funds, which would reduce and standardize the Controller's Office workload associated with maintaining such funds. In addition, the Controller's Office should annually assess the necessity for Cash Revolving Funds and recommend the elimination of those funds with zero transactions occurring during a fiscal year and the reduction of the authorized amounts for underutilized Cash Revolving Funds. Cash Revolving Funds should be set at the minimum amount necessary for departments. Implementation of our recommendations would reduce Cash Revolving Funds by $487,100, and would reduce the risk associated with cash disbursements in the affected departments.

The Controller should:

7.1 Conduct an annual risk assessment of Cash Revolving Funds;

7.2 Conduct an annual analysis of Cash Revolving Fund utilization;

7.3 Develop and implement clear policies on frequency of replenishments to Cash Revolving Funds;

7.4 Develop and implement clear policies on disbursement of cash among locations within departments;

7.5 Request that the Board of Supervisors repeal the Administrative Code authorization for the 19 Cash Revolving Funds listed in Section 7, Table 7.1 of this report, resulting in reduced authorization of $29,600; and

7.6 Request that the Board of Supervisors reduce the authorized amount for the 38 Cash Revolving Funds listed in Appendix 7.1 of this report, resulting in reduced authorization of $457,500.

Our recommendations can be accomplished within the normal management responsibilities within the organization. Our recommendations would result in tighter controls over Cash Revolving Funds and reduce cash authorizations by a total of $487,100.

8. Countywide Cost Allocation Plan

The Controller's Office is responsible for preparing the Countywide Cost Allocation Plan which allocates the costs of support and administrative services to benefiting programs, departments and agencies. These allocated costs are then able to be appropriately reimbursed either through direct billing or by including the costs in claims for reimbursement, typically through federal or State programs, and in fees charged to the public. In today's environment of decreasing budgets, it is increasingly important for the City, in general, and the Controller, specifically, to accurately identify the true costs of services being provided and to aggressively maximize revenues.

The Controller has not approached the Countywide cost allocation plan and cost recovery in a systematic and comprehensive manner. Accordingly, the current cost allocation plan, as it is prepared, is incomplete and does not represent the actual cost of City support services and administration. Allowable costs have not been included in the Countywide cost allocation plan's preparation and additional entities may be able to be billed for their costs. For example, according to Section 4180 of the State Controller's handbook, a county is considered non-insured for General Liability if it has not established a self-insurance program but rather finances any losses through current appropriations, issuance of debt, or other "spur-of-the- moment" financing. According to the State Controller's Office, the City is considered non-insured for general liability costs pursuant to OMB Circular A-87 guidelines, because it has not established a self-insurance program. Accordingly, the City cannot be reimbursed by federal or State programs for the actual costs of liability claims.

The State Controller's Office reported that the City along with the County of Los Angeles are the only two counties in the State that are considered non-insured. However, both entities were "grandfathered-in" under A-87 cost allocation guidelines with respect to workers' compensation costs and can receive reimbursement under their "pay-as-you-go" systems. For general liability, however, the State Controller's Office asserts that it has repeatedly advised the City of the "millions of dollars" that it has forgone in reimbursements by not establishing a self-insurance program and liability reserves, but the City has chosen to continue in a non-insured status since the late 1970's. Because the issue is over 20 years old, neither the State Controller's Office nor the City Controller's Office could provide the Budget Analyst with information or documentation of this issue, including the State Controller's recommendations. These deficiencies have resulted in lost revenues every year and potentially could result in non-compliance with A-87 guidelines and other legal issues with regard to billing cost plan allocations.

Potentially, an additional $29,271,533 in allowable costs could be included and allocated through the Countywide cost allocation plan, which represents an increase of 36.6 percent in allocated costs. These costs would be allocated among City activities including those reported in the General Fund, special revenue funds and enterprise funds. To the extent that the Controller can identify additional entities and programs that receive support and administrative services which can be billed, costs will be reimbursed and revenues will be increased.

The Controller's response states that "The Controller concurs with a recommendation to perform further work in this area to determine if additional costs may be allocated. However, the Controller believes the Analyst overstates the potential benefit of this work." The Budget Analyst does not believe that we have overstated the potential benefits of conducting a comprehensive assessment of the cost plan. The Budget Analyst explicitly did not estimate the General Fund impact of increasing allocable costs because we understand the complexities of the cost plan. Rather, we provide an estimate of potential increased allocable costs to merely provide an order of magnitude and state these costs may be allocable to all City activities, including those reported in the General Fund, special revenue funds, and enterprise funds.

Further, the Controller states "The Analyst's discussion of additional costs that could be included in the cost allocation plan is inaccurate and largely overstates the potential benefits. . . . We pointed out to the Analyst that a substantial majority of liability claim amount listed in their table relates to enterprise activities such as the MUNI Railway, are already directly billed to them and therefore would not be processed through our cost allocation plan." With respect to the inclusion of all liability claims as an allocable cost, the Controller is correct that these costs are direct billed to departments and agencies, specifically MUNI. However, for purposes of this analysis, whether or not the cost is direct billed is irrelevant. At issue is that none of these costs are currently claimed against federal and State funding sources because the City has been deemed uninsured. Even if the costs are direct billed, MUNI cannot claim them for cost reimbursement purposes until the City and the Controller address this issue.

Lastly, the Controller notes "The Analyst incorrectly implies it is the Controller's decision regarding which agencies are billed for allocated costs when in fact this decision is made by the Mayor and the Board of Supervisors in the budget process." The Budget Analyst agrees that it is a policy decision for the Mayor and the Board of Supervisors whether or not to bill agencies and other funding sources for indirect costs. However, the Controller is responsible for calculating and processing the billings. It is not clear which agencies and other funding sources incur indirect costs, and which agencies and other funding sources are or are not billed pursuant to the direction of the either the Mayor or the Board. The Controller should:

8.1 Perform a comprehensive assessment of Citywide support services and administration and treatment in the Countywide cost allocation plan and report back to the Board of Supervisors by June 30, 2004;

8.2 Assess and address the issues noted in this report and report back to the Board of Supervisors by June 30, 2004, on the following areas:

i Self-insurance and general liability costs;

ii Treasurer-Tax Collector functions;

iii Equipment use allowance;

iv Retirement billing;

v County Office of Education billing;

vi Other Special Revenue Fund billing; and

vii Cost of Living Adjustment.

8.3 Request that the City's independent financial auditors review the application of the Cost of Living Adjustment and roll forward methodology for computing cost plan billings, and report back to the Board of Supervisors on their findings;

8.4 Establish written internal policies and procedures for the preparation and billing of the Countywide cost allocation plan;

8.5 Consolidate the preparation and billing of the Countywide cost allocation plan in the Budget and Analysis Division; and

8.6 Require the Budget and Analysis Director to supervise the preparation of the Countywide cost allocation plan, annually review the Countywide cost allocation plan document, and be actively involved in the State Controller's annual review of the City's Countywide cost allocation plan, including participating in discussions with the State Controller's Office on any identified issues and findings.

While there are costs associated with the comprehensive assessment of the Countywide cost allocation plan and its application, there will be increased revenues by addressing the issues outlined in this report. The Controller should utilize existing Controller analytical resources other than the current staff responsible for Countywide cost allocation plan preparation.

9. Multi-Tiered Cost Plans

The Controller's Office annually prepares a Countywide cost allocation plan pursuant to federal Office of Management and Budget regulations that are contained in Circular A-87 and State guidelines. Local governments must comply with these regulations when charging indirect costs to grants or other programs that are funded by the federal and State governments.

Pursuant to Circular A-87, certain costs cannot be claimed on grants or programs funded by the federal and State governments. Appropriately, the Controller's Office has identified certain costs as unallowable in the Countywide cost allocation plan.

However, the City also applies Circular A-87 regulations when allocating indirect costs to programs that are not funded by federal or State governments. This is not required. In other California jurisdictions, full multi-tiered cost plans have been developed and are used to ensure that the maximum amount of eligible indirect costs are allocated to programs other than those governed by federal or State cost allocation regulations. A multi-tiered cost allocation plan serves to maximize indirect cost reimbursement to the General Fund from user fee, enterprise and special fund activities, and is endorsed by the State Controller.

As an example, Los Angeles County reports that it annually prepares a multi-tiered full cost allocation plan, including (1) an A-87 plan for State and federal programs and grants; (2) an enterprise fund plan; (3) a plan for internal use with other County funds; and, (4) a plan for use when charging non-County government entities. The City and County of San Francisco currently prepares a single plan which generally conforms with the regulations contained in OMB Circular A-87. According to the Controller, the preparation of a full multi-tiered cost plan would yield very little benefit to the County, since much of the A-87 unallocated cost is either recovered through direct charges to departments or would be charged to General Fund departments or other funds which are incapable of reimbursing the General Fund.

While there is some merit to the Controller's comments, these assertions were not convincingly demonstrated or documented during the course of this management audit. For example, if the full cost allocation were to yield an average increase of only one percent on the $81.2 million in fees collected by the City each year, over $800,000 in additional income would be realized.

The Controller states in his response that "We also note that the State Controller does not `endorse' this method, but merely suggests it as an option for counties." The California State Controller's Handbook of Cost Plan Procedures for California Counties, Section 1460 and 1470 states (in part), "Non-grantee departments should note the cost recovery limits set by OMB A-87 and, if necessary, adjust their costs to recover as nearly as possible the total costs of doing business. Although the cost plan as approved by the State Controller's Office includes only those costs considered reimbursable for federal and state purposes under the current cost principles, it is the best tool available to accomplish the task described above. A county could prepare a "full costing plan" to identify all county overhead costs to the appropriate departments, including those costs that are currently considered unallowable (e.g., general government costs)." This statement by the State Controller appears to the Budget Analyst to be an endorsement of the full cost allocation plan methodology that is described.

As a result, the Controller's Office may have missed opportunities to maximize reimbursement for the legitimate cost of providing support services to programs that are not funded by the federal or State governments. If such costs are allocated to these programs in FY 2002-03, additional revenues could be recovered by the General Fund.

The Controller should:

9.1 Direct staff to conduct a test allocation of A-87 unallocated costs, to determine potential General Fund revenues that could be realized from implementing a multi-tiered cost plan;

9.2 If appropriate based on the results of the test plan, direct staff to prepare multi-tiered full cost plans, in accordance with State Controller guidelines and modeled after similar plans in other counties, such as Los Angeles; and,

9.3 Allocate full costs to departments and non-General Fund activities in order to maximize reimbursement to the General Fund.

The Board of Supervisors should:

9.4 Based on the results of the Controller's test plan, consider adoption of legislation that would require the Controller to annually prepare multi-tiered full cost plans, which appropriately allocates costs to departments and non-General Fund activities. The full cost plans would include allocations of costs that are not allocable for federal or State claiming purposes under Circular A-87 regulations.

The Controller will incur some additional staff time during the development of the full cost plan models. Staff from the Internal Audit Division or City Projects Division can be temporarily diverted to assist the Cost Plan Accountant during the development phase. Accordingly, there should be no incremental costs associated with the implementation of these recommendations.

The General Fund will recover additional revenue annually in reimbursements from user fees and charges to other funds and agencies, although the actual amount of revenue can not be estimated until the Controller's Office identifies and distributes the unallocated costs.

10. Departmental Indirect Cost Rates

The San Francisco Administrative Code charges the Controller with the responsibility to direct and approve indirect cost rates for each City department. Such rates are applied to user fees and grants in order to reimburse the City for administrative and support costs associated with fee and grant activities.

The Controller's Office has not established consistent methodology for calculating departmental indirect cost rates and their application to City fees. In some cases, the departments calculate their own indirect cost rates and the Controller merely checks for reasonableness. For the remaining departments, the Controller has three different methods for calculating departmental indirect costs. These methods are either calculated at the program level or by department. In addition, some are based on budgeted costs and some are based on actual costs.

The Controller states in his response that "The Controller issues technical instructions to guide departments in proposing fee increases and fee revenues in their budget." However, the Budget Analyst notes that these technical instructions do not provide information on developing indirect cost rates for those departments for which the Controller has not provided a rate calculation. Out of 70 departments (and divisions) for which the Controller records an overhead rate, the Controller's Office calculated only 18 rates for FY 2002-03. The remaining 52 departments or divisions either calculated their own rates, or rates have not yet been determined. For departments that calculated their own rates, the Controller's Office does not offer formal policies or training to departments regarding indirect cost allocation principles or methodologies. According to an analyst in the Controller's Budget and Analysis Division who works with fee administration, the check for reasonableness consists of reviewing individual cost computations to ensure that the rate prepared by the department is "reasonably accurate".

The Controller states in his response that "The Controller believes the City uses appropriate methodologies for calculating departmental indirect cost rates. It would not be reasonable to require MUNI Railway, the Public Utilities Commission, the Airport, the Department of Public Works and others with very different `businesses' to use one consistent methodology when various ones are legally available and maximize revenue.'

We concur with the Controller that departments such as MUNI, which has a contract with an outside consultant to develop their departmental indirect cost rates in compliance with A-87 guidelines, should continue to use their current methodology. Our recommendation is to develop clear and consistent policies and procedures for the calculation of departmental overhead rates, using actual costs rather than budgeted costs. In our analysis of the 11 highest revenue producing user fees in the City, indirect cost methodologies varied. Two of these eleven fees, charged by the County Clerk's Office, applied an indirect cost rate that was calculated by the department based on budgeted costs. Five fees charged by the Department of Public Health's Food program applied an indirect cost rate that was calculated by the department based on actual costs. The remaining four fees, charged by County Medical Examiner and the Fire Department, applied indirect cost rates that were calculated by the Controller using budgeted costs. These 11 fees represented $6.5 million in fee revenues in FY 2002-2003.

As is illustrated in this small sample of high revenue generating fees, the indirect cost rate methodology managed by the Controller's Office is highly inconsistent and allows potential for inaccuracies. The Controller's Office methods of calculating indirect cost rates are inefficient, as some departments calculate their own rates using actual numbers and some departments use budgeted numbers. Similarly, the Controller's Office, when calculating rates in-house, uses both budgeted and actual numbers, depending on what is available. Such discrepancies could yield entirely different indirect cost rates. Such differences could result in over-charging for fees and potential legal liability, and some could result in under-charging for fees and lost revenue to the City.

For example, the Controller's Office calculates a departmental overhead rate for the Police Department from budgeted costs (not actual costs) included in the Annual Appropriation Ordinance. The Police Department's rate is calculated at 22.55 percent for FY 2002-03. The rate was obtained by dividing their total Operations and Administrative budget of $49,667,012 by total salaries and benefits (less administration salaries and benefits) of $220,293,945. However, in some instances budgeted costs differ significantly from actual costs. In the Police Department's Operations and Administrative budget, costs were $1.36 million dollars less than actual costs in FY 2001-02, and $4.49 million dollars less in FY 2002-03. If actual costs had been used in the indirect cost rate calculation, a significantly lower rate would have been produced. Thus, if the Controller sets the indirect cost rate too high, as is evident in this example, the Police Department might be overcharging for its fees, a potential legal liability for the City.

The Controller's Office has no involvement with the analysis or application of indirect cost rates for grants. The Grants Management Unit only checks to ensure the completeness of grant documentation before grants are forwarded to the Board of Supervisors for approval. The Controller's Office does not certify that provisions for appropriate indirect cost reimbursement are included in grant budgets, pursuant to Section 10.170-1 of the Administrative Code.

The Controller's Office should develop consistent policies and procedures for calculating departmental indirect cost rates. The Controller's Office should also perform analyses of grant budgets to determine whether indirect cost amounts are accurate; and, if not included in the grant budget, that such costs are accurately disclosed. While it is a policy matter for the Board of Supervisors to decide whether grant applications should include indirect costs (if allowable), the Controller's Office should ensure that the Board of Supervisors has complete information prior to grant approval.

The Controller should:

10.1 Develop clear and consistent policies and procedures for the calculation of departmental overhead rates, using actual costs rather than budgeted costs;

10.2 Develop standards to determine when individual programs or divisions require individual indirect cost rates, or whether department-wide rates are sufficient;

10.3 Develop and disseminate procedures for departments to follow when calculating indirect cost rates. Such procedures should mirror Controller's procedures for calculating indirect cost rates;

10.4 Develop procedures for the Controller's Office to certify that provisions for appropriate indirect cost reimbursement are included in the grant budget, as pursuant to Section 10.170-1 of the Administrative Code; and,

10.5 Require that all indirect costs be disclosed on the Grant Information Form, even if costs will not be paid by the grantor. This will enable the Board of Supervisors to make a more informed decision regarding how grant money should be allocated and whether administrative costs should be absorbed in order to benefit the direct program costs.

There would be no new costs to implement these recommendations.

The recommendations would increase the Controller's ability to manage indirect cost rate development. Additionally, the recommendations would ensure that the Controller's Office provides full disclosure of indirect costs associated with grant administration to the Board of Supervisors.

11. Cost-Based Fees for Service

In FY 2002-03, the City and County of San Francisco generated approximately $77.4 million in fee revenue, and departments estimate fee revenues will generate $81.2 million in FY 2003-04. Some of these fees are set by statute while others are set based on market rates. A significant number of these fees are cost-based.

San Francisco City Charter Section 3.105 charges the Controller with the responsibility to provide "general supervision over the accounts of all officers, commissions, boards and employees of the City and County charged in any manner with the receipt, collection or disbursement of City and County funds." As an extension of this general mandate, the Controller has established some procedures for tracking, controlling and annually evaluating cost-based fees charged by the departments.

Despite these efforts, the Controller's Office has not yet compiled a comprehensive fee schedule for information or control purposes, nor has the Office provided City departments with written standards or procedures to ensure that fees are annually reviewed or consistently analyzed based on generally accepted cost accounting principles. Further, no criteria have been established to guide departmental fee-setting, so that costs are accurately computed and maximum revenue is recovered.

To better control and manage fee development and analysis throughout City departments, the Controller should create, publish, and actively maintain a master fee schedule of all fees charged in the City. A comprehensive fee schedule will act as a tool to record and analyze extensive fee information. Such a control document would therefore allow administrators and policy makers to manage the fee development process with more accurate and timely information. Additionally, a master fee schedule would provide the public with more timely information about fees. It is imperative the Controller establish a master fee schedule as a basis for a comprehensive fee analysis and review, as mandated by the City Charter.

Section 3.7 of the Administrative Code requires departments to submit a comprehensive schedule of fees and estimates of fee revenue with each year's budget submission, except for fees regulated by federal or State law. In the Controller's Technical Instructions for Budget Year 2003-2004, the Controller requested all departments that budget revenue from licenses, permits, fines and or service charges to complete and submit to the Controller's Office a "Form 2b." Form 2b contains a brief description of the fee, authorizing Code citation, whether the authorizing code provides for an automatic CPI adjustment, sub-object number, index code, fee per unit in previous year, estimated quantity in units for the previous year, estimated percentage of the overall cost of the service recovered in the previous year, proposed fee per unit of service, estimated quantity in units for the budget year, estimated percentage of the projected cost of the service in the budget year that will be covered by the proposed fee, the date of the last increase, and the fee prior to the last increase. In the Budget Technical Instructions, the Controller stated that all departments were required to submit a completed Form 2b to the Controller's Office by Friday, January 10, 2003.

The Controller's Office was unable to provide the Budget Analyst staff with exact receipt dates of submitted Form 2b's. However, by March 13^th, 2003, only 21 of 35 applicable departments had submitted a Form 2b to the Controller's Office. Two other departments submitted general fee information to the Controller by March 13^th, but not on the Form 2b. Instead, these two departments submitted less formal analysis and fee proposals. Out of the 21 Form 2b's submitted by March 13^th, only 14 departments included cost recovery analysis, as specifically requested on Form 2b. Cost recovery and other fee analysis was obtained from 10 departments directly by the Budget Analyst's Office, after the Controller's Office was unsuccessful in obtaining documents directly from departments.

The Controller states that "We have repeatedly reminded departments of this requirement; however, some have not complied." Although we understand the difficulty in gaining cooperation from some City departments, the Budget Analyst was able to get information from departments by assertively calling and following up with departments for information. We believe that the Controller should take a more assertive stance toward obtaining such information from departments.

Since a comprehensive fee analysis or schedule has not been presented to the Board of Supervisors on an annual basis, the Board of Supervisors has not been provided with a regular opportunity to consider the question of full cost recovery for many City departments. As a consequence, the Board of Supervisors' fee policies for City department activities are inconsistent. Further, policy decisions by the Board of Supervisors to determine which fees should fully recover cost and which fees should be subsidized by the General Fund or other funding sources, have not been made on a City-wide basis.

The Controller's Office should annually produce and maintain a comprehensive fee schedule, which can be used as a control document to ensure that fees are appropriately evaluated and submitted for consideration by the Board of Supervisors each year.

In addition, the Controller should establish and disseminate written criteria, standards and procedures for cost-based fee analysis to all City departments. Such procedures should provide methods for compiling direct costs, analyzing and applying indirect costs, and analyzing cost recovery information. Included within the Controller's responsibilities of overseeing fee administration is cost analysis. As the Chief Financial Officer of the City, the Controller's Office should be the authoritative agency in determining costs of departmental fees. However, the Controller's Office does not determine or develop the cost of fees. Rather, such determinations are left to the operating departments. Further, the Controller's Office does not provide procedures or guidelines to City departments in terms of determining the cost of fees. Departments independently determine the cost of providing services with no training or guidance from the Controller's Office. Some departments find determining the cost of fees to be difficult.

For example, legislation to require a license for fortunetellers was proposed by the Board of Supervisors in November of 2002. The Police Department's Permits Division was charged with determining direct costs of the fortuneteller license fee. The cost of the license was calculated and submitted to the Controller by the department at least three times over the course of several months. Each time, the Controller's Office checked for the "reasonableness" and then certified the fee. However, the proposed fee for the fortuneteller license ranged from $240 to $295 and the direct costs associated with providing a fortuneteller license ranged from $188 to $33,957 amidst the three cost submissions. Each submission was subsequently certified by the Controller's Office and forwarded to the Budget Analyst's Office for a budget analyst report. The Controller's Office was not involved with the calculation of the direct costs. Rather, the Controller's Office only checked such costs for reasonableness. Clearly, the calculation of direct costs was unreliable, if not inaccurate.

The Controller states that "the Analyst points out that proposed fees related to a particular project-licensing of fortunetellers-changed dramatically over the course of several months. The report implies that these changes mean that the numbers were incorrect in the earlier versions and not caught by the Controller. As we pointed out to the Analyst, the program's parameters changed considerably over the course of the Board's deliberations so it is not surprising the costs also changed." The Budget Analyst agrees with the Controller that the proposed fee was initially submitted as a one-time fee, and then was resubmitted as a one-time and an ongoing fee. However, the Police Department submitted three different fee proposals for the one-time fee with very different cost estimates for a program with consistent service parameters. Although the Controller attested to the reasonableness of each fee proposal, the Controller did not review the expenditure estimates supporting the fees.

The Police Department acknowledges that its staff have insufficient background calculating direct costs, and often uses time and motion studies that have not been reviewed since the mid-1980s, as their basis for current fee costs. With no training or expertise provided by the Controller's Office, departments must estimate costs to the best of their ability. But as in the case of the Police Department, such estimates can be highly inaccurate. Such inaccuracies can lead to over or under charging of fees.

Likewise, the Controller's Office has not established a consistent methodology for calculating indirect cost rates to be applied towards departmental fees. In some cases, the departments calculate their own indirect cost, or overhead rate, and the Controller checks for the reasonableness of their rates. For the remaining departments, the Controller has three different methods for calculating departmental overhead, some of which are calculated by program, some by department. Some are calculated using budgeted numbers, some are calculated using actual numbers. These inconsistent methods are discussed in more detail in Section 10 of this report.

Many City departments were unable to provide or compute a cost recovery analysis for individual fees. Therefore, it is not clear whether departments currently possess the tools or expertise to determine those fees which fully recover costs. The departments' general difficulties conducting full cost recovery fee analyses results in an inability to fully advise the Board of Supervisors with information regarding the need for General Fund discretionary program support. The Controller should provide procedures and guidance for these departments. In the absence of such guidance, several issues can arise.

The potential exists for some City departments to be overcharging for their services. For example, in a memo dated April 15, 2003 written to the Budget Analyst from the Assessor/Recorder, department staff indicated that a cost recovery analysis of services has not been conducted. Yet, based on documentation provided by the Assessor/Recorder's Office, the FY 2002-2003 projected actual revenue from fees is nearly double the budgeted amount, even though the Assessor/Recorder's Office budgeted fee revenue equal to the full recovery of fees. Therefore, it appears very possible that the Assessor/Recorder's Office is in excess of full cost recovery for services. In the absence of detailed cost recovery analyses, it may prove difficult for the City to defend against litigation that may claim that fees are generating more than the cost of providing services. Therefore, the development of a full cost recovery plan should be required and reviewed by the Controller's Office for all City departments.

There is also a significant cost to the City that results from undercharging, or not fully recovering the costs of providing services. In a small sample of nine City departments, our research indicates that City departments could collect an additional $4.2 million in revenue, assuming the selected fees were set at full cost, or 100 percent recovery. The analysis was adjusted to consider a more conservative list of 34 fees in six departments, where increases were not considerable, thus a more realistic analysis. The additional revenue in this narrowed sample of fees would still be approximately $880,000 annually for the City¹. The Controller's Office should ensure that complete cost recovery analysis is presented to the Board of Supervisors and all City Commissions that have fee-setting authority. Full cost recovery analysis is essential to understand the degree to which discretionary resources are being used to subsidize services.

The Controller states that "the Board has had full information about the major fees the Analyst recommends be raised to full cost recovery and made the decision not to do so." Although not subject to Board of Supervisors approval, the Municipal Transportation Authority approved an increase of the Tow Administration Fee from $30 to $50 based on a proposal presented by the Department of Parking and Traffic to increase the fee to $50. However, the actual fee required for 100 percent cost recovery equals $59.24, which was not presented to the Municipal Transportation Authority for approval. The Board of Supervisors approved the Medical Examiner's Removal of Remains and Storage of Remains fees during the FY 2002-2003 budget review based on a proposal of $175 and $50 respectively, which were less than cost recovery. The Budget Analyst's report to the Board of Supervisors identified that these fees were below cost recovery. However, neither the department nor the Controller independently provided that information to the Board of Supervisors. The Street Artist fee increase is pending before the Board of Supervisors. The Budget Analyst will present a report to the Board of Supervisors which identifies that these fees will be below cost recovery.

Comparatively, in some instances where the Budget Analyst was able to conduct full cost recovery analyses, it was clear there may be valid policy reasons for not increasing fees to full cost recovery levels. For instance, the Board of Appeals attempted to implement a fee increase of approximately 105 percent per fee for FY 2003-2004. Such proposed fee increases would only recover approximately 29.4 percent of these costs, based on total FY 2003-2004 costs of $433,534 and fee revenue projections of $127,459. According to the Board of Appeals, the Board of Appeals did not propose to increase their FY 2003-2004 fees to be 100 percent cost recovery because such fees would be prohibitively high. According to the Board of Appeals, significantly higher Board of Appeals fees would discourage ordinary residents, neighborhood associations, business operators and other individuals, other than the most wealthy, from having access to the administrative review process that the Board of Appeals offers for appealing City permits and other department actions.

The Controller commented on statements in our report related to a fee proposal submitted by the Planning Department which would have recovered revenues far in excess of costs. In his response, the Controller stated "Finally, the Analyst has stated that the Budget Committee placed $1.38 million of Planning department fees on reserve since they were `illegal.' The Controller is not aware of any determination that these fees were illegal, though was aware that as of the time of the Board's review the department had not provided to our office the necessary fee materials for review."

The Budget Analyst notes that the Planning Department proposed fee increases in the FY 2003-2004 budget, resulting in cost recovery ranging up to 493 percent, clearly violating California Government Code Section 66016. The Controller's Office repeatedly stated that they were not involved with the Planning Department's FY 2003-2004 fee proposals. Because the Planning Department's FY 2003-04 budget was balanced on illegal fee proposals, the Budget Committee placed $1.38 million of the Planning Department budget on reserve, pending receipt of proper fee analysis.

By (a) establishing formalized control mechanisms; (b) creating formal fee development criteria, standards and procedures; and, (c) monitoring compliance and reporting to the Board of Supervisors, the City and County would be provided greater assurance that fees recover full costs, when appropriate. If a sample of only six Departments increased a total of 34 fees to full cost recovery levels, the City could generate at least $880,000 in additional fee revenues annually.

The Controller's Office should:

11.1 Develop and maintain a Master Fee Schedule for all City Departments to be reviewed on an annual basis;

11.2 Develop and disseminate written procedures to City departments detailing methodologies for direct costs, indirect costs, and cost recovery analysis for fees;

11.3 Provide training to City departments on fee cost analysis methodology and cost recovery analysis;

11.4 Continue to work with Departments to ensure that analysis of cost recovery is conducted for each individual fee; and,

11.5 Provide quality control by reviewing fees submitted to the Board of Supervisors for conformity with State law, City policy, and cost accounting guidelines.

City Departments should:

11.6 Work cooperatively with the Controller's Office to analyze fees, analyze cost recovery, and develop recommendations for fee changes.

These recommendations can be accomplished within the normal management responsibilities of the organization. Our recommendations would increase the Controller's ability to analyze fee revenues and, therefore, forecast more accurate revenues for the City. In a small sample of total cost recovery of fees in six departments, we estimate that the City could generate at least an additional $880,000 annually.

12. Monitoring Claims for State-Mandated Costs Reimbursements

The Controller contracts with an outside contractor for the preparation and submission of the City's mandated cost claim to the State. The Controller oversees the claiming activities performed by the contractor. The Controller's Office does not exercise sufficient oversight over the City departments, which file claims for reimbursements for State-mandated programs, known as the SB 90 program. The Controller's Office does not monitor the quality of the SB 90 claims prepared and submitted by the contractor.

In his written response to our recommendations, "The Controller agrees that a written report on the City's SB 90 claims with more detailed information would be informative and will make such a report available to the Board of Supervisors. However, the Controller disagrees with the Analyst's assertion that the City has lost significant revenue and may be subject to auditing and disallowance of costs."

The Budget Analyst does not assert that the City has lost significant revenue. However, the Budget Analyst believes that errors in the filing of SB 90 claims could result in the disallowance of claim costs by the State Controller's Office. The Controller's Office does not monitor the quality of the SB 90 claims prepared and submitted by the contractor. A review of four SB 90 claims, filed by the Controller with the State for FY 2001-2002, revealed inconsistent methodology and errors in the claims. For example, the contractor used a methodology for calculating the Election Department's indirect cost rate that was inconsistent with the methodology used for other departments' indirect cost rates. The Budget Analyst estimates that the City would have received an additional $21,000 in departmental indirect cost reimbursements for the Absentee Ballot program if consistent methodology had been used.

The management audit also found errors in the calculation of hourly staff rates. These errors resulted in inaccurate amounts being claimed for reimbursement and could result in the disallowance of claim costs by the State Controller's Office during a desk audit. Specifically, the management audit found multiple errors in the actual calculation of productive hourly rates for the Mandate Reimbursement Process, the Domestic Violence Arrest Policies and Standards program, and the Peace Officers Procedural Bill of Rights program. We reviewed the average hourly productive rates for Election Department positions, which were mostly temporary positions, and found them to be generally accurate. However, we reviewed 26 positions, for which claims were filed under the Peace Officers Procedural Bill of Rights program, the Mandate Reimbursement program, and the Domestic Violence Arrest Policies and Standards program and found errors in the calculation of productive hourly rates for nine of the 26 positions reviewed, or an error rate of 35 percent.

· One principal administrative analyst pay rate was entered into the claim as $31.22 per hour when the actual rate was $46.99;

· One police officer III position was entered into the claim as a police officer II;

· Seven positions had hourly pay rates entered into the claim form which differed from the hourly rate reported by the Department, although the reason for the difference was not identifiable.

In FY 2001-2002, the City filed reimbursement claims for 31 State-mandated programs out of 54 eligible programs. Although the contract with DMG Maximus, the contractor responsible for assisting City departments in preparing and submitting SB 90 claims to the State for reimbursement, requires documentation of the reasons that City departments do not file SB 90 claims, the Controller's Office has not required the contractor to provide such documentation, nor does the Controller have such documentation.

Audits of SB 90 claims in two other California counties suggest that San Francisco could increase total SB 90 claims reimbursements by reviewing claims to ensure that all allowable costs are captured and that all possible claims are filed. A review of FY 1999-2000 Santa Clara County claims found that reimbursements could be increased by $1,610,256 and a review of FY 2000-2001 San Bernardino County claims found that claimed reimbursements could be increased by $621,000. The Controller should conduct a post claim audit of FY 2002-2003 SB 90 claims to ensure that all allowable costs are captured and that claims are filed for all applicable mandates.

Further, the Budget Analyst identified State-mandated services provided by San Francisco for which claims were not filed. The Budget Analyst estimates that, based on the claims filing experience of other California counties, San Francisco could receive at least an additional $95,000 in State reimbursement revenue annually by filing SB 90 claims for these services.

The Controller states in his response that "Finally, we do not agree with the Analyst's speculation that the City would save money by bringing the SB 90 filing in-house." The Budget Analyst does not speculate that the City would save money by bringing the SB 90 filing in-house. Rather, the Budget Analyst has recommended that the Controller develop a quality improvement program to assure the standardization and quality of cost claims. Alternatively, the Controller's Office could bring the work of claims processing in-house, and allocate a position in the Controller's Office to work with departments to track, process and submit claims. If the Controller's Office decides to terminate the contract with the contractor to prepare SB 90 claims and to bring the work in-house, the savings for terminating the contract will likely offset the increased personnel costs for performing the work in-house. It should be noted that all costs, whether contract or in-house, are fully reimbursed by the State.

The Controller's Office should:

12.1 Develop a quality improvement program to assure the standardization and quality of cost claims, including conducting audits of claims;

12.2 Alternatively, bring the work of the contractor in-house to exercise increased oversight over the SB 90 claims preparation and submission process;

12.3 Develop a reporting system for all City departments regarding which claims are filed and not filed. Document the reasons for not filing claims for all State-mandated programs applicable to San Francisco, and submit an annual written report to the Board of Supervisors regarding which claims are filed and the reasons for not filing claims and,

12.4 Conduct a post-claim audit for FY 2002-2003 and adjust future claims appropriately.

If the Controller's Office decides to terminate the contract with the contractor to prepare SB 90 claims and to bring the work in-house, the savings for terminating the contract would likely offset the increased personnel costs for performing the work in-house. In addition, these costs are reimbursed from the State. If the Controller's Office works with City departments to ensure that all applicable SB 90 claims are filed, the estimated increased annual revenue to the City would be at least $95,000.

13. Audits Division Productivity

The Administrative Code charges the Controller's Office with establishing an auditing function to monitor the economy and efficiency of departments and agencies of the City and County of San Francisco.

The Audits Division does not complete all planned audits and tasks included in its Audit Schedule. If unnecessary and obsolete mandates were eliminated from the Audit Plan, then the division could refocus on more valuable audits including Payroll audits.

The Audits Division is not meeting the same level of productivity as other county and city auditors responding to the National Association of Local Government Auditors' (NALGA) Benchmarking and Best Practices Survey, and management does not manage and limit training and time reporting as closely as it should. The Division's Time Distribution Reports show that for fiscal year 2002-2003, the Controller's audit staff spent on average 61.6 percent of the time reported on timesheets on audit and project work. Training and professional development accounted for 6.1 percent of the time reported, other general tasks and administration accounted for 14.7 percent of the time reported, and leave from work accounted for an additional 17.6 percent of time reported.

The Controller states in his response that "The Analyst has selectively used the second measure of productivity where the Division's usage time is 62% as compared to the average of 65%." The measure used in the Budget Analyst's report is consistent with the NALGA methodology, and was chosen because the Controller's Office timesheets do not segregate work hours in a manner that permits reliable comparison using the alternative measure reported by NALGA. Nonetheless, as shown in Table 13.1 of the report, the Controller's Office Internal Audit staff achieved a productivity of only 74.8 percent in FY 2002-03 compared to an average reported by the NALGA survey respondents of 76 percent, using the alternative methodology that the Controller cites in his response.

Further, Audits Division staff received an average credit of 62 hours of training for fiscal years 2001-02 and 2002-03. This is 55 percent more than the minimum requirements for training of audit staff. In addition, the Audits Division reported more training hours than required to meet continuing professional education hours. The inclusion of informal training hours increases the Audits Division reporting of training hours to 87 hours per auditor for FY 2002-2003, which is more than double the minimum standard of 40 hours per year for government auditors.

The Controller states in his response that "The Controller believes that well-trained staff are more efficient in their work and that additional training of staff is particularly warranted by the fact that 60% of the audit staff have been with the office for less than three years. He also believes the minimum training requirement should not be viewed as a standard or cap." The Budget Analyst agrees that the minimum training requirement should not be viewed as a "standard or cap." Nonetheless, it is an accepted industry benchmark which can be used to gauge acceptable levels of training in an audit organization. Although the Budget Analyst believes that training is essential for City employees, the fact that Controller's Office Internal Audit staff averaged double the number of hours included in the industry benchmark, with some individuals receiving as much as two and a half times the minimum number of training hours in a single year, is questionable. Combined with the statistics showing that productivity is below the average in other similar public sector audit organizations, we have recommended that the Controller increase productivity and strive toward the higher end of the productivity range reported by NALGA survey respondents.

At least one respondent to the National Association of Local Government Auditors' Benchmarking and Best Practices Survey reported productivity of 77 percent or more. The Audits Division's current level of productivity is 15.4 percent less than 77 percent. The 15.4 percent difference in productivity is equivalent to 2.65 FTEs for FY 2002-2003. The loss of 2.65 FTE in productivity is equivalent to salary costs of $220,895 based on the average salary for audit staff.

In response to this finding, the Controller stated that "Further, the Analyst concludes that the Internal (Audit) Division should be measured against a target of one standard deviation from the mean of responders and calculates a savings from a 77% productivity number on the second measure. This is a questionable methodology." The standard deviation is an accepted statistical test which can be used to determine where individual sample results fall in relation to the mean (or average). As stated in our report, like an average, the standard deviation provides a statistical indicator of relative performance within a sample population. Because detailed survey responses were not available to determine exactly how each jurisdiction reported performance, we used the standard deviation to estimate the degree to which high performers reported productivity above the average. We believe this measure is appropriately used in the context of the report recommendations.

The Controller should:

13.1 Evaluate the risk associated with the current mandates of the Audits Division;

13.2 Prioritize the mandates and request the Board of Supervisors to eliminate any unnecessary mandates;

13.3 Reduce training to required and/or necessary hours;

13.4 More closely monitor training hours in order to maintain appropriate and necessary training hours and prevent over use of training hours;

13.5 Improve productivity; and

13.6 Expand the number of audits for which it directly charges City departments to recover full costs for audits performed

There are no costs associated with increasing productivity or decreasing training hours to a more reasonable level. Increased efficiency in the Audits Division would result in more audits performed of City departments, funds, vendors and contractors.

We would like to thank the Controller, his staff and various representatives from City departments for their cooperation and assistance throughout this management audit.

Respectfully submitted,

Harvey M. Rose

Budget Analyst

Cc: President Gonzalez

Supervisor Ammiano

Supervisor Daly

Supervisor Duffy

Supervisor Ma

Supervisor Maxwell

Supervisor McGoldrick

Supervisor Peskin

Supervisor Newsom

Supervisor Sandoval

Mayor Brown

Clerk of the Board

Edward Harrington, Controller

Ben Rosenfield

Ted Lakey

¹ The Budget Analyst notes that one of the departmental fees included in this analysis, the Street Artist's Certificate Fee, is proposed for an increase and is pending before the Board of Supervisors. Such proposed fees do not fully recover costs.