Report on Internal Control and on Compliance and … ON INTERNAL CONTROL AND ON COMPLIANCE AND OTHER...

REPORT ON INTERNAL CONTROL AND ON COMPLIANCE AND OTHER MATTERS

SCHOOL DISTRICT OF PHILADELPHIA

FISCAL 2012

June 5, 2013 Pedro A. Ramos, Esq., Chairman and Members of the School Reform Commission 440 N. Broad Street Philadelphia, PA 19130 Dear Chairman Ramos and Members: In accordance with the Philadelphia Home Rule Charter, the Office of the City Controller conducted an audit of the basic financial statements of the School District of Philadelphia, Pennsylvania as of and for the fiscal year ended June 30, 2012, and has issued its Independent Auditor’s Report dated February 11, 2013. In planning and performing our audit, we considered the School District of Philadelphia, Pennsylvania’s internal control over financial reporting as a basis for designing our auditing procedures for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the School District of Philadelphia, Pennsylvania’s internal control over financial reporting. Accordingly, we do not express an opinion on the effectiveness of the District’s internal control over financial reporting. Attached is our report on internal control over financial reporting and on compliance and other matters, dated February 11, 2013 and signed by my deputy who is a Certified Public Accountant. The findings and recommendations contained in the report were discussed with management at an exit conference. We included management’s written response to the findings and recommendations and our comments on that response as part of the report. We believe that, if implemented by management, these recommendations will improve the School District of Philadelphia, Pennsylvania’s internal control over financial reporting. We would like to express our thanks to the management and staff of the School District of Philadelphia for their courtesy and cooperation in the conduct of our audit. Respectfully submitted, ALAN BUTKOVITZ City Controller cc: William R. Hite, Jr., Ed.D., Chief Executive Officer and Superintendent of Schools Matthew E. Stanski, Chief Financial Officer Marcy F. Blender, CPA, Deputy CFO and Comptroller

REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH

GOVERNMENT AUDITING STANDARDS To the Chair and Members of The School Reform Commission of the School District of Philadelphia We have audited the financial statements of the governmental activities, the business-type activities, each major fund, and the aggregate remaining fund information of the School District of Philadelphia, Pennsylvania (School District), a component unit of the City of Philadelphia, Pennsylvania, as of and for the year ended June 30, 2012, which collectively comprise the School District's basic financial statements and have issued our report thereon dated February 11, 2013. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Internal Control Over Financial Reporting Management of the School District is responsible for establishing and maintaining effective internal control over financial reporting. In planning and performing our audit, we considered the School District’s internal control over financial reporting as a basis for designing our auditing procedures for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the School District’s internal control over financial reporting. Accordingly, we do not express an opinion on the effectiveness of the School District’s internal control over financial reporting. Our consideration of internal control over financial reporting was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control over financial reporting that might be significant deficiencies or material weaknesses and therefore, there can be no assurance that all deficiencies, significant deficiencies, or material weaknesses have been identified. However, as described in the accompanying report, we identified a certain deficiency in internal control over financial reporting that we consider to be a material weakness and another deficiency that we consider to be a significant deficiency.

C I T Y O F P H I L A D E L P H I A O F F I C E O F T H E C O N T R O L L E R

A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis. We consider the following deficiency described in the accompanying report to be a material weakness:

• Ineffective procedures for reconciling reported equity in pooled cash and investment amounts to the balance of cash and investments in the bank resulted in the failure to timely detect material financial statement errors.

A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. We consider the following deficiency described in the accompanying report to be a significant deficiency:

• Inadequate design and operation of controls over the furniture and equipment inventory increased the risk of asset misappropriation.

Compliance and Other Matters As part of obtaining reasonable assurance about whether the School District’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. We noted certain other conditions that represent deficiencies in internal control over financial reporting and compliance that are listed in the table of contents and described in the accompanying report. We also identified other internal control deficiencies during an assessment of information technology general controls conducted by an independent accounting firm engaged by us, which will be communicated to School District management in a separate report. Additionally, we noted a compliance condition that will be communicated to School District management in separate correspondence. The School District’s written response to the material weakness, significant deficiency, and other conditions identified in our audit is included as part of the accompanying report. We did not audit the School District’s response and, accordingly, we express no opinion on it. We have also included our comments to the School District’s responses that we believe do not adequately address our findings and recommendations.

C I T Y O F P H I L A D E L P H I A O F F I C E O F T H E C O N T R O L L E R

This report is intended solely for the information and use of the management of the School District, the School Reform Commission, and others within the entity, and is not intended to be and should not be used by anyone other than these specified parties. February 11, 2013 GERALD V. MICCIULLA, CPA Deputy City Controller

CONTENTS

Page MATERIAL WEAKNESS Cash Reconciliation Procedures Needed Improvement ........................................................... 1 SIGNIFICANT DEFICIENCY Safeguarding and Recordkeeping over School Furniture and Equipment Were Inadequate ......................................................................................................................... 3 OTHER CONDITIONS

Management of Petty Cash Remained Deficient ..................................................................... 13 Oversight of Student Activity Funds Remained Problematic ................................................. 15 Controls over Student TransPass Activity Continued to Need Enhancing ............................. 19 Financial Statement Review Procedures Needed Management’s Attention .......................... 21 Eligible Costs Were Not Always Capitalized .......................................................................... 22

Artwork Records Not Yet Adequately Updated ...................................................................... 23 Monitoring of Unapproved Payrolls Continued to Need Strengthening ................................ 25 Tax Treatment for Termination Payments Has Still Not Received State and City Confirmation ...................................................................................................................... 27

Long Outstanding Termination Pay Should Be Escheated ..................................................... 28 Review Procedure for Processing Termination Compensation Not Adequately Documented ........................................................................................................... 30 Integrity of Payroll Passwords Continued to Be Compromised .............................................. 30 Non-Compliance with Statement of Financial Interest Filing Requirements ......................... 31 Minutes of Public Meetings Not Published .............................................................................. 32 Procedures for School Security Cameras Still Required Formal Approval ............................ 32

CORRECTIVE ACTIONS TAKEN BY DISTRICT

Student Dental Care Benefits No Longer Paid Through the Public School Health Fund ................................................................................................................................ 34 Encumbrance Policy Now Clarified ......................................................................................... 34 CAFR Preparation Procedures Now Improved ........................................................................ 35 Completed Project Costs Now Properly Transferred Out of Construction in Progress ................................................................................................................................. 35

APPENDIX I: OBSERVATIONS AT FORMER WEST PHILADELPHIA HIGH SCHOOL .........................................................................................................................37

RESPONSE TO AUDITOR’S REPORT

Matthew E. Stanski, Chief Financial Officer ........................................................................... 38

AUDITOR’S COMMENTS ON AGENCY’S RESPONSE ....................................................... 53

MATERIAL WEAKNESS

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CASH RECONCILIATION PROCEDURES NEEDED IMPROVEMENT School District of Philadelphia (District) reconciliation procedures for equity in pooled cash and investments1 need to be improved, as District accountants failed to timely detect millions of dollars in errors. Our testing of the account disclosed that the District initially reported a balance of equity in pooled cash and investments at June 30, 2012 that was $66 million higher than bank records indicated on that same date. District accountants were unaware of the error until we brought it to their attention during the audit. Management’s subsequent investigation of the discrepancy disclosed that accountants:

• Failed to detect the improper accounting treatment of the last bi-weekly payroll for fiscal year 2012 by the District’s computerized accounting system, which incorrectly increased the District’s payroll liabilities fund equity in pooled cash and investments account by $30 million. The increase of $30 million should have more appropriately been recorded as a transaction in fiscal year 2013 instead of fiscal year 2012. This error materially misstated the fund’s assets and related liabilities.

• Erroneously recorded a year-end accounting adjustment involving accrued fringe benefit

expenditures that led to a $36 million overstatement in the District’s general fund equity in pooled cash and investments. District accountants made the incorrect adjustment to the books in October 2012.

Once we brought the $66 million discrepancy to management’s attention and they determined the above-described causes with which we concurred, District accountants made the appropriate adjustments to correct the financial statements. While District accounting management asserted that they perform a reconciliation of total funds’ equity in pooled cash and investments to the cash and investment bank balances, it did not appear to be an effective or timely reconciliation since it failed to detect the $66 million of errors. The only reconciliation the District provided to us during our audit fieldwork was a schedule, received in early January 2013, which reflected the revised equity in pooled cash and investment amounts after the $66 million of errors were corrected.

Recommendation: To improve monitoring of equity in pooled cash and investments, we recommend that District accountants periodically reconcile the total funds’ equity amounts to the cash and investment bank balances throughout the fiscal year – preferably monthly but no less frequently than

1 It is a common practice for governmental entities to pool the cash and investments of various funds to improve investment performance. Each fund’s share of this internal investment pool is reported in the Comprehensive Annual Financial Report as an asset titled equity in pooled cash and investments. An important accounting procedure to ensure the accuracy of the reported cash and investment amounts is to reconcile the total balance recorded on the books with the amount held by the bank.

MATERIAL WEAKNESS

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quarterly. Discrepancies noted should be promptly investigated and resolved. Also, to ensure the accuracy of reported equity in pooled cash and investments, we recommend that the reconciliation be performed as one of the final procedures in completing the fund financial statements. Each reconciliation should be independently reviewed and approved by supervisory personnel. To evidence performance of these tasks and affix accountability, District accounting management should require that documentation be maintained on file for all reconciliations completed [600112.01].

SIGNIFICANT DEFICIENCY

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SAFEGUARDING AND RECORDKEEPING OVER SCHOOL FURNITURE AND EQUIPMENT WERE INADEQUATE The District needs to better safeguard and account for its $272.6 million furniture and equipment inventory. We found nearly 67 percent (87 of 130) of furniture and equipment items selected from District records for testing at eleven different schools could not be located.2 The unlocated items, with a cost value of $196,000, consisted of computers, printers, various audio visual devices, cameras, snow blowers, musical instruments, air conditioners, medical equipment, and athletic equipment. Additionally, we also found that 23 percent of another 90 items chosen haphazardly from furniture and equipment we observed at nine of the eleven selected schools could not be found in the District’s inventory records for the schools.3 These too were items such as computers, a printer, musical instruments, audio visual equipment and a snow blower. Our audit disclosed the following deficiencies and breakdowns in the District’s procedures over its furniture and equipment inventory, which increased the risk of asset misappropriation and contributed to our inability to locate sampled assets and find selected items on the District’s inventory records:

• A new computerized inventory system did not provide for adequate accountability over deleted furniture and equipment.

• District personnel did not maintain adequate records to document what happened to

equipment or furniture left behind in the old facilities when certain schools were relocated to newly constructed facilities.

• District personnel frequently failed to affix school property tags to equipment and furniture.

• Some District personnel removed equipment from school premises without proper

authorization and documentation.

2 For our testing of items chosen from the District’s furniture and equipment records, we selected ten school locations with high dollar amounts of inventory according to the District’s records as of March 27, 2012. The ten selected schools were as follows: West Philadelphia High School, High School of the Future, Edward Bok High School, Overbrook High School, Strawberry Mansion High School, Thomas A. Edison High School, Jules E. Mastbaum High School, Frances E. Willard Elementary School, Warren G. Harding Middle School, and Baldi Middle School. In addition, our sample also included Samuel S. Fels High School, which was tested during the previous audit and required follow-up of prior noted conditions. 3 For the sample of furniture and equipment inventory chosen from observation, we used the same ten school locations selected for the test of items picked from the District’s furniture and equipment records. See note 2 above. During our visit to one of these ten schools (High School of the Future), we were unable to locate any tagged items. Therefore, our test only included a sample of tagged items from the other nine schools. The deficiency regarding various schools’ failure to ensure that furniture and equipment were properly tagged is discussed in more detail on pages 6 and 7 of the report.


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• School personnel frequently did not update their inventory records for furniture and

equipment dispositions.

• Certain schools failed to submit the required annual physical inventory reports for the furniture and equipment located at their facilities.

• Idle equipment observed at a closed school building indicated the District may not always

be optimizing its use of available assets. Each of these deficiencies is discussed in more detail below. New Inventory System Did Not Provide Adequate Accountability over Deleted Furniture and Equipment In fiscal year 2012, the District upgraded its computerized recordkeeping system for furniture and equipment inventory so that personnel at individual schools or units could electronically make changes to their school’s inventory records. Transactions entered by a District school or unit required the electronic signoffs of the designated preparer and the principal or unit administrator. The deletion of items from a school/unit’s inventory records also required the electronic approval of accounting personnel in the District’s Office of Accounting Services and Audit Coordination (OASAC). For certain deletions, such as furniture and equipment less than five years old that was damaged, lost, or stolen, school/unit personnel also had to submit a Serious Incident Report (Form EH-31) before OASAC would approve the removal. However, deletions of items five years or older did not require the submission of any supporting documentation. OASAC management informed us that, for items five years or older which could not be found, school/unit personnel were instructed to delete the items using the “obsolete” disposition code even though there were separate codes which could be used to report damaged, lost, and stolen equipment. Under the new system, the amount of furniture and equipment removed from the District’s inventory records in fiscal year 2012 amounted to $46.3 million, which was more than three times the prior year deletion total of $14.9 million. Of the $46.3 million in deleted furniture and equipment, $44.5 million was coded as “obsolete”. Table 1 on the next page provides a breakout by asset type and age of the $44.5 million in “obsolete” equipment deletions.4 In our opinion, the practice of allowing undocumented deletions increases the chance that thefts of furniture and equipment at District locations can occur and not be detected. Additionally, generic use of the “obsolete” code for these deletions resulted in the District’s inventory records not accurately portraying what happened to certain furniture and equipment. For example, with regard to 28 of the 87 items we were unable to locate – which included computers, printers, a scanner, projectors, an air conditioner, a camera, a camcorder, a saxophone, a piano, a copier, and a television – school personnel removed these items from their inventory records after we visited those schools. Since all 28 items were five years or older, school personnel assigned the “obsolete”

4 The dollar figures presented in this paragraph represent the original cost amounts for the deleted assets. The net carrying value of the fiscal year 2012 deleted furniture and equipment was $1.8 million (original cost of $46.3 million less accumulated depreciation of $44.5 million).


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Table 1: Fiscal Year 2012 Furniture and Equipment Deletions Coded as “Obsolete” (amounts in thousands)* Age of Equipment

Equipment Type

5 to 6 Years

6 to 7 Years

7 to 8 Years

8 to 9 Years

9 to 10 Years

Over 10 Years Totals

Computer Hardware &

Software $841 $4,611 $4,644 $3,475 $2,658 $12,721 $28,950 Buses &

Other Vehicles 0 47 0 535 0 5,384 5,966 Furniture &

Fixtures 14 106 80 143 51 4,652 5,046 Musical

Instruments 0 1 1 21 1 1,325 1,349 Audio Visual Equipment 61 247 133 369 99 199 1,108 All Other

Types 33 193 232 227 117 1,235 2,037 Totals $949 $5,205 $5,090 $4,770 $2,926 $25,516 $44,456 Source: Prepared by the City Controller’s Office based on analysis of District furniture and equipment records. *Dollar amounts represent the original cost of the deleted assets.

disposition code to these deletions and thus were not required to submit supporting documentation. However, for 7 of the 28 deletions, school officials had shown us items similar in description to the sampled assets; we could not definitively identify those items because there were no property identification tags affixed to them. Additionally, with regard to 4 of the 28 deleted items, school personnel asserted they had previously disposed of the equipment. When we requested to observe the electronic signoffs of the unit personnel who initiated and approved these 28 asset deletions, OASAC personnel informed us that, due to a limitation with the District’s new system, they were unable to retrieve the history of which employees initiated and approved inventory change transactions. In August 2012, OASAC personnel indicated that they have brought this system limitation to the attention of the District’s Office of Information Technology (OIT). District Personnel Did Not Keep Adequate Records to Document Dispositions of Furniture and Equipment During Relocation to New Facilities In our prior report, we commented that, for certain schools which relocated to newly constructed facilities, District personnel did not maintain adequate records to document what happened to furniture and equipment not moved to the new facility. We again noted this condition during the current audit. As a result, certain schools’ furniture and equipment records were not properly updated to reflect equipment disposals and transfers and, therefore, were not accurate. Two of the schools included in our review – Frances E. Willard Elementary School (Willard) and West Philadelphia High School (West Philadelphia) – moved to newly constructed facilities in September 2010 and September 2011, respectively. When we visited both locations in April 2012, we could not locate and observe 15 of 18 items we chose from the two schools’ furniture and


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equipment records that had been acquired prior to the relocations.5 Officials at both schools failed to supply us with any documentation to support the disposition of the items in question. Subsequently, in July 2012, we requested the deputy chief financial officer (deputy CFO) in charge of the District’s OASAC to provide us with any available records detailing furniture and equipment dispositions during the relocation of the two schools. For the Willard relocation, OASAC provided us with documents, dated October 26, 2010. Those documents had been received and processed by OASAC in March 2012 and indicated that various computer equipment from Willard’s former facility had been transferred to the Spring Garden School and the OIT’s education technology warehouse. From our review of the documents, we could account for only 1 of the 5 items that we had been unable to locate at Willard. However, this item had not been removed from Willard’s inventory records because of an oversight when OASAC personnel processed the relocation documents. When we brought this oversight to OASAC’s attention, its employees adjusted Willard’s records accordingly. In response to our July 2012 request for documentation about the two school relocations, the deputy CFO for OASAC also made inquiries of personnel in the District’s OIT, Facilities and Operations Department, and the Office of Grants Development and Compliance as to what information these units had. In August 2012, OIT furnished OASAC with schedules indicating that several interactive whiteboards and projectors had been removed from West Philadelphia during October 2011 and June 2012 and were either transferred to other schools, stored at the education technology warehouse, or disposed of due to being damaged. OASAC personnel then updated West Philadelphia’s inventory records for these changes. However, none of the ten items we were unable to locate at West Philadelphia were on the schedules submitted by OIT. OIT also provided OASAC with a computer file containing information on West Philadelphia’s computer equipment. However, OASAC personnel stated that the file did not contain usable information for them to update the school’s inventory listing for equipment deletions and transfers. On September 10, 2012, OASAC personnel informed us that they were working with OIT and West Philadelphia officials to clean up the school’s inventory records. District Personnel Frequently Failed to Ensure Furniture and Equipment Were Tagged District Policy 750.0, which establishes procedures over equipment security, requires that all District-owned furniture and equipment be properly identified by affixing a standard property identification tag to it. Property tags are used to track and identify District-owned equipment and serve as a safeguard against theft. As in prior year audits, our visits to selected schools continued to disclose numerous instances of when District personnel failed to ensure that furniture and equipment were tagged. The instances are described below:

• For 42 of the 87 items we could not observe, school officials showed us an item similar in description to the sampled asset. However, we could not positively identify these items as

5 For 6 of the 15 items unable to be observed, school officials showed us an item similar in description to the sampled asset. However, we could not definitively identify these items as the sampled assets because there were no property identification tags affixed to them. The deficiency regarding various schools’ failure to ensure that furniture and equipment were properly tagged is discussed in more detail above.


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the sampled assets because there were no property identification tags affixed to them. Additionally, even though the District’s inventory records listed the manufacturer’s serial number as an available information field, the District’s records did not indicate the serial number in most cases so we were unable to identify the items through use of the serial number.

• During our visit to High School of the Future, we were unable to find any furniture and

equipment with property identification tags affixed to them. According to the District’s inventory records, High School of the Future had a total of 1,282 items valued at $2,365,764.

• In June 2011 during the prior audit, we observed at Samuel S. Fels High School (Fels) a bag

containing 324 property identification tags that were not affixed to any equipment. These tags pertained to various office furniture purchased in fiscal year 2010 at a total cost of $220,000. We again visited Fels in April 2012 and found that the 324 tags had still not been affixed to the related office furniture. School personnel informed us they had a brief description of the related office furniture but did not know where the specific items were located in the school. Also, during our April 2012 visit, we observed that the bag contained three additional tags, which pertained to computer software and instructional aids purchased in June 2009, September 2010, and December 2011 at a total cost of $9,009.

• During a visit to West Philadelphia High School in April 2012 to locate certain equipment

selected from its inventory records, we observed school personnel affixing the identification tags to two selected items – a saxophone and subwoofer that had been purchased in August 2011. Another sampled item – a television purchased in August 2011 – was found still in the box in which it arrived and after eight months had still not been tagged.

• At Warren G. Harding Middle School, we chose from our observations at the school a

tagged printer and discovered that, although its property tag number was located on the school’s inventory records, the equipment associated with the tag number was actually a computer. Therefore, the wrong tag had been placed on the printer.

District Personnel Removed Equipment from School Premises Without Proper Authorization and Documentation District Policies 750.0 (for equipment other than computers) and 750.1 (for computers), require that before removing equipment from a school, employees must prepare and submit specific documentation to the principal for approval. The principal must then retain the documentation. We continued to find that school personnel did not always prepare and submit the required documentation and obtain appropriate authorization when removing equipment from school premises. Specific examples noted during the audit included:

• At High School of the Future, we could not locate a laptop computer selected from the school’s inventory records. School personnel asserted that the laptop had been taken by the previous principal and never returned. They were unable to provide any supporting documentation for the removal of the laptop from the school premises.


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• At High School of the Future, initially we could not locate a sewing machine chosen for

testing. School officials subsequently discovered that an employee had taken a sewing machine off the premises without obtaining the proper authorization from the principal. At the principal’s request, the employee brought the sewing machine back to the school. We returned to the school and observed this sewing machine; however, the item did not have a property identification tag affixed to it.

• During our April 2012 visit to Baldi Middle School, at first we were unable to find a desktop

computer selected for observation. When the school operations officer questioned the teacher in whose classroom the computer was supposed to be located, the teacher stated that she had taken the computer home during the previous summer because of a theft in her classroom during the school year. Our further inquiries revealed that the teacher had removed the computer from the school without submitting the appropriate documentation and obtaining the principal’s approval and then never returned the computer to the school. The school operations officer directed the teacher to return the computer. Upon its return to the school, we observed the computer.

• At Frances E. Willard Elementary School, school personnel informed us that a laptop

computer we could not observe had been taken home by the principal. However, again we determined that the required documentation for removing the computer was not available for inspection at the time of our testing.

School Officials Frequently Did Not Update Inventory Records for Equipment Dispositions To ensure the accuracy of the furniture and equipment inventory records, District policy and procedures require that each District location give an account of all changes to its inventory, including transfers, disposals, losses, thefts, and additions. As discussed in a previous section of this report, in fiscal year 2012 the District upgraded its computerized system for tracking furniture and equipment inventory so that school/unit personnel could electronically make changes to their location’s inventory records. However, as noted in several prior audits, we continued to find numerous instances of when school officials did not take appropriate action to update their inventory records to account for equipment dispositions. Of 7 items we could not observe at four schools visited in April 20126 – a sound module synthesizer, a snow blower, a printer, three computers, and audio visual equipment – school personnel asserted that the equipment had been either disposed of or transferred. However, as of July 2012, officials at the four schools had not taken action to revise their inventory records to reflect these disposals and transfers. Failure of school personnel to properly update their inventory records also contributed to our inability to locate several items selected from observation in the District’s furniture and equipment

6 The four schools were High School of the Future, Edward Bok High School, Strawberry Mansion High School, and Warren G. Harding Middle School.


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inventory records for the schools where we had observed the items. Specific examples noted included:

• For three items chosen from observation at schools – a laptop computer at Edward Bok High School, a smartboard at Thomas A. Edison High School, and an overhead projector at Baldi Middle School – the equipment was eventually located in the inventory records under a different school location.

• At Edward Bok High School (Bok), we observed 90 laptop computers that did not appear in

the inventory records.7 These computers had been transferred to Bok from two other schools but still appeared on those two schools’ furniture and equipment inventory.

• Four computers selected from observation at West Philadelphia High School, Strawberry

Mansion High School, and Jules E. Mastbaum High School, had been incorrectly removed from the District’s inventory of furniture and equipment. These erroneous asset removals occurred because the four computers were recorded in the District’s records under incorrect school locations. School personnel at these locations then directed OASAC to delete the items since the equipment was not physically present at the locations. In all of the instances, District personnel failed to properly update their inventory records to show the assets’ correct locations.

• For 12 items selected from observations at six schools,8 OASAC personnel informed us that

there was no record of the items in the District’s computerized database of furniture and equipment. School personnel had failed to update their inventory records to report the existence of these items.

Certain Schools Did Not Always Submit Required Annual Physical Inventory Reports School principals are directed to perform a yearly inventory of furniture and equipment physically located at their facilities. A properly performed physical inventory is an important control procedure to ensure the accuracy and completeness of the reported inventory. To document its performance, principals are required to submit a physical inventory report, which should be signed by the principal who certifies that the furniture and equipment on the report has been observed and is located at the school. With regard to the eleven schools where we conducted audit testing,9 the following four schools did not submit their physical inventory reports for fiscal year 2012: West Philadelphia High School, High School of the Future, Edward Bok High School, and Samuel S. Fels High School.

7 These 90 laptop computers observed at Bok were not part of our sample of 90 tagged furniture and equipment items selected from observations at nine schools as discussed on page 3 of the report. 8 The six schools were West Philadelphia High School, Edward Bok High School, Strawberry Mansion High School, Jules E. Mastbaum High School, Warren G. Harding Middle School, and Baldi Middle School. 9 See note 2 for a list of these eleven schools.


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Idle Equipment Observed at Closed School Building Suggests the District May Not Always Be Optimizing Use of Available Assets District protocol for closing schools provides general guidelines to be followed in the event of a school building closure and directs school officials to work with District central office personnel in assessing and developing re-distribution plans for various available assets such as furniture and equipment, artwork, and textbooks/instructional aids. However, based upon certain observations made during our audit testing, it appeared that the District’s procedures were not always effective in achieving optimal use of available assets. In light of the serious fiscal challenges facing the District, in our opinion, management needs to make use of every available resource. One of the schools included in our testing – West Philadelphia High School (West Philadelphia) – moved to a new facility in September 2011 after its former building closed in June 2011. When we visited the closed West Philadelphia facility approximately one year later in April and June 2012, we observed several instances of idle equipment and supplies still sitting in this closed school building. Our observations, most of which are illustrated in Appendix I, included the following:

• A classroom still set up as a computer lab containing 22 desktop computers and a printer, which were all powered on and ready for use (Figure 1).

• Various rooms stored numerous additional desktop computers, some of which were in

boxes. Records showed that several of the desktop computers were a little over two years old (Figure 2).

• One room housed a cart with several laptop computers.

• Interactive whiteboards were located in various classrooms (Figure 3).

• An exercise room contained various weight training machines, such as bench presses and a

leg press (Figure 4).

• Various musical instruments were still located in the building, including an organ and four pianos (Figure 5).

• Two artwork items – a bronze plaque and an antique grandfather clock – still remained in

the closed building.

• Several boxes of new textbooks were observed in classrooms and hallways.

• Eight boxes of what appeared to be new band uniforms were stored in the music room (Figure 6).

After we brought our observations to District management’s attention, OIT personnel informed us that the computer lab and interactive whiteboards were set up to temporarily house an alternative education program for District high school students run by a non-profit corporation, whose facility was deemed to need emergency repairs. We observed a School Reform Commission resolution


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authorizing an agreement between the District and the non-profit corporation for the use of the old West Philadelphia building, the term of which ran from October 24, 2011 through November 23, 2011. OIT officials asserted that, once the non-profit corporation’s student program left the old West Philadelphia building in November 2011, the computer lab and interactive whiteboards were left intact during the remainder of the school year in case the space was needed again for another emergency. With regard to the other computers and interactive whiteboards observed, OIT personnel indicated that many of them were older models whose warranty expired so OIT intended to use them for replacements and parts. As for the newer model desktop computers noted, OIT management stated that these units were stored in the closed building until the student success center in West Philadelphia’s new facility was ready to house a computer lab. OIT provided us with a list of 16 computers, all purchased in fiscal year 2010, that were moved to the student success center in June 2012. OIT’s list indicated that two additional computers also scheduled for transfer to the student success center could not be located at the time of the move.

Recommendations:

To improve the safeguarding and recordkeeping of furniture and equipment assets, we recommend that District management contact the principals at the affected schools and work with them to reconcile the remaining differences noted during our testing [600112.02].

To improve controls over its new computerized furniture and equipment inventory system, District management should take the following actions:

• Instruct school/unit personnel that, instead of generically using the “obsolete”

disposition code for equipment deletions over five years old, they must use the disposition code reflecting what actually happened to an item so that inventory records accurately reflect whether items were damaged, lost, or stolen. For items five years or older that are damaged or stolen, school/unit personnel should submit a Serious Incident Report (Form EH-31) [600112.03].

• Given the steep increase in equipment deletions in fiscal year 2012, analyze deletions by location to identify schools/units with large amounts of deletions. Contact the principals or unit administrators at these locations to explain the increase in asset removals [600112.04].

• Revise the computerized system to provide the capability to retrieve the names of the

school/unit employees who initiate and approve each inventory change transaction [600112.05].

• Require that, when a manufacturer’s serial number is available for an item of equipment,

District personnel enter this information into the system’s serial number field to provide an additional way to identify and track equipment [600112.06].


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In order to properly account for equipment dispositions during school relocations, we continue to recommend the District establish procedures requiring school personnel and other District staff conducting the relocation to maintain records of the furniture and equipment that is not moved to the school’s new facility. These records should list the items by identification tag number and indicate the final disposition of the items, whether scrapped or transferred to another school [600111.06].

To improve safeguarding of furniture and equipment at schools, management should send principals a directive (1) requiring them to contact OASAC to request identification tags for untagged equipment; (2) instructing them to immediately affix identification tags to all equipment once received; (3) advising them of the requirements of District Policies 750.0 and 750.1 regarding the removal of equipment from school premises; (4) reminding them to promptly report all changes in inventory on the computerized furniture and equipment tracking system; and (5) emphasizing the need to comply with established District furniture and equipment procedures for submitting a complete and accurate yearly physical inventory report [600108.01]. To improve utilization of available assets from school closures, we recommend District management provide a directive to school officials and responsible central office personnel detailing the specific steps to be taken in assessing and developing re-distribution plans for available equipment and supplies. District management should monitor compliance with this directive, including visiting the closed facility to ensure that usable equipment and supplies are not sitting idle. Providing detailed procedures for school closures is especially important in light of the many school closures planned at the end of fiscal year 2013 [600112.07].

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MANAGEMENT OF PETTY CASH REMAINED DEFICIENT In several past reports, we have commented on numerous control weaknesses and instances of non-compliance with established control procedures involving operations of the District’s petty cash funds at the schools. Our visits to six selected schools in April and May 2012 disclosed that schools’ management of these funds continued to be deficient. Observations we made during the visits included finding: (1) significant account shortages; (2) noncompliance with the District’s expenditure policy; (3) inadequate segregation of duties; (4) infrequent account usage; and (5) failure of certain locations to take action to reduce their account balances to authorized levels. These findings, which are discussed in more detail below, adversely affect the District’s ability to properly safeguard and account for its $540,000 petty cash funds.

Significant Shortages Noted For Selected Schools While District accounting records indicated that the six schools we visited should have had total petty cash funds of $20,682.41 in their custody, our review of the schools’ supporting bank and disbursement records only accounted for $6,328.84 of this amount. Therefore, these schools’ petty cash funds were short by a total of $14,353.57, as detailed in Table 2 below. With regard to High School of the Future, we discovered that, while District accounting records at June 30, 2012 carried a petty cash fund balance of $5,000 for this school, its bank account had actually been closed out in September 2008, almost four years ago.

Table 2: Petty Cash Fund Discrepancies Noted for Selected Schools Visited

School

Balance Per

District Records as of June 30,

2012

Balance Accounted

For By Auditor

Account Overage

(Shortage) High School of the Future $ 5,000.00 $ 0.00 ($ 5,000.00) George Pepper Middle School 5,000.00 7.81 (4,992.19) Theodore Roosevelt Middle School 5,164.80 807.34 (4,357.46) Morris E. Leeds Middle School 1,517.61 1,511.49 (6.12) Austin Meehan Middle School 2,000.00 2,002.20 2.20 Woodrow Wilson Middle School 2,000.00 2,000.00 0.00 Total $20,682.41 $6,328.84 ($14,353.57) Source: Prepared by the City Controller’s Office based on analysis of selected schools’ petty cash records

Certain Schools Did Not Comply with the District’s Petty Cash Expenditure Policy Our review of petty cash disbursements at the schools visited disclosed the following instances of non-compliance with the District’s petty cash expenditure policy:

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• We noted $1,672 in refreshments and other items purchased for various school meetings - $1,478 at Morris E. Leeds Middle School (Leeds) and $194 at Theodore Roosevelt Middle School (Roosevelt) – which District policy did not permit to be paid out of petty cash unless eligible to be reimbursed from available grant funds. In the case of Leeds, these purchases were incurred in fiscal years 2007 and 2008 but had not yet been reimbursed because Leeds failed to submit a reimbursement request before the grant award expired. Additionally, we found that one of Leeds’ refreshment purchases exceeded the $200 petty cash transaction limit. In October 2012, the District’s chief academic officer approved an exception to District policy so the $1,478 of expenditures could be reimbursed by the District’s general fund. With regard to Roosevelt’s $194 purchase, incurred in fiscal year 2008 but not yet submitted for reimbursement, the related imprest fund voucher indicated that the school would request reimbursement from the general fund, which District policy does not permit unless an exception is granted by upper District management.

• At Austin Meehan Middle School, our audit disclosed $105 spent from petty cash funds to

purchase wholesale club store memberships for three school employees to buy goods for student incentives. Our discussion with District accounts payable personnel indicated that this expenditure should more appropriately have been paid out of the school’s student activity funds.

Inadequate Segregation of Duties Was Noted At Selected Schools To reduce the risk of undetected errors and / or theft of funds, proper control procedures suggest that someone other than the petty cash custodian reconcile the fund’s bank account. However, at all five middle schools visited, we found insufficient segregation of duties, noting the fund custodian maintained the checkbook and also reconciled the petty cash bank account.

Selected Schools Infrequently Used Their Petty Cash Accounts Of the six schools visited, only two schools used their petty cash accounts in fiscal year 2012, and that use was very infrequent. At Austin Meehan Middle School and Woodrow Wilson Middle School, which each had a $2,000 fund, there were only six disbursements (three at each school) totaling $749 during fiscal year 2012.

Certain Locations Failed to Reduce Account Balances to Authorized Levels In fiscal year 2008, District management announced plans to reduce the authorized amount of the petty cash imprest funds held at various locations. To reduce each location’s authorized amount, management decided it would process but not repay the locations’ petty cash reimbursement requests until the individual fund balances equaled the revised lower amounts. This practice was ineffective in achieving the desired petty cash reductions because of the large number of funds with low turnover. In November 2009, District management issued a directive instructing location administrators with petty cash funds higher than desired to draw and submit checks to the Accounts Payable Unit in the amount needed to reduce the authorized balances. Despite management’s efforts, as of March 11, 2013, there were still 72 District locations (42 schools and 30 program offices) where the petty cash account balance exceeded the desired authorized amount by a total of $90,819.

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Recommendations:

With regard to the petty cash shortages found by our audit, District management should take the following actions:

• Work with the affected schools’ personnel to investigate the causes of these shortages and resolve the discrepancies appropriately. If adequate documentation cannot be found to account for the shortages, then District management should request that responsible school personnel reimburse the District for the shortages [600112.08].

• Adjust District accounting records accordingly to reflect the correct petty cash

balances for the affected schools [600112.09].

To enhance internal controls and minimize the risk of undetected errors or theft of petty cash funds, we continue to recommend that the District monitor and enforce policies and procedures relating to the management and reconciliation of all petty cash imprest funds [600108.04].

For all petty cash funds where the planned reduction in the authorized amount has not been completed, District management should enforce its November 2009 directive instructing location administrators to reduce their petty cash funds by paying those monies directly over to the District via a check drawn on the fund’s bank account. Additionally, the District should review the funds for infrequent activity and reduce the authorized amounts accordingly [600112.10].

OVERSIGHT OF STUDENT ACTIVITY FUNDS REMAINED PROBLEMATIC During several previous audits, we reported upon control deficiencies observed in the course of our review of student activity funds at selected schools. Although the District had developed a comprehensive School Fund Manual for student activity funds (Manual), which provided very specific responsibilities and detailed procedures, we found non-compliance with the Manual to be a common occurrence at the schools we visited. In May 2012, we performed a limited review of student activity funds at three high schools – John Bartram High School (Bartram), Philadelphia High School for Creative and Performing Arts (CAPA), and Philadelphia High School for Girls (Girls’ High). Additionally, for 20 schools (the 15 schools with the largest reported cash balances along with 5 other haphazardly selected schools), we examined the fiscal year-end student activity funds financial reports on file in the District’s Office of Accounting Services and Audit Coordination. Our review continued to note non-compliance with the Manual and deficiencies in handling student activity funds, which totaled $5 million for all schools at May 31, 2012. Specifically, we found:

• inadequate procedures over one school activity’s collections; • several instances of expenditures with no supporting documentation; • improper use of student body activity account funds; • non-compliance with bidding requirements; • failure of a principal to review and approve bank reconciliations; • finance committees not being established;

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• budgets not being prepared by activity sponsors; • activities with negative account balances; • improper retention of school-related funds;10 • failure to close inactive account balances; • long outstanding checks needed better monitoring; and • long outstanding deposits in transit appeared questionable.

Each of these deficiencies, which are discussed below, increases the risk for fraud to occur at the schools and not be timely detected. Procedures Over One School Activity’s Collections Were Inadequate At Bartram, we found inadequate procedures over collections for its student incentives activity which, according to deposit records, totaled $17,422 in fiscal year 2012.11 Collections for the student incentives activity, which were used to fund various student rewards, came from donations received by either the principal or school operations officer, and the sale of t-shirts by the school safety director. When activity sponsors collect money, the District’s Manual requires schools to maintain records that detail the amount, source (e.g. name of student), date received, and purpose of the collection. In spite of this requirement, the principal informed us that no such records were maintained for the student incentives activity. We believe the principal’s failure to require employees responsible for these monies to maintain records in accordance with the Manual created opportunities for the misappropriation of cash. One School Was Unable to Provide Documentation to Support Certain Expenditures The Manual requires that all disbursements from student activity funds be supported by an original invoice and a payment voucher (Form H-201), which the principal signs to evidence approval of the transaction. Our audit disclosed that Bartram school personnel were unable to provide the supporting payment voucher and invoice for expenditures totaling $1,265 – a $1,075 disbursement for a senior class activity and a $190 payment made to a bus company. Also, Bartram officials could not locate the supporting invoices for another $650 of expenditures, which, according to the payment vouchers, included a $150 reimbursement to a student for a stolen cell phone, a $150 purchase of championship game tickets, and a $350 payment to a pizzeria for a student incentive event. Student Body Activities Account Was Improperly Used The Manual requires that funds included in the student body activities account (SBAA) be spent for the general welfare of the student body and states that it is inappropriate to spend these monies on the purchase of normal classroom or office equipment. However, we observed disbursements totaling $2,093 from all three schools’ accounts that appeared questionable. Specifically, we noted the following: 10 School-related funds are monies collected by schools such as fees for transcripts, lost books and equipment, and identification card replacements. While these monies are not considered student activity funds, it is a common practice for schools to deposit, maintain, and disburse these funds from their student activity fund checking accounts. 11 This represents total collections according to deposit records as of April 24, 2012.

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• At Girls’ High, $1,627 was expended from the SBAA for postage and toner. • CAPA’s disbursement records indicated that $316 of SBAA funds were spent for office

supplies, such as a calendar, toner, and a desk display.

• The unsupported reimbursement to a student for a stolen cell phone discussed above was disbursed from Bartram’s SBAA.

Non-Compliance With Bidding Requirements The Manual’s bidding requirements direct school officials to obtain and retain on file at least three competitive bids for any purchase exceeding $4,000 as well as all yearbook and photography contracts. However, when awarding the yearbook contract in fiscal year 2012, Bartram personnel only obtained two bids. Furthermore, Bartram officials informed us that they did not always solicit bids for the yearbook contract each year and the same vendor had produced the school’s yearbook since 2009. While Girls’ High personnel asserted that they obtained three bids for their yearbook contract, we were only able to observe two of these bids. When schools fail to comply with Manual bidding requirements, there is no assurance that the services are being obtained at a competitive price, and it gives the appearance that the selection process may have been intentionally biased to favor one vendor over others. School’s Principal Did Not Review and Approve Bank Reconciliations The Manual requires that principals review the student activity fund bank reconciliations to ensure their accuracy and identify any errors or irregularities requiring investigation. The principal should sign and date the bank reconciliation form to provide evidence and affix responsibility for the performance of this task. Our inquiries of Bartram’s principal disclosed that she did not review and approve the bank reconciliations. We observed Bartram’s bank reconciliations for the months of July 2011 through March 2012 and found no evidence of principal review. Schools Did Not Establish Finance Committees Student activity fund balances at the three high schools visited totaled $528,871 at May 31, 2012. Because of the significance of these amounts, the Manual requires principals to establish finance committees that advise them on investing cash in excess of current needs. Despite this requirement, Bartram, CAPA, and Girls’ High had not established a finance committee. In addition, we noted that all of CAPA’s funds, which totaled $145,302 at May 31, 2012, were on deposit in a non-interest bearing checking account. Activity Budgets Were Not Prepared At Bartram, budgets that disclosed anticipated income and expenditures were not being prepared on a consistent basis for all activities. According to the Manual, budgets should be constructed as a fiscal management tool for each activity by sponsors, working with student representatives and principals.

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Negative Activity Account Balances Improperly Created Our review of the fiscal year-end financial reports indicated 11 of 20 schools reported negative equity for at least one type of student activity. This negative equity ranged from ($18) to ($25,001) and totaled ($74,114). The existence of negative balances for individual activities means that expenditures were made even though there were insufficient funds to cover expenses. As a result, the schools used monies from other activities with positive balances to pay for the expenses. This is not permitted under Manual guidance. School-Related Funds Were Improperly Retained School-related funds represent amounts received by schools such as fees for transcripts, lost books and equipment, and identification card replacements. Schools deposit these funds in their student activity accounts and are required to establish separate ledgers to segregate them and facilitate their accounting. The Manual directs that schools remit these fees to the District’s Office of Management and Budget (OMB), who will credit the funds to each school’s operating budget. Our review of the year-end student activity funds financial reports disclosed that, as of May 31, 2012, 14 of 20 schools had not forwarded to the OMB $70,302 in fees related to transcripts, lost books and equipment, and identification card replacements. Inactive Account Balances Were Not Closed Based upon our observations of year-end financial reports, we noted 16 of 20 schools had 174 accounts totaling $135,858 for which there was no activity during the school year. The existence of long dormant balances provides the opportunity to use funds for unauthorized purposes and is addressed in the Manual. According to this guidance, student groups are to designate the use of any funds remaining after each program’s conclusion. In the absence of such designation, excess funds are to be transferred to each school’s student body activities account and used for the general benefit of students. Long Outstanding Checks Needed Better Monitoring The Manual instructs both the principal and school operations officer to monitor outstanding checks as part of the bank reconciliation process. Our review of bank reconciliations submitted with the year-end financial reports disclosed 13 of 20 schools listed checks that had been outstanding for long periods of time (some over 13 years old). In total for all 13 schools, we found 264 checks totaling $22,319 which had been outstanding for over one year. Failure to properly resolve long outstanding checks unnecessarily complicates the bank reconciliation process, and indicates non-compliance with the state’s escheat laws.12 Long Outstanding Deposits In Transit Appeared Questionable Our audit revealed that bank reconciliations for three schools – Julia R. Masterman High School (Masterman), South Philadelphia High School, and Thomas A. Edison High School (Edison) – listed several deposits in transit totaling nearly $10,000 which had been outstanding more than one year. In one case, a $2,011 deposit in transit, which was cited in the last two audit reports, had been

12 The Commonwealth of Pennsylvania’s escheat laws require that unclaimed property (other than payroll checks) be turned over to the state after remaining unclaimed for five years.

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listed as outstanding on Edison’s bank reconciliation since July 2001. In another instance, Masterman’s bank reconciliation contained a $7,000 deposit in transit outstanding since January 2010. At the exit conference, District accounting management asserted that, in accounting for adjustments of voided checks on bank reconciliations, school personnel label these adjustments as deposits in transit. However, the District provided no evidence to enable us to determine whether the above deposits in transit carried for so long on the bank reconciliations represented voided check adjustments or missing monies that had been stolen.

Recommendations:

We continue to recommend that principals and school operations officers take steps to comply with guidance described in the Manual to strengthen control procedures and prevent misuse of funds. District management should reinforce the importance of compliance with Manual guidance at the annual training session for principals [600108.03].

Additionally, we again suggest that principals establish control procedures over collections for any activity that generates sales during the year. Activity sponsors should control collections through the use of a cash register or pre-numbered receipts, the information from which should then be reconciled to the counted cash and/or checks. Documentation of this reconciliation should be retained by the activity sponsors and periodically reviewed by the principal [600110.09].

CONTROLS OVER STUDENT TRANSPASS ACTIVITY CONTINUED TO NEED ENHANCING Since fiscal year 2008, the District’s student TransPass program has provided free transportation to Philadelphia public and non-public students by issuing weekly student TransPasses to students living 1.5 or more miles from school, special education students, students participating in desegregation programs and living one mile or more from assigned schools, and students who must cross hazardous roads on their commute.13 Prior reports have disclosed weaknesses and breakdowns in the District’s controls over the distribution and accounting for student TransPasses at individual schools. During the current audit, we performed a limited review of TransPass procedures at five high schools.14 While our current testing disclosed a significantly reduced number of unaccounted TransPasses as compared to the prior audit’s findings, we continued to note some problems with schools’ management of the student TransPass program, which had total expenditures of $35.3 million in fiscal year 2012. Our review of the actual TransPass practices at five selected high schools revealed the following instances of non-compliance with the District’s established procedures for TransPass activity:

• At four high schools – Communications Technical, Germantown, Abraham Lincoln, and Northeast – we observed that the vast majority of TransPass distribution listings were

13 The District purchases student TransPasses from the Southeastern Pennsylvania Transportation Authority (SEPTA). 14 The five high schools where we reviewed TransPass procedures were the following: Communications Technical High School, Germantown High School, Abraham Lincoln High School, Northeast High School, and Philadelphia Military Academy at Leeds.

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not signed by the employees who gave out the passes to attest that all students whose name was checked off actually received passes.

• At Philadelphia Military Academy at Leeds, we observed the Summary of Free Student

TransPasses report, which details the number of TransPasses received, distributed, and returned for the month, was not signed and dated by the principal to evidence her review of the report.

Furthermore, at two high schools visited (Germantown and Northeast), personnel who prepared the monthly Summary of Free Student TransPasses report informed us that the reported number of TransPasses distributed was essentially a plug, derived by calculating the difference between the number of TransPasses received and the count of TransPasses to be returned. In order for the monthly Summary of Free Student TransPasses to serve as an effective reconciliation to detect unaccounted TransPasses, personnel should instead determine the amount of TransPasses actually given out by reviewing the distribution listings. For the five schools visited, we reviewed TransPass activity for one selected week15 and, using records provided by each school and the District’s Transportation Services Department, recalculated the number of TransPasses not claimed by students. For each school, we compared our recalculated amount for unclaimed TransPasses to the reported number of unclaimed TransPasses returned to the Transportation Services Department. Table 3 on the next page presents the results of our reconciliation. In total for all five schools, we could not account for 71 TransPasses, which were estimated to cost $1,243.16 While officials at the five schools asserted that employees giving out TransPasses were required to document distribution by either checking off names on the eligibility lists or having students initial or sign the lists, this requirement did not always appear to be followed on a consistent basis. As a result, we could not determine whether the unaccounted TransPasses were a result of improper recordkeeping or irregularities.

Recommendations:

To improve control procedures over TransPass activity and reduce the risk of theft and irregularities, we continue to recommend that the District monitor and enforce policies and procedures relating to the distribution and accounting for student TransPasses [600111.08].

To provide greater accountability over TransPasses, school personnel responsible for preparing the monthly Summary of Free Student TransPasses report should be instructed to determine the number of TransPasses actually given out by reviewing the distribution listings, rather than deriving that number as the difference between the number received and those to be returned. Any unaccounted passes detected from this review should immediately be brought to the attention of the principal and investigated promptly [600111.09].

15 We selected the week of February 6, 2012 through February 10, 2012 for testing, except for Germantown High School where we expanded our review to the entire month of February 2012 because of various differences noted on its monthly Summary of Free Student TransPasses report. 16 The estimated cost figure of $1,243 was calculated by multiplying the price of a five-day student TransPass by the number of unaccounted passes. According to the District’s Transportation Services Department, the price of a five-day student TransPass in fiscal year 2012 was $17.50.

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Table 3: Auditor’s TransPass Reconciliation for Five Selected High Schools17 Column A High School

Column B

Number of TransPasses

Received Per

Auditor

Column C Number of

TransPasses Distributed

Per Auditor

Column D Number of

TransPasses Unclaimed

Per Auditor

(Col. B – C)

Column E


Unclaimed Per School

District

Column F


Unaccounted (Col. D – E)

Northeast 1,415 1,239 176 129 47 Abraham Lincoln 1,032 815 217 204 13 Germantown 1,474 1,138 336 327 9 Communications Technical 292 277 15 13 2 Military Academy at Leeds 200 197 3 3 0 Total 4,413 3,666 747 676 71 Source: Prepared by the City Controller’s Office based on analysis of the data from the sources listed in footnote 17 below.

FINANCIAL STATEMENT REVIEW PROCEDURES NEEDED MANAGEMENT’S ATTENTION Previously, we reported on deficiencies in the District’s financial statement review procedures. While District accounting management established a formal, written review process for the fiscal year 2011 Comprehensive Annual Financial Report (CAFR), audit testing had still uncovered accounting errors not caught by this review process. Examples of errors noted included the incorrect reporting of a new asset and mistakes in the calculation of the net assets invested in capital assets, net of related debt. While the net assets computation was very complex and involved numerous adjustments to arrive at the related debt amount, there was no evidence of accounting management review. During the current audit, we observed that District accounting management now documented its review of the net assets invested in capital assets, net of related debt calculation on a written form signed by the responsible accounting manager. Therefore, we consider this prior deficiency resolved [600111.10]. Despite the above corrective action, and the District’s continuation of its formal review process, our current testing still found instances of when District accountants did not catch large mistakes with their review procedures.18 For example, we again noted mistakes in the computation of the net assets invested in capital assets, net of related debt, which resulted in a $9.6 million understatement

17 The sources of information for the TransPass reconciliation presented in Table 3 were as follows:

• Figures in columns B were obtained from the auditor’s review of TransPass receipt/delivery records at the school and the District’s Transportation Services Department.

• Amounts in column C represented the auditor’s count of checkmarks and/or student initials or signatures appearing on the distribution listings provided by school personnel.

• Figures in column E were obtained from the District’s Transportation Services Department.

18 Once we brought these errors to management’s attention, they made the appropriate adjustments to correct them.

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of this account. Also, our testing of the food service fund’s statement of cash flows disclosed that the reported ending cash balance and cash flow activity were both understated by $5.7 million. District accounting management’s review failed to detect that the statement of cash flows did not include a $5.7 million equity in pooled cash and investments asset – an account which had not shown a reported balance on the food service fund’s year-end financial statements since fiscal year 2006.19

Recommendation:

To further strengthen the District’s procedures for detecting and correcting financial statement errors, we continue to recommend that District management emphasize to personnel responsible for the CAFR review the need to pay particular attention to accounts involving complex calculations and transactions related to new activity [600112.11].

ELIGIBLE COSTS WERE NOT ALWAYS CAPITALIZED Previously, we commented that the District’s capital asset accounting system did not always ensure the capitalization of all eligible capital project fund costs in the year of acquisition, as required by generally accepted accounting principles. As a result, capital assets were understated, and current year expenses were overstated. The prior audit disclosed this condition occurred because of the following:

• The costs for a project involving multiple asset locations were improperly expensed because the responsible District unit did not provide the information necessary to identify the related assets.

• It was the District’s policy not to capitalize furniture and equipment expenditures until

items were tagged with an identification label. We previously reported that District accountants attributed some of the delays in tagging the assets to the extra research required when purchase orders failed to contain sufficiently detailed descriptions of the equipment purchased. Insufficiently detailed purchase orders occurred because the District had not established a formal directive that required units to enter details of purchase requisitions into the accounting system. Our current review disclosed that management issued such a directive to District units on May 16, 2012. Accordingly, we consider our recommendation advising the District to issue a directive regarding purchase requisitions as implemented [600111.05]. However, because the directive was issued towards the end of fiscal year 2012, we will evaluate District units’ compliance with the directive and any resulting effect on equipment tagging in a future audit. Current audit testing found that $4.8 million of fiscal year 2012 information technology (IT) equipment purchases were improperly expensed. District accounting personnel stated these purchases involved networking equipment for which they needed the expertise of the Office of Information Technology (OIT) to determine the specific assets to be tagged and thus capitalized. 19 The District did not report an equity in pooled cash and investments asset for the food service fund during fiscal years 2007 through 2011 because the food service fund had incurred deficits which caused it to overdraw its share of pooled cash and investments. The overdraft was covered by the District’s general fund and properly reported as an interfund payable due to the general fund.

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District accountants only sent the list of these IT equipment purchases to OIT personnel for review in mid-October 2012. OIT provided District accountants with an analysis of the taggable equipment on January 14, 2013. Since this IT equipment was not tagged by fiscal year-end, the District did not capitalize these assets in fiscal year 2012.20 Our discussions with both District accounting and OIT personnel indicated they planned to implement corrective actions. The OIT manager responsible for analyzing IT related expenditures to determine taggable equipment asserted that fiscal year 2012 was her first year in this role and stated OIT would provide more detailed descriptions for future purchase orders so accounting personnel could more readily identify taggable IT equipment. In addition, District accountants informed us that, in the next fiscal year, they plan to review capital project fund expenditures prior to the close of the fiscal year to identify purchases that may require additional information from other District units so assets can be tagged and capitalized in the year of acquisition.

Recommendations:

To improve capital asset accounting, we recommend that District accountants implement their plan to review capital project fund expenditures during the fiscal year to identify asset purchases that may require additional information from other District units. The information needed from other units should be requested on a timely basis to enable accounting personnel to record the assets in the year of acquisition [600112.12]. District management asserted the extra effort to include the balance of untagged equipment in reported capital asset amounts was not warranted from a cost-benefit perspective because the cost of the untagged personal property was immaterial. We continue to recommend that management annually review the amount of untagged personal property costs to ensure its immateriality in future years [600110.08].

ARTWORK RECORDS NOT YET ADEQUATELY UPDATED In fiscal year 2008, the District completed a comprehensive inventory of its artwork collection (valued at $8.1 million as of June 30, 2012), which included $242,350 worth of items listed as “Not Observed” because they were located in closed school buildings, and $250,950 worth of items that the District listed as “Can Not Locate.” Corrective actions taken to date have not been effective in determining the existence, condition, or actual value of the items in these two classifications. During our current year audit, District accountants informed us that they had still not observed the artwork in the closed school buildings. Prior year actions taken by the District with respect to these items included the removal in fiscal year 2009 of one $3,500 item based upon paperwork submitted by personnel from a charter school that occupied the building where records listed the item as being located. Also, in fiscal year 2011, District accounting personnel deleted seven murals with a total value of $210,000, from the “Not Observed” category. The accountants asserted they were told the murals had been painted over during a building renovation by the charter school that had taken over the building where District records indicated the murals were located. However, there was no written documentation to support the deleted artwork. 20 We proposed an adjustment to correct the District’s financial statements for this error. However, the District elected not to book our adjustment. We determined that the District’s failure to record the $4.8 million of equipment did not materially misstate its financial statements.

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Current year testing disclosed two items with a total value of $300, previously categorized as “Not Observed”, which were removed from this classification but still appeared in the June 30, 2012 reported artwork inventory. District accountants indicated the receipt of updated location information from school personnel led to the removal of the two items from the “Not Observed” category. During fiscal years 2009 and 2010, 26 “Can Not Locate” items valued at $76,800 were dropped from the artwork inventory based solely upon paperwork received from the school locations. In the current year, District accountants removed one “Can Not Locate” item with a value of $100 on the basis of paperwork submitted by school personnel. Additionally, our review of the District’s June 30, 2012 “Can Not Locate” artwork listing found that seven items valued at $104,000 were removed from this classification but still appeared in the fiscal year-end reported artwork inventory. For six of these seven items, school personnel submitted updated location information that led to their removal from the “Can Not Locate” category. For the remaining item, District accounting personnel were unable to explain the basis for its deletion. Because of the risk inherent in an artwork collection, we selected a sample of 20 items from the District’s artwork inventory for testing during our current audit. We were unable to locate three of the selected items, none of which had previously been classified as “Can Not Locate” or “Not Observed”. Twelve of the items that were observed did not have identification tags designating them as District property. When we brought these findings to the attention of the District employee who maintains the artwork inventory records, he informed us that these items remained on the inventory because the necessary paperwork to remove them had not been processed by the principals at the school locations. As a result, the District’s reported artwork inventory continued to include $28,550 of items listed as “Not Observed” and $70,050 of inventory items classified as “Can Not Locate”.

Recommendations:

To improve the accuracy of its artwork inventory records, we continue to recommend that the District:

• Observe the artwork in its closed school buildings. Authorization to remove items

previously listed as “Not Observed” should be based upon the observation and investigation of responsible District personnel.

• Reinforce to principals the importance of completing the proper documentation

authorizing the removal of “Can Not Locate” items from the inventory. District accountants should provide school personnel with the list of “Can Not Locate” artwork and instruct them to submit the required artwork deletion paperwork if these items cannot be found.

• Require school personnel to contact the District’s Office of Accounting Services and

Audit Coordination to request identification tags for untagged artwork [60106.01].

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MONITORING OF UNAPPROVED PAYROLLS CONTINUED TO NEED STRENGTHENING Previously, we reported that the District processed its bi-weekly payroll regardless of whether responsible administrators had approved their units’ online payroll entries as required by the District’s established procedures for authorizing payroll. Prior to processing the payroll, the District’s Payroll Department did not follow up with unit administrators who had failed to approve payroll. Instead, the District’s computerized payroll system automatically approved the payroll entries for those units with no administrator approval. District management asserted this practice was necessary because of time constraints with the District’s payroll processing schedule, the large volume of pay locations, Payroll Department staffing shortages, and system limitations. However, the District had not implemented any monitoring procedures to identify those administrators failing to approve payroll and take appropriate action to ensure compliance. While there was a report that listed unapproved payrolls, it did not identify the non-complying administrators, and no one reviewed the report. As a result, we found that payroll was not being approved for an average of approximately 4,200 District employees (18 percent) each pay period during fiscal year 2011. This weakness in the District’s payroll processing procedures increased the risk of undetected errors and fraud. Our current audit revealed that District management implemented certain corrective actions to address this condition. On May 16, 2012, the Chief Recovery Officer and Acting Superintendent sent a memorandum to all unit administrators reminding them of the established payroll approval policy and informing them of new procedures put in place to monitor compliance with the policy. To improve oversight of payroll approvals, management

• Developed a new unapproved payroll report that identified the administrators who had not approved payroll along with the affected locations and number of employees with unapproved payrolls.

• Analyzed these new unapproved payroll reports and created a spreadsheet to track the non-

complying administrators and each pay period they did not approve payroll.

• Sent e-mails to the non-complying administrators and their managers after each violation, stating the number of times the administrator failed to approve payroll and requesting they follow established payroll approval procedures. After the third e-mail notification, the non-complying administrators began receiving telephone calls from a representative of the Superintendent’s office, who requested that the administrators correct their violation of the District’s payroll approval policy.

Management implemented the above described procedures in May and June 2012. As a result, there was a significant decrease in the number of unapproved payrolls. For example, our review of the unapproved payroll report for the pay period ending June 29, 2012 noted a total of 532 employees whose payroll was not approved. In light of the large decrease in unapproved payrolls and the significant amount of staff time the new monitoring procedures had involved, District management discontinued those procedures at the end of fiscal year 2012 and replaced them with a new process effective July 2012. Steps taken so far in fiscal year 2013, some of which involved changes to the payroll approval structure, included:

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• The District changed its payroll close time to 5:00 p.m. instead of 4:30 p.m. to give administrators more time to approve payroll.

• The District’s Chief Academic Office (CAO) agreed to follow a practice of not pulling

principals from their schools the entire afternoon of payroll close.

• During the summer, principals received payroll training, which included instruction on payroll approval procedures.

• Management instructed administrators to appoint a back-up person (e.g. assistant principal)

at their location to approve payroll in their absence.

• Management also designated an official from the District’s CAO as a back-up payroll approver for schools when principals are absent. However, we question this practice since this central office official would not be present at a school’s location to review employee attendance records before approving the payroll.

District accounting personnel now review the unapproved payroll reports less frequently, performing this analysis quarterly and looking only at a sample of reports to identify administrators with a high number of violations. District accounting management informed us that they call these non-complying administrators to remind them to approve payroll and contact the CAO for principals violating the payroll approval policy. However, management did not document these follow-up phone calls, although they provided us with one example of an e-mail sent to a non-complying administrator in November 2012. As of March 25, 2013, the last quarterly analysis that District accountants could provide us was a spreadsheet prepared in November 2012 listing administrators with unapproved payrolls for two selected pay periods. With less frequent monitoring, our review of unapproved payroll reports for the first half of fiscal year 2013 revealed that the number of employees whose payroll was not approved had again increased in certain pay periods. For example, we observed one pay period in November 2012 where the payroll was not approved for 1,069 employees and a December 2012 pay period in which 840 employees had unapproved payrolls. We observed that approximately half of the unapproved payrolls in the November 2012 pay period were attributable to one unit administrator who, according to District management, was on vacation at the time of payroll close and had failed to appoint a back-up person to approve the payroll in his absence.

Recommendations:

While we commend the District on its efforts to improve compliance with its payroll approval policy, we believe the less frequent reviews of the unapproved payroll reports increase the risk for higher levels of unapproved payrolls, which we have already noted as happening in fiscal year 2013. Therefore, we recommend that management institute more frequent reviews of the unapproved payroll reports to identify non-complying administrators and maintain an ongoing spreadsheet to track the number of violations by administrators. Management should document all follow-up telephone calls and notices to non-complying administrators. Also, we recommend that management consider establishing some form of progressive discipline for administrators who consistently violate the payroll approval policy [600111.01].

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TAX TREATMENT FOR TERMINATION PAYMENTS HAS STILL NOT RECEIVED STATE AND CITY CONFIRMATION Effective June 1, 2005, District management redefined termination payments (i.e., accrued vacation, sick, personal days, etc) made to retiring employees as employer contributions deposited into an employee’s 403(b) deferred compensation plan. Employer contributions deposited directly into qualified 403(b) plans are not subject to FICA, state and local taxation. The District and its retirees benefit from this arrangement as no FICA, state or local taxes are being withheld on these large payouts. In our prior reports, we questioned whether these termination payments made to the 403(b) plan accounts actually represented compensation subject to FICA, state, and local taxes. Our question was based on the fact that the contracts between the District and its collective bargaining units define termination pay as compensation earned and accrued by employees during their employment. The District, based on the advice of its legal counsel, believed the tax treatment accorded termination payments was proper and its position would be upheld if challenged by any taxing authority. Since the accumulated amount of the potential tax liability would eventually become material and affect our audit opinion, we recommended that District management request a Private Letter Ruling (PLR) from the Internal Revenue Service (IRS), citing the facts specific to the case. In fiscal year 2008, the District initially submitted a PLR request to the IRS. In lieu of issuing a PLR, the IRS reviewed this matter as part of an employment tax examination of the District. In October 2012 after the conclusion of the examination, the IRS sent a letter to the District which confirmed that the tax treatment accorded termination payments was appropriate and no federal employment tax liability existed. Therefore, we consider the issue about whether the termination payments are subject to federal taxes as resolved [60106.07]. Regarding the local taxes, in January 2013 the District’s legal counsel submitted a memorandum to the city’s Revenue Commissioner explaining the reasons why the District believes it is not required to withhold city wage tax from the termination payments it forwards to the 403(b) plan. On April 2, 2013, the city’s Revenue Commissioner informed us that the city had not made its final determination on the matter although a decision was expected shortly thereafter. As for state taxes, management indicated they have been advised by the District’s legal counsel that the District is not required to withhold state personal income tax from the termination payments made to the 403(b) plan. As support for this position, the District’s legal counsel cited an October 2005 Personal Income Tax (PIT) Ruling made by the Commonwealth of Pennsylvania’s Department of Revenue (PA DOR)21 in which the PA DOR ruled that a certain taxpayer’s payment of accumulated sick leave to a retiring employee’s 403(b) tax sheltered annuity was not subject to the state personal income tax or employer withholding. The District’s legal counsel has asserted that the District’s circumstances are nearly identical to those of the taxpayer described in the PIT Ruling. Our review of the cited PIT Ruling noted that it expired in October 2010, five years after its issuance. We asked District management if they have requested a determination from the state on whether the termination payments made to the 403(b) plan are subject to state tax. Management responded that

21 The specific case cited was Pennsylvania Personal Income Tax Ruling No. PIT-05-020 entitled “Contribution of Accumulated Sick Leave to a § 403(b) Tax Sheltered Annuity”, issued on October 14, 2005.

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such a request was unnecessary because of the PIT Ruling discussed above. However, we believe that, since the District has already presented documentation to the IRS and city to obtain their positions on the taxability of the termination payments, the District should also request a direct ruling from the PA DOR specific to its circumstances. Our calculations at June 30, 2012 indicated that a potential tax liability exceeding $9.8 million could result from successful challenges by the city and state. We determined that this potential tax liability was not material to the District’s fiscal year 2012 financial statements.

Recommendation:

Although District management continues to believe that the possibility it will be liable for any back city and state taxes is remote, it has disclosed the matter in the footnotes to its financial statements. Until this issue is resolved, we will continue to monitor the materiality of the potential liability. We recommend that management request a direct ruling from the PA DOR on whether the termination payments made to the 403(b) plan are subject to state tax [600112.13].

LONG OUTSTANDING TERMINATION PAY SHOULD BE ESCHEATED The District annually reports in its financial statements a liability for termination compensation (termination pay). Included in this amount is the liability to former employees for accumulated leave. In several previous reports, we commented that the District’s Vacation, Personal and Illness Leave (VPIL) report, the source of its annual termination pay liability, included leave balances associated with a substantial number of former employees, some of whom had been separated from employment for more than ten years. Our current year audit of District records revealed that as of June 30, 2012, approximately $4.4 million was still owed to 1,793 employees who had been separated for more than a year. Table 4 below summarizes the termination pay liability owed to these separated employees.

Table 4: Employee termination pay outstanding for more than one year as of June 30, 2012

Column A

Fiscal year of

separation

Column B

Number of employees

owed termination

pay

Column C Termination

pay owed to those age 55 & over at

separation (in millions)

Column D Termination

pay owed to those under age 55 at

separation (in millions)

Column E Total

termination pay owed

(in millions) (Col. C + D)

2011 144 $0.5 $0.1 $0.6 2010 104 0.4 0.1 0.5 2009 173 0.4 0.1 0.5

2008 & prior 1,372 1.9 0.9 2.8 Total 1,793 $3.2 $1.2 $4.4

Source: Prepared by the City Controller’s Office based on analysis of the VPIL report Pennsylvania escheat laws require that unclaimed wages revert to the state after two years. In prior reports dating back to fiscal year 2004, we have repeatedly recommended that termination pay for any former District employees who could not be located be escheated to the state as required. However, as of March 2013, the District had not yet escheated to the state any of the unclaimed

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termination pay for employees still on the VPIL who had been separated for more than two years. This amount totaled $3.8 million.22 Additionally, of the $4.4 million in unclaimed termination pay shown above in Table 4, $3.2 million pertained to individuals who severed employment at age 55 or older. District officials asserted that the unclaimed funds for this group are not subject to Pennsylvania escheat laws. Because the District’s 403(b) plan required termination pay for employees age 55 or older at separation to be directly deposited into 403(b) plan accounts as employer contributions, the District has taken the position that such unclaimed amounts represent 403(b) plan assets and thus are not escheatable. However, our audit disclosed that District management had still not contacted the state Treasury Department to obtain its opinion on the District’s position. In its response to the fiscal year 2010 audit report, management indicated that, during fiscal year 2011, the District’s 403(b) plan providers followed up with former employees who had not established 403(b) plan accounts and assisted those individuals in setting up the accounts. Termination payments were then forwarded to these 403(b) accounts. For the former employees who had not responded to contact efforts to set up 403(b) accounts, the District planned to transfer their unclaimed termination pay to accounts established by the plan providers. As of March 2013, this planned transfer had not yet occurred. Additionally, in responding to the fiscal year 2011 report, District officials stated that, in an effort to clean up the VPIL report and reduce the amount of long outstanding termination pay, a team of employees was researching the leave balances for employees who separated in prior years and were liquidating balances as appropriate. Management explained that this research is important so the District does not escheat invalid termination pay to the state. In March 2013, management informed us that the team was currently devoting its efforts to completing the processing of terminations from June 2012 and, once processing time for current terminations is reduced to under thirty weeks, research on the remaining older cases will resume.

Recommendations:

To bring the District into compliance with Pennsylvania’s escheat law, we continue to recommend that management remit all unclaimed termination pay funds that are due to the state Treasury Department [600108.08].

With regard to the District’s position that unclaimed monies related to termination pay owed to former employees age 55 or older at separation cannot be escheated because they represent 403(b) plan assets, we again urge the District to contact the state Treasury Department and obtain its opinion on the District’s position [600111.11].

To ensure the accuracy of the VPIL report and the termination pay liability, the District should continue its efforts in researching the leave balances of employees who separated in prior years and liquidate the balances as appropriate [600112.14].

22 The figure of $3.8 million represents the portion of the termination pay liability outstanding for more than two years as of June 30, 2012 (i.e. separation date occurred in fiscal year 2010 and prior).

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REVIEW PROCEDURE FOR PROCESSING TERMINATION COMPENSATION NOT ADEQUATELY DOCUMENTED In our prior report, we remarked that, while the District had revised its written procedures for processing termination compensation (termination pay) to require Payroll Department (Payroll) personnel verify that accumulated leave balances for separated employees were zeroed out in the ADVANTAGE system,23 Payroll personnel did not document these reviews. Such reviews are necessary to ensure that separated employees who receive termination pay do not remain on the District’s VPIL report indefinitely, possibly resulting in the need to perform detailed, labor-intensive analyses of this report in the future. Also, since the VPIL is the source of the reported termination pay liability, failure to perform these reviews can result in errors within the reported liability. Lastly, we believed and continue to believe that the review procedure should be formalized so as to mitigate the possibility it will not be performed. Our current year review of the termination pay process disclosed that Payroll personnel still did not document the control procedure during fiscal year 2012. However, a Payroll manager asserted that, effective in March 2013, personnel were required to document their verification that a separated employee’s leave balances were zeroed out in ADVANTAGE by marking the employee’s termination worksheet with a “PAID” stamp and then initialing this stamp. While we observed examples of termination worksheets with the initialed “PAID” stamp, the District’s formal, written procedures for processing termination pay had not been revised to include this new step. We believe that, instead of the initialed “PAID” stamp, a clearer method of documenting the control procedure would be to add a section at the bottom of the termination worksheet where Payroll personnel can certify performance of the review.

Recommendation: To provide clearer documentation of Payroll personnel’s review of selected employees, we recommend that the District amend the termination worksheet form to include a section whereby Payroll personnel can certify performance of the review. The District should also formally amend its procedures for processing termination pay to include this new step [600110.10].

INTEGRITY OF PAYROLL PASSWORDS CONTINUED TO BE COMPROMISED Current year testing of the District’s payroll system again revealed that certain principals and administrators, in a breach of confidentiality, improperly delegated the authority for approving payroll by disclosing the payroll closeout code to payroll secretaries and other unauthorized personnel at 6 of 64 (9 percent) school locations visited. Consequently, these payroll secretaries and other unauthorized personnel, instead of principals and administrators, were approving attendance records and attesting to the accuracy of time and attendance entries and the authenticity of employees. These conditions seriously compromise the integrity of the payroll system by not ensuring an independent review of the payroll prior to its submission to the Payroll Department. As a result,

23 ADVANTAGE- the District’s accounting and payroll system – tracks the accumulated leave balances for employees and is the source of the information that appears on the Vacation, Personal and Illness Leave (VPIL) report.

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there is an increased risk that falsification of payroll time and attendance could occur and not be detected. Recommendation:

We again recommend that management (1) re-issue closeout codes to any principals or administrators who have shared their codes with other District personnel, (2) continue to instruct principals and administrators of the necessity to maintain the confidentiality of their closeout codes, and (3) consider establishing other mitigating control procedures. Management must emphasize to principals and administrators the importance of segregating the incompatible duties of entering and approving payroll [600108.07].

NON-COMPLIANCE WITH STATEMENT OF FINANCIAL INTEREST FILING REQUIREMENTS The Pennsylvania Public Official and Employee Ethics Act (PA Act 93 of 1998), (Act), requires District employees responsible for taking or recommending official action of a non-ministerial nature to annually complete a Statement of Financial Interest (SFI). Examples of these employees include members of the School Reform Commission, District management (e.g. chief executive officer and chief financial officer), office heads, and principals. The Commonwealth of Pennsylvania may impose penalties, such as a fine and/or imprisonment, upon any person subject to the Act who fails to make a complete, accurate, and timely filing. In our prior report, we noted that 36 of 572 (6 percent) employees did not comply with SFI filing requirements. In an effort to improve compliance, in February 2012 the District’s Office of Human Resources (OHR) sent a written notification to employees and former employees required to submit SFI forms, informing them of their filing responsibility and possible penalties for non-compliance. In April 2012, the OHR sent a written reminder to those individuals who had not yet submitted their SFI forms. Despite these notices, our review of the calendar year 2011 SFI forms on file at the OHR revealed a significantly reduced level of compliance, finding that 83 of 556 (14.9 percent) employees did not complete the required SFI forms. Fifty of the 83 non-filers were active employees and represented 11.5 percent of the total active employees required to file SFI forms. Among the active employees who did not file the required SFI forms were upper management officials from both the District’s central administration and schools, such as the budget director, several unit deputies and directors, as well as numerous principals.

In addition, although not required by law, we previously recommended that submitted SFI forms be reviewed to identify potential conflicts of interest or related party transactions, which may require financial statement disclosure. In its response to last year’s audit report, management indicated that the District intended to implement a review process during fiscal year 2012. However, current year testing disclosed that such a review had not been performed.

Recommendation:

We recommend that the District continue its efforts to achieve full compliance with SFI filing requirements, particularly with regard to active District employees and top District management. In addition, management should ensure that all SFIs submitted are independently reviewed to determine whether any financial statement disclosures are required [60107.05].

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MINUTES OF PUBLIC MEETINGS NOT PUBLISHED Pennsylvania Consolidated Statutes Title 65, Section 706, titled “Minutes of Meetings, Public Records and Recording of Meetings,” (commonly referred to as the Sunshine Act) requires written minutes of all open meetings of agencies, including school governing bodies. The Act requires minutes to include the following:

• date, time and place of meeting; • names of members present; • substance of all official actions and a record by individual member of the roll call votes

taken; and, • names of all citizens who appeared officially and the subject of their testimony.

Our audit testing disclosed that, for meetings held in May 2011 and March through May 2012, the District did not prepare or publish minutes of public meetings held by its governing body, the School Reform Commission (SRC). Audit procedures require that we review minutes of SRC meetings to determine the existence of undisclosed transactions, subsequent events, or related party transactions. Because all SRC meeting minutes were not available, auditors had to use time consuming and less reliable alternate procedures, such as reviewing agendas, proposed summary resolutions, and voting cards from meetings to satisfy audit requirements. In addition, failure to comply with the Commonwealth of Pennsylvania’s Sunshine Act could subject the District to fines and prosecution in accordance with provisions of the law.

Recommendation: We recommend that District management comply with state law by ensuring that written minutes are produced and published for all public meetings of the SRC. If District personnel are unable to perform this function in a timely manner, consideration should be given to hiring an outside service to transcribe the minutes [600112.15].

PROCEDURES FOR SCHOOL SECURITY CAMERAS STILL REQUIRED FORMAL APPROVAL In our prior year report, we commented that, while the District’s Office of School Safety established a written usage and care policy governing security camera systems at District locations, the policy was not formally approved in writing by the chief inspector for the Office of School Safety. In addition, the policy failed to incorporate our suggested requirement to label and date used tapes and recordings sequentially. The current audit disclosed that the policy governing District security camera systems had still not been formally approved in writing by the chief inspector for the Office of School Safety. With regard to our recommendation to revise the policy to include a requirement to label and date used tapes and recordings sequentially, in their response to the prior report, management stated that there were very few tapes to label and date because most of the District security camera systems were digital. According to information provided by the Office of School Safety, only 10 of 171 District schools with security camera systems used videotapes while another four locations utilized a combination of videotapes and digital recording. Given the small amount of District locations that use videotapes, we will no longer report on this finding [600110.11].

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Recommendation:

We continue to recommend that the policy governing security camera systems be formally approved in writing by the chief inspector for the Office of School Safety and then disseminated to the appropriate parties [600112.16].


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As part of our current review, we followed up on the conditions brought to management’s attention during our last review. We routinely monitor uncorrected conditions and report on them until management takes corrective action or until changes occur that resolve our recommendations. Our follow-up has disclosed that the District made progress addressing several prior issues. We blended the status of some resolved prior-noted conditions24 with new observations and reported upon these matters in the previous sections of this report. Other resolved prior year issues are discussed below. We commend the District on its efforts. STUDENT DENTAL CARE BENEFITS NO LONGER PAID THROUGH THE PUBLIC SCHOOL HEALTH FUND In several prior reports, we commented that the District’s control procedures over dental benefits paid through its Public School Health Fund (the Fund)25 were inadequate and required improvement. Specifically, we found that one dental-service provider was paid despite failing to submit to the District the required American Dental Association (ADA) billing claim forms which indicate the date and type of service as well as the amount billed. Other deficiencies noted were the District’s failure to obtain verification from the parent or guardian that the services billed were actually provided, and the lack of formal contracts with the dental-service providers. The current audit disclosed that the District stopped paying dental benefits through the Fund in fiscal year 2012. Total Fund expenditures during fiscal year 2012 amounted to only $1,000, consisting of two payments made to dental-service providers in December 2011. Our review of fiscal year 2013 District accounting records found no further dental-service payments made from the Fund as of February 28, 2013. Given the District’s termination of dental benefits paid through the Fund, we will no longer report on this finding. We will, however, continue to monitor the amount and type of disbursements in the Fund during future audits to determine the need to review controls over Fund expenditures [60106.10]. ENCUMBRANCE POLICY NOW CLARIFIED During the fiscal year 2009 audit, we commented that District personnel failed to liquidate significant amounts of encumbrances that no longer represented valid purchase commitments at fiscal year-end because the District’s encumbrance policy was neither clear nor adequately communicated to the responsible unit managers. Accounting management asserted it was the responsibility of unit managers to notify the District’s Office of Management and Budget (OMB) to cancel an encumbrance. However, District encumbrance policy documents indicated that the OMB would cancel any remaining fiscal year-end encumbrances. Our fiscal year 2010 and 2011 audits revealed significant improvement in the District’s year-end encumbrance cancellation process, noting a greatly reduced amount of unnecessary encumbrances. However, District policy documents

24 The resolved prior-noted conditions involved (1) documentation of accounting management’s review of the calculation of net assets invested in capital assets, net of related debt; (2) establishment of a directive for preparation of purchase requisitions; (3) the issue about whether termination payments made to the 403(b) plan are subject to federal taxes; and (4) a recommendation to revise the school security camera policy to include a requirement to label and date used tapes and recordings sequentially. 25 The Fund was established through private donations to pay for needy, eligible students’ dental/orthodontic treatment, eye care, and hearing exams.


35

remained unchanged and still contained conflicting information that did not clearly direct unit managers of their responsibility to notify OMB to cancel encumbrances. Our current audit testing of year-end encumbrances disclosed continued improvement in the District’s encumbrance liquidation process, as we found no significant instances of invalid encumbrances. While the District’s encumbrance policy documents remained unchanged in fiscal year 2012, accounting management provided updated guidance to clarify the responsibilities of unit managers during fiscal year 2013. On February 4, 2013, the District’s chief financial officer issued a memorandum to unit managers which instructed them on their responsibility to cancel open encumbrances no longer valid. We, therefore, consider this finding resolved [600109.02]. CAFR PREPARATION PROCEDURES NOW IMPROVED Our fiscal year 2010 report disclosed that the District had not established and disseminated to its accountants formal, written policies and procedures that governed the preparation and review of its Comprehensive Annual Financial Report (CAFR). During the fiscal year 2011 audit, we noted that District accounting management disseminated a CAFR production manual (manual) to accounting staff in November 2011. The manual incorporated the new financial statement review procedures implemented by the District for fiscal year 2011. However, while the manual included detailed procedures for preparing financial statement information for governmental funds, it did not contain such detailed procedures for the District’s proprietary funds, agency funds, and private purpose trust funds. The current audit disclosed that District accounting management revised the manual in February 2013. Our review of the updated manual revealed the inclusion of more detailed procedures for preparing financial statement information for the District’s proprietary funds, agency funds, and private purpose trust funds. We therefore consider this finding resolved [600110.05]. COMPLETED PROJECT COSTS NOW PROPERLY TRANSFERRED OUT OF CONSTRUCTION IN PROGRESS Previously, we had commented that the District’s capital asset accounting procedures did not always ensure that completed capital project costs were properly transferred out of construction in progress (CIP) and into the respective long-term asset account. During the prior audit we found several instances of completed project costs totaling $69.5 million that improperly remained in CIP, principally caused by the following factors:

• The District’s fixed asset accountant claimed to have missed $36.4 million in costs for a new elementary school because of a computer program error that occurred when he sorted the data file of projects by location number. We had recommended that District accounting personnel search the CIP account for projects with high dollar cost amounts and then analyze these projects to determine their completion status.

• Accumulated costs of approximately $22 million incurred over several fiscal years for

project management and communication system upgrades remained in the CIP account because they were not project specific and because accountants asserted they had no time to analyze and then distribute the costs to the appropriate long-term fixed asset account. Given the immateriality of these costs compared to the total net book value of District capital assets (approximately $2 billion), we had recommended that accountants allocate


36

these costs across existing assets and book the allocation as a prior period adjustment to beginning net assets in its fiscal year 2012 financial statements.

The current audit disclosed that the District took corrective actions to improve its accounting for CIP. The District’s fixed asset accountant performed a review of the CIP account for projects with high dollar cost amounts to identify completed assets. Our testing of selected projects from the CIP account found no significant instances of completed assets improperly remaining in CIP. In addition, District accountants prepared an adjustment to transfer the $22 million of prior year outside project manager and communication system upgrade costs out of CIP and into long-term asset accounts. This transfer was recorded as a prior period adjustment to beginning net assets. Therefore, we consider these conditions resolved [600111.02, 600111.03].

APPENDIX I: OBSERVATIONS AT FORMER WEST PHILADELPHIA HIGH SCHOOL

37

Figure 1: Classroom still set-up as computer lab Figure 2: Desktop computers in boxes Figure 3: Interactive whiteboard in classroom Figure 4: Exercise room with equipment Figure 5: Musical instruments, including this Figure 6: Band Uniforms grand piano


38


39


40


41


42


43


44


45


46


47


48


49


50


51


52

AUDITOR’S COMMENTS ON AGENCY’S RESPONSE

53

Government Auditing Standards require auditors to report instances where the auditee’s comments to the findings, conclusions, or recommendations are not, in the auditor’s opinion, valid or do not address the recommendations. We believe that to be the case with certain statements made in the School District of Philadelphia’s (District’s) response to our comments regarding the following:

• Cash reconciliation procedures needed improvement. • Safeguarding and recordkeeping over school furniture and equipment were inadequate.

• Monitoring of unapproved payrolls continued to need strengthening.

Cash Reconciliation Procedures Needed Improvement In its response on page 40, District management attributes the $66 million overstatement of reported equity in pooled cash and investments to a “payroll system programming limitation which impacted $66 million of payroll liabilities and fringe benefits…” As discussed in the audit report, only $30 million of the $66 million cash overstatement occurred because of an error generated by the District’s payroll system. The system error led to an improper accounting entry associated with the District’s last bi-weekly payroll for fiscal year 2012. The remainder of the $66 million cash error occurred in October 2012 when District accountants erroneously recorded a manual accounting adjustment involving accrued fringe benefit expenditures that led to a $36 million cash overstatement. In its response on page 40 management also asserts that District accountants, through the management review process they performed before turning over the preliminary financial statements to the auditors, discovered there was an issue impacting the general fund and agency fund cash balances. Management also contends “there was a misunderstanding that the preliminary financial statements provided to the auditors didn’t need further adjustment for this issue once the details were sorted out by the District.” When District accountants provided us with the preliminary fund financial statements on November 7, 2012, they neither informed us of any potential problems with the cash balances nor indicated they were in the process of conducting research to determine if the preliminary financial statements required revision. We first became aware of the $66 million cash error when our audit testing of the equity in pooled cash and investments account identified the discrepancy. District accountants’ first indication to us that they were investigating this matter to determine the causes of the discrepancy occurred after we notified them of the $66 million cash error. Safeguarding and Recordkeeping Over School Furniture and Equipment Were Inadequate Regarding the use of the obsolete disposition code for recording furniture and equipment deletions, management in its response on page 43 asserts “schools are instructed to not automatically use the obsolete delete code for assets over 5 years old, but to code it as damaged, lost or stolen with

AUDITOR’S COMMENTS ON AGENCY’S RESPONSE

54

appropriate back-up where applicable and known, and submit the documentation of a serious incident report or a damaged technology form.” However, as noted on page 4 of the audit report, management from the District’s Office of Accounting Services and Audit Coordination informed us that, for furniture and equipment items five years or older which could not be found, school/unit personnel were instructed in fiscal year 2012 to delete the items using the obsolete disposition code even though there were separate codes which could be used to report damaged, lost, or stolen assets. In explaining the significant increase in the number of furniture and equipment deletions in fiscal year 2012, on pages 41 and 42 management states that, “in an attempt to clean up old inventories reflected in the system, schools were given the opportunity to delete assets identified as obsolete that were fully depreciated and over 5 years old,” and the deleted assets “had little to no value.” While the net book value of the obsolete equipment deletions was relatively immaterial, a number of these assets may still have had functional value for use in school operations. We reiterate our opinion that the practice of allowing these obsolete asset deletions, which required no supporting documentation, increased the risk of undetected asset thefts. Given the current financial challenges of the School District, in our opinion, management should be making use of every available functioning asset regardless of its net book value. With regard to pictures of the assets observed by us at the closed West Philadelphia High School (West Philadelphia) building (as illustrated in Appendix I), management in its response on page 43 incorrectly states the pictures “were taken in April 2013 before the books closed in June 2013.” As discussed on page 10 of the audit report, we visited the closed West Philadelphia building and observed the instances of idle equipment and supplies in April and June 2012, approximately one year after the building’s closure. Monitoring of Unapproved Payrolls Continued to Need Strengthening On page 48, management comments that several corrective actions implemented during fiscal year 2012 “resulted in a significant reduction in the number of unapproved employees’ payroll from an average of 4,200 in fiscal year 2011 down to a low of 532 by June 29, 2013.” The date of June 29, 2013 in this statement is inaccurate. As noted on page 25 of the audit report, the unapproved payroll report for the pay period ending June 29, 2012 showed a total of 532 employees whose payroll was not approved.

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