REPORT TO COUNCIL
SUBJECT
Title
Discussion and Council Direction on Assigned Responsibilities of City Council Appointed City Auditor [Council Pillar: Enhance Community Engagement and Transparency]
Report
BACKGROUND
Following the resignation of the former City Clerk in 2018, the Council appointed the Assistant Finance Director as the City Auditor. This appointment was codified in Santa Clara City Code section 2.105.015, which expanded the role of the City Auditor from that set forth in Charter Section 909.
The Assistant Finance Director shall perform the functions of the City Auditor. These duties and responsibilities include conducting in-depth financial and performance audits, overseeing the City’s performance management system, auditing and approving all bills, invoices, payrolls, demands or charges against the City government before payment and, with the advice of the City Attorney, making reports to the City Council as to the regularity, legality and correctness of such claims, demands or charges.
Since the appointment in August 2018, the Assistant Finance Director/City Auditor (City Auditor) has begun to reintroduce the internal audit function and existence to City staff. The City Auditor prepared and presented the City’s first formal Internal Audit Charter (attachment 1) and Audit Work Plan for FY18-19 (mid-year) and FY19-20 (attachment 2), and Council successfully approved it. In addition, the City Auditor, with the help of the City Manager’s Office, has created a new webpage for the City Auditor’s Office for the public to access audit reports and provide suggestions for potential future audit topics. The Internal Auditor job series was also established and approved in 2019 to allow the City Auditor to start recruiting for critical internal audit positions to assist with carrying out the projects in the Audit Work Plan.
In September 2019, as part of the reorganization within the Finance Department, the Assistant Finance Director/City Auditor has requested to be relieved from the City Auditor position and transfer back to operations and assist the Director of Finance with City operations under the Assistant Finance Director role. With all the administrative and internal audit work’s foundation completed (i.e. the Internal Auditor job series, the Audit Work Plan and the Internal Audit Charter), the Council will now have the option to provide direction on the City’s internal audit function.
DISCUSSION
Professional skills have evolved since the drafting of the City Charter duties and, as such, the Council voted to move the position of the City Auditor to the Finance Department and assigned the responsibilities to the Assistant Finance Director on June 26, 2018. In addition to the City Charter duties, such as auditing and approving all bills, invoices, payrolls, demands or charges against the City before payment and advising the Council as to the regularity, legality and correctness of such claims, demands or charges, the Council voted to expand the duties of the City Auditor to conduct in-depth financial and performance audits for the City under the Santa Clara City Code section 2.105.015.
Option 1: Maintain the current hybrid model for the internal audit function.
Because the City Auditor is appointed by the Council, but is also an Assistant Finance Director under the purview of the Appointing Authority (City Manager), a hybrid model of in-house and outsourced or co-sourced audit services is necessary in order to preserve the independence required in the internal audit function. The City Auditor’s hybrid internal audit model includes a team of two internal auditors (i.e. the City Auditor and a Senior Performance Auditor) and a Management Analyst to perform the audit and day to day Charter work. The City Auditor can properly contract for and oversee the work of the outside contract auditors, and this model also allows the City to reduce the billable hours/contract costs associated with each such audit project. The benefits of such a structure are:
• Management focus - contracting for support services frees staff capacity to focus on improving core business processes identified in audit recommendations and; allow audit staff to perform ad-hoc audit work or investigations for the Council and management.
• Maintain the independence of the auditor.
• Gaining expertise - a consultant may have specialized skills or knowledge and allow for staff to leverage on their expertise and resources.
• Cost savings - economies of scale may be achieved through contracting and co-sourcing the audits. This is attributable to having a lower in-house hourly cost compared to the consultant’s rate, which is significantly higher (see below cost comparison).
|
Cost Range |
Blended Hourly Rate |
|
Low Range |
$190 |
|
Mid Range |
$220 |
|
High Range |
$250 |
|
|
|
|
In-house Staff (fully burdened) |
$170 |
In addition to reducing the project costs, co-sourcing allows for the City to contract for more audits than if all the audits were to be done fully in-house by staff.
The City Auditor’s Office is responsible for:
• Interfacing with City employees, management and Council to gather information to prepare the annual risk assessment for the City;
• Preparing the annual Audit Workplan and identifying the audit subjects based on the risk assessment;
• Monitoring the fraud, waste, and abuse hotline and performing the necessary investigations;
• Performing the day to day Charter duties for all cash disbursement transactions;
• Performing and carrying out the audit work in the workplan;
• Managing the audit contracts, and coordinating and monitoring all audits performed under contract;
• Providing ad-hoc audit work or investigations for the Council and management;
• Providing audit status reports on the workplan to the Council and;
• Tracking audit recommendations and providing annual audit recommendation status updates to the Council.
The current hybrid structure provides an internal audit presence onsite for employees to ask questions, solicit for best practice recommendations, and report incidents of fraud, waste or abuse. The in-house internal auditors, unlike consultants, are available to provide continuity of review and oversight, and to follow up on how management implements audit recommendations.
With the groundwork to setup the City’s internal audit function completed, the Council will now have the opportunity to provide direction on how the Council wishes to assign the Appointed City Auditor’s responsibilities.
Below is a summarized list of pending and ongoing projects in the Audit Workplan that the City Auditor’s Office is responsible for:
|
Description |
Status |
|
1. Audit the City’s Vendor Master File and 1099 Reporting |
One-time - co-source project |
|
2. Perform a Citywide Fraud Risk Assessment |
One-time - outsource project |
|
3. Review Financial Procedures and Controls for the Santa Clara Stadium Authority |
One-time - co-source project |
|
4. Review of the Stadium Authority’s Construction Fund transactions |
One-time - outsource project |
|
5. Develop a Fraud, Waste, and Abuse Reporting Policy (Fraud Policy) |
One-time - internal |
|
6. Implement and manage a Fraud, Waste and Abuse Hotline for the City |
Ongoing - internal |
|
7. Perform day to day Charter work for all cash disbursement transactions |
Ongoing - internal |
|
8. Prepare Annual Risk Assessment for the City |
Ongoing - internal |
|
9. Prepare Annual Audit Work Plan for the City |
Ongoing - internal |
|
10. Manage the annual external financial audit contracts for the City and Stadium Authority |
Ongoing - internal |
|
11. Provide Semi-Annual Audit Status Report |
Ongoing - internal |
|
12. Provide Annual Audit Recommendation Status Report |
Ongoing - internal |
Option 2: Build a traditional in-house Internal Audit function
The Council could take action to request the City Auditor to build a traditional in-house internal audit function like other governmental agencies. Under this model, the City Auditor’s staff will continue to perform the day to day Charter duties, perform the majority of the audit projects, and manage and coordinate some audit contracts. The City Auditor’s Office will be responsible for all the tasks noted above including performing most of the audit projects in the Audit Work Plan. There will be limited consultant services since the in-house team is responsible for doing all the audit work.
Under the in-house model, the City Auditor’s Office will need to increase the number of internal audit staff to a minimum of five staff, which includes a City Auditor, an Internal Audit Manager, a Senior Performance Auditor, and two Performance Auditors. An audit requires multiple layer of reviews and proofing so a full team is needed in order to ensure that the audit was completed in conformity with the auditing standards and on time. The proposed increase in FTEs will likely increase the current budget by $721,000 from $1,237,000 to $1,958,000. Below is a cost comparison table on the in-house internal audit structure at nearby agencies:
|
Agency Name |
Annual Expenses |
# of FTEs |
Annual Audit Budget |
# of FTEs in Audit |
Average # of Audits Completed Annually |
|
City of Palo Alto |
$508,426,000 |
1,059 |
$1,458,175 |
5 |
3 to 4 |
|
City of Berkeley |
$387,216,873 |
1,532 |
$1,600,000 |
6 |
5 to 6 |
|
City of Oakland |
$1,060,720,000 |
3,418 |
$2,200,000 |
10 |
5 to 8 |
|
|
|
|
|
|
|
|
City of Santa Clara |
$907,827,980 |
1,105 |
$1,237,543 |
2 |
3 to 4 |
|
(This data was provided by Kevin W. Harper CPA & Associates. The firm was hired by the City of Palo Alto to prepare the cost survey in 2019). |
The above proposed FTE and budget is for the internal audit staff only and did not include another FTE for the day to day charter duties. If the Council’s direction is to build a traditional in-house internal audit function, then a revision to the current ordinance may be necessary in order to establish that the Council-appointed City Auditor, and his/her staff, are independent from the rest of the City staff that they audit.
Option 3: Assign certain City Auditor responsibilities to contract employees
The Council may consider formally assigning certain professional City Auditor duties to contract (as-needed) employees by amending the City Code Section 2.105.015. The contract employees will be responsible for conducting all financial and performance audits, which includes all audit work, meeting, planning, coordination, risk assessments, and workplan preparation. They will also be responsible for monitoring the fraud, waste, and abuse hotline once it is implemented. Under this model, the Council will need to assign someone independent of management to make, execute, monitor, and renegotiate the audit contracts. The Audit Committee can also serve this responsibility in-lieu of assigning it to a staff member.
Additionally, it is worth noting that although the practice of outsourcing the audit work is not uncommon, the City will not have an internal audit presence onsite. The City will have the traditional benefits of outsourcing the work, which includes management focus and gaining expertise. However, some of the challenges of outsourcing all the audit responsibilities to consultants are:
• Lack of an in-house audit subject matter expert;
• Lack of continued review and oversight over audit recommendations by internal audit staff, which could result in ongoing internal control and performance management gaps;
• Potential longer completion time for the projects due to the consultant’s schedule and staffing;
• Diminished capacity resulting in heavy reliance on the consultants and;
• Potential higher spending when contractual costs are higher than anticipated.
For example, staff anticipated for the Master Vendor Audit to take approximately 800 hours, or $132,000, to complete. However, after reviewing the City’s vendor information, the final estimate for the project came in around 1,400 hours, or $265,000. This is due to the City having a larger than anticipated active vendor list, which requires additional work. The proposed cost for the project resulted in a potential budget overrun of up to $65,000 for the fiscal year’s budget, which is $200,000 for contractual services. As a result, staff engaged in discussions with the vendor to co-source the audit work to bring down the costs, which could be reduced to $114,000.
If the Council were to choose this option, staff will return with a Study Session to discuss the roles, duties and qualifications of outside professional services for the internal audit function. Furthermore, the primary day-to-day operation responsibilities for the following City Charter and City Code provisions would remain with City staff since it is expensive to outsource the daily cash disbursement transactions review to consultants:
• Overseeing the City’s performance management system; and
• Auditing and approving all bills, invoices, payrolls, demands or charges against the City government before payment and, with the advice of the City Attorney, making reports to the City Council as to the regularity, legality and correctness of such claims, demands or charges.
The Management Analyst will continue to perform the day to day Charter duties and report to the Assistant Finance Director/City Auditor or designee. The Council will need to designate either the Audit Committee or a staff member to be the liaison between the contract employee and the Council to carry out the projects in the Audit Workplan.
ENVIRONMENTAL REVIEW
The action being considered does not constitute a “project” within the meaning of the California Environmental Quality Act (“CEQA”) pursuant to CEQA Guidelines section 15378(b)(5) in that it is a governmental organizational or administrative activity that will not result in direct or indirect changes in the environment.
FISCAL IMPACT
There is no fiscal impact related to this report. If the City Council maintains the current internal audit setup, staff will continue to maintain the current structure as included in the budget. If the City Council recommends assigning current internal audit function to consultants, funding in the current budget will need to be directed to contractual services to fund future audit activities as discussed in this report. In this scenario, the deletion of existing positions and the allocation of additional contractual services funding may be required. Budget actions based on direction provided by the Council will be considered separately at a later date, if necessary.
COORDINATION
This report has been coordinated with the City Attorney’s Office and the City Manager’s Office.
PUBLIC CONTACT
Public contact was made by posting the Council agenda on the City’s official-notice bulletin board outside City Hall Council Chambers. A complete agenda packet is available on the City’s website and in the City Clerk’s Office at least 72 hours prior to a Regular Meeting and 24 hours prior to a Special Meeting. A hard copy of any agenda report may be requested by contacting the City Clerk’s Office at (408) 615-2220, email clerk@santaclaraca.gov <mailto:clerk@santaclaraca.gov> or at the public information desk at any City of Santa Clara public library.
ALTERNATIVES
1. Take action on whether to build a traditional in-house internal audit function.
2. Take action on whether to outsource certain City Auditor responsibilities, and have staff return to Council with a Study Session on the model.
3. Take no action to assign certain City Auditor responsibilities, and maintain the current hybrid model for the internal audit function.
4. Any other alternatives as determined by the Council.
RECOMMENDATION
Recommendation
Staff makes no recommendation.
Staff
Prepared and Approved by: Linh Lam, Assistant Finance Director/City Auditor
ATTACHMENTS
1. Internal Audit Charter
2. Audit Work Plan FY 18-19 (mid-year) and FY 19-20