Three Common Mistakes Found During School District Audits

It has been a few months since the audit deadline and hopefully everyone has had a chance to breathe a sigh of relief after surviving the implementation of GASB 68. However, it is always important to identify ways that the district can continue to streamline the accuracy and efficiency of its financial records. In hopes of helping Michigan school districts in this process, we have identified the three audit issues that arose most frequently during the 2015 audit season. Don’t worry, we left GASB 68 out of it!

Proper Recording of a Lease Agreement

School districts may enter into two different types of leasing transactions. It is important to know which type of lease your district is dealing with as there are also two different methods of recording the lease on the books.

The first type of lease is an operating lease. This type of lease is fairly simple and lease payments are recorded on the books when paid in the same manner as other expenses. The annual budget would only include the amount of the current year lease payments. There is no effect on debt or capital assets for your district-wide statements.

The other type of lease is a capital lease. This is where it gets tricky. To determine if you have a capital lease, remember this useful acronym: OWNS.

O – Ownership: The ownership of the asset is shifted to the district at the end of the lease period.

W – Written option for bargain purchase: The district can buy the asset from the lessor at the end of the lease term for a below-market price (often $1).

N – Ninety percent of the leased property’s fair market value exceeds the present value of the lease payments.

S – Seventy-five percent or more of the asset’s useful life is being committed in the lease term.

If any one of these four items are met, the transaction is considered a capital lease. Following is a summary of the effects of a capital lease on the district’s financial statements:

• One hundred percent of the principal portion of all lease payments will be recorded as an Other Financing Source on the fund statements and also as a capital outlay expense. Do not forget to consider the additional capital outlay in your budget amendment, or there is a chance that the district will be over budget in these accounts.
• All lease payments should be allocated between principal and interest. If the lease agreement does not provide this information, an amortization schedule should be created.
• The district-wide statements will need to include the asset related to the lease transaction, and the asset will be depreciated accordingly. This is often missed by external fixed asset management companies, unless the district requests that the asset is added.

Bond Refundings in the Fund Statements

What is a bond refunding? It is the issuance of new debt whose proceeds are used to repay previously issued (old) debt. Most bond refundings today are considered “current refundings” and the new debt is used to pay off old debt almost immediately. The other type of refunding is an “advance refunding,” which occurs when the new debt is placed with an escrow agent and invested until it is used to pay principal and interest on the old debt in the future. Due to the favorable rates, most refundings since the late 90s are “current refundings.”

Bond refundings are becoming more frequent, but typically districts do not have a lot of experience recording the transactions related to them. As with anything that is not a routine part of accounting, it is easy to mix up the journal entries necessary to record a bond refunding on the district’s fund statements. Keeping this in mind, we compiled the following guidelines for proper recording:

• New debt should be recorded as an Other Financing Source in the governmental fund receiving the proceeds.
• Payments to the escrow agent from the resources provided by the new debt should be recorded as an Other Financing Use.
• If payments are made to the escrow agent from other resources of the district, this should be reported as debt service expenditures.

The company that prepares the final bond documents should provide at least one schedule that will break out the individual pieces of the transaction to help when recording this on the district’s books.

It is important to remember that there are many pieces to the puzzle in a bond refunding, and we encourage you to consult your auditors when a bond refunding occurs. That one phone call could save you a lot of headaches in the long run.

Equipment Management

This deficiency is most commonly reported for district’s undergoing single audits; however, it is a good control to have in place regardless. In the past, most districts considered any equipment purchased in their food service department to be obtained using local or state sources, therefore not requiring the district to maintain the level of record-keeping mandated at the federal level. However, due to the large percentage of funding most districts receive from federal dollars to run their food service programs, it is becoming increasingly hard to argue that all equipment purchased is in fact locally or state funded.

Therefore, it is our recommendation to all districts to actively manage this equipment. The compliance standards require that all equipment over $5,000 purchased with federal funds be tagged and separately identified from those items not purchased with federal funds. These items must be listed with the following characteristics: serial number (or other identifying number), source, who holds title, acquisition date and cost, percentage of federal participation in the cost, location, condition, and disposition data (if applicable). Further, an inventory of food service equipment purchased with federal funds is required to be performed every two years. It might be extra work up-front, but it will contribute to smoother monitoring by the state and external auditors.

We at Yeo & Yeo thank you, our clients, for another great school audit season. We hope that these guidelines will keep your district on track in the future. If you have questions about these audit issues, please contact your local Yeo & Yeo office.