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- Inadequate Financial Management Hinders Lynwood’s Fiscal Stability
- Violations of State Law, Weak Oversight, and Policy Breaches make Lynwood Susceptible to Fraud and Waste
- Ineffective Organizational Management Diminishes Lynwood’s Ability to Provide Public Services
Persistent operating deficits, inaccurate general fund balance estimates, and questionable use of a one‑time revenue source in its current budget place Lynwood at a high risk of being unable to meet its future financial obligations. As Table 1 shows, Lynwood’s general fund balance declined from approximately $6.5 million to $2.6 million from the end of fiscal year 2012–13 through the conclusion of fiscal year 2016–17. Lynwood’s annual expenditures consistently exceeded its revenue during this period.
|FISCAL YEAR||ENDING GENERAL FUND BALANCE|
Source: Lynwood’s comprehensive annual financial reports (CAFR).
Lynwood’s city council reported several reasons for the ongoing decline, including limited revenue growth and increased operating costs. The city council declared a fiscal emergency in July 2016, stating in a resolution that despite its efforts to reduce spending over several fiscal years, it expected future expenditures to outpace revenue at a rate that would nearly exhaust Lynwood’s general fund balance by the end of fiscal year 2016–17.
To address the ongoing budget deficit, the city council approved a temporary sales tax ballot measure for the November 2016 election through which the city estimated that it could generate up to $4.5 million in additional annual revenue. Lynwood voters subsequently approved this 10‑year, 1 cent general purpose sales tax increase, and it became effective in April 2017. In part because of the additional total revenue anticipated by the tax increase, Lynwood estimated in July 2018 that its fiscal year 2017–18 operating revenue would exceed operating expenditures and that it would be able to balance its budget without tapping its general fund reserves, which would be the first time since fiscal year 2012–13 that Lynwood’s spending did not outpace its income.
Throughout this report we refer to financial activity in terms of operating revenue and expenditures. There is an important difference betweenoperating revenue and expenditures and total revenue and expenditures: Operating revenue and expenditures exclude transfers to and from other funds. As Figure 1 shows, Lynwood’s operating expenditures exceeded operating revenue each fiscal year from 2013–14 through 2016–17. Given this pattern of spending behavior, we remain concerned that Lynwood’s operating expenditures will exceed its operating revenue beyond fiscal year 2017–18.
Lynwood Operated With a Structural Deficit During Fiscal Years 2013–14 Through 2016–17, Which It Will Likely Experience Again in Fiscal Year 2019–20
Source: Lynwood’s CAFRs for fiscal years 2012–13 through 2016–17 and fiscal year 2018–19 proposed budget.
* Amounts represent projected year-end estimates for fiscal year 2017–18, as reported in the fiscal year 2018–19 budget approved by Lynwood’s city council in July 2018. Actual amounts were not available because the city had not completed its fiscal year 2017–18 CAFR.
† Amounts represent proposed operating revenue and expenditures for fiscal year 2018–19, as reported in the fiscal year 2018–19 budget presented to Lynwood’s city council in July 2018, which would result in a surplus of $100,000.
‡ Proposed operating revenue and expenditures for fiscal year 2019–20 are identical to the previous year, but with adjustments to reflect the loss of a one‑time revenue source realized in fiscal year 2018–19 and two expenditures the city manager identified he could eliminate in future years, which would result in a deficit of $425,000.
Even though Lynwood’s fiscal year 2018–19 budget projects operating revenue in excess of operating expenditures, it is only by a margin of about $100,000. This amount provides the city a narrow margin for addressing unexpected costs without relying on reserves in its general fund. Furthermore, Lynwood may not be able to sustain its level of financial activity beyond fiscal year 2018–19, and the city’s planning leaves little room to account for faulty estimates, finance department errors, or the cessation of a one‑time revenue source. In any of these potential circumstances, if Lynwood does not reduce operating expenditures or increase its operating revenue, the city may, once again, have to rely on its general fund reserves to keep the city operating.
Fund Balance Estimates
Lynwood’s Estimates of Its Fiscal Year 2016–17 Ending General Fund Balance Have Fluctuated Wildly
Source: Lynwood’s budget documents, mid-year budget updates, and fiscal year 2016–17 CAFR.
* Lynwood’s external auditor issued an unmodified opinion on the fiscal year 2016–17 financial statements, which reported $2.6 million as the general fund ending balance.
In March 2018, the finance department performed a reconciliation of financial data from multiple fiscal years and adjusted its estimate of the fund balance yet again to slightly less than $1 million. Despite performing this reconciliation nine months after adopting the fiscal year 2017–18 budget, this estimate was still inaccurate; the actual fiscal year 2016–17 general fund ending balance Lynwood reported in its audited CAFR was $2.6 million, $1.6 million more than the previous estimate.1 According to the city manager and the finance director, the March 2018 estimate was understated primarily because the finance department recorded cash receipts late. Accurately estimating the year‑end fund balance is critical because that amount establishes the starting point for future budgets and is the basis for determining whether the city has maintained a reserve of 10 percent of operating expenditures as required by its policies. Lynwood ended fiscal year 2016–17 with only 9 percent in reserve and failed to meet the reserve requirement.
Lynwood’s finance department generated inaccurate budget estimates for both fiscal years 2016–17 and 2017–18. As Table 2 shows, Lynwood overestimated its beginning‑of‑year fund balance for its general fund by $2 million in its budget for fiscal year 2016–17 and again by more than $1 million in its budget for fiscal year 2017–18.
||BEGINNING-OF-YEAR FUND BALANCE|
|FISCAL YEAR||ESTIMATED AMOUNT REPORTED IN ADOPTED BUDGET||ACTUAL AMOUNT REPORTED IN AUDITED CAFR||OVERSTATEMENT|
Source: Lynwood’s adopted budgets and CAFRs.
Although Lynwood anticipates that its fiscal year 2018–19 general fund beginning balance will be approximately $4.6 million, this estimate will likely be overstated if the finance department followed the same approach it used in the previous year for determining the beginning balance. During the fourth quarter of fiscal year 2016–17, finance staff calculated the fiscal year 2017–18 beginning balance by starting with the actual fund balance at the beginning of fiscal year 2016–17 and then adding estimated revenue, subtracting estimated expenditures, and adjusting for any transfers for that year, as Table 3 shows. However, we determined that the finance department’s estimates for revenue, expenditures, and transfers were inaccurate—most notably that staff underestimated expenditures by approximately $1.5 million—thus leading to the inflated beginning balance for fiscal year 2017–18. If the finance department overestimated the beginning balance for fiscal year 2018–19 by the same amount of $1.2 million as it did in the previous fiscal year, then Lynwood’s beginning general fund balance in fiscal year 2018–19 would actually be only $3.4 million.
||AMOUNT ESTIMATED IN ANNUAL BUDGET||AMOUNT REPORTED IN AUDITED CAFR||TOTAL AMOUNT OVERESTIMATED (UNDERESTIMATED)|
|Fiscal Year 2016–17 Beginning-of-Year General Fund Balance||$2.50||$2.5||–|
Source: Analysis of Lynwood’s fiscal year 2017–18 adopted budget and fiscal year 2016–17 CAFR.
We further identified that the largest underestimate of expenditures was from the community development department, which underestimated its expenditures by approximately $848,000. The current city manager, who served as the finance director during the development of the fiscal year 2017–18 budget, attributed the underestimates to the community development department’s interim director not sufficiently overseeing the budget process for his department. The city manager also stated that understaffing in the finance department and delays in reconciling financial data resulted in the department not being able to verify expenditure estimates. The current finance director additionally stated that he believed that the finance department did not verify expenditure estimates that city departments submitted for fiscal year 2017–18 because the budget process was rushed.
The finance department coordinates the city’s budget process, which Lynwood’s budget calendar identifies should begin in January—six months prior to the start of the fiscal year. However, we observed that the city manager and finance department did not distribute budget preparation instructions to city department directors until April—three months behind schedule—for both the fiscal years 2017–18 and 2018–19 budgets. Accordingly, we are concerned that Lynwood rushed its fiscal year 2018–19 budget process similarly to how its finance director said it rushed the fiscal year 2017–18 budget process. Further, because the current finance director used the same methodology as his predecessor to calculate the beginning balance for fiscal year 2018–19, we are concerned that the general fund starting balance for the fiscal year 2018–19 budget may also be overestimated. However, we were unable to verify whether the beginning‑of‑year fund balance for fiscal year 2018–19 was overestimated because the city has not yet produced its audited CAFR for fiscal year 2017–18.
We are additionally concerned that Lynwood is using estimates of one‑time revenue as a technique to balance its fiscal year 2018–19 budget. In preparing its budget, Lynwood anticipated generating approximately $1.5 million in one‑time revenue from selling utility credits, which we define in the text box. Cities may use utility credits to pay for their own projects to move overhead utility lines underground or sell them to other cities for their use on similar projects. Selling utility credits to other cities is a long‑standing practice in California.
Utility Credit Definition
Utility credits: Under the California Public Utilities Commission’s Rule 20 program, utility companies provide an annual allocation of credits to municipalities to subsidize moving overhead utility lines underground.
Source: California Public Utilities Commission.
We believe that Lynwood may have overestimated the revenue that it can generate from the sale of its utility credits. Lynwood’s finance director estimated that the city will sell its utility credits for 60 percent of their value to another local government in fiscal year 2018–19. We reviewed eight other sales of utility credits for which such data was publicly reported and determined that other cities received an average of only 46 percent of their credits’ value through similar sales, with the highest return being 55 percent. The city manager also said that to the best of his knowledge Lynwood has never previously sold such credits, leading us to question the city’s ability to sell these credits at such a high value.
The city manager informed us in October 2018 that Lynwood had subsequently reached an informal agreement with the city of Newport Beach to purchase the credits for 60 percent of their value. However, it is not clear whether Lynwood will actually obtain revenue at the amount budgeted because it does not plan to seek the city council’s approval until after the November 2018 election, at which point the new city council could decide not to sell the credits. We are accordingly concerned the city may be overstating its projected revenue for fiscal year 2018–19. As Table 4 shows, if Lynwood does not sell its credits at the intended price, it would need to sell its credits for at least 56 percent of their value—more than the highest rate of return we identified among other cities—in order for its fiscal year 2018–19 budget to remain balanced. Selling credits for less than 56 percent of their value will likely result in operating expenditures exceeding operating revenue. Moreover, if Lynwood does not sell any of its credits in fiscal year 2018–19, its operating expenditures will exceed its operating revenue by nearly $1.4 million, and even if it does sell the credits it will still only operate with a $100,000 operating surplus.
|IF LYNWOOD SELLS ITS UTILITY CREDITS FOR|
OF THIER VALUE
OF THIER VALUE
OF THIER VALUE
|IF LYNWOOD DOES NOT SELL ITS UTILITY CREDITS|
Source: Analysis of Lynwood’s fiscal year 2018–19 budget preparation documents.
Lynwood has not developed specific actions to adjust its budget if it does not sell its utility credits in fiscal year 2018–19. After we discussed with the city manager our concern regarding the city’s potential budget deficit in future years, he informed us that he could consider reducing certain expenditures. The city manager indicated that he could eliminate two expenditures totaling approximately $960,000 from future years’ budgets: funding in the fiscal year 2018–19 budget for a summer law enforcement team and funding for certain road maintenance and improvement projects. However, the city manager did not have a specific plan to address the remaining shortfall of approximately $425,000, instead indicating that he expected to identify cost reductions among various city departments in their department‑specific consulting and discretionary expenditures. Nevertheless, it is unclear whether any of these subsequent reductions would be for recurring costs because the city has not yet made this determination.
Further, Lynwood’s recurring expenditures are partly supported by revenue that the city will not realize in future years. As Figure 1 shows, if Lynwood maintains the same operating revenue in fiscal year 2019–20 as in fiscal year 2018–19 but does not sell its utility credits, even if it reduces its fiscal year 2019–20 operating expenditures to account for the two expenditures the city manager identified, it would still incur a structural deficit. Best practices from the Government Finance Officers Association (GFOA), whose mission is to advance excellence in state and local government financial management, emphasize that one‑time revenue cannot be relied upon in future budget periods. Therefore, although Lynwood proposes a balanced budget for fiscal year 2018–19, it does not appear that the city will be able to sustain its current level of expenditures in the future without operating at a deficit.
Recommendations to Address This Risk
- To improve the accuracy of the budget estimates of beginning fund balances in its general fund, the finance department should critically review the accuracy of the estimated expenditures and revenue that city departments submit for each year’s budget.
- To allow sufficient time to review revenue, expenditure, and fund balance estimates, Lynwood should begin its fiscal year 2019–20 budget process according to its planned timeline.
- When anticipating future revenue from one‑time sources, Lynwood should develop realistic estimates of the timing and amount of those inflows.
Lynwood lacks many policies related to budgeting and does not follow best practices for budgeting that the GFOA recommends.2 The GFOA has identified budgeting as one of the most important activities undertaken by governments and an operational area in which many governments are in need of guidance. The GFOA accordingly advises that government budgeting should have a long‑range planning perspective in order to consider the longer‑term consequences of budget decisions, including whether program and service levels can be sustained in the future. We evaluated Lynwood against recommended GFOA budget best practices and found, as Table 5 shows, that it did not follow, or only partially followed, 10 of the 11 recommended practices.
|BUDGETING BEST PRACTICES THAT THE GFOA RECOMMENDS||EXTENT TO WHICH LYNWOOD’S EXISTING BUDGET POLICY OR PRACTICE FOLLOWS THE BEST PRACTICE|
|Budget Policy Guidelines: Prepare general policy guidelines and budget preparation instructions for each budget cycle.||Fully Followed.|
|Balanced Operating Budget Policy: Develop a policy that defines a balanced operating budget, encourages commitment to a balanced budget under normal circumstances, and provides for disclosure when a deviation from a balanced operating budget is planned or when it occurs.||Partially Followed. Although Lynwood has a policy that defines a balanced operating budget, it does not have a policy to disclose when it deviates from a balanced operating budget.|
|Reserve Policy: Develop policies to guide the creation, maintenance, and use of resources—such as a reserve—for financial stabilization purposes.||Partially Followed. Although Lynwood has a policy guiding the creation and use of a reserve, it does not have guidance on how the reserves should be established.|
|Fee‑Setting Policy: Adopt policies that identify the manner in which fees and charges are set and the extent to which they cover the cost of the service provided.||Partially Followed. Lynwood does not have such a policy but it contracts for a user‑fee study, which includes an analysis of the full cost of its services, projected potential fee revenue, and recommendations for fees, along with associated levels of cost recovery.|
|Capital Asset Inventory: Identify and conduct an assessment of its capital assets, including the condition of the assets and factors that could affect the need for or ability to maintain the assets in the future, and develop a process for inventorying capital assets.||Partially Followed. Although Lynwood has a capital asset policy, its external auditor reported as an audit finding that the city has not conducted an inventory of its capital assets.|
|Budget Review Procedures: Institute procedures to review the budget periodically, such as quarterly, and decide on actions to bring the budget into balance.||Partially Followed. Although Lynwood does not have documented procedures to periodically review the budget, it performed a mid-year financial review for fiscal years 2016–17 and 2017–18.|
|One‑Time Revenue Policy: Adopt a policy limiting the use of one-time revenues for ongoing expenditures.||Not Followed.|
|Multiyear Revenue Projections: Prepare multiyear projections of revenue and other resources.||Not Followed.|
|Multiyear Expenditure Projections: Prepare multiyear projections of expenditures for each fund and for existing and proposed new programs.||Not Followed.|
|Revenue Diversity Policy: Adopt a policy that encourages a diversity of revenue sources.||Not Followed.|
|Identify Unpredictable Revenue: Identify major revenue sources considered unpredictable and define how this revenue may be used.||Not Followed.|
Source: GFOA's Recommended Budget Practices: A Framework for Improved State and Local Government Budgeting, Lynwood finance department documents, and interviews with Lynwood finance department staff.
The only GFOA practice that Lynwood has fully implemented addresses guidelines and instructions for preparing its budget. We identified that for each of its three most recent budget cycles, the city prepared general policy guidelines and budget preparation instructions that it distributed to the city’s department directors. However, as we previously noted, the city distributed these instructions for the fiscal year 2017–18 and 2018–19 budgets later than stipulated in its budget schedule.
Further, we identified five best practices that Lynwood only partially followed. For example, the GFOA recommends that governments identify and conduct an inventory of their capital assets, including the condition of the assets and factors that could affect the need for or ability to maintain these assets in the future. Although Lynwood does have a policy requiring the finance department to conduct an annual physical inventory of the city’s capital assets, in fiscal year 2015–16 Lynwood’s external auditor identified that the city does not have a list of capital assets by department and does not perform a capital asset inventory. The finance director, who began working with the city in March 2018, told us that steps had not been taken yet to address this deficiency.
Finally, we identified five other best practices that the city does not follow. Notably, the finance director stated that Lynwood does not perform multiyear revenue and expenditure projections, which we believe would be beneficial toward identifying the need for resources to sustain city services. Multiyear expenditure projections can provide critical information to decision makers about whether projected expenditure levels can be sustained in the future. The finance director stated that beginning with fiscal year 2019–20, he intends to develop a two‑year budget in order to better project the city’s future revenue and expenditures. However, he believes that budget projections beyond two years are less accurate and less meaningful.
Additionally, he intends to develop a five‑year capital improvement plan—a document projecting the city’s planned capital improvement expenditures and funding sources, something he said Lynwood does not currently have—in fiscal year 2019–20. He further explained that he intends to develop other five‑year projections for changes to citywide pension costs, the effect of statewide mandates on city expenditures, and estimated infrastructure maintenance costs. He stated that he intends to update these projections annually. We believe that developing these projections would be beneficial to the city and would better inform stakeholders and decision makers of the sustainability of future expenditures.
Recommendations to Address This Risk
Lynwood Risked Future Deficits by Significantly Increasing the Number of Employees and Their Salaries When It Could Not Afford to Do So
When Lynwood’s city council declared a fiscal emergency in July 2016 and took steps to reduce its structural deficit in fiscal year 2016–17, it also imposed a hiring freeze on new employees for fiscal year 2016–17. However, the city undermined its own efforts by significantly increasing personnel costs in fiscal year 2017–18 and continuing to do so in fiscal year 2018–19.
Figure 3 shows that the city decided to increase city staffing by 15 percent, from 165.5 to 190.5 full‑time‑equivalent staff members, in its fiscal year 2017–18 budget. Finally, the city increased its staffing again in its fiscal year 2018–19 budget from 190.5 to 211.5 full‑time‑equivalent staff. Consequently, Lynwood estimates fiscal year 2018–19 personnel expenditures will be $1.7 million greater than it incurred in fiscal year 2016–17.
Lynwood’s City Council Continued to Approve Increased Personnel Expenditures Despite the City's
Ongoing Fiscal Problems
Source: Analysis of Lynwood’s city council resolutions, adopted budgets, and mid‑year financial reviews. Staff numbers are full‑time‑equivalent positions.
Lynwood asserted that it increased staff salaries to provide its employees with competitive pay. According to the city manager, Lynwood increased its staff salaries because the city council believed that the city’s employees were being paid below market rate. Although Lynwood had not provided a cost‑of‑living salary increase to its employees since fiscal year 2013–14, we question whether increasing salaries was an appropriate decision given the city’s poor financial position and in light of its March 2018 decision to impose a hiring freeze on nonrevenue‑generating positions through the end of fiscal year 2017–18.
Moreover, Lynwood was unable to justify the amounts of its salary increases and may have increased salaries higher than market rates. Lynwood’s base salary increases for each classification we reviewed ranged from 2 percent to 72 percent and averaged 27 percent overall. According to the city manager, the city decided on these amounts using the results of a salary survey conducted by its staff and a consultant that the city contracted with for general human resources services. For each classification, the survey results consisted of a table listing the entities, classification titles, and salaries it used for the survey. The results also presented an average salary and identified the median3 salary for each classification.
However, as Figure 4 shows, we question the survey’s use of cities with populations and budgets substantially larger than Lynwood. Although we did not evaluate the government structures of these cities, their significantly larger budgets, population, and geographic size suggest that their employees may have different levels of responsibility than their counterparts in Lynwood. Moreover, the city could not explain why the survey used information from any of these cities, which leads us to further question their comparability. In addition, the survey included other entities, namely school districts and counties—entities serving different purposes than Lynwood. A more reasonable approach would have been for Lynwood to use a focused survey of cities similar in population, geographic size, and expenditures.
Lynwood Performed a Salary Survey Using 67 Cities of Which Many Were Not Comparable
Source: Cities’ CAFRs and the U.S. Census Bureau.
For 10 of the 40 classifications we reviewed, affecting 21 employees, the city council approved base salaries that were above the average rates identified of those surveyed. The base salaries that the council approved for the 10 classifications ranged from $131 to $846 per month over the salary levels in the survey. For example, the survey results for one of the positions, senior water service/wastewater worker, identified the median and average base monthly salary to be $4,073 and $3,973, respectively. The city council, however, ultimately approved a base monthly salary of $4,919. We are unclear as to why the city council chose to approve amounts higher than comparable salaries in the surveys. We reviewed the staff reports provided to the city council for those salary increase resolutions it approved and found the reports presented only the new recommended salary amounts without disclosing the results of the salary survey. Furthermore, the city was also unable to explain why staff presented to the city council for approval recommended amounts that were higher than those in the survey.
Lynwood may not be able to sustain its increased personnel costs given its current revenue structure. The city is currently able to support the increased personnel costs within its budget because it plans to use the equivalent of 20 percent of the revenue it estimates it will receive from its temporary sales tax to cover the general fund portion of those costs. However, after the voter‑approved sales tax expires in fiscal year 2026–27, the city may find that it is committed beyond its means.
Recommendation to Address This Risk
VIOLATIONS OF STATE LAW, WEAK OVERSIGHT, AND POLICY BREACHES MAKE LYNWOOD SUSCEPTIBLE TO FRAUD AND WASTE
Lynwood violated state law by using its water and sewer funds to subsidize salaries without justification, and it may have violated state law when using water and sewer funds to pay for city overhead costs and to partially fund a significant capital improvement project. Water and sewer revenue comes primarily from fees and charges paid by users and is accounted for in restricted funds. State law requires that revenue derived from a property‑related fee or charge not be used for any purpose other than that for which the fee or charge was imposed. Further, state law requires that revenue derived from the fee or charge on behalf of properties in the jurisdiction receiving service not exceed the costs required to provide the service.
Lynwood has inappropriately used water and sewer revenue to fund two staff members’ personnel costs, which include salaries and benefits. State law permits using these funds but only to the extent that they pay for the actual cost of support for water and sewer operations. For example, the city’s practice is to fund positions in some of its departments—such as finance, technology and media services, and public works—partly with water and sewer funds because these positions perform certain functions that support these operations. Our review of Lynwood’s fiscal year 2018–19 budget, however, led us to conclude that the city is violating state law by funding two positions in its finance department entirely with water and sewer revenue even though these two positions have job responsibilities that are unrelated to the city’s water and sewer operations. Lynwood budgeted $317,000 for these two positions in fiscal year 2018–19.
We identified that Lynwood also budgeted $389,000 for these same two positions in fiscal year 2017–18 to be paid entirely with water and sewer funds. When we questioned the city manager regarding the validity of this funding, he agreed that it was incorrect for the city to fully fund the two positions from water and sewer funds and stated that he would modify the funding sources to more accurately reflect the work they perform. We asked Lynwood’s finance director when this adjustment would be made, and he stated that he would review and reassess the funding for these two positions during the fiscal year 2018–19 mid‑year budget review.
Lynwood also cannot justify the amount it funds other positions through water and sewer revenue. The amount of each staff member’s salary that is funded by water and sewer revenue is determined by percentages given by department directors to the finance department. However, we identified that those percentages are not based on the actual work department staff perform in support of those services. For example, according to the technology and media services director, he does not track or maintain specific details on all of the work his employees perform and consequently uses his best approximation to determine the proportion of personnel costs that should be funded using water and sewer revenue. In fiscal year 2018–19, the city budgeted $178,000 of the department’s $508,000 total personnel costs to be funded using water and sewer revenue.
In another example, the public works director stated that his department’s use of water and sewer revenue to fund personnel costs is based on estimations rather than on actual work hours. Lynwood budgeted approximately $1.6 million of his department’s personnel costs in fiscal year 2018–19 to be funded using water and sewer revenue, but because these directors did not have documentation to support their estimates, the city cannot justify the amount of water and sewer revenue used to fund these personnel costs. Without such justification, Lynwood cannot demonstrate that it has complied with the state law requirement that revenue derived from fees or charges for property‑related services not be used for any purpose other than that for which the fee or charge was imposed.
Lynwood’s audited financial statements include a general fund revenue category titled administrative support, which was reported as $1,118,246 for each year between fiscal years 2010–11 and 2016–17. Documentation supporting its fiscal year 2018–19 budget also reports administrative support revenue in fiscal years 2017–18 and 2018–19 of almost identical amounts to those of the previous years. We determined that the source of this amount is from transfers from the city’s water and sewer funds. The city manager informed us that these revenue transfers are for the water and sewer funds’ share of the city’s overhead costs, such as shared administrative costs where a department incurs costs for support that it provides to other departments. The finance director provided a cost allocation plan completed in 2006 that indicated the city should allocate overhead costs of approximately $1.1 million to the water and sewer funds.
The city manager informed us that a cost allocation plan completed by the city in July 2018 determined that Lynwood should recover only approximately $876,000 from its water and sewer funds for overhead costs, an amount significantly less than it had recovered or budgeted to recover during each of the past nine fiscal years. The city manager was not aware of the 2006 cost allocation plan and did not know whether or when the city had completed another cost allocation plan prior to the July 2018 plan.
Again, state law permits the use of water and sewer revenue to fund only the costs of providing those services. Thus, for fiscal year 2018–19, Lynwood’s allocation of $1.1 million in water and sewer revenue exceeded its costs of $876,000, which violates the law. The finance director stated that starting with the fiscal year 2019–20 budget, he plans to use the recently completed cost allocation plan as a basis for the transfer from the water and sewer funds to the general fund. However, we believe it should revise its fiscal year 2018–19 budget to align it with its current cost allocation plan to correct its violation of state law.
Moreover, Lynwood has not performed cost allocation studies as frequently as best practices suggest. According to the GFOA, a cost allocation plan should be updated at a minimum of once every three years and potentially more frequently when used to charge back costs to governmental departments. Because Lynwood appears to have used the same plan for as many as 12 years without updating the plan, it may have either overstated or understated the cost of general fund services allocated to the water and sewer funds in those years. The city manager stated that he would like the city to update its cost allocation plan every three to five years to ensure that the city is correctly recovering its costs.
Further exacerbating the risk that Lynwood may unlawfully use revenue from its water and sewer funds is a lease arrangement it has in place over its water infrastructure with no apparent purpose other than to provide the city with the ability to use water and sewer funds to subsidize its general fund.Because state law requires that revenue derived from providing water and sewer services to properties within the jurisdiction may not exceed the cost of providing those services, and because Lynwood derives 99 percent of its water and sewer revenue from properties within its jurisdiction, there is no legal basis for accumulating surplus revenue or using the revenue to make lease payments for a purpose unrelated to providing water and sewer services. Without legal authority for these payments and because the utility authority is exclusively controlled by the city, we question the validity and necessity of the utility authority’s existence.
The Structure of the Utility Authority Lease Agreement Allows Lynwood to Lease Its Water and Sewer Infrastructure From Itself
Source: Analysis of Lynwood’s utility authority lease agreement and relevant city council resolutions.
* The utility authority is currently comprised solely of the city of Lynwood. The utility authority was formerly comprised of Lynwood and its redevelopment agency. However, with the dissolution of redevelopment, the city assumed the role of successor agency to the redevelopment agency.
† State law requires that revenue derived from water service fees and charges in the jurisdiction not exceed the amount required to provide the service.
Although we did not identify any payments from the utility authority to Lynwood that were specifically referred to as lease payments, we are concerned that the lease agreement’s undefined payment structure provides a mechanism in which the city could inappropriately use its water and sewer funds to subsidize its general fund. When we informed the city manager of our concern regarding the legality of Lynwood’s water and sewer overhead cost payments that we discussed previously, he indicated that if the city could not legally justify the transfers as overhead cost payments, Lynwood could instead justify the transfers under the lease agreement by characterizing them as lease payments from the utility authority to the city. It is this very perspective that demonstrates how the lease agreement’s undefined payment structure allows the city’s management to characterize any otherwise unjustified payment or allocation from the water and sewer funds to the general fund as a lease payment.
Lynwood may have unlawfully used water fund revenue to construct a new city hall annex that the city council approved in 2013. The budget for this project included various sources of funding, including an amount from the water fund totaling $2.3 million that was comprised of three components: the water operation’s share of construction costs and two reimbursements from the water fund to the general fund.4 We question the appropriateness of the construction cost charged to the water fund—amounting to $1.1 million—because it was based on a consultant’s analysis for a previously planned version of the new city hall annex. That version included working space for staff of the city’s water operations. Lynwood subsequently reduced the planned size of the annex when it recognized that it did not have sufficient funding to pay for that version. The revised scope of the annex did not include space for water operations staff, and we observed that none of those staff are physically located in that building. Consequently, Lynwood should have determined a new amount of construction cost to charge to the water fund that reflected the revised scope of the annex.
Lynwood also cannot justify the two reimbursements it made from the water fund to its general fund, amounts that were then used to pay for construction of the city hall annex. These reimbursements from the water fund, totaling $1.2 million, were for past payments made by other city funds that the city later determined should have been made by the water fund. Lynwood was unable to provide any documentation supporting the appropriateness of the reimbursements, so it could not demonstrate its compliance with legal requirements precluding the use of water revenue for any purpose other than that for which the fee or charge was imposed.
Because of our concerns with the city hall annex, we also reviewed a capital improvement project of $1.9 million that included funding of $900,000 from the water fund for street improvements and repairs that the city council included in its fiscal year 2017–18 budget. In this case, Lynwood was able to demonstrate that this project had budgeted water fund revenue that was reasonably related to expenditures for water. For example, one of the improvements budgeted to be paid for with water fund revenue involved the installation of pipes to existing water mains. Although Lynwood was able to justify the use of water fund revenue for this recently approved capital improvement project, both the director and the special projects manager acknowledged that the public works department did not have written guidelines for how water fund revenue can be spent on capital improvement projects. After we called this to their attention, the public works director distributed a new policy establishing a process for how to allocate water and sewer funds to capital improvement projects. Additionally, the special projects manager stated she is not aware of a documented procedure for developing budgets for capital improvement projects for the public works department. Without documented guidance and procedures, Lynwood risks inappropriately using water fund revenue for capital improvement projects in ways that are not compliant with state law.
Recommendations to Address This Risk
- Lynwood should develop and implement policies that ensure reimbursements made from its water and sewer funds to other funds are properly structured and that they are thoroughly documented to show that the reimbursement is an expenditure related to the cost of providing water and sewer service.
- Lynwood should follow its documented guidance regarding how to allocate costs for capital improvement projects to the water and sewer funds.
- Lynwood should develop policies and procedures for developing budgets for capital improvement projects, including procedures for justifying the funding sources for those projects.
Lynwood’s Use of Competitive Bidding Exceptions Within Its Municipal Code and Insufficient Contract Management Increase Its Risk of Wasting Public Funds
Exceptions within Lynwood’s municipal code sections governing purchasing and the city's poor contract management increase the risk that the city will not obtain the best value for goods and services for which it contracts. We determined that unique provisions within Lynwood’s municipal code provide opportunities for the city to avoid competitive bidding and that the city has not always executed its contracts prudently.
By signing this contract amendment, the city committed itself to paying $250,000 more in fiscal year 2018–19 than it would have had the scope of services remained the same. Furthermore, the contract stipulates that the cost of service will increase annually for each of the remaining six years in accordance with the consumer price index for Los Angeles, Riverside, and Orange counties.
City management was unable to explain the rationale for this decision. Lynwood’s municipal code related to purchasing requires city council approval for amendments that increase the value of the original contract amount by at least $50,000, or 25 percent. It does not, however, specify whether a contract should be rebid through a competitive bidding process if a proposed amendment significantly changes the scope of the contract. The lack of such a requirement increases the city’s susceptibility to wasting public funds because the city council could essentially authorize a new contract without directing city staff to seek competitive bids. Had Lynwood solicited bids for comprehensive removal of graffiti throughout the city, it may have been able to obtain the service at a better value or recognized that using existing city staff could be a more cost‑efficient approach to graffiti control for the city.
Competitive Bidding Exceptions
For contracts that are not for public works projects, no competitive bidding of any kind is required under the following circumstances:
- When an emergency requires that an order be placed with the most available source of supply;
- When the supplies, equipment, services, or contract could be obtained from only one source;
- If the city council shall find, by a resolution adopted by not less than four‑fifths of its members, that such an acquisition may be more economically and efficiently effected through the use of an alternate procedure; or
- When the city is seeking a contract for garbage collection.
Source: Lynwood municipal code, section 6-3.13.
We believe that the vagueness of this criteria may result in the city not consistently obtaining the best value for goods and services, particularly because the municipal code lacks a requirement for the city council to document the reasons for that determination. We identified that between June 2016 and June 2018, the city council used the exemption on at least 49 occasions for contracts that ranged between approximately $19,000 and $500,000 and totaled at least $4 million. The types of goods and services in these contracts—which included contracts for office furniture, temporary staffing in the finance department, and executive search services for city positions—are generally not specialized, and the city may have been able to obtain the goods and services at a better price and value through competitive bidding. We were also unable to determine how many contracts in total Lynwood had entered during this period because the city could not provide a complete list of its contracts as of September 2018.
We also found an instance in which the city council did not obtain the necessary votes to exempt a contract from competitive bidding. We determined that the city council bypassed the requirement by approving a $20,000 contract for legal services in April 2018 with only three council members voting in favor. After we brought the inappropriate approval to its attention, the city amended the contract to lower its value below the level required for competitive bidding requirements at the time it was originally approved.
Finally, we question whether Lynwood should have had city staff, along with a consultant providing Lynwood general human resources services, conduct the salary survey we discussed rather than seeking competitive bids for that service from a subject‑matter expert. .As we discussed previously, the consultant and city staff used many entities for its survey that do not appear comparable to Lynwood, leading us to question the value of the salary survey. Given the specialized nature of a salary survey, we find it concerning that the city directed these services to its staff and an existing consultant without seeking bids from other vendors who may have offered a better value to the city in terms of cost and quality. The city manager explained that the city did not anticipate using this consultant to complete a salary survey at the time it negotiated the contract, but subsequently assigned the duty to the consultant because it considered the consultant’s role to be serving in place of city staff assigned to perform the survey. Nevertheless, Lynwood should have entered into a new contract by seeking competitive bids for the salary survey.
Recommendations to Address This Risk
To ensure that it receives the best value for the goods and services it contracts for, Lynwood should do the following:
- Only assign duties to contractors that are expressly described within their contracted scope of services.
Lynwood Has Several Recurring Control Weaknesses in Its Financial Operations That Make It Susceptible to Fraud and Waste
Lynwood’s operations are susceptible to fraud and waste because it has failed to address significant recommendations made by its external auditors. When we began our fieldwork in June 2018, the city had not yet issued its CAFR for fiscal year 2016–17. Therefore, we reviewed the CAFR for the previous fiscal year—fiscal year 2015–16—that was issued in February 2017 and included the most recently reported findings and recommendations that its external auditor identified pertaining to the city’s controls over financial operations. Appendix B beginning on page 33 shows that Lynwood’s external auditor reported 12 findings that highlight a lack of policies and procedures governing the city’s financial operations. As of June 2018, the city had addressed only one of the 12 corresponding recommendations—tracking insurance claims—even though it had been more than a year since the external auditor reported the findings. By September 2018, the city subsequently implemented six other recommendations, leaving five recommendations that the city has still not implemented. According to the city manager, the previous city manager assigned a staff member in the finance department the responsibility of coordinating the city’s actions to address those findings, but that individual did not do so.
Many of the external auditor’s findings focused on the city’s finance department and its procedures pertaining to purchasing and payroll. For example, the external auditor identified that the city issued some purchase orders after it had made the related purchases. Without an approved purchase order, the finance department cannot ensure the transaction was authorized. To address the issue, the external auditor recommended the city create a policy that describes the procurement and cash disbursement processes that staff should follow. When we asked the current finance director, who started in March 2018, whether he had addressed that recommendation, he informed us he had not created a policy because he has been focused on preparing the city’s fiscal year 2018–19 budget. However, he intends to develop relevant policies in the next six months. Without addressing this control weakness, employees could make unauthorized or fraudulent purchases that could result in the city wasting funds.
Another finding the external auditor reported, but that Lynwood has not addressed, is that the city is not conducting bank reconciliations in a timely manner. The external auditor found that bank reconciliations were not performed promptly for each of the four months that it reviewed. The external auditor also found that the city has no systemic method for ensuring timely and complete year‑end closing procedures are in operation. By not establishing such procedures or completing bank reconciliations promptly, the city may not detect accounting errors, resulting in misstated account balances and creating delays in preparing financial statements.
Recommendations to Address This Risk
- Lynwood should develop and implement a plan to address the findings in the city’s fiscal year 2015–16 single audit—and any findings in its fiscal year 2016–17 single audit—including reasonable time frames for completion and a mechanism for tracking progress in addressing the findings. The city should assign responsibility to specific city staff to coordinate the city’s actions.
- Lynwood should develop policies and procedures that establish how the city will track and address future audit findings.
Lynwood’s Leadership Has Not Created a Strategic Plan That Would Direct Its Departments’ Goals and Objectives Towards a Unified Vision
Lynwood lacks a comprehensive and cohesive framework, such as a strategic plan, for guiding its departments. Strategic planning is of particular importance to Lynwood as it states on its website—its vision is to create and maintain a clean, safe, attractive, well‑informed, self‑reliant, and pride‑filled community that provides access to outstanding social, cultural, recreational, educational, and economic opportunities for residents and businesses. The GFOA recommends that all governmental entities use some form of strategic planning to provide a long‑term perspective for service delivery and budgeting. The GFOA believes strategic planning establishes logical links between authorized spending and broad organizational goals. According to the GFOA, the focus of strategic planning should be on aligning organizational resources to bridge the gap between present conditions and the envisioned future.
According to the GFOA, a city should agree on a small number of broad goals to include in its strategic plan that address the most critical issues facing its community. Instead, Lynwood includes 185 goals in its budget document, and many do not address the critical issues the city is facing, such as its long‑term financial viability. Further, the budget document does not include a clear action plan that describes how the city will implement strategies to address its goals and objectives nor does it include measurable objectives and performance measures that can clearly demonstrate whether those goals have been met—all elements that the GFOA recommends for a strategic plan. Although Lynwood does not have a comprehensive strategic plan in place, the city manager recognizes the importance of a strategic plan and would like to establish one for the city.
We believe that there are clear benefits from having a formal strategic plan in place. Specifically, a comprehensive citywide strategic plan can provide an overall framework for the city to operate within as well as articulating the goals it desires to achieve. City departments can build upon the plan by crafting their own goals and objectives, which helps to direct their delivery of public services in the most effective manner. A strategic plan can also facilitate efforts by the departments to address issues of particular concern to the city, such as the risk the city is facing that it may be unable to meet its future obligations. Finally, the strategic plan can align department goals and provide performance measures for the city to use to evaluate its success.
Recommendation to Address This Risk
Lynwood should assign its city manager’s office, with the support and involvement of department directors, the duty of facilitating the development of a citywide strategic plan that follows the recommendations established by the GFOA.
Some of Lynwood’s Departments Claim to Be Understaffed, but Do Not Effectively Measure Their Staffing Needs
In recent years, Lynwood has attempted to provide a greater level of service while employing fewer staff. Figure 6 shows that at the beginning of fiscal year 2009–10 the city had 229 full‑time‑equivalent staff, a number that declined to 165.5 full‑time‑equivalent employees by the end of fiscal year 2016–17. In fiscal year 2017–18, the city increased its staff to 190.5 full‑time‑equivalent employees and as of the beginning of fiscal year 2018–19, the city budgeted for 211.5 full‑time‑equivalent staff. Even with the most recent increase, the city’s staffing level remains 8 percent below its fiscal year 2009–10 level.
Even After Recent Increases, Lynwood’s Current Staffing Is Not at the Level It Was in Fiscal Year 2009–10
Source: Lynwood budget documents.
According to its budget documents, however, the city has increased services in some areas over this same period and now must provide these services with fewer staff members. For example, the city has constructed three new parks since 2011. This increased the need for park maintenance throughout the city by nine acres, or 23 percent, but the number of public works staff dedicated to this duty has decreased by two, or 14 percent. In addition, the recreation and community services director had to assign more duties to the superintendent of the playgrounds and camps division to accommodate a new community center that opened in 2017. He indicated that the superintendent is now essentially working two jobs by managing both the playgrounds and camps division as well as the new community center.
Some departments were able to identify for us the need to fill specific positions because of responsibilities they are currently unable to address. For example, the human resources department has a designated position assigned to administer a comprehensive risk management program that manages the city’s workers’ compensation policy, its insurance policies, and general liability strategies. The city eliminated this position in 2012, and the human resources director said the position’s duties have been performed since then by city staff who do not have the appropriate certification needed to complete certain duties. Similarly, the finance department has three accounting positions it is currently filling with contractors but will eventually need to fill with permanent staff. Because the departments are budgeted for positions to address specific responsibilities, they are able to justify their need to hire individuals to fill the positions that are vacant or filled by temporary contractors.
Similarly, the technology and media services director does not track all of the work his staff completes. According to the director, he records work requests that are submitted to his staff through his department’s work request computer system. However, we found that the system does not track the actual hours employees incur to complete tasks. The director informed us the system allows him to manage the day‑to‑day operations of his department but was not intended to provide hourly summaries. Consequently, although he believes he needs two additional staff members to address his department’s workload effectively, he cannot quantify his current needs.
Without quantifying the amount of work individual staff members are able to complete or the work hours needed to complete their anticipated workloads, Lynwood’s departments cannot effectively evaluate their staffing needs and are at risk of inadequately or inefficiently providing services. Given Lynwood’s uncertain financial outlook discussed previously, we believe that it is important for the city to identify actual staffing needs to provide services at appropriate costs. Without this critical information, each department is at risk of being over‑ or understaffed, which can unnecessarily add to the city’s potential structural deficit, lead to inadequate service for the public, or limit proper support for other city departments.
Recommendations to Address This Risk
- Using the key performance measures identified as part of its strategic plan as well as relevant workload data, Lynwood should conduct a staffing analysis to determine appropriate staffing levels for each of its departments.
- After tracking its effectiveness in providing services, Lynwood should prioritize adjusting its departments’ staffing levels to align with their predicted workloads.
Lynwood Does Not Have Adequate Succession Planning to Retain Its Institutional Knowledge When Turnover Occurs in Key Leadership Positions
Lynwood Has Experienced Significant Turnover In Recent Years Among Its Key Leadership Positions
Source: Lynwood’s personnel forms and city council resolutions.
* There were brief transition periods when positions may have been vacant.
Lynwood’s turnover in key leadership positions and lack of documentation of its decision‑making processes have resulted in its departments having less institutional knowledge. Throughout our audit we observed that department directors could not always explain the decision processes of their predecessors. For example, the human resources director could not explain the rationale the city used when making decisions to increase salaries of numerous positions because she was not there when the decisions were made and she could not find documentation to explain the rationale. In another example, the city manager informed us that he could not explain why a previous finance director’s budget estimate was incorrect. In yet another example, the city spent $23,000 to contract with a human resources firm in 2015 to produce updated personnel rules underlying citywide policies regarding topics such as sexual harassment. However, the human resources director said the personnel rules had not been implemented likely due to turnover. Consequently, it appears that the reason the rules were not implemented was because the department lost track of them.
Better succession planning could have helped Lynwood by ensuring the sharing of institutional knowledge that would allow current leaders to better understand past actions and carry forward operations more effectively. In fact, the GFOA suggests that governments adopt formal succession plans that identify risks and strategies and thereby provide a guiding framework for specific succession initiatives. In addition, the GFOA recommends that entities facilitate leadership development as part of their succession planning. GFOA best practices state that when leadership development occurs, the organization benefits from developing a leadership pool for other positions. Thus, a leadership pool would provide the city with more internal staff who have knowledge of the city’s operations and who are qualified to replace leaders when positions become vacant.
A well‑developed succession plan and policies to document decision‑making processes could help Lynwood ensure continuity and consistency in the event of leadership turnover. For example, a consultant who temporarily filled the human resources director position prior to the current director acknowledged that her short tenure did not make her the ideal individual to direct the creation of a policies and procedures manual. Had the department used a city staff member from a leadership pool to assume the role of acting director, that individual may likely have had the time and been more committed to performing in the city’s best interest to effectively address the issue. Similarly, if the city had required its previous finance director to document the process he used to create the April 2017 estimated balance of the general fund for fiscal year 2016–17, the city would be able to review and update that methodology based on actual fund balance activity and create more accurate fund balance estimates in future years.
Lynwood’s management recently began developing a succession plan. Although Lynwood’s human resources department included a goal in the city’s fiscal year 2017–18 budget document to create a succession plan, the department did not start this process until September 2018. According to the current human resources director, who has been in her position since January 2018, she had not prioritized the development of such a plan because she needed to focus on addressing issues that are more critical. However, in October 2018, the city completed a draft plan it intended to submit to its city council for approval in early November 2018. By developing and adopting a formal succession plan, the city would establish a framework for recognizing, developing, and retaining key management employees. Such a plan would also identify key gaps in expertise that staff currently in leadership positions could fill through training and recruitment.
Recommendations to Address This Risk
- Lynwood should develop a policy to require that its managers document the processes they use to make key decisions, such as the rationale for increasing salaries above the amounts determined from survey results or the methodology used to develop budget estimates, to provide continuity among leadership.
We conducted this audit under the authority vested in the California State Auditor by section 8543 et seq. of the California Government Code and according to generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives specified in Appendix A. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.
ELAINE M. HOWLE, CPA
California State Auditor
December 4, 2018
2 The GFOA coordinated with the National Advisory Council on State and Local Budgeting to issue Recommended Budget Practices: A Framework for Improved State and Local Government Budgeting. Go back to text
3 Median is defined as the middle term (or average of the middle two terms) of a series arranged in order of magnitude. Go back to text
4 The issue we identified pertaining to the city hall annex involves only the water fund and not the sewer fund. Go back to text