Report 2020-803
May 14, 2021

Corrective Action Plan and Assessment—City of El Cerrito

El Cerrito's Failure to Manage Its Spending Resulted In the Depletion of Its General Fund Reserves

Subject May 2021 September 2021
Continual diminishing of financial reserves through overspending Pending Pending
Ineffective budget development and monitoring practices Pending Partially Addressed

Without a More Coordinated Effort, El Cerrito's Financial Condition Will Continue to Deteriorate

Subject May 2021 September 2021
Lack of formal financial recovery plan Pending Pending
Insufficient reductions in ongoing costs Pending Pending
Missed opportunities to increase revenue Pending Pending




Corrective Action Plan and Assessment—City of El Cerrito

May 14, 2021

View El Cerrito's Corrective Action Plan from May 14, 2021

The city of El Cerrito (El Cerrito) submitted its corrective action plan on May 14, 2021, in response to the audit report titled City of El Cerrito: Excessive Spending and Insufficient Efforts to Address Its Perilous Financial Condition Jeopardize the City's Ongoing Fiscal Viability (2020-803) issued by the California State Auditor as part of our high-risk local government agency audit program. After reviewing the corrective action plan, we prepared the following assessment of El Cerrito's action items to address the high-risk areas we identified, as referenced on page v of our report. Many of the activities El Cerrito discusses in its plan are ongoing and are expected to be completed in fiscal year 2021–22. We will review the city's progress in its next update, due in September 2021, and will evaluate whether to remove the high risk designation from the city at that time.

El Cerrito's Failure to Manage Its Spending Resulted In the Depletion of Its General Fund Reserves

Continual Diminishing of Financial Reserves Through Overspending
California State Auditor's Assessment Status:
Pending
Although El Cerrito describes certain actions it has taken to address its financial condition, the city will likely need to reduce its overspending during the next several years to replenish its reserves. In its fiscal year 2019–20 audited financial statements, El Cerrito reported that general fund expenditures exceeded revenue by $71,000 during that year and that its general fund reserves continue to be negative by $1.8 million at the end of the fiscal year. Based on financial data through February 2021, El Cerrito estimated that it would end fiscal year 2020–21 with $633,000 more in revenue than expenditures in its general fund. However, such a surplus would offset only a portion of its negative reserves.

El Cerrito states that it expects to receive $4.8 million in funding from the federal American Rescue Plan Act and plans to use those proceeds to address its negative reserves, although it acknowledges that regulations for these funds are still pending. The city subsequently informed us of its understanding that such regulations will likely require it to spend these funds by December 2024 but may enable the city to use other funding sources to replenish its reserves.

The status of El Cerrito's financial condition is contingent on the city's ability to develop a fiscally prudent spending plan as part of its fiscal year 2021–22 budget. City management has taken some action thus far to involve the community in the development of the budget, which will assist in its efforts to manage its spending.

Ineffective Budget Development and Monitoring Practices
California State Auditor's Assessment Status:
Pending
El Cerrito has taken some action to improve its budget development and monitoring, but it will need to fully address our report's recommendations to ensure that its budget practices effectively oversee citywide spending. After we issued our audit report, El Cerrito implemented a new policy requiring departments to ensure that they have specific budget authority by type of expenditure before spending city resources. The change in policy was designed to address the concern we identified about overriding budgetary safeguards in the city's financial accounting system. El Cerrito provided examples of emails to city departments reminding them of this policy, as well as documentation of an instance when its finance department rejected a spending request by a department that did not have sufficient budget authority.

El Cerrito also implemented a procedure to improve its budget development process. To provide more detail for its fiscal year 2021–22 budget, the city now requires departments to complete a standard form justifying expenditures of more than $10,000 that are included in the budget.

To assist with its budget development and monitoring, El Cerrito prepared a five-year financial forecast in March 2021 after our audit's completion. This forecast includes options for permanent citywide spending reductions of $1 million and $2 million, which will help the city identify the amount and timing of specific expenditure reductions it will need to make. However, the city may still need to consider making additional spending reductions. Even if El Cerrito can achieve a $2 million reduction in spending in fiscal year 2021–22, the city stills projects to spend more than its revenue in fiscal years 2023–24 and 2024–25.

Despite the progress it has made, El Cerrito acknowledges that there are several recommendations from our audit that it is in the process of addressing. For instance, one of the critical budgeting practices we identified is the need to track and present financial information by individual department. The city council could use such information to hold departments responsible for their spending. El Cerrito states that it will research the issue and potentially make this change during fiscal year 2021–22.

Further, El Cerrito states that it complies with certain Government Finance Officers Association (GFOA) best practices. However, the city did not provide evidence during the audit of complying with such policies. Our audit identified that El Cerrito does not adhere to many GFOA best practices pertaining to budget development and monitoring. As we state in our report, El Cerrito does not develop revenue projections based on an analysis of past performance and assumptions regarding future performance, which has resulted in overspending by its departments. Further, the city does not disclose in its budget the specific assumptions used for expenditure projections in relation to revenue assumptions, as we note, thereby limiting the ability of the city council to determine the appropriateness of its spending.

Without a More Coordinated Effort, El Cerrito's Financial Condition Will Continue to Deteriorate

Lack of Formal Financial Recovery Plan
California State Auditor's Assessment Status:
Pending
El Cerrito states that it is working on its fiscal recovery plan to include the elements we described in our report, and it anticipates completing the plan in the summer of 2021. We look forward to reviewing the city's fiscal recovery plan after its completion.
Insufficient Reductions In Ongoing Costs
California State Auditor's Assessment Status:
Pending
We are concerned that El Cerrito's corrective action plan does not identify a targeted approach to reduce its spending. El Cerrito's five-year forecast noted the need to make significant reductions in spending starting with its fiscal year 2021–22 budget but did not outline how it planned to do so. In response to our cost-reduction recommendations, El Cerrito indicated that it is unlikely that it will complete a salary and compensation study until fiscal year 2022–23. As we acknowledge in our audit report, any effort by the city to revise its salary costs will involve negotiations with its employee unions. In March 2021, El Cerrito sent letters to its labor unions requesting to meet and discuss the city's financial challenges. However, to fully engage in salary negotiations, the city will need information from a compensation study to substantiate any proposed revisions to the compensation for its employees. Moreover, the city could consider contracting certain city services as we recommended. Despite initially disagreeing with this recommendation, the city now states in its corrective action plan that it will explore this option with the city council and the community.

In its corrective action plan, El Cerrito reiterates its belief that it is limited in its ability to conduct a compensation study. Although the city expressed concern regarding the cost of a study, it did not address other key actions we recommended that it perform beforehand, such as analyzing its organizational structure and the functions it needs to achieve its goals and analyzing the duties and responsibilities assigned to its current staff positions. Such an effort should be undertaken before seeking a consultant to conduct a compensation study. Further, the city's concern about the initial cost of conducting a compensation study does not acknowledge the long-term savings that could result from implementing changes recommended from the study, such as potential opportunities to reduce the costs of employee benefits, similar to the opportunities we note. By not conducting a compensation study and related analyses, El Cerrito is limiting its ability to reduce its spending.

Another example of an area that El Cerrito has not demonstrated its commitment to managing its spending pertains to salary increases for its management positions. Our audit described a process that the city used to authorize or agree to salary increases for certain management employees that exceeded the threshold established in the city's salary schedules. El Cerrito's response to the audit stated that the city had suspended the process for 2020 and would consider eliminating the process later in fiscal year 2020–21. However, El Cerrito now states in its corrective action plan that it will not consider permanently eliminating the process until the completion of a compensation study. The city manager stated that any changes to the city's salary structure would need to be studied to determine the best option for the city. However, our audit cited specific examples of management employees being paid in excess of the city's salary schedule and greater than similar positions of nearby cities, so we are unclear why a compensation study is necessary to determine whether this process should be eliminated.

Furthermore, El Cerrito's corrective action plan reiterates its initial response to the audit that it eliminated cost of living increases. However, this statement fails to disclose the full financial impact of the city's negotiations. Even though El Cerrito negotiated with its employee unions to eliminate cost-of-living salary increases for fiscal year 2020–21, it nevertheless agreed to such salary increases for subsequent years as we describe in our audit report. Consequently, the city should expect its costs to increase by at least $1.7 million in fiscal year 2021–22, thereby placing greater pressure on it to identify other cost reductions. El Cerrito stated that it will freeze salaries during fiscal year 2021–22 for management employees not represented by an employee union, but it is unclear how long the city can continue to defer pay increases for that group.

Missed Opportunities to Increase Revenue
California State Auditor's Assessment Status:
Pending
Although El Cerrito updated some fees for its swim center and senior services, it plans to conduct an analysis of demand and cost recovery as conditions relating to the COVID-19 pandemic are more stable. In May 2021, El Cerrito updated swim center fees and senior services fees in its master fee schedule. It increased many of its fees for its swim center by 2 to 10 percent, although those increases do not take effect until September 2021. For its senior services, the city increased the fee by $1 for some of its services. While these fee increases are likely to result in greater revenue for the city, El Cerrito still has additional opportunities to increase its revenue.




Corrective Action Plan and Assessment—City of El Cerrito

September 16, 2021

View El Cerrito's Corrective Action Plan Update from September 16, 2021

The city of El Cerrito (El Cerrito) submitted its corrective action plan update on September 16, 2021, in response to the audit report titled City of El Cerrito: Excessive Spending and Insufficient Efforts to Address Its Perilous Financial Condition Jeopardize the City's Ongoing Fiscal Viability (2020-803) issued by the California State Auditor in March 2021 as part of its high-risk local government agency audit program. After reviewing this update, we prepared the following assessment of El Cerrito's efforts to address the high-risk areas we identified. Although the city has made some progress addressing these areas, many of the activities El Cerrito discusses in its update are ongoing efforts with expected completion dates in fiscal year 2021–22. We will continue to review the city's progress in its next update, due in March 2022, and will evaluate the extent to which it has fully addressed any of the risk areas.

El Cerrito's Failure to Manage Its Spending Resulted In the Depletion of Its General Fund Reserves

Continual Diminishing of Financial Reserves Through Overspending
California State Auditor's Assessment Status:
Pending
Recent federal assistance has significantly aided El Cerrito in improving its financial reserves, but such progress may be temporary if the city does not address its underlying financial condition. The city received $6.1 million under the American Recovery Plan Act (ARPA) and expects to receive more revenue than it spends in fiscal years 2020–21 and 2021–22. As a result, it could end fiscal year 2021–22 with a $7.5 million reserve, representing 19 percent of general fund expenditures. This reserve level would be a substantial improvement from the negative reserve the city had in fiscal year 2019–20 and slightly above the 17 percent reserve recommended as a best practice. Because of its improved financial position, El Cerrito was able to reduce the amount of short-term borrowing it has used to fund its operations from $8.5 million in fiscal year 2019–20 to $6 million in fiscal year 2021–22, and it hopes to end this practice in fiscal year 2022–23.

El Cerrito has been able to improve its financial position in large part because of one-time federal revenues and an unexpectedly robust real estate market. The change in the city's general fund can be attributed to its receipt of $6.1 million in ARPA funds during fiscal years 2020–21 and 2021–22. Nevertheless, the city cannot expect to sustain substantial revenue from this source in future years. In addition, the city's real estate transfer tax generated $4 million in fiscal year 2020–21, 53 percent more than expected. If the city had received the amount of the transfer tax that it budgeted for, the city would have $1.4 million less in revenue. A highly variable revenue source such as this tax can leave the city vulnerable to overspending if the city increases its revenue projection based on a peak year but ultimately receives a much lower amount.

Despite its recent progress, El Cerrito still needs to take long-term action to balance its revenue and expenditures. The city's budget for fiscal year 2021–22 includes a five-year forecast that shows expected revenue and expenditures through fiscal year 2025–26. That projection shows that El Cerrito expects to spend $3.2 million more than its revenue from fiscal years 2022–23 through 2025–26, which would reduce much of the reserve that resulted from ARPA funding.

Moreover, El Cerrito has taken only initial efforts to address its pension costs. The city states in its update that the police and fire chiefs, who are part of a union, have agreed to pay a higher proportion of their pension costs, although other unions that represent most employees have not agreed to any pension-related changes. El Cerrito also indicates that it is researching vendors to establish a Section 115 trust that can be used to pre-fund pension costs, which it expects to finalize in fiscal year 2022–23. In addition, the city states that it working with its benefits broker to address the health care subsidy the city provides to its retirees but has not yet identified any specific action it will take.

Ineffective Budget Development and Monitoring Practices
California State Auditor's Assessment Status:
Partially Addressed
El Cerrito has incorporated several improvements into its budget process, although it still needs to address our concern regarding the lack of budget monitoring by department. The city's fiscal year 2021–22 budget, adopted in June 2021, included several improvements to the information provided to the public. This most recent budget document clearly outlines the assumptions that city management used to prepare the budget, includes a five-year forecast with a comparison to the prior five-year period, and provides detailed budgets and major expenditures for its departments. Each of these items adds to the transparency in the budget process and facilitates more informed feedback from stakeholders.

In our May 2021 assessment of El Cerrito's corrective action plan, we noted that one of the critical budgeting items still needed was to track and present financial information by department. Maintaining information at this level of detail could help the city council hold departments accountable for their spending. El Cerrito states in its update that it will begin presenting this information to its city council in October or November 2021 and is still researching if it will change its policies to budget by department.

To address its budget development and monitoring, city management has proposed to hire a budget manager. Such a position could assist El Cerrito with the budgetary issues we identified in our audit and help ensure that the city continues to maintain a budget that is relevant and useful for stakeholders. City management anticipates presenting the position to city council for approval in October and would seek to fill the position by December.

Without a More Coordinated Effort, El Cerrito's Financial Condition Will Continue to Deteriorate

Lack of Formal Financial Recovery Plan
California State Auditor's Assessment Status:
Pending
El Cerrito continues to report that it is developing a financial recovery plan. The city indicated that its consultant facilitated a study session with its city council to discuss short-term recovery and long-term financial sustainability. From that effort, El Cerrito is now in the process of preparing its Fiscal Recovery and Sustainability Plan.
Insufficient Reductions In Ongoing Costs
California State Auditor's Assessment Status:
Pending
Although El Cerrito's current financial condition has improved, the city still needs to take specific action to control the growth of its salary and benefit costs, especially given its projection of expenditures exceeding revenue in future years. In response to our recommendations to reduce costs, El Cerrito continues to state that it does not anticipate completing a salary and compensation study until fiscal year 2022–23. Further, the city has deferred a decision to permanently end its system of allowing certain management employees the ability to receive salary increases above the threshold established in the city's salary schedules. At this time, the city states that it has suspended the process pending its completion of the compensation study. As referenced in our review of the May 2021 corrective action plan, El Cerrito indicated that any changes to the city's salary structure would need to be studied to determine the best option for the city. However, our audit cited specific examples of management employees being paid in excess of the city's salary schedule and greater than similar positions of nearby cities, so we are unclear why a compensation study is necessary to determine whether this process should be eliminated.

El Cerrito's other efforts to address its salary and benefit costs have not resulted in substantial savings. The city indicated in its update that it met with two employee unions to discuss changes in salary and benefits to current contracts but those unions declined to make any changes.

Missed Opportunities to Increase Revenue
California State Auditor's Assessment Status:
Pending
El Cerrito's corrective action plan update refers to the fee adjustments it made in May 2021 that it previously reported in its initial corrective action plan. The city continues to state that it will conduct a demand and cost recovery analysis for swim center and senior services after normal operations resume. Nevertheless, El Cerrito should not delay efforts to ensure that its fees cover the cost of its services regardless of changes in demand. For fiscal year 2021–22, El Cerrito still expects the cost of operating its swim center and senior services to exceed the revenue obtained from fees, thus resulting in the city needing to subsidize those services. El Cerrito also reports in its update that it is currently researching options to recover the cost of its emergency medical services and plans to provide information to its city council.