The Office of the State Comptroller recently audited the fiscal operations of the Hudson City School District (District). A separate report discusses the results of that audit. This report addresses one phase of that audit, the procurement of quality audit services. The District is required to have an annual financial statement audit, and it contracted with the certified public accounting (CPA) firm Raymond G. Preusser, CPA, P.C. to perform this service for the 2004-05 fiscal year.

Scope and Objectives

We reviewed the District’s audit service procurement procedures, and the work done by the CPA firm retained by the District to audit the District’s general purpose financial statements for the period July 1, 2004 - June 30, 2005. The objectives of our audit were to determine the adequacy of existing practices for the procurement of audit services and the effectiveness of such audit services as a means for the timely detection of errors and irregularities. Our audit addressed the following questions:

• Did the District follow appropriate policies and procedures when procuring audit services?
  
  
• Did the audit work of the CPA firm meet the purposes, terms and conditions of the contract of engagement and provide effective oversight for District fiscal operations?

Audit Results

The District did not effectively procure its annual audit services by obtaining requests for proposals. Instead, District officials contracted with a CPA firm that they used in the past without seeking competitive offers from other firms.

We found that the CPA firm’s annual audit of the District did not meet several professional standards. For example, the CPA firm did not comply with auditing standard requirements relating to the consideration of fraud. The standardized checklists that the CPA firm used did not contain the CPA’s conclusions regarding the risk of fraud. We found no indication that the CPA firm formulated an audit response to the risk of District management overriding controls. Auditing standards mandate such a response, which stems from the many recent instances in which an entity’s upper management has overridden internal controls to perpetrate and cover-up fraudulent activity.

We also found that the CPA firm did not perform certain tests required under professional standards to test for management override of controls. Professional standards require the auditor to test journal entries and other adjustments and accounting estimates for evidence of material misstatement due to fraud. The CPA is also required to evaluate the business rationale of unusual transactions. The workpapers did not contain documentation of the completion of these steps. In addition, we noted that the CPA firm did not document a segregation of duties issue in the payroll system as a potential fraud risk.

Professional standards require that audit documentation related to planning, conducting, and reporting on the audit should contain sufficient information to enable an experienced auditor who has had no previous connection with the audit to ascertain from the audit documentation the evidence that supports the auditors’ significant judgments and conclusions. However, we found that the CPA firm’s workpapers contained 25 instances where the CPA firm did not provide conclusions or workpaper references to conclusions.

Professional standards state that when the auditor expresses a qualified opinion, he or she should disclose all of the substantive reasons in one or more separate explanatory paragraph(s) preceding the opinion paragraph of the report. The auditor should also include, in the opinion paragraph, the appropriate qualifying language and a reference to the explanatory paragraph. The CPA firm issued a qualified opinion for the extra-classroom financial statement for the fiscal year ended June 30, 2005. The Independent Auditors’ Report for this financial statement does not include a paragraph explaining the reason for the qualification.

The District reported expenditures of $3,591,908 of Federal funds for the fiscal year ended June 30, 2005. The schedule of Federal awards expended did not include a Community Service Block Grant for suspended students. The amount of Federal expenditures for the grant during the 04-05 school year totaled $184,684. The CPA firm documented materiality for Federal expenditures at $40,275. Based on the omission of the grant from the schedule of Federal awards, we believe that the schedule of Federal awards was not presented fairly, in all material respects, in conformity with generally accepted accounting principles.

Finally, the CPA firm did not disclose all significant instances of the District’s non-compliance with laws and regulations. As part of our audit of Hudson’s internal control structure, we found nine instances of non-compliance with procurement in accordance with General Municipal Law totaling $267,383.¹ The CPA firm’s test of transactions included two payments included in the nine instances of non-compliance we found; however, the firm concluded that the District properly procured these items.

Comments of District Officials

The results of our audit and recommendations have been discussed with District officials and their comments, which appear in Appendix C, have been considered in preparing this report. District officials generally agreed with our recommendations and indicated that they planned to initiate corrective action.

The Board has the responsibility to initiate corrective action. Pursuant to Section 35 of the General Municipal Law, the Board should prepare a plan of action that addresses the recommendations in this report and forward the plan to our office within 90 days. For guidance in preparing the plan of action, the Board may refer to applicable sections in the publication issued by the Office of the State Comptroller entitled Local Government Management Guide. We encourage the Board to make this plan available for public review in the District Clerk’s office.
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¹ See Report 2007M-39, Hudson City School District - Internal Controls Over Financial Operations