Part I: A “Clean” Audit Is Not an All-Clear
By Buck Fuller
This is a two-part article because audits can be complicated. And the results of this year’s audit deserve a deeper dive. There is good discussion to be had because the City finally hired a new auditor. The Portsmouth residents had a new set of eyes looking at the City’s finances.
Part I will look at the auditor’s “clean” opinion. Part II will look at the Management Letter.
Background
The City of Portsmouth finally changed auditors after using Melanson, LLC for 27 years. This was long overdue. Usually, a municipality changes auditors every 5 to ten years to make sure the relationship with the auditor stays at arm’s-length.
The new auditor, CliftonLarsonAllen, LLP (CLA) audited the fiscal year 2023 City finances. The 2023 fiscal year ends on June 30, 2023. The audit was done by the end of 2023.
Accounting and audits are no different than any other specialty. There are a lot of confusing terms. What do these terms mean for the Portsmouth residents who finally got a new set of auditor eyes to look at the City’s finances?
A clean auditor’s opinion? What does mean? And what does it NOT mean?
In Part II, we discuss the four-page Management Letter which has more comments and more meat than what we have seen in any recent Melanson Management Letter.
Can we trust our City management now?
The Tricky World of Auditors’ Opinions (and Other Lingo)
Focus on Internal Controls
When conducting an audit, accountants look closely at the “internal controls” that exist in an entity, either a corporation or a municipality. What are internal controls?
From Wikipedia, Internal controls are accounting and auditing processes used in a company’s or a government’s finance department that ensure the integrity of financial reporting and regulatory compliance. Internal controls help companies or governments comply with laws and regulations and prevent fraud. Note that these are a central responsibility of the finance department.
Clean Opinion: Not “All-Clear”
CLA gave the City a “clean” opinion. What does that mean?
You can read the Independent Auditor’s Report in this year’s Annual Comprehensive Financial Report on page 23 of the report.
FY 2023 Annual Comprehensive Financial Report
A clean opinion means CLA found the City’s financial statements to be in order given the sampling done in accordance with accounting standards and procedures.
If something had been found to be amiss, there would have been a “qualified” opinion rendered. If outright fraud had been found, CLA could have resigned.
What Does a Clean Opinion Mean?
An auditor’s opinion is important to understand for what it does NOT cover. In our case, CLA is not expressing an opinion on the effectiveness of the City’s internal controls over its finances and budget controls.
Material Weaknesses Defined
Because the auditor must rely on sampling to check on internal controls, he or she cannot identify all shortcomings in the City’s internal controls that could cause significant problems known as “weaknesses or other deficiencies in reporting.” These weaknesses could include: inadequate segregation of duties (a controller who approves his or her own purchase requisitions), ineffective risk assessments (overlooked changes in business practices that create unexpected potential errors), insufficient management review procedures (management doesn’t bother to diligently oversee transactions in his or her department) or inappropriate reliance on accounting software (not using common sense to ask important and relevant questions).
From its sampling, CLA did not find deficiencies in internal controls that would cause material weaknesses.
However, CLA might be quick to add that material weaknesses may exist that were not identified.
Statistical Sampling
Imagine that you have a jar of red-colored balls. At least, you think only red balls were put into the jar, but there is a possibility a few blue balls are in the jar. You are aware that there 100 balls in the jar. You have decided that a reasonable check would mean you will randomly take out ten balls as a sample of the population of balls in the jar. You fish out the balls. All ten balls are red. This confirms your hypothesis that all balls are red since all sampled balls were red.
There is a possibility a blue ball is in the jar. Or maybe more than one. But you have no evidence of a blue ball based on the test you did. So you have to go with your conclusion.
It is possible that if you sampled all 100 balls, you would find a blue ball. That would require a different level of investigation, one for which you were not hired.
Clean Is Not All-Clear
In the case of CLA’s audit of the Portsmouth finances, it found no material deficiencies or weaknesses in the City’s recording and maintaining the City’s books based on its sampling procedures. That’s not a 100%, all-clear finding. But it suffices for what is required for a financial audit.
Keep in mind that a clean opinion has these qualifications attached to it. In the auditing world, though, a clean opinion is indeed “clean.”
Buck Fuller is one of the Pulse’s staff writers. He is a close observer of the Portsmouth scene and is knowledgeable about an array of issues, including financial matters. His local email address is: buck@portsmouthpulse.com.
