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2010 Monticello Auditor's Management Letter Management Report for City of Monticello, Minnesota December 31, 2010 To the City Council and Management City of Monticello, Minnesota We have prepared this management report in conjunction with our audit of the City of Monticello, Minnesota’s (the City) financial statements for the year ending December 31, 2010. The purpose of this report is to communicate information relevant to city finances in Minnesota and to provide comments resulting from our audit process. We have organized this report into the following sections: • Audit Summary • Funding Cities in Minnesota • Governmental Funds Overview • Financial Trends and Analysis • Accounting and Auditing Updates We would be pleased to further discuss any of the information contained in this report or any other concerns that you would like us to address. We would also like to express our thanks for the courtesy and assistance extended to us during the course of our audit. This report is intended solely for the information and use of those charged with governance of the City, management, and those who have responsibility for oversight of the financial reporting process and is not intended to be, and should not be, used by anyone other than these specified parties. June 22, 2011 -1- AUDIT SUMMARY The following is a summary of our audit work, key conclusions, and other information that we consider important or that is required to be communicated to the City Council, administration, or those charged with governance of the City. OUR RESPONSIBILITY UNDER AUDITING STANDARDS GENERALLY ACCEPTED IN THE UNITED STATES OF AMERICA AND GOVERNMENT AUDITING STANDARDS We have audited the financial statements of the governmental activities, the business-type activities, each major fund, and the aggregate remaining fund information of the City as of and for the year ended December 31, 2010. Professional standards require that we provide you with information about our responsibilities under auditing standards generally accepted in the United States of America and Government Auditing Standards, as well as certain information related to the planned scope and timing of our audit. We have communicated such information to you verbally and in our audit engagement letter. Professional standards also require that we communicate to you the following information related to our audit. PLANNED SCOPE AND TIMING OF THE AUDIT We performed the audit according to the planned scope and timing previously discussed and coordinated in order to obtain sufficient audit evidence and complete an effective audit. AUDIT OPINION AND FINDINGS Based on our audit of the City’s financial statements for the year ended December 31, 2010: • We have issued an unqualified opinion on the City’s annual financial statements. • We noted one matter involving the City’s internal control over financial reporting that we consider to be a material weakness: 1. During our audit procedures, we proposed audit adjustments that were considered material to the financial statements that had not been recorded properly in accordance with accounting principles generally accepted in the United States of America that were not initially identified by the City prior to our audit procedures detecting the misstatements. Auditing standards consider the identification by the auditor of a material misstatement in the financial statements prepared by the City that was not initially identified by the City to be a material weakness in the related internal controls. • The results of our testing disclosed no instances of noncompliance that are required to be reported under Government Auditing Standards. • We reported two findings based on our testing of the City’s compliance with Minnesota laws and regulations: 1. If a city invests in mutual funds, it must invest in shares of an investment company that is rated in one of the two highest rating categories for mutual funds by at least one nationally recognized statistical rating organization. One mutual fund the City invested in during fiscal 2010 did not meet this requirement as the mutual fund was not rated. 2. We noted that the claims for payroll for the liquor store and community center employees did not have the required signed declarations for employees. -2- OTHER RECOMMENDATIONS We offer the following observations and recommendations for the continued improvement of the City’s internal controls over financial reporting: • Information Technology Contingency Planning – Management is responsible for establishing and maintaining effective internal controls, including entity-level controls (control environment, risk assessment, information and communication, and monitoring) and for the fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America. Auditing and reporting standards specify that we report deficiencies in the design of the entity-level controls of the City’s internal controls. As part of our audit, we noted the City has designed the general controls over the information technology (IT) system in the City, including having a contingency plan developed for alternative processing in the event of loss or interruption of IT functions. These controls are intended to prevent the possibility of the IT system of the City from not being able to provide complete and accurate information consistent with the financial reporting objectives and current needs of the City. We recommend, however, that the City improve these internal controls over the IT functions of the City by having these contingency plans formally documented and written to be included in the design of the general controls over the IT system in the City. This formal documentation would include distribution of the contingency plan developed for alternative processing in the event of loss or interruption of IT functions to all city employees. • FiberNet Billing and Cash Collection Reconciliation – During the course of the audit, it was noted that the City’s internal controls over the accounting and reconciliation of billed amounts to cash collections in FiberNet were limited. As a result of a lack of ideal internal controls, the City is subject to a higher risk that errors or fraud could occur and not be detected in a timely manner. We recommend that the City improve these internal controls, including the development of procedures to reconcile these balances on a timely basis. We also recommend the internal controls in this area include a review and approval of this process by an appropriate level of management. SIGNIFICANT ACCOUNTING POLICIES Management is responsible for the selection and use of appropriate accounting policies. The significant accounting policies used by the City are described in Note 1 of the notes to basic financial statements. No new accounting policies were adopted and the application of existing policies was not changed during the year. We noted no transactions entered into by the City during the year for which there is a lack of authoritative guidance or consensus. All significant transactions have been recognized in the financial statements in the proper period. ACCOUNTING ESTIMATES AND MANAGEMENT JUDGMENTS Accounting estimates are an integral part of the financial statements prepared by management and are based on management’s knowledge and experience about past and current events and assumptions about future events. Certain accounting estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ significantly from those expected. -3- The most sensitive estimates affecting the financial statements of the City include the following: • Depreciation – Management’s estimates of depreciation expense are based on the estimated useful lives of the assets. • Net Other Post-Employment Benefit (OPEB) Liabilities – Actuarial estimates of the net OPEB obligation is based on eligible participants, estimated future health insurance premiums, and estimated retirement dates. • Land Held for Resale – These assets are stated at the lower of cost or net realizable value based on management’s estimates. • Compensated Absences – Management’s estimate is based on current rates of pay and sick leave balances. • Allowance for Doubtful Accounts – Management’s estimate of the allowance for doubtful accounts is based on historical revenues, historical loss levels, and an analysis of the collectability of individual accounts. Management expects any differences between estimates and actual amounts of these estimates to be insignificant. We evaluated the key factors and assumptions used by management in the areas discussed above in determining that they are reasonable in relation to the financial statements taken as a whole. DIFFICULTIES ENCOUNTERED IN PERFORMING THE AUDIT We encountered no significant difficulties in dealing with management in performing and completing our audit. CORRECTED AND UNCORRECTED MISSTATEMENTS Professional standards require us to accumulate all known and likely misstatements identified during the audit, other than those that are trivial, and communicate them to the appropriate level of management. Where applicable, management has corrected all such misstatements. During our audit we made a number of audit adjustments that had a material impact on the financial statements. These audit adjustments were reviewed and approved by management and incorporated into the basic financial statements of the City. DISAGREEMENTS WITH MANAGEMENT For purposes of this report, professional standards define a disagreement with management as a financial accounting, reporting, or auditing matter, whether or not resolved to our satisfaction, that could be significant to the financial statements or the auditor’s report. We are pleased to report that no such disagreements arose during the course of our audit. MANAGEMENT REPRESENTATIONS We have requested certain representations from management that are included in the management representation letter dated June 22, 2011. -4- MANAGEMENT CONSULTATIONS WITH OTHER INDEPENDENT ACCOUNTANTS In some cases, management may decide to consult with other accountants about auditing and accounting matters, similar to obtaining a “second opinion” on certain situations. If a consultation involves application of an accounting principle to the City’s financial statements or a determination of the type of auditor’s opinion that may be expressed on those statements, our professional standards require the consulting accountant to check with us to determine that the consultant has all the relevant facts. To our knowledge, there were no such consultations with other accountants. OTHER AUDIT FINDINGS OR ISSUES We generally discuss a variety of matters, including the application of accounting principles and auditing standards, with management each year prior to retention as the City’s auditors. However, these discussions occurred in the normal course of our professional relationship and our responses were not a condition to our retention. -5- FUNDING CITIES IN MINNESOTA LEGISLATION The following is a summary of significant legislative activity passed in calendar year 2010 affecting the finances of Minnesota cities: Local Government Aid and Market Value Homestead Credit – The 2009 legislative session ended without an agreement on how to address significant projected state budget deficits for the 2009 and 2010 fiscal years. The Governor vetoed the budget bill proposed by the Legislature and balanced the budget using his power of unallotment. The Governor’s unallotment plan included delays in the payment of state revenues to school districts, and a reduction in appropriations to other state programs, including local government aid (LGA) and market value homestead credit (MVHC) to Minnesota cities. The unallotments included reductions of approximately $128 million to calendar year 2010 LGA and MVHC, calculated at 7.64 percent of the total calendar year 2009 aggregated levy and LGA of the city, not to exceed $55 per capita. Cuts were to be first taken from LGA and then from MVHC, as necessary. Cities with populations below 1,000 and below the state-wide average tax base per capita were exempted from these cuts. The February 2010 state budget forecast predicted an additional shortfall of $994 million for the remainder of the 2010–2011 biennium. The 2010 Legislature passed a supplemental budget bill in April that addressed roughly $312 million of the additional shortfall. The bill reduced fiscal 2010 LGA and MVHC for cities by an additional $52.5 million, calculated at 3.43 percent of the total 2010 aggregated levy, LGA, and taconite aid of the city, not to exceed $28 per capita. These cuts were to be first taken from MVHC and then from LGA, as necessary. Cities with populations below 1,000 exempted from previous LGA and MVHC cuts were included in this round of cuts. The April 2010 supplemental budget bill also reduces city LGA and MVHC for fiscal 2011 by $56.5 million. About $25.4 million of this reduction is a permanent extension of the MVHC portion of the cuts originally made through the Governor’s unallotments. The Legislature also made a permanent reduction of $31.1 million to the state’s annual LGA appropriation for cities, beginning in 2011. In May 2010, the Minnesota Supreme Court issued a ruling on a lawsuit overturning the Governor’s unallotment of funding to a state special nutrition program. The decision, which applied only to the cuts to this specific program, called into question all of the Governor’s July 2009 unallotments. In a one-day special session in May, the 2010 Legislature took action to ratify the majority of the Governor’s 2010 unallotments, and dealt with the remaining projected shortfall. Levy Limitations – A 2008 law limited general operating property tax levy increases for cities with populations over 2,500 to an inflationary increase based on the state determined implicit price deflator (IPD) to a maximum of 3.9 percent annually for the next three calendar years. Modifications were made in subsequent legislative sessions to allow cities subject to levy limitation to declare “special levies” to replace the LGA and MVHC losses described above. The 2010 Legislature also established a floor of zero percent for the inflationary increase, so levies would not be reduced in the event of IPD deflation. The Governor’s proposal to extend levy limits was not adopted by the 2010 Legislature, and levy limits remain set to expire after the 2011 tax year. However, the extension of levy limits is expected to be revisited by the 2011 Legislature. -6- State Stimulus/Jobs Bill – This jobs creation bill included a number of provisions that applied to cities, including: • Authority for local governments to finance energy conservation improvements and collect repayments as special assessments at the request of the property owner. • Creation of a new “compact development” type of tax increment financing (TIF) district. • Expanded authority to use TIF for general economic development for one year. • Expanded authority to use excess TIF to finance new private development. • Expanded authority for certain cities to use TIF for housing replacement in response to the foreclosure crisis. Interest Rates on Awards and Judgments – The 2010 Legislature exempted government entities from a 2009 law change that increased the required interest rate on awards and judgments over $50,000 to 10 percent, returning the rate to the pre-2009 maximum of the greater of 4 percent or the secondary market rate of one year U.S. Treasury bills as determined in December each year. Pension Funding and Sustainability – The 2010 Legislature made a number of changes to improve the sustainability of state-wide pension plans, including those administered by the Public Employees Retirement Association (PERA). Among the changes to the Public Employee Retirement Fund Coordinated Plan were required increases to the employer and employee contribution rates of 0.25 percent of salary each, effective January 1, 2011. Public Employee’s Police and Fire Fund employee and employer contribution rates also increased 0.2 percent and 0.3 percent of salary, respectively, effective January 1, 2011. STATE OUTLOOK AND IMPORTANCE OF INTERNAL CONTROLS The state of Minnesota has experienced a series of major budget shortfalls and a steadily deteriorating financial condition in recent years. Local governments and other entities dependent on the state for funding have, in turn, had to deal with the resulting state aid cuts, holdbacks, and unallotments. For the fiscal year 2010–2011 biennium, the state budget was balanced using several large accounting “shifts” and one-time federal stabilization funds that greatly reduced the amount of actual aid reductions necessary. The accounting shifts included delaying state aid payments to and accelerating property tax revenue recognition of Minnesota school districts, essentially utilizing cash “borrowed” from the districts to help balance the state budget. The state intends to pay these shifts back when it has the financial ability. Current state budget projections for 2011–2012 predict further significant shortfalls that will need to be addressed. Realistically, the state has already used up most of the accounting shifts available for this purpose, and additional federal assistance cannot be counted on. The economy, while showing some signs of recovery, is unlikely to turn around quickly enough to solve the state’s budget issues in the short-term. All of this adds up to a period of continued financial uncertainty and a strong likelihood of further funding cuts for Minnesota municipalities. These circumstances have resulted in a sustained cycle of budget reductions for most Minnesota cities. Among our clients, we have seen numerous examples of staffing cuts and reassignments that have potentially weakened internal controls by reducing the segregation of accounting duties or delaying the performance of key control procedures. Unfortunately, the economic downturn has also placed additional financial strain on many individuals, elevating the risk of fraud and theft. Recent communications from the Minnesota Office of the State Auditor have reported a substantial increase in incidents of fraud and theft involving local governments reported to their office recently. A sound system of internal controls is critical to safeguarding city assets and assuring that accurate and timely financial information is available to manage the City. When faced with difficult budgetary decisions, we encourage our clients to remain mindful of these factors and to continue to make sound financial controls a top priority. -7- PROPERTY TAXES Minnesota cities rely heavily on local property tax levies to support their governmental fund activities. In recent years this dependence has been heightened as revenue from state aids and fees related to new development have dwindled due to the struggling economy. This has placed added pressure on local taxpayers already beset by higher unemployment, lower property values, and tighter credit markets. As a result, municipalities in general are experiencing increases in tax delinquencies, abatements, and foreclosures. This instability has led to significant fiscal challenges for many local governments, and increased the investing public’s concerns about the security of the municipal debt market. Property values within Minnesota cities experienced average increases of 1.5 percent for taxes payable in 2009 and an average decrease of 3.0 percent for those payable in 2010, reflecting the weak housing market and economic recession experienced in recent years. It is important to remember that the 2010 market value is based on estimated values as of January 1, 2009, and the housing market is still experiencing difficult times. In comparison, the City’s market value declined by 2.9 percent in 2009 and 4.6 percent in 2010. The following graph shows the City’s changes in taxable market value over the past nine years: $– $200,000,000 $400,000,000 $600,000,000 $800,000,000 $1,000,000,000 $1,200,000,000 $1,400,000,000 200220032004200520062007200820092010 Taxable Market Value -8- Tax capacity is considered the actual base available for taxation. It is calculated by applying the state’s property classification system to each property’s market value. Each property classification, such as commercial or residential, has a different calculation and uses different rates. Consequently, a city’s total tax capacity will change at a different rate than its total market value, as tax capacity is affected by the proportion of a city’s tax base that is in each property classification from year-to-year, as well as legislative changes to tax rates. The City’s tax capacity increased 3.7 percent for 2009 and decreased 3.0 percent for 2010. The following graph shows the City’s change in tax capacities over the past nine years: $– $2,000,000 $4,000,000 $6,000,000 $8,000,000 $10,000,000 $12,000,000 $14,000,000 $16,000,000 $18,000,000 $20,000,000 200220032004200520062007200820092010 Local Tax Capacity The following table presents the average tax rates applied to city residents for each of the last two levy years, along with comparative state-wide and metro area rates. The general increase in rates reflects both the increased reliance of local governments on property taxes and the recent decline in tax capacities previously discussed. Rates expressed as a percentage of net tax capacity 2009201020092010 20092010 Average tax rate City 36.9 39.2 33.7 36.0 46.2 45.8 County 39.3 41.0 34.7 36.8 32.5 35.8 School22.0 23.0 22.1 24.0 26.1 25.0 Special taxing5.5 5.9 5.9 6.5 2.1 1.7 Total103.7 109.196.4 103.3 106.9 108.3 City of MonticelloMetro Area Seven-CountyAll Cities State-Wide The City’s portion of the average tax rate for its residents was well above the state-wide and metro area averages for the last two years. -9- GOVERNMENTAL FUNDS OVERVIEW This section of the report provides you with an overview of the financial trends and activities of the City’s governmental funds. Governmental funds include the General Fund, special revenue funds, debt service funds, and capital project funds. We have also included the most recent comparative state-wide averages available from the Office of the State Auditor. The reader needs to consider the effect of inflation and other known changes or differences when comparing this data. Also, certain data on these tables may be classified differently than how they appear on the City’s financial statements in order to be more comparable to the state-wide information, particularly in separating capital expenditures from current expenditures. We have designed this section of our management report using per capita data in order to better identify unique or unusual trends and activities of your city. We intend for this type of comparative and trend information to complement, rather than duplicate, information in the Management’s Discussion and Analysis. An inherent difficulty in presenting per capita information is the accuracy of the population count, which for most years is based on estimates. Keep in mind that your city’s per capita revenue and expenditures maybe higher or lower than average due to your city’s level of commercial development and activity for a city in your population class. GOVERNMENTAL FUNDS REVENUE The amounts received from the typical major sources of revenue will naturally vary between cities based on their particular situation. This would include the City’s stage of development, location, size and density of its population, property values, services it provides, and other attributes. The following table presents the City’s revenue per capita of its governmental funds for the past three years, together with state-wide averages: Year 200820092010 Population2,500–10,000 10,000–20,000 20,000–100,000 11,36611,47611,501 Property taxes367$ 365$ 391$ 636$ 654$ 636$ Tax increments46 62 59 103 104 100 Franchise fees and other taxes23 34 36 – 4 32 Special assessments86 47 62 226 215 127 Licenses and permits21 19 27 81 23 19 Intergovernmental revenues284 273 168 48 147 141 Charges for services82 80 77 201 219 251 Other 81 76 61 146 105 131 Total revenue990$ 956$ 881$ 1,441$ 1,471$ 1,437$ December 31, 2009 City of Monticello Governmental Funds Revenue per Capita With State-Wide Averages by Population Class State-Wide The City has generated more property tax revenue for its governmental funds revenue compared to the average Minnesota city. The City continues to generate more tax increment revenue per capita than average, as it has made use of this tool to finance commercial development. The City generates more special assessment revenue (typically used for new development) as the City continues to be in a growth phase. The City’s per capita governmental funds revenue for 2010 was $1,437, a decrease of about 2.3 percent from the prior year. Special assessment revenue decreased by $88 per capita as the city had less development activity that used special assessment financing in fiscal 2010 when compared to prior years. -10- GOVERNMENTAL FUNDS EXPENDITURES Similar to our discussion of revenues, the expenditures of governmental funds will vary from state-wide averages and from year-to-year, based on the City’s circumstances. Expenditures are classified into three types as follows: • Current – These are typically the general operating-type expenditures occurring on an annual basis, and are primarily funded by general sources such as taxes and intergovernmental revenues. • Capital Outlay and Construction – These expenditures do not occur on a consistent basis, more typically fluctuating significantly from year-to-year. Many of these expenditures are project-oriented, which are often funded by specific sources that have benefited from the expenditure, such as special assessment improvement projects. • Debt Service – Although the expenditures for debt service may be relatively consistent over the term of the respective debt, the funding source is the important factor. Some debt may be repaid through specific sources such as special assessments or redevelopment funding, while other debt may be repaid with general property taxes. The City’s expenditures per capita of its governmental funds for the past three years, together with state-wide averages, are presented in the following table: Year 200820092010 Population2,500–10,000 10,000–20,000 20,000–100,000 11,36611,47611,501 Current 120$ 107$ 79$ 139$ 142$ 174$ 217 233 241 153 239 146 112 106 82 209 181 136 61 81 86 195 205 188 81 81 96 92 121 277 591$ 608$ 584$ 788$ 888$ 921$ Capital outlay and construction336$ 325$ 267$ 310$ 170$ 360$ Debt service 196$ 135$ 126$ 443$ 588$ 435$ 73 51 39 193 157 135 269$ 186$ 165$ 636$ 745$ 570$ Governmental Funds Expenditures per Capita With State-Wide Averages by Population Class City of Monticello Principal December 31, 2009 State-Wide Interest and fiscal General government Public safety Street maintenance and lighting Recreation All other The City’s governmental funds current per capita expenditures are higher than state-wide averages for cities in the same population class. Current operating costs increased $33 per capita in 2010. Most of this increase relates to the negative adjustment of land held for resale to market value as a result of the poor economy and significant decreases in land values. The City’s per capita expenditures for capital will vary on a yearly basis depending on current, ongoing capital projects. Debt service costs are significantly higher than other cities state-wide. Debt service costs were $175 per capita lower in calendar 2010. -11- FINANCIAL TRENDS AND ANALYSIS GENERAL FUND The City’s General Fund accounts for the financial activity of the basic services provided to the community. The primary services included within this fund are the administration of the municipal operations, police and fire protection, building inspection, streets and highway maintenance, and culture and recreation. The following graph displays the City’s General Fund trends of financial position and changes in the volume of financial activity. Fund balance and cash balance are typically used as indicators of financial health or equity, while annual expenditures are often used to measure the size of the operation. $– $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000 $5,000,000 $5,500,000 $6,000,000 $6,500,000 $7,000,000 $7,500,000 $8,000,000 $8,500,000 2004200520062007200820092010 General Fund Financial Position Year Ended December 31, Fund Balance Cash Balance (Including Interfund Borrowing)Expenditures The City’s General Fund cash and investments balance (including interfund borrowing) at December 31, 2010 was $5,755,382, which decreased about $869,058 from 2009. Total fund balance at December 31, 2010 was $4,981,034 down $116,599 from the prior year. Of this total fund balance, $336,286 was reserved, $3,195,000 was designated based on the city’s fund balance policies for working capital and contingencies, and $1,449,748 was undesignated. This fund balance level represents approximately 79 percent of the City’s annual General Fund expenditures, based on 2010 expenditure levels. Having an appropriate fund balance is an important factor because a government, like any organization, requires a certain amount of equity to operate. Generally, the amount of equity required typically increases as the size of the operation increases. A healthy financial position also allows the City to avoid volatility in tax rates; helps minimize the impact of state funding changes; allows for the adequate and consistent funding of services, repairs, and unexpected costs; and can be a factor in determining the City’s bond rating and resulting interest costs. -12- The following illustrations provide you with the components of the City’s General Fund revenue compared to budget for 2010 and for the past eight years: Other Charges for Services Intergovernmental Licenses and Permits Property Taxes General Fund Revenue Budget to Actual Budget Actual Total General Fund revenues for 2010 were $7,309,509, which was $1,025,059 (16.3 percent) over the final budget. Property taxes were less than budget by $251,129, mostly due to increases in delinquent and unpaid local property taxes. Charges for services were over budget by about $1,034,000, mostly due to city development charges and reimbursements being about $997,000 over budgeted amounts. The following graph presents the City’s General Fund revenue sources for the last eight years. The graph reflects the City’s increasing reliance on taxes and user fees to finance its General Fund operations. $– $400,000 $800,000 $1,200,000 $1,600,000 $2,000,000 $2,400,000 $2,800,000 $3,200,000 $3,600,000 $4,000,000 $4,400,000 $4,800,000 $5,200,000 $5,600,000 TaxesIntergovernmentalOther General Fund Revenue by Source Year Ended December 31, 2003 2004 2005 2006 2007 2008 2009 2010 Overall, General Fund revenues increased $303,544 (4.3 percent) from the previous year. The largest decline was in intergovernmental revenue, which declined almost $221,000. Charges for services increased about $634,000. The increases in this area were in a number of areas, but mainly the result of city development charges and reimbursements being about $995,000 higher than the prior year. -13- The following illustrations provide you with the components of the City’s General Fund spending compared to budget for 2010 and for the past eight years: General Governmental Public Safety Public Works Culture and Recreation Other General Fund Expenditures Budget to Actual Budget Actual Total General Fund expenditures for 2010 were $6,267,108 which was only $58,342 (0.9 percent) under budget. $– $250,000 $500,000 $750,000 $1,000,000 $1,250,000 $1,500,000 $1,750,000 $2,000,000 $2,250,000 $2,500,000 General Governmental Public SafetyPublic WorksCulture and Recreation Other General Fund Expenditures by Function Year Ended December 31, 2003 2004 2005 2006 2007 2008 2009 2010 Overall, General Fund expenditures decreased $1,793,577 (22.2 percent) from the prior year. General government expenditures decreased about $712,156, which was mainly due to a land acquisition completed in fiscal 2009. Public safety decreased $593,178, mainly due to the purchase of a fire truck in fiscal 2009. Public works costs decreased $301,982 in fiscal 2010 as engineering, inspection, street, and capital outlay costs were decreased in the budget as well as lower than projected. -14- ENTERPRISE FUNDS The enterprise funds comprise a considerable portion of the City’s activities. These funds help to defray overhead and administrative costs and provide additional support to general government operations by way of annual transfers. We understand that the City is proactive in reviewing these activities on an ongoing basis and we want to reiterate the importance of continually monitoring these operations. Over the years we have emphasized to our city clients the importance of these utility operations being self-sustaining, preventing additional burdens on general governmental funds. This would include the accumulation of net assets for future capital improvements and to provide a cushion in the event of a negative trend in operations. Water Enterprise Fund The following graph presents eight years of comparative operating results for the City’s Water Enterprise Fund: $– $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000 $900,000 $1,000,000 $1,100,000 20032004200520062007200820092010 Water Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2010, the Water Enterprise Fund had a cash balance of $3,065,935 and net assets of $14,767,458. Net assets consisted of $11,387,461 in amounts invested in capital assets and $3,379,997 in unrestricted net assets. Operating revenue in the Water Enterprise Fund is $846,792, a decrease of $129,497 from the prior year. This decrease is related to a decrease in consumption. Water Enterprise Fund operating expenses for 2009 were $936,718, a decrease of $81,380, mostly in personal service costs. As shown in the above graph, operating income before depreciation declined for the second straight year after having steadily increased for several years. It is important that this fund continue to have positive operating results so as not to place an additional burden on other city funds. It is also important that the City continue to monitor water rates so that they are designed to also provide for future repairs and replacement of the infrastructure assets. -15- Sewer Enterprise Fund The following graph presents eight years of comparative operating results for the City’s Sewer Enterprise Fund: $(200,000) $– $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 $1,400,000 $1,600,000 $1,800,000 $2,000,000 $2,200,000 20032004200520062007200820092010 Sewer Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2010, the Sewer Enterprise Fund had a cash balance of $2,069,820 and net asset balance of $23,141,721. Net assets consisted of $20,692,931 invested in capital assets, net of related debt and $2,448,790 of unrestricted net assets. Sewer Enterprise Fund operating revenues for 2010 were $1,497,953, which is $94,852 more than the previous year. Most of this increase relates to an increase in sewer rates. Operating expenses for 2010 were $2,081,920, which is $39,180, or 1.9 percent, higher than 2009. As shown in the above graph, operating income before depreciation has been steadily increasing over the past several years. It is important that this fund have positive operating results so as not to place an additional burden on other city funds. It is also important that the City continue to monitor sewer rates so they are designed to also provide for future repairs and replacement of the infrastructure assets. -16- Liquor Enterprise Fund The following graph presents eight years of operating results for the Liquor Enterprise Fund: $– $300,000 $600,000 $900,000 $1,200,000 $1,500,000 $1,800,000 $2,100,000 $2,400,000 $2,700,000 $3,000,000 $3,300,000 $3,600,000 $3,900,000 $4,200,000 $4,500,000 $4,800,000 20032004200520062007200820092010 Liquor Enterprise Fund Year Ended December 31, Sales Cost of Sales Operating Expenses Operating Income (Loss) The Liquor Enterprise Fund ended 2010 with net assets of $3,519,711, an increase of $390,396 from the prior year. Of the net asset balance, $420,981 represents the investment in liquor capital assets, leaving $3,098,730 of unrestricted net assets. Liquor sales for 2010 were $4,477,651, an increase of $123,225 (2.8 percent) from last year. Sales have steadily increased over the last several years, increasing by about 33.1 percent since 2003. The Liquor Enterprise Fund generated a gross profit of $1,174,767 in 2010, or about 26.2 percent of gross sales. The Liquor Enterprise Fund’s gross profit margin has been similar for the last several years, ranging from 24.0 percent to 26.6 percent between 2003 and 2010. Operating expenses for 2010 were $637,574, a decrease of $32,366 from last year, mainly due to decreased personnel costs. -17- Fiber Optics Enterprise Fund In 2007, the City started its Fiber Optics Project, which will run a fiber optics system to every premise in the City to provide customers with phone, high-speed Internet, and cable television services as a self-supporting system with competitive pricing, which will act as an economic development tool for the City. The project is still in the startup phase as of the year ended December 31, 2010. The following graph presents two years of operating results for the Fiber Optics Enterprise Fund: $(1,500,000) $(1,200,000) $(900,000) $(600,000) $(300,000) $– $300,000 $600,000 $900,000 $1,200,000 $1,500,000 $1,800,000 $2,100,000 20092010 Fiber Optics Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2010, the Fiber Optics Enterprise Fund had a deficit cash balance (including interfund borrowing) of $1,264,909 and a deficit net asset balance of ($7,122,780). Net assets consisted of a deficit of ($4,555,283) invested in capital assets, net of related debt and a deficit of ($2,567,497) of unrestricted net assets. We recommend that the City continue to monitor this fund balance deficit. We also recommend as part of the annual budget process that the City approve a financial plan for the elimination of this fund balance deficit. CAPITAL PROJECT FUND At December 31, 2010, the City’s Capital Project Fund has a deficit fund balance that totals $1,532,220. This is an decrease of $592,171 over fiscal 2009. We recommend that the City continue to address this fund balance deficit by approving a financial plan for eliminating this fund balance deficit. -18- GOVERNMENT-WIDE FINANCIAL STATEMENTS The City’s financial statements include fund-based information that focuses on budgetary compliance, and the sufficiency of the City’s current assets to finance its current liabilities. The Governmental Accounting Standards Board (GASB) Statement No. 34 reporting model also requires the inclusion of two government-wide financial statements designed to present a clear picture of the City as a single, unified entity. These government-wide statements provide information on the total cost of delivering services, including capital assets and long-term liabilities. Statement of Net Assets The Statement of Net Assets essentially tells you what your city owns and owes at a given point in time, the last day of the fiscal year. Theoretically, net assets represent the resources the City has leftover to use for providing services after its debts are settled. However, those resources are not always in spendable form, or there may be restrictions on how some of those resources can be used. Therefore, the Statement of Net Assets divides the net assets into three components: • Invested in Capital Assets, Net of Related Debt – The portion of net assets reflecting equity in capital assets (i.e. capital assets minus related debt). • Restricted Net Assets – The portion of net assets equal to resources whose use is legally restricted minus any non-capital-related liabilities payable from those same resources. • Unrestricted Net Assets – The residual balance of net assets after the elimination of invested in capital assets, net of related debt and restricted net assets. The following table presents the components of City’s net assets as of December 31, 2010 and 2009, for governmental activities and business-type activities: Increase 20102009 (Decrease) Net assets Governmental activities Invested in capital assets, net of related debt 31,901,676$ 33,712,370$ (1,810,694)$ Restricted18,337,866 17,688,193 649,673 Unrestricted26,876,421 28,183,161 (1,306,740) Total governmental activities77,115,963 79,583,724 (2,467,761) Business-type activities Invested in capital assets, net of related debt 28,556,355 29,910,696 (1,354,341) Restricted19,350 19,350 – Unrestricted6,363,148 2,846,018 3,517,130 Total business-type activities34,938,853 32,776,064 2,162,789 Total net assets 112,054,816$112,359,788$(304,972)$ December 31, The City’s total net assets at December 31, 2010 were $304,972 lower than at the beginning of the year. The overall financial results would be better if not for the significant decline in net assets related to the Fiber Optics Project, which totaled $3.3 million. The decline in the governmental activities net assets and the overall increase in the business-type net assets occurred due to a transfer of water and sewer capital assets to business-type activities in fiscal 2010 totaling $6.0 million. -19- Statement of Activities The Statement of Activities tracks the City’s yearly revenues and expenses, as well as any other transactions that increase or reduce total net assets. These amounts represent the full cost of providing services. The Statement of Activities provides a more comprehensive measure than just the amount of cash that changed hands, as reflected in the fund-based financial statements. This statement includes the cost of supplies used, depreciation of long-lived capital assets, and other accrual-based expenses. The following table presents the change in net assets of the City for the years ended December 31, 2010 and 2009: 2009 Program ExpensesRevenuesNet ChangeNet Change Net (expense) revenue Governmental activities General government 2,065,463$ 491,304$ (1,574,159)$ (1,316,872)$ Public safety 1,766,712 243,802 (1,522,910) (1,579,234) Public works 3,579,291 5,465,765 1,886,474 (2,074,439) Sanitation 534,903 165,387 (369,516) (380,041) Culture and recreation 2,609,429 1,422,329 (1,187,100) (1,708,948) Economic development 2,647,687 214,104 (2,433,583) (493,996) Interest on long-term debt 1,464,012 – (1,464,012) (1,673,431) Business-type activities Water 936,718 828,635 (108,083) 1,292 Sewer 2,495,976 1,470,537 (1,025,439) (702,671) Liquor 637,574 1,174,767 537,193 373,316 Cemetery 26,659 8,620 (18,039) (7,535) Fiber optic 3,815,377 456,820 (3,358,557) (2,792,813) 22,579,801$ 11,942,070$ (10,637,731) (12,355,372) General revenues Taxes 8,631,963 8,870,085 General aids and grants 37,665 406,735 Investment earnings 1,095,714 958,356 Other revenues 567,417 450,494 10,332,759 10,685,670 (304,972)$ (1,669,702)$ 2010 Total net (expense) revenue Total general revenues Change in net assets One of the goals of this statement is to provide a side-by-side comparison to illustrate the difference in the way the City’s governmental and business-type operations are financed. The table clearly illustrates the dependence of the City’s governmental operations on general revenues, such as property taxes and unrestricted grants. It also shows if the City’s business-type activities are generating sufficient program revenues (service charges and program-specific grants) to cover expenses. This is critical given the current downward pressures on the general revenue sources. -20- ACCOUNTING AND AUDITING UPDATES GASB STATEMENT NO. 54 – FUND BALANCE REPORTING AND GOVERNMENTAL FUND TYPE DEFINITIONS The objective of this statement is to enhance the usefulness of fund balance information by providing clearer fund balance classifications that can be more consistently applied and by clarifying the existing governmental fund type definitions. This statement establishes fund balance classifications (nonspendable, restricted, committed, assigned, and unassigned) that comprise a hierarchy based primarily on the extent to which a government is bound to observe constraints imposed upon the use of the resources reported in governmental funds. The definitions of the general, special revenue, capital projects, debt service, and permanent fund types are clarified by the provisions in this statement; which could necessitate changes in fund structure, particularly for existing special revenue funds. Elimination of the reserved component of fund balance in favor of a restricted classification will enhance the consistency between information reported in the government-wide statements and information in the governmental fund financial statements and avoid confusion about the relationship between reserved fund balance and restricted net assets. The requirements of this statement are effective for financial statements for periods beginning after June 15, 2010. GASB STATEMENT NO. 60 – ACCOUNTING AND FINANCIAL REPORTING FOR SERVICE CONCESSION ARRANGEMENTS This statement provides accounting and financial reporting guidance for governments that participate as either a transferor or an operator in a service concession arrangement (SCA). SCAs are arrangements whereby a government transfers the rights to operate one of its capital assets to a third party operator (either a private party or another government) for consideration, with the operator then being compensated from the fees or charges collected in connection with the operation of the asset. To qualify as an SCA, an arrangement must meet all of the following criteria: 1) the transferor must convey to the operator both the right and the obligation to use one of its capital assets to provide services to the public; 2) the operator must provide significant consideration to the transferor; 3) the operator must be compensated from the fees or charges it collects from third parties; 4) the transferor must have the ability to either determine, modify, or approve what services are to be provided to whom at what price; and 5) the transferor must retain a significant residual interest in the service utility of the asset. This statement provides guidance to governments that are party to an SCA for reporting the assets, obligations, and flow of revenues that result from the arrangement; along with the required financial statement disclosures. The requirements of this statement must be implemented for fiscal year ending December 31, 2012, with earlier implementation encouraged. GASB STATEMENT NO. 61 – THE FINANCIAL REPORTING ENTITY: OMNIBUS This statement amends the current guidance in GASB Statement No. 14, “The Financial Reporting Entity,” for identifying and presenting component units. This statement changes the fiscal dependency criterion for determining component units. Potential component units that meet the fiscal dependency criterion for inclusion in the financial reporting entity under existing guidance will only be included if there is also “financial interdependency” (an ongoing relationship of potential financial benefit or burden) with the primary government. This statement also clarifies the types of relationships that are considered to meet the “misleading to exclude” criterion for inclusion as a component unit; changes the criteria for blending component units; gives direction for the determination and disclosure of major component units; and adds a requirement to report an explicit, measurable equity interest in a discretely presented component unit in a statement of position prepared using the economic resources measurement focus. The requirements of this statement must be implemented for fiscal year ending June 30, 2013, with earlier implementation encouraged.