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2014 Monticello Auditor's Management Letter Management Report for City of Monticello, Minnesota December 31, 2014 THIS PAGE INTENTIONALLY LEFT BLANK 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 ended December 31, 2014. The purpose of this report is to provide comments resulting from our audit process and to communicate information relevant to city finances in Minnesota. We have organized this report into the following sections:  Audit Summary  Governmental Funds Overview  Enterprise Funds Overview  Government-Wide Financial Statements  Legislative Updates  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. The purpose of this report is solely to provide those charged with governance of the City, management, and those who have responsibility for oversight of the financial reporting process comments resulting from our audit process and information relevant to city finances in Minnesota. Accordingly, this report is not suitable for any other purpose. Minneapolis, Minnesota June 25, 2015 THIS PAGE INTENTIONALLY LEFT BLANK -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, 2014, and the related notes to the financial statements. 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 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, 2014:  We have issued an unmodified opinion on the City’s basic financial statements.  We reported no deficiencies in the City’s internal control over financial reporting that we considered to be material weaknesses.  The results of our testing disclosed no instances of noncompliance 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: o The City is required by Minnesota Statute § 412.271, Subd. 2, paragraph (b) to have supervisors sign a declaration indicating the facts recited on the payroll are correct to best of the declarant’s information and belief. We noted that for 4 of 25 claims for payroll, 2 community center employees and 2 Fibernet employees, the City did not receive the required signed approval declaration. This is a current and prior year finding. o We noted that 1 of 40 disbursements tested was not paid within the 35-day period as required by Minnesota Statute § 471.425, Subd. 2. This is a current and prior year finding. FOLLOW-UP ON PRIOR YEAR FINDINGS AND RECOMMENDATIONS As a part of our audit of the City’s financial statements for the year ended December 31, 2014, we performed procedures to follow-up on the findings and recommendations that resulted from our prior year audit. We reported the following findings that were corrected by the City in the current year:  In the prior year, we reported a material weakness in the City’s internal controls over financial reporting due to the City having recorded a prior period adjustment to correct a material error in the previous year’s financial statements. There was no similar finding in the current year. -2- 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 fiscal year ended December 31, 2014. 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. The most sensitive estimates affecting the financial statements were:  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. We evaluated the key factors and assumptions used by management to develop these estimates in determining that they are reasonable in relation to the basic financial statements taken as a whole. The financial statement disclosures are neutral, consistent, and clear. 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. In addition, none of the misstatements detected as a result of audit procedures and corrected by management, when applicable, were material, either individually or in the aggregate, to each opinion unit’s 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. -3- 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 25, 2015. 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. OTHER MATTERS We applied certain limited procedures to Management’s Discussion and Analysis, and budgetary comparison schedules for the General Fund and major special revenue funds, and Schedules of Funding Progress for the Monticello Fire Department Relief Association Pension Plan, and the City of Monticello Other Post-Employment Benefits Plan, which are required supplementary information (RSI) that supplements the basic financial statements. Our procedures consisted of inquiries of management regarding the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We did not audit the RSI and do not express an opinion or provide any assurance on the RSI. We were engaged to report on the combining and individual fund statements accompanying the financial statements, which are not RSI. With respect to this supplementary information, we made certain inquiries of management and evaluated the form, content, and methods of preparing the information to determine that the information complies with accounting principles generally accepted in the United States of America, the method of preparing it has not changed from the prior period, and the information is appropriate and complete in relation to our audit of the financial statements. We compared and reconciled the supplementary information to the underlying accounting records used to prepare the financial statements or to the financial statements themselves. We were not engaged to report on the introductory section, other supplementary schedules, and the statistical section, which accompany the financial statements but are not RSI. We did not audit or perform other procedures on this other information and we do not express an opinion or provide any assurance on it. -4- 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, which includes the General, special revenue, debt service, and capital project funds. These funds are used to account for the basic services the City provides to all of its citizens, which are financed primarily with property taxes. The governmental fund information in the City’s financial statements focuses on budgetary compliance, and the sufficiency of each governmental fund’s current assets to finance its current liabilities. PROPERTY TAXES Minnesota cities rely heavily on local property tax levies to support their governmental fund activities. For the 2013 fiscal year, local property tax levies provided 41.1 percent of the total governmental fund revenues for cities over 2,500 in population, and 35.5 percent for cities under 2,500 in population. Property tax levies certified by Minnesota cities for 2014 increased about 1.6 percent over 2013, compared to an increase of 2.3 percent the prior year. This moderate increase was due in part to a one-year levy limit for 2014 imposed on cities over 2,500 in population. The total market value of Minnesota cities increased about 1.1 percent for the 2014 levy year, ending a four-year trend of declining market values that began in 2010 and peaked with a state-wide decline of about 8.8 percent for levy year 2012. Market values showed modest increases in all property categories for 2014, with the largest gains in agricultural and non-homestead residential properties. Because the assessed valuation used for levying property taxes is based on values from the previous fiscal year (e.g. the market value for taxes payable in 2014 is based on estimated values as of January 1, 2013), market value improvement has lagged behind recent upturns in the housing market and the economy in general. The City’s taxable market value increased 10.2 percent for taxes payable in 2013, but decreased 1.5 percent for taxes payable in 2014. The following graph shows the City’s changes in taxable market value over the past 10 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 2005200620072008200920102011201220132014 Taxable Market Value -5- 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 the 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 for taxes payable in 2013 increased 17.7 percent and decreased 2.8 percent in 2014. The following graph shows the City’s change in tax capacities over the past 10 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 2005200620072008200920102011201220132014 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 rates. Rates expressed as a percentage of net tax capacity 20132014 20132014 Average tax rate City48.8 48.8 42.3 44.7 County48.5 47.6 44.3 43.4 School28.5 28.9 26.2 28.3 Special taxing7.2 7.3 0.6 – Total133.0132.6 113.4116.4 City of Monticello All Cities State-Wide Fiscal 2013 and 2014 average tax rates are below state-wide averages for the first time in several years as a result of improved market values and tax capacities in 2013. The increase in market values and local tax capacity in 2013 is related to significant increases to market values at the Xcel power plant. -6- GOVERNMENTAL FUNDS REVENUE AND EXPENDITURES The following table presents the per capita revenue of the City’s governmental funds for the past three years, along with state-wide averages. We have included the most recent comparative state-wide averages available from the Office of the State Auditor to provide a benchmark for interpreting the City’s data. The amounts received from the typical major sources of governmental fund revenue will naturally vary between cities based on factors such as the City’s stage of development, location, size and density of its population, property values, services it provides, and other attributes. It will also differ from year-to-year due to the effect of inflation and changes in the City’s operation. 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. Year 201220132014 Population2,500–10,000 10,000–20,000 20,000–100,000 12,93512,96412,993 Property taxes422$ 388$ 423$ 637$ 616$ 647$ Tax increments30 42 40 79 75 64 Franchise fees and other taxes31 39 34 26 25 28 Special assessments63 58 72 147 159 147 Licenses and permits27 26 38 21 26 29 Intergovernmental revenues253 268 148 42 98 56 Charges for services109 84 91 161 142 131 Other56 33 30 119 40 91 Total revenue991$ 938$ 876$ 1,232$ 1,181$ 1,193$ December 31, 2013 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 2014 was $1,193, an increase of about 1.0 percent from the prior year. Property taxes increased $31 per capita as the City’s tax levy and excess tax increment collections increased in 2014. Other revenue also increased $51 per capita, mainly as a result of a positive market value adjustment on the City’s investment portfolio in 2014. These increases were offset by a decrease in intergovernmental revenues of $42 per capita due to a significant amount of state aid revenues received for specific projects in the prior year. -7- The expenditures of governmental funds will also vary from state-wide averages and from year-to-year, based on the City’s circumstances. Expenditures are classified into three types as follows:  Current – These are typically the general operating type expenditures occurring on an annual basis, and are primarily funded by general sources such as taxes and intergovernmental revenues.  Capital Outlay and Construction – These expenditures do not occur on a consistent basis, more typically fluctuating significantly from year-to-year. Many of these expenditures are project-oriented, and are often funded by specific sources that have benefited from the expenditure, such as special assessment improvement projects.  Debt Service – Although the expenditures for debt service may be relatively consistent over the term of the respective debt, the funding source is the important factor. Some debt may be repaid through specific sources such as special assessments or redevelopment funding, while other debt may be repaid with general property taxes. The City’s expenditures per capita of its governmental funds for the past three years, together with state-wide averages, are presented in the following table: Year 201220132014 Population2,500–10,000 10,000–20,000 20,000–100,000 12,93512,96412,993 Current 129$ 100$ 83$ 156$ 122$ 112$ 244 235 239 134 139 142 123 121 91 132 132 138 83 99 85 176 191 184 66 73 91 101 117 124 645 628 589 699 701 700 Capital outlay and construction303 288 219 219 105 171 Debt service 164 133 102 400 408 416 55 43 39 100 72 51 219 176 141 500 480 467 Total expenditures1,167$ 1,092$ 949$ 1,418$ 1,286$ 1,338$ Governmental Funds Expenditures per Capita With State-Wide Averages by Population Class City of Monticello Principal December 31, 2010 State-Wide Interest and fiscal charges General government Public safety Street maintenance and lighting Recreation and culture All other The City’s governmental funds current per capita expenditures are higher than state-wide averages for cities in the same population class. The City’s per capita expenditures for capital outlay and construction will vary on a yearly basis depending on current, ongoing capital projects. Debt service costs are significantly higher than other cities state-wide due to the stage of development of the City. -8- GOVERNMENTAL FUND BALANCES The following table summarizes the changes in the fund balances of the City’s governmental funds during the years ended December 31, 2013 and 2014, presented both by fund balance classification and by fund: Increase 20132014 (Decrease) Fund balances of governmental funds Total by classification Nonspendable2,081,026$ 1,941,414$ (139,612)$ Restricted10,928,985 10,453,449 (475,536) Assigned6,485,727 7,321,744 836,017 Unassigned3,656,463 4,204,731 548,268 Total governmental funds 23,152,201$ 23,921,338$ 769,137$ Total by fund Major funds General3,914,563$ 4,331,058$ 416,495$ Community Center271,204 440,824 169,620 Economic Development Authority7,115,305 6,911,674 (203,631) Debt Service2,750,079 3,919,070 1,168,991 Capital Projects3,479,694 2,895,619 (584,075) Park and Pathway Dedication973,433 738,333 (235,100) Nonmajor funds4,647,923 4,684,760 36,837 Total governmental funds 23,152,201$ 23,921,338$ 769,137$ Governmental Fund Changes in Fund Balance Fund Balance as of December 31, As reflected in the table above, total governmental fund balance increased by $769,137. The increase was largely due to the increase in fund balance in the General Fund. -9- 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 recreation and culture. 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 2005200620072008200920102011201220132014 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, 2014 was $4,639,206, which increased $618,266 from 2013. Total fund balance at December 31, 2014 was $4,331,058, up $416,495. This fund balance level represents approximately 67.6 percent of the City’s annual General Fund expenditures, based on 2014 expenditure levels. The City’s adopted fund balance policy requires that the City set aside fund balance to represent 45 percent of expenditures for working capital and contingencies. 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. -10- The following illustrations provide you with the components of the City’s General Fund revenue compared to budget for 2014: Other Charges for Services Intergovernmental Licenses and Permits Property Taxes General Fund Revenue Budget to Actual Budget Actual Total General Fund revenues for 2014 were $7,119,002, which was $359,002 (5.3 percent) over the final budget. As reflected in the table above, other revenues were over budget by $198,384, which was mainly due to small amounts over budget spread across many categories. Licenses and permits revenue also exceeded budgeted amounts by $105,130 as a result of conservative budgeting in the revenue category. The following graph presents the City’s General Fund revenue sources for the last five years. $– $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 $6,000,000 TaxesIntergovernmentalOther General Fund Revenue by Source Year Ended December 31, 2010 2011 2012 2013 2014 The graph reflects the City’s increasing reliance on taxes to finance its General Fund operations. Overall, General Fund revenues increased $130,657 (1.9 percent) from the previous year. Property taxes decreased $77,143 due to a decrease in the General Fund tax levy. Other revenues increased $299,140 due to the market value adjustment on investments reported in the current year in a sharp contrast to the negative adjustment on investments reported in the prior year. -11- The following graphs illustrate the components of General Fund spending for 2014 compared to budget: General Governmental Public Safety Public Works Recreation and Culture Other General Fund Expenditures Budget to Actual Budget Actual Total General Fund expenditures for 2014 were $6,409,507, which was $257,493 (3.9 percent) under budget. The public works area was under budget by $125,176, mainly in street repairs. Recreation and culture was under budget by $128,296 mainly within park operations. The following illustrations provide you with the components of the City’s General Fund spending by function for the past five years: $– $250,000 $500,000 $750,000 $1,000,000 $1,250,000 $1,500,000 $1,750,000 $2,000,000 General Governmental Public SafetyPublic WorksRecreation and Culture Other General Fund Expenditures by Function Year Ended December 31, 2010 2011 2012 2013 2014 Overall, General Fund expenditures decreased $50,782 (0.8 percent) from the prior year. General government expenditures decreased $104,602, which was mainly due to decreased spending for information technology services. This was offset by an increase in public works by $92,724 due to increased costs for street repairs. -12- ENTERPRISE FUNDS OVERVIEW The City maintains a number of enterprise funds to account for services the City provides that are financed primarily through fees charged to those utilizing the service. This section of the report provides you with an overview of the financial trends and activities of the City’s enterprise funds, which includes the Water Utility, Sewage Utility, Liquor Operations, Fiber Optics, and Deputy Registrar Funds. ENTERPRISE FUNDS FINANCIAL POSITION The following table summarizes the changes in the financial position of the City’s enterprise funds during the years ended December 31, 2013 and 2014, presented both by classification and by fund: Increase 20132014 (Decrease) Net position of enterprise funds Total by classification Net investment in capital assets20,496,832$ 42,117,264$ 21,620,432$ Unrestricted6,461,685 9,112,037 2,650,352 Total enterprise funds 26,958,517$ 51,229,301$ 24,270,784$ Total by fund Water15,220,444$ 14,901,305$ (319,139)$ Sewage22,564,278 20,761,130 (1,803,148) Liquor979,250 987,433 8,183 Fiber Optics(12,030,506) 14,198,557 26,229,063 Deputy Registrar225,051 380,876 155,825 Total enterprise funds 26,958,517$ 51,229,301$ 24,270,784$ Enterprise Funds Change in Financial Position Net Position as of December 31, In total, the net position of the City’s enterprise funds increased by $24,270,784 during the year ended December 31, 2014. A special item contributed to the significant increase in net position in the Fiber Optics Fund. The fund experienced a $21 million gain on extinguishment of debt. The Fiber Optics Fund also received a total of $6.4 million of transfers from other funds related to judgement bonds issued in the current year. The Sewage Fund operating decline relates to a transfer of $1.7 million to the debt service fund to finance outstanding debt obligations. -13- WATER ENTERPRISE FUND The following graph presents 10 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 $1,200,000 $1,300,000 $1,400,000 2005200620072008200920102011201220132014 Water Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income Before Depreciation At December 31, 2014, the Water Enterprise Fund had a cash balance of $4,377,060 and a net position balance of $14,901,305. Net position consisted of $10,149,892 in net investment in capital assets and $4,751,413 in unrestricted net position. Operating revenue in the Water Enterprise Fund is $1,117,226, a decrease of $121,857 from the prior year. This decrease is related to a significant decrease in consumption, mostly related to colder weather conditions in 2014. Water Enterprise Fund operating expenses for 2014 were $1,086,006, an increase of $76,134, which is mainly due to the increase in supplies and maintenance for the purchase and installation of water meters. 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. -14- SEWAGE ENTERPRISE FUND The following graph presents 10 years of comparative operating results for the City’s Sewage 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 $2,400,000 $2,600,000 $2,800,000 2005200620072008200920102011201220132014 Sewage Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2014, the Sewage Enterprise Fund had a cash balance of $2,982,398 and a net position balance of $20,761,130. Net position consisted of $17,618,227 in net investment in capital assets and $3,142,903 of unrestricted net position. Sewage Enterprise Fund operating revenues for 2014 were $2,081,660, which is $74,942 more than the previous year. Operating expenses for 2014 were $2,676,729, which is $292,805 higher than 2013. This increase is due to increased engineering fees and waste water treatment plant services all related to projects the City completed in 2014. 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 sewage rates so they are designed to also provide for future repairs and replacement of infrastructure assets. -15- LIQUOR ENTERPRISE FUND The following graph presents 10 years of operating results for the Liquor Enterprise Fund: $– $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 2005200620072008200920102011201220132014 Liquor Enterprise Fund Year Ended December 31, Sales Cost of Sales Operating Expenses Operating Income (Loss) The Liquor Enterprise Fund ended 2014 with a net position balance of $987,433, an increase of $8,183 from the prior year. Of the net position balance, $264,790 represents the investment in liquor capital assets, leaving $722,643 of unrestricted net position. Liquor sales for 2014 were $5,165,737, an increase of $79,813 (1.6 percent) from last year. Sales have steadily increased over the last several years, increasing by about 45.9 percent since 2005. The Liquor Enterprise Fund generated a gross profit of $1,289,040 in 2014, or about 25.0 percent, of gross sales. The Liquor Enterprise Fund’s gross profit margin declined slightly after improving over the prior two years. Operating expenses for 2014 were $694,567, an increase of $4,618 from last year. -16- FIBER OPTICS ENTERPRISE FUND The following graph presents five years of operating results for the Fiber Optics Enterprise Fund: $(1,500,000) $(1,000,000) $(500,000) $– $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 20102011201220132014 Fiber Optics Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2014, the Fiber Optics Enterprise Fund had a cash balance of $42,559 and a net position balance of $14,198,557. Net position consisted of $14,036,591 in net investment in capital assets and $161,966 of unrestricted net position. Operating revenue in this fund was $1,761,978, an increase of $140,316, or 8.7 percent, in 2014. Operating expenses declined $493,347 in fiscal 2014. This was mainly due to decreased professional fees, including lower legal costs and software and maintenance agreements in fiscal 2014. The operating loss before depreciation in this fund during this year was $606,176. This was an improvement of $665,775 in the current year, mostly related to decreased operating expenses as previously discussed. As a result of improved but still poor operating results, we recommend the City continue to monitor the financial results of this fund. The continued monitoring of this fund would include a discussion on how the current financial results compare to the future strategic plan for this fund. Most importantly, the future strategic plan should continue to include a discussion on the impact this fund is having on the overall financial health of the City, including what impact the changes made to the plan are expected to have on the City as a whole in the short-term but also over the long-term. -17- Legal Settlement With Revenue Bondholders Resulting in Gain on Extinguishment of Debt On June 6, 2012, the City notified the trustee for the $26,445,000 Monticello Telecommunications Revenue Bonds, Series 2008 that it would no longer make monthly sinking fund payments from supplemental sources. A technical default occurred on July 1, 2012, when the City failed to make the sinking fund payment. On December 1, 2012, the first payment default occurred, as the trustee opted not to tap the $2.3 million in the bond reserve funds in order to make an $882,669 interest payment due on that date. A second non-payment default occurred on June 1, 2013, when an $882,669 interest and $85,000 principal payment was not made. A third non-payment default occurred on December 1, 2013, when an $879,906 interest payment was not made. Under the threat of litigation from bondholders, the City entered into a tolling agreement with the trustee on April 1, 2013 in order to permit time for good faith negotiations toward a settlement agreement. On October 2, 2013, the City and trustee, on behalf of bondholders, entered into a settlement agreement whereby the City would pay a $5.75 million settlement (21.7 percent of original par) in exchange for release from all future debt service requirements on the bonds, release from any future claims from bondholders, and the ability to continue to own and operate the telecommunications enterprise. The settlement agreement received approval by state and federal courts in 2014. The City sold tax-supported general obligations bonds in December 2014 and paid the settlement amount prior to year-end. The extinguishment of debt resulted in a $20,990,451 Fiber Optics Fund gain on extinguishment of debt, which is reported as a special item in the Statement of Activities and the Statement of Revenues, Expenses, and Changes in Net Position – Proprietary Funds. The gain is calculated by subtracting the $5.75 million settlement and amounts held in trust accounts from the par value of bonds outstanding plus accrued interest payable. -18- DEPUTY REGISTRAR ENTERPRISE FUND The following graph presents seven years of comparative operating results for the City’s Deputy Registrar Enterprise Fund: $– $50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 $500,000 $550,000 2008200920102011201220132014 Deputy Registrar Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) before depreciation At December 31, 2014, the Deputy Registrar Enterprise Fund had a cash balance of $363,479 and a net position balance of $380,876. Net position consisted of $47,764 in net investment in capital assets and $333,112 of unrestricted net position. Deputy Registrar Enterprise Fund operating revenues for 2014 were $497,798, which is $41,414 more than the previous year mostly due to an increase in charges for services. Operating expenses for 2014 were $302,709, which is $8,571 higher than 2013. As shown in the above graph, operating income before depreciation has been steadily increasing over the past several years. -19- GOVERNMENT-WIDE FINANCIAL STATEMENTS In addition to fund-based information, the current reporting model for governmental entities also requires the inclusion of two government-wide financial statements designed to present a clear picture of the City as a single, unified entity. These government-wide statements provide information on the total cost of delivering services, including capital assets and long-term liabilities. STATEMENT OF NET POSITION The Statement of Net Position essentially tells you what your city owns and owes at a given point in time, the last day of the fiscal year. Theoretically, net position represents the resources the City has leftover to use for providing services after its debts are settled. However, those resources are not always in spendable form, or there may be restrictions on how some of those resources can be used. Therefore, net position is divided into three components: net investment in capital assets, restricted, and unrestricted. The following table presents the components of the City’s net position as of December 31, 2013 and 2014, for governmental activities and business-type activities: Increase 20132014 (Decrease) Net position Governmental activities Net investment in capital assets44,268,757$ 48,253,810$ 3,985,053$ Restricted13,570,548 10,453,449 (3,117,099) Unrestricted18,034,821 14,792,521 (3,242,300) Total governmental activities75,874,126 73,499,780 (2,374,346) Business-type activities Net investment in capital assets20,496,832 42,117,264 21,620,432 Unrestricted6,463,638 9,121,952 2,658,314 Total business-type activities26,960,470 51,239,216 24,278,746 Total net position 102,834,596$ 124,738,996$ 21,904,400$ December 31, The City’s total net position at December 31, 2014 was $21,904,400 higher than the prior year. The overall financial results are reflective of the significant increase in net position in the Fiber Optics Project, which was due to the special item reported in 2014 as previously discussed. -20- STATEMENT OF ACTIVITIES The Statement of Activities tracks the City’s yearly revenues and expenses, as well as any other transactions that increase or reduce total net positions. These amounts represent the full cost of providing services. The Statement of Activities provides a more comprehensive measure than just the amount of cash that changed hands, as reflected in the fund-based financial statements. This statement includes the cost of supplies used, depreciation of long-lived capital assets, and other accrual-based expenses. The following table presents the change in the net position of the City for the years ended December 31, 2013 and 2014: 20132014 Net (expense) revenue Governmental activities General government (1,476,483)$ (1,308,098)$ Public safety (1,535,078) (1,531,029) Public works (3,432,146) (3,335,479) Sanitation (470,615) (469,571) Transit – (10,000) Recreation and culture (1,568,111) (1,180,833) Economic development (1,005,813) (1,084,620) Interest on long-term debt (235,265) (649,854) Business-type activities Water 204,970 113,635 Sewer (485,169) (273,360) Liquor 628,717 596,393 Fiber optic (3,634,151) (1,157,192) Deputy registrar 162,754 197,562 (12,846,390) (10,092,446) General revenues Taxes 8,927,164 9,219,737 Franchise taxes 320,640 357,409 General aids and grants 65,228 27,502 Investment earnings (306,303) 1,184,104 Other general revenues 555,250 217,643 Gain on sale of assets 3,885 – Special item: gain on extinguishment of debt – 20,990,451 9,565,864 31,996,846 (3,280,526)$ 21,904,400$ Total net (expense) revenue Total general revenues Change in net position Net Change 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. -21- LEGISLATIVE UPDATES The 2014 legislative session began with a projected budget excess for the remainder of the biennium of $1.09 billion, later revised upward to a projected excess of $1.23 billion in the February 2014 economic forecast. The Legislature utilized a portion of the projected excess to bolster the state’s financial condition; repaying $246 million “borrowed” from K–12 education through previous financing shifts, and using $150 million to replenish the state “Rainy Day Fund” budget reserve. The Legislature also approved increases to future funding for local government aid, and expanded the sales tax exemption approved for cities in 2013 to include joint powers entities and other instrumentalities of local government. The following is a summary of recent legislation affecting Minnesota cities in 2014 and into the future: Local Government Aid (LGA) – The Legislature completely overhauled the LGA formula for fiscal year 2014 and thereafter, creating a three-tiered formula that includes separate “need factor” calculations for cities with populations under 2,500, between 2,500 and 10,000, or over 10,000. The new formula simplified the LGA calculation, and reduced the volatility of the LGA distribution by limiting the amount it may decline in a given year. Under the new formula, the minimum LGA 2014 distribution for each city was an amount equal to their 2013 LGA. Beginning in 2015, any reduction to a city’s calculated LGA distribution will be limited to the lesser of $10 per capita, or 5 percent of their previous year net tax levy. For cities that gain under the new formula, the increases will be distributed proportionate to their unmet need, as determined by the new “need factor” calculations. The state-wide LGA appropriation was $507.6 million for fiscal 2014, $516.9 million for 2015, and $519.4 million for fiscal 2016 and thereafter. Sales Tax Exemption – Cities are exempted from paying sales tax on qualifying purchases, effective for purchases made on or after January 1, 2014. Purchases of goods or services by an exempt local government for a publically provided liquor store, gas or electric utility, golf course, marina, campground, café, laundromat, solid waste hauling or recycling operation, or landfill will remain taxable. The definition of “cities” for this statute include both home-rule and statutory cities. The 2014 Legislature extended the definition of tax exempt local government to include all special district; city, county, or township instrumentalities; economic development authorities; housing and redevelopment authorities; and all joint power boards or organizations. However, this expanded exemption list is not effective until January 1, 2016. Proposed Property Tax Levy Certification Date – The deadline for cities to certify their proposed annual tax levies was extended from September 15 to September 30. Agricultural Homestead Market Value Credit – The rate of agricultural homestead market value was increased to a maximum of $490 at a market value of $270,000 and over. Capital Investment Act Requirements – The Legislature approved capital improvement projects totaling about $1.1 billion under two separate capital investment (bonding) acts. Both require that, to the extent practicable, a public entity receiving an appropriation of public money for a project under these acts must assure those facilities are built with American-made steel. Authority to Inspect Public Buildings and State-Licensed Facilities – A formal delegation process was established that must be used by the state Department of Labor and Industry (DLI) when delegating the authority to inspect public buildings and state-licensed facilities to local building officials. The new provisions did not alter the circumstances under which the DLI is required to delegate this authority in most circumstances, only the process to be followed. However, for certain smaller construction projects designated as “reserved projects,” the DLI is now required to delegate inspection authority to any municipality with a designated building official without going through the formal delegation process. -22- Open Meeting Law – A change was made to the Open Meeting Law to clarify that the use of social media by members of a public body does not violate the Open Meeting Law if the use is limited to exchanges open to the public. The new statute specifically excludes email but does not otherwise define the term social media. Deputy Registrar Residency – The statutory requirement that an individual appointed as deputy registrar for a statutory or home-rule charter city be a resident of the county in which the city is located was repealed. Local Campaign Finance – Changes were made to increase the campaign contribution limits for local elections. For candidates in a territory with a population of 100,000 or less, the contribution limits were raised to $600 in an election year and $250 in a non-election year. For candidates in a territory with a population over 100,000, the limits were raised to $1,000 in an election year and $250 in a non-election year. In addition, all campaign finance reports required to be filed with a local government must now be published on the local government’s website, if the local government maintains a website. Data Practices – Several changes were made to address unauthorized access of private data by public employees, requiring local governments to: establish security measures to help ensure private data is only accessible to public employees whose work assignment reasonably requires access to the data, and that the data is only being accessed by those individuals for the purposes of their work assignment; follow the data breach reporting requirements that were previously only applicable to state agencies; and perform annual security assessments of personal information maintained by the entity. The statute also states that accessing private data without authorization is a misdemeanor, and willful violation by a public employee constitutes just cause for suspension without pay or dismissal. Part-Time Peace Officers – A change in the statutes now prohibits law enforcement agencies from hiring new part-time peace officers, existing part-time peace officers from transferring to new agencies, and the Peace Officer Standards and Training Board from licensing new part-time peace officers. Part-time peace officers that are currently employed may continue to serve indefinitely with their current employer, but must turn in their license upon leaving their current place of employment or otherwise becoming unemployed. Responsible Contractor Requirement – Contractors who bid on public contracts in excess of $50,000 are now required to certify that they are a “responsible bidder” in order to be awarded a contract as the lowest responsible bidder or best value alternative. A responsible contractor must be in compliance with various state and federal requirements for income tax, workers’ compensation, unemployment insurance, minimum wage, and safety. City solicitations for bid must include: the definition of “responsible contractor,” which may include criteria in addition to the statutory requirements established by the city, or reference to the statutory definition; a statement that a contractor failing to meet the criteria or verify compliance is ineligible to be awarded or perform work on the contract; a statement that submitting a false verification renders the contractor ineligible and can result in termination of the contract; and a statement requiring the contractor to provide copies of verification forms for all subcontractors upon request. Cities are not obligated to verify any of the information in the contractor verification; and have no liability if reasonably relying on the certification when awarding the contract, or declining to award the contract based on a reasonable determination that a contractor failed to verify compliance. Disaster Assistance Contingency Fund – A new state account was created to provide emergency cash flow for local governments located in counties declared federal disaster areas. The fund may be used to meet non-federal fund matching requirements to speed the availability of federal funds. -23- Pensions – A number of changes to the Public Employees Retirement Association (PERA) General Plan were adopted, including:  The minimum salary threshold for inclusion into the PERA General Plan was changed from $425 in any one month to $5,100 on any year for non-school employees or $3,800 in any year for school employees.  Employers are required to provide written notice to any employee excluded from membership in the PERA General Plan within two weeks of the determination on a form prescribed by the PERA executive director.  PERA contribution rates for both employees and employers were increased by 0.25 percent of salary effective January 1, 2015. -24- ACCOUNTING AND AUDITING UPDATES GOVERNMENTAL ACCOUNTING STANDARDS BOARD (GASB) STATEMENT NO. 68 – ACCOUNTING AND FINANCIAL REPORTING FOR PENSIONS—AN AMENDMENT OF GASB STATEMENT NOS. 27 AND 50 The primary objective of this statement is to improve accounting and financial reporting by state and local governments for pensions. This statement replaces the requirements of GASB Statement Nos. 27 and No. 50, as they relate to pensions that are provided through pension plans administered as trusts or equivalent arrangements that meet certain criteria. The requirements of GASB Statement Nos. 27 and No. 50 remain applicable for pensions that are not covered by the scope of this statement. This statement establishes standards for measuring and recognizing liabilities, deferred outflows of resources, deferred inflows of resources, and expenses/expenditures. In addition, this statement details the recognition and disclosure requirements for employers with liabilities (payables) to a defined benefit pension plan and for employers whose employees are provided with defined contribution pensions. This statement also addresses circumstances in which a non-employer entity has a legal requirement to make contributions directly to a pension plan. This statement is effective for financial statements for fiscal years beginning after June 15, 2014. Earlier application is encouraged. Included in this statement are major changes in how employers that participate in cost-sharing pension plans, such as the Teachers’ Retirement Association (TRA) and PERA, account for pension benefit expenses and liabilities. In financial statements prepared using the economic resources measurement focus and accrual basis of accounting (government-wide and proprietary funds), a cost-sharing employer that does not have a special funding situation is required to recognize a liability for its proportionate share of the net pension liability of all employers with benefits provided through the pension plan. A cost-sharing employer is required to recognize pension expense and report deferred outflows of resources and deferred inflows of resources related to pensions for its proportionate share of collective pension expense and collective deferred outflows of resources and deferred inflows of resources related to pensions. In addition, the effects of (1) a change in the employer’s proportion of the collective net pension liability and (2) differences during the measurement period between the employer’s contributions and its proportionate share of the total of contributions from employers included in the collective net pension liability are required to be determined. These effects are required to be recognized in the employer’s pension expense in a systematic and rational manner over a closed period equal to the average of the expected remaining service lives of all active and inactive employees that are provided with pensions through the pension plan. GASB STATEMENT NO. 72 – FAIR VALUE MEASURE AND APPLICATION GASB Statement No. 72 addresses accounting and financial reporting issues related to fair value measurements. The requirements of this statement are intended to enhance comparability among government financial statements by requiring certain assets and liabilities be reported at fair value, using a consistent definition of fair value and accepted valuation techniques. The requirements of this statement are effective for financial statements for periods beginning after June 15, 2015, with earlier application encouraged. GASB Statement No. 72 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are generally assumed to take place in the government’s principal or most advantageous market, taking into account the highest and best use for a nonfinancial asset, and assuming market participants would act in their economic best interest. The statement requires a government to use measurement techniques that are appropriate under the circumstances and for which sufficient data are available to measure fair value; consistent with a market, (replacement) cost, or income approach. It also establishes a hierarchy of inputs to be used in valuation techniques. -25- The statement establishes or clarifies the applicability of fair value measurement for certain assets and liabilities. Fair value is generally required for investments, defined as securities or other assets held primarily for the purpose of generating income, or which have a present service capacity based solely on their ability to generate cash. The statement requires measurement at acquisition value for donated capital assets, donated works of art, historical treasures, and capital assets received through a service concession arrangement. The statement also outlines the required financial statement disclosures about fair value measurements, valuation techniques, and the hierarchy of inputs used for valuation. CHANGES TO REQUIREMENTS FOR FEDERAL GRANTS In December 2013, the OMB issued Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Audits, which supersedes all or parts of eight OMB circulars; consolidating federal cost principles, administrative principles, and audit requirements in one document. The “Super Circular” includes a number of significant changes to the federal Single Audit process, including: an increase in dollar threshold for requiring a Single Audit from $500,000 to $750,000; changes to the thresholds and process used for determining major programs; reductions in the percentages of expenditures required to be covered by a Single Audit from 50 percent to 40 percent for high-risk auditees and from 25 percent to 20 percent for low-risk auditees; revised criteria for determining low-risk auditees; and an increase in the threshold for reporting questioned costs from $10,000 to $25,000. Auditees are required to implement the administrative requirements of the new “Super Circular” by December 26, 2014. The revised audit requirements will be effective for fiscal year 2015 city audits, with an optional one-year grace period for implementing the new procurement standards included in this guidance. -26- COSO INTERNAL CONTROL FRAMEWORK The clarified auditing standards applicable to governmental audits incorporate a definition of internal control that is based on the internal control integrated framework developed and issued in 1992 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In May 2013, COSO issued an updated framework which supersedes the original after December 15, 2014. The new COSO framework retains the basic definition of internal control and its five components established in its original framework, along with the fundamental requirements to consider these five components and to use judgment when assessing and evaluating the effectiveness of a system of internal controls. The new COSO framework enhances and clarifies a number of concepts from the original framework to make it easier to use and apply. One of the more significant enhancements was the establishment of 17 principles, associated with the 5 components of internal control, intended to assist users in understanding the requirements of effective internal control and designing effective systems of internal control. The 5 components of internal control and 17 underlying principles are as follows: Control Environment – 1. Organization demonstrates a commitment to integrity and ethical values. 2. Governing body is independent from management and exercises oversight control. 3. Management establishes structure, reporting lines, authority, and responsibilities. 4. Organization demonstrates a commitment to the competence of individuals involved with internal control. 5. Organization holds individuals accountable for internal control responsibilities. Risk Assessment – 6. Organization specifies clear objectives for the identification and assessment of risks. 7. Organization identifies and analyzes risk. 8. Organization assesses the potential for fraud risks. 9. Organization identifies and assesses significant changes that could impact internal control. Control Activities – 10. Organization selects and develops control activities to mitigate risks. 11. Organization selects and develops general IT controls. 12. Organization establishes and implements control policies and procedures. Information and Communication – 13. Organization uses relevant, quality information to support internal control. 14. Organization communicates internal control information internally. 15. Organization communicates internal control information externally. Monitoring – 16. Organization conducts ongoing and/or separate internal control evaluations. 17. Organization evaluates and communicates deficiencies to responsible parties for corrective action. COSO defines an effective system of internal control as one that reduces to an acceptable level the risk of failing to achieve an organizational objective in the areas of operations, compliance, or reporting. According to the new framework, an organization can achieve effective internal control by applying all of the principles listed above. To achieve this, each of these five components and the relevant principles must be present and functioning, and the five components must operate in an integrated manner. Local governments should be reviewing their internal control systems to assure these principles have been incorporated and implemented.