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2011 Monticello Auditor's Management LetterManagement Report for City of Monticello, Minnesota December 31, 2011 U 61 ALI ACCOUN PUBLIC A N T S To the City Council and Management City of Monticello, Minnesota PRINCIPALS Thomas M. Montague, CPA Thomas A. Karnowski, CPA Paul A. Radosevich, CPA William J. Lauer, CPA James H. Eichten, CPA Aaron J. Nielsen, CPA Victoria L. Holinka, CPA 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, 2011. 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 • 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. 0-00Lf n fa���, Karnowsk ,01ose� ;of r �, z0.4 May 22, 2012 Malloy, Montague, Karnowski, Radosevich & Co., P.A. 5353 Wayzata Boulevard • Suite 410 • Minneapolis, MN 55416 • Telephone: 952 -545 -0424 • Telefax: 952 -545 -0569 - www.minkr.com 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 find, and the aggregate remaining fund information of the City as of and for the year ended December 31, 2011. 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, 2011: • 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: During our audit procedures, we proposed one audit adjustment that was 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 was 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 one finding based on our testing of the City's compliance with Minnesota laws and regulations: We noted that 1 out of 25 disbursements tested were not paid within the 35 -day period as required by Minnesota Statute. -1- 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, 2011, 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 that a mutual fund the City invested in during fiscal 2010 was not rated in one of the two highest rating categories for mutual funds by at least one nationally recognized statistical rating organization. During this year's audit testing, it was noted that the City no longer invests with this mutual fund. In the prior year, we noted that all the claims for payroll for liquor store and community center employees did not have the signed declarations from employees as required by Minnesota Statute § 412.271. During fiscal 2011, the City implemented an additional approval process which includes the declaration requirement. 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. 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. For the year ended December 31, 2011, the City has implemented Governmental Accounting Standards Board (GASB) Statement No. 54, "Fund Balance Reporting and Governmental Fund Type Definitions." This statement established new fund balance classifications 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. It also clarifies existing governmental fund type definitions to improve the comparability of governmental fund financial statements. -2- 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 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. The financial statement disclosures are neutral, consistent, and clear. 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. -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 May 22, 2012. 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 INFORMATION IN DOCUMENTS CONTAINING AUDITED FINANCIAL STATEMENTS Our audit was conducted for the purpose of forming opinions on the financial statements that collectively comprise the City's basic financial statements. The introductory section, combining nonmajor fund statements, and statistical section, as listed in the table of contents, are presented for purposes of additional analysis and are not required parts of the basic financial statements. The combining nonmajor fund statements are the responsibility of management and were derived from and relate directly to the underlying accounting and other records used to prepare the basic financial statements. The information has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the basic financial statements as a whole. The introductory and statistical sections have not been subjected to the auditing procedures applied in the audit of the basic financial statements and, accordingly, we do not express an opinion or provide any assurance on them. -4- FUNDING CITIES IN MINNESOTA LEGISLATION The 2011 legislative session began with the state facing a projected budget deficit of $6.2 billion (later revised down to $5.0 billion in the February 2011 Economic Forecast) for the 2012 -2013 biennium. In addition, the 2010 election dramatically changed the state's political landscape. A Democratic Governor was in power for the first time since 1991, while Republicans had majority control of both the House and the Senate for the first time since 1971. Predictably, as the session progressed, the Governor and Legislature had difficulty agreeing on a state budget for the next biennium. Shortly after the 2011 regular session ended, the Governor vetoed eight major state appropriation bills and the omnibus tax bill passed by the Legislature, which left the majority of state agencies without a budget for the next fiscal year. This resulted in a shutdown of "nonessential" state agencies that began July 1, 2011 and effectively ended with the passing of appropriation bills in a special session on July 19th and 20th. The large projected budget deficit facing the 2011 Legislature was typical of the financial challenges the state has experienced in recent years. Unfavorable economic conditions have caused a steady deterioration of the state's financial condition, which has resulted in a series of cuts and holdbacks in state aids to local governments and other entities. As was the case in the last biennium, the Legislature utilized several one -time revenue sources, transfers, and accounting shifts to minimize the need for tax increases or state aid cuts to balance the state budget. The following is a summary of significant legislative activity passed in calendar year 2011 affecting the finances of Minnesota cities: Local Government Aid (LGA) and Market Value Homestead Credit (MVHC) — One of the appropriation bills passed in the 2011 special session was the omnibus tax bill, which includes the appropriations for LGA and MVHC. The Legislature retroactively reduced the fiscal 2011 appropriation for LGA by approximately $102 million, leaving a total appropriation of $425.3 million for 2011 LGA. Minnesota cities will receive 2011 LGA equal to the lesser of their final 2010 LGA (after the cuts by the Legislature and Governor) or their 2011 certified LGA amount, The first half LGA payment for 2011 was also delayed one week to July 27, so the reduced LOA amounts could be recomputed after the government shutdown. The total LGA appropriation for fiscal 2012 will be $425.2 million, with cities again receiving the lesser of their 2010 actual or 2011 certified amounts. In essence, this bill extended the LGA cuts originally made in fiscal 2010 for the two subsequent years. For fiscal 2013 and beyond, the LGA appropriation is set at $426.4 million, to be allocated using the LGA formula. The omnibus tax bill also extended the 2010 MVHC reductions of approximately $48 million to fiscal 2011, with cities to receive the same allocation. Beginning in fiscal 2012, the MVHC reimbursement program is eliminated. Rather than receiving a property tax credit, qualifying homeowner taxpayers will have a portion of the market value of their house excluded from their taxable market value. This new system will provide homeowners property tax relief by shifting a portion of their potential tax burden to other property classifications, rather than directly reducing their taxes through a state paid tax credit reimbursement. While this new homestead exclusion is calculated in a similar manner to the repealed MVHC, the actual tax relief to individual homeowner taxpayers may vary significantly depending on the makeup of the taxing jurisdictions that levy on their particular property. The agriculture market value credit, however, will continue as a state -paid tax credit -5- 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. 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 2011 Legislature passed an omnibus tax bill during the regular session that would have extended levy limits for two years (taxes payable in 2012 and 2013). However, this was among the bills vetoed by the Governor, and the final omnibus tax bill passed in the special session did not address levy limits. Sales and Use Taxes — A number of changes and clarifications were made to Minnesota sales and use tax provisions, including: • Made water used directly for public safety purposes (fighting fires) exempt from sales tax. • Expanded the sales tax exemption for the lease of motor vehicles used as ambulances to the lease of vehicles used for emergency response. • Added townships to the list of entities exempt from sales tax. • Provided an exemption from sales tax for technology and electricity for qualifying large data centers as a business incentive. • Clarified the sales tax regulations for online hotel sales. "Buy American" Provision Repealed — The "Buy American" provision, enacted in 2010, which prohibited public employers from purchasing or requiring employees to purchase any uniforms, safety equipment, or protective accessories not manufactured in the United States, was repealed. Cities may continue to purchase American-made uniforms and equipment, but they are not required to do so. Prohibition of Referendum Spending — Political subdivisions, including cities, are prohibited from expending funds to promote a referendum to support imposing a local option sales tax. The political subdivision may only expend finds to conduct the referendum. Tax Exempt Period for Economic Development Property — The maximum allowable holding period for property held by a political subdivision for economic development to be exempt from property taxes was increased from eight years to nine years. Concurrent Detachment of Parcels — State law for the concurrent detachment of property from one city to another has been changed. In the past, both cities involved had to support the change for it to be considered. Now, if the property owner and one of the involved cities petition for the detachment, the proposed boundary adjustment qualifies for consideration. Civil Immunity for Donated Public Safety Equipment — Immunity from civil tort claims is extended to municipalities that donate public safety equipment to another municipality, unless the claim is a direct result of fraud or intentional misrepresentation. The statute defines "public safety equipment" as vehicles and equipment used in firefighter, ambulance and emergency medical treatment services, rescue, and hazardous material response. -6- PROPERTY TAXES Minnesota cities rely heavily on local property tax levies to support their governmental fiord 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 decreases of 3.0 percent and 5.7 percent for taxes payable in 2010 and 2011, respectively, reflecting the weak housing market and economic conditions experiences in recent years. In comparison, the City's market value declined by 4.6 percent in 2010 and 6.9 percent in 2011. The market value for taxes payable in 2011 is based on estimated values as of January 1, 2010. The following graph shows the City's changes in taxable market value over the past 10 years: $1,400,000,000 $1,200,000,000 $1,000,000,000 $800,000,000 $600,000,000 $400,000,000 $200,000,000 Taxable Market Value 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -7- 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 decreased 3.0 percent for 2010 and 4.4 percent for 2011. The following graph shows the City's change in tax capacities over the past 10 years: Local Tax Capacity $20,000,000 $18,000,000 $16,000,000 $14,000,000 $12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 $— 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 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. 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 All Cities State -Wide City of Monticello 2010 2011 2010 2011 Average tax rate City 39.2 42.5 45.8 46.8 County 41.0 43.7 35.8 39.3 School 23.0 25.2 25.0 27.0 Special taxing 5.9 6.4 1.7 1.5 Total 109.1 117.8 108.3 114.6 The City's portion of the average tax rate for its residents was well above the state -wide averages for the last two years. The average tax rate for the City as a whole is very similar to all cities state -wide. -8- 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 Fund, 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 ]mown 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: 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 2011 was $1,296, a decrease of about 9.8 percent from the prior year. Property taxes decreased $64 per capita as the City had a 10.9 percent increase in population. Charges for services decreased $75 per capita due to fewer development fees and a decrease in the charges to the City for its services on construction projects. -9- Governmental Funds Revenue per Capita With State -Wide Averages by Population Class State -Wide City of Monticello Year December 31, 2010 2009 2010 2011 Population 2,500- 10,000 10,000- 20,000 20,000 - 100,000 11,476 11,501 12,759 Property taxes $ 386 $ 359 $ 407 $ 654 $ 636 $ 572 Tax increments 45 52 56 104 100 82 Franchise fees and other taxes 26 34 30 4 32 27 Special assessments 74 60 66 215 127 145 Licenses and permits 19 22 29 23 19 20 Intergovernmental revenues 291 271 149 147 141 112 Charges for services 89 83 76 219 251 176 Other 73 70 57 105 131 162 Total revenue $ 1,003 $ 951 $ 870 $ 1,471 $ 1,437 $ 1,296 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 2011 was $1,296, a decrease of about 9.8 percent from the prior year. Property taxes decreased $64 per capita as the City had a 10.9 percent increase in population. Charges for services decreased $75 per capita due to fewer development fees and a decrease in the charges to the City for its services on construction projects. -9- GOVERNMENTAL FUNDS EXPENDITURES Similar to our discussion of revenues, the expenditures of governmental finds 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: Governmental Funds Expenditures per Capita With State-Wide Averages by Population Class Capital outlay and construction $ State -Wide $ 320 City of Monticello Year $ December 31, 2010 $ 2009 2010 2011 Population 2,500- 10,000 10,000- 20,000 20,000- 100,000 11,476 11,501 12,759 Current Principal General government $ 125 $ 102 $ 85 $ 142 $ 174 $ 160 Public safely 227 223 235 239 146 135 Street maintenance and 53 43 157 lighting 108 107 86 181 136 131 Culture and recreation 75 93 87 205 188 190 All other 81 81 91 121 277 133 $ 615 $ 606 $ 584 $ 888 $ 921 $ 749 Capital outlay and construction $ 299 $ 320 $ 232 $ 170 $ 360 $ 319 Debt service Principal $ 180 $ 180 $ 111 $ 588 $ 435 $ 381 Interest and fiscal 63 53 43 157 135 108 $ 243 $ 234 $ 154 $ 745 $ 570 $ 489 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 decreased $172 per capita in 2011. This decrease is due to all other costs decreasing $144 per capita as a result of a market value adjustment to land held for resale in fiscal 2010. 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 due to the stage of development of the City. Debt service costs were $81 per capita lower in calendar 2011 due to the payoff of tax increment bonds in fiscal 2010. -10- 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. $8,500,000 $8,000,000 $7,500,000 $7,000,000 $6,500,000 $6,000,000 $5,500,000 $5,000,000 $4,500,000 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 General Fund Financial Position Year Ended December 31, 2005 2006 2007 2008 2009 2010 2011 � Fund Balance o Cash Balance (Including Interfund Borrowing) — Expenditures The City's General Fund cash and investments balance (including interfund borrowing) at December 31, 2011 was $5,198,791, which decreased $556,591 from 2010. Total fund balance at December 31, 2011 was $4,410,637, down $656,430 from the prior year. Most of this decline was due to transfers to support other funds totaling $728,383. Of this total fund balance, $386,616 is nonspendable, $3,374,200 was committed based on the City's fund balance policy for working capital and contingencies, and $649,821 was unassigned. This fund balance level represents approximately 68 percent of the City's annual General Fund expenditures, based on 2011 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. The fund balance level is 23 percent more than what is set aside. As discussed earlier in this report, the City implemented the provisions of GASH Statement No. 54, increasing beginning equity by $85,892 due to this change in accounting principle. 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. -11- The following illustrations provide you with the components of the City's General Fund revenue compared to budget for 2011: Property Taxes Licenses and Permits Intergovernmental Charges for Services Other General Fund Revenue Budget to Actual 000 000 000 000 000 000 000 000 000 000 000 �h0o, ,000, �y0o, 000, 500 000, 500 000, BOO, 000, 500, �N, �5, Sy, ®Budget ❑Actual Total General Fund revenues for 2011 were $6,600,267, which was $133,391 (2.1 percent) over the final budget. Charges for services were over budget by $67,452, mostly due to city development charges and reimbursements being $75,571 over budgeted amounts. Investment earnings also exceeded budgeted amounts by $99,476. 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. $5,600,000 $5,200,000 $4,800,000 $4,400,000 $4,000,000 $3,600,000 $3,200,000 $2,800,000 $2,400,000 $2,000,000 $1,600,000 $1,200,000 $800,000 $400,000 General Fund Revenue by Source Year Ended December 31, Taxes Intergovernmental Other 112004 ® 2005 ■ 2006 ❑ 2007 ■ 2008 W2009 02010 E2011 Overall, General Fund revenues decreased $709,242 (9.7 percent) from the previous year. The largest decline was in charges for services, which decreased $940,759. The decreases in charges for services were in a number of areas, but were mainly the result of city development charges and reimbursements being about $850,000 lower than the prior year. -12- i The following illustrations provide you with the components of the City's General Fund spending compared to budget for 2011 and by function for the past eight years: I General Fund Expenditures Budget to Actual General Governmental Public Safety Public Works Culture and Recreation Other 1�( 00 00 00 00 00 00 00 00 00 O O O O O O O O O X00, X00, X600,00+ X000, ��00, ��00, �(3 ® Budget ■ Actual Total General Fund expenditures for 2011 were $6,528,314, which was only $60,710 (0.9 percent) over budget. $2,500,000 $2,250,000 $2,000,000 $1,750,000 $1,500,000 $1,250,000 $1,000,000 $750,000 $500,000 $250,000 $— General Fund Expenditures by Function Year Ended December 31, General Public Safety Public Works Culture and Other Governmental Recreation E2004 E2005 ■ 2006 ❑ 2007 ■ 2008 M2009 W2010 M2011 Overall, General Fund expenditures increased $261,206 (4.2 percent) from the prior year. Culture and recreation expenditures increased $130,051, which was mainly due to the increase in supplies and small equipment to operate the parks. The other functions increased $130,307, mainly due to the reorganization of special revenue fund to General Fund categories to comply with GASB pronouncements. This change in classification resulted in an increase of $80,766 to the General Fund expenditures; however, the operation of these functional units remained stable from 2010. -13- ENTERPRISE FUNDS The enterprise funds comprise a considerable portion of the City's activities. These finds 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: $1,200,000 $1,100,000 $1,000,000 $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 Water Enterprise Fund Year Ended December 31, 2004 2005 2006 2007 2008 2009 2010 2011 O Operating Revenue Operating Expense — Operating Income (Loss) Before Depreciation At December 31, 2011, the Water Enterprise Fund had a cash balance of $3,567,937 and net assets of $14,789,228. Net assets consisted of $10,878,744 in amounts invested in capital assets and $3,910,484 in unrestricted net assets. Operating revenue in the Water Enterprise Fund is $1,089,854, an increase of $261,219 from the prior year. This increase is related to the City implementing a tiered rate billing structure. Water Enterprise Fund operating expenses for 2011 were $1,167,572, an increase of $230,854, mostly in personal service costs and supplies and maintenance. As shown in the above graph, operating income before depreciation increased to the same level as 2009 after a one year decline. 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- Sewer Enterprise Fund The following graph presents eight years of comparative operating results for the City's Sewer Enterprise Fund: $2,400,000 $2,200,000 $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $(200,000) Sewer Enterprise Fund Year Ended December 31, 2004 2005 2006 2007 2008 2009 2010 2011 o Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2011, the Sewer Enterprise Fund had a cash balance of $2,277,928 and net asset balance of $22,387,257. Net assets consisted of $19,644,551 invested in capital assets, net of related debt and $2,742,706 of unrestricted net assets. Sewer Enterprise Fund operating revenues for 2011 were $1,737,131, which is $239,178 more than the previous year. Most of this increase relates to an increase in sewer rates. Operating expenses for 2011 were $2,315,491, which is $233,571, or 11.2 percent, higher than 2010. This increase is due to the increase in depreciation expense due to the full year of depreciation on new infrastructure assets capitalized in the prior year. 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 infrastructure assets. -15- Liquor Enterprise Fund The following graph presents eight years of operating results for the Liquor Enterprise Fund: $4,800,000 $4,500,000 $4,200,000 $3,900,000 $3,600,000 $3,300,000 $3,000,000 $2,700,000 $2,400,000 $2,100,000 $1,800,000 $1,500,000 $1,200,000 $900,000 $600,000 $300,000 Liquor Enterprise Fund Year Ended December 31, 2004 2005 2006 2007 2008 2009 2010 2011 D Sales � Cost of Sales ® Operating Expenses — Operating Income (Loss) The Liquor Enterprise Fund ended 2011 with net assets of $3,964,936, an increase of $445,225 from the prior year. Of the net asset balance, $394,060 represents the investment in liquor capital assets, leaving $3,570,876 of unrestricted net assets. Liquor sales for 2011 were $4,653,384, an increase of $175,733 (3.9 percent) from last year. Sales have steadily increased over the last several years, increasing by about 36.4 percent since 2004. The Liquor Enterprise Fund generated a gross profit of $1,151,171 in 2011, or about 24.7 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 2004 and 2011. Operating expenses for 2011 were $658,999, an increase of $21,425, or 3.4 percent, from last year. -16- Fiber Optics Enterprise Fund In 2007, the City started its Fiber Optics Project, which will rim 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 was completed as of the year ended December 31, 2010 and became fully operational. The following graph presents two years of operating results for the Fiber Optics Enterprise Fund: $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $(500,000) $(1,000,000) $(1,500,000) Fiber Optics Enterprise Fund Year Ended December 31, 2010 2011 o Operating Revenue Operating Expense — Operating Income (Loss) Before Depreciation At December 31, 2011, the Fiber Optics Enterprise Fund had a deficit cash balance (including interfrmd borrowing) of $3,446,738 and a deficit net asset balance of ($9,817,781). Net assets consisted of a deficit of ($6,493,142) invested in capital assets, net of related debt and a deficit of ($3,324,639) of unrestricted net assets. The Fiber Optics Fund completed its first full year of operating in fiscal 2011. The operating loss in this fund during this year was around $755,000. After you add in over $1,940,000 in interest on borrowing from other funds and bonds outstanding the total overall loss in the fund was almost $2.7 million. This is a staggering figure considering the total overall annual expenses of the City are around $23.3 million. At December 31, 2011, this fiord had $26.4 million outstanding in bonds and another $3.3 million outstanding in debt payable to other funds, including about $3,000,000 to the Liquor Fund. If the financial results of the past years are any indication of future results, the City will have difficulty meeting its debt service obligations unless dramatic changes are made in the operation of this fund. As a result of these poor operating results, we highly recommend the City take immediate action toward developing a revised strategic plan for the future of this fund. The development of this plan would include a discussion on how the current Financial results compare to the original strategic plan for this fund. The City will need to determine how past performance should guide the City in what we believe are significant changes necessary to improving the financial results of this fund. The development of this plan should consider all options available to the City as it relates to this enterprise fiord. Most importantly, this plan should include a discussion on the impact this fund is having on the overall financial well -being 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- CAPITAL PROJECTS FUND At December 31, 2011, the City's Capital Projects Fund has a deficit fund balance that totals $1,360,666. We recommend that the City continue to address this fund balance deficit by approving a financial plan for eliminating this fund balance deficit. 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 GASH 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, 2011 and 2010, for governmental activities and business -type activities: Net assets Governmental activities Invested in capital assets, net of related debt Restricted Unrestricted Total governmental activities Business -type activities Invested in capital assets, net of related debt Restricted Unrestricted Total business -type activities Total net assets December 31, Increase 2011 2010 (Decrease) $ 38,242,040 16,894,936 24,758,269 79,895,245 25,031,043 19,350 6,901,353 31.951.746 $ 31,901,676 18,337,866 26,876,421 77,115,963 28,556,355 19,350 6,363,148 34,938,853 $ 6,340,364 (1,442,930) (2,118,152) 2,779,282 (3,525,312) 538,205 (2,987,107) $ 111,846,991 $ 112,054,816 $ (207,825) The City's total net assets at December 31, 2011 were $207,825 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 $2.7 million. -18- 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, 2011 and 2010: 2011 2010 Program Expenses Revenues Net Change Net Change Net(expense)revenue 8,631,963 19,359 37,665 1,963,264 Governmental activities 1,910,010 567,417 12,685,144 10,3 32,759 General government $ 2,111,710 $ 521,182 $ (1,590,528) $ (1,574,159) Public safety 1,788,595 358,407 (1,430,188) (1,522,910) Public works 4,838,544 2,150,058 (2,688,486) 1,886,474 Sanitation 495,693 52,304 (443,389) (369,516) Culture and recreation 1,724,348 1,757,067 32,719 (1,187,100) Economic development 1,199,936 — (1,199,936) (2,433,583) Interest on long -term debt 1,248,716 — (1,248,716) (1,464,012) Business -type activities Water 1,167,572 1,078,133 (89,439) (108,083) Sewer 2,340,555 1,712,058 (628,497) (1,025,439) Liquor 658,999 1,151,171 492,172 537,193 Cemetery 28,849 22,390 (6,459) (18,039) Fiber optic 5,702,480 1,610,258 (4,092,222) (3,358,557) Total net (expense) revenue $ 23,305,997 $ 10,413,028 (12,892,969) (10,637,731) General revenues Taxes General aids and grants Investment earnings Other revenues Total general revenues Change in net assets 8,792,511 8,631,963 19,359 37,665 1,963,264 1,095,714 1,910,010 567,417 12,685,144 10,3 32,759 $ (207,825) $ (304,972) 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. -19- ACCOUNTING AND AUDITING UPDATES 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). SCAB 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 periods beginning after December 15, 2011, 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 periods beginning after June 15, 2012, with earlier implementation encouraged. GASB STATEMENT No. 63 - FINANCIAL REPORTING OF DEFERRED OUTFLOWS OF RESOURCES, DEFERRED INFLOWS OF RESOURCES, AND NET POSITION This statement provides financial reporting guidance for deferred outflows of resources and deferred inflows of resources; which are defined as the consumption or acquisition of net assets, respectively, applicable to a future reporting period. The statement amends certain reporting requirements in GASB Statement No. 34 and related pronouncements, providing a format for a new Statement of Net Position, which reports deferred outflows of resources and deferred inflows of resources separately from assets and liabilities. It also renames the residual of assets, deferred outflows of resources, liabilities, and deferred inflows of resources as net position, rather than net assets. The requirements of this statement must be implemented for periods beginning after December 15, 2011, with earlier implementation encouraged. -20- GASB PENSION EXPOSURE DRAFTS In June 2011, GASB issued two exposure drafts on accounting and reporting for pensions, one for the reporting of pension benefits within the financial statements of participating employers and the other for pension plan financial reporting. These two exposure drafts are intended to update or replace the current guidance for pension reporting in GASB Statement Nos. 25 and 27. The exposure drafts propose a variety of changes in financial statement presentation, measurement, and required disclosures relating to pension benefits. Included are proposed major changes in how employers that participate in cost - sharing defined benefit pension plans, such as TRA and PERA, account for pension benefit expenses and liabilities. Currently, employers participating in such plans recognize pension expenses and liabilities only to the extent of their contractually required annual contributions to the plan. The exposure draft proposes that those employers recognize their proportionate share of the collective net pension liability and collective pension expense for all participating employers. If adopted, this guidance could have a significant impact on the financial statements of the participating employers, as participants in plans with a substantial unftmded liability would be required to report their proportionate share of the unfunded liability in their government -wide financial statements. The proposed effective dates for both exposure drafts are for periods beginning after June 15, 2012, if certain conditions are met, otherwise for periods beginning after June 30, 2013. FEDERAL FUNDING ACCOUNTABILITY AND TRANSPARENCY ACT (TRANSPARENCY ACT) Effective October 1, 2010, the Transparency Act requires federal award recipients to report specific data, including compensation data in certain circumstances, related to subawards. One of the key requirements of the Transparency Act was the creation of a single, searchable website that provides the public with greater access to information on federal spending. The Transparency Act requires recipients to report first -tier subaward and executive compensation data for new federal grants as of October 1, 2010, if the initial award is equal to or over $25,000. Pass through entities (primary recipients) must report subaward data through the Federal Funding Accountability and Transparency Subaward Reporting System (FSRS) by the end of the month following the month in which the subaward obligation is made. For a more detailed discussion of the Transparency Act see Part 3, Section L of the 2011 U.S. Office of Management and Budget (OMB) Circular A -133 Compliance Supplement available at www.whitehouse.gov /omb. The OMB has issued several documents that provide guidance on the Transparency Act, including Open Government Directive — Federal Spending Transparency and Subaward and Compensation Data Reporting, available at www.whitehouse.gov /omb /open. -21-