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2012 Monticello Auditor's Management Letter Management Report for City of Monticello, Minnesota December 31, 2012 -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, 2012 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, 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, 2012:  We have issued an unqualified opinion on the City’s financial statements. Our audit opinion included an emphasis of a matter paragraph to direct the financial statement readers’ attention to the discussion of the City’s default on the telecommunication bonds.  We noted one matter involving the City’s internal control over financial reporting that we considered to be material weaknesses: o During our audit, we noted a material prior period adjustment, as detailed in the notes to basic financial statements, that was necessary to adjust for payments made in prior periods on escrow deposits that were initially expensed, rather than reducing the current liabilities. Auditing standards consider the necessity of recording a material prior period adjustment to be indicative of a material weakness in the related internal controls.  The results of our testing disclosed no instances of noncompliance required to be reported under Government Auditing Standards.  We reported three findings based on our testing of the City’s compliance with Minnesota laws and regulations: o The City held two time deposits that exceeded Federal Depository Insurance Coverage (FDIC) coverage limit deeming them improper under Minnesota Statute § 118A.05. o The City entered into contracts that did not follow state statute § 471.425, which states each contract of a municipality must require the prime contractor to pay any subcontractor within 10 days of the prime contractor’s receipt of payment from the municipality for undisputed services provided by the subcontractor. The contractor must require the prime contractor to pay interest of 1 1/2 percent per month to the subcontractor on any unpaid balance. o The City is required by Minnesota Statute § 412.271 to receive signed declarations for payments to employees. We noted that for several claims for payroll, mainly community center employees, the City did not receive the required signed declaration. -2- 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, 2012, 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 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. 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. During this year’s audit testing, no similar adjustment was noted.  In the prior year, we noted that the City had one disbursement that was not paid within the 35-day period as required by Minnesota Statute. During this year’s audit testing, all disbursements we tested were paid within the 35-day period. 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 fiscal year ended December 31, 2012, the City implemented Governmental Accounting Standards Board (GASB) Statement No. 63, Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position. This statement changed how governmental entities present a statement of net position, adding two new basic financial statement elements, and replacing “net assets” with “net position” as the terminology used to describe the difference between the other four elements. The two basic financial statement elements added are “deferred inflows of resources” and “deferred outflows of resources.” These new elements are differentiated from assets (deferred outflows of resources) and liabilities (deferred inflows of resources), but have similar effects on net position. -3- 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 to develop these accounting 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. 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. -4- MANAGEMENT REPRESENTATIONS We have requested certain representations from management that are included in the management representation letter dated June 26, 2013. 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. Other information, including the introductory section, supplemental information, 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. With respect to the supplemental information accompanying the financial statements, 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 supplemental information to the underlying accounting records used to prepare the basic financial statements or to the basic financial statements themselves. With respect to the introductory section and the statistical section accompanying the basic financial statements, our procedures were limited to reading this other information, and in doing so we did not identify any material inconsistencies with the audited financial statements. -5- FUNDING CITIES IN MINNESOTA LEGISLATION The 2011 Legislative Session was very long and difficult. It featured a large budget deficit and a very contentious battle between the Democratic Governor and the Republican-led House and Senate; and resulted in numerous vetoes, a special session, and the longest shutdown of non-essential state government services in Minnesota history. The outlook going into the 2012 Legislative Session was brightened somewhat by positive economic news. The November 2011 financial forecast projected a surplus of $876 million in the state general fund for the biennium ending June 30, 2013, later revised to a surplus of almost $1.2 billion in the February 2012 forecast. This meant that the Legislature would not have to pass a “supplemental budget” to deal with projected shortfalls for the second half of the biennium, as was the case in the previous short session. The positive feeling was short-lived, however, as the 2012 Legislative Session quickly degenerated into more partisan squabbling. Once again, the Governor exercised his veto power a number of times to block Republican legislative initiatives. The Republican Legislature reacted by introducing several potential amendments to the state constitution, which once passed would be subject to a public vote and could not be vetoed by the Governor. Two potential amendments, addressing voter identification and the legal definition of marriage, made it on the ballot for the November 2012 election and were voted down by the public. In the end, the main accomplishment of the session was a hard-fought compromise on partial public funding for a Vikings stadium. The 2012 Legislature did pass a state bonding bill, a technical tax bill (after two omnibus tax bills were vetoed), and a few other bills that impacted Minnesota cities. The following is a summary of recent legislative activity affecting the finances of Minnesota cities in 2012 and into the future: Local Government Aid (LGA) – The state-wide LGA appropriation for fiscal 2012 was $425.2 million. For fiscal 2012, cities received the lesser of their 2010 actual or 2011 certified LGA allocations. For fiscal 2013 and beyond, the state-wide LGA appropriation had been set to increase to $426.4 million; however, the 2012 Legislature made some changes. LGA payments for 2013 are frozen at 2012 levels for cities with a population of 5,000 or more. For cities with populations below 5,000, 2013 LGA will be the greater of their 2012 aid or the amount they would have received for 2013 under existing law. The Legislature also froze the base for calculating the maximum increases and decreases for a city’s 2013 and 2014 LGA to their 2012 aid. Beginning in 2015, the previous year’s LGA payment will be used to calculate the minimum and maximum increases. Market Value Homestead Credit (MVHC) – The 2011 Legislature eliminated the MVHC reimbursement program beginning in fiscal 2012. Rather than receiving a property tax credit, qualifying homeowner taxpayers had a portion of the market value of their house excluded from their taxable market value. This new system provides 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 varies depending on the makeup of the taxing jurisdictions that levy on their particular property. Depositories Authorized to Redeposit City Funds – Banks designated as depositories of city funds are authorized to redeposit the funds in another bank, savings and loan, or credit union located within the United States, provide the redeposited funds are fully covered by federal depository insurance (FDIC or NCUA). This law change was enacted to make additional federal depository insurance available to cover municipal deposits in anticipation of the December 31, 2012 sunset of the temporary unlimited coverage for non-interest bearing municipal accounts provisions of the Dodd-Frank Act. -6- Municipal State Aid (MSA) Eligibility – Three changes were made that protect the MSA of cities dropping below a population of 5,000, which is the eligibility threshold for receiving MSA for street maintenance. Under previous law, if a city that formerly had a population of 5,000 or more fell below a 5,000 population at the 2010 decennial census, it would have been ineligible for MSA beginning in fiscal 2012. The first change enacted allows previously eligible cities falling below 5,000 population at a decennial census to continue to be considered to have a population of 5,000 for purposes of calculating MSA, thereby remaining eligible, until the end of the fourth year of the decade. The second change enacted states that for purposes of calculating MSA, which is based 50 percent on population, a city is deemed to have a population equal to the greater of 5,000 or as otherwise determined by statute. The final change requires that, for 2013 MSA only, the aid be allocated in a manner that backfills the MSA cities lost in 2012 due to population drops. Contractor Bond Threshold – The threshold at which a municipality is required to obtain contractor performance and payment bonds for public construction contracts was increased from $75,000 to match the current competitive bid law threshold of $100,000. Municipal Detachment of Parcels – A number of corrections and clarifications were made related to petitions for the detachment of parcels from a municipality. The changes affect petition requirements, the hearing process, and the sharing of associated hearing and mediation costs with the landowners. Tort Liability Limits for Cities Contracting With Certain Nonprofits – The liability limit on claims against cities involving nonprofit organizations that are engaged in or administer outdoor recreational activities that are funded or authorized by a municipality were lowered from $1.5 million to $1.0 million. -7- PROPERTY TAXES Minnesota cities rely heavily on local property tax levies to support their governmental fund activities. In recent years this dependence has been heightened due to reductions in state aids and fees from new development due to the struggling economy. As a result, many cities have repeatedly been faced with the difficult choice of either reducing services or increasing taxes on their already overburdened constituents. Property values within Minnesota cities experienced average decreases of 5.7 percent and 8.8 percent for taxes payable in 2011 and 2012, respectively, as market values have continued to slide despite recent signs of improvement in other areas of the economy. In comparison, the City’s taxable market value decreased 4.6 percent for taxes payable in 2011 and decreased 6.9 percent for taxes payable in 2012. The market value for taxes payable in 2012 is based on estimated values as of January 1, 2011. 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 2003200420052006200720082009201020112012 Taxable Market Value 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 2011 decreased 2.2 percent and decreased 4.4 percent in 2012. 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 $20,000,000 2003200420052006200720082009201020112012 Local Tax Capacity -8- The following table presents the average tax rates applied to city residents for each of the last two levy years, along with comparative state-wide and metro-area rates. The general increase in rates reflects both the increased reliance of local governments on property taxes and the recent decline in tax capacities. Rates expressed as a percentage of net tax capacity 20112012 20112012 Average tax rate City 42.5 46.3 46.8 49.8 County 43.7 46.8 39.3 43.5 School25.2 27.3 27.0 28.3 Special taxing6.4 6.8 1.5 1.2 Total117.8127.2 114.6122.8 City of Monticello All Cities State-Wide The City’s portion of the tax rate has been higher than average in recent years. The increase for 2012 was caused by the City’s need to increase its levy to offset reductions in state aids. -9- GOVERNMENTAL FUNDS OVERVIEW This section of the report provides an overview of the financial trends and activities of the City’s governmental funds, which includes the General Fund, special revenue, debt service, and capital projects funds. These funds are used to account for the basic services the City provides to all of its citizens, which are financed primarily with property taxes. The governmental fund information in the City’s financial statements focuses on budgetary compliance, and the sufficiency of each governmental fund’s current assets to finance its current liabilities. GOVERNMENTAL FUND BALANCES The following table summarizes the changes in the fund balances of the City’s governmental funds during the year ended December 31, 2012, presented both by fund balance classification and by fund: Increase 20122011 (Decrease) Fund balances of governmental funds Total by classification Nonspendable2,259,503$ 1,685,673$ 573,830$ Restricted21,480,938 22,140,662 (659,724) Committed– 6,036,324 (6,036,324) Assigned8,655,488 9,138,626 (483,138) Unassigned3,136,127 (927,735) 4,063,862 Total governmental funds 35,532,056$ 38,073,550$ (2,541,494)$ Total by fund Major funds General3,478,507$ 4,410,637$ (932,130)$ Special revenue funds Community Center179,500 978,008 (798,508) Economic Development Authority7,461,554 7,478,651 (17,097) Debt Service Fund12,952,896 13,640,364 (687,468) Capital Project Fund Capital Outlay Revolving1,945,695 2,329,525 (383,830) Sanitary Sewer Access1,866,876 3,135,748 (1,268,872) Capital Projects1,911,603 (1,360,666) 3,272,269 Nonmajor funds5,735,425 7,461,283 (1,725,858) Total governmental funds 35,532,056$ 38,073,550$ (2,541,494)$ Governmental Fund Changes in Fund Balance Fund Balance as of December 31, As reflected in the table above total governmental fund balance decreased by $2,541,494. The decrease reflects the approved use and spend down of fund balance. The classification of fund balances changed dramatically in fiscal 2012, based on changes in policy approved by the City Council. The decline in the Community Center Fund balance mostly relates to capital related costs, which totaled $1,662,666 in fiscal 2012. -10- GOVERNMENTAL FUNDS REVENUE The following table presents the per capita revenue of the City’s governmental funds for the past three years, along with state-wide averages. We have included the most recent comparative state-wide averages available from the Office of the State Auditor to provide a benchmark for interpreting the City’s data. The amounts received from the typical major sources of governmental fund revenue will naturally vary between cities based on factors such as the City’s stage of development, location, size and density of its population, property values, services it provides, and other attributes. It will also differ from year-to-year due to the effect of inflation and changes in the City’s operation. Also, certain data on these tables may be classified differently than how they appear on the City’s financial statements in order to be more comparable to the state-wide information, particularly in separating capital expenditures from current expenditures. We have designed this section of our management report using per capita data in order to better identify unique or unusual trends and activities of your city. We intend for this type of comparative and trend information to complement, rather than duplicate, information in the Management’s Discussion and Analysis. An inherent difficulty in presenting per capita information is the accuracy of the population count, which for most years is based on estimates. Year 201020112012 Population2,500–10,000 10,000–20,000 20,000–100,000 11,50112,75912,840 Property taxes390$ 363$ 406$ 636$ 572$ 641$ Tax increments40 48 51 100 82 80 Franchise fees and other taxes27 36 30 32 27 26 Special assessments70 56 56 127 145 148 Licenses and permits23 21 31 19 20 21 Intergovernmental revenues283 263 152 141 112 42 Charges for services95 79 78 251 176 162 Other 65 75 65 131 162 120 Total revenue993$ 941$ 869$ 1,437$ 1,296$ 1,240$ December 31, 2011 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 2012 was $1,240, a decrease of about 4.3 percent from the prior year. Property taxes increased $69 per capita as the City had an increase in property tax levy. This increase is offset by a decrease in intergovernmental revenues of $70 per capita due to a significant portion of revenues received in the prior year were earmarked for specific projects such as the purchase of Phase III of the Bertram Chain of Lakes. Other revenue also decreased, $42 per capita, mainly as a result of slower appreciation in values on long-term investments and lower yields on new investments. -11- GOVERNMENTAL FUNDS EXPENDITURES Similar to our discussion of revenues, the expenditures of governmental funds will vary from state-wide averages and from year-to-year, based on the City’s circumstances. Expenditures are classified into three types as follows:  Current – These are typically the general operating-type expenditures occurring on an annual basis, and are primarily funded by general sources such as taxes and intergovernmental revenues.  Capital Outlay and Construction – These expenditures do not occur on a consistent basis, more typically fluctuating significantly from year-to-year. Many of these expenditures are project-oriented, which are often funded by specific sources that have benefited from the expenditure, such as special assessment improvement projects.  Debt Service – Although the expenditures for debt service may be relatively consistent over the term of the respective debt, the funding source is the important factor. Some debt may be repaid through specific sources such as special assessments or redevelopment funding, while other debt may be repaid with general property taxes. The City’s expenditures per capita of its governmental funds for the past three years, together with state-wide averages, are presented in the following table: Year 201020112012 Population2,500–10,000 10,000–20,000 20,000–100,000 11,50112,75912,840 Current 126$ 99$ 82$ 174$ 160$ 158$ 231 225 238 146 135 135 114 108 89 136 131 133 79 96 87 188 190 177 74 81 82 277 133 101 624$ 609$ 578$ 921$ 749$ 704$ Capital outlay and construction258$ 271$ 233$ 360$ 319$ 220$ Debt service 186$ 148$ 109$ 435$ 381$ 403$ 60 48 41 135 108 101 246$ 196$ 150$ 570$ 489$ 504$ Interest and fiscal General government Public safety Street maintenance and lighting Culture and recreation All other Governmental Funds Expenditures per Capita With State-Wide Averages by Population Class City of Monticello Principal December 31, 2010 State-Wide 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 $45 per capita in 2012 mainly due to the decrease in all other costs (mostly economic development) decreasing $32 per capita. 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 $15 per capita higher in calendar 2012 as approved with the individual debt service schedules. -12- GENERAL FUND The City’s General Fund accounts for the financial activity of the basic services provided to the community. The primary services included within this fund are the administration of the municipal operations, police and fire protection, building inspection, streets and highway maintenance, and culture and recreation. The following graph displays the City’s General Fund trends of financial position and changes in the volume of financial activity. Fund balance and cash balance are typically used as indicators of financial health or equity, while annual expenditures are often used to measure the size of the operation. $– $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000 $5,000,000 $5,500,000 $6,000,000 $6,500,000 $7,000,000 $7,500,000 $8,000,000 $8,500,000 20052006200720082009201020112012 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, 2012 was $3,582,587, which decreased $1,616,204 from 2011. Total fund balance at December 31, 2012 was $3,478,507, down $932,130 (including the prior period adjustment) from the prior year. Most of this decline was due to transfers to support other funds totaling $2,326,995. Of this total fund balance, $342,380 is nonspendable and $3,136,127 was unassigned. This fund balance level represents approximately 53.4 percent of the City’s annual General Fund expenditures, based on 2012 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. -13- The following illustrations provide you with the components of the City’s General Fund revenue compared to budget for 2012: Other Charges for Services Intergovernmental Licenses and Permits Property Taxes General Fund Revenue Budget to Actual Budget Actual Total General Fund revenues for 2012 were $7,313,348, which was $564,950 (8.4 percent) over the final budget. Property taxes were over budget by $275,411, mostly due to collections of prior year delinquencies and lower abatements than allowed for in the budget. Other revenues also exceeded budgeted amounts by $260,836 as a result of receiving a nearly $200,000 insurance claims during the year. The following graph presents the City’s General Fund revenue sources for the last five years. The graph reflects the City’s increasing reliance on taxes and user fees to finance its General Fund operations. $– $400,000 $800,000 $1,200,000 $1,600,000 $2,000,000 $2,400,000 $2,800,000 $3,200,000 $3,600,000 $4,000,000 $4,400,000 $4,800,000 $5,200,000 $5,600,000 $6,000,000 TaxesIntergovernmentalOther General Fund Revenue by Source Year Ended December 31, 2008 2009 2010 2011 2012 Overall, General Fund revenues increased $713,081 (10.8 percent) from the previous year. The largest increase was in property taxes, which increased $593,907 due to an increase in the tax levy and an increase in the collections on delinquent accounts. -14- The following graphs illustrate the components of General Fund spending for 2012 compared to budget: General Governmental Public Safety Public Works Culture and Recreation Other General Fund Expenditures Budget to Actual Budget Actual Total General Fund expenditures for 2012 were $6,510,668, which was $237,730 (3.5 percent) under budget. The public works area was under budget by $183,555, which included $96,000 allocated for capital outlay that went unspent. The following illustrations provide you with the components of the City’s General Fund spending compared to budget for 2012 and 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 $2,250,000 $2,500,000 General Governmental Public SafetyPublic WorksCulture and Recreation Other General Fund Expenditures by Function Year Ended December 31, 2008 2009 2010 2011 2012 Overall, General Fund expenditures decreased $17,646 (0.3 percent) from the prior year. Economic development expenditures decreased $103,419, which was mainly due to the decrease in other services and charges for the downtown study in the prior year. -15- ENTERPRISE FUNDS OVERVIEW The City maintains a number of enterprise funds to account for services the City provides that are financed primarily through fees charged to those utilizing the service. This section of the report provides you with an overview of the financial trends and activities of the City’s enterprise funds, which includes the Water Utility, Sewage Utility, Liquor Operations, Cemetery, and Fiber Optics Funds. ENTERPRISE FUNDS FINANCIAL POSITION The following table summarizes the changes in the financial position of the City’s enterprise funds during the year ended December 31, 2012, presented both by classification and by fund: \ Increase 20122011 (Decrease) Net position of enterprise funds Total by classification Net investment in capital assets23,698,091$ 25,031,043$ (1,332,952)$ Restricted19,350 19,350 – Unrestricted7,642,046 6,901,353 740,693 Total enterprise funds 31,359,487$ 31,951,746$ (592,259)$ Total by fund Water15,462,946$ 14,789,228$ 673,718$ Sewage23,072,290 22,387,257 685,033 Liquor1,008,519 3,964,936 (2,956,417) Cemetery622,747 628,106 (5,359) Fiber Optics(8,807,015) (9,817,781) 1,010,766 Total enterprise funds 31,359,487$ 31,951,746$ (592,259)$ Enterprise Funds Change in Financial Position Net Position as of December 31, In total, the net position of the City’s enterprise funds decreased by $592,259 during the year ended December 31, 2012. The significant operating loss of about $3.4 million in the Fiber Optics Fund contributed to the overall decrease. Transfers into these funds of $2,420,489 limited the over decline in fiscal 2012. Depreciation expense on capital assets in excess of current year additions reduced the overall net investment in capital assets in enterprise fund operations. The Liquor Fund net position declined due to transfers to other funds totaling $3.5 million in fiscal 2012. -16- Water Enterprise Fund The following graph presents nine 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 200420052006200720082009201020112012 Water Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income Before Depreciation At December 31, 2012, the Water Enterprise Fund had a cash balance of $4,287,475 and net position of $15,462,946. Net position consisted of $10,854,254 in net investment in capital assets and $4,608,692 in unrestricted net position. Operating revenue in the Water Enterprise Fund is $1,334,445, an increase of $244,591 from the prior year. This increase is related to the City implementing a rate increase in its billing structure. Water Enterprise Fund operating expenses for 2012 were $1,118,789, a decrease of $48,783, mostly in miscellaneous expenses related to uncollectible accounts. As shown in the above graph, operating income before depreciation has been steadily increasing over the past few years. It is important that this fund continue to have positive operating results so as not to place an additional burden on other city funds. It is also important that the City continue to monitor water rates so that they are designed to also provide for future repairs and replacement of the infrastructure assets. -17- Sewage Enterprise Fund The following graph presents nine 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 200420052006200720082009201020112012 Sewage Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2012, the Sewage Enterprise Fund had a cash balance of $2,755,120 and net position balance of $23,072,290. Net position consisted of $19,883,076 in net investment in capital assets and $3,189,214 of unrestricted net position. Sewage Enterprise Fund operating revenues for 2012 were $1,875,351, which is $138,220 more than the previous year. Most of this increase relates to an increase in sewage rates. Operating expenses for 2012 were $2,458,932, which is $143,441, or 6.2 percent, higher than 2011. This increase is due to the increase in professional fees related to the waste water treatment plant services. 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 sewage rates so they are designed to also provide for future repairs and replacement of infrastructure assets. -18- Liquor Enterprise Fund The following graph presents nine 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 200420052006200720082009201020112012 Liquor Enterprise Fund Year Ended December 31, Sales Cost of Sales Operating Expenses Operating Income (Loss) The Liquor Enterprise Fund ended 2012 with net position of $1,008,519, a decrease of $2,956,417 from the prior year. Of the net position balance, $358,854 represents the investment in liquor capital assets, leaving $649,665 of unrestricted net position. Liquor sales for 2012 were $4,854,798, an increase of $201,322 (4.3 percent) from last year. Sales have steadily increased over the last several years, increasing by about 42.3 percent since 2004. The Liquor Enterprise Fund generated a gross profit of $1,214,745 in 2012, or about 25.0 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 2012. Operating expenses for 2012 were $662,002, an increase of $3,003 from last year. -19- Fiber Optics Enterprise Fund In 2007, the City started its Fiber Optics Project, which will run a fiber optics system to every premise in the City to provide customers with phone, high-speed Internet, and cable television services as a self-supporting system with competitive pricing, which will act as an economic development tool for the City. The project was completed as of the year ended December 31, 2010 and became fully operational. The following graph presents three 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 201020112012 Fiber Optics Enterprise Fund Year Ended December 31, Operating Revenue Operating Expense Operating Income (Loss) Before Depreciation At December 31, 2012, the Fiber Optics Enterprise Fund had a cash balance (including interfund borrowing) of $2,993,788 and a deficit net position balance of ($8,807,015). Net position consisted of a deficit of ($8,001,487) in net investment in capital assets and a deficit of ($805,828) of unrestricted net position. The Fiber Optics Fund completed its second full year of operating in fiscal 2012. The operating loss in this fund during this year was $1,586,147. After you add in over $1,848,137 in interest on borrowing from other funds and bonds outstanding the total overall loss in the fund was almost $3.5 million. This is a staggering figure considering the total overall annual expenses of the City are around $23.8 million. At December 31, 2012, this fund had $26.4 million outstanding in bonds. As a result of the continued operating loss, the City went into default on these bonds by not making the scheduled December interest payment on the bonds. As a result of poor operating results, we highly recommend the City continue to take action toward revising its strategic plan for the future of this fund. The continued development of this plan would include a discussion on how the current financial results compare to the original strategic plan for this fund. The continued development of this plan should consider all options available to the City as it relates to this enterprise fund. Most importantly, this 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. -20- 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 financial 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 capital assets, restricted, and unrestricted. The following table presents the components of City’s net position as of December 31, 2012 and 2011, for governmental activities and business-type activities: Increase 20122011 (Decrease) Net position Governmental activities Net investment in capital assets40,525,009$ 38,242,040$ 2,282,969$ Restricted13,061,044 16,894,936 (3,833,892) Unrestricted25,119,107 24,758,269 360,838 Total governmental activities78,705,160 79,895,245 (1,190,085) Business-type activities Net investment in capital assets23,698,091 25,031,043 (1,332,952) Restricted19,350 19,350 – Unrestricted7,642,046 6,901,353 740,693 Total business-type activities31,359,487 31,951,746 (592,259) Total net position 110,064,647$ 111,846,991$ (1,782,344)$ December 31, The City’s total net position at December 31, 2012 was $1,782,344 lower than at the beginning of the year. The overall financial results would be better if not for the significant decline in net position related to the Fiber Optics Project, which totaled $3.4 million before transfers. -21- STATEMENT OF ACTIVITIES The Statement of Activities tracks the City’s yearly revenues and expenses, as well as any other transactions that increase or reduce total net position. These amounts represent the full cost of providing services. The Statement of Activities provides a more comprehensive measure than just the amount of cash that changed hands, as reflected in the fund-based financial statements. This statement includes the cost of supplies used, depreciation of long-lived capital assets, and other accrual-based expenses. The following table presents the change in net position of the City for the years ended December 31, 2012 and 2011: 2011 Program ExpensesRevenuesNet ChangeNet Change Net (expense) revenue Governmental activities General government 2,103,737$ 619,992$ (1,483,745)$ (1,590,528)$ Public safety 1,819,378 322,945 (1,496,433) (1,430,188) Public works 5,045,729 2,334,360 (2,711,369) (2,688,486) Sanitation 500,037 53,077 (446,960) (443,389) Culture and recreation 2,693,598 1,130,463 (1,563,135) 32,719 Economic development 803,594 – (803,594) (1,199,936) Interest on long-term debt 1,298,869 – (1,298,869) (1,248,716) Business-type activities Water 1,118,789 1,304,923 186,134 (89,439) Sewer 2,480,657 1,850,919 (629,738) (628,497) Liquor 662,002 1,214,745 552,743 492,172 Cemetery 26,132 19,810 (6,322) (6,459) Fiber optic 5,228,428 1,747,587 (3,480,841) (4,092,222) 23,780,950$ 10,598,821$ (13,182,129) (12,892,969) General revenues Taxes 8,746,348 8,792,511 Franchise taxes 339,518 341,362 General aids and grants 38,618 19,359 Investment earnings 1,032,311 1,963,264 Other general revenues 640,959 1,910,010 Gain on sale of assets 11,575 – 10,809,329 12,685,144 (2,372,800)$ (207,825)$ 2012 Total net (expense) revenue Total general revenues Change in net assets One of the goals of this statement is to provide a side-by-side comparison to illustrate the difference in the way the City’s governmental and business-type operations are financed. The table clearly illustrates the dependence of the City’s governmental operations on general revenues, such as property taxes and unrestricted grants. It also shows if the City’s business-type activities are generating sufficient program revenues (service charges and program-specific grants) to cover expenses. This is critical given the current downward pressures on the general revenue sources. -22- ACCOUNTING AND AUDITING UPDATES 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. 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. 65 – ITEMS PREVIOUSLY REPORTED AS ASSETS AND LIABILITIES This statement establishes accounting and financial reporting standards that reclassify, as deferred outflows of resources or deferred inflows of resources, certain items previously reported as assets and liabilities; and recognizes, as outflows or inflows of resources, certain items previously reported as assets and liabilities. This statement also provides financial reporting guidance related to the impact of the financial statement elements deferred outflows of resources and deferred inflows of resources, such as changes in the determination of the major fund calculations and limiting the use of the term deferred in financial statement presentations. The provisions of this statement are effective for financial statements for periods beginning after December 15, 2012. Earlier application is encouraged. GASB STATEMENT NO. 67 – FINANCIAL REPORTING FOR PENSION PLANS – AN AMENDMENT OF GASB STATEMENT NOS. 25 AND 50 The primary objective of this statement is to improve financial reporting by state and local government pension plans. GASB Statement No. 67 replaces the requirements of GASB Statement Nos. 25 and 50 for pension plans that are administered through trusts or equivalent arrangements that meet the following criteria: contributions from employers and nonemployer contributing entities to the pension plan and earnings on those contributions are irrevocable; pension plan assets are dedicated to providing pensions to plan members in accordance with the benefit terms; and pension plan assets are legally protected from the creditors of employers, nonemployer contributing entities, and the pension plan administrator. If the plan is a defined benefit pension plan, plan assets also are legally protected from creditors of the plan members. The requirements of GASB Statement Nos. 25 and 50 remain applicable to pension plans that are not administered through trusts covered by the scope of this statement and to defined contribution plans that provide post-employment benefits other than pensions. The statement makes a number of changes in the financial statement presentation, measurement, and required disclosures relating to the reporting of these types of pension plans. This statement is effective for financial statements for fiscal years beginning after June 15, 2013. Earlier application is encouraged. 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 50, as they relate to pensions that are provided through pension plans administered as trusts or equivalent arrangements that meet certain criteria (as described earlier for GASB Statement No. 67). The requirements of GASB Statement Nos. 27 and 50 remain applicable for pensions that are not covered by the scope of this statement. -23- This statement establishes standards for measuring and recognizing liabilities, deferred outflows of resources, deferred inflows of resources, and expense/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 nonemployer 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 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. 69 – GOVERNMENT COMBINATIONS AND DISPOSALS OF GOVERNMENT OPERATIONS This statement provides accounting and financial reporting guidance, including disclosure requirements, for government combinations and disposals of government operations. Government combinations include mergers, acquisitions, and transfers of operations. Included within the scope of this statement are combinations of governmental entities or combinations of governmental entities, with nongovernmental entities (such as a nonprofit entity) as long as the new or continuing organization is a government. This statement does not apply to combinations in which a government acquires an organization that continues to exist as a separate entity, or acquires an equity interest in an organization that remains legally separate from the acquiring government. A disposal of operations occurs when a government either transfers or sells specific operations. The provisions of this statement are effective for financial statements for periods beginning after December 15, 2013. Earlier application is encouraged. PROPOSED CHANGES TO REQUIREMENTS FOR FEDERAL GRANTS The U.S. Office of Management and Budget (OMB) has issued for comment Proposed OMB Uniform Guidance: Cost Principles, Audit, and Administrative Requirements for Federal Awards, which proposes broad revisions to OMB Circular A-133 and other key grant reforms. The proposed guidance includes a number of significant changes to the federal Single Audit process, including; an increase in dollar threshold for requiring a Single Audit, changes to the process for determining major programs, a reduction in the percentage of expenditures required to be covered by a Single Audit, revised criteria for determining low-risk auditees, a reduction in the types of compliance requirements to be tested, and an increase in the threshold for reporting questioned costs. The proposed guidance would also consolidate OMB circulars and cost principles; and change certain federal requirements related to indirect costs, time and effort reporting, and grant administration.