On Feb. 3, 2022, the state of California finally produced its audited financial statements for its fiscal year that ended June 30, 2020. The filing, known as an annual comprehensive financial report, was over a year late and came with an unpleasant surprise in the form of a qualified audit opinion.
State and local governments are normally expected to produce financial statements within six-to-nine months of the fiscal year’s end. California has now missed the nine-month municipal bond market filing deadline for three consecutive years. And, with less than two months to the deadline for its fiscal year 2021 financial reports (for the fiscal year that ended June 30, 2021), another late filing seems inevitable.
California’s financial reporting performance compares poorly with most other states. According to data from Truth in Accounting, the median U.S. state produced its 2020 annual comprehensive financial report 184 days after the end of its fiscal year. By contrast, California took 583 days, nearly 20 months, to file its annual comprehensive financial report for fiscal year 2020. For added perspective, it is worth noting that the Securities and Exchange Commission gives large corporations just 60 days to produce their audited financials.
State Controller Betty Yee blamed much of the delay on California’s new financial reporting system. In her cover letter of the California Annual Comprehensive Financial Report (ACFR), Yee noted she’s been flagging problems with FI$Cal:
I have consistently emphasized the need for accountability, transparency, and accuracy in the State’s financial reporting process. To provide value to stakeholders, financial reporting must be both timely and accurate. The challenges the state has experienced in its transition to FI$Cal have been thoroughly documented and are now readily apparent. In its recent FI$Cal Status report, dated January 4, 2022, the California State Auditor (CSA) highlighted missed FI$Cal project dates, insufficient staffing for project completion and maintenance, and continued financial reporting delays that potentially compromise the state’s credit rating and access to federal funds. In addition, CSA’s Internal Control and Compliance Audit Report for the Fiscal Year Ended June 30, 2020, which should be read in conjunction with this report, identified multiple departments that failed to consistently reconcile their FI$Cal accounting records to supporting information and to the accounts of SCO prior to submitting their year-end financial reports for inclusion in the ACFR, a practice that my office adamantly opposes. Such reconciliations should be an inherent requirement of a viable stand-alone accounting system, and unsatisfactory reconciliations have been a large contributor to reporting delays. The CSA’s report also identified “pervasive” findings in the overall information technology general controls environment of FI$Cal, which present a considerable risk to the state if unaddressed.
Although the state began the FI$Cal project back in 2006 and has spent almost $1 billion on it thus far, the system is still not being used in all departments and lacks certain key features, such as support for statewide loan accounting.
Further, despite this financial report taking 19 months, the state controller was unable to produce financial statements that satisfied the sate auditor. Most ACFRs are prefaced by what accountants call a “clean” audit opinion in which the auditor states that the financial statements present fairly, in all material respects, the financial position of the audited entity. In California, the State Auditor, a politically independent office, rendered such an opinion regarding the state’s Fiscal Year 2019 financial statements. But, for 2020, the state auditor provided a qualified opinion, stating:
The Employment Development Department had inadequate internal control over its accounting of money it received and spent related to unemployment benefits. As a result, the department was unable to provide complete and accurate accounting information supporting transfers from the Federal Fund to the Unemployment Programs Fund, and the amount of expenditures associated with the State’s unemployment program and with federally-funded unemployment programs…
Our responsibility is to express opinions on these fnancial statements based on our audit. Because of the matters described in the Basis for Disclaimer of Opinion on the Unemployment Programs Fund paragraph, however, we were not able to obtain sufcient appropriate audit evidence to provide a basis for an audit opinion on the fnancial statements of the Unemployment Programs Fund.
Controller Yee’s introduction section noted the “modified audit opinions”:
Finally, CSA’s report identified material and pervasive accounting and reporting deficiencies involving the State’s unemployment programs, linked to a large state department’s transition to FI$Cal. These deficiencies resulted in the modified audit opinions expressed by CSA on the accompanying financial statements of the state for the year ended June 30, 2020, the first modified opinion received on California’s ACFR in nearly two decades.
In its more detailed Report on Internal Control over Financial Reporting and on Compliance, the report submitted by acting State Auditor Michael S. Tilden elaborated on its concerns with California’s unemployment insurance accounting. For example, the state auditor was not convinced that the Employment Development Department (EDD) reasonably estimated the volume of fraudulent unemployment claims it paid in the wake of the COVID-19 pandemic. This estimate has accounting implications because states cannot use federal funds for improper unemployment payments. If fraudulent payments are underestimated, the state’s reimbursements receivable from the federal government are overstated.
The qualified audit opinion is the latest blow suffered by the Employment Development Department as it tries to recover from a variety of problems. On Jan. 28, a week before the state audit appeared, Employment Development Department Director Rita Saenz stepped down, just over a year of taking on the position. Under her leadership, EDD had fully implemented just five of 21 recommendations made by the state auditor to both combat fraud and improve its ability to make timely payments. The Associated Press highlighted some of the problems:
California’s troubled unemployment benefits department will soon have its third director in the last two years.
Employment Development Department Director Rita Saenz stepped down Friday after just over one year on the job. She’ll be replaced by Nancy Farias, who has been a deputy director at the department since 2020. She’ll earn a salary of $204,613.
Saenz, who led the California Department of Social Services in the early 2000s and is a former executive with Xerox Corp., came out of retirement to lead the department in 2021 as it was plagued by fraud and a backlog of payments. The department was overwhelmed with unemployment benefits at the start of the COVID-19 pandemic after Gov. Gavin Newsom issued the nation’s first statewide stay-at-home order that forced many businesses to close.
Since then, the agency has received 26.4 million claims and paid $180 billion in benefits. But about $20 billion of those payments went to scammers who posed as prison inmates and, in one instance, U.S. Sen. Dianne Feinstein to fool state officials into sending them checks.
The issues with Fi$Cal and the Employment Development Department are among the many information technology management challenges plaguing the California’s state government right now. Fi$Cal’s slow, overbudget and error-riddled implementation is increasingly looking like a failure. State leaders need to answer the questions raised in this state audit, get moving on the next audit, and start to provide taxpayers with more transparency and accountability.