What to Look for In Audit Reports
Fundamentals of Understanding Governmental Audit Reports
Citizen's Guide to Understanding Financial statements
What Type of Accounting System is used?
Any type of government unit that isn't the State of Michigan is called a unit
of local government or local unit. Local units and the State of Michigan use an
accounting system that is identified as fund accounting. It is called fund
accounting because financial data is grouped into funds, also known as accounts.
The accounts share a similar purpose. By grouping the accounts with similar
purposes together a local unit can easily identify resources (money) for a
specific purpose or task.
There are three general categories of funds in a local unit's audit report,
- Governmental Funds: Governmental funds are used to cover expenditures of
general operations (just like a person pays his or her household or business
bills). Examples of general operations expenditures include:
- Construction Costs
- Debt Repayment
- Local unit services that are not covered by fees Such as Public Health
and Public Safety.
- Proprietary Funds: Proprietary funds are used to keep track of (account
for) business like activities (activities supported, in part, by fees or
charges) Examples of proprietary funds include:
- Trash Collection Fees
- Water and Sewer Fees
- Park Fees
- Highway Repair Fees
- Fiduciary Funds: Fiduciary funds are used to keep track of (account for)
funds (money) that are held by the local unit in a purely custodial capacity
for a third party. An example of a fiduciary fund is the "Current Tax
Collection Fund," which holds money on behalf of another governmental unit,
such as the State of Michigan or the United States Internal Revenue Service.
How Often are Audit Reports Filed?
Local units within the State of Michigan are required by law to file an audit
report. Local units with population less than 4,000 are required to file their
audit report every two years instead of every year. All other local units with
populations over 4, 000 are required to file their audit report each year.
Occasionally, you will hear the term "CAFR" used. This stands for "Comprehensive
Annual Financial Report". A CAFR includes statistical data and additional
schedules. As the name suggests, it is more comprehensive than an audit. A local
unit is not required to file a CAFR with the State but it is not prohibited.
What is an Audit?
A local unit contracts with an independent Certified Public Accounting (CPA)
firm to opine on whether the financial statements prepared by the local unit and
presented by its management are fairly presented. In part, the CPA (auditor)
tests a sampling of financial transactions to ascertain the reliability of the
financial statements. An audit provides reasonable assurances, not absolute,
that the financial statements are free of material misstatements. Examples of
financial transactions can include verifying bank account balances, tracing
invoices, tracing cash receipts, and reviewing contracts to determine
compliance. The CPA also obtains an understanding of internal controls to assess
the risk of a material misstatement. Once the CPA completes the testing, the CPA
issues an opinion letter. This letter does the following:
- Asserts that the audit was conducted in accordance with generally accepted
- Provides an opinion on the fair presentation of the financial statements.
The opinion could be one of the following four:
- Unqualified-There are no reservations concerning the financial
statements. This is also known as a clean opinion meaning that the financial
statements appear to be presented fairly.
- Qualified-the auditor has taken exception to certain current-period
accounting applications or is unable to establish the potential outcome of a
material uncertainty which could have a material effect on the financial
statements. A qualified opinion typically includes an "except for" clause or
- Disclaimer-The auditors were engaged to perform an audit, but are unable
to express an opinion. This may be due to a lack of independence on the
auditors' part; limitations on the scope of the audit, for example, the
inability to obtain sufficient evidence; or material uncertainties for which
the auditors were unable to obtain reasonable assurance about the outcome
- Adverse-This is a type of audit opinion which states that the financial
statements do not fairly present the financial position, results of
operations, and changes in financial position, in conformity with generally
accepted accounting principles.
What is in an Actual Audit Report?
Most Audit Reports contain the following information:
- Financial Statements of the Local Unit including:
- Statement of Net Assets (Assets minus Liabilities)
- Statement of Activities (Net cost of a function)
- Balance Sheet (Assets=Liabilities plus Fund Balances)
- Statement of Revenues, Expenditures, and Changes in Fund Balance which
shows what money came into the local unit, the bills paid, and how the fund
balance has changed from one year to the next.
Financial Statements are usually presented in two different ways in the same
- Government - Wide Financial Statements: Government - Wide Financial
Statements show the financial position of the whole local unit and should be
used to assess the local unit in its entirety.
- Fund Financial Statements: Fund Financial Statements focus on the current
financial position of the separate funds of the local unit.
To have an overview of how a local unit of government is performing
financially you should focus on the financial statements of the General Fund. In
particular, you should look closely at the Statement of Revenues, Expenditures,
and Changes in Fund Balance that contains the following:
- Revenues: This tells you how much money the local unit has received from
its own operations during a fiscal year, such as:
- Property taxes
- License Fees
- Fees for Permits
- Expenditures: This tells you the bills paid by the local unit during a
fiscal year, such as:
- General Government Expenses
- Utility charges
- Public safety
- Other Financing Sources/Uses: You may see other sources or uses of money
not generated by the day to day operations. Those monies are received or used
on a one time basis and are not expected to be repeated. Examples of one time
sources of income include:
- Money resulting from issuing bonds (public borrowing of money)
- Borrowing from other funds of the local unit (interfund transfers)
- Sale of capital assets such as buildings or land.
Examples of one time uses of income include:
- Loans to other funds (interfund transfers)
- Payments related to refunding a bond
- Fund Balance: This item shows you the changes in the Fund balance, such
- If the local unit is receiving more revenue than it needs to pay its
bills its fund balance (net worth) will increase.
- If the local unit is paying out more money on its bills than it is
receiving then its fund balance will go down.
- If the fund balance goes down far enough it creates a negative fund
balance called a deficit. In Michigan any local unit with a deficit in any
of its funds at the end of its fiscal year must prepare and send to the
Michigan Department of Treasury, for approval, a Deficit Elimination Plan.
This plan provides detail of how the local unit will eliminate the deficit
within a stated period of time.
To figure out the net worth of a local unit the calculation is usually,
revenues minus expenditures, plus or minus other financing sources/uses that
will either increase or decrease the fund balance (net worth).
Fund Balances can be split into two more categories:
- Restricted Funds: Restricted funds are monies being held in this fund for
a specific purpose.
- Unrestricted Funds: Unrestricted funds are monies being held in the
general fund for all general operating purposes of the local unit.
The ending general fund balance shows the "net worth" or equity of the local
unit. The ending general fund balance should be the same number as is shown for
the fund balances reported on the balance sheet.
Notes to the financial statements are usually found in the middle of the
audit report. When you read the notes they give you insight into the details of
the financial statements and are very important for you to understand the
Budgetary comparison information is another useful part of the audit report
to review. This typically presents the original budget, the final appropriated
amounts, and the actual inflows, outflows, and balances. This is useful to
determine if resources were obtained and used in accordance with the legally