This article was previously published in the Rochester Business Journal on April 2, 2021.
“Experience is what you get when you didn’t get what you wanted.”
-- Randy Pausch
The past 12 months have been anything but normal. The pandemic has certainly provided each of us with experience that we will never forget. However, in every cloud, there is usually some silver lining. This article is focused on what I have learned during the pandemic in terms of improving communications with our client Board and Management Team members.
Most of you know that there have been four significant pieces of legislation at the Federal level providing an extraordinary amount of Federal stimulus:
- Coronavirus Aid, Relief, and Economic Security (CARES) Act – March 2020
- Paycheck Protection Plan Flexibility Act – June 2020
- Trump’s Consolidated Appropriations Act – December 2020
- Biden’s American Rescue Plan – March 2021
The Federal stimulus amounts received by tax-exempt providers have resulted in substantial uncertainty with respect to how New York State will intend to take advantage of the provider receipt of Federal stimulus, which may be recouped, clawed back, or viewed as a duplicative double dip of what otherwise would have been State budget dollars. As a result of the situation described, in many cases, Management and Board members of tax-exempt providers have been and continue to be in a very difficult position related to how much of Federal stimulus dollars can be reported as revenue in calendar 2020, with a similar dilemma existing for 2021.
Management and external auditors need to have clarity regarding the following unknowns:
- New York State funding sources, directed by Governor Cuomo, have consistently informed providers that there is a distinct possibility of claw backs and recoupments of State funding that has been supplemented by the various Federal stimulus initiatives.
- New York State is expected to receive $30-50 billion of additional funding from the American Rescue Plan. We can thank Senator Schumer for leading this successful effort.
- The dilemma and uncertainty, without regard to Governor Cuomo’s current situation, is that no one knows what decisions will be made with respect to how the State will proceed with respect to the allocation of the $30-50 billion as well as deciding whether funding for State programs and services should be recouped and replaced with Federal stimulus dollars received by providers.
If you are confused by the foregoing paragraph, please join the crowd of every tax-exempt CEO and their respective audit firms. No one knows or can predict with certainty how this situation will be resolved from a financial perspective.
The situation described above requires an extraordinary level of timely and candid communication between and among Board members, the Management Team, and your external auditors.
The following is a brief summary of what to expect from your auditors, and more importantly, what to ask them during this once-in-a-century pandemic.
What to Expect
1. Turnover rates have increased substantially for many providers. There is no separate classification or reporting of turnover costs in traditional financial reporting. Turnover costs include but are not limited to the following:
- Exit interview and processing time for termination from payroll and fringe benefit programs
- Recruiting and posting of position
- Review of applicants
- Cost of interview process
- Offer letter and registration for fringe benefits including cost of background /reference checks
- New orientation training and onboarding process with basic training
We believe that reporting the number of both terminated and newly hired employees together with an estimated average cost associated with the cost elements described above is extremely important information that is typically not determinable from monthly financial reporting or annual audited financial statements. Our experience to date demonstrates that a single position turnover can require incremental costs of $4,000 to $8,000 for most tax-exempt service providers.
2. In addition to the above, the pandemic may have resulted in significant increases in overtime dollars and hazard pay. These are data elements that should be identified and reported together with a clear understanding of how Management has effective procedures in place to monitor and properly approve these costs as effectively as possible.
3. For the better part of 20 years, auditors have been required to communicate certain matters mandated by auditing standards. This Required Communications report covers many areas, including important disclosures related to audit adjustments, management estimates used in preparing the financials, fraud/illegal acts discovered in the audit, internal control weaknesses, and any unusual accounting adjustments reflected in the financial statements. This required document is a qualitative assessment of the annual audit process.
4. Auditors are required to report internal control weaknesses and recommendations identified during the audit process. If your organization has not received internal control recommendations in a formal management letter, ask the auditors why. The absence of a management letter should not be interpreted as perfection in your internal control procedures.
5. The audited financial statements, with required footnote disclosures, are virtually unintelligible and mind-numbing to the typical reader lacking formal accounting expertise. This situation has led many organizations to develop dashboards providing Key Performance Indicators and Key Financial Ratios. For example, the audited financial statements will not tell you the vacancy percentage in residential programs, which is a key data element in understanding the impact of the pandemic on your financial statements. Dashboards typically provide approximately 20 data elements that both Management and Board view as important to understanding the traditional financial statement format.
As tax-exempt Boards and their Audit Committees receive the external auditor’s presentation of audit results, I believe that the required reports should be supplemented by the following value-added information:
- Discussion and analysis of financial results for the year by program/service component.
- Multi-year comparison of key financial ratios in comparison to industry targets/benchmarks.
- Reporting of the Key Performance Indicators that have been developed by Management and hopefully summarized during the course of the year in its monthly financial reporting package, preferably in a dashboard format.
- Report or commentary on Information Technology / Cybersecurity and Regulatory Compliance procedures and controls.
- Summary of additional audit procedures performed to address the risk of fraud and illegal acts.
- Assessment of the quality and level of audit preparation by internal financial staff.
- Summary of operating and/or strategic issues that the Board should consider for further discussion.
A clear and comprehensive audit report communicated to the Board or its designated Committee is a critical component of effective Board governance and oversight.
What to Ask Your Auditors
Finally, Board members, and particularly those serving on the Audit Committee, should ask questions of their auditors. The following is my “Top 10” list of questions to auditors that deserve FAQ status:
- Please describe how Federal stimulus dollars have been recorded in the audited financial statements and what risks does the auditor believe to be of continuing concern that may be dependent on future decisions made by New York State and Federal Government funding sources.
- What was the surplus (deficit) for the year by program or service component and how were deficits subsidized?
- Is there a balance on the bank line of credit at year end and why?
- How many days’ revenue are outstanding in accounts receivable, and is the number appropriate for our industry segment?
- Are we in compliance with Governor Cuomo’s Executive Compensation reporting requirements?
- Are vendor payments, required payroll tax deposits, and retirement plan contributions being made in a timely manner?
- What was the amount of capital purchases for the year and the net change in outstanding debt obligations (that is, how much was financed of total capital purchases)?
- What government-sponsored regulatory reform initiatives (e.g., Managed Care) and/or enforcement audits (e.g., OMIG/OIG) are in process and has any liability settlement been recorded?
- How does the external auditor assess our financial statements, in the spectrum from conservative to aggressive, in terms of accounting presentation (e.g., bad debt reserve)?
- Are there any new or pending accounting pronouncements or standards that will have an impact on our organization?
The questions above represent examples of the type of discussion that is important dialogue between Board members and audit representatives. In addition, at least once each year, the auditors should meet with the independent Board members/Audit Committee in executive session. As a standard process, this approach establishes a healthy environment for communication directly between the Board and your audit firm.
Your bottom-line objective should be to achieve transparency and accountability between and among Management, Board, and your external auditors, with particular emphasis on achieving the objectives in a SAFE manner – that is, Scalable, Affordable, Feasible, and Enforceable.
The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.