Where did all the auditors go?
And why the accountant shortage could cost taxpayers.
Happy Finance Friday, readers! I have a story out in Route Fifty this week about the auditor shortage and how that’s affecting local governments. It’s a follow up to my Long Story Short newsletter on the warning S&P Global Ratings gave to 149 local government entities about their late financial reports.
There were so many interesting tidbits I learned during my interviews that I didn’t include in the final article that I decided to build this week’s LSS around what I left on the proverbial cutting room floor. I believe the current situation facing local governments and their financial transparency will get worse before it gets better—and it’s one of the most worrisome developments I’ve seen in a long time.
Short-staffed and suffering the consequences
To quickly recap, last month S&P placed 149 entities it rates on “CreditWatch with negative implications” because the ratings company had not yet received 2021 financial statements from these issuers. It gave issuers until mid-April to produce information or potentially face a credit consequence.
Following the deadline last week, the ratings firm released a notice that it was withdrawing its rating for 64 of those issuers. A ratings withdrawal means the issuer may face a higher borrowing cost the next time it issues debt in the municipal market. Most of them were small localities and districts, but not all of them. Turlock, California, and Springdale, Arkansas, both home to populations of more than 70,000 people, are some of the larger cities on the list. (Email me if you want the full list.)
The response from some of the cities to last month’s warning has ranged from getting out in front of the story—as Santa Fe, N.M., has done—to quietly complying, as appears to be the case in Jersey City, N.J. after I spoke to a councilmember there.
But the root cause here is the same: There just aren’t enough people to do the work. This is of course true pretty much everywhere but when it comes to public finance, the shortage of accountants can have direct consequences for taxpayers via higher borrowing costs for their government and less financial transparency. When residents start getting less bang for their buck and it’s not clear why, they start distrusting their local officials. And a slide in confidence can make it more difficult for elected leaders to do their jobs.
Annual Comprehensive Financial Reports, or ACFRs, are the official, audited record of the prior year’s financials. It takes some time for finance departments to gather the year-end data, but getting those numbers audited is the last and generally the most time-consuming step before publishing the annual financial report. In some cases, like in Indiana and Ohio, the audit is conducted or signed off by the state auditor’s office. In other instances, localities hire a firm to audit their financial statements.
The shortage of accountants is an issue in both the private and public sector and the rest of this newsletter will examine some of the underlying issues.
Firms are dropping government clients
The accounting profession has had a pipeline problem for years but increasingly stringent auditing standards are also turning people off from government accounting in particular. So much so, that several people I interviewed said that they knew of several large auditing firms that are no longer taking government clients.
Here’s what the American Institute of Certified Public Accountants’ (AICPA) Mary Foelster, senior director of governmental auditing and accounting, told me over email:
Government audits require additional expertise and competence overall. The audits often need to be performed under Government Auditing Standards and U.S. Office of Management and Budget (OMB) rules for compliance audits of federal funds. These auditing rules layer on top of the AICPA’s auditing standards. Further, the financial statements of governmental entities are prepared under the standards of the Governmental Accounting Standards Board. Some firms have decided that the effort and cost to maintain staff competencies in these additional auditing requirements and accounting standards outweigh the benefit to the firm based on the number of governmental clients they have, so they have made the decision to stop doing government audits.
It’s unfortunate timing given that more governments now need to get single audits, which is a specialized area, of their federal pandemic relief spending.
Read the AICPA’s tipheet on single audit requirements for governments.
My colleague and F&A President Mark Funkhouser told me “standards overload” has been an issue for a long time. He equates it to responding to a 911 call from a home and inspecting one room in the house from top to bottom but running out of time to inspect the other rooms before it’s time to leave. “The standards,” he said “have become more and more focused on what I think are the small issues and not enough on the big issues.”
I did a rudimentary search of municipal RFPs and found at least one city on S&P’s list—East Point, Georgia—that is currently looking for audit services. I’d wager there are others.
The state auditing backlog
State auditing offices in some places are contributing to the backlog. Research by the University of Illinois Chicago and Merritt Research Services shows that most localities that send their financials to the state to audit have to wait a month and a half longer than those getting audited by private firms.
Compared with the private sector, the average public sector auditor takes….
44 days longer for cities
37 days longer for counties
97 (!!) days longer for school districts
The staffing shortage “gets exacerbated in states with requirements for state auditors to sign off on local governments’ audited financial documents due to the sheer numbers of local governments for which short-staffed public auditor offices must conduct financial audits,” the research report said.
But it is by no means a rule that all cities needing sign-off from their state auditor will suffer delays. Santa Fe, for one, has struggled for years to submit financial audits on time to the State Auditor’s Office. (The city’s new finance director has made it a goal to submit completed financial audits for fiscal years 2021 and 2022 by June.)
Meanwhile, Columbus, Ohio, which also needs state auditor approval, is exceedingly fast: the city has already posted its 2022 ACFR for the fiscal year ending Dec. 31.