Do the Existing Financial Reporting and Auditor Reporting Standards Adequately Protect the Public Interest? a Case Study

Article excerpt

ABSTRACT.

In 2004, City of Gardena was unable to meet its obligations on $26 million in debt. The authors examined City of Gardena financial reporting as of June 30, 2004 and 2003 to determine if the publicly available financial reports adequately disclosed the situation. Information about the long-term debt was properly displayed in the financial statements and disclosed in notes. There was no mention of the situation in the MD&A either year. The auditors' did not include an explanatory paragraph highlighting the debt, nor did they issue a 'substantial doubt about the ability to continue to exist as a going concern' report. This paper examines existing accounting and auditing standards to determine their adequacy to protect the public interest.

INTRODUCTION

Are users of governmental financial statements well served by existing financial reporting and auditing standards? To examine this question, consider the case of City of Gardena. In December, 2004 City of Gardena found itself unable to make the principal payments on over $26 million in long-term debt which, after several refinancings, finally came due. At that time, a newspaper article reported that "(t)wo weeks ago, the banks gave the City another six months to work out a solution, still a far from promising situation, given that municipal credit agencies are threatening to lower the city's rating to junk status" (Sterngold, 2004). As of November, 2005, no principal payments had been made on the past due debt nor had any restructuring arrangements been proposed by the debt holders. While only two principal payments have been made on the debt since 1999, interest payments have been made regularly. As the City struggled under a heavy debt load, its citizens seem to have been unaware of the financial woes until November, 2004 when the City approved the hiring of bankruptcy attorneys. The seriousness of the financial situation was not evident in the June 30, 2003 financial statements because, at that time, the debt was still classified as longterm debt.1 Although the debt was appropriately reclassified in the June 30, 2004 financial statements as 'current portion of long term debt,' the auditors did not include an explanatory paragraph in the audit opinion highlighting the fact that the City had approximately $4 million in General Fund 'cash and investments' and over $26 million in 'current portion of long-term debt,' nor did they include a modification of the unqualified report noting the possibility that the going concern assumption might not be appropriate for the City.

This paper will address how well the accounting standards issued by the Governmental Accounting Standards Board (GASB) and the audit reporting standards issued by the American Institute of Certified Public Accountants (AICPA) served financial statement users. The GASB issues governmental accounting standards designed to provide users of governmental financial reports with adequate information to satisfy a variety of needs. The AICPA issues auditing standards intended to protect the public interest. This paper will not address the additional audit standards issued by the Government Accountability Office (Government Audit Standards), those issued by the U.S. Office of Management and Budget (OMB Circular A-133), or the auditing requirements of the Single Audit Act.

This paper presents information from the Comprehensive Annual Financial Report (CAFR) for City of Gardena (prepared using GASB Statement No. 34) to demonstrate that while the new reporting model does indeed provide better information for users of governmental financial statements, it still does not easily convey necessary information to users of financial statements. This paper also presents information from and about City of Gardena's audit report to demonstrate that existing auditing standards also did not serve the public well.

Background information on the objectives of governmental external financial reporting, existing external financial reporting requirements (promulgated by GASB), and existing audit reporting standards (promulgated by the AICPA), is presented to provide a basis on which to evaluate the adequacy of existing accounting and auditing standards to provide relevant information and to protect the public interest. …