8.The FPP also included internal audit requirements. Do you think it is necessary to have a claims auditor and an internal audit function? To whom should the internal auditor report? What activities should the internal auditor perform on a routine basis?

9.The FPP attempted to improve independent auditing by requiring a competitive audit requisitioning process (RFP). What are the main differences between an auditor RFP requirement versus an auditor rotation requirement? Would mandatory audit rotation have allowed the scandal to be uncovered earlier?

10.After the FPP, the auditing markets in New York became more specialized. Does greater concentration of audit providers make the audit market more or less competitive? Do you believe the changes in the audit market improved audit quality?

11.How did the FPP affect audit quality in New York? Do you believe changes in audit quality are the result of the comptroller?s inspection of school districts and audit firm working papers or the result of auditor requisitioning and auditor changes leading to the use of more specialized auditors?

The Roslyn School District Fraud: Improving the School District Internal Control and Financial Oversight Randal J. Elder Professor of Accounting Joseph I. Lubin School of Accounting Martin J. Whitman School of Management Syracuse University Syracuse, NY 13244 rjelder@syr.edu Alfred A. Yebba Assistant Professor of Accounting School of Management Binghamton University - SUNY Binghamton, NY 13902 aayebba@binghamton.edu September 15, 2016 We thank the associate editor and two anonymous reviewers for helpful comments. We also thank workshop participants in the Governmental and Nonprofit educational session at the 2015 AAA Annual Meeting for their comments, as well as the undergraduate auditing students who provided case feedback. The Roslyn School District Fraud: Improving School District Internal Control and Financial Oversight ABSTRACT: The voters in Roslyn, New York inadvertently funded a multi-year embezzlement of $11 million of school district tax funds. Disguised by exceptional school rankings, and supported through a strong tax base, it was the largest embezzlement of school district funds to occur in the United States. Perpetrated by a school superintendent and his conspirators, initial evidence of the cash fraud was discovered two years prior to a formal investigation, however, a series of cover-ups by board of education members along with substandard audit work allowed the embezzlement to continue. State regulators responded to the crisis with the passage of a series of fiscal reform legislation aimed at improving school district internal control through changes in school district governance, the procurement of independent auditing, and state agency oversight. The case explores the incentives, rationalization, and opportunities for the perpetration and concealment of the Roslyn fraud as well as the overall impact of the State's fiscal reform legislation on New York's independent audit markets and reporting quality. This case is suitable for use in both auditing and governmental and not-for-profit courses. Keywords: Auditor regulation; fraud; internal control; auditor requisitioning; auditor rotation 1 The Roslyn School District Fraud: Improving School District Internal Control and Financial Oversight INTRODUCTION \"The apparent misappropriation of public assets on this scale is shocking...they illustrate what can happen when oversight boards fail to take their responsibilities seriously, and when those responsible for safeguarding public funds decide to take advantage of their position of trust.\" New York State Comptroller Alan G. Hevesi (Office of the New York State Comptroller, 2005a) During 2002, Frank Tassone, the widely admired superintendent of the Roslyn Union Free School District, Long Island, New York (Roslyn) walked into a conference room and told the District's Board of Education that his assistant superintendent of business, Pamela Gluckin should not be prosecuted for a theft of $223,000 from the district. The board agreed with Tassone, and accepted Gluckin's resignation and reimbursement of the stolen monies, hoping to spare the district from public embarrassment. Gluckin's apology only further disguised the ongoing criminal acts being perpetrated by her co-conspirators and postponed the scrutiny to unfold throughout New York State. The political reaction to the depth of the Roslyn scandal was the basis for a fiscal reform program that would ultimately change the control environments at school districts as well as the market characteristics of audit firms serving the specialized school district audit market. Participating in Gluckin's settlement was the district's independent CPA firm, Miller, Lilly & Pearce, LLP (MLP), a Long Island based audit firm specializing in school district audits and auditor for the Roslyn school district since 1992. During 2002, the engagement partner, Andrew Miller, was personally notified by a whistleblower that Gluckin was making unusual purchases with the district's credit cards at a Home Depot some 50 miles away from Roslyn and immediately contacted a member of Roslyn's audit committee (OSC 2005a). MLP was perceived 2 as the top accounting firm when it came to the nuances of New York school district auditing and served at least 50 of the 124 Long Island school districts, and also supported school district accounting with a home grown accounting software called \"Finance Manager.\" Under supervision of Roslyn's audit committee and Tassone, the firm examined cash disbursement transactions personally entered into the payables system by Gluckin and identified a dozen fraudulent vendor amounts. Trusting the work of their long-time CPA and superintendent, the board accepted the findings and reimbursement of monies with no further investigation.1 Despite MLP's involvement in the investigation, its year-end audit workpapers did not contain an assessment of fraud risks nor were any additional testing procedures completed as part of the 2002 annual audit (OSC 2005b). Two years later, acting on an anonymous letter, the Nassau County District Attorney began charging school officials with embezzlement and board members began resigning. Under severe political pressure and in light of a record number of budget referenda defeats, the Office of the New York State Comptroller (OSC) began a forensic audit of Roslyn and discovered aggregate misappropriations in excess of $11 million (OSC 2005a). The critical investigation contributed towards a massive shedding of MLP clients and the firm's ultimate failure. Shortly thereafter, two legislative acts, organized as \"The Five Point Plan\" and \"Fiscal Audits of School Districts,\" aimed at improving school district accountability, were signed into law. SUPERVISION OF SCHOOL DISTRICT OPERATIONS IN NEW YORK STATE A superintendent is the public figure providing the daily management of a school district and is responsible for the overall quality of education, while the assistant superintendent of business provides the routine financial management for the district. Both of these parties are 1 Interestingly, an Office of the New York State Comptroller (OSC) replication of MLP's engagement work pertaining to the 2002 fraud examination identified in excess of $1.6 million of questionable charges (Lambert 2005). 3 agents of a district's elected, all-volunteer Board of Education (board) whose main responsibility is to supervise the district and develop the district's annual operating budget. In New York's roughly 700 school districts, budgets and their corresponding property tax levies are approved through referendum voting, the purpose of which is to disperse budgeting and tax levying power, allowing local constituents the right to approve district spending and management on an annual basis.2 The Office of the New York State Comptroller (OSC) has the authority to regulate and oversee the finances of local governmental units and performs detailed and routine control inspections at many of these entities. However, unlike other government forms in New York (cities, townships, etc.), the finances of school districts receive additional monitoring from the state education department which requires school districts to contract for an annual independent CPA audit.3 Due to the combination of oversight provided through budget referenda voting, state agency monitoring, and independent CPA audits, and due to budgetary constraints, the OSC has not performed routine inspections at school districts since the late 1970s. INCENTIVES, RATIONALIZATION, AND CONTROL ENVIRONMENT CONTRIBUTING TO THE ROSLYN FRAUD Located in an affluent village of Long Island, New York, Roslyn residents consider high property taxes to be a fair trade-off for top-flight schools, which Frank Tassone delivered. The average homeowner in Roslyn paid a school assessment of $9,700 during the scandal years, some of the highest property taxes in the United States, and district voters never once denied a budget referendum (O'Donnell, Albin and Cave 2004; Lambert 2005). Tassone was initially 2 Referendum voting is a vestige of the colonial period and is most common in the northeastern region of the United States. At least five other states in this region (New Hampshire, Vermont, Maine, Connecticut, and New Jersey) utilize a similar voting process (Archbold 2001). 3 No other local government forms in New York have a statutory audit requirement. 4 hired by the Roslyn board in 1992, and at the time the fraud was revealed, was entrusted with managing a school district which had a $70 million dollar operating budget, 610 employees, and five schools serving 3,300 students. While superintendent, not only did Roslyn schools gain a national reputation for excellence, but Tassone's personality allowed him to gain the trust of the all-volunteer board whose primary concern was with educational quality and reputation rather than with administrative functions, such as managing budgets or oversight of their respected leader. The well-dressed, personable Tassone, who happened to spend approximately $37,000 of the district's funds on his personal dry cleaning, earned an image as the CEO of Long Island schools and was often cited for his beliefs that educational leaders in the public sector should be compensated in a similar fashion as private sector business leaders (Kolker 2004). Under his leadership, Roslyn became the top performer on Long Island, evidenced by a 95% graduation rate, small class sizes, and a sizable number of graduates accepted to top universities. While using district performance to gain trust of the board, Tassone, a literary Dickens scholar himself, used outings such as weekly book club meetings with parents and annual dinner-dances with senior citizens to build relationships with voters in the district. All the while, he was rationalizing the multi-year embezzlement as due benefits under the terms of his liberal employment contract and especially as compensation for exceptional job performance. Gluckin, the district's long-time assistant superintendent of business expert, was increasingly pressured to commit thefts by her lavish lifestyle which also included extensive personal financial obligations (Kolker 2004). In school districts, internal control over cash disbursements is provided through two positions, the internal claims auditor and the district's treasurer. The internal claims auditor approves invoice voucher packages for completeness and summarizes vouchers for payment on a 5 listing, known as a warrant report. The treasurer is the district's chief accounting officer and relies upon the judgment and work of the internal claims auditor in approving a warrant report for disbursement. The treasurer also serves as the information link between the board and a district's budgetary status. Although not legally required prior to 2005, Roslyn hired an internal auditor in 1992 to oversee control risks at the district; he also happened to be the brother of a close friend of Tassone. Early on, Tassone discovered that as long as the school rankings continued to rise, the tax referenda would be passed by the voters and no fiscal pressure would be applied by the taxpayers.4 The district had no written policies for basic transaction approval (cash, payroll, custody of signature plates, etc.). Further, the internal claims auditor and treasurer attended roughly five of 19 annual board meetings (OSC 2005a) and never reported consistent patterns of budget shortfalls or fund transfers to the board (known as a \"Budget Status Report\"). As a result, Tassone and his co-conspirators had opportunity to any district assets they felt rewarded their exemplary job performance.5 Collectively, $11 million dollars went missing and at least 30 individuals benefited from the scheme, highlighted by personal credit card use of $5.9 million, the payment of private mortgages and loans of $1.1 million, and related party transactions in excess of $1 million. CONCEALMENT OF THE SCHEME AND INDEPENDENT AUDITING AT ROSLYN The superintendent's office overrode controls by recording fraudulent vendor payments outside the normal flow of transactions primarily through \"hand-drawn\" check warrants (OSC 4 For example, during the height of the scandal period, adjusted tax levies in Roslyn rose from $45 million (19992000) to $70 million (2003-04), an increase of 55%, with no questioning from the voters (OSC 2005a). 5 A budget status report compares a district's budget against actual revenue and expenditures at a point in time to ensure that the district does not overspend. The treasurer must present the board with the budget status report for each fund at least quarterly, and monthly if transfers were made. 6 2005a). In addition to having her relatives employed in other accounting functions at the district, Gluckin relied upon unsupervised check signing ability and journal entry access as well as unrestricted general ledger control over any necessary inter-fund transfers in concealing the fraud through a vendor numbering scheme.6,7 The use of hand-drawn warrants circumvented Roslyn's routine bi-monthly cash disbursement cycle by issuing cash immediately, outside approval of the claims auditor and signature of the treasurer. Due to the heightened fraud risk involved with this type of transaction, it is generally limited by policy and effective auditing targets these postings through substantive audit procedures. MLP's audit workpapers recognized the existence of these transactions but never expanded procedures to target them with substantive or other specially designed tests, despite documented control findings in their workpapers and at least one annual audit being completed in a post-SAS 99 audit environment (OSC 2005b).8 Adding to these issues, \"Finance Manager,\" the software package developed and majority owned by MLP partners and used by Roslyn and approximately 250 New York school districts, was being manipulated so that a check could be paid to a fraudulent vendor, but the general ledger could subsequently be altered to reflect a legitimate expenditure.9 Through a software 6 In the governmental sector, the management of funds represents a form of internal control. In most districts, the board is required to approve overages of fund spending or transfers between funds. In Roslyn, the board never reviewed fund balances and gave Tassone unlimited ability to transfer balances among funds. 7 A vendor numbering scheme uses a coding system to classify fraudulent expenditures using valid vendor names in the general ledger, allowing the fraudster to disguise the expenses. 8 SAS 99 (now included in AU-C 240) formally required auditors to assess the risk of material misstatement due to fraud and plan and perform procedures to obtain reasonable assurance any identified fraud risks did not result in material misstatements. 9 For example, vendor #9172 was for checks paid to \"AMEX\" but the transactions were altered in the general ledger to appear as \"Houghton Mifflin,\" a textbook publisher. Observing cancelled checks in the testing of disbursements would have detected the scheme. 7 patch, Finance Manager as a platform had adequate controls to prevent this type of alteration, but despite auditing their own system, MLP failed to verify the revised applications at Roslyn (Hevesi in Lambert 2005). On February 25, 2004, \"finadmin,\" a user name reserved for software company personnel, logged into the District's computer system from Roslyn's administrative building, and before being interrupted by the periodic system backup, used a coding system to alter transactions relating to 12 of the 15 vendors (Figure 1) later identified as fraudulent by the OSC (OSC 2005a). In the two hours \"finadmin\" was logged in and altering payees following the vendor numbering scheme, three phone calls were made; first, to a former district account clerk, secondly, to a board member, and finally, to Gluckin, who had been dismissed at least one year earlier. (Insert Figure 1 about here) Upon OSC review, MLP's cash disbursement testing workpapers for audit years 2001/02 and 2002/03 documented the selection of several disbursements the OSC identified as fraudulent and concealed through the vendor coding scheme. Interestingly, the audit workpapers contained the revised payee names and were signed off as being vouched to invoices but not to a cancelled check. The engagement partner, Andrew Miller was asked how his audit testing could contain vendor names not placed into the cash disbursement records until several months or years after his sample was drawn, and how his firm observed invoices the district could not later substantiate. He replied the information, including the invoices, was given to his firm directly by Gluckin; no explanation was given relative to the year Gluckin was not employed by the district. FISCAL REFORM UNDER COMPTROLLER ALAN G. HEVESI New York State Comptroller Alan Hevesi was outraged by the extent of mismanagement 8 at Roslyn, and in response to a record number of referendum defeats throughout the state was charged with fighting corruption in New York school districts. Hevesi's statements \"Taxpayers are furious, and they have the right to be furious\" and \"we're going to clean this up...and put the systems in to make sure this never happens again\" (Hevesi in Lambert 2005) were the basis for two notable reform programs signed into New York law during 2005. The reform programs The Five Point Plan (FPP) required school districts to adopt improvements in board oversight and training, including having audited financial statements presented directly to board members, and also required board response to audit findings. Claims processing was also enhanced through routine expenditure reporting which the claims auditor became required to present directly to the board, and internal controls were directly enhanced through establishment of internal audit procedures.10 The plan also required a mandatory audit firm requisitioning process (known as a request for proposal or \"RFP\") that requires the school district to put the audit out for competitive bid in five-year cycles. Unlike mandatory rotation, which requires replacement of the existing auditor, in a mandatory RFP process the incumbent auditor may be reappointed as part of the bidding process. As part of this process, the school district considers audit pricing, a firm's specialized knowledge, firm independence, experience, and anticipated staffing on the engagement in making its auditor selection. The second program, \"Fiscal Audits of School Districts\" increased the presence of governmental agencies at school districts, effectively supplementing independent auditing of control systems by incorporating an OSC review of controls at every school district in New York at least one time within five years, 10 Technically, the provisions of the FPP require board members to approve all expenditures but most boards delegate this task to claims auditors who, acting as agents of the board, report summarized expenditure activity to board members. 9 promoting better disposition of public funds. Provisions of both programs are summarized in Figure 2. (Insert Figure 2 about here) Hevesi's site visits to local school districts were news-making as his office discovered widespread fraud at 18 districts (OSC 2010a) and internal control deficiencies throughout New York State; as appropriate, his office began referring school officials for criminal prosecution. When his focus turned to the CPA firms serving the New York school district market, he was again infuriated with his findings. Hevesi's auditors reviewed engagement workpaper documentation at ten local firms throughout New York State and repeatedly found a lack of appropriate engagement planning, including incomplete fraud risk assessment.11 Additionally, accounting matters requiring auditor documentation and judgment, such as the need to expand procedures in light of audit risk or the documentation of control deficiencies, was often incomplete. Hevesi believed this was caused by the narrow scope of independent auditing in which CPA firms focus on assuring that materially correct information is provided to outside stakeholders, and not necessarily on assuring the appropriate disposition of all tax dollars (Hevesi in Colson 2004). IMPACT OF THE OSC PROGRAMS ON THE AUDIT MARKET AND AUDIT QUALITY 11 Except for larger entities, most governmental auditing is performed by non-Big 4 firms, and Big 4 involvement in governmental auditing further decreased after passage of Sarbanes-Oxley as the Big 4 firms concentrated on other markets that were presumably more lucrative (Lpez and Peters, 2010). Because the auditing of school districts is largely performed by local and regional firms, and school district auditing involves state-specific nuances, most firms' practices do not cross state lines (Chase 1999). As a result, most auditing of districts is performed by statebased practices. This case does not include discussion of New York's \"big five\" (Yonkers, New York City, Rochester, Syracuse, and Buffalo) districts; these districts do not utilize referendum voting in the budgeting process and have different agency concerns than the local districts targeted by the legislation in the remainder of the state. 10 Tradeoffs between auditor tenure and independence have been debated by regulators for a long time.12 These debates center on user's need for quality auditing where quality can be defined as a firm's technical ability to detect a misstatement and the firm's willingness to report audit findings (independence). Mandatory requisitioning policies, where the incumbent firm is periodically required to be compared with other firms through an RFP process is one way to address auditor complacency while still maintaining a board's ability to engage and retain the auditor of its choice. Alternatively, with mandatory auditor rotation, the incumbent auditor is periodically replaced, which reduces a firm's temptation to compromise its independence for ongoing audit and consulting fees. The U.S. House Financial Service Committee and U.S. House of Representatives suggest that policy influencing auditor tenure is not in the public interest as stakeholders should make auditor decisions and not be influenced by regulatory bodies.13 The PCAOB, citing the Cohen Commission (AICPA 1978), suggests that auditor rotation is in the public interest as it introduces a fresh viewpoint to the audit process (PCAOB 2011). Although government audit markets are very different than the audit market for publicly-traded companies, the Government Accountability Office (GAO 1987) also encourages active auditor procurement. Under the FPP, the legislation left auditor selection and tenure up to the discretion of individual school boards, but the process a board undergoes in making its auditor selection may be periodically reviewed 12 Recently, the European Union adopted provisions requiring public companies to appoint a new auditor every 10years. Through optional competitive requisitioning, the auditor's term can be extended an additional 10 years (Tysiac 2013, 2014). The PCAOB issued a concept release on auditor rotation, but has removed the issue from its agenda. Interestingly, during 2015 the SEC proposed rulings seeking to require public firms to disclose auditor tenure, further highlighting regulatory concerns surrounding independence (McKenna 2015). 13 The Audit Integrity and Job Protection Act (H.R. 1564) of the 113 Congress would have amended the SarbanesOxley Act of 2002 to prohibit the PCAOB from requiring public companies to use specific auditors or to rotate auditors (U.S House 2013), however, the bill was not taken up for consideration by the U.S. Senate. 11 by OSC inspectors. The policy enacted under the FPP encourages board and audit committee discussion of technical and servicing abilities of the bidding audit firms in addition to considerations of audit pricing and discourages selection of an audit firm solely because it was the lowest bidder. Figure 3 presents the market characteristics of independent auditing firms submitting federal reports under the Single Audit Act for New York school districts.14 Audit firms are classified in three levels based on the number of annual audit reports submitted by the respective firm: non-specialists (fewer than 5 reports); midsize firms (6-20 reports); and specialist firms (more than 20 reports). Though the FPP did not mandate auditor rotation through policy, Panel A indicates that on average, there were approximately 27 auditor changes per year in the pre-fraud period. In contrast, there were an average of 41 changes per year in the post-fraud years, with a sizeable spike just after passage of the 2005 legislation followed by a second spike several years later. (Insert Figure 3 about here) The auditor switching activity presented in Panel A represents the results of active auditor procurement.15 Figure 3, Panel B illustrates a rebalancing of school district audit clients within the audit market. Using an average annual sample of approximately 515 of the State's 700 school districts reporting under the Single Audit Act, prior to the fraud, on average 32% of these districts engaged a specialist audit firm; the comparable number is 50% for the period after the 14 Reporting under the Single Audit Act (OMB Circular A-133) is required when a recipient organization expends greater than a specified level in federal grant funds. This level was $500,000 and increased to $750,000 in 2015. Single audits contain heightened levels of program specific reporting of controls testing performed by independent CPAs, which should help foster a stronger overall control environment for these districts. Approximately 75% (approximately 515) of the school districts in New York report under the Single Audit Act on an annual basis. 15 Auditor changes resulting from the failure of MLP or initial engagement of MLP, or any other firm cited by the OSC for poor audit quality, are not included in Figure 3. 12 fraud. More notably, the average engagement of non-specialist firms decreased from 35% of the pre-fraud school district reports filed to just 20% of the post-fraud market. Recent proposals by the AICPA put forth changes in the peer review process of independent audit firms, with targeted examinations for firms which audit a low-volume of highrisk or complex engagements, such as single audits. The AICPA proposals highlight the notion that audit quality is enhanced with auditor experience and expertise and suggest the rebalancing of the state's audit markets may be associated with changes in quality (AICPA 2014). Similarly, the GAO has found evidence suggesting a link between active auditor procurement and the selection of a quality auditor (GAO 1987) while the Anderson Committee Report (AICPA 1986) and National Commission on Fraudulent Financial Reporting, known as the \"Treadway Commission Report\" (COSO 1987) cite auditor competition and resultant fee pressure as detrimental to audit quality. These contradictory regulatory findings support the continuing debate over whether mandatory competition in audit markets (RFP or rotation) improves audit quality.16 The comptroller's inspections of school districts found widespread internal control weaknesses (ICW), including significant deficiencies and material weaknesses that were not previously reported. The comptroller's programs were designed to address underlying governance and expenditure procurement, hoping to improve the overall control environment including board awareness of fiscal monitoring and fiduciary responsibility. Consequently, after the legislative reforms, auditors became incentivized to detect ICWs, and boards, through the public disclosure of corrective action plans, became responsible for their timely remediation. 16 According to PCAOB board member Lewis Ferguson, chairman of the International Forum of Independent Audit Regulators, regulators have found early evidence of decreases in audit fees from the adoption of mandatory requisitioning/rotation policies in European markets. This heightened fee pressure has generated audit quality concerns (Cohn 2014). 13 Most New York school districts received significant federal funds and are required to have a single audit report. A single audit report is more comprehensive than a typical audit report in that it includes (1) an audit of the federal grantee's financial statements, (2) a review of the grantee's internal control systems, and (3) a compliance examination of the grantee's disposition of federal funds in accordance with laws and regulations. Any significant deficiencies or material weaknesses in internal control are reported as part of the single audit. 17 Figure 4 highlights the trends in internal control reporting and illustrates the sharp jump in reported significant deficiencies and material weaknesses corresponding with the comptroller's inspection programs; evidence of both greater detection and independence within the overall audit markets as a result of changes in reporting incentives brought about in response to the legislative acts. (Insert Figure 4 about here) EPILOGUE The OSC is still active in the fiscal oversight of New York's school districts and since completing the comptroller's ambitious five-year audit plan has continued to oversee internal control systems and sporadically discovers corruption (OSC 2010b; OSC 2014). However, as local school districts improved their control environments, OSC auditing shifted towards examination of more program specific concerns, such as compliance with Medicaid spending and reimbursement or district budgeting relative to tax assessments, and has since begun to relax certain provisions of the FPP. All told, nearly $18 million in fraud was found at 19 school districts throughout New York State (OSC 2010a) and several audit firms received disciplinary action. Detection of these frauds came at a substantial cost. The estimated taxpayer costs of 17 Significant deficiencies were referred to as reportable conditions prior to 2006. 14 administering the Comptroller's program exceeded $6 million for the first five years alone. These costs do not include the costs incurred by individual school districts to comply with the legislative provisions. Roslyn's leader, Frank Tassone, who stole approximately $2.2 million, was sentenced to four to twelve years in prison, the toughest sentence of those charged. Pamela Gluckin, the former assistant superintendent of business who admitted to stealing at least $4.3 million, and collectively, with the enrichment she provided to her family members, was responsible for the greatest share of the thefts, was sentenced to three to nine years in prison (Vitello 2006). On January 25, 2006, Andrew Miller, the principal partner in the defunct accounting firm Miller, Lilly & Pearce, pleaded guilty to record tampering and was sentenced to four months in jail and five years of probation (Chang 2006). 15 CASE REQUIREMENTS 1. What are some of the inherent limitations in internal control that allowed the fraud to occur at Roslyn? 2. Identify the fraud risk factors present within the control system at Roslyn. What common auditing procedures might have targeted the potential opportunities for a cash fraud? SAS 99 (now AU-C 240) became effective for audits of became effective for audits of financial statements for periods beginning on or after December 15, 2002. How might these risks have been anticipated and documented by MLP following the adoption of SAS 99? Do you believe the Roslyn fraud is evidence of an auditing standards policy failure, an independent auditing failure, neither, or both? 3. Should internal controls be tested in all audit engagements? How might the extent of controls testing performed by the OSC have differed from that of a CPA firm? How could substantive testing of account balances and analytical procedures using benchmarks or budgets have helped detect the fraud? 4. Technology impacts both client controls and how auditors document audit testing. a. Should auditors be required to test the flow of transactions through a client's computerized system, or is auditing around a system adequate? b. How might an auditor's electronic audit workpaper environment, where audit samples cannot subsequently be altered, have changed the Comptroller's conclusions regarding MLP's audit work? 5. Should independent audit firms be allowed to develop and service their own accounting software to clients? Does your answer vary dependent upon audit firm specialization and market segment (i.e., large enterprise software versus school district accounting)? 6. The Five Point Plan (FPP) requires establishment of an audit committee and six hours of board training on financial oversight responsibilities. What role might these provisions have in preventing frauds such as the one at Roslyn? 7. The FPP addressed cash handling risks through changes in claims processing. What effect does having the claims auditor report directly to the board have on the potential for fraudulent expenditures? 8. The FPP also included internal audit requirements. Do you think it is necessary to have a claims auditor and an internal audit function? To whom should the internal auditor report? What activities should the internal auditor perform on a routine basis? 9. The FPP attempted to improve independent auditing by requiring a competitive audit requisitioning process (RFP). What are the main differences between an auditor RFP 16 requirement versus an auditor rotation requirement? Would mandatory audit rotation have allowed the scandal to be uncovered earlier? 10. After the FPP, the auditing markets in New York became more specialized. Does greater concentration of audit providers make the audit market more or less competitive? Do you believe the changes in the audit market improved audit quality? 11. How did the FPP affect audit quality in New York? Do you believe changes in audit quality are the result of the comptroller's inspection of school districts and audit firm working papers or the result of auditor requisitioning and auditor changes leading to the use of more specialized auditors? 17 REFERENCES American Institute of Certified Public Accountants (AICPA). 1978. The Commission on Auditors Responsibilities: Report, Conclusions, and Recommendations. New York, NY: AICPA. American Institute of Certified Public Accountants. 2014. Enhancing Audit Quality: Plans and Perspectives for the U.S. CPA Profession. New York, NY: AICPA. American Institute of Certified Public Accountants. Anderson Committee Report. 1986. Restructuring Professional Standards to Achieve Professional Excellence in a Changing Environment. New York, NY: AICPA. Archbold, R. 2001. School Budgets: Many reasons why voters may say no. New York Times (May 21). Available at: http://www.nytimes.com/2001/05/21yregion/school-budgetsmany-reasons-why-voters-may-say-no.html Chang, S. 2006. School Scandals: A Scorecard. New York Times (February 5) Available at: http://www.nytimes.com/2006/02/05yregionyregionspecial2/05lischo.html?_r=0 Chase, B. 1999. The influence of auditor change and type on audit fees for municipalities. Research in Governmental and Nonprofit Accounting 10: 49-63. Cohn, M. 2014. Audit firm rotation leading to lower audit fees in Europe. Accounting Today (December 5). Available at: http://www.accountingtoday.comews/auditing/audit-firmrotation-leading-to-lower-audit-fees-in-europe-72945-1.html Colson, R. 2004. Public Accountability: An interview with New York state comptroller Alan Hevesi. The CPA Journal (October). 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New York Times (September 20) Available at: http://www.nytimes.com/2006/09/20yregion/20roslyn.html?_r=0&pagewanted=print 20 Figure 1 - Fraudulent vendor numbering scheme Vendor # Vendor Used for Fraudulent Expenditure Vendor as Reported in Accounting Records 7154 8498 9172 9537 9583 9726 9779 10075 10440 10878 11115 11133 11134 11384 11485 American Express Nations AMEX Chase Chase Citibank MBNA Key First USA Bank of America American Express First U.S.A. Key Providian Travelers Sargent-Welch National Comp Sys Houghton Mifflin EDC Publish Nassau Cnty BOCES Nassau County BOCES MacMillen Publish Landsdown School Fischer Science Educ MacMillan Publish Champion Products Fischer Educ Kinderprint Co Protech Comp Systems Transition Dynamic Source: Office of the New York State Comptroller 2005a Figure 1 summarizes the vendor coding system used by the fraud perpetrators at Roslyn. The vendor number is the identifier used to record the payments for the fraud perpetrator's personal benefit. After the fraudulent cash payment was issued, the cash disbursements system was altered prior to system posting so that ledgers would reflect a legitimate school expenditure using the changed vendor identifier. 21 Figure 2 - Legislative Reforms Five Point Plan (Chapter 263, Laws of 2005) Claims auditor is to report directly to the board. Internal audit function to be established and performs risk assessments of controls. Five Point Plan Audit to be presented to the board. RFP to be followed every 5 years. Audit committees to be established and advise boards on internal and external auditing matters. School board members to receive 6 hours of training on financial oversight, fiscal accountability, and fiduciary Fiscal Audits of School Districts (Chapter 267, Laws of 2005) OSC to audit controls at all 700 school districts at least once by March 31, 2010. Fiscal Audits of School Districts School district audit reports and OSC reports are made publicly available including corrective action plans. Formalized funding for OSC hiring and training programs. OSC audits provide some assurance on controls but not substitute for independent audits. Figure 2 summarizes the major provisions of the school district reform legislation passed in New York State. The Five Point Plan assigns fiscal responsibility to school boards and also defines improvements to be made in internal control systems including mandatory auditor procurement, claims processing, board training, and internal auditing. Fiscal Audits of School Districts formally assigns fiscal oversight responsibility to the OSC and charged the OSC with reviewing and improving controls at each of the State's 700 school districts. The program also established funding sources for the programs and ensured public transparency of the OSC's program findings. 22 Figure 3 - Audit Firm Market Analysis Panel A - School Districts Changing Auditors between 1998 and 2012 Auditor Changes 80 67 70 60 50 50 36 40 30 20 20 25 40 33 29 23 20 29 35 34 2008 2009 40 35 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2010 2011 2012 Panel B -School District use of Auditor Type Before and After Fiscal Reform Programs Figure 3 illustrates changes in the audit markets resulting from the passage of the 2005 legislative acts. In Panel A, the number of auditor changes per year is presented. Panel B illustrates the consequences of the auditor changes on the type of independent auditor engaged and the resultant extent of auditor specialization within the State's school district audit markets. Panels A and B both include an average annual sample of 515 of the State's 700 school districts drawn from districts reporting under the Single Audit Act and in Panel B, market shares are calculated based on the number of school district audits submitted by auditor type. 23 24 Figure 4 - Reported Significant Deficiencies and Material Weaknesses in Internal Control over Time Significant Deficiencies and Material Weaknesses 250 191 200 183 154 150 110 124 139 119 88 100 52 47 50 50 47 8 15 22 15 8 8 11 0 1998 1999 2000 2001 2002 2003 2004 49 34 44 21 2005 Significant Deficiencies 46 45 2007 2008 54 53 47 33 13 2006 2009 2010 2011 2012 Material Weaknesses Figure 4 illustrates the number of significant deficiencies and material weaknesses reported by auditors in single audit reports. The average annual sample includes 515 of the State's 700 school districts and presents audit findings for the years 1998 - 2012. 25