Last November, I contributed an opinion piece exploring the challenges facing local government auditing throughout Minnesota. To quickly recap, excessive privatization of Minnesota’s local audit function, in conjunction with an antiquated scope of authority for our duly elected Office of the State Auditor (OSA) and a looming shortage of external auditors, is putting Minnesota’s 3,600 or so local governments in financial peril. As a gentle reminder, local governments in the North Star State spend over $64 billion annually – 15.3% more than what state agencies spend in aggregate.
Despite the dire circumstances, the fiscal oversight challenges facing localities are neither so intractable nor the policy alternatives so untested that state leaders are incapable of enacting meaningful good government reforms. We’re talking about local audits, after all, not wicked problems like reducing the national debt, achieving lasting peace in the Holy Land or mitigating greenhouse gas emissions responsible for anthropogenic climate change. There’s no need to reinvent the wheel. Other states have already adopted innovative local audit practices that can be replicated right here in Minnesota to address the auditor shortage.
For example, Utah’s elected state auditor is statutorily designated as “auditor of public accounts,” meaning his oversight authority transcends state and local jurisdictions. Despite this broad authority, financial audits of local governments in the Beehive State are largely carried out not by the state auditor but instead by private accounting firms. Nevertheless, the Utah Office of the State Auditor still plays a critical role. Foremost, the state auditor is charged with prescribing uniform accounting, budgeting and financial reporting systems used by all Utahn local governments. Moreover, the state auditor’s Local Government Division receives and files financial audit reports.
This regulatory environment just so happens to be identical to what we have here in Minnesota. The key difference, however, is that Utah’s state auditor is also the external auditor of last resort. Whenever a locality fails to engage an accountant, or the accountant quits mid-engagement, the state auditor’s office steps in to complete the annual financial audit. If this commonsense reform were enacted here in Minnesota, the days of local governments and charter schools scrambling to find or replace an external auditor would be a thing of the past. This reform would also render moot the irresponsible idea of loosening Minnesota’s CPA credentialing requirements.
The New Mexico Office of the State Auditor provides another example of how to responsibly and concisely address the auditor shortage. As is the case in Minnesota and Utah, New Mexicans elect their state auditor. And just like in Minnesota and Utah, financial audits of New Mexican localities are largely performed by private accounting firms and filed with the auditor’s office as a matter of public record. But unlike Minnesota’s or, indeed, Utah’s local audit arrangements, New Mexico’s state auditor actually regulates audit procurement — contracting with private accounting firms to audit local governments and reviewing their workpapers post-engagement for compliance with reporting requirements.
In a similar vein, New Mexico’s state auditor administers a tiered reporting system applicable to all local governments that assigns the level of contracted assurance services based on progressively graduated revenue thresholds. Under this statutory system, a large city such as Albuquerque must receive a full-blown financial audit every year — as would be expected for a municipality with a $1.37 billion annual budget. Conversely, this same tiered audit reporting framework provides flexibility for smaller localities. New Mexican villages, towns, special purpose districts, and other local governments with gross revenues less than $500,000 annually are only required to undergo annual agreed-upon procedures. For any curious readers, agreed-upon procedures are a type of attestation engagement under generally accepted auditing standards which, unlike an actual audit of financial statements, performs only limited testing of accounting records and internal controls. Agreed-upon procedures are, by their nature, cheaper and quicker to execute than conventional financial audits.
New Mexico’s tiering is superior to Minnesota’s one-size-fits-all audit revenue thresholds because of this regulatory flexibility, whereby assurance services are proportionate to organizational cash flows and potential fraud risk. Unfortunately, the status quo does not provide any semblance of proportionality here in Minnesota. Indeed, a fourth-class city must undergo the same comprehensive audit of its financial statements as the first-class cities of Minneapolis, St. Paul, Duluth and Rochester. A tiered audit reporting system tailored to Minnesota’s needs would ease the regulatory burden on rural communities facing the brunt of the auditor shortage and expand the pool of potential external auditors capable of providing assurance services throughout the state.
In summary, I have described two simple but innovative reforms to strengthen Minnesota’s local audit function: (1) name the state auditor as the external auditor of last resort for all local governments, and (2) enact through legislation a tiered audit reporting system that incorporates a procurement oversight role for the state auditor. Taken together, these policy alternatives will actionably and pragmatically address the auditor shortage hitting our local governments especially hard in a post-pandemic world.
The policy alternatives also recognize a tempered reality: OSA does not have the financial or human resources to singlehandedly audit the financial statements of every political subdivision in this state. Here in Minnesota, successful local government financial auditing requires continued cooperation between our duly elected state auditor, her 100 or so professional staff, and the private accounting firms carrying out the bulk of assurance services provided to localities. Converting our state’s local financial audit activity into an exclusively public sector enterprise would otherwise require a state auditor’s office with at least 600 full time employees. OSA simply doesn’t have the institutional capacity or budgetary support from the Legislature to achieve such a feat. Hence the importance of bolstering the current public-private partnership.
Maintaining said partnership necessitates making provision for the aforementioned best practices by way of legislation. Successful implementation, in turn, depends upon the adoption of a robust desk review process administered by OSA — one that will ultimately strengthen public accountability for privately contracted audits. What that process should entail will be the focus of a future essay.
Noah McVay is a resident of St. Paul, a soon-to-be graduate of the Master of Public Policy and Administration program at Colorado State University, and a Master of Accountancy student at Rutgers University.
