· The Controller's Office is responsible for preparing the Countywide Cost Allocation Plan which allocates the costs of support and administrative services to benefiting programs, departments and agencies. These allocated costs are then able to be appropriately reimbursed either through direct billing or by including the costs in claims for reimbursement, typically through federal or State programs, and in fees charged to the public. In today's environment of decreasing budgets, it is increasingly important for the City, in general, and the Controller, specifically, to accurately identify the true costs of services being provided and to aggressively maximize revenues.

· The Controller has not approached the cost plan and cost recovery in a systematic and comprehensive manner. Accordingly, the current cost plan, as it is prepared, is incomplete and does not represent the actual cost of City support services and administration. Allowable costs have not been included in the cost plan's preparation and additional entities may be able to be billed for their costs. These deficiencies have resulted in lost revenues every year and potentially could result in non-compliance with A-87 guidelines and other legal issues with regards to billing cost plan allocations.

· Potentially, an additional $29,271,533 in allowable costs could be included and allocated through the cost plan, which represents an increase of 36.6 percent in allocated costs. These costs would be allocated among City activities including those reported in the General Fund, special revenue funds and enterprise funds. To the extent that the Controller can identify additional entities and programs that receive support and administrative services which can be billed, costs will be reimbursed and revenues will be increased.

According to Administrative Code Section 10.195, "The Controller shall prepare those budgetary procedures, regulations, reporting requirements and guidelines sufficient...to determine for each service rendering agency the costs of its operation to the extent services are rendered or facilities provided to recipient agencies and, if not funded directly by recipient agencies, to allocate the cost of that operation on and amongst recipient agencies..." In that capacity, the Controller's Office is responsible for preparing the Countywide Cost Allocation Plan (cost plan) which allocates the costs of support and administrative services to benefiting programs, departments and agencies. These allocated costs are then able to be appropriately reimbursed either through direct billing or by including the costs in claims for reimbursement, typically through federal or State programs, and in fees charged to the public.

Pursuant to federal regulations authorized by the Budget and Accounting Act of 1921 and several other related acts, the federal Office of Management and Budget (OMB) has prepared OMB Circular A-87 entitled Cost Principles for State, Local and Indian Tribal Governments. The purpose of this circular is to standardize claims for the reimbursement of costs related to federal programs and grants, according to uniform principles of cost accounting and definitions of allowable indirect costs. The federal agency responsible for implementing OMB Circular A-87 (A-87) is the Department of Health and Human Services (HHS). In that capacity, HHS designated the State Controller's Office as the cognizant agency to oversee implementation of A-87 cost plan procedures in California. Accordingly, the State Controller has developed and issued a handbook of procedures and requirements to be followed by counties.

The cost plan is compiled using actual costs from two years prior to the year the cost plan is used for billing and claiming purposes. Accordingly, the cost plan includes an adjustment every year to correct for the difference between what was allocated in any given year, the base allocation (using two year old data), and the actual costs for that year. This adjustment is called the roll forward.

The City's cost plan used in the fiscal year ending June 30, 2003 reported $560,989,520 in support and administrative services, with unallocated or unallowed costs totaling $366,682,644. Additionally, $113,709,541 of support and administrative services are directly billed and are therefore not allocated to benefiting departments through the cost plan. However, these costs may be included in departmental indirect cost rates. Support and administrative services allocated to benefiting departments and agencies though the cost plan total $80,597,335.

Inclusion of All Allowable Costs

While the State Controller's Office reviews and approves the City's cost plan annually, the State Controller's Office is primarily concerned with whether any unallowable support or administrative costs have been included in the cost plan. It is not the focus of the State Controller's Office to attest to completeness of the plan. The following areas have been identified as support or administrative costs that may be allowable costs pursuant to A-87, but have not been included in the City's annual cost plan. These costs would be allocated among City activities including those reported in the General Fund, special revenue funds, and enterprise funds.

Self-Insurance and General Liability Costs

According to the State Controller's handbook, insurance costs for tort liability losses, property losses, and employee-related losses are allowable costs. It is common practice among California counties to have a self-insurance program rather than purchase insurance from private insurance companies or join public insurance pooling arrangements. The State Controller's handbook describes a self-insurance program as follows:

"A statement of purpose, program administration, including safety, claims, and legal services coordination, and cost savings analysis are all integral parts of both risk management and self-insurance administration. Other elements that enter into the administration of self-insurance programs are methods of funding and cost distribution to benefiting departments."¹

Self-insurance programs include the estimation of risk and the establishment of reserves to cover future costs.

According to Section 4180 of the State Controller's handbook, a county is considered non-insured if it has not established a self-insurance program but rather finances any losses through current appropriations, issuance of debt, or other "spur-of-the-moment" financing. According to the State Controller's Office, the City is considered non-insured for general liability costs pursuant to OMB Circular A-87 guidelines, because it has not established a self-insurance program. Accordingly, the City cannot be reimbursed by federal or State programs for the actual costs of liability claims. The State Controller's Office reported that the City along with the County of Los Angeles are the only two counties in the State that are considered non-insured. However, both entities were "grandfathered-in" under A-87 cost allocation guidelines with respect to workers' compensation costs and can receive reimbursement under their "pay-as-you-go" systems.

However, for general liability, the State Controller's Office asserts that it has repeatedly advised the City of the millions of dollars that it has forgone in reimbursements by not establishing a self-insurance program and liability reserves, but the City has chosen to continue in a non-insured status since the late 1970's. Because the issue is over twenty years old, neither the State Controller's Office nor the City Controller's Office has maintained any information or documentation of the issue or the State Controller's recommendations.

The County of Los Angeles has obtained a waiver for these insurance costs from the federal and State governments because that County has established an analytical model which uses ten years of loss experience to estimate the amount of their annual budget appropriation for liability claims settlement needs. Further, Los Angeles allocates these costs to departments based on historical experience as well as current employee count in order to account for the assumption of future risk.

This review noted that while Workers Compensation is included in the Cost Allocation Plan, general liability costs are not. In order to provide an estimate of the general liability costs that could be claimed if the City either established a self-insurance program or obtained a waiver similar to the County of Los Angeles, claims and litigation payments as reported by the City Attorney's Office have been reviewed. Although the City Attorney's Office's Office has identified limitations on their data, such as the fact that activity is not reconciled to the Controller's reporting of these costs in FAMIS, our review indicates that the data still provides a reasonable estimate of general liability costs and may in fact be conservative in that the Controller's amounts are significantly larger on average over the last five years² and these costs do not include any administrative costs that may be incurred in the administration of a general liability program.

Table 8.1

General Liability Claims Costs (1)

FY 2002-2003	$18,120,457
FY 2001-2002	16,780,641
FY 2000-2001	16,815,702
FY 1999-2000	10,115,262
FY 1998-1999	26,439,193
Total	$88,271,255
5-Year Average	$17,654,251

(1) Amounts exclude payments made on behalf of the Tax Collector because the payments appear to be related to tax disputes and not related to general liability costs.

Using the City Attorney's data to estimate general liability costs, over the last five years, the Controller has not allocated to benefiting programs, departments and agencies approximately $88,271,255 in allowable costs. While these costs can fluctuate significantly from year to year, it is clear that the Controller is not including and allocating approximately $17,654,251 in general liability costs annually.

The Controller notes that a significant portion of these costs would be allocated to the Municipal Transit Agency (MTA) and accordingly would not benefit the General Fund. However, it should be noted that the MTA does obtain significant funding from federal and State revenue sources. According to the Comprehensive Annual Financial Report for FY 2001-2002, federal and State operating grants were approximately $211.3 million dollars or 64.4 percent of operating and non-operating revenues. Additionally, MTA receives substantial federal and State monies in the form of capital grants. To the extent that general liability costs can be claimed by MTA for federal and State reimbursement, MTA's revenues would increase.

Treasurer-Tax Collector Functions

The Treasurer-Tax Collector provides administrative support to all City functions. While some Treasurer-Tax Collector activities are not considered allowable, such as the tax collection function, others are allowable. According to the Controller's Office, bank charges used to be included in the cost plan, but were removed in FY 1999-2000 because, at that time, the Treasurer-Tax Collector ceased cashing checks for cash assistance recipients. However, cashing checks by the Treasurer-Tax Collector is not the only direct administrative support provided by bank charges and according to the State Controller's Office, bank charges are typically allowable. According to the Office of the Treasurer-Tax Collector, bank charges in FY 2002-2003 totaled $1,784,694.

Other Treasurer-Tax Collector costs, such as those for the treasury and the collections function may also be allowable. According to the State Controller's Office, costs related to the treasury and the collections functions are not explicitly unallowable per A-87 guidelines. Cost plans should be constructed to the benefit of the claiming agency and to the extent that costs are not explicitly unallowed and they can be supported by the claiming agency, they should be included in the cost plan. If at a later time a cost is disallowed, the claiming agency is no worse off than had the cost not been included.

According to the Annual Appropriation Ordinance, appropriations for these two functional areas in FY 2003-2004 are $2,472,852 for Treasury and $4,676,659 for Delinquent Revenue. If the Treasurer-Tax Collector applies all interdepartmental recoveries of $1,463,212 and an additional $700,000 in off-setting revenues for Delinquent Revenue to these areas, potential costs including banking charges that can be included and allocated through the cost plan total approximately $6,770,993 annually.

The Controller reports that Treasury costs, including banking charges, are recovered by being offset by interest earnings. Accordingly, such costs cannot be allocated through the cost plan and recovered for a second time from other sources. While this is accurate, it seems the Controller has not considered that the City is the prime recipient of interest revenue and as such continues to absorb Treasury costs. To recover the City's component, the Controller can either identify those costs and allocate them directly through the cost plan or the Controller can allocate all Treasury costs through the cost plan, with a direct bill or allocation to those agencies that would have otherwise experienced a reduction in their interest earnings. The second methodology is preferable as it clearly identifies and segregates the accounting transactions, makes the costs transparent, and is simple to administer.

Equipment Use Allowance

Equipment use allowance is a typical and commonly included cost allocated through the cost plan. According to the State Controller's Office handbook, "a standard percentage of the total cost of each fixed asset...may be claimed each year that the asset is in use. Six and two-thirds percent of the total acquisition cost of each piece of equipment...may be claimed." According to the Controller staff, these costs were included in the City's cost plan until FY 1993-1994, when the State Controller's audit of the cost plan found that the City's fixed asset inventory was inadequate and unable to provide accurate historical cost information on the City's equipment inventory. Instead of addressing the State Controller's concerns, the costs were simply dropped from the cost allocation plan.

In FY 2000-2001, the Controller implemented a new fixed assets tracking system, FAACS, in order to comply with GASB 34 reporting requirements. Therefore, the Controller has had in place an adequate and accurate accounting of the City's equipment for the last two fiscal years. According to the reports prepared by the Controller for the production of the Comprehensive Annual Financial Report, as of June 30, 2002, historical cost of the City's General Fund equipment (net of accumulated depreciation) was approximately $72,658,000. Equipment usage allowance of 6.67 percent results in approximately $4,846,289 in allowable costs that should be included and allocated through the cost plan annually. An alternative method for recovering costs related to equipment use is to allocate depreciation expense. The Controller should analyze both methodologies, equipment use allowance and depreciation expense, and select the method that would yield the largest amount.

According to the Controller, most of equipment use costs would be allocated to non-"paying" departments, such as the Sheriff's department, and therefore there is no discernable benefit to the City from allocating these costs. However, to the extent that departments charge fees or have federal and State grants, these costs can be recovered. By way of example, according to the Annual Appropriations Ordinance for FY 2003-2004, the Sheriff has budgeted 38.4 percent of its revenues from federal and State funding sources and 8.0 percent from fee revenues.

In addition to the issues identified above, the format and content of the cost allocation plan does not adequately capture and report Citywide support services. The cost plan should compile all Citywide administrative costs and then distribute those costs into either allowable costs or unallowable costs pursuant to A-87 guidelines. The current cost plan places all unallowable costs in an "unallocated" column and there are no costs identified as unallowable in the cost plan. Further, the unallocated costs contain such activity as the General Fund contributions to the enterprise funds, which are clearly not administrative costs. The Controller should perform an overall assessment of Citywide support services and administrative costs and should develop a cost plan that comprehensively and accurately represents the true cost of City functions and activities.

Billing of Allocable Costs

The Budget and Analysis Division calculates the allocable costs to be charged to non-General Fund City agencies and programs as well as independent entities that receive general City support. In FY 2002-2003, the calculation included a cost of living adjustment applied to base allocable costs.

Billing All Agencies and Programs that Incur Support Services and Administrative Costs

According to the Controller's Office, it is Controller policy to bill allocable costs unless there is a reason that billing would be inappropriate. The Controller's Office asserts that the billing is reviewed and adjusted every year. The following agencies and programs may be able to be charged for support services and administrative costs incurred on their behalf:

Retirement

The cost plan allocates indirect costs to the San Francisco City and County Employees' Retirement System (Retirement System). According to the Retirement System, many administrative costs are already directly billed to the Retirement System. However, as Table 8.2 demonstrates, considerable costs are not directly billed and are, therefore, not reimbursed.

Table 8.2

Allocated Retirement System Indirect Costs

Fiscal Year	Allocated Indirect Costs (1)
2002-2003	$(49,993)
2001-2002	687,149
2000-2001	769,634
1999-2000	307,309
1998-1999	(102,147)
1997-1998	(53,205)
1996-1997	552,226
Seven-Year Total	$2,110,973

(1) Negative charges result from the roll forward adjustment.

The City, as employer, has not had to make a contribution to the Retirement System since FY 1995-1996, indicating that Retirement resources have been sufficient to cover at least a portion of its indirect costs. Over the last seven years, the City has failed to charge the Retirement System approximately $2,110,973 in allowable costs. To the extent that the City continues to not have to make employer contributions to the Retirement System, indirect costs allocated through the cost plan should be billed to the Retirement System.

County Office of Education

The County Office of Education (COE) receives a substantial allocation from the cost plan every year. However, these costs are not charged to the COE. Table 8.3 provides allocated costs for the past six years:

Table 8.3

Allocated County Office of Education Indirect Costs

Fiscal Year	Allocated Indirect Costs
2002-2003	$3,270,498
2001-2002	3,517,932
2000-2001	2,412,000
1999-2000	2,339,742
1998-1999	180,689
1997-1998	2,145,417
Six-Year Total	$13,866,278

Provided that charging the County Office of Education is not legally prohibited, it is a policy decision for the Board of Supervisors as to whether to bill indirect costs incurred by the agency.

Other Special Revenue Funds

Select special revenue funds are billed for countywide indirect costs. However, out of a total of 185 special revenue sub-funds, only 7 were billed in FY 2002-2003. Additionally, as noted in Section 6 of this report, the Dispute Resolution Program sub-fund has not been billed for indirect costs, although the Administrative Code explicitly permits the charging of administrative costs of up to 10 percent of program funds. The Controller should do a thorough review of the City's special revenue funds and identify those sub-funds that programmatically receive support from the central service agencies and conduct an analysis of what those costs are. It is a policy decision for the Board of Supervisors as to whether or not these sub-funds should be billed for indirect costs, thereby reducing available funding for direct program costs and services.

Application of the Cost of Living Adjustment

In prior years, the Controller billed specific entities and programs the base allocation in the annual cost allocation plan and applied a cost-of-living-adjustment (COLA). In FY 2002-2003, the Controller revised its billing procedures and now bills specific entities and programs the base allocation, the COLA (applied to the base allocation only), and the roll forward. The application of a COLA is not traditionally applied by counties when billing cost plans. Because of the recent change in billing procedures, we were unable to discern exactly how the roll forward and COLA are being applied and, given the scope of our audit and the its time constraints, we did not conduct a full assessment. The State Controller's Office expressed concern over the application of a COLA and roll forward when asked about it specifically. Given these factors and the concern that there may be an issue of double counting, we recommend the independent financial auditors review this issue.

It was also noted that the Controller applied a COLA to Child Support Services. Because Child Support Services is 100 percent funded by federal and State sources, the COLA which totaled $7,907 in FY 2002-2003 is not allowable pursuant to A-87 guidelines.

Quality Control and the Big Picture

Cost plan activities are split between two Divisions in the Controller's Office. The cost plan is prepared in the Grant Management Unit of the Accounting Operations and Systems Division, while calculation of billing amounts occurs in the Budget and Analysis Division. In the Grant Management Unit, there is no management review of the cost plan or supervision over its preparation. The staff responsible for the preparation of the cost plan, when asked about a supervisory review, stated that the State Controller's Office is really the authority that he answers to. As noted above, there are several examples of areas where management and supervisory oversight should have addressed and resolved the underlying issues. As an additional example, the FY 2002-2003 cost plan includes a reference to tuition reimbursement that has not been allocated through the cost plan because "The City has not implemented an appropriate allocation basis."³ The staff responsible for the cost plan preparation stated that this phrase should have been removed and it was no longer applicable as the program was direct billed to benefiting departments by the Department of Human Resources. This example brings up two issues: 1) an allocation method should have been developed for application in prior years and 2) there should have been a supervisory review to identify the error in the FY 2002-2003 cost plan.

The Controller asserts that the cost plan has had comprehensive and supervisory reviews over time. He reports that the former managers of the Grant Management Unit used to review the cost plan in detail and that he, too, has reviewed it at some length in the past. Further, he advises that the new Grant Manager will review the next cost plan.

The Controller has noted that for cost plan purposes, support and administrative services must be allowable, distributed to benefiting departments and agencies using a justifiable allocation methods, and must result in the recovery of costs. According to the Controller, the previously identified examples do not necessarily meet these three criteria and, therefore, the perceived benefits do not exceed the costs of allocating the identified support and administrative costs. However, in today's environment of decreasing budgets, it is increasingly important for the City, in general, and for the Controller, specifically, to accurately identify the true cost of services being provided and to aggressively maximize revenues. Until an analysis is completed that compiles all support and administrative costs, determines methods of allocation, and identifies external funding sources, the cost and benefits of these issues as well as any others identified in a comprehensive review are unknown and not estimable.

We recommend that the preparation of the cost plan be transferred to the Budget and Analysis Division for several reasons. First, the cost plan is a complex document that requires strong analytical skills in its preparation and its review. Second, the Budget and Analysis Division is the Division where other cost functions are performed, including the review and preparation of indirect cost rates, and it is the Division that determines the cost plan billings. Finally, the Budget and Analysis Division has the understanding of and exposure to the broader contextual issues that effect the City and its support and administrative services, and the impacts that these issues have on the cost plan.

Conclusions

The Controller has not approached the cost plan and cost recovery in a systematic and comprehensive manner. Accordingly, the current cost plan, as it is prepared, is incomplete and does not represent the actual cost of City support services and administration. These deficiencies have resulted in lost revenues every year and potentially could result in non-compliance with A-87 guidelines and other legal issues with regards to billing cost plan allocations.

Recommendations

The Controller should:

8.1 Perform a comprehensive assessment of Citywide support services and administration and treatment in the cost plan and report back to the Board of Supervisors by June 30, 2004;

8.2 Assess and address the issues noted in this report and report back to the Board of Supervisors by June 30, 2004, on the following areas:

i. Self-insurance and general liability costs;

ii. Treasurer-Tax Collector functions;

iii. Equipment use allowance;

iv. Retirement billing;

v. County Office of Education billing;

vi. Other Special Revenue Fund billing; and

vii. Cost of Living Adjustment.

8.3 Request that the independent financial auditors review the application of the COLA and roll forward methodology for computing cost plan billings, and report back to the Board of Supervisors on their findings;

8.4 Establish written internal policies and procedures for the preparation and billing of the cost plan;

8.5 Consolidate the preparation and billing of the cost plan in the Budget and Analysis Division; and

8.6 Require the Budget and Analysis Director to supervise the preparation of the cost plan, annually review the cost plan document, and be actively involved in the State Controller's annual review of the City's cost plan, including participating in discussions with the State Controller's Office on any identified issues and findings.

Costs and Benefits

While there are costs associated with the comprehensive assessment of the cost plan and its application, there will be increased revenues by addressing the issues outlined in this report. The Controller should utilize existing Controller analytical resources other than the current staff responsible for cost plan preparation.

¹ California State Controller's Office, Handbook of Cost Plan Procedures for California Counties, Section 4130, March 2001.

² According to a special report prepared by the Controller's Office, Judgements and Claims expenditures over the last five years averaged $40,906,803 annually and ranged from $26,975,946 to $89,290,649.

³ Cost Allocation Plan, City and County of San Francisco, For the Plan Year Ending June 30, 2003, Schedule 3.001, page 19.