September 8, 2003

Mr. Harvey Rose
Board of Supervisors Budget Analyst Office
1390 Market Street Suite 1025
San Francisco, CA 94102

Dear Mr. Rose,

This is the Controller's Office (Controller) response to your management audit of our office conducted in July and August of 2003.

The Controller is pleased that there are few or no findings or recommendations regarding most of the core functions of the office, such as budget preparation and monitoring, property tax operations, payroll, vendor payments, and bond and financial statement reporting activities. As auditors, we understand and welcome comments that point out areas for improvement in our activities.

We have reviewed the Budget Analyst's (Analyst) recommendations and summarize our response here and provide more detailed responses on the pages that follow. We apologize in advance if the comments do not exactly match the text of the Analyst's final report due to the rushed nature of this audit and the limited time available for both the Analyst to prepare and the Controller to respond to this audit.

We believe the great majority of the Analyst's comments fall into three areas:

In general, the Analyst believes the Controller should put more emphasis on compiling, creating, documenting, and promulgating policies and procedures in various areas. Eighteen, or 26% of the 69 recommendations in the report fall in this area. In general, we agree that this would be beneficial to the City and will prioritize this, taking into consideration limited budget resources and a cost benefit approach to working on the most important areas first.

The Analyst spent a considerable amount of time looking at how we could increase the ability of the City to increase reimbursement for costs from other agencies or within the city structure. The Controller has focused in the past on those items that we believe had the greatest expectation of actually producing funds for the City and particularly for the General Fund. The Analyst's report, while not finding any significant items that have been missed, encourages us to focus on this area. We agree to do so, again taking into consideration a cost benefit approach and limited staffing.

The Analyst correctly points out that we have aging budget, accounting and purchasing technology systems that require upgrade and eventual replacement. The basic systems are not flexible enough to easily meet changing, but reasonable, departmental expectations. They do, however, enable the City to prepare a budget, pay its employees and vendors, and meet all bond

and financial reporting requirements. The Controller is currently working on a number of upgrades to these systems. The eventual replacement is expected to cost $25 to $30 million for outside software and assistance plus the efforts of a considerable number of City staff. The Controller welcomes an opportunity to discuss with the Board the possibility and timing of funding such an endeavor.

On the pages that follow, we have summarized what we believe to be the Analyst's key findings for the reader's convenience. This summary should not be viewed as a substitute for reading the Analyst's report. We look forward to seeing your final, complete report and following up on its recommendations.

Sincerely,

Ed Harrington
Controller

Encl.

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The Analyst has recommended that the Board of Supervisors consider whether it wishes to continue non-mandated functions performed by the Controller's City Projects and Performance Management Divisions. The Analyst also recommends that the Controller disband the Performance Management and Grant Units, redistribute the work among other divisions, eliminate the Grants Manager position and downgrade the Performance Management Director position.

The Controller does not agree with the recommendations to disband the Performance Management Division and the Grants Units and redistribute its work to employees of other divisions. We also do not agree with the recommendation to downgrade the Performance Management Director and to delete the Grants Manager position. Although we do not agree with these specific recommendations, the Controller will review and, if necessary, revise its organizational structure based on the outcome of the proposed Charter amendment (Proposition C) at the November election to increase the performance measurement and auditing functions of the Controller.

The Controller has added performance management and special projects functions to improve the performance of the City and believes these functions have added value. The City Projects Division was created by the Controller in consultation with and approval of the Mayor and the Board of Supervisors to improve the efficiency and effectiveness of City operations. The City Projects staff provide analysis and assistance to departments in the implementation of management and operational changes. The Performance Management Division staff consult with and coordinate departmental efforts to develop and track their performance measures and mandated efficiency plans, and manages the citywide annual citizen survey. The work that has been performed by staff in both divisions has led to improvements in the operations of City services. The Analyst found no fault or inefficiency in the operation of these units. The Controller believes they add considerable value to the City.

The Grants Management Unit was added in the mid 1990's as a response to a material weakness in the City's operations identified by the City's independent auditor. The addition of this unit has corrected the material weakness from the independent auditor's perspective. The grants unit oversees budget transactions for grants, establishes account structures for new grants, performs reconciliations of grant funds, provides training and technical assistance to City departments, conducts periodic audits of grant accounting transactions, and prepares the Countywide Cost Allocation Plan. The recommendation to delete the manager position, which manages and performs these functions, would jeopardize the gains that have been made. The Analyst criticizes the grants unit for not doing more to manage the City's grant activities, but instead of recommending efforts be increased, recommends the Controller disband the unit and reduce the staffing. The Analyst's assertion that these duties should be performed in other divisions would not streamline the functions, but rather would increase the workload among fewer employees. The Controller believes the savings being claimed by the Analyst would be small compared to the risk of the loss of grant funds.

The Analyst recommends compilation of existing policies and instructions regarding financial activities, and development of new policies. He also recommends an assessment of City departmental reporting needs, consolidating responsibility for the accounting structure into one work unit, and increased enforcement in the Controller's review of user access to the financial system.

The Controller agrees that more emphasis can be placed on creating, documenting and promulgating policies and procedures in various areas, but notes that new technology allows more options for doing this than a traditional procedures manual. The Controller believes the Analyst misunderstands the reporting needs of the various departments and how they are being met. Finally the Controller believes security measures currently in place provide adequate system security, but could be enhanced.

The Controller agrees that more emphasis can be placed on creating, documenting and promulgating policies and procedures in various areas. However some of the Analyst's comments come from a lack of familiarity with how the City's financial systems and their inherent controls are designed to work. In general the City's financial systems have been changed, over the last ten years, from relying on written procedures attempting to enforce adherence to hundreds of financial practices, to rules-based systems with on-line edits and system controls. The City's financial systems require that staff set up structures, and initiate and process transactions, within parameters that include accounting, classification, and organizational codes and several types of expenditure and budget allocation and control. In most cases, inappropriate or incorrect entries are either automatically rejected by the system or disapproved by Controller staff reviewing the material or transaction on-line.

The post-audit process conducted by the Controller analyzes the errors that do occur and uses the results to develop new coding, system controls, and training to address weaknesses. The Analyst's statement that the number of exceptions identified in the Controller's last post audit indicates a decrease in adherence to policies and procedures does not give a complete picture. The Analyst does not consider that the dollar value of the errors dropped significantly, nor recognizes that the Controller focused its last review solely on those departments with the most exceptions in the prior year. In the last post-audit, we found appreciable improvement in the financial areas that the Controller targeted as representing the most risk to the City and therefore provided additional procedures, training, and oversight. For example, transactions initiated and approved by the same person dropped by 87%. This indicates that the training and follow-up corrective action plans developed concurrently by the Controller and user departments have led to improvements in the financial transactions posted over the past year.

The Analyst correctly states that the City budget and accounting systems are aging and that that they do not meet all of the City's reporting needs. The Controller notes here that the systems provide the functions that mainframe computers are designed for-among them allowing for the City to process thousands of daily transactions, prepare a budget, pay vendors and meet all bond and financial reporting requirements. The Controller's office has addressed the real need for more flexible use of financial data at the department and other levels on multiple fronts. We have added on-line inquiries, created and maintain a Microsoft Access database with the reports requested most often, distribute written monthly revenue, expenditure, and spending rate report, provide downloads into Excel file format, provide staff assistance to departments who have specialized reporting needs and have developed the Executive Information System (EIS), which is a flexible, menu-driven reporting and analysis software. EIS is now used for the Controller's citywide reporting including the Comprehensive Annual Financial Report (CAFR), and by 13 departments representing 77% of the City's budget. The Controller will be happy to work with any City departments who have not yet taken advantage of these tools, or of Controller's training, for their reporting and management needs. (The systems area is the focus of Chapter 3 of this report; the reader may want to refer to comments in that section for a complete understanding of the issue.)

The Controller maintains central control where it is critical-over the chart of accounts, the major classification structures of the system, and the fund architecture that supports comprehensive auditing and reporting. The Analyst is incorrect is stating that the Controller does not provide centralized monitoring of the City's accounting structure. Only a limited number of Controller staff can create or change all but the lowest level of accounting codes. In this area, it is very odd that the Analyst cites as evidence of weakness the fact that departments restructure their accounting frameworks with consultation, problem-solving and approval provided by the Controller's Office. The Analyst states "there should be no reason to change it [accounting structure] for political or other human influences." The Controller believes reorganizations occur in response to real world change-for example the advent of district elections in part caused the Recreation and Park department to want to analyze their spending geographically, and a charter amendment mandated the consolidation of MUNI and Parking and Traffic into one department, requiring changes to their accounting and reporting structure. We anticipate that regardless of any Controller policy or procedure, the City's business requirements and elected and appointed leadership will continue to change, and the accounting structure may need to change accordingly. A "consistent working group" to respond to this need in the Controller's Office as recommended by the Analyst is exactly what exists now.

The City has multiple controls and security reviews which protect access to the financial system. The Analyst recommends that the Controller ensure that its annual security reviews be conducted in a timely manner and that the Controller deny system access for users whose status is not confirmed. This is the process that is in place under the existing security review, but this area can be emphasized more in the future. In addition, the Department of Telecommunications and Information Services has controls not reviewed by the Analyst which add further security in this area. It should be noted that in reviewing the Controller's process, the Analyst did not find any cases of inappropriate user access to the system.

The Analyst states that the City's current financial information systems are inadequate to meet the financial reporting and fiscal management needs of the departments and that the Controller should assess departmental financial reporting and accounting needs and be prepared to move forward with a replacement system when it becomes necessary or financially feasible.

The Controller concurs that the City's systems are aging and need to be upgraded and eventually replaced. However the current systems perform all required functions, and the cost to replace them exceeds $25 to $30 million. Departmental needs are currently being met to a large degree by separate reporting mechanisms.

The Controller recognizes that the existing systems are over ten years old, and that we need to plan for eventual replacement of the systems. Major advances have been made in information technology since the City's systems were installed in the mid-1990's. Newer systems would offer departments and the City as a whole more flexibility in responding to today's needs.

However, with the current systems the City is able to perform all of its mandated financial functions, including paying our employees and vendors, meeting our accounting and budgeting requirements, and developing financial statements and producing the City's Annual Financial Report. These required functions are not in danger of failure with the current systems.

Santa Clara County has recently spent $13 million simply to upgrade its financial system. Outside experts have estimated it would cost the City $25 to $30 million in external software and assistance to upgrade its financial, budgeting and purchasing systems. There would be additional costs to dedicate City staff to this effort. This need must be considered in relation to all other City priorities. The Controller would welcome discussing this need with the Mayor and the Board.

The Controller's staff has initiated several short-term enhancements to improve the City's financial reporting capabilities that will be in place until we can invest in a new system. For example, the Controller is continuing to roll out the Executive Information System (EIS), a flexible, user-friendly financial reporting system that is being used in 13 City Departments representing 77% of the City's current budget. In addition, the Controller is developing web-based tools to enable departments to access additional budget reports. These short-term improvements will provide added functionality to the financial reporting capabilities that department users have requested.

(The Analyst also includes a discussion of system needs in Chapter 2. The reader may also want to refer to that discussion).

The Analyst recommends changes to maintain financial auditor independence to comply with changing federal regulations enacted in the past few years. He also recommends considering a Citywide internal control review and a financial auditor report on the internal control review.

The Controller wants to make it clear that at no time has the City's external independent auditor been out of compliance with any legal or industry rule or regulation in any work conducted on behalf of the City. The Controller is quite comfortable that the City's independent auditor is selected by the Board and the Board is free to make whatever rules they would like in this area.

The Controller believes that the City's external auditors have always complied with all legal and industry rules and practices related to their independence. The Analyst lists several projects that the City's current auditor has done for the City. We want to make it completely clear that this work was not and is not out of compliance with any regulation.

The Charter gives the Board authority over the selection of the City's external auditor and the Board should feel free to make whatever changes it deems fit in this area. It has been the City's policy to do a complete selection process every five years for external audit services related to the audit of the Controller's records. This winter we intend to start that process because we are coming to the end of our five-year cycle. Last time this was done, the Board President sat on the selection panel and the Board formally adopted the resulting contract. The City's auditor regularly meets with the Board Audit Committee. The Board should feel free to make changes in this area in the Administrative Code, in the new audit contract, or by giving the auditor specific direction.

One of the recommendations being made by the Analyst is that the City have a policy that the Audit partner on this engagement be changed every five years. As noted above, the Board has the opportunity every five years to change not just the audit partner, but the entire audit firm. The current partner on the City's engagement has been in that capacity for three years.

The City needs to decide the costs and potential benefits of doing a comprehensive internal control review and purchasing an external audit of the review. Internal controls are important to the City. Our external auditors test internal controls to the extent they need to rely on them to give an opinion on the City's financial statements. But there are multiple levels of internal control throughout the City. At least a portion of these controls are presumably not documented or tested for a variety of reasons-chief among them is that area being controlled is financially immaterial or the reasonableness of the resulting expense or balance can be ascertained without a detailed review of the controls. To document all of these controls would be expensive and time consuming. There would be an additional cost to have auditors test and report on the controls. Since this is not a requirement in any legislation or an industry practice, the City needs to consider the relative priority and additional cost of City staff and outside contractors.

The Analyst recommends changes in the area of Board reserves and carry-forward of appropriations.

The Controller concurs with the Analyst's recommendation that the technical parameters for establishing appropriation reserves be enhanced in order to assure that funds are controlled at the same level as they are appropriated and are closed out when no longer needed. The Controller believes that current procedures regarding the carry-forward of unspent appropriations are adequate, but would be happy to work with the Mayor and Board to amend or codify any policies they deem appropriate.

The Controller will continue to enhance reserve controls to meet the needs of policymakers. The Controller has established and rescinded hundreds of reserves worth millions of dollars over the years. The Analyst notes two reserves where funds were spent before Board approval and two old reserves that can be removed. The Controller believes these are anomalies but will implement procedures to prevent these occurrences in the future. For example, the Controller will adjust the reserve procedures for work orders and for ongoing projects to ensure that the reserves are properly segregated from other funds to facilitate the monitoring and closing of these funds.

The Controller believes current practices related to the carry-forward of unspent appropriations from one year to the next are appropriate, but would be willing to work to amend or codify any changes desired by the Mayor or Board. The Analyst reports that the Controller approves most of the Departments' requests to carry forward unexpended funds from one year to the next when they meet the Controller's guidelines implying this indicates inadequate review. However, the Analyst has not substantiated his opinion that in some instances, approvals granted to carry-forward funds have exceeded the Controller's policies.

The Analyst also implies but has not shown any instance that the carry-forward process circumvented the Board's appropriation authority. In no instance has the Controller allowed Departments to carry-forward funds that were not already approved by the Board of Supervisor, or circumvented the appropriation process of the Mayor and the Board of Supervisors.

The Analyst recommends formal City policies and procedures for the creation of certain types of funds, a review of balances in some City funds and sub-funds, and that the Board of Supervisors specify "accounts" rather than "funds" as a preferable accounting mechanism.

The Controller believes the City's funds are properly set up and maintained according to Generally Accepted Accounting Principles (GAAP), with full oversight exercised by the Controller. We also believe the dollar amounts that will be available to the General Fund from the process of reconciling and closing the funds listed are likely to be much less than that claimed by the Analyst. Finally we agree with the recommendation that the Board specify "accounts" rather than "funds" and have worked with the City Attorney on this for the past several years.

The City's funds are set up and maintained according to Generally Accepted Accounting Principles (GAAP), with full oversight exercised by the Controller. We do not agree with the assertion that inadequate oversight is provided and that the City has funds which do not meet GAAP standards. Only the Controller's staff has the authority to set up new funds in the financial system, and they do so according to GAAP requirements, including the criteria of sound financial administration. For example, among the six funds that are listed as unnecessary in the Analyst's opinion are one that is specified in the recent update to the Administrative Code, and three that account for activities that are multi-year in nature and are not paid for by operating funds. These funds serve the legitimate operating purpose of keeping General Fund budget authority available for true General Fund activity. In addition, the City's external auditors have concurred that the City's funds are appropriately within GAAP guidelines in their annual financial review.

The dollar amounts available to the General Fund from the process of reconciling and closing the funds listed are likely to be much less than that claimed by the Analyst. The Controller's Office agrees that there are existing funds that can be closed out, and indeed some of the specific funds listed by the Analyst are already included the Controller's year-end close process for FY 2002-2003.

However, the Analyst spent most of their time reviewing selected sub-funds and accounts. The City controls its budget at the fund level. So while the Analyst identified positive balances in some accounts, he did not have time to fully research all of the related accounts that might have offsetting negative balances. For example a department might account for revenues in one sub-fund and expenses in another, or process revenue transfers between funds and sub-funds. As long as we control at a fund level these variances can be reconciled. It is by no means "certain" the process of reconciling all special and fiduciary funds will produce surplus monies-both because there are negative as well as positive balances to be analyzed, and because restrictions attached to fiduciary funds must be honored before the criteria of closing inactive funds is applied.

We are pleased to add that among the types of funds reviewed for the Analyst's report, there are literally billions of dollars that are managed consistently. In addition, analysis done by the Controller's Office has helped close out and make available millions of dollars to balance the budget in the most recent fiscal years. For example, the agency fund where property tax revenue is managed has over $1 billion in transactions annually, including allocations to the Unified School District, Redevelopment Agency, and other taxing entities. Over $49 million from various sources was analyzed, closed out and made available to the General Fund to help balance the budget in FY 2002-2003. As noted, the Controller's Office does reconciliation and analysis on a priority and staff availability basis and focuses its limited time on managing larger dollar value activity.

Significant progress has been made by the Controller on the issue of fund maintenance in recent years. As noted in the report, the Controller's Office has worked to ensure that new financial structures called for in legislation be worded such that the Controller can establish the appropriate form in which the activity will be recorded, and we are pleased that the Budget Analyst further recommends this approach to the Board. This has and will effectively reduce the numbers of new funds created. In FY 2000-2001, the Controller's Office initiated a process to simplify and consolidate the City's special funds by creating a standardized categorization system specifying how the fund's finances are to be managed. Outmoded and inconsistent fund references throughout the municipal codes were also repealed as part of the effort. The next phase of this project, already underway, will close outmoded funds and simplify reporting. The function of the files called for by the Analyst will be served instead by on-line tools including a new screen with data fields supplementing the fund information which is printed annually in the CAFR.

The Analyst recommends an annual risk assessment and audit of cash revolving funds, changes to policies and procedures for these funds, and closing out or reducing authorization for a number of revolving funds.

The Controller's Office agrees that the assessment of authorization amounts and elimination of unnecessary cash revolving funds is desirable. We also concur that policies and procedures in this area could be enhanced.

The Controller's Office agrees that the assessment of authorization amounts and elimination of unnecessary cash revolving funds is desirable. Over the last seven years, the City has reviewed all of its revolving funds. Based on recommendations by the Controller's Office the number of funds was reduced from 107 to 64 and the total authorization from approximately $1.8 million to under $800,000. It is appropriate to do this same type of analysis on a periodic basis. However, given the existing controls, audit schedule, and the relatively small dollar amounts remaining in cash revolving funds, the Controller's Office believes that periodic reviews are appropriate and that an annual risk and utilization analysis is not indicated. We should note that the amounts currently authorized in revolving funds were the result of considerable negotiation between the Controller and departmental operating staff and we would want to consult with department staff before making changes.

It is the Controller's policy is to audit revolving funds on a periodic basis, not every year. The Analyst notes that only three audits of cash revolving funds were conducted in FY 2001-2002. This is true, however over the period of the five fiscal years ending with that year (FY 2001-2002), the Internal Audits Division had audited all of the revolving funds in which there were activities.

The Controller's current policies and procedures for cash revolving funds could be enhanced. The Controller has general guidelines for estimating the appropriate size of revolving funds and how often they should be replenished. However, these guidelines could be strengthened and promulgated more widely.

The Analyst believes the Controller has not aggressively sought to maximize the charging of allowable indirect costs. The Analyst concludes that an additional $29 million of costs could be included in the City's cost allocation plan and further implies that once costs are allocated, they should be collected from all agencies. Finally, the Analyst suggests that the City is at risk for non-compliance with State and Federal guidelines under OMB Circular A-87 Cost Principles for State, Local and Indian Tribal Governments (OMB Circular A-87).

The Controller concurs with a recommendation to perform further work in this area to determine if additional costs may be allocated. However, the Controller believes the Analyst overstates the potential benefit of this work. The Controller also believes that once the costs are determined it is a decision of the Mayor and the Board to charge departments and agencies for the full cost. The Controller notes that the City is in full compliance with all legal requirements and guidelines in this area, and that annually the City's cost plan is certified by the State Controller.

The Analyst's discussion of additional costs that could be included in the cost allocation plan is inaccurate and largely overstates the potential benefits. To be of benefit and justify making detailed calculations in the cost plan, a cost must be eligible, allocable and ultimately collectible. The two largest components of the Analyst's additional costs are for general liability claims and Treasury costs-they represent $25 of the $29 million dollars noted in the report. It has not been shown that these items meet the three criteria.

Approximately $18 million of the additional costs listed by the Analyst relate to general liability payments. We pointed out to the Analyst that a substantial majority of liability claim amount listed in their table relates to enterprise activities such as the MUNI Railway, are already directly billed to them and therefore would not be processed through our cost allocation plan. In addition, major MUNI funding sources like the Transportation Authority have a finite amount of funding available and any increase to overhead costs would simply reduce the amount available for direct service or project spending. Approximately $7 million of the additional costs relate to activities of the Treasurer. All of these charges are currently being spread in other ways and additional analysis would be needed to show whether inclusion in a cost allocation plan would bring any revenues to the City. In addition to these issues, an insurance plan of the type described by the Analyst involves up-front costs such as completing an actuarial analysis and establishing loss reserves. A cost-benefit review of these cost recovery methodologies is necessary.

The Analyst incorrectly implies it is the Controller's decision regarding which agencies are billed for allocated costs when in fact this decision is made by the Mayor and the Board of Supervisors in the budget process. The only significant non-billing pointed out by the Analyst is that City policymakers have chosen not to bill the School District for charges properly calculated in the Controller-prepared plan. Should the Board wish to bill the School District for the approximately $3.3 million due the City in FY 2002-2003, we would be happy to attempt to collect.

The Analyst recommends that the Controller test the effect of allocating costs that are excluded, under Federal and State guidelines, from the City's current indirect cost plan to determine if a "multi-tiered" methodology would increase reimbursements to the General Fund from enterprise funds and fee-supported functions within the City structure.

The Controller believes that all significant costs that can be reimbursed are being captured at this time. The Controller agrees that a test could provide more information to determine if the City should consider the preparation of a multi-tiered cost plan

The Controller's Office has focused its efforts on those approaches to cost recovery that we believe have the greatest expectation of producing funds for the City and particularly the General Fund. To that purpose, we prepare a Cost Allocation Plan in compliance with OMB Circular A-87, and increasingly are working with departments on their indirect cost rates and on full cost recovery fee analysis (also see Sections 8, 10 and 11). Over the last three budget cycles, we have also worked in coordination with the Mayor's Office on identifying and moving staff and costs that benefit enterprise and fee-based City functions directly into those functions. These approaches have produced an immediate benefit to the General Fund, with less effort than would likely be required to produce a multi-tiered cost plan.

Development of a multi-tiered cost plan would not be free. The Analyst suggests that there would be no incremental cost to develop a multi-tiered cost plan. The Controller does not agree that it would be a matter of temporarily diverting staff to produce a multi-tiered cost plan, and notes that the State Controller similarly cautions governments considering this approach that it is "not a simple task" and that "each individual grant or contract should be analyzed to determine to what extent indirect costs are reimbursable." We also note that the State Controller does not "endorse" this method, but merely suggests it as an option for counties. We also note that a multi-tiered cost plan is particularly beneficial to governments that do not have other indirect cost recovery tools, but that this is not the case in San Francisco. Nevertheless, the Controller's Office will review this approach, taking into consideration the cost benefit and limited staff availability.

The Analyst states that the Controller has not established consistent methodology for calculating department indirect costs and their application to City fees. He further states that the Controllers' Office has no involvement with the analysis of indirect rates for grants, and that we should develop policies and procedures for calculating department indirect cost rates.

The Controller believes the City uses appropriate policies and procedures to calculate departmental indirect costs rates, but there is always room for continuous improvement. The Controller believes that the approach of decentralizing the calculation of indirect cost rates with limited central direction and review is appropriate, and notes that should the Board desire additional Controller oversight, additional staff will be needed.

The Controller believes the City uses appropriate methodologies for calculating departmental indirect costs rates. It would not be reasonable to require MUNI Railway, the Public Utilities Commission, the Airport, the Department of Public Works and others with very different "businesses" to use one consistent methodology when various ones are legally available and maximize revenue.

The Controller does not need to establish a `City only' methodology for establishing indirect costs because we already use existing State methodologies. We use the California State Controller's Handbook of Cost Plan Procedures for California Counties as a guide in developing and implementing cost plans. Additionally, for fee setting the Controller uses the Municipal Revenue Sources Handbook (published by the California League of Cities) and the California Constitutional provisions and Code sections that govern taxation and fee setting. Further, the requirements for taxation are clearly outlined in Article XIII of the California Constitution, and recovery of funds in excess of the cost of providing service is deemed to be taxation.

The Controller assists departments in the preparation and approval of indirect costs and reviews the results for reasonableness. The Controller issues technical instructions to guide departments in proposing fee increases and fee revenues in their budget. This provides the necessary tools for departments to be able to perform fee cost recovery analysis, including both direct and indirect costs. Additionally, departments are encouraged to meet with the Controller's Office Revenue Unit in advance of any proposed fee change to ensure that an appropriate and full-cost analysis is made.

Further, the Mayor's Policy Instructions & Controller's Technical Instructions For Budget Year 2003-2004 provided detailed instructions to Departments for submitting information on Licenses, Permits, Fees and Service Charges. As part of this process, departments are provided a basis for estimating reasonable indirect costs for both citywide central service and departmental overhead rates. Central service overhead rates are calculated using the Countywide Cost Allocation Plan (COWCAP), which is developed in accordance with the California Controller's Handbook on Cost Plan Procedures and the Federal government's OMB Circular A-87.

The Controller calculates Departmental Overhead Rates based on the adopted budget. Additionally, departmental overhead rates are based on department-specific adopted budget pertaining to centralized department administrative costs.

As part of our centralized, high-level direction and review, in the FY 2004-05 budget process the Controller will continue to work with departments to increase the fluency of department fiscal staff in fee setting and overhead rate calculation methods. Additionally, we will be working with Departments to increase consistency where desirable for capturing centralized departmental costs.

The Analyst also suggests that the Board of Supervisors require that indirect cost calculations be shown for every grant application, even if the grantor does not pay indirect costs. This is a decision for the Board.

The Analyst believes the Controller has not developed policies and procedures to systematically calculate cost-based fees. He recommends the Controller produce a comprehensive fee schedule. He also indicates that additional work in this area would produce at least $880,000 annually.

The Controller communicated to the Board as part of the FY 2003-2004 budget deliberations our intent to provide additional work in this area, but also believes that appropriate procedures are in place to make correct fee calculations. Adoption of fees at a level that would result in full cost recovery is a policy decision for the Mayor, Board of Supervisors or, in some cases, the Municipal Transportation Authority (MTA).

The Board has had full information about the major fees the Analyst recommends be raised to full cost recovery and made the decision not to do so. Of the $880,000 listed in the Analyst's report $826,000 is under three departments as follows:

The Controller has provided substantial direction to departments related to fee calculation. In the annual Budget Instructions and on the City's intranet, we provide templates and instructions for completing fee calculations. Where departments have used this information, the Mayor and Board have been able to make fee decisions based on complete information. But some departments have not followed our instructions or responded to our requests.

The Analyst points out that proposed fees related to a particular project-licensing of fortunetellers-changed dramatically over the course of several months. The report implies that these changes mean that the numbers were incorrect in the earlier versions and not caught by the Controller. As we pointed out to the Analyst, the program's parameters changed considerably over the course of the Board's deliberations so it is not surprising the costs also changed.

The Controller developed a comprehensive fee schedule already for departments who provided the information and made this data available to the Budget Analyst and the Mayor's Budget Office during the FY 2003-2004 budget process. Administrative Code Section 3.7 requires all departments to provide a comprehensive fee schedule as part of their budget submission. We have repeatedly reminded departments of this requirement; however, some have not complied. We will continue to work with departments to achieve full compliance with the Code requirements.

Finally, the Analyst has stated that the Budget Committee placed $1.38 million of Planning department fees on reserve since they were "illegal." The Controller is not aware of any determination that these fees were illegal, though was aware that as of the time of the Board's review the department had not provided to our office the necessary fee materials to review. And, in fact, the Controller recommended reserving of appropriation authority until adequate fee documentation was provided by the department.

The Analyst recommends a quality improvement program for the City's claims to the State under the SB90 Program (reimbursement of the cost of state mandated programs) or, alternatively, bringing the task of filing the claims (currently done by a consultant) in-house, a report detailing which claims are filed, and a post-audit of claims for FY 2002-2003.

The Controller agrees that a written report on the City's SB 90 claims with more detailed information would be informative and will make such a report available to the Board of Supervisors. However, the Controller disagrees with the Analyst's assertion that the City has lost significant revenue and may be subject to auditing and disallowance of costs. Further, the Controller does not believe that bringing this program in-house would be cost-effective. Finally, we note that the State has not budgeted funds to reimburse counties under SB 90 over the last two budget cycles and that the City does not have any expectation of getting actual revenue from this source in the foreseeable future.

The City's consultant can apply different indirect cost rate approaches to maximize the City's claims. We concur with the Analyst that some errors have occurred in salary reporting and will take corrective action in this area. In the case of the OCC, a default indirect cost rate of 10 percent was appropriately used to maximize the claimed amount because the program already claims virtually all of its costs as direct costs. In the case of the Elections Department, the City's consultant used a higher rate assuming it would maximize revenue, but in this case the Analyst appears to be correct that it did not.

There is a need for departments to provide information for SB 90 claims to both the Controller's Office and the consultant in a timely fashion. City departments are responsible for their own processes related to SB 90 claims and the Controller's Office works with the consultant to monitor the process, provide assistance, make site visits, and facilitate participation by departments. Most departments are doing a good job of providing their SB 90 data, tracking their costs and building solid source documentation. However, it does happen that even after several contacts departments put off providing their claim data. What is shown by the Analyst's review is a need for departments to be diligent in providing the information for SB 90 claims. The Adult Probation Department, which administers the one major program for which the City is eligible but has not filed, should work with the Controller's Office and the consultant to file a claim for the domestic violence treatment program (annual value under $100,000).

Finally, we do not agree with the Analyst's speculation that the City would save money by bringing the SB 90 filing work in-house. San Francisco's consultant provides this service for most of the counties in the State, and stays current on the law and regulations related to the program. We have reviewed this issue recently, and concluded that duplicating the technical expertise of the consultant would not be an efficient use of the Controller's limited staff time.

The Analyst's report states that the Internal Audits Division is not meeting the same level of productivity as other county and city auditors, that auditors in the Controller's Office exceed minimum requirements for training, and that the Internal Audits Division should eliminate unnecessary mandates in order to free up additional audit time.

The Controller believes that there is always room for improvement, but that we are operating at the average of other audit units of our size. We agree that we provide more training opportunities than the minimum required for licensure, but we believe the training is justified. We agree with the Analyst that continuous risk assessment and prioritization of audits is important.

The Controller's Internal Audits Division productive audit time is 75% to 80% depending on how break time required under the City's labor contracts is reported, as compared to the productive audit time of survey respondents of 76%, where it is unknown how similar break time is reported. The Analyst compares the Controller's productivity to the responses of 17 similar government audit units who answered the National Association of Local Government Auditors (NALGA) survey (only four percent of membership). The NALGA survey measures time usage two ways: the first compares audit time to total available time (excludes paid time off). The second measure compares audit time to total time (includes paid time off). The first measure is the reasonable one to use for comparative purposes, as it measures how time is spent when auditors are at work. And it excludes factors beyond the Internal Audits Division's control such as negotiated paid time off where the City offers higher than average benefits. The Analyst has selectively used the second measure of productivity where the Division's usage time is 62% as compared to the average of 65%.

Further, the Analyst concludes that the Internal Division should be measured against a target of one standard deviation from the mean of responders and calculates a savings from a 77% productivity number on the second measure. This is a questionable methodology.

The Controller believes that well-trained staff are more efficient in their work and that additional training of staff is particularly warranted by the fact that 60% of the audit staff have been with the office for less than three years. He also believes the minimum training requirement should not be viewed as a standard or cap. Professional training provided to Internal Audits Division auditors includes fraud detection, government auditing standards, government financial auditing, assessing risk in the public sector, sexual harassment prevention, diversity training, auditing not-for-profit organizations, among others. These training sessions are important to maintain the high standards among the Controller's auditing staff.

The Controller believes that most mandated audit work that is justified. In recent years, we have worked with the Board to raise the threshold of revenue for required concession audits, thereby reducing some low value audits. Although the Controller agrees that outdated mandates be eliminated, the one example identified by the Analyst would free up only 100 hours each year.