ITEM 3.8 City of Otsego - 2016 Communications Letter
City of Otsego
Wright County, Minnesota
Communications Letter
December 31, 2016
City of Otsego
Table of Contents
Report on Matters Identified as a Result of
the Audit of the Financial Statements 1
Material Weakness 3
Significant Deficiency 4
Required Communication 5
Financial Analysis 9
1
BerganKDV, Ltd.
bergankdv.com
Report on Matters Identified as a Result of
the Audit of the Financial Statements
Honorable Mayor, Members of the
City Council and Management
City of Otsego
Otsego, Minnesota
In planning and performing our audit of the financial statements of the governmental
activities, business-type activities, and the aggregate remaining fund information of the City
of Otsego, Minnesota, as of and for the year ended December 31, 2016, in accordance with
auditing standards generally accepted in the United States of America, we considered the
City's internal control over financial reporting (internal control) as a basis for designing
audit procedures that are appropriate in the circumstances for the purpose of expressing our
opinions on the financial statements, but not for the purpose of expressing an opinion on the
effectiveness of the City's internal control. Accordingly, we do not express an opinion on the
effectiveness of the City's internal control.
Our consideration of internal control was for the limited purpose described in the preceding
paragraph and was not designed to identify all deficiencies in internal control that might be
material weaknesses or significant deficiencies and, therefore, material weaknesses or
significant deficiencies may exist that were not identified. In addition, because of inherent
limitations in internal control, including the possibility of management override of controls,
misstatements due to error, or fraud may occur and not be detected by such controls.
However, as discussed below, we identified certain deficiencies in internal control that we
consider to be a material weakness and an other deficiency that we consider to be a
significant deficiency.
A deficiency in internal control exists when the design or operation of a control does not
allow management or employees, in the normal course of performing their assigned
functions, to prevent, or detect and correct, misstatements on a timely basis. A material
weakness is a deficiency, or a combination of deficiencies in internal control, such that there
is a reasonable possibility that a material misstatement of the City's financial statements will
not be prevented or detected and corrected, on a timely basis. The material weakness
identified is stated within this letter.
A significant deficiency is a deficiency, or a combination of deficiencies, in internal control
that is less severe than a material weakness, yet important enough to merit attention by those
charged with governance. The significant deficiency identified is stated within this letter.
2
The accompanying memorandum also includes financial analysis provided as a basis for
discussion. The matters discussed herein were considered by us during our audit and they do
not modify the opinion expressed in our Independent Auditor's Report dated May 24, 2017,
on such statements
This communication is intended solely for the information and use of management, the City
Council, others within the City and state oversight agencies and is not intended to be, and
should not be, used by anyone other than these specified parties.
St. Cloud, Minnesota
May 24, 2017
3
City of Otsego
Material Weakness
MATERIAL AUDIT ADJUSTMENT
During the course of our engagement, we proposed a material audit adjustment that would not have been
identified as a result of the City's existing internal control system and, therefore, could have resulted in a
material misstatement of the City's financial statements. The material misstatement detected as a result
of audit procedures was corrected by management.
We recommend that the City review the internal control process over the year-end closing process to
ensure there are no adjustments needed.
4
City of Otsego
Significant Deficiency
LACK OF SEGREGATION OF ACCOUNTING DUTIES
The City had a lack of segregation of accounting duties due to a limited number of office employees.
Adequate segregation of accounting duties is in place when the following four areas of a transaction
have been separated: authorization, custody, recording, and reconciliation. Examples of functions
within the City that demonstrate this lack of segregation of accounting duties include, but are not limited
to, the following:
• Cash Receipts – The Utility Billing Clerk and Accountant have access to initiate and record
receipts. The Utility Billing Clerk is also responsible for depositing cash receipts. The
Accountant is also involved in the reconciliation process and has full access to the general
ledger.
• Utility Billing Process – The Utility Billing Clerk is responsible for handling customer payments,
depositing payments received, and recording adjustments to accounts.
• Disbursements – Due to small staff the City allows access to other employees to perform
disbursement related activities in order to fill in for normal roles and responsibilities in the
absences of other staff. The Accountant has access to record and cut checks, access to blank
checks, can enter manual adjustments to the general ledger and is involved in the reconciliation
of cash.
• Financial Reporting and Journal Entry Process – The Finance Director and Accountant have full
access to the general ledger and can make adjustments without review during the monthly and
yearend financial closing process.
Management and the City Council must remain aware of this situation and management should
continually monitor internal control, including changes that occur.
5
City of Otsego
Required Communication
We have audited the financial statements of the governmental activities, business-type activities, each
major fund, and the aggregate remaining fund information of the City as of and for the year ended
December 31, 2016, and have issued our report thereon dated May 24, 2017. Professional standards
require that we provide you with the following information related to our audit.
OUR RESPONSIBILITY UNDER AUDITING STANDARDS GENERALLY ACCEPTED IN
THE UNITED STATES OF AMERICA AND GOVERNMENT AUDITING STANDARD
As stated in our engagement letter, our responsibility, as described by professional standards, is to
express opinions about whether the financial statements prepared by management with your oversight
are fairly presented, in all material respects, in conformity with accounting principles generally accepted
in the United States of America. Our audit of the financial statements does not relieve you or
management of your responsibilities.
As part of our audit, we considered the internal control of the City. Such considerations were solely for
the purpose of determining our audit procedures and not to provide any assurance concerning such
internal control.
As part of obtaining reasonable assurance about whether the financial statements are free of material
misstatement, we performed tests of the City's compliance with certain provisions of laws, regulations,
contracts, and grants. However, the objective of our tests was not to provide an opinion on compliance
with such provisions.
Generally accepted accounting principles provide for certain required supplementary information (RSI)
to supplement the basic financial statements. Our responsibility with respect to the RSI, which
supplement(s) the basic audit financial statements, is to apply certain limited procedures in accordance
with generally accepted auditing standards. However, the RSI was not audited and, because the limited
procedures do not provide us with sufficient evidence to express an opinion or provide any assurance,
we do not express an opinion or provide any assurance on the RSI.
Our responsibility for the supplementary information accompanying the financial statements, as
described by professional standards, is to evaluate the presentation of the supplementary information in
relation to the financial statements as a whole and to report on whether the supplementary information is
fairly stated, in all material respects, in relation to the financial statements taken as a whole.
PLANNED SCOPE AND TIMING OF THE AUDIT
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements; therefore, our audit involved judgment about the number of transactions to be
examined and the areas to be tested.
6
City of Otsego
Required Communication
PLANNED SCOPE AND TIMING OF THE AUDIT (CONTINUED)
Our audit included obtaining an understanding of the City and its environment, including internal
control, sufficient to assess the risks of material misstatement of the financial statements and to design
the nature, timing, and extent of further audit procedures. Material misstatements may result from
(1) errors, (2) fraudulent financial reporting, (3) misappropriation of assets, or (4) violations of laws or
governmental regulations that are attributable to the City or to acts by management or employees acting
on behalf of the City.
QUALITATIVE ASPECTS OF ACCOUNTING PRACTICES
Management is responsible for the selection and use of appropriate accounting policies. The significant
accounting policies used by the City are described in the notes to financial statements. The City adopted
a new capital asset policy that increased the capitalization threshold for the year ending December 31,
2016. We noted no transactions entered into by the City during the year for which there is a lack of
authoritative guidance or consensus. All significant transactions have been recognized in the proper
period.
Accounting estimates are an integral part of the financial statements prepared by management and are
based on management's knowledge and experience about past and current events and assumptions about
future events. Certain accounting estimates are particularly sensitive because of their significance to the
financial statements and because of the possibility that future events affecting them may differ
significantly from those expected. The most sensitive estimates affecting the financial statements were:
Depreciation – The City is currently depreciating its capital assets over their estimated useful lives,
as determined by management, using the straight-line method.
Expense Allocation – Certain expenses are allocated to programs based on an estimate of the benefit
to that particular program. Examples are salaries, benefits, and supplies.
Net Pension Liability, Deferred Outflows of Resources Related to Pensions, and Deferred Inflows of
Resources Related to Pension Activity – These balances are based on allocation by the pension plans
using estimates based on contributions.
We evaluated the key factors and assumptions used to develop the accounting estimates in determining
that they are reasonable in relation to the financial statements taken as a whole.
The financial statement disclosures are neutral, consistent, and clear.
DIFFICULTIES ENCOUNTERED IN PERFORMING THE AUDIT
We encountered no significant difficulties in dealing with management in performing and completing
our audit.
7
City of Otsego
Required Communication
CORRECTED AND UNCORRECTED MISSTATEMENTS
Professional standards require us to accumulate all known and likely misstatements identified during the
audit, other than those that are clearly trivial, and communicate them to the appropriate level of
management. Management did not identify, and we did not notify them of any, uncorrected financial
statement misstatements.
The following material misstatement detected as a result of audit procedures was corrected by
management.
• Contracts payable and related expenditures
DISAGREEMENTS WITH MANAGEMENT
For purposes of this letter, a disagreement with management is a financial accounting, reporting, or
auditing matter, whether or not resolved to our satisfaction that could be significant to the financial
statements or the auditor's report. We are pleased to report that no such disagreements arose during the
course of our audit.
MANAGEMENT REPRESENTATIONS
We requested certain representations from management that are included in the management
representation letter.
MANAGEMENT CONSULTATIONS WITH OTHER INDEPENDENT ACCOUNTANTS
In some cases, management may decide to consult with other accountants about auditing and accounting
matters, similar to obtaining a "second opinion" on certain situations. If a consultation involves
application of an accounting principle to the City's financial statements or a determination of the type of
auditor's opinion that may be expressed on those statements, our professional standards require the
consulting accountant to check with us to determine that the consultant has all the relevant facts. To our
knowledge, there were no such consultations with other accountants.
OTHER AUDIT FINDINGS OR ISSUES
We generally discuss a variety of matters, including the application of accounting principles and
auditing standards, with management each year prior to retention as the City's auditors. However, these
discussions occurred in the normal course of our professional relationship and our responses were not a
condition to our retention.
8
City of Otsego
Required Communication
OTHER MATTERS
We applied certain limited procedures to the RSI that supplements the basic financial statements. Our
procedures consisted of inquiries of management regarding the methods of preparing the information
and comparing the information for consistency with management's responses to our inquiries, the basic
financial statements, and other knowledge we obtained during our audit of the basic financial statements.
We did not audit the RSI and do not express an opinion or provide any assurance on the RSI.
With respect to the supplementary information accompanying the financial statements, we made certain
inquiries of management and evaluated the form, content and methods of preparing the information to
determine that the information complies with accounting principles generally accepted in the United
States of America, the method of preparing it has not changed from the prior period and the information
is appropriate and complete in relation to our audit of the financial statements. We compared and
reconciled the supplementary information to the underlying accounting records used to prepare the
financial statements or to the financial statements themselves.
9
City of Otsego
Financial Analysis
The following pages provide graphic representation of select data pertaining to the financial position and
operations of the City for the past five years. Our analysis of each graph is presented to provide a basis
for discussion of past performance and how implementing certain changes may enhance future
performance. We suggest you view each graph and document if our analysis is consistent with yours . A
subsequent discussion of this information should be useful for planning purposes.
GENERAL FUND
The following graph summarizes the past five years of General Fund revenues, expenditures, and fund
balance. For the year ended December 31, 2016, revenues for the City's General Fund totaled
$5,791,496. This represents an increase of $702,154, or 13.8%, from 2015. General Fund expenditures
totaled $4,712,360 in 2016, which is an increase of $287,541, or 6.5%, from 2015. Revenue and
expenditure activity, combined with other financing sources resulted in a increase in fund balance of
$755,679 in 2016.
The ending General Fund balance of $3,646,202 is further broken down into spending categories;
$110,973 of the fund balance has already been spent on prepaid items while $192,408 is assigned for
insurance funding. This leaves $3,342,821 available for spending on any purpose, which is considered
unassigned fund balance. The City's policy is to maintain a minimum fund balance in the General Fund
of 45.0% of the subsequent years' expenditures. The fund balance at December 31, 2016, represents
72.3% of 2017 budgeted expenditures of $5,040,565.
2012 2013 2014 2015 2016
Total Revenues $3,697,348 $3,779,808 $5,307,292 $5,089,342 $5,791,496
Total Expenditures 3,521,355 3,654,491 4,165,186 4,424,819 4,712,360
Fund Balance 1,764,591 1,912,075 3,393,638 2,890,523 3,646,202
$-
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
General Fund
10
City of Otsego
Financial Analysis
GENERAL FUND REVENUES
Trends for each of the City's major revenue classifications over the past five years are graphically
portrayed in the bar chart below.
As stated earlier, General Fund revenues increased $702,154, or 13.8%, from 2015. The most significant
increase was in licenses and permits which increased $482,429 from 2015 to 2016, due to increased
building and development in 2016. The second most significant increase was taxes, which increased
$181,718. This increase was due to an increase in levy in 2016. Intergovernmental revenue decreased
$125,796 due to recording local government aid (LGA) in the Street Management Fund in 2016. Other
revenue sources were similar to the prior year.
2012 2013 2014 2015 2016
Taxes $3,245,677 $3,449,691 $3,442,280 $3,444,175 3,625,893
Intergovernmental 208,822 217,630 337,779 195,363 69,567
Licenses and Permits 33,915 36,455 1,238,823 1,179,136 1,661,565
Charges for Services 59,996 38,321 192,168 174,878 286,614
Investment Income 93,509 (5,403)37,427 15,015 21,233
Other 55,429 43,114 58,815 80,775 126,624
$-
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
General Fund Revenues
11
City of Otsego
Financial Analysis
GENERAL FUND REVENUES (CONTINUED)
The allocation of revenues by source within each major classification is presented below for 2016 and
2015. The City continues to rely on tax revenue as the majority of its General Fund revenue, accounting
for 62.6% of its total revenue in 2016. Sources of revenue were fairly consistent with the prior year, with
the exception of licenses and permits making up a larger proportion of total revenues in 2016 due to
increased building and development.
Taxes
62.6%
Intergovernmental
1.2%
Licenses and Permits
28.7%
Charges for Services
4.9%
Investment Income
0.4%Other
2.2%
2016 General Fund Revenues
Taxes
67.7%Intergovernmental
3.8%
Licenses and
Permits
23.2%Charges for
Services
3.4%
Investment Income
0.3%
Other
1.6%
2015 General Fund Revenues
12
City of Otsego
Financial Analysis
GENERAL FUND REVENUES (CONTINUED)
The graph below outlines the budget and actual results for General Fund revenues.
Taxes Intergovernmental Licenses and Permits Charges for Services Investment Income Other
Budget $3,651,352 $343,590 $641,565 $57,000 $50,000 $-
Actual 3,625,893 69,567 1,661,565 286,614 21,233 126,624
$-
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
$1,800,000
$2,000,000
$2,200,000
$2,400,000
$2,600,000
$2,800,000
$3,000,000
$3,200,000
$3,400,000
$3,600,000
$3,800,000
2016 General Fund Revenues
Budget and Actual
Overall, actual revenue exceeded budgeted revenue by $1,047,989, or 22.1%. The largest variance was
for licenses and permits which was $1,020,000 over budget. This was the result of budgeting
conservatively for building and commercial construction permits for 2016. The second largest variance
was in charges for services which was $229,614 over budget due to budgeting conservatively for
commercial development and building activity in 2016. The third largest variance was in other revenue,
which was $126,624 over budget due to the City not budgeting for other revenue. Other revenue
includes Special Assessments, Fines and Forfeitures, and Contributions and Donations. Investment
income was budgeted at $50,000 based on past results while actual investment earnings and changes in
fair market value were only $21,233.
13
City of Otsego
Financial Analysis
GENERAL FUND EXPENDITURES
As discussed previously, total General Fund expenditures increased $287,541, or 6.5%, from 2015.
Public safety expenditures increased $162,779, which was across several departments. The increase was
also across all expenditure types (personal services, supplies, and other services and charges) largely due
to the fire contracts increasing which are based on the City's tax capacity, as well as a large increase in
building inspections.
2012 2013 2014 2015 2016
General Government $920,619 $973,051 $1,188,802 $1,150,130 1,240,005
Public Safety 1,235,982 1,263,881 1,496,112 1,666,509 1,829,288
Public Works 998,144 1,109,949 1,014,937 1,034,524 1,010,620
Parks and Recreation 277,605 304,324 461,240 477,445 534,122
Economic Development 89,005 3,286 4,095 96,211 98,325
$-
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
$4,500,000
$5,000,000
General Fund Expenditures
14
City of Otsego
Financial Analysis
GENERAL FUND EXPENDITURES (CONTINUED)
The following charts illustrate the allocation of General Fund expenditures by program/function. The
allocation of total expenditures by program has fluctuated between the past two years as a result of the
changes in expenditures as discussed on the previous page.
General
Government
26.3%
Public Safety
38.8%Public Works
21.5%
Parks and
Recreation
11.3%
Economic
Development
2.1%
2016 General Fund Expenditures
General
Government
26.0%
Public Safety
37.7%
Public Works
23.3%
Parks and
Recreation
10.8%Economic
Development
2.2%
2015 General Fund Expenditures
15
City of Otsego
Financial Analysis
GENERAL FUND EXPENDITURES (CONTINUED)
The graph below outlines the budget and actual results for General Fund expenditures.
General Government Public Safety Public Works Parks and Recreation Economic
Development
Budget $1,255,768 $1,757,000 $1,098,952 $535,652 $105,300
Actual 1,240,005 1,829,288 1,010,620 534,122 98,325
$-
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
$1,800,000
$2,000,000
2016 General Fund Expeditures
Budget and Actual
Overall, actual expenditures were under budgeted amounts by $40,312, or 0.8%. The public works
program had the largest variance, coming in $88,332 under budget. This variance is primarily due to
conservative budgeting and less sand and salt needed in 2016.
16
City of Otsego
Financial Analysis
ANALYSIS OF TAX LEVY INFORMATION
The chart below graphs the tax capacity, certified tax levy, and City tax rate for 2012 through 2016.
Comparing 2012 through 2016, the City's tax capacity has increased $2,959,876, or 28.8%, to
$13,238,424. The City's certified levy increased $759,274, or 17.8%, over the same time frame. As a
result, the City's tax capacity rate has decreased from 41.45% in 2012 to 37.92% in 2016. When
comparing 2015 to 2016 the chart indicates that even with a levy increase of $340,167 the tax rate
decreased from 41.20% to 37.90% due to a $1,879,809 increase in the total tax capacity.
$4,260,869 $4,378,021 $4,500,188 $4,679,976 $5,020,143
$10,278,548
$9,470,288
$10,095,765
$11,358,615
$13,238,424 41.45%
46.23%
44.58%
41.20%
37.92%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
$-
$2,000,000
$4,000,000
$6,000,000
$8,000,000
$10,000,000
$12,000,000
$14,000,000
2012 2013 2014 2015 2016
Tax Capacity, Levy, and Rates
Tax Levy Total Tax Capacity Tax Capacity Rate
17
City of Otsego
Financial Analysis
WATER FUND
2012 2013 2014 2015 2016
Operating Revenues $986,597 $1,195,892 $1,114,528 $1,163,963 $1,266,379
Operating Expenses 877,076 907,185 853,551 911,243 943,066
Operating Income (Loss) with Depreciation 109,521 288,707 260,977 252,720 323,313
Operating Income without Depreciation 582,900 763,931 733,738 726,399 805,049
$(200,000)
$-
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
Water Fund
The Water Fund experienced operating income of $323,313 in 2016. This is the fifth consecutive year
with an operating income. We have also illustrated the operating income for the past five years with
depreciation, a non-cash expense, factored out of operating expenses. In 2016, the City experienced
operating income of $805,049 with depreciation expense factored out of operating expenses.
Depreciation expense amortizes the original cost of fund capital assets over their total useful lives.
In 2016, operating revenues increased $102,416, or 8.8%, while operating expenses increased $31,823,
or 3.5%. The increase in operating revenues was due to an increase in usage. Operating expenses
increased primarily as a result of increased professional services and supplies.
After factoring in non-operating items and capital contributions, in the form of connection fees, and
transfers the net position in this fund increased by $1,548,083
18
City of Otsego
Financial Analysis
SEWER FUND
2012 2013 2014 2015 2016
Operating Revenues $1,043,570 $1,186,523 $1,325,181 $1,477,603 $1,590,795
Operating Expenses 1,571,150 1,529,321 1,458,714 1,612,830 1,888,280
Operating Loss with Depreciation (527,580)(342,798)(133,533)(135,227)(297,485)
Operating Income without Depreciation 298,662 481,694 689,589 689,210 542,132
$(1,000,000)
$(500,000)
$-
$500,000
$1,000,000
$1,500,000
$2,000,000
Sewer Fund
In 2016, the Sewer Fund continued to generate an operating loss. In 2016, the Sewer Fund experienced
an operating loss of $297,485 with depreciation. Operating revenues increased $113,192 or 7.7% over
the prior year, while operating expenses increased $275,450, or 17.1%. The increase in operating
revenues is due to an increase in rates, as well as an increase in users. The increase in operating
expenses was a result of engineering costs related to projects and additional chemical purchases to
address an odor issue.
The increase in operating loss in 2016 is an indication that this Fund has not effectively established rates
to cover all operating expenses. Without depreciation, operating income totaled $542,132. We
recommend the City continue to monitor operations and fee structures of this Fund to ensure positive
operating results.
After factoring in non-operating items, capital contributions, in the form of connection fees, and
transfers, the net position in this fund increased $2,173,131.
19
City of Otsego
Financial Analysis
STORM WATER FUND
2012 2013 2014 2015 2016
Operating Revenues $37,231 $41,831 $45,570 $45,066 $46,811
Operating Expenses 69,834 72,944 57,977 95,533 42,342
Operating Income (Loss) with Depreciation (32,603)(31,113)(12,407)(50,467)4,469
Operating Income (Loss) without Depreciation (14,845)(13,355)5,376 (29,051)28,520
$(70,000)
$(50,000)
$(30,000)
$(10,000)
$10,000
$30,000
$50,000
$70,000
$90,000
$110,000
Storm Water Fund
Operating revenues increased slightly from the prior year while operating expenses decreased, as shown
in the graph above. The Storm Water Fund experienced a small increase in operating revenues of $1,745
or 3.9% from 2015. Operating expenses decreased $53,191 or 55.7% from 2015 to 2016. The Fund
experienced operating income of $4,469 in 2016. Without depreciation included in operating expenses,
the Fund experienced operating income of $28,520.
After factoring in non-operating items and transfers, this Fund's net position increased by $388,643.