When the Wellington School District budget crisis hit the local newspaper, citizens were shocked. The superintendent, Tina Franken, and business manager, William McKenzie, implemented innovative programs that improved employee morale and productivity — not only for the central office, but also for the eight schools within the district. Before Franken’s arrival, the school district was often an embarrassment to the town, as employee issues led to frequent firings or resignations and the airing of dirty laundry in the local news. When the longtime district accountant resigned and filed a legal complaint against McKenzie, which consisted of fraud, abuse of town policies, and violations of state laws, gossip among district employees and citizens implied there were ties between the legal complaint and the budget crisis.
With a school budget shortfall of $2 million at fiscal year-end and a legal complaint, the select board for the town had no choice but to act. It asked the town’s internal auditor, Denise Silva, to review the school district’s budget process.
Silva knew town government issues could get messy and complicated. So she prepared a high-level audit program and planned to spend a lot of time exploring. First, she reviewed the district’s budget policies and procedures and requested the previous year’s approved budget with all planning comments and 12 months of results by month and account. She planned to interview employees involved in the process and take deeper dives into any areas with significant overruns. After receiving the budget documents, she realized that she needed to clear her calendar.
- The budget process should be included in the risk assessment and reviewed regularly, especially in regulated environments like municipalities. A quick review would have caught many of these issues in the first year.
- Removing key controls from important processes should raise red flags. If the controls had been reviewed regularly, the budget crisis and fraud could have been avoided.
- Small internal audit departments should consider rotational reviews that provide greater coverage across the organization. In this example, reviews of petty cash, budget, vendors, payroll, or accounting would have identified smaller issues that would have raised red flags and the need for additional reviews.
- Messy situations may require internal audit to shut down the audit schedule for the rest of the year. Not only is it important to focus internal audit resources on high-risk areas, but it is critical to those responsible for oversight that they receive the clearest picture possible to make the most informed decisions about how to move forward.
Silva detected several red flags in her initial review of the budget documents. First, McKenzie put the budget together under four large categories — instructional supplies, curriculum, payroll, and equipment — with lump sum amounts under each. Once the town approved it, the business manager arbitrarily assigned amounts to line item accounts in each category. Silva could not discern any reason for the assignment of funds. The second thing that stood out to her were hundreds of transfers throughout the line item accounts each month that were not approved by the school committee or board. Lastly, there were no budgets in place for revenue accounts, even though large amounts of money were collected for sports fees, bus fees, and student activities. These collections were recorded as petty cash for the school district to use on purchases.
Silva first interviewed McKenzie about his budget process. He explained that the budget process was cumbersome and a source of significant productivity issues, so he streamlined the two-month planning cycle to one week. Instead of providing a detailed number for each line item, McKenzie broke the accounts down into four categories based on prior years and departmental needs, and assigned each category a lump number. The school committee and board voted on and approved the categories. The town approved this process because it trusted Franken and McKenzie.
When Silva asked about missing revenue accounts in the process, McKenzie insisted that the district accountant required that all cash collections be received into petty cash, so budget figures weren’t necessary. Adjustments were made at the end of the year to reflect the accounting. McKenzie blamed the district accountant for many of the budget challenges.
Silva’s findings list was filled with broken policies, regulations, and accounting rules, but she knew more data was needed. Some basic analytical testing found that administrators in the central office were using funds to purchase large flat screen televisions, office equipment, and laptops. However, these items could not be located anywhere in the district, so Silva assumed that administrators were taking them home. She began testing invoices, which showed that the district often reimbursed administrators for conferences and travel more than once. On several of the travel reimbursements, spouses were included and paid for by the district. The amounts submitted for reimbursement exceeded the threshold specified in the district’s policy.
When Silva conducted interviews with staff in the central office, she found there were relatives of administrators on the payroll who never showed up for work. And though the office was open until 5 p.m., many administrators left at 2 p.m. Lastly, an employee who worked in disbursements revealed that administrators received kickbacks from vendors for large purchases and the awarding of contracts.
Silva identified $2 million of fraud and abuse while reviewing five years of data. But she was unable to quantify much of the activity, such as the vendor kickbacks. A reasonable comparison of the actual costs of big-ticket items and what was paid by the school district added another $2 million to the total.
As a result of Silva’s investigation, Franken and McKenzie were forced to resign and are currently serving jail time for their part in the fraud schemes. Silva quantified the known abuses — like the technology gifts, no-show jobs, time theft, and travel and expense violations — per administrator, and found that nearly every one of them received, on average, an additional $10,000 per year on top of their salary. Those in higher levels of administration received more. The district accountant received none and acted as a whistleblower by filing a legal complaint. Franken and McKenzie were making significant money with kickback and petty cash schemes, using gifts, no-show jobs, and abridged schedules to keep staff from complaining or noticing, and covering their tracks with a convoluted budget process.