STATE OF HAWAII
BOARD OF EDUCATION
Nanakuli Public Library
89-070 Farrington Highway, Heleakala Meeting Room
Waianae, Hawaii 96792
Thursday, May 2, 2019
Catherine Payne, Committee Chairperson
Dwight Takeno, Committee Vice Chairperson
Brian De Lima, Esq.
Kenneth Uemura, Ex Officio
Captain Lyn Hammer (military representative), Ex Officio
Christina Kishimoto, Superintendent
Amy Kunz, Assistant Superintendent and Chief Financial Officer, Office of Fiscal Services
Denise Yoshida, Director, Internal Audit Office
Yi Chen, Audit Specialist, Internal Audit Office
Brian Shigaya, Audit Specialist, Internal Audit Office
Kurt Wakatsuki, Audit Specialist, Internal Audit Office
Guy Nishihira, Principal, Engagement Manager, KKDLY LLC
Adrienne Pedregon, Manager, KKDLY LLC
Joel Zablan, Manager, KKDLY LLC
Alison Kunishige, Executive Director
Kenyon Tam, Board Analyst
Regina Pascua, Board Private Secretary
Irina Dana, Secretary
I. Call to Order
The Audit Committee (“Committee”) was called to order by Committee Chairperson Catherine Payne at 3:33 p.m.
II. *Public testimony on Audit Committee (“Committee”) agenda items
Committee Chairperson Payne called for public testimony. There was no public testimony at this time.
III. Approval of Meeting Minutes of November 1, 2018
ACTION: Motion to approve the Audit Committee Meeting minutes of November 1, 2018 (De Lima/Kawano). The motion carried unanimously with all members present voting aye.
IV. Discussion Items
A. Presentation of the Department of Education’s Internal Audit Plan—Quarterly Update through March 31, 2019
Note: Committee Chairperson Payne took this agenda item after agenda item V.A, entitled “Committee Action on the Department of Education’s Annual Financial and Single Audit for the fiscal year ended June 30, 2018.”
Denise Yoshida, Director, Internal Audit Office (“IA”) stated that the Department of Education’s (“Department”) internal audit plan quarterly update covers the last three months through March 31, 2019. She reviewed an executive summary of assurance projects; consulting, monitoring, and fiscal reviews; and other projects. Yoshida highlighted that IA completed the amended Investigation Process Review. IA plans to complete and issue the Operational Audit of the Extracurricular Section in June 2019. She highlighted that IA assisted the certified public accounting firm KKDLY LLC (“KKDLY”) with the annual financial and single audit for the fiscal year ending on June 30, 2018 by gathering documents for testing.
Yoshida reviewed the management action item dashboard summary and the status of IA observations and recommendations from previously issued reports as reported by management. She detailed that management is working on five outstanding management action plans. Yoshida explained that IA reviews the status of management action plans on a quarterly basis and adjusts target due dates accordingly.
Kurt Wakatsuki, Audit Specialist, IA, reviewed the Fraud and Ethics Hotline summary. He reviewed hotline cases for the three most current fiscal years and detailed the distribution of cases, including the number of cases handled by complex areas and Department offices. Wakatsuki noted that there were 201 hotline cases in Fiscal Year (“FY”) 2017, 203 in FY 2018, and 190 in FY 2019 thus far. IA expects that the number of total hotline cases for FY 2019 will be higher than in previous years. Wakatsuki reviewed the status of all open hotline cases as of March 31, 2019, and noted that 18 cases from FY 2019 have been open for less than three months. Wakatsuki reviewed activity by case priority and detailed that IA assigns complaints and allegations for case review and then prioritizes cases under the “investigation,” “management review,” “minor issue,” or “unspecified” categories. He explained that IA categorizes cases as “unspecified” when it has not yet given the case a designated priority. Wakatsuki reviewed case types, classification definitions, and case statuses. He detailed that the Fraud and Ethics Hotline received 594 cases during the three most current fiscal years. IA closed 570 cases with 24 still open. He noted that two of the 203 cases from FY 2018 and 22 of the 190 cases from FY 2019 are still in progress. Wakatsuki highlighted that there are no outstanding cases from prior years. Wakatsuki reviewed the outcome of assigned cases, case types of substantiated cases, and disposition of substantiated cases. He detailed that out of the 254 cases that IA assigned for formal case review prior to closure, 85 were substantiated and 169 were unsubstantiated. Wakatsuki noted that the primary issues in the substantiated cases were human resources issues, misuse of Department resources, and other issues.
Committee Member Nolan Kawano asked IA to include the number of cases handled by complex areas under the activities by priority and case type components of its reports so that the Committee could review trends.
Ex Officio Committee Member Kenneth Uemura commented that several complex areas and state offices, including the Office of the Superintendent, have shown an increase in the number of hotline cases over the three most current fiscal years. He expressed concern that the Fraud and Ethics Hotline is possibly receiving serious complaints and allegations, which is why IA is assigning these cases to the Office of the Superintendent. Wakatsuki commented that each complex area experienced multiple complaints that were similar in nature.
Ex Officio Committee Member Uemura asked about the number and duration of open cases. Wakatsuki stated that 13 cases were open for longer than three months at this time last year. Ex Officio Committee Member Uemura asked if IA investigated and closed these cases. Yoshida confirmed that it did.
Ex Officio Committee Member Uemura commented on case types, including the misuse of resources, and substantiated versus unsubstantiated cases. He noted that the misuse of resources constitutes serious violations and commented that the disposition of substantiated cases might not align with the seriousness of the violation. He noted that it appears that similar violations might result in different consequences. Yoshida explained that the disposition depends on the outcome of the case and stated that she could provide the Committee with further details.
Committee Chairperson Payne stated that different cases involve different individuals, behaviors, and situations, which might explain the various determinations.
Committee Member Brian De Lima encouraged IA to review determinations for similar violations.
Ex Officio Committee Member Uemura agreed that IA should review dispositions and asked IA to define and label case types. Christina Kishimoto, Superintendent, stated that IA closely monitors case types and outcomes.
Ex Officio Committee Member Uemura commented on IA’s observations and recommendations from previous reports issued and emphasized the importance of IA observing trends. He expressed concern over lack of compliance observations and stated that the Department needs to develop training for schools regarding policies and procedures.
Ex Officio Committee Member Uemura commented on the Construction Process and Internal Controls Follow-Up Review and noted that IA listed the Department’s Facilities Master Plan (“FMP”) as completed. He stated that IA should not report the FMP as completed because the FMP is in draft form, and the Department has not yet brought it before the Board of Education (“Board”) for approval. Brian Shigaya, Audit Specialist, IA, explained that the FMP satisfied audit purposes because the Department addressed IA’s recommendations, which is why IA reported the FMP as completed. Ex Officio Committee Member Uemura asked IA to note that the Department completed the draft of the FMP in future reports because it is subject to approval.
V. Recommendation for Action
The Board recessed at 4:40 p.m. and reconvened at 4:43 p.m.
Military Representative Captain Lyn Hammer entered at 4:44 p.m.
A. Committee Action on the Department of Education’s Annual Financial and Single Audit for the fiscal year ended June 30, 2018
Note: Committee Chairperson Payne took this agenda item before agenda item IV.A, entitled “Presentation on the Department of Education’s Internal Audit Plan – Quarterly Update through March 31, 2019.”
Yoshida introduced Guy Nishihira, Principal, Engagement Manager, KKDLY; Adrienne Pedregon, Manager, KKDLY; and Joel Zablan, Manager, KKDLY.
Nishihira briefly reviewed KKDLY’s scope of services. He detailed that KKDLY audited the Department’s financial statements for FY 2018 and performed a single audit of the Department’s federal programs in accordance with uniform guidance. He noted that the Department federal expenditures total $253 million.
Nishihira stated that KKDLY delivered five reports. The first was an independent auditors’ report on the Department’s financial statements. He explained that KKDLY completed this audit in accordance with auditing standards and issued an unmodified opinion on the financial statements and schedule of expenditures of federal awards. The second report was an independent auditors’ report on internal control over financial reporting and on compliance and other matters. He stated that KKDLY found no material weaknesses in internal controls over financial reporting and did not note instances of noncompliance. However, KKDLY reported findings pertaining to the accounting for capital assets. Nishihira stated that the third report was the single audit. He detailed that KKDLY audited three major programs, including community investment, Title I grants to local education agencies, and school improvement grants, and KKDLY issued an unmodified opinion on compliance. KKDLY did not find material weaknesses in internal control over compliance but reported findings pertaining to the procurement of goods and services. Nishihira noted that two findings were similar but stretched out over two major programs. He explained that KKDLY needed to issue an independent report for each finding because KKDLY tested several major programs. Nishihira stated that KKDLY delivered a required communications letter to the Office of the Auditor and the Board as well as a management letter. He noted that KKDLY listed recommendations to improve processes in the management letter but did not list material weaknesses or significant deficiencies.
Nishihira reviewed the conduct of the audit, including the qualitative aspects of accounting policies. He stated that management has the responsibility for the selection and use of appropriate accounting policies. He noted that there were no new adoptions of accounting policies that had a significant effect on the Department’s financial statements and stated that the application of existing policies were unchanged during the year. Nishihira stated that KKDLY did not encounter significant difficulties in dealing with management in performing and completing the audit. He stated that there were no disagreements with management on financial accounting, reporting, or auditing matters that, if not satisfactorily resolved, would have caused a modification of the reports.
Nishihira stated that accounting estimates are an integral part of the financial statements prepared by management. The more significant accounting estimates affecting the Department’s financial statements include the valuation of workers’ compensation claims reserve and the valuation of the carrying value of capital assets. He stated that KKDLY evaluated key factors and assumptions used by management to develop the estimates and determined that estimates are reasonable in relation to the financial statements as a whole. Nishihira stated that KKDLY corrected and uncorrected audit adjustments. He noted that professional standards require KKDLY to accumulate and communicate all significant audit adjustments KKDLY identified during the audit. He noted that KKDLY made corrected audit adjustments to adjust capital assets, accumulated depreciation, and depreciation expense to the proper balance. He detailed that the Department understated net capital assets by $6.9 million. Nishihira detailed that uncorrected audit adjustments consisted of an adjustment for an overstatement of workers’ compensation claims of $7.3 million. He stated that this was not material to the financial statements. The second adjustment was an adjustment to record public charter school capital assets of $16.8 million and accrued vacation of $1.7 million. He stated that the Department did not record these two items in its financial statements. Nishihira highlighted that management determined that the effects of the uncorrected audit adjustments were immaterial to the Department’s financial statements taken as a whole.
Nishihira reviewed findings, recommendations, and corrective action plans. He detailed that findings include classifications of capital assets versus expenditures, adjustments to reconcile capital assets and depreciation expenses, input errors made for equipment purchases, and missing signed and approved Form 10-B or documentation evidencing that the required number of price quotes were obtained. He stated that KKDLY recommends proper classification of capital expenditures, timely reconciliation and adjustments for capital assets and depreciation expenses, timely review of capital asset additions recorded for accuracy, adherence to procurement code and Department policies, and strengthening of internal controls and supervisory review over purchases. Nishihira stated that in order to correct these findings, the Department plans to establish capital asset guidelines and evaluate processes for tracking capital assets, review equipment purchases recorded in the equipment inventory system, and conduct in-person and web-based training pertaining to the use of price and vendor lists, policies and procedures for small purchases, and maintenance of procurement documentation.
Ex Officio Committee Member Uemura asked if KKDLY worked with IA to perform its audit. Nishihira confirmed that KKDLY coordinated with IA and other offices on specific areas, such as student activity funds.
Ex Officio Committee Member Uemura asked about materiality. Zablan explained that KKDLY based materiality on different components, such as whether KKDLY audits general funds or federal funds. He detailed that materiality varies and noted that materiality for the Department was $30 million. Ex Officio Committee Member Uemura asked if this was a reasonable amount. Nishihira explained that materiality is on a case-by-case basis, and KKDLY reviews financial statements to determine whether certain amounts are material.
Ex Officio Committee Member Uemura asked if KKDLY had discussions with the Office of Fiscal Services. Nishira stated that KKDLY might have reviewed materiality in initial planning meetings and detailed how KKDLY determined materiality during the audit. Ex Officio Committee Member Uemura asked if KKDLY could set materiality at $5 million rather than $30 million. Nishihira explained how auditors conduct testing and how auditors could review materiality of $5 million. Ex Officio Committee Member Uemura stated that lower materiality could result in more extensive testing and noted that the Board might feel more comfortable with lower numbers.
Ex Officio Committee Member Uemura expressed concern over overstatement amounts. Nishira detailed audit adjustments. Ex Officio Committee Member Uemura asked if KKDLY reviewed certain adjustments. Nishihira confirmed that procedures require KKDLY to review journal entries and adjustments.
Ex Officio Committee Member Uemura asked if KKDLY’s findings are significant and whether KKDLY included all findings in its presentation. Nishihira explained that the three findings were significant deficiencies but not material weaknesses. Ex Officio Committee Member Uemura asked if KKDLY is concerned over any of the findings. Nishihira explained that KKDLY coordinates with the Department to communicate findings and ensure improvement. He noted that KKDLY did not discover anything pervasive.
Ex Officio Committee Member Uemura expressed concern over the classification of capital assets versus expenditures, compliance policies, and internal controls.
Committee Member De Lima asked about KKDLY’s contract. Nishihira detailed that KKDLY has a three-year contract. He stated that the Office of the Auditor pays for KKDLY’s services and determines the scope of services.
Committee Member De Lima stated that previous audits focused on identifying funds spent at the school level. He noted that KKDLY’s audit does not include percentages for similar items even though previous audits included percentages. He stated that the public is interested in how the Department spends funds at school, complex area, and administrative levels. Committee Member De Lima asked KKDLY to review how the Department spends funds at different levels in a future audit.
Committee Member De Lima commented on fund balances and unencumbered funds and asked if KKDLY compared this year’s balances to previous years. Nishihira confirmed that KKDLY reviewed prior years as part of the audit. Committee Member De Lima asked whether this year’s fund balances are lower than prior years. Zablan stated that this year’s might be lower but he was unsure. Committee Member De Lima commented that the Board and Department have discussed the use of fund balances and emphasized the importance of the Department spending funds for what it budgeted funds for or reallocating funds. Nishihira stated that the Department’s fund balances and unencumbered funds did not raise concerns. He stated that KKDLY would have asked management for reasons for a significant decrease.
Committee Member De Lima expressed concern over litigation expenses and asked how KKDLY determined that legislative appropriations from the state general fund would fund adverse judgements. Nishihira explained that KKDLY confirmed and received a list of litigation from the Department of the Attorney General (“AG”). He stated that KKDLY is aware that there are instances when the Department is responsible for making payments for litigation. In these instances, KKDLY receive best estimates from management as to the liability that the Department needs to record in its financial statements.
Committee Member De Lima stated that the Legislature determines who is responsible for litigation expenses rather than the AG. Nishihira detailed that KKDLY reviewed both legislative lists and lists from the AG to make its determination. Committee Member De Lima stated that the Legislature determines that the Department needs to pay litigation expenses in some instances, which might not be fair to the Department. He stated that KKDLY needed to include this information in its audit. Nishihira stated that KKDLY could consider this for future audits.
Committee Member Kawano asked about unrestricted balances and total fund balances. He asked for a reconciliation of these two amounts. He asked how these amounts relate to carryover. Zablan explained the difference between net positions versus budgetary amounts and explained how amounts could decrease due to depreciation. Committee Member Kawano detailed amounts on a cash basis versus Generally Accepted Accounting Principals (“GAAP”) and stated that the Department should not have a large amount of money left over. Nishihira stated that he could provide details and further information later.
Amy Kunz, Assistant Superintendent and Chief Financial Officer, Office of Fiscal Services, detailed general funds versus amounts that include capital improvement program and federal funds. She stated that special interest funds and capital projects might be the reason for differing amounts. Committee Member Kawano asked for a reconciliation.
ACTION: Motion to recommend that the Board accept the Department of Education’s Annual Financial and Single Audit for the fiscal year ended June 30, 2018 as presented (De Lima/Kawano). The motion carried unanimously with all members present voting aye.
B. Committee Action on the Department of Education’s Investigation Process Review – Amended
Yi Chen, Audit Specialist, Internal Audit Office, reviewed the changes that IA made to the Department’s amended investigation process review report. She stated that IA went back into the field and interviewed multiple principals at different complex areas to get a better understanding of the investigation process. She reviewed various details of the amended investigation process review, including who should conduct investigations. IA determined that complainants could bring issues to higher levels in the Department if complainants feel that other levels mishandled their complaints. Chen reviewed other mechanisms through which complainants could report, such as the Civil Rights Compliance Branch, the Communications Office, the Office of the Superintendent, and the Board. Chen highlighted that the Department revised its investigation process to allow for independent reviews of complaints received through the Fraud and Ethics Hotline. Chen stated that IA found that the Department’s controls related to investigation processes are functioning at a “marginal” level. Some improvements are necessary to bring the area to an acceptable status. Chen noted that IA changed one of its observations of its review, stating that investigations at the school level are time consuming and may be perceived to be subjective.
Committee Member Kawano commented on who should handle complaints and noted that management’s contact is the Office of Talent Management.
ACTION: Motion to recommend that the Board accept the Department of Education’s amended Investigation Process Review (De Lima/Kawano). The motion carried unanimously with all members present voting aye.
Committee Vice Chairperson Dwight Takeno entered at 4:45 p.m.
C. Committee Action on the Department of Education’s Updated Risk Assessment and Internal Audit Plan (July 1, 2019–June 30, 2022)
Yoshida reviewed the Department’s updated risk assessment and internal audit plan. She stated that it covers three fiscal years between July 1, 2019 and June 30, 2022. She detailed that the updated audit plan focuses primarily on evaluating and testing key control processes mitigating the “high’ risk ranked auditable areas and highly significant and likely risks affecting the Department. Yoshida stated that projects include assurance projects and consulting and monitoring projects. IA currently has four assurance projects in progress, and IA identified 30 assurance projects that focus on addressing the high risks and specific concerns raised within the Department. IA has scheduled nine assurance projects for completion over the next three years, and IA documented the remaining 21 assurance projects on a project watch list that IA could schedule from in the future. IA identified five assurance, consulting, and monitoring projects that it should perform continuously.
Committee Member Kawano noted that the Department might have $50 to $60 million in special funds, which is more than the Department has in carryover funds. He asked if IA would audit special funds. Committee Member Kawano noted that there have been concerns regarding the mismanagement of funds. Yoshida stated that the Committee could assign additional projects for IA to review. Committee Member Kawano asked IA to include an audit of special funds in its scheduled projects.
Committee Chairperson Payne stated that some special funds have a specific use, and the Department cannot use these funds for other purposes. Committee Member Kawano stated that IA should review whether the Department is spending special funds appropriately.
Ex Officio Committee Member Uemura asked if it would be possible for IA to add this to its list of audit projects. Yoshida stated that IA could review the scope of the audit, objectives, and a timeline. IA could determine what projects it might need to put on hold in order to audit special funds and come back to the Committee. She stated that IA could edit its list of projects later after Board approval.
Committee Member De Lima commented that the Office of the State Auditor audited special funds in 2016, including the Department’s special funds. He stated that the Board Support Office could locate this audit and distribute it to Committee members to discuss at a future Committee meeting. He noted that the audit was limited to special education and stated that an operational audit might be more appropriate. Committee Member De Lima stated that operational audits could review shortfalls and the achievement gap. He stated that information from an operational audit might be helpful for the Department to improve services for students who are struggling.
Committee Chairperson Payne stated that reviews of shortfalls and the achievement gap might not be appropriate for IA or an operational audit and might be more appropriate for other offices within the Department because a review of this kind focuses on curriculum rather than financial matters. Committee Member De Lima agreed with Committee Chairperson Payne. He emphasized that this information is important for when the Department tries to acquire resources and receive funding from the Legislature.
Committee Member Kawano stated that an audit of special education, English learner programs, or how funding is spent that aligns with the Board and Department’s Joint Strategic Plan (“Strategic Plan”) might be helpful for the Department.
Ex Officio Committee Member Uemura commented on IA’s risk rating. He stated that IA changed risk ratings for the budget execution, management, and monitoring area from “high” risk to “medium” risk. Ex Officio Committee Member Uemura emphasized the importance of the Department’s budget and funding plan. He stated that the budget is a key component, and the Department risks not receiving funding if it does not have a strong budget process. He stated that IA should change the risk from “medium” to “high.”
Committee Chairperson Payne asked why IA changed the risk for this area.
Chen explained that IA assessed, interviewed, and received more information on the Department’s budget process and noted that there are many controls in the budget process. She stated that she understands the Committee’s concerns, but these concerns might not relate to this area. Chen explained that IA decreased the risk because of the various controls in place. She stated that IA could embed these concerns in other areas, such as operational areas.
Ex Officio Committee Member Uemura emphasized the importance of how the Department prepares its budget. He stated that various levels would need to understand what it costs to educate students and highlighted the benefits and importance of zero-based budgeting. He stated that IA should review how the Department prepares the budget and how the budget aligns with the Strategic Plan rather than solely controls.
Kishimoto emphasized the importance of mindset shifts and operational changes, including how the Department should be budgeting with more of a lens on adequacy and looking at how much is needed to adequately fund the design of a program and the outcome.. Kishimoto stated that the need to review budgeting is not an issue of audit risk as much as it is a programmatic design that the DOE is undergoing. Ex Officio Committee Member Uemura stated that the risk is that the Department might not receive adequate funds.
Committee Chairperson Payne stated that a different office should review Ex Officio Committee Member Uemura’s concerns. She noted that IA looks for risks in controls.
Committee Member Kawano stated that IA should reevaluate to determine whether it should increase or decrease the risk rating. He stated that IA should review other risk factors in addition to internal controls, such as credibility and strategic planning. He stated that the risk rating would be “low” if the Department had strong internal controls.
Ex Officio Committee Member Uemura stated that other risks might include resource allocation and security. He stated that IA should reevaluate and consider these other risks to determine whether it needs to change the rating for this area. Yoshida stated that IA included a project related to the budget in its watch list and stated that IA will audit this area and include it in the audit plan regardless of the rating.
Committee Member De Lima stated that IA should review other risks in addition to internal controls. He stated that IA should present on its report at the following Committee meeting. Yoshida stated that IA would need to begin assurance projects in July and August before the next Committee meeting.
Committee Chairperson Payne stated that she understood the Committee’s concerns and could review whether IA should address these concerns through an audit or if a different office should review these concerns. She stated that the Department understands the Committee’s concerns related to zero-based budgeting and legislative inquiries. However, separate processes and offices might need to address these concerns rather than IA.
Committee Member De Lima suggested that the Committee approve the risk assessment and internal audit plan in order for IA to begin its projects but asked IA to review its risk assessment ratings and processes for different areas.
ACTION: Motion to recommend that the Board approve the Department of Education’s Updated Risk Assessment and Internal Audit Plan July 1, 2019 – June 30, 2022, as attached to the Department’s memorandum dated May 2, 2019, except for the risk assessment ratings (De Lima/Kawano). The motion carried unanimously with all members present voting aye.
Committee Chairperson Payne adjourned the meeting at 5:10 p.m.