STATE OF HAWAII
BOARD OF EDUCATION
AUDIT COMMITTEE

Queen Liliuokalani Building
1390 Miller Street, Room 404
Honolulu, Hawaii 96813
Thursday, May 3, 2018

PRESENT:
Nolan Kawano, Committee Chairperson
Kenneth Uemura, Committee Vice Chairperson
Margaret Cox
Brian De Lima, Esq.

EXCUSED:
None

ALSO PRESENT:
Christina Kishimoto, Superintendent
Denise Yoshida, Director, Internal Audit Office
Jennifer Luke, Audit Specialist, Internal Audit Office
Matthew Denton, Audit Specialist, Internal Audit Office
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 Nolan Kawano at 9:32 a.m.


II. *Public testimony on Audit Committee (“Committee”) agenda items

Committee Chairperson Kawano called for public testimony. There was no public testimony at this time.


III. Approval of Meeting Minutes of February 1, 2018

ACTION: Motion to approve the Audit Committee Meeting minutes of February 1, 2018 (Uemura/Cox). The motion carried unanimously with all members present voting aye. IV. Discussion Items

Note: The Committee took this agenda item after agenda item V.A., Committee Action on the Department of Education’s Annual and Financial Single Audit for the fiscal year ended June 30, 2017, but before agenda item V.B., Committee Action on the Department of Education’s Updated Risk Assessment and Internal Audit Plan (July 1, 2018 – June 30, 2021).

Denise Yoshida, Director, Internal Audit Office (“IA”), stated that the Department of Education’s (“Department”) internal audit plan quarterly update covers the period between January 1, 2018 and March 31, 2018. She reviewed an executive summary of assurance projects and highlighted that IA completed the investigation process review and the capital construction oversight and management implementation follow-up review in May or June of 2017. She further highlighted that IA completed and presented its equipment and fleet maintenance follow-up review in February 2018. Yoshida detailed that IA began its student information system post-implementation review/data integrity follow-up review in March 2018. She detailed that in addition to assurance projects, IA is involved in consulting, monitoring, fiscal reviews, and other projects. Yoshida detailed IA’s standard practices project and highlighted that it has established an internal worksite on the intranet to automate the standard practices process as well as provide standardized templates. It has updated 155 standard practices drafts to the new intranet worksite using the new templates. Upon approval, IA will post them to the public website. As of March 2018, IA has published 22 Office of Fiscal Services standard practices to the public site. Yoshida briefly summarized that other components of the internal audit plan include the management action item dashboard summary, outstanding management action plans, and the Fraud and Ethics Hotline summary.

Matthew Denton, Audit Specialist, Internal Audit Office, reviewed the Fraud and Ethics Hotline, including the number of cases handled by complex area or office, case priority, case type, and case outcome.

Committee Vice Chairperson Kenneth Uemura asked if the Fraud and Ethics Hotline summary includes the annual number of hotline cases for the three most current fiscal years as of March 2018. Denton confirmed that it does.

Yoshida reviewed the observation analysis of completed reports and explained that this list includes a listing of common observations based on IA’s previously completed reports. She highlighted that audit ratings and common observations are improving. Committee Chairperson Uemura commented that the observation analysis of completed reports shows that the Department is improving.

Committee Chairperson Kawano stated that IA is receiving a high amount of calls on its Fraud and Ethics Hotline, which contradicts that the Department is improving. He noted that the amount of calls the Fraud and Ethics Hotline receives indicates that there are still issues. Yoshida explained that the observation analysis of completed reports covers assurance projects results. The assurance projects may not cover issues that IA discovers through the Fraud and Ethics Hotline. The Fraud and Ethics Hotline may uncover areas that do not rise to high risk. Yoshida detailed that IA takes the types of complaints into consideration when it performs its risk assessment to see if there are additional areas of risk it needs to consider.

Committee Chairperson Kawano asked if IA is incorporating additional procedures as it moves forward. Yoshida confirmed that it is.


V. Recommendation for Action

Note: The Board took this agenda item before agenda item IV.A., Presentation of the Department of Education’s Internal Audit Plan – Quarterly Update through March 31, 2018, but after agenda item III., Approval of Meeting Minutes of February 1, 2018.

Yoshida introduced Lawrence Chew, Audit Principal, N&K CPAs, Inc. (“N&K”) and Carol Lee, Senior Manager, N&K. Chew briefly detailed that N&K conducted its financial audit of the Department for the fiscal year ended June 30, 2017, in accordance with the terms of its contract with the State Office of the Auditor. He noted that the financial audit of the Department includes the financial statements and related notes, opinions, and supplementary information; a report on internal control over financial reporting as well as compliance and other matters; a report on compliance with requirements that could have a direct and material effect on each major program as well as internal control over compliance; the schedule of findings and questioned costs; the Department’s response; and a summary schedule of prior audit findings.

Chew reviewed the summary of the auditor’s results. He stated that N&K issued an unmodified opinion on the Department’s financial statements. Chew stated that, with respect to internal controls over financial reporting, N&K did not identify any material weaknesses but identified significant deficiencies. He mentioned that N&K did not note any noncompliance material to the financial statements. Chew stated that N&K audited federal expenditures of federal awards. It also issued an unmodified opinion on compliance for major federal programs. With respect to internal controls over major federal programs, N&K did not identify any material weaknesses nor did N&K report any identified significant deficiencies. Federal regulations, pursuant to section 2 CFR 200.516(a), do not require N&K to report the disclosed audit findings. Chew listed the five major federal programs N&K reviewed, including grants to states, preschool grants, twenty-first century community learning centers, English language acquisition state grants, and supporting effective instruction state grants. Chew detailed that the single audit process involves risk assessment in accordance with guidelines. Auditors use a dollar threshold to distinguish between Type A and Type B programs. The Department qualifies as a low-risk auditee.

Lee reviewed N&K’s internal control findings and significant deficiencies related to tracking and accounting for capital assets.

Committee Vice Chairperson Uemura asked Lee to explain the difference between material and significant deficiencies. Lee explained that auditors find significant deficiencies in programs or financial statements where the Department is unable to prevent, detect, or correct errors in a timely manner in the ordinary course of business. Material weaknesses indicate that errors are such that the Department is unable to detect them and the errors are of interest to those in charge of government. Committee Vice Chairperson Uemura asked if the auditors base the differences on how errors affect financial statements. Lee confirmed that they do, to a degree.

Lee stated that the Department’s Office of School Facilities and Support Services (“OSFSS”) is responsible for planning and directing capital projects, repairs and maintenance, and the related funds released for such projects. The Accounting Services Branch within the Office of Fiscal Services relies on information provided by OSFSS to prepare the construction projects in progress and fixed assets schedule for the Department’s government-wide financial statements. Complete, accurate, and timely information provided by OSFSS is crucial for proper reporting of capital assets and repair and maintenance in the Department’s financial statements. These schedules track costs incurred by construction projects.

Lee stated that N&K noted two conditions related to the schedules summarizing projects managed by OSFSS. First, certain jobs are comprised of multiple contracted projects. Five of these jobs, classified as construction-in-progress, included repairs and maintenance projects of approximately $30.9 million as of June 30, 2017, of which the Department incurred costs of approximately $4.8 million in previous years. Because of the misclassification, the Department overstated the construction-in-progress category by approximately $30.9 million as of June 30, 2017. Second, the Department should have classified nine electrical upgrade jobs and three heat abatement jobs as construction-in-progress rather than as repair and maintenance. The cumulative costs for these jobs was approximately $14.5 million as of June 30, 2017, of which the Department incurred costs of approximately $6.2 million in previous years. Because of the misclassification, the Department understated the construction-in-progress category by approximately $14.5 million as of June 30, 2017. Lee highlighted that the Department corrected its errors once N&K brought them to the Department’s attention, thereby properly reflecting them in the financial statements.

Chew noted that N&K issued a management letter in addition to a financial report, which has additional comments and recommendations. Per N&K’s contract, it reviews student activity funds with the State Office of the Auditor. Chew highlighted that N&K included its results and suggestions regarding student activity funds in its management letter.

Committee Vice Chairperson Uemura asked if N&K included comments when conducting testing in its management letter. Lee confirmed that it did.

Committee Vice Chairperson Uemura stated that five of N&K’s six comments are repeat comments, which means that the Department did not correct the condition this year that N&K identified last year. He noted that the Department indicated that the Department would correct these conditions by June 2018. Committee Vice Chairperson Uemura requested that the Department provide the Committee with an update on the status of N&K’s comments at the next Committee meeting. He noted that he does not want the same comments to reappear in N&K’s report the following year.

Committee Chairperson Kawano stated that IA would provide an update on its findings. He asked if N&K could provide a comment on any new and significant accounting pronouncements. Lee stated that similar to the pension pronouncement several years ago, a post-retirement benefits pronouncement would affect all state and local governments. However, the State would treat this pronouncement similarly to pension benefits in that the Department would not reflect allocations at its level. She noted that she does not believe there would be a major effect.

Committee Chairperson Kawano asked if N&K identified compliance risks as part of its single audit. Lee confirmed that it did.

Committee Member Brian De Lima noted that N&K mentioned litigation in its financial report under commitments and contingencies. He asked if N&K received a list of litigation and explanations from the Department. Chew confirmed that it did. He explained that as part of the audit process, N&K sends a letter to the Department of the Attorney General (“AG”), and the AG sends N&K its response. Committee Member De Lima stated that he would like a copy of the list. Committee Chairperson Kawano stated that IA has a copy and can provide it to Committee Member De Lima.

Committee Member De Lima stated that N&K’s litigation summary is inaccurate and noted that it is not always the case that judgments against the Department are judgments against the State and funded by legislative appropriations through the state general fund. He asked if N&K was aware of this. Chew stated that N&K is aware and noted that in situations where the Department made payments, those payments were for services that it already incurred. He stated that N&K’s comment on damages could be clearer. Committee Member De Lima stated that Chew’s response was also inaccurate because payments were for services that may occur, not for services that the Department already incurred. Committee Member De Lima stated that the Board of Education (“Board”) is not involved in determinations of whether the Department settles matters or not and noted that the Legislature determines the level it is willing to fund. He emphasized that litigation is not black and white, and potential liabilities may have a material adverse effect on the financial position of the Department. Committee Member De Lima noted that in the past, N&K’s comment would have been accurate. However, it is not currently accurate because current practices are different. Chew stated that the Department and N&K should revisit this note moving forward.

Committee Member De Lima reiterated that the Board is not involved in determinations of settling litigation claims. Perhaps by focusing a light on this matter, the Legislature may take full responsibility of the State’s liability as it has in the past and rethink having the Department fund settlements. He stated that he would like N&K’s comment to reflect current practices because the Department needs all of the funds allocated by the Legislature in order to meet its mission.

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, 2016 as presented (Uemura/De Lima). The motion carried unanimously with all members present voting aye.

Yoshida introduced Jennifer Luke, Audit Specialist, Internal Audit Office, and stated that Luke was in charge of the Department’s updated risk assessment and internal audit plan.

Yoshida stated that the Department’s risk assessment and internal audit plan covers three fiscal years between July 1, 2018 and June 30, 2021. She noted that professional standards developed by the Institute of Internal Auditors require that IA develop the audit plan based on a risk assessment.

Yoshida reviewed the risk assessment reevaluation process. The process begins with the results of the prior year’s updated risk assessment. IA identifies changes to the Department’s auditable areas or new areas. IA then updates key risks by assessing current conditions, interviewing senior management and the Board, and identifying new and emerging risks relevant to the Department. IA then prioritizes key risks, concerns, and issues. Yoshida noted re-ranking each auditable area by risk score and reassessing inherent and residual risk factors to develop a composite risk score. IA then develops and presents the new audit plan for approval.

Yoshida reviewed IA’s proposed assurance projects and noted that IA ranks areas based on the likeliness of risk and significance to the Department and creates a risk-based audit plan. She reviewed IA’s proposed projects for the next three years as a result of IA’s risk assessment, including details of projects and which areas IA is reviewing for each project. She highlighted that once IA begins a project, it conducts another risk assessment at the project level. Yoshida further highlighted that IA is always reviewing projects through a lens of assessing risk.

Committee Chairperson Kawano detailed that IA’s proposed assurance projects for the first fiscal year of the risk assessment and internal audit plan include a leave without pay audit, decision-making process audit, operational audit of the extracurricular section, and data access controls follow-up audit. For the second fiscal year, proposed assurance projects include business continuity and disaster recovery plan testing, use of facilities audit, grant and award management audit, and HawaiiPay system post-implementation audit/payroll follow-up audit. For the third fiscal year, proposed assurance projects include student assessment administrative follow-up audit, operational audit of the Civil Rights Compliance Office, repair and maintenance audit, and workers’ compensation follow-up audit for the third fiscal year. Committee Chairperson Kawano asked why IA prioritized these audits. Yoshida explained that IA ranks areas using a numbering system and prioritizes areas where numbers indicate that the area is at the highest risk within IA’s range. Luke further explained that IA uses its ranking system to plot projects that have the highest score first. She noted that IA tries not to audit one office the entire fiscal year and spreads its audits between different offices so that offices have time to address IA’s findings.

Committee Vice Chairperson Uemura asked if IA currently has the full staffing necessary to complete its assurance projects. Yoshida confirmed that it does. Committee Vice Chairperson Uemura asked if IA staffs based on the number of projects it has. He asked if IA could complete six assurance projects per year if the Committee requested additional projects. Yoshida stated that IA would be able to complete additional projects, including Committee requests, but it would need to reprioritize its other projects. In addition to assurance projects, IA works on auditing the student activity fund. It audits schools each year and would like to conduct rotations, but it has other projects it needs to prioritize. In order to conduct audits on more schools, IA would need more auditors. Committee Vice Chairperson Uemura asked for additional clarity on IA being able to complete more than four assurance projects in one fiscal year. Yoshida stated that IA has the staff to complete its proposed assurance projects. Committee Vice Chairperson Uemura commented that IA would not be able to complete six assurance projects in a fiscal year because it has additional responsibilities.

Committee Member De Lima commented that the Department hired a consulting firm in 2011 that provided the Department with a matrix it could use to determine high-risk areas. He asked if IA is following the same protocol that the consulting firm followed in order to make its risk determinations. Yoshida confirmed that it is.

Committee Member De Lima commented that he did not agree with the projects listed in IA’s proposed assurance projects list. He stated that IA should focus on areas that affect the Department’s funding, such as impact aid and Medicaid reimbursements. He stated that he questions whether the Department could implement better practices to maximize the number of impact aid forms it submits in order to receive higher amounts of reimbursements. Committee Member De Lima stated that the Department is attempting to focus and accelerate Medicaid reimbursements and noted that Hawaii is one of the few states that receives little to no money for reimbursements, which indicates that the Department could be going about reimbursements in the wrong way. He stated that IA should focus on these two areas because he believes it is systemic as to why the Department is not receiving higher amounts of reimbursements. Committee Member De Lima stated that he would like IA to make these areas a higher priority.

Committee Member De Lima stated that individuals taking advantage of communities’ fundraising efforts and stealing money victimize schools each year. When schools identify these individuals, it shows that schools have a system in place that allows them to catch these individuals. However, sometimes schools catch these individuals a year or two after stealing from fundraisers. Committee Member De Lima noted that the Board has heard presentations in the past and learned that sometimes parent groups have their own accounts and operate outside of the Department’s financial systems. He commented that individuals stealing money affects the reputation of a school and has a statewide effect on fundraising efforts. Furthermore, these individuals affect the quality of students’ educational experiences in the community. He stated that this area should be a higher priority for IA as well. Committee Member De Lima stated that he recalls asking IA to send emails and conduct spot audits and is unsure when or where IA should do this. Yoshida stated that she could make a note of Committee Member De Lima’s comments. She explained that initially when going through its risk assessment, IA asks for input and feedback and asks many individuals to participate in interviews. At this time, IA could further review Committee Member De Lima’s comments.

Committee Chairperson Kawano agreed with Committee Vice Chairperson Uemura and Committee Member De Lima. He stated that IA has the ability to conduct consultant engagements in addition to internal control audits. He noted that some of the areas mentioned by Committee Member De Lima might fall under the consultant engagement category rather than internal control. Committee Chairperson Kawano stated that IA could offer advice on what the Department should be doing versus reviewing controls around specific areas. He asked if IA has the time to do consulting engagements. Yoshida stated that the Department requested funding in the Department’s budget in order to do more consulting engagements. She noted that IA would like to address fundraising issues and private outside boosters. Yoshida stated that IA is able to audit student activity funds when schools hold fundraisers and house money, but IA is unable to audit private groups. She noted that IA could control procedures for guidance on external fundraising.

Committee Chairperson Kawano suggested that IA let Committee Members know what kind of consulting engagements in which IA could participate in the upcoming fiscal year. He noted that this might entail Committee Members meeting with IA. Committee Chairperson Kawano stated that Committee Members could communicate suggested priority areas to IA, and IA could report on whether it has time to review these areas. He noted that these areas would look different from IA’s assurance projects because IA would be doing consulting engagements rather than auditing internal controls. He stated that it is positive for IA to review these areas because it would help schools.

Committee Vice Chairperson Uemura asked if IA has the flexibility to work on special projects if a special project comes up that is not included in IA’s proposed list, such as a special project requested as a priority by a Committee Member. Yoshida explained that it is dependent on the budget and on the amount of Fraud and Ethics Hotline work IA has. She stated that IA always manages to complete what it needs to do. Yoshida stated that IA may need to put certain projects on hold but would be able to complete priority projects. Committee Vice Chairperson Uemura asked if IA defers projects. Yoshida confirmed that sometimes it does. Committee Vice Chairperson Uemura stated that IA commented that it could defer projects or put projects on hold. He stated that he does not believe that IA budgets for flexibility. Committee Vice Chairperson Uemura commented that IA could review Committee project requests if it has time but should be able to review Committee project requests because it budgeted for flexibility. He stated that IA should be able to review Committee requests versus having to defer other projects or take time away from other projects. Yoshida stated that IA would ask for approval of change if it needed to shift a project.

Committee Chairperson Kawano recommended that IA contact Committee Members on its list of projects in order to update Committee Members and receive feedback so that it uses its budget properly.

ACTION: Motion to recommend that the Board approve the Department of Education’s Updated Risk Assessment and Internal Audit Plan July 1, 2018 – June 30, 2021 (Uemura/De Lima). The motion carried unanimously with all members present voting aye.


VI. Adjournment

Committee Chairperson Kawano adjourned the meeting at 10:11 a.m.