How an Auditor Shortage Could Hurt Local Governments

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Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week I’m writing about a new, potentially harmful development regarding the staffing shortages in public finance.

It’s no surprise to anyone at this point that local governments are struggling to find workers. But finance departments are especially hard-hit when it comes to brain drain. A National Association of State Treasurers study found that 60% of public finance workers are over 45 while less than 20% are younger than 35.

The private sector is facing similar issues. According to the American Institute of Certified Public Accountants (AICPA), the accounting profession has an acute shortage of workers as the population of graduates with accounting degrees has declined over the years. 

Now consider this: Public sector finance departments have been under heightened pressure for the last several years as they have not only navigated a pandemic and wave of retirements, but have also been tasked with managing and reporting on millions of dollars of new federal funding. In addition, as I reported for Route Fifty almost two years ago, the demand for government auditors in the private sector has likely increased because more localities will be subject to the federal government’s single audit requirement.

Under the rule, governments that spend $750,000 or more of federal awards in any given year are subject to the federal Single Audit Act, which requires they submit an external audit to verify they’ve spent the money according to the guidelines.

In some cases, governments in 2022 were going through the single audit process for the first time ever, according to Mary Foelster, senior director of governmental auditing and accounting. She added that “the increase in the demand for new government audits came during the same time as entities and firms were trying to work on the backlog of previous audits [for governments who were given filing extensions during the pandemic].” 

The crush of demand and shrinking supply has started to take a toll. An increasing number of local governments are falling behind on publishing their annual comprehensive financial reports (ACFRs)—so much so, that it could even affect their credit standing. Combined with the very practical fact that policymakers need audited financial data to make informed spending decisions, the lag in financial reporting threatens to translate into more costs for governments.

The Financial Reporting Slow Down

ACFRs, unlike quarterly or other interim reports, are the official account of a government’s finances for the previous year and show how those numbers compare with previous years. It takes some time for finance departments to gather the year-end data, but getting those numbers audited is the last and generally the most time-consuming step before publishing the annual financial report. In some cases, like in Indiana and Ohio, the audit is conducted or signed off by the state auditor’s office. In other instances, localities hire a firm to audit their financial statements.

According to new data published by the University of Illinois Chicago and Merritt Research Services, the last decade has seen a 13% increase in the median amount of time for local government audits to be completed. That means most governments are posting their ACFRs at least three weeks later in the year compared with a decade ago. Nearly half of the increase has occurred over the last two years. The research focuses on the median—rather than the average—because some governments are extreme outliers and take a year and a half or even more than two years to file their annual report. 

“So, not only is there not improvement over time, there’s deterioration,” said Richard Ciccarone, president emeritus of Merritt Research Services. He also noted that the trend hurts transparency. “There hasn’t been the appreciation that bondholders need that information as well as government watchdog groups to be able to assess the financial condition of a particular area.”

State auditing offices in some places are contributing to the backlog. The data show that most localities that send their financials to the state to audit have to wait a month and a half longer than those getting audited by private firms.

“Anecdotally, we think it’s due to workforce constraints—there just aren’t enough people doing the work,” said Deborah Carroll, director of the Government Finance Research Center at the University of Illinois Chicago. “If an issuer is in a state where the public sector auditor has to complete sign-off for all governmental units, that seems to be contributing to the lack of timelines.”

Financial Implications

The slowdown in audited reports has already had financial consequences. Last week, S&P Global Ratings withdrew its rating for 64 local governments and districts because they have yet to produce their audited 2021 financial report. The withdrawal came one month after the ratings firm placed those issuers (and 85 others) on watch for not having updated financial information and gave them four weeks to comply. A ratings withdrawal can result in being charged a higher interest rate the next time an issuer borrows in the municipal market.

Many of those that had their rating ultimately withdrawn are small localities and districts, but not all of them. Turlock, California, and Springdale, Arkansas, both home to populations of more than 70,000 people, are some of the larger cities on the list. That lines up with Carroll and Ciccarone’s research findings that debunk the notion that only very large governments and smaller—less-resourced—governments have trouble producing financial reports on time.

The reason for why the other 85 cities did not have their ratings withdrawn varies. Santa Fe, N.M., for instance, was originally flagged by S&P., but city finance officials are now in talks with the agency about providing updated financial data. 

In Jersey City, N.J., Councilmember James Solomon said when reached by phone last week that it was the first he’d heard about S&P’s warning to the city. He added that earlier in the week, the council had received a message that the city’s ACFR was finished and assumes the two events were connected. 

Solomon, who has expressed disappointment before about the city’s delay in posting audited financial reports, said it was frustrating not to have updated information while making policy decisions.

“The information contained in audits in Jersey City are crucial to understanding our finances,” he said. “If there’s an error in our information, the sooner you catch that, the sooner you can fix it. if you catch it a year later, you've been budgeting and operating on bad numbers that whole time.”

Can Technology Help?

S&P warned last month that, given the workforce shortage, it expects more governments to have delayed financials. The AICPA has launched several initiatives to combat the accounting pipeline problem, including a draft plan to accelerate the pipeline and partnering with the Center for Audit Quality’s Accounting+ Program.

Still, there’s clearly a need now for additional capacity—as well as a push from the federal government and private sector for governments to make their financial reporting more tech-friendly via the Financial Data Transparency Act (FDTA). Mark Funkhouser, chair of the International Center for Performance Auditing, said that the Great Recession kickstarted a wave of purpose-built software for government budgeting and that he expects the FDTA may spur a similar wave for financial reporting.

“The crises arise and then the technology follows,” said Funkhouser, who is also president of the consulting firm Funkhouser & Associates (of which I am a member). “There’s been a lot of technology with budgeting and that focus has been nice but I think the FDTA has made people realize that financial statements matter too. So the tech has been delayed, but I think it’s coming.”