1. Material Weaknesses in Internal Control over Compliance for Federal Grants to U.S. Counties Julie C. Hyde The University of Memphis Dissertation Chair: Dr. Carolyn M. Callahan

2. Presentation Outline Background Dissertation Overview Motivation Paper 1 Paper 2 Paper 3

3. Over $645 billion Federal grant outlays to state and local governments for fiscal year 2011 Budget of the United States Government, Fiscal Year 2011

4. Background: OMB Circular A-133 Total federal expenditures exceeding $500,000 Internal controls over 14 compliance requirements ( a) Activities allowed or unallowed (h) Period of availability of Federal funds (b) Allowable costs/cost principles(i) Procurement and suspension and debarment (c) Cash management (j) Program income (d) Davis-Bacon Act(k) Real property acquisition and relocation assistance (e) Eligibility (l) Reporting (f) Equipment and real property management (m) Subrecipient monitoring (g) Matching, level of effort, earmarking (n) Special tests and provisions

5. Background: OMB Circular A-133 Reporting: Financial statements/Federal Expenditures Compliance with requirements applicable to major programs and internal control over compliance in accordance with OMB Circular A-133 MATERIAL WEAKNESS

6. Noncompliance Grant fund repayments –New York - $540 million –Boone County, MO - $750,000 –Chattanooga, TN - $129,000 Increased monitoring activities

7. Overview and Integration COSO OMB A-133 Material Weakness Reported County Characteristics Auditor Characteristics Size Financial health Complexity F/S weakness PCAOB AICPA GAQC F/S weakness New audito r Paper 3 Paper 2 Paper 1

8. Motivation Interest to county administrators, grantor agencies, and auditors Increased understanding of internal controls for federal grants Addition to material weakness literature (Boyle et al. 2004; Ge and McVay 2005; Klamm and Wilson 2009)

9. Paper 1 Can material weaknesses in internal control over compliance for federal grants be categorized into COSO internal control framework elements?

10. COSO Internal Control Framework Elements

11. Prior Research Boyle et al. (2004) were first to classify internal control weaknesses into COSO elements. Ge and McVay (2005) look at descriptions of SOX Sections 302 and 404 MWs and categorize, without using COSO. Klamm and Watson (2009) classify SOX Section 404 MWs into COSO elements, with focus on IT controls.

12. Sample Selection Federal Audit Clearinghouse –159 counties with at least one material weakness in internal control over compliance in 2007 (356 material weaknesses) –Hand collection of single audit reports for “Schedule of Findings and Questioned Costs”

13. Results Control Activities (61%) Control activities include approvals, authorizations, verifications, reconciliations, reviews, security of assets, and segregation of duties

14. Conclusions Contribution to body of literature studying internal control weaknesses using COSO framework with same conclusion for the prevalence of control activity weaknesses (Boyle et al. 2004; Klamm and Wilson 2009) but with new setting Disproportions for COSO elements and A-133 compliance requirements

15. Implications Results point auditors to areas where internal control breakdowns occur for federal grants and can aid in audit planning and testing Identification of weak areas aids in the development of effective policies Possible audit focus on control activities

16. Paper 2 What entity characteristics are associated with the reporting of a material weakness in internal control over compliance for federal grants?

17. Prior Research Registered firms with MW are small, complex, and financially weak. –Doyle et al. (2007); Ashbaugh-Skaife et al. (2007); Ge and McVay (2005)

18. Hypotheses County characteristics associated with material weaknesses Material Weakness County Size Financial Health Complexity MW on F/S

19. Sample Selection Federal Audit Clearinghouse –159 counties with material weaknesses in internal control over compliance in 2007 –Matched control group (159) –Hand collection of county financial reports

20. Material weakness is a f(x): County size Financial health Complexity Material weakness on the financial statements Change in federal expenditures from 2006 to 2007 Material weakness reported in prior year

21. Logistic Regression Results

22. Conclusions Like SEC companies, counties with complex operations and poor financial health are more likely to report material weaknesses (Doyle et al. 2007; Ge and McVay 2005; Bryan and Lilien 2005). Relation between material weaknesses on both internal controls over financial statements and over compliance for federal grants Unlike SEC companies, no relation between size and material weaknesses could result because grants are administered by departments, not the entity-wide control system.

23. Implications From a single audit perspective, size does not present additional risks for MWs. Grantor agencies could evaluate financially weak and complex counties as having increased likelihood of MWs in awarding grants or determining monitoring activities. Auditors may adjust risk assessments using the results of this study.

24. Paper 3 Are auditor characteristics associated with the reporting of a material weakness in internal control over compliance for federal grants?

25. Hypotheses Auditor characteristics associated with reported material weaknesses: PCAOB Registered AICPA GAQC F/S Weakness New Auditor Material Weakness Reported

26. Sample Selection Federal Audit Clearinghouse –4,560 counties with 459 material weaknesses in internal control over compliance 2006 (153 MW of 1,555) 2007 (165 MW of 1,534) 2008 (141 MW of 1,471) –Electronic sources

27. Material weakness is a f(x): PCAOB registration Firm membership with AICPA Governmental Audit Quality Center Material weakness on the financial statements Initial auditor Government auditor High-risk auditee Size of federal expenditures Number of firm’s county audit clients Client risk portfolio Material weakness reported in prior year Year

28. Logistic Regression Results

29. Conclusions Contribution to the body of literature related to auditor changes and reported internal control weaknesses (Ashbaugh- Skaife et al. 2007; Zhang et al. 2007) and adds a governmental setting. Relation between material weaknesses on both internal controls over financial statements and over compliance for federal grants

30. Dissertation Conclusions High percentage of MWs are mapped as control activities Counties with MWs are complex, financially weak, and have MW on financial statements. Auditors that report MWs are initial year auditors who also report MW on financial statements.

31. Limitations Generalizability of results Time frame Instances where material weaknesses in internal controls over compliance were present but were unreported

32. Future Research Include entity types such as municipalities, school districts, universities, and nonprofit organizations Longer time frame Determinants of material weaknesses over financial reporting

33. Questions and Comments