City Cost Allocation Plan - Denver J. Gallagher . Auditor . Office of the Auditor . Audit Services Division . City and County of Denver . City Cost Allocation Plan . Performance Audit

Dennis J. Gallagher Auditor

Office of the Auditor Audit Services Division

City and County of Denver

City Cost Allocation Plan Performance Audit

October 2012

The Auditor of the City and County of Denver is independently elected by the citizens of Denver. He is responsible for examining and evaluating the operations of City agencies for the purpose of ensuring the proper and efficient use of City resources and providing other audit services and information to City Council, the Mayor and the public to improve all aspects of Denver’s government. He also chairs the City’s Audit Committee.

The Audit Committee is chaired by the Auditor and consists of seven members. The Audit Committee assists the Auditor in his oversight responsibilities of the integrity of the City’s finances and operations, including the integrity of the City’s financial statements. The Audit Committee is structured in a manner that ensures the independent oversight of City operations, thereby enhancing citizen confidence and avoiding any appearance of a conflict of interest.

Dennis Gallagher, Chair Robert Bishop

Audit Committee

Maurice Goodgaine Jeffrey Hart Leslie Mitchell Timothy O’Brien, Vice Chair Rudolfo Payan

Audrey Donovan, Deputy Director, CIA, CRMA

Audit Staff

Dawn Hume, Audit Supervisor Brian Hartman, Lead Auditor, MPA Kevin Vehar, Senior Auditor, MPA

You can obtain copies of this report by contacting us at:

Office of the Auditor 201 West Colfax Avenue, Department 705 Denver CO, 80202

(720) 913-5000 Fax (720) 913-5247

Or download and view an electronic copy by visiting our website at:

www.denvergov.org/auditor

http://www.denvergov.org/auditor�

To promote open, accountable, efficient and effective government by performing impartial reviews and other audit services that provide objective and useful information to improve decision making by management and the people.

We will monitor and report on recommendations and progress towards their implementation.

City and County of Denver 201 West Colfax Avenue, Department 705 • Denver, Colorado 80202 • 720-913-5000 • FAX 720-913-5247 • www.denvergov.org/auditor


October 18, 2012 Ms. Cary Kennedy, Deputy Mayor, Chief Financial Officer City and County of Denver Dear Ms. Kennedy: Attached is the Auditor’s Office Audit Services Division’s report of their audit of the City’s Cost Allocation Plan. The purpose of the audit was to assess the extent to which the full cost allocation plan is reasonable and equitable, to determine whether the plan provides for full reimbursement to the City for services provided to enterprise fund agencies, and to understand how the plan process is managed and how the plan is applied. The audit revealed that the plan appears to be reasonable and equitable. However, in the past two plan years, the City’s Budget and Management Office (BMO) did not require the Golf Enterprise Fund (Golf) to pay its full cost allocation. This resulted in more than $1.2 million in lost reimbursements to the general fund for services the City provided to Golf. Furthermore, the discount granted to Golf for its cost allocation was not accounted for in the City’s or Golf’s financial documentation, resulting in a lack of transparency and accountability. In a time when the City must account for millions of dollars in budget shortfall each year, it is imperative that enterprise funds at the very least be held accountable for their indirect cost allocations. If the City finds that it is necessary to offer subsidies to enterprise fund agencies at the expense of the general fund, such determination should be conducted in a manner that is transparent so that City leadership can be given the opportunity to weigh in. It is our hope that from this point forward BMO will conduct its application of the full cost allocation plan in a way that is transparent in publicly available financial documentation. If you have any questions, please call Kip Memmott, Director of Audit Services, at 720-913-5000. Sincerely,

Dennis J. Gallagher Auditor DJG/blh

cc: Honorable Michael Hancock, Mayor Honorable Members of City Council Members of Audit Committee


Ms. Kennedy October 18, 2012 Page two



Ms. Janice Sinden, Chief of Staff Ms. Stephanie O’Malley, Deputy Chief of Staff Ms. Beth Machann, Controller Mr. Doug Friednash, City Attorney Ms. Janna Bergquist, City Council Executive Staff Director Mr. L. Michael Henry, Staff Director, Board of Ethics Mr. Brendan Hanlon, Budget Director



City and County of Denver 201 West Colfax Avenue, Department 705 • Denver, Colorado 80202 • 720-913-5000 FAX 720-913-5247 • www.denvergov.org/auditor


AUDITOR’S REPORT

We have completed an audit of the City’s Cost Allocation Plan. The purpose of the audit was to assess the extent to which the full cost allocation plan is reasonable and equitable, to determine whether the plan provides for full reimbursement to the City’s general fund for services provided to enterprise fund agencies, and to understand how the plan process is managed and how the plan is applied.

This performance audit is authorized pursuant to the City and County of Denver Charter, Article V, Part 2, Section 1, General Powers and Duties of Auditor, and was conducted in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

For many years, the City has used a consultant to create the annual full cost allocation plan. This plan is used as the basis for the City’s billings to enterprise fund agencies to collect reimbursement for centralized services provided by City agencies and departments. Our examination of the City’s cost allocation process revealed that the plans provided by the consultant are thorough and based on a methodology that is more precise than the City could perform. While the plan is sound, the audit identified an issue where the City’s Budget and Management Office (BMO) has not billed the Golf Enterprise Fund for its full cost allocation amount in the past two years, resulting in $1.2 million in lost reimbursements to the City’s general fund. In addition, BMO did not record the discount in a way that was transparent.

We extend our appreciation to the Deputy Mayor and Chief Financial Officer, the Budget Director, and the personnel who assisted and cooperated with us during the audit.

Audit Services Division

Kip Memmott, MA, CGAP, CRMA

Director of Audit Services


TABLE OF CONTENTS

EXECUTIVE SUMMARY 1

INTRODUCTION & BACKGROUND 3

SCOPE 7

OBJECTIVE 7

METHODOLOGY 7

FINDING 9

Formal Policy Needed to Ensure Accountability and Transparency in City’s Application of the Cost Allocation Plan 9

RECOMMENDATION 13

APPENDICES 14

Appendix A – Definition of Terms 14

Appendix B – Benchmarking of Cost Allocation in Other Cities and Counties 15

AGENCY RESPONSE 17

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EXECUTIVE SUMMARY Cost allocation is a budgeting principle that allows central service departments in an organization to distribute the costs of providing services to other departments in a fair and equitable manner. Each year, the City and County of Denver creates a cost allocation plan that calculates the value of central services provided to each department in the City. Based on these calculations the City can recover the cost of central services provided to City-owned enterprises such as Denver International Airport. The cost allocation plan is important because not all City agencies are funded in the same way. Most City agencies are funded by taxpayers through the City’s general fund because they generally serve the public at large. The City’s four enterprise fund agencies, on the other hand, are funded by fee-for-service dollars. Figure 1 provides examples of the City’s central service agencies and enterprise fund agencies and how they are respectively funded. The cost allocation plan provides the best estimate of each department’s share of the cost of central services and allows the City to receive reimbursement from enterprise fund agencies for those services.

Formal Policy Needed to Ensure Accountability and Transparency in City’s Application of the Cost Allocation Plan

Each year, the City’s consultant, MGT of America, Inc., creates a fair and equitable full cost allocation plan that attributes indirect costs to City agencies that receive services from other agencies.1

We found this action to be problematic in two areas. First, BMO provided the discount without documenting the policy decision for doing so. Although recovering costs from enterprise fund agencies through cost allocation is not required by law or executive

After the plan has been finalized and City agencies generally agree upon the methodologies used to assign and distribute costs, the Budget and Management Office (BMO) bills the City’s four enterprise fund agencies for their costs as determined by the plan. However, in the past two years, BMO has discounted the amount calculated in the full cost allocation plan when requesting payment from the City’s Golf Enterprise Fund (Golf), resulting in $1.2 million in lost reimbursements to the general fund.

1 An indirect cost is incurred for a common or joint purpose benefiting more than one cost objective and is not readily assignable to the cost objectives specifically benefited, without effort disproportionate to the results achieved.

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order, BMO should document policy decisions supporting discounted allocation amounts from enterprise fund entities in a manner that recognizes the implications and liability to the City’s general fund of these decisions. The City’s leadership, including elected officials, who review and approve the City’s budget should be aware of these decisions as they conduct their deliberations.

Second, the lack of a formal policy for addressing instances when an enterprise fund agency lacks the funds to cover its annual cost allocation amount has diminished BMO’s ability to hold enterprise funds financially accountable, which is a critical element to the City’s efforts to promote fiscal transparency and responsibility. It should be the policy of the City that enterprise funds pay their full cost allocation amounts. If in the future an enterprise fund agency requests subsidies to cover its cost allocations, the request should be handled through the budget process, not through the cost allocation process.

The City’s full cost allocation plan is a data-driven estimate of each department’s share of costs incurred by central service agencies and the costs therein should be treated as real operational costs. BMO should ensure that City leadership, including elected officials, and citizens clearly understand the full operational costs of enterprise fund agencies. Requiring full cost allocation payments and deferring discussions of enterprise fund subsidies to the budget process would increase transparency and accountability within both BMO and the enterprise funds.

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One of the goals of cost allocation is to promote fair

and equitable sharing of

indirect costs.

INTRODUCTION & BACKGROUND Cost Allocation

Cost allocation is a budgeting principle by which the costs for centrally provided services are identified and assigned to benefitting internal entities. Cost allocation makes use of both direct and indirect costs. Direct costs can be attributed to a specific department, program, or activity. Indirect costs, in contrast, are not easily attributable to specific departments, programs, or activities.2

Cost allocation can be performed in a variety of ways using simple or complex methodologies. More complex cost allocation plans typically produce more accurate cost calculations than simpler cost allocation plans. For governments that track all activities by department, indirect cost allocation may not be necessary because the activities incurring costs can be accounted for by directly billing the recipient parties. However, for larger or more complex governments, the time and effort required to track

direct-billing activities may be disproportionate to the benefit of the direct billing itself. In these cases, creating a government-wide full cost allocation plan is ideal.

For example, the cost for an accounting department to perform one specific service for one specific department would likely be categorized as a direct cost. However, if the accounting department were to perform the service for multiple departments in proportions that were not easy to determine, the cost to perform that service would likely be categorized as an indirect cost. Another example of an indirect cost is the cost to pay executives whose activities benefit multiple parties in proportions that are difficult to determine. As is the case in the City and County of Denver, many indirect costs are incurred by central service agencies such as the Career Service Authority (CSA) or Technology Services (TS). All or most of the costs these departments incur benefit most other departments in the City, but the amount that their services benefit each department is not easy to determine.

Purposes of Cost Allocation

Cost allocation serves many purposes. First, it promotes fair and equitable sharing of indirect costs within an organization. Second, cost allocation helps departments and agencies recognize the full cost of their operations by estimating their shares of indirect costs. Departments and agencies can use the cost allocation plan to

improve budget and resource management or better align user fees with the true cost of doing business. Finally, cost allocation allows budget personnel to charge other funds for services provided by general fund departments and agencies. In the case of Denver,

2 See Appendix A for definition of terms.

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Only the City’s enterprise funds are required to reimburse the general

fund for central services because their operations should be fully funded by

fee-for-service dollars.

cost allocation is used to determine reimbursement amounts for services provided to enterprise fund entities by general fund agencies.3

In addition to using cost allocation to calculate reimbursements to general fund agencies, the federal government requires governmental entities receiving federal grant funding to provide a citywide indirect cost allocation rate to estimate what portion of federal grant funding is used for grant administration. To meet both purposes, the City creates two basic types of cost allocation plans every year: the Office of Management and Budget A-87 plan and the Citywide full cost allocation plan.

The Office of Management and Budget A-87 plan – This plan results in an annual Citywide indirect cost allocation rate that is used by City agencies for federal grant administration. This plan is based on federal regulations in U.S. Office of Management and Budget Circular A-87 (OMB A-87), which outlines what types of costs can and cannot be included in an indirect cost allocation for federal grant administration.4

Citywide full cost allocation plan – Unlike the OMB A-87 plan, the Citywide full cost allocation plan can include any costs that the City deems appropriate. The purpose of the full cost allocation plan is to capture, identify, and attribute all appropriate Citywide costs to agencies that have received central services, and to collect reimbursements from the City’s four enterprise fund agencies—Aviation, Environmental Services, Golf, and Wastewater—for their share of these costs. Only enterprise funds are required to reimburse the general fund for central services received, as they have been established as fee-for-service entities, the costs of which should generally be covered by fees charged to citizens who directly benefit from the services. In effect, payments made by enterprise fund agencies to the general fund for indirect costs is a form of reimbursing taxpayers for

The OMB A-87 plan is required by the federal government to ensure that proper indirect cost rates are calculated for federal monies granted to the City. Examples of federal monies awarded to the City are grants to Denver Human Services or through the American Recovery and Reinvestment Act. The Colorado Department of Human Services, by proxy for the federal government, annually verifies and approves the City’s OMB A-87 plan and indirect cost rate. The OMB A-87 cost allocation plan is also included in the City’s annual single audit performed by BKD, LLP, the City’s external accounting firm, and it serves as the basis for the Citywide full cost allocation plan. Because the OMB A-87 cost allocation plan is federally regulated and heavily audited, this audit focused on Denver’s Citywide full cost allocation plan.

3 General fund agencies are funded by taxpayer monies, whereas enterprise fund agencies perform core activities that generate revenue by charging customers for sales and services delivered. 4 Effective August 31, 2005, OMB Circular A-87 was republished in Title 2 in the Code of Federal Regulations, Subtitle A, Chapter II, Part 225—Cost Principles for State, Local, and Indian Tribal Governments (OMB Circular A-87). OMB A-87 was relocated to provide the public with a central location for federal government policies regarding grants and agreements.

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services provided by the City to enterprises that only serve specific groups of citizens rather than the public at large.

Enterprise funds have reimbursed the City’s general fund more than $51.5 million over the last three years for central services. During this period, reimbursements from the Golf and Environmental Services enterprise funds to the general fund amounted to approximately $1 million each, while reimbursements from the Wastewater and Aviation enterprise funds to the general fund amounted to $6.4 million and $43.3 million respectively. Table 1 illustrates the specific reimbursement amounts paid by the funds in fiscal years 2008 through 2010.

Table 1: Enterprise Fund Payments to General Fund for Indirect Costs, FY2008-FY2010

Aviation Wastewater Golf

Environmental Services

Total Payments

FY2008 $15,377,890 $1,983,716 $307,368 $407,060 $18,076,034 FY2009 $14,489,967 $2,560,003 $307,368 $118,939 $17,476,277 FY2010 $13,385,765 $1,902,394 $365,460 $338,106 $15,991,725 TOTAL $43,253,622 $6,446,113 $980,196 $864,105 $51,544,036 Source: Auditor’s Office analysis of BMO data.

The City’s consultant, MGT of America, Inc. (MGT), also creates cost allocation plans for specific departments, which allow for even more precise calculations of indirect costs. These departments have determined that the City’s cost allocation plan does not determine with great enough precision the amounts owed each department by the enterprise funds that use their services.5

Denver’s Cost Allocation Methodology

The City’s Budget and Management Office (BMO) oversees the creation of the City’s cost allocation plan every year. The full cost allocation plan, prepared by MGT, is sophisticated and complex, and it allocates indirect costs in a consistent manner across all City departments, including the enterprise fund agencies. The main purpose of performing the full cost allocation plan is to distribute indirect costs of central services provided by City agencies to all of the City agencies receiving those services. Although the full cost allocation plan is not required by any law or executive order, the City develops a plan to determine an accurate and reasonable reimbursement for City services provided to the enterprise fund agencies.

Because it can take the City more than six months from the end of a fiscal year to finalize that year’s financial data, MGT uses the previous fiscal year’s final financial data to create both the OMB A-87 and full cost allocation plans. The full cost allocation plan must be finalized before the end of the fiscal year so that enterprise fund agencies can submit payment for their cost allocations by fiscal year end. For example, at the time of

5 MGT has contracts with the Department of Safety and the Department of Public Works to create department-specific cost allocation plans. For example, the Department of Safety (Safety) provides a large portion of its services to the Aviation Enterprise Fund (Aviation), and having a department-specific cost allocation plan created allows for a higher degree of accuracy in estimating the cost of the services provided by Safety to Aviation.

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this report’s issuance, the most recently completed full cost allocation plan was finalized at the end of FY2011, using FY2010 financial data. Once the full cost allocation plan is completed and approved, BMO bills the City’s four enterprise fund agencies for their costs as determined by the plan. BMO has contracted with MGT for nearly ten years to collect the data and conduct the analysis necessary to create the plans. MGT adjusts the plans each year to reflect changes in the organizational structure of the City or changes in functions or services provided. These adjustments ensure that the full cost allocation plan continues to reflect the actual costs incurred by general fund agencies to provide central services to City agencies, departments, and enterprises.

The City’s full cost allocation plan is created using the “double step-down” allocation methodology, which allows for the most accurate estimation of how costs should be

distributed across government agencies.6

BMO mediates any disagreements about methodology between enterprise funds, central service agencies, and MGT as they arise. For example, when MGT provides a draft full cost allocation plan to the enterprise fund agencies for review, disagreements occasionally arise regarding the allocation amount or services provided. BMO will meet with MGT and the enterprise fund to discuss and resolve the point of conflict.

In the plan, City agencies and departments are identified as either an allocating agency—one that provides services to other agencies or departments—or a receiving agency—one that only receives services from other agencies or departments. The allocating agencies include central service agencies such as CSA or TS, which provide multiple services across multiple departments. The receiving agencies include Denver’s four enterprise fund agencies. In the full cost allocation plan these four agencies cannot distribute costs to other agencies. Allocating agencies not only distribute costs to receiving agencies, but they also allocate costs to other central service

agencies that receive their services, as illustrated in Figure 2.

6 The double step-down methodology is also referred to as a reciprocal methodology.

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SCOPE The audit reviewed the City's methodology used to create the Citywide full cost allocation plan and the process for allocating internal service costs to agencies and departments that received services.

OBJECTIVE The audit focused on three audit objectives:

• To determine if the methodology used to create the full cost allocation plan is reasonable and equitable

• To determine if the full cost allocation plan provides full reimbursement for services the City provides to enterprise funds

• To assess how the full cost allocation plan is managed and evaluate how the final plan is applied

METHODOLOGY The team used various methodologies to gather information to complete this audit:

• Interviewed allocating agencies and enterprise fund agencies regarding service provided by BMO and MGT7

• Interviewed BMO and MGT personnel regarding their functions and responsibilities during the cost allocation process

• Interviewed personnel at the Colorado Department of Human Services about their review and approval of the City’s OMB A-87 plan

• Reviewed MGT’s allocation program for completeness and accuracy

• Performed trend analysis on the previous five years of the City’s full cost allocation plans to determine if there were significant fluctuations in cost allocation results and if those fluctuations appeared reasonable

• Reviewed prior full cost allocation plans and internal billings to enterprise funds to determine if full reimbursement for services provided was recorded

• Reviewed federal, state, and local laws regarding cost allocation practices

• Reviewed U.S. Office of Management and Budget Circular A-87 requirements regarding cost allocation plan creation

• Reviewed Federal Aviation Association Revenue Diversion Requirements to determine the impact on the full cost allocation plan

7 MGT is the consultant retained by the City to create the Citywide full cost allocation plan and the U.S. Office of Management and Budget A-87 cost allocation plan.

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• Surveyed eight municipalities regarding their cost allocation plan methodology, monitoring, and plan costs. Survey responses were received from San Francisco, CA; Broomfield, CO; Louisville, KY; Boston, MA; Las Vegas, NV; Nashville, TN; El Paso, TX; and Seattle, WA.8

8 Survey results are available in Appendix B.

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Our analysis showed that the process used by

the City and MGT to create the full cost allocation plan is reasonable and

equitable.

FINDING Formal Policy Needed to Ensure Accountability and Transparency in City’s Application of the Cost Allocation Plan

The annual Citywide full cost allocation plan created by the City’s consultant, MGT of America, Inc. (MGT), allows the City to improve budget and resource management, better align user fees with the true cost of doing business, and recover costs for central services provided to the City’s four enterprise funds. Enterprise funds operate much like a business and are generally required to recover their costs, including cost allocation payments, primarily through user charges. The methodology utilized to create the full

cost allocation plan is widely used among other municipalities, and our analysis showed that the process used by the City and MGT to create the plan is reasonable and equitable.9

General Fund Lost Reimbursements of $1.2 Million over Two Years

However, the audit revealed that the City’s Budget and Management Office (BMO), which oversees the City’s use of the full cost allocation plan, has not applied the plan equitably among the four enterprise fund agencies. Additionally, the City does not have a formal policy in place to ensure accountability and transparency in the application of the full cost allocation plan. As a result, in the last two years, BMO made an undocumented policy decision to discount the Golf Enterprise Fund’s (Golf) cost

allocation by more than $1.2 million, setting a precedent for future subsidies. In addition, the discount was not documented in the City’s or Golf’s financial statements. The City cannot ensure fiscal responsibility without a formal policy that holds enterprise funds accountable for their cost allocation payments.

Until two years ago, BMO consistently applied the full cost allocation plan by billing the City’s enterprise fund agencies for the amounts allocated in the full cost allocation plan each year.10

9 The scope of this audit did not include actual validation of specific calculations or vetting of the proprietary software that MGT uses to perform its calculations, but our work did not uncover major discrepancies or the appearance of impropriety in the cost allocation process.

However, in the two most recent cost allocation plan years—FY2009 and FY2010—BMO made the policy decision to discount a substantial portion of Golf’s allocation. This discount totaled more than $1.2 million over the two years—$687,913 in FY2009 and $574,939 in FY2010—representing a loss in reimbursement to the general fund, as demonstrated in Table 2. The City’s other three enterprise fund agencies—Aviation,

10 Charges to the enterprise fund agencies are often made with minor adjustments to the full amounts in the plan; these adjustments include accounting for direct bills or other costs that could not easily have been accounted for in the plan itself and usually amount to adjustments in the thousands of dollars or fewer.

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Environmental Services, and Wastewater—paid their full cost allocation amounts.11 If the same discount were applied to the other three enterprise funds over the same two-year period, the City would have lost an additional $21.3 million in reimbursements to the general fund.12

Table 2: Indirect Costs Incurred by Golf Enterprise Fund versus

BMO Charge to Golf, FY2008-FY2010

Indirect Costs Incurred by Golf in Full Cost Plan

Charge to Golf by BMO

Lost Reimbursement to General Fund

FY2008 $307,368 $307,368 $0 FY2009 $995,281 $307,368 $687,913 FY2010 $940,399 $365,460 $574,939 TOTAL $2,243,048 $980,196 $1,262,852

Source: Auditor’s Office analysis of BMO data.

The abrupt increase in Golf’s allocation between FY2008 and FY2009 was the result of several factors. In FY2009, the City implemented its shared services initiative, resulting in increased central service costs such as those incurred by Technology Services and the Controller’s Office. This prompted MGT to allocate departmental administrative costs, including for the Department of Parks and Recreation and the Office of Economic Development.13

Golf Enterprise Fund Cost Allocation Discounts Lacked Transparency

Additional changes in the plan, including a change in methodology for allocating costs of the Career Service Authority, also were made that year. These changes collectively tripled Golf’s allocation amount from FY2008 to FY2009.

BMO’s decision to discount Golf’s cost allocation payments lacked transparency. The City’s full cost allocation plan is the best estimate of each department’s share of the costs incurred by central service agencies and the costs therein should be treated as real costs. However, BMO provided the discount to Golf without documenting the full liability in the City’s or Golf’s financial records. As a result, Golf was effectively provided a subsidy without the knowledge of citizens and City leadership.

Golf management informed BMO that they could not meet all of the fund’s other obligations and also pay the cost allocation amounts attributed to the fund starting for the FY2009 allocation year. As a result, BMO agreed to allow Golf to pay in FY2009 the same amount it paid in FY2008. The following year, Golf management again indicated

11 As noted in Table 1 on page 5, in FY2009 the Aviation, Environmental Services, and Wastewater enterprise funds paid $14.5 million, $119,000, and $2.6 million, respectively. In FY2010 the Aviation, Environmental Services, and Wastewater enterprise funds paid $13.4 million, $338,000, and $1.9 million, respectively. 12 Golf received an average discount of 65.2 percent in FY2009 and FY2010. In the same two years, the other three enterprise funds paid a total of $32,795,174 in reimbursements to the general fund. If that amount were offset by a 65.2 percent discount, the City would have lost an additional $21,382,453 in reimbursements. 13 In plans prior to the FY2009 full cost allocation plan, the Golf Enterprise Fund had not been allocated administrative costs of the Department of Parks and Recreation, which is Golf’s administrative general fund agency. In the same time period, the Environmental Services and Wastewater enterprise funds had been allocated administrative costs of their respective administrative general fund agencies, the Department of Environmental Health and the Department of Public Works.

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Should taxpayers be subsidizing enterprise

fund activities that benefit only a select group of citizens?

that the fund could not pay the full cost allocation amount and meet other business obligations. BMO again allowed Golf to pay a reduced amount, so long as the discount did not exceed 10 percent of Golf's operating budget for that year, to comply with the Taxpayer’s Bill of Rights (TABOR) in the state constitution.14 For FY2010, BMO based the cost allocation amount charged to Golf on a comparison with three golf enterprise funds in other cities, and with the City's three other enterprise funds.15

By recording in financial statements the full costs incurred by City agencies serving enterprise funds and any related discounts, BMO would increase transparency in a way that would provide citizens and City leadership, including elected officials, more accurate information about enterprise funds’ and the City’s financial condition.

This comparison led BMO to decide to charge Golf 5 percent of Golf's operating budget for its cost allocation in FY2010. In effect, BMO abandoned the established data-driven methodology in favor of an alternative methodology for Golf that was inconsistent with that used for all other City agencies and departments. BMO indicated that initially they expected Golf's inability to pay the full allocation to be a temporary issue. However, according to BMO and the Department of Parks and Recreation, it is likely that Golf’s management will again ask for a discount for the FY2011 cost allocation amount.

Lack of a Formal Policy Hinders BMO’s Ability to Hold Enterprise Funds Accountable for Cost Allocation Payments

Currently the lack of a formal policy for addressing an enterprise fund agency’s inability to pay its cost allocation has left BMO without formal guidance to support the City’s efforts to promote fiscal responsibility through holding enterprise funds financially accountable for their full cost allocations. BMO’s actions set a precedent for other enterprise fund agencies to expect future cost allocation discount considerations and may make it more difficult for the City to hold enterprise funds accountable for their financial obligations. If the City had a formal policy in place, BMO would have been better prepared to address the issue in a manner that was transparent and that held Golf accountable for its full cost allocation payments.

After the initial increased cost allocation for Golf in FY2009, Golf management could have forecasted for FY2010 a cost allocation amount similar to the increased amount in FY2009. Instead, Golf relied on the decision BMO made to discount the amount in the FY2009 cost allocation plan as precedent that they would not be held accountable for their full cost allocation amounts in the future. By the City's definition, "Enterprise Funds account for operations that are financed and operated in a manner similar to private business enterprises where the intent of the

14 The City Attorney advised BMO to adhere to TABOR, which defines enterprise as a “government-owned business authorized to issue its own revenue bonds and receiving under 10% of annual revenue in grants from all Colorado state and local governments combined.” Colo. Const. Art. X, § 20 (2)(d). 15 The average allocation percentages of operating budgets paid by the City’s enterprise fund agencies in FY2005 through FY2009 were 4.38 percent (Aviation), 3.82 percent (Environmental Services), 4.04 percent (Golf), and 3.07 percent (Wastewater).

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governing body is that the costs of providing goods and services to the general public on a continuing basis be financed or recovered primarily through user charges."16

Because the full cost allocation plans are the City's best estimates of each department’s share of indirect costs, the amounts in the plans represent actual costs to the enterprise fund agencies and should be evident in Golf’s financial statements. Any other treatment of the allocation amounts diminishes the intent of the full cost allocation plan. Not only is the special treatment of Golf's allocation payment unfair to the other three enterprise fund agencies, but it also degrades the purpose of the full cost allocation plan, which is to estimate the shares of indirect costs attributable to all of the agencies in the City for central services provided in a way that treats all agencies the same.

Given this definition of an enterprise fund, it is the responsibility of the enterprise fund to determine how to finance business costs—including cost allocation amounts—and taxpayers should not be held liable for those costs.

It should be the policy of the City that enterprise funds pay their full cost allocation amounts. If in the future an enterprise fund agency requests subsidies to cover its cost allocations, the request should be handled through the budget process. City leadership, including elected officials, and BMO together should decide if it is in the City’s best interest to provide subsidies for the enterprise funds’ activities, especially in this time of economic hardship.

16 City and County of Denver, Mayor’s 2012 Budget, p. 147.

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RECOMMENDATION The Auditor’s Office offers the following recommendation.

1.1. Cost Allocation Payment Policy—The City’s Chief Financial Officer should create a formal policy through a fiscal rule that holds all enterprise fund agencies accountable for their full cost allocation amounts and requires appropriate documentation of the liability of the costs in financial statements. The policy should require that general fund subsidy requests be considered for approval by City leadership, including elected officials, during the budget process and not through cost allocation.

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APPENDICES Appendix A – Definition of Terms

Allocating agency or department – City and County agency or department that provides support to other City and County agencies or departments.17

Central service agency or department – See “allocating agency or department.”

Central service cost allocation plan – The documentation identifying, accumulating, and allocating or developing billing rates based on the allowable costs of services provided by a governmental unit on a centralized basis to its departments and agencies. The costs of these services may be allocated or billed to users.18

Cost objective – A function, organizational subdivision, contract, grant, or other activity for which costs data are needed and for which costs are incurred.

19

Direct cost – Costs that can be identified specifically with a particular final cost objective.

20

Enterprise fund – A type of proprietary fund that closely resembles private sector accounting, in which fees are charged for the goods and services provided. Government entities use enterprise funds to account for business type activities.

General fund – A type of governmental fund primarily funded by general sales and property taxes, expenses from which are for basic government functions.

Indirect cost – A cost incurred for a common or joint purpose benefitting more than one cost objective and not readily assignable to the cost objectives specifically benefitted, without effort disproportionate to the results achieved.21

Indirect cost rate – A device for determining in a reasonable manner the proportion of indirect costs each program should bear. It is the ratio (expressed as a percentage) of the indirect costs to a direct cost base.

22

Indirect cost rate proposal – The documentation prepared by a governmental unit or component thereof to substantiate its request for the establishment of an indirect cost rate.

23

Receiving or grantee agency or department – City and County agency or department that receives support from other City and County agencies or departments.

24

17 City and County of Denver, Colorado, Full Cost Allocation Plan, FY 2010 Actual Expenditures, MGT of America, Inc., 2011, Section 3, “Reading the Full Cost Allocation Plan.”

18 Circular A-87, Revised 2004, United States Office of Management and Budget (OMB), Attachment A, p. 7. 19 Ibid. 20 Ibid., p. 10. 21 Ibid., p. 11. 22 Ibid., Attachment E, p. 51. 23 Ibid. 24 City and County of Denver, Colorado, Full Cost Allocation Plan, FY2010 Actual Expenditures, MGT of America, Inc., 2011, Section 3, “Reading the Full Cost Allocation Plan.”

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Appendix B – Benchmarking of Cost Allocation in Other Cities and Counties

As part of our audit, we surveyed eight cities and counties to compare Denver’s indirect cost allocation process with similar jurisdictions.25

Table 3: Monies Contributed Annually to General Fund through Cost Allocation

We found that Denver collects more money through its cost allocation process than the other cities and counties. Part of this variation may be attributable to the fact that Denver’s enterprise fund agencies are larger. Denver International Airport—one of the largest airports in the country—is among the City’s enterprise fund agencies. Table 3 shows the average amounts collected annually through cost allocation of the jurisdictions we surveyed.

Dollar Amount City/County $0 Boston, Louisville Less than $5 million Broomfield, El Paso, Las Vegas $10-$15 million Nashville, San Francisco, Seattle More than $15 million Denver Source: Auditor’s Office benchmarking survey, conducted May 2012.

Our survey also found a variety of methodologies used for cost allocation. Six of the eight jurisdictions indicated that they perform cost allocation internally rather than hiring a consultant. Among the jurisdictions that perform cost allocation internally:

• Two use a more direct or “activity-based” methodology by which city employees track their time precisely so that departments can be billed accordingly for services provided

• Two of the jurisdictions conduct a less precise cost allocation by computing a jurisdiction-wide rate that departments can apply to gain reimbursement for services provided

• Two jurisdictions use proprietary software to perform the cost allocation process internally

The remaining two cities use an external consultant to perform a more precise cost allocation, known as a reciprocal or “double step-down” methodology, like Denver. Table 4 shows the various methodologies used by the jurisdictions we surveyed.

25 For a complete list of the cities and counties surveyed, see the Scope and Methodology section of the report on page 8.

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Table 4: Methodologies Used for Cost Allocation Cost Allocation Methodology City/County

Direct or “Activity Based,” performed internally Las Vegas, Seattle Simple indirect cost rate, performed internally Louisville, San Francisco Purchased software, performed internally Boston, Nashville “Double Step-Down” or Reciprocal method, performed by consultant

Broomfield, Denver, El Paso

Source: Auditor’s Office benchmarking survey, conducted May 2012.

Lastly, our survey found that the majority of the jurisdictions, including Denver, use cost allocation plans not only for grant administration—as required by federal law—but also to calculate amounts to be billed to enterprise or special revenue fund agencies for central services provided by other city agencies. Table 5 shows how the surveyed jurisdictions apply their plans.

Table 5: Applications of Cost Allocation Plans Application of Plan City/County

Only for grant administration Boston, Louisville For grant administration and to recover costs incurred by central service agencies

Broomfield, Denver, El Paso, Las Vegas, Nashville, San Francisco, Seattle

Source: Auditor’s Office benchmarking survey, conducted May 2012.

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AGENCY RESPONSE

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Documents

City Cost Allocation Plan - Denver J. Gallagher . Auditor . Office of the Auditor . Audit Services Division . City and County of Denver . City Cost Allocation Plan . Performance Audit