Magnolia Complaint - Exhibit 20

7/24/2019 Magnolia Complaint - Exhibit 20

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Exhibit 20

LAUSD Audit Report OA 12 - 486: Magnolia Science Academy-Charter Schools

08/20/2012

Pages 1 - 53


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Audit Report

Magnolia Science Academy-Charter Schools

OA 12 486 August 20, 2012

Los A ngeles Uni f ied School Distr ict

Office of the Inspector GeneralInternal Audit

Exhibit 20, Page 1 of 53


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August 20, 2012

Dr. Mehmet ArginChief Executive OfficerMagnolia Public Schools13950 Milton Avenue, Suite 200BWestminster, CA 92683

Dear Dr. Argin:

This is our report on the audit of selected Magnolia Science Academy-Charter Schools.

These are the reports key sections:

The Executive Summary describes the scope of the audit and provides an overview of whatwe audited and found.

The two Findings and Recommendations section describes in detail the conditions wefound, our recommendations and your comments.

Appendix A is a summary of questioned costs identified in this audit. Appendix B is asummary of questionable accounting practices. Annex A contains your verbatim commentson our recommendations. Annex B lists other receiving copies of the report. Annex C liststhe members of the audit team.

I appreciate the courtesies and cooperation extended to us during the audit.

Cc. Magnolia Public Schools Board of Directors

333 South Beaudry Avenue, 12 thFloor, Los Angeles, California 90017Telephone: (213) 241-7700 Fax: (213) 241-6826

Los Angeles City Board of EducationOffice of the Inspector General

Mnica Garca, President

Tamar Galatzan

Bennett Kayser

Marguerite Poindexter LaMott

Nury Martinez

Richard A. Vladovic

Steve ZimmerMembers of the Board

John E. Deasy, Ph.D

Superi ntendent of Schools

Alfred RodasI nspector General , I nterim



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About the Office of the Inspector General

The Office of the Inspector General reports directly to the Board of Education.We conduct independent audits, reviews and investigations of Districtoperations, contracts and vendors in order to:

Find ways to improve processes, programs, functions and activities

Provide information that supports effective decision making

Identify real or potential misuse of District resources

Prevent and detect waste, fraud and abuse within the District

Through our work, we strive to encourage a culture of accountability,transparency, collaboration and excellence and to assist the Board and theSuperintendent in their efforts to provide a high quality education for the

students and parents of the Los Angeles Unified School District.



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Why did the OIG do this audit?

Charter Schools are now an important part of the public education system in the areas served bythe District. Audits of selected charter schools are requested by the Charter School Division toassist them in their oversight responsibilities over charter schools. The audit of selected charterschools is part of the OIGs Annual Work Plan.

What was the main objective?

To evaluate whether the Board of Directors and management of Magnolia Science AcademyCharter Schools (MSA Schools) were adhering to the conditions, standards and procedures

outlined in the Charter Agreement.

What OIG goals does this audit support?

Find ways to improve processes, programs, functions and activities

Provide information that supports effective decision making

What District key strategies does this audit support?

Provide a portfolio of high quality schools for youth, families and communities

Operate an effective, efficient, and transparent organization in order to assure thepublic trust

Areas requir ing attenti on and what the Distr ict should do next are discussed

brief ly in the Executi ve Summary of thi s report.



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TABLE OF CONTENTS

Executive Summary ..1

Findings and Recommendations

Finding A Compliance with Charter Agreement....5

Finding B Internal Controls....................................................................................................21

Appendix

Appendix A Questioned Costs....37

Appendix B Questionable Accounting Practices 38

Annexes

A Verbatim Comments ...39

B Report Distribution...................46

C Audit Team...........................47



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EXECUTIVE SUMMARY

This report contains the results of our audit of Magnolia Science Academy Charter Schools

(MSA Schools). The MSA Schools referred to in this audit were the Magnolia ScienceAcademy-1, Magnolia Science Academy-2 and Magnolia Science Academy-3. The MSASchools are part of twelve Magnolia Public Schools (MPS) operated by the MagnoliaEducational and Research Foundation (MERF). The MSA Schools are located in Los Angeles,California and serve students from sixth grade through twelfth grade. The Magnolia PublicSchools Central Office executes the decisions and policies set by the Magnolia Public SchoolsBoard of Directors (aka Magnolia Education and Research Foundation Board) and manages thebusiness operations of the Magnolia Public Schools.

The organization chart below shows the relationship between the Magnolia Public Schools andthe MERF.

Magnolia Public Schools

Board of Directors

(aka Magnolia Educational

and Research Foundation

Board)


Central Office

Chief ExecutiveOfficer

Executive

Assistant

Project

Manager

All Charter School

Principals(12 charter schools

under the MPS)

Data and

Accountability

MPS Chief

Academic Officer

MPS Chief

Operational

Officer

MPS Chief

Financial Officer

Magnolia Public SchoolsOrganization Chart

This audit was part of the Annual Work Plan of the Office of the Inspector General for fiscalyear 2012 and is intended to support the Innovation and Charter Schools Division in monitoring

the operational and financial aspects of District Charter Schools.

Objective

Our audit objective was to determine whether the Board of Directors and management of theMagnolia Public Schools Central Office were adhering to the conditions, standards andprocedures outlined in its Charter Agreement with the Los Angeles Unified School District



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(LAUSD or District). For this audit, we reviewed the following areas:

Governance Structure

Employment Documentation/Qualifications of Staff

Admission/Enrollment Requirements

Financial Audits Fund Reserves, and

Internal Controls

Summary of Key Audit F indings

Areas Requiring Attention:

Our audit found that the MSA Schools were not in full compliance with the selected provisions,standards and procedures outlined in their respective Charter Agreements. We also noted that the

MSA Schools needed to strengthen their internal control systems and theiroversight of fiscal andfinancial operations. Some of the significant conditions we noted during the audit included:

The governing board needed to review its existing governance structure to allow for theincreased participation of parents, community members and other parties in the CharterSchools policy decision areas and other school advocacy.

The MSA Schools did not maintain all employment documentation in the employeefiles as prescribed by the California Education Code and the Charter Agreement.

The MSA Schools did not maintain all the enrollment documentation required by the

written enrollment procedures and by the provisions of the Charter Agreement.

Review of the financial statements and accounting records noted: non-disclosure ofrelated party transactions; failure to maintain required fund reserves; failure toappropriately apply accrual basis of accounting; lack of monitoring of cash receipts anddeposits process; lack of documentation for disbursements; lack of control over journalentries, and lack of adequate training for the accounting staff.

The processes and controls over the bank reconciliation were inadequate. We found oneCharter School that dated all reconciliations three days prior to this audit. We also notedthat some deposits in transit remained outstanding in bank reconciliations from five

months to almost a year.

Conclusion: Our audit noted control weaknesses in governance structure, employmentdocumentation and qualifications of staff, admission/enrollment requirements and variousfinancial control issues managed by the Magnolia Public Schools Central Office at the MSASchool sites visited. The information provided in this report should benefit the MSA CharterSchools to significantly improve their internal control system as well as its oversight of fiscaland financial operations. We believe that the Magnolia Public Schools Board of Directors



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should revisit the provisions of the approved charter petition to preclude potential violations ofthe Charter Agreement with the District and other provisions of the California Education Code.

Potential Impact

The conditions described above, along with their underlying causes, may have increased therisk of fraud, waste and abuse of the MSA Charter Schools funds that could potentially resultfrom the inability to detect irregularities, improper use of public funds or misappropriation ofassets. Also, the questioned costs and questionable accounting practices identified in the courseof the audit may have resulted in misstated and inaccurate financial statements of the MSACharter Schools.

What The Board of Dir ectors of Magnolia Publi c Schools Should Do Next:

Summary of Key Recommendations

We provided the Magnolia Public Schools Board of Directors with eleven recommendations toensure full compliance with the Charter Agreement and to enhance the current internal controlssystem. A complete description of these recommendations is included in the body of the report.Some of the more significant recommendations we made included the following:

Review the existing school governance structure and consider the increasedparticipation of parents, community members and other parties in the policy decisionareas and other school advocacy.

Enhance controls over employee qualifications and documentation requirements.

Enhance controls over the established enrollment procedures and maintenance ofrequired student records.

Ensure that all related party transactions are disclosed in the financial statements,required fund reserve is maintained, cash balances are properly controlled, bankreconciliations are timely completed, proper documentation is maintained for alldisbursements, journal entries are adequately supported and in general, the GenerallyAccepted Accounting Principles (GAAP) are followed for all accounting functions.

Establish formal job descriptions for the accounting staff and provide training on a

regular basis.

Charter School Comments:The Charter School executive management agreed with all of ourfindings and stated that they have already taken some corrective actions and plan to take furtheractions in the future to ensure that OIG recommendations are adequately and timelyimplemented.



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Inspector General Response: Managements response to our audit findings andrecommendations indicate an understanding of the issues presented. We considermanagements planned actions to be constructive steps towards improving the processesreviewed in this audit.

Scope & Methodology

We conducted this audit in accordance with Generally Accepted Government AuditingStandards. 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 onour audit objectives. We believe that the evidence obtained provides a reasonable basis for ourfindings and conclusions based on our audit objectives. The audit covered the activities for theperiod from July 1, 2010 through June 30, 2011. In order to address the audit objectives, weperformed certain procedures, which included, but were not limited to the following:

Reviewed applicable laws and regulations pertaining to charter school operations.

Reviewed and examined records to verify compliance with the provisions of theMagnolia Public Schools Charter Agreement with the District.

Performed walkthroughs of each audit area with key personnel to obtain anunderstanding of the current fiscal and financial processes of the Charter School.

Reviewed the existing accounting policies and procedures to assess the design andoperational effectiveness of internal controls.

Examined general ledger transactions, components of the assets and liabilities, audited

financial statements, and other related records and reports.

Tested statistically selected samples of revenue and expenditure transactions.

Assessed the adequacy of the Charter Schools governance structure.

Reviewed the employment documentation for compliance with the Charter Agreementsand applicable laws.

Obtained the enrollment procedures and assess the completeness of enrollmentrequirements.

Assessed the sufficiency of the available fund reserves.

During the course of our audit, we also interviewed selected personnel of the MSA Schools andthe Magnolia Public Schools Central Office with responsibilities related to our audit objectives.We performed the audit from February 2012 through June 2012.



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FINDING AND RECOMMENDATIONS

FINDING A: Compliance with Charter Agreement

For the Board of Directors, Magnolia Public Schools

BACKGROUND

The Magnolia Educational and Research Foundation (MERF) is a non-profit organizationfounded in 1997 (under the name Dialog Foundation) and was granted a 501(c) (3) tax-exemptstatus by the Internal Revenue Service in 1998. The first charter school, Magnolia ScienceAcademy was established in 2002. Since then, the MERF has established 12 charter schools(aka Magnolia Public Schools) in the State of California.

The MERF is ultimately in charge and oversees the operations of the 12 Magnolia PublicSchools. The Los Angeles Unified School District (LAUSD or District) has currentlyauthorized the operation of eight charter schools (MSA-1, MSA-2, MSA-3, MSA-4, MSA-5,MSA-6, MSA-7, and MSA-8) while the other four schools operate outside of Los AngelesCounty. The MSA-San Diego was authorized by the San Diego Unified School District, theMSA-Santa Clara was authorized by the Santa Clara County Office of Education, and both thePacific Technology School (PTS)-Santa Ana (Orange County) and PTS-Orange Vale (ElDorado County) were authorized by the State Board of Education.

The MERFs educational philosophy and mission are to serve students in grades 6-12 by:

(1) Preparing students to become responsible, educated citizens who have the skills andunderstanding to participate and work productively in a diverse, multicultural, globallyoriented environment;(2) Providing a sound educational plan with emphasis on math, science and technology; and(3) Providing a rigorous, innovative, and challenging enhanced curriculum with a focus onpreparing students to attend the universities of their choice.

The student population represents the demographics of the local communities where thestudents reside, which are primarily in the metropolitan areas of Los Angeles, and othermetropolitan areas throughout the state. MERF specifically targets low-achieving students,

English language learners, and students coming from socio-economically disadvantagedfamilies.

Organizational Structure

The Magnolia Public Schools Board of Directors (aka Magnolia Educational and ResearchFoundation Board) is responsible for establishing the broad policies to implement the missionof the Magnolia Educational and Research Foundation for the Magnolia Public Schools. The



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Board is also responsible for ensuring that staff carry out the school programs in compliancewith Board policy and the applicable state and federal laws and regulations and for makingsound financial decisions that are in the best interest of the public. In addition, Board membersappoint and evaluate the performance of the Chief Executive Officer.

The Chief Executive Officer (CEO) and management are responsible for carrying out theBoards policy decisions and for managing the day-to-day school operations of the MagnoliaPublic Schools. They are to establish and maintain an effective internal control system toensure that each charter school meets appropriate goals and objectives, safeguards publicassets, follows laws and regulations and reports reliable financial information.

Exhibit 11below shows the organization chart of the Magnolia Public Schools.

Magnolia Public School

Board of Directors(aka Magnolia Educational and

Research Foundation Board)

MPS Central Office

Chief Executive

Officer

Executive Assistant

Project

Manager

All Charter School

Principals(12 charter schools

under the MPS)

Data and

Accountability

Chief Academic

Officer

Chief Operational

Officer

Chief Financial

Officer

Exhibit 1


Organization Chart

The Board appointed the Magnolia Public Schools Central Office to execute the decisions andpolicies set by the Board and to manage the business operations of the Magnolia PublicSchools. Currently, the headquarters of the Magnolia Public Schools Central Office is locatedat 13950 Milton Avenue, Westminster, CA 92683. The Magnolia Public Schools Central Office

receives annual fees for the services provided to the schools which include, but are not limitedto (i) Overseeing Magnolia Public Schools operations to ensure compliance with the charteragreements, (ii) Curriculum development, (iii) Hiring school principals, (iv) Payroll, (v)Purchasing, (vi) Budgeting, (vii) Annual audit, (viii) Community outreach, and (ix) Publicrelations.

1 Magnolia Foundation WASC Wiki Site :https://sites.google.com/a/magnoliafoundation.org/msa2wasc/

https://sites.google.com/a/magnoliafoundation.org/msa2wasc/https://sites.google.com/a/magnoliafoundation.org/msa2wasc/https://sites.google.com/a/magnoliafoundation.org/msa2wasc/https://sites.google.com/a/magnoliafoundation.org/msa2wasc/


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DISCUSSION

This section discusses the following areas:


Employment Documentation/Qualifications of Staff Admission/Enrollment Requirements

Financial Audit

Fund Reserves

Basis of Accounting


The governing board needed to review its existing governance structure to allow for the

increased participation of parents, community members and other parties in the CharterSchools policy decision areas and other school advocacy.

The California Code of Regulations states that the required elements of the charter petitionshould include The governance structure of the school, including, but not limited to, theprocess to be followed by the school to ensure parental involvement in supporting the school'seffort on behalf of the school's pupils, as required by Education Code section 47605(b) (5)(D).

The Charter Agreement states that the Board of Directors shall consist of a minimum of three(3) and a maximum of twenty one (21) voting members. In addition, the chartering agency isentitled to have a representative on the Board as an additional non-voting member, pursuant to

the Education Code 47604(b). The Board is ultimately in charge of the Charter Schoolsoperation and governance.The Magnolia Public Schools Central Office was appointed by theBoard to be responsible for the execution on behalf of the Board. The Chief Executive Officer(CEO) is hired, supervised and evaluated by the Board of Directors. The CEO and themanagement are responsible for carrying out the Boards policy decisions and for managing theschool operations. They are to establish and maintain an effective internal control system,ensuring that the Charter Schools meet appropriate goals and objectives, safeguards publicassets, follows laws and regulations and reports reliable financial information.

The Magnolia Public Schools Central Office, headed by the CEO, manages all the businessactivities of the Charter Schools and is responsible for the (i) curriculum development, (ii)

hiring of principals, (iii) financial operations such as budgeting, payroll, procurement andaccounting, and (iii) ensuring compliance with the charter agreement and applicable state andfederal laws and regulations.

A School Site Council (the Council) formed at each school is accountable to the MagnoliaPublic Schools Central Office for the local school operations. The Council is mainly anadvisory body holding the school responsible for its operations. The Council consists of:



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The school Principal

1 Teacher representative elected by the faculty

1 Parent representative elected by the Parent Club

1 Student representative elected by the Student Council

1 Community representative appointed by the Magnolia Public Schools Central Office

1 Representative from the Chartering Agency.

The Council also makes policies for issues unique to the school. The school Principal willcommunicate these policies to the Magnolia Public Schools Central Office.

Test Work Performed

We performed the following procedures to determine the adequacy of the Charter Schoolsgovernance structure:

(1) Assessed the Boards composition and qualifications in terms of the Charter Agreement,

(2) Reviewed Magnolia Public School articles of incorporation and bylaws,(3) Evaluated the organizations structure,(4) Reviewed the Minutes of the Meeting of the Board of Directors,(5) Assessed the operating principles, values, and philosophy of the school,(6) Evaluated the Charters requirements for School Site Council (Council), and(7) Reviewed the minutes of the Council.

The Magnolia Public Schools Board of Directors (aka Magnolia Educational and ResearchFoundation Board), governs and exercises oversight over the school and fiscal operations of allthe twelve Magnolia Public Schools. The Charter Agreements state that Board meetings are tobe held at least four times a year. We noted that the Board held the meetings every month in FY

2010 and every two months during FY 2011, wherein the majority of the meetings wereconvened in the evening.

Based on our review of the Charter Agreements, Minutes of the Meetings, and Boardqualifications, we determined the following:

The Board was comprised of seven (7) voting members, including one parentrepresentative. Although there were eight District authorized charter schools, the parentmember in the Board came from the lone charter school operating in the Orange County.

The Charter Agreements specified that the Council is mainly an advisory body which shall

consist of six representatives. We reviewed the minutes of the Council meeting and notedthat the Council met once or twice in a year. We also observed that some of the Councilmeetings were not well represented by the parents and other council members.

These conditions occurred because the governing Board appeared to be not so rigorous insharing the governance responsibility with the majority of the parents/community members.



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The failure to include appropriate members of the governing Board and school committees mayhave resulted in:

A lack of awareness for parents and community representatives especially involvingdecisions of the charter school regarding students issues.

Perceived unethical selection of the members of the Board of Directors. Diminished public trust for lack of organizational transparency. Non-compliance with the Education Code and the approved Charter Petition.

We discuss the actions needed to correct these conditions in Recommendation A-1.

Employment Documentation/Qualifications of Staff

The MSA Schools did not maintain all employment documentation in the employee files asrequired by the California Education Code and the Charter Agreements.

The California Education Code, Sections 442372, 47605 (5) (E) and (F)3and 494064 and theCharter Agreement require that school employees furnish the school with the followingdocuments prior to the first day of work:

Medical clearance including proof of medical exam and tuberculosis (TB) testing.

Fingerprinting and the service fee to the Department of Justice for a criminal recordcheck. Applicants will be required to provide a full disclosure statement regarding priorcriminal record.

Documents establishing legal status, and current copies of all teacher certificates.

Per Charter Agreement, the documents listed above should be kept on-site and be ready forinspection.

Best practices suggest that a good employee file system helps maintain the organizationalstructure, as well as a protection for both the employer and the employee. By compiling thenecessary and complete employee documentation, the employer may (i) make decisions andtake actions based on the organizations personnel policies, (ii) establish defense against legalaction/s brought by employee/s, (iii) be prepared for a government audit related to tax orimmigration issues, and (iv) comply with applicable laws and regulations

Test Work Performed

We obtained the list of MSA School employees and examined the personnel files to determinewhether the folders contained the required employment documentation. Table 1 belowsummarizes the missing documents at each school site.

2California Education Code, Section 44237, Part 25 - Employees, Chapter 2/Article 2 - Teacher Credentialing3

Ibid, Section 47605 (5) (E) and (F), Part 26.8 - Charter Schools, Chapter 2 - Establishment of Charter Schools4Ibid, Section 49406 (a) and (b), Part 27-Pupils, Chapter 9 Pupil and Personnel Health



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Table 1

Missing Employment Documentation

Type of Documents

MSA-1

(out of 23

employees)

MSA-2

(out of 20

employees)

MSA-3

(out of 22

employees)

Total

Number of

Exceptions

TB Test/Chest X-ray 5 1 3 9DOJ Clearance/Fingerprinting 2 4 1 7

Current Teachers Credential 1 - - 1

Based on our review of the required documentation, we noted the following conditions:

Six employees did not have supporting documentation that TB tests were performed.Also three employees had TB test documentation that was done more than 4 years ago.

Three employees did not have a DOJ clearance on file. In addition, the supportingdocumentation on file showed that four employees were permitted to work beforereceiving a DOJ clearance.

One employee had an expired teachers credential certificate.

We have also observed that other employment forms were not consistently maintained in thepersonnel file folders, such as the Performance Evaluation Form, Employee Handbook ReceiptForm, and the Proof of Child Abuse Awareness Training. According to the CFO, the MagnoliaPublic Schools Central Office is continuously monitoring the employees up-to-dateemployment documentation. However, some documents may have been misfiled at the schoolsite or were maintained in separate folders. During the course of the audit, the CFO providedsome of the missing TB tests and DOJ clearances.

These conditions occurred because (i) the MSA Schoolsoverlooked the requirement to obtain

and maintain the necessary employment documentation from new hires and from employeeswho were currently employed, and (ii) there was inadequate management and control of theemployee file system.

As a result, the failure to obtain and maintain the necessary employment documentation could(i) increase the potential risk that the MSA Schools and the employees may not be protectedshould lawsuits arise, and (ii) have compromised the health and safety of the students andemployees.


Admission/Enrollment Requirements

The MSA Schools did not maintain all the enrollment documentation required by the writtenenrollment procedures and by the provisions of the Charter Agreements.

The admission policy requires the charter schools to admit all students residing in Californiawho wish to attend on a space-available basis. If student applications exceed capacity, priority



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for admission will be given to siblings of existing students. Then a public lottery is held toselect the students to be admitted. In the lottery, all names are drawn and listed in order,separately, for each grade level.

A written application is required for each student. Furthermore, the enrollment procedures

require the submission of a completed enrollment packet consisting of the followingdocumentation for a student to enroll:

Copy of birth certificate

Copy of current immunization

Proof of TDAP vaccine

Proof of residence

Pupil Accounting Report (PAR)

Official Transcript and Last Report Card Received

Copy of Individualized Education Plan, if child has one

California Standard Test (CST) scores and California English Language Development Test

(CELDT), and Other school registration forms, such as the health history card, emergency card, school

permission slip, parent-student compact and emergency treatment form.

Test Work Performed

We obtained the written enrollment procedures and the list of enrolled students as of September2010 from each of the MSA Schools. From the list, we determined the sample size of thestudents files to be tested using a computer assisted statistical sampling plan. Based on thesampling results, a total of 45 students were selected for detailed testing: 15 out of 496 studentsfrom MSA-1, 14 out of 218 students from MSA-2 and 16 out of 249 students from MSA-3. We

examined the enrollment documentation to determine whether the charter schools werecompliant with the established enrollment policies and procedures. Based on our review, wenoted that the MSA Schools did not maintain all the enrollment documentation, as shown inTable 2 below:

Table 2

Missing Enrollment Documentation

Missing Enrollment

Documents

MSA-1

(out of 15

students)

MSA-2

(out of 14

students)

MSA-3

(out of 16

students)

Total Number

of Exceptions

Birth certificate - 1 2 3

Immunization Records - - 2 2

Proof of T-dap Vaccine - 3 2 5

Proof of residence - 4 2 6

Health history card - 2 4 6

School Entrance Medical Record - 3 4 7

Emergency Treatment Form - 4 3 7

Emergency Card 2 4 4 10

School Permission Slip - 4 2 6

Parent-Student Compact - 4 2 6



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These conditions occurred because the MSA Schools failed to obtain and follow-up on themissing documents from the students upon enrollment.

As a result of the conditions described above, students may not have been enrolled inaccordance with the California Education Code and the health and safety of the students may

have been compromised.


Financial Audit

The audited financial statements did not adequately disclose the organizational relationshipbetween the MSA Schools and the Magnolia Educational and Research Foundation, includingits related party loan transactions.

The California Schools Accounting Manual (CSAM) states, Not-for-profit charter schoolsapproved under Education CodeSection 47604 that operate as or are operated by a nonprofitpublic benefit corporation pursuant to Section 501(c) (3) of the Internal Revenue Codetypically use the not-for-profit accounting model and the accrual basis of accounting. Theauthoritative source of GAAP for this model is the Financial Accounting Standards Board(FASB).5

The FASB Accounting Standards Codification (ASC) 850-10-50 contains the disclosurerequirements for related party relationships and transactions. Certain relationships, such asparent-subsidiary or investor-investee, may be clearly evident of a related party transaction.

Transactions, that because of their nature, may be indicative of the existence of related partiesinclude: i) borrowing or lending on an interest-free basis or at a rate of interest significantlyabove or below market rates prevailing at the time of the transaction, and ii) making loans withno scheduled terms for when or how the funds will be repaid.6

One of the main purposes of audited financial statements is to provide the accountability,accuracy, as well as financial credibility of an organization. The CPA firm is required toinclude disclosure notes for some financial statement elements. Also, other information isprovided when required by specific situations in the interest of full disclosure. As such, theexistence of material related party transactions that could affect the financial statements and ofcommon ownership or management control relationships requires disclosure. 7

Test Work Performed

We examined the MSA Schools audited financial statements for the years ended June 30, 2010and June 30, 2011, and noted the following:

5California School Accounting Manual, Procedure 810-1, Charter Schools, March 2008

6Generally Accepted Auditing Standards, AU 334.03 Related Party

7Ibid, AU 334.04



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The organizational relationship between the Magnolia Educational and ResearchFoundation and the MSA Schools was not disclosed in the audited financial statements.During the course of the audit, we noted that the MSA Schools bank deposit accounts wereunder the name of the Magnolia Educational and Research Foundation, as well as the

employers name and the identification number on the payroll tax remittances. We wereinformed by the Chief Financial Officer that the Magnolia Educational and ResearchFoundation is the legal entity and the parent non-profit organization Doing Business As(DBA) the Magnolia Science Academy. The MSA Schools are considered to be thesubsidiaries of the Magnolia Educational and Research Foundation.

The Audited Financial Statements of MSA #1 for FY 2011 clearly showed a substantialbalance in the Other Assets-Loans Receivable-related partyamounting to $322,509. Onthe contrary, the Cash and cash equivalentshad a zero balance. Further analysis of thegeneral ledger and the bank statements revealed that on several occasions, the MagnoliaEducational and Research Foundation had borrowed an aggregate total of $397,409 from

the MSA#1. During the audit, we were provided with the copy of the Loan Agreementdated 06/30/11 issued by the Magnolia Educational and Research Foundation for theremaining balance of the loan. We noted that there was no definite time of repayment andthe loan was interest-free.

Considering that the organizational structure of the MSA Schools is relevant information, theaudited financial statements should provide the nature of its relationship with the MagnoliaEducational and Research Foundation. For the MSA#1, the related party loan transaction wassubstantial and may have a material impact on its actual financial position. We believe that theinformation should have been disclosed in the Notes to Financial Statements in the interest offull disclosure and in compliance with Generally Accepted Accounting Principles.

These conditions occurred because the Magnolia Public Schools Central Office and theindependent external auditors overlooked the full disclosure of the organizational relationshipbetween the MSA Schools and the Magnolia Educational and Research Foundation, includingits related party loan transactions, in the Audited Financial Statements.

As a result, the failure to appropriately disclose pertinent and material information in theaudited financial statements may be perceived as intentional conduct to omit relevant financialinformation. Additionally, the principle of full disclosure under the Generally AcceptedAccounting Principle may not have been followed.




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Fund Reserves

The MSA Schools did not meet the minimum unrestricted reserves required by the CaliforniaCode of Regulations.

The California Code of Regulations, Section 15450 states, Available reserves for any of thebudget year or two subsequent fiscal years are not less than the following percentages oramounts as applied to total expenditures and other financing uses:

a) the greater of 5% or $55,000 for districts with 0-300 ADAb) the greater of 4% or $55,000 for districts with 301-1,000 ADA. 8

Additionally, the Innovation and Charter Schools Division provides that the charter school willat all times maintain a fund balance (reserve) of its expenditures as required by Section 15450,Title 5 of the California Code of Regulations. Currently, the required reserve is 5% of totaloperational expenditures.9

The Charter School Annual Performance Evaluation criteria indicates that an existing schoolshall have an ending cash reserve that exceeds 4% or more of prior audited expenses.

Test Work Performed

We reviewed the cash balances reflected in the audited financial statements and compared thecash balances with the bank statements to determine the available reserve of the MSA Schools.We noted that as of June 30, 2011, the MSA#2 did not have sufficient cash reserve while theMSA#1 and MSA# 3 had zero cash balances in the bank. Based on our analysis, the MSASchools had deficit fund reserves, as shown in Table 3 below:

Table 3

Analysis of Fund Reserve

Description MSA #1 MSA #2 MSA #3

Total Expenditures for FY 2011 $3,937,956 $1,821,234 $1,746,770

Average Daily Attendance (ADA) 475 221 245

Required Percentage of Available Reserve(based on ADA)

4% 5% 5%

Minimum Reserve Requirement(Total Expenditures x % of reserve)

$157,518 $91,062 $87,339

Available Reserve (Cash and cash equivalents)(based on the Audited Financial Statements for FY 2011)

$0 $56,802 $0

Excess/(Deficient) Fund Reserve ($157,518) ($34,260) ($87,339)

8California Code of Regulations, Title 5, Division 1, Chapter 14, Subchapter 8, Article 1, Section 154509 Innovation and Charter Schools Division, Boiler Plate for Charter School Petitions, 2008



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It appeared that the MSA Schools did not retain a sufficient amount of fund reserves for theincoming fiscal year 2012. Particularly, the MSA #1 disbursed a considerable amount of relatedparty loan payments to the Magnolia Educational and Research Foundation without settingaside a fund reserve for the school. As of June 30, 2011, the MSA #1 had an outstanding loansreceivable from the Magnolia Educational and Research Foundation amounting to $322, 509.

These conditions occurred because:

i) There was a lack of effective policy and procedures to project and maintain adequatecash balances throughout the year,

ii) The Magnolia Public Schools Board and the executive management were notconscientious in addressing the MSA Schools budgetary objectives including fundingpriorities, maintenance of fund reserves and cash balances, and incurrence of debt.

iii)The MSA Schools did not receive all the revenues for fiscal year 2011.

As a result, the failure to maintain the required fund reserve may have endangered the financialstability of the schools against unforeseen revenue shortfalls or unexpected expenditures.


Basis of Accounting

The Magnolia Public Schools Central Office did not apply the appropriate accrual basis ofaccounting in recording and reporting the financial transactions of the MSA Schools.

The California School Accounting Manual (CSAM) provides guidance on Generally AcceptedAccounting Principles (GAAP) for all local educational agencies (LEAs), as well as specificguidance for LEAs in California. Section 15071 of Title 5 of the California Code ofRegulations requires that charter schools follow the guidelines in CSAM, to the extent theguidelines apply, for reporting of financial data.10 The term Generally Accepted AccountingPrinciples refers to the standards, rules, and procedures that serve as the norm for the fairpresentation of financial statements. Conformity with GAAP is essential for consistency andcomparability in financial reporting. 11

The Charter Agreement of the Charter Schools states, The accounting procedures must followthe GAAP. The Magnolia Public Schools Central Office will identify staff responsible forfinancial administrative functions and the qualifications of staff assigned to these functions, andwill also provide assurance that the accounting systems adopted would adhere to GAAP anddescribe the process of internal controls.12

10California School Accounting Manual, Procedure 810-1, March 200811California School Accounting Manual, Procedure 101-1, July 200512Magnolia Science Academy Charter Agreement, Additional Requirements 2: Financial and Budget Matters-FiscalManagement, January 31, 2007



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The written financial policies and procedures manual also states, The Magnolia PublicSchools Central Office is responsible for the financial management of the school. ThePrincipal/CFO must ensure that all provisions of the manual and local board policies andprocedures are complied with, that all accounting records are maintained accurately, and that all

financial reports are prepared and submitted in a timely manner. MSA/PTS schools are tomaintain its accounting records on the accrual basis of accounting, modified at year end toreflect any receivables or payables that may exist. Revenues and expenditures are to berecognized when the transaction has occurred.13As such, revenues and expenses are recordedusing the accrual basis of accounting and requires that revenues are recognized in theaccounting period in which they are earned and expenses are recognized in the period in whichgoods or services are received or incurred.

Test Work Performed

We reviewed the procedures on how the Magnolia Public Schools Central Office processed,reported and maintained the financial transactions of the MSA Schools at the end of theaccounting period. During our audit, we noted the following conditions:

The Magnolia Public Schools Central Office was unable to provide supportingschedules or analysis to back-up the accrued revenues reflected in the general ledger asof year-end of FY 2011.

Some subsequent disbursements, which pertained to expenditures incurred in FY 2010,were not identified in the accounts payable. Based on our review of selected samples ofexpenditures, we found that some expenses were not reported in the appropriateaccounting period when the goods or services were incurred. The expenses were

recognized and accounted for in FY 2011 when the payments were made to the vendors.The Table 4 below shows the details of the mismatched expenses.

13Magnolia Foundation Schools Academic and Financial Policies and Procedures, page 43, per copy provided to the internalauditor on February 2012



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Table 4

Details of Improperly Matched Expenses

July 1, 2010 to June 30, 2011(Based on the review of randomly selected samples of disbursements)

These conditions occurred because (i) the process of identifying and recording period end

accounts payable was inadequate, (ii) the Magnolia Public Schools Central Office did not fullyobserve the accrual basis of accounting as stated in the written policies and procedures, and (iii)the matching principle under GAAP was overlooked or ignored.

As a result, the failure to report the obligations on its financial statements understated theorganizations liabilities and expenses and increased the risk that the financial information wasinaccurate and unreliable.


Name ofSchool

Nature of Expenses

Period the

Expenses were

Incurred

Amount Date Recorded asExpenses

MSA-1 Books and Supplies 09/17/09 $16,298.74 07/21/10

Central Office Fees for June 2010 06/30/10 22,560.25 08/02/10

Food Expenses-April, May & June 2010 04/01/10 to

06/30/10

45,905.16 09/15/10

Liability Insurance -March 2010 to June 2010 03/01/10 7,753.42 10/19/10

Total Amount of Expenses $92,517.57

MSA-2 School Information System Software Fee 06/01/10 804.95 07/20/10

Building Rental and utilities 06/01/10 20.244.24 08/15/10

Other Textbooks 06/04/10 802.85 08/15/10

Professional/Consulting Services 06/01/10 1,500.00 08/25/10

Central Office Fees-April 2010 through June 2010 04/01/10 to

06/30/10

24,317.31 10/15/10

Food Expenses-December 2009 through

March 2010

12/31/09 to

03/31/10

17,953.18 09/12/10

Food Expenses-April 2010 through

June 2010

04/30/10 to

06/30/10

15,496.48 02/17/11


MSA-3 Health Ins. Premium-April, May & June 2010 04/01/10 to

06/30/10

30,000.00 07/08/10

Special Education Cost for March 2010 03/31/10 15,951.26 10/11/10

Special Education Cost for April 2010 04/30/10 16,038.46 11/06/10




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RECOMMENDATIONS AND COMMENTS

Recommendation A-1:The Board of Directors of the Magnolia Public Schools is encouragedto review its existing governance structure to allow for the increased participation of parents,

community members and other parties in the policy decision areas and other school advocacy.By doing so, this may increase the public trust that the organization follows the laws, behavesin an ethical manner, and does not waste the resources trusted in its care.

Charter School Comments:The management agreed with our recommendation and statedthat the Board of Directors will review its existing governance structure to allow for theincreased participation of parents, community members and other parties in the policy decisionareas and other school advocacy. It will be discussed during the August, 2012 board meetingand appropriate actions will be taken in October, 2012 board meeting.

Recommendation A-2: The Board of Directors of Magnolia Public Schools should:

Remind the Chief Executive Officer to instruct the Principals to ensure that individualsemployed by the school meet the required qualifications and that all required and necessaryemployment documentation is maintained in the employee files.

Instruct the Chief Executive Officer to improve the oversight over the employee filessystem.

Charter School Comments: The management agreed with our recommendation. Followingthe audit, MPS management implemented additional controls to ensure that individuals

employed by the schools met the required qualifications and that all required and necessaryemployment documentation is maintained in the employee files. In addition, MPS managementhas created Chief Operating Officer position to enhance the internal control and furtherimprove the oversight over the employee files system. However, we would like to note that allMPS employees are asked to provide DOJ clearances, TB test results and teaching credentials(for teachers). MPS will make sure that all required employment documentations andqualifications are met prior to employment. There may have been few instances where DOJclearances are misplaced and kept in the MPSs central office or TB results are expired whichwere addressed immediately following the audit.


Direct the Chief Executive Officer in coordination with the Chief Academic Officer, toremind the Principals to ensure that established enrollment procedures are observed and thatall students attending the Charter Schools have all the necessary and completedocumentation that are reviewed and maintained on file.



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Charter School Comments:The management agreed with our recommendation and statedthat the Board of Directors will direct the Chief Executive Officer, in coordination with theChief Operating Officer, to remind the Principals to ensure that established enrollmentprocedures are observed and that all students attending the Charter Schools have all thenecessary and complete documentation that are reviewed and maintained on file. The target

date of implementation is August 31, 2012.


Direct the Chief Executive Officer, in coordination with the Chief Financial Officer, todisclose in the audited financial statements the relevant information about theorganizational relationship between the Charter Schools and the Magnolia Educational andResearch Foundation including the related party transactions.

Charter School Comments:The management agreed with our recommendation and stated

that the Board of Directors will direct the Chief Executive Officer, in coordination with theChief Financial Officer, to disclose in the audited financial statements the relevant informationabout the organizational relationship between the Charter Schools and the MERF, including therelated party transactions. The target date of implementation is August 31, 2012.


Direct the Chief Executive Officer in coordination with the Chief Financial Officer toensure that the fund balance/reserve will be maintained at the required reserve levelthroughout the year.

Instruct the Chief Executive Officer to establish effective policy and procedures to monitorand perform regular cash projections to ensure that cash balances were accurate, availableand the funds are not overspent.

Charter School Comments:The management agreed with our recommendation and statedthat the Board of Directors will direct the Chief Executive Officer, in coordination with theChief Financial Officer, to ensure that the fund balance/reserve will be maintained at therequired reserve level. In addition, the Board of Directors will instruct the Chief ExecutiveOfficer to enhance policies and procedures to better monitor and perform regular cashprojections to ensure that cash balances were accurate, available and the funds are notoverspent. The target date of implementation is September 30, 2012.


Direct the Chief Executive Officer, in coordination with the Chief Financial Officer, to:

o Be diligent in implementing the Generally Accepted Accounting Principles inrecording and reporting the financial transactions of the Charter Schools.



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o Provide adequate oversight to ensure that the Charter Schools shall comply with theaccounting procedures as stated in the approved Charter Agreement, the writtenpolicies and procedures and as required by law.

Charter School Comments: The management agreed with our recommendations. Followingthe audit, MPS management implemented additional controls over accounting procedures andhas taken number of actions to avoid any possible incompliance with generally acceptedaccounting principles in recording and reporting financial transactions of the Charter Schools.In addition, the Board will improve the oversight to ensure that the Charter Schools shall fullycomply with the accounting procedures as stated in the approved Charter Agreement, thewritten policies and procedures and as required by law. The target date of implementation isAugust 31, 2012.



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FINDING AND RECOMMENDATIONS

FINDING B: Internal Controls

For the Board of Directors, Magnolia Public Schools

BACKGROUND

Control Activities are the policies, procedures, techniques, and mechanisms that enforcemanagements directives. Transactions and other significant events should be authorized andexecuted only by persons acting within the scope of their authority. Authorizations should beclearly communicated to managers and employees. 14

Internal control and all transactions and other significant events need to be clearly documented,and the documentation should be readily available for examination. All documentation andrecords should be properly managed and maintained. 15

We obtained a copy of the Magnolia Foundation Schools Academic and Financial Policies andProcedures manual to determine whether the internal control system of the Charter Schools isin place. The financial policies and procedures were designed to provide guidance to theMagnolia Public Schools to systematically record, summarize, and report all the financialtransactions of the organization. The manual specified that The school Central Office isresponsible for the financial management of the school. The Principal/CFO must ensure that allprovisions of the manual and local board policies and procedures are complied with, that all

accounting records are maintained accurately, and that all financial reports are prepared andsubmitted in a timely manner. According to the CFO, the policies and procedures manual wascreated in 2008.

We also obtained documentation supporting the activities performed and the transactionsprocessed by the Magnolia Public Schools Central Office and the school staff to determinewhether the policies and procedures specified in the manual were followed in practice.

14Standards for Internal Control in the Federal Government, issued by the United States General Accounting Office, November

1999, p.1415Ibid, p.15



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DISCUSSION

This section discusses the following areas:

Cash Receipts and Deposits

Expenditures/Disbursements Bank Reconciliation Statements

General Journal Entries

Competency of Staff

Cash Receipts and Bank Deposits

The MSA Schools did not adequately monitor the cash receipts and deposits process. Severalaccounting errors and lack of supporting documentation were noted.

The written accounting policies and procedures manual states, All funds collected must bedeposited intact in a bank account. To minimize the risk of loss or theft, it is recommended thatbank deposits be made upon receipt but no later than seven days. Each bank deposit slip mustcontain the following information: i) the name of the school, ii) the bank account number, iii)the date the deposit slip was completed, iv) the total amount of cash included in the deposit, iv)the total amount of the deposit. Receipts should be adequately safeguarded and properlyrecorded on a timely basis using the account codes prescribed in the Chart of Accounts Avalidated bank deposit receipt should be retained for each bank deposit... As part of theprocedure, the Accountant counts the cash receipts and reviews the supporting documentation,Cash Receipts Summary, and deposit slip, then, indicates review on the cash receipts summary.

The Accountant makes the deposits and files the supporting documentation, Cash ReceiptSummary and validated bank deposit receipt by deposit date.

Test Work Performed

We reviewed the bank statements, deposit slips, general ledger and the audited financialstatements to determine whether the amounts recorded as receipts represent valid andauthorized transactions, were classified in the correct account, were accurately reported in theproper accounting period, and were properly presented and disclosed in the financialstatements.

During the audit, we noted the following conditions, as summarized in Table 5 below:



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Table 5

Summary of ExceptionsCash Receipts and Bank Deposits

July 1, 2010 to June 30, 2011

Conditions NotedNumber of

Exceptions

% vs. Total

SamplesAmount

Inadequate or missing documentation.Some depositswere recorded in the general ledger without the

supporting documents or source records (i.e. deposit

slips, photocopies of warrants, Cash Receipts

Summary, etc.)

MSA-1 (85 samples tested)



42

44

38

49%

64%

49%

$1,291,607.81

977,354.91

390,552.04

Double posting of deposit. The deposit was recorded

twice in the general ledger on 07/27/10. This amount

has remained a reconciling item as deposit in transit in

the bank reconciliation statement as of 06/30/11.

MSA-2 1 1% $23,665.69

Incorrect accounting entries for bounced checks. The

payments returned by the bank due to No Sufficient

Funds (NSF) were credited to the revenue account

instead of voiding the previously recorded bill

payments.

MSA-1

MSA-2

5

2

6%

5%

$13,359.90

60,090.34

Deposit transactions were not recorded in the proper

accounting period. Some deposits received in FY 2011

were not recorded in the general ledger. Further

analysis revealed that these deposits were for accrued

revenues that were recorded as Cash in Bank on

06/30/10 even though the funds had not beenreceived. The accrued revenues should have been

recorded as Accounts Receivable.

MSA-1

MSA-2

MSA-3

4

2

1

5%

3%

1%

$488,968.20

115,059.82

32,643.53

Lack of review and approval of deposit transactions.

There was no clear procedure for the review,

authorization and approval of the cash receipts and

deposits prior to recording to the general ledger.

MSA-1

MSA-2

MSA-3

83

53

73

98%

77%

94%

$4,024,384.53

1,439,540.58

1,508,450.33

These conditions occurred because (i) the Magnolia Public Schools Central Office improperlyrecorded some deposits in the wrong accounting period and account classification, (ii) thewritten policies and procedures were inadequate to implement effective controls over completeand accurate documentation of the cash receipts and deposits, and (iii) there was lack ofadequate oversight in recording and reporting the actual financial transactions of the MSASchools.



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As a result, there was an increased risk that (i) the cash reported in the audited financialstatements was inaccurate; (ii) the financial information was unreliable and inaccurate, and (iii)the reliability of management oversight is questionable.

We discuss the actions needed to correct these conditions in Recommendation B-1.

Expenditures/Disbursements

The expenditures/disbursements were not adequately documented to support payments forgoods or services and were not properly controlled.

The written accounting policies and procedures manual states, All disbursements must bemade by check or EFT. The check must be payable to the individual or vendor to whom thepayment is being made. Every check and check stub must be completely filled out at the timethe check is issued. The following procedures should be implemented to comply with statutoryrequirements and maintain adequate internal control over disbursements. 1) Purchase ordersshould be prepared for all school disbursements except for exempted items such as salaries andrelated costs, utilities, or where a contract exists. 2) Disbursements from authorized bankaccounts should be made with numbered checks. 3) Unused checks should be physicallysafeguarded and access to them limited to authorized personnel. California School AccountingManual (CSAM) is the main guide to identify the correct classification and listing of categoriesin the chart of accounts. Chart of Accounts is the list of accounts used to record financialtransactions including processing income and expenditures, processing asset purchases,recording loans or loan payments, etc. Expenditures are the regular payments from the schoolaccount that appropriate expense items are used. To process any expenditure, the followingitems should be filed: i) Proper invoice ii) Approval for the payment.

Test Work Performed

We reviewed the disbursements recorded in the general ledger for the period July 1, 2010through June 30, 2011 for each selected MSA School. We used statistical sampling todetermine the number of cash disbursements to be analyzed for testing: 46 samples out of 420disbursements for MSA-1, 46 out of 282 disbursements for MSA-2, and 43 out of 244disbursements for MSA-3.We determined whether the amounts recorded were valid andauthorized transactions, were classified in the correct account, and were supported by sufficientdocumentation.

During our review, we noted the following conditions, as summarized in Table 6 below:



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Table 6

Summary of ExceptionsExpenditures/Disbursements

July 1, 2010 to June 30, 2011

Conditions NotedNo. of

Exceptions

% vs. Total

SamplesTotal Amount

Incomplete or missing documentation. Supportingdocumentation such as purchase orders, invoices,

and receipts were not properly maintained. Some

payments were supported by photocopies of vendor

invoices or copy of electronic mail from the CFO.




8

13

19

17%

28%

44%

$184,201.83

58,127.16

90,402.61

Lack of proper review and approval. Some payments

did not indicate the appropriate review and approval

of authorized signatories. There was only one

signatory who approved the payments and signed

the checks.

MSA-1

MSA-2

MSA-3

9

24

22

20%

52%

51%

$109,741.81

126,640.71

150,535.74

Incorrect Account Code Used. Some disbursements

were not properly coded and classified in accordance

with the California School Accounting Manual (CSAM)

and the established chart of accounts.

MSA-1

MSA-2

MSA-3

11

8

8

24%

17%

19%

$74,948.58

66,864.49

13,284.35

Inadequate control of paid documents. Majority of

the invoices and supporting documentation were not

effectively identified with stamped PAID to preventduplicate payments.

MSA-1*

MSA-2

MSA-3

*In four instances, the MSA#1 made double paymentstovendors totaling to $43,565.18. The payments were

improperly supported by duplicate invoices or emails.

33

31

28

72%

67%

65%

$334,312.24

135,619.37

191,242.12

We also noted that there was no clear policy and procedure for payments processed through thewire transfer or Electronic Fund Transfer (EFT). The supporting documentation or the detailed

explanation as to the nature of the payments was deficient. In addition, there was a lack ofappropriate review and approval of the authorized signatories.

These conditions occurred because (i) the written policies and procedures were inadequate toimplement the effective processes and controls over the expenditures and disbursements, and(ii) there was a lack of management oversight to ensure that disbursements were valid,documented, accurately prepared, properly classified and authorized for payment in accordancewith the written policy and procedures and good business practices.



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As a result, there was an increased risk of inappropriate or unauthorized expenditures to remainundetected and a potential risk of fraud, abuse and misuse of public funds.


Reconciliation of Bank Statements

The processes and controls over the bank reconciliation were inadequate to ensure that thefunds of the organization were fully accounted for and that financial records were accurate andreliable. We found one Charter School that dated all reconciliations three days prior to thisaudit. We also noted that some deposits in transit remained outstanding in bank reconciliationsfrom five months to almost a year.

The written accounting policies and procedures manual states Every bank account must bereconciled monthly as soon as possible after the bank statements are received. Any differencesnoted between the balance reflected in the schools checkbook and the bank statement must beresolved immediately. After the bank reconciliations are completed, the bank statements are tobe signed by Accounting Manager.16

Good business practices suggest that reconciliations, verifications and analytical review offinancial records should be performed. Reconciliations involve the comparison of two sets ofaccounting records. For instance, the cash balances carried in the accounting records should bereconciled to bank statements. Amounts reported in the general ledger should be reconciled tothe subsidiary ledgers.

Test Work Performed

We reviewed all the monthly bank reconciliation statements for the FY 2011 to verify whetherthe bank statements were prepared timely. We also verified whether the bank statements andthe general ledger balances reconciled. Based on our examination of the bank reconciliationstatements provided by the Magnolia Public Schools Central Office staff, we noted thefollowing findings and observations:

For MSA#1 and MSA #2, the majority of the bank reconciliation statements were datedbetween three to six months after the end of the month. For MSA #3, all thereconciliation statements were dated three days prior to the start of this audit. As such,there was no assurance whether the bank account information provided to the auditors

were the same as that provided to the independent CPA firm.

The cash balances in the bank statements as compared to the general ledger did notreconcile, as shown in Table 7 below.

16 Magnolia Foundation Schools Academic and Financial Policies and Procedures, page 46, as of February 2012



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Table 7

Number of Unreconciled Cash Balances

Bank Reconciliations Statements vs. General Ledger

As of end of June 30, 2011

Name of Charter

School

Number of Instances

over the 12- monthperiod

Percentage of

Occurrence

MSA #1 12 100%

MSA #2 10 83%

MSA #3 * 0 N/A

* The bank reconciliation statements for MSA #3 were prepared

three days prior to this audit, therefore, the integrity of the

information was uncertain.

Some deposits-in-transit could not be traced to the subsequent bank statements, asshown in the table below. Deposits-in-transit are funds recorded in the general ledger,

and deposited to the banks, that have not yet been posted by the banks. These depositsare reflected in the general ledger, even if it may take the bank a few days to process thedeposits. As of June 30, 2011, we noted that some deposits in transit, as shown in Table8 below, had remained outstanding in bank reconciliations for a period of five monthsto almost a year. In addition, there was no supporting documentation or explanation toestablish the nature of the deposit transactions.

Table 8

List of Outstanding Deposits-in-Transit


Name of

Charter

School

Amount of

Deposits-in-

Transit

Date when deposits were

initially reflected in the

reconciliation statements

Number of

months

outstanding

Bank ReconciliationReviewed By

MSA #1 $ 1,955 12/31/10 6 Accounting Manager

3,282.85 01/31/11 5 Accounting Manager


Total $22,112.79

MSA #2 $ 490.00 07/31/10 11 Accounting Manager



Total $100,246.69

MSA #3* N/A

* All the bank reconciliation statements for MSA #3 were prepared three days prior to th is audit,

therefore, the integrity of the information was uncertain.

Some check payments dated 12 months and over were consistently carried forward inthe bank reconciliation statements as outstanding checks, as shown in the Table 9below. Apparently, there was no indication of a periodic inquiry or investigation todetermine why these checks remained as reconciling items in the bank reconciliationstatements, even after a considerable period of time.



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Table 9

List of Stale-dated/Outstanding Checks


Name of

Charter School

Check Issue

Date

Check

Number

Amount of

Check

Number of

months

outstandingMSA #1 4/27/2010 5375 $ 303.80 15

5/5/2010 5382 500.00 14

5/14/2010 5385 150.00 145/17/2010 5418 620.00 145/17/2010 5414 514.25 145/17/2010 5415 370.96 146/11/2010 5455 636.55 13

6/30/2010 5753 1,955.00 13

Total Amount $ 5,050.56

MSA #2 8/29/2008 GL# 13 1,779.76 34

8/29/2008 GL #14 1,555.59 34

9/4/2008 20043 307.37 3312/9/2009 20537 190.00 20

12/9/2009 20536 87.00 20

1/12/2010 20585 105.00 19

5/5/2010 20567 500.00 14

7/20/2010 20720 100.00 11

7/20/2010 20715 17.99 11

7/31/2010 EFT 27,256.45 11

Total Amount $31,899.16

MSA #3 2/5/2009 30200 29.53 29

6/22/2009 30329 1,250.00 25

10/15/2009 30397 50.00 21

11/2/2009 30399 76.00 204/30/2010 DB 169.00 14

5/5/2010 30492 500.00 14

6/29/2010 30512 820.00 13

6/30/2010 0.26 13

Total Amount $2,894.79

These conditions occurred because (i) there was a lack of effective policies and procedures forthe bank reconciliation process, (ii) the reconciling items such as, deposits in transit andoutstanding checks were not appropriately resolved by the Magnolia Public Schools CentralOffice accounting staff in a timely manner, and (iii) there was a lack of management oversightover the bank reconciliations process resulting in inaccurate reconciliation statements beingsigned off by the Accounting Manager in numerous cases.

As a result, there was an increased risk of misstated financial reports and undetected loss ofassets and a higher risk of fraud.




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General Journal Entry

The Magnolia Public Schools Central Office did not have effective processes and controls overthe journal accounting entries recorded in the general ledger.

The written accounting policies and procedures manual states, Each posting must include thefollowing: the date of the transaction; receipt or check number listed in numeric order, name ofpayer or payee; and individual account(s) for which the collection or disbursement was made.A cash control/balance column must be maintained to reflect the cash balance available at anytime in the fund. If errors are found to exist, they must be identified and corrected as soon aspossible by using correcting journal entries. Make the necessary journal entries and include abrief explanation of why the adjusting entries are made.17

Best practices suggest that the accounting staff generates a report at month-end from thegeneral ledger system of all journal entries recorded in the period. The report will be reviewed

and approved by a supervisory level employee who does not have access to record transactionsin the system.

Test Work Performed

We reviewed the journal entries recorded in the general ledger of the MSA Schools andselected the journal entries for testing. We reviewed the nature of the journal entry transactionsand determined the completeness of documentation. Based on our review, we noted thefollowing:

The journal entries did not have the underlying evidence and documentation to support the

entries or a clear description explaining the nature of the transactions.

The Magnolia Public Schools Central Office staff could not provide a copy of the GeneralJournal Entry Report as of the end of the accounting period. According to the FinanceManager, the Magnolia Public Schools Central Office was not creating periodic reports ofjournal entries recorded in the general ledger since the posted transactions were accessiblein the accounting system.

The Magnolia Public Schools Central Office lacked an effective process to ensure that thejournal entries were properly reviewed and approved prior to posting to the general ledger.

These conditions occurred because written policies and procedures were not in place to ensurethat all journal entries were properly prepared, supported with descriptions and documentation,and reviewed and approved by a designated person with authority prior to recording in thegeneral ledger.

As a result, (i) there was an increased likelihood of questionable and unjustified accountingentries, (ii) the financial statements may be misstated, and (iii) the failure to implement

17Magnolia Foundation Schools Academic and Financial Policies and Procedures, page 44, as of February 2012



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effective processes and procedures over journal entry transactions increased the potential risksof fraud, abuse and misuse of funds.


Competency of Staff

The Magnolia Public Schools Central Office accounting staff lacked adequate competency andtraining necessary for the proper accounting and reporting of the financial transactions of theCharter Schools.

The United States General Accounting Office Standards for Internal Control in the FederalGovernment states, A positive control environment is the foundation for all other standards. Itprovides discipline and structure as well as the climate which influences the quality of internalcontrol. Several key factors affect the control environment.

One key factor is the managements commitment to competence. All personnel need to possessand maintain a level of competence that allows them to accomplish their assigned duties, aswell as understand the importance of developing and implementing good internal control.Management needs to identify appropriate knowledge and skills needed for various jobs andprovide needed training, as well as candid and constructive counseling, and performanceappraisals. 18

Test Work Performed

During our review of the accounting records and the activities performed by the Magnolia

Public Schools Central Office staff, we noted several deficiencies in the manner the accountingstaff processed and maintained the financial transactions:

Accounting records were not properly recorded and maintained, such as:

o Some bounced checks (No Sufficient Fund) were recorded as deposits andrevenues.

o Some transactions were misclassified to the incorrect account code (i.e. Dues andMembership instead of Professional/Consulting Services, Travel and Conferencesinstead of Rentals and Leases, Travel and Conferences instead of Employee

Benefits.)

o Some transactions were not recorded in the proper accounting period (i.e. FY 2010liabilities recorded in FY 2011, FY 2011 deposits recorded in FY 2010.)

18Standards for Internal Control in the Federal Government, issued by the United States General Accounting Office, page 8,November 1999.



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o Some checks and EFT payments were processed based on copies of electronic mail,statement of accounts, duplicate invoice, etc. which resulted in a number ofduplicate payments.

o Some accounting records and reports were not completely maintained (i.e.

transaction journals not printed and filed, deposits records on file were incomplete.)

The Magnolia Public Schools Central Office management and staff did not strictly observethe policies and procedures for authorization and approval of transactions (i.e. journalentries, disbursements, cash receipts/deposits, bank reconciliation statements).

These conditions occurred because i) the responsibilities for the accounting of financialtransactions and records were not clearly defined, ii) the Magnolia Public Schools CentralOffice staff lacked adequate training and proficiency in the use of the accounting system,including the proper use of the chart of accounts, and iii) there was inadequate supervision andguidance of staff.

As a result, the failure to assign competent and adequately trained staff to carry out the fiscaland accounting responsibilities of the organization increased the risk of unreliable financialrecords. This could also result in reduced credibility of the financial statements due to errors inprocessing and reporting of accounting transactions.




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RECOMMENDATIONS AND COMMENTS

Recommendation B-1: The Board of Directors of the Magnolia Public Schools should:

Direct the Chief Executive Officer, in coordination with the Chief Financial Officer to:

o Ensure that cash receipts and bank deposits are reconciled, reviewed and adequatelysupported with appropriate documentation and source records prior to processingand recording in the general ledger.

o Update and enhance the cash receipt and deposit processes to include the clearassignment of responsibilities, documentation and record retention, recording andreconciliation, and the review, authorization and approval procedures.

o Provide adequate oversight over the cash receipts and bank deposits to ensure thatoperational procedures and internal controls provide adequate assurance that

authorized transactions are processed completely and accurately in a timely manner.

Charter School Comments:The management agreed with our recommendation. Followingthe audit, the Chief Executive Officer, in coordination with the Chief Financial Officer,implemented additional controls regarding the cash receipts and deposit processes. The ChiefExecutive Officer and the Chief Financial Officer are working collaboratively to ensure that allcash receipts and bank deposits are reviewed and adequately supported with appropriatedocumentation and source records prior to processing and recording in the general ledger. Also,the written policies and procedures will be updated to include job descriptions, documentationand record retention, recording and reconciliation, and the review, authorization and approvalprocedures. In addition, the Board will instruct the Chief Executive Officer to provide adequate

oversight over the cash receipts and bank deposits to ensure that operational procedures andinternal controls provide assurance that authorized transactions are processed completely andaccurately in a timely manner. The target date of implementation is September 30, 2012.

Recommendation B-2: The Board of Directors of Magnolia Public Schools should:

Instruct the Chief Executive Officer, in coordination with the Chief Financial Officer to:

o Ensure that purchases/expenditures are authorized, approved and adequatelysupported with pertinent documents and source records prior to processing of the

payment. Also, the approver should review all documentation before signing thechecks to ensure that the transactions actually occurred, and are recorded in thegeneral ledger for the correct amount, to the appropriate account code, in the properaccounting period.

o Update and enhance the policies and procedures over the purchasing anddisbursement processes to include the clear assignment of responsibilities,



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appropriate documentation and record retention, proper review and reconciliation,and authorization and approval procedures.

o Strengthen policies and procedures over the EFT transactions by providing adequatecontrols to ensure that EFT payments are limited to immediate or emergency

situations only.

o Provide adequate oversight and enforcement of controls over the expenditures anddisbursement to ensure that operational procedures and internal controls are workingeffectively.

Charter School Comments: The management agreed with our recommendation. Followingthe audit, the Chief Executive Officer, in coordination with the Chief Financial Officer,implemented additional controls regarding the expenditures and the payments processedthrough the electronic fund transfers (EFT). MPS management has utilized a software(CoolSIS) to ensure that all purchases/expenditures are properly authorized, approved andadequately supported with pertinent documents and source records prior to processing of thepayment. In addition, the Chief Executive Officer, in coordination with the Chief FinancialOfficer will i) update and enhance the policies and procedures over the purchasing anddisbursement processes to include the clear assignment of responsibilities, appropriatedocumentation and record retention, proper review and reconciliation, and authorization andapproval procedures, ii) strengthen policies and procedures over the EFT transactions byproviding adequate controls to ensure that EFT payments are limited to immediate oremergency situations only. In addition, the Board will provide adequate oversight andenforcement of controls over the expenditures. The target date of implementation is September30, 2012.


Remind the Chief Executive Officer, in coordination with the Chief Financial Officer to:

o Ensure that monthly bank reconciliation statements are prepared, matched to thebalances of the general ledger, and compared to the accounting records to validatethat the payments and receipts are fully accounted for.

o Ensure that the reconciling items in the bank reconciliation statements are identified,investigated and explained and the corrective action are taken appropriately.

o Ensure that the bank reconciliation statements are reviewed for accuracy,completeness and timeliness by someone who has authority or supervisory role, andis able to authorize, provide direction to the staff, and make decisions about theitems under review. The evidence of review and approval should be documented,signed or initialed, and dated by the reviewer/approver.

o Provide adequate oversight and enforcement of controls over the bank reconciliationstatements.



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Charter School Comments: The management agreed with our recommendation. Followingthe audit, the Chief Executive Officer, in coordination with the Chief Financial Officer, hasimplemented controls regarding the bank reconciliation processes. In addition, the Board willprovide adequate oversight and controls over the bank reconciliation statements. The Chief

Executive Officer and the Chief Financial Officer will work collaboratively to: i) ensure thatmonthly bank reconciliation statements are reviewed, matched to the balances of the generalledger, and compared to the accounting records to validate that the payments and receipts arefully accounted for, ii) ensure that the reconciling items in the bank reconciliation statementsare identified, investigated and explained and the corrective action are taken appropriately, iii)ensure that the bank reconciliation statements are reviewed for accuracy, completeness andtimeliness by someone who has authority or supervisory role, and is able to authorize, providedirection to the staff, and make decisions about the items under review. The evidence ofreview and approval will be documented, signed or initialed, and dated by thereviewer/approver. The target date of implementation is August 31, 2012.


Direct the Chief Executive Officer, in coordination with the Chief Financial Officer to:

o Develop effective policies and procedures to ensure that all journal entries areaccurately prepared, adequately supported with explanation for the entry andevidenced by proper review and approval of an authorized signatory prior torecording in the general ledger.

o Ensure that the accounting staff is trained on how to effectively process the journalaccounting entries. The staff should generate a report, at month-end, of all journalentries recorded in the period, for review and approval by a supervisory levelemployee who does not have access to recording transactions in the general ledgersystem.

o Ensure that the general journal entry reports are printed and retained on fileespecially at the end of the fiscal year.

o Provide adequate oversight and enforcement of controls over the use of generaljournal entries.

Charter School Comments:The management agreed with our recommendation and statedthat the Board of