Audit Report

Magnolia Science Academy-
Charter Schools















OA 12 – 486 August 20, 2012

Los Angeles Unified School District
Office of the Inspector General
Internal Audit








August 20, 2012


Dr. Mehmet Argin
Chief Executive Officer
Magnolia Public Schools
13950 Milton Avenue, Suite 200B
Westminster, CA 92683

Dear Dr. Argin:

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

These are the report’s key sections:

 The Executive Summary describes the scope of the audit and provides an overview of what
we audited and found.

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

 Appendix A is a summary of questioned costs identified in this audit. Appendix B is a
summary of questionable accounting practices. Annex A contains your verbatim comments
on our recommendations. Annex B lists other receiving copies of the report. Annex C lists
the 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
th
Floor, Los Angeles, California 90017
Telephone: (213) 241-7700 Fax: (213) 241-6826
Los Angeles City Board of Education
Office of the Inspector General


Mónica García, President
Tamar Galatzan
Bennett Kayser
Marguerite Poindexter LaMotte
Nury Martinez
Richard A. Vladovic
Steve Zimmer
Members of the Board

John E. Deasy, Ph.D
Superintendent of Schools

Alfred Rodas
I nspector General, I nterim























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 District
operations, 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 the
Superintendent in their efforts to provide a high quality education for the
students and parents of the Los Angeles Unified School District.



Why did the OIG do this audit?

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


What was the main objective?

To evaluate whether the Board of Directors and management of Magnolia Science Academy
Charter 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 the
public trust




Areas requiring attention and what the District should do next are discussed
briefly in the Executive Summary of this report.







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


1


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 Science
Academy-1, Magnolia Science Academy-2 and Magnolia Science Academy-3. The MSA
Schools are part of twelve Magnolia Public Schools (MPS) operated by the Magnolia
Educational and Research Foundation (MERF). The MSA Schools are located in Los Angeles,
California and serve students from sixth grade through twelfth grade. The Magnolia Public
Schools Central Office executes the decisions and policies set by the Magnolia Public Schools
Board of Directors (aka Magnolia Education and Research Foundation Board) and manages the
business operations of the Magnolia Public Schools.

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

Magnolia Public Schools
Board of Directors
(aka Magnolia Educational
and Research Foundation
Board)

Magnolia Public Schools
Central Office


Chief Executive
Officer

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 Schools
Organization Chart


This audit was part of the Annual Work Plan of the Office of the Inspector General for fiscal
year 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 the
Magnolia Public Schools Central Office were adhering to the conditions, standards and
procedures outlined in its Charter Agreement with the Los Angeles Unified School District

2

(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 Findings

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 their oversight of fiscal and
financial 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 the
increased participation of parents, community members and other parties in the Charter
Schools’ policy decision areas and other school advocacy.

 The MSA Schools did not maintain all employment documentation in the employee
files 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 of
related party transactions; failure to maintain required fund reserves; failure to
appropriately apply accrual basis of accounting; lack of monitoring of cash receipts and
deposits process; lack of documentation for disbursements; lack of control over journal
entries, and lack of adequate training for the accounting staff.

 The processes and controls over the bank reconciliation were inadequate. We found one
Charter School that dated all reconciliations three days prior to this audit. We also noted
that 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, employment
documentation and qualifications of staff, admission/enrollment requirements and various
financial control issues managed by the Magnolia Public Schools Central Office at the MSA
School sites visited. The information provided in this report should benefit the MSA Charter
Schools to significantly improve their internal control system as well as its oversight of fiscal
and financial operations. We believe that the Magnolia Public Schools Board of Directors

3

should revisit the provisions of the approved charter petition to preclude potential violations of
the 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 the
risk of fraud, waste and abuse of the MSA Charter Schools’ funds that could potentially result
from the inability to detect irregularities, improper use of public funds or misappropriation of
assets. Also, the questioned costs and questionable accounting practices identified in the course
of the audit may have resulted in misstated and inaccurate financial statements of the MSA
Charter Schools.

What The Board of Directors of Magnolia Public Schools Should Do Next:

Summary of Key Recommendations

We provided the Magnolia Public Schools’ Board of Directors with eleven recommendations to
ensure full compliance with the Charter Agreement and to enhance the current internal controls
system. 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 increased
participation of parents, community members and other parties in the policy decision
areas and other school advocacy.

 Enhance controls over employee qualifications and documentation requirements.

 Enhance controls over the established enrollment procedures and maintenance of
required student records.

 Ensure that all related party transactions are disclosed in the financial statements,
required fund reserve is maintained, cash balances are properly controlled, bank
reconciliations are timely completed, proper documentation is maintained for all
disbursements, journal entries are adequately supported and in general, the Generally
Accepted 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 our
findings and stated that they have already taken some corrective actions and plan to take further
actions in the future to ensure that OIG recommendations are adequately and timely
implemented.


4

Inspector General Response: Management’s response to our audit findings and
recommendations indicate an understanding of the issues presented. We consider
management’s planned actions to be constructive steps towards improving the processes
reviewed in this audit.

Scope & Methodology

We conducted this audit 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. The audit covered the activities for the
period from July 1, 2010 through June 30, 2011. In order to address the audit objectives, we
performed 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 the
Magnolia Public Schools’ Charter Agreement with the District.

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

 Reviewed the existing accounting policies and procedures to assess the design and
operational 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 School’s governance structure.

 Reviewed the employment documentation for compliance with the Charter Agreements
and applicable laws.

 Obtained the enrollment procedures and assess the completeness of enrollment
requirements.

 Assessed the sufficiency of the available fund reserves.

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


5


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 organization
founded in 1997 (under the name Dialog Foundation) and was granted a 501(c) (3) tax-exempt
status by the Internal Revenue Service in 1998. The first charter school, Magnolia Science
Academy 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 Public
Schools. The Los Angeles Unified School District (“LAUSD” or “District) has currently
authorized 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 Angeles
County. The MSA-San Diego was authorized by the San Diego Unified School District, the
MSA-Santa Clara was authorized by the Santa Clara County Office of Education, and both the
Pacific Technology School (PTS)-Santa Ana (Orange County) and PTS-Orange Vale (El
Dorado County) were authorized by the State Board of Education.

The MERF’s 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 and
understanding to participate and work productively in a diverse, multicultural, globally
oriented 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 on
preparing students to attend the universities of their choice.

The student population represents the demographics of the local communities where the
students reside, which are primarily in the metropolitan areas of Los Angeles, and other
metropolitan areas throughout the state. MERF specifically targets low-achieving students,
English language learners, and students coming from socio-economically disadvantaged
families.

Organizational Structure

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

6

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

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

Exhibit 1
1
below 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
Magnolia Public Schools
Organization Chart


The Board appointed the Magnolia Public Schools Central Office to execute the decisions and
policies set by the Board and to manage the business operations of the Magnolia Public
Schools. Currently, the headquarters of the Magnolia Public Schools Central Office is located
at 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 limited
to (i) Overseeing Magnolia Public Schools’ operations to ensure compliance with the charter
agreements, (ii) Curriculum development, (iii) Hiring school principals, (iv) Payroll, (v)
Purchasing, (vi) Budgeting, (vii) Annual audit, (viii) Community outreach, and (ix) Public
relations.



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

7

DISCUSSION

This section discusses the following areas:

 Governance Structure
 Employment Documentation/Qualifications of Staff
 Admission/Enrollment Requirements
 Financial Audit
 Fund Reserves
 Basis of Accounting


Governance Structure

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 Charter
School’s policy decision areas and other school advocacy.

The California Code of Regulations states that the required elements of the charter petition
should include “The governance structure of the school, including, but not limited to, the
process to be followed by the school to ensure parental involvement in supporting the school's
effort 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 is
entitled 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 Schools’
operation and governance. The Magnolia Public Schools Central Office was appointed by the
Board 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 the
management are responsible for carrying out the Board’s policy decisions and for managing the
school operations. They are to establish and maintain an effective internal control system,
ensuring that the Charter Schools meet appropriate goals and objectives, safeguards public
assets, follows laws and regulations and reports reliable financial information.

The Magnolia Public Schools Central Office, headed by the CEO, manages all the business
activities of the Charter Schools and is responsible for the (i) curriculum development, (ii)
hiring of principals, (iii) financial operations such as budgeting, payroll, procurement and
accounting, and (iii) ensuring compliance with the charter agreement and applicable state and
federal laws and regulations.

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



8

 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 will
communicate these policies to the Magnolia Public Schools Central Office.

Test Work Performed

We performed the following procedures to determine the adequacy of the Charter Schools’
governance structure:

(1) Assessed the Board’s composition and qualifications in terms of the Charter Agreement,
(2) Reviewed Magnolia Public School articles of incorporation and bylaws,
(3) Evaluated the organization’s 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 Charter’s 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 Research
Foundation Board), governs and exercises oversight over the school and fiscal operations of all
the twelve Magnolia Public Schools. The Charter Agreements state that Board meetings are to
be 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 were
convened in the evening.

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

 The Board was comprised of seven (7) voting members, including one parent
representative. Although there were eight District authorized charter schools, the parent
member 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 noted
that the Council met once or twice in a year. We also observed that some of the Council
meetings were not well represented by the parents and other council members.

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



9

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

 A lack of awareness for parents and community representatives especially involving
decisions 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 as
required by the California Education Code and the Charter Agreements.

The California Education Code, Sections 44237
2
, 47605 (5) (E) and (F)
3
and 49406
4
and the
Charter Agreement require that school employees furnish the school with the following
documents 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 record
check. Applicants will be required to provide a full disclosure statement regarding prior
criminal 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 for
inspection.

Best practices suggest that a good employee file system helps maintain the organizational
structure, as well as a protection for both the employer and the employee. By compiling the
necessary and complete employee documentation, the employer may (i) make decisions and
take actions based on the organization’s personnel policies, (ii) establish defense against legal
action/s brought by employee/s, (iii) be prepared for a government audit related to tax or
immigration 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 determine
whether the folders contained the required employment documentation. Table 1 below
summarizes the missing documents at each school site.


2
California Education Code, Section 44237, Part 25 - Employees, Chapter 2/Article 2 - Teacher Credentialing
3
Ibid, Section 47605 (5) (E) and (F), Part 26.8 - Charter Schools, Chapter 2 - Establishment of Charter Schools
4
Ibid, Section 49406 (a) and (b), Part 27-Pupils, Chapter 9 – Pupil and Personnel Health

10

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 9
DOJ Clearance/Fingerprinting 2 4 1 7
Current Teacher’s 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 supporting
documentation on file showed that four employees were permitted to work before
receiving a DOJ clearance.
 One employee had an expired teacher’s credential certificate.

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

These conditions occurred because (i) the MSA Schools overlooked the requirement to obtain
and maintain the necessary employment documentation from new hires and from employees
who were currently employed, and (ii) there was inadequate management and control of the
employee 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 protected
should lawsuits arise, and (ii) have compromised the health and safety of the students and
employees.

We discuss the actions needed to correct these conditions in Recommendation A-2.


Admission/Enrollment Requirements

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

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

11

for admission will be given to siblings of existing students. Then a public lottery is held to
select 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 following
documentation 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 September
2010 from each of the MSA Schools. From the list, we determined the sample size of the
students’ files to be tested using a computer assisted statistical sampling plan. Based on the
sampling results, a total of 45 students were selected for detailed testing: 15 out of 496 students
from 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 were
compliant with the established enrollment policies and procedures. Based on our review, we
noted that the MSA Schools did not maintain all the enrollment documentation, as shown in
Table 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


12

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

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

We discuss the actions needed to correct these conditions in Recommendation A-3.


Financial Audit

The audited financial statements did not adequately disclose the organizational relationship
between the MSA Schools and the Magnolia Educational and Research Foundation, including
its related party loan transactions.

The California Schools Accounting Manual (CSAM) states, “Not-for-profit charter schools
approved under Education Code Section 47604 that operate as or are operated by a nonprofit
public benefit corporation pursuant to Section 501(c) (3) of the Internal Revenue Code
typically use the not-for-profit accounting model and the accrual basis of accounting. The
authoritative 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 disclosure
requirements for related party relationships and transactions. Certain relationships, such as
parent-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 parties
include: i) borrowing or lending on an interest-free basis or at a rate of interest significantly
above or below market rates prevailing at the time of the transaction, and ii) making loans with
no 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 to
include disclosure notes for some financial statement elements. Also, other information is
provided when required by specific situations in the interest of full disclosure. As such, the
existence of material related party transactions that could affect the financial statements and of
common 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, 2010
and June 30, 2011, and noted the following:

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

6
Generally Accepted Auditing Standards, AU 334.03 Related Party
7
Ibid, AU 334.04

13


 The organizational relationship between the Magnolia Educational and Research
Foundation and the MSA Schools was not disclosed in the audited financial statements.
During the course of the audit, we noted that the MSA School’s bank deposit accounts were
under the name of the Magnolia Educational and Research Foundation, as well as the
employer’s name and the identification number on the payroll tax remittances. We were
informed by the Chief Financial Officer that the Magnolia Educational and Research
Foundation 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 the
subsidiaries of the Magnolia Educational and Research Foundation.

 The Audited Financial Statements of MSA #1 for FY 2011 clearly showed a substantial
balance in the “Other Assets-Loans Receivable-related party” amounting to $322,509. On
the contrary, the “Cash and cash equivalents” had a zero balance. Further analysis of the
general ledger and the bank statements revealed that on several occasions, the Magnolia
Educational 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 Agreement
dated 06/30/11 issued by the Magnolia Educational and Research Foundation for the
remaining balance of the loan. We noted that there was no definite time of repayment and
the loan was interest-free.

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

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

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

We discuss the actions needed to correct these conditions in Recommendation A-4.








14

Fund Reserves

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

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

a) the greater of 5% or $55,000 for districts with 0-300 ADA
b) 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 will
at 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 total
operational expenditures.
9



The Charter School Annual Performance Evaluation criteria indicates that an existing school
shall 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 the
cash 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 the
MSA#1 and MSA# 3 had zero cash balances in the bank. Based on our analysis, the MSA
Schools 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)



8
California Code of Regulations, Title 5, Division 1, Chapter 14, Subchapter 8, Article 1, Section 15450
9
Innovation and Charter Schools Division, Boiler Plate for Charter School Petitions, 2008


15

It appeared that the MSA Schools did not retain a sufficient amount of fund reserves for the
incoming fiscal year 2012. Particularly, the MSA #1 disbursed a considerable amount of related
party loan payments to the Magnolia Educational and Research Foundation without setting
aside a fund reserve for the school. As of June 30, 2011, the MSA #1 had an outstanding loans
receivable 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 adequate
cash balances throughout the year,

ii) The Magnolia Public Schools Board and the executive management were not
conscientious in addressing the MSA Schools’ budgetary objectives including funding
priorities, 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 financial
stability of the schools against unforeseen revenue shortfalls or unexpected expenditures.

We discuss the actions needed to correct these conditions in Recommendation A-5.


Basis of Accounting

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

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


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


10
California School Accounting Manual, Procedure 810-1, March 2008
11
California School Accounting Manual, Procedure 101-1, July 2005
12
Magnolia Science Academy Charter Agreement, Additional Requirements 2: Financial and Budget Matters-Fiscal
Management, January 31, 2007


16


The written financial policies and procedures manual also states, “The Magnolia Public
Schools Central Office is responsible for the financial management of the school. The
Principal/CFO must ensure that all provisions 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 and submitted in a timely manner. MSA/PTS schools are to
maintain its accounting records on the accrual basis of accounting, modified at year end to
reflect any receivables or payables that may exist. Revenues and expenditures are to be
recognized when the transaction has occurred.”
13
As such, revenues and expenses are recorded
using the accrual basis of accounting and requires that revenues are recognized in the
accounting period in which they are earned and expenses are recognized in the period in which
goods 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 the
accounting period. During our audit, we noted the following conditions:

 The Magnolia Public Schools Central Office was unable to provide supporting
schedules or analysis to back-up the accrued revenues reflected in the general ledger as
of 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 of
expenditures, we found that some expenses were not reported in the appropriate
accounting 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.
















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

17


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 fully
observe 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 the
organization’s liabilities and expenses and increased the risk that the financial information was
inaccurate and unreliable.

We discuss the actions needed to correct these conditions in Recommendation A-6.










Name of
School
Nature of Expenses
Period the
Expenses were
Incurred
Amount
Date Recorded as
Expenses
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
Total Amount of Expenses $81,119.01
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
Total Amount of Expenses $61,989.72

18


RECOMMENDATIONS AND COMMENTS

Recommendation A-1: The Board of Directors of the Magnolia Public Schools is encouraged
to 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, behaves
in an ethical manner, and does not waste the resources trusted in its care.

Charter School Comments: The management agreed with our recommendation and stated
that the Board of Directors will 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. It will be discussed during the August, 2012 board meeting
and 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 individuals
employed by the school meet the required qualifications and that all required and necessary
employment documentation is maintained in the employee files.

 Instruct the Chief Executive Officer to improve the oversight over the employee files
system.

Charter School Comments: The management agreed with our recommendation. Following
the audit, MPS management implemented additional controls to ensure that individuals
employed by the schools met the required qualifications and that all required and necessary
employment documentation is maintained in the employee files. In addition, MPS management
has created Chief Operating Officer position to enhance the internal control and further
improve the oversight over the employee files system. However, we would like to note that all
MPS employees are asked to provide DOJ clearances, TB test results and teaching credentials
(for teachers). MPS will make sure that all required employment documentations and
qualifications are met prior to employment. There may have been few instances where DOJ
clearances are misplaced and kept in the MPS’s central office or TB results are expired which
were addressed immediately following the audit.


Recommendation A-3: The Board of Directors of Magnolia Public Schools should:

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



19

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 the
Chief Operating Officer, to remind the Principals to ensure that established enrollment
procedures are observed and that all students attending the Charter Schools have all the
necessary and complete documentation that are reviewed and maintained on file. The target
date of implementation is August 31, 2012.


Recommendation A-4: The Board of Directors of Magnolia Public Schools should:

 Direct the Chief Executive Officer, in coordination with the Chief Financial Officer, to
disclose in the audited financial statements the relevant information about the
organizational relationship between the Charter Schools and the Magnolia Educational and
Research 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 the
Chief Financial Officer, to disclose in the audited financial statements the relevant information
about the organizational relationship between the Charter Schools and the MERF, including the
related party transactions. The target date of implementation is August 31, 2012.


Recommendation A-5: The Board of Directors of Magnolia Public Schools should:

 Direct the Chief Executive Officer in coordination with the Chief Financial Officer to
ensure that the fund balance/reserve will be maintained at the required reserve level
throughout the year.

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

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 the
Chief Financial Officer, to ensure that the fund balance/reserve will be maintained at the
required reserve level. In addition, the Board of Directors will instruct the Chief Executive
Officer to enhance policies and procedures to better monitor and perform regular cash
projections to ensure that cash balances were accurate, available and the funds are not
overspent. The target date of implementation is September 30, 2012.


Recommendation A-6: The Board of Directors of Magnolia Public Schools should:

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

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

20


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

Charter School Comments: The management agreed with our recommendations. Following
the audit, MPS management implemented additional controls over accounting procedures and
has taken number of actions to avoid any possible incompliance with generally accepted
accounting 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 fully
comply with the accounting procedures as stated in the approved Charter Agreement, the
written policies and procedures and as required by law. The target date of implementation is
August 31, 2012.

































21


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 enforce
management’s directives. Transactions and other significant events should be authorized and
executed only by persons acting within the scope of their authority. Authorizations should be
clearly 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 and
records should be properly managed and maintained.
15


We obtained a copy of the “Magnolia Foundation Schools Academic and Financial Policies and
Procedures” manual to determine whether the internal control system of the Charter Schools is
in place. The financial policies and procedures were designed to provide guidance to the
Magnolia Public Schools to systematically record, summarize, and report all the financial
transactions of the organization. The manual specified that “The school Central Office is
responsible for the financial management of the school. The Principal/CFO must ensure that all
provisions 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 and
submitted in a timely manner”. According to the CFO, the policies and procedures manual was
created in 2008.

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









14
Standards for Internal Control in the Federal Government, issued by the United States General Accounting Office, November
1999, p.14
15
Ibid, p.15

22

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. Several
accounting errors and lack of supporting documentation were noted.

The written accounting policies and procedures manual states, “All funds collected must be
deposited intact in a bank account. To minimize the risk of loss or theft, it is recommended that
bank deposits be made upon receipt but no later than seven days. Each bank deposit slip must
contain 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 properly
recorded on a timely basis using the account codes prescribed in the Chart of Accounts… A
validated bank deposit receipt should be retained for each bank deposit... As part of the
procedure, 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 Receipt
Summary and validated bank deposit receipt by deposit date.”


Test Work Performed

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

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








23

Table 5
Summary of Exceptions – Cash Receipts and Bank Deposits
July 1, 2010 to June 30, 2011

Conditions Noted
Number of
Exceptions
% vs. Total
Samples
Amount
Inadequate or missing documentation. Some deposits
were 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)
MSA-2 (69 samples tested)
MSA-3 (78 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 been
received. 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 improperly
recorded some deposits in the wrong accounting period and account classification, (ii) the
written policies and procedures were inadequate to implement effective controls over complete
and accurate documentation of the cash receipts and deposits, and (iii) there was lack of
adequate oversight in recording and reporting the actual financial transactions of the MSA
Schools.


24

As a result, there was an increased risk that (i) the cash reported in the audited financial
statements 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 for
goods or services and were not properly controlled.

The written accounting policies and procedures manual states, “All disbursements must be
made by check or EFT. The check must be payable to the individual or vendor to whom the
payment is being made. Every check and check stub must be completely filled out at the time
the check is issued. The following procedures should be implemented to comply with statutory
requirements and maintain adequate internal control over disbursements. 1) Purchase orders
should be prepared for all school disbursements except for exempted items such as salaries and
related costs, utilities, or where a contract exists. 2) Disbursements from authorized bank
accounts should be made with numbered checks. 3) Unused checks should be physically
safeguarded and access to them limited to authorized personnel. California School Accounting
Manual (CSAM) is the main guide to identify the correct classification and listing of categories
in the chart of accounts. Chart of Accounts is the list of accounts used to record financial
transactions including processing income and expenditures, processing asset purchases,
recording loans or loan payments, etc. Expenditures are the regular payments from the school
account that appropriate expense items are used. To process any expenditure, the following
items 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, 2010
through June 30, 2011 for each selected MSA School. We used statistical sampling to
determine the number of cash disbursements to be analyzed for testing: 46 samples out of 420
disbursements for MSA-1, 46 out of 282 disbursements for MSA-2, and 43 out of 244
disbursements for MSA-3.We determined whether the amounts recorded were valid and
authorized transactions, were classified in the correct account, and were supported by sufficient
documentation.

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








25

Table 6
Summary of Exceptions – Expenditures/Disbursements
July 1, 2010 to June 30, 2011

Conditions Noted
No. of
Exceptions
% vs. Total
Samples
Total Amount
Incomplete or missing documentation. Supporting
documentation 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.
MSA-1 (46 samples tested)
MSA-2 (46 samples tested)
MSA-3 (43 samples tested)





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 prevent
duplicate payments.
MSA-1*
MSA-2
MSA-3
*In four instances, the MSA#1 made double payments to
vendors 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 the
wire 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 of
appropriate review and approval of the authorized signatories.

These conditions occurred because (i) the written policies and procedures were inadequate to
implement 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 accordance
with the written policy and procedures and good business practices.


26

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

We discuss the actions needed to correct these conditions in Recommendation B-2.


Reconciliation of Bank Statements

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

The written accounting policies and procedures manual states “Every bank account must be
reconciled monthly as soon as possible after the bank statements are received. Any differences
noted between the balance reflected in the school’s checkbook and the bank statement must be
resolved immediately. After the bank reconciliations are completed, the bank statements are to
be signed by Accounting Manager.”
16


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

Test Work Performed

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

 For MSA#1 and MSA #2, the majority of the bank reconciliation statements were dated
between three to six months after the end of the month. For MSA #3, all the
reconciliation 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 not
reconcile, as shown in Table 7 below.




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

27

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- month
period
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, as
shown 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 deposits
are reflected in the general ledger, even if it may take the bank a few days to process the
deposits. As of June 30, 2011, we noted that some deposits in transit, as shown in Table
8 below, had remained outstanding in bank reconciliations for a period of five months
to almost a year. In addition, there was no supporting documentation or explanation to
establish the nature of the deposit transactions.

Table 8
List of Outstanding Deposits-in-Transit
As of end of June 30, 2011

Name of
Charter
School
Amount of
Deposits-in-
Transit
Date when deposits were
initially reflected in the
reconciliation statements
Number of
months
outstanding
Bank Reconciliation
Reviewed By
MSA #1

$ 1,955 12/31/10 6 Accounting Manager
3,282.85 01/31/11 5 Accounting Manager
16,874.94 01/31/11 5 Accounting Manager
Total $22,112.79
MSA #2

$ 490.00 07/31/10 11 Accounting Manager
76,091.00 07/31/10 11 Accounting Manager
23,665.69 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 this audit,
therefore, the integrity of the information was uncertain.

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


28

Table 9
List of Stale-dated/Outstanding Checks
As of end of June 30, 2011

Name of
Charter School
Check Issue
Date
Check
Number
Amount of
Check
Number of
months
outstanding
MSA #1

4/27/2010 5375 $ 303.80 15
5/5/2010 5382 500.00 14
5/14/2010 5385 150.00 14
5/17/2010 5418 620.00 14
5/17/2010 5414 514.25 14
5/17/2010 5415 370.96 14
6/11/2010 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 33
12/9/2009 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 20
4/30/2010 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 for
the bank reconciliation process, (ii) the reconciling items such as, deposits in transit and
outstanding checks were not appropriately resolved by the Magnolia Public Schools Central
Office accounting staff in a timely manner, and (iii) there was a lack of management oversight
over the bank reconciliations process resulting in inaccurate reconciliation statements being
signed off by the Accounting Manager in numerous cases.

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

We discuss the actions needed to correct these conditions in Recommendation B-3.



29


General Journal Entry

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

The written accounting policies and procedures manual states, “Each posting must include the
following: the date of the transaction; receipt or check number listed in numeric order, name of
payer 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 any
time in the fund. If errors are found to exist, they must be identified and corrected as soon as
possible by using correcting journal entries. Make the necessary journal entries and include a
brief explanation of why the adjusting entries are made.”
17


Best practices suggest that the accounting staff generates a report at month-end from the
general 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 transactions
in the system.

Test Work Performed

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

 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 General
Journal Entry Report as of the end of the accounting period. According to the Finance
Manager, the Magnolia Public Schools Central Office was not creating periodic reports of
journal entries recorded in the general ledger since the posted transactions were accessible
in the accounting system.

 The Magnolia Public Schools Central Office lacked an effective process to ensure that the
journal 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 ensure
that 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 the
general ledger.

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

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

30

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

We discuss the actions needed to correct these conditions in Recommendation B-4.


Competency of Staff

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

The United States General Accounting Office – Standards for Internal Control in the Federal
Government states, “A positive control environment is the foundation for all other standards. It
provides discipline and structure as well as the climate which influences the quality of internal
control. Several key factors affect the control environment.

One key factor is the management’s commitment to competence. All personnel need to possess
and maintain a level of competence that allows them to accomplish their assigned duties, as
well as understand the importance of developing and implementing good internal control.
Management needs to identify appropriate knowledge and skills needed for various jobs and
provide needed training, as well as candid and constructive counseling, and performance
appraisals.”
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 accounting
staff 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 and
revenues.

o Some transactions were misclassified to the incorrect account code (i.e. Dues and
Membership instead of Professional/Consulting Services, Travel and Conferences
instead 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 2010
liabilities recorded in FY 2011, FY 2011 deposits recorded in FY 2010.)



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

31

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 of
duplicate 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 observe
the policies and procedures for authorization and approval of transactions (i.e. journal
entries, disbursements, cash receipts/deposits, bank reconciliation statements).

These conditions occurred because i) the responsibilities for the accounting of financial
transactions and records were not clearly defined, ii) the Magnolia Public Schools Central
Office 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 and
guidance of staff.

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

We discuss the actions needed to correct these conditions in Recommendation B-5.

























32

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 adequately
supported with appropriate documentation and source records prior to processing
and recording in the general ledger.

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

o Provide adequate oversight over the cash receipts and bank deposits to ensure that
operational 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. Following
the audit, the Chief Executive Officer, in coordination with the Chief Financial Officer,
implemented additional controls regarding the cash receipts and deposit processes. The Chief
Executive Officer and the Chief Financial Officer are working collaboratively to ensure that all
cash receipts and bank deposits are reviewed and adequately supported with appropriate
documentation 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, documentation
and record retention, recording and reconciliation, and the review, authorization and approval
procedures. 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 and
internal controls provide assurance that authorized transactions are processed completely and
accurately 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 adequately
supported with pertinent documents and source records prior to processing of the
payment. Also, the approver should review all documentation before signing the
checks to ensure that the transactions actually occurred, and are recorded in the
general ledger for the correct amount, to the appropriate account code, in the proper
accounting period.

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

33

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 adequate
controls to ensure that EFT payments are limited to immediate or emergency
situations only.

o Provide adequate oversight and enforcement of controls over the expenditures and
disbursement to ensure that operational procedures and internal controls are working
effectively.

Charter School Comments: The management agreed with our recommendation. Following
the audit, the Chief Executive Officer, in coordination with the Chief Financial Officer,
implemented additional controls regarding the expenditures and the payments processed
through the electronic fund transfers (EFT). MPS management has utilized a software
(CoolSIS) to ensure that all purchases/expenditures are properly authorized, approved and
adequately supported with pertinent documents and source records prior to processing of the
payment. In addition, the Chief Executive Officer, in coordination with the Chief Financial
Officer will i) update and enhance the policies and procedures over the purchasing and
disbursement processes to include the clear assignment of responsibilities, appropriate
documentation and record retention, proper review and reconciliation, and authorization and
approval procedures, ii) strengthen policies and procedures over the EFT transactions by
providing adequate controls to ensure that EFT payments are limited to immediate or
emergency situations only. In addition, the Board will provide adequate oversight and
enforcement of controls over the expenditures. The target date of implementation is September
30, 2012.


Recommendation B-3: The Board of Directors of Magnolia Public Schools should:

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

o Ensure that monthly bank reconciliation statements are prepared, matched to the
balances of the general ledger, and compared to the accounting records to validate
that 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, and
is able to authorize, provide direction to the staff, and make decisions about the
items 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 reconciliation
statements.

34


Charter School Comments: The management agreed with our recommendation. Following
the audit, the Chief Executive Officer, in coordination with the Chief Financial Officer, has
implemented controls regarding the bank reconciliation processes. In addition, the Board will
provide adequate oversight and controls over the bank reconciliation statements. The Chief
Executive Officer and the Chief Financial Officer will work collaboratively to: i) ensure that
monthly bank reconciliation statements are reviewed, matched to the balances of the general
ledger, and compared to the accounting records to validate that the payments and receipts are
fully accounted for, ii) ensure that the reconciling items in the bank reconciliation statements
are identified, investigated and explained and the corrective action are taken appropriately, iii)
ensure that the bank reconciliation statements are reviewed for accuracy, completeness and
timeliness by someone who has authority or supervisory role, and is able to authorize, provide
direction to the staff, and make decisions about the items under review. The evidence of
review and approval will be documented, signed or initialed, and dated by the
reviewer/approver. The target date of implementation is August 31, 2012.


Recommendation B-4: The Board of Directors of Magnolia Public Schools should:

 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 are
accurately prepared, adequately supported with explanation for the entry and
evidenced by proper review and approval of an authorized signatory prior to
recording in the general ledger.

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

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

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

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 the
Chief Financial Officer, to develop effective policies and procedures to ensure that all journal
entries are accurately prepared, adequately supported with explanation for the entry and
evidenced by proper review and approval of an authorized signatory prior to recording in the
general ledger. The Board will provide adequate oversight and controls over the use of general
journal entries. The Chief Executive Officer and the Chief Financial Officer will work
collaboratively to: i) ensure that the accounting staff is trained on how to effectively process the


35

journal accounting entries. The staff will generate a report, at month-end, of all journal entries
recorded in the period, for review and approval by a supervisory level employee who does not
have access to recording transactions in the general ledger system, and ii) ensure that the
general journal entry reports are retained on file especially at the end of the fiscal year. The
target date of implementation is August 31, 2012.


Recommendation B-5: The Board of Directors of Magnolia Public Schools should:

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

o Assess the level of staffing and the competency of the individuals assigned to perform
the accounting of the financial transactions of the schools.

o Determine whether the current knowledge and skills are adequate to perform the
required tasks.

o Provide the accounting staff with the formal job description defining the tasks and the
duties and responsibilities required of the job.

o Provide continuous training and updates on the accounting system, policies and
procedures, rules and regulations and generally accepted accounting principles.

Charter School Comments: The management agreed with our recommendation. Following
the audit, the Chief Executive Officer, in coordination with the Chief Financial Officer, has: i)
assessed the level of staffing and the competency of the individuals assigned to perform the
accounting of the financial transactions of the schools, ii) determined whether the current
knowledge and skills of the staff are adequate to perform the required tasks, iii) provided the
accounting staff with the formal job description defining the tasks and the duties and
responsibilities required of the job, iv) started an ongoing onsite training and oversight as well
as updating on the accounting system, policies and procedures, rules and regulations and the
generally accepted accounting principles, v) asked some staff members to attend necessary
workshops and seminars like Chief Business Officers seminar, QuickBooks workshops, and
etc.


Questioned Costs: The summary of questioned costs (please refer to Appendix A) represent
amounts identified in the review of statistically selected documentation supporting the financial
activities of the three MSA Schools only. The dollar amounts represent (i) costs that were not
supported by adequate documentation, (ii) costs that may have resulted to noncompliance or
possible noncompliance of applicable requirements of a law, regulation, and the Charter
Agreement, and (iii) the potential misuse of funds.


Magnolia Public Schools’ Comments: We have reviewed the summary of questioned costs.
The Chief Executive Officer, in coordination with the Chief Financial Officer, has met with the
accounting staff to review the amounts identified in the audit. We have worked collaboratively

36

to make the necessary corrections and adjusting journal entries, and to recoup the amounts of
double payment. Furthermore, we have implemented additional controls and monitoring
procedures to preclude the erroneous processing and reporting of the financial transactions of
the Charter Schools.












































37

APPENDIX A

SUMMARY OF QUESTIONED COSTS
IDENTIFIED IN THIS AUDIT*



* The amounts included in this appendix represent questioned costs identified in the course of the audit of the three
selected Charter Schools only. The dollar amounts represent (i) outdated and unsupported reconciling items in the
bank reconciliation statements, and (ii) potential misuse of funds.














DESCRIPTION AMOUNT CATEGORY
1) Unsupported and unresolved reconciling items in the Bank Reconciliation Statements

i. Outstanding/Staled Checks
MSA-1
MSA-2
MSA-3


5,050.56
31,899.16
2,894.79




$39,844.51

Outstanding checks dated 12
months and over remained as
reconciling items even after a
considerable period of time.




2) Questionable expenditures/disbursements

i. Duplicate payments to vendors
MSA-1


$43,565.18



$43,565.18


Potential misuse of funds; the
payments were improperly
supported by duplicate invoices
or emails.




TOTAL QUESTIONED COSTS $83,409.69

38

APPENDIX B

SUMMARY OF QUESTIONABLE ACCOUNTING PRACTICES
IDENTIFIED IN THIS AUDIT*

* The amounts included in this appendix represent questionable accounting practices identified in the course of the
audit of the three selected Charter Schools only. The dollar amounts represent costs that resulted from
i) irregular accounting practices, and ii) misapplication of the Generally Accepted Accounting Principles.


DESCRIPTION AMOUNT CATEGORY
1) Unsupported and unresolved reconciling items in the Bank Reconciliation Statements

i. Deposit in Transit
MSA-1
MSA-2


$22,112.79
100,246.69



$122,359.48

Deposits in transit that remained
outstanding from five months to
almost a year as of June 30, 2011.

2) Questionable and unsupported cash receipts/bank deposits

i. Double posting of deposit
MSA-2


$23,665.69


$23,665.69

Recorded twice in the general
ledger on 07/27/10. No adjusting
entry has been made as of June
30, 2011.


ii. Bounced checks (“No Sufficient Fund”)
recorded as revenue
MSA-1
MSA-2



13,359.90
60,090.34





$73,450.24


Bill payments returned by the
bank due to “NSF” were credited
to the revenue account. No
adjusting entry has been made as
of June 30, 2011.

3) Misapplication of the Generally Accepted Accounting Principles

i. Deposit transactions were not recorded
in the proper accounting period.
MSA-1
MSA-2
MSA-3



$488,968.20
115,059.82
32,643.53






$636,671.55


Deposits actually received on FY
2011 were recorded as Cash in
Bank on June 30, 2010. As a
result, the financial records
reflected positive balances in the
Cash in Bank instead of zero or
negative balances.


ii. The Matching Principle of expenses
was overlooked or ignored.
MSA-1
MSA-2
MSA-3



92,517.57
81,119.01
61,989.72





$235,626.30

The goods and services incurred
on FY 2010 were not accrued on
June 30, 2010. The expenses were
recognized on FY 2011 when the
payments were made.

TOTAL $1,091,773.26

39

ANNEX A

Verbatim Comments



40



41



42



43



44



45





46

ANNEX B


Report Distribution

Members, Board of Education
Superintendent of Schools
Sr. Deputy Superintendent of School Operations
General Counsel
Director, Innovation and Charter Schools Division
Business Advisor, Innovation and Charter Schools Division





































47

ANNEX C


Audit Team


Jas Ahmed, Audit Manager
Dolores Mabini, Senior Internal Auditor
Emmaliza Baquir, Internal Auditor







































48



Know about fraud, waste or abuse?

Tell us about it.

Maybe you are a School District
Employee, or maybe you are a private
citizen. Either way, you are a
taxpayer.

Maybe you know something about
fraud, or waste, or some other type of
abuse in the School District.

The Office of the Inspector General
has a hotline for you to call. You can
also write to us.

If you wish, we will keep your identity
confidential. You can remain
anonymous, if you prefer. And you are
protected by law from reprisal by your
employer.


















Call the Hotline:

(213) 241-7778
Or
1-866-LAUSD-OIG

Write to us:

Fraud Hotline Center
333 S. Beaudry Ave., 12
th

Floor
Los Angeles, CA 90017

Website:
www.lausdoig.org