audit of the los angeles world airport's financial operations

7/28/2019 Audit of the Los Angeles World Airport's Financial Operations

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AUDIT OF THE

LOS ANGELES WORLD AIRPORTSFINANCIAL OPERATIONS

Submitted to the

City of Los AngelesOffice of the Controller

By

Vasquez & Company LLP

JUNE 12, 2013


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TABLE OF CONTENTS

EXECUTIVE SUMMARY ..................................................................................................... 1

CONTROLLERS ACCOUNTABILITY PLAN .................................................................. 6

BACKGROUND, OBJECTIVES, SCOPE AND METHODOLOGY ................................ 12

AUDIT FINDINGS AND RECOMMENDATIONS ............................................................. 15

SECTION I: ORGANIZATIONAL AND GENERAL MATTERS .................................. 15

SECTION II: FINANCIAL PLANNING AND RISK MANAGEMENT .......................... 23

SECTION III: BUDGET DEVELOPMENT AND CONTROL ........................................ 24

SECTION IV: REVENUE MANAGEMENT AND DEVELOPMENT ............................ 26

SECTION V: CONTRACT MONITORING AND PROCUREMENT ............................ 28

SECTION VI: CAPITAL ASSET MANAGEMENT AND INVENTORY CONTROL .. 29

SECTION VII: DEBT MANAGEMENT AND BOND FINANCING ............................... 32

SECTION VIII: REGULATORY COMPLIANCE AND FINANCIAL REPORTING .. 34

SECTION IX: INFORMATION TECHNOLOGY ............................................................. 35

SECTION X: OTHER MATTERS ....................................................................................... 38


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EXECUTIVE SUMMARY

The Los Angeles World Airports (LAWA or the Department) is a proprietary, self-supportingCity of Los Angeles department that owns and operates the Airport System, consisting of threeFAA-certified airports: (Los Angeles International, LA/Ontario International, and Van Nuys) andthe noncertified LA/Palmdale Regional Airport. The firm of Vasquez & Company LLP(Vasquez) was engaged by the Los Angeles City Controllers Office to conduct a performanceaudit to assess the effectiveness and efficiency of LAWAs financial operations, and identifyopportunities for improvement. The audit focused on internal controls, processes, personnel andsystems relevant to its core financial activities.

Background

As a department of the City, LAWA is governed by a board (the Board of AirportCommissioners, or BOAC), appointed by the Citys Mayor. The LAWA organization consists ofoperating departments reporting to a Chief Operating Officer or Chief Executive Officer. Keyfunctions provided by these departments are operations, facilities management, security,development including capital expansion, and administration including finance, budget,information technology and internal audit.

LAWA is responsible for the physical elements of the airports it operates, which includerunways, fueling facilities, passenger terminals and ground transportation facilities. From thesecapital assets LAWA generates revenues in the form of aircraft landing fees, lease fees,concession fees from tenants and parking fees. As a self-supporting department with no taxbase, these revenues must be sufficient to fund LAWAs operating, maintenance and capitalexpenses, debt service and required reserves. Annual revenues and capital grants for LAWAwere approximately $1.1 billion in fiscal year 2012, while expenses were $809 million, resultingin an increase in net assets of approximately $279 million.

The Los Angeles International Airport (LAX) is the predominant airport in the LAWA system,and is the sixth busiest airport in the world. Although the economic recovery is progressingslowly, LAX passenger traffic increased by 3.8% in fiscal year 2012 as compared to fiscal year2011. LAWA is in the midst of a multi-billion-dollar capital improvement program aimed atmodernizing LAX, centered around a new international terminal, replacement of the centralutility plant, terminal renovation, improved baggage handling and screening facilities, and newor upgraded moving walkways, escalators and elevators.

Objectives, Scope and Methodology

The primary objective of the audit was to assess the effectiveness and efficiency of LAWAsfinancial operations, and identify opportunities for improvement. Our audit was performed inaccordance with Generally Accepted Government Auditing Standards (GAGAS) and coveredconditions, activities and processes as of June 30, 2011, with consideration given to current


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conditions when considered relevant to the conclusions reached.

The specific audit objectives included identifying LAWAs significant/core financial activitiesand assessing the Departments fiscal organizational structure, policies and procedures over thesecore financial activities, skills of personnel, financial information systems, fiscal processes,

budgeting and management controls, and overall system of internal controls.In order to develop an understanding of the control environment, organizational structure andprocesses related to the identified fiscal areas, we conducted numerous interviews, observedbusiness processes, reviewed finance-related documents and performed analyses of accounts,reports and data.

Summary of Audit Results

Overall we found that LAWAs policies and procedures pertaining to core financial activities arecomparable to those found in a governmental enterprise environment, and are generally up-to-

date and communicated to appropriate personnel. The organization structure provides for keyfunctions and reasonable reporting relationships. Personnel interviewed possessed qualificationscommensurate with their roles and demonstrated an adequate understanding of theirresponsibilities. Information technology is in a transitional state as new system implementationsare underway, planned or recently completed. The internal control systems with respect to fiscalprocesses, budgeting and management were found to be designed appropriately to safeguardassets and promote adherence to BOAC and management approved policies and procedures.

Notwithstanding the above general observations, we found that the Departments executivemanagement lacks sufficient support and relies extensively on outside consultants in carrying outkey modernization management functions. Further, there are opportunities to strengthen controls

and processes to maximize revenues, ensure LAWA assets are effectively managed, strengthensecurity over the use of information technology, ensure accuracy and completeness of financialreporting, and obtain more meaningful management information from its accounting systems.

The following summarizes the audits key findings:

Organizational and General Matters

1. LAWA lacks the position of Chief Financial Officer which generally enhances thecoordination of financial planning, budgeting and monitoring of actual results in relation tofinancial plans while also providing a focal point of responsibility for the development,

implementation and continual review of internal accounting and administrative controls.

2. The key positions of CEO, Chief Operating Officer (COO), Director of AirportDevelopment, and Director of Capital Development and Budget are filled by qualified,experienced executive-level personnel. However, restrictions of the Citys Civil ServiceClassification Plan as well as inadequate training programs have limited the availability ofexperienced supporting staff capable of stepping into their positions in the event of an


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unexpected vacancy. Succession planning to ensure the orderly transition of responsibilitiesat key executive levels has not occurred.

3. LAWA does not have a robust and independent internal audit function. The Internal AuditDivision reports to the Deputy Executive Director of Administration, who also manages

many of the departments subject to audit. Also, the Internal Audit Division lacks sufficientpersonnel, further decreasing its ability to perform, coordinate, review and follow up onfinancial, compliance and operations audits.

4. Communication of BOAC and managements goals, strategies and plans, both short-term andlonger-term, is not adequate to ensure awareness by Department staff. As a result,opportunities to gain insights and knowledge from those serving LAWAs constituents maybe lost.

Financial Planning and Risk Management

5. LAWA does not have a complete Enterprise Risk Management Program for the purposes of

proactively identifying risks and developing mechanisms to effectively manage or eliminaterisks to achieve LAWAs operational objectives.

Budget Development and Control

6. The LAWA budgeting process does not include consideration of levels of performance inrelation to budgeted costs. The LAWA cost accounting system does not provide costinformation by activity or unit as needed to effectively implement performance-basedbudgeting. Accordingly, because the accounting system does not measure and reportperformance measures or the costs of achieving any specific level of performance, data is notavailable to implement a comprehensive performance-based budget.

Revenue Management and Development

7. Self-reported revenues from airlines and concessionaries are validated by LAWA auditors ona test basis, yet identified underpayments do not result in expanded testwork and furtherinvestigation in accordance with LAWAs policies and documented procedures.

8. Interest and penalties resulting from late payments pursuant to contractual agreements (suchas airlines and tenants) are not consistently charged or computed by the Revenue AssetManagement System as provided for by contract terms and conditions. LAWA hassuccessfully managed to achieve a high collection rate of receivables; however, a formal

process for the calculation, recording and, when appropriate, waiver of late fees is importantto ensure transparency, consistency and equitable treatment of all contractors.

Contract Monitoring and Procurement

9. Management of compliance with procurement contracts is weakened by process deficienciesand the lack of initial and continual involvement of Designated Contract Administrators toadequately oversee the procurement processes for cost effectiveness, efficiency andcompliance with LAWA policies and relevant laws and regulations.


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Capital Asset Management and Inventory Control

10.There is no regularly scheduled physical count of capital assets, including furniture andequipment, fleet inventory, and supplies inventory. The weapons inventory used by LAWA

police has not been subjected to an externally validated physical count by internal or externalauditors, thus limiting the assurance that these items are properly safeguarded, reported andavailable to LAWA security personnel.

11.Reports of construction expenditures produced by PROLOG, LAWAs constructionmanagement system, do not consistently agree with construction project expenditures asreported in the general ledger. The PROLOG-generated construction expenditure reports areprovided to Executive Management for their use in evaluating the progress and costs of thecapital improvement program.

Debt Management and Bond Financing

12. LAWAs debt management policy is incomplete and has not been updated for at least sixyears to address matters such as the criteria for selecting debt instruments, establishing atargeted debt service coverage ratio, and identifying personnel responsible for debtmanagement.

Regulatory Compliance and Financial Reporting

13.LAWA provides limited financial reporting to the governing body, and reports tomanagement omit budgetary compliance information and statements of cash flows.

Information Technology

14.LAWAs IT systems could benefit from more frequent data backup, disaster recovery plantesting, enhanced procedures for change management, expanded and updated documentation,and improved methodologies for software selection.

Other Matters

Independent Reconciliation of LAWA Costs to Rates and Charges

15.The fees and charges which generate a large majority of LAWA revenues are based oncalculations which are not independently validated by the LAWA Deputy Executive

Director, Comptroller who maintains LAWAs official accounting records.

Recording Encumbrances

16.There is no centralized area or individual assigned responsibility for monitoring LAWAdivisions to ensure that commitments are properly encumbered.


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Review of Report

A draft of this report was provided to LAWA on February 12, 2013. We discussed the draftreport with LAWA management at an exit meeting held on February 27, 2013, and weconsidered comments and additional information provided as we finalized this report.

We would like to thank LAWA management and staff for their cooperation and assistanceduring the audit.


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CONTROLLERS ACCOUNTABILITY PLAN

RecommendationsPage

Reference

MayorAction

Required

CouncilAction

Required

DepartmentAction

Required

Organization and General Matters

1. LAWAs Executive Management should establishthe position of Chief Financial Officer with areporting relationship directly to the ChiefExecutive Officer (CEO). The skills associatedwith a CFO for a large complex organization suchas LAWA should include experience withorganizational leadership, business riskmanagement, performance management, strategic

planning, debt financing, integration of currenttechnology into finance-related functions, and theability to understand and explain complexfinancial issues, strategies, and opportunities inaddition to comprehensive interim and annualhistorical reports of financial position and resultsof operations.

15 X

2. LAWA should identify critical positions such as theExecutive Director, Chief Operating Officer,Director of Airport Development and Director of

Capital Development and Budget, and supplementtheir positions with additional qualified supportpersonnel. LAWA, in conjunction withappropriate City officials, should evaluate theposition classifications in relation to the CivilService System and develop new or revisedposition classifications as appropriate. These newposition classifications will be beneficial inselecting personnel who can ultimately be trainedand mentored to assume the role of the C-levelexecutives if needed. In addition, LAWA should

require all divisions/departments to implementstaff cross training, document key processes, andsupport all significant decisions by appropriatedocumentation.

17 X X

3. LAWA should provide the Internal Audit Divisiona more independent organizational placement,

19 X


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equip the function with more senior leadership, andprovide greater access to information and a moreprominent role in monitoring LAWAs overallcompliance with approved policies, legalrequirements, management directives and the

internal control framework.

While staffingreductions may be balanced by allowing theDivision to outsource audits, it is essential thatInternal Audit employ and retain personnel whoare competent to perform a meaningful riskassessment, monitor the status of prior auditdeficiencies and recommendations, direct andevaluate the work of external contracted auditors,and perform short-term investigations when theneed arises.

4. LAWA should endeavor to consolidate, codify,communicate and publish on its intranet allsignificant policies and procedures. These shouldbe updated routinely as new additions andrevisions occur. Management should also developmethods to disseminate organizational goals,strategies and plans throughout the organization ata level of detail appropriate for the subject matter.Methods may include a formal process ofcommunicating and linking the organizationsgoals, objectives and strategies to those of each

division and each employee within the division, aswell as expanded use of the LAWA intranet,meetings, and training sessions.

21 X

Financial Planning and Risk Management

5. To enhance the risk identification and managementprocesses, and consistent with best practices,LAWA should work to develop and implement an

overall organization-wide ERM. The ERM shouldprovide a structured and continuous process foridentifying, assessing, responding to and reportingon opportunities and threats that affect theachievement of LAWAs objectives. The ERMshould also incorporate an integrated approach toinformation technology risk management thatprovides for the identification, measurement,

23 X


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monitoring and controlling of technology-relatedrisks throughout LAWA, and that will be treated asan essential management function of theorganization.

Budget Development and Control

6. LAWA should prepare for the implementation ofperformance budgeting by acquiring or developingthe tools to identify, analyze and report the costs ofkey activities. LAWA should coordinate theperformance based budgeting process with theestablishment of goals and objectives for divisionsand the organization.

24 X

Revenue Management and Development

7. LAWA should consider the following actions:a) Consider incorporating the responsibility for

audits of self-reported revenues into theInternal Audit Division.

b) Expand documentation to include explanationsas to why deviations from LAWA policyappeared reasonable to the auditor. Acoverage target should be established, sothat management can gain a level of comfortthat a reasonable range (5% or 10%) of totalself-reported revenues is being reviewed. Anydecisions to negotiate audit results or foregoexpanded tests of apparent system deficienciesshould require the documented review of topmanagement.

c) Consider engaging an external consultantspecializing in this area to conduct one ormore audits as a co-sourcing opportunity, inorder to evaluate their approach andmethodology and, if deemed beneficial,incorporate lessons learned into future LAWAaudits. LAWA can then utilize best practicesto develop a revised program for LAWAsrevenue compliance audit activities.Development of a coverage minimum shouldbe established as a goal for the department.

26 X


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8. LAWA should take the following actions:a) Revise policies and procedures to incorporate

a consistent approach to calculating penaltiesand interest pursuant to contractualagreements. In addition, a consistent policyshould be communicated and enforcedregarding the waiver of interest and penalties.

b) Ensure that any write offs or forgiveness ofamounts are reviewed and approved bysomeone independent of the contractmonitoring and negotiation function. Further,LAWA should perform consistent calculationsof these penalties and interest amounts.

27 X

Contract Monitoring and Procurement

9. LAWA management should further develop,clarify, communicate and integrate into the initialproject phases the roles of DCAs andProject/Contract Managers in order to optimizedivisional administrative expertise and ensureadherence to LAWA Procurement Policiesand Procedures. Also, DCA training on LAWAProcurement Policies and Procedures should beextended to any and all project cost managers.

29 X

Capital Asset Management and Inventory Control

10.LAWA should ensure that inventory counts areconducted periodically at the division level andultimately every two years as an organization. Adepartment (Internal Audit, Financial Accountingor Procurement) should be assigned theresponsibility of collecting the informationregarding interim asset counts, reconciling thecounts to the general ledger and verifying the countresults. A department (Internal Audit, Financial

Accounting or Procurement) should be assignedthe responsibility of collecting the informationregarding interim asset counts, reconciling thecounts to the general ledger and verifying the countresults.

30 X

11.LAWA should investigate the feasibility of31 X


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integrating the PROLOG and SAP systems. If thisis not realistic, the LAWA Financial ServicesDivision should obtain copies of the PROLOGreports and related reconciliations on a timely basisand ensure that costs and liabilities are recorded in

the SAP general ledger system when incurred.Further, management should inform users of thePROLOG reports of the potential misstatement ofcosts in order to more accurately evaluate projectcosts.

Debt Management and Bond Financing

12.LAWA should create a process and timeline for theexpansion of its debt management policy. TheFinance and Budget Division should also review

its use of external consultants and ensure that theirmethodologies and conclusions are appropriatelymonitored, understood and validated by qualifiedinternal personnel.

32 X


13.LAWA finance personnel should provide completefinancial reporting packages to management, theBOAC and the Audit Committee on a monthly

basis. These should include information withrespect to sources and uses of cash and budgetarycomparisons to demonstrate compliance withapproved budgets, and should be published on theLAWA web site as a demonstration oftransparency and full disclosure in financialreporting.

34 X

Information Technology

14.IT Security management at LAWA should addressthe noted opportunities for improvement in theareas of:a. operational plans for IT security systemsb. disaster recovery testingc. daily offsite storage of tape data backup media.d. change management frameworke. version management controls

35 X


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f. close out and documentation of completedchanges within the Change ManagementSystem

g. documentation of data flow diagrams outlininghow SAP interfaces with other applications

and databases.h. use of a formal software selection methodologyi. implementation of a Project Quality

Management System.

Other Matters

15.LAWA management should assign the DeputyExecutive Director, Comptroller responsibility forunderstanding the methodology utilized to identify

costs and re-calculating the user rates and chargesassessed to recover them.

38 X

16.LAWA management should assign to the DeputyExecutive Director, Comptroller responsibility forensuring that all expenditures are analyzed forindications of recurring payments which may bedue to financial commitments. Evidence ofcommitments in the form of leases, contracts andpurchase orders should be reviewed and agreed tothe related encumbrance recorded in the

accounting records.

39 X


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Background, Objectives, Scope and Methodology

Background

As a self-supporting proprietary City department, LAWA plans, constructs and maintains its own

buildings, and controls its own funds in accordance with the City Charter. LAWA has no taxbase and therefore must generate sufficient revenues to fund its operating and capital expenses,debt service and required reserves.

The Mayor of the City of Los Angeles appoints, subject to City Council approval, the seven-member Board of Airport Commissioners (BOAC). The BOAC formulates airport policy. TheCity Council and BOAC approve LAWAs annual budget. An Executive Director, appointed bythe Board and confirmed by the Mayor and City Council, is responsible for implementing Boardpolicies and overseeing LAWAs day-to-day operations. LAWA is subject to the provisions ofthe Los Angeles City Charter and is subject to civil service employee rules and regulations.Because LAWA operates commercial service airports, it is also subject to the Federal Aviation

Administration's (FAA) regulations, guidelines and directives in administering its three airports.

All of LAWAs operating departments report to the Chief Operating Officer, other than theAirport Development Group which reports directly to the Chief Executive Officer. The LAWAoperating departments are listed below.

Airport Development Group

Administration

Commercial Development

Operations and Emergency Management

Law Enforcement and Homeland Security

LAWA Facilities Management Group Finance and Budget

Information Management and Technology Group

An overview of the LAWA organization is provided on the following chart.


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The LAWA Comprehensive Annual Financial Report (CAFR) reported total assets at June 30,2012 in excess of $8.6 billion, of which $5.3 billion represented capital assets. LAWA reported$480 million of unrestricted net assets, or 59% of 2012 expenses.

Annual revenues and capital grants for LAWA were approximately $1.1 billion in fiscal year2012, while expenses were $809 million, resulting in an increase in net assets of approximately$279 million.

A summary of fiscal year operating results in 2012, 2011 and 2010 follows:

Summary of Operating Results

(Amount in Thousands)

BoardofAirportCommissioners

ExecutiveDirector

ChiefOperatingOfficer

FacilitiesManagement

Group

LawEnforcement&ProtectionServices

Group

Operations&EmergencyManagement

CommercialDevelopment

GroupAdministration

InformationManagement&TechnologyGroupFinanceandBudget

AirportsDevelopment

GroupExternalAffairs

FY 2012 FY 2011 FY 2010

Total revenue and capital grants $ 1,088,862 $ 1,041,618 $ 1,048,977Total expenses 809,370 834,071 765,513

Increase in net assets $ 279,492 $ 207,547 $ 283,464


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Objectives, Scope and Methodology

The objective of this audit was to assess the effectiveness and efficiency of LAWAs financialoperations, and identify opportunities for improvement. Specific objectives were to identify

LAWAs significant/core financial activities and assess the following areas with respect to theimpact on the successful functioning of these financial activities. The areas assessed were:

the Departments fiscal organizational structure,policies and procedures over core financial activities, skills of personnel, financial information systems, fiscal processes,budgeting and management controls, and systems of internal controls.

Our audit was performed in accordance with Generally Accepted Government AuditingStandards (GAGAS). Those standards require that we plan and perform the audit to obtainsufficient, appropriate evidence to provide a reasonable basis for our findings andconclusions based on our audit objectives. We believe that the evidence obtained provides areasonable basis for our findings and conclusions based on our audit objectives. The scope ofour audit covered conditions, activities and processes as of June 30, 2011, with considerationgiven to current conditions when considered relevant to the conclusions reached.

Fieldwork was conducted between May 2012 and September 2012, although additional analysiswas conducted through October 2012. In conducting our audit, we:

interviewed management and staff of selected departments; reviewed relevant policies and procedures to obtain an understanding of key

processes; reviewed reports issued by external independent auditors, internal auditors and

concessionaire auditors; reviewed reports, official statements and covenants regarding LAWAs outstanding debt; reviewed reports and selected records regarding LAWAs construction program; and analyzed selected accounting records during the audit period and then selected samples

of records for further review.

The project was conducted in two phases. Phase I constituted the data gathering/planning phase

during which preliminary issues were identified for further investigation during Phase II. PhaseII efforts focused on detailed substantive testing as required to research issues identified duringPhase I.

The Phase I efforts resulted in the identification of seven significant/core fiscal cycles whichwere assessed in accordance with the criteria previously described. LAWAs significant/corefinancial activities selected for review were:

Financial Planning and Risk management


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Budget Development and Control Revenue Management and Development Contract Monitoring and Procurement Capital Asset Management and Inventory Controls Long Term Debt Management and Bond Financing


In order to develop an understanding of the control environment, organization structure andprocesses related to the identified fiscal cycles, we conducted numerous interviews, observedbusiness processes, reviewed finance-related documents and performed analyses of accounts,reports and data.

In Phase II we performed further inspection, examination and analysis in those areas identified asmeriting further review.

The remainder of this report details our findings, comments and recommendations.

Audit Findings and Recommendations

SECTION I - ORGANIZATIONAL AND GENERAL MATTERS

______________________________________________________________________________

As LAWA has intensified its efforts on updating and renovating the airport facilities,modernizing financing alternatives, and implementing state-of-the-art technology, the need for a

senior-level finance official with a broad knowledge base and skill set has become apparent, buthas not yet transitioned into the creation of a Chief Financial Officer (CFO) position. Othermembers of LAWAs executive management team have been recruited or promoted from withinthe organization, as necessary to provide the top talent needed to lead the Department duringthese demanding times. However, there has been little succession planning for these positionsand the limited depth of support suggests a lack of available personnel to step into vacantpositions at the chief executive management level. Other opportunities to strengthen theorganization include enhancing the independence of the internal audit function and initiatingefforts to increase communication throughout the Department.

LAWA Lacks the Position of Chief Financial Officer

Finding #1: The LAWA organization does not include the position of CFO whichenhances the coordination of financial planning, budgeting and

monitoring of actual results in relation to financial plans, while also

providing a focal point of responsibility for the development,implementation and continual review of internal accounting and

administrative controls.


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A CFO provides the development and communication of entity-wide financial strategy, long andshort-term financial planning and budgeting, and the identification and consideration of financialalternatives, all of which should be based on an analysis of historical financial information inconsideration of the organizations goals and objectives. The CFO should act as an advisor to theChief Executive Officer (CEO), helping to shape and, when appropriate, challenge the

Departments strategy. Particularly at LAWA, with its ongoing and planned renovations andimprovements, sensitivity to community and environmental concerns, evolving use oftechnology, and intense regulatory environment, a CFOs skills in interpreting, analyzing andpresenting financial information to facilitate problem identification, understanding of options andavailable opportunities are crucial to the organization.

At LAWA, the responsibilities normally associated with a CFO are divided into two positions: 1)a Deputy Executive Director, Comptroller (accounting and financial reporting) and 2) theDirector of Capital Development and Budget (financial planning, operational and capitalbudgeting, revenue management, debt management, and capital financing). The coordination ofefforts between these functions is hindered as they primarily focus on their respective areas(historical results versus future planning) without the central vision and focus on the overall

financial condition and strategies of LAWA as a complete organization. Further, while financialpresentations are made to the governing body, particularly with respect to the financialimplications of on-going construction and renovation programs (based on the work of theDirector of Capital Development and Budget), limited historical financial reporting of actual

financial results (based on the work of the Deputy Executive Director,Comptroller) is providedto the governing body, and such reporting omits statements of financial position and budgetarycompliance information.

Our review determined that many of the typical CFO responsibilities lie primarily with theDirector of Capital Development and Budget. These responsibilities include operational andcapital budgeting, financing, reporting the Board of Airport Commissioners (BOAC), reporting

to Executive Management, representing LAWA at industry airport organizations, cash flowanalysis, managing the negotiations with airlines in relation to rates and charges and managingmany of the consultants involved in the financing and rate setting process. While this position isacting as a de-facto CFO in many aspects, it lacks the oversight of the historical financialinformation which is critical to accurately projecting future financial results. It also is not placedat a sufficiently senior level within the LAWA framework to ensure appropriate oversight,communication and authority on finance-related matters throughout the organization. Thisposition also lacks the depth of supporting staff resources to ensure continued financial oversightif the Director of Capital Development and Budget were to leave the Department.

In a public sector environment characterized by continuing change, competition and increasing

demands to deliver quality services within a framework of responsible financial and resourcemanagement, the role of the CFO is critical to achieving success. The CFO is responsible foreffectively communicating on financial matters, providing high-level leadership, establishing anappropriate financial management framework, instituting and maintaining strong financialmanagement systems and processes, and understanding and ensuring compliance with relevantfederal, state and local finance-related laws and regulations. The CFOs functions should alsoinclude contributing to strategic initiatives, providing advice to the governing body and to theentire organization on finance-related matters, implementing and enforcing an effective internal


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control framework and establishing reporting relationships with those at thedivision/departmental level who have responsibility for the procurement and use of LAWAresources and accounting-related matters. Further, a CFO should occupy a senior position withinthe organization, which provides the authority and allows the vision to focus on organization-wide improvements and facilitate change and advancement.

Without the position of a chief financial officer knowledgeable of LAWAs financial risks,strategies, plans, budget assumptions, financing options, management and reporting functions,the Department may not realize the benefits of top-level financial assessment, guidance,communication and accountability as would be expected from a CFO. LAWA not only risksincomplete information and analyses, but also risks ineffective communication of importantfinancial considerations to the BOAC and executive management, and a lack of potentialcoordination between independent divisions/departments with respect to finance and accounting-related matters.

Recommendation #1: LAWAs Executive Management should establish the position of ChiefFinancial Officer with a reporting relationship directly to the Chief Executive Officer (CEO).

The skills associated with a CFO for a large complex organization such as LAWA should includeexperience with organizational leadership, business risk management, performance management,strategic planning, debt financing, integration of current technology into finance-relatedfunctions, and the ability to understand and explain complex financial issues, strategies, andopportunities in addition to comprehensive interim and annual historical reports of financialposition and results of operations.

______________________________________________________________________________

Lack of Organizational Depth and Succession Planning

Finding #2: For the key positions of CEO, Chief Operating Officer (COO), Director ofAirport Development, and Director of Capital Development and Budget,

LAWA does not have back-up personnel capable of stepping into their

positions. LAWA lacks a succession plan in the event of an unexpectedvacancy.

Complex and evolving organizations require stability and consistency during times of transitionat the leadership level. Tools which ensure steadiness and minimize disruption of operationsinclude succession planning, personnel who are trained in their responsibilities and cross-trainedin those of other positions, effective sustainable processes and comprehensive documentedpolicies and procedures.

LAWA, as a department of the City of Los Angeles, is subject to the civil service employee rulesand regulations. These civil service regulations influence LAWAs ability to develop andmaintain a succession plan. Employee promotions, retention, incentives and rewards are subjectto stipulated rules which may conflict with the identification, mentoring, training, retention andultimately promotion of the most qualified individuals to assume executive-level managementpositions. These restrictions hinder LAWAs ability to manage the risks associated withconcentrating all key functions in a limited number of executive-level positions.


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The top leadership positions at LAWA require senior-level personnel with specialized industryexpertise. Their primary duties and responsibilities are summarized below.

Chief Executive Officer The position of CEO is responsible for developing andimplementing high-level strategies, making major business decisions, managing the overall

operations and resources, representing the organization to the public and regulatory bodies, andacting as the main point of communication between the governing body (BOAC) and LAWAoperations. At LAWA the CEO is the Executive Director.

Chief Operating Officer The COO is responsible for operations management, meaning thedevelopment, design, operation, and improvement of the systems that LAWA utilizes to serve itsconstituency. The COO is responsible for ensuring that operations are efficient and effective andthat the proper management of resources and provision of services to customers occurs. Thisposition also ensures that resources are utilized effectively and efficiently, facilitatescommunication of LAWAs goals and objectives to lower-level operational staff, is a keyparticipant in organizational planning, maintains and monitors staffing levels and productivity,

and motivates staff to drive maximum performance.

The Director of Airport Development This position is responsible for the multi-billion dollarmodernization of Los Angeles International Airport (LAX) and oversees all major constructionprojects at LA/Ontario International Airport and Van Nuys Airport.

The Director of Capital Development and Budget As previously discussed, this position directs,guides and oversees the functions of planning, operations, capital budgeting, operational budgetdevelopment and monitoring, determination of user charge rates and fees, debt management andthe allocation of direct and indirect costs.

The key positions described above are filled by qualified, experienced personnel who joinedLAWA with or subsequent to the appointment of the CEO in 2005. Considering the dynamicnature of LAWAs operational and modernization activities, the organization requires anaccomplished executive team that is capable of developing and executing strategies to meet thechallenges attendant with rapid growth and modernization.

However, there is limited mid-level staffing support for each of these positions and no apparentsuccession planning in the event the positions become vacant. Restrictions of the Citys CivilService Classification Plan as well as inadequate training programs have limited the availabilityof experienced supporting staff capable of stepping into the executive positions in the event of anunexpected vacancy. While LAWA has five Deputy Executive Directors (of Administration,Commercial Development, Law Enforcement & Homeland Security, Facilities Management andOperations and Emergency Management), the requirements of these positions do not incorporatethe organizational strategy, planning, financing, construction management and operationscomponents that are key aspects of the roles of the CEO, COO and Director of AirportDevelopment and Director of Capital Development and Budget. The level of staffing, whileappropriate for maintaining current operations, does not include personnel who have been trainedand mentored to step into these very demanding executive-level positions.


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It is also relevant that the CEO is appointed by the Mayor. The possibility of turnover at this keyposition could lead to significant turnover at other executive management positions, andaccordingly is likely a negative factor in LAWAs ability to recruit top talent for its executivemanagement ranks.

The importance of the CEO position is self-evident. With respect to the COO, recent studiesnote that large and complex organizations have found it increasingly difficult for one personalone to have total oversight of the operations of an entire organization. Therefore, additionalexecutive management positions frequently supplement or replace the COO position, and providean additional source for succession planning and knowledge sharing. One of these executivemanagement positions is typically the Chief Financial Officer which, as noted previously,LAWA does not have. Accordingly, while it could be assumed that the COO can serve as thereplacement in the absence of a CEO, at LAWA the complete lack of support for the COOposition negates this as a viable alternative.

Limited depth of personnel and lack of succession planning can be mitigated by effectivesustainable processes and comprehensive documented policies and procedures. However, there

has been a relatively short tenure of the occupants of these key management positions, and thehigh level of activity (new construction, managing during a recession, upgrading of systems,negotiation and renewal of critical airline and tenant contracts) has demanded managementstime to the detriment of creating, communicating and documenting sustainable processes. Acentral codified set of policies and procedures does not exist at LAWA.

LAWA has retained and recruited highly qualified senior-level personnel. However, restrictivecivil service regulations, limitations on the number of positions exempt from these regulations, andthe uncertainty associated with a structure in which the entire BOAC and Executive Managementcould be replaced pursuant to a mayoral election heightens the risk of losing key organizationaltalent.

Recommendation #2: LAWA should identify critical positions such as the Executive Director,Chief Operating Officer, Director of Airport Development and Director of Capital Developmentand Budget, and supplement their positions with additional qualified support personnel. LAWA,in conjunction with appropriate City officials, should evaluate the position classifications inrelation to the Civil Service System and develop new or revised position classifications asappropriate. These new position classifications will be beneficial in selecting personnel who canultimately be trained and mentored to assume the role of the C-level executives if needed. Inaddition, LAWA should require all divisions/departments to implement staff cross training,document key processes, and support all significant decisions by appropriate documentation.______________________________________________________________________________

Independence of the Internal Audit Function

Finding #3: The Internal Audit Division at LAWA lacks the framework to be aneffective Internal Audit Organization.

As one of the largest airports in the world, with more than $1 billion in revenues, LAWA meritsa robust internal audit function lead by a senior executive-level director. The position ofDirector of Internal Audit should report to the head of the BOACs Audit Committee and have


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significant interaction with the Chairman of the BOAC, the CEO, members of the AuditCommittee, and other board members. The Director of Internal Audit should have a full grasp ofoperations, strategies and constraints in order to assess LAWAs financial and compliance risksas necessary to plan and execute financial and operational audits. Qualifications for such a toplevel position include advanced relevant education, significant experience in the profession of

internal auditing and, ideally, in the industry, and the ability to work successfully in partnershipswith various internal and external stakeholders.

At LAWA the head of the Internal Audit Division is a manager classification. The positiondescription states that the Internal Audit Manager reports to the Chief Financial Officer or othersenior manager and receives assignments stated in terms of broad objectives and work isreviewed in terms of results obtained. Qualifications for the position are a bachelors degree inbusiness administration, accounting or other related field; CPA or Certified Internal Auditorcredential; and 3 years experience managing financial and performance auditing activities in agovernmental audit organization or public accounting firm. These qualifications do not ensurethe experience, credibility, leadership and industry knowledge that are merited for this position at

a billion dollar enterprise.

Further, the standards for the professional practice of internal auditing require that theorganizational status of the internal auditing department be sufficient to permit theaccomplishment of its audit responsibilities. While a dual-reporting relationship is possible (tothe Audit Committee and to Senior Management), internal auditors must be objective, andobjectivity requires that internal auditors do not subordinate their judgment on audit matters toothers. The Internal Audit Division was created in 2005 in response to a City Council Motion(Council File No. 04-2416), which stated that the newly-created internal audit unit should reportdirectly to the BOAC to provide a direct line of communication with the individuals responsiblefor oversight of the department. The Motion also requested LAWA (and other Citydepartments covered by the motion) to strengthen their internal audit capabilities, including anyadditional staffing and resources that are necessary.

At LAWA the Internal Audit Manager presents the annual audit plan to the BOACs Audit andEthics Committee. The Internal Audit Plan is the product of a risk assessment, which identifiesdivisions and functions to be audited based on certain risk factors. However, the risk assessmentresults can be modified by LAWA management prior to presentation to the BOACs Audit andEthics Committee. Further, LAWA Executive Management reviews and may requestmodifications to Internal Audit reports prior to their presentation to the BOACs Audit andEthics Committee.

In addition, when matters from other LAWA personnel are brought to the attention of Internal

Audit, the Division does not have the authority to commence an investigation regardingallegations without management approval. If management determines that the allegation is notmaterial or significant, the investigation will not take place. These actions, while contrary to theprinciples of an independent internal audit function, may be due to the perception that theInternal Audit Manager does not have the operational understanding or perspective to evaluatethe relevant risks and the optimal use of internal audit resources.


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Internal Audit has also experienced staff reductions in recent years. Presently, Internal Audit hasa staff of four auditors, and functions primarily to facilitate contracted audits or minor specialprojects. While staffing reductions may be balanced by allowing the Division to outsourceaudits, it is essential that Internal Audit employ and retain personnel who are competent toperform a meaningful risk assessment, monitor the status of prior audit deficiencies and

recommendations, direct and evaluate the work of external contracted auditors, and performshort-term investigations when the need arises. A strong independent internal audit departmentcan serve as a crucial resource for an organization, like LAWA, that is experiencing a significantamount of change.

Limiting the independence of the Internal Audit division may redirect the audit focus from areasthat are LAWAs high risk areas.

Recommendation #3: LAWA should provide the Internal Audit Division a more independentorganizational placement, equip the function with more senior leadership, and provide greateraccess to information and a more prominent role in monitoring LAWAs overall compliancewith approved policies, legal requirements, management directives and the internal control

framework. While staffing reductions may be balanced by allowing the Division to outsourceaudits, it is essential that Internal Audit employ and retain personnel who are competent toperform a meaningful risk assessment, monitor the status of prior audit deficiencies andrecommendations, direct and evaluate the work of external contracted auditors, and performshort-term investigations when the need arises.

______________________________________________________________________________

Organizational Communication

Finding #4: Communication of BOAC and managements goals, strategies and plans,

both short-term and longer-term, is not adequate to ensure awareness byDepartment staff. As a result, opportunities to gain insights and

knowledge from those serving LAWAs constituents may be lost.

The BOAC has directed executive management of LAWA to initiate and implement an ambitiousplan to modernize, improve and provide for previously deferred maintenance and upgrade ofairport facilities. Plans include areas requiring urgent attention as well as longer termdevelopment goals. Although management has implemented various measures designed to fostercommunication of goals, objectives and strategies, such as meetings, open forums, newslettersand web site postings, communication of these initiatives to lower level employees has not beeneffective and those we interviewed were generally not aware of LAWAs long-term plans and

current initiatives. In addition, Executive Management appears to have overall goals andobjectives, some of which are shared with division directors; however, it appears that manyemployees below that level are not involved or knowledgeable of future plans or changes.LAWA continues to function primarily in a reactive mode and therefore staff is workingdiligently to complete their daily tasks while remaining unaware of any impeding changes orgoals.


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There is currently no process for the establishment of individual performance goals which arelinked to Division goals and ultimately to the overall LAWA goals. Such a system couldfacilitate the communication of goals and of strategies employed and planned to attain thosegoals. However, staff does not have the benefit of performance goals and measures whichwould improve top-down communication as well as facilitate effective performance of staffs

daily duties and responsibilities, and further the accomplishment of organizational goals andobjectives.

LAWA also does not have codified and comprehensive standard operating policies andprocedures addressing finance, budget, accounting and financial reporting sections. The absenceof centralized and current policies and procedures is of heightened importance in the currentenvironment of change due to large-scale improvement and modernization. A changingorganization leads to evolving policies and procedures. Communication of new policies andprocedures is critical to managing the risk associated with organizational change. The lack offormal codified policies and procedures presents a risk that revised policies may not beimplemented and conflicting policies may co-exist.

LAWA is a large organization with numerous divisions and departments. Eachdivision/department focuses on their primary tasks or roles. Some divisions have as few as threemembers, and communication between them is limited unless necessary for completion of dailytasks or projects.

The small size of the executive management team reduces the time available for communicationwith staff throughout the organization. The existence of multiple divisions further complicateseffective communication. And finally, the absence of individual performance goals andmeasures linked to the organizations goals and performance measures as well as the lack ofcodified, comprehensive documented policies and procedures obstructs employees efforts toobtain current information in these areas.

Communication throughout an organization the size of LAWA is challenging. However, in orderto ensure that all members of a cohesive organization strive to further the entitys mission andachieve its goals and objectives, and do so in a cost effective and efficient manner and incompliance with BOAC policies and managements directives, all employees must have accessto pertinent information on a timely basis.

RECOMMENDATION #4: LAWA should endeavor to consolidate, codify, communicate andpublish on its intranet all significant policies and procedures. These should be updated routinelyas new additions and revisions occur. Management should also develop methods to disseminateorganizational goals, strategies and plans throughout the organization at a level of detailappropriate for the subject matter. Methods may include a formal process of communicating andlinking the organizations goals, objectives and strategies to those of each division and eachemployee within the division, as well as expanded use of the LAWA intranet, meetings, andtraining sessions.


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SECTION II - FINANCIAL PLANNING AND RISK MANAGEMENT

LAWA has initiated an aggressive modernization and improvement program with attendantincreases in staffing and contracting activities and upgrades to the technology environment.Significant change increases risk, and accordingly LAWAs need for a formal Enterprise RiskManagement (ERM) Process is heightened.

______________________________________________________________________________

Lack of Formal Enterprise Risk Management (ERM) Processes

Finding #5: LAWA does not have a formal Enterprise Risk Management Program for

the purposes of proactively identifying risks and developing mechanisms tomanage or eliminate risks to the achievement of LAWA objectives. LAWA

has also not implemented a complete enterprise-wide information

technology (IT) risk management process for further understanding of itsinternal technology control structure and potential control weaknesses, and

creating an effective plan of action for controlling those risks.

The goal of an effective enterprise risk management program is to help an entity, on anorganization-wide level, identify, document, prioritize, and mitigate risks whenever possible.This allows management to manage risks proactively, predicting when a risk will occur andassessing the impact it will have on the organization. A 2008 report issued by the City of LosAngeles Controller recommended that all City departments implement an organization-wideERM program; in order to identify, assess, aggregate, monitor and mitigate risks on a consistentbasis. A 2004 report by the Committee of Sponsoring Organizations of the Treadway (COSO),which is used by many large governmental entities as an internal control model, recommendedthat organizations implement ERM programs as part of their internal control structures and toprovide reasonable assurance regarding the achievement of entity objectives. This concept has

been further promoted through the 2002 Sarbanes-Oxley legislation and by the Securities andExchange Commission and Public Company Accounting Oversight Board.

LAWAs Internal Audit department has conducted an organization-wide risk assessment in aneffort to establish and identify areas of concern for consideration when developing their annualaudit plan. The risk assessment involved accumulating data and information from the variousdivisions/departments at LAWA as appropriate to develop a ranking of risk. This audit riskassessment has been utilized exclusively to develop and propose Internal Audits audit plan.LAWA also has a risk management group but its focus is primarily on workers compensation andother insurance related matters. There is an IT Security function that incorporates a number ofbest-practice information security controls. However, this IT Security function is not responsible

for other areas of the IT control structure that can have an impact on risk such as businesscontinuity, application controls over data integrity, process-based controls, physical andenvironmental controls, systems development, staffing, vendor management, projectmanagement, data backup and restoration, and strategic planning.

We are not aware of other organization-wide risk assessments and evaluations. Each of LAWAsdivisions is solely responsible for identifying, assessing, monitoring and mitigating risks withintheir respective divisions.


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As noted previously, LAWA is a large organization that is moving quickly and has functionedprimarily in a reactive mode with respect to risk management. Many or most employees areworking to complete their immediate tasks, and tend to focus on their specific area orresponsibilities. Executive Management has focused on those activities determined to be themost critical or crucial. LAWA captures risk at the divisional level and such risks are to be

resolved by individuals (division directors) with the authority to implement the necessarychanges within their division to address the risks identified. With respect to informationtechnology, LAWA has primarily focused on IT risks to meet the current demands that externaland internal threats place on an organization of its size, complexity, and notoriety. Managerialprocesses that allow management to better understand technology risks and controls at thevarious levels of the organization have not taken shape.

The implementation of a formal ERM program would provide LAWA with the opportunity toconduct an organization-wide risk assessment and develop consistent methodologies forresolving and mitigating identified risks. An organization-wide approach provides guidance,measurement and consistency on handling identified risks. Retaining LAWAs divisionalapproach to risk assessment continues a focus on LAWAs divisions as independent components

of the organization and does not recognize the potential effect of risk threats and managementacross divisions. Through a formal, structured organization-wide process, the capturedinformation can be utilized to improve future planning and decision making. Ultimately, thepurpose of all ERM programs is to establish processes which lead organizations to betterdecision making, improving operations and reducing the impact of risks.

Recommendation #5: To enhance the risk identification and management processes, andconsistent with best practices, LAWA should work to develop and implement an overallorganization-wide ERM. The ERM should provide a structured and continuous process foridentifying, assessing, responding to and reporting on opportunities and threats that affect theachievement of LAWAs objectives. The ERM should also incorporate an integrated approach

to information technology risk management that provides for the identification, measurement,monitoring and controlling of technology-related risks throughout LAWA, and that will betreated as an essential management function of the organization.

SECTION III - BUDGET DEVELOPMENT AND CONTROL

The City Council of the City of Los Angeles has adopted a phased approach to the City-wideimplementation of performance based budgeting in an effort to utilize performance metrics tostrengthen program evaluation, set outcome-based priorities, increase accountability, and linkperformance measures to resource allocation. To comply with this directive and to realize thebenefits of a fully functional cost accounting system, LAWA will require an improvedaccounting system.

Lack of Performance Based Budget Process

Finding #6: The LAWA budgeting process does not include consideration of levels of

performance in relation to budgeted costs. Further, the cost accounting


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system does not provide costing information by activity as necessary to

fully evaluate the costs of providing services to airlines, concessionaires,

the general public and other stakeholders. Accordingly, because the

accounting system does not measure and report performance measures orthe costs of achieving any specific level of performance, data is not

available to implement a comprehensive performance-based budget.

Performance-based budgeting considers the relationship between program funding levels andexpected results. This approach, which involves weighing accomplishments in relation toresource consumption, has been advocated by many governments at all levels since the 1990s.Recognizing that performance budgeting provides an objective basis for the allocation of scarceresources, the City of Los Angeles is undertaking an effort to implement performance budgetingCitywide. The LAWA budget is not a performance-based budget. Rather, it addresses revenuesby type (landing fees, rentals, user charges) and expenses by object (salaries and benefits,materials and supplies, contractual services, etc.). These budgeted costs are not based on atargeted measure of performance, such as number of landings, square footage of building heatedor miles of landing strip maintained. Such costing information, when available, allows for

comparisons of cost effectiveness within LAWA and in relation to other airports.

LAWA has primarily accounted for its costs by individual transaction (invoice, payroll report)aggregated by type of expenditure (payroll, materials, services and capital), and further groupedby division or subdivision for management reporting purposes. Historical accounting data hasbeen updated on a regular basis, however, other information useful in calculating and estimatingthe cost of service or function has never been fully developed. Accordingly, the costs ofescalator maintenance cannot be reviewed to help decide when replacements are required; thecosts of electricity or water consumption at terminals cannot be compared to determine unusualvariances; and costs per unit of activity are not known so that exceptional productivity or betterwork practices cannot be identified and acknowledged. LAWA has made attempts to estimate

such data utilizing excel and extracted data, however, it is not systematically captured. LAWAhas also made an attempt, via the purchase of MAXIMO, an asset management softwarepackage, to track certain facilities costs.

LAWA has utilized its SAP general ledger system to effectively provide historical financialstatements in conformity with generally accepted accounting principles. This information hasserved the organizations needs in the past, but it is not sufficient to support strategic analysis ofcosts compared to productivity, or to provide automated notifications of higher than expectedcosts in specific functional or geographic areas.

Recommendation #6: LAWA should prepare for the implementation of performance budgeting

by acquiring or developing the tools to identify, analyze and report the costs of key activities.LAWA should coordinate the performance based budgeting process with the establishment ofgoals and objectives for divisions and the organization.


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SECTION IV - REVENUE MANAGEMENT AND DEVELOPMENT

LAWAs revenues are derived primarily from airlines and concessionaires, and the amountsfluctuate based on volume of passengers served, sales, and related measures which are self-reported by the payers. It is therefore vital that the information on which the revenues are basedis validated by LAWA in a comprehensive and professional manner. LAWA has been verysuccessful with collecting amounts due and has a low rate of uncollectible accounts. However,when accounts are delinquent, it is important that all customers be treated equitably, in terms ofinterest and penalties applied on delinquent balances.

______________________________________________________________________________

Audits of Self-Reported Revenues

Finding #7: Self-reported revenues from airlines and concessionaries are audited on a

test basis and audit results are not validated in accordance with LAWAspolicies and documented procedures.

Audits are performed on selected contractors based on identified risk factors. Accordingly,revenues from some sources are not subject to audit annually. For audits that are conducted, thetest period is, per the audit guidance provided by the concessionaire auditors, to be two to threemonths total for each fiscal year within the audit period, which is generally a three-year period.However, all five of the audits we reviewed included tests of only two sample months coveringthe entire three years of self-reported revenues. We noted that the total amount of revenuesassociated with the audits selected represents a minor percentage of the total self-reportedrevenues.

The identification of errors resulting from audit tests of a sample of transactions indicates aheightened risk for additional errors, weak systems of internal control, or improper reporting at

the direction of auditee management. Accordingly, the sample size and therefore the scope oftesting should be expanded. We noted that audit exceptions did not result in expanded testworkbut rather were extrapolated on a non-statistical basis in order to calculate the dollars associatedwith the exceptions noted. Accordingly, there was no determination as to whether the errorswere isolated, indicative of a larger control deficiency, or caused by changes in personnel, newsystems, or other factors which could mitigate or expand the significance of the error. Errors inreporting of self-assessed revenues are indicative of poor systems or a willful failure to adhere toagreed procedures. In either event, their existence should lead an auditor to increase the riskassociated with the entity, increase the sample size and place the entity on a list for increasinglyfrequent audits. This does not occur at LAWA.

The unit that conducts audits of self-reported revenues, consisting of 6 auditors, is not part of theInternal Audit Division, although its staffing includes Internal Auditor positions as defined bythe City of Los Angeles position descriptions and it is led by an experienced internal auditor.Considering the sensitive nature of these audits, this function should be based on annual riskassessments and performed in accordance with professional auditing standards and LAWApolicy. Currently this does not occur.


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The existence of two separate audit functions within LAWA was justified with the rationale thatone function focuses on internal LAWA operations while the other focuses on externalconcessionaires, lessees, etc. However, combining these functions could allow all auditpersonnel to benefit from standardized processes in accordance with professional auditingstandards, training programs, and enhanced review processes. LAWA would benefit by realizing

efficiencies in scheduling audit staff resulting in less non-productive time. Further, the numberof audits performed and the quality of audits undertaken by both functions would likely improvewith additional experienced personnel available to each function.

Self-reported revenues from airlines and tenants represent a significant source of revenue toLAWA. Deviations from policies can affect LAWAs ability to negotiate with the airlines orthose that owe LAWA money. In some instances, we noted that although amounts were paid toLAWA, the airlines maintained a stipulation that they did not agree with the calculated amounts.These discrepancies are then subject to discussions and negotiations. If auditors do not followstated policies, LAWA can be subject to further discrepancies.

RECOMMENDATION #7: LAWA should consider the following actions:

a) Consider incorporating the responsibility for audits of self-reported revenues into theInternal Audit Division.

b) Expand documentation to include explanations as to why deviations from LAWA policyappeared reasonable to the auditor. A coverage target should be established, so thatmanagement can gain a level of comfort that a reasonable range (5% or 10%) of totalself-reported revenues is being reviewed. Any decisions to negotiate audit results orforego expanded tests of apparent system deficiencies should require the documentedreview of top management.

c) Consider engaging an external consultant specializing in this area to conduct one or moreaudits as a co-sourcing opportunity, in order to evaluate their approach and methodology

and, if deemed beneficial, incorporate lessons learned into future LAWA audits. LAWAcan then utilize best practices to develop a revised program for LAWAs revenuecompliance audit activities. Development of a coverage minimum should be establishedas a goal for the department.

______________________________________________________________________________

Adherence to Contract Terms Regarding Delinquent Collections

Finding#8: Interest and penalties resulting from late payments pursuant to

contractual agreements (such as airlines and tenants) are not consistently

charged or computed by the Revenue Asset Management System asallowed by contract terms and conditions.

LAWA has as achieved a high receivables collection rate. However, an opportunity exists toimprove internal controls, ensure consistent treatment of contractors, and potentially furtherenhance the collection rate of delinquent accounts. Interest and penalties resulting from latepayments pursuant to contractual agreements are not computed automatically by the system andare therefore not charged or collected in accordance with the contracts terms and conditions. Wewere informed that LAWA has a standing unwritten policy of not assessing penalties and intereston delinquent invoices, although interest is charged on approved repayment plans.


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The decision as to whether and how much to charge with respect to interest and penalties restswith the Designated Contract Administrators and Division Heads who are also responsible fornegotiating contract terms and monitoring compliance, thus creating independence concerns.Decisions to not charge interest and penalties result in lost income. Interest and penalties areprovided for in the Airport Facilities Use Terms and Conditions. The agreement stipulates that a

late charge and even an additional late charge are to be levied for delinquent payments.Therefore, the non-charging of late payment fees is a violation of the terms and conditions of thesigned agreement or contract.

All revenues subject to negotiated terms should be based on the terms and conditions of thesigned agreement or contract. These revenues should be completely and accurately accountedfor, monitored and reported in the financial statements. Even if the interest and penalties arewritten off, the calculation of such amounts provides useful information to LAWAsmanagement, airlines and tenants and can be useful for future negotiations or decision makingprocesses. The reason interest and penalties were waived, according to Division Managers, wasthat the waivers were necessary to maintain good business relationships.

We obtained the accounts receivable aging (Top 25 over 60 days) as of May 1, 2012. From thisschedule, and using conservative interest rates, unbilled interest and penalties would exceed$834,000. Based on the nature of the amounts owed and the work performed by LAWAsdepartments responsible for follow up and investigation, including the City Attorney, some ofthese amounts would be subsequently written off. However, other amounts would be subject tocollection and would represent additional resources for the LAWA organization.

Recommendation #8: We recommend LAWA take the following actions:

a) Revise policies and procedures to incorporate a consistent approach to calculatingpenalties and interest pursuant to contractual agreements. In addition, a consistent policyshould be communicated and enforced regarding the waiver of interest and penalties.

b) Ensure that any write offs or forgiveness of amounts are reviewed and approved bysomeone independent of the contract monitoring and negotiation function. Further,LAWA should perform consistent calculations of these penalties and interest amounts.

SECTION V - CONTRACT MONITORING AND PROCUREMENT

Recognizing the high volume of procurement activity associated with the improvement andrenovation activities presently underway, LAWA has created the position of Designated ContractAdministrator. The role of this position is to promote and facilitate compliance withprocurement policies, laws and regulations.

______________________________________________________________________________


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Utilization of Designated Contract Administrators

Finding #9: Management of compliance with procurement contracts is weakened by

process deficiencies and the lack of initial and continual involvement ofdesignated Contract Administrators.

Designated Contract Administrators are not consistently involved throughout the project lifecycleand their expertise is not always utilized in providing administrative policy guidance, especiallyat the inception of the process. Due to their lack of involvement, instances of erroneous and/ormissing information have been identified, indicating that certain contracts do not comply with theadministrative requirements. These contractual deficiencies require LAWA personnel to performadditional procedures to resolve such discrepancies. It is the view of the Procurement ServicesDivision that early and continual involvement of the Contract Administrators would significantlyreduce the number of discrepancies. Our review of discrepancy reports noted that matters wereidentified including errors, payments after contract expiration, payments to contractors with noinsurance, payments inconsistent with the purchase order, payments for services outside of theapproved service period and payments in excess of authorized amounts.

According to LAWA policy A Designated Contract Administrator (DCA) is a LAWAemployeethat is responsible forensuring the respective Division or Office complies withall Board of Airport Commissioners policies, regulations and other applicable laws thatgovern the LAWA procurement process. This position is responsible for all aspects ofcontract administration from identification of potential contractors to close-out and evaluation ofcontractor performance on completed contracts. Their participation in the administration ofcontracts is an important component of the internal control structure in this important area.

Project/Contract Managers lack adequate training on LAWAs Procurement Policies andProcedures. The DCAs mitigate this weakness because they are familiar and well-trained in

LAWAs procurement policies and procedures. However, the DCAs are not included as part ofthe Project Team at the Project planning phase. Including the DCAs at this phase maybring value to the Project and the Project Team as they could provide up-to-date information onprocurement policy and procedures that may set the project on an appropriate procurement track.In addition, the DCAs could provide feedback on any problematic vendors or firms whichLAWA has utilized in the past in order to correct or avoid future similar concerns.

Recommendation #9: LAWA management should further develop, clarify, communicate andintegrate into the initial project phases the roles of DCAs and Project/Contract Managers inorder to optimize divisional administrative expertise and ensure adherence to LAWAProcurement Policies and Procedures. Also, DCA training on LAWA Procurement Policies andProcedures should be extended to any and all project cost managers.

SECTION VI - CAPITAL ASSET MANAGEMENT AND INVENTORY CONTROL

The LAWA modernization program, coupled with hardware, infrastructure and mobile devicesassociated with updated technology, will greatly increase the Departments capital assetsinventory. Controls over these capital assets, including the periodic physical inventories, will


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assume greater importance. While construction is underway, systems to account for constructioncosts, including engineering, architectural, construction contracting, legal and in-house labor,become critical in forecasting and managing costs and ensuring accountability.

______________________________________________________________________________

Absence of Periodic Inventory of Fixed Assets

Finding #10: There is no regular physical inventory of capital assets, including

furniture and equipment, fleet inventory, and supplies. LAWA policydoes not require that the weapons inventory used by LAWA police be

subjected to an externally validated physical count, and no such

validation has occurred by internal or external auditors.

The last physical inventory of capital assets (equipment and furniture) was in 2008. The lastphysical count of supplies inventory was January 2011, and this count contained errors requiringa second inventory count which was performed in June of 2012. There is no record of a physical

inspection of all fleet vehicles occurring in recent years. LAWA policy requires that LAWApolice conduct their own audit of all City-owned firearms. However, there has been noverification of the weapons inventory by an independent party such as the Internal AuditDivision.

LAWA maintains policies and procedures for fixed assets and inventories. There are also policiesfor the Facilities Management Group (FMG) which cover a comprehensive range of airportplanning, engineering, environmental and maintenance services associated with the developmentand management of LAWA facilities. However, there is no regular physical count of capitalassets, fleet vehicles and supplies inventory. Because capital assets and inventory counts werenot made on a regular basis, and weapons inventory is not independently validated, there is no

assurance that the recorded assets and inventory are accurate because they have not been verifiedby inspection.

Section 2.4.1 of the Controllers User Department Manual requires departments such as LAWAto conduct biennial physical inventories of all equipment items. It also requires that, uponcompletion of the inventory, all changes/discrepancies be annotated on the inventory listings andbe reported to management for review and corrective action. At LAWA, responsibility for mostassets falls within each division and each division is to perform periodic counts of its assignedassets. There is no central point of responsibility to monitor compliance with this area.

LAWA is currently evaluating and developing policies and procedures to conduct physicalinventories of capital assets, in addition to smaller equipment (i.e. phones and tablets) and hastaken steps to start the inventory process for the larger more significant capital assets.

LAWAs capital assets represent a significant portion of the balance sheet. As LAWA continuesto renovate, these amounts will continue to grow. Although the risk of material misstatement issomewhat reduced by the fact that many of the capital assets are immoveable, many aremoveable and a physical inspection also helps to identify potential impairment or obsolescenceof the asset which should be reflected in its recorded value.


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Recommendation #10: LAWA should ensure that inventory counts are conducted periodicallyat the division level and ultimately every two years as an organization. A department (InternalAudit, Financial Accounting or Procurement) should be assigned the responsibility of collectingthe information regarding interim asset counts, reconciling the counts to the general ledger andverifying the count results.

______________________________________________________________________________

Incomplete and Inconsistent Recording of Construction Expenditures

Finding #11: Reports of construction expenditures produced by PROLOG, LAWAsconstruction management software, do not consistently agree with

construction project expenditures as reported in the general ledger.

The PROLOG-generated construction expenditure reports are providedto Executive Management for their use in evaluating the progress and

costs of the capital improvement program (CIP).

LAWA is in the midst of a major capital improvement initiative involving the expenditure of

more than $4 billion towards construction costs. To facilitate the planning, coordination,accounting and monitoring of capital costs, LAWAs Capital Development Group hasimplemented a Project Control System using PROLOG, a contract monitoring system. PROLOGis not integrated with SAP, LAWAs official general ledger system. Although PROLOGinformation is regularly reconciled to SAP by those who prepare the PROLOG reports, themonthly reports submitted to the Executive Management and the Board of AirportCommissioners are based on un-reconciled PROLOG information that may include materialdifferences in project amounts when compared to SAP-generated information. Further, thePROLOG reports are not reviewed and variances from the general ledger are not investigated bythe Financial Reporting Division which is responsible for LAWAs official audited financialstatements.

PROLOG reports may have material differences in project amounts when compared to SAP-generated information due to data entry errors or the timing of recording information, such as thefollowing:

1. Initial planning costs2. Contract retainages3. Environmental costs4. Research costs5. Other costs recorded via journal voucher.

These reconciling items are typically recorded in the SAP general ledger system at a later time.

For example, contract retainage amounts are generally not recorded until the final retainage is tobe paid. This practice may result in the omission of material unrecorded liabilities from theLAWA financial statements. During our audit we noted unrecorded contract retainage liabilitiesof more than $24 million.

The magnitude of the capital improvement program demands complete, accurate and timelyreporting of construction costs and related liabilities as required by generally acceptedaccounting principles and for effective financial oversight and management. However, the


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PROLOG system and the SAP general ledger systems are not integrated nor are they reconciledby Finance Division personnel. The lack of integration between systems is a significantcontributor to the variances noted.

The existence of two accounting systems reporting conflicting information places LAWA at risk

of making management decisions based on reported information which may not be entirelyaccurate. Significant variances between PROLOG and SAP information potentially affect thesedecisions.

RECOMMENDATION #11: LAWA should investigate the feasibility of integrating thePROLOG and SAP systems. If this is not realistic, the LAWA Financial Services Divisionshould obtain copies of the PROLOG reports and related reconciliations on a timely basis andensure that costs and liabilities are recorded in the SAP general ledger system when incurred.Further, management should inform users of the PROLOG reports of the potentialunderstatement of costs in order to more accurately evaluate project costs.

SECTION VII - DEBT MANAGEMENT AND BOND FINANCING

As the primary instrument for financing LAWAs capital program, long-term debt has increasedsubstantially in the past five years. The magnitude of LAWAs debt demands vigilantmonitoring against a comprehensive debt management policy.

Debt Management Policies

Finding #12: LAWA has a debt management policy in place which is incomplete andhas not been updated for at least six years.

The existing debt management policy has many prudent provisions including requiring thatactivities be consistent with the debt management policy of the City of Los Angeles and that theBOAC and the City Council approve the issuance of debt and establishment of rates in amountssufficient to meet the revenue requirements associated with outstanding and newly-incurred

audit of the los angeles world airport's financial operations

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