SD18 - Internal Service Funds Within the Department of General Services


Executive Summary:
Internal service funds are used to finance and account for goods and services provided by one agency to other governmental agencies or units on a cost-reimbursement basis. When properly administered, these funds can take advantage of economy of scale savings through centralized operations.

The Joint Legislative Audit and Review Commission (JLARC) has certain oversight responsibilities for internal service funds as defined in Section 2.1-196.1 of the Code of Virginia. In keeping with JLARC's oversight responsibilities, reviews of the funds are completed about every five years.

This review examines the five internal service funds within the Department of General Services (DGS): Central Warehouse, the Office of Graphic Communications, State Surplus Property, Federal Surplus Property, and Maintenance and Repair Projects. The review focused on both financial and operational aspects of each of the internal service funds. Study activities assessed rates and charges, fund balances, billing procedures, operational efficiency, and user satisfaction.

In general, review findings indicate that some of the internal service funds are well-managed, while others experience financial and operational difficulties. The majority of fund users are satisfied with service provision. The major exception occurs in the maintenance and repair area, where user responses are mixed. Additional attention should be given to financial concerns such as rates and charges, while a total of $162,245 in excess funds should be transferred to the general fund.

This report summary briefly references study findings and recommendations. Detailed explanations of analyses and findings are contained in the text of the report.

General Concerns (pp. 7-14)

Most issues examined during this review of internal service funds within DGS related directly to one of the five specific funds. Four general concerns which affect all five funds were also reviewed.

Inconsistent Terminology within the Code of Virginia. The Code of Virginia contains inconsistent references to internal service funds. The Governmental Accounting Standards Board recommended substituting the term "internal service fund" for "working capital fund," and JLARC subsequently recommended adoption of the terminology change within the Code in 1982. Although two sentences within Section 2.1-196.1 were amended, other references within Sections 2.1-196.1 and 2.1-425 still contain references to "working capital fund" accounts. These references should be updated to reflect the new terminology.

Recommendation. During its next review of Title 2.1 of the Code of Virginia, the Code Commission should substitute the term "internal service fund" for "working capital fund" in the instances in which it still appears. This revision would reflect currently accepted terminology and ensure consistency in the use of the terms and in the interpretation of the Code.

Designation of Functions as Internal Service Funds. A review of DGS operations indicated that the five current internal service funds are appropriately designated as such, and that no other DGS section warranted formal designation as an internal service fund. For financial reporting purposes, the Auditor of Public Accounts and the Department of Accounts have decided to report Risk Management's financial data according to internal service fund guidelines to comply with generally accepted accounting principles. However, Risk Management should continue to be designated and budgeted as a trust and agency fund. In addition, DGS should contract for the completion of actuarial studies for a number of its insurance programs.

Recommendation. The Division of Risk Management should continue to be designated and budgeted as a trust and agency fund. The Auditor of Public Accounts and the Department of Accounts, however, may report financial data according to internal service fund guidelines to comply with generally accepted accounting principles.

Compensation for Administrative Support. DGS has lacked a clear, consistent policy in regard to charging its non-general fund units for administrative support. This has resulted in internal service funds being inconsistently charged for support services, which has not allowed fund staff to plan for such expenditures and consider them when calculating rates.

Recommendation. The Department of General Services should develop a comprehensive and consistent methodology for assessing administrative support costs to its non-general fund sections. This methodology should serve as the basis for a cost allocation plan for administrative support services. The internal service funds should not be charged for unbudgeted, random departmental expenses.

Transfer of Excess Earnings. JLARC is specifically authorized by statute to transfer excess internal service fund balances to the general fund. Such transfers can be problematic, however, if the fund balance includes fixed assets which cannot be readily converted into cash. An internal service fund which has a significant investment in fixed assets or inventory may show a high fund balance without having cash resources to revert to the general fund.

A more reasonable approach would be to examine each internal service fund's cash resources to determine whether excessive earnings have been retained. A guideline for maximum cash resources which examined both average expenses and the time required to collect accounts receivable was developed for the internal service funds.

Recommendation. Cash resources rather than fund balance should be used in determining whether internal service funds have retained excess earnings. This would ensure that fund transfers are based on liquid assets, rather than fixed assets or inventory.

Central Warehouse (pp. 15-32)

Central Warehouse was established July 1, 1960, to provide State agencies and political subdivisions with a centralized purchasing and distribution center. Approximately 822 State agencies, political subdivisions, and non-profit organizations purchased from the warehouse during FY 1987.

Central Warehouse has experienced financial difficulties since the last JLARC review in 1982. The warehouse's overhead mark-up has not covered the full cost of its operation, resulting in a steady reduction of its cash resources. Although the Warehouse applies a mark-up of 5.8 percent to the acquisition cost of all items sold to cover its overhead expenses, its cash resources have steadily deteriorated since FY 1983. On June 30, 1987, the warehouse had a cash deficit of $1.56 million. This indicates that the mark-up percentage should be increased.

Recommendation. Central Warehouse should request a revised mark-up that will cover its operational costs and eliminate its cash deficit within five years.

Central Warehouse has improved its efficiency in several operational areas including: the establishment of item reorder points, an increase in the fill rate for customer orders, a decrease in the inventory error rate, and a decrease in the delivery time required for small orders. However, the warehouse still needs to improve its accuracy in filling orders and the quality of its inventory controls.

Recommendation. The Central Warehouse should take steps to improve inventory controls and decrease its inventory error rate and gross stock adjustment ratio. Special efforts should be taken to verify the accurate filling of orders.

Additional recommendations are made for increased supervision of warehouse operations, different treatment for accounting purposes of prompt payment discounts, quarterly price and item updates for customers, and other operational modifications.

Office of Graphic Communications
(pp. 33-40)

In December 1980, the Office of Graphic Communications was created as an internal service fund. Graphic Communications provided graphic design, publication layout, and other graphics services to 61 State agencies during FY 1987.

The Office of Graphic Communications appears to be well-managed both financially and operationally. Areas which warrant attention relate to the reversion of excess cash resources to the general fund, billing improvements related to the timely collection of accounts receivable, and staffing needs.

The Office of Graphic Communications held cash resources of $62,567 at the end of FY 1987. By comparing these resources to the guideline recommended in this study, $15,414 in excess earnings were identified for reversion to the general fund. Further financial review indicated that billing procedures for the Office of Graphic Communications were adequate, although an excessive 52 percent of accounts receivable were outstanding for 31 or more days.

Recommendation. JLARC should direct the Comptroller to transfer$15,414 in excess cash from the Office of Graphic Communications internal service fund to the general fund.

Recommendation. The Bureau of Fiscal Services should follow up on all Office of Graphic Communications' accounts receivable which are outstanding over 30 days. In addition, OGC should review its billing procedures to ensure that practices and communications encourage prompt payment.

In general, the Office of Graphic Communications operates well. Although minimal records were kept regarding overtime worked and service requests denied during FY 1987, the office director believes that staffing is inadequate to fulfill all service requests.

Recommendation. The Office of Graphic Communications should work with Department of General Services management to replace one temporary artist position with a salaried artist position. In addition, the Office of Graphic Communications should maintain records of all service requests denied and overtime worked by staff. These records will provide OGC management with quantifiable justification for future staffing requests.

State Surplus Property (pp. 41-50)

State Surplus Property was established as an internal service fund on July 1, 1984. This internal service fund is responsible for the transfer and sale of property that has been declared as surplus by State agencies.

The State Surplus Property operation appears to be well-managed. Operationally, no problems were noted during the review. The only concern relates to the retention of excess cash resources. State Surplus Property ended FY 1987 with cash resources of $82,768. By applying the guideline recommended in this report, $15,766 in excess holdings were identified for reversion to the general fund.

Recommendation. JLARC should direct the Comptroller to transfer $15,766 in excess funds from the State Surplus Property internal service fund to the general fund.

Federal Surplus Property (pp. 51-64)

A federal surplus property redistribution operation has functioned since the 1940s. It was established as an internal service fund on July 1, 1986. Over 1,000 State agencies, political subdivisions, and non-profit organizations are currently eligible to receive property through the Federal Surplus Property program.

Federal Surplus Property has demonstrated both financial and operational problems recently. A combination of low service charges and a decline in the quality of goods available from the federal government resulted in Federal Surplus Property being unable to generate adequate revenue to cover expenses for the past two years. Consequently, a total of $135,807 in net losses were incurred for FY 1986 and FY 1987. Further, the collection of outstanding accounts receivable warrants improvement.

Recommendation. Federal Surplus Property should set service charges at levels that cover the cost of its operations. If this is impossible due to the quality of available federal surplus property, the Department of General Services should assess the long-term prospects for FSP and consider submitting a proposal to JLARC outlining options for FSP, including elimination of the function.

Recommendation. The Department of General Services should take two steps to aggressively follow up on overdue Federal Surplus Property accounts. First, the Bureau of Fiscal Services should aggressively follow up on accounts which are outstanding for over 60 days. Second, the administrator of surplus property programs should take corrective action against donees which have accounts that are outstanding for more than 90 days.

For the last four years, Federal Surplus Property's ending inventory value has steadily risen, but the donation of surplus property has not kept pace with the acquisition of property. Corrective measures have been initiated to address this redistribution problem. Further, the program seemed to be heading towards an unfavorable equipment position during FY 1987. Development of a vehicle and equipment replacement schedule would ensure that equipment needs are met at all times and that disproportionate replacement costs are not incurred in anyone year.

Recommendation. DPS management should monitor the success of the changes instituted to increase the donation of federal surplus property. At the end of FY 1988, the amount of property donated should increase while ending inventory should be significantly lower than at the end of FY 1987.

Recommendation. The surplus property administrator should develop a vehicle and equipment replacement schedule for Federal Surplus Property.

Maintenance and Repair Projects
(pp. 65-92)

The Bureau of Buildings and Grounds is responsible for the maintenance of 36 buildings at the seat of government. The maintenance of five of these buildings (the Highway Building, the Highway Annex, the Jefferson Building, the Capitol, and the General Assembly Building) has been financed by the Maintenance and Repair Projects fund since January 1, 1985.

While the Bureau of Buildings and Grounds has provided better maintenance and repair services since it ceased carrying out construction and renovation work in 1984, financial and operational problems still exist. Problems were found in the calculation of overhead charges, billing procedures involving the coding of some maintenance performed within the Capitol and the accuracy of worker timesheets, and the retention of unnecessary cash resources. The Bureau should also strengthen its supervision of contract custodial crews, implement service agreements with certain agencies, take additional steps concerning preventive maintenance, and improve communication with customer agencies.

Financial Concerns. The Bureau of Buildings and Grounds' service charges are composed of hourly labor costs, material and supply costs, and an overhead component used to recover administrative costs. No problems were found with the calculation of materials and supplies and labor rates. However, the methodology for computing the overhead rate should be revised to more accurately reflect administrative costs.

Recommendation. The Bureau of Fiscal Services should revise its overhead methodologies to eliminate inconsistent treatment of similar activities. The methodologies should provide for fair and equitable compensation for overhead expenses incurred in the conduct of Maintenance and Repair Projects activities. The revised methodologies and resulting rate should be presented to JLARC for approval prior to June 1988. The current rate of 20 percent should continue until the new methodologies are approved.

Two billing deficiencies were found during the review. First, worker timesheets contain coding mistakes which result in incorrect billing if they are not corrected. Second, a third cost code is needed to account for the shared building-wide costs in the Capitol. This deficiency resulted in 100 percent of Capitol charges being assessed to the legislature.

Recommendation. The Bureau of Buildings and Grounds should develop formal, mandatory procedures for reviewing worker timesheets. These procedures should include routine comparison of timesheets to original work orders and verification of the cost codes, building numbers, trade descriptions, and number of hours worked.

Recommendation. The Bureau of Fiscal Services should establish a third cost-code for the Capitol. This cost code should be used to account for services specified in the service agreement to be charged 85 percent to the legislature and 15 percent to the Governor's Office. The code should be in use by January 1, 1988.

The Maintenance and Repair Projects fund has maintained unnecessary cash resources of $131,065 for the past two years. Maintaining these resources is unnecessary, as the fund operates on a break-even basis by giving agencies credits for budget overages or collecting for budget shortages at the end of each fiscal year.

Recommendation. JLARC should direct the Comptroller to transfer $131,065 in excess funds from the Maintenance and Repair Projects internal service fund to the general fund.

Operational Considerations. Generally the Bureau of Buildings and Grounds has improved the provision of maintenance services in recent years. Three difficulties were observed in the custodial services area, however. First, Buildings and Grounds needs to more closely monitor the performance of the private custodial crews to eliminate unauthorized activities. Second, some day custodians do not have specific jobs and in some instances have to be told when routine jobs need to be completed. Third, the assignment schedule for a day custodian position in the Capitol, General Assembly Building, and the Bell Tower does not place custodial resources where they are most needed.

Recommendation. The Bureau of Buildings and Grounds should monitor the activities of the contracted nightly custodial crews more closely to ensure that prohibited activities such as using State phones and taking breaks do not occur.

Recommendation. The Bureau of Buildings and Grounds should develop a schedule of custodial tasks to be completed by the day custodians in the internal service fund buildings each week. Also, custodial supervisors should perform more structured inspections to ensure that tasks are being satisfactorily completed.

Recommendation. The Bureau of Buildings and Grounds management should shift assignment of the day custodial position assigned to the Capitol, General Assembly Building, and Bell Tower to ensure that custodial services are being provided at the most essential locations.

User Satisfaction. Representatives from each agency whose maintenance is financed through the internal service fund were surveyed to determine customer agency satisfaction with maintenance services. While opinions in most areas were fairly mixed, there was a strong consensus among the users regarding their discontent with the heating and air conditioning systems in their buildings. The need for improved communications between the Bureau of Buildings and Grounds and the internal service fund agencies was also noted.

Recommendation. The Bureau of Buildings and Grounds should take steps to improve communications with internal service fund agencies. This would include having workers notify agencies when work is being performed, notifying agencies when a partially completed task will be delayed, and annually distributing preventive maintenance and day custodian schedules to affected agencies. In addition, agencies should ensure that they understand service agreements and seek written clarification when they have questions concerning maintenance services.