How to determine local government materiality threshold policy

by | Jul 5, 2024 | BCS Management, Compliance, Municipalities, Project Management

When I say thief, what pops into your head?

More and more, the image of a hacker – like the one above – is conjured in our heads due to the rise of ransomware and similar cybersecurity threats. And yet, the most likely culprit is probably your own employees or elected officials. Like a firewall on a route for cybersecurity, internal controls help prevent the loss of government funds and property.

Key points in this article:

  • Materiality in a financial reporting or an accounting matter is an amount or item judged to be of economic significance
  • Indiana state law (IC § 5-11-1-27) requires all erroneous or irregular material variances, losses, shortages, or theft of government funds or property to be reported to the State Board of Accounts (SBOA)
  • The State examiner guides local government units to determine their own materiality threshold; or apply by default a $0 threshold.
  • Each political subdivision must consider the costs, benefits, and risks of setting a higher than $0 materiality threshold

Government accountability and transparency is a foundational principle to democracy. The voters, taxpayers, and ratepayers have entrusted the government with their money to provide a public good or service. Internal controls help safeguard that trust. And yet, it is expensive to investigate variances or missing assets. Would it be wise to spend $1000 to find $10? So knowing when to sound the alarm by setting a materiality threshold helps.

A good materiality threshold policy helps bring clarity to an incident of missing government funds (i.e. money) and property.

Consider the following excerpt from the Amended State Examiner Directive 2015-6

Indiana Code § 5-11-1-27(j) states:

‘All erroneous or irregular material variances, losses, shortages, or thefts of political subdivision funds or property shall be reported immediately to the state board of accounts…

In general, each political subdivision must develop their own policy on materiality because the causes of irregular variances, losses, shortages, and thefts are as broad and varied as the political subdivisions in which the incidents occur. For example, a $500 variance in Fort Wayne is not necessarily as concerning as a $500 variance in Pershing Township, Jackson County. On the other hand, a $100 variance in Fort Wayne that occurs every Friday may be material.

So what? The State Examiner is saying those closest to the matter should set the policy. And if they do not, then the threshold is automatically zero. That’s right, every penny missing is a report to the SBOA. Would that be making a buffalo out of a bug?

Ozzy is the Town of Osgood’s nickname for their buffalo statue located next to their town letters. Photo by Jp Valery on Unsplash.

Take a look at this example taken from the Town of Osgood’s materiality threshold policy.

“Materiality, in the Town of Osgood, Indiana Government, is defined as $150 per occurrence… If there is a series of events, within the same office or department that appears to be a structuring event to defraud or misappropriate town funds or property, that event or series of events should be reported.

(Emphasis added; excerpt presented, not entirety of the ordinance)

In this example, the quantitative factor set is $150+ of missing funds or property. And yet $10 missing each week from the same department would provide the necessary qualitative factor to sound the alarm. Buffalo!

Look at the below examples to see some of the local differences.

Government Unit Area Population (2020 Census) Materiality Threshold (Resolution / Ordinance)
Town of Osgood 1,587 $150 (Ordinance 2016-3)
Town of Centerville 2,748 $500 (Ordinance 2016-12)
City of Vincennes 16,759 $500 (Ordinance 58-2016)
Muncie Sanitary District 65,194 $1000 (Resolution 2020-12)

While this small sample shows a positive correlation between population and materiality threshold, there are specific qualitative and quantitative factors to consider in setting the policy for each local government unit.

Conclusion:

By default, all Indiana government entities have a $0 materiality threshold for reporting erroneous or irregular variances to the SBOA in order to promote government accountability and transparency. And yet it may be prudent for each local government unit to set a higher threshold for pragmatic reasons. The examples shared in this article are presented for illustrative purposes only. Reach out to BCS today so we can help you craft a materiality threshold policy fitting your regional sewer district, town, city, or municipality.