Auditors Say Warnings to Schools Unheeded : Education: L.A. district faces tough decisions after continuing practice of spending more than it collects, then borrowing from reserves.

More than 18 months ago, auditors warned Los Angeles Unified School District officials that unless they took “comprehensive and permanent” steps to reduce spending and revamp their budget practices, the school system faced the prospect of a crippling financial crisis.

The district was spending more than it was collecting, then it borrowed from its reserves and other accounts to cover recurring shortages, said the report by the consulting firm of Coopers & Lybrand.

But the warnings went unheeded. To counter a stream of deficits, the school board since 1990 has approved a series of budget cuts totaling almost $600 million. But it did not address what officials admit are fundamental deficiencies in the district’s financial planning process.

Now, the disclosure of an additional $150-million shortfall has focused attention on the district’s pattern of financial triage and revealed a “crumbling support system” that has hampered management of the $3.8-billion schools budget.

At a special meeting today, the school board will discuss how to fund the nation’s second-largest school district through June.

School finance chief Robert Booker is expected to urge the board to, once again, cover its deficit by draining its $31-million emergency reserve account, postponing $90 million in payments to its employee insurance funds and freezing spending for classroom supplies to make up the balance.

But Booker said he also intends to advocate an end to the district’s cycle of using financial reserves and other special accounts to pay bills, a practice that an outside auditor last week likened to “mortgaging the future.”

An examination of the district’s finances reveals that officials have used this strategy for at least three years to avoid making deeper cuts at its 600 campuses, which are burdened with overcrowded classrooms.

Even though such strategies are employed by many other school districts around the state, financial experts say it is risky.

In Los Angeles, the gap between income and expenses has widened as state funding has declined, leaving the district with an ever-larger deficit during the past three years.

“There are no more (financial) shock absorbers,” said Booker.

Los Angeles’ deficit was disclosed last month. A routine midyear financial review revealed serious miscalculations: The district spent $125 million more than budgeted and took in $24 million less than expected.

This occurred just months after another budget crisis led to the layoffs of 2,000 teachers, 3% pay cuts for district employees and an increase in class size.

The district has been repeatedly rebuked by state officials for contributing to its financial problems by hiking employee pay in excess of the cost-of-living increases granted by the state. Over the past eight years, the salaries of district employees rose by more than 90%, while cost-of-living payments from the state--which provides three-quarters of the district’s funding--allowed for growth of less than 50%.

The failure to accurately predict the district’s latest financial problems resulted from several internal conditions, according to interviews with auditors, school officials and budget experts. These include antiquated and incompatible computer systems and the failure of staff members to relay key financial information to each other.

In addition, the district has operated for the past year without anyone to conduct its long-range financial planning, a function that was eliminated for budgetary reasons.

These and other problems, The Times found, have prevented officials from getting up-to-date reports on the district’s financial condition.

The district suffers from a “crumbling support system,” said Dave Elbaum, the Ernst & Young manager who conducted a brief survey of district budget problems after the deficit was revealed last month.

The district has nine incompatible computer systems, meaning that staff members must manually relay budget information between departments.

Officials are rushing to create a single computer system that will be able to handle budget, accounting, personnel and payroll duties. But they said it will take more than two years to get the system.

Behind the immediate question of why the miscalculations occurred are deeper issues--the method used to balance the budgets the past few years, and how the district will regain its financial footing.

Los Angeles is not alone among the state’s 1,068 districts in its midyear money crisis. State officials say more school districts than ever are reporting difficulty reconciling their budgets at midyear.

Many small districts are worse off than Los Angeles because they do not have enough reserves to cover shortfalls. Richmond Unified School District in Northern California filed for bankruptcy in 1991 and required a $19-million bailout from the state. Several smaller districts have teetered on the brink of insolvency.

According to an October, 1991, report from the state controller’s office, 32 school districts filed midyear reports indicating financial difficulties during the past school year. The total does not include districts such as Los Angeles that were able to shift funds to cover their deficits.

By routinely spending more than they take in, many school districts have depleted their reserve funds. Nearly one-third of the state’s school systems have faced budget overruns or used deficit spending in the past two years, the report said.

Like a financially troubled family that draws upon a child’s college fund to pay everyday bills, school officials have used reserves and special funds to maintain campus services. But they never have received the state windfall that they needed to repay the debt.

The problem is complicated by several factors: a statewide recession that has made less government money available to school districts; the unpredictability of lottery revenues, and a state budget process that forces school districts to draft spending plans before they know how much money will be available from the state.

Most districts, the state report said, tend to overestimate income and underestimate expenses--and to increase long-term debt to cover shortages.

As a result, the report said, deficit spending among school districts has skyrocketed, financial reserves are at an all-time low and budget overruns are increasing dramatically.

In such a climate, the report said, “any unexpected events . . . may be catastrophic.”

So far, said Patricia Meyer, financial officer for the Los Angeles County Office of Education, the L.A. city school system’s increasing debt is not enough to raise fears of financial failure.

Each March, school districts must give county officials an estimate of their financial position so threatened districts can be identified.

“They (L.A.) have a financial plan to cover that ($150-million shortfall) problem,” said Meyer. “I have confidence that the district will be able to manage their financial picture.”

Two other county districts, Montebello and Antelope Valley Union High School, are in worse shape than Los Angeles, she said, although neither is in immediate danger of failing.

But the sheer size of the Los Angeles shortfall is enough to stun school administrators from San Francisco to San Diego.

“We know that this year’s been a problem year,” said Bob Golton, assistant superintendent for fiscal affairs in the 60,000-student San Francisco Unified School District, which has a shortfall of several million dollars because of declining lottery revenues. “But $150 million . . . W o w! That’s a lot.”

Los Angeles so dwarfs other school systems in the state that even San Diego--with 126,000 students, the second-largest district--could operate for three months on the Los Angeles shortfall. San Diego is in the process of estimating its midyear shortfall.

Los Angeles Supt. Bill Anton said deeper cuts will be needed in the 1992-93 fiscal year, starting in July, if the state does not increase the district’s funding enough to allow replenishment of money shifted to balance the budget this year.

Officials say the district expects to face another shortfall for 1992-93 of more than $150 million. That includes $12 million that the district promised to repay teachers, who took a 3% cut from their salaries this year to help balance the budget.

In 1989, striking teachers won a three-year contract with 8% annual raises and the district extended that increase to all employees--despite warnings from Booker and others that the pay hikes would have to be financed by cutting district services and borrowing from reserve funds.

Later that year, to balance its 1989-90 budget the school board did have to cut $43 million and borrow $12.8 million from reserves and other accounts.

The next spring, the board began its 1990-91 budget deliberations $220 million in the hole--a deficit Booker blamed on high salary levels, low state funding and a continuing erosion in the balances of most district accounts.

To guide the board in making the cuts, the district sought the help of Coopers and Lybrand to study its management structure. The firm’s report, in June, 1990, acknowledged fluctuations in state funding, but laid blame for the continuing financial problems squarely on the district’s largess:

“The primary cause of LAUSD’s financial crisis is embedded in the fact that annual costs (primarily salaries and fringe benefits) are rising at a rate in excess of revenues,” the report said.

Still, the district continued to borrow from itself--tapping its insurance funds, construction accounts, cafeteria fund and other reserves to bankroll employee salaries and blunt the impact of cuts in campus and administrative services.

The practice left the system facing each new year already in debt, and that debt was compounded as funding from the state--now facing its own financial crisis--was scaled back.

During its annual audit of 1990-91 expenses, Ernst & Young said failure to set aside the full amount needed to pay all workers’ compensation claims and health and welfare benefits violated “generally accepted accounting principles”--a warning that the district was straying from strict financial procedures.

When an interim review last February revealed an $88-million projected shortfall, the district followed much the same course being proposed this time--draining its reserve fund, freezing school spending and deferring payments into other district accounts.

That allowed the district to balance its budget on paper--but contributed to a $241-million deficit at the beginning of this fiscal year.

That deficit reached $275 million last summer when Booker discovered that his staff had underestimated many of the same kinds of expenses involved in the current budget snafu.

After teachers were laid off and salaries were cut, officials thought they had solved he problem. But then came January’s disclosures of a new $150-million shortfall.

Just weeks before the shortfall was uncovered, district budget director Henry Jones warned that the district was operating too close to the edge.

“There is no margin for error,” he told The Times. “We have squeezed the resources of the district beyond what is reasonable for an institution of this size. You cannot run a $4-billion operation without leaving some leeway for problems. . . . If you run as close to the line as we do, you’re asking for trouble.”