In Brief

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Charter schools are a controversial topic in education and politics because the public funding they receive makes them quasi-public organizations; thus, political groups, authorizing bodies, and local communities are all greatly interested in their financial results. Even CPAs who specialize in school district audits may need a refresher on charter schools, which have very different governance concerns and audit risks. This article provides an overview of New York State charter schools, including funding, governance structure, and audit requirements—and how these characteristics create unique financial audit issues for CPAs. The authors’ examination of 54 internal control audits of New York charter schools conducted by the Office of the State Comptroller over the past six years can help CPAs become familiar with some common charter school control deficiencies.

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Charter schools are privately managed public schools, independently operated under an authorizing body; in New York State, this is the Board of Regents (sometimes through an approved application forwarded by a chartering entity, such as the State University of New York Board of Trustees). The type of authorizer and level of oversight varies from state to state, but in New York State, charters are required to file an annual report that includes detailed enrollment and fiscal information. The New York State legislature decided in 2010 that charters would be subject to the same ethics and conflict of interest laws that pertain to school districts, which empowered the New York State and New York City comptrollers to audit charter school operations. The New York State charter board reassesses schools every five years and, at that time, can deny continuation of a charter.

Management of charter schools varies: though every New York State charter school must be a nonprofit organization under Internal Revenue Code section 501(c)(3), they may operate independently or under either a nonprofit or for-profit management company or sponsoring organization. Though a small number of schools operate under for-profit management, starting in 2010 this practice was not allowed for new charters. Regardless of the charter’s organization, school board members are forbidden from having a financial interest in the management company or any other vendor of the school. Any conflicts of interest should be disclosed in the annual report filed with the New York State Department of Education.

Charter schools are funded in accordance with state law, based on per-pupil spending in the students’ home school district. They may receive donations as a charity, but are not allowed to charge tuition or impose special entrance requirements; they can issue bonds, but may not pledge per-pupil funding to repay the debt. Charters generally have increased autonomy with respect to budgeting and governance because they are independent of local school boards.

Required Audits

New York State charter schools are required under the terms of their charters to have at least one annual financial statement audit, conducted in accordance with U.S. GAAS and U.S. Generally Accepted Government Auditing Standards (GAGAS) and comparable in scope to school district audits (although, as nonprofits, charter schools follow FASB rather than GASB standards). In addition, an initial statement on internal controls is required for new schools within 120 days of issuance of a charter; any deficiencies must be remedied promptly. Schools might also be subject to particular agreed-upon procedures if they receive certain grant funding from the state. Federal funding of $750,000 or more will subject a charter school to the Single Audit Act, which requires an independent audit with specific guidelines issued by the Office of Management and Budget.

Audit Guidance for CPAs

In 2016, New York State charter school audits took on added importance as additional funding was allocated to charters and the cap on the number of schools was raised to 460. Following these changes, the New York State Department of Education noted variations in the audit quality and in auditors’ understanding of charters; it also published an audit guide for charter schools (“Charter School Audit Guide,” The guide addresses some issues unique to charter schools:

  • A legal requirement to maintain an escrow account with monies to cover legal and audit expenses related to potential dissolution
  • The need to confirm receivables from school districts billed for tuition and other parties, such as USDA food service
  • Payroll for teachers at nonprofit charters who are on 10- or 11-month employment contracts
  • FASB accounting standards for pensions applied to state retirements
  • Investment policies
  • Per-pupil funding
  • Co-locations of charters in public school buildings that would otherwise be empty
  • Management fees
  • Other fraud considerations, such as misappropriation of assets due to the high use of credit cards and related-party transactions.

The guide also outlines issues specific to financial statement presentation in charters and the separate report on internal controls required under GAGAS. In addition, it includes Single Audit Act guidance for schools receiving significant federal funding, as well as the agreed-upon procedures guidance required for recipients of certain New York State grants. Finally, the guide contains many useful audit schedules and templates for CPAs conducting audits of New York State charters.

Control Issues at Charter Schools

The National Alliance for Public Charter Schools estimates that there were 6,939 charter schools educating 3.1 million students in the United States during the 2016/17 school year ( Thus, strong financial controls and CPA audit expertise are crucial for prudent management of this growing education sector.

The Center for Popular Democracy is one proponent of increased accountability for charter schools. In its 2014 report, “Charter School Vulnerabilities to Waste, Fraud and Abuse” (, examining large charter markets across 15 states, it found evidence of control failures, including—

  • public funds being used for personal gain,
  • school revenues being used to support charter operators’ other businesses,
  • illegal inflation of enrollment numbers, and
  • revenue generated from services not provided.

The economic magnitude, rapid growth, and relatively new and variable regulatory environment constitute significant fraud risk, which merits a closer look at the audit practices and control pitfalls in charter schools.

Many charter schools in New York State are located in New York City, where audit responsibility rests with the city comptroller; however, a search of the city comptroller’s website revealed only four audits of charter schools. As a result, this discussion examines audits of charter schools outside the city, which are subject to audit by the Office of the State Comptroller (OSC). The OSC conducted audits of internal controls in 54 charter schools between 2011 and mid-2017.

Many of the control issues uncovered by the OSC are related to internal control issues common in both traditional school districts and charter schools, such as procurement, payment, and payroll or a need for information technology policies (“Routine Public School Audit Issues” in the Exhibit). Other internal control problems might be less familiar to auditors because they deal with matters that would not arise in a regular school district (“Charter-Specific Issues” in the Exhibit). This examination of the state comptroller’s audits yielded 205 audit recommendations (see the Exhibit).


Public School Issues versus Charter School Issues

Audits; Recommendations Routine Public School Audit Issues Procurement and purchasing; 11; 35 Payment practices; 9; 25 Payroll and benefits; 5; 13 Budget issues; 4; 10 Information technology; 7; 26 Other; 3; 5 Subtotal; 114 Charter-Specific Issues Contracts with sponsoring organizations; 16; 45 Conflicts of interest; 5; 6 Space issues; 7; 15 Residency and billing; 10; 25 Subtotal 91 Total 205

The economic magnitude, rapid growth, and relatively new and variable regulatory environment constitute significant fraud risk.

Of the 54 audits, 38 addressed charter school–specific control issues related to the following four areas: contracts with sponsoring organizations, conflicts of interest, space issues, and residency and billing issues.

Contracts with Sponsoring Organizations

Charter schools typically have a sponsoring organization (i.e., a foundation or a management company) that provides various services to the school, such as financial, legal, information technology, procurement, advocacy, curriculum design, or other services. A contract between the school and the sponsoring organization indicates the services to be provided and the management fee to be paid.

With respect to contracts in general, the OSC has set forth general guidance:

Schools require a number of services to adequately conduct business. Professional services generally include services requiring specialized or technical skills, expertise or knowledge, the exercise of professional judgment or a high degree of creativity. A school can choose to obtain these services in a variety of ways, including receiving a service from an employee or hiring an independent service provider. Ultimately, it is the Board’s responsibility to choose a method that provides the School with the required services in the most cost efficient manner possible. When acquiring services through a written agreement, the agreement should provide all parties with a clear understanding of the nature and extent of the services to be provided, provide for a means to measure/monitor service quality and establish a level of compensation for those services. (See, e.g.,

When the contracts for services involve the charter school’s sponsoring organization, extra scrutiny by auditors is appropriate. This topic accounted for the largest number of audit recommendations in the 54 audits analyzed. The following issues occurred repeatedly across multiple audits:

  • The board did not review and approve contracts with sponsoring organizations or amendments to those contracts on a timely basis.
  • Payments to the sponsoring organization were not appropriately reviewed by school officials and board members.
  • The sponsoring organization contracted to provide services in several areas, but specific services were not detailed. This often led to a question of whether the school was making duplicate payments to acquire services from other sources that should have been provided under the sponsoring organization’s contract.
  • Services received from the sponsoring organization could not be identified, and it could not be demonstrated that the contracted services were actually received.
  • Fees to the sponsoring organization were often based upon a percentage of student tuition revenue. Auditors often objected to this basis of payment as unreasonable because the contracted services were not linked to the number of students.
  • When the sponsoring organization handled the budget and financial functions, not enough detail or background data were provided to school officials and board members, so they couldn’t ensure that school funds were being used for appropriate school purposes; this lack of data also contributed to inadequate oversight of the school’s budget and finances. Often, bank statements and bank reconciliations were not made available, and reports to the board lacked sufficient detail.
  • When the sponsoring organization allocated its indirect costs to the school, school officials and board members were often not given adequate detail to assess the reasonableness of the allocations.

A lack of transparency, failure to engage in proper reporting, and fee-setting issues between the sponsoring organization and the school were major control issues in the OSC’s audits.

Conflicts of Interest

This issue is not unique to charter schools; it arises in all school districts from time to time. Typically, conflicts of interest involve board members who also engage in direct or indirect financial transactions with the school. Board members are expected to disclose conflicts that exist and to recuse themselves from participating in a decision when a conflict is present.

The unique structure of charter schools, however, means that some board members could also have ties to the sponsoring organization. This relationship, not present for board members of non-charter-school districts, creates additional conflict opportunities; in fact, five of the 54 audits raised conflict-of-interest issues. A few merely involved lack of disclosure of or a policy concerning conflicts, but others were more serious:

  • A former board president engaged in transactions with a construction company that had received more than $2 million in contracts from the school; the school did have a conflict policy, but it was not always followed.
  • A board member personally provided a loan for the school to purchase a building. This is a prohibited transaction under general municipal law.
  • A board member was a partner in a law firm that provided legal services to the school.
  • A school issued a promissory note to a board member.
  • A board member was an investor in the company that leased a building to the school.

Board members have a duty to ensure that transactions are in the best interest of the school, and conflicts of interest are inconsistent with that duty.

Building and Space Issues

Many charter schools are in the early years of their existence, and one of their major initial needs is the acquisition of appropriate space to house their operations. Under the New York Education Law, the state’s Office of General Services provides to existing and prospective charter schools its list of suitable vacant and unused stateowned buildings. Furthermore, upon request, a school district must make available a list of vacant and unused school buildings within the district, including private school buildings. If suitable space can be found on these lists, the charter school’s task may be simplified; this process, however, often doesn’t yield results. The charter school must then buy, build, or lease space via other sources.

Seven of the 54 audits raised concerns about the processes and decisions involved in contracting for space. Common issues included the absence of any documentation that the board examined and compared alternative space sources, or that the board conducted appropriate financial analysis on the cost-effectiveness of the space they decided upon. The following are additional issues raised in the audits:

  • In one audit, the board could not demonstrate that it examined alternative site options. Rather, it allowed the managing foundation to select the site, arrange financing, and construct the building, which was then leased to the charter school. For another school, the board leased a foundation-owned building that had been vacated by a different charter school. The auditors found substantial differences between the two lease agreements, criticizing the board for inadequate analysis of the lease terms. Moreover, the board had the option to buy rather than lease the first building. The audit demonstrated that, at financing rates below about 7.3%, the option to buy would have been preferable; however, there was no evidence the board had conducted such an analysis.
  • In a second audit, the board considered 10 buildings as possible school sites and eight other buildings as possible gymnasium sites. It leased a building, but the school soon outgrew the space. A developer’s proposal to buy the building, expand it, and lease it back to the school was rejected due to the high lease cost and the requirement for a 21-year lease commitment. The board then partnered with another company—described as “in business for less than a year with no apparent real estate experience and with limited financial resources”—to buy and renovate a building of interest and lease it to the school. The auditors found the lease agreement to be extremely unfavorable to the charter school, as it was expected to yield the developer/lessor a return on investment in excess of 200%.
  • In a third audit, the board hired an architect, and there was no evidence that it interviewed or contacted any others. The owner’s representative was hired as project manager, again without evidence of alternatives. The project manager considered three general contractors and recommended one believed to be best qualified in the type of construction involved and to be financially solvent. After being paid more than 90% of the original contract, the general contractor filed for bankruptcy, leaving the project incomplete and several subcontractors unpaid. Completing the project led to cost overruns of $2.6 million (about 30% over budget). The auditors believed that a more competitive process would have prevented this waste.
  • A charter school entered into a 15-year lease with an affiliated nonprofit, with rent based on amortization of a loan between the nonprofit and a real estate partnership. Subsequently, there were additional loans, along with a developer fee. The interest rate on all these arrangements was 20%, apparently with no prepayment rights. Again, the board was faulted for accepting an agreement that seemed to benefit the real estate partnership far more than the charter school.
  • Three other audits involved various issues surrounding building leases. In one case, the board could have saved at least $2.3 million by buying and renovating the building itself, rather than entering into a lease. The other two cases also involved issues of excessive lease payments and inadequate analysis.

Charter schools are not required to use competitive bidding when hiring general contractors or related professional services—yet the board has a duty to acquire these services under the most beneficial terms and conditions. Good practices include issuing requests for proposals, examining the qualifications of prospective service providers, and entering into detailed written contracts. Furthermore, the board should conduct and document its financial analyses concerning the project, especially when buying or leasing space, which is likely the single largest financial decision the school will face.

The board has a duty to acquire these services under the most beneficial terms and conditions.

Residency and Billing Concerns

New York State charter schools receive tuition payments from the school districts in which their students live. While many charters draw the large majority of their students from a single district, it is common for a charter to enroll students from multiple districts. As a result, a charter school must verify the residency of each of its students and keep these records upto-date as student addresses change. Parents enrolling their child in a charter school must provide documentation of residency, such as utility bills, lease agreements, social service correspondence, or other documents bearing the address of the parent or guardian where the student resides. If a student’s address changes, this documentation must be updated.

The state Department of Education establishes the rates of reimbursement that districts must pay charter schools; multiple rates may apply, as in the case of special-needs students. Charter schools bill the home districts six times per school year, beginning in July. Students who are not enrolled for the entire school year are billed on a full-time equivalent (FTE) basis. At year-end, the charter school must prepare a reconciliation of revenues due and revenues received, based on actual FTEs for the school year.

Ten of the 54 audits examined contained recommendations regarding a charter school’s handling of residency and billing; in seven of them, this was the sole issue raised. In six of the 10 audits, billings were found to be generally correct, but the school’s proof of residency was lacking or out-of-date. Noncompliance rates were fairly high, as samples of 15 to 47 student files in five cases found noncompliance for 28% to 53% of the files examined. Two of these six audits did find minor errors in the billing rates applied. One school’s outside billing entity failed to adopt revised rates for special education students, leading to underbilling of $2,260.

Four of the 10 audits had major issues with respect to residency and billing:

  • In one audit, a student moved three times during the year, and the school had no proof of residency for one district; that district refused to pay the $5,629 bill.
  • A second audit involved a charter school drawing students from five districts. Poor residency records led to initial rejection of more than $300,000 in billings for more than 120 students. Many, but not all, of the rejected billings were ultimately resolved.
  • A third audit had issues with proper FTEs in billing, including the offsetting of departing students with entering students. In one instance, a district was billed during two billing periods for a student who enrolled but never attended. Reconciliations were inaccurate or not completed at all.
  • A fourth audit found that, for a sample of 42 of the school’s 598 students, 15 had no current address on file, 15 had no documentation of residency (or the documentation was old), one student’s file was missing, and one student was billed based on an old address even though a new address was on file. In the year-end reconciliation, auditors found that 21 of 598 students were either in the student information system but were not billed out, or were billed out but were not in the system. The school’s reconciliation calculation that it had overbilled one district by over $99,000 was corrected by the auditors to nearly $56,000—saving the school more than $43,000.

Because charter schools are financed by billings to home districts, accurate residency records, use of current rates, and proper year-end reconciliations are essential to their financial outcomes.

Additional Considerations

There is fertile ground for financial auditors to explore. Charter schools are unique entities, and the issues outlined above require careful consideration by CPAs conducting such audits. In addition to traditional public school audit issues, charter school audits also require consideration of the appropriateness and review of contracts and transactions with the sponsoring organization; conflicts of interest by board members, especially if they have ties to the sponsoring organization; the processes and decisions relating to acquisition of space; and documentation of student residency and accuracy of billings to home districts. Specific knowledge of these distinctive internal control issues faced by charter schools will help CPAs assess their potential impact on the financial statement audit.

Marie Blouin, PhD, CPA is an associate professor of accounting in the school of business at Ithaca College, Ithaca, N.Y.
Ronald J. Huefner, PhD, CPA, CMA is a SUNY Distinguished Teacher Professor Emeritus at the University of Buffalo, Buffalo, N.Y.