KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) COMBINING STATEMENT OF REVENUES, EXPENSES, AND CHANGES IN NET ASSETS YEAR ENDED JUNE 30, 2010 Kansas Lottery Expanded Total Lottery Lottery ** 2010 Operating revenues: Net game revenues $ 235,414,168 $ $ 235,414,168 Expanded lottery revenues 20,663,987 20,663,987 Expanded lottery reimbursements 983,472 983,472 Phone reimbursements 951,265 951,265 Retailer fees and miscellaneous income 481,220 481,220 Total operating revenues 236,846,653 21,647,459 258,494,112 Operating expenses: Game prizes 132,609,974 132,609,974 Casino operator management fee 15,084,710 15,084,710 Retailer commissions 13,670,875 13,670,875 On-line games service bureau 5,611,400 5,611,400 Salaries and benefits 4,440,779 431,444 4,872,223 Cost of instant tickets 3,819,565 3,819,565 Advertising 2,935,830 2,935,830 Other administrative expense 2,464,705 197,684 2,662,389 Depreciation 122,418 1,226,562 1,348,980 City and County expanded lottery fees 619,920 619,920 Professional services 168,032 142,250 310,282 On-line service bureau - lottery gaming 212,094 212,094 Telecommunications 183,950 183,950 Total operating expenses 166,027,528 17,914,664 183,942,192 Operating income 70,819,125 3,732,795 74,551,920 Nonoperating revenues (expenses): Transfers to the State Gaming Revenue Fund (67,750,000) (67,750,000) Transfers to the State General Fund (26,898) (4,546,077) (4,572,975) Transfers to the Problem Gaming Fund (413,280) (413,280) Loss on disposal of capital assets (137,756} (137,756) Total nonoperating revenues (expenses) (67,914,654} (4,959,357) (72,874,011) Income (loss) before contributions 2,904,471 (1,226,562) 1,677,909 Capital contributions 9,115,652 9,115,652 Change in net assets 2,904,471 7,889,090 10,793,561 Net assets, beginning of year 3,131,123 3,131,123 Net assets, end of year $ 6,035,594 $ 7,889,090 $ 13,924,684 ** Expanded Lottery operations reflect only the operations from opening date in December 2009 through June 30,2010 30 This is trial version www.adultpdf.com KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) COMBINING STATEMENT OF CASH FLOWS YEAR ENDED JUNE 30, 2010 Kansas Lottery Expanded Total Lottery Lottery ** 2010 Cash flows from operating activities: Cash received from sales and reimbursements $ 236,242,999 $ 21,566,118 $ 257,809,117 Cash paid for prizes, commissions, and other expenses (161,763,430) (15,523,835) (177,287,265) Cash paid to employees (4,440,779) (431,444) (4,872,223) Net cash provided by operating activities 70,038,790 5,610,839 75,649,629 Cash flows from non capital financing activities: Payments to State Gaming Revenue Fund (69,000,000) (69,000,000) Payments to State General Fund (26,898) (4,478,380) (4,505,278) Payments to State Problem Gaming Fund (413,280) (413,280) Net cash used by non capital financing activities (69,026,898) (4,891,660) (73,918,558) Cash flows from capital and related financing activities: Purchases of capital assets (237,926) (237,926) Net cash used by capital and related financing activities (237,926) (237,926) Net increase in cash 773,966 719,179 1,493,145 Cash, beginning of year 4,935,880 4,935,880 Cash, end of year $ 5,709,846 $ 719,179 $ 6,429,025 Reconciliation of operating income to net cash provided by operating activities: Operating income $ 70,819,125 $ 3,732,795 $ 74,551,920 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation 122,418 1,226,562 1,348,980 Changes in operating assets and liabilities: Accounts receivable (662,852) (81,341) (744,193) Other receivable 59,198 59,198 Instant ticket game inventory (6,111 ) (6,111) Accounts payable and accrued liabilities 142,254 732,823 875,077 Prize liability (435,242) (435,242) Net cash provided by operating activities $ 70,038,790 $ 5,610,839 $ 75,649,629 Noncash capital and related financing activities: Contributed capital assets $ $ 9,115,652 $ 9,115,652 ** Expanded Lottery operations reflect only the operations from opening date in December 2009 through June 30,2010 31 This is trial version www.adultpdf.com KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) BALANCE SHEETS - LOTTERY JUNE 30, 2010 AND 2009 Lottery 2010 ASSETS Current Assets: Cash: Operating fund $ 4,814,317 $ Prize payment fund 895,529 Accounts receivable, net of allowance for doubtful accounts of $618,583 and $480,163 at 2010 and 2009, respectively 3,426,331 Accounts receivable - unbilled 5,897,136 Other receivable 153,378 Instant ticket game inventory 2,014,378 Total current assets 17,201,069 Capital assets, net of depreciation: Property and equipment - Lottery 442,494 2009 3,944,668 991,212 2,912,262 5,748,353 212,576 2,008,267 15,817,338 464,742 Total assets $ 17,643,563 $ 16,282,080 LIABILITIES AND NET ASSETS Current liabilities: Accounts payable and accrued liabilities $ 1,748,973 $ 1,606,719 Due to the State of Kansas 4,500,000 5,750,000 Prize liability 5,358,996 5,794,238 Total current liabilities 11,607,969 13,150,957 Net assets: Invested in capital assets 442,494 464,742 Unrestricted 5,593,100 2,666,381 Total net assets 6,035,594 3,131,123 Total liabilities and net assets $ 17,643,563 $ 16,282,080 32 This is trial version www.adultpdf.com KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) SCHEDULES OF REVENUES, EXPENSES, AND CHANGES IN NET ASSETS - LOTTERY YEARS ENDED JUNE 30, 2010 AND 2009 Operating revenues: Net game revenues Phone reimbursements Retailer fees and miscellaneous income Total operating revenues Operating expenses: Game prizes Retailer commissions On-line games service bureau Salaries and benefits Cost of instant tickets Advertising Other administrative expense Telecommunications Professional services Depreciation Total operating expenses Operating income Nonoperating revenues (expenses): Transfers to the State Gaming Revenue Fund Transfers to the State General Fund Write-off and adjustment of capital assets Total nonoperating revenues (expenses) Change in net assets Net assets, beginning of year Net assets, end of year 33 Lottery 2010 $ 235,414,168 951,265 481,220 236,846,653 132,609,974 13,670,875 5,611,400 4,440,779 3,819,565 2,935,830 2,464,705 183,950 168,032 122,418 166,027,528 70,819,125 (67,750,000) (26,898) (137,756) (67,914,654) 2,904,471 3,131,123 2009 $ 230,505,668 941,450 691,759 232,138,877 130,911,165 13,446,468 5,327,748 4,227,749 4,814,812 3,317,511 2,352,474 130,233 387,557 132,178 165,047,895 67,090,982 (67,250,000) (937,612) (68,187,612) (1,096,630) 4,227,753 $ 6,035,594 $ 3,131,123 This is trial version www.adultpdf.com KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) SCHEDULES OF CASH FLOWS - LOTTERY YEARS ENDED JUNE 30, 2010 AND 2009 Lottery 2010 2009 Cash flows from operating activities: Cash received from sales and reimbursements $ 236,242,999 $ 232,991,850 Cash paid for prizes, commissions, and other expenses (161,763,430) (160,280,453) Cash paid to employees (4,440,779) (4,800,558) Net cash provided by operating activities 70,038,790 67,910,839 Cash flows from noncapital financing activities: Payments to State Gaming Revenue Fund (69,000,000) (67,500,000) Payments to State General Fund (26,898) (937,612) Net cash used by noncapital financing activities (69,026,898) (68,437,612) Cash flows from capital and related financing activities: Purchases of capital assets (237,926) (236,537) Net cash used by capital and related financing activities (237,926) (236,537) Net increase (decrease) in cash 773,966 (763,310) Cash, beginning of year 4,935,880 5,699,190 Cash, end of year $ 5,709,846 $ 4,935,880 Reconciliation of operating income to net cash provided by operating activities: Operating income $ 70,819,125 $ 67,090,982 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation 122,418 132,178 Changes in operating assets and liabilities: Accounts receivable (662,852) 164,351 Other receivable 59,198 688,622 Instant ticket game inventory (6,111 ) (287,329) Accounts payable and accrued liabilities 142,254 (738,428) Prize liability (435,242) 860,463 Net cash provided by operating activities $ 70,038,790 $ 67,910,839 34 This is trial version www.adultpdf.com COCHRAN HEAD VICK & CO., P.A. - & Co 1333 Meadowlark Lane Kansas City, KS 66102 -(913) 287-4433 (913) 287-0010 FAX Other Offices 1251 NW Briarcliff Pkwy Suite 125 Kansas City, MO 64116 (816) 453-7014 (816) 453-7016 FAX 400 Jules Street Suite 415 St, Joseph, MO 64501 (816) 364-1118 (816) 364-6144 FAX 6700 Antioch Rd, Suite 460 Merriam, Kansas 66204 (913) 378-1100 (913) 378-1177 FAX Certified Public Accountants Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards Legislative Post Audit Committee Kansas State Legislature: We have audited the financial statements of the Kansas Lottery (the Lottery), a component unit of the State of Kansas, as of and for the year ended June 30, 2010, and have issued our report thereon dated December 27, 2010. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Internal Control Over Financial Reporting In planning and performing our audit, we considered the Lottery's internal control over financial reporting as a basis for designing our auditing procedures for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing . an opinion on the effectiveness of the Lottery's internal control over financial reporting. Accordingly, we do not express an opinion on the effectiveness of the Lottery's internal control over financial reporting. Our consideration of internal control over financial reporting was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control over financial reporting that might be significant deficiencies or material weaknesses and therefore, there can be no assurance that all deficiencies, significant deficiencies, or material weaknesses have been identified. However, as described in the accompanying schedule of findings and responses, we identified certain deficiencies in internal control over financial reporting that we consider to be material weaknesses and deficiencies that we consider to be significant deficiencies. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected on a timely basis. We consider the deficiencies described in the accompanying Schedule of Findings and Responses as item 2010-1 to be material weaknesses. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. We consider the deficiencies described in accompanying Schedule of Findings and Responses as items 2010-2 and 2010-3 to be significant deficiencies. 35 This is trial version www.adultpdf.com Compliance and Other Matters As part of obtaining reasonable assurance about whether the Lottery's financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing standards. We noted certain matters that we reported to management of the Lottery, in a separate letter dated December 27,2010. The Lottery's responses to the findings identified in our audit are described in the accompanying schedule of findings and responses. We did not audit the Lottery's responses and, accordingly, we express no opinion on them. This information is intended solely for the use of the Legislative Post Audit Committee, Kansas Lottery Commission and management of the Kansas Lottery and is not intended to be and should not be used by anyone other than these specified parties. December 27, 2010 36 This is trial version www.adultpdf.com Kansas Lottery (A Component Unit of the State of Kansas) Schedule of Findings and Responses Year Ended June 30, 2010 Finding 2010-1 - Material Weaknesses Financial Statement Preparation Condition - Under our professional standards, we are required to assess the Lottery's controls over financial statement preparation including assessing the controls necessary to prevent, detect, and correct a material misstatement. As part of our audit, management requested us to prepare a draft of the Lottery's financial statements and the related notes. Management reviewed, approved, and accepted responsibility for those statements prior to their issuance. The outsourcing of these services is not unusual; however, we cannot be considered part of the Lottery's internal control over financial reporting. Our audit procedures identified certain financial statement misstatements which required adjustment in order to accurately report the Lottery's financial information and to agree balances to the underlying supporting documentation provided to us. These adjustments included the following: > An adjustment was required to record electronic gaming machines contributed to the Expanded Lottery for the Boot Hill Casino & Resort operations totaling $9,115,652. The related accumulated depreciation of the machines totaling $1,226,562 was also required. > An adjustment was required to write-off certain capital assets no longer in use and agree amounts recorded on the Lottery's books of account to physical inventory records as of June 30, 2010. The reduction to gross capital assets was $2,873,628, offset by an adjustment to reduce accumulated depreciation of $2,735,872, with the difference of $137,756 reflected as a decrease of operating income. > Adjustments were required to account for Expanded Lottery activities including adjustments to cash, accounts receivable and accounts payable to correct accounting errors. The net impact of these entries was an increase to liabilities by $436,719, an increase to revenues of $183,309, and an increase to expenses of $620,028. > An adjustment was made to correct year-end accounts payable which resulted in an increase to accounts payable of $376,834, an increase in retailer fees of $39,883, and an increase in expenses totaling $416,716. > An adjustment was made to record an additional prize liability primarily related to unpaid taxes resulting in an increase to liabil ities and game prize expense of $497,158. > An adjustment was made to capital assets to expense items erroneously capitalized resulting in a decrease in capital assets of $220,746, a decrease in depreciation expense of $27,302, and an increase in supplies expense of $248,048. > An Adjustment was made to correct an error in operating cash balance resulting in an increase in cash and income of $196,386. > An adjustment was made to the instant ticket inventory to correct year-end purchase cutoff. The net impact of this entry resulted in an increase to instant ticket inventory and accounts payable of $166,130. Criteria - A system of internal control over financial reporting includes controls over financial statement preparation, including footnote disclosures and includes identifying and correcting misstatements and reconciling account balances to the underlying supporting documents. 37 This is trial version www.adultpdf.com Cause - The Lottery does not have controls over preparation of the financial statements which would prevent or detect a misstatement in the financial statements. We noted that for many of the accounts associated with the corrected misstatements, the Lottery only performs a reconciliation of the balance on an annual basis. Effect - The financial statements may be materially misstated and/or not contain all required disclosures. Recommendation - We recommend that management review processes for making year-end closing entries and reviewing account balances to ensure that accounts agree to reconciliations and underlying supporting documentation. We also recommend that management perform more frequent reconciliations for significant accounts, in particular the Lottery's cash accounts and accounts receivable. Performing more frequent reconciliations will allow staff to more easily identify differences as they occur, and quickly make adjusting entries to correct if necessary. In addition, due to the complexities of financial statement reporting including inclusion of required disclosures, we recommend that management explore various alternatives to improving the controls over financial reporting including the use of continuing education and training courses and the use of reference guides provided by the Government Finance Officers Association, (GFOA), the American Institute of Certified Public Accountants, (AICPA), the Governmental Accounting Standards Board (GASB) and other various financial publishing companies. Management's Response (Unaudited)- The last few years the prior auditors prepared the final statements and updated the footnotes. When the new auditors came in they mentioned that the prior auditors had completed these tasks, and they suggested that they could update them also. In the future we will not take their offer. Preparing the financial pages and footnotes is not a problem for us. They asked for a trial balance, which was provided. Also provided to them was the format that we wished the financials to be presented. They chose a different format. The cash balance and other accounts were reconciled daily in the Accounts & Reports system STARS, and they are also monitored daily in the new system SMART. The accounts were not reconciled often in our accounting software package. The new SMART management system is posted directly from the vouchers and deposits. Thus our daily review of the cash balance and other accounts is being completed on a daily basis. Finding 2010-2 - Significant Deficiency Journal Entry Preparation and Approval Condition - We noted that journal entries are not formally reviewed and approved prior to being entered into the general ledger. Additionally, we noted there is no formal process for documenting journal entries and the related support. Criteria - A system of internal controls over financial reporting includes the formal review and approval of journal entries. Cause - The Lottery does not have policies and procedures that require formal supervisory review and approval of all journal entries Effect - The financial statements may be materially misstated. Recommendation - We recommend that management review and revise current poliCies and procedures to require formal supervisory review and approval of all journal entries. While we did not note any journal entries that were not adequately supported during our testing, we believe that formalization of this process would greatly strengthen internal controls over financial reporting. To accomplish this, we recommend that management consider developing a standard form to use for all journal entries. Such a form should document what accounts the entry is posted to and who prepared, posted, and approved each entry. Supporting documentation could then be attached to each form to clearly document that all journal entries are accurate and are properly reviewed and approved. 38 This is trial version www.adultpdf.com Management's Response (Unaudited) In our old accounting package, journal entries were for routine entries. The entry format has been reviewed by supervisors and used regularly therefore each entry did not accompany a reviewer sign-off. There is supporting documentation for the entry. In our current environment most reports and paperwork is electronic in spreadsheets or scanned in PDF or TIF, and can be located rapidly for review. The new SMART system requires several levels of approval for all transactions, electronically recorded. Finding 2010-3 - Significant Deficiency Expanded Lottery Monitoring Condition - In accordance with the Kansas Lottery Act (the Act), the Lottery is responsible for the collection and distribution of Expanded Lottery revenues, and is responsible for the operations of the gaming facilities in accordance with the Act. The Kansas Racing and Gaming Commission (KRGC) is responsible for the regulatory compliance with the Act of the facility manager including but not limited to oversight of internal controls. We understand that certain reports related to internal control activities either prepared by KRGC or the gaming facility's internal audit department were not requested by or provided to Lottery management. We have also been informed that certain required gaming facility manager's internal audit reports are behind schedule. Recommendation - We recommend that Lottery management obtain and review all internal control related reports prepared by either the KRGC or the gaming facility's internal audit department to evaluate and monitor any process or control changes related to significant findings or recommendations contained in the reports. Management's Response (unaudited) The Lottery staff, the casino staff, and the Kansas Racing and Gaming Commission (KRGC) staff work closely in regard to daily internal controls at the casino. We are advised on only major changes in KRGC policies and procedure. KRGC has the regulatory duties at the casinos and a strict separation of duties from the Lottery's ownership. The relationship in regard to reports will be reviewed before the next year's audit. 39 This is trial version www.adultpdf.com . 31 This is trial version www.adultpdf.com KANSAS LOTTERY (A COMPONENT UNIT OF THE STATE OF KANSAS) BALANCE SHEETS - LOTTERY JUNE 30, 2010 AND 2009 Lottery 2010 ASSETS Current Assets:. General Fund Write-off and adjustment of capital assets Total nonoperating revenues (expenses) Change in net assets Net assets, beginning of year Net assets, end of year 33 Lottery. Legislature: We have audited the financial statements of the Kansas Lottery (the Lottery), a component unit of the State of Kansas, as of and for the year ended June 30, 2010, and have issued