HomeMy WebLinkAbout07/10/1972 Item # H - 6a-- .IUL 11 �9%Z CITY OF NEWPORT BEACH
OFFICE OF THE CITY MANAGER
By the CITY COUNCIL
r ITY ;*F NrYOT'"i wr.ACH July 10, 1972
TO: MAYOR AND CITY COUNCIL
FROM: City Manager
SUBJECT: TRANSMITTAL OF REPORT FROM CITY
COUNCIL AGENDA
ITEM H -6(a)
AUDITOR; BINDER,
AY CLUB AUDIT
RECOMMENDATION:
Receive:and direct staff to prepare Memoranda Of Understanding
covering the points raised by the auditor.
DISCUSSION:
Transmitted for your information is a copy of the auditor's find-
ings in the. recently completed Balboa Bay Club ground. lease audit.. The
auditor's report has covered the Bay Club reports. of gross operating revenue
since lease inception in 1948. Because of incomplete records, estimates of..
amounts due the City, for certain years have been prepared.,
It is the:auditing firm's opinion, based on examination of the
books and consultation.with the Bay Club's own contract auditors and finan-
cial administration executives, that the Bay Club rental payments over the
twenty -two year period, have been understated by $6,529, A bill will be
sent to the Club to collect this amount. The net amount the City will re-
ceive after payment of our auditor's expenses of $1,500 is approximately
$7,029.
Another property management audit of the Armstrong Petroleum Com-
pany West Newport oil production lease is now under way and will soon be
reported to the Council. Additional audits have been budgeted this fiscal
period for the;Beacon Bay ground lease and the Corona del Mar State and City
Beach Park food take -out and beach equipment.rental concession.
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AUG 211972'
By the CITY COUNCIL .
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P 111972'
By the CITY COUNCIL
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BINDER, MESTYANEK & JOHNSON.
ACCOUNTANTS PROFESSIONAL CORPORATION
HAROLD E. MESTYANEK. C.P.A.
LAWRENCE K. JOHNSON. C.P.A.
JOSEPH E. MEBTYANEK. JR_ C.P.A.
Mr. Robert L. Wynn
City Manager
City of Newport Beach
3300 Newport Boulevard
Newport Beach, California 92660
Dear Mr. Wynn:
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2822 CAMPUS DRIVE • SUITE 204
NEWPORT BEACH, CALIFORNIA 82000
( 714) 070.2289
At the request of the City Manager's office,
an examination related to the unimproved property
City of Newport Beach and the Balboa Bay Club.
History of Lease
July 5, 1972
we have performed
.lease between the
The Balboa Bay Club is operating a private club facility on
26.85 acres of city -owned harbor frontage, tidelands, and uplands
located at 1221 West Coast Highway in the City of Newport Beach. The
leased area includes 1,574.84 feet of water frontage. The Club is
required to pay to the City certain minimum rentals plus additional
rentals based upon a percentage of the gross operating revenues (as
defined in the lease) derived by the Club from the premises.
The minimum rental for the use and occupancy of the premises is
$45,000 a year payable in equal quarterly installments in advance on
January 1, April 1, July 1, and October 1 of each year. In addition
the Club is required to pay to the City 5% of the gross operating
revenues of the Club (not including sales of off -sale liquor) up to
$750,000, 4% of the next $250,000 of such revenues, 3% of such revenues
in excess of $1,000,000 and 2% of sales of off -sale liquor, less the
minimum rental payable. The Club also pays to the City certain per-
centage rentals based upon the gross sales of subtenants of the Club.
The original fifty -year lease was executed on March 24, 1948 by
the City and Newport Bay Company, a California corporation doing
business as Balboa Bay Club and will expire on August 31, 1998. On
March 28, 1960 an amendment to the lease was approved by the City
Council assigning the lease from Newport Bay Company to Wrather Invest-
ment, Inc., a California corporation. Subsequently, Wrather Investment,
Inc. changed its name to Balboa Bay Club, Inc. On December 20, 1971
the owners of the stock of Balboa Bay Club, Inc., who were J. D. Wrather,
Jr., J. D. Wrather, Jr. as Executor of the Estate of Mazie Wrather,
John Loeb, Richard Stevens, Monte Livingston, and Inwood Investment Co.,
sold the stock to William D. Ray, who in turn transferred the stock to
International Bay Clubs, Inc.,the present owners of the Club.
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The purpose of our examination was to determine whether.all rentals
due to the City for the period from inception of the lease March 24, 1948
through December., 31,. 1.971 had been properly'.reported and.paid as called
for in the lease.
Scope of Examination
Our examination included the following procedures:
1. We inspected the original lease document dated March 24, 1948,
three lease amendments dated April 10., 1950, September 29, 1952, and
March 28,. 1960, and certain other correspondence related thereto which was
made available to us.
2: We inspected, where available, financial statements of Newport
Bay_Company.and Balboa Bay Club, Inc. certified to by the respective
entities' independent auditors.
3.. We inspected gross operating revenue amounts provided to us by
the independent auditors of the Balboa Bay Club, Inc., for certain years
where certified audit reports were not available.
4. We inspected, where available, statements of rental computations
submitted to the City, prepared either by Club personnel or the Club's
independent auditors.
5. We inspected, where available, certain internal accounting work
papers related to gross operating revenues prepared by Club personnel.
6. We made inquiries of City personnel, Club personnel, and Club
independent auditors and discussed with them various matters related to
provisions of the lease.
7. We made our own independent computations, where possible, of
rentals due from the above information made available to us. These
computations are 'summarized under "Results of Examination."
8.. We compared various provisions of the lease, as amended, to
current operations of the Club and noted certain matters which are either
not covered in the lease or ambiguous under the terms of the lease.
9. We prepared a schedule comparing gross operating revenues and
rentals due reported by the Club to the City with our own computations
of the same amounts.
Results of Examination
Summary
The following is.a summary of gross operating revenues and rentals
due reported by the Club to the City, where available, and our computa-
tions, where possible:
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(a) Information incomplete or unavailable
(b) Lessee entitled to use premises without payment of any rental
*This amount does not include the amount of estimated rental underpayments
for the period 1952 through 1956 and 1959 through 1963 as explainer( in
item S. of "Comments" and item 2. of "Recommendations."
The underpayments and overpayments of rent determined in the above
schedule are explained as follows:
1. Year ending August 31, 1951 - Gross revenues reported to the
City for this year were $10,295 less than gross revenues disclosed in the
independent auditor's report. This results in an underpayment of rent
in the amount of $416..
SCHEDULE OF'GROSS
OPERATING
REYEN.UES.AND
RENTALS DUE
Gross
Rentals due
Years or
periods
operating
revenues
Under
Beginning
Ending
Reported
Computed
Reported
Computed
(over)
3 -24 -48
8 -31 -48
(a)
(a)
(b)
(b)
9 -01 -48
8 -31 -49
(a)
(a)
25,000
(a)
9 -01 -49
8. -31 -50
639.,.10.1
(a),
32,100
(a)
9 -01 -50
8 -31 -51
846,473
.856,768
40,020
40,436
416
9 -01 -51
8- 31 -52
1,028,227
1,027,737
46,547
46,527
( 20)
9 -01 -52
12 -31 -52
277,035
(a)
12,086
(a)
.1 -01 -53
12 -31 -53
1,085,803
(a)
49,272
(a)
1 -01 -54
12 -31 -54
(a)
('a)
50,372
(a)
1 -01 -55
12 -31 -55
(a)
(a)
63,408
(a)
1 -01 -56
12 -31 -56
(a)
(a)
56,245
(a)
1 -01 -57
12 -31 -57
1.,354,999
1,369,214
58,095
58,521
426
1 -01 -58
12 -31 -58
1,452,564
1,466,040
61,009
61,413
404
1 -01 -59
12 -31 -59
1,462,490
(a)
61,514
(a)
1 -01 -60
12 -31 -60
1,624,113
(a)
66,459
(a)
1 -01 -61
12 -31 -61
1,489,690
(a)
62,519
(a)
1 -01 -62
12 -31 -62
1,354,959
(a)
58,679
(a)
1 -01 -63
12- 3.1 -63
1,380,416
(a)
59,284
(a)
1 -01 -64
12 -31 -64
1,649,663
1,660,380
67,367
67,689
322
1 -01 -65
12231165
1,837,207
1,843,767
72,843
73,040
_ 197
1 -01 -66
12 -31 -66
1,893,893
1,892,790
73,684
73,651
( 33)
1 -01 -67
12. -31 -67
2,454,571
2,508,591
90,453
92,074
1,621
1 -01 -68
12 -31 -68
3,,470,035
3,497,887
121,258
121,589
331
1 -01 -69
12 -31 -69
3,677,482
3,761,684
127,110
129,090
1,980
1 -01 -70
12 -31 -70
3,752,302
3,749,282
130,232
130,171
( 61)
1 -01 -71
12 -31 -71
4,163,282
4,134,802
142,736
141,882
( 854)
$ 1,628,292
$
4, ,728*
(a) Information incomplete or unavailable
(b) Lessee entitled to use premises without payment of any rental
*This amount does not include the amount of estimated rental underpayments
for the period 1952 through 1956 and 1959 through 1963 as explainer( in
item S. of "Comments" and item 2. of "Recommendations."
The underpayments and overpayments of rent determined in the above
schedule are explained as follows:
1. Year ending August 31, 1951 - Gross revenues reported to the
City for this year were $10,295 less than gross revenues disclosed in the
independent auditor's report. This results in an underpayment of rent
in the amount of $416..
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r.ending..:August.31,.1952 - The:st.atement of rental computation
submitted to the. City for this year :contained an arithmetic addition error
of $1,000, but included in reported gross operating revenues was an un-
explained overstatement in the amount of $510. This resulted in a net
overpayment of rent in the amount of $20.
3.. Year ending December 31, 1957 - Gross operating revenues reported
in the statement of rental computation submitted tp. the City for this year
did not include charges to tenants for telephone calls totalling $14,215,
resulting in an underpayment of rent in the amount of $426.
4., Year ending December 31, 1958 - Gross operating revenues reported
in the statement of 'rental computation submitted to the City for.this year
did not include charges to tenants for telephone calls totalling $13,476,
resulting in an underpayment of rent in the amount of $404.
5_. Year ending December 31, 1964
in the statement of rental computation
did not include charges to tenants for
but included in reported gross operati
overstatement in the amount of $5.,.964.
of rent in the amount of $322.
- Gross operating revenues reported
submitted to the City for this year
telephone calls totalling $16,681,
ig revenues was an unexplained revenue
This resulted in a net underpayment
6. Year ending December 31, 1965 - Gross operating revenues reported
in the statement of rental computation submitted to the, City for this year
did not include charges to tenants for telephone calls totalling $14,267,
but included in gross operating revenues was an unexplained revenue over-
statement in the amount of $7,707. This resulted in a net underpayment of
rent in the amount of $197.
7.. Year ending December 31., 1966 . - Gross operating revenues reported
in the statement of rental computation submitted to the City for this year
did not .ihc:lgde tbargesAo .te:nai�tS to..teleph:blle , ca,11 ._totall }�Ig l?,:s�18, but
included in gross operating revenues was an unexplained revenue overstate-
ment of $13.,521. This resulted in a net overpayment of rent in the amount
of $33.
8. Year ending. December 31, 1967 - Gross operating revenues reported
in'the statement of rental computation submitted to the City for this year
did not include charges to tenants for telephone calls, but included other
unexplained items., a net difference of $11,210 in gross operating revenues,
which resulted in a net underpayment of rent in the amount of $336. In
addition., gross operating revenues reported did not include beauty shop
revenues totalling $42,810 which resulted in ah underpayment of rent in the
amount of $1.,.285_, The total underpayment of rent for the year was $1,621.
9. Year ending December 31., 1968 - Gross operating revenues reported
in the statement of rental computation submitted to the City for this year
contained a difference in beauty shop revenues of $16,271, a difference in
off -sale liquor revenues of $12,.601, but included in reported gross
operating revenues an unexplained revenue overstatement in the amount of
$1.,020.. This resulted in a net underpayment of rent in the amount of $331.
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10. Year ending December 31, 1969 - Gross operating revenues reported
iii the statement of rental computation submitted .to the City for this year
contained a difference in revenues from membership dues of $60,597 and a
difference in off-sale liquor revenues of $13,605. In addition, the state-
ment of rental computation contained several arithmetic errors. These
differences resulted in a net underpayment of rent in the amount of $1,980.
11. Year ending December 31, 1970 — Gross operating revenues reported
in'the" statement of rental computation submitted to the City for this year
were overstated by an unexplained amount of $3,020. In addition, the state-
ment of rental computation contained arithmetic errors. These differences
resulted in a net overpayment of rent in the amount of $61.
12... Year ending December 31,. 1971 - Gross operating revenues reported
in the statement of rental computation submitted to the City for this year
included fees for management assistance to related entities of the Club
engaged in development projects at Indian Wells and Catalina Island. These
do not appear to constitute revenues derived from the Balboa Bay Club
premises under the terms of the lease and, therefore, percentage rental
on these amounts would not apply. The result is an overpayment of rent in
the amount of $854.
The differences described in items 1. through 12. above result in a
total net.underpayment of rent in the amount of $4,729. This amount does
not include the amount of estimated rental underpayments for the period
1952 through 1956 and 1959 through 1963 as explained in item 5. of "Comments"
and item 2. of "Recommendations.."
Comments
1. Information incomplete or.unavailable - Every attempt was made
by City personnel, Balboa Bay-Club personnel, and independent auditors of
the Club to obtain accounting records, reports, and related financial data
to enable us to verify rent computations for the entire term of the lease
through 1971- As disclosed in the above "Schedule of Gross Operating
Revenues and Rentals Duer;'' information was either incomplete or unavailable
in 13 out of 25 reporting periods from March 24, 1948 through December 31,
1971. . As a result underpayments or overpayments of rent, if any, for
these periods are not determinable.. It should be noted that we computed
either a rent underpayment or a rent overpayment for each of the 12
reporting periods for which accounting records and reports were available
and adequate for us to make such computations.
2.. Rents received by City - No attempt was made dn. 6wr.- Jurt'to
trace the amount of minimum and percentage rentals due into the City's
records of cash receipts and bank deposits. In order to expedite our
examination we have presumed that all rentals due have been received by
the City on the proper due dates as provided for in the lease.
3.. Deferred income - The Club records certain rents received in
advance as deferred income in its accounting records. This deferred
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income was included in gross operating revenues under the terms of the
lease in the year such income was received for the periods from March
24, 1948 through December 31, 1966. The deferred income amount ranged
from approximately $5,000 to $50,000 on the ending dates of each of these
periods. For the five years beginning with 1967 and ending with 1971
the deferred income was included in gross operating revenues for lease
purposes, not in the year when it was received, but in subsequent years
when such rent income was earned by the Club. As of December 31, 1971 the
amount of deferred rent income was $322,412. Percentage rental has not
yet been paid on this amount to the City. It will, however, be included
in gross operating revenues in years subsequent to 1971 when such deferred
rent income is earned by the Club.
4.. Cash basis vs. accrual basis - During the periods from March 24,
1948 through December 31, 1960 the Club included in gross operating
revenues only those revenues actually received during that period (cash
basis). The terms of the lease define "gross operating revenues" in part
as "....the aggregate amount of all sales of merchandise or services made
at, in or about the demised premises whether for cash, charge or credit
(and in case of credit or charge sales, regardless of whether the money
for such sales be collected or not)...." ...Forithe. periads::from January 1,
1961,. thEgugh° December '31., ^.1971-r.the'c.Clyb has been':includi g•;xn:groBSUdperating
revenues both cash and charge or credit sales (accrual basis). No attempt
has been made on our part to recompute the rentals due for the periods for
which the cash basis was used in reporting gross operating revenues since
the resulting overall differences in rent due, if any, would be immaterial.
5. Telephone call charges - We have 'determined that charges to tenants
for telephone ca is were not included in gross operating revenues for the
years 1957, 1958, and 1964 through 1967.. As a result there is good reason
to assume that similar charges were not included in gross operating revenues
for the years 1959 through 1963. .. Accounting records for these latter years
were incomplete or unavailable. In addition, it is possible that such
telephone call charges were not included in gross operating revenues for
the period 1952 through 1956 where again accounting records were incomplete
or unavailable.. Based on telephone call charges for years for which such
records were available, it would appear that telephone call charges could
have averaged about $12,000 for each of the years 1952 through 1956 and
$15,000 for each of the yearsi- 1969'�thr'oUgh::_1983. The result would appear to
be rent underpayments in the amount of $1:,500 for the earlier period and
$2,300 for the later period.
6. Sales of subtenants - Gross operating revenues as defined in the
lease and amendments to the lease include sales of subtenants. The Balboa
Bay Club had two subtenants, an apparel shop and a beauty shop. For the
most part, the sales of these subtenants were included in gross operating
revenues., except where otherwise noted.. No attempt was made on our part
to verify these sales because of the practical problem of obtaining and
assembling accounting records from the various owners of these businesses
and the distinct possibility that such records could not be found.
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?. County slip rentals. - Certain boat slips formerly owned by.the
Balboa Bay lub extended over tidelands owned by the County of Orange
adjacent to the western perimeter of the city -owned premises operated by
the Club. Rental income received by the Club from these particular boat
slips has not been included in gross operating revenues reported to the
City for purposes of the City's rent computation.
8. Insurance - There are no provisions in the lease requiring the .
Balboa Bay Club to maintain certain limits of fire or liability insurance.
However, the lease provides that upon termination, all buildings, structures,
and improvements placed at, in, or about the premises by the Club belong to
and become the property of the City. We have made no attempt to determine
whether the City has any liability for losses on the premises from fire,
accident, and related incidents.
9.. Fiscal year - The amendment to the lease dated September 29, 1952
provides for reporting gross operating revenues for the period January 1.
through December 31 of each year. Since 1960 the fiscal year of the Balboa
Bay Club has been October 1 through September 30 of each year.
In order to arrive at gross operating revenues to prepare the state-
ment of rental computation the Club since then has taken its revenues from
its certified audit reports for the twelve months ended September 30, The
Club has then deducted from these amounts the revenues for the first three
months of that fiscal year (October, November, and December) and added the
revenues for October, November, and December of the current year, which at
that point in time were unaudited. The gross operating revenues, therefore,
do not come directly from the Club's audited financial statements but rather
an interim work sheet prepared by Club personnel reflecting the above adjust-
ments.
Recommendations
Based upon our examination and findings we recommend the following:
1. Rental underpayment - The Balboa Bay Club should pay to the City
the rental underpayment of $4,729 computed for those periods for which
accounting records were complete enough to make the computation.
2. Telephone receipts - The Balboa Bay Club should pay to the City
an estimated agreed rental underpayment for the years 1959 through 1963
and probably the period 1952 through 1956 for which periods there is
reason to assume that charges to tenants for telephone calls were not
included in gross operating revenues but accounting records for such years
are incomplete or unavailable.. As explained in item 5. of "Comments" we
feel that a reasonable estimate of the underpayment is $1,500 for the period
1952 through 1956 and $2,300 for the years 1959 through 1963, or a total of
$3,800.
3. Audited rental statement - The City of Newport Beach should require
the Balboa Bay Club to submit annually a statement of rental computation
accompanied by the opinion of the Club's certified public accountants that
the statement fairly presents the gross operating revenues from the premises
as defined in the lease agreement and fairly presents the rentals due to the
City for the period covered by the statement.
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4. Insurance coverage. - The City of Newport Beach should engage
their insurance risk management analyst or other qualified person to
review the insurance coverage held by the Club. The extent to which the
City might be liable for losses on the premises from fire, accident, and
related incidents should be determined. If such a liability should exist
the Balboa Bay Club should be required to carry limits of coverage as
determined to be adequate to cover such losses, naming the City of Newport
Beach as an additional insured,. It should also be determined if adequate
fire loss coverage is maintained for buildings and improvements which
become City property upon termination of the lease.
5. Lease year - The lease reporting year should be changed from
December t'3ptember 30 to coincide with the fiscal year end of the
Balboa Bay Club. This will facilitate the preparation of the statement
of rental computation by the Club, enable the Club's certified public
accountants to express an opinion on this statement, and provide the City
with a statement of gross operating revenues and rental due that can be
relied upon.
6.. Written understanding to clarify lease administration - A letter
of understanding should be entered into, signed by both parties, which
would accomplish the following:
(a) Clarify whether deferred income should be included in gross
operating revenues as defined in the lease agreement in the
year received or the year earned.
(b) Clarify the fact that gross operating revenues shall be reported
on the accrual method of accounting and not cash method or any
other method.
(c) Clarify the fact that charges to tenants for telephone calls
shall be included in gross operating revenues as defined in
the lease agreement.
(d) Clarify and specify that certain revenue producing activities
of the Club do not pertain to the premises and thserefore such
revenues are not to be included in gross operating revenues
as defined in the lease agreement (for example, the Balboa
Racquet Club and certain management fees).
(e) Require the Balboa Bay Club to meet certain insurance require-
ments if it is determined that the City is subject to liability
in connection with the premises.
(f) Change the lease reporting year from December 31 to September 30,
providing for an allocation of the minimum rental for the
,initial short period.
(g) Require an audited statement of rental computation as described
in 3. above.
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We "shkll be happy to discuss our findings with you and to discuss
assisting you in implementing our recommendations.
Very truly yours,
BINDER, MESTYANEK & JOHNSON,
Accountants Professional Corporation
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Harold E. Mestyanek