Y2K snarls could show up on state and local audits.

The enormous unknown in the Y2K dilemma could wreak havoc with state and local financial audits this year because governments are now required to let auditors know how they're doing in solving the approaching calendar problem.

The Y2K requirement may lead to "qualified" opinions from auditors reviewing state and local government financial statements, raising a red flag that something is amiss, says Florida's Deputy Auditor General Sam McCall, who represents the National Conference of State Legislatures on the Government Accounting Standards Advisory Council.

"While governments would prefer to receive an unqualified opinion on their financial statements, the important issue is full disclosure of government actions to address Y2K," McCall says. "Auditors, elected officials and the public must know where we're at in solving the Y2K problem."

Y2K information is required by the Governmental Accounting Standards Board (GASB) on statements where the auditor's report is dated after Oct. 31, 1998. Governments must report in the notes to their financial statements the stage of readiness of internal computer systems and other electronic equipment that is dependent on microchip technology and necessary for continued and uninterrupted operations. They are not required, however, to assert that the systems are Y2K compliant or predict their ability to be compliant by Jan. 1, 2000.

The move has been met with trepidation. Since no one can say with certainty what will actually happen on Jan. 1, 2000, the American Institute of Certified Public Accountants fears that its auditor members will not have sufficient evidence to verify a state's assertions on its Y2K status. It has advised its members to consider issuing "a qualified opinion (scope limitation) with respect to such disclosures." A significant factor to the auditors is concern about potential litigation. Lawsuits may result from the failure of the government's own computer systems to operate properly or from problems of the vendors that it relies upon.

"As an investor, we expect issuers to fully disclose their Y2K readiness," says Rich Ciccarone of Van Kampen Investments. He says that as long as the information reflects progress on becoming Y2K compliant in a timely manner, an auditor's qualified opinion would not be detrimental. "On the other hand, the refusal to disclose Y2K implications in the financial statements would raise a serious red flag with respect to any governmental body with bonds outstanding."

Hy Grossman of Standard and Poor's says "a qualified audit report related to Y2K, in and of itself, will not result in a lower bond rating. Our primary concern is full disclosure."

Under the GASB requirement CPAs have three choices:

* If the required Y2K disclosures are not in the notes to the financial statements, and such disclosure is material to the government's operations, CPAs must qualify their report because the absence of disclosure is a violation of generally accepted accounting principles.

* If Y2K disclosures are made, an auditor may elect to restrict the scope of the audit to exclude the Y2K notes and issue a qualified opinion because of concern about evidence and future events.

* The auditor could accept the disclosures as sufficient and, based upon available evidence and associated risk, decide to issue an unqualified opinion.

The full text of GASB's disclosure requirements (Technical Bulletin 98-1) can be found on the Internet at http://www.gasb.org or ordered by calling [phone], ext. 10. Please ask for Product Code No. GTB 98-1.