UPDATE 1-Pennsylvania audit finds 'extreme dysfunction' in Scranton schools

(Adds comment from school district superintendent)

HARRISBURG, Pa., Oct 24 (Reuters) - Pennsylvania's top state auditor on Tuesday said he found such "extreme dysfunction" and "serious financial instability" in the Scranton School District that he referred the matter to local, state and federal authorities for possible further action.

"Unless the district makes significant operational changes and reverses the current state of its financial affairs it may well be placed in Financial Recovery Status which means loss of local control of district operations," said Pennsylvania Auditor General Eugene DePasquale in a statement.

The 10,000-student district had a cumulative operating deficit of more than $25 million over four years through 2015 and had incurred unsustainable amounts of debt, DePasquale said.

It sank deeper into the red even though its total revenues were rising - by 13 percent over the four-year audit period.

In the audit released on Tuesday, DePasquale's office found that Scranton school district officials borrowed $4 million in 2013 and 2014 from its own capital projects fund to remain operational and pay debt service costs. It also took out a $62 million bank loan in 2015.

"Scranton School District is taking out loans to pay for a loan," DePasquale said. "Such a financial shell game while not prohibited by the Public School Code is unsustainable in the long-term."

Superintendent Alexis Kirijan said in an emailed statement the findings "are well taken, and must be addressed."

"Two years ago the district developed a strategic plan with an embedded financial plan to begin the work to get the district back on track," Kirijan said.

"The audit is a snap shot in time," Kirijan said. "By strategically realigning resources, properly distributing workloads, providing teacher and leader training, realistically managing the budget and working together the district will regain financial solvency overtime," Kirijan said in the email.

DePasquale's office referred the audit to the Lackawanna County District Attorney, the Pennsylvania Department of Revenue and the Internal Revenue Service.

The audit also found excessive spending and poor contract oversight.

For example, auditors found that for more than a decade, the district paid a non-employee mechanic, who did work on the automotive fleet, for tasks that were vaguely described in invoices.

Between 2010 and 2016 the district paid the mechanic $672,321 for work on contract. Payments for prior years back to 2005 could not be determined because it was beyond the seven-year record retention period.

The district also paid the same health and dental coverage costs for the mechanic and his spouse as it did for full-time employees. (Reporting by David DeKok in Harrisburg; Editing by Hilary Russ and Chris Reese)