ST/ESA/PAD/SER.E/18
Department of Economic and Social AffairsDivision for Public Economics and Public Administration
INTEGRATED FINANCIALMANAGEMENT IN LEASTDEVELOPED COUNTRIES
United Nations, New York, 1999
NOTES
The designations employed and the presentation of material in this publication do not imply the expressionof any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal statusof any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers orboundaries.
The designations “developed” and “developing” economies are intended for statistical convenience and donot necessarily express a judgement about the stage reached by a particular country or area in thedevelopment process.
The term “country” as used in the text of this publication also refers, as appropriate, to territories or areas.
The term “dollar” normally refers to the United States dollar ($).
Comments and inquiries regarding this report may be directed to:
Mr. Guido BertucciDirector, Division for Public Economics and Public AdministrationDepartment of Economic and Social AffairsUnited Nations, New York, NY 10017United States of AmericaFax: 1-212-963 9681Telex: 42231 UN U1
FOREWORD
The focus of this publication is on governmentfinancial management in least developedcountries (LDCs). Government financialmanagement is concerned with financialmanagement of central government, includingministries, departments and field offices. Publicfinancial management is a broader conceptwhich embraces financial management inorganizations which have their own income andexpenditure budgets, eg. non-governmentalorganizations, public enterprises, local and urbanauthorities, and independent public institutionssuch as universities.Much work has already been written on financialmanagement systems in both developing anddeveloped countries, and there is extensiveliterature. There have also been a number ofefforts to enhance public-sector financialmanagement in LDCs. These have emanatedfrom the perceived costs of inadequate financialmanagement, and potential benefits fromimproved systems. Most of these efforts havebeen piecemeal in nature, focusing on just oneaspect of financial management, eg. budget oraccounting. These attempts at enhancedsystems have met with varying degrees ofsuccess. Some have never been fullyimplemented, many have failed when externalsupport was withdrawn, and a few have providedlasting benefits. They have generally beenconstrained by the lack of resources (especiallyhuman resources) and the inadequateinfrastructure in most LDCs. In broadermacroeconomic terms, there is evidence that
only a few countries have been able to use financialmanagement to significantly improve theirperformance in terms of fiscal management orallocative or technical efficiency. Yet the strategies for effective financial managementsystems expounded in this book are matters ofgeneral agreement. The challenge is to implementthem so as to achieve policy objectives within thecontext of LDCs.This study was prepared for the Public Finance andPrivate Sector Development Branch by MichaelParry and Phil Harding, with contributions from MikeFrazer and David Fletcher, of InternationalManagement Consultants Ltd., the United Kingdom. The views expressed are those of the individualauthors and do not imply any expression of opinionon the part of the United Nations.
Guido Bertucci Director
Integrated Financial Management in Least Developed Countries iii
Division for Public Economics and PublicAdministrationDepartment of Economic and Social Affairs.
EXECUTIVE SUMMARY
In general terms the least developedcountries are those which are very poor, ascharacterized by low per capita grossdomestic product (GDP) and other criteria3/.The UN has classified 48 countries asleastdeveloped. While this is not the onlytaxonomy of countries to indicate theirrelative poverty, it is the basis used for thisbook.
In many LDCs, the existing financialmanagement subsystems are failing to copewith the demands placed on them. Planningsystems have typically lost credibility withthe failure to achieve targets in earlier plans.Budgets are often poor predictors of financialout-turns and rarely act as an effectiveresource allocation tool. Accounting systemsare being asked to handle governmenttransactions of a scale and complexity notenvisaged when the systems were designed,and government accounts are often years inarrears. Auditing, both internal and external,has often been ineffective, even forcompliance control, and virtually never forperformance enhancement. Financialregulations are typically outmoded, withinadequate delegation or financial powers.Within this environment there are rarelyadequate information flows, and suchinformation as exists is often either late orunreliable, or both. Corruption and"leakages" from the system exist to varyingextents in many LDCs.
Conditions existing in LDCs do not form anencouraging background for high-qualitypublic financial management. Financialmanagement is often carried out underdifficult conditions, sometimes with quiterudimentary resources. The skills necessaryfor good financial management are likely tobe absent, or at least in very short supply.
Granting LDC status recognizes a country’sspecial economic and social needs. It istherefore tantamount to an invitation fordonors to provide assistance. Figures forofficial development assistance (ODA),4/
show that donors provide proportionatelymore to LDCs than they do to developingcountries as a whole. As a result, in thesecountries, ODA often forms a significantelement of three important flows: revenues,official foreign exchange receipts anddevelopment expenditure. This createsspecial financial management problems. Forinstance, if development expenditure isfunded mostly from ODA, development plansand budgetary procedures have to adapt tothe requirements of donors. Similarly,financial controls, reporting mechanisms andaccountability arrangements generally haveto meet donor needs. In addition toprocedural implications, the receipt of largeamounts of ODA creates competition forcounterpart resources, producesconditionality dilemmas for governmentswishing to match their own agendas with
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those of donors, and results in dependency,both financial and otherwise.
No general survey exists of the status offinancial management in LDCs. A 1991 UNreport on government financial managementin LDCs was based on survey work in sixcountries: Bangladesh, Bhutan, Malawi,Nepal, Sierra Leone and Somalia.5/ Forthese countries a range of problems in thefield of government financial management
was reported, but of no greater severity thanthat which is generally supposed to exist indeveloping countries generally.6/ This isconfirmed by the practical experiences of theauthors of this book. Recent work in anumber of LDCs, as well as other countries,indicates that LDCs have financialmanagement systems which could besignificantly improved. This experience isconfirmed by the authors.
TABLE OF CONTENTS
FOREWORD iii
EXECUTIVE SUMMARY .iv
I.INTRODUCTION 1
II. GOVERNMENT FINANCIAL MANAGEMENT–AN OVERVIEW
Benefits of good financial management3
Institutional structure for effective financial management5
Differing activity life cycles within financial management6
The impact of changes in information technology7
The boundaries of financial management .................................................................................. 8Financial management in the public sector contrasted to the private sector ................................. 8
III. PLANNING
Introduction13
Long-term plans .................................................................................................................. 13Public investment programmes (PIPs)
14Medium-term financial plans
14Expenditure prioritization ...................................................................................................... 19IV. ANNUAL BUDGETING
Introduction ............................................................................................................. 21Budget quality indicators .......................................................................................... 22The budgeting process ............................................................................................. 24Institutional framework of budgeting and planning ........................................................ 26
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Non-financial performance measures ......................................................................... 27Alternative budget approaches .................................................................................. 30Specific country experiences .................................................................................... 33Some specific budget issues .................................................................................... 36Presenting information in budgets ............................................................................. 41Summary of elements of an effective planning/budget system ...................................... 44
V. ACCOUNTING, MONITORING, EXPENDITURE CONTROL,REPORTING
Introduction ............................................................................................................. 45The accounting model and basis ........................................................................................... 46Accounting standards in government accounting ........................................................ 50Fund release procedures .......................................................................................... 52Government accounting and record-keeping ............................................................... 53Initial recording of transactions .................................................................................. 54Information flows and consolidation ........................................................................... 55Expenditure control, monitoring and reporting ............................................................. 57
Public expenditure review process ............................................................................. 58Cash and liquidity management ............................................................................................ 58VI. CODING AND CLASSIFICATION
Introduction 61Multiple objectives of a classification system ............................................................. 61Classification linkages to stages of the financial management cycle ............................. 63Criteria against which to evaluate a classification system ............................................ 68Concepts underlying classification structure ............................................................... 68Impact of accrual accounting on the analytic model .................................................... 70Financial assets and liabilities and financing flows ...................................................... 70Revenue and grants ................................................................................................. 71Functional and economic classification ...................................................................... 72Legal aspects of classification .................................................................................. 74Conclusions 74VII. FINANCIAL STATEMENTSIntroduction ............................................................................................................. 75What are the financial statements? ........................................................................... 75Entity concept ......................................................................................................... 76Elements of financial statements .............................................................................. 77Characteristics of elements of financial statements ..................................................... 80Financial statements in the context of financial management ....................................... 83Benefits of financial statements ................................................................................ 86Conclusions ............................................................................................................ 87Annex: Format of financial statements ....................................................................... 87
VIII. INTERNAL AND EXTERNAL AUDITING
Introduction ............................................................................................................. 93External audit of government ..................................................................................... 94Internal audit ........................................................................................................... 95The performance audit .............................................................................................. 96Overview of the role of auditing in the integrated financial management approach ........... 97Conclusions ............................................................................................................ 97
IX. IMPACT OF INFORMATION TECHNOLOGYIntroduction ............................................................................................................. 99
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Scope for more integrated systems ......................................................................... 108Constraints ........................................................................................................... 110Practical issues .................................................................................................... 110Systems design .................................................................................................... 113Problems of system sustainability ........................................................................... 119Conclusion ............................................................................................................ 120
X. IMPLEMENTING INTEGRATED FINANCIAL MANAGEMENTIntroduction ........................................................................................................... 123Physical constraints and their resolution .................................................................. 124Measuring the benefits of good financial management when applied to governments ................ 125Change management ............................................................................................. 129Communications strategy ....................................................................................... 133Risk analysis ........................................................................................................ 133The process approach to financial management upgrading ........................................ 134Human resource development and training ............................................................... 134Organizational, institutional and human resource management issues ........................ 137Problems encountered ........................................................................................... 138Conclusions .......................................................................................................... 138
Exhibit 1. The financial management process ......................................................... 1Exhibit 2. Model of an integrated financial management system ............................... 2Exhibit 3. Benefits of high-quality financial management .......................................... 5Exhibit 4. Institutional arrangements and expenditure outcomes ............................... 7Exhibit 5. Timing of financial management activities ................................................. 8Exhibit 6. Public compared to commercial financial management ............................ 10Exhibit 7 Example of three-year rolling budget ....................................................... 14Exhibit 8. Planning time-scales ............................................................................ 15Exhibit 9. Major stages in preparation of the three-year rolling budget ....................... 15Exhibit 10. The three-year rolling budget model (single year) ..................................... 16Exhibit 11. Description of components and relationships ........................................... 17Exhibit 12. Multi-year three year-rolling budget relationships ..................................... 18Exhibit 13. Overview of the budget process .............................................................. 21Exhibit 14. Budget quality indicators ....................................................................... 22Exhibit 15. Key stages in the annual budget process ............................................... 25Exhibit 16. Typical planning/budget structure .......................................................... 26Exhibit 17. Linkage between economy, efficiency and effectiveness ........................... 28Exhibit 18. Activity-based costing applied to government .......................................... 32Exhibit 19. Model of recurrent impact of development projects ................................... 36Exhibit 20. Manpower reconciliation statement ........................................................ 37Exhibit 21. Recurrent and development budgets ...................................................... 37Exhibit 22. Pattern of expenditure over typical project life cycle ................................. 38Exhibit 23. Project expenditure monitoring format ..................................................... 39Exhibit 24. Recording non-monetary donor assistance .............................................. 40Exhibit 25. Classification of flows by time for liquidity management ............................ 41Exhibit 26. Features of a good budget presentation .................................................. 42Exhibit 27. Example of ministry expenditure budget (currency 000s) .......................... 43Exhibit 28. Elements of an effective budget-planning system .................................... 44Exhibit 29. Model of planning-budgeting relationships ............................................... 44Exhibit 30. Expenditure release, accounting, monitoring and expenditure control ........ 45Exhibit 31. Accrual model link between flows and balances ...................................... 46
Exhibit 32. Analytic framework of balance sheet and operating statement .................. 47
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Exhibit 33. Tracking expenditure flows .................................................................... 48Exhibit 34. Different accounting bases .................................................................... 49Exhibit 35. Comparison of accounting bases ........................................................... 50Exhibit 36. Fund release procedures ....................................................................... 52Exhibit 37. Votes ledger example ........................................................................... 55Exhibit 38. Existing accounting information flows in typical least developed countries .. 56Exhibit 39. Reporting structure model ..................................................................... 57Exhibit 40. Cash management ............................................................................... 58Exhibit 41. Classification dimensions ...................................................................... 62Exhibit 42. Model of an integrated financial management system .............................. 63Exhibit 43. Linkage of stages of financial management cycle to classification ............ 66Exhibit 44. Criteria for classification systems ........................................................... 68Exhibit 45. State-owned enterprises ........................................................................ 69Exhibit 46. GFS analytic framework ........................................................................ 69Exhibit 47. Alternative treatment of financing ............................................................ 71Exhibit 48. GFS analysis of revenue and grants ....................................................... 72Exhibit 49. GFS economic and functional cross-classification ................................... 73Exhibit 50. Important accounting categories in Bangladesh ....................................... 74Exhibit 51. Concepts of government and commercial entities compared ..................... 76Exhibit 52. Objectives of financial reporting .............................................................. 77Exhibit 53. Elements of financial statements under different accounting bases ............ 78Exhibit 54. Liabilities recognized under different bases of accounting ......................... 81Exhibit 55. Net equity under different bases of accounting ......................................... 82Exhibit 56. Accountability under different accounting bases ...................................... 83Exhibit 57. Financial statements/performance analysis in financial management cycle 84Exhibit 58. Assets and liabilities--alternative classification approaches ...................... 85Exhibit 59. Benefits of financial statements ............................................................. 86Exhibit 60. Audit overview ...................................................................................... 93Exhibit 61. Audit comparison ................................................................................. 95Exhibit 62. Audit objectives and performance indicators ............................................ 96Exhibit 63. Approaches to information technology .................................................. 103Exhibit 64. Degree of integration ........................................................................... 105Exhibit 65. Data flows in an integrated system ....................................................... 109Exhibit 66. Relationship between business processes ............................................ 114Exhibit 67. Information flows ....................................................................................... 115Exhibit 68. Accounting systems configuration with links to core system ........................ 116Exhibit 69. PRINCE structure ..................................................................................... 118Exhibit 70. Plans ...................................................................................................... 119Exhibit 71. Implementation issues and strategies ......................................................... 123Exhibit 72. Physical progression of changes ................................................................ 124Exhibit 73. Benefits of good financial management and costs of weak
financial management in government .......................................................... 125Exhibit 74. Model of measurement of activity-benefits relationship ................................. 126Exhibit 75. Functional activities to benefits cross-walk .................................................. 127Exhibit 76. Change management model ...................................................................... 130Exhibit 77. Accounting information system stakeholders and institutions ....................... 131Exhibit 78. Risks ............................................................................................................ 133Exhibit 79. The competence training model ................................................................. 137
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I. INTRODUCTION
Focus of book
The focus of this book is on government financialmanagement in least developed countries (LDCs).Government financial management is concerned withfinancial management of central government,including ministries, departments and field offices.Public financial management is a broader conceptwhich embraces financial management inorganizations which have their own income andexpenditure budgets, eg. non-governmentalorganizations, public enterprises, local and urbanauthorities, and independent public institutions suchas universities.The definition of LDCs is examined in section 1.3,below.Much work has already been written on financialmanagement systems in both developing anddeveloped countries, and there is extensive literature.There have also been a number of efforts to enhancepublic-sector financial management in LDCs. Thesehave emanated from the perceived costs ofinadequate financial management, and potentialbenefits from improved systems. Most of these
efforts have been piecemeal in nature, focusing on justone aspect of financial management, eg. budget oraccounting. These attempts at enhanced systems have metwith varying degrees of success. Some have never beenfully implemented, many have failed when externalsupport was withdrawn, and a few have provided lastingbenefits. They have generally been constrained by thelack of resources (especially human resources) and theinadequate infrastructure in most LDCs. In broadermacroeconomic terms, there is evidence that only a fewcountries have been able to use financial management tosignificantly improve their performance in terms of fiscalmanagement or allocative or technical efficiency. Yet the strategies for effective financial managementsystems expounded in this book are matters of generalagreement. The challenge is to implement them so as toachieve policy objectives within the context of LDCs.
Integrative approach to financialmanagementIt is commonplace to depict government financialmanagement as a circular process made up of severalinterrelated systems. The concept of a circle of financial
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management control probably originated in thenineteenth century. It remains a popular expositionaltool. For instance, in 1985 a version of it appearedprominently in a major United States GeneralAccounting Office publication on managing the costof government,1/ as set out below.
In fact the subsystems are more extensive thanindicated in this model, and are as follows:• Planning–perspective and medium-term;
• Budgeting–recurrent, development and revenue;
• Fund release and liquidity management;
• Accounting and monitoring;
• Internal and external audit;
• Systems of information feedback and reporting;and
• The system of rules, procedures and financialdelegation powers which link the subsystemstogether.
Integration of these subsystems facilitates datatransfer between components, ensures consistencyand reduces duplication. All of this enhances theability to use information for decision-making,control and monitoring. Recent developments ininformation technology have made integrated publicfinancial management systems a feasible objective.LDCs are now enabled to implement major reformsin their financial management systems and to achievelevels of functionality and integration which were notpreviously practical options.On the other hand, there are sometimes good reasonsfor a separation of subsystems, for instance betweenaccounting and auditing.2/ In such cases it may bemore helpful to talk of establishing links, so that the
two subsystems can make their maximum contribution tothe overall objective of good financial management. Forexample, a computerized accounting system may includean audit trail to facilitate effective audit and mayincorporate a number of built-in internal controls. It mayalso provide opportunities not present in a manual systemfor the auditor to access data. Nevertheless, accountingand auditing have to remain separate processes, becauseof the concept of audit independence.The concept of integration and linkages will be developedthrough the following sections to lead to a morecomprehensive integrated financial management model,as set out in Exhibit 2 below.
Exhibit 1. The financial management process
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The benefits from integration of, or linkages between,subsystems are substantial:• As illustrated by the model in Exhibit 2, the
information outflows from one component areinflows to another component;
• All utilize a common financial valuation andmeasurement model;
• Recognition of the linkages and commonality canimprove performance within each sub-component,and hence of the system as a whole;
• By treating the system as a whole, more effectiveprocedures, information flows, training, andsystems tools can be developed; and
• Modern information technology makes it bothmore feasible, and the gains greater, to treatfinancial management as a single system.
Least developed countries, theircharacteristics, and the challenge offinancial management reform
In general terms the least developed countries are thosewhich are very poor, as characterized by low per capitagross domestic product (GDP) and other criteria 3/. TheUN has classified 48 countries as least developed. Whilethis is not the only taxonomy of countries to indicate theirrelative poverty, it is the basis used for this book. In many LDCs, the existing financial managementsubsystems are failing to cope with the demands placedon them. Planning systems have typically lost credibilitywith the failure to achieve targets in earlier plans. Budgetsare often poor predictors of financial out-turns and rarelyact as an effective resource allocation tool. Accountingsystems are being asked to handle governmenttransactions of a scale and complexity not envisaged whenthe systems were designed, and government accounts areoften years in arrears. Auditing, both internal andexternal, has often been ineffective, even for compliancecontrol, and virtually never for performance enhancement.Financial regulations are typically outmoded, withinadequate delegation or financial powers. Within thisenvironment there are rarely adequate information flows,and such information as exists is often either late orunreliable, or both. Corruption and "leakages" from thesystem exist to varying extents in many LDCs.
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Conditions existing in LDCs do not form an encouragingbackground for high-quality public financialmanagement. Financial management is often carriedout under difficult conditions, sometimes with quiterudimentary resources. The skills necessary for goodfinancial management are likely to be absent, or atleast in very short supply.Granting LDC status recognizes a country’s specialeconomic and social needs. It is therefore tantamount
to an invitation for donors to provide assistance. Figuresfor official development assistance (ODA),4/ show thatdonors provide proportionately more to LDCs than theydo to developing countries as a whole. As a result, inthese countries, ODA often forms a significant element ofthree important flows: revenues, official foreign exchangereceipts and development expenditure. This createsspecial financial management problems. For instance, ifdevelopment expenditure is funded mostly from ODA,development plans and budgetary procedures have toadapt to the requirements of donors. Similarly, financialcontrols, reporting mechanisms and accountabilityarrangements generally have to meet donor needs. Inaddition to procedural implications, the receipt of largeamounts of ODA creates competition for counterpartresources, produces conditionality dilemmas forgovernments wishing to match their own agendas withthose of donors, and results in dependency, both financialand otherwise.No general survey exists of the status of financialmanagement in LDCs. A 1991 UN report on governmentfinancial management in LDCs was based on survey workin six countries: Bangladesh, Bhutan, Malawi, Nepal,Sierra Leone and Somalia.5/ For these countries a range ofproblems in the field of government financialmanagement was reported, but of no greater severity thanthat which is generally supposed to exist in developingcountries generally.6/ This is confirmed by the practicalexperiences of the authors of this book. Recent work in anumber of LDCs, as well as other countries, indicates thatLDCs have financial management systems which could besignificantly improved. This experience is confirmed bythe authors.
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II. GOVERNMENT FINANCIAL MANAGEMENT–AN OVERVIEW
Benefits of good financial management
The benefits of high-quality government financial management are substantial. The matrix below summarizes themajor benefits, and indicates typical financial management activities related to achieving such benefits.
Exhibit 3. Benefits of high-quality financial management
Area of benefit Specific activities• Enhanced resource mobilization Managing the collection of domestic revenues and other
receipts to ensure that the highest feasible level ofcollection is attained within the legislative framework.Provide information to identify the most effectivedomestic revenue mobilization policies.
Managing the receipt of external resources, includingloans and official development assistance, throughproper procedures and controls which comply withrequirements of lenders and donors.
• Improved macro-level fiscal management andexpenditure control through more effectiveinstitutions, processes, and control mechanisms
Managing planning and budgeting systems for revenuesand expenditure envelopes. Establishing systems forpreparing, reviewing and consolidating medium-termfinancial plans and budgets. Their presentation toParliament. Implementation and monitoring ofauthorized policies and amendments thereto.
• More optimal resource allocation decisions toachieve clearly articulated public policy objectivesthrough enhanced identification of the costs andbenefits of alternative expenditure decisions
Planning and prioritizing investments and their funding.Establishing and managing systems for identifyingpolicy priorities, cost and benefits of decisionalternatives, presenting information and implementingmonitoring and reporting on outcomes.
• More effective liquidity management of inflowsand outflows
Anticipating the liquidity needs of government andplanning for and deploying surpluses. This is to achievemaximum use of liquid funds which are temporarilyavailable and which can be invested in short-termmarkets, without endangering the funding of normaloperations.
• Improved technical efficiency in managing andutilizing resources through improved informationflows more relevant to decision responsibilities ofmanagers
Ensuring that expenditures and other resources areapplied to the maximum advantage of government, ie.ensuring that resources are properly utilized with regardto efficiency and effectiveness. Directing resources outof lower into high priority uses, involving analysis ofcosts, actions to achieve higher productivity by changingthe cost-mix, and the transfer of resources to placeswhere they are most needed.
• Enhanced transparency and accountability ofgovernment, providing better historic informationas a guide to the future
Recording, accounting for, analysing and reporting onthe financial transactions, assets and liabilities ofgovernment. This is important for two purposes: as abasis for external accountability, and so thatmanagement has accurate, timely and relevant sources ofinformation with which to manage its resources.
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• Good management of public funds and assets,resulting in reduction in the levels of corruptionand leakages
Protecting and enhancing the rights of government toreceive money or money’s worth. This entails themanagement of both income flows and assets (eg.forests, fishery resources) so that the government andthe country as a whole receive as much benefit fromthem as possible.Controlling expenditure and the exercise of financialauthority. This is to ensure that transactions involvingfinance or with important financial implications(particularly matters such as contracts and procurementwhere large sums are at stake which may be vulnerableto manipulation) are correctly undertaken by reference tolaws, regulations, applicable management guidelines andestablished controls.
Carrying out the necessary financial business ofgovernment: government has bills to settle, staff to payand revenue to collect. This aspect of financialmanagement is often forgotten. It is of paramountimportance because of the need to conduct efficientlythe everyday financial business of government.
Ensuring government’s financial reputation amongcustomers, investors etc. The terms on which anorganization conducts its financial business with theoutside world depends upon its standing. Thus the costand availability of funds to government depend on thegovernment’s reputation. Good financial managementcan enhance a government’s reputation and thereforeimprove the terms on which funds are available.
Institutional structure for effectivefinancial managementRecent World Bank research by Campos and Pradhan(“Budgetary Institutions and Expenditure Outcomes,”Ed Campos and Sanjay Pradhan, World Bank PolicyResearch Department, September 1996), focused onexpenditure management of national governments.This was narrower than the present study, whichembraces revenue issues, but at the same time theCampos and Pradhan study was broader in that itconsidered factors outside the parameters of financialmanagement.The study identified three key performanceindicators:• Fiscal discipline at the aggregate level (second
item in the list above);
• Prioritization for allocative efficiency and equity(third item in the list above); and
• Technical efficiency (fifth item in the list above).
The institutional arrangements Campos and Pradhanidentified to achieve improvements within these extendoutside the parameters of financial management, and aresummarized in Exhibit 4 below.
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Exhibit 4. Institutional arrangements and expenditure outcomes
Institutional arrangements Accountability Transparency
• Aggregate fiscal disciplineMacro framework and co-ordinationarrangements
Ex post reconciliation Published
Dominance of central ministries Sanctions Made publicFormal constraints Openness of financial markets Freedom of pressHard budget constraintsComprehensiveness of budget
• Prioritization
Forward estimates Reporting of outcomes PublishedComprehensiveness of the budget Ex post evaluations Freedom of pressFlexibility of line agencies Hard budget constraints Made publicBreadth of consultations Technical capacity of Parliament ComprehensibleUse of objective criteria
• Technical efficiencyCivil service pay and merit-basedrecruitment/promotion
Clarity/purpose of task Published
Managerial autonomy of line agencies Chief executive tenure Made publicPredictability of resource flow Financial accounts, audits, client surveys,
contestability in service deliveryFreedom of press
Source: Campos and Pradhan, 1996
These conclusions are broadly consistent with those of theauthors of this study. Clearly they extend to some areasnot addressed herein, while this study considers a numberof aspects not considered by Campos and Pradhan.
Differing activity life cycles withinfinancial management
Perspective and medium-term planning, budgeting,accounting and auditing can be thought of as a seriesof cycles starting with planning and proceedingthrough a number of interrelated stages. Each fullcycle lasts more than a year. Thus several cycles
overlap, and at any point in time financial managersmay be involved in different aspects of differentcycles, eg. perspective planning for the next fiveyears, medium-term planning for three years,budgeting for one year, accounting for the currentyear and taking remedial action on auditrecommendations for last year. The simple linearityimplied by the above list may be misleading as someaspects may be occurring concurrently; eg. internalaudit may occur at the same time as accounting, asillustrated in Exhibit 5.
Exhibit 5. Timing of financial management activities
Previousyear
Currentyear
Future years
-1 0 +1 +2 +3 +4 +5
Perspective planMedium-term plan
BudgetAccounts
Audit
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The impact of changes ininformation technologyThese are analysed in more detail in Section IX, butan initial overview is discussed below. Recentchanges in information technology provide theopportunity for the major shift in financialmanagement referred to earlier.Financial services and banking are among the highestspenders on information technology, as they seek toglobalize their businesses.7/ Similar scope for usinginformation technology exists in government financialmanagement. The key factors permitting such changescan be summarized as dramatic changes in theincreasing environment tolerance and their enhancedcapability to process and report information.These changes have created the conditions forconnecting and integrating information systems, on ascale which would have been difficult to imagine onlya few years ago.8/ A recent discussion paper from theWorld Bank presents the different informationsystems required to support the public financialmanagement process.9/ The main systems areidentified as macro fiscal planning; budgetpreparation; monitoring and control; management ofthe public sector work programme; debt management;foreign aid management; revenue administration;human resources management; governmentaccounting; and auditing. Each of these is furtherdivided first into subsystems and then into datarequirements. Significantly, the paper notes that"these systems are usually implemented ascomponents of separate projects responding tospecific needs, with little appreciation of requirementsin other areas and little thought to criticalinterrelationships. As a result the information systemsare often disparate and segmented, with little or nocapacity for sharing data. They have overlapping andsometimes conflicting functionality, and provideincomplete coverage, particularly for managerialinformation requirements that normally span severalfunctional areas." Clearly current changes ininformation technology are creating the conditions tocorrect such problems. Integrated financialmanagement information systems are capable ofeliminating overlaps and data duplication, making therequired links between different systems andproviding the necessary financial information on thestatus of key business processes to staff in differentparts of government.
The use of information technology for integration ofsubsystems raises a number of issues.• There is a distinction between integrated core systems
and linkages between systems. Accounting is almostcertainly a core system, and all accounting functions,eg. payments and advances, would be fully integrated.On the other hand, for example, budgeting might be ona different software platform, with data transferred onlyat a summary level.
• In strict terms, integration means "to make one,” but infinancial system terms there are difficulties in such arigid approach. Most government accounting systemshave a significant bespoke (tailored) element. This isbecause the accounting needs in different parts ofgovernment differ, eg. the need to be able to reportexpenditure in a form required by a donor applies onlyto projects funded by that donor; development projectshave different accounting information needs from thoseof recurrent activities. While there may be a coreaccountancy system for such things as cash expenditure,revenue collections, fund release and so on, otherlower-level financial systems (such as projectaccounting) may be sufficiently different to beconsidered independently of a common financial systemstrategy.
• It may be more effective and efficient for line ministriesto have their own computer systems (a distributedprocessing concept). Thus systems may be integrated inthe sense of sharing common coding structures andcapability to transfer data. A distributed processingenvironment makes systems more robust and ensurescoincidence of management responsibility andoperational control; and if data is transferred betweensystems, then one of the key goals of integration (theavoidance of the need to input the same data intoseveral systems) can be accomplished. However, toachieve this the component parts of the financial systemmust have been designed to complement andcommunicate with each other.
The boundaries of financialmanagementThere is no precise definition of the parameters ofgovernment financial management. It has tended tobecome broader with the development of non-financialperformance indicators. The following quotations allemphasize different aspects of a financial system.• As a conceptual model of an entity "accounting is first
and foremost a conceptual framework used for planning
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economic activities, . . . its function as a controlinstrument is a derived one" (Most, 1972).
• As a measurement system, accountancy is "theprocess of identifying, measuring andcommunicating economic information to permitinformed judgements and decisions by users of theinformation" (American Accounting Association,1966). This view is similar to that of Ijiri (1967)and Edwards and Bell (1961).
• As an information system, "The accounting systemis the major quantitative information system inalmost every organization" (Horngren, 1982).
• As a control system, "Accounting information is animportant control tool within the organization"(Emmanuel and Otley, 1985).
Each of these quotations identifies a differentviewpoint of the nature of accountancy. They are notincompatible. Enthoven (1982) refers to "accountingas an information measurement system" whichcombines 2 and 3 above.To see accounting as only an informationmeasurement system, however, seems too narrow. AsDew and Gee (1973) point out, accountants havedominated commercial information systems becausethey have created the only comprehensive model ofthe firm. To broaden this to include organizationsother than firms (eg. public sector enterprises),accountancy may be seen as a model representingquantitatively activities within an organization. This isclose to the view of Samuels and Oliga (1982), whostate that "we can represent accounting as a system(with inputs, throughput, and output) interacting withits environment . . . If viewed as essentially embeddedin the organization itself, the latter now becomes thefocal system interacting with its environment."It is concluded that there is no reason to restrict theview of financial management to purely financialsystems. It can also embrace related systems andparticularly non-financial indicators of performance.
Financial management in the publicsector contrasted to the privatesectorFinancial management in government has notachieved the same status as it has in the private sector.There are many reasons, but one critical differencebetween the private and public sectors is the absenceof money measures of outputs in the public sector.
This is explained by contrasting government andcommercial entities.Commercial entity inputs and outputs, ie. purchases andsales, are automatically defined in money. Profit is thedifference between them. Thus the accounting systemprovides a comprehensive input-output model which isuniversally applicable to all businesses. Accounting hasbecome the dominant method by which businessperformance is judged. The primary objective ofmanagement is to maximize profit, appropriately defined.Government inputs are also automatically defined inmoney terms. However, outputs are generally servicedelivery, and cannot be expressed as money. Furthermore,government revenues are not normally dependent ongovernment expenditure. Thus accounting provides aninput-only model. Outputs must be defined in non-financial terms. Hence there can be no concept of profit.
This lack of a simple input-output model, or financialperformance measures, must be seen as a major problemof applying financial management to any public-sectororganization, including national governments.
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Exhibit 6. Public compared to commercial financial management
Commercial accounting model
Public-sector accounting model
There are a number of other reasons why the financialtransactions of governments are significantly differentfrom those of private-sector entities, or even publiccorporations. • It is difficult to identify the boundaries of the
government as an economic entity;
• Budgets have a greater, and different, significancefor the public sector than for the commercial sector,and the budget process will to a greater extent drivethe classification system;
• Expenditure transactions have to be tracked fromplanning to cash movement stages;
• The longer-term expenditure commitments implicitin current transactions need to be recognized forfinancial planning purposes;
• Government activities have to be considered in thecontext of national policies, since they impact oneach other;
• The nature and purpose of government activities,transactions, and assets and liabilities arefundamentally different from those of a commercialentity;
• Government activities have a multifaceted impact,and this is reflected in the need for multifacetedanalysis of the transactions for different purposes;
• Economic transactions will include a numberwithout any defined monetary value, eg. grants ofcommodities or technical assistance, giving rise toproblems of assigning budget and accountingfigures;
• Government accounting systems have as one oftheir design objectives to provide an historiccomparison of estimates (budgets) with actualexpenditures for detailed public expenditure reviewprocess.
Some of these factors are considered below, others areexpanded later in the text.
Implications of the distinction betweenpublic and commercial financialmanagement
Traditionally government financial management hasbeen about expenditure control–the input side of themodel. A survey of senior government officers inAustralia in 1983 found that 94 per cent saw financialmanagement as “spending no more and no less thantheir budget allocation.” Controlling expenditureagainst budget is a legitimate and fundamental role ofpublic-sector managers.
Input $ Output $ Outputs*goods*services
The business activity
Inputs*materials*labour*capital
Government activity
OutputInput $ (not expected
Outputs*servicedelivery
Inputs*materials*labour*capital
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The conclusion above indicates, however, that iffinancial management is to be an effective tool ofgovernment policy, then financial inputs must belinked to physical output indicators, ie. relatingexpenditure, defined in monetary terms, with outputs,defined in physical terms. Thus the need is to movethe focus of government financial management awayfrom looking only at inputs, and instead to develop anoutput focus–a goal-oriented approach.Before this can be achieved, the actual components ofthe traditional financial management system requireenhancement. Normally governments are the biggestspending entity in any economy. Yet the budget andaccounting systems of many governments are archaicand have benefited little from modern developmentsin financial management–a comment Kenneth Clarke,the Chancellor, made even about the UK system in theNovember 1993 budget. Budgeting and accountinghave been seen primarily as tools of fiscal and policymanagement, with the main emphasis on the public-sector borrowing requirement, and hence expenditurecontrol.Only relatively recently has the need to turn financialmanagement into a tool enabling managers to betterperform their tasks been recognized. New Zealand hasrevolutionized its system of government with thedevelopment of output-based budgeting and accrualaccounting. Australia has moved to an output-basedthree-year rolling budget. The UK has introducedresource accounting and budgeting, based on a formof accrual accounting. Similar programmes are beingadopted in other countries.National impact of government activities
The duality in the economic role of government is onefactor which makes its own financial management sodifficult. Governments have a responsibility formanaging national economy. At the same timegovernments are also responsible for directlymanaging their own executive and activities.Governments seek to manage both the nationaleconomy and their own organizations effectively andefficiently. Very often these two objectives converge,but it is easy to envisage conflicts, for examplebetween the need for capital expenditure to promoteefficiency as against macroeconomic policyobjectives of restricting government borrowing.10/
Almost certainly the information needs of these twoobjectives will be significantly different.
Nature of government transactions, assetsand liabilities
Government assets typically contain a high proportionof infrastructure assets, eg. roads and sewage systems.These present problems in establishing an accrualaccounting system, because of the difficulty ofarriving at meaningful estimates of value or life. Inmany instances such assets have no identifiable finitelife, original cost is difficult to identify and there is noalternative use.Government assets also include tax revenues forwhich assessments have been raised but not yetreceived (ie. tax receivable). Accounting conventionsadopt a conservative approach to asset valuation,anticipating any shortfalls between receivables andanticipated receipts. Therefore the tax receivableneeds to be reduced by a statistical estimate of theshortfall, based on historic experience. Provisionshave to be introduced within the classification system.Many governments have a large unfunded pensionliability, which has never been recognized under cashaccounting. Not merely accrual accounting but thewhole approach of anticipating committed futureflows requires such a pension liability to be properlyestimated and recognized. The liability arises from thecontractual commitment to pay future pensions toretired employees, for which no separately identifiedfund has been established. The amount of the pensionliability is the actuarial estimate of the present valueof future pension payments. In many countries thisliability can be very large in relation to governmentassets. It presents problems of treatment andclassification–should the cost when first recognizedbe treated as an operating cost, or a capitalmovement?Multifaceted impact of government activities
The nature of government is that it delivers a range ofservices to different sub-sets of the population. Allhave a legitimate interest as stakeholders, and theseinterests are often articulated through a range ofpressure groups. A major part of public policy isabout the amounts of and the manner in whichresources are allocated to different groups. It isincumbent upon governments to provide transparentinformation about such resource allocations.Often the required resource allocation information forany one group will be unique, and not required forany other purpose. Information may be required by
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geographical area, or combining the impact of avariety of activities on one group of stakeholders. It isprobably infeasible that any system can ever bedesigned that meets all of the potential informationneeds, but at least the financial management systemshould identify the major stakeholder groups and theirlikely information requirements.Who are the “managers” in governmentfinancial management?
Ultimately the managers in a democracy are theelected representatives of the people. The executivearm of these representatives is the senior ministers,and they in turn operate through full-time publicservants. For practical purposes these senior officialsare the managers within the entity of government.
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III. PLANNING
IntroductionPlanning is the first of the financial managementsubsystems to be considered. Planning and budgetingtogether refer to four typical and distinct processes,each resulting in a documented output. It is unlikelythat all four would be present in any country.• Long-term planning–five years or longer, resulting
in the production of, for example, a “Five-YearPlan.” Such plans rarely contain any financialforecasts other than in very general terms, and arenot in any meaningful sense part of the financialmanagement process;
• Public investment plans (PIPs), setting out thecapital expenditure plans, typically for a three-yearperiod. These PIPs will normally estimate thecapital outflows, but will not link these to otheroutflows or resources available. PIPs are properlyregarded as part of financial management;
• Three-year rolling plans, or budgets. These are formost countries an innovation, and will generallyboth embrace and replace the PIP. A three-yearrolling budget (TYRB) is an example; it extendsthe time-frame of the traditional annual budget to athree-year horizon, and includes capital andrecurrent expenditure, revenues and financing.Medium-term financial plans largely replace theneed for PIPs, and are again part of the financialmanagement system;
• The annual budget, the legal document authorizingthe raising of revenues and expending of publicmonies, and containing the annual financialforecasts. In most countries the annual budget ispart of the constitutional framework, and it is at theheart of the financial management system.
Long-term plans
For almost all LDCs, “planning” is linked to the ideathat “development” is a formal process, which doesnot just happen, but must be planned. Many LDCs hadno formal planning institutional structure before thecommencement of official development assistance.The formal planning process may take the form of a“Planning Ministry” or “Planning Commission.” In
some countries, such as Botswana, planning is a divisionof the Ministry of Finance.The responsibility of such planning institutions andsystems typically extends beyond development projectsand programmes, to embrace macroeconomic planningand management. Also, even in relation to projects,planning institutions will be concerned with all aspects ofimplementation, not just (or even primarily) financialaspects. Indeed, a criticism of many planning institutionsis their limited financial planning capability, and suchinstitutions would not normally see themselves as part ofthe financial management system.However, the following activities typically carried out byplanning institutions and systems are in fact part of thefinancial management process:• Identifying development objectives;
• Developing strategies and programmes to achieveobjectives;
• Assessing resources available;
• Prioritizing between objectives and expenditure plansso as to match expenditures to available resources;
• Establishing criteria for, and carrying out, projectevaluation and selection; and
• Monitoring project progress against plans and othercriteria.
The present status and role of planning bodies in LDCs isoften somewhat confused. There is a general move awayfrom long-term perspective planning, and a greateremphasis on more detailed medium-term financialplanning. In some countries this has resulted in thedowngrading of planning institutions. Nevertheless, inmany LDCs planning institutions and systems continue tobe a significant part of the institutional framework.To the extent that planning systems and institutions exist,there are strong reasons for seeking to integrate themwithin the financial management system. The roles of theplanning process indicated above are part of financialmanagement, and it is very desirable that they use thesame classification structure and valuation models that areused by other parts of the financial management system,and the subsystems should be able to exchange data. Forexample, project monitoring should use informationderived from the accounting system; project budgets
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should be based on the financial forecasts used inproject evaluation, and so on.
Public investment programmes (PIPs)PIPs have been encouraged by donors to provide a“hard” financial investment plan. They provide amechanism through which capital investmentprogrammes can be prioritized, projects selected, andtheir financial costs aggregated and recognized. Thesecosts can then be used in financial modeling, andshould feed into the budget process.
PIPs are normally generated as part of the planningprocess. They are useful in particular because theybring together a series of separate decisions onprojects, and enable their aggregate impact onresources to be assessed. However, they do notaddress the issue of overall resource requirements,because they do not take account of non-capitalexpenditure programmes. PIPs encourage a focus on projects and identifyingexternal donor funding. Because of this focus they candistort a rational approach to policy prioritization.Also the concept of a PIP is fiscally expansionary, inthat most public investments demand future resourcesto maintain and sustain the activity. Finally, theconcept of a PIP encourages the dual budget approachof a development and recurrent expenditure budget.It is concluded that PIPs are not an effective planningtool unless clearly embraced within a broadermedium-term financial planning framework.
Medium-term financial plansMedium-term financial plans typically take the form ofthree-year rolling budgets (TYRBs). In the UK they arereferred to as the “Economic Survey,” but fulfil the samerole. Such medium-term plans (hereinafter referred to asTYRBs) meet a number of financial managementrequirements.• Macroeconomic fiscal management essentially requires
a medium term planning framework. A TYRB movesthe planning horizon from one year to three years,forcing more systematic advance planning of activities,expenditures and resource implications;
• As a result there is an enhanced ability to focus onpriority sectors, and more effective utilization ofavailable resources. Resource constraints can beidentified at a much earlier stage, and the fiscal impactof starting projects can be seen more clearly;
• Most projects have lives beyond one year, and single-year planning does not provide any framework foranalysing their financial impact over a longer period;
• A forecast is provided of the impact on recurrentexpenditure of development projects which come to anend, and where the activities have continuing resourcerequirements;
• Annual budgets do not provide any mechanism for theproblem of under- or overspending on an individualproject in one year and transferring budgets to lateryears;
• TYRBs provide improved annual budgeting and moreeffective expenditure control.
Exhibit 7. Example of three-year rolling budget
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TYRBs form an integral part of any financialmanagement reform process. Australia has led the wayin introducing three-year plans, but many countries arenow following. It is interesting that the imperativebehind Australia’s three-year budget process was tocurtail expenditure, 11/ but some LDCs now see such a
medium-term framework as a mechanism for increasingdonor aid utilization.Conceptually, medium-term plans fit into a spectrumbetween longer-term plans and annual budgets, in whichthe amount of plan detail increases as the planning timehorizon shortens.
Annual budgets are typically aconstitutional requirement, and legallypermit expenditure for the next fiscal year.Though a rolling budget has no such legalstatus, nevertheless it should impact on thebudget process. This has been seen as themajor benefit in Australia. The challengethere has been to move the three-yearbudgets from merely “wish lists” ofexpenditure to serious forecasts which areseen as restricting the ability to makeexpenditure decisions in annual budgets notalready in the three-year plan.The Australian experience has alsodemonstrated the need to see such three-year budgets as part of an overall process ofbudgetary reform, where the emphasis shifts
towards identifying output goals. Thesewider perspectives are dealt with further below.Preparation of a TYRBThe three-year budget should be rolled forward each yearas part of the annual budget exercise, and published inparallel to the budget. This will enable the current year’sbudget to be reviewed as part of the medium-termprogramme. In order to be meaningful, the TYRB shouldembrace all recurrent and development expenditure,revenue estimates and official development assistance, andso identify financing needs. Therefore it needs to beclosely linked with the development programmingexercise. The major activities are set out in Exhibit 9,below, and then explained in detail in the subsections thatfollow.
Exhibit 8. Planning time-scales
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Exhibit 9. Major stages in preparation of the three-year rolling budget
Requests in budget call notices Included in call notices for budget and development programme requests forthree-year forward estimates, revenue forecasts and other data as identifiedabove
Resource ceilings Indicative resource ceilings established for each of the three years for internaland external resources, allocated over sectors according to priorities
Ministry review Review with plan objectives and declared government priorities
Conduct economic appraisal of proposalsDiscussions with line ministries following above analysis, leading to modifiedestimates
Preparation of TYRB Analysis of macroeconomic implications and resource implications of TYRB
Analysis of manpower, organizational and physical resource implications
The resource ceilings must separately identifydomestic and foreign resources. In order to arrive atdomestic resource availability, separate projectionsmust be made of:• Tax and other revenues;
• Cash grants and loans;
• Other types of foreign assistance providingcounterpart funds;
• Debt service costs;
• Net flows from public enterprises; and
• Domestic borrowing targets.
The TYRB will be prepared in money units, ie. theactual cash income and expenditure. Thereforeaccount will have to be taken of changes in pricelevels of specific inputs. Particularly significant willbe:• Changes in government wage levels within the
period (the only factor amenable to a policydecision);
• Changes in prices of other major inputs; and
• Exchange rate movements and their impacts oninputs and also on interest and principal flows onforeign loans.
At a technical preparation level, many LDCs find itdifficult to make the forecasts of official developmentassistance which are required. The approachdeveloped below will in many cases obviate thisproblem.
Single-year model
As part of the work for preparation of the TYRB, it isnecessary to develop a model showing theinterrelationships of the components of the forecasts. Thiswill enable the implications of initial forecasts to be seen,and then the effect of decision alternatives. The basicmodel is set out in Exhibit 10, below.
Exhibit 10. The three-year rolling budget model (single year)
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Note that this model is only for a single year.Extension into a multi-year model is further discussedbelow.In Exhibit 10, above, the components of the model,their interrelationship, and the extent to which theycan be controlled is explained. Important features tonote are:• Foreign inflows are treated as a function of project
expenditure. This is a heroic assumption, but can bejustified in the context of most LDCs because oflow levels of foreign resource utilization, and thefact that the constraint is primarily foreignresources. However, it must be recognized thatwhile this may be valid at a macro level, it isunlikely to be always valid in relation to individualprojects;
• Debt service costs are treated as fixed. While this isobvious for foreign borrowing over such a shortperiod, it is less obvious for domestic borrowing,since this is the balancing item. However, in realitydomestic borrowing is likely to lie within certainparameters, and the impact within those parametersof variation is unlikely to impact significantly on asingle-year model.
Thus the model becomes primarily a tool fordetermining feasible levels of project expenditure andallocation between projects, within the broadconstraints of government tax and economic policy.
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Exhibit 11. Description of components and relationships
Component DescriptionExtent to which component can be
changed and dependencies
Development budget(or capital expenditureprogramme if nodevelopment budget)
Three-year forecasts for projects. Forecastsidentify major categories of expenditure, andsources of funding segregating foreign grantand loan
Policy decisions can change withoutlimiting expenditure on, or existence of,projects. Therefore there is a two-wayrelationship.
Recurrent budget Three-year forecasts for recurrent (revenue)expenditure
Difficult to significantly change the regularbudget forecasts without major changes tostructure and organization of government
Debt service costs Forecasts of the interest and principal payableon foreign borrowing. Government borrowingneeds to be separately identified fromborrowing by State-owned businesses andNGOs. Domestic lending service costs onlyincludes interest payments.
No short-term control over foreign debtservicing costs. Domestic debt service is afunction of domestic borrowing, butchanges of a realistic level are unlikely tohave a significant impact in the year inwhich they take place.
Budget inflows Subdivide into several categories. Domestic revenue–taxes and otherincome–received by central government.Direct budget support from foreign sources.Foreign resources including both grants andloans. Items not passed through governmentbudget (technical assistance, commodity aid,NGOs and public enterprises) should beexcluded
Domestic revenues are a function of, interalia, taxation policy.
Direct budget support is a matter ofagreement with foreign organizations
Foreign resources are treated as a functionof project expenditure
Domestic borrowing Net increase or decrease in domesticborrowing
This is regarded as the balancing item
Multi-year model
As indicated above, the model is a single-year model,but by definition the TYRB is a multi-year model. Inextending to a multi-year model it must be recognizedthat the relationship is serial and asymmetric. Thussome components in the model are directly dependenton the previous year, eg. domestic debt servicing costsare dependent on cumulative domestic borrowing.However, second-year borrowing has no impact onfirst-year borrowing.Most components are related by practical constraints.Thus, for example, project expenditure on individualprojects cannot be increased and decreased from yearto year to meet budgetary needs. Rather, it is dictatedby physical project implementation needs, and there isnormally going to be a regular trend of expenditureover the project life cycle. Similar constraints apply toregular expenditure and tax revenues.These interrelationships are summarized in Exhibit 12,below.
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This indicates a set of relationships largely determinedby practical considerations. The only modelingrelationship that needs to be incorporatedmathematically is the dependency of year n + 1domestic debt service costs on year n domesticborrowing.External relationships
The model does not of course exist in isolation. It isasymmetrically linked to a number of externalities.The most important include:• Domestic money supply and interest rates;
• Rate of inflation and asset price changes;
• Changes in GDP; and
• Other sectors directly controlled by government,eg. public enterprises.
However, for the purpose of a specific budget exercisethese may be treated as fixed, and there is no attemptto build in any relationship. The reason for this is thatthe three-year rolling budget exercise takes placewithin largely pre-defined parameters, eg. levels ofdomestic borrowing, tax revenue and so on. Thedecision process is primarily an allocative one withinthe model. Therefore it is reasonable to ignore theexternalities.
Content and presentation of TYRBs
The TYRB should form an integral part of the budgetprocess. It is essential that it be presented to Parliament aspart of the budget documentation. The forecasts in theTYRB must be seen as an extension of the current year's
Exhibit 12. Multi-year TYRB relationships
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budget into the future. The current year budget mustbe seen as year 1 in the TYRB, and obviously thefigures must be the same.This is best achieved by integrating the productionprocess for both the budget and the TYRB. The TYRBwill fail to achieve its objectives if it is produced at adifferent time, by a different process, is presented in aseparate format, or has figures which differ from theannual budget. Yet these are all failures which havebeen observed in countries which have introduced, orsought to introduce, a TYRB.The TYRB can be combined with the annual budgetpresented to Parliament. Additional columns can beincluded to show the forward estimates. These wouldnot need to be at the same level of detail as the currentannual budget estimates, and careful considerationneeds to be given to the extent of detail and thepresentation design so as to retain clarity andtransparency.
Expenditure prioritizationA major function of the planning process is to allocatelimited resources between competing claims. Aspecific problem of public financial management isthat claims for resources will always tend to exceedresources available, since the cost of such resourceshas no significant impact on the recipients, eg. healthcare is very expensive to the community as a whole,but for the individual patient in hospital the extra taxhe or she pays is insignificant in relation to thebenefits of health care received personally.Therefore resources need to be allocated according topublic policy priorities within overall resourceceilings. However, there are a number of factorswhich make such resource allocations difficult withinLDCs.• Particularly within the relatively immature political
systems of many LDCs, competing politicalpressures make it convenient not to articulate policypriorities too clearly;
• It is difficult to establish with any degree ofreliability the costs and benefits of specificactivities and programmes. This is especially so ifmarkets are not open and market prices do notrepresent opportunity costs. Even without thisproblem, benefits of government activities are oftendifficult to express using common measurementscales;
• In general there is better information on such costsand benefits at a decentralized level than at thecentre;
• Donors and official development assistance can distortthe process. Donors have their own priorities, and donorfunding not only appears free (since it may not easily befungible), but also carries hidden benefits to recipientorganizations, eg. study awards overseas.
The challenge is to incorporate within institutions andprocesses an approach to address these problems andprovide a consistent methodology for expenditureprioritization which is the best feasible compromisetowards consistently optimal resource allocation decisions.The main elements of such an approach are identifiedbelow.First, there needs to be a single consistent approach toprioritization and allocation. If there is an ability to getround objections by, for example, direct approaches toState finance institutions or external donors, then anysystem will fall into disrepute and become of limitedeffectiveness.Secondly, policy priorities do need to be clearly andpublicly articulated through the political process, so thatthe basis for selection can become transparent. Similarly,the costs and benefits associated with decision alternativesneed to be identified, and made public, in the knowledgethat the persons will be held accountable in an ex postreview process.Within overall and sectoral resource constraints, individualexpenditure decisions should as far as feasible bedelegated to local levels, where the stakeholders can beinvolved in discussion and decisions. However, there is adanger that powerful local levels may be able to obtaincontrol of this process, which may limit the feasibility ofsuch decentralized decision processes.Actual procedures for making decisions need to beestablished, documented, made transparent, and appliedconsistently. A discussion of approaches is set out belowin the section on ex ante performance measures.The whole process needs to be documented and madeopen and transparent. There should be a process ofproviding information in a similar manner on outcomes(hence the importance of using consistent classificationand valuation models with the accounting system), so thatthose involved are held accountable for original forecasts.
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IV. ANNUAL BUDGETING
The government’s annual budget is the embodiment of the legal authorization by Parliament of the country’sexpenditure and taxation proposals for the coming financial year. It should be: (i) a means of allocating resources toachieve the objectives of the government, (ii) a management tool for national economic and fiscal planning, and (iii) ameans of controlling and monitoring the use of funds to ensure that they meet stated objectives. Exhibit 13, below,illustrates the budget process. Many LDCs incorporate provision for such a process in their legislation and
regulations.
Exhibit 13. Overview of the budget process
For governments, financial management is to a largeextent driven by the budget and annual appropriationlegislation. There are a number of factors which makebudgets so important for governments, and which aredifferent from the budgets in commercial activities.• Government budgets are not only about managing
government activities, they are also tools of nationaleconomic management;
• Government expenditures are not directly affected byrevenue raised, since government transactions aregenerally non-requited;
• The budget is a legal authority to spend, with limitswhich may not be exceeded without furtherParliamentary authority;
• The budget is also the legal authority to impose taxesand raise other revenues;Many countries divide theirbudgets between development and recurrent;
• Company budgets are predictions (best estimates oflikely sales and expenditure necessary to achievethose sales), whereas government budgets areplanned revenue raising and expenditures (out-turnsexpected to be achieved).
Thus the government budget becomes the legalfinancial policy instrument, to be adhered to unlessformally amended. Commercial budgets, on the otherhand, are merely best guess predictions, with a lessstrong obligation that they must be observed.As an example, in a commercial entity if there is a largeproduction cost excess over budget because salesexceed budget, this is regarded as a managementsuccess. In governments, such expenditure overrunwould be illegal unless prior authorization wasobtained. This illustrates a very fundamental differencebetween commercial and government entities, and alsoa problem of governments in managing commercial
Quantify objectives
Evaluate
Determine income
AuthorizeSet taxes
Communicate Coordinate
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operations. Most treasuries resist linking specificrevenues (eg. examination fees) to specific revenues(eg. examination administration).
Budget quality indicators
Exhibit 14. Budget quality indicators
Some of the key factors which make a budget processeffective include:
Transparency _ Budget documents should provide a clear link between objectives and expenditures
_ All participants in the budgetprocess clear about their roles and responsibilities
_ Procedures simple and welldocumented
_ Basis of budgeting should bedefined, eg. incremental, zero based
_ Departmental targets and resourcesused clearly indicated, explainedand published
Management _ Effective budgeting involves notonly preparing annual budgets, but also the management andmonitoring of the budget
Link tomacroeconomicframework
_ Budgeting should take place withina macroeconomic framework whichidentifies resources available andborrowing targets
_ There should be budget expenditureceilings, which must be adhered to
Central budgetcontrol overexpendituredecisions
_ The budgets of the line ministriesshould embrace all expenditures bythose ministries and governmentactivities under their control
_ There should be no extrabudgetaryfunds
Decentralization _ Decision-making within the budgetprocess should be decentralized asfar as feasible to increaseparticipation and commitment by allstakeholders
Prioritization _ Formal statements of governmentpriorities as the basis for allocatingresources between competingdemands
_ Costs and benefits of decisionalternatives should be transparentlypresented as the basis of allocationdecisions
Coordinationand cooperation
_ Ensure links between recurrent anddevelopment budgets and otheraspects of the financial managementsystem
Integration _ Recurrent costs of developmentprojects built into recurrentexpenditure planning and the trade-offs between recurrent anddevelopment expendituresconsidered
Flexibility _ To respond to changingcircumstances built into the system,so that implications of any changesare sufficiently analysed to still fitwithin government’s overallobjectives and priorities
Discipline _ The system should combineflexibility with effective controlover expenditures
_ Any changes to the budget shouldbe carefully analysed and justified
_ Only limited use should be made of supplementary estimates
_ There should be penalties for breach of rules and regulations
Link to medium-term framework
_ There should be a link between the resource framework and theannual budget
_ There should be a link betweenpolicies and budget allocations
Accountabilityand credibility
_ There should be politicalinvolvement and commitment
_ Involvement and accountability of senior managers in all stages of the process
_ If ministries do not believe they will be held to their ceilings or ifthey can easily bypass normalprocedures, the whole process ofbudgeting can be undermined
_ Budgets should be reliably close to the actual out-turn
Comprehensive _ Budget process and documents need to include, as far as feasible,all revenues and expenditures,including all aid funds
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_ Budget should also containinformation on previous year’s and current year’s expenditures
_ Impact of the budget measuredthrough output performanceindicators for recurrent anddevelopment expenditures
Ex post budgetreview
_ Amendments to the budget andactual outcomes should be reported as soon as feasible after the period end, in a format thatenables comparison with originaldecisions, and the results publicized
Evidence of weak budget procedures
There are a number of factors which would evidence aweak budget system and procedures.• Comparison over a 10-year period of budget
estimates as compared to actual out-turns. Persistentlarge forecasting errors would be indicative of aweak budget process;
• Budget documentation identifying the budget stagesand procedures. Omission of major stages, or theinability to clearly identify them taking place, wouldindicate problems in implementing budgetprocedures. Final budget documents should betransparent to non-technical Parliamentarians, andmake the nature and implication of decisions as clearas feasible;
• A transparent link to the macroeconomic process,with resource envelopes set and call notices issued ingood time. Many LDCs have problems in forecastingresource envelopes, and consequently the wholebudget process is delayed. Call notices are oftenbadly designed, giving staff in line Ministries basicclerical problems in completing them. In one LDC, itwas observed that some line ministries hadestablished PC-based systems to prepare theinformation, but the Ministry of Finance rejectedthese and insisted on handwritten completion of itsown badly designed forms;
• Ability to clearly identify line ministries which arecontrolling the budgets of their subsidiary units.Senior ministry officers should be seen to beparticipating in the budget process. Operations underministries should not have access to extrabudgetaryfunds. In one LDC, projects negotiated directly withthe Ministry of Finance on their budgets, with only
nominal ministry participation in the process;
• Line ministries should submit in advance of budgetnegotiations their comprehensive budget estimates,within resource ceilings, backed by appropriateschedules, or argue cogently why they may haveexceeded the allocated resource envelope. Thereshould then be an informed discussion at a seniorlevel between the line ministry and the Ministry ofFinance, in which spending priorities are discussedand from which appropriate decisions emerge. Atbest, reality is only likely to approximate to thisprocess. Negotiations between line ministries and theMinistry of Finance are often more of the nature of agame scenario, in which the participants manoeuvretowards their differing objectives. Massive and/orarbitrary reductions in original ministry estimates toapproved budgets indicates system weakness;
• The budget process should be completed in sufficienttime so that the budget can be presented toParliament, discussed and enacted well before thestart of the fiscal year. In many LDCs budgetprocesses go well into the fiscal year to which theyrelate, and interim procedures have to exist to allowgovernmental spending units to continue to operate;
• Extensive transfers between budget heads(virements), or supplementary budgets, would beindicative of allocative inefficiency in the budgetprocess. In some countries this is difficult to identify,because the process is informal–expenditure ismisdescribed so as to keep within budget limits;
• Procedures for managing the budget, eg. trackingbudget allocations to spending units, virements,supplementary budgets, any emergency allocationsand comparison with actual outcomes. Theseprocedures should be systemic, not ad hoc, and berelated to responsibility points and control timingrequirements (this is discussed in more detail underaccounting).
• These indicators are not a comprehensive list.However, when combined with the list of budgetperformance indicators they enable a review processto establish the quality of the budget system.
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Budget as a resource allocation tool
The allocation of funds through the budget should bebased on the priorities and activities of departments,ministries and the government as a whole. It should alsobe based on actual requirements, rather than inflatingthe previous year’s expenditures. Zero-based budgeting(see below) has been developed as a tool to achieve thisobjective.It is important to recognize the major role of the budgetas a resource allocation tool. Indeed, the primaryfunction of the budget is to allocate limited resourcesaccording to government priorities over the activities ofthe government. The whole budget process should begeared to this objective. The concepts and approacheshave been discussed above in the section on planning.Comprehensiveness of the budget
Effective budgeting requires that the budget processdoes in fact control all of the expenditures by centralgovernment. Extrabudgetary funds weaken the budgetboth as a resource allocation tool and as a tool of fiscalmanagement. Most systems have the potential for largeextrabudgetary expenditures. Some examples include:• Funds received by line agencies which are then
available for expenditure, without passing throughthe consolidated fund. There may be merit onoccasion for linking expenditures to revenues raised,but these need to be controlled through a centralbudget process;
• Quasi-fiscal activities of state financial institutions,eg. loans at low interest rates, and/or without the
expectation of repayment, to State enterprises;
• Direct access by projects to donor funds. From aproject management perspective, it may be desirableto bypass the bureaucracy and have direct access todonor funds, and indeed donors often encourage sucha system. However, this reduces the effectiveness ofthe budget process to control expenditure.
One of the problems of an inefficient financialmanagement and fund-release system is that entitieswithin government will seek to obtain direct access tofunding, to meet legitimate desires to deliver outputs. Amore appropriate solution is to address the systemicfailures.
The budgeting process
The budget preparation process should involve thoseresponsible for all stages in budget planning andimplementation and should enable budget managers andpoliticians to make rational choices between differentuses of funds.Stages in the budget process
Generally the Budget Office, Department or Division,normally within the Ministry of Finance, orchestratesthe actual budget exercise. The central planninginstitution may also be involved in the process,particularly in respect of development projects. Whilethe actual process, institutions and timing vary fromcountry to country, certain key stages are almostinvariably common.
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Exhibit 15. Key stages in the annual budget process
Stage ActivityLikely timing(months from
fiscal year end)
1 Forecast resource envelope and sectoral allocations -6 to -9
2 Issue the budget circulars to line ministries requiring budgets to besubmitted
-8 to -4
3 Line ministries obtain estimates from subsidiary units, eg. departments,divisions, cost centres, projects
-7 to -3
4 Line ministries consolidate estimates and discuss and negotiate withsubsidiary units to bring them within resource envelope
-6 to -2
5 Aggregation of budgets by line ministries and submission to Ministry ofFinance/planning institution
-5 to -2
6 Budget review and negotiations between Ministry of Finance, planninginstitution, and line ministries
-5 to -1
7 Agreement of final budget figures, preparation of budget for submissionto Parliament
-4 to -1
8 Parliamentary review process leading to enactment of budget(commonly a system is in place to allow spending to continue duringbudget discussions)
-3 to 0
9 Budget allocation to spending units, and authority for release of funds(warranting in some countries)
-1 to +1
10 System for viring funds during year to different heads of expenditure,and supplementary budget procedures if total budget proves inadequate
+2 to +12
Virtually all countries, including LDCs, follow a budgetprocess similar to the above. The problem within LDCsis typically implementation of the procedures.Examples of problems identified in countries of whichthe authors have experience include:• Budgets prepared very late and not completed until
well after the start of the fiscal year, givinginadequate time for proper procedures to be carriedout;
• Lack of adequate reliable financial information onexpenditures and revenues to date in current year,and forecasts to end of fiscal year;
• Line ministries failing to act effectively in control ofthe budget estimates of their subsidiary units, notcarrying out a proper role of allocating their ownresource envelope according to priorities, and leavingall decisions to the final budget negotiations;
• Estimates prepared without adequate analysis andforecasting;
• Excessively high initial estimates as negotiatinggambits, failing to provide a meaningful basis forallocation decisions;
• Weak system of allocating national budgets toindividual spending units;
• Extensive use of virement (transfers between budgetheads) and/or supplementary budgets; and
• Inability to properly control expenditures withinnational borrowing targets.
Budget procedures, documentation and training
For budgets to be effective they need to involve allentities within government. It is essential that thebudget procedures and stages and the roles ofindividuals are fully understood if the budget is toachieve its objectives. This requires:• Planned procedures allowing adequate time for every
stage;
• Well designed budget documentation and/orcomputer systems;
• Procedure manuals setting out clearly the processesand responsibilities;
• An institutional framework with clearly definedresponsibilities for stages within the budget process;
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• A timetable which is known to all concerned;
• Transparent procedures for deciding betweencompeting claims to limited resources on the basis ofestablished procedures;
• Training of all those involved in the budget processso that they are able properly to carry out their tasks.
A budget system will require computer support. This isdealt with separately in Section IX, below.Tracking budget stagesBudgets (annual and three-year rolling) go through aseries of stages, eg.:• Initial estimates from rolling budget and/or
departments within ministry;
• Linking these to resource ceilings to generate finalministry budget proposals;
• Agreed ministry and national budgets as submitted toParliament;
• Transfer between budget heads (virements) asallowed under financial regulations; and
• Supplementary budgets and other changes.
Systems and procedures are needed to track thesestages, ensure they are in accordance with laid-downprocedures, and provide information which can be usedfor budget monitoring and control. This informationneeds to be available at collecting/spending unit,ministry and central levels.
Institutional framework of budgetingand planning
In any review of the budget and planningsubcomponents of the financial management system,account must be taken of the institutional structure. Thelong-term sustainability of any programme ofimprovements critically depends on such institutions,and failure to recognize institutional constraints andwork through those constraints is one of the majorreasons for improvement programmes collapsing oncedonor assistance ceases.As noted above, typically LDCs have a separateplanning institution from that responsible for thebudget. Many planning institutions were developed as“think tanks,” but have tended over time to becomeinstitutionalized and staffed by regular governmentstaff. Budget functions tend to come under the Ministryof Finance. A typical structure may be as illustrated inExhibit 16, below.
Exhibit 16. Typical planning/budget structure
Planning institutionsAs indicated above, the roles of planning institutionstend to have widened, so that they may include areaswhich impinge on, or replace, some of the budgetactivities of the budget institution. For example, insome LDCs the Planning Commission is responsible forthe annual development programme, which becomesthe basis of the budget. In such situations it is oftenconfusing to know where one set of responsibilitiesends and another begins.In one LDC, responsibility for the developmentprogramme has recently been moved from the FinanceMinistry to the Planning Commission. However, theFinance Ministry retains responsibility for actuallypreparing the development budget and its submissionby the Finance Minister to Parliament. One secretary ofa line ministry commented, “before we had to agree thebudget just once, with the Finance Ministry. Now wehave to separately agree it with the PlanningCommission and also with the Finance Ministry.”12/
Furthermore, institutional theory would anticipate thateach of the respective institutions develop its ownidentity, and officers within the institution seek toexpand the power and the influence of the institution.Thus in practice many planning institutions and budgetbodies, while declaring how well they cooperate, are infact conducting an ongoing battle to establish their areasof influence.Any plan to improve the budget and planning
Government
May be intermediate bodyeg. Resources Committee,National DevelopmentCommittee
Planning Institutioneg. Planning
Budget Institutioneg. Ministry of
Accountant General
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subsystems would need to include an institutionalstrategy to address this problem. An ideal solution maybe to merge the two organizations, but this may not be afeasible option. Alternatively, simply setting upmechanisms for them to work together, combined withimproved communication links, may be sufficient.Ministry of Finance
The responsibility for much of government financialmanagement rests on this ministry. The functions of aMinistry of Finance differ from country to country. Inmany countries the Accountant General is part of theMinistry of Finance, in other countries thisorganization, or its equivalent, is separate. Again, insome countries planning and finance are combined, butin most they are separate institutions. However, some ofthe common functions of a Ministry of Finance include:• Supervision of the budget process;
• Exercise of powers of financial approval anddelegation;
• Control of expenditure;
• Evolution of tax policies;
• Supervision of tenders, contracts, supplies and theprocurement process;
• Enforcement and development of financialregulations;
• Management of liquidity, borrowing and lending;
• Conduct of external financial relations with donors,lenders etc.;
• Maintenance of the central accounting system;
• Supervision of financial relations betweengovernment and the public enterprise sector; and
• Initiating action to improve financial standards andperformance.
While institutional structures vary considerablybetween countries, the essential processes of financialmanagement do not. Thus for a country to have a goodsystem of financial management the processes ofplanning, budgeting, implementing,accounting/reporting, auditing and remedial action mustbe properly developed, within institutional structuresappropriate to the country.
Non-financial performance measuresAs identified above, in the public sector financialmeasures are normally inadequate for service delivery.
Therefore alternative non-financial performancemeasures need to be developed. Performance measuresmay be ex ante or ex post.• Ex ante measures–used primarily to decide between
decision alternatives;
• Ex post measures–used to evaluate performanceagainst previously identified criteria.
The concept of performance also needs to be furtherrefined. Performance must be seen in terms ofachieving public policy objectives, and is usuallymeasured in terms of economy, efficiency andeffectiveness (the “three Es”).• Economy–achieving the policy objective with the
minimum required resources, particularly minimumfinancial resources;
• Efficiency–achieving the policy objective in the mostefficient manner (this is close to the concept ofeconomy, but emphasizes non-monetary resources);
• Effectiveness–effectively achieving the policyobjective, eg. if the policy objective was improvededucation in all geographic regions, large regionalschools might be economic and efficient, but theywould not be effective in achieving the policyobjective.
Both ex ante and ex post measures are properly part offinancial management. Also, both need to be integratedwith other components of financial management, forreasons already indicated–the needs for commonclassification and valuation models and the transfer ofinformation.Ex ante performance measures
As indicated above, ex ante measures are used primarilyin deciding between alternatives, and they properlyrequire a book in their own right. Essentially theprocedures involve three stages.
Stage 1 Identify policy issue and decisionalternatives;
Stage 2 Construct an “effect matrix” to identifythe effect of each alternative;
Stage 3 Apply an evaluation approach to decidebetween decision alternatives.
There are a number of approaches to evaluation:• Cost-benefit analysis–this involves the quanification
in monetary terms of costs and benefits, and thendiscounting them to their present value. Where costsor benefits are not expressed in money units, then“shadow” prices are created. This approach has beenused extensively, but suffers from the fact that
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shadow prices are based on subjective assumptions;
• Cost-effectiveness analysis–seeks to identify theminimal cost method of achieving a given policyobjective;
• Scorecard approach–a matrix is constructed whichidentifies costs and benefits of decision alternatives,expressed in different units, and allows decisionmakers to use this in making a decision, withoutformally assigning weights;
• Matrix-criteria analysis–this approach takes thescorecard approach and assigns weights to thevarious elements.
As indicated above, ex ante performance measures, andtheir application to decision making, is a large subject
beyond the scope of this book. The brief descriptionabove serves to identify the issues and indicate somepossible approaches.Ex ante performance measures should ideally becomethe basis of ex post performance measures. Thus, forexample, when a national planning body uses ex antemeasures in deciding on a project, those measuresshould become the basis on which ex post performancemeasures are established.Ex post performance measures
As indicated above, the need is to measure economy,efficiency and effectiveness. The link between thesecan be expressed in different ways, but may berepresented as in the model in Exhibit 17, below.
It should be noted that there is a distinction betweenperformance measures and performance indicators.Measures are used where performance can be measuredon a scale with a degree of precision, eg. averagefemale participation in primary education. Indicators,on the other hand, imply a lower level of measurability,eg. establishment of an effective primary educationmanagement structure in 70 per cent of districts.Applying performance measures andindicators in LDCsWithout indicators of achievement, financial measuresare of limited value. Also in many LDCs, both planningbodies and donors are de facto using performancemeasures for projects. The need is to integrate theseinto the financial management system, but in a flexiblemanner. Therefore the following practical guidelinesare suggested.• The starting point should be any existing system, eg.
a monitoring system established by the planningbody;
• Ministries should be encouraged to include within
the budget a broad statement of their policyobjectives;
• Indicators should ideally be set when a project isinitiated, and followed through the project’s life;
• Wherever feasible, monetary measures should beused. In a surprising number of cases, monetarymeasures of efficiency are available (eg. costs perhospital operation, examination fees compared tocosts), but cannot be calculated because ofdeficiencies in the accounting system;
• The focus should be on indicators which are simpleand easily measured, eg. primary educationparticipation rates are easy to calculate, whereaseffectiveness of the education is much more difficultto evaluate;
• Measures can be used which require an element ofjudgement, eg. establish an operational and effectivehealth care management unit in X per cent ofdistricts;
Exhibit 17. Linkage between economy, efficiency and effectiveness
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• It is necessary to “stand back” from a system ofperformance indicators and ask how they relate topolicy objectives;
• Performance measures should be set by the managerresponsible for their achievement.
Problems in introducing performancemeasures
The first problem is likely to be organizationalresistance, often exacerbated by previous badexperience of attempts to introduce programmebudgeting. Also, the linkages between financialmanagement and performance targets may not beperceived.Secondly, in many government organizationalstructures responsibilities for achieving outputs are notclearly defined, and so it is difficult to link performancemeasures to management responsibility. Also managersmay change, again diluting responsibility forperformance.Thirdly, in many LDCs systems for gathering,recording and reporting the information are inadequateand unreliable. Indeed, in many cases even basicfinancial information is difficult to acquire in a usefulformat.Finally, there is the need to establish routine proceduresfor publishing criteria, and then gathering and reportinginformation on performance as compared to the criteria.This will require the establishment of an appropriatedatabase, linked to the budget and accounting systems.Reporting of performances should be integrated withroutine financial reporting. In addition, at a more macrolevel, there is a need to include with governmentfinancial statements some indication of performance.This latter is discussed later in this book.Conclusions on applying performancemeasures
Performance criteria cannot be avoided, and alwaysexist, at least subjectively. The object should be tointegrate them with financial measures. Any reforms infinancial management should take account of the needfor performance criteria, and allow for their eventualincorporation. Such criteria are within the capacity ofmost LDCs, and indeed the concept may be easier toadd to systems already geared up to handlingdevelopment projects and donors.Ultimately, performance criteria must be integratedwithin a financial management system. Without suchcriteria, the system lacks any good orientation. Suchcriteria should be set as part of the planning/budgeting
process, and then reported on in parallel to financialreporting.
Alternative budget approaches
The analysis above has indicated that the majordifference between the commercial and governmententity is that the latter has no monetary output. Therevenues of government are not directly related to thequality or quantity of outputs of services from thatgovernment. Therefore financial management involvescomparing monetary inputs (expenditure) to non-monetary output measures, ie. physical measures. Muchof modern financial management has involved a moveto a more goal-oriented approach to financialmanagement requiring output indicators that can beused as part of a financial management system. Ideallysuch output indicators need to be capable of being set aspart of the planning (budget) process, and also to bemeasurable (normative), so they can be included in themonitoring and reporting system.The most obvious approach would be to convertphysical measures of service delivery into monetaryunits. In practice this approach is not feasible in anypractical way. Attempts have been made to put moneyvalues on government outputs, through cost-benefitanalysis. However, though these have been successfulat the project level, it is not practical to extend costbenefit to financial management at a more aggregatedlevel, eg. ministries. It is therefore concluded thatoutput indicators will have to be expressed in a mixtureof financial and physical terms.Incremental budgeting
National budgets are aggregations of a large number ofbudgets of small spending units. Ideally budgets, targetsand output indicators should be set by managers of suchunits within an overall resource envelope, whichindicates national priorities. In practice this approach israrely achieved, and budgets tend to be set at a muchhigher level by incrementing last year’s figures forknown changes. This approach is unsatisfactory for anumber of reasons:• It fails to identify clearly managerial responsibility
and make managers responsible for their own targets;
• Since managers have budgets imposed on them, anddo not identify their own targets, it is not a good wayof motivating them to achieve specified outputtargets;
• It encourages spending and discourages saving, sinceit is difficult to justify an increase if last year’sbudget was underspent;
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• Needs and resources are not matched in any rationalmanner;
• It makes performance monitoring more difficult,since output targets are not set by those responsiblefor achieving them (if they are set at all); and
• It does not provide an adequate framework forevaluating and discussing budget decisions at anational level.
The following sub-sections consider a number ofalternative approaches to budget setting that have beendeveloped in an attempt to overcome these problems.Although none of these approaches has proved feasibleas a long-term system, they have provided the basis ofmodern thinking on government budgeting.Planning-programming-budgeting system(PPBS)Under PPBS the various activities of government areseen as “programmes” with related benefits and costs.Most programmes have alternative ways of achievingthe same ends, which can also be costed. Benefits needto be defined in normative terms. PPBS identifiesgovernment objectives and the impact of programmeson objectives, and hence provides a rational frameworkfor selecting programmes. Its most significantapplication has been in the US Department of Defense.Despite its advantages, PPBS has three majordifficulties:• Defining output in a way which allows comparison
between alternatives on anything other than asubjective basis;
• Many government activities are an essential part ofgovernment, and any attempt to specify outputsmerely states what will happen. For example,catching criminals is an output of police activity, butcan hardly be seen as an alternative to anything else;and
• The benefits gained may be outweighed by the inputsnecessary to make PPBS successful.
PPBS has made a valuable contribution to thedevelopment of budget approaches, but it has notproved feasible in itself as a budget approach to beapplied over a long period of time.
Programme budgeting
Programme budgeting is a less formal alternative toPPBS. Programme budgeting retains the PPBS conceptof moving the focus away from administrativestructures or economic classification of costs to a seriesof “programmes,” each with defined objectives. Eachprogramme requires certain resources in order toachieve the target programme outputs. Programmebudgeting seeks to identify programmes, allocatedresources and related outputs.It has been recognized in many countries that aprogramme approach is more applicable to developmentactivities and projects, and therefore the programmeapproach is sometimes restricted to the developmentbudget (see above). An example would be treating anumber of distinct activities and projects relating toeducation, drainage and agriculture in one geographicarea as all being part of a “rural developmentprogramme.”Programme budgeting can be regarded either as ananalytic tool or as a managerial approach. As ananalytic tool it is a matter of designing a system toaggregate resources allocated to, and outputs from, aseries of programmes. However, if it is to be regardedas a managerial approach, then financial andadministrative responsibilities need to be linked toprogrammes, and the concept moves much closer toPPBS, with the difficulties outlined above.It is concluded that programme budgeting is bestregarded as an analytic tool. In this context it is useful,but does not resolve the budget problems alreadyidentified.
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Zero-based budgeting (ZBB)
ZBB was also developed in the USA as acomprehensive budget approach. It requires that theactivities and ex post objectives of government beidentified and turned into a series of “decisionpackages.” There is no presumption as to any pastpattern of expenditure, hence the term zero-based. Eachdecision package is a programme under the control ofone manager, with defined and measurable impacts andobjectives. These are then categorized, ranked andevaluated so as to lead the government to a decisionabout which packages to implement, and the costsassociated with each. This is similar to the approachsometimes referred to in the UK as “priority-basedbudgeting.” ZBB requires identifying and evaluatingthe decision packages, and hence involves veryconsiderable time and effort. At the end many of theprogrammes are those which are anyway already inplace, and about which there is little choice. Attempts toapply ZBB have not generally been sustained.Current approaches to performance budgeting
Whereas programme budgeting focuses on identifyingrelated activities as programmes, the emphasis ofperformance budgeting is linking financial inputs tonon-financial output targets. The approach recognizesthat most government activities yield service deliveryoutputs. Because these are not represented in thefinancial budget process, the tendency is to judgeperformance by expenditure according to budgettargets–what the expenditure leads to is not considered.Performance budgeting seeks to move the emphasisaway from expenditure to a focus on outputs, measuredin non-financial units. This requires the identification ofnormative output performance indicators linked to thefinancial inputs.Performance budgeting therefore requires theidentification of goals for budget activities, and thetranslation of these goals into normative outputindicators. The output indicators become theperformance targets against which managers arejudged–the benchmarks for management. Such outputindicators should be identified as part of the transparentbudget process.
Activity-based budgeting and costing
Activity-based costing (ABC) is an approach that hasbeen developed in the context of commercial entities asan alternative to traditional product costing approaches.It represents a new approach to aggregating costs, andwhere applied has major implications for the costclassification system. It is easiest to describe ABC inthe product-costing context in which it has beendeveloped. Its potential application to governmentfinancial management is then considered.Manufacturing companies consume a range ofresources–human, material, and overhead–in producinga range of products. Traditional costing has directlylinked material and direct labour costs to individualproducts, but then apportioned overhead costs on thebasis of product volumes. This approach has beendeveloped to value inventory for financial reporting, buthas been widely used (some would say misused) forproduct costing for decisions about, for example,product pricing.Activity-based costing recognizes that simpleapportionment of overheads as described above is acrude measure of the costs of products, and its use fordecision purposes may lead to sub-optimal decisions.For example, a small-volume product may result in aseries of production runs, each incurring set-up costs,which become disproportionately high compared tothose for a high-volume product. Managers understandthis intuitively, but ABC seeks to quantify therelationship through a four-stage process.• Identify the major activities within the organization,
eg. setting up machines for production runs;
• Create a cost pool (or cost centre) for each activity,eg. all set-up costs;
• Determine the cost driver for each activity, eg. thenumber of new set-ups;
• Assign costs of activities on the basis of the costdriver to each product, eg. set-up costs times numberof set-ups per product.
This exercise is repeated for all cost activities, oftenwith multi-stage assignment until final product costs areachieved. These activity-based costs provide a moremeaningful approximation of the product costs fordecision-making. However, the question is whatrelevance this product-costing tool has to governmentfinancial management.ABC is a relatively new technique even for productcosting.13/ There is limited literature on its application inthe public sector, and all the examples to date have been
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Stage 4 – allocateStage 3 – identify costs to service
Stage 1 and 2 – identify activities as cost pools cost drivers services delivered
within sub-units of government.14/ To our knowledge ithas not been applied to the central government of anycountry as a whole. Nor is it the purpose of this book toexplore the applicability of ABC to governmentfinancial management. However, it is apparent thatgovernment “products” are the delivery of a series ofservices, which draw on a pool of resources. ABCprovides a tool linking the costs of those resources tothe different services delivered, and hence deriving ameasure of the costs of such services. Meaningful costsof services delivered by government provide a basis for
rationally allocating limited resources in accordancewith public policy priorities.An example of the application of ABC in the publicsector has been within the UK health service. Patientsrequire different services according to the nature oftheir treatment, eg. patients at a clinic, patients inintensive care at a hospital, accident victims and so on.An ABC approach applied within a hospital wouldrecognize the different cost pools and associateddrivers, and use these to estimate the cost of servicesprovided to patients.
Exhibit 18. Activity-based costing applied to government
ABC can be extended from historic costs to budgeting,and this sort of information provides a more rationalbasis for resource allocation decisions. Theimplementation of ABC for national governments forboth budgeting and accounting would have significantimplications for cost classification and analysis.• Traditional economic cost classifications, eg. wages
and communications, are less useful than costsrelated to activities, though both could co-exist;
• Cost centres would have to be developed for all the“activities” (as defined above) within government,irrespective of whether or not these constitutedadministrative cost centres;
• The concepts of ABC are clearly linked to theconcepts of programme budgeting, in that both focuson the outputs of government activities, and seek toidentify costs and resource implications of suchoutputs.
The limitations of ABC also need to be recognized.Most fundamental is that it does not directly relate tothe responsibility hierarchy reflected in the budget
allocations. Unless it can be linked to suchresponsibilities, ABC may fall into disuse. Also thetechnique is very new, there are practical problems ofidentifying cost pools and cost drivers, and the impactof ABC on organizational effectiveness is as yetunproven.Nevertheless, ABC is potentially so useful that anyclassification system should at least be structured so asto allow for the subsequent implementation of ABC.Nor is such design inherently difficult. Essentially, itmeans that the cost pools must be identified within theclassification system to allow for derivation of activity-based costs. ABC is being widely introduced in the UKin the context of agencies and setting targets (seebelow).Conclusions from the above approaches
In attempting to improve government financialmanagement, lessons can be learned from all of theseapproaches.• There must be a move away from incremental
budgeting to an approach which regards allexpenditure as discretionary;
Patient inintensive
care
Out-patient
Geriatricpatient
Costallocated toservicesdelivered
Hours ofutilization
Patient beddays
Patient beddays
Actual usage
Totalhospital
costs
Operating theatre
Intensivecare ward
Traumaward
Medicalequipment
Divided between cost pools of which these are illustrativeexamples More realistic
costing of patientservices for pricing
Cost driversbased on analysis
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• The focus must be on results, involving identifyingprogrammes, defining objectives and settingperformance targets;
• Managerial responsibility must be identified and madeexplicit, and within overall constraints managers should be responsible for their own budgets and output targets;
• Bureaucratic controls should be simplified andrationalized to encourage managers to focus onresults;
• Overly complex budget systems and proceduresshould be avoided;
• Activity-based costing and budgeting provides a newtechnical approach to the problem of identifying thecosts of activities, which appears to be very relevantto government activities;
• There is an essential need to add to the budget amedium-term framework, eg. a TYRB.
All the experience of setting performance targets forpublic-sector activities suggests that it is very difficultto identify meaningful indicators against whichperformance can be measured and evaluated.Sometimes indicators can be counter-productive,because managers then focus only on their “score,”rather than their broader responsibilities. In settingperformance indicators and targets, certain points needto be considered.• They are best set at the micro level by the managers
who have to achieve them;
• They should relate to broader national policyobjectives;
• Wherever possible, revenue generation should berelated to expenditure, eg. museum sale receiptslinked to expenditure by that museum, so as tominimize the need for physical indicators;
• There should be “soft” general indicators or targets,even if these are not easily measurable, as well as“hard” measurable indicators;
• Targets should be set as part of the planning andbudget process, not as a separate exercise.
Specific country experiences
The Australian financial managementimprovement programme (FMIP)
In Australia, the FMIP sought to radically changeattitudes. Elements of the approach include:
• Three-year rolling budgets, with forward estimatesautomatically converting to budgets if there are nochanges;
• Clear link to macroeconomic framework andresources to establish hard budget ceilings, and amechanism for deciding between competingpriorities;
• Focus on results, with the introduction of programmemanagement and budgeting (PMB);
• Development of performance measures; and
• Concept of running costs which can be allocatedwithin the discretion of ministries.
The Australian system has to be seen in the context of awholesale reform of management of the public sector. Itcould not be implemented in isolation. Nevertheless, itcontains important pointers to the way budgeting andfinancial management of government is likely todevelop. In Australia, despite initial problems, it is nowregarded as having been a successful approach tomanaging the public sector in a period of financialconstraint.The New Zealand reform experience
The New Zealand reforms were concerned more withthe incentive structure than technical reforms of thebudget process. Indeed, the biggest technical reform hasbeen to move the whole government budget andaccounting system to a commercial-style accrualaccounting model. This has been linked to radicalreforms in management structures and responsibilities,with ministries allowed considerable autonomy withinoverall hard budget constraints.United States of America
Recent thinking in the USA is best exemplified by theGore Report on Reinventing Government. The report issub-titled: “Creating a government that works betterand costs less,” which means escaping from red tape,bureaucratic waste, cost escalation and a civil servicenot sufficiently attuned to performance and service tocustomers. The status quo is neatly summed up as“industrial era bureaucracies in an information age.”The answer is said to be “creating entrepreneurialorganizations.” This has four elements, each of which ismade up of a number of steps.• Cutting red tape (which means simplifying the
regulatory environment and stressing missionaccomplishment);
• Putting customers first;
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• Empowering employees to get results;
• Producing better government for less (which meansre-engineering programmes and processes withemphasis on improving productivity andeffectiveness).
With the return of a Republican majority to Congress,the future of the Gore report is uncertain. Nevertheless,financial management reform generally is gainingimpetus. The Chief Financial Officers Act (1990), theGovernment Performance and Results Act (1993) andthe Government Management Reform Act (1994) aresteps in this process.The first establishes in each of 23 large agencies theposition of Chief Financial Officer, responsible foroverview of financial management. This person is todevelop and maintain an integrated accounting andfinancial management system for the agency,performing according to specified criteria (including forinstance the integration of accounting and budgetinginformation, and audited annual financial statements).The Act also requires the Office of Management andBudget to report annually on the status of FederalGovernment financial management, and to submit afive-year plan for its improvement. The second calls foragency programme and performance budgets by 1999.The third requires audited financial statements for theentire Federal Government by 1998.Reforms within the United Kingdom
The United Kingdom focus has been on reducing thescale of the public sector, through a process ofprivatization, outsourcing or “agentization” (see below).Under the “Thatcher” reforms, government departmentshave been forced to consider these alternatives forvirtually all of their activities. Linked to this has beenan earlier move to a medium-term financial planningframework, and an ongoing move to an accrual styleaccounting and budget approach.The United Kingdom Government in 1982 launched theFinancial Management Initiative.15/ This aimed toensure that managers are aware of what they areexpected to deliver, assess and measure performance inrelation to measurable objectives, and create well-defined responsibility for the use of resources, outputsand value for money.In addition, the Public Expenditure Survey providesthree-year forward expenditure estimates, and is linkedto the Treasury macroeconomic models. A multi-departmental study of budgeting in 1986 emphasizedfour principles.
• All managers from top to bottom should beresponsible for setting and reviewing budgets. Thusthey should develop a sense of ownership;
• Budgets must be linked to the Government’s three-year forward review of public spending;
• Budgets should include output and performance datato allow monitoring of achievements againstobjectives;
• Top managers must organize their own work and thatof their departments, so as to make clear theresponsibilities for setting priorities, managingresources and reviewing performance.
Where privatization (the first preference) has not been afeasible option for government activities, governmentoperations have been “contracted out” to privateoperations. This contracting out, or outsourcing, hasembraced activities from computerization to refusecollection. Finally, the third option has been to turngovernment departments into quasi-commercialagencies (the “Next Steps” initiative of 1988). Thoughstill part of the public sector, such agencies operate witha high degree of autonomy. The major principles are:• Service delivery is to be kept distinct from the policy
aspects of government, and the former carried out byagencies under each department;
• Chief executive officers (CEOs) are appointed toagencies for fixed-term contracts of three to fiveyears;
• A framework agreement defines the relationshipbetween the agency and its department, setting out:(1) the agency’s aims and objectives; (2) theboundaries which exist between its responsibilitiesfor service delivery and those of its parentdepartment; (3) monitoring, accountability andreporting arrangements; and (4) measures forassessing performance and the personalresponsibilities of the chief executive;
• The CEO and the parent department develop anannual performance agreement containing specifictargets to be achieved. It and the end-year report onprogress achieved are both published, with the latteraudited by the National Audit Office.
The move to agencies has been swift. Some areestablished as trading funds and are financed oncommercial lines; others are funded fromappropriations. Other developments in the UK havebeen: (1) the Citizen’s Charter, which identifies aclient-supplier relationship between civil servants and
11
the public, with defined and published service-qualitystandards; (2) the Efficiency Unit, which conductsefficiency scrutinies and shows how cost savings can bemade; and (3) performance and output measures andtheir publication in departments’ annual managementplans. Efficiency gains are expected to be reflected insavings of at least 1.5 per cent of running costs per year.To achieve changes, particularly in the fields of costsaving, value for money and efficiency, more flexibilitywas needed. As a result powers have been delegated tomanagers in order to free up decision-making.• Control by staff numbers has given way to control by
the aggregate of running costs. Budgets arecommonly controlled gross, although the net basismay be applied when there are significant receipts;
• Greater year-end flexibility has been introduced byallowing the carry-forward of a proportion ofunderspending, with the use of the savings delegateddown to the level of individual managers;
• Greater freedom now applies to the creation oftrading funds; to recruitment and promotion; and tofixing remuneration (pay can be varied by location,skill and performance).
The United Kingdom Government has also introduceddepartmental resource accounting ( a form of accrualaccounting, dealt with in the next section) and resourcebudgeting. These link to the departments beingresponsible for the efficient and effective use ofresources under their control, and the concepts ofperformance budgeting.Conclusions on country experiences
Australia, New Zealand and the United Kingdom are atthe leading edge of reforming government management,with financial management as one aspect. Each countryhas taken a somewhat different route, but it can be seenthat they embrace the principles established above forreforms within the budget systems.A number of developing countries or newly emergingeconomies have sought to emulate these reforms,basing themselves on some combination of theavailable models. A problem may be the robustness ofthe reforms in the face of economic adversity, eg. the1997 problems facing South-East Asia. Nevertheless,the appropriate direction of reforms is clear.
Some specific budget issues
Recurrent impact of development projects
Budgeting often fails to forecast adequately theimpact on the recurrent budget as projects arecompleted, and their activities are transferred to therecurrent budget. In fact this impact is likely to besubstantial, since virtually every project needs to besustained, and this will require additional staff andoperational expenses. This model is set out in Exhibit19, below.
12
Projects are in general fiscally expansionary. Thereare alternatives:• Projects should either be self-financing after
completion, or generate savings at least equal tothe additional resources required; or
• Donor organizations should be prepared tosubsidize a growing budget deficit.
These are issues which an effective planning andbudgeting process should clearly identify, even if itdoes not provide the solutions.Manpower forecasts within budgets
For most governments, manpower costs are asignificant part of government expenditure, onaverage about two thirds of recurrent expenditure.Therefore it is essential that the budget system have amechanism for monitoring those costs and themanpower decisions implicit within them.
Exhibit 19. Model of recurrent impact of development projects
13
Exhibit 20. Manpower reconciliation statement
Establishment Grade A posts Grade B posts Grade C posts Total
Approved posts 1998 100 150 300 550
New posts 1998 20 30 50 100
Less forfeited posts 1999 -15 -20 -40 -75
Approved establishment1999
105 160 310 575
Less vacant posts -30 -25 -50 -105
Filled posts 75 135 260 470
Financial provision $ xxx $ xxx $ xxx $ xxx
Note: figures are for illustrative purposes only.
The definitions of Grades A, B and C would beachieved by summarizing existing gradings (eg. GradeA might be gazetted officers), and is intended forsimplicity. Indeed the point about this analysis is itssimplicity, but nevertheless it includes valuableinformation. In addition, projects should identifymanpower implications during and after the project.
Dual budgeting – the development budgetMany governments in developing countries divide theirbudgets into recurrent and development budgets.Development budgets are primarily concerned withdevelopment projects, which have defined objectivesand a finite life. The recurrent budget deals with routineongoing expenditure, where outputs are more difficultto define, and there is no finite end to the expenditure.Ideally this budget division should coincide with thedistinction between recurrent and capital expenditurebudgets, but in our experience development budgetsoften include expenditure of a revenue nature, andconversely recurrent budgets include capitalexpenditure. Thus a classification matrix emerges.
Exhibit 21. Recurrent and development budgets
Type of budget Capital expenditure Recurrent expenditure Total
Non-development budget (often called “recurrent budget”) 20 90 110
Development budget 50 30 80
Total 70 120 190
Development budgets were initiated to identify andfocus attention on public investment programmes.Development budgets are frequently linked todevelopment or public investment plans, and are subjectto control and prioritization by a planning authority.One of their objectives is to ring-fence developmentexpenditure so that socially desirable activities can becontinued even in the face of fiscal restraints.There are a number of disadvantages of segregatingdevelopment and recurrent budgets:
• The administrative and procedural dichotomybetween development and recurrent often reduces theeffectiveness of fiscal control and policyprioritization;
• Difficulty is caused in identifying and evaluatingaggregate resources allocated to sectors, becausethey are spread over two budgets;
• The development budget tends to receive more
14
attention than the recurrent budget, though the latteris often larger in value;
• Recurrent maintenance expenditure is discouraged infavour of new projects, which may replace poorlymaintained assets;
• The fact that a flow of development projects mustlead to an ever-increasing recurrent budget asprojects are completed is often ignored, and theimpact of such projects on the recurrent budgets isnot properly assessed in planning future aggregatelevels of government expenditure; and
• It leads to confusion on the more importantdistinction between capital and revenue.
On the other hand, a separate development budget canoften be administratively convenient. A separate“development fund” can be established, and funding ofprojects and the handling of donor inputs dealt withthrough that medium. Furthermore, the problem is notthe development budget per se, but rather theadministrative arrangements and the way information ispresented and handled.While in an ideal world a single budgeting structurewould be preferable, it may be difficult to change theexisting budget structure, often for good reasons. Insuch cases, the objective should be to integrate thepreparation, format, classification and presentation ofthe two budgets. Also the distinction betweendevelopment and recurrent expenditure budgets shouldbe made coincident with the distinctions betweencapital and revenue expenditure.The problem of year-end cut-off
One of the problems of government budgeting is its linkwith the fiscal year of the government, and the need tobudget for just that one year. This posed no majorproblem when most expenditure was ongoing recurrentexpenditure. It does now pose a major problem wherethe expenditure is capital in nature, and extends overmore than one accounting period. This pattern is typicalof most development projects.Exhibit 22, below, provides a typical pattern ofexpenditure on a capital infrastructure project, eg. ahydroelectric scheme. Over the several-year life of theproject (which project years may not coincide with thegovernment fiscal years), expenditure builds up to apeak of construction activity, then declines to acommissioning and handover phase. For budgetpurposes this has to be broken down into fiscal yearestimates, but clearly these have little significance inthe context of the project.
Exhibit 22. Pattern of expenditure over typicalproject life cycle
Not only may the budget forecasts for the project bewrong in total, but also the timing of the expendituremay vary from the predicted pattern. For example, theproject could be delayed by adverse weather, oralternatively a good period of weather could lead to theopportunity to accelerate some of the expenditure andspeed completion. To be locked into a rigid annualbudget cycle, unable to spend funds allocated to theproject because they had not been anticipated for thecurrent year, is a frustration experienced by manyproject managers in this situation. Equally, to find fundshave been “lost” because the activity slipped a fewweeks over a fiscal year end is equally frustrating.Furthermore, such timing variances often have no realfiscal impact, because for LDCs the funding will almostcertainly come from a lending agency, and will alreadyhave been committed.The budget system within an LDC must develop amechanism to handle such timing problems. There areseveral approaches.• To allow automatic carry-over of unspent
development project budgets–but this means thegovernment is not able properly to predictexpenditure and funds available for other purposes. Italso fails to deal with the problem of wanting fundsearlier than budgeted;
• To provide in the budget system for requests forcarrying forward unspent funds, together with anexpenditure monitoring system which allows forthose funds to be estimated before the year-end. Thisstill does not overcome the problem of fundsrequired earlier, and also requires expendituremonitoring/forecasting systems to be in place;
• To recognize the economic distinction between loan-funded components (where timing of expenditure hasno fiscal impact) and domestic funds (which need tobe more closely controlled). Rules may allow loan-funded elements to vary in timing even if outside thebudget, whereas the domestic-funded elements mustbe subject to budgetary constraint, though with somesystem of carry forward as in (2) above.
For most countries this would require a modification to thefinancial regulations, and it is necessary to establish a
0
5
10
15
20
25
30
'96 '97 '98 '99
Start-up period
Importation of equipment
Construction
Commissioning
15
monitoring system for projects outside the normalbudget monitoring system, reflecting the multi-year
nature of the exercise. A possible format is set out inExhibit 23, below.
Exhibit 23. Project expenditure monitoring format
Project informationTitle NumberStart date Target end dateTotal cost Donor(s)
Type ofexpen-diture
Previous years Current year’sbudget
Current year’sactual
Next year’s
budget
Balance of budget
Govt Foreign Total Govt Foreign Total Govt Foreign Total Govt Foreign Total Govt Foreign Total
Note: The information would need to be based on, and reconciled with, the information in the government budgetand accounting system.
Non-monetary flowGovernments participate in a variety of economictransactions which are never actually monetized, orwhere monetary values do not reflect economic values.Four actual examples are as follows:• Country X is provided with technical assistance in
the form of consulting services from a bilateral donorto upgrade education. Details of the amounts paid bythe bilateral for the consulting services are neverrevealed in detail to the recipient government;
• A loan from country X at below-market interest rateshas as a requirement that equipment must bepurchased from country X, even though the pricesare higher than would be paid for such equipment iftendered internationally;
• Surplus agricultural production is gifted to a countrywithout any value being attached. Such food is soldat subsidized prices to certain groups of thepopulation, and the funds so created used forspecified development purposes;
• Internal payments are made in kind, eg. debts settled
by transferring assets. This is particularly prevalentin the former Soviet Union countries.
These unmonetized flows can be substantial. In Nepal,for example, it is estimated that some 30 per cent ofofficial development assistance does not pass throughthe government budget. Clearly this creates problemsfor national economic fiscal management, and there arealso problems of ensuring the propriety of expenditureand proper accounting for the assets so created.However, there are also problems with incorporating allsuch flows into the budget system. First, there arepractical problems. Some of the information, especiallyon technical assistance, is available only if and when inthe format that donors choose to provide suchinformation.Secondly, budget monitoring becomes much moredifficult. Budgets now include notional as well asmonetary expenditures. Information on the latter maynot be controlled by government managers, and doesnot pass through the accounting systems.Exhibit 24, below, sets out a methodology for handlingand recording such flows.
Exhibit 24. Recording non-monetary donor assistance
Acquisition method
Fundingmethod
Type ofexpenditure
Budgetandaccou
nts
Other records
Loanrecords
Assetrecords
Externalassistance
records
16
ACTUALTURN
???
ACTUALTURN
Actual cashinflows and
outflows
Government payment,subsequent reimbursement
Loan Equipment 3 3 3Other 3 3 3
Direct payment by donor Loan Equipment 3 3 3 3Other 3 3 3
Grant Equipment 3 3 3Other 3
Paid from special/imprestaccounts
Loan Equipment 3 3 3 3Other 3 3 3
Internal transaction in kind N/A Settlement ofdebts 3
This approach provides a comprehensive recording,monitoring and control mechanism, while keeping theactual budget and expenditure monitoring systemssimple.The IMF system of government finance statistics (GFS)states that “Grants in kind should be valued byreference to market prices for comparable products.”16/
This approach appears entirely appropriate for thepurpose identified. The concept could be applied to allof the transactions identified above. It does not mattergreatly if such estimates are less than totally precise, aslong as they are consistent.From the perspective of management of governmentactivities the transactions identified above cannot becontrolled. Very often information on them depends onreports from the donor. The transactions do not enterthe government accounting system until they areconverted to cash; eg. the food is sold. Therefore, wherethey are recorded in the budget, they need to beseparately classified so that they can be excluded fromreports on management performance.This separate classification and reporting also serves tofocus management on their separate responsibilities inrespect of such transactions. This also makes the natureof such transactions more transparent for the publicexpenditure review process (see below).
Classification by timeTiming of transactions is significant in four contexts:• Timing of budget receipts and payments is important
to profile financing requirements through the year;
• Timing of actual payments is important as part of the“tracking” process described above;
• Timing of transactions and flows is important so thatthe cut-off between accounting periods can beestablished, and they are recorded in the appropriateperiod;
• Where projects extend over more than oneaccounting year, the flows will need to be classifiedby accounting period as well as in total.
Historic transactions will be dated, and this serves as atime classification. Budgets need to be profiled overtime periods. Furthermore, for liquidity managementpurposes it is the timing of cash movements that iscritical. Accrual measures do not directly reflect cashmovements, and are therefore less useful for liquiditymanagement. Predicting and tracking cash flows overtime can thus add complexity to the classification offlows based on accrual accounting.
Exhibit 25. Classification of flows by time forliquidity management
As in
Cash flows compared by period for liquidity management purposes
ALLOCATED TOTIME PERIODS:Jan JulyFeb Aug
March SepApril OctMay NovJune Dec
As in cashbudgeting
BUDGET
Accrual flows
converted tocash inflows and
outflows.
BUDGETAccrual
accountingrevenue andexpenditure
f lows
ACTUAL
Revenuesand
expenditures
ACTUALActualcash
inflows andoutflows
17
This represents quite a complex classification problem,which is generally not recognized as such. One of thearguments against accrual accounting is that it makeshandling liquidity management more difficult, because itdoes not either predict or measure cash flows. The abovediagram does exemplify the problem.The financial management of multi-year projects does notsit easily with conventional accounting systems, which arefocused on the annual financial year. For projects totalexpenditures need to be monitored and tracked over thelife of the project. Therefore the system must allow forsuch expenditures to be aggregated and monitored againsttotal budgets, but divided into annual periods fortraditional budget and accounting purposes. Future expenditure commitments
Transactions entered into by a government in the currentperiod will often have expenditure implications for futureperiods. Examples would be:• A decision to make a large infrastructure investment
which will take several years to complete and will havecapital expenditure implications for each of those yearsand maintenance cost implications indefinitely into thefuture;
• A development project to expand primary educationfacilities which will have a recurrent cost impact ofteachers, teaching materials and school maintenanceinto the future;
• A policy decision to pay pensions to persons over acertain age which will commit substantial expenditureuntil the (politically difficult) decision is made tocancel all pensions.
In developing the budget, it is important to identify clearlysuch committed expenditure, since there is onlydiscretionary control through major policy reversals. Formany governments a substantial portion of the totalbudget expenditure may be committed this way, and theareas of discretion relatively small. Failure to recognizethe recurrent impact of development activities has led toproblems of sustainability.
Presenting information in budgets
The budget documents should be transparent;clearly link resources to policies and priorities; andcomprehensively cover all government revenues andexpenditures. The challenge is to design apresentation format which achieves all of theseobjectives and yet retains sufficient simplicity for itto be comprehensible.
Ultimately, budgets have to be presented to Parliament forapproval. The object of the system should be to presentinformation clearly so that the decision implications areclearly identified. Criteria include:• Clarity and avoidance of technical jargon;
• Revenue and expenditure shown in a singlepresentation, with net financing implications clearlyidentified;
Annual Budgeting18
• Structured approach with summary expenditureschedules clearly linking to detail schedules;
• Comprehensive, but avoiding excess detail, andwith appropriate levels of rounding; and
• Development and recurrent expenditure clearlyaggregated by ministry and department, and linkedto a narrative statement of objectives.
These requirements sound obvious, yet are rarelyachieved. In any review of a budgeting system, agood starting point is the budget itself. While there isno single ideal presentation, the following aresuggested as features of a good presentation.
Exhibit 26. Features of a good budget presentation
Feature Comments
Single document showing financing and recurrentand development expenditure
The document should contain a summary openingschedule, clearly referenced to supportingdocumentation and schedules
Should incorporate medium-term financial plans The TYRB or other medium-term financial planshould be incorporated within the budget document
Responsibility clearly identified by ministries andsubsidiary organizations of ministries, eg.departments, projects, etc.
Accounting regulations normally identify one personin each ministry as responsible for that ministry’sexpenditure, and this principle should also befollowed in the budget
Note: some budgets are organized by economicsector. While such an analysis should be part of thebudget documentation, the main focus should be onministerial responsibility
Each ministry should provide a simple, clear,statement of its objectives and priorities
A simple narrative statement can serve to focus onbudget objectives, and provide benchmarks for laterperformance review
For each ministry and subsidiary unit, expenditure inthe development and recurrent budgets should bepresented together, so the total resources committedto each activity can be clearly identified
One of the problems of the separation of developmentand recurrent expenditure is that it can often bedifficult to see the net impact on a particular sector.For this reason they should be presented together
Limited but essential expenditure analysis should beprovided
There is no need within a budget submitted toParliament to provide detailed expenditure analysis,but the major categories of expenditure should beidentified. These should include (i) personnel costs;(ii) other recurrent costs; (iii) debt service costs; (iv)capital expenditure; (v) flows between governmentand public enterprises; and (vi) any other importantgrants or major flows.
Additional analysis in terms of programmes,functions or otherwise as appropriate
The same information may need to be analysed indifferent formats, probably only in summary, forother economic and managerial purposes
19
Feature Comments
Comparatives should be included Ideally these should include the previous year’sbudget expenditure and income, and current estimatesof actual expenditure
This list is not of course comprehensive, and wouldneed to be developed on a country-specific basis, butit does provide an indication of what is required. Theexample below suggests how this approach could be
applied to the expenditure budget of the Ministry ofCommunications in a country with separatedevelopment and recurrent budgets.
Exhibit 27. Example of ministry expenditure budget (currency 000s)
Ministry ofCommunications
Previous year budget
Estimated actual forprevious year
Current year’s proposed budget
Recurrent Develop-ment
Recurrent Develop-ment
Recurrent Develop-ment
Total budget 200 500 190 485 230 780
Ministry objectives These are (i) to establish the cellular telephone system in a format that is suitablefor privatization within two years: (ii) to implement successfully the new digitaldata system in [the capital]; (iii) to reduce costs of routine activities by 2.5 per cent
Lunar station
Personnel costs 80 – 80 – 100 –
Other recurrent costs 120 – 110 – 130 –
Capital cost – 50 – 55 – 100
TOTAL 200 50 190 55 230 100
Cellular telephone project
Personnel costs – 100 – 110 – 110
Other recurrent costs – 50 – 60 – 70
Capital costs – 300 – 270 – 500
TOTAL – 450 – 440 – 680
45
Summary of elements of an effective planning/budget systemFrom the analysis in the previous sections it is possible to summarize the key elements of an effective financialmanagement planning/budget process. The table below summarizes these elements.Exhibit 28. Elements of an effective budget-planning system
Transparent macroeconomic framework identifyingresource envelopes
Providing hard budget constraints within which allconcerned know they must operate
Publicly articulated policy priorities and sectoralallocations
Used as the basis of capital project approvals and budgetresource allocations
Medium-term financial planning framework as basis ofannual budgets
A TYRB, or its equivalent, covering both resources andexpenditures, and integrated with the annual budgetprocess
Systematic transparent budget procedures which delegatebudget decision-making within ministry control over allbudget funds
It is essential that the systems and procedures for budgetpreparation be well documented, transparent and carriedout efficiently. Under these procedures budget decisionsshould be delegated to the lowest feasible levels, butwithin a structure of overall budget control by ministries.
Expenditure budgets linked to responsibility for activitieswith clearly defined non-financial performance targets
Budget responsibility is fundamental. Budget authorisesexpenditure, but this must be linked to goals andperformance targets
Budget systems which provide time for ministerial budgetnegotiations and presentation to Parliament before start offinancial year
Systems must be in place which allow budget estimates tobe evaluated, discussed and negotiated, and presented toParliament before the start of the financial year
Comprehensive and transparent presentation to Parliamentof budget proposals
Designed to make decisions within budget transparent,and to set out clearly fiscal and performance targets
Systems for tracking budget virements and other changes,and linking these to outcomes
The budget process does not end with parliamentaryapproval. Budgets continue to be varied through the year,and this must be tracked
It was indicated at the commencement of this bookthat the traditional planning-budget-accounting-feedback cycle was over-simplistic. The aboveanalysis of the budgeting and planning processes
enables the commencement of a revision of themodel, dealing with planning budgeting componentsonly. The relationship now begins to look more as setout in Exhibit 29, below.
Exhibit 29. Model of planning-budgeting relationships
Macroeconomic frameworkResource framework
Sectoral ceilings
Long-termperspective plans
Medium-termplans, eg. three-yearrolling budgets
Annual budgets–development, recurrentand revenue
46
V. ACCOUNTING, MONITORING,EXPENDITURE CONTROL, REPORTING
IntroductionPlanning and budgeting are essentially predictive offuture events, ie. they involve forecasts about the future.This section is concerned with the recording, reportingand management and monitoring of actual financialtransactions, ie. historic information.Traditionally government accounting has been seen as asimple cash-based process. Its objective has been toensure that the expenditure takes place, and revenue israised, according to financial regulations, and inconformity with budget decisions. The major linkagewith the budget process on the expenditure side hasbeen, and continues to be, the “fund release process,”ie. the process by which funds allocated for expenditurewithin the budget are made available (“released”) to theadministrative units responsible for such expenditure.The control mechanism will seek to ensure that fundsare released in conformity with budget authorizations.Revenues generally have no direct linkage withexpenditure–they are non-requited. The objective ofrevenue monitoring will be to ensure that the flow of
incoming funds is able to match the anticipatedexpenditure. Government expenditure control systemsoften focus on commitments, because these contain apredictive element of actual cash flows.Furthermore, because budgets have a legal significance,expenditure should not only keep within total limits, butbe for the purpose intended. For this reason, mostgovernment regulations place restrictions on transfersbetween budget heads (“virements”), allowing suchtransfers only under specified conditions andconstraints.In many LDCs, the basic functions of fund release,expenditure and revenue monitoring, and accountingare performed inadequately, and are often poorlyintegrated with each other. This section reviews howthese can be upgraded and integrated, and extended toplay a role in a more goal-oriented financialmanagement system. Under this approach, the separatetasks of fund release, accounting, monitoring andexpenditure control all become components within asingle subsystem.
Exhibit 30. Expenditure release, accounting, monitoringand expenditure control
1
Later in this paper this model will be combined with theplanning-budget model developed in Exhibit 29.
The accounting model and basis
Traditional government accounting has, as indicatedabove, been primarily concerned with recording cashpayments and receipts. This required only a simple cashaccounting system. However, as financial managementhas become of greater importance, a number ofproblems in the cash accounting model have becomeapparent.• Important assets and liabilities are excluded–eg.
accounts payable and receivable, inventories, fixedassets, pension liabilities–and as a result informationis at best incomplete, and at worst seriouslydistorted;
• Because these assets and liabilities are excluded,there is no meaningful measure of the cost ofresources used within any accounting period;
• Because assets and liabilities are not recorded, thereis no balance sheet, and therefore there is a lack ofcontrol over assets and liabilities;
• Cash accounting does not form an internallyconsistent measurement and valuation model, and asa result has difficulty in handling such problems asyear end cut-off.
These problems have led to some countries adopting anaccrual, or modified accrual, accounting model. Thefollowing subsections will first define the alternativeapproaches, then consider their relative merits.Cash accountingCash accounting records cash inflows and outflows, ie.receipts and payments. However, when applied togovernment accounting a number of modifications aremade to a simple receipts and payments accountingsystem.• Transfers to, and balances on, certain assets and
liability accounts are maintained, eg. suspenses,
advances, deposits, bank and loan balances. Theasset and liability accounts are often referred to as“below-the-line” accounts;
• Unallocated stock (inventory) is also treated as anasset (below-the-line) account;
• Deductions from salary payments to governmentemployees for pensions are often shown as expenses,although no liability for pension payments isestablished;
• In some countries, cheques written after the year-endfor accounts payable are passed through the books inthe financial year to which they relate (rather than thefinancial year in which they are cleared).
These are essentially ad hoc solutions to practicalproblems encountered when applying the cash basis.In addition, government accounting systems frequentlyinclude some form of commitment accounting underwhich expenditure is recorded when the organizationcommits itself to spend the funds. Commitmentaccounting is an addition to, not a replacement for, cashaccounting. Definitions of commitment vary, butnormally it would be when an order is placed or acontract signed. However, in some countries, funds areregarded as committed when released to a spendingunit.From the above, it becomes clear that there is no singleclear “cash accounting” model. The way cashaccounting is applied varies between countries.The accrual accounting model
The accrual accounting model is the accounting modeldeveloped for commercial environments, and provides alogically consistent approach to measuring financialflows, assets and liabilities. Flows represent inflows oroutflows of assets and liabilities over a period; assets orliabilities are valued at specific points in time, eg. thebeginning and end of accounting periods. Under theaccrual model, flows represent the change in balancesover time.
Exhibit 31. Accrual model link between flows and balances
Net assets at time tn+1 - Net assets at time tn = Net flows over period 1
This contrasts with the cash model, which measures only financial flows, assets and liabilities. The accrual
2
model also clearly differentiates revenue flows,reflected in the “Operating Statement,” from capitalflows, which are recorded as schedules identifying suchchanges.This fundamental relationship leads to the accrualanalytic framework used for commercial entities. This
uses balance sheets and operating statements (the latterrepresenting flows over a period), and is the model usedby New Zealand in producing its government financialstatements. Exhibit 32, below, provides a simplifiedanalytic framework using this model.
Exhibit 32. Analytic framework of balance sheet and operating statement
Balance sheet of the Government of X as at 31 December 1998
31 December 1997 31 December 1998Assets
Non-financialFixed assets $200 $220
Current assets $50 $60Total non-financial assets $250 $280
FinancialLong-term $40 $40
Current $60 $90Total financial assets $100 $130
Total assets $350 $410Liabilities
Short-term $120 $125Long-term $210 $245
Net liabilities $330 $370Net worth (commonly the consolidated fund) $20 $40
Operating statement of the Government of X for the year to 31 December 1998
Revenues and grants
RevenuesTax revenues $50
Other revenues $40Total revenues $90Grants $30
Total revenue and grants $120Expenditures $110
Net economic flows $10Transactions other than economic flows $10
Total net operating flow (equals change in netassets over period)
$20
It is noteworthy that under this model the only capitaltransactions reflected in the operating statement relateto such items as depreciation, revaluation or changes involume (eg. new mineral deposits, loss in war) ofcapital (fixed) assets. The actual capital cost ofpurchases or receipts from disposals does not form partof the equation.The balance sheet is a statement at a point in time,
whereas the operating statement relates to flows over aperiod of time. Therefore the titles of the two statementsneed to identify, respectively, the point in time orperiod of time to which they apply. Movements inassets not reflected in the operating statements,particularly capital transactions, eg. acquisition of fixedassets, lending and borrowing, would be reflected inseparate schedules attached to the above statements. A
3
TIME
cash-flow statement links these together and providesuseful supplementary information. Such a statement ismandatory for commercial entities under internationalaccounting standards.Modified accrual accounting
Because of the problems explained below of applyingthe accrual model to government activities, a thirdoption is the so-called “modified accrual.” There is noprecise definition, but it generally refers to an approachwhere accrual accounting is applied to current assetsand liabilities–accounts receivable and payable,inventories, and financial assets and liabilities. Thisavoids the problems of valuing infrastructure assets orliabilities such as pension obligations.Implications of different accounting models
Without accrual accounting, the only relevant analysisis of expenditure and receipt flows. In a cash-basedsystem the only assets and liabilities are financial, andtheir recording does little more than prove thearithmetic accuracy of the record of flows. Since thereare no physical assets or liabilities, only cashtransactions occur. Therefore the analytic framework ismuch simpler.Accrual accounting has been developed for commercialentities to meet two specific needs:• To determine profits available for distribution to
shareholders as dividends; and
• To determine the profit as a basis of calculating the
tax liability.
Neither of these requirements has any relevance toGovernments. On the other hand, Governments do havespecific needs, some of which do not apply tocommercial entities.• The requirements of fiscal management. These are
entirely related to cash flows, and hence accrualaccounting has no direct relevance to fiscalmanagement;
• Resource allocation decisions–these decisions arealso required of commercial entities. Most projectappraisal models are based on predicted cash, ratherthan accrual, flows;
• Liquidity management–requires cash flowinformation;
• Resource management–it is in this area that accrualaccounting has claimed advantages, because itprovides a better measure of assets being consumed,and also provides records of assets and liabilities forcontrol purposes;
• The need to track expenditure flows through theirvarious stages in a manner that is not relevant tocommercial entities. This is illustrated in Exhibit 33,below.
Exhibit 33. Tracking expenditure flows
It is apparent that for some purposes accrual accountingis most appropriate, but for others cash flowinformation will be required.
The differences between the accounting bases issummarized in Exhibit 34, below.
Medium-termfinancial plan Payment
Invoicefrom
supplier
Purchaseorder issued
Expenditurewarranted
Budgettransfers
(virements)
Supplemen-tary budgets
Annualbudget
Financial planning and Fund control Commitment Accrual Cashbudget system system accounting accounting accounting
4
Exhibit 34. Different accounting bases
Element of financial statements
Cash-based accounting Modified accrual basis
Accrual accounting
5
Financial assets All financial assets andliabilities recognized asbelow-the-line accounts
As cash basis, plus:Receivables outstanding(but not normally taxreceivables)Advances and deposits
As modified accrual basis
Other assets Unallocated stock
Advances
InventoryWork in progressAccounts receivable
Other current assets
As modified accrual basisplus:Fixed and intangibleassetsInvestments
Other liabilities Deposits As cash basis, plus:Accounts payable
Other current liabilities
As modified accrual basisplus:
pension and other accruedliabilities
Revenue and otherreceipts
Revenue recognized whencash is received
Revenue treated asincome when invoices areraised – but difficult toapply this to tax revenue
As modified accrual basis
Expenditure andother outflows
Expenditure recognized whencash is paid
Expenditure recognizedwhen liability incurred
Fixed assets expensed infull when acquired
As modified accrual basis,less capital expenditure,except fixed assetsexpensed only over life ofasset throughdepreciation.
Flows not involvingtransactions
Not recognized Not recognized Revaluation and physicalincrease/ decrease inassets
Balance sheet Only financial assets andliabilities and other below-the-line accounts
Full balance sheetexcluding capital assetsand provisions
Full balance sheet
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The choice of an accounting base
Careful consideration has to be given to whether accrualaccounting, developed to meet the above needs ofcommercial organizations, is an appropriate accountingmodel for Governments. Consideration also needs to begiven to the practicality and resource implications ofmoving from a cash to an accrual accounting base.The relative merits of the bases are set out below.
Exhibit 35. Comparison of accounting bases
Advantages of cash accounting Advantages of accrual accounting
Simplest approach currently in use in mostcountries, therefore requires no additionalinvestment in resources (except countriesemerging from central direction with noestablished systems)
A logically coherent model which embraces allassets, liabilities and financial flows within asingle system, and for which there are well-established standards
Provides information required for fiscalmanagement, capital expenditure evaluation andliquidity management
Provides a measure of resources consumed byentities within government that is moremeaningful than cash flows
When combined with commitment accountingand a tracking system, can provide asophisticated expenditure control system
Provides a comprehensive record of assets andliabilities, and focuses attention on importantissues such as pension liabilities
Avoids the investment in establishing systems,valuing assets and creating parallel cashmanagement systems.
Enables standard commercial accountingpackages to be used for accounting purposes.
Accrual accounting does have significant advantagesand benefits. However, it needs to be combined with aninformation system that also tracks expenditure andprovides information on cash flows–a sophisticatedrequirement. To move from a cash basis to an accrualbasis requires significant accounting skills to beavailable, and even then a substantial investment intime. Within the UK the move to resource accounting (aform of accrual accounting) has required a verysubstantial investment.For most LDCs the move is probably not feasible, andwould almost certainly be a misdirection of scarceresources. The only exception could be a situationwhere there was effectively no system, and it was amatter of designing a system from a zero base.
Accounting standards in governmentaccountingThere are no international standards for governmentaccounting. The Public Sector Committee of theInternational Federation of Accountants (IFAC-PSC)has produced two papers on financial reporting bynational Governments, 17/ but they contain no proposedstandards. The International Organization of SupremeAudit Institutions (Committee on AccountingStandards) (INTOSAI-CAS) has developed a number ofaccounting standards, primarily for use by auditinstitutions.There is an argument that government accountingstandards are not needed, since there is only onereporting entity in each country, and the standardsshould be contained in the rules and regulations.However, accounting standards deal with matters notnormally explicitly covered by such rules, eg. the basisof accounting and definitions. If, as in the UnitedKingdom, departments and agencies are required to beself-accounting, there is a need for a common set ofstandards.
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A number of individual countries have developedgovernment accounting standards. In the United Statesthey are set by the Government Accounting StandardsBoard. Australia, Canada and New Zealand have alladopted standards, though in the case of the last theyare now the same as those for private enterprises. In theUnited Kingdom the commercial accounting standardsapply except in cases where they are inappropriate, orother standards have been set. Pakistan and China areboth in the process of developing and adoptingstandards.Although in general commercial internationalaccounting standards can be used by governments, thereare many areas where they are inappropriate. These arefurther discussed in the subsections which follow.Transactions other than economic flows
An implication of the accrual model is that there will bechanges in the value of assets other than throughtransactions. These divide into two categories:• Revaluations, which further subdivides into
depreciation, and other revaluations;
• Changes in volume.
It could be argued that depreciation is in fact atransaction, but this is a matter of semantics.Depreciation can be regarded as serving any of threepurposes: (i) a measure of the loss of value of an assetover time; (ii) creating an accounting fund for thereplacement of the asset; or (iii) a periodic charge forthe use of an asset whose economic life extends overseveral accounting periods. The modern view would betowards the last definition, but the purpose does notchange the classification issue. Depreciation is both areduction in the value of an asset and an expenditure inthe operating statement. Both aspects must be recordedwithin the system, hence the importance of linkingassets to operating units.Assets may otherwise be revalued to reflect changes intheir economic value expressed in money terms. Indeedthe GFS implies the use of current economic values,which would require annual revaluations. The need forrevaluation may be because of general or asset-specificprice changes, or physical factors altering its value. Anyrevaluation has two impacts: a non-transaction flow,and a corresponding change in the value of the asset.Finally there may be changes in the volume of assets,for example destruction through war or natural disaster,or the discovery of new mineral deposits. As withrevaluations, such events would have two impacts: anon-transaction flow, and a corresponding change in thebalance sheet value of the asset.
There is an issue of presentation of flows relating toboth revaluations and also volume changes. These arenot “operating flows,” since they do not result fromoperations of government. Therefore they need to beseparately identified and reported, either in theoperating statement or in a separate statement. Capital expenditure
The distinction between capital and revenueexpenditure is fundamental. There is general agreementon the definition of fixed assets: “non-financial assetsintended for repeated use or use for more than one yearin the process of production.”18/ Under an accrualaccounting model, capital expenditure should not beshown in the operating statement (see above). Goodpresentation would be a separate schedule showingmovements on fixed assets. Fixed assets should beidentified by major category and by the operating unitor sub-unit to which they relate, and identify:• Original cost or valuation;
• Revaluations;
• Changes in physical volume as reflected in valuation;
• Annual depreciation charge; and
• Cumulative depreciation to date.
A well-designed system would keep this informationfor each major asset in a separate fixed asset register,linked to the main accounting system. Such a registerwould also facilitate physical control of assets.Transactions without a defined monetaryvalue
Governments participate in a variety of economictransactions which are never actually monetized, orwhere monetary values do not reflect economic values.Three examples are as follows (all actual examples).• Country X is provided with technical assistance in
the form of consulting services from a bilateral donorto upgrade education. Details of the amounts paid bythe bilateral donor for the consulting services arenever revealed in detail to the recipient Government;
• A loan from country X at below-market interest rateshas a requirement that equipment must be purchasedfrom country X, even though the prices are higherthan would be paid for such equipment if tenderedinternationally;
• Surplus agricultural production is gifted from onecountry to another without any values being attached.Such food may then be sold at subsidized prices to
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certain groups of the population, and the funds socreated used for specified development purposes.
Such transactions present problems of valuation,classification and management. Though it could beargued that since they are generally not fungible theycould be ignored, there is a widely held view that theyshould be recorded as part of the flows under thecontrol of government. Certainly the GFS takes thisposition, as stated in the Non-monetary flow section onpage 39.
Fund release procedures
The starting point of any accounting system is therelease of funds in accordance with the budgetallocations. This essentially involves the followingstages:• Identifying spending units and funds allocated to
each unit;
• Assessing funds available for release
• Authorization for the expenditure in an approvedformat; and
• Making it possible for such units actually to incur theexpenditure.
The manner in which these stages are achieved variesconsiderably between countries. In essence there aretwo issues:• Whether the budget is regarded as sufficient
authority for the expenditure, or whether there has tobe some further release procedure for spending units,eg. a warranting procedure; and
• Whether funds are actually transferred to subsidiarybank accounts, or whether they are drawn from asingle group of central bank accounts.
Those alternatives form a 2 x 2 matrix as illustrated below.
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Exhibit 36. Fund release procedures
Release procedureThe issue of how to release funds, and the system ofactually paying cheques and salaries, are at the heart ofthe practical concerns of most government accountingsystems. Each of these issues is dealt with below.In general there is a reluctance within Government toregard the budget as sufficient authority to release fundsthough this would normally be the practice incommercial entities. The reason for this reluctance isthat (i) budgets often have inadequate detail ofindividual spending units, and (ii) there is a need toretain some control over cash flows through the year,and to be able to restrict expenditure if receipts arebelow budget forecasts.Therefore, most government accounting systemsprovide for funds to be released periodically throughoutthe year. This may be quarterly, or even monthly. Inone LDC the releases are treated as imprests, to bereplenished within budget limits as expenditure isincurred. In all cases the release system provides thefirst accounting indication of funds expected to be spentover the forthcoming period, and therefore it is valuableinformation that should be recorded. Of course this isless useful if, say 25 per cent is released each quarter,rather than the imprest system described above.Banking procedureMost LDCs have problems of communication withremote offices. For example, in Nepal some projectfield offices are at best a trek of several days over theHimalayas, and during the winter are completelyinaccessible. Such offices are without telephone,electricity, or air communications. On the other hand inmost LDCs there is now a geographically extensivebanking system.
The issue facing government accountants is how tomake use of the bank accounts to receive revenues andmake payments. As indicated in Exhibit 36 above, thereis a spectrum of possibilities. The simplest is to keep afew central bank accounts, and allow field officesand/or district treasuries to draw on them. Thisminimizes the cash balances held, but makes bankreconciliation an almost impossible task.The other extreme is to open a separate bank accountfor every field office. An intermediate position is tohave district treasury branches, each with its own bankaccount to make payments for field offices of ministriesand projects within its area. In all such cases there is theissue of how to replenish these accounts, and avoidhaving large idle bank balances in multiple bankaccounts all over the country. A solution in one LDC isa set-off system, whereby there is a contract betweenthe central bank and the two major commercial banks(both State-owned). Under this arrangement, individualoffices may have balances in credit or debit, but there isa central set-off, with appropriate transfers to or fromthe central bank.In general, if bank accounts are few, the problem ofreconciliation is greater, but the system is easier tooperate.
Government accounting and record-keeping
The basis of any system of government accounting mustbe a set of procedures for capturing, recording andsummarizing financial transactions for use in thecontrol and reporting systems. In many LDCs, problemsexist at the basic level with procedures that result ininformation that is delayed, unreliable, or not usefullyaggregated for management purposes. Furthermore,
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existing accounting systems often use arcane languagethat is not meaningful to the non-accountant, eg.“below-the-line accounts,” “public accounts,”“virement,” “funds,” and so on.It should be recognized that government accountingconsists essentially of four functions.• Carrying out and recording transactions regarding the
receipt, transfer and disposition of government fundsand property;
• The analysis and accumulation of transactions intomeaningful categories (usually using a chart ofaccounts and a coding scheme);
• The maintenance of reliable financial records;
• The regular reporting of the resultant data formanagement and accountability purposes.
Actual accounting procedures vary from country tocountry, though they all tend to follow a pattern. Alsothere may be varying degrees of centralization ordecentralization between two polar extremes:• The centralized model–all financial transactions
directly controlled by a single central agency such asthe Ministry of Finance; and
• The decentralized model–financial transactionsexecuted and recorded by departments andorganizations, with the central authority responsibleonly for establishing procedures and for finalconsolidation.
There is no single ideal model of the extent ofcentralization or decentralization, and what isappropriate depends very much on the administrativestructure. There are also technical and practical issues,which are discussed below.The major practical issues regarding governmentaccounting are:• The actual mechanics of recording, summarizing and
transmitting accounting information, including theuse of double entry and technology;
• The procedures for collating information centrally,and in particular whether this is through lineministries or directly through a central accountingsystem.
These issues are addressed in the subsections thatfollow.
Initial recording of transactionsThe starting point of the accounting system is the initial
recording of a transaction. In many LDCs this may takeplace in a physically remote field office, lackingtelephones or electricity, and with inadequately trainedstaff. This traditional image is complicated by twofactors:• While in many LDCs the picture above may be
accurate for many field accounting offices, inpractice the major value of transactions is likely to beprocessed in a few large urban centres; and
• Field offices in such urban centres have available, atleast potentially, most modern facilities.
For example, in Nepal, 11 out of 75 district treasuryoffices process 75 per cent by value of all expenditure.Thus there is likely to be a requirement for a dualstandard of systems with a few offices in large urbancentres using sophisticated systems suitable to handlelarge volumes and value of transactions, while in alarger number of more remote offices, simpler manualsystems will continue to be needed. However, even inthe remote offices, improvements are feasible, includingthe use of double entry, which is well suited for evenvery small accounting offices, improved form design,and possible use of carbon-copy-based systems togenerate multiple documents from one entry (anexample of simple intermediate technology which maybe appropriate), and the use of manually operatedcalculating machines.In the larger offices, typically in the capital city or otherlarge urban centres, it may be appropriate to introducesimple computerized systems for data entry andrecording. Such systems can be run on stand-alonemicrocomputers. They can use simple accountingpackages, requiring only the recording of cashtransactions or just a computerized votes ledger.The votes (appropriation) ledgerThe votes ledger is a traditional, simple, but effectivetool of financial management. Its name derives from theappropriations, sums “voted” by parliament for variouspurposes within the budget. (Many budget documentsformally divide expenditure into “vote” headings; inother cases these are implicit in the budget allocations).The votes ledger keeps a record against each budgetvote, or head, of the sums committed and expended,and the balance left unspent. An example of a votesledger format appears below.
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Exhibit 37. Votes ledger example
Budget head reference: .....................................................Spending unit: ....................................................................Amount of budget: ............................................................
Date Description Ref. Commitment ExpenditureBalanceremaining
This very simple format provides a key expenditurecontrol tool. It is also very easy to computerize.However, a problem with such computerization couldbe the lack of data security controls. This and otherrelevant issues are addressed below.Storing informationA problem in many LDCs is the storage of documents.Typically offices have inadequate filing systems, lackphysical facilities, and also lack any structured methodfor managing and retrieving documents. This is a matterof considerable concern in a system based ondocumentation, and where secure storage and ease ofretrieval are of vital importance.Systems need to be established which securely andmethodically store all documentation in a manner thatfacilitates its location and retrieval when required.These can use a combination of manual filing systems,or more modern approaches, eg. microfilm ormicrofiche, scanning and digital storage. This is anissue of great concern.
Information flows and consolidation
Information must flow from the office initiallyrecording the transaction to a central point, or points,within the Government, for the purposes ofconsolidation, monitoring and control. Traditionallygovernment accounting systems have been verycentralized, with all of the information flowing to the
Accountant General, or equivalent. However, moderndevelopments have emphasized departmentalresponsibility, and departments in many countries havebecome increasingly self-sufficient in accounting.Thus for example, the thrust of the changes in theUnited Kingdom has been to develop departmentalaccounting responsibility so that departments areresponsible for their own budgets, expenditure andaccounting. The changes in New Zealand have goneeven further, and turned departments into largelyautonomous units. These changes have paralleledsimilar changes in information technology, which havemade it more feasible and economic to disperse dataprocessing away from monolithic mainframe systems todistributed systems. Thus organizational andtechnological changes have gone in parallel.However, in most LDCs, and indeed most developingcountries, these organizational changes have not evenbegun. Governments remain very centralized, withconsiderable power in the hands of the finance ministry.Accounting is a centralized process.Nevertheless, in many countries accounting systemsalso have flows directly to departmental and/or projecthead offices. This reflects the accounting responsibilityof the secretary or other senior officer. Thus it is quitecommon to have two sets of information flows, asillustrated below.
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Exhibit 38. Existing accounting information flows in typical LDCs
Clearly the exact titles of the institutions will varybetween countries, but the flows outlined above remaintypical, with two parallel flows of information, onethrough the central accounting organization, and theother through the line ministries. Experience in mostLDCs is that these two flows are never adequatelyreconciled.The problem facing any programme of reform andupgrading of the accounting system, is whether to:• Develop and upgrade existing information flows, and
rely on a reconciliation procedure; or
• Focus on one of the two information flows–and if so,which one?
As indicated above, the move in most high-incomeindustrialized countries is towards distributed systemsfocusing on departmental responsibility, and with thedepartments responsible for their own accounting.However, it is doubtful if this model is feasible in manyLDCs.• A distributed accounting system relies on the
capability within each line ministry to establish itsown accounting systems and procedures inaccordance with central guidelines. This requires asource of trained staff, which often simply does not
exist;
• In order to provide a flow of information also formacroeconomic planning and control, technologyand systems of a relatively sophisticated nature forconsolidation are required, and again these do notgenerally exist;
• Most LDCs suffer problems of losses throughmalpractice, and their likelihood increases if controlis taken away from a central accounting body anddispersed over a range of ministries.
It is therefore concluded that initial efforts at reform arelikely to focus on developing the main accountinginformation flows to a central accounting system. Itwould be unwise to try to stop the parallel informationflows. The long-run efforts should be to developprocedures whereby both information systems arefeeding from common data, and the fact that this isrepeated in two directions becomes immaterial.This model is further complicated where there is anyform of federal structure, as in Pakistan or Papua NewGuinea. In these cases responsibility is divided betweenregional and central Governments, and accountinginformation flows are similarly divided. This can lead
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to complex budgetary and accounting problems.
Expenditure control, monitoring and reporting
The end-products of the accounting system are reportswhich enable managers to perform their functions moreeffectively. However, the effectiveness of any monitoring
system is greatly reduced if budgets are not set carefullyand properly in the first place. Though many reports areneeded, they can all be summarized in a single model, asillustrated below.
Exhibit 39. Reporting structure model
• Reports are required at a range of levels. At highermanagement levels, the span should be extended toreflect responsibility, and detail reduced, withincreased use of exception reporting;
• Commitment accounting is provided by a “votebook” system;
• Financial statements should be available regularly,not just at the year end, and for lower levels ofresponsibility as well as aggregated;
• Performance monitoring is the stage where financialdata on resources consumed is combined with non-financial performance data to provide meaningfulmeasures of performance towards goals;
• All reports should provide comparative data(“benchmarks”) so the information can be evaluated.Normally these will include budget or previousperiod figures;
• Most reports are required annually, but this is tooinfrequent for most managerial control. Normallyreports are also required monthly–some even morefrequently. To make monthly reports meaningful,
budgets also need to be analysed into months.
In addition, all reports should be:• Timely–data rapidly loses its value if not available
promptly;
• Reliable–though excessive precision is redundant;
• Clearly presented–the format should be clear andattractive; and
• Simple–only relevant data should be included.
A modern accounting and reporting system will almostcertainly be computerized, possibly partially at first andcompletely in time and, when this becomes feasible, atremote offices. In developing a reporting system, theemphasis should be to keep it simple initially so as to meetexpenditure control objectives, but with the flexibility todevelop later to meet more sophisticated needs.
Public expenditure review process
In most parliamentary democracies there will be amechanism whereby a committee of parliamentregularly reviews actual expenditures against theamounts in the budget estimates. This process may be
BenchmarksComparison with budget,
earlier periods or net assets
Reporting periodsMonthly, trimestral,quarterly, annual
ReportingUnit
National ministry,department,project, cost
centre
Physical outputscompared to
financial inputs(performancemonitoring)
Expenditurecompared to
revenue (cash monitoring
and financialstatements)
Total budgetcompared to
funds released(commitment
accounting) andto expenditure(expenditure
control)
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linked to review of reports from the supreme auditinstitution within the country. Government officers willbe called before the committee to explain their actionsand any apparent failures. Such failures would includeunauthorized budget overruns.Therefore the reporting system must be designed tomake relevant information available. Original budgets,supplementary budgets, and approved virements mustbe combined to show the final authorized expenditures,and compared to actual expenditures. Expendituresmust be presented and compared to such authority. Insome countries legislation may require this comparisonto be on a cash, not accrual, basis.
This review process exemplifies the objectives oftransparency and accountability. Information should beavailable to the public on government financialactivities in a clear and useful manner.
Cash and liquidity managementCash management should be an important part offinancial management. Yet in many countries the onlygovernment cash management is at a highly aggregatedlevel by the central bank. Aspects of this are summarizedbelow.
Exhibit 40. Cash management
Why is cash management ignored?
• Government departments and spending agencies experience no benefits or costs for managing funds wellor badly.
• The main focus of budget execution is on the release of funds, and the actual spending of money is notwell coordinated with apportionment of budget appropriations.
• The main focus of government accounting is on the propriety of expenditure, not the efficiency of funduse.
Why is it important?
• Impact on public sector borrowing requirement–bad cash management can increase the need fortemporary borrowing.
• There is a real interest cost or benefit to the Government.• Important for fund stabilization programmes.
The four components of effective cash management.• Cash flow forecasts, profiling over the year the timing of cash inflows and outflows.• Cash inflow control–measures to accelerate flow of receipts.• Cash outflow control–management of timing of disbursements.• Bank balance management–keeping balances in subsidiary bank accounts to a minimum.
Ineffective cash management could mean that theGovernment will have to resort to short-term borrowingto meet temporary deficits. It should also be borne inmind that the cost of financing a deficit, either short- orlong-term, can have a significant impact on resources
available for other purposes. Borrowing costs moneyand to do so unnecessarily is simply a waste.Cash management needs to be specifically integratedwithin the system of financial management. This isnormally relatively easy to introduce as part ofredesigning other components.
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VI. CODING AND CLASSIFICATION
Introduction
Budgets are a structured representation of anticipatedincome and expenditure flows. Accounting consists oforganizing a large volume of individual transactionsinto the same structure. The link between these two isthe classification system.A classification system may thus be defined as:
The revenue and expenditure categoriesestablished by the Government to plan revenues,expenditures, financing, and other financial flowsin the budget/ planning system, and subsequentlyused as codes in the accounting system to classifyactual revenues, expenditures, financing and otherflows, and to record assets and liabilities. Theclassification system also embraces the variousanalyses derived from such a coding system.
The classification system will manifest itself through:• The structure and presentation of financial forecasts
and budgets in planning and budget documents(sometimes referred to as budget codes);
• The structure of the formal authority by parliament toraise revenues and expend public monies(expenditure authority through an appropriation act);
• The chart of accounts (sometimes referred to asnominal ledger codes) used to record revenues andexpenditures within the accounting system and also,if an accrual system is used, to record assets andliabilities;
• Analysis of revenues and expenditures derived fromthe revenue and expenditure coding system; and
• The financial statements of the government.
Because government budgets and accounts servemultiple objectives–legal and constitutional,macroeconomic, and normal expenditure and revenuecontrol–information must be presented in a variety offormats. This requires a well-designed classificationstructure.
Multiple objectives of a classificationsystemThere is no single, self-evident analytic frameworkwhich is suitable for all purposes. By its nature, anysystem of classification and aggregation of transactioninformation means a loss of detail. If the classificationsystem does not provide for identification of data insome particular way, it will not be possiblesubsequently to identify data in that way. This is less ofa problem in budgets, where the figures are by theirnature forecasts of aggregates; but it is a real problemfor accounting information.Classification systems within Government are madecomplex because of the need to be able to analyze thefinancial information in a variety of formats fordifferent purposes. This variety can be envisioned interms of the levels of information, the needs of users, orthe technical financial information system. These areexplained in the following subsections.Levels of information
There are three major levels of information..Level 1: Economic or macro level, as
exemplified by the GFS Manual ofGovernment Finance Statistics (GFS)and the System of National Accounts(SNA)
Level 2: Resource allocation level, exemplifiedby programme and performancebudgeting, three-year rolling budgets
Level 3: Legal and managerial level,exemplified by the tax raising andexpenditure appropriations in thebudget to specific units of government,and subsequent revenue andexpenditure control processes
Needs of users
User needs impose a separate set of requirements on theclassification system. Governments have specificmanagerial responsibilities in relation to the publicsector and for the economy generally, and areaccountable to all citizens. This creates a series of userneeds.
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• Managers within the Government need theclassification system to provide financial informationrequired in their role as managers, eg. cash control,budget management, etc;
• Government activities have to be considered in thecontext of national policies, since they impact oneach other. The classification system must meet theneeds of policy makers and managers in relation tothe whole economy;
• There will always be demands for governmentexpenditure in excess of resources available. Theclassification system must be useful in makingdecisions on how to prioritize the use of limitedresources;
• The system must be capable of translatingparliamentary expenditure authorizations into asystem for authorizing expenditure to specificspending units;
• Government activities have a multi-faceted impacton a range of stakeholders, all of whom have alegitimate interest and requirement for analysisrelevant to their specific concerns;
• The system must be able to provide an historiccomparison of estimates (budgets) with actualexpenditures for detailed review by a PublicAccounts Committee (or its equivalent).
Financial information systemFinally there are the different requirements imposed bythe technical financial information system.• Budgets have a greater and different significance for the
public sector than for the commercial sector, and thebudget process will tend to drive the classificationsystem;
• Governments maintain their accounts using eithercash or accrual approaches, or some intermediatesystem. The choice impacts on the classificationsystem. Asset and liability classifications arerequired under an accrual approach, but only forfinancial assets and liabilities under a cash approach;
• Statistical systems–eg. national accounts–approachclassification issues from a different perspective tobudget and accounting systems, and have their ownanalytic requirements.
While at first it would appear that almost unlimitedclassification capabilities are required to meet allconceivable needs, in fact, a seven dimensional analysis
is normally the maximum that is required, as illustratedin the diagram. The significance and purposes of thedimensions are summarized below.
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Exhibit 41. Classification dimensions
Classificationdimension Meaning Purpose
Functional A functional classification divides into thebroad functions of government, eg. defence,law and order, transportation andcommunications.
Identifying broad sectoral allocations ofresources, and identifying priorities. Sectorsoften, but not invariably, coincide withministries or departments.
Administrativestructure
The Government organization, from ministriesat the top to the smallest unit responsible forexpenditure, and also taking account of suchlegal differences as consolidated fund andpublic account, charged and non-charged.
Legal authorization of expenditure. It is alsosuitable for identifying responsibility forexpenditure control, especially if classifieddown to the lowest levels of responsibility.
Programme Classification of expenditure by programmesand projects, which may extend over more thanone ministry.
Monitor and control expenditure.
Economic The type of expenditure, eg. capital, revenue,payroll, equipment, telephone, and so on.
Economic analysis and comparisons.
Legal Legal nature and authority for expenditure Public expenditure and revenue raising inaccordance with law.
Financial Financing and link between expenditure andsources of finance
Debt management and identification ofsources of finance
Assets/ liabilities The balance sheet Links money flows to assets and liabilitiescreated
The above descriptions are based on expenditure.Income analysis is usually simpler, concentrating on thetype of income (taxes, grants, licence fees), and thesource (domestic, foreign). Lending and borrowing arenormally treated as a separate group of flows. Finally, incountries which have inherited a British-style system,government accounts are divided between theconsolidated fund (recording normal income andreceipts), and the public account (mainly containingfunds held in trust, and temporary balances). All of thesehave to be accommodated in a classification system.
Classification linkages to stages ofthe financial management cycleThe financial management cycle, as illustrated inExhibit 42 below, links all stages of the financialmanagement process within a single system. Stages inthe cycle have roles in resource allocation, control oraccountability. The paragraphs below consider thelinkage of classification to each stage in the cycle forthese roles.
Exhibit 42: Model of an integrated financial management system
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Planning system and project appraisalIn all countries there must be some mechanism forplanning major projects that involve expenditures andbenefits extending over a number of years. Theapproved projects may be structured within a formalplan, such as a “five-year plan” or a “publicinvestment programme” or they may be made andrecorded on an ad hoc basis.Investment decisions should be based on the costsand benefits of the project. There are well establishedtools to facilitate this evaluation process, but theprocess must involve prediction of future moneyflows associated with the project. The decision willnot be affected by the manner in which such moneyflows are classified, but there are reasons even at thisstage for presenting such money flows in accordancewith the Government’s standard classificationsystem, as indicated below.
Medium-term budget systemIt is increasingly recognized that the annual budget is aninadequate tool for financial planning, and that somemedium-term framework is required. The premierexample is the Australian rolling three-year budget,though some other countries have similar systems, forexample the Economic Survey in the United Kingdom.Such forward plans will not normally go to the level ofdetail in an annual budget, since they are not directly usedas a basis for raising revenues or releasing funds.Nevertheless it is very important that they follow the sameclassification structure as the annual budget.
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Annual budget system
Annual budgets are at the heart of the financialprocedures of Governments. They are the legalmechanism by which revenues are raised andexpenditure authorized. It is therefore of the utmostimportance that budgets are presented in as clear aformat as possible to maximize transparency. It maywell be that there is more than one presentationformat within the budget, for example byadministrative structure and also by programmestructure. On the other hand, it would beinappropriate within the budget presented toParliament to show all of the underlying detail that isnecessary in order to be able to release funds tospending units, or to raise specific forms of revenue.The classification system provides an all-embracingstructure to facilitate these different requirements.Fund release, expenditure control andtreasury management
There is an intermediate stage between budgetauthorization and actual expenditure. This is the fundrelease stage–procedures by which spendingdepartments are authorized actually to spend thefunds authorized by the budget. This is often referredto as the process of warranting. This process isvariously used for liquidity management, expenditurecontrol and allocating expenditure to decentralizedspending units.19/ In order to maintain the integrity ofthe system, it is vitally important that the budgetclassification system is consistently followed throughto the fund release stage. This will involve additionaldetail in the system to identify the decentralizedspending units.Accounting systemThe accounting system is the stage at which actualrevenues and expenditures are recorded, using eitheraccrual or cash accounting. It is essential that thesame classification system be used as for the budget,in order to make monitoring and control feasible.However, there will be a need for additionalclassification heads for accounting not required forbudget purposes. These particularly relate to assetand liability accounts. Even under a cash accountingsystem, some asset and liability accounts will beretained, eg. suspense accounts, advances, deposits.20/
In an accrual accounting system the asset accountswill be much more extensive, and will include fixedassets, depreciation, accounts payable and receivable(creditors and debtors), inventory, and accruedliabilities such as pensions.
Reporting and financial statements
The periodic financial reports and annual financialstatements are the tools of the control system.Government accounting systems have traditionally notbeen seen as reporting systems. Reports are oftenrestricted to monthly reports, often late, withoutcomparisons to budget, and poorly presented. To be usefulfor control purposes reports must be up to date, producedwith a frequency related to the control cycle, andpresented with benchmarks so as to be able to identifytrends and where action is required. This is feasible onlythrough a consistent and appropriate classificationstructure.Audit system
Governments are subject to audit by the supreme auditinstitution, often the Auditor General. Historically,government audit has differed from commercial audit inthat the former has concentrated on the propriety oftransactions and the latter on the reliability of the financialstatements. The trend is for government auditing toembrace at least a review of, and expression of opinionon, the financial statements. This will include acomparison with budget authorizations, so consistency ofclassification is essential.
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Expenditure review system
Most parliamentary systems incorporate someprocess by which Parliament reviews publicexpenditures, typically a public expenditure reviewcommittee. Such a committee will be concerned withthe authorization, propriety and effectiveness of suchexpenditure. The review will be based on the auditreports, financial statements and budgets of theGovernment.Conclusions on the financial managementcycle and classification
The key point to emerge from this analysis is therelevance of the classification system to every stagein the cycle, and the need for a single system appliedconsistently. Therefore the system must beappropriate to the requirements at each stage in thecycle. The matrix in Exhibit 43 below summarizesthe impact of classification at each stage of the cyclein terms of resource allocation, control andaccountability.
22
Exhibit 43. Linkage of stages of financial management cycle to classification
Stage in cycle Resource allocation Control Accountability
Planning system andproject appraisal
Once projects are approved, their financialflows will be included within medium-term andannual budgets, and will represent pre-emptedresources, thus restricting resources available tobe allocated for other activities. The process ofidentifying the annual flows associated withprojects will be facilitated if they are alreadypresented in the classification structure. Thisalso applies if there is a public investmentprogramme the financial implications of whichhave to be incorporated within a budget.
Furthermore, post-event comparisons ofpredicted and actual cash flows can be valuablein improving the quality of future forecasts.This evaluation is feasible only if they are bothanalysed within the same structure.
Projects should be subject to ongoingmonitoring, and this will include comparingpredicted and actual cash flows. Theaccounting system should be used to generatethe latter information, and will do so inaccordance with the standard classificationsystem.
Accountability is enhanced if financialinformation about projects is presented in astandardized format.
Medium-term budgetsystems
The use of a standardized classification systemfacilitates comparisons for resource allocationpurposes, and also the incorporation of pre-empted project expenditure as indicated above.
Medium-term budgets are an importantexpenditure control tool, forcing an evaluationof the impact of expenditure decisions onresource ceilings. This can be madeeffectiveonly if medium-term budgets can betranslated into annual budgets, and this makesa standard classification system essential.
Medium-term budgets are part of thetransparency of government. They are moreeffective as a communication tool if presentedin a standardized format.
Annual budget system The annual budget is the legal tool forallocating resources. As such it must use thestandard classification system.
Budgets are a key control tool. Actualexpenditure is compared to budgets (seebelow), and therefore both must use thestandard classification system.
Budgets are the prime mechanism foraccountability. This is enhanced by a clearand transparent presentation, which in turnrequires an appropriate classification system.
Stage in cycleResource allocation Control Accountability
23Fund release,expenditure control andtreasury management
Resource allocation decisions within the budgetcan, deliberately or accidentally, be distortedthrough inconsistent fund releases. Suchdistortions can be identified through aconsistent classification system, combined withfinancial monitoring procedures.
Fund release is an essential element withinthe control cycle.
Accountability is achieved by being able tomonitor fund releases against original budgetauthorizations.
Accounting system The accounting system records historicinformation, and therefore has no direct role inresource allocation. However, such informationis a guide to future money flows. Also bycomparing predictions and out-turns, thequality of predictions, and hence resourceallocation decisions, can be improved overtime.
Historic accounting information is a basicelement in a control mechanism. Althoughnothing can change past costs, bycomparison with plans trends can beidentified and any appropriate correctiveaction implemented. This makes consistentclassification systems essential.
Historic accounting information forms thebasis of reporting on financial out-turn, andhence accountability.
Reporting and financialstatements
Reporting has no direct link to resourceallocation, though as noted above may indicatefuture cash flows.
Reports are the basis of the control system. Annual financial statements are a veryimportant element in achieving accountability,and are usually the basis of audit andexpenditure reviews.
Audit system Auditing has no direct relevance for resourceallocation, though a “value for money” auditcan provide information to guide futureinvestment decisions.
Audit is a fundamental part of the controlprocess within government.
Similarly, audit is a fundamental part of themechanism for ensuring accountability ofpublic servants.
Expenditure reviewsystems
The expenditure review has no direct impact onresource allocation, but the review ofeffectiveness may provide guidance for futuredecisions.
This is another important element in thecontrol process.21/
The public expenditure review process is amanifestation of accountability.
24
Criteria against which to evaluate a classification system
It is useful to develop criteria against which both present and proposed classification systems can be evaluated.These are set out in Exhibit 44, below.
Exhibit 44. Criteria for classification systems
No. Criterion Explanation
1 Comprehensive Covers all categories of income and expenditure
2 Structured So that the different categories of codes are clearly segregated,and analysis is possible
3 Simple and workable In order to make analysis feasible given the level of clericalskill and automation available
4 Meets budget, expenditure control,resource allocation and accounting needs
So that one system can be used for all purposes
5 Suitable for computerization This is an essential requirement for any modern system
6 Capable of developing The system must be designed so that it is capable of beingdeveloped and amended to meet additional and changingrequirements without a fundamental redesign
Concepts underlying classificationstructureThere are a number of important concepts underlying aclassification structure. These are set out in thesubsections that follow.Capital and revenue
Capital transactions involve payments or receipts forthe acquisition, construction or sale of non-financialassets meant to be used for more than one year in theprocess of production. Intangible assets and land areincluded in capital, or fixed, assets.22/ The distinction isregarded as important because it differentiates betweenexpenditure for current consumption and expenditurefor long-term consumption. Note that the definitionprimarily focuses on the purpose of the expenditure.However, there is some dispute about the definition ofcapital in the public sector, and some authorities link itto the source of funding. Furthermore, the value of thecapital/current distinction is much reduced under cashaccounting, where there is no attempt to record capitalassets in a balance sheet.
Public enterprises operated as departments
An example is provided by Bangladesh Telephone andTelegraph Board. The telephone system in Bangladesh isoperated as a government department. In such cases, theinformation in the government budget and accounts should beon a cash basis, but the enterprises need to keep memorandumaccounts on an accrual basis because of their commercialnature.It is preferable that all such commercial activities besegregated and treated as public enterprises. However, wherethis is not possible within the administrative structure, it canstill be achieved within the classification structure.State-owned bodies
State-owned bodies include financial institutions,commercial enterprises and other non-commercialentities, eg. welfare associations and educational bodies.Commonly in LDCs it is not possible to identify netflows of funds to or from these organizations from thebudget. In the development budget, often no distinctionis made between projects where the funds aresubsequently lent to autonomous bodies, and thereforemove out of the direct legal control of government, andprojects which are conducted directly by theGovernment.
25Exhibit 45. State-owned enterprises
The coding structure should clearly identify gross flowsof funds to and from State-owned bodies as being: (i)subsidies or grants; (ii) loans or repayments; (iii)interest on loans; (iv) dividends or profit share paid togovernment; or (v) equity investments. This system isextended to development expenditure so as to clearlyidentify projects which pass through the governmentaccounting system from those accounted for by thepublic enterprises.This has implications for expenditure control. Thegovernment accounting system will provide the sourcedata for the financial management of projects operateddirectly by government. For those operated throughautonomous bodies, expenditure control information
must come from the autonomous body itself.The GFS/SNA analytic framework
The IMF Manual of Government Finance Statistics(GFS) 23/ and the System of National Accounts (SNA) 24/
are statistical analytic tools. These form internationalstandards for fiscal analysis and comparison. Theproposed changes to the GFS adopt an accrual approach,which is in line with the SNA.The GFS organizes money flows into broad categories asindicated in the matrix below. Note that the layout of thisand subsequent presentations differs from that used inthe GFS Manual, in order to facilitate comprehension.
Control over
Public
Dealt with throughgovernment
Directly by
Dealt with throughpublic-enterprise
26
Exhibit 46. GFS analytic framework
Description Current Capital TotalRevenue and grants
Taxes and other income 2,000 1,500 3,500Grants 1,000 800 1,800Total 3,000 2,300 5,300
Expenditure –3,200 –1,700 –4,900Lending – repayments
Lending –1,100Repayments 500Net –600
Deficit/surplus on current account –200Financed by:
Increase in government liabilities to others –600Increase in others’ liabilities to government 400
Net financing –200
Note: Figures are for illustrative purposes only.
27The distinction between capital and revenue is afundamental part of the classification of receipts andexpenditure. As noted in the subsection on capital andrevenue, the definition used by the GFS is that capitaltransactions involve payments or receipts for theacquisition, construction or sale of non-financial assetsmeant to be used in the process of production for morethan one year. Intangible assets and land are included incapital assets. Taxes are regarded as revenue receipts, andgrants are capital receipts only if for the purpose ofacquiring capital assets. Lending minus repayments is notclassified as capital or revenue. Government lending orborrowing may be either for public policy purposes, inwhich case it is classified as lending minus repayment, orfor liquidity management, in which case it is classified asfinancing.
Impact of accrual accounting on the analytic model
Without accrual accounting, the only relevant analysisis of expenditure and receipt flows. In a cash-basedsystem the only assets and liabilities are financial, andtheir recording does little more than prove thearithmetic accuracy of the record of flows. Since thereare no physical assets or liabilities, only cashtransactions occur. Therefore the analytic framework ismuch simpler.Either a cash or accrual analytic framework requires aclassification system for economic flows. This is all thatwill normally be required for the budget classificationunder any model. The use of the accrual model adds therequirement for accounting classifications for assets,liabilities, and transactions other than economic flows.The impact of the choice of model on classification istherefore in terms of the additional analysis.
Financial assets and liabilities and financing flowsThe GFS divides financial assets according to thepurpose for which they are held:• Those held for policy purposes, which are shown as
“net acquisition of financial assets for policypurposes”;25/ and
• Those held for liquidity management, which shouldbe shown under financing.
The GFS admits that it is difficult to identify these twogroups on the basis of types of assets, and therefore thedistinction must be based on “motives underlying thetransactions.” The 1986 GFS Manual provides someguidance. In practice most financial assets will be heldfor policy purposes, and liquidity management assetsrelate to specific purposes, eg. as a fund to meet pensionliabilities as they mature.Liabilities, on the other hand, are classified within theGFS primarily on the basis of domestic or foreign.Interestingly, the GFS contains no guidance on thefunctional classification of interest payments. Thoughthese may be embraced within an economicclassification, it is necessary to define consistentlywhere interest payments are recorded within thedifferent government functions.This explanation refers to the present GFS. Underproposed changes to the GFS the treatment of net policylending will change. Whereas at present policy lending isregarded as deficit-creating, under the new proposals itwill be treated the same as liquidity lending, ie. as part ofthe financing section.The GFS treatment of financial assets and liabilities,and related flows, is significantly different from thatapplied to accounts under generally-acceptedaccounting principles. Under GAAP there are“operating assets,” ie. those used in the operations ofgovernment, and non-operating assets, which wouldinclude assets held for liquidity management purposes.Similarly, liabilities need to be divided betweenoperating liabilities (commercial entities treat these assynonymous with “current liabilities,” ie. those with amaturity less than one year, but this may not be anappropriate assumption for Governments), andfinancing liabilities.The GFS does not distinguish between operating flowsrecorded in the operating statement and other changesin the amounts of assets and liabilities. Interest receiptsand payments form part of operating expenditure andrevenues. On the other hand changes in the amount ofassets are not operating flows, and would be identifiedseparately through separate schedules, linked to balancesheet movements. Exhibit 47 seeks to relate thesedifferent approaches.
28
Exhibit 47. Alternative treatment of financing
GFS approach GAAP approach
Balance sheet Balance sheet
Financial assets held for policy purposes
Included within: Operating assets
Financial assets held forliquidity managementpurposes
Substantiallysame concept Non-operating assets
Liabilities – domestic(sub-divided by type)
Classified indifferent manner
Operating liabilities
Liabilities – overseas(sub-divided by type)
Liabilities held for financingentity
Operating statement Operating statement
Interest receipts Substantiallysame concept
Interest receipts
Interest expenses Substantiallysame concept
Interest expenses
Gains/losses resulting fromexchange rate changes
Statement of changes infinancial assets andliabilities Presented in a
substantially
different manner
Statement of changes infinancial assets andliabilities
Net movement in assets/liabilities held for policypurposes
Gross movements shown forall major categories of assetsand liabilities
Gross movements in otherfinancial assets/liabilities
Gains/losses from amountswritten off shown separately
There is no incompatibility between these differentapproaches, which reflect different information needs ofdifferent groups of users. Provided the classificationsystem contains sufficient information for eitherpurpose, then either analysis can be derived as required.The approaches to all three are summarized in theparagraphs that follow, and then our conclusions on the
system as a basis for classification are drawn, usingBangladesh as an example.
Revenue and grantsThese are classified according to the following system(upper case Roman numerals in parentheses are thoseused in the GFS Manual):
29Exhibit 48. GFS analysis of revenue and grants
Main category Examples Illustrativevalues
Tax revenue (IV) Taxes on income 200
Property taxes 100
etc. 150
Total 450
Non-tax revenue (V) Fees and charges 80
Property income 60
etc. 20
Total 160
Total current revenue (III) 610
Capital revenue (VI) Sales of fixed capital assets 90
Capital transfers from non-government sources, eg. residentsabroad
120
Total 210
Total revenue (II) 820
Grants (VII) From abroad 150
From other levels of nationalgovernment
20
From/to supranational bodies 220
Total 390
Total revenue and grants (I) 1,210
This is an analytic framework which is acceptable formost purposes. However, note that it fails to identifyrevenue in terms of units of government, which arelikely to be required for control and managementpurposes. Also the accounting system will need toidentify individual sources of grants.
Functional and economicclassification
The GFS Manual uses a two-way split of items: (i)functional and (ii) economic.The functional classification divides expenditureaccording to the broad functions of government, eg.defence, law and order, health, education and so on.This will usually, but not invariably, follow theadministrative structure of Government and the variousministries. For example, in Bangladesh the educationfunction is divided between the Ministry of Educationand the President’s Office, with the latter being directlyresponsible for primary education.
30The economic classification divides expendituresaccording to their nature, eg. payroll, interest, subsidies.This is sometimes referred to as an object classification.In order to reconcile these two classificationapproaches, a matrix is proposed which is reproducedbelow in a simplified format, and without showing thesubdivisions of the economic classification.
Exhibit 49. GFS economic and functional cross-classification
Economicclassification
Functional classification
Totalexpenditureand lending
minusrepayments
Totalexpenditure
Currentexpenditure
Capitalexpenditure
General public servicesDefencePublic order and safetyEducation
HealthSocial security and welfareHousing and community servicesRecreation, culture, religionFuel and energyAgriculture, forestry, fishery and huntingNon fuel mining, manufacturing andconstructionTransportation and communicationsOther economic services
Non-classifiedTotal
The above analysis is not intended to provide a systemfor expenditure control, in that it does not identifymanagerial responsibility for expenditure decisions.This highlights the multi-dimensional nature ofclassifying government expenditure. From the GFSperspective, it is primarily information for economicanalysis; from the perspective of public-sectormanagers it is primarily a system of expendituremonitoring and control. The latter requires informationfocused on individual responsibility, which is irrelevantfor economic analysis.
Legal aspects of classificationIn most countries, the classification structure is to someextent circumscribed by the legal and administrative structure. This in turn will be influenced by the historic
background of the country. In most countries with aBritish system background, government monies aretypically divided between consolidated fund and publicaccount. In practice, the consolidated fund is furtherdivided between the development budget and therevenue budget. Finally, expenditure from the revenuebudget is divided between charged (ie. that expenditurewhich does not have to be voted on and debated byparliament) and non-charged. The distinction betweenconsolidated fund and public account is important, andreflects the very different nature of the transactions interms of both budgeting and expenditure control. TheBangladesh model is used as an example.
75
It will be essential for any classification system toallow the identification of these categories of incomeand expenditure.
ConclusionsThere is no single correct classification. On the otherhand, there are certain requirements which anycoding structure must achieve.• It must comply with constitutional and legal
provisions and the administrative structure of thecountry;
• It must be suitable for the different components offinancial management–planning, budgeting,
accounting and monitoring–so as to be a tool in theprocess of integration;
• It must enable the various types and required levelsof analysis, including that required for managerialcontroland also for economic management;
• It must be sufficiently simple to be feasible forimplementation;
• It must be designed so that it is flexible and allowsfor future development.
The structure proposed by the GFS provides a conceptualbasis meeting the needs of economic management. It isnot intended to meet the needs of administrativestructures and managerial control. It is possible to meetall analytic requirements within a single classification
structure by the use of “look-up tables.” These are builtinto the computer system, and enable a series ofclassification analyses to be derived from one singlesystem.
Exhibit 50. Important accounting categories in Bangladesh
1
VII. FINANCIAL STATEMENTS
Introduction
Financial statements are the final element linking theother components of the financial management system.They relate actual outcome to plans and budgets, forboth financial elements and performance criteria.Although most governments produce financialstatements, they are typically low-key affairs. Often thedocuments are buried in other papers, and not easilyaccessible. This does not apply just to LDCs. TheUnited Kingdom, for example, has never actuallypublished its consolidated financial statements, thoughthe information within them is available from a numberof other documents.This contrasts with commercial entities, where thepublication of the annual financial statement is a legalrequirement and is regarded as a marker, the point whenthe performance of the entity and its management arejudged. This of course links back to the accountingmodel as the universal standard for commercial entities(see Exhibit 6).There is a strong case for a positive effort to upgradethe status, quality and timeliness of the financialstatements of LDCs as part of the process of developingan integrated financial management system. Suchstatements provide tangible evidence of goodaccountability and enhance transparency in government,and their production provides a target for the financialsystem reforms. They provide a marker in the processof implementing “good government” reforms.There is a trend within governments generally to movein this direction. New Zealand, for example, nowpublishes a full set of financial statements, laid out likethose of a commercial enterprise. 26/ The InternationalAccounting Standards Committee studies on the publicsector have focused on the concept of the publishedfinancial statements.This section seeks to answer two questions:• What should the published financial statements of a
government look like?
• What are the gains to an LDC from upgrading itsfinancial statements?
In addition, this section reviews the role of internal andexternal audit in the context of government financialmanagement.
What are the financial statements?
Financial statements refer to a set of documents,recording information on financial transactions over aperiod of time, together with a statement of assets andliabilities at the end of the period. These may beexpanded to include other documents recording theinformation in more detail, or in a different manner. Inthe case of governments, the period is invariably theirfinancial year. This subsection seeks to identify the components offinancial statements that should ideally exist. These areprovided as examples in the annex at the end of thissection.In government accounting there has always been oneprime financial statement.
The statement of revenues and expenditures (1)
Where government accounts are kept on a cash basis,this is a cash flow statement. If an accrual or modifiedaccrual basis is used, then a separate statement shouldbe added, showing cash movements over the sameperiod.
A statement of cash flows (2)
Many countries add to this a statement of assets andliabilities at the end of the period.
A balance sheet (3)
In addition to these major statements, additionalstatements may be added, almost at discretion. Forexample, the United Kingdom resource accountingproposals 27/ include two further statements.
Main objective analysis (4)
Output and performance analysis (5)
In addition to these a number of further schedules, eg.of borrowings, may be included, but the above areconsidered the major components of governmentfinancial statements.
2
The entity conceptFundamental to the concept of the financial statement isthe “entity concept”–that the reporting organization canbe regarded as self-contained with defined boundariesthat are clear to all concerned. This easily applies to acommercial organization in that most countries have alegal definition of a company as a separate legal entity.One definition of an entity is:A set of resources, (or assets) employed for a commonpurpose, and of obligations (or liabilities) incurred infurtherance of that purpose. The difference between themoney value imputed to assets and liabilities is knownas equity.28/
It is difficult to recognize this as the description of agovernment entity. A government has much widerobjectives than those defined above. Its boundaries areunclear–with municipal authorities, local and districtgovernment, state-owned entities, quasi-governmentalactivities, and so on. The definition and limits of
government are likely to vary according to the situation.It may be that there is a case for a more precisedefinition of the limits of government so that it may beseen as an entity. Certainly this has been done in NewZealand, but as part of an overall reform of thegovernment process rather than just to serve the needsof accounting. Any attempt to create a governmentbalance sheet must inevitably move towards an entityconcept of government.The entity concept does not essentially require legalrecognition, but such recognition is certainly helpful toclarify the process. It exists for companies under Britishlaw, and students will recollect the wonderfullyevocative legal phrase “the veil of incorporation,”which epitomises the clear distinction between the legalperson of the company and the outside world. Mostother Western-based legal systems have similarconcepts.
Exhibit 51. Concepts of government and commercial entities compared
To account for an entity, even where there is no “legalperson,” it is essential to be able to define clearly theboundaries of the entity in order to express assets andliabilities. Governments sometimes find this difficult
because they represent the State, but the assets theymanage are controlled by the government as aneconomic entity. One of the problems of theprivatization process has often been achieving such a
3
definition, which it has not been necessary to clarifywhen the entity was simply an arm of government. Thisis even more difficult for the government as a whole.The entity concept links to the importance for privatecommercial organizations of measuring period profit,since this is the prime measure of success, and profitdetermines the capability to pay dividends and taxation,and also share value. Much of commercial accounting isconcerned with identifying changes in assets andliabilities over time, and hence calculations ofprofitability.Governments have a very different focus on the budgetflows, as indicated above. Indeed cash-based budgetingand accounting does not require any identification ofassets and liabilities. In traditional government budgetand accounting systems, assets and liabilities have notbeen recognized. Where they have to be accounted for,eg. loans and advances, such traditional systems haveadded so-called “below-the-line” accounts, to indicatethat assets and liabilities are not part of the budget.As long as a government accounting system remainscash-based, this creates no problems for classification.
However, any move to an accrual accounting baserequires the establishment of asset and liabilityaccounts, and the concept of government as an entitywith defined boundaries.
Elements of financial statementsA major study by the International AccountingStandards Committee provides an analysis of theelements of financial statements in the public sector.This is a fairly narrow study, in that it appears to focusprimarily on relating government to commercialfinancial statements. Nevertheless, it provides someinteresting insights into the nature of governmentfinancial statements. This subsection will review theconcepts as developed within that study, and then go onto consider their relevance to government financialmanagement. The following analysis is based on theIASC study, with actual quotations shown in italics.The IASC paper defines the objectives of financialreporting, as set out below.
Exhibit 52. Objectives of financial reporting29/
Financial reporting should demonstrate the accountability of government (or governmentunit) for the financial affairs and resources entrusted to it, and provide informationuseful for decision-making by:
Indicating whether resources were obtained and used in accordance with the legally adopted budget.
Indicating whether resources were obtained and utilized in accordance with legal and contractualrequirements, including financial limits established by appropriate legislative authorities.
Providing information about the sources, allocation and uses of financial resources.
Providing information about how the government or unit financed its activities and met its cashrequirements.
Providing information that is useful in evaluating the government’s or unit’s ability to finance itsactivities and to meet its liabilities and commitments.
Providing information about the financial condition of the government or unit and changes in it.
Providing aggregate information useful in evaluating the government’s or unit’s performance in termsof its service costs, efficiency and accomplishments.
The elements of the financial statements will depend on the accounting basis. The next exhibit provides an analysis.
4Exhibit 53. Elements of financial statements under different accounting bases
Basis of accounting Elements of financial statements Presentation in financial statements
The cash basis of accounting recognizestransactions and events only when cash hasbeen received or paid. A statement of receipts and payments (orexpenditures) is prepared to discloseinformation about cash flows during a periodand cash balances at the end of that period.
Cash receipts.Cash disbursements.Cash balances.Receipts and disbursements will include cashinflows and outflows from taxation; loans andgrants from external donors; the provision ofgoods and services; the purchase and sale ofplant, equipment and investments; andborrowings and other financing transactions.
Classified to highlight major components, orsources of cash inflows and cash outflows; andthe extent to which cash balances have beendedicated for particular uses, or relate to theprovision of certain services or the acquisitionof certain types of assets.For example, financial transactions involvingloan receipts and disbursement may beclassified separately from other transactions.Capital outlays and development expendituresmay be segregated from other expenditures.
The full accrual basis of accounting is gearedtowards recognizing the financial effects oftransactions and events in the periods in whichthey occur, irrespective of whether or not cashhas been received or paid.It reports on the economic resources or servicepotentials (assets) and obligations (liabilities)of the entity, and changes therein. It requiresthe capitalization of expenditures on theacquisition of all capital assets and thedepreciation of those assets as their servicepotential is consumed.
The full accrual basis of accounting willrecognize all assets, liabilities, revenues andexpenses (including depreciation) of the entity.
Particular components or characteristics ofeach of the elements may be highlighted bysub-classification. For example, assets may beclassified as current/non-current and/or on thebasis of the functions they serve or the types ofservices they provide. Similarly, revenues andexpenses may be classified on the basis ofparticular activities or programmes and/or bytype of revenue or expense (for example,taxation revenue, user charges, salaries andwages and depreciation).
5Basis of accounting Elements of financial statements Presentation in financial statementsThe modified accrual basis approximates tothe accrual basis of accounting, where themodel lies on the spectrum between cash andfull accrual accounting, and therefore the natureof the elements which are reported will dependon the nature and extent of the modifications.Usually expenditure on capital items isexpensed when it occurs.
A common modification to full accrualaccounting is to exclude physical assets. Theelements of the financial statements will thenbe:
$ Liabilities;$ Revenues;$ Assets which are
available to meetliabilities as they falldue (financial assets);
$ Expenditures on theacquisition of assets foruse in the provision ofgoods and services(including capitalassets).
Similar to full accrual accounting, but capitalassets will be expensed when acquired, andhence not show in balance sheet.
The modified cash basis approximates to thecash basis of accounting. Comments as above.
A common modification to cash accounting isto include in the financial statementsinformation about those transactions and eventswhich will result in cash receipts ordisbursements within a short periodimmediately following year-end, as well asinformation about cash flows and cashbalances. The elements of the financial reportthen encompass:Cash flows during the period; andSome receivables and payables.
The financial statements will highlight currentor short-term financial resources and changestherein during the reporting period.
6
Reporting modelsAdoption of a particular basis of accounting does notrequire the preparation of any particular set of financialstatements, nor does it mandate the configurations to beadopted for display of financial information.
The argument is that the reporting model is independentof, and can be disengaged from, the basis of accounting,but this is only partly true. If information does not existbecause of the system of accounting, for example oncapital assets and depreciation, it cannot be included inthe financial statements. However, what is correct isthat the financial statements can be supplemented byother statements showing additional information, eg.cash-based accounts could be supplemented by astatement of borrowings.Generally, the most comprehensive reporting model isprovided by full accrual accounts. However, this doesnot provide information about non-financial objectivesand performance, which will have to be provided byadditional statements. Nevertheless, decisions regardingthe reporting model should take into account users’needs and the producers’ capabilities; accounts shouldbe simple and as clear as possible.
Decisions regarding the reporting model to beadopted, and the relationship between financialstatements, notes thereto and supplementaryschedules should be made after consideration ofsuch factors and the particular “messages” to behighlighted and users’ ability to understand thefinancial statements. Such should also beconditioned by a concern to reflect, in an unbiasedmanner, complex transactions and events.
Characteristics of elements offinancial statements
Assets
An asset is defined by the IASC as follows:An asset is a resource controlled by the enterpriseas a result of past events, and from which futureeconomic benefits are expected to flow to theenterprise. 30/
Under a modified accrual or cash basis of accountingsome assets, as defined above, would be recognized.Under the cash basis of accounting, the only assetrecognized will be cash. Under full or modified accrualaccounting, at a minimum, all financial assets should berecognized. In applying the IASC definition of assets togovernments and non-business public-sector entities,service potential should be interpreted to encompass the
delivery of services and programmes rather than onlythe generation of cash inflows.The concept of service potential that an asset shouldpossess if it is to be reported in the financial statementsunder different bases of accounting will thereforedepend on the message to be communicated by thefinancial statements and the objective of financialreporting. For example, if the objective of financialreporting is:• Compliance with financial regulations during the
reporting period, then assets reported in the financialstatements should be limited to cash or near cashequivalents;
• Evaluation of a government’s financial condition,and changes therein during the reporting period, thenthe financial statements should report cash and otherresources on hand and available to finance thegovernment’s activities and meet its liabilities andcommitments;
• Accountability for all the resources that governmentscontrol, and changes in those resources during thereporting period, then the financial statements shouldreport assets that assist the entity in achieving itsobjective, whether that objective is to generatepositive cash flows or to provide needed goods andservices consistent with government priorities. Theconcept of service potential would thereforeencompass physical as well as financial assets.
Therefore the assets included in financial statementsdepend on the objective of such statements.
As governments move along the spectrum fromcash towards accrual accounting the messagescommunicated by their financial statements willchange, and those statements will evidenceaccountability for more of their assets. In suchcircumstances, the importance of developingagreed, well understood definitions of assets forgovernments and other public sector entitiesincreases. As the range and complexity of thetransactions and events that are “captured” byfinancial statements increases, the relevance andreliability of financial reports are increasinglydependent on the consistent application of suchdefinitions.
However, adoption of the IASC definition of assets willraise a number of issues not yet confronted by manygovernments. These will include:• Whether governments or other public-sector entities
should be accountable for the assets they own, or theassets they control, and how ownership or control
7
should be defined;
• Whether plant, equipment, buildings, infrastructureassets (such as roads, parks, libraries), State-run healthcentres, monuments and historical treasures should berecognized in the financial statements. These provideservices to beneficiaries, and are therefore assets withinthe IASC definition. However, in many cases, thepurposes for which they can be used and theiravailability for liquidation to meet liabilities arerestricted.
Liabilities
The IASC definition of liability is as follows:A liability is a present obligation of the enterprisearising from past events, the settlement of which isexpected to result in an outflow from the
enterprise embodying economic benefits.31/
Adoption of different bases of accounting results indifferences in the liabilities which are recognized in thefinancial statements. Moving from cash towards fullaccrual accounting results in obligations which will besettled further into the future and recognized asliabilities. For example, under a pure cash basis ofaccounting, no liabilities are recognized; under amodified cash basis of accounting, only thoseobligations to be settled in a nominated period from thereporting date will be recognized as liabilities; whereasunder forms of accrual accounting, obligations to besettled in the longer term, such as employee pensionentitlement and other post-employment benefits, maybe recognized as liabilities.
Exhibit 54. Liabilities recognized under different bases of accounting
Liabilities may be limited to those obligations which arelegally enforceable, or may encompass all presentobligations which are “expected” to be settled in thefuture (as in the IASC definition), ie. equitable orconstructive obligations. Therefore, depending on howliabilities are defined, different transactions and eventsmay be recognized in the financial statements asliabilities under all forms of accrual accounting.Most obligations are legally enforceable in that theystem from legally binding contracts or are imposed bylegally authorized bodies or government statute.Examples of obligations arising from contractualarrangements include amounts borrowed, amounts duefor asset purchases and amounts owed for obtaining theservices of labour.Equitable or constructive obligations arise from normalpractices, from custom and from a desire to maintaingood relations with the public or to act in a fair and just
manner. If liabilities were not to be limited to legallyenforceable obligations, the amounts expected to beexpended in accordance with the government’s policyin relation to disasters which have occurred wouldconstitute obligations which could be reported asliabilities. In the absence of a clear legal responsibilityin respect of such matters, the existence of a presentobligation would be assessed on the basis of availableevidence.
Net assets
A balance sheet may be prepared under all of the cash,accrual, modified accrual or modified cash bases of accounting. Its contents depend on the basis ofaccounting, as will the residual surplus of assets overliabilities (or vice versa) as illustrated below.
Liabilitiesrecognized
Accountingbasis
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Exhibit 55. Net equity under different bases of accounting
Basis of accounting Nature of balance sheet Composition of net equity
Cash basis Financial assets and liabilities andcertain other assets and liabilities inbelow-the-line accounts
Consolidated fund equals net financialassets and other below-the-lineaccounts
Modified accrual basis Full balance sheet excluding fixedassets
Consolidated fund is net assetsexcluding fixed assets and certainliabilities
Accrual basis Balance sheet which would discloseinformation about assets and liabilities
Consolidated fund equivalent tocompany concept of net equity
Under the full accrual basis of accounting, the change innet assets over a reporting period is a financial measureof the change in the capacity of the government (or otherentity) to provide goods and services in the future,whether that change flows from the consumption ofexisting service potential, a reassessment of the value ofservice potential or the acquisition and/or disposal ofcertain assets.
Revenue/income, expenses and expenditure
The IASC definition of revenue/income is as follows:Income is increases in economic benefits duringthe accounting period in the form of inflows orenhancements of assets or decreases ofliabilities that result in increases in equity,other than those relating to contributions fromequity participants.
Under most bases of accounting, the core of itemsrecognized as revenue, or cost recovery, will becommon. They will include taxes, fines, fees andother imposts, user charges, investment income andwindfall gains. In addition, LDCs are likely to receivesubstantial inflows in the forms of grants andcommodity aid. The timing of recognition of items asrevenue under cash accounting will be only in thefinancial statements in the period in which cash isreceived, but under many forms of accrual andmodified accrual accounting, revenue will berecognized in the period in which the transaction orevent giving rise to the increase in resources occurs.Therefore, the basis of accounting adopted willdetermine whether, for example, a governmentwould:• Recognize income taxes as revenue when income
is earned by the taxpayer, when taxes are due andpayable or when taxes are received; or
• Recognize sales tax as revenue when the sale is made,when the tax is payable or when the tax is paid.
It is our view that in most cases it is not feasible torecognize tax and similar income until the liability hasbeen accepted by the paying party. This is because taxassessments are much more likely to be reduced thanincreased, and to base revenue on estimates wouldsystematically over-estimate revenues.Expenses and expenditure are defined by the IASC asfollows:
Expenses are decreases in economic benefits duringthe accounting period in the form of outflows ordepletions of assets or incurrence of liabilities andthat result in decrease in equity, other than thoserelating to distributions to equity participants.
Under the cash basis of accounting, appropriateclassifications of cash outflows will enable users todistinguish between those cash outflows which relate tothe provision of goods and services and those which relateto the repayment of debt or the acquisition of assets.Adoption of a modified cash or modified accrual basis ofaccounting would result in the reporting of a wider definition ofexpenses than under the cash basis. In particular capitalexpenditure would be spread over the life of the asset throughdepreciation under a full accrual basis.
Accountability
Accountability is a function of the accounting basis. Thedifferent forms of accountability are summarized below.
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Exhibit 56. Accountability under different accounting bases
Cash basis Recognizes cash flows and cashbalances as the only elements offinancial statements. The modified cashbasis of accounting recognizes amountsreceivable and payable within anominated period from reporting date aswell as cash flows during the reportingperiod and cash balances as at the end ofthe reporting period
Relevant for the “compliance” aspect ofaccountability (demonstrating compliance withregulations and budget) Unlikely to reflect the costs of service deliveryor the results of resource managementUnlikely to provide sufficient information foran assessment of the economic condition of anentity and its efficiency in allocating andmanaging scarce resources for the achievementof service delivery objectives
Modified accrualbasis
Recognizes liabilities, financial assets,revenues, expenditures and net assets asthe elements of financial statements
Highlights the extent to which the results ofactivities during the current period haveenhanced or eroded the government’s ability tomeet its liabilities and future activities fromfinancial assets
Full accrual basis Recognizes assets, liabilities, revenues,expenses and net assets. Financialstatements prepared consistent with thisbasis will report on the costs of servicesprovided during the period, the extent towhich those costs were recovered fromrevenues generated during the periodand the sources of those revenues andthe resources controlled during theperiod
May identify financial assets available to meetliabilities. However, statements constructed todisclose revenues and expenses will not reportcash flows (as under the cash basis) norhighlight whether, as a result of the period’sactivities, the entity’s ability to meet itsliabilities and fund additional activities fromfinancial assets has been enhanced or eroded
While the accrual basis is most appropriate for reportingon resources controlled, cost efficiencies and costrecoveries, it may not be if other objectives aredetermined to be primary, for example, if reporting oncosts is relatively less important than reporting on cashreceipts and disbursements.
Financial statements in the context offinancial management
The above sections have analyzed financial statementsof governments, and considered how financialinformation can be presented, particularly in the contextof the accounting base adopted. However, this has notaddressed the fundamental questions.• What should the published financial statements of a
government look like?
• What are the gains to an LDC from an upgrading ofits financial statements?
In answering those questions, the objectives andpurpose of financial statements have to be identified.Exhibit 52 sets out the objectives of financial reporting
according to the IASC. These divide into a retrospectiveanalysis of government financing and a performanceanalysis of the enterprise. The focus of the IASC study has been on how theconventional financial statement format of commercialentities can best be adapted to meet the needs ofgovernment financial statements. However, it must berecognized that conventional financial statements arefundamentally unsuited to attempts to measuregovernment performance. This is because governmentaccounting models are one-sided. It is therefore notfeasible for conventional financial statements to providemore than an explanation of income andexpenditure–they provide no measure of outputs.Financial management is essentially concerned withusing financial tools to achieve managerial objectivesrelating to resource allocation and management. It isdifficult to see how conventional financial statementscan make more than a marginal contribution to thisprocess. However, if they could be integrated withoutput, or performance measures, then they wouldbecome a valuable historic measure of achievement,which could be used to provide quantifiable output
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objectives, and hence improve performance.
Incorporating non-financial objectives withinfinancial statements
From the above it would seem fundamental that iffinancial statements are to be developed as significanttools in government financial management, whether ofLDCs or generally, then output and performancemeasures must be incorporated within the system. Theybecome not just optional additional statements, butfundamental components of the financial statements.The resource accounting method being adopted in theUnited Kingdom provides an approach to this issue.Under it there will be five statements.• Operating cost statement;
• Cash flow statement;
• Balance sheet;
• Main objective analysis; and
• Output and performance analysis.
This coincides with the financial statement analysis onpage 77. It adds two key documents to those consideredin the IASC paper, which meet the need for an analysisbased on relating financial performance to non-financialperformance indicators. A format of financialstatements for governments based on this approach, butadapted for LDCs, is set out on pp. 90-93.This approach turns the financial statements into avaluable feedback document within the financialmanagement process. They can be seen as linked intothe budget accounting cycle, as indicated in Exhibit 57,below. Note that this exhibit only indicates the link toother system components.
Treatment of capital assets
One of the persistent problems facing public-sectoraccounting is the treatment of capital (or fixed) assets. In the private sector, the system of depreciation isneeded to provide a measure of annual profitability forpurposes of calculating taxation and distributions.Management writers have long recognized theirrelevance of depreciation in any decision process, andtextbooks are replete with phrases such as “ignore sunkcosts and past expenditure.” Indeed, several theoreticalstudies of financial reporting in the private sector32/
have advocated moving away from depreciation, and inpractical terms this is reflected by an increasingemphasis on cash-flow reporting.It is difficult to see how capitalizing expenditure on
fixed assets contributes to better governmentmanagement, indeed quite the reverse. Managers mayfind their current activities constrained by capitalexpenditure decisions made many years before, stillcharged to their operating cost statement, yet whichshould be irrelevant in any decision process.Assets and liabilities under the GFS approach
The classification of assets and liabilities within theGFS and SNA appears very different from that used forcommercial entities, since it focuses on the distinctionbetween financial and non-financial assets. Commercialentity classification of assets and liabilities focuses ontheir nature and liquidity. Exhibit 58 compares the GFSclassification to that used for commercial entities.
Exhibit 57. Financial statements/performance analysis in financial management cycle
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Exhibit 58. Assets and liabilities BB alternative classification approaches
COMMERCIAL ENTITY CLASSIFICATION APPROACH GFS CLASSIFICATION APPROACHFixed assets Assets
Produced assets, eg. equipment, buildings $100 Non-financialNon-produced assets, eg. land $70 ProducedIntangible assets $50 Fixed assets $100
Total fixed assets $220 Inventories $60
Current assets Total produced $160
Inventories $60 Non-produced
Accounts receivables, eg. taxationreceivable
$40 Land $70
Financial assets, eg. loans, securities $80 Intangible $50
Cash and bank balance $20 Total non-produced $120
Total current assets $200 Total non-financial $280
Total assets $420 Financial
Acquired for policy $75
Acquired for liquidity management
$65
Total financial assets $140
Total assets $420
Current liabilitiesAccounts payable $30
Short-term loans and other financialliabilities
$50
Total current liabilities $80 LiabilitiesNet current assets $120 Domestic $180
Fixed assets + net current assets $340 Abroad $110
Long-term liabilities Total liabilities $290
Long-term borrowings $210 Net financial worth –$150
Net worth $130 Net worth $130
Note that both models arrive at the same net worth, butinvolve significantly different approaches to classifyingand analyzing the assets and liabilities. The commercialentity model emphasizes the purpose for which theasset is held, and the liquidity, and for liabilities focuseson liquidity. The GFS model focuses on the relevanceof the assets and liabilities to national economicmanagement.Both models provide useful information for differentpurposes. The commercial entity model can be appliedto government, and is particularly relevant for relatingassets to flows and their related costs for sub-units ofgovernment. On the other hand analysis under the GFSmodel is also essential. Therefore the classificationsystem for government needs to be able to provide
analysis under both models. The analysis above is included in outline only.Significantly more detail of the make-up of the assetsand liabilities would be required for both analyticmodels. If suitably designed a single classificationsystem could be used to aggregate and present dataaccording to either model.
Benefits of financial statementsTo introduce financial statements on the lines indicatedwould involve considerable effort in most LDCs. Thebenefits clearly relate to the form of financialstatements. The matrix below relates the benefits to thecontents.
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Exhibit 59. Benefits of financial statements
Type of financial statement Benefits Costs• Simple cash operating
statementLimited–a historic record ofexpenditure against budget for futureanalysis and basis of forecasts.However, use of detailedsupplementary statements can enhanceusefulness
Minimal–normal system outputs
• As above, but with simplebalance-sheet-basedmodified accrual basisshowing current financialassets and liabilities
Considerable–provides a mechanismfor controlling assets and liabilities,which are frequently a majoraccounting problem. Also provides a“lock” on the accounting system’sreliability
Can normally be achieved withoutmajor reorganization of theaccounting system. However, firstattempt requires considerable work toascertain opening balances
• As above, but based on fullaccrual basis includingcapitalized assets anddepreciation charges
Opinions differ on the value of theadditional information. Does provideinformation on total assets used andspreads costs more equitably.However, doubtful if depreciation orother systems of capital chargingreflect the real cost of assets consumed
Substantial. Accounting system wouldnormally have to be completelychanged. Also major task of valuingall assets
• As either (2) or (3) above,with additional statementsrelating financialperformance andnon-financial performanceindicators
Considerable–for the first time beginsto provide an output measure related tofinancial inputs in government.However, value depends on ability toset meaningful non-financialindicators, and the reliability ofmonitoring information.
Substantial–requires a redesign of thewhole planning, budgeting andmonitoring process to incorporatespecific monitorable targets.
It must be recognized that this is an area in which thereis as yet no broad consensus on the benefits of differenttypes of financial statements.
Conclusions
There are important decisions to be made by LDCs andthose involved in upgrading financial managementsystems. To what extent should efforts be focused ondeveloping financial statements, rather than other areaswhich require improvement? • All countries should at least produce an operating
cost and revenue statement, suitably presentedcompared to budget and to previous years, as ahistoric record and basis of future forecasts;
• Adding a simple balance sheet, in addition tooperating cost statements, is nearly always
· worthwhile, if only for the extra reliability itadds to the financial statements;
• For LDCs it is very doubtful indeed if the cost ofcreating a full accrual balance sheet including fixedassets is going to make it a worthwhile exercise;
• Ideally, all LDCs should aim for performancestatements comparing financial performance againstnon-financial indicators. However, this is feasibleonly after the budget has been developed so thatmonitorable performance targets are set as a matterof routine for all government activities.
Annex. Format of financialstatementsThe statements that follow are based on those in theUnited Kingdom paper33/, but modified so that they maybecome a suitable model for LDCs.
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Statement 1 – BALANCE SHEET
FIXED ASSETS (1)Tangible non-financial 3,000Intangible assets 1,500Financial capital assets 500Public enterprises 1,000Other investments and loans 500
6,500CURRENT ASSETS (2)
Stocks and inventory 300Debtors (amounts receivable within 1 year) 900Financial current assets 800Cash at bank and in hand 500
2,500CURRENT LIABILITIES (3)
Short-term financial liabilities 200Creditors (amounts payable within 1 year) 400
600NET CURRENT ASSETS (4) = (2) – (3) 1,900FIXED AND NET CURRENT ASSETS (5) = (1) + (4) 8,400BORROWINGS (6)
Domestic 2,000Foreign 3,000
5,000NET ASSETS (7) = (5) – (6) 3,400CONSOLIDATED FUND (8)
Opening balance 2,445Add: surplus from operating statement 955Closing balance (= 7 above) 3,400
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Statement 2 – OPERATING COST AND REVENUE STATEMENT
REVENUESDomestic income
Tax revenues (detail in subsidiary schedule) 1,800Fees, licences and other income (detail in subsidiary schedule) 450Miscellaneous items (detail in subsidiary schedule) 350Total domestic income (1) 2,600
Foreign incomeForeign grants 1,500Other foreign income 200Total foreign income (2) 1,700
Total income all sources (3) = (1) + (2) 4,300
EXPENDITUREPersonnel and associated salary costs 1,900Non-personnel recurrent costs 250Depreciation (or capital expenditure if on cash basis) 500Net transfers to/from public enterprises 450Grants and subsidies 245
Total expenditure (4) 3,345
DEBT SERVICE COSTSInterest paid
Domestic 200Foreign 300Total interest paid (5) 500
Interest receivedDomestic 230Foreign 270Total interest received (6) 500Net interest costs (7) = (5) – (6) –
NET REVENUE SURPLUS/DEFICIT (8) = (3) – (4) – (7) 955
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Statement 3 – CASH FLOW
CURRENT EXPENDITURENet revenue surplus/deficit (as per Statement 2) 955
CURRENT RESOURCESAdjust for movements in working capital other than cash –400Adjust for non-cash transactions: Depreciation 500
100
NET CASH FLOWS FOR CURRENT EXPENDITURE 1,055
CAPITAL EXPENDITUREAdditions –900Disposals 250
CAPITAL EXPENDITURE CASH FLOWS –650
NET CASH FLOW 405
FINANCINGNet lending flowsDomestic 600Foreign –400Loans to other public sector bodies 200
NET CASH INFLOW FROM FINANCING 400
CHANGE IN CASH AND CASH EQUIVALENTS 805
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Statement 4 – MAIN OBJECTIVE ANALYSIS
MAIN OBJECTIVE 1 (specified in narrative)Direct support to district authorities 1,200Direct support to other public bodies 805
2,005
MAIN OBJECTIVE 2 (specified in narrative)Direct support to district authorities 320Direct support to other public bodies 420
740
MAIN OBJECTIVE 3 (specified in narrative)Direct support to district authorities 120Direct support to other public bodies 230
350
MAIN OBJECTIVE 4 (specified in narrative)Direct support to district authorities 120Direct support to other public bodies 130
250
TOTAL AS PER STATEMENT 2 3,345
Statement 5 – OUTPUT AND PERFORMANCE ANALYSIS
Plan/Target Achieved
OutputCost
[currency]million
OutputCost
[currency]million
Main objective 1For example:To improve quality of A 2% improvement 35 2.5% improvement 34To draft new legislation on B 31 December 1998 15 15 January 1999 16To test C Daily 24 6 out of 7 days 25To detect and prosecute D 2,000 detections 40 2,100 detections 40
190 successfulprosecutions
18 175 successful prosecutions 18
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Independence a Independence not afundamental concept fundamental concept
VIII. INTERNAL AND EXTERNAL AUDITING
Introduction
Historically, auditing is the process of examiningfinancial transactions and activities, and related assetsand liabilities, with a view to presenting some form ofreport. Audit of commercial activities has become avery well-defined activity, and leads to an expression ofopinion on the financial statements (“certificationaudit”).
Nowadays the term is used in a variety of contexts, so itcan extend beyond financial audit to “operational”audit. In fact, the term “audit” can refer to a range ofactivities, with distinctly different objectives. Also auditsubdivides into internal and external. The possiblerange of activities and objectives is summarized below.
Exhibit 60. Audit overview
This model highlights the overlap between the activitiesof internal and external audit. In many LDCs these areconfused and work and roles duplicated. The
fundamental distinction between internal and externalaudit lies in reporting responsibility and the relevanceof the concept of independence.
Internal audit Is part of management process, and reports tosenior management
Cannot be independent since part ofmanagement
External audit Reports to the ultimate owner, ie. theshareholders of a company or the public forthe Government
Must be independent – often provided underthe constitution
Because of the importance of the concept ofindependence, it is not possible to “integrate” externalaudit within financial management. External audit is asubsystem within the financial management system, andcan be linked to other subsystems, but must remain
independent. Internal audit, on the other hand, is part ofthe management process. Hence it can be integratedwithin a financial management system.A brief description is provided below of the types ofaudit activity in the above model.
Operational auditObjective ofimprovingperformance ofany activity
Performance(VFM) auditObjective ofimprovingfinancialperformance
CertificationauditObjective ofexpressingopinion onfinancialstatements
Report to internalusers, eg. managers
Report to externalusers, eg. Parliament
INTERNAL AUDITEXTERNAL
Compliance auditObjective ofensuringcompliancewithregulations andprocedures
2Certification audit Under this activity, the auditor “certifies” the financial statements of an entity, ie. he
expresses an opinion on them. This has always been the primary role of the commercialauditor, but in government this type of opinion is a relatively recent introduction.
Compliance audit The auditor examines financial transactions to ensure that they comply with regulations,procedures and standards of propriety. This has historically been the main focus ofgovernment audit, both internal and external. In some countries the audit has becomeinextricably linked with accounting operations, and independence has been lost.
Performance, orvalue-for-money,audit
The auditor examines activities, both financial and other, to see whether they could havebeen performed more efficiently, and hence value for money improved. The object ofthis type of audit is to improve financial performance.
Operational audit An extension of performance audit, but the focus moves completely away from financialactivities and performance of the government.
The relevance of these types of audit to financialmanagement is further reviewed below.
External audit of government
Historically, the external audit of central government ofany country has been perceived as an importantfunction, carried out by a supreme audit institution(SAI), eg. the United States General Accounting Officeor the Auditor General of New Zealand. Where there isa written constitution, the role and authority of the SAIis usually specified. Such SAIs have developed quiteseparately from commercial audit and are normallystaffed by civil servants.An external audit, often referred to as a statutory audit,has been described as “the independent examination of,and expression of opinion on, the financial statementsof an enterprise, by an appointed auditor in pursuanceof that appointment and in compliance with anystatutory obligations.” The emphases have been addedto highlight their importance.Independence from others in terms of authority, controlor influence is regarded as the fundamental requirementfor an auditor. Without it, it is difficult for auditors tobe objective in their work and therefore maintain theircredibility with users of the audited financialstatements. It is axiomatic that unless the auditorexpresses an opinion (reports on his findings), thereasons for an audit are invalidated, since the results arenot available for inspection. The nature of the reportand the audit itself will depend upon the regulatoryframework governing the audit process and may varywith the type of organization. Limited-liability-company auditors, for example, are usually required toreport whether the accounts show a true and fair view,while within the public sector the statutory duty of an
auditor may be as broad as reviewing the performanceof the entity or restricted to a statement as to whether ornot expenditure has been made in accordance with theregulations. What therefore distinguishes the auditapproach in the public and private sectors is simply thestatutory basis on which the audit is conducted.For many years, government auditing was restricted toan assessment of whether the transactions compliedwith the financial rules and orders laid down bygovernment, and in many developing countries this isstill the case. In recent years, however, there have beena number of changes in government auditing whichhave imposed additional responsibilities on governmentexternal auditors. The most important of these are themoves to verification audit and the development of the“performance audit,” sometimes referred to as the“value-for-money” (VFM) audit, with its emphasis onsecuring economy, efficiency and effectiveness in anorganization’s operations. This is in line with the moremodern view which sees government accounting andbudgeting as part of an integrated system which focuseson accountability and the provision of financialinformation to management. The audit process ingovernment is becoming one of the most importantaspects of the system by providing useful informationfor planning and control purposes. This contrasts starklywith the private sector, where the audit is regarded as acertification process which does not require anycomment by the auditor on the entity’s performance–theusers of the financial statements are, in effect, left todraw their own conclusions.A comparison between government and commercialexternal audits is summarized below.
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Exhibit 61. Audit comparison
Audit area Government audit Commercial auditCertification audit Certification of accounts produced by
the governmentCertification of annual financialstatements
Compliance audit Compliance with government rules andregulations
Not normally part of the audit functionto ensure compliance with any rulesother than in respect of financialstatements
Performance audit To ensure efficiency, effectiveness andeconomy in government activities
Not part of the audit function
As indicated above, external audit in government is bydefinition independent, and hence cannot be part of thefinancial management process. However, the threetypes of external audit all serve to enhance theperformance of the financial system, and thus contributepositively to the financial management process.
Internal auditIt is the experience of the writers that in many LDCsthere is a lack of clarity about the role of internal audit.As a result it has become a duplicate of external audit,but controlled by the finance ministry rather than thesupreme audit institution.Internal audit is part of the management process, andhence it should be controlled by the managers. Ingovernment these are generally the heads ofdepartments or ministries. Any central direction tointernal audit should be in setting standards, providingtraining and creating operational documentation.Internal auditors are employees of the organization.They are responsible to management and their dutiesmay be determined by management. The internalauditing function is no longer restricted to one ofmerely checking the arithmetic accuracy of the recordsor the efficiency of the system of internal control.Internal auditing is now regarded as including a serviceelement whereby the auditor can assist the organizationthrough an examination and evaluation of its activities.The rationale underlying this thought is that the internalauditors’ access to all parts of the organization enablesthem to perform a wider role. This is not limited to thenarrow field of compliance but is concerned withpromoting efficiency in policy implementation. It istherefore important for the internal auditor to be giventhe necessary status and authority to carry out thesefunctions and for reports to be made directly to seniorgovernment officials who can act on therecommendations. It is not, however, the auditor’sresponsibility to make and implement decisions whichchange the current operations; their task is one ofreporting and recommending. The additional responsibilities placed on internal
auditors require the acquisition of new skills. No longeris internal auditing merely a matter of checking whethertransactions have been processed in the prescribedmanner. Internal auditing is a positive process whichrequires an investigative and innovative approach to theproblems of government. The opportunity now existsfor auditors to play a positive role in improving theperformance of government departments. Theperformance audit is one way in which the problem canbe tackled.
The performance auditThe theme of “value for money” is central to theperformance audit, which seeks to reduce extravaganceand waste in government departments by improvingtheir efficiency and economy in the acquisition and useof resources. Performance audits may be required understatute (external audit), or organizations mayvoluntarily institute the process (internal audit) toimprove efficiency. The object of the performance audit is to report on theextent to which the organization maximizes the servicepotential (outputs) from its resources (inputs). Inpractice it involves an analysis of the 3 Es (efficiency,effectiveness and economy) which are defined asfollows:• Εφφιχιενχψ: τηε ρατιο οφ ρεσουρχεσ χονσυµεδ
το ουτπυτ;
• Effectiveness: an assessment as to how well theoutput is achieving the desired results;
• Economy: appropriate resources at the minimumcost.
The performance audit is a valuable tool for control andperformance evaluation within government. There are,however, difficulties in its implementation because ofthe intangible nature of many government outputs. Forexample, it is not easy to give precise meanings toqualities such as health, welfare and education,particularly when the benefits may be spread over timeand may also arise in a number of different areas(externalities).
4Despite the difficulty of setting performance indicators,this is a worthwhile task. The principal methodsadopted have employed a wide range of measuresincluding indices and indicators which provideinformation for both historical (time-series analysis)and comparative (cross-sectional analysis) perspectivesof the results. The approach is not without its problemsin determining relevant measures of performance for
service industries; it requires careful thought and oftensome ingenuity in order to arrive at appropriatemeasures–but it can be done. The Nepalese DrinkingWater and Sewerage Corporation (DWSC), forexample, set the following objectives and performanceindicators:
Exhibit 62. Audit objectives and performance indicators
Objectives Performance indicatorsTo process more water Annual quantity of water produced
Number of reservoirsNumber of treatment plants
To rectify the biological andchemical quality of water
Quantity failing to comply with biological standardsQuantity failing to comply with chemical standards
To reduce unreliability ofwater supplies
Number of customers without water for 12 hours ormorePercentage of severe cut-offsPercentage of severe pressure deficiencies
5Altogether the DWSC indicated 14 objectives andproduced 39 performance indicators.
Overview of the role of auditing inthe integrated financial managementapproachThe above discussion indicates that the work of theexternal auditor is often dictated by statute. Unless thelaw includes specific provisions relating to performanceaudits, it is doubtful that external audits will providemuch useful information for the financial managementprocess, beyond an assessment of the existing financialcontrols and whether they will be appropriate in thefuture.Where, however, the auditor (either internal or external)is required to undertake a performance audit, positiveadvantages can accrue within the financial managementprocess. Planning and control are two important aspectsof financial management in government. Theperformance audit provides information which will beuseful for both of these activities.
• Γοϖερνµεντ περφορµανχε αυδιτσ αρε διρεχτεδτοωαρδσ ιµπροϖινγ εχονοµψ, εφφιχιενχψ ανδεφφεχτιϖενεσσ ωιτηιν τηε εχονοµψ. Βψ δεφινιτιοντηισ ωιλλ βε ιν τηε φυτυρε ανδ τηε αυδιτρεχοµµενδατιονσ ωιλλ τηερεφορε προϖιδε αν ινπυτιντο τηε πλαννινγ ανδ βυδγετ προχεσσεσ;
• Control is the process by which officers seek todirect their efforts towards the attainment ofgovernment’s goals. It cannot be exercised without(i) feedback as to the actual events; and (ii) a plan, ordesired state, to compare with. Performance auditsprovide this information, together with an indicationof the deviations between budgeted and actualperformance.
Conclusions
The conclusion that emerges is that, while externalaudit must remain independent, internal audit can bepart of the financial management process. Of particularrelevance in this respect is compliance audit. Byensuring compliance with prescribed regulations andprocedures, internal audit reinforces the moves tointegration of the different aspects of financialmanagement.
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IX. IMPACT OF INFORMATION TECHNOLOGY
IntroductionInformation technology–computerization–is a tool offinancial management. In itself it does not add anythingto the procedures and approaches described above, butrather it is a mechanism for recording, processing andpresenting the information.However, although the above statement is accurate, it isin many ways too narrow a view of the impact of thenew changes in information technology. This is becausedevelopments in information technology:• Χηανγε dramatically the cost/benefit balance of
providing information and analysis, so that for LDCsit has now become economically feasible to havemodern high-quality financial management systems;
• Create for the first time the ability to establishsystems in environments where the surroundingorganizational and human infrastructure is weak; and
• Προϖιδε Λ∆Χσ ωιτη τηε οππορτυνιτy to make a“technology leap”–moving directly from manual orsimple mechanical systems to the most moderninformation technology, making use of low-costhigh-performance computers and user-friendlysoftware.
Each of these aspects is reviewed below, beforeproceeding to a more technical review of applyinginformation technology to financial management inLDCs. The section then reviews issues relating to thesuitability of computers for LDCs, and the problems ofsustainability. Changes in the cost-benefit balance
Accounting and financial management systems requirethe use of scarce resources, and are therefore expensiveto establish and maintain, despite the low labour costsin most LDCs, because:• Λαβουρ χοστσ αρε νοτ λοω ιν ρελατιον το τηε
λιµιτεδ βυδγετσ οφ Λ∆Χστο σετ υπ µανυαλφινανχιαλ µαναγεµεντ σψστεµσ ρεθυιρεσ τηευσε οφ µανψ περσονσ, ωιτη α ρεαλ βυδγετιµπαχτ ωηιχη ισ διφφιχυλτ φορ µοστ Λ∆Χσ τοφινανχε;
• Τηε σορτ οφ λαβουρ ρεθυιρεδ ισ ιν σηορτσυππλψπροφεσσιοναλ αχχουνταντσ ανδεχονοµιστσ αρε νοτ νορµαλλψ αϖαιλαβλε ον
γοϖερνµεντ σαλαριεσ, ανδ ηαϖε το βε ηιρεδ ονσπεχιαλ τερµσ, πυττινγ εϖεν φυρτηερ πρεσσυρεον χοστσ; ανδ
• Ηιστοριχαλλψ, χοµπυτερ σψστεµσ ηαϖε βεεναν εξπενσιϖε οπτιοντηε ηαρδωαρε ηασ βεενχοστλψ το βυψ ανδ µαινταιν ανδ ηασ ρεθυιρεδσπεχιαλ πηψσιχαλ φαχιλιτιεσ; αλσο, σχαρχεανδ ηιγηλψ παιδ σταφφ are needed to develop andimplement software.
However, modern information technology is much lessexpensive to acquire and maintain, does not requirespecial buildings and can use packaged software withmuch reduced human resource costs. In fact, it placeswithin reach of LDCs financial management systemswhich can integrate the various components at a costwhich is normally feasible.When talking about cost savings, it has to be recognizedthat in many LDCs actually reducing the number ofgovernment staff is not a politically feasible option.However, the fact that numbers are not increased,coupled with the opportunities to reassign staff, doesserve to limit or reduce the real costs of new systems.Computers as a means of overcoming humanresource and institutional limitations
One of the consistent problems facing the developmentof financial management systems has been inadequatehuman resources, together with institutional structureswhich make it difficult to recruit or retain appropriatelytrained staff. Until now computers have been seen asexacerbating this problem, in that they create demandfor yet more skilled personnel, and in technical gradeswhich do not fit well into the structure of mostgovernment services.However, it is increasingly possible to see informationtechnology as at least a partial solution to many of theproblems. Indeed modern systems (i) reduce the numberof persons required to operate a system, and (ii) “de-skill” many of the tasks. The first comment has alreadybeen dealt with above, on cost implications. However,the comment on de-skilling is important. Moderncomputer systems, once designed, can be operated bystaff with only limited accounting and data entrytraining. They do not create the demand for a largebody of trained accountants that would be required tooperate a comparable upgraded manual system. In fact,this change has significant implications for training,dealt with below. What are likely to be required are:
8• Α ϖερψ σµαλλ γρουπ οφ σκιλλεδ φινανχε ανδ
ινφορµατιον τεχηνολογψ εξπερτσ, το µαινταινανδ δεϖελοπ τηε σψστεµσ ανδ προχεδυρεσ, ανδτο συππορτ συβσιδιαρψ υνιτσ;
• Α ρατηερ λαργερ γρουπ οφ αχχουνταντστραινεδ το οπερατε ιν αν ινφορµατιοντεχηνολογψ ενϖιρονµεντ, χαπαβλε οφ µαναγινγδατα φλοωσ ανδ ηανδλινγ θυεριεσ; ανδ
• Α συβσταντιαλ νυµβερ οφ ινπυτ χλερκσ, ωιτηλιµιτεδ πραχτιχαλ τραινινγ ιν δαψ−το−δαψοπερατιον ανδ δατα ινπυτ.
The training for groups (2) and (3) above is likely to betask-specific. There is no need to train a large body ofprofessional or technical accountants to operate thesystem. Instead small and specialized trainingprogrammes can be developed. This does make many ofthe programmes of upgrading accounting and financeskills seem less important.However, these changes may well make it even moredifficult to operate information technology systems in atypical LDC government institutional structure. Mostgovernments have organizational structures based onthe colonial power which controlled them or, if theywere never colonies, on the nearest available model.These public-service structures typically recruitgovernment staff into lifetime careers, in which theyexpect to move gradually up the promotion ladder. Inmany countries, the main objective of public servants isto avoid adverse criticism, and to make a number ofsideways transfers to add experience. There is noconcept of developing technical skills, because publicservants are seen as administrators. As it was put to usin one LDC, “We did not join the government tooperate computers.” In many LDCs the system isfurther distorted by the need to obtain governmentpositions which have power, since this power leads to arange of benefits, eg. “In Bangladesh, power and wealthare interchangeable commodities.”Finally, many systems are based on a concept of regularstaff transfers. This is particularly true in South Asia,where those public servants who are recruited throughthe entry examinations (fast-track recruits) expect to betransferred at very regular intervals throughout theircareer. This means that if staff are trained in specialskills, they will be transferred, often within a year, andoften to some totally unrelated task. It is extraordinarilydifficult to change this system, which is deep within theorganizational culture.This organizational background is not conducive todeveloping a core group of highly skilled professionals.If government officers, they are very likely to betransferred within a few years to other sectors of
government. If hired on a contract basis (and mostLDCs are very reluctant to enter into such contracts),they tend to move onto other assignments once thedevelopment phase is completed–after all, there is nopromotion path for them. This is a problem all LDCsare going to have to face in the future; it is furtheraddressed below.The technology leap
Finally, there is the concept of LDCs making atechnology leap. This is best understood by examiningthe history of government financial management-relatedinformation technology systems in LDCs.Information technology systems have had a somewhatchequered history in LDCs over the last 20 years. Manyof the initial systems used technology which wasbecoming outdated even as it was being put in place.Early excursions with mainframes were expensive, andthose that were introduced were often not the “latest”model from the manufacturer. The introduction of these“big” systems also had other consequences in that itcreated a “remote computer centre” which suppliedaccounting information on a time-sharing basis alongwith census, statistics and other information. Theselarge systems typically have (for they still exist) anumber of problems.• ∆ατα ισ υσυαλλψ ινπυτ ιν βατχηεσ, ιε.
δοχυµεντσ αρε γατηερεδ τογετηερ φροµαχχουντινγ οφφιχεσ ιντο α σινγλε βυνδλε, ορβατχη, ωηιχη ισ τηεν σεντ το τηε χοµπυτερχεντρε φορ προχεσσινγ. Τηισ χρεατεσ α σενσεοφ ρεµοτενεσσ οφ τηε χοµπυτερ χεντρε φροµ τηεπεοπλε ωηο ρεθυιρε τηε αχχουντινγινφορµατιον;
• Ουτπυτ ισ υσυαλλψ χονσιδεραβλε ϖολυµεσ οφπριντουτσ ον χοµπυτερ παπερ, οφτεν ωιτη ονλψλιµιτεδ ναρρατιϖε δεσχριπτιον αγαινστ α µασσοφ νυµβερσ. Συχη ουτπυτ µαψ χονταιν µυχηδατα, βυτ ιτ ισ ινεφφεχτιϖε ασ α χοµµυνιχατιοντοολ;
• Ινπυτ ανδ ουτπυτ αρε νορµαλλψ εντιρελψ ινΕνγλιση, ρατηερ τηαν νατιοναλ λανγυαγεσ;
• Ινφορµατιον φλοωσ το ανδ φροµ τηε computercentre in such a system are usually very slow, andnot focused on individual users’ needs. The computeroperation tends to have a life of its own, with thecomputer “experts” making all the decisions. Usersof the system feel disenfranchised, unable toinfluence decisions because they are faced withtechnical jargon and concepts they do notunderstand.
9Systems, as described above, do have uses for large-volume accounting procedures, such as payroll, but asan aid to general financial management they are not ofany great significance. A further problem is that suchlarge systems need to be upgraded regularly and thephysical environment sustained. While the original set-up may have been aid-funded, the ongoing support isusually left to the government. As a result, the cost ofcomputer and physical maintenance is often notadequately funded and systems have failed to beupgraded and developed, leading to a progressivedegradation in their effectiveness and reliability.More recently, developing countries have had newopportunities because of improved and cheapertechnology. The advent of the high-powered personalcomputer (PC) with its increased capacity and variety ofsoftware has led to a move away from large, sharedcomputers. PCs have significant advantages for LDCs.• Λοω χαπιταλ ανδ οπερατινγ χοστσ;
• Μορε ενϖιρονµενταλλψ τολερανταιρ−χονδιτιονινγ ισ νοτ νορµαλλψ ρεθυιρεδ (τηουγηηιγη ηυµιδιτψ ανδ δυστ χαν στιλλ γιϖεπροβλεµσ);
• Αϖαιλαβιλιτψ οφ εασιλψ υνδερστοοδ σοφτωαρεωηιχη χαν βε υσεδ βψ περσονσ ωιτηουττεχηνιχαλ βαχκγρουνδσ;
• Ουτπυτ ωηιχη ισ µυχη easier to use and read.
There is no doubt that PCs have done much to makecomputing available to a variety of users in LDCs.However, for financial applications the very ease of useof PCs has to some extent proved a problem.• Συβσψστεµσ ηαϖε βεεν δεϖελοπεδ
ινδεπενδεντλψ οφ οτηερ σψστεµσ, ωιτηουτ ανψαττεµπτ ατ ιντεγρατιον, υσινγ λοχαλλψ ωριττενσοφτωαρε ωηιχη φοχυσεσ ον τηε σπεχιφιχ νεεδοφ ονε εντιτψ ωιτηουτ δυε χογνιζανχε οφ τηεπλαχε τηε σψστεµ µιγητ ηαϖε ιν αν οϖεραλλφινανχιαλ σψστεµ στρατεγψ;
• Μανψ οφ τηεσε σψστεµσ ηαϖε βεεν δεϖελοπεδαδ ηοχ ανδ δοχυµεντατιον ον ινφορµατιονφλοωσ το τηε σψστεµ, σψστεµσ δεσιγν, ανδπρογραµµε χοδε ισ νοτ αϖαιλαβλε, ασπρογραµµινγ ισ γιϖεν γρεατερ εµπηασισ τηανσψστεµσ αναλψσισ ανδ δεσιγν. Τηισ λεαδσ τοονγοινγ µαιντενανχε ανδ σψστεµσ δεϖελοπµεντπροβλεµσ;
• Ολδερ ϖερσιονσ οφ ∆ΟΣ−βασεδ αππλιχατιονσπρεδοµινατε ασ τηε δεϖελοπµεντ τοολ. Τηερεασονσ φορ τηισ αρε µανψ, βυτ τηε µαϕορ
φαχτορ ισ τηατ ιν µανψ Λ∆Χσ τηε σοφτωαρε ινυσε ιν τηε πριϖατε σεχτορ ισ οφτεν ολδερ,υνρεγιστερεδ ϖερσιονσ οφ σοφτωαρε προδυχτσ.Μυχη οφ τηε πριϖατε−σεχτορ αχχουντανχψσοφτωαρε ιν Λ∆Χσ ισ τηεν δεϖελοπεδ ωιτη ολδπαχκαγεσ, ανδ τηισ σκιλλ ισ τηεν υτιλιζεδ φοργοϖερνµεντ αχχουντινγ δεϖελοπµεντσ;
• Σψστεµσ ηαϖε βεεν ωριττεν ωιτηουτ αδεθυατεχονσιδερατιον φορ δατα ιντεγριτψ ανδσεχυριτψ, φεατυρεσ τηατ ωουλδ βε βυιλτ ιντοµοστ αχχουντινγ σοφτωαρε παχκαγεσ. Ιν φαχττηερε ισ ϖερψ λιττλε υσε οφ παχκαγεδαχχουντινγ σοφτωαρε, βεχαυσε τηε λοω χοστσοφ προγραµµινγ υσυαλλψ µακε ιτ χηεαπερ ανδεασιερ το ωριτε ταιλορεδ σοφτωαρε ωηιχησιµπλψ χοµπυτεριζε εξιστινγ προχedures andforms.
Some of these PC systems have been networked, andsometimes they perform accounting or other financialmanagement functions. Many, however, are usedprimarily for data analysis and/or word processing.The result is that many LDCs have a mixture ofsystems. Most basic data entry and recording is stilldone on manual handwritten systems, and indeed inmany cases accounting is still mainly done manually.There may be a mainframe system dealing with payrollor central accounting. There will almost certainly bePC-based systems for budget and other specific tasks.These systems are not likely to be linked, and it maywell be that data formats are incompatible, with databeing re-keyed for transfer between systems.The opportunity for a transformation in dataprocessing
There is now the opportunity for a paradigm shift in theapproach to data processing for financial managementsystems. Certain parameters can be set for this change.• Ιτ µυστ βε αχχεπτεδ τηατ µυχη οριγιναλ δατα
εντρψ, ανδ µανψ σµαλλ γοϖερνµεντ οφφιχεσανδ διστριχτ τρεασυριεσ, ωιλλ ρεµαιν ωιτηµανυαλ σψστεµσ φορ τηε φορεσεεαβλε φυτυρε;
• Ηοωεϖερ, φορ µοστ Λ∆Χσ, δατα προχεσσινγ ινχαπιταλ χιτιεσ ανδ οτηερ υρβαν χεντρεσ, χανµοϖε το ΠΧ−βασεδ σψστεµσ φορ ινιτιαλ δαταεντρψ. Σοφτωαρε χαν βε ειτηερ παχκαγεδ ορδεϖελοπεδ ιν ηιγη−λεϖελ λανγυαγεσ, ανδουτπυτ χαν βε ιν τηε νατιοναλ λανγυαγε;
• Χεντραλλψ, σεπαρατε σψστεµσ χαν βε σετ υπτο ηανδλε φυνχτιονσ ρελατινγ το αχχουντινγ,πλαννινγ ανδ βυδγετινγ. Τηεσε χαν βε σχαλεδ
10ασ αππροπριατε φορ τηε ϖολυµε οφτρανσαχτιονσ, σψστεµσ χοµπλεξιτψ ανδρεθυιρεδ υσερ αχχεσσ, βυτ αλλ χαν εξχηανγεδατα ωιτη εαχη οτηερ ιν µαχηινε−ρεαδαβλεφορµατ;
• Ιν αδδιτιον, δατα φροµ τηε σµαλλερ υρβανχεντρεσ ιδεντιφιεδ ιν (2) αβοϖε χαν αλσο βετρανσφερρεδ ιν µαχηινε-readable format, eitherover telephone lines using modems, or by physicallysending disks between the centres.
The key to this is the availability of software which cancommunicate with other systems, the ability to scalesystems as appropriate without introducing dataincompatibilities, and the existence of a range ofoptions for the scale of systems. This is the technologywhich high-income industrialized countries are movingtowards, but they are hampered by heavy investment inextensive and expensive mainframe systems which stillwork, even if better options are available. Most LDCslack the baggage of such hangovers, and hence canmake the “technology leap” to the latest software.This is not a “window of opportunity” which will goaway; rather, it will expand as hardware and softwareimprove in capability and ease of use. It is importantthat LDCs make correct decisions today, so that theyare not burdened with inappropriate or incompatiblesystems for later development.Are computers appropriate tools in LDCs?
A question that must be faced is whether computers areappropriate tools in LDCs. There are a number ofarguments against the use of computers.• Τηεψ ρεπρεσεντ σοπηιστιχατεδ λαβουρ−σαϖινγ
τεχηνολογψ, ωηεν τηε µαϕορ νεεδ ισ φορ σιµπλελαβουρ−ιντενσιϖε τεχηνολογψ;
• Τηε ηιστορψ οφ φαιλεδ σψστεµσ λεαδσ το τηεϖιεω τηατ ρεσουρχεσ αρε βεινγ πυτ ιντοχοµπυτεριζατιον ωιτη λιµιτεδ βενεφιτσ, ωηεντηε σαµε ρεσουρχεσ χουλδ µακε α ρεαλ ανδδιρεχτ ιµπαχτ ον ποϖερτψ αλλεϖιατιον;
• Τηεψ ενχουραγε τηε παττερν οφ αιδ γοινγ ιντοχεντραλιζεδ βυρεαυχραχιεσ, ρατηερ τηαν βεινγδιστριβυτεδ γεογραπηιχαλλψ;
• Βεχαυσε οφ τηε ηιγη τεχηνολογψ, τηεψ χρεατεδεπενδενχε ον φορειγν ηαρδωαρε ανδ σοφτωαρε
συππλιερσ ανδ foreign consultants.
There is no doubt that there is validity in all of thesecriticisms. They were even more true of largemainframe systems than of PC-based systems, but stillretain a significant element of truth.The major countervailing argument for computers isthat they provide benefits which are cost-effective, orare simply not available by other means. For example,Nepal typically uses less than 40 per cent of pipelineofficial development assistance. If expenditure oncomputerization could unlock even one tenth of thebalance of unused aid, the level of investment would beeasily justified, and this would refute the criticisms.On the other hand, there is a responsibility on anyoneinvolved in the development process to be aware thatthey are using scarce resources, and computerization forits own sake can never be justified. There must be aclear benefit from the systems which outweighs thecosts, and alternatives considered should always includeimprovements to manual systems.Effects of changes in information technology
The Agency for International Development, in itsstrategy to improve accountability, financialmanagement and audit in Latin America and theCaribbean (called STRATAC),34/ indicates that the corecomponents or subsystems of an integrated systeminclude budget, treasury, debt and accounting. Theintegrated financial system in technological terms canbe summarized as being between two extremes, that ofa database shared by all and a set of autonomoussystems with little or no transfer of data. Theconstituent parts of an integrated system are:• Χοϖεραγετηε σχοπε οφ φινανχιαλ δατα ωηιχη
τηε σψστεµ ενχοµπασσεσ;
• Databases–the number and interrelationship andcommonality of data tables and platforms;
• Principles–the refinement and practice ofaccountancy standards throughout the different levelsof government; and
• Level of automation–the ability and ease to transferand share data.
In diagrammatic form, the centre of the diagram belowis the “target,” as illustrated in Exhibit 63.
11
Exhibit 63. Approaches to information technology
In addition, integration may encompass externalintegration in the form of how information is transferredto other agencies such as banks, suppliers etc.Control of resources is ensured through the internalcontrol, internal audit and external audit functions.Competent and responsible financial management isbased on the integration of all these elements and theirsystemic operation, hence Integrated FinancialManagement System (IFMS). The specific meaningattached to integration, within the STRATAC initiative,has been further explained by Wesberry.35/ It includes:• Νατιοναλ−λεϖελ φινανχιαλ ρεγυλατιονσ,
ρυλεσ ανδ γυιδελινεσ ετχ.: α χοµµον λανγυαγε;
• Budgeting and accounting systems at the nationallevel: a common classification;
• Agency-produced financial data, with centrallyproduced financial data: a single base of financialdata;
• The phases of the management cycle: a uniform flowof management information;
• Flow of data throughout the agencies and thegovernment: clear interlinkage of data flow,accumulation and reporting;
• Basic subsystems of financial management withineach agency: budgeting, cash and debt managementand accounting;
• The basic subsystems at the national level; and
• The methods of processing financial information.
Integration is not a single-dimension concept. From theabove it can be seen that it has several aspects, each ofwhich is a continuum. For instance, a shared databasefor accounting, financial management and certain non-
D i f f e r e n t p r i n c i p l e s a t d i f f e r e n t l e v e l s o fg o v e r n m e n t , c e n t r a l s t a t e m e n t sp o s s i b l e b u t p o o r v e r t i c a l i n t e g r a t i o nD i f f e r e n t l e v e l s o f g o v e r n m e n t d o n o tsha re same f inanc ia l managemen ts t a n d a r d s
A l l t r a n s f e r smanua l
12financial functions is at one end of the spectrum ofintegration. At the other, there are completely stand-alone systems without data corruption, loss etc. Mostsystems are likely to be located between these extremes.Five criteria are suggested for judging the degree ofintegration of a financial management system, eachrepresenting a continuum of possibilities: (i) the degreeof coverage of financial management processes; (ii) thedegree of integration of databases; (iii) the degree ofvertical and horizontal integration of the underlyingsystems; (iv) the degree of automaticity in data transfer;and (v) the degree of external integration. Applyingthese criteria would probably reveal very few cases ofhighly integrated government financial managementsystems.
13Exhibit 64. Degree of integration
Degree ofintegration
Description DatabasesDegree of vertical
and horizontalintegration
Degree ofautomaticity
in data transfer
Degree of externalintegration
Highly integrated Covers accounting,financial managementand related non-financial processessuch as procurement,performancemeasurement, etc.
All information on asingle data base
Uniform financialmanagementprinciples are at alllevels of government.Entities at the sameorganizational leveland also those invertical relationshipwith each other haveuniform financial andaccounting rules.Consequently,meaningful financialstatements for eachlevel of governmentand for government asa whole can besupplied with ease
System managers,system users and dataentry personnel,wherever they areworking, have accessto the same databasevia networks
Data from the systemis transferred inmachine-readableform to the automatedsystems of otheragencies such asbanks, suppliers,employees, etc., withwhich governmenthas major financialrelationships
Integrated Covers core financialmanagementprocesses such asbudgeting, accountingand debtmanagement.
Several data baseswith the facility viainterfaces anddownloading totransfer most dataautomaticallybetween systems.
Similar financialmanagementprinciples apply to alllevels of government.There is a high degreeof horizontaluniformity eg. alllocal governments usethe same accountingand financialmanagementprinciples. To produceconsolidated financialstatements for thegovernment sector
Some of theparticipants havedirect access to thedatabase vianetworks, but othersdo not. The databasesof the latter areupdated from time totime in a variety ofways: problemsencountered in thetransfer of data arenot significant.
Some such transfers.
14
Degree ofintegration
Description DatabasesDegree of vertical
and horizontalintegration
Degree ofautomaticity
in data transfer
Degree of externalintegration
and for its majorhorizontal divisions ispossible, but requiresadjustments to bemade to put data ontoa common basis
Partially integrated Covers all majoraccountingcomponents
Several databaseswith some automatictransfer of data andsome stand-alonesystems. In a partiallyintegrated system,significant amounts ofdata may have to beentered manually orre-entered for transferinto related systems
Financialmanagementprinciples differ forthe different levels ofgovernment.Consolidated financialstatements can besupplied for centralgovernment.However, there areelements of diversityand this prevents theproduction of fullyarticulatedconsolidatedstatements bothhorizontally andvertically
Less use of networks;more use of otherdata-transfer methods;more problemsresulting from datatransfer; less access tousers
Some such transfers
Unintegrated Minimal necessarylinkages are present,eg. between budgetand accountingclassifications.
All transfers of databetween systems aremanual.
The different levels ofgovernment do notshare the samefinancial managementand accountingprinciples.Consolidatedaccounts forgovernment as awhole and its parts
No use of networksfor the transfer ofdata. Other transfermethods areinadequate and greatdifficulty isexperienced inupdating records:significant categoriesof information users
No automatedtransfers of data.
15
Degree ofintegration
Description DatabasesDegree of vertical
and horizontalintegration
Degree ofautomaticity
in data transfer
Degree of externalintegration
can only be producedwith difficulty andeven then lackmeaning because oflack of standardizeddefinitions.
do not have directaccess to informationsystems.
16Difficulties encountered in establishingintegrated systems
Despite such advantages, the degree of actualintegration has generally been quite limited. Forinstance, government accounting systems aretraditionally made up of several subsystems such as ageneral ledger, a budgetary control system, anaccounting system, a tax collection system, a payroll, asystem for managing foreign debt and other assistanceand so on. Some of these subsystems are integratedwith the accounting system, and others remain more orless free-standing, for example:
“Today, to put it simply, the federal booksare a mess. Any business with separateuncoordinated systems for budgeting,accounting and product sales would soonbe bankrupt. But the federal governmenthas such systems.” 36/
Thus the National Performance Review summarized thesituation facing the United States Government. Thesame point was made less emotionally in a 1988publication of the Joint Financial ManagementImprovement Programme:
“There are presently several hundredfinancial management systems inoperation in the Federal Government. Ingeneral, each department and agency hasindependently designed and implementedits own financial management systems.Further, over the years, many uniquebureau and division systems have beendeveloped and for the most part thesesystems have not been integrated withdepartment or agency level systems. Theresult is that federal government systemsare fragmented and antiquated.Successful reform of these systemsrequires that an integrated approach betaken....” 37/
If this is the situation in one of the wealthiest and mosttechnologically advanced countries, there must be goodreasons for it. Why are integrated financial managementsystems not the norm in government? What are thefactors explaining the current lack of integration?Consider these in the context of the United States.First, the pace of financial management improvement isgradual. Because of the high costs and risks of change,few governments have attempted a completereplacement of existing systems. Thus few have been in
a position to achieve the degree of system integrationwhich information technology now permits. Most areengaged in the gradual overhaul and modernization ofsystems introduced at various times in the past. Thusthey focus on improving the effectiveness of existingsystems and building interfaces between them. Thisincreases the integration of systems, but often theremaining scope for further integration is substantial.Secondly, until recently the technology to supportcheap, adaptable and user-friendly integrated financialmanagement systems did not exist.Thirdly, the traditional focus of government accountinghas been budgetary control. Accounting systemsdesigned predominantly for this purpose are usuallybased on cash and commitment data. This is not a goodbasis for integrated financial management. The lack ofasset accounting in such systems necessarily results inthe establishment of separate add-on systems forparticular purposes such as debt, cash and fixed assetmanagement.Fourth, organizational factors often result in separateinformation systems for different agencies and even fordifferent branches of the same agency. For instance, inthe United States the tendency is for each agency tohave its own hardware and software for accountingpurposes. As a result, vertical integration presentsconsiderable difficulties. Generally agencies producemonthly cash statements according to Office ofManagement and Budget information requirements, andthese are then consolidated by a database system.Fifth, the apparently high costs and vulnerability ofintegrated systems may have resulted in a relativelyslow move to highly integrated systems.
Scope for more integrated systems
In LDCs as elsewhere, integration of financialmanagement systems is likely to reduce their costs andincrease their usefulness. Given the specialcircumstances in which LDCs find themselves, thelikelihood of installing modern integrated systemsdepends significantly on the availability of externalassistance. Assuming that such assistance is availablethere remain a number of important constraints.• Τηε βαλανχε οφ ωηατ ισ δεσιραβλε αγαινστ
ωηατ ισ φεασιβλεσιµπλε σψστεµσ ωηιχη χανβε συσταινεδ αρε αλωαψσ πρεφεραβλε τοχοµπλεξ σψστεµσ ωηιχη ωιλλ χολλαπσε ονχεεξτερναλ συππορτ ισ ρεµοϖεδ, βυτ συχη σιµπλεσψστεµσ µαψ βε λεσσ τηαν ιδεαλ.;
• Initial estimates of costs and of dates ofcommencement of operation of new systems arelikely to be exceeded, probably significantly if thenew systems are radically different from prior ones;
17• The need for staff training;
• The costs of maintenance and technical support oncethe system is installed;
• The need to involve government officers at all stagesthrough the system design and implementation, evenif this slows the process;
• The problem of creating dependence on foreignsuppliers and/or expatriate staff;
• The effectiveness of the new system will bedetermined to a large extent by factors external to thesystem: accurate, timely and comprehensive input ofdata; efficient maintenance of databases; systemsmanagement; and ability to use the informationprovided;
• Factors external to a computer system, eg. the degreeto which financial procedures and accountingclassifications have been standardized, etc.
Assuming that the conditions necessary to install anintegrated system are not present, what policies should governments pursue? Clearly, in many countries a greatdeal can be done both to increase linkages betweensystems and to create conditions favourable to eventualintegration, including:• ∆εχιδινγ ον α στρατεγψ σο τηατ ινχρεµενταλ
µοϖεσ χαν βε µαδε τοωαρδσ φυτυρειντεγρατιον, εγ. στανδαρδιζινγ σοφτωαρε ανδηαρδωαρε φορ χονσιστενχψ ωιτη φυτυρειντεγρατιον πλανσ;
• Creating electronic data transfer linkages wherepossible, eg. for the consolidation of financial data;
• Establishing common procedures, classifications andcoding schemes for all processes which willeventually be integrated;
• Increasing the accuracy, timeliness etc. of record-keeping and reporting; and
• Promoting and maintaining a financial cadre with theskills necessary for efficient business operations.
Outline of data flows in an integrated system
The data flows in an integrated model may followseveral different patterns. Discussion has already takenplace on basic accounting flows from the field to thecentre, and also on distributed versus centralizedsystems. The model below indicates in outline how datamight flow in an integrated system.
Key:bi-directional data flowuni-directional data flow
Projects,departments,
Field officesand projects
Districtaccounting
Lineministries
Coreaccounting
Budget system
Planningsystem
Monitoringsystem
Exhibit 65. Data flows in an integrated system
18There is no one model of the direction of data flowsbetween field offices, line ministries, projects ordepartments, and the core accounting system. Theimportant objective is that at the end of the day allshould have access to common, reconciled information.The main implication of this analysis of integration isthat full integration is a goal which cannot beconsidered in isolation. The technology needs to beconsidered in the wider context of the informationneeds of the government, and the whole financialmanagement system. Rather than focus on just thehardware and software, the whole information processrequirements need to be examined, with the technologyfollowing definition of requirements.
Constraints
Many of the constraints have already been mentioned inthe preceding paragraphs, but in summary they are:• ∆ιφφιχυλτιεσ ωιτη τηε πηψσιχαλ
ινφραστρυχτυρε;
• Lack of sufficiently skilled human resources in bothgovernment and the private sector;
• A history of computer systems failing to meetexpectation;
• Difficulty in sustaining system operations after initialfunding support;
• Emphasis on local bespoke programming; and
• Reluctance of vendors to enter the market forpackage solutions and appoint local representatives.
It is clear therefore that, in LDCs, systems developmentcannot be isolated from other issues. While this mayalso be true in more developed countries, facts such asthe domination of the supplier market by one firm, andgovernment contracts for systems developed by thatfirm–as the only one with local support–may exacerbatethe problem.
Practical issues
Distributed compared with centralizedsystems
The model in Exhibit 2, an integrated financialmanagement system, should not be taken to imply thatthere would be one single centralized database. In fact,the trend, reinforced by both operational need andtechnology is to move to distributed systems. This tendsto be more economical, and also focuses managementresponsibility and control over information at the samepoint.Under a distributed system, integration might beachieved by several different data bases, holding
different information, but able to exchange data witheach other as required. Such databases might be locatedin the planning body, Ministry of Finance, AccountantGeneral’s Office and line ministries. Ideally the systemwould be totally transparent to a user, in that the userwould be unaware of using information from differentdatabases when making enquiries or preparing reports.However, in LDCs there may be a countervailingpressure for more centralized systems. The reasons are:• Τηε σηορταγε οφ χοµπυτερ σκιλλσ, ανδ τηε νεεδ
το δεϖελοπ σψστεµσ ωηιχη χαν βε εασιλψµαναγεδ, µαψ µακε ιτ µορε αττραχτιϖε τοχεντραλιζε σψστεµσ;
• The relatively small scale of financial activities inmany LDCs takes away much of the case fordistributed systems;
• Poor telephone connections may make distributedsystems infeasible; and
• The need to link with manual systems, and activitieswhich move between manual and computer-basedsystems, may be easier to handle with a centralizedsystem.
Therefore, although the general presumption will be infavour of distributed systems, in the case of LDCs theremay be good reasons to favour systems that are at leastpartly centralized.The problems of applying packaged solutionsin public-sector financial management
Although the discussions above have emphasized thewidespread availability of packaged software solutions,in fact their application to public-sector financialmanagement in LDCs presents a number of problems.These relate to the design objectives of the software, theproblems of adaptation and local support. They areaddressed below, first in general terms, then in relationto specific components of financial management.Packaged software tends to fall into three maincategories:• Γενεραλ−πυρποσε σοφτωαρε, οφ ωηιχη τηε
µαϕορ εξαµπλεσ αρε ωορδ−προχεσσινγ,σπρεαδσηεετ, δαταβασε (ινχλυδινγ ρελατιοναλδαταβασεσ), ανδ γραπηιχ παχκαγεσ. Τηισ ιστηε µασσ µαρκετ, ωηιχη ηασ βεχοµεινχρεασινγλψ δοµινατεδ βψ α φεω βιγπλαψερσ, εγ. Μιχροσοφτ, Λοτυσ−ΙΒΜ, Οραχλε;
• Specialized software, eg. accounting software, designsoftware, etc.–a market where there are manyrelatively small software suppliers;
• Applications for resale developed using general-
19purpose software–usually relational databases–asdevelopment tools. Sometimes this is supported bythe supplier of the general-purpose software, eg.Oracle Financial Systems, in other cases it is aspecialized software supplier.
Ideally all systems should be fully “scalable,” ie. theyshould be able to operate equally well on a stand-alonePC, a large client-server or even a mainframe system. Inpractice this ideal is rarely achieved, and most softwareis either PC or large system-oriented. This tends to beeven more so for specialized software, eg. accounting.All of the requirements for a financial managementsystem are for specialized software. These will includeaccounting systems, budget and planning systems andmonitoring tools. However, the reality is that thedemand for public financial management systems issmall in relation to the demand for commercial systems.Furthermore, because most industrialized countrieshave earlier computerized public finance activities onmainframes, the remaining market for down-sizedsystems is even more restricted.The result of this is that government financialmanagement systems generally have to rely on either (i)their own custom-written software or (ii) adaptations ofsoftware written for commercial organizations. Thepreference is always for adapting packaged software,but the practicalities of this need to be considered in thecontext of the information needs of LDCs.A further problem is that there is unlikely to be localsupport for more than a small range of packagedsoftware. For example, in most LDCs there is no localsupport for large accounting packages. This is becauseof the small scale of the local market, the high costs ofoperating therein and the widespread problem ofsoftware piracy. These general problems are considered below in thecontext of three common financial managementapplications: (i) accounting, (ii) budget and (iii) payroll.Accounting packages
Accounting packages provide an apparently easysolution to the budget and financial management needsof government financial management. Certainly in anyconsideration of options, the use of packagedaccounting software needs to be very seriouslyconsidered. However, there are likely to be a number ofarguments which will need to be evaluated.• Αχχουντινγ παχκαγεσ ωιλλ νορµαλλψ βε
δεσιγνεδ φορ χοµµερχιαλ αππλιχατιονσ. Ασαλρεαδψ ιδεντιφιεδ, τηερε αρε α νυµβερ οφδιφφερενχεσ βετωεεν τηεσε ανδ γοϖερνµεντφινανχιαλ µαναγεµεντ νεεδσ;
• Τηε σψστεµσ ωιλλ βε ωριττεν φορ α φυλλ
αχχρυαλ σψστεµ, βασεδ ον α νοµιναλ λεδγερ,ωηερεασ µοστ γοϖερνµεντσ αρε υσινγ τηε χασηβασισ, χεντρεδ αρουνδ τηε χαση βοοκ;
• There is no concept of commitment accounting incommercial accounting, yet this is very important ingovernment;
• Similarly, commercial accounting packages are notdesigned to track expenditure through the variousstages from medium-term financial planning, budgetsand amendments, and fund release beforecommitment stages are even reached;
• There will be no provision for incorporating non-financial performance indicators, or for producingthe style of reports required for the public sector;
• The extent of data analysis required by the publicsector is much greater, often requiring longer codingstructures than the package provides capability tohandle;
• The systems are not designed to handle partiallymanual systems, where data may arrive as originaltransactions, summarized manually or on a PC;
• Commercial entities monitor against monthlybudgets, whereas governments monitor againstcumulative annual budgets;
• In many LDCs, there is no local support for thelarger accounting packages.
This does not make it impossible to use packagedcommercial accounting software. A number of softwarehouses are willing to work with users, or consultants, toadapt their software to meet specific needs. This tendsto be more so with large systems, but these are thesystems least likely to have local support. In general itis the larger and more expensive systems which havethe greater degree of flexibility, so they can bedeveloped to meet the needs of users.Accounting packages do have several countervailingadvantages which need to be considered:• Established packages are fully developed, and
demonstrably work. They will have been de-bugged;
• They will be supported by manuals, designed forease of use, and have built-in audit trails andsecurity;
• They will be regularly upgraded to take accounts ofnew developments, eg. new versions of operatingsystems;
• They will be supported by a software house whichshould assist with problems.
20There are some public-sector accounting packages, butthey tend to have been written with a particular client inmind, eg. United Kingdom local authorities. Theirspecial needs may mean the software is as difficult toadapt as commercial accounting software, and thechances of local support are even less likely.In addition, most LDCs require some simple “votesledger” software for initial data entry in field offices,and for monitoring of expenditure. The generalexperience is that “small” accounting packages, whilecheaper, are even more inflexible, and that it is verydifficult to find a packaged solution to this problem at ajustifiable cost. However, votes ledgers can easily bewritten with modern relational databases.In making decisions about systems, a careful evaluationwill need to be made taking into account all relevantfactors. Accounting packages should always beregarded as an option, and the relative merits anddemerits weighed against each other.Budget systems
There are few commercial budget systems as such.Normally budgeting is a module within an accountingsystem. These are typically single-year modellingsystems, designed to input budget data into theaccounting system. However, as the earlier analysis ofplanning and budgeting indicates, the requirement is fora much more sophisticated tool, able to handle multipleyears, to include non-financial objectives and to takeaccount of complex resource constraints.At the other extreme there are specialist economicmodelling tools, such as the “Revised MinimumStandard Model” developed by the World Bank.However, these are general national macroeconomicmodels rather than tools for preparing budgets and plansof a government.At this time it appears that there are no proprietarypackages for modelling government budgetsadequately. A solution may be to develop a budget“front-end” to fit with an adapted accounting package.However, this requires careful design.Payroll
Payroll would appear to be an obvious target for usingexisting packages, since there are many payroll systemsin existence. However, even here there are problems.• Μανψ γοϖερνµεντ παψρολλσ ηαϖε α χοµπλεξ
αλλοωανχε σψστεµ, ωηιχη ισ βεψονδ τηε δεσιγνπαραµετερσ οφ χοµµερχιαλ παχκαγεσ;
• The scale of the payroll (ie. number of employees) insome countries can also be beyond the design limitsof commercial packages;
• Commercial systems do not allow for employees
moving to offices where there is a manual payroll,and vice versa, with consequent transfer of recordsbetween manual and computer systems;
• Most government systems require the ability toaccess information about pay going back over severalyears, whereas most commercial systems tend tohold only current data.
Conclusions on packaged software
As stated above, the initial presumption should alwaysbe in favour of a packaged software solution. The majoradvantages are as follows:• Χοστ (τηουγη τηε αλτερνατιϖε οφ χυστοµ
δεϖελοπµεντ χαν βε ινεξπενσιϖε ιν Λ∆Χσ);
• The system is developed and tested, and willcontinue to be maintained (lack of these elements iscommonly a problem with bespoke software);
• Data integrity and security (especially important inaccounting systems) are well established, and therewill be proper audit trails; and
• The system will be well documented, and developedfor easy use.
However, this will need to be balanced against thefunctionality of the proposed package in terms of userneeds, costs and feasibility of adaptations, and thequality and reliability of local support. These factorswill need to be carefully evaluated in making a decisionon packaged software. Consideration will also need tobe given to the capacity of the software to comply withfinancial regulations, and a compromise betweenrevising regulations and software choices will benecessary. If the regulations cannot be changed, thentailored (bespoke) software may be the only feasiblesolution. One of the incidental advantages of moving LDCs tofull or modified accrual accounting is that theapplication of packaged software would be a muchsimpler task.Hardware and operating system issues
Today hardware is rarely an important issue. Theappropriate approach is to design the system first, andthen specify the hardware to meet the operationalrequirements. Of much greater significance are issuesrelating to operating systems.Operating systems are the link between the applicationsoftware and the actual hardware. At one time eachmanufacturer had its own operating system, but todaymost hardware uses a limited number of operatingsystems. These are generally DOS/Windows 95 or 98for PCs and small networks, and Windows NT or UNIX
21for larger systems. However, some major databasesystems, such as Oracle or Infomix, which operate on arange of operating systems, include some of the moreimportant proprietary systems. In such cases it is thechoice of the database, rather than the operating system,which is critical.In a number of countries, especially in Asia, thelanguage is written in a character set which is differentfrom English characters, on which most computers arebased. It is clearly important to be able to produceoutput in the language and script of the country. Atpresent only Windows (and the Macintosh, but this is oflittle importance in financial management) has thiscapability.
Systems design
This wider-perspective picture should be encompassedin an overall “financial information systems strategy”(FISS). Several styles and approaches to theestablishment of such strategies exist, with manyspecific tools used by specialists and governments, butas a general guideline all such strategies should includethe following, in the sequence shown.• Ρεϖιεω οφ βυσινεσσ προχεσσεσ ανδ
ινφορµατιον νεεδσ;
• Information architecture;
• Systems and technology architecture;
• Project management and implementation planning.
Together these are known as RISP (from the initialletters above). The sections that follow deal with eachof the RISP components.One structured approach to developing an FISS isSSADM (Structured Systems Analysis and DesignMethodology). The latest version of SSADM isSSADM 4.2, and the stages that follow are based on theSSADM model.
Review of business process and informationneeds
The term “business process” is deliberately introducedalthough we are talking about government. This is toemphasize the need for public-sector activities to seethemselves as operating in the same environment as theprivate sector, with identified “business” objectives.This review involves developing an understanding ofand documenting what happens in an organization.Functional processes vary from country to country ingovernment terms, but for historical reasons manyLDCs have adopted the approach of a more developedcountry, eg. Bangladesh follows the British model.It is essential that a thorough background examinationbe made and the anticipated information requirementsidentified to form the basis for what is required. InLDCs this phase of work should typically examine:• Βυσινεσσ προχεσσεσ;
• Procedures;
• Legal/regulatory framework for public finance; and
• Strengths and weaknesses of the governmentdepartments.
Information architecture
In government there are usually several levels ofhierarchy, eg. central, provincial, local etc.Nevertheless, it is possible to identify nine business-process information areas. In terms of informationarchitecture, the detailed relationship of all of theirconstituent parts and their ranking in terms ofimportance must be established when consideringintegration. As an example and at a high level only, thebasic relationship between the nine business processescan be illustrated by the diagram below.
22
This diagram is deliberately not in the style of anyparticular methodology and is an example of high-leveloutput only. However, it represents the possiblebusiness process groupings that might be typical of anintegrated financial system.The information in Exhibit 66 would be based ondetailed analysis. Below this top level would be a seriesof detailed information or data-flow diagrams showing
how information flows between the constituent parts ofeach business group. Examples of the flows in Exhibit66 include those in Exhibit 67.
AuditGovernmentHuman
RevenuesForeign aid
Debt
Public sectorworks
Budgets
Fiscal policyand plans
Exhibit 66. Relationship between business processes
23
24Exhibit 67. Information flows
Planning flows There are several types of planning flow: • Information flows on fiscal policy and plans to plan
budgets.• Information on budgets and cash goes to business
groupings for execution of the work programme.• As the financial year progresses, information on
expenditure, budgets, etc. flows back to allow adjustment.Accounting flows Information on commitments, payments, receipts.Cash flows Information on balances from accounting business process
and forecasts on cash position.Work programme flows Information from work programmes flows to foreign aid and
human resources business processes, and also to specificprojects.
Audit flows Audit observation on different business process areas andfeedback from audit.
Systems architecture
The systems architecture is based on the establishedinformation architecture. Taking Exhibit 66 as anexample, each business support system may comprise anumber of subsystems. For example, in the accountingprocess, a typical configuration would include:• Γενεραλ λεδγερ (ινχλυδινγ βυδγετσ);
• Accounts payable;
• Accounts receivable;
• Fixed assets (if full accrual is used); and
• Cost accounting.
Additional systems for commitment accounting,purchase orders etc. are dependent on the review of thebusiness processes and information needs, eg. cash oraccruals accounting.A typical systems design architecture would include thecomponents set out in Exhibit 68.
25
Exhibit 68. Accounting systems configuration with links to core system
26
27
Exhibit 68 adopts certain standards as the basis fordesign, eg. similar processes are identified by the samesymbol. The establishment of standards in systemdesign is an integral part of progressing towards anintegrated financial system in government as a whole.The technology architecture part of this phase is toestablish the hardware, software and communicationstechnology required to support the information andsystems design. It will include elements such as thenature, scale and distribution of information technology(IT) processing facilities as well as software type andcommunications. Many of these elements are directlyrelated to the IT capabilities in a particular country.However, there are issues that are common and must beconsidered:• ςολυµε οφ στανδινγ δατα;• Volume and frequency of transactions;• Volume and frequency of information flows
between component parts;• Centralized or distributed processing;• Type of data, ie. alphanumerical or text; • Output required; and• Availability of off-the-shelf packages.Data volume and transaction rates have traditionallydictated the computing power of a particular part of asystem, with larger data volumes and transactionsrequiring mainframe computers. However, theincreasing capability of PCs means that distributedprocessing is now much more a possibility.The normal trend in developed countries is to usepackaged solutions where possible, although, as alreadydiscussed above, this is not necessarily the norm inLDCs, and the risk in bespoke software development ishigher. Perhaps the most significant recent change intechnology architecture over the past few years hasbeen the advent of local language fonts in the Windowsenvironment. This allows the production of accountinginformation in the national language, eg. in Nepal,Bangladesh, Kyrgyzstan.
Whatever the chosen software, it should have a built-infunctionality that makes it easy to amend and change.The development of “open-systems architecture” meansthat flexibility in technology choice is now more of areality. Combined with software packages that canoperate on different platforms, this means that users arenot locked into one type of hardware.Project management and implementationplanning
Throughout any IT project it is sensible to use anappropriate and pragmatic application of a projectmanagement tool. The British Government, forexample, favours the use of the PRINCE (Projects in aControlled Environment) methodology. In introducingsystems to LDCs, it is critical that a sound projectorganization that meets local needs be established.Failure to do so will lead to a repeat of thedisappointing outcomes of the past where governmentshave not “owned or maintained” the financial system.One of the fundamental concepts of projectmanagement is to distinguish between the technical taskof delivering products and the management aspects,such as organization, plans and controls for managingthe technical task. The end user needs to be involvedthroughout. This would include scoping of projectsusing standard product breakdown structures as well ascontrolling the overall project and sub-projectrelationships with concurrent projects.Using project management methodology ensures thecreation of the distinct stages necessary to provideregular formal assessment points throughout the project.Stage-end and key control points or milestones will beestablished and agreed with the overall project controlboard. Assessment, checkpoint and quality reviewprocedures will be established.For example, the standard organizational structurewithin PRINCE-controlled developments is set out inExhibit 69. It should be noted that this structure may bescaled down for smaller projects.
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While accepting the overall concept of tools such asPRINCE, it is usual to apply a degree of intelligenttailoring to the methodology. This is particularly so inLDCs. Most projects would benefit by applying thoseelements of the methodology which are appropriate inthe context of the individual project.The major problem with the application of a detailedproject management approach in the context of LDCs isthe lack of sufficient persons with any technical
knowledge to fill the various roles. Training forcontrolling systems development must be included inany overall proposed system. This emphasis on projectmanagement is needed to promote ownership bygovernment of the financial systems introduced inLDCs. Involving local representatives in the process isessential to overcome this problem.As part of a project management tool, the followingplans would be expected.
Exhibit 69. PRINCE structure
29
ExceptionPlan
Exhibit 70. Plans
USER
PROJECT
BOARD
ProjectResourcePlan
ProjectTechnicalPlan
WHENCREATEDPROJECTINITIATION
PROJECT &STAGEMANAGERS
StageResourcePlan
StageTechnicalPlan
END OF PREVIOUSSTAGE
STAGE
TEAMS
DetailedResourcePlan
DetailedTechnicalPlan
AS REQUIRED
IN ANYSTAGE
INDIVIDUAL IndividualWorkPlan
While all of the above is technically correct, the realityin LDCs is that compromise will be necessary. Themost acute problem is the scarcity of the local skillsnecessary to implement, and then, most importantly,provide ongoing support to, government-wide systems.It is sometimes possible to facilitate developments inlarge urban areas but the technical skills required areoften not available in more remote parts of the country.In order to succeed, some projects need a componentthat is specifically geared to promoting the developmentof support organizations both within government and inthe private sector to increase the long-termsustainability of financial systems. As already stated,the emphasis in most LDCs is on “programmers” whotend to develop the system they understand is neededrather than to agree user requirements and systemsdesign.Apart from the human resources issue, anothersignificant factor in systems development in LDCs isthe lack of suitable infrastructure. In many places theelectricity supply is not reliable, and uninterruptiblepower supply equipment and generators do notnecessarily overcome this. Generators tend to be usedother than for running the computer systems and it isnot uncommon that when the office’s annual fuelallocation is exhausted there is no more electricity.Options such as using notebook computers may help toovercome some difficulties, but on the risk side theyalso make the systems more susceptible to unauthorized
use. Even if the power problems can be overcome,communications problems and the fact that theenvironment in many government offices is not suitablefor technology mean that major investment is necessaryin building infrastructure to parallel the introduction ofinformation systems.The more appropriate option in many cases is to reducethe expectation of what can be achieved in terms ofreal-time financial systems and allow the flow ofmanually completed forms to a part of the organizationwhere data can be reliably input.
Problems of system sustainabilityExperience indicates that most computer systemsinstalled in LDCs have degraded or completely failedafter the withdrawal of external support. A number ofcauses can be identified.• Βαδλψ δεσιγνεδ σψστεµσ ωηιχη διδ νοτ µεετ
υσερ νεεδσ, ανδ ωηιχη, βεχαυσε οφ τηε λαχκοφ βενεφιτ, υσερσ δισχοντινυεδ.;
• Inability to continue to operate systems for want ofappropriate in-country skills and/or maintenancefacilities;
• Government organizational structures which made itimpossible to continue to operate the systemseffectively, eg. the loss or transfer of trainedpersonnel, and inadequate maintenance budgets.
The issue of sustainability needs to be addressed beforeinitiating a project to establish any computer-based
30
system. A strategy needs to be developed whichprovides a viable path to sustainability after the end ofexternal assistance. Issues to be addressed include:• µαιντενανχε οφ ηαρδωαρε ανδ σοφτωαρειτ
νεεδσ το βε εσταβλισηεδ τηατ τηερε αρελοχαλλψ αϖαιλαβλε ρεσουρχεσ ανδ σκιλλσ τοµαινταιν τηε σψστεµσ, ανδ α χοµµιτµεντ φροµτηε γοϖερνµεντ το βυδγετ φορ τηε ρεθυιρεδχοστσ;
• The creation and maintenance of a pool of staffcapable of operating and managing the systems. Ifthis is not possible within the government’sorganizational structure, then the services must bebought in, either through the use of contract staff, orby actually contracting out the whole operation ofthe computer facility; and
• The system must meet the perceived needs ofgovernment. This can be achieved only through theinvolvement of government participants in thedevelopment of the system.
Strategies also need to consider the problem ofcomputers in remote locations. It may be necessary toestablish a “help” desk to provide telephone or personalsupport to such locations. Systems of managing files,backups, data security and provision of consumables allneed to be addressed within the strategy.The year 2000 problemThe software industry has created its own virus–themillennium bug. By programming all computer “chips”with the year as two digits, eg. “98” instead of “1998,”manufacturers have created a system which will fail atthe end of the century.The problem manifests itself in three ways:• Hardware–the BIOS on PCs manufactured up until a
year or so ago was not year-2000 compliant, and thesame applies to most mainframes and minis.
• Operating systems–DOS and most proprietarysystems, and older versions of Windows, are notyear 2000 compliant.
• Software–even today, many accounting packagesand much other software are not year-2000compliant.
So what will happen? No one really knows. In order tofind out, each system would need to be testedindividually, by (1) advancing the system clock to 31December 1999, (2) allowing it to cross the millenniumand (3) running a batch of test data extending over atleast the first month, and producing all standard reports.The result is unpredictable, and may vary from simply
printing dates wrong to producing corrupt data or evencrashing.No user can afford to risk this. It must be assumed untildemonstrated otherwise that every system will fail (notethat this also includes some machinery, such as trafficlight systems, if it uses dates programmed into thechip). The only exceptions are probably very simplesystems such as word processors and spreadsheets–andeven in these there can be no guarantee that there willnot be problems.This is a huge problem, which even developed countriesare finding difficult to address. It means for developingcountries that most older accounting systems andhardware must be replaced or upgraded before the year2000. In practice, unless written on recent software,replacement must be the only feasible option. This is anenormous problem, which in our experience is notbeing properly addressed.
ConclusionGiven the continuing drop in the price of computerequipment and improvements in the performance,adaptability and usefulness of packaged systems, thefurther integration of government financial managementsystems is both inevitable and desirable. Integrationoffers the possibility of reducing redundant data,problems associated with the transfer and re-entry ofdata and with the reconciliation of figures, problems ofyear-end cut-offs, delays in the availability ofinformation and the costs of record-keeping andreporting generally. At the same time, integration islikely to lead to improvements in the accuracy,timeliness and usefulness of accounting information andin better communication between financial managersand other managers.There are three major risks: (i) the newly designedsystem may not perform as planned, (ii) it may bevulnerable to disruption and (iii) there may be asignificant cost overrun. All of these are distinctpossibilities. The second one includes problems ofsystem security and continuity of service under adversecircumstances. Disaster recovery planning attempts tomitigate the resultant problems. All three risks arereduced by a gradualist approach to integration, whichenables systems to grow incrementally in response toexternal conditions.Notes of caution and realism need to be raised. First,information technology specialists tend to emphasizethe capabilities of their stock in trade and to overlook itslimitations. These include cost and time overruns andsystems which do not solve the problems they wereinstalled to address. Second, there is big money chasingintegrated systems, and thus optimism often triumphs
31
over realism. Third, for many governments a highdegree of integration must remain a distant goal, giventhe current status of their financial managementsystems. And fourth, in countries where basic financialsystems perform very badly, integration is not even ahigh-priority goal.Fully integrated systems for financial management inLDCs are a longer-term goal, and full integration maynever by achievable, or even desirable. However, there
are many intermediate steps which would significantlyimprove the quality and effectiveness of financialmanagement. These steps are potentially significantfinancial systems developments in themselves, but theadvent of new technology allays the risk by allowingmore distributed processing. This balanced appreciationof the need for integration against practical and physicalrealities is a crucial constituent of developing suchsystems. Many LDCs are missing the opportunity tomove along the integration path even in subsystemdevelopments.The application of sophisticated project managementand systems design methodologies in their totality maybe inappropriate, but some form of structured systemsdesign and project control is essential. An overallfinancial systems strategy needs to be established sothat developments are consistent and conform to anoverall direction in terms of an integrated financialsystem. However, it is critical that such a strategyproperly address physical infrastructure areas andresource issues. The philosophy can be encapsulated inthe acronym EDGE:• Εχονοµιχ χοστ οφ ινσταλλατιον ανδ λονγ−τερµ
µαιντενανχε οφ τηε σψστεµ.;• Detailed appraisal of potential operating
environment;• Gauging capabilities of present and potential users;• Effectiveness level required to be of positive benefit
to the government in the short and long term.This approach introduces appropriate factors relating toLDCs in a more specific manner.
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33
X. IMPLEMENTING INTEGRATED FINANCIAL MANAGEMENT
IntroductionThe analysis in the preceding sections has identified thenature of an integrated financial management system,the benefits and some of the issues. However, morethan anything else, the question must be the feasibilityof implementing the identified improvements andintegrating a system in the environment of a typicalLDC.It must be recognized that LDCs are far from being ahomogeneous group. At one extreme are countries with
substantial resources, which are already operating quitesophisticated systems. At the other end there arecountries which have been involved in civil wars, wherethe whole administrative system and economy havecollapsed, and there are virtually no resources.Clearly what is feasible, and the implementationstrategy, must be country-specific. Nevertheless thereare a number of general features of the problems, andalso of approaches to change, which can be made.These are summarized below.
Exhibit 71. Implementation issues and strategies
Issues Strategies• Lack of financial resources to acquire equipment,
software and expertise• Most LDCs will require external financial and technical
support to move towards integrated financialmanagement systems
• Lack of technical expertise to design strategies andevaluate options
• As above, there is need for external design studies
• Inadequate physicanfrastructure, eg. power supplies,telecommunications, adequate buildings withair-conditioning
• Proposed systems must recognize physicalconstraints, and either (i) operate within them, or (ii)provide resources for improvement
• Lack of awareness of need for, or benefits from,change
• There is no point in attempts to “impose” systems,since they almost inevitably fail. Rather, the approachshould be to work with recipient governments toidentify needs and develop appropriate strategies
• Inadequate human resources to manage and operateenhanced systems
• The issue has already been addressed of the ability ofmodern technology to reduce demand for humanresources. Nevertheless, new skills are required, andthere must be a strategy to meet these needs
• Organizational and institutional structure poorly suitedto either integrated systems or the use of informationtechnology
• The strategy must either embrace organizational andinstitutional change (in which case host governmentsupport is essential), or work within these constraints
• Inability to sustain systems after the end of externalsupport
There is a need to analyse carefully the causes of pastfailures and to draw on these lessons in developing astrategy. Any strategy for change which does notrecognize historic problems and have specific methodsof avoiding the same mistakes must inevitably fail
• Resistance to change from persons with a perceivedvested interest
• It is common in any change situation to find individualsor groups that oppose it. Change management is awhole range of techniques designed to overcomethese obstacles, and its application becomes evenmore important in LDCs
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This section will focus on the different aspects ofchange, as identified above.
Physical constraints and theirresolutionIn many LDCs physical constraints are a realproblem. For example, in one LDC there are 75districts, each with its own treasury office. Ofthese, 17 had no telephone connection, while onlyeight had an official vehicle, despite the fact thatthey are responsible for the internal audit of morethan 4,000 field paying offices. Undoubtedly, aneven smaller proportion of the field offices havetelephones, and many operate without any meansof communication with the outside world except bywalking. In some LDCs supplies of governmentforms are limited, and copies have to be purchasedin the market. Even in a wealthy LDC, someremote districts can lack telephone and electricity.Government offices in many LDCs are low quality,and badly maintained. Air-conditioning is rare,despite extensive problems of dust and humidity.These environmental problems create difficultiesfor upgrading financial management systems. Poorcommunications delay the transfer of information.
Unreliable electricity supplies and voltagefluctuations cause computer problems. Dust andhumidity create problems, even for modern,environmentally tolerant computers. In general thepoor working environment is not conducive todeveloping modern financial management systems.There are two options: either to upgrade officefacilities or to work with the existing problems.Most projects have to accept some compromise,with some upgrading, but usually not extending toall offices. Also some problems, such as lack ofelectricity or telephone links, may be outside thecontrol of a financial management upgradingprogramme.It must be accepted that in most LDCs many fieldoffices will continue to operate manual systems forthe foreseeable future. The pattern is likely to be aprogressive move outwards of computer systemsfrom the centre. Concurrently, improvements canbe made to manual systems, eg. by usingintermediate technology–manual add-listingmachines, better-designed forms, card indexsystems and so on. Thus the pattern may be asindicated by the model below.
Under this model, in the initial stages, there is likely tobe as much emphasis on upgrading manual systems ason developing computer-based systems. However, in
carrying out this exercise, four factors need to be takeninto account:• Σπεχιαλ χονσιδερατιον νεεδσ το βε γιϖεν το
Exhibit 72. Physical progression of changes
35τηε ιντερφαχε βετωεεν µανυαλ ανδ χοµπυτερσψστεµσ, εσπεχιαλλψ ωηεν σοµε χοµπονεντσ,εγ. περσοννελ, µαψ µοϖε βετωεεν τηε σψστεµσ;
• Outlying computer systems are likely to be simplerthan those at the centre (eg. stand-alone PCs in theformer), but still need to be able to exchange datawith each other;
• Portable notebook computers are often a moreviable solution in remote areas because (i) they tendto be tougher and more environmentally tolerant, (ii)they have built-in batteries which can normallyoperate for several hours, and (iii) in the event ofmechanical failure, they can be transported easilyfor repair;
• New manual systems in the field locations need tobe fully compatible with new central computersystems, and hence both need to be designedtogether.
In practice integration is unlikely to involvecomputerization at all locations in the short to mediumterm and therefore integration between manual andcomputer-based systems will be essential.
Measuring the benefits of goodfinancial management when appliedto governments
It is necessary to be able to identify indicators ofimprovements in financial management. This raises themore general problem of how to identify indicators ofsuccess in improvement programmes, against whichprogress can be measured. As a starting point, Exhibit73, below, identifies the primary benefits of goodfinancial management in government and converselythe costs of weak financial management.
Exhibit 73. Benefits of good financial management and costs of weak financial management in government
Benefits of good financial management Costs of weak financial managementSound financial basis for medium-term and annual fiscalplanning and management, and framework within whichbroad economic policies can be structured and broad resourceallocations planned
Inadequate financial planning framework with no medium-termhorizon, lack of basis for sound fiscal planning and resourceallocation decisions, leading to ad hoc allocation decisions andweak fiscal management
Enhanced resource mobilization; domestic through improvedtax collection foreign through improved utilization of officialand private inflows
Poor resource mobilization: low rates of tax collection comparedto GDP; failure to properly mobilize and utilize foreign resources
More optimal allocative efficiency in terms of focusing onpriority activities and allocating adequate resources to suchactivities
Poor allocative efficiency, typified by a large number ofinadequately funded projects and recurrent activities
Efficient release of funds ensuring minimal delays, andrelease in accordance with priorities as laid down in budgetsand laws
Delayed and inefficient fund release, funds often not used inaccordance with budget allocations
Effective and prompt monitoring of expenditure and revenuereceipts to ensure that objectives are being achieved inconformity with plans
Lack of timely or reliable financial information on expenditureand collection, making effective monitoring difficult orineffective
Clear linkage of financial expenditures to physical measuresof achievement
Failure to link expenditure to physical targets, and henceinability to monitor progress effectively
Procedures ensure propriety of expenditure in accordance withgovernment policies and procedures, with minimal systemleakages
Inadequate measures to ensure propriety of expenditure,extensive system leakages and malpractices
Effective cash management to minimize government short-term borrowing requirements and to maximize interest inflows
Ineffective cash management leading to short-term borrowingand periodic and unanticipated cash shortages
Many of the costs identified in this matrix will befamiliar. For example, Nepal typically utilizes only 30per cent of official development aid, and has one of thelowest tax-to-GDP ratios in the world (though bothratios are improving).38/ Many LDCs have over anumber of years consistently failed to forecast correctlytheir budget surplus or deficit. Again, many LDCs havefar too many projects driven by donors rather thaneffective government management, and most arenotorious for the leakages from the system and the
extent of improper expenditure. Again citing Nepal, the“irregular payments” reported by the Auditor Generalamount to a cumulative total of more than six monthsexpenditure.39/
While the benefits and costs are well known, it is muchmore difficult to identify measures of thesebenefits/costs, and hence to establish benchmarksagainst which progress can be measured.
36Many financial management improvement projects tendto have as output measures physical targets which aremerely intermediate steps. For example, developing abudget is not in itself a benefit. Benefits must bedefined in broader terms, for example improvedfinancial and resource planning, enhanced utilization ofdomestic and foreign resources and more optimalresource allocation. Indeed, ultimately all activitiesshould lead to the broad objective of welfare anddistribution improvements for the population as awhole.Clearly in moving from narrow and specific activityoutputs, the range of external variables which canimpact on the benefit increase, to the point where itbecomes meaningless to attempt to identify any directcausal linkage between activity and benefit. Theobjective is to identify intermediate measures, whereexternal factors can be identified and substantiallyeliminated, and yet which can act as surrogate measuresof the benefits. This is represented in the model inExhibit 74, below.
Exhibit 74. Model of measurement of activity-benefits relationship
From this model, certain conclusions can be drawn:• Immediate outputs (“deliverables”) are a useful
measure of whether the activity has been properlyperformed, but typically provide little informationon ultimate benefits;
• Ultimate benefits are the ideal measure, but in mostsituations they are influenced by so many externalvariables as to provide little evidence of the impactof the activity; also, or alternatively, they may notbe amenable to objective measurement, eg. is amore optimal resource allocation one which reduces
income inequality or one which promotes averageeconomic growth?
In most situations intermediate measures need to beidentified which are amenable to normative evaluationand not subject to too many external variables, yetprovide surrogate measures of the ultimate benefits.As an example from a financial managementimprovement project in an LDC, the four functionalareas for improvement and related benefits areidentified in Exhibit 75, below.
Exhibit 75. Functional activities to benefits cross-walk
Project activity,eg. run budget
workshops
Surrogate measures of benefit, eg. perceptions of budget process,
predictive reliability
Externalvariables
Immediate output,eg. participation in
workshops
Ultimate benefit, eg. more optimal resource allocation decisions
Rules andprocedures
improvementsProject accounting
improvements
Financialmanagementinformation system team
Budgetimprovements
Budget more effective tool forresource allocation, predictionEnhanced control overgovernment activities at microEnhanced government cashflow through reduction in
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Moving from benefits to surrogate measurableindicators is not always easy. For example, the financialmanagement information system should lead to “bettercontrol over government activities at a micro and macrolevel.” How can this be measured? There are noobvious direct measures, so a surrogate measure mustbe sought. Improved control should be exhibited bymore timely and focused control actions utilizing thenew information available. These could not beevaluated in quantitative terms, but they are sufficientlyobjective to be amenable to evaluation through aprocess of analysis of control decisions before and afterthe reforms.However, this points to the need for “before” measuresas benchmarks. It is essential before the start of thereform process to carry out a study which could bereplicated after the changes, so as to measure theimprovements (if any).The implications of this analysis are:• Attempts to measure benefits cannot replace
“deliverables” as direct output measures of progress.They are complementary, not alternative, measures;
• If there is to be a serious attempt to measurebenefits, they need to be identified at the projectdesign stage;
• Target benefits need to be agreed with the recipientgovernment to ensure a convergence of goals;
• Benchmarking studies need to be carried out beforethe start of the reforms, and replicated at a later dateto evaluate impact;
• Such studies have a cost which must be allowed forin the project budget.
The need for, and approach to, externalsupport
The responsibility for financial management, as with allgovernment activities, lies with the governmentconcerned. It is the responsibility of that government toidentify a need for enhanced financial management, andthen to identify resource requirements and, ifconsidered appropriate, seek external assistance.However, in that process, governments are likely to beinfluenced by external factors. These will includepressure from international organizations, eg. the IMFfor improved fiscal control, the World Bank forimproved project accounting, and donor agenciesgenerally because of problems of disbursement andmanagement of aid funds.In most cases, and ideally, there will be a convergencebetween the problems identified by government and theviews of donor organizations. Financial managementupgrading programmes are most likely to succeed inthis situation; they are least likely to succeed wherethey are “imposed” by donor organizations as acondition of other support.Although governments may be aware of problems withcomponents of the financial management system, theyare unlikely to have a clear concept of the nature of therequired changes. Nor in general is there a vision of anintegrated system. This is because most administrativetraining in government has failed to emphasize thesignificance of public-sector financial management, andmost staff training courses treat accounting andbudgeting as separate, routine exercises where themajor emphasis is on learning rules and regulations.In general, donor organizations are willing to supportfinancial management improvement programmes. Fromthe perspective of donors such programmes are likely tomeet a number of objectives.• Νατιοναλ εχονοµιχ ανδ φισχαλ µαναγεµεντ
ανδ πλαννινγ αρε λικελψ το βε ιµπροϖεδ, ανιµπορταντ οβϕεχτιϖε φορ µαϕορ µυλτιλατεραλαγενχιεσ συχη ασ τηε Ωορλδ Βανκ ανδ ΙΜΦ;
• Governments’ capability to allocate resources topriority areas will be enhanced;
• Governments’ ability to manage aid funds andreport on projects will be enhanced, always a matter
More reliable financialinformation and
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of concern to all donors because of their owninternal audit and reporting requirements;
• Accountability and government will be enhanced, aspecific priority of some donors, such as the Britishofficial development assistance.
Hindrances to good financial management
These may include:40/
• Λαχκ οφ ρεσουρχεσ, βοτη ηυµαν ανδοτηερωισε;
• Outdated systems which work imperfectly;• Inability to recruit and retain skilled staff at
prevailing rates of remuneration;• Lack of integration between systems;• An environment which allows corruption and
financial management by the privileged; and• Lack of commitment by senior management to good
financial management.To the extent that these factors apply, there is a need fora change of basic policies. For instance, a regimecommitted to good governance would not only seekimprovements in government financial management; itwould also seek changes in related areas, eg. improvedpublic accountability, reduced corruption, judicialreform etc., which would be conducive to greaterdemands for good financial management. This would bea way of starting a virtuous circle of improvement. Incountries in which corruption is not a seriousimpediment, but where resources are scarce, policies tomake the human factor more effective are likely to havean important impact on financial management. Thesewould stress high-quality training, the creation of careerconditions favourable to the recruitment and retentionof skilled staff and proper staffing of financialprocesses. Despite the lack of resources, such policiesare possible. Nevertheless, some aspects of financialmanagement remain difficult to improve withoutexternal assistance, which is the subject of thefollowing section.
Sources of assistance and steps in the process
Sources of assistance can be subdivided by source(multilateral or bilateral) and method of funding (grant,loan). Some bilateral grants are available only in theform of commodities, eg. equipment, food. Majormultilateral sources include the World Bank, the UnitedNations Development Programme (UNDP), theInternational Monetary Fund, the European Union andregional development banks such as the AfricanDevelopment Bank, the Inter-American DevelopmentBank and the Asian Development Bank. Bilateralsources are the governments of individual donorcountries. UNDP and many bilaterals provide grants,sometimes in packages partly funded by loan, andtypically for purposes of technical assistance. TheWorld Bank and regional development banks provide“soft” loans (ie. loans at below-market interest rateswith concessional repayment terms) to countries whereper capita income is low. Sometimes projects arefinanced by a mixture of full interest-bearing loans andsoft loans. For obvious reasons, most governments tend to prefergrants to loans. Since they are generally available fortechnical assistance projects, and financial managementimprovement programmes come within this description,grant funding is common. However, this is unlikely tocover the cost of a major upgrading of physicalfacilities, for which loan funds are likely to be required.The procedures applicable to assistance vary in detailfrom donor to donor. The responsibility foridentification, design and implementation of a financialmanagement upgrading programme rests with thegovernment of the country concerned.41/ Thegovernment does not necessarily carry out all theseaspects alone, and outside experts are usually employedin all three phases. However, it does mean thatgovernment has the ultimate say in identifying needs,choosing the means and taking the necessary actions toaddress those needs. The World Bank project cycle has six phases:• Ιδεντιφιχατιον: τηισ προϖιδεσ τηε προϕεχτ
χονχεπτ ιν τερµσ οφ τηε νεεδσ το βε αδδρεσσεδ,τηε οβϕεχτιϖεσ οφ τηε προϕεχτ, τηε εξπεχτεδουτχοµε, α ρουγη ινδιχατιον οφ τηε ινπυτσ ανδτηε προποσεδ µετηοδσ ανδ αππροαχη;
• Preparation: this reflects mutual agreement on theproject concept. After consideration of the technical,economic, social and institutional aspects of theproject, a project document is drawn up;
• Appraisal: this is a comprehensive review of theproject which tests for viability, technical validity,cost-effectiveness etc.;
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• Approval: having made final adjustments toimprove the project, the parties to the agreementdiscuss conditions, legal obligations andprocurement issues and finally approve the project;
• Implementation: funds are now made available toacquire the inputs needed for implementation.Appropriate staff carry out the project in accordancewith plans, and report regularly on financial andnon-financial progress.;
• Evaluation: this normally occurs after the project iscompleted. It is assessed in terms of its benefits,costs, outputs and sustainable results, so that lessonsof experience can be passed on to future projects.
Change management
Most projects fail. This bald statement applies toprojects by most consultants and with most donors,because, though the original technical reforms may beachieved (and even this is the exception), systems tendto degrade once external support–financial, technicaland managerial–is removed. This problem is not unique to projects in LDCs. Asmanagement has become more dynamic, more prone tochange, the problem of achieving and sustaining changein organizations has become a major issue, and hasspawned its own jargon term–”change management.”This is not a separate issue that can be dealt with bycalling in a change management expert (though such aperson may well be needed). It is a fundamental part ofproject implementation and management.The term “change management” is used to refer to themanagement of the process of transformation that isrequired to achieve the changes implicit in any reformprogramme. It embraces a number of distinct aspects ofchange that have to be dealt with within any project, assummarized in the model in Exhibit 76, below.
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Plan institutionaland support
Agreeoutputs andmilestones
Agreeproject plan
and
Identifychangedrivers
Identifybenefits andstakeholders
Exhibit 76. Change Management Model
The checklist below is developed from one used by theUK Department for International Development (DFID),and provides a useful summary of the issues to beaddressed. It should be read in conjunction with theabove diagram.• Αρε τηε ποτεντιαλ υσερσ αωαρε οφ τηε πυρποσε
οφ τηε αχτιϖιτψ ανδ ισ τηειρ περχεπτιον οφωηατ ισ το βε αχηιεϖεδ τηε σαµε ασ τηατ οφτηε προϕεχτ τεαµ?
• Αρε τηε οβϕεχτιϖεσ οφ τηε αχτιϖιτψ βεινγυνδερτακεν χλεαρλψ δεφινεδ ανδ αγρεεδ ωιτητηε ποτεντιαλ υσερσ?
• Ηαϖε αλλ κεψ στακεηολδερσ βεεν ιδεντιφιεδανδ µαδε αωαρε οφ τηε αχτιϖιτψ?
• Ηαϖε γοϖερνµεντ ρεπρεσεντατιϖεσ βεεναπποιντεδ το ωορκ ωιτη τηε προϕεχτ ανδχηαµπιονσ οφ τηε παρτιχυλαρ αχτιϖιτψ βεενιδεντιφιεδ?
• Ηαϖε προϕεχτ µαναγεµεντ, πλανσ ανδ ουτπυτσβεεν αχχεπτεδ ανδ αγρεεδ?
• Ηασ τηε ιντερφαχε βετωεεν τηε αχτιϖιτψ ανδανψ συππορτινγ αχτιϖιτιεσ βεεν χλεαρλψιδεντιφιεδ ανδ τηε τιµινγ οφ δεπενδεντασσοχιατεδ αχτιϖιτιεσ αχχεπτεδ ανδ χονφιρµεδ(φορ εξαµπλε τραινινγ)?
• Ηασ α τιµεταβλε φορ δελιϖερψ, ινχλυδινγ κεψµιλεστονεσ, βεεν σετ υπ ανδ αγρεεδ ωιτη τηεθυαλιτψ ασσυρανχε τεαµ?
• Ηαϖε θυαλιτψ ασσυρανχε προχεδυρεσ βεενιδεντιφιεδ ανδ δο τηεσε ινϖολϖε γοϖερνµεντρεπρεσεντατιϖεσ?
• Ιs there a strategy for ensuring that the changes arenot merely technical, but achieve the anticipatedmanagement benefits?
• Ηασ αναλψσισ τακεν πλαχε οφ ηοω τηεαχτιϖιτψ ισ το βε µαινταινεδ ανδ συππορτεδ
ποστ−ενδ προϕεχτ ανδ αγρεεµεντ φροµ τηεγοϖερνµεντ τhat this will take place (in ITorientated activities this may well include acommitment to agree to a maintenance contract fromthe outsourced software vendor)?
• Ισ τηερε α φινανχιαλ στρατεγψ φορ τηε χοστ οφτηε προϕεχτ αχτιϖιτιεσ αφτερ τηε ενδ οφ τηεπροϕεχτ?
• Ισ αν εξιτ στρατεγψ ιν πλαχε φορ χονσυλταντσωηιχη ωιλλ λεαϖε συσταιναβλε προϕεχταχτιϖιτιεσ ιν πλαχε?
To properly address change-management strategies thatlead to sustainability takes longer than simplyimplementing technical changes. This is often ignoredby donors, and recipient governments tend even torefuse to accept that there is a problem. It is tempting torush in with a technical solution, eg. a new computer-based accounting system, when the real issues, eg.management, institutional, human resources, are beingignored. Much accounting reform involves new technology.There is no question that modern IT tools provideenormous potential for systems improvement, but it isalways necessary to look at sustainability. InBangladesh, the authors used Foxpro in preference toMS Access because local support and developmentwere available for the former. In Nepal, clients hadabandoned earlier database systems in favour of simplespreadsheets which they understood.In developing and installing systems, questions need tobe asked.• Χαν τηε σοφτωαρε/ηαρδωαρε βε συππορτεδ
αφτερ τηε χονσυλταντσ λεαϖε, εϖεν ιφ σταφφαρε τρανσφερρεδ?
• Σηουλδ αδϖανχε αγρεεµεντ το τηε γοϖερνµεντβυψινγ ιν σψστεµσ συππορτ ανδ µαιντενανχε βε
Technical
•Communication•Building consensus•Human resource management•Skills transfer•Task related training•Participation
STAKEHOLDERS
Organizational changes Qualityassurance
and approvalprocedures
Initialsystemstatus
Terminalsystemstatus
Human resource changes
Attitude changes
Exit strategy leavingsustainable project
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σουγητ ασ α χονδιτιον οφ τηε προϕεχτ, ανδ ιφσο ωηατ σψστεµσ χαν βε συππορτεδ βψ λοχαλφιρµσ?
• Σηουλδ α λοχαλ φιρµ βε ασκεδ το δεϖελοπ τηεσψστεµ, προβαβλψ ωιτη χονσυλταντ συππορτ?
• Ηοω ωιλλ τηε σψστεµ βε οπερατεδ ωηενχυρρεντ σταφφ αρε τρανσφερρεδ?
• Ωηατ ισ τηε ηιστορψ οφ οτηερ ΙΤ προϕεχτσωιτηιν τηε χουντρψ, ανδ ωηατ λεσσονσ χαν βελεαρνεδ?
The biggest hindrances to reforms and sustainability aretypically organizational, institutional and managerial.Bureaucracies are inherently opposed to change, andbecome major barriers to reform and sustainability. Yetwithin almost all organizations there are change driversand champions of change. These must be identified andtheir support elicited.Organizational, managerial and institutional barriers tochange must be identified and addressed. At the veryminimum they are identified risk factors. There arealways strategies to remove or reduce such barriers. Forexample, staff transfers are a problem in manycountries. Ideally the transfer policy should be changed,but if that is not feasible (and it should always berecommended if desirable), then agreement torestricting transfers during project implementation, andmethods for training new staff in the future, will reducetheir impact.
Stakeholders in financial management
A stakeholder is any person, group or institution thathas an interest in, for example, a financial managementupgrading programme. This definition includes bothintended beneficiaries and intermediaries, winners andlosers, and those involved in or excluded from decision-making processes. Stakeholders can be divided into twovery broad groups.• Πριµαρψ στακεηολδερσ αρε τηοσε ωηο εξπεχτ
το βενεφιτ φροµ, ορ βε αδϖερσελψ αφφεχτεδ βψ,αιδ. Τηεσε αρε διφφιχυλτ το ιδεντιφψ ιν αφινανχιαλ µαναγεµεντ υπγραδινγ προγραµµε,βεχαυσε τηεψ αρε ιν εφφεχτ τηε ωηολεποπυλατιον.;
• Secondary stakeholders are the departments andministries involved in the upgrading programme, andthose who expect to gain from improved financialmanagement, eg. donor organizations. In practicefinancial management programmes focus onsecondary stakeholders.
In general terms, stakeholders are groups of people whoshare a common interest, for example “the consultancycompany,” “the project management,” “the Ministry ofFinance,” “the local authorities,” etc. Analysis mightconclude that the concept of “government officer” ismeaningless because there are so many differentinterests between departments or individuals which maybe stronger than commitments to the institutions as awhole. Thus government officers would have to besubdivided into different stakeholder groups. Exhibit 77below provides an example of stakeholders.
Exhibit 77. Accounting IS stakeholders and institutions
Institution Stakeholders Interest and power Likely attitude• Finance
divisionSenior officers Users of system and
information – control (toplevel) and influence (lowerlevels)
Support from top level.Lower levels suspiciousof technology and impacton jobs.
•• Controllergeneral ofaccounts
All accountingofficers and staff
Operators of accountingsystem – control (top level)and influence (lower levels)
Generally supportive ofchanges, though someconcern about newtechnology and its impact
•• Comptrollerand auditorgeneral
All audit andaccounts cadre(note overlapCGA officers)
Constitutional responsibilityfor form of accounts. Controlover cadre. Auditresponsibility
Generally supportive ofchanges, thoughconcerns as above
•• Lineministries
Principalaccounting officer
Statutory responsibility foraccounting and expenditurewithin division. Major user ofinformation.
At present little interestin changes, since they donot impact on perceivedrole
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Institution Stakeholders Interest and power Likely attitude•• Etc.
Participation by stakeholders contributes to the chancesof financial management upgrading programmes beingeffective and sustainable because: • By drawing on a wide range of interested parties,
the prospects for appropriate project design andcommitment to achieving objectives are likely to bemaximized; and
• People are more likely to be committed to carryingon the activity after external support stops, and moreable to do so given that participation itself helpsdevelop skills and confidence.
Stakeholder analysis is a tool which helps discover thekey stakeholders in financial management upgradingprogrammes. It is the first step in helping decide whoshould be encouraged and assisted to participate.Stakeholder analysis aims to: • Ιδεντιφψ ανδ δεφινε τηε χηαραχτεριστιχσ οφ
κεψ στακεηολδερσ;
• Assess the manner in which they might affect, or beaffected by, the programme/project outcome;
• Understand the relations between stakeholders,including an assessment of the real or potentialconflicts of interest and expectation betweenstakeholders; and
• Assess the capacity of different stakeholders toparticipate.
The outside intervention by a donor agency, bringingadditional resources into an area, may in itself createnew stakeholder groups. Stakeholder analysis differsfrom institutional analysis, which is concerned withlooking at the appropriateness and effectiveness ofinstitutional arrangements and assessing the strengths,weaknesses and development needs of individualorganizations.As an example of stakeholder conflict, to achieve thebenefits of financial management upgrading, there maybe a requirement to reduce the size of the workforce andpay higher salaries (and thus enhance motivation) tothose remaining. Without careful planning, it is likelythat staff faced with redundancy will resist reform; thiscan be overcome either by redundancy packages or by acommitment to reallocate all staff without redundancyor demotion.
Checklists for enhanced participation
This section identifies some of the steps to be taken toenhance the participation of stakeholders in financialmanagement upgrading programmes and to develop astronger partnership with those government institutionsthat are involved in the programme (and henceintermediary stakeholders, since the primary ones, thepublic, are not generally accessible). This particularlyapplies to that institution (the sponsor) which has themain interest and responsibility for implementing theproject, eg. the Ministry of Finance.• Ινστιτυτιοναλ χαπαχιτψ: a project’s first phase
may need to focus on developing institutionalcapacity;
• Conflict management: negotiating systems mayneed to be developed for handling conflictinginterests between different groups of stakeholders;
• Transparency: all stages of project activities must bepublicly visible, including decision-making processes;
• Decision-making: institutional mechanisms must beestablished to consult people in defining problems,before the goals and purpose of the project areirrevocably set;
• Identify sponsor institution: at project identificationstage, ensure that there is at least one stakeholderinstitution (or a number of people within thatorganization) really committed to the idea of theproject;
• A shared vision: attempt to involve a wide range ofstaff from the sponsor institution. Seek agreementon the project’s goal and purpose;
• Project design: consider providing the opportunityfor sponsor and other key stakeholders to visitsimilar projects elsewhere in the world; and alsoconsider establishing a pattern of exchange visitsbetween countries;
• Consultants: make full use of local consultantswherever possible for project preparation;
• Stakeholder analysis: with the partner (sponsor)institution, identify the key stakeholders in theproject and agree how they can be involved in theproject design;
• Planning workshops: with the sponsor institution,and assistance of a local facilitator, organize aplanning workshop for all significant stakeholders;
• Risk analysis: with partner institution and otheridentified stakeholders, identify and rank theprincipal sources and types of risk and agree a risk
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management plan;• Process approach: identify which elements of the
project need a process approach; ensure sufficienttime and resources for institution-building insponsoring organization and with other stakeholders.
Communications strategyEffective communications form an important part ofbuilding support for change, since much opposition isoften founded in ignorance or a perception of exclusion.The following approaches to communication may beutilized:• Ωεεκλψ µεετινγσ οφ χονσυλταντσ ωιτη γοϖερνµεντ
οφφιχερσ ινϖολϖεδ ιν τηε προϕεχτ το σηαρεινφορµατιον ανδ ϖιεωσ;
• Ρεγυλαρ µεετινγσ οφ ανψ τεαµσ;• Ρεγυλαρ µεετινγσ οφ τηε στεερινγ χοµµιττεε ορ
ιτσ εθυιϖαλεντ;• Ινφορµαλ µεετινγσ ωιτη σενιορ οφφιχερσ το
δισχυσσ ανδ αγρεε χηανγεσ, ινχλυδινγ αλλιδεντιφιεδ στακεηολδερσ;
• Α προγραµµε οφ πρεσεντατιονσ ασαππροπριατε ον σπεχιφιχ χηανγεσ το χονχερνεδπερσονσ;
• Μεετινγσ ωιτη σταφφ γρουπσ;• Μεετινγσ ωιτη τηε παρλιαµενταρψ αχχουντσ
χοµµιττεε, ορ ιτσ εθυιϖαλεντ;• Α νεωσλεττερ φροµ τιµε το τιµε συµµαριζινγ τηε
προϕεχτ αχτιϖιτιεσ.Any meeting should have a procedure for taking eitherminutes or at least a note of any decisions taken orissues to be followed up, and for quickly distributingthem. Risk analysis
Risk analysis is not strictly part of change management,but it is linked in that the risks typically relate tochange-management issues. It is important to identifyrisks at the design stage, within inception reports, andon an ongoing basis within monthly or otherintermediate reports. A useful framework for analysingrisks is provided below.
Exhibit 78. Risks
RiskLikelihood
of risk situationoccurring
Impact of riskoccurring on
achieving objectives
Strategy to reduce risk and impact ifsituation occurs
• Ιναδεθυατε τοπ−λεϖελγοϖερνµεντ χοµµιτµεντ τοφινανχιαλ µαναγεµεντ ρεφορµσ
Low–commitment inPFP and other policypapers
High None
• Χοντινυινγ ηιγη λεϖελ οφσταφφ τρανσφερσ αχροσσ τηεχιϖιλ σερϖιχε
High Potentially serious Ongoing training
• Ετχ.The process approach to financial managementupgrading
Participation in projects with a process approach islikely to be more significant throughout the projectcycle because planning is iterative. A project with a participatory process approach ischaracterized by the following: • Χοµπρεηενσιϖε ασσεσσµεντ οφ σεχτοραλ ανδ
ινστιτυτιοναλ χαπαχιτψ, ϕοιντλψ σηαρεδβετωεεν κεψ σεχονδαρψ στακεηολδερσ;
• Mutual understanding and design of any supportproject or main project;
• Jointly shared implementation and learning processbetween relevant donors and the recipient country’simplementing agency(ies);
• Building of capacity at individual and institutionaland possibly sectoral level;
• Reviews and evaluation which include all key
stakeholders; • Designing and implementing the project to ensure
that learning takes place for all key stakeholders,including the dnor; and
• The project having a measurable impact, withindicators for measurement identified and agreed bythe key stakeholders.
Essentially the process approach contrasts with themore structured, formal, output-oriented approach toprojects. It seeks to work with, and from within, thepartner organization, identifying needed, wanted andfeasible changes and helping the host develop a strategyto achieve them. It tends to be small-scale and flexibleand fits very closely with the concept of stakeholders asdescribed above. In contrast, the more traditionalproject approach is larger (and hence necessarily morebureaucratic within itself), focused on achievingpredetermined outputs, more separate from the partnerorganization, with the project seeking to control its own
44
activities. The latter is inevitable given the need toattain predetermined targets, but can lead to conflictwith a partner organization seeking to manage a project.Process approaches can work well in the context offinancial management, particularly where there islimited institutional capacity and/or support for change.A process approach can initiate reform as an alternativeto macro-diagnostic studies. It can also serve in itself asa diagnostic phase for later larger-scale intervention.
Human resource development andtraining
Almost all projects involve the need to improve humanresource skills and motivation. These two separaterequirements need to be clearly identified andseparated. Training can provide skills and knowledge–itdoes not provide motivation.In most projects, the benefits of formal classroomtraining and lectures are minimal. Skills can best belearned on the job, or in simulated situations inclassrooms. Formal training may occasionally be useful,eg. learning basic computer skills, but should be usedsparingly and for specific purposes. This is not apopular approach–in many countries formal extendedclassroom training is seen as the solution to allproblems. A compromise may be provided by thecompetence-based approach, which seeks to buildspecific skills within an overall training and educationprogramme.We are often required to implement study awards.Historically these have little impact, and long academiccourses are the least effective of all. However, studyawards are typically as much political as technical. Weshould seek to make them as effective as possible, notleast by using them for people who are likely tochampion change.Upgraded financial management systems will not work,nor will the benefits materialize, without attention to thehuman factor. In financial management three keygroups can be identified: • Τηοσε ωηο µακε τηε σψστεµσ ωορκ
(οπερατορσ ανδ τηειρ µαναγερσ);
• Those who receive services from the system(“clientele”); and
• Those who use the outputs of the system (“users”).In stakeholder terminology, both (2) and (3) above aresecondary stakeholders.The difference between clientele and users is that theformer are passive recipients of services, eg. customersand staff who receive money the government owesthem, while the latter are active users of services, eg.managers who need financial information to reach good
decisions. In any analysis of financial management,users are of great importance. Financial managementsystems can be really useful only if there is a skilledclass of users in a position to use the results. Indeed,financial management systems have to be adaptedspecifically to achieve this, and often users have to betrained to get maximum benefit from financial systems.On the other side of the equation, operators and theirmanagers clearly need a range of relevant skills iffinancial management is to be carried out successfully.The acquisition, development and retention of skillsresult from a combination of good training and goodmanagement policies. As far as training is concerned,basic skills in arithmetic and language are essential.Higher skills vary with the type of work, which maydemand competence in communication, economics,management, accounting, computing, public finance,auditing information systems etc. The need is partly forthe appropriate academic ability (which may result fromacademic studies), and partly for knowledge ofparticular skills (which may result from professionalstudies and on-the-job training). For certain financialmanagement jobs, eg. in accounting, auditing andtaxation, there commonly is a need for very specificjob-related training provided by specialist units attachedto appropriate government departments.To maximize results from training, appropriatemanagement policies and actions are needed. Forinstance, the work of financial management should beanalyzed and the duties, qualifications and experienceneeded for different posts specified. Those with therequired characteristics should be recruited and then ifnecessary further trained to meet job requirements. Toarrive at this result, governments frequently recognizespecialist cadres in financial management. These areseparately managed groups of professional staff, formedto promote the development of particular professionalskills. They are governed by general civil service rulesbut have their own career structures, and promotion andtransfers are usually within the cadre. The head of thecadre is responsible for professional standards and theprofessional development of its members. He isresponsible for ensuring that government’s needs forspecialist staff are met. For example, the AccountantGeneral usually heads the accounting cadre, andresponds to requests from other ministries foraccounting staff.The organizational changes necessary to implement andoperate an integrated financial management system willinevitably result in a need to retrain governmentofficers. Taken together with the computerizationprocess, which may also be associated with thechangeover, the total training requirements for
45
government can become very substantial. Neither willthe training be restricted to one level of officers; as thesystems are introduced it will be necessary for everyonefrom senior government officials to junior staff to beaware of their new responsibilities and duties. Allofficers will need to have an appreciation of theprinciples of budgetary control, financial managementand the legal regulatory framework and, whereappropriate, possess the ability to apply basic computertechniques. It is therefore inevitable that changes withinthe systems operated by government will necessitatesome retraining of personnel.For this to be successful, a structured approach isrequired in the design of training strategies, whichshould include the following activities:• Σπεχιφιχατιον οφ τηε οβϕεχτιϖεσ οφ τηε
τραινινγ προχεσσ ιν τερµσ οφ τηε κνοωλεδγεανδ σκιλλσ νεχεσσαρψ το περφορµ τηε ωορκ−βασεδ τασκσ;
• Preparation of a training needs analysis to assessexisting skills and knowledge in order to determinethe gap between them and the required skills;
• Development of a training plan to prioritize thetraining needs to meet the gap; and
• Designing a programme to implement the trainingplan.
Training, in this context, is perceived as an activityrelating to the acquisition of skills which will assiststaff in the performance of their duties in the workplace.This approach is known as competence-based training. Competence-based training
Competence-based training is a move away from thetraditional knowledge-based training to training wherethe ability to perform tasks within an occupation isemphasized. It requires that the skills acquired shouldbe clearly relevant to the workplace and is intended tofacilitate progression within employment. To be“competent” a person must demonstrably possess:• Σκιλλσ το σπεχιφιχ στανδαρδσ;• Relevant knowledge and understanding;• The ability to use skills and apply the knowledge;
and• Understanding, allowing the performance of relevant
tasks.An essential ingredient of competence-based training isthat the standards should be set in consultation withemployers and not by the trainers. A partnership existsbetween the providers and users of training whichensures that competence and achievement are
recognized and rewarded. The basic assumption of competence-based training isthat training through appropriate work performance canbe improved, providing that people are aware of what isexpected of them and that their performance at workcan be assessed reliably against standards ofcompetence. This approach has, in general, resulted ingreater flexibility in training, an improvement in theidentification of training needs and an involvement ofstaff in the overall performance (and thereforeefficiency) of organizations. This is to be welcomed,although it should be noted that the transformationprocess from a traditional knowledge-based structure toa competence-based one can be fraught with problems.Four areas require specific attention in the design ofcompetence-based programmes:• Τηε στανδαρδ−σεττινγ προχεσσ. Στανδαρδσ οφ
χοµπετενχε σηουλδ βε ρελεϖαντ το τηε νεεδσοφ εµπλοψερσ/δεπαρτµενταλ ηεαδσ, ωηοσηουλδ βε ινϖολϖεδ ιν τηε σεττινγ προχεσσ τοενσυρε τηατ τηε τραινινγ ισ ρελεϖαντ το τηεεµπλοψεεσ ωορκ;
• Assessment procedures. Training without anassessment of the output is of limited use. Thebenchmark should be predetermined standards ofcompetence, with candidates being assessed aseither “competent” or “not yet competent” in thework-based activities they undertake.;
• Provision of trainers. For training to be effective, interms of improving performance, trainers mustunderstand the key concepts and issues involved inthe development of competence-based programmes.They need to appreciate how standards aredeveloped and their application, and be skilled inassessing performance against those standards;
• Alternative sources of evidence. Competence maybe demonstrated in different ways, including naturalperformance in the workplace, case-studies whichsimulate activity in it or a common assessmentprocess to verify a candidate’s underpinningknowledge. The acceptance of alternative sources ofevidence provides an opportunity for greaterflexibility within the design of training programmesfor individual staff members.
46
Development of training programmes
Once the training plan has identified the trainingpriorities it will be necessary to develop the trainingprogrammes. The methodology adopted should,wherever possible, be competence-based and driven bythe user departments, which must specify the standardstheir officers must achieve in order to be consideredcompetent. These will form the foundation on which the
course is designed. The efficacy of the programmes willbe tested at the pilot stage which may result in an earlymodification to the training programme. Allprogrammes should be subject to evaluation and anassessment of the competence of the trainees. Thisphased approach can also be viewed diagrammaticallyas a training model.
It can be seen from the diagram that modifications intraining programmes are triggered by two events: (i)user departments indicating that current practices havechanged and/or (ii) trainers identifying improvements tothe existing training practices. This clearly illustrates that a fully integrated financialmanagement system must encompass the trainingfunction. Management systems are dynamic, in thatthey develop over time, and this in turn leads tomodifications in working practices. Training isnecessary to ensure that the changes are adopted andcorrectly executed within the system. Without trainingit is doubtful that the system will be able to continue tooperate effectively.
ConclusionFinancial management systems are not capable ofsustaining their existence without trained and competentstaff. Competence-based training is a mechanism forproviding personnel who will be able not only to assurethe continuity of the system but also to contribute to itsfuture improvement.
Organizational, institutional andhuman resource management issues
Training in isolation is demonstrably not effective. Itmust be integrated with a human resource management
(HRM) policy to make effective use of the newlyacquired skills. The problem in many LDCs has been oftraining without adequate consideration of the HRMaspects. Particular problems have included:
Modifications totraining programme
Evaluation andassessment
Pilot delivery oftraining programme
Outgoing delivery of training
Exhibit 79. The competence training model
47
• Τραινινγ τηε ωρονγ περσονσ, φορ εξαµπλεσενδινγ οφφιχερσ ον τραινινγ οϖερσεασ ασ αρεωαρδ φορ σερϖιχεσ;
• Training persons in techniques which they cannotapply because the new techniques have not beenadopted in government procedures; and
• Training staff who are quickly reassigned to othertasks.
A major problem is that public-sector administrationhas traditionally been regarded as a generalist activity,for which specific skills are not required. Thereforeofficers should be seen as being able to be transferred toany administrative post. Since some jobs, such asaccounting and computer systems, patently requiretechnical skills, technical specialists have sometimesbeen recruited, but outside the general managementstructure, and without any promotion path.This approach is clearly inappropriate in the context offinancial management. Officers are required who havefinance skills (eg. accounting, economics), and whounderstand the computer systems being introduced.Once acquired, these are valuable skills which havelittle relevance if the person is transferred to, say, theMinistry of Agriculture.In addition, most LDCs have antiquated staff appraisaland promotion methodologies which emphasizepersonal characteristics rather than task performance.These tend to militate against any strong desire on thepart of officers either to acquire technical skills, or toperform well at technical tasks. Promotion is largely onthe basis of time-serving, obtaining appropriatetransfers and not doing anything wrong.The very hierarchical structure of many LDC officeenvironments is directly opposed to the move to the“flatter” organizational structures which moderninformation technology both encourages and requires.In Hindu countries, the “peon” (messenger) is a caste;what happens to the caste’s members when offices useelectronic mail? In some countries there is a strongcultural attitude that senior officers dispensejudgements, and deal with other important issues, ratherthan actually perform tasks.All of these factors may serve to make training and newsystems ineffective, or achieve less than anticipated.They may also mean that, within a few years, computersystems are being operated by persons with no training,and consequently the systems degrade or fail.Ideally these problems should be tackled at a broadorganizational level. Very often, short-term change isinfeasible, and financial management systems must bedeveloped to operate within the above environment.
Strategies must be designed to work around theproblems.
Problems encounteredProjects to improve government financial managementhave a long history and are many and varied.42/ Manyhave failed to achieve significant sustainable change.The basic concept is simple enough: that externalresources can compensate for internal deficiencies.Thus technical assistance projects provide inputs suchas skilled advisers and consultants, equipment, softwareetc. Frequently encountered problems are:• Ιναδεθυατε ιντεγρατιον βετωεεν εξτερναλ ανδ
ιντερναλ ινπυτσ;
• Inadequate skills transfer;
• Lack of appropriate counterparts for externaladvisers;
• Advisers who prefer to do everything themselveswithout involving nationals;
• Nationals who are trained but are then transferred topositions unconnected to the content of training;
• Systems which work until the contract of the expertis terminated;
• Governments which give only superficial support forfinancial management improvement;
• External experts lacking the qualities necessary forpassing on skills and experience;
• Lack of sustainable results after the external inputscome to an end;
• Failure of the host government to create conditionsfor improvements in financial management; and
• Misdiagnosis of a country’s financial managementneeds.
Despite such factors, projects to improve financialmanagement continue to attract donor support.
ConclusionsNeither the computer nor an integrated system issufficient in itself to transform financial management.Indeed, there are plenty of examples in whichcomputers are in fact part of the problem.It is possible to create the most sophisticated budget andreporting system, yet fail to have any effect on thequality of decision-making or financial management.Studies of the impact of budgets in the private sectorhave concluded that managers seek to perform wellagainst those measures by which their performance is
48
assessed. In the context of government financialmanagement, this means that it will be effective only ifmanagers see themselves as being judged by theirperformance against the indicators in the system. If it isa purely cosmetic exercise, and what really matters is,for example, appeasing pressure groups, then thesystem will prove ineffective. This is confirmed by theAustralian and New Zealand experience that radicalchange in financial management systems is effectivewhen backed by a government determined to make itwork.This document has sought to identify the scope forenhancing government financial management systems,
49
and to provide some pointers on approaches particularlyin developing countries. The key concepts are:• ∆εϖελοπινγ α µορε γοαλ−οριεντεδ αππροαχη;
• Relating the system to managerial responsibility; and
• Improving capability to meet the fundamental needfor effective financial management.
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Endnotes
1/ Managing the Cost of Government: Building anEffective Financial Management Structure, GeneralAccounting Office, Washington, 1985.2/ INTOSAI Auditing Standards, InternationalOrganization of Supreme Audit Institutions,Vienna, 1992.3/ A UN committee decides on the criteria fordetermining LDC status. The criteria comprisegross domestic product per capita and twocomposite indices, the first representing humanresource development and the second industrialdiversification. The first combines four indicators,measuring adult literacy, school enrolment, dailysupply of calories per capita and life expectancyrespectively. The second combines indicators of theshare of manufacturing in the economy, the percapita output of electricity, the degree of exportconcentration and the proportion of the labour forcein industry. Also the committee has decided toexclude new admissions to LDC status where thepopulation is over 75 million. See Committee forDevelopment Planning, report of the 27th session,United Nations, New York, April 19914/ Official development assistance is a term coinedby the Development Assistance Committee of theOrganization for Economic Cooperation andDevelopment, which is accepted by the donorcommunity. It denotes grants or loans, undertakenby the official sector on concessional financialterms, with promotion of economic development orwelfare as a main objective. It includes food aid,technical cooperation, and concessional loanswhere the grant element is calculated to be 25% ormore. It excludes flows from private voluntaryagencies and military flows.5/ Government financial management in leastdeveloped countries, Department of TechnicalCooperation for Development, United Nations,New York, 1991 (ST/TCD/SERE/15).6/ See for instance “Assessing the quality ofgovernment accounts of 135 countries,” by Peter N.Dean and Salvatore Favazza, Journal ofInternational Accounting, Auditing and Taxation,1994, where recent reports on the quality offinancial management in developing countries arebriefly reviewed.
7/ See p.103 of Information Technology: theManagement Challenge, N. Caroline Daniels, TheEconomist Intelligence Unit, Addison-Wesley,New York, 1994. See also Strategic SystemsPlanning for Financial Institutions: UsingAutomated Solutions and Technology forCompetitive Advantages, Geoffrey H. Wold andRobert F. Shriver, Probus Publishing Co., Chicago,1993.8/ See for instance, Paradigm Shift: the NewPromise of Information Technology, Don Tapscottand Art Caston, McGraw-Hill, New York, 1993.9/ Information Systems Strategies for PublicFinancial Management, World Bank DiscussionPaper No. 193, The World Bank, Washington,D.C., 1993.10/ As an aside it could be argued that theproblems of managing commercial operations aspublic corporations stem at least partly from theconflict between macro-level national and micro-level firm policy objectives.11/ “Rolling Expenditure Plans: AustralianExperience and Prognosis” by Michael Keating andDavid Rosalky in Government FinancialManagement, edited by A. Premchand, IMF, 1990.12/ Quote from a Secretary in a Ministry in one ofthe LDCs in which the writers have been working.13/ See the writings of Cooper and Kaplan, eg. TheDesign of Cost Management Systems (Prentice Hall1991) for the basis of this approach.14/ “Activity Based Costing and its Application inthe National Health Service,” CIMA 1993.15/ Material in this section is based on a paperprepared by Dr. Peter Dean of the Department forDevelopment Support and Management Services ofthe United Nations, for the Government of CyprusStaff Seminar on Modern Government FinancialManagement, Nicosia, March 1995.16/ IMF. A Manual on Government FinancialStatistics 1986, para 74.17/ IFAC, Elements of the Financial Statements ofNational Governments 1993, and FinancialReporting by National Governments 1991.18/ GFS Annotated Outline, para. 140.19/ One of the problems of using commercialaccounting packages for government is that they
51
rarely provide for such procedures, which are notnormal commercial practice.20/ Under cash accounting these are often referredto as “below-the-line accounts.”21/ It may be argued that the expenditure reviewprocess represents over-control, in that itdiscourages initiative for fear of subsequentcriticism.22/ IMF, A Manual on Government FinanceStatistics, 1986.23/ Published in 1986, but there is a new draftversion summarized as an Annotated Outline andpublished in 1996.24/ System of National Accounts (1993) preparedunder the auspices of the Inter-Secretariat WorkingGroup on National Accounts of the EU, IMF,OECD, UN and World Bank.25/ GFS Annotated Outline, para. 280.26/ The Economist commented on the new system.“It could be good news for tomorrow’s taxpayers.It is even better news for all the accountants NewZealand has had to hire,” The Economist, 15August 1992, p. 57.27/ Better Accounting for the Taxpayer’s Money,Cmd 2626, London, HM Stationery Office, July1994.28/ International Accounting Standards Committee,Framework for the Preparation and Presentationof Financial Statements, London, 1989.29/ Ibid30/ Ibid.31/ Ibid32/ Trueblood Report in the United States and theCorporate Report in the United Kingdom.33/ See note 28.34/ STRATAC and IFMS, a paper presented to the9th LAC Region Donor Working Group Meetingby James P. Wesberry, Washington, September1991.35/ Ibid36/ From page 1 of Creating a Government ThatWorks Better and Costs Less: Improving FinancialManagement, accompanying report of the NationalPerformance Review, United States GovernmentPrinting Office, Washington, 1993.37/ Core Financial System Requirements, JointFinancial Management Improvement Progam,Washington, 1988. 38/ Official statistics produced by the Governmentof Nepal.39/ Report of the Auditor General of Nepal, 1992-93.40/ Obstacles to good financial management indeveloping countries generally are discussed atgreater length in Foreign Aid Accountability:Perspectives of Donors and Recipients, Department
of Technical Cooperation for Development, UnitedNations, New York, 1992 (TCD/SEM.92/3, INT-01-R79), pp. 23-26.41/ Development Assistance Committee, Principlesfor Effective Aid, Organization for EconomicCooperation and Development, Paris, 1992, p. 33.42/ The history and problems of such projects havebeen reviewed in the Price Waterhouse report forUSAID, August 1987.Other references
K.S. Most, “Sombart’s Propositions Revisited,”The Accounting Review, pp. 722-734, 1972.Y. Ijiri, The Foundations of AccountingMeasurement, Englewood Cliffs, USA, PrenticeHall, 1967.Clive Emmanuel and David Otley, Accounting forManagement Control, Van Nostrand Reinhold(UK), 1985.R.B. Dew and K.W. Gee, Management Controland Information: Studies in the Use of ControlInformation by Middle Management inManufacturing, The Macmillan Press Limited,1973.J.M. Samuels and J.C. Oliga, “The AccountingStandards in Developing Countries,” TheInternational Journal of Accounting, 1982.Michael Keating and David Rosalky, “RollingExpenditure Plans: Australian Experience andPrognosis,” Government Financial Management,
A. Premchand, ed., IMF, 1990.
