Islamic Republic of Pakistan NWFP Provincial Financial ... · Report No.27706-PAK Islamic Republic...

Report No.27706-PAK

Islamic Republic of Pakistan NWFP Provincial Financial Accountability Assessment

January 15, 2004

Financial Management Unit South Asia Region

Document of the World Bank

NWFP Provincial Financial Accountability Assessment

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GOVERNMENT FISCAL YEAR

JULY 1 – JUNE 30

CURRENCY EQUIVALENTS

Currency Unit = Pakistan Rupees (PKR) US$ = PKR 57.57

ACRONYMS AND ABBREVIATIONS

AATI Audit and Accounts Training Institute ADB Asian Development Bank ADP Annual Development Program AG Accountant General AGP Auditor General of Pakistan AGPR Accountant General Pakistan Revenues AMR Annual Maintenance and Repairs CAATs Computer Assisted Audit Techniques CCB Citizens Community Board CFAA Country Financial Accountability Assessment CGA Controller General of Accounts CIA Certified Internal Auditor CoA Chart of Accounts CoC Chart of Classification DAC Departmental Accounts Committee DAO District Accounts Officer DCIC District Citizen Information Centre DCO District Coordination Officer DDF District Development Fund DDO Drawing and Disbursing Officer DDP District Development Program DFID Department for International Development (UK) DIC District Implementation Committee EDO Executive District Officer EDPC Electronic Data Processing Cell EIROP Essential Institutional Reforms Operationalization

Program EPZ Export Promotion Zone FD Finance Department FI Financial FMC Fiscal Monitoring Committee FY Fiscal Year GFR Government Financial Rules GoNWFP Government of North West Frontier Province GoP Government of Pakistan GPF General Provident Fund HQ Head Quarters HR Human Resource IAS International Accounting Standard IIA Institute of Internal Auditors (USA) IMF International Monetary Fund INTOSAI International Organization of Supreme Audit

Institutions

KPP Khushhal Pakistan Program KW Kilo Watt LG Local Government LGO Local Government Ordinance LGRDD Local Government and Rural Development

Department MIS Management Information System PE Public Entreprises MTBF Medium Term Budget Framework NAM New Accounting Model NBP National Bank of Pakistan NGO Non-Governmental Organization NIPA National Institute of Public Administration NRB National Reconstruction Bureau NWFP North West Frontier Province O&M Operation and Maintenance OAG Office of the Auditor General P&D Dept. Planning and Development Department PAD Pakistan Audit Department PAO Principle Accounting Officer PEs Public Enterprises PFAA Provincial Financial Accountability Assessment PFC Provincial Finance Commission PFM Public Financial Management PIFRA Project for Improvement in Financial Reporting

and Auditing PLA Personal Ledger Account PRP Provincial Reform Program PRSP Poverty Reduction Strategy Paper SAI Supreme Audit Institution SBP State Bank of Pakistan SDA Sarhad Development Authority SDC Swiss Development Corporation SORs Schedule of Rates TA Technical Assistance TAO Tehsil Accounts Officer TLF Tehsil Local Fund TMA Tehsil Municipal Administration TO Tehsil Officer TPV Third Party Validation ULF Union Local Fund UNDP United Nations Development Program


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NWFP PROVINCIAL FINANCIAL ACCOUNTABILITY ASSESSMENT STUDY

Table of Contents

Preface iii

Executive Summary 1 System ...................................................................................................................................1 Key Findings..........................................................................................................................1 Recommended Institutional Reforms ....................................................................................3 Recommended Capacity Building.........................................................................................3 Conclusion.............................................................................................................................4

Chapter 1: Introduction 5 Financial Management in NWFP ..........................................................................................5 Objectives ..............................................................................................................................5 Scope .....................................................................................................................................6 Benchmarks ...........................................................................................................................6 System ...................................................................................................................................7

Chapter 2: Public Sector Budgeting Processes 8 Benchmarks ...........................................................................................................................8 System ...................................................................................................................................8 Major Issues with the Current System...................................................................................9 Reform Agenda in Place......................................................................................................12 Recommendations ...............................................................................................................13

Chapter 3: Accounting, Financial Reporting and Internal Control Systems of the NWFP Government 15

Benchmarks .........................................................................................................................15 System .................................................................................................................................15 Accounting, Reporting, Internal Controls, and Internal Audit Issues .................................16 Reform Agenda in Place......................................................................................................18 Recommendations ...............................................................................................................19

Chapter 4: Accounting, Financial Reporting and Internal Control Systems of Local Governments in NWFP 21

Benchmarks .........................................................................................................................21 System .................................................................................................................................21 District Accounting: ............................................................................................................21 Tehsil Accounting: ..............................................................................................................24 Union Accounting: ..............................................................................................................24 Issues ...................................................................................................................................25 Internal Controls ..................................................................................................................26 Fiscal Transfers....................................................................................................................27 Reform Agenda in Place......................................................................................................28 Recommendations ...............................................................................................................29


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Chapter 5: Public Sector Auditing 30 Benchmarks .........................................................................................................................30 System .................................................................................................................................30 Issues ...................................................................................................................................31 Reform Agenda in Place......................................................................................................32 Recommendations ...............................................................................................................33

Chapter 6: Oversight of Public Sector Financial Management 35 Benchmarks .........................................................................................................................35 System .................................................................................................................................35 Issues ...................................................................................................................................36 Reform Agenda in Place......................................................................................................36 Recommendations ...............................................................................................................37

Chapter 7: Action Matrix 38

List of Technical Annexes 40

Annex A: Functional Distribution of Responsibilities Among LGs 1

Annex B: Overall Structure of Accounting, Auditing and Treasury Management in The Local Governments 1

Annex C: Internal Auditing for Local Governments 1

NWFP Provincial Financial Accountability Assessment Preface

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Preface

This document reports on the conduct of the GoNWFP Provincial Financial Accountability Assessment (PFAA) by describing the existing financial systems briefly, identifying the issues and related on-going reform agenda and finally by providing recommendations. The report has been divided into 7 chapters which cover the financial management systems as a whole and each individual component; budgeting, accounting, internal controls, funds transfer, audit and legislative oversight. The final chapter contains an Action Matrix for implementation of the recommendations arising from this assessment. This document will be used as a foundation for the government’s commitment for programs of institutional reorganization and legal reforms and for the implementation of the devolution of financial functions under the local government program. As the financial management structures and systems have their basis in the law (The Constitution, laws, rules, regulations etc.), a legal reform strategy will be required to realign the legislative framework to support the new systems. The report has been reviewed by members of the government-led Steering Committee and appointed Peer Reviewers and discussed at length among various stakeholders through two workshops. The work on the report was undertaken between January to July 2003 by a team comprising World Bank staff, government counterparts, and consultants. The work was carried out through a combination of field study in specific areas, review of existing studies and on-going self-assessment reports of the government, desk research, and extensive discussion and dialogue with concerned stakeholders in the government, private sector, legislature, media, civil society and donors. Mr. Nauman Mahmood, ACA, served as a research consultant to the World Bank and provided the original draft of this Report which was released for review to the peer reviewers on behalf of the government and the PFAA Provincial Steering Committee. The Bank’s PFAA team comprised Hasan Saqib, Arif Yaqub, Mike Jacobs (Lead International Consultant), P.K. Subramanian, Donna Thompson, Anthony Graeme Lee, Paul Wade, Hanid Mukhtar, Zareen F. Naqvi, Ahsan Ali. Ismaila Ceesay carried out the updating of the Report and Altaf Ahmad coordinated the production of the final document. The peer reviewers for this study include Ian Mackintosh, Ijaz Nabi, John Panzer, Parvez Hasan, Riyaz Bokhari (Ex. Auditor General of Pakistan), Jackie Charlton (DFID), Doug Porter (ADB). The PFAA team gratefully acknowledges the cooperation extended by government counterparts, donors, civil society representatives and the support received from other sector units within the Bank. The draft Report was widely disseminated and two workshops were held with the stakeholders to accommodate their concerns in this final report.

NWFP Provincial Financial Accountability Assessment Executive Summary

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Executive Summary

NWFP Provincial Financial Accountability Assessment (PFAA)

The objective of the PFAA is to enhance the Bank’s knowledge of public sector financial management and accountability arrangements in sub-national governments. As a diagnostic tool, the PFAA supports both the Bank’s fiduciary responsibilities by identifying strengths and weaknesses of public sector financial management so that potential risks to Bank funds can be managed, and the Bank’s development objectives by facilitating a common understanding by the borrower, Bank, and other development partners to assist in the design of financial management capacity building programs. The PFAA also assists clients in assessing fiduciary risks associated with the management of public resources. It provides recommendations for strengthening the institutional framework and organizational capacity for enhancing the effectiveness of the Government’s financial management of public resources.

The PFAA is being undertaken in support of the NWFP Structural Adjustment Credit (SAC) and also to support the overall Country Financial Accountability Assessment (CFAA) which was completed in December 2003. The PFAA covers a range of financial management processes, including budget preparation; budget execution; accounting, internal controls, and reporting; external auditing; and legislative oversight. The report is based upon a series of previous studies and extensive consultation with the Government of NWFP.

System The public sector financial management supports the achievement of the economic objectives set through various policies, action plans and strategy papers. The process starts from budgeting in accordance with the medium term objectives being narrated into the annual budget framework. Line departments give their separate budget proposals for the development and recurrent components of the budget. The development projects are appraised and evaluated by the Planning and Development Department whereas the overall budget is compiled at the Finance Department. Budget is debated and approved by the legislature and sent back to the line departments for execution. Board of Revenue and Excise & Taxation are two major revenue administration departments. All receipts are deposited with the State Bank of Pakistan or the National Bank of Pakistan acting as an agent of SBP. The overall funds are managed into two accounts including the Provincial Consolidated Fund and Public Account. There is a separate food account. With a few exceptions, all expenditure bills are submitted to the District Accounts Offices/Treasury Offices which after the pre-audit and budgetary scrutiny issue cheques for payment. Later these offices maintain the accounts of the provincial government. The Auditor General of Pakistan performs the statutory audit as required under the Constitution and submits his reports to the legislature. Public Accounts Committee is mandated by the legislature to perform a detailed legislative scrutiny.

Under the recent devolution program, new structures were created at the District, Tehsil/Town and Union levels which now have a broader mandate than the previous local bodies. New Local Governments will be the sole providers of critical social services including education, health, water supply, and sanitation. As a result, more funds are at the disposal of local governments to be budgeted and spent in accordance with local priorities. Fiscal decentralization is underway but there are certain transition issues adversely affecting financial accountability at the local level.

Key Findings Public financial accountability in NWFP is improving under the on-going reform initiatives but results remain mixed across the overall government financial management system.

• Budget preparation is encumbered by a combination of reliance on the federal government for up to 90% of receipts and very high recurrent expenditures. It leaves little fiscal space for development expenditures and new spending priorities. There is a need to strengthen the relationship between the


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long term planning framework and yearly budgets. Provincial and local budgets overlap which may lead to weak financial accountability. Budgetary process is more procedural and incremental in nature and not directly based on the desired performance outcomes. There is dearth of specialized people in finance and planning offices at the local government level.

• Budget execution has weaknesses in monitoring of spending programs, outcomes, and service delivery

along with the lack of information to track actual versus planned expenditures.

• Accounting, financial reporting, and internal controls are improving but technical capacity and difficult management and organization issues involving both federal and provincial staff cadres need to be resolved. Financial management systems are largely manual except for some in-house computerization activities in 17 out of the 24 districts and roll-out of the new automated accounting system under PIFRA which is currently at the pilot stage. In the short to medium term, hybrid financial records will remain cumbersome and lack the accessibility and flexibility of on-line reporting. At the district and sub-district levels, financial accountability is governed by different rules and procedures. And among local government bodies, the application of these rules and procedures varies considerably.

• External Auditing has developed improved capacity at the provincial level but local audit lacks

capacity and power to audit to the same standards as the AGP. A District Audit infrastructure has been established under the responsibility of the Director General, District Audit. This new office will support the decentralization initiative for local governments.

• Legislative Oversight of budget activities is weak due to limited technical capacity and the uncertain

charter for PACs. To compound the situation, the information PACs receive is often difficult to understand and less timely. In general, there is weak enforcement and implementation of the oversight recommendations. The laws and subsidiary legislation require updating by removing obsolete items and modernizing concepts and terminology.

Overall, the financial management systems in NWFP can be further enhanced to benefit from new developments in systems, budgeting, accounting, and auditing. The on-going PIFRA implementation has already introduced significant changes from past practices in financial management, but a significant investment is required to capture these benefits. As staff resources are assigned to manage the implementation of PIFRA and the devolution programs, they are diverted from existing operations. One example for increased workload during the transition is that DAOs are to maintain separate books of accounts for district governments. These initiatives, while time-saving in the long run, need to be resourced and managed within existing staffing and capacity levels. Although detailed efforts have been made by NRB and ADB for devising new systems that are suitable for devolved local governments, subordinate legislation has yet to be framed and ratified by the provincial government. Legacy provincial systems are being used on the provincial component of finances in the interim. These include the old Accounts Codes with the old Chart of Classification – General Financial Rules. These legacy systems do not meet the full information requirements of the local governments, including maintenance of accounts by cost centers, compilation of records at district level, and financial reporting to local elected representatives. They also lack the consolidation of local government accounts into provincial and national accounts. The Local Government Accounting Manual has recently been notified by the AGP and new initiatives need be taken to implement the manuals consistent with the decentralization strategy. The internal audit function, established in 19 provincial departments, is weak and needs to be revitalized with additional resources along with an enhanced role based on international benchmarks. An internal audit manual has been produced under the auspices of the PIFRA project to support the progressive establishment of functional internal audit units in all governments. The Department of the Auditor General, responsible for external auditing, is faced with new challenges including certification of accounts and audit of newly created


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local governments. There remains substantial pending work for the newly established PAC which requires both institutional as well as resource strengthening.

To address these concerns, it is recommended that the Government of NWFP move forward on two broad fronts: i) continue with on-going institutional reforms while preparing a program for updating legislation and rules to address institutional issues, and ii) embrace capacity building programs being defined under the umbrella of the CFAA, including training, to improve overall financial management, transparency, and accountability.

Recommended Institutional Reforms ♦ The key challenges ahead for GoNWFP will be to sustain and expand the current wide-ranging reform

programs, including PIFRA, to the districts, and to coordinate with federal programs and other provincial projects by cooperation and use of their experience.

♦ Merge provincial accounts in the local governments with their own source revenues and move towards the mainstream budgeting, accounting and auditing processes. Strengthen the continued reform efforts in relation to NAM implementation, reconciliation of accounts, and closure of unnecessary PLAs.

♦ Rationalise the pre-audit framework at all levels and strengthen the internal audit regimes. In addition, the province should initiate the implementation of the LG Accounts Manual which has been notified by the Auditor General after it has received Presidential assent.

♦ Revise the old rules and regulations by making the rules consistent with PIFRA, NAM, and international best practices; eliminating obsolete contents and references; and modernizing the language, terminology, and usage to create consistency across the departments. There is also a need for an on-going mechanism to review adequacy of existing rules and regulations to meet ever-changing requirements. It may be pointed out however that the Government Financial Rules shall be revised under a PIFRA consultancy in the very near future. NWFP would need to gear itself to embracing the new rules as soon as they are notified at the federal level.

♦ Frame the LG Budget Code, LG Internal Audit Rules and Guidelines, LG Procurement Rules and other LG related subordinate legislation. This is important to implement the Local Government Ordinance, 2001 and to move from the transitional systems. Recently, NRB has sent the LG Budget Codes for final review before official issuance. .

♦ Excess budget statements should be prepared and submitted to the legislature.

Recommended Capacity Building ♦ Provide suitable resource levels to manage local government finances in the functions of planning,

accounting, auditing, procurement, and cash management.

♦ Establish LG Internal Audit Offices and reorganize the Tehsil level accounting structures in concert with the office of the CGA and consistent with PIFRA developments in the province.

♦ Actively support the imparting of PIFRA/NAM related training for successful implementation of SAP R/3 in NWFP and integration of data entered at various sites.

♦ Support the simplification of DAO staff reporting lines by resolving the duality of control and related issue of provincialization of accounts in association with the CGA.

♦ Strengthen the provincial PAC secretariat by framing better procedures, providing support, and devising bye-laws for the business of Accounts Committees in LGs to ensure efficient proceedings .


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Conclusion The assessment concludes that there are substantial opportunities for introducing institutional reforms for strengthening public financial accountability in NWFP despite substantial progress already being achieved. There is every indication that the political will for reforms can be sustained. The PFAA provides a time-bound action plan for moving forward on the fundamental areas of reform.

The Bank and the Government of NWFP recognize that building institutional capacity is a process that takes time. Accordingly, this assessment emphasizes the importance of taking actions that both stimulate demand for prudent financial management and build capacity of the government to respond to the public’s requirements for more efficient and effective delivery of services. The government has made satisfactory progress in the reform agenda agreed under a World Bank Structural Adjustment Credit I for NWFP and some of the summary recommendations given above formed part of the extension of the reform measures of the program. These reform measures, when judiciously pursued and implemented, would help to strengthen the systems and capacity required to provide enhanced coverage to the fiduciary risks that may be associated with adjustment lending. The system in place, however, does provide reasonable safeguards for reliance on Government financial accountability systems to ensure that funds are used for the purposes intended.

NWFP Provincial Financial Accountability Assessment Chapter 1: Introduction

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Chapter 1: Introduction

NWFP is the third largest province of Pakistan. It is landlocked as the country’s only port is over 1500 km to the south. Land routes to the north are few and difficult through a hilly terrain. The province itself is largely mountainous, with only 30 percent cultivated land. Nearly 50% of the population live in the mountainous and arid areas. NWFP shares a long border with eastern and southern Afghanistan and most of its population has the same ethnic background (Pushtoon) as parts of bordering Afghanistan. Over the past two decades, NWFP has been the frontline province vis-a-vis Afghanistan, hosting more than two million Afghan refugees. With around 13% of Pakistan’s population, the estimated per capita income of the province is around 30% lower than the average for Pakistan. Historically, the provincial economy has been mostly dependent on agriculture (livestock, timber, tobacco, horticultural production), services, public employment especially in the armed forces, and low skilled workers remittances from inside and outside the country. The province has been growing at a low rate for a number of years while population has been fast increasing (including the influx of Afghan refugees) which has led to depleting natural resources and under-development. NWFP has a weaker resource base than other provinces, and value-added in agriculture and most industries is very low. NWFP derives one-third of its income from largely traditional agriculture but remains dependent on food grain produced in other provinces to feed its population. The Province faces difficult and unique development challenges due to its geography, history and location. It is one of the poorest provinces in Pakistan with 31% of the urban and 47% of the rural population living below poverty line. The social indicators are equally poor with highest level of gender disparities. Close to 90% of provincial receipts come from the federation (including WAPDA), reflecting the very limited provincial tax base. Financial Management in NWFP GoNWFP has adopted a comprehensive medium-term fiscal strategy which includes: (i) increasing provincial revenues through further tax reform and accelerating user charge increases and saving interest payments through improved debt management; (ii) divesting inessential activities; (iii) implementing fiscal devolution; (iv) improving budgetary process, financial management, procurement process and transparency; (v) strengthening the legislative oversight arrangements; and (vi) formulating a medium term budget framework. Objectives The NWFP PFAA has three objectives:

a) Provide the underpinning fiduciary risk analysis for program and adjustment lending, where there is to be reliance on Government financial accountability systems to ensure funds are used for the purposes intended.

b) Articulate short, medium and long term requirements for strengthening financial accountability in NWFP – to provide a base for client dialogue and for supporting related capacity building and policy reforms.

c) Provide an overall framework for the financial management-related agenda, accountability in implementing agencies which receive and manage Bank funds for project implementation.

The Bank and the Government of NWFP recognize that building institutional capacity is a process that takes place over time. Accordingly, this assessment emphasizes the importance of taking actions that both stimulate demand for prudent financial management and build capacity of the government to respond to the public’s requirements for more efficient and effective delivery of services. An action oriented approach for


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strengthening public financial accountability and management is crucial for economic growth and sustaining a strong economy. Scope

The PFAA is being undertaken, in the main, in support of the SAC for the Province and also to feed into the Country Financial Accountability Assessment (CFAA) which has now been finalized. The report includes a review of:

a) Previous assessments of the accounting, auditing and related legal frameworks to determine their compatibility with the needs of the province as well as with internationally accepted accounting and auditing standards

b) Financial architecture for public sector accountability including: planning and budgeting, treasury operations, disbursement and receipts, accounting systems, internal control, internal audit, and related practices at the provincial, district, tehsil and union levels

c) Roles, responsibilities, powers and expertise of the provincial finance department, Principal Accounting Officers and PACs as they relate to accountability arrangements along with the existing processes and systems and associated impacts on legislative oversight.

The conduct of the NWFP PFAA is one of the requirements of the $90 million Structural Adjustment Credit agreement with the World Bank. Benchmarks The objective of good public sector financial management is to ensure proper utilization of public resources. This can be achieved by improved financial transparency, accountability, adequate systems used by trained personnel.

REVENUE ESTIMATES

A MODULAR VIEW OF GOVERNMENT FINANCIAL MANAGEMENT

DEVELOPMENTPLANS

FISCAL

TRANSFERS

PERFORMANCE

DATA

DEVELOPMENT BUDGETS

BUDGETING ACCOUNTING AUDITFINANCIAL REPORTING

SERVICE COSTESTIMATES

PROCUREMENT

TREASURY

DEBT

Fiscal Year Fiscal Year

MANAGEMENT

FINANCIAL

POLICY

OPERATIONS

Fiscal Year

PAC


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System

The PFAA has been so devised to cover the whole public sector financial management system. The above diagram presents a two-year cycle of financial management describing various modules of financial management which contribute to effective financial governance and accountability. All these modules prevail in the province’s financial management system, and institutions and structures are in place to service these processes on a continuous basis. The public policy set by the provincial Cabinet directs the planning and budget-making processes which lead to execution, disbursement and accounting of operations. Internal controls are defined in the form of financial rules, delegation of financial powers, pre-audit, budgetary control, segregation of responsibilities, centralized accounting etc. Audit observations along with other information are presented before the Public Accounts Committee, which exercises the legislative oversight.

There are some computerization initiatives but the core systems of financial management are maintained mainly through manual processes.

NWFP has been selected as a pilot province for PIFRA implementation thus envisaging a significant shift from the past practices in the area of financial management. The PIFRA supported computerized accounting system (NAM, SAP R/3) has been installed in the AG & AGPR offices and District Accounts Offices at Swat and Mohmand Agency (at Ghallanai). The province is by far the most advanced in the implementation of the PIFRA in Pakistan. Training, under the project, in the areas of financial information management, human resources and the system administration modules in preparation for the roll-over launch of the system is in progress in Peshawar. This will cover the 7 roll-out sites (Kohat, Bannu, D I Khan, Nowshehra, Charsadda, Mardan and Haripur) envisaged to be made operational under PIFRA by May, 2004. At present, the PIFRA SAP R/3 system is being implemented successfully at the first district pilot site at Abbotabad, has been operating at full production over the past 6 months. Later the model will be replicated to other districts which will finally lead to roll out to all locations including 24 DAOs, FD and other offices. The NRB, with support from the ADB, has devised new systems suitable for devolved local governments. As yet, the system has not been rolled-out by way of implementation, any of the 4 provinces of Pakistan to meet the information requirements of the local governments, including maintenance of accounts by cost centers and amalgamation of figures into provincial and national accounts. The successful implementation of the new systems would logically complement the progressive roll-out of the PIFRA system since the current architecture of PIFRA includes a district functionality for accommodating the requirements of lower tiers of government.

NWFP Provincial Financial Accountability Assessment Chapter 2: Public Sector Budgeting Processes

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Chapter 2: Public Sector Budgeting Processes

Benchmarks Good public sector budgetary processes aim achieving three things: (i) ensure that the aggregate fiscal framework is consistent with economic stability: i.e. an environment of low and stable inflation and interest rates, predictability and adequate financial resources for private economic activity; (ii) allocate public expenditures in line with national policy goals of growth, attain allocative efficiency, and equity; and (iii) transparency and accountability in the preparation and implementation of the budget to ensure that public expenditures are spent as intended and are effective. Clarity of roles and responsibilities within the public sector, public availability of information, well defined and open budget preparation processes, greater emphasis on outputs and outcomes of budgets, reliable accounting and monitoring of expenditure and outcomes of public expenditures, and timely dissemination of this information, as well as independent audit of budget expenditures are the desired goals of a good budget process. System

Budget preparation is based on well-defined timetables in the GoNWFP. On the expenditure side, 8 to 10 months before submission of the budget, circulars issued by Finance and Planning and Development Departments initiate the preparation process. In these circulars (known as Budget Call Circulars), agencies are requested to submit:

• A statement of permanent expenditures on the recurrent budget and proposals for new expenditures, and

• Projected expenditures on existing projects, and as well as proposals for expenditures on new projects, in the case of the development budget.

The review of the budget proposals varies greatly depending on whether the expenditures are “permanent” or are “new”. The bulk of the budget — more than 90% in the case of the recurrent budget — is covered by existing expenditures and is treated as fixed and not subject to review. All establishment (i.e. personnel) and pension costs, un-allocable charges, debt servicing charges, and office administration fall under “old” or “fixed” expenditures. The projects in the Annual Development Program (ADP) are examined by a Committee. There are also detailed rules on the approval procedures for new projects in the ADP depending on the size of the project. The Finance Department and respective line Departments review new items of expenditure. Large investment projects undergo more systematic review of their Project Concepts (PCs) through the review of the project proposals, and their investment and recurrent expenditure implications in future years.

The Finance Department and P&DD review proposals for new expenditures for the recurrent and development budgets respectively and enter into negotiations with the line departments on the size of their proposals. This process of bilateral negotiations is continued until March or April (at this time the revised estimates of the ongoing year — based on nine months of actual expenditures and three months of projected expenditures — are also prepared). Negotiations with line departments are closed after expenditure aggregates have become consistent with revenue forecasts and later fine-tuned after the approval of Federal Budget where the amount to be transferred to GoNWFP is indicated. Finally the budget is presented to the legislature for final approval.

During the budget execution re-appropriation, powers are distributed at various levels. Principal Accounting Officers are required to submit a statement of excesses and surrenders at specified times and in specified forms to Finance Department. If funds for excess expenditures are not available within grants, then a Supplementary Grant can be approved by the Finance Department on a temporary basis. All supplementary grants are subject to approval by the legislature sometimes under the approval of a supplementary budget and sometimes under the approval of the revised budget, which is approved at the time of approving the next year’s budget. Normally, the revised budget is approved by the Assembly on a fait accompli basis.


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The Secretary of the Department is the Principal Accounting Officer (PAO), and is explicitly accountable for the proper implementation of the budget, except in cases where overruled by the Minister. There are procedures for a mid-year review of the budget based on reconciled accounts, so that a strategy for budget implementation for the rest of the fiscal year can be formulated.

Appropriation Accounts are prepared by the Accountant General. These are discussed along with Finance Accounts and Audit Reports by the PAC. The appropriation accounts present a variance analysis of actual versus budgeted expenditures. There is requirement for the preparation of an Excess Budget Statement for submission to, and ratification by, the legislature.

Major Issues with the Current System a) Budget Preparation

Approximately 90% of provincial receipts come from the federation, including the net hydel profit payable by WAPDA, and there is a very limited provincial tax base. The resource mobilization is not easy considering the nature and the spread of the tax base that the provincial government can levy. Studies are underway to measure the tax potential. This high level of dependency on the federal receipts makes judicious financial management more difficult. The province has run fiscal deficits and cuts have been imposed on developmental and non-salary expenditures.

i) Dearth of specialized people in finance and planning offices at local government level: There is

a shortage of technical staff in the finance and planning discipline. There are a large number of vacant positions in various offices. The Province has followed a rigid restraint in recruitment for the past five years. Positions have also been abolished through attrition. Persons with appropriate skills are short in numbers. There are plans under which positions in District Governments are being rationalized. These reductions in staffing would need to be accompanied by appropriate reorganization and assignment of duties supported by necessary training.

ii) Emphasis of scrutiny on new/continuing expenditures: The budget planning focuses on “new/continuing” expenditures (only about 10% of the budget). “Permanent” expenditure status is achieved by the maintenance of ‘new items’ in the budget for more than 5 successive years. This means that about 90% of the budget is considered to be beyond intensive scrutiny and these constraints militate against application of proper budget analysis. This approach towards permanent expenditures needs to be changed.

iii) Annual budget framework: The project planning framework for small projects has been annual and has not ensured budgeting for O&M (annual maintenance and repairs or AMR). There are weaknesses in the implementation of project monitoring and evaluation systems. Maintenance expenditures for completed projects sometimes continue to be financed by the development budget.

iv) Project Appraisal: Appraisal criteria for estimation of costs and benefits, and provision of AMR need improvements. The SoR Norms (are much less than the total value of the facility) and contribute to under-funding of projects.

v) Motivational and incentive mechanisms in place: The motivational and incentive mechanisms in place consist of honoraria based on the workload and input in the process of budget preparation. Improved incentive systems are needed. The Provincial Finance Controller has been appointed to initiate and lead the NWFP financial management reform program. There are provisions for incentive based honorariums in the Local Government Ordinance, 2001 and some District Governments are considering their implementation.

vi) Need for evaluation of expenditure levels from district to district: North-West Frontier Province consists of twenty-four districts spread between the tribal area on the West to Punjab in


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the East and Azad Jammu and Kashmir in the North. The Province borders Balochistan in the South. There is a great diversity in population patterns, urbanization, industrialization and development across districts.

There seems to be a horizontal imbalance among the actual allocations of budget amounts to districts in the absence of any evaluation of respective public expenditure levels and justification of the variation. For example, Haripur, Lakki Marwat and Malakand are almost equal in terms of population size but represent three different levels (minimum, medium and maximum) in terms of government expenditures. There is a formula for allocations for the provincial development funds into districts. There needs to be some assessment of the actual recurrent expenditures from the provincial budget to different districts and application of certain criteria for per capita expenditures should be considered. Devolution of certain functions to local governments has partly addressed the problem by allocating funds on certain bases under the Provincial Finance Award.

GoNWFP has taken steps in making medium term sectoral interventions in priority areas and linking those with the medium term budget projections in the Annual Budget Statement. The P-PRSP has been developed and has been fed into the country PRSP, thus resulting to the fine-tuning of the medium term plans earlier prepared.

vii) Lack of systematic connection between the recurrent impact of development projects with the

fiscal space in future years: Most recurrent expenditures are pre-committed to wages. A key issue is the sharp distinction between the recurrent and the development budgets. The latter, in principle, costs outputs and sets strict resource envelopes for individual development projects. Likewise, in principle, the future recurrent costs of the Annual Development Program (ADP) are estimated at the project design stage. In practice, existing procedures do not ensure use of this information for the assessment of the sustainability of the ADP. Moreover, budgeting for almost all the resources under the recurrent budget takes place in a strictly incremental manner. These rigidities are a feature of the formal process of budget preparation. Development needs to be in line with the needs and availability of resources in the long-run.

viii) Income estimation: There are recent efforts by GoNWFP to ascertain the tax potential in different areas. Information on the resource base would help in deciding on policy changes in the tax structure and rates. Currently, information about actual previous receipts is used but these data are only relevant for the short-term and not the long term future of possible policy measures.

Revenue estimation has some inherent weaknesses at the provincial level. The Province now receives about 90% of their funds from the federal divisible pool (including WAPDA) and it is difficult to estimate any shortfall in these transfers with any regularity or accuracy. This produces fiscal instability as revenues do not materialize during the year, rendering effective service delivery nearly impossible. Unpredictability of funding within and between years contributes to poor operational performance.

ix) Separate budgets for provincial and local funds in the local governments: About 30 provincial

departments have been devolved to district level along with more than 10 new offices envisaged. These offices are planned to be merged and restructured to form 11 groups of offices and different sections of old local bodies are to be amalgamated. The first phase involved combining under the EDO. The complete restructuring can only be done after the resolution of civil service structure issues. The budgeting is also done in a transitional manner where two separate budgets are being made. One for the devolved departments managed with the provincial receipt money and the other for old local body institutions managed with the own source receipts. These budgets are increasingly becoming overlapping therefore causing problems. This may ultimately lead to weak financial accountability.


11

Under the revised LGO 2001, there has to be one fund at each tier/level. District Governments should have District Fund and Tehsil and Union Administrations should have their respective Tehsil/Union Local Funds. Merging of two funds is yet to be achieved.

x) The guidelines provide an incremental budget framework and budgets not effectively linked

to performance or program implementations: The budget call letter and other guidelines usually make reference to increment levels in the budget preparation documents that effectively make the process an incremental budgeting exercise.

xi) LG Budget Code has not been framed: The LG Budget Code has not yet been framed, notified and rolled out by the provincial government and therefore the budgeting is being done in a transitional manner. Recently, a draft LG Budget Code has been received by the Government and it will need to be finalized by giving a high level of priority.

xii) Estimate of establishment expense: The salary component is a major component of the annual expenditure. This is estimated on the basis of number of posts sanctioned and is not a realistic estimate of the actual people posted. The vacancies can be filled anytime; the budget provision is made according to the sanctioned strength. This causes over-provision of budget amounts which are then claimed as extraordinary savings which can be re-appropriated to cover surplus on other heads or meeting the budget deficit. This systematic unrealistic budgeting practice also results in high variations of actual figures from the initial budget.

b) Budget Execution and Monitoring

i) Procurement procedures: Procurement procedures and their implementation have been reviewed to allow for improved transparency. Work on this has been completed as part of PRP and the public procurement law has been passed. Operating Rules for procurement of goods, works and services have been notified on 29 November 2003. The province, through the Planning Department, has also notified the type of bidding documents to be used, based on the model recommended by the Pakistan Institute of Engineers. What is required now is the enforcement of the application of the rules at all levels of government to reinforce accountability and transparency.

ii) Pre-audit conducted by the DAO: Expenditure controls during implementation rely on pre-audit,

which is cumbersome. These controls increase procurement costs and encourage corruption attempts to circumvent them. At times, the pre-audit is ineffective and only procedural in nature. The DAO relies, essentially, on the statement of DDO/PAO that “all the requisite formalities have been met”. Modern control-based accounting systems segregate ‘authorizing’ and ‘certifying’ functions within the line process, supported by proper record keeping, internal and external audit scrutiny, and disciplinary processes for dereliction.

iii) Since there is still a strong opinion at the provincial level that the pre-audit function acts as an

effective deterrent to fraud and irregular payments, it should be strengthened through increasing powers, rationalization of checks and building capacity of DAO staff

iv) Weak Monitoring and Evaluation of Development Projects: Development projects have suffered

from (a) delayed releases caused by inaccurate estimation of revenues and/or transfers of funds to other project priorities, (b) design changes during implementation that were not approved, (c) lack of monitoring of physical progress because departments viewed projects as their responsibility and resisted intrusions by P&D departments and (d) PC-3 used for quarterly progress review is not being filled in.

v) Excess Budget Statement: Excess Budget Statement is an important requirement which is to be

prepared after the PAC recommendations for ratification. This completes the accountability cycle.


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The practice of preparation and submission of Excess Budget Statement is not being regularly followed.

Reform Agenda in Place

The GoNWFP has agreed a range of actions to improve budgetary transparency and performance with the World Bank under the Structural Adjustment Credit. This package of technical assistance will support actions targeted to achieve outcomes as follows:

• More reliable, comprehensive, timely and accurate information pertaining to provincial and district government financial transactions.

• Improved internal control environment. • Improved financial management of all levels of NWFP government. • Improved external audit and legislative oversight. • More open and answerable government.

Other reform measures taken by GoNWFP include the following:

a) GoNWFP has approved a Medium Term Budget Framework (MTBF) for FY03-05, to strengthen the provincial finances and help implement the Provincial Reform Program. The projections are included in the published Annual Budget Statement 2002-03. DFID is providing technical assistance to the federal government on the MTBF. NWFP is also eager to capitalize on these central efforts and earlier efforts made in this respect in order to move towards a complete MTBF.

The comprehensive MTBF is to be implemented in a phased manner. It is expected to have a major impact on the budget management of the government by:

i) (a) formulating realistic projections of budgetary resources; (b) stressing program budgets that

improve expenditure prioritization and removes the artificial bifurcation between recurrent and development budgets; (c) better accounting of government’s "extra-budgetary" transactions; (d) inclusion into the budget as a memorandum item of government’s "deferred" (including pensions and Provident Fund) and "contingent" liabilities; and (e) a general shifting of the budgetary focus from inputs to outputs and outcomes;

ii) issuing the "Budget Call Circular" with a number of provisions aimed at improving budget

preparation in line with the requirements of an MTBF, including information required from each line department on their mission statement and performance indicators against which their budget requests can be evaluated;

iii) taking the decision to reform the Budget classification that would enable budget presentation and

accounting to be carried out uniformly consistent with the new chart of accounts in the NAM as well as with the new GFS/COFOG classification; and

iv) preparing reports on public debt and GoNWFP contingent liabilities that will be presented in a

transparent way alongside the budget.

b) Appointment of Provincial Finance Controller (PFC) with the main task to implement financial management and public financial accountability reforms. In addition, he is responsible for accounting and financial reporting (jointly with the AG), developing provincial capacity to handle accounting and payroll, organizing finance and accounting functions of the government, staffing and training, internal controls and audit, financial policies and procedures, and addressing audit observations and systemic issues.


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c) Setting up of Fiscal Monitoring Committee (FMC) that monitors budget implementation, making the consolidated government’s quarterly fiscal accounts publicly available, and presenting statements of contingent liabilities and tax expenditures in the Annual Economic Survey of FY 2000-01.

d) Essential Institutional Reforms Operationalization Program (EIROP) funded by UNDP and SDC, is

underway which provides support to decentralization reform, focusing on creating district citizen information centers (DCICs) for transparency. There is a long menu of activities that GoNWFP is going to execute through EIROP including institutional development/strengthening and capacity building at the district and sub-district levels.

e) In case of NWFP there has been a readiness to move ahead with Citizens Community Board (CCB)

operationalization on which other Provinces have remained reluctant. This has been in the form of finding a solution in which the local councilors can find more ownership of the CCBs which is not a definitive mechanism. In contrast with other Provinces, the NWFP has a long experience in participatory development. Various donor-funded projects in the last one decade have been designed and implemented using this methodology. A large number of community-based organizations exist in addition to NGOs. These will be eager to utilize the CCB mode for local development.

f) Punjab has moved ahead with Performance Based Budgeting (PBB) in the two out of the thirty four

Districts. In the first phase it is also attempting PBB in two Province Departments. This is a DFID assisted effort. It has also moved on providing basic training to finance and planning personnel in the LGs. NWFP has a strong desire to learn from the experience of Punjab in PBB.

g) Restricted use of Personal Ledger Accounts (PLAs): PLAs are used for the amounts allocated to

government departments. The cheque books are kept with the departmental authorities who draw cheques. The respective DAO checks the funds availability and accounts for the transaction. The payment is made by the SBP in the same manner as applicable for normal treasury cheques. Except for some specific purpose grants, all other PLAs are lapsable on the close of fiscal year and need to be recouped by the next budget. GoNWFP is closing the unnecessary and non-operative PLAs.

Assignment accounts are accounts opened with the National Bank of Pakistan and a ceiling is allocated to the operating authority. National Bank makes payment when the cheque is presented and later claims the amount from SBP. Finally the record of payments comes to DAO; therefore no budgetary control is exercised on Assignment Accounts. Assignment Accounts are usually used for donor-funded projects. Recently the procedure for operating Assignment Accounts has been improved by the CGA and is being implemented in the province.

Recommendations a) Reinforce the Initiation of Performance Budgeting:

Provincial and Local Governments should start preparing and executing budgets on the basis of (1) estimated service costs, (2) planned sectoral priorities, (3) evaluated past year expenditures. They should build up operational capacities to prepare and implement performance-based budgets by setting targets and standards for services within a framework of integrated physical results and financial/accounting performance reporting. As initiatives have already been taken in this direction, a practical model of PBB can be effectively implemented within a couple of years. Availability of funds must be projected beyond a single year and the needs must be prioritized and consistent with the framework that encourages performance-based budgets and the analysis of means-ends. As a matter of priority, however, the PIFRA architecture would need to be assessed as to its potential to service the needs of PBB preparation, even through interface basis.


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b) Implement the Medium Term Budget Framework: Sectoral MTBF - Local conditions may require beginning with sectoral MTBF. This requires proper estimation and definition of sectoral resource envelope, review of financing mechanisms, and preparation and prioritization of expenditure plans.

Chapter 3: Accounting, Financial Reporting and Internal NWFP Provincial Financial Accountability Assessment Control Systems of the NWFP Government

15

Chapter 3: Accounting, Financial Reporting and Internal Control Systems of the NWFP Government

Benchmarks

Key principles which are generally relevant to good accounting, financial reporting and internal control are: (i) the quality of the control environment, particularly the accountability chain within the civil service, the ethical framework and competence of the staff assigned to the functions; (ii) the clarity of the roles and responsibilities; (iii) the scope of accounting and internal control policies and procedures; (iv) the capacity and reliability of accounting information system to provide timely and accurate information consistent with International Public Sector Accounting Standards; and (v) the adequacy of monitoring and risk assessment systems. System Drawing & Disbursement Officers (DDOs) submit bills for expenditures for endorsement of payment authorization to the DAO. DDOs are nominated officers in the spending departments. DDOs also keep records of financial transactions made by these departments and the PAO of the department draws departmental financial statements from these records. The accounting at all levels is on cash basis and accruals are only made in respect of some public debt instruments. Separate stock registers are maintained to record assets.

The following figure presents the system of accounts headed by the CGA. Provincial AG reports the provincial accounts to CGA which are based on the summaries obtained from the DAOs/TOs. The DAO plays a central role in the process as he receives the bills from DDOs, performs pre-audit and exercises budgetary control before endorsing payment requests to the State Bank of Pakistan or National Bank of Pakistan as an agent of SBP, and finally records in the transaction in the government accounts.

The World Bank’s Project for Improvement of Financial Reporting and Auditing (PIFRA) is in its pilot phase and the accounting and financial reporting manuals have been developed. The project is introducing automation, standardization and increased coordination of DAOs with the Accountant General and the

AGPR & Its SUB OFFICES

MAG & Its SUB OFFICES

CONTROLLER GENERAL OF ACCOUNTS

GM (MIS)PROJECT COORDINATOR

PIFRA

PROVINCIAL AGs

DISTRICT ACCOUNTS OFFICERS/

TREASURY OFFICERS PROVINCIAL FINANCE

DEPARTMENTS

DDOs SUB TREASURIES

DISTRICT GOVERNMENT

CHIEF AO –DEPARTMENTALISED

ACOUNTS

PWD Divisional Accountant

Stat

eB

ank

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akis

tan

–as

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16

Auditor General of Pakistan. The project also envisages a change-over to double entry accounting system and modified cash/commitment basis for the financial reporting. This, in itself, does provide for the production of financial reports in conformity with the IPSAS Cash Basis of Accounting. Accounting, Reporting, Internal Controls, and Internal Audit Issues a) Old accounting procedures

i) The accounting procedures are very old and difficult to learn. ii) The combined accounts codes are very detailed and not user friendly and many chapters/details

stand obsolete due to changed environment over the years. b) Method and basis of accounting

The method of accounting is single entry and cash basis of accounting is used for accounting of transactions. The single entry method gives chances for misappropriation and misstatements. It does not provide an enabling environment for the accrual basis of accounting planned as part of the NAM. Cash basis of accounting does not follow the matching principle where the revenues could be matched with related expenses to arrive at surplus or deficit. Modified cash basis, from which an IPSAS standard of cash basis of accounting report can be derived, shall provide acceptable financial reports giving relatively a fairer view of the government financial statements. This is a transitional issue, as PIFRA supported implementation of NAM will improve the method and basis of accounting to double entry and commitment bases respectively.

c) Record of assets

The record of assets (dead stock register) is not being integrated in, or reconciled with, the accounting records and thus no asset accounting is being done. Again, PIFRA implementation provides for asset accounting, and the challenge is to collect and feed the data relating to the public assets in existence.

d) Food Accounts

Food account with SBP is mainly maintained for the wheat trading by the provincial government and is known as Account No. 2. All the receipts and payments relating to sale and purchase of wheat respectively are dealt with in this account. Proper income and expenditure statements and running accounts statement to indicate the net annual activity are not being prepared. There is a need to keep accounting/costing records of stocks and incidentals separately. The net activity in this account is included in the annual budget of the provincial government so providing an indirect disclosure of the viability of the trading activity.

e) Chart of classification – function-cum-object; the function element is used in a multipurpose

manner and causing inconsistencies: The legacy "Chart of Classification", of Provincial Government Receipts and Disbursements constitute Appendix 2 of the Account Code, Vol. I, and has been issued by the Auditor-General of Pakistan, with the approval of the President, under Article 170 of the Constitution of Islamic Republic of Pakistan, 1973, forming part of the Provisional Constitution Order, 1981. The Chart of Classification coding is used by the provincial government for classification of receipts and expenditures in appropriate heads of accounts on which the consolidated accounts are based upon. The Budget of governments is also allocated in the same classification. The Constitution provides for the Consolidated Fund and the Public Account. All revenues received by a Government, all moneys received by it in repayment of any loans and the Public Debt raised by it are


17

credited to the Consolidated Fund. The expenditure on Revenue or Capital account or on servicing the Public Debt is debited to it. The Public Account comprises all other moneys received by or on behalf of a Government or those deposited with courts of law and the remittances, suspense accounts etc. The receipts in the Consolidated Fund are classified by assigning a Major Head, a Minor Head and Detailed Receipt Head. The expenditure is classified in two segments, one for the ’Function Classification’ and other for ’Object Classification’. In addition to these coding structures, one digit segment is assigned to the left of expenditure code to identify recurrent and development expenditures met from revenue and capital receipts respectively. These accounts coding schemes have some deficiencies. In practice, the Drawing & Disbursing Officers (DDOs) are allotted separate identification codes, so as the District Accounts Officers (DAOs) etc. and the actual coding structure goes to 20 or more digits to identify each transaction separately. Further, the existing structure of Functional classification cannot be consistently applied to identify any specific data element. At places it identifies a Department or a Division’s Headquarters, at another place it refers to a function or an activity and at certain other places it even identifies the objects of expenditure. The examples of such inconsistencies can be found, among others, in the following:

- 00000 - 02000 - 02100 Finance Division (An office) - 02800 Superannuation and Pension (An activity) - 00000 - 03000 - 03001 Commerce Division (An office) - 03304 Import and Export Control (A function) - 03305 Export Promotion Bureau (An attached department) - 03308 External Exhibitions and Fairs (An object)

It is the result of this inconsistency that both the Budget and Accounting Offices are constrained to use additional codes, outside the COC, to identify division, attached department and field offices or DDOs, grant number and other areas.

The NAM Chart of Accounts is so devised to cope with all the above stated anomalies and therefore will improve the provision of accounting information and the state of financial accountability.

f) The classified abstracts not utilized as statements containing information by the Principal

Accounting Officers: The classified abstracts other such statements that are generated by the accounting system are useful for principal accounting officers but these are seldom utilized. A very important role of an accounting system is to provide the required financial information for the purpose of facilitating the process of management decision making.

g) The internal audit function:

Although some positive strides have been made in the establishment and operation of Internal Audit Units at the provincial level, the prevalent internal auditing systems have proved to be faulty and ineffective, and the internal audit staff lack the necessary expertise for performing the traditional roles and responsibilities of internal auditors. This is affecting the whole framework of internal controls and financial accountability systems. Initially internal audit units were established in four main departments including Health, Education, Police and Public Works Departments and these have been asked to send their annual reports to the Provincial Finance Controller. The GoNWFP has now notified the establishment of Internal Auditors in all other provincial departments. The scope taken is too narrow, usually junior staff with low institutional support have been assigned to conduct the audits, and duplication of work with pre-audit activities are some of the lacunas in the system that made it quite ineffective in the past. Also, the internal audit function has not seen as a stand-alone activity. It is merged with other functions responsible for the preparation of departmental budgets and accounts. At the


18

moment, internal auditors are deployed, on part-time basis, from a cadre of DDOs and are expected to carry out introspections of the internal control environment annually rather than focus on reviews of systems and procedures on an on-going basis in order minimize the incidences of fraud and embezzlement otherwise identified and reported through the external audit process. Under PIFRA however, the system of internal audit will be fully revitalized in all government departments.

h) Shortage of adequately qualified staff supporting DDOs:

There is a shortage of accounts-knowing staff to assist the DDOs in following the prescribed rules and regulations especially in the Education and Health departments. The DDOs and their assistants have to be properly trained, particularly when the rules are changed.

i) Internal Controls in Public Enterprises:

Key principles relevant for Public Enterprises (PEs) include: independence and autonomy of the management board in the case of commercially oriented PEs.; accountability and competence of the management; financial management and accountability rules based on clear legal foundations; use of IAS for preparing accounts including good public disclosure standards; use of independent auditors for auditing. The overall accountability arrangements of PEs in the province would need resuscitating for compliance with international best practice.

j) Public Accounts, Inter-Government Accounts, Suspense Accounts, Receipts etc. Reconciliations:

Public Accounts, inter-government accounts, suspense/sundry accounts, deferred liabilities and public debt have not been reconciled on a periodic basis. This may affect the accuracy and presentation of the Finance Accounts of the provincial governments in addition to causing delays. Periodic reconciliation framework for the receipts records in the line departments with those of the Bank and Accounts Offices is not ensured for all collections. The accounting mechanisms for the foreign aided (both grant and loan) projects and reconciliations of project accounts with those of SBP, Economic Affairs Division and AG have been reviewed under the auspices of the CGA. A comprehensive reconciliation framework will soon be prepared and implemented under the PIFRA project to provide real time reconciliations of accounts when the project creates the necessary interface between CBR, SBP, NBP, AG and DAOs.

Reform Agenda in Place a) GoNWFP is committed to improve the quantity and quality of fiscal information disseminated to the

public to ensure fiscal transparency and thereby strengthen financial accountability. b) Upgrading of computerization systems at twelve major DAOs covering close to 60% of provincial

transactions. c) GoNWFP has been the first provincial government which presented the reconciled and compiled

Consolidated Fund expenditures and receipts of the province as well as for the district to the CGA for the fiscal year 2001-2002.

d) Establishment and functionalization of Fiscal Monitoring Committee (FMC) and Departmental Accounts

Committees (DACs), as well as the appointment of a Provincial Financial Controller e) GoNWFP is committed to implement the integrated financial management system (PIFRA supported

reforms) which can meet internationally accepted standards of completeness, accuracy, reliability, timeliness and usefulness. It wishes to situate the responsibilities for accounting functions in a manner that promotes ownership of and accountability for good financial management within the executive arm of Government. It seeks to establish the public accounting system as a robust platform for transparency in the management of public funds, for economic decision making within Government to promote program


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efficiency and effectiveness, and for provision of auditable financial information to various stakeholders within the province and federation as well as to donors and international financiers. PIFRA Pilot sites located in the province have achieved tremendous implementation progress.

f) GoNWFP is also making satisfactory efforts to accomplish the financial management and accountability

goals set in the context of the IMF Stand By Arrangement and the World Bank’s Structural Adjustment Credit.

g) Improvement of the timeliness of monthly reconciliations of Provincial accounts with financing sources,

bank records, and line department records, underpinned by full implementation of CGA instructions for daily bank reconciliations at district level.

h) The role of FMC and DACs has remained very effective and reconciliations of receipts and expenditures

are done in a timely manner. Reconciliation between the AG and the SBP has also improved substantially. Reconciliation with DDOs and for the departmentalized accounts like PWD and forestry has always been an issue, but recently there have been efforts to streamline it. New instructions from CGA regarding the reconciliations have improved the situation.

i) GoNWFP is reducing the role of public sector where the private sector can effectively meet the market requirements through asset lease or outright privatization.

Recommendations a) Continued commitment to the reform agenda in place:

Since the reform agenda by GoNWFP and PIFRA supported actions, including the comprehensive reconciliation framework to be devised under PIFRA, cover major issues, full, sustained and unflinching commitment for their success is advocated.

b) The classified abstracts and appropriation accounts not utilized as statements containing

information by the Principal Accounting Officers:

Accounting information should be disseminated to the relevant stakeholders in an accurate and timely manner and efforts must be made to increase the use of this information in the decision making.

c) The internal audit function:

Some positive strides have been achieved in the establishment and operation of Internal Audit units at the Provincial level. Initially internal audit units were established in four main departments including Health, Education, Police and Public Works Departments and these have been asked to send their annual reports to the Provincial Finance Controller. The GoNWFP has also notified the establishment of Internal Auditors in all other provincial departments. The prevalent internal auditing systems in the public sector have proved to be faulty and ineffective. The scope taken is too narrow, usually junior staff with low institutional support have been assigned to conduct the audits, and duplication of work with pre-audit activities are some of the lacunas in the system that made it quite ineffective in the past. Also, the internal audit function has not been as a stand-alone activity that does not in itself constitute part of the team preparing departmental budgets and accounts. At the moment, internal auditors are deployed, on part-time basis, from a cadre of DDOs and are expected to carry out introspections of the internal control environment annually rather than focus on reviews of systems and procedures on a on-going basis in order minimize the incidences of fraud and embezzlement otherwise identified and reported through the external audit process.


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d) Duality of Control:

Resolve the issue of duality of control of the DAOs and ensure uniform control over all staff in DAOs in concert with the CGA and the AGP.

e) Update the Financial Rules and Treasury Rules:

Consistent with the Government Financial Rules to be reviewed under PIFRA, NWFP would require to initiate updating its rules to reinforce internal controls and eliminate archaic terminology and practices.

f) Avoidance of establishing off-budget expenditure accounts:

Devise a strategy that ensures the progressive closure of all unnecessary PLAs.

Chapter 4: Accounting, Financial Reporting and Internal MWFP Provincial Financial Accountability Assessment Control Systems of Local Governments in NWFP

21

Chapter 4: Accounting, Financial Reporting and Internal Control Systems of Local Governments in NWFP

Benchmarks a) Good financial management and accountability systems must address the risks of aggregate fiscal

indiscipline and instability, increasing geographical inequalities and elite capture under decentralization. They should promote pro-poor budgeting, high quality accounts and expenditure monitoring, timely auditing and effective accountability and follow up at local levels.

b) Internal auditing is an independent, objective assurance and consulting activity designed to add value and

improve a Local Government’s operations. Internal auditing helps a Local Government accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

System a) Under the local government program, local governments have been formed at three levels: District,

Tehsil, and Union. The plan is to devolve powers to the grass root level where people can be empowered to monitor the basic services provision by the public funds and equitable distribution of resources. The devolution of power to local level inevitably requires the fiscal decentralization where the elected representatives of the people have the authority to plan and execute the optimum utilization of the money and also can be monitored and held accountable by the people on a continuous basis.

b) The rationale behind development of new financial management systems/modification of existing systems

is to keep the stakeholders (management, elected representatives, citizens etc.) informed about the government activities and their financial impact. The efficient functioning of financial management systems ensure transparency leading to greater citizen involvement and accountability.

c) The reorganization of resources and division of responsibilities has been articulated, keeping in view both

the objectives of fiscal decentralization and international best practices as far as applicable, given the resources available. The main objective of the local government program is to empower each tier of the government (or administration) i.e., District, Tehsil/Town, Union and later on Village/Mohalla as independent financial units where no higher level can exercise undue interference in the responsibilities and authorities of lower level government. This necessitates an independent financial management system to provide the needs of the decision makers and other groups at each level. These financial management systems must be capable of providing the consolidated information in an accurate and timely manner. Therefore, three centralized and comprehensive accounting systems are envisaged, i.e., one for each local government.

District Accounting:

i) The Auditor General of Pakistan is constitutionally responsible under Article 170, to determine the form of accounts of the Federation and the Provinces and submit the reports to the President or the Governors who will submit them to the Assemblies. Two Ordinances [The Controller General of Accounts (Appointment, Functions and Powers) Ordinance, 2001, and The Auditor General (Functions, Powers and Terms of Conditions of Service) Ordinance, 2001] have been promulgated to replace the Pakistan (Audit and Accounts) Order, 1973. Through these ordinances, the segregation of duties between audit and accounts functions is ensured.


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ii) The Controller General of Accounts (CGA), has the overall responsibility:

• to prepare and maintain the accounts of the Federation, the Provinces and district governments in such forms and in accordance with such methods and principles as the Auditor-General may, with the approval of President, prescribe from time to time

• to authorize payments • to prepare and maintain accounts of such organizations as may be assigned • to provide District Government such information as such Governments may from time to time

require. (Section 5, CGA Ordinance, 2001)

iii) The issue regarding the Constitutional validity of the CGA Ordinance was raised, and there are decisions to be incorporated in this Ordinance; yet the interim arrangements for four years remain in substance similar to what the Ordinance intended.

iv) Under the supervision of CGA, the Accountant General of Pakistan Revenues (AGPR) and the

Accountant General (AG) of each province are responsible for recording the transactions at the Federal and Provincial level respectively. Additionally the AGPR is responsible for the consolidation of summarized financial information prepared by federal self accounting entities. The AGPR receives accounts and reports from the DAOs, Federal Treasuries, SBP/NBP and provides Annual Accounts to the Auditor General of Pakistan and consolidated monthly accounts to the Federal Finance Division. The Accountant General of each province performs the aforementioned functions at the provincial level with the help of the DAOs. The AGPR and all AGs also deal with matters of accounting policy and procedure at the Federal and Provincial level respectively.

v) Under the CGA Ordinance, 2001, Section 7, "the Controller General will … prepare and submit to

the Auditor-General for each financial year a Consolidated and General Financial Statement incorporating the summary of accounts of the Federation, all provinces and district authorities. The Auditor-General, after authentication, will forward the same to the Federal Government, Provincial Governments and district authorities."

vi) Presently, before the Local Government Ordinance, 2001, the provincial departments of Local

Government and Rural Development supervise the functions performed by various local bodies (municipal/metropolitan corporations, development authorities, town committees, zila councils, union councils etc.). Accounting in these bodies is handled by their accounting staff. There is no centralized accounting mechanism in the districts or other constituency for the accounting or consolidation of accounts of these bodies. The funds generated by the local bodies do not constitute a part of provincial consolidated fund. These local funds are treated as non-lapsable.

a) One set of books with District Accounts Officer:

i) The District Accounts Officer represents the Controller General at each district and prepares and maintains accounts for the Federation and the related province. As noted above, in the CGA Ordinance, 2001, CGA is required to keep the accounts of districts also. The DAO will be the responsible officer in this regard to provide periodical and ad-hoc reporting to the district authorities. The DAO will make all the disbursements from the Provincial Funds (allocated share of district from Provincial Consolidated Fund) vis-à-vis the local funds (district own source revenues).

ii) If two separate set of books are maintained for each of the funds, it will end up having two

incomplete statements relating to each entity (school, college, hospital, water supply scheme etc.) each showing expenditures from a separate fund. Other problems include difficulty in accomplishing the required consolidation efforts and the duplication and unnecessary cost of conducting two different audits for the two funds.


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iii) In addition to the above, DAO will record the transactions made by the line departments from the provincial and district budgets separately in different set of books. The devolved departments will continue providing services to provincial departments for inter district and large projects, which the province will be executing. Any attributable fiscal transfers from the province in relation to this specific service provision by the devolved departments will be recorded to give effect to its nature as such. Similarly, any establishment or other costs incurred by the province on behalf of the devolved departments will be charged to these departments.

b) Financial reporting functions to District Authorities

i) Before the promulgation of CGA Ordinance, 2001, the DAO was not responsible to provide any reports to district authorities. Therefore, the present system of accounting and financial reporting does not meet the needs of local officials. Particularly, where there is a revolutionary change in the political structure of the country, and with the devolution of financial management, budgeting, decision making to the lowest level, the existing system will fail to meet the increased requirements. The existing financial reporting system has shown significant inadequacies in meeting all the requirements of the changed scenarios. There is no reporting channel available to the district level at present and with the creation of district government, the need to establish a financial reporting system has emerged. The existing system provides reporting to the Federal and Provincial level in different formats for different accounts maintained.

ii) In the new scenario, the district will be responsible for generation of its own resources and using

them. Moreover the local governments will be empowered to re-appropriate funds received from the provinces. This creates the need to establish a financial reporting framework at the district government level. This will enable the newly formed district and other stakeholders to be provided with financial information at appropriate intervals, in sufficient detail. This will help the council in making informed decisions. Similarly other stakeholders will be better able to monitor the activities and be in a position to be answerable to the local governments.

iii) The requirements have been changed because of the Local Government Decentralization Program. The local governments have a variety of reporting requirements, both internal and external. Internal reports may include, but will not be limited to, budgetary, cash flow, cost and investment reports. The similar data can be utilized for financial and trend analyzes for the service efforts, costs, and performance indicators. All these reports are difficult to compile at the DAO level owing to the workloads, level of competence available, and prevailing form of records. Efforts should be made to use such analysis reports on a step-by-step basis at both the DAO office and by the Finance Officer under DCO based on the data provided by DAO and the line departments.

iv) Financial reporting is the basis of sound decision-making and is the most important element of the

managerial functions. It enables managers to perform planning for both short term and long term controlling, and the most important job of the managers to make decisions. Financial reports provide data for preparing budget and forecasts. Sound decision-making is not possible without appropriate financial information. Thus the importance of financial reporting cannot be understated and the Nazims and Naib Nazims will require financial information for effective and efficient running of the newly formed local governments. The Nazims and Naib Nazims will be using financial information for:

o Making budgets and making decisions such as re-appropriations. o Controlling the day-to-day affairs of the government. o Making long-term decisions such building schools, roads, hospitals and bridges etc.

v) The external reports include the comprehensive financial statements including statements on

revenues and expenditures, balance sheet etc.


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vi) The function of local government is quite different from the function of businesses in the private sector. The reasons for this include the more diverse and inclusive constituencies for local governments and that the customers (citizens) are much more interested in monitoring their contributions to the exchequer than to a private provider of goods and services. The district authorities and citizens are concerned to the level of each identifiable unit of organization.

vii) The PIFRA model now incorporates a district functionality which would cater for the specific needs

of the different tiers of government for financial information

viii) The role of the DAO in the district will be enhanced because he will be coordinating with the district governments as their accounting manager in addition to his duties as the representative of the Controller General of Accounts in the district. He will furnish periodical accounting reports to Nazims and Naib Nazims. He will be closely coordinating with these district authorities and will provide any financial information required by them for planning, controlling and decision-making.

Tehsil Accounting:

i) The tehsil administration is entrusted with the following four functions:

(a) Rural urban Planning (b) Land development (c) Municipal services (d) Finance and accounts

ii) Under the LGO 2001, the tehsil administration will operate independently for the provision of

services to the tehsil citizens in the area of municipal functions, rural-urban planning and land development. For this, the tehsil needs a full-fledged financial management system that will independently be capable of planning, budgeting and execution. Therefore, it is imperative to have a Tehsil Accounts Office (TAO) at the tehsil along with other fiscal functionality. The TAO should function in a similar manner in the tehsil as the DAO in the district. The tehsil DDOs/TOs should send their bills for disbursements to the TAO and these bills will be subjected to compliance check and budgetary control before endorsement of payment and recording. The processed bills will be returned to the DDOs and the accounts will be updated on receipt of disbursement scroll from the bank. The revenues should be recorded on receipt of details from the bank and then reconciled with the records of collection agency.

iii) The sub-treasuries functioning at the tehsils work like a post office or messenger, as they collect the

bills for disbursements periodically from the DDOs stationed in the tehsil and bring these bills for processing to the DAO. After the processing at DAO payment instruments (endorsed bills or cheques) are returned to the DDOs. .

iv) TAOs can be established by transferring the accounting staff in the local bodies functioning at the

district or tehsil/town levels. These personnel should be trained for the centralized accounting and reporting for the tehsil.

Union Accounting:

The Union Secretary keeps the original supporting documents with the bills in order and safe custody and is required to prepare the annual financial statements for audit and provide any detailed information and documentation in this regard.


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Issues

a) Chart of accounts/classifications used by municipal committees, union councils, zila councils, development authorities etc. being used for local funds accounting

Each provincial government has its own local government handbook containing relevant laws, instructions from the Local Government and Rural Development Department, bye-laws and rules etc. The Local Government and Rural Development Department is the provincial department which supervises the operations of local bodies in rural as well as urban areas. These local bodies included municipal committees, union councils, zila councils, development authorities etc. The local government handbook does provide for a chart of classifications to be used by the local bodies for budgeting and accounting for the transactions in each account head but these account heads are not coded. Therefore, the local bodies generally do not use the account coding except a few metropolitan corporations where the accounting system is automated or is in the process of automation. The same chart of accounts is being used by the local governments for the budgeting and accounting of local funds.

b) Multiple Systems of Accounting

As discussed earlier, there are two frameworks for accounting; one performed by the Controller General of Accounts for the federal and provincial accounts and the other is accounting done by the local bodies. In the given scenario of local government program, the following are the limitations:

i) There are more than one accounting infrastructure using different chart of classification/accounts

for two different organizational frameworks. One for the provincial governments and other for the local bodies. Under the new system of local governments the two organizational frameworks shall be merged in one district government and so there can only be one set of accounting books that can present a complete picture relating to each accounting entity.

ii) The chart of classification’s function segment cannot be consistently applied to identify any specific

data element and at different places it confuses between department, activity and funds (as discussed earlier).

iii) PIFRA project proposes the New Chart of Accounts (exposure draft approved by the Chief

Executive of Pakistan) that is expected to be implemented through a full-blown computerized accounting system at 52 sites catering 80% of transactions within a couple of years. It serves as a constraint for any change in the chart of classification that has to be in line with or that can help PIFRA implementation and not making hurdles in its way.

iv) The share of a district from the provincial consolidated fund under the provincial finance award

will be given in the district provincial account. The funds in this account will come as appropriated in 34 departments/functions as provided in the existing chart of classification. In the district these funds can be merged in the 11 groups of offices according to the original reconstruction or departmental grouping scheme. But after the re-appropriation in the 11 groups of offices, the reverse allocation/accounting to the 34 provincial departments is difficult, as the funds become non-traceable upon re-appropriation.

v) The district departments under the local government program are not the same as the provincial

departments and so cannot be easily identified except under the district functionality regime which is now in being put in place.

c) The adaptation of federal and provincial system to the local governments

The adaptation of federal and provincial system to the local governments as practiced in transition towards fiscal decentralization is not appropriate since the accounting and information needs of both


26

levels are quite different. This difference is due to various factors prevailing for LGs, for example, 1) non-authorization for incurring of debt, 2) most services are competitive to private sector, 3) cheques may be dishonored by the Bank, 4) extra-credibility due to unlimited sources of funds not available to LGs, 5) close proximity to the community serviced, 6) additional transparency and accountability requirements under LGO. This requires a more relevant and disaggregated information for the decision-makers in a timely manner which is surely not the attributes of old accounting system.

d) The internal audit

The internal audit offices in the local governments have not been established and operationalized. LG Internal Audit Rules and Guidelines have not been framed and notified.

e) LG Accounts Manual

LG Accounts Manual has now been framed and notified, but roll-out has yet to take place. In absence of one complete accounts framework, the practices are varying from LG to LG. The differences are in proforma, classification and procedures. Unless there is a successful and expeditious roll-out, LG accounts will remain in a shape which will be very difficult to compare and consolidate.

Internal Controls The institutional reorganization demands a carefully designing of new internal controls policies and procedures in order to safeguard the resources and to protect against any financial/non-financial risks and threats. This is pertinent because the restructuring of departments can initially loosen the traditional controls (job/responsibility/resource assignments, segregation of duties, checks and balances etc.) and there will be a potential risk that the opportunists will take the benefit, which can eventually threaten the success of devolution plan. Efforts will need to be made to devise a control environment where a balance of protective, detective and corrective control procedures can be implemented in all the functional departments of the district, tehsil and union.

Issues

i) Under the LGO 2001, local governments are empowered to manage their finances independently. Therefore the surpluses and deficits in bank balances will have to be managed by the local governments themselves for the sake of smooth running of operations. The treasury management functions in addition to safeguarding of cash and internal controls include the following:

(a) Depository procedures (b) Bank reconciliations (c) Managing cash flows (short-term surpluses and deficits) (d) Investment policies (e) Banking services

ii) Cash inflows are cyclical and can vary widely at different times during the year. For example, cash inflows will be strongest immediately after a tax or utility billing. While cash outflows, or cash requirements, can also vary, those patterns are often more stable and easier to ascertain.

iii) On other occasions the cash requirements are difficult to predict, for example, a major construction project. Construction can be delayed or accelerated, depending on many variables such as weather, contractor schedules, and other unforeseen circumstances.

iv) This requires additional controls to be implemented by the DAOs and close co-ordination with the

banks. The banks will have to provide services to facilitate cash management for each local government and assist in cash forecasting so that it can help governments in leveling its cash flows.


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v) Government managers have to monitor the cash flows closely where the assistance from the banking sector experts will be very valuable.

vi) Further section 120 of LGO, 2001 states that "No local government shall incur any debt except in

the manner provided in this Ordinance" but the short-term cash flow management under a long-term arrangement with the banks must be allowed. The terms of such a service from the banks may be done individually negotiated by each district. Otherwise it may be economical if the provincial governments on behalf of all local governments negotiate with a large scheduled bank.

Fiscal Transfers The Provincial Finance Commission was constituted in NWFP on June 18, 2002 which gave its recommendations on June 28, 2002 for the FY02-03. According to these recommendations 40% of the Provincial Consolidated Fund after charging the mandatory expenditure will be retained by the province whereas 60% will be distributed among the local governments in the province. 90% of distributed amount will be allocated based on a formula with three factors: population:50%; Backwardness:25%; Lag in infrastructure:25%. The remaining 10% is distributed to cover the difference between past expenditures and the formula grant (this is called fiscal equalization). The formula distribution will give 60% of this allocable amount to districts whereas tehsils/towns and unions will get 30% and 10% respectively.

Fiscal Transfers

Development Expenditure

Non-Development Expenditure

TLFULF

DLF

PCF

DP 32.5%

FCF

¾Direct Taxation

¾Indirect Taxation

¾Local & Foreign Debts

¾Privatization Receipts

¾Profit from Investments

AGPR

DAO

Investments

Debt Servicing

Miscellaneous

Development Expenditure

Non-Development Expenditure

PA

Provincial Receipts

AG

DAO

DDO 1

Suppliers

Donors

DDO 1

DDO 2

Grant

DAO

TAO

Tehsil Administration Expenditures

Union Expenditures

Union Secretary

District Receipts

Tehsil Receipts

Union Receipts


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Issues

i) The province is transferring amounts to the local governments but withholds the salary component of provincial employees serving in local governments. This treatment causes two problems. First, the savings on account of these salaries are not transferred to the LGs thereby reducing the due share of LGs under the provincial finance award.

Second, the AG is required to pay these salaries from Account # 1 and therefore record in provincial accounts for reconciliation of SBP deposit account. DAOs are instructed to charge this amount to respective local governments where these employees are serving. This makes a double count of the charge. AG, DG Audit and DG District Audit are all aware of the issue and are taking measures to implement an accounting solution to the problem.

ii) NWFP imposes the completion of on-going schemes by deduction from districts amounts, and

imposes on districts to spend 70% of their development funds on social sector (education, health, drinking water) projects. It is not clear if this is a suggestion, a result that will be achieved through administrative interference or a legally binding constraint. In any case this appears to be against the spirit of devolution.

Reform Agenda in Place a) Financial management and accountability in local governments have become urgent issues in Pakistan and

a number of reform programs specifically attempting to remedy the situation are being geared up. These programs include PIFRA II, ADBs Fiscal Decentralization TA and lately Devolution Support Program, UNDP and SDC Essential Institutional Reforms Operationalization Program etc.

b) A number of actions have been taken including:

i) NWFP Government set up Provincial Finance Commission (PFC) to; (a) estimate the one-time transition cost of devolution; (b) make base-line projections for the stream of expenditures of district governments; (c) determine the types and quantum of Provincial transfers to the district governments (at least in the first year) keeping in view the inter-district disparities; (d) identify Provincial taxes which could be devolved to district governments; (e) rationalize user-charges on Provincial/local services; (f) determine rates of local taxes; and (g) formulate the throw-forward of development schemes (which would be transferred to district governments).

ii) PFC so established has given the provincial finance award for the allocations of resources among

government entities in NWFP.

iii) District Implementation Committees (DICs) have been established in each district of the country under the designated DCOs to iron out the possible implementation problems.

iv) ADB/DFID - Country wide training of over 2000 LG functionaries in four key areas including

budgeting, accounting, revenue mobilization and internal auditing. c) EIROP – NWFP Governance benchmark survey where perception of the more than 2500 audience from

five different groups including elected representatives, government employees, general public, civil society organizations and media was gathered about the old and new systems and existing state of governance in the province. Based on the survey a reform agenda has been established by EIROP for conducting coordinated efforts for effective decentralization in NWFP.


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Recommendations a) Identification of appropriate, soft and robust FMIS application under PIFRA which can interface with

SAP, and which has minimal operating costs for implementation at government tiers below the DAO level.

b) Rolling out LG Budget Code and LG Accounts Manual. c) Establish Tehsil/Town Accounts Offices and adapting an accounting framework for accounting in local

governments, if decision is so taken. d) Training plans for all accounting staff including local level accounting staff to improve accountability. e) Establishment of effective internal audit units in the local governments. For effective financial

accountability and governance, the establishment of internal audit offices under the LGO, 2001 to provide value addition and framing of draft subordinate legislation (ADB FD TA) are very important.

f) Merge the provincial accounts in the local governments with their own source revenues and move towards

the mainstream budgeting, accounting and auditing processes.

g) Devise and operationalize a consolidation/aggregation framework for the local government accounts into the provincial finance accounts and later into the national accounts.

h) Build awareness, information sharing, and research capacity of the local government functionaries and

elected representatives at the local level. In particular there is need to train these groups of people in financial management to augment the training initiatives already undertaken by the provincial government either independently or with the assistance of development partners.

i) Devise and implement a performance based incentive regime for rewarding compliance with the standards

of public-sector financial accountability.

MWFP Provincial Financial Accountability Assessment Chapter 5: Public Sector Auditing

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Chapter 5: Public Sector Auditing

Benchmarks The International Organization of Supreme Audit Institutions (INTOSAI), a professional organization of most of the Supreme Audit Institutions (SAIs) around the world, has published public auditing standards which, while not having mandatory application, reflect a “best practices” consensus among SAIs around the world. These standards have been adopted by the PAD, a member of INTOSAI. The major focus of INTOSAI standards is on the conditions assuring the independence, objectivity, competence and due care of the SAI and its auditors.

The Supreme Audit Institution's audit objectives--legality, regularity, economy, efficiency and effectiveness of financial management--basically are of equal importance. However, it is for each Supreme Audit Institution to determine its priorities on a case-by-case basis. To ensure the achievement of above mentioned objectives following functions to be performed:

• an Attest function • a Compliance audit • a Performance audit • a Program audit (achievements of program goals)

System a) According to Section 7 of the Auditor-General's (Functions, Powers and Terms and Conditions of

Service) Ordinance 2001 the scope of responsibilities of the Auditor General has been defined to include certification on the annual receipts and disbursements of the Federation, of each Province and of each district. He shall submit the certified accounts with such notes, comments or recommendations as he may consider necessary to the President or the Governor of a Province or the designated District Authority, as the case may be.

b) These sections have enforced a welcome change in the nature of the audit performed by the Auditor-

General. Before this, the annual test-based audit was carried out, where a sample (5% to 10%) of transactions were selected for audit and the audit reports (paras) were prepared solely on these basis. The emphasis was to find irregularities in the selected transactions rather than to form an overall opinion covering the whole financial statements. Although the audit personnel on many occasions went beyond the selected transactions, yet a spirit to certify the financial statements was not there. Now the Auditor-General will have to adopt a risk-based approach to auditing where the sampling procedures are applied systemically to reduce the audit risk and provide maximum assurance that the auditor's opinion on the truth and fairness of financial statements is not inappropriate.

c) The emphasis of audit procedures will move from the vouching of transactions to other innovative audit

techniques including:

• analytical procedures • third-party confirmations • management inquiries • internal control evaluation • assets' physical verification • calculations and re-computations


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d) This requires the risk-based audit approach where the auditor identifies the high risk areas and concentrates his work in those areas and, in effect, reduces his overall reporting risk to an acceptable level.

e) The Director Local Fund Audit under the Finance Department is responsible for the audit of local funds generated by the Tehsil/Town Municipal Administrations and Union Administrations. The resident teams perform pre-audit of major local bodies/governments. The Local Fund Audit Department also performs post audit for these local governments. The audit reports are not submitted to the legislature/PAC.

f) Local fund audit does not have powers of physical verification of assets and third party confirmations are

seldom obtained. The auditors do not have adequate capacity or skills to conduct auditing based on recognized standards.

Issues a) More emphasis on compliance and performance rather than financial attestation:

The Office of Auditor General has over the years developed products in three different domains namely compliance, performance and certification. The level of expertise and quality of outputs in the first two domains is satisfactory whereas the financial certifications as required under the Auditor General (AG) Ordinance, 2001 is the weaker area. PAD is working on the issues and the Certification Audits have been started and there are number of efforts being taken to improve the quality of this function.

b) Test based audit which covers only sample of transactions selected from 5% to 15% and the audit

paras are based only on that:

The regularity audits follow the test based audit approach where the auditor selects a percentage of transactions based on the examination of which he comes up with his observations. This is not the risk based audit approach by which the auditor while drawing a sample of transactions ensures that he will be able to form an opinion on the whole of financial statements as result of all the transactions during a period. Current audit approach is narrowly focused since audit scope is on transaction verification of selected months to ensure compliance with government regulations. This practice is being changed because of the Certification Audits where the auditor uses a risk-based audit approach to measure the audit risk and to reduce it to a reasonable level. This ensures that all of the areas of the financial statements and transactions taking place throughout the year have been considered by the auditor and multiple levels of audit tests were performed to enable him to form a comprehensive opinion.

The reason for more emphasis on transactions based audit is partly because of the lack of internal controls which are a pre-requisite for adopting a risk-based audit approach.

c) The audit of local funds is not done by the Auditor General which means that the quality of audit

work on public finances is not the same all over:

The audit of local funds is being done by the Local Fund audit staff which essentially means that there are different audit standards being practiced. The competence level in the staff and the quality of audit work also differ from those of the OAG.

d) OAG is under capacity to meet requirements of Auditor General’s ( ) Ordinance, 2001 and LGO,

2001: Thus, it is within the ambit of the Auditor-General to report on the annual financial statements of the district governments and tehsil/town and union administrations. These reports will be made to the respective Nazims, who will present these to the councils.


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However, in NWFP an amendment was made in Section 115 of NWFP LGO vide which a proviso was added to the original Section whereby “the audit of the Tehsil Municipal Administration, Town Municipal Administration and Union Administration shall be conducted by the Local Fund Audit Department in the prescribed manner till such time that adequate capacity is developed to conform to the national audit system notified by the Auditor General of Pakistan”. This provision has been questioned as opposing the provisions of the Constitution and the Auditor General’s (Functions, Powers and Terms and Conditions of Service) Ordinance, 2001. With the District Audit infrastructure currently established, albeit with less than ideal strength, the situation of AGP capacity to audit the local authorities would most likely improve soon.

The annual audit of all districts, tehsils/towns and unions will, however, be a major increment to the work load of the Auditor-General's resources and particularly after the close of the financial year. In addition there is already lack of competent resources for conducting the certification audits.

e) Procedural Issues:

Consideration is required to certain discrete procedural issues which impact the audit process, e.g., delays in audit reporting, tendency to focus on old and some time non-material transactions, stereotyped objections, uneven quality, difficulties in prompt access to relevant records, reluctance to settle audit paras after submission of Audit Reports, lack of adequate attention to overall effectiveness of internal controls etc. This shortcoming has been programmed to be remedied by the AGP under the aegis of the auditing component of PIFRA.

f) Reporting of Audit of Local Government:

There are different interpretations of the Constitution, the Auditor General ( ) Ordinance and the Local Government Ordinance regarding the reporting of audit report of the local government to the provincial Public Accounts Committee, Accounts Committee of the respective Council or both. There should be one forum for legislative scrutiny in order to avoid duplication of authority and effort and possible conflicts.

Reform Agenda in Place a) The auditing component of the PIFRA Project would plug into the ongoing developments and the

emerging organizational vision to provide optimal benefit to the department from the available funding. It has proposed a shift from audit of transactions to audit of computerized systems and accounts. The internal audit function in all the Government departments and agencies will be strengthened and external auditors will not act as internal auditors. The resources thus saved could be utilized for audit in the areas like environment audit, social audit, debt audit etc. The capacity building will enable the organization to accept challenges of audit and accountability in the new millennium. The emerging organizational vision seeks to achieve the following objectives:- i) Develop an integrated and effective response to the keen legislative interest in the working of the

Department, demonstrated at different times and the general expectation that the AGP should emerge as an independent and effective institutional arrangement for accountability of the public sector.

ii) Introduce timely, significant and qualitative special audit reports to generate interest in the audit product.

iii) Approach new areas like investment in social sector and foreign-aided projects in a systematic manner.

iv) Promote merit, performance reward and demonstrable integrity in the department.

v) Improve audit planning and supervision both at the HQ and field level.


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vi) Focus audit resources in a planned manner and introduce strategic planning.

vii) Re-orientate the traditional audit process towards system based approach leading to an opinion on the accounts of the audited entity.

viii) Introduce quality assurance and effective review systems for audit findings.

ix) Improve and standardize documentation of audit evidence.

x) Put emphasis on new areas like forensic, social and environmental audit.

xi) Promote use of information and communication technologies and equip the Department to carry out in fully/partially computerized accounting environment.

xii) Explore areas of optimal benefit for interaction with the private sector.

xiii) Promote internal accountability and responsiveness to audit in audited organization.

b) The government seeks to modernize the public audit system of Pakistan in line with international practices

and auditing standards. The first fundamental step in that process is the promulgation of new legislation to strengthen the mandate and independence of the Auditor General, in particular by transferring from him the responsibilities for compilation and preparation of accounts. Capacity building is being pursued through PIFRA, which supports the adoption of computer based audit techniques to be able to effectively audit the new computerized accounting system under development in the same project, as well as to provide capacity building within PAD to minimize the gap between actual practice and the aspiration of the Auditor General for public audit in Pakistan to meet international auditing standards set by INTOSAI.

c) Training and quality assurance functions are being developed to support expanding the scope of work to

cover an independent ongoing examination of internal controls; introducing third party validation (TPV) audits across the public sector, on the pattern of TPVs presently undertaken for the Social Action Program; reinforcement of the concept of certification (financial statement attest) audit; expansion of audits of government revenue and receipts; undertaking of special audits in areas of interest to the public, such as audit of privatization initiatives and environmental auditing; and giving more emphasis to modem internal audits. The Auditor General has also committed to forging a partnership with the private sector for undertaking audits of public sector undertakings; and in due course, outsourcing some of PAD’S non-core functions to the private sector on a selective basis. This would impact positively on audit deliverables in the province.

d) Actions Taken include:

i) Promulgation of the Auditor General’s and Controller General of Account’s Ordinances.

ii) Publication of key guidelines to underpin quality building efforts within PAD. Reporting guidelines for field offices were published in FY 1998-99. Guidelines for the audit of Government Financial Statements were developed in FY 2000-01 with technical assistance from Australia. Guidelines for reporting on internal control were published in January 2001.

iii) Preparation by the PAD of a corporate audit plan providing for full coverage over a three year cycle of all public sector corporations, autonomous bodies and authorities, and reinforcement of the requirement for conduct of audits by the Auditor General in these entities by prescription (January 2001) of the ad-hoc Public Accounts Committee,

iv) Inclusion in the CGA Ordinance of a responsibility of the CGA to coordinate and ensure resolution of audit observations of the PAD with concerned departments.

Recommendations a) Since comprehensive program for the improvement of the audit function is underway, the continued

commitment with the reform agenda will ensure the enhancement of financial accountability.


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b) The enhanced responsibilities on the PAD can be met by adopting various options. One of the options for the Auditor-General is to perform joint audits, where needed, with corporate auditors having audit practicing licenses from the Institute of Chartered Accountants of Pakistan. This will provide the competence required in risk-based audit techniques and may lead eventually to complete outsourcing of local government audits.

Another option may be to have multiple auditing calendars for different local governments and distribute the workload evenly throughout the year. For example having four year-ending dates on 30th June, 30th September, 31st December and 31st March. Finally, Local Fund Audit can be merged with the Auditor General for the conduct of the Audit of local governments.

c) Resolve the arrangements between the Auditor General of Pakistan and Local Fund Audit in respect of

audit of local governments through an institutional development plan.

d) Develop new audit and reporting methodologies e) Use of Computer Assisted Audit Techniques (CAATs) by AGP. PIFRA supported reforms are underway

for use of CAATs f) Build capacity of audit staff for Certification Audits by applying risk-based audit approach. g) Use materiality screen. h) Agree on one forum for legislative scrutiny of the local government financial statements and audit reports

thereon.

NWFP Provincial Financial Accountability Assessment Chapter 6: Oversight of Public Sector Financial Management

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Chapter 6: Oversight of Public Sector Financial Management Benchmarks

Timely and well informed legislative oversight of the manner in which public funds are managed by the executive is an internationally accepted good governance practice. Oversight should cover all public funds. INTOSAI standards indicate that public enterprises also, regardless of the manner in which they are constituted, their functions, degree of autonomy or funding arrangements, should be ultimately accountable to the supreme law making body. They also indicate, for reasons of transparency, that the proceedings of the Public Accounts Committee charged with oversight responsibilities should be open to the public. System a) The functions of the PAC are to examine the accounts showing the appropriation of sums granted by the

Assembly for the expenditure of the Government, the report of the Auditor General of Pakistan, and other matters as the Minister of Finance may refer to the Committee.

b) In accordance with the Procedure and Conduct of Business Rules, Provincial Assembly of NWFP and

procedure of standing committee, the PAC is required to ensure that;

i) The moneys shown in the accounts as having been disbursed were legally available for, and applicable to, the service or purpose to which they were applied or charged.

ii) The expenditure conforms to the Authority which governs it and

iii) Every re-appropriation has been made in accordance with such rules as may have been prescribed by Government in this behalf.

c) The PAC is also required to:

i) Examine the statement of accounts showing the income and expenditure of province, corporations,

trading and manufacturing schemes, concerns and projects together with the balance sheets and statement of profit and loss which the President may have required to be prepared or are prepared under the provisions of the rules regulating the financing of particular corporation trading or manufacturing scheme or concern or project and the relevant report of the Auditor General of Pakistan thereon,

ii) Examine the statement of accounts showing the income and expenditure of autonomous and semi autonomous bodies, the audit of which may be conducted by the Auditor General of Pakistan either under the directions of the Governor or under statute, and

iii) Consider the report of the Auditor General of Pakistan in cases where the President may have required him to conduct the audit of any receipts or to examine the accounts of stores and stocks.

d) If any money has been spent on any service during a financial year in excess of the amount granted by the

assembly for that purpose the Committee examines the facts of each case, the circumstances leading to such excess, and makes recommendations. i) The report of the Committee is required to be presented within one year from the date on which the

Assembly referred to it unless the assembly extends the period by resolution.

ii) The PACs should give the final decision or direction on the audit reports.


36

Issues a) Time lag in performance of legislative oversight:

The PACs do not remain active for longer times and thus there are lags in the legislative oversight. PAC has not functioned on several occasions for extended periods of time and this has often created a backlog of unattended audit reports at the Federal and Provincial levels that go back many years. The audit reports and accounts for fiscal years 1998/99 to 2001/02 have yet to be reviewed by the PAC. The delay was attributed to the delayed receipt of the reports and accounts by the Provincial Assembly from the Office of the Governor.

b) Role of Departmental Accounts Committees:

The role of DACs is very important in the whole accountability framework. However, due to lack of regular DACs, audit observations remain unresolved. This leads to waste of time at PAC and related follow-up. One main reason for delay in presentation and subsequent implementation of audit report is that DAC meetings are not held as frequently as these should be. Many a time, the directives/instructions given by DAC are not implemented by the executive authorities. DACs should effectively perform their role by causing the provision of relevant information to the auditors and resolving the maximum number of audit points at that level.

c) Enforcement

Enforcement of disciplinary processes following PAC reports has remained an issue partly because the actions become late due to delayed action by PAC and partly because of the limited enforcement powers of the PAC.

d) Value-for-money issues & program effectiveness Assessing the value-for-money and effectiveness of programs should be one of the core responsibilities of PAC.

e) Chairman of PAC In NWFP, the Speaker of the Provincial Assembly, as per Rules of Business of the Provincial Assembly (Procedure and Conduct), is the Chairman of the PAC. He is from the ruling party. Convention however allows the Chairman of the Committee to come from the opposition party as an indicator of reinforced accountability. There is an opinion that this gives an additional strength to the recommendations of the PAC and since the view point of opposition is well-presented and recorded at PAC proceedings.

f) Transparency

The proceeding of the PAC are not open to the public but the daily outcome of deliberations are reported to the public by way of press release through the committee’s public relations officer.

Reform Agenda in Place a) The government realizes that there is an urgent need to assess the working of PACs across Pakistan and

develop measures to enhance the capacity for them to undertake more timely reviews based on audit reports submitted by the Auditor General. The government also appreciates that there is need to inculcate greater ownership within the key institution of the government to improve their internal controls and fulfill the related fiduciary obligations to the public through more effective working of the PAC process. The Auditor General is considering commissioning a diagnostic study on the workings of PACs in Pakistan with a view to further enhancing the performance of these Committees in line with international


37

best practice. To this end, the World Bank and other donors may be requested to provide support towards strengthening PAC Secretariats.

b) Other improvements in transparency and oversight arrangements have the potential to significantly improve financial accountability in Pakistan: The GoP has committed to making Auditor General’s reports public. A Freedom of Information law has been drafted and is expected to be promulgated soon. Aggregate Federal and Provincial fiscal data is now being presented in the Ministry of Finance’s public website. The important next step will be to introduce fiscal transparency practices in the Provinces.

Recommendations a) Continue with, and deepen, the current reform agenda and capitalize on the work so far done.

b) Such measures shall be taken so as to reduce the pressure of routine work on the PAC by a judicious

selection of audit paras and presentation of basic issues of accountability for discussion at that forum. This will be supported under PIFRA

c) Discharge of responsibilities: PAC should schedule sufficient, regular meetings to discharge their responsibilities (especially where so much work is pending). Ideally Committee reports shall be arrived at after consensus. Committee shall report at least annually.

d) Capacity of PAC to recommend on an efficient and effective manner: There should be an orientation (may be two-week) for the PAC members for the introduction of whole financial accountability mechanism and terminology frequently used. PACs should be given professional staff to assist them at their secretariat.

e) Follow-up and enforcement of PAC recommendations to be strengthened. f) Rules of procedure for Accounts Committees of the Local Councils should be devised with an

institutional development plan. g) Seek technical assistance support from donors to support the implementation process of some of the above

recommendations.

NWFP Provincial Financial Accountability Assessment Chapter 7: Action Matrix

38

Chapter 7: Action Matrix

Domain Actions Agency

Budget Development and Execution

• Strengthen Budget Manual to improve fiscal performance and budget stability and reliability through the use of a complete MTBF

• Implement Comprehensive performance based budgeting to interface with PIFRA

• Complete compliance with the Local Government Ordinance for delegating budget making and re-appropriations to local governments

• Train staff in line ministries in budget execution

• P&D, FD, March 2005

• P&D, FD, March 2005

• PFC, LGC, FD, LGRDD, March 2005

• PFC, FD, Line Depts., Sept. 2004

Accounting and Reporting

• Improve bank and account reconciliation processes at provincial and district levels and achieve progressive reconciliation levels for revenues, expenditures, PLA accounts, suspense accounts, and inter-governmental accounts

• Develop a strong internal control framework at all levels

of the Province, including districts and tehsils

• Establish functional internal audit functions in all provincial departments and commence roll-out to Districts

• Resolve the duality of control in respect of the DAOs in

the province

• Progressively close PLA accounts and create no new off-but accounts

• PFC, FD, AG, June 2004 and on-going

• PFC, FD, June 2005

• FD, PFC, Line Depts., March 2006

• FD, AG, PFC, June 2005

• FD, AG, PFC,

December 2004

External Audit • Hold DAC meetings and clear all audit paragraphs within 3 months of receipt of audit reports

• Submit Auditor General’s reports and annual audited

accounts to the Provincial Assembly within 30 days of presentation to the Governor.

• All provincial and District Governments, June 2004 - ongoing

• Governor’s Office, Speaker’s Office, June 2004 – ongoing

NWFP Provincial Financial Accountability Assessment Chapter 7: Action Matrix

39

Domain Actions Agency

Legislative Scrutiny

• Convene regular Provincial PAC sessions and progressively clear backlogs of audit reports and accounts

• Follow up with executive departments to obtain responses on pending audit reports

• Develop strategy to focus PAC on recent and subsequent

reports, while clearing backlogs • Develop greater awareness among PAC members and

staff about practices of legislative accountability

• Develop position papers to brief PACs

• Discuss PAC findings in Plenary Session of the National Assembly

• Initiate technical assistance request to Donors to support

strengthening PAC Secretariat

• PAC, June 2004 –ongoing

• PAC Secretariat, June

2004 • PAC, June 2004

• PAC and PAC Secretariat, September 2004

• PAC Secretariat, June

2004 • Provincial Assembly,

September 2004 • Provincial Assembly,

May 2004

NWFP Provincial Financial Accountability Assessment List of Technical Annexes

40

List of Technical Annexes

Annex A – Functional Distribution of Responsibilities Among LGs Annex B – Overall Structure of Accounting, Auditing and Treasury Management in The Local

Governments Annex C – Internal Auditing for Local Governments

NWFP Provincial Financial Accountability Assessment Annex A: Functional Distribution of Responsibilities Among LGs

A - 1

Annex A: Functional Distribution of Responsibilities Among LGs

Thefollowing tableshows theoverall functional responsibilities of three levelsof local governments:

DISTRICT GOVERNMENT TEHSIL/TOWN ADMINISTRATION UNION ADMINISTRATIONLawJustice & Law CourtsLitigationLegal adviceLegislation of local bodiesEnvironmentEducationEducationBoys SchoolGirls SchoolBoys Primary SchoolGirls Primary SchoolTechnical educationCollegesSports (Education)HealthHealthBasic & Rural HealthChild & Women HealthHospitalsPublic HealthCommunity DevelopmentSports & RecreationSocial security & Social WelfareLabor welfareCommunity OrganizationCooperatives & Registration OfficesSpecial EducationCommunity CentersCooperativesAgriculture/Live stockAgriculture(Extension)LivestockForestsFisheries

On Farm Water ManagementSoil FertilitySoil conservationWorks & ServicesDistrict RoadsDistrict BuildingsWater Supply, Sanitation, Sewerageand Refuse DisposalHousing & Urban DevelopmentEnergy (Fuel and Power)Information TechnologyIT DevelopmentIT PromotionDatabaseRevenue ManagementProperty TaxesExciseMotor VehicleOther LeviesCoordinationHuman Resource ManagementCivil DefenseFiscal ManagementFinance & BudgetPlanningEconomic RegulationAccountsEnterprise & Investment PromotionLiteracyLiteracy CampaignsContinuing EducationVocational Education

Municipal RegulationsLicensingManagement of LandManagement of PropertyMunicipal Laws

Infrastructure and ServicesRoads and StreetsParks and Play GroundsWater & SanitationSewerage

PlanningLand DevelopmentBuilding ControlCoordination

FinanceAccountingPlanning & BudgetingCCB - PlanningTaxation

Inter-villages MunicipalInfrastructureCommunity OrganizationTrainingCommunity LawsCommunity CentersCattleFairs and MarketsRecreational Centers, Parks,Gardens etc.Union Guards

CCB PlanningLand developmentBuilding ControlCoordinationMusalihat Anjuman

Information CentreSocio-economic InformationRegistrations (births, deaths andmarriages etc.)Libraries

FinanceAccountingPlanning & BudgetingTaxation

Annex B: Overall Structure of Accounting, Auditing and MWFP Provincial Financial Accountability Assessment Treasury Management in The Local Governments

B - 1

Annex B: Overall Structure of Accounting, Auditing and Treasury Management in The Local Governments

The following diagram depicts the overall structure of accounting, auditing and treasury management in the local governments:

District Accounts

Officer (DAO)

Tehsil Accounts

Officer (TAO)

Union secretary

(UA)

Set of Books for

Federation

Set of Books for Province

Set of Books for District

Set of Books for

Tehsil/Town

Set of Books for Union

AU

DIT

OR

-GE

NE

RA

LO

FP

AK

IST

AN

Bank

Bank

Bank

Sub-Office of AGPR

Accountant General

District Authorities

Tehsil/Town Authorities

Union Authorities

MWFP Provincial Financial Accountability Assessment Annex C: Internal Auditing for Local Governments

C - 1

Annex C: Internal Auditing for Local Governments

The following picture represents in brief the internal audit model recommended for the local governments under ADB Fiscal Decentralization TA.

ž SHAPE \* MERGEFORMAT − ˚ ˚

The above picture shows that the Internal Auditor in a local government will be under the Nazim. He will mainly be performing three functions namely, annual appraisal, periodical internal audit of various offices and special investigation, if mandated. All the reports of Internal Audit will be highly circulated. The annual appraisal will be based on information from many sources and very limited testing or verification performed. This would be an analytical tool and provide the LG management with an independent assurance that the summaries/reports being sent to them from the normal channel are in line with the actual performance. For carrying out the periodical assessments of LG offices, the Internal Auditor presents a number of products which will be conducted on a rotational and need based mechanism. The purpose of this rotation is continuous improvement in the systems, processes, organization, governance, procedures etc.

InfoSystems

Audit

SystemsReview

Internal Auditor

Annual Appraisal of Local Government

Periodical Internal Audit of Offices

InternalControls

Assessment

Perfor-mance

Audit

Governance Process

Evaluation

Special Investigation

Information

Citizen’sSocial Audit

DistrictData

Office

ComplaintCell

District Ombudsma

n

OtherSources

Nazim Copies

9 Council

9MonitoringCommittees Public Document

OtherOffices

MWFP Provincial Financial Accountability Assessment Annex C: Internal Auditing for Local Governments

C - 2

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