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III.  Open Budget Preparation, Execution, and Reporting  (continued)

Procedures for Budget Execution

3.3 Procedures for the execution and monitoring of approved expenditure and for collecting revenue should be clearly specified.

127. The Code includes good practices relating to: (1) the accounting system; (2) procurement and employment; (3) internal audit; and (4) tax administration.

The accounting system

3.3.1 There should be a comprehensive, integrated accounting system which provides a reliable basis for assessing payment arrears.

128. This is a basic requirement of fiscal transparency. Accounting systems should be based on well-established internal control systems, allow for the capture and recording of information at the commitment stage, generate reports on payment arrears, cover all externally financed transactions in a timely way, and maintain records on aid-in-kind. Best practice is that the accounting system should have the capacity for accounting and reporting on an accrual basis, as well as for generating cash reports.

Internal control systems

129. Internal control systems are intended to provide assurance that management's objectives are being achieved.110 Responsibility for internal control therefore rests with the head of each individual government agency. However, a central government agency might be assigned responsibility for developing a government-wide standard approach to internal control.

Box 18. The Public Sector Balance

    Public sector quasi-fiscal activities can be conducted through the central bank, public financial institutions, or nonfinancial public enterprises. A relatively narrow extension of the general government balance could be where the main concern is with quasi-fiscal activities of the central bank and public financial institutions. Mackenzie and Stella (1996) suggested that central bank losses could be amalgamated into an adjusted fiscal deficit. Other forms of augmented balance (see, for instance, Daniel, Davis, and Wolfe (1997)) have also been advocated to capture balance sheet transactions such as assumption of debt, and some forms of these are used on a pragmatic basis in some Fund programs. Operationally, however, it is now considered more practicable to encourage broader institutional-based reporting rather than to attempt to derive a hybrid balance concept.

    A fully consolidated public sector balance would in principle have the potential to capture many quasi-fiscal activities wherever they are conducted, and to present a more accurate measure of fiscal activity and the macroeconomic impact of government. Consolidated reporting would also facilitate crosschecking of transaction flows between subcomponents of the public sector.

    In practice, the overall balance of the nonfinancial public sector is the expanded balance concept of most relevance. In many countries, nonfinancial public enterprises are used for a variety of quasi-fiscal purposes. In such cases the balance of the nonfinancial public sector should be reported, calculated by adding the net balance of public enterprises to government revenue or expenditure. This will be particularly important where nonfinancial public enterprises are large, where government taxes or subsidizes through them; crowds out the private sector through them (e.g., by paying above-market interest or wages), and accumulates debt or lends through them.

    Consolidating only the nonfinancial public sector in the overall balance preserves the separate identification of the financing of the government and nonfinancial public enterprises by the central bank and/or public financial institutions. In those countries where the central bank and/or public financial institutions are also involved in extensive quasi-fiscal activity, it may be desirable for some analytical purposes to also calculate and report a fully consolidated public sector balance.

    The overall balance of the nonfinancial public sector should be presented alongside the overall balance of general government. This is important for diagnosing the sources of fiscal problems, and for preserving the key distinction between general government and nonfinancial public enterprises which, while used to some extent to carry out fiscal policy, are usually primarily concerned with commercial objectives. Separate treatment of subsectors also helps reduce the possibility that presentation of a nonfinancial public sector balance could be construed as implying the government is more likely to use nonfinancial public enterprises for fiscal purposes.

    On the other hand, the fact that governments own these institutions and have the capacity to direct them to conduct quasi-fiscal activities—whether or not they currently exercise that capacity—argues for the importance of more general reporting of supplementary information on the nonfinancial public sector balance. The application of generally accepted accounting standards (which focus on the ability to control as a criterion for consolidated reporting) to government financial reporting may in future provide added impetus to reporting on the fully consolidated public sector, with separate reporting by subsector.

130. As defined by INTOSAI, the objectives of internal control systems are to promote orderly, economical, efficient, and effective operations; to safeguard resources against loss due to waste, abuse, mismanagement, errors, and fraud; to adhere to laws, regulations, and management directives; to develop and maintain reliable financial and management data; and to disclose these data in timely reports.111 To be effective, internal controls must be appropriate, function consistently as planned throughout the period, and be cost-effective. A set of guidelines for internal control standards issued by INTOSAI is summarized in Box 19. Internal control systems in all countries should conform to INTOSAI guidelines.

Box 19. INTOSAI Guidelines for Internal Control Standards

INTOSAI has issued a set of general and detailed standards defining a minimum level of acceptability for a system of internal control.

General standards

  • Specific control objectives are to be set for each activity of the organization, and are to be appropriate, comprehensive, reasonable, and integrated into the organization's overall objectives.

  • Managers and employees are to maintain a supportive attitude to the standards at all times, and are to have the integrity and sufficient competence to meet the standards.

  • The system is to provide reasonable assurance that the objectives of an internal control system will be met.

  • Managers are to continually monitor their operations and to take prompt remedial action where necessary.

Detailed standards

  • Full documentation of all transactions and of the control system itself are to be provided.

  • Transactions and events should be promptly and properly recorded.

  • Execution of transactions and events should be properly authorized.

  • Key responsibilities at different stages of a transaction should be separated among individuals.

  • Competent supervision is to be provided to ensure control objectives are being achieved.

  • Access to resources and records is to be limited to authorized individuals who are accountable for their custody or use.

131. An example of a government-wide approach to internal control is that taken in France and in countries based on the French administrative system, where there is a clear distinction imposed by law between the public agency requesting a payment, a special unit of the ministry of finance that approves all expenses, and the accounting department of the ministry of finance that makes all payments.112 Other systems also separate the power to authorize commitments from that of making payments, but are more decentralized and emphasize the responsibility of management of each individual government agency for setting a sound control environment.

Assessment of arrears

132. In addition to being an indicator of serious flaws in fiscal management, a failure to identify arrears—on the payments or receipts side—can be a major impediment to fiscal transparency. To the extent that arrears are unreported, the fiscal position is wrongly stated. Effective government accounting systems should provide enough information to assess the extent of payment or tax arrears.

133. Cash accounting in government understates the real government deficit to the extent that governments have substantial or persistent payment arrears (e.g., to suppliers, employees, and pensioners). Payment arrears are rarely an issue in advanced economies, but are only too common in developing countries and countries in transition, for the reasons given in Box 20. This problem can often arise more from poor budget preparation than from accounting system weaknesses, but a robust accounting system does help to remedy the problem and avoid its recurrence.

134. A basic requirement of fiscal transparency is that cash accounting reports should be supplemented by accounts-based reports of bills due for payment to assess arrears.113 Data on arrears would not be generated as a matter of course from a simple cash accounting system, but should be provided in supplementary reports. Therefore, all governments should move toward an accounting standard that facilitates end-period reports on accounts due for payment as well as reports on a cash basis—whatever basis of accounting is used. An accrual or a modified accrual system would achieve this objective, and may be appropriate for some countries.

135. On the revenue side, governments must also account for taxes and other revenue that have not been received on time.114 For example, the stock of tax arrears can be substantial, but it is difficult to know how much of the stock is actually collectible because many countries do not write off bad debts. As with the expenditure side, it is essential that the tax administration and accounting systems recognize and record payments due, and that, to the extent possible, they report the monthly and annual flows of unpaid taxes, penalties, and interest.115

Box 20. Stages of Payment and Payment Arrears

A payment arrear occurs when a bill or other obligation is due for payment but is not paid on or before the due date. To assess arrears, it is necessary to identify both when a bill is due for payment and whether or not actual payment has occurred. In a typical payment process, all accounting systems observe four basic stages:

  • commitment: a prospective expenditure resulting from placement of an order, signing of a contract, or other agreement for the provision of goods or services;

  • verification: confirmation by the authorized receiving agent that an ordered good or service has been received and, thereby, that a liability and due date of payment are recognized;

  • payment issue: issuance of a check or payment order to the supplier of a good or service or to meet a transfer obligation fallen due; and

  • cash payment: payment of cash or transfer of funds to a supplier or recipient's account after presentation and processing of check or payment order.

In advanced economies, it is customary for many suppliers of goods and services to provide between 30 and 60 days of credit from the verification to the payment-issue stage. That is, bills are "payable" after verification, and "due for payment" after the lapse of whatever credit period is allowed. Cash and modified cash accounting systems record and report expenditure on a "payments issue" (or sometimes on a "cash-payment") basis. However, with less-developed accounting systems, it is often difficult to get reliable estimates of earlier payment stages and of accounts due for payment. Accrual and modified accrual accounting systems record and report expenditure at the point of verification, and generally maintain more comprehensive records for all stages of payment. It is therefore easier to assess payment arrears from these latter systems.

Coverage of domestic and externally financed transactions

136. The accounting system should bring all public transactions to account in a timely way, and cover both domestic and externally financed transactions. In developing countries with large external aid inflows, it is common that many externally financed transactions are not captured by the government accounting system. Sometimes this occurs as a direct consequence of donor financing arrangements. For example, expenditure may be debited directly to donor agency or trust accounts, and special accounting arrangements may be set up to ensure accountability to the donors, usually at the expense of transparency and accountability in the recipient country. All countries (with donor country support, where appropriate) should develop comprehensive and integrated accounting systems covering public transactions, irrespective of the source of financing. Cash systems can meet this objective, the principal requirement being that special measures should be taken to ensure that all transactions are accounted for in a timely way.

Aid-in-kind

137. A related and very common weakness in accounting systems of many developing countries is that noncash aid is rarely fully recorded. This means that the public accounts do not reveal the true level of resources used nor their allocation by sector, organization, or region. An equally important failing is that assets thereby created or acquired are not recorded in a way that helps to identify long-term operations and maintenance needs. The transfer of such assets to the government when donor financing is completed can then lead to unexpected pressures on the budget. There are also problems with the timely recording and valuation of such assistance, and some measures should be taken to include aid-in-kind transactions to improve transparency. Cash systems are generally unsatisfactory as a means of tracking such transactions, and a full accrual system would be needed to deal with nonfinancial assets in a fully integrated way. It is proposed that all countries maintain at least memorandum-level records of significant receipts of aid-in-kind, showing forecast receipts in the budget and audited receipts with the annual accounts.

Procurement and employment

3.3.2 Procurement and employment regulations should be standardized and accessible to all interested parties.

Procurement and tendering

138. Contracting for goods and services, particularly where large contracts are involved, must be open and transparent to provide assurance that opportunities for corruption are minimized and that public funds are being properly used. Similar considerations should apply to contracting out government services or management processes, and to privatization.

139. Appropriate tendering mechanisms should be set up for contracts above a threshold size, and procurement regulations should give independent authority to a tender committee or board and require that its decisions be open to audit.116 Where services formerly provided within government are contracted out to the private sector, these procedures should be subject to the same or similar procurement regulations.117 In this area, the OECD and the World Bank have helped a number of countries establish modern procurement systems, and good progress has been made in countries in transition toward establishing sound and transparent procurement systems. Some countries developed a procurement law based on the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Procurement of Goods, Construction, and Services.118

Employment

140. Procedures governing employment in the public service should be clearly specified and accessible. Any public-service-wide recruitment and pay regulations should be published. Vacancies should be advertised and filled through competition, with clearly defined selection criteria. In a number of advanced economies, significant powers are being delegated to agency heads to set their own recruitment and—within varying limits—pay policies. Clarity and openness of procedures, of course, remain fundamental requirements.

Internal audit

3.3.3 Budget execution should be internally audited, and audit procedures should be open to review.

141. Effective internal audit by government agencies is one of the first lines of defense against misuse and/or mismanagement of public funds.119 It should be based on a sound internal control environment, and not seen as a substitute for one. Checking by internal auditors also provides valuable material for the review of financial compliance by external audit agencies. The existence and effectiveness of internal audit should be assured by requiring that internal audit procedures be clearly described in a way that is accessible to the public, and that the effectiveness of these procedures should be open to review by the external auditors.

Tax administration

3.3.4 The national tax administration should be legally protected from political direction and should report regularly to the public on its activities.

142. Tax administration should be, and be seen to be, conducted in a fair and impartial manner, free of political intervention. For this reason, heads of tax administration should be appointed by law, and be given some statutory protection against removal from office and political direction in interpreting tax laws. The statutory appointment of tax commissioners with clearly specified powers over interpretation of tax laws is one approach that helps to provide assurance of integrity. The tax collection process should also be open, and to this end revenue collecting agencies should provide a timely annual report to the legislature on their activities during the year. These reports, as well as covering performance data such as actual collections relative to budget, should provide details of actions being taken to improve compliance with tax laws. A recent development in some advanced countries is a requirement to publish with new or amended tax legislation a statement of the compliance cost of proposed measures.120

110 Under this broad definition, internal control covers administrative controls (procedures governing decision-making processes) and accounting controls (procedures governing the reliability of financial records).
111 See INTOSAI (1992).
112 Tunisia provides a good example of this organization of internal control following the French system. See the ROSC for Tunisia, Fiscal Transparency Module, at http://0-www-imf-org.library.svsu.edu/external/np/rosc/tun/index.htm.
113 See more detailed discussion of these issues in Potter and Diamond (1998) and IFAC (2000a).
114 Since tax revenue is compulsory and unrequited, there are more difficulties in establishing recognition points to establish tax liability than on the expenditure side. IFAC (2000a) notes a number of possible recognition points that could apply under an accrual system and gives examples of recognition points for different taxes (paragraphs 517-28), but notes that "because of the differences in legislation and administrative systems across countries, it is possible that different countries will have different recognition points for similar taxes" (paragraph 524).
115 Although offsetting arrangements are generally not recommended in government transactions, it is important that a unified approach be taken to assessment of tax liabilities. A single taxpayer identification number and tax file for each taxpayer would permit such an assessment; if a taxpayer is in arrears for one tax and entitled to a refund from another tax, the refund could be used to offset the tax arrears.
116 Korea provides a good example of a clear, comprehensive and transparent framework at all levels of the general government for procurement and tendering. See the ROSC for the Republic of Korea, Fiscal Transparency Module, paragraph 22, at http://0-www-imf-org.library.svsu.edu/external/np/rosc/kor/index.htm, paragraph 22.
117 Guidelines on public procurement are available through the OECD/PUMA web site, which cites relevant legislation under multilateral trade arrangements like the World Trade Organization's Government Procurement Agreement (http://www.aiia.com.au/publications/WTO9902.html) and the European Union's Procurement Directives, (http://formby.wiganmbc.gov.uk/pub/bsu/eudirect.htm) which set legal obligations for national systems and practices.
118 See http://www.uncitral.org/english/texts/procurem/proc93.htm. One such country is Poland, which received technical assistance from OECD/SIGMA. It operates a highly decentralized procurement system, with a central public procurement office responsible for developing rules and regulations.
119 Internal audit is defined here as internal to the executive branch of government, and independent audit as external to the executive. Internal audit therefore covers both an audit of an agency by staff of the agency itself (ideally, reporting directly to senior management) and an audit of an agency by another agency (e.g., by an audit body under the control of the ministry of finance or the prime minister).
120 In Australia, these are referred to as "compliance cost impact statements."

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