ST/ESA/PAD/SER.

E/18

Department of Economic and Social Affairs

Division for Public Economics and Public Administration

INTEGRATED FINANCIAL
MANAGEMENT IN LEAST
DEVELOPED COUNTRIES

United Nations, New York, 1999

 NOTES

The designations employed and the presentation of material in this publication do not imply the expression
of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status
of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or
boundaries.

The designations “developed” and “developing” economies are intended for statistical convenience and do
not necessarily express a judgement about the stage reached by a particular country or area in the
development process.

The term “country” as used in the text of this publication also refers, as appropriate, to territories or areas.

The term “dollar” normally refers to the United States dollar ($).

Comments and inquiries regarding this report may be directed to:

Mr. Guido Bertucci

Director, Division for Public Economics and Public Administration
Department of Economic and Social Affairs
United Nations, New York, NY 10017
United States of America
Fax: 1-212-963 9681
Telex: 42231 UN U1
 FOREWORD

The focus of this publication is on government only a few countries have been able to use financial
financial management in least developed management to significantly improve their
countries (LDCs). Government financial performance in terms of fiscal management or
management is concerned with financial allocative or technical efficiency.
management of central government, including Yet the strategies for effective financial management
ministries, departments and field offices. Public systems expounded in this book are matters of
financial management is a broader concept general agreement. The challenge is to implement
which embraces financial management in them so as to achieve policy objectives within the
organizations which have their own income and context of LDCs.
expenditure budgets, eg. non-governmental This study was prepared for the Public Finance and
organizations, public enterprises, local and urban Private Sector Development Branch by Michael
authorities, and independent public institutions Parry and Phil Harding, with contributions from Mike
such as universities. Frazer and David Fletcher, of International
Much work has already been written on financial Management Consultants Ltd., the United Kingdom.
management systems in both developing and The views expressed are those of the individual
developed countries, and there is extensive authors and do not imply any expression of opinion
literature. There have also been a number of on the part of the United Nations.
efforts to enhance public-sector financial
management in LDCs. These have emanated
from the perceived costs of inadequate financial
management, and potential benefits from
improved systems. Most of these efforts have
been piecemeal in nature, focusing on just one
aspect of financial management, eg. budget or
accounting. These attempts at enhanced
systems have met with varying degrees of
success. Some have never been fully
implemented, many have failed when external
support was withdrawn, and a few have provided
lasting benefits. They have generally been
constrained by the lack of resources (especially
human resources) and the inadequate
infrastructure in most LDCs. In broader
macroeconomic terms, there is evidence that Guido Bertucci Director
Integrated Financial Management in Least Developed Countries
Division for Public Economics and Public
Administration
Department of Economic and Social Affairs.
EXECUTIVE SUMMARY
In general terms the least developed
countries are those which are very poor, as
characterized by low per capita gross
domestic product (GDP) and other criteria3/.
The UN has classified 48 countries as
leastdeveloped. While this is not the only
taxonomy of countries to indicate their
relative poverty, it is the basis used for this
book.
In many LDCs, the existing financial
management subsystems are failing to cope
with the demands placed on them. Planning
systems have typically lost credibility with
the failure to achieve targets in earlier plans.
Budgets are often poor predictors of financial
out-turns and rarely act as an effective
resource allocation tool. Accounting systems
are being asked to handle government
transactions of a scale and complexity not
envisaged when the systems were designed,
and government accounts are often years in
arrears. Auditing, both internal and external,
has often been ineffective, even for
compliance control, and virtually never for
performance enhancement. Financial
regulations are typically outmoded, with
inadequate delegation or financial powers.
Within this environment there are rarely
adequate information flows, and such
information as exists is often either late or
unreliable, or both. Corruption and
"leakages" from the system exist to varying
extents in many LDCs.
iii
Conditions existing in LDCs do not form an
encouraging background for high-quality
public financial management. Financial
management is often carried out under
difficult conditions, sometimes with quite
rudimentary resources. The skills necessary
for good financial management are likely to
be absent, or at least in very short supply.
Granting LDC status recognizes a country’s
special economic and social needs. It is
therefore tantamount to an invitation for
donors to provide assistance. Figures for
official development assistance (ODA), 4/
show that donors provide proportionately
more to LDCs than they do to developing
countries as a whole. As a result, in these
countries, ODA often forms a significant
element of three important flows: revenues,
official foreign exchange receipts and
development expenditure. This creates
special financial management problems. For
instance, if development expenditure is
funded mostly from ODA, development plans
and budgetary procedures have to adapt to
the requirements of donors. Similarly,
financial controls, reporting mechanisms and
accountability arrangements generally have
to meet donor needs. In addition to
procedural implications, the receipt of large
amounts of ODA creates competition for
counterpart resources, produces
conditionality dilemmas for governments
wishing to match their own agendas with
those of donors, and results in dependency,
both financial and otherwise.
No general survey exists of the status of
financial management in LDCs. A 1991 UN
report on government financial management
in LDCs was based on survey work in six
countries: Bangladesh, Bhutan, Malawi,
Nepal, Sierra Leone and Somalia. 5/ For
these countries a range of problems in the
field of government financial management
was reported, but of no greater severity than
that which is generally supposed to exist in
developing countries generally.6/ This is
confirmed by the practical experiences of the
authors of this book. Recent work in a
number of LDCs, as well as other countries,
indicates that LDCs have financial
management systems which could be
significantly improved. This experience is
confirmed by the authors.

TABLE OF CONTENTS

FOREWORD iii

EXECUTIVE SUMMARY .iv

I.INTRODUCTION 1

II. GOVERNMENT FINANCIAL MANAGEMENT–AN OVERVIEW

Benefits of good financial management
3
Institutional structure for effective financial management
5
Differing activity life cycles within financial management
6
The impact of changes in information technology
7
The boundaries of financial management .................................................................................. 8
Financial management in the public sector contrasted to the private sector ................................. 8
III. PLANNING
Introduction
13
Long-term plans .................................................................................................................. 13
Public investment programmes (PIPs)
14
Medium-term financial plans
14
Expenditure prioritization ...................................................................................................... 19
IV. ANNUAL BUDGETING
Introduction ............................................................................................................. 21
Budget quality indicators .......................................................................................... 22
The budgeting process ............................................................................................. 24
Institutional framework of budgeting and planning ........................................................ 26

iii
Non-financial performance measures ......................................................................... 27
Alternative budget approaches .................................................................................. 30
Specific country experiences .................................................................................... 33
Some specific budget issues .................................................................................... 36
Presenting information in budgets ............................................................................. 41
Summary of elements of an effective planning/budget system ...................................... 44

V. ACCOUNTING, MONITORING, EXPENDITURE CONTROL,

REPORTING
Introduction ............................................................................................................. 45
The accounting model and basis ........................................................................................... 46
Accounting standards in government accounting ........................................................ 50
Fund release procedures .......................................................................................... 52
Government accounting and record-keeping ............................................................... 53
Initial recording of transactions .................................................................................. 54
Information flows and consolidation ........................................................................... 55
Expenditure control, monitoring and reporting ............................................................. 57

Public expenditure review process ............................................................................. 58

Cash and liquidity management ............................................................................................ 58
VI. CODING AND CLASSIFICATION
Introduction 61
Multiple objectives of a classification system ............................................................. 61
Classification linkages to stages of the financial management cycle ............................. 63
Criteria against which to evaluate a classification system ............................................ 68
Concepts underlying classification structure ............................................................... 68
Impact of accrual accounting on the analytic model .................................................... 70
Financial assets and liabilities and financing flows ...................................................... 70
Revenue and grants ................................................................................................. 71
Functional and economic classification ...................................................................... 72
Legal aspects of classification .................................................................................. 74
Conclusions 74
VII. FINANCIAL STATEMENTS
Introduction ............................................................................................................. 75
What are the financial statements? ........................................................................... 75
Entity concept ......................................................................................................... 76
Elements of financial statements .............................................................................. 77
Characteristics of elements of financial statements ..................................................... 80
Financial statements in the context of financial management ....................................... 83
Benefits of financial statements ................................................................................ 86
Conclusions ............................................................................................................ 87
Annex: Format of financial statements ....................................................................... 87
VIII. INTERNAL AND EXTERNAL AUDITING
Introduction ............................................................................................................. 93
External audit of government ..................................................................................... 94
Internal audit ........................................................................................................... 95
The performance audit .............................................................................................. 96
Overview of the role of auditing in the integrated financial management approach ........... 97
Conclusions ............................................................................................................ 97
IX. IMPACT OF INFORMATION TECHNOLOGY
Introduction ............................................................................................................. 99

iv
Scope for more integrated systems ......................................................................... 108
Constraints ........................................................................................................... 110
Practical issues .................................................................................................... 110
Systems design .................................................................................................... 113
Problems of system sustainability ........................................................................... 119
Conclusion ............................................................................................................ 120

X. IMPLEMENTING INTEGRATED FINANCIAL MANAGEMENT

Introduction ........................................................................................................... 123
Physical constraints and their resolution .................................................................. 124
Measuring the benefits of good financial management when applied to governments ................ 125
Change management ............................................................................................. 129
Communications strategy ....................................................................................... 133
Risk analysis ........................................................................................................ 133
The process approach to financial management upgrading ........................................ 134
Human resource development and training ............................................................... 134
Organizational, institutional and human resource management issues ........................ 137
Problems encountered ........................................................................................... 138
Conclusions .......................................................................................................... 138

Exhibit 1. The financial management process ......................................................... 1

Exhibit 2. Model of an integrated financial management system ............................... 2
Exhibit 3. Benefits of high-quality financial management .......................................... 5
Exhibit 4. Institutional arrangements and expenditure outcomes ............................... 7
Exhibit 5. Timing of financial management activities ................................................. 8
Exhibit 6. Public compared to commercial financial management ............................ 10
Exhibit 7 Example of three-year rolling budget ....................................................... 14
Exhibit 8. Planning time-scales ............................................................................ 15
Exhibit 9. Major stages in preparation of the three-year rolling budget ....................... 15
Exhibit 10. The three-year rolling budget model (single year) ..................................... 16
Exhibit 11. Description of components and relationships ........................................... 17
Exhibit 12. Multi-year three year-rolling budget relationships ..................................... 18
Exhibit 13. Overview of the budget process .............................................................. 21
Exhibit 14. Budget quality indicators ....................................................................... 22
Exhibit 15. Key stages in the annual budget process ............................................... 25
Exhibit 16. Typical planning/budget structure .......................................................... 26
Exhibit 17. Linkage between economy, efficiency and effectiveness ........................... 28
Exhibit 18. Activity-based costing applied to government .......................................... 32
Exhibit 19. Model of recurrent impact of development projects ................................... 36
Exhibit 20. Manpower reconciliation statement ........................................................ 37
Exhibit 21. Recurrent and development budgets ...................................................... 37
Exhibit 22. Pattern of expenditure over typical project life cycle ................................. 38
Exhibit 23. Project expenditure monitoring format ..................................................... 39
Exhibit 24. Recording non-monetary donor assistance .............................................. 40
Exhibit 25. Classification of flows by time for liquidity management ............................ 41
Exhibit 26. Features of a good budget presentation .................................................. 42
Exhibit 27. Example of ministry expenditure budget (currency 000s) .......................... 43
Exhibit 28. Elements of an effective budget-planning system .................................... 44
Exhibit 29. Model of planning-budgeting relationships ............................................... 44
Exhibit 30. Expenditure release, accounting, monitoring and expenditure control ........ 45
Exhibit 31. Accrual model link between flows and balances ...................................... 46

Exhibit 32. Analytic framework of balance sheet and operating statement .................. 47

i
Exhibit 33. Tracking expenditure flows .................................................................... 48
Exhibit 34. Different accounting bases .................................................................... 49
Exhibit 35. Comparison of accounting bases ........................................................... 50
Exhibit 36. Fund release procedures ....................................................................... 52
Exhibit 37. Votes ledger example ........................................................................... 55
Exhibit 38. Existing accounting information flows in typical least developed countries .. 56
Exhibit 39. Reporting structure model ..................................................................... 57
Exhibit 40. Cash management ............................................................................... 58
Exhibit 41. Classification dimensions ...................................................................... 62
Exhibit 42. Model of an integrated financial management system .............................. 63
Exhibit 43. Linkage of stages of financial management cycle to classification ............ 66
Exhibit 44. Criteria for classification systems ........................................................... 68
Exhibit 45. State-owned enterprises ........................................................................ 69
Exhibit 46. GFS analytic framework ........................................................................ 69
Exhibit 47. Alternative treatment of financing ............................................................ 71
Exhibit 48. GFS analysis of revenue and grants ....................................................... 72
Exhibit 49. GFS economic and functional cross-classification ................................... 73
Exhibit 50. Important accounting categories in Bangladesh ....................................... 74
Exhibit 51. Concepts of government and commercial entities compared ..................... 76
Exhibit 52. Objectives of financial reporting .............................................................. 77
Exhibit 53. Elements of financial statements under different accounting bases ............ 78
Exhibit 54. Liabilities recognized under different bases of accounting ......................... 81
Exhibit 55. Net equity under different bases of accounting ......................................... 82
Exhibit 56. Accountability under different accounting bases ...................................... 83
Exhibit 57. Financial statements/performance analysis in financial management cycle 84
Exhibit 58. Assets and liabilities--alternative classification approaches ...................... 85
Exhibit 59. Benefits of financial statements ............................................................. 86
Exhibit 60. Audit overview ...................................................................................... 93
Exhibit 61. Audit comparison ................................................................................. 95
Exhibit 62. Audit objectives and performance indicators ............................................ 96
Exhibit 63. Approaches to information technology .................................................. 103
Exhibit 64. Degree of integration ........................................................................... 105
Exhibit 65. Data flows in an integrated system ....................................................... 109
Exhibit 66. Relationship between business processes ............................................ 114
Exhibit 67. Information flows ....................................................................................... 115
Exhibit 68. Accounting systems configuration with links to core system ........................ 116
Exhibit 69. PRINCE structure ..................................................................................... 118
Exhibit 70. Plans ...................................................................................................... 119
Exhibit 71. Implementation issues and strategies ......................................................... 123
Exhibit 72. Physical progression of changes ................................................................ 124
Exhibit 73. Benefits of good financial management and costs of weak
financial management in government .......................................................... 125
Exhibit 74. Model of measurement of activity-benefits relationship ................................. 126
Exhibit 75. Functional activities to benefits cross-walk .................................................. 127
Exhibit 76. Change management model ...................................................................... 130
Exhibit 77. Accounting information system stakeholders and institutions ....................... 131
Exhibit 78. Risks ............................................................................................................ 133
Exhibit 79. The competence training model ................................................................. 137

1

Focus of book
The focus of this book is on government financial
management in least developed countries (LDCs).
Government financial management is concerned with
financial management of central government,
including ministries, departments and field offices.
Public financial management is a broader concept
which embraces financial management in
organizations which have their own income and
expenditure budgets, eg. non-governmental
organizations, public enterprises, local and urban
authorities, and independent public institutions such
as universities.
The definition of LDCs is examined in section 1.3,
below.
Much work has already been written on financial
management systems in both developing and
developed countries, and there is extensive literature.
There have also been a number of efforts to enhance
public-sector financial management in LDCs. These
have emanated from the perceived costs of
inadequate financial management, and potential
benefits from improved systems. Most of these
I. INTRODUCTION
efforts have been piecemeal in nature, focusing on just
one aspect of financial management, eg. budget or
accounting. These attempts at enhanced systems have met
with varying degrees of success. Some have never been
fully implemented, many have failed when external
support was withdrawn, and a few have provided lasting
benefits. They have generally been constrained by the
lack of resources (especially human resources) and the
inadequate infrastructure in most LDCs. In broader
macroeconomic terms, there is evidence that only a few
countries have been able to use financial management to
significantly improve their performance in terms of fiscal
management or allocative or technical efficiency.
Yet the strategies for effective financial management
systems expounded in this book are matters of general
agreement. The challenge is to implement them so as to
achieve policy objectives within the context of LDCs.
Integrative approach to financial
management
It is commonplace to depict government financial
management as a circular process made up of several
interrelated systems. The concept of a circle of financial
2
management control probably originated in the
nineteenth century. It remains a popular expositional
tool. For instance, in 1985 a version of it appeared
prominently in a major United States General
Accounting Office publication on managing the cost
of government,1/ as set out below.
Exhibit 1. The financial management process
two subsystems can make their maximum contribution to
the overall objective of good financial management. For
example, a computerized accounting system may include
an audit trail to facilitate effective audit and may
incorporate a number of built-in internal controls. It may
also provide opportunities not present in a manual system
for the auditor to access data. Nevertheless, accounting
and auditing have to remain separate processes, because
of the concept of audit independence.
The concept of integration and linkages will be developed
through the following sections to lead to a more
comprehensive integrated financial management model,
as set out in Exhibit 2 below.

In fact the subsystems are more extensive than

indicated in this model, and are as follows:
• Planning–perspective and medium-term;
• Budgeting–recurrent, development and revenue;
• Fund release and liquidity management;
• Accounting and monitoring;
• Internal and external audit;
• Systems of information feedback and reporting;
and
• The system of rules, procedures and financial
delegation powers which link the subsystems
together.
Integration of these subsystems facilitates data
transfer between components, ensures consistency
and reduces duplication. All of this enhances the
ability to use information for decision-making,
control and monitoring. Recent developments in
information technology have made integrated public
financial management systems a feasible objective.
LDCs are now enabled to implement major reforms
in their financial management systems and to achieve
levels of functionality and integration which were not
previously practical options.
On the other hand, there are sometimes good reasons
for a separation of subsystems, for instance between
accounting and auditing.2/ In such cases it may be
more helpful to talk of establishing links, so that the
3
The benefits from integration of, or linkages between,
subsystems are substantial:
• As illustrated by the model in Exhibit 2, the
information outflows from one component are
inflows to another component;
• All utilize a common financial valuation and
measurement model;
• Recognition of the linkages and commonality can
improve performance within each sub-component,
and hence of the system as a whole;
• By treating the system as a whole, more effective
procedures, information flows, training, and
systems tools can be developed; and
• Modern information technology makes it both
more feasible, and the gains greater, to treat
financial management as a single system.
Least developed countries, their
characteristics, and the challenge of
financial management reform
In general terms the least developed countries are those
which are very poor, as characterized by low per capita
gross domestic product (GDP) and other criteria 3/. The
UN has classified 48 countries as least developed. While
this is not the only taxonomy of countries to indicate their
relative poverty, it is the basis used for this book.
In many LDCs, the existing financial management
subsystems are failing to cope with the demands placed
on them. Planning systems have typically lost credibility
with the failure to achieve targets in earlier plans. Budgets
are often poor predictors of financial out-turns and rarely
act as an effective resource allocation tool. Accounting
systems are being asked to handle government
transactions of a scale and complexity not envisaged when
the systems were designed, and government accounts are
often years in arrears. Auditing, both internal and
external, has often been ineffective, even for compliance
control, and virtually never for performance enhancement.
Financial regulations are typically outmoded, with
inadequate delegation or financial powers. Within this
environment there are rarely adequate information flows,
and such information as exists is often either late or
unreliable, or both. Corruption and "leakages" from the
system exist to varying extents in many LDCs.
4
Conditions existing in LDCs do not form an encouraging
background for high-quality public financial
management. Financial management is often carried
out under difficult conditions, sometimes with quite
rudimentary resources. The skills necessary for good
financial management are likely to be absent, or at
least in very short supply.
Granting LDC status recognizes a country’s special
economic and social needs. It is therefore tantamount
to an invitation for donors to provide assistance. Figures
for official development assistance (ODA),4/ show that
donors provide proportionately more to LDCs than they
do to developing countries as a whole. As a result, in
these countries, ODA often forms a significant element of
three important flows: revenues, official foreign exchange
receipts and development expenditure. This creates
special financial management problems. For instance, if
development expenditure is funded mostly from ODA,
development plans and budgetary procedures have to
adapt to the requirements of donors. Similarly, financial
controls, reporting mechanisms and accountability
arrangements generally have to meet donor needs. In
addition to procedural implications, the receipt of large
amounts of ODA creates competition for counterpart
resources, produces conditionality dilemmas for
governments wishing to match their own agendas with
those of donors, and results in dependency, both financial
and otherwise.
No general survey exists of the status of financial
management in LDCs. A 1991 UN report on government
financial management in LDCs was based on survey work
in six countries: Bangladesh, Bhutan, Malawi, Nepal,
Sierra Leone and Somalia.5/ For these countries a range of
problems in the field of government financial
management was reported, but of no greater severity than
that which is generally supposed to exist in developing
countries generally.6/ This is confirmed by the practical
experiences of the authors of this book. Recent work in a
number of LDCs, as well as other countries, indicates that
LDCs have financial management systems which could be
significantly improved. This experience is confirmed by
the authors.
5
 II. GOVERNMENT FINANCIAL
MANAGEMENT–AN OVERVIEW
Benefits of good financial management
The benefits of high-quality government financial management are substantial. The matrix below summarizes the
major benefits, and indicates typical financial management activities related to achieving such benefits.
Exhibit 3. Benefits of high-quality financial management
Area of benefit
• Enhanced resource mobilization
• Improved macro-level fiscal management and
expenditure control through more effective
institutions, processes, and control mechanisms
• More optimal resource allocation decisions to
achieve clearly articulated public policy objectives
through enhanced identification of the costs and
benefits of alternative expenditure decisions
• More effective liquidity management of inflows
and outflows
• Improved technical efficiency in managing and
utilizing resources through improved information
flows more relevant to decision responsibilities of
managers
• Enhanced transparency and accountability of
government, providing better historic information
as a guide to the future
5
Specific activities
Managing the collection of domestic revenues and other
receipts to ensure that the highest feasible level of
collection is attained within the legislative framework.
Provide information to identify the most effective
domestic revenue mobilization policies.
Managing the receipt of external resources, including
loans and official development assistance, through
proper procedures and controls which comply with
requirements of lenders and donors.
Managing planning and budgeting systems for revenues
and expenditure envelopes. Establishing systems for
preparing, reviewing and consolidating medium-term
financial plans and budgets. Their presentation to
Parliament. Implementation and monitoring of
authorized policies and amendments thereto.
Planning and prioritizing investments and their funding.
Establishing and managing systems for identifying
policy priorities, cost and benefits of decision
alternatives, presenting information and implementing
monitoring and reporting on outcomes.
Anticipating the liquidity needs of government and
planning for and deploying surpluses. This is to achieve
maximum use of liquid funds which are temporarily
available and which can be invested in short-term
markets, without endangering the funding of normal
operations.
Ensuring that expenditures and other resources are
applied to the maximum advantage of government, ie.
ensuring that resources are properly utilized with regard
to efficiency and effectiveness. Directing resources out
of lower into high priority uses, involving analysis of
costs, actions to achieve higher productivity by changing
the cost-mix, and the transfer of resources to places
where they are most needed.
Recording, accounting for, analysing and reporting on
the financial transactions, assets and liabilities of
government. This is important for two purposes: as a
basis for external accountability, and so that
management has accurate, timely and relevant sources of
information with which to manage its resources.
• Good management of public funds and assets,
resulting in reduction in the levels of corruption
and leakages
Institutional structure for effective
financial management
Recent World Bank research by Campos and Pradhan
(“Budgetary Institutions and Expenditure Outcomes,”
Ed Campos and Sanjay Pradhan, World Bank Policy
Research Department, September 1996), focused on
expenditure management of national governments.
This was narrower than the present study, which
embraces revenue issues, but at the same time the
Campos and Pradhan study was broader in that it
considered factors outside the parameters of financial
management.
The study identified three key performance
indicators:
• Fiscal discipline at the aggregate level (second
item in the list above);
• Prioritization for allocative efficiency and equity
(third item in the list above); and
• Technical efficiency (fifth item in the list above).
Protecting and enhancing the rights of government to
receive money or money’s worth. This entails the
management of both income flows and assets (eg.
forests, fishery resources) so that the government and
the country as a whole receive as much benefit from
them as possible.
Controlling expenditure and the exercise of financial
authority. This is to ensure that transactions involving
finance or with important financial implications
(particularly matters such as contracts and procurement
where large sums are at stake which may be vulnerable
to manipulation) are correctly undertaken by reference to
laws, regulations, applicable management guidelines and
established controls.
Carrying out the necessary financial business of
government: government has bills to settle, staff to pay
and revenue to collect. This aspect of financial
management is often forgotten. It is of paramount
importance because of the need to conduct efficiently
the everyday financial business of government.
Ensuring government’s financial reputation among
customers, investors etc. The terms on which an
organization conducts its financial business with the
outside world depends upon its standing. Thus the cost
and availability of funds to government depend on the
government’s reputation. Good financial management
can enhance a government’s reputation and therefore
improve the terms on which funds are available.
The institutional arrangements Campos and Pradhan
identified to achieve improvements within these extend
outside the parameters of financial management, and are
summarized in Exhibit 4 below.
1
 Exhibit 4. Institutional arrangements and expenditure outcomes
Institutional arrangements Accountability Transparency
• Aggregate fiscal discipline
Macro framework and co-ordination Ex post reconciliation Published
arrangements
Dominance of central ministries Sanctions Made public
Formal constraints Openness of financial markets Freedom of press
Hard budget constraints
Comprehensiveness of budget
• Prioritization
Forward estimates Reporting of outcomes Published
Comprehensiveness of the budget Ex post evaluations Freedom of press
Flexibility of line agencies Hard budget constraints Made public
Breadth of consultations Technical capacity of Parliament Comprehensible
Use of objective criteria
• Technical efficiency
Civil service pay and merit-based Clarity/purpose of task Published
recruitment/promotion
Managerial autonomy of line agencies Chief executive tenure Made public
Predictability of resource flow Financial accounts, audits, client surveys, Freedom of press
contestability in service delivery
Source: Campos and Pradhan, 1996

These conclusions are broadly consistent with those of the
authors of this study. Clearly they extend to some areas
not addressed herein, while this study considers a number
of aspects not considered by Campos and Pradhan.
Differing activity life cycles within
financial management
Perspective and medium-term planning, budgeting,
accounting and auditing can be thought of as a series
of cycles starting with planning and proceeding
through a number of interrelated stages. Each full
cycle lasts more than a year. Thus several cycles
overlap, and at any point in time financial managers
may be involved in different aspects of different
cycles, eg. perspective planning for the next five
years, medium-term planning for three years,
budgeting for one year, accounting for the current
year and taking remedial action on audit
recommendations for last year. The simple linearity
implied by the above list may be misleading as some
aspects may be occurring concurrently; eg. internal
audit may occur at the same time as accounting, as
illustrated in Exhibit 5.

Exhibit 5. Timing of financial management activities

Previous Current Future years

year year
-1 0 +1 +2 +3 +4 +5
Perspective plan
Medium-term plan
Budget
Accounts
Audit

2
The impact of changes in
information technology
These are analysed in more detail in Section IX, but
an initial overview is discussed below. Recent
changes in information technology provide the
opportunity for the major shift in financial
management referred to earlier.
Financial services and banking are among the highest
spenders on information technology, as they seek to
globalize their businesses.7/ Similar scope for using
information technology exists in government financial
management. The key factors permitting such changes
can be summarized as dramatic changes in the
increasing environment tolerance and their enhanced
capability to process and report information.
These changes have created the conditions for
connecting and integrating information systems, on a
scale which would have been difficult to imagine only
a few years ago.8/ A recent discussion paper from the
World Bank presents the different information
systems required to support the public financial
management process.9/ The main systems are
identified as macro fiscal planning; budget
preparation; monitoring and control; management of
the public sector work programme; debt management;
foreign aid management; revenue administration;
human resources management; government
accounting; and auditing. Each of these is further
divided first into subsystems and then into data
requirements. Significantly, the paper notes that
"these systems are usually implemented as
components of separate projects responding to
specific needs, with little appreciation of requirements
in other areas and little thought to critical
interrelationships. As a result the information systems
are often disparate and segmented, with little or no
capacity for sharing data. They have overlapping and
sometimes conflicting functionality, and provide
incomplete coverage, particularly for managerial
information requirements that normally span several
functional areas." Clearly current changes in
information technology are creating the conditions to
correct such problems. Integrated financial
management information systems are capable of
eliminating overlaps and data duplication, making the
required links between different systems and
providing the necessary financial information on the
status of key business processes to staff in different
parts of government.
The use of information technology for integration of
subsystems raises a number of issues.
• There is a distinction between integrated core systems
and linkages between systems. Accounting is almost
certainly a core system, and all accounting functions,
eg. payments and advances, would be fully integrated.
On the other hand, for example, budgeting might be on
a different software platform, with data transferred only
at a summary level.
• In strict terms, integration means "to make one,” but in
financial system terms there are difficulties in such a
rigid approach. Most government accounting systems
have a significant bespoke (tailored) element. This is
because the accounting needs in different parts of
government differ, eg. the need to be able to report
expenditure in a form required by a donor applies only
to projects funded by that donor; development projects
have different accounting information needs from those
of recurrent activities. While there may be a core
accountancy system for such things as cash expenditure,
revenue collections, fund release and so on, other
lower-level financial systems (such as project
accounting) may be sufficiently different to be
considered independently of a common financial system
strategy.
• It may be more effective and efficient for line ministries
to have their own computer systems (a distributed
processing concept). Thus systems may be integrated in
the sense of sharing common coding structures and
capability to transfer data. A distributed processing
environment makes systems more robust and ensures
coincidence of management responsibility and
operational control; and if data is transferred between
systems, then one of the key goals of integration (the
avoidance of the need to input the same data into
several systems) can be accomplished. However, to
achieve this the component parts of the financial system
must have been designed to complement and
communicate with each other.
The boundaries of financial
management
There is no precise definition of the parameters of
government financial management. It has tended to
become broader with the development of non-financial
performance indicators. The following quotations all
emphasize different aspects of a financial system.
• As a conceptual model of an entity "accounting is first
and foremost a conceptual framework used for planning
3
 economic activities, . . . its function as a control This is explained by contrasting government and
instrument is a derived one" (Most, 1972). commercial entities.
Commercial entity inputs and outputs, ie. purchases and
• As a measurement system, accountancy is "the sales, are automatically defined in money. Profit is the
process of identifying, measuring and difference between them. Thus the accounting system
communicating economic information to permit
provides a comprehensive input-output model which is
informed judgements and decisions by users of the universally applicable to all businesses. Accounting has
information" (American Accounting Association, become the dominant method by which business
1966). This view is similar to that of Ijiri (1967) performance is judged. The primary objective of
and Edwards and Bell (1961).
management is to maximize profit, appropriately defined.
• As an information system, "The accounting system Government inputs are also automatically defined in
is the major quantitative information system in money terms. However, outputs are generally service
almost every organization" (Horngren, 1982). delivery, and cannot be expressed as money. Furthermore,
government revenues are not normally dependent on
• As a control system, "Accounting information is an government expenditure. Thus accounting provides an
important control tool within the organization" input-only model. Outputs must be defined in non-
(Emmanuel and Otley, 1985). financial terms. Hence there can be no concept of profit.
Each of these quotations identifies a different
viewpoint of the nature of accountancy. They are not This lack of a simple input-output model, or financial
incompatible. Enthoven (1982) refers to "accounting performance measures, must be seen as a major problem
as an information measurement system" which of applying financial management to any public-sector
combines 2 and 3 above. organization, including national governments.
To see accounting as only an information
measurement system, however, seems too narrow. As
Dew and Gee (1973) point out, accountants have
dominated commercial information systems because
they have created the only comprehensive model of
the firm. To broaden this to include organizations
other than firms (eg. public sector enterprises),
accountancy may be seen as a model representing
quantitatively activities within an organization. This is
close to the view of Samuels and Oliga (1982), who
state that "we can represent accounting as a system
(with inputs, throughput, and output) interacting with
its environment . . . If viewed as essentially embedded
in the organization itself, the latter now becomes the
focal system interacting with its environment."
It is concluded that there is no reason to restrict the
view of financial management to purely financial
systems. It can also embrace related systems and
particularly non-financial indicators of performance.
Financial management in the public
sector contrasted to the private
sector
Financial management in government has not
achieved the same status as it has in the private sector.
There are many reasons, but one critical difference
between the private and public sectors is the absence
of money measures of outputs in the public sector.

4
 Exhibit 6. Public compared to commercial financial management

Commercial accounting model

Inputs Input $ Output $ Outputs

*materials *goods
The business activity
*labour *services
*capital

Public-sector accounting model

Inputs Output Outputs
*materials Input $ (not expected *service
*labour delivery
*capital

There are a number of other reasons why the financialGovernment• activity

transactions of governments are significantly different
from those of private-sector entities, or even public
corporations.
• It is difficult to identify the boundaries of the
• Government activities have a multifaceted impact,
government as an economic entity;
• Budgets have a greater, and different, significance
for the public sector than for the commercial sector,
• Economic transactions will include a number
and the budget process will to a greater extent drive
the classification system;
• Expenditure transactions have to be tracked from
planning to cash movement stages;
• The longer-term expenditure commitments implicit
in current transactions need to be recognized for
financial planning purposes;
• Government activities have to be considered in the
context of national policies, since they impact on
each other;
The nature and purpose of government activities,
transactions, and assets and liabilities are
fundamentally different from those of a commercial
entity;
and this is reflected in the need for multifaceted
analysis of the transactions for different purposes;
without any defined monetary value, eg. grants of
commodities or technical assistance, giving rise to
problems of assigning budget and accounting
figures;
• Government accounting systems have as one of
their design objectives to provide an historic
comparison of estimates (budgets) with actual
expenditures for detailed public expenditure review
process.
Some of these factors are considered below, others are
expanded later in the text.

Implications of the distinction between

public and commercial financial
management
Traditionally government financial management has
been about expenditure control–the input side of the
model. A survey of senior government officers in
Australia in 1983 found that 94 per cent saw financial
management as “spending no more and no less than
their budget allocation.” Controlling expenditure
against budget is a legitimate and fundamental role of
public-sector managers.

5
The conclusion above indicates, however, that if
financial management is to be an effective tool of
government policy, then financial inputs must be
linked to physical output indicators, ie. relating
expenditure, defined in monetary terms, with outputs,
defined in physical terms. Thus the need is to move
the focus of government financial management away
from looking only at inputs, and instead to develop an
output focus–a goal-oriented approach.
Before this can be achieved, the actual components of
the traditional financial management system require
enhancement. Normally governments are the biggest
spending entity in any economy. Yet the budget and
accounting systems of many governments are archaic
and have benefited little from modern developments
in financial management–a comment Kenneth Clarke,
the Chancellor, made even about the UK system in the
November 1993 budget. Budgeting and accounting
have been seen primarily as tools of fiscal and policy
management, with the main emphasis on the public-
sector borrowing requirement, and hence expenditure
control.
Only relatively recently has the need to turn financial
management into a tool enabling managers to better
perform their tasks been recognized. New Zealand has
revolutionized its system of government with the
development of output-based budgeting and accrual
accounting. Australia has moved to an output-based
three-year rolling budget. The UK has introduced
resource accounting and budgeting, based on a form
of accrual accounting. Similar programmes are being
adopted in other countries.
National impact of government activities
The duality in the economic role of government is one
factor which makes its own financial management so
difficult. Governments have a responsibility for
managing national economy. At the same time
governments are also responsible for directly
managing their own executive and activities.
Governments seek to manage both the national
economy and their own organizations effectively and
efficiently. Very often these two objectives converge,
but it is easy to envisage conflicts, for example
between the need for capital expenditure to promote
efficiency as against macroeconomic policy
objectives of restricting government borrowing.10/
Almost certainly the information needs of these two
objectives will be significantly different.
6
Nature of government transactions, assets
and liabilities
Government assets typically contain a high proportion
of infrastructure assets, eg. roads and sewage systems.
These present problems in establishing an accrual
accounting system, because of the difficulty of
arriving at meaningful estimates of value or life. In
many instances such assets have no identifiable finite
life, original cost is difficult to identify and there is no
alternative use.
Government assets also include tax revenues for
which assessments have been raised but not yet
received (ie. tax receivable). Accounting conventions
adopt a conservative approach to asset valuation,
anticipating any shortfalls between receivables and
anticipated receipts. Therefore the tax receivable
needs to be reduced by a statistical estimate of the
shortfall, based on historic experience. Provisions
have to be introduced within the classification system.
Many governments have a large unfunded pension
liability, which has never been recognized under cash
accounting. Not merely accrual accounting but the
whole approach of anticipating committed future
flows requires such a pension liability to be properly
estimated and recognized. The liability arises from the
contractual commitment to pay future pensions to
retired employees, for which no separately identified
fund has been established. The amount of the pension
liability is the actuarial estimate of the present value
of future pension payments. In many countries this
liability can be very large in relation to government
assets. It presents problems of treatment and
classification–should the cost when first recognized
be treated as an operating cost, or a capital
movement?
Multifaceted impact of government activities
The nature of government is that it delivers a range of
services to different sub-sets of the population. All
have a legitimate interest as stakeholders, and these
interests are often articulated through a range of
pressure groups. A major part of public policy is
about the amounts of and the manner in which
resources are allocated to different groups. It is
incumbent upon governments to provide transparent
information about such resource allocations.
Often the required resource allocation information for
any one group will be unique, and not required for
any other purpose. Information may be required by
geographical area, or combining the impact of a
variety of activities on one group of stakeholders. It is
probably infeasible that any system can ever be
designed that meets all of the potential information
needs, but at least the financial management system
should identify the major stakeholder groups and their
likely information requirements.
Who are the “managers” in government
financial management?
Ultimately the managers in a democracy are the
elected representatives of the people. The executive
arm of these representatives is the senior ministers,
and they in turn operate through full-time public
servants. For practical purposes these senior officials
are the managers within the entity of government.

7
 III. PLANNING
Introduction
Planning is the first of the financial management
subsystems to be considered. Planning and budgeting
together refer to four typical and distinct processes,
each resulting in a documented output. It is unlikely
that all four would be present in any country.
• Long-term planning–five years or longer, resulting
in the production of, for example, a “Five-Year
Plan.” Such plans rarely contain any financial
forecasts other than in very general terms, and are
not in any meaningful sense part of the financial
management process;
• Public investment plans (PIPs), setting out the
capital expenditure plans, typically for a three-year
period. These PIPs will normally estimate the
capital outflows, but will not link these to other
outflows or resources available. PIPs are properly
regarded as part of financial management;
• Three-year rolling plans, or budgets. These are for
most countries an innovation, and will generally
both embrace and replace the PIP. A three-year
rolling budget (TYRB) is an example; it extends
the time-frame of the traditional annual budget to a
three-year horizon, and includes capital and
recurrent expenditure, revenues and financing.
Medium-term financial plans largely replace the
need for PIPs, and are again part of the financial
management system;
• The annual budget, the legal document authorizing
the raising of revenues and expending of public
monies, and containing the annual financial
forecasts. In most countries the annual budget is
part of the constitutional framework, and it is at the
heart of the financial management system.
Long-term plans
For almost all LDCs, “planning” is linked to the idea
that “development” is a formal process, which does
not just happen, but must be planned. Many LDCs had
no formal planning institutional structure before the
commencement of official development assistance.
The formal planning process may take the form of a
“Planning Ministry” or “Planning Commission.” In
some countries, such as Botswana, planning is a division
of the Ministry of Finance.
The responsibility of such planning institutions and
systems typically extends beyond development projects
and programmes, to embrace macroeconomic planning
and management. Also, even in relation to projects,
planning institutions will be concerned with all aspects of
implementation, not just (or even primarily) financial
aspects. Indeed, a criticism of many planning institutions
is their limited financial planning capability, and such
institutions would not normally see themselves as part of
the financial management system.
However, the following activities typically carried out by
planning institutions and systems are in fact part of the
financial management process:
• Identifying development objectives;
• Developing strategies and programmes to achieve
objectives;
• Assessing resources available;
• Prioritizing between objectives and expenditure plans
so as to match expenditures to available resources;
• Establishing criteria for, and carrying out, project
evaluation and selection; and
• Monitoring project progress against plans and other
criteria.
The present status and role of planning bodies in LDCs is
often somewhat confused. There is a general move away
from long-term perspective planning, and a greater
emphasis on more detailed medium-term financial
planning. In some countries this has resulted in the
downgrading of planning institutions. Nevertheless, in
many LDCs planning institutions and systems continue to
be a significant part of the institutional framework.
To the extent that planning systems and institutions exist,
there are strong reasons for seeking to integrate them
within the financial management system. The roles of the
planning process indicated above are part of financial
management, and it is very desirable that they use the
same classification structure and valuation models that are
used by other parts of the financial management system,
and the subsystems should be able to exchange data. For
example, project monitoring should use information
derived from the accounting system; project budgets
8
should be based on the financial forecasts used in
project evaluation, and so on.
Public investment
programmes (PIPs)
PIPs have been encouraged by donors to provide a
“hard” financial investment plan. They provide a
mechanism through which capital investment
programmes can be prioritized, projects selected, and
their financial costs aggregated and recognized. These
costs can then be used in financial modeling, and
should feed into the budget process.
PIPs are normally generated as part of the planning
process. They are useful in particular because they
bring together a series of separate decisions on
projects, and enable their aggregate impact on
resources to be assessed. However, they do not
address the issue of overall resource requirements,
because they do not take account of non-capital
expenditure programmes.
PIPs encourage a focus on projects and identifying
external donor funding. Because of this focus they can
distort a rational approach to policy prioritization.
Also the concept of a PIP is fiscally expansionary, in
that most public investments demand future resources
to maintain and sustain the activity. Finally, the
concept of a PIP encourages the dual budget approach
of a development and recurrent expenditure budget.
It is concluded that PIPs are not an effective planning
tool unless clearly embraced within a broader
medium-term financial planning framework.
Exhibit 7. Example of three-year rolling budget
Medium-term financial plans
Medium-term financial plans typically take the form of
three-year rolling budgets (TYRBs). In the UK they are
referred to as the “Economic Survey,” but fulfil the same
role. Such medium-term plans (hereinafter referred to as
TYRBs) meet a number of financial management
requirements.
• Macroeconomic fiscal management essentially requires
a medium term planning framework. A TYRB moves
the planning horizon from one year to three years,
forcing more systematic advance planning of activities,
expenditures and resource implications;
• As a result there is an enhanced ability to focus on
priority sectors, and more effective utilization of
available resources. Resource constraints can be
identified at a much earlier stage, and the fiscal impact
of starting projects can be seen more clearly;
• Most projects have lives beyond one year, and single-
year planning does not provide any framework for
analysing their financial impact over a longer period;
• A forecast is provided of the impact on recurrent
expenditure of development projects which come to an
end, and where the activities have continuing resource
requirements;
• Annual budgets do not provide any mechanism for the
problem of under- or overspending on an individual
project in one year and transferring budgets to later
years;
• TYRBs provide improved annual budgeting and more
effective expenditure control.
9
TYRBs form an integral part of any financial
management reform process. Australia has led the way
in introducing three-year plans, but many countries are
now following. It is interesting that the imperative
behind Australia’s three-year budget process was to
curtail expenditure, 11/ but some LDCs now see such a
Exhibit 8. Planning time-scales
Annual budgets are typically a
constitutional requirement, and legally
permit expenditure for the next fiscal year.
Though a rolling budget has no such legal
status, nevertheless it should impact on the
budget process. This has been seen as the
major benefit in Australia. The challenge
there has been to move the three-year
budgets from merely “wish lists” of
expenditure to serious forecasts which are
seen as restricting the ability to make
expenditure decisions in annual budgets not
already in the three-year plan.
The Australian experience has also
demonstrated the need to see such three-
year budgets as part of an overall process of
budgetary reform, where the emphasis shifts
medium-term framework as a mechanism for increasing
donor aid utilization.
Conceptually, medium-term plans fit into a spectrum
between longer-term plans and annual budgets, in which
the amount of plan detail increases as the planning time
horizon shortens.
towards identifying output goals. These
wider perspectives are dealt with further below.
Preparation of a TYRB
The three-year budget should be rolled forward each year
as part of the annual budget exercise, and published in
parallel to the budget. This will enable the current year’s
budget to be reviewed as part of the medium-term
programme. In order to be meaningful, the TYRB should
embrace all recurrent and development expenditure,
revenue estimates and official development assistance, and
so identify financing needs. Therefore it needs to be
closely linked with the development programming
exercise. The major activities are set out in Exhibit 9,
below, and then explained in detail in the subsections that
follow.
10
 Exhibit 9. Major stages in preparation of the three-year rolling budget
Requests in budget call notices Included in call notices for budget and development programme requests for
three-year forward estimates, revenue forecasts and other data as identified
above
Resource ceilings Indicative resource ceilings established for each of the three years for internal
and external resources, allocated over sectors according to priorities
Ministry review Review with plan objectives and declared government priorities
Conduct economic appraisal of proposals
Discussions with line ministries following above analysis, leading to modified
estimates
Preparation of TYRB Analysis of macroeconomic implications and resource implications of TYRB
Analysis of manpower, organizational and physical resource implications

The resource ceilings must separately identify Single-year model

domestic and foreign resources. In order to arrive at
domestic resource availability, separate projections As part of the work for preparation of the TYRB, it is
must be made of: necessary to develop a model showing the
• Tax and other revenues; interrelationships of the components of the forecasts. This
will enable the implications of initial forecasts to be seen,
• Cash grants and loans; and then the effect of decision alternatives. The basic
model is set out in Exhibit 10, below.
• Other types of foreign assistance providing
counterpart funds;
• Debt service costs;
• Net flows from public enterprises; and
• Domestic borrowing targets.
The TYRB will be prepared in money units, ie. the
actual cash income and expenditure. Therefore
account will have to be taken of changes in price
levels of specific inputs. Particularly significant will
be:
• Changes in government wage levels within the
period (the only factor amenable to a policy
decision);
• Changes in prices of other major inputs; and
• Exchange rate movements and their impacts on
inputs and also on interest and principal flows on
foreign loans.
At a technical preparation level, many LDCs find it
difficult to make the forecasts of official development
assistance which are required. The approach
developed below will in many cases obviate this
problem.

Exhibit 10. The three-year rolling budget model (single year)

11
Note that this model is only for a single year.
Extension into a multi-year model is further discussed
below.
In Exhibit 10, above, the components of the model,
their interrelationship, and the extent to which they
can be controlled is explained. Important features to
note are:
• Foreign inflows are treated as a function of project
expenditure. This is a heroic assumption, but can be
justified in the context of most LDCs because of
low levels of foreign resource utilization, and the
fact that the constraint is primarily foreign
resources. However, it must be recognized that
while this may be valid at a macro level, it is
unlikely to be always valid in relation to individual
projects;
• Debt service costs are treated as fixed. While this is
obvious for foreign borrowing over such a short
period, it is less obvious for domestic borrowing,
since this is the balancing item. However, in reality
domestic borrowing is likely to lie within certain
parameters, and the impact within those parameters
of variation is unlikely to impact significantly on a
single-year model.
Thus the model becomes primarily a tool for
determining feasible levels of project expenditure and
allocation between projects, within the broad
constraints of government tax and economic policy.

12
 Exhibit 11. Description of components and relationships
Extent to which component can be
Component Description
changed and dependencies
Development budget Three-year forecasts for projects. Forecasts Policy decisions can change without
(or capital expenditure identify major categories of expenditure, and limiting expenditure on, or existence of,
programme if no sources of funding segregating foreign grant projects. Therefore there is a two-way
development budget) and loan relationship.
Recurrent budget Three-year forecasts for recurrent (revenue) Difficult to significantly change the regular
expenditure budget forecasts without major changes to
structure and organization of government
Debt service costs Forecasts of the interest and principal payable No short-term control over foreign debt
on foreign borrowing. Government borrowing servicing costs. Domestic debt service is a
needs to be separately identified from function of domestic borrowing, but
borrowing by State-owned businesses and changes of a realistic level are unlikely to
NGOs. Domestic lending service costs only have a significant impact in the year in
includes interest payments. which they take place.
Budget inflows Subdivide into several categories.
Domestic revenue–taxes and other
Domestic revenues are a function of, inter
income–received by central government. alia, taxation policy.
Direct budget support from foreign
Direct budget support is a matter of
sources. agreement with foreign organizations
Foreign resources including both grants and
Foreign resources are treated as a function
loans. Items not passed through government
of project expenditure
budget (technical assistance, commodity aid,
NGOs and public enterprises) should be
excluded
Domestic borrowing Net increase or decrease in domestic This is regarded as the balancing item
borrowing
Multi-year model
As indicated above, the model is a single-year model,
but by definition the TYRB is a multi-year model. In
extending to a multi-year model it must be recognized
that the relationship is serial and asymmetric. Thus
some components in the model are directly dependent
on the previous year, eg. domestic debt servicing costs
are dependent on cumulative domestic borrowing.
However, second-year borrowing has no impact on
first-year borrowing.
Most components are related by practical constraints.
Thus, for example, project expenditure on individual
projects cannot be increased and decreased from year
to year to meet budgetary needs. Rather, it is dictated
by physical project implementation needs, and there is
normally going to be a regular trend of expenditure
over the project life cycle. Similar constraints apply to
regular expenditure and tax revenues.
These interrelationships are summarized in Exhibit 12,
below.

13
 Exhibit 12. Multi-year TYRB relationships

This indicates a set of relationships largely determined Content and presentation of TYRBs
by practical considerations. The only modeling
relationship that needs to be incorporated The TYRB should form an integral part of the budget
mathematically is the dependency of year n + 1 process. It is essential that it be presented to Parliament as
domestic debt service costs on year n domestic part of the budget documentation. The forecasts in the
borrowing. TYRB must be seen as an extension of the current year's
External relationships
The model does not of course exist in isolation. It is
asymmetrically linked to a number of externalities.
The most important include:
• Domestic money supply and interest rates;
• Rate of inflation and asset price changes;
• Changes in GDP; and
• Other sectors directly controlled by government,
eg. public enterprises.
However, for the purpose of a specific budget exercise
these may be treated as fixed, and there is no attempt
to build in any relationship. The reason for this is that
the three-year rolling budget exercise takes place
within largely pre-defined parameters, eg. levels of
domestic borrowing, tax revenue and so on. The
decision process is primarily an allocative one within
the model. Therefore it is reasonable to ignore the
externalities.
14
budget into the future. The current year budget must
be seen as year 1 in the TYRB, and obviously the
figures must be the same.
This is best achieved by integrating the production
process for both the budget and the TYRB. The TYRB
will fail to achieve its objectives if it is produced at a
different time, by a different process, is presented in a
separate format, or has figures which differ from the
annual budget. Yet these are all failures which have
been observed in countries which have introduced, or
sought to introduce, a TYRB.
The TYRB can be combined with the annual budget
presented to Parliament. Additional columns can be
included to show the forward estimates. These would
not need to be at the same level of detail as the current
annual budget estimates, and careful consideration
needs to be given to the extent of detail and the
presentation design so as to retain clarity and
transparency.
Expenditure prioritization
A major function of the planning process is to allocate
limited resources between competing claims. A
specific problem of public financial management is
that claims for resources will always tend to exceed
resources available, since the cost of such resources
has no significant impact on the recipients, eg. health
care is very expensive to the community as a whole,
but for the individual patient in hospital the extra tax
he or she pays is insignificant in relation to the
benefits of health care received personally.
Therefore resources need to be allocated according to
public policy priorities within overall resource
ceilings. However, there are a number of factors
which make such resource allocations difficult within
LDCs.
• Particularly within the relatively immature political
systems of many LDCs, competing political
pressures make it convenient not to articulate policy
priorities too clearly;
• It is difficult to establish with any degree of
reliability the costs and benefits of specific
activities and programmes. This is especially so if
markets are not open and market prices do not
represent opportunity costs. Even without this
problem, benefits of government activities are often
difficult to express using common measurement
scales;
• In general there is better information on such costs
and benefits at a decentralized level than at the
centre;
• Donors and official development assistance can distort
the process. Donors have their own priorities, and donor
funding not only appears free (since it may not easily be
fungible), but also carries hidden benefits to recipient
organizations, eg. study awards overseas.
The challenge is to incorporate within institutions and
processes an approach to address these problems and
provide a consistent methodology for expenditure
prioritization which is the best feasible compromise
towards consistently optimal resource allocation decisions.
The main elements of such an approach are identified
below.
First, there needs to be a single consistent approach to
prioritization and allocation. If there is an ability to get
round objections by, for example, direct approaches to
State finance institutions or external donors, then any
system will fall into disrepute and become of limited
effectiveness.
Secondly, policy priorities do need to be clearly and
publicly articulated through the political process, so that
the basis for selection can become transparent. Similarly,
the costs and benefits associated with decision alternatives
need to be identified, and made public, in the knowledge
that the persons will be held accountable in an ex post
review process.
Within overall and sectoral resource constraints, individual
expenditure decisions should as far as feasible be
delegated to local levels, where the stakeholders can be
involved in discussion and decisions. However, there is a
danger that powerful local levels may be able to obtain
control of this process, which may limit the feasibility of
such decentralized decision processes.
Actual procedures for making decisions need to be
established, documented, made transparent, and applied
consistently. A discussion of approaches is set out below
in the section on ex ante performance measures.
The whole process needs to be documented and made
open and transparent. There should be a process of
providing information in a similar manner on outcomes
(hence the importance of using consistent classification
and valuation models with the accounting system), so that
those involved are held accountable for original forecasts.
15
 IV. ANNUAL BUDGETING

The government’s annual budget is the embodiment of the legal authorization by Parliament of the country’s
expenditure and taxation proposals for the coming financial year. It should be: (i) a means of allocating resources to
achieve the objectives of the government, (ii) a management tool for national economic and fiscal planning, and (iii) a
means of controlling and monitoring the use of funds to ensure that they meet stated objectives. Exhibit 13, below,
illustrates the budget process. Many LDCs incorporate provision for such a process in their legislation and

regulations.

Exhibit 13. Overview of the budget process

Quantify objectives

Evaluate
Determine income

Authorize
Set taxes

Communicat
e Coordinate

For governments, financial management is to a large
extent driven by the budget and annual appropriation
legislation. There are a number of factors which make
budgets so important for governments, and which are
different from the budgets in commercial activities.
• Government budgets are not only about managing
government activities, they are also tools of national
economic management;
• Government expenditures are not directly affected by
revenue raised, since government transactions are
generally non-requited;
• The budget is a legal authority to spend, with limits
which may not be exceeded without further
Parliamentary authority;
• The budget is also the legal authority to impose taxes
and raise other revenues;Many countries divide their
budgets between development and recurrent;
18
• Company budgets are predictions (best estimates of
likely sales and expenditure necessary to achieve
those sales), whereas government budgets are
planned revenue raising and expenditures (out-turns
expected to be achieved).
Thus the government budget becomes the legal
financial policy instrument, to be adhered to unless
formally amended. Commercial budgets, on the other
hand, are merely best guess predictions, with a less
strong obligation that they must be observed.
As an example, in a commercial entity if there is a large
production cost excess over budget because sales
exceed budget, this is regarded as a management
success. In governments, such expenditure overrun
would be illegal unless prior authorization was
obtained. This illustrates a very fundamental difference
between commercial and government entities, and also
a problem of governments in managing commercial
operations. Most treasuries resist linking specific
revenues (eg. examination fees) to specific revenues
(eg. examination administration).
Budget quality indicators
Exhibit 14. Budget quality indicators
Some of the key factors which make a budget process
effective include:
Transparency _ Budget documents should provide
a clear link between objectives
and expenditures
_ All participants in the budget
process clear about their roles
and responsibilities
_ Procedures simple and well
documented
_ Basis of budgeting should be
defined, eg. incremental, zero
based
_ Departmental targets and resources
used clearly indicated, explained
and published
Management _ Effective budgeting involves not
only preparing annual budgets,
but also the management and
monitoring of the budget
Link to _ Budgeting should take place within
macroeconomic a macroeconomic framework which
framework identifies resources available and
borrowing targets
_ There should be budget expenditure
ceilings, which must be adhered to
Central budget _ The budgets of the line ministries
control over should embrace all expenditures by
expenditure those ministries and government
decisions activities under their control
_ There should be no extrabudgetary
funds
Decentralization_ Decision-making within the budget
process should be decentralized as
far as feasible to increase
participation and commitment by all
stakeholders
Prioritization _ Formal statements of government
priorities as the basis for allocating
resources between competing
demands
19
_ Costs and benefits of decision
alternatives should be transparently
presented as the basis of allocation
decisions
Coordination _ Ensure links between recurrent and
and cooperation development budgets and other
aspects of the financial management
system
Integration _ Recurrent costs of development
projects built into recurrent
expenditure planning and the trade-
offs between recurrent and
development expenditures
considered
Flexibility _ To respond to changing
circumstances built into the system,
so that implications of any changes
are sufficiently analysed to still fit
within government’s overall
objectives and priorities
Discipline _ The system should combine
flexibility with effective control
over expenditures
_ Any changes to the budget should
be carefully analysed and justified
_ Only limited use should be made
of supplementary estimates
_ There should be penalties for
breach of rules and regulations
Link to medium- _ There should be a link between
term framework the resource framework and the
annual budget
_ There should be a link between
policies and budget allocations
Accountability _ There should be political
and credibility involvement and commitment
_ Involvement and accountability
of senior managers in all stages
of the process
_ If ministries do not believe they
will be held to their ceilings or if
they can easily bypass normal
procedures, the whole process of
budgeting can be undermined
_ Budgets should be reliably close
to the actual out-turn
Comprehensive _ Budget process and documents
need to include, as far as feasible,
all revenues and expenditures,
including all aid funds
 _ Budget should also contain nominal ministry participation in the process;
information on previous year’s
• Line ministries should submit in advance of budget
and current year’s expenditures
negotiations their comprehensive budget estimates,
_ Impact of the budget measured within resource ceilings, backed by appropriate
through output performance schedules, or argue cogently why they may have
indicators for recurrent and
exceeded the allocated resource envelope. There
development expenditures should then be an informed discussion at a senior
Ex post budget _ Amendments to the budget and level between the line ministry and the Ministry of
review actual outcomes should be Finance, in which spending priorities are discussed
reported as soon as feasible after and from which appropriate decisions emerge. At
the period end, in a format that best, reality is only likely to approximate to this
enables comparison with original process. Negotiations between line ministries and the
decisions, and the results Ministry of Finance are often more of the nature of a
publicized game scenario, in which the participants manoeuvre
towards their differing objectives. Massive and/or
arbitrary reductions in original ministry estimates to
Evidence of weak budget procedures
approved budgets indicates system weakness;
There are a number of factors which would evidence a
weak budget system and procedures. • The budget process should be completed in sufficient
time so that the budget can be presented to
• Comparison over a 10-year period of budget
Parliament, discussed and enacted well before the
estimates as compared to actual out-turns. Persistent
start of the fiscal year. In many LDCs budget
large forecasting errors would be indicative of a
processes go well into the fiscal year to which they
weak budget process;
relate, and interim procedures have to exist to allow
• Budget documentation identifying the budget stages governmental spending units to continue to operate;
and procedures. Omission of major stages, or the
• Extensive transfers between budget heads
inability to clearly identify them taking place, would
(virements), or supplementary budgets, would be
indicate problems in implementing budget
indicative of allocative inefficiency in the budget
procedures. Final budget documents should be
process. In some countries this is difficult to identify,
transparent to non-technical Parliamentarians, and
because the process is informal–expenditure is
make the nature and implication of decisions as clear
misdescribed so as to keep within budget limits;
as feasible;
• Procedures for managing the budget, eg. tracking
• A transparent link to the macroeconomic process,
budget allocations to spending units, virements,
with resource envelopes set and call notices issued in
supplementary budgets, any emergency allocations
good time. Many LDCs have problems in forecasting
and comparison with actual outcomes. These
resource envelopes, and consequently the whole
procedures should be systemic, not ad hoc, and be
budget process is delayed. Call notices are often
related to responsibility points and control timing
badly designed, giving staff in line Ministries basic
requirements (this is discussed in more detail under
clerical problems in completing them. In one LDC, it
accounting).
was observed that some line ministries had
established PC-based systems to prepare the • These indicators are not a comprehensive list.
information, but the Ministry of Finance rejected However, when combined with the list of budget
these and insisted on handwritten completion of its performance indicators they enable a review process
own badly designed forms; to establish the quality of the budget system.
• Ability to clearly identify line ministries which are
controlling the budgets of their subsidiary units.
Senior ministry officers should be seen to be
participating in the budget process. Operations under
ministries should not have access to extrabudgetary
funds. In one LDC, projects negotiated directly with
the Ministry of Finance on their budgets, with only

20
Budget as a resource allocation tool
The allocation of funds through the budget should be
based on the priorities and activities of departments,
ministries and the government as a whole. It should also
be based on actual requirements, rather than inflating
the previous year’s expenditures. Zero-based budgeting
(see below) has been developed as a tool to achieve this
objective.
It is important to recognize the major role of the budget
as a resource allocation tool. Indeed, the primary
function of the budget is to allocate limited resources
according to government priorities over the activities of
the government. The whole budget process should be
geared to this objective. The concepts and approaches
have been discussed above in the section on planning.
Comprehensiveness of the budget
Effective budgeting requires that the budget process
does in fact control all of the expenditures by central
government. Extrabudgetary funds weaken the budget
both as a resource allocation tool and as a tool of fiscal
management. Most systems have the potential for large
extrabudgetary expenditures. Some examples include:
• Funds received by line agencies which are then
available for expenditure, without passing through
the consolidated fund. There may be merit on
occasion for linking expenditures to revenues raised,
but these need to be controlled through a central
budget process;
• Quasi-fiscal activities of state financial institutions,
eg. loans at low interest rates, and/or without the
21
expectation of repayment, to State enterprises;
• Direct access by projects to donor funds. From a
project management perspective, it may be desirable
to bypass the bureaucracy and have direct access to
donor funds, and indeed donors often encourage such
a system. However, this reduces the effectiveness of
the budget process to control expenditure.
One of the problems of an inefficient financial
management and fund-release system is that entities
within government will seek to obtain direct access to
funding, to meet legitimate desires to deliver outputs. A
more appropriate solution is to address the systemic
failures.
The budgeting process
The budget preparation process should involve those
responsible for all stages in budget planning and
implementation and should enable budget managers and
politicians to make rational choices between different
uses of funds.
Stages in the budget process
Generally the Budget Office, Department or Division,
normally within the Ministry of Finance, orchestrates
the actual budget exercise. The central planning
institution may also be involved in the process,
particularly in respect of development projects. While
the actual process, institutions and timing vary from
country to country, certain key stages are almost
invariably common.
 Exhibit 15. Key stages in the annual budget process
Likely timing
Stage Activity (months from
fiscal year end)
1 Forecast resource envelope and sectoral allocations -6 to -9
2 Issue the budget circulars to line ministries requiring budgets to be -8 to -4
submitted
3 Line ministries obtain estimates from subsidiary units, eg. departments, -7 to -3
divisions, cost centres, projects
4 Line ministries consolidate estimates and discuss and negotiate with -6 to -2
subsidiary units to bring them within resource envelope
5 Aggregation of budgets by line ministries and submission to Ministry of -5 to -2
Finance/planning institution
6 Budget review and negotiations between Ministry of Finance, planning -5 to -1
institution, and line ministries
7 Agreement of final budget figures, preparation of budget for submission -4 to -1
to Parliament
8 Parliamentary review process leading to enactment of budget -3 to 0
(commonly a system is in place to allow spending to continue during
budget discussions)
9 Budget allocation to spending units, and authority for release of funds -1 to +1
(warranting in some countries)
10 System for viring funds during year to different heads of expenditure, +2 to +12
and supplementary budget procedures if total budget proves inadequate

Virtually all countries, including LDCs, follow a budget
process similar to the above. The problem within LDCs
is typically implementation of the procedures.
Examples of problems identified in countries of which
the authors have experience include:
• Budgets prepared very late and not completed until
well after the start of the fiscal year, giving
inadequate time for proper procedures to be carried
out;
• Weak system of allocating national budgets to
individual spending units;
• Extensive use of virement (transfers between budget
heads) and/or supplementary budgets; and
• Inability to properly control expenditures within
national borrowing targets.
Budget procedures, documentation and training

• Lack of adequate reliable financial information on
expenditures and revenues to date in current year,
and forecasts to end of fiscal year;
• Line ministries failing to act effectively in control of
the budget estimates of their subsidiary units, not
carrying out a proper role of allocating their own
resource envelope according to priorities, and leaving
all decisions to the final budget negotiations;
• Estimates prepared without adequate analysis and
forecasting;
• Excessively high initial estimates as negotiating
gambits, failing to provide a meaningful basis for
allocation decisions;
For budgets to be effective they need to involve all
entities within government. It is essential that the
budget procedures and stages and the roles of
individuals are fully understood if the budget is to
achieve its objectives. This requires:
• Planned procedures allowing adequate time for every
stage;
• Well designed budget documentation and/or
computer systems;
• Procedure manuals setting out clearly the processes
and responsibilities;
• An institutional framework with clearly defined
responsibilities for stages within the budget process;

1
• A timetable which is known to all concerned;
• Transparent procedures for deciding between
competing claims to limited resources on the basis of
established procedures;
• Training of all those involved in the budget process
so that they are able properly to carry out their tasks.
A budget system will require computer support. This is
dealt with separately in Section IX, below.
Tracking budget stages
Budgets (annual and three-year rolling) go through a
series of stages, eg.:
• Initial estimates from rolling budget and/or
departments within ministry;
• Linking these to resource ceilings to generate final
ministry budget proposals;
• Agreed ministry and national budgets as submitted to
Parliament;
• Transfer between budget heads (virements) as
allowed under financial regulations; and
• Supplementary budgets and other changes.
Systems and procedures are needed to track these
stages, ensure they are in accordance with laid-down
procedures, and provide information which can be used
for budget monitoring and control. This information
needs to be available at collecting/spending unit,
ministry and central levels.
Institutional framework of budgeting
and planning
In any review of the budget and planning
subcomponents of the financial management system,
account must be taken of the institutional structure. The
long-term sustainability of any programme of
improvements critically depends on such institutions,
and failure to recognize institutional constraints and
work through those constraints is one of the major
reasons for improvement programmes collapsing once
donor assistance ceases.
As noted above, typically LDCs have a separate
planning institution from that responsible for the
budget. Many planning institutions were developed as
“think tanks,” but have tended over time to become
institutionalized and staffed by regular government
staff. Budget functions tend to come under the Ministry
of Finance. A typical structure may be as illustrated in
Exhibit 16, below.
2
Exhibit 16. Typical planning/budget structure
Government
May be intermediate body
eg. Resources Committee,
National Development
Committee
Planning Institution Budget Institution
eg. Planning eg. Ministry of
Accountant General
Planning institutions
As indicated above, the roles of planning institutions
tend to have widened, so that they may include areas
which impinge on, or replace, some of the budget
activities of the budget institution. For example, in
some LDCs the Planning Commission is responsible for
the annual development programme, which becomes
the basis of the budget. In such situations it is often
confusing to know where one set of responsibilities
ends and another begins.
In one LDC, responsibility for the development
programme has recently been moved from the Finance
Ministry to the Planning Commission. However, the
Finance Ministry retains responsibility for actually
preparing the development budget and its submission
by the Finance Minister to Parliament. One secretary of
a line ministry commented, “before we had to agree the
budget just once, with the Finance Ministry. Now we
have to separately agree it with the Planning
Commission and also with the Finance Ministry.”12/
Furthermore, institutional theory would anticipate that
each of the respective institutions develop its own
identity, and officers within the institution seek to
expand the power and the influence of the institution.
Thus in practice many planning institutions and budget
bodies, while declaring how well they cooperate, are in
fact conducting an ongoing battle to establish their areas
of influence.
Any plan to improve the budget and planning
subsystems would need to include an institutional
strategy to address this problem. An ideal solution may
be to merge the two organizations, but this may not be a
feasible option. Alternatively, simply setting up
mechanisms for them to work together, combined with
improved communication links, may be sufficient.
Ministry of Finance
The responsibility for much of government financial
management rests on this ministry. The functions of a
Ministry of Finance differ from country to country. In
many countries the Accountant General is part of the
Ministry of Finance, in other countries this
organization, or its equivalent, is separate. Again, in
some countries planning and finance are combined, but
in most they are separate institutions. However, some of
the common functions of a Ministry of Finance include:
• Supervision of the budget process;
• Exercise of powers of financial approval and
delegation;
• Control of expenditure;
• Evolution of tax policies;
• Supervision of tenders, contracts, supplies and the
procurement process;
• Enforcement and development of financial
regulations;
• Management of liquidity, borrowing and lending;
• Conduct of external financial relations with donors,
lenders etc.;
• Maintenance of the central accounting system;
• Supervision of financial relations between
government and the public enterprise sector; and
• Initiating action to improve financial standards and
performance.
While institutional structures vary considerably
between countries, the essential processes of financial
management do not. Thus for a country to have a good
system of financial management the processes of
planning, budgeting, implementing,
accounting/reporting, auditing and remedial action must
be properly developed, within institutional structures
appropriate to the country.
Non-financial performance measures
As identified above, in the public sector financial
measures are normally inadequate for service delivery.
3
Therefore alternative non-financial performance
measures need to be developed. Performance measures
may be ex ante or ex post.
• Ex ante measures–used primarily to decide between
decision alternatives;
• Ex post measures–used to evaluate performance
against previously identified criteria.
The concept of performance also needs to be further
refined. Performance must be seen in terms of
achieving public policy objectives, and is usually
measured in terms of economy, efficiency and
effectiveness (the “three Es”).
• Economy–achieving the policy objective with the
minimum required resources, particularly minimum
financial resources;
• Efficiency–achieving the policy objective in the most
efficient manner (this is close to the concept of
economy, but emphasizes non-monetary resources);
• Effectiveness–effectively achieving the policy
objective, eg. if the policy objective was improved
education in all geographic regions, large regional
schools might be economic and efficient, but they
would not be effective in achieving the policy
objective.
Both ex ante and ex post measures are properly part of
financial management. Also, both need to be integrated
with other components of financial management, for
reasons already indicated–the needs for common
classification and valuation models and the transfer of
information.
Ex ante performance measures
As indicated above, ex ante measures are used primarily
in deciding between alternatives, and they properly
require a book in their own right. Essentially the
procedures involve three stages.
Stage 1 Identify policy issue and decision
alternatives;
Stage 2 Construct an “effect matrix” to identify
the effect of each alternative;
Stage 3 Apply an evaluation approach to decide
between decision alternatives.
There are a number of approaches to evaluation:
• Cost-benefit analysis–this involves the quanification
in monetary terms of costs and benefits, and then
discounting them to their present value. Where costs
or benefits are not expressed in money units, then
“shadow” prices are created. This approach has been
used extensively, but suffers from the fact that
 shadow prices are based on subjective assumptions;
• Cost-effectiveness analysis–seeks to identify the
minimal cost method of achieving a given policy
objective;
• Scorecard approach–a matrix is constructed which
identifies costs and benefits of decision alternatives,
expressed in different units, and allows decision
makers to use this in making a decision, without
formally assigning weights;
• Matrix-criteria analysis–this approach takes the
scorecard approach and assigns weights to the
various elements.
As indicated above, ex ante performance measures, and
their application to decision making, is a large subject
Exhibit 17. Linkage between economy, efficiency and effectiveness
It should be noted that there is a distinction between
performance measures and performance indicators.
Measures are used where performance can be measured
on a scale with a degree of precision, eg. average
female participation in primary education. Indicators,
on the other hand, imply a lower level of measurability,
eg. establishment of an effective primary education
management structure in 70 per cent of districts.
Applying performance measures and
indicators in LDCs
Without indicators of achievement, financial measures
are of limited value. Also in many LDCs, both planning
bodies and donors are de facto using performance
measures for projects. The need is to integrate these
into the financial management system, but in a flexible
manner. Therefore the following practical guidelines
are suggested.
• The starting point should be any existing system, eg.
a monitoring system established by the planning
body;
• Ministries should be encouraged to include within
4
beyond the scope of this book. The brief description
above serves to identify the issues and indicate some
possible approaches.
Ex ante performance measures should ideally become
the basis of ex post performance measures. Thus, for
example, when a national planning body uses ex ante
measures in deciding on a project, those measures
should become the basis on which ex post performance
measures are established.
Ex post performance measures
As indicated above, the need is to measure economy,
efficiency and effectiveness. The link between these
can be expressed in different ways, but may be
represented as in the model in Exhibit 17, below.
the budget a broad statement of their policy
objectives;
• Indicators should ideally be set when a project is
initiated, and followed through the project’s life;
• Wherever feasible, monetary measures should be
used. In a surprising number of cases, monetary
measures of efficiency are available (eg. costs per
hospital operation, examination fees compared to
costs), but cannot be calculated because of
deficiencies in the accounting system;
• The focus should be on indicators which are simple
and easily measured, eg. primary education
participation rates are easy to calculate, whereas
effectiveness of the education is much more difficult
to evaluate;
• Measures can be used which require an element of
judgement, eg. establish an operational and effective
health care management unit in X per cent of
districts;
• It is necessary to “stand back” from a system of
performance indicators and ask how they relate to
policy objectives;
• Performance measures should be set by the manager
responsible for their achievement.
Problems in introducing performance
measures
The first problem is likely to be organizational
resistance, often exacerbated by previous bad
experience of attempts to introduce programme
budgeting. Also, the linkages between financial
management and performance targets may not be
perceived.
Secondly, in many government organizational
structures responsibilities for achieving outputs are not
clearly defined, and so it is difficult to link performance
measures to management responsibility. Also managers
may change, again diluting responsibility for
performance.
Thirdly, in many LDCs systems for gathering,
recording and reporting the information are inadequate
and unreliable. Indeed, in many cases even basic
financial information is difficult to acquire in a useful
format.
Finally, there is the need to establish routine procedures
for publishing criteria, and then gathering and reporting
information on performance as compared to the criteria.
This will require the establishment of an appropriate
database, linked to the budget and accounting systems.
Reporting of performances should be integrated with
routine financial reporting. In addition, at a more macro
level, there is a need to include with government
financial statements some indication of performance.
This latter is discussed later in this book.
Conclusions on applying performance
measures
Performance criteria cannot be avoided, and always
exist, at least subjectively. The object should be to
integrate them with financial measures. Any reforms in
financial management should take account of the need
for performance criteria, and allow for their eventual
incorporation. Such criteria are within the capacity of
most LDCs, and indeed the concept may be easier to
add to systems already geared up to handling
development projects and donors.
Ultimately, performance criteria must be integrated
within a financial management system. Without such
criteria, the system lacks any good orientation. Such
criteria should be set as part of the planning/budgeting
5
process, and then reported on in parallel to financial
reporting.
Alternative budget approaches
The analysis above has indicated that the major
difference between the commercial and government
entity is that the latter has no monetary output. The
revenues of government are not directly related to the
quality or quantity of outputs of services from that
government. Therefore financial management involves
comparing monetary inputs (expenditure) to non-
monetary output measures, ie. physical measures. Much
of modern financial management has involved a move
to a more goal-oriented approach to financial
management requiring output indicators that can be
used as part of a financial management system. Ideally
such output indicators need to be capable of being set as
part of the planning (budget) process, and also to be
measurable (normative), so they can be included in the
monitoring and reporting system.
The most obvious approach would be to convert
physical measures of service delivery into monetary
units. In practice this approach is not feasible in any
practical way. Attempts have been made to put money
values on government outputs, through cost-benefit
analysis. However, though these have been successful
at the project level, it is not practical to extend cost
benefit to financial management at a more aggregated
level, eg. ministries. It is therefore concluded that
output indicators will have to be expressed in a mixture
of financial and physical terms.
Incremental budgeting
National budgets are aggregations of a large number of
budgets of small spending units. Ideally budgets, targets
and output indicators should be set by managers of such
units within an overall resource envelope, which
indicates national priorities. In practice this approach is
rarely achieved, and budgets tend to be set at a much
higher level by incrementing last year’s figures for
known changes. This approach is unsatisfactory for a
number of reasons:
• It fails to identify clearly managerial responsibility
and make managers responsible for their own targets;
• Since managers have budgets imposed on them, and
do not identify their own targets, it is not a good way
of motivating them to achieve specified output
targets;
• It encourages spending and discourages saving, since
it is difficult to justify an increase if last year’s
budget was underspent;
• Needs and resources are not matched in any rational
manner;
• It makes performance monitoring more difficult,
since output targets are not set by those responsible
for achieving them (if they are set at all); and
• It does not provide an adequate framework for
evaluating and discussing budget decisions at a
national level.
The following sub-sections consider a number of
alternative approaches to budget setting that have been
developed in an attempt to overcome these problems.
Although none of these approaches has proved feasible
as a long-term system, they have provided the basis of
modern thinking on government budgeting.
Planning-programming-budgeting system
(PPBS)
Under PPBS the various activities of government are
seen as “programmes” with related benefits and costs.
Most programmes have alternative ways of achieving
the same ends, which can also be costed. Benefits need
to be defined in normative terms. PPBS identifies
government objectives and the impact of programmes
on objectives, and hence provides a rational framework
for selecting programmes. Its most significant
application has been in the US Department of Defense.
Despite its advantages, PPBS has three major
difficulties:
• Defining output in a way which allows comparison
between alternatives on anything other than a
subjective basis;
• Many government activities are an essential part of
government, and any attempt to specify outputs
merely states what will happen. For example,
catching criminals is an output of police activity, but
can hardly be seen as an alternative to anything else;
and
• The benefits gained may be outweighed by the inputs
necessary to make PPBS successful.
PPBS has made a valuable contribution to the
development of budget approaches, but it has not
proved feasible in itself as a budget approach to be
applied over a long period of time.
6
Programme budgeting
Programme budgeting is a less formal alternative to
PPBS. Programme budgeting retains the PPBS concept
of moving the focus away from administrative
structures or economic classification of costs to a series
of “programmes,” each with defined objectives. Each
programme requires certain resources in order to
achieve the target programme outputs. Programme
budgeting seeks to identify programmes, allocated
resources and related outputs.
It has been recognized in many countries that a
programme approach is more applicable to development
activities and projects, and therefore the programme
approach is sometimes restricted to the development
budget (see above). An example would be treating a
number of distinct activities and projects relating to
education, drainage and agriculture in one geographic
area as all being part of a “rural development
programme.”
Programme budgeting can be regarded either as an
analytic tool or as a managerial approach. As an
analytic tool it is a matter of designing a system to
aggregate resources allocated to, and outputs from, a
series of programmes. However, if it is to be regarded
as a managerial approach, then financial and
administrative responsibilities need to be linked to
programmes, and the concept moves much closer to
PPBS, with the difficulties outlined above.
It is concluded that programme budgeting is best
regarded as an analytic tool. In this context it is useful,
but does not resolve the budget problems already
identified.
Zero-based budgeting (ZBB)
ZBB was also developed in the USA as a
comprehensive budget approach. It requires that the
activities and ex post objectives of government be
identified and turned into a series of “decision
packages.” There is no presumption as to any past
pattern of expenditure, hence the term zero-based. Each
decision package is a programme under the control of
one manager, with defined and measurable impacts and
objectives. These are then categorized, ranked and
evaluated so as to lead the government to a decision
about which packages to implement, and the costs
associated with each. This is similar to the approach
sometimes referred to in the UK as “priority-based
budgeting.” ZBB requires identifying and evaluating
the decision packages, and hence involves very
considerable time and effort. At the end many of the
programmes are those which are anyway already in
place, and about which there is little choice. Attempts to
apply ZBB have not generally been sustained.
Current approaches to performance budgeting
Whereas programme budgeting focuses on identifying
related activities as programmes, the emphasis of
performance budgeting is linking financial inputs to
non-financial output targets. The approach recognizes
that most government activities yield service delivery
outputs. Because these are not represented in the
financial budget process, the tendency is to judge
performance by expenditure according to budget
targets–what the expenditure leads to is not considered.
Performance budgeting seeks to move the emphasis
away from expenditure to a focus on outputs, measured
in non-financial units. This requires the identification of
normative output performance indicators linked to the
financial inputs.
Performance budgeting therefore requires the
identification of goals for budget activities, and the
translation of these goals into normative output
indicators. The output indicators become the
performance targets against which managers are
judged–the benchmarks for management. Such output
indicators should be identified as part of the transparent
budget process.
7
Activity-based budgeting and costing
Activity-based costing (ABC) is an approach that has
been developed in the context of commercial entities as
an alternative to traditional product costing approaches.
It represents a new approach to aggregating costs, and
where applied has major implications for the cost
classification system. It is easiest to describe ABC in
the product-costing context in which it has been
developed. Its potential application to government
financial management is then considered.
Manufacturing companies consume a range of
resources–human, material, and overhead–in producing
a range of products. Traditional costing has directly
linked material and direct labour costs to individual
products, but then apportioned overhead costs on the
basis of product volumes. This approach has been
developed to value inventory for financial reporting, but
has been widely used (some would say misused) for
product costing for decisions about, for example,
product pricing.
Activity-based costing recognizes that simple
apportionment of overheads as described above is a
crude measure of the costs of products, and its use for
decision purposes may lead to sub-optimal decisions.
For example, a small-volume product may result in a
series of production runs, each incurring set-up costs,
which become disproportionately high compared to
those for a high-volume product. Managers understand
this intuitively, but ABC seeks to quantify the
relationship through a four-stage process.
• Identify the major activities within the organization,
eg. setting up machines for production runs;
• Create a cost pool (or cost centre) for each activity,
eg. all set-up costs;
• Determine the cost driver for each activity, eg. the
number of new set-ups;
• Assign costs of activities on the basis of the cost
driver to each product, eg. set-up costs times number
of set-ups per product.
This exercise is repeated for all cost activities, often
with multi-stage assignment until final product costs are
achieved. These activity-based costs provide a more
meaningful approximation of the product costs for
decision-making. However, the question is what
relevance this product-costing tool has to government
financial management.
ABC is a relatively new technique even for product
costing.13/ There is limited literature on its application in
the public sector, and all the examples to date have been
 within sub-units of government.14/ To our knowledge it
has not been applied to the central government of any
country as a whole. Nor is it the purpose of this book to
explore the applicability of ABC to government
financial management. However, it is apparent that
government “products” are the delivery of a series of
services, which draw on a pool of resources. ABC
provides a tool linking the costs of those resources to
the different services delivered, and hence deriving a
measure of the costs of such services. Meaningful costs
of services delivered by government provide a basis for
rationally allocating limited resources in accordance
with public policy priorities.
An example of the application of ABC in the public
sector has been within the UK health service. Patients
require different services according to the nature of
their treatment, eg. patients at a clinic, patients in
intensive care at a hospital, accident victims and so on.
An ABC approach applied within a hospital would
recognize the different cost pools and associated
drivers, and use these to estimate the cost of services
provided to patients.

Exhibit 18. Activity-based costing applied to government

Stage 4 – allocate
Stage 3 – identify costs to service
Stage 1 and 2 – identify activities as cost pools cost drivers services delivered

Operating Patient in
theatre intensive
care
Actual
Patient
Hoursusage
bed
of
utilization
days
Intensive
Total
care ward
hospital Cost
costs allocated to Out-patient
Divided between services
Trauma
cost pools of which ward Cost delivered
drivers
these are illustrative based on
examples analysis More realistic
costing of patient
Medical Geriatric
ABC can be extended from historic costs to budgeting,
equipment allocations. Unless it can be linked to such services for pricing
patient
and this sort of information provides a more rational responsibilities, ABC may fall into disuse. Also the
basis for resource allocation decisions. The technique is very new, there are practical problems of
implementation of ABC for national governments for identifying cost pools and cost drivers, and the impact
both budgeting and accounting would have significant of ABC on organizational effectiveness is as yet
implications for cost classification and analysis. unproven.
• Traditional economic cost classifications, eg. wages Nevertheless, ABC is potentially so useful that any
and communications, are less useful than costs classification system should at least be structured so as
related to activities, though both could co-exist; to allow for the subsequent implementation of ABC.
Nor is such design inherently difficult. Essentially, it
• Cost centres would have to be developed for all the means that the cost pools must be identified within the
“activities” (as defined above) within government, classification system to allow for derivation of activity-
irrespective of whether or not these constituted based costs. ABC is being widely introduced in the UK
administrative cost centres; in the context of agencies and setting targets (see
• The concepts of ABC are clearly linked to the below).
concepts of programme budgeting, in that both focus Conclusions from the above approaches
on the outputs of government activities, and seek to
In attempting to improve government financial
identify costs and resource implications of such
management, lessons can be learned from all of these
outputs.
approaches.
The limitations of ABC also need to be recognized. • There must be a move away from incremental
Most fundamental is that it does not directly relate to budgeting to an approach which regards all
the responsibility hierarchy reflected in the budget expenditure as discretionary;

8
• The focus must be on results, involving identifying
programmes, defining objectives and setting
performance targets;
• Managerial responsibility must be identified and made
explicit, and within overall constraints managers should
be responsible for their own budgets and output targets;
• Bureaucratic controls should be simplified and
rationalized to encourage managers to focus on
results;
• Overly complex budget systems and procedures
should be avoided;
• Activity-based costing and budgeting provides a new
technical approach to the problem of identifying the
costs of activities, which appears to be very relevant
to government activities;
• There is an essential need to add to the budget a
medium-term framework, eg. a TYRB.
All the experience of setting performance targets for
public-sector activities suggests that it is very difficult
to identify meaningful indicators against which
performance can be measured and evaluated.
Sometimes indicators can be counter-productive,
because managers then focus only on their “score,”
rather than their broader responsibilities. In setting
performance indicators and targets, certain points need
to be considered.
• They are best set at the micro level by the managers
who have to achieve them;
• They should relate to broader national policy
objectives;
• Wherever possible, revenue generation should be
related to expenditure, eg. museum sale receipts
linked to expenditure by that museum, so as to
minimize the need for physical indicators;
• There should be “soft” general indicators or targets,
even if these are not easily measurable, as well as
“hard” measurable indicators;
• Targets should be set as part of the planning and
budget process, not as a separate exercise.
Specific country experiences
The Australian financial management
improvement programme (FMIP)
In Australia, the FMIP sought to radically change
attitudes. Elements of the approach include:
• Three-year rolling budgets, with forward estimates
automatically converting to budgets if there are no
changes;
• Clear link to macroeconomic framework and
resources to establish hard budget ceilings, and a
mechanism for deciding between competing
priorities;
• Focus on results, with the introduction of programme
management and budgeting (PMB);
• Development of performance measures; and
• Concept of running costs which can be allocated
within the discretion of ministries.
The Australian system has to be seen in the context of a
wholesale reform of management of the public sector. It
could not be implemented in isolation. Nevertheless, it
contains important pointers to the way budgeting and
financial management of government is likely to
develop. In Australia, despite initial problems, it is now
regarded as having been a successful approach to
managing the public sector in a period of financial
constraint.
The New Zealand reform experience
The New Zealand reforms were concerned more with
the incentive structure than technical reforms of the
budget process. Indeed, the biggest technical reform has
been to move the whole government budget and
accounting system to a commercial-style accrual
accounting model. This has been linked to radical
reforms in management structures and responsibilities,
with ministries allowed considerable autonomy within
overall hard budget constraints.
United States of America
Recent thinking in the USA is best exemplified by the
Gore Report on Reinventing Government. The report is
sub-titled: “Creating a government that works better
and costs less,” which means escaping from red tape,
bureaucratic waste, cost escalation and a civil service
not sufficiently attuned to performance and service to
customers. The status quo is neatly summed up as
“industrial era bureaucracies in an information age.”
The answer is said to be “creating entrepreneurial
organizations.” This has four elements, each of which is
made up of a number of steps.
• Cutting red tape (which means simplifying the
regulatory environment and stressing mission
accomplishment);
• Putting customers first;
9
• Empowering employees to get results;
• Producing better government for less (which means
re-engineering programmes and processes with
emphasis on improving productivity and
effectiveness).
With the return of a Republican majority to Congress,
the future of the Gore report is uncertain. Nevertheless,
financial management reform generally is gaining
impetus. The Chief Financial Officers Act (1990), the
Government Performance and Results Act (1993) and
the Government Management Reform Act (1994) are
steps in this process.
The first establishes in each of 23 large agencies the
position of Chief Financial Officer, responsible for
overview of financial management. This person is to
develop and maintain an integrated accounting and
financial management system for the agency,
performing according to specified criteria (including for
instance the integration of accounting and budgeting
information, and audited annual financial statements).
The Act also requires the Office of Management and
Budget to report annually on the status of Federal
Government financial management, and to submit a
five-year plan for its improvement. The second calls for
agency programme and performance budgets by 1999.
The third requires audited financial statements for the
entire Federal Government by 1998.
Reforms within the United Kingdom
The United Kingdom focus has been on reducing the
scale of the public sector, through a process of
privatization, outsourcing or “agentization” (see below).
Under the “Thatcher” reforms, government departments
have been forced to consider these alternatives for
virtually all of their activities. Linked to this has been
an earlier move to a medium-term financial planning
framework, and an ongoing move to an accrual style
accounting and budget approach.
The United Kingdom Government in 1982 launched the
Financial Management Initiative.15/ This aimed to
ensure that managers are aware of what they are
expected to deliver, assess and measure performance in
relation to measurable objectives, and create well-
defined responsibility for the use of resources, outputs
and value for money.
In addition, the Public Expenditure Survey provides
three-year forward expenditure estimates, and is linked
to the Treasury macroeconomic models. A multi-
departmental study of budgeting in 1986 emphasized
four principles.
10
• All managers from top to bottom should be
responsible for setting and reviewing budgets. Thus
they should develop a sense of ownership;
• Budgets must be linked to the Government’s three-
year forward review of public spending;
• Budgets should include output and performance data
to allow monitoring of achievements against
objectives;
• Top managers must organize their own work and that
of their departments, so as to make clear the
responsibilities for setting priorities, managing
resources and reviewing performance.
Where privatization (the first preference) has not been a
feasible option for government activities, government
operations have been “contracted out” to private
operations. This contracting out, or outsourcing, has
embraced activities from computerization to refuse
collection. Finally, the third option has been to turn
government departments into quasi-commercial
agencies (the “Next Steps” initiative of 1988). Though
still part of the public sector, such agencies operate with
a high degree of autonomy. The major principles are:
• Service delivery is to be kept distinct from the policy
aspects of government, and the former carried out by
agencies under each department;
• Chief executive officers (CEOs) are appointed to
agencies for fixed-term contracts of three to five
years;
• A framework agreement defines the relationship
between the agency and its department, setting out:
(1) the agency’s aims and objectives; (2) the
boundaries which exist between its responsibilities
for service delivery and those of its parent
department; (3) monitoring, accountability and
reporting arrangements; and (4) measures for
assessing performance and the personal
responsibilities of the chief executive;
• The CEO and the parent department develop an
annual performance agreement containing specific
targets to be achieved. It and the end-year report on
progress achieved are both published, with the latter
audited by the National Audit Office.
The move to agencies has been swift. Some are
established as trading funds and are financed on
commercial lines; others are funded from
appropriations. Other developments in the UK have
been: (1) the Citizen’s Charter, which identifies a
client-supplier relationship between civil servants and
the public, with defined and published service-quality Some specific budget issues
standards; (2) the Efficiency Unit, which conducts
efficiency scrutinies and shows how cost savings can be Recurrent impact of development projects
made; and (3) performance and output measures and
their publication in departments’ annual management Budgeting often fails to forecast adequately the
plans. Efficiency gains are expected to be reflected in impact on the recurrent budget as projects are
savings of at least 1.5 per cent of running costs per year. completed, and their activities are transferred to the
To achieve changes, particularly in the fields of cost recurrent budget. In fact this impact is likely to be
saving, value for money and efficiency, more flexibility substantial, since virtually every project needs to be
was needed. As a result powers have been delegated to sustained, and this will require additional staff and
managers in order to free up decision-making. operational expenses. This model is set out in Exhibit
19, below.
• Control by staff numbers has given way to control by
the aggregate of running costs. Budgets are
commonly controlled gross, although the net basis
may be applied when there are significant receipts;
• Greater year-end flexibility has been introduced by
allowing the carry-forward of a proportion of
underspending, with the use of the savings delegated
down to the level of individual managers;
• Greater freedom now applies to the creation of
trading funds; to recruitment and promotion; and to
fixing remuneration (pay can be varied by location,
skill and performance).
The United Kingdom Government has also introduced
departmental resource accounting ( a form of accrual
accounting, dealt with in the next section) and resource
budgeting. These link to the departments being
responsible for the efficient and effective use of
resources under their control, and the concepts of
performance budgeting.
Conclusions on country experiences
Australia, New Zealand and the United Kingdom are at
the leading edge of reforming government management,
with financial management as one aspect. Each country
has taken a somewhat different route, but it can be seen
that they embrace the principles established above for
reforms within the budget systems.
A number of developing countries or newly emerging
economies have sought to emulate these reforms,
basing themselves on some combination of the
available models. A problem may be the robustness of
the reforms in the face of economic adversity, eg. the
1997 problems facing South-East Asia. Nevertheless,
the appropriate direction of reforms is clear.

11
 Exhibit 19. Model of recurrent impact of development projects

Projects are in general fiscally expansionary. There

are alternatives:
• Projects should either be self-financing after
completion, or generate savings at least equal to
the additional resources required; or
• Donor organizations should be prepared to
subsidize a growing budget deficit.
These are issues which an effective planning and
budgeting process should clearly identify, even if it
does not provide the solutions.
Manpower forecasts within budgets
For most governments, manpower costs are a
significant part of government expenditure, on
average about two thirds of recurrent expenditure.
Therefore it is essential that the budget system have a
mechanism for monitoring those costs and the
manpower decisions implicit within them.

12
 Exhibit 20. Manpower reconciliation statement

Establishment Grade A posts Grade B posts Grade C posts Total

Approved posts 1998 100 150 300 550
New posts 1998 20 30 50 100
Less forfeited posts 1999 -15 -20 -40 -75
Approved establishment 105 160 310 575
1999
Less vacant posts -30 -25 -50 -105
Filled posts 75 135 260 470
Financial provision $ xxx $ xxx $ xxx $ xxx

Note: figures are for illustrative purposes only.

The definitions of Grades A, B and C would be
achieved by summarizing existing gradings (eg. Grade
A might be gazetted officers), and is intended for
simplicity. Indeed the point about this analysis is its
simplicity, but nevertheless it includes valuable
information. In addition, projects should identify
manpower implications during and after the project.
Exhibit 21. Recurrent and development budgets
Dual budgeting – the development budget
Many governments in developing countries divide their
budgets into recurrent and development budgets.
Development budgets are primarily concerned with
development projects, which have defined objectives
and a finite life. The recurrent budget deals with routine
ongoing expenditure, where outputs are more difficult
to define, and there is no finite end to the expenditure.
Ideally this budget division should coincide with the
distinction between recurrent and capital expenditure
budgets, but in our experience development budgets
often include expenditure of a revenue nature, and
conversely recurrent budgets include capital
expenditure. Thus a classification matrix emerges.

Type of budget Capital expenditure Recurrent expenditure Total

Non-development budget (often called “recurrent budget”) 20 90 110

Development budget 50 30 80

Total 70 120 190

Development budgets were initiated to identify and
focus attention on public investment programmes.
Development budgets are frequently linked to
development or public investment plans, and are subject
to control and prioritization by a planning authority.
One of their objectives is to ring-fence development
expenditure so that socially desirable activities can be
continued even in the face of fiscal restraints.
There are a number of disadvantages of segregating
development and recurrent budgets:
• The administrative and procedural dichotomy
between development and recurrent often reduces the
effectiveness of fiscal control and policy
prioritization;
• Difficulty is caused in identifying and evaluating
aggregate resources allocated to sectors, because
they are spread over two budgets;
• The development budget tends to receive more

13
 attention than the recurrent budget, though the latter
is often larger in value;
• Recurrent maintenance expenditure is discouraged in
favour of new projects, which may replace poorly
maintained assets;
• The fact that a flow of development projects must
lead to an ever-increasing recurrent budget as
projects are completed is often ignored, and the
impact of such projects on the recurrent budgets is
not properly assessed in planning future aggregate
levels of government expenditure; and
• It leads to confusion on the more important
distinction between capital and revenue.
On the other hand, a separate development budget can
often be administratively convenient. A separate
“development fund” can be established, and funding of
projects and the handling of donor inputs dealt with
through that medium. Furthermore, the problem is not
the development budget per se, but rather the
administrative arrangements and the way information is
presented and handled.
While in an ideal world a single budgeting structure
would be preferable, it may be difficult to change the
existing budget structure, often for good reasons. In
such cases, the objective should be to integrate the
preparation, format, classification and presentation of
the two budgets. Also the distinction between
development and recurrent expenditure budgets should
be made coincident with the distinctions between
capital and revenue expenditure.
The problem of year-end cut-off
One of the problems of government budgeting is its link
with the fiscal year of the government, and the need to
budget for just that one year. This posed no major
problem when most expenditure was ongoing recurrent
expenditure. It does now pose a major problem where
the expenditure is capital in nature, and extends over
more than one accounting period. This pattern is typical
of most development projects.
Exhibit 22, below, provides a typical pattern of
expenditure on a capital infrastructure project, eg. a
hydroelectric scheme. Over the several-year life of the
project (which project years may not coincide with the
government fiscal years), expenditure builds up to a
peak of construction activity, then declines to a
commissioning and handover phase. For budget
purposes this has to be broken down into fiscal year
estimates, but clearly these have little significance in
the context of the project.
For most countries this would require a modification to the
14
Exhibit 22. Pattern of expenditure over typical
project life cycle
30
25
20
Construction
15
10
5
Importation of
Not only period
Start-up may the budget
equipmentforecasts for the project be
Commissioning
0
wrong
'96 in total, but
'97 also the timing'98 of the expenditure
'99
may vary from the predicted pattern. For example, the
project could be delayed by adverse weather, or
alternatively a good period of weather could lead to the
opportunity to accelerate some of the expenditure and
speed completion. To be locked into a rigid annual
budget cycle, unable to spend funds allocated to the
project because they had not been anticipated for the
current year, is a frustration experienced by many
project managers in this situation. Equally, to find funds
have been “lost” because the activity slipped a few
weeks over a fiscal year end is equally frustrating.
Furthermore, such timing variances often have no real
fiscal impact, because for LDCs the funding will almost
certainly come from a lending agency, and will already
have been committed.
The budget system within an LDC must develop a
mechanism to handle such timing problems. There are
several approaches.
• To allow automatic carry-over of unspent
development project budgets–but this means the
government is not able properly to predict
expenditure and funds available for other purposes. It
also fails to deal with the problem of wanting funds
earlier than budgeted;
• To provide in the budget system for requests for
carrying forward unspent funds, together with an
expenditure monitoring system which allows for
those funds to be estimated before the year-end. This
still does not overcome the problem of funds
required earlier, and also requires expenditure
monitoring/forecasting systems to be in place;
• To recognize the economic distinction between loan-
funded components (where timing of expenditure has
no fiscal impact) and domestic funds (which need to
be more closely controlled). Rules may allow loan-
funded elements to vary in timing even if outside the
budget, whereas the domestic-funded elements must
be subject to budgetary constraint, though with some
system of carry forward as in (2) above.
financial regulations, and it is necessary to establish a
 monitoring system for projects outside the normal nature of the exercise. A possible format is set out in
budget monitoring system, reflecting the multi-year Exhibit 23, below.
Exhibit 23. Project expenditure monitoring format
Project information
Title Number
Start date Target end date
Total cost Donor(s)
Type of Previous years Current year’s Current year’s Next year’s Balance of
expen- budget actual budget budget
diture

Govt Foreign Total Govt Foreign Total Govt Foreign Total Govt Foreign Total Govt Foreign Total

Note: The information would need to be based on, and reconciled with, the information in the government budget
and accounting system.
Non-monetary flow
Governments participate in a variety of economic
transactions which are never actually monetized, or
where monetary values do not reflect economic values.
Four actual examples are as follows:
• Country X is provided with technical assistance in
the form of consulting services from a bilateral donor
to upgrade education. Details of the amounts paid by
the bilateral for the consulting services are never
revealed in detail to the recipient government;
• A loan from country X at below-market interest rates
has as a requirement that equipment must be
purchased from country X, even though the prices
are higher than would be paid for such equipment if
tendered internationally;
• Surplus agricultural production is gifted to a country
without any value being attached. Such food is sold
at subsidized prices to certain groups of the
population, and the funds so created used for
specified development purposes;
• Internal payments are made in kind, eg. debts settled
Exhibit 24. Recording non-monetary donor assistance
by transferring assets. This is particularly prevalent
in the former Soviet Union countries.
These unmonetized flows can be substantial. In Nepal,
for example, it is estimated that some 30 per cent of
official development assistance does not pass through
the government budget. Clearly this creates problems
for national economic fiscal management, and there are
also problems of ensuring the propriety of expenditure
and proper accounting for the assets so created.
However, there are also problems with incorporating all
such flows into the budget system. First, there are
practical problems. Some of the information, especially
on technical assistance, is available only if and when in
the format that donors choose to provide such
information.
Secondly, budget monitoring becomes much more
difficult. Budgets now include notional as well as
monetary expenditures. Information on the latter may
not be controlled by government managers, and does
not pass through the accounting systems.
Exhibit 24, below, sets out a methodology for handling
and recording such flows.

Other records
Budget
Funding Type of andaccou
method expenditure External
Acquisition method nts Loan Asset
assistance
records records
records

15
Government payment, Loan Equipment 3 3 3
subsequent reimbursement
Other 3 3 3
Direct payment by donor Loan Equipment 3 3 3 3
Other 3 3 3
Grant Equipment 3 3 3
Other 3
Paid from special/imprest Loan Equipment 3 3 3 3
accounts
Other 3 3 3
Internal transaction in kind N/A Settlement of
debts 3

This approach provides a comprehensive recording, Classification by time

monitoring and control mechanism, while keeping the
actual budget and expenditure monitoring systems Timing of transactions is significant in four contexts:
simple. • Timing of budget receipts and payments is important
The IMF system of government finance statistics (GFS) to profile financing requirements through the year;
states that “Grants in kind should be valued by • Timing of actual payments is important as part of the
reference to market prices for comparable products.”16/ “tracking” process described above;
This approach appears entirely appropriate for the
purpose identified. The concept could be applied to all • Timing of transactions and flows is important so that
of the transactions identified above. It does not matter the cut-off between accounting periods can be
greatly if such estimates are less than totally precise, as established, and they are recorded in the appropriate
long as they are consistent. period;
From the perspective of management of government
• Where projects extend over more than one
activities the transactions identified above cannot be
accounting year, the flows will need to be classified
controlled. Very often information on them depends on
reports from the donor. The transactions do not enter by accounting period as well as in total.
the government accounting system until they are Historic transactions will be dated, and this serves as a
converted to cash; eg. the food is sold. Therefore, where time classification. Budgets need to be profiled over
they are recorded in the budget, they need to be time periods. Furthermore, for liquidity management
separately classified so that they can be excluded from purposes it is the timing of cash movements that is
reports on management performance. critical. Accrual measures do not directly reflect cash
This separate classification and reporting also serves to movements, and are therefore less useful for liquidity
focus management on their separate responsibilities in management. Predicting and tracking cash flows over
respect of such transactions. This also makes the nature time can thus add complexity to the classification of
of such transactions more transparent for the public flows based on accrual accounting.
expenditure review process (see below).
Exhibit 25. Classification of flows by time for
liquidity management
ALLOCATED TO
BUDGET TIME PERIODS: ACTUAL
ACTUAL ACTUAL
Accrual BUDGET Jan July TURN
Actual As in ACTUAL
TURN
As in cash
accounting Accrual flows Feb Aug cash Revenues
budgeting Actual cash ???
revenue and March Sep
converted to inflows
inflowsand
and and
expenditure Cash flows compared by period
April for liquidity
Oct management purposes
cash inflows and May Nov outflows
outflows expenditures
flows outflows. June Dec

16

Presenting information in budgets
The budget documents should be transparent;
clearly link resources to policies and priorities; and
comprehensively cover all government revenues and
expenditures. The challenge is to design a
presentation format which achieves all of these
objectives and yet retains sufficient simplicity for it
to be comprehensible.
17
This represents quite a complex classification problem,
which is generally not recognized as such. One of the
arguments against accrual accounting is that it makes
handling liquidity management more difficult, because it
does not either predict or measure cash flows. The above
diagram does exemplify the problem.
The financial management of multi-year projects does not
sit easily with conventional accounting systems, which are
focused on the annual financial year. For projects total
expenditures need to be monitored and tracked over the
life of the project. Therefore the system must allow for
such expenditures to be aggregated and monitored against
total budgets, but divided into annual periods for
traditional budget and accounting purposes.
Future expenditure commitments
Transactions entered into by a government in the current
period will often have expenditure implications for future
periods. Examples would be:
• A decision to make a large infrastructure investment
which will take several years to complete and will have
capital expenditure implications for each of those years
and maintenance cost implications indefinitely into the
future;
• A development project to expand primary education
facilities which will have a recurrent cost impact of
teachers, teaching materials and school maintenance
into the future;
• A policy decision to pay pensions to persons over a
certain age which will commit substantial expenditure
until the (politically difficult) decision is made to
cancel all pensions.
In developing the budget, it is important to identify clearly
such committed expenditure, since there is only
discretionary control through major policy reversals. For
many governments a substantial portion of the total
budget expenditure may be committed this way, and the
areas of discretion relatively small. Failure to recognize
the recurrent impact of development activities has led to
problems of sustainability.
Ultimately, budgets have to be presented to Parliament for
approval. The object of the system should be to present
information clearly so that the decision implications are
clearly identified. Criteria include:
• Clarity and avoidance of technical jargon;
• Revenue and expenditure shown in a single
presentation, with net financing implications clearly
identified;
 Annual Budgeting
18

• Structured approach with summary expenditure

schedules clearly linking to detail schedules;
• Comprehensive, but avoiding excess detail, and
with appropriate levels of rounding; and
• Development and recurrent expenditure clearly
aggregated by ministry and department, and linked
to a narrative statement of objectives.
These requirements sound obvious, yet are rarely
achieved. In any review of a budgeting system, a
good starting point is the budget itself. While there is
no single ideal presentation, the following are
suggested as features of a good presentation.
Exhibit 26. Features of a good budget presentation

Feature
Single document showing financing and recurrent
and development expenditure
Should incorporate medium-term financial plans
Responsibility clearly identified by ministries and
subsidiary organizations of ministries, eg.
departments, projects, etc.
Each ministry should provide a simple, clear,
statement of its objectives and priorities
For each ministry and subsidiary unit, expenditure in
the development and recurrent budgets should be
presented together, so the total resources committed
to each activity can be clearly identified
Limited but essential expenditure analysis should be
provided
Additional analysis in terms of programmes,
functions or otherwise as appropriate
Comments
The document should contain a summary opening
schedule, clearly referenced to supporting
documentation and schedules
The TYRB or other medium-term financial plan
should be incorporated within the budget document
Accounting regulations normally identify one person
in each ministry as responsible for that ministry’s
expenditure, and this principle should also be
followed in the budget
Note: some budgets are organized by economic
sector. While such an analysis should be part of the
budget documentation, the main focus should be on
ministerial responsibility
A simple narrative statement can serve to focus on
budget objectives, and provide benchmarks for later
performance review
One of the problems of the separation of development
and recurrent expenditure is that it can often be
difficult to see the net impact on a particular sector.
For this reason they should be presented together
There is no need within a budget submitted to
Parliament to provide detailed expenditure analysis,
but the major categories of expenditure should be
identified. These should include (i) personnel costs;
(ii) other recurrent costs; (iii) debt service costs; (iv)
capital expenditure; (v) flows between government
and public enterprises; and (vi) any other important
grants or major flows.
The same information may need to be analysed in
different formats, probably only in summary, for
other economic and managerial purposes
 19

Feature Comments
Comparatives should be included Ideally these should include the previous year’s
budget expenditure and income, and current estimates
of actual expenditure

This list is not of course comprehensive, and would applied to the expenditure budget of the Ministry of
need to be developed on a country-specific basis, but Communications in a country with separate
it does provide an indication of what is required. The development and recurrent budgets.
example below suggests how this approach could be

Exhibit 27. Example of ministry expenditure budget (currency 000s)

Ministry of Previous Estimated actual for Current year’s

Communications year budget previous year proposed budget
Recurrent Develop- Recurrent Develop- Recurrent Develop-
ment ment ment
Total budget 200 500 190 485 230 780
Ministry objectives These are (i) to establish the cellular telephone system in a format that is suitable
for privatization within two years: (ii) to implement successfully the new digital
data system in [the capital]; (iii) to reduce costs of routine activities by 2.5 per cent
Lunar station
Personnel costs 80 – 80 – 100 –
Other recurrent costs 120 – 110 – 130 –
Capital cost – 50 – 55 – 100
TOTAL 200 50 190 55 230 100
Cellular telephone project
Personnel costs – 100 – 110 – 110
Other recurrent costs – 50 – 60 – 70
Capital costs – 300 – 270 – 500
TOTAL – 450 – 440 – 680
 45

Summary of elements of an effective planning/budget system

From the analysis in the previous sections it is possible to summarize the key elements of an effective financial
management planning/budget process. The table below summarizes these elements.
Exhibit 28. Elements of an effective budget-planning system

Transparent macroeconomic framework identifying
resource envelopes
Publicly articulated policy priorities and sectoral
allocations
Medium-term financial planning framework as basis of
annual budgets
Systematic transparent budget procedures which delegate
budget decision-making within ministry control over all
budget funds
Expenditure budgets linked to responsibility for activities
with clearly defined non-financial performance targets
Budget systems which provide time for ministerial budget
negotiations and presentation to Parliament before start of
financial year
Comprehensive and transparent presentation to Parliament
of budget proposals
Systems for tracking budget virements and other changes,
and linking these to outcomes
Providing hard budget constraints within which all
concerned know they must operate
Used as the basis of capital project approvals and budget
resource allocations
A TYRB, or its equivalent, covering both resources and
expenditures, and integrated with the annual budget
process
It is essential that the systems and procedures for budget
preparation be well documented, transparent and carried
out efficiently. Under these procedures budget decisions
should be delegated to the lowest feasible levels, but
within a structure of overall budget control by ministries.
Budget responsibility is fundamental. Budget authorises
expenditure, but this must be linked to goals and
performance targets
Systems must be in place which allow budget estimates to
be evaluated, discussed and negotiated, and presented to
Parliament before the start of the financial year
Designed to make decisions within budget transparent,
and to set out clearly fiscal and performance targets
The budget process does not end with parliamentary
approval. Budgets continue to be varied through the year,
and this must be tracked

It was indicated at the commencement of this book enables the commencement of a revision of the
that the traditional planning-budget-accounting- model, dealing with planning budgeting components
feedback cycle was over-simplistic. The above only. The relationship now begins to look more as set
analysis of the budgeting and planning processes out in Exhibit 29, below.

Exhibit 29. Model of planning-budgeting relationships

Macroeconomic framework
Resource framework
Sectoral ceilings

Long-term Medium-term Annual budgets–

perspective plans plans, eg. three-year development, recurrent
rolling budgets and revenue
46
V. ACCOUNTING, MONITORING,
EXPENDITURE CONTROL, REPORTING
Introduction
Planning and budgeting are essentially predictive of
future events, ie. they involve forecasts about the future.
This section is concerned with the recording, reporting
and management and monitoring of actual financial
transactions, ie. historic information.
Traditionally government accounting has been seen as a
simple cash-based process. Its objective has been to
ensure that the expenditure takes place, and revenue is
raised, according to financial regulations, and in
conformity with budget decisions. The major linkage
with the budget process on the expenditure side has
been, and continues to be, the “fund release process,”
ie. the process by which funds allocated for expenditure
within the budget are made available (“released”) to the
administrative units responsible for such expenditure.
The control mechanism will seek to ensure that funds
are released in conformity with budget authorizations.
Revenues generally have no direct linkage with
expenditure–they are non-requited. The objective of
revenue monitoring will be to ensure that the flow of
Exhibit 30. Expenditure release, accounting, monitoring
and expenditure control
incoming funds is able to match the anticipated
expenditure. Government expenditure control systems
often focus on commitments, because these contain a
predictive element of actual cash flows.
Furthermore, because budgets have a legal significance,
expenditure should not only keep within total limits, but
be for the purpose intended. For this reason, most
government regulations place restrictions on transfers
between budget heads (“virements”), allowing such
transfers only under specified conditions and
constraints.
In many LDCs, the basic functions of fund release,
expenditure and revenue monitoring, and accounting
are performed inadequately, and are often poorly
integrated with each other. This section reviews how
these can be upgraded and integrated, and extended to
play a role in a more goal-oriented financial
management system. Under this approach, the separate
tasks of fund release, accounting, monitoring and
expenditure control all become components within a
single subsystem.

Later in this paper this model will be combined with the
planning-budget model developed in Exhibit 29.
The accounting model and basis
Traditional government accounting has, as indicated
above, been primarily concerned with recording cash
payments and receipts. This required only a simple cash
accounting system. However, as financial management
has become of greater importance, a number of
problems in the cash accounting model have become
apparent.
• Important assets and liabilities are excluded–eg.
accounts payable and receivable, inventories, fixed
assets, pension liabilities–and as a result information
is at best incomplete, and at worst seriously
distorted;
• Because these assets and liabilities are excluded,
there is no meaningful measure of the cost of
resources used within any accounting period;
• Because assets and liabilities are not recorded, there
is no balance sheet, and therefore there is a lack of
control over assets and liabilities;
• Cash accounting does not form an internally
consistent measurement and valuation model, and as
a result has difficulty in handling such problems as
year end cut-off.
These problems have led to some countries adopting an
accrual, or modified accrual, accounting model. The
following subsections will first define the alternative
approaches, then consider their relative merits.
Cash accounting
Cash accounting records cash inflows and outflows, ie.
receipts and payments. However, when applied to
government accounting a number of modifications are
made to a simple receipts and payments accounting
system.
• Transfers to, and balances on, certain assets and
liability accounts are maintained, eg. suspenses,
Exhibit 31. Accrual model link between flows and balances
Net assets at time tn+1 - Net assets at time tn = Net flows over period 1
This contrasts with the cash model, which measures only financial flows, assets and liabilities. The accrual
1
advances, deposits, bank and loan balances. The
asset and liability accounts are often referred to as
“below-the-line” accounts;
• Unallocated stock (inventory) is also treated as an
asset (below-the-line) account;
• Deductions from salary payments to government
employees for pensions are often shown as expenses,
although no liability for pension payments is
established;
• In some countries, cheques written after the year-end
for accounts payable are passed through the books in
the financial year to which they relate (rather than the
financial year in which they are cleared).
These are essentially ad hoc solutions to practical
problems encountered when applying the cash basis.
In addition, government accounting systems frequently
include some form of commitment accounting under
which expenditure is recorded when the organization
commits itself to spend the funds. Commitment
accounting is an addition to, not a replacement for, cash
accounting. Definitions of commitment vary, but
normally it would be when an order is placed or a
contract signed. However, in some countries, funds are
regarded as committed when released to a spending
unit.
From the above, it becomes clear that there is no single
clear “cash accounting” model. The way cash
accounting is applied varies between countries.
The accrual accounting model
The accrual accounting model is the accounting model
developed for commercial environments, and provides a
logically consistent approach to measuring financial
flows, assets and liabilities. Flows represent inflows or
outflows of assets and liabilities over a period; assets or
liabilities are valued at specific points in time, eg. the
beginning and end of accounting periods. Under the
accrual model, flows represent the change in balances
over time.
2

model also clearly differentiates revenue flows,
reflected in the “Operating Statement,” from capital
flows, which are recorded as schedules identifying such
changes.
This fundamental relationship leads to the accrual
analytic framework used for commercial entities. This
uses balance sheets and operating statements (the latter
representing flows over a period), and is the model used
by New Zealand in producing its government financial
statements. Exhibit 32, below, provides a simplified
analytic framework using this model.

Exhibit 32. Analytic framework of balance sheet and operating statement

Balance sheet of the Government of X as at 31 December 1998

31 December 1997 31 December 1998

Assets
Non-financial
Fixed assets $200 $220
Current assets $50 $60
Total non-financial assets $250 $280
Financial
Long-term $40 $40
Current $60 $90
Total financial assets $100 $130
Total assets $350 $410
Liabilities
Short-term $120 $125
Long-term $210 $245
Net liabilities $330 $370
Net worth (commonly the consolidated fund) $20 $40

Operating statement of the Government of X for the year to 31 December 1998

Revenues and grants
Revenues
Tax revenues $50
Other revenues $40
Total revenues $90
Grants $30
Total revenue and grants $120
Expenditures $110
Net economic flows $10
Transactions other than economic flows $10
Total net operating flow (equals change in net $20
assets over period)
It is noteworthy that under this model the only capital whereas the operating statement relates to flows over a
transactions reflected in the operating statement relate period of time. Therefore the titles of the two statements
to such items as depreciation, revaluation or changes in need to identify, respectively, the point in time or
volume (eg. new mineral deposits, loss in war) of period of time to which they apply. Movements in
capital (fixed) assets. The actual capital cost of assets not reflected in the operating statements,
purchases or receipts from disposals does not form part particularly capital transactions, eg. acquisition of fixed
of the equation. assets, lending and borrowing, would be reflected in
The balance sheet is a statement at a point in time, separate schedules attached to the above statements. A
 3

cash-flow statement links these together and provides tax liability.

useful supplementary information. Such a statement is
Neither of these requirements has any relevance to
mandatory for commercial entities under international
Governments. On the other hand, Governments do have
accounting standards.
specific needs, some of which do not apply to
Modified accrual accounting commercial entities.
Because of the problems explained below of applying • The requirements of fiscal management. These are
the accrual model to government activities, a third entirely related to cash flows, and hence accrual
option is the so-called “modified accrual.” There is no accounting has no direct relevance to fiscal
precise definition, but it generally refers to an approach management;
where accrual accounting is applied to current assets
• Resource allocation decisions–these decisions are
and liabilities–accounts receivable and payable,
also required of commercial entities. Most project
inventories, and financial assets and liabilities. This
appraisal models are based on predicted cash, rather
avoids the problems of valuing infrastructure assets or
than accrual, flows;
liabilities such as pension obligations.
Implications of different accounting models • Liquidity management–requires cash flow
information;
Without accrual accounting, the only relevant analysis
is of expenditure and receipt flows. In a cash-based • Resource management–it is in this area that accrual
system the only assets and liabilities are financial, and accounting has claimed advantages, because it
their recording does little more than prove the provides a better measure of assets being consumed,
arithmetic accuracy of the record of flows. Since there and also provides records of assets and liabilities for
are no physical assets or liabilities, only cash control purposes;
transactions occur. Therefore the analytic framework is
• The need to track expenditure flows through their
much simpler.
various stages in a manner that is not relevant to
Accrual accounting has been developed for commercial
commercial entities. This is illustrated in Exhibit 33,
entities to meet two specific needs:
below.
• To determine profits available for distribution to
shareholders as dividends; and
• To determine the profit as a basis of calculating the
Exhibit 33. Tracking expenditure flows

TIME

Medium-term Budget Purchase Invoice

financial plan Annual Supplemen- Expenditure
transfers order from Payment
budget tary budgets warranted
(virements) issued supplier

Financial planning and Fund control Commitment Accrual Cash

budget system system accounting accounting accounting

It is apparent that for some purposes accrual accounting The differences between the accounting bases is
is most appropriate, but for others cash flow summarized in Exhibit 34, below.
information will be required.
4

Exhibit 34. Different accounting bases

Element of Cash-based accounting Modified Accrual

financial statements accrual basis accounting

Financial assets All financial assets and
liabilities recognized as
below-the-line accounts
Other assets Unallocated stock
Advances
Other liabilities Deposits
Revenue and other Revenue recognized when
receipts cash is received
Expenditure and Expenditure recognized when Expenditure recognized
other outflows cash is paid when liability incurred
Flows not involving Not recognized
transactions
Balance sheet Only financial assets and
liabilities and other below-
the-line accounts
5
As cash basis, plus: As modified accrual basis
Receivables outstanding
(but not normally tax
receivables)
Advances and deposits
Inventory As modified accrual basis
Work in progress plus:
Accounts receivable Fixed and intangible
assets
Other current assets
Investments
As cash basis, plus: As modified accrual basis
Accounts payable plus:
Other current liabilities pension and other accrued
liabilities
Revenue treated as As modified accrual basis
income when invoices are
raised – but difficult to
apply this to tax revenue
As modified accrual basis,
less capital expenditure,
Fixed assets expensed in except fixed assets
full when acquired expensed only over life of
asset through
depreciation.
Not recognized Revaluation and physical
increase/ decrease in
assets
Full balance sheet Full balance sheet
excluding capital assets
and provisions
6
The choice of an accounting base
Careful consideration has to be given to whether accrual
accounting, developed to meet the above needs of
commercial organizations, is an appropriate accounting
model for Governments. Consideration also needs to be
given to the practicality and resource implications of
moving from a cash to an accrual accounting base.
The relative merits of the bases are set out below.
Exhibit 35. Comparison of accounting bases
Advantages of cash accounting
Simplest approach currently in use in most
countries, therefore requires no additional
investment in resources (except countries
emerging from central direction with no
established systems)
Provides information required for fiscal
management, capital expenditure evaluation and
liquidity management
When combined with commitment accounting
and a tracking system, can provide a
sophisticated expenditure control system
Avoids the investment in establishing systems,
valuing assets and creating parallel cash
management systems.
Accrual accounting does have significant advantages
and benefits. However, it needs to be combined with an
information system that also tracks expenditure and
provides information on cash flows–a sophisticated
requirement. To move from a cash basis to an accrual
basis requires significant accounting skills to be
available, and even then a substantial investment in
time. Within the UK the move to resource accounting (a
form of accrual accounting) has required a very
substantial investment.
For most LDCs the move is probably not feasible, and
would almost certainly be a misdirection of scarce
resources. The only exception could be a situation
where there was effectively no system, and it was a
matter of designing a system from a zero base.
Advantages of accrual accounting
A logically coherent model which embraces all
assets, liabilities and financial flows within a
single system, and for which there are well-
established standards
Provides a measure of resources consumed by
entities within government that is more
meaningful than cash flows
Provides a comprehensive record of assets and
liabilities, and focuses attention on important
issues such as pension liabilities
Enables standard commercial accounting
packages to be used for accounting purposes.
Accounting standards in government
accounting
There are no international standards for government
accounting. The Public Sector Committee of the
International Federation of Accountants (IFAC-PSC)
has produced two papers on financial reporting by
national Governments, 17/ but they contain no proposed
standards. The International Organization of Supreme
Audit Institutions (Committee on Accounting
Standards) (INTOSAI-CAS) has developed a number of
accounting standards, primarily for use by audit
institutions.
There is an argument that government accounting
standards are not needed, since there is only one
reporting entity in each country, and the standards
should be contained in the rules and regulations.
However, accounting standards deal with matters not
normally explicitly covered by such rules, eg. the basis
of accounting and definitions. If, as in the United
Kingdom, departments and agencies are required to be
self-accounting, there is a need for a common set of
standards.

A number of individual countries have developed
government accounting standards. In the United States
they are set by the Government Accounting Standards
Board. Australia, Canada and New Zealand have all
adopted standards, though in the case of the last they
are now the same as those for private enterprises. In the
United Kingdom the commercial accounting standards
apply except in cases where they are inappropriate, or
other standards have been set. Pakistan and China are
both in the process of developing and adopting
standards.
Although in general commercial international
accounting standards can be used by governments, there
are many areas where they are inappropriate. These are
further discussed in the subsections which follow.
Transactions other than economic flows
An implication of the accrual model is that there will be
changes in the value of assets other than through
transactions. These divide into two categories:
• Revaluations, which further subdivides into
depreciation, and other revaluations;
• Changes in volume.
It could be argued that depreciation is in fact a
transaction, but this is a matter of semantics.
Depreciation can be regarded as serving any of three
purposes: (i) a measure of the loss of value of an asset
over time; (ii) creating an accounting fund for the
replacement of the asset; or (iii) a periodic charge for
the use of an asset whose economic life extends over
several accounting periods. The modern view would be
towards the last definition, but the purpose does not
change the classification issue. Depreciation is both a
reduction in the value of an asset and an expenditure in
the operating statement. Both aspects must be recorded
within the system, hence the importance of linking
assets to operating units.
Assets may otherwise be revalued to reflect changes in
their economic value expressed in money terms. Indeed
the GFS implies the use of current economic values,
which would require annual revaluations. The need for
revaluation may be because of general or asset-specific
price changes, or physical factors altering its value. Any
revaluation has two impacts: a non-transaction flow,
and a corresponding change in the value of the asset.
Finally there may be changes in the volume of assets,
for example destruction through war or natural disaster,
or the discovery of new mineral deposits. As with
revaluations, such events would have two impacts: a
non-transaction flow, and a corresponding change in the
balance sheet value of the asset.
7
There is an issue of presentation of flows relating to
both revaluations and also volume changes. These are
not “operating flows,” since they do not result from
operations of government. Therefore they need to be
separately identified and reported, either in the
operating statement or in a separate statement.
Capital expenditure
The distinction between capital and revenue
expenditure is fundamental. There is general agreement
on the definition of fixed assets: “non-financial assets
intended for repeated use or use for more than one year
in the process of production.”18/ Under an accrual
accounting model, capital expenditure should not be
shown in the operating statement (see above). Good
presentation would be a separate schedule showing
movements on fixed assets. Fixed assets should be
identified by major category and by the operating unit
or sub-unit to which they relate, and identify:
• Original cost or valuation;
• Revaluations;
• Changes in physical volume as reflected in valuation;
• Annual depreciation charge; and
• Cumulative depreciation to date.
A well-designed system would keep this information
for each major asset in a separate fixed asset register,
linked to the main accounting system. Such a register
would also facilitate physical control of assets.
Transactions without a defined monetary
value
Governments participate in a variety of economic
transactions which are never actually monetized, or
where monetary values do not reflect economic values.
Three examples are as follows (all actual examples).
• Country X is provided with technical assistance in
the form of consulting services from a bilateral donor
to upgrade education. Details of the amounts paid by
the bilateral donor for the consulting services are
never revealed in detail to the recipient Government;
• A loan from country X at below-market interest rates
has a requirement that equipment must be purchased
from country X, even though the prices are higher
than would be paid for such equipment if tendered
internationally;
• Surplus agricultural production is gifted from one
country to another without any values being attached.
Such food may then be sold at subsidized prices to
 8

certain groups of the population, and the funds so

created used for specified development purposes.
Such transactions present problems of valuation,
classification and management. Though it could be
argued that since they are generally not fungible they
could be ignored, there is a widely held view that they
should be recorded as part of the flows under the
control of government. Certainly the GFS takes this
position, as stated in the Non-monetary flow section on
page 39.
Fund release procedures
The starting point of any accounting system is the
release of funds in accordance with the budget
allocations. This essentially involves the following
stages:
• Identifying spending units and funds allocated to
each unit;
• Assessing funds available for release
• Authorization for the expenditure in an approved
format; and
• Making it possible for such units actually to incur the
expenditure.
The manner in which these stages are achieved varies
considerably between countries. In essence there are
two issues:
• Whether the budget is regarded as sufficient
authority for the expenditure, or whether there has to
be some further release procedure for spending units,
eg. a warranting procedure; and
• Whether funds are actually transferred to subsidiary
bank accounts, or whether they are drawn from a
single group of central bank accounts.
Those alternatives form a 2 x 2 matrix as illustrated below.

Exhibit 36. Fund release procedures
Release procedure
The issue of how to release funds, and the system of
actually paying cheques and salaries, are at the heart of
the practical concerns of most government accounting
systems. Each of these issues is dealt with below.
In general there is a reluctance within Government to
regard the budget as sufficient authority to release funds
though this would normally be the practice in
commercial entities. The reason for this reluctance is
that (i) budgets often have inadequate detail of
individual spending units, and (ii) there is a need to
retain some control over cash flows through the year,
and to be able to restrict expenditure if receipts are
below budget forecasts.
Therefore, most government accounting systems
provide for funds to be released periodically throughout
the year. This may be quarterly, or even monthly. In
one LDC the releases are treated as imprests, to be
replenished within budget limits as expenditure is
incurred. In all cases the release system provides the
first accounting indication of funds expected to be spent
over the forthcoming period, and therefore it is valuable
information that should be recorded. Of course this is
less useful if, say 25 per cent is released each quarter,
rather than the imprest system described above.
Banking procedure
Most LDCs have problems of communication with
remote offices. For example, in Nepal some project
field offices are at best a trek of several days over the
Himalayas, and during the winter are completely
inaccessible. Such offices are without telephone,
electricity, or air communications. On the other hand in
most LDCs there is now a geographically extensive
banking system.
9
The issue facing government accountants is how to
make use of the bank accounts to receive revenues and
make payments. As indicated in Exhibit 36 above, there
is a spectrum of possibilities. The simplest is to keep a
few central bank accounts, and allow field offices
and/or district treasuries to draw on them. This
minimizes the cash balances held, but makes bank
reconciliation an almost impossible task.
The other extreme is to open a separate bank account
for every field office. An intermediate position is to
have district treasury branches, each with its own bank
account to make payments for field offices of ministries
and projects within its area. In all such cases there is the
issue of how to replenish these accounts, and avoid
having large idle bank balances in multiple bank
accounts all over the country. A solution in one LDC is
a set-off system, whereby there is a contract between
the central bank and the two major commercial banks
(both State-owned). Under this arrangement, individual
offices may have balances in credit or debit, but there is
a central set-off, with appropriate transfers to or from
the central bank.
In general, if bank accounts are few, the problem of
reconciliation is greater, but the system is easier to
operate.
Government accounting and record-
keeping
The basis of any system of government accounting must
be a set of procedures for capturing, recording and
summarizing financial transactions for use in the
control and reporting systems. In many LDCs, problems
exist at the basic level with procedures that result in
information that is delayed, unreliable, or not usefully
aggregated for management purposes. Furthermore,
10
existing accounting systems often use arcane language
that is not meaningful to the non-accountant, eg.
“below-the-line accounts,” “public accounts,”
“virement,” “funds,” and so on.
It should be recognized that government accounting
consists essentially of four functions.
• Carrying out and recording transactions regarding the
receipt, transfer and disposition of government funds
and property;
• The analysis and accumulation of transactions into
meaningful categories (usually using a chart of
accounts and a coding scheme);
• The maintenance of reliable financial records;
• The regular reporting of the resultant data for
management and accountability purposes.
Actual accounting procedures vary from country to
country, though they all tend to follow a pattern. Also
there may be varying degrees of centralization or
decentralization between two polar extremes:
• The centralized model–all financial transactions
directly controlled by a single central agency such as
the Ministry of Finance; and
• The decentralized model–financial transactions
executed and recorded by departments and
organizations, with the central authority responsible
only for establishing procedures and for final
consolidation.
There is no single ideal model of the extent of
centralization or decentralization, and what is
appropriate depends very much on the administrative
structure. There are also technical and practical issues,
which are discussed below.
The major practical issues regarding government
accounting are:
• The actual mechanics of recording, summarizing and
transmitting accounting information, including the
use of double entry and technology;
• The procedures for collating information centrally,
and in particular whether this is through line
ministries or directly through a central accounting
system.
These issues are addressed in the subsections that
follow.
Initial recording of transactions
The starting point of the accounting system is the initial
recording of a transaction. In many LDCs this may take
place in a physically remote field office, lacking
telephones or electricity, and with inadequately trained
staff. This traditional image is complicated by two
factors:
• While in many LDCs the picture above may be
accurate for many field accounting offices, in
practice the major value of transactions is likely to be
processed in a few large urban centres; and
• Field offices in such urban centres have available, at
least potentially, most modern facilities.
For example, in Nepal, 11 out of 75 district treasury
offices process 75 per cent by value of all expenditure.
Thus there is likely to be a requirement for a dual
standard of systems with a few offices in large urban
centres using sophisticated systems suitable to handle
large volumes and value of transactions, while in a
larger number of more remote offices, simpler manual
systems will continue to be needed. However, even in
the remote offices, improvements are feasible, including
the use of double entry, which is well suited for even
very small accounting offices, improved form design,
and possible use of carbon-copy-based systems to
generate multiple documents from one entry (an
example of simple intermediate technology which may
be appropriate), and the use of manually operated
calculating machines.
In the larger offices, typically in the capital city or other
large urban centres, it may be appropriate to introduce
simple computerized systems for data entry and
recording. Such systems can be run on stand-alone
microcomputers. They can use simple accounting
packages, requiring only the recording of cash
transactions or just a computerized votes ledger.
The votes (appropriation) ledger
The votes ledger is a traditional, simple, but effective
tool of financial management. Its name derives from the
appropriations, sums “voted” by parliament for various
purposes within the budget. (Many budget documents
formally divide expenditure into “vote” headings; in
other cases these are implicit in the budget allocations).
The votes ledger keeps a record against each budget
vote, or head, of the sums committed and expended,
and the balance left unspent. An example of a votes
ledger format appears below.
 11

Exhibit 37. Votes ledger example

Budget head reference: .....................................................

Spending unit: ....................................................................
Amount of budget: ............................................................

Balance
Date Description Ref. Commitment Expenditure
remaining

This very simple format provides a key expenditure
control tool. It is also very easy to computerize.
However, a problem with such computerization could
be the lack of data security controls. This and other
relevant issues are addressed below.
Storing information
A problem in many LDCs is the storage of documents.
Typically offices have inadequate filing systems, lack
physical facilities, and also lack any structured method
for managing and retrieving documents. This is a matter
of considerable concern in a system based on
documentation, and where secure storage and ease of
retrieval are of vital importance.
Systems need to be established which securely and
methodically store all documentation in a manner that
facilitates its location and retrieval when required.
These can use a combination of manual filing systems,
or more modern approaches, eg. microfilm or
microfiche, scanning and digital storage. This is an
issue of great concern.
Information flows and consolidation
Information must flow from the office initially
recording the transaction to a central point, or points,
within the Government, for the purposes of
consolidation, monitoring and control. Traditionally
government accounting systems have been very
centralized, with all of the information flowing to the
Accountant General, or equivalent. However, modern
developments have emphasized departmental
responsibility, and departments in many countries have
become increasingly self-sufficient in accounting.
Thus for example, the thrust of the changes in the
United Kingdom has been to develop departmental
accounting responsibility so that departments are
responsible for their own budgets, expenditure and
accounting. The changes in New Zealand have gone
even further, and turned departments into largely
autonomous units. These changes have paralleled
similar changes in information technology, which have
made it more feasible and economic to disperse data
processing away from monolithic mainframe systems to
distributed systems. Thus organizational and
technological changes have gone in parallel.
However, in most LDCs, and indeed most developing
countries, these organizational changes have not even
begun. Governments remain very centralized, with
considerable power in the hands of the finance ministry.
Accounting is a centralized process.
Nevertheless, in many countries accounting systems
also have flows directly to departmental and/or project
head offices. This reflects the accounting responsibility
of the secretary or other senior officer. Thus it is quite
common to have two sets of information flows, as
illustrated below.
12
Exhibit 38. Existing accounting information flows in typical LDCs
Clearly the exact titles of the institutions will vary
between countries, but the flows outlined above remain
typical, with two parallel flows of information, one
through the central accounting organization, and the
other through the line ministries. Experience in most
LDCs is that these two flows are never adequately
reconciled.
The problem facing any programme of reform and
upgrading of the accounting system, is whether to:
• Develop and upgrade existing information flows, and
rely on a reconciliation procedure; or
• Focus on one of the two information flows–and if so,
which one?
As indicated above, the move in most high-income
industrialized countries is towards distributed systems
focusing on departmental responsibility, and with the
departments responsible for their own accounting.
However, it is doubtful if this model is feasible in many
LDCs.
• A distributed accounting system relies on the
capability within each line ministry to establish its
own accounting systems and procedures in
accordance with central guidelines. This requires a
source of trained staff, which often simply does not
exist;
• In order to provide a flow of information also for
macroeconomic planning and control, technology
and systems of a relatively sophisticated nature for
consolidation are required, and again these do not
generally exist;
• Most LDCs suffer problems of losses through
malpractice, and their likelihood increases if control
is taken away from a central accounting body and
dispersed over a range of ministries.
It is therefore concluded that initial efforts at reform are
likely to focus on developing the main accounting
information flows to a central accounting system. It
would be unwise to try to stop the parallel information
flows. The long-run efforts should be to develop
procedures whereby both information systems are
feeding from common data, and the fact that this is
repeated in two directions becomes immaterial.
This model is further complicated where there is any
form of federal structure, as in Pakistan or Papua New
Guinea. In these cases responsibility is divided between
regional and central Governments, and accounting
information flows are similarly divided. This can lead
 13

to complex budgetary and accounting problems. system is greatly reduced if budgets are not set carefully
and properly in the first place. Though many reports are
Expenditure control, monitoring needed, they can all be summarized in a single model, as
and reporting illustrated below.
The end-products of the accounting system are reports
which enable managers to perform their functions more
effectively. However, the effectiveness of any monitoring
Exhibit 39. Reporting structure model

Reporting periods
Monthly, trimestral,
quarterly, annual

Total budget
Reporting compared to Expenditure Physical outputs
Unit funds released compared to compared to
(commitment revenue financial inputs
National ministry, accounting) and (cash monitoring (performance
department, to expenditure and financial monitoring)
project, cost (expenditure statements)
centre control)

Comparison with budget,
earlier periods or net assets
• Reports are required at a range of levels. At higher
management levels, the span should be extended to
reflect responsibility, and detail reduced, with
increased use of exception reporting;
• Commitment accounting is provided by a “vote
book” system;
• Financial statements should be available regularly,
not just at the year end, and for lower levels of
responsibility as well as aggregated;
• Performance monitoring is the stage where financial
data on resources consumed is combined with non-
financial performance data to provide meaningful
measures of performance towards goals;
• All reports should provide comparative data
(“benchmarks”) so the information can be evaluated.
Normally these will include budget or previous
period figures;
• Most reports are required annually, but this is too
infrequent for most managerial control. Normally
reports are also required monthly–some even more
frequently. To make monthly reports meaningful,
Benchmarks
budgets also need to be analysed into months.
In addition, all reports should be:
• Timely–data rapidly loses its value if not available
promptly;
• Reliable–though excessive precision is redundant;
• Clearly presented–the format should be clear and
attractive; and
• Simple–only relevant data should be included.
A modern accounting and reporting system will almost
certainly be computerized, possibly partially at first and
completely in time and, when this becomes feasible, at
remote offices. In developing a reporting system, the
emphasis should be to keep it simple initially so as to meet
expenditure control objectives, but with the flexibility to
develop later to meet more sophisticated needs.
Public expenditure review process
In most parliamentary democracies there will be a
mechanism whereby a committee of parliament
regularly reviews actual expenditures against the
amounts in the budget estimates. This process may be
 14

linked to review of reports from the supreme audit
institution within the country. Government officers will
be called before the committee to explain their actions
and any apparent failures. Such failures would include
unauthorized budget overruns.
Therefore the reporting system must be designed to
make relevant information available. Original budgets,
supplementary budgets, and approved virements must
be combined to show the final authorized expenditures,
and compared to actual expenditures. Expenditures
must be presented and compared to such authority. In
some countries legislation may require this comparison
to be on a cash, not accrual, basis.
Exhibit 40. Cash management
This review process exemplifies the objectives of
transparency and accountability. Information should be
available to the public on government financial
activities in a clear and useful manner.
Cash and liquidity management
Cash management should be an important part of
financial management. Yet in many countries the only
government cash management is at a highly aggregated
level by the central bank. Aspects of this are summarized
below.

Why is cash management ignored?

• Government departments and spending agencies experience no benefits or costs for managing funds well
or badly.
• The main focus of budget execution is on the release of funds, and the actual spending of money is not
well coordinated with apportionment of budget appropriations.
• The main focus of government accounting is on the propriety of expenditure, not the efficiency of fund
use.
Why is it important?
• Impact on public sector borrowing requirement–bad cash management can increase the need for
temporary borrowing.
• There is a real interest cost or benefit to the Government.
• Important for fund stabilization programmes.
The four components of effective cash management.
• Cash flow forecasts, profiling over the year the timing of cash inflows and outflows.
• Cash inflow control–measures to accelerate flow of receipts.
• Cash outflow control–management of timing of disbursements.
• Bank balance management–keeping balances in subsidiary bank accounts to a minimum.

Ineffective cash management could mean that the

Government will have to resort to short-term borrowing
to meet temporary deficits. It should also be borne in
mind that the cost of financing a deficit, either short- or
long-term, can have a significant impact on resources
available for other purposes. Borrowing costs money
and to do so unnecessarily is simply a waste.
Cash management needs to be specifically integrated
within the system of financial management. This is
normally relatively easy to introduce as part of
redesigning other components.
15
 16
VI. CODING AND CLASSIFICATION
Introduction
Budgets are a structured representation of anticipated
income and expenditure flows. Accounting consists of
organizing a large volume of individual transactions
into the same structure. The link between these two is
the classification system.
A classification system may thus be defined as:
The revenue and expenditure categories
established by the Government to plan revenues,
expenditures, financing, and other financial flows
in the budget/ planning system, and subsequently
used as codes in the accounting system to classify
actual revenues, expenditures, financing and other
flows, and to record assets and liabilities. The
classification system also embraces the various
analyses derived from such a coding system.
The classification system will manifest itself through:
• The structure and presentation of financial forecasts
and budgets in planning and budget documents
(sometimes referred to as budget codes);
• The structure of the formal authority by parliament to
raise revenues and expend public monies
(expenditure authority through an appropriation act);
• The chart of accounts (sometimes referred to as
nominal ledger codes) used to record revenues and
expenditures within the accounting system and also,
if an accrual system is used, to record assets and
liabilities;
• Analysis of revenues and expenditures derived from
the revenue and expenditure coding system; and
• The financial statements of the government.
Because government budgets and accounts serve
multiple objectives–legal and constitutional,
macroeconomic, and normal expenditure and revenue
control–information must be presented in a variety of
formats. This requires a well-designed classification
structure.
Multiple objectives of a classification
system
There is no single, self-evident analytic framework
which is suitable for all purposes. By its nature, any
system of classification and aggregation of transaction
information means a loss of detail. If the classification
system does not provide for identification of data in
some particular way, it will not be possible
subsequently to identify data in that way. This is less of
a problem in budgets, where the figures are by their
nature forecasts of aggregates; but it is a real problem
for accounting information.
Classification systems within Government are made
complex because of the need to be able to analyze the
financial information in a variety of formats for
different purposes. This variety can be envisioned in
terms of the levels of information, the needs of users, or
the technical financial information system. These are
explained in the following subsections.
Levels of information
There are three major levels of information..
Level 1: Economic or macro level, as
exemplified by the GFS Manual of
Government Finance Statistics (GFS)
and the System of National Accounts
(SNA)
Level 2: Resource allocation level, exemplified
by programme and performance
budgeting, three-year rolling budgets
Level 3: Legal and managerial level,
exemplified by the tax raising and
expenditure appropriations in the
budget to specific units of government,
and subsequent revenue and
expenditure control processes
Needs of users
User needs impose a separate set of requirements on the
classification system. Governments have specific
managerial responsibilities in relation to the public
sector and for the economy generally, and are
accountable to all citizens. This creates a series of user
needs.
 17

• Managers within the Government need the is normally the maximum that is required, as illustrated
classification system to provide financial information in the diagram. The significance and purposes of the
required in their role as managers, eg. cash control, dimensions are summarized below.
budget management, etc;
• Government activities have to be considered in the
context of national policies, since they impact on
each other. The classification system must meet the
needs of policy makers and managers in relation to
the whole economy;
• There will always be demands for government
expenditure in excess of resources available. The
classification system must be useful in making
decisions on how to prioritize the use of limited
resources;
• The system must be capable of translating
parliamentary expenditure authorizations into a
system for authorizing expenditure to specific
spending units;
• Government activities have a multi-faceted impact
on a range of stakeholders, all of whom have a
legitimate interest and requirement for analysis
relevant to their specific concerns;
• The system must be able to provide an historic
comparison of estimates (budgets) with actual
expenditures for detailed review by a Public
Accounts Committee (or its equivalent).

Financial information system

Finally there are the different requirements imposed by
the technical financial information system.
• Budgets have a greater and different significance for the
public sector than for the commercial sector, and the
budget process will tend to drive the classification
system;
• Governments maintain their accounts using either
cash or accrual approaches, or some intermediate
system. The choice impacts on the classification
system. Asset and liability classifications are
required under an accrual approach, but only for
financial assets and liabilities under a cash approach;
• Statistical systems–eg. national accounts–approach
classification issues from a different perspective to
budget and accounting systems, and have their own
analytic requirements.
While at first it would appear that almost unlimited
classification capabilities are required to meet all
conceivable needs, in fact, a seven dimensional analysis
 18

Exhibit 41. Classification dimensions

Classification
Meaning Purpose
dimension
Functional A functional classification divides into the Identifying broad sectoral allocations of
broad functions of government, eg. defence, resources, and identifying priorities. Sectors
law and order, transportation and often, but not invariably, coincide with
communications. ministries or departments.
Administrative The Government organization, from ministries Legal authorization of expenditure. It is also
structure at the top to the smallest unit responsible for suitable for identifying responsibility for
expenditure, and also taking account of such expenditure control, especially if classified
legal differences as consolidated fund and down to the lowest levels of responsibility.
public account, charged and non-charged.
Programme Classification of expenditure by programmes Monitor and control expenditure.
and projects, which may extend over more than
one ministry.
Economic The type of expenditure, eg. capital, revenue, Economic analysis and comparisons.
payroll, equipment, telephone, and so on.
Legal Legal nature and authority for expenditure Public expenditure and revenue raising in
accordance with law.
Financial Financing and link between expenditure and Debt management and identification of
sources of finance sources of finance
Assets/ liabilities The balance sheet Links money flows to assets and liabilities
created

The above descriptions are based on expenditure. Classification linkages to stages of

Income analysis is usually simpler, concentrating on the
type of income (taxes, grants, licence fees), and the
source (domestic, foreign). Lending and borrowing are
normally treated as a separate group of flows. Finally, in
countries which have inherited a British-style system,
government accounts are divided between the
consolidated fund (recording normal income and
receipts), and the public account (mainly containing
funds held in trust, and temporary balances). All of these
have to be accommodated in a classification system.
the financial management cycle
The financial management cycle, as illustrated in
Exhibit 42 below, links all stages of the financial
management process within a single system. Stages in
the cycle have roles in resource allocation, control or
accountability. The paragraphs below consider the
linkage of classification to each stage in the cycle for
these roles.

Exhibit 42: Model of an integrated financial management system


Planning system and project appraisal
In all countries there must be some mechanism for
planning major projects that involve expenditures and
benefits extending over a number of years. The
approved projects may be structured within a formal
plan, such as a “five-year plan” or a “public
investment programme” or they may be made and
recorded on an ad hoc basis.
Investment decisions should be based on the costs
and benefits of the project. There are well established
tools to facilitate this evaluation process, but the
process must involve prediction of future money
flows associated with the project. The decision will
not be affected by the manner in which such money
flows are classified, but there are reasons even at this
stage for presenting such money flows in accordance
with the Government’s standard classification
system, as indicated below.
19
Medium-term budget system
It is increasingly recognized that the annual budget is an
inadequate tool for financial planning, and that some
medium-term framework is required. The premier
example is the Australian rolling three-year budget,
though some other countries have similar systems, for
example the Economic Survey in the United Kingdom.
Such forward plans will not normally go to the level of
detail in an annual budget, since they are not directly used
as a basis for raising revenues or releasing funds.
Nevertheless it is very important that they follow the same
classification structure as the annual budget.
20

Annual budget system Reporting and financial statements

Annual budgets are at the heart of the financial The periodic financial reports and annual financial
procedures of Governments. They are the legal statements are the tools of the control system.
mechanism by which revenues are raised and Government accounting systems have traditionally not
expenditure authorized. It is therefore of the utmost been seen as reporting systems. Reports are often
importance that budgets are presented in as clear a restricted to monthly reports, often late, without
format as possible to maximize transparency. It may comparisons to budget, and poorly presented. To be useful
well be that there is more than one presentation for control purposes reports must be up to date, produced
format within the budget, for example by with a frequency related to the control cycle, and
administrative structure and also by programme presented with benchmarks so as to be able to identify
structure. On the other hand, it would be trends and where action is required. This is feasible only
inappropriate within the budget presented to through a consistent and appropriate classification
Parliament to show all of the underlying detail that is structure.
necessary in order to be able to release funds to Audit system
spending units, or to raise specific forms of revenue.
The classification system provides an all-embracing Governments are subject to audit by the supreme audit
structure to facilitate these different requirements. institution, often the Auditor General. Historically,
government audit has differed from commercial audit in
Fund release, expenditure control and that the former has concentrated on the propriety of
treasury management transactions and the latter on the reliability of the financial
There is an intermediate stage between budget statements. The trend is for government auditing to
authorization and actual expenditure. This is the fund embrace at least a review of, and expression of opinion
release stage–procedures by which spending on, the financial statements. This will include a
departments are authorized actually to spend the comparison with budget authorizations, so consistency of
funds authorized by the budget. This is often referred classification is essential.
to as the process of warranting. This process is
variously used for liquidity management, expenditure
control and allocating expenditure to decentralized
spending units.19/ In order to maintain the integrity of
the system, it is vitally important that the budget
classification system is consistently followed through
to the fund release stage. This will involve additional
detail in the system to identify the decentralized
spending units.
Accounting system
The accounting system is the stage at which actual
revenues and expenditures are recorded, using either
accrual or cash accounting. It is essential that the
same classification system be used as for the budget,
in order to make monitoring and control feasible.
However, there will be a need for additional
classification heads for accounting not required for
budget purposes. These particularly relate to asset
and liability accounts. Even under a cash accounting
system, some asset and liability accounts will be
retained, eg. suspense accounts, advances, deposits.20/
In an accrual accounting system the asset accounts
will be much more extensive, and will include fixed
assets, depreciation, accounts payable and receivable
(creditors and debtors), inventory, and accrued
liabilities such as pensions.
 21

Expenditure review system

Most parliamentary systems incorporate some
process by which Parliament reviews public
expenditures, typically a public expenditure review
committee. Such a committee will be concerned with
the authorization, propriety and effectiveness of such
expenditure. The review will be based on the audit
reports, financial statements and budgets of the
Government.
Conclusions on the financial management
cycle and classification
The key point to emerge from this analysis is the
relevance of the classification system to every stage
in the cycle, and the need for a single system applied
consistently. Therefore the system must be
appropriate to the requirements at each stage in the
cycle. The matrix in Exhibit 43 below summarizes
the impact of classification at each stage of the cycle
in terms of resource allocation, control and
accountability.
22
Exhibit 43. Linkage of stages of financial management cycle to classification
Stage in cycle Resource allocation
Planning system and Once projects are approved, their financial
project appraisal flows will be included within medium-term and
annual budgets, and will represent pre-empted
resources, thus restricting resources available to
be allocated for other activities. The process of
identifying the annual flows associated with
projects will be facilitated if they are already
presented in the classification structure. This
also applies if there is a public investment
programme the financial implications of which
have to be incorporated within a budget.
Furthermore, post-event comparisons of
predicted and actual cash flows can be valuable
in improving the quality of future forecasts.
This evaluation is feasible only if they are both
analysed within the same structure.
Medium-term budget The use of a standardized classification system
systems facilitates comparisons for resource allocation
purposes, and also the incorporation of pre-
empted project expenditure as indicated above.
Annual budget system The annual budget is the legal tool for
allocating resources. As such it must use the
standard classification system.
Resource allocation
Stage in cycle
Control Accountability
Projects should be subject to ongoing Accountability is enhanced if financial
monitoring, and this will include comparing information about projects is presented in a
predicted and actual cash flows. The standardized format.
accounting system should be used to generate
the latter information, and will do so in
accordance with the standard classification
system.
Medium-term budgets are an important Medium-term budgets are part of the
expenditure control tool, forcing an evaluation transparency of government. They are more
of the impact of expenditure decisions on effective as a communication tool if presented
resource ceilings. This can be made in a standardized format.
effectiveonly if medium-term budgets can be
translated into annual budgets, and this makes
a standard classification system essential.
Budgets are a key control tool. Actual Budgets are the prime mechanism for
expenditure is compared to budgets (see accountability. This is enhanced by a clear
below), and therefore both must use the and transparent presentation, which in turn
standard classification system. requires an appropriate classification system.
Control Accountability

Fund release, Resource allocation decisions within the budget
expenditure control and can, deliberately or accidentally, be distorted
treasury management through inconsistent fund releases. Such
distortions can be identified through a
consistent classification system, combined with
financial monitoring procedures.
Accounting system The accounting system records historic
information, and therefore has no direct role in
resource allocation. However, such information
is a guide to future money flows. Also by
comparing predictions and out-turns, the
quality of predictions, and hence resource
allocation decisions, can be improved over
time.
Reporting and financial Reporting has no direct link to resource
statements allocation, though as noted above may indicate
future cash flows.
Audit system Auditing has no direct relevance for resource
allocation, though a “value for money” audit
can provide information to guide future
investment decisions.
Expenditure review The expenditure review has no direct impact on
systems resource allocation, but the review of
effectiveness may provide guidance for future
decisions.
Fund release is an essential element within
the control cycle.
Historic accounting information is a basic
element in a control mechanism. Although
nothing can change past costs, by
comparison with plans trends can be
identified and any appropriate corrective
action implemented. This makes consistent
classification systems essential.
Reports are the basis of the control system.
Audit is a fundamental part of the control
process within government.
This is another important element in the
control process.21 /
23
Accountability is achieved by being able to
monitor fund releases against original budget
authorizations.
Historic accounting information forms the
basis of reporting on financial out-turn, and
hence accountability.
Annual financial statements are a very
important element in achieving accountability,
and are usually the basis of audit and
expenditure reviews.
Similarly, audit is a fundamental part of the
mechanism for ensuring accountability of
public servants.
The public expenditure review process is a
manifestation of accountability.
24
Criteria against which to evaluate a classification system
It is useful to develop criteria against which both present and proposed classification systems can be evaluated.
These are set out in Exhibit 44, below.

Exhibit 44. Criteria for classification systems

No. Criterion Explanation

1 Comprehensive Covers all categories of income and expenditure
2 Structured So that the different categories of codes are clearly segregated,
and analysis is possible
3 Simple and workable In order to make analysis feasible given the level of clerical
skill and automation available
4 Meets budget, expenditure control, So that one system can be used for all purposes
resource allocation and accounting needs
5 Suitable for computerization This is an essential requirement for any modern system
6 Capable of developing The system must be designed so that it is capable of being
developed and amended to meet additional and changing
requirements without a fundamental redesign

Concepts underlying classification Public enterprises operated as departments

structure
There are a number of important concepts underlying a
classification structure. These are set out in the
subsections that follow.
Capital and revenue
Capital transactions involve payments or receipts for
the acquisition, construction or sale of non-financial
assets meant to be used for more than one year in the
process of production. Intangible assets and land are
included in capital, or fixed, assets.22/ The distinction is
regarded as important because it differentiates between
expenditure for current consumption and expenditure
for long-term consumption. Note that the definition
primarily focuses on the purpose of the expenditure.
However, there is some dispute about the definition of
capital in the public sector, and some authorities link it
to the source of funding. Furthermore, the value of the
capital/current distinction is much reduced under cash
accounting, where there is no attempt to record capital
assets in a balance sheet.
An example is provided by Bangladesh Telephone and
Telegraph Board. The telephone system in Bangladesh is
operated as a government department. In such cases, the
information in the government budget and accounts should be
on a cash basis, but the enterprises need to keep memorandum
accounts on an accrual basis because of their commercial
nature.
It is preferable that all such commercial activities be
segregated and treated as public enterprises. However, where
this is not possible within the administrative structure, it can
still be achieved within the classification structure.
State-owned bodies
State-owned bodies include financial institutions,
commercial enterprises and other non-commercial
entities, eg. welfare associations and educational bodies.
Commonly in LDCs it is not possible to identify net
flows of funds to or from these organizations from the
budget. In the development budget, often no distinction
is made between projects where the funds are
subsequently lent to autonomous bodies, and therefore
move out of the direct legal control of government, and
projects which are conducted directly by the
Government.

Exhibit 45. State-owned enterprises
Control over
Public
Dealt with through
public-enterprise
The coding structure should clearly identify gross flows
of funds to and from State-owned bodies as being: (i)
subsidies or grants; (ii) loans or repayments; (iii)
interest on loans; (iv) dividends or profit share paid to
government; or (v) equity investments. This system is
extended to development expenditure so as to clearly
identify projects which pass through the government
accounting system from those accounted for by the
public enterprises.
This has implications for expenditure control. The
government accounting system will provide the source
data for the financial management of projects operated
directly by government. For those operated through
autonomous bodies, expenditure control information
25
Directly by
Dealt with through
government
must come from the autonomous body itself.
The GFS/SNA analytic framework
The IMF Manual of Government Finance Statistics
(GFS) 23/ and the System of National Accounts (SNA) 24/
are statistical analytic tools. These form international
standards for fiscal analysis and comparison. The
proposed changes to the GFS adopt an accrual approach,
which is in line with the SNA.
The GFS organizes money flows into broad categories as
indicated in the matrix below. Note that the layout of this
and subsequent presentations differs from that used in
the GFS Manual, in order to facilitate comprehension.
26
Exhibit 46. GFS analytic framework
Description Current Capital Total
Revenue and grants
Taxes and other income 2,000 1,500 3,500
Grants 1,000 800 1,800
Total 3,000 2,300 5,300
Expenditure –3,200 –1,700 –4,900
Lending – repayments
Lending –1,100
Repayments 500
Net –600
Deficit/surplus on current account –200
Financed by:
Increase in government liabilities to others –600
Increase in others’ liabilities to government 400
Net financing –200

Note: Figures are for illustrative purposes only.


The distinction between capital and revenue is a
fundamental part of the classification of receipts and
expenditure. As noted in the subsection on capital and
revenue, the definition used by the GFS is that capital
transactions involve payments or receipts for the
acquisition, construction or sale of non-financial assets
meant to be used in the process of production for more
than one year. Intangible assets and land are included in
capital assets. Taxes are regarded as revenue receipts, and
grants are capital receipts only if for the purpose of
acquiring capital assets. Lending minus repayments is not
classified as capital or revenue. Government lending or
borrowing may be either for public policy purposes, in
which case it is classified as lending minus repayment, or
for liquidity management, in which case it is classified as
financing.
Impact of accrual accounting
on the analytic model
Without accrual accounting, the only relevant analysis
is of expenditure and receipt flows. In a cash-based
system the only assets and liabilities are financial, and
their recording does little more than prove the
arithmetic accuracy of the record of flows. Since there
are no physical assets or liabilities, only cash
transactions occur. Therefore the analytic framework is
much simpler.
Either a cash or accrual analytic framework requires a
classification system for economic flows. This is all that
will normally be required for the budget classification
under any model. The use of the accrual model adds the
requirement for accounting classifications for assets,
liabilities, and transactions other than economic flows.
The impact of the choice of model on classification is
therefore in terms of the additional analysis.
Financial assets and liabilities
and financing flows
The GFS divides financial assets according to the
purpose for which they are held:
• Those held for policy purposes, which are shown as
“net acquisition of financial assets for policy
purposes”; 25/ and
• Those held for liquidity management, which should
be shown under financing.
27
The GFS admits that it is difficult to identify these two
groups on the basis of types of assets, and therefore the
distinction must be based on “motives underlying the
transactions.” The 1986 GFS Manual provides some
guidance. In practice most financial assets will be held
for policy purposes, and liquidity management assets
relate to specific purposes, eg. as a fund to meet pension
liabilities as they mature.
Liabilities, on the other hand, are classified within the
GFS primarily on the basis of domestic or foreign.
Interestingly, the GFS contains no guidance on the
functional classification of interest payments. Though
these may be embraced within an economic
classification, it is necessary to define consistently
where interest payments are recorded within the
different government functions.
This explanation refers to the present GFS. Under
proposed changes to the GFS the treatment of net policy
lending will change. Whereas at present policy lending is
regarded as deficit-creating, under the new proposals it
will be treated the same as liquidity lending, ie. as part of
the financing section.
The GFS treatment of financial assets and liabilities,
and related flows, is significantly different from that
applied to accounts under generally-accepted
accounting principles. Under GAAP there are
“operating assets,” ie. those used in the operations of
government, and non-operating assets, which would
include assets held for liquidity management purposes.
Similarly, liabilities need to be divided between
operating liabilities (commercial entities treat these as
synonymous with “current liabilities,” ie. those with a
maturity less than one year, but this may not be an
appropriate assumption for Governments), and
financing liabilities.
The GFS does not distinguish between operating flows
recorded in the operating statement and other changes
in the amounts of assets and liabilities. Interest receipts
and payments form part of operating expenditure and
revenues. On the other hand changes in the amount of
assets are not operating flows, and would be identified
separately through separate schedules, linked to balance
sheet movements. Exhibit 47 seeks to relate these
different approaches.
28
Exhibit 47. Alternative treatment of financing
GFS approach GAAP approach
Balance sheet Balance sheet
Financial assets held Included within: Operating assets
for policy purposes

Financial assets held for Substantially

liquidity management same concept Non-operating assets
purposes

Liabilities – domestic Operating liabilities

(sub-divided by type)
Classified in
different manner
Liabilities – overseas Liabilities held for financing
(sub-divided by type) entity

Operating statement Operating statement

Interest receipts Substantially Interest receipts
same concept

Interest expenses Substantially Interest expenses

same concept

Gains/losses resulting from

exchange rate changes

Statement of changes in Statement of changes in

financial assets and financial assets and
liabilities Presented in a liabilities
Net movement in assets/ substantially Gross movements shown for
liabilities held for policy all major categories of assets
purposes different manner and liabilities

Gross movements in other Gains/losses from amounts

financial assets/liabilities written off shown separately

There is no incompatibility between these different
approaches, which reflect different information needs of
different groups of users. Provided the classification
system contains sufficient information for either
purpose, then either analysis can be derived as required.
The approaches to all three are summarized in the
paragraphs that follow, and then our conclusions on the
system as a basis for classification are drawn, using
Bangladesh as an example.
Revenue and grants
These are classified according to the following system
(upper case Roman numerals in parentheses are those
used in the GFS Manual):
 29
Exhibit 48. GFS analysis of revenue and grants

Main category Examples Illustrative

values
Tax revenue (IV) Taxes on income 200
Property taxes 100
etc. 150
Total 450
Non-tax revenue (V) Fees and charges 80
Property income 60
etc. 20
Total 160
Total current revenue (III) 610
Capital revenue (VI) Sales of fixed capital assets 90
Capital transfers from non- 120
government sources, eg. residents
abroad
Total 210
Total revenue (II) 820
Grants (VII) From abroad 150
From other levels of national 20
government
From/to supranational bodies 220
Total 390
Total revenue and grants (I) 1,210

This is an analytic framework which is acceptable for Functional and economic

most purposes. However, note that it fails to identify
revenue in terms of units of government, which are
likely to be required for control and management
purposes. Also the accounting system will need to
identify individual sources of grants.
classification
The GFS Manual uses a two-way split of items: (i)
functional and (ii) economic.
The functional classification divides expenditure
according to the broad functions of government, eg.
defence, law and order, health, education and so on.
This will usually, but not invariably, follow the
administrative structure of Government and the various
ministries. For example, in Bangladesh the education
function is divided between the Ministry of Education
and the President’s Office, with the latter being directly
responsible for primary education.
30
The economic classification divides expenditures
according to their nature, eg. payroll, interest, subsidies.
This is sometimes referred to as an object classification.
In order to reconcile these two classification
approaches, a matrix is proposed which is reproduced
below in a simplified format, and without showing the
subdivisions of the economic classification.

Exhibit 49. GFS economic and functional cross-classification

Economic Total
expenditure
classification Total Current Capital
and lending
minus expenditure expenditure expenditure
Functional classification repayments
General public services
Defence
Public order and safety
Education
Health
Social security and welfare
Housing and community services
Recreation, culture, religion
Fuel and energy
Agriculture, forestry, fishery
and hunting
Non fuel mining, manufacturing and
construction
Transportation and communications
Other economic services
Non-classified
Total

The above analysis is not intended to provide a system
for expenditure control, in that it does not identify
managerial responsibility for expenditure decisions.
This highlights the multi-dimensional nature of
classifying government expenditure. From the GFS
perspective, it is primarily information for economic
analysis; from the perspective of public-sector
managers it is primarily a system of expenditure
monitoring and control. The latter requires information
focused on individual responsibility, which is irrelevant
for economic analysis.
Legal aspects of classification
In most countries, the classification structure is to some
extent circumscribed by the legal and administrative
structure. This in turn will be influenced by the historic
background of the country. In most countries with a
British system background, government monies are
typically divided between consolidated fund and public
account. In practice, the consolidated fund is further
divided between the development budget and the
revenue budget. Finally, expenditure from the revenue
budget is divided between charged (ie. that expenditure
which does not have to be voted on and debated by
parliament) and non-charged. The distinction between
consolidated fund and public account is important, and
reflects the very different nature of the transactions in
terms of both budgeting and expenditure control. The
Bangladesh model is used as an example.

Exhibit 50. Important accounting categories in Bangladesh
It will be essential for any classification system to
allow the identification of these categories of income
and expenditure.
Conclusions
There is no single correct classification. On the other
hand, there are certain requirements which any
coding structure must achieve.
• It must comply with constitutional and legal
provisions and the administrative structure of the
country;
• It must be suitable for the different components of
financial management–planning, budgeting,
The structure proposed by the GFS provides a conceptual
basis meeting the needs of economic management. It is
not intended to meet the needs of administrative
structures and managerial control. It is possible to meet
all analytic requirements within a single classification
75
accounting and monitoring–so as to be a tool in the
process of integration;
• It must enable the various types and required levels
of analysis, including that required for managerial
controland also for economic management;
• It must be sufficiently simple to be feasible for
implementation;
• It must be designed so that it is flexible and allows
for future development.
structure by the use of “look-up tables.” These are built
into the computer system, and enable a series of
classification analyses to be derived from one single
system.

VII. FINANCIAL STATEMENTS
Introduction
Financial statements are the final element linking the
other components of the financial management system.
They relate actual outcome to plans and budgets, for
both financial elements and performance criteria.
Although most governments produce financial
statements, they are typically low-key affairs. Often the
documents are buried in other papers, and not easily
accessible. This does not apply just to LDCs. The
United Kingdom, for example, has never actually
published its consolidated financial statements, though
the information within them is available from a number
of other documents.
This contrasts with commercial entities, where the
publication of the annual financial statement is a legal
requirement and is regarded as a marker, the point when
the performance of the entity and its management are
judged. This of course links back to the accounting
model as the universal standard for commercial entities
(see Exhibit 6).
There is a strong case for a positive effort to upgrade
the status, quality and timeliness of the financial
statements of LDCs as part of the process of developing
an integrated financial management system. Such
statements provide tangible evidence of good
accountability and enhance transparency in government,
and their production provides a target for the financial
system reforms. They provide a marker in the process
of implementing “good government” reforms.
There is a trend within governments generally to move
in this direction. New Zealand, for example, now
publishes a full set of financial statements, laid out like
those of a commercial enterprise. 26/ The International
Accounting Standards Committee studies on the public
sector have focused on the concept of the published
financial statements.
This section seeks to answer two questions:
• What should the published financial statements of a
government look like?
• What are the gains to an LDC from upgrading its
financial statements?
In addition, this section reviews the role of internal and
external audit in the context of government financial
management.
What are the financial statements?
1
Financial statements refer to a set of documents,
recording information on financial transactions over a
period of time, together with a statement of assets and
liabilities at the end of the period. These may be
expanded to include other documents recording the
information in more detail, or in a different manner. In
the case of governments, the period is invariably their
financial year.
This subsection seeks to identify the components of
financial statements that should ideally exist. These are
provided as examples in the annex at the end of this
section.
In government accounting there has always been one
prime financial statement.
The statement of revenues and expenditures (1)
Where government accounts are kept on a cash basis,
this is a cash flow statement. If an accrual or modified
accrual basis is used, then a separate statement should
be added, showing cash movements over the same
period.
A statement of cash flows (2)
Many countries add to this a statement of assets and
liabilities at the end of the period.
A balance sheet (3)
In addition to these major statements, additional
statements may be added, almost at discretion. For
example, the United Kingdom resource accounting
proposals 27/ include two further statements.
Main objective analysis (4)
Output and performance analysis (5)
In addition to these a number of further schedules, eg.
of borrowings, may be included, but the above are
considered the major components of government
financial statements.
2
The entity concept
Fundamental to the concept of the financial statement is
the “entity concept”–that the reporting organization can
be regarded as self-contained with defined boundaries
that are clear to all concerned. This easily applies to a
commercial organization in that most countries have a
legal definition of a company as a separate legal entity.
One definition of an entity is:
A set of resources, (or assets) employed for a common
purpose, and of obligations (or liabilities) incurred in
furtherance of that purpose. The difference between the
money value imputed to assets and liabilities is known
as equity.28/
It is difficult to recognize this as the description of a
government entity. A government has much wider
objectives than those defined above. Its boundaries are
unclear–with municipal authorities, local and district
government, state-owned entities, quasi-governmental
activities, and so on. The definition and limits of
Exhibit 51. Concepts of government and commercial entities compared
To account for an entity, even where there is no “legal
person,” it is essential to be able to define clearly the
boundaries of the entity in order to express assets and
liabilities. Governments sometimes find this difficult
government are likely to vary according to the situation.
It may be that there is a case for a more precise
definition of the limits of government so that it may be
seen as an entity. Certainly this has been done in New
Zealand, but as part of an overall reform of the
government process rather than just to serve the needs
of accounting. Any attempt to create a government
balance sheet must inevitably move towards an entity
concept of government.
The entity concept does not essentially require legal
recognition, but such recognition is certainly helpful to
clarify the process. It exists for companies under British
law, and students will recollect the wonderfully
evocative legal phrase “the veil of incorporation,”
which epitomises the clear distinction between the legal
person of the company and the outside world. Most
other Western-based legal systems have similar
concepts.
because they represent the State, but the assets they
manage are controlled by the government as an
economic entity. One of the problems of the
privatization process has often been achieving such a
 3

definition, which it has not been necessary to clarify
when the entity was simply an arm of government. This
is even more difficult for the government as a whole.
The entity concept links to the importance for private
commercial organizations of measuring period profit,
since this is the prime measure of success, and profit
determines the capability to pay dividends and taxation,
and also share value. Much of commercial accounting is
concerned with identifying changes in assets and
liabilities over time, and hence calculations of
profitability.
Governments have a very different focus on the budget
flows, as indicated above. Indeed cash-based budgeting
and accounting does not require any identification of
assets and liabilities. In traditional government budget
and accounting systems, assets and liabilities have not
been recognized. Where they have to be accounted for,
eg. loans and advances, such traditional systems have
added so-called “below-the-line” accounts, to indicate
that assets and liabilities are not part of the budget.
As long as a government accounting system remains
cash-based, this creates no problems for classification.
However, any move to an accrual accounting base
requires the establishment of asset and liability
accounts, and the concept of government as an entity
with defined boundaries.
Elements of financial statements
A major study by the International Accounting
Standards Committee provides an analysis of the
elements of financial statements in the public sector.
This is a fairly narrow study, in that it appears to focus
primarily on relating government to commercial
financial statements. Nevertheless, it provides some
interesting insights into the nature of government
financial statements. This subsection will review the
concepts as developed within that study, and then go on
to consider their relevance to government financial
management. The following analysis is based on the
IASC study, with actual quotations shown in italics.
The IASC paper defines the objectives of financial
reporting, as set out below.

Exhibit 52. Objectives of financial reporting 29/

Financial reporting should demonstrate the accountability of government (or government

unit) for the financial affairs and resources entrusted to it, and provide information
useful for decision-making by:

Indicating whether resources were obtained and used in accordance with the legally adopted budget.
Indicating whether resources were obtained and utilized in accordance with legal and contractual
requirements, including financial limits established by appropriate legislative authorities.
Providing information about the sources, allocation and uses of financial resources.
Providing information about how the government or unit financed its activities and met its cash
requirements.
Providing information that is useful in evaluating the government’s or unit’s ability to finance its
activities and to meet its liabilities and commitments.
Providing information about the financial condition of the government or unit and changes in it.
Providing aggregate information useful in evaluating the government’s or unit’s performance in terms
of its service costs, efficiency and accomplishments.
The elements of the financial statements will depend on the accounting basis. The next exhibit provides an analysis.
4
Exhibit 53. Elements of financial statements under different accounting bases
Basis of accounting
The cash basis of accounting recognizes
transactions and events only when cash has
been received or paid.
A statement of receipts and payments (or
expenditures) is prepared to disclose
information about cash flows during a period
and cash balances at the end of that period.
The full accrual basis of accounting is geared
towards recognizing the financial effects of
transactions and events in the periods in which
they occur, irrespective of whether or not cash
has been received or paid.
It reports on the economic resources or service
potentials (assets) and obligations (liabilities)
of the entity, and changes therein. It requires
the capitalization of expenditures on the
acquisition of all capital assets and the
depreciation of those assets as their service
potential is consumed.
Elements of financial statements
Cash receipts.
Cash disbursements.
Cash balances.
Receipts and disbursements will include cash
inflows and outflows from taxation; loans and
grants from external donors; the provision of
goods and services; the purchase and sale of
plant, equipment and investments; and
borrowings and other financing transactions.
The full accrual basis of accounting will
recognize all assets, liabilities, revenues and
expenses (including depreciation) of the entity.
Presentation in financial statements
Classified to highlight major components, or
sources of cash inflows and cash outflows; and
the extent to which cash balances have been
dedicated for particular uses, or relate to the
provision of certain services or the acquisition
of certain types of assets.
For example, financial transactions involving
loan receipts and disbursement may be
classified separately from other transactions.
Capital outlays and development expenditures
may be segregated from other expenditures.
Particular components or characteristics of
each of the elements may be highlighted by
sub-classification. For example, assets may be
classified as current/non-current and/or on the
basis of the functions they serve or the types of
services they provide. Similarly, revenues and
expenses may be classified on the basis of
particular activities or programmes and/or by
type of revenue or expense (for example,
taxation revenue, user charges, salaries and
wages and depreciation).

Basis of accounting
The modified accrual basis approximates to
the accrual basis of accounting, where the
model lies on the spectrum between cash and
full accrual accounting, and therefore the nature
of the elements which are reported will depend
on the nature and extent of the modifications.
Usually expenditure on capital items is
expensed when it occurs.
The modified cash basis approximates to the
cash basis of accounting. Comments as above.
5
Elements of financial statements Presentation in financial statements
A common modification to full accrual Similar to full accrual accounting, but capital
accounting is to exclude physical assets. The assets will be expensed when acquired, and
elements of the financial statements will then hence not show in balance sheet.
be:
$ Liabilities;
$ Revenues;
$ Assets which are
available to meet
liabilities as they fall
due (financial assets);
$ Expenditures on the
acquisition of assets for
use in the provision of
goods and services
(including capital
assets).
A common modification to cash accounting is The financial statements will highlight current
to include in the financial statements or short-term financial resources and changes
information about those transactions and events therein during the reporting period.
which will result in cash receipts or
disbursements within a short period
immediately following year-end, as well as
information about cash flows and cash
balances. The elements of the financial report
then encompass:
Cash flows during the period; and
Some receivables and payables.
6
Reporting models
Adoption of a particular basis of accounting does not
require the preparation of any particular set of financial
statements, nor does it mandate the configurations to be
adopted for display of financial information.
The argument is that the reporting model is independent
of, and can be disengaged from, the basis of accounting,
but this is only partly true. If information does not exist
because of the system of accounting, for example on
capital assets and depreciation, it cannot be included in
the financial statements. However, what is correct is
that the financial statements can be supplemented by
other statements showing additional information, eg.
cash-based accounts could be supplemented by a
statement of borrowings.
Generally, the most comprehensive reporting model is
provided by full accrual accounts. However, this does
not provide information about non-financial objectives
and performance, which will have to be provided by
additional statements. Nevertheless, decisions regarding
the reporting model should take into account users’
needs and the producers’ capabilities; accounts should
be simple and as clear as possible.
Decisions regarding the reporting model to be
adopted, and the relationship between financial
statements, notes thereto and supplementary
schedules should be made after consideration of
such factors and the particular “messages” to be
highlighted and users’ ability to understand the
financial statements. Such should also be
conditioned by a concern to reflect, in an unbiased
manner, complex transactions and events.
Characteristics of elements of
financial statements
Assets
An asset is defined by the IASC as follows:
An asset is a resource controlled by the enterprise
as a result of past events, and from which future
economic benefits are expected to flow to the
enterprise. 30/
Under a modified accrual or cash basis of accounting
some assets, as defined above, would be recognized.
Under the cash basis of accounting, the only asset
recognized will be cash. Under full or modified accrual
accounting, at a minimum, all financial assets should be
recognized.
In applying the IASC definition of assets to
governments and non-business public-sector entities,
service potential should be interpreted to encompass the
delivery of services and programmes rather than only
the generation of cash inflows.
The concept of service potential that an asset should
possess if it is to be reported in the financial statements
under different bases of accounting will therefore
depend on the message to be communicated by the
financial statements and the objective of financial
reporting. For example, if the objective of financial
reporting is:
• Compliance with financial regulations during the
reporting period, then assets reported in the financial
statements should be limited to cash or near cash
equivalents;
• Evaluation of a government’s financial condition,
and changes therein during the reporting period, then
the financial statements should report cash and other
resources on hand and available to finance the
government’s activities and meet its liabilities and
commitments;
• Accountability for all the resources that governments
control, and changes in those resources during the
reporting period, then the financial statements should
report assets that assist the entity in achieving its
objective, whether that objective is to generate
positive cash flows or to provide needed goods and
services consistent with government priorities. The
concept of service potential would therefore
encompass physical as well as financial assets.
Therefore the assets included in financial statements
depend on the objective of such statements.
As governments move along the spectrum from
cash towards accrual accounting the messages
communicated by their financial statements will
change, and those statements will evidence
accountability for more of their assets. In such
circumstances, the importance of developing
agreed, well understood definitions of assets for
governments and other public sector entities
increases. As the range and complexity of the
transactions and events that are “captured” by
financial statements increases, the relevance and
reliability of financial reports are increasingly
dependent on the consistent application of such
definitions.
However, adoption of the IASC definition of assets will
raise a number of issues not yet confronted by many
governments. These will include:
• Whether governments or other public-sector entities
should be accountable for the assets they own, or the
assets they control, and how ownership or control

should be defined;
• Whether plant, equipment, buildings, infrastructure
assets (such as roads, parks, libraries), State-run health
centres, monuments and historical treasures should be
recognized in the financial statements. These provide
services to beneficiaries, and are therefore assets within
the IASC definition. However, in many cases, the
purposes for which they can be used and their
availability for liquidation to meet liabilities are
restricted.
Liabilities
The IASC definition of liability is as follows:
A liability is a present obligation of the enterprise
arising from past events, the settlement of which is
expected to result in an outflow from the
Exhibit 54. Liabilities recognized under different bases of accounting
Accounting
basis
Liabilities
recognized
Liabilities may be limited to those obligations which are
legally enforceable, or may encompass all present
obligations which are “expected” to be settled in the
future (as in the IASC definition), ie. equitable or
constructive obligations. Therefore, depending on how
liabilities are defined, different transactions and events
may be recognized in the financial statements as
liabilities under all forms of accrual accounting.
Most obligations are legally enforceable in that they
stem from legally binding contracts or are imposed by
legally authorized bodies or government statute.
Examples of obligations arising from contractual
arrangements include amounts borrowed, amounts due
for asset purchases and amounts owed for obtaining the
services of labour.
Equitable or constructive obligations arise from normal
practices, from custom and from a desire to maintain
good relations with the public or to act in a fair and just
7
enterprise embodying economic benefits.31/
Adoption of different bases of accounting results in
differences in the liabilities which are recognized in the
financial statements. Moving from cash towards full
accrual accounting results in obligations which will be
settled further into the future and recognized as
liabilities. For example, under a pure cash basis of
accounting, no liabilities are recognized; under a
modified cash basis of accounting, only those
obligations to be settled in a nominated period from the
reporting date will be recognized as liabilities; whereas
under forms of accrual accounting, obligations to be
settled in the longer term, such as employee pension
entitlement and other post-employment benefits, may
be recognized as liabilities.
manner. If liabilities were not to be limited to legally
enforceable obligations, the amounts expected to be
expended in accordance with the government’s policy
in relation to disasters which have occurred would
constitute obligations which could be reported as
liabilities. In the absence of a clear legal responsibility
in respect of such matters, the existence of a present
obligation would be assessed on the basis of available
evidence.
Net assets
A balance sheet may be prepared under all of the cash,
accrual, modified accrual or modified cash bases of
accounting. Its contents depend on the basis of
accounting, as will the residual surplus of assets over
liabilities (or vice versa) as illustrated below.
8

Exhibit 55. Net equity under different bases of accounting

Basis of accounting Nature of balance sheet Composition of net equity

Cash basis Financial assets and liabilities and
certain other assets and liabilities in
below-the-line accounts
Modified accrual basis Full balance sheet excluding fixed
assets
Accrual basis Balance sheet which would disclose
information about assets and liabilities
Consolidated fund equals net financial
assets and other below-the-line
accounts
Consolidated fund is net assets
excluding fixed assets and certain
liabilities
Consolidated fund equivalent to
company concept of net equity

Under the full accrual basis of accounting, the change in • Recognize sales tax as revenue when the sale is made,
net assets over a reporting period is a financial measure
when the tax is payable or when the tax is paid.
of the change in the capacity of the government (or other
entity) to provide goods and services in the future, It is our view that in most cases it is not feasible to
whether that change flows from the consumption of recognize tax and similar income until the liability has
existing service potential, a reassessment of the value of
been accepted by the paying party. This is because tax
service potential or the acquisition and/or disposal of
certain assets. assessments are much more likely to be reduced than
increased, and to base revenue on estimates would
Revenue/income, expenses and expenditure systematically over-estimate revenues.
Expenses and expenditure are defined by the IASC as
The IASC definition of revenue/income is as follows:
follows:
Income is increases in economic benefits during
Expenses are decreases in economic benefits during
the accounting period in the form of inflows or
the accounting period in the form of outflows or
enhancements of assets or decreases of
depletions of assets or incurrence of liabilities and
liabilities that result in increases in equity,
that result in decrease in equity, other than those
other than those relating to contributions from
relating to distributions to equity participants.
equity participants.
Under the cash basis of accounting, appropriate
Under most bases of accounting, the core of items
classifications of cash outflows will enable users to
recognized as revenue, or cost recovery, will be
distinguish between those cash outflows which relate to
common. They will include taxes, fines, fees and
the provision of goods and services and those which relate
other imposts, user charges, investment income and
to the repayment of debt or the acquisition of assets.
windfall gains. In addition, LDCs are likely to receive Adoption of a modified cash or modified accrual basis of
substantial inflows in the forms of grants and accounting would result in the reporting of a wider definition of
commodity aid. The timing of recognition of items as expenses than under the cash basis. In particular capital
revenue under cash accounting will be only in the expenditure would be spread over the life of the asset through
financial statements in the period in which cash is depreciation under a full accrual basis.
received, but under many forms of accrual and
Accountability
modified accrual accounting, revenue will be
recognized in the period in which the transaction or Accountability is a function of the accounting basis. The
event giving rise to the increase in resources occurs. different forms of accountability are summarized below.
Therefore, the basis of accounting adopted will
determine whether, for example, a government
would:
• Recognize income taxes as revenue when income
is earned by the taxpayer, when taxes are due and
payable or when taxes are received; or
 9

Exhibit 56. Accountability under different accounting bases

Cash basis Recognizes cash flows and cash Relevant for the “compliance” aspect of
balances as the only elements of accountability (demonstrating compliance with
financial statements. The modified cash regulations and budget)
basis of accounting recognizes amounts Unlikely to reflect the costs of service delivery
receivable and payable within a or the results of resource management
nominated period from reporting date as Unlikely to provide sufficient information for
well as cash flows during the reporting an assessment of the economic condition of an
period and cash balances as at the end of entity and its efficiency in allocating and
the reporting period managing scarce resources for the achievement
of service delivery objectives
Modified accrual Recognizes liabilities, financial assets, Highlights the extent to which the results of
basis revenues, expenditures and net assets as activities during the current period have
the elements of financial statements enhanced or eroded the government’s ability to
meet its liabilities and future activities from
financial assets
Full accrual basis Recognizes assets, liabilities, revenues, May identify financial assets available to meet
expenses and net assets. Financial liabilities. However, statements constructed to
statements prepared consistent with this disclose revenues and expenses will not report
basis will report on the costs of services cash flows (as under the cash basis) nor
provided during the period, the extent to highlight whether, as a result of the period’s
which those costs were recovered from activities, the entity’s ability to meet its
revenues generated during the period liabilities and fund additional activities from
and the sources of those revenues and financial assets has been enhanced or eroded
the resources controlled during the
period

While the accrual basis is most appropriate for reporting
on resources controlled, cost efficiencies and cost
recoveries, it may not be if other objectives are
determined to be primary, for example, if reporting on
costs is relatively less important than reporting on cash
receipts and disbursements.
Financial statements in the context of
financial management
The above sections have analyzed financial statements
of governments, and considered how financial
information can be presented, particularly in the context
of the accounting base adopted. However, this has not
addressed the fundamental questions.
• What should the published financial statements of a
government look like?
• What are the gains to an LDC from an upgrading of
its financial statements?
In answering those questions, the objectives and
purpose of financial statements have to be identified.
Exhibit 52 sets out the objectives of financial reporting
according to the IASC. These divide into a retrospective
analysis of government financing and a performance
analysis of the enterprise.
The focus of the IASC study has been on how the
conventional financial statement format of commercial
entities can best be adapted to meet the needs of
government financial statements. However, it must be
recognized that conventional financial statements are
fundamentally unsuited to attempts to measure
government performance. This is because government
accounting models are one-sided. It is therefore not
feasible for conventional financial statements to provide
more than an explanation of income and
expenditure–they provide no measure of outputs.
Financial management is essentially concerned with
using financial tools to achieve managerial objectives
relating to resource allocation and management. It is
difficult to see how conventional financial statements
can make more than a marginal contribution to this
process. However, if they could be integrated with
output, or performance measures, then they would
become a valuable historic measure of achievement,
which could be used to provide quantifiable output
10
objectives, and hence improve performance.
Incorporating non-financial objectives within
financial statements
From the above it would seem fundamental that if
financial statements are to be developed as significant
tools in government financial management, whether of
LDCs or generally, then output and performance
measures must be incorporated within the system. They
become not just optional additional statements, but
fundamental components of the financial statements.
The resource accounting method being adopted in the
United Kingdom provides an approach to this issue.
Under it there will be five statements.
• Operating cost statement;
• Cash flow statement;
• Balance sheet;
Treatment of Exhibit
capital 57.
assets fixed assets contributes to better government
Financial statements/performance analysis in financial management cycle
One of the persistent problems facing public-sector
accounting is the treatment of capital (or fixed) assets.
In the private sector, the system of depreciation is
needed to provide a measure of annual profitability for
purposes of calculating taxation and distributions.
Management writers have long recognized the
irrelevance of depreciation in any decision process, and
textbooks are replete with phrases such as “ignore sunk
costs and past expenditure.” Indeed, several theoretical
studies of financial reporting in the private sector32/
have advocated moving away from depreciation, and in
practical terms this is reflected by an increasing
emphasis on cash-flow reporting.
It is difficult to see how capitalizing expenditure on
• Main objective analysis; and
• Output and performance analysis.
This coincides with the financial statement analysis on
page 77. It adds two key documents to those considered
in the IASC paper, which meet the need for an analysis
based on relating financial performance to non-financial
performance indicators. A format of financial
statements for governments based on this approach, but
adapted for LDCs, is set out on pp. 90-93.
This approach turns the financial statements into a
valuable feedback document within the financial
management process. They can be seen as linked into
the budget accounting cycle, as indicated in Exhibit 57,
below. Note that this exhibit only indicates the link to
other system components.
management, indeed quite the reverse. Managers may
find their current activities constrained by capital
expenditure decisions made many years before, still
charged to their operating cost statement, yet which
should be irrelevant in any decision process.
Assets and liabilities under the GFS approach
The classification of assets and liabilities within the
GFS and SNA appears very different from that used for
commercial entities, since it focuses on the distinction
between financial and non-financial assets. Commercial
entity classification of assets and liabilities focuses on
their nature and liquidity. Exhibit 58 compares the GFS
classification to that used for commercial entities.
 11

Exhibit 58. Assets and liabilities B alternative classification approaches

COMMERCIAL ENTITY CLASSIFICATION APPROACH GFS CLASSIFICATION APPROACH
Fixed assets Assets
Produced assets, eg. equipment, buildings $100 Non-financial
Non-produced assets, eg. land $70 Produced
Intangible assets $50 Fixed assets $100
Total fixed assets $220 Inventories $60
Current assets Total produced $160
Inventories $60 Non-produced

Accounts receivables, eg. taxation $40 Land $70

receivable
Financial assets, eg. loans, securities $80 Intangible $50
Cash and bank balance $20 Total non-produced $120
Total current assets $200 Total non-financial $280
Total assets $420 Financial
Acquired for policy $75
Acquired for liquidity $65
management
Total financial assets $140
Total assets $420
Current liabilities
Accounts payable $30
Short-term loans and other financial $50
liabilities
Total current liabilities $80 Liabilities
Net current assets $120 Domestic $180
Fixed assets + net current assets $340 Abroad $110
Long-term liabilities Total liabilities $290
Long-term borrowings $210 Net financial worth –$150
Net worth $130 Net worth $130

Note that both models arrive at the same net worth, but
involve significantly different approaches to classifying
and analyzing the assets and liabilities. The commercial
entity model emphasizes the purpose for which the
asset is held, and the liquidity, and for liabilities focuses
on liquidity. The GFS model focuses on the relevance
of the assets and liabilities to national economic
management.
Both models provide useful information for different
purposes. The commercial entity model can be applied
to government, and is particularly relevant for relating
assets to flows and their related costs for sub-units of
government. On the other hand analysis under the GFS
model is also essential. Therefore the classification
system for government needs to be able to provide
analysis under both models.
The analysis above is included in outline only.
Significantly more detail of the make-up of the assets
and liabilities would be required for both analytic
models. If suitably designed a single classification
system could be used to aggregate and present data
according to either model.
Benefits of financial statements
To introduce financial statements on the lines indicated
would involve considerable effort in most LDCs. The
benefits clearly relate to the form of financial
statements. The matrix below relates the benefits to the
contents.
12

Exhibit 59. Benefits of financial statements

Type of financial statement Benefits Costs

• Simple cash operating
statement
• As above, but with simple
balance-sheet-based
modified accrual basis
showing current financial
assets and liabilities
• As above, but based on full
accrual basis including
capitalized assets and
depreciation charges
• As either (2) or (3) above,
with additional statements
relating financial
performance and
non-financial performance
indicators
Limited–a historic record of Minimal–normal system outputs
expenditure against budget for future
analysis and basis of forecasts.
However, use of detailed
supplementary statements can enhance
usefulness
Considerable–provides a mechanism Can normally be achieved without
for controlling assets and liabilities, major reorganization of the
which are frequently a major accounting system. However, first
accounting problem. Also provides a attempt requires considerable work to
“lock” on the accounting system’s ascertain opening balances
reliability
Opinions differ on the value of the Substantial. Accounting system would
additional information. Does provide normally have to be completely
information on total assets used and changed. Also major task of valuing
spreads costs more equitably. all assets
However, doubtful if depreciation or
other systems of capital charging
reflect the real cost of assets consumed
Considerable–for the first time begins Substantial–requires a redesign of the
to provide an output measure related to whole planning, budgeting and
financial inputs in government. monitoring process to incorporate
However, value depends on ability to specific monitorable targets.
set meaningful non-financial
indicators, and the reliability of
monitoring information.

It must be recognized that this is an area in which there
is as yet no broad consensus on the benefits of different
types of financial statements.
Conclusions
There are important decisions to be made by LDCs and
those involved in upgrading financial management
systems. To what extent should efforts be focused on
developing financial statements, rather than other areas
which require improvement?
• All countries should at least produce an operating
cost and revenue statement, suitably presented
compared to budget and to previous years, as a
historic record and basis of future forecasts;
• Adding a simple balance sheet, in addition to
operating cost statements, is nearly always
· worthwhile, if only for the extra reliability it
adds to the financial statements;
• For LDCs it is very doubtful indeed if the cost of
creating a full accrual balance sheet including fixed
assets is going to make it a worthwhile exercise;
• Ideally, all LDCs should aim for performance
statements comparing financial performance against
non-financial indicators. However, this is feasible
only after the budget has been developed so that
monitorable performance targets are set as a matter
of routine for all government activities.
Annex. Format of financial
statements
The statements that follow are based on those in the
United Kingdom paper33/, but modified so that they may
become a suitable model for LDCs.
 13

Statement 1 – BALANCE SHEET

FIXED ASSETS (1)
Tangible non-financial 3,000
Intangible assets 1,500
Financial capital assets 500
Public enterprises 1,000
Other investments and loans 500
6,500
CURRENT ASSETS (2)
Stocks and inventory 300
Debtors (amounts receivable within 1 year) 900
Financial current assets 800
Cash at bank and in hand 500
2,500
CURRENT LIABILITIES (3)
Short-term financial liabilities 200
Creditors (amounts payable within 1 year) 400
600
NET CURRENT ASSETS (4) = (2) – (3) 1,900
FIXED AND NET CURRENT ASSETS (5) = (1) + (4) 8,400
BORROWINGS (6)
Domestic 2,000
Foreign 3,000
5,000
NET ASSETS (7) = (5) – (6) 3,400
CONSOLIDATED FUND (8)
Opening balance 2,445
Add: surplus from operating statement 955
Closing balance (= 7 above) 3,400
14

Statement 2 – OPERATING COST AND REVENUE STATEMENT

REVENUES
Domestic income
Tax revenues (detail in subsidiary schedule) 1,800
Fees, licences and other income (detail in subsidiary schedule) 450
Miscellaneous items (detail in subsidiary schedule) 350
Total domestic income (1) 2,600
Foreign income
Foreign grants 1,500
Other foreign income 200
Total foreign income (2) 1,700
Total income all sources (3) = (1) + (2) 4,300

EXPENDITURE
Personnel and associated salary costs 1,900
Non-personnel recurrent costs 250
Depreciation (or capital expenditure if on cash basis) 500
Net transfers to/from public enterprises 450
Grants and subsidies 245
Total expenditure (4) 3,345

DEBT SERVICE COSTS

Interest paid
Domestic 200
Foreign 300
Total interest paid (5) 500
Interest received
Domestic 230
Foreign 270
Total interest received (6) 500
Net interest costs (7) = (5) – (6) –
NET REVENUE SURPLUS/DEFICIT (8) = (3) – (4) – (7) 955
 15

Statement 3 – CASH FLOW

CURRENT EXPENDITURE
Net revenue surplus/deficit (as per Statement 2) 955

CURRENT RESOURCES
Adjust for movements in working capital other than cash –400
Adjust for non-cash transactions:
Depreciation 500
100

NET CASH FLOWS FOR CURRENT EXPENDITURE 1,055

CAPITAL EXPENDITURE
Additions –900
Disposals 250

CAPITAL EXPENDITURE CASH FLOWS –650

NET CASH FLOW 405

FINANCING
Net lending flows
Domestic 600
Foreign –400
Loans to other public sector bodies 200

NET CASH INFLOW FROM FINANCING 400

CHANGE IN CASH AND CASH EQUIVALENTS 805

16

I
Statement 4 – MAIN OBJECTIVE ANALYSIS
MAIN OBJECTIVE 1 (specified in narrative)
Direct support to district authorities 1,200
Direct support to other public bodies 805
2,005

MAIN OBJECTIVE 2 (specified in narrative)

Direct support to district authorities 320
Direct support to other public bodies 420
740

MAIN OBJECTIVE 3 (specified in narrative)

Direct support to district authorities 120
Direct support to other public bodies 230
350

MAIN OBJECTIVE 4 (specified in narrative)

Direct support to district authorities 120
Direct support to other public bodies 130
250

TOTAL AS PER STATEMENT 2 3,345

Statement 5 – OUTPUT AND PERFORMANCE ANALYSIS

Plan/Target Achieved
Cost Cost
Output [currency] Output [currency]
million million
Main objective 1
For example:
To improve quality of A 2% improvement 35 2.5% improvement 34
To draft new legislation on B 31 December 1998 15 15 January 1999 16
To test C Daily 24 6 out of 7 days 25
To detect and prosecute D 2,000 detections 40 2,100 detections 40
190 successful 18 175 successful prosecutions 18
prosecutions
 1

VIII. INTERNAL AND EXTERNAL AUDITING

Introduction
Historically, auditing is the process of examining
financial transactions and activities, and related assets
and liabilities, with a view to presenting some form of
report. Audit of commercial activities has become a
very well-defined activity, and leads to an expression of
opinion on the financial statements (“certification
audit”).
Nowadays the term is used in a variety of contexts, so it
can extend beyond financial audit to “operational”
audit. In fact, the term “audit” can refer to a range of
activities, with distinctly different objectives. Also audit
subdivides into internal and external. The possible
range of activities and objectives is summarized below.

Exhibit 60. Audit overview

EXTERNAL INTERNAL AUDIT

Independence a Independence not a

fundamental concept fundamental concept

Report to external Report to internal

users, eg. Parliament users, eg. managers
Compliance audit
Objective of
ensuring
compliance
Certification with Performance Operational audit
audit regulations and (VFM) audit Objective of
Objective of procedures
This model highlights the overlap between the activities Objective of
fundamental distinction between improving
internal and external
expressing
of internal and external audit. In many LDCs these are improving performance
audit lies in reporting responsibility of
and the relevance
confused andopinion
work onand roles duplicated. The of financial
the concept of independence.any activity
financial performance
Internal audit
statementsIs part of management process, and reports to Cannot be independent since part of
senior management management

External audit Reports to the ultimate owner, ie. the Must be independent – often provided under
shareholders of a company or the public for the constitution
the Government

Because of the importance of the concept of
independence, it is not possible to “integrate” external
audit within financial management. External audit is a
subsystem within the financial management system, and
can be linked to other subsystems, but must remain
independent. Internal audit, on the other hand, is part of
the management process. Hence it can be integrated
within a financial management system.
A brief description is provided below of the types of
audit activity in the above model.
2
Certification audit Under this activity, the auditor “certifies” the financial statements of an entity, ie. he
expresses an opinion on them. This has always been the primary role of the commercial
auditor, but in government this type of opinion is a relatively recent introduction.
Compliance audit The auditor examines financial transactions to ensure that they comply with regulations,
procedures and standards of propriety. This has historically been the main focus of
government audit, both internal and external. In some countries the audit has become
inextricably linked with accounting operations, and independence has been lost.
Performance, or The auditor examines activities, both financial and other, to see whether they could have
value-for-money, been performed more efficiently, and hence value for money improved. The object of
audit this type of audit is to improve financial performance.
Operational audit An extension of performance audit, but the focus moves completely away from financial
activities and performance of the government.

The relevance of these types of audit to financial
management is further reviewed below.
External audit of government
Historically, the external audit of central government of
any country has been perceived as an important
function, carried out by a supreme audit institution
(SAI), eg. the United States General Accounting Office
or the Auditor General of New Zealand. Where there is
a written constitution, the role and authority of the SAI
is usually specified. Such SAIs have developed quite
separately from commercial audit and are normally
staffed by civil servants.
An external audit, often referred to as a statutory audit,
has been described as “the independent examination of,
and expression of opinion on, the financial statements
of an enterprise, by an appointed auditor in pursuance
of that appointment and in compliance with any
statutory obligations.” The emphases have been added
to highlight their importance.
Independence from others in terms of authority, control
or influence is regarded as the fundamental requirement
for an auditor. Without it, it is difficult for auditors to
be objective in their work and therefore maintain their
credibility with users of the audited financial
statements. It is axiomatic that unless the auditor
expresses an opinion (reports on his findings), the
reasons for an audit are invalidated, since the results are
not available for inspection. The nature of the report
and the audit itself will depend upon the regulatory
framework governing the audit process and may vary
with the type of organization. Limited-liability-
company auditors, for example, are usually required to
report whether the accounts show a true and fair view,
while within the public sector the statutory duty of an
auditor may be as broad as reviewing the performance
of the entity or restricted to a statement as to whether or
not expenditure has been made in accordance with the
regulations. What therefore distinguishes the audit
approach in the public and private sectors is simply the
statutory basis on which the audit is conducted.
For many years, government auditing was restricted to
an assessment of whether the transactions complied
with the financial rules and orders laid down by
government, and in many developing countries this is
still the case. In recent years, however, there have been
a number of changes in government auditing which
have imposed additional responsibilities on government
external auditors. The most important of these are the
moves to verification audit and the development of the
“performance audit,” sometimes referred to as the
“value-for-money” (VFM) audit, with its emphasis on
securing economy, efficiency and effectiveness in an
organization’s operations. This is in line with the more
modern view which sees government accounting and
budgeting as part of an integrated system which focuses
on accountability and the provision of financial
information to management. The audit process in
government is becoming one of the most important
aspects of the system by providing useful information
for planning and control purposes. This contrasts starkly
with the private sector, where the audit is regarded as a
certification process which does not require any
comment by the auditor on the entity’s performance–the
users of the financial statements are, in effect, left to
draw their own conclusions.
A comparison between government and commercial
external audits is summarized below.

Exhibit 61. Audit comparison
Audit area Government audit
Certification audit Certification of accounts produced by
the government
Compliance audit Compliance with government rules and
regulations
Performance audit To ensure efficiency, effectiveness and
economy in government activities
As indicated above, external audit in government is by
definition independent, and hence cannot be part of the
financial management process. However, the three
types of external audit all serve to enhance the
performance of the financial system, and thus contribute
positively to the financial management process.
Internal audit
It is the experience of the writers that in many LDCs
there is a lack of clarity about the role of internal audit.
As a result it has become a duplicate of external audit,
but controlled by the finance ministry rather than the
supreme audit institution.
Internal audit is part of the management process, and
hence it should be controlled by the managers. In
government these are generally the heads of
departments or ministries. Any central direction to
internal audit should be in setting standards, providing
training and creating operational documentation.
Internal auditors are employees of the organization.
They are responsible to management and their duties
may be determined by management. The internal
auditing function is no longer restricted to one of
merely checking the arithmetic accuracy of the records
or the efficiency of the system of internal control.
Internal auditing is now regarded as including a service
element whereby the auditor can assist the organization
through an examination and evaluation of its activities.
The rationale underlying this thought is that the internal
auditors’ access to all parts of the organization enables
them to perform a wider role. This is not limited to the
narrow field of compliance but is concerned with
promoting efficiency in policy implementation. It is
therefore important for the internal auditor to be given
the necessary status and authority to carry out these
functions and for reports to be made directly to senior
government officials who can act on the
recommendations. It is not, however, the auditor’s
responsibility to make and implement decisions which
change the current operations; their task is one of
reporting and recommending.
The additional responsibilities placed on internal
3
Commercial audit
Certification of annual financial
statements
Not normally part of the audit function
to ensure compliance with any rules
other than in respect of financial
statements
Not part of the audit function
auditors require the acquisition of new skills. No longer
is internal auditing merely a matter of checking whether
transactions have been processed in the prescribed
manner. Internal auditing is a positive process which
requires an investigative and innovative approach to the
problems of government. The opportunity now exists
for auditors to play a positive role in improving the
performance of government departments. The
performance audit is one way in which the problem can
be tackled.
The performance audit
The theme of “value for money” is central to the
performance audit, which seeks to reduce extravagance
and waste in government departments by improving
their efficiency and economy in the acquisition and use
of resources. Performance audits may be required under
statute (external audit), or organizations may
voluntarily institute the process (internal audit) to
improve efficiency.
The object of the performance audit is to report on the
extent to which the organization maximizes the service
potential (outputs) from its resources (inputs). In
practice it involves an analysis of the 3 Es (efficiency,
effectiveness and economy) which are defined as
follows:
• Εφφιχιενχψ: τηε ρατιο οφ ρεσουρχεσ χονσυµεδ
το ουτπυτ;
• Effectiveness: an assessment as to how well the
output is achieving the desired results;
• Economy: appropriate resources at the minimum
cost.
The performance audit is a valuable tool for control and
performance evaluation within government. There are,
however, difficulties in its implementation because of
the intangible nature of many government outputs. For
example, it is not easy to give precise meanings to
qualities such as health, welfare and education,
particularly when the benefits may be spread over time
and may also arise in a number of different areas
(externalities).
4
Despite the difficulty of setting performance indicators,
this is a worthwhile task. The principal methods
adopted have employed a wide range of measures
including indices and indicators which provide
information for both historical (time-series analysis)
and comparative (cross-sectional analysis) perspectives
of the results. The approach is not without its problems
in determining relevant measures of performance for
Exhibit 62. Audit objectives and performance indicators
service industries; it requires careful thought and often
some ingenuity in order to arrive at appropriate
measures–but it can be done. The Nepalese Drinking
Water and Sewerage Corporation (DWSC), for
example, set the following objectives and performance
indicators:

Objectives Performance indicators

To process more water
To rectify the biological and
chemical quality of water
To reduce unreliability of
water supplies
Annual quantity of water produced
Number of reservoirs
Number of treatment plants
Quantity failing to comply with biological standards
Quantity failing to comply with chemical standards
Number of customers without water for 12 hours or
more
Percentage of severe cut-offs
Percentage of severe pressure deficiencies

Altogether the DWSC indicated 14 objectives and
produced 39 performance indicators.
Overview of the role of auditing in
the integrated financial management
approach
The above discussion indicates that the work of the
external auditor is often dictated by statute. Unless the
law includes specific provisions relating to performance
audits, it is doubtful that external audits will provide
much useful information for the financial management
process, beyond an assessment of the existing financial
controls and whether they will be appropriate in the
future.
Where, however, the auditor (either internal or external)
is required to undertake a performance audit, positive
advantages can accrue within the financial management
process. Planning and control are two important aspects
of financial management in government. The
performance audit provides information which will be
useful for both of these activities.
5
• Γοϖερνµεντ περφορµανχε αυδιτσ αρε διρεχτεδ
τοωαρδσ ιµπροϖινγ εχονοµψ, εφφιχιενχψ ανδ
εφφεχτιϖενεσσ ωιτηιν τηε εχονοµψ. Βψ δεφινιτιον
τηισ ωιλλ βε ιν τηε φυτυρε ανδ τηε αυδιτ
ρεχοµµενδατιονσ ωιλλ τηερεφορε προϖιδε αν ινπυτ
ιντο τηε πλαννινγ ανδ βυδγετ προχεσσεσ;
• Control is the process by which officers seek to
direct their efforts towards the attainment of
government’s goals. It cannot be exercised without
(i) feedback as to the actual events; and (ii) a plan, or
desired state, to compare with. Performance audits
provide this information, together with an indication
of the deviations between budgeted and actual
performance.
Conclusions
The conclusion that emerges is that, while external
audit must remain independent, internal audit can be
part of the financial management process. Of particular
relevance in this respect is compliance audit. By
ensuring compliance with prescribed regulations and
procedures, internal audit reinforces the moves to
integration of the different aspects of financial
management.
6

IX. IMPACT OF INFORMATION TECHNOLOGY
Introduction
Information technology–computerization–is a tool of
financial management. In itself it does not add anything
to the procedures and approaches described above, but
rather it is a mechanism for recording, processing and
presenting the information.
However, although the above statement is accurate, it is
in many ways too narrow a view of the impact of the
new changes in information technology. This is because
developments in information technology:
• Χηανγε dramatically the cost/benefit balance of
providing information and analysis, so that for LDCs
it has now become economically feasible to have
modern high-quality financial management systems;
• Create for the first time the ability to establish
systems in environments where the surrounding
organizational and human infrastructure is weak; and
• Προϖιδε Λ∆Χσ ωιτη τηε οππορτυνιτy to make a
“technology leap”–moving directly from manual or
simple mechanical systems to the most modern
information technology, making use of low-cost
high-performance computers and user-friendly
software.
Each of these aspects is reviewed below, before
proceeding to a more technical review of applying
information technology to financial management in
LDCs. The section then reviews issues relating to the
suitability of computers for LDCs, and the problems of
sustainability.
Changes in the cost-benefit balance
Accounting and financial management systems require
the use of scarce resources, and are therefore expensive
to establish and maintain, despite the low labour costs
in most LDCs, because:
• Λαβουρ χοστσ αρε νοτ λοω ιν ρελατιον το τηε
λιµιτεδ βυδγετσ οφ Λ∆Χσ το σετ υπ µανυαλ
φινανχιαλ µαναγεµεντ σψστεµσ ρεθυιρεσ τηε
υσε οφ µανψ περσονσ, ωιτη α ρεαλ βυδγετ
ιµπαχτ ωηιχη ισ διφφιχυλτ φορ µοστ Λ∆Χσ το
φινανχε;
• Τηε σορτ οφ λαβουρ ρεθυιρεδ ισ ιν σηορτ
συππλψ προφεσσιοναλ αχχουνταντσ ανδ
εχονοµιστσ αρε νοτ νορµαλλψ αϖαιλαβλε ον
7
γοϖερνµεντ σαλαριεσ, ανδ ηαϖε το βε ηιρεδ ον
σπεχιαλ τερµσ, πυττινγ εϖεν φυρτηερ πρεσσυρε
ον χοστσ; ανδ
• Ηιστοριχαλλψ, χοµπυτερ σψστεµσ ηαϖε βεεν
αν εξπενσιϖε οπτιον τηε ηαρδωαρε ηασ βεεν
χοστλψ το βυψ ανδ µαινταιν ανδ ηασ ρεθυιρεδ
σπεχιαλ πηψσιχαλ φαχιλιτιεσ; αλσο, σχαρχε
ανδ ηιγηλψ παιδ σταφφ are needed to develop and
implement software.
However, modern information technology is much less
expensive to acquire and maintain, does not require
special buildings and can use packaged software with
much reduced human resource costs. In fact, it places
within reach of LDCs financial management systems
which can integrate the various components at a cost
which is normally feasible.
When talking about cost savings, it has to be recognized
that in many LDCs actually reducing the number of
government staff is not a politically feasible option.
However, the fact that numbers are not increased,
coupled with the opportunities to reassign staff, does
serve to limit or reduce the real costs of new systems.
Computers as a means of overcoming human
resource and institutional limitations
One of the consistent problems facing the development
of financial management systems has been inadequate
human resources, together with institutional structures
which make it difficult to recruit or retain appropriately
trained staff. Until now computers have been seen as
exacerbating this problem, in that they create demand
for yet more skilled personnel, and in technical grades
which do not fit well into the structure of most
government services.
However, it is increasingly possible to see information
technology as at least a partial solution to many of the
problems. Indeed modern systems (i) reduce the number
of persons required to operate a system, and (ii) “de-
skill” many of the tasks. The first comment has already
been dealt with above, on cost implications. However,
the comment on de-skilling is important. Modern
computer systems, once designed, can be operated by
staff with only limited accounting and data entry
training. They do not create the demand for a large
body of trained accountants that would be required to
operate a comparable upgraded manual system. In fact,
this change has significant implications for training,
dealt with below. What are likely to be required are:
8
• Α ϖερψ σµαλλ γρουπ οφ σκιλλεδ φινανχε ανδ
ινφορµατιον τεχηνολογψ εξπερτσ, το µαινταιν
ανδ δεϖελοπ τηε σψστεµσ ανδ προχεδυρεσ, ανδ
το συππορτ συβσιδιαρψ υνιτσ;
• Α ρατηερ λαργερ γρουπ οφ αχχουνταντσ
τραινεδ το οπερατε ιν αν ινφορµατιον
τεχηνολογψ ενϖιρονµεντ, χαπαβλε οφ µαναγινγ
δατα φλοωσ ανδ ηανδλινγ θυεριεσ; ανδ
• Α συβσταντιαλ νυµβερ οφ ινπυτ χλερκσ, ωιτη
λιµιτεδ πραχτιχαλ τραινινγ ιν δαψ−το−δαψ
οπερατιον ανδ δατα ινπυτ.
The training for groups (2) and (3) above is likely to be
task-specific. There is no need to train a large body of
professional or technical accountants to operate the
system. Instead small and specialized training
programmes can be developed. This does make many of
the programmes of upgrading accounting and finance
skills seem less important.
However, these changes may well make it even more
difficult to operate information technology systems in a
typical LDC government institutional structure. Most
governments have organizational structures based on
the colonial power which controlled them or, if they
were never colonies, on the nearest available model.
These public-service structures typically recruit
government staff into lifetime careers, in which they
expect to move gradually up the promotion ladder. In
many countries, the main objective of public servants is
to avoid adverse criticism, and to make a number of
sideways transfers to add experience. There is no
concept of developing technical skills, because public
servants are seen as administrators. As it was put to us
in one LDC, “We did not join the government to
operate computers.” In many LDCs the system is
further distorted by the need to obtain government
positions which have power, since this power leads to a
range of benefits, eg. “In Bangladesh, power and wealth
are interchangeable commodities.”
Finally, many systems are based on a concept of regular
staff transfers. This is particularly true in South Asia,
where those public servants who are recruited through
the entry examinations (fast-track recruits) expect to be
transferred at very regular intervals throughout their
career. This means that if staff are trained in special
skills, they will be transferred, often within a year, and
often to some totally unrelated task. It is extraordinarily
difficult to change this system, which is deep within the
organizational culture.
This organizational background is not conducive to
developing a core group of highly skilled professionals.
If government officers, they are very likely to be
transferred within a few years to other sectors of
government. If hired on a contract basis (and most
LDCs are very reluctant to enter into such contracts),
they tend to move onto other assignments once the
development phase is completed–after all, there is no
promotion path for them. This is a problem all LDCs
are going to have to face in the future; it is further
addressed below.
The technology leap
Finally, there is the concept of LDCs making a
technology leap. This is best understood by examining
the history of government financial management-related
information technology systems in LDCs.
Information technology systems have had a somewhat
chequered history in LDCs over the last 20 years. Many
of the initial systems used technology which was
becoming outdated even as it was being put in place.
Early excursions with mainframes were expensive, and
those that were introduced were often not the “latest”
model from the manufacturer. The introduction of these
“big” systems also had other consequences in that it
created a “remote computer centre” which supplied
accounting information on a time-sharing basis along
with census, statistics and other information. These
large systems typically have (for they still exist) a
number of problems.
• ∆ατα ισ υσυαλλψ ινπυτ ιν βατχηεσ, ιε.
δοχυµεντσ αρε γατηερεδ τογετηερ φροµ
αχχουντινγ οφφιχεσ ιντο α σινγλε βυνδλε, ορ
βατχη, ωηιχη ισ τηεν σεντ το τηε χοµπυτερ
χεντρε φορ προχεσσινγ. Τηισ χρεατεσ α σενσε
οφ ρεµοτενεσσ οφ τηε χοµπυτερ χεντρε φροµ τηε
πεοπλε ωηο ρεθυιρε τηε αχχουντινγ
ινφορµατιον;
• Ουτπυτ ισ υσυαλλψ χονσιδεραβλε ϖολυµεσ οφ
πριντουτσ ον χοµπυτερ παπερ, οφτεν ωιτη ονλψ
λιµιτεδ ναρρατιϖε δεσχριπτιον αγαινστ α µασσ
οφ νυµβερσ. Συχη ουτπυτ µαψ χονταιν µυχη
δατα, βυτ ιτ ισ ινεφφεχτιϖε ασ α χοµµυνιχατιον
τοολ;
• Ινπυτ ανδ ουτπυτ αρε νορµαλλψ εντιρελψ ιν
Ενγλιση, ρατηερ τηαν νατιοναλ λανγυαγεσ;
• Ινφορµατιον φλοωσ το ανδ φροµ τηε computer
centre in such a system are usually very slow, and
not focused on individual users’ needs. The computer
operation tends to have a life of its own, with the
computer “experts” making all the decisions. Users
of the system feel disenfranchised, unable to
influence decisions because they are faced with
technical jargon and concepts they do not
understand.

Systems, as described above, do have uses for large-
volume accounting procedures, such as payroll, but as
an aid to general financial management they are not of
any great significance. A further problem is that such
large systems need to be upgraded regularly and the
physical environment sustained. While the original set-
up may have been aid-funded, the ongoing support is
usually left to the government. As a result, the cost of
computer and physical maintenance is often not
adequately funded and systems have failed to be
upgraded and developed, leading to a progressive
degradation in their effectiveness and reliability.
More recently, developing countries have had new
opportunities because of improved and cheaper
technology. The advent of the high-powered personal
computer (PC) with its increased capacity and variety of
software has led to a move away from large, shared
computers. PCs have significant advantages for LDCs.
• Λοω χαπιταλ ανδ οπερατινγ χοστσ;
• Μορε ενϖιρονµενταλλψ τολεραντ αιρ−
χονδιτιονινγ ισ νοτ νορµαλλψ ρεθυιρεδ (τηουγη
ηιγη ηυµιδιτψ ανδ δυστ χαν στιλλ γιϖε
προβλεµσ);
• Αϖαιλαβιλιτψ οφ εασιλψ υνδερστοοδ σοφτωαρε
ωηιχη χαν βε υσεδ βψ περσονσ ωιτηουτ
τεχηνιχαλ βαχκγρουνδσ;
• Ουτπυτ ωηιχη ισ µυχη easier to use and read.
There is no doubt that PCs have done much to make
computing available to a variety of users in LDCs.
However, for financial applications the very ease of use
of PCs has to some extent proved a problem.
• Συβσψστεµσ ηαϖε βεεν δεϖελοπεδ
ινδεπενδεντλψ οφ οτηερ σψστεµσ, ωιτηουτ ανψ
αττεµπτ ατ ιντεγρατιον, υσινγ λοχαλλψ ωριττεν
σοφτωαρε ωηιχη φοχυσεσ ον τηε σπεχιφιχ νεεδ
οφ ονε εντιτψ ωιτηουτ δυε χογνιζανχε οφ τηε
πλαχε τηε σψστεµ µιγητ ηαϖε ιν αν οϖεραλλ
φινανχιαλ σψστεµ στρατεγψ;
• Μανψ οφ τηεσε σψστεµσ ηαϖε βεεν δεϖελοπεδ
αδ ηοχ ανδ δοχυµεντατιον ον ινφορµατιον
φλοωσ το τηε σψστεµ, σψστεµσ δεσιγν, ανδ
προγραµµε χοδε ισ νοτ αϖαιλαβλε, ασ
προγραµµινγ ισ γιϖεν γρεατερ εµπηασισ τηαν
σψστεµσ αναλψσισ ανδ δεσιγν. Τηισ λεαδσ το
ονγοινγ µαιντενανχε ανδ σψστεµσ δεϖελοπµεντ
προβλεµσ;
• Ολδερ ϖερσιονσ οφ ∆ΟΣ−βασεδ αππλιχατιονσ
πρεδοµινατε ασ τηε δεϖελοπµεντ τοολ. Τηε
ρεασονσ φορ τηισ αρε µανψ, βυτ τηε µαϕορ
9
φαχτορ ισ τηατ ιν µανψ Λ∆Χσ τηε σοφτωαρε ιν
υσε ιν τηε πριϖατε σεχτορ ισ οφτεν ολδερ,
υνρεγιστερεδ ϖερσιονσ οφ σοφτωαρε προδυχτσ.
Μυχη οφ τηε πριϖατε−σεχτορ αχχουντανχψ
σοφτωαρε ιν Λ∆Χσ ισ τηεν δεϖελοπεδ ωιτη ολδ
παχκαγεσ, ανδ τηισ σκιλλ ισ τηεν υτιλιζεδ φορ
γοϖερνµεντ αχχουντινγ δεϖελοπµεντσ;
• Σψστεµσ ηαϖε βεεν ωριττεν ωιτηουτ αδεθυατε
χονσιδερατιον φορ δατα ιντεγριτψ ανδ
σεχυριτψ, φεατυρεσ τηατ ωουλδ βε βυιλτ ιντο
µοστ αχχουντινγ σοφτωαρε παχκαγεσ. Ιν φαχτ
τηερε ισ ϖερψ λιττλε υσε οφ παχκαγεδ
αχχουντινγ σοφτωαρε, βεχαυσε τηε λοω χοστσ
οφ προγραµµινγ υσυαλλψ µακε ιτ χηεαπερ ανδ
εασιερ το ωριτε ταιλορεδ σοφτωαρε ωηιχη
σιµπλψ χοµπυτεριζε εξιστινγ προχedures and
forms.
Some of these PC systems have been networked, and
sometimes they perform accounting or other financial
management functions. Many, however, are used
primarily for data analysis and/or word processing.
The result is that many LDCs have a mixture of
systems. Most basic data entry and recording is still
done on manual handwritten systems, and indeed in
many cases accounting is still mainly done manually.
There may be a mainframe system dealing with payroll
or central accounting. There will almost certainly be
PC-based systems for budget and other specific tasks.
These systems are not likely to be linked, and it may
well be that data formats are incompatible, with data
being re-keyed for transfer between systems.
The opportunity for a transformation in data
processing
There is now the opportunity for a paradigm shift in the
approach to data processing for financial management
systems. Certain parameters can be set for this change.
• Ιτ µυστ βε αχχεπτεδ τηατ µυχη οριγιναλ δατα
εντρψ, ανδ µανψ σµαλλ γοϖερνµεντ οφφιχεσ
ανδ διστριχτ τρεασυριεσ, ωιλλ ρεµαιν ωιτη
µανυαλ σψστεµσ φορ τηε φορεσεεαβλε φυτυρε;
• Ηοωεϖερ, φορ µοστ Λ∆Χσ, δατα προχεσσινγ ιν
χαπιταλ χιτιεσ ανδ οτηερ υρβαν χεντρεσ, χαν
µοϖε το ΠΧ−βασεδ σψστεµσ φορ ινιτιαλ δατα
εντρψ. Σοφτωαρε χαν βε ειτηερ παχκαγεδ ορ
δεϖελοπεδ ιν ηιγη−λεϖελ λανγυαγεσ, ανδ
ουτπυτ χαν βε ιν τηε νατιοναλ λανγυαγε;
• Χεντραλλψ, σεπαρατε σψστεµσ χαν βε σετ υπ
το ηανδλε φυνχτιονσ ρελατινγ το αχχουντινγ,
πλαννινγ ανδ βυδγετινγ. Τηεσε χαν βε σχαλεδ
10
ασ αππροπριατε φορ τηε ϖολυµε οφ
τρανσαχτιονσ, σψστεµσ χοµπλεξιτψ ανδ
ρεθυιρεδ υσερ αχχεσσ, βυτ αλλ χαν εξχηανγε
δατα ωιτη εαχη οτηερ ιν µαχηινε−ρεαδαβλε
φορµατ;
• Ιν αδδιτιον, δατα φροµ τηε σµαλλερ υρβαν
χεντρεσ ιδεντιφιεδ ιν (2) αβοϖε χαν αλσο βε
τρανσφερρεδ ιν µαχηινε-readable format, either
over telephone lines using modems, or by physically
sending disks between the centres.
The key to this is the availability of software which can
communicate with other systems, the ability to scale
systems as appropriate without introducing data
incompatibilities, and the existence of a range of
options for the scale of systems. This is the technology
which high-income industrialized countries are moving
towards, but they are hampered by heavy investment in
extensive and expensive mainframe systems which still
work, even if better options are available. Most LDCs
lack the baggage of such hangovers, and hence can
make the “technology leap” to the latest software.
This is not a “window of opportunity” which will go
away; rather, it will expand as hardware and software
improve in capability and ease of use. It is important
that LDCs make correct decisions today, so that they
are not burdened with inappropriate or incompatible
systems for later development.
Are computers appropriate tools in LDCs?
A question that must be faced is whether computers are
appropriate tools in LDCs. There are a number of
arguments against the use of computers.
• Τηεψ ρεπρεσεντ σοπηιστιχατεδ λαβουρ−σαϖινγ
τεχηνολογψ, ωηεν τηε µαϕορ νεεδ ισ φορ σιµπλε
λαβουρ−ιντενσιϖε τεχηνολογψ;
• Τηε ηιστορψ οφ φαιλεδ σψστεµσ λεαδσ το τηε
ϖιεω τηατ ρεσουρχεσ αρε βεινγ πυτ ιντο
χοµπυτεριζατιον ωιτη λιµιτεδ βενεφιτσ, ωηεν
τηε σαµε ρεσουρχεσ χουλδ µακε α ρεαλ ανδ
διρεχτ ιµπαχτ ον ποϖερτψ αλλεϖιατιον;
• Τηεψ ενχουραγε τηε παττερν οφ αιδ γοινγ ιντο
χεντραλιζεδ βυρεαυχραχιεσ, ρατηερ τηαν βεινγ
διστριβυτεδ γεογραπηιχαλλψ;
• Βεχαυσε οφ τηε ηιγη τεχηνολογψ, τηεψ χρεατε
δεπενδενχε ον φορειγν ηαρδωαρε ανδ σοφτωαρε
συππλιερσ ανδ foreign consultants.
There is no doubt that there is validity in all of these
criticisms. They were even more true of large
mainframe systems than of PC-based systems, but still
retain a significant element of truth.
The major countervailing argument for computers is
that they provide benefits which are cost-effective, or
are simply not available by other means. For example,
Nepal typically uses less than 40 per cent of pipeline
official development assistance. If expenditure on
computerization could unlock even one tenth of the
balance of unused aid, the level of investment would be
easily justified, and this would refute the criticisms.
On the other hand, there is a responsibility on anyone
involved in the development process to be aware that
they are using scarce resources, and computerization for
its own sake can never be justified. There must be a
clear benefit from the systems which outweighs the
costs, and alternatives considered should always include
improvements to manual systems.
Effects of changes in information technology
The Agency for International Development, in its
strategy to improve accountability, financial
management and audit in Latin America and the
Caribbean (called STRATAC),34/ indicates that the core
components or subsystems of an integrated system
include budget, treasury, debt and accounting. The
integrated financial system in technological terms can
be summarized as being between two extremes, that of
a database shared by all and a set of autonomous
systems with little or no transfer of data. The
constituent parts of an integrated system are:
• Χοϖεραγε τηε σχοπε οφ φινανχιαλ δατα ωηιχη
τηε σψστεµ ενχοµπασσεσ;
• Databases–the number and interrelationship and
commonality of data tables and platforms;
• Principles–the refinement and practice of
accountancy standards throughout the different levels
of government; and
• Level of automation–the ability and ease to transfer
and share data.
In diagrammatic form, the centre of the diagram below
is the “target,” as illustrated in Exhibit 63.
 11
Exhibit 63. Approaches to information technology

All transfers
manual

Different principles at different levels of

government, central statements
possible but poor vertical integration
Different levels of government do not
share same financial management
standards

In addition, integration may encompass external
integration in the form of how information is transferred
to other agencies such as banks, suppliers etc.
Control of resources is ensured through the internal
control, internal audit and external audit functions.
Competent and responsible financial management is
based on the integration of all these elements and their
systemic operation, hence Integrated Financial
Management System (IFMS). The specific meaning
attached to integration, within the STRATAC initiative,
has been further explained by Wesberry.35/ It includes:
• Νατιοναλ−λεϖελ φινανχιαλ ρεγυλατιονσ,
ρυλεσ ανδ γυιδελινεσ ετχ.: α χοµµον λανγυαγε;
• Budgeting and accounting systems at the national
level: a common classification;
• Agency-produced financial data, with centrally
produced financial data: a single base of financial
data;
• The phases of the management cycle: a uniform flow
of management information;
• Flow of data throughout the agencies and the
government: clear interlinkage of data flow,
accumulation and reporting;
• Basic subsystems of financial management within
each agency: budgeting, cash and debt management
and accounting;
• The basic subsystems at the national level; and
• The methods of processing financial information.
Integration is not a single-dimension concept. From the
above it can be seen that it has several aspects, each of
which is a continuum. For instance, a shared database
for accounting, financial management and certain non-
12
financial functions is at one end of the spectrum of
integration. At the other, there are completely stand-
alone systems without data corruption, loss etc. Most
systems are likely to be located between these extremes.
Five criteria are suggested for judging the degree of
integration of a financial management system, each
representing a continuum of possibilities: (i) the degree
of coverage of financial management processes; (ii) the
degree of integration of databases; (iii) the degree of
vertical and horizontal integration of the underlying
systems; (iv) the degree of automaticity in data transfer;
and (v) the degree of external integration. Applying
these criteria would probably reveal very few cases of
highly integrated government financial management
systems.
 13
Exhibit 64. Degree of integration

Degree of vertical Degree of

Degree of external
Degree of Description Databases and horizontal automaticity
integration
integration integration in data transfer
Highly integrated Covers accounting, All information on a Uniform financial System managers, Data from the system
financial management single data base management system users and data is transferred in
and related non- principles are at all entry personnel, machine-readable
financial processes levels of government. wherever they are form to the automated
such as procurement, Entities at the same working, have access systems of other
performance organizational level to the same database agencies such as
measurement, etc. and also those in via networks banks, suppliers,
vertical relationship employees, etc., with
with each other have which government
uniform financial and has major financial
accounting rules. relationships
Consequently,
meaningful financial
statements for each
level of government
and for government as
a whole can be
supplied with ease
Integrated Covers core financial Several data bases Similar financial Some of the Some such transfers.
management with the facility via management participants have
processes such as interfaces and principles apply to all direct access to the
budgeting, accounting downloading to levels of government. database via
and debt transfer most data There is a high degree networks, but others
management. automatically of horizontal do not. The databases
between systems. uniformity eg. all of the latter are
local governments use updated from time to
the same accounting time in a variety of
and financial ways: problems
management encountered in the
principles. To produce transfer of data are
consolidated financial not significant.
statements for the
government sector
14
Degree of vertical Degree of
Degree of external
Degree of Description Databases and horizontal automaticity
integration
integration integration in data transfer
and for its major
horizontal divisions is
possible, but requires
adjustments to be
made to put data onto
a common basis
Partially integrated Covers all major Several databases Financial Less use of networks; Some such transfers
accounting with some automatic management more use of other
components transfer of data and principles differ for data-transfer methods;
some stand-alone the different levels of more problems
systems. In a partially government. resulting from data
integrated system, Consolidated financial transfer; less access to
significant amounts of statements can be users
data may have to be supplied for central
entered manually or government.
re-entered for transfer However, there are
into related systems elements of diversity
and this prevents the
production of fully
articulated
consolidated
statements both
horizontally and
vertically
Unintegrated Minimal necessary All transfers of data The different levels of No use of networks No automated
linkages are present, between systems are government do not for the transfer of transfers of data.
eg. between budget manual. share the same data. Other transfer
and accounting financial management methods are
classifications. and accounting inadequate and great
principles. difficulty is
Consolidated experienced in
accounts for updating records:
government as a significant categories
whole and its parts of information users
 15
Degree of vertical Degree of
Degree of external
Degree of Description Databases and horizontal automaticity
integration
integration integration in data transfer
can only be produced do not have direct
with difficulty and access to information
even then lack systems.
meaning because of
lack of standardized
definitions.
16
Difficulties encountered in establishing
integrated systems
Despite such advantages, the degree of actual
integration has generally been quite limited. For
instance, government accounting systems are
traditionally made up of several subsystems such as a
general ledger, a budgetary control system, an
accounting system, a tax collection system, a payroll, a
system for managing foreign debt and other assistance
and so on. Some of these subsystems are integrated
with the accounting system, and others remain more or
less free-standing, for example:
“Today, to put it simply, the federal books
are a mess. Any business with separate
uncoordinated systems for budgeting,
accounting and product sales would soon
be bankrupt. But the federal government
has such systems.” 36/
Thus the National Performance Review summarized the
situation facing the United States Government. The
same point was made less emotionally in a 1988
publication of the Joint Financial Management
Improvement Programme:
“There are presently several hundred
financial management systems in
operation in the Federal Government. In
general, each department and agency has
independently designed and implemented
its own financial management systems.
Further, over the years, many unique
bureau and division systems have been
developed and for the most part these
systems have not been integrated with
department or agency level systems. The
result is that federal government systems
are fragmented and antiquated.
Successful reform of these systems
requires that an integrated approach be
taken....” 37/
If this is the situation in one of the wealthiest and most
technologically advanced countries, there must be good
reasons for it. Why are integrated financial management
systems not the norm in government? What are the
factors explaining the current lack of integration?
Consider these in the context of the United States.
First, the pace of financial management improvement is
gradual. Because of the high costs and risks of change,
few governments have attempted a complete
replacement of existing systems. Thus few have been in
a position to achieve the degree of system integration
which information technology now permits. Most are
engaged in the gradual overhaul and modernization of
systems introduced at various times in the past. Thus
they focus on improving the effectiveness of existing
systems and building interfaces between them. This
increases the integration of systems, but often the
remaining scope for further integration is substantial.
Secondly, until recently the technology to support
cheap, adaptable and user-friendly integrated financial
management systems did not exist.
Thirdly, the traditional focus of government accounting
has been budgetary control. Accounting systems
designed predominantly for this purpose are usually
based on cash and commitment data. This is not a good
basis for integrated financial management. The lack of
asset accounting in such systems necessarily results in
the establishment of separate add-on systems for
particular purposes such as debt, cash and fixed asset
management.
Fourth, organizational factors often result in separate
information systems for different agencies and even for
different branches of the same agency. For instance, in
the United States the tendency is for each agency to
have its own hardware and software for accounting
purposes. As a result, vertical integration presents
considerable difficulties. Generally agencies produce
monthly cash statements according to Office of
Management and Budget information requirements, and
these are then consolidated by a database system.
Fifth, the apparently high costs and vulnerability of
integrated systems may have resulted in a relatively
slow move to highly integrated systems.
Scope for more integrated systems
In LDCs as elsewhere, integration of financial
management systems is likely to reduce their costs and
increase their usefulness. Given the special
circumstances in which LDCs find themselves, the
likelihood of installing modern integrated systems
depends significantly on the availability of external
assistance. Assuming that such assistance is available
there remain a number of important constraints.
• Τηε βαλανχε οφ ωηατ ισ δεσιραβλε αγαινστ
ωηατ ισ φεασιβλε σιµπλε σψστεµσ ωηιχη χαν
βε συσταινεδ αρε αλωαψσ πρεφεραβλε το
χοµπλεξ σψστεµσ ωηιχη ωιλλ χολλαπσε ονχε
εξτερναλ συππορτ ισ ρεµοϖεδ, βυτ συχη σιµπλε
σψστεµσ µαψ βε λεσσ τηαν ιδεαλ.;
• Initial estimates of costs and of dates of
commencement of operation of new systems are
likely to be exceeded, probably significantly if the
new systems are radically different from prior ones;

• The need for staff training;
• The costs of maintenance and technical support once
the system is installed;
• The need to involve government officers at all stages
through the system design and implementation, even
if this slows the process;
• The problem of creating dependence on foreign
suppliers and/or expatriate staff;
• The effectiveness of the new system will be
determined to a large extent by factors external to the
system: accurate, timely and comprehensive input of
data; efficient maintenance of databases; systems
management; and ability to use the information
provided;
• Factors external to a computer system, eg. the degree
to which financial procedures and accounting
classifications have been standardized, etc.
Assuming that the conditions necessary to install an
integrated system are not present, what policies should
governments pursue? Clearly, in many countries a great
deal can be done both to increase linkages between
systems and to create conditions favourable to eventual
integration, including:
• ∆εχιδινγ ον α στρατεγψ σο τηατ ινχρεµενταλ
Exhibit 65. Data flows in an integrated system
Planning Budget
system system
Line
ministries
Projects,
departments,
Field offices
and projects
17
µοϖεσ χαν βε µαδε τοωαρδσ φυτυρε
ιντεγρατιον, εγ. στανδαρδιζινγ σοφτωαρε ανδ
ηαρδωαρε φορ χονσιστενχψ ωιτη φυτυρε
ιντεγρατιον πλανσ;
• Creating electronic data transfer linkages where
possible, eg. for the consolidation of financial data;
• Establishing common procedures, classifications and
coding schemes for all processes which will
eventually be integrated;
• Increasing the accuracy, timeliness etc. of record-
keeping and reporting; and
• Promoting and maintaining a financial cadre with the
skills necessary for efficient business operations.
Outline of data flows in an integrated system
The data flows in an integrated model may follow
several different patterns. Discussion has already taken
place on basic accounting flows from the field to the
centre, and also on distributed versus centralized
systems. The model below indicates in outline how data
might flow in an integrated system.
Core Monitoring
accounting system
District
accounting
Key:
bi-directional data flow
uni-directional data flow
18
There is no one model of the direction of data flows
between field offices, line ministries, projects or
departments, and the core accounting system. The
important objective is that at the end of the day all
should have access to common, reconciled information.
The main implication of this analysis of integration is
that full integration is a goal which cannot be
considered in isolation. The technology needs to be
considered in the wider context of the information
needs of the government, and the whole financial
management system. Rather than focus on just the
hardware and software, the whole information process
requirements need to be examined, with the technology
following definition of requirements.
Constraints
Many of the constraints have already been mentioned in
the preceding paragraphs, but in summary they are:
• ∆ιφφιχυλτιεσ ωιτη τηε πηψσιχαλ
ινφραστρυχτυρε;
• Lack of sufficiently skilled human resources in both
government and the private sector;
• A history of computer systems failing to meet
expectation;
• Difficulty in sustaining system operations after initial
funding support;
• Emphasis on local bespoke programming; and
• Reluctance of vendors to enter the market for
package solutions and appoint local representatives.
It is clear therefore that, in LDCs, systems development
cannot be isolated from other issues. While this may
also be true in more developed countries, facts such as
the domination of the supplier market by one firm, and
government contracts for systems developed by that
firm–as the only one with local support–may exacerbate
the problem.
Practical issues
Distributed compared with centralized
systems
The model in Exhibit 2, an integrated financial
management system, should not be taken to imply that
there would be one single centralized database. In fact,
the trend, reinforced by both operational need and
technology is to move to distributed systems. This tends
to be more economical, and also focuses management
responsibility and control over information at the same
point.
Under a distributed system, integration might be
achieved by several different data bases, holding
different information, but able to exchange data with
each other as required. Such databases might be located
in the planning body, Ministry of Finance, Accountant
General’s Office and line ministries. Ideally the system
would be totally transparent to a user, in that the user
would be unaware of using information from different
databases when making enquiries or preparing reports.
However, in LDCs there may be a countervailing
pressure for more centralized systems. The reasons are:
• Τηε σηορταγε οφ χοµπυτερ σκιλλσ, ανδ τηε νεεδ
το δεϖελοπ σψστεµσ ωηιχη χαν βε εασιλψ
µαναγεδ, µαψ µακε ιτ µορε αττραχτιϖε το
χεντραλιζε σψστεµσ;
• The relatively small scale of financial activities in
many LDCs takes away much of the case for
distributed systems;
• Poor telephone connections may make distributed
systems infeasible; and
• The need to link with manual systems, and activities
which move between manual and computer-based
systems, may be easier to handle with a centralized
system.
Therefore, although the general presumption will be in
favour of distributed systems, in the case of LDCs there
may be good reasons to favour systems that are at least
partly centralized.
The problems of applying packaged solutions
in public-sector financial management
Although the discussions above have emphasized the
widespread availability of packaged software solutions,
in fact their application to public-sector financial
management in LDCs presents a number of problems.
These relate to the design objectives of the software, the
problems of adaptation and local support. They are
addressed below, first in general terms, then in relation
to specific components of financial management.
Packaged software tends to fall into three main
categories:
• Γενεραλ−πυρποσε σοφτωαρε, οφ ωηιχη τηε
µαϕορ εξαµπλεσ αρε ωορδ−προχεσσινγ,
σπρεαδσηεετ, δαταβασε (ινχλυδινγ ρελατιοναλ
δαταβασεσ), ανδ γραπηιχ παχκαγεσ. Τηισ ισ
τηε µασσ µαρκετ, ωηιχη ηασ βεχοµε
ινχρεασινγλψ δοµινατεδ βψ α φεω βιγ
πλαψερσ, εγ. Μιχροσοφτ, Λοτυσ−ΙΒΜ, Οραχλε;
• Specialized software, eg. accounting software, design
software, etc.–a market where there are many
relatively small software suppliers;
• Applications for resale developed using general-

purpose software–usually relational databases–as
development tools. Sometimes this is supported by
the supplier of the general-purpose software, eg.
Oracle Financial Systems, in other cases it is a
specialized software supplier.
Ideally all systems should be fully “scalable,” ie. they
should be able to operate equally well on a stand-alone
PC, a large client-server or even a mainframe system. In
practice this ideal is rarely achieved, and most software
is either PC or large system-oriented. This tends to be
even more so for specialized software, eg. accounting.
All of the requirements for a financial management
system are for specialized software. These will include
accounting systems, budget and planning systems and
monitoring tools. However, the reality is that the
demand for public financial management systems is
small in relation to the demand for commercial systems.
Furthermore, because most industrialized countries
have earlier computerized public finance activities on
mainframes, the remaining market for down-sized
systems is even more restricted.
The result of this is that government financial
management systems generally have to rely on either (i)
their own custom-written software or (ii) adaptations of
software written for commercial organizations. The
preference is always for adapting packaged software,
but the practicalities of this need to be considered in the
context of the information needs of LDCs.
A further problem is that there is unlikely to be local
support for more than a small range of packaged
software. For example, in most LDCs there is no local
support for large accounting packages. This is because
of the small scale of the local market, the high costs of
operating therein and the widespread problem of
software piracy.
These general problems are considered below in the
context of three common financial management
applications: (i) accounting, (ii) budget and (iii) payroll.
Accounting packages
Accounting packages provide an apparently easy
solution to the budget and financial management needs
of government financial management. Certainly in any
consideration of options, the use of packaged
accounting software needs to be very seriously
considered. However, there are likely to be a number of
arguments which will need to be evaluated.
• Αχχουντινγ παχκαγεσ ωιλλ νορµαλλψ βε
δεσιγνεδ φορ χοµµερχιαλ αππλιχατιονσ. Ασ
αλρεαδψ ιδεντιφιεδ, τηερε αρε α νυµβερ οφ
διφφερενχεσ βετωεεν τηεσε ανδ γοϖερνµεντ
φινανχιαλ µαναγεµεντ νεεδσ;
• Τηε σψστεµσ ωιλλ βε ωριττεν φορ α φυλλ
19
αχχρυαλ σψστεµ, βασεδ ον α νοµιναλ λεδγερ,
ωηερεασ µοστ γοϖερνµεντσ αρε υσινγ τηε χαση
βασισ, χεντρεδ αρουνδ τηε χαση βοοκ;
• There is no concept of commitment accounting in
commercial accounting, yet this is very important in
government;
• Similarly, commercial accounting packages are not
designed to track expenditure through the various
stages from medium-term financial planning, budgets
and amendments, and fund release before
commitment stages are even reached;
• There will be no provision for incorporating non-
financial performance indicators, or for producing
the style of reports required for the public sector;
• The extent of data analysis required by the public
sector is much greater, often requiring longer coding
structures than the package provides capability to
handle;
• The systems are not designed to handle partially
manual systems, where data may arrive as original
transactions, summarized manually or on a PC;
• Commercial entities monitor against monthly
budgets, whereas governments monitor against
cumulative annual budgets;
• In many LDCs, there is no local support for the
larger accounting packages.
This does not make it impossible to use packaged
commercial accounting software. A number of software
houses are willing to work with users, or consultants, to
adapt their software to meet specific needs. This tends
to be more so with large systems, but these are the
systems least likely to have local support. In general it
is the larger and more expensive systems which have
the greater degree of flexibility, so they can be
developed to meet the needs of users.
Accounting packages do have several countervailing
advantages which need to be considered:
• Established packages are fully developed, and
demonstrably work. They will have been de-bugged;
• They will be supported by manuals, designed for
ease of use, and have built-in audit trails and
security;
• They will be regularly upgraded to take accounts of
new developments, eg. new versions of operating
systems;
• They will be supported by a software house which
should assist with problems.
20
There are some public-sector accounting packages, but
they tend to have been written with a particular client in
mind, eg. United Kingdom local authorities. Their
special needs may mean the software is as difficult to
adapt as commercial accounting software, and the
chances of local support are even less likely.
In addition, most LDCs require some simple “votes
ledger” software for initial data entry in field offices,
and for monitoring of expenditure. The general
experience is that “small” accounting packages, while
cheaper, are even more inflexible, and that it is very
difficult to find a packaged solution to this problem at a
justifiable cost. However, votes ledgers can easily be
written with modern relational databases.
In making decisions about systems, a careful evaluation
will need to be made taking into account all relevant
factors. Accounting packages should always be
regarded as an option, and the relative merits and
demerits weighed against each other.
Budget systems
There are few commercial budget systems as such.
Normally budgeting is a module within an accounting
system. These are typically single-year modelling
systems, designed to input budget data into the
accounting system. However, as the earlier analysis of
planning and budgeting indicates, the requirement is for
a much more sophisticated tool, able to handle multiple
years, to include non-financial objectives and to take
account of complex resource constraints.
At the other extreme there are specialist economic
modelling tools, such as the “Revised Minimum
Standard Model” developed by the World Bank.
However, these are general national macroeconomic
models rather than tools for preparing budgets and plans
of a government.
At this time it appears that there are no proprietary
packages for modelling government budgets
adequately. A solution may be to develop a budget
“front-end” to fit with an adapted accounting package.
However, this requires careful design.
Payroll
Payroll would appear to be an obvious target for using
existing packages, since there are many payroll systems
in existence. However, even here there are problems.
• Μανψ γοϖερνµεντ παψρολλσ ηαϖε α χοµπλεξ
αλλοωανχε σψστεµ, ωηιχη ισ βεψονδ τηε δεσιγν
παραµετερσ οφ χοµµερχιαλ παχκαγεσ;
• The scale of the payroll (ie. number of employees) in
some countries can also be beyond the design limits
of commercial packages;
• Commercial systems do not allow for employees
moving to offices where there is a manual payroll,
and vice versa, with consequent transfer of records
between manual and computer systems;
• Most government systems require the ability to
access information about pay going back over several
years, whereas most commercial systems tend to
hold only current data.
Conclusions on packaged software
As stated above, the initial presumption should always
be in favour of a packaged software solution. The major
advantages are as follows:
• Χοστ (τηουγη τηε αλτερνατιϖε οφ χυστοµ
δεϖελοπµεντ χαν βε ινεξπενσιϖε ιν Λ∆Χσ);
• The system is developed and tested, and will
continue to be maintained (lack of these elements is
commonly a problem with bespoke software);
• Data integrity and security (especially important in
accounting systems) are well established, and there
will be proper audit trails; and
• The system will be well documented, and developed
for easy use.
However, this will need to be balanced against the
functionality of the proposed package in terms of user
needs, costs and feasibility of adaptations, and the
quality and reliability of local support. These factors
will need to be carefully evaluated in making a decision
on packaged software. Consideration will also need to
be given to the capacity of the software to comply with
financial regulations, and a compromise between
revising regulations and software choices will be
necessary. If the regulations cannot be changed, then
tailored (bespoke) software may be the only feasible
solution.
One of the incidental advantages of moving LDCs to
full or modified accrual accounting is that the
application of packaged software would be a much
simpler task.
Hardware and operating system issues
Today hardware is rarely an important issue. The
appropriate approach is to design the system first, and
then specify the hardware to meet the operational
requirements. Of much greater significance are issues
relating to operating systems.
Operating systems are the link between the application
software and the actual hardware. At one time each
manufacturer had its own operating system, but today
most hardware uses a limited number of operating
systems. These are generally DOS/Windows 95 or 98
for PCs and small networks, and Windows NT or UNIX

for larger systems. However, some major database
systems, such as Oracle or Infomix, which operate on a
range of operating systems, include some of the more
important proprietary systems. In such cases it is the
choice of the database, rather than the operating system,
which is critical.
In a number of countries, especially in Asia, the
language is written in a character set which is different
from English characters, on which most computers are
based. It is clearly important to be able to produce
output in the language and script of the country. At
present only Windows (and the Macintosh, but this is of
little importance in financial management) has this
capability.
Systems design
This wider-perspective picture should be encompassed
in an overall “financial information systems strategy”
(FISS). Several styles and approaches to the
establishment of such strategies exist, with many
specific tools used by specialists and governments, but
as a general guideline all such strategies should include
the following, in the sequence shown.
• Ρεϖιεω οφ βυσινεσσ προχεσσεσ ανδ
ινφορµατιον νεεδσ;
• Information architecture;
• Systems and technology architecture;
• Project management and implementation planning.
Together these are known as RISP (from the initial
letters above). The sections that follow deal with each
of the RISP components.
One structured approach to developing an FISS is
SSADM (Structured Systems Analysis and Design
Methodology). The latest version of SSADM is
SSADM 4.2, and the stages that follow are based on the
SSADM model.
21
Review of business process and information
needs
The term “business process” is deliberately introduced
although we are talking about government. This is to
emphasize the need for public-sector activities to see
themselves as operating in the same environment as the
private sector, with identified “business” objectives.
This review involves developing an understanding of
and documenting what happens in an organization.
Functional processes vary from country to country in
government terms, but for historical reasons many
LDCs have adopted the approach of a more developed
country, eg. Bangladesh follows the British model.
It is essential that a thorough background examination
be made and the anticipated information requirements
identified to form the basis for what is required. In
LDCs this phase of work should typically examine:
• Βυσινεσσ προχεσσεσ;
• Procedures;
• Legal/regulatory framework for public finance; and
• Strengths and weaknesses of the government
departments.
Information architecture
In government there are usually several levels of
hierarchy, eg. central, provincial, local etc.
Nevertheless, it is possible to identify nine business-
process information areas. In terms of information
architecture, the detailed relationship of all of their
constituent parts and their ranking in terms of
importance must be established when considering
integration. As an example and at a high level only, the
basic relationship between the nine business processes
can be illustrated by the diagram below.
22

This diagram is deliberately not in the style of any how information flows between the constituent parts of
particular methodology and is an example of high-level each business group. Examples of the flows in Exhibit
output only. However, it represents the possible 66 include
Exhibit 66. Relationship those inbusiness
between Exhibit 67.
processes
business process groupings that might be typical of an
integrated financial
Fiscalsystem.
policy
The information and
in plans
Exhibit 66 would be based on
detailed analysis. Below this top level would be a series
of detailed information or data-flow diagrams showing
Budgets

Public sector
works

Debt Government
Human
Audit Foreign aid
Revenues
23
24
Exhibit 67. Information flows

Planning flows There are several types of planning flow:

• Information flows on fiscal policy and plans to plan
budgets.
• Information on budgets and cash goes to business
groupings for execution of the work programme.
• As the financial year progresses, information on
expenditure, budgets, etc. flows back to allow adjustment.
Accounting flows Information on commitments, payments, receipts.
Cash flows Information on balances from accounting business process
and forecasts on cash position.
Work programme flows Information from work programmes flows to foreign aid and
human resources business processes, and also to specific
projects.
Audit flows Audit observation on different business process areas and
feedback from audit.

Systems architecture • Accounts receivable;

The systems architecture is based on the established
information architecture. Taking Exhibit 66 as an
example, each business support system may comprise a
number of subsystems. For example, in the accounting
process, a typical configuration would include:
• Γενεραλ λεδγερ (ινχλυδινγ βυδγετσ);
• Accounts payable;
• Fixed assets (if full accrual is used); and
• Cost accounting.
Additional systems for commitment accounting,
purchase orders etc. are dependent on the review of the
business processes and information needs, eg. cash or
accruals accounting.
A typical systems design architecture would include the
components set out in Exhibit 68.
 25
Exhibit 68. Accounting systems configuration with links to core system
26

Exhibit 68 adopts certain standards as the basis for
design, eg. similar processes are identified by the same
symbol. The establishment of standards in system
design is an integral part of progressing towards an
integrated financial system in government as a whole.
The technology architecture part of this phase is to
establish the hardware, software and communications
technology required to support the information and
systems design. It will include elements such as the
nature, scale and distribution of information technology
(IT) processing facilities as well as software type and
communications. Many of these elements are directly
related to the IT capabilities in a particular country.
However, there are issues that are common and must be
considered:
• ςολυµε οφ στανδινγ δατα;
• Volume and frequency of transactions;
• Volume and frequency of information flows
between component parts;
• Centralized or distributed processing;
• Type of data, ie. alphanumerical or text;
• Output required; and
• Availability of off-the-shelf packages.
Data volume and transaction rates have traditionally
dictated the computing power of a particular part of a
system, with larger data volumes and transactions
requiring mainframe computers. However, the
increasing capability of PCs means that distributed
processing is now much more a possibility.
The normal trend in developed countries is to use
packaged solutions where possible, although, as already
discussed above, this is not necessarily the norm in
LDCs, and the risk in bespoke software development is
higher. Perhaps the most significant recent change in
technology architecture over the past few years has
been the advent of local language fonts in the Windows
environment. This allows the production of accounting
information in the national language, eg. in Nepal,
Bangladesh, Kyrgyzstan.
27
Whatever the chosen software, it should have a built-in
functionality that makes it easy to amend and change.
The development of “open-systems architecture” means
that flexibility in technology choice is now more of a
reality. Combined with software packages that can
operate on different platforms, this means that users are
not locked into one type of hardware.
Project management and implementation
planning
Throughout any IT project it is sensible to use an
appropriate and pragmatic application of a project
management tool. The British Government, for
example, favours the use of the PRINCE (Projects in a
Controlled Environment) methodology. In introducing
systems to LDCs, it is critical that a sound project
organization that meets local needs be established.
Failure to do so will lead to a repeat of the
disappointing outcomes of the past where governments
have not “owned or maintained” the financial system.
One of the fundamental concepts of project
management is to distinguish between the technical task
of delivering products and the management aspects,
such as organization, plans and controls for managing
the technical task. The end user needs to be involved
throughout. This would include scoping of projects
using standard product breakdown structures as well as
controlling the overall project and sub-project
relationships with concurrent projects.
Using project management methodology ensures the
creation of the distinct stages necessary to provide
regular formal assessment points throughout the project.
Stage-end and key control points or milestones will be
established and agreed with the overall project control
board. Assessment, checkpoint and quality review
procedures will be established.
For example, the standard organizational structure
within PRINCE-controlled developments is set out in
Exhibit 69. It should be noted that this structure may be
scaled down for smaller projects.
28
Exhibit 69. PRINCE structure
While accepting the overall concept of tools such as
PRINCE, it is usual to apply a degree of intelligent
tailoring to the methodology. This is particularly so in
LDCs. Most projects would benefit by applying those
elements of the methodology which are appropriate in
the context of the individual project.
The major problem with the application of a detailed
project management approach in the context of LDCs is
the lack of sufficient persons with any technical
knowledge to fill the various roles. Training for
controlling systems development must be included in
any overall proposed system. This emphasis on project
management is needed to promote ownership by
government of the financial systems introduced in
LDCs. Involving local representatives in the process is
essential to overcome this problem.
As part of a project management tool, the following
plans would be expected.
 29

Exhibit 70. Plans

USER Project Project WHEN
Resource Technical CREATE
PROJECT Plan Plan D
BOARD PROJECT
INITIATION

PROJECT & Stage Stage END OF

STAGE Resource Technical PREVIOUS
MANAGERS Plan Plan STAGE

Exception
Plan
STAGE Detailed Detailed AS REQUIRED
TEAMS Resource Technical IN ANY
Plan Plan STAGE

INDIVIDUAL Individual
Work
Plan

While all of the above is technically correct, the reality
in LDCs is that compromise will be necessary. The
most acute problem is the scarcity of the local skills
necessary to implement, and then, most importantly,
provide ongoing support to, government-wide systems.
It is sometimes possible to facilitate developments in
large urban areas but the technical skills required are
often not available in more remote parts of the country.
In order to succeed, some projects need a component
that is specifically geared to promoting the development
of support organizations both within government and in
the private sector to increase the long-term
sustainability of financial systems. As already stated,
the emphasis in most LDCs is on “programmers” who
tend to develop the system they understand is needed
rather than to agree user requirements and systems
design.
Apart from the human resources issue, another
significant factor in systems development in LDCs is
the lack of suitable infrastructure. In many places the
electricity supply is not reliable, and uninterruptible
power supply equipment and generators do not
necessarily overcome this. Generators tend to be used
other than for running the computer systems and it is
not uncommon that when the office’s annual fuel
allocation is exhausted there is no more electricity.
Options such as using notebook computers may help to
overcome some difficulties, but on the risk side they
also make the systems more susceptible to unauthorized
use. Even if the power problems can be overcome,
communications problems and the fact that the
environment in many government offices is not suitable
for technology mean that major investment is necessary
in building infrastructure to parallel the introduction of
information systems.
The more appropriate option in many cases is to reduce
the expectation of what can be achieved in terms of
real-time financial systems and allow the flow of
manually completed forms to a part of the organization
where data can be reliably input.
Problems of system sustainability
Experience indicates that most computer systems
installed in LDCs have degraded or completely failed
after the withdrawal of external support. A number of
causes can be identified.
• Βαδλψ δεσιγνεδ σψστεµσ ωηιχη διδ νοτ µεετ
υσερ νεεδσ, ανδ ωηιχη, βεχαυσε οφ τηε λαχκ
οφ βενεφιτ, υσερσ δισχοντινυεδ.;
• Inability to continue to operate systems for want of
appropriate in-country skills and/or maintenance
facilities;
• Government organizational structures which made it
impossible to continue to operate the systems
effectively, eg. the loss or transfer of trained
personnel, and inadequate maintenance budgets.
The issue of sustainability needs to be addressed before
initiating a project to establish any computer-based
30
system. A strategy needs to be developed which
provides a viable path to sustainability after the end of
external assistance. Issues to be addressed include:
• µαιντενανχε οφ ηαρδωαρε ανδ σοφτωαρε ιτ
νεεδσ το βε εσταβλισηεδ τηατ τηερε αρε
λοχαλλψ αϖαιλαβλε ρεσουρχεσ ανδ σκιλλσ το
µαινταιν τηε σψστεµσ, ανδ α χοµµιτµεντ φροµ
τηε γοϖερνµεντ το βυδγετ φορ τηε ρεθυιρεδ
χοστσ;
• The creation and maintenance of a pool of staff
capable of operating and managing the systems. If
this is not possible within the government’s
organizational structure, then the services must be
bought in, either through the use of contract staff, or
by actually contracting out the whole operation of
the computer facility; and
• The system must meet the perceived needs of
government. This can be achieved only through the
involvement of government participants in the
development of the system.
Strategies also need to consider the problem of
computers in remote locations. It may be necessary to
establish a “help” desk to provide telephone or personal
support to such locations. Systems of managing files,
backups, data security and provision of consumables all
need to be addressed within the strategy.
The year 2000 problem
The software industry has created its own virus–the
millennium bug. By programming all computer “chips”
with the year as two digits, eg. “98” instead of “1998,”
manufacturers have created a system which will fail at
the end of the century.
The problem manifests itself in three ways:
• Hardware–the BIOS on PCs manufactured up until a
year or so ago was not year-2000 compliant, and the
same applies to most mainframes and minis.
• Operating systems–DOS and most proprietary
systems, and older versions of Windows, are not
year 2000 compliant.
• Software–even today, many accounting packages
and much other software are not year-2000
compliant.
So what will happen? No one really knows. In order to
find out, each system would need to be tested
individually, by (1) advancing the system clock to 31
December 1999, (2) allowing it to cross the millennium
and (3) running a batch of test data extending over at
least the first month, and producing all standard reports.
The result is unpredictable, and may vary from simply
printing dates wrong to producing corrupt data or even
crashing.
No user can afford to risk this. It must be assumed until
demonstrated otherwise that every system will fail (note
that this also includes some machinery, such as traffic
light systems, if it uses dates programmed into the
chip). The only exceptions are probably very simple
systems such as word processors and spreadsheets–and
even in these there can be no guarantee that there will
not be problems.
This is a huge problem, which even developed countries
are finding difficult to address. It means for developing
countries that most older accounting systems and
hardware must be replaced or upgraded before the year
2000. In practice, unless written on recent software,
replacement must be the only feasible option. This is an
enormous problem, which in our experience is not
being properly addressed.
Conclusion
Given the continuing drop in the price of computer
equipment and improvements in the performance,
adaptability and usefulness of packaged systems, the
further integration of government financial management
systems is both inevitable and desirable. Integration
offers the possibility of reducing redundant data,
problems associated with the transfer and re-entry of
data and with the reconciliation of figures, problems of
year-end cut-offs, delays in the availability of
information and the costs of record-keeping and
reporting generally. At the same time, integration is
likely to lead to improvements in the accuracy,
timeliness and usefulness of accounting information and
in better communication between financial managers
and other managers.
There are three major risks: (i) the newly designed
system may not perform as planned, (ii) it may be
vulnerable to disruption and (iii) there may be a
significant cost overrun. All of these are distinct
possibilities. The second one includes problems of
system security and continuity of service under adverse
circumstances. Disaster recovery planning attempts to
mitigate the resultant problems. All three risks are
reduced by a gradualist approach to integration, which
enables systems to grow incrementally in response to
external conditions.
Notes of caution and realism need to be raised. First,
information technology specialists tend to emphasize
the capabilities of their stock in trade and to overlook its
limitations. These include cost and time overruns and
systems which do not solve the problems they were
installed to address. Second, there is big money chasing
integrated systems, and thus optimism often triumphs

over realism. Third, for many governments a high
degree of integration must remain a distant goal, given
the current status of their financial management
systems. And fourth, in countries where basic financial
systems perform very badly, integration is not even a
high-priority goal.
Fully integrated systems for financial management in
LDCs are a longer-term goal, and full integration may
never by achievable, or even desirable. However, there
31
are many intermediate steps which would significantly
improve the quality and effectiveness of financial
management. These steps are potentially significant
financial systems developments in themselves, but the
advent of new technology allays the risk by allowing
more distributed processing. This balanced appreciation
of the need for integration against practical and physical
realities is a crucial constituent of developing such
systems. Many LDCs are missing the opportunity to
move along the integration path even in subsystem
developments.
The application of sophisticated project management
and systems design methodologies in their totality may
be inappropriate, but some form of structured systems
design and project control is essential. An overall
financial systems strategy needs to be established so
that developments are consistent and conform to an
overall direction in terms of an integrated financial
system. However, it is critical that such a strategy
properly address physical infrastructure areas and
resource issues. The philosophy can be encapsulated in
the acronym EDGE:
• Εχονοµιχ χοστ οφ ινσταλλατιον ανδ λονγ−τερµ
µαιντενανχε οφ τηε σψστεµ.;
• Detailed appraisal of potential operating
environment;
• Gauging capabilities of present and potential users;
• Effectiveness level required to be of positive benefit
to the government in the short and long term.
This approach introduces appropriate factors relating to
LDCs in a more specific manner.
32

X. IMPLEMENTING INTEGRATED
FINANCIAL MANAGEMENT
Introduction
The analysis in the preceding sections has identified the
nature of an integrated financial management system,
the benefits and some of the issues. However, more
than anything else, the question must be the feasibility
of implementing the identified improvements and
integrating a system in the environment of a typical
LDC.
It must be recognized that LDCs are far from being a
homogeneous group. At one extreme are countries with
Exhibit 71. Implementation issues and strategies
Issues
• Lack of financial resources to acquire equipment,
software and expertise
• Lack of technical expertise to design strategies and
evaluate options
• Inadequate physicanfrastructure, eg. power supplies,
telecommunications, adequate buildings with
air-conditioning
• Lack of awareness of need for, or benefits from,
change
• Inadequate human resources to manage and operate
enhanced systems
• Organizational and institutional structure poorly suited
to either integrated systems or the use of information
technology
• Inability to sustain systems after the end of external
support
• Resistance to change from persons with a perceived
vested interest
33
substantial resources, which are already operating quite
sophisticated systems. At the other end there are
countries which have been involved in civil wars, where
the whole administrative system and economy have
collapsed, and there are virtually no resources.
Clearly what is feasible, and the implementation
strategy, must be country-specific. Nevertheless there
are a number of general features of the problems, and
also of approaches to change, which can be made.
These are summarized below.
Strategies
• Most LDCs will require external financial and technical
support to move towards integrated financial
management systems
• As above, there is need for external design studies
• Proposed systems must recognize physical
constraints, and either (i) operate within them, or (ii)
provide resources for improvement
• There is no point in attempts to “impose” systems,
since they almost inevitably fail. Rather, the approach
should be to work with recipient governments to
identify needs and develop appropriate strategies
• The issue has already been addressed of the ability of
modern technology to reduce demand for human
resources. Nevertheless, new skills are required, and
there must be a strategy to meet these needs
• The strategy must either embrace organizational and
institutional change (in which case host government
support is essential), or work within these constraints
There is a need to analyse carefully the causes of past
failures and to draw on these lessons in developing a
strategy. Any strategy for change which does not
recognize historic problems and have specific methods
of avoiding the same mistakes must inevitably fail
• It is common in any change situation to find individuals
or groups that oppose it. Change management is a
whole range of techniques designed to overcome
these obstacles, and its application becomes even
more important in LDCs
 34
This section will focus on the different aspects of
change, as identified above.
Physical constraints and their
resolution
In many LDCs physical constraints are a real
problem. For example, in one LDC there are 75
districts, each with its own treasury office. Of
these, 17 had no telephone connection, while only
eight had an official vehicle, despite the fact that
they are responsible for the internal audit of more
than 4,000 field paying offices. Undoubtedly, an
even smaller proportion of the field offices have
telephones, and many operate without any means
of communication with the outside world except by
walking. In some LDCs supplies of government
forms are limited, and copies have to be purchased
in the market. Even in a wealthy LDC, some
remote districts can lack telephone and electricity.
Government offices in many LDCs are low quality,
and badly maintained. Air-conditioning is rare,
despite extensive problems of dust and humidity.
These environmental problems create difficulties
for upgrading financial management systems. Poor
communications delay the transfer of information.
Exhibit 72. Physical progression of changes
Under this model, in the initial stages, there is likely to carrying out this exercise, four factors need to be taken
be as much emphasis on upgrading manual systems as into account:
on developing computer-based systems. However, in • Σπεχιαλ χονσιδερατιον νεεδσ το βε γιϖεν το
Unreliable electricity supplies and voltage
fluctuations cause computer problems. Dust and
humidity create problems, even for modern,
environmentally tolerant computers. In general the
poor working environment is not conducive to
developing modern financial management systems.
There are two options: either to upgrade office
facilities or to work with the existing problems.
Most projects have to accept some compromise,
with some upgrading, but usually not extending to
all offices. Also some problems, such as lack of
electricity or telephone links, may be outside the
control of a financial management upgrading
programme.
It must be accepted that in most LDCs many field
offices will continue to operate manual systems for
the foreseeable future. The pattern is likely to be a
progressive move outwards of computer systems
from the centre. Concurrently, improvements can
be made to manual systems, eg. by using
intermediate technology–manual add-listing
machines, better-designed forms, card index
systems and so on. Thus the pattern may be as
indicated by the model below.

τηε ιντερφαχε βετωεεν µανυαλ ανδ χοµπυτερ
σψστεµσ, εσπεχιαλλψ ωηεν σοµε χοµπονεντσ,
εγ. περσοννελ, µαψ µοϖε βετωεεν τηε σψστεµσ;
• Outlying computer systems are likely to be simpler
than those at the centre (eg. stand-alone PCs in the
former), but still need to be able to exchange data
with each other;
• Portable notebook computers are often a more
viable solution in remote areas because (i) they tend
to be tougher and more environmentally tolerant, (ii)
they have built-in batteries which can normally
operate for several hours, and (iii) in the event of
mechanical failure, they can be transported easily
for repair;
• New manual systems in the field locations need to
be fully compatible with new central computer
systems, and hence both need to be designed
together.
Exhibit 73. Benefits of good financial management and costs of weak financial management in government
35
In practice integration is unlikely to involve
computerization at all locations in the short to medium
term and therefore integration between manual and
computer-based systems will be essential.
Measuring the benefits of good
financial management when applied
to governments
It is necessary to be able to identify indicators of
improvements in financial management. This raises the
more general problem of how to identify indicators of
success in improvement programmes, against which
progress can be measured. As a starting point, Exhibit
73, below, identifies the primary benefits of good
financial management in government and conversely
the costs of weak financial management.

Benefits of good financial management Costs of weak financial management

Sound financial basis for medium-term and annual fiscal Inadequate financial planning framework with no medium-term
planning and management, and framework within which horizon, lack of basis for sound fiscal planning and resource
broad economic policies can be structured and broad resource allocation decisions, leading to ad hoc allocation decisions and
allocations planned weak fiscal management
Enhanced resource mobilization; domestic through improved Poor resource mobilization: low rates of tax collection compared
tax collection foreign through improved utilization of official
to GDP; failure to properly mobilize and utilize foreign resources
and private inflows
More optimal allocative efficiency in terms of focusing on Poor allocative efficiency, typified by a large number of
priority activities and allocating adequate resources to suchinadequately funded projects and recurrent activities
activities
Efficient release of funds ensuring minimal delays, and Delayed and inefficient fund release, funds often not used in
release in accordance with priorities as laid down in budgetsaccordance with budget allocations
and laws
Effective and prompt monitoring of expenditure and revenue Lack of timely or reliable financial information on expenditure
receipts to ensure that objectives are being achieved in and collection, making effective monitoring difficult or
conformity with plans ineffective
Clear linkage of financial expenditures to physical measuresFailure to link expenditure to physical targets, and hence
of achievement inability to monitor progress effectively
Procedures ensure propriety of expenditure in accordance Inadequate
with measures to ensure propriety of expenditure,
government policies and procedures, with minimal system extensive system leakages and malpractices
leakages
Effective cash management to minimize government short-Ineffective cash management leading to short-term borrowing
term borrowing requirements and to maximize interest inflows and periodic and unanticipated cash shortages

Many of the costs identified in this matrix will be
familiar. For example, Nepal typically utilizes only 30
per cent of official development aid, and has one of the
lowest tax-to-GDP ratios in the world (though both
ratios are improving).38/ Many LDCs have over a
number of years consistently failed to forecast correctly
their budget surplus or deficit. Again, many LDCs have
far too many projects driven by donors rather than
effective government management, and most are
notorious for the leakages from the system and the
extent of improper expenditure. Again citing Nepal, the
“irregular payments” reported by the Auditor General
amount to a cumulative total of more than six months
expenditure.39/
While the benefits and costs are well known, it is much
more difficult to identify measures of these
benefits/costs, and hence to establish benchmarks
against which progress can be measured.
36
Many financial management improvement projects tend
to have as output measures physical targets which are
merely intermediate steps. For example, developing a
budget is not in itself a benefit. Benefits must be
defined in broader terms, for example improved
financial and resource planning, enhanced utilization of
domestic and foreign resources and more optimal
resource allocation. Indeed, ultimately all activities
should lead to the broad objective of welfare and
distribution improvements for the population as a
whole.
Clearly in moving from narrow and specific activity
outputs, the range of external variables which can
impact on the benefit increase, to the point where it
becomes meaningless to attempt to identify any direct
causal linkage between activity and benefit. The
objective is to identify intermediate measures, where
external factors can be identified and substantially
eliminated, and yet which can act as surrogate measures
of the benefits. This is represented in the model in
Exhibit 74, below.

Exhibit 74. Model of measurement of activity-benefits relationship

Project activity, Immediate output,

eg. run budget eg. participation in
workshops workshops

Surrogate measures of benefit,

eg. perceptions of budget process,
predictive reliability

From this model, certain conclusions can be drawn: income inequality or one which promotes average
• Immediate outputs (“deliverables”) are a useful economic growth?
External InUltimate benefit, eg.
measure of whether the activity has been properly most situations intermediate measures need to be
more optimal resource allocation decisions
variables
performed, but typically provide little information identified which are amenable to normative evaluation
on ultimate benefits; and not subject to too many external variables, yet
• Ultimate benefits are the ideal measure, but in most provide surrogate measures of the ultimate benefits.
situations they are influenced by so many external As an example from a financial management
variables as to provide little evidence of the impact improvement project in an LDC, the four functional
of the activity; also, or alternatively, they may not areas for improvement and related benefits are
be amenable to objective measurement, eg. is a identified in Exhibit 75, below.
more optimal resource allocation one which reduces
Exhibit 75. Functional activities to benefits cross-walk

Financial Budget more effective tool for

Budget
Rules and resource allocation, prediction
management Enhanced
Enhancedgovernment
control over
cash
improvements
Project accounting
procedures
information government
flow through
activities
reduction
at micro
in
improvements
system team

Moving from benefits to surrogate measurable
indicators is not always easy. For example, the financial
management information system should lead to “better
control over government activities at a micro and macro
level.” How can this be measured? There are no
obvious direct measures, so a surrogate measure must
be sought. Improved control should be exhibited by
more timely and focused control actions utilizing the
new information available. These could not be
evaluated in quantitative terms, but they are sufficiently
objective to be amenable to evaluation through a
process of analysis of control decisions before and after
the reforms.
However, this points to the need for “before” measures
as benchmarks. It is essential before the start of the
reform process to carry out a study which could be
replicated after the changes, so as to measure the
improvements (if any).
The implications of this analysis are:
• Attempts to measure benefits cannot replace
“deliverables” as direct output measures of progress.
They are complementary, not alternative, measures;
• If there is to be a serious attempt to measure
benefits, they need to be identified at the project
design stage;
• Target benefits need to be agreed with the recipient
government to ensure a convergence of goals;
• Benchmarking studies need to be carried out before
the start of the reforms, and replicated at a later date
to evaluate impact;
• Such studies have a cost which must be allowed for
in the project budget.
37
More reliable financial
information and
The need for, and approach to, external
support
The responsibility for financial management, as with all
government activities, lies with the government
concerned. It is the responsibility of that government to
identify a need for enhanced financial management, and
then to identify resource requirements and, if
considered appropriate, seek external assistance.
However, in that process, governments are likely to be
influenced by external factors. These will include
pressure from international organizations, eg. the IMF
for improved fiscal control, the World Bank for
improved project accounting, and donor agencies
generally because of problems of disbursement and
management of aid funds.
In most cases, and ideally, there will be a convergence
between the problems identified by government and the
views of donor organizations. Financial management
upgrading programmes are most likely to succeed in
this situation; they are least likely to succeed where
they are “imposed” by donor organizations as a
condition of other support.
Although governments may be aware of problems with
components of the financial management system, they
are unlikely to have a clear concept of the nature of the
required changes. Nor in general is there a vision of an
integrated system. This is because most administrative
training in government has failed to emphasize the
significance of public-sector financial management, and
most staff training courses treat accounting and
budgeting as separate, routine exercises where the
major emphasis is on learning rules and regulations.
In general, donor organizations are willing to support
financial management improvement programmes. From
the perspective of donors such programmes are likely to
meet a number of objectives.
• Νατιοναλ εχονοµιχ ανδ φισχαλ µαναγεµεντ
ανδ πλαννινγ αρε λικελψ το βε ιµπροϖεδ, αν
ιµπορταντ οβϕεχτιϖε φορ µαϕορ µυλτιλατεραλ
αγενχιεσ συχη ασ τηε Ωορλδ Βανκ ανδ ΙΜΦ;
• Governments’ capability to allocate resources to
priority areas will be enhanced;
• Governments’ ability to manage aid funds and
report on projects will be enhanced, always a matter
38
of concern to all donors because of their own
internal audit and reporting requirements;
• Accountability and government will be enhanced, a
specific priority of some donors, such as the British
official development assistance.
Hindrances to good financial management
These may include:40/
• Λαχκ οφ ρεσουρχεσ, βοτη ηυµαν ανδ
οτηερωισε;
• Outdated systems which work imperfectly;
• Inability to recruit and retain skilled staff at
prevailing rates of remuneration;
• Lack of integration between systems;
• An environment which allows corruption and
financial management by the privileged; and
• Lack of commitment by senior management to good
financial management.
To the extent that these factors apply, there is a need for
a change of basic policies. For instance, a regime
committed to good governance would not only seek
improvements in government financial management; it
would also seek changes in related areas, eg. improved
public accountability, reduced corruption, judicial
reform etc., which would be conducive to greater
demands for good financial management. This would be
a way of starting a virtuous circle of improvement. In
countries in which corruption is not a serious
impediment, but where resources are scarce, policies to
make the human factor more effective are likely to have
an important impact on financial management. These
would stress high-quality training, the creation of career
conditions favourable to the recruitment and retention
of skilled staff and proper staffing of financial
processes. Despite the lack of resources, such policies
are possible. Nevertheless, some aspects of financial
management remain difficult to improve without
external assistance, which is the subject of the
following section.
Sources of assistance and steps in the process
Sources of assistance can be subdivided by source
(multilateral or bilateral) and method of funding (grant,
loan). Some bilateral grants are available only in the
form of commodities, eg. equipment, food. Major
multilateral sources include the World Bank, the United
Nations Development Programme (UNDP), the
International Monetary Fund, the European Union and
regional development banks such as the African
Development Bank, the Inter-American Development
Bank and the Asian Development Bank. Bilateral
sources are the governments of individual donor
countries. UNDP and many bilaterals provide grants,
sometimes in packages partly funded by loan, and
typically for purposes of technical assistance. The
World Bank and regional development banks provide
“soft” loans (ie. loans at below-market interest rates
with concessional repayment terms) to countries where
per capita income is low. Sometimes projects are
financed by a mixture of full interest-bearing loans and
soft loans.
For obvious reasons, most governments tend to prefer
grants to loans. Since they are generally available for
technical assistance projects, and financial management
improvement programmes come within this description,
grant funding is common. However, this is unlikely to
cover the cost of a major upgrading of physical
facilities, for which loan funds are likely to be required.
The procedures applicable to assistance vary in detail
from donor to donor. The responsibility for
identification, design and implementation of a financial
management upgrading programme rests with the
government of the country concerned.41/ The
government does not necessarily carry out all these
aspects alone, and outside experts are usually employed
in all three phases. However, it does mean that
government has the ultimate say in identifying needs,
choosing the means and taking the necessary actions to
address those needs.
The World Bank project cycle has six phases:
• Ιδεντιφιχατιον: τηισ προϖιδεσ τηε προϕεχτ
χονχεπτ ιν τερµσ οφ τηε νεεδσ το βε αδδρεσσεδ,
τηε οβϕεχτιϖεσ οφ τηε προϕεχτ, τηε εξπεχτεδ
ουτχοµε, α ρουγη ινδιχατιον οφ τηε ινπυτσ ανδ
τηε προποσεδ µετηοδσ ανδ αππροαχη;
• Preparation: this reflects mutual agreement on the
project concept. After consideration of the technical,
economic, social and institutional aspects of the
project, a project document is drawn up;
• Appraisal: this is a comprehensive review of the
project which tests for viability, technical validity,
cost-effectiveness etc.;
 39

• Approval: having made final adjustments to

improve the project, the parties to the agreement
discuss conditions, legal obligations and
procurement issues and finally approve the project;
• Implementation: funds are now made available to
acquire the inputs needed for implementation.
Appropriate staff carry out the project in accordance
with plans, and report regularly on financial and
non-financial progress.;
• Evaluation: this normally occurs after the project is
completed. It is assessed in terms of its benefits,
costs, outputs and sustainable results, so that lessons
of experience can be passed on to future projects.
Change management
Most projects fail. This bald statement applies to
projects by most consultants and with most donors,
because, though the original technical reforms may be
achieved (and even this is the exception), systems tend
to degrade once external support–financial, technical
and managerial–is removed.
This problem is not unique to projects in LDCs. As
management has become more dynamic, more prone to
change, the problem of achieving and sustaining change
in organizations has become a major issue, and has
spawned its own jargon term–”change management.”
This is not a separate issue that can be dealt with by
calling in a change management expert (though such a
person may well be needed). It is a fundamental part of
project implementation and management.
The term “change management” is used to refer to the
management of the process of transformation that is
required to achieve the changes implicit in any reform
programme. It embraces a number of distinct aspects of
change that have to be dealt with within any project, as
summarized in the model in Exhibit 76, below.
40
Human resource changes
Exhibit 76. Change Management Model
Technical
Initial Organizational changes
system
status
Attitude changes
Identify Identify Agree
change benefits and project plan
drivers stakeholders and
The checklist below is developed from one used by the
UK Department for International Development (DFID),
and provides a useful summary of the issues to be
addressed. It should be read in conjunction with the
above diagram.
• Αρε τηε ποτεντιαλ υσερσ αωαρε οφ τηε πυρποσε
οφ τηε αχτιϖιτψ ανδ ισ τηειρ περχεπτιον οφ
ωηατ ισ το βε αχηιεϖεδ τηε σαµε ασ τηατ οφ
τηε προϕεχτ τεαµ?
• Αρε τηε οβϕεχτιϖεσ οφ τηε αχτιϖιτψ βεινγ
υνδερτακεν χλεαρλψ δεφινεδ ανδ αγρεεδ ωιτη
τηε ποτεντιαλ υσερσ?
• Ηαϖε αλλ κεψ στακεηολδερσ βεεν ιδεντιφιεδ
ανδ µαδε αωαρε οφ τηε αχτιϖιτψ?
• Ηαϖε γοϖερνµεντ ρεπρεσεντατιϖεσ βεεν
απποιντεδ το ωορκ ωιτη τηε προϕεχτ ανδ
χηαµπιονσ οφ τηε παρτιχυλαρ αχτιϖιτψ βεεν
ιδεντιφιεδ?
• Ηαϖε προϕεχτ µαναγεµεντ, πλανσ ανδ ουτπυτσ
βεεν αχχεπτεδ ανδ αγρεεδ?
• Ηασ τηε ιντερφαχε βετωεεν τηε αχτιϖιτψ ανδ
ανψ συππορτινγ αχτιϖιτιεσ βεεν χλεαρλψ
ιδεντιφιεδ ανδ τηε τιµινγ οφ δεπενδεντ
ασσοχιατεδ αχτιϖιτιεσ αχχεπτεδ ανδ χονφιρµεδ
(φορ εξαµπλε τραινινγ)?
• Ηασ α τιµεταβλε φορ δελιϖερψ, ινχλυδινγ κεψ
µιλεστονεσ, βεεν σετ υπ ανδ αγρεεδ ωιτη τηε
θυαλιτψ ασσυρανχε τεαµ?
• Ηαϖε θυαλιτψ ασσυρανχε προχεδυρεσ βεεν
ιδεντιφιεδ ανδ δο τηεσε ινϖολϖε γοϖερνµεντ
ρεπρεσεντατιϖεσ?
• Ιs there a strategy for ensuring that the changes are
not merely technical, but achieve the anticipated
management benefits?
• Ηασ αναλψσισ τακεν πλαχε οφ ηοω τηε
αχτιϖιτψ ισ το βε µαινταινεδ ανδ συππορτεδ
Terminal
system
status
S
T •Communication
A Quality
•Building consensus
K assurance
•Human resource
E and approval
H management
O •Skills transfer procedures
L •Task related
D training
E •Participation
R Agree
S outputs and
Plan institutional Exit strategy leaving
and support sustainable project
milestones
ποστ−ενδ προϕεχτ ανδ αγρεεµεντ φροµ τηε
γοϖερνµεντ τhat this will take place (in IT
orientated activities this may well include a
commitment to agree to a maintenance contract from
the outsourced software vendor)?
• Ισ τηερε α φινανχιαλ στρατεγψ φορ τηε χοστ οφ
τηε προϕεχτ αχτιϖιτιεσ αφτερ τηε ενδ οφ τηε
προϕεχτ?
• Ισ αν εξιτ στρατεγψ ιν πλαχε φορ χονσυλταντσ
ωηιχη ωιλλ λεαϖε συσταιναβλε προϕεχτ
αχτιϖιτιεσ ιν πλαχε?
To properly address change-management strategies that
lead to sustainability takes longer than simply
implementing technical changes. This is often ignored
by donors, and recipient governments tend even to
refuse to accept that there is a problem. It is tempting to
rush in with a technical solution, eg. a new computer-
based accounting system, when the real issues, eg.
management, institutional, human resources, are being
ignored.
Much accounting reform involves new technology.
There is no question that modern IT tools provide
enormous potential for systems improvement, but it is
always necessary to look at sustainability. In
Bangladesh, the authors used Foxpro in preference to
MS Access because local support and development
were available for the former. In Nepal, clients had
abandoned earlier database systems in favour of simple
spreadsheets which they understood.
In developing and installing systems, questions need to
be asked.
• Χαν τηε σοφτωαρε/ηαρδωαρε βε συππορτεδ
αφτερ τηε χονσυλταντσ λεαϖε, εϖεν ιφ σταφφ
αρε τρανσφερρεδ?
• Σηουλδ αδϖανχε αγρεεµεντ το τηε γοϖερνµεντ
βυψινγ ιν σψστεµσ συππορτ ανδ µαιντενανχε βε
 41

σουγητ ασ α χονδιτιον οφ τηε προϕεχτ, ανδ ιφ Stakeholders in financial management

σο ωηατ σψστεµσ χαν βε συππορτεδ βψ λοχαλ
φιρµσ?
• Σηουλδ α λοχαλ φιρµ βε ασκεδ το δεϖελοπ τηε
σψστεµ, προβαβλψ ωιτη χονσυλταντ συππορτ?
• Ηοω ωιλλ τηε σψστεµ βε οπερατεδ ωηεν
χυρρεντ σταφφ αρε τρανσφερρεδ?
• Ωηατ ισ τηε ηιστορψ οφ οτηερ ΙΤ προϕεχτσ
ωιτηιν τηε χουντρψ, ανδ ωηατ λεσσονσ χαν βε
λεαρνεδ?
The biggest hindrances to reforms and sustainability are
typically organizational, institutional and managerial.
Bureaucracies are inherently opposed to change, and
become major barriers to reform and sustainability. Yet
within almost all organizations there are change drivers
and champions of change. These must be identified and
their support elicited.
Organizational, managerial and institutional barriers to
change must be identified and addressed. At the very
minimum they are identified risk factors. There are
always strategies to remove or reduce such barriers. For
example, staff transfers are a problem in many
countries. Ideally the transfer policy should be changed,
but if that is not feasible (and it should always be
recommended if desirable), then agreement to
restricting transfers during project implementation, and
methods for training new staff in the future, will reduce
their impact.
A stakeholder is any person, group or institution that
has an interest in, for example, a financial management
upgrading programme. This definition includes both
intended beneficiaries and intermediaries, winners and
losers, and those involved in or excluded from decision-
making processes. Stakeholders can be divided into two
very broad groups.
• Πριµαρψ στακεηολδερσ αρε τηοσε ωηο εξπεχτ
το βενεφιτ φροµ, ορ βε αδϖερσελψ αφφεχτεδ βψ,
αιδ. Τηεσε αρε διφφιχυλτ το ιδεντιφψ ιν α
φινανχιαλ µαναγεµεντ υπγραδινγ προγραµµε,
βεχαυσε τηεψ αρε ιν εφφεχτ τηε ωηολε
ποπυλατιον.;
• Secondary stakeholders are the departments and
ministries involved in the upgrading programme, and
those who expect to gain from improved financial
management, eg. donor organizations. In practice
financial management programmes focus on
secondary stakeholders.
In general terms, stakeholders are groups of people who
share a common interest, for example “the consultancy
company,” “the project management,” “the Ministry of
Finance,” “the local authorities,” etc. Analysis might
conclude that the concept of “government officer” is
meaningless because there are so many different
interests between departments or individuals which may
be stronger than commitments to the institutions as a
whole. Thus government officers would have to be
subdivided into different stakeholder groups. Exhibit 77
below provides an example of stakeholders.

Exhibit 77. Accounting IS stakeholders and institutions

Institution Stakeholders Interest and power Likely attitude
• Finance Senior officers Users of system and Support from top level.
division information – control (top Lower levels suspicious
level) and influence (lower of technology and impact
levels) on jobs.
• Controller All accounting Operators of accounting Generally supportive of
general of officers and staff system – control (top level) changes, though some
accounts and influence (lower levels) concern about new
technology and its impact
• Comptroller All audit and Constitutional responsibility Generally supportive of
and auditor accounts cadre for form of accounts. Control changes, though
general (note overlap over cadre. Audit concerns as above
CGA officers) responsibility
• Line Principal Statutory responsibility for At present little interest
ministries accounting officer accounting and expenditure in changes, since they do
within division. Major user of not impact on perceived
information. role
42
Institution Stakeholders
• Etc.
Participation by stakeholders contributes to the chances
of financial management upgrading programmes being
effective and sustainable because:
• By drawing on a wide range of interested parties,
the prospects for appropriate project design and
commitment to achieving objectives are likely to be
maximized; and
• People are more likely to be committed to carrying
on the activity after external support stops, and more
able to do so given that participation itself helps
develop skills and confidence.
Stakeholder analysis is a tool which helps discover the
key stakeholders in financial management upgrading
programmes. It is the first step in helping decide who
should be encouraged and assisted to participate.
Stakeholder analysis aims to:
• Ιδεντιφψ ανδ δεφινε τηε χηαραχτεριστιχσ οφ
κεψ στακεηολδερσ;
• Assess the manner in which they might affect, or be
affected by, the programme/project outcome;
• Understand the relations between stakeholders,
including an assessment of the real or potential
conflicts of interest and expectation between
stakeholders; and
• Assess the capacity of different stakeholders to
participate.
The outside intervention by a donor agency, bringing
additional resources into an area, may in itself create
new stakeholder groups. Stakeholder analysis differs
from institutional analysis, which is concerned with
looking at the appropriateness and effectiveness of
institutional arrangements and assessing the strengths,
weaknesses and development needs of individual
organizations.
As an example of stakeholder conflict, to achieve the
benefits of financial management upgrading, there may
be a requirement to reduce the size of the workforce and
pay higher salaries (and thus enhance motivation) to
those remaining. Without careful planning, it is likely
that staff faced with redundancy will resist reform; this
can be overcome either by redundancy packages or by a
commitment to reallocate all staff without redundancy
or demotion.
Interest and power Likely attitude
Checklists for enhanced participation
This section identifies some of the steps to be taken to
enhance the participation of stakeholders in financial
management upgrading programmes and to develop a
stronger partnership with those government institutions
that are involved in the programme (and hence
intermediary stakeholders, since the primary ones, the
public, are not generally accessible). This particularly
applies to that institution (the sponsor) which has the
main interest and responsibility for implementing the
project, eg. the Ministry of Finance.
• Ινστιτυτιοναλχαπαχιτψ: a project’s first phase
may need to focus on developing institutional
capacity;
• Conflict management: negotiating systems may
need to be developed for handling conflicting
interests between different groups of stakeholders;
• Transparency: all stages of project activities must be
publicly visible, including decision-making processes;
• Decision-making: institutional mechanisms must be
established to consult people in defining problems,
before the goals and purpose of the project are
irrevocably set;
• Identify sponsor institution: at project identification
stage, ensure that there is at least one stakeholder
institution (or a number of people within that
organization) really committed to the idea of the
project;
• A shared vision: attempt to involve a wide range of
staff from the sponsor institution. Seek agreement
on the project’s goal and purpose;
• Project design: consider providing the opportunity
for sponsor and other key stakeholders to visit
similar projects elsewhere in the world; and also
consider establishing a pattern of exchange visits
between countries;
• Consultants: make full use of local consultants
wherever possible for project preparation;
• Stakeholder analysis: with the partner (sponsor)
institution, identify the key stakeholders in the
project and agree how they can be involved in the
project design;
• Planning workshops: with the sponsor institution,
and assistance of a local facilitator, organize a
planning workshop for all significant stakeholders;
• Risk analysis: with partner institution and other
identified stakeholders, identify and rank the
principal sources and types of risk and agree a risk

management plan;
• Process approach: identify which elements of the
project need a process approach; ensure sufficient
time and resources for institution-building in
sponsoring organization and with other stakeholders.
Communications strategy
Effective communications form an important part of
building support for change, since much opposition is
often founded in ignorance or a perception of exclusion.
The following approaches to communication may be
utilized:
• Ωεεκλψ µεετινγσ οφ χονσυλταντσ ωιτη γοϖερνµεντ
οφφιχερσ ινϖολϖεδ ιν τηε προϕεχτ το σηαρε
ινφορµατιον ανδ ϖιεωσ;
• Ρεγυλαρ µεετινγσ οφ ανψ τεαµσ;
• Ρεγυλαρ µεετινγσ οφ τηε στεερινγ χοµµιττεε ορ
ιτσ εθυιϖαλεντ;
• Ινφορµαλ µεετινγσ ωιτη σενιορ οφφιχερσ το
δισχυσσ ανδ αγρεε χηανγεσ, ινχλυδινγ αλλ
ιδεντιφιεδ στακεηολδερσ;
Exhibit 78. Risks
Likelihood
Risk of risk situation
occurring
• Ιναδεθυατε τοπ−λεϖελ Low–commitment in
γοϖερνµεντ χοµµιτµεντ το PFP and other policy
φινανχιαλ µαναγεµεντ ρεφορµσ papers
• Χοντινυινγ ηιγη λεϖελ οφ High
σταφφ τρανσφερσ αχροσσ τηε
χιϖιλ σερϖιχε
• Ετχ.
The process approach to financial management
upgrading
Participation in projects with a process approach is
likely to be more significant throughout the project
cycle because planning is iterative.
A project with a participatory process approach is
characterized by the following:
• Χοµπρεηενσιϖε ασσεσσµεντ οφ σεχτοραλ ανδ
ινστιτυτιοναλ χαπαχιτψ, ϕοιντλψ σηαρεδ
βετωεεν κεψ σεχονδαρψ στακεηολδερσ;
• Mutual understanding and design of any support
project or main project;
• Jointly shared implementation and learning process
between relevant donors and the recipient country’s
implementing agency(ies);
• Building of capacity at individual and institutional
and possibly sectoral level;
• Reviews and evaluation which include all key
43
• Α προγραµµε οφ πρεσεντατιονσ ασ
αππροπριατε ον σπεχιφιχ χηανγεσ το χονχερνεδ
περσονσ;
• Μεετινγσ ωιτη σταφφ γρουπσ;
• Μεετινγσ ωιτη τηε παρλιαµενταρψ αχχουντσ
χοµµιττεε, ορ ιτσ εθυιϖαλεντ;
• Α νεωσλεττερ φροµ τιµε το τιµε συµµαριζινγ τηε
προϕεχτ αχτιϖιτιεσ.
Any meeting should have a procedure for taking either
minutes or at least a note of any decisions taken or
issues to be followed up, and for quickly distributing
them.
Risk analysis
Risk analysis is not strictly part of change management,
but it is linked in that the risks typically relate to
change-management issues. It is important to identify
risks at the design stage, within inception reports, and
on an ongoing basis within monthly or other
intermediate reports. A useful framework for analysing
risks is provided below.
Impact of risk Strategy to reduce
occurring on risk and impact if
achieving objectives situation occurs
High None
Potentially serious Ongoing training
stakeholders;
• Designing and implementing the project to ensure
that learning takes place for all key stakeholders,
including the dnor; and
• The project having a measurable impact, with
indicators for measurement identified and agreed by
the key stakeholders.
Essentially the process approach contrasts with the
more structured, formal, output-oriented approach to
projects. It seeks to work with, and from within, the
partner organization, identifying needed, wanted and
feasible changes and helping the host develop a strategy
to achieve them. It tends to be small-scale and flexible
and fits very closely with the concept of stakeholders as
described above. In contrast, the more traditional
project approach is larger (and hence necessarily more
bureaucratic within itself), focused on achieving
predetermined outputs, more separate from the partner
organization, with the project seeking to control its own
44
activities. The latter is inevitable given the need to
attain predetermined targets, but can lead to conflict
with a partner organization seeking to manage a project.
Process approaches can work well in the context of
financial management, particularly where there is
limited institutional capacity and/or support for change.
A process approach can initiate reform as an alternative
to macro-diagnostic studies. It can also serve in itself as
a diagnostic phase for later larger-scale intervention.
Human resource development and
training
Almost all projects involve the need to improve human
resource skills and motivation. These two separate
requirements need to be clearly identified and
separated. Training can provide skills and knowledge–it
does not provide motivation.
In most projects, the benefits of formal classroom
training and lectures are minimal. Skills can best be
learned on the job, or in simulated situations in
classrooms. Formal training may occasionally be useful,
eg. learning basic computer skills, but should be used
sparingly and for specific purposes. This is not a
popular approach–in many countries formal extended
classroom training is seen as the solution to all
problems. A compromise may be provided by the
competence-based approach, which seeks to build
specific skills within an overall training and education
programme.
We are often required to implement study awards.
Historically these have little impact, and long academic
courses are the least effective of all. However, study
awards are typically as much political as technical. We
should seek to make them as effective as possible, not
least by using them for people who are likely to
champion change.
Upgraded financial management systems will not work,
nor will the benefits materialize, without attention to the
human factor. In financial management three key
groups can be identified:
• Τηοσε ωηο µακε τηε σψστεµσ ωορκ
( οπερατορσ ανδ τηειρ µαναγερσ);
• Those who receive services from the system
(“clientele”); and
• Those who use the outputs of the system (“users”).
In stakeholder terminology, both (2) and (3) above are
secondary stakeholders.
The difference between clientele and users is that the
former are passive recipients of services, eg. customers
and staff who receive money the government owes
them, while the latter are active users of services, eg.
managers who need financial information to reach good
decisions. In any analysis of financial management,
users are of great importance. Financial management
systems can be really useful only if there is a skilled
class of users in a position to use the results. Indeed,
financial management systems have to be adapted
specifically to achieve this, and often users have to be
trained to get maximum benefit from financial systems.
On the other side of the equation, operators and their
managers clearly need a range of relevant skills if
financial management is to be carried out successfully.
The acquisition, development and retention of skills
result from a combination of good training and good
management policies. As far as training is concerned,
basic skills in arithmetic and language are essential.
Higher skills vary with the type of work, which may
demand competence in communication, economics,
management, accounting, computing, public finance,
auditing information systems etc. The need is partly for
the appropriate academic ability (which may result from
academic studies), and partly for knowledge of
particular skills (which may result from professional
studies and on-the-job training). For certain financial
management jobs, eg. in accounting, auditing and
taxation, there commonly is a need for very specific
job-related training provided by specialist units attached
to appropriate government departments.
To maximize results from training, appropriate
management policies and actions are needed. For
instance, the work of financial management should be
analyzed and the duties, qualifications and experience
needed for different posts specified. Those with the
required characteristics should be recruited and then if
necessary further trained to meet job requirements. To
arrive at this result, governments frequently recognize
specialist cadres in financial management. These are
separately managed groups of professional staff, formed
to promote the development of particular professional
skills. They are governed by general civil service rules
but have their own career structures, and promotion and
transfers are usually within the cadre. The head of the
cadre is responsible for professional standards and the
professional development of its members. He is
responsible for ensuring that government’s needs for
specialist staff are met. For example, the Accountant
General usually heads the accounting cadre, and
responds to requests from other ministries for
accounting staff.
The organizational changes necessary to implement and
operate an integrated financial management system will
inevitably result in a need to retrain government
officers. Taken together with the computerization
process, which may also be associated with the
changeover, the total training requirements for

government can become very substantial. Neither will
the training be restricted to one level of officers; as the
systems are introduced it will be necessary for everyone
from senior government officials to junior staff to be
aware of their new responsibilities and duties. All
officers will need to have an appreciation of the
principles of budgetary control, financial management
and the legal regulatory framework and, where
appropriate, possess the ability to apply basic computer
techniques. It is therefore inevitable that changes within
the systems operated by government will necessitate
some retraining of personnel.
For this to be successful, a structured approach is
required in the design of training strategies, which
should include the following activities:
• Σπεχιφιχατιον οφ τηε οβϕεχτιϖεσ οφ τηε
τραινινγ προχεσσ ιν τερµσ οφ τηε κνοωλεδγε
ανδ σκιλλσ νεχεσσαρψ το περφορµ τηε ωορκ−
βασεδ τασκσ;
• Preparation of a training needs analysis to assess
existing skills and knowledge in order to determine
the gap between them and the required skills;
• Development of a training plan to prioritize the
training needs to meet the gap; and
• Designing a programme to implement the training
plan.
Training, in this context, is perceived as an activity
relating to the acquisition of skills which will assist
staff in the performance of their duties in the workplace.
This approach is known as competence-based training.
Competence-based training
Competence-based training is a move away from the
traditional knowledge-based training to training where
the ability to perform tasks within an occupation is
emphasized. It requires that the skills acquired should
be clearly relevant to the workplace and is intended to
facilitate progression within employment. To be
“competent” a person must demonstrably possess:
• Σκιλλσ το σπεχιφιχ στανδαρδσ;
• Relevant knowledge and understanding;
• The ability to use skills and apply the knowledge;
and
• Understanding, allowing the performance of relevant
tasks.
An essential ingredient of competence-based training is
that the standards should be set in consultation with
employers and not by the trainers. A partnership exists
between the providers and users of training which
ensures that competence and achievement are
45
recognized and rewarded.
The basic assumption of competence-based training is
that training through appropriate work performance can
be improved, providing that people are aware of what is
expected of them and that their performance at work
can be assessed reliably against standards of
competence. This approach has, in general, resulted in
greater flexibility in training, an improvement in the
identification of training needs and an involvement of
staff in the overall performance (and therefore
efficiency) of organizations. This is to be welcomed,
although it should be noted that the transformation
process from a traditional knowledge-based structure to
a competence-based one can be fraught with problems.
Four areas require specific attention in the design of
competence-based programmes:
• Τηε στανδαρδ−σεττινγ προχεσσ. Στανδαρδσ οφ
χοµπετενχε σηουλδ βε ρελεϖαντ το τηε νεεδσ
οφ εµπλοψερσ/δεπαρτµενταλ ηεαδσ, ωηο
σηουλδ βε ινϖολϖεδ ιν τηε σεττινγ προχεσσ το
ενσυρε τηατ τηε τραινινγ ισ ρελεϖαντ το τηε
εµπλοψεε σ ωορκ;
• Assessment procedures. Training without an
assessment of the output is of limited use. The
benchmark should be predetermined standards of
competence, with candidates being assessed as
either “competent” or “not yet competent” in the
work-based activities they undertake.;
• Provision of trainers. For training to be effective, in
terms of improving performance, trainers must
understand the key concepts and issues involved in
the development of competence-based programmes.
They need to appreciate how standards are
developed and their application, and be skilled in
assessing performance against those standards;
• Alternative sources of evidence. Competence may
be demonstrated in different ways, including natural
performance in the workplace, case-studies which
simulate activity in it or a common assessment
process to verify a candidate’s underpinning
knowledge. The acceptance of alternative sources of
evidence provides an opportunity for greater
flexibility within the design of training programmes
for individual staff members.
46

Development of training programmes
Once the training plan has identified the training
priorities it will be necessary to develop the training
programmes. The methodology adopted should,
wherever possible, be competence-based and driven by
the user departments, which must specify the standards
their officers must achieve in order to be considered
competent. These will form the foundation on which the
course is designed. The efficacy of the programmes will
be tested at the pilot stage which may result in an early
modification to the training programme. All
programmes should be subject to evaluation and an
assessment of the competence of the trainees. This
phased approach can also be viewed diagrammatically
as a training model.

Exhibit 79. The competence training model

Evaluation and Pilot delivery of

assessment training programme

Outgoing delivery Modifications to

of training training programme

It can be seen from the diagram that modifications in Conclusion

training programmes are triggered by two events: (i)
user departments indicating that current practices have Financial management systems are not capable of
changed and/or (ii) trainers identifying improvements to sustaining their existence without trained and competent
the existing training practices. staff. Competence-based training is a mechanism for
This clearly illustrates that a fully integrated financial providing personnel who will be able not only to assure
management system must encompass the training the continuity of the system but also to contribute to its
function. Management systems are dynamic, in that future improvement.
they develop over time, and this in turn leads to
modifications in working practices. Training is
necessary to ensure that the changes are adopted and
correctly executed within the system. Without training
it is doubtful that the system will be able to continue to
operate effectively.
Organizational, institutional and (HRM) policy to make effective use of the newly
acquired skills. The problem in many LDCs has been of
human resource management issues training without adequate consideration of the HRM
Training in isolation is demonstrably not effective. It aspects. Particular problems have included:
must be integrated with a human resource management

• Τραινινγ τηε ωρονγ περσονσ, φορ εξαµπλε
σενδινγ οφφιχερσ ον τραινινγ οϖερσεασ ασ α
ρεωαρδ φορ σερϖιχεσ;
• Training persons in techniques which they cannot
apply because the new techniques have not been
adopted in government procedures; and
• Training staff who are quickly reassigned to other
tasks.
A major problem is that public-sector administration
has traditionally been regarded as a generalist activity,
for which specific skills are not required. Therefore
officers should be seen as being able to be transferred to
any administrative post. Since some jobs, such as
accounting and computer systems, patently require
technical skills, technical specialists have sometimes
been recruited, but outside the general management
structure, and without any promotion path.
This approach is clearly inappropriate in the context of
financial management. Officers are required who have
finance skills (eg. accounting, economics), and who
understand the computer systems being introduced.
Once acquired, these are valuable skills which have
little relevance if the person is transferred to, say, the
Ministry of Agriculture.
In addition, most LDCs have antiquated staff appraisal
and promotion methodologies which emphasize
personal characteristics rather than task performance.
These tend to militate against any strong desire on the
part of officers either to acquire technical skills, or to
perform well at technical tasks. Promotion is largely on
the basis of time-serving, obtaining appropriate
transfers and not doing anything wrong.
The very hierarchical structure of many LDC office
environments is directly opposed to the move to the
“flatter” organizational structures which modern
information technology both encourages and requires.
In Hindu countries, the “peon” (messenger) is a caste;
what happens to the caste’s members when offices use
electronic mail? In some countries there is a strong
cultural attitude that senior officers dispense
judgements, and deal with other important issues, rather
than actually perform tasks.
All of these factors may serve to make training and new
systems ineffective, or achieve less than anticipated.
They may also mean that, within a few years, computer
systems are being operated by persons with no training,
and consequently the systems degrade or fail.
Ideally these problems should be tackled at a broad
organizational level. Very often, short-term change is
infeasible, and financial management systems must be
developed to operate within the above environment.
47
Strategies must be designed to work around the
problems.
Problems encountered
Projects to improve government financial management
have a long history and are many and varied.42/ Many
have failed to achieve significant sustainable change.
The basic concept is simple enough: that external
resources can compensate for internal deficiencies.
Thus technical assistance projects provide inputs such
as skilled advisers and consultants, equipment, software
etc. Frequently encountered problems are:
• Ιναδεθυατε ιντεγρατιον βετωεεν εξτερναλ ανδ
ιντερναλ ινπυτσ;
• Inadequate skills transfer;
• Lack of appropriate counterparts for external
advisers;
• Advisers who prefer to do everything themselves
without involving nationals;
• Nationals who are trained but are then transferred to
positions unconnected to the content of training;
• Systems which work until the contract of the expert
is terminated;
• Governments which give only superficial support for
financial management improvement;
• External experts lacking the qualities necessary for
passing on skills and experience;
• Lack of sustainable results after the external inputs
come to an end;
• Failure of the host government to create conditions
for improvements in financial management; and
• Misdiagnosis of a country’s financial management
needs.
Despite such factors, projects to improve financial
management continue to attract donor support.
Conclusions
Neither the computer nor an integrated system is
sufficient in itself to transform financial management.
Indeed, there are plenty of examples in which
computers are in fact part of the problem.
It is possible to create the most sophisticated budget and
reporting system, yet fail to have any effect on the
quality of decision-making or financial management.
Studies of the impact of budgets in the private sector
have concluded that managers seek to perform well
against those measures by which their performance is
48

assessed. In the context of government financial

management, this means that it will be effective only if
managers see themselves as being judged by their
performance against the indicators in the system. If it is
a purely cosmetic exercise, and what really matters is,
for example, appeasing pressure groups, then the
system will prove ineffective. This is confirmed by the
Australian and New Zealand experience that radical
change in financial management systems is effective
when backed by a government determined to make it
work.
This document has sought to identify the scope for
enhancing government financial management systems,
 49

and to provide some pointers on approaches particularly

in developing countries. The key concepts are:
• ∆εϖελοπινγ α µορε γοαλ−οριεντεδ αππροαχη;
• Relating the system to managerial responsibility; and
• Improving capability to meet the fundamental need
for effective financial management.
 50
Endnotes
1/ Managing the Cost of Government: Building an
Effective Financial Management Structure, General
Accounting Office, Washington, 1985.
2/ INTOSAI Auditing Standards, International
Organization of Supreme Audit Institutions,
Vienna, 1992.
3/ A UN committee decides on the criteria for
determining LDC status. The criteria comprise
gross domestic product per capita and two
composite indices, the first representing human
resource development and the second industrial
diversification. The first combines four indicators,
measuring adult literacy, school enrolment, daily
supply of calories per capita and life expectancy
respectively. The second combines indicators of the
share of manufacturing in the economy, the per
capita output of electricity, the degree of export
concentration and the proportion of the labour force
in industry. Also the committee has decided to
exclude new admissions to LDC status where the
population is over 75 million. See Committee for
Development Planning, report of the 27th session,
United Nations, New York, April 1991
4/ Official development assistance is a term coined
by the Development Assistance Committee of the
Organization for Economic Cooperation and
Development, which is accepted by the donor
community. It denotes grants or loans, undertaken
by the official sector on concessional financial
terms, with promotion of economic development or
welfare as a main objective. It includes food aid,
technical cooperation, and concessional loans
where the grant element is calculated to be 25% or
more. It excludes flows from private voluntary
agencies and military flows.
5/ Government financial management in least
developed countries, Department of Technical
Cooperation for Development, United Nations,
New York, 1991 (ST/TCD/SERE/15).
6/ See for instance “Assessing the quality of
government accounts of 135 countries,” by Peter N.
Dean and Salvatore Favazza, Journal of
International Accounting, Auditing and Taxation,
1994, where recent reports on the quality of
financial management in developing countries are
briefly reviewed.
7/ See p.103 of Information Technology: the
Management Challenge, N. Caroline Daniels, The
Economist Intelligence Unit, Addison-Wesley,
New York, 1994. See also Strategic Systems
Planning for Financial Institutions: Using
Automated Solutions and Technology for
Competitive Advantages, Geoffrey H. Wold and
Robert F. Shriver, Probus Publishing Co., Chicago,
1993.
8/ See for instance, Paradigm Shift: the New
Promise of Information Technology, Don Tapscott
and Art Caston, McGraw-Hill, New York, 1993.
9/ Information Systems Strategies for Public
Financial Management, World Bank Discussion
Paper No. 193, The World Bank, Washington,
D.C., 1993.
10/ As an aside it could be argued that the
problems of managing commercial operations as
public corporations stem at least partly from the
conflict between macro-level national and micro-
level firm policy objectives.
11/ “Rolling Expenditure Plans: Australian
Experience and Prognosis” by Michael Keating and
David Rosalky in Government Financial
Management, edited by A. Premchand, IMF, 1990.
12/ Quote from a Secretary in a Ministry in one of
the LDCs in which the writers have been working.
13/ See the writings of Cooper and Kaplan, eg. The
Design of Cost Management Systems (Prentice Hall
1991) for the basis of this approach.
14/ “Activity Based Costing and its Application in
the National Health Service,” CIMA 1993.
15/ Material in this section is based on a paper
prepared by Dr. Peter Dean of the Department for
Development Support and Management Services of
the United Nations, for the Government of Cyprus
Staff Seminar on Modern Government Financial
Management, Nicosia, March 1995.
16/ IMF. A Manual on Government Financial
Statistics 1986, para 74.
17/ IFAC, Elements of the Financial Statements of
National Governments 1993, and Financial
Reporting by National Governments 1991.
18/ GFS Annotated Outline, para. 140.
19/ One of the problems of using commercial
accounting packages for government is that they
 51

rarely provide for such procedures, which are not of Technical Cooperation for Development, United
normal commercial practice. Nations, New York, 1992 (TCD/SEM.92/3, INT-
20/ Under cash accounting these are often referred 01-R79), pp. 23-26.
to as “below-the-line accounts.” 41/ Development Assistance Committee, Principles
21/ It may be argued that the expenditure review for Effective Aid, Organization for Economic
process represents over-control, in that it Cooperation and Development, Paris, 1992, p. 33.
discourages initiative for fear of subsequent 42/ The history and problems of such projects have
criticism. been reviewed in the Price Waterhouse report for
22/ IMF, A Manual on Government Finance USAID, August 1987.
Statistics, 1986. Other references
23/ Published in 1986, but there is a new draft
version summarized as an Annotated Outline and K.S. Most, “Sombart’s Propositions Revisited,”
published in 1996. The Accounting Review, pp. 722-734, 1972.
24/ System of National Accounts (1993) prepared Y. Ijiri, The Foundations of Accounting
under the auspices of the Inter-Secretariat Working Measurement, Englewood Cliffs, USA, Prentice
Group on National Accounts of the EU, IMF, Hall, 1967.
OECD, UN and World Bank. Clive Emmanuel and David Otley, Accounting for
25/ GFS Annotated Outline, para. 280. Management Control, Van Nostrand Reinhold
26/ The Economist commented on the new system. (UK), 1985.
“It could be good news for tomorrow’s taxpayers. R.B. Dew and K.W. Gee, Management Control
It is even better news for all the accountants New and Information: Studies in the Use of Control
Zealand has had to hire,” The Economist, 15 Information by Middle Management in
August 1992, p. 57. Manufacturing, The Macmillan Press Limited,
27/ Better Accounting for the Taxpayer’s Money, 1973.
Cmd 2626, London, HM Stationery Office, July J.M. Samuels and J.C. Oliga, “The Accounting
1994. Standards in Developing Countries,” The
28/ International Accounting Standards Committee, International Journal of Accounting, 1982.
Framework for the Preparation and Presentation Michael Keating and David Rosalky, “Rolling
of Financial Statements, London, 1989. Expenditure Plans: Australian Experience and
29/ Ibid Prognosis,” Government Financial Management,
30/ Ibid. A. Premchand, ed., IMF, 1990.
31/ Ibid
32/ Trueblood Report in the United States and the
Corporate Report in the United Kingdom.
33/ See note 28.
34/ STRATAC and IFMS, a paper presented to the
9th LAC Region Donor Working Group Meeting
by James P. Wesberry, Washington, September
1991.
35/ Ibid
36/ From page 1 of Creating a Government That
Works Better and Costs Less: Improving Financial
Management, accompanying report of the National
Performance Review, United States Government
Printing Office, Washington, 1993.
37/ Core Financial System Requirements, Joint
Financial Management Improvement Progam,
Washington, 1988.
38/ Official statistics produced by the Government
of Nepal.
39/ Report of the Auditor General of Nepal, 1992-
93.
40/ Obstacles to good financial management in
developing countries generally are discussed at
greater length in Foreign Aid Accountability:
Perspectives of Donors and Recipients, Department