Report No. 27576-BUL Bulgaria Country Financial Accountability Assessment September 2003 Operations Policy and Services Unit Europe and Central Asia Region Document of the World Bank Currencv Currency Unit = Leva US$ 1=Leva 1.786(as of August 31,2003) Fiscal Year January 1-December 31 ACRONYMS AND ABBREVIATIONS M A Annual Budget Act MTOSAI International Organization of Supreme AEAF Agency for Economic Analysis and Audit Institutions Forecasting IPSAS International Public Sector Accounting B&T Budget and Treasury Standards BDZ Bulgarian RailwaysCompany LM Line Ministry BEEPS Business Environment and Enterprise MoEW Ministry of Environmentand Water PerformanceSurvey MoF Ministry of Finance BFC Budget and Finance Committee MTBF Medium Term Budget Framework BNB Bulgarian NationalBank NAO National Audit Office BTC Bulgarian TelecommunicationCompany NCA National CustomsAgency CAS CountryAssistanceStrategy NEC National ElectricityCompany CBA CurrencyBoard Arrangement NRA National RevenueAgency CFAA Country Financial Accountability NSSI National Social Security Institute Assessment OBL Organic Budget Law CoA Chart of Accounts OECD Organization for Economic Cooperation CoM Council of Ministers and Development coso Committee of Sponsoring Organizations PAL ProgrammaticAdjustment Loans of the TreadwayCommission PER Public Expenditure and Institutions CPAR CountryProcurementAssessment Report Review DSK State SavingsBank PEM Public ExpenditureManagement EAD Bulgarian StateRailways PFM Public Financial Management EBF Extra BudgetaryFunds PID Public Investment Directorate EBRD European Bank for Reconstruction and PIFCA Public Internal Financial Control Agency Development PIU Project ImplementationUnit EC European Commission PMR Project ManagementReport EIB European Investment Bank PPD Public ProcurementDirectorate ESA European System of Integrated Economic RAR Revenue AdministrationReform Project Accounts ROSC Report on Observance of Standards and FESAL Financial and Enterprise Sector Codes Adjustment Loans SAI SupremeAudit Institution FMIS Financial Management Information SBA Stand-ByArrangement System SCA State CollectionAgency FMR Financial Management Reports SEBRA System for Electronic Budget GDP GrossDomestic Product tRAnasaction GEF Global Environmental Fund SIGMA Support for Improvement in Governance GFS Government FinanceStatistics and Management GOB Government of Bulgaria SOE State Owned Enterprises GTD GeneralTax Directorate SPD StateAdministrationDirectorate IAS International Accounting Standards TOR Terms of Reference IASC International Accounting Standards TSA Treasury SingleAccount Committee TTFSE Trade and Transport Facilitation in IASB International Accounting StandardsBoard SoutheastEurope ICM Implementation Completion USAID United States Agency for International Memorandum Development IFRS International Financial Reporting VAT Value Added Tax Standards IMF International Monetary Fund Regional Vice-president: ShigeoKatsu,ECAVP Country Director: Anand Seth, ECCUS Sector Director: Alain Colliou,ECSPS Sector Manager: John Hegarty, ECSPS Task Team Leader: SanjayN. Vani, ECSPS TABLEOF CONTENTS PREFACE ....................................................................................................................................... i EXECUTIVESUMMARY ........................................................................................................ i11 INTRODUCTIONAND BACKGROUND .................................................................................. 1 Relationshipto CAS. lendingprogramandpolicy dialogue with the country authorities ..........2 Objectiveo fthe CFAA................................................................................................................ Country background.................................................................................................................... 1 1 2 Government participation............................................................................................................ Scope ofthe CFAA...................................................................................................................... 3 Monitoringfuture reforms........................................................................................................... 3 PUBLICSECTORBUDGETING ................................................................................................ 4 Legal framework .......................................................................................................................... 4 Budget comprehensiveness.......................................................................................................... 5 Budgetrealism............................................................................................................................. 6 Budgetbasis and classification .................................................................................................... Budgetpreparation...................................................................................................................... 6 7 9 Multi-year budgetpreparation................................................................................................... Capital expenditure budgets ........................................................................................................ 10 Programmatic budgetpreparation.............................................................................................. 10 Budgetexecution ....................................................................................................................... Recommendations ..................................................................................................................... 11 13 CASHMANAGEMENT ............................................................................................................. 15 Operational descriptiono f cash management............................................................................ 15 SEBRA system controls ............................................................................................................ 16 Recommendations ..................................................................................................................... 17 INTERNALCONTROLS ....................................................... i................................................... 19 Legal framework........................................................................................................................ 19 Ex-post controls......................................................................................................................... 19 Financial controls ...................................................................................................................... 20 Procurement controls................................................................................................................. 21 Developments inmanagingEC funds ....................................................................................... 22 Payroll controls.......................................................................................................................... 22 22 Recommendations ..................................................................................................................... Staff resourcesand capacity relatedto intemal control............................................................. 23 ACCOUNTINGAND REPORTING ......................................................................................... 25 Accounting principles, practices, and regulations ..................................................................... 25 Organization for financial reporting.......................................................................................... 26 FinancialManagement Information System (FMIS)................................................................. 27 Recommendations ..................................................................................................................... 28 REVENUECOLLECTIONAND MANAGEMENT ............................................................... 29 Tax administration ..................................................................................................................... 29 Current arrangements................................................................................................................ 29 Tax arrears................................................................................................................................. 31 Customs administration............................................................................................................. 32 Issues intax administration ....................................................................................................... 31 INTERNAL AUDIT ..................................................................................................................... 34 Legal framework........................................................................................................................ 34 Structure .................................................................................................................................... 34 34 Working o f PIFCA .................................................................................................................... Scope of PIFCA activities ......................................................................................................... 35 36 Human resources and capacity buildinginPIFCA.................................................................... Internal audit reports.................................................................................................................. 36 Inspectorate within line ministries............................................................................................. 37 Recommendations ..................................................................................................................... 37 EXTERNAL AUDIT ................................................................................................................... 39 Legal fi.amework ........................................................................................................................ 39 Independence ............................................................................................................................. 39 Scope of audit ............................................................................................................................ 39 40 Audit process............................................................................................................................. Structure o fNAO....................................................................................................................... 40 NAOreports .............................................................................................................................. 42 Audit ofNAOfinancial statements........................................................................................... 43 Recommendations ..................................................................................................................... 44 Humanresources andcapacity buildinginNAO...................................................................... 43 LEGISLATIVE SCRUTINY ...................................................................................................... 46 Parliamentary involvement duringbudgetpreparation ............................................................. 46 Parliamentary involvement duringbudget execution ................................................................ 46 Committee proceedings ............................................................................................................. 47 Recommendations ..................................................................................................................... 47 FISCALTRANSPARENCYAND PUBLICAVAILABILITY OFINFORMATION .........48 Recommendations ..................................................................................................................... 48 ANTI-CORRUPTION PROGRAM ............................................................................................ 49 National anti-corruption strategy............................................................................................... 49 Recommendations ..................................................................................................................... 50 STATE-OWNEDENTERPRISES(SOE) ................................................................................. 51 Recent developments................................................................................................................. 51 Organization, oversight and reporting....................................................................................... 51 Accounting and budgeting......................................................................................................... 52 Internal and external audits........................................................................................................ 53 Recommendations ..................................................................................................................... 53 FIDUCIARY ARRANGEMENTS FORBANK-FINANCEDPROJECTS ........................... 55 Bank assistanceprograminBulgaria ........................................................................................ 55 Organizationof Bank-financedprojects and staffing................................................................ 55 Accounting andreporting.......................................................................................................... 56 Audit arrangements.................................................................................................................... 56 Recommendations ..................................................................................................................... 57 OVERALL FINANCIAL MANAGEMENT RISK ASSESSMENT ....................................... 58 ANNEX I .SUMMARY OFRECOMMENDATIONS ............................................................ 62 ANNEX I1 SEBRA PROCESS FLOW DESCRIPTION . ........................................................ 69 LISTOFTABLES: 7 2. Bulgaria: World Bank Operations (net o fcancellations) ........................................ 1. General Government Budget vs.Actual (1999-2001) ............................................ ..55 LISTOFBOXES: Box 2.1:Bulgaria -BudgetTimetable for 2004 ......................................................... 8 Box 2.2: Bulgaria -Hierarchy within Budget Execution System.................................... 12 Box 4.1: COS0 Evolution ................................................................................ 23 Box 3.1: System for Electronic Budget Transaction SEBRA ........................................ 16 25 30 Box 8.1: NAO and INTOSAIAudit Standards ......................................................... BOX6.1: FlowChartfor Tax Collections ............................................................... Box 5.1: Structure ofthe Chart o f Accounts ........................................................... 41 Box 12.1:Bulgarian StateRailways AD ................................................................ 52 PREFACE This report is based on the findings o f a series of World Bank missions to Bulgaria from December 2002 to March 2003 by a Task Team that included Sanjay Vani, Task Team Leader, Rossen Stefanov Papazov (ECSPS), Gopala Krishna Potluri and Janardhana Reddy Isanaka (TROIS). The Government counterpart team was led by Tzvetan Tzvetkov, Adviser (Financial Control), MoF. Other counterpart team members were Vladimir Tudjarov (PIFCA), Elena Avramova (MoF), Aneta Georgieva, (GTD), Venelin Philipov (GTD), and henRusinova (MoF). NahitZiya, Deputy Minister (MoF), was the maininterlocutor onbehalfo fthe Government o fBulgaria. The findings were drawn from interviews with public authorities and a detailed analysis of the laws and other relevant information. Government counterparts fully supported the CFAA mission and engaged with the Bank team in a comprehensive dialogue. The Bank i s grateful to the Government o fBulgaria for this cooperation. Purposeof the Report CFAA reports consider the strength o f financial accountability in both the public and private sectors. However, given the comprehensiveness o f the recent Report on Observance o f Standards and Codes -Accounting and Auditing--the CFAA for Bulgaria did not review private sector issues. Rather, the report focuses on whether the public sector framework, as designed and practiced, can ensure proper use and reporting of Government resources, along with those from the Bank and other institutions. Although public accountability covers all levels o f Government, this CFAA restricts itself to the central Government, as envisaged during the planning stage. The municipal sector will be analyzed at a later date, when municipalities assume greater financial independence andmanage a higher share o f overall public funds. A key purpose o f the CFAA is to assess the risks posed with respect to financial accountability as they affect Bank programs and the use of Bank funds; also, it aims to propose suitable measures to manage these risks. In addition, the CFAA supports a dialogue with borrower countries and development partners on financial accountability matters, andhelps designprograms to buildfinancial management capacity. As a diagnostic exercise covering the financial management systems o f a country's public sector, the CFAA is not an audit and does not guarantee that all funds are being used for intended purposes. However, it strives for a well-informed and objective assessment of the strengths and weaknesses of financial management systems, a diagnosis o f problems and advice on their resolution, and an indication of the level o f financial management riskinthe country concerned. The executive arm of Governmenthas an obligation to safeguard and properly use public resources, and provide a credible legal/institutional/regu1atory framework to promote good financial governance in both the private and public sectors. The institutional and Bulgaria: Countrv Financial Accountability Assessment ii legal/regulatory regime constitutes the country's public financial accountability framework. The Bank's interest in the CFAA lies mainly inproviding inputs for managing fiduciary risks. The Bank's fiduciary responsibilities to its shareholders and the borrowing Government's fiduciary responsibilities to its citizens are closely related. Countries must develop a sound financial accountability system, in design as well as inpractice; and the CFAA must focus on the systemic weaknesses that produce fiduciary risks, as well as advise on developmental needs. Acknowledgements The Bank mission acknowledges the extensive cooperation and assistance received from officials o f the Government, parliamentary committees, State andother agencies. Andrew Vorkink, ex-Country Director, and Oscar De Bmyn Kops, Country Manager offered guidance incarrying out the CFAA. Vladislav Krasikov (ECSPS); Rosalinda Quintanilla, Stella Ilieva, Tracey Marie Lane (ECSPE); Giovanni Mascarenhas (TROIS); Deepak Bhatia (ISGIA); Bjom Stale Haavik (IMF Resident Adviser) provided useful comments and valuable information. Valeria Nikolaeva and Emil Lyudmilov Todorov (ECCBG) Team Assistants in the Bank's Sofia Office, provided excellent support with logistic arrangements for the mission. Roula Balkash (ECSPS) helped extensively in the report production. Barbara Koeppel, Consultant, edited the report. John Hegarty, E C A Regional Financial Management Manager, and peer reviewers David Shand (OPCFM), Mark Davis (ECSPE), and IanMackintosh (SAIWM)offered valuable comments and provided other important inputs to the task. flukaria CFAA: Executive Summarv iii EXECUTIVESUMMARY 1. Entry into the European Union (EU) is highon the Government's economic and socio-political agenda. This objective increasingly shapes Bulgaria's ambitious program o f reforms in several areas, including public financial management (PFM). 2. The country has a well developed system and structure of financial management that relies heavily on information technology (such as inthe area of cash management), and has independent external audits and parliamentary oversight committees. Although many laws and institutional arrangements have been established, institutions still need technical assistance and training to absorb the methods andinternational best practices. 3. Sound legislation exists to prepare, implement and monitor the budget, as do well-defined roles for the executive branch, the National Audit Office (NAO) and the National Assembly (the parliament). 4. In recent years, the Government has taken various steps to improve the budget process. The most important are: 0 Significantly reducing the number of extra-budgetary funds (EBF), thereby improving the budget's comprehensiveness. At present, only seven EBFs are permitted, which constitute only a fraction o f the total budget. 0 Adopting a pilot programmatic approach in three ministries and thereby strengthening the budget-policy link. Until now, however, the ministries do not appear to view the approach as a high priority and lack the technical capacity/tools to implement it effectively. 0 Creating a Treasury Single Account to service all budgetary institutions. 5. Budget estimates are becoming more realistic with the adoption o f sound assumptions and a macroeconomic framework. The three-year budget framework has yet to provide the line ministries with firm information about expenditure priorities since it is invariably changed duringthe second and thirdyears. 6. InApril 2003, the Government restructured the capital expenditure function to reduce the layers of approvals required. However, it is still unclear how capital projects will be monitored and if the newly created comprehensive database will continue to be used in the monitoring process. Also, investment appraisals continue to be weak and inordinate emphasis i s placed on engineering issues, as opposed to those regarding appropriateness, effectiveness or outcomes. 7. Cash allocation is highly centralized and monitored closely through an automated System for Electronic Budget Payments (SEBRA) and a Treasury Single Account BukrariaCFAA:Executive Summarv iv maintained at the Bulgarian National Bank (BNB). These procedures ensure that budget priorities are largely followed andpromote efficient cash management. 8. Systems o f ex-post program evaluation remain weak, and feedback from civil society on the quality o f service and appropriatenessof priorities is virtually non- existent. Current budget monitoringfocuses on fiscal targets and little attention is paid to assessing the programs' effectiveness. Thus, future reforms need to establish a reliable system to evaluate whether programs meet their goals, the findingso fwhich should bereflected infbture budgets. 9. The automated SEBRA system has reasonably good internal controls. However, a few areas need attention, such as makingdata entry controls uniform, preparing a data recovery plan (in case o f disaster), and improving physical security for the servers. 10. By enacting the Public Internal Financial Control Act in 2000, the Government formally established a financial management and control framework. A recent amendment introduced the new position of financial controller, to strengthen ex-ante control. The intemal control framework is reasonably satisfactory, although to strengthen "soft" controls, department heads need to be trained inthe notions o f internal controls and risk management so they can pursue a management philosophy that nurtures and respects these functions. The Act has a few important shortcomings, such as ambiguous accountability among managers andthe nature o foversight exercised by financial controllers. 11. A new Chart ofAccounts that conforms to GFS-2001 classifications and ESA 95 was developed for accrual-based financial accounting. However, revenues from taxes and duties are still calculated on a cash basis and tax arrears are neither included nor disclosed inthe financial statements. Further, the implementation of a state-of-the-art Financial Management Information System (FMIS), runningon SAP R/3 software, continues to pose problems: Line ministries have not yet adopted the system and lower-level units use a wide array o f basic accounting software-which prevents easy sharing o f data. Thus, until these obstacles are resolved, the SAP R/3 implementation will continue to be delayed. 12. Bulgaria recently created a new National Revenue Agency (NU) to integrate the collection of tax and social contributions, which are currently handled by two agencies. The new agency is beingdeveloped along the lines proposed by the European Commission (EC) and is receiving World Bank financing to establish automated accounting and information systems that will conform to international norms. 13. Bulgaria has a strong internal audit body in the form of the Public Internal Financial Control Agency (PIFCA), which has about 1,225 staff throughout the country. This Agency has received substantial technical assistance under the EU- Phareprogram and has developed several comprehensive manuals and guidelines. However, as it combines the function o f internal audit with the authority to develop preventive control systems, it has created apotential conflict o f interest. Bukran'a CFAA: Executive Summarv V 14. External audits are performed by the National Audit Office (NAO), which submits its reports to the National Assembly, has adequate operational independence, resources and staff. It has the authority to conduct all types of audits and recently began two pilot performance audits with technical inputs from its twinning partner (the UnitedKingdom's NAO). An area o f concern i s the lack o f a comprehensive strategy to audit revenues to ensure reliability and effectiveness of tax assessments, collections and arrears. Another concern is an apparent lack o f manuals and skills needed to audit automated systems. Given the highdegree o f automation andwidespread use o f on-line and real-time systems, this area should receive highpriority. 15. The Parliament is quite involved in the budget formulation process. However, its oversight o f budget execution is hampered by substantial delays in discussing and adopting budget execution reports: The reports for 1997, 1998, 1999 and 2000, although submitted regularly by the Government, were not adopted by the National Assembly until2001. 16. Despite the absence of specific provisions in the Organic Budget Law, a high level of fiscal transparency exists: Extra budgetary fimds have been reduced, budget execution reports are audited regularly by independent external auditors, fiscal information i s available in the MoF and BNB periodic reports, NAO has a well designed website where it posts all its reports, and parliamentary committee meetings are generally open to the public. 17. Bulgaria has made steady progress in fighting official corruption. However, public procurement is still a major source of corruption. 18. Despite the shortcomings mentioned above, the CFAA found that the public financial management system in Bulgaria provides reliable information. Adequate systems and controls exist to record, report andtrack receipts anduse of funds, andthere is ahighdegree o f fiscal transparency. 19. Ample safeguards exist in BNB to record and track funds received under the Bank's adjustment lending program. The overall financial management risk to Bank funds i s low. However, if recommendations contained in this report were adopted, public financial management systems would be strengthened even further. 20. Investment projects financed by the Bank are executed by stand-alone Project ImplementationUnits (PW), which maintain special accounts with the BNB; their annual project financial statements are audited by a representative firm o f one o f the Big 4 international audit firms with offices in Sophia. A review of past audits andsupervision missionreports reveals no significant accountability issues. Thus, the financial management risk to Bank funds in Bulgaria's investment projects is low. 21. A key theme inthe CFAA recommendations is the need for Government to build capacity to implement the laws and regulations All recommendations to address Bulaaria CFAA: Executive Summarv vi the issues identified in the CFAA are summarized in Annex 1. However, those with the highest priority are listedbelow. 0 Develop guidelines for planning and evaluating public investments that will improve transparency in the selection o f capital expenditure projects. Further, capacity must be improved in project appraisal, since current procedures focus only on technical (engineering) issues. 0 Considering the importance of the SEBRA database, data recovery plans should urgently be developed. 0 Develop detailed job descriptions for financial controllers to ensure that responsibilities are not scattered or merely assumed, thus weakening internal controls. 0 Establish a government-wide IT function that will set benchmarks and develop an IT strategy for all government offices. This would ensure that compatible hardware and software would be installed and thus avoid the current problems that result from the lack o f compatibility among the various systems. 0 Incorporate user needs while implementing SAP W3 so as to ensure that line ministries do not develop their own systems and thereby duplicate efforts. 0 Review and revise the provisions regarding PIFCA's responsibility to devise and introduce internal control policies and establish preventive control systems. This is important in order to avoid possible conflicts of interest. 0 Develop training programs for NAO auditors in risk assessment and incorporate the results o f risk assessment in the preparation o f the annual audit program. 0 Develop comprehensive strategies, guidelines and training programs for auditing revenues andIT-based systems. 0 Develop the skills o f PIFCA and NAO auditors in forensic auditing by providing training inthis area so as to strengthen the enforcement capacity infightingcorrupt practices. 20. Monitoring Future Reforms. PAL I1and I11will be the Bank's major vehicles for monitoring progress in implementing recommendations. Tax administration reforms, such as introducing automated accounting and information systems that conform to international norms, will be monitored under the Revenue Administration Reform project. I t is expected that, as other donors (most notably EU-Phare and US AID) increase their technical assistance, they will continue to have a high stake inmonitoring PFM improvement. Bulqaria CFAA: lntroductionand Backqround 1 1. INTRODUCTIONAND BACKGROUND Country background 1.1 Since the end o f Communist rule in 1989, Bulgaria witnessed political stability for the first time only after the 1997 parliamentary elections. After the disappointing early transition years that culminated in a severe financial crisis in 1996-97, Bulgaria has achieved macroeconomic stability, lowered inflation (from the average of 1,000 percent in 1996-97, and improved investor confidence. The Currency Board Arrangement (CBA)' ,introduced in July 1997, has served Bulgaria well in providing a stable monetary environment. Real GDP growth rates averaged 3 percent in 1998-99, and 5 percent in 2000-01. Real GDP growth for 2002 reached 4.8 percent, despite an unsettled external environment that included continued slow growth among Bulgaria's tradingpartners. 1.2 Bulgaria is one o f the EasternEuropean countries considered for the second wave of European Union (EU) accession: The December 2002 Copenhagen European Council Summit confirmed 2007 as the target date for EU accession for Bulgaria. The latest European Commission report2 on Bulgaria's preparedness for accession to the EU identifies Bulgaria, for the first time, as a " functioning market economy." Accession to the EU is high on the Government's economic and sociopolitical agenda. This objective is increasingly shaping the ambitious program o f reforms inseveral areas. 1.3 Under the Constitution adopted in 1991, the highest legislativepower lies with the single-chamber National Assembly (the Parliament - Sobranje) o f 240 representatives, who are elected every four years indirect elections. The Government is parliamentary, comprises the Council of Ministers (CoM) and is headed by the Prime Minister. The head o f State is the President, directly elected once every five years for a maximum of two terms. The President has the power to delay legislation, although Parliament may re-enact bills sent back by the President by a simple majority. In general, the President's role is largely representational. Objective of the CFAA 1.4 The overall objective of the CFAA is to provide relevant information to the Bank and the Government on the public sector financial accountability arrangements in Bulgaria, and to jointly develop a program for reforms and capacity buildingto improve transparency and accountability for the use o f public funds. Given the fairly large 'The currency-board framework pegs the lev to the euro at a rate of Lv 1.95583: Euro 1. Under the currency-board scheme, foreign exchange reserves at the central bank must cover at least 100%of base money - substantial additional reserves are retained to allow the bank to perform"lender o f last resort" intervention in the event o f threats to the banking system, and to ease the servicing o f foreign debt. Controls on the money supply and o n credit expansion are therefore tight, and include bans on lending by the central bank to the Government and on refinancing commercial banks, except inextreme circumstances 'oEuropean f systemic threat. Conmission's "2002 Regular Report on Bulgaria 's Progress Towards Accession" dated October 2002. Bulqaria CFAA:Introductionand Backaround 2 adjustment lending program in Bulgaria, the CFAA analyzes the fiduciary risk to Bank funds that are merged into the overall Government budget. Where analytical work was already available, the CFAA did not duplicate, but updated the information. Specific objectives o fthe CFAA were the following: 0 Updateknowledge o fprimarypublic financial accountability institutions 0 Identify the most significant financial management (FM) risks and related capacity issues that require the Government ofBulgaria's (GOB)attention. Relationship to CAS,lendingprogram andpolicy dialogue with the country authorities 1.5 The Country Assistance Strategy (CAS) for B~lgaria,~covering FY 2003-05, declares the Bank's intention to deepen its analysis o f reform policies and to focus on evaluating reform outcomes and fine-tuning subsequent policy measures. Completion o f the CFAA inFY 03 i s one o fthe triggers for the base-case lendingscenario. 1.6 The base-case scenario envisages a series of three Programmatic Adjustment Loans (PALS) to support the Government's policy framework reforms. PAL I, was which approved by the Bank's Board in February 2003, focuses on advancing structural, regulatory, and institutional reforms in the real and financial sectors. In addition to continuing policy measures agreed inPAL I, PAL I1will focus on reforms in the public sector. PAL I11will focus onreforms inthe labor and social sectors. 1.7 The CFAA action plani s organized andprioritized in close consultation with the Government to attain progress indicators inthe PAL I1policy matrix, specifically inthe areas ofpublic financial management. PAL I1i s scheduledfor Boardpresentation inearly 2004. Scope of the CFAA 1.8 Indrawing the scopeofthe CFAA, considerationwas givento the available sector work in the area of public financial management. Inparticular, this included the Bank's Public Expenditure and Institutional Review (PER) o f August 2002, the Country Procurement Assessment Report (CPAR) issued in May 2000, the IMF Report on Observance of Standards and Codes (ROSC) - Fiscal Transparency Module (Fiscal ROSC) reissued in March 2000, ROSC Report on Private Sector Accounting and Auditing (issued inMay 2003), the annual Regular Reports of the European Commission (EC) on the progress o f the candidate countries towards membership o f the European Union (particularly Chapter 28 - Financial Control, and Chapter 29 - Financial and Budgetary Provisions), and the IMF Safeguards Assessment for the Bulgarian National Bank (BNB) (report dated June 2002). The CFAA covers the components of the public sector financial management system. In addition, it discusses fiduciary risks in Bank- financed projects. "Memorandum of the President of TheInternational Bankfor Reconstruction and Development and The International Finance Corporation to the Executive Directors on a County Assistance Strategy of The World Bank Groupfor Bulgaria" datedMay 31,2002 - Report No. 23927-BUL Bulqaria CFAA: Introduction and Backuround 3 1.9 Given the Government's highly centralized financial operations, the CFAA restricts itself to the central government as envisaged during the planning stage. The municipal sector will be considered for future diagnostic work, when municipalities assume greater financial independence and manage a higher share o f overall public funds. 1.10 Further, in view o f the recent Report on Observance o f Standards and Codes - Accounting and Auditing4, the CFAA does not review private sector accounting and auditingissues. Governmentparticipation 1.11 The Government appointed a counterpart team o f six officials to work with the Bank team. The counterpart team was actively involved in the entire process and the report has benefited from their valuable input. Monitoringfuture reforms 1.12 PAL T I and I11will be the Bank's major vehicles for monitoring progress in implementing recommendations. Tax administration reforms, such as introducing automated accounting and information systems that conform to international norms, will be monitored under the Revenue Administration Reform project. It is expected that, as other donors (most notably EU-Phare and U S AID) increase their technical assistance, they will continue to have a highstake inmonitoring PFM improvement. 4see http:iiwww.worldbank.org/ifalrosc bgr.pdf for the report 2. PUBLIC SECTOR BUDGETING 2.1 Bulgaria recently introduced several reforms to manage its budget process. These include (1) changing budget preparation procedures, (2) producing a "budget policy paper" that lists inter-sectoral priorities and estimates the fiscal impact of policy changes, (3) improving budget guidelines, (4) revising the time frame for producing the budget, (5) setting expenditure ceilings, (6) requiring multi-year expenditure requests, (7) prioritizing programs overall and by agency and (8) establishing an automated payment system and Treasury Single Account to service all the line ministries. Some of the reforms, particularly those related to allocative efficiency and budget preparation, respond to recommendations in the PER' and the Fiscal ROSC. To design and implement the reforms, the country received substantial technical assistance from bilateral and EUpre-accession programs, and from the IMF6. 2.2 This report compares the features of Bulgaria's budgetary process with the recent reforms and standard criteria to determine how the changes are being appliedandto what effect.7 Specifically, it evaluates the current practices and reforms with regard to their adherence to certain criteria such as the legal framework, comprehensiveness, realism, classifications, formulations, capital expenditures and execution. The criteria are described in the World Bank`s Public Expenditure Management Handbook (PEM) and the IMF's Code of Good Practices in Fiscal Transparency. Each of these features is discussed below. Legalframework 2.3 Bulgaria has comprehensive laws and agreements that regulate the budgetary process. 0 The 1996 Organic Budget Law (OBL) aptly describes all aspects o f the process, including preparation, approval, implementation, executionheportingand provisions for extra-budgetary funds. It also defines the roles of the Ministry o f Finance (MoF), line ministries, the Council of Ministers (CoM), the National Audit Office (NAO), and the NationalAssembly (Parliament). 0 The National Audit Office Act 2001 and Public Intemal Financial Control Act 2000 further define the specific provisionsrelated to the budgetary process. 0 The Currency Board Arrangement (CBA), introduced in 1997, established a conservative fiscal policy. Report No. 23979-BUL Bulgaria - Public Expenditure Issues and Directions for Reform- August 2002 IMFapproved a 24-month Stand-By Arrangement (SBA) inFebruary 2002 and is helpingBulgaria safeguard macroeconomic stability and promote structural reforms. To this end, the SBA includes certain conditionalities such as a ceiling on the size o f the overall deficit of the general government. 'Public Sector Budgeting, particularly budget formulation, is extensively covered inthe World Bank's PEIR.This CFAA presents key issues ina summarized and updated form. 0 The newly enacted Law on Government Debt 2002 limits the Government's options for financing the budgetdeficit. 0 The National Assembly approves the budget through the Annual Budget Act (ABA), which is followed by a Council o f Ministers (CoM) decree that provides guidelines for executing it. Budget comprehensiveness 2.4 The extent of large extra-budgetary funds (EBF) operating outside the budget framework has been greatly reduced as Bulgaria successhlly eliminated many o f them: The Annual Budget Act 2003 permits only seven EBFs to operate. Besides being listed in the ABA, expenditures from most o f the EBFs are handled through the Treasury Single Account and constitute only a fraction o f the total budget. However, a few f h d s are registered as enterprises to avoid being classified as EBFs, although most o f these, such as the Environmental Enterprise Fund, depend on State subsidies. To further improve transparency and budget comprehensiveness, such funds should be closed. Further, separate laws govern the State Social Insurance Fund (SSIF) and the National Health Insurance Fund (NHIF), whose annual budgets are approved by the National Assembly and audited by NAO. Budgetary transfers to SSIF and NHIF are shown separately inthe Government budget. 2.5 Although subsidies to non-financial State Owned Enterprises (SOEs) are shown as separate line items in the ABA, neither their annual budgets nor financial statements are presented to the National Assembly during the annual budget deliberations. Parliamentary committees, however, have the right to ask for their documents and other information. Some SOEs perform activities that are uneconomic or provide services far below actual costs that result, directly or indirectly, in the State providing subsidies to these SOEs for their quasi-fiscal activities. For example, -the Bulgaria State Railway (BDZ) operates a large number o f uneconomic lines, mandated by the State, that are public service obligations and involve a State contribution that averaged 0.8percent o f GDP inrecent years.8 However, it shouldbe noted that a large privatizationprogram has substantially reduced the number o f SOEs, particularly 'in the non-utility sectors. See Section 12 for discussion on SOEs. 2.6 The ABA also lists recurrent and capital expenditures as well as transfers to municipalities and state bodies as separate line items. Further, it specifies the means o f financing annual budget deficits and the maximum amount o f new sovereign debt and sovereign guarantees that can be issued: In2003, these totaled 2 billion levs. The ceiling on outstanding sovereign debt as o f December 2003 may not exceed 19.9 billion levs. 2.7 The annual budget includes foreign financed expenditures; the budget for each foreign-financed project is consolidated in the budget o f the respective line ministry. Receipts from foreign funders for these projects/programs are shown as separate line Source : PEIR. This figure does not include other forms of State support such as arrears due to other State-owned companies such as utilities, or interest payments on loans to BDZ by the EIB. Bulgaria CFAA: Public SectorBudaeting 6 items in the ministries' budgets9. However, the main source for such expenditures, the EUpre-accession funds, does not appear inthe line ministries' budgets. Rather, they are listed inthe National Fundmanaged by the MoF, which is an extra-budgetary find. Only the co-financing amount is shown as a line item in the ABA. In the future, EU pre- accession funds should be listed under the respective line-ministries, e.g. EU-funds for environmental purposes should be included in the Ministry o f Environment budget (whichisresponsible for implementing the projects). Budget realism 2.8 Ingeneral, budget estimates are becomingmore realistic as is evident from Table 1, which compares the budget against actual expenditures for a three-year period. Inthis regard, the Agency for Economic Analysis and Forecasting (AEAF) plays an important role. It is independent, reports to the MoF and provides a realistic view o f the macroeconomic framework and assumptions used inbudget formulation. Budget basis and classification 2.9 The budget is cash-based and its classification system is developed in line with the reporting requirements o f the Manual on Government Finance Statistics (GFS) 198610 o f the International Monetary Fund (IMF). The hnctional classification comprises nine major functions such as education, health etc. There are about 100 paragraphs that describe revenues, expenditures and financing by economic classification. 11 A new budget classification system that complies with the accrual- based GFS 2001 Manual is expected to be introduced in the 2005 budget. Bulgaria has also developed a separate Chart of Accounts, as well as rules for recognition, valuation and classification, which are based on the GFS 2001 Manual and European System o f Integrated Economic Accounts 95 (ESA 95). The revenue and expenditure account heads in the Chart of Accounts generally match with the economic classifications used inthe current budget classification. See the section on accounting for details on the Chart of Accounts. (Section 5.1) Please refer to Section 13.4 for the discussion on acceptability o f government financial accounting systems for the Bank-financed project. loA revisedGFS Manual issuedby the IMFinDecember 2001introduced accrual-based financial reports andbalance sheets. For more information, please see http://www. inlf.orglextemalipubs/ft/gfslmanualiindex.htm I'Economic classifications identify the types o f expenses incurred by Government for discharging its economic responsibilities, such as compensation to employees, subsidies, grants, etc. The functional classifications provide information on the purpose for which an expense was incurred, such as for education or environment protection. Functional classifications should not be confused with the Government's administrative organizational structure. Insituations where functional classifications are not aligned properly with the Government ministries, these could lead to dispersed accountabilities, since more than one line ministrymay be responsible for implementing the same program or function. Bulqaria CFAA:Public Sector Budsefino 7 Table 1. GeneralGovernment Budgetvs. Actuals 1999-2001 (inmillions ofleva) 1999 2000 2001 Budgeted Actual Budgeted Actual Budgeted Actual rota1revenues and grants 8776 9690 10129 11065 11427 11837 Zurrentrevenue 8775 9476 10127 10861 11152 11474 Tax revenue 7789 7481 8531 8707 9292 9190 \Ton-taxrevenues 986 1995 1596 2154 1861 2284 rota1expenditure and net lending 9460 9912 10484 11334 11851 12097 hrrent expenditure 8452 8491 9345 10072 10653 10780 Goods and services 3274 3550 3786 4078 3608 3496 Wages and salaries 1176 1279 1246 1363 1485 1295 Social security contributions 560 572 750 ' 705 513 442 Other goods and services 1538 1699 1789 2010 1610 1759 Defense andsecurity 954 999 1120 1114 1267 1189 Interest payments 1181 898 1154 1083 1391 1106 Subsidies 352 391 208 295 237 709 Social expenditure 2670 2632 3054 3487 4137 4189 Pensions 2000 1953 2235 2536 2590 2702 Social assitance 670 678 819 950 1547 1487 Other current4 21 21 23 15 13 91 2apital expenditure 608 1077 782 1037 888 1197 hate reserve 22 58 14 89 13 40 (et lending 93 263 31 101 37 79 Ither 30 12 15 zontingency 254 24 299 36 245 Iverall deficitisurplus -684 -222 -355 -269 -424 -260 'rimary deficitisurplus 498 676 799 814 968 847 Zurrent deficitisurplus 323 985 782 789 499 694 (otes: 1. Consolidated general government expenditure since 1997 includes social contributions paidby the government onbehalfof government employees. Intergovernmentaltransfers for 1999 and 2001 which are not consolidated are shown as non-tax revenues. 2. Includes wages, salaries, and other remuneration. 3. Includes maintenance and scholarshp expenditure. 4. Includes membership remittances. 5. Includes unconsolidated transfers. jource: Ministry o f Finance Budgetpreparation 2.10 A number of changes in the budget preparation procedures were recently introduced to make the process more strategic, better prioritize the line ministries' needs with respect to the country's development plans, and involve them more and earlier inthe budget formulation process. However, the first level spending units are finding it difficult to respect the earlier deadlines and, as a result, the CoM revised certain target dates for the 2004 budget. I t is important that the budget timetable be respected to ensure adequate time for discussion and revision. (See Box 2.1 for a description o f the preparation cycle for the 2004 budget). Further, the CoM required the Government to define inter-sectoral priorities and the line ministries to estimate the fiscal impact o f policy changes. The Government set expenditure ceilings for the line ministries, requiring that their spending requests relate more closely to overall development goals. Of critical importance, the Government also required the ministries to produce multi-year expenditure requests. Box2.1: Bulgaria-Budgettimetable for 2004 - Task Reseonsibilitv Deadline FirstPhase: Reporton medium-termbudgetary limitations Minister ofFinance Feb. 13,2003 Analysis of the development in2002, trends for 2003, views LineMinisters March 6,2003 on implementationofpoliciesduring2004-2006. Preliminaryestimatestowardsthe medium-termbudget PrimaryBudgetSpending March 3,2003 Units Macroeconomicframework analysis AEAF March 6,2003 A draft three-year budgetforecast for 2004 - 2006 MoF April 17,2003 Review main strategies, decidekey priorities CoM April 24,2003 SecondPhase: Prepareand issue guidelines MoF Within 10days from the CoM meeting Detailedexpenditure ceilings for 2004 MinistriedAgencies May 30,2003 Proposalfor the expenditure ceilings MoF June 20,2003 Reviewand decide expenditure ceilings CoM June 27,2003 Prepare and issuedetailedbudget guidelines MoF Within 10days from the CoMmeeting Hold discussions and sign agreements with primary budget MoF August 4,2003 spending units Submit draft budget for 2004 to MoF MinistriedAgencies September 10,2003 Submit draft annual budgetto CoM MoF September 30,2003 Review and submit draft annual budget to the National CoM October24.2003 Assembly Source Decree of the CoM no 87, dated February 11,2003 2.11 The impact o f these changes will need to be reviewed after at least a year's experience with implementation. However, it appears the line ministries are not analyzing policies sufficiently and the link between the policies and the medium-term macroeconomic and fiscal framework continues to be a major issue. Another problem is that political uncertainty over expenditure allocations continues almost up to the end of the budget preparation cycle, which means priorities cannot be finalized until late in the process 2.12 Although the OBL prohibits the earmarking o f revenues within the budget (Article 2) to ensure their fungibility, the line ministries, in fact, spend the revenues earned during the year beyond their voted appropriations, albeit with explicit approval Bulqaria CFAA Public Sector Budsetins 9 from the MoF. Thus, this practice undermines the role o f the National Assembly in approving annual appropriations. This issue was also highlighted in the 2001 NAO Annual Report. However, over the past few years, the amount o f revenues available to the line ministries has been reduced considerably12 and its percentage in the ministries' budgets is small. The OBL also gives MoF the lead role both for preparation and execution and requires the final budget to be approved by the National Assembly. 2.13 An interesting aspect o f the budget preparation process is the assessment conducted by NAO o f compliance with the legal and procedural requirements regarding the compilation o f annual budgets and the possible risks in executing them. NAO's opinion on the draft annual budget for 2003, submitted to the Parliamentarycommittee on Budget and Finance, did not find any major non-compliance with the laws; however, it noted that the document contained a number o f provisions that could affect several different laws over the long term and should therefore be handled separately rather than through the "Transitory and Concluding" provisions inthe annual budget law. 2.14 Although the current budget presentedto the National Assembly includes apolicy statement (along with annexes), it lacks information about each ministry's objectives and expected results. Thus, the budget would be a more usefbl document if it contained text and indicators about the Government's main programs, as well as medium-term expenditure estimates for the MTBF period. A beginning was made in 2003 by submitting a detailed report to the National Assembly as a supplement to the main budget containing information regarding policy aims and expected results for main activities of each first level spending units. However, financial impact o f the policy/program was not provided inthe supplementary information. Capital expenditurebudgets 2.15 As part of the effort to streamline the reporting o f capital expenditures, MoF's Public Investment Directorate (PID), the entity responsible for managing the public capital investment program, introduced the following changes: It (1) set cash limits for capital expenditures for first-level spending units and municipalities, (2) developed software (SQL-server based) to track all ongoing projects, which was then made available, along with a detailed manual, to all the units, (3) introduced several reporting formats to rationalize the process o f capital expenditure reporting and monitoring and (4) required that quarterly reports which would monitor project implementation be submitted within 15 days o f the quarter's closing. However, in March, PID's responsibility was transferred to other entities. The capital expenditure budget for fiscal 2003 is approximately 1.23 billion levsl3 (approx US$680 million) o f which the share o f externally financed projects i s roughly 60 percent. 2.16 InApril 2003, the Government restructuredthe capital expenditure function: PID was abolished and some of its functions were transferred to other directorates within MoF. The most important reason for restructuring was to simplify the approval process. l2For example, the Ministry of Environment and Water that received Eco fees on fuel no longer receives it. l3One estimate has put the requirement o f funds to complete all ongoing projects at about 5 billion levs (about US$ 2.8 billion). Now, MoF will no longer be requiredto approve every investment proposal; instead, the task will be handled by the line ministries. For its part, the MoF, based on the public investment strategy, will set capital expenditure limits, and the line ministries will be responsible for designing and implementing projects without seeking MoF's approval for each case. M o F will maintain a database for only those projects that have national importance. 2.17 Although the rationale for restructuring is laudable and will help reduce MoF's centralized control, it is unclear as to how projects that are far behind schedule or those that are abandoned midway will be monitored. Inits 2001 Annual Report, NAO pointed to some weaknesses in capital expenditures, including reporting them as maintenance expenditures as well as purchasing assets that did not originally appear on the MoF's approved list. Thus, it is vital that the M o F develops clear monitoring guidelines and responsibilities. 2.18 To rationalize and improve the long-term efficiency o f capital expenditures, sound and transparent criteria must be in place to define technical, economic, financial, environmental, and social requirements14. As yet, such criteria have not been developed, and, as a result, funds could be misallocated. However, this risk has been minimized, since many o f Bulgaria's capital expenditures are supported by external finances that are heavily scrutinized by their funders. The 7-year National Plan for Economic Development and international commitments (e.g. made to the EU) did, to some extent, determine sector priorities. But, project appraisals are still inadequate, since most focus largely on engineering aspects. In this regard, huge amounts of technical documents (related to engineering issues) are produced, but these have limited use with respect to evaluating or prioritizing projects according to social, economic or environmental concerns. Given the reduced role for the M o F after April 2003, it is imperative that clear project appraisal guidelines and criteria be developed. Multi-year budgetpreparation 2.19 The 1996 OBL, which required that budgets be prepared for three-year periods, enshrined the concept o f multi-year budgetingin the budget preparation process (Article 14). This concept built upon earlier budget practices, when this was the norm in the centrally planned economy. However, the reality is that only the first year estimates are relevant, since the budget is invariably changedduringthe remainingperiod. Programmatic budgetpreparation 2.20 The Government recently introduced a pilot programmatic approach, particularly to strengthen the budget-policy link. The Ministry o f Environment and Water (MoEW), starting in 2003, is the first to pilot it and two other ministries (Labor and Social Policy, l4 The newly established Public Investment division, within the Budget Directorate o fMoF, is expected to prepare a long-term National Public Investment Strategy that will serve as a framework for the preparation o f annual capital expenditure budget plans and also clarify the state priorities inthe selection o f investment projects. Final selection o f investment projects will be approved by the yet to be established Public Investment Council. However, given the nascent stage o f new procedures, evaluation of the effectiveness of these procedures will have to be done at a later stage. Bu/qariaCFAA: Public Sector Buduetinu 11 Transport and Communications) were also chosen to participate. The impact o f these pilot projects will need to be reviewed after at least a year to determine their success. However, to date, the ministries involved do not appear to view the process as a high priority and also lack the technical capacity and tools to implement it effectively. Thus, theywill needsubstantial training and technical assistanceifit is to be internalized. 2.21 To successhlly introduce a program budgeting approach, outcomes will need to be evaluated periodically and findings will need to be integrated into the next year's budget strategy. Given the importance o fmacroeconomic stability and fiscal balance, the process now used to monitor the budget understandably focuses on fiscal targets; however, little attention is paid to assessingprograms' effectiveness. Budget execution 2.22 MoF's Budget and Treasury (B&T) Directorate15, as well as first-level spending units in each ministry are responsible for implementing and monitoring the budget (see Box 2.2 for the hierarchy within the budget process). The cash allocation and payment approval system is highly centralized and monitored closely by the two groups through the automated System for Electronic Budget Payments (SEBRA) and a Treasury Single Account maintained at the Bulgarian National Bank (BNB). These procedures were adopted to ensure that budget priorities are followed (see Section 3 for details on the treasury process and controls). 2.23 The budget i s executed according to the Budget Execution Decree, passed by the CoM, which offers detailed instructions regardingseparatebudgets for each line ministry, number o f staff, number of motor vehicles etc. The decree is based on the appropriations approved in the Annual Budget Act. However, the decree does not contain limits on commitment levels, which are monitored through the financial accounting reports (see section 5.3). As mentioned in2.15-2.1 8, commitments relatingto capital expenditures are monitoredclosely by MoF. 2.24 The Decree is normally issued within a monthfrom the time the ABA is passed. For the 2003 budget, it was issued in on January 30, 2003. However, if it were issued earlier, this would give the ministriedagencies more time to execute their plans. 15Afier the current restructuring is completed, the responsibility will be shared between the newly constituted Budget Directorate, the Expenditure Directorate, and the State Treasury Directorate. Buluaria CFAA:Public Sector Budqetins 12 BOX 2.2 :BULGARIA HIERARCHY - WITHIN BUDGETEXECUTION SYSTEM First Level SpendingUnit ____ Generallyline ministry headoffices (about 33) SecondLevel SpendingUnit ____ Major departmentswithin the ministry or regional/local officeswithin the ministry (about 1400) Third Level SpendingUnit ____ Territorial offices (particularly ministrieshavingmajor departments)(about 1100) For Example: First level Ministry of Finance Ministry o fEducation I I Secondlevel General Tax Directorate National Customs 780 state schools anduniversities Agency I I Third level Territorial Offices Territorial Offices 2.25 To ensure fiscal control, Bulgaria has adopted the practice o f releasing 90 percent (88 percent in2003) o f the formal budget allocation contained inthe ABA, thus ensuring a general contingency reserve o f about 10 percent. However, this practice usually means expenditures are bunched every December when the ministries scramble to spend the balance. This routinely occurs because the spending units fear that ifthey do not spend all the funds, their budgets may be reduced in the future--although the budget is not mandatory and the' executive is not obliged to spend all the appropriations approved by the National Assembly. 2.26 MoF's B&T Directorate sets the cash limit for each first-level spending unit in SEBRA, generally following the formula o f 1/12th o f the 88percent (90percent prior to 2003) o f the annual budget appropriation. In turn, these units using the SEBRA system allocate cash limits to lower-level spending units and also approve every single payment request, thereby exercising significant control. By setting a single limit (usually a separate limit is set for capital expenditures), MoF allows ministries to decide how to allocate funds among different budget heads. The cash limits are generally set on a monthly basis and occasionally adjusted when required. However, these limits barely cover non-discretionary expenditures and first-level spending units constantly ask that higher ceilings be set. This apparent lack o f predictability o f funding for discretionary and capital expenditures stems primarily from MoF's tight cash management practices. The recent restructuring of the capital expenditure function, together with changes in BuloariaCFAA:Public Secfor Buduetinq 13 approval procedures, are expected to provide some operating flexibility to line ministries inthis regard. 2.27 First-level spending units compile monthly cash budget execution reports, based on the reports they receive from lower-level spending units, and use them to monitor budget utilization. Quarterly budget execution reports, compiled by the first-level spending units, are audited byNAO. 2.28 The OBL prohibits the Government from making expenditures or assuming obligations that would cause the budget balance to deteriorate; it also bans it from introducing programs or projects that are not inthe Annual Budget Act (Article 36). The OBL also requires CoM to submit a proposal to amend the ABA ifsituations arise during the fiscal year that would adversely affect the projected deficit. Generally, the OBL empowers M o F to shift appropriations from one head to another, as long as the budget balance is maintained and certain procedures are followed (Article 34). This provision has granted tremendous flexibility to the executive during the budget execution process and eliminated the need to seek legislative approval for reallocations. Although this practice could theoretically lead to the legislative intent being disregarded, recent adjustments of this sort have been inconsequential and it seems that the parliamentarians are not unduly concerned. 2.29 Negotiationswith the E C on Chapter 29 - Financial and Budgetary Provisions are ongoing and the 2002 EC Regular Report advised Bulgaria, inter alia, to focus on administrative structures. Recommendations 2.30 Most o f the recommendations listed below are included in the PEIR, the October 2002 EC report and the Fiscal ROSC. e Bulgaria recently introduced several reforms for preparing and executing the budget, and improving the budget process overall. To realize their full benefit and ensure their sustainability, efforts should be made to guarantee that they be continued. Also, a more comprehensive budget preparationprocess, medium-term in outlook and more closely linked to policy goals, needs to be mainstreamed. Further, to support the program budgeting pilots that were recently introduced, staff in all three ministries will need significant training and technical assistance. Moreover, considerable work will need to be done in defining and measuring outputs and outcomes. 0 The Government has introduced the practice o f recording and tracking capital expenditures, and the software is working well as it provides mangers with important information. However, it appears that investment planning is weak, and investment evaluations, as now applied, are inefficient: As mentioned earlier, project appraisal is commonly misunderstood as engineering analysis. Thus, guidelines need to be set for planning and evaluating investments, and capacity needs to be developed inproject appraisal. Buluaria CFAA:Public Secfor Budsetins 14 0 Current budget documents presented to the National Assembly include a policy statement (along with annexes), but it lacks information about financial impact of ministry policies and programs. Thus, the statement should include data on medium-term fiscal projections, narratives and indicators with regard to the Government's main programs, medium-term expenditure estimates for the MTBF period, and a statement on tax changes. 0 Systems o f ex-post evaluation remain weak, and feedback from civil society on the quality of service and appropriateness of priorities i s virtually non-existent. Further, current budget monitoring focuses on fiscal targets and little attention is paid to assessing the programs' effectiveness. Thus, future reforms need to establish a reliable system to evaluate whether programs meet their goals and the findings would be reflected in future budgets. Periodic analysis of budget outcomes, whose findings would be included in the next year's budget, are vital for improving the overall efficiency of public expenditures and increasing program managers' accountability. 0 With respect to budget execution, the Decree could be issued earlier, say, during the first two weeks of the year, instead of after a month has passed, because this would offer ministries more time to execute their plans. Bu/qaria CFAA: Cash Management 15 3. CASHMANAGEMENT 3.1 The following section analyzes cash management controls and the associated risks ofunpredictable cash flows, floats inthe banking system andidle funds. Operational descriptionof cash management 3.2 The Budget and Treasury Directorate within MoF is responsible for cash management, which includes establishing cash limits for first-level spending units. Once set inthe system, the limits are changed infrequently, which ensures predictability. Inthis effort, MoF has introduced an online country-wide computerized System for Electronic BudgetTransactions (SEBRA) that enables it to effectively control cashresources. It also recently developed a Treasury Single Account (TSA) l6 that is maintained at the Bulgarian National Bank (BNB). Under this mechanism, balances in more than 600 transit bank accounts are transferred to the T S A daily. The authorized banks that collect Government revenues transfer them to the TSA. In turn, BNB sends daily bank statements to MoF for preparing a daily funds position report. Together, these measures enable M o F to manage cash resources efficiently and eliminate any risk of float in the system. 3.3 SEBRA, a web-based computerized system, connects MoF, first-level spending units, agent commercial banks and BNB using the data network, BA"ETI7. Together, SEBRA and BANKNET are operated and maintained by Bankservice, an independent joint-stock company promoted and owned by BNB and about 35 commercial banks. Based on an agreement with MoF, selected (agent) commercial banks assist in making budgetary payments and collect revenues throughout the country. 3.4 The process for setting cash limits operates as follows. The B&T Directorate establishes cash limits for each first-level spending unit in the SEBRA system; the limits are set in the aggregate, not by budget classification, and priorities are determined by the spending units. In turn, the first-level spending units allocate the limits through the SEBRA to lower-level spending units under them, and these submit their payment requests to agent commercial banks, which enter them into SEBRA. The system to authorize individual payment transactions is substantially centralized: First-level spending units approve (through SEBRA) every payment request made by the lower- level spending units. And, while the former can approve a payment request from the latter inexcess ofthe limit set for that spending unit (subject to the overall ceiling for the line ministry), the system rejects payment requests that exceed the overall limit set for the first-level spending unit. See Annex 2 for details on the flow o f transactions and Box 3.1 for a graphic description ofthe system. l6Bank accounts held by municipalities remain beyond the scope of the TSA. BNB has recently - inJune 2003 - implemented a Real Time Gross Settlement Payment System (RTGS) inplace ofearlier batch process-based interbank settlement systemBISEFW.Under this systempayments over 100,000 leva are executed inreal time. Bulgaria CFAA: Cash Management 16 3.5 SEBRA is primarily designed for managing funds rather than for accounting. As such reports generated by SEBRA are inthe nature o f funds management reports and not budget execution or accountingreports. Box3.1: SYSTEMFORELECTRONIC BUDGET TRANSACTIONSEBRA nsaction SEBRA BISERA LAN in BNB Interface with GL SOFl First-level budget unit Commercial Managementof the bank's branch limitdpayments SEBRAsystem controls 3.6 Given the high degree o f automation and use o f countrywide communication networks, the CFAA team reviewed the SEBRA system18 controls and found that overall, they are adequate. '*SEBRA isa three-tier web-enabledsystem that uses an Apache web server and Oracle 8i database. The web server and the Oracle 8i databaserun undera Linux Operating System on Dell PowerEdge 2400 servers. The web interface is developedusing PHP. Users access the system through an Internet Explorer browser. Bulgaria CFAA: Cash Management 17 Recommendations 3.7 Although the SEBRA system control framework is effective, the following measures would strengthen it further. 0 Data entry controls. Because budget payment orders are submitted to agent commercial Banks on paper, errors can occur when amounts or beneficiary details are entered into the system, as neither can be detected automatically. Agent commercial banks have developed their own data entry systems: Some have common systems across all their branches while others have individual systems. Most data entry modules have incorporated several control features such as verifying spending unit codes. However, the best way to reduce errors duringdata entry, if not eliminate them completely, is to implement a two-step data entry process in which one person enters the information and a second verifies and authorizes the payment order. To improve the process further, MoF should provide common minimum guidelines for data entry for all the agent commercial banks. It should also check to see that guidelines are being followed through periodic site visits. 0 Source code management. Procedures for managing the SEBRA source code, developed by Bankservice, are inadequate. This could make future maintenance and modifications difficult. Thus, MoF should require Bankservice to develop acceptable procedures for managing SEBRA source code. 0 Security environment. Considering the sensitive nature o f the database maintained by the independent entity, Bankservice, security needs to be improved. In this regard, physical access to SEBRA servers should be restricted and monitoredclosely throughthe use o f electronic access cards. 0 Disaster recovery plan. Although backup servers for SEBRA exist, they are situated in the same premises. In case o f a disaster, all files would be lost. Thus, an adequate disaster recoveryplan for SEBRA must be developed. 0 Upscale band-width. The current band-width between MoF and Bankservice is 128kbps. To improve the systems' performance and response time, the band- width shouldbe increased. 0 Capacity upgrade. Since SEBRA processes an average o f 10,000 budget payment orders daily, and the Dell PowerEdge 2400 server is running to full capacity, any increase in transactions could cause the system to crash. Thus, the database should be migrated to a more powerful server. 0 Development environment. Bankservice maintains a dedicated test environment for SEBRA, along with the regular production environment. To improve security, Bankservice should also maintain a separate development environment for SEBRA. Bulgaria CFAA: Cash Manaoement 18 a User requirements. While developing the SEBRA system, scant regard was paid towards the user requirements o f first-level and lower-level spending units. Thus, there is a need to do a quick user requirement analysis to identify the scope for future improvements and to make the system more user-friendly. To improve the system, the following changes are suggested: (a) Since payment orders in SEBRA are currently displayed only in a default order sequence, the system should provide an option to sort them using different criteria; (b) A two-digit code is provided for "Payment Type" and many users prefer additional codes, since that could improve analysis. For example, the code for maintenance ("lO") should have sub-headings, such as for water and electricity; (c) SEBRA reports need to be expanded. For example, first-level spendingunits can obtain information about the number o f rejected payments but have no details about each individual rejectedpayment. Bulgaria CFAA: lnternal Contrds 19 4. INTERNAL CONTROLS Legalframework 4.1 Legislative development with respect to intemal controls substantially began with the enactment o f the Public Internal Financial Control Act in November 2000, which created the Public Internal Financial Control Agency (PIFCA). The Act also defined the requirements o f financial management and control systems. Further, it explicitly holds spenders o f budgets responsible for establishing financial management and control systems within their ministries, based on guidelines providedby PIFCA. 4.2 In 2002, the law was amended to introduce a new provision that requires first-level spending units to appoint "Financial Controllers". The law, however, allows the spenders to determine at which subordinate structures the financial controllers will be appointed. Financial controllers are expected to undertake "ex-ante" control functions and will be barred from simultaneously performing accounting or management functions. 4.3 Although the Act is based on a sound concept that is well articulated in the policy paper on public internal financial control, it and the 2002 amendment have a few shortcomings. First, it does not specify who the spenders are who could be held accountable for the economic and efficient use o f budgetary recourses, e.g. whether they are ministers, directors or other officials. Second, it does not clearly specify what sort of ex-ante control is to be provided by financial controllers though the stated intention is to focus on legality o f expenditures. While most line ministries have designated an existing staff member as financial controller (due to restrictions with regard to appointing new staff), officials are unsure of their exact roles and responsibilities. Third, it is unclear how the financial controllers, located almost exclusively at the head would exercise ex-ante control, given the decentralized nature o f the line-ministries (most expenditures occur at lower-level units). 4.4 It appears this control function (financial controller) was created mainly due to extemal pressure, perhaps from the EU. However, care must be taken to prevent too much concentration o f administrative power at the head office inthe hands o f a financial controller (given the decentralized nature o f line ministries) or to add yet another layer to the bureaucracy that could lead to dispersed accountabilities. Ex-post controls 4.5 The Act strengthened the intemal control framework by creating PIFCA, which is expected to conduct intemal audits o f all Government revenues and expenditures. The agency has been vested with substantial power, since the Act assigned it both the functions of internal audit as well as financial control2'. (See section 7.6 for more l 9The first level spending units are, however, empowered to also appoint financial controllers at the lower *'PIFCAhas level spending units depending upon specific circumstances and assessed risks. yet to invoke the powers of financial controls. information). As a result, to some extent, it has blurred the role of management control andthe role o fPIFCA. 21 4.6 Another layer of control is held by an inspectoratecreated within most line ministries22 whose primary role is to monitor administrative processes and legal requirements. It i s also responsible for conducting investigations requested by ministers 23 Financial controls 4.7 The internalcontrol system includes standard measures such as requiring all payment requests submitted to agent commercial banks to be signed by two individuals (one being an accountant), and segregating duties. The financial controller is expected to ensure legality o f the transaction before the payment documents are submitted to the accountant for his signature. 4.8 As required under the Act, PIFCA issued guidelines for establishingfinancial management and control systems in budget spending units. Based on these guidelines, the spendingunits are required to establish appropriate financial management and control systems taking into account the specific nature o f their operations. While this is positive, PIFCA should also consider submitting an annual assurance letter to the line minister certifying that satisfactory financial management andcontrol systems exist. 4.9 By requiring first-level spending units to approve all payment requests of lower-levelspending units, the SEBRA provides an additionallayer of control over expenditures and promotes proper budget and cash management. However, it is doubtful that this process can prevent wasteful or fraudulent expenditures. For example, the Ministry o f Education, as a first-level spending unit, approves payment requests o f more than 700 lower-level spending units around the country; it would be difficult far officials located in Sofia to prevent wasteful or fraudulent expenditures in a remote corner o f the country. Thus, responsibility should be delegated to a regional directorate that i s better placedto analyze the situation on the ground. 4.10 The control and monitoringprocess between first and lower-level spending unitsis well definedwith detailedreportingprocesses on a regular basis. 4.11 Bank reconciliationbetweenTSA balancesand financial reports is regularly carried out. Reconciliation between SEBRA cash balances and book records is performed daily by the lower-level spendingunits. 2'PIFCA's role, responsibility and operations are discussed in Section 7. 22Inspectorates were formally established in 1998. 23The overlap betweenthe functions of the inspectorates and PIFCA is discussed in a later section 4.12 The EC has provisionally closed negotiations on Chapter 28 - Financial Control due to Bulgaria's considerable progress in establishing a sound institutional and legal basis for financial control24. Procurement controls 4.13 A Public Procurement Law, enacted in 1999 and amended in May 2002, substantially reformed procurement activities. Since the Country Procurement Assessment Report (CPAR) was issued inMay 2000 (based on findings from a 1999field visit), Bulgaria introduced several measures, inparticular, to respond to EUrequirements (Directive 89/665)inthe area o f public procurement legislation. Although the law covers all aspects o f procurement, some o f its provisions are inconsistent with the Directive and involve areas such as the value o f thresholds, time limits for submitting tenders, evaluation criteria and, most important, the review system. The CoM is considering preparinga new draft ofthe Public Procurement Law aimed at bringingit inline with the new Directives adopted recently. 4.14 Authority for procurement has been substantially decentralized to each public sector agency or institution which thus ensures clear lines of accountability and that authority will be matched with responsibility. According to the law, procurement should be done through open tendering so as to guarantee transparency and competition. However, agencies can adopt restricted or negotiated procedures in specific circumstances. 4.15 Though some progress has been made and important recommendations o f CPAR have been implemented, public procurement, in general, is still perceivedwithin the country, and reported in the mass media, as an area fraught with corr~ption~~. The Public Procurement Directorate (PPD), which was established about three years ago under the CoM, has not received enough support from .the Government and lacks sufficient capacity to ensure proper implementation and enforcement o f the law. The situation seems to have worsened after the resignation o f the head of the PPD. 4.16 PIFCA has prepared a detailed manual and 10 checklists for conducting internal audits of procurement including procedures for ensuring free and fair competition. While the manual appears comprehensive, the challenge now is to train internal auditors to implement the procedures. 4.17 The 2001 Annual Report of NAO observed frequent violations of public procurementprocedurese.g. packages are split to avoid biddingprocedures. The NAO recommendation o f extending the time limit for determining violations has since been implementedbymaking amendments to the Law on Public Procurement. 24European Commission's "2002 Regular Report on Bulgaria's Progress Towards Accession" dated October 2002. 25The Corruption Assessment Report 2002 by Coalition 2000 revealed over half the companies that participated in tenders resorted to bribes when obtaining procurement contracts. See Section 11for more information. Payroll controls 4.18 To date, the risks of ghost employees, double payments and salaries that exceed approved levels appear to have been contained by the country's having adopted a number o f measures: In CoM's Budget Execution Decree, the Government specified the total number o f employees (including those under contract) and set ceilings for wages and salaries. Also, most employees are paid through a debit card26and the handlingo f cash is negligible, which further strengthens the payroll controls. To ensure the guidelines are followed, PIFCA and NAO apply the limits contained in the Decree while performing ex-post audits. Intotal, the wage bill accounts for just about 10percent of total expenditures (including interest and capital expenditure) and about 13 percent o f current non-interest expenditures. Giventhese precautions, neither PIFCA nor NAO has identified serious payroll control violations inthe recent past. 4.19 At present, because payroll activities are decentralized, payrolls are prepared within the lower-level spending units; since the units have not adopted standard payroll software, they use different brands of off-the-shelf varieties. Thus, there is no single employee database to monitor employee numbers, track salary levels, and exercise aggregate control over this important element o f expenditures. To remedy this and to strengthen controls, the State Administration Directorate (SPD) within CoM is creating a centralized database funded under the EU-Phare-finan~ed~~program, which is expected to be completed by December 2003. Once it is introduced, SPD should reconcile its database with those o f the lower-level spending units andthus ensure the data integrity. Developments in managing ECfunds 4.20 Acknowledging Bulgaria's progress in managing the Special Accession Program for Agriculture and Rural Development (SAPARD) funds, the EC, in May 2001, provisionally conferred management authority on a hlly decentralized basis to. the SAPARD agency. It will be usefhl to consider rotating staff and short developmental assignments to transfer skills and experience gained by agencies such SAPARD to the rest of the ministries and agencies. Staff resources and capacity related to internal control 4.21 Research in the past decade, notably by the U S government's Committee o f Sponsoring Organizations (COSO), changed the concept o f internal controls with respect to overall management of operations. Traditional theories, which primarily addressed financial controls, were broadened to consider not only the hard controls (such as segregation o f duties), but also soft controls (such as employee competence and professionalism as well as management philosophy and operating style). As a result, COSO notes that, "Internal control is broadly defined as a process, effected by management, designed to provide reasonable assurance regarding the achievement o f 26 Debit cards are "recharged" by the agent banks with the net salaries o f employees at the end o f pay periods. Employees can, using the card, withdraw their pay anytime afterwards. 2' The Phare program provides financial support to accession candidate countries intheir efforts to adopt the acquis and strengthen the institutions necessary to implement and enforce it. From 2000-2002, financial assistance under the Phare program to Bulgaria amounted to around euro 100millionannually. objectives in the following three categories: effectiveness and efficiency o f operations, reliability o f financial reporting, and compliance with applicable laws and regulations." However, even a well-designed system o f internal controls can be circumvented by employee collusion and management fraud. Thus, humanresources must remain a critical component of the management control framework well into the future. See (Box 4.1) for details on COSO's evolution. 4.22 In general, the Bulgarian civil service has a fairly large number of young, well educated and talented staff that have helped ease the problems that arise when new approaches and methods are adopted. Specifically, staff were largely responsible for PIFCA's successfblly introducing modem risk-based audit techniques, which differ greatly from the compliance-based approach used in the past. However, because managerial staff and departmental heads lack training in differentiating between compliance and effectiveness, ongoing efforts in training the managers in modem management techniques must continue. Box4.1: COSOEVOLUTION The savings and loan scandals in the US led to the formation of COSO that sponsoredthe National Commission on FraudulentFinancial Reporting, an independent private sector initiative which studied the causal factors that can lead to fiaudulent financial reporting and developed recommendationsfor public companies and their independent auditors, for the Securities and Exchange Commission and other regulators, and for educationalinstitutions. The Chairman of the National Commission was Mr. Treadway, General Counsel of Paine Weber, and thus the commission was known as the Treadway Commission. In 1987, it called for sponsoring organizations to work together to integrate the various internal control concepts and definitions, and to develop a common reference point. In 1992, after several years of research, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) published a report that is widely recognized as an authoritative work on internal control conceptsand evaluations. COSO goes beyond the fmancial and accounting aspects o f governance to focus on people, their ethical values, integrity and competence, management's operating style, risk management, staff training and career development. Thus, COSO, which had an accounting origin, has now become a generalmanagementfiamework. See httrx//www.coso.org/ for more information. 4.23 Various laws, such as on state administration, administrative services and the Civil Servants Act, govern the workings o f the civil service. The laws have adequate safeguards to prevent arbitrary transfers and there is a well-defined appeals process. Interestingly, tax administration staff are not considered to be civil servants, and are governed under separate legislation. However, the newly established National Revenue Agency is considering adopting a common civil service act. Recommendations 4.24 To respond to some of the problems described above, the following measures are recommended. Bduan'a CFAA lnfernal Confrols 24 0 Job descriptions for financial controllers must be clarified, including their roles and responsibilities, particularly with respect to transactions of the lower-level spending units. 0 PIFCA should provide annual assurance letters to the line ministers certifying the existence of satisfactory financial management and control systems within their ministries. The existing practice of providingannual report to each first level spending unit achieves this objective to a certain extent. 0 The relative accountability of ministers, department heads, chief accountants and financial controllers must be clearly defined to comply with the current law, which holds "spenders" ofbudgets responsible for internal controls. 0 The practice of requiring first-level units to approve the payment requests of all lower-level units should be assessed and, on a pilot basis, such authority should be delegated to regional levels. 0 A centralized employee database, reconciled with those of lower-level spending units, should be introduced. 0 Introductory training in the latest concepts of internal controls, which would include how to interpret risks and early warning signals, should be provided to departmental heads. 5. ACCOUNTINGAND REPORTING Accounting principles, practices, and regulations 5.1 The new Chart of Accounts (CoA) conforms to the new GFS classification and ESA 9528.The CoA was developed by the MoF in 2001 after consulting with advisors from the European Commission, OECDISIGMA, and IMF technical support missions. A Transitional Manual and a bridge table for converting to the new CoA were also developed to help accounting staff in line ministries adopt the new CoA and understand the changed accounting practices. The economic classifications used in the budget conform, to some extent, to the CoA revenue and expense groupings. However, there is a need to fully harmonize the budget classifications and CoA so as to ensure accounting and budgeting information have a consistent format. The principles and regulations contained in these documents appear to conform with recently developed international norms. See Box 5.1 for the structure o fthe CoA. BOX5.1: STRUCTUREOF THE CHARTOF ACCOUNTS Section (one digit code) - 8 sections (5 for balance sheets, 2 for expenses & revenues, 1for off-balance sheets) Groups (two digit code) Subgroups (three digit code) General Ledger (GL) Account (four digit code) For example, I Section 3 -Inventory Section 6 -Expense Accounts Group 30 - Materials, Finished Goods Group 60 -Non-interest exp. Subgroup 302 - Materials Subgroup 604 -Wages & Salaries G L Account 3023 -Medicines GL Act 6041- for State employees 5.2 Accounting in the public sector, as well as in the private sector, is governed by the 2001 Accountancy Law that authorizes MoF to set public sector accounting standards. Bulgariahas adopted International Accounting Standards (IAS) for the private sector and since several of these also apply to the public sector, MoF has decided to issue standards and guidelines that are specific to the public sector budget spending units. MoF plans to introduce these in 2003. To further improve practices in the sector, authorities could consider adopting the International Public Sector Accounting Standards (IPSAS)29, *'The Government Financial Statistics (GFS) Manual issued by the IMF inDecember 2001 introduced accrual accounting and balance sheets; European System o f IntegratedEconomic Accounts (ESA) i s developed by the EU. ESA 95 is a statistical system intended to provide member countries with a set o f harmonized statistics. 29See 1ittv:iiwww.ifac.ordPublicSectori for fiuther information.. The PSC o f the IFAC is working with the IMFand the EU for reducingthe differences betweenIPSAS, GFS, and ESA.The group also plans to Bulqaria CFAA: Accountins and Reportinu 26 since the country has already applied IAS to the corporate sector and IPSAS are based on IAS. MoF also needs to prepare and issue guidelines for valuation and depreciation o f assets. 5.3 The basis of financial accounting is accrual. In the past, Bulgarian staff performed asset and liability accounting and are therefore somewhat familiar with accrual accounting principles. Going beyond the accrual principles, the new CoA requires capturing o f commitments3' (Section 9 - OffBalance Sheet Accounts). 5.4 Consolidation practices in public sector financial reporting are generally consistent with international standards. However, SOEs controlled and/or owned by the State are not subject to consolidation3'. Since the few SOEs that remain are important--some o f which indulge inquasi-fiscal activities-- M o F should adopt IPSAS 6 on Consolidated Financial Statements that provides guidelines for consolidating financial statements for the Government on the basis o fthe entity "control" concept. Organizationfor financial reporting 5.5 The MoF Division of Accounting and Statistics is responsible for developing accounting methodology, consolidating accounts, and preparing periodic reports and annual financial statements. 5.6 In general, the quality, timeliness and availability of cash-based budget execution reports or monitoring are adequate. Lower-level spending units prepare them on a monthly and quarterly basis in a format specified by M o F and submit them to their respective first-level units. M o F generally prepares the monthly consolidatedbudget execution report within 20-25 days o f the end o f the month and the quarterly reports within 45 days. The budget and actual expenditures are listed side-by-side for comparative purposes. The monthly report does not provide information on functional classifications (rather, only major economic classifications) but the more comprehensive quarterlyreports follow the full budget classification scheme. 5.7 To ensure their quarterly consolidated reports are reliable, the first-level spending units submit them to NAO for audit and reconciliation with the BNB bank statements. The audited reports are then sent to M o F for consolidation. A similar process is adopted for annual reports. M o F prepares the annual budget execution report generally by the end of May. Though the OBL requires MoF to submit annual budget execution reports to the CoM and National Assembly, it does not set deadlines for its delivery. devise reconciliation statements which concisely set out the differences between GFS, ESA reports and IPSAS-based financial statements. 30 The t e m "commitments," "expenditures," and "payments" are often confused. Simply stated commitments are the value o f the purchase order or contract that binds the agency to buy certain goods or services to the extent specified in the contract or the purchase order; expenditures are the actual o f amount of goods or services supplied for which full payment may or may not have taken place; payments are the amounts transferred from the agency's bank account to the credit o f the supplier's bank account. 31Financial statements o f SOEs are aggregated separately, outside the consolidation procedures, for statistical purposes and fiscal analysis. Bulsaria CFAA:Accountincr and Reporfincr 27 5.8 Aggregate accrual-based annual financial statements, that cover only the central Government budget, were first preparedby MoF on a pilot basis for 2001. Revenues from taxes and duties continue to be accounted for on a cash basis, in other words, tax arrears are not disclosed in the financial statements. At present, M o F is developing accounting methodology for tax revenues and arrears. Accountants in lower- level spending units prepare annual accrual-based trial balances and send them to first- level spending units for verification and consolidation. After this, the chief accountant/director (of accounts) consolidates the trial balances and sends them to the to MoF. M o F plans to prepare proper financial statements consisting o f an operating statement, balance sheet, and cash flow statement for the year 2002. For the future, M o F should consider preparing semi-annual accrual-based and, later, quarterly financial statements. Annual accrual-based financial statements should be audited by NAO. 5.9 Although accrual-based accounting statements contain various sorts of financial information, it is doubtful as to what use is made of it by department managers--unlessthey specifically request it. Thus, to ensure demand for and proper use o f accrual-based financial information, training should be included that would enable the managers to understand financial management reports. More important, the best approach to managing results would require switch to managing on accruals basis - accountability for costs, liabilities and, assets - from the current emphasis on managing within cash- basedbudget constraints. Financial Management I nformation System (FMIS) 5.10 After more than two years and US$5 million investment in staff and equipment, Bulgaria is still struggling to implement a state-of-the-art integrated FMIS running on SAP R/3 software. The fundamental reason for this delay is not because Bulgaria lacks computer skills or equipment, but because it has yet to devise an information technology plan for the Government as a whole. Lacking this, most line ministries purchased or developed their own accounting and information systems that use different hardware and software. Further, not only is the equipment incompatible at the level o f the line ministries but the problem exists equally in the lower-level spending units, which also bought their own non-standardized software. As a result, first-level spending units need to prepare consolidated reports using excel spreadsheets and then inputthe information into the SAP R/3 system. Further,accounting data at the originating locations continue to be entered manually or with the incompatible software and hardware. This raises serious concerns about data integrity and, more importantly, about the need to implement a sophisticated system just to merge the data from the 33 first- level units. Although line ministries have installed the equipment and SAP R/3 graphical user interfaces in their offices, they are reluctant to use them since they perceive little benefit from the exercise and consider it a burden. 5.11 In its 2001 Annual Repot, NAO noted that several spending units3*failed to establish accounting and reporting systems that could guarantee reliable financial 32The report does not mention number of spending unitsbut it appears that the number is not large enough to warrant disclaimer of audit opinion. Buk~~ariaCFAA: Accountinu and Reporfino 28 reporting and are unableto apply the prescribed CoA, partly due to use o f non-uniform accounting software. 5.12 Inthe context ofpre-accession (to the EU)negotiations, candidate countriesneed to produce standard, comprehensive data on Government financial statistics; to this end, an integrated system such as SAP R/3 based FMIS could ensure reliable and timely information that could also be used to monitor financial performance and decision making. However, the system will have to respond to user needs and, more importantly, reduce duplication-both in terms o f data capture and processing. In this context, the IT department must determine how the original data can best be captured, processed and transmitted to the SAP W3 based FMIS, and how data already in the SEBRA can be used by lower-level units to ensure the same data is not entered twice. Many of these issues could be easily resolved if the IT department would develop a govemment-wide IT strategy that would provide standards for hardware and software, andinterface benchmarks. The MoF is currently preparingthe FMIS strategy that should clearly spell out the future roadmap for implementation: it is important that line ministries are properly involved in this process to ensure their information needs and capacity constraints are considered. 5.13 Currently, the SAP lU3 modules used are for funds management, financial accounting, and cash management. Two additional modules - for fixed assets accounting and materials management - are being introduced as pilots. Once the system is fully implemented and stabilized, the M o F and the Bank could explore the possibility o f using it for World Bankproject financial management Recommendations Harmonize budget classifications and the CoA more fully. Prepare IPSAS-based financial statements using the GFS-2001 based reports. Consolidate the SOEs financial statements into those o fthe Government. Revise the OBL to include deadlines for submitting the annual budget execution reports and audit opinions to the C o M andNational Assembly. Develop methodology for accounting for tax revenues andarrears. Prepare half-yearly accrual-based financial statements. Intensify training o f department managers in interpreting accrual-based financial management reports. Establish a government-wide IT function that could set benchmarks and develop IT strategy for all public offices. Incorporateuser needs while implementing the SAP W3. Buluaria CFAA: Revenue Collectionand Manasement 29 6. REVENUE COLLECTION AND MANAGEMENT Tax administration 6.1 Agency (NRA) to collect both taxes and social contribution^^^ which are currently Recent developments. Bulgaria recently created a new National Revenue handled by two agencies, the General Tax Directorate (GTD) and National Social Security Institute (NSSI), respectively. The new agency is being developed along the lines proposed by the EC, whose annual report noted that, although Bulgaria made good progress in aligning its tax legislation with the acquis, 34 little was accomplished to reform the tax administration. By collapsing the two agencies into one, it is expected the collection effort will be rationalized, the public will be better served, and savings will be realized. 6.2 To help Bulgaria develop the new agency, the World Bank is supporting the Revenue Administration Reform Project (RAR), with financing o f US$40 million (Board approval is slated for July 2003). The project aims to establish an economically efficient public revenue collection system and to create automated accounting and information systems in the NRA that will conform to international norms. Earlier, Bulgaria received assistance in the form of a twinning arrangement with the Dutch tax authorities (main partner), under the EU-Phare "Reform and Modernization o f the BulgarianTax Administration" project. Current arrangements 6.3 In view of the yet to be established systems and processes inNRA, which are expected to be different but more efficient than the one currently used, this report does not analyze the existing systems and processes; rather, it briefly summarizes their workings. 6.4 GTD administers and collects both central and localtaxes and levies. Various taxes are the subject o fdifferent laws such as the Value Added Tax Act, Excise DutyAct, Corporate Income Tax Act, Taxation o f the Income of Individuals Act, as well as in regulations for local taxes and levies. Also, the Tax Procedure Code, adopted in January 2000, provides regulations for legal procedures and constitutes the foundation for the entire taxation process. 6.5 The GTD has five regional and 29 territorial tax directorates inaddition to 120tax offices that together employ over 9,400 staff. Also, GTD created a separate large taxpayer directorate for over 480 taxpayers who account for about 65percent o f total tax collection^.^^ By creating this directorate, GTD has improved service to the large 33The share of various taxes in total revenuesis as follows: personal income tax 11-12%, corporate income (profit) tax 8-9%, value-added tax (VAT) 27-28%, social security contributions 35% (collected by the National Social Security Institute), excise tax 14-15%, customs duties 1% 34acquis communautaire comprises the policies and rules o f the EU 35There are about 870,000 registeredtaxpayers. taxpayers, reduced costs, and unified processes and information, thereby operating more efficiently. 6.6 All taxpayers are required to complete tax returns and submit them to the tax office, where their records have been computerized. Under the self-assessment system, taxpayers must calculate their tax liabilities and pay them by a certain date. Anyone who fails to do so or fumishes false information can, in theory, face criminal prosecution. 36 However, untilnow, no one has been convicted under the law. 6.7 The payment process works as follows. Individuals pay taxes through their banks,.the funds are credited to the agent bank o f the tax office, and ultimately, all funds are transferred to the Treasury Single Account within the BNB (see Box 6.1 for details). Agent banks provide daily data (mostly in electronic form) to the tax office for daily reconciliation with the information furnished by taxpayers. Through this procedure, the risk o f float inthe system is minimized. BOX 6.1: FLOW CHART FORTAXCOLLECTIONS 1copypaymentorder Tax Office Order payment order Reconcileddaily i "I Daily tax collection statement ! Bank of I I Tax Payer Funds III + CollectingBank o fthe Tax Department i Diskette Remittance 1 Office 6.8 The system of tax audits is well organized and clearly defined in the Tax Procedure Code. Cases selected for further investigation are based on risk assessment criteria developed by the head office.37 The system contains good controls such as performing audits based on intemal orders from audit department heads, thus avoiding arbitrary decisions. Tax audit teams consist o f at least two inspectors and the final tax assessment order i s reviewed by the head o f the tax audit department inthe territorial and regional offices. As an incentive for increasing tax collections, 35percent o f the 36 Tax Procedure Code (Article 53) 37 Tax Procedure Code (Article53) additional taxes collected (due to the audits) is allotted to a fund used primarily for the department's capital expenditures. 6.9 A separate inspectorate exists within the tax administration that investigates appeals and complaints and performs internal audits. With a staff o f about 100, the inspectorate reviewed about 350 complaints in 2002, o f which about 30 related to corruption; of these, seven were proved, which resulted in 32 staff being dismissed. Further, the inspectorate transferred about 1,200 cases to the prosecutor's office for further action. In addition, the inspectorate has good working relationships with both PIFCA and NAO. Taxarrears 6.10 Total tax arrears as of September 30, 2002 were Levs 2.77 billion, of which Levs 2.04 billion were due to reassessed tax liabilities (based on audits) and only Levs 0.72 billion due to self-assessments. The total arrears includes Lev 1.33 billion (about 50 percent) that are classified as doubtful of recovery, since the enterprises indefault lack sufficient cashhank balances or other assets to pay tax liabilities. 6.11 A new agency, the State Collection Agency (SCA), began operating in early 2002 and is responsible for (a) pursuing and collecting all public financial claims, (b) representing the State inbankruptcy proceedings where the State is the creditor, and (c) receiving and disposing of property acquired or confiscated as a result of outstanding financial claims. SCA has a staff o f 567, including 525 collectors. 6.12 Although all taxes overdue for more than six months can be transferred to the SCA for collection, the GTD selectively transfers only those cases it determines could not be collected through normal procedures. SCA has a separate account with Bulbank and transfers the taxes it collects to the respective agency in the Treasury Single Account; in 2002, the Agency collected approximately Lev 104 million. Funds lying in the regional directorates' bank accounts are not transferred automatically to the Treasury Single Account, since they represent collections on behalf o f several different agencies. SCA's regional directorates are required to prepare orders for transferring fimds to the T S A to the credit o f respective agencies. SCA's head office is required to monitor the transfer of these funds, but the effort needs to be improved. 6.13 Other areas that need strengthening are recording, monitoring and tracking the properties confiscated or acquired by SCA in the process of realizing public financial claims. To this end, SCA should consider developing an integrated inventory system to manage the properties and prevent their misuse. Issues in tax administration 6.14 The RAR project documentation lists several issues in tax administration. These include: 0 A crisis approachto management, with continuous encroachment by headquarters on the collection activities of the tax offices; as a result, managers lose their focus Buloaria CFAA: Revenue Collectionand Manauement 32 on developing strategic and future planning, direction and control of the organization; 0 Lack o f a sound strategy for managinghumanresources; 0 An operational strategy that lacks the necessary support or processes to serve the taxpayers; at present, operations are based on outdated business processes with little in the way o f information technology and no credible risk assessment strategy; 0 A fragmented and dysfunctional national network of offices, spans of control and layers of management; the problem is exacerbated by GTD's need to collect both national taxes and local taxes such as property taxes; 0 Claims o ftaxpayer harassment and intemalcorruption; 0 Inadequate information systems and weak management o f information technology. 6.15 The RARproject aims to help establish efficient systems inthe NRA and create a professional workforce inthe tax administration. To this end, it will assist the Agency in introducing a state-of-the-art management information system, a modem integrated revenue and registration system, a modem human resources management function, extensive training and several other activities. Customs administration 6.16 The National Customs Agency (NCA) has about 3,825 staff, five regional directorates and 120 customs offices across the country. The Agency is responsible for collecting customs duties and excise taxes, andVAT that relateto imported goods. 6.17 Bulgaria's customs system i s closely aligned with the EUcustoms a c q u i ~its~ ~ ; tariffs also comply with the Harmonized System and Combined Nomenclature o f2002. 6.18 The internal controls in the system of remittances to the TSA with BNB appear sound. Revenues are collected either through bank transfers or cash deposits at agent banks located at customs offices. In a manner similar to the GTD process, the banks transfer the collections daily to the Treasury Single Account with BNB and provide daily balance statements that are then reconciled with BNB data. In turn, each customs office prepares monthly and outstanding revenue statements that are consolidated at the regional level and submittedto the head office. 6.19 Revenue audits and investigations are conducted regularly by the Internal Investigation and Operational Security Department at the head office. The Department focuses on NCA's intemal operations and ensures that internal staff comply with the laws and regulations: In 2002, about 100 staff were penalized as a result of its 38European Commission2002 Regular Report on Bulgaria's Progress Towards Accession Bulgaria CFAA: Revenue Collecf:on and Management 33 investigations. To facilitate its work, a hotline was created, allowing citizens to lodge complaints. 6.20 PIFCA has nominated two delegated auditors to work with NCA. At present, the delegated auditors are inthe process o f learningand devising their strategies. 6.21 NCA has benefited from outside expertise in the reform process-most notablyfrom the twinningarrangementswith Germanand Frenchcounterpartsand consultancyinputs from Crown Agents o f the UK. 6.22 The Agency is now introducing a modern Integrated Customs Information Systemthat shouldprovide arange ofdata to managers on a timely basis. Bulgaria CFAA: lnfernal Audit 34 7. INTERNAL AUDIT Legalframework 7.1 The Government, in response to EU requirements, enacted the Public Internal Financial Control Act in 2000 and established the Public Internal Financial Control Agency (PIFCA)39 to provide "control over financial activities for the purpose o f assessing legality and compliance with the principles o f effectiveness, efficiency, and economy." The Act mandatesPIFCA to plan, manage and implementan integrated policy in public internal financial control and supervise overall internal control activities. Such wide-ranging powers pose risks with regard to conflicts o f interest: That is, PIFCA objectivity could be at risk if it is required to simultaneously devise and supervise the internal control policy. More important, such powers blur the responsibility o f the managers responsible for the internal control systems within their departments. Thus, those performing internal audits should not have primary responsibility for establishing and maintaining internal controls; instead, internal auditors should only evaluate andreport the effectiveness o f control systems and suggest improvements. Structure 7.2 PIFCA is managed by a Director who is appointedby the Minister o f Finance and approved by the Prime Minister under a renewable contract, with an initial term o f four years. At present, PIFCA has 28 regional directorates and a staff o f about 1,300. 7.3 Initially conceived as a centralized internal audit agency under the MOF;' PIFCA has begun the practice of deputingdelegated auditors to most of the first- level spending units.41Although these auditors report to PIFCA, they are expected to work with the department heads to strengthen the financial management and control systems. However, they are still considered as "external" compliance testers by department managers and it will take some time before the auditors are seen as internal. Inthe longrun, efforts mustbemadeto integratethese auditors withinthe lineministries, and have themreport directly to the ministers. Scopeof PIFCA activities 7.4 The Act affords PIFCA broad powers to conduct internal audits in all the ministries, as well as in authorities that administer revenues, extra-budgetary funds and local authorities. 7.5 PIFCA is also empowered to do internal audits in the SOEs. Most SOEs, which are registered asjoint stock companies (such as the Bulgarian Railway Company), have established or are in a process of introducing their own internal auditors and/or departments-and PIFCA is obviously "external" to this structure. Since SOEs are 39PIFCA traces its origin to the erstwhile Control Inspectorate. 40PIFCA enjoys the status o f a separate legal entity. 4'The ministries o f Defense and the Interior also have their own internal financial control units--although PIFCA also has a few delegated auditors inthese ministries as well. already subject to external audit by private professional firms, the provision that authorizes PIFCA, which is external to SOEs, to audit them needs to be reviewed to avoid duplicated efforts. To this end, it would be more efficient if PIFCA's role were redefined as an agency that sets standards, provides guidelines and training, executes quality control and relies on the work o f SOE's internal auditors provided that their technical capabilities and professional independence are secured. 7.6 The Act authorizes PIFCA to require financial controllers to consult PIFCA auditors prior to incurring any expense or assuming financial liability where PIFCA has found "errors or weaknesses inthe financial management and control systems o f the auditee." The Act also empowers PIFCA to establish a "preventive control system" inthe auditee departments in question. This provides sweeping powers to PIFCA and an opportunity to get involved in executive decision making that can prove counter- productive and create situations o f conflict o f interest where, after PIFCA approves a transaction, a financial loss i s incurred. Although ex-ante control was a common control approach in the past, in modem internal audits, authorities act on the root cause of the problem and take measures to strengthen the control framework rather than having auditors approve every transaction. 7.7 PIFCA has a broad scope as the Act authorizes it to carry out systems audits, performance audits, financial audits, and information technology audits. Working of PIFCA 7.8 PIFCA's internal operations are regulated by a decree (Regulation on the Implementation o f the PIFC Act) adopted by the C o M in 2001. This decree requires PIFCA to prepare an annual plan of internal audits based on risk assessments. To this end, the Agency received substantial technical inputs under the EU-Phare-financed twinning project for preparing laws and other documents.42 However, PIFCA faces a. bigger challenge in ensuring the laws are implemented properly and that line ministries perceivevalue added inefficient management controls. 7.9 The regulations require that internal auditors present their findings with substantial evidence and prevent them from making recommendations when audits reveal no weaknesses or errors. Such provisions ensure that the auditors offer realistic recommendations backed by solid evidence. 7.10 According to the policy of delegating auditors, PIFCA has deputed up to three delegated auditors for most first-level spending units. However, if this policy is to succeed, it is important that PIFCA seconds enough internal audit staff in each ministry based on the volume o f work and needs o f the department. In the long run, although the delegated auditors would continue to receive functional guidance from PIFCA, their accountabilities should be clearly established in the ministries where they work. 42The twinning partner is the FrenchMinistry of Economy, Finance and Industry Bulgaria CFAA: lnfemal Audit 36 7.11 With technical assistance from its twinning partner, PIFCA has finalized several manualsand guidelinesfor theinternalauditstaff. It has also prepared a Code o f Ethics, is developing a manual on Standards on Internal Audits, and plans to produce one on risk assessment. These manuals are extensive, detailed andwill facilitate the work of internal auditors. Although PIFCA has already organized several training programs, given the large number and relatively young staff (the average age is about 35 years), PIFCA will need to continue its training programs, at least in the near future. Another area requiring attention is the internal audit of IT systems. As the use o f IT systems is widespread, PIFCA should prepare a manual for auditing them and provide extensive training to the staff. 7.12 Good cooperation exists between PIFCA and NAO, 43 as PIFCA shares its annual internal audit plans and reports with NAO. PIFCA also follows up on NAO's recommendations to line ministries andNAO participates inthe steering committee ofthe twinningproject. Internal audit reports 7.13 PIFCA auditors are required to prepare draft audit reports and submit them to the heads of the departments, agencies, or SOEs audited. The audit reports are expected to assess the financial management and control systems; they are also to recommend ways to strengthen the control system. The department heads must provide opinions within 14 days and the internal auditors' final reports need to state why they accept or reject the department heads' findings. 7.14 PIFCA prepares a consolidated annual activity report44to submit to the Minister of Finance. However, no plans exist to prepare a consolidated annual internal audit (which would consist of PIFCA and delegated auditors' reports) for each line ministry that could offer line ministers an overview of the -key issues in the internal control framework within their ministries. Human resources and capacitybuilding in PIFCA 7.15 One of PIFCA's priorities has been improvingits staff`s internalaudit skills. To this end, Bulgaria received significant EU-Phare assistance the area of public internal financial control, includingtraining programs. InNovember 2001, PIFCA entered into a two-year twinning agreement with the French Ministry of Economy, Finance and Industry; one of the components was developing human resources to improve the professional standards and general competence of PIFCA auditors. PIFCA is now finalizing its 2003 EU-Phare support to establish a training center and facilitate the professional qualification o f its auditors. Thus, training activities have received a good deal of support; but the need for added resources for further training, particularly in risk assessment, revenue audit and IT-based audits, is substantial. 43 PIFCA andNAO signed an agreement inJuly 2002. 44The annual activity report for 2002 contains many statistics, inaddition to a summary o f major issues. These issues correspond to many of the findings inthis report, such as the need for better accounting and reporting guidelines and standards, better written policies and procedures, better training o f accounting and financial staff. Bulqaria CFAA: lntemal Audit 37 7.16 PIFCA's budget is financed entirely from the national budget; the salaries of PIFCA auditors are consistent with national civil service norms. However, the Act providesfor supplementarybonuses of up to 25percent of the annualsalary budget. PIFCA has been conducting annual written tests to determine the individuals' eligibility for such bonuses. This provides some flexibility inthe salary system, allowing managers to reward excellence and promote the adoption o f new techniques. Despite the added bonus, salary levels are not large enough to attract professionally qualified auditors. However, this i s true for the entire Government sector (inBulgaria andelsewhere). Inspectorate within line ministries 7.17 All line ministries have a control inspectorate4' whose primary role is monitoringadministrativeprocesses and legal requirements, along with canying out specific investigations requested by the ministers. The inspectorate reports directly to the line minister. A sample review of an annual activity report for 2002 o f the control inspectorate in the Ministryo f Education and Science (which has a staff o f 10 ) reveals an overlap between the work of PIFCA and the inspectorate. For example, the inspectorate performed 17 inspections duringthe year, o f which five related to execution of the budget, while four related to contracts, bookkeeping and other documents. Most o f these activities are within PIFCA's scope o f work. Another example o f the overlap is the financial management and control regulations inthe Ministryof Environment and Water that specifically empower the control inspectorate to exercise internal financial controls. Since delegated auditors were created for each ministry, it is important that the Government review the policy o fhaving inspectorates within each line ministry. Recommendations Review and revise the provisions regarding PIFCA's responsibility to devise and implement internal financial control policies at the same time that it audits the internal control systems-producing a potential conflict o f interest. To reduce the risk, PIFCA should remain aninternal audit body; Intensify efforts to integrate delegated auditors within the line ministries at the same time that they maintain their hnctional independence; Review the PIFCA policy with regard to its performing internal audits in corporate SOEs; instead, consider establishing (and in some cases strengthening) internal audit units within the SOEs; Review and revise PIFCA's authority to establish preventive control systems within the organizations audited; Review and supplement the number o f delegated auditors in each ministry and important lower-level units; 45Governed under the Law on Administration(Article 46) Bulsaria CFAA: lnfernal Audit 38 0 Develop manuals on revenue and IT-based audits, as well as risk assessment; develop trainingprograms for bothtypes ofaudits; 0 Develop internal audit standards that are based on international standards; Consider preparing consolidated annual internal audit reports for each ministry; Continue providingadequate resources for training auditors; 0 Review the policy of continuing control inspectorates in line ministries once an adequate number o f auditors are delegated. Bulqaria CFAA External Audit 39 8. EXTERNAL AUDIT Legalframework 8.1 The Bulgarian National Audit Office (NAO) is the Supreme Audit Institution (SAI) in Bulgaria created by the Constitution and the National Audit Office Act. The NAO has a long history of more than 120 years and traces its roots to the Supreme Audit Act o f 1880. The newly adopted 2001 NAO Act harmonizes to a large extent with similar laws o fEUmember states. Independence 8.2 NAO's functionaland operationalindependenceis ensuredby the provisions in the Constitution and the NAO Act in two ways. First, the Constitution required the National Assembly to establish an independent NAO. Second, the 2001 NAO Act guaranteed that NAO's budget would be separate fiom the national budget, that the Government would not be allowed to amend NAO's draft budgets (Article 20 o f the OBL and Article 23 of the Act) and that neither the Government nor the National Assembly could interfere inNAO's activities. The Act also specified that the President and NAO's 10 members would be elected by the National Assembly for nine-year terms, that the President may serve only one term andthat NAO would report to the National Assembly Scope of audit 8.3 The 2001 Act mandates NAO to audit all public and statutory funds, including extra-budgetary funds, the State Social Insurance Institute, and the National Health Insurance Fund, as well as municipalities. It also audits BNB expenditures and the annual surplus of income over expenditure due to the State budget, although it may not audit BNB's full financial statements, which are audited by one of the local offices ofthe Big4 audit firms. 8.4 Unlike PIFCA, NAO does not have the mandate to audit the SOES~~, which are audited by private audit firms. Such an arrangement could be problematic, given the vast amount o f public resources invested in SOEs, the need to ensure they are effectively and efficiently used, and the varied quality o f the private firms' audits47. Thus, it is advisable that NAO, as the Supreme Audit Institution, be authorized to audit the SOEs under certain circumstances: For example, when the financial audit by a private firm reports serious issues, when N A O has sufficient reasons to believe that the financial audit carried out by a private audit firm is unsatisfactory, or when the National Assembly asks for a special audit. 46NAO ,however, is empowered to audit usage ofbudgetary funds received bythe SOEs. 47The ROSC- A&A Report observed "While many audit firms make strenuous efforts to carry out audits inaccordance with national standards basedon ISA, there are claims that few shareholders, directors, and members o f management understand the purpose of an audit, therefore making it difficult to obtain appropriate audit evidence. While this problem undoubtedly occurs in other countries, including those with developed audit requirements and practices, it i s understood that the extent ofsomeproblems is more widespread in Bulgaria than in other-countries." Buloaria CFAA: External Audit 40 8.5 The NAO has the authority to carry out all types of audits - financial statements audits, financial audits, performance audits and other specific audits (Article 36). The Act requires NAO to audit and certify annual accounts o f line ministries, extra- budgetary funds, and budgetary organizations. Under the EU-PHARE financed twinning project, NAO began two pilot performance audits with technical inputs from its twinning partner (the United Kingdom NAO). 8.6 Further, NAO has the authority, when requested by the National Assembly or the CoM, to express opinions on annual budget bills, Government programs, bills related to accountability and the control of public funds. As mentioned in the Section on Public Sector Budgeting, NAO has been providing opinions on the annual draft budget to the National Assembly. Structureof NAO 8.7 The NAO is managed by its President, whose broad powers include approving and terminating employee contracts. In addition, a Secretary General is responsible for coordinating the development, implementation, and reporting o f its audit activities and information systems. 8.8 The Act states that its meetings are considered valid when two thirds o f its members are present; also, that decisions can be made by a simple majority. However, the Act is unclear with respect to which decisions should be taken by the collegium or the President. 8.9 The headquarters consist of ten departments managed by NAO members, while six regional offices are organized on a territorial basis and managed by directors. Each regional office is hrther subdivided into sectors, managed by Chief Auditors, which mainly cover municipalities inrespective regions. Auditprocess 8.10 The Act (Article 14) requires NAO to adopt audit standards that comply with international standards. To this end, with the help o f its twinning partner, NAO has adopted a set of 10 audit standards that are largely based on INTOSAI audit standards. SeeBox 8.1 for a list o fstandards that apply to all audits performed byNAO. 8.11 NAO preparesan annualauditprogram,taking into consideration the statutory requirements and up to five special audits requested by the National Assembly. In this process, NAO coordinates with PIFCA as discussed earlier. The annual audit program i s submitted to the National Assembly for information. The need for risk assessment in developing its annual audit program is recognized but the concept is still not clearly understood. Thus, NAO will require further training andtechnical assistance. Bukaria CFAA: demal Audit 41 Box8.1 :NAOAUDIT STANDARDS ..................... 1 GENERALSTANDARD ON THE AUDIT The Audit standard No. 1 sets out the general issues with reference to the ACTIVITY OF THE NATIONAL AUDIT National Audit Office audit activity. OFFICE ............................................ ................................ ........... ......... ............ ...... 2 PLANNING OF AUDIT ACTIVITIES AND The Audit standard No. 2 sets out the general principles and requirements for AUDIT TASKS planning of audit activities and individual audit tasks. The planning of audit tasks section of this Standard shall be applied to all audits carried out by the ..................... NationalAudit Office. ................................................................................. ........... _- .............. .................. .. 3 FINANCIALAUDIT The Audit Standard No. 3 defines the character, objectives and scope of financial audit, the responsib es and criteria for assessment, planning, accomplishingand reportingof the financial audit. The standard applies to all _ _ _ _ financial audits carriedout by the NationalAudit Office. __"_ ..... ................... 4 PERFORMANCEAUDIT The Audit standard No. 4 sets out the performance audit character, objectives and scope, criteria for assessment, planning, accomplishing and reporting of performance audits. The standardapplies to all performance audits carried out by the National Audit Office of programs, activities or functions, of budgetary or other public funds, as well as funds from the European Union and other internationalorganizations. .. ........... . ~ " ~ " 5 AUDIT EVIDENCE Audit Standard No. 5 defines audit evidence. It sets out the requirements to audit evidence, the types of audit evidence, as well as the approach, techniques and procedures to be adopted when obtaining them. This standard shall be appliedin all types of audit carriedout by theNationalAudit....Office. -. ......... " _" ......_- ._ ..... AUDIT SAMPLING Audit StandardNo. 6 defines and audit sample. It sets out the requirements to use audit samples, how to design sampling methods and select samples, and how to evaluate results. This standard shall be applied in all types o f audit carriedout by the National Audit Office, when samplingis used. MATERIALITY AUDIT RISKAND Audit Standard No. 7 defines materiality and audit risk. The Standard shall ........................................................ applyto all types of audit carriedout by the............. National Audit Office. ...... .................................................................. ANALYTICAL PROCEDURES Audit Standard No. 8 defines analyticalprocedures. It sets out the reasons for using analytical procedures and the procedures for selecting them during the audit. This standard shall be applied in all types of audit carried out by the .-............. NationalAudit Office. WORKING PAPERS Audit Standard No. 9 defines audit working papers and sets out requirements for them and for audit files. The standardshall be appliedto all types of audit ................... ". carriedout by the National Audit Office. ...........................^ REPORTING Audit Standard No. 10 defines reporting and sets out the main reporting principlesand requirements. The standardshall be appliedto all types of audit carriedout by the National Audit Office. INTOSAIAUDIT STANDARDS Consistoffour parts : III (a)......... Basic Principles ; .................................................................... .^............... ..... ......._......... (b) GeneralStandards(recruitment, training, manualsand instructionsto the audit staff, skills, internalreviews) (c) Fieldstandards(Planning, supervision, audit evidence, study and evaluationof internalcontrol) - _ . (d) Reportingstandards (written report, audit opinion) Bulqaria CFAA:External Audit 42 8.12 Once NAO completes its audits, it submits a draft audit report to the audited organization (auditee) for comments. A final report, after incorporating comments of the auditee, is adopted at the meeting of NAO members, and thereafter sent to the auditee together with recommendations for improvements. NAO is also required to regularly send to the National Assembly information on adopted reports duringthe quarter. 8.13 The NAO 2001 Annual Report noted satisfactory progress by auditee organizations in implementing its recommendations. Managers of the organizations audited must implement the audit recommendations and inform NAO in writing within the time specified. 8.14 Iftheydonot, NAOspecificallyforwards the report, withitsrecommendations, to the National Assembly and/or the CoM or higher-level authority. In the same manner, when NAO detects violations in public procurement procedures, the audit report is also sent to the Minister of Finance and Minister of Public Administration so they can take appropriate actions. In2001,29 reports were submitted. 8.15 NAO conducts limited audit of the quarterly budget execution reports of the first-level spending units, which consolidate the reports o f the lower-level spending units. This is accomplished by verifying the reports with Bank statements and other data. NAO does not regularly audit the lower-level units, where most transactions occur and original records are maintained. The regional offices audit primarily municipal budgets, although NAO's head office may occasionally request staff from regional offices to help the NAO departments audit selectively the lower-level spending units. NAO has no mandate to carry out physical verification of assets. 8.16 Untilnow, NAO has not compiled a comprehensive strategy or guidelines for auditing revenues; such a strategy would include procedures to ensure the reliability and effectiveness of tax assessments, collections and arrears systems. Thus, revenue audits are generally restricted to verifying bank statements and collection records. 8.17 Further, NAO has not yet developed specific manuals/guidelines to audit IT- based systems. But, given the high degree o f automation and widespread use o f on-line and real-time systems, this area should be a highpriority. NAO reports 8.18 The quality of NAO reports has steadily improved over the past few years. The mainreasons are clarity over the types ofreports inthe Act, exposure to international audit standards, and training under the twinning project. The NAO submits its reports to the National Assembly, including those on special audits, annual activities, execution of the State Budget, the State Social Insurance Fund budget, the National Health Insurance Fundbudget, and BNB expenditures. The 2001 Annual Report provides major findings and recommendations with respect to each line ministry and agency in addition to results of audits carried out inmunicipalities. 8.19 NAO has the power to deny certification of annual accounts (budget execution reports) of line ministries and agencies. In 2000, it refused to certify annual accounts of three ministries (the Ministry of Health, Ministry o f Interior, and Ministry of Bulaaria CFAA: ExternalAudif 43 Defense) on the grounds that annual accounts failed to observe applicable accounting procedures andguidelines. 8.20 The NAO annualactivity report must be submittedto the NationalAssembly by June 30 every year; inturn, the Assembly must approve the report by December 31. Inthe past there were substantial delays inadoption of NAO annual activity reports due to lack o f a specific provision (specifying a time limit for adoption o f annual report) in the Act. For example, NAO annual activity report for the years 1997, 1998, and 1999 were submittedagain to the National Assembly in2001, which were then adopted. Dueto the provision in the 1995 NAO Act that barred publication of NAO reports until their adoption by the National Assembly, the NAO reports for these years were not publicly accessibleuntiltheir adoption in2001. 8.21 There are similar delays insubmitting the NAO audit reports on the State budget execution to the National Assembly. This delay i s caused due to a provision in the Act that requires an audit report to be sent to the National Assembly only after the Assembly adopts the Government's budget execution report (Article 49). As a result, althoughthe audit report for 2001 was ready much earlier, it was not sent to NationalAssembly untilMarch 2003, due to the fact that the State budgetexecutionreportfor the year was not adoptedbythe NationalAssembly. This provisioncreates a situation wherethe National Assembly i s expected to adopt accounts without considering the audit report; it also prevents NAO from publicizing the audit results until they are adopted by the National Assembly (see below). Thus, the public had no access to the audits o f 1997, 1998 and 1999 until they were adopted by the National Assembly in 2001, which weakens the chain o f accountability. 8.22 The Act requires NAO to make the audit reports public (other than specific audits requested by the National Assembly) after their adoption by the National Assembly, and allows it.to select the method by which to achieve this. To this end, NAO has developed a website (http://www.bulnao.government.bg/) where audit reports and other documents can be accessed. However, in the absence of analytical information regardingpublic visits to the website, it is unclear to what extent that civil society was able to access the website and use the reports, to holdthe Government accountable. Audit of NAOJinancial statements 8.23 While the practice is not common in all countries, in Bulgaria, NAO's financial statementsare audited.This is a good practice as no agency remains beyond audit. The Act requires a separate committee of the National Assembly to audit NAO's annual financial accounts, although the Act does not specify any qualifications for members of this committee. The committee report i s thensent to the NationalAssembly. Human resources and capacity building in NAO 8.24 NAO has about 450 staff, the average age o f which i s over 40. This figure is higher than the average in PIFCA, which has attracted a significant number of younger staff. As provided in the Act, a minimum of a masters degree in economics or law is requiredfor auditors. New recruits are appointed after they pass examinations conducted by NAO and interviews with the commission comprising three NAO members. NAO BulaariaCFAA: External Audit 44 salary levels are slightly higher than average government salaries thus providing some flexibility in attracting new talent. 8.25 NAO has benefited from the twinning project with the UK NAO. The project's components included developing a legal framework, developing and implementing audit standards, strengthening management and administrative capacity, and developing internal IT support. However, to progress even further, it should seek peer review from one o f the SAIs in the EU, which could help it assess its implementation o f various standards and the quality o f the audit processes it has followed. 8.26 Once the peer review indicates satisfactory results, the Bank should consider, initially on a pilot basis, that NAO audit financial statements o f Bank-financed projects. 8.27 The NAO has also established a well-equipped training center and library with financial assistance from the EU.Given the similar interests o f PIFCA and NAO, it would save on scarce resources and avoid duplication ifajoint training center for PIFCA and NAO staff were established; it would also serve financial management and accounting staff o f the line ministries. Training could be offered in financial management, internal controls, and internal and external audits. The Public Finance School, being established under MoF, could be considered for this purpose. Recommendations Review and consider empowering NAO to audit SOEs under specific circumstances; Clarify the decision-making areas that would be assigned to the collegium and the President o f the NAO; Develop specific training programs in risk assessment and incorporate their results inpreparing the annual audit program; Develop a strategy for auditing lower-level spending units and consider mandating NAO to demand physical verification o f assets bythe management and authorizing NAO to attend such physical verification procedures whenever deemed necessary by NAO; Develop a comprehensive strategy, guidelines and training programs for auditing revenues; also consider incorporating them inthe next twinningproject; Develop manuals and guidelines, and specific training programs for auditing IT- based systems; Review the provisions in the Act that require the NAO audit report on the State budget execution to be submitted to the National Assembly only upon adoption by the National Assembly o f the government report on the State budget execution; Consider peer review o fthe audit practices by one o f the SAIs inthe EU; !3u/~ariaCFAA: ExfemalAudit 45 0 Consider establishing a joint training center for staff from PIFCA, NAO and line ministries on financial management, intemal controls, and intemal and external audits. This would be a more efficient use o f scarce resources; 0 Consider authorizing NAO for auditing the financial statements ofBank-financed projects upon a satisfactory peer review report. Bulgaria CFAA: LegislafiveScrutiny 45 9. LEGISLATIVE SCRUTINY Parliamentary involvement during budgetpreparation 9.1 Parliamentary inputs in the budget preparation process are mainly accomplished through its Budget and Finance Committee (BFC). Since the 22- member BFC (13 ruling party members and nine from the opposition) is chaired by a member o f the ruling party, a close working relationship exists between this member and the Minister of Finance during the budget preparation process. Although .the BFC is assisted by three hll-time advisers and 6/7 part-time staff, the Committee relies heavily on the M o F for data and analytical reports. BFC's report on the Government's draft annual budget is presented by its chairman to the National Assembly. Before being adopted, the draft annual budget prepared by the Government undergoes two readings in the Parliament. 9.2 The OBL effectively prohibits the National Assembly from increasing budget expenditure proposals unless an equal amount of revenues i s identified, thereby maintaining a balanced budget. Parliamentary involvement during budget execution 9.3 During the budget implementation stage, the BFC has a right to summon any minister to discuss the progress and status o f budget implementation within hidher ministry. 9.4 The National Assembly has no role in reallocating appropriations among various budget heads; rather, the OBL assigns this function to the MoF. Although this practice could theoretically lead to the legislative intent being subverted, recent adjustments o f this sort have been inconsequential. Similarly, the C o M and MoF, rather than the Assembly, determine how revenues earned by the line ministries will be appropriated among various activities and programs. Also, in situations where actual revenues exceed budgeted revenues, the C o M and MoF decide how the extra revenue should be spent. Again, such practices provide flexibility to the Government but could underminethe authority o fthe legislature to approve all appropriations. 9.5 There have been substantial delays in considering and adopting budget execution reports submitted by the CoM. For example, budget execution reports for the years 1997, 1998, 1999, and 2000, though submitted regularly by the Government, were adopted by the National Assembly only in 2001. The budget execution report for the year 2001 has yet to be approved (as of March 2003). Such delays weaken accountability and postpone public discussioddebate on the budget performance to such a degree that it is largely non-existent. Equally problematic, due to an unusual provision in the in NAO Act (Article 49), which requires the audit report be submitted to the National Assembly only after it has adopted the Government budget execution report, discussion o fthe audit report inthe Parliament is seriously delayed. 9.6 The BFC reviews the budget execution report and presents its findings to the National Assembly. 9.7 Although SOEs' annual budgets and financial statements are not presented to the National Assembly, either for information or approval, parliamentary committees may still request these and other documents. As noted in Section 2.5 because some SOEs perform quasi-fiscal activities, it is important that a formal mechanism be established that would allow the NationalAssembly to deliberate onthese reports. 9.8 NAO submits annual activity reports and audit reports on the budget execution to the National Assembly, where they are reviewed by the BFC. Also, NAO alerts the National Assembly when line ministries and agencies fail to implement audit recommendations. As mentioned earlier, the submission and adoption ofNAO reports are significantly delayed. Committeeproceedings 9.9 Parliamentarycommittee rules permit the Chairman to decide ifmeetings will be open to the public. Generally, the public is allowed to attend, which helps promote transparency. Recommendations 0 Review current procedures for allowing line ministries to spend their own revenues subject to approval from MoF and define a role for the legislature; 0 Adopt the latest budget execution reports before the next annual budget is approved; 0 Adopt annual NAO audit reports simultaneously with the Government's budget execution; 0 Review and consider formal mechanisms for legislative oversight o f the SOEs' annual financial statements on a selective basis. Buloaria CFAA:Fiscal Transparencv and Public Availabilitvof lnformation 48 10.FISCAL TRANSPARENCY PUBLICAVAILABILITY OFINFORMATION AND 10.1 Budget development occurs through a transparent process, both within the executive branch and inthe National Assembly. It is a well-defined process, governed by an established timetable as discussed inthe section on public sector budgeting. 10.2 Fiscal transparency of extra-budgetary funds and accounts has improved substantially since 1999 as the number o f such accounts has been reduced and entire Government payments and collections are routed through a treasury single account. Financial statements of EBFs are audited byNAO. 10.3 The OBL does not explicitly address the issue of transparency by providing the public with details on the annual budget and execution reports. Nevertheless, fiscal information is publicly available in M o F and BNB monthly, quarterly and annual reports. Also, an aggregated report of the consolidated budget, based o n cash flows from the central budget, is included in MoF's monthly bulletinand website (http://www.minfin.govemment.bg/en/). And, while data on contingent liabilities, tax expenditures, and quasi-fiscal activities are not published, they are available to the National Assembly. In addition, the MoF and BNB together publish a detailed monthly survey of domestic and external debt.48 However, accrual-based financial statements and budgets are yet to be publishedor posted on the website. 10.4 Unlike the OBL, the NAO Act is quite explicit with respect to principles of transparency, requiringthat NAO reports be made public after being submitted to the National Assembly. To this end, NAO has created a well-designed website (http://www.bulnao.government.bg/), where all its reports are posted. 10.5 While these activities have greatly improvedtransparency, the Government could move in a few other areas to take the process even further. For example, it could post information about capital projects, such as intended benefits and completion dates, that could be of interest to civil society. Recommendations 0 Review the OBL and consider adding explicit provisions to make budget documents and budget execution reports public; 0 Consider postingdetails about capital expenditure projects on the website. 48IMFReport onFiscal Transparency ROSC 11.ANTI-CORRUPTIONPROGRAM 11.1 Although Bulgaria has made some progress in its drive against corruption, the Corruption Assessment Report 2002 by Coalition 20004' and a report by the EU Accession Monitoring Program of the Open Society Institute" observed that many Bulgarians still believe the Government has yet to achieve tangible results in reducing corrupt practices and the issue is still perceived as one o f the gravest problems o f the transition. The Business Environment and Enterprise Performance Survey (BEEPS), developed jointly by the World Bank and the European Bank for Reconstruction and Development, found more than a quarter o f respondents observed a moderate impact on their businesses due to unofficial paymentdgifts to public officials. One o f the reports found significant restraint with respect to political corruption but a relativelyhighamount among lower-level officials. The public also perceived widespread corruption among customs officials, although reforms were launched, such as an Ethics Code for Customs Officials andtechnical consultancy inputsfrom Crown Agents. 11.2 Public procurement continues to be one of the main sources of corruption: The Corruption Assessment Report 2002 revealed over half the companies that participated in tenders resorted to bribes when obtaining procurement contracts. For example, packages were split to avoid bidding procedures. Such practices continue despite the 2002 amendment to the Public Procurement Law aimed at improving transparency and ensuring greater competition. The NAO report has also observed frequent violations o fthe public procurement procedures. 11.3 Privatization through tenders and auctions and abolition o f non-transparent privatization procedures such as negotiations with potential buyers and management- employee buy-outs has had a positive effect. However, slowdown in the privatization o f Bulgartabac and Bulgarian Telecom Company (BTC) has understandably raised public doubts. National anti-corruption strategy 11.4 The Government has made anti-corruption activities a high priority area: CoM adoptedthe national anti-corruption strategy inOctober 2001 and an anti-corruption program in February2002. The strategy revolves around creating a common institutional and legal environment for curbing corruption, reforming the judiciary, and formalizing anti-corruption cooperation among Government institutions, NGOs and the media. Several efforts, such as the Law on Property Disclosure by Persons Occupying Senior Positions in the State, and NAO being empowered to serve as a public registry for such declarations, have been positive. So too have the privatizations through tenders and auctions, and abolition o f non-transparent privatization procedures, such as negotiations with potential buyers andmanagement-employeebuy-outs. 49Coalition 2000 is an initiative of Bulgarian non-governmental organizations launched in 1997with the aim to counter corruption inBulgariansociety (http:llwww.anticormption.bglenglcoalitioniabout.htm) j0http:llwww.eumap.orgl Bukqaria CFAA: Anti-Corruption Procram 50 11.5 Moreover, much of the PAL program is designed to explicitly or implicitly reduce opportunities both for State capture and administrative corruptions1.Some o f its features include opening the electricity and gas markets, restructuringthe railway, developing independent regulators for the energy and telecom sectors, strengthening arrangements for freedom o f information, strengthening the regime to combat conflicts o f interest and to declare assets (by public officials), and preventing informal payments for education and health services. The R4.R and Trade and Transport Facilitation in Southeast Europe (TTFSE) projects aim for hrther reforms intaxation and customs. 11.6 Nevertheless, a slowdown in the privatization of Bulgartabac and the Bulgarian Telecom Company (BTC) has caused the public to doubt the Government's intent. Also, progress appears to have lagged with the initial expectations, partlydue to inconsistent implementation andintense partisan conflict, such as that which delayed the sale o fBulgartabac andBTC. 11.7 Thus, such laws and programs cannot alone prevent corruption. Rather, corrupt practices will only cease through their strong enforcement (with particular emphasis on creating capacity to uncover fraud and corrupt practices), with persistent political commitment, and an active civil society. Recommendations 0 In order to create capacity to investigate corrupt practices and to enforce regulations, it is important that PIFCA and NAO are trained in forensic auditing; normal audit techniques are generally inadequate to detect and uncover corrupt practices. 5 'administrative corruption -refers to the intentional impositiono f distortions in the implementation o f legislation and policies to benefit individual officials; state capture -refers to actions by political and business elites to influence the formulation o f legislation and governmental policies to benefit a narrow range o f beneficiaries Buluaria CFAA: State-OwnedEnterprises (SO) 51 12.STATE-OWNEDENTERPRISES (SOE) Recent developments 12.1 Since 1995, Bulgaria has divested about 95 percent (based on the asset value) o f its non-infrastructure state-owned enterprises (SOEs). In addition, about 85 percent o f the banking system assets and 100 percent o f the insurance sector are now in private hands; with the sale of the State Savings Bank (DSK) 52 almost complete, the banking system will be basically privatized. The large non-utility companies include the Bulgarian Telecommunication Company (BTC) and the tobacco processor, Bulgartabac, in which the Government intends to sell a strategic stake. In the energy sector, the process o f unbundlinghas begun, with power distribution companies andmost producers converted into joint stock companies, separated fiom the monopolistic National Electricity Company (NEC). Similarly, distribution companies are also slated for privatization. The World Bank had approved Financial andEnterprise Sector Adjustment Loans (FESAL Iand 11), whose two main objectives were accelerating the privatization or liquidation of SOEs and maintaining financial discipline in those that remained. The Implementation Completion Report concludes that most o f the objectives under FESAL I1were achieved. Organization, oversight and reporting 12.2 SOEs are companies registered under the Trade Act with majority state ownership. They are managed by a Board of Directors appointed by the line ministries (see Box 12.1) The individual ministers can, as principals, execute the power o f the main shareholder and change the composition o f the Board at any time. This often means that most members o f the Board are replaced when changes in the respective line ministry occur. The Board is responsible for the SOEs' daily management, although for some major decisions (such as changes in tariffs or approval of the TOR for major bids), it mustconsult andobtain clearance from the line ministry. 12.3 SOEs producea numberof reportsto Governmentinstitutions. As registered companies, they are required to publish annual financial statements that comply with the 2001 Accountancy Law. Also, the SOEs submit monthly income statements, balance sheets, cash flow statements and statements on changes inequity to the line ministries, in the format specified by the MoF. In addition, a set o f reports are sent quarterly to the MoF and the National Statistical Institute; the M o F consolidates and classifies the information, andcompares it to private sector data. 12.4 Some SOEs receive funds fiom international lending institutions under state guaranteed international contracts with IBRD, EBRD and EIB; in such cases, a special set of reports i s produced and sent to those institutions according to their requirements. 52The contract for sale of 100%ofthe shares of DSK was signedbetweenthe Bank Consolidation Company and the Hungarian bank OTP on May 20,2003 . BuloariaCFAA: State.OwnedEntemrises (SO) 52 Box 12.1 :BULGARIANSTATERAILWAYSAD As stipulated by the Law on Railway Transport, the Bulgarian Railways Company (BDZ) ended its activities without liquidation as of January 1, 2002. At that point, the Company's assets and liabilities were split in two parts and transferred to a newly established company as opening balances. The National Company Railway Infrastructure inherited infrastructure assets and liabilities, while Bulgarian State Railways EADtook over the assets that related to passenger and freight services. Both new companies are fully owned by the Government. As a result o f the split, BDZ's activities were entirely transferred to the new entities and experienced no discontinuation. The Bulgarian State Railway is managed by a Board appointed by the Minister of Transport and Communications. The company has a head office, six territorial sub-divisions that manage passenger and freight transport, 10 divisions that maintain rolling stock, a forwarding division, a division for revenue control and international settlements, and an IT division. Each has separate management and accounting departments and produces financial statements that are consolidated at HQ each month; in turn, these are used to produce consolidated financial statements for the company. The Railways employ 18,000 staff, o f which 230 work in accounting and finance. Accounting and budgeting 12.5 SOEs keep their accounts and produce reports according to Bulgarian National Accounting Standards. At present, the country is adopting International Accounting Standards which will be effective as o f January 2005. Some companies, such as financial institutions and public companies, were required to shift to I A S reporting by January 2003, while other companies were allowed to delay until January 2005. However, the largest SOEs, such as the Bulgarian State Railways and Bulgarian Telecommunications Company are already producing .IAS-compliant financial statements. Training in IAS was provided by representatives o f the Big 4 companies in Bulgaria, professors from the University of National and World Economics in Sofia and certified public accountants, however, it is unknown whether the staff o f these SOEs are comfortable with the new accounting and reporting requirements. In general, training should continue, so as to support not only the top accounting staff but also operational accountants at regional SOE offices, as they are the ones most likely to need support duringthis transition period. 12.6 I t appears that line ministries focus on transaction level controls over the SOEs' operations. SOE budgets are developed by their managers, who receive objectives and guidelines from the line ministries, which also approve the budgets. Approval is also needed for their capital expenditure programs and loan commitments. With increasing professionalism inSOEs' top management, focus shouldshift to strategic 53I A S were issued by the Board o f the International Accounting Standards Committee (IASC). The International Accounting Standards Board (IASB), which is an independent, privately-funded accounting standard setter based in London, the UK, has adopted the body o f Standards issuedby the Board of the IASC and publishes its Standards ina series o f pronouncements called International Financial Reporting Standards (IFRS). The IASC (1973-2001) was the predecessor body o f the IASB. The term I A S inthis report refers to IFRS also. Bulgaria CFAA: Sfate-Owned Enterwises (SO) 53 controls such as financial targets. The subsidy needed by the SOE or expected dividends that would accrue from the SOE are then considered in the budget o f the line ministry. The approved SOE budget is allocated to its territorial and functional divisions. The divisions are free to plan and spend their resources as long as they are within the approved budget. This process is controlled through each division's monthly reports that are sent to HQcontaining analysis of previous and current expenditures against the budget. Limits are set that specify the value o f commitments beyond which clearance needs to be obtained from the HQor line ministry. 12.7 The Real Sector Directorate in the MoF is also involved in monitoring, analyzing, and restructuringthe SOEs. Also, it must approve all subsidies from line ministries and dividends to the line ministries. Internal and external audits 12.8 Most of the largest SOEs have either established an internal audit department, or are in the process of doing so. Staff usually come from finance, accounting and more rarely, audit firms. The auditors have a work program, but the audits are more often requested by the SOEs management or line ministries. Risk-based work programs are recognized as powerful tools for creating efficient internal audit departments, but auditors will need special training ifsuch programs are to be introduced. The intemal audit departments report to the Board o f Directors or the CEO, but in some cases, they do not have their own budgets, which could negatively affect the smooth operation or the independence o f the internal audit function. 12.9 The PublicInternalFinancialControlAgency (PIFCA) also audits the SOEs through its delegated auditors inthe line ministries. Untilnow, however, there has been limitedor no communication between the PIFCA auditors and the SOEs' intemal audit departments. This reduces the efficiency o f the internal audit and could lead .to duplicated efforts, as well as failure to cover all the risk areas within SOE operations. 12.10 As they are companies, all SOEs registered under the Trade Act are audited by an independent auditor. The largest SOEs are auditedby representativesof the Bigfour auditfirms with offices in Bulgaria.The SOEs that receive financing from international institutions under contracts guaranteed by the State are audited according to intemational standards. 12.11 Most SOEs do not have an audit committee and it i s usually the CEO or CFO who communicates with the extemal auditors. Such an arrangement could produce conflicts o f interest and harm the extemal auditors' independence. SOEs are also subject to audits by the National Audit Office, but only invery limited cases (see Section 8.4) Recommendations e Ensure the SOE top management's independence from political changes in the respective line ministries to guarantee professionalism and management continuity; Bulqaria CFAA: State-Owned Enterprises (SOH 54 Extend IAS training and provide it to all accounting SOE staff who are in transition or preparingto adopt IAS; Reinforce the SOEs' intemal audit departments as independent units with their own budgets,reporting directly to the CEOs; Provide the necessary training to SOE intemal auditors so they can introduce modem auditing techniques likerisk-based audit work programs; Strengthen collaboration between the SOEs' intemal audit departments and PIFCA during the planning o f audits; share the results o f audits performed and recommendations made. 13.FIDUCIARY ARRANGEMENTSFORBANK-FINANCED PROJECTS Bank assistanceprogram in Bulgaria 13.1 The Bank-assisted program in Bulgaria consists o f 30 operations for a total commitment o f US$1.75 billion. This includes 10 adjustment loans (US$1.05 billion), 17 investment projects (US$682.4 million), and two Bank-managed Global Environmental Fund (GEF) grants for US$17.4 million. Of the 30, 21 have been completed, two of which were restructured and partially cancelled during implementation, and nine are currently being implemented. 13.2 The current portfolio consists o f projects with commitments o f US$380.6 million (Table 2) and complements the reform agenda devised by the Government and supported by PAL-I. The portfolio was designed to upgrade education and health services, improve child welfare, support environmental interventions, develop modern registration and cadastre systems, and modernize the water and transport sectors. The projects underway are inthe early stages o f implementation, with only three that are over two years old. Table 2. Bulgaria: World Bank Operations (net of cancellations) No. Operation Amount Board Date 1. Environment and Privatization Support US$ 50 million 2000 Adjustment Loan 2. Trade and Transport Facilitation in Southeast US$ 7.4 million 2000 Europe 3. Health Sector Reform US$ 63.3 million 2000 4. EducationModernization US$ 14.4 million 2000 5. Child Welfare Reform US$ 8 million 2001 6. Registrationand Cadastre US$ 30 million 2001 7. Wetlands Restoration and Pollution Reduction US$ 7.5 million 2002 (GEF Grant) 8. Social Investment and Employment Promotion US$ 50 million 2002 9. P A L 1 US$ 150million 2003 Organization of Bank-fnanced projects and staffing 13.3 For the most part, the agencies handling Bank projects are standalone Project Implementation Units (PIUs), having a separate legal status. Most PIUs are connected to line ministries, and the financial managers include local staff and consultants employed on varying TORS,length o f contracts and salaries. In general, the line ministries pay the salaries, and, as the remuneration is not competitive, it is somewhat difficult to recruit and retain highlyqualified financial management staff. Accounting and reporting 13.4 For World Bank reporting purposes, most o f the projects use software developed by a local company. However, it does not have the capacity to keep accounting records and produce reports according to statutory budget accounting requirements. Thus, most PIUs have to enter all transactions into two different systems -one for WB reporting and one for reporting to the line ministry. As mentionedin Section 5.10, the MoF is in the process of implementing a state-of-the-art FMIS. Once the system is fully implemented and stabilized, the MoF and the Bank could explore the possibility of usingit for projectfinancialmanagement. 13.5 The PIUs submit project quarterly reports (PMRs or FMRs) to the Bank on a regular basis; their quality seems to be steadily improving--especially those for the projects inmore advanced stages. Audit arrangements 13.6 Local offices of the Big 4 international audit firms audit the portfolio of Bank-financedprojects, includingthose of revenue-earningentities. The auditors are appointed annually by each PIU and some, subject to satisfactory performance, extend the auditors' existing contracts for another year or more. For revenue-earning projects, the entities appoint their own auditors, who must be acceptable to the World Bank. Inthe last few years, almost all audit reports were submitted to the Bank before the due date o f June 30. Overall, the audit compliance o f projects improved significantly, compared to previous years. In July 2002, Bulgaria achieved 1OOpercent audit compliance and it became the first ECA country to be deemed fully compliant. 13.7 The Bank has not yet formally assessed the audit firms based in Bulgaria, which, in addition to the Big 4, include local companies. However, the ROSC report on private sector accounting and auditing indicates that standards are neither uniform nor effectively applied. Moreover, a review o f audit reports received to date suggests that some auditors do not fully understand the Bank's financial management, disbursement and procurement requirements. Thus, it is recommended that the Bank undertake a review o f the audit firms inBulgariato determine their eligibility to audit Bank-financed projects. 13.8 Based on a review o f past audit reports for adjustment operations, there are no major issues. Moreover, the safeguard assessment o f the central bank carried out by the IMF has not reveled any major problems that could affect BNB's capacity54 to handle funds for Bank-financed projects. Given the above and the well developed public financial management systems discussed in earlier sections, the fiduciary risk to Bank funds is consideredlow. 13.9 NAO has the necessary operational independence, resources and staff to audit Government financial statements. Staff have received substantial training inmodemaudit 54IMFandthe World Bank'sTreasuryDepartmenthave providedsupport for the institutionalbuildingand systems development efforts of BNB. Bulgaria CFAA: Fiduciaw Arrangements for Bank-Financed Projects 57 techniques and have been auditing EU funds provided to Bulgaria. However, NAO has yet to demonstrate clearly that it has achieved good and sustainable results. To this end, this report recommends that a peer review of audit processes followed by NAO by another SAI. Once the peer review indicates satisfactory implementation o f audit standards and processes, the Bank should consider, initially on a pilot basis, that NAO audit financial statements of Bank-financed projects. Recommendations 0 On full implementation o f the SAP R/3 FMIS software, explore the possibility of using it for both Bank and statutory reporting requirements; 0 Determine the skills gap between PTU financial management staff and line ministry civil servants; then, explore the possibility o f involving the latter in the financial management o f Bank-financed projects, with the aim of mainstreaming the project-introduced improvements into the line ministries; 0 Conduct a formal assessment o f the audit firms' capacity - both the Big 4 and local entities -to audit Bank-financed projects; 0 Uponsatisfactory peer review report, consider, initially on a pilot basis, that NAO audit financial statements ofBank-financed projects. Bulqaria CFAA: Overall financial Manaaemenf Risk Assessment 58 14.OVERALLFINANCIAL MANAGEMENT RISKASSESSMENT 14.1 Overall institutional and legal framework for the PFM system. Sound legislation exists to prepare, implement and monitor the budget, as do well-defined roles for the executive branch, NAO and the National Assembly. Within the executive, there is a clear division and understanding o f roles and responsibilities between the M o F and line ministries. 14.2 Budgeting. The Government's budget preparation and implementation are facilitated by a well developed legal framework. In recent years, the Government has taken various steps to improve the budget process. These include (a) preparing a "budget policy paper" that clarifies inter-sectoral priorities, (b) revising the timetable for producing the budget, thus facilitating early involvement o f line ministries inthe budget process, (c) significantly reducing the number of extra budgetary funds, thus reducing the risk of public funds being used without the rigorous scrutiny that accompanies budgetary funds, (d) routing all revenues and payments through the Treasury Single Account (e) eliminating the risk o f funds remaining idle outside the control o fMoF, and (f) adopting a budget classification system in line with the reporting requirement o f GFS 1986. The recent restructuring o f MoF, particularly aspects relating to capital expenditures, though too early to judge, are expected to streamline the procedures and reduce bureaucratic delays. 14.3 These reforms are new and to realize their full benefit and ensure their sustainability, efforts should be made to guarantee that they be continued. The area that needs further attention is investment appraisal: As now applied, investment appraisal procedures are inefficient and are commonly misunderstood as engineering analysis. Another area that needs further work is the system o f ex-post evaluation--whether programs meet their goals and how the findings can be incorporated in future budgets. Based on the above, the overall FM risk associated with budgeting is considered moderate. 14.4 Cash management and treasury. The online country-wide computerized SEBRA system enables MoF to effectively control cash resources and the line ministries to effectively monitor budget utilization. Further the introduction o f the Treasury Single Account has eliminated the risk o f idle funds inthe system and enhanced control over the payment process. The process o f setting cash limits is well defined andtransparent. 14.5 SEBRA has generally sound controls, but some areas, such as data recovery plans and data entry controls need further attention. Further, while it allows for tight control over the fiscal balance, the practice o f keeping a 10 percent contingency reserve in cash allocations relegates a large chunk o f expenditures to December, when the line ministries scramble to spend the balance. With improved budget forecasts and a fully networked cash management system, MoF needs to reconsider its cash allocation strategy. The overall FMrisk associated with cash managementand treasury is considered low. 14.6 Internal controls. The Public Intemal Financial Control Act is based on a sound concept that was well articulated inthe policy paper on public internal financial controls; the Act has helped define the requirements o f financial management and control systems. Bulaaria CFAA: Overall Financial Manasement Risk Assessment 59 14.7 To strengthen ex-ante controls a new function of "financial controllers" was introduced in January 2003. Financial controls include standard measures such as double signatures and segregation o f duties. Another strong feature o f ex-ante control is the requirement for first-level spending units to approve all payment requests o f lower-level spending units. Controls with respect to employee payrolls are generally sound. The regimen o f ex-post controls involves the Public Internal Financial Control Agency and inspectorates withineach line ministry. 14.8 The PIFC Act has a few shortcomings, such as ambiguous accountability among managers and the nature o f oversight exercised by financial controllers. More important, current controls in public procurement are generally considered weak. The recent NAO report also observed frequent violations of public procurement procedures. Based on the above, the overall FMrisk associated with intemal controls is moderate. 14.9 Accounting, reporting, and transparency. A new Chart o f Accounts that conforms to GFS-2001 classifications and ESA 95 was developed for accrual-based financial accounting. Generally, the quality, timeliness and availability o f cash-based budget execution reports for monitoring are adequate. Quarterly cash-based budget execution reports are audited by NAO, which ensures their reliability. Bulgaria i s implementing a state-of-the-art Financial Management Information System which is expected to not only speed up the preparation o f reports but also ensure availability o f standard, comprehensive data on government financial statistics that conforms to international standards. There is a high level of transparency in reporting: Fiscal information is available inthe M o F and BNB periodic reports, NAO has a well designed website where it posts all its reports, and parliamentary committee meetings are generally open to the public 14.10 The implementation o f FMIS, running on SAP W3 software, continues to pose problems: Line ministries have not yet adopted the system and lower-level-units use a wide array o f basic accounting software-which prevents easy sharing o f data. The overall FMrisk associated with accounting and reporting i s considered low. 14.11 Internal Audit. Bulgaria has a strong intemal audit body in the forrn of the PIFCA, which hasbroadpowers and adequate staff. This Agency has received substantial technical assistance under the EU-Phare program to develop skills of intemal auditors and it has developed several comprehensive manuals and guidelines to facilitate and standardize intemal audit activities. Recently, PIFCA started assigning delegated auditors to most o f the first-level spending units, thus improving the interaction between departmental managers and intemal auditors. 14.12 The PIFC Act combines the functions of internal audit with the authority to develop preventive control systems within PIFCA. Such sweeping powers to PIFCA provide an opportunity to the Agency to get involved in executive decision making that can prove counter-productive and create conflict o f interest. The overall FM risk for internal audit is low. 14.13 External Audit. The National Audit Office has adequate operational independence, resources and staff. The 2001 NAO Act guaranteed that neither the Government nor the National Assembly could interfere in NAO's activities. It has the Buluaria CFAA: OverallFinancial ManauementRiskAssessment 60 authority to conduct all types o f audits and recently began two pilot performance audits with technical inputs from its twinningpartner (the United Kingdom's NAO). NAO has adopted audit standards that conform with the international standards. The quality o f NAO reports has steadily improved over the past few years. Moreover, the auditee organizations have regularly responded to audit recommendations as noted by the NAO 2001 Annual Report. 14.14 An area o f concern is the lack o f a comprehensive strategy to audit revenues, which in turn could ensure that tax assessments, collections and arrears were reliable and effective. Another concern is an apparent lack o f manuals and skills needed to audit automated systems. Given the high degree o f automation and widespread use o f on-line and real-time systems, this area should receive high priority. Based on the above, the overall FMrisk associatedwith external audit is low-to- moderate. 14.15 Parliamentary oversight. The National Assembly is actively involved in the budget formulation process through its Budget and Finance Committee, which is assisted by three full- time advisers and 6/7 part-time staff. During the budget implementation stage, the BFC may summon any minister to discuss the progress and status o f budget implementation within hisher ministry. 14.16 The National Assembly has no role in reallocating appropriations among various budget heads; rather, the OBL assigns this function to the MoF. Similarly, the CoM and MoF, rather than the Assembly, determine how revenues earned by the line ministries or the extra revenue earned in excess o f budgeted revenues will be appropriated among various activities and programs. These practices provides flexibility to the Government but could undermine the authority o f the legislature to approve all appropriations. A key concern is the delay in considering and adopting budget execution reports submitted by the CoM. For example, budget execution reports for the years 1997, 1998, 1999, and 2000 were only adopted by the National Assembly in 2001. Based on the above, the overall FMrisk associated with parliamentary scrutiny i s considered significant. 14.17 The overall FMrisks with respect to individualcomponents o f the PFM system i s summarized as follows: P F M Component - Risk Budgeting Moderate. Cash management andtreasury L o w Internal controls Moderate Accounting, reporting,andtransparency Low Internal audit Low External audit L o w Parliamentaryoversight Significant Buluaria CFAA: Overall Financial Manaoement Risk Assessment 61 14.18 Based on the relative importance of individual components o f the PFM system, the overall FMrisk associated with the PFMsystem is considered low. ~~ ANNEXI.SUMMARY OFRECOMMENDATIONS OBJECTIVES MEASURES TIMEFRAME To have a comprehensive 1. Define clearly outputs and Ongoing budget process closely linked outcomes and develop to policy goals. mechanisms for measuring them. 2. Develop guidelines for Priority planning and evaluating investments, and develop capacity inproject appraisal. 3. Expand the scope of budget Short Term documents presented to the National Assembly. 4. Develop systems o f ex-post MediumTerm evaluation. 5. Issue the Budget Execution Short Term Decree earlier. 3. CASHMANAGEMENT To strengthen cash 1. Provide common minimum Short Term management and SEBRA guidelines for SEBRA data controls. entry by agent commercial banks. 2. Develop acceptable Short Term procedures for the SEBRA source code management. 3. Improve physical access Short Term security around SEBRA servers. 4. Develop a disaster recovery Priority plan for SEBRA. 5. Increase the band-width Short Term between MoF and Bankservice. 6. Migrate the SEBRA Short Term database to a more powerful server. 7. Maintain a separate Short Term development environment for SEBRA. 8. Carry out user requirement Short Term analysis to identify the scope for future improvements to SEBRA. I 4. INTERNAL CONTROLS To improve the internal control 1. Develop job descriptions Priority environment . for financial controllers. 2. Provide annual intemal Short Term control assurance letters to the line ministers. 3. Clearly define the Short Term accountabilities of officials. 4. Review the practice o f Short Term requiring first-level units to approve payment requests o f all lower-level units. 5. Establish a centralized Short term employee database reconciled with those of lower-level spendingunits. 6. Provide training inconcepts Ongoing o f intemal controls, including how to interpret risks and early warning signals, to departmental heads. I 5. ACCOUNTING AND REPORTING To develop accounting systems 1. Harmonize budget Short Term that conform with classification and CoA more internationalnorms. fully. 2. Adopt the IPSAS and issue Short Term Government Accounting Standards. 3. Consolidate financial MediumTerni statements o f SOEs in the consolidated financial statements of the general government. 4. Revise the OBL to include Short Term deadlines for submission of annual budget execution reports and audit opinions to the CoM and the National Assembly. 5. Develop methodology for Short Term accounting for tax revenues and arrears. 6. Prepare half-yearly accrual- MediumTerm based financial statements. 7. Intensify training of Ongoing department managers in interpreting accrual-based financial management reports. 8. Establish a government- Priority wide IT function that could set benchmarks and develop IT strategy for the Government as a whole. 9. Incorporate user needs Priority while implementing SAP W3. m 6. REVENUE COLLECTIONAND MANAGEMENT ~~~~ strengthen revenue 1. Strengthen the funds Short Term collectionprocedures. monitoring mechanism in SCA's head office. 2. Develop an integrated Short Term inventory system to manage the properties acquired or confiscated by SCA and preventtheir misuse. 3. Strengthen the internal Short Term audit capacity o f PIFCA's delegated auditors inNCA. 7. INTERNALAUDIT To strengthen the intemal audit 1. Review and revise the Priority function and ensure itsprovisions regarding PIFCA's independence from the internal responsibility to devise and control function. implement internal financial control policies. 2. Review and revise PFCA's Priority authority to establish preventive control systems within the organizations audited. 3. Intensify efforts to integrate Ongoing delegated auditors within the line ministries. 4. Review the PIFCA policy Short Term with regard to its performing intemal audits in corporate SOEs. 5. Review and supplement the Short Term number o f delegated auditors in each ministry and important lower-level units. 6. Develop manuals on Short Term revenue and IT-based audits, as well as risk assessment; develop training programs for both types o f audits. 7. Develop intemal audit Short Term standards. 8. Consider preparing Short Term consolidated annual intemal audit reports for each ministry. 9. Continue providing Ongoing adequate resources for training auditors. 10. Review the policy o f Short Term continuing control inspectorates in line ministries once an adequate number o f auditors are delegated. 8. EXTERNAL AUDIT To strengthen the external 1. Review and consider Short Term audit function to provide better empowering NAO to audit assurance on the use o f public SOEs under specific resources. circumstances. 2. Clarify the decision-making Short Term areas that would be assigned to the collegium and the President of the NAO. 3. Develop specific training Priority programs in risk assessment and incorporate the results of risk assessment in preparing annual audit programs. Bul~ariaCFAA: Annex I: Summaw of Recommendations 66 4. Develop a strategy for Short Term auditing lower-level units and consider mandating NAO to demand physical verification o f assets by the management and attend such physical verification program. 5. Develop a comprehensive Priority strategy, guidelines and training programs for auditing revenues. 6. Develop manuals and Priority guidelines, and specific training programs for auditing IT-based systems. 7. Review the provisions in Short Term the Act that require NAO audit report on the budget execution be submitted to the National Assembly only after the Assembly has adopted the government budget execution report. 8. Consider peer review o f the MediumTerm audit practices by one o f the SAIs inthe EU. 9. Consider establishing a MediumTerm joint training center for staff from PIFCA, NAO and line ministries on financial management, intemal controls, and internal and external audits. 9. LEGISLATIVE SCRUTINY To improve public financial 1. Review current procedures Short Term accountability and for allowing line ministries to transparency. spend their own revenues. 2. Adopt budget execution Short Term reports before the next annual budget i s approved. 3. Adopt annual NAO audit Priority reports simultaneously with the Government's budget execution. 4. Review and consider formal Short Term mechanisms for legislative oversight o f the SOEs' annual financial statements on a selective basis. 10. FISCALTRANSPARENCYPUBLICAVAILABILITY AND To improve public financial 1. Review the OBL and Short Term accountabilitv and consider adding explicit transparency. provisions to make budget documents and budget execution reports public. 2. Consider posting details Short Term regarding capital expenditure projects onthe website. 11.ANTI-CORRUPTION PROGRAM To strengthen the enforcement 1. Train PIFCA and NAO in Short Term capacity to fight corrupt forensic auditing. practices. 12. STATE OWNEDENTERPRISES (SOE) To strengthen the 1. Ensure the SOE Short Term accountability of the SOEs. boardmanagers' independence from political changes in the respective line ministries to guarantee professionalism ' and management continuity. 2. Extend I A S training and Ongoing provide it to all accounting SOE staff who are in transition or preparing to adopt the IAS. 3. Reinforce the SOEs' Short Term internal audit departments as independent units with their own budgets, reporting directly to the CEOs. 4. Provide the necessary Ongoing training to SOE internal auditors so they can introduce modern auditing techniques like risk-based audit work programs. BulgariaCFAA: Annex I: Summarvof Recommendations 68 5. Strengthen collaboration Short Term between the SOEs' intemal audit departments and PIFCA during the planning of audits; share the results o f audits performed and recommendations made. 13. FIDUCIARYARRANGEMENTS FOR BANK-FINANCED PROJECTS 1. Determine the skills gap Short Term between PW financial management staff and line ministry civil servants; then, explore the possibility o f involving the latter in the financial management o f Bank-financed projects, with the aim o f mainstreaming the project-introduced improvements into the line ministries. 2. On full implementation o f MediumTerm the SAP R/3 FMIS software, explore the possibility o f using it for both Bank and statutory reporting requirements. 3. Conduct a formal Short Term assessment o f the audit firms' capacity - both the Big 4 and local entities - to audit Bank- financed projects. 4. Upon satisfactory peer Short Term review report, consider, initially on a pilot basis, NAO to audit financial statements o f Bank-financedprojects (Short Term measures generally refer to the timeframe of 1 to 2 years and Medium Term 3 to 5 years) Bulgaria CFAA. Annex /I: SEBRA Process Flow Descriotion 69 ANNEX11. SEBRA PROCESS FLOW DESCRIPTION 1. The B&T Directorate establishes cash limits for first level spending units generally on a monthly basis directly in the SOFI System of BNB. The limits are transferred to SEBRA on a daily basis at 15.00 hrs. 2. Using the SEBRA, first-level spending units distribute the cash limits to lower-level spending units under them. 3. Lower-level spending units go to designated agent commercial banks with budget payment requests. These, in turn, are submitted in a standardized "Budget Payment Order" (1092P1) form signed by two authorized personnel. 4. Agent commercial banks input the budget payment request into their individually developed Budget Payment Process systems and convert it into electronic files for transferring to SEBRA. There i s a 15:OO hours deadline for the agent commercial banks to transfer the files to SEBRA. 5. SEBRA processes files received from agent commercial banks and, if an error in any message inthe file i s detected, it rejects the whole file. 6. First-level spending units start approving, rejecting or withholding payment requests of lower-level units in SEBRA. When payments are approved, the cash limits are automatically adjusted. First-level units generate electronic files with approved payments in SEBRA and send them to BISERA for settlement. 7. BISERA has a cut-off time of 21:30 hours. BISERA settles all the payments received from SEBRA along with non-SEBRA related interbank payment requests received from all the commercial banks. 8. At 06:OO hours(t+l day), BISERA sends settlement results to SEBRA for processing the information and generating files for agent commercial banks. SEBRA generates statements providingthe status of all payment orders and the revised cash limits for the respective spending units. 9. Starting from 07:30 (t+l day), the agent commercial banks process the information received from SEBRA and print statements for the respective lower-level spending unitwith the following information: Status o f payment orders submitted earlier; Total sum o f approved payments for the day; Total sum o fpayments made since the beginningof the year; Balance inthe cash limit.