Document of The World Bank FOR OFFICIAL USE ONLY Confidential REPORT No: 24242 UKRAINE COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT October 15, 2001 V|RLD BANK |I Core Services Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Regional Vice-President: Johannes F. Linn, ECAVP Country Director: Luca Barbone, ECC I Sector Director: Constance Bemard, ECSCS Task Team Leader: Sanjay Vani, ECSCS ii FOR OFFICLIL USE ONLY CURRENCY Currency Unit = Ulkrainian Hryvnia (UAH) US$ 1 = UAH 5.44 (as of 01/01/2001) GOVERNMENT FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AC Accounting Chamber ACCA Association of Chartered Certified Accountants AMB Accounting Methodology Board CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment EC European Commission EU-TACIS European Union-Technical Assistance for Commonwealth of Independent States FAO Fiscal Analysis Office FEE European Federation of Accountants GDP Gross Domestic Product IFAC International Federation of Accountants IFC International Finance Corporation IMF International Monetary Fund IAS Intemational Accounting Standards IASC International Accounting Standards Committee INTOSAI International Organization of Supreme Audit Institutions IOSCO International Organization of Securities Commission ISA International Standards on Auditing IT Information Technology KRU Kontrolno Reviziyne Upravlinnia (Control and Revision Department) MoF Ministry of Finance MTEF NAS National Accounting Standards NBU National Bank of Ukraine NGO Non-governmental Organization ROSC Report on Observance of Standards and Codes (IMF) SAI Supreme Audit Institution SCI Statement of Corporate Intent SOE State Owned Enterprises SSMSC Securities and Stock Market State Commission STA State Tax Administration TTRRS Treasury Transaction Registration and Reporting System RC Revision Commission UFPAA Ukrainian Federation of Professional Accountants and Auditors USAID United States Agency for International Development This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Ukraine: Country Financial Accountability Assessment Table of Contents Preface.v Executive Summary .............................................. vii 1. Country and Economic Background ............................................1 2. Legal and Institutional Framework ............................................1 3. Budgeting ...............................................2 Budget Preparation and Approval ...............................................2 Offsets and Extra-budgetary Funds ...............................................3 Budget Implementation ...................................................................3 Recent Developments ..............4 4. Accounting and Financial Reporting ..............5 State Treasury ..............5 Payments ..............6 Spending Units ..............8 Reporting ..............9 5. Internal Controls ..............9 State Control and Revision Service .............................................. 10 State Tax Administration .............................................. 12 6. External Audit .............................................. 12 Scope of Accounting Chamber's Mandate ................................... 13 Accounting Chamber Funding and Staffing ................................. 14 Accounting Chamber Annual Report Findings ............................ 14 Audit of SOEs and Local Governments ....................................... 15 7. Legislative Oversight over the Executive .................................. 16 8. Private Sector Accounting and Auditing .................................. 17 National Accounting Standards .............................................. 17 Ukrainian Federation of Professional Accountants & Auditors ... 20 Audit .............................................. 21 Chamber of Auditors .............................................. 21 Audit Practices .............................................. 22 Appointment of Auditors .............................................. 23 Enforcement .............................................. 25 9. Recommendations .............................................. 25 Policy Level Decisions .............................................. 26 Systemic hnprovements .............................................. 26 Annexes 1. List of Counterparts Met 2. Governance and Accountability Arrangements for SOEs in Australia iv UKRAINE Countrv Financial Accountability Assessment PREFACE This report was prepared on the basis of the findings of a series of World Bank missions to Ukraine from December 2000 to May 2001 by a Task Team comprised of Sanjay Yani, Team Leader and Maxim Ljubinsky, Consultant. The report is based on the results of interviews with public and private institutions as well as on detailed analysis of the laws, documents and other information collected. On the part of the Govermnents' and private sector's institutions, the counterparts to the assessment lent their full and proactive support to the CFAA mission and engaged with the Bank's team in a comprehensive dialogue about the issues identified by the assessment. The Bank is grateful to the Government of Ukraine for this cooperation. The list of counterparts met is provided in Annex 1. Purpose of the Report A CFAA considers the strength of the financial accountability framework in both the public and private sectors. The aim is to assess whether the existing framework, as designed and as practiced, is sufficient to ensure proper use of fimds, both the country's own resources and those provided by the Bank and other institutions. One of its main purposes is to assist the Bank in assessing the risks which the financial accountability framework poses for the implementation of Bank programs and the use of Bank funds, and proposing suitable measures to manage these risks. It also supports dialogue with the borrower country and development partners on financial accountability matters, and assists in the design of programs to build financial management capacity. The CFAA involves a diagnostic exercise covering the financial management systems of both public and private sectors of a country. It is not an audit, and it does not provide assurance that all funds are being used for intended purposes. However, it provides a well-informed and objective assessment of the strengths and weaknesses of financial management systems, a diagnosis of problems and advice on their resolution, and an indication of the level of financial accountability risk in the country concerned. Each CFAA is expected to cover a minimum core content-areas that must be covered in all CFAAs. Although financial accountability encompasses a wide range of activities in the private and public sectors of an economy, for the purpose of CFAA, the following are considered to be core: > Transparent and Accountable Budgeting > Public Sector Accounting and Financial Reporting > Public Sector Internal Control System > Public Sector Auditing > Legislative Scrutiny of Public Sector Financial Management v > Private Sector Financial Accounting and Auditing Practices In the context of a country's overall governance environment, the executive arm of the government has an obligation to the public for safekeeping and proper use of public resources entrusted by its constituents, and to provide a credible legal/regulatory framework to promote good financial governance in both private and public sectors of the economy. The institutional and legal/regulatory regime that seeks to provide this assurance constitutes the public financial accountability framework in a country. In the context of the private sector, the financial accountability frameworks should provide reasonable assurance to interested parties that financial operations are conducted properly and that investments are managed with due care and are protected from the risk of fraud and misuse. The Bank's interest in the CFAA primarily lies in providing 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. If the borrowing government meets its fiduciary responsibilities to the citizens, the Bank's fiduciary responsibilities are automatically met. It is therefore necessary for a country to develop a proper financial accountability framework, in design as well as in practice. The CFAA, therefore, needs not only to focus on the existing systemic weaknesses giving rise to fiduciary risks, but also to present advice on developmental needs. Acknowledgements The mission members wish to acknowledge the extensive cooperation and assistance received from officials and staff of the public organizations, state agencies and private sector institutions interviewed. Messrs. Luca Barbone, Country Director for Ukraine and Belarus, and Dusan Vujovic, Program Team Leader for the Programmatic Adjustment Loan to Ukraine, offered invaluable assistance and information in carrying out the CFAA. Ms. Anna Musakova, Team Assistant in the Bank's Kiev Office, provided support with logistic arrangements for the mission. Mr. John Hegarty, ECA Regional Financial Management Adviser, and peer reviewers Messrs. Vinod Sehgal (OED), Ronald Points, (EAP), Janis Platais, IMF, offered invaluable comments and provided other important inputs to the task. Ms. Suzanne Snell, Consultant, assisted with the editing and formatting of the report. vi Executive Summary 1. Ukraine, after 70 years of Soviet rule, is seeking to move away from the centrally planned and controlled economy inherited from the Soviet past to a market-based economy by enacting laws and evolving different incentive structures. This is a massive effort, as it not only involves creating a new set of rules of the game but also requires changes in the attitude of the of the civil service, which for decades was entrenched in centralized and secretive ways of conducting their work. In spite of the progress made in introducing new laws and regulations, the civil service, particularly at the middle and lower levels, has yet to come to terms with the workings of a market-based economy. .2. Presently, Ukraine is a presidential democracy, with several characteristics similar to other European countries, and undergoing an often contentious debate on the clear demarcation and separation of powers. The President and the Cabinet of Ministers that he appoints, hold executive power. Legislative oversight is provided by the unicameral Parliament. The law states that the Cabinet of Ministers reports to the President and is overseen by Parliament. The President appoints directly a number of key ministers, such as defense, foreign affairs, and interior, and has considerable moral suasion on the working of the Cabinet. The President's accountability is to the general public through the ballot box. Although, the Constitution provides for the possibility of impeachment of the President, it has not yet been exercised. Civil society is growing but still weak compared to other countries. The Parliament is a fragmented body and only since the beginning of the year 2000 has there been a working majority supporting the large program of reforms. 3. The President and the Cabinet of Ministers exercise control over the spending units through the Central Control and Revision Department (KRU), which functions as the vigilance department, detecting illegal expenses and breaches of rules and regulations, and levying fines and penalties on the spending units. The function of internal audit, which is much broader than compliance work and involves assessing controls and assisting management in improving their performance according to the guidelines on internal controls issued by INTOSAI, is lacking in Ukraine. 4. A noticeable gap in public accountability arrangements in Ukraine is that revenues are not audited by an independent auditor. KRU also has no authority to conduct inspections of tax revenues. The Constitution prohibits the Accounting Chamber from auditing the revenues of the state. As a result, Parliament, which is supposed to provide legislative oversight over the executive, has no independent means to obtain an assurance on the accuracy and reasonableness of the revenue amounts provided in the annual financial statements. 5. Until recently, the budgeting system in the country was a legacy of the centralized planning and control regime of the past and the budgeting practices were incremental in nature and did not permit correlation of line ministry objectives with resources allocated. There have been several major improvements in this area, the two most important being the enactment of a new Budget Code, which is a substantial improvement over the old Law on Budget Systems, and the introduction of program budgeting for. efficient resource allocation. The biggest challenge now is to educate and train line ministry staff in vii preparing the new program-oriented budgets, lest the top-down, centralized approach should continue. 6. One good thing about the Soviet legacy is systematic bookkeeping and preparation of reports by the budget spending units. There are enough laws, decrees, and regulations governing maintenance of accounts and preparation of reports by the budget spending units. What is lacking is a good management infonnation system that could provide useful information to the decision-makers. The accounting staff, which has excellent bookkeeping skills, needs to be trained in the concepts of management accounting and performance reporting. This presents a challenge, as existing staff has been carrying on for decades just with bookkeeping. It will be necessary to induct young qualified staff to supplement the training of existing staff. In addition, departmental managers will need to be trained in using information provided by the management accounting systems. 7. The Treasury performs the function of "Accountant General" for the state. It prepares annual financial statements and acts as the sole dispenser of funds for the government. Cash management in the public sector is still inefficient, in spite of progress made in establishing the Treasury and the allocation of funds on a weekly rather than daily basis. While allocating funds, commitments made by the spending units are not taken into account, which results in accumulation of treasury cash balances in the banking system. A treasury modernization project financed by the World Bank envisages implementing automated systems that would perform basic accounting functions and provide status of actual expenditures vis-a-vis budgets, but it is running behind schedule. 8. The Parliament's Budget Committee does not have adequate capacity to review and provide follow-up on the audit reports submitted by the AC, particularly technical and research support similar to the support received from FAO during the review of the budget proposals. Since Parliament is the recipient of the audit reports and is required to provide oversight over the AC, it is essential for it to have adequate capacity to conduct a detailed review of the audit reports (including the ability to ask for clarifications from the executive and or the AC), to provide directions to the government based on this review, and to conduct follow-up required to ensure that adequate actions are taken to address the issues. 9. The accountability of the State Owned Enterprises (SOEs) is not clear. The SOEs are not subject to audit by the Accounting Chamber (AC), except for the auditing of budgetary allocations received by the SOE during the year. The financial audits ofjoint stock companies owned by the state are performed by Ukrainian auditing firms. However, such audited annual financial statements of the SOEs are not placed before the Parliament for its review. 10. The Law on Accounting declares that International Accounting Standards (IAS) are the benchmark for accounting standards in Ukraine. However, Ukraine has chosen to create its own Ukrainian accounting standards, at times differing from the IAS, causing confusion in the minds of potential foreign investors. Despite the adoption of simplified accounting standards, compliance with national accounting standards is weak and the oversight mechanisms, such as auditors and the Securities and Stock Market State Commission, are unable to enforce compliance. Lack of adequate trained accountants is one of the reasons for low compliance with mandatory accounting standards. On the viii positive side, the National Bank of Ukraine has adopted IAS for preparation of its financial statements and has also made IAS mandatory for commercial banks. 11. The auditing profession in Ukraine is still building its credibility and professional competence (For instance, the National Bank of Ukraine does not permit auditors licensed by the Chamber of Auditors to audit major commercial banks). The main reasons are the very relaxed entry procedures (comprising just an oral examination) and lack of strict disciplinary enforcement mechanisms that could ensure high professional standards. Most members of the Chamber of Auditors, which governs the audit profession, are not practicing audit professionals. It is essential for a professional governing body, such as the Chamber of Auditors, to have a majority of members who are practicing audit professionals. 12. The fiduciary risks in Bank-financed projects are contained by requiring annual audits of project financial statements by audit firms acceptable to the Bank. However, considering the important shortcomings in the audit profession, such as relaxed entry requirements and lack of effective disciplinary and enforcement mechanisms, it is advisable that the Bank carry out a review of the capacity and auditing practices followed by the audit firms to determine their eligibility to audit Bank-financed projects in Ukraine. 13. Ukraine has several strengths, such as an educated work force, strong bookkeeping skills, and commitment to reforms, and a long-term vision ofjoining the European Union. In order to strengthen existing public financial accountability, Ukraine will need to build on its strength by undertaking several measures. Experience in many other countries shows that several required changes entail reaching political consensus, reforming existing institutions, or creating new institutions. This suggests that a realistic timetable for improvement in the public financial accountability will have to stretch over several years and will depend on strong leadership from the top. The most important areas for action are: > bringing revenues under the scope of independent external auditors, > introducing the concept of internal audit, > strengthening the capacity of the AC to conduct financial statement audits, > strengthening the accountability of the SOEs, > introducing IAS for selected enterprises, > adopting international best practices for licensing of audit professionals, and strengthening the disciplinary committee of the Chamber of Auditors to provide effective oversight. 14. In addition to these measures, Ukraine also needs to > train departmental staff in implementation of program budgeting, > fully implement the Budget Code, > expedite the implementation of the Treasury modernization project, ix > implement standardized automated accounting and reporting systems in budget spending units capable of providing MIS reports to managers and train accounting staff in management accounting, > strengthen revision and control departments in the line ministries to perform internal audit, > strengthen the oversight capacity of the regulatory authorities such as NBU and SSMSC, and > amend business laws to strengthen corporate governance (particularly the rules regarding appointment and removal of auditors) x UKRAINE COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT 1 . Country and Economic Background 1. Ukraine is a unitary state whose President is the highest State officer and is directly elected by the citizens for a five-year term. The same person may not hold the office of the president for more than two consecutive terms. The President is responsible for appointing the Prime Minister, subject to parliamentary approval, and other members of the Cabinet of Ministers upon recommendation of the Prime Minister. The Prime Minister and other ministers are not required to be Members of Parliament. The Cabinet of Ministers is directly responsible to the President and is also controlled by Parliament to some extent. The Parliament, by a majority, can adopt a no-confidence motion against the Cabinet of Ministers. For example, in May 2001, Parliament passed a no-confidence motion against the sitting Cabinet of Ministers, resulting in the resignation of the Prime Minister and the Cabinet. 2. Ukraine has four tiers of government: the State, 26 oblasts, 680 rayons and large cities, and about 1 0,000 local governments. The oblasts and rayons are constituted both as arms of the central government and as independent govermnent entities. Governors, who are directly appointed by the President, head oblasts. The deputies in the oblast and rayon councils are elected by popular vote. This report examines public financial accountability issues at the State level. 2. Legal and Institutional Framework 3. The legal and institutional framework for public sector financial management and accountability in Ukraine is determined by the Constitution of Ukraine (1996), the Law on Budget System (1990), the decree of the President on State Treasury of Ukraine (1995), the Law on the Accounting Chamber (1996), and numerous other cabinet resolutions. 4. The authorities of the President, the Cabinet of Ministers, and the Parliament are defined in the Constitution. The President and Cabinet of Ministers whom he appoints hold executive power. The law states that the Cabinet of Ministers is the main executive power responsible to the President and controlled by Parliament. Unlike the Cabinet of Ministers, the President is not controlled by or accountable to Parliament. The President's accountability is to the general public through the ballot box. Civil society is weak although becoming increasingly assertive. Parliament holds legislative power and oversees the workings of government, for example, by approving the annual budget and its implementation. 3. Budaetine 5. Subsequent to completion of CFAA diagnostic work and preparation of draft CFAA report, the government enacted the new Budget Code on July 24, 2001. The World Bank is preparing a Public Expenditure and Institutional Review (PEIR) for Ukraine. The PEIR report will examine budgetary systems, including institutional aspects, in greater detail, including the new Budget Code. 6. The Ukrainian Constitution has very few provisions relating directly to the country's budget system. The only detailed provisions are contained in the Budget Code (2001), which defines the process of preparation and approval of State and local budgets. The annual State budget is enacted as a law each year. The Constitution states that the amount and the purpose of any State expenditure for public purposes must be determined exclusively in the annual law on State budget (Article 95). This article prevents the State from incurring any expenditure for public purposes that is not included in the annual budget law. 7. The annual State budget is required to be based on the broad policy guidelines contained in the Budget Resolution, which is approved by Parliament no later than June 15 of the previous year. This Budget Resolution provides an overall framework to the government for preparation of detailed budget estimates and to Parliament for consideration of laws that would have an impact on the State budget revenues and expenditures. Budget Preparation and Approval 8. The Ministry of Finance (MoF) is the nodal agency for the preparation of the annual budget. The Ministry of Economy has an important role in the budgeting process, as it is responsible for budgeting for capital projects. The MoF compiles and submits the draft budget to the Cabinet of Ministers for consideration. In respect of unsettled issues, the MoF submits its recommendations to the Cabinet of Ministers for a final decision. Article 96 of the Constitution requires the Cabinet of Ministers to submit the draft budget for the consideration of Parliament by September 15 of the previous year. 9. The Budget Committee, on behalf of Parliament, conducts a detailed review of the budget proposals. In Parliament, draft budget proposals pass through a maximum of three readings. For example, the annual budget law for the year 2001 was passed by Parliament after the third reading on December 7, 2000. After Parliament approves the annual budget, the President may sign the law or return it to Parliament with his comments and suggestions. If the Law on Budget is not adopted by Parliament by December 2 of the previous year, then Parliament is authorized to adopt a procedure for funding necessary expenses until the Law is adopted. 10. The revenues and expenditures in the budget follow a functional and economic classification set out in the Law on Structure of Budget Classification, 1996 (No. 327) and MoF directive No. 265, dated December 3, 1997. The Report on Observance of 2 Standards and Codes (ROSC) on fiscal transparency prepared by the IMF in September 1999 mentions that the governnent has adopted the IMF-approved Government Finance Statistics (GFS) budget classification. However, the Treasury modernization project financed by the World Bank faced bottlenecks due to disagreement between the Treasury IT team, the accounting and methodology department, and the IMF over the Chart of Accounts (see para. 34 below). 11. The Ministry of Economy is responsible for monitoring the budgeting for capital projects. The Ministry of Economy, in liaison with the MoF and the line ministries, decides upon the projects that should be included in the next year's budget. The decision on which projects to select is not based on a clearly defined criterion and is subject to negotiation. To facilitate the process of capital budgeting, the ministry maintains a database of capital projects and updates it with the actual expenditure figures, as and when they are available. Offsets and Extra-budgetary Funds 12. A peculiar system of offsets/settlements exists in Ukraine, which involves renunciation by the State of tax claims in return for the cancellation of payment liabilities. Though officially discontinued in December 1999, this system is still being used in certain cases to reduce payment arrears. This system of offsets not only undermines expenditure management discipline but also reduces transparency in the budget system. 13. The State budget law for 2001 has to a large extent abolished extra-budgetary funds such as the Innovation Fund and the Chemobyl Fund. The only remaining miajor extra- budgetary funds are the Pension Fund, Social Insurance Fund, and National Unemployment Insurance Fund. The Pension Fund is financed out of special mandatory payments/charges by the taxpayers. Similarly, the annual budget law for year 2001 has suspended the practice of certain public institutions to use extra-budgetary revenues, such as forestry/water/mineral resources charges, State land lease charges, and 10 percent of license fees, to cover extra-budgetary expenses. These revenues are now included in the annual budget and cannot be used by the institutions for incurring extra-budgetary expenses. Budget Implementation 14. Most government guarantees issued in the past resulted in State indebtedness and increased the debt-servicing burden on the State. In order to secure budget discipline, the Law on State Budget for 2001 provides for * a ban on debt restructuring or writing off arrears of enterprises that are subject to government guarantees; and * a ban on issuing government guarantees against foreign credits to Ukrainian enterprises, except for borrowings from International Financial Institutions. 15. Until recently (late 1999), the MoF determined day-to-day spending priorities based on actual cash flows. Such a situation, on the one hand, created uncertainty at the spending unit levels and, on the other hand, led to ignoring the legislature's intent in setting spending priorities. While this practice did succeed in keeping cash spending in line with cash collections, it did not restrict actual commitments made (which later 3 resulted in payables). With the budget returning a surplus since 2000, the practice of day- to-day rationing of cash by MoF has been discontinued. Currently, the budget estimates from the spending units are divided into monthly requirements. This allows the State Treasury to work out a resource budget, which facilitates forecasting of surplus or deficit on a monthly basis and provides a steady income to the spending units for the implementation of their plans. 16. The MoF is responsible for supervision of budget implementation, reporting to the President and the Parliament any infringements, and imposing appropriate sanctions. The government is required to submit a report on the implementation of the State Budget to the President and to Parliament before May 1 of the following year. The President introduces the report and the Finance Minister presents the report at a sitting of the Parliament. The focus of the report is on indicating whether budgetary resources were used according to the appropriation, and not on providing information about the results or outputs of such spending. Recent Developments 17. A new Budget Code of Ukraine has been prepared to replace the existing Law on Budget System (1990), which has been amended several times and which contains several provisions that contradict the later decrees, rules, and resolutions. The new Budget Code was first read in Parliament two years ago, in May 1999. It then underwent several modifications and improvements and was first adopted by Parliament after its third reading in March 2001. It then underwent further changes before being readopted by Parliament in June 2001, and was adopted by government in July 2001. 18. While this CFAA was prepared prior to the adoption of the new Code, the Code's content was known and briefly reviewed. The new Budget Code is expected to provide clear a legislative mandate regarding the respective roles, authorities, and responsibilities of various participants in the budget process. In addition, it is expected to provide a new framework for the inter-budgetary relationships of the State, oblast, rayon and city budgets. The Budget Code envisages fiscal separation of the rayon- and city-level budgets from the oblast budgets; and the local rayon and city budgets are expected to have an independent relationship vis-a-vis the State budget. The Treasury would take over banking arrangements and payment controls for local budgets. The new Budget Code provides much more detailed guidelines for enacting various amendments in different situations. 19. In the past, the budgetary process in Ukraine essentially followed an incremental approach rather than correlating line ministries objectives with the selection of new capital projects and considering the impact of current capital projects on future budgets in terms of increased operations and maintenance expenses. This resulted in several programs remaining underfinanced. Budgetary practices in effect supported a centralized planning system, where the MoF determined allocations and the line ministries just executed the budgets. The line ministries received budget allocations based on the numbers of staff they had to pay and offices they maintained, and not because they had certain specific objectives to achieve. Past procedures provided no guidance to the spending units about how to correlate their expenditure plans with the programs envisaged by the government, thus effectively creating an incremental approach to budgeting. 4 .20. The government has embarked on a new program of budget preparation that is based on program budgeting concepts. This approach requires the ministries to correlate their plans and programs in the medium term with their annual budgets. It also requires the ministries to prioritize programs that meet their main objectives. It is expected that the parliamentary budget resolution for the year 2002 would endorse this approach and the Cabinet of Ministers would adopt a resolution to this effect. In spite of the introduction of program budgeting, Ukraine will have to evolve an effective mechanism for ensuring the efficient allocation of limited resources. 21. Another challenge faced by the Budget Department is educating the line ministries in the concept of a programmatic approach to budgeting. The capacity in the line ministries to undertake a systenatic budgeting exercise is very limited and it may take a few years for the line ministries to truly absorb the concept. It is important that the new approach does not remain just an idea of the budget department, but that it percolates down to the spending units in the line ministries that must prepare the estimates. In order to achieve this objective, it will be necessary to conduct training programs at the budget spending unit-levels on a periodic basis until the staff fully absorb these concepts. 22. The Budget Code should also address the following issues: > more clarity concerning the limits and purposes of providing State guarantees, since these guarantees could have an impact on the finances; > incorporation of the concept of program budgeting in the annual budgetary process. 4. Accounting and Financial Reporting 23. Govermnent accounting in Ukraine is performed by two different organizations. The spending units, which number about 140,000, follow a modified accrual basis of accounting and maintain their own accounting records in prescribed formats. The State Treasury follows a cash basis of accounting and maintains records of all revenues and payments. Due to the different bases of accounting adopted by the spending units and the Treasury, there is an inherent risk of data incompatibility and inefficient reporting. State Treasury 24. The State Treasury was established as part of the MoF in 1995. The Treasury has branches at all oblast and rayon headquarters. The State Treasury functions as the "Accountant General" for the government. The preparation and submission of periodic reports on State budget execution, including annual accounts, is the responsibility of the State Treasury. The Order of the State Treasury' requires preparation of the following documents by the State Treasury: the State Budget Execution Statement containing a list of balances, such as cash balances, local and foreign currency bank balances, and revenue and expenditure balances; the State Budget Execution Report, (containing details of revenues and expenditures; the Cash Flow Statement; the Report on Deposits; the Spending Units Arrears Report, and an Explanatory note to the annual report. However, the annual report does not contain a statemnent of accounting policies. Proper recognition of assets and liabilities, and establishing rules for consolidating accounts according to internationally accepted practices, would take some time. 'Orders of the State Treasury 30. 28 and 52. dated March 6, 2001 and April 9, 2001. 5 25. The State Treasury Order No. N 114, dated December 10, 1999, prescribed a Chart of Accounts to be used by all budget spending units, effective January 1, 2000. The Chart of Accounts is divided into eight groups representing fixed assets, inventory, cash and debtors, equity, long-term liabilities, current liabilities, revenues, and expenses. Group 9 is used to report off-balance accounts such as leased assets, guarantees, and contingent liabilities. This Chart of Accounts is based on the modified accrual basis of accounting followed in the budget spending units. 26. The resolution of the Cabinet of Ministers requires the spending units to submit to the State Treasury and the Accounting Chamber (AC) consolidated quarterly financial reports within 30 days after the end of the quarter and annual reports within two months after the end of the year. The MoF and the State Treasury are authorized to suspend payments to budget institutions that fail to submit the financial reports on time. The Treasury has established a system of monthly reporting on spending units' accounts payable and receivable. However, MoF and Treasury are still in the process of establishing a system of controlling and reporting on spending units' commitments. 27. Ukraine has succeeded in centralizing all government payments through the Treasury, except Customs, Internal Security, and extra-budgetary funds such as the Pension Fund and the Social Insurance Fund. It is unclear as to why Customs department is outside the scope of the treasury system and operates its own bank account. The centralization of all government payments was done at the recommendation of the IMF. The IMF had weighed the advantages and disadvantages of a centralized versus a decentralized system in the early 1990s and had concluded that a centralized approach is more appropriate for Ukraine. The major advantage of the centralized approach is that it eliminates the buildup of idle cash balances in spending unit bank accounts by eliminating the need for spending units (ministries, departments) to open their own bank accounts for making payments to the suppliers and contractors. Instead the Treasury acts as a banker to the spending units. 28. Budgetary spending units have only the registration accounts in the Treasury, which serve the purpose of accounting for spending. This arrangement also strengthens internal controls, as the contracting units are themselves not responsible for making payments. Another major advantage is that the Treasury is able to compile the accounts quickly. Further extending the coverage of the Treasury over extra-budgetary funds and other budget institutions will increase the transparency of the budget execution process and will allow the use of the same rules and regulations for expenditure, accounting and reporting. Payments 29. Payments are made by the State Treasury within the appropriations approved by Parliament and within the availability of cash at the Treasury. The heads of the ministries and departments (distributors of funds) receive allocations from the main State Treasury office. To finance spending at the regional (oblast) budgetary agencies, the main State Treasury office transmits funds to the regional Treasury offices. Based on allocations made by the regional offices of the budgetary institutions, the oblast Treasury office transmits funds to the rayon Treasury offices. 30. The Treasury has initiated processing of all payments through a single correspondent account with the National Bank of Ukraine (NBU). Once the Treasury office receives funds from the main Treasury, the Treasury office informs the spending unit regarding the amount and purpose of funds received. The spending unit gives the invoices to the 6 Treasury office for effecting the payment. The Treasury office transfers the funds to the Bank account of the supplier/creditor directly. The actual bank transactions take place through accounts maintained with central or branch offices of the National Bank of Ukraine. There are plans to consolidate, by the end of this year (2001), Treasury banking operations through the Treasury Single Account at the NBU by linking regional Treasury internal payment systems with the System of Electronic Payment operated by NBU for the purposes of electronic inter-bank settlement. This will enable the Treasury offices to effect the transactions directly. The Treasury office scrutinises the invoices and thus provides ex-ante control over the expenditures paid out of the budget provisions. 31. After making the payment, the Operational and Control department of the Treasury makes the required entries on special cards maintained for each of the spending units. At the end of a month, the Operational and Control department submits a report on the use of budget funds by the spending units to the Accounting and Reporting department of the Treasury office. The report is compared with the reports received from the spending units before submitting it to the upper-level Treasury office. The Treasury office also submits a copy of the registration account statement to the spending unit every day so that the spending unit can record and reconcile the accounts. Generally, the reconciliation is effective and timely2. 32. As the State Treasury of Ukraine currently does not have a fully automated and integrated treasury system, it cannot ensure real-time reliable information on amounts of balances on Treasury accounts (the accounts of spending units registered with Treasury offices around the country). Moreover, the transfer of funds to the local Treasury offices on behalf of the spending units follows a rule of proportionality to total budget appropriations and does not consider commitments made by the spending units. This may result in the accumulation of balances for units having no immediate commitments. Another factor that influences the accumulation of balances is the requirement that an adequate balance be available in the unit's Treasury account before initiating a tender process. Such practices create inefficient cash management that results in the accumulation of balances (in spite of centralization of payments through the Treasury) and interim deficits of budget allocations, even when the overall budget is in surplus. 33. All the Treasury offices in oblasts and rayons have computer hardware, but hardware is not standardized. These offices are permitted to choose their own application software for transaction processing and accounting, with interface to the standard Treasury-wide reporting system. Some offices use spreadsheets for accounting and preparing reports. 34. The government has undertaken a major program to modernize the treasury system, financed by the World Bank (Ln. 4285-UA). The loan agreement was signed on September 1998 and is due to close next year, in June 2002. The project envisages implementing automated systems at the Treasury head office, and at each of the oblast (about 27) and rayon branches (more than 690) of the Treasury, to process and control central government payments. This system is expected to perform basic accounting functions, provide status of actual expenditures, and provide financial information to the Treasury and line agencies. The Treasury Transaction Registration and Reporting System (TTRRS), currently restricted to expenditure processing, is now operational in 21 oblasts and 400 rayons within these oblasts. The project faced several bottlenecks, including 2 IMF ROSC Report on Fiscal Transparency, September 1999. 7 disagreement between the Treasury IT team, its Accounting and Methodology department, and the IMF over the Chart of Accounts. It is important to note that the Treasury basically follows a cash basis of accounting but the system is designed to capture payables and commitment data received from the budget spending units. In order to perform both Treasurer and Accountant General functions efficiently and effectively, it is important that the Treasury modernization project be completed expeditiously and that uniform systems for transaction processing and reporting be implemented in all Treasury offices. Spending Units 35. Some of the budget spending units use computers for bookkeeping and reporting. However, due to frequent changes in the rules and procedures on accounting and financial reporting, the spending units end up doing lot of manual work. Moreover, accounting and reporting software is not standardized. Some spending units have procured programs developed in dBase and Fox Pro from local companies. Furthermore, there is no provision for management accounting data that could provide useful information on costing and performance accounting to the managers. There is a need to introduce uniform accounting and reporting software in budget spending units. The accounting software should be integrated software that could keep track of budget provisions, commitments, liabilities, and actual expenses. The budget spending units should be able to provide data to key spending units in electronic form so that it could be compiled quickly to provide consolidated information to the department head. 36. At the spending unit level, the controls on entering into commitments are weak, as evidenced by the accumulation of huge arrears. The recent requirement to have an adequate balance in the Treasury before initiating the tender process would restrict the ability of the spending units to enter into unfunded commitments. Simultaneously, with the countrywide rollout of the TTRRS in Treasury offices, it would be possible to identify quickly the extent of commitments entered into by the spending units. As a first step, the State Treasury has issued an order that requires the Treasury offices to register commitments made by the budget spending units3. 37. Each budget spending unit has an accounting office that verifies bills before forwarding them to the Treasury for payment, keeps records, and prepares reports related to budget execution. The accounting staffs in the spending units are very experienced in bookkeeping and reporting but lack skills in management accounting and reporting. Many of these accounting departments are understaffed. The main reasons are that - the low grade and wages discourage prospective candidates; current wages vary from UAH 90 (USD 17) to UAH 150 (USD 26) a month;4 - unfilled vacancies result in extra work for existing staff, who then receive overtime for additional work; and - the lack of training and education facilities limits career development opportunities. 3"On approving the procedure for accounting of commitments made by the budget spending units in the State treasury bodies" N2 103 dated October 19, 2000. 4The wages of accountants with central ministries and State agencies are roughly twice as high as those emnployed at the level of oblast, oblast rayon, city, and city rayon. 8 38. The job descriptions for accounting staff in the line ministries are not very well defined. For example, the Chief Accountant is responsible for a number of routine jobs, such as maintaining the General Ledger and some other books. In contrast, lower level staff have very narrow job descriptions, e.g., cash receipts, school meals, or teachers' wages. Lower-level accountants get higher extra pay for extra work done (1.8 times the normal rate). Formal annual performance evaluation of the staff either is not carried out at all or is done only if the staff member is to be promoted to a higher job grade. These practices have resulted in high turnover of accounting staff, low morale, and inability to attract well-qualified candidates. There is an urgent need to strengthen the human resource management function in the line ministries. Reporting 39. The MoF prepares the Monthly Budget Review reports and provides macroeconomic and fiscal indicators. The MoF's Monthly Budget Review is made available to the public on the Internet at www.minfin.gov.ua.. The Ministry of Economy prepares a quarterly report, The Economic Trends, also available on the web at www.me.gov.ua. This publication focuses on economic events, assumptions and risks, GDP, consumption, investments, prices, employment, balance of payments, capital markets, exchange market, and so forth. The State Committee on Statistics regularly issues a Statistical Bulletin, covering selected public sector data, such as accounts receivable and payable, capital investments, and State-owned shares in privatized enterprises. 40. The new Budget Code is more comprehensive in terms of specifying the accountabilities and responsibilities of the State Treasury for accounting and reporting. It has specific provisions for submission of monthly, quarterly, and annual reports by the State Treasury to the Parliament, the AC, the Cabinet of Ministers, and the MoF. It also specifies the procedures for review of the annual report on execution of the State budget by the AC and the Parliament. 5. Internal Controls 41. The internal controls at the Treasury and the budget spending unit levels are well documented in various rules, regulations, and decrees. Internal controls typically focus on identifying and reporting non-compliance in the payment process. Internal Treasury procedures on transfer of funds to the local Treasury offices for effecting payments on behalf of the spending units are governed by the Treasury Order5. The procedure outlined in the Order is quite detailed and has a number of controls. For example, the Expenditure and Control division in the Treasury head office prepares the order on transfer of funds to the local Treasury offices for credit to the spending unit's account. The order is verified and approved by another division in the Treasury office, the Accounting and Reporting division. 42. The Treasury has issued detailed guidelines for effecting payments by the Treasury offices on behalf of the spending units (see footnote 7). The spending units are responsible for ensuring the correctness of the payment documents. The payment documents received from the spending units are checked for correctness and 5 Order of the State Treasury of Ukraine No. 3 dated January 22, 2001, "On Approving the Procedure for Cash Execution of State Budget." 9 completeness at the Treasury office, including availability of budget and allocation. In the event of incorrect or incomplete documents, the payment order is sent back to the spending unit with a note explaining the reason for the rejection. The documents, stamped with the treasurer's seal, are sent back to the spending unit after the payment has been made. The amount of each payment and the date of payment are recorded on the last page of the contract that envisages several payments in installment. Payment of expenses is made by wiring funds directly in favor of suppliers of goods, services, and works. Written rules are excessive in some areas and incomplete in others, which leads to an incomprehensive system of internal controls. Frequently excessive effort is spent on insignificant and small payments, leaving insufficient resources for controlling large and vulnerable payments. Financial risk assessment to determine the focus of attention is practically non-existent. 43. In July 2000, the State Treasury established an Internal Audit unit within the Treasury to strengthen internal controls. The predecessor of this unit concentrated on reviewing spending units rather than regional and local Treasury offices. The head office of the State Treasury Internal Audit unit has a staff of nine. The revision and control staff in the oblast and rayon treasuries do not report directly to the Internal Audit unit in the head office. The Internal Audit unit has prepared a concept paper on conducting internal audit in the Treasury. There are several overlapping roles between the Treasury's internal audit and the Control and Revision Department (Kontrolno Reviziyne Upravlinnia or KRU)6 and it is important that the concept paper being prepared by the unit clarify the role of Treasury's internal audit in greater detail. State Control and Revision Service 44. Ukraine has established a separate organization, KRU, for detecting illegal expenses and breaches of rules and regulations, known as the "control and revision" function7. The control and revision function can better be compared with the vigilance function than with the internal audit function. KRU until recently was authorized to levy fines and penalties for breaches and non-compliance. It may judge whether persons are guilty of any financial wrongdoing (particularly in respect of non-compliance and concrete breaches such as improper accounting, failure to submit reports, or conduct inventory checks), even before the case is in the hands of law enforcement officers. 45. KRU is not designed to operate publicly but rather to conduct its activities in secrecy KRU derives much of its tradition from the Soviet system of checks and investigations. KRU reports directly to the President and the Cabinet of Ministers and it is therefore not internal to the line ministries. It is significant that the KRU Chairman and deputy heads are appointed by the President and not by the Cabinet of Ministers. Moreover, the Chairman may be dismissed by the President. KRU's loyalties are clearly with the executive. 46. KRU serves as the central control and revision agency, the line ministries are also required to have their own Control and Revision departments within each ministry. For 6 The central Control and Revision Department (HOLOVKRU) together with control and revision units (KRU) in oblasts, cities of Kyiv and Sevatopol, and autonomous republic of Crimea constitutes the State Control and Revision Service of Ukraine (DKRS). However, the term KRU is used loosely to mean the function of control and revision in Ukraine. 7Law On the State Control and Revision Service of Ukraine, 1993. 10 example, the Ministry of Labor and Social Policy and the State Committee on Statistics have Control and Revision divisions comprising seven and three staff respectively. However, certain ministries do not have a functioning Control and Revision department, for example, the Ministry of Health. The Control and Revision departments within the ministries are required to plan their annual work programs in consultation with KRU's schedule to avoid overlapping and duplication. They are also required to submit quarterly reports to the KRU. 47. KRU has enormous powers and authority, specified in a Presidential decree dated November 2000 (No. 1265/2000). This decree granted the status of a central body of the executive to KRU and enhanced its powers. KRU is responsible for preparing standards for conducting revisions and controls. It has unimpeded access to books and records, warehouses and other premises. KRU also has the overriding authority to counter-check organizations and entities that did business with the entity being inspected. The decree also empowers KRU to issue instructions that are binding on budget spending units, local self-government bodies, and enterprises. The decree also authorizes KRU to levy sanctions (penalties / fines) on entities found contravening the laws/rules/regulations. KRU is also authorized to conduct checks on State Owned Enterprises (SOEs)8. 48. KRU has established a board for resolving important issues. Board members are appointed by the Cabinet of Ministers on recommendation of the Chairman of the KRU. 49. Current provisions oblige KRU to carry out planned revisions and checks once every two years. But actual practice is to conduct this exercise once every four years. For example, in 1998, out 140,000 budgetary units, only 27,000 were covered by KRU. KRU has reported the following interesting audit outcomes, indicating billions of UAH lost due to illegal disbursement, stealing, and other breaches.9. Audit Outcomes 1997 1998 1999 2000 Illegal disbursement, stealing, and other 1.1 1.6 1.7 0.9 breaches (UAH billions) Number of officials implicated 16,000 14,000 13,500 17,000 Number of officials dismissed 1,700 1,500 1,200 1,000 50. The general perception within the line ministries is that KRU is driven by a need to report the maximum number of offences/faults, thereby increasing the amount of fines and penalties it can levy and proving its efficiency. This is not surprising, given the fact that until recently, KRU received 15 percent of the fines and penalties resulting from its inspections as extra-budgetary resources for financing its operations. Even assuming that this criticism is true to some extent, it can be concluded that the internal controls in the spending units and Treasuries are weak. 51. It is important to introduce the concept of internal audit in Ukraine and to define its role as one of assisting management in strengthening internal controls and evaluating 8 The Presidential Decree No. 1031/2000 dated August 27, 2000, "On Measures To Increase Efficiency of C&R Activities." 9 Source: KRU's official magazine, Financial Control, April-May 2000, and letter No. 02-14/84 dated March 23, 2001, from the Chairman of KRU, Mr. Kalensky. 11 program implementation. Ideally, KRU itself should be reorganized to act as the State's intemal auditor, responsible for standard setting, quality assurance, oversight, and training for the reorganized internal audit departments within the line ministries. KRU needs to change its role from the "budget police" to that of State intemal auditor. KRU cannot be easily and quickly transformed into a transparent, focused, and improvement- oriented organization. The transformation will be difficult because of lack of conceptual understanding of the internal audit function. At the same time, it is also essential to clearly define the role of the control and revision departments within the line ministries, which in many ways resemble current KRU operations. The control and revision units within the line ministries should be strengthened to perform the role of intemal auditor and to assist management by carrying out internal control and performance reviews. State Tax Administration 52. Tax revenue is the domain of the State Tax Administration (STA), which de facto reports directly to the President. In spite of KRU's powerful status, it has no right to oversee revenue collection, nor does the AC have any mandate to audit revenues. The secrecy surrounding tax revenue controls is a legacy of the past and has created a serious gap in Ukraine's public accountability arrangements. The image of STA is further damaged by its alleged use to silence critical media, independent trade unions and "oppositional" entrepreneurs'0. 53. The STA has a separate Control and Revision department reporting directly to the STA Chairman. Its first priority is to verify and check STA budget expenses. The department has a staff ofjust 15, all located at headquarters. The staffing strength is inadequate for it to carry out proper inspection of tax revenues. 6. External Audit 54. According to the Constitution (Article 98), the Accounting Chamber (AC) exercises control over the use of State budget finances of the State budget of Ukraine on behalf of Parliament. The AC was set up in 1996 and became operational in 1997. In effect, the AC is an arm of Parliament for obtaining assurances on budget execution, just as KRU provides such assurances to the executive. However, the term "control" does not have the same meaning as in the "control and revision" function performed by KRU. The AC has neither the authority to levy penalties or fines nor the authority to issue instructions to the line ministries (as does KRU). The AC is perceived as functioning under the control of Parliament and is sometimes criticized for being influenced in its work by powerful political forces in Parliament. As a result, occasionally the reports of the AC are read with skepticism by the government. 55. The role and responsibilities of the AC are defined in the Law on Accounting Chamber (1996). Its main tasks are supervision (compliance verification) of budget expenditures and public debt, and of the financing of State programs and the legality and timeliness of budgetary flows are the main tasks of the AC. The AC is required to report regularly to Parliament on the budget execution and repayment of public debt. The AC is a member of the International Organization of Supreme Audit Institutions (INTOSAI). ' Nations in Transit (2001), 669-670. 12 Scope of the Accounting Chamber's Mandate 56. The Law on Accounting Chamber has been the subject of a debate between Parliament and the President that required hearings at the Constitutional Court. The President requested the Constitutional Court to consider certain provisions of the 1996 law as unconstitutional. The contested provisions were: - the title, "Accounting Chamber of the Supreme Council of Ukraine;" - the status of the AC as the supreme public institution for State financial and economic control; - immunity for the Head, the First Deputy Head, Chief Controllers, and the Secretary; - control over State budget revenues; - control over sale of State-owned property and privatization; - authority to examine and possess any document; - authority to freeze bank accounts of an organization in case of repeated defaults; - control over printing of currency and use of gold reserves; and - control over maintenance of State property. 57. The Constitutional Court, in its decision on February 23, 1997, upheld the request of the President and considered the above provisions as unconstitutional. The Parliament responded by approving another Law on Accounting Chamber in 1998. In a further appeal to the Constitutional Court, the President requested it to repeal the new 1998 law on the grounds that it was unconstitutional because it contravened the directions of the Constitutional Court requiring an amendment to the original law rather than enactment of a new one. The Court, in its decision in December 2000, declared the controversial provisions of the new law as unconstitutional. In the meantime, the 1996 law was amended, restricting the mandate of the AC, most notably by removing from its purview the audit of State revenues, the State Property Fund, and the SOEs. 58. The Parliament had approached the Constitutional Court to consider an amendment to Article 98 that would extend the mandate of the AC to cover the audit of revenues and audit of local budgets. The Constitutional Court granted permission to propose such an amendment but it has yet to be proposed and its passage would require a two-thirds majority vote in Parliament. 59. The several appeals to the Constitutional Court over the mandate of the AC are clear signals of the politicization of this important organ of public financial accountability. The Constitution of the country has created the AC as a standing body, subordinated and accountable to Parliament, to exercise control over the finances of the State budget. Since the AC is detached from the government, it can form an independent opinion on the financial operations of the government and provide checks and balance in the governance system. However, since it is dependent upon Parliament and since the top brass in AC is appointed by Parliament, the opinion of the members of Parliament does influence its reports . This arrangement creates a credibility gap vis-a-vis the AC's findings, at least from the standpoint of the government. It is essential that the AC, being the Supreme 13 Audit Institution (SAI) of the country, be able to perform its functions without any bias. The general public, through Parliament, has a right to receive an independent audit report on the execution of the State budget. The AC, whose mandate is restricted to audit only expenditures, cannot be said to provide such an audit report to Parliament. This is a serious weakness in the financial accountability arrangements of Ukraine. Accounting Chamber Funding and Staffing 60. The AC is headed by a Chairman, who is appointed by Parliament for a period of seven years, renewable for a second seven-year term only. Similarly, the deputies, the Chief Controllers (heads of department), and the Secretary are appointed by Parliament for a single term of seven years (Article 10 of the Law on Accounting Chamber, 1996). The Chairman and other appointees of the Parliament are required to possess a higher degree in economics or law and experience in public sector. Parliament may remove the deputies, heads of department and the Secretary for inefficient performance or non- compliance with the law (Article 11). 61. The budget allocation for the AC for the first couple of years of its existence was based on broad estimates, as its staffing and functions were evolving. In the subsequent two years the allocation decreased, as the Constitutional Court confirmed the reduced role of the AC. Currently, AC has no infrastructure at the local oblast or rayon level and is planning to set up regional offices during this year (2001). Accordingly, it has received a significantly higher allocation for this year. However, the CFAA team was given to understand that the plan of the AC to set up regional offices is being put on hold by the government. 1997 1998 1999 2000 2001 Allocations to AC (UAH million) 15 12.4 7.9 4.6 11.4 Source: Annual budget laws. 62. The current staff strength in AC is 230. According to the AC's own estimate, it needs an additional 120 staff to adequately carry out its current mandated responsibilities. On a comparative note, KRU has a total staff of more than 8,500 and neither KRU nor AC has the authority to check tax revenues. Another significant limitation for the AC is sparse budget for the training of its staff. There is an urgent need for skills upgrading and acquisition of new skills by AC staff, particularly in the areas of risk assessment and intemal control assessments. A systematic training needs assessment, including preparation of training courses and curriculum, is urgently recommended. ACAnnual Report Findings 63. The law does not clearly specify the minimum reporting requirements nor indicate which matters should be subject to a formal audit opinion or certification. Parliament has not clarified its minimum expectations regarding the nature of audit coverage or the principal risks that need to be assessed. The AC's annual report is more of an activities report than an audit report on the financial statements of the government. The current annual report of the AC comprises the following information: * Number of revisions, checks, and other activities carried out by the AC; * Analysis of the budget execution by the government; 14 * Achievements of the AC: > Names of the budget spending units and budget financed programs audited > Amounts misused or inefficient use of State funds > Non-compliance with the laws > Recommended actions * Internal workings of the AC The structure and format of the annual audit report needs to be improved to include an assurance on the financial statements of the government by adopting international standards on audit reports. 64. The annual report of the AC for the year 1999 highlighted the misuse of funds by spending units as follows: * Purposeless expenditures UAH 1,932 millions * Illegal expenditure UAH 477 millions * Inefficient expenditure UAH 1,240 millions For the same period, KRU had reported illegal disbursement, stealing, and other breaches amounting to UAH 1.7 billions. AC does consider KRU reports when prepaning its own reports. 65. The Budget Committee discusses the annual reports of the AC, though there are no written rules or regulations governing these hearings. These internal hearings are not open to the public or the media. 66. The AC is actively engaged in disseminating its findings in the media. The AC also has a website, http://www.ac-rada.gov.ua/main.asp, which is maintained in three languages (Ukrainian, Russian, and English)' l. The website, however, does not provide the full text of the annual reports laid before Parliament, nor of other reports prepared by the AC. It certainly needs enhancement but it should be recognized that the AC has made a good beginning by creating the website on its own initiative. The AC also publishes monthly bulletins on selected topics, an effort that received UNDP support in 2000. Audit of SOEs and Local Governments 67. The SOEs are not subject to audit by the AC, except for budgetary allocations received by the SOEs during the year. The financial audits ofjoint stock companies owned by the State are performed by Ukrainian auditing firns. However, such audited annual financial statements of the SOEs are not placed before Parliament for its review. Since the SOEs are formed with State funds, the AC should have the authority to audit all SOE finances, not just the portion received during the year through the budget, if the review of audited financial statements indicates serious accountability issues or if Parliament so determines. 68. The local budgets of oblasts and rayons, which are not financed out of the State budget, are not audited by AC, although KRU has a mandate to conduct inspections of "The website is well visited and had registered over 138,000 hits as of June, 2001. 15 the local budgets. There are no explicit provisions in the Law On Self Government (1997) for independent audit of the local budgets. It is important to note that the share of local budgets in the consolidated budget of the country is about 30 percent. 7. Legislative Oversight over the Executive 69. The Constitution has provided for legislative oversight over the executive in several ways, for example, by requiring Parliament to approve the annual budget and the annual report of the government on budget execution, and to review the AC's annual report. The Parliament has established a Budget Committee to look into details of the proposed budget and actual execution of the budget. The committee comprises 30 elected representatives. The Chairman of the Budget Committee is elected by Parliament. 70. There are no specific rules or regulations governing the working of the Budget Committee but the general rules governing the working of the parliamentary committees apply to the Budget Committee as well. The Budget Committee has 12 staff, of which 8 are professional experts. A noteworthy development in the recent past has been the establishment of a Fiscal Analysis Office (FAO), funded by USAID and staffed by a consulting firm, to provide analytical support to Parliament. FAO analyses the annual budget proposals. Members of the Budget Committee confirm that the FAO analytical work has been useful to them. However, FAO's continuity in the long run is not guaranteed, as Parliament has yet to take a decision on absorbing FAO staff, and whether the staff would work at reduced public sector salaries is another issue. 71. The Budget Committee also has the responsibility to conduct a detailed review of the budget execution reports and the AC annual reports, but it has little capacity do so. Moreover, FAO has no mandate to provide analytical support in this respect to the Budget Committee. Since Parliament is the recipient of the audit reports and is required to provide oversight over the AC, it is essential that it have adequate capacity to conduct a detailed review of the audit reports, including the ability to ask for clarifications from the executive and the AC, to provide directions to the government based on this review, and to conduct follow-up required to ensure that adequate actions are taken to address the issues. It would also be desirable to have specific rules/regulations governing the review of audit reports by the Budget Committee, along with clear guidelines for the executive to take follow-up action on the recommendations of the Budget Committee. In order to enhance transparency and strengthen public accountability, the Budget Committee should consider opening the proceedings to the media and/or public when it holds discussions on the audit reports. 72. The accountability of the State Owned Enterprises (SOEs) to Parliament is not clear. The law contains no specific provisions requiring SOEs to submit their annual audited financial statements and audit reports to Parliament. Nor are SOEs subject to audit by the AC. The financial audits of joint stock companies owned by the State are performed by Ukrainian auditing firms. However, the annual audited financial statements and audit reports of the SOEs are not placed before Parliament. Since SOEs are an integral part of the State, their audited financial statements and audit reports should be subject to Parliamentary review. An Australian model describing the accountability arrangements for SOEs in Australia is presented in Annex 2. 16 8. Private Sector Accounting and Auditine 73. Private sector investment is still evolving in Ukraine. Powerful businessmen, known as oligarchs, and foreign business interests own a majority of enterprises formed in the private sector. A majority of the largest enterprises is still owned by the State, while most of the roughly 10,000 small and medium enterprises (SMEs) have been privatized. The privatization of SMEs has created a large number of employee-owners. However, the individual investor base in Ukraine is still negligible. The general public still hesitates to place their savings in the banks and are even less incline to invest in capital markets. There are fewer than 25 companies listed on the Ukrainian Stock Exchange'2. 74. The majority of the 500,000 accountants estimated to be working in Ukraine possess no formal accounting qualifications. The leadership role in developing the accounting profession in Ukraine, purely on a voluntary basis and without any legal or government recognition, is performed by a self-regulatory NGO, the Ukrainian Federation of Professional Accountants and Auditors (UPFAA). Though UFPAA has a membership of less that 1 percent of the accountants working in Ukraine, it has succeeded in creating some awareness about International Accounting Standards (IAS), and in introducing professional accountancy curriculum and examinations in Ukraine. The achievements of UFPAA are commendable, considering the fact that it has received practically no support from the government. 75. There are about 3,000 licensed auditors in Ukraine. The five largest international accounting firms ("Big 5") have opened offices in Ukraine. The Law on Accounting and Reporting requires all open joint stock companies to publicly disclose their annual audited financial statements, no later than June 1 of the following year, through publication in periodicals. 76. A major problem faced by many companies is that they have two sets of accounts to maintain, one set for financial reporting and another for tax authorities. Many companies prefer to maintain two sets of records because the tax laws are so cumbersome and the treatment of transactions is so different under accounting standards than for tax requirements. While it is common practice in other countries besides Ukraine to have tax computation requirements that differ at times from generally accepted accounting practices, in many of these countries, a single financial statement forms the starting point for tax computation In Ukraine, many businesses prepare a separate financial statement for the tax authorities. The disparities in Ukraine are related to the fact that there was little consultation between STA and AMB during the preparation of the Chart of Accounts, in order to synchronize tax disclosure and accounting requirements. There is a need for greater dialogue and cooperation between AMB and STA. National Accounting Standards 77. In October 1998, the Cabinet of Ministers passed a resolution that launched, and provided important guidance for, the transformation of, the national accounting system to bring it in compliance with the requirements of a market-based economy13. In July 1999, 12htt://www.ukrse.kiev.ua/eno/about/maR.htm. 13 Resolution No. 1706, "On Approval of the Program of Reforming the System of Accounting using International Standards." 17 Parliament approved the Law On Accounting and Financial Reporting in Ukraine, effective from January 1, 2000, which requires establishing National Accounting Standards (NAS) that do not contradict International Accounting Standards (IAS). 78. The Law recognizes the following concepts as the main principles of accounting and reporting: going concern, consistency, prudence, complete disclosure, matching of costs and revenues, and accrual. The Law empowers the MoF to prescribe NAS for all legal entities in Ukraine except the banks. The National Bank of Ukraine is empowered to prescribe Accounting Standards for the banks. In addition, MoF has provided Chart of Accounts to be adopted by enterprises when preparing their accounting statements14. 79. The Law created an Accounting Methodology Board (AMB) to act as an advisory body to the MoF and assist it mainly in the following tasks: - developing NAS, - improving the organization and methods of accounting in Ukraine, and - recommending improvements in training of accountants. The members of the AMB come from various sectors of the economy, for example, the State Tax Administration, the association of industries and business, the business council attached to the Cabinet, the Securities and Stock Market State Commission (SSMSC), the Ministry of Justice, the Chamber of Auditors, the Union of Auditors, the UPFAA, the association of small and medium enterprises, the State Treasury, NBU, and the anti- monopoly committee. 80. The AMB has developed NAS with the support of technical assistance from UPFFA. The following list indicates the schedule of adopting NAS in Ukraine. Schedule of Adoption of National Accounting Standards NAS MoF Adoption Date NAS 1: General requirements to financial statements March 31, 1999 NAS 2* Balance sheet March 31, 1999 NAS 3: Income statement March 31, 1999 NAS 4: Cash flow statement March 31, 1999 NAS 5 : Equity statement March 31, 1999 NAS 6: Correction of errors and amendments in financial statements May 5, 1999 NAS 7: Fixed assets April 27, 2000 NAS 8: Tangible assets October 18, 1999 NAS 9: Inventory October 20, 1999 NAS 10: Debtors October 8, 1999 NAS 11: Liabilities January 31, 2000 NAS 12: Investments April 26, 2000 NAS 13 : Financial instruments To be adopted in 2001 NAS 14: Lease July 28, 2000 NAS 15: Revenues November 29, 1999 NAS 16: Expenses December 31, 1999 NAS 17: Profit tax December 28, 2000 4 Order No. N 291 dated November 30, 1999. 18 NAS 18 : Long term contracts April 28, 2001 NAS 19: Merging/amalgamation of companies July 7, 1999 NAS 20 Consolidated financial statements July 30, 1999 NAS 21: Effects of changes in foreign exchange rates July 10, 2000 NAS 22: Effects of changing prices and inflation To be adopted in 2001 NAS 23: Information disclosure on related party and segment reporting June 18,2001 NAS 24: Earnings per share July 16, 2001 NAS 25 : Financial statement for small business February 25, 2000 81. Although NAS are mandatory, actual adoption of NAS in the preparation of financial statements by the enterprises is far from satisfactory. The survey of financial statements of 192 companies by the USAID consultant Financial Markets International Inc. revealed significant gaps in the presentation of financial statements and disclosure practices. In many companies, the financial data did not tally with the notes to the accounts. The survey observed inadequate disclosure of information regarding production, license, business description and other topics. Virtually all companies (98 percent) omitted notes to the accounts. The main reasons cited for non-compliance were lack of skilled accountants in implementing the standards, lack of skilled auditors in assessing compliance with NAS, and more importantly, lack of any enforcement mechanism by the regulatory authorities such as SSMSC. 82. The law explicitly requires NAS not to contradict IAS. Although NAS are based on IAS, they do differ from IAS in several major respects, for example: - NAS allows depreciation rates and methods prescribed in the Tax laws that do not take into account useful life of the assets. - Liabilities are recorded only if adequate documents (such as shipment documents or work completion reports) are available. - Provision for liabilities is made only in respect of certain specified expenses, such as leave salary, retirement benefits, and guarantee obligations. - There is no prescribed standard for deferred taxes. - NAS does not recognize the concept of general provision for doubtful debts. Moreover, NAS have not kept pace with the changes and amendments introduced in the IAS. NAS also have a separate accounting standard for small business that has no IAS equivalent. 83. An increasing interdependency of financial markets has given rise to a need for reliable, transparent, and comparable financial statements by securities issuers. The recent past has witnessed IAS emerging as an intemationally acceptable accounting standard. The European Commission (EC) has proposed legislation which, when adopted by the Council of Ministers and European Parliament, would require all listed companies in EC to prepare financial statements following IAS from 2005 at the latest. Similarly, the Intemational Organization of Securities Commission (IOSCO) has recommended that its members should allow intemational issuers to file financial statements based on IAS. The Basel Committee on Bank Oversight has also announced its support for IAS. A survey of Ukrainian stock exchanges by USAID consultants Financial Markets Intemational Inc. found a positive reaction from the stock exchanges towards introduction of IAS for listed companies. 19 84. In view of the developments taking place in Europe and Ukraine's stated objective of integrating with the European Union, Ukraine needs to formulate a strategy of adopting IAS for listed companies, insurance companies, utilities, and companies seeking foreign investment, both for enhanced transparency and international comparability. But so far, experience in Ukraine in adopting NAS has been far from satisfactory. Adoption of full IAS will require greater capacity on the part of those preparing the financial statements and those auditing these statements. Fortunately, considering the small number of listed companies in Ukraine, this increase in capacity is not an insurmountable problem. 85. Ukraine will have to concentrate on providing rigorous education and training in LAS to accountants and auditors, so that lack of trained accountants does not remain a cause of non-compliance. This upgraded training is important, as the IFC survey of Ukrainian enterprises also identified accounting as the most important business area that requires training and professional help. Considering UFPAA's lead in conducting training and professional examinations in Ukraine, UFPAA may be given the lead role in this task. In addition, the auditing profession will need to gear up to audit financial statements prepared on the basis of LAS. Simultaneously, SSMSC will also need to strengthen its capacity by inducting well-qualified accountants to ensure proper compliance. 86. The banking sector has witnessed several reforms in the areas of accounting and auditing. Most of these reforms were introduced as part of the World Bank-financed Financial Sector Adjustment Loan. The National Bank of Ukraine (NBU) is the regulatory authority for the banking sector in Ulkraine. In 1998, the NBU made it mandatory for all banks operating in Ukraine to move to IAS in the preparation of their financial statements, a move required under the Financial Sector Adjustment Loan. USAID and the EU's Technical Assistance for Commonwealth of Independent States (EU-TACIS) provided technical assistance to commercial banks in making the transition to LAS. The World Bank supervision mission reports conclude that most of the commercial banks have succeeded in preparing their financial statements on the basis of IAS. However, supervision capacity in NBU to monitor continuing compliance by the banks needs to be strengthened by inducting additional qualified staff who have skills in IAS. Ukrainian Federation of Professional Accountants and Auditors 87. The Ukrainian Federation of Professional Accountants and Auditors (UFPAA) was created in 1996'5. It represents the interests of over 4,000 of the estimated 500,000 accountants working in Ukraine. UFPAA's mission is to establish IAS-based accounting standards and practices, a professional code of ethics, and professional education and certification in Ukraine. UFPAA, with assistance from USAID, has been conducting several training programs in IAS for accountants and auditors. It has also developed a curriculum based on the Association of Chartered Certified Accountants (ACCA), including study materials in Ukrainian, and administers two levels of examinations. Since 1997, more than 1,350 students have taken the lower level examination, with more than 550 passing the examination. However, only about 15 have managed to pass the higher level examination. It is not necessary for accountants to pass these examinations to become members of UFPAA. Any person with a Bachelor's degree and two years' 5 http://www.ufpaa.kiev.ua/SiteMapE.htm 20 experience, or five years' experience without a Bachelor's degree, can become a member of UFPPA. 15. UFPAA has also assumed a leadership role in the CIS countries in promoting the accounting and auditing profession. UFPAA is an active participant in the International Regional Federation of Accountants and Auditors, Eurasia, whose secretariat is located in Kiev, Ukraine'6. Eurasia's goals are to implement and promote the use of IAS and International Standards on Auditing (ISA), IFAC's code of ethics, and professional education and certification programs in member countries. UFPAA's Chairperson also chairs the Eurasia council, and UFPAA council members are active in several committees of Eurasia. . Audit 88. The Law on Audit, adopted in 1993 (as amended) provides the foundation for the establishment of the auditing profession. The law has created two bodies: the Chamber of Auditors and the Union of Auditors. The Union of Auditors was created mainly to serve the interests of its members and to nominate five elected members and five academicians or experts to the Chamber of Auditors. Though there are about 3,000 certified auditors in Ukraine, only about 1,400 auditors, including eight audit firms, have elected to join the Union of Auditors. Certified auditors have-a right but no obligation to join the Union of Auditors. The Union of Auditors has no power to govem the audit profession, apart from their role in nominating ten of the 20 members of the Chamber of Auditors. Chamber ofAuditors 89. The State has delegated the regulatory function for the auditing profession to the Chamber of Auditors, which is controlled by the govenmment to a very large extent. The Chamber of Auditors, which is responsible for certification and licensing of auditors, issuing auditing standards, and training, has a total of 20 members who serve five-year terms. Only five members are licensed auditors. Of the remaining 15 members, some of whom are certified auditors, five are nominated by the government-one representative each from the MoF, STA, NBU, Ministry of Justice, and Ministry of Statistics-and ten are specialists from educational, scientific, and other organizations, of which half are nominated by the Union of Auditors and the other half by the same five government agencies. 90. Given the stage of private sector development in Ukraine, where the business oligarchs have overwhelming influence over business-related activities in the country, it is not inappropriate for the government to retain significant control over the governance of public-interest professions such as audit. However, in the long run, it is essential that a professional governing body such as the Chamber of Auditors be composed, in the majority, of licensed audit professionals. 91. The Chamber of Auditors administers an oral examination to eligible candidates, who are required to have a bachelor's degree and at least three years' working experience. Successful candidates receive a license to practice for a period of five years. The license is renewable but requires a written report from the licensee on his efforts to keep up-to- date on auditing standards and related developments. The Chamber of Auditors has 16 http://www.irfaa-eurasia.org/sitemap_e.shtml 21 recently taken a decision to introduce a computer-based multiple-choice test, in addition to an interview, before awarding a license. 92. There is an urgent need for the Chamber of Auditors to thoroughly review the eligibility criteria and adopt comparable international practices for examination of candidates desiring a professional license. Notwithstanding the decision to introduce a computer-based test, the system of screening candidates for awarding the audit license falls short of the high professional standards expected from the audit profession. Audited financial statements and audit reports are the most important documents relied upon by investors and other stakeholders. Unreliable and substandard audited financial statements and audit reports are of little use. The NBU also has reservations about the professional competence of auditors certified by the Chamber of Auditors and requires the major commercial banks to get their financial statements audited by international firms. 93. In December 1998, the Chamber of Auditors issued auditing standards for auditing professionals. The Chamber of Auditors has declared its intention of adopting the full International Standards on Auditing (ISA) for Ukraine. The Chamber of Auditors needs to prepare a time-bound action plan for adopting ISA. 94. The Chamber of Auditors also issued a code of ethics for auditing professionals in December 1998. The Chamber of Auditors has a Committee on Professional Ethics and Compliance that acts as the Chamber's disciplinary committee. However, the Committee maintains no records or statistics on disciplinary cases handled or actions taken against its members. Such inadequate governance arrangements not only lead to favoritism and mismanagement but also lower the confidence of the investors and other stakeholders in the audited financial statements. The Chamber of Auditors needs to strengthen the procedures of the disciplinary committee, including publication of cases handled and actions taken. 95. An important role of a professional regulatory body is to establish quality control mechanisms to ensure that licensed professionals render a high quality of professional service. In the absence of quality control mechanisms, the professional regulatory body may end up playing a fire-fighting role, acting on complaints about services rendered by auditors on an ad hoc basis. The Chamber of Auditors has no such quality control mechanism. It is not suggested that the Chamber of Auditors duplicate the work of the regulatory agencies, but it should determine whether allegations of audit deficiencies indicate a need for corrective action by the member firm involved, including follow-up or reconsideration of the relevant professional standards. In this regard, the Chamber of Auditors should also consider a system of peer review of work done by audit firms. Audit Practices 96. According to the Law on Auditing, the following organizations are required to get their annual accounts audited: commercial banks, funds, exchanges, open joint stock companies, cooperatives, associations, and other economic entities whose accountability is to the public (Article 10). The Law has a seemingly ridiculous provision that requires audit to be done only once every three years for organizations having an annual turnover of less than 250 times the tax-free business income threshold, which is only UAH 4,250! There are hardly any organizations that would benefit from this exemption. 22 97. The Law requires "confirmation of reliability and completeness" of year-end balances. The term "auditing" is defined in the law (Article 4) as "revision" of accounting, original documents, and other information pertaining to the financial- economic activity of entities, for the purpose of accurately estimating accounting results and assessing accountability and compliance with laws and established norms. This definition connotes the requirement of absolute assurance/confirmation, rather than an opinion following a "true and fair view" of the financial statements. But an absolute assurance in auditing is not attainable, because of such factors as use of testing, need for judgment, and the fact that most of the evidence available to the auditors is persuasive, rather than conclusive in nature. The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with an identified set of reporting standards. Auditing in market economies puts the emphasis on the professional opinion of the auditor rather than on "confinnation of the reliability and completeness of the financial statements.. The current definitions in use in Ukraine are another part of the legacy that emphasized "confirmation of correctness and completeness." 98. The Law also requires "verification of the financial grounds" of founders of commercial banks, enterprises with foreign investments, joint stock companies, holding companies, investment fimds, and trust funds. This requirement is apparently intended to ensure that the founders of commercial banks and other organizations have sound financial credentials and are not acting as a front for the real owners. There is no evidence to suggest that this requirement has precluded the oligarchs from forming companies using pseudo-owners, as the law itself does not define the financial credentials, nor does it specify what sort of accounts or financial statements an individual should prepare for audit. Moreover, there is no mention of who might be the responsible authority to monitor compliance with this provision. This seemingly ill-drafted provision is an exatnple of how the lack of comprehensive analysis of practical repercussions can render a provision unenforceable. 99. The Law on Business Associations requires each joint stock company to form a Revision Committee (RC) to be elected by the shareholders (Article 49). The RC exercises oversight over the financial and business activity of the company, reporting to the assembled General Body of shareholders and presenting conclusions on annual financial statements. This provision provides the RC with unfettered right to take part in the meetings of the company's board of directors, and, surprisingly, also provides it with voting rights at such meetings. The law does not distinguish between internal controls and accountability issues on the one hand, and pure business issues on the other, and has provided the RCs with sufficient voting power to influence discussions at board meetings. Yet it is the board that is accountable for business results, and not the RC, meant to be an oversight body. This practice is inconsistent with good corporate governance and needs to be changed. Appointment ofAuditors 100. The Law on Audit requires an auditor to be a Ukrainian national (Article 5). Furthermore, it stipulates that a Ukrainian auditor should confirm any audit report prepared and signed by a foreign auditor for submission to the official agencies. The objective of this provision is to ensure that foreign audit firms do not monopolize the 23 market. Currently, there is only a handful of foreign audit firms operating in Ukraine including the "big five." 101. The law contains no clear and explicit rules regarding who is responsible for appointment of an auditor. The Law on Business Associations (1991, as amended), which defines the right and duties of the General Body of shareholders (Article 41), also contains no reference to the appointment of auditors. In practice, company management appoints the auditor. It is also not clear to whom the auditor should address the audit report-to management, the Board of directors, or the shareholders? Similarly, there are no explicit rules for removal of an auditor. It is no surprise that auditors insist on receiving 70 percent of their fees before starting an audit assignment. However, the Code of Ethics issued by the Chamber of Auditors does contain specific provisions relating to substitution of an auditor by another auditor (Section 12.14 through 12.26). Absence of specific provisions in the. law regarding appointment and removal of auditor is a serious lacuna in the corporate governance arrangements in Ukraine. 102. In order to ensure the independence of the auditor and to avoid any possible conflict of interest, Article 24 of the law specifies certain instances that prohibit the auditor from accepting an audit assignment. However, the language is vague and subject to varying interpretations to suit the convenience of the interpreter. For example, it states that a "direct relative" of the "leader" of the enterprise should not undertake an audit assignment. Similarly, it prohibits a person from auditing an organization in which he has "personal property interests," but without defining the term "personal property interests." Such vagueness in the legal provisions not only leads to interpretations that benefit the individuals holding the-power but also leads to lax enforcement by the monitoring agencies. 103. World Bank financed projects in Ukraine are required to get annual project financial statements audited by firms acceptable to the Bank. However, considering the important shortcomings of the audit profession, such as relaxed entry requirements and lack of strong disciplinary and enforcement mechanisms, it is advisable that the Bank carry out a review of auditing practices followed by the audit firms to determine their eligibility to audit Bank-financed projects in Ukraine. Considering the limited capacity of the AC to audit financial statements, the audit of project financial statements by the AC is not recommended at this stage. 104. For the past few years, an international audit firm has audited NBU itself. In February 1999, NBU issued an order, "Measures for Further Development of Banking Audit," -that required the ten largest banks, of which eight were privately owned and two were State owned, to get their annual financial statements for 1999 audited in accordance with ISA by international audit firms. In a further development, the recently enacted Law on Banks and Banking empowers NBU to specify eligibility criteria for bank auditors. This provision provides overriding power to NBU to pre-qualify audit firms operating in Ukraine. Ukraine has recently obtained a Dutch grant, administered by the World Bank, to fund technical assistance for continuing banking sector reforms. The grant would finance training of eligible audit firms to strengthen their skills in bank audit and technical assistance to NBU to strengthen its supervision capacity. 24 Enforcement 105. A transparent and uniform system of financial reporting requires a sound infrastructure. A key element of such infrastructure is effective enforcement. Enforcement encompasses all procedures employed in a country to ensure that accounting principles and standards are applied properly. A key feature of enforcement is the ability to require the restatement of financial statements that do not comply with applicable accounting standards. 106. The European Federation of Accountants (FEE) has recently published a major factual study of enforcement mechanisms that exist in Europe'7. Six different levels of enforcement are distinguished: 1. Self-enforcement: preparation of financial statements 2. Statutory audit of financial statements 3. Approval of financial statements 4. Institutional oversight system 5. Judicial: sanctions/complaints * Public and press reactions. The study focuses on the enforcement of financial reporting standards by means of reviews that are substantive in nature, rather than limited to formal checks. It concludes that for nearly half of the countries surveyed, there is no such oversight system in place. 107. As part of its enforcement arrangements, Ukraine has established the Securities and Stock Market State Commission (SSMSC) as a regulatory authority in 199618. However, SSMSC lacks the capacity to enforce adoption of NAS, as highlighted in the USAID- funded review of financial statements (see section on NAS above, para. 92). There is no formal mechanism in place to communicate instances of unacceptable audits or unfair audit practices to the Disciplinary Committee of the Chamber of Auditors. In order to make the SSMSC an effective enforcement body, Ukraine needs to strengthen its capacity by inducting well-qualified accountants who understand accounting and auditing standards, and by evolving a fornal mechanism for communicating with the Chamber of Auditors. 9. Recommendations 108. This CFAA has identified the following major issues in public financial accountability: > lack of KRU or AC authority over revenue audit, > weak accountability arrangements for SOEs, 17 http://194.78.202.133/WebSite/Fee_Publication.nsf/4af68051 f492beeOc 12569aO0047b4fl/ 27e753ddO 167903ccl256a42005081 a6?OpenDocument i' The SSMSC is subordinated to the President. The Commission has a Chairman and six comrnissioners appointed and dismissed by the President with consent of Parliament. 25 > absence of internal audit function, > weak management information systems, and > weak institutional capacity to undertake programmatic budgeting. 109. In the area of private sector accounting and auditing, the major issues are: > the need to create transparent and reliable reporting requirements for listed companies and other enterprises that depend heavily on public funds, > inadequate accounting capacity to prepare financial statements as per NAS or IAS, > low credibility of the auditing profession due to lack of strong disciplinary and oversight mechanisms, > weak corporate governance requirements, and > vague provisions in the audit law. 110. The recommendations of the CFAA are grouped into important policy-level decisions and systemic improvements. Policy-level Decisions > Extend the scope of the AC and the KRU to audit revenues. > Define clearly the accountability of the SOEs and government agencies in charge of equity holdings. Annual audited financial statements and the audit reports should be made part of annual government fiscal accounts and placed before Parliament. The AC should have the authority to audit all SOE finances, not just the portion received through the budget, if the review of audited financial statements indicates serious accountability issues, or at the discretion of Parliament. > Develop a strategy and an action plan for implementing IAS. In the medium term, IAS should be made mandatory for selected enterprises, such as listed companies. In the short run, Ukraine should issue an accounting standard for disclosure of related part transactions. > Adopt international best practices in licensing auditors. The Chamber of Auditors should strengthen the disciplinary committee functioning. The disciplinary committee should keep a record of its cases and publish case outcomes. > Amend the Law on Business Associations to specify the shareholders' right to appoint auditors during general meetings, and the auditors' obligation address the audit report to the shareholders. The Law should also include specific provisions regarding removal of an auditor before the end of the assignment and changing an auditor at the end of the assignment. Systemic Improvements > Introduce uniform accounting and reporting software in budget spending units. The accounting software should be integrated software that can keep track of 26 budget provisions, commitments, liabilities, and actual expenses. Conduct training programs for accountants in management accounting and reporting. > Expedite the implementation of the Treasury modernization project to strengthen accounting and reporting systems and make them capable of generating fiscal and management reports directly from the Treasury transaction database. > Strengthen the skills of the line ministry staff to undertake programmatic budgeting, now adopted by the government, by conducting extensive training programs. > Reorganize KRU to act as an internal audit department focusing on controls and risk assessment and internal audit standards. Realign the activities of the internal control and revision departments within the ministries so that they assist departmental management in improving controls and carrying out program audits. > Adopt internationally recognized standards, such as INTOSAI or ISA, in preparation of annual audit reports on the financial statements of the government (AC). > Strengthen the capacity of the Budget Committee to conduct detailed reviews of the audit reports, including the ability to ask for clarifications from the executive and/or the AC, to provide directions to the government based on this review, and to conduct follow-up required to ensure that adequate actions are taken to address the issues. As the AC submits the audit reports to Parliament, the accountability loop needs to be closed by having a detailed review of the audit reports by Parliament. > Adopt International Standards on Auditing (Chamber of Auditors). 111. 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