Report No. 41041-AF Afghanistan Public Sector Accounting and Auditing A Comparison to International Standards October 2007 Financial Management Unit South Asia Region Document of the World Bank ABBREVIATIONSAND ACRONYMS ACCA AssociationofCharteredCertifiedAccountants, UnitedKingdom ARTF AfghanistanReconstructionTrust Fund ASOSAI Asian Organizationof SupremeAudit Institutions CAO ControlandAudit Office CGA ControllerGeneralof Accounts CFO ChiefFinancialOfficer CIPFA CharteredInstituteof Public FinanceandAccountancy, UnitedKingdom IAASB InternationalAuditingandAssurance Standards Board IAS InternationalAccountingStandard IASB InternationalAccountingStandards Board IES International EducationStandardsfor ProfessionalAccountants IFAC InternationalFederationofAccountants IFRS InternationalFinancialReportingStandard INTOSAI InternationalOrganizationof SupremeAudit Institution IPSAS InternationalPublic Sector AccountingStandard(of IFAC) ISA InternationalStandardon Auditing PEFA PublicExpenditureandFinancialAccountability PFEM PublicFinanceandExpenditureManagement PFM PublicFinancialManagement SA1 SupremeAudit Institution SOE State-OwnedEnterprise SY Solar Year UNDP UnitedNationsDevelopmentProgram ... 111 Acknowledgments This assessment of accounting and auditing standards and practices in a public sector review was carried out inactive collaboration with the Government of Afghanistan and various stakeholders, particularly the offices of the Auditor General andthe Ministry of Finance, and their advising consultants, Deloittes and Bearing Point. The review was conducted through a participatory process that involved these stakeholders, and an assessment report was providedto the Government. The responses to issues raised by the diagnostic questionnaires were especially usehl, as were the reports and information available from the advising consultants and recent World Bank assessments of public financial management. The team of advisors and development partners also contributed greatly to the early stages o f the concept note and framework development, as well as the drafting of earlier reports, for this study which covers the countries of the South Asia Region: Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. The Afghanistan report also benefited from the comments o f its peer reviewers, Marius Koen, and Irene Ponniah, Senior Financial Management Specialists. Valuable comments were received also from Paul Sisk, Donna Thompson, and Stephane Guimbert. The Task Team was responsible for writing this report with general guidance from the advisors and the development partnerswho collaborated on this review program. The draft report after a consultative workshop in Kabul on September 13, 2006 was provided to the Government for comment, and the comments have been considered in this country report. Task Team P. K. Subramanian, Lead Financial Management Specialist Paul E. Sisk, Sr. Financial Management Specialist Kenneth0.Okpara, Sr. Financial ManagementSpecialist Manoj Agrawal, Sr. Financial Management Consultant Ronald Points, Lead Consultant, Accounting MichaelJacobs, Lead Consultant, Auditing Review ProgramAdvisors Simon Bradbury, Loans Department, World Bank David Goldsworthy, International Technical Cooperation Program, UK National Audit Office Noel Hepworth, Chartered Instituteof Public Finance and Accountancy, London Abdul Mudabbir Khan, Fiscal Affairs Department, International Monetary Fund IanMackintosh, Chairman, UK Accounting Standards Board Paul Sutcliffe, International Public Sector Accounting Standards Board, International Federation o f Accountants iv Development Partner Collaborators David Biggs, UK Department for International Development Kathleen Moktan, AsianDevelopment Bank V Contents ExecutiveSummary .......................................................................................................... 1 I Introduction . .................................................................................................................. 1 I1 PublicSector Accounting . ............................................................................................ 3 A InstitutionalFrameworkfor Public Sector Accounting............................................. . 3 2.Education and Training...................................................................................................... 1.AccountingLaws andRegulations...................................................................................... 3 3. Code of Ethics..................................................................................................................... 5 6 B.4AccountingStandardsas Practiced............................................................................ .Public Sector AccountantArrangements............................................................................ 6 6 C.Assessment of Accounting andAuditing inState-OwnedEnterprises...................... 7 I11 PublicSector Auditing . ............................................................................................... 8 A. Statutory Frameworkfor Public Sector Auditing...................................................... 8 8 2. SettingAuditing Standards.................................................................................................. I.StatutoryFramework.......................................................................................................... 3. EnsuringIndependence..................................................................................................... 9 10 4. Qualijkations and Skillsfor the Auditors........................................................................ 5. Training............................................................................................................................. 13 . . 12 6.Auditor Competence.......................................................................................................... 13 B.7Auditing Standardsas Practiced.............................................................................. . QualityAssurance............................................................................................................. 13 14 2.Audit Supervision.............................................................................................................. 14 1.Audit Planning .................................................................................................................. 14 3. ReviewingInternal ManagementControl Procedures..................................................... 15 4. Analyzing Financial Statements....................................................................................... 15 5.Reporting on Financial Statements................................................................................... 15 6. Reporting on Fraud........................................................................................................... 7. Reporting on Compliance................................................................................................ 16 17 IV ActionPlans . .............................................................................................................. 18 Annex A Methodologyof the Assessment.. 22 Annex B AccountingandAuditing Standards .. ................................................................. ........................................................... 24 International Public Sector Accounting Standards ...................................................... 25 International Education Standards ............................................................................... International Financial Reporting and International Accounting Standards ..............25 26 INTOSAI Code of Ethics andAuditing Standards ........................................................ 27 International Standards on Auditing ............................................................................ 29 Annex C AfghanistanAuditingandAccountingLegislation . .................................... 30 Annex D BenefitsofAccrualAccounting 40 Annex E PFMReformAgenda .. ................................................................... .................................................................................... 43 SupplementaryTable of Standardsand Gaps .......;..................................................... 47 vi Executive Summary 1. This assessment of public sector accounting and auditing is generally meant to help implement more effective Public Financial Management (PFM) through better quality accounting, reporting and public audit processes in Afghanistan, and to provide greater stimulus for more cost-effective outcomes of government spending. Annex A explains the methodology used for the assessment. Reporting is a major outcome of the public accounting process that provides an important basis for PFM accountability. More specific objectives are (a) to provide the country's accounting and audit authorities and other interested stakeholders with a common strongly founded knowledge as to where local practices stand against the internationally developed norms of accounting, financial reporting and auditing; (b) to assess the prevailing variances; (c) to chart paths for improving the accordance with international standards; and (d) to provide a continuing basis for measuring improvements. The adoption of a firmly based accounting, reporting, and auditing framework is a solid value proposition; the alternative is a gross wastage of public anddonor funds. One ofthe foremost challenges facing the adoption of aclear-cut accounting, reporting, and auditing framework, is the lack of a program for ensuring sustainable national capacity development in Afghanistan. Unless this happens, Afghanistan will remain excessively dependent on foreign expertise indefinitely, and be highly vulnerable to reductions in aid flows and external technical assistance. Capacity development will also require wider public administration reforms (recruitment, pay, human resources); organizational restructuring and improvements; and training; these are not the specific topics of this assessment. Better management of the massive amounts of external technical assistance currently being injected into Afghanistan, is also needed to ensure that the technical assistance supports longer-term national capacity development. Adequate implementation of accounting and auditing, based on international standardsis crucial to underpin these PFM systems. Response by the Treasury on the draft country report found that the accounting aspects of the Gap Analysis Report are accurate and useful, the options expressed are for the most part practical and can be implemented,and that in some cases the timing of implementation depends on further development of the environment in the country. The Auditor General responded that the audit aspects provided a valuable guide for setting the way forward and providing guidance on upgrading the operations of the CAO to comply appropriately with international practice. 2. The World Bank has developed a general PFM reform agenda; insofar as this covers accounting and audit, it is summarized in Annex E. This gap analysis report has taken note of the action planagreed by the Government of Afghanistan. This i s especially noted inthe continuing severe capacity constraints inthe field of accounting and auditing and the reliance placed on support from foreign consultants and advisors to sustain the existing PFM framework. The report also notes the urgent need for these consultants and advisors to work with Afghan counterparts, to build up their indigenous capacity to take over these functions eventually. 3. Adoption of international standards for accounting and auditing provides the basis for competent financial reporting and transparency. The International Public Sector 1 Accounting Standards Board (IPSASB) of the International Federation of Accountants (IFAC) has developed a core set of accrual-basedInternational Public Sector Accounting Standards (IPSAS) and also a comprehensive IPSAS on the cash basis of accounting. These IPSAS establish an authoritative set of independent international financial reporting standards for governments and others inpublic sector organizations. The study has taken the international standards as axiomatic with any acceptable options incorporated in the standards. The study has not assessed whether the country should adopt a limited version of the standards, as the processes of developing the standards have already considered any acceptable options that can be incorporated into the text of the standards, but they do not override authoritative national standards issued by governments, regulatory or professional accounting bodies. Application o f IPSAS by national authorities will support developments in public sector financial reporting directed at improving decision making, financial management, and accountability and it will be an integral element of reforms directed at promoting social and economic development. The IPSASB has also developed guidance on the transition from cash- to accrual-based reporting. The traditional emphasis on cash accounting has been found inadequate through failure to recognize true costs, and all assets and liabilities. Cash accounting can too easily neglect asset management, accumulating arrears, future liabilities (e.g., pensions), and contingent liabilities(e.g., guarantees). 4. The desiredactions indicated by the gap analysis assessment are summarized below. 5. Adopt InternationalPublic Sector Accounting Standards starting with the Cash Basis IPSAS as the basis for buildingin-countrypublic sector financialmanagement capacity expertise. With the adoption of International Public Sector Accounting Standards (IPSAS), the Cash Basis IPSAS should be applied first with a longer-term program for subsequent implementation of Accrual Basis IPSAS. The International Federation of Accountants (IFAC) issues IPSAS. Annex B gives a general description of IFAC and a listing of the IPSAS. At the present time, Afghanistan does not comply with the Cash Basis IPSAS, Part 1, in its annual accounts. The Government of Afghanistan should reformat the present cash basis of reporting to conform to the Cash Basis IPSAS. Annex C gives current Afghanistan auditing and accounting legislations. Benefits from eventually adopting accrual reporting are set out in Annex D. In its response to the draft country paper, the Treasury noted that that the PFEM law specifically requires the application of international accepted standards and principles but does not specify which standards are to be followed. The intentions of the Treasury as the organization given the responsibility for information and reporting, is to report Solar Year (SY)1385 (2006) and S Y 1386 (2007) on a cash basis according to Cash Basis IPSAS with the required supplemental schedules as well as other schedules as needed. The PFEML also requires the Ministryto provide a full accounting (auditable) of all assets held by the State at the end of the fiscal year. At this stage, an accounting of identifiable assets with supportable values will be provided as a supplementary schedule. Considering the environment in Afghanistan, it will be several years before reliable informationabout State assets will be available. 2 6. Take steps to more effectively, involve local staff in the accountingand reporting processes, modernize reporting, and strengthen legislation. Computerization is proceeding under the broad Public Administration and Capacity Building Program. The accounting advising consultant, Bearing Point, i s preparing most of the financial reports andannual financial statements, but localization is neededfor sustainability. The Public Finance and Expenditure Management (PFEM) Law needs strong accountability arrangements, including the implementation of a chief financial officer function. There is a severe humanresource constraint inaccounting inAfghanistan. The Government needs to lead indeveloping a government accounting cadre from a critical mass of professional accountantsinAfghanistan. 7. Increase efforts for bringing in professional accounting and auditing training to Afghanistan. As part of the Public Administration and Capacity-Building Program, a training facility is being created for accountants and auditors from the Ministry of Finance and the Control and Audit Office under the Auditor General. These accountants and auditors are expected to undergo dedicated full-time basic accounting and auditing training followed by examination and certification. The Ministry of Finance and the Auditor General should establish staff qualification requirements and make use of these facilities by developing separate professionally qualified accountancy and auditing cadres. Inresponse to the draft report, the Treasury advised that it is planning to put into place in SY1386 (2007) an extensive staff and hiring program with educational and training standards for government accountants, and that the UK Association of Chartered Certified Accountants program will be a valuable asset in training accountants who would be able to serve inthe government as well as inprivate industry.The Treasury also advised that it is essential that a professional accounting organization be formed by members of the profession and supported by the Ministry of Finance. This is a longer term responsibility that should be coordinated with academic, professional and governmental individuals and supported by professional dues, governments and private enterprises. 8. Monitor more adequately the reporting for state-owned enterprises. Only a few state-ownedenterprises produce annual accounts for audit. Regulation arrangements are neededfor reporting for all firms with some public ownership. 9. The Supplementary Table of Standards and Gaps at the end of this report provides a matrix detailing the accounting standards, the present position, and options for improvement. A summary of the key accounting standards issues is shown inTable ES1. Standard Current starus Action needed to move towards international standards 1. Doesthe Public Sector Accounting Yes. Law adopt IPSAS? 2. Does accountingeducation andtraining No. The assistancefrom a professional accordwith IES? distance-learning institution may be takento buildlocal training 3. Doesthe Code of Ethics match No. Relevant parts ofthe IFAC Code 3 Standard Current status Action needed to move towards international standards international standards? should be adopted. 4. I s there a body to prescribe public Law specifies sector accounting standards? international standards. 5. Are the financial statements inaccord No. Use the IPSAS reporting format. with the IPSAS standard? 6. I s the statement o f cash receipts and No. Use the IPSAS reporting format. payments inIPSAS form? 7. Are accounting policies and No. Use the IPSAS reporting format. explanatory notes required? 8. Are other disclosures in accord with No. Use the IPSAS reporting format. IPSAS? 9. Does the government issue a No. Not feasible inthe short term. consolidated financial statement which consolidates all controlled entities? 10. Adopt the IFAC-issued International Standards on Auditing (ISA) and the International Organization of Supreme Audit Institutions (INTOSAI) Auditing Standards. The Control and Audit Office (CAO) of Afghanistan has plannedto adopt auditing standards that are developed on the basis of the INTOSAI Auditing Standards. Implementation of the CAO standards needs improvement. The application of international standards on auditing would be improved by the preparation of a more modem audit manual. This manual, which will be based on INTOSAI Auditing Standards, is in the CAO development program. The application of these standards requires adequate professional competence, organizational independence, and adequate resources and systems. The weak areas need the investment of financial and human resources if staff skills are to meet the required standards. (See Annex B for a general description of INTOSAIand IFAC and a listing of their respective auditing standards). 11. Institute a new National Audit Act. A new National Audit Act supported by the Constitution i s neededto support an independent audit office. A newNational Audit Act i s needed to provide greater discretion to the Control and Audit Office in the areas of financing and personnel policies. There is a need to improve audit impact. Audit recommendations and observations go unheeded intoo many instances. The application of audit findings needs to be greatly improved through a mix of strategies. Greater transparency through more interaction with the media, along with more focused and effective report writing and report follow-up processeswould increase the incentives for auditees to take action on audit findings. The long-standing Control and Audit Law provides for an Audit and Control Department (more generally called the Control and Audit Office) to organize the audit and control affairs of public properties. An adequate audit law should remove the control elements of the current laws as they are inconsistent with the role of a modern audit office. This would mean properly establishing the position of Auditor General and its office thus allowing it to carry out a full range o f audits, includingthe audit ofthe performance of the budget andthe annual accountsof all 4 levels o f government and state-owned enterprises. A change to the Constitution should include establishing the Auditor General as a constitutional office. 12. Implementthe 2004-2009 StrategicDevelopmentPlan. The Strategic Development Plan provides an effective development path and an in-house method of monitoring progress. The Auditor General has been allocated an advisor who should be entrusted with developing an appropriate program for implementing the Auditor General's Strategic Development Plan and fulfill further development needs. For example, the Control and Audit Office should contract with private sector auditors who could concentrate on conducting the audits o f World Bank projects and funds, which would improve government audits. 13. The Supplementary Table o f Standards and Gaps at the end o f this report shows the present position for each component o f the standards, and the options for improvements that would bringAfghanistan into closer conformance with the international standards. A summary o f auditing standards issues i s shown inTable ES2 below. 14. Monitoraccountingand audit impact under current programs. The use of PFM- indicators surveys, suitably extended in detail, would provide a comprehensive basis for monitoring progress in adopting and applying international standards in accounting and auditing. In the absence of, or the delay in preparing, such a survey, improvements in accounting and audit impact should be measured over the next few years by monitoring the progress o f strengthening current programs for the Ministry o f Finance and the Office o f the Auditor General. Table ES2. standards beenadopted? ' Guidance i s provided by two model laws: (1) a general prescription of a Model Law developed by the UNDP Program for Accountability and Transparency (PACT) and (2) A Model National Audit Ofice Act, The Association of CharteredCertifiedAccountants, UK, 2004 5 Standard Current status Action needed to move towards international standards auditors conform to INTOSAI and IES? distance-learning institution may be taken to build localtraining. 8. I s the SA1equipped with the audit No. The Strategic Development Planwill be methods andtechnologies to meet the o f assistance, but additional resources INTOSAI standards? will be needed. 9. Does the SA1have the quality No. The Strategic Development Plan will introduce the process: No. A new manual of audit procedures and Yes. - complied with? 12Does the auditor prepare an audit Yes. opinion on the financial statements ina form that matches international standards? 13. Does the consideration o f fi-aud and Yes. error inan audit o f financial statements accord with international standards? 14. Are the Auditor General's reports No. The Audit Law should arrange for reports made public? to be tabled and made public when tabled. 15. I s the process for taking action on Follow up is Stronger scrutiny processes are needed. audit recommendations sufficiently inadequate. effective to meet international standards? 6 1. Introduction 1. This assessment of public sector accounting and auditing is generally meant to help implement more effective public financial management (PFM) through better quality accounting and public audit processes inAfghanistan and to provide greater stimulus for more cost-effective outcomes of government spending. More specific objectives are (a) to provide the country's accounting and audit authorities and other interested stakeholders with a common firmly basedknowledge as to where local practices stand in accordance with international standards of financial reporting and auditing; (b) to assess the prevailing variances; (c) to chart paths for improving the accordance with international standards; and (d) to provide a continuing basis for measuring improvements. 2. As part of the general support program in South Asia for assessment and improvement of public sector accounting and auditing, the World Bank, with the cooperation of member governments, is conducting a Review of Public Sector Accounting and Auditing Practices in member countries. In conducting this assessment, a set of diagnostic questionnaires [developed to be consistent with the context of the PFM Performance Measurement Framework' used by the Public Expenditure and Financial Accountability (PEFA) Program3]was used to gather substantial insight into country performance with regard to the PFM indicators relating to external auditing and financial statement reporting. Annex A discusses the methodology used for conducting the assessment in this report. 3. The diagnostic questionnaires were used to gather information on the prevalent national standards and practices for accounting, financial reporting, and auditing in the general government sector and inthe state-owned enterprise (SOE) sector. Conducted in cooperation with country authorities, the diagnostic questionnaires incorporate the principles contained in the public sector accounting and auditing standards promulgated by International Organization of SupremeAudit Institutions (INTOSAI) and International Federation of Accountants (IFAC). Annex B summarizes the international frameworks that were used in this assessment. The responses to these questionnaires stimulated further discussions among the World Bank team and country authorities. These discussions examined accounts, financial statements, audit reports, and working papers as a means to explore the quality ofprocesses andproducts. `The PFM Performance Measurement Framework has been developed as a contribution to the collective efforts of many stakeholders to assess and develop essential PFM systems, by providing a common pool of information for measurementand monitoring of PFMperformanceprogress,and acommonplatform for dialogue. The PEFA Program is a partnership among the World Bank, the European Commission, the UK Department for InternationalDevelopment, the Swiss State Secretariat for EconomicAffairs, the FrenchMinistry of ForeignAffairs, the Royal Norwegian Ministry of Foreign Affairs, the InternationalMonetary Fund, and the Strategic Partnership with Africa. A Steering Committee, comprising members of these agencies, manages the Program. A Secretariat is locatedat the World Bank inWashington, DC. 1 4. The Emergency Public Administration Project, established in 2002 with the World Bank, provided support to Afghanistan while degradedfinancial management institutions were reconstructed. An advising consultant assistedthe ControlandAudit Office to audit the budgets from Solar Year (SY) 1381 (2002) and the donor funds. Another advising consultant helped to set up and operate the accounting and reporting system in cooperation with the Ministryof Finance. 5. With redeveloped capacities and reformed institutions, attention should turn to more focused capacity building and localization of core government functions. The basic needs for supplies, equipment, and salaries require continued attention inthe accounting and auditing institutions. Added to the list is the provision of expert technical assistance for training and support in adopting modern accounting and auditing methods. With the assistance of long-term consultancies and in association with donor agencies, Afghanistan continues to address reforms inthe accounting and auditing fields. 6. The World Bank has been assisting Afghanistan inadopting IFAC-issued International Public Sector Accounting Standards (IPSAS) and INTOSAI Auditing Standards in the following ways: Financial management reporting capacity is being strengthened in line ministries and the Ministry of Finance, but currently with very extensive support from consulting firms. A computerized accounting system has been implemented to assist with financial reporting in conformity with international standards and is being progressively extended. Audit work has been re-ordered around evidence-based opinions in line with INTOSAI Auditing Standards but with extensive support from advising consulting firms for the audit of the Afghanistan Reconstruction Trust Fund (ARTF) and various World Bank projects. The Auditor General has beenauditing ministries as entities and expressing an audit disclaimer opinion on the annual State accounts because of major reconciliation and records deficiencies. Further development is neededfor this to be conducted as requiredby the INTOSAI Auditing Standards. A systems andrisk-based audit manual needs to be developed that will enable the Controland Audit Office to audit more effectively. 7. There needs to be a more comprehensive plan for Afghanistan to adopt the Cash Basis IPSAS in the short- to medium-term as part of a long-term program to adopt accrual-basedIPSAS reporting for each government entity. There needs to be a plan for the Control and Audit Office to adopt the IFAC-issued International Standards on Auditing (ISA), as well as the higher-level INTOSAI Auditing Standards in its day-to- day auditing work. 2 II. Public Sector Accounting A. Institutional Frameworkfor PublicSector Accounting 8. The institutional framework should include adherence to international accounting standards and use of qualified accounting staff to provide timely, relevant, and reliable financial information that is needed to support all fiscal and budget management, decision-making, and reporting processes. The diagnostic questionnaires that were used in this assessment have collected information on the current arrangements and the apparent gaps in Afghanistan for accounting laws and regulations; education andtraining of public sector accountants; application of a code of conduct; andnumbers and characteristicsof public sector accountants. 1.Accounting Laws and Regulations 9. Afghanistan accountinglaws and regulations should endorse the specific use of internationalaccountingstandards. Satisfactory legislative arrangements are in place with respect to accounting and the use of international accounting standards. Implementation of a new finance law is underway. The 2005 Public Finance and Expenditure Management (PFEM) Law is based on Article 75, paragraph 4, of the Constitution. The PFEM Law covers the management of financial affairs; protection of public assets; preparation o f budget; and the management of, and reporting on, public expenditure of the state administrations inside and outside Afghanistan. Under the Law, transactions are to be recorded according to budget classification and accounting rules compliant with internationally accepted standards and principles. The regulations should do more to identifythe specific standards. 10. The integratedfinancial management system should be run by the Ministry of Finance with the assistance of consultancies. Computerization i s proceeding under the broad Public Administration and Capacity Building Program; the advising consulting firm i s doing most of the reporting work within the Treasury located inthe Ministry of Finance. The accounting package and systems in place are to be enhanced to provide the functionality and geographic spread required to meet the needs of the PFEM Law. There needs to be a concurrent program to strengthen the capacity of the Ministry of Finance staff to run the system and prepare the accounts andreports. 11. Afghanistan should adopt the Cash Basis IPSAS. The IFAC Public Sector Committee recognizes the right of governments and national standard-setters to establish guidelines and accounting standards for financial reporting. The Public Sector Committee considers the CashBasis IPSAS to be an important step forward in improvingthe consistency and comparability of financial reporting and encouragesits adoption. The PFEM Law is not explicit about the application of IPSAS but is explicit about the use of international accounting standards. Various articles of the 3 PFEM Law refer to revenue and expenditure, and assets and liabilities items that should be accounted. The Treasury staff and consulting advisors, Bearing Point, consider that presentation o f accounts inaccordance with Cash Basis IPSAS could be achieved with current systems. It i s recommended that this be done. To enhance this, notes should be used for those accrual requirements o f the PFEM Law where accounting information i s available. As the functionality o f the accounting system i s rolled out, elements o f accrual basis o f reporting can be considered. 12. Table 1identifies the current position and the steps required ifthe Cash Basis IPSAS are to be adopted. Requirements Current Activity required to adopt position Cash BasisIPSAS Financial statements presented inthe IPSAS No Format can be followed Statement o f cash receipts and payments Yes Accounting policies and explanatory notes N o Can be supplied General considerations N o Can be supplied Reportingperiod I Adequacy o f information about the entity Presentation o f comparative information lI lI I Correction o f errors disclosed No Can be supplied 0 Nature o f error 0 Amount o f correction I I Comparative informationrestated Consolidated financial statements N o Not practical inthe short-term Treatment o f foreign currency cash receipts, payments, and N o Not practical inthe short-term balances incompliance with IPSAS 13. To enhance the reliability of annual accounts within the government, accounting, reporting systems, and staffing need to be improved. For the last two years, the Control and Audit Office conducted audits o f annual government accounts. The audit opinions have been disclaimed because the auditors were dissatisfied with the degree o f consistency o f the annual accounts with other records. Ministries do not have the capacity to accept responsibility and enforce accountability on accounting matters. This capacity is important for budget execution and for general accountability arrangements. The accountability chain must be clear; designated individuals must hold positions o f responsibility for the internal control system. The PFEM Law provides for this action to become effective ifenforced by Ministry of Finance. 4 14. In the longer term, the Government of Afghanistan can be assisted in the transition from Cash Basis IPSAS to the Accrual-based IPSAS by utilizing IFAC g~idance.~ The guide has four mainparts: 0 Introduction. Chapters 1-3 address general planning and project management issues. General Financial Reporting Issues. Chapters 4 and 5 deal with the selection, development, and approval of accounting policies and issues associated with the definition and identification of reporting entities. 0 Financial Elements. Chapters 6-8 outline the broad steps required for the identification, recognition, measurement, and disclosure of assets, liabilities, revenues, and expenses. The broad approaches discussed could be adapted and applied to particular items. 0 Specific Topics. Chapters 9-15 highlight implementation issues associated with four specific accrual IPSAS, and provide guidance in relation to a selection o f topics not addressed, or only partially addressed, by existing IPSAS. 2. Educationand Training 15. Current recruitment and training of government accountants does not provide satisfactory skills and the necessary professional accounting cadre. There is an urgent need to develop a critical mass of professional accountants in Afghanistan. The Government of Afghanistan must take the lead with its own accounting service. It i s important that accounting staff be adequately skilled at their work. The recruitment and training arrangements should provide for this in the most efficient and effective manner. Accounting and audit specialist recruitment should require more relevant academic training and practical experience. The Auditor General recognizes that training needs to be better coordinated to meet the needs of government accountants. As part of the Public Administration and Capacity Building Program, a training facility i s being created for accountants and auditors from the Ministry of Finance and the Control and Audit Office. These accountants and auditors are expected to undergo dedicated full-time basic accounting and auditing training followed by examination and certification. This i s a realistic initiative and the Ministry of Finance should establish educational and training standards for government accountants; similarly the Auditor General should do this for auditors. 16. A phased and progressive education and training program combined with practical experience is needed. A sustainable and effective system of public financial management and public audit can only be brought about by developing and promoting an accounting culture, which can receive impetus by the creation and promotion of a critical mass of accounting professionals in Afghanistan. As part o f the curricula for the training facility planned under the Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities, International FederationofAccountants, Public Sector Committee Study 14, December2003. 5 Public Administration and Capacity Building Program, the Ministry of Finance and the Auditor General should establish training requirements and training programs for their respective accounting and auditing staff. The training facility also provides a recognized institution where existing accounting and auditing staff can come together for networking and continued professional development. New graduates can be inducted and provided formal accountancy education at both technical and professional levels. In due course, a body of continuously well- trained professionals will provide service to various government agencies in all facets of accounting and auditing. For longer-term, high-level support for the proposed government accounting training, distance-learning programs could be used. Two distance-learning programs from the United Kingdom are offered by the Association of Chartered Certified Accountants (ACCA) and the Chartered Institute of Public Finance and Accountancy (CIPFA). 3. Codeof Ethics 17. A code of ethics based on the IFAC Code of Ethics for Professional Accountants is needed. A code of ethics for accountants based on the fundamental principles of the IFAC-issued Code of Ethics for Professional Accounts should be implementedand observed. There should be arrangementsto ensure that accountants confirm on a regular basis that they are operating in accordance with the code. The Control and Audit Office has already adopted such a code. The Treasury indicated that the requirement of adherence to a professional code of ethnics for public and private sector accountants should primarily be promulgated by a professional accounting and auditing organization whose principles are adoptedor agreedto by the Ministryof Finance. 4. Public Sector Accountant Arrangements 18. The Chief FinancialOfficer (CFO) function needs development. For each public sector body that prepares annual accounts, there should be a responsible CFO function for maintaining systems of internal financial controls that manage risks and for preparing the accounts for signature by the chief accounting officer. Article 7 o f the PFEM Law gives the Treasury of the Ministry of Finance broad treasury and accounting responsibilities and authority, but it does not provide for a CFO function.The Ministry of Finance should establish regulations for CFO functions in the executive government departments. It is important that proper segregation o f duties i s incorporated in the design and evolution of the PFM systems. The Treasury agreed with the proposals in this report noting that implementation of this program will be a longer term objective given the present environment inAfghanistan. B. Accounting Standards as Practiced 19. The diagnostic questionnaires collected information on the current arrangements and the apparent gaps in Afghanistan for setting public sector 6 accounting standards and for presenting financial reports. Out o f this exercise came recommended activities that will help to bring local current standarddpractices inline with international standards. 20. Adequate implementation arrangements are needed for setting accounting standards for the public sector. The PFEM Law requires the use o f international standards and gives responsibility to the Ministry o f Finance. Under PFEM Law, Article 7, the Treasury o f the Ministry of Finance maintains its general-ledger by recording transactions according to budget classifications and accounting rules which are compliant with internationally accepted standards and principles. The Ministryalso publishes a final budget reconciliation report and a set o f audited financial statements covering revenue, expenditure, assets, and liabilities in accordance with international standards. There is a needto create a regulatory body for dealing with interpretation and monitoring o f the application of accounting and auditing standards for the public and private sectors. This i s a longer-term prospect in Afghanistan, but the Ministry of Finance should be the body responsible for making the arrangements when conditions allow and in the interim should undertake the function itself. c.Assessment of Accounting and Auditing in State-Owned Enterprises 21. The State-Owned Enterprises (SOE) Law provides for audit by the Ministry of Finance and for annual balance reports. There are about 100 state-owned enterprises in existence in Afghanistan, but many are not functioning at all, or not functioning in the way intended. The Control and Audit Office carries out transaction checks on the budget expenditures of the state-owned enterprises and also audits the annual accounts. Only a few state- owned enterprises produce annual income and expenditure accounts and balance sheets accounts for audit. A more rigorous review of the desirable reporting and monitoring processes for the state-owned enterprises and an updating o f the SOE Law i s needed so that state-owned enterprises report according to international reporting standards. 22. A Financial Reporting Council should be established to regulate commercial government authorities. Action is needed to require state- owned enterprises to amend their accounts in accordance with audit findings, so that true and fair accounts may be issued for general public scrutiny within a stipulated period, consistent with that o f listed enterprises. One approach would be to establish a Financial Reporting Council that would be responsible for adoption, monitoring, and enforcement o f international accounting and auditing standards with respect to financial reporting by the public interest entities. 7 111. Public Sector Auditing A. StatutoryFramework for PublicSector Auditing 23. Effective scrutiny by the legislature to ensure efficient implementation o f fiscal and expenditure policies should comprise comprehensive, competent, external audits that are underpinned by international standards on a~diting.~The environment for an effective Supreme Audit Institution (SAI) requires a comprehensive approach to public financial management (PFM). Supreme audit institutions are not stand-alone institutions. They are part o fa PFM architecture that includes budgeting, accounting, internal control, audit and legislative oversight, and government response. Improving the way the supreme audit institution functions is integral to providing information for improving the overall PFM system. But the action must be withinthe executive branch, yet under the watchful eyes o f the legislature and the public. A strong demand for good public sector external auditing i s necessary, for the supreme audit institution to be able to make an impact. This requires willingness on the part o f the executive branch, to accept and respond to external scrutiny over its management o f funds, and to ensure that corrective action i s taken. It also requires public presentationo f the audit reports to secure public support for effective action. All o f these requirements are covered by the INTOSAI and IFAC standards. These international auditing standards should be adopted by the Auditor General. 24. The diagnostic questionnaires facilitated the collection o f information describing current arrangements and the apparent gaps inthe country inthe following areas: Institutional framework for the supreme audit institution, Process for setting auditing standards, Use o f code o f ethics or conduct, Arrangements to ensure accountability inthe supreme audit institution, Arrangements to ensure independence, Arrangements to ensure adequate skills and qualifications o fthe auditors, Arrangement for providing training, Arrangements to ensure auditor competence, Arrangements for quality assurance. Those areas with significant scope for improvement are discussed below. 1. Statutory Framework 25. The draftNationalAudit Act should be finalized and legislated. A draft National Audit Act has been under preparation inthe Control and Audit Office for some time. The new National Audit Act will ineffect include the following actions: removing the control ~~ Scope,qualify, andfollow-up of externalaudit is performanceindicator No. 26 inthe PFMperformance measurement frameworksupportedby the Bank andother development agencies. 8 elements of the current laws; properly establishing the Auditor General and hisher office; and requiring the audit office to carry out a full range of audits, including the audit of the performance o f the budget and the annual accounts of all levels of government and the state-ownedenterprises. The Auditor Generaladvised inJuly 2007 that after consultation, final changes to the draft had beenprovided to the legislation directorate of the Ministry of Justice for further process. 26. The new NationalAudit Act, whichprovidesfor a modernaudit function,should be supported by the Constitution. Simultaneously with the enactment of the new National Audit Act, a Constitutional amendment should be made to ensure the statutory independence of the Auditor General. The Constitution should include clauses establishing an Auditor General. The long-standing Control and Audit Law (Annex C) provides for the General Department of Audit and Control to organize the audit and control affairs of public properties. This Departmenthas beenadministratively converted into the Control and Audit Office headedby the Auditor General. The Auditor General i s appointed by Presidential Decree. The PFEM Law governs certification audit of the annual government accounts but does not specifically name the Auditor General as the auditor. The Auditor General noted that he is not able to sponsor a change to the constitution at this stage. The Action Plan inPart IV notes that it is important that this be done whenpracticable. 27. The ControlandAudit Officeshould contractthe audits of World Bankprojects and funds to private sector auditors and disengage from controlwork. Current audit agent arrangements should be refined so that agents conduct non-governmental audits and the Auditor General conducts a full range of government audits. The control work should be the responsibility of internal audit. The current CAO role in managing domestic auditors should be transferred to the internal audit regime. The Auditor General has been allocated an advisor who should be given the task of developing an appropriate program to implement the Auditor General's Strategic Development Plan. The CAO noted the training value provided by the World Bank audits andthat some policy analysis i s required in conjunction with other agencies to realign or affirm roles in respect of control work. Inrespect of the loss of training opportunities afforded by the World Bank projects, the Strategic Development Plan for the Control and Audit Office at paragraph 38 i s to include a proposed training program, which would take into consideration any necessaryalternatives. 2. SettingAuditing Standards 28. The new NationalAudit Act should adopt InternationalStandardson Auditing. The Control andAudit Office has adopted INTOSAI Auditing Standards.However, these standards are too general for adequate guidance. The IFAC-issued International Standards on Auditing are neededfor providing effective guidance to improve the audit work by the staff. The International Audit and Assurance StandardsBoard (IAASB), part o f IFAC, i s progressively rolling out International Standards on Auditing. The INTOSAI i s moving from maintaining its own auditing standards toward supporting IAASB in the development of its auditing standards, in particular, so that the IFAC/IAASB International Standards on Auditing appropriately reflect the interests of the international 9 public sector audit community. The CAO noted that the revision to the audit act will affirm the adoption o f International Standards for Auditing. It i s already affirmed in the Strategic Development Plan for the CAO. 29. The IFAUIAASB International Standards on Auditing represent best international practices for the auditing profession, particularly in areas o f fundamental auditing practice such as: audit evidence, documentation, audit materiality, fraud, audit errors, audit opinions, audit planning, control environment assessments, and supervisingthe work o f audit staff. 30. Afghanistan will benefit from the adoption of the more comprehensive International Standards on Auditing issued by the IAASB to supplement the INTOSAI Auditing Standards. With this in mind, it is generally recognized that INTOSAI Auditing Standards need the underpinning support o f the more detailed IFACAAASB International Standards on Auditing. With the decision by INTOSAI to adopt IFAC/IAASB standards and to prepare public sector practice notes, where necessary, to support each o f these standards, the way i s open for Afghanistan to use the more comprehensive IFAUIAASB International Standards on Auditing to guide its work. This move i s quite appropriate as Afghanistan i s a member o f INTOSAI and its regional group, the Asian Organization o f Supreme Audit Institutions (ASOSAI). 3. Ensuring Independence 31. The new NationalAudit Act is needed to provideeffectiveindependence. All o f the core principles o f SA1independence that were set out by INTOSAI are only partially, if at all, met by the current legislative and administrative framework. These principles include: the existence and de facto application o f an appropriate and effective constitutional and legal framework; the independence o f the SA1 Head, including security o f tenure and legal immunityinthe normal discharge o fduties; a sufficiently broad mandate and full discretion in the discharge o f SA1 functions; unrestrictedaccess to information; the obligation to report to the legislature on their work; 10 0 financial and managerial autonomy and the availability of appropriate human, material, andmonetary resources; 0 the freedom to decide on the content andtiming oftheir reports and to publish anddisseminatethem; and 0 existence o f effective follow-up mechanisms on SA1recommendations. 32. More statutorilyindependentarrangementsfor staffing and for establishingthe budget should be legislated. The CAO officers and staff are under the administrative control of the Finance Division of the Ministry of Finance, which controls the appointment, promotion, and disciplinary action for CAO employees.The CAO independence, as upheld in the Constitution, has beenjeopardized by this administrative practice. The Control and Audit Office should be separated from the executive branchof the Government and connected with the Parliament. The Auditor General should be vested with more financial powers. Also, as practiced in other ministries, the annual budget o f the Control and Audit Office needs to be considered and approved by the Ministry of Finance. The more preferable arrangements would be for a Parliamentary Committee to consider the CAO budget and audit plans prior to approval by the Parliament. Inresponseto the draft report the Auditor General advised that CAO is now an independentbudgetary unit and is responsible for its own staffing arrangements. This will bereinforced by the proposed legislative changes. 33. Implementation of the new National Audit Act should give the Control and Audit Officethe independence,mandate,powers,protections,scrutiny,support, and organizationalarrangementsof a modernsupreme audit institution. To achieve this institutional quality, there is a need to ensure: (a) the supply o f equipment and facilities for operating in accordance with a modern audit manual; (b) the continued development of CAO auditing capacities o f financial statements; (c) the re-design of audit approaches for CAO regularity auditing o f the implementation of the budget; (d) the introduction of performance auditing to improve the efficiency and client service o f government programs; (e) training of CAO staff in audit techniques; (f) modification of CAO management procedures to ensure accountable performance by its staff and its managers; and (g) the re-development ofthe audit reviewprocesses by ministriesandby committees ofthe new Assembly. 34. Legislationshould provide an environmentin which the quantity and quality of resources, including staff salaries, are adequate for the usual SA1 regularity and performanceaudit mandate. The Control and Audit Office is included in the Priority Reform and Restructuring Program within the framework of salary restructuring already granted by the President to the Control and Audit Office. The Control and Audit Office should have its own budget separate from the Departmentof Administrative Affairs. The budget has to be adequate for the Control and Audit Office to do the job that it has been given. Currently the scope o f the CAO audit is narrowly focused. Supreme audit institutions normally conduct performance audits on overall financial management performance issues o f state bodies; this i s an important type o f audit for the development ofAfghanistan and it i s not being serviced. 11 35. Legislationshould providean environmentinwhich the Auditor General is free to arrange for appropriate involvementwith the media on audit reports. The audit reports should be discussed with the media to ensure that audit findings are not misunderstood. The CAO noted that it will have the authority to brief the media on the results o f audits once they have been appropriately referred to a parliamentary commission for consideration. 36. Improved Public Accounts Committees and departmental administrative processes are needed for following up audit reports.6 Article 60 o f the PFEM Law provides that the Government shall report to the National Assembly on decisions taken pursuant to the audit and control report. The Control and Audit Office noted inthe report on the SY1383 (2004) accounts that there were substantial pending issues from the previous SY1382 (2003) and SY1381 (2002) audit reports. Follow up has been inadequate, and the Public Accounts Committee (or Commission) needs to give close attention to ensuring that the issues raised by audit reports are dealt with properly. The CAO advised in response to the draft report that the National Assembly has appointed a commissionunder the name o f financial and budget commission. Presentations have been made through the Parliamentary Affairs Ministry to the Parliament andto members o f the Finance and Budget Commission. Material has been prepared on training the members o f the Commission and its support staff. The PFEMLaw provides for the Auditor General to recommend fines. To some degree, improved audit methodology and report writing skills will help, but the fundamental processes for scrutiny need reform. In the longer term, Audit Committees and corporate governance arrangements for departments and agencies need to be reformed along with improvements to the audit processes. Better protocols may be useful between the Auditor General and departments to ensure access, and minimize disruption in the functioning o f the departments. In addition, better protocols would help ensure that draft audit reports are reviewed quickly by departments for accuracy and fairness. The protocols also would ensure that the Control and Audit Office and departments, as far as possible, reach an agreement on reports before they are made public. Similar protocols are needed between Parliament and the Control and Audit Office covering, for example, how audit reports will be handled. 4. Qualifications and Skills for the Auditors 37. When being recruited for the Control and Audit Office, qualified candidates should preferably (and where practicable) have an accounting degree. The current recruitment criteria for CAO financial auditors give attention to accounting qualifications. Graduates with modern accounting educational backgrounds are generally unavailable in the Control and Audit Office. Many new recruits have law or political science degrees and require additional professional training if expected to undertake certification audits, an unnecessary step if accounting graduates with proper training could have been hired from the start. The current CAO staff members are not Legislative scrutiny of external audit reports is performance indicator No. 28 in the PFMperformance measurement framework supportedby the World Bank andother developmentagencies 12 well-qualified in accounting and need to be provided with audit, legal, book-keeping, and accounting training. The Control and Audit Office should be able to set up a modern audit methodology with associated audit manuals, rules, regulations, working practices, and procedures. This list should be included in the assistance over the next few years as part o f the overall CAO Strategic Development Plan. Inresponse to the draft report the CAO agreed with the recommendations, but accounting and auditing training needs to be carried out in-house until USAID and other initiatives produce a range o f suitable candidates. 5. Training 38. The Control and Audit Office should operate a continuing professional developmentprogramfor accountingand auditstaff.The Strategic Development Plan for the Control and Audit Office includes a proposedtraining program which needs to be well-implemented. 6. Auditor Competence 39. It is necessary to strengthen the technical and professional competence of the Control and Audit Office and improve its operational capacity to produce and disseminate quality audit reports that meet internationalstandards and serve the needs of the stakeholders. The Control and Audit Office has historically concentrated on the compliance audits needed to support proper execution o f the budget. It now needs to improve resources and training to build in-house capacity for financial, performance, forensic, environmental, and information technology audits. It is not sensible to offer the excuse that Afghanistan i s short o f expertise and deny the Control and Audit Office the opportunity to build these needed skills and functions. The Control and Audit Office needs to create a core group o f professional accountants for the certification o f public accounts. Substantially enhanced technology support i s needed, both in hardware and software. Additional computers will be useful for improved audit working papers, audit analysis, and reporting as computer-technology training develops staff competence. Resources for field-work are limited and a development program needs to consider the needs. The Strategic Development Plan includes major elements that will strengthen competence but not increase the resources available. 7. QualityAssurance 40. Improvedstructures and indexingof more comprehensiveauditworking papers would help audit supervisors to ensure that audits meet specified standards of quality. A robust quality assurance regime needs to be in place and operating effectively. Such a process should ensure that audit reports are systematically reviewed for quality by line managers before beingreleased. There should be a subsequent internal independent review process-operating on a sample basis-to ensure that the work o f all auditors i s reviewed regularly. Such a system can be further enhanced through the use o f external reviewers. The Strategic Development Plan provides for developing a more formal process o f quality assurance withinthe structure o f revised audit methodologies. 13 B. Auditing Standards as Practiced 41. The diagnostic questionnaires facilitated the collection of information about the current arrangements for the audit methodology and the apparent gaps in the country in the following areas: audit planning, audit supervision, reviewing internal controls, reviewingcompliance with laws, ensuring adequate audit evidence is collected, analyzing whether the financial statementsaccord with accounting standards, preparing audit opinions, reporting on fraud, and reporting on compliance. Out of this exercise came recommended activities that will help bring local standards in line with international standards. 7. Audit Planning 42. The new audit methodology should introduce more comprehensive planning requirements. The 2004-2009 Strategic Development Plan includes a technical assistance project which needs to be staged in accordance with absorptive capacity and priorities for feasible audit programs. An overall audit work program needs to be developed in accordance with the control risks and weak capacities. The Strategic Development Plan states the following: We aim to provide Parliament, Government, Afghan society, and, where necessary, the international community, with good quality information and assurance on the financial control of State resources and the activities of public administration. This will build confidence in the controls over public money, financial accountability, and safeguarding public assets by making the management o f public money more transparent for citizens and, ultimately, the Parliament of Afghanistan. The overall audit work program must be directedto achieving these aims. 2. Audit Supervision 43. A more comprehensively structured working paper system is needed to attain the normal audit objectives regarding the validity of transactions. Current supervision is hampered by inadequate working paper systems and an outdated audit methodology. A training course for 50 staff members over the period April to August 2003, covering INTOSAI Auditing Standards, was intendedto lead to the designing of new audit methodologies and practices, based on the Audit Implementing Guidelines prepared by INTOSAI. The new audit methodologies and practices, including 14 . appropriate supervision arrangements, should be included in a new modern audit methodology manual. 3. ReviewingInternal Management Control Procedures 44. Introduce a modern audit methodology manual that includes an audit risk model. Current control audits are strongly linked to examine accordance with regulations. Few certification audits are undertaken.For the audit of the annual accounts requiredby the PFEM Law, certification audit procedures should be included in a new manual of audit methodology. In addition, the audit methodology manual should clearly outline the following points: audit confidence level; requirementsfor audit planning, audit work papers, andaudit reporting; how audit materiality is determined and what i s an acceptable level of audit riskandconfidence; and how to develop an appropriate mix of audit work to address the audit risks. The audit should be completed by a process which covers how audit errors are summarizedand evaluated against audit materiality. 4. Analyzing Financial Statements 45. Auditors need to be able to rely on better accountingdata and systems so as to be able to form a reliable audit opinion. The accounting data for the annual government accounts i s inadequate for producing a valid audit. There are too many scope limitations because of inadequate records and security barriers to access by auditors (most provinces cannot be visited). Similarly there have been limitations on the testing that the advising consulting firm, Deloittes, has done for the donor funds. 5. Reportingon Financial Statements 46. Auditors need to improve reporting by using opinions expressed in terms of international standards on auditing. The infrastructure for financial reporting on the budget and review o f audit reports has not yet been fully established. Government accounts for SY1383 (2004) were audited by the Control and Audit Office. The advising consulting firm to the Control and Audit Office did not assist with this audit, apparently because the accounting records were inthe local language. The Control and Audit Office was concerned that there were large discrepancies between the accounts and other records, andthus provideda disclaimer on the audit opinion. The audits of the ARTF and the World Bank projects for SY1383 (2004) were assisted substantially by the advising consulting firm. For all intents and purposes the audit was conducted by the Advising Consulting firm with the assistance of CAO staff for some testing purposes. The audits however tended to check accounting aggregations rather than a complete test of the accounting assertions normally carried in an audit opinion. So these audit opinions have 15 substantial scope limitations on the adequacy of the testing. A true and fair opinion is not provided; rather the audit provides an assessment of the (a) adequacy o f the accounting and internal control systems, (b) the ability to maintain adequate documentation of transactions, and (c) the eligibility of incurredexpenses for IDA financing. 47. Future ARTF and World Bank project audits should be conducted in accordancewith IFACAAASBInternational Standards on Auditing, and signed off by advising consulting firms selected by the Auditor General (subject to no objection by the World Bank). The terms of reference for the audit of ARTF and World Bankprojects refer to INTOSAI Auditing Standards. The advising consulting firm advised that the audits on these projects were conducted according to these standards rather than the IAASB International Standards on Auditing. The report on the accounts states that both INTOSAI and IAASB auditing standards were applied. Incontrast to the TORS,the usual international practice i s for IAASB International Standards on Auditing to be applied as per the routine practices of international accounting firms. With its core role of reporting on the accounts of the Government of Afghanistan, the Control and Audit Office does not have sufficient capacity to provide an opinion according to international standards on the ARTF and the World Bank projects. Under the current contract, the advising consulting firm i s obligated to assist with the audit of all these accounts. Inpractice the advising consulting firm provides little or no assistancewith the Government of Afghanistan accounts; rather, it provides at least 80 percent of the effort onthe ARTF and the World Bankprojects. The CAO contribution, under the direction of the advising consulting firm, is at the lower levels of the audit. This is a poor and ineffective use o f CAO resources, even for training and familiarization purposes. Following this current practice, the Auditor General signs the accounts, e.g. for the ARTF, although the advising consulting firm does all of the higher-level assessment work inthe audit. This process does not properly place the responsibility for signing the opinion on the accounts. As a result, confidence inthe audit opinion on these accounts is less than desirable. The audit process should be improved by having the advising consulting firm sign, and take responsibility for the accounts; and conduct the audit in accordance with international auditing standards.The Auditor General should continue to play apart inthe review of the consulting firm's work. 48. The Auditor Generalshould receivethe reports of the auditors for his use in the audit of the annual accounts of the Government of Afghanistan. The Control and Audit Office should conduct the audit of the accounts ofthe Government of Afghanistan, as is the current practice. The work of the advising consulting audit firm on the ARTF and other donor expenditures that make up part of the Government of Afghanistan accounts can be relied upon as appropriate by the Control and Audit Office inits audit of these accounts. 6. Reporting on Fraud 49. The audit reportingand follow-upsystems need to be reviewed. There could be a survey of ministries to establish the actions taken on findings reported since the establishment of the Afghanistan Interim Administration and develop options for improving reporting and response, based on international practice. In the longer term, 16 statutory deadlines for response to audit queries and management letters and the crucial role o f a Public Accounts Committee might be effective in encouraging adequate response to audit findings. This is likely to take at least five years, since there i s no previous experience o f these processes inAfghanistan. 7. Reporting on Compliance 50. Improve the effectiveness of the audit report by more efficient review action through the Public Accounts Committeeand agency audit committees. There are no institutional arrangements for review o f reports by the Auditor General. 17 G Y 8 m Y 0 h. VI B E, a, % 0 I 1 E L I - I I I a I i e I E I 6 I L i I L i L i I L I c I L -I!r: I I L r: - Y Annex A. Methodology of the Assessment As part of the general support program in South Asia for assessment and improvement of public sector accounting and auditing against international standards, the World Bank, with the cooperation of member governments, is conductingthe Review of Public Sector Accounting and Auditing Practices in member countries. The development of the Public Financial Management (PFM) Performance Measurement Framework' by the Public Expenditure and Financial Accountability (PEFA) Program' has opened the way for a diagnostic tool to be developed that is referenced to the accounting and auditing standards of International Federation o f Accountants (WAC) and International Organization of Supreme Audit Institutions (INTOSAI), and other relevant internationalbenchmarks. I The Performance Measurement Framework has an indicator on public accessto key fiscal information that considers the following as essential: Year-end financial statements: The statements are made available to the public through appropriate means within six months of completed audit. External audit reports: All reports on central government consolidated operations are made available to the public through appropriate means within six months of completed audit. The Framework has an indicator on the quality and timeliness of annual financial statements, which are considered to be critical for transparency in the PFM system. To be complete in all respects, the financial statements must be based on details for all ministries, independent departments and other state-owned units. Ithas an indicator on the scope, nature and follow-up o f external audit. For this indicator the Framework considers the key elements of the quality of actual external audit to comprise the scope/ coverage o f the audit, adherence to appropriate auditing standards, including independence of the external audit institution (ref. INTOSAI and IFAC/IAASB), focus on significant and systemic PFM issues in its reports, and performance o f the full range o f financial audit such as reliability of financial statements, regularity of transactions and functioning of internal control and procurement systems. Inclusion o f some aspects of performance audit (e.g. value for money in major infrastructure contracts) would also be expected of a highquality audit function. This exercise provides substantial insight into country performance with regard to the external auditing and financial statement reporting PFM indicators. A set of 6 questionnaires is used inthe survey conducted by this study to collect relevant information on country practices: 'The PFM Performance Measurement Framework has been developed as a contribution to the collective efforts of many stakeholders to assess and develop essential PFM systems, by providing a common pool of information for measurement and monitoring of PFMperformanceprogress, anda commonplatform for dialogue. 8The PEFA Program is a partnershipamong the World Bank, the European Commission, the UKs Department for InternationalDevelopment, the Swiss State Secretariat for Economic Affairs, the FrenchMinistry of ForeignAffairs, the RoyalNorwegianMinistry of ForeignAffairs, the InternationalMonetaryFundandthe Strategic Partnershipwith Africa. A Steering Committee, comprising members of these agencies, manages the Program. A Secretariat is locatedinthe World Bank inWashington, DC. 22 Annex A The public sector accounting environment-collecting basic information about financial laws and standards-setting arrangements, educational requirements for accountants compared with IFAC International Education Standards (IES), ethical requirements compared with the IFAC Code of Ethics for Professional Accountants. Public sector accounting practices for the general budget sector if using the cash basis of accounting -compared with the requirements of the Cash Basis International Public Sector Accounting Standards (IPSAS). Public sector accounting practices for the general budget sector if usingthe accrual basis of accounting-compared with the IPSAS requirements that govern accrual reporting for the public sector. Public sector auditing environment-compared with the provisions of the INTOSAI Code of Ethics and the INTOSAIgeneral standards. Public sector auditing practices-compared to the requirements o f the INTOSAIfield standards and reporting standards, and the IFAC International Standardson Auditing(ISA). Accounting and auditing practices for state-owned enterprises-compared with the requirements of the International Financial Reporting Standards (IFRS) and International Standards on Auditingthat govern commercial reporting. The responsesto the diagnostic questionnaires, prepared by the relevant country authorities with the help of in-country experts retained by the World Bank, are supplemented by a due diligence review conducted by membersof a World Bank task team. Various documents are examined as part of the review, including relevant laws, codes of conduct, national accounting and auditing standards, accountant selection and promotion processes, training needs assessments, accountancy training course outlines, curricula and accreditation methods, sample accounts and sample audit reports, and working paper sets. A country report on the assessment is prepared for each country and reviewed by a panel of expert advisors, before examination by the World Bank country team. The draft i s then shared with the Government for responsebefore finalization. Discussions are also heldwith the relevant stakeholders to devise an implementation plan to address the way forward with a view to minimizing deviations from international standards. 23 Annex B Annex B. Accounting and Auditing Standards This annex contains a summary of the frameworks that have been used for the public sector accounting and auditing assessment The International Accounting Standards Board (IASB),the International Federation of Accountants (IFAC) and the International Organization of Supreme Audit Institutions (INTOSAI) are cooperating insetting international standardsfor accounting and auditing. The IASB is an independent, privately funded accounting standard-setter based in London, UK. The IASB members come from nine countries and have a variety of functional backgrounds. Inthe public interest, IASB is committed to developing a set of high-quality, understandable, and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the IASB co- operates with national accounting standard-setters to achieve convergence in accounting standardsaround the world. The IASB-issuedInternational Accounting Standards (IAS) from 1973 to 2000. Since 2000, they have issued International Financial Reporting Standards (IFRS). The IFAC has its headquarters in New York, USA, and comprises 163 member bodies, mainly the national professional accountancy bodies of most countries around the world. The IFAC Board established the International Public Sector Accounting Standards Board (IPSASB) to develop high-quality accounting standards for use by public sector entities around the world in the preparation of general purpose financial statements. These are the International Public Sector Accounting Standards (IPSAS). The full text of Standards and Exposure Drafts currently on issue is available at http://www.ifac.org/publicsector. The first 20 IPSAS are based on IASB-issued International Accounting Standards to the extent appropriate for the public sector. IFAC also has established the International Auditing and Assurance Standards Board (IAASB) to prepare and promulgate International Standards on Auditing (ISA) and is now working in cooperation with INTOSAI on preparing public sector guidance onthe use of ISA. The INTOSAI includes the Auditors General from almost all national government audit departments around the world and has its Secretariat in the Vienna offices of the Auditor General of Austria. Its Auditing Standards Committee, chaired by the Auditor General of Sweden, produces the INTOSAI Code of Ethics and Auditing Standards, a set of standards at a higher and more generic level than the IFAC-issued International Standards on Auditing. The Auditing Standards Committee is working with the IAASB to prepare practice notes explaining the application of each ISA inthe public sector.' The various standardsare listed on the following pages. 9"Working Group on Financial Audit Guidelines," INTOSAI Auditing Standards Committee, Swedish National Audit Office, 2004. 24 ANNEXB International Public Sector Accounting Standards IPSAS 1,Presentation of Financial Statements IPSAS 2, CashFlow Statements IPSAS 3,Net Surplus or Dejcit for the Period, Fundamental Errors and Changes in Accounting Policies IPSAS 4, TheEffects of Changes in Foreign ExchangeRates IPSAS 5, Borrowing Costs IPSAS 6, Consolidated Financial StatementsandAccountingfor Controlled Entities IPSAS 7, Accountingfor Investments in Associates IPSAS 8, Financial Reporting of Interests in Joint Ventures IPSAS 9, RevenueJi.omExchange Transactions IPSAS 10, Financial Reporting in Hyperinflationary Economies IPSAS 11,Construction Contracts IPSAS 12, Inventories IPSAS 13,Leases IPSAS 14, Events after the Reporting Date IPSAS 15, Financial Instruments: Disclosure and Presentation IPSAS 16, InvestmentProperty IPSAS 17, Property, Plant and Equipment IPSAS 18, Segment Reporting IPSAS 19, Provisions, Contingent Liabilities andAssets IPSAS 20, RelatedParty Disclosures IPSAS 21,Impairment of Non-cash GeneratingAssets CashBasis IPSAS,Financial Reporting under the CashBasis of Accounting International Education Standards IES 1,Entry Requirementsto a Program of Professional Accounting Education IES 2, Content of Professional Accounting Education Programs IES 3, Professional Skills IES 4, Professional Values,Ethics andAttitudes IES 5, Practical Experience Requirements IES 6, Assessment of Professional Capabilities and Competence IES 7, ContinuingProfessional Development IES 8, CompetenceRequirementsfor Audit Professionals 25 ANNEXB InternationalFinancial Reporting and InternationalAccounting Standards IFRS 1, First-time Adoption of InternationalFinancial Reporting Standards IFRS2, Share-basedPayment IFRS 3, Business Combinations IFRS4, Insurance Contracts IFRS 5, Non-current Assets Heldfor Sale and Discontinued Operations IAS 1, Presentation of Financial Statements IAS 2, Inventories IAS 7,CashFlow Statements IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors IAS 10, Events after the Balance SheetDate IAS 11, Construction Contracts IAS 12, Income Taxes IAS 14, Segment Reporting IAS 16, Property, Plant and Equipment IAS 17, Leases IAS 18, Revenue IAS 19, EmployeeBenefits IAS 20, Accountingfor Government Grants and Disclosure of Government Assistance IAS 21, TheEffects of Changes in Foreign ExchangeRates IAS 23, Borrowing Costs IAS 24, RelatedParty Disclosures IAS 26, Accounting and Reporting by Retirement Benefit Plans IAS 27, Consolidated and Separate Financial Statements IAS 28, Investments in Associates IAS 29, Financial Reporting in Hyperinflationary Economies IAS 30, Disclosures in the Financial Statementsof Banks and Similar Financial Institutions IAS 31, Interests in Joint Ventures IAS 32, Financial Instruments: Disclosure and Presentation IAS 33, Earningsper Share IAS 34, Interim Financial Reporting IAS 36, Impairment of Assets IAS 37, Provisions, Contingent Liabilities and ContingentAssets IAS 38, Intangible Assets IAS 39, Financial Instruments: Recognition and Measurement IAS 40, InvestmentProperty IAS 41, Agriculture 26 ANNEXB INTOSAI Code of Ethics and Auditing Standards Codeof ethics Integrity. Auditors have a duty to adhere to high standards o f behavior (e.g. honesty and candidness) inthe course o ftheir work and intheir relationships with the staff o f audited entities. Independence, objectivity and impartiality. The independence of auditors should not be impaired by personal or external interests. There is a need for objectivity and impartiality inthe work and the reports, which should be accurate and objective. Conclusions inopinions and reports should be based exclusively on evidence obtained and assembled inaccordance with the SAI's auditing standards. Professional secrecy. Auditors should not disclose information obtained inthe auditing process to third parties except for the purposes o f meeting the SAI's statutory responsibilities. Competence. Auditors must not undertake work which they are not competent to perform. Basicpostulates for the auditingstandards (a) The SA1should consider compliance with the INTOSAI auditing standards in all matters that are deemed material. Certain standards may not be applicable to some o fthe work done by SAIs, including those organized as Courts o f Account, nor to the non-audit work conductedby the SAL The SA1 should determine the applicable standards for such work to ensure that it i s o f consistently high quality. (b) The SA1should apply its ownjudgment to the diverse situations that arise inthe course o fgovernment auditing. (c) With increased public consciousness, the demand for public accountability o f persons or entities managingpublic resources has become increasingly evident so that there is a needfor the accountability process to be inplace and operating effectively. (d) Development o fadequate information, control, evaluation and reporting systems within the government will facilitate the accountability process. Management is responsible for correctness and sufficiency o fthe form and content o fthe financial reports and other information. (e) Appropriate authorities should ensure the promulgation o f acceptable accounting standards for fmancial reporting and disclosure relevant to the needs o f the government, and audited entities should develop specific and measurable objectives and performance targets. (f) Consistent application o f acceptable accounting standards should result inthe fair presentation o f the financial position and the results o f operations. (g) The existence o fan adequate systemo finternal control minimizes the risko ferrors and irregularities. It is the responsibility o f the audited entity to develop adequate internal control systems to protect its resources. It is also the obligation o fthe audited entity to ensure that controls are inplace and functioning to help ensure that applicable statutes and regulations are complied with, and that probity and propriety are observed indecision making. The auditor should submit proposals and recommendations where controls are found to be inadequate or missing. (h)Legislative enactments would facilitate the co-operation ofaudited entities inmaintaining andproviding access to all relevant data necessary for a comprehensive assessment o fthe activities under audit. (i) All audit activities should be within the SAI's audit mandate." u) Legislative enactments would facilitate the co-operation o f audited entities inmaintaining and providing access to all relevant data necessaryfor a comprehensive assessmento fthe activities under audit. [k) SAIs should work toward improvingtechniques for auditing the validity ofperformancemeasures. [l) SAIs should avoid conflict o f interest between the auditor and the audited entity. * The Regularityaudit embraces: . full scope o fgovernment auditing includes regularity andperformance audit. .. Attestation o f financial accountability o f accountable entities, involving examination and evaluation o f financial records and expression o f opinions on fmancial statements; Attestation o f financial accountability o f the government administration as a whole; Audit of financial systems and transactions includinganevaluation o fcompliance with applicable statutes and regulations; Audit o f internal control and internal audit functions: 27 ANNEXB I Audit of the probity and propriety o fadministrative decisions taken within the audited entity; and Reporting o f any other matters arising from or relating to the audit that the SA1considers should be disclosed. Performance audit entails the audit of economy, efficiency and effectiveness and embraces: I Audit o fthe economy of administrative activities inaccordance with sound administrative principles and practices, and management policies; 1 Audit ofthe efficiency o futilizationo fhuman, financial and other resources, including examination o f information systems, performance measures and monitoring arrangements, and procedures followed by audited entities for remedying identified deficiencies; and 1 Audit o fthe effectiveness ofperformance inrelation to the achievement o fthe objectives ofthe audited entity, and audit o f the actual impact o f activities compared with the intendedimpact. General auditing standards The auditor andthe SA1must be independent. The auditor and the SA1must possess the requiredcompetence. The auditor andthe SA1must exercise due care and concern incomplyingwith the INTOSAIauditing standards. This involves due care inplanning, specifying, gathering and evaluating evidence, and in reporting findings, conclusions and recommendations. The SA1should adopt policies andprocedures to recruit personnel with suitable qualifications. The SA1should adopt policies and procedures to develop andtrain SA1employees to enable them to performtheir tasks efficiently, and defme the basis for the advancement o f auditors and other staff. The SA1should adopt policies and procedures to prepare manuals and other written guidance and instructions concerning the conduct o f audits. The SA1should adopt policies and procedures to support the skills and experience available within the SA1 and identify the skills which are absent; provide a good distribution o f skills to auditing tasks and assign a sufficient number o fpersons for the audit; and ensure proper planning and supervisionto achieve its goals at the required level o f due care and concern. The SA1should adopt policies andprocedures to review the efficiency and effectiveness o fthe SAI's internal standards and procedures. Field standards (a) The auditor should plan the audit ina manner that ensuresthat an audit o f highaualitv is carried out in - . - an economic, efficient and effective way and ina timely manner. (b) The work ofthe audit staff at each level and audit phase should be properly supervisedduring the audit; and documented work should be reviewed by a senior member o f the audit staff. (c) The auditor, indetermining the extent and scope o fthe audit, should study and evaluate the reliability o f internal control. (d) Inconductingregularity (financial) audits, a test should be made o f compliance with applicable laws andregulations. The auditor should design audit steps andprocedures to provide reasonable assurance o f detecting errors, irregularities, and illegal acts that could have a direct and material effect on the financial statement amounts or the results o fregularityaudits. The auditor also should be aware o fthe possibility of illegal acts that could have an indirect and material effect on the financial statements or results o f regularity audits. Reporting standards (a) At the end o f each audit, the auditor should prepare a written opinion or report, as appropriate, setting out the findings inan appropriate form; its content should be easy to understand and fiee from vagueness or ambiguity, include only information which is supported by competent and relevant audit evidence, and be independent,objective, fair and constructive. (b) It is for the Auditor Generalto decide finally on the action to be takeninrelation to fraudulent practices, or serious irregularities discovered by the auditors. 28 ANNEXB InternationalStandards on Auditing Framework: Audit Evidence: International Frameworkfor Assurance 500 Audit Evidence Engagements 501Audit Evidence Additional Considerationsfor - Specific Items GeneralPrinciplesand Responsibilities: 505 External Conjrmations 510Initial Engagements Opening Balances - 200 Objective and General Principles Governing 520Analytical Procedures an Audit of Financial Statements 530Audit Sampling and Other Means of Testing 210 Terms of Audit Engagements 540Audit of Accounting Estimates 220 Quality Controlfor Audits of Historical Information 545 Auditing Fair ValueMeasurementsand Disclosures 230 Documentation 550 RelatedParties 230RAudit Documentation 560 SubsequentEvents 240 TheAuditor's Responsibility to Consider Fraud in an Audit of Financial Statements 570 Going Concern 240A Fraud and Error 580 ManagementRepresentations 250 Consideration ofLaws and Regulations in an Audit of Financial Statements Usingthe Work of Others: 260 Communicationsof Audit Matters with Those Chargedwith Governance 600 Using the Work of Another Auditor 610 Considering the Work of Internal Auditing RiskAssessment andResponseto Assessed 620 Using the Work of an Expert Risks: Audit Conclusionsand Reporting: 300 Planning anAudit of Financial Statements 3 15 Understandingthe Entity and Its I00 TheAuditor's Reports on Financial Statements Environment andAssessing the Risks of Material 700R TheIndependentAuditor's Report on a Misstatement CompleteSet of General Purpose Financial 320Audit Materiality Statements 330 TheAuditor's Procedures in Response to I 01Modifications to the IndependentAuditor's Assessed Risks Report 402 Audit ConsiderationsRelating to Entities 710 Comparatives UsingService Organizations 720 Other Information in Documents Containing Audited Financial Statements SpecializedAreas: 800 TheAuditor's Report on Special PurposeAudit Engagements 29 Annex C Annex C. Afghanistan Auditing and Accounting Legislation Auditing Legislation (N.B this is an old translationof the still prevailing 1996 law and has been amended for grammatical sense -there is a need to read the original text for exactness)) Inthe Name ofGod, the Compassionate,the Merciful The IslamicEmirateof Afghanistan ControlandAudit Law GeneralOrdinances Chapter One Part 1. This law is specially issued for organizing the audit and control affairs of public properties. Part 2. The basic objectives of the law are as follows: (a) Getting precise account for expenses of public property. (b) Effective control of accounting and financial affairs of state departments, organizations, and firms. (c) Control for state program outcomes and that the expenses of affairs provide advantages accruing to the state. (d) Performance of audit and control to strengthen and improve the state economy. (e) Saving public property through audit and control. The aforementioned terms inthis law shall have the following meanings. Part 3. Control i s a process that gives assurance from true performance of activities in different economic and social sections. The control mentioned in this part is in three kinds: (a) Primary Control is a process that will be performed to avoid any kind of abuse and violation before starting activities. (b) Progressive Control is a process which will control activities progressively to avoid any kindof maltreatment and abuse during the work. (c) Final Control i s a process that checks and compares accomplished and unaccomplished affairs. Audit i s an annual check of activities considering existing evidence. Auditor i s a professional official who performs the audit and control affairs. Part 4. Ministries, departments, firms, cooperatives, social organizations, state agencies, banks, andmunicipalities are namedunder control organizations. 30 ANNEXC Part 5. General Department of Audit and Control (ACD) is the highest and the most competent referencefor audit and control inthe country. This Department may run its activities according to Islamic Sharia and domestic laws. Part 6. The General Department of Audit and Control consists of the Heading Council, the General President of Departmentand assistants, and the Chairmen of special sections of the Department. Part7. The General President and the assistants of the Department will be appointed according to the proposal of the Prime Minister andratificationofthe President. Part 8. The General Presidenthas responsibility for carrying out the assigned affairs. The Heading Council i s the most competent reference in the Department. Appointment of the membersof this Council will be according to the proposal of the General President of the Department and the approval of the President. The Heading Council will have the following tasks: (a) Making the planfor the Department. (b) Receiving reports from related offices, and determining about their activities. Part 10. Determination and approval of the Heading Council will be according to a referendum(vote). Part 11. Experienced professionals and experts are preferred for appointment to the Department. Part 12. The General Department of Audit and Control provides timely reports for high- ranking government authorities. Part 13. The following evaluation will be carried out by ACD: (a) Certain accounts for state expenses. (b) Considering the dominant role for accountantsinpreparing andorganizing the budget of state departments. (c) Better expenses of properties, and evaluating the state income processes. (d) Evaluating performance of the domestic auditors, for better cooperation in work and efficient development of activities. Part 14. The domestic auditors are under direct control of the minister.They have mutual responsibilities and can play a contributing role with ACD. Part 15. The domestic auditors have responsibilities in providing reports about their performance to ACD. Part 16. ACD has the right to recheck the documents and reports provided by domestic auditors. 31 ANNEXC CHAPTER I11 Competenceand Responsibilities Part 17. ACD auditors have the following functions: (a) Auditing of state incomes, cash, expenses and valuable documents and materials. (b) Visual checking ofprovision, conservation, distributionand costs of materials. (c) Checking the existence of cash, materials andvaluable documents; locking up the properties andthe safes inemergency cases. (d) Receiving essentialinformationfrom officials about references. (e) Checking the evidence and asking for the reports and information from the responsible officials regarding their previousperformance. (0 Providingspecial ACD reportsoutliningreforms so asto prohibitfuture abuse andviolations. (8) Providing urgent ACD reports in case of instances o f abuse, illegal expenses andviolation by officials. (h) Keepingdocumentary evidence of illegalities temporarily, until they are sent to related reference authorities. (i)Dualauditing ofbothreferencesincases ofconnected affairs andprecise observation and comparison of documents. (i) Issuinginstructions for stopping illegaloperationsundercontrolreferenceand providingtimely ACD reports. (k) Control of manufactures duringthe production process and implementationof plansfor improving quality. Part 18. Auditor and controllers of ACD have the following responsibilities: (a) Impartiallyperforming of duties according to law. (b) Limiting time for providing information and explanations on related references. (c) Offering fast, clear, adequate, reasonable, and legal suggestions. (d) Devising the logical way for using property inorder to enhance the efficiency of activities. (e) Proving causes and conditions which may create wastage, shortage, and embezzlement o f state properties. Part 19. Auditors and controllers will be consideredguilty inthe following cases: (a) Ignorance of illegal performance. (b) Non-disclosure of suspicious papers. (c) Non-disclosure o f lost papersand files. (d) Hidingor collectionofpapersfor maltreatment. (e) Accusing officials without documentary evidence. 32 ANNEXC (f) Fabrication, andtamperingof documents. (g) Any action which may cause lossesfor the government. (h) Violation ofthe law. Part 20. Audit and control department has the following responsibilities: (a) Offering systematic reports about the result of evaluation which may need urgentdecisions, to state authorities. (b) Taking necessary decisions towards improving diagnostic faults in economic and social affairs. (c) Offering suggestions about adjustment and responsibilities of under control organizations to state authorities. (d) Sending improvement suggestions to those responsible for the reference to avoid violations and faults which appearedduringcontrol. (e) Establishing relationships with international supreme audit institutions for cooperation with them intechnical and professional fields. Part 21. Organisation under control referenceshave the following obligations: (a) Providingsufficient facilities for ACD officials duringwork. (b) Providingexperts, professional workers and experienced officials to cooperate with auditors. (c) Observing Chapter 3, Part 18 of this law about providing necessary informationto auditors. (d) Drawing the attention of auditors to budget drafting and financial arrangementsoftheir organization. (e) Providingspecial reports about the result of their activities. CHAPTERIV The FinalOrdinances Part22. For securing the public property, the ACD is considered as cooperator for exposure o f crimes. Part 23. (a) High Court of Islamic Emirate of Afghanistan (IEA) has responsibilities in providing reports of the assignedaffairs to ACD. (b) Incase of objections, justices of IEA should deliver the files back to ACD for solution. (c) Justices have to state reason to ACD in case of not following up legally the assignedissues. Part 24. ACD's officials in combination with delegates of Ministries and state departments responsible for signing economic and financial agreements can travel abroad after approval from state authorities. 33 ANNEXC Part25. ACD can observe the activities of State agencies abroad considering the principals ofthe government. Part 26. ACD officials can only be employed for thejobs mentioned inthis constitution. Part 27: ACD officials have special identification cards. Part 28. To avoid corruption, controllers of the other references including the high court, cannot use the ordinance of this law. They have to carry out only their own occupations. Part 29. This law, after issue is dominant and will be inserted in the state official publication. And any domestic ordinances, ifcontrary to this, will be cancelled. 34 ANNEXC AccountingLegislation Extractsfrom the BudgetLaw of the DemocraticRepublicof Afghanistan 6-5 State accountants-within their ownjurisdictions-will keep adequate records o f the uncollected revenues and will execute the expenditures o f the appropriate departments on the provincial levels. Further, after accounting for expenditures in the current month, the said state accountants shall transfer-to the general accounts receivable (administered by the Treasury through the Ministry o f Finance) o f the government-any additional revenues which cannot possibly be used for expenditures for the next month. Furthermore, if [during a givenperiod] the revenues should not prove adequate for meeting the expenditures o f a state, based on the request o f the state accountants and when the necessity o f the same shall be adequately evidenced, the Treasury may allow the transfer o f fundsfiom its own resources to the said state so as to bridge the gap. 8.4 Government expenditures are comprised o f amounts paid by the government in exchange for execution o f services, delivery o f goods, and carrying out o f other obligations for the purpose of: growth o f national economy; advancement o f material and cultural level o f the nation; strengthening o f the national defense; and providing for the consumption of the governmental bureaucracy. Any payment for expenditures must take place in accordance with-and under the guidance of-the applicable laws and regulations and generally accepted accounting standards [mavazeen-e hessabi: hereinafter, GAAS]. Public Finance and Expenditure ManagementLaw extracts- Article 4. The Ministryo f Finance i s responsible for implementing the provisions o f this .. law, and shall have the following duties and authorities: Settingthe financial andpublic expenditure policy o fAfghanistan. .. To report to the government and the National Assembly [of Islamic Republic o f Afghanistan] onthe implementationofthe provisions o fthis law. To propose the adoption o f regulations to the government To adopt procedures (tarzulamal) and rules (layeha), for [ensuring] better implementation o f this law. Article 6. The responsible authorities for financial affairs o f state administrations shall have the following obligations: 1. To prepare, arrange andsubmit the draft budgetto the Ministry o f Finance 2. To submit report o f financial affairs in accordance with this law, and the related regulations and Rules To ensure that this Law is applied concerning expenditure commitments within the established budget allotments, regulation o f the financial system and efficient controls on the executions withinthe relevant administration. 35 ANNEXC Article 7. In order to carry out the relevant affairs, the Treasury of the Ministry of Finance shall have the following responsibilities and authorities: Maintaining the Treasury General Ledger and recording transactions according to budget classification and accounting rules compliant with internationally accepted standards and principles; Providing regular reports on the implementation of the State's budget and other financial matters for the Ministry of Finance Uponthe confirmationofthe Ministry of Finance, issuing necessaryinstructions covering the relevant affair. Performing management for the debts of the state Compilation of the annual accounts of the financial operations of state including appropriation accounts and financial statements Managing and controlling the affairs related to processing of expenditures and other treasury related responsibilities inthe Mustufiats of centre and provinces Article 34. The financial statistics such as revenues, expenditures and financing in the annual budget documentation shall be set out, organized and published by the International Monetary Fund, in consistency with the Government Finance Statistics classification. Article 53. Classification of budgetrecords 1) The Ministry of Finance shall establish classification systems for budget andaccounting records inobservanceofthe following: (1) To facilitate the control of expenditures by state administrations; [and] (2) To permit analysis of expenditure by organization, function, and economic category according to the Government Financial Statistics cash basis classification requirements as set out by the International Monetary Fund. 2) To achieve the objectives of paragraph one, the Ministry of Finance shall maintain, records of: a. Government income receipts; b. Appropriations and adjustments to appropriations of state administrations 36 ANNEXC c. Documents for Actual expenditures made and outstanding liabilities. d. Appropriations made available to state administrations for expenditure by means of allotment form; 3) State administrations shall maintain accounting records inaccordance with Ministry of Finance instructions and provide copies of the accounting records to the Ministry of Finance when requested, except in cases where the lawprovides for the confidentiality o f suchrecords. Article 55. FinalReport on the Budget 1) The Ministry o f Finance shall publish the following information upon submissionto the President andthe government: (1) Final budget reconciliation report on the budgetfor previous fiscal year. This shall be submittedno later than the end o f the month of Sonbola (the second quarter o f the year); [and] (2) A set o f financial statements compiled according to the international accounting principles that have been audited as required by article 59. 2) The final budget reconciliation report referred to in paragraph one shall cover the following issues: a. Budget overview information; b. A revenue and expenditure report; [and] c. Assets and liabilities information. Article 56. Budget overview information The budget overview information will include: (1) Tasks accomplishedandthe mainplanfor the new fiscal year; (2) An overview o f important actual revenues and expenditures; (3) Details o f how a budget deficit was financed or how a surplus was invested; and (4) Other information considered necessary by the Ministry o f Finance. Article 57. Revenue and expenditure report The revenue and expenditure report shall include: (1) Actual revenues compared with projected revenues; 37 ANNEXC (2) Actual special funds receivedduringthe fiscal Year; (3) Actual expenditures from special funds appropriations; (4) Actual number o f permanent and temporary State employees paid from appropriations inthe fiscal year; (5) Actual payments o f interest or amounts inthe nature o f interest on debt owed by the State and [for] repayment o f debt principal; (6) Actual expenditures in respect o f each appropriation category compared with the budget appropriation for that category, the actual expenditure for that category in the previous fiscal year, anddetails of additional appropriations underthis law; (7) Details o f all recipients o f public grants and the amount they received; (8) Details o f the contingency expenditures; (9) Details o f all adjustments made to appropriations in the fiscal year; (10) Actual user fee receipts for the fiscal year; [and] (11) Other information considered necessary by the Ministry o f Finance. Article 58. The assets and liabilities information The assets and liabilities information will include: (1) Details o f investments o f public money made during the fiscal year; (2) Details o f any changes made to loans duringthe previous fiscal year; (3) Details o f any loans made by the State during the fiscal year; (4) Details o f any borrowings by the State duringthe fiscal year; (5) Details o f differences in the amount o f guarantees planned to be made and loans to be incurred by the State during the fiscal year and guarantees actually made and loans actually incurred; (6) Details o f difference between the estimated amount o f contingent liabilities o f the State that were expected to give rise to actual liabilities during the fiscal year and amount o f contingent liabilities that actually gave rise to liabilities; (7) A full accounting of assets held by the State at the end o f the fiscal year; [and] (8) Other information considered necessary by the Ministry o f Finance. Article 59. Independent Audit 1. The independent auditors shall have the right to acquire all information and explanations deemed necessary for auditing. 38 ANNEXC 2. The administration for inspection and control shall prepare an independent audit report with in six months from the end of a fiscal year and submit it to the government. The independentaudit report shall include: (a) Certificationof the appropriation accounts; and (b) Recommendations for fines to be applied consistent with this Law. 3. The government shall submit the report referred to in paragraph 2 of this article to the first meeting of the National Assembly. The report shall be made publicly available uponsubmissionto the NationalAssembly. Article 60. Reporting to the National Assembly The government shall report to the National Assembly on decisions taken pursuantto the audit and control report. Article 61. Audit Powers of the Ministryof Finance 1. The Ministryo f Finance shall establish an internal audit administration and appoint auditors to audit the financial and accounting affairs of all State administrations. 2. The auditors referenced in paragraph one may require the relevant administrations to provide all information needed for auditing financial affairs. Article 64. Exceptions State-owned companies and enterprises are not subject to this law, and their affairs shall be regulated undertheir related Laws. Article 65. Entry into Force This law shall be enforced from the date of signature and shall bepublishedin the official Gazette and with its entry into force the budget Law dated 30/8/1362, publishedin official gazette # 544, and other contrary provisions shall be eliminated. 39 Annex D Annex D. Benefits of Accrual Accounting Extract from Study No. 14 "Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities," IFAC Public Sector Committee, December 2003 1.18 The PSC has commented extensively on the benefits of accrual accounting for governments and individual public sector entities in previous Studies (Studies 5, 6, 8, 9 10 and 11) and Occasional Papers (Papers 1, 3, 5, 6 and 7). In order to provide some context for readers who are not familiar with the PSC's other publications, this section contains a summary of the benefits of reporting on the accrual basis. 1.19 The information contained inreports preparedon an accrual basis is useful both for accountability and decision-making. Financial reports prepared on an accrual basis allow users to: assess the accountability for all resourcesthe entity controls and the deployment ofthose resources; assess the performance, financial positionandcash flows ofthe entity; and makedecisions about providingresourcesto, or doing business with, the entity. 1.20At a more detailed level, reporting on anaccrual basis: shows how a government financed its activities and met its cash requirements; allows users to evaluate a government's ongoing ability to finance its activities andto meet its liabilities andcommitments; shows the financial positionof a government and changes in financial position; provides a government with the opportunity to demonstrate successful management of its resources; and i s useful in evaluating a government's performance interms of its service costs, efficiency and accomplishments. Financial Position 1.21 Accrual accounting provides information on an entity's overall financial position andcurrent stock of assets andliabilities. Governments needthis informationto: make decisions about the feasibility of financing the services they wish to provide; demonstrate accountability to the public for their management of assets and liabilities recognized inthe financial statements; planfor future fundingrequirementsof asset maintenance and replacement; planfor the repayment of, or satisfaction of, existingliabilities; and manage their cashposition and financing requirements. 40 ANNEXD 1.22 Accrual accounting requires organizations to maintain complete records o f assets and liabilities. It facilitates better management o f assets, including better maintenance, more appropriate replacement policies, identification and disposal o f surplus assets, and better management o f risks such as loss due to theft or damage. The identification o f assets and the recognition o f depreciation help managers to understand the impact o f using fixed assets in the delivery o f services, and encourage managers to consider alternative ways o f managing costs and delivering services. 1.23 Accrual accounting provides a consistent framework for the identification o f existing liabilities, and potential or contingent liabilities. The recognition o f obligations meeting the definition o f a liability and the criteria for recognition: compels governments to acknowledge and plan for the payment o f all recognized liabilities, notjust borrowings; provides information on the impact o f existing liabilities on future resources; means that it i s possible to allocate responsibility for the management o f all liabilities; and provides necessary input for governments to assess whether they can continue to provide current services and the extent to which they can afford new programs and services. 1.24 Accrual accounting highlightsthe impact o f financing decisions on net assets/equity and may lead governments to take a longer term view when making financing decisions than is generally possible when relying on cash or modified cash reports. Information on net assetdequity also means that governments may be held accountable for the financial impact o f their decisions, on both current and future net assets/equity. Changes in an entity's net assetdequity between two reporting dates reflect the increase or decrease in its wealth during the period, under the particular measurement principles adopted and disclosed in the financial statements. Under the accrual basis o f accounting, the financial statements will include a Statement o f Financial Position which discloses information about assets and liabilities. Where assets and liabilities are not equal, a residual figure for net assets/equity will be reported. Where this figure is positive it can be interpretedas the net resources that may be applied for the provision o f goods or services inthe future, and therefore the community's investment in the reporting entity. Where the figure i s negative, it may be viewed as the amount o f future taxation or other revenues which are already committed to paying o f f debt and other liabilities. Net assets/equity can comprise some or all o fthe following components: contributed capital; accumulated surpluses and deficits; and reserves (for example revaluationreserve; foreign currency translation reserve). Financial Performance 1.25 Accrual accounting provides information on revenues and expenses, including the impact o f transactions where cash has not yet been received or paid. Accurate 41 ANNEXD information on revenues is essential for assessing the impact o f taxation and other revenues on the government's fiscal position, and in assessing the need for borrowing in the long term. Information on revenues helps both users and governments themselves to assess whether current revenues are sufficient to cover the costs o f current programs and services. 1.26 Governments need information about expenses in order to assess their revenue requirements, the sustainability o f existing programs, and the likely cost o f proposed activities and services. Accrual accounting provides governments with information on the fullcosts oftheir activities so that they can: consider the cost consequences o f particular policy objectives and the cost o f alternative mechanisms for meeting these objectives; decide whether to fund the production of services within government sub- entities, or whether to purchase goods and services directly from non- government organizations; decide whether user fees should cover the costs associated with a service; and allocate responsibility for managing particular costs. 1-27 Accrual accounting can provide financial information on whether sub-entities are delivering specified services, and delivering them within agreed budgets. The same information, at a more detailed level, can also be used within sub-entities for the management o f activity and program costs. 1.28 Accrual accounting allows an individual entity to: record the total costs, including depreciation o f physical assets and amortization o f intangible assets, o f carrying out specific activities; recognize all employee-related costs and to compare the cost o f various types o f employment or remuneration options; assess the most efficient way o f producing their goods and services and o f managingthe resources over which they have been delegated authority; determine the appropriateness o f cost-recovery policies; and monitor actual costs against budgeted costs. CashFlows 1.29 Accrual accounting provides comprehensive information on current cash flows and certain projected cash flows, including the cash flows associated with debtors and creditors. It can therefore lead to better cash management and may assist in the preparation of more accurate cash budgets. 42 Annex E. PFM Reform Agenda The analysis o f public financial management (PFM) conducted by the World Bank in 2005 developed a program o f reform to concretely move forward. The two main points from the recommendations relating to accounting and auditing reforms, deal with the capacity development of the key PFM institutions. Without stronger capacity and institutional reforms, improvements inPFM performance, as well as progress toward key national development objectives, will be difficult to achieve and impossible to sustain. Priority areas include training, recruitment practices, pay structures, organizational reforms, detailed business processes, and specific information technology systems. While these issues cut across all levels o f government, the Ministry o f Finance's capacity is o f particular importance. Since the Ministry i s chief custodian o f the PFM system, its capacity to develop and implement policies i s at the core o f PFM performance. Progress toward Ministry o f Finance Strategic Plan (initiated in May 2005) will be important in developing its capacity and performance. The PFM capacity development in line ministries also is important but will take more time. The Government should adopt a clear action plan to improve PFMperformance with time-bound milestones, quantified objectives, and clearly identified responsible agencies. The PFM analysis report seeks to provide a comprehensive, high-level roadmap o f policy reforms (as illustrated in Table 10.1 o f the report). It is comprehensive in the sense that all areas o f public financial management are covered. It i s high level in the sense that some concrete next steps are identified for the next 6-12 months, but many actions are less specific and will need to be converted into detailed action plans later, by the respective government departments. Also, some key accountability, left out o f the PFEM Law, will need to be fully specified, especially with regard to the respective roles o f the Ministry o f Finance andthe line ministries. The Procurement Law clearly gives authority to line ministries. Progress along this roadmap could be measured by key fiscal outcomes and implementation and progressive improvement o f the Medium Term Financial Framework, and by the PFM performance indicators presented in this report. Monitoring o f progress along with a meaningful feedback loop into subsequent decision- making, will be as important as the actionplan itself. Key actions relevant to accounting and auditing reforms forming part o f the way forward inthe PFManalysis report are summarized inthe followingtable. Area Short-termactions Medium-term actions (next 6 to 12months) beyond 6 to 12months Accounting inyear of Automate reconciliation of Develop public accounting standards and reporting government accounting records with clarify role of lineministries (regulations banking data, particularly the to implement PFEM Law) Treasury Single Account (TSA) Enforce use of modem budget classification and increase capacity to issue 43 Area Short-termactions Medium-term actions (next 6 to 12months) beyond 6 to 12months timely monthly reports Complete roll-out o f AFMIS to line ministriesfor complete and timely in-year reporting Undertake roll-out o f AFMIS to Mustoufiats Develop accounting capacity of municipalities Develop accounting capacity o f SOEs Move toward modernized accounting standards over time Transparent and Develop the means to capture and Disclose state enterprises annual financial accessible external report accurately expenditures o f results and financial position, company financial reporting donor implemented projects objectives, ownership, governance structure and informationon employees Ministry of Finance (MoF) to commit to preparing formal All information should be audited. All accounting period cut-offs at least SOEs (regardless o f form o fpublic quarterly ownership) should be covered Establishthe procedures andrequirements for the line ministries for collection, review andfollow-up o fthe external audits of donor implemented projects External audit Carry-out accounting and auditing Finalize draft and gazette new Audit Law certification process for all professional staff Develop external audit regulation, implement Audit Law Develop audit work o f whole-of- Government annual accounts Develop external audit o f procurement Create Public Accounts Committee and its processes Develop a system for scrutiny and response to audit reports including responses by involved ministries and scrutiny by a Public Accounts Committee o f Parliament Develop role o f media and civil society in the scrutiny ofthe budget (formulation and execution) 44 x a .-c 0 IA . . . . 9" 3 40a . 0 0 0 2ird s E I C . .E8 . ri W . . c e 0 b n n n z a ? 3