Report No. 39699-PK Pakistan Public Sector Accounting and Auditing A Comparison to International Standards Country Report May 2007 Financial Management Unit South Asia Region Document of the World Bank Acknowledgments This assessment of accountingand auditingstandardsand practices in the public sector is part of a review program in the South Asia Region.It has been carriedout in active collaboration with the Government of Pakistanand various stakeholders, particularlythe offices of the Auditor General and the ControllerGeneral ofAccounts. Discussions were also heldwith senior officers of the Audit and Accounts Training Institute (AATI) and the Project for Improvement o f Financial Reportingand Auditing (PIFRA). In particular, the following individuals contributed their valuable time and expertiseto this assessment: Mr.M.YounisKhan, Auditor General Mr.IftikharAhmedKhan,ControllerGeneralofAccounts (retiredon January27,2007) Mr.NaimatuallahAbid, Acting ControllerGeneral ofAccounts Mr. RashidAhmed Saleh, DeputyAuditor General Mr.Sikandar Aziz Esker,DeputyAuditor General Mr.ShaikhNaseer Ahmad, DeputyAuditor General,CommercialAudit Mr.MohsinKhan, DeputyAuditor General Mr.ShabirAhmedDahar,DeputyControllerGeneralofAccounts Mr.MohammadIqbal,DirectorGeneral,Accounts Mr.MuhammadAyub KhanTareen, Accountant GeneralPakistanRevenues Mr.Jalal-udDin, DirectorGeneral Mr.ImranIqbal, DirectorGeneral,Civil Audit, Punjab Mr.JamilBhatti,DirectorGeneral, DistrictAudit, Punjab Mr.KhalidAli Shah, DirectorGeneral, Training Mr. IftikharAhmad, DirectorGeneralDefenseAudit Mr. Waheed Ahmad Shad, Director General, Drought Emergency Relief Assistance Audit Mr. Baseer, Director General, Earthquake Rehabilitationand Reconstruction Authority Audit Mr.SharsharAhmadKhan, DirectorGeneralFederalAudit Mr. MuhammadJunaid, DirectorGeneralCommercialAudit, Lahore Mr.MushtaqAhmadMemon,DirectorGeneralCommercialAudit, Karachi Mr.ZiaAkhter, GeneralManager,ManagementInformationSystems Mr.Akmal Minallah,DirectorAudit, PIFRA Mr.MuhammadZaheer, Director,Accounts Mr.Abdul Bari, Director Dr.TalatImtiaz,Director,CommercialAudit Mr.Salah-udDin, Director,Administration,AATI Mr.Yousaf Satti, Director,Drought EmergencyReliefAssistance, Audit Mr. HammadYounis, PIFRA Mr.Khan, PIFRA The review was conductedthrough a participatoryprocessthat involvedthe stakeholders listed above. The responses to the diagnostic questionnaires were especially useful, as were the reports, manuals, and information available from the PIFRA Project and recent World Bank assessmentsofpublic financialmanagement inPakistan. The World Bank Task Team was responsible for this report with general guidance from the advisors and the development partners who collaborated on this review program. The draft .. 11 report developed after a consultative workshop inIslamabad on December 16,2006 was provided to the Government for comment, and the comments made have been considered in this country report. Task Team P. K. Subramanian, Lead Financial Management Specialist Ismaila B.Ceesay, Senior Financial Management Specialist / Country FMCoordinator Furqan Saleem, Financial Management Specialist RonaldPoints, Lead Consultant, Accounting Michael Jacobs, Lead Consultant, Auditing Review Program Advisors Simon Bradbury, Loans Department, World Bank David Goldsworthy, InternationalTechnical Cooperation Program, UKNational Audit Office Noel Hepworth, Chartered Instituteof Public Finance and Accountancy, London Abdul Mudabbir Khan, Fiscal Affairs Department, InternationalMonetary Fund Ian Mackintosh, Chairman, UK Accounting StandardsBoard Paul Sutcliffe, International Public Sector Accounting Standards Board, International Federation of Accountants Development Partner Collaborators on the Review Program DavidBiggs, UK Department for InternationalDevelopment KathleenMoktan, Asian Development Bank ... 111 Contents ExecutiveSummary .......................................................................................................... 1 I Introduction 8 I1 PublicSector Accounting .. .................................................................................................................. .......................................................................................... 10 A. Institutional Framework for Public Sector Accounting .......................................... 10 (1)Accounting Laws and Regulations...................................................................... 10 (2) Education and Training.................................................................... (3) Code of Conduct................................................................................ B.(4) Accounting Standards as Practiced......................................................................... Public Sector Accountant Arrangements .......................................... 13 (1)Setting Public Sector Accounting Standards.................................................. (2) Presenting Financial Reports.............................................................................. 13 C.Assessment of Accounting and Auditing in State-OwnedEnterprises.................... 15 I11 PublicSector Auditing . ............................................................................................. 17 A. Statutory Framework for Public Sector Auditing ................................................... 17 (1) Statutory Framework........................................................................................... 18 (2) Setting Auditing Standards.................................................................................. 20 (3) Code ofEthics ..................................................................................................... 21 (4) Ensuring Independence....................................................................................... 21 (5) Accountability in the SupremeAudit Institution ................................................. 24 (6) Qualifications and Skillsfor the Auditors ........................................................... 24 (7) Training............................................................................................................... 25 (8) Auditor Competence..................................................................................... B.(9) 26 Auditing Standards as Practiced............................................................................... Quality Assurance ............................................................................................... 26 (1)Audit Planning..................................................................................................... 26 (2) Audit Supervision ................................................................................................ 27 (3) Reviewing Internal Management Control Procedures........................................ 27 (4) Audit Evidence..................................................................................................... 28 (5) Analyzing Financial Statements.......................................................................... 28 (6) Reporting on Financial Statements..................................................................... 28 (7) Reporting on Fraud............................................................................................. 29 (8) Reporting on Compliance............................ .................................................... 29 I V Action Plans . .............................................................................................................. 30 Annex A Methodologyof the Assessment 35 Annex B Accountingand AuditingStandards .. ................................................................... ........................................................... 37 International Public Sector Accounting and Education Standards.............................. 38 INTOSAICode of Ethics andAuditing Standards........................................................ International Financial Reporting StandardsandAccounting Standards ...................39 40 International Standards on Auditing ............................................................................ 42 iv Annex C PakistanAuditing and AccountingLegislation ........................................... 43 Annex D BenefitsofAccrual Accounting .. .................................................................. 46 SupplementalTable of Standardsand Gaps ................................................................ 49 IPublicSectorAccounting . ............................................................................................ 49 A.Assessment ofthe National Public Sector Accounting Environment...................... 49 B.Assessment ofNational Public Sector Accounting Standards ................................. 54 C. Assessment of Accounting and Auditing inState-Owned Enterprises.................... 56 I1 Public Sector Auditing . .............................................................................................. 58 A Assessment ofthe Public Sector Auditing Environment......................................... . 58 B.Assessment of Public Sector AuditingStandards andPractices.............................. 72 V Executive Summary 1. This assessment o f public sector accounting and auditing is generally meant to helpimplement more effective public financial management (PFM) through better quality accounting and public audit processes in Pakistan and to provide greater stimulus for more cost-effective outcomes o f government spending. 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 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. Annex A explains the methodology usedfor the assessment. The desiredactions indicatedby this assessment are summarized below. 3. Adopt International Public Sector Accounting Standards. The International Public Sector Accounting Standards Board (IPSASB) of the International Federation o f Accountants (IFAC) issues International Public Sector Accounting Standards (IPSAS). Annex B gives a general description o f IFAC and a listing o f the IPSAS. At the present time, Pakistan does not comply with the IPSAS in preparing its annual accounts. The country's accounts do not provide a statement o f cash receipts and payments which (a) recognizes all cash receipts, cash payments, and cash balances controlled by the entity; and (b) separately identifies payments made by third parties on behalf of'the entity in accordance with paragraph 1.3.24 of this IPSAS. In addition, the country's accounts do not provide accounting policies and explanatory notes. A general program i s underway for the adoption o f accounts in a form specified in its New Accounting Model (NAM). This form o f reporting was developed in 1998 and adopted the then proposed modified cash basis o f accounting standard.' The IPSASB has not approved this form o f reporting as an official standard. It has established standards for accrual-based reporting and also the Cash Basis IPSAS together with guidance for transition to an accrual basis of accounting. Under the guidance o f the Auditor General o f Pakistan (AGP), the Controller General o f Accounts (CGA) needs to restructure the present cash basis o f financial reporting to conform fully to the Cash Basis IPSAS. While the IPSAS-2 reporting format has been designated by the Auditor General as additional reporting requirementsfor the government, it would be appropriate to set up a committee to review and steer the process to implement Cash Basis IPSAS on a continuous basis. With strengthened capacity effected by recruiting financial reporting specialists for the CGA administration, a transition to full Cash Basis IPSAS-while also adopting the Modified Cash Basis IPSAS as per the New Accounting Model (NAM) - c a n be smoothly accomplished, although the problem o f consolidation of controlled entities would still I The modified cash basis of accounting helps in controlling not only cash but also commitments against budget, allowing the production of a statement of receipts and payments, a statement of assets and liabilities,and a cash flow statement. 1 persist. The Government noted in its response to the draft report that the requirementso f the cash basis o f accounting have been incorporated in the NAM Manual o f Accounting Principles and its Procedures Manual and that the progressive implementation o f the NAM will meet all the requirements. As a next step, a transitional path should be developed that presents the full accrual information to best serve the general financial statements as required under Section 7(b) of the CGA (Appointment, Functions and Powers) Ordinance 2001. Annex C includes the pertinent text o f the Constitution and the AGP and CGA Ordinances. Benefits from adopting accrual reporting are set out in Annex D. 4. A Supplementary Table o f Standards and Gaps o f this report provides a matrix detailing the current standards, the present position, and options for improvement. A summary o f the accounting standards issues i s shown inTable ES1. Table ES , Summary of Accounting Standar, Issues in Pakistan 9 Standard Current status Activity required to adopt international standards 1. Does the Public Sector Only partially. The notification of A committee should be set up to Accounting Law adopt the adoptionofthe IPSAS-2 cash review and steer the processto IPSAS? flow reporting format as part ofthe implement full cashbasis of financial overall reporting requirementsof reporting on a continuousbasis. The the governmentis astep inthe financial reporting specialistsshould right direction. steer the process as key members of the committee.Uponimplementation ofthe Cash Basis IPSAS as additional reporting requirementsof the government, the committee shouldgradually begin the transition to adopting accrual-basedIPSAS. The PIFRA project is providing the necessary support for computerization ofthe accounts and capacitybuilding ofthe staff. 2. Does the education and Partly. A comprehensive training Implement the training and training of accountants strategy is directedtoward the professionalization strategy, and accord with IES? professionalizationof accounting include IPSAS inAATI syllabi. staff through IES-compliant qualifications. 3. Does the code of ethics Yes. The Auditor Generalhas The code of ethics shouldbe made a match international adoptedthe INTOSAICode of part of the staff contracts. standards? Ethics. 4. I s there abody to Yes. The Constitution of Pakistan While IPSAS should be the core prescribe publicsector delineatesthe authority ofthe framework for financial reporting, accountingstandards? Auditor Generalof Pakistanto with the ModifiedCash Basis under prescribethe form, principles, and the NAM, IAS/IFRS shouldbe the methods of accounts ofthe approvedstandards for accounting Federationand ofthe Provinces and financial reporting for all state- with the approvalofthe President. owned enterprises. 5. Are financial To a limited extent. The Cash There are 3 identifiedgaps: (1) statements presentedin Basis IPSAS for financial Accounting policies and notes to the accordwith the IPSAS? reporting is not yet followed, nor is accounts are absent. (2) Third party the accrual-based IPSAS.The transactionsare not included. (3) CGA has the responsibility for Controlled entities' financial 2 Standard Current status Activity required to adopt international standards preparing and maintaining the information i s not consolidated.The accounts of the Federation,the hnctions of the chief financial Provincesand district officer and internal auditing within governments.The CGA also lays each governmententity shouldbe down the principles governing strengthened to assist with the internal financial control but reliability of the reporting. Duality certain accountingoffices still of control by provincial andnational remain with the provincial governmentsover some offices under governments. the CGA authority needsto be resolvedfor coherentreporting and undiluted administration ofthe accountingand reporting function. 6. I s the statement of cash No. A basic statement of cash A statement of cash receiptsand receiptsand payments in receipts and paymentsis provided paymentsas per the IPSAS Cash IPSAS form? but this information is currently Basis can be preparedusing existing presentedin formats inconsistent information from the accounting with the IPSAS. records. This work requires some restructuring ofthe financial reporting formats. 7. Are accountingpolicies No. Statements of accounting There is aneedto state the and explanatorynotes policies are not provided inthe accountingpolicies andthe basis on required? budget or accounts documents. which the accounts are prepared. 8. Are other disclosures in Partly. Financial statements are Itwould be necessaryto reduce the accordwith IPSAS? not availablewithin 6 months of reporting lag, improve the reporting period; some items reconciliations, and disclose further are not disclosed, andpresentation information (e.g., on the treatment of does not meet some transparency foreign currency). requirements. 9. Does the government No. A statement of cashreceipt and issue a consolidated payment as per the CashBasis financial statement that IPSAS can be prepared. Further consolidates all controlled steps will be neededto consolidate entities? the financial information ofthe controlled entities. 5. Implement the Financial Audit Manual that has been prepared using the IFAC-issued International Standards on Auditing (ISA), as well as of the International Organization of Supreme Audit Institutions (INTOSAI). The Auditor General of Pakistan has approved the new Financial Audit Manual, which follows the modern risk-based certification audit approach. A program for implementation of this Manual is in preparation. The Auditor General has already formally adopted the INTOSAI Auditing Standards with minor modifications. The INTOSAI recognizes that its Auditing Standards are broad in nature and that the IFAC-issued International Standards on Auditing provide a further level of detail for public sector audit guidance. The INTOSAI is working with IFAC inthe longer term to develop practice notes to assist with the implementation of each ISA in the public sector. Annex B lists the INTOSAI and IFAC standards. 3 6. Improve the jurisdiction, mandate, and functions of the Auditor General of Pakistan as envisaged in the Auditor General Ordinance 2001, and strengthen the reportingand disclosureprocessesof audit conclusions. Auditing practicesneedto be revised in line with the INTOSAI Auditing Standards, IFAC-issued International Standards on Auditing, and the new Financial Audit Manual. Reporting of audit results needs to be more timely and to be disseminated more publicly. The incentives for auditeesto take action on audit findings would increase by facilitating easy access to, and greater dissemination of, audit reports. And this would be helped by more focused and effective report writing andreport follow-up processes. 7. A Supplementary Table of Standards and Gaps o f this report provides a matrix detailing the current standards, the present position, and options for improvement. A summary of auditing issues is shown inTable ES2. '1 ble ES2. Summary of Auditing Sta dard Issues Standard Current status Activity required to adopt international standards 1. I s the SA1statutory Partially. Some additionalpowers Some revisions inthe Auditor framework inaccordwith needto be establishedby GeneralOrdinance 2001are the needs ofthe INTOSAI legislationas set out below. required. Auditing Standards? 2. I s there a body to Yes. It has beenconstruedfrom To improve onthis, the Auditor prescribepublic sector various provisions of legislation, Generalshould coordinate with ICAP auditingstandards? includingSection22 ofthe Auditor to form a Public Sector Committee GeneralOrdinance2001that the for review and adoption of ISA. Auditor General wouldbe the standard-settingauthority for public sector auditing. Thus, the Auditor Generaladopted INTOSAI Auditing Standards as recommendedby a committee of senior officers inthe DAGP. 3. Have INTOSAIand Partly. The Auditor Generalhas A Public Sector Committee should IFAC audit standards adoptedINTOSAI Auditing be usedto adopt ISA and develop beenadopted? Standards. formal implementationnotes for guidance, 4. Has a code of ethics Yes. equivalent to the INTOSAIAuditing Standardsbeen adopted? 5. I s the accountability Yes. process inthe SA1in accordwith INTOSAI Auditing Standards? 6. Doesthe SA1legal Largely. The Auditor General needs improved framework meet the legislationto exclude limitationson INTOSAIAuditing jurisdiction, mandate, and function of Standards for this position;and improvedoffence independenceand clauses together with enhancement in powers? transparency and disclosureof audit Pakistan should nominate persons to the Reference Panel of the INTOSAI Working Group on Financial Audit Guidelines,which is a subcommitteeofthe INTOSAI Auditing Standards Committee. 4 Standard Current status Activity required to adopt international standards conclusions. While not mandatory, the national audit legislation should match international model^.^ 7. Does the educationand Partly. Staff needs more The AATI should continue to review training ofthe auditors professionaltraining. its syllabusto cover all areas accord with INTOSAI recommendedby the IFAC and IES? educationalstandards. 8. I s the SA1equipped Yes. But not implementedin full Improved methodologiesare being with the audit methods at the moment. implemented.The technology and technologiesto meet requiredto support amanagement the INTOSAIAuditing information system for the Auditor Standards? General is missing. The requirements are being acquiredthrough PIFRA. The implementation plan will review capacity for implementing the new Financial Audit Manual. 9. Does the SA1havethe Partly. Internal quality assurance Improved working paper guidance requisitequality assurance and supervisionprovide review and computerization combinedwith programsto meet arrangements among the field audit more effective supervisionand more international standards? offices. independentquality review processes are needed. 10. Doesthe processto Partly. Improved methodologies The audit process shouldbe risk- planthe audits meet are being implemented. basedallowing sufficient flexibility internationalstandards? to the auditorsto articulate and apply appropriateaudit procedureson methodically selected samplesto arrive at representativeaudit conclusions. 11. Does the process of Partly. Working paper systems The revisedworking paper structure supervisingthe audits and audit methodologiesdo not shouldbe implementedtogetherwith meet international currently enable effective the new Financial Audit Manual for standards? supervision. Improved audit supervision. methodologiesare being implementedunder PIFRA. 12. Does the process of Partly. Improved methodologies The methodology needs to be more evaluatingthe reliability are being implemented. risk-and systems-based. of internal control meet the international standards? 13. Does the process used Partly. Improved methodologies The methodology needs to be risk- in auditsto assess are being implemented. and systems-basedand may be compliance with laws integratedas plannedwith the annual meet international certification audit. standards? 14. Does the audit process Partly. The evidence to support More rigorous plans for audit testing usedto obtain evidenceto audit criticisms on individual needto be developedas per the support conclusions meet transactionsis for the mostpart Financial Audit Manual. The international standards? betterthan that availableto provide evidence for more general audit the more general audit assurance assurance needs better organization. Guidance i s provided by (1) a general prescription of a model law developed by the UNDP Program for Accountability and Transparency (PACT) and (2) the Model National Audit Office Act by The Associationof CharteredCertified Accountants, UK,2004. 5 Standard Current status Activity required to adopt international standards on the summary figures inthe financial statements. 15. Doesthe audit analyze Partly. The existing structure of The full implementation of IPSAS the financial statementsto the financial statements only would improve the DAGP's ability to establishwhether provides limited scope for financial do meaningful and reliable financial acceptable accounting analysisthat is useful for analysis. standards for financial certification audit. reporting and disclosure are complied with? 16. Doesthe auditor Not fully at this stage. The The CGA program to provide annual preparean audit opinion Auditor Generalsigns an opinion accounts inthe IPSAS format needs on the financial on the accounts; but because the to be establishedreliably. The statements in a form that financial statements are not timetable and program for the accords with international preparedinaccordancewith implementation ofthe newly adopted standards? adequate standards,the wording of Financial Audit Manual needs to be the audit opinion does not contain specified to accordwith the all ofthe requirementsof ISA 700, availability of auditableaccounts. TheAuditor's Reports on The Manual is aimed at forming an Financial Statements. The opinion on the truth and fairness of wording does not clearly indicate the financial statementsso that the the fmancial reporting framework Auditor Generalcan sign an opinion usedto prepare the financial inaccordance with ISA 700. statements, nor does it state the The audit methodology specifieshow auditor's opinion as to whether the the audit work can be plannedto financial statements give atrue and meet the confidence level that is fair view (or are presentedfairly, implicit inthe audit opinion, and in all materialrespects) in identify the level and extent of audit I accordancewith that financial testing required inorder to express reporting framework. that opinion. 17. Does the Partly. Audits focus on examining The testing needsto be more considerationof fraud and transactionsfor discrepancies and statistically based. Forensic audit error in an audit of regulatory breaches. Muchof the training is neededto categorize the financial statements reporting seems to relateto observationas either a mistaken accordwith international fraudulent behaviorand suggesting violation or a deliberate and standards? recoverieswithout exposingthe intentional act to take undue benefit. facts indetail. 18. Are the Auditor Apparently. But only after tabling The audit legislation shouldformally General's reportsmade inthe Parliamentandconsideration provide for reportsto bemade public? by the Public Accounts public, and publicly availablewhen Committee. The legislation does tabled inthe Parliament. not specifically require publication. 19. Is the process for Partly. Improved audit, Public Improved audit methodology and taking action on audit Accounts Committee, and report writing on the one hand and recommendations departmentaladministrative reform ofthe fundamentalprocesses sufficiently effective to processesare neededfor follow-up for scrutiny on the other, are required meet international of audit reports. There is an to reduce this backlog. standards? enormous backlogby the Public Accounts Committee inreviewing the audit observations.Effective review ofthe backlog is becoming increasinglyimpossible. 6 8. The Commercial Audit Wing of the Auditor General Pakistan should perform a stronger review role for the compliance with International Accounting Standards and International Financial Reporting Standards (IASDFRS) by the state-owned enterprises. Since the financial statements o f many of the state-owned enterprises (SOE) are not audited by the Auditor General o f Pakistan, there are transparency issues relatingto the use o f public funds inthese enterprises that may not be subjected to legislative scrutiny by the Public Accounts Committee. The reasons include, but are not limited to, the lack of capacity in the office of the Auditor General to coordinate and review the work o f the external auditors o f these enterprises. There i s a need for specialized training inthe use o f international accounting and auditing standards, and inusing the work o f other auditors. Many o f the state-owned enterprises are outside the IAS/IFRSand other financial reportingand enforcement regimeso fthe Securities and Exchange Commission o f Pakistan and the State Bank o f Pakistan. Those state-owned enterprises registered by the Securities and Exchange Commission o f Pakistan should be audited by professional accounting firms that are selected by, and report through the Auditor General. There i s a need for the DAGP Commercial Audit Wing (after it i s strengthened) to review all state-owned enterprises for IAS/IFRS compliance. In addition, the Corporate Finance Wing inthe Ministry o f Finance, whose responsibility i s to do more general monitoring, will be strengthened under a proposed capacity-building project. This project, fundedby the World Bank, has not yet started. 9. Continue to improve public financial management through the reform program.Public financial management relies on a comprehensive and timely accounting and financial reporting system. This system should be supported by a professional audit function that assures competency and reliable information within the system. Current enforcement o f adequate compliance with financial regulations in the general budget sector and corporate governance in the public enterprise sector falls short o f satisfactory performance. The Country Financial Accountability Assessment for Pakistan concluded that there are significant challenges remaining within the country's public financial management reform agenda to improve the effectiveness and productivity o f public pen ding.^ Ongoing reforms and capacity-building measures will help to strengthen performance in the PFM arena. Accountability based on the formal adoption o f international accounting and auditing standards i s a timely step for the Government o f Pakistan to take now. And the implementation o f these standards needs to be supported by a more comprehensive PFM reform program to achieve substantial positive impact. The P I F M I1is covering most o f the required reform elements. The Finance Division has issued in September 2006 a memorandum5 covering a new system o f financial control and budgetingwhich includes inter alia the specific duties and responsibilities o f Principal Accounting Officers, Chief Finance and Accounts Officers, and Financial Advisers. Economy and regularity are the two main principles to be observed. World Bank, Country Financial Accountability Assessmentfor Pakistan, South Asia Region. December 2003. EstablishmentDivision O.M. No F.3(2) Exp.III/2006 dated 13/9/2006 7 10. Improve accounting and auditing skills of the Pakistan Accounts and Audit Service. For bringing about improvements in compliance with international standards there i s a need for properly trained staff. Current programs are providing strong support inthis area. The success will depend onhow well the strategies are implemented. 1. Introduction 1. This assessment of public sector accounting and auditing is generally meant to help implement a more effective public financial management (PFM) through better quality accounting and public audit processes inPakistan and to provide greater stimulus for more cost effective outcomes o f government spending. More specific objectives are: (a) to provide the country's accounting and audit authorities and other interested stakeholders with a common, sound knowledge as to where local practices stand in accordance with international standards o f 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 o f public sector accounting and auditing, the World Bank, with the cooperation o f member governments, i s conducting a Review o f Public Sector Accounting and Auditing Practices in member countries. In conducting this assessment, a set o f diagnostic questionnaires [developed to be consistent with the context o fthe PFM Performance Measurement Framework6 used by the Public Expenditure and Financial Accountability (PEFA) Program7], was used to gather substantial insight into country performance with regard to the external auditing and financial statement reporting PFM indicators. Annex A discusses the methodology used for conducting the assessment in this report. 3. The diagnostic questionnaire was used to gather information on national standards and practices for accounting, financial reporting, and auditing in the government budget sector and in the 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 the International Federationo f Accountants (IFAC) and the InternationalOrganization The PFM Performance Measurement Framework has been developed as a contribution to the collective efforts of many stakeholdersto assess and develop essential PFM systems, by providing a commonpool of information for measurement and monitoring of PFM performance progress, and a common platform 'for dialogue. The PEFA Program is a partnership among the World Bank, the European Commission, the UK Department for International Development, the Swiss State Secretariatfor Economic Affairs, the French Ministry of ForeignAffairs, the RoyalNorwegian Ministry of Foreign Affairs, the International Monetary Fund, and the Strategic Partnership with Africa. A Steering Committee, comprising members of these agencies, managesthe Program. A Secretariat is locatedat the World Bank in Washington, DC. 8 o f Supreme Audit Institutions (INTOSAI). Annex B summarizes the international accounting and auditing frameworks that were used in this assessment. The responses to these questionnaires stimulated further discussions among the World Bank team and senior staff in the offices o f the Auditor General o f Pakistan (AGP) and Controller General o f Accounts (CGA). These discussions examined accounts and audit reports and working papers as a means to jointly explore the quality o f processes and products. 4. The maintenance system for public accounts inPakistan is long standing. Since 1997, the World Bank Project for Improvement o f Financial Reporting and Auditing (PIFRA) has supported the comprehensive reform efforts by the Government o f Pakistan to streamline its accounting and auditing systems and procedures, while developing the institutional and individual capacities for better public financial management. The initial reforms included some separation o f audit and accounts activities through promulgation o f legislation relating to separate roles for the Auditor General and the Controller General o f Accounts. They also included designing modem accounting and auditing processes and devising a comprehensive human resource management plan. The replacement o f inefficient manual and outdated accounting processes in the general government sector by faster and updated computerized programs (using.the accounting software package SAP W3) is underway with a program to computerize all district accounting offices by the end o f 2007. Annex C includes excerpts from Pakistan auditing and accounting legislation. 5. The second phase o f the PIFRA project, PIFRA 11, will help the government to build capacity to improve the accuracy, comprehensiveness, reliability, and timeliness o f intra-year and year-end government financial reports at federal and provincial levels.' The PIFRA I1 will also initiate the process at district and sub district levels thereby strengthening the financial accountability cycle. The project would therefore directly support the commitment o f the Government o f Pakistan in improving public financial management, accountability, and transparency, and enhance the capacity o f public sector managers to meaningfully use credible financial information for better and informed decision-making. It will facilitate public oversight o f the use o f public monies, and increase the national and international credibility o f the national and provincial governments' financial statements and assurance proces~es.~ 6. The reform efforts need to include identification o f the relevant international standards o f accounting and auditing applicable to the public sector and help achieve compliance with those standards. Adoption o f International Public Sector Accounting Standards (IPSAS) for accounting and financial reporting and the IFAC-issued International Standards on Auditing (ISA) in addition to the INTOSAI Auditing Standards are important steps in improving the basis for adequate public financial management. 8PIFRA I1has 4 core components: (a) financial accounting and budgeting systems, (b) capacity building for the office of the Auditor General of Pakistan, (c) capacity building for the office of the Controller Generalof Pakistan, and (d) project management. 9Project Appraisal Document, Second Improvement to Financial Reporting and Auditing Project, World Bank,August 5,2005. 9 II. Public Sector Accounting A. Institutional Framework for Public Sector Accounting 7. The institutional framework for public sector accounting should include adherence to international accounting standards and use o f qualified accounting staff to provide timely, relevant, and reliable financial information that i s needed to support all fiscal and budget management, decision-making, and reporting processes. The diagnostic questionnaires, which were used in this assessment, have collected information on the current arrangements and the apparent gaps in Pakistan for accounting laws and regulations; education and training o f public sector accountants; application o f a code o f conduct; and numbers and characteristics of public sector accountants. (1) Accounting Laws and Regulations 8. The Constitution of Pakistan delineates the authority of the Auditor Generalof Pakistanfor prescribingthe form, principles,and methods of accounts of the Federationand of the Provinces with the approvalof the President. Underthese conferred powers, the Auditor General has endorsed the Accounts Codes (Volume Ito IV) and a New Accounting Model (NAM) for implementation when practicable." The PIFRA project i s computerizing the accounting functions to enable the New Accounting Model to be implemented. Accounting functions are the responsibility o f the Controller General o f Accounts. 9. A committee should be setup to review and steer the process of implementation of IPSAS on a progressive basis. The committee should have oversight o f the financial reporting specialists in steering the adoption o f IPSAS towards the accrual basis o f accounting." The NAM development in 1998 used the IFAC-issued Guidelines for Governmental Financial Reporting and best practice from other countries.'* There i s now an opportunity to apply the IPSAS, that have been developed since 1998, in the New Accounting Model and review the accounting model during its implementation. The Auditor General o f Pakistan and Controller General o f Accounts have already been engaged in deliberations to move towards adopting IPSAS. The loThe New Accounting Model is a set of 7 books: Accounting Principles Manual, Accounting Policies and Procedures Manual, Chart of Accounts, Accounting Guidelines, Accounting Procedures for Self- Accounting Entities, Book of Forms, and Financial ReportingManual. Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities, ''InternationalAccounting Federationof Accountants Public Sector Committee Study 14, December2003. The New Model sets the national standards of accounting and financial reporting. PricewaterhouseCoopers analyzed differences between IPSAS and the New Accounting Model in 2004. The New Accounting Model is being implementedusing the cash basis of accounting and will gradually move towards the accrualbasis. Formal adoption of IPSAS would enable the customization of the N A M financial reporting formats incompliancewith relevant IPSAS requirements. 10 adoption of IPSAS I1cash flow formats i s a step inthis dire~tion.'~The NAM Financial Reporting Manual provides for such reporting, which generally complies with Cash Basis IPSAS.14 This reporting also includes the optional disclosure requirements that are required to accord with IPSAS, such as third party payments and receipts that needto be identified and shown in a separate column. State-owned enterprise results should be consolidated into the annual accounts. Annex D discusses the benefits o f accrual basis o f reporting. 10. The PIFRA project is supporting the implementation of the New Accounting Model. Institutional and individual capacities in both the public sector financial management agencies, as well as the executivehervice delivery formations are being developed through implementation o f a comprehensive capacity development program mainly sponsored by PIFRA. The PIFRA project is supporting the implementation o f the New Accounting Model through the implementation o f computer accounting hardware and software application to all district accounts offices. (2) Education and Training 11. The Audit and Accounts Training Institute (AATI) is a countrywide network providing professional training in public financial management to both accounting and executive arms of the government. The AATI conducts long-term courses that lead to the Pakistan Institute o f Public Finance Accountants (PIPFA) certification.l5 The AATI also conducts short courses for professionaldevelopment. 12. The AATI has included the use of IPSAS in its course work. Through the technical assistance provided under the PIFRA, AATI has revitalized its syllabi and learning methodologies. It i s now geared to teach areas o f practical application, including IPSAS. The AATI has developed a comprehensive annual training program and has set targets for the first year. 13. Offering international education standards will help to develop more professionalaudit and accountingstaff. The strategy is to offer learning opportunities to develop qualifications that are compliant with the IFAC International Education Standards (IES) and acceptable to other professional accountancy bodies. The AATI has been cooperating with professional accountancy bodies to seek acceptance o f AATI qualifications that would meet the qualifications for professional accreditation o f other professional bodies -the Association o f Chartered Certified Accountants (ACCA), UK; l3 Notification of financial reporting policy, dated June 29, 2005, adopts Cash Basis IPSAS with a trial implementationofthe policy for FY2004-05 and effective date inFY2005-06. 14 The annual financial statements consists of the following: (a) statement of assets and liabilities, (b) statement of revenues and expenditures (by function and by object), (c) statement of cash flows, (d) notes to financial statements, (e) summary of appropriation accounts by grants and appropriation, (Q appropriation accounts by economic function and department/division (g) appropriation accounts by grant, and (h) analysis of revenueby divisioddepartment. 15The PIPFA is abody of professional accountants and an associate member of the International Federation of Accountants. It is a joint initiative of the Auditor General of Pakistan, the Institute of Chartered Accountantsof Pakistan,and the Institute of Cost and Management Accountants of Pakistan. 11 Institute o f Chartered Accountants o f Pakistan (ICAP); and Institute o f Cost and Management Accountants o f Pakistan (ICAMP). 14. The selection and training of government accountants differs from one departmental cadre to another, and falls short in ensuring the qualifications essential for providing competent professional accounting service in the public sector. The bachelor o f commerce/accounting i s the minimum academic requirementsfor an individual seeking to work in the departmental cadre o f public sector accountants. However, the inter-departmental cadre civil servants do not require such qualifications; they are recruited as generalists through the Federal Public Service Commission. These inter-departmental officers are given nine-months o f probationary training at the AATI and are encouraged to take further specialist training. Nevertheless, this approach continues to fail to provide for competent professional accounting service, equivalent to that provided by the private sector with its ICAP requirements. (3) Code of Conduct 15. A code of ethics should be included in staff contracts. The INTOSAI Code o f Ethics has been adopted by the Auditor General o f Pakistan and should be followed by staff doing audits and maintaining accounts.16 The same has been included in the AATI syllabus. As such, the code o f ethics i s part o f the overall guidance provided by the head o f an organization to each staff member. Non-compliance o f the code could lead to actions in accordance with Efficiency and Discipline Rules o f the Government o f Pakistan. The code o f ethics should be made a part o f staff contracts upon acceptance o f ajob, or separately signed by the employees as a legally enforceable document. (4) Public Sector Accountant Arrangements 16. Duality of control over accounting staff should be resolved. With the exception o f a few departmentalized accounts, the Government follows a regime o f centralized accounting offices that keep accounts o f all departments in their regional jurisdiction. Out o f 10,000 staff posted in the accounts offices, 921 staff members are employed by the federal government. The remaining staff comes mainly from the treasury services under the provincial finance departments. These provincial offices serve under the technical supervision of the Accountant General who is responsible to the Comptroller o f General Accounts; but treasury staff i s answerable to the Secretary o f Finance o f the relevant province. This duality o f control over the accounting staff remains a problem o f administration and authority and needs to be resolved. 17. Budget officers (chief financial officer) should be adequately qualified to maintaininternal financial control. The budgetofficers should have the qualifications l6 Some adaptations and deletions were made by a committee constituted by the Auditor General of Pakistan in connection with issuing the INTOSAI Code of Ethics and Auditing Standards. Only one paragraphrelatingto political neutrality (paragraph 21) was deleted from the Code of Ethics and minor changes ofnomenclaturewere made. 12 to undertake responsibility for maintaining systems o f internal financial controls that manage risks, and for preparing regular financial management reports for the principal accounting officer.l7 The principal accounting officer i s generally supported by a budget officer from within that line agency. These agency staff members require substantial training to equip them with the necessary tools o f financial management to effectively assist the principal accounting officers. New positions o f Chief Finance and Accounts Officers (CFAO) have been introduced under the system o f financial control and budgetingintroduced in September 2006. The system specifies that the CFAO shall be a well-trained and experienced officer. It is important that the Establishment Division which i s to arrange the postings o f these officers, ensures that this requirement reflects the expertise needed for the function. 18. Internal audit units should be established as per staffing and operational planningdevelopedunder PIFRA. Under PIFRA, a comprehensive plan was developed to initiate the internal audit function in government agencies for which a center o f excellence i s envisaged within the office o f the Comptroller o f General Accounts. Chief audit officers have been posted in 15 federal ministries with responsibilities for internal audit, reconciliation o f accounts, coordination with departmental and parliamentary Public Accounts Committees, and the financial propriety o f expenditure and receipts. More funding should be arranged to enable an effective internal audit function as per the staffing and operational plans developed under PIFRA. B. Accounting Standards as Practiced 19. The diagnostic questionnaires collected informationon the current arrangements and the apparent gaps in Pakistan for setting public sector accounting standards, and for presenting financial reports. (1) Setting Public Sector Accounting Standards 20. In the existingformat of the finance and appropriation accounts, there are considerabledepartures from Cash Basis IPSAS. Gradually the budget sector is being converted to the NAM Chart o f Accounts. Conversion to the NAMreporting framework i s dependent on the roll-out o f the PIFRA accounting systems and the implementation o f all the accounting functions. Pensions, general provident fund, and asset accounting are examples o f functional modules yet to be implemented. Government accounts are presented inthe old formats o f the finance and appropriationaccounts. (2) Presenting Financial Reports 21. Use of the cash basis of financial reporting provides a necessary scope to the implementationof the New Accounting Model. One particularly useful feature of "Theprincipalaccountingofficerisusuallythesecretaryofaministryorheadofthelinedepartment. 13 the Cash Basis IPSAS format i s the disclosure o f third party payments in separate columns on the face o f the statement o f cash receipts and payments. These disclosures enable users to identify the total amount o f payments made; the purposes for which they were made; and whether, for example, the payments were made from amounts allocated or appropriated from general revenue or from special purpose funds or other sources. A case in point within the government sector i s the payment o f the electricity utility, WAPDA, by the central government, which then deducts these payments at source from its transfers to provincial governments. Provincial governments in turn deduct at source from transfers to local governments. As provincial and local governments are not well- notified o f these deductions (as would be required in meeting Cash Basis IPSAS), they become a source o f confusion and inefficiency. The government entities are unaware o f their power costs and hence less likely to seek ways to be more economical. Also, as bills are already "paid," there is less incentive for the utility to ensure that its records reconcile with customers' records. 22. Table 1 identifies the current position and steps required if the Cash Basis IPSAS were to be adopted. Cash Basis IPSAS Requirements Current deficiencies Activity required to adopt Cash Basis IPSAS Financial The Pakistanreporting structure A statement of cashreceipt and payment statements focuses on consolidatedfund and as per the Cash Basis IPSAS can be presentedinIPSAS public accounts and the CashBasis preparedusing existing information from IPSAS for financial statements is not the accountingrecords.Also, for each followed. entity (Le., ministry and department), an additional statement inaccordwith Cash Basis IPSAS can be prepared.This may require some restructuring ofthe NAM computerizedreporting formats." Information All this information is available on This work requiresrestructuring ofthe required in the governmentreporting system, but reporting formats andrectification of accordance with i s in formats inconsistentwith errors inrecording and compiling the IPSAS inthe IPSAS. Some negativebalances are accounts. Third party paymentswould be statement of cash appearinginthe finance accounts. shown separately inthe Cash Basis receiptsand The cashbalanceappearing inthe IPSAS format. payments financial statements is not reconciled with the bank accounts and receivables are appearing from bodiesthat no longer exist. Accounting Statements of accountingpolicy are There is a needto state the accounting policies and not provided in the budgetor policies for various elements ofthe explanatory notes accounts documents. financial statements and the basis on which the accounts are prepared. General At present financial statements are It would be necessaryto reducethe considerations not available within 6 months ofthe reporting lag; and to disclose further 0 reporting period reporting period; cash balancesthat information. Legislation shouldenforce adequacy of are available for use and cash specific timelines for the publication of 18 It is understood that changes in the financial reporting formats would not be considered as a departure from the new structure of accounting policies and practices as approved by the Auditor Generalwith the consent ofthe President. 14 Requirements Current deficiencies Activity required to adopt Cash Basis IPSAS information about balancesthat are subjectto external annual audited financial statements of the the entity restrictions and un-drawnborrowing government. 0 presentationof facilities are not disclosed, and comparative presentationdoes not meet certain information transparency requirements. Although the authorization date is mentioned on the accounts, it i s not clear when these financial statementsbecome accessible to the general public or media. Correction of The nature of errors inprior periods, Further training andbetter supervisionof errors disclosed the amount ofthe correction, and the accounts officers would be neededto 0 natureof error fact that comparative information has correctly classify expendituresand 0 amount of beenrestated, or that it is disclosureof errors rectified prior to the correction impracticableto do so, is not reporting period and restatement of 0 comparative disclosed. comparativeinformation where information practicable. restated Consolidated The governmentbudget sector is a A statement of cashreceipt and payment financial reporting entity, as well as an as per the Cash Basis IPSAS can be statements economic entity. prepared.Further steps will be neededto includecontrolled entitiesas per IPSAS and Section7(b) of the CGA Ordinance. Treatment of The government largely follows Need to comply with the disclosure foreign currency IPSAS except for the disclosure aspects of the accountingand financial cash receipts, aspects inrespect of accounting reporting treatment of foreign currency. payments, and treatment of foreign currency. balancestreated in compliance with IPSAS Effective date of The governmenthas not formulated a Need for the Auditor Generalto formally IPSAS Part Iand migration path andtimeline for adopt IPSAS and for the CGA to prepare transitional achieving CashBasis IPSAS, PartI, an implementation plan andtimeline provision compliance. setting out specific steps to be taken, compliance. including disclosure, ifnecessary, of application ofthe transitional provision (Le., fillcomplianceachievedwithin 3 years) for reportingperiodsbeginning on a date within 3 years of first adoptionof IPSAS. C. Assessment of Accounting and Auditing in State-Owned Enterprises 23. I t should be mandated by law that the financial statements of the state owned enterprises be prepared in accordance with the IASAFRS. Many state-owned enterprises are registered under the Company Law. Under the Companies Ordinance 15 1984, it is obligatory for all listed companies to present their financial statements in accordance with IAS/IFRS.l9 These companies are required under the Companies Ordinance to be audited by a chartered accountant. The Institute of Chartered Accountants in Pakistan has mandated the observance o f International Standards on Auditing by its members. Upon receipt from the IFAC, exposure drafts of proposed International Standards on Auditing are sent to ICAP members for comments. These comments are returned for consideration by IFAC. When the final standard i s issued, ICAP adopts the International Standard on Auditing without modification. For non-listed companies, the implementation and enforcement o f IASAFRS i s not finalized. Enforcement o f International Standards on Auditing for the audit o f non-listed companies i s less stringent thanthat for the listed companies. State-owned enterprises, which are not incorporated under the Company Law, do not usually apply IAS/IFRSfor accounting and financial reporting. The financial statements are generally audited after a long lag time. 24. There are serious issues relating to the use of public funds in state-owned enterprises that are not subjected to legislative scrutiny by the Public Accounts Committee. A review o f a sample of financial statements o f state-owned enterprises that are audited by Chartered Accountants indicated that the audit reports generally contained either significant qualifications and/or emphasis o f matter paragraphs modifying the audit opinion. The Auditor General o f Pakistan while conducting the regularity or performance audit cannot utilize the qualifications given in the audit report on the financial statements. The Auditor General does not have access to the management letter given by the external auditors to the state-owned enterprises, nor do they have access to the financial audit working papers. Thus serious issues relating to the use o fpublic funds are not subjected to legislative scrutiny by the Public Accounts Committee through consideration o f the Auditor General's reports. The preferable practice i s for the Auditor General to be able to review the working papers and reports o f the contracted audit 25. There is a need for specialized training in the utilizing of IASAFRS, ISA, and using the work of other auditors. The resources for auditing public sector enterprises inthe DAGP are in short supply; and DAGP staff generally i s not adequately trained in accounting. The need for additional specialized training in the applications o f IAS/IFRS and ISA and using the work of other auditors has been recognized as a need. Greater provision o f this training could be provided perhaps through the AATI or outsourced to the private sector institutions. 26. The Commercial Audit Wing of the Auditor General of Pakistan should perform a monitoring role for the compliance of IASAFRS by state-owned enterprises. Monitoring o f state-owned enterprises needs improvement. There is currently no Public Sector Enterprises Monitoring Board as established inother countries. This role is performedby the Corporate Wing o fthe Ministryo f Finance. Some proposals The Report of Observance of Standards and Codes - Accounting and Auditing in, Pakistan, 2005, *' providestheimplementationstatus of IAS IFRS andrelatedissues. Section 25, A Model NationalAudit Office Act, The Association of Chartered CertifiedAccountants, UK,2004. 16 are in place for strengthening the Corporate Wing. There i s little involvement o f the Auditor General in the selection o f the external auditors o f these state-owned enterprises.21 The respective ministrieddepartments with which individual state-owned enterprises are attached exercise varying levels o f monitoring on these bodies. Many o f these state-owned enterprises are outside the enforcement mechanisms (of IAS/IFRS and other financial reporting) by the Securities and Exchange Commission o f Pakistan and the State Bank of Pakistan. Hence, there is a need for the Commercial Audit Wing of the Auditor General o f Pakistanto be strengthenedto perform a more comprehensive review role for the compliance o f IAS/IFRSby state-owned enterprises. 111. Public Sector Auditing A. Statutory Framework for Public Sector Auditing 27. Effectual scrutiny by the legislature to ensure effective implementation o f fiscal and expenditure policies needs comprehensive and competent external audits that are underpinned by international standards on auditing.22 The environment for an effective Supreme Audit Institution (SAI) requires a comprehensive approach to public financial management. Supreme Audit Institutions are not stand-alone institutions. They are part o f a PFM architecture that includes budgeting, accounting, internal control, audit and legislative oversight, and government response. Improving the way the supreme audit institution functions i s integral to providing information for improving the overall PFM system. But the action mustbe withinthe executive branch yet under the watchful eyes o f the legislature and the public. A strong demand for good public sector external auditing is necessary for the supreme audit institution to have any impact. This requires willingness o f the executive branch to accept and respond to external scrutiny over its management o f funds and to ensure that reform action is taken. It also requires public presentation of the audit reports to ensure public support for effective action. All o f these requirements are covered by the INTOSAI and IFAC auditing standards listed in Annex B. These should be adopted by the Auditor General o f Pakistan. The Government noted in its response to the draft report that the statutory framework included considerations of the Constitution and that it was not appropriate to compare with the frameworks o f other countries as the frameworks reflect the choices made by the people o f each country. Recognizing this, the report does not make comparisons between country's Constitutions; rather it identifies how the Constitution for Pakistan or other elements o f the legal statutory framework make provision for the auditing principles that are set out in INTOSAI guidance. 28. The diagnostic questionnaires have collected information describing current arrangements and the apparent gaps inthe country inthe following areas: *'Although there is a requirementto get approval of the selectedauditor's (CA) name, in many cases it is not observed. Evenwith compliance, in practice management finalizes the selection of the audit firm, a practicethat throws into questionthe independenceofthese auditors. 22Scope, quality, and follow-up of external audit is performanceindicatorNo. 26 in the PFM Performance MeasurementFrameworksupportedby the World Bankand other developmentagencies. 17 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 for the auditors, Arrangementsfor providing training, Arrangementsto ensure auditor competence, Arrangementsfor quality assurance. 29. Those areas with significant scope for improvement are discussed below. (1) Statutory Framework 30. The Auditor General's Ordinance 2001 requires some improvements. The Auditor General i s appointed under provisions stipulated in the Constitution o f Pakistan 1973 (as amended). The Auditor General's (Functions, Powers and Terms and Conditions o f Service) Ordinance 2001 details the mandate, role, and powers o f the Auditor General o f Pakistan. The Ordinance requires some improvements to remove jurisdictional limitations on the AGP mandate: (a) make an explicit mention o f the proprietary, efficiency, effectiveness, and economy in the use o f public funds; and (b) provide for necessary dissemination arrangements for the audit reports. 31. The Auditor Generalof Pakistanshould havethe authorityto conduct a full rangeof audits for all government-ownedor -controlledentities.The Auditor General has full authority for auditing all budget sector receipts and expenditures from all government accounts, including defense expenditure^.^^ The Auditor General has the authority to audit any body or authority established by the government, or which has received a loan or grant; however, there are some exclusion clauses allowed for, in the Constitution as well as in the Auditor General's Ordinance. Article 169(b) o f the Constitution limits the powers and function o f the Auditor General in relation to any authority or body established by the government depending on the provisions contained in the respective legislation establishing that authority body. Similarly, Sections 9 (explanation), 11 (proviso), 15, and 16 o f the Ordinance impose certain conditions on the powers and function o f the Auditor General in relation to the audit o f public sector enterprises. These jurisdictional limitations are under review; potential revision o f the Ordinance to remove the restrictive or exclusion clauses i s underway by a committee o f the Auditor General, Secretary Finance, and Secretary Law. The Public Accounts Committee o fthe Parliament i s pursuingthis issue. 32. The Auditor General of Pakistan should have the authority to conduct a full range of audits, including regularity, financial, and performance audits. The 23 There are minor exclusions of practice relating to receipts kept as local funds or so called non-public funds by some institutions. 18 Auditor General's (Functions, Powers and Terms and Conditions o f Service) Ordinance, 2001 specifies the following types o f audits: 0 Section 7, Certification Audit (Accounts) 0 Section 8, Regularity Audit 0 Section 9, Audit o f Authorities having loans or grants from public money Section 12, Audit o f Receipts Section 8 & 9, Receipts and Expenditures (includes authorities and bodies substantially financed by loans and grants) 0 Section 10, Studyreports (which may include performance, governance, debt-management, or environment) 0 Section 15, Audit o f Companies and Corporations established underthe public sector. 33. There i s no explicit mention o f the proprietary, efficiency, effectiveness, and economy o f use o f public funds in the Auditor General's Ordinance, yet many o f the senior staff categorized these as the main objectives o f the AGP audit. The proposed review o f the Ordinance to resolve jurisdictional issues should also look into providing for a specific mandate o f the Auditor General in relation to proprietary, economy, efficiency, and effectiveness o f utilization o f public funds along the lines o f the model legislation proposed by the UNDP or the ACCA.24 34. The legislation should clearly set out penalties and their appropriate application in the event of noncompliancewith auditing requirements. Section 14 o f the Auditor General's Ordinance applies to any person or authority hindering the audit functions o f the Auditor General with regard to inspection o f accounts; this person or authority shall be subject to disciplinary action under relevant Efficiency and Discipline Rules, as applicable to their actions. Section 14 does not mention who would initiate such an action. Either the Auditor General, Public Accounts Committee, Public Accounting Officer, or another body could potentially initiate the action. Consequently, the implementation of this section could be problematic. In case of any hindrance or problem, the Public Accounts Committee generally issues directives to the executives with regardto compliance of auditing requirements. This process is lengthy and subject to many delays thereby reducing the effectiveness o f the provision. The Auditor General should have specific powers to initiate action against persons who refuse to provide auditable accounts and relevant records to the DAGP staff. 35. Necessary dissemination arrangements for the audit reports should be clearly laid down in the legislation. The legislative scrutiny is not supported by public scrutiny due to un-disseminated audit reports and government financial statements. There i s confusion as to when audit reports and government financial statements become public documents. Specific provisions in the Auditor General's Ordinance should make public 24 Section 21 of the Model Law developed by the UNDP Program for Accountability and Transparency (PACT); and Sections 32 and 55 of A Model National Audit Office Act, The Association of Chartered Certified Accountants, UK, 2004. 19 the audit reports and other documents in line with the ACCA model legislation as follows:25 0 All reports issued by the Auditor General shall be considered public documents when the reports are presented to Parliament. As public documents they shall be made available to the public for a minimal cost-recovery fee. The Auditor General may make his/her reports publicly available inelectronic format on the Internet. 0 The Auditor General shall provide copies of hidher publishedreports to the government archivist, all public and universitylibraries (inrelevant locations); National Broadcasting Corporation; and the press. 0 The Auditor General or hidher staff may provide comments and interviews to the press or other mediaon the subject o f any published audit reports. (2) Setting Auditing Standards 36. The IFAC-issued International Standards on Auditing should be formally adopted, preferably by way of mention in the FinancialAudit Manual. There is an Audit Code which lays down the basic principles of auditing in line with the Constitutional provisions and the Auditor General's (Functions, Powers and Terms and Conditions o f Service) Ordinance 2001. The Auditor General o f Pakistan adopted the INTOSAI Auditing Standards in 2002 with minor adaptations. The INTOSAI Auditing Standards form the basis o f the auditing methodology and process for the office of the Auditor General o f Pakistan. This methodology and process i s further explained in the Procedure for Certification Audit of Appropriation and Finance Accounts preparedby the Auditor General. The Auditor General has approved the new Financial Audit Manual which would gradually replace the current procedures.26The INTOSAI recognizes that the INTOSAI Auditing Standards are broad in nature and that the IFAC-issued International Standards on Auditing provide another level o f detail for public sector audit guidance. The INTOSAI i s working with IFAC in the longer term to develop practice notes to assist with implementationo f each ISA inthe public sector. Therefore, explicitly prescribing the IFAC standards as the applicable auditing standards in addition to the INTOSAI Auditing Standards would ensure that the relevant developments in the auditingprocess are learned and applied on a continuous basis. 37. A committee should be set up to review and adopt the International Standards on Auditing on a continuous basis. It has been construed from various provisions o f the legislation, including Section 22 o f the Auditor General's Ordinance 2001 that the Auditor General would be the standard-setting authority for the public sector auditing. As an active member of INTOSAI, the Auditor General usually 25A Model National Audit Office Act, The Association of Chartered Certified Accountants, UK, 2004, Section38. 26Chapter 4 of Financial Audit Manual mentions that the INTOSAI Auditing Standards have been considered as the general framework for the auditing methodology and procedures. Although the new Financial Audit Manual does not mention specifically the International Standards on Auditing, the overall approach and methodology is consistentwith them. 20 subscribes to the declarations o f the international organization for implementation with regard to transference to the local setup and environment. Therefore, the INTOSAI Auditing Standards were adopted. The adoption process consisted o f a review of the INTOSAI Code o f Ethics and Auditing Standards by a committee o f senior officers assembled by the Auditor General. A similar committee should review and adopt the IFAC-issued International Standards on Auditing for effect on a continuous basis. It would be useful to include on this committee representation from the Institute o f Chartered Accountants o f Pakistan, which i s in the process o f adopting ISA compliance by its members.The process o f ISA adoption should start with input at the exposure draft stage and continue through to issuing practical guidance on local application o f the International Standards on Auditing. Pakistan has nominated persons to the Reference Panel o f the INTOSAI Working Group on Financial Audit Guidelines, which i s a subcommittee o f the INTOSAI Auditing Standards Committee. The Government can similarly nominate persons for an ISA-adoption committee under the jurisdiction of the Auditor General, as per hisher authority under the Constitution, (Section 170). (3) Code of Ethics 38. Improvedmonitoringfor adherence to the Code of Ethicsis needed, as well as review by the Controller General of Accounts. The INTOSAI Code of Ethics, which was prepared for auditors, was adopted by the Auditor General o f Pakistan in2002 to be followed by the DAGP audit staff and the CGA staff responsible for maintenance o f accounts. Some minor adaptations and deletions were made while issuing the INTOSAI Code o f Ethics and Auditing Standards to make them compatible with the local setup and environment. There i s a need for taking practical steps to ensure compliance with the Code o f Ethics. These steps might include guidance from the procedural mechanisms included in the IFAC Code o f Ethics for Professional Accountants and review o f the INTOSAI Code by the Controller General o f Accounts to compare the ICAP Code for relevance for accountants. (4) Ensuring hdependence 39. Notwithstandingthe limitationsidentifiedearlier, the legislationprovidesa strongenablingenvironmentwhere the Auditor Generalof Pakistancan performits scrutiny functions with considerable independence. The Constitution guarantees the protection o f service o f the Auditor General o f Pakistan. Similarly, the charged expenditures o f the DAGP are not subject to Parliamentary vote, therefore protecting the DAGPbudget. Section 19 o f the Auditor General's Ordinance gives the Auditor General f i l l powers to incur expenditures within the budgetary provisions. As the head o f a civil service cadre, the Pakistan Audit and Accounts Service, the Auditor General has substantial control over personnel and over the Audit and Accounts Training Institute, a powerful internal training and professional development mechanism. The overall status o f the Auditor General ensures the independence o f the position and an effective organization within the DAGP by virtue o f the Auditor General's constitutional mandate; protection o f term in office; financial and human resource independence; exercise o f authority over the type of, schedule, and duration o f audit; powers to examine records; 21 direct liaison with the parliamentarians inthe Public Accounts Committee; and INTOSAI representation. However, the Auditor General does have some limitations regarding managing staffing. Inorder to create new posts, the Auditor General must negotiate with the Ministry of Finance/government, which inpractice does not considerably infringe on the AGP independence. However, the recruitment o f civil servants inthe Pakistan Audit and Accounts Service is done through the Federal Public Service Commission, an arrangement that has significant expertise issues. 40. The AGP term of office is secure. The Auditor General o f Pakistan is appointed by the President o f Pakistan and his oath i s administered by the Chief Justice o f Pakistan. The AGP term o f office i s 5 years or until the attainment o f 65 years o f age by the incumbent, whichever is earlier. The Auditor General is secure in this position throughout the term and can carry out mandates without fear o f retribution. Once appointed, the Auditor General can only be removedby reference o fthe Supreme Judicial Council and affirmed by majority vote in the Parliament (the same procedure for removing a Supreme Court judge). Therefore, even the appointing authority does not have the termination powers. Re-appointment i s not allowed before two years after vacating the office, thereby limiting opportunities for re-appointment. The UNDP model legislation recommends a 12-year term, and the ACCA recommends appointment to retirement age o f 65. The Government noted in its response to the draft report that it considered that the Constitutional guarantees sufficed and that a longer term was not needed. 41. The Auditor General's Ordinance sets the AGP's right to access informationand obligation to report to the President. The Section 14 of the Auditor General's Ordinance 2001 indicates the powers o f the Auditor General inconnection with access to all offices having accounts and other related documents and some guidance on how to deal with any person hindering the audit functions. Article 171 stipulates that the Auditor General shall submit reports to the President who inturn delivers the same to the Parliament. The Parliament sends these reports to the Public Accounts Committee for detailed scrutiny. There has never been an amendment to any audit reports after being submittedto the President. 42. Before submission to the President, there i s ample opportunity for the executive to resolve the audit observations through holding o f (Special) or Departmental Accounts Committee meetings or simply by taking administrative action as recommended in the Audit Information Report. Nevertheless, the resolutionof issues often does not occur. 43. The audit reportingrequirementsneed to be made more specific. Section 7 o f the Auditor General's Ordinance 2001 relates to the certification audit. This section assigns responsibility to the Auditor General for certifying accounts on the basis o f the AGP audit for each financial year and presenting corresponding notes, comments, or recommendations related to those accounts. The Ordinance does not specify the timeline for submission o f the certified annual accounts. Similarly, the Ordinance does not requirethe Auditor General to submit an annual report on hidher performance. Section 7 states the minimum audit requirements from the Auditor General as the certification o f 22 annual accounts. The Auditor General must plan to have available the resources needed to conduct the certified audit and know how much time can be allocated to other types o f audits in a year in addition to the mandatory certification o f accounts. The PIFRA i s trying to achieve an integration o f the certification and regularity audit by introducing more concurrent audit activities focusing on regularity and compliance as part o f the certification audit. This would also lead to a timely certification o f the accounts and meaningful and complete representation sent to the legi~lature.~~ 44. Legislationshould providean environment inwhich the Auditor Generalis free to meet with the media on audit reports. In Pakistan, unlike in other countries, the audit report i s never discussed with the media. The only point in time when the press gets formal acknowledgement o f an audit report i s when the Public Accounts Committee deliberates on the audit observations. The model legislation for Supreme Audit Institutions reads, "The Auditor General or hidher authorized staff may provide comments and interviews to the press or other media on the subject o f any published audit reports."28 45. There are some issues which can hamper the independence of the audit staff on individual assignments. The separation o f audit and accounts has resolved the independence issue to some extent. However the rotations o f assignments, including deputations to other departments and back to audit offices, need to be reviewed. Similarly, the dependence on the auditee organizations for providing logistics can affect the highest level of independence. It is preferable to adopt the IFAC Code o f Ethics with regard to procedures for enhanced independence as required by rotation o f assignments and nominal dependency for logistics on some auditees. 46. Improved processes of the Public Accounts Committee and departmental administrations are needed for following up audit reports.29 Despite many opportunities, resolution o f audit observations frequently does not occur before submission o f reports to the President and subsequent review by the Public Accounts Committee. This suggests an apparent indifference by senior departmental managers. It i s important that there be certainty that audit observations are dealt with seriously by the legislature and the central agencies, such as the Ministry o f Finance. This lack o f resolution at the audit stage has led to an enormous backlog by the Public Accounts Committee in hearing the audit observations. Improved audit methodology and report writing, and reformation o f the fundamental processes for scrutiny need to be undertaken to reduce this backlog. Better protocols may be useful between the Auditor General and various departments to ensure that auditor access is made easy and disruption in departments is kept at a minimum. In addition, better protocols would help ensure that 21 There is a lack o f connection between certification and regularity audit reporting. The certification audit gives partial compliance in the form o f "can be relied upon" subject to both qualifications contained therein, as well as the issues reported elsewhere inregularity audit reports. The certification audit reports are seldom discussed by the Public Accounts Committee thereby limiting the general disseminatiodavailabilityand use o fthe government financial statements by the stakeholders. 28 A ModelNational Audit Office Act, The Association o f CharteredCertifiedAccountants, London, 2004. 29 Legislative scrutiny of external audit reports is performance indicator No. 28 in the P F M performance measurement framework supported by the Bank and other development agencies. 23 draft audit reports are reviewedquickly by the departments for accuracy and fairness and that the Auditor General and departments, as far as possible, reach an agreement on reports before they are made public. Similar protocols are needed between Parliament and the Auditor General covering, for example, how the audit reports will be handled. An audit-observation tracking system is being implemented under PIFRA 11, which would improve the post-audit accountability system. However, the primaryresponsibility o f follow-up o f actions i s with the Public Accounts Committee secretariat that i s closely coordinated by the Auditor General for compliance with its part o f directives/recommendations.30The Auditor General does not have statutory power for imposing sanctions directly. (5) Accountability in the Supreme Audit Institution 47. The Office of the Auditor Generalof Pakistanshouldbe accountablefor its performanceand reportto the legislature. The Inspection, Regulation, Vigilance, and Monitoring o f the Training Wing are independent branches o f the Office o f the Auditor General o f Pakistan, which performs its functions under a Deputy Auditor General. This function i s a kind o f internal audit within the Office of the Auditor General that conducts inspections o f all activities, including field audit offices. It i s the intendedgood practice o f the Office o f the Auditor General to prepare an annual report each year, but other priorities interrupt meeting the schedule. The last annual report was published for 2002. The Corporate Audit Plan (2001-2002) contained the vision and mission statement that was reinterpreted into the annual audit plan. An annual report for the year 2004 i s still under preparation and a 3-year planis inthe process of being written. The Office of the Auditor General does not undergo peer review or an independent performance audit, nor does any independent external body audit its activities. However there are interconnected arrangements for audits within the field audit offices that provide peer review assurance within the organization. The Office o f the Auditor General should undergo an accountability mechanism in line with that suggested under the proposed legislation for Supreme Audit Institutions involving review o f the annual corporate plan and annual report by the Public Accounts Committee.31The Office o f the Auditor General should prepare and disseminate its annual corporate plan, as well as the annual performance report o f its office ina timely manner. (6) Qualifications and Skills for the Auditors 48. The AATI should continueto review its syllabus in order to cover all areas recommendedby IFAC-issued InternationalEducational Standards (IES). In an effort to meet the AATI and higher academic and professional qualifications, an elaborate system o f training o f accounting and auditing staff at different hierarchical levels exists at 30 Although the Public Accounts Committee writes "directives" for its decisions, many stakeholders perceive in line with the decision of NWFP High Court declaringthese as "recommendations," which are subject to voluntarycompliance by the executive. 3 1A ModelNationalAudit Office Act, The Association of CharteredCertifiedAccountants, UK,2004, Part VIII. 24 local and foreign universities and professional training bodies. The Auditor General has developed a comprehensive training plan. The PIPFA qualification has become mandatory for audit officers. The syllabi o f AATI probationers have been revamped. A substantial portion o f funding in PIFRA I1 has been earmarked for auditing and accounting training. All these factors contribute to the enhancing o f the qualifications and skills o f the auditors. The AATI should ensure that all IES-recommended areas are covered by all training providers and inall training material. (7) Training 49. Despite good training opportunities available for auditing staff, further upgrading is needed. The AATI annual training plan provides many opportunities for their continuing professional development. The training plan encompasses more than 50 different short courses or workshops. Civil servants are required to take 12 working days o f mandatory training.32 Allocating certain training days in each annual audit plan is good practice for time budgeting. Rigorous capacity-building exercises are being identified, designed, and delivered as part o f PIFRA 11. There are currently too few auditors with ICAP qualifications in the Office o f the Auditor General. These auditors must have adequate professional expertise and technical knowledge to carry out the certification audits and to recommend that the Auditor General sign audit opinions. The current AATI arrangements are not yet adequate to meet international standards for auditing annual accounts and signing audit opinions. Further upgrading o f AATI courses and o f promotion criteria for senior audit staff i s needed. (8) Auditor Competence 50. The new FinancialAudit Manual shouldbe implemented. The development o f a new Financial Audit Manual for auditing the financial statements o f federal and provincial governments was outsourced to foreign consultants under PIFRA. The consultants have developed the guidelines and the methodologies with the help o f the Accounting Policy Wing, which would be responsible for future maintenance and updating o f the Manual. In addition, the Office o f the Auditor General through PIFRA procured an audit department management system with modules for audit planning and implementation, risk assessment, personnel management, and recommendation tracking.33 An action plan for implementation o f the new Financial Audit Manual i s needed for an effective FY2004-05 and FY2005-06 audit. The implementationo f the new Financial Audit Manual should be linked to the capacity-building and computerization activities. 32EstablishmentDivisionO.M. No 1/6/2002.0P.II, dated 5-4-2002. 33The Audit CommandLanguage software has been acquired for computer-assistedaudit techniques and appliedon some transaction data inSAP W3 systems inaccountingoffices. 25 (9) Quality Assurance 51. Audit documentation and report writing for quality assurance needs improvement. Supervision occurs at the field audit office level where the Director General personally certifies the quality o f audit reports; there i s further review at the Deputy Auditor General level for quality assurance. Finally there is a Quality Assurance Review Committee at the Office o f the Auditor General o f Pakistan, which reviews all audit reports before their release. This process needs to be supported by formal mechanisms and adequate working papers as per ISA 220, Quality Control for Audit Work. The new Financial Audit Manual (Chapters 5 to 15) describes in detail the procedures for direction, supervision, and review o f audit work. The World Bank's project team was not able to review recent audit reports because they had not been made public. Therefore, scrutiny o f this important area i s incomplete and inadequate in this assessment. B. Auditing Standards as Practiced 52. The diagnostic questionnaires have collected 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, reviewing compliance with laws, ensuring adequate audit evidence i s collected, analyzing whether the financial statements accord with accounting standards, preparing audit opinions, reporting on fraud, and reporting on compliance. Out o f this exercise came recommended activities that will help bring local standards in line with international standards. (1) Audit Planning 53. The planning process should collect informationabout the audited entity. Certification audit procedures suggest that the audit staff prepare work flow, procedure diagrams, or systems outlines, and list the main accounting areas in order to be familiarized with the audited entity; however, this does not include risk assessment and determination o f materiality levels, which are more or less pre-defined by the procedures. The procedures define the objectives of each o f the six audit areas: establishment costs, contingencies, pensions, receipts, general provident funds, and accounts compilation. The objectives are not refinedin accordance with risks o f understatement, overstatement, 26 or misstatement that can be associated with any o f the audit areas; and audit tests are not accordingly articulated. Internal audit function i s evaluated as part o f the regularity audit. However, since internal audit in government departments i s in its infancy,34 the certification audit does not place reliance on the internal audit. 54. Engagement of chartered accountants, as part of the audit teams for conducting of certification audit, can build skills. The planning documents currently prepared do not identify specific risks.The new Financial Audit Manual should introduce more comprehensive planning requirements based on the specific objectives o f the audits. Engagement o f chartered accountants as part o f the audit teams for conducting certification audit can be very helpful in skill development. The memorandum o f understanding between the Auditor General o f Pakistan and the Institute o f Chartered Accountants o f Pakistan may be utilized for procuring such services with ICAP quality assurance support. The Government's response to the draft report noted that in addition to these interactions the DAGP i s partnering with the international bodies INTOSAI, ACCA, and IIA. (2) Audit Supervision 55. When implementing the new Financial Audit Manual, the supervisory staff-including the Director and the Deputy Director-should test and demonstrate the new audit methodologies in the presence of field audit teams. The current supervision process generally concentrates on reviewing the findings o f the audit team and documentation o f the audit evidence, and referencing and sequencing o f the audit working papers; less emphasis i s placed on involvement in the field work and on the overall assurance levels achieved. The shift should be made toward the risk-based audit approach. In the risk-based audit approach, the auditor minimizes risk through applying judgment in the design and conduct o f field testing in order to provide the requiredassurance that the financial statementsprovide atrue and fair view. (3) Reviewing Internal Management Control Procedures 56. The new audit methodology and process should be rolled out immediately to improve environmentalrisk assessment, compliance testing, and sampling. The existing certification audit procedures are mechanical and do not provide the requisite flexibility to the auditor to exercisejudgment and innovation inachieving a higher degree o f assurance. The techniques used for compliance testing and sampling need improvement. For example, the results o f compliance testing have limited impact on the sample size for the substantive procedures, and the results o f the compliance testing are seldom usedto tailor the selection o f sample transactions based on an identifiedpattern o f errors. Therefore, the new audit methodology should be rolled out as early as possible without waiting for the implementation o f the New Accounting Model and 34An Internal Audit PlanandInternalAudit Manualwere developedunder PIFRA I,and chief audit officers postedin 15 ministries havebeengiventhe exposuretraining. 27 computerization o f the accounting systems. An audit methodology should answer the following points: What i s the audit confidence level? 0 What are the requirements for audit planning, audit work papers, and audit reporting? 0 How i s audit materiality determined, and what i s an acceptable level o f audit risk and confidence? How i s an appropriate mix o f audit work developed to address the audit risks? 57. The audit should be completed by a process that provides information on how audit errors are summarized and evaluated against audit materiality. (4) Audit Evidence 58. The new Financial Audit Manual provides details of the audit programs and documentationguidelines. Audit evidence is crucial to an effective audit. Current practice produces audit evidence that i s poorly documented, filed, and referenced. The Financial Audit Manual offers guidelines that would help improve the capture and documentation o f the audit evidence. The Financial Audit Manual should be implemented. (5) Analyzing Financial Statements 59. The transaction-basedfinancial statements provide some limited scope for financial analysis that is usefulfor the audit. The auditor's ability to perform and use the various analyses o f financial statements i s hampered when these lack meaningful and reliable information with respect to assets or liabilities balances. However, analysis o f the ratios o f one expenditure head to another head, comparison of variations o f expenditures over time, and relationships among financial and non-financial information (e.g. number o f staff to payroll) can provide useful indicators o f possible errors. (6) Reporting on Financial Statements 60. There should be a reference to the financial reporting framework used when preparing financial statements (including identifying the country of origin of the framework when the IAS framework is not used). There is no specific reference to the reporting framework inany procedures inuse inPakistan. The only mention relates to the provisions o f Section 5(a) o f the Controller General o f Account Ordinance 2001 whenreadwith the Article 169 o fthe Constitution. The IPSAS should be identifiedas the relevant financial reporting framework in the audit certificate once the accounts are prepared inthis form. 61. The audit certificate should completelycomply with the specimen formats given in the Financial Audit Manual and procedures being followed. The opinion 28 paragraph gives an expression that the financial statements "can be relied upon." This i s not consistent with the specimen audit reports given in the Procedures for the Certification Audit, which requires stating that "the accounts are complete and accurate inall material aspects." 62. The audit report should be a stand-alone document giving complete assurance on the financial statements and should not refer to other reports. The certification audit report makes mention o f the other AGP reports covering aspects o f financial governance or economical, efficient, and effective utilization o f public resources, which are submitted separately to the President. These reports provide information relating to weaknesses in the system of financial control or accounting, in addition to those mentioned in audit comments annexed to the audit certificate. The details o f all such referenced AGP reports mentioned inthe audit certificate on the financial statements should be reattached to the audit certificate for a complete analysis. (7) Reporting on Fraud 63. Forensic audit training is needed. The Supreme Audit Institution does not focus on fraud in a sufficiently systematic way. Much o f the reporting seems to relate to fraudulent behavior and to suggest recoveries without detailing the facts. The ISA 240, The Auditor's Responsibility to Consider Fraud and Error in an Audit of Financial Statements, requires the auditor to obtain information that is used to identify the risks of material misstatement due to fraud; to evaluate the design o f the entity's related controls, including relevant control activities; and to determine whether they have been implemented. The auditing standard also requires the auditor to inform the auditee's management and the Board, if there i s one, o f any fraud and failure in internal control that led to the fraud. The auditor's report should identify the action that the entity is taking about the fraud. The Auditor General on special request may cooperate with other government agencies, like the National Accountability Bureau, on specific incidence o f fraud. (8) Reporting on Compliance 64. The audit should be understood as a tool for gradual improvement in the controlsystems and processes over time. The general tendency is for the audit to cover and report on all compliance issues confronting an organization instead o f emphasizing the most critical issues. The audit report can add significant value ifthe auditors focus on more critical issues with impact on the organization and recommend ways to resolve those issues. 29 0 m m N m m m Annex A. Methodology of the Assessment As part o f the general support program in South Asia for assessment and improvement o f public sector accounting and auditing against international standards, the World Bank, with the cooperation o f member governments, is conducting the Review of Public Sector Accounting and Auditing Practices in member countries. The development ofthe PFMPerformance Measurement Framework3' by the Public Expenditure and Financial Accountability (PEFA) Program36has opened the way for a diagnostic tool to be developed that is referenced to the accounting and auditing standards o f the International Federation o f Accountants (IFAC) and the International Organization o f Supreme Audit Institutions (INTOSAI), and other relevant international benchmarks. This exercise provides substantial insight into country performance in regard to the external auditing and financial statement reportingfinancial management indicators. A set o f 6 questionnaires were usedto collect relevant information on country practices: 1. 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, ethical requirements compared with the IFAC Code o f Ethics for Professional Accountants. 2. Public sector accounting practices for the general budget sector if using the cash basis o f accounting-compared with the requirements o f the Cash Basis International Public Sector Accounting Standards (IPSAS). 3. Public sector accounting practices for the general budget sector if using the accrual basis o f accounting-compared with the IPSAS requirements that govern accrual reporting for the public sector. 4. Public sector auditing environment compared with the provisions o f the INTOSAI Code o f Ethics and the INTOSAIgeneral standards. 5. Public sector auditing practices compared to the requirements o f the INTOSAI field standards and reporting standards, and the IFAC International Standards on Auditing. 6. Accounting and auditing practices for state-owned enterprises compared with the requirements o f the International Financial Reporting Standards (IFRS) and International Standards on Auditingthat govern commercial reporting. The responses to the diagnostic questionnaires, prepared by the relevant country authorities with the help o f in-country experts retained by the World Bank, are supplemented by a due diligence review conducted by members o f a World Bank task team. 35The PFM Performance Measurement Framework has been developed as a contribution to the collective efforts of many stakeholdersto assess and develop essential PFM systems, by providing a commonpool of information for measurement and monitoring of PFM performance progress, and a common platform for dialogue. 36 The PEFA Program is a partnership among the World Bank, the European Commission, the UK's Department for International Development, the Swiss State Secretariat for Economic Affairs, the French Ministry ofForeignAffairs, the RoyalNorwegian Ministry ofForeignAffairs, the International Monetary Fund and the Strategic Partnership with Africa. A Steering Committee, comprising members of these agencies, manages the Program.A Secretariatis locatedinthe World Bank inWashington, DC. 35 Various documents are examined as part o f the review, including relevant laws, codes o f 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 an expert panel of advisors before examination by the World Bank country team. The draft is then shared with the Government for response before finalization. Discussions will also be held with the relevant stakeholders to devise an implementation plan to address the way forward with a view to minimize variances from international standards. 36 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 o f Supreme Audit Institutions (INTOSAI) are cooperating insetting international standards for accounting and auditing. The IASB i s an independent, privately funded accounting standard-setter based in London, UK. The Board members come from nine countries and have a variety of functional backgrounds. In the public interest, IASB i s committed to developing a set o f 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 standards around the world. The IASB issued International Accounting Standards (IAS) from 1973 to 2000. Since 2000, they have issued International Financial Reporting Standards (IFRS). IFAC has its headquarters inNew York, USA and comprises 163 member bodies, mainly the national professional accountancy bodies o f most countries around the world. The IFAC Board established the International Public Sector Accounting Standards Board (IPSASB) to develop highquality 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 o f Standards and Exposure Drafts currently on issue i s available at http://www.ifac.org/publicsector. The first 20 IPSAS are based on IAS 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 i s now working in cooperation with INTOSAI on preparingpublic sector guidance on the use o f ISA. INTOSAI includes the Auditors General from almost all national government audit departments around the world and has its Secretariat in the Vienna offices o f the Auditor General o f Austria. Its Auditing Standards Committee, chaired by the Auditor General o f Sweden, produces the INTOSAI Code o f Ethics and Auditing Standards, a set o f standards at a higher and more generic level than the IFAC-issued ISA. The Auditing Standards Committee i s working with the IAASB to prepare practice notes explaining the application o f each ISA inthe public sector.37 The various standards are listedon the following pages. 37Working Group on Financial Audit Guidelines, INTOSAI Auditing Standards Committee, Swedish National Audit Office, 2004. 37 international Public Sector Accounting and Education Standards International Public Sector Accounting Standards IPSAS 1, Presentation of Financial Statements IPSAS2, CashFlow Statements IPSAS 3, Net Surplus or Deficit for the Period, Fundamental Errors and Changes in Accounting Policies IPSAS4, TheEffects of Changes in Foreign Exchange Rates IPSAS5, Borrowing Costs IPSAS6, Consolidated Financial Statements andAccountingfor ControlledEntities IPSAS7, Accountingfor Investments in Associates IPSAS 8,Financial Reporting of Interests in Joint Ventures IPSAS9, Revenuefrom Exchange Transactions IPSAS 10, Financial Reporting in Hyperinflationary Economies IPSAS 11,Construction Contracts IPSAS 12, Inventories IPSAS 13, Leases IPSAS 14, EventsAfter 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 IPSAS20, RelatedParty Disclosures IPSAS21, 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 IES2, Content of Professional Accounting Education Programs IES 3, Professional Skills IES4, Professional Values,Ethics andAttitudes IES 5, PracticalExperience Requirements IES 6,Assessment of Professional Capabilities and Competence IES 7, ContinuingProfessional Development IES 8, CompetenceRequirementsfor Audit Professionals 38 International Financial Reporting Standards and Accounting Standards IFRS 1, First-time Adoption of International Financial Reporting Standards IFRS 2, Share-basedPayment IFRS 3, Business Combinations IFRS 4, 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, EventsAfter the Balance Sheet Date 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, Employee Benefits IAS 20, Accountingfor Government Grants and Disclosure of GovernmentAssistance IAS 21, TheEffects of Changes in Foreign Exchange Rates IAS 23, Borrowing Costs IAS 24, Related Party Disclosures IAS 26, Accounting and Reporting by RetirementBeneJit 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 see also: See also Financial Instruments - other issues IAS 33, Earningsper Share IAS 34, Interim Financial Reporting IAS 36, Impairment of Assets IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 38, Intangible Assets IAS 39, Financial Instruments: Recognition and Measurement see also: See also Financial Instruments - other issues IAS 40, InvestmentProperty IAS 41, Agriculture 39 INTOSAI Code of Ethics and Auditing Standards Code of Ethics Integrity. Auditors have a duty to adhere to high standards ofbehavior (e.g. honesty and candidness) inthe course of their work and intheir relationshipswith the staff of auditedentities. Independence,objectivity and impartiality. The independence of auditors should not be impaired by personalor external interests. There is aneedfor objectivity and impartiality inthe work andthe reports, which shouldbe accurate and objective. Conclusions inopinions andreports should be basedexclusively on evidence obtainedand assembledin accordance with the SAI's auditing standards. Professional secrecy.Auditors should not disclose information obtainedinthe auditing process to third parties except for the purposes of meetingthe SAI's statutory responsibilities. Competence.Auditors must not undertakework which they are not competentto perform. BasicPostulatesfor Auditing Standards (a) The SA1shouldconsider compliancewith the INTOSAIauditing standards inall mattersthat are deemedmaterial. Certain standardsmay not be applicableto some ofthe work done by SAIs, including those organized as Courts of Account, nor to the non-audit work conductedby the SAL The SA1 should determinethe applicable standards for suchwork to ensure that it is of consistentlyhigh quality. (b) The SA1should apply its ownjudgment to the diverse situationsthat arise inthe course of government auditing. (c) With increasedpublic consciousness,the demand for public accountability ofpersons or entities managingpublic resourceshas become increasingly evident so that there i s aneedfor the accountability process to be inplace and operating effectively. (d) Developmentof adequate information, control, evaluationandreporting systems within the government will facilitate the accountability process.Managementis responsible for the correctness and sufficiency ofthe form and content ofthe financial reports and other information. (e) Appropriate authoritiesshould ensure the promulgation of acceptable accountingstandards for financial reporting and disclosure relevantto the needs ofthe government, and auditedentities should develop specific and measurable objectives andperformancetargets. (0Consistentapplication ofacceptable accountingstandards shouldresult inthe fair presentationofthe financial position and the results of operations. (g) The existence of an adequate system of internal control minimizes the risk of errors and irregularities. It is the responsibility of the auditedentity to develop adequate internal control systems to protect its resources. It is also the obligation ofthe auditedentity to ensure that controls are inplace and functioning to help ensure that applicable statutes and regulationsare complied with, and that probity and propriety are observedindecision making. The auditor shouldsubmit proposalsand recommendationswhere controls are found to be inadequate or missing. (h) Legislative enactments would facilitate the cooperationof auditedentities in maintaining and providing access to all relevantdata necessary for a comprehensive assessment ofthe activities under audit. (i)AllauditactivitiesshouldbewithintheSAI'sauditmandate.* (i) Legislative enactmentswouldfacilitate theco-operationofauditedentities inmaintaining and providingaccess to all relevant data necessary for acomprehensiveassessment ofthe activities under audit. (k) SAIs shouldwork toward improving techniques for auditing the validity ofperformancemeasures. (1) SAIs should avoid conflict of interest betweenthe auditor and the audited entity. * The full scope ofgovernment auditing includesregularity andperformance audit. Regularity audit embraces: 1 Attestation of financial accountability of accountable entities, involving examination and evaluationof financial recordsand expressionof opinions on financial statements; 1 Attestation of financial accountability of the government administration as awhole; 1 Audit of financial systems andtransactionsincluding an evaluationof compliancewith applicable statutes and regulations; 1 Audit of internal control and internal audit functions; 40 .. Audit ofthe probity andpropriety of administrative decisionstaken within the auditedentity; and Reporting of any other matters arising from or relating to the audit that the SA1considersshould be disclosed. Performance audit entails the audit of economy, efficiency and effectiveness, and embraces: Audit ofthe economy of administrative activities in accordance with sound administrative principles and practices, and management policies; 1 . Audit of the efficiency of utilization of human, financial and other resources, including examinationof information systems, performancemeasures and monitoringarrangements, and proceduresfollowed by auditedentities for remedyingidentified deficiencies; and Audit ofthe effectiveness ofperformanceinrelation to the achievementofthe objectives of the auditedentity, and audit ofthe actual impact of activities comparedwith the intendedimpact. General Auditing Standards The auditor and the SA1must be independent. The auditor and the SA1must possess the required competence. The auditor and the SA1must exercise due care and concernincomplying with the INTOSAIauditing standards. This embraces due care inplanning, specifying, gatheringand evaluating evidence, and in reporting findings, conclusionsand recommendations. The SA1shouldadopt policies and proceduresto recruit personnelwith suitable qualifications. The SA1shouldadopt policies and proceduresto develop andtrain SA1employeesto enable them to perform their tasks effectively, and to define the basis for the advancement o f auditors and other staff, The SA1shouldadopt policies and proceduresto prepare manuals and other written guidance and instructionsconcerningthe conduct of audits. The SA1shouldadopt policies and proceduresto support the skills and experienceavailable within the SA1 and identify the skills which are absent; provide agood distribution of skills to auditing tasks and assign a sufficient number of persons for the audit; and have proper planning and supervisionto achieve its goals at the required level of due care and concern. The SA1shouldadopt policies and proceduresto review the efficiency and effectiveness of the SAI's internal standards and procedures. Field Standards (a) The auditor shouldplanthe audit in a mannerthat ensures that an audit of high quality is carried out in an economic, efficient and effective way, and inatimely manner. (b) The work ofthe audit staff at each level and audit phase shouldbe properly supervisedduring the audit; and documentedwork should be reviewed by a senior member ofthe audit staff. (c) The auditor, indetermining the extent and scope ofthe audit, shouldstudy and evaluate the reliability of internal control. (d) Inconductingregularity (financial) audits, atest shouldbe made of compliancewith applicable laws and regulations.The auditor should designaudit steps andprocedures to provide reasonable assurance of detectingerrors, irregularities, and illegal acts that could have a direct and material effect on the financial statementamountsor the results of regularity audits. The auditor also shouldbe aware ofthe possibility of illegal acts that could have an indirect andmaterial effect on the financial statements or results ofregularity audits. ReportingStandards (a) At the end of each audit the auditor shouldprepare awrittenopinion or report, as appropriate, setting out the findings inan appropriateform; its content shouldbe easy to understandand free from vagueness or ambiguity, includeonly information which is supportedby competentandrelevant audit evidence, and be independent,objective, fair and constructive. (b) It is for the Auditor Generalto decide finally on the actionto be taken inrelation to fraudulent practices or serious irregularities discoveredby the auditors. 41 International Standards on Auditing IntroductoryMatters Audit Evidence 100AssuranceEngagements 500 Audit Evidence 110 Glossary of Terms 501Audit Evidence - Additional Considerationsfor 120Framework of ISAs Specific Items 505 External Confirmations Responsibilities 5 10 Initial Engagements - OpeningBalances 200 Objective and General Principles Governing 520 Analytical Procedures anAudit of Financial Statements 530 Audit Sampling 210 TermsofAudit Engagements 540 Audit of Accounting Estimates 220 Quality Controlfor Audit Work 550 RelatedParties 230 Documentation 560 SubsequentEvents 240 TheAuditor's Responsibility to Consider 570 Going Concern Fraud and Error in an Audit of Financial Statements 580 ManagementRepresentations 240A Fraud and Error 250 Consideration of Laws and Regulations in an Usingthe Work of Others Audit of Financial Statements 600 Using the Work of Another Auditor 260 Communications of Audit Matters with Those 610 Considering the Work of Internal Auditing Charged with Governance 620 Using the Work of an Expert Planning Audit ConclusionsandReporting 300 Planning 700 TheAuditor's Reports on Financial Statements 3 10 Knowledge of the Business 710 Comparatives 320 Audit Materiality 120 Other Information in DocumentsContaining Audited Financial Statements Internal Control 400 Risk Assessments and Internal Control SpecializedAreas 800 TheAuditor's Report on Special Purpose Audit 401Auditing in a Computer Information Systems Engagements Environment 810 TheExamination of Prospective Financial 402 Audit Considerations Relating to Entities Information UsingService Organizations RelatedServices 910Engagementsto Review Financial Statements 920 Engagementsto Perform Agreed-Upon Procedures Regarding Financial Information 930 Engagements to CompileFinancial Information 42 Annex C. Pakistan Auditing and Accounting Legislation (A) The Constitution of the Islamic Republic of Pakistan 169. The Auditor General shall, inrelationto - (a) the accounts o f the Federationand o fthe Provinces; and (b) the accounts of any authority or body established by the Federation or a Province, perform such functions and exercise such powers as may be determined by or under Act ofMajlis-e-Shoora (Parliament) and, untilso determined, by order o f the President. 170. The accounts of the Federation and o f the Provinces shall be kept in such form and in accordance with such principles and methods as the Auditor General may, with the approval o fthe President, prescribe. 171. The reports o f the Auditor General relating to the accounts of the Federation shall be submittedto the President, who shall cause themto be laidbefore the National Assembly and the reports o f the Auditor General relating to the accounts o f a Province shall be submitted to the governor o f the Province, who shall cause them to be laid before the Provincial Assembly. (B) Auditing Legislation Extracts from the Auditor General's (Functions, Powers and Terms and Conditionsof Service) Ordinance, 2001 Section 4. Term of Office - The Auditor General shall, unless he resigns earlier or is removed from office in accordance with the Constitution, hold office for a fixed term of five years from the date on which he assumes such office or he attains the age of sixty- years, whichever i s earlier... Section 7. Auditor General to certify accounts. - The Auditor General shall, on the basis o f such audit as he may consider appropriate and necessary, certify the accounts, compiled and prepared by Controller General o f Accounts or any other person .....and shall submit the certified accounts with such notes, comments or recommendation as he may consider necessary to the President.. .. Section 8. Provisionsrelatingto Audit-The Auditor General shall - (a) audit all expenditures from the Consolidated Fund ....to ascertain whether the moneys shown inthe accounts as havingbeendisbursedwere legally available for and applicable to the service and purpose to which they have beenapplied.... (b) audit all transactions.. (c) audit all trading, manufacturing, profit and loss accounts and balance sheets and other subsidiary accounts.. .. (d) audit, subject to provisions of this Ordinance, the accounts of any authority or body established ... 43 Section 9. Audit of receipts and expenditure of holders of authorities substantially financed by loans and grants ..... Auditor General shall .. ..have authority- Section 14. Powers of Auditor General in connection with audit of accounts. (1) The . (a) to inspect any office o f accounts.. . (b) to require that any accounts, books, papers.. . (c) to enquire or make such observations.. . (2) The officer incharge o f any office or department shall afford all facilities.. ., (3) Any person or authority hindering the audit functions or the Auditor General regarding inspection o f accounts shall be subject to disciplinary action under relevant Efficiency and Discipline Rules, applicable to such person. Section 22. Power to make regulations .... (C)Accounting Legislation Extracts from the Controller General of Accounts (Appointment, Functions and Powers) Ordinance,2001 Section 4. Controller General of Accounts. - There shall be a Controller General o f Accounts who shall be appointed by the President from amongst the officers o f the Accounts Group and shall be a PBS 22 officer. Section 5. Functions of the Controller General. - The functions o f the Controller General shall be - (a) to prepare and maintain the accounts o f the Federation, the Provinces and district governments in such form and inaccordance with such methods and principles as the Auditor General may, with the approval of the President, prescribe from time to time; (b) to authorize payments and withdrawals from the Consolidated Fund and Public Accounts. .. (c) to prepare and maintain accounts o f such organizations and authorities established, set up or controlled by the Federation or Provinces as may be assigned to him by the President or, as the case may be, the Governor o f a Province; (d) to lay down the principles governing the internal financial control for Government departments inconsultation withthe Ministry o f Finance.. . (e) to render advice on accounting procedure for new scheme, programmes or activities undertakenby the Government concerned; (f) to submit accounts compiled by him... to the Auditor General .. . within the time- . frame prescribedby the Auditor General; (g) to provide ....information 44 (h) develop and maintain as efficient system of pension, provident funds and other retirement benefits... (i)toco-ordinateandensureresolutionofauditobservationoftheAuditDepartment withthe concerned departments; and (j) to prescribe syllabus, standards and provide facilities for training o f officers and staff under his administrative control. Section 6. Certain offices to work under the control of the Controller General ... Section 7. Reports. - From the accounts directly kept or maintained by him or by accounts officers subordinate to him, and from the accounts kept and maintained by other entities, including self-accounting entities, the Controller General shall - (a) prepare each year the appropriation and finance accounts.. ..for submission to the Auditor General. ... (b) prepare and submit to the Auditor General for each financial year a Consolidated . (c) .... and General Financial statement .., Section 12. Power to make regulations. ... 45 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,December2003. 1.18 The IFAC Public Service Committee has commented extensively on the benefits o f 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 Public Service Committee's other publications, this section contains a summary o f the benefits o f reporting on the accrual basis. 1.19 The information contained in reports preparedon an accrual basis i s useful both for accountability and decision-making. Financial reports prepared on an accrual basis allow users to: assess the accountability for all resources the entity controls and the deployment o f those resources; assess the performance, financial position and cash flows o f the entity; and make decisions about providing resources to, or doing business with, the entity. 1.20 At a more detailed level, reporting on an accrual 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 and to meet its liabilities and commitments; shows the financial position o f a government and changes infinancial position; provides a government with the opportunity to demonstrate successful management o f its resources; and i s useful in evaluating a government's performance in terms o f its service costs, efficiency and accomplishments. FinancialPosition 1.21 Accrual accounting provides information on an entity's overall financial position and current stock o f assets and liabilities. Governments needthis information to: make decisions about the feasibility o f financing the services they wish to provide; demonstrate accountability to the public for their management o f assets and liabilities recognized inthe financial statements; planfor future fundingrequirementso fassetmaintenance andreplacement; plan for the repayment of, or satisfaction of, existing liabilities; and manage their cashposition and financing requirements. 1.22 Accrual accounting requires organizations to maintain complete records of 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 46 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 meetingthe 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 assetdequity and may lead governments to take a longer term view when making financing decisions than i s 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 assetdequity. 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 inthe 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 assetdequity will be reported. Where this figure i s positive it can be interpreted as the net resources that may be applied for the provision o f goods or services in the 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 off debt and other liabilities. Net assetdequity can comprise some or all o fthe following components: contributed capital; accumulated surpluses and deficits; and reserves (for example revaluation reserve; 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 information on revenues i s 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. 47 1.26 Governments need information about expenses in order to assess their revenue requirements, the sustainability of existing programs, and the likely cost of 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 meetingthese objectives; decide whether to fund the production o f 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 remunerationoptions; assess the most efficient way o f producing their goods and services and o f managing the resources over which they have been delegated authority; determine the appropriateness o f cost-recovery policies; and monitor actual costs against budgetedcosts. Cash Flows 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." 48 * m- 8 53 c, C .I Ece> W S .-c P) e c, 0 3 48 0 c, 0 0) v) .I 0 ?i - n 3 (II c 0 .I c, z(II Q) 5 IC 0 c, C E tn tn 2tn Q) a 0 IA Y " * B C s sm 0 rc 0 -0 x 0 I, e .-20" 63 m v, m YE s .eo 0 n Q z -.-tiE Q u D e, i5e, ,o L .i 0 0a V $ 2 W S Q G W I D x I ur E .su 8 I 3E d e e4 8 & 0 .e 2 Y -0 m 4 a w 8 80E W c! $ - d b a k 0 VY 0 00 0 Y L