Framework For Effective Local Government Finance

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Framework For Effective Local Government Finance

• World Bank Public Sector Management Thematic
  Group
• Michael Schaeffer
• March 2005

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The Quick Start Framework

• Components of Effective Local Government Finance
• A Shift in the Nature of Local Government
  Budgeting
• The Capital Budget
• The Role of Financial Reporting and Accounting
• The Treasury System
• Sequencing of Management Reforms

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Essential Components

• Control Structure Derived From Legislative
  Framework
• A Standardized Chart of Accounts / Accounting
  System
• An Effective Treasury and Cash Management System
• Internal / External Reporting
• Effective Timely Budget and Reporting System

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An Effective Financial Management System
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Shift in the Nature of Local Government Budgeting
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Framing Local Government Policy

• Budgets are Fundamental for Meeting Three
  Important Policy Objectives
• Aggregate Fiscal Discipline
• Allocation of Resources Consistent with
  Strategic Policy and Priorities And,
• Efficiency and Effectiveness

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Effective Financial Management and Budgeting

• Set of Activities Where Intentions of Local
  Government Managers and Politicians Becomes
  Operational
• One Mechanism to Determine Local Government
  Performance is Audit
• Performance Based Local Government Unit LGU
  Financial Management Necessitates a Change in
  Local Government Financial Management and
  Organization
• Must Produce Information in an Integrated Manner
  Budgeting, Accounting, Cash (Treasury) and Debt
  Management Must be Linked

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Working Within Proper Legal Environment

• Detailed Rules with Respect to Local Government
  Budgeting, Accounting, Cash And Debt Management
• Internal / External Audit Responsibilities Should
  be Designated
• Role of Any Oversight Agency Should be Defined
• Jurisdictions, Level of Autonomy, and the
  Components of Local Government Financial
  Management Systems Should be Spelled Out

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Perspective on Budgeting

• Establish Clear Operating Procedures Between
  Management Sections of Each Implementing
  Department
• Limit Programmatic Classifications to Only What
  is Necessary for Effective Decision-making
• Simplify and Limit Account Classifications
• Match Budget Authority with Operating Level
• Codify Budget Procedures in a Manual
• Develop Performance Measurements that Can Be Used
  to Measure Efficiency / Effectiveness

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Budget Formulation and Adoption

• Local Government Budget Should include the
  Following
• Program Elements Should Be Limited / Meaningful
• Present Multi-Year Data to Include Prior, Current
  and Forecast
• Include all Units that Require Government
  Resources in the Budget Formulation Process

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Revenue Mobilization and Forecasting

• Two Principles
• Own-source Revenues Should Be Sufficient to
  Enable LGUs to Finance all Locally Provided
  Services From Own Resources
• To Extent Possible, LGU Revenues Should Be
  Collected at the Local Government Level
• Most Basic Forecast Use Revenues From Current
  Year Increased By a Growth Factor
• Better to Use Information on Forecasted Tax Bases
  and Planned Rates to Explicitly Calculate What is
  Legally Collectible
• Should Use Information on Tax Compliance Levels
  to Determine Likely LGU Revenues

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Expenditure Forecast and Control

• LGU Budgets Should Be Examined For Conservative
  Characteristics
• Appropriations Should Be Fixed at Levels
  Determined By Best Estimates of Available Work,
  Services, and Price Levels For the Year
• Local Population and, Legislature Have Right to
  Know LGU Policy Objectives and Targets
• Informing General Public Increases Transparency,
  Accountability, and Allows For a General
  Consensus to Be Reached

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Budget Execution and Expenditure Control

• Key Elements For Consideration in The Financial
  Management of Budget Implementation
• Provide Guidelines For Re-programming Budget Line
  Items
• Re-programming Requiring Higher Level Approval
  Should Only Be For Shifts Between Major Line
  Items
• Establish Clear Procedures for Committing Funds
• Establish Clear Procedures for Distributing
  Allotted Budget Authority on a Quarterly
  Monthly Basis
• Quarterly Budget Allocations Must Be Made in
  Conjunction With Aggressive Cash Management

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Factors Influencing Escalating Expenditures

• Soft Budget Constraints
• Fragmented Approaches to Budgeting
• Creating Future Expenditure Commitments By Under
  provisioning
• Lack of Transparency
• Systematic Errors in Budget Forecasting

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The Capital Budget

• Concerned With Creation of Long-Term Assets
• Organized Along Multi-Year (5-Year) Capital
  Investment Plan
• Financing of Investments Often Requires a
  Different More Complex Set of Capacities
• Officials Also Need Skills to Procure
  Construction Services in a Cost-Effective, Open
  Manner

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Structure of Capital Budget

• Inventory of Capital Assets
• Multi-Year Capital Investment Plan (CIP)
• Financing Plan

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Structure of a Capital Budget
Source A. Premchand (2000) Capital Budgets
Theory and Practice.
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Determining Capital Expenditure Resource
Allocation

• Used in the Production Supply of Goods and
  Services Productivity Criteria
• Life Extends Beyond a Fiscal Year
• Not Intended For Resale in the Ordinary Course of
  Operations

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Number of Capital Projects that LGU Can Finance,
Depends On

• Level of Recurring Future Operating Expenditures
• Cost Recovery Elements
• Availability of Cost Sharing By Different Tiers
  of Government or PPP
• Debt Structures and Instruments

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Capital Budget Issues
Source A. Premchand (2000) Capital Budgets
Theory and Practice, and Schaeffer et al Croatia
Investment Packaging Manual (2004)
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Role of Accounting and Financial Reporting

• Accounting is Systematic Gathering of Financial
  Transactions
• Compiling and Reporting of Transactions in a
  Meaningful and Systematic Manner

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Unified Chart of Accounts

• Represents Basic Structure of Municipal Financial
  Accounting
• Must Include all Categories of Assets,
  Liabilities, Revenue and Expenditures, And Equity
  Accounts
• Provides a Logical Structure For Classifying
  Transactions

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Accounting Treatments

• Cash
• Simplest of All Accounting Procedures
• Records How Much is Received
• Records How Much is Paid Out
• Records How Much is in the Bank
• Simplest to Implement
• However, May not Provide for Adequate Controls on
  LGU Transactions

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Cash Accounting Not Recommended By GAAP

• Cash Received as Loan Illustrated as Revenue on
  Operating Statement not as Liability on Balance
  Sheet
• To Correct Most Cash Accounting Systems
  Recognize not only Cash, But Other Assets and
  Liabilities Arising Through Prior Cash
  Transactions.
• Does Not Alter Fact that Outstanding Obligations
  In the Form of Contract or Purchase Orders are
  Not Immediately Reflected In Accounting Records
  records.
• Available Balance May Be Overstated
• Can Lead to Unwise LGU Expenditures and Potential
  Overspending
• LGUs Operating on A Cash Basis May Ignore
  Obligations to Vendors For Services Received But
  Not Yet Paid
• This Type of Action Creates A Floating Debt
  Outside the Normal Financial Management System
• Cash Basis Accounting Does Not Adequately Record
  Liabilities Either to Provide Future Services or
  In Recognition of Services or Goods Received For
  Which the Bill Has Not Been Paid.

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Accrual Accounting

• Relates Revenues and Expenditures Not to the Time
  in Which the Cash is Received or Disbursement
  Made, But To the Period For Whose Benefit The
  Transaction Occurs
• Involves Shifting Existing Financial Features of
  Current LGU Financial Operations
• Shifting the Recording Basis From Cash To
  Commitment
• Separation of Financial Activities into Current
  and Capital
• Include Full Depreciation Allowances that Permit
  Allocation of Costs over the Life of The Asset
  Rather Than Recording Expenses When they are
  Incurred
• Preparation of Financial Statements in Conformity
  with International Accounting Standards (IAS) or
  Generally Accepted Accounting Principles (GAAP)

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Modified Accrual

• Most Transactions are Accrued in the Period in
  Which Benefit Received
• Other Transactions Especially Revenue are
  Accrued on a Cash Basis
• General Rule
• Expenses are Accrued
• Income From Taxes, Fees, and Other Sources are
  Recorded only When Collected (Cash Basis)
• Net Effect
• Bring Income in Line With Actual Cash Available
  to Pay Bills
• Ensuring the Recording of Expenses cannot be
  Manipulated by Delaying Until the Bill is Paid

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Deciding On An Accounting System

• Moving From Cash to Modified, Accrual Systems
  Requires Changes in the Organization Flow of
  Local Government Institutions and Increase in LGU
  Capacity
• Primary Importance of LGU Accounting System is
  that Financial Information Should be Timely,
  Transparent and Complete

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Universal Features of Accounting Systems

• Common Denominator
• All Systems Should Track Appropriations
• Supplementary Estimates
• Use of Appropriations
• Release of Funds
• Commitments
• Expenditures at Verification Stage
• Payments
• May be More Effective to Assist LGUs in Improving
  Cash Basis Accounting First Rather than
  Shifting to Other Accounting Systems

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Financial Reporting

• Process of Compiling and Organizing Financial
  Information Into Meaningful Reports
• Financial Reports Should In General Include
• Balance Sheet Not with Cash However Can Use
  Simple Balance Sheet Recording Assets /
  Liabilities
• Income Statement
• Cash Flow Statement

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Auditing

• Audit Report Should
• Analyze the Financial Position of the Local
  Government
• Include Trends
• Quality of Receipts Revenues
• Expenditure Analysis
• Evaluate Performance of Government on Various
  Financial Management and Accounting Issues
• Include Audit Observations

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Auditing and Local Government

• Audit Function of Local Government Found at Three
  Levels
• The Local Government Itself (Internal)
• Central Supreme Audit Office
• External Private Auditing Companies

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Shortcomings In LGU Audits

• Audit Oriented Toward Reviewing Transactions
  Rather than Performance
• Do Not Focus on Systematic Review of the
  Effectiveness of Internal Control Systems
• In Some Cases, Appropriate Certification of
  Financial Reports Annual Accounts Not Provided

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Treasury System

• Treasury Function Covers the Following
• Cash Management
• Management of Bank Accounts
• Financial Planning and Cash Flow Forecasting
• Public Debt Management
• Administration of Grants and Transfers
• Financial Asset Management

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What is Cash Management?

• Controls Aggregate Local Government Spending
• Implements the Budget Efficiently
• Minimizes the Cost of Borrowing
• Maximizes Opportunities for Using Government
  Resources

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Controlling Cash Flows

• Minimizing the Interval Time When Cash is
  Received and the Time Available For Financing
  Expenditure Programs
• Excess Cash Resources Should Not Be Idle
• LGU Treasurer Should
• Establish Written Procedures for Certifying
  Payments and Transferring Payment Requests to
  Cash Management
• Continuously Update Cash Flow Projections
• Develop Payment Schedules that Allow Individual
  Departments to Track Payment Requests
• Establish Standards and Procedures to Assure that
  Expenditures are Paid Within a Stipulated Time
  Frame

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Framework For LGU Financial Management
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Sequencing

• Chart of Accounts
• Accounting
• Local Government Fiscal Discipline
• Treasury and Budget Systems