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May 26, 2010

Prioritizing PFM Reforms: A Robust and Functioning Accounting and Reporting System is a Prerequisite

Posted by Sanjay Vani, Lead Financial Management Specialist, World Bank 

Much has been written about prioritizing and sequencing PFM Reforms, including Allen Schick’s often-quoted 1998 article, Why Most Developing Countries Should Not Try New Zealand's Reforms.  While working on the OECD-DAC Report on the Use of Country Systems in PFM a year or two ago, I was struck by how much more we know about what does not work than about what does work. For example, almost all PFM professionals would agree that introducing a medium-term budget formulation or performance budgeting in an environment of poor budget execution is not likely to be effective; and attempting performance audit without agreed performance benchmarks and proper systems to record and track performance is equally unlikely to be effective.

Here I would like to develop a hypothesis that, I am convinced, deserves serious attention from the community of PFM professionals. The hypothesis is this:  NO significant PFM reforms are likely to succeed unless a robust and functioning accounting and reporting system is in place.  In other words, a robust and functioning accounting and reporting system is a prerequisite to other PFM reforms.

Since we are talking about PFM reforms, let us assume a country with weak PFM systems, including its accounting and reporting system, that is unable to prepare timely, reliable, and consistent financial reports. Let us then examine the feasibility of undertaking in this country some key PFM reforms that are in vogue in many developing and transition countries.

(A) Could MTEF reforms work in this country, which is unable to prepare even basic financial reports on time? MTEFs generally require assessing total budget resource availability and costing of continuing and new activities by spending ministries (as part of their sector strategies). Without reliable and timely financial data on current resource collections and availability, it is difficult to imagine that the finance ministry will be able to prepare a sound estimate of future resource availability. Similarly, it will be impossible for spending ministries to prepare cost estimates for continuing and new programs without reliable financial and costing data. It is therefore apparent that accounting and reporting reforms should precede the introduction of MTEF.

(B) Could cash management / debt management / commitment control reforms succeed in this country, which is unable to prepare reliable and timely financial reports?  The availability of financial data is of utmost importance for efficient cash or debt or commitment management, and the lack of such data—which can only be provided through a sound and robust accounting and reporting system—will hamper efforts to strengthen these functions.

(C) Could external audit reforms be effective in this country, when financial statements are not ready for audit? One of the key objectives of external audit by a country’ supreme audit institution is to provide an audit opinion on the annual budget execution report (financial statement). If the annual budget execution reports are presented to the SAI for audit more than 12 months after the close of the financial year, it is doubtful whether strengthening the SAI’s capacity will yield much benefit.  It will be necessary first to strengthen the accounting and reporting systems so that they are capable of producing reliable and timely financial statements for audit.

I rest my case:  strengthening accounting and reporting system is a prerequisite for undertaking MTEF or cash/debt management or external audit reforms.  But we can test the hypothesis from another angle by studying the degree of relationship between PEFA scores for accounting and reporting and overall PFM performance scores. An analysis of 106 country PEFA reports produced over the past five years reveals a positive coefficient of correlation of (r) +0.58 between the PEFA indicator PI 25 score (quality and timeliness of annual financial statements) and the overall PFM performance score. This correlation indicates that strong accounting and reporting systems go hand in hand with stronger PFM performance or conversely weak accounting and reporting systems are symptomatic of weak PFM performance.

In terms of prioritizing PFM reforms, it is imperative that countries undertake accounting and reporting reform before attempting other PFM reforms.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.


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i strongly agree with what you have put forward. From experience working in a couple of emerging economies and also in my various roles in Canada, having the basics right is a prerequisite. I would offer another thought that is connected. Having the professional capacities to deliver and maintain the systems is very important. Therefore, developing the professional financial groups and making sure they are part of the system and supported over time is vital. Too often systems are created that are intended to meet the needs of sound accounting and financial systems and then left on their own without proper support. The second thought, and central to concerns i have, is the development of financial literacy in the leadership group, be it political or bureaucratic.

I think that Sanjay is correct, but more specifically we need to get the basics right, which I think means addressing basic financial controls first.

So, before we think about introducing an MTEF, we need to ensure that basic budgetary and commitment controls are robust and working well.

This leads on to the second area of cash and debt management which includes some fairly basic controls, especially around cash management.

In the third area of external audit, the main area of work of external auditors in English and French speaking countries is actually compliance or regulatory audit. This is an essential basic control, especially if the audit reports actually include recommendations for improvement, rather than just listing irregularities discovered.

Auditors General, Cours des comptes (Accounts Court) or Inspection Générale d’Etat (General State Inspectorate) do not need to wait for the financial statements to be produced before they do their main work. In deed, in some countries, Nigeria, for example, the annual report of the Auditor General has been split into two volumes. Volume one covers the regulatory and compliance work and so it can be issued even if the accounts are delayed. Volume two includes the audit opinion on the accounts and other comments.

On accounting and reporting reforms themselves we also need to concentrate on the basics first. This means ensuring that the financial statements are issued promptly (within in a year of the financial year end and ideally less) rather than worrying too much about compliance with international accounting standards (and certainly not moving to the accrual basis).

There is considerable looseness the language of Dr Sanjay's hypothesis. Exactly how reliable and robust should these information and reporting systems be before we brave any other reforms. Show me a system that produces 'sound' estimates or show me as system that 'accurately' costs activities, and I will show you a set of questionable assumptions and parameters and variables. We will be waiting a long time for cash management, commitment control or MTEF if we wait for sound and accurate information systems. They all rely on estimates, quotations and forecasts. Does Dr Sanjay seriously expect governments to wait until they can 'accurately' cost hospital episodes or activities before we implement MTEF?

I agree with Mr. Higgins. Those of us who work in the field realise very quickly that theory is good but practice is sometimes getting things going without waiting for perfection- else we will wait forever. There needs to be a balance between what is best and what is practical.
Having said that, it is also clear that without getting the basics right "braving other reforms", especially the more advanced ones, is neither possible not sensible. Unfotunately, too often, there is excessive donor pressure to "do as we do", leading to form and no content.

This rejoinder is in response to a very specific question raised by Mr. Higgins. There is a need to distinguish here between Financial Accounting Systems and Cost/Management Accounting Systems. From the comment, it appears that Mr Higgings is referring to Costing/Management Accounting Systems, which generate information such as cost of an operation in a hospital. I was referring to Financial Accounting System and not Cost and Management Accounting System. I am suggesting that unless ministries/agencies have access to reliable and timely financial data, it is difficult to imagine undertaking other reforms that are predicated upon the availability of such data. Just to re-emphasize - how could a health ministry do a MTEF when it is unable to know, even after a lapse of several months, how much it has spent on various accounts (budget classification heads). Such information is generally retrieved easily from an accounting system, when one is functioning properly.

I support the view that program managers and other users of public financial management information systems must have access to the necessary and sufficient financial information. This would allow them to take financial decisions in an opportune manner and ensure that a public good or service is provided, in the amount and quality required. In the case of hospitals, this implies having access to a unified and centralized government accounting system that records the new recruits to the existing medical staff, and itemizes the inventories of medicines and vaccines, their expiration date, medical equipment, etc. Similarly, in project investment management, infrastructure monitoring and treasury district officials should be able to have access to contracts management and performance indicators provided through the inputs and outputs provided in the accounting system to authorize a payment order. Contractor journals to record the execution of contracts and internal control and internal audit officials to verify contract compliance are not integrated, so payment decisions rest mainly on incomplete information. The challenge lying ahead is to integrate the costing accounting to the budget and treasury accounting system to ultimately the financial accounting system that enable financial managers to use public resources in the most rational and cost effective manner so that public expenditures can achieve the strategic sector goals and policy objectives set forth within MTEF. Accountants and IFMIS developers can play a vital role in better assisting client governments, particularly the priority programs, and move beyond the actual pace of PFM reforms to focus more on VFM matters while maintaining fiscal prudence and shared fiscal responsibility. It is complex and costly indeed, but the cost of keeping PFM reforms unchanged and off course will be much higher.

The aspiration is noble and well targeted; a lack of timely financial information is an impediment to government’s core function - the delivery of services to its people. And there is a real sense in which this needs to be a primary (perhaps fundamental/standing) area of focus for reform.

However once you get past this over-arching statement and start to unpack the implications, you see that in government the challenge is broad and multi-faceted with so many people requiring the use of the financial data for their own valid purposes. So I hear what Mr. Higgins is saying, in practise you don't work from a blank canvas and are forced to make improvements as and when you are permitted access through opportunity. As professionals we are most often subject to the tyranny of opportunity over need.

I would further propose that this timely financial information needs to be available not only as hardcopy reports but also as electronic data (raw) available for further analysis. When used well (financial) information is a critical means of monitoring performance, influencing future behaviour and developing evidence-based policy.

The basic question that is raised is well put, what PFM initiatives should we rightly consider postponing in favour of addressing the inherent weakness in the government accounting system.

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