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Acknowledgement
PublicSectorFinancialManagementforManagershasbeen producedfortheCanadianGovernanceSupportOfficewith fundingfromtheCanadianInternationalDevelopmentAgency, GovernmentofCanada,asageneralguideforfinancial managementforlinemanagersintheAfghanistanpublicservice. ItcanbefreelyreproducedbyanyAfghanMinistry,Government DepartmentorAgency. PleaseacknowledgetheGovernmentofCanadainany reproductions. Usebyinternationalorganizationsrequirestheexpress permissionofCANADEM.
CANADEM 2011
Table of Contents
Section1:TheNatureofPublicSectorFinancialManagement......................................................1 KeyPoints....................................................................................................................................1 Question1:WhatisthePublicsector?....................................................................................... 2 5KeyFeatures:................................................................................................................................2 Question2:WhatisFinancialManagement?............................................................................. 3 8KeyFeatures:................................................................................................................................3 Section2:CornerstoneOne:AllocatingResourcesBudgets.......................................................5 KeyPoints....................................................................................................................................5 TheBudgetCycle......................................................................................................................... 5 BudgetMethodologies................................................................................................................ 6 OrganizingBudgetInformation....................................................................................................... 6 ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005...........................................8 TraditionalBudgetingversusPerformanceBudgeting ..................................................................10 Section3:UnderstandingtheBudgetaryProcess......................................................................... 11 KeyPoints..................................................................................................................................11 BudgetsandPlanningCycles..................................................................................................... 11 ElementsofanEffectiveBudgetCycle.................................................................................. 12 StrategicPlanningPhase....................................................................................................... 12 CostAnalysisPhase................................................................................................................... 13 TheRoleofRevenueinCostAnalysis................................................................................... 13 HowtoDetermineCosts....................................................................................................... 13 FixedandVariableCosts ........................................................................................................ 14 GettingApprovaltoSpend:TheAppropriationProcess...........................................................14 CentralAgencyversusProgramOrganizations..................................................................... 15 TheNewVersustheOld........................................................................................................ 15 ComplexityversusClarity...................................................................................................... 15 OnBudgetVersusOffBudget ................................................................................................ 15 Conclusion.................................................................................................................................16 Section4:Budgeting:CapitalPlanning.......................................................................................... 17 KeyPoints..................................................................................................................................17 CapitalBudgets.......................................................................................................................... 17 CharacteristicsofCapitalAssets............................................................................................ 17
Public Sector Financial Management for Managers
ToolsofCapitalPlanningandBudgeting................................................................................... 18 CapitalImprovementPlans................................................................................................... 18 TimeValueofMoney................................................................................................................ 20 PresentValueandFutureValue............................................................................................ 20 NetPresentValue.................................................................................................................. 22 RiskAssessment........................................................................................................................ 22 ExamplesofRiskCategoriesinAssessingCapitalAssetRisks.......................................................22 Conclusion.................................................................................................................................23 Section5:CornerstoneTwo:MonitoringMoneyManagerialControl......................................25 KeyPoints..................................................................................................................................25 WhatisManagementControl?................................................................................................. 25 ManagementControlFramework......................................................................................... 25 RiskandRiskManagement................................................................................................... 26 UnderstandingandDefiningtheRisks............................................................................. 27 ControlProceduresandPolicies ............................................................................................ 28 WhoandWhentoControl............................................................................................... 28 WhoistheController?..................................................................................................... 29 TrustandEthicsinControl.................................................................................................... 29 Trust ..................................................................................................................................29 Ethics................................................................................................................................29 ValuesandEthicsApproaches .......................................................................................... 30 ControllershipCapacityChecklist.............................................................................................. 31 StrategicLeadership......................................................................................................... 31 ClearAccountability......................................................................................................... 32 SharedValues&Ethics..................................................................................................... 32 MatureRiskManagement................................................................................................ 32 IntegratedPerformanceInformation............................................................................... 32 MotivatedPeople............................................................................................................. 32 RigorousStewardship....................................................................................................... 33 Section6:CashManagement:InYearControl............................................................................. 35 KeyPoints..................................................................................................................................35 ObjectivesofEffectiveCashManagement,MonitoringandControl.......................................35 EstablishingaCashManagementSystem............................................................................. 36 InyearBudgetDesignFactors.......................................................................................... 37
Public Sector Financial Management for Managers
EstimatingWorkFlows..................................................................................................... 37 UseofHistoricalData....................................................................................................... 38 MonitoringFinancialPerformanceandVarianceAnalysis....................................................38 SettingupaMonitoringTimetable.................................................................................. 39 Governance...................................................................................................................... 39 PerformanceReports....................................................................................................... 39 EastbrookCorrectionalFacility,Eastbrook,NovaScotia..............................................................39 Staffing:PlanversusActual........................................................................................................... 40 VarianceReports.............................................................................................................. 40 ForecastedversusActualReport ...................................................................................... 40 AnalysisofKeyVariancesReport..................................................................................... 40 HistoricalInformation...................................................................................................... 41 HistoricalStaffingPatterns:CustodialOnly:YearAverage...........................................................41 ReallocationandReadjustment............................................................................................ 42 TheAuthoritytoReallocate............................................................................................. 42 FreeingUptheFunds....................................................................................................... 42 Conclusion.................................................................................................................................43 Section7:CornerstoneThree:ReportingOnHowMoneyIsSpentAccounting.......................44 KeyPoints..................................................................................................................................44 AccountingPrinciples................................................................................................................ 44 1.TheEntityPrinciple....................................................................................................... 44 2.MoneyasaMeasure/theCostPrinciple..................................................................... 45 3.TheGoingConcernPrinciple........................................................................................ 45 4.TheConservatismandCostConcept............................................................................ 45 5.TheMatchingPrinciple................................................................................................. 46 6.TheConsistencyPrinciple............................................................................................. 46 7.TheMaterialityPrinciple.............................................................................................. 46 8.TheDualityPrinciple..................................................................................................... 46 9.TheAccrualPrinciple.................................................................................................... 47 TheQualityofInformation.................................................................................................... 47 TheOutputsofAccounting .................................................................................................... 48 TheAccountingCycle....................................................................................................... 48 DoubleEntryBookkeepingandtheFundamentalAccountingEquation......................................48 DebitsandCredits......................................................................................................................... 49 ExamplesofDebitsandCreditsTransactions............................................................................... 49
Public Sector Financial Management for Managers
Wherearetheseactivitiesactuallyrecorded?.............................................................................. 50 KeyDefinitionsofTermsUsedInFinancialStatements................................................................50 AnExampleofDepreciation.......................................................................................................... 52 Equity/NetAssets/FundBalance................................................................................................... 53 TheBalanceSheet......................................................................................................................... 53 TheIncomeStatement.................................................................................................................. 54 ByObject:salaries,benefits,rentals,costofservices ................................................................... 54 IncomeStatementOrganizedbyObject(PlusYeartoYearComparison)....................................54 TheStatementofCashFlows........................................................................................... 54 Conclusion.................................................................................................................................55 Section8:AccrualAccounting:ProvidingaFullerStory ................................................................56 KeyPoints..................................................................................................................................56 WhydoweneedAccrualAccounting?...................................................................................... 56 CashBasisAccounting:AnOverview ..................................................................................... 57 AnotherExampleofCashAccounting........................................................................................... 57 ExampleofCashAccounting......................................................................................................... 57 AccrualBasisAccounting:AnOverview................................................................................ 57 ExampleofAccrualAccounting............................................................................................. 58 TheDifferencebetweenCashandAccrualAccounting........................................................58 CashVersusAccrualTreatmentofAssetAcquisitionandUse......................................................59 ImplicationsoftheAccrualAccounting................................................................................. 59 AnExampleofaWeekintheLifeofOneGovernment................................................................60 FinancialReportsoftheGovernment........................................................................................... 61 TheProsandConsofCashandAccrualAccountingandBudgeting.....................................62 ConclusionsandOverview........................................................................................................ 64 Section9:AccountabilityandReporting....................................................................................... 65 KeyPoints..................................................................................................................................65 WhatisAccountability?............................................................................................................. 65 TheRelationshipofAccountabilityandFinancialManagement...........................................66 TheUsersofFinancialandPerformanceReports..................................................................... 67 TheObjectivesofFinancialandPerformanceReporting..........................................................68 TheRoleofAuditintheAccountabilityProcess....................................................................... 69 InternalAuditFunctions................................................................................................... 69 LegislativeAuditors.......................................................................................................... 70
Public Sector Financial Management for Managers
These e3Cornerst tonesofPub blicsectorFin nancialMan nagementcanbebroken ndowninto variousparts,wh hichwillbeexplored e indetailed d thro oughoutthis sguide.Wecan c beginto o
Public Sect tor Financial Management M for Managers s 1
identifysomeofthecomponentsofthesethreebroadstagesbyaskingthequestions: WhatisthePublicsector,andwhatisFinancialManagement?
5KeyFeatures1:
i)ThePublicsectorisbroad.Itencompassesallorganizationsthatreceivetheirfunding frompublicsourcessuchastaxes,feesorlicences.Therefore,itwillembracenotjust governmentdepartments,butalsogovernmententerprises. ii)ThePublicsectorhasmultiplegoals.Ratherthanhavingasinglebottomline,the publicsectorhasseveral,whicharebeingpursuedatonce. iii)ThePublicsectorusesvarioustoolstoreachitgoals.Thereareaseriesof instrumentsusedtoachievethegoalsofgovernment2. iv)ThePublicsectoroftenusesthePrivateSectortodeliverPublicGoods.Modern governmentsfrequentlyusecontractswithprivatecorporationsasameansofacquiring neededexpertise,outsourcingwork,orextendingtheirworkforceswhileseemingto containthegrowthofthepublicservice. Thiscontractedworkdoesnotmeanthattheregularpublicserviceisrelievedofits accountabilityforpublicfunds.Governmentsdevoteconsiderableenergyto administeringcontracts,especiallyduringaperiodofincreasedscrutinybythepublic andbythecontractingcommunityinparticular. v)ThePublicsectorisademocraticinstitution.Governmentsownnoneofthe resourcestheyspend.Taxpayersdo.Inademocraticsociety,thewaysinwhich governmentsspendresourcesmustbetransparentandreadilyopentoquestioning. AccountingforPublicsectorfundsandtheirproperexpenditureisnotonlypartofgood management,itisessentialtogoodgovernmentandgoodgovernanceofthepublic enterprise.Itisalsowheregovernmentsaremostheavilyscrutinizedandwherethey cangetintoagreatdealoftrouble.Suchscrutinyisoneofthebasisofagovernments legitimacy.
CICAPublicsectorAccountingHandbook,RevisedUpdateNo.18,SectionPS1100,AppendixA Salamon,LesterA,RethinkingPublicManagement:ThirdPartyGovernmentandtheToolsof GovernmentAction,PublicPolicy29,no.1(Summer,1981)andSalamon,LesterAandMichaelS.Lund, TheToolsApproach:BasicAnalysitcsinBeyondPrivatization;TheToolsofGovernmentActionedited byLesterASalamon,..2350,Washington,UrbanInstitutePress,1989
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8KeyFeatures:
i)FinancialManagementinvolvesthecollectionofmoney.ThePublicsectormakes mostofitsmoneythroughtaxation,transfers,fees,thesaleofgoods. ii)FinancialManagementinvolvesallocatingresources.TheincomeofthePublicsector isnottiedtoanyonespecificgoal.Rather,Publicsectorfundsareconsolidatedintoa ConsolidatedRevenueFund(CRF)andsubjectedtoademocraticdecisionmaking processthatdistributesthemacrossarangeofactivities.Thisisknownasthebudgetary process.Thereareexceptionstothisruleinwhichspecifictaxesorfeesaredirectedto specificprograms. ABudgettellsthepublichowthegovernmentintendstospenditsmoney.The budgetaryprocessisaplanningtoolandatoolofregulationandcontrol.Agovernment budgetsetsalegallimitforexpenditures.Italsocreatesthelegalauthorizationfor delegatedofficialstospendfund. ABudgetisalsothetoolbywhichthegovernmentsfinancialperformanceisjudged. Managersareheldtoaccountfortheirperformancerelativetothebudget. iii)FinancialManagementinvolvesspendingmoney.Delegatedofficialsareexpected tospendpublicfundsforthepurposesforwhichtheywereallocated.Therefore, financialmanagementinvolveshavingcontrolsinplacetomonitorexpenditures. iv)FinancialManagementinvolvesoversightwatchingthemoney.Thegovernment mustfrequentlyandsystematicallymonitorandreportontheflowofmoney.This ensuresactualfinancialactivitymatchesplannedfinancialactivity.Financialrolesand responsibilitiesaswellasfinancialreportingtimelines,areoutlinedinlawtoensure specificindividualsarelinkedtothesuccessorfailureofaparticularstageinthe financialprocess.Informationsystemssupporttheserolesbymakingpublicservants awareoftheirlevelofprogress. Legislationcreatingpublicorganizationscanbeverybroadwithrespecttotheamount oflegislativecontrolthatisexertedastheorganizationgoesaboutitsdaytoday business.Legislaturesseldomengageintheactualmanagementofpublicorganizations. Rather,theyserveotherkeyroles:creatingtheorganization,settingoutthepolicies thattheywillcarryout,providingthefundingtocarryoutthepolicies,holdingthe
Public Sector Financial Management for Managers 3
organizationtoaccounteitherdirectlyorthroughexternalauditorsappointedbyand responsibletothelegislatures. v)FinancialManagementinvolvesaccountingformoneycollectedandmoneyspent. ThePublicsectormustassurethepublicthatitsmoneyisbeingspentwell.Thismeans theyneedtoask: Ismoneybeingspentforanappropriateuseforthepublicgood? Arefundsbeingallocatedforthestatedpurpose? Arefundsbeingspentaccordingtotherulesthatapply? Didthefundsachievetheintendedresults? Canthefundsbetracedandidentified? Canothersassessthefinancialinformationoftheorganizationexternalreview oraudit?
Essentially,pastfinancialbehaviormustbereconciled,audited,andreviewedinrelation tothebudgettogivethelegislatureandpublictheassurancesthatfundswerespentfor theirintendedpurpose.Thepublicaccountsandtheassociatedfinancialstatementsare themaindocumentsusedbygovernmenttoshowfinancialactivity. vi)FinancialManagementinvolvestakingcareofassets.Publicsectororganizations buildoracquirecapitalassets.Theyowncapitalassets,whichcanbeconsiderable,in ordertodeliverservicesandthepublicgoodobjectivesthattheywanttoachieve. Consequently,thePublicsectorhasconsiderablemaintenancerequirementsand operationalcosts.Financialmanagersmustensurethatassetsareproperlypurchased andsustainable. vii)FinancialManagementdoesrequiredueregardforprocess,recordkeepingand reporting.Therecanbeatensionbetweentheobjectivesofthepublicservicetoquickly servetheneedsofcitizensandeffectivefinancialmanagement,seeingitasinhibiting effectiveclientservicethroughexcessivecontrols,inadequatefundingora preoccupationwithpaperwork.Nonetheless,theserequirementsremainessentialfor propercontrolandaccountabilityaswellaspublicconfidenceinthegovernments financialprudenceandhonesty. viii)FinancialManagementisEverybodysBusiness:Oftenpublicservantsdonotsee themselvesasmanagersofresources,butratheraspolicymanagersofhighly specializedfunctions.BecauseofthecomplexityofthePublicsector,thefinance functionwillhaveitsownseniormanagerswhoareoftenseparatefromlineor operatingmanagers.Tensionsoftenensuebetweenthesetwocultures.Theseare normaland,whenwellmanaged,healthyandnecessary. Inreality,allmanagersarefinancialmanagers.Theabilitiestoobtainresourcesto achieveprogramobjectives(budgeting),maximizeprogrambenefitswithinthebudget (allocation),effectivelymanagethebudgettoachievefullbenefit(cashmanagement), anddemonstrateresultsandprocessadherence(accountability),areimportant managementskillsforallgovernmentemployees.
Public Sector Financial Management for Managers 4
Section2:CornerstoneOne:AllocatingResourcesBudgets
Key Points
A budget is a time limited plan that puts resources in place to implement the goalsofanorganization. Forthepublicsector,abudgetisalegallyauthorizedannualmonetizedplanthat establishesspendinglimitsforthevariousprogramsthatcomeoutoflegislation, policy,andorganizationalintent.Abudget,therefore,doestwothings: 1)Ittranslatespolicyintentionintospecificactivitiesthroughresource allocation. 2)Itisalsothebasisforfinancialcontrolwithinthepublicsectororganizationin thatitarticulatesexpectationsofrevenueandexpenditures.Assuch,itisa usefulbenchmarktocontroltheoperationsofgovernmentdepartmentsand agencies. Typically,aGovernmentwillhaveanorganizationwidebudget. Thisdocumentwillthengetdividedintopartsinordertoformdepartmentbudgets. And then those department budgets will be further divided in order to produce branchbudgetsofvarioussorts.
Inthissection,wewillexplorethevarioustypesofbudgetsusedinthepublicsector.
Importantly, this third budget life the past is critical since so much of the budgeting process is incremental in nature, as changes are made in small increments based on prior years levels of resources, e.g. an increase of 2% per annum with no change in program fund distribution. Many organizations make the majority of their budget decisions based on past performance and allotments. How much was actually used in thepastisanimportantfactor.
Budget Methodologies
Core Elements: There are three core elements to a budget: revenue, operations and capital.Thesearedescribedbriefly. Revenue Budgets: For the most part, governments manage their revenue strategies at the whole of government level, imposing taxes and fees. They then distribute money to departments through the budgetary and appropriations process. Individual managers have little to do with this part of the budget process, unless they work on the revenue sideofgovernment. Operating Budgets: Operating budgets describe the programs and resources used to carrythemoutwithinaspecifiedperiodoftime.Theoperatingbudgetcontainstheplan forrevenuesandexpendituresfortheperiod,usuallyreferredtoasafiscalyear. In governmental terms, the expenditure plan represents the authorized limit of expenditures for the operating unit.Most operating budget provide funds for such elements as staff, benefits, supplies and operating expenses as well as grants and disbursements. Capital Budgets: Capital budgets contain the plans and resource allocations for capital acquisitions..They receive different treatment than operating funds because their use is often a more complex and longerterm proposition than the oneyear operating funds. Theyofteninvolvecomplexplanningprocesseswithconsiderablefinancialriskandcash outlay. Land and buildings are wellknown capital goods. Increasingly, information technology infrastructure is a part of the capital budgets. Determining what is and what is not treatedasacapitalitemisamatterofpolicywithinpublicsectororganizations. OrganizingBudgetInformation Budgets vary considerably in complexity. This will depend upon the purpose for which they were created andhow they will be used. In seekingthe best way to display budget
information, there are three main approaches, each with useful intent as well as limitations: Lineitembudgets, Programbudgets, Functionalbudgetswhichcombinetheformertwo,and Performancebudgeting. Mostgovernmentpracticeallthreeforms,usingthemtomeetthevariousgoalsofa budget.Forinstance,asimplelineitembudget,describedbelow,willmeettheneedsof amanagertounderstandwhatresourcesshehasandforwhatkindofpurpose,e.g., staff,supplies,etc.Aprogrambudgetwilllinksuchinformationtotheprogramswithina particularunit.Afunctionalbudget,averycommontool,combinesthelineand programbudget.Aperformancebudgetwilllinkthemoneyallocatedtospecific anticitipatedperformanceoutcomes,e.g.,pavingsomanykilometersofroadsforso muchmoney.Eachisusefulinitsownturn. LineItemBudgets:The lineitembudgetisone oftheeasiesttoprepareandoneofthe mostusefulintermsofcontrolofbudgetswithinaspendingperiod. The financial information is organized according to the types of expenses or cost categories. These generally focus on staff, supplies, rentals, and contracts, all of which canbecharacterizedascostsofoperations. AsimplelineitembudgetfortheOttawaGeneralHospital,focusingonexpensesonly,is shownhere. Line-Item Budget of the Ottawa General Hospital for Fiscal Year 2005 Object Budget 100. Salaries $8,000,000 200. Supplies 2,000,000 300. Rentals 250,000 400 .Professional Fees 750,000 Total $11,000,000 Themainorientationofalineitembudgetisexpenditurecontrolandaccountability. Thisbudgetwillinformthemanagerorstakeholderswhatisbeingspentonwhatitem ofexpenditure.Theseareknownasinputsinthattheyidentifythecategoriesof resources,e.g.stafforsupplies,neededtodothework.Sinceitusescommonobjectsor objectscodes,italsopermitsinterbudgetcostcomparisonsbetweenprogramsor
Public Sector Financial Management for Managers 7
organizationswithsimilarfunctions.Agoodexample,ifallhospitalsusedthesame objectcodesorlineitems,isthatitwouldenableaninterestedobservertodetermineif theOttawaHospitalhadahigherstaffcosttooverallbudgetratiothananothersimilar hospital. ProgramBudgets:Programbudgetsarebudgetswhichareorganizedfordisplay purposesaccordingtoprogramtypes.Itshowshowresourcesareallocatedtoeach particularprogram.Thistypeofbudgetassignsresourcestotheoperatingunit,zone, areaorspecializedprogramwithinwhichitisbeingspent. ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005 Unit Budget 1.OperatingRoom $4,000,000 2.Laboratory 1,000,000 3.Radiology 1,000,000 4.PatientCare 2,500,000 5.OutpatientCare 1,500,000 6.Administration 1,000,000 Total $11,000,000 FunctionalBudgets:Afunctionalbudgetisabudgetthatcombinesthelineitembudget withtheunitbudgettoprovideamorecompletepictureoftheresourcedistribution withinanorganization. Thisisoftentheformatthatisusedforexternalreportinginformation.Ithasthebenefit ofallowingabetterbasisforcomparisonamongunits.Forinstance,oneareamayhave highsalarycosts,e.g.operatingroomwhileanother,e.g.,administration,maybelower. Thatmayreflectthelabourintensityoftheworkorthesizeoftheunitaswellasthe costoftheprofessionalandsupportstaffineachunit. Thefunctionalbudgetdeliversabetterunderstandingofwhatfundsaretobespentfor. Itcombinesinformationaboutinputsandunitsorprogramsthatarebeingfunded. BelowisadisplayofthefunctionalbudgetofOttawaGeneralHospital.
FunctionalBudgetoftheOttawaGeneralHospitalforFiscalYear2005
Unit 1.Operating Room 2.Laboratory 3.Radiology 4.PatientCare 5.Outpatient Care 6. Administration Total 100.Salaries 3,250,000 550,000 450,000 2,000,000 1,200,000 475,000 7,925,00 200.Supplies 250,000 350,000 450,000 400,000 175,000 325,000 2,000,000 300.Rentals 50,000 25,000 0 0 25,000 50,000 150,000 400.Professional Total Fees 450,000 4,000,000 75,000 100,000 100,000 100,000 100,000 925,000 1,000,000 1,000,000 2,500,000 1,500,000 1,000,000
11,000,00
PerformanceBudgets:Performancebudgetsareintendedtolinkresourcestothe resultsdesiredfromaprogram.Whilealineitembudgetisfocusedentirelyoninputs andazerobasedbudgetgoesbacktobasicsandreinventsitselfeachyear,the performancebudgethascertainfeaturesthatmoveitmoreintotherealmofpublic sectoraccountabilitywithagreateremphasisonoutcomesandresults: 1. thereismeasurementofthegoodsandservicetobedelivered, 2. unitcostsaredeveloped, 3. budgetfiguresaredevelopedbasedonthelevelofserviceasdeterminedby multiplyingtheunitcostandlevelofservice, 4. expectedoutputsarereportedwithinthebudget. Theperformancebudgetisdesignedtoprovideaclearerpictureofwhatlevelofservice istobeprovidedforhowmuchmoneyandwithwhatresults.Anexampleofthiswould betoaddadditionalinformationtotheOttawaHospitalbudgetdocumentsthatoutline someofthefollowingoutcomes: a. numberandtypesofoperations, b. waitingtimesforoperations c. costperoperations d. overheadcostsasapercentageofoverallbudget e. changesinservicelevels. Theperformancebudgetisagoodsteptowardscostingofservices,identifyingclearly servicelevelsofcurrentresourcesandhelpingdecisionmakersmakeabetterlink betweenthosetwowhendeterminingfutureresourcing.
TraditionalBudgetingversusPerformanceBudgeting TraditionalBudgeting PerformanceBudgeting BudgetOrientation MoneyControl Linkingmoneytoprogram andactivities AppropriationControl Department Program Level BasicBudgetingUnit Object,objectcodeorline Activity item EfficiencyMeasurement None Unitcost,volumes ResultMeasurement None Programlevels,activity (Effectiveness/Quality) levels BudgetPeriod Oneyear Ongoingyearoveryear Someofthekeyelementsofperformancebasedbudgetsare: 1. servicesaredefinedandmeasurescreatedforthem, 2. disaggregatingofservicespermitsindividualcostingandthedevelopmentof workloadmeasurements 3. servicestandardsaredeveloped, 4. thereisastandardizedcostingmethodology, 5. unlikeotherbudgetformats,therewillbeaconsiderableamountofnarrativeto explainservicelevels,how 6. theyarecostedandhowcostsaredistributed, 7. someformofbenchmarkingisinvolved:thisprovidescomparativedataofcosts andworkloadlevelsinsimilarcircumstance,e.g.comparingthecostofgarbage collectionfromonetowntoanother.
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Section3:UnderstandingtheBudgetaryProcess
Key Points
Agoodbudgetprocessisfarmorethanthepreparationofalegaldocumentthat appropriatesfunds. Goodbudgetingisabroadlydefinedprocessthathaspolitical,managerial, planning,communication,andfinancialdimensions. Agoodbudgetprocessischaracterizedbyseveralessentialfeatures.Agood budgetprocess:
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Review,Auditand R Evaluation
Performance Monitoring
ElementsofanEffective E Bud dgetCycle Itcreatesaco ommonfram meworkforalltheplayer rsintheproc cesstouse. Th hecycleensu uresthatpoliticalpriorit tiesareset. Th he budget cycle is linked to th he overall planning cycle c of th he de epartment. Th here is a com mmon appr roach across s governmen nt to permit t compariso on an ndcomparat tivecosting. Th here is an ag greed upon timetable for preparation and con nsideration of o bu udgetswithintheorgani ization. Go overnments provide guidance g to managers on budget limits an nd im mportantinfo ormationab bouttolerabl lecostlevels s. Th hereisacom mmoncostin ngmethodol logyforcom mmoninputs ssuchasstaff salaries,equip pment,etc. Theelements e can nberolledup u intothree eessentialphases: StrategicPlanningPhase, CostAnalysisPhase,and a ApprovalPhase StrategicPlannin ngPhase Strate egic plans usually u cont tain a funda amental set t of components that describe th he purpo oseoftheorganizationand a itsinten ndeddirectio onoveraprescribedper riod.
Public Secto or Financial Management M fo or Managers 12
Missioncomprehensivestatementexpressingthepurposeoftheorganization. Visionstatementoftheendresultspursuedbytheorganization. GuidingPrinciplesphilosophythatsteerstheorganizationindeliveringservices andaccomplishingitsmission. SituationAnalysisdescriptionofkeyinternalandexternaltrendsthatarelikely tohaveanimpactontheagencyoverthetimeperiodoftheplan. Goals statements that describe the agencys destination, direction, and intent fortheperiodoftheplan. Objectivesinitiativesthatimplementthegoals. Performance Measuresand Targets precise milestones for each objective that will help the organization will evaluate progress toward the objectives and the goalsthatitsupports. Linkage of General Goals to Annual Performance Plan description of the relationship between annual goals in the performance plan andthe general multiyeargoalsandobjectivesinthestrategicplan. Resources Needed description of the human, capital, information, and other resources and the operational processes, skills, and technology needed to achieve the agency goals; highlighting where significant change from currently available resources will be needed. Note: this is not the budget for the coming year, but a resource discussion that will certainly affect budget decisions in futureyears. ProgramEvaluationsdescriptionofhowtheresultsofprogramsorpolicywill beevaluated.
Cost-Analysis Phase
TheRoleofRevenueinCostAnalysis Managers have to make predictions about anticipated revenues because without understanding what resources will be available to government, it becomes extremely difficulttodecidewhatprojectsshouldbeallocatedresources.Usinghistoricaltrenddata is an easily available and useful tool for predicting revenue. Once a prediction is made, attentioncouldthenbemadeaboutcostsandthespendingprioritiesofgovernment. HowtoDetermineCosts One way of examining costs is to divide them into two basic categories: Direct and Indirect.
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Direct costs are costs incurred within the organizational unit for which the manager has responsibility, and costs of resources used for direct provision of goods or services or activitiesthatrelatetothecoremissionoftheorganization.3 Indirect costs or Overhead are: costs assigned to an organizational unit from elsewhere in the organization e.g. information technology support, and costs within a unit that are notincurredfordirectprovisionofgoodsorservices,i.e.corebusinessormissioncentral, but are nonetheless needed to provide those services, e.g. logistical support, information technology,physicalplant,financialservices.4 Often organizations fail to fully take into account all the costs of service delivery. The objective of sound budgeting practice, however, is to arrive at a full understanding of the total cost of providing the missioncritical services of the organizations. Therefore, both indirectanddirectcostsneedtobeincludedinanybudget. FixedandVariableCosts Another essential tool of costing is the use of fixed and variable costs. This analysis is important for it enables the manager to determine how costs will react when certain variables are changed. It can establish cost sensitivity, i.e. the point at which costs can either be reduced or increased with changes in activity. Establishing an understanding of cost sensitivities will enable the manager to better understand the impact of program changes. Fixed costs are those costs that do not change in total as the volume of service units changes over a relevant range of activity.5Variable costs are costs that vary directly with changesinthevolumeofserviceunitsoverarelevantrangeofactivity.6
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CentralAgencyversusProgramOrganizations Typically, during the budgetary cycle, the overall planning and legislative process is supported by central agencies such as the Ministry of Finance. Central agencies provide a wholeofgovernment assessment of the supply of revenue as well as the tolerable scope for program expansion. They ensure that debt is avoided by looking at the bigpicture of programspending.Centralagenciesusetheanalyticaltoolsmentionedabovetoprovidea detailed assessment of the costs of government programs and then provide recommendationstothelegislature. Thereisaninherenttensionbetweenthedesiresofprogramdepartmentsofgovernment to spend to meet all their program needs and aspirations and the desire of central agencies to control the demands to what is both realistic within government revenue projections and desirable within the governments overall priorities. Such tension means that program managers will have to work effectively with central agencies if they are to besuccessfuldefendersoftheirprogramfundsorproponentsofnewfunding. TheNewVersustheOld Perhaps one of the greatest sources of tension within budgetary systems and the budgetary approval process is the desire by governments to extract funds from one spending centre and move it to another. While this goes by many names, it is generally known as reallocation of existing funds. This is often a matter of funding new programs withexistingfunds. Governments will be continually looking for ways to improve efficiency of current operationstoreducecosts.Theywillalsobelookingforprogramsthatnolongerservean importantpublicpurpose. ComplexityversusClarity Budgetsaremadeupofastreamofdecisions,somewhatinvolvespendingandsomethat involve limiting spending. Very fewdecisions are alikeanda variety ofpolitical, social and economicfactorscomeintoplayintheircreation.Formanypublicsectororganizations,in order to achieve the objective of public involvement and transparency, the budget process can be a long one, involving many different forums, in order to arrive at a final product. OnBudgetVersusOffBudget
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A challenge for many countries is getting a true picture of government expenditures. Oftengovernmentswillseektominimizethescopeofpublicexpendituresbytakingsome expenditure items offbudget. This can be done for legitimate policy and accounting reasons. For instance, if a public sector program is selffunding, such as one that obtains all of its revenues from service fees, it can be said to operate offbudget as it does not take up any appropriated funds from the budget. Often such entities establish financial reporting statements seperate from the overall government financial statements. This servesonegoodofclarity.However,itisalsocontendedthatremovingitfromthegeneral government books distorts the degree of public sector spending. This debate is universal. One element of concern, however, is when offbudget entities are created to deliberately mask or distort either government revenues, e.g. development grants from external sourcesorremoveeffectivelegislativeoversightofthispartofthepublicsector.
Conclusion
The process of formulating and getting approval for a budget, at any level andin any kind of public sector organization, is an integral part of how that organization carries out its mission. It can be complex or simple, depending on the nature of the organization. However,somecommonelementsforpublicsectororganizationsemerge: Budgetsbringtogetherneedsandcapacity,oftenfromdifferentpartsof theorganizations,whetheritistaxcapacityandprogramdemandsorclient needsandfundraisingcapacityoftheorganization. Budgetsdemandatechnicalcommandofthekeyelementsofneeds measurement,effectivecostingofprogram,revenueprojections. Budgetsinthepublicsectorarelegaldocumentsthatdefineexpenditures authoritiesandlimitittothoselevelsonceapprovedbytheauthorizing legislature. Budgetmakingtakesplaceinanorganizationalculture,richinnuance,with powerplayingasmucharoleofgoodpolicymaking. Budgetsareinherentlytransparentinthepublicsector,bothintermsof howtheyareformedandinhowtheyareexecuted. Budgetsareboththeresultofplanningbasedonpastexperienceandthe existingpolicyormissionframeworkoftheorganizationandfuture orientations. Budgetsinthepublicsectoraresubjecttointensescrutinynotonlyby thosewhowillmanagethem,butalsothosewhowillbenefitfromorbe subjecttothem.
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Section4:Budgeting:CapitalPlanning
Key Points
Capital assets are expensive, have a long life, can lock in an organization in terms ofalternativeoremergingtechnology. Thetotalcostofacapitalassetovertimemayincludesizeableoperatingexpenses. Its acquisition can distort operational planning if this is not adequately considered attheplanningphase. Capital requires some special treatment both from the budgeting and accounting perspective.
Capital Budgets
Acapitalbudgetisaplanfortheacquisitionofbuildingsandequipmentthatwillbeused bytheorganizationinoneormoreyearsbeyondtheyearofacquisition.Adistinction thathasalreadybeendrawnbetweenoperatingandcapitalbudgetsisthatoftime. Operatingbudgetsareappropriatedandreporteduponforasinglefiscalyear.Generally, theoperatingassetsareapprovedandusedupwiththeyear.Thecapitalbudget,whileit involvesactualcashdisbursementswithinthecourseofafiscalyear,moreofteninvolves aflowofcashoveranumberofyearstocreateanasset,whichhasalifelongerthanone yearataminimum. Therefore,boththeinvestmentflowandtheassetreturnextendoveraconsiderable periodoftime.Havingcapitalprojectsdependentonyeartoyearapprovalsrestrictsthe capacityoftheorganizationtocommittothefullcostoftheproject.Approvingthefirst phaseofamajorconstructioninvestmentandthenreviewingitentirelywhilenot approvingthenextphasecanleadtoaseriesofcomplicationsfromwasteofpublicfunds toareluctancetoengageinthehighriskventureinthefirstplace. Finally,itisoftenthecasethatcapitalprojectsinvolvelongtermdebtforthe organization.Thechallengeoflongtermfinancinginvolvesagoodunderstandingofthe truecostsoftheinvestment. CharacteristicsofCapitalAssets Fromanaccountingpointofview,somethingisacapitalassetwhenitmeetsfourcriteria: thattheyareusedintheproductionorsupplyofgoodsand services(productivitycriterion),
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thattheirlifeextendsbeyondafiscalyear(longevitycriterion) thattheyarenotintendedforresaleintheordinarycourseofoperations that the monetized value of the asset is sufficiently high (materiality principle)
o Technologicalchanges:Technologicalimperativesareessential considerationstoday,especiallyasbusinessprocessesbecomemoreweb based. o Economicorbusinesschanges:Theseincludecurrentandprojected financialormarkettrendsandopportunitiesandemergingtrendsinthe waybusinessisconducted.Anexampleistheemergenceofservice providersasalternativeservicedeliverersofpublicservices. o Legislation:Factorstoconsiderhereincludeanynewstatutory requirementsaffectingtheorganizationoritsserviceplan. o Environmentalfactors:Theseincludetheimpactofanypotentialchanges toenvironmentalstandards. o InventoryandConditionAnalysis:Acomprehensiveassetinventory,includingan assessmentofthephysicalcondition,functionality(i.e.abilitytosupportcurrent programdelivery)andutilization(capacity)ofitscapitalstock.Thisshouldbe updatedonanannualbasis.Thefollowinginformationshouldbepartofthis analysis: o Baselineinformation:Informationonassetssuchasland,buildings, buildingsystemsandequipment,trackingsuchfactorsas: i. ownershipstatus ii. locationandzoning iii. structuraltypes iv. size(landareaifapplicable,squarefootage,vehiclecapacity,etc.) v. ageandhistory(e.g.rehabilitation,repairs,maintenanceactivity, additions,renovations) vi. value vii. currentuse, viii. estimatedservicelife;and ix. anyothersignificantissuessuchasenvironmentalliabilities. o Physicalconditionandriskfactors:Anassessmentorratingofthephysical conditionoftheinventory,includingmaintenancerequirements,seismic vulnerability,asbestos,etc. o Functionality:Anassessmentofhoweffectivelyeachassetmeetsexisting programorserviceneeds;functionalityissometimesmeasuredasthe differencebetweencurrentoperatingcostsandtheprojectedcostof operatinga"stateoftheart"facility. o PurposeorUseoftheAsset:Anassessmentofhoweachassetisbeing used;thisissometimesmeasuredbycomparingforecastservicedemand againstanassetscurrentcapacity o Maintenance Needs: Maintenance requirements must be identified in capital plans. Plans should also explain the methodologies used to develop the
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maintenance forecasts (e.g. measurement tools, standards and formulas based on assetvalueorsquarefootage). o Estimates of Required Resources: Estimates of capital asset related needs should beaggregatedintoidentifiablecategories.Theoverallcapitalcosts,whenoutlined thoroughly, can be staggering for public sector organizations. Very seldom do revenue expectations match the straightline anticipated capital costs. Usually at thispoint,variousprioritysettingprocessescomeintoplay. o Development of Strategies and Alternatives: The Capital Improvement Plan (CIP) itself does not provide decisions about capital expenditures. Rather, it is the background against which the public sector organization will set priorities. One important service it can provide is to offer alternative strategies for dealing with capital pressures. For instance, the CIP could also identify alternative delivery forms such as publicprivate partnerships that would, in essence, transfer the capital costs of a new building to the private sector builder while imposing a downstream operating cost for government in the form of guaranteed rental and paymentofdebtcostsbacktothesupplier.
Applying techniques of interest compounding and discounting, it is possible to determine either the present value (PV) or future value (FV) of a capital investment, using a simple formula that applies interest and time to the amounts that are either available now for investmentincapitalorthepresentvalueofafuturepayment.Thevariablesusedinboth calculationsare: PV=PresentValue FV=FutureValue i=InterestRatePerPeriod n=NumberofCompoundingPeriods Present Value is an amount today that is equivalent to a future payment, or series of payments, that has been discounted by an appropriate interest rate. Since money has time value, the present value of a promised future amountis worth less the longer you have to wait to receive it. The difference between the two depends on the number of compoundingperiodsinvolvedandtheinterest(discount)rate. Therelationshipbetweenthepresentvalueandfuturevaluecanbeexpressedasshown:
Example: You want to buy an emergency generator for the Fire Department
that will only become useful 5 years from now for $150,000. Assuming a 6% interest rate compounded annually, how much should you invest today to yield $150,000 in 5 years? FV = 150,000 i =.06 n=5 PV = 150,000 [ 1 / (1 + .06)5 ] = 150,000 (1 / 1.3382255776) = 112,088.73
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NetPresentValue Net Present Value (NPV) is a means to calculate whether the public sector organization will be better or worse off if it make a capital investment. It does so by calculating the presentvalueofinflowsminusthepresentvalueofoutflows. NPV=PVInflowsPVOutflows
Risk Assessment
It is critical to understand and assess the risk involved in each initiative. Risks should be identifiedat theearliest stage of planning as they may impact financingand procurement options. Once risks have been identified, they must be analyzed and evaluated to determine the likelihood, consequences and level of risk. Finally, a risk management and/ormitigationstrategymustbeputinplace. Risksshouldalsobereviewedandupdatedastheinitiativemovesforward. Thetablebelowprovidesexamplesoftheriskcategoriesthatshouldbeconsideredwhen planning and managing infrastructure expenditures. It also provides examples of how these types of risks may be treated to reduce the likelihood or consequences of potential losses. ExamplesofRiskCategoriesinAssessingCapitalAssetRisks7
RiskCategory
GeneralRisks
DescriptionandTreatment
Examples include highlevel concerns related to the decision to undertake an initiative. Risk treatment may include documenting how an initiative fits with established strategic objectives; assessing the requirements for a new corporate structure; enhancing the initiatives profile with the public, media andgovernments;andworkingcollaborativelytoenhancelabourandindustrial relations. Examples include the likelihood that an initiative represents, or may be affected by, a major shift in government or agency policy, or change in legislation. Examplesincludetheinitiativesenvironmentalimpactanditsrelationtopublic health, safety and security issues. Risk treatment may include working with neighbours and the community to address public concerns in the initiative planningphase. Examples include the complexities associated with partnerships, investments and management. Risk treatment may include managing dependencies on linkedfundingandcontingentinvestments;ensuringtheavailabilityofqualified initiativemanagers;andensuringtheinitiativedevelopmentteamhasaccessto appropriateexpertisewhenundertakinganewtypeofinitiative.
PolicyRisks
PublicInterestRisks
Managementor OrganizationalRisks
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PoliticalRisks
Examplesincludesponsorrisk(e.g.,thelikelihoodthataprivatepartnermaybe unable to deliver) and general supplier/market capacity. Risk treatment may include ensuring the availability of material and equipment supplies; ensuring that experienced designers, contractors and trades people are available in the required time frame; anticipating the need for community permits and approvals; and designing construction windows to avoid delays due to adverse weather. Often unspoken, but certainly real are many political risks associated with capitalprojects.Examplesofsomeare: short tenure of a government that may mean the project is re evaluatedorchangedbyanewgovernment, local opposition to a project that leads to considerable political controversyandreversalongroundsofcommunityconcerns failure to adequately consult or take into account various stakeholder interests
SiteRisks Examplesincludetherisksassociatedwithsiteselectionandacquisition. Risktreatmentmayincludeensuringthatthesiteisavailableatanaffordableprice; evaluatingsitechallengessuchassoilcontaminationorpotentialflooding;andensuring thedesiredsiteisfreeofpotentiallandclaimissues. Examplesincludeanentitysabilitytodrawtherequiredfinancialresourcesandthe overallfinancialviabilityoftheinitiative.Risktreatmentmayincludeensuringthat financingisavailableattheappropriatetime;anticipatingtheimpactofinterestrate increases;andevaluatingthecreditworthinessofpotentialpartners. Examplesincludeallpossibleeventsthatcouldaffectcashflowduringinitiative development.Risktreatmentmayincludeplanningforcontingenciesinthemarketsuch asadropindemandforservices;anticipatingthepotentialforlabourormaterialcost escalations;ensuringfundingisavailabletocoveroperations,maintenanceand administration;andassessingthepotentialforcompetingfacilities. Examplesincludelabour relations,maintenance,andtechnicalandassetobsolescence risks.Risktreatmentmayincludetakingstepstokeepmaintenanceinlinewithforecast levelsandtakingappropriatemeasurestoaddressthelikelihoodofabandonment. Risksthatcouldbesubstantiveandrequireresolutionand/or managementpriortocommitmenttotheexpenditure,orduringdelivery,including uncontrollableforcemajeureriskssuchasweatherandglobaluncertainty.Risk treatmentmayincludedevelopingcontingencyplanstoavoidorreduceconstruction delaysduetoemergenciesordisaster;andensuringthatbusinesscontinuityplans addressawiderangeofpotentialevents.
FinancingRisk
Conclusion
Theconceptualtoolsandplanningprocessessuggestedhereisanimportantpartof organizationalfinancialmanagementwherevercapitalplaysanimportantroleincarrying outthatorganizationsmission.Thinkingaboutcapitaloftenchallengesthelinemanager toescapetheyeartoyearoperatingbudgetorientationandlookattheimplicationsof suchelementsastheactualcostofaninvestmentincapitalforbothoperatingcostsdown theroadandfurthercapitalinvestments.
Public Sector Financial Management for Managers 23
One of the other very important reasons to have a special awareness of capital budgets and how capital behaves over time is that often in government, the issue of maintenance and replacement of capital goods is easily deferred when difficult budget cuts have to be made. What this has led to in some countries is a serious underinvestment in infrastructure that will now cost much more, in present value terms, to replace. This has beenthevictoryoftheshorttermoverthelongterm.Unseensewersveryseldomattract politicalattentionuntiltheybreakdown.
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Anunderstandingoftherisksinherentintheprogramandthe environmentalinwhichitistakingplace Positivemitigationandmonitoringtoolstocontinuallyreassesstherisks Aseriesofcontrolproceduresandpoliciestobothaddresstherisks identifiedandtosatisfycertainlegislativeorpolicycreatedrequirements foradequatecontrol Asystemofmonitoringatboththeoperationalandfinanciallevelto ensurethattheorganizationfullyunderstandswhatishappeningrelative toitsgoalsandtheriskenvironment Asystemofauditingandevaluation,bothinternalandexternal,that providesassurance,fromanindependentperspective,thatthereisan adequatecontrolframework,thatitisworking(andnotjustpaper)and thattheoutcomes,bothoperationalandfinancial,areastheorganization claims.
Risk and Risk Management Inmanyways,actuallyexercisingcontrolmeansanticipatingandmitigatingriskswithin theorganizationorprogram.ControlisaboutRiskManagement.Riskandrisk managementhavebothanarrowdefinitionassociatedwithfinanciallossandalarger, morecomprehensiveoneassociatedwithorganizationalgoalsandthethreatstoattaining them.Inthecontextoffinancialmanagement,riskmanagementencompassesboth. Nonetheless,riskcanbroadlybedefinedasfollows:anythreat,event,patternofpastor anticipatedbehaviourorpredictedeventthatcoulddetertheorganizationfromachieving itsgoals. Inapplyingthisdefinitiontopublicsectorfinancialmanagement,thereareclearlysome conditionsthathavetotakenintoaccount.First,thegoalsofallpublicsector organizationsaretoperformapublicgoodinthemannerprescribedbylaworpolicyina costeffectivemanner.Second,itispossibletoreadilyinterpretthisdefinitioninfinancial termsinanumberofways: Thedangerofnotmanagingentrustedfundseffectivelyorlegally, Thedangerofinadequatefundingcombinedwithexaggeratedobjectives, Thedangerofspendingoverbudgetwithouttakingmitigatingmeasures, Thedangeroffraudormisuseoffunds, Thedangerofunforeseencircumstancesthatstrainorthreatenthe financialcapacityoftheorganization, Thedangeroflossofconfidencefromthepublic,thelegislature,donorsor stakeholdersinthecapacityoftheorganizationtodeliveritsservicesas promised.
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Riskmanagement,therefore,istheestablishmentofproceduresandmanagement systemstoidentify,assess,validate,mitigateandmonitorriskstotheorganizationinsuch awaytoeliminatethem,effectivelyreducetheirimpactorbepreparedtorespondto them. UnderstandingandDefiningtheRisks Akeypartofriskmanagementinvolvestheneedformanagerstomakedecisionsabout whatriskstoactonandwhichonesdonotrequireanyactionatthetimeofreview. . Notallrisksarethesame.Itisnecessaryfortheorganizationtodecidewhichonesare importantanddemandingofacertainlevelofmitigationandwhichonesareeithernota significantthreat,nottimelyoreasilymitigatediftheydooccur. Anumberofsystemshavebeenestablishedtohelporganizationsdeterminethelevelof riskthattheycanaccept.Suchsystemsarevaluableastheyestablishacommonlanguage andframeworkfororganizationstoeffectivelycometoanunderstandingoftherisksthey faceandthemeaningoftheiridentificationofthem.Ensuringthatalllevelsofthe organizationsusesuchcommontoolsensuresthatmisunderstandingsaboutrisksandthe controlneedsthatmayflowfromthemarereduced. Belowisastandardgridtoenableorganizationtorankriskontwokeyaxes:impactand likelihood.Withoutdeterminingwhatthelikelihoodandpotentialimpactofanyidentified risk,thereisnoreasonablewaytodeterminewhattodoabouttherisk.Further,thisis thekeywaytodifferentiaterisksanddeterminewheretoapplyscarcemanagerial resourcesinthemitigationprocess. POTENTIAL RISK MANAGEMENT ACTIONS Considerable Extensive Must manage and management management Significant monitor risks required essential Risks may be worth Management effort Management effort Moderate accepting with worthwhile required monitoring Accept risks Accept, but monitor Manage and Minor risks monitor risks
IMPACT
LOW
MEDIUM
HIGH
LIKELIHOOD
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Control Procedures and Policies WhoandWhentoControl Nowthatwehaveanideaaboutwhereourobjectivesmaybecompromisedthrougha riskidentificationprocess,weneeddecidehowtoachievethekindsofcontrolsthatare needed.Theactofcontrollingfinancialresourcesisanactiveonethatboththemanager oftheprogramandthefinancialexpertshavebeengagedin.Itcannotbelefttofinance toprovideallthecontroloversight.Itistoocloselytiedtothemanagersresponsibilities todeliverthepublicgoodforwhichheorsheisresponsible. Thefirstcontrolquestiontoaskwhencontemplatingthemeansofcontrolis:whoto controlandwhentodoit. Intermsofwhotocontrol,therearetwochoices:theorganizationasawholeoran individual.Theindividualmaybeapersonwithintheorganizationwhoismakinga decisiontospendfundsonbehalfoftheorganization.Alternatively,theindividualmaybe therecipientofapublicgoodorentitlement.Inmanycases,whentheorganizationisto bethesubjectofcontrol,thecontrolswillentailinformationatanaggregatedlevelof performance,e.g.quarterlyreportsoncontractsauthorizedandlevels.Ifitisan individual,itmaybeattheindividualtransactionlevel. Intermsoftimeorwhentocontrol,thealternativesaretoexercisecontroleitherbefore oraftertheindividualororganizationhasacted.Beforethefact,orexante,controls involvesubjectingadecisionthattheorganizationorindividualisabouttomaketosome levelofapprovalorreviewinadvance.Asanexample,anorganizationmayrequire approvalfromitscentralofficebeforepurchasingequipmentoverthevalueof$50,000. Thisapprovalisaformofcontrolandrequiredbecauseofthematerialityofthepurchase. Thisisinspiteofthefactthatpurchaseofthisitemmayhavebeenapprovedaspartofa largerbudgetplan. Afterthefact,orexpost,controlinvolvesareviewprocessfordecisionsandexpenditures thathavealreadybeenmade.Insuchcircumstances,theactor,beittheindividualorthe organization,isfullyresponsiblefortheactionthatwastaken,astheyhadtheauthority toapproveitandactionwastakenasaresultoftheirauthorization.Forexample,a chequemaybeissuedontheauthorityofanindividual,notsubjecttoanyotherreview, excepttoverifythatitistheapprovedofficialwhohasthatauthority.However,some formofcontrol,throughmonitoring,sampling,summarizedreportingorvarianceanalysis, isputinplacetooverseethequalityofdecisionsalreadymadeeitheratanindividual,or aggregatelevel.Thisisthemorecommonformofcontrolexercisedoverfinancial transactionswithinorganizations.Itismoreefficientintermsofprocessingpayments, etc.italsofocusespriorapprovalsontheriskiertransactions,therebyeffectively budgetingseniormanagementandgovernancentime.
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WhoistheController? Thenextquestiontoaskiswhothecontrolleris.Thesimplefactisthat controller/controlleerelationshipsexistatmanylevelsandoperateinmanyways. Therefore,whileonemanagermayexercisecontroloveragroupofstaffandsetup processesofcontrolsuchasregularperformancereviews,delegationtolimitstodefine discretion,etc.,thatverymanagerwillalmostcertainlybesubjecttocontrolsbothfroma superiorandalsofromoversightbodiessuchasexternalauditors.Anotherpointisthat theyareimperfectandoftencloudedbyothermatters,betheyoperational,financialor political. Trust and Ethics in Control Ifriskmanagementisthefaceofcontrolthewayinwhichcontrolisexpressedthan trustandethicsaretheheartofcontroltheculturalrealitythateithersupportor destroyeventhemostperfectcontrolplan. Fundamentally,allcontrolsarebuiltaroundtwonotions: thedegreeoftrustthecontrollerplacesintheorganizationorpersonswith authorityandresponsibility,and theassumptionsaboutethicalbehaviorinthecultureandlegalframework oftheorganization. Trust Trustisacalculationthatismadebytheorganizationaboutitsownpeople,aboutother organizationsandotherpeopleaswellasitsleadership.Trustisalsoanimportant elementinbalancingthedesireforfullassurancethroughcontrol(nosurprises,noerrors) withthecostorimprobabilityinachievingit.Intheend,morecontrolsystems,nomatter howtechnologicallysoundordetailed,dependonthepeoplerunningthemandoperating withinthem.Therefore,adegreeoftrustisnecessarilyextendedtooperatorsofthe systemswiththeassumptionthattheirintentionsaresoundandthat,basedontheir trackrecord,suchtrustisdeserved. Ethics Notallcontrolisaboutsystems,procedures,documentationandprocess.Infact,allof thiscontrolcouldbehappeningand,withthewrongvaluesinplay,seriousintrusionsinto pubictrustcouldbeaccruing.Thiscouldbeeitherthroughmisappropriationofpublic funds,usingthemforpurposesnotintendedortheirdiversiontootherpurposesofa personalnature.Itisaxiomaticthatthepublicsectororganizationsandthepeoplewithin themhavetoactinanethicalmanner. Therefore,ensuringthattheethicalframeworkoftheorganizationsanditspersonnelis soundisyetanotherformofcontrol,onethatisessentialtothesuccessofallother efforts.
Public Sector Financial Management for Managers 29
Oneofthemostimportantelementsofestablishingstrongvaluesandethicsisthrough ethicalleadershipwithintheorganization.Notethatthisisthefirstitemidentifiedbythe OECDinitsframeworkforethicalpublicsectororganizations,aslistedbelow: Values and Ethics Approaches Political and senior management leadership that promotes ethical conduct Clear statements of values and ethics or codes of conduct Approaches to decision making that o require consideration of values and ethics o align management policies to support ethical conduct o offer recourses to report ethical concerns Clear guidance for interaction between the public and private sectors Assessment of and reporting on effectiveness of values and ethics initiatives Source: Organization for Economic Co-operation and Development (OECD), Principles for Managing Ethics in the PublicService TheattributesofethicalleadershipweredocumentedbytheCanadianfederal governmentsTaskforonPublicServiceEthics9:
Createasupportiveworkenvironmentthat o valuespeople,treatingthemwithdignity,civilityandfairness; o emphasizesopennessandthesharingofinformation; o promoteshonestandcollegialleadership; o encouragesandsupportsspeakingtruthtopower;and o supportsabalancedfamilyandworklife. Makedecisionsthat o servethepublicinterest; o respectdemocraticprinciplesandtheruleoflaw; o ensuredueprocess,impartialityandobjectivity; o provideeffectiveservicestocitizens;and o promotetransparency,probityandaccountability.
AStrongFoundation:ReportoftheTaskForceonPublicServiceServiceValuesandEthics,JohnC.Tait, Q.C.,Chair,availableathttp://www.myschoolmonecole.gc.ca/Research/publications/html/p91/1_e.html
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Someofthetoolsthatpublicorganizationscananddousetoensurethattheyhave promotedethicalbehaviourare: establishingcodesofconductorethicstosignaltheimportantvaluesofthe organization supportingsanctionsforethicalmisconduct usingmeritprinciplesinhiringandpromotion awidevarietyoftraininginitiativesonethicsforbothnewemployeesand thosealreadyinposition identificationofhighriskpositions(notpersons)whereeitherspecial trainingonethicalchallengesorspecialsurveillanceiscalledfor disclosureofanyconflictsofinterestandpoliciestosupportthis,noting thatthisbecomesmoreimportantthehighertheleveloftheposition, toolstoreportmisconductofsuperiorsandadequatesafeguardsforthose reporting,i.e.confidentialchannelsandwhistleblowerlegislation Ombudsmenpositions ethicalcounselors,trainers,offices theinvolvementofprofessionalassociations,suchasCICA,todevelop ethicalguidelinesformembership
Leadershipcommitment:Awarenessandcommitmentofdeputyheadandsenior managementtoestablishingandimplementingamodernmanagementpractices environment Managerialcommitment:Awarenessofmanagersoftheirmodernmanagement practicesresponsibilities,andcommitmenttoimplementingthem Seniordepartmentalfunctionalauthorities:Extenttowhichseniordepartmental functionalauthorityandsupportingorganizationareusedforobjective commentaryandindependentadvice Planning:Strategic,businessandoperationalplanning,andthelinkagesbetween themandtoresourceallocation ResourceManagement:Mechanismsforrankingprogramoptions,identifying fundingrequirementsandallocatingresources,andbudgetingandforecasting
Public Sector Financial Management for Managers 31
Managementofpartnerships:Partnershipsareusedextensivelybythe organizationinsupportofservicedeliverybyleveragingthecapabilitiesofexternal stakeholders,partners,andothergovernmentorganizations Clientrelationshipmanagement:Commitmenttoconsciouslystrengthening relationshipswithclientorganizations,andtointegratingandcoordinatinghow clientservicesaredevelopedanddelivered ClearAccountability Clarityofresponsibilitiesandorganization:Clarityofassignmentof responsibilitiesandaccountabilitiesthroughouttheorganization Performanceagreementsandevaluation:Extenttowhichtheachievementof financialandoperatingresultsisembeddedinperformanceagreements Specialistsupport:Availabilityoftopflightcounseltohelpmanagersmake judgmentcallsonmodernmanagementandoperationalissues Externalreporting:ExtenttowhichParliamentary,centralagencyandkey stakeholderinformationreportingrequirementsaremet SharedValues&Ethics Valuesandethicsframework:Leadershipofpoliciesandactivitiesthatvisibly supporttheethicalstewardshipofpublicresourcesandgivepriorityto"modern managementpractices" MatureRiskManagement Integratedriskmanagement:Measuresareinplacetoidentify,assess, understand,acton,andcommunicateriskissuesinacorporateandsystematic fashion Integratedmanagementcontrolframework:Appropriatenessofmanagement controlsinplace,andlinkagesbetweencontrolsthroughanintegratedcontrol framework IntegratedPerformanceInformation Integrateddepartmentalperformancereporting:Keymeasuresexisttomonitor overallorganizationwideperformanceandbestvalueresults Operatinginformation:Measuresandsystemstomonitorservicequalityand efficiencyofprogramdelivery Measuringclientsatisfaction:Utilizationofclientsurveyinformationon satisfactionlevels,andimportanceofservices Servicestandards:Monitoringagainstclientservicestandardsandmaintaining andupdatingstandards Evaluativeinformation:Utilizationofnonfinancialinformationrelatedto programeffectivenessandoutcomes Financialinformation:Reliablefinancialinformationisavailableinatimelyand usefulfashion Costmanagementinformation:Mechanismsforusingactivity/product/results basedcosts MotivatedPeople
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Modernmanagementpracticescompetencies:Extenttowhichmodern managementpracticescompetenciesaredefinedandmanagershaveaccessto training Employeesatisfaction:Mechanismsinplacetomonitoremployeemoraleand staffrelations Enablingworkenvironment:Practicesforcommunication,wellness,safetyand supportthatenablestafftoprovideclientfocuseddeliverywhilereachingtheir fullpotential SustainableWorkforce:Theenergiesofstaffaremanagedwiselytohelpsustain theorganization'sviability Valuingpeoples'contributions:Extenttowhichtheorganizationalculturefosters staffparticipation,teambuilding,sharingofideas,risktaking,innovation,and continuouslearning;andrewardsorprovidesincentivesforsuchbehaviour RigorousStewardship
Businessprocessimprovement:Extenttowhichprocessesareclearlyunderstood, areconductedinauniformfashion,andarecontinuouslyimprovedinlinewith bestpractices Managementtoolsandtechniques:Rangeofanalyticaltechniques(e.g.,cost benefit,sensitivity,lifecycle,benchmarking)availabletomanagers Knowledgemanagement:Performance/managementinformationisreadily accessibletointernalandexternalusersviatechnology,andlessonslearntare sharedacrosstheorganization Accountingpractices:Recordsoffinancialtransactionsarekeptonaconsistent andusefulbasisforpurposesofauditandreporting,andareconsistentwith generallyacceptedaccountingpracticesandtheFinancialInformationStrategy (FIS)10 Managementofassets:Assetsaremanagedandutilizedefficientlybasedona lifecycleapproach,recordsofassetsaremaintained,andassetsareaccountedfor onanaccrualbasisaccordingtoGAAP/FIS.
InexplainingwhattheFISis,thefederalgovernmentofCanada,statesthefollowing:FISisagovernment wideinitiativedesignedtoenhancedecisionmakingandaccountabilityacrossgovernment,andimprove organizationalperformancethroughthestrategicuseoffinancialandnonfinancialperformance information.ThethreekeycomponentsofFISare: Systemstheintroductionofnewmodernintegratedinformationsystems; Policiestheadoptionoffullaccrualaccountingsimilartowhatispractisedinthe private sector; Peopleaculturalchangefocussedonenhancedanalysisanduseofinformation. Accountingisonlythestartingpoint.ThegreatergoalofFISistobringaboutalltheattendantchangesin systems,policiesandpeople.Ultimately,FISaimsatnothinglessthanchangingthecultureofresource managementintheGovernmentofCanada. http://www.tbssct.gc.ca/fin/sigs/fissif/faq/faqfissif_e.asp#whatis
10
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Key Points
Inadditionto,exanteandexpostcontroltools,therearealsotoolsofcontrolwithinthe currentyearmanagementofresources.Thisisrealtimecontrol,whentheissuescanbe quitevisceralforanorganization.Willtherebeenoughcashtopaythestaffattheendof themonth?Areweareontargetforourbudgetprojections?Howdowefindresources forthisunexpectedemergency?Wherecanwefindfundstomeetsomeshortterm demandsthatarewellwithinourmandateandauthority,butthatwehavenotallocated fundsfor?Whatwillwedowiththisunexpectedsurplusduetoadropinprogramlevels thatwehadnotexpected? Manyoftheanswerstothesequestionsarecontainedinaprocessknownascash management.Someofthekeystogoodcashmanagementare: effectivecashflowprojectionsandforecastinginordertoassesstheorganization performanceagainstplanandbudget, reportstotheappropriateauthoritiestoalerttochanges,confirmthatthebudget willbespentaccordingtoplans,releasesurplusfundingforreallocationand monitormanagerialperformancetomakeadjustmentsintheshortterm governanceprocedurestoensurethetimelyreviewoffinancialandperformance informationandtomakedecisionstoadjustprograms,reassessbudgetsorfind alternativestrategiessuchasincreasingcashavailableorreallocatingfundsnot needed.. Inessence,cashmanagementembracesabroadrangeofcontrolpracticesassociated withthemonitoringoffinancialperformancewithinthecurrentfiscalyear(inyear)to assurethatadjustmentscanbeandaremadetoaccommodatechangesinrelationtothe planandbudget.
Toreallocateavailablefundstomeetemerging,shorttermpriorities.
Establishing a Cash Management System Oncethereisabasicunderstandingofcashinflow,youcannowmoveontodeveloping cashmanagementsystem.Beyondsimplyfocusingonsourcesofcashandfocusingonin yearbudgetmanagement,acashmanagementsystemwillhavethefollowingelements: Anappropriatedbudget Buildinchangesandmodificationstotheapprovedbudgettocreateanadjusted budget Cashflowprojectionsoverthebudgetperiod:theinyearcashfloworexpenditure plan Asystemofmeasuringactualfinancialperformanceinrelationtotheprojected plan Asystemofmonitoringperformance,identificationofvariancesandreporting resultsattheappropriatelevel Thecapacityformanagementdiscussionandanalysisoftheresultsandvariances Agovernancemechanismsthatwould o reviewtheresults, o assessvariances, o determineadjustmentsneededand o makedecisionsneededtoaffectthoseadjustments. Inthecycleabove,rolesandresponsibilitieswillvarydependingontheorganization,but anycashforecasting,monitoringandmanagementsystemwillinvolveacombinationof interestsandtasks: Seniormanagementmustsetbudgetsandprogramdirection, Resourcesshouldbeallocatedasfullyaspossible,withexceptionssuchasreserves andholdbacksagainstuncertainties, Linemanagersmustmanagetheresourcestheyaregiventocarryoutprograms, Financialadvisorsmustprovideinformationfordecisionmakingtobudgetsetters aswellasadvicetolinemanagersabouttheirbudgets, Financialadvisorsmustalsoprovideinformationandanalysistoidentifyvariances, offercomparisonsandfurtheranalysisofbudgetperformandmake recommendationstolinemanagersandseniormanagers, Financialadvisorsmustpreparereportsforseniormangerstomakedecisions, Linemanagersmustrespondtovariancesagainstplanswithexplanations, solutionsandalternatives,and Seniormanagersmustdeterminewhatactionstotakebasedonthesetwosetsof inputs.
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Fortunately,formanygovernmentorganizations,theissueofcashinflowsisnotonethat theyhavetoaddress.Budgetsaresetinapredictablemannerandthemanagerdoesnot havetobeconcernedaboutfindingthemoneytomeettheobligations. Thefocusisonthecashmanagementofexpensesthataredetailedintheoperating budgetoftheorganization.Thisusuallyencompassesfundsforstaff,benefits,supplies, equipmentandoperationalfunds,betheyfordisbursementstoindividuals,various elementsofthecareandsupporttoclients,orthepurchaseofservicestomeetprogram objectives. InyearBudgetDesignFactors Whenpreparingforcashmanagementofexpensesandthusdesigninganinyearbudget plan,youmusttakeintoaccountthefollowingfactors: Thedegreeofdetailneeded:Shouldtheplanbebasedontheapprovedlineitemsin thebudget?Shoulditbeattheresponsibilityheadlevelormoredisaggregatedor aggregated?Forinstance,theresponsibilityheadmayhavefourunitsperforming essentiallythesamedutiesbutindifferentlocationsandwithsomewhatdifferent staffingpatterns.Theresponsibilityheadmaywanttoprojectexpenditurepatternson aunitbyunitbasistopermithertobettermonitorandmanageeachunits managementofitsresources.She,inturn,mayonlybeaskedtoprepareaplanforall herunit. Theperiodfrequency:Istheplantobebuiltonamonthlyorquarterlybasis?Inhigh riskareas,thereportingmayneedtobeevenmorefrequent.Heretheissuehastobe materialityjusthowimportantisittoknowthepatternofexpendituresatthislevel oftimedetail? Theroleofbudgetcapsorconditions:Onechallengeforbudgetmanagersisthatthe seniorlineorstaffmanagersatthecorporatelevelmayinterveneintheapproved budgetstolimitthemanagersdiscretionortosetanexpendituretargetbelowwhat thebudgetpermits.Perhapsthelessonthatismostimportantincreatingbudget plansisthatformallyapprovedbudgetsarealwayspotentiallysubjecttomodification andmanagementbyhigherauthoritieswithintheorganization. Reservesorholdbacks:Doestheorganizationdistributethefullbudgettothe responsibilitycentremanagersorissomeheldinreservetobedistributedlateronin theyearbasedonneedandmerit?Thisisacomplexcashmanagementquestion. Organizationsfollowmanydifferentrouteswithaneyetoenforcegoodmanagement andtoalsohaveflexibilitytorespondtoemergingissuesatthecorporatelevel.Such issuesinthepublicsectorareoftenpoliticalandshortterminnature.Othersare catastrophiceventsdemandingmassiveandtimelyresourceresponses. EstimatingWorkFlows Managerswhoareaskedtosubmitbudgetforecastsarereallyestimatingtheworkflowin theorganizationthattheycanachievewiththefundstheyhave.Theyareassessingthe
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environment,measuringrisksandsettinginplacetheirbestpredictionsofhowresources willbespent. UseofHistoricalData Itisoftenarguedthatoperationalmanagersinthepublicsectorfaceanumberof demandsthattheycannotpredict.Whilethisistrue,theexerciseofbudgetforecastingis nottodealwithexceptions,butratherwithrules.Rulesincludethoseimposedbythe organizationforhowthemanagerwillmanagefundsinthecomingyear,butalsotherule ofhistorywhichisthat,allotherthingsbeingequal,organizationswillrepeattheir behaviorunlesstheymakespecificmovestochangeit.Therefore,thebestpredictorof howfundswillbespentinthefutureishowtheywerespentinthepast.Historicaldata withintheorganizationshouldbeaguideforforecastingfuturebehavior. Monitoring Financial Performance and Variance Analysis Thereasonforallthisdetailedplanningandprojectingissotheorganizationisableto havethecapacitytorespondtochangesinitsenvironment,dealwithunexpected outcomesandmaximizetheuseofthelimitedresourcesatitsdisposal.Todoso,itmust haveinformationaboutwhatisgoingon,howitisperformingrelativetoitsexpectations andwhereithastofocusitslimitedcorrectivecapacityshouldthesituationinonearea reachacriticalstagewherechangesarerequired. Theorganizationthereforemustestablishandusereportingsystemsthatprovide informationfordecisionmakingaboutcashmanagement.Usually,thiswillbecoordinated bythecentralfinancialgroup,alongwithwhateverstaffsupportunitshaveastrong interestinarrivingatdecisionsaboutresources. Thequestionsthatthereportsmustanswerare: Arewegoingtobewithinourbudgetallotments? Areweoperatingaccordingtoourbudgetplan? Howdoesourperformancecomparewithrelevanthistoricaldata? Doesthisperformancemeanthatmorefundsmaybenecessaryorthatsome fundsmaybecomesurplusinthisareaandavailableforreallocation? Whatarethevariancesandwhyhavetheyoccurred? Whatistheresponsibilitycentremanagergoingtodoaboutthenegative variances? Arepositivevarianceswithinaretentionrangeforthelocalmanagerorarethey availableforotherneedsoutsidetheunitbutwithintheorganization? Dowehavetheneedsandauthoritiestoreallocatethesefunds? Whatdoesthisinformationtellusabouttheperformanceofthemanagerinthis unit? Whatdoesthisinformationtellusaboutthelongtermfunding?
Public Sector Financial Management for Managers 38
SettingupaMonitoringTimetable Allorganizationsreceiveregularfinancialreports.Mostorganizationswillwantto establishapatternofreviewthatmakesitpossibletogatherperformanceandfinancial dataonaregularbasiswithsomecertaintyandinastandardformat.Developingtheright formattakessometimeandexperimentationfororganizations.Generally,aquarterly reviewisenoughtopermittheorganizationtoidentifyareasofbothcostoverrunsand potentialsurpluses. Governance Thecycleofcashmanagementreportingshouldcoincidewithhowtheorganization governsitself.Therefore,iftimelyfinancialperformanceinformationisprovidedtosenior management,theyshouldbeinapositiontodosomethingaboutitinatimelyanduseful manager.Receivingquarterlyreportsbutnothavingthemanalyzedandconsideredfor decisionmakingwillpossiblymeetsomebureaucraticneedbutproducefewresults. Therefore,reportsshouldbepreparedforseniormanagementsothattheyareina positiontoaskandgetanswerstothetypesofquestionsthatarelistedabove. PerformanceReports Thenatureofthefinancialperformancereportingwillvaryfromorganizationto organization.Insomecases,theinformationwillsimplybethecomparisonofbudgetplan toactualperformancedoneonaquarterlybasis.Inothers,moredetailedoperational informationwillbeprovided.ThefollowingexampleoftheEastbrookCorrectionalFacility looksindetailattwoparticularlineitems:staffcostsandovertimeforthisfederal correctionalfacility. BudgetFigures EastbrookCorrectionalFacility,Eastbrook,NovaScotia: QuarterlyFinancialReport,December,2007 StaffingandOvertime,CustodialStaffOnly TotalStaff(Custodial) 225 AverageSalary 61,000K TotalBudgetCost 13.725K AdjustedSalaryBudget(OperatingTarget 12.900K 11 =211.5FTEs ) TotalOvertimeHoursBudgeted 54,900 TotalBudget(FullAllocation) 2.745K AverageCostperOvertimeHour 50
11
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VarianceReports Wheninformationissubmittedintheformatabove,itbegsmanyquestions.Normally, theorganizationwillidentifythatthereisadifferencebetweentheplannedandactual budgets.Thisisthevariancereport:areportthatspecificallyidentifieddifferencesin financialandoperationalbehaviourfromwhatwasexpectedbytheorganization.Itis importanttodeterminethematerialityorimportanceofthevariance.Bythiswemean thatthedifferencesaresuchthatsomeformofreactionwillbeneeded. ForecastedversusActualReport Theprincipalissueforthesereportsisthatonlymaterialandsubstantialvariancesare reportedandsubmittedforaction,eitherbytheresponsiblemanagerorbysuperior levelsoftheorganization. AnalysisofKeyVariancesReport Duetotheneedforcontextualinformation,forecastsofplansversusactualmustbe accompaniedbyananalysisofwhydifferencesorvariancesoccurorareanticipated. Fromthefinancialside,anumberofanalyticaltoolsareusefultosetthevariancein context: Historicalcomparisons Thecostofthevariancetodate,i.e.howmuchoftheactualbudgethas beenspent
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Themanagermustalsoanalyze: Whatcausedthegapbetweenexpectationsandresults? Workloaddeterminantsthatchangedinactualperformance Inefficienciesthatremain Limitationsofthebudgetitself Actionsthatcouldbetakentocorrectthesituation Whatdoesthetrendlooklike:isitintherightdirection? Isthisisolatedtothisunitorageneralphenomenon? Didwesetrealistictargets? Canwefundtheshortfallthatweseeemerging? HistoricalInformation
ReferencehasalreadybeenmadeinthisChaptertotheutilityofhistoricalcomparisonsin termsoflookingatpredictionsaboutfuturespendingandinexaminingvariances. IntheinformationprovidedontheCorrectionalFacility,nosuchdatawasoffered.Only informationforthecurrentyearispresented.However,itcanbereadilymadeavailablein anumberofways.Onemeansistolookatannualstaffinglevelsonayearlyaveragebasis. Thefigurebelowprovidessuchinformation.Oneinterestingfactthatemergesfrom havingthisinformationandcombiningitwiththeperformanceinoneyearisthat,even thoughweknowtheactualstafflevelsarehigherthanplannedthisyear,theyareactually thelowesttheyhavebeenforseveralyears. HistoricalStaffingPatterns:CustodialOnly:YearAverage
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Therelevanceofthisinformationisthatthereductionsinsalarycoststhatsenior managementwantsis,generally,ontrack. Reallocation and Readjustment Thefinalphaseofthecashmanagementcycleinvolvesmakingadjustmentstothe availablecashorfundsforthemanagersusebasedonthevariancereportingand analysis.Thisisanorganizationalgovernancefunctionthatmakestheprocesstrulya financialmanagementexerciseandnotsimplyamatterofprovidingfinancialreportsthat donotgetused.Itmustalsoengageallmanagersandnotsimplyfinancialexperts becauseallocationdecisionsalterprogrammaticoutcomes. TheAuthoritytoReallocate Ingeneral,publicsectorbudgetsareapprovedatagenerallevelbytheauthorized legislatureorBoard,whichpermitsafairamountofinternalreallocationwithinthe budget.Forexample,generaladministrativefundsarenotbrokenintooperatingunitsby thelegislature.Theyaredistributedbythedepartmentalseniormanagementand,as such,theycanbereallocated.However,certainbarrierstoreallocationmayexistandmay createasituationwheretheorganizationhasfundstomeetneedsbutcannotusethem. Someexamplesofsuchrulesare: Fundsspecificallyvotedforasingleprogram Rulescreatedbycentralagenciesthatforbidthereallocationofcertain funds,e.g.themovementofcapitalfundstooperatingorthetransferof suppliesorequipmentfundstosalarydollars Specificministerialorpoliticalcommitmentthatfundsdesignatedfora specificprogramwillonlyusedinthatprogram Restrictedfundscreatedbyspecialpurposeendowmentsorwithrulesthat thefundscannotbemovedfromonefundtoanother. Theseniormanagementoftheorganizationhastoknownotonlytheformalrules governingthereallocationoffunds,butalsothedynamicsofreallocation.Thisrequires somejudgmentaboutwhatthereactionwillbeofspecificstakeholdergroupstothe redirectionoffundsthatweredesignatedtoanareaofinteresttothem. FreeingUptheFunds Committingthefundsmeansthatthemanager,inacashenvironment,willindicatethat thefundsunderhisorherresponsibilitywillbespent.Thenatureandfirmnessofthese commitmentsissomethingthatthefinancialadvisorswithintheorganizationneedto spendtimeconsidering.Acommitmentthatinvolvesanapprovedcontractiscertainly firmerandlesschangeablethanacommitmentthanisearmarkingmoneytobespent laterintheyear.
Public Sector Financial Management for Managers 42
Conclusion
Thedegreeofriskandneedwillprobablydictatethekindofcashandbudgetary monitoringthatoccursthroughouttheyear.Inaddition,thedegreeofinterestbysenior managementinfinancialissueswillalsobeanindicatoroftheamountoftimethatthey wanttospendonit.However,effectivepublicmanagementmeansbeingincreasingly awareoftherelationshipbetweenresourcesandtheiruse.Settinguponeelementofa financialmanagementsystem,usingthetransactional,lowermanagementsidewithout theothertheoversightandgovernancesendssignalswithintheorganizationthatthe effectiveuseofresourcesisnotthatimportant. Inmakingacashmanagementsystemeffective,itmustbeseentohavetheattentionand supportofseniormanagers.Whilethedangeralwaysexiststhatsuchprocesseswilldrag seniormanagersintotoomanydetailsofoperations,theymusthaveinformationatthe rightlevelthatisusefultotheminmakingdecisionsaboutthecashsituationofthepublic organizations.
Public Sector Financial Management for Managers 43
Accounting Principles
AsetofbasicprinciplesexistreferredtoasGenerallyAcceptedAccountingPrinciples (GAAP)guidehowfinancialinformationwillbecreated,reported,audited,andgenerally understood.Aroundtheworld,anumberofboardsororganizationsareinvolvedin settingaccountingstandardsandindefiningexactlywhatGAAPmeansandhowitapplies inavarietyofcircumstances. InCanada,forexample,thestandardsettingbodyforalllevelsofgovernmentisthe PublicSectorAccountingBoard(PSAB),whichispartoftheCanadianInstituteof CharteredAccountants(CICA).Inordertobecredibleandunderstandabletothepublic, financialstatementfromthegovernmentmustcomplywiththestandardsofPSAB.Here arenineoftheGAAPPrinciplesinCanada: 1.TheEntityPrinciple Increatingfinancialreports,thefirsttaskistodefinetheunit,orentity,thatisbeing reportedonandincludeanythingthatisrelatedtothatentity.Forexample,inreviewing
Public Sector Financial Management for Managers 44
thefinancialstatementsfortheCityofOttawa,wemustbeabletoassumethatthe informationwearelookingatdealsexclusivelyandcompletelywiththeentityweknowas theCityofOttawa.Therefore,anemployeeoftheCitysgovernmentcannotbuysome buildingmaterialforhisownuseandrecordthatmaterialaspartoftheCitysequipment inventory. Definingtheentitypermitstheorganizationtocreateabudgetforit,measureand monitoritsuseandreportretrospectivelywithconfidencethatitisprovidingfull informationonthebehaviorofthebudget,itsmanagersandtheobjectivesforwhichit wassetinplace. 2.MoneyasaMeasure/theCostPrinciple Allfinancialinformationmustberecordedintermsofthemoneycollectedorexpended. Accountingrecognizesonlythoseactivitiesthatcanbeexpressedinmonetaryterms.The advantageofthisprincipleisthatitisabletopulltogetherseeminglydissimilar information,e.g.staff,suppliesandrentals,andthenexpressitinasinglelanguagethat ofmoney. Themonetizationorcostprinciplepermitsanorganizationtodevelopanunderstanding ofthevalueofitsassets,usingthecommonlanguageofcost.Thisprincipleisused whetherornotactualmoneychangedhandsinatransaction.Forinstance,ifa governmentreceivedgiftsinkindsuchasmedicalequipment,forthepurposesofits financialaccounting,itwillplaceamonetaryvalueonthosegoods. Themostcommonlyusedtoolinplacingamonetizedvalueonanassetisthehistoriccost, shouldthatinformationexist. 3.TheGoingConcernPrinciple Thisprincipleassumesthatanorganizationwillcontinuetooperatefortheforeseeable future.Assetsarethentreatedaccordingtowhatisexpectedtohappenoverthenormal courseofoperations.Theywillbeexpectedtodepreciateinvalueorbeamortized accordingtoreasonableexpectationsabouthowtheywilldecreaseinvalue,e.g.20%of historicalvalueeachyearfor5years. 4.TheConservatismandCostConcept Thisprinciplerequiresthataccountantsvalueassetsattheloweroftheirhistoricalcostor marketvalue.GAAPholdsthattheaccountant,andbyextension,theorganization,will accepttheleastoptimisticfinancialposition.Thishasbeendescribedasaprinciplein whichaccountantsrecognizenogainsuntiltheyhappenbutrecordallpossiblelosses evenbeforetheytakeplace.Hence,whenindoubt,itisbettertooverstateexpenseand understaterevenue.
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5.TheMatchingPrinciple Thematchingprinciplestatesthatallexpensesmustberecordedinthesameaccounting periodastherevenuethattheyhelpedtogenerate.Whenexpensesarematchedwiththe revenuetheyhelpedtoproduce,externalandinternalusersoffinancialstatementscan makebetterjudgmentsaboutthefinancialpositionandoperatingperformanceofthe organization. 6.TheConsistencyPrinciple Thisprincipleholdsthattheorganization,onceithasadoptedasetofaccountingand financialreportingstandards,willcontinuetousethemtopermitconsistentcomparisons betweentimeperiods.Organizationshaveoptionswithrespecttohowtheyvalueassets andreportexpenses.Oncetheyhavedecidedhowtodothis,theyshouldcontinuetodo so.Whentheychangethem,theyhavetoprovidewhatisacalledacrosswalktoexplain wherechangeshavebeenmade. 7.TheMaterialityPrinciple Inthecontextoffinancialmanagement,whenarevenuesourceorexpenditureissaidto bematerial,thatmeansitisanamountsubstantialenoughthatitisadeterminingfactor infinancialdecisionmaking.Accountingstandardsapplyonlytomaterialitems.Insome cases,itmaybeappropriatefortheorganizationtotakeasimplermorepractical approach,ratherthanspendtimeandeffortapplyingtheaccountingstandardsto immaterialamounts.Forexample,theorganizationmayestablishadollarthresholdfor capitalizingcapitalassets.Capitalexpendituresbelowthisthresholdwouldbeexpensed insteadofcapitalizedonthegroundsthattheyarenotmaterial,evenintotal. Materialityisalsolinkedtothefinancialrisksthattheorganizationseesasimportant.For instance,manygovernmentorganizationswillaskfordetailedinformationandreporting oncontractswithprivateproviders,usuallysettingathresholdbelowwhichthesereports arenotneeded.Thisthreshold,e.g.$10,000,isseenasariskfactorabovewhichmore informationandcontrolisneeded.Thisisaformofmateriality. 8.TheDualityPrinciple Theconceptholdsthefollowingequationaskey:assetsequalliabilitiesplusequity.It matchesassetswithliabilitiesandfunds,providingthesystemwithinternalchecksby relatingeachinflowtoanoutflowintheorganization. Thisprincipalexpressesitselfinthepracticeofdoubleentryaccounting.Indoubleentry accounting,everytransactionhasatleasttwobalancingjournalentriesofdebitsand credits,wheredebitsmustalwaysequalcredits.Doubleentryaccountingkeeps"the accountingequation"ineffectandisthebasisforallaccountingsystems.Every transactionaffectsatleasttwoaccounts,sincetherehastobeatleastonedebitandone creditforeachtransaction.Entriesthatarenotmadetoabalancesheetaccountare madetoanincomeorexpenseaccount.
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9.TheAccrualPrinciple Theaccrualprincipledemandsthat: Revenuerecognitiontakesplacewhengoodsandservicesareprovidedevenif paymenthasnotoccurred Expensesarerecordedonconsumptionoftheassets Accrualisseenasprovidingamuchmorecompletepictureofthefinancialconditionofan organization. The Quality of Information Forgoodreason,withinmostgovernmentsthereisacontinuingpreoccupationnotonly withconformitytostandards,buttothequalityofinformation. Evenifallprinciplesarefollowed,faultyandinaccuratefinancialperformancedatacan greatlydistortinternalmanagementcontrol.Ontheexternalsideitcanmisleadkey stakeholderswithconstitutionalrightstobeaccuratelyinformed.Ineachcase,the credibilityoftheaccountingsystemandtheorganizationitselfcomesintoquestion. TheCICAPublicSectorAccountingHandbookmakesrecommendationsforassuringthe reliabilityoffinancialreporting.TheHandbooksuggeststhefollowingqualitiesshould belookedforinfinancialinformation:12 Representationalfaithfulness:Transactionsandeventsaffectingtheentity arepresentedinfinancialstatementsinamannerthatisinagreementwith theactualunderlyingtransactionandevents. Completeness:Noneofthedatanecessarytoachieverepresentational faithfulnessismissing. Neutrality:Informationisfreefrombiasthatwouldleaduserstowards makingdecisionthatinfluencedbythewaytheinformationismeasuredor presented. Verifiability:Knowledgeableandindependentobserverswoulddiscernthat theinformationisinagreementwiththeactualunderlyingtransactionor eventwithareasonabledegreeofprecision.
12
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The Outputs of Accounting Governmentsusetheaboveprinciplesasboundariesorsignpostsintheirattemptsto produceaseriesofdocumentsthatpaintapictureoffinancialactivityingovernment. ThesedocumentswillconformtoanapprovedChartofAccountswhichisadocument thatdefinesthestructureofthefinancialrecordingandreportingsystemofthe organization.Thesereportswillconsistof:aBalanceSheet,anIncomeStatement,anda CashflowStatement. TheAccountingCycle TheBalanceSheetwillshowthestateofthegovernmentsassetsandliabilities.The IncomeStatementwillshowhowmuchandwherepublicmoneywasspent.Andthe CashflowStatementwillshowtheamountofcashgoinginandtheamountofcash goingoutduringaparticulartimeperiod. These documents are prepared according to the Accounting Cyclewhich can be thought of as a set of financial steps that a government is expected to carry out during the year. Some of these steps are taken every day. Other bigger steps are taken only at the end of the year. The end result of all of these steps is that the organization then hasin addition to its principles a procedure for analyzing, recording, classifying, summarizing, and reporting its financial transactions. This process is represented graphicallybelow.
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DoubleEntryBookkeepingandtheFundamentalAccountingEquation TheAccountingCycleandthecreationoffinancialreportsarebuiltuponsomevery simpleconcepts: doubleentrybookkeepingand theFundamentalAccountingEquation. Fromthere,arangeofreportscanbecreatedtomeettheorganizationsneeds. Doublyentrybookkeepingisbasedontherecognitionthatallfinancialtransactions involveanexchangebetweentwoaccounts.Therefore,inadoubleentrysystemeach transactionisrecordedintwoaccounts.Additionally,eachaccounthastwocolumns. Morespecifically,whentwoentriesaremadeforeachtransaction,oneentryismadein thedebitcolumnofoneaccount,andtheotherentryismadeinthecreditcolumnof anotheraccount.ThetwoentrieskeeptheFundamentalAccountingEquationinbalance sothat: Assets=Liabilities+Equity Thefundamentalaccountingequationestablishestherulethat:foreveryactionthereis an opposite and equal reaction. In more concrete terms, for every increase in the value ofonecomponent,thereisadecreaseinanother. DebitsandCredits Itisimportanttounderstandthatinaccountingterms,debitmeanstoorleftsideand creditmeansfromorrightside.Anyentrytotheleftsideofanaccountisadebitand anyentrytorightsideisacredit.Debitsincreaseassetsordecreaseliabilitiesorowners equity.Creditsincreaseliabilitiesordecreaseassets.Thefollowingexampleand doubleentryjournalrecordwillillustratethis. ExamplesofDebitsandCreditsTransactions
Increase/Decrease Columns Debit/Credit Definition 1.Acompanymows ayardandreceives paymentof$50. 2.Thesame companybuys$100 worthofoffices suppliesandstores Assets= Increase Debit 50(cash) Decrease Credit Liabilities+ Decrease Increase Debit Credit Equity Decrease Debit Increase Credit 50
100 (supplies)
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them.Theoffice supplystoresgive themaninvoice thatallowsthemto payforthemin15 days. 3.Thecompany placesanadinthe localnewspaper andreceivesthe invoiceandpays thebillof$25. 4.Thecompany buysfivemowers for$10,000and financesthemwith abankloan 6.Thecompany receivesacheque for$75owedfrom acustomer.
25(Cash)
25
10,000 (equipment)
75(cash)
75 (accounts receivable)
Wherearetheseactivitiesactuallyrecorded? The General Journal is a chronological listing of all financial events that affect the organization. The General Ledger is a summary of this information organized according tothetypesofaccountsusedintheorganizationsfinancialreports. The primary rule for journal entries, the individual transactions that make up a general journal, is that they must fully respect the Fundamental Accounting Equation, meaning the recording of the transaction must reflect both its positive and negative elements to permitittodoso,asdiscussedabove. KeyDefinitionsofTermsUsedInFinancialStatements Assets are resources owned, or in some cases, controlled, by an individual or organization as a result of transaction or events from which future economic benefits areexpectedtoflowtothatindividualororganizations.Theyrepresenttheresourcesof theorganizationasmeasuredinmonetaryterms. Currentassetsarethoseassetsthatcanbereasonablyexpectedtobeconsumedwithin the fiscal year of the organization in order to meet its needs. Therefore, they are available for use and considered part of the resources needed to carryout the activities oftheorganizationwithinagivenperiod.
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Cashismoneyinanyform,eitherheldonhandoronheldinfinancialinstitutionsthatis readyfordisbursementatanytime. Accounts receivable is money owed to the organization or individual in exchange for goods and services it has provided or for obligations such as taxes, fines and duties. Receivables can take many forms and often reported in ways that reflect those forms. Forinstance,amunicipalitymaymailouttaxformsthat,takentogether,haveavalueof $3,780,000. That figure could be reported by the city as an accounts receivable, or, to providegreaterclarity,asataxreceivablewhichisanotherformofthesamething. Inventories are materials and supplies held for use in providing services or making a product.Inventorieshaveatleasttwodifferentmeanings: Supplies not for sale but for use in the delivery of goods and services, e.g. kitchenutensilsforalongtermcarehomekitchenformealpreparation; A detailed list showing quantities, descriptions and values of owned property, e.g. desks, electronic equipment and other items typically found in the fixed assetgroupneededtocarryouttheoperationsoftheorganization. Issues of inventory management can be important to many public sector organizations. Someofthese,especiallysurroundingtheirvaluation,willbedealtwithlaterinthistext. Some organizations have very large inventories, often with highly cost sensitive items thatareofhighvalue. Prepaid expenses include assets that have been paid for and have not yet been used but that will be used within the fiscal year. These include items such as fire insurance premiums paid in full at the beginning of a year but covering the whole year and rent paidinadvanceofuse. Marketable securities are, after cash, the most liquid of the assets that appear on a balancesheet.Marketablesecuritiesareanyformofshortterminvestment,e.g.stocks, bonds,readilyconvertiblemutualfunds,investmentsortreasurycertificatesthatcanbe convertedtocash. Fixedassetsarethoseassetsthatwillnotbeuseduporconvertedtocashwithinafiscal year; referred to as longterm assets. These assets include categories such as land, buildings and equipment. In assigning value to fixed assets, it is valuable to go back to the GAAP principle on cost conservatism. Hence, all accounting begins with the cost of the asset not its value at the present time. For example, the purchase of land is recorded at cost. The market value of the land may fluctuate over the years. However, from an accounting perspective this asset is fixed. Therefore, the organization will list thecostofthelandatthetimeofpurchase. The principle of depreciation is that all equipment and plant are used up over a period of time defined by the owners and that, at the end, replacement or refurbishment of
Public Sector Financial Management for Managers 51
some kind would be necessary. The accrual system plays an important role in recognizing depreciation. Both plant and equipment are used up over their lives, not all atonce.Therefore,thevalueoftheassetatagiventimefromafinancialreportingpoint of view is the original cost minus the depreciation rate that is applied to the particular item. Depreciation therefore will equal the annual use of the item in a monetized fashion.Eachyearthisisrecognizedinthebalancesheetandotherreportsdealingwith equipment. Depreciationplaysasecondroledistributingvalueoftheassettotheyearsitisused, notsimplyupfrontwhenthepurchaseismade.Forexample,adepartmentbuysa vehicleatacostof$35,000toaddtoanexistingfleet.Inlistingthisexpenseinits journal,thefullamountof$35,000willbereportedasreductionincash.$35,000willbe addedtothefixedassets. However,thedepartmentwillalsomakeadecisionabouttheusablelifeofthevehicle, assumingappropriatemaintenanceisfactoredin.Letussaythatthisis5years.The departmentcanalsoassume,basedeitheronexperienceoronanaccounting conventiondevelopedwithintheorganizationthat,attheendofitslife,$5000willbe recoupedthroughthesaleoftheusedvehicle.Therefore,toattributefullvaluefrom theasset,$30,000willbedistributedoverthelifeofthevehicle.Thistranslatedintothe followingdepreciationrateandvalueassignedattheendofeachyeartotheasset. AnExampleofDepreciation Year 1 2 3 4 5 Amountof 6,000 6,000 6,000 6,000 6,000 Depreciation NetValue 29,000 23,000 17,000 11,000 5,000 reportedin BalanceSheet Liabilitiesarelegalfinancialobligationstheorganizationhastooutsiders. Currentliabilitiesarethoseobligationsthatwillcomedueinarelativelyshortperiodof time,usuallywithinthefiscalyearforwhichthereportsarebeingprepared. AccountsPayablerepresenttheamountsthattheorganizationowesitssuppliers, creditors,serviceagents,etc.Thiscategoryishighlycurrent,usuallyrequiringpayment withinonemonthi.e.staffsalaries. Longtermliabilitiesareobligationsthatarenotrequiredtobemetforatleastoneyear ormorei.e.mortgages.
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Equity/NetAssets/FundBalance Equity shows the amount of funds obtained from other sources but not needed to dischargeliabilities.Intheprivatesectormodel,equityrepresentstheamountoffunds that should be available for shareholders or shareholder wealth. When a company is privately owned, it represents the worth of the company to the owner. For the public sector,equityisrepresentedasnetdebtorsurplusorfundbalance.
FinancialStatementsAGeneralOverview
TheBalanceSheet The Balance Sheet reports on the resources controlled by the organization. It is a snapshot of the financial position of the organization. It is inclusive of all resources regardlessofhowaccessibletheyareforcurrentuse. A typical Balance Sheet for a small organization is shown below. Hope for Street Kids HSK is an organization helping homeless kids through counseling and by liaising with schoolsandsocialagencies. HopeforStreetKids StatementofFinancialPosition November30,2010 Assets Liabilities CurrentAssets CurrentLiabilities Cash 10,000 AccountsPayable 40,000 AccountsReceivable 20,000 AccruedWages 10,000 Inventory 50,000 TotalCurrentLiabilities 50,000 TotalCurrentAssets 80,000 LongTermLiabilities FixedAssets Bondspayable 200,000 Equipment 250,000 Mortgagepayable 150,000 Building 150,000 TotalLongTermLiabilities 350,000 Land 110,000 TotalFixedAssets 510,000 NetAssets RestrictedFund(Perm) 100,000 UnrestrictedFund 40,000 Reserve 50,000 TotalNetAssets 190,000 TotalAssets 590,000 TotalLiabilities 590,000
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TheIncomeStatement Unlike, the Balance Sheet, which is a snapshot on a given day, the Income Statement covers the financial transactions of the organization for a given period of time a month, a quarter, a year. This report set outs the details of the organizations revenues andexpensesfortheperiod. Organizationsmayuseanumberofdifferentwaystogrouptogetherorcategorizetheir revenuesandexpensesintheIncomeStatement: ByObject:salaries,benefits,rentals,costofservices By Function: e.g., research, client service, inspection, support or administrative services ByProgram:operationsunit,administrationunit,etc. IncomeStatementOrganizedbyObject(PlusYeartoYearComparison) HopeforStreetKids IncomeStatement FirstQuarterendingNovember30,2005 2005 2004 Revenues GovernmentGrantsrestricted 17,500 15,000 GovernmentGrantsgeneral 0 2,000 Contributionsrestricted 4,000 7,500 Contributionsunrestricted 6,000 10,000 0 1,000 Fees Interest 2,300 2,800 Total 29,800 38,300 Expenses Salaries,benefitcosts 10,000 10,000 Rentals,equipment 2,000 2,200 Supplies 5,000 6,000 Aid to Kids: Program Grants, ShortTerm 19,000 23,000 FinancialAssistance,TravelHome Total 36,000 41,200 Increase(Decrease)inNetAssets (6,200) (2,900) TheStatementofCashFlows Though most public sector organizations use some form of accrual accounting, there is also a need to display changes in cash and cash equivalents resulting from the organizationsactivitiesduringtheperiod.Thus,CashFlowsStatementismorenarrowly defined, focusing on cash transactions as opposed to such noncash items as
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depreciation. This Statement gives information about the current financial viability of theoperation. Cash flow statements typically report on the following categories of financial information: Cash flows from operations: This will include all cash receipts taxes, fees, pledges and contribution and disbursements resulting from the main service deliveryactivitiesoftheorganization. Cash flows from investing activities: This includes cash outflows related to the purchase of capital assets and the purchase of investments and cash received fromthedisposalofassetsofasimilarkind. Cash flows from financing activities: This includes cash used to pay for prior financial obligations and the acquisition of debt through bonds, loans, treasury bills,etc. Noncashfinancingandinvestingactivities:Certainfinancingandinvesting activitiesdonotinvolvethereceiptanduseofcash.Forexample,contributions ofcapitalassetsoraninvestmentportfoliotobeheldforanendowmentfund.
Conclusion
Thesimplerealityisthatyoucannotmakeagooddecisionwithoutgoodinformation presentedinanunderstandableandpredictableway.Naturally,thisrealityappliesto financialdecisionsandfinancialinformation.Finding,using,controllingandaccounting forgovernmentresourcesdemandsareliableandcrediblefinancialandmanagement accountingcapacitywithintheorganization. Publicsectoraccountingistheunderlyingfoundationofthemanagementcyclewithin publicorganizations.Theneedtohavestandardsthatprotecttheintegrityofthe accountingsystemisgreat,especiallyinthepublicsectorwheretheusersinterestsare varied,andcredibilityisabsolutelynecessaryandalwaysunderchallenge.Additionallya standardreportingprocedure,andcommonreportingtemplatesincreasethe legitimacy,transparency,andusefulnessofthefinancialinformationcollectedby governments. Whenfinancialinformationiscollectedandpresentedproperly,itsatisfiesthepublic andempowersmanagersinthepublicservices.Itsupportsaninformedandevidence basedpolicyprocess.
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Cash Basis Accounting: An Overview Ifanorganizationoperatesonacashbasis,itrecognizesincomewhenitreceivesitand expenseswhentheyareactuallypaid. Forexample,agovernmentprovidesaservicetooneofitsclientonDecember31st,e.g. alicense.However,theclientdoesnotpayuntilJanuary31st.Ifthegovernmentuses cashaccounting,itdoesnotcountthesaleasincomeuntilitcollectsthemoneyinthis caseJanuary. AnotherExampleofCashAccounting Anewcomputersystembudgetedfor$2.5millionisbeinginstalledin20023and2003 4fiscalyears.Thecomputersareboughtonaccountand$1.75millionwillbepaidatthe beginningofthefiscalyear.Thebalancewillbepaidatthebeginningofthenextfiscal year.Acashbasedaccountingsystemwoulddisplaytheseitemsthisway: ExampleofCashAccounting FiscalYear NewComputerSystem 200506 1,750,000 200607 750,000
Accrual Basis Accounting: An Overview In accrual accounting, income is recognized when the income is earned, regardless of whenpaymentisreceived.Expensesarerecognizedwhentheliabilityisincurred. When an organization using an accrual basis for accounting sells a good, it places the future payment for that good in an accounts receivable as part of its asset base. Similarly, when it obtains goods and takes them into inventory from a supplier, it recognizes two things: it has created a liability in the form of accounts payable, it has
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alsoincreaseditsassetbasebyaddingtoitsinventory.Inthisway,theorganizationhas betterpictureofitsactualfinancialposition. Accrual accounting is the reason for the existence oftwo major accounts that we have previously examined on the balance sheet. Accounts Receivable is the total of all the monies owed to the organization. Accounts Payable is the total of all debts owed to suppliers and vendors. For each transaction, a separate record is maintained with detailed information on each customer or vendor. This detail is referred to as the Accounts Receivable and Accounts Payable subledgers. The total of the detail of each subledger must equal to the total on the balance sheet for each of the two major accounts. Example of Accrual Accounting Taking the same computer system referenced in the previous section, to reflect when the asset would actually be used, it is assumed that it has a five year life cycle. Even though the actual cash outlay is the same as shown in the cash example, the accrual system recognizes the expense when it occurs not when the money is paid. Hence, an accrual financial report would show the costs in the following way FiscalYear Computer System Another distinction between the cash and accrual basis is that the accrual system will recognize that assets depreciate over time and will include the depreciation as a non cashliabilityincalculatingoverallfinancialposition. The Difference between Cash and Accrual Accounting ComparisonofTreatmentofPurchaseEventsunderTwoBasesofAccounting Event Articleorderedfromsupplier ArticlearrivesinInventory Articleisused Cash Noeffect Noeffect Noeffect Accrual Noeffect Increaseaccountspayableand IncreaseInventory DecreaseinventoryandDecrease fundbalance 200405 500,00 200506 500,00 200607 500,000 200708 500,000 200809 500,000
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Articleispaidfor
Decreasecash Decreasefundbalance
Decreasecash Decreaseaccountspayable
CashVersusAccrualTreatmentofAssetAcquisitionandUse Transaction Assetboughtbutnotpaid for(oncreditoraccount) Assetconsumedorused Cash Noentryi.e.recognitionin accountingsystem Noentry Accrual Assetandliability recognizedandrecorded Useanddecreaseinasset valuerecognized Decreaseinliabilityand cashrecognized Revenueandaccounts receivablerecognized Noentry
Assetpurchasedoncreditis Decreaseincashandasset paidforbycash recognized Servicedelivered Noentry Billsentforservice delivered Billpaidincash Noentry
Implications of the Accrual Accounting As the example below demonstrates, perceptions of financial health can be very dependentontheaccountingsystemused. Inthefollowingexample,wecanseethat,onacashbasis,thegovernmentisinsurplus. On an accrual basis, it faces a deficit. This deficit does not mean the government needs toimmediatelyraisecashtopaydownthedeficit.Rather,itmeansthatthefullfinancial resourcesofthegovernmentaredisplayedsothatitsfullliabilitiesovertimeareshown. Therefore,thegovernmentisnotcurrentlyinapositiontoincreasespendingasthecash reportmightsuggest. An example of this is the way in which pension obligations are managed. On a cash accounting basis, the $30 million pension obligation is ignored until the pension paymentsareactuallymade,usuallyyearslater. Ontheotherhand,accrualaccountingimmediatelyrecognizestheobligation.Such recognitionhasbothpositiveandnegativeimpacts,especiallyonpublicorganizations. Asalreadynoted,itprovidesamoreaccuratepictureofthefullfinancialobligationsof thegovernmentinquestion.Italsoforcesthegovernmenttotakethisobligationinto accountasitmakespolicyandprogramdecisions.Suchinformation,especiallyexpenses thatwillnotbedischargedforaconsiderableamountoftimeandwhosevaluewill
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changeovertime,maynotberelevanttoshorttermdecisionmaking.Theymayhave theperverseeffectofdampeningthecapacityofagovernmenttomeetshortterm needs. AnExampleofaWeekintheLifeofOneGovernment13 A series of financial events.. Thefollowingexamplesconsideraweekinthelifeofasmallgovernment.Theeffects ofthefollowingfivetransactionsareshowninthefinancialstatementsbelow. Corporatetaxpayersarerequiredtomaketaxpaymentsof$100 milliontothegovernmentbutonly$90millionisreceived.Attheend oftheweek,$10millionisoutstanding. Thegovernmentsellsfixedassetsfor$100million.Theassetshad beenvaluedat$100million. Governmentsalarypaymentsaremadeduringtheweek.Inaddition topayingemployees$60million,thegovernmentisobligatedto providefortheirpensionswhentheyretireemployeesearned$30 millioninfuturepensionrightsduringtheperiod. Thegovernmentsettlesalongrunninglegaldispute.Itagreestopay $30milliontotheplaintiffintwomonthstime. Allthegovernmentsborrowingsareheldinforeignexchange.The exchangeratedeclinedby2%duringtheweek.
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FinancialReportsoftheGovernment
AccrualAccounting Information
Cash Accounting Information Cash Flow Statement Receipts a.Taxation 90 b. Asset 100 Sales s/t 190 Payments
BalanceSheet 100 100 90 Assets Bank Receivables FixedAssets s/t Opening 50 20 700 770 Changes 130 a.10 b.100 40 Closing 180 30 600 810
c.Salaries
10 30
Liabilities Litigation
d.30
30
130 30
500 500
c.30 e.10 70 30 30
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The Pros and Cons of Cash and Accrual Accounting and Budgeting Someoftheadvantagesofthecashsystemofaccountingandbudgetingarethatitis: simple linkswithcashbudgetandtaxationsystems easytounderstand easytoauditandcontrol(withinitsownparametersofbeingfora specifiedperiodanddealingonlywithcashrequirements) Theriskstoacashapproachinclude: theabilitytomanipulatecashflowsoverreportingperiods(especiallyfrom reportingperiodtoreportingperiodtominimizedeficitsoroverexpenditures)14, thetendencytospendallavailableresourceswithinthefinancialyearand,with someexceptions,failuretopermitinterperioduseofcashfunds, assetsandliabilitiesignored,therebydistortingthetruefinancialsituation, cashstatementdoesnotprovideafullpictureofthefinancialpositionespecially forshortandlongtermliabilities,asnoted,butincludingdepreciationaswell, nolinkwitheconomicanalysesororganizationaloutputs. Accrualaccountingiscertainlymorecomplexanddifficult.Itdoes,however,havethe advantageofprovidingmoreusefulfinancialinformation.Someoftheotheradvantages oftheaccrualbasisare: accrualaccountingismorecompletethancashandprovideafullbalance sheetapproach, scopeformanipulationofcashisremovedwithanunderstandingthat issuesofmanipulationareneverfullyremovedfromanyaccountingor budgetingsystems, facilitatesbetterqualityfinancialmanagement,
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Ofcourse,accrualaccountingfacesthesameproblemwiththeissuerecognizingincome.
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Therisksassociatedwithaccrualaccountingare: itcanbeseenasatechnocraticexerciseandnotdrivenbymanagementneeds especiallywhenitislefttothefinancialexperts; alackofadequateaccountingstandardsmaymeanthattheinterpretationofthe financialinformationfromaccrualaccountingwillhavedifferentmeaningsfor differentusers,standardscapableofmanipulation; theremaybeapoorlinkagetobudgetinformationwhenthebudgetsarestillona cashbasismakingtheunderstandingoffinancialreportingdifficulttofollowand createtheneedforcrossoverreportswhichcanleadtoconfusion. politiciansordirectorsmaynotimposefiscaldiscipline,e.g.costofcapitalor demandforfullcostimplicationsofintergenerationalliabilitiessuchaspensions,a matterofleadershiporwillthatnosystemwillrectifyorreplace; managementunwillingorunabletouseaccrualinformationtoimprovecontrolof resources,effectiveoversightormakechangesasaresult; managementadoptsaccrualbasisforexternalrequirementsbutstilloperatesblack booksystemsonoldbasis;15 opensthepossibilityofotherformsofmanipulationssuchasseenintheprivate sector,e.g.therecognitionoffictionalincome; Producesreportsthataremoredifficulttounderstandanduse.
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Key Points
Accountabilityisaconceptwithabroadreach,especiallyforpublicsectororganizations. Itstraddlesthedividebetweenoperationalprocessandmanagementandcontrol.It alsoappliestotheinternalmanagementandcontrolofpublicsectororganizationsin termsoftheeffectivenessofthosecontrols,theefficiencywithwhichtheorganization carriesoutitsworkanditsadherencetothelawsandrequirementsforprobity.These elementsformthebasisofwhatiscalledexecutiveaccountability,appliedtothe internalmanagementoforganizations. However,accountabilityalsoappliestoexternalauthoritiessuchasthelegislatureand externalagenciesofreview,mostnotablylegislativeauditors.Heretheaccountabilityis torenderanaccountofonesdutiesandreporttothatauthorityontheexecutionofthe responsibilitiesthatyouhavereceivedfromthem.Inthiscontext,italsomeanstobe subjecttoscrutiny,questioningandformalreview. Accountabilityalsoextendstorelationshipswithserviceprovidersbothwithinthe publicsectorandintotheprivatesectorthroughcontractedservices,contribution agreementsandfundingsupports.Theserelationshipsincludesomeformofreporting oraccountingforthefunds.
What is Accountability?
Accountabilityistherequirementtoexplainandacceptresponsibilityforcarryingout anassignedmandateinlightofagreeduponexpectations.Itisparticularlyimportantin situationsthatinvolvepublictrust.However,acommitmenttoaccountabilityshouldbe thoughofnotonlyasansweringtoexternalaudiences,butalsoasaconstructivetool fororganization,development,enhancingmanagementpractices,selfevaluationand strategicplanning. Theapplicationofaccountabilityinvolvesthreeelements: Takingintoconsiderationthepublictrustintheexerciseofresponsibilities; Providingdetailedinformationshowinghowresponsibilitieshavebeencarried outandwhatoutcomeshavebeenachieve;and Acceptingtheresponsibilityforoutcomes,includingproblemscreatedornot correctedbyanorganizationoritsofficialsandstaff.17
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Whatthen,aretheprincipalcharacteristicsofaccountabilityrelationshipsinthepublic sector? AssignmentofAuthority,PowerandResources:Thisisthedownward delegationofdutiestoanindividualororganization.Thiscanbebylaw,by policy,bywayofformaldelegationmatricesorbythecompletionofan organizationalworkplan,budgetdistributionandperformancecontracts.Itcan alsobeimplicitorindirect,suchasusingformalpositiondescriptionstodescribe dutiesthathavedelegationsofauthorityinthemandstatementofexpected dutiestoperformand,possibly,outcomeexpectations. AccountabilityforPerformanceandResults:Thisistheyinandtheyanabove. Inacceptingtheauthority,powerandresources,theindividualororganization alsotakesontheresponsibilitytoperformtheworkandaccountfortheresults. AssignmentofDuties:Inassigningdutiesformally,thegrantingauthorityalso providescleardirection,legislativeorregulatoryguidance,resourcesconsistent withtheexpectation. RequirementtoReport:Thenecessitytoreportinaformalway,often prescribedbythegrantingauthoritydealswiththreeelements: Resultsachieved Compliancetolegalandproceduralrequirements,and Efficiency. JudgmentExercised:Atsomelevel,beitwithintheorganizationandwiththe publicatlarge,publicsectoraccountabilityinvolvestherightofthegranting authoritytomakejudgesabouthowtheaccountabilityhasbeenexercisedand actonthatjudgment.Intheultimatetestinademocracysuchasours,thatmay meanthedownfallorreelectionofagovernment.Inmoremundaneterms,it maybecleanbillofhealthonafinancialstatementbyalegislativeauditor. The Relationship of Accountability and Financial Management Financialmanagement,becauseofititssystematicreportingcharacter,isanimportant toolofaccountability.Financialreportscontaininformationinaprescribedand,at times,legislated,format.Theyalsoindicatehowtheindividualororganizationhas providedgoodmanagementandstewardshipoffunds.Theycanprovideinformationon theresultsachieved,althoughonlyalimitedways. Goodfinancialmanagement,therefore,canbeattheheartofestablishing accountability.Oneofthefeaturesofpublicsectoraccountabilityisthatitistransient andvolatile.Regardlessoftheadequacyofreportingtoolsandtheconfidenceinthe system,muchdependsontrustinthoseprovidingtheinformation.Havingsound financialsystemsthatproducereliabledataisameansofestablishingsuchtrust.
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http://www.ctf.ca
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IndividualDonorsandFundingOrganizations:Itishighlyunlikelythatfunding organizationswillprovidemorefundingwhentheyloseconfidenceinthe organizationsabilitytomanageitsfinances.Similarly,somepublicorganizations mayhavedirectoversightandcontrolrolesinrelationshiptootherpublic organizations.Thisismostprevalentinthegovernment/voluntarysector interface.Financialreportinganditsqualitymayhaveaneffectonthelongterm financialsupportthatisgiven. Creditorsandcreditratingorganizations:Applyingtobothgovernmentandthe voluntarysector,oneofthefirstconcernsofanylenderwillbethefinancial conditionoftheorganizations,beitatown.
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LegislativeAuditors Legislativeauditorsareappointed,generallythroughaCabinetdecision,toserveand reportongovernmentwideissues.Theyareindependentofgovernmentandreport directlytothelegislatureofthejurisdiction. Fromtheviewoflegislators,thevalueoflegislativeauditorshasnotsimplybeenintheir technicalexpertiseithasalsobeenintheirabilitytoconductauditsthatmaynot pleasethosebeingexamined,andtoreporttheirfindingspubliclyandindependently. Theyhavesubjectedtheoperationsofthepublicsectortoregular,independent examinations,actinginthepublicinterest,asadvocatesoftransparentgovernment. Independence Independencethestateofbeingimpartialandfreefrombiasandconflictsof interestisthecornerstoneofauditing.Anythingthatimpedesanhonestand straightforwardapproachtotheperformanceofanauditwillreducepublicconfidence. InCanada,legislativeauditorshavetoworkatearningtheconfidenceoflegislatorsand thepublic.Thefactthatthisindependenceisbackedbylegislationinstillspublic confidenceintheprocess. ThepracticesusedintheappointmentofanAuditorGeneralvaryacrossgovernments. However,inallcases,thelegislatureisinvolvedinsomewayinensuringtheir independence.Theyhaveassuredthisindependenceinanumberofways: Thelegislatureusuallyhassomeinvolvementintheappointmentofthe auditor. Appointmentsaregenerallyforfixedterms,withremovalpermittedonly forcauseorincapacity. RemunerationoftheLegislativeAuditorisusuallyattachedtoareference group,topreventgovernmentsfromchangingpaylevelswhenonetoo manybadreportscomein. Legislationprovideslegislativeauditorswithimmunityfromlegalaction. Legislationallowslegislativeauditorstodecidehowbesttoundertake audits(forexample,byusinginhousestaff,contractedstaff,or contractedfirms). ReportingtotheLegislature Legislativeauditorsgenerallyreportdirectlytotheirauthorizinglegislatures,atleast annually,onanythingtheythinkshouldbebroughttothelegislatorsattention.The auditorsreportsbecomeamatterofpublicrecordandcoverawiderangeofissuesof interesttolegislatorsandthepublic,includingcompliance,propriety,theeconomy,and theefficiencyandeffectivenessofgovernmentoperations.LegislativeAuditorsalso
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havedirectaccesstoeachlegislaturesPublicAccountsCommittee.Thisprovidesthem withaformalmeansofdiscussingtheirreportedauditfindingswiththelegislators. ThirdPartyAccountabilityandtheBurdenofOversight OverthepasttwentyyearsandcloselyassociatedwiththeNewPublicManagement19 phenomenoninvariouscountries,contractingofserviceshasincreased.Thirdparty deliverybyprivateornonprofitentitieshasincreasedinarangeofgovernment services.Manygovernmentsviewthisflexibilityindeliveryaspositive.Theybelievethat theycanrealizesavingsinbuyingratherthanbuildingservicedeliverytools.Further, throughtheintegrationofbackroomservices,i.e.thosesupportfunctionsthat generallyhavenopublicprofile,theycanrealizethebenefitsofbothcentralizationand, tosomedegree,outsourcing.Finally,thesearrangementscanallowgovernmentsto decentralizeandlocalizeservicedeliverytothepublicthroughcontractingthatmatches localcircumstances. However,despitethemanybenefits,theaccountabilityquestionsraisedthrough contractingforservicesandusingthirdpartiesaremany.Someare: Dothesamestandardsofaccountabilitythatapplytogovernmentalsoapplyto nongovernmentalproviders? Arereportingrequirementsthesamewhentheobjectiveofcontractingisto focusonresults,notprocess? Isthepublicagencydoingthecontractinglessabletobeaccountablefor financialprobityandconformancetorules?Isyes,howdoesitensurethistakes place? Doesthepublicagencymanagingthecontractbecomeaformofauditoraswell asabuyerofservices? Doprivateorpublicsectorfinancialstandardsapply? Whatisthecostandburdenespeciallyforvoluntaryagenciesintermsof reporting? Thekeycontrastwiththeprivatesector,andtoacertaindegreewiththevoluntary sectoristhat,whilethesesectorstendtofocusonresultsoftheirefforts,government focusesbothonresultsandprocess.Someofthedifficultythatthevoluntarysector confrontsindealingwithgovernmentisthatprocessdemandsforreports,conformity withgovernmentstandards,detailedinformationneedsoverwhelmtheresults
TheliteratureonNewPublicManagementisexhaustive.However,LesterSalamon,op.cit,providesa goodoverviewofthemostrecentdevelopments.Similarly,PeterAucoin,theNewPublicManagement: CanadainComparativePerspective,Montreal,InstituteforResearchonPublicPolicy,1995,isagood earlyintroduction.Foramoreretrospectivelookaroundtheworld,seeTHEAGENCYCONCEPTINNORTH AMERICA:FAILURE,ADAPTATION,ANDUNEXPECTEDBENEFITS,AndrewGrahamandAlasdairRobertsin UnbundledGovernment,editedbyChristopherPollittandColinTalbot,Routledge,2003
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intentionsofthearrangement.Thisrobsthearrangementofthebenefitthatisderived fromhavingthevoluntarysectorinvolvedinthefirstplace. Excessivedemandsbygovernmentfordetailedlevelsofaccountabilitycanbothcripple thevoluntaryorganizationandrenderthereasonforthearrangementinthefirstplace creativity,localdelivery,uniqueskillsetofthevoluntarysectorsomewhatuseless. Theypointoutthefollowingchallenges: Moredetailedreviewandreporting Thinkingsmallandinsidethebox:projectdesignandaccountabilityarehighly riskaverseandtendtowardsprocesscomplianceratherthanprogramand resultsperformance Delaysinapprovalandrenewalprocessesduetothemoreonerouscontract negotiationandreportingdemandsofgovernment Changeinroleofgovernmentprojectofficerfromfunderanddeveloperof programmingtocontrollerandmonitor Arushtooutputandoutcomemeasurestomeetcomplianceneedsoverlonger termperspectives,especiallyinareasofsocialservice,wheremuchofthe voluntarysectorsstrengthlies.20 Establishingeffectivecontractmanagementtoenablegoodfinancialadministration demandsthatcertainfeaturesoftherelationshipbewellstructured.Someoftheseare: Aclearunderstandingofthedesiresoutcomesordeliverables Cleardefinitionsofaccountabilitiesofallpartiesinvolved Goodcosting,notonlyoftheservicesorgoodsdeliveredbutalsotheoversight costs Appropriatecontractdesignandcontractprocessadministration,includingthe additionofprobityauditsinrealtimeforhighriskcontractingprocesses Clearguidelinesonreportingrequirementsbybothparties Anagreedcashflowarrangement Effectivecontractgovernancetoenableproblemsolving Appropriatepostcontractevaluation. Thirdpartycontractinginnowaydilutestheaccountabilitiesofpubicofficialsforthe publicgood.Itcomplicatesthataccountability,however.Thecostsofthesenewforms ofaccountabilityhavetobefactoredintotheoverallassessmentoftheuseofathird partyinservicedelivery.However,thesamehastobesaidforthecostofeffective accountabilitywiththetraditionalstructuresofthepublicsector.Neitherisfree.
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Conclusion
Effectiveaccountabilityisthetouchstoneofpublicsectormanagementingeneraland financialmanagementspecifically.Theeffectivemeasuresthatpublicsector organizationsusetoreportontheirperformance,explaintheactionsandprovide transparencyinbothinformationandprocessesestablishtheircredibilityandenable theirpoliticalmasterstoexercisetheiruniqueaccountabilitieswithinthedemocratic frameworkinwhichtheseorganizationsoperate.Similarly,withinorganizations,the establishmentofclearlinesofresponsibility,wellunderstoodobjectives,arobust meansofmeasuringandholdingindividualsandmangerstoaccountofthe responsibilitiesthattheyassumeisameasureofthehealthoftheorganization. Unfortunately,inthepublicsector,exercisingeffectiveaccountabilitycanbetempered byahighlypoliticizedenvironment.Nomeasureofeffectiveannualreportingwilldrive outthetaintanddamageofaspecificincident,beitfraud,misuseoffundsorpolitical interferenceintheuseoffunds.Thisatmospherecreatesariskadverseculturewhichis incapableofdistinguishingbetweenthepotentiallyembarrassingexceptionandthe generalruleofgoodmanagement.Infact,theonenegatestheother.Thereisnosuch thingasariskfreeenvironment.Inturn,thereisnoamountofaudit,internalor external,thatcanpreventindividualsfromactingillegally.Theothertruthisthatthe costsofcontrolsimposedasaresultofsinglyincidentsoftenoutweighthetrueriskof fraudormisuseoffunds. Thechallengeremainsinthepublicsectortoaggressivelydealwithfraudandpolitical interference.However,thereactionshouldbeproportionaltotheaction.Theresponse shouldmatchtherisk.
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Section
1.TheNatureofPublicSector FinancialManagement 2.CornerstoneOne:Allocating ResourcesBudgets 3.UnderstandingtheBudgetary Process 4.Budgeting:CapitalPlanning 5.CornerstoneTwo:Monitoring MoneyManagerialControl 6.CashManagement:InYear Control 7:CornerstoneThree:ReportingOn HowMoneyIsSpentAccounting 8:AccrualAccounting:Providinga FullerStory Section9:Accountabilityand Reporting
SubSection
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TheBudgetCycle BudgetMethodologies
8 9 14 14 18 21 21 22 24 26 29 29 30 32 33 35 39 39 40 42 46 49 49 53 58 63 63 64 64 69 72 72 74 75 76
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