# Public Financial Management and Internal Control

The Importance of Managerial Capability for Successful Reform in Developing and Transition Economies

Noel Hepworth

Public Financial Management and Internal Control

# Noel Hepworth Public Financial Management and Internal Control

The Importance of Managerial Capability for Successful Reform in Developing and Transition Economies

Noel Hepworth Kenley, UK

ISBN 978-3-031-35065-8 ISBN 978-3-031-35066-5 (eBook) https://doi.org/10.1007/978-3-031-35066-5

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# **Foreword**

Good public fnancial management is fundamental to a well-functioning public sector and is at the heart of Chartered Institute of Public Finance and Accountancy (CIPFA)'s work. Te principles of fnancial management are internationally recognised and apply in all jurisdictions around the world, and include accountability, transparency, and long-term sustainability. When followed, these principles bring wider benefts as public money is handled carefully, promoting trust between government and its citizens and preventing corruption.

Te shift from public fnancial administration to public fnancial management (PFM) is a vital step towards unlocking these social benefts. Tis book outlines how to successfully achieve this reform, highlighting the various aspects to consider and providing guidance for the implementation process. Te particular focus of the book is on managerial capability as a driver for change and a key determinant of success. Strong leadership is a core component of efective PFM and this kind of transformation requires buy-in from the top alongside managers at all levels taking responsibility.

Tere are many diferent elements to PFM reform, and this book takes a comprehensive view, including setting the ground at the beginning of the process, risk management, the role of government ministers, and the impact on second-level organisations. Te benefts of undertaking reform are set out alongside the potential costs, indicating what can be achieved as long as there is sufcient determination to make the most of the transformation opportunities.

As the only professional accountancy body in the world exclusively dedicated to public fnance, CIPFA is committed to working for the public good both in the UK and internationally. Our aim, and one of our charitable objectives, is to advance the feld of public fnancial management and promote best practice throughout the global public sector. We work closely with international bodies, government ministries, technical development partners, public accounting organisations and supreme audit institutions to further this aim and develop a global perspective on common issues.

In line with this work, CIPFA is proud to sponsor this book and support the implementation of public fnancial management and internal control to strengthen developing economies. If executed well, the benefts of this type of reform are clear, and this book will be a valuable tool to help reach that goal. Noel Hepworth's research and guidance provide a roadmap that will ultimately improve lives in communities around the world.

London, UK Rob Whiteman

# **Preface**

I was moved to write this guide because, based upon my experience of working in many developing and transition economy countries, I felt that little substantial progress in reform to the public fnancial management and internal control (PFM/IC) arrangements was being achieved. Tis was because the focus was always on technical developments without regard to the cultural, political, and managerial context in which the reform was being applied. Te main thrust of this guide is that to achieve successful reform that context is of overriding importance and simply focussing on the bureaucracy of reform processes, as mainly seemed to happen, was no signal of success. Te change that is required can perhaps be best summarised in this remark by William Faulkner "You cannot swim for new horizons until you have courage to lose sight of the shore."

Having said that, the country ofcials I have worked with have almost all been enthusiastic about and supportive of the reform. Working with them and learning from their experiences has been very rewarding.

Improving the techniques included the adoption of the international best practice that is the standards of internal control advocated by the Committee of Sponsoring Organisations (COSO). Tis approach was complemented by an emphasis upon the development of internal audit, as in efect the 'guardians' of internal control. Financial management in this context was perceived of as being limited to fnancial and budgetary control. Tat limitation, however, is quite inadequate in a modern managerial environment. It says nothing about how to improve efciency and efectiveness in public expenditure, or alternatively public sector productivity. It also says nothing about supporting a government to achieve its policy objectives towards the delivery of public services. Consequently, I concluded that this approach to the application of PFM/IC was inappropriate and a diferent approach was required.

Adopting international best practice or standards is not as simple as it might seem because individual countries have diferent historical and cultural backgrounds and international best practice may not be easily transferable. International best practice also incorporates a set of assumptions which, whilst they are not explicit, are very important and they do need to be taken into account. So far as PFM/IC is concerned any adopter should recognise these implicit assumptions. Tey focus around the idea of management. What has not been recognised by those responsible for supporting the implementation of PFM/IC, that is, donors, consultants, or governments, is that if the benefts of improving efciency and efectiveness as well as assisting governments to deliver their objectives are to be achieved, this reform should be regarded as fundamentally a management reform.

As a management reform this means that it afects the relationships between politicians and civil and local government-appointed ofcials, budgeting and accounting systems, and personnel appointment and management arrangements. Terefore, these all need to be addressed with managerial reform being central to success. Tis includes the commitment and support of the top ofcials, both elected and appointed. Tey should recognise and appreciate the benefts that the reform can generate and should want to achieve them. Tis guide indicates where that commitment and support are of particular importance. Without that the reform will not achieve the benefts. Achieving control of public expenditure is relatively easy but doing so and achieving better value public services is much more difcult. Tis is why establishing highquality public fnancial management and internal control is so important and why success demands management commitment.

Who should read this guide? Tose who aspire to the position of minister of fnance ought to do so but I recognise that this is unlikely to occur. Te ministry of fnance state secretary (or equivalent) and the head of the department of that ministry responsible for the implementation of the reform should read the whole text. Other heads of operational management in public organisations and their supporting staf also ought to do so because they have key managerial responsibilities. Equally, heads of fnance ideally should read the whole guide, paying particular attention to those sections which specifcally relate to their responsibilities. Internal and external auditors also should read the whole guide. Aid agency ofcials framing proposals for reform and consultants advising on this reform also should read this guide. It will afect the framing of proposals. Other readers should be those concerned with public administration reform, including human resources reform. Although this is a practitioner text, academics interested in public sector management should also read this guide, not least because they often will have training responsibilities.

In writing this guide I have had enormous assistance and advice from Dr. Stephen Peterson—retired lecturer and Faculty Chair of the Executive Program in Public Financial Management at the Harvard Kennedy School. He has not only given me technical advice but also been a source of encouragement and support during a very lengthy writing and research process. I am very grateful to him. He has been very generous with his time.

I am also very appreciative of the advice and support I have had from my daughter, Dr. Sarah Hepworth. She has a wide experience of working in developing countries and her research expertise as well as her critical appraisal of the text has proved invaluable to me.

I am also grateful to many former colleagues and friends who, based on their experiences, have given me wise advice and guidance. In particular, Joop Vrolijk, Alastair Swarbrick, and Brian Finn, former colleagues from Support for Improvement in Governance and Management (SIGMA), have shared their very considerable knowledge and have been very encouraging.

Kenley, UK Noel Hepworth

# **Contents**












**Index** 567

# **List of Tables**


# **Changing from Financial Control to Financial Management in the Public Sector: An Introduction to the Changes That Will Be Required**

Tis chapter describes the key aspects of public fnancial management and internal control reform, viewed through a managerial lens. It describes how, without a thorough appreciation of the linkage with management, this reform will at best fail to meet the intended objectives and at worst could add to administrative bureaucracy and hence costs. Tese are recurrent themes throughout this guide. Tis chapter introduces some of the terms and facets of the reform that will be explored in more depth in later chapters. Overall, this should be regarded as a major reform and it will take several years to achieve. It afects the quality of policy making, the relationships between politicians and the civil (or local government) service ofcials, the operational managerial arrangements and the approach to internal control and budgetary and accounting information. To undertake the reform is not a simple task: it has wide-reaching efects including the arrangements for delegation, accountability and transparency. Te requirements of the reform may be in confict with traditional customs and practices and these may afect whether or not the reform can be efectively implemented.

# **1.1 The Aim of and Audience for This Guide**

Tis guide is about the development and then the practical application of the public fnancial management and internal control (PFM/IC) reform. It aims to help countries seeking to adopt PFM/IC to undertake this successfully and to avoid common pitfalls experienced by many countries which have tried to adopt PFM/IC, but ended up ultimately with only superfcial reforms. Te critical pitfall that this guide seeks to highlight and help countries avoid is the common assumption that focusing solely on the technical procedures and bureaucratic processes of introducing PFM/IC will achieve the substantive benefts of the reform. It will not! Te technical aspects of the PFM/IC reform are important but to achieve a robust reform, managerial changes will almost certainly be required. Changes to governance arrangements and transparency are also likely to be needed. Te nature of the necessary reforms may confict with traditional custom and practice with the risk that such reforms may be difcult to embed.

Unfortunately, this failure to recognise the impact upon management and traditional custom and practice has been a typical feature of fnancial management reform activities, both of PFM/IC and other PFM reforms, such as programme budgeting and accrual accounting, leading to some being described as 'fake' reforms.1 A key message of this guide is that countries should do their utmost to avoid this failure. To do that, countries should recognise that introducing PFM/IC requires a major managerial reform and it should be treated as such by senior politicians and senior appointed ofcials. Tis guide demonstrates the complexities of the reform.

Before PFM/IC is introduced, countries will have in place some form of public fnancial administration and internal control (PFA/IC). Te principal diference between the two systems is that PFA/IC has a focus on the control of fnancial *inputs*, whereas the more advanced PFM/IC has a focus not only on control of fnancial *inputs* but also upon the efcient and efective delivery of the *outputs* of public services. Tis applies equally to revenue collection arrangements, including taxation. Tis change of focus is central to improving public sector productivity. With PFM/IC the operational management2 of a public organisation has considerably more discretion over the detail of spending (and revenue collection arrangements), that is, the mix of inputs and levels of spending in order to achieve objectives (outputs) and to do so efciently and efectively, than it would with PFA/IC. Discretion is also needed when circumstances require that economies have to be made so that minimum damage occurs to existing services and activities. PFM/IC

<sup>1</sup> See an article published by the Institute for State Efectiveness in a discussion about performance and policy-based budgeting—how to spot the fakes: Andrew Laing: https://efectivestates.org/publication/ performance-and-policy-based-budgeting-how-to-spot-the-fakes/.

<sup>2</sup>Operational management is the day-to-day responsibility for the delivery of public services. In developed economy countries, operational management would be the responsibility of the civil or local government service. Te policy and strategy on which operational management is based would be the responsibility of the political management. But that policy has to be operationally realistic and that requires cooperation between the politicians and senior civil servants. However, in many developing and transition economy countries, the political management aims to undertake both sets of responsibilities.

consequently has the potential beneft of making the fnancial system more resilient by being able, through a more efective management, to utilise whatever level of resources are available in an optimum manner.

Te aim of PFM/IC is to provide the information and authority operational management requires to deliver the policies of the organisation making the best use of public resources. Tese policies will be expressed through the budget along with complementary objectives and performance standards. Te operational manager's responsibility is to deliver those policies and objectives efciently and efectively, to time and within the law and budget. Efciency and efectiveness apply equally to the utilisation of current resources (i.e., employee costs, supplies and services costs, transport costs and property costs as well as overhead costs) and to the utilisation of assets. It also means ensuring that all resources are only used for public purposes.

Tus, the aim of reform is positive, that is, focussed on achieving the outputs of a public organisation. It is not 'defensive' or alternatively negative in concept, that is, simply to impose controls and reduce fnancial misconduct or misuse, which is how some appear to treat it.3 If the objective of a government is solely to develop or strengthen defensive controls this does not require the extensive managerial reform that would be necessary with the implementation of PFM/ IC. Te techniques accompanying PFM/IC should be aimed to facilitate, not constrain, managerial discretion. Consequently, in considering this reform this guide advises that, contrary to much advice on the introduction of PFM/IC, countries should start by focussing on and addressing the managerial implications of this reform rather than considering only the technical bureaucratic features. Ultimately, no matter how 'clever' the techniques or the bureaucratic rules, without management the benefts of the reform will not be achieved.

Te purpose of this guide therefore is to enhance understanding of what a PFM/IC reform is meant to achieve, how to then apply this type of reform and the consequences for managerial arrangements. Te key argument is that PFM/IC should be seen as much a management reform, not just a technical audit or accounting reform nor just about improving fnancial and budgetary control, although if properly applied it will achieve such benefts. It will also facilitate improvements in policy development through the availability of additional information, not least about the causes of the costs of providing services (i.e., those factors that drive costs) or the costs of revenue collection and weaknesses in revenue collection policies.

Te guide is predominantly directed at countries either planning or undergoing reform, that is, developing and transition economy countries. However,

<sup>3</sup> Institute of Internal Auditors: Lines of Defence IIA Exposure document June 2019.

because PFM/IC has been widely treated as simply a technical fnancial reform, rather than a management reform even by developed economy countries, such countries which have already been through a reform process would beneft from questioning whether or not they are in practice achieving the benefts of the reform. Not the least of which are improvements in efciency and efectiveness in the delivery of public services and activities and in the utilisation of assets.

Tis guide is also aimed at development agencies who often advocate sophisticated reforms when there is little or no local managerial capacity to implement them, much less operate advanced systems. Tis author has argued elsewhere that "a fnancial reform must ft with how the state operates' and that fnancial reforms are not free standing."4 Yet such reforms are regularly promoted as technical improvements with no recognition of the managerial impact. Where countries are not prepared to make the managerial changes that the PFM/IC reform requires, the reform should not be proceeded with and instead countries should focus upon improving public fnancial administration and internal control.

Countries considering, or are in the process of implementing, the PFM/IC reform should ask themselves a series of questions which will indicate whether they have recognised the full implications of the reform and not least the managerial impact of the reform? (Table 1.1).

If these types of question have not been addressed in planning the implementation of PFM/IC, then there is a real possibility that the resulting reform will not produce the benefts that countries should be looking for and will, in all probability, simply add to costs. Terefore, countries who answer 'no' to all or most of the self-assessment questions in fgure 1, apart from those marked with a \*, should consider revisiting the reform and use this guide to help rethink and adapt how they have implemented, or intend to implement the policy and apply it.

# **1.2 Why Is Management Relevant and Important?**

Development agencies, multi- and bilateral, do often advocate advanced public fnancial management reforms because they represent 'international best practice'. Usually, they are treated as technical fnancial reforms even though

<sup>4</sup>Hepworth (2013, p. 3) cited in Public Finance and Economic Growth: S. Peterson, Routledge 2015 (p. 252).

**Table 1.1** A self-assessment questionnaire to determine if the comprehensiveness and managerial aspect of PFM/IC reform has been suffciently realised


#### **Table 1.1** (continued)


the managerial implications of the reform have been recognised

a COSO: International standards of internal control advocated by the Committee of Sponsoring Organisations (COSO). https://www.coso.org/Pages/default.aspx

they require a managerial capacity if advantage is to be taken of those reforms. Yet there may be limited or even no local managerial capacity to both sustain those reforms on an ongoing basis and achieve the benefts that those reforms make possible. Examples of such reforms include accrual accounting and programme and performance budgeting as well as PFM/IC. Any fnancial or management reform must also ft with how the state operates including its traditional customs and practices. Reforms are not free standing and will fail or become simply superfcial if the promoters of the reform do not sufciently recognise the context or the complexity of the managerial task in implementing and then delivering the reform into the future.

Te reality is that most studies, advice and reform programmes appear to treat PFM/IC reform simply as a fnancial technique. Te discussion contained in such documents makes no reference to the management implications for the utilisation of the technique. Tis fails to recognise that simply treating it as a fnancial technique completely overlooks that someone has to apply that technique if there are to be improvements in the utilisation of public resources and that better quality public services result. Tat 'someone' is the manager.

Taking a management perspective recognises that what may be construed initially as simply technical fnancial reforms actually have a signifcant managerial impact. For example, line ministry5 managers have diferent information needs so far as budgeting and accounting is concerned from a ministry of fnance; managers need clarity of objectives (both operational and performance) and performance standards to work to which can often be difcult to defne with any precision, adding to the complexity of the managerial task. Tis complexity can produce conficting objectives which in turn need to be managed. For example, what is the purpose of prison: is it retribution, incarceration, deterrence, rehabilitation or elements of all four and is it the same for all prisoners of both sexes? Managers also should be accountable, not just internally but also externally and in particular through parliamentary scrutiny. Accountability is the process that strengthens management through the consequential scrutiny activity. (Parliament may need to establish one or more specifc committees to undertake the scrutiny process.)

A misunderstanding about PFM/IC reform, particularly at the political level, is that it is simply about reducing fraudulent or corrupt activity or introducing tighter budgetary and fnancial controls. Te approach to implementation, especially in European infuenced countries, has been through focussing on the technical elements of the reform and not least on the fnancial and budgetary control elements partly because the initial PFM/IC reform activity has been on the development of internal audit. Te idea that the reform is also designed to support managers in achieving objectives efciently and efectively does not appear to be appreciated. Te management perspective has been almost entirely overlooked. Delegation and managerial accountability have been developed, at best, principally in the context of fnancial and budgetary control, not in the context of the delivery of objectives and the achievement of efciency and efectiveness.

As a result, other features, which recognise the relevance of the reform to management, such as the responsibilities of the diferent levels of management for the delivery of objectives and for achieving efciency and efectiveness have been overlooked. Consequently, the need for clarity of objectives (both operational and performance) and performance standards for managers to work to along with the specifc fnancial and performance information that

<sup>5</sup>A line ministry is a government ministry responsible for implementing a program or group of programs as opposed to one responsible for general fnance, economic management, planning and administration.

managers require have also been overlooked. Tus, managers should have available to them detailed budgetary information for the area of activity or service for which the manager is responsible; budgets should be consistent with the objectives and performance standards managers are expected to meet. Managers need authority and some degree of control over the utilisation of resources, even over what may be regarded as sensitive resources such as personnel and assets. Tis in turn requires delegated authority, that is, the ability to exercise discretion. PFM/IC requires strengthening managerial discretion. Management structures need to be so organised that they secure efective management of the diferent elements of a service or activity with mechanisms to enable managers to be held to account by more senior operational managers leading to accountability to the political management of an organisation. Tose managerial accountability arrangements have to be efective and that means that those more senior managers must respond to accountability reports. Ultimately, reporting should be to parliament as part of the government responsibility to demonstrate how budgetary resources have been used. Two forms of parliamentary scrutiny could occur, one which responds to the report of the state auditor (sometimes by establishing a committee perhaps called a 'public accounts or public audit committee') and the other which investigates the quality of the management of public resources which again can be undertaken through a parliamentary committee arrangement.

## **1.2.1 Management**

Te question then is, who is the operational manager and what is the environment in which that manager is operating? Te manager barely gets a mention in most reform strategies, because of the focus upon PFM/IC as a fnancial control technique. Neither does management training apart from the notion that somehow training in the technique will solve all problems. Yet success with this PFM/IC reform depends upon the information the manager has available and upon the capacity of the manager to use that information.

However, for public sector organisations a difculty can be determining who is the manager? Is the manager the minister or mayor or other political head of the organisation, supported by their deputies or in Francophone countries by a politically appointed cabinet? Is such a person responsible for policy development, policy implementation and operational management in the delivery of public services? Or, is there a distinction between a minister or mayor responsible for policy and strategy and a civil or local government service responsible for policy implementation and operational service management, as occurs, or should occur, in Anglophone systems? In most systems the politically appointed head will have overall responsibility for the successes and failures of the organisation but may not have day-to-day responsibility for operational management (i.e., policy implementation). In such circumstances the political head is likely to have a responsibility to supervise the quality of the operational management ensuring that it delivers the policy objectives and maintains budgetary and other controls. In many countries adopting PFM/IC, the managerial situation is quite unclear and the law often refers to the responsibility for the implementation and quality of PFM/IC as that of the 'top manager' by which is meant the political head of the organisation. As is shown later in this guide, this is not a practical arrangement with the implementation of PFM/IC unless accompanied by operational management reform.

In Anglophone systems there is, in theory, usually a clear distinction between the responsibilities of the political head of the organisation and the administrative head. Te latter should be responsible for policy delivery and operational management. Te administrative head is very often known as a permanent secretary. Permanent secretaries are the 'accounting ofcers', meaning that they are responsible for ensuring that public funds allocated to the ministry through the budget process are appropriately spent. Te permanent secretary is responsible for the application and quality of PFM/IC within the ministry. Tis ofcial can be called to account by parliament as part of the parliamentary scrutiny process. However, a constitutional convention is that a cabinet minister bears the ultimate responsibility for the actions of their ministry or department. Tis means that if an administrative failure occurs within a ministry, the minister is responsible even if the minister had no knowledge of the actions which led to that failure. In other countries this distinctiveness in the allocation of responsibilities is not so clear and the political appointee may be responsible for both policy and day-to-day operational management and this results in some countries in the minister undertaking minor administrative tasks.

A feature of the implementation of the European Commission's version of PFM/IC which is called 'public internal fnancial control' (PIFC) and which is to be applied by countries wishing to join the European Union or beneftting from its funds as neighbourhood countries is the recognition of a need for delegation and the corresponding development of accountability. Tis ought to mean the delegation of operational management responsibility from the political to the civil service (or local government service) level. But in practice because the reform is treated as a fnancial technique, delegation is usually limited to aspects of fnancial control and relatively minor administrative matters.

A manager is defned as a person responsible for controlling or administering the whole or part of an organisation or group of staf.6 Managers ought to exist at all levels in an organisation and a clear management structure should exist. Managers at diferent levels within an organisation should have diferent levels of responsibility and these will be, or ought to be, set out in delegation arrangements. Each level of management should be accountable to a higher level of management and ultimately to the top manager, whether a political fgure or an ofcial. Where operational management is the responsibility of the civil or local government service, a state secretary (or equivalent), or head of a local government service, would be the top operational manager and therefore responsible for the application of PFM/IC. Tat top operational manager should be responsible for the quality of operational management including the delivery of objectives and performance standards efciently and efectively and to time and for the control of income and expenditure to within budgetary limits. In turn that top operational manager should be responsible for the quality of operational management to the political manager.

Success with the application of PFM/IC depends very heavily upon the quality of management but changing the role and responsibilities of civil servants and local government ofcials to incorporate managerial responsibilities does not somehow automatically make them efective managers. Good quality managers in most public sectors are in short supply, and therefore, countries embarking on the PFM/IC reform should recognise that a heavy investment in management training is likely to be required. (Who is the manager is also discussed in Chap. 2.)

<sup>6</sup>Oxford English Dictionary: https://www.lexico.com/defnition/manager.

#### **1.2.2 Leadership and Organisational Culture**

Te leadership responsibility in the development and application of PFM/IC would in most countries fall upon the minister of fnance, and the responsibility of that ministry would extend to ensuring that the application of the PFM/ IC policy in individual public organisations followed the specifed policy guidance. Tere should be overall government support for the reform and head of government (prime minister or president) support as well as that of the cabinet of ministers is necessary. Parliamentary support for the reform is also essential, and this should include parliamentary approval to the reform itself and the process for implementing the reform. Parliament should also be informed periodically of implementation progress.

Overall responsibility for operational implementation leadership of PFM/ IC for the public sector should lie with the head of the civil service in the ministry of fnance (the state secretary or equivalent). Responsibility for the leadership of the operational application of the reform within each ministry or other public organisation should lie with its head of the civil or local government service under the guidance of the head of the civil service within the ministry of fnance. (In some countries there is no single civil servant who has the role of 'head' within a ministry: where this is the situation with PFM/IC this arrangement will almost certainly require change as this guide demonstrates.)

Delegation of operational management and managerial accountability are not only key features of PFM/IC but they are essential to make PFM/IC work, as this guide will show. However, for some countries the introduction of delegation and managerial accountability will represent a radical cultural change. Politicians who have traditionally been responsible for operational decisions as well as policy development and the strategy for the application of that policy may fnd such a change difcult to accommodate because it runs against traditional cultural approaches. Tis will be a factor in the extent to which PFM/IC reform is possible, and certainly, it will afect the timetable for implementation.

Tis distinction between policy development and operational management must be addressed by the political and civil service leadership responsible for the implementation of PFM/IC. Tis is because, if properly applied, PFM/IC is about the professionalisation of operational management, and a minister or mayor will fnd it impossible to remain responsible for both operational decision making and policy and strategy development. Tis is because of the demands that PFM/IC will make upon the time and skills required for efcient and efective delivery of operational objectives and performance standards. (However, efective policy development and the strategy for its application depend very heavily upon cooperation between the politician and operational management for it is the latter who has, or should have, the experience and information necessary to turn political ideas into operationally efective public services.)

Te features of PFM/IC afect the way in which an operational manager would carry out a particular task and therefore the operational manager must become familiar with them because they impact upon the achievement of objectives and improvements in efciency and efectiveness. Tey have the potential to generate public service improvements, better quality policy making (because more information should become available) and more efcient resource utilisation. However, they will not do so unless they are accompanied by a managerial capacity to take advantage of them. Failing to recognise the importance of management and simply focussing on techniques (which usually are simply defned as the international standards7 and the bureaucracy associated with those standards), which appears to be almost always how

<sup>7</sup>Te techniques which are referred to here are the fve elements of the international standards defned by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). However, to improve efciency and efectiveness much more is required and not least a more analytical approach to fnance which is demonstrated in this guide.

PFM/IC is developed, will not achieve the benefts that the reform can bring. It simply adds bureaucracy and hence costs and can have a negative efect on morale as well as upon the possibility of other future reforms if no benefts become apparent. Not recognising the managerial changes PFM/IC requires and simply focussing on these techniques will not cause public services and activities to be delivered more efciently and efectively. Yet an important objective of all PFM/IC reform is to improve service delivery, the achievement of objectives along with improved operational efciency and efectiveness and asset utilisation.

Another critical factor that is frequently overlooked in the introduction of PFM/IC reform is the extent of cultural change required within organisations. Such change is not simply about reforming the organisational structure but is also about changing human behaviour and the relationships between diferent organisations such as between a ministry of fnance and spending (line!) ministries. With PFM/IC spending ministries should have more discretion to make decisions within a context set by a central ministry such as a ministry of fnance. Tis in turn raises the question of 'trust', that is, will a central ministry 'trust' a spending ministry to utilise its resources efciently and efectively? Similarly, the delegation of operational management to the civil service requires civil servants to make decisions and consequently to take risks. Will the political level 'trust' the civil service to do that? Another feature of the reform afecting culture and behaviour is leadership. How the leader performs and the attitudes of the leader can be signifcant in the successful implementation of the reform and in its subsequent operational application.

However, in many countries there is a problem with requiring the head of the civil service in a ministry or other public organisation, to undertake the leadership role in the implementation of PFM/IC. Tis is because in many countries the law provides that the organisation leader is the top political ofcial who is directly responsible for all activity and therefore feels that he/ she must make all decisions. Tis person should have ultimate oversight of the implementation of the reform but that is diferent from having responsibility for day-to-day implementation. In countries where the operational management leader is a permanent, rather than elected, ofcial, such as a state secretary, whilst a politically appointed ofcial can infuence the culture and managerial approach of the organisation, there is a potential to maintain a continuum in the approach (although this may be 'good' or 'bad'). Political change may cause policy and strategy change, but where there is separation between responsibility for policy development and operational management, political change does not necessarily afect how operational management is conducted. Operational management needs to remain stable for successful sustainability of the reform. In addition, the requirements falling upon the top ofcial with PFM/IC are such that an elected ofcial would not have the time or the training to undertake all the managerial responsibilities that would fow from the reform.

Te cultural change that introducing PFM/IC will cause requires the support of the political leadership. Because that cultural change will cause civil servants to make managerial decisions, they will need to be prepared to take risks: all decisions involve some element of risk. Tis is a factor which will afect the willingness of civil servants to take decisions because in many countries there exists a fear of personal penalty for error of judgement or mistake or even of making a potentially controversial decision. So, in introducing PFM/IC, consideration should be given as to how these penalty arrangements will impact upon the attitude and approaches of civil servants.

Almost inevitably change induces resistance amongst some and a feeling of 'this is not how we do things here'. Again, this impacts upon operational leadership, and the question then becomes how can the operational leadership arrangements have a positive impact on the changing culture of an organisation? Such issues are rarely, if ever, considered as important to the success of PFM/IC reform. Te positive commitment of the head of operational management is essential as is management training for the diferent levels of management. Usually, any training that is provided is concerned simply with technique in terms of applying the bureaucratic requirements of PFM/IC and this is regarded as all that is necessary. Te application of a sophisticated reform such as PFM/IC requires the application of sophisticated management and a thorough review of how organisations are managed and the training available to managers. Tis applies equally to the penalty and reward structures applying to management. Management training and the impact upon human relations (HR) policies are often overlooked in the reform process with the only staf management concern being expressed is through 'training in technique'.8

<sup>8</sup>For a more extensive discussion of managerial and cultural aspects of organisational arrangements, see, for example, Management and Organisational Behaviour by Laurie J. Mullins: Pearson Education Limited 2016.

#### **1.3 Key Terms and Facets of PFM/IC Reform**

Te technical aspects of PFM reform are covered in many text books and handbooks on the subject (e.g., 'Financial Management and Control Manual'9 and PIfC10). However, they rarely, if ever, describe the critical role the manager needs to play in each of the technical areas. Tey do not discuss the role of the leader or the distinction between policy and strategy development and operational management. Tis section highlights some of the key terms and facets of PFM/IC reform that will be explored in more detail later in the guide and highlights the managerial versus the technical aspect of the function.

#### **1.3.1 The Budget**

A precondition for PFM/IC reform is that the budget provides a clear and reliable basis on which management can build the policies, strategy and objectives that an organisation aims to achieve. Te budget, as far as possible, should be consistent with the objectives (and performance standards) that an organisation is expected to achieve. Te individual managers within an organisation should be involved in the budget preparation process and agree that the objectives (and performance standards) they are expected to achieve can be delivered within that budget. Where the overriding consideration is the level of the budget, if that is insufcient in the view of the manager to deliver the objectives and performance standards, then either the objectives or the performance standards or both should be modifed to ft with budgetary availability or the budget should be adjusted to ensure that there is compatibility.

With PFM/IC the disciplines surrounding the budget should be such that manipulative activities to avoid budgetary and fnancial controls should be eliminated as far as possible. Budgetary discipline is particularly important because for managers to deliver objectives and performance standards within a specifed budget efciently and efectively adds signifcantly to the pressures upon them compared with simply ensuring that spending does not exceed a specifed budget. Tis means that ideally there should be no scope for public organisations to avoid the budgetary limitations by, for example, transferring items of expenditure between revenue and capital (or investment) budgets or by using second-level bodies such as agencies or state-owned companies to

<sup>9</sup>Published by the Ministry of Finance of Albania—and similar manuals published by other countries.

<sup>10</sup>Published privately by Robert de Koning: information and orders from: www.pifc.eu. (Tis book is a major explanation of the technical aspects of the European Commission policy on the introduction of its application of PFM/IC including internal audit.)

incur expenditure as proxies for their controlling or owning frst-level public organisations or by transferring payments between years. Again, there should be no scope for moving expenditure apparently into the private sector through 'of-balance sheet' arrangements, leasing and other similar devices11 or for using extra-budgetary funds except within very clearly specifed circumstances. Tis should extend to use of 'own funds' generated by either frst- or second-level organisations. With PFM/IC a risk is that the added pressure on managers to deliver objectives efciently and efectively may cause managers to try to avoid the impact of budgetary and fnancial controls. Tis imposes an added responsibility on ministries of fnance to ensure that budgetary and fnancial controls are rigorously observed.

Te budget also provides the key fnancial mechanism by which parliament exercises fnancial control. In addition, a question that will need to be considered is the extent to which the traditional budget, and in some countries the budget law, should be modifed to include objectives and performance indicators. PFM/IC enhances the opportunities for parliamentary scrutiny. In other words, PFM/IC potentially increases transparency and public accountability.

#### **1.3.2 Cash Management**

Budgetary control rules will be complemented by cash management rules. A ministry of fnance will want to ensure that it is not forced to borrow unnecessarily through unplanned or erratic expenditure patterns or revenue forecasts that cannot be fulflled. With PFM/IC the fows of expenditure will afect the ability of the manager to deliver efciency and efectiveness and therefore managers should be consulted about cash fow calculations and they should not simply be determined by the interests of the ministry of fnance.

With PFM/IC the operational management will have much greater scope for decision making than they would with PFA/IC. Tis includes having automatic authority to spend (subject to any overriding or specifc constraints) with only managerial approvals as necessary within their organisation but without further ministry of fnance approval. Managers must also respond to changing circumstances especially as they will be expected to deliver objectives and this could afect the traditional arrangements for the approval of budgetary variations (virement). All of this should afect attitudes to cash management controls which in practice will mean that such controls should become more strategic rather than detailed.

<sup>11</sup> See, in particular, IMF Working Paper /15/238: Defning the Government's Debt and Defcit: Timothy Irwin.

#### **1.3.3 Management Accounting**

Managing the budget of a public organisation to deliver objectives to time, to standard, efciently and efectively is no simple task and it requires highly trained and fnancially aware managers. Te operational manager needs to understand what causes costs to be what they are, that is, what drives costs, and which parts of the organisation are operating efciently and efectively and which are not. Tis is a contrast with administering a budget within the context of a PFA/IC regime where the administrator's task is much more limited to ensuring compliance with the ministry of fnance external controls. What this also means is that both budgets and fnancial information need to be allocated in accordance with the needs of the manager, not solely in accordance with the needs of the ministry of fnance.

Te development of management accounting therefore should be a feature of this reform. Management accounting responds to a manager's requirement not only for diferent budgetary and fnancial information for efective management from that required by a ministry of fnance, which has diferent interests from the manager. What are also required are systems which deliver performance information and which need to be linked to the management accounting system. Tis linkage should afect the construction of the budget as well as the type of fnancial analysis the manager should require. Te form of analysis that suits a ministry of fnance is rarely likely to meet the needs of the manager, especially where the manager is responsible for delivering efciency and efectiveness and service quality. Tis involves a challenge to the traditional practices and controls exercised by a ministry of fnance. It also requires the development within public organisations, other than a ministry of fnance, of more sophisticated fnancial analytical systems and the capacity of organisational fnancial analysts and managers to utilise those systems. Tis in turn raises questions about the capacity of fnance ofcers within organisations. Do they have the training to provide the information that managers require? Tese requirements are not simply those of fnancial controller and bookkeeper12 but managers will require fnancial analytical information and that a capacity exists to provide advice and support including over the implementation of policy, the strategy for the implementation of that policy as well as over the development and implementation of investment projects. Tese are not skills that are readily available within governments and require the

<sup>12</sup>*A bookkeeper* records the fnancial transactions of an organisation, and the fnancial controller role in public organisations in transition and developing economy countries usually includes ensuring that such transactions are within budget and comply with the relevant fnancial regulations and meet legal requirements.

employment of professional, that is, more expensive, staf. A question then is how are such skilled persons to be recruited, used and integrated into existing career structures? Integration is important because such skilled professionals need to become 'part of the team' and not perceived as 'outsiders'.

## **1.3.4 Control**

Te term 'control' has a wide range of meanings. Tese can range from 'prohibit' to 'manipulate', and within this range there are two major themes. First, there is the idea of control as 'domination'. Secondly there is the idea of control as 'regulation'.13 Both meanings can exist within the use of the term in the PFM/IC management arrangements.

Advisers and others promoting PFM/IC sometimes talk about 'control' in terms of 'lines of defence' focussing on ensuring that public resources and assets are not misused through fraud or corrupt activity.14 Tis often occurs where internal audit has been developed before PFM/IC and the 'policy focus' is dominated by internal audit concerns. Tis is quite appropriate if the only concern is fnancial and budgetary control which leads to a robust public fnancial administration. But the result is not fnancial management. It also makes the mistake of focussing control on adherence to procedures and budgetary compliance not recognising that bringing together public fnancial management and internal control broadens the meaning of internal control to include the management controls necessary to secure the achievement of objectives and to do so to time, to standard, within budget, efciently and efectively. Te issue for management is how to 'control' (a better term might be 'steer') the organisation to ensure that it delivers its objectives and at the same time makes the best use of resources. Tis is not about defence. Tis is achieved by deciding upon the best strategy that will achieve success and that strategy will depend upon how best to utilise all the resources that a government has available for a specifc purpose and how to do so efciently and efectively. Delivery of that strategy depends upon the quality of management and that is why the focus of PFM/IC is upon 'management' and its ability to achieve its objectives. Merely thinking about control in terms of 'defence' will not achieve that.

<sup>13</sup>Accounting controls in perspective: Emmanuel and Otley: Explorations in fnancial control (p. 129). Editors Lapsley and Wilson 1997.

<sup>14</sup> See, for example, Institute of Internal Auditors (IIA) exposure document June 2019 and subsequent updates. https://global.theiia.org.

#### **1.3.5 External and Internal Control**

Te development of PFM/IC has the consequence that detailed fnancial and budgetary control shifts from external control to internal control. Tis means that instead of an external organisation such as a ministry of fnance or a state auditor or some other external body, that is, external to the ministry or other public organisation, approving expenditure and ensuring that spending does not exceed approved budgets or that personnel appointments and procurement arrangements conformed with externally set regulations, such controls would be exercised by the management of the public organisation itself. Tis is characteristic of moving from an administrative style of public service organisation to a managerial style. Tus, the organisation management would act as the controller, albeit exercising that control according to centrally agreed rules and it would be accountable for how it had applied those rules. Te beneft of this is that it facilitates the exercise of discretion by the management of an organisation and therefore creates the opportunity to improve efciency and efectiveness in the utilisation of public resources. Tis element of the reform is counterbalanced by enhanced arrangements for managerial accountability. Professor Allen Schick argued in 1978 in an article on Contemporary Problems in Financial Control15 that the evolution from external to internal control was a 'sea change' in fnancial systems, that is, "Internal control is much more than a procedural matter. It represents a fundamental shift in attitude about government. In an era of big activist government, internal control signifes that public agencies can police themselves, that it is much more important to get on with the job than to worry about preventing the misuse of funds." Terefore, where a country wishes to implement PFM/IC it does need to ask itself this question: Given the growth in the scale of public services with the growing demand for more and better quality services can we continue to administer those services in the same manner that we have always done and still achieve the objectives of public expenditure, or do we need to rethink the administrative arrangements? Te substantive introduction of PFM/IC, that is, with a managerial perspective, raises this question. It also adds to this question by asking, what is the purpose of the control? Is it simply budgetary and fnancial control to maintain a traditional and tight control to meet the particular needs of the ministry of fnance (and other central ministries) or should the control refect not just those needs but also those of the manager required to help the manager achieve objectives and performance

<sup>15</sup>Public Administration Review, Vol. 38, No. 6 (Nov.–Dec., 1978), pp. 513–519. Published by Wiley on behalf of the American Society for Public Administration.

standards? Managerial control needs are likely to be diferent from those of a ministry of fnance because a line manager may require greater fexibility in the management of budgets in order to deliver objectives and to make improvements to efciency and efectiveness: a ministry of fnance is in no position to do either of these. To reconcile the 'control' interests of a ministry of fnance and a manager, a necessary parallel reform should be to establish a diferent approach to the external control framework of regulations and guidance so that it focuses on strategic issues rather than on the detail. Reform also needs to occur to the budgeting and accounting arrangements. Such a reform would allow budgetary and accounting information to be analysed in a manner that suits two sets of needs, that is, those of the manager and the ministry of fnance. No longer should a ministry of fnance have a monopoly on how such information should be presented. Tis will require the development of more sophisticated data analytical arrangements.

Another feature of efective management is how well managers cope with austerity. Periods of austerity are almost inevitable and the challenge for managers in such circumstances is how then to continue with the highest possible level of service delivery. It is not simply a matter of 'cuts' but of prioritising services, seeking out inefciencies, disposing of underused or surplus assets and rethinking how services can be delivered within a constrained fnancial envelope. Again, line ministry managers are more likely to be efective in managing austerity at the individual service level than the ministry of fnance, emphasising again the signifcance of internal control being exercised by the organisation management.

Whether or not such a change from external to internal control could or should occur or be achieved depends upon the quality of the existing public administration arrangements. It also depends upon the level of trust that exists between the political and the ofcial levels of the public administration and between a ministry of fnance and other central ministries and line ministries and other public organisations. In some countries, such trust does not exist and results in the politicisation of the civil or local government administration with a reluctance to ofer any concessions on control by central ministries. Tis lack of trust, in turn, encourages elected ofcials to see their role as including that of operational management, sometimes at a very detailed level.

'Trust', which needs to exist at all levels, is not just trust that 'inputs' are controlled but that the 'outputs' meet expectations compared with those 'inputs'. Tose expectations though need to be explicit rather than implicit. 'Trust' is a product of the professionalism of the management.

Another factor is that central ministries may also be very reluctant to lose their powers to exercise detailed control. An example of central ministries wanting to maintain central control is that given by De Geyndt referring to devolution of responsibility to hospital management in low- and middleincome countries with the aim of making their hospitals more performing, that is:

Policies granting autonomy to public hospitals have had limited success. In all cases Boards of Directors have been created. Governance of autonomized hospitals by Boards however is obstructed by the resistance of central level entities to have their authority diminished. Te Ministry of Finance tends to maintain control over revenues and expenditures. Te Public Service Commission resists abdicating its role to hire, promote, transfer and dismiss government employees. Te Ministry of Health attempts to keep its authority to appoint hospital staf, procure medical supplies and equipment; it may do so directly or indirectly by selecting and appointing Board members. Management information systems continue to collect activity measures to be aggregated at the national level for statistical purposes and do not provide fnancial and clinical data useful for decision making by the Boards and by senior management.16

Also attempts to establish sophisticated systems of public fnancial management, including PFM/IC, when existing systems of public fnancial administration are weak, are mistaken. Examples of public fnancial management reform failures are given in a research study 'Evaluation of Public Financial Management Reform'.17

Weakness in public fnancial administration is identifed by extensive levels of corruption and fraud, weak budgetary and fnancial controls or poor application of such controls, by lack of trained and experienced civil or local government staf and by instability in stafng arrangements, often demonstrated by political interference in operational management because of a lack of trust. Tis in turn prevents the development of the ideas of 'delegation' and 'managerial accountability', both of which are essential to the establishment of PFM/IC and management more generally. In such circumstances introducing sophisticated systems which, if they are to work, means giving more discretion to individuals without a strengthening of accountability. Tis will only exacerbate current problems, not lead to their solution. Tis point about building quality before switching from external to internal control has been made by Stephen Peterson in his book on the lessons from Ethiopia's 12-year reform18

<sup>16</sup> Social Science and Medicine 2017, Pgs. 74–80, De Geyndt: journal homepage: www.elsevier.com/ locate/socscimed.

<sup>17</sup>OECD, published by Swedish International Development Agency (SIDA) 2012.

<sup>18</sup>Public Finance and Economic Growth: S. Peterson. Routledge, 2015, p. 254.

"A coherent fnancial reform requires an alignment of the *purpose* of the fnancial reform, building fnancial administration or management, with the operation of the state, administration or management. A principal and possibly key reason that fnancial reforms have failed in developing countries, especially Africa, has been the attempt to insert fnancial management into states that have weak administration." As Professor Peterson says, "How can you build a sophisticated fnancial management system onto a weak public administration system?"

# **1.4 Implementing Reform from a Management Perspective**

Looking at the implementation of PFM/IC from a management perspective this raises a specifc set of issues that need to be considered. Tese are discussed in the following sections.

Tese are questions that the top management (ministerial and state secretary or equivalent in local government) together ought to be asking and they involve cooperation between political and operational management. Tey apply equally to both expenditure and income.


Te order of the importance of each of these questions and which element of management has the most interest in them lies with the circumstances that prevail in each country seeking to introduce PFM/IC. Failure to approach this reform in this manner will afect its success. In answering these questions, the top management, both political and ofcial, also need to ensure that the culture prevailing in the organisation is one that is focussed upon the interests of the user of public services; that those to whom authority is delegated are prepared to accept the conditions of delegation and accountability and that the operational environment enables them to do so. Te public interest should be paramount.

Tese managerial elements of the reform process are not addressed just by the technicalities of PFM/IC. Tey need to be addressed as part of the processes of a public administration reform leading to a focus on management. (Te relationship between the PFM/IC reform and public administration reform is discussed in Chap. 14.) Tat such a public administration reform should occur and ideally precede a PFM/IC reform is essential as part of the preparation for the introduction of PFM/IC. A PFM/IC reform cannot be used to drive managerial reform: managerial reform needs to come frst. As the PFM/IC reform requires a high degree of managerial skill the reform should not be entered into without a full appreciation of what will be required in terms of managerial capability as well as the extent of the technical reforms that will be required.

If the argument is that the civil service/local government service does not have that capability, this in fact raises the whole question as to whether a PFM/IC reform is appropriate anyway. Introducing the PFM/IC reform without civil and local government service reform, unless it already has a managerial capacity, is a mistake. A consequence, if the reform is to go ahead, is that the reform will take much longer to implement with the risk, even likelihood, that the benefts will not be achieved. However, the reality is that this is what frequently occurs. (Personnel development is discussed in Chap. 14.)

Planning the implementation of PFM/IC, as is shown above and in later chapters of this guide, should recognise that there are a series of important strands that need to be addressed to accommodate both the managerial and fnancial changes that accompany the reform. Tese include


Because PFM/IC represents such a radical managerial change the cultural environment in which decisions are made also needs to change because this creates new risks. Tis is addressed in Chap. 6.

A crucial element of this reform should be to create a civil and local government service that has a capacity to advise ministers (and mayors) on policy issues based upon their experience of operational management and to deliver public services efciently and efectively within budgetary and legal specifcations and the politically determined policies.

Also, citizens want to see that public funds (their funds!) are well spent and that legal and regulatory rules are adhered to. Managers and policy makers do not have a monopoly of wisdom over decisions about service levels and there is an increasing trend to encourage public participation in decision making processes including in the budget process. Te benefts have been summarised in this way:

Good public participation practices can help governments be more accountable and responsive to their communities, and can also improve the public's perception of governmental performance and the value the public receives from their government. Transparency is a core value of governmental budgeting. Developing a transparent budget process will improve the government's credibility and trust within the community.19

Te solution to public sector problems frequently requires reliance on several public organisations coordinating their activities. It may also require coordination with private organisations. A single organisation thinking that it can alone solve a social or other form of public problem (such as the alleviation of homelessness), that is, a silo mentality approach, can be mistaken. Yet very often individual ministries are allocated specifc responsibility even

<sup>19</sup>https://www.gfoa.org/materials/public-engagement-in-the-budget-process.

though an efective solution depends very heavily upon utilising the resources and expertise of other organisations. A feature of PFM/IC is information and coordination and that just does not mean within an organisation but more widely. Tis again is a management responsibility and is not simply addressed by thinking only in terms of budgetary and fnancial control within a single organisation. Management needs to consider this wider dimension in preparing budgets and in the form of the accounting and performance arrangements that will be necessary to enable managers to maintain control and determine how well they are achieving their objectives and very often in cooperation with managers from other organisations. Tis again raises the question of how such operational service coordination that can be required over time can be best achieved. Tat coordination may be essential in considering how to achieve efciency and efectiveness.

However, preventing the development of a 'silo mentality' can be extremely difcult. Programme budgeting is in theory a solution to this problem but programmes are frequently just focussed on individual ministries with line ministry managers reluctant to share budgets with other organisations.20 A ministry of fnance can exercise pressure to encourage budget sharing but, in practice, to be successful a cabinet decision led by the prime minister (or in some countries by a president) with parliamentary support may be essential.

#### **1.4.1 Longer Term Public Financial Management**

In many countries, whether operational management is the responsibility of political or civil service ofcials, public services and activities are not *managed* but are *administered* in accordance with traditional practice. Tis means that the focus of fnancially based control is on spending the items of the current year's line-item budget with little or no regard to the longer term even where medium term budgeting exists. Also, no practical regard is had to how to improve efciency and efectiveness as part of the administrative arrangements even though often budgetary announcements may be coupled with expressions of intent to make such improvements in public service delivery. However, most public sector objectives along with improvements in efciency and efectiveness cannot be achieved within a single year or even a mediumterm time horizon of a three- or four-year budgetary period. Efective management of public services requires that regard should be had to the longer term time horizon over which objectives may be achieved along with

<sup>20</sup>A senior UK civil servant once informed this author that she would not be prepared to advise her minster to agree to any sharing of the budget.

improvements in efciency and efectiveness. Tis is not about multi-year budgeting but is about establishing a longer term fnancial perspective of the costs of implementing public policy in providing particular services. Tat longer term fnancial perspective is necessary for a better quality of budgeting. Tat fnancial perspective is likely to reach beyond the conventional three- or four-year period of medium-term budgeting. Longer term budgeting is also not a simple projection forward of existing budgets and allowing for infation. It needs much more extensive analysis. Efective management requires that an organisation has a capacity to prepare long-term fnancial forecasts refecting all circumstances such as the ongoing future costs of current policies and investments as well as the factors that are likely to afect those future costs and the ongoing fnancial resilience of the organisation. Tese other factors would include the fnancial impacts of, for example, changes in the population, legislation, technology, in the environment, including climate change and so on. Only then can management prepare longer term service plans where the impact of potential 'shocks', such as budgetary limitations, on service delivery can be properly assessed. If such longer term analyses are not made, those responsible for service delivery can then be forced into short-term 'service cuts' to accommodate unforeseen events which are almost inevitably uneconomic and damaging to service delivery. Longer term fnancial forecasting, which may cover any period from three to ten years (depending upon the service concerned such as its capital intensiveness) is an important factor in achieving greater efciency and efectiveness in service delivery and is an important element in the development of PFM/IC. Again, this is frequently overlooked in its implementation or if forecasting is attempted it is treated as a token type of exercise.

Another feature of longer term public fnancial management is the longterm fnancial resilience of a public organisation. Political management should be advised by the civil or local government service against making policy or investment decisions which are unlikely to be capable of being fnanced over the longer term. Tat way leads to a lack of fnancial resilience or an inability to continue with the present patterns and standards of service delivery or, for say a local government. an inability to remain solvent. (Te fnancial perspective of a state secretary (or equivalent) is always likely to be longer than that of a politically appointed ofcial and this should be refected in how a state secretary considers the fnancial viability of an organisation.)

#### **1.4.2 Ownership of the PFM/IC Reform and Stability in the Reform Process**

Another factor which is frequently not considered is the ownership of the PFM/IC reform and stability within that ownership. Tis is also an element in the cultural issues that were referred to earlier. 'Ownership' raises the question, whose reform is it and that in turn afects its acceptability? Is it an externally imposed reform as part of a fnancial aid package (bearing in mind that the motives of the providers of fnancial aid packages are not necessarily the same as those of the recipient government)? Or, as for European countries, is adoption of the reform a condition of membership of the European Union? Is it a reform wholly embraced by the government itself or only by the ministry of fnance? Within individual government organisations the question becomes, is it a reform that a ministry or local government itself wishes to see implemented or is it to be imposed by an external organisation such as the ministry of fnance. And within that as the reform is applied who becomes the 'owner' within individual organisations?

Tere is also the question of the overall owner within a government. Usually this is the minister of fnance but whether this is a sufciently high level of ownership depends upon the status and experience of the minister of fnance and of the ministry of fnance. If that minister does not have a high status within the government, to be successful the overall owner might have to be the prime minister, whose support is essential anyway. High-level ownership is essential to successful implementation.

Externally imposed reforms have much less chance of being successful in the longer term, especially where the benefts cannot be perceived. Tis is because they are lost in the bureaucratic arrangements which often occur with such reforms (not least with public fnancial management reforms). Equally, even if reforms are externally imposed, there does need to be a 'local owner' and leader who is sponsor of the reform within the organisation. Te question then is who is that to be? Tis in turn raises the question of consistency. If the 'owner' or leader changes frequently, as is possible when the owner or leader is a political appointee, can consistency of policy be maintained and maintained continuously? At the individual public organisation level, such as line ministries and local governments, ownership ought to lie jointly with the political leadership and the civil service or local government ofcial leadership. Civil service or local government ownership is essential where operational management is their responsibility. Te technical aspects of PFM/IC do require considerable technical knowledge and the owner must also have considerable persuasive powers to secure implementation within large and complex organisations (as ministries and larger local governments are).

Similarly, a minister of fnance or the state secretary within that ministry will need to persuade key ofcials within the ministry to accept the implications of the reform for that ministry. For example, the head of the budget department will need to be persuaded that the budgetary arrangements should be redesigned to meet the needs of the manager as well as those of the ministry of fnance and similarly with fnancial information. Again, persuading the department or ministry responsible for personnel to recognise the need to allocate personnel costs in a manner which promotes efective management may also prove difcult. Also, persuading those responsible for determining salary structures to recognise the enhanced role of the head of fnance and fnance department staf and hence to attract appropriately trained and skilled personnel may prove difcult. (Not the least of these reasons for difculty will be that they upset traditional arrangements.)

Achieving 'ownership' and its continuity are among the most signifcant challenges to be faced by those responsible for the application of this reform, yet they are usually never considered where the reform is treated as a technical bureaucratic reform ignoring all these managerial and cultural implications. Or where the pressure for reform comes from external organisations such as providers of aid, the driver of implementation is likely to be the donor rather than an 'internal' owner. Neither of these approaches will lead to success in terms of achieving the benefts of the reform.

## **1.4.3 Corporate Governance (or 'Good Governance')**

Corporate governance is rarely considered in the process of introducing PFM/ IC. Tis is even though an essential feature of the reform is promoting good governance, including transparency and accountability. Corporate governance has been defned as being about the way in which public organisations are directed and controlled. Te design of the structures of governance within organisations and not least between political and appointed ofcials and between frst- and second-level organisations should have regard to the requirements of corporate governance. A failure in such relationships can lead to serious adverse consequences.21

<sup>21</sup>A recent example of such consequences was described in a report on the fnancial problems of Croydon Council, a UK local authority. Te Penn report 2023 | Croydon Council, www.croydon.gov.uk.

#### **1 Changing from Financial Control to Financial Management…**

Accountability is an important feature of corporate governance and associated with accountability is transparency. Transparency is a key factor in developing 'trust'. Tere are two elements to accountability. One is internal accountability. A need for operational management accountability as an essential element of the PFM/IC reform is widely accepted. It should demonstrate how efciently and efectively objectives and performance standards have been delivered to the senior and top management of an organisation. A second is accountability to external interests, that is, external to organisations such as parliament, to the service user and taxpayer, that is to civil society. External accountability, particularly to parliament, has been referred to earlier in this chapter but is usually not considered in PFM/IC reform proposals. A fear appears to be that external accountability exposes governments to criticism and risk. Yet, transparency and accountability enhance the benefts from the implementation of PFM/IC as the following quotation demonstrates: "International experience, from research, … show(s) that there is a strong positive correlation between accountable and transparent political and economic institutions and the sustainability of the development outcomes."22

Corporate governance should be therefore a factor that the government, the minister of fnance and ministers and mayors as well as senior civil service and local government ofcials should take into account and incorporate into guidance on the application of PFM/IC.

PFM/IC, if properly implemented, improves the quality of governance because it makes clearer who is responsible for what. It also causes the distribution of responsibilities through the introduction of delegation accompanied by managerial accountability arrangements, so that those responsibilities are no longer focussed wholly upon a single or very few senior, usually political, ofcials. Because PFM/IC encourages the separation of policy decision making and the strategy for implementing those policy decisions from the actual execution and operational decision making, it gives to top and senior management more time to focus on strategy and policy and hence potentially improve the quality. It also potentially allows operational decision making to occur at the level of an experienced operational management. Tis is because through delegation, operational decisions are more likely to be made by persons (civil or local government ofcials) who should have longer operational experience of a service or activity than elected ofcials whose tenure in ofce can be limited and often they will have no practical experience in the delivery

<sup>22</sup>Keynote Address: Transparency and Public Accountability is at the Core of Good Corporate Governance: Dr. Idah Pswarayi-Riddihough, World Bank Country Director for Sri Lanka and the Maldives: April 2018: https://www.worldbank.org**/**en/news/speech/2018/04/10/keynote-address**-**transparency**.**

of the service or activity for which they are responsible. Separation of operational decision making also allows operational decision makers to focus on the operational considerations rather than being infuenced by political considerations, although such considerations may infuence operational decisions.

Governance also includes the arrangements put in place to ensure that the intended outcomes for stakeholders, who could include service users, taxpayers and other interested parties (i.e., civil society), are defned and achieved.

An international framework23 describes the fundamental function of good governance in the public sector as being to ensure that public organisations achieve their intended outcomes while always acting in the public interest. Tis framework further defnes what acting in the public interest means, that is:

Acting in the public interest requires:

A. Behaving with integrity, demonstrating strong commitment to ethical values, and respecting the rule of law.

B. Ensuring openness and comprehensive stakeholder engagement.

In addition to the overarching requirements for acting in the public interest in principles A and B, achieving good governance in the public sector also requires efective arrangements for:

C. Defning outcomes in terms of sustainable economic, social and environmental benefts.

D. Determining the interventions necessary to optimise the achievement of the intended outcomes.

E. Developing the entity's capacity, including the capability of its leadership and the individuals within it.

F. Managing risks and performance through robust internal control and strong public fnancial management.

G. Implementing good practices in transparency, reporting and audit, to deliver efective accountability.

## **1.4.4 The Timing of the Reform**

Because introducing PFM/IC is a major reform, there is no 'quick fx' such as simply introducing a law specifying what is to be done coupled with the introduction of a series of additional bureaucratic procedures. Te introduction of PFM/IC will take a considerable period of time to implement across a public

<sup>23</sup> International Framework: Good Governance in the Public Sector: IFAC: CIPFA (2014).

sector, maybe 10–15 years24 or more, although where there is a decentralised state each with a regional government implementation is likely to take longer. Not only within this period will the techniques associated with PFM/IC need to be implemented, including the extended fnancial and performance information systems, but also and fundamentally the managerial changes that will be required, including the inculcation of managerial skills. Tis will require the development and/or employment of skilled managers and in some countries a refocusing of elected ofcial interests away from day-to-day administrative and operational arrangements towards the development of policy and strategy together with an oversight responsibility for operational management activity.

Indeed, introducing PFM/IC is really an ongoing reform as experience is gained and new ideas emerge. What is important in the frst stage in the implementation of PFM/IC is to put in place the basic elements of this reform, that is:


<sup>24</sup>Comprehensive reform programmes usually have a time perspective of 10–15 years. Tis will allow capacity development measures to start at the earliest stage of reform planning without necessarily delaying the reform work. However, in practice, there may be a confict between this view and the desire of certain donors and government to start implementation at the earliest possible date without providing scope for capacity development. Te result may be the early production of reform plans that can be characterised as shopping lists rather than reform eforts. Tere will be a need for a strategy on when and how to use technical assistance and also to liaise with and incorporate ongoing reform eforts in order not to waste knowledge and lose momentum. Public Finance Management in Development Co-operation—A Handbook for SIDA Staf 2007 para 6.3.1.


Only towards the end of this schedule of activity would it be appropriate to seek to introduce the bureaucratic elements associated with the reform such as the fve elements of international best practice bureaucratic (i.e., COSO) requirements (see Chap. 11). What PFM/IC is *NOT* about is simply introducing those fve elements. Yet this has been the focus of much reform activity, especially in countries joining or aiming to join the European Union and then seeing this as the starting point for the reform. Tese practices are important but they are only facilitators and what matters is the quality of leadership and management and how management utilises the information becoming available from those practices. In other words, these are techniques for management to utilise.

Because of the length of time that the reform will take to implement, there is a risk of 'reform fatigue'. Terefore, a staging process should be developed where key milestones are established with progress measured against those milestones.

# **1.5 Applying This Reform**

Applying this reform will be complex as well as requiring a long-term time horizon. Set out below is a summary of the key practical issues that need to be taken into account.

## **1.5.1 The Practical Consequences of the PFM/IC Reform**

Tis section brings together issues that have been referred to earlier in this chapter. As has been shown the consequences of applying the reform extend well beyond introducing the various bureaucratic requirements because of the signifcant managerial implications and the impact upon budgeting and accounting arrangements. (A detailed summary of the impacts of the reform, which are very wide-ranging, is given in the annex to this chapter.) However, a key preliminary condition before countries should adopt PFM/IC is that their present public fnancial administration/fnancial control arrangements are robust. Tis means that fraud and corruption have limited efects; that very importantly a robust system of fnancial control exists and consequently that budgets are well managed. If this is not the situation, then a preliminary reform should be to ensure that the present arrangements for public fnancial administration are reformed to make them robust and that manipulation of the public fnances does not occur through any systematic abuse of the control system. Examples of the latter have been given earlier in this chapter. Why the existence of a robust control is so essential is that a key feature of PFM/IC is the development of managerial discretion and delegation with the transfer of control responsibility from an external control by a ministry of fnance to an internal control by an organisation itself. Te quality of internal control then becomes primarily the responsibility of the management of each public organisation.

Another key practical, and in some countries controversial, consequence of the reform is the delegation of operational management from the political level of management to the ofcial civil service or local government service level. For some countries this will be a signifcant change of approach and will require change to organisational structures. Tese will, in efect, be demanded by the practicalities of establishing a professionalised approach to the management of the delivery of public services. Tis will have major consequences for how civil and local government service ofcials are trained as well as how accountability arrangements evolve between the ofcial and political levels of management. However, the reality is that not all operational management decisions need to be delegated and there will be some circumstances where delegation is inappropriate. (In Chap. 14 a discussion is included about where and where not delegation is appropriate.) A major advantage of delegation is that it creates a more informed civil (and local government) service. Tis is potentially to the signifcant advantage of the politician in the formulation of policy where cooperation between the political and operational managerial levels is highly desirable.

Because managers will require diferent budgetary and fnancial information for efective management from a ministry of fnance, this will potentially expose diferences between a ministry of fnance budget department and line ministry managers. Tis could be a source of resistance and tension. Te manager also requires performance information. Finance and performance need to be linked and this linkage should afect the construction of the budget as well as the type of fnancial analysis the manager should require. Again, this is a potential source of tension between the manager and the ministry of fnance budget and fnancial accounting (sometimes called treasury) departments. As has been pointed out earlier, the form of analysis that suits a ministry of fnance is rarely likely to meet the needs of the manager, especially where the manager is responsible for delivering objectives and performance standards efciently and efectively as well as service quality. Tis involves a challenge to the traditional practices and controls exercised by a ministry of fnance. It also requires the development within public organisations, other than a ministry of fnance, of more sophisticated fnancial analytical systems (i.e., management accounting) with the development of the capacity of managers to utilise those systems. Tis also raises questions about the capacity of fnance ofcers within organisations. Do they have the training to provide the information that managers require including advice about the development and strategy for the implementation of policy? Tey also need the analytical skills to identify those factors which impact upon efciency and efectiveness. Te question then is how are such skilled persons to be trained, recruited, used, retained and integrated into existing career structures? Tese are not skills that are readily available within governments and require the employment of professional, that is, more expensive, staf. Tose responsible for implementing PFM/IC need to address such questions.

Also required will be performance information systems. Tese must be robust, relevant to the needs of the manager but subject to independent control so that the manager is not able to manipulate the information fowing from those systems and in that way demonstrate a better performance than is actually occurring.

A managerial responsibility with PFM/IC is to deliver an objective to time, to standard, within budget, efciently and efectively. Tis is a far more difcult task than a simple requirement to ensure that expenditure does not exceed a prescribed budgetary limit. Tis demands a skill and expertise that requires development, and this in itself will mean that PFM/IC cannot be introduced without managerial change and then over a period of time as experience is gained. PFM/IC establishes a need for a high quality of managerial skill. Consequently, the reform should not be entered into without a full appreciation of what will be required in terms of managerial capability as well as the extent of the technical reforms that will be required. Tis therefore means thinking about how such managerial staf will be trained and/or recruited and retained. Are there, for example, to be negotiations with a university to provide appropriate managerial courses, and if there is not a capability to provide such courses, then how are they to be developed?

#### **1.5.2 How Will the Existing Political and Operational Management React in Practice to Advanced Public Financial Management Reforms?**

Where advanced public fnancial management reforms are to be introduced, reformers need to address how operational management is likely to respond to such reforms. Tis determines how efective they are likely to be. Mellett et al. (2007) have pointed out that in the example of the application of accrual accounting in the United Kingdom's National Health Service, which has a sophisticated management, managers did not in fact utilise accrual accounting information.25 Similarly, in a review of three decades of public sector reform in the United Kingdom, Christopher Hood and Ruth Dixon concluded: "As to reform making the Government Work Better and Cost Less there has been No Change."26

Again, with the introduction of another technical reform, programme budgeting, although there are diferent approaches (analytic and managerial), a study in 2012 by the Korea Institute of Public Finance and the World Bank pointed out that even though "experience in some … countries have shown that programs need to have clearly designated 'owners' with responsibility for the performance of each program. In practice, more than one 'owner' for a program means that resource allocation usually remains unresolved among the diferent owners, which defes one of the most important rationales for program budgeting. Furthermore, in such cases, it has proven extremely diffcult to assess the individual performance of the 'owners' involved." Tis study also identifed that "a program inherently is a broader category of expenditure than an activity; hence, switching to a program structure inevitably enlarges the capacity of managers to decide how operating resources are used."27 Te questions that this raises include is there the managerial capacity to support a programme approach and are the budgetary and accounting systems capable of adapting to the managerial requirements of a programmatic approach?

<sup>25</sup>NHS Resource Accounting in Wales: Problems of Implementation: Mellet et al. (2007).

<sup>26</sup>A Government that Worked Better and Costs Less? Evaluating Tree Decades of Reform and Change in UK Central Government. Oxford University Press. Hood and Dixon (2015, Table 9.2, p. 182).

<sup>27</sup>From Line-item to Program Budgeting Global Lessons and the Korean Case 2012. Edited by John M. Kim: Korea Institute of Public Finance and the World Bank: pages 21/22.

Another example illustrating the reaction to advanced fnancial management reforms where either strong coordination/support with local management did not occur or was inadequate or the purpose of the reforms was not fully understood has been described in a study investigating the implementation of public sector accounting reforms in Egypt, Nepal and Sri Lanka. Tis study described the factors that afected implementation resulting in "resistance, internal conficts and unintended consequences, including the fabrication of results, in all three countries without any evidence of yielding better results for public sector and accountability."28

Tese examples emphasise the need for much greater consideration to be given by advocates of PFM reforms to the impact upon organisational cultures, management and leadership arrangements. How are managers to be encouraged to support the reform and to make use of the reform information for practical managerial purposes? From a PFM/IC perspective, unless this occurs the benefts will not materialise. For example, whilst the opportunity will emerge to improve efciency and efectiveness it will only happen if the manager wants to do so and utilises the information that becomes available. Te role of the leadership of the organisation (political and senior ofcial) is to encourage the operational manager in this approach and to create the environment that accepts this as 'normal and expected' behaviour.

# **1.6 Individual Governments and This Reform**

Each government wishing to introduce PFM/IC will need to make some adaptations to what is described in this guide in order to refect their own administrative, legal and cultural backgrounds. However, in making any such adaptations those responsible for the reform should not move away from the principle that this reform must require a management capability to be efective. Financial management and internal control *are* a managerial responsibility. In other words, governments should not treat this reform as simply a reform designed to further tighten fnancial and budgetary controls. Tough there are exceptions—some glaringly so—most countries already have tight budgetary and fnancial controls. Tese controls are often achieved in theory by systems/techniques (e.g., IT-based treasury fnancial accounting systems). Where weaknesses exist, the source of those

<sup>28</sup>Unintended Consequences in Implementing Public Sector Accounting Reforms in Emerging Economies: Evidence from Egypt, Nepal and Sri Lanka: Adhikari, Kuruppu, Ouda, Grossi, Ambalangodage: International Review of Administrative Sciences October 2019.

weaknesses is usually a management failure in one form or another. What are also frequently lacking in countries adopting PFM/IC reform are objectives and performance standards along with those controls designed to achieve those objectives and performance standards. Tis is frmly a managerial responsibility, and this reform is designed to remedy that. Another defciency is a lack of substantive measures to improve efciency and efectiveness. Another commentator on management, Peter Drucker, defned efectiveness as 'doing the right thing' and efciency as 'doing the right thing right': this is succinct and illuminating.29 Whilst the terms efciency and efectiveness are used frequently, in many countries they are not supported by substantive measures to identify how efciency and efectiveness can actually be improved. Te PFM/IC reform, if properly defned and applied, will address this and make such improvements possible, providing managers are prepared to take the necessary actions, that is, again a management issue.

PFM/IC adds signifcantly to the day-to-day responsibilities of operational managers. Tis is because there are several features that improve the quality of operational management. Tese include the setting of and accountability for the achievement of objectives and performance standards, strategic and business planning and fnancial analysis to achieve efciency and efectiveness and the emphasis upon risk identifcation and management. Tese are all factors which are designed to facilitate the achievement of objectives efciently and efectively and hence for managers to be engaged in. Tese features alone may require the signifcant organisational change as well as budgetary and accounting change referred to earlier. Not to recognise these will simply mean that the reform is just a cosmetic and is not worth the efort and cost because it will not produce the benefts that could otherwise accrue. How quickly the reform can be introduced will depend upon the administrative, cultural and legal background. Terefore, the timescales and approaches are likely to difer between countries.

Countries should also recognise that this reform is a continuing process as experience is gained and circumstances change. Tere is efectively no 'end date'.

Te long timescales—years if not a decade or more—will create a challenge to the ability to apply the PFM/IC reform. Te ofcials driving the reform will change. Importantly, if the reform relies on foreign aid funding, the patience of the funder and/or availability of funds is rarely long term. A critical policy question for governments is whether they should even rely on

<sup>29</sup> "Efciency is doing things right; Efectiveness is doing the right thing." Peter F. Drucker.

external funding for the reform of core government systems. Te term dates for such funding are generally relatively short and do not refect the complexity and timescales for the reform of such systems including PFM/IC. In such circumstances governments should consider whether to fund this reform directly treating any aid funding as a 'bonus'. Te argument in this guide is that this reform is so important, with its managerial implications, that it is desirable in any event. A country's fnancial system is at the core of its sovereignty and that makes it desirable for a government to be determined in its ownership and hence its willingness to secure the reform over time with its own funds as far as possible.

# **1.7 Structure of This Guide**

Te initial chapters of this guide provide an overview of PFM/IC. A detailed explanation is also provided of the diferences between public fnancial management and internal control and public fnancial administration and internal control. Following this diferent chapters explain the responsibilities of the key ofcials who will be involved in implementing this reform. Tis is then followed by chapters explaining diferent aspects of the reform including the benefts and costs, the international standards of internal control, the impact upon the management of second-level organisations, the signifcance of transparency about the quality of the internal control arrangements and the relationships with public administration reform.

# **1.8 Summary**

Tis chapter emphasises the nature of this reform and, in particular, that it is not just some form of fnancial technique but requires a management reform. What is also necessary is that there is clarity of understanding by parliament and particularly at the higher levels of government, and of their commitment to the reform. With that commitment they need to recognise what this reform is really about, namely, that the reform is principally about the more efective achievement of the government's policy objectives and making better use of public money. Tis consequently afects attitudes to external accountability, not least to parliament including the information available to parliament and also to civil society.

#### **1 Changing from Financial Control to Financial Management…**

Tis reform cannot be successful unless it is linked to public administration or civil service reform. Such reforms ought to change the role of political leaders as well as appointed ofcials with, in principle, policy execution including operational management becoming the responsibility of the civil or local government service ofcials and with the political level focussing on the development of policy, the strategy for the implementation of that policy and the supervision of the operational management. However, to be successful the reform must have regard to the local culture, the support of the local leadership and the present quality of the public administrative arrangements. Trying to build an advanced form of public fnancial management onto a weak administrative structure will not work and a frst step in such circumstances has to be to improve the quality of the present administrative arrangements. Merely regarding this reform as desirable because it represents international best practice is a mistake because international best practice has no regard for the local culture and it contains assumptions that do need to be considered in its application.

Other factors afecting success with this reform are ownership, leadership of the reform process and a willingness to change established practices so that managers can have the information that they need, not least fnancial and performance information, and this information may be diferent from that required by a ministry of fnance.

In undertaking this reform regard should be had to the impact on the corporate governance arrangements and that applying the reform will take a long period of time. Consequently, consistent political support will be needed.

Tis introductory chapter deals only briefy with many aspects of the reform. Later chapters will address individual issues in considerably more detail.

## **Annex 1**

#### **Likely Consequences of the Reform**

Tere are many consequences of the adoption and application of the PFM/IC reform. Some are referred to in detail in Chap. 1 and others are discussed in more detail in later chapters in this guide. Tese consequences are summarised below.

## **Te Managerial Consequences of the PFM/IC Reform**


require the employment of skilled and qualifed accountants even though such skills are usually not readily available in the public sector.


#### **Te Control and Budgetary Consequences of the Reform**

• Te structures of control change. External control should move from a detailed control to a strategic form of control. Detailed control becomes an internal organisational responsibility, albeit so far as fnancial controls are concerned within parameters set by the ministry of fnance. Other controls need to be developed by internal management to secure the delivery of objectives and performance standards, to time, within budget, efciently and efectively. Tis would represent a radical change in control arrangements compared with traditional controls.


cient and efective levy and collection arrangements. (Taxation policies will have more complex objectives than simply revenue raising. Tey will include, e.g., income redistribution, improving the operation of the economy, discouragement of imports to reduce an adverse balance of payments, promote stability in the economy, discouragement of the consumption of certain products such as tobacco and alcohol, and as a support to the promotion of government policies such as combating climate change. Taxation policies can be afected by international agreements, especially those afecting the taxation of companies.)


#### **Te Accountability and Transparency Consequences of the Reform**


Tis is a signifcant list of managerial, technical and accountability consequences of the reform. However, it does illustrate that this reform is a signifcant reform with important impacts upon the managerial arrangements within ministries, local governments and other public organisations. As a consequence, this is a reform that is likely to take a considerable period to implement.

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# **2**

# **Implementing Public Financial Management and Internal Control (PFM/IC)**

Tis chapter explains what is necessary to implement public fnancial management and internal control (PFM/IC). It discusses the role of parliament, how the diferent elements of PFM/IC can be achieved including what sound fnancial management means, what are cost drivers and cost centres and why such information is required by managers. It explains why there is a need to 'professionalise' management and the difculties with doing so. It discusses briefy the role of the head of fnance and the arrangements for the control of second-level organisations. It also considers how to achieve the benefts of the reform. Tis chapter expands on the argument introduced in Chap. 1 that the reform is not simply achieved by introducing a series of bureaucratic reforms based upon international standards. Management is of the essence and without good quality management the benefts will not be achieved. However, achieving the reform will not be easy and potential difculties are identifed and discussed.

# **2.1 The Context for Public Financial Management and Internal Control (PFM/IC)**

Te regulatory framework governing PFM/IC should be specifed in a law or set of laws and other regulations approved by a country's parliament. Te powers and duties of the diferent bodies involved in the processes of PFM/IC should prescribe how income is to be raised through taxation and other means and how public organisations are to utilise the resources made available to them. Te law and the complementary regulations should be transparent and their application predictable. Tis is so that those involved in the processes are clear in their responsibilities, that there is a consistency of approach and that civil society can comment on the political and managerial decisions that are made in the utilisation of public resources. Te budget, which is the core fnancial document, will be developed by the ministry of fnance and approved by the cabinet of ministers. It will represent government policy. Parliament should want to approve the allocation of resources and decisions about the raising of taxation and other revenues. It would do this through the approval of the budget which will then be enacted in a budget law. Parliament may establish a committee (e.g. a budget committee) to undertake detailed scrutiny of the budget proposals. At the end of the fnancial year, the parliament should also approve or not how resources have actually been spent during the year and in addition should have a view about how well that money has been spent. It may do this in three ways, one through the consideration of periodic expenditure statements submitted by the minister of fnance including proposals for variations to the budget ('virement'), secondly through consideration of the report of the state auditor via the establishment of a public accounts/audit committee (or equivalent) and thirdly through scrutiny of the quality of public expenditure in some detail via the establishment of a special committee. Exactly how parliament would undertake these specifc responsibilities would depend upon the arrangements applying in a particular country. For example, it may wish to approve all changes to the budgetary allocations or only the more signifcant ones. In some countries parliament may establish committees with the specifc responsibility of reviewing public expenditure by diferent ministries.

In principle, this is no diferent from the traditional budgetary framework. However, with PFM/IC the content will be diferent.

PFM/IC creates the opportunity for greater parliamentary scrutiny and accountability because the budgetary arrangements ought to have a focus upon outputs as well as inputs. Traditionally the scrutiny role of parliament has been to review what has been spent against the approved budget and to approve or not any variations. PFM/IC adds to that scrutiny role by making it possible, because of the additional focus on outputs, for parliament to consider not only how public resources have been spent, but also how well they have been spent and whether objectives have been achieved and performance standards maintained. Parliament may be advised in this process of review by the state auditor. Parliament could do this by holding either the government itself or individual ministers to account on whether they have achieved the objectives and performance standards set out in the budget or indirectly through its use of the type of committee referred to above. An indicator of the strength of the parliamentary processes should be the existence of specifc arrangements within parliament to review the efectiveness of the PFM/IC arrangements. A key fgure in this review process should be the state auditor. Te state auditor role should include ensuring that governmental activities are carried out in a manner consistent with parliament's intentions, and are efective, efcient and economical. Te existence of a budget focussed upon outputs as well as inputs facilitates the development of this role.

Consequently, parliament should approve the laws and regulations relating to the introduction and development of this reform. Parliament should be consulted by the government about the policy of implementation and on progress during the application of the reform. As PFM/IC creates new opportunities for parliament to assess the quality of public expenditure, parliament should be concerned about the arrangements for the reporting of the activities of government and the quality of its performance. With PFM/IC as parliament is able to move from a simplistic concern for spending to a more complex concern for what public resources have achieved or not achieved, that is, both 'inputs' and 'outputs'. Tis provides greater opportunity to hold government to account and also individual ministries. (Chap. 13 discusses the form of reporting and the information that the report should contain.)

Te ministry of fnance will be the key ministry that parliament should relate to over the establishment of PFM/IC. Tis ministry should provide reports to parliament on the development of the PFM/IC policy and on its application within government organisations. Parliament should hold the ministry of fnance to account for progress (or lack of it). Tis accountability process should act as a driver of the reform. Te efectiveness of the PFM/IC reform should be refected in the achievement by the government and, by extension, by individual ministries, of the approved policies, and objectives. Terefore, the focus of accountability is extended. Parliament should also be in a better position to ask questions about the efciency and efectiveness of public expenditure and the economical use of public resources. Traditional public fnancial administration arrangements would not achieve these accountability benefts.

Te conclusion is that PFM/IC can only be applied efectively if a functioning parliament exists. Parliament has an important role in the processes of implementing PFM/IC and in the complementary accountability processes. A functioning parliament is one that gives the public voice, ensures transparency, and has the capacity to efectively challenge the government through an accountability process. Political stability in the country should also be an important feature prior to the implementation of PFM/IC. Political stability is about the integrity and durability of the government structures. It does not mean that there can be no change of government rather that a change of government does not result in such an inconsistency of policy that long-term reform (such as PFM/IC) cannot be implemented, that political consensus about the signifcance of the reform cannot be achieved and, in the example of PFM/IC, that the ministry of fnance and its political leadership is unable to consistently focus upon the reform. Political instability may also be evidenced by social unrest which distracts policy makers from efective consideration of managerial issues.

# **2.2 Implementing PFM/IC Reform**

Public fnancial management as a discipline consists of two main areas of activity covering all the components of a country's budget process. One is 'upstream' (including strategic economic planning, the development of medium-term expenditure frameworks, and annual budgeting): the other is 'downstream' including expenditure management to deliver services and activities efciently and efectively, to ensure that assets are fully and properly utilised, that all resources are only used for approved public purposes, that revenues due to public organisations are managed efciently and that procurement, control, accounting, reporting, monitoring and evaluation, audit and oversight are efective.1 Tis guide focusses on the 'downstream' element of public fnancial management recognising that there is an overlap with the budget making process. (Te quality of annual and medium-term budgeting arrangements signifcantly afects the quality of the 'downstream' activities.)

Public fnancial management covering both upstream and downstream activity has become by far the most common theme of public sector fnance related reforms. A reason for this lies in the increasing use of budget support funding by aid agencies with their corresponding concern to ensure that such funding is not abused. As noted in Chap. 1, whilst countries may themselves initiate their own reform to implement PFM/IC, very often the initiative comes from third parties such as multi- and bilateral organisations as a condition for the granting of budget support funding. Budget support funding involves the transfer of funds directly to a country's own treasury and therefore relies on the strength and capacity of a country's own systems to ensure that funds are used for the agreed purposes and that they are used efciently and efectively. Budget support funding, despite its advantages, does expose donor countries to greater risks of waste, fraud, and corruption and, as a result, there is a greater emphasis on countries to address these problems.

<sup>1</sup> See also OECD (2009) quoted by Bietenhader and Bergmann principles for sequencing public fnancial reforms in developing countries: *International Public Management Review* · electronic journal at http:// www.ipmr.net, Volume 11 Issue 1, 2010, International Public Management Network.

#### **2 Implementing Public Financial Management and Internal Control…**

When countries make the decision to adopt the PFM/IC reform unfortunately much of the advice that they receive from bi-and multilateral agencies is driven by the conditions attached to budget support. Very often this is based upon 'form' not 'substance', with short time-scales. Also, such advice may not be suited to the local bureaucratic and cultural context. Consequently, the focus in such circumstances is on developing and implementing the laws, systems, and accompanying bureaucracy that needs to be in place rather than considering the broader issues such as the human or managerial consequences. Tose laws and systems are usually defned to represent international best practice which as was pointed out in Chap. 1 may be completely irrelevant to local needs. Tis is because a country may not have the governance, managerial capabilities, information or disciplinary structures, and skills that are necessary to ensure that international best practice provides a workable solution. Tere also may be inconsistencies with local cultural traditions. (Te experience of this author is that, despite these problems, aid agency pressure tends to be to encourage countries to adopt advanced practice such as PFM/IC, based upon the idea that 'international best practice' represents the most appropriate solution rather than recognising that, as in this example, ensuring initially that PFA/IC is robust and that a managerial capability exists before proceeding with the more advanced reform.)

#### **2.3 Who Is the Manager?**

Because PFM/IC is as much a management reform as a technical fnancial reform, the question that then arises is 'who is the manager' and what are his/ her responsibilities. Tis was discussed in Chap. 1 where the point was made that in some countries all management responsibilities covering policy and strategy development, policy execution and all other aspects of operational management2 are the responsibility of politicians or politically appointed ofcials. In other countries, with more developed arrangements, a distinction is drawn between the responsibilities of politicians including other politically appointed ofcials, who are responsible for policy and strategy development and oversight of policy execution, with operational management including policy execution, being the responsibility of civil servants and local government ofcials.

<sup>2</sup> In this guide, policy execution and all other aspects of operational management are collectively called 'operational management'.

As has been explained previously, with PFM/IC in each public organisation there should be an ofcial appointed with overall responsibility for the quality of operational management. Tis would include responsibility for the development of the organisational structure with managers appointed at diferent levels in the organisation. In some countries a state secretary (or equivalent) would have the authority to make the decisions about the management structure whilst in others agreement with the minister or other politically appointed ofcial may be necessary. With the introduction of PFM/IC the state secretary (or equivalent) has a central role because he/she should also be responsible for the practical application of the PFM/IC policy and its ongoing quality, including the efciency and efectiveness with which public resources are utilised.

It was also pointed out in Chap. 1 that 'management' requires the making of judgements and all judgements require the acceptance by the decision maker of some degree of risk. Accepting the need for risk taking will be new to many civil servants and local government ofcials where operational management responsibility is to be delegated to them from politically appointed ofcials as part of the PFM/IC reform. Tis could well cause them to resist the changes that the reform entails. Yet central to the reform is delegation and managerial accountability. Te 'upside' to this for these ofcials is a more efective operational role coupled with better quality decision making. For elected ofcials this removes from them many administrative responsibilities, some of which can be quite trivial, and gives them time to focus on their primary responsibilities of policy development, strategy, and monitoring. However, in many countries with traditional legally based public fnancial administration and internal control arrangements (PFA/IC) civil service rules or laws can inhibit initiative and threaten civil servants with penalties if they make mistakes or errors of judgement. Financial inspection arrangements can also discourage risk taking. In many developing and transition economy countries even the most senior ofcials in line ministries have limited authority to make decisions, not because of political constraints but because approval has to be sought from central ministries. And in those central ministries the responsibility for approving a line ministry decision often lies with a lower level ofcial. So in efect who is the manager? Is it the ofcial in the line ministry or the ofcial in a central ministry giving the approval?

Before the introduction of PFM/IC, as explained in Chap. 1, the ministry of fnance should satisfy itself that a robust PFA/IC exists (see Chap. 3 for a detailed explanation of the diferences between PFM/IC and PFA/IC). Te focus with PFA/IC is upon control and compliance, rather than on the achievement of objectives efciently and efectively, to time and to standard as well as within budget. Control and compliance are critical attributes which all countries ought to strive to attain and they should be maintained with the introduction of PFM/IC. If control and compliance do not exist, a sophisticated system is being introduced without the underpinning basic fnancial stability and without recognition and acceptance of the structures necessary to achieve and maintain that stability. Tis is the equivalent to building a physical structure on sand, that is, without appropriate foundations: a structure which will be unable to withstand the bufeting of events.

# **2.4 Effciency and Effectiveness and PFM/IC Reform—Why Countries Should Want to Introduce the Reform**

#### **2.4.1 Securing Effciency and Effectiveness**

Most governments, taxpayers, service users and external development partners (i.e. bilateral and multilateral agencies) want efcient and efective arrangements for the raising of public revenues and for the utilisation of public fnancial resources. Introducing PFM/IC is a core strategy to help achieve this aim. 'Efciency and efectiveness' were defned in Chap. 1 by referring to a defnition attributed to Peter Drucker, that is, efciency is doing things right; efectiveness is doing the right thing. Doing the right thing depends upon the quality of the policy determining what services are to be delivered and how they are to be delivered. However, achieving efciency and efectiveness in practice is not at all easy and whether it can be achieved depends very heavily upon the quality of the policy operational management is required to implement. Te changes required to achieve efciency and efectiveness, for most, if not all, developing and transition economy countries will require signifcant management and fnancial reform, a reform to the control framework exercised by bodies external to a ministry or local government such as the ministry of fnance and the ministry responsible for personnel management, as well as to budgetary and fnancial information arrangements. It will also require the existence of focussed pressure to achieve improved utilisation of resources and that pressure may be generated by the ministry of fnance through the budgetary process, or directly by the political and/or operational leadership of a ministry or other public organisation. Once that pressure is established the leadership of the operational management (the state secretary or equivalent) and the head of fnance should have a specifc responsibility to identify inefcient and inefective operational activity whether it be in the raising of revenues or in public expenditure. Each individual manager should also have a responsibility to achieve efciency and efectiveness in delivering the services or activities for which they are responsible.

To develop a policy that will facilitate efciency and efectiveness both the political ofcials and the operational manager (i.e. the civil servant or local government ofcial) need to be involved. Te former should set the policy based upon the political agenda of the government which should be developed in consultation with the operational management. (Te operational manager should be able to advise, based upon experience, on the practicalities of implementing policy.) Efciency and efectiveness are not simply about compliance with laws, regulations and policies and budgets or just spending less money, although they can include all of these attributes. Efciency is about producing the results intended (i.e. the objectives and performance standards) and doing so in a manner which maximises those results for the least input of resources, both current resources, such as personnel and supplies, and services and investment resources, such as assets. Efectiveness is about results being those that the user of the service or activity requires or which meets their needs and does so to time and standard, rather than the results that the supplier wishes to produce. Efectiveness can only be established by identifying the impact of the activity, including asking the user. Te user may be external to the organisation or internal. However, consultation with the user is an important dimension in improving the quality of public service provision. Sometimes, however, the results can be perverse and managers need to be alive to such a risk. For example, a drug prevention scheme in the USA probably increased marijuana use.3

To achieve efciency and efectiveness, the manager needs discretion and that is why the traditional framework of external controls needs to change.

However, not all countries want a focus on efciency and efectiveness with policy being more concerned with maximising public sector employment. Where this is the situation, such countries should concentrate on improving the quality of PFA/IC rather than seeking to adopt PFM/IC.

## **2.4.2 The Role of the Operational Manager in Achieving Effciency and Effectiveness**

Although the terms 'efciency and efectiveness' have become widely used in the processes of public fnancial management reform there is no 'automatic' driver as in the private sector, where the market ultimately forces in efcient and efective management of resources. In the public sector the driver has to be political coupled with managerial initiative, ultimately driven by political debate and end user reaction (i.e. through accountability).

<sup>3</sup>Quoted in a paper by David Ainsworth and referring to an example quoted by Caroline Fiennes: https:// charityawards.co.uk/article/made-to-measure-how-should-charities-assess-efectiveness/.

To deliver operational efciency and efectiveness as the manager needs discretion this requires the delegation of authority from the politician. Another factor afecting discretion is the extent to which the manager is subject to detailed control by an external organisation. Where that occurs (e.g. by a ministry of fnance or the organisation responsible for personnel management), achieving operational efciency and efectiveness can become impossible.

Compared with the private sector achieving efciency and efectiveness in the public sector context is much more complex. In the private sector products and services are relatively easily identifable and a supplier, for example, does not have to supply every potential customer. In the public sector products and services can be less easy to defne. Tus, what are the specifc objectives of 'education' or 'security'? Also, very often the public sector supplier cannot choose who to supply or not supply. Again, in the public sector if the terms efciency and efectiveness are to have any real meaning, managers need not only discretion but require operational objectives and providing clarity of objectives can be difcult. Changes are also required to traditional methods of public sector working. For example, a manager requires diferent fnancial information than a ministry of fnance requires for budgetary and fnancial control purposes, although a manager needs that as well for the manager's specifc area of responsibility. To facilitate efective management the fnance made available through the budget should be linked to objectives and performance standards including performance objectives. Tis then makes it possible for the operational manager, provided that manager has agreed that the budget and objectives and performance standards and objectives are compatible, to deliver objectives and performance within budgetary constraints and to be held accountable for doing so. To achieve management discipline in this context the operational manager needs to be under systematic pressure from his/her superior manager, who ultimately may be a politician.

## **2.5 Defning 'Sound Financial Management'**

#### **2.5.1 Sound Financial Management**

An aim of the PFM/IC reform is to give 'reasonable assurance' that a public organisation's transactions comply with the principles of 'sound fnancial management', that is, 'transparency, efciency, efectiveness, and economy, as well as with relevant legislation and budget descriptions'.4 Sound fnancial management therefore means much more than a traditional approach to

<sup>4</sup>Welcome to the World of Public Internal Financial Control, European Commission, 2006.

internal control which is focussed on legality and fnancial and budgetary control. Financial management encompasses all the activities within an organisation that are concerned with the raising and use of resources designed to achieve the objectives of the organisation efciently and efectively:

Financial management is a core part of successful management, central to each organisation's decision-making process and an essential part of the overall performance management. It is essential to the efective corporate governance of an organisation and fundamental to achieving objectives. High performing organisations and those with a track record of improving services consistently demonstrate strengths in leadership, performance management and fnancial management.

Financial management encompasses all the activities within an organisation that are concerned with the use of resources and that have a fnancial impact. CIPFA has defned fnancial management for public bodies as the system by which the fnancial aspects of a public body's business are directed and controlled to support the delivery of the organisation's goals.

Te fnancial management arrangements within public sector organisations provide information that management use to:


Terefore, in the context of fnancial management, 'internal control' has a much wider application than simply the traditional transactional approach to fnancial and budgetary control envisaged in the context of PFA/IC. It includes those controls that are necessary to ensure that the management delivers the objectives and performance within the law and any budgetary constraints, efciently and efectively. Tose controls need to be defned and made operationally efective.

Te idea of the discharge of accountability is not one that is confned to internal accountability but incorporates external accountability to the user of services and their representative groups, to parliament and to the taxpayer. In other words, PFM/IC also involves a greater degree of transparency and accountability than traditional administrative systems.

<sup>5</sup>Financial management as defned by the Chartered Institute of Public Finance and Accountancy (CIPFA) Technical Information Service Volume: Financial Management and Corporate Governance. Introduction to Financial Management (cipfa.org) Introduction to Financial Management and Corporate Governance updated Nov. 2017.

#### **2.5.2 Financial Control**

Financial management incorporates 'fnancial control'. Financial control is designed to ensure that the operational managers of the organisation, at all levels, follow in practice the rules and regulations about all fnancial matters (usually set out in 'fnancial regulations') including the safeguarding of assets. Financial management also incorporates 'budgetary control' which requires that the operational managers ensure that budgets are not overspent or overcommitted and are only used for the purposes for which those budgets are intended, or that where income is to be generated that income forecasts are achieved.

Financial management within a particular area is the responsibility of the manager for that area although the organisation's head of fnance should be involved in this as a provider of key information and as an adviser to the manager.

#### **2.5.3 Cost Drivers and Cost Centres**

To achieve 'sound fnancial management', as has been indicated above, operational objectives and performance standards need to be defned and linked to the policy and budgetary objectives a manager is expected to achieve. Tis means that the traditional process of developing a budget by taking the previous year, adding for infation, and then adjusting the total to refect economic forecasts, will no longer be appropriate. If a budget is to have any meaning in managerial terms it must be linked to policy objectives and to performance standards. Tis is what a change to PFM/IC ultimately requires. Tose policy objectives in many circumstances will also be 'cost drivers'. A cost driver is a factor that afects the level of costs that an organisation is likely to incur and therefore how policy impacts on the budget. Examples of cost drivers can be quite simple such as the policy towards the numbers of children to be educated, or elderly persons to be cared for by the state or total numbers of persons held in prisons or the number of children to be vaccinated. But they can be more complex and may depend heavily upon the complexity of the policy being pursued or they could be a combination of both simple and complex cost drivers. For example, the number of crimes, depending upon their type, can afect the demand for police resources but how the police and the judicial system address the consequences of criminal activity will afect the total budget that is needed. In efect a cost driver can be a particular political or management policy or it can be a numerical factor such as the pupil/teacher ratio. Changing the cost driver can signifcantly afect costs. Another example would be penal policy, where the policy approach to sentencing afecting the length of prison sentences for diferent types of crime can have a material impact on costs. Or again it could be the age at which children are vaccinated and the range of vaccinations to be provided. If costs are to be kept under control regard should be had to such cost drivers.

Identifcation of cost drivers and associated costs is an important factor in the establishing quality in the policy making process.

Te operational manager needs to be able to allocate costs over diferent areas of activity, that is, over cost centres. A cost centre could be a regional ofce or prison, or police unit or operating theatre, or university course and so on. Te manager will also need to know the level of the operational performance of each cost centre. Some cost centres will operate more efciently than others and the manager must know this. Only then is the manager able to take any necessary corrective action. Tat action may include changing the cost centre manager or its stafng or reorganising the cost centre organisational arrangements to refect changes in demand for its services. To make such a detailed allocation of costs possible more elaborate coding of costs and more detailed information about performance will be required.

Making operational decisions based upon cost driver and cost centre information should be the responsibility of the operational manager. To support the manager the head of fnance should be able to provide the information the manager needs to identify which cost drivers to address, and which cost centres require his attention if costs are to be kept under control and efciency improved. Te operational manager should inform the policy maker where the cost driver is having efects upon budgetary limitations, and the policy maker should then decide on any action to be taken. Cost drivers are highly signifcant in translating policy ideas into practical and operationally efective public services. Tere is a legitimate question about whether particular policies, or the methods of delivering those policies, result in the efcient and efective utilisation of public resources. (Poor policy formulation can be a cause of inefcient and inefective public services.) Cost centre analysis is about efciency and efectiveness and whilst operational management should be the responsibility of the civil service or local government manager the reorganisation or sometimes closure of cost centres may require political authority.

Overall, with 'sound fnancial management' developed through the adoption of PFM/IC objectives and performance standards will be more likely to be achieved than would occur with traditional systems of fnancial and budgetary control which focus simply upon fnancial parameters.

# **2.6 Appreciating the 'Management' in Public Financial Management**

#### **2.6.1 The Professionalisation of 'Management'**

Public fnancial management when considered from a 'downstream' perspective is based, as the name implies, upon the idea of management. Public fnancial management is not simply a collection of technical tools (i.e. application of international standards, laws, and systems with associated training) that if implemented will, of themselves achieve a range of benefts leading ultimately to economic improvement. Much more is required. In particular 'managerial professionalism' is needed. Professionalism refers to the behaviour, attitude, competence, accountability, and integrity standards expected of managers and impacts upon how they undertake their responsibilities, including the exercise of leadership within their organisation and accountability for their organisation's performance. 'A state that promotes management promotes professionalism—discretion, performance and stewardship.'6

Te European Union in its advocacy of public fnancial management reform has recognised this. A key feature of the public fnancial management reform it requires to be undertaken includes the development of managerial structures accompanied by appropriate delegation and managerial accountability. Tis means:


In other words what is required in practice is that to achieve efective PFM/ IC there does need to be a separation of responsibility for policy and strategy development from operational management, the former being a political responsibility and the latter a civil or local government service responsibility. However, efective policy making does depend upon close cooperation between the operational manager and the policy maker with the former advising the latter on the feasibility and cost of policy. Tis also has an impact upon

<sup>6</sup>Public Finance and Economic Growth in Developing Countries: Lessons from Ethiopia's Reforms by Stephen B. Peterson (New York: Routledge, 2015), page 285.

budgetary, fnancial and performance information arrangements (these are discussed in Chaps. 5 and 8) as well as upon decision making processes and how the responsibilities for control are exercised.

Te introduction of PFM/IC with the professionalisation of management also imposes signifcant additional technical responsibilities upon the manager which would make very difcult the combination of policy and strategy development with operational management. In that event the likelihood would be that one or other would not be properly undertaken.

However, as has been commented upon previously, in some transitional and developing economy countries, even though they may nominally be introducing PFM/IC, operational management efectively remains a responsibility of the political level which therefore undertakes the two roles of defning policy and the strategy for its delivery and the operation management of service or activity delivery. Consequently, delegation and managerial accountability between the civil or local government service and the political level are not being achieved. Tis does not encourage the development of an efective and responsible civil and local government service management or the opportunity for the provision of independent informed advice to political policy makers. It also casts doubt on the quality of both policy development and operational management.

Countries wishing to join the European Union are expected to absorb a managerial dimension into public fnancial reform from the outset of the reform process. Other countries may not be required, or wish, to undertake the same comprehensive reform as those European infuenced countries and therefore may only wish to address the internal controls that lead to an improved quality of public fnancial administration.7

<sup>7</sup>With the European Union reform diferent terms are often used to describe the same thing. One term that is commonly used is 'fnancial control'. Tis though is often used as a generic term covering external audit, internal audit and public fnancial management, and internal control. 'Public internal fnancial control', another term used by the European Commission, is a derivative of 'fnancial control' and includes three elements, internal audit, fnancial management and internal control, and the establishment of what is called a central harmonisation unit whose function is to introduce and manage the other two elements of public fnancial management and internal control. (Te public internal control reform is specifed in the 'Conditions of Membership' for countries wishing to join the EU. Chapter 32 of the Conditions of Membership [the *acquis communautaire*] specifes the criteria that apply to applicant countries in the feld of 'Financial Control'. Tese conditions require the development of public fnancial management and internal control.)

#### **2.6.2 Challenges to Professionalising Management**

One problem with developing a professional management is resistance both by the political level and by the ofcial level to this management element of the reform. Also, the public administrative culture may not be compatible with the introduction of advanced PFM reforms as the following report on a regional workshop sponsored by the IMF on the challenges of developing MTEFs and PBB (a similar advanced PFM reform to PFM/IC) in East Africa indicates8 :

Participants concluded that regional MTEF and PBB reform objectives are not fully reconciled with the structure, processes, laws, regulations, procedures, practices and capacity in place, hence failing to reap the benefts of these reforms. Tey also noted that the prevailing public service management culture does not encourage the delegation of responsibility for managing programmes and budgets at the ministry and agency level, or the development of improved decision making within government on the prioritisation and allocation of budgetary resources. Te incentives for civil servants to improve performance are quite weak. In addition, improved macro-fscal forecasting is hampered by weak national statistical databases.

Te workshop further concluded that:

'existing reforms of MTEF and PBB focus too much on the formal technicalities (e.g. developing new reporting templates and elaborate systems of performance indicators) without much consideration of how these techniques and data should be used to improve decision making on the prioritisation and allocation of resources. Ministries and agencies often lack the capacities to analyse performance information, and the new reporting formats and performance data are not fully integrated into existing platforms (IFMIS) for managing fnancial information. Finally, the Cabinet debate is not informed by the need for improved performance, while parliamentary interest in holding the executive accountable for performance is limited.'

'Above all, countries should invest in changing the culture and 'mindset' of public ofcials so as to support improvements in the efciency and efectiveness with which public services are delivered. Key stakeholders should be sensitised to encourage a common understanding and ownership of the MTEF and PBB reforms, and to reduce their resistance to these reforms. Such a programme of change management is not a simple matter and will require leadership and commitment over a sustained period. Borrowing from experiences in more advanced countries, and taking account of the magnitude of the reforms, participants

<sup>8</sup>Public Financial Management Blog: Making Public Money Count—Fiscal Afairs Department—IMF March 2016.

proposed therefore that a phased approach to adopting MTEFs and PBB was more sustainable.'

A second problem is that civil servants and local government ofcials do not somehow automatically become managers once the title of 'manager' is bestowed upon them. Management is a skill which is in short supply, especially in the public sector and particularly in developing and transition economy countries. Tis means that success with this reform is likely to require a heavy investment in management training, which in turn may require the making of special arrangements with an appropriate training institution such as a university. It will also afect human relations (personnel) policy, the quality of the work that civil servants and local government ofcials are engaged in, how they are to be incentivised and rewarded (and this is not just about pay) and the training that is to be provided. Political management also needs to show evidence that the skills are valued and that staf are encouraged to develop their skills within government through promotion and other career development opportunities. Te same circumstances apply to fnancial managers. Teirs too is a skill in short supply in the public sector and specifc skill training is likely to be required with the same problems as for managers, that is, skill retention, incentives, and rewards. (Tese topics are discussed more extensively in Chap. 14.)

Bearing in mind the potential for increased accountability, resistance to a reform involving delegation could also exist for other reasons. For example, at the political level it afects opportunities for patronage (including rent seeking), perceived status and requires that a signifcant degree of trust exists between politically appointed and civil service and local government ofcials. For the ofcial level, taking decisions involves risk and the possibility of penalties. Te civil or local government service may lack trust in the willingness of the politically appointed ofcials to take their share of the blame if something goes wrong. Given that the ideal civil or local government service should be non-political establishing 'trust' can be difcult for both sets of parties.

To achieve the gains from the PFM/IC reform countries need to recognise that managerial reform is essential as a prior condition and that reform should start at the top of organisations, usually at the political level, that is, with the minister or mayor, as the report quoted above demonstrates. Tis is even though reform at this level can be the hardest to achieve, especially where organisational and management structures are highly hierarchical, where challenge to authority can be very difcult to sustain without adverse consequences, and where a need for delegation of operational management is not recognised.

However, having applied the PFM/IC reform and developed the managerial and fnancial capacity to support the management the further problem is how to sustain the reform. Tis depends very heavily upon an ability to retain those skilled managers and fnancial managers. A political policy that relies on political appointees only to fll senior civil and local government management positions does not help.

#### **2.6.3 Management Structures and Delegation**

Exactly what the management structure should be for each organisation will depend upon various factors, including:


Te efectiveness of a management structure depends upon the clarity of its objectives, performance standards and performance objectives, the powers, the resources (including the information available to the managers at diferent levels in the organisation), the spans of control10 of diferent managers, that is, are they relevant for the responsibilities that the manager has? In other words, is the degree of delegation and are the corresponding accountability arrangements for that manager appropriate?

<sup>9</sup>Tis is a feature for many public sector objectives because for many of them the solution lies not just in a single organisation but in cooperation between one or more public organisations including between central and local government and possibly cooperation with private organisations such as charities. However, in practice, this is very difcult to achieve because as has been pointed out previously public organisations are notoriously reluctant to share budgets and whole of government planning is also very difcult to achieve.

<sup>10</sup> 'Span of control' refers to the number of subordinates that a manager or supervisor can directly control.

# **2.7 Internal Control and Management**

Internal control has been defned by INTOSAI as follows:

Internal control is an integral process that is efected by an entity's management and personnel and is designed to address risks and to provide reasonable assurance that in pursuit of the entity's mission, the following general objectives are being achieved:


\*Internal control is a dynamic integral process that is continuously adapting to the changes an organisation is facing. Management and personnel at all levels have to be involved in this process to address risks and to provide reasonable assurance of the achievement of the entity's mission and general objectives.11

Tis defnition of internal control emphasises the role of management (note: at all levels, not just at a top and senior level) and that of the mission of the organisation which is about the achievement of the organisation's objectives (i.e. corporate objectives). A mission cannot be left vague: it must be defned and this means that its objectives need to be clearly identifed and as far as possible measurable.12 Tose objectives also need to be cascaded down to the diferent levels of management. (In practice to achieve the overall objectives of an organisation, the political objectives may have to be divided over sub-objectives, and sometimes sub-sub-objectives, with a manager being responsible for the delivery of each sub-objective or very often, more than one sub-objective.) Organisational budgets should be linked to those objectives and in practice organisational policy objectives should be supplemented by performance standards, and performance objectives (such as waiting times for accident and emergency patients or the utilisation rates for operating theatres or school examination success rates for pupils, or reduced reofending rates for prisoners).

Internal control when used in a management context incorporates the INTOSAI defnition but should be developed to include not only the

<sup>11</sup>Te Guidelines for Internal Control Standards for the Public Sector (INTOSAI GOV 9100), INTOSAI, http://www.intosai.org/issai-executive-summaries/intosai-guidance-for-good-governance- intosai-gov.html.

<sup>12</sup>Tey should have the characteristics of SMART objectives—SMART is an acronym for Specifc, Measurable, Achievable, Relevant, Time bound.

controls necessary to secure budgetary compliance and adherence with the law and fnancial regulations, but also, and very importantly those controls necessary to:


One feature of those controls would be an efective system of risk management. A second would be systems of managerial accountability and how managerial accountability reports are responded to by higher-level management. A third would be the systematic assessment of the efectiveness of public services and activities in achieving their objectives.

Introducing PFM/IC requires that a manager considers a range of issues that would not be considered with a more traditional public administration structure. With PFM/IC each manager should have an appreciation of the fnancial implications of decisions and all that this entails in terms of delivering objectives and performance standards efciently and efectively. Tis involves a consideration of risk. What are the risks that could prevent a manager achieving the objectives efciently and efectively? Tis should be a main concern of management. Without the existence of objectives, risk cannot be properly assessed. Tis goes beyond risk to systems although that is frequently how this is interpreted in practice and often emphasised by auditors.

Te experience of this author in reviewing the implementation of PFM/IC in many of the countries of central, eastern, and southern Europe and some neighbourhood countries shows no practical recognition of this broader concept of internal control which should be associated with the idea of 'management'. Similarly, there can also be a reference to the idea of 'achieving efciency and efectiveness' but without the managerial arrangements, clarity of objectives and the fnancial and performance information systems and skills necessary to achieve it. Consequently, delivering efciency and efectiveness remains a 'nominal concept'.

# **2.8 The Ministry of Finance and Its Controls**

Financial and budgetary controls are the controls with which the ministry of fnance is primarily concerned not least because the traditional parliamentary concern is just about fnancial and budgetary control. Tey are also usually the only controls that are considered by those responsible for implementing public fnancial management reforms. However, both sets of controls are usually designed to meet the needs of the ministry of fnance. Tey will require modifcation with the introduction of PFM/IC and particularly if the impact of the introduction of PFM/IC is to encourage parliament to widen its control interest to consider 'outputs' as well as 'inputs'.

Whilst a ministry of fnance should require that all non-market public organisations such as ministries, their second-level organisations and local governments implement fnancial controls, how successfully they are implemented depends upon several factors, including the following:


• Does any systematic consultation occur with ministries and other line organisations about the costs of implementing those controls and their relevance?

An example of a fnancial control activity that is frequently imposed upon senior ofcials in line organisations and in some countries upon politicians, but which is undesirable except for exceptional transactions, is a need for them to sign all invoices and payment schedules before payments are actually made.

So far as budgetary controls are concerned, those required by a ministry of fnance should be those that are central to overall economic management and to the maintenance of parliamentary authority over the budget. Because with PFM/IC the budgetary analysis which suits a ministry of fnance is most unlikely to be appropriate for managerial purposes an alternative, probably additional form of analysis will be required so that fnancial inputs can be linked to the achievement of outputs. Tose controls may need to be extended should parliament broaden its interest to incorporate performance.

A question therefore is, do the budgetary control regulations issued by the ministry of fnance recognise the change of circumstances generated by the introduction of PFM/IC, or indeed by any extension of parliamentary interest? Or are traditional controls being maintained because they enable a ministry of fnance to efectively determine the policy of the spending or line ministry (as De Geyndt pointed out in the quotation in Chap. 1). In that circumstance, the reality will be that relatively junior ministry of fnance ofcials will probably be responsible for the controlling or authorising decisions made by senior spending ministry ofcials. Tis is not conducive to the development of PFM/IC within spending ministries and other organisations and in particular to achieving efciency and efectiveness.

Usually, ministries of fnance impose controls without consultation and as a result top and senior ofcials of ministries and other public organisations may not see the need for such controls or may resent them. Tis can be especially true where senior managers are politically appointed and therefore have no civil or local government service backgrounds or experience. An important lesson for ministries of fnance therefore is that with PFM/IC they should do their utmost through consultation and agreement to encourage spending ministries and other public organisations to 'take ownership' of these controls as far as possible rather than just seek to impose them without any consultation or recognition of their relevance to those organisation's needs.

With PFM/IC a consequence of the shift from external to internal control will be that the ministry of fnance should not be required to approve every variation to budgets or cash fow calculations because that in efect puts the ministry of fnance in the position of the actual service manager even though the nominal service manager is located within a spending ministry or local government. Te ministry of fnance control should therefore change from a detailed form of control to a more strategic form of control. Consequently, instead of being required to approve every variation, the ministry of fnance should focus only on the key or main changes proposed by line ministries or local governments whilst maintaining control of ceilings.

Even though a ministry of fnance will need to recognise and accept that managerial requirements for budgetary and fnancial information are likely to be diferent from the requirements of the ministry of fnance this does not mean in any way weakening or changing the information available to a ministry of fnance but of recognising that managerial needs within a line ministry are, or can be, very diferent from the budgetary and fnancial management control needs of the ministry of fnance. Te core fnancial information should remain the same, that is, line ministry managerial information should be derived from the ministry of fnance information systems and be capable of being reconciled with the ministry of fnance information. (Further discussion about this is included in Chap. 5.)

# **2.9 Second-Level Organisations**

Governments and local governments sometimes provide public services through agencies and state owned enterprises, that is, second-level organisations. Very often neither agencies nor public enterprises (sometimes called 'public corporations') are well managed or controlled by the relevant ministries or local governments. Controlling/owning ministries or local governments often lack an adequate policy capacity able to set objectives for second-level organisations and to efectively supervise their performance. As a result, there is a tendency for second-level organisations to dominate the relationships with the frst-level organisation because the management of the second-level organisation has greater knowledge not just about the detail of the second-level organisation's activities but also about its policy objectives and performance. Tis indicates a weakness in the accountability arrangements. As a result, decisions are likely to be made in the interests of the agency or enterprise rather than in the interests of the controlling/owning ministry or local government. Consequently, second-level organisations can be a signifcant source of inappropriate utilisation of funds and /or the development of activities which are inconsistent with the interests and objectives of the frstlevel body.

OECD evidence13 suggests that inefcient or poorly managed public corporations can impose substantial economic and fscal costs.14 Te mere fact that public services or activities are provided on behalf of a ministry or local government by a second-level organisation should not exempt the controlling ministry or local government from incorporating them into the PFM/IC arrangements that apply elsewhere in the ministry or local government. Te precise administrative arrangements may be diferent from those of the controlling/owning organisation, but the controlling ministry or local government should defne what it expects of the agency or public enterprise. Tere is a responsibility upon controlling ministries and local governments to ensure that the agencies and enterprises they are responsible for deliver their objectives, meet performance standards and operate efciently and efectively. Tis responsibility should be set down in some form of formal document which can change annually with an annual budget settlement or preferably over a longer period where the budget settlement is for a longer period. Such formal documents are often referred to as 'service-level' or 'performance' agreements. (A full discussion about the control of second-level organisations is included in Chap. 12.) Te controlling ministry or local government should also systematically monitor the performance of the agency or enterprise against such an agreement.

What this consequently means is that the objectives, management, performance standards and governance arrangements of second-level organisations should be consistent with those of the frst-level organisation and be subject to regular review. Te management of second-level organisations should have clear objectives set for them by the frst-level organisation, the resources and discretionary authority to make decisions about the delivery of those objectives should be defned in the agreement and they must be accountable for their successes and failures. Tis should require a change of managerial approach by frst-level organisations which should follow from the introduction of PFM/IC.

<sup>13</sup> See 'How to note—November 2016 "FISCAL POLICY How to Improve the Financial Oversight of Public Corporations"'.

<sup>14</sup>Extract from the 'How to Note': in the absence of strong performance incentives, public corporations also often produce at high costs, overcharge customers, and under-provide often essential services such as power, water, and telecommunications' 'loss-making public corporations can be a persistent drag on public fnances in the form of government guarantees, subsidies, loans, or capital injections' 'many public corporations are pressured or mandated to fulfl political objectives and engage in quasi-fscal activities that bear little relationship to their core commercial operations and for which the companies are not compensated from the budget' 'such quasi-fscal activities include, for example, public service obligations that are below cost-recovery, price regulations that imply cross-subsidies, ancillary operations outside the public corporation's core mandate, or excessive employment levels' 'public corporations can be used as a mechanism for circumventing traditional fscal controls, and as a conduit for fnancial corruption' (p. 2).

# **2.10 The Head of Finance**

With PFM/IC to be efective the role of the head of fnance in an organisation becomes more signifcant. Managers at all levels, that is, including the political level, must be supported by a strengthened fnancial management capability. Tat capability requires the upgrading of the traditional fnance ofcer role from that of bookkeeper/fnancial controller15 to become the equivalent of a fnance director in a private sector company. Tat would mean ensuring that the head of fnance and the department he/she is responsible for has a fnancial analytical capability, a fnancial planning and forecasting capability and an ability to act as adviser at all managerial levels in the organisation. Te head of fnance should be concerned about the efcient and efective utilisation of all the resources of the organisation including the available assets. Te aim with the latter should be to encourage either more efective utilisation or, alternatively, disposal if assets cannot be demonstrably efciently and efectively utilised.

Te head of fnance should have the status and ability to advise top and senior-level political as well as operational managers on the costs and fnancial viability of their plans and the objectives they wish to meet. Tey should also support both levels of management in the development of forward operational planning and have a capacity to prepare long-term forward fnancial plans. He/ she should advise the managers (political and operational) about the long-run fnancial resilience of the organisation and therefore how it can be managed.

Overall, the head of fnance should be responsible for securing the fnancial discipline processes that are essential with the development of PFM/ IC. Ideally, he/she should work in partnership with the head of operational management. (A full description of the role of the head of fnance is included in Chap. 8.)

# **2.11 The Time Horizon for Decision Making Under PFM/IC**

A feature of PFM/IC relates to the time horizon for the delivery of public policy objectives. Tis is usually long term and rarely coincides with the time horizon envisaged in budgets even medium term (or 3 yearly) budgets or with the electoral cycle. Consequently, an important feature of PFM/IC should be

<sup>15</sup>For a defnition of bookkeeper/fnancial controller responsibilities see footnote 11, Chap. 1.

an assessment of the longer-run consequences of public policy. Without that longer-run assessment managers (both policy makers and operational managers) cannot be sure that an organisation will be able to deliver its objectives or to remain fnancially viable over time. Financial viability over both the short and the long term should be a very important political consideration. If such viability is not a factor in policy making there is the possibility that at the extreme the organisation, if a body such as a local government or agency or state owned enterprise, may become bankrupt or incapable of continuing to operate without further cash injections which would be likely to be accompanied by stringent conditions. Or if the body is a ministry, it may require additional fnancial support which could have been avoided with more careful fnancial management and which in some circumstances may not be available. In a ministry, a lack of attention to the longer-run fnancial viability of the organisation may mean that it will have to make forced budgetary savings that can both be extremely wasteful and cause considerable discomfort to the users of the services provided by the organisation. Added to that, the reputational risk is substantial, which is likely to be of major concern to elected representatives. Consequently, those responsible for a public organisation should always consider the long-run fnancial strategy for the organisation and its long-run fnancial resilience. Politicians who have the ultimate responsibility for an organisation have a primary responsibility to ensure that adverse fnancial circumstances do not arise or, if they are likely to arise, for example, because of changes to government policy that the organisation is fully prepared. Financial viability and the achievement of objectives are intertwined.

Most public policy decisions made in one year have long-run implications which can extend well beyond the usual budgetary horizon. Although many countries have adopted a medium-term budget process, in practice those budgets are either based upon the current-year budget and spending plus an allowance for infation or refect the allocation of budgetary resources envisaged as available through the macro-economic planning process and government assessment of its priorities. Tis is not the same as organisation fnancial planning and neither do such arrangements form the basis for the development of a fnancial strategy. Public organisations will have to abide by any limits that are imposed but those responsible for the fnancial health of an organisation need to have a clear idea of what an organisation is committed to fnancially in the longer term and therefore of the consequences that restrictions on future fnances may generate.

Where a long-run fnancial assessment has been made those responsible for an organisation are better placed to:


Tere are also the longer-run consequences of demographic change, the impacts of technology, the consequences of a better educated and wealthier population, environmental and climate change and other factors that cannot yet be properly foreseen. However, as far as possible, assessments should be made about their potential fnancial impact even if these can be only vaguely forecast. Attempts at spurious precision are not helpful. Te questions that then arise are these:


A specifc example would be over the application of technology to a particular service or activity which is likely to require substantial investment, but which also may have a dramatic efect upon ongoing costs. Another example would be environmental changes, especially given the efects of climate change.

Financial management and internal control if properly implemented asks the types of question set out above. Take fnancial resilience: does anyone at present with traditional fnancial control and budgetary arrangements ask the question, can this organisation aford, within likely budgetary constraints and given the demographic and environmental changes which are occurring, to continue with its present policies over the next 5–10 years? Of course, to answer such a question does require speculative judgements to be made but it is either this or doing nothing and then suddenly fnding that an existing policy cannot be pursued because the fnance is not available, or it is not sustainable for other operational reasons. Trying to answer such a question at the very least encourages policy makers to consider the options that are available. Political time horizons will be shorter than those of appointed ofcials but asking this question does require the 'ofcial' part of the organisation to prepare a strategy to take such possibilities into account and this will ultimately beneft political decision making. (Longer-run planning is also discussed in Chap. 8 on the role of the head of fnance.)

## **2.12 Effective Public Financial Management and the Information Requirements**

Efective public fnancial management introduces a demand by managers for a wide range of new information. Tat demand can also extend to parliament depending upon how it approaches its role given the introduction of PFM/ IC. Information is central to efective management. If information needs are not fully considered, the management dimension to the PFM/IC reform is efectively being ignored. Managers will also require information to enable them to advise efectively on the development of policy and if policy is poorly defned it becomes difcult in turn to defne objectives and to prepare budgets. However, information in itself is of little value unless the manager has the authority and capacity to use that information, that is, unless accompanied by appropriate delegation and managerial accountability arrangements. A manager requires information. Tat requirement must go beyond the limits of budgetary and fnancial controls because the responsibility of the manager is to deliver improvements in efciency and efectiveness. Tat information requirement also extends to decisions made elsewhere in government because decisions made in one part of government can have an impact on other parts of government. Te information required needs to include information that can afect both fnance and performance such as changes to national or international standards. Tis does add to the cost and complexity of introducing the PFM/IC reform but without this additional information the manager will not be able to control costs or achieve improvements in efciency and efectiveness or even deliver objectives (see above about the development of cost driver and cost centre analyses). Exactly what a manager's information needs are will depend upon the manager's specifc responsibilities.

# **2.13 Achieving the Benefts of PFM/IC**

## **2.13.1 Management and the Benefts of the Reform**

Te benefts from introducing PFM/IC derive from the impact that it has upon the management arrangements. Te system itself does not deliver the benefts. Te system creates opportunities for a manager that a traditional system does not and therefore what matters is the quality of the management if those benefts are to be achieved.

Evidence from other countries16 of the impact of public fnancial management reforms has shown that, frstly, many years17 and in some cases many decades are required to implement substantive and sustainable changes. Secondly, political economy issues, together with the history and culture of a country, are enormously important factors in determining the success of a reform strategy. Strong public fnancial management systems are not created out of weak institutions and therefore an initial action should be to strengthen existing institutions as necessary (by, e.g., ensuring that the arrangements for PFA/IC are both sound and efective) and by encouraging parliament to take that broader interest in public fnance referred to above (which may require support from the state auditor). Tirdly, prioritisation and the correct sequencing of the implementation of the reform are essential for the success of any reform strategy. Fourthly, capability constraints in the public administration play an important role. Strengthening capability is not about training alone. Capability is a wider concept. Capability includes the ability to mobilise and direct all resources to achieve an objective (fnance, assets, personnel, IT systems and so on depending upon the organisation) in an efcient and efective way.18 A further (ffth) factor that should under no circumstances be ignored is that fnancial management and internal control require a capacity to think and plan strategically. Tis is not a simple matter of the forward forecasting of the impact of events but also of how those events, together with cultural and environmental changes, are likely to afect how management should react and how the changing expectations of the electorate, the service user and the

<sup>16</sup> IMF Director for Africa quoted by Richard Allen, IMF Blog 2 December 2013: https://blog-pfm.imf. org/pfmblog/2013/12/is-there-a-new-consensus-on-pfmreform.html?utm\_source=feedburner&utm\_ medium=email&utm\_campaign=Feed%3A+pfmblog+%28PFM+blog%29reform.html?utm\_ source=feedburner&utm\_medium=email&utm\_campaign=Feed%3A+pfmblog+%28PFM+blog%29.

<sup>17</sup> See the assessment of SIDA referred to in Chap. 1—footnote 22.

<sup>18</sup>For a full discussion see *Building State Capability: Evidence, Analysis Action*: Andrews, Pritchett, Woolcock: Oxford University Press 2017.

taxpayer will afect attitudes to public services and those responsible for their delivery in the future.

As experience of managing within a PFM/IC environment is gained further changes are likely to be required particularly to the defnition of objectives, performance measures or indicators and the analysis arrangements designed to assist managers improve efciency and efectiveness. Changes in technology will also impact upon the processes of fnancial management and internal control. Given the complexity and length of time that implementing PFM/IC will take, as was pointed out in Chap. 1, political consensus about the desirability of the reform is highly desirable. Tis will be particularly important where a consequential management change is to move responsibility for operational management from elected ofcials to appointed civil service and local government ofcials. Tis will mean that ofcials will need to be trained in management techniques and that the managerial ethos facilitates decision making and the making of operational service delivery judgements.

In summary the benefts of the reform are derived from a better quality of management with more efcient public services, an increased focus on achieving objectives and with greater regard for the needs and interests of the user of public services (efectiveness) usually expressed through civil society. (Te benefts that can be obtained from this reform are discussed in Chap. 10.)

#### **2.13.2 Integrating PFM/IC Reform with Managerial Reform**

Given that the introduction of PFM/IC should be regarded essentially as a management reform the introduction of PFM/IC should be coordinated with civil service or public administration reform, although it rarely is. As has been pointed out a central feature of PFM/IC is the separation of responsibility for policy and strategy development from policy execution and all aspects of operational management with the delegation of operational management to civil service and local government ofcials. (Te extent of delegation will depend upon the particular operational circumstances and where delegation is appropriate and where not is discussed in Chap. 14.) Tis means that a management structure should be developed which is appropriate to the needs of the organisation. However, the development of a management oriented organisation cannot simply be driven by the needs of PFM/IC. Te development of a managerially oriented public administration, because of its farreaching implications for policy development, the relationships between politicians and ofcials and staf management go well beyond the remit of a ministry of fnance. However, the development of PFM/IC does mean that managers, at all levels, need to be fnancially aware. Financial awareness is not simply about knowing what budget is available and securing budgetary control. Financial awareness also means that managers know what the total costs are of the services or activities for which they are responsible and how any changes of whatever type will afect those costs (e.g. of those factors which drive costs). Where managers are responsible for the development and management of income sources, including taxation they need information on the efectiveness of the policies in achieving the objectives as well as information about the costs and losses on collection. Tey also need to be aware of the total resources, current and capital (investment), that they are using and of the commitments that they are proposing to enter into. Tis too may represent a signifcant change because very often administrators, such as heads of departments, in developing and transition economy countries are not aware of the total costs of the department for which they are responsible because some costs may not be allocated over services and activities and in some countries, particularly lower-level administrators, may not know at all of either the budget they have available or the actual costs that are being incurred. Te only fnancial information that it is often deemed necessary for an administrator to know is that necessary to maintain budgetary control over those expenditure lines for which the administrator has a direct responsibility. With PFM/IC this nowhere near enough! Neither is it enough for only the fnance department to be responsible for the efectiveness of the fnancial and budgetary control arrangements: this should be primarily the responsibility of the manager. A particular responsibility of the head of fnance is to promote fnancial awareness in all its aspects amongst managers (see next section).

## **2.13.3 Promoting Financial Literacy and Awareness**

Managers need budgetary and fnancial information which meets their needs and as has been explained above these needs will be diferent from those of the ministry of fnance. Whilst budgetary control must be maintained in accordance with the requirements of the ministry of fnance that budgetary information needs to be reanalysed in a manner which supports the manager and as far as possible linked to performance information. Only by this occurring can a manager assess how efciently and efectively services are being provided and through that the development of fnancial awareness. Tis also supports the development of managerial accountability. Tat will mean providing individual managers with the specifc budgetary and accounting information they require to enable them to manage their part of the business of the organisation. To meet these diferent requirements more sophisticated fnancial analytical processes will be necessary. A single coding structure for the whole of government will be most unlikely to have the capability to achieve this. In developed economy countries the problem has been addressed by allowing public organisations to develop their own coding structures but in accordance with conditions specifed by the ministry of fnance that allow the ministry of fnance to maintain the control and fnancial information it requires. A specifc example is provided in Chap. 5.

Reluctance often exists in many developing and transition economy countries to provide budgetary and fnancial accounting information to managers other than to the top level of management and in any form other than that required by a ministry of fnance. Tis will need to change.

#### **2.13.4 Engaging a Wider Set of Actors in Financial Decision Making**

Rather than confning debate about budgetary allocations to senior ofcials, line ministry and local government managers at all levels ought to be involved in decisions afecting the level of budgetary allocations (within any overall ceilings) given the objectives and performance standards they are expected to meet. Tey should also be involved in decisions about budgetary variations required during the year and cash fow calculations. In summary, if those managers are to be responsible for the delivery of objectives, performance standards and levels of operational performance they need to agree the resources necessary to do so and if resource availability is not at the level to achieve them, then changes will need to be made to objectives, performance standards or performance levels to match the available resources. Only the manager is in a position to give advice on that.

## **2.14 Learning Lessons from the Experience of Countries Aiming to Introduce PFM/IC**

Where countries have not had regard to the managerial dimension to the PFM/IC reform the impression is that they have not asked themselves these questions:


Unless these questions can be answered positively the main point of the reform is being missed and the potential benefts will not be achieved.

Also, the linkages between this reform and public administration reform or civil and local government service reform have not been recognised. In most countries, public administration reform and PFM/IC reform operate as it were, on parallel lines, not recognising the signifcant relationships between the two. What has also been missing is a recognition that budgeting and fnancial accounting systems also need to meet the needs of line ministry managers as well as those of the ministry of fnance. Some budget headings which may be currently centralised in some countries (such as personnel and premises costs) may need to be allocated over individual management areas of responsibility to provide managers with the information that they require if they are to deliver services efciently and efectively.

Tese weaknesses in the approach to the fnancial management and internal control reform appear to have partly come about, at least in countries with a legalistic tradition of public administration, because of the traditional focus upon adherence to that legalistic approach exemplifed by bureaucratic rules and procedures. Te legal approach has a focus on structure and functions allowing the exercise of power. It emphasises formality, the powers available and the limitations of power. It afects the discretionary authority of

<sup>19</sup>Te main procedural requirements are included in the guidelines for internal control standards for the public sector published by INTOSAI—see footnote 11.

administrators. Tis contrasts with the approach exemplifed in PFM/IC where the focus is more upon the public service user, the outputs, efciency, and efectiveness in delivering those outputs. Te legalistic approach in these countries also refects concerns about the misuse of funds leading to a focus upon 'fnancial and budgetary control'. Te reform approach that has been adopted in many countries has been to strengthen public fnancial administration, not 'management'. However, that also refects a limited view of the meaning of 'control'. An internal audit based approach, which is the point from which many developing and transition economy countries start the reform, with a focus on compliance with procedures and systems to ensure that they are properly implemented has been usually the approach adopted. Whilst such controls are very important, thought has not been given to the outputs of those procedures and systems. Tis is not the end outcome that PFM/IC is aiming for. It ignores the point set out above in this chapter that 'control' is also about ensuring that the organisation delivers its objectives and does so efciently and efectively and without risk to the fnancial resilience of the organisation. In other words, 'control' is also about where the organisation is heading and how well it is using its resources. Tat is a management responsibility. To use a motoring analogy, control is about more than just the accelerator and brake (i.e. the systems and procedures), it is also about steering towards the objective (i.e. where is the organisation trying to get to). Consequently, implementing PFM/IC in countries with a legal tradition does mean a signifcant cultural change and cultural change in all circumstances is very difcult requiring careful preparation.

Te lesson from this is that whilst the experience of other countries can be valuable it does need to be treated with great care recognising that many (perhaps most) other countries have had a very narrow perception of what this reform is mainly about in that they have not recognised the managerial impact of the reform.

#### **2.15 PFM/IC and Delegation**

Countries with highly centralised power structures may have difculty with the concept of delegation. Tere are two aspects to delegation, one is from politicians to the civil or local government service ofcials and the other is from central organisations to line organisations such as individual ministries.

Te frst aspect from political appointees to ofcials tends to occur because of a lack of 'trust' in the civil or local government service ofcials and concerns about competence. Tis can be accentuated where the civil and local government service has been politicised and has no reputation for independence. Power also provides important benefts to those who hold it, such as patronage and in some countries, as has been said earlier, opportunities for rent seeking. Tis is unlike in those developed economy countries, such as the Netherlands and other western European countries which have a long history of implementing PFM/IC. Here responsibility for delivering operational activities lies with the civil and local government ofcials and policy and strategy development and monitoring lies with politicians, that is, the elected ofcials. Exactly where the boundary lies between policy and strategy and operational activity varies considerably from country to country, as do the reporting arrangements, but either the civil and local government service is not politicised or politicisation is strictly limited.

Te second factor is that in many developing and transitional economy countries power may be concentrated in a limited number of central ministries such as the ministry of fnance (or there may be a separate ministry responsible for investment control) which may have to approve spending decisions where they do not conform with traditional practice, or cause variations to existing budgets. Or again a central ministry may be responsible for all employment levels and arrangements and this central ministry may have to approve personnel changes or appointments. Tis limits the discretion of line ministries to make decisions about the way in which services are delivered and how they can be made more operationally efcient. In practice, such controls are not related to the efcient and efective delivery of a service or the achievement of objectives but are simply about budgetary or policy control and sometimes a perceived need to avoid creating precedents. Such arrangements confict with the managerial responsibility to improve efciency and efectiveness and where authority must be sought from another organisation, decisions are likely to be made in the interests of the organisation exercising the power. Terefore, for example, where a line ministry may require a change to budget structures or change the personnel structure to facilitate improvements in efciency and efectiveness meaning that a diferent form of budgetary analysis is necessary or diferent personnel arrangements, a central ministry can efectively prevent this if it will not agree to those reforms that a line ministry may require. A legitimate question then is who in fact is the manager of that service or activity?

#### **2.16 PFM/IC and Decentralisation**

Decentralisation transfers authority and responsibility from central government to regional and local government of certain government functions. Tis responsibility may include all aspects of service delivery from policy formulation, the strategy for implementing that policy to the detailed arrangements for service delivery. Exactly what the arrangements will be depends upon individual country arrangements. An important factor afecting decentralisation will be the level of fnancial resources available to each level of government. Some subordinate governments may have local taxation resources but usually these are insufcient to fnance the costs of the more major public services such as education or poverty relief or security. In such circumstances local revenues sources are usually supplemented through grants from central governments which can attach conditions to the provision of grant aid including conditions about how such funds are to be managed, for example, by the adoption of PFM/IC.

With the introduction of PFM/IC at the central government level a decision will need to be made about its implementation by these diferent levels of government. How far a central government can impose a requirement for a subordinate government to adopt particular managerial or administrative arrangements will depend very much upon the local constitutional arrangements. Whilst a central government can use the lever of the provision of fnancial resources to encourage or cause subordinate governments to undertake reform, there may also be other reasons why central governments should require subordinate governments to undertake reform. An example is of governments wishing to join the European Union where the equivalent of PFM/ IC is expected to be adopted by both central and local government as well as any intermediate levels of government.

Te ideal position though is that all levels of government within a country should be encouraged or required to adopt PFM/IC recognising that the timetable and the specifc arrangements may well be diferent from those applying to central government.

### **2.17 Summary**

Te PFM/IC reform is likely to challenge the traditional cultural approach to the delivery of public services. It also afects the distribution of power within and between organisations and afects how some organisations have traditionally operated as well as the roles that they have traditionally undertaken, including the parliament. Tis can make the reform difcult to implement. However, as a key component of PFM/IC, namely management with the responsibility to deliver objectives efciently and efectively, this inevitably will lead to challenge to existing power structures particularly with the development of a delegated but much more disciplined managerial approach to the delivery of public services and activities. It will also require a more fexible attitude to budgeting and fnancial accounting compared with traditional arrangements.

Some civil and local government ofcials will appreciate the benefts of this, but others could object especially as their 'comfort zones' will be challenged with them being expected to accept new responsibilities that could be potentially frightening and risky.

Te possibility is that together these concerns will generate resistance to the reform and may cause those responsible for the reform to argue that either it is not really relevant to the needs of the country or it so runs against the grain of the culture of the country that at least some aspects of the reform are inappropriate. In some countries the result has been that the PFM/IC reform has been quite superfcial and limited to legal changes and requirements but with no substantive management or budgetary or accountability changes. Delegation often has been limited and largely restricted to relatively minor administrative matters. Because delegation has been so minor, the accountability arrangements have also been of superfcial impact. Terefore, there is little or no prospect of achieving the benefts of the reform.

Another important lesson from those countries that have sought to implement a PFM/IC reform is that to be efective it must be complemented by a public administration/civil service reform. (Tat too has not always been appreciated.)

Given the difculties with implementing and sustaining a full PFM/IC reform, what the reform may only in practice result in is improvements to public fnancial administration. Tis in itself could well be an important step forward, as well as a necessary step as a precursor to the much more substantive managerial PFM/IC reform. Te important point is that those with the ultimate responsibility for reform should recognise this.

Overall, the objectives of PFM/IC are to ensure:

• Public services are managed and delivered efciently and efectively and that a focus exists upon the user and the delivery of objectives and performance standards, not just fnancial and budgetary control.

#### **2 Implementing Public Financial Management and Internal Control…**


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# **3**

# **The Distinction Between Public Financial Management and Internal Control (PFM/ IC) and Public Financial Administration and Internal Control (PFA/IC)**

Te previous chapters explained PFM/IC and the implementation arrangements. Tis chapter distinguishes between public fnancial administration and internal control (PFA/IC), with a detailed explanation of what is meant by PFA/IC and compares it with public fnancial management and internal control (PFM/IC). Te main diference lies in the role of 'management' and the greater discretion that management has in the decisions about the delivery of services with PFM/IC, including responsibility for achieving greater efciency and efectiveness in service delivery. In the previous chapter the statement was made that PFM/IC should not be introduced until a robust PFA/IC exists, and this chapter explains what a robust PFA/IC involves. It also highlights defciencies in the PFA/IC arrangements when compared with PFM/IC.

# **3.1 Public Financial Administration and Internal Control (PFA/IC)**

#### **3.1.1 Control Prior to the Adoption of PFM/IC**

Before the introduction of PFM/IC should be attempted a robust PFA/IC should exist. Te focus with PFA/IC is upon control and compliance. Control and compliance are critical attributes which all countries ought to strive to attain. Tey mean that spending conforms with budgetary limits, that all spending is in accordance with the relevant laws and regulations, and that such expenditure is only for public policy purposes. If control and compliance do not exist, the sophisticated system which is PFM/IC, with the increased discretion available to managers, is being introduced without the underpinning basic fnancial control stability and without recognition and acceptance of the structures necessary to achieve and maintain that stability and propriety. With their present PFA/IC arrangements, many governments have *potentially* good-quality fnancial and budgetary control systems. Tese 'good-quality' fnancial and budgetary control systems, often known as integrated fnancial management information systems (IFMIS), will be electronic information (IT) systems. Tey may be local 'custom-built' systems or 'of-the-shelf' commercial systems. Tey are designed to help governments and ministries of fnance maintain control and compliance whilst operating within a PFA/IC framework. Te accompanying fnancial, budgetary, and procurement regulations should complement the PFA/IC arrangements and be designed to prevent inappropriate actions.

However, such systems have their weaknesses often caused by poor security or by non observance of the accompanying rules and procedures. IT security in some countries can be limited and IT systems can be subject to hacking or made vulnerable by a lack of IT discipline. A further problem is that countries using advanced commercial 'of-the-shelf' IT systems need to adapt their processes and arrangements to meet the requirements of the IT system, rather than the other way round. Tis adds to the difculty of application which can take a considerable period to apply1 (up to 9–11 years in some countries) and causes delay in the implementation of other fnancial management reforms. Such systems also tend to be very expensive. Claims are also made that implementing such a system will result in improvements in efciency and efectiveness but, such claims can only apply to the fnancial processes and not to the delivery of public services where the crucial factor is the quality of management. Consequently, that such systems may exist should not be a reason to argue that a PFM/IC reform is unnecessary. Teir existence also does not guarantee that a robust PFA/IC presently exists. Te adoption and application of the PFM/IC policy will not automatically remove any weaknesses. Te same types of operational challenges will remain.

## **3.1.2 The Control Environment**

Parliament through its approval of the budget and, in most countries the accompanying budget law, should dominate the approach to control. Parliament should approve variations to budgetary allocations in accordance

<sup>1</sup> 'Te introduction of an FMIS in a developing country should be regarded as part of a long process of reform. Tis process takes years to fully implement, costs millions of dollars, and has a substantial recurring operating cost.' Introducing Financial Management Information Systems in Developing Countries by Jack Diamond and Pokar Khemani: OECD JOURNAL ON BUDGETING, Volume 5, No. 3 2006.

with the requirements of the budget law, where these are found to be necessary. It should also be informed of signifcant variations in the income generating capacity of government. Te ministry of fnance has a responsibility for the overall operational control of the budget, reporting to parliament where budgetary spending changes are required and seeking parliament's approval.

Te budget law with PFA/IC will focus on fnancial limits rather than also on the 'outputs' to be achieved although the statements accompanying the budget are likely to include broad political aims, rather than specifc managerial objectives. Some countries have experimented with diferent forms of budgeting such as programme and performance budgeting in order to increase the emphasis upon 'outputs' but with diferent degrees of success. Such budgetary reforms have not usually been accompanied in developing and transition economy countries by any managerial reforms, which are essential if they are to be efective. Te following is a quotation from an OECD report on 'Budgeting and Public Expenditures in OECD Countries 2019'.2 It illustrates the importance of the comprehensive cultural change that is required to extend the concept of control based upon the budget to include 'outputs'. Adopting PFM/IC, although not specifcally referred to in the quotation, is an important element in that change:

[Performance budgeting] PB is a recurring focus of innovation because eforts to base allocations on results often fall short of the mark. Instead of abandoning the pursuit of performance, various countries have retained the PB label and reoriented it from performance-based to performance-informed budgeting or from central budget decisions to performance management in line ministries. Many countries have repeatedly tinkered with the defnition and classifcation of key concepts, such as outcomes and results, and with their use in the submission and review of budget requests. Others have shifted from PB's original focus as an instrument for deciding the budget to a means of classifying or displaying decisions taken during constructing the budget.

Some Member countries [i.e. of the OECD] have had considerable success with PB-type arrangements by recognising that performance has to be embedded in the culture and systems of public management, especially the strategic processes and goals of government, and has a robust infrastructure across government to support the production and use of performance information. Tese critical linkages are recognised and defned in the OECD Good Practices for Performance Budgeting. To this writer, several key insights emerge from the Good Practices and if properly adopted, will open the door to more efective

<sup>2</sup> https://www.oecd-ilibrary.org/docserver/9789264307957-en.pdf?expires=1596273746&id=id&accna me=guest&checksum=502CA11F8D42BE832A2E23BACABBCC68:pp27 and 28: author Professor Allen Schick.

application of performance budgeting. First, PB cannot be a stand-alone innovation; it must be closely aligned to national performance and mediumterm expenditure frameworks and evidence- based assessments of policies and resources. Second, PB should be adapted to country circumstances, with due regard to the role and interests of important stakeholders. Tird, there should be systematic use of performance information, guided by the central budget authority, but also involving line ministries, the legislature, and the supreme audit institution. Centres of Government (CoGs) have a critical stake in orienting programmes and line ministries to performance and results, but their role usually is limited. COGs can inspire and prod, they can demand performance information, and occasionally review budget options in the light of evidence on results. Overall, however, COGs have many other things on their mind that crowd out sustained attention to performance. Moreover, they may regard it prudent or necessary to leave sensitive questions—for example, how to improve the performance of teachers and schools—to others.

With PFA/IC the responsibility for detailed day-to-day fnancial and budgetary control lies with the ministry of fnance or its equivalent. Tus, with PFA/IC the central ministry of fnance is initially responsible if there is evidence of losses due to the failure of budgetary and fnancial control. Of course, it may seek to blame others, but the initial question is why it was possible for such losses to occur? Why were the ministry of fnance controls not efective? Whilst deliberate manipulation may have occurred within a line ministry or other public organisation which the central ministry responsible for control did not identify, the question then becomes, why not? Consequently, although the actual source of the failure may lie within a line or spending ministry or other public organisation a ministry of fnance cannot shift all responsibility for the inefectiveness of the control arrangements onto individual organisation managements. With arrangements for PFA/IC line ministry or service administrators3 will be subject to the detailed central control over 'inputs' exercised by central controlling ministries. Te usual organisational structure in line ministries and other organisations is for administrators to be appointed who may be politicians or civil and local government ofcials. Teir control focus will be on 'inputs' because that will be the primary concern of the controlling central organisations and parliament. Tey usually will not have the performance and fnancial analytical information to enable them to deliver services and activities efciently and efectively and to standard or to ensure that the arrangements for the collection of income have the same

<sup>3</sup>Te term 'administrators' in used in this context rather that 'managers' because with PFA/IC the administrator has such limited scope for taking managerial actions.

characteristics. Te likelihood also is that clarity of objectives will be lacking and management disciplines such as risk management will not exist or if they do, they will tend to be cosmetic in nature.

Whilst the main input controls exercised by a ministry of fnance with PFA/IC will be fnancial ones, a central ministry, either the ministry of fnance or another central ministry may also control the numbers and types of personnel who may be employed. Such numbers may be included in the budget documents and may in some countries form part of the budget law. Such personnel controls may also extend to the rates of pay that may be available, including payments to consultants, such as engineers working to support particular public service provision. Tis also has the efect of removing an important area of responsibility from a line organisation's administrations, such as a ministry responsible for delivering individual services. Similarly, line organisations may have responsibility for the instigation of procurements, although often the actual procurement processes are managed through a central ministry. Where though a line organisation has a responsibility for the actual procurement process, it should be expected to operate within centrally specifed procurement rules.

Improvements to PFA/IC will be focussed by central ministries upon securing a strengthening of control over 'inputs', including commitments. In some developing and transition economy countries attempts may be made to incorporate 'outputs' especially where countries are seeking to introduce programme budgeting. Control over 'inputs' is an important requirement but, as explained, can be a limiting management requirement if those controls are externally imposed and have no regard to the expected outputs. Such fnancial and budgetary controls will be designed to ensure that spending does not exceed that approved for individual budget lines or groups of lines and that the detailed fnancial control regulations are observed. Tis process in efect denies to administrators the discretion they would require as efective managers, as well as not recognising that they will need diferent and more detailed information if they are to deliver objectives efciently and efectively. Managers also need more fexibility if they are to succeed in this and that means that the virement rules need to be more relaxed. Tis, in turn, depends upon the attitude of parliament. Budgetary policy will also be designed to ensure that budget funds are allocated in accordance with government 'input' priorities such as 'we wish as a government to spend more money on schools, or healthcare, or prisons, or infrastructure'. Only rarely will this be translated into a specifc objective linked directly to the available budget because the information available to do so does not usually exist. And then with PFA/IC a management with the discretion able to actually deliver the specifc objective will not exist either.

Because responsibility for the strength of such fnancial and budgetary controls with PFA/IC rests with the ministry of fnance within any confnes set by parliament, that ministry will dominate the control process requiring public organisations to meet its requirements. In other words, the ministry of fnance will defne and secure the application of the control processes and how those control processes will operate. Te aim will be to ensure that through its control mechanisms, spending conforms to budgetary limits, that is, 'inputs', specifed in the budget law.

Te budgetary structure is also important in determining how efectively managers can operate. With PFA/IC line ministries and other public organisation administrators may have little or no say in the budgetary structure and they will be responsible for compiling the budget in accordance with that externally imposed structure. Tat externally imposed budget structure will be approved by parliament and be designed principally to meet the needs of the ministry of fnance. Tese needs, in turn, are likely to refect the analysis required for international statistical reporting purposes, not the needs of the individual public organisations. In some countries the ministry of fnance may also set out in detail how budgets are to be constructed indicating, for example, unit allowances for such items as vehicle running costs, or even ministry administrative costs. Where variations are required to any budget heading or, in some countries, groups of headings, ministry of fnance approval will be required.

No matter how detailed ministry of fnance control is over the construction of the budget it may also specify in fnancial regulations how day-to-day fnancial control is to be exercised to ensure that fnancial resources (both current and investment resources) are used to ensure that they are used only for public purposes and that efective day-to-day control exists to ensure that fraudulent, corrupt, or other improper activity does not occur. As was pointed out in the previous chapter those afected by the ministry of fnance control processes are unlikely to have any say in how they should be applied.

A further control exercised by a ministry of fnance is cash fow control. Tis will require other public organisations to ensure that spending complies with forecasts of cash fow requirements. Cash fow controls in some countries can be very detailed and be applied to most (or all) budgetary headings and in others can be limited to the main headings only. Te dominating interest with cash fow controls is likely to be that of the ministry of fnance. However, the more detailed the cash fow controls the more this draws a ministry of fnance into line ministry and other organisation decision making processes. Also, the more detailed the cash fow controls are the more unreliable they are likely to be, and this is likely to afect the level of 'trust'.

In summary, systematic accountability arrangements with PFA/IC within line organisations is likely to be limited to ensuring that budgetary and fnancial controls over inputs are maintained and that the requirements of the associated regulations are met.

Tese budgetary control rules may or may not apply to second-level nonmarket organisations such as agencies but are unlikely to apply to state owned enterprises. If they do not apply in detail to agencies, they will usually apply to the subventions from the frst to the second-level bodies. In some countries this allows second-level bodies direct control over what is regarded as its 'own income', where it engages in activities that provide sources of income. Consequently, income generated by an agency may not be subject to control at all and may not even be refected in the budgetary calculations of the controlling ministry or local government. (Indeed, one of the reasons in some countries for establishing such agencies is to avoid the detailed budgetary controls that would apply to the controlling frst-level organisation.) Although this is the reality of the situation this arrangement is inappropriate and can lead to abuse. In particular, an agency's 'own income' ought to be incorporated into the budgetary process and the controlling frst-level body should ensure that the methods used by an agency to determine 'own income' charges are appropriate and that forecasts of 'own income' are reliable and are met in practice. Te frst-level body should also ensure that all second-level bodies, other than state owned or local government owned enterprises, apply the same budgetary and fnancial control rules as the frst-level body irrespective of whether PFA/IC or PFM/IC applies.

Where state owned enterprises are exempted from budgetary control rules and the fnancial regulations that apply to non-market public organisations the controlling or owning frst-level body should have a responsibility to ensure that equivalent or appropriate controls are applied and are efective. Tese other forms of control should include the arrangements for governance and could also include specifc fnancial controls such as rates of return on capital to be achieved, limitations on payments to members of boards of directors, limitations on certain types of expenditure such as entertainment, a ban on the acceptance of fscal risks without the specifc approval of the controlling/owning frst-level body and/or the ministry of fnance. In Chap. 12 a more extensive discussion of the controls that should exist over second level organisations is set out.

#### **3.1.3 Limitations of PFA/IC**

PFA/IC, when applied well, is a robust system to ensure fnancial probity and compliance with public budgetary rules and regulations. However, even when applied efectively there remain limitations, hence the general drive towards the development and application of PFM/IC.

Te principal defciency with the whole concept of PFA/IC is the narrowness of the focus of the fnancial interest onto budgetary and fnancial compliance. A complementary focus is also on the current budget, whether 1 year or 3 years. Te broader fnancial and operational environment with the ability of the manager to deliver better value is not addressed and neither is the longer-term fnancial viability of the organisation. Also, there is no linking of fnance with objectives and performance standards and with the establishment of mechanisms to determine efciency and efectiveness. In other words what is lacking is a reference to the quality of public expenditure and sustainability. (PFA/IC is not alone in this and international measures, such as PEFA4 also just focus upon expenditure and do not refect quality.) In addition, even with a sophisticated IFMIS the system itself says nothing about the quality of public expenditure, that is, whether it is efcient or efective. Adopting PFM/IC will not change this if it simply concerns itself with technical changes and ignores the managerial impact dimension. Corruption, where it exists, complicates the introduction of PFM/IC because PFM/IC relies on the integrity of the managerial structures.

What is important in the development of a PFM/IC reform is a strengthening of the quality of policy development and operational management. As was pointed out in the previous chapters this requires the separation of policy and strategy development from operational management with the delegation of operational management responsibility from the political level coupled with greater accountability. But this can only occur with the development of a quality, managerially oriented civil or local government service. Added to this should be a strengthening of the overall governance arrangements and greater transparency. Tis will improve the quality of the checks and balances in the system, enhance user pressure to make public services more efcient and responsive to user needs (i.e. efective) as well as lessening the risks of corrupt and fraudulent activity.

Tis also impacts upon the role of a ministry of fnance. Te more the ministry of fnance seeks to control the detail of public expenditure the more it

<sup>4</sup>PEFA: Public expenditure and fnancial accountability framework: PEFA is a methodology for assessing public fnancial management performance. It identifes 94 characteristics (dimensions) across 31 key components of public fnancial management (indicators) in seven broad areas of activity (pillars).

discourages line ministry and other ofcials from becoming 'fnancially aware' and ensuring that public funds are spent efciently and efectively and achieve specifc objectives.

# **3.2 Comparing PFM/IC and PFA/IC**

#### **3.2.1 An Overview of the Comparison**

Tis next section compares PFA/IC and PFM/IC and highlights the systemic and operational changes that need to be considered in any transition to PFM/IC.

With the application of PFM/IC the parameters that need to be kept under review are much more extensive than those required with PFA/IC. A comparison is summarised in Table 3.1 (a detailed comparison is set out in the Annex to this chapter.)


**Table 3.1** Summary comparison of public fnancial administration and public fnancial management

aPerformance objectives cover the amount of work to be undertaken in a specifed time. An example would be the number of social security claims to be dealt with in a specifed period. This contrasts with performance standards which would be the quality of the way in which claims have been dealt with, such as responses within a specifed time by offcials, say within 1 week, and the number of errors made. All of this would be within an overall service objective of ensuring that the organisation had the capacity to deal with a forecast number of social security claims within the agreed budget

Introducing PFA/IC compared with PFM/IC does not have the same impact upon traditional customs and practices and therefore is easier and speedier to develop. In practice in this author's experience many of the reforms aiming to introduce PFM/IC have only had the efect of strengthening PFA/ IC. Tis is not a 'bad thing' but it does not achieve the benefts that can be achieved through the application of PFM/IC.

Key elements that need to be considered before any move to PFM/IC should be considered are encapsulated in the comments of Antoinette Sayeh, former Director of the IMF's African Department:5


Antoinette Sayeh went on to say:

3. 'Consolidation of responsibilities often yields better results. Te success of Treasury Single Account development and strengthened cash management in some countries is an impressive example of how consolidation can achieve excellent results. For macroeconomic stability, centralized decisionmaking is important to enforce fscal rules and budget discipline. Tese topics, with reliable fscal reporting, still comprise the "bread and butter" of technical assistance by the IMF in African countries.'

Tese three elements need to be addressed before a move to PFM/IC should be contemplated. However, point 3 potentially conficts with the PFM/IC requirement for the devolution of decision making and authority to make budgetary decisions. Central departments with control responsibilities, because of these types of risk and for other reasons can be very reluctant to relinquish their responsibilities. Also, there is a certain tension between point 3, 'the consolidation of responsibilities', and the devolution of responsibilities envisaged by PFM/IC. Te example from hospital services provided by De

<sup>5</sup>Keynote speech by Antoinette Sayeh, Director of the IMF's African Department at the UK's Overseas Development Institute's annual CAPE Conference, November 2013.

<sup>6</sup>PEFA—Public Expenditure and Financial Accountability (PEFA) is a tool for assessing the status of public fnancial management. See also footnote 4 above.

Geyndt and quoted in Chap. 17 also illustrates this tension. Yet to achieve improvements in performance, change is needed and that change requires managerial involvement in the delivery of services and activities with managers having a focus on the quality of services provided, that is, 'outputs' and the authority to make changes without central authority, except in specifc cases, such as those involving high political resonance or high cost and risk. Te introduction of PFM/IC makes this change possible but a critical factor in the devolution of responsibility is the existence of confdence by central controlling ministries, not least the ministry of fnance, that devolution will not result in a damaging loss of control over 'inputs' and will actually achieve the 'output' benefts that are claimed. Tose damaging consequences can be caused by incompetence, a failure to recognise the importance of control and not least fnancial and budgetary control, an inability to balance of service demands against available resources and worst of all, corrupt practice. What this does is to emphasise yet again that central to the success of PFM/IC reform is managerial reform and the prior existence of a robust PFA/IC. In turn it also emphasises that ministries of fnance and other central controlling organisations need to rethink how they exercise control. Unless demonstrably, the concerns expressed by Antoinette Sayeh in point 3 of her remarks can be met the PFM/IC should not be proceeded with until macroeconomic stability, fscal rules and budget discipline together with reliable fscal reporting can be achieved.

#### **3.2.2 The Objectives of Control**

As described in Chap. 2, the objectives of control are diferent between PFA/ IC and PFM/IC. Control with PFM/IC is not simply about fnancial, budgetary, and legal/regulatory control as with PFA/IC (see Sect. 3.1.1 above) but is also about achieving objectives to time, to standard, efciently and efectively. Parliament and a ministry of fnance (and possibly another ministry if a separate ministry is responsible for investment expenditure) will have an interest in each of these elements of control, but a ministry of fnance cannot be held responsible for these wider elements of control, nor is it in any position to achieve them. Responsibility frmly lies with the manager of a line ministry and other public organisations.

<sup>7</sup> See footnote 18 of Chap. 1.

With PFM/IC responsibility for the quality of controls is moved away from a ministry of fnance (and that other ministry if applicable) onto the management of each public organisation. Te primary responsibility for control therefore lies with the line ministry or other public organisation management and not with a central ministry. Consequently, blame cannot be so easily shifted. Tis creates an opportunity for the development of greater public transparency and accountability, not least to parliament who should be able to broaden its interest to the quality of the management responsible for the delivery of public objectives, that is, the quality of public expenditure. Parliament may need to adapt its scrutiny arrangements through the development of specialist committees to enable it to do this and with the support of the state auditor.

What should be of particular concern to a ministry of fnance is securing the achievement of overall macroeconomic stability, the observance of fscal rules and overall budgetary discipline together with reliable fscal reporting. It will want to secure the quality of the budget process ensuring that the objectives and performance standards for which the budget has been allocated are delivered. In addition, a ministry of fnance may wish to ensure that expenditure on certain key items, such as personnel does not exceed specifed limits and where that is the situation it may introduce specifc controls to secure its interest (although it should be borne in mind the more it does so it detracts from the management of a public organisation responsibility for the delivery of its objectives). With PFM/IC therefore the ministry of fnance in particular and also possibly the ministry responsible for personnel management, should be substituting detailed control for a macro type of control to enable line ministry management to exercise its full control responsibilities. However, to allow a ministry of fnance to do that it must be satisfed that the overall fnancial and budgetary control and personnel controls will be efectively exercised by line ministries and the subsidiary organisations for which they are responsible. Te ofsetting potential gain is an improvement in the quality of the utilisation of public resources in terms of achieving objectives and not least in efciency and efectiveness. Consequently, the development of PFM/IC represents a risk for central controlling ministries, although as noted in Chap. 1, the need to prevent the misuse of funds may be superseded by the need to deliver results.8 In other words, is the traditional practice of detailed control of inputs still relevant, to quote Schick in 'an era of big activist government'?

But whether that 'fundamental shift' will occur depends very much upon the existence of 'trust'. Do those central ministries or politicians who will be

<sup>8</sup> See footnote 15, Chap. 1.

required to relinquish control or the opportunity to make decisions through the development of delegation really trust others, line organisations and ofcials, to actually take on the responsibilities for control and to make decisions? Merely saying that they will be required to do so will not be efective! Tis is because ways will always be found round any notional reforms. Sometimes there is more at stake than simply concern about control, as was pointed out in Chap. 2, because the PFM/IC reform can mean a loss of authority and power and even opportunities for promoting particular objectives or indeed personnel. 'Trust' has to be built over time and 'trust' will develop when it can be demonstrated that devolution of control can work well, that objectives can be delivered and that public organisations can operate more efciently and efectively. Tis in turn afects the length of time that will be needed to implement the reform. Consequently, building 'trust' is a factor that reformers should not overlook (although unfortunately this never seems to be a factor in reform agendas).

Te central point, made in previous chapters, is that ministries of fnance should recognise that with PFM/IC to the traditional 'inputs' focus of control is added a focus on 'outputs', which are what service users and taxpayers are really interested in, that is, the quality, relevance, timing, and volume of public service availability. Unless attention is paid to 'outputs' no improvements in efciency and efectiveness can be achieved. Service quality, relevance, and timing are very much functions of management. Service volume in most countries will be linked to the totality of the budget inputs rather than to a conscious decision about service quality and efectiveness (i.e. the outputs).

An unresolved question is whether 'outputs' should be incorporated into the budget and hence into the budget law. Te introduction of PFM/IC because of the emphasis placed upon management and managerial discretion would clearly help but it would be impractical to incorporate into the budget law and for parliament to seek to exercise oversight at the managerial level. It would equally be difcult for a ministry of fnance to also exercise such detailed output control and this would also risk a ministry of fnance in efect becoming the ultimate decision maker rather than the manager of the line ministry or other public organisation. However, what could be appropriate in some countries, but only as a managerially oriented public service becomes established would be for the ministry of fnance to require line ministries and other public organisations to specify what is to be achieved from the utilisation of budgetary resources and how performance is to be assessed. Tis would be difcult to specify where public service outputs cannot be easily defned in specifc performance terms (see Chap. 6 on risks and unintended consequences). However, making line ministries and other public organisations more managerially oriented through budgetary disciplines should be a characteristic of the development of PFM/IC and of accountability and transparency.

An article in 2007 in the OECD Journal on Budgeting9 discussing the benefts of incorporating performance information commented:

Increasing the use of performance information in budget processes is an important initiative that is widespread across OECD countries. It is part of an ongoing process that seeks to move the focus of decision making in budgeting away from inputs (how much money can I get?) towards measurable results (what can I achieve with this money?). OECD countries have reported a number of benefts from the use of performance information (PI):


# **3.2.3 Budgetary Control**

Tere are two types of budgetary control, namely one centralised within the ministry of fnance and the other decentralised within ministries and agencies. Tese have been described in an IMF paper10 with their advantages and disadvantages as follows:

Centralized systems, particularly with centralized commitment and accounting controls, have the advantage of: (i) reducing the scope for variable interpretation and application of control criteria by multiple agencies; (ii) facilitating integration between aggregate cash control and commitment control at the transaction level; and (iii) allowing the ministry of fnance direct access to a centralized repository of expenditure data for budget execution monitoring/reporting. At the same time, centralization has the disadvantage of: (i) undermining spending responsibilities of managers in line agencies in the day-to-day management of line ministries/agencies' budgets; (ii) increasing the risks of noncompliance and/

<sup>9</sup> Improving Public Sector Efciency: Challenges and Opportunities: OECD Journal on Budgeting Volume 7 –2007.

<sup>10</sup>https://www.imf.org/external/pubs/ft/tnm/2016/tnm1602a.pdf.

or collusion (as both the authority to spend and the responsibility to ensure the regularity of transactions is assigned to the same agency) in the absence of strong internal and external audit functions; and (iii) inefcient decision-making (including superimposed prioritization) and rigid controls by the ministry of fnance when it lacks the detailed information on the spending requirements of agencies; and (iv) presenting opportunities for rent seeking by ofcials implementing multiple and cumbersome controls.

Decentralized frameworks have the advantage of: (i) aligning expenditure decision making with the spending priorities of line agencies; (ii) minimizing/ eliminating redundant controls which in turn improves the efciency and speed of expenditure execution; and (iii) making each line agency directly accountable for its spending programs. At the same time, they have the disadvantage of: (i) potential disparate application of controls by various agencies particularly when the control criteria are not well defned; (ii) increasing the risks of noncompliance and/or collusion (as both the authority to spend and the responsibility to ensure the regularity of transactions is assigned to the same agency) in the absence of strong internal and external audit functions; and (iii) prolonging the preparation of fnancial reports (as expenditure data has to be collected and complied from multiple sources) required by central agencies for budget execution monitoring.

Te actual process of budgetary control where PFA/IC exists will normally be exercised by the ministry of fnance through an IT-based IFMIS (see Sect. 3.1.1) and therefore be representative of the centralised system also described above. Te approved budget will be entered into that system as will actual line ministry spending (and for local governments if they are using the same system). Tat system would normally block any proposed spending for which there is no budgetary provision. Ideally commitments should also be entered into the system but this can be a weakness or if commitments are entered the information is not comprehensive being limited to current orders for goods and services and not refecting future orders to be placed during the remainder of the year or impacting upon future years. However, how efective such systems are in facilitating budgetary control depends upon the controls that in turn exist over the operation of this system and the managerial attitude to control. As was pointed out in Sect. 3.1.1, weaknesses in security particularly, can lead to abuse and misuse of resources.

Consequently, with PFM/IC the budgetary control process will be more devolved and hence more representative of the decentralised system referred to above. A ministry of fnance will still require information about spending in accordance with the framework specifed by that ministry no matter how budgetary and accounting information is reanalysed for internal public organisation managerial purposes. How frequently the central ministry of fnance will require that information will depend upon local country arrangements. An example from Canada (see also Chap. 5) illustrates how such information can be collected by the central ministry:11

Te government-wide chart of accounts is a framework that explains how departments [i.e. ministries] and agencies should identify, collect and report fnancial transactions to consistently satisfy the government's corporate information requirements. Te chart of accounts contains the accounts and codes for all the felds that comprise the government-wide coding block.

Departments and other reporting entities use these accounts and codes to input their monthly trial balances in the felds that make up the governmentwide coding block. Te departments then transmit these balances to the Central Financial Management Reporting System.

What this shows is that decentralisation does not automatically prevent the ministry of fnance from obtaining the information it requires.

A crucial control where PFM/IC has been established is to ensure that the information contained in the fnancial information system used by the manager is entirely consistent with that used by the ministry of fnance. To secure that consistency should be a responsibility of the head of fnance (see Chap. 8 on the role of the head of fnance). Regular reconciliation between the line ministry system and the ministry of fnance system should be a consistent feature of fnancial management. Tis can be ensured through a coding system which has the fexibility to allow both the manager in a line ministry or other public organisation and the ministry of fnance to obtain the information that they both require. Tis may be facilitated using modern IT systems.

## **3.2.4 Development of Budgets**

Te responsibility of line ministry administrators where PFA/IC applies from a fnancial perspective is limited to ensuring that budgetary limits are not exceeded, that fnancial regulations (including procurement regulations) and any cash fow limitations are observed. Tese line ministry responsibilities are usually exercised by the line ministry or local government accountant/fnance ofcer, rather than by the actual administrators. Te administrator responsible for a particular area of activity may not know exactly what budget is available for what service delivery purpose, because the structure of the budget and

<sup>11</sup>https://www.tpsgc-pwgsc.gc.ca/recgen/pceaf-gwcoa/index-eng.html.

the corresponding accounting arrangements will be designed to meet the needs of the ministry of fnance rather than the needs of the administrator. For example, personnel budgets may be amalgamated into a single heading for a whole ministry rather than be allocated to each element of a service or activity and budgetary control will be exercised on that basis.

With PFA/IC there is often no linkage of budgets to specifed managerial objectives and performance standards, although broad political objectives (aspirations!) are frequently included in budget statements. Neither is there a requirement to achieve efciency and efectiveness except again as a broad political objective. Tere will be no specifc managerial structures with delegated powers and accountability arrangements specifcally designed to deliver objectives or improvements in efciency and efectiveness. Te budget making process is likely to be dominated by the interests of the ministry of fnance who will specify in the annual budget circular how the budget is to be compiled. Administrators are unlikely to have the ability to intervene in budget making, except at the margins, and anyway without objectives and performance standards or the information to enable a judgement to be made about efciency and efectiveness the relevance of budgetary allocations to political policies and objectives is difcult to determine with any sort of precision. What will dominate is the overall fscal situation and the government view of political priorities. Terefore, budgets can come to be regarded as being 'imposed' externally rather than being 'owned' by the administrator. Te result is therefore that pictured by Antoinette Sayeh, namely that budgets can be better prepared than executed.

Service administrators are under diferent pressures than a ministry of fnance. Service administrators will want to respond to pressures from customers or clients of the public services for which they are responsible. However, the likelihood is that budgets in these circumstances will be dominated by the objectives of the ministry of fnance rather than jointly determined between the ministry of fnance and the line ministry administrator.

Tis contrasts with the situation where PFM/IC exists and where there is a much greater actual or potential opportunity for the establishment of budgetary 'ownership' by the manager and hence for both better-quality budget making and execution. Tis is because the manager should have a responsibility not only to secure budgetary control but also to deliver a set of objectives and performance standards. If the manager is to do that, that manager must be involved in the budgetary decisions. If the manager is not involved no commitment can be given to deliver those objectives and standards.

How the information about actual levels of spending (and income) against the budget will be provided will depend, as shown above, upon whether the budgetary control system is centralised or decentralised. In some countries information about spending against budgets is provided within line organisations only every three months although in others the routine is monthly reporting. With more advanced IT systems, whether there is a centralised or decentralised system, 'on-line' arrangements mean that spending information is current but only provided in accordance with the budgetary analysis required by the ministry of fnance because of the need to control against budget inputs. Te frequency of reporting is important for management reasons but with PFA/IC these management reasons are limited to those seen as important to the ministry of fnance. With PFM/IC three monthly reporting is quite inadequate because it gives too little time for adjustments to be made to spending patterns to enable managers to maintain or adjust service levels where budgets appear as though they will be exceeded *and* objectives may not be met. Or if the indication is that budgets will be under-spent and yet objectives met managers, with three monthly reporting managers are in no position to consider alternative fund usage provided the ministry of fnance budgetary controls permit this. With PFM/IC managers should also be provided with information about performance and such information, depending upon the activity, could be provided at diferent intervals, some of which could be very short intervals. Consequently, managers should be making operational as well as fnancial performance judgements and therefore reporting arrangements do need to be linked as far as possible.

With PFA/IC 3-monthly reporting anyway is also inadequate. Tis is because if spending appears as though it will not meet budgetary limits, and the emphasis is simply upon spending, and the indicator is that if budgets will be under-spent the incentive will be just to increase spending not least in order to maintain a claim on the same level of budget for the next fnancial year. Tis is even if funds are allowed to be transferred to meet an overspending elsewhere. If there is a possibility of overspending the incentive will be to make cuts to spending levels without necessarily any regard to the quality of service or the achievement of objectives. If, as with PFA/IC, the focus is only on spending levels, rather than also on the achievement of objectives, and there is a risk of overspending the budget, pressure is then generated to permit supplementary estimates or budgetary variation arrangements or to use 'other devices' to avoid breaching budgetary limits. An example of 'other devices' would be allowing the accumulation of arrears of payments to creditors or service levels are abruptly reduced or attempts can be made to reclassify current expenditure as capital investment. Such devices usually result in increased costs or greater inefciencies or inefectiveness in public service delivery and there is no regard to the achievement of objectives. Tis could also happen with PFM/IC but the likelihood is that the incentives will be less and the circumstances in which the possibilities will arise will be fewer, not least because of the focus upon the achievement of efciency and efectiveness.

An associated weakness with PFA/IC is that countries do not seem to require that regular re-forecasts are made of expenditure and income to the end of the year. Consequently, there is no opportunity to plan for how potential overspendings might be accommodated (or under-spendings). Such reforecasting ought to be an automatic requirement exercised by the head of fnance where PFM/IC has been implemented although there is no reason why it should not occur with PFA/IC. However, the incentive is much less because the focus is simply upon budgetary control not also on the delivery of objectives.

#### **3.2.5 Parliamentary Scrutiny**

Another factor afecting the frequency of reporting is the need to keep parliament informed of progress against the budget (i.e. for both expenditure and income) and to allow for efective fnancial scrutiny by parliament. Te purpose of parliamentary fnancial scrutiny is part of the process of developing transparency and accountability. Te aim is to make the government, individual ministries and other public bodies accountable for their fnancial decisions—in other words, requiring them to justify their revenue-raising and spending plans. With the development of PFM/IC the government and individual ministries and other public bodies should be able to explain whether the expenditure achieved its objectives and, if not, why not. Te degree of detail involved in the parliamentary scrutiny process will vary between countries, but the underlying principles should be to:


• Hold the government, individual ministries and other public bodies to account for their fnancial decisions and quality of fnancial management; and through the scrutiny process to contribute to an improvement in the quality of fnancial decisions and management and improved value for money in public services.

Financial scrutiny matters because the quality of fnancial decisions and fnancial management is likely to be higher if they are made transparent and if those responsible for them know that they will be scrutinised rigorously and mismanagement will be exposed. Better fnancial scrutiny should therefore result in more efcient and efective public services.12

To enable scrutiny to be efective parliament will need an appropriate level of support resources. Tis can be provided by the development of parliament's own staf and/or through support from the state auditor.

How frequently reporting to parliament should occur will depend upon local country circumstances but the OECD in a 2002 report on Best Practices for Budget Transparency13envisaged monthly, mid-year, and annual reports. Tese reports would serve diferent purposes, but detailed scrutiny could not occur monthly and probably only annually. In practice, the likelihood is that detailed parliamentary scrutiny of individual public service provision budgets would occur on a cyclical basis.

## **3.2.6 Internal and External Audit**

Whether PFA/IC or PFM/IC exists there is an important role for internal audit. Internal audit should identify and suggest remedies to address control weaknesses. Te potential weaknesses depend upon whether control is centralised or decentralised, as the IMF paper referred to above has identifed. However, realistically, if control weaknesses are extensive with PFA/IC because of a divided responsibility between a ministry of fnance and a line organisation or a lack of interest or involvement in fnancial, budgetary, and other controls by line ministry administrators, the likelihood of internal audit being efective will be limited, even where the internal auditor may report directly

<sup>12</sup>UK House of Commons Liaison Committee Parliament and Government Finance: Recreating Financial Scrutiny: Second Report of Session 2007–08: https://publications.parliament.uk/pa/ cm200708/cmselect/cmliaisn/426/426.pdf#:~:text=The%20principles%20which%20should%20 underlie%20the%20Government%E2%80%99s%20fnancial,an%20assessment%20of%20the%20 quality%20of%20fnancial%20management.

<sup>13</sup>https://www.oecd.org/governance/budgeting/Best%20Practices%20Budget%20Transparency%20-%20 complete%20with%20cover%20page.pdf.

to the political head of the organisation. Tis also suggests that changing to PFM/IC could enhance the efectiveness of internal audit because of the clear focus of responsibility for the operational efectiveness of all controls would be the responsibility of the head of operational management. But then that raises the question of to whom the internal auditor should report? With PFM/ IC the more appropriate reporting line would be to that head of operational management, rather than to the political head. (Tis question of reporting for internal audit is discussed elsewhere in this guide, see Chap. 7.) Another factor afecting the quality of internal audit will be the relationship with and attitude of the external auditor. External auditor support for the internal audit in some countries will be essential in developing internal audit quality and independence. Te development of PFM/IC also creates greater opportunity for the internal auditor to undertake value for money audits, partly because of the fnancial and performance information which becomes available and partly because the managerial orientation that would be required of management should encourage such an audit approach. Te same would also be true for external audit which has an increasing focus upon audits which address the issue of public value through performance audits.

#### **3.2.7 Consequential Features of PFM/IC That Do Not Exist with PFA/IC**

Tere are consequential features of PFM/IC which do not exist, and usually cannot exist with PFA/IC. One important feature in securing the achievement of objectives is the development of risk management, that is the identifcation and management of those risks that will afect the achievement of the objectives and performance standards and performance objectives of the organisation. Another is that to be confdent of achieving objectives managers must engage in strategic and business planning. Such planning will help managers identify the practicality of achieving the objectives of the organisation within the fnancial constraints that will inevitably exist, not only within the budgetary period but also over time, the length of time depending upon a particular service. A usually completely overlooked feature of PFM/IC, is that management should be always concerned with the longer-run fnancial resilience of the organisation. Tis is not simply, as has been indicated previously, a matter of preparing, say, 3-year medium-term budgets but of looking much further forward and assessing the impact of current policies and investment decisions as well as external factors (such as demographic changes) upon the possible future fnancial resources of the organisation.

Each of these features of PFM/IC is addressed in detail in later chapters of this guide.

# **3.3 Summary**

Before PFM/IC is developed there should be in existence, as emphasised previously, a robust PFA/IC. Te principal diferences between them are:


# **Annex: A Detailed Comparison of PFA/IC and PFM/IC**

Te chart set out below compares diferent aspects of public fnancial administration and public fnancial management.





determined by the ministry of fnance (and with PFA/IC

may be operated by the ministry of fnance), with PFM/

IC, implementation of the controls will be a responsibility

of the line organisation manager. However, output

controls designed to achieve objectives and performance

standards should be controls established by the line

organisation. Line organisation management should

therefore have a specifc interest in their appropriateness

and success. PFA/IC does not present these issues to the

manager because the focus of control is only on inputs.





resources and ultimately about

effciency and effectiveness.


(*continued*)


set for the second-level body.

implementation.


'Owning' organisations should defne the role and appoint the governing boards, defne the governance structures, set rates of return and other performance objectives ensuring that appropriate allowances are made for the costs of capital and for commercial risk. Arrangements should exist for the regular and systematic monitoring of the performance of state owned enterprises with the periodicity of such monitoring depending upon the nature of the business of the enterprise, its political salience, and other local circumstances.

Although the controlling arrangements would be similar, whether PFM/IC or PFA/IC were adopted, although in practice the likelihood is that the fnancial disciplines required for the effective application of PFM/IC would affect how the responsibilities of the 'owning' organisation towards a state owned enterprise were effected. The 'managerial culture' where PFM/IC is employed would be very different from that where PFA/ IC exists and it would be exceptional to expect one culture to apply within an organisation and another towards a second-level organisation, whether an agency or an enterprise. No enterprises should be allowed to accept fscal risks 

without the specifc permission of the 'owning'

organisation and if appropriate the ministry of fnance.

(*continued*)


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# **4**

# **The Practical Steps for Initiating a Successful PFM/IC Reform**

Tis chapter looks at the practicalities of introducing PFM/IC. It sets out a series of tests that should be applied before adopting and applying the reform. It also suggests that an initial study is carried out to assess whether a government is really willing and able to undertake the scale of the reform necessary to apply PFM/IC. Te chapter builds upon the discussions in previous chapters but focuses on the practicalities of successfully achieving change and the consequences when this is only partially realised.

# **4.1 This Is a Management Reform!**

# **4.1.1 The Managerial Impact**

Government is about hard policy choices and those choices are bound to attract criticism from those who are adversely afected. Given the increasing signifcance of public expenditure and the impact upon individual lives improving the quality of the management and delivery of public services, that is improving public value, is essential. PFM/IC is an important contributor to achieving that objective. Simply regarding PFM/IC as a technical fnancial reform focussing on the arrangements for fnancial and budgetary control will not deliver that contribution. In the previous chapters the argument has been that not adequately considering the substantive management reforms that must accompany the technical fnancial reforms which are part of the PFM/IC reform will prevent the achievement of the benefts of the reform and will probably add to costs. Te overall purpose of the PFM/IC reform is to deliver better quality public services, to make better use of public money and assets and to ensure that income generating policies achieve their objectives. Tis reform also aims to ensure that both expenditure and income are efciently and efectively managed. Te reform can be summarised as aiming to achieve six purposes:


Achievement of these six purposes provides the basis for judging whether the reform has been successful. Quality management, including leadership, is central to this. Leadership means that the top and senior political and appointed ofcials are committed to and actively support the reform. Local ownership is also very important.

Introducing PFM/IC is a major reform. As has been pointed out in the previous chapters, PFM/IC can impact radically on the roles of elected and appointed ofcials. Te extent of the change depends upon the present organisational arrangements. It may also lead to questions about the shape of the government organisation. Elected ofcial's area of responsibility should be to concentrate on the development of policy and the strategy for the implementation of policy. Appointed ofcials, the civil and local government service responsibility, is that of operational management, that is, 'delivery'. To achieve efective policy development though, cooperation is required between operational and political management. A role of the operational management is to assist the politician turn political ideas into deliverable public services and activities.

Decisions about policy determine the objectives the political head of an organisation (a ministry or a local government) wishes to achieve. Tis will afect the management structure of an organisation and the range of stafng skills required. Clarifying objectives therefore may well raise questions about the appropriateness of the present organisational structure. Te head of operational management should be responsible for determining the most appropriate structure to deliver the objectives. Tis though may be in consultation with the political head of the organisation.

Many of the most difcult problems that governments have to address cannot be solved by a single ministry or within a single year and decisions made by one ministry can have impacts upon other ministries and public organisations. Tey require cooperation between ministries and between diferent types of organisations, such as central ministries and local governments and sometimes private organisations. For example, homelessness cannot be solved simply by making more accommodation available and therefore be a sole responsibility of a ministry responsible for housing. Or again, solving a drugs problem is not simply a function of the justice system. Consequently, a focus on objectives will require a capacity for politicians and the ofcials responsible for operational management to cooperate across organisations to provide solutions, and this in turn requires a fexibility of approach to budgeting and to fnancial and performance reporting arrangements. Efective cooperation may require budget sharing and as has been shown earlier this can be very difcult to achieve without a determined 'whole of government' approach. Te complex nature of many problems that the public sector is required to address does mean that thought should be given to the longer term fnancial consequences in managing these problems. Very few problems can be addressed within a single budgetary year or even over a mediumterm budgetary cycle. As has been explained in the previous chapter this means much more than simply thinking about the current and medium-term budgets.

Devolution of operational management to the civil or local government service is a feature of PFM/IC but coupled with managerial accountability. In reality as this guide shows, it will not be feasible for operational management to be retained by the political level and at the same time implement PFM/ IC. Tis is because of all the managerial features of PFM/IC. It requires the development of competent professional managers and, where appropriate, managers with specialist knowledge and experience. Te search for efciency and efectiveness requires the creation of opportunities for the exercise of managerial discretion. Tat discretion is necessary to enable managers to experiment with alternative solutions to problems, but they can only do that if fnancial analytical information is available coupled with performance information. In some circumstances the approval of the political management may be required to alternative operational solutions, but there will be many circumstances where operational managers should use their own initiative to achieve greater efciency and efectiveness in the delivery of objectives and in the day-to-day management of public services.

To achieve these benefts the civil or local government service must be well organised. Tat means, as is shown in Chap. 14, that the organisational arrangements essentially follow the principles of bureaucracy specifed by Max Weber1 and then are adapted to a managerial style of public organisation.

Te characteristics of an appropriate modern civil service organisation should include the following:

	- (ix) A fnancially aware management.
	- (x) A management trained in managerial concepts.
	- (xi) Managers having the discretion to make decisions about how to achieve their objectives and therefore how to utilise the resources available to them, or in some instances to dispose of those resources such as redundant assets.

<sup>1</sup>Max Weber: a German-born sociologist and political economist who developed a theory of bureaucracy.

(xiii) An external organisational control focus upon accountability for the achievement of the organisation's objectives and performance standards, efciently and efectively and within the relevant laws and regulations.

Each of these characteristics is addressed in the chapters of this guide.

As these characteristics indicate, operational managers should be accountable for their actions and for the performance that has been achieved. Accountability will be from lower to more senior levels of operational management and ultimately to the political levels of management and from them to parliament and the consumer/user of public services.

In some countries, as has been mentioned previously, extensive use is made by frst-level organisations such as ministries and local governments, of second-level organisations whose objectives are intended to deal with specifc problems. Te frst-level organisation must remain in efective control of a second-level organisation and should determine its objectives, performance standards and governance arrangements. Tis is essential, otherwise a secondlevel organisation will develop its own objectives and policies and make coordination between the frst- and second-level organisation difcult. Te introduction of PFM/IC should generate a discussion about the need for and the role and management of second-level organisations (see Chap. 12).

Te need for coordination may also generate a challenge to other public fnancial management reforms such as programme budgeting where very often programmes are built around individual ministries and are designed to deliver the specifc objectives of individual ministries, rather than around the problems that governments, as a whole, are aiming to address.

#### **4.1.2 The Benefts of the PFM/IC Reform**

Te politician and the senior civil and local government ofcials should be aware of and seek to make use of the benefts that the policy of applying PFM/ IC at all levels of government make possible. Tese benefts can be summarised as follows:


Tis in turn refects in the advice available to the political level of management.


Tese benefts are discussed in more detail in Chap. 10.

# **4.1.3 Control**

Where the focus is simply upon budgetary and fnancial control maintaining that control, as required with PFA/IC, can be a relatively simple exercise. It does not require a sophisticated management, but with PFM/IC delivering a service and achieving an objective efciently and efectively, does. Terefore, politicians and senior civil and local government ofcials in considering this reform need to question the quality of the managerial arrangements with honesty and openness. Success with the reform depends heavily upon the quality of management and whether the present managerial arrangements are ft for purpose or not? To answer this question politicians and civil and local government ofcials should consider not only the role of other civil and local government ofcials, but their own roles as well. Answering this question challenges how elected ofcials perform their responsibilities as well as appointed ofcials.

Financial and budgetary control, which is the focus of pre-PFM/IC policies, is not management. Certainly, fnancial and budgetary control are an essential precondition, a building block, in the process of establishing efciency and efectiveness in the achievement of objectives. If, though, a ministry of fnance or an organisation responsible for personnel controls tries to maintain exactly the same form of control with PFM/IC as it traditionally has, what it is likely to do is to actually prevent the development of PFM/IC. Te approach to fnancial and budgetary control must change to refect the managerial environment then applying in line ministries and other public organisations.

PFM/IC will also require the deployment of new skills, both fnancial and managerial skills. Tis will mean that considerable efort will need to be devoted to training and the practical development of both sets of skills in 'real life' situations. Te training that is required is not simply technical training but very importantly should include the development of managerial skills which are essential to the development of a quality civil and local government service. How the operational management is appointed depends upon the arrangements in a particular country, but the underlying theme should be that such ofcials should be appointed on merit. A statement about the appointment of civil servants setting out 14 principles has been issued by the OECD2 and SIGMA has published a set of 'Principles of Public Administration' which are discussed in detail in Chap. 14. Tese provide guidance to countries introducing PFM/IC on the professionalisation of public service management, but they also demonstrate how important is the integration of PFM/IC reform with public administration/civil service reform.

#### **4.1.4 The Timetable for the Reform and the Role of Parliament**

Te full requirements of the reform cannot be accomplished quickly or even comprehensively across the public sector, except possibly in the smallest of countries. Where a country is decentralised with powers devolved to regions and local governments the time taken to undertake a comprehensive reform is likely to be even longer. Tis is not simply a matter of introducing new laws

<sup>2</sup>OECD, Recommendation of the Council on Public Service Leadership and Capability, OECD/ LEGAL/0445: 2019.

and regulations, although this is likely to be part of the process, and then assuming that because such laws and regulations exist, they will be obeyed. (In the experience of this author this is how ofcials in some countries have reacted to the introduction of PFM/IC, largely because they have seen it simply as a technical reform.)

Treating the reform as a technical reform or even as a managerial reform does not necessarily consider the development of external accountability and in particular to parliament. In no policy papers seen by this author has the impact upon parliamentary accountability been discussed. Yet parliament through the development of PFM/IC should have a greater ability to review how decisions have been made and the factors that have been taken into account. In particular an issue that should be considered is the extent to which the budget should incorporate information about performance indicators and other managerial objectives (see Chap. 3).

As has been explained previously in Chap. 2, parliament ought also to be involved with the reform from the outset. It should be asked to approve the policy and its purpose. It should approve the timetable and proposals for the staging of the reform. It should also hold ministers, and in particular the minister of fnance, to account for the achievement of the timetable and the objectives of the reform, including the benefts. In this sense parliament should act as a driver of the reform.

Countries are often under pressure from external organisations to introduce this reform, but such organisations seem to focus only on the technical aspects of the reform overlooking the managerial context. Yet whether this is an appropriate reform for a country depends upon the political, cultural and operational circumstances prevailing in a country and its willingness to undertake the scale of the reforms needed. To assist a country in making this decision a series of tests have been developed (set out below) which should be applied by those seeking to apply the reform.

Countries also tend to want to undertake this type of reform when there is a crisis. But that is often the worst time to do so because there are immediate pressures for results and yet as has been shown a PFM/IC reform is a longterm reform and managerial change often takes several years to become embedded. A much better approach would be to plan for and apply the reform in a more normal situation.

#### **4.1.5 The Tests That Can Be Applied to Assess the Feasibility of the Reform3**

Based upon the experience of this author, those governments contemplating the introduction of PFM/IC ought to apply the following tests to establish whether this is a feasible reform given the circumstances of the country. Tis would be a novel approach, but if the requirements identifed in these tests cannot be met, the likelihood is that the reform will not be successful. Most of these tests cannot be met immediately. Te aim should be to ensure that over time they can be.

Success should be measured by the extent of the achievement of the benefts of the reform. Success should not be judged by the existence of the bureaucracy associated with the reform: that is no test, although, in the experience of this author, that is the judgement that is often made.

Te tests, and there are nine, refect the political and senior ofcial 'will' that is required to achieve the substantive change process that results in success and for the benefts to be fully achieved. Tey are separate from the structural systems and processes that provide the platform upon which PFM/IC can be built. Each test is individually important but a failure to meet one or more of the tests would not necessarily be fatal, apart from tests 1 and 2, but it would make the achievement of the benefts of the reform much more diffcult. However, the experience of this author is that some form of these tests is rarely, if ever, applied. Te assumption appears to be made that because PFM/IC represents 'international best practice' almost by defnition, if the bureaucracy associated with PFM/IC is introduced, it will result in the removal of defciencies that presently exist. It will not!

#### **Test 1** *Is the present system of public fnancial administration and external control robust?*

Tis frst test should be to assess the current strength of the present system of public administration and control (i.e., some form of PFA/IC). Does it sufer from those weaknesses identifed in previous chapters? Tis is a crucial test. If this test is failed, then no further substantive progress can be made. Te remedy is to ensure that this test can be met by strengthening the present system. Tis is because the change to PFM/IC shifts responsibility for budgetary and fnancial control from an external control, essentially by a ministry of fnance, to an internal control by the managers of a public organisation. Te

<sup>3</sup>Tese tests have been developed by this author and are based upon the analysis contained in this guide.

risk, if this test cannot be met, is that the ministry of fnance loses control of the fnances of the government and this is too great a risk.

In Chap. 1 the distinction between external control (i.e., by a ministry of fnance or other ministries external to the organisation concerned) and internal control (i.e., by the management of the organisation itself) was identifed, and in Chap. 3, the diferences between public fnancial administration and public fnancial management were described. Only when weaknesses in the present controls have been removed should the introduction of PFM/IC be commenced. Unfortunately, in many countries in the experience of this author, this test is not considered.

**Test 2** *Is there the recognition and acceptance by the government that PFM/IC is primarily a management reform and that its introduction will have an impact upon the allocation of responsibilities for operational management between the political and the ofcial levels of management. Coupled with this are top operational managers (state secretaries and others) willing to accept the additional responsibilities and be prepared to fully support implementation? Tis also creates an opportunity to increase parliamentary accountability and is that recognised as acceptable?*

Tis is a critical test because it asks if the government and the top opertional management is willing to accept that PFM/IC involves signifcant managerial changes and the enhancement of accountability to parliament. Tis test strikes at the heart of the custom and practice often existing within a country. Te most important change that is likely to be required afecting the political level of management will be to separate most decisions about operational responsibility for the day-to-day delivery of services from responsibility for the development of policy towards the delivery of those services and the oversight of the quality of service delivery. Responsibility for operational management would become a civil or local government service responsibility and policy, strategy and oversight would be a political responsibility. (Tere may be some exceptions to this general rule and these are discussed in Chap. 14.) Parliament also has a greater potential opportunity to assess managerial performance in the delivery of objectives and performance standards. Te analysis of the PFM/IC reform contained in this guide as indicated above shows that in practice, given the additional managerial activities that PFM/IC imposes upon a manager and the experience and training required to undertake those responsibilities, continued political management of most operational activity would be most unlikely to be successful.

Tere are potentially signifcant cultural implications that may make this test difcult to address. It can also raise the question of 'trust'. Te tradition in many countries is that an election gives to the elected ofcials authority to make all decisions and, as is pointed out elsewhere in this guide, that for some, unless elected ofcials have that power to make all decisions they do not feel in full control. Tat power to make all decisions, no matter how trivial, creates an illusion of control. An important activity in the establishment of PFM/IC is to encourage elected ofcials to recognise that PFM/IC is about the development of managerial professionalism. Elections give the elected ofcial an implicit mandate to put into efect the policies that they have been elected to pursue. Te emphasis is upon policies not upon detailed operational matters. A key question therefore is, is there the political will to accept the delegation of operational management to the civil and local government service? Is there also a corresponding willingness of the top operational management, not just in the ministry of fnance but throughout the central and local government sector, to accept and support the reform? Involved in this decision is this question of 'trust'. Do the politicians trust the civil service and do the civil service trust the politicians?

A consequence of this separation will be that the civil and local government service organisational arrangements may need to be restructured to accommodate its additional responsibilities for operational management. For example, state secretaries, or equivalent, may need to be appointed with substantive executive authority over operational service delivery matters. Exactly where any boundary exists between decision making about operational matters and policy will be largely a matter for local decision based upon local circumstances. Te precise boundary between policy and strategy and operational management will also vary over time, with personalities and operational circumstances. However, efective policy development depends upon an appreciation of the issues that will need to be addressed by operational management (emphasising the importance of cooperation between operational managers and those responsible for policy development), and not least the fnancial issues.

Another objection to the reform may be that enhanced accountability to parliament thus allowing parliament to question in more detail the quality of management would be inappropriate. But then transparency and accountability are essential to democratic control of government activity and can serve to support government in improving the quality of the management and hence delivery of the objectives efciently and efectively.

Tis test will indicate whether the government and top appointed management accepts that this is a managerial reform or sees it simply as a technical fnancial control reform. If the latter, either the government needs to be persuaded otherwise or it should be made clear that the benefts of the reform will not be achieved. Tere is no point in spending public resources on introducing the appearance of a reform that will have no substantive benefts and will add to costs. Te possibility also exists that pressure will develop to modify the cosmetics of the reform when there is a recognition that the benefts are not being achieved, and return to the status quo ante.

**Test 3** *Is the budget designed to facilitate the development of managerial objectives and if not, can it be?*

Because PFM/IC should be regarded as a management reform as well as a technical reform, the budget should be designed to make it possible for management to deliver its objectives (i.e., outputs) as well as to secure the control of inputs. Most budgets focus on inputs although the accompanying budget statements very often describe the broad objectives to be achieved. Budget structures generally are designed to largely meet the needs of the ministry of fnance, rather than those of the operational manager. For PFM/IC to be efective an important budgetary reform should be to develop linkages between budgetary inputs and the outputs expected from those inputs. Tese linkages can only be developed over time, and the reorganisation of the budget structures to meet the needs of the manager should depend upon individual managerial requirements. To meet this test initially the ministry of fnance should frst acknowledge that budgetary reform is required and that it needs to occur as PFM/IC is developed. It should then cooperate with those responsible for the PFM/IC reform to ensure that the two reforms are compatible. Budgetary reform should also make possible the development of parliamentary scrutiny. However, the main concern with budgetary reform should be to ensure that these three concerns are addressed:


Tis may mean for some expenses, for example, such as personnel or property costs, that instead of such budget lines being consolidated, they are analysed over individual services or activities. Tis would have also the advantage of facilitating parliamentary scrutiny.

A feature of management in some developing and transition economy countries is that a main activity of managers/administrators within line ministries is to manage the delivery of public services within a context of unstable budgets or budgetary uncertainty with budgetary allocation shortfalls, often represented by a shortage of cash. Introducing PFM/IC in such circumstances is inappropriate. PFM/IC will do nothing to remove such problems. A key requirement of PFM/IC is the existence of a budget to which objectives and performance standards and performance objectives can be linked. Tis will facilitate efective management, and therefore, such budgetary and cash management defciencies need to be addressed before attempting to implement PFM/IC.

Unfortunately, in the experience of this author, in no country has any consideration been given to the impact of the PFM/IC reform upon budgetary or cash management arrangements to meet either the needs of the manager or to facilitate improved parliamentary scrutiny. (See also tests 4 and 5.)

**Test 4** *Is there a willingness by the ministry of fnance to accept that changes to the traditional budgetary and accounting arrangements will be required to allow for the development of managerial control by individual managers and for the development of management accounting, thereby allowing managers to deliver improvements in efciency and efectiveness?*

Te frst change that will be required for efective management is that budgets will need to take into account not only the fnancial limitations but also the policy objectives, performance objectives and performance standards the government wishes to see achieved. Tese will also have to be cascaded down to each level of management. It is these factors which ought to determine the available budget to each manager, not simply last year's budget plus infation and then adjusted for the overall fscal position. Terefore, if the fnancial ceiling is insufcient to facilitate the achievement of the desired policy objectives, performance objectives and performance standards one or other should be changed. Te second change is that the traditional budget structure will not be analysed in a manner to meet the needs of the manager. (Tere is most unlikely to be any correspondence between the allocation of resources required for ministry of fnance budgetary control purposes and the allocation of budgets for management purposes.) With PFM/IC a manager should know the total budget available to him/her (i.e., all budget headings) in order to achieve the objectives for which the manager is responsible for delivering. Te manager should also be aware of those costs that are fxed and those that are variable and therefore those on which a manager can have an impact, sometimes short term and sometimes long term. Tis can be a particularly difcult analysis because some costs deemed to be fxed, although not in accounting terms, such as employee costs and some overhead costs, along with accommodation costs are, in reality, variable. To achieve efciency a manager should be prepared to take on the challenge of questioning whether such costs are predetermined and necessary. For example, is it really necessary to occupy a particular building, or can the way in which the service is delivered be changed in order to increase efciency or to take advantage of new technology or new ways of working using modern technology?

Meeting managerial needs can become more difcult where, as in some countries, there is a separation between current and investment budgets with the ministry of fnance being responsible for the current budget and a separate ministry, such as a ministry of planning, responsible for the investment budget.

In summary, with PFM/IC the budgetary analysis (and hence also fnancial accounting information) needs to serve at least two purposes: the interests of the ministry of fnance and the interests of the manager. It may also need to address the specifc needs of the parliament for parliamentary scrutiny purposes. Tis will mean changes in some countries where comprehensive budgetary information is not available to the manager because some budgetary headings, as pointed out in the comments on test 3, such as personnel and overheads which can be regarded as 'fxed' costs, are not analysed over objectives but are held as centrally controlled budgets.

Consequently, a further test associated with the change from an administrative to a managerial culture is to recognise that budget structures required for managerial purposes, and indeed parliamentary scrutiny purposes, may require considerable reform.

A further consequence of this is that where the manager is expected to deliver objectives and performance objectives and standards within a specifed budget, the manager responsible should be committed to the delivery of those objectives, to the performance standards *and* to the available budget because otherwise that manager cannot be held to account. Tis may require changes to the consultation arrangements associated with budget preparation (i.e. the budget circular) with the manager being involved in detail in budget preparation and agreeing that the available budget is sufcient to deliver the objectives and performance objectives and standards expected within a budgetary limit.

Experience shows that ministries of fnance can be reluctant to see diferent forms of budgetary analysis and accounting information develop. Tis may be a particular problem where ministries of fnance have adopted 'of the shelf' commercial software packages. Tis is because such commercial packages can be difcult to amend to facilitate managerial needs as well as those of the ministry of fnance. Ministries of fnance may also fear loss of budgetary and fnancial control and a potential weakening of their ability to provide internationally required statistical information. Tey may also be driven by a concern that they cannot trust other public organisations to properly control costs. Or as was pointed out by De Geyndt (see Chap. 1), central bodies can be unwilling to see changes which would afect their apparent authority. Te result may be inappropriate budgeting and a budget which is incompatible with managerial objectives.

In general, changes to the arrangements for budgetary and fnancial analysis are not considered as one of the consequences of the introduction of PFM/ IC. However, they are essential if managers are to deliver objectives, performance standards and objectives and efciency and efectiveness. If a ministry of fnance is unwilling to accept the need for such changes, this will make difcult, if not impossible, the achievement of the benefts of PFM/IC.

(Some argue that a ministry of fnance and the manager should be concerned not with outputs but with outcomes. However, outcomes are even more difcult to defne and to manage than outputs, not least because the factors afecting outcomes are often not under the control of the manager and they are likely to take many years to realise.)

**Test 5** *Is there the recognition by the ministry of fnance that traditional budgetary, cash fow and personnel controls exercised by central ministries may need to change as may the virement control arrangements to accommodate the responsibility of managers to deliver improvements in efciency and efectiveness?*

A key feature of a managerial culture is that managers have the freedom to develop initiatives to ensure that they can deliver objectives and performance standards along with improvements in efciency and efectiveness. In practice this means that managers need the discretion to make changes to the allocation of resources.

Consequently, a managerial culture does mean that the traditional detailed control exercised by ministries of fnance and by the ministry or department responsible for personnel management will require reform. Unless these ministries accept that discretion is needed line ministry management will not be able to take advantage of the managerial opportunities that the adoption of PFM/IC generates. Consequently, the controls exercised by the ministry of fnance should also be reformed taking into account not only the control of expenditure (i.e., inputs) to a control based upon the achievement of objectives (i.e., outputs). A managerial capacity to develop initiatives may afect the timing of expenditure as well as the detail of expenditure, and this could also mean that cash fow control may also require review. Similar points apply to the central organisation responsible for personnel controls. Improvements in efciency and efectiveness are not achieved simply by exercising fnancial and budgetary control or even by requiring that the lowest tender is always the one to be accepted, although this is sometimes how improvements in efciency are defned. A consequence of the reform, therefore, is likely to be that line ministries will require considerable freedom about how they organise, direct and manage the resources put at their disposal through the budget process. Without that if a ministry of fnance or the organisation responsible for personnel control seeks to continue to exercise control through detailed regulation requiring it to approve all changes, in efect that shifts responsibility from the line organisation manager to those central organisations who efectively become the decision makers. Tis is not to argue that such controls should be totally removed but it does mean that the way in which they are exercised may need to be changed. In other words, the introduction of PFM/ IC should cause countries to review the way in which such central controls are applied. If a ministry of fnance (and any other central organisation) is not willing to change their approach, the benefts of PFM/IC are unlikely to materialise, or at least fully materialise.

A ministry of fnance or the organisation responsible for personnel controls therefore should change their approach to control from detail to focus on developing policy guidance about the types of transactions or personnel policies which they feel they ought to be consulted about, that is, a shift to a strategic form of control allowing the development of a managerial capacity.

#### **Test 6** *Is a reform of the civil and local government service responsibilities and organisational structures (public administration reform) also being undertaken and is this review compatible with the requirements of the PFM/IC reform?*

Following on from test 5, whilst the PFM/IC reform has signifcant management characteristics, that reform on its own cannot drive public administration reform. Tat drive needs to come through an overall review of how the civil and local government service operates, that is, its responsibilities, management structures, leadership arrangements and the relationships with the political level of management. Public administration reform will also need to prepare the civil and local government service to take on the leadership, operational management and other responsibilities that the PFM/IC reform will require the civil and local government service to absorb. Tere is no feasible option for those involved in the PFM/IC reform but to ensure that a comprehensive management reform is compatible with the managerial reform requirements of PFM/IC. Success in improving the quality of public services depends very heavily upon the quality of management.

An essential feature of the reform therefore will be that the PFM/IC and public administration reform programmes are fully coordinated and are developed in parallel. Te initial focus of the public administration reform should be to facilitate the separation of operational management from policy and strategy development responsibilities and to facilitate the development of management structures (see also test 7). What should not happen is a public administration reform that seeks to specify in detail how each ministry and other organisation should be structured and the diferent categories of ofcial that should be employed. Te person who is the head of operational management should have sufcient authority to determine the actual management structure within the organisation for which he/she is responsible.

Coordination of the PFM/IC and public administration reform programmes is not an activity that usually occurs. Both reform programmes are usually considered separately, and this is because the PFM/IC programme is simply regarded as a technical reform. But without that coordination, which has the practical efect of bringing fnance into the management processes, the benefts of the PFM/IC reform will not be achieved. Terefore, can this test be met?

Associated with this test will be the need to establish an efective managerial control over second-level organisations. Not only will that mean the preparation of agreements setting out the objectives and performance criteria for such organisations and that such agreements are regularly reviewed, but also the frst-level organisation having a capability to determine and systematically monitor the policies and performance of the second-level organisations it is responsible for.

**Test 7** *Are the arrangements for the management and motivation of civil and local government ofcials consistent with the need for them to take on the responsibilities of management including taking initiatives and making judgements?*

Central to the successful application of PFM/IC are 'people' and their motivation. Te reform is not simply about systems and technical 'fxes'. Systems and technical 'fxes' must be applied by people, that is, by the civil and local government service ofcials. With delegation and managerial accountability, an important consideration should be the motivation of civil and local government service ofcials to make judgements and to take decisions, that is, their engagement in the business of the organisation. Tis is not just a matter of training in the techniques and technical 'fxes', important though these may be, but it is also about culture and management: how to develop and direct organisations to achieve whatever it is they are expected to achieve and to do so in a manner that has regard to the public interest. Tis requires rather more than training but an investment in the development of civil and local government ofcials as managers and leaders. Tis involves the linking of theoretical training with problem solving as well as developing those skills that a manager requires. Such development training would include, for example, the transition from administration into management; an appreciation of the diferent management styles; communication and interpersonal skills; building teams and focussing on organisational goals; developing leadership skills, building relationships with ministers and mayors; efective policy making; as well as establishing an understanding of the tools, techniques and concepts of good fnancial management. Tis also emphasises the signifcance of the role of the head of the civil or local government service in an organisation and how that person exercises his/her leadership role.

Te development of an efective management starts with the head of the civil or local government service in an organisation and then throughout the organisation. Management training is important because it involves planning and goal setting and creating a vision for the organisation. It requires the interpretation of the political objectives and putting them into a form that will be operationally practicable, along with motivation of staf to execute the operational plans. Staf management and motivation are also especially important (see test 8). Efective management creates a direction for the organisation and communicates the vision internally and externally to the diferent stakeholders.

To achieve this, though, requires the recognition by elected ofcials of the need for the motivation of the civil or local government service ofcials. With PFM/IC the role of the civil and local government service is enhanced. No matter how good the management and technical training, if ofcials feel frustrated or if they feel they have no efective authority, this will adversely afect their performance. "Efective government agencies have high levels of motivation among their members, including high levels of public service motivation, mission motivation, and task motivation."4 Many of the reforms implemented in the public sector such as PFM/IC are likely to afect the incentives that infuence motivation and thus afect individual and organisational performance. "Employees are an important ingredient in determining the quality, efectiveness and responsiveness of public services, especially when fnancial resources are scarce or there are novel challenges to face. How they think and feel about their jobs and working conditions inevitably afects the way they carry out their tasks (Rainey & Steinbauer, 1999)."5 Much depends upon local circumstances but in introducing PFM/IC regard should be had to such factors because the introduction of a managerial work ethic is a signifcant reform and therefore regard should be had to those factors that inhibit performance. Motivation is not necessarily simply a function of pay and other fnancial rewards, although especially for specialist skills competitive pay should be ofered. Motivation can be a function of a wide range of factors

<sup>4</sup>Rainey and Steinbauer (1999) Galloping Elephants: Developing Elements of a Teory of Efective Government Organizations: /Journal of Public Administration Research and Teory Jan 1999, p. 23.

<sup>5</sup>Quoted by Wouter Vandenabeele & Chris Skelcher: Public Money and Management: Public service motivation—practical problems, scientifc evidence and the role of a research community: Ps. 321–327: July 2015 Pages 321–327 | Published online: 03 Jul 2015.

including the nature of the work, the efectiveness of the activity, the opportunities for preferment.6

Te question that then arises is who is to be responsible for civil service and local government staf management and motivation within organisations? Given that delegation of operational management should occur, responsibility ought to lie with the head of the operational staf of an organisation such as the state secretary or the equivalent in local government. Tis is a question that ought to be addressed with the introduction of PFM/IC, but no evidence has been seen that it actually has been considered in countries introducing PFM/IC or in the relevant literature. Yet quality staf management and motivation is highly desirable, indeed essential, for successful management. (A reality that will need to be considered is that career development in many civil services is not afected by success or failure in meeting objectives but the development of a managerial performance-oriented culture, ought over time, at least, to challenge this reality even if it means allowing preferment to those with new ideas and able to develop and deliver new initiatives.)

#### **Test 8** *Is there a willingness to rethink the penalties and sanctions and the arrangements for the discipline of civil and local government ofcials?*

In many transition and developing country economies, the disciplinary penalty and sanction arrangements, whether imposed upon civil and local government ofcials through the budget law or in other specifc laws, are often designed to refect the legalistic and authoritarian nature of the public administration regime that exists or has existed in the recent past. Te aim is to achieve strict adherence to the laws, rules and regulations with little or no scope for the exercise of judgement. Tese disciplinary and sanction arrangements are often reinforced by specifc inspection arrangements. Tey tend to impact more heavily upon lower level ofcials than upon either elected ofcials or senior appointed ofcials. A primary aim of such sanctions and disciplinary arrangements is often to reduce the risk of decisions being made that might cause budgetary constraints to be ignored or avoided or to minimise the risk of fraudulent or corrupt activity. Introducing PFM/IC places more responsibility upon ofcials to make decisions, and making decisions involves risk. Delegation of operational management will not be efective if those ofcials remain concerned about how the system of sanctions and discipline may

<sup>6</sup>Tere are many publications on staf motivation and, for example, see those of Neel Doshi and Lindsay McGregor. Pay is not necessarily a factor and what can be of signifcance are, for example, the quality of the job, the ability of the employee to engage with all aspects of the job, the corporate culture and leadership.

adversely afect them. In some countries the legal code afecting the way in which civil and local government ofcials undertake their responsibilities has provisions for sanctioning them for what may be vague ofences such as, in an example from one country, 'exceeding competences' and 'criminal indiference'. In practice such provisions may be only rarely applied but the fact that they exist creates a perception that they can be used and this can cause ofcials to rigidly limit their activities and to avoid taking any risks by referring all decisions upwards. Tis discourages even senior ofcials as well as middle and lower level managers from taking risks or rethinking how public services should be delivered. Yet PFM/IC is about how public ofcials make decisions about the utilisation of resources to deliver public services efciently and efectively and at the same time achieve their objectives within what can be a changing and challenging operational environment. With the delegation of operational management, operational managers (who ought to be the civil and local government ofcials) need to exercise judgements: that is what making decisions is all about. As any judgement involves risk and particularly where public services have a direct impact upon individuals who may object, ofcials, who have been traditionally risk averse, may have difculty in accepting the responsibilities associated with a PFM/IC regime.

What this means is that where such a traditional legal and disciplinary framework exists, the introduction of PFM/IC will require change to avoid inhibiting management action by the operational managers. Without a reform which recognises the signifcance and consequences of devolving operational management responsibilities, the operational environment will discourage operational managers from taking those actions which will deliver more efcient and efective public services as well as those actions which will secure the delivery of objectives and performance standards.

A feature of introducing the PFM/IC reform, therefore, should be a review of the penalties and sanctions regime which can have a critical bearing on organisational performance. Is there a willingness to undertake such a review and if not the managerial reforms which PFM/IC envisages will be difcult to introduce?

**Test 9** *Does the ministry of fnance recognise that to secure success in the establishment of a managerial culture both it and the ministry responsible for civil or public service reform will require that they are able to provide a high quality of*  *advice and support to line ministries that will complement the development of PFM/IC? Tis will mean that the role of a ministry of fnance will need to change to become much more supportive than simply acting as a 'controller'.*

Te main gains from this change will be a management focus upon the achievement of objectives, standards of performance and efciency and efectiveness, that is, outputs as well as inputs. In other words, a better use of public resources. Consequently, there will be a much greater emphasis upon developing fnancial awareness, an awareness that goes well beyond knowledge of budgetary limits and fnancial control processes. Tat gain will only occur with the active and ongoing encouragement and support from the ministry of fnance. With PFM/IC former administrators will be operating in a managerial environment, and this does mean changing the whole culture of the organisation including at the lower levels of stafng. Tis will require a radical change of approach in how the civil or local government service operates. Te focus upon achieving outputs and doing so efciently and efectively represents a very diferent approach from a traditional administrative approach dominated by concerns about budgetary and fnancial control.

Te ministry of fnance should provide advice and guidance on technical issues such as the development and interpretation of costing information, on fscal risks, on the fnancial controls that should be applied to second-level organisation including state and local government-owned companies as well as on long-term fnancial planning. Tis advice should be available to both managers and to specialist ofcials concerned with fnancial management. Managers also will require advice, including training, on how to improve efciency and efectiveness (e.g., on such issues as how to identify, manage and allocate costs against cost drivers, how to identify, manage and allocate costs against cost centres and how to develop the performance information that should accompany such analyses), how to identify risks and the management of those risks. Heads of fnance and their staf may also require training in the development of analytical techniques such as cost accounting and managerial information systems such as new ministry or local government coding structures including how to link these with ministry of fnance coding structures. Tis adds signifcantly to the role of the ministry of fnance as well as changing the traditional role. Is there a willingness on the part of a ministry of fnance to take on this 'educational' type role which will change its traditional relationships with line ministries and other public organisations?

# **4.2 How Is the PFM/IC Reform to Be Undertaken?**

#### **4.2.1 Who Should Be Responsible for the Development of the PFM/IC Reform Policy, Its Application and Local Ownership of the Reform**

Because this is a major reform, political and top operational management support for it is essential. Also, because the reform involves long-term change, that support ideally should have cross party political support. In addition, the prime minister and minister of fnance (and their successors) should be committed to the reform and their responsibility is to secure commitment from other ministers and where the reform extends to local government, from mayors and other local government leaders.

Very often the reform will be initiated by an external organisation such as an aid organisation or, for countries seeking to join the European Union or to beneft from its funding as neighbourhood countries, the European Commission. Financial support in these circumstances will usually accompany such an initiative. However, the timing and advice about the development of the reform policy and its application as well as the period of the funding in such circumstances will be determined by the provider of the funds. Te driver in these circumstances will be external to the country and the motivation to introduce the reform may be wider than simply the PFM/ IC reform itself. Te fact that the driver is external to the country can afect how political support is mobilised and the continuation of that support, especially if there are diferences of view about the wider objectives.

Because this reform has such an impact upon the roles and responsibilities of civil and local government ofcials, their commitment, through the support of the senior civil and local government service, is also essential. Once the principles of the reform have been established and parliamentary support obtained, the ministry of fnance would normally be responsible for its application. Support for the actual application of the reform as it afected political ofcials should be the responsibility of the prime minister and the minister of fnance. So far as the overall operational application of the reform is concerned, the responsibility for securing its application should lie with the state secretary (or equivalent) of the ministry of fnance. Tat person should have the authority to require his/her equivalent in other ministries to apply the PFM/IC application policy and their commitment to and support for the reform is essential. Terefore, within each ministry or local government, subject to the overall guidance of the state secretary (or equivalent) of the ministry of fnance, the application responsibility should be that of the head of the civil or local government service (i.e., the state secretary or equivalent) reporting as appropriate to the political head of the organisation. Te head of the civil or local government service in each public organisation should have the authority to continue with the reform even when political personalities change, unless there is a central government political policy change afecting the acceptability of this reform. Without that delegation to the head of the civil or local government service, a risk could be that a 'stop/start' process occurs caused by changes of ministers (or mayors) which will be disruptive to the application process. Achieving that civil and local government service authority to proceed with the application of the reform is an essential practical requirement. Te role of the state secretary in the ministry of fnance is discussed in detail in Chap. 5.

However, there is a potential problem where politicians feel that they must be involved in all decisions, which could be the situation in some developing and transition economy countries (as well as in some developed economy countries). Tis potential problem is that as political post holders change, they may feel that even though the policy in principle remains they may wish to impose their opinions on the application processes. Te result can become an erratic application which will be disruptive. A consistent approach is highly desirable, and it will avoid delay.

Whoever has responsibility for the development and application of the reform, a critical frst step should be an assessment of the results of the tests described above. Unless the response is positive to these tests, even though the reforms needed cannot be implemented speedily, the benefts of applying the reform will not be achieved and that will raise questions as to whether the reform is worthwhile at this particular point in time. Te attitudes of the ministry of fnance and the department or ministry responsible for personnel management demonstrated in the response to these tests will afect:


As has been pointed out earlier, introducing PFM/IC is a major reform there is no 'quick fx' such as introducing a law specifying what is to be done coupled with the introduction of a series of additional bureaucratic procedures. Te introduction of PFM/IC will take a considerable period to implement across a public sector, maybe 10 to 15 years7 or more. Not only within this period will the techniques associated with PFM/IC need to be introduced, including the extended fnancial and performance information systems but also fundamentally the managerial changes that will be required, and it is with these managerial changes that the reform process should start. Unfortunately, this rarely, if ever, occurs and the reality is that reform usually starts with the introduction of the bureaucracy associated with the reform and with that associated with the introduction of international best practice, that is, the COSO requirements.

# **4.2.2 Achieving Local Ownership**

Achieving 'local ownership' of the reform, even at an individual organisation level, is an essential step and it will be demonstrated by the strength of the commitment of the key political and senior ofcials. Ownership is important for these reasons:


<sup>7</sup>Comprehensive reform programmes usually have a time perspective of 10–15 years. Tis will allow capacity development measures to start at the earliest stage of reform planning without necessarily delaying the reform work. However, in practice, there may be a confict between this view and the desire of certain donors and government to start implementation as soon as possible without providing scope for capacity development. Te result may be the early production of reform plans that can be characterised as shopping lists rather than reform eforts. Tere will be a need for a strategy on when and how to use technical assistance and also to liaise with and incorporate ongoing reform eforts in order not to waste knowledge and lose momentum. Public Finance Management in Development Co-operation—A Handbook for SIDA Staf 2007 para 6.3.1.

#### **4 The Practical Steps for Initiating a Successful PFM/IC Reform**


Te reform will involve the development and/or employment of skilled managers and, as indicated, a refocusing of elected ofcial interests away from day-to-day administrative and operational arrangements towards the development of policy and strategy together with an oversight responsibility for operational management activity. Tis emphasises the importance of local ownership. None of these elements of the reform will be easy or short term.

#### **4.2.3 The Role of Parliament**

In many countries if this reform is to be driven forward, as has been explained in previous chapters, there is an important role for the parliament. Parliament should not be concerned with the detailed application of PFM/IC within individual public organisations except in the context of external audit reports about those organisations. However, parliament should be concerned frstly about the appropriateness of the proposed policy and that will mean that parliament has a clear appreciation from the outset of what the reform involves including its costs and benefts and then secondly about the progress with the reform as it is applied. Tis means that parliament ought to approve a timetable for the application of the reform and that the minister of fnance should be accountable to the parliament for progress. Should the minister of fnance wish to make changes to the timetable for application, then parliamentary approval should be sought. Trough this process accountability pressure would be exerted on the minister of fnance and that in turn would be refected

<sup>8</sup>Lienert, Ian. 2003. "A Comparison Between Two Public Expenditure Management Systems in Africa." IMF *Working Paper* 03/2. January. 2003 Abstract.

on the ofcials responsible for the operational application of the reform, not least on the ministry of fnance state secretary.

In efect through this accountability process, parliament becomes an efective driver of the reform requiring explanations where the timetable is not being met or the managerial changes required are not being made. If there is no such accountability process, the reform remains wholly an internal organisational reform to be pursued at a time of choosing by the minister or ministry of fnance which in turn means that the timetable will be afected by the current priorities of that ministry.

Te main adviser to the parliament would in most countries be the state auditor but exactly how a parliament would exercise this responsibility would depend upon its traditions. For example, it could do so through a specialist committee, such as a committee established to consider external audit reports.

## **4.2.4 The Basic Elements of This Reform Recognising That This Is an Ongoing Reform**

As developing PFM/IC will take several years as experience is gained, new ideas will emerge and circumstances will change. Tis means that there should be a fexibility of approach. However, what is important in the implementation of PFM/IC is frst to put in place the basic elements of this reform, that is:


Given that these initial elements have been established, then for each ministry implementing the reform the following steps should be taken (with the equivalent steps applying where local government is involved):

(i) Te state secretary of the ministry of fnance agreeing with the most senior appointed ofcial in each ministry (state secretary or equivalent) undergoing the reform about how and when the reform will be implemented in practice including the acceptance within that ministry (or local government) of the delegation of operational management responsibilities to the civil (or local government) service. (See Chap. 14 for a detailed discussion of the limitations of the delegation of operational management.)


expected of frst-level organisations and that their objectives are compatible with those of the frst level owning organisation.

(ix) A review of the human resource (HR) arrangements is undertaken to ensure that they facilitate the establishment of a managerial culture including a review of the penalty and inspection arrangements.

As has been pointed out earlier, what PFM/IC is *not* about is simply introducing a series of bureaucratic practices such as those relating to risk management or information and communication or the control environment, that is, the COSO bureaucratic requirements. Yet this has been the focus of much reform activity, especially in countries joining or aiming to join the European Union. Tese bureaucratic requirements are important, but they are only facilitators for management to use and what matters is the quality of leadership and management and how management utilises the information becoming available from those requirements. Tose responsible for the reform ought to recognise from the outset that the long-term nature of the reform will require a consistent application policy. Tis again points to a need to ensure that the policy is 'politically neutral' in its application and therefore ideally that operational implementation is a function of appointed, rather than political ofcials.

Countries should also recognise that introducing PFM/IC is a continuing process as experience is gained and circumstances change. Tere is efectively no 'end date'. Whether or not external fnancial support is available (and such support is likely only to be available for the initial stages of implementation), the argument in this guide is that this reform is so important, with its managerial implications, and that it is desirable in any event. However, there is such a thing as 'reform fatigue' and therefore how the reform is implemented is important. Tere ought to be clear steps in the reform process when assessments of the success (i.e., benefts) can be made. Te most important initial stage is to put in place the basic elements of the reform, that is, the managerial elements of the reform, the enhancement of the fnancial management capabilities and the reform to the budgetary and accounting processes. Tese should be supported through the enhancement of the parliamentary scrutiny processes. Beyond these basic elements of the reform the main driver will be 'practical experience' as managements, both political and civil service, become more confdent about how they can improve quality in the utilisation of public expenditure.

To emphasise a point made previously, countries considering adopting the policy of PFM/IC will already have in place a more or less satisfactory version of PFA/IC. Tese PFA/IC arrangements may need to be considerably modifed in some circumstances if:


To emphasise a point made previously, before any attempt is made to introduce PFM/IC the PFA/IC system should be reformed to ensure that the PFA/ IC is efective and that also means understanding why the PFA/IC control system has not been efective, if that is the situation. If the present control system is weak, the remedy is not to change the system by trying to introduce PFM/IC but to improve or remedy the defciencies of the present system not least because the likelihood is that whatever the defciencies of the present system they will creep into any new system. What should also be borne in mind is that if the objective is to make it more possible to achieve the objectives of the government, this will not happen without complementary reforms to management. Tis may mean that the PFM/IC reform ought to be delayed and sometimes for a considerable period. Against this though can be the political imperative that 'something has to be done'. Te responsibility of the civil service in such circumstances should be to accommodate the staging of the reform in such a manner that the major defciencies of the present PFA/IC system are addressed frst. Tis is likely to mean that the discretion available to managers with PFM/IC is moderated recognising that this will defer the achievement of the potential benefts of the reform.

If, though, the reason is that the government wishes simply to adopt PFM/ IC as international best practice, will such a reform for this reason be successful? Public fnancial reforms are not 'freestanding': they must ft into a context and the context is a country's history, culture, economic, political and bureaucratic arrangements. Financial reforms do not always succeed, and a real risk is that the formalities of a reform (i.e., the bureaucracy associated with it) may be established but not the substance. So, whilst the appearance of reform exists in practice, the benefts cannot be achieved. Te result is more bureaucracy and higher administrative costs and ultimately disillusionment. International best practice has no regard for local contexts. It also carries with

<sup>9</sup>For example, Malawi following the 'cashgate' scandal discovered in 2013.

it certain assumptions (see Chap. 11 which discusses the COSO reform requirements) and the implications of these assumptions must be addressed. With PFM/IC those assumptions are about the existence of objectives, the existence of an efective management, the delegation of responsibilities and managerial accountability arrangements. A principal and possibly key reason that fnancial reforms have not been successful or at best have only resulted in more bureaucracy in developing and transition economy countries has been the attempt to insert best international practice into an inappropriate local context. Tis applies particularly to PFM/IC if the aim is to introduce it into a country that has a traditional system of public administration with no or a limited concept of management and a strong centralised control. If there is no indication that the government is willing either to recognise the need for managerial change or to actually undertake such change and to accept that decentralisation of control will have to occur or if there is no support for the reform amongst senior ofcials (both political and appointed) then the reform will fail. Aid organisations in particular ought to recognise these potential risks.

Change therefore may be the inappropriate answer, especially where change involves the introduction of sophisticated public fnancial management systems like PFM/IC when the real answer lies in making the existing system of PFA/IC work more efectively. Changing rather than improving entails signifcantly higher risk and cost. Changing to PFM/IC is both expensive and risky because it is a fundamental reform and is not a simple technical fnancial change. To emphasise, the change from PFA/IC to PFM/IC is to a major and very advanced reform.

An expert adviser on fnancial reform in developing and transition economy countries, Professor Stephen Peterson, has summarised the key factors that need to be addressed in reform using this acronym: COPS,10 that is:


Te reform strategy which the state secretary in the ministry of fnance, supported by the department responsible for the implementation of the reform, should consider is that it should have four elements: 'recognise' what exists; 'improve' what exists; 'change' [where necessary] what exists; 'sustain'

<sup>10</sup>Peterson, Stephen; Public Finance and Economic Growth in Developing Countries: Lessons from Ethiopia's reforms, 2015: pp. 13–36.

the improvements and changes that have been introduced.11 It is not simply therefore just about change. Frequently the reform focus is on 'recognise', 'improve' and 'change'. Te missing element is 'sustain'. Tis is one of the most important aspects of reform. Because the PFM/IC reform is not simply about technical systems but is about management and the distribution of powers within and between public organisations (and not least between elected and appointed ofcials and between the ministry of fnance and line ministries), pressure is likely to exist over sustaining the reform. Because of the impact upon the distribution of 'power', pressures are always likely to exist to return to the *status quo ante* and therefore a positive sustain policy is necessary. Te De Geyndt study is evidence of this.12 Another factor afecting sustainability is 'cost'. Te drive to sustain the reform should be led and resourced by a government itself because it is most unlikely that third parties, such as aid agencies, would be willing to fnance such an ongoing activity over a long period of time. A further factor afecting sustainability is that those who will be expected to share resources to solve cross-boundary problems, which a focus on outputs will generate, will be reluctant to do so. Overall, therefore, the risk is that at least over time the internal pressures will be to return to a form of PFA/IC, that is, the *status quo ante*.

# **4.3 Will Delegation of Operational Management to the Civil or Local Government Service Cause Politicians to Lose Control13?**

Tis question is not about 'internal control', rather it is about 'political control', and one that will be very important in some countries and can be central to addressing local culture. Tose responsible for the implementation of PFM/IC will have to consider it. In some countries where PFM/IC has been, or is proposed to be, introduced, concern has been expressed by political ofcials that if they do not make all decisions (i.e., that there should be no delegation to appointed civil or local government ofcials), they will lose control of the organisation. Tis has been a cause of objection to PFM/IC reform in

<sup>11</sup>Peterson, Stephen; Public Finance and Economic Growth in Developing Countries: Lessons from Ethiopia's reforms, 2015: p. 36.

<sup>12</sup> See footnote 18, Chap. 1.

<sup>13</sup> See also Chap. 14.

some countries. Even if the reform proceeds, this concern may limit the extent to which delegation and managerial accountability develop.

Associated with this concern about a potential loss of political control, other concerns about delegation may exist including about the ability of civil or local government ofcials to undertake the delegated responsibilities or a lack of political trust in the civil or local government service ofcials and vice versa. Te problem of inexperienced civil or local government service ofcials is not solved by appointing inexperienced political ofcials but has to do with the overall quality of the civil or local government service. Tis in turn raises questions about recruitment and training processes for such ofcials, but it also is afected by the atmosphere or 'tone' of the relationships between political and appointed ofcials. If that is threatening, the risk to ofcials is increased, and where there are few alternative job opportunities, ofcials will be unlikely to accept delegated responsibilities that involve a higher degree of risk. As has been pointed out previously, making decisions involves making judgements and, by defnition, making judgements involves risk. 'Trust' is much more difcult to address and can involve many factors. Without the civil or local government service having a tradition of demonstrable independence, irrespective of the political control, political trust in the public administration can be difcult to establish. Control is not addressed by politicising the civil or local government service through appointing 'political friends' of the government to civil or local government service positions. Alternative solutions are required. Te answer lies in civil service or public administration reform, including the training and entry requirements. Without a quality civil service, the introduction of the PFM/IC reform is much more problematic. Tis emphasises the importance of establishing a 'Weberian' style of civil service (see Chap. 14).

However, apart from these questions about competence and trust, the main points to be made in any debate about this question of potential loss of control by politicians include:

• Te political head of a public organisation, a minister or mayor and their political deputies are frequently chronically overburdened given their responsibilities for the development of policy, the strategy for implementing that policy and the political considerations of government as well as detailed responsibility for operational management (where that is the situation). Tis adversely afects these ofcials' ability to focus on their most difcult task which is the development of policy and strategy and the management of their political relationships. Good quality policy is central to efcient and efective policy execution.


difcult in practice, and where this difculty extends to operational management, the quality of governance inevitably sufers. (A responsibility of a civil service ofcial is to set out the facts and relevant issues even where they make uncomfortable reading for the political ofcials, and they should not be adversely afected by doing so.)


Trying to make every decision does not put the minister or mayor in control: the result is an illusion of control.

With PFM/IC in place and with the consequential establishment of delegation and managerial accountability, the head of the organisation is in more efective control of an organisation than by trying to take every decision. Tis enables those top and senior politically appointed ofcials to focus upon developing the policy and strategy for implementing that policy by the organisation and to supervise through the managerial accountability processes what is happening operationally within the organisation. It enables top and senior managers, both political and appointed, to just focus on the key issues and avoid involvement in items of lesser importance. Introducing PFM/IC adds to the responsibilities of the manager because it envisages a higher quality (i.e., professionalisation) of management than do traditional systems of public fnancial administration. Tis alone makes the task of the operational manager much more substantial. Overall, the likelihood is that without delegation the additional responsibilities arising from the adoption of PFM/IC would not be efectively undertaken and therefore the benefts would be lost.

Tere is a further aspect to the question of the allocation of responsibilities between political and appointed ofcials and that is how will parliament react to this element of the reform? As has been indicated earlier, parliament ought to be consulted about and kept informed of the reform progress and it can be kept informed regularly through the work of the state auditor. Parliament ought to have a view about the arrangements that are being made not least because of the accountability of the political leadership to parliament and the overriding concern that parliament should have for the utilisation of public resources. Parliament may wish not only to challenge political ofcials about policy and the delivery of the objectives of that policy, but it may also wish to question ofcials (political and appointed) on their utilisation of public resources in the delivery of policy objectives. Parliament may also be concerned about securing transparency and accountability in the utilisation of public resources. Properly implemented, PFM/IC provides greater opportunities for parliament to do all of this.

# **4.4 How Should the Reform Be Applied Across the Public Sector?**

A decision needs to be taken about the practical arrangements for applying the PFM/IC reform throughout the public sector. Tis should be a government decision taken with the advice of the minister of fnance who should in turn consult with other ministers and parliament should be informed of this decision. Te questions are:


Operational managers at each stage would require extensive training support.

If the decision were to apply the reform in stages, the possible stages are set out in Chart 4.1. No specifc reference is made in these stages to the application of international best practice (i.e., such as the COSO standards).

#### **4 The Practical Steps for Initiating a Successful PFM/IC Reform**

**Chart 4.1** Stages in the application of PFM/IC

However, as operational implementation of those standards would be the responsibility of the operational management within each public organisation that management would require extensive management training. Te expectation therefore should be that the application of such standards would be during stages 2 and 3, that is, not at stage 1.

Te decision about how and when to proceed will depend partly upon the availability of resources to develop the detailed advice and support operational managers will require as well as the fnancial advisory functions and systems. Not the least of these will be the training needs of managers and heads of fnance. If this advisory and training resource is limited, then this would inevitably point to the use of a pilot and staged application process. However, the most important factor determining the application arrangements will be the current administrative arrangements, the willingness of politically appointed ofcials and senior civil and local government ofcials to accept and adapt to the implications of the reform as it afects what they see as their authority, their responsibilities, their potential liabilities and their accountability. Tis very often revolves around the question of 'trust', which has been referred to earlier and an important issue should be how to build 'trust'. Tat question applies not only to political/appointed ofcial relationships but also to relations between central and line ministries.

Te strength of opposition to the implementation of the reform is likely to be a determining factor in the arrangements for its introduction. And that will only be established through extensive pre-reform consultation. (Tis is not something that usually occurs.)

# **4.5 Establishing a 'Driving Force for Change' Within a Ministry of Finance**

For this reform to be successful there must be a 'driving force for change' within the ministry of fnance. Although this guide suggests that this should be the most senior civil servant in a ministry of fnance, this person will need to ensure that a detailed and practical day-to-day support is available to public organisations and to act as an adviser and supporter to themselves. Te European Commission in its advocacy of the PFM/IC type reform for countries seeking to join the Union and for neighbourhood countries benefting from European Union funds has recognised this and required that such countries establish a special unit or department specifcally designed to promote, introduce and supervise the implementation of the reform and to maintain its continuing quality.14 Its role is defned as:

A policy unit attached and directly reporting to the Minister of Finance on the status of internal control in the entire public sector, responsible for redesigning, updating and maintaining the quality of the internal control systems, for harmonising and co-ordinating defnitions, standards and methodologies, for networking between all actors (managers, fnancial ofcers, internal auditors), for the establishment and co-ordination of sustainable training facilities, including the setting of criteria for the certifcation of public internal auditors and for all other actions to improve public internal control systems.

Note: Given the focus described in this guide the head of this unit's reporting line should be to the chief ministry of fnance ofcial, not directly to the minister.

Te head of that department should be knowledgeable about PFM/IC and its managerial implications and provide detailed implementation advice and support, as necessary. Te department should have the status of other ministry of fnance departments, and it may well be required to challenge existing ministry of fnance departments and their policies. Tat department should be stafed with the diferent skills needed in the application of PFM/IC including accounting, fnancial analytical and forecasting skills and, importantly, managerial experience. Unfortunately, where such departments have been established, because the broad managerial and fnancial implications of the reform have not been recognised neither have the broad stafng requirements. In European countries the initial focus has been on internal audit

<sup>14</sup>Welcome to the world of PIFC: 2006 http://ec.europa.eu/budget/index.htm.

which can result in an inappropriate approach to the PFM/IC reform. Tis has focussed the reform simply on fnancial and budgetary control. (Chap. 9 explains how this department should be organised and what should be its agenda of activity.)

Te idea of establishing a formal 'driving force' to support the chief ofcial in the ministry of fnance is important but if not properly directed and supported such a ministry of fnance department will fnd it very difcult to achieve its objectives. Tat direction and support must come initially from the chief appointed ofcial in the ministry of fnance who in turn should be reporting on progress to the minister of fnance. Te minister of fnance should report to the prime minister and ultimately parliament. Without this chain there is a risk that other events will intervene to divert attention away from ensuring that the PFM/IC reform is efectively implemented and to time.

## **4.6 Summary**

In implementing this reform, politicians should be clear about the fve objectives involved in the management of public money and the nine tests that should be applied to determine whether the reform is practically possible and appropriate. Te use of these tests will also help countries assess how long the reform is likely to take and what it involves. Once the policy has been determined and agreed with the parliament, responsibility for actual application should lie with the minister of fnance under the authority of the prime minister with managerial implementation being the responsibility of the most senior ofcial in the ministry of fnance. Tat ofcial should be supported by a specialist 'driver' department which should be appropriately stafed and have the status of other ministry of fnance departments. Tat department would have the practical responsibility of driving the reform forward under the authority of the chief civil service ofcial within the ministry of fnance.

Te chain of responsibility back to parliament is very important to ensure that reform progress occurs.

Te reform is fundamentally about the professionalisation of the management of the delivery of public services and as a result imposes considerable additional requirements upon civil (and local government) ofcials. Tese additional requirements make it difcult to see how politicians in countries where they have maintained responsibility for operational management can continue to undertake such responsibilities. Consequently, a feature of the reform will be the delegation of operational management responsibility from the political level of management. Tis also means that public administration or civil service reform should be coordinated with the PFM/IC reform.

Because the reform is complex and has wide-ranging consequences, countries do need to consider how they will implement the reform. Should it cover all public organisations at the same time, or be phased? Should the reform be staged to allow lessons to be learnt as each stage is implemented? In driving the reform forward regard to the risk of 'reform fatigue' and to allow the benefts of the reform at diferent stages to be demonstrated.

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# **5**

# **The Responsibilities of the Minister of Finance, the State Secretary, and the Ministry in the Development of a PFM/IC Policy**

In this chapter the main responsibilities of the minister of fnance in the application of PFM/IC are described, including the impact that the reform will have on the main departments and activities of the ministry of fnance itself. Te reform is a complex reform, and as with many complex reforms, there is always a risk of unintended consequences. Te possibilities of this occurring are discussed in Chap. 6. If ministries of fnance stand in the way of such developments and do not recognise the managerial consequences, this will make achieving the benefts of the reform very difcult.

Te reform will impact upon the budgetary and fnancial accounting arrangements within line ministries and local governments, and the ministry of fnance should both recognise and encourage this development. Tis is because individual managers within line ministries and local governments with PFM/IC will want to know what the total budgets are for their areas of responsibility set against their objectives and performance standards. Tey need this information to establish efciency and efectiveness in service delivery. A consequential need will be to develop management and cost accounting because the traditional fnancial accounting arrangements will not provide the type of information a management requires to secure efciency and efectiveness.

An important activity of a ministry of fnance ought to be to challenge line ministries about the cost and quality of the policies ministries are proposing to adopt and the quality of their proposed objectives and performance standards, along with the resources they require to achieve them.

Te reform will also impact upon the parliament by increasing the ability of parliament to scrutinise the budget and the operational management of line ministries and other public organisations. Te ministry of fnance as a result is likely to be expected to provide evidence to parliament to support its scrutiny arrangements.

Successful application of PFM/IC also depends upon the management of line ministries and local governments accepting that they are responsible for adopting a disciplined internal control structure and ensuring that internal control is efective. An objective of internal control is to control risks to an organisation. Tose risks can be to the delivery of the objectives and performance standards of an organisation, to achieving efciency and efectiveness as well as fnancial, legal, environmental, and wider reputational risks. Where a ministry of other organisation is involved in the collection of income, including taxation, internal control applies equally to these activities. Internal control is not simply about fnancial and budgetary control, and neither is it simply about the short-term fnancial/budgetary situation.

In some countries other ministries besides the ministry of fnance may also be involved in the fnancial management process such as a ministry of planning responsible for the control and approval of investment expenditure. Whatever the benefts of such an arrangement, this does complicate the implementation of PFM/IC. It also adds to the complexities of the role of the head of fnance not least because constraints on current budgets may not be replicated in the investment budgets. Tis also has to be taken into account in implementing PFM/IC.

# **5.1 The Responsibilities of a Minister of Finance and Senior Offcials**

Tis chapter covers the impact of the application of PFM/IC on and the specifc responsibilities of the minister of fnance, the most senior civil servant within that ministry, and other senior ministry ofcials. Application success depends very heavily on the extent to which these ofcials recognise their responsibilities for the reform and the changes that the reform will bring about. Also discussed is the relationship of the minister with parliament.

Te chapter covers the critical aspects of the reform that are likely to require decisions by the minister and the ministry staf before, during, and in sustaining the reform. Although the minister will take the key decisions, in practice many of the day-to-day responsibilities will be addressed by staf within this ministry. Te key fgure in the ministry who should, in efect, supervise application throughout all line ministries and other public organisations should be the chief ofcial of the ministry (the state secretary or equivalent).

#### **5.1.1 The Minister of Finance and PFM/IC**

Te fnance minister will be a senior minister within a government responsible usually for the management of the government fnances, economic policy, levy and collection of taxes, government borrowing, and fnancial regulation. Tis minister may also be responsible for monetary policy, although this can be a responsibility of the central bank. (Actual responsibilities do vary widely between countries.) Within this broad range of responsibilities, the ministry of fnance will have the specifc objectives of determining and raising taxes, maintaining budgetary and fnancial control of public expenditure, and improving public sector productivity. It will also be concerned with the achievement of the government objectives and ensuring that line ministries and local governments do not enter into commitments which may be difcult to fnance in the future or which to fnance them may have adverse efects upon other current activities of an organisation. Te minister of fnance would normally be the minister with overall responsibility for the introduction of the policy of PFM/IC.

In exercising these responsibilities, a particular activity of a minister of fnance and by extension the ministry of fnance should be to challenge how well a line ministry or other public organisation has defned and costed policy and used available public resources to achieve its objectives and performance standards. In assessing the quality of that utilisation, a ministry of fnance should be concerned about the improvements in efciency and efectiveness, if any, with which those resources have been used. Te implementation of PFM/IC will help them to achieve these objectives:

Te challenge function will be thought of as the investigation and scrutiny of the spending, expenditure management processes and policy choices of line ministries, departments and agencies. Where these do not align with the objectives of the fnance ministry, an efective challenge function typically means the fnance ministry asking, requiring or persuading line ministries to do something diferent to what they might otherwise have done. Such a relationship is necessary if a fnance ministry is to deliver its many functions and achieve its economic, spending and policy goals.1

Whether or not the tests described in Chap. 4 to assess the feasibility of the reform can be met depends heavily upon the reaction of the minister and staf

<sup>1</sup>Te ministry of fnance 'challenge function': A public fnancial management introductory guide Sierd Hadley and Bryn Welham pp. 7/8: https://www.odi.org/sites/odi.org.uk/fles/resource-documents/ 11067.pdf

of the ministry of fnance. Te most important departments of the ministry that will be directly afected by the reform are the budget department and the department responsible for treasury matters including fnancial accounting and overall government fnancial control. (If the ministry of fnance is also responsible for procurement, that department too is also likely to be signifcantly afected.) Not only will these departments be afected technically but they will see the modifcation to some of the powers that they presently have. If the minister of fnance, and by extension the ministry of fnance, is not willing to agree to the quite fundamental changes which will facilitate the establishment of a managerial culture, then the PFM/IC reform should not proceed. Terefore, that these departments of the ministry should have a clear appreciation and an acceptance of their role in the reform, is pivotal.

Earlier chapters in this guide show how the application of PFM/IC impacts upon the whole approach to public fnancial management. It shifts the focus of management from control of inputs to control of outputs, although still requiring a control of inputs. Te result, if the reform is successful, is the establishment of a managerial culture compared with a traditional administrative culture.

# **5.2 Before the Reform!**

Introducing PFM/IC should not be regarded as simply a matter for ofcials. As was pointed out in Chap. 4, parliament has a potentially powerful role in approving and driving forward the application of the reform. In doing so parliament would hold the minister of fnance to account for progress. As was pointed out in Chap. 4 a reform of this operational signifcance in the management of public expenditure is, in reality, likely to cause resistance to change, especially to the managerial reforms that will be required and potentially delay the implementation timetable. Parliamentary support for the reform can therefore be of considerable assistance to a minister of fnance in broadening political support, even within the government.

Te responsibility of the minister of fnance should be to secure parliamentary appreciation of the signifcance of the reform, what the reform requires by way of managerial changes and the distinction that will be necessary between responsibility for operational management and that for policy and strategy development. Parliament should also be made aware of the potential costs and benefts as well as approval to the reform application arrangements. Tis would include the reform timetable. Te minister of fnance should report periodically on the progress in the application of the reform, say six monthly, with parliament then being required to approve changes to the timetable for application and made aware of major difculties.

Te involvement of parliament is not normal practice in this author's experience nor is this a requirement referred to in literature on the subject.2

#### **5.2.1 The Initial Assessment**

As has been previously explained, establishing a managerial culture has a major impact upon how line ministries and local governments are organised and the relationships between political ofcials and the civil or local government service ofcials. PFM/IC afects the relationship between central ministries, particularly the ministry of fnance, and line ministries. Public administration (civil service) reform and PFM/IC reform activity also needs to be integrated. Before any decision is made to adopt this reform there ought to be a clear appreciation of these impacts (see the tests outlined in Chap. 4) not least because this indicates not only the managerial impact but also the scale of the reform. Tis may of course lead to a decision that this is not an appropriate reform at this time. It is far better to make such a decision at the outset rather than part way through the process.

As was explained in Chap. 4, the person who should have responsibility for explaining these impacts at the highest levels of the public administration ideally should be the chief civil service ofcial in the ministry of fnance (the state secretary or equivalent). Tis ofcial should have a central role in the development of PFM/IC. Not only has this ofcial responsibility for explaining to the minister of fnance what the implications of the reform are, but for the reform to be successfully applied, he/she needs to convince and involve the equivalent ofcials in line ministries (and in some countries, local governments as well) in the development of the reform. Not only does this provide a greater appreciation of what the reform involves, but it also encourages 'local ownership'. In those countries where there is a separate head of the civil service, then the ministry of fnance state secretary should also consult with this ofcial whose support would be essential. He/she may also need to consult with the staf of the parliament to explain how the changes are likely to impact on the role of parliament.

Te aim of the ministry of fnance state secretary should be to establish an appreciation throughout government of what this reform involves and the benefts arising from the reform. Tis may require collaboration with those

<sup>2</sup> See, for example, Welcome to the World of Public Internal Financial Control, European Commission, 2006.

responsible for civil service reform to ensure that such reforms are compatible with the needs arising from the PFM/IC reform. It will also mean collaboration with the most senior civil servant in each ministry or public body to inform them of the main consequences of the reform for themselves and the civil service organisation they are, or should be, responsible for. Not least this will involve a switch in the focus of control from simply a control of inputs to in addition a control of outputs and then to ensure that regard is had to enhancing public value, that is, the efcient and efective use of public resources.

As was pointed out in Chap. 4 to assist the ministry of fnance state secretary ideally a specialist department should be established with a specifc responsibility for *driving* the implementation of the reform. (Te responsibilities of such a department are discussed in Chap. 9.)

Te frst step in the implementation of PFM/IC should be for the ministry of fnance state secretary, with the assistance of the *driver* department, to commission research into the practical implications of the reform and to prepare a 'strategic analytical and planning policy paper' for the minister of fnance and the cabinet of ministers to explain the implications of the reform. (How this should be undertaken and the details of the areas that should be covered in this policy paper are described in Chap. 9). In preparing this policy paper the ministry of fnance state secretary should consult with the chief civil servants in other ministries and public organisations. Tis 'strategic analytical and planning policy paper' would cover not only the principles of the reform but also the key changes that would be required including such matters as the management changes, budgetary and accounting changes, the redistribution of authority between the politician and the civil servant, the implementation processes and timescale, the costs that are likely to arise from the application of the reform policy and the potential benefts. (Te benefts and costs are described in detail in Chap. 10.)

Where the reform is also intended to cover local government then all the points referred to above would also need to be discussed with representatives of local government.

## **5.2.2 The Appropriateness of the Decision to Introduce PFM/IC**

Te 'strategic analytical and planning policy paper' would enable the government to decide whether to proceed with the PFM/IC reform. Tis is not necessarily an easy decision especially where a country is under pressure from external organisations, such as aid organisations, to introduce the reform because it represents best international practice (and consequently, by defnition, must be a 'good thing'). Such pressure usually comes with an ofer of funds. However, there are critical factors in determining whether to proceed with the reform and which should be addressed by the minister of fnance and the state secretary. Tese are described in the nine tests set out in Chap. 4 which may be summarised as the potential risks arising from the reform. Tese include whether:


Some argue that where weaknesses exist in the control arrangements a strengthening of internal audit within organisations would be the reform that is required. Tat though is an inappropriate reform where the management is weak, governance poor and fnancial analytical capability low. It would certainly not address the managerial or the fnancial management problems that are necessary to achieve a successful PFM/IC reform.

To make a thorough assessment of the risks associated with the reform the ministry of fnance state secretary risk assessment should be an important factor in the discussions with other senior ofcials before drawing up the strategic analytical and planning policy paper.

<sup>3</sup>Good governance means there should be a focus on the interests of citizens and service users, that decisions should be informed and transparent and that there should be clear accountability for decisions. (A summary of advice contained in Te Good Governance Standard for Public Services published by the Ofce for Public Management [OPM] and the Chartered Institute of Public Finance and Accountancy [CIPFA] 2004—see Chap. 1.)

Unless the proposed strategic analytical and planning policy paper can be positive about the issues referred to above, introducing the PFM/IC reform would be inappropriate and other reforms would be required frst.

To emphasise, where such a strategic analytical and planning paper demonstrates that adverse circumstances exist for the introduction of PFM/IC then a conclusion is likley to be that this is the wrong reform. Instead probably the most appropriate reform should be to strengthen PFA/IC. Tis could be coupled with proposing the introduction of the basic managerial elements of PFM/IC through proposals for the reform of the public administration. Tis will mean maintaining the external controls exercised by the ministry of fnance over line ministries and local governments, or if the external controls exercised by the ministry of fnance are weak, strengthening those controls.

#### **5.2.3 A Critical Issue for a Minister of Finance**

A principal responsibility of a minister of fnance is that of the annual budget preparation. In preparing the budget a minister of fnance will almost always be under pressure to increase public expenditure. Tis pressure may come from parliament, civil society as well as individual line ministries. As result the minister is bound to ask this question: 'if we adopt PFM/IC, can we still maintain control of public expenditure when line ministries and local governments4 have more control over expenditure decisions and can we raise our income more efciently and efectively?' As adopting PFM/IC, introduces a managerial culture into line ministries and local governments, managers need to have the discretion to make decisions and those decisions may afect both the levels and the distribution of public expenditure. Hence, potential ministry of fnance anxiety!

However, the PFM/IC reform, *if properly applied*, is consistent with ministry of fnance objectives of maintaining budgetary and fnancial control of public expenditure, securing adherence to the laws and regulations, achieving objectives, improving efciency and efectiveness and ensuring that line ministries and local governments do not enter into commitments which may be difcult to fnance in the future or which to fnance them may have adverse efects upon other current activities of the organisation. In addition, PFM/IC should result in an improvement in the quality of the operational management and ultimately in the quality of policy making. Managers should also become more fnancially aware. In addition here should be a greater focus

<sup>4</sup>Te references to line ministries and local governments throughout this chapter include their secondlevel organisations.

on the efectiveness of public sector activity, improved availability of the information necessary to inform efective policy making, a better quality of accountability and an improvement in corporate governance, not least because of improvements in decision making processes, including in internal control. It should also result in an improvement in the budgeting process because of an increased emphasis upon the linkage of fnancial inputs with the outputs expected from those inputs. In the managerial environment that PFM/IC introduces, as has been shown, fnance is not simply about costs and income and comparisons with budgets. It is also about how well the money is spent and how all resources are raised and used in achieving the policy objectives and performance standards and objectives expected of an organisation. All of these benefts would be of advantage to a ministry of fnance.

Parliamentary and ministry of fnance interests in the establishment of PFM/IC should in large measure coincide. PFM/IC creates the opportunity for parliament to have available to it a better quality of information about objectives and performance, with potentially greater accountability and transparency and that in turn improves the quality of parliamentary scrutiny of the budget, of line ministry and other public organisation management which in turn impacts upon the quality of budgetary preparation and accountability.

To enable managers to make judgements about how well money is being spent or being raised, as has been pointed out previously, they are likely to require diferent analyses of information than that required for ministry of fnance purposes. Te minister of fnance (and, by extension, the ofcials in that ministry), should accept this. Tey should also accept that this reform has consequential efects upon traditional budgetary and fnancial accounting arrangements within line ministries and local governments. Te minister should recognise that as PFM/IC is a management reform, managers within line ministries, whilst continuing to meet the fnancial, budgetary and cash fow controls set by the ministry of fnance, will need extended budgetary and accounting information in order to deliver their objectives efciently and efectively. Tis will require the development of management accounting (including costing) within line ministries and local governments and the minister of fnance should encourage this. Management accounting will provide a diferent form of analysis from that required for ministry of fnance fnancial accounting and statistical reporting purposes. (A fuller description of the diferences between fnancial and management accounting and the relationships between the two is given in Chap. 8.) Te main point is that the determinant of that analysis should be the individual manager, usually in conjunction with the line ministry or local government's head of fnance, *not*

the ministry of fnance. Budgets also should be much more closely tied to expected outputs than normally occurs with traditional arrangements. (Tese radical changes point to advantages accruing from a pilot reform process before launching a full scale reform so that the ideas associated with the reform can be tested.) Individual operational managers will also need information about the total budget for their areas of operation, not just some elements (and very often with traditional arrangements in many countries heads of departments (the potential managers) will only have available to them limited budgetary information) . Tis will mean that the ministry of fnance should accept from the outset that line ministry and local government budgets will probably have to be reanalysed to allocate them over managerial responsibilities. Tis reallocation would be a responsibility of the diferent public organisation managements. Tis means, for example, the allocation of all personnel, supplies and services, transport costs, all maintenance costs of assets and overhead costs. With current arrangements some, or all, of these costs may be held centrally by each line ministry or local government. Te management accounting information required by the manager should enable the manager to identify the costs of diferent areas of activity including diferent cost centres and cost drivers. (See previous chapters.) A minister of fnance should ensure that the top operational managers in line ministries and local governments have the willingness and capacity to provide the information managers need to deliver their objectives efciently and efectively and within budget limits.

As a result, the minister of fnance should recognise that ministries and other organisations will want to develop their own analyses of expenditure and income and hence coding structures for their own management purposes. Tis will be in addition to the coding specifed by the ministry of fnance for its purposes. Te responsibility of a minister of fnance is not to prevent this but to encourage it and at the same time ensure that the information it requires for fnancial reporting, international statistical purposes and for budgetary control purposes in accordance with the format of the budget approved by the parliament, is still available. An example of how this objective might be achieved is set out below in Sect. 5.3.4.

## **5.2.4 The Benefts and Costs of the Reform**

Te minister of fnance will want to ensure that the benefts arising from the reform are achieved and the areas of cost arising from the application of this reform are fully identifed. Te minister will also require an assessment of the period over which these benefts will accrue, and costs will be spread. Chapter 10 describes in detail the range of benefts and costs that could result. Te benefts potentially are substantial because they arise from a better quality of management and that strengthening internal control, which with the introduction of PFM/IC will have a focus upon outputs as well as inputs. However, such benefts are not immediately quantifable. Costs can be immediate and quantifable, and the principal costs will arise from the development of IT systems needed to facilitate fnancial analyses and to provide performance information, as well as investment in training of both managers and fnance stafs. IT costs can be very substantial, especially if the country adopting PFM/IC has purchased an 'of-the-shelf' IFMIS which is not sufciently fexible to allow alternative analytical information to meet the needs of managers.

Te minister of fnance should be determined to ensure that policies are developed to ensure that the potential benefts actually emerge, and that in turn depends upon the quality of management.

#### **5.2.5 The Ministry of Finance and the Finance Function Within Line Ministries and Local Governments**

An assumption in this section is that the current and investment budgets are integrated. If they are not this adds to the complexity of securing quality in public expenditure, especially where the diferent budgets are subject to different fnancial pressures. A further complication may also be that responsibility for expenditure on stafng may also lie outside the ministry of fnance. A risk in such circumstances is to the development of a managerial culture within a line ministry of other public organisation, again raising questions about the appropriateness of the PFM/IC reform.

A managerial culture if properly developed should raise questions about how well public money is being spent and whether public resources are achieving the objectives and performance standards and objectives expected of line ministries and local governments. Tis, in turn, raises further questions that should exercise the minister of fnance and the staf of that ministry about the quality of the fnancial and performance information on which a line ministry or local government's policy and the strategy decisions for applying that policy are made. Tis should afect how a ministry of fnance looks at their expenditure planning and budget execution processes. Other questions will include those about the fnancial resilience of the organisation. Te answers to these questions, given a decision to proceed with the reform, will (or should!) afect ministry of fnance judgements about the allocation of budgetary resources and how far it feels able to relinquish or modify its own controls. Tis consequently draws a minister of fnance into considerations about the quality of line ministry or local government fnancial management.

An important feature therefore of the introduction of PFM/IC is the development of the role and responsibilities of the head of fnance within ministries and local governments. A key management challenge is how to make the best use of public resources and an understanding of fnance is central to that. Te internal control standards referred to below in Sect. 5.3.5 (i.e. COSO) emphasise the importance of achieving efciency and efectiveness. Te head of fnance is central to achieving that objective. Te head of fnance should aim to develop and maintain fnancial awareness and the policies and processes, such as management accounting and costing to control and manage the efcient and efective use of resources by the organisation's management including that of second-level organisations. Te head of fnance should also be required to develop a long-term fnancial planning capability. All this information should be designed to support managers in the delivery of objectives efciently and efectively. In Chap. 8 the responsibilities of the head of fnance are described in detail. Given the enhanced role of the head of fnance with PFM/IC the position should be of high status and where the senior staf of an organisation are formed into a 'management team' then the head of fnance should be a member of that team. Te state secretary in a ministry of fnance should exercise infuence to ensure that this occurs.

In many countries the quality of fnancial management (i.e. as compared with fnancial control) will be a new area of interest for a ministry of fnance. A ministry of fnance should want to ensure that each line ministry or local government has a sufciently high quality of fnancial management to enable it to deliver the objectives and performance standards and objectives that are or should be incorporated within the budgetary settlement, do so efciently and efectively, and at the same time maintain budgetary and fnancial control. A better quality of fnancial information should also feed into the policy making process as operational management provides advice on the practicality of political proposals. With PFM/IC fnance should be at the heart of decision making within each line ministry and local government. Because the role of fnance is so central to the development of efciency and efectiveness, as well as to control, a ministry of fnance, with the application of PFM/IC should want to ensure that the quality of fnancial management across the public sector is of a consistently high standard. Tis would mean that as part of the reform the ministry of fnance should consider the possibility of incorporating within it a department with a specifc responsibility for enhancing the quality of fnancial management in all line ministries and local governments by:

• Developing through training a resilient and expert community of fnance professionals.

#### **5 The Responsibilities of the Minister of Finance, the State Secretary…**


A head of fnance in a line ministry or local government adopting PFM/IC is not simply to act as a recorder of fnancial information, that is, levels of spending and income, acting as a fnancial controller. In most developing and transition economies, currently this is what the role appears to be. With PFM/ IC it must be much more than that and a purpose of a ministry of fnance should be to ensure that this wider role is appreciated and established in practice. Tis wider role includes ensuring:


Tis also means ensuring that fnancial data and data impacting upon fnance, such as performance data, is robust.

Te competencies needed by a head of fnance have been defned by the Chartered Institute of Public Finance and Accountancy (CIPFA) and include:


Because the capability of the head of fnance coupled with the capabilities of the fnance department of each line ministry and local government are central to the successful delivery of PFM/IC, the ministry of fnance through the department responsible for the application of PFM/IC should be confdent about this capability. Without this the benefts of the reform are unlikely to be achieved. Judgements about the head of fnance capability would be based upon actual performance in the post and in the efectiveness of the fnance department in meeting managerial requirements, and where appropriate those of the ministry of fnance.

Te development of the role of the head of fnance may have the consequence that it leaves that ofcial exposed to inappropriate pressures to approve of managerial actions (sometimes ofcial and sometimes political) afecting fnance which the head of fnance may fnd difcult to resist even though such pressures may lead to a breach of the government wide fnancial regulations or to inappropriate decisions being made. Examples of inappropriate decisions are the overstatement of likely revenues to be derived from a particular activity, an understatement of the fnancial or fscal risks that might accrue from pursuing a particular course of action. An issue therefore that a minister of fnance should consider is whether the appointment and dismissal of a head of fnance should be subject to the approval of the minister of fnance, even

<sup>5</sup>Finance competencies for public services: Shaping the fnance function to meet new and future challenges: CIPFA: https://www.cipfa.org/policy-and-guidance/reports/fnance-competencies-for-public-services-shaping-the-fnance-function-to-meet-new-and-future-challenges.

though the actual appointment may be the responsibility of the relevant line ministry or local government. Te need for the approval of the minister of fnance to the appointment and dismissal of a head of fnance would have the efect of strengthening the position of the head of fnance where inappropriate pressures may develop. However, the role of the minister of fnance would have to be exercised sensitively because a head of fnance could not function efectively if he/she were regarded as a creature of the minister of fnance rather than being wholly committed to the employing organisation.

In Chap. 7 the responsibilities of the head of operational management within a line ministry or local government are set out, and in Chap. 8 the changed role of the head of fnance is discussed in depth.

#### **5.2.6 How the Minister of Finance Should Regard PFM/IC**

Critical to the introduction of PFM/IC is that the minister of fnance regards the introduction as a:


A minister of fnance should accept that this reform is neither easy nor quick to introduce. It is a major reform which has an impact upon how public services and activities are managed. Te impact of the reform may require a considerable change to traditional human resource (HR) and other administrative arrangements (see Chap. 14).

## **5.2.7 Coordination with the Different Ministry of Finance Technical Departments**

Close cooperation will be necessary between the ministry of fnance departments responsible for budgeting, treasury, and fnancial accounting activity (depending upon how the ministry of fnance is organised) and a department established to support the state secretary in overseeing the application of PFM/IC. Tis is because the interests of the budgeting, treasury, and fnancial accounting departments will dominate the control interests of the ministry of fnance; whereas the department responsible for the application of PFM/IC has a wider management focussed remit. Tese traditional departments of the ministry of fnance may also perceive a loss of power because responsibility for some expenditure decisions will be transferred to line ministries. An objective of the department responsible for the application of PFM/IC should be to introduce into these ministry of fnance departments an appreciation of the fnancial management information needs of management. Te person with the principal responsibility for securing coordination between these diferent departments should be the ministry of fnance state secretary. However, experience indicates that those more well-established traditional departments within the ministry of fnance can be difcult to convince of the need for those changes that will be required for the efective application of PFM/ IC. Te overriding concern of those departments will be to ensure that budgetary control in the format for which the ministry of fnance expects to be accountable is not weakened and that the ministry of fnance's ability to complete international statistical returns for organisations such as the IMF, the UN, Eurostat, and the Organisation for Economic Cooperation and Development (OECD) is not afected.6

However, another problem will arise from the impact of the reform upon the fnancial information system in use by the ministry of fnance. Where the ministry is using a standard 'of the shelf' commercial package there could be these types of problem which could cause difculties for a ministry of fnance:

<sup>6</sup>Tese returns will usually follow internationally defned formats such as the Classifcation of the Functions of Government (COFOG) developed by the OECD.


If a country has developed its own fnancial information system, these problems may not apply, but even so such a system is likely to require modifcation, not least to accommodate the additional information managers may require. Individual ministries may still need to develop their own fnancial information systems which must link with the ministry of fnance system (see also Sect. 5.3.5).

Te department responsible for the application of PFM/IC should recognise the existence of these concerns but at the same time explain the needs of line ministry and local government managements if they are to deliver objectives and performance standards efciently and efectively. Some of the fears of these departments of the ministry of fnance should not be realised provided that line ministries and local governments have an appropriate managerial and technical capacity to apply the PFM/IC reform. Tis is the point where confdence (trust!) does need to be built and if that does not exist these departments of the ministry of fnance may be reluctant to engage in the reform.

Te coordinating role of the ministry of fnance state secretary is more complex in those countries where the investment budget is the responsibility of a ministry other than the ministry of fnance and where responsibility for civil service stafng (HR) is also the responsibility of an organisation lying outside the ministry of fnance. Te policies of these ministries/organisations will need to be adjusted to refect the development of PFM/IC.

#### **5.2.8 The Minister of Finance and Other Ministers**

PFM/IC should be accepted as a government wide reform with the prime minister (or in some countries, the president) having an overall responsibility. Te minister of fnance would need to work closely with this ofcial to secure acceptance of the reform and this is likely to include the minister of fnance having a responsibility to persuade fellow ministers of the need for this reform and the benefts that will accrue from its application. Tis will be part of the process for achieving local ownership at the organisation level. Te minister of fnance will also have to persuade them that to achieve the benefts of PFM/ IC, organisational changes will be necessary to establish a managerial culture including changes to the public administration and HR arrangements. Terefore, other ministers would need to accept that there would be changes in how they work and in their day to day responsibilities. Te changes were described in Sect. 4.2.4 of Chap. 4 and may be summarised as ministers responsible for line ministries should recognise that responsibility for operational management should be delegated to experienced civil service managers and that their own focus should be on policy and strategy development with an oversight role of the performance of the operational management. Te minister of fnance responsibility would be to persuade other ministers that this separation would be essential to the introduction of PFM/IC and the benefts it could bring. Tis also recognises that with the introduction of PFM/IC management becomes much more demanding. No longer will it be simply a matter of delivering an activity within budget. Te minister of fnance will need to make clear to other ministers that the PFM/IC reform will also require that 'activities' are clarifed with objectives and performance standards and objectives and that their responsibility is to ensure that those objectives are delivered to time, to standard, efciently and efectively as well as within budget and in conformity will all legal and regulatory requirements. As a result, the quality of budgets will need to be improved with objectives and performance standards and objectives being linked to budgets. Tis means that ministers and their operational managers agree that the objectives and performance standards and objectives are capable of being delivered within the available budget. (If not, as has been explained previously, then either the budget or the objectives and performance standards should be changed.) A similar understanding would need to be communicated by the ministry of fnance state secretaries to equivalent ofcials in other public organisations.

Political management will also be required to satisfy itself that senior operational managers at all diferent levels, as well as themselves, can maintain overall control of the organisation, including over second-level organisations (see Sect. 5.3.9 and Chap. 12). To achieve that managerial accountability arrangements will have to become established which complement the arrangements for delegation. Ministers will also have to be persuaded by the minister of fnance that they should invest in improving the capabilities of their organisations to deliver services efciently and efectively. Tis means that operational managers have the fnancial and performance information that they need to secure efciency and efectiveness.

Whilst the ministry of fnance should welcome this reform other ministers may not do so. Tis can be due to several factors. For example, there may be resistance to increased transparency and accountability, a lack of willingness to delegate operational responsibility, tighter control over second-level organisations may be objected to because it reduces the scope for budgetary manipulation, tighter budgetary control because ministers will be accountable for delivering objectives and performance standards and objectives, as well as meeting budgetary controls, and doing so efciently and efectively. A minister of fnance should be prepared for these arguments and be willing to resist them.

Where the reform is intended to apply also to local government the minister of fnance and the state secretary will need to establish similar relationships with mayors or their representative bodies.

In some countries a ministry of fnance may seek to impose its view of efciency. However, a ministry of fnance is really in no position to make such a judgement. Te responsibility lies with the operational management within a line ministry. However, a ministry of fnance should have the capacity to challenge the judgement of that management and ought to do so where appropriate. Such challenges may occur during, for example, budgetary negotiations. Success in such negotiations depends upon the establishment of trust between a line ministry and the ministry of fnance. A line ministry should set realistic and deliverable performance targets and not try to 'game' the system. Te ministry of fnance should be able to trust the judgement of line ministry specialists and as a result make available reliable funding.

#### **5.2.9 The Minister of Finance and Parliament**

Te minister of fnance should have not only a responsibility to agree the introduction of the PFM/IC policy with parliament and that means explaining all the diferent features of the policy, but also a responsibility to keep parliament informed of progress. Tis means that the minister should report regularly to parliament and where changes to the implementation policy occur, as they could well do, that parliamentary approval is sought. Te minister should be accountable for success or failure to parliament.

Te success with implementation should be assessed annually through the preparation of a 'statement of internal control' (see Chap. 13). Tis statement would be prepared by each public organisation, submitted to the ministry of fnance who in turn should report on this statement to parliament. Te statement would also be available to the external auditor who should review progress as part of the normal external audit activity and will provide a brief to parliament. Tis may form the basis for the interrogation of the minister of fnance.

# **5.3 During the Reform!**

## **5.3.1 Establishing the Appropriate Organisational Structures to Apply the Reform**

As has been pointed out previously, the responsibility for operational application should be delegated from the minister of fnance to the ministry state secretary who should be supported by a specifc department responsible for the operational application of PFM/IC throughout the public sector. Tis department should issue detailed guidelines about how to apply the reform and should report to the chief ofcial in the ministry of fnance about the organisational application of the reform. It should also be responsible for maintaining the quality of the reform over time ensuring that the PFM/IC arrangements also refect the changing operational environment.

Te minister of fnance, together with the state secretary should ensure that the department is appropriately stafed and has an ongoing capacity to oversee the reform. (Te capacity requirements are set out in Chap. 9.) Countries wishing to join the European Union are required to establish such a department, often called a central harmonisation unit or department. Te existence of such a department is regarded as one of the three pillars to the successful application of PFM/IC within those countries aspiring to meet the European Commission requirements. Tis arrangement provides a model that other countries could well follow. However, other aid organisations involved in supporting the application of PFM/IC may take a diferent view of the need for such a specialist department, although this author would regard such a department as an essential feature of the successful development of PFM/IC.

Tere will be some responsibilities that the state secretary can alone undertake. Tat ofcial should have a personal responsibility for informing and coordinating the responses of equivalent chief ofcials in line ministries and for establishing regular meetings with such ofcials to review progress and to decide collectively how to address emerging problems. Tese personal responsibilities could also extend to local governments but whether they would depends upon the constitutional relationships between central and local government (see also Chap. 7). How the coordination arrangements should operate and the role of the state secretary are described in Chap. 9.

#### **5.3.2 Cooperation with the Ministry or Department Responsible for Public Administration or Civil Service Reform**

A crucial feature of success in the application of PFM/IC will be cooperation between the department responsible for overseeing the reform in the ministry of fnance and the ministry or department responsible for civil service and public administration reform. If coordination does not occur, perhaps because no public administration reform programme exists (which in this author's experience does occur) the PFM/IC reform, because it is a managerial reform, will seek to drive civil service and public administration reform. However, in practice it cannot do this. Te minister of fnance, and by extension the state secretary, has a responsibility to ensure that this coordination occurs, and that civil service and public administration reform takes into account the requirements of the PFM/IC reform. If no public service reform plan exists then it is doubtful if the PFM/IC reform will be successful. Consequently, this need for coordination will afect the timing of the arrangements for the application of PFM/IC reform. (It should be borne in mind that even though PFM/IC is a major reform, so too is civil service/public administration reform and it will similarly take a long time to become established.)

#### **5.3.3 The Use of Performance Information**

Many governments, usually through the ministry of fnance, use performance indicators (sometimes called 'key performance indicators'—KPIs) to assess the performance of organisations towards achieving policy objectives. Tese indicators can be simple (recording one element only of an activity), or composite (covering several aspects of an organisation's activities). An example of a performance indicator is measuring the number of caesarean births (C-sections) and using that as a proxy indicator for the availability of certain maternity services. Such a measure could also be used as a key performance indicator expecting that a level of between, say, 5% and 15% of such births in a population would be through C-section with a higher or lower proportion raising questions about why this is the situation. Such a measure could then lead on to an investigation into the reasons.

However, performance information also needs to be used with care and can lead to unanticipated consequences. Tere is always the risk that a management focus is on what can be measured rather than the total service delivery context and ministries of fnance should be aware of this.

A further issue that the ministry of fnance ought to consider is whether performance objectives and/or performance indicators should be published along with the relevant fnancial information. Tis is important from an accountability point of view and the information needs of its key stakeholders such as consumer groups, parliament, and taxpayers. Publication may also be required for some services to meet international statistical requirements, such as those of the World Health Organisation. Publication may lead to challenge, but the benefts of challenge should not be overlooked, uncomfortable though on occasion, challenge might be.

Te ministry of fnance with the development of PFM/IC in making budgetary allocations should take an interest in the development of objectives and/or performance indicators by line ministries and other public organisations. Its interest will be much wider than that of external parties because it will need to be satisfed that the relationships between the fnancial allocations and the objectives, performance standards and performance objectives are robust and therefore that, as far as possible, each element represents reality. Tis again points to the need for trust to be established between the ministry of fnance and line ministries.

Achieving precision in policy objectives is likely to take some time and the reality is that policy objectives and performance indicators will be refned over time. Tat precision will usually focus on the defnition of the 'outputs' of policy objectives which for some services can be relatively easily defned, but for others, not, or there can be confict in the objectives. Consequently, performance measurement can be difcult.

However, some would argue that anyway, 'outputs' are not that important and that what governments should aim for, is to achieve 'outcomes'. Te problem with 'outcomes' is that from a management point of view not only are they difcult to defne with precision but 'outcomes' so far as public services are concerned can be infuenced by many factors which lie beyond the ability of individual managers to control the results, no matter the level of budgetary resources which are available. 'Outcomes' rarely can be captured by a single budget or programme heading or even by a single public organisation. Outcomes can also take many years to achieve and would require very longterm budgeting, that is, well beyond the 3 years that apply even in the most developed economy countries. Terefore, for all practical management purposes the focus of fnancial management and internal control should be upon the achievement of the 'outputs' of policy objectives, with high-quality managers recognising that this only represents an interim step in achieving policy 'outcomes'. For example, a policy outcome of reducing crime depends upon many factors and the activities of many organisations. First, the nature of crime has to be defned and what type of crime is the policy aimed at? Secondly the causes of that type of crime need to be understood and these can include, poverty, social attitudes, quality of housing, levels of policing, policing policies, public attitudes to the police, sanctions (that is both the level and types of sanction) and so on. Te policy 'outcome' can only be achieved through a management structure designed to address each aspect of the policy with the results then coordinated. To do that efectively, individual managers need to be clear about what they are to achieve, that is, the 'outputs' and their activities need to be coordinated with a wide range of other managers, including coordination of budgets (often an impossible task). Some desired policy 'outcomes' are also not capable of being managed and require long-term societal changes of attitude, for example, to the role of the police and how society regards its relationships with the police.

Another approach is to require objectives to be broken down into subobjectives because the sub-objectives are easier to defne and hence the subsequent performance measures. Tis would then allow policy makers and senior ofcials to make decisions about what they wish to achieve in specifc areas, rather than in a broader, but less easily defnable, overall objective.

Te same points also apply to 'performance standards'. As indicated, an important element of management is to defne the operational performance standards that should be applied. Some will be quite simple to apply, at least superfcially, such as all customer queries must be replied to within 1 week, but that says nothing about the quality of the reply. Tat can only be judged by the quality of the managerial supervision and the existence of arrangements where the customer can complain about or follow up, in this example, on the quality of the reply. Other performance standards can be extremely complex, such as assessments of the educational performance of children, which in turn can depend upon a wide range of factors, or in the development of health policy measures to assess public and personal health. And then there is the question of performance objectives. Tese will identify or set targets for the amount of work to be undertaken, such as to undertake a particular number of vaccinations within a given period or to complet a specifed number of asylum claims within a given period.

Or again both objectives and performance standards and objectives can be short term or long term, such as care for homeless persons. If the objectives or performance standards are short term, this will not address what could be the underlying problems and in that event the problems that they are designed to address will merely be repeated.

Tis though is the nature of public services. Political decisions may be required about specifc objectives and performance and that can add to the complexity of any measures. (Tis is what makes the management of public services so difcult compared with the management of market based services and why political judgements need to be made.) However, despite these diffculties, with PFM/IC some measurement of success should be available to the manager even if it does not specifcally address the overall main objective that a top or senior political manager is concerned about. Terefore, the reality is that in practice compromises may be necessary because precision in objectives or performance standards cannot be achieved.

None of this means that PFM/IC should not be developed; it however does demonstrate that achieving public policy objectives can be very difcult in practice and the limitations should be recognised. Te boundary of these limitations will change over time as more experience is gained and information is obtained. PFM/IC is a practical recognition of that and that is why the implementation of the PFM/IC policy is so desirable, but the appropriate conditions must exist if the benefts are to be achieved. Te benefts are also likely to take some time to emerge because of the fundamental nature of the reform and the learning processes involved.

## **5.3.4 The Organisation of Financial Information for Management Purposes**

To facilitate the achievement of the benefts of PFM/IC managers in line ministries and local governments will require that budgetary and fnancial information is available to them in a form that suits their needs as well as those of the ministry of fnance. Tere is no reason why individual line ministries (and local governments) should not develop their own fnancial analyses to suit their own needs and a ministry of fnance should not stand in the way of this. In practice it would mean that individual public organisations develop their own coding structures designed to meet their own managerial needs but with the important proviso that such coding structures should link with those of the ministry of fnance. Te head of fnance should have a key role in working with individual managers to determine their fnancial information requirements. (However, as has been pointed out previously, where countries have purchased of-the-shelf IFMIS this may be difcult because of the infexibility of their coding structures.)

To illustrate the approach an extract is set out below from the government of Canada7 :

<sup>7</sup>Government of Canada—Section 2—Introduction and description of the coding classifcation structure for 2018 to 2019: https://www.tpsgc-pwgsc.gc.ca/recgen/pceaf-gwcoa/1819/2-eng.html

Te **Receiver General—Central Accounting and Reporting Sector**<sup>8</sup> is responsible for maintaining the accounts of Canada under Section 63 of the *Financial Administration Act* which includes the day to day management of the government-wide Chart of Accounts (COA) which specifcally involves the creation, deletion or modifcation of accounts or codes, and the publishing of updates on the Receiver General government-wide COA website. In addition, the Receiver General provides functional direction, supporting operational instructions and other guidance to departments and agencies pertaining to the government-wide COA and government-wide coding. Te Receiver General also performs a monitoring role for the overall quality of the information contained in the departmental monthly trial balances submitted to the Central Financial Management Reporting System (CFMRS) for inclusion in the accounts of Canada.

*Departments are responsible for ensuring that their departmental coding is linked to the appropriate accounts and codes contained in the government-wide COA and that their fnancial transactions are complete and accurate. At the end of each month, departments summarize their fnancial transactions (based on the government-wide coding) and send their trial balances to the CFMRS for inclusion in the accounts of Canada.* (Author's emphasis)

Although this extract refects the arrangements in Canada for the management of fnancial information for the purposes of fnancial and statistical reporting purposes, it also recognises the need for individual departments [i.e. ministries] to develop their own fnancial analytical arrangements but with the condition that whatever those analytical arrangements, each organisation must retain the capability to provide the information that the central fnance organisation requires. Terefore, management accounting information, however it is produced, should be linked to the fnancial accounting systems of the ministry of fnance to ensure that the ministry can fulfl its responsibilities. Tis linkage also ensures that the same basic fnancial information is used for budgetary control, fnancial reporting, and managerial purposes.

A consequence of introducing PFM/IC therefore will be a need for additional information technology capacity (IT) to provide the analysis managers require.

Because the PFM/IC reform extends the idea of control beyond simply budgetary and fnancial controls to include those controls designed to achieve the objectives of an organisation, to standard, to time, efciently and

<sup>8</sup>Te Receiver General for Canada is responsible for making and accepting payments to the Government of Canada each fscal year and preparing the Public Accounts of Canada, containing annual audited fnancial statements of the Government of Canada.

efectively this extension creates the opportunity for ministries of fnance to link budgetary inputs with the outputs expected for those budgetary inputs. Tis also means that managers should commit themselves to delivering those outputs. Tis is an important feature of PFM/IC.

## **5.3.5 Internal Control Arrangements Within Line Ministries and Local Governments**

Success in applying PFM/IC depends upon the management of line ministries and local governments adopting a disciplined internal control structure and a ministry of fnance has a key interest in this. Internal control enables the management of an organisation, and external stakeholders, including the ministry of fnance, to have greater confdence that its objectives will be achieved, that fnancial and performance reports are reliable, that resources will be used only for the purposes of the organisation and that they will be utilised efciently and efectively. Te minister of fnance should be responsible for specifying the principles of internal control that should apply within line ministries and local governments. In many countries the principles would be those developed by the Treadway Commission (COSO)9 and these are explained in detail in Chap. 11. Te responsibility for applying those principles within each line ministry and local government lies with the management of the organisation. Te actual person responsible for the quality of internal control would be the person responsible for operational management, that is, the head of the civil service within a ministry (or equivalent in local government). Tat person should then report to the political head as appropriate under the managerial accountability arrangements. Te ministry of fnance should satisfy itself about the quality of these internal control arrangements which also provide an indicator of the success of the implementation of PFM/ IC, and that the efectiveness of such controls is monitored and maintained as operational circumstances, policies, and personnel change over time. (See Sect. 5.4.3 on the annual review arrangements and also Chap. 13 on the 'statement of internal control'.) Te quality of the internal control arrangements would be subject to review by the state auditor who should report to parliament on that quality.

<sup>9</sup>Tere are diferent defnitions of internal control but one that is widely applied in a European context, and which has been adopted by the European Commission and the International Organisation of Supreme Audit Institutions (INTOSAI), is that advocated by the Committee of Sponsoring Organisations of the Treadway Commission (COSO). (Other countries may adopt diferent defnitions of internal control.)

Te responsibility of the ministry of fnance (if a country decides to adopt the COSO approach) should be to ensure that the principles of internal control defned by COSO are properly applied. 'Properly applied' means that the management regards them as central to the management process, appreciates the managerial assumptions that lie behind them and is not prepared to accept a superfcial approach which amounts to a focus only on the bureaucracy of the application of the 5 standards. Tat approach amounts to 'tokenism'.

#### **5.3.6 PFM/IC and Budgetary Control**

Te minister of fnance, as part of the budget preparation process, will issue a budget circular. Tis circular will set out the guidelines for framing the budget and any instructions about how to address specifc items. It will include a timetable for the provision of information to the ministry of fnance and may also include a set of forms which individual ministries will be expected to complete. A consequence of the application of PFM/IC is that the content of the budget circular should be expected to change, and in some countries, this would be a considerable change, especially where the current budget circular contains very detailed instructions about the calculation of individual line item. (In one country known to this author the detail required included a specifcation of the amount of drinking water that could be allowed for by ministry employees.) Tis type of detail would be inappropriate with PFM/IC. Te government through the ministry of fnance would still determine budgetary policy including policy decisions about the overall allocation of resources and the totality of expenditure within any ceilings although the assessment of those ceilings should be better informed because of the linkages between input costs and outputs. Where medium-term budgeting has been developed the existence of detailed instruction about the development of the future year's budgets will also require change. Te reason for such changes is that as a key objective of PFM/IC is to encourage line ministries to become managerially oriented making their own decisions about the best way of achieving objectives efciently and efectively, they need the scope to do so. In other words, PFM/IC allows managers increased discretion to use their initiative and detailed instructions from a ministry of fnance about how to construct budgets can have the efect of removing or at best limiting managerial initiative.

PFM/IC also can afect the way in which many ministries of fnance exercise control over budgetary changes proposed by line ministries, that is, over virement arrangements. Te extent to which approval currently may be required depends upon the precise arrangements within the country and specifed within the law. With PFM/IC ministries of fnance should not seek to 'second guess' line ministries or seek to control at a detailed level the decisions of line ministries, or local governments especially where their managers are aiming to make changes to improve efciency and efectiveness. For a ministry of fnance to question every detail of a proposed change efectively puts them into a form of 'superior' manager exercising fnancial control, even if it does not intend to act in that way. Tis is incompatible with the idea of managerial competence, discretion, and hence accountability.

Consequently PFM/IC will impact upon ministry of fnance/line ministry relationships, that is, they cannot remain the same. Indeed, if a ministry of fnance tried to ensure that they remained the same this would undermine a key objective of PFM/IC which is to encourage line ministries to become managerially oriented making their own decisions about the best way of achieving objectives efciently and efectively. In other words, PFM/IC allows managers increased discretion to use their initiative. Tight budgetary development rules and virement controls stifes initiative.

Terefore, some 'control' changes afecting the ministry of fnance will be required, for example:


What this means for budgetary control is that the ministry of fnance with PFM/IC should be willing to shift its 'control approach' with the adoption of PFM/IC from that of detail to a broader concern for how a line ministry or local government is delivering its objectives to time, to standard, efciently and efectively but within an overall budgetary envelope. (A traditional budgetary process may result in a tight budgetary and cash fow control, but it efectively inhibits managerial initiative within line ministries or local governments, aimed at achieving objectives.) However, to emphasise, such a shift should not occur unless the ministry of fnance has full confdence that overall fnancial and budgetary control will be maintained by the line ministry and other public organisation management (see test of 1 Chap. 4).

#### **5.3.7 PFM/IC and the Quality of Public Expenditure**

Developing managerial initiative is an objective of PFM/IC. Te aim is to improve the quality of public expenditure. Improving the quality means considering not just the control of spending but determining what is being achieved for that spending and how it is being achieved. PFM/IC therefore has the efect of highlighting a confict, which should not exist, between traditional budgetary and cash fow controls and a desire to improve efciency and efectiveness in public expenditure. Traditional controls have no regard for efciency and efectiveness even though they remain essential if the conditions described in test 1 of Chap. 4 cannot be met. A ministry of fnance should recognise the existence of this confict and its adverse efect upon any drive to improve efciency and efectiveness. Consequently, ministers of fnance should reconsider how traditional budgetary controls operate. Ministers of fnance will always remain concerned about pressures to increase public expenditure and their budget ofcers will be very alive to this issue. With the introduction of PFM/IC a minister of fnance should look for ways of reconciling the requirements for expenditure control (the inputs) with the policy outputs that managers should be aiming to achieve.

Similar types of control to those which exist for expenditure may also exist for personnel. Tey have the same efect of limiting a manager's ability to make changes to the personnel structure without the approval from another ministry or the ministry of fnance. Again, the introduction of PFM/IC should cause a rethinking of the purpose and efectiveness of such controls. If a manager has no or very limited control over the utilisation of personnel resources, then the manager's ability to deliver objectives efciently and efectively can also be limited. (An example given to this author by the head of a maternity hospital was that he was not allowed to change a gardener post for a nurse post, at the same cost, to improve the utilisation of resources because the ministry of fnance would not approve because of the risk of creating a precedent.)

A further feature of PFM/IC is that a consequence of the requirement to improve efciency and efectiveness is that line ministries and local governments should take a longer-term view of their fnances. (A ministry of fnance should encourage this.) Tis means that they will need to develop long-term fnancial planning, that is, which may go well beyond the requirements for 3 or 4-year medium-term budgeting. Public services usually require long-term commitments and therefore efciency and efectiveness should also be considered over the longer term. Decisions should not be made which do not have regard to the long-run fnancial implications of that decision, both on a particular service or activity and on other services and activities provided by the organisation. (Tat a particular decision secures a lower cost result in the short term does not necessarily improve efciency and efectiveness: consideration should also be given to those other factors, such as quality, which will afect the long-run costs even if that means higher immediate costs.) Assessing long-run costs should be a key factor in decision making. It should also be a factor in securing the long-run fnancial resilience of an organisation. Tis should be of active concern to a head of fnance. (Tis also illustrates the difculty of relying simply upon foreign aid fnance to support the development of PFM/IC because such aid is usually only committed for short periods and can be variable depending upon the interests and circumstances of the donor country.)

#### **5.3.8 The Impact of PFM/IC on the Control of Second-Level Bodies Such as Agencies and State-Owned Enterprises**

Te PFM/IC reform will also require a much tighter control by frst-level organisations, that is, by line ministries and local governments over secondlevel organisations such as agencies and state- and local government–owned enterprises. Overall, there should be a strengthening of accountability between second-level and frst-level organisations, whether agencies or state- and local government–owned enterprises. Te ministry of fnance should consequently encourage controlling or owning frst-level organisations to set for second-level organisations, objectives, and standards of performance and then frst-level organisations must develop a capacity to efectively monitor the activities of those second-level organisations. Without this second-level organisations will tend to drive frst-level organisations, rather than the other way round. Tis is because a second-level organisation will always know in more detail than the controlling or owning frst-level organisation about their operational environment, and they will also be protective of their own interests and resist pressure to reform including pressure to improve efciency and efectiveness. Terefore, the frst-level organisation must always have the capacity to challenge.

Te minister of fnance also should ensure that where a frst-level organisation wishes to establish a second-level organisation, that this is an appropriate action. Te minister of fnance should also ensure that when established the second-level organisation is efciently managed and efectively supervised by the controlling frst-level organisation. Controls over second-level organisations in countries with traditional public administrative systems tend to be weak. Introducing PFM/IC creates an opportunity for the minister of fnance to require the strengthening of the controls and reporting arrangements for these second-level organisations. Set out below are the key policy points the minister of fnance should address in strengthening controls (control requirements are discussed in full in Chap. 12). Tese key policy points ought to be included within a report to parliament:


#### **5 The Responsibilities of the Minister of Finance, the State Secretary…**

• Te external audit arrangements for state- and local government–owned enterprises.

Parliament should have the ability to scrutinise the operations of secondlevel bodies and be able to call the management to account as part of the scrutiny arrangements.

No second-level organisation should be permitted to agree its budget directly with the ministry of fnance and ultimately with parliament, apart from those with a judicial authority and the state auditor. Tis is the practice in some countries but with PFM/IC all communications with the ministry of fnance should be through the frst-level organisation. Budgetary information about second-level organisations should be incorporated into the relevant frst-level organisation budget which in turn should provide appropriate reports to parliament identifying the budgets for the second-level organisations controlled by the frst-level organisation. If there are to be any exceptions these should be specifcally agreed with the parliament.

With non-market second-level organisations the minister of fnance should ensure that frst-level controlling organisations satisfy themselves that the objectives and performance standards of the second-level organisation are consistent with their own and that they monitor the performance of the second-level organisation during the year.

Te ministry of fnance should ensure that a periodic review process exists to determine whether the second-level organisation should continue in existence.

#### **5.3.9 PFM/IC: Securing the Managerial and Technical Capacity: Advice and Training**

A particular responsibility of the department within the ministry of fnance responsible for the application of PFM/IC will be to provide advice on managerial questions and technical support to line ministries and local governments. Examples of the type of advice that may be required include on managerial structures, delegation, and managerial accountability arrangements and on the management of relations with second-level bodies. Technical advice could include the specifcation and utilisation of fnancial information and for fnance ofcials on budgetary, fnancial, cost and management accounting and on longer-term fnancial forecasting.

Civil servants will require training to help them develop the managerial skills that will be required. Heads of fnance will require training to develop the skills needed to support a managerially oriented public administration. Skilled managers and fnance ofcers are in short supply especially in the public sectors in many countries. Tis indicates a serious need to accompany the PFM/IC reform with the development of appropriate training programmes. Such training can be expensive, but the issue is 'no training, no management'. (Note: this is NOT about training in the bureaucratic requirements of the COSO internal control arrangements.) Te department responsible for the application of PFM/IC should not be expected to deliver such management and fnancial training but in conjunction with the organisation responsible for public administration/civil service reform should specify what is required. Te training itself should be undertaken by an expert training organisation such as a local university and almost inevitably would require that training organisation to develop specialist post graduate courses. So far as fnance ofcer training is concerned, such ofcials would require a basic training in accounting and economics, and they would need advanced training to develop the competencies set out in Sect. 5.2.5. Te department responsible for the application of PFM/IC may specify what the training should cover but as with management training, the programme of training should be provided by a university or a similar training institution such as a professional accountancy body.

Tere is another aspect of training that is frequently overlooked and that is the training of parliamentarians and especially those involved in the scrutiny processes. Parliamentarians will need advice on the impact of PFM/IC and how it will afect the construction of the budget, the management of public services, the distribution of responsibilities between the members of the government and the civil service and the arrangements for accountability and transparency. Without such training there is a risk that parliamentary scrutiny will continue along traditional lines and that too, over time, at least, will afect the success of the PFM/IC reform.

## **5.3.10 Encouraging Managerial Initiative: A Need to Review Penalty and Inspection Arrangements**

Test 8 in Chap. 4 identifed a need to review the penalty, inspection, and sanction arrangements afecting civil servants and local government ofcials and the way in which inspection arrangements operate. Te minister of fnance should assess whether such arrangements remain appropriate in an environment where delegation and managerial accountability are such a key element in reform. Tis is because current civil service laws as well as existing inspection and penalty arrangements can act as a barrier to the exercise of initiative, and the delegation of responsibility. Tey can lead not only to fnancial penalties but also to disciplinary action being taken against a civil or local government ofcial for making what some critics may regard as a wrong judgement. Tis is even though such a judgement has been made in conformity of all the relevant rules and regulations. Tis can occur where, for example, a political ofcial takes a diferent view from that of the decision making appointed ofcial. However, where the bureaucratic arrangements follow Weberian principles, civil service ofcials should be protected from political sanction. However, quite properly, civil or local government ofcials should be subject to disciplinary arrangements, and even to criminal investigation for wrongful acts, abuse of power, a failure to act in the public interest or actions which cause damage to public assets. Te code of conduct afecting public ofcials should not expose ofcials to undue sanctions or pressure when making decisions under the delegation arrangements developed as part of the PFM/IC reform.10

A very useful paper11 has been published which examines how a regime of penalties or sanctions for breaching public fnancial management (PFM) laws and regulations can be designed to increase compliance with these laws. It advocates that designers of penalty regimes should have regard to fve principles, that is:


<sup>10</sup> See, for example, Liabilities and discipline of civil servants By Francisco Cardona—SIGMA 2003: http://www.sigmaweb.org/publications/37890790.pdf

<sup>11</sup>Do Sanctions Improve Compliance with Public Finance Laws and Regulations? Allen and Koshima: Public Budgeting & Finance: 10 July 2018: https://doi.org/10.1111/pbaf.12197


#### **5.3.11 Financial Regulations and Other Advice to Be Issued by the Minister of Finance**

Many governments through the minister of fnance have issued a set of fnancial regulations which determine how specifc fnancial transactions are to be dealt with. Such fnancial regulations ought to be issued and reviewed regularly by ministries of fnance in conjunction with line ministries and local governments. Tese regulations could be signifcantly afected by the introduction of PFM/IC and the decision to introduce this reform should stimulate review. For example, because a feature of this reform is that delegation and managerial accountability are developed, this will impact upon existing fnancial regulations if there is no recognition currently of the existence of these features. Again, advice could be provided through the fnancial regulations on the scope that could be granted by individual ministers or other senior ofcials, such as state secretaries, for the delegation of the approval of contracts and invoice payments, depending upon the size, complexity, and sensitivity of the transaction.

Te coverage of those regulations is summarised in an annex to this chapter.

### **5.4 Sustaining the Reform**

#### **5.4.1 The Minister of Finance and the Timescale for Application**

As was indicated previously, because of the fundamental nature of the reform the timescale for application is likely to be lengthy. In Chap. 4 there was a discussion about timing. In summary, ministers of fnance ought to envisage at least 10 years from the development of the policy to actual application although in reality, fnancial management and internal control reform is an ongoing process as new experience is gained, new ideas developed and operational circumstances change. Exactly how long the initial application process will take though depends upon the starting point. Tus, if there is already a developed managerial culture with extensive delegation of decision making authority and developed managerial accountability processes, the timescale could well be much shorter. Again, where management accounting (including costing) has already been developed then this too will permit a shorter initial application period. What could also be an important factor in the time period is the extent to which both management training and accounting technical skills require developing. Te length of time required to introduce PFM/IC will also depend upon whether other public fnancial management reforms are being introduced at the same time. For example, where accrual accounting is being introduced, this will have a signifcant impact upon the management accounting arrangements, upon fnancial and budgetary control and upon the responsibilities of management. Accrual accounting is both a technical and a managerial reform, if properly introduced. Application of both reforms at the same time, if the needs of both are to be properly considered will be delayed. Again, the same applies where programme budgeting is being introduced as well as the PFM/IC reform. Whilst these are complementary reforms developing them at the same time will stretch out of the reform timetable.

Another factor afecting the length of time the reform will take to apply will be the timetable for the reform of public administration.

Too many reforms undertaken in parallel also risk overstretching the resources of the ministry of fnance and those departments or ministries responsible for civil service or public administration reform.

## **5.4.2 The Need for a Consistency of Approach over Time and for Consensus Between Different Strands of Political Opinion**

Because of the length of time that it will take to introduce the PFM/IC reform ideally an agreed approach supported by all strands of political opinion, should be adopted. An important responsibility of a minister of fnance would be to encourage this 'cross-party' support. Consistency in the reform policy over time will be an important factor in securing efective delivery in the shortest possible timescale. Even though a government may still remain controlled by the same political group(s) individual ministers may change. In such circumstances ministers of fnance should recognise that there is a real risk that approaches to the application of PFM/IC may also change. Terefore, a minister of fnance should ensure that arrangements do exist to secure consistency over time. Parliamentary oversight of the reform could also secure consistency of support and stimulate application especially where there is a regular change to elected ofcials.

In some countries the administrative and managerial arrangements within a ministry are governed by a ministerial decree issued by a minister and those issued by one minister may not be automatically continued in force without the specifc authority of a new minister. Such a decree is unlikely to challenge the principle but may afect how the PFM/IC reform is applied in practice. Te minister of fnance has a responsibility to ensure that this situation does not occur, and this can be achieved in several ways. One would be regular assessments by the cabinet of ministers of progress in the application of the reform. A second would be by legislation requiring that ministerial decrees afecting the application of PFM/IC were approved by the ministry of fnance (perhaps by the department responsible for the application of PFM/IC on behalf of the minister of fnance). A third would be by a legislative requirement that ministerial decrees afecting the application of PFM/IC had no efect unless they were agreed with the ministry of fnance. Or alternatively, by some combination of these approaches!

## **5.4.3 The Ministry of Finance and Annual Arrangements for the Review of the Impact of PFM/IC**

Annually line ministries and local governments should prepare a formal statement explaining how they have applied PFM/IC and its efectiveness, including what has gone wrong, identifying failures to meet objectives and performance standards and objectives, and what corrective actions have been taken. Tis statement could also incorporate information about the risk assessment arrangements, including information about the types and level of risk that the organisation is willing to accept (the 'risk appetite'). (See Chap. 11 for a detailed discussion about risk.) If this statement about the application of PFM/IC did not incorporate the information about risk, then a separate statement should be published. Tis statement should be signed both by the head of operational management and by the political head of the organisation. (A full description of such an annual statement, a statement of internal control, is included in Chap. 13.)

Tis is potentially a very important statement for a ministry of fnance to consider. It should provide valuable information about the quality of PFM/IC within an organisation. Ideally this statement before it is issued should be reviewed by internal audit and following publication by external audit. Te ministry of fnance ought to consider the content of this annual statement and this should afect this ministry's view of the quality of the PFM/IC arrangements applying not only in a particular organisation, but as all line ministries and local governments should prepare such a statement, including state-owned enterprises, more generally across the public sector. (Te department responsible for the application of PFM/IC should have the responsibility to prepare a report of fndings from these statements.)

Te ministry of fnance should issue guidance on the content of such statements. Tese statements should be publicly available and ought to be submitted to parliament as a feature of the accountability and transparency arrangements. When submitted to parliament they should normally form an element of the annual report which all public organisations ought to prepare, and which should be subject to review by the state auditor.

So far as local government is concerned a minister of fnance should ensure (subject to individual country constitutional arrangements) that individual local governments also make public annually such a statement including for local government–owned enterprises.

#### **5.5 Summary**

Te minister of fnance has the principal responsibility for securing the efective application of PFM/IC. Te ministry of fnance is the 'mechanism' through which this responsibility will be exercised and the benefts achieved. Te main aims of the reform are to secure the delivery of policy with the achievement of the objectives of a line ministry or local government, to do so efciently and efectively and to improve governance, transparency, and accountability. Te driving force for the application of the reform should be the minister of fnance together with the state secretary who should be supported by a specialised implementation department.

Because the PFM/IC reform is primarily a management reform a key minister of fnance responsibility is to ensure that coordination exists between those responsible for public administration (or civil service) reform and the staf of the department in the ministry of fnance responsible for the PFM/IC reform. Te minister of fnance should also recognise the broad impact the reform will have upon many of the responsibilities of the ministry of fnance. In particular, the introduction of PFM/IC will afect or complement:


#### **5 The Responsibilities of the Minister of Finance, the State Secretary…**


Te minister of fnance should ensure that internal control arrangements exist in conformity with its guidelines and that it assesses annually the quality and adequacy of line ministry and local government compliance. Line ministries and local governments should be expected to prepare an annual statement setting out how well the internal control mechanisms have performed during the year including failures and defciencies (such as not meeting objectives and performance standards) and the corrective actions that have been taken.

A critical feature in the success of the PFM/IC reform will be the ability of the prime minister or other head of government supported by the minister of fnance to convince fellow ministers of the need for this reform and the benefts that will fow from efective application. Te minister of fnance will consequently require a capacity to challenge the arguments of those who wish to retain traditional arrangements.

Te reform is a long-term reform. An important responsibility of the minister of fnance is to maintain the momentum of the reform over time and to ensure that it has widespread political support, that is, local ownership of the reform. A key to maintaining the momentum of the reform will be the establishment within the ministry of fnance of a well-resourced and expert specialist department responsible for the detailed introduction and development of PFM/IC. Tis department should have equal status to other ministry of fnance departments.

Te benefts from the application of the reform are substantial but there are costs that will ofset some of those benefts. However, if the reform is not properly applied and is regarded simply as a technical fnancial control reform focussed on introducing additional bureaucratic procedures the benefts of the reform will not be achieved.

# **Annex**

Te content of fnancial regulations afecting transactions should include:


#### **5 The Responsibilities of the Minister of Finance, the State Secretary…**

**201**

Tey may also cover arrangements for the:


Te regulations may also include requirements about consultation with the head of fnance:


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# **6**

# **Risks and Unintended Consequences of the Reform**

As with many reforms there are risks and unintended consequences. Tese can afect the level of benefts that may be achieved and the utilisation of public resources causing actual losses through corruption or other forms of misuse of public resources as well as a misdirection of resources. Failure to achieve objectives and performance standards may also be an unintended consequence. Pressure may also emerge to either abandon the reform or focus on the bureaucracy of the reform rather than its managerial substance because it will impact upon individual responsibilities and the distribution of responsibilities and power within and between organisations. Tose who feel they have lost may wish to regain that power and those responsibilities or they may not feel that the new managerial environment is appropriate for their organisation, or indeed country. A responsibility of the head of the government (prime minister or president) and the minister of fnance is to ensure that regard is had to these potential risks and unintended consequences that might arise. Tis chapter suggests some areas where these phenomena could emerge.

# **6.1 The Background to Risk and Unintended Consequences**

## **6.1.1 Defnitions**

What constitutes risks and what are unintended consequences in the context of the PFM/IC reform? Risks arise from not addressing adequately the nature of the PFM/IC reform and in not addressing the management as well as technical considerations. Tese risks may also arise from the approach of donors where they are driving the reform as well as from internal actors involved in the reform. Te most important of those risks is that a country ends up with a 'fake' or 'non-reform', leading to higher costs with little or no benefts plus the costs and disruption caused by seeking to impose a reform that may be inappropriate for a country at this particular time given its current circumstances. As has been shown in earlier chapters if this reform is to be undertaken properly, it is a major reform with a very large 'to do' list of activity to be undertaken over a long period of time. Tis all adds to risk.

Unintended consequences are those consequences that result from the reform being applied correctly, but still having unforeseen efects. An example would be that as budgetary and fnancial controls are relaxed to allow managers greater scope to make decisions to improve efciency and efectiveness the traditional 'checks and balances' are not replaced by 'checks and balances' attuned to the changed operational environment and decisions are made which result in consequences that undermine the benefts of the reform.

Donors and others advising on the reform should bear in mind that this reform is a major reform and that many developing and transition economy countries may not have the administrative and technical capacity to undertake all aspects of the reform and therefore the risk of unintended consequences is that much greater.

## **6.1.2 Causes of Unintended Consequences**

In 1936, Robert K. Merton, the American sociologist listed fve possible causes of unintended or using his terminology, unanticipated consequences.1 Te fve are as follows:


<sup>1</sup> *Sociological Review* Vol. 1, No. 6 (Dec., 1936), pp. 894–904 (American Sociological Association).

Introducing PFM/IC, as has been said, is a major reform and as with all major reforms the possibility of risks emerging and of unintended consequences is greater and potentially more damaging than with lesser reforms. Not the least of these risks is that as the PFM reform will result in changes to existing power structures within and between organisations inherent pressure will exist, at least for a considerable period of time, for those who perceive a loss of power to seek to recover that loss by one means or another (see De Geyndt, Chap. 1).2 Consequently, a risk for a minister of fnance is that the reform may not be properly or fully applied in individual organisations or may have consequences that were not anticipated. Te factors that ought to be taken into account in deciding whether or not PFM/IC is an appropriate reform have been explained in previous chapters but they may be summarised as: culture; relevance to the country's own administrative and organisational structures; appropriateness given the current circumstances in the country, including levels of fraudulent and corrupt activity; and the quality of management. If these are not fully taken appreciated in the processes of reform there could well be unintended consequences.

Te World Bank has described a set of fve principles3 to refect good practice in public fnancial management (PFM) reform, whatever the precise nature of the reform. Te approach set out in these principles is in the form of advice to World Bank staf but is relevant to a minister of fnance engaged in PFM/IC reform to ameliorate the possibility of unintended consequences emerging (but not remove the possibility entirely). Te application of these principles will militate against potential risks as well as unintended consequences. Te principles are:


<sup>2</sup> See also footnote 18, Chap. 1.

<sup>3</sup>Public Financial Management in World Bank operations: a strengthened approach to enhance development and fduciary objectives 2004.

should add value to Government budget and reform processes, and should be aligned with government decision-making cycles.


Tese principles emphasise the importance of the reform having regard to local circumstances and that adopting a reform merely because it represents international best practice, as has been pointed out, is a mistake. However, these principles are not always followed and, for example, donors, despite good intentions, may focus simply upon their own interests and approach. In practice, donor support for capacity building can be limited in scope or simply focus on the legal and procedural aspects of a reform and ignore the wider managerial constraints that go with, in this example, the PFM/IC reform.

An international programme designed to measure improvements in public fnancial management is the PEFA4 framework. However, whilst this is a very useful tool countries should recognise that it is a one dimensional metric and does not have regard to the quality of public expenditure, yet a focus of PFM/ IC is upon quality. PEFA does not attempt to assess the quality of the managerial structures afecting public fnancial management.

An article by Polzer et al. in their analysis of the application of the international standards of public sector accounting drew out issues which have similar characteristics to those which would apply with the application of PFM/ IC, that is,

the hesitation amongst politicians to give up their budgetary control and their attempt at maintaining dominance in public sector decision-making has in many developed countries resulted in extending uncertainty in the difusion trajectory of ACC.A [accrual accounting] at the implementation phase.

#### And again:

[T]he forceful adoption of IPSASs in many African countries, as part of complying with the WB's [World Bank's] lending conditionality, has resulted in

<sup>4</sup>PEFA: Public Expenditure and Financial Accountability Framework: "Te PEFA program provides a framework for assessing and reporting on the strengths and weaknesses of public fnancial management (PFM) using quantitative indicators to measure performance." (Quote from the PEFA website: https:// www.pefa.org/about.)

disastrous results, promoting the rise of corruption, patronage politics and neopatrimonialism (Hopper et al., 2017). For instance, in their study of IPSASs in Nigeria, Bakre et al. (2017) have demonstrated how the adoption of these IPSASs enabled the politicians to conceal widespread patronage and corruption in the sale of government properties. A similar situation has been experienced in Benin where IPSASs and other public sector accounting reforms have provided a space for clientelism, corruption and patronage to fourish rather than leading to any improvements in governance and accountability (Lassou, 2017). It is concluded that 'decoupling appeared to be facilitated or prompted by the prevailing neo-patrimonial governance system wherein implementation decisions are taken in informal settings underpinned by a culture of secrecy.' (Lassou, 2017, p. 502)5

#### **6.1.3 Reducing the Potential for Risks and Unintended Consequences**

To achieve efective change the minister of fnance with the ministry state secretary, will need to prepare carefully for the introduction of the reform. As has been pointed out in Chap. 5, to do that the minister of fnance and the state secretary ought to consult widely about the PFM/IC reform and endeavour to ensure that it is not perceived as being imposed. In other words, 'local ownership', which has been pointed out as necessary in earlier chapters, is equally important to reduce risks and unintended consequences. 'Local ownership' means involvement in the design, stafng, and funding of the reform and it can also mean instead of launching an entirely new system, building upon what currently exists, identifying the weaknesses and correcting these because otherwise these may merely repeat themselves in any reformed system (see Chap. 9 on the need for a strategic analysis of and plan for the reform before implementation). Te 'tone at the top' in each organisation should be one of commitment to the reform. Te point also has been made previously that, because of the wide ranging nature of this reform, in turn this means that both politicians and appointed ofcials (civil service and local government ofcials) should be involved in the discussions about its application and the commitment of top and senior ofcials is essential to success. However, in general the wider the consultation process the better and limiting consultation to just a single group, such as fnance ofcers or even to the top political and civil service and local government ofcials, in an organisation would be a mistake as would a ministry

<sup>5</sup>Tese quotations have been taken from "Does your walk match your talk?" Analyzing IPSASs difusion in developing and developed countries: Polzer, Gårseth-Nesbakk, Adhikari: International Journal of Public Sector Management Vol. 33 No. 2/3, 2020, pp. 117–139.

of fnance deciding to apply the reform without consulting other ministries and public organisations. Also, because this is a reform impacting upon both technical and managerial arrangements, consultation may be extended to others, such as academics, where they may have specifc experiences in both these areas. In some circumstances consultation may also be extended to civil society. Tese diferent consultees will have diferent views and they will bring diferent perspectives to the reform. Tese views should afect how the reform is to be applied. What this consultation process will also do is to provide the minister of fnance with an indication of from where the risks to the reform and the nature of those risks, is likely to emerge as well as the possibility of unintended consequences. Tis will provide an essential underpinning of the reform. Tis emphasis upon wide consultation is quite contrary to the approach of many transition and developing economy countries which is to regard this reform as wholly a ministry of fnance reform with only those who should be consulted being the fnance ofcers within public organisations. Tis refects that the reform, in practice, is perceived of as just a technical fnancial reform.

## **6.1.4 Protecting Against Risks and Unintended Consequences, Including a Role for Internal and External Audit**

Te minister of fnance and the ministry state secretary should be aware that introducing PFM/IC, as with many other reforms, may result in added or diferent risks from those that have existed prior to the reform as well as unintended consequences. Risks to some extent can be foreseen and planned for but obviously, by defnition, unintended consequences will be difcult to foresee. However, these ofcials should be aware of the possibility of such risks and unintended consequences occurring and therefore should ensure that within the ministry of fnance a resource capability exists to monitor the possibility of risks emerging and be able to respond should unintended consequences emerge. Also, by envisaging how and why risks and unintended consequences might develop precautionary steps could be taken to protect against their emergence. Tat resource capability would largely (but not wholly) be expected to be a responsibility of the specialist department of the ministry of fnance established to support the state secretary with the implementation of the reform.

Tere does exist though a potential additional resource capability to assess the quality of application and that is the state auditor. Te state auditor has an important role in not only auditing the fnancial statements but also assessing the quality of the fnancial systems which underpin those fnancial statements and for reviewing the efciency and efectiveness of public expenditure and the use of public resources as a contribution to improving public value. Tis should include the PFM/IC reform and particularly the regulatory framework governing the reform. Te head of the department responsible for the application of PFM/IC should cooperate with the state auditor, taking into account the advice that the auditor is able to ofer. Tat advice ofered in an independent manner could well help to reduce the level of potential risk and unintended consequences.

As this is a major reform covering a wide range of factors one unintended consequence is that of 'reform fatigue'. Tose responsible for the application of the reform should take this into account in the planning for the reform. Tat will mean that the reform programme probably should be broken down into identifable stages so that clear assessments of progress can be defned and judgements made about the successes and problems which have emerged or may be emerging.

With PFM/IC the control exercised through the managerial accountability arrangements is internal to the organisation and allows for the exercise of increased discretion by internal management. As has been pointed out earlier, this changes the framework of external control exercised particularly by the ministry of fnance, but also some other central organisations. Te role of the ministry of fnance and other central organisations with PFM/IC is to set the guidelines and to create the conditions in which the management of those organisations responsible for the delivery of public services can do so efciently and efectively and meet their objectives and performance standards. Assuming that the PFM/IC reform has been properly applied there remains a possibility that the changed role of these central organisations may result in the unintended consequence that the managements of line ministries and other public organisations may take actions which can be disadvantageous to the government and/or add to risk through, for example, inappropriate contracting and procurement arrangements, the accumulation of debts, weak income collection arrangements or make poor investment decisions and adopt policies that have unforeseen consequences. To reduce the possibility of this occurrence, although it cannot be removed entirely, the ministry of fnance and other central organisations should balance the freedoms that PFM/IC requires with a strong regulatory type framework which would prescribe how certain activities were to be undertaken, the roles and responsibilities of diferent ofcials and the managerial and accountability context in which decisions were to be made, reviewed, and accounted for.

Terefore, accompanying the decision to adopt PFM/IC should be a review of existing regulations covering the following areas, or if no such regulations presently exist, such regulations should be developed, that is,


Review of such regulations, where they currently exist, should be one of the frst actions to be undertaken by those responsible for the development of the PFM/IC policy. Te head of operational management in each public organisation should be responsible for ensuring that such regulations are properly followed within the organisation.

Tere would also be consequential efects upon the role and responsibilities of internal audit which should help to limit unintended consequences. Tese efects would not change the international internal audit standards but they would afect their application. For example, those standards refer to the 'chief audit executive' having 'direct and unrestricted access to senior management and the board'. (Tese terms need to be interpreted in the context of the governance arrangements within each public sector organisation in a country.) In some countries this requirement is interpreted as the internal auditor should report directly to the political head of the organisation rather than to the chief operational management ofcial such as a state secretary. Te point has been made elsewhere in this guide that with PFM/IC there should be a clear distinction between the political level of management and its responsibilities for policy setting and strategy along with the overall supervision of operational management from responsibilities for operational management, including policy execution. Tis latter should be the responsibility of the civil or local government service ofcials under the authority of the head of operational management (i.e. the state secretary or equivalent). Te internal auditor should therefore, in the normal course of internal audit reporting, report to the head of operational management with the application of PFM/IC rather than directly to the political head of the organisation. Te only exception to this should be where the internal auditor felt that such were the circumstances that to report to the head of operational management would be inappropriate. Te reporting arrangements would be diferent again where an audit committee existed or where some form of board arrangement existed responsible for operational management. In such circumstances the auditor should also report to the audit committee or to the board (where one existed). Tis means that the internal auditor should have a clear understanding of the roles of the diferent ofcials with the application of PFM/IC, that is, the roles of the political head of the organisation, the head of operational management, the head of fnance and where one exists, that of the audit committee, a board and other key ofcials or relevant decision-making groups as well as how they relate to each other.

Tis regulatory framework developed to accommodate PFM/IC should be designed to ensure that these organisational structures and arrangements which are fundamental to accountability and governance are strong enough to withstand the pressures upon them that will undoubtedly emerge and which could lead to unintended consequences. Tese could include, for example, pressure from politicians or from senior operational management to present results in a manner that may be regarded as politically or managerially attractive but which do not actually demonstrate the reality of the situation, or to take short-term decisions where a longer-term approach would be more appropriate. Another potential area of weakness (i.e. risk and unintended consequence) is likely to be in the relationships between frst and second level bodies and as is shown in Chap. 12 in the need for robust agreements between such bodies to determine the areas of competence of the second level bodies, the arrangements for their management and governance and the fnancial parameters within which they are to work.

Unforeseen consequences could also arise from pursuing policies that may apparently achieve the result intended but which have other efects that were not envisaged. In this circumstance the procedures may have been correct but the initial analysis leading to the policy decision was inadequate. Te regulatory framework could not be expected to cover such unintended consequences which may always be a possibility, particularly given the complexity and wide ranging efects of many public service decisions. Consequently, the accountability and governance processes should provide for systematic arrangements for policy review. Again, this would impact upon the role of internal audit given the defnition of internal audit as: 'Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation's operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the efectiveness of risk management, control and governance processes.'6 Te consulting services of internal audit which should be designed to add value and improve an organisation's governance, risk management and control processes with the application of PFM/IC should provide a facility to advise operational management on the types of risk that the PFM/IC reform could generate, including those that might lead on to unintended consequences.

Again, those responsible for the regulatory framework should ensure that it is properly monitored. Tis should be by the department responsible for the application of PFM/IC and could be a feature of an annual review being treated as an aspect of the proposed statement of internal control (see Chap. 13). Tat regulatory framework should also be subject to review by the state external auditor.

In Chap. 5 the point was made that the ministry of fnance state secretary should be confdent that a robust fnancial management structure exists within individual line ministries and other public organisations and that those responsible for that structure (the head of the civil service within the organisation and possibly also the head of fnance) have a specifc personal responsibility to object where decisions are proposed to be taken which are contrary to regulatory requirements or which potentially add to fnancial risk. (Tat objection may be simply made internally within the organisation or in some countries to an external authority. Whatever the arrangements that objection should be 'on the record'.) Internal, and external audit, may have specifc added responsibilities to report on the circumstances leading to the objection.

Another important potential source of information which could reveal unintended consequences is the assessment of efectiveness. For example, where a service impacts directly upon civil society, systematic assessments involving civil society cooperation can provide an important source of information about the impact of public service delivery. In the private sector the customer determines efectiveness through purchasing decisions. In the public sector, this is usually not possible so a more direct approach to the service user, or the service user representatives, may be necessary.

Following such arrangements will help to reduce the possibilities of risks and unintended consequences emerging. However, this author has not come across any country which has sought to establish such a framework which is a signifcant weakness in reform arrangements.

<sup>6</sup>https://www.iia.org.uk/resources/ippf/defnition-of-internal-auditing/.

#### **6.2 Examples of Unintended Consequences**

A main purpose of the PFM/IC reform is to ensure that the potential benefts become substantive benefts and that unforeseen adverse efects do not occur. Tose benefts will emerge from the managerial element of the reform and unforeseen adverse efects will require management action to overcome them.

Examples from countries of the failure of reforms to impact upon decision making processes and more generally to deliver the envisaged benefts are given below.

#### **Accrual Accounting in the United Kingdom National Health Service**

Tis study about the application of accrual accounting to the UK National study into the Health Service showed that a number of technical reasons caused a failure to achieve the benefts of the reform but in addition, and these reasons have more general relevance, a number of behavioural issues were uncovered, that is: 'Te frst (reason) related to the level of difusion, that is, the spreading of new ideas and the second to the level of organisational coupling, which refects the level of communication between those whose activities are subject to the new measurement system and those imposing the system.'

Te study found that 'the revised accounting policy … was not well received and had not been difused throughout the organisation. Implementation at the operational level did not occur, as top level management was focussed on the satisfying of regulatory requirements.' Tis example also showed that in slightly diferent organisational circumstances (i.e. in Northern Ireland), '[i]nformation was retained within the ambit of high-level managements rather than being devolved to the day to day users who should have been the ultimate drivers of the reform'.

#### **Introduction of Programme Budgeting in Korea**

Te Korea example, showed how a failure to properly address the managerial arrangements and managerial requirements associated with the reform meant that problems emerged which afected its success.

What both these examples from the UK and Korea show is that a focus on technicalities and not paying enough attention to the managerial environment associated with the reform risks losing some, or all, of the benefts.

#### **Te Use of Targets in the United Kingdom**

A feature of PFM/IC is the emphasis upon the development of measurable objectives and performance standards where this is possible and the linking of those measurable objectives and performance standards to budgetary availability. However, there are potential unintended consequences arising from an emphasis upon the use of performance data as targets. An example was well illustrated in a review of the use of targets in policing in the United Kingdom:7

Numeric targets have seen extensive use in policing for many years, as part of both local and national police performance frameworks. Te Public Service Agreements (PSAs) of the 1990s in particular created a slew of national targets in policing and across the public sector more widely. Since then, problems associated with targets such as 'gaming' and 'perverse incentives' have been well documented and targets have gradually been dropped by many [police] forces.

What has come through most clearly in the review is the diference between performance cultures that are narrowly focused on 'chasing numbers' to the detriment of other aspects—and those that have developed a broader defnition of performance, which supports evidence-based problem-solving and genuine improvement of services. Te review has found that while the former was often associated with targets, the simple removal of targets by itself does not turn the one into the other. Over time, the priorities, processes and behaviours that develop under a target-driven regime can become entrenched—and the removal of targets alone is not sufcient to efect change. Te challenge [police] forces face is to develop a performance framework that not only provides a good understanding of the business in order to help efective decision making, but also enables individuals to be appropriately held to account, whilst ensuring that they remain focused on doing the right thing for the public and for victims and in an environment where they are empowered to do so.

What this report illustrates is the importance of wide ranging consultation and the need for high-quality management.

Relying simply on measurable targets can also generate other forms of unanticipated behaviour. For example, research has shown that

linking high-powered incentives to targets will result in improvements in reported performance and also in attempts to game the system, such as 'hitting the target and missing the point'. Tis highlighted two strategic lessons for policymakers on when such an approach will and will not result in improved performance outcomes for public services. First, targets with sanctions can work when the targets accurately measure key dimensions of performance that cannot easily be manipulated by gaming. Examples include hospital waiting times,

<sup>7</sup>Te use of targets in policing—Review 2015. https://assets.publishing.service.gov.uk/government/ uploads/system/.

ambulance response times and school league tables. Second, where targets can only be framed as proxies for important dimensions of performance, the manipulative efects of gaming may undermine their use. An example is policing, where the nature of the targets means that pressure to meet them can result in such dysfunctional behaviour that performance deteriorates.8

In those countries where public administrative arrangements are based upon a legal tradition, the greatest risk is that the focus of reform will be on the bureaucratic arrangements, including any specifc legal requirements. As has been pointed out, such a focus will not achieve the benefts that the PFM/ IC reform is intended to achieve and those responsible for this reform need to pay particular attention to this risk, not least to the risk of slipping back into a legalistic approach unless that approach can be made compatible with the managerial environment implicit in the PFM/IC reform.

Similarly, people may adjust how they behave (gaming) to the reward and penalty system that exists. Such reward and penalty systems which in the public sector are often designed for reasons which have nothing to do with improving managerial performance, will afect how managers behave. (see also Chap. 5).

What is essential where a culture of meeting targets exists is that an essential feature of management is the application of 'common sense'.

#### **Accounting Reform in Ghana and Benin and in Egypt, Nepal, and Sri Lanka**

An example of unintended consequences of a public fnancial management reform was documented in a recent study which showed that formal government accrual accounting reforms, including the implementation of IPSASs,9 have been used in two developing economy countries as a façade to hide 'patronage and clientelism [which] abound within an informal setting, which make adopted accounting rules and procedures redundant; hence the observed limited role of accounting in improved accountability, governance, and ultimately development (e.g. poverty reduction)'.10

Tis example illustrating the reaction to advanced fnancial management reforms where either strong coordination/support with local management did not occur or was inadequate or the purpose of the reforms was not fully

<sup>8</sup>http://www.lse.ac.uk/Research/Assets/impact-pdf/public-services-targets-sanctions.pdf.

<sup>9</sup> IPSASs is an abbreviation for international public sector accounting standards.

<sup>10</sup>Lassou, P. (2017), "State of government accounting in Ghana and Benin: a 'tentative' account", Journal of Accounting in Emerging Economies, Vol. 7 No. 4, pp. 486–506.

understood has been described in a study investigating the implementation of public sector accounting reforms in Egypt, Nepal, and Sri Lanka. Tis study described the factors that afected implementation resulting in 'resistance, internal conficts and unintended consequences, including the fabrication of results, in all three countries without any evidence of yielding better results for public sector accountability'.11

PFM/IC in some respects has similar characteristics to accounting reform in that if properly implemented, as with accrual accounting reform, it does devolve power thus reducing detailed central control. Yet few commentators or advisers appear to address the managerial consequences of this feature of the reform. Again, like accrual accounting, it is also appears relatively easy to introduce the bureaucracy associated with the reform, but not achieve the substance of the reform. Terefore, the reform can appear to have been applied when in practice it has not. (i.e. the 'fake reform' syndrome). A minister of fnance should be very alive to this application risk.

# **6.3 Performance Information and Using 'Bureaucracy' as an Indicator of Performance**

In Sect. 6.2 above a reference was made to the possible problems which can emerge from a managerial emphasis upon the use of performance information. Tis showed that the development of performance measures and indicators is not easy and unless carefully thought through can have entirely unintended consequences. A discussion about the issues that should be considered is included in a World Bank paper 'Defning and Using Performance Indicators and Targets in Government M&E [monitoring and evaluation] Systems'.12 Te paper makes the point that '[l]ow or inadequate use of performance information in management and particularly budgeting is often a problem for many indicator systems. Quite frequently this situation signals not only problems with performance data availability and quality, but also the existence of challenges with political consultation or a lack of buy-in of the performance indicators and the types of information produced. Lack of consultation and validation are often signs of a weak institutional environment, which tends to result in indicator "infation"—too many indicators but a very

<sup>11</sup>Unintended Consequences in Implementing Public Sector Accounting Reforms in Emerging Economies: Evidence from Egypt, Nepal and Sri Lanka: Adhikari, Kuruppu, Ouda, Grossi, Ambalangodage: International Review of Administrative Sciences October 2019.

<sup>12</sup>PREM*notes* July 2011 no. 12: https://openknowledge.worldbank.org/bitstream/handle/10986/1106 1/643870BRI0Def00Box0361535B0PUBLIC0.pdf;sequence=1.

low rate of utilization—which in turn deteriorates their quality. Ofcials in such environments tend to perceive that information is not a problem; for them, information may in fact be abundant, while for others (the producers), underutilization of the information they produce provides a very weak incentive to take data and indicators seriously.' Te fnal section of this World Bank paper 'emphasises the importance of quality data and processes and the necessity of tailoring performance indicator systems to match available resources and capacities'. Other World Bank information is also available as is information from countries about their use of performance information.

An evaluation of World Bank projects by the Independent Evaluation Group commented: 'Many of the stories of success were actually limited to improvements in better forms i.e., what laws, systems, and processes "look like" which were unlikely to have a noticeable positive efect on the overall performance of the public sector'.13

Tis 'bureaucracy' is very often the indicator of performance that many aid agencies look for when judging the success of PFM/IC reforms, but that is a mistake. It is not even a proxy. Another factor regarded by aid agencies and other international organisations is improvements in the efectiveness of fnancial and budgetary control. Important though this is, what also matters is improvement in the quality of public expenditure and international comparative assessments, such as PEFA14 do not address this. To do this they should be looking for the achievement of the benefts or a proxy for that, but the problem is that the benefts usually take some time to emerge, that is, beyond the end of any aid period. A consequence is that it does mean that the external pressure upon those concerned with the application of the reform is on the form, rather than the substance, of the reform. Te comment about 'fake' reforms (see footnote 1 of Chap. 1) is relevant. Countries engaged in a reform process need to recognise that risks and unintended consequences do exist. Where they rely upon aid agencies for advice and fnancial support risk and unintended consequences should be taken into account, and that would mean for example, being cautious about advice and recommendations that focus on the form, rather than the substance of the reform (see Sect. 6.4 below).

A question that those responsible for the development of the PFM/IC policy and for the development of the budget should consider is, in the interests of accountability and transparency to what extent should performance indicators along with objectives be incorporated into the budgetary documents for

<sup>13</sup>Quoted in a report by the World Bank on Malawi: How (Not) to Fix Problems Tat Matter: Assessing and Responding to Malawi's History of Institutional Reform: 2017: Policy Research Working Paper 8289. <sup>14</sup> See footnote 4.

approval by parliament. Too much information would not actually be helpful but parliamentary scrutiny would be facilitated by including key objectives and the associated performance indicators. Te inclusion of objectives and performance indicators would also facilitate the development of an informed civil society. Such parliamentary and civil society scrutiny would have the beneft of providing challenge to management (political and operational management) and through challenge improve the quality of the information being made available. It can also reduce risk and unintended consequences through the strengthening of the scrutiny process. As has been indicated previously, challenge may be uncomfortable but it can be a very valuable learning tool.

# **6.4 Managing Relations with Aid Agencies with the Aim of Avoiding Risks and Unintended Consequences Arising from Aid Support**

Aid agencies are a very important source of fnance and technical support. Teir contributions are usually highly welcome by beneftting countries. But beneftting countries should recognise that whilst the benefts can be considerable potential problems can emerge which may afect the success of the reform. Tese problems can include or arise from (some of these have been referred to already):


Terefore, in deciding whether to accept aid agency fnancial support and advice, beneftting countries should consider what drives aid agencies to give that fnancial aid and advice. Te following are factors that a ministry of fnance should bear in mind:


Te beneftting country should have a clear idea of what the problem is and what needs to be done, how long the reform is likely to take and then having control of the aid supported reform process. It should aim to achieve local ownership of the reform. Unfortunately, this is hardly ever the situation and countries may not have the capacity to undertake the initial analysis of what is required. Tey may need a third party to assist them. A useful model is provided for countries wishing to join the European Union or neighbourhood countries beneftting from its funding and who know that they will be expected to apply PFM/IC, because the European Commission through SIGMA15 is able to provide policy advice which would form the agenda for aid support. Of course, it is up to a country to decide whether to accept such advice and if several aid agencies become involved, some of whom may have strong views about a particular reform, compromises may be made over which a benefciary country may have little infuence. Tis raises the question of sovereignty.

Public money and its administration/management is at the heart of a nation's sovereignty and therefore allowing a third party to dominate the reform agenda adds to risk, not least to the long run sustainability of a reform and particularly to a complex and major management reform like PFM/ IC. Te reform process should be dominated by the interests of the country and owned by the government. If aid agencies dominate the agenda, they are in efect demeaning that sovereignty.

Of course, aid agencies will be concerned about the misuse of aid funds and that will afect their attitude to the utilisation of such funds. As the PFM/IC reform will take many years to achieve this timescale is usually wholly incompatible with the timescales available to aid agencies. Te risk for a country is that the agenda of the reform process acceptable to an aid agency may be incompatible with what is appropriate to achieve a long run reform. Using examples given earlier in this chapter, changes to the law and the institution of a bureaucracy provide 'easy' performance indicators for an aid agency but do not necessarily provide substantive evidence of the reform. Tus, a country may introduce the bureaucracy associated with risk management but this is of little value if no policy objectives linked to budgets exist or management to make judgements about the signifcance of the risks. Terefore, the risk, in this example, for those responsible for the application of PFM/IC is that they may think they have introduced risk management, when, in reality, they have not.

Another area of potential risk is that as introducing PFM/IC is a management not just a technical reform there is a possibility that an aid agency may not appreciate the full extent of the reform required or the length of time is will take to develop and apply. Tis reform is risky not least to the aid agency because it has very long time scales, 10–15 years according to SIDA (see footnote 25 of Chap. 1). Te risk for a beneftting country is that as a result an aid agency may try to convert the reform into a shorter run technical reform.

<sup>15</sup> SIGMA: (Support for Improvement in Governance and Management) is a joint initiative of the OECD and the European Union. Its key objective is to strengthen the foundations for improved public governance, and hence support socio-economic development through building the capacities of the public sector, enhancing horizontal governance and improving the design and implementation of public administration reforms, including proper prioritisation, sequencing, and budgeting.

Alternatively, another risk is that an aid agency may try to convert the reform into a larger scale reform such as a reform afecting the whole budgeting and fnancial control process. Tere can be strong incentives for an aid agency to support such a wider reform especially where an aid agency wishes, for its reasons, to establish an enduring 'business relationship'.

A country should be prepared to resist this even though it may mean forgoing aid funding in the short term. Te main message for a country seeking to beneft from aid support is that there are risks associated with aid funding which should not be overlooked. To minimise such risks, the recipient country should follow the fve points set out above, which can be summarised as 'retain control of the reform agenda'.

Where an aid agency is not prepared to allow a recipient country to retain that control or to accept that PFM/IC is a managerial reform or wants to simply focus upon limited bureaucratic indicators, or the government does not have the managerial capability to engage in a wide ranging reform, the recipient government may fnd it more appropriate to seek support for a more limited reform. Tat would mean seeking aid support for the strengthening of the current PFA/IC process.

# **6.5 The Factors Which May Be a Cause of Risks and Unintended Consequences**

Examples of the factors which may generate adverse efects leading to unintended consequences are set out below. Tese are not simply factors caused by the introduction of PFM/IC, although some are. Tey can apply equally to other fnancial based reforms. Te examples include:

	- over time the original power structures will reassert themselves and therefore the benefts of the reform will be lost;
	- second level bodies will be used to avoid controls placed upon frst level bodies unless specifc steps are taken to prevent this; and
	- the existence of a new range of powers for some organisations will be exploited sometimes for corrupt or fraudulent purposes unless the overall regulatory framework is strengthened.
	- a narrow interpretation of policy objectives;
	- an overemphasis upon performance measures which can result from a political emphasis upon a simplistic message, with consequently managers not having regard to the wider operational environment; and
	- the development of 'gaming' to demonstrate policy achievement: where targets are a key factor in assessing performance an important feature of the performance management process is that it should be entirely independent of the manager because otherwise the manager will be under pressure to manipulate the performance information to demonstrate

success.16 Without this independence the manager can manipulate performance information to suit his/her particular needs. Te result can be unforeseen misjudgements about progress, efciency and efectiveness and the utilisation of budgets.

	- reduced efciency and efectiveness and
	- poorer standards of accountability resulting in corruption in reporting.
	- committing to policies or investment decisions that have long run fnancial consequences without a fnancial plan about how such costs would be fnanced;
	- not recognising the ongoing costs of current activities resulting in, for example, cutting those costs in order to fnance new policies or investment activity; and

<sup>16</sup>A notable comment was once made to this author when performance was questioned because it appeared to be too good to be true was 'this is what they want so this is what they get'.

– not being prepared to address (i.e. manage) what may be defned as fxed costs (although not necessarily in accounting terms) such as employee and property costs as well as overheads because existing policies or methods of delivering services are not being reconsidered given other new commitments or changes in circumstances.

Te consequences will include inefciency in public expenditure and damage to accountability. To overcome this problem, managers should be aware therefore of the need to develop strategic fnancial and business planning so that when decisions are made regard is had not only to the more immediate fnancial and operational impact of those decisions but also to their longerrun impacts, and particularly fnancial impacts. (Note: the development of medium-term budgeting is not an adequate response to this problem.)


What these examples indicate is that the benefts of the reform depend very heavily upon the recognition of the cultural and management changes that will be required. Te specifc features of these cultural and management changes have been referred to in earlier chapters but if this recognition does not occur then the prospect is that they could result in added risks and unintended consequences which may include the deterioration in the quality of public services; attempts to conceal that deterioration (for example through 'gaming'); and weakened accountability.

Corruption, as an unintended consequence, is always a risk. A feature of PFM/IC should be a strengthening of governance:

Te presence of corruption generally indicates shortcomings in 'good governance', which have, at the end, consequences for the efectiveness of PFM [public fnancial management] processes and controls. One important lesson is that PFM diagnostics require a rigorous understanding of the political context of the country, how political power is exercised, and how corruption fts into the country's political and administrative culture.17

An appreciation of the cultural and managerial changes that will be required to avoid or minimise risks and unintended consequences can help reformers determine the extent to which political leaders and decision makers are committed to PFM reform and, if not, how best to infuence their thinking.

Te extent of these risks and unintended consequences will depend upon the circumstances and not least upon the regulatory framework governing those areas of potential risk which has been referred to above. Te minister of fnance and the ministry of fnance state secretary should therefore take all these diferent factors into account in how it assesses and makes judgements about the success of the application of this reform. Te solution though does not lie in a reversion to a traditional approach to public administration, for example, to a detailed external line-item control by a ministry of fnance (i.e. a reversion to PFA/IC). Rather it lies in a strengthening of corporate governance, in the leadership provided by ministers and particularly by the most senior civil and local government service ofcials and by the recognition of the importance of the quality of the internal and external accountability arrangements. Internal accountability is a two-way process meaning that it is not simply a matter of junior ofcials reporting to more senior ofcials but of senior ofcials taking action on accountability reports and doing so in a nonthreatening manner. PFM/IC will result in a more demanding external accountability process because of the focus upon both the control of inputs and the management of outputs. Accountability is also an important factor in

<sup>17</sup> Integrating PFM and Anti-Corruption Strategies; IMF Blog Feb. 4th 2019: Concepcion Verdugo-Yepes.

helping the ministry of fnance develop efective budgetary arrangements through providing information about the utilisation of resources and with PFM/IC, including the achievement of objectives and performance standards. As has been pointed out previously, external accountability together with transparency are both key features of the PFM/IC reform and facilitate challenge which ultimately is benefcial to the whole process. Terefore, attempts to reduce transparency and accountability should be frmly resisted.

Tese and other areas of the possibilities of unintended consequences occurring arise from the improper or inadequate application of the reform and poor-quality management, including fnancial management. Both political and operational management need to work together to increase success in meeting objectives and performance standards and in enhancing efciency and efectiveness.

# **6.6 The Warning Signs Leading to Potential Unintended Consequences**

Te main warning signs of unintended consequences emerging arise from:


approach'.18 (Although this ought to be an objective, as has been pointed out above in Sect. 6.4 there can be considerable risks from relying heavily upon the advice of aid agencies.)


Te efectiveness of the reform may well depend heavily upon a better understanding of behaviour and what is necessary to change behaviour. Tis is not a usual area of concern for those responsible for PFM/IC (and other PFM reforms for that matter) but especially because this is a management reform afecting how ofcials behave full regard should be had to this in the development of the reform. Tis aspect of a reform process is described in a

<sup>18</sup> See footnote 3.

Guide prepared by the UK National Audit Ofce.19 A summary of this Guide's fndings which relate to the development of ministry programmes of activity, covers:

Behaviour Change and Value for Money [VFM]

Behaviour change is important for value for money (VFM) because it can often contribute to, or be a prerequisite for achieving a policy outcome costefectively. Risks to delivery will be exacerbated if departments [ministries] have a poor understanding of either the behaviours they are seeking to change or the impact of diferent behaviour change mechanisms. Broadly, risks to VFM can arise at these stages:


Te Guide acknowledges that reporting on the VFM of behavioural change can, however, be difcult:

[P]rogrammes may involve a variety of interventions, be of long duration, and produce benefts that can be hard to assign a monetary value to.

Tis is typical of a PFM/IC reform. Although this Guide is designed for auditors specifcally concerned with VFM assessments of ministry programmes, those responsible for the PFM/IC reform ought to equally have regard to its fndings in both formulating how the reform should be applied and the assessment of application progress particularly to lessen the risk of unintended consequences and risks arising from the reform.

According to the Guide there are fve key areas to consider when assessing a behaviour change and these are:

Understanding the audience Understanding behaviour Understanding the levers Designing the intervention Evaluating the intervention

<sup>19</sup> See UK National Audit Ofce Guide to auditing behaviour change 2011. Although this guide is directed to auditors and their work in reviewing the efectiveness of government policy towards the provision of public services, this Guide has important lessons for those concerned with behavioural change in other circumstances.

Take as an example, understanding the levers! What are the levers that are available to achieve efective PFM/IC reform? Are they just legislative levers, as occurs in many countries (i.e. this is what the law says and as it is the law it will be obeyed: this has been said to this author in several countries) or could such levers include fnancial levers, such as budgetary allocations being dependent upon the development of PFM/IC, or will personal promotion depend upon success in establishing PFM/IC, or how material is training or the incentive of more freedom in decision making?

Tis is an area of activity where the head of the department responsible for the PFM/IC reform should seek specialist advice, probably from a university or other organisation specialising in human resource management. Introducing PFM/IC will require signifcant behavioural change within organisations but this is not normally addressed in policy papers concerned with the introduction of the reform.

# **6.7 Arrangements for the Monitoring and Evaluation of the Reform**

Te ministry of fnance responsibility is to monitor, report on, and evaluate the application of PFM/IC. Tis is a vital activity which should be undertaken by the department responsible for the application of PFM/IC. A specifc purpose of monitoring and reporting is to identify problems. Examples of the problems include: is an organisation achieving its objectives and performance standards and performance objectives and if not, why not (see Chap. 13); are the managerial structures appropriate, is delegation of operational responsibility actually occurring, do examples exist to prove this and similarly for the managerial accountability arrangements, what difculties are developing, what unexpected consequences are emerging or have emerged? Recommendations then need to be made for solving emerging problems as the strategy is applied. Tat may mean adapting the strategy. Te monitoring, reporting, and evaluation system should be developed and established as part of the development of the PFM/IC strategy. Which issues are then likely to be addressed as a result of the monitoring process should be made clear to those responsible within public organisations for the application of PFM/IC. Te form of the monitoring should be expected to change over time. Initially the monitoring should be designed to establish how far the principles of PFM/IC have been accepted by public organisations. Once the principles have been applied monitoring should be able to focus on the results identifed in the preparation by public organisations of the statement of internal control (see Chaps. 5 and 13).

A SIGMA toolkit on public administration reform clarifed the role of monitoring, reporting, and evaluation as a

help to identify and present information about emerging challenges and implementation bottlenecks. Such knowledge can be used to design and propose solutions for improving the strategy design and operational plan, overcoming specifc implementation difculties, and making better use of the existing management and co-ordination structures. In other words, proper use of the system of monitoring, reporting and evaluation is fundamental for timely, efective and efcient achievement of the planned reform results. In addition, monitoring, reporting and evaluation are also about accountability. Te information and data generated through monitoring and reporting help to hold public institutions accountable for commitments made and refected in the strategies. It is fundamental that results of the monitoring process, as well as any evaluation, be shared with stakeholders and the wider public, both to ensure that all afected parties are informed about what has or has not progressed, how and what results have been achieved, as well as to validate the key fndings themselves.20

Internal and external audit also have a role to play in assessing the content of the statement of internal control.

Tis annual process of review will impose an additional burden upon the department responsible for the application of PFM/IC and it should therefore be stafed to enable it to properly review these statements and to report to the minister of fnance on their fndings. As indicated in Chap. 13, that report ought ultimately to be presented to the cabinet of ministers and, depending upon individual country arrangements, to the parliament.

Te ministry of fnance, through the department responsible for the application of PFM/IC, may also consider commissioning specialist research to establish whether unintended consequences are occurring along with the causes.

## **6.8 Summary**

As with most reforms there are risks and not all consequences can be fully foreseen. Ministers of fnance and the ministry state secretary (or equivalent) should be aware of the risks arising from the application of the reform along with the possibilities of unintended consequences. Most of these risks and

<sup>20</sup> SIGMA Paper 57 Toolkit for the preparation, implementation, monitoring, reporting and evaluation of public administration reform and sector strategies, p. 85.

unintended consequences are likely to emerge from imposing an advanced reform upon an administrative culture that is unprepared for the changes that will result and where there is unfortunately an acceptance of corrupt practice. At one extreme these risks will add to that risk of corruption. Equally likely though is that the risks that will arise will not just be in the abuse of public funds, but to the quality of public services, in decision making, and to accountability and to transparency.

Te cause of unintended consequences will usually lie in a failure to appreciate the managerial context in which PFM/IC should be developed and therefore the strengthening of management should not be overlooked as an essential feature of the reform.

Because this is a radical reform involving signifcant changes in the distribution of power and responsibility, including the move from external to internal control, an important complementary feature of the reform should be a strengthening of overall regulatory controls which afect key areas of risk and the potential for the emergence of unintended consequences.

Te ministry of fnance through an annual assessment process of the quality of the reform (i.e. by developing a statement of internal control) should address the potential for weaknesses to emerge. Tis statement should not simply focus upon procedural arrangements. In some circumstances the ministry of fnance should consider commissioning a specifc study into whether unintended consequences are emerging, or have, emerged.

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# **7**

# **The Responsibilities of the Top Operational Management Offcial in Public Organisations for the Implementation and Quality Control of PFM/IC**

Te responsibility for the day-to-day application of PFM/IC and the maintenance of the appropriate standards within a line ministry or other public organisation should be that of the top civil or local government ofcial responsible for operational management. In a line ministry or other public organisation, this would be a state secretary or equivalent. Teir responsibility as the top operational management ofcial is to ensure that throughout the organisation, PFM/IC is properly applied and follows guidance issued by the ministry of fnance. Tat ofcial would be accountable for the quality of the application of the reform.

In countries where a minister or mayor or other politically appointed ofcial is nominally responsible for the efective and efcient administration of a public organisation, the reality is that a politically appointed ofcial normally would have neither the time nor the relevant background to introduce such a signifcant managerial reform as PFM/IC. Teir responsibility in such circumstances should be to ensure that the reform is properly applied by the top operational management ofcial. Te political head of the organisation would be accountable to the government for that.

Tis chapter describes the responsibilities that fall upon this top operational management ofcial with the application of PFM/IC.

# **7.1 Nominal and Real Responsibility for the Application and Quality Control of PFM/IC**

## **7.1.1 The PFM/IC Leadership Application Arrangements**

Te top political ofcial such as a minister or mayor may have a nominal legal responsibility for the overall quality of the management of a public organisation. However, the person who should have the substantive responsibility for the overall quality of the management of a public organisation including the operational application and maintenance of the quality of PFM/IC should be the most senior operational management ofcial within the organisation. Tis would be a state secretary1 or equivalent or a similar status ofcial in local government. Tis should be the normal situation and is a prerequisite to applying the PFM/IC reform. If there is no such ofcial it will be impossible to properly implement PFM/IC even where a politician has nominal responsibility for the quality of the public administration. Tis chapter therefore is written on the assumption that responsibility for operational management within a line ministry or other public organisation has been delegated to the civil or local government service and that the head of that service in that ministry or other public organisation is therefore responsible for the application of PFM/IC and the maintenance of its quality. Te range of responsibilities that will fall upon that head will be substantial and in the sections below the 'before PFM/IC and after' responsibilities are compared. How a politically appointed ofcial, if there were no delegation, given the level of practical knowledge and experience that would be required and the day-to-day demands upon his/her time, could undertake this responsibility and at the same time also carry out their political responsibilities is difcult to see. Te state secretary (or equivalent) would be responsible for not only implementing the reform but also for ensuring that the administration remains capable of addressing whatever is required by the current operational environment. Tis ofcial has a key role in securing the quality of operational management. He/she also has a responsibility to advise the politicians on the practical application of political objectives and that in turn afects the quality of operational management. Te practical application of policy includes the politician working with the operational manager to set the objectives and performance standards and objectives which the operational management should be expected to meet. Operational management in the

<sup>1</sup> In Anglophone systems the title would be 'permanent secretary' or 'principal fnance and establishment ofcer'.

main (see also Chap. 14) should be delegated to the civil (or local government) service. In those countries where the delegation of operational management has not occurred, as has been explained in previous chapters, the reality is that PFM/IC could not be properly applied. (In some countries the state external auditor may be asked to comment upon the quality of the proposed arrangements with the application of PFM/IC. Te state auditor would not approve the procedures but usually would ofer advice.)

Given that a state secretary, or equivalent, is responsible for the application of the PFM/IC reform, this ofcial would then be accountable to the top political ofcial, the minister or mayor for the quality of the application and the maintenance of that quality. Tis is how the legal responsibility of the top political ofcial would be fulflled, that is, through the accountability arrangements. Te state secretary or equivalent would also have a responsibility to the ministry of fnance because that ministry would have overall responsibility for the application of the PFM/IC policy and quality maintenance. In efect, a state secretary has two reporting lines, one to the relevant minister and the other to the ministry of fnance state secretary.

For second-level organisations the top ofcial should be the responsible ofcial for the application of PFM/IC. He/she should be accountable to the head of operational management for the controlling frst-level organisation for the quality of application, that is, to the state secretary or equivalent. (Te exact accountability arrangements for local government would depend upon the constitutional relationships between central and local government but an important element of that accountability would be from the chief ofcial to the mayor or in some countries to a political leader where the mayor has only ceremonial responsibilities.)

In some countries a state secretary has only limited responsibilities such as those only relating to administrative matters. However, with the introduction of PFM/IC and the increased emphasis upon the delegation of operational management responsibilities from the political level, this limitation cannot be sustained. Tat would mean that either the current state secretary's responsibilities were extended or another ofcial was appointed with the appropriate authority.

Again, in some countries no state secretary post exists and the diferent 'directors' or heads of department report directly to a minister or deputy minister. Tis arrangement with PFM/IC cannot be sustained (see Sect. 7.1.5 below).

Whatever the exact civil service or local government organisational arrangements, with PFM/IC the person holding the role of state secretary (or equivalent) should have two essential characteristics. One is that they should be 'politically' aware because they work directly at the interface between the political and operational elements of public administration. Te second is that they should possess leadership qualities. Leadership qualities include being willing to accept the risk that reform entails and to overcome the systemic constraints that tend to exist in established bureaucracies. Leadership qualities have also been described as inspiring, confdent and empowering.2

## **7.1.2 The Responsibilities of a State Secretary or Equivalent Before the Application of the PFM/IC Policy**

Te exact responsibilities of a state secretary (or equivalent), where such a post exists, before the introduction of PFM/IC will vary from country to country but they could include the following, although this is unlikely except in those countries where advances are being made in the quality of the public administration and where the implementation of PFM/IC is likely to be most successful:


Prior to the implementation of PFM/IC in many countries, there is unlikely to be a clear distinction between the responsibilities of the political level of management and the civil service for operational management activity. Also, in some countries on a change of government the state secretary may also change and where this occurs political loyalty may be regarded as more important than actual experience or even competence. But then with traditional public administration arrangements, the emphasis is upon administration, adherence to the relevant regulations and fnancial and budgetary control, rather than management, that is, the delivery of objectives and performance standards and objectives efciently and efectively. As is shown in the next section, the former is less demanding in terms of experience and technical knowledge than would be required of a state secretary

<sup>2</sup>Civil Service Leadership Statement: https://www.gov.uk/government/publications/civil-serviceleadership-statement/civil-service-leadership-statement: 2016.

with the implementation of PFM/IC. For example, in practice objectives may have been specifed by a minister but they are unlikely to be defned in a manner which is suitable for management purposes. Performance standards and objectives are unlikely to exist. Nor will an efective requirement exist to secure efciency and efectiveness in the delivery of objectives. Objectives and performance standards are unlikely to be linked to budgetary availability. Consequently, the state secretary and the administrative staf are most unlikely to have available to them the information and authority they require for efective management purposes. (Tis would be true whether the operational manager was a political appointee or a civil or local government ofcial.) Te state secretary would be likely to have these fnancial, as opposed to fnancial management, related responsibilities:


these matters may be retained by political appointees such as the minister or deputy ministers or equivalent in local government.

6. Providing fnancial reports to the minister of fnance, including year-end fnancial statements and responding to external audit enquiries.

Te state secretary may also have what amounts to a token responsibility for securing efciency and efectiveness but in practice such a responsibility will be simply nominal because neither the budgetary nor accounting and performance information systems are likely to provide the information that will be required to enable these to be achieved. Te linkage of the performance information systems, where they exist, to the budgetary and accounting systems is also unlikely to occur. Certainly, it would be possible to make savings by, say, improving purchasing arrangements, but that is diferent from achieving efciency and efectiveness in the delivery of objectives. Tis is more about 'economy' and sometimes may be counterproductive in efciency and efectiveness terms. Savings may also be made by introducing IT systems and the adoption of 'e-government' arrangements. Managements should always be encouraged to make such savings, under whatever fnancial management arrangements exist, but this is not the same as delivering the wider efciency and efectiveness gains that become possible with PFM/IC. For example, switching to an IT system to deliver a service will not somehow automatically improve efciency and probably not efectiveness, although it may be more economical. To achieve greater efciency requires a systematic approach to the reform of the way in which services are delivered involving detailed cost analysis compared with operational performance. Efectiveness involves the measurement of achievements against defned objectives including identifying the views of the user of the service or activity. Te state secretary would have no responsibilities for risk management which is a key requirement of PFM/IC and is necessary to secure the achievement of objectives. Internal audit would usually report directly to a minister rather than to a state secretary.

#### **7.1.3 The Role and Responsibilities of a State Secretary (or Equivalent) Operating in a Managerial Environment**

While the minister or mayor may ultimately be held to account by parliament for the efective application of the PFM/IC policy with actual application being the responsibility of the most senior civil or local government ofcial (i.e., the state secretary or equivalent), the political head should be confdent about the quality of the application through the delegation and managerial accountability arrangements that should be established. Tose managerial accountability arrangements should be focussed on the key issues of concern to the political head and should not be overwhelmed by detail. (Te arrangements for parliamentary accountability may require in some countries that the appropriate minister and the most senior ofcial should appear together to answer to parliamentary scrutiny. Parliamentary scrutiny may be informed by reports of the state auditor who would be expected to review the quality of the PFM/IC arrangements.) Given the complexity of contemporary government ministers and mayors cannot be held directly responsible for all operational failings in their ministries or local governments, or in the second-level organisations through which services and activities are often delivered unless they can be shown to be systemic or of major signifcance. If they are systemic or signifcant, they should have been identifed through the managerial accountability arrangements and then the political leadership can be held accountable.

Te role of state secretary (or equivalent) is extremely demanding and complex. Introducing PFM/IC as has been shown previously, means that the style of public administration needs to change which adds to the complexities of the role. Te change would be from a traditional administrative style to a managerial style (see also Chap. 14).

Te functions of a state secretary with a managerial style of government include the following3 :


<sup>3</sup>Tese seven roles summarised in the italicised script were defned in a paper published by the Institute for Government for the equivalent of a state secretary in the UK civil service. In some respects, the UK civil service is unusual, so some of these seven diferent roles may not apply or only partially apply in a particular country. For example, the UK civil service must be apolitical and prepared to serve any government. However, the UK has a well-established PFM/IC system. Tis model could be adapted to suit individual country needs, culture and circumstances.

Accountability at the Top: Supporting Efective Leadership in Whitehall: Paun and Harris: Dec 2013 p12–14: https://www.instituteforgovernment.org.uk/

policies, personnel and systems. Tis is of particular importance when there is an emphasis upon improving efciency and efectiveness in the delivery of public services, including the collection of any income that is due: this is a key feature of PFM/IC. Tis may well require state secretaries to become involved in the direct management oversight of operations, or management oversight through networks of complex devolved relationships to second-level organisations or where activities are contracted out to the private sector, to the implementation of those contracts. For second-level bodies, the frst-level state secretary remains responsible for ensuring that efective arrangements exist to ensure that second-level bodies and market-based contractors deliver the required results.


#### **7.1.4 The Specifc Financial Responsibilities of a State Secretary with the Implementation of PFM/IC**

Applying PFM/IC4 is about the professionalisation of management. Tis afects the fnancial management responsibilities of a state secretary. As change in operational and policy circumstances will inevitably occur this also means that a state secretary will need to initiate changes to the PFM/IC arrangements.

To undertake all these responsibilities arising from the implementation of PFM/IC, a state secretary, because he/she cannot possibly undertake all these responsibilities personally, will need to be supported by several departments within the ministry administration. Exactly what those departments would include would depend upon local circumstances but should normally include the fnance/economics department, the administration department, the procurement department, the human resources department, the legal department and any general policy department, for example, a policy department which should be responsible, amongst other things for the supervision of second-level bodies.5 Te internal audit department should have a close working relationship with the state secretary and for most internal audit activity the reports ought to be to the state secretary and only exceptionally to the political head of the organisation. Te state secretary should agree the internal audit programme of activity. (In some countries where audit committees have been established, the internal auditor will also report to that committee.)

In the table below the specifc responsibilities of the state secretary or equivalent are described and compared with the seven diferent roles of a state secretary referred to above. (Tis range of responsibilities contrasts with those which would exist for a state secretary acting simply as an administrator (Table 7.1).)

<sup>4</sup> In the paragraphs below, the references are to a ministry but apply equally to local government and other public organisations. Readers would therefore need to apply the observations if they are not from a central government ministry to their own circumstances.

<sup>5</sup> Second-level bodies would include those agencies and state-owned enterprises and the equivalent in local government for which the frst-level body has a responsibility.




(*continued*)

5. Developing a managerial approach that incorporates fnancial awareness as a key feature of management 6. As part of that managerial culture establishing an approach which is focussed upon the needs of the customers or clients of the organisation and which is responsive to changes in customer/client circumstances 7. Ensuring that a communications process exists which allows information to be disseminated throughout the organisation, that is, fowing up, down and across the organisation and including with second-level organisations. This communications process should also include coordination of activities and proposed policy developments with other ministries as appropriate. For effective management, managers at all levels and staff within a ministry and second-level bodies need to know both what the ministry's objectives are as well as their own objectives. This enables the organisation to 'pull together' in the same direction. In other words, managers need to know not only what is expected of them but also the operational context. That operational context includes information about the resources available to them in a format they require, that is, their budgets, how actual expenditure or income is occurring during the year, performance information that relates directly to their areas of responsibility, whether the demands upon a particular service are rising or falling, the short- and longer term strategic objectives, the pressure to improve effciency and effectiveness, actual and potential legislative, environmental and other changes affecting their operational environment. The extent of the information which is made available will obviously depend in large degree upon the specifc responsibilities of individual managers and staff members

	- 8. Ensuring that second-level organisations have clear policy and operational objectives which are consistent with the government and ministry objectives (and in practice with programme objectives where programme budgeting has been established)
		- 9. Ensuring that the second-level organisations have established performance standards setting out the quality of services that they aim to provide and that those standards are compatible with those of the controlling ministry

had to user, customer and other stakeholder interests


IV. To be

**7 The Responsibilities of the Top Operational Management Offcial…**

	- 6. Although monitoring is a management responsibility, management can be assisted in this if the internal audit programme of activity is adjusted to refect the managerial environment of the ministry (see next section of this chapter). The effectiveness of the control activities should be assessed by each level of management as part of the routine accountability reporting process. (There could be circumstances where a separate specifc investigation may be commissioned by the state secretary where a particular problem has occurred such as a signifcant failure to deliver objectives or performance standards or where serious losses have occurred through error or misjudgement or fraudulent activity)
		- 7. Ensuring that regard is given to external accountability, particularly to the government via the cabinet of ministers, to the parliament, to the public service user (or customer/client) and where appropriate to the taxpayer through ministry reporting arrangements. Accountability for this purpose includes transparency. This may also include responding directly to parliamentary scrutiny requirements or providing 'briefs' to political offcials to enable them to do so. (Effective external accountability including transparency gives confdence to the voter and taxpayer and to them also via pressure groups, the media and other forms of public scrutiny)
	- 9. Completing statements of internal control (see Chap. 13) to demonstrate the effectiveness of the internal control arrangements

Developing an ethical approach within the organisation such that in conducting its business it treats its employees,

10. Responding to the requirements of the state auditor

> V. To be the 'guardians of propriety' and of the rules and conventions of how government should operate

organisation

customers/clients, the wider community and the assets and resources of the organisation, responsibly; this includes strengthening arrangements for transparency and accountability The state secretary should also ensure that problems are identifed early and dealt with appropriately, that the ministry and second-level organisations take into account wider social and environmental issues in making decisions and that a high reputation for the integrity of the organisation is established. This also means that it aims to protect the broader government interest, the interests of employees and others with a direct interest in the performance of the


VI. To be

**7 The Responsibilities of the Top Operational Management Offcial…**


**248**

**Table 7.1**

(continued)

#### **7.1.5 Where No State Secretary Post Exists But Each Department Within a Ministry Is Headed by a 'Director' Who Reports Directly to a Minister**

In those countries where there is no single civil servant responsible for all the activities of the civil service in a ministry and instead individual senior civil servants, sometimes called directors, are appointed to report directly to ministers or deputy ministers on particular topics, can this arrangement be maintained with the introduction of PFM/IC? Te answer is 'no' for the reasons set out below.

Whilst each 'director' could take on the individual responsibilities described in items I to VI in the table above there would be no coordination at the civil service level of the standard of those individual activities and there would be no routine exchange of information or coordination of actions. In efect, what would exist is a series of 'sub-ministries' with the only coordination occurring at the ministerial level. Tis is not consistent with the idea of delegation. Also, the idea that a minister could ensure that the same standards applied in every department of the ministry would in efect turn that minister into a part time secretary general. Tis is not feasible given all the pressures upon a minister.

With PFM/IC, this arrangement therefore needs to be rethought because efectively it means that there is no single person responsible for the management of the whole ministry. Efciency and efectiveness apply throughout the whole ministry as does fnance. And where the functions of a ministry are divided over diferent directors and there is no single head, the opportunities for coordination and common approaches to problems are small or nonexistent, and what develops is a 'silo mentality'.

Few public sector problems can be fully addressed by a narrowly focussed approach. Te result is a lack of sharing information, objectives, ideas, priorities and processes. Given that there is a single source of fnance, the taxpayer, this is highly inefcient with, for example, no opportunity for savings in one area of activity to be used to support other areas within the same ministry. Similarly, within a ministry there is a need to ensure that all regulations are properly followed throughout the whole organisation. Tere would be no single person able to do that, unless that were a responsibility of the minister. Within a ministry there would be a single fnance department having overall responsibility for budget preparation and the overall quality of fnancial management. As was explained in Chap. 6 the ministry of fnance state secretary should be confdent that a robust fnancial management structure exists within individual line ministries (and other public organisations). Unless a state secretary position exists the only person the ministry of fnance state secretary could look to would be the head of fnance. And that head of fnance then ought to have a specifc personal responsibility to object where decisions are proposed to be taken which are contrary to regulatory requirements or which potentially add to fnancial risk. Would a head of fnance have the authority to challenge individual directors? Tis would be most unlikely and the only available appeal would be to the minister again drawing the minister into operational management issues. Similarly, internal audit would have no single authority to agree an audit programme with or to report to other that the minister which again negates the idea of the delegation of operational management to the civil service.

## **7.1.6 The Importance of Good Corporate Governance Arrangements**

Good corporate governance is fundamental to any efective organisation and not least to public sector organisations. A failure of the corporate governance arrangements is likely to be a cause of serious difculty to the top management, political and operational. Corporate governance is discussed in Chap. 1 but given the managerial responsibilities that will be expected to fall upon the civil and local government service with the introduction of PFM/IC, the quality of the corporate governance arrangements assumes added signifcance. Te responsibility for securing the quality of corporate governance in an organisation lies with the head of the organisation, that is, both with the relevant minister and the state secretary. Te corporate governance arrangements should not be regarded as 'one-of' arrangements but should be expected to evolve over time. Te corporate governance processes should consider the arrangements for:

• Leadership: the arrangements should distinguish between the responsibilities of the civil or local government operational service head of the ministry or local government and that of the minister or mayor: this should clarify frst the roles of the political leadership and its responsibility for setting the objectives, performance standards and the performance objectives and, secondly, the operational leadership responsibility for securing the performance of the organisation in accordance with those objectives and for doing so efciently and efectively.

#### **7 The Responsibilities of the Top Operational Management Offcial…**


Good corporate governance is an important tool for securing the quality of the services being provided by ministries and local governments and how they treat their clients/customers/patients. Where the corporate government requirements are incorporated into a formal code, then the general rule should be that public organisations should comply with the code or where they do not, explain the reasons for this.

#### **7.1.7 The Relationship Between Line Ministry State Secretaries and the Ministry of Finance State Secretary with the Application of PFM/IC**

Te ministry of fnance state secretary has a critical role in the development and application of PFM/IC and in the maintenance of its quality, that is, unless another ofcial had this responsibility such as a head of the civil service. Te list of responsibilities falling upon a state secretary described above in Sect. 7.1.4 with the implementation of PFM/IC is substantial. Terefore, the likelihood is that considerable advice and support will be required as well as detailed guidance. Tis means that an important initial role of the ministry of fnance through its state secretary should be to engage with line ministry state secretaries and other heads of public organisations to explain the nature of the reform and its implications for them. Tis would be an important element in developing 'local ownership'. State secretaries together could act also as an advisory group on the processes of implementation. Without local ownership, resistance could well emerge and pressure to return to the *status quo ante* could well develop over time. Ideally the ministry of fnance state secretary should establish an ongoing relationship with this group of key ofcials throughout the whole development and implementation process. A useful addition to this group of ofcials probably in the form of a commentator would be the state external auditor who could make an important contribution to issues about 'control' in its broadest forms. Another adviser to the group could be the head of the government training institution or a university tutor responsible for management development training. As the leader, the ministry of fnance state secretary should ensure that an agenda item was 'emerging concerns'. Te ministry of fnance state secretary would almost certainly require support in undertaking this responsibility. Probably the head of the department responsible for the day-to-day application of PFM/IC should act as secretary to the group and coordinator of its activities (see Chap. 9 which discusses the functions of this department). An ongoing responsibility of this group should be to review and advise on the arrangements for the application of PFM/IC to coordinate experiences and encourage discussion between the diferent state secretaries involved. Coordination at this high level within the civil service is very important. However, in most countries applying PFM/IC discussions usually occur at a much lower level because it is seen as just a technical fnancial reform with no impact upon management.

A state secretary involved in this activity would need to consider and report upon:

#### **7 The Responsibilities of the Top Operational Management Offcial…**


Te ability/willingness of an organisation to respond to the requirements of PFM/IC and its capacity to absorb those requirements will depend heavily upon the characteristics of the current bureaucratic organisation and the capacity of the civil service. Tus, ideally the existing organisation should have the characteristics which are appropriate to the needs of a managerial style organisation, that is, the employees have specifc objectives and performance standards and objectives they are expected to work to, an appropriate organisational structure exists, employees are clear about the scope of their responsibilities through the existence of written rules and procedures, all employees are required to conduct their activities in an unbiased manner, and employees should be appointed to jobs based upon their technical skills. If these characteristics do not exist or only partly exist, the frst step is to establish these characteristics as part of the initial moves to PFM/IC.

Once a decision has been made to implement the PFM/IC reform policy, this process of consultation and coordination should be continued so that state secretaries (and as necessary other ofcials such as the fnance ofcers) could participate in a continuing process of learning. (If the reform is being fnanced from aid funds it may also be desirable to include within the consultation process ofcials from the aid organisation.)

#### **7.1.8 The State Secretary, Internal Audit and Inspection**

In previous chapters and earlier in this chapter, the changed reporting arrangements for internal auditors have been discussed. Prior to the introduction of PFM/IC the traditional arrangement would be that the internal auditor would report directly to the political level of management, the minister. In some countries an inspection regime also exists designed to secure adherence to formal rules and procedures. Sometimes there is an overlap with internal audit. However, a clear separation of internal audit and inspection responsibilities should exist. To summarise those changes and the particular impact upon state secretaries, with PFM/IC as the quality of operational management is frmly the responsibility of a state secretary (or equivalent) in the normal course of internal audit activity, the auditor should report to the state secretary about the internal control arrangements rather than to the minister. (Bearing in mind that the defnition of internal control with PFM/IC is much wider than in a traditional organisation.) Tis is because with PFM/IC the state secretary would have a direct responsibility for internal control. A minister would not have such a direct responsibility, except in the broad terms of having responsibility for the overall quality of the management of the ministry. With PFM/IC if serious problems exist, the internal auditor could always report directly to the minister although in practical terms, this would be likely to raise serious tensions with the state secretary to whom the auditor should normally report.6 Exactly the same arrangements should apply with inspection.

Auditors may feel that this change would be a cause of concern. However, such a concern could be alleviated by the appointment of a truly independent audit committee and some may regard such a move as an appropriate complementary reform to the implementation of PFM/IC. Te internal auditor would then report not only to the state secretary but also to the audit committee.

<sup>6</sup>Te conventional theory is that the internal auditor should report directly to the head of the organisation. However, the head of the organisation, the minister or mayor, in practice is unlikely to have the time or the detailed knowledge to enable him/her to make the judgements necessary to properly identify which elements of internal control should be reviewed by the internal auditor or to evaluate internal audit reports about the internal control activities. On the other hand, the senior ofcial responsible for the implementation and monitoring of PFM/IC, that is, a state secretary, would have that detailed knowledge. For this reason, the suggestion is made here that as part of the usual work routine the internal auditor should liaise closely with this ofcial in formulating the internal audit plan of activity for reviewing the internal control activities and be responsible for considering the reports of the internal auditor. However, with this practical arrangement, nothing should prevent the internal auditor reporting directly to the political head of the organisation where the internal auditor feels that that would be appropriate. In some countries, a more appropriate arrangement may be the appointment of an independent audit committee, as discussed in the main text.

## **7.2 Summary**

Te responsibilities of the ofcial (i.e., state secretary or equivalent) for the application of PFM/IC within a public organisation are considerable and much greater than those exercised by such an ofcial prior to the implementation of PFM/IC. Tey refect the fact that applying PFM/IC is about managerial reform and therefore is about how public organisations are organised and managed to deliver objectives as well as to ensure that public resources are properly utilised and deliver better public value, with responsibilities being allocated between the political and the ofcial levels of management. Consequently, the responsibilities of that ofcial are not just about the technicalities of PFM/IC but they also cover the managerial implications of the reform. Te signifcant change that this reform will bring about is the professionalisation of civil service management coupled with the delegation of operational management from the political to the ofcial level. Consequently, an important responsibility of a state secretary will be to retain the confdence of the political level of management in the competence of the operational management and its capacity to deliver the objectives and performance standards set by the minister efciently and efectively and to maintain fnancial and budgetary control.

A ministry of fnance through its state secretary should systematically engage with other public organisation state secretaries (or equivalent) about the application of PFM/IC through establishing a coordinating group. Te role of the head of the department in the ministry of fnance responsible for the application of PFM/IC should be to support the ministry of fnance state secretary and act as secretary/coordinator of the group of state secretaries. Such engagement arrangements would form part of the process of generating 'local ownership' of the reform. Tat coordinating group should be prepared to consult with other persons as necessary such as the state external auditor and the head of the government's training institution or a university tutor with experience of managerial training.

Te introduction of PFM/IC will also afect the role and reporting responsibilities of internal audit and those of an inspection arrangement. Tose reporting responsibilities should primarily be to the state secretary but with a right to still report to the minister where necessary. Internal audit concerns about this reporting change could be alleviated by the appointment of an independent audit committee to whom the internal auditor would also be required to report.

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# **8**

# **The Role of the Head of Finance and the Finance Department in Line Ministries and Other Public Organisations with the Application of PFM/IC**

Prior to the introduction of PFM/IC the role of the head of fnance would be largely limited to that of fnancial controller including that of bookkeeper. Te head of fnance would be the main channel of communication with the ministry of fnance and in those countries which have separated the responsibility for the capital or investment budget from the current budget, with the ministry responsible for the capital or investment budget too. A principle responsibility of the head of fnance would be the development of the budget but in many developing and transition economy countries that budgetary role would usually be limited to the assembly of the budget in accordance with the ministry of fnance and other central ministry requirements. Te head of fnance would not be expected to advise the manager on the appropriateness of the budget or on the linkages between the budget and expected performance (if the latter linkage is considered at all). Te focus of accounting would be on fnancial accounting with little or no attention paid to management accounting (including costing).

However, with the introduction of PFM/IC the role of the head of fnance would be expanded considerably. Tis chapter describes that expanded role. Where there is a separation of the current and investment budgets the head of fnance will be expected to bring these together so that each manager is aware of the total availability of resources. Again, the head of fnance will have a key role in raising manager fnancial awareness and be expected to analyse the available budgetary resources over cost centres, cost drivers and any other form of analysis that a manager requires. Finance staf therefore will need to have the expertise and information to enable them to properly support the management of organisations, not least in providing managers with the fnancial information they require to deliver greater efciency and efectiveness. Tat will involve the extensive development of cost and management accounting, as well as the reallocation of budgets to meet the needs of managers. Te head of fnance will also need to develop an advisory role to support managers in interpreting fnancial information, especially in the context of performance and to help them analyse information so that they are able to fulfl their responsibilities to deliver objectives and performance standards efciently and efectively. Tis applies to both expenditure and income. It will mean that fnancial information systems will require development so that they can meet not only the needs of the ministry of fnance but also those of the manager. Other responsibilities of the head of fnance will include advising the manager on the diference between fxed and variable costs and on the management of fxed costs, not least because fxed costs dominate the budget. Te head of fnance should undertake the monitoring of both fnancial and operational performance and provide an assessment of the short- and longrun fnancial resilience of the organisation.

As the civil (or local government) service will have a responsibility to support the political level of management in the development of policy the head of fnance is likely to be an important contributor to that process. An appreciation of cost and afordability should be important components in policy decision making.

# **8.1 The Signifcance of Financial Management**

## **8.1.1 Financial Management in Public Organisations**

Public service organisations are unlike many private sector organisations because they are highly diverse and complex and their objectives can be difcult to defne with precision. Tere is no equivalent to market share or return on capital or proftability or other commonly used market-based measures that a head of fnance should be constantly monitoring. Public service organisations are also usually very much larger than private commercial organisations and often more complicated organisationally. Current or ongoing expenditure is usually fnanced from taxation or for some activities an element of funding will be raised from charges. Current expenditure should not be fnanced from borrowing because that will result in structural defcits. On the other hand, investment expenditure will usually be fnanced from borrowing rather than from internally generated funds or from investment capital. Tere will be no share capital. In some countries these various sources of funds may be supplemented from grant aid, for example, from the European Union, and where this occurs special rules may be applied to demonstrate how such funds have been used. Heads of fnance should have a thorough appreciation of the diferent sources of fnance and where it is appropriate to use those diferent resources.

Te accounting arrangements will traditionally have been based upon cash but there is an increasing tendency to move towards accruals-based accounting systems but only for fnancial reporting purposes. Budgets are almost always prepared on a cash basis. Because of the diferent approaches to funding, budgets have always assumed a much more dominant role in the public sector than in the private sector. Efective public fnancial management does not require the development of accrual accounting or variants of the cash and accrual accounting bases. As has been shown earlier in this guide, accrual accounting, unless properly implemented with a well-trained management, can be a cause of additional risk from a public fnancial management perspective and is not a precondition to an improvement in the quality of public fnancial management.

A major problem in managing public expenditure at the organisation level arises from these features of public expenditure:


Tese features are why public services are not provided by the market. A consequence of these features is that 'fnancial awareness' is not an inherent characteristic of public sector management. A further complication is that many of the problems that public sector organisations seek to address cannot be solved by a single public sector organisation and require cooperation between public organisations, such as other ministries and local governments (always very difcult to achieve in practice), and sometimes also with private sector organisations, such as charities. Te timescales for achievement are frequently inconsistent with the timescales for resource availability. However, heads of fnance should always be aware of 'avoidable costs' and that the factors above should not provide an excuse for a head of fnance not to pursue a rigorous assessment of the costs of providing public services.

A principal concern of a head of fnance has traditionally been to ensure that expenditure is controlled so that budgetary allocations are not overspent and that decisions about spending conform to legal and regulatory requirements. An important aim has been to prevent the misuse of public funds. However, given the increasing importance of public expenditure and the size of many public sectors, a single focus upon 'fnancial and budgetary control' is no longer adequate. Much greater regard should be had to the quality of public expenditure and that requires a more sophisticated approach to public fnancial management focussing, as far as possible, upon what is being achieved for the input of resources. Heads of fnance should also be concerned about the future sustainability of public services and that will mean having a concern for the long-run future fnancial viability of the organisation.

## **8.1.2 Financial Management, Decision Making and the Role of the Head of Finance**

As has been explained previously, a core principle of PFM/IC is that operational decision making is delegated to operational managers. Tey are the managers who are nearest to the problem and have the greatest need for operational information, both fnancial and performance. Tey are also those most likely to be more familiar with the risks and problems that afect the arrangements for the delivery of a service. Such ofcials probably also will be best placed to judge the value of the expenditure and corresponding opportunities, provided they have the information and support that they require to make good quality decisions. Te accountability arrangements for such ofcials (and for subordinate organisations where they are involved) should refect the delegation arrangements.

An essential feature of that information and support that such managers need is that derived from efective fnancial management. An important element of the PFM/IC reform is driving higher standards of fnancial management and ensuring that fnance is integral to decision making at the very highest levels in public organisations. Finance leadership in a line ministry or other public organisation is central to this. Te head of fnance should be the principal fnancial adviser to the management and most particularly to the top operational manager, the state secretary or equivalent. In this leadership role the head of fnance must ensure that fnancial standards are maintained and that the fnance function is developed so that it is able to provide the information managers at all levels require in a timely manner. An important requirement of the head of fnance is that he/she should possess excellent interpersonal skills, have experience of managing what is likely to become, especially in larger ministries a large, complex fnance function, and have a considerable appreciation of the political context in which public organisations operate.

Financial management therefore goes well beyond exercising fnancial and budgetary control. Te management information that managers require includes the full costs1 of the services and activities that they are responsible for and what drives those costs, then ensuring that this understanding will be used to better inform decision making. Tis means that a head of fnance identifes, with managers, the information they require, not least to ensure that services and activities are delivered efciently and efectively (and the same applies to the arrangements for the collection of income). Tis will mean that a responsibility of the head of fnance will be the development of management accounting and costing systems relevant to the needs of the manager.

Te head of fnance should have a specifc responsibility for:


<sup>1</sup>Full costs include personnel, supplies and services, transport, property costs, overheads and an appropriate share of investment costs.


A state secretary (or equivalent) has a responsibility to support the political level of management with the development of policy and the strategy for the implementation of policy. Tis support will largely be based upon the practical experience of operational management. To develop efective policy the politician requires information about costs and in particular what drives costs. Te politician also requires an appreciation of how proposed policies are likely to ft with the budgetary envelope likely to be available to the organisation as well as upon the future fnances of the organisation. Tis will be important information in negotiations with the ministry of fnance about the implementation of a proposed new policy. Te head of fnance should have a central role in providing that information.

Te personal qualities of the head of fnance should include the skills and personality to act as fnancial adviser to the most senior operational management ofcials and where a management team exists, to that team. He/she should have an ability to communicate and manage; strong problem-solving skills and ability to make decisions based on accurate and timely analysis; a high level of integrity and dependability; good delegation skills; an ability to show and exercise good judgement, to make recommendations and to implement decisions. Also, because there is likely to be a large volume of data the head of fnance should have an ability to determine what is important and what is not.

# **8.2 Functions of the Head of Finance Prior to the Application of PFM/IC**

## **8.2.1 The Background**

With traditional systems of public administration, fnancial considerations generally are not central to decision making except in one respect which is to secure budgetary and fnancial control. Managers are not required to constantly search for ways of improving efciency and efectiveness in the delivery of public services or activities nor indeed are tools and advice available to enable them to do so. (Tere may be 'token' requirements in legislation but mostly these will have no substantive meaning.) Nor are managers required to look forward to assess the fnancial impact that current and future policy developments as well as any external factors, such as environmental or demographic change, may have upon the longer run fnancial resilience of the organisation. Similarly, the stock of public assets is not treated as something to be managed so that efective use is made of this very important resource. Te asset stock is not usually regarded as a manageable resource. Accounting is primarily a bookkeeping function dominated by the need to maintain budgetary control. Te budgetary analysis will be determined by the requirements of the ministry of fnance with the manager having little or no say in that analysis. Tere will be little or no management accounting to meet the needs of individual managers. In countries with traditional systems of public administration, budgets are usually based upon historical information and then sometimes adjusted for infation. (In reality, budgets are frequently prepared hurriedly with little time for detailed analysis and the previous year's budget is then repeated with no amendment to refect changing circumstances. So quality is not necessarily a defning characteristic.) Te detailed formulation of the budgets and the budgetary calculation processes may be specifed by the ministry of fnance leaving little or no discretion to the manager of the service or activity. As some key budgetary elements may be determined centrally by a ministry of fnance or another central ministry, they may not be within the discretion of the manager responsible for the delivery of the budget. An example of this would be personnel budgets. In some countries, even relatively minor budgets may also be determined centrally, such as vehicle fuel consumption and as noted in a previous chapter even the allowance made for water consumption by individual members of staf. Because the structure of the budget and hence the fnancial control processes will be determined by the ministry of fnance, this in turn afects the design of the accounting system and the information which is available to the manager of the service or activity. Overoptimistic assumptions about income, both taxable and non-tax income, can also be a feature of budgeting.

A consequence of poor quality budgeting, and particularly instability of funding, is that heads of fnance are frequently engaged in crisis or 'cut-back' management to accommodate unforeseen circumstances and emerging defcits during the year.

#### **8.2.2 A Summary of the Responsibilities of the Head of Finance Before the Introduction of PFM/IC**

Te primary responsibilities of the head of fnance with a traditional system of public administration refect the more limited role of a state secretary (see Chap. 7) and include:


Variations to this list of responsibilities may occur depending upon local circumstances. For example, a head of fnance may have a responsibility for the transfer of funds from a ministry to a second-level organisation or a nongovernmental organisation (NGO) and then act as a fnancial controller to ensure that such funds are not overspent or are spent in accordance with any accompanying conditions.2 Where the budget includes a medium-term perspective, a head of fnance may be involved in the calculation of forward year forecasts although frequently this just involves an adjustment for anticipated infation beyond the base year. A head of fnance may also be involved in preparing forecasts of the future ongoing costs of new investment. Te extent of the head of fnance's role in preparing any fnancial statements and supporting documents will depend upon whether a single set of fnancial statements is published for the government as a whole or each public organisation is required to publish a separate set of fnancial statements. Again, these responsibilities will be afected by whether a cash- or modifed cash-based, modifed accrual- or accrual-based accounting system is in place. Te head of fnance may also have a responsibility for treasury management, particularly for the investment of short-term (e.g., overnight) funds, especially where there is no

<sup>2</sup>With the introduction of PFM/IC the responsibility for transfer of funds should lie with the relevant manager responsible for the oversight of the second-level organisation and that manager should also ensure that the transferred funds are used only for the purposes for which the funds were made available. 'Control' should therefore extend well beyond simply fnancial control.

centralised treasury single account. Otherwise, that responsibility will lie with the ministry of fnance or treasury.

Te head of fnance will usually have no role in the assessment of the appropriateness of the budgets of second-level bodies, other than for the purpose of assimilating those budgets into the budget proposals for a ministry as a whole (or a local government) or for the review of the fnancial performance of a state-owned enterprise which a ministry is responsible for supervising.

Little or no management or cost accounting is likely to exist and the head of fnance is unlikely to be required to analyse the budget or accounting information in a way that would facilitate the development of efcient and efective management. Tere would be no long-term fnancial planning (which should not be confused with medium-term budgeting). Te head of fnance would not be required to act as a fnancial adviser to the manager other than for fnancial and budgetary control purposes.

Te advice of the head of fnance is unlikely to be sought in the development of policy and the head of fnance is unlikely to have the type of information available that would enable the head to make an efective contribution other than to the possible impact upon budgetary limits.

In summary, the principal functions of the head of fnance would be to act as bookkeeper and fnancial controller. Tese are important responsibilities and are consistent with the requirements of public fnancial administration as described in Chap. 3, but they are not sufcient with the development of the managerial culture implicit in the introduction of PFM/IC.

# **8.3 The Responsibilities of a Head of Finance with the Introduction of PFM/IC**

## **8.3.1 The Changed Background**

Te most important changes afecting the role of the head of fnance following the application of PFM/IC are that the head of fnance must respond both to the development of a managerial culture and to the consequences of a greater focus on the interests of the stakeholders. Tis latter is demonstrated by the linkage between PFM/IC and improvements in transparency and corporate governance. Tese changes have a signifcant impact upon how fnancial information is analysed, utilised and made available both internally to operational managers and externally to stakeholders. Te budgetary analysis arrangements required by the ministry of fnance, which dominate traditional arrangements, are unlikely to be adequate for operational managerial purposes and the information required for public fnancial reporting purposes is unlikely to be relevant to the needs of most stakeholders. Traditional fnancial reporting arrangements will not in general facilitate transparency about how an organisation has utilised available public resources when compared with the achievement of objectives. Te operational manager as has been shown previously, if he/she is to be efective, will require that fnancial information is provided in diferent ways, that is, it will need to be interpreted, classifed, analysed, reported and summarised diferently for management and stakeholder reporting purposes compared with that for year-end fnancial reporting and ministry of fnance budgetary control purposes. With traditional pre-PFM/IC public administration systems these managerial and stakeholder needs have not been regarded as important, or recognised at all, because 'control' has been the driving factor rather than 'management' with 'control' and reporting being focussed upon the requirements of the ministry of fnance. Te responsibility of the operational manager to achieve objectives efciently and efectively will not have been a central requirement. With the application of PFM/IC the control of inputs remains important but there is an added focus upon achieving the outputs (i.e., the objectives of the organisation) and doing so efciently and efectively. To do that there has to be efective management. Heads of fnance with traditional systems of public administration have not therefore expected to be trained professional fnancial managers in the way they would be expected to be in a managerial environment. Consequently, with the introduction of PFM/IC the responsibilities and approach to fnance must change signifcantly to complement the adoption of a managerial approach to the delivery of public services.

An aim of the fnance function within each public organisation should be to drive improvements which support the delivery of high-quality efcient and efective public services. To do this the head of fnance should seek to provide management-focussed advice, that is, to respond to the manager's needs and to provide those specialist fnancial services that the manager requires. An example would be specialist management accounting information. A further aim should be to ensure that the capital stock of the organisation is used efciently and efectively. Tis includes not just assets but also ensuring that the levels of debtors and creditors are being efectively managed.

As a manager operating in a managerial environment will require diferent forms of analysis to those provided by conventional budgetary documents, the determinant of that analysis should be the manager rather than the ministry of fnance. Te adviser to the manager for this purpose should be the head of fnance for the organisation. Tis requires the development of an operational partnership between the manager and the fnance ofcial. In addition to this for efective fnancial management with a focus upon efciency and efectiveness, the manager will require detailed information about operational performance. Tis is likely to require the development of new information systems and the linking of operational performance information with fnancial information. Tis will mean that cost and management accounting information the manager will require will afect the range of fnancial support available to the manager. Consequently, this is likely to afect how that information is provided and the specialist skills and analyses that will be required. For example, each hospital or major educational establishment will require particular forms of fnancial analytical information. Tat need, in turn, may afect how the fnance function is organised. Tus, should the whole fnance function be centred on the head of fnance or should particular managers (such as of a hospital or a major college or university) have their own fnance stafs. If the latter they, in turn, would need to liaise with the ministry or local government head of fnance. (Tis is discussed in Sect. 8.7 below.)

Appreciating these requirements also shows that with the introduction of PFM/IC the professionalisation of fnancial management is a necessary condition. Te role of head of fnance as well as of operational management with PFM/IC is more demanding and hence more time consuming than that expected with traditional public administration arrangements. A higher level of technical knowledge is required as well as considerable experience of the operational environment.

For the fnance role to be efective in a PFM/IC-dominated environment the head of fnance must ensure that the core fnancial processes, systems and management information provide the information the manager requires. As that information is likely to difer from manager to manager, the head must ensure that consistent fnancial standards and policies are applied and that managers are familiar with them and regard them as relevant to their operational environment. To achieve that the head of fnance must ensure that expert people are employed in fnance departments and that they have a clear career structure and opportunities for training and development exist (see Sect. 8.5 below). Te organisation structure should promote collaboration with management and knowledge sharing. Finance ofcials should strive to become trusted partners of the management at all levels in the organisation. A main point that should come to be appreciated is that: "Finance is not just about money: it is about whether our organisations are delivering expected policy outcomes on time and to budget. Tis means we need to understand how policy and strategy connect through to delivery performance, and how risks and opportunities are identifed and managed."3

#### **8.3.2 The Key Changes That the Head of Finance Should be Prepared for, Including Support to Managers**

With PFM/IC a key change, as was pointed out above, will be in the information that a manager requires and which the fnance department will be expected to provide. Tis will involve not only diferent budgetary analyses but also the provision of cost and management accounting information where required by management to complement fnancial accounting information. Tis is part of the process of preparing fnancial information for operational managers in a form that is required by the manager. Te analysis of budgetary information should be designed so that information is provided in a form that allows for the interpretation of that information for managerial purposes. Te management accounting reports should provide accurate and timely fnancial and performance information to managers. Tis is to enable them to make short-term and long-term decisions about the achievement of the objectives of the organisation, including whether it is doing so efciently and efectively and at the same time containing expenditure and income within prescribed budgets.

In practice, line ministry managers will require considerable support in developing a managerial approach to managing public money and not least over how to achieve improvements in efciency. Tis is likely to be entirely new to them and will require advice and training on how expenditure and income should be analysed. For example, an operational manager may require analysis over cost drivers and cost centres, the development of appropriate cost accounting techniques (see a later section of this chapter) and so on. Te head of fnance should be able to provide that advice.

Management accounting difers from fnancial accounting. Financial accounting provides the information to a ministry of fnance and to the management of an organisation primarily for budgetary control purposes and to enable the ministry of fnance to prepare the annual fnancial statements. Tat information will be organised to suit the needs of the ministry of fnance, rather than those of the manager. Cost accounting provides an analysis of the

<sup>3</sup>Government Finance Function Strategy 2019–2023 Executive Summary: Comment by Rachel McLean Finance Director General, Ministry of Housing, Communities and Local Government p5: UK Government: Government Finance Function—GOV.UK (www.gov.uk).

actual costs of service operations, processes, activities or products and the analysis of variances from the detailed budgets for those individual activities and where standard costs are calculated variances from those standard costs. (A standard cost is the estimated cost of a providing a service, activity or product.)

In summary, with PFM/IC the fnancial information system must provide two basic analyses of information:


Te analyses that will be required will be more complex where there is a separation of the current budget from the investment budget with reporting to two diferent ministries. Managers will require detailed information about both budgets and meet what may be the diferent control requirements of different ministries.

Te head of fnance must ensure that these two forms of analysis utilise the same basic accounting information.4 Consequently, the coding structure should be devised in such a manner that it can provide both the information that the manager needs and that required by the ministry of fnance for its purposes. (Very often coding structures are devised simply to meet the needs of the ministry of fnance and then only for budgetary control purposes.)

Te operational manager will require the management and cost accounting information necessary to enable him or her:

<sup>4</sup> See Chap. 5 and the reference to the Canadian arrangements.


Tus, the head of fnance in conjunction with the operational managers in an organisation will need to develop a fnancial analytical system, that is, a management accounting system, specifcally designed to meet the needs of each manager's area of responsibility. Terefore, the coding structure should be designed to provide the information that individual managers may need as well as the ministry of fnance.

#### **8.3.3 The Head of Finance and the Development of Policy, Including Securing Short- and Long-Run Financial Resilience**

With the managerial information requirements that should be developed with the implementation of PFM/IC the head of fnance should be able to make an efective contribution assisting the state secretary support the political leadership in the development of policy. As the role of the civil service in policy making is to provide advice on how political ideas can be converted into practical public services able to be delivered within budget and in such a manner as to be capable of being maintained within a longer term forecast fnancial framework for the organisation, the fnancial contribution is extremely important.

Efective policy can only be developed if it is accompanied by an analysis of the fnancial consequences of that policy including the identifcation and impact of the relevant cost drivers (such as pupil/teacher ratios or penal policy). Te head of fnance should be able to contribute to that policy making role. For this contribution to be efective the head of fnance must gain the confdence of the head of operational management, (the state secretary) and the policy maker.

Both the political head of a ministry or local government or other public organisation and the head of the operational management within that organisation should also be concerned about the short- and long-run fnancial resilience of the organisation.

What is meant by fnancial resilience? In simple terms, this is the ability, from a fnancial perspective, to respond to changes in delivery or demand without placing the organisation at risk of fnancial failure. Tis means having the ability and fexibility to forecast and manage both expenditure and income to meet requirements as they change while delivering a balanced budget. What are the key indicators of fnancial resilience? Tey will depend upon the type of service that a public organisation is providing and the circumstances in a country under which a public organisation is operating. Each present a risk to the viability of an organisation. A head of fnance together with the head of operational management should assess and report to the political head of the organisation on the fnancial resilience of the organisation following the assessment, because the result may have a major impact upon existing and future policy.

In assessing fnancial resilience an aim will be to identify those factors,5 which might impact upon the longer run fnances of the organisation. A result should be that consideration is given through the development of contingency plans to how costs should be managed in the event of adverse fnancial circumstances emerging, as periodically they inevitably will. Tis approach would be much more efective and facilitate the more efcient utilisation of resources than simply reacting to a fnancial crisis without any pre-planning. Short-, medium-term and longer run fnances will be afected by such factors as an economic downturn, increases in interest rates, the impact of legal changes, technological change, environmental change and, where foreign aid is signifcant, changes to the level of that foreign aid. Another feature in assessing fnancial resilience will be to ensure that new development proposals can be introduced without impacting adversely upon the ability of the organisation to maintain its current services and assets. In assessing new development proposals a factor that should be considered should be how that new policy could be afected if in the future, economies have to be made because of changed economic circumstances or a failure to generate the revenues that underpin the budget.

Of course, the head of fnance will need to continue to provide the information the ministry of fnance requires and to ensure that the budgetary and cash fow controls established by the ministry of fnance are fully observed, that is, through the fnancial accounting system. But such controls are nowhere near enough to secure fnancial resilience. Short-run fnancial resilience requires that fows of service delivery activity are consistent with the availability of fnance, both domestic and foreign aid, not simply that budgetary

<sup>5</sup> See also Sect. 8.3.6 below.

controls are observed. Tis means that commitments must be fully recorded even though no actual payments may have been made. Terefore, an important element of fnancial management is to ensure that payments and commitments together do not cause budgets to be exceeded. Consequently, the head of fnance and the manager together should review budgets monthly and re-forecast the likely outturn for the remainder of the fnancial year. In practice in many developing and transition economy countries, particularly in southern and eastern Europe, fnancial reports are prepared only three monthly and no re-forecasting occurs at all. Consequently, towards the end of the year the risk is that the manager suddenly fnds that the budget will be overspent and that a supplementary budget is required or short-run cuts must be made to the provision of services and activities. Either way the result is inefcient management. Tree monthly fnancial reporting does not allow sufcient time to make realistic service or activity adjustments to ensure that budgets are not overspent and that is why activity and spending should be reviewed monthly. Re-forecasting enables managers to take decisions earlier in the year to avoid overspendings occurring or to ensure that unused funds are not hurriedly spent at the end of the year, merely to utilise a budgetary allowance irrespective of the merits of that expenditure. Spending should also be linked with performance, that is, is the spending achieving the objectives? Over- or under-spending on its own is not a sufcient indicator and the responsibility of the head of fnance and the manager is to link spending with performance. Tis will indicate whether there is genuine under- or overspending, or merely if overspending, increased inefciency.

Te argument put to this author in some southern and eastern European countries is that there is no need for short-run fnancial planning because there can be no budgetary overspending. Tis is because 'the treasury control system would prevent it' and therefore efective budgetary control exists. Tis, however, ignores the point that commitments may be entered into particularly afecting future periods and that arrears of payments to creditors can and do exist as one of the processes for ensuring that overspending does not occur (or more accurately can be concealed). Terefore, the fact that the ministry of fnance treasury control system prevents overspending does not mean that there is efective budgetary control; it can merely disguise the fact that such overspendings are occurring and the consequences are being borne by the following year's budget or by the creditor, that is, the private element of the economy. (Tis can be accompanied by price infation as creditors seek to recoup their added costs.)

Many ministries and local governments establish second-level organisations. A further factor therefore that the head of fnance should be concerned about is the fnancial management of such organisations, whether agencies or state-owned public corporations. A state secretary (and the political level of management) should want to ensure that not only are the objectives of such organisations consistent with the policy expectations of the frst-level organisation but that all second-level organisations are managed in such a manner that their objectives and performance standards are delivered efciently and efectively and that they do not incur liabilities which could have an adverse efect upon the frst-level organisation. Te head of fnance should ensure that he/she is well informed about the quality of fnancial management in such second-level organisations so that, in turn, the state secretary and/or the political level of management can be properly informed (see also Chap. 12).

Longer run fnancial resilience depends upon the quality of all those processes that involve fnance including the relevant corporate governance arrangements such as:


In Annex 2 to this chapter the diferent criteria which should be considered in assessing fnancial resilience are discussed.

# **8.3.4 Accountability and Transparency**

A feature of PFM/IC is increased accountability and transparency. Te COSO framework referred to in Chap. 5 is described in detail in Chap. 11, included reporting objectives. Tese objectives are about both internal and external reporting and accountability and transparency. Tey relate to fnancial and non-fnancial reporting. Te factors in the COSO framework specifcally referred to include reliability, timeliness and transparency but the framework recognises that other factors may be relevant as well depending upon local requirements, and for public sector organisations, this should include information about whether violations have occurred to budgetary allocation limitations. Bearing in mind that the COSO framework applies to private sector companies, application to the public sector could introduce a range of additional requirements. Not the least of these requirements would be those expected by parliament to enable it to fulfl its scrutiny responsibilities. Transparency also embraces the information required by civil society and how that information is presented. Te linkage of fnance with objectives and performance will be key elements in accountability and transparency.

Te head of fnance will have a responsibility to prepare the annual fnancial statements of the organisation or alternatively provide the information that the ministry of fnance requires to enable it to complete the fnancial statements of the whole of government. Tese statements will be subject to external audit, whether they are published separately for each organisation or sent to the ministry of fnance for consolidation into a government wide set of fnancial statements.

Financial statements, especially consolidated fnancial statements, do not provide the information that stakeholders, not least parliaments, usually require about the operation of individual public organisations. From a corporate governance point of view this is inadequate and information should be published in a form which is accessible to the user or stakeholder in each public organisation and that information should inform the reader about much more than the fnances of the organisation. Tis may require the publication by each organisation of an annual report which specifcally addresses the interests of the stakeholder and demonstrates how public funds have been used against budgets, the level of performance achieved against objectives set, the factors which are likely to afect performance into the future, details of strategically important matters such as sustainability, ethics, values and/or corporate social responsibility and information on environmental matters (exactly what should be published will depend upon the scope of the responsibilities of the organisation) and also the strengths and weaknesses of the internal control arrangements (see also Chap. 13 on the statement of internal control).

Te head of fnance has a key role in enabling management to fulfl its accountability and transparency responsibilities. Tis raises the question as to whether in addition to the conventional fnancial statements, if an organisation is to fulfl the accountability and transparency requirements envisaged by COSO, it should also publish separate fnancial and performance reports to complement consolidated fnancial statements published by the ministry of fnance?

Te department responsible for the application of PFM/IC should issue guidance on how ministries, local governments and other public organisations should meet accountability and transparency requirements. Particular attention in developing the reporting specifcation should be paid to the needs of parliament so that parliament has an opportunity to appreciate the extent to which the government and/or individual public organisations have met their objectives and performance standards. Tis is not simply about underor overspending compared with budgetary approvals.

## **8.3.5 Managing Costs**

Maintaining fnancial resilience as well as improving efciency and efectiveness also depends very heavily upon a public organisation's ability to manage its costs. Improving efciency and efectiveness very often requires that difcult decisions are required, not least in attacking what are often deemed to be the fxed costs6 of an organisation. Tose fxed costs can include employee pay (not least because of the contractual arrangements with employees and perhaps a political unwillingness to change the level of the number of employees), social benefts, the costs of servicing debt, the costs of maintaining assets which may be out of date or are inefcient to use or which are surplus to requirements or cannot be adapted to meet modern conditions (such as medical facilities) and stafng. Yet it is these 'fxed' costs that dominate budgets and which often cause so much difculty when budgetary changes are required.

How budgets are developed will, or should, also be afected by the development of PFM/IC. For example, budgetary calculations should refect the underlying performance information and the management/political policies. To manage costs an operational manager should not simply be concerned with how much individual transactions cost but with what causes those costs to be what they are, that is, what is it that drives the costs and can those cost drivers be changed. Consequently, in developing budgets regard should be had to the identifcation and impact of those cost drivers. Substantive cost management should be aimed at those cost drivers, rather than simply at cost totals. Managers should be judged therefore not just by their ability to keep costs within a defned budgetary allocation but also by their ability to deliver performance and at the same time to identify and manage those factors that drive those costs. (Changing cost drivers may not always be possible for an

<sup>6</sup>Fixed costs in accounting terms include those costs which remain the same whether activity increases or decreases. However, in the public sector this defnition can be widened to include those costs which the politician does not wish to see changed, such as employee costs, whatever the circumstances and such costs can be a major contributor to total budgetary costs.

operational manager and political authority may be needed and that of course shifts the responsibility to the politician and away from the operational manager.)

Associated with the identifcation of cost drivers by those responsible for the development of budgets within ministries delivering public services is also the need to ensure that ministry of fnance ofcials responsible for negotiating budgets (and if there is a separate budget for investment, the ofcials of the ministry responsible for that budget) in turn have an appreciation of what drives costs. Tat will require close coordination between those ofcials and the head of fnance within ministries responsible for the delivery of public services. Unless ofcials from these central ministries have an appreciation of what drives costs in individual ministries, the risk for them is that they will not be able to make efective judgements about the appropriate allocation of budgetary resources.

A related factor is that individual ministries or other public organisations may not be totally in control of their own costs, and decisions made by other ministries and public organisations can infuence them. An important responsibility of the head of fnance is to ensure that he/she is aware of such possibilities. For example, should a decision be made to increase signifcantly the number of police by the responsible ministry that will infuence the budgets of other ministries such as those responsible for the court system, for prisons, for the probation service, for the maintenance of family cohesion where there may be an increase in the arrest of the main family income earners.

#### **8.3.6 The Role of the Head of Finance as a 'Check' on Managerial Aspirations and as a Reviewer of the Utilisation of Assets**

Te head of fnance will also be the person who acts, either directly or through the state secretary, or equivalent, as a 'check' on the aspirations of managers (political and appointed) because their proposals are not fnancially viable. Te head of fnance may also wish to secure transparency and accountability by publishing information those managers may prefer to not disclose. Tese responsibilities may put the head of fnance into confict with managers, even political managers within an organisation, and this will require that the head of fnance has the support of the state secretary in a ministry (or equivalent in local government) for the actions proposed to be taken. What should not happen is that the head of fnance allows another ofcial to determine the content of a fnancial report or advice. In extreme circumstances a head of fnance may need to discuss the circumstances with the external auditor and/

or with the ministry of fnance. Te overriding responsibility of the head of fnance is to secure the fnancial integrity of the organisation and to make clear where there is a possibility of that fnancial integrity being compromised. Financial integrity is central to the determination of the reputation of an organisation and to public confdence in the organisation.

A further important role of the head of fnance with PFM/IC, which has been referred to above, should be to have regard, *inter alia*, to the stock (value!) of the assets that an organisation owns and the utilisation of those assets. Te head of fnance therefore ought to be engaged in balance sheet management. Tis requires much more than the recording of the assets. Balance sheet management would be an entirely new concept which should be a critical part of any change to accrual accounting but even without that the head of fnance should ensure that asset records are not only maintained for control purposes (in one respect this is a minor element) but more importantly to ensure that those assets are fully and efectively used. Tis is an essential element of PFM/ IC. Tis is not about the delivery of public services but the efcient and efective use of resources.

Consequently, each head of fnance of a public organisation should ensure that the managers of that organisation have due regard to the stock of assets and the extent of their utilisation and if not fully used what are the possible alternatives, which may include an alternative use by either the present owner or by transfer to another public sector body or ultimately sale. A further feature of the need for efective asset management has been demonstrated in an IMF Country Report on Ireland:

Te lack of asset surveys, together with issues concerning valuation and ownership, present a challenge for the management and maintenance of public assets. With no solid estimate of the capital stock, the amount that should be provided for maintenance and rehabilitation of the assets is unclear. Currently, funding of maintenance is provided on a relatively *ad hoc* basis, and anecdotal evidence gives a clear sense of premature deterioration in assets. Te absence of systematic data on the stock of assets is also likely to present a challenge when asset sales take place. A current example is the planned combination of three hospitals into a single national paediatric hospital in Dublin. Two of the hospitals to be replaced are owned by private orders, though these have been state funded for decades, while the third is a state hospital.7

Tis is a clear example of the importance of asset management and of the implications for future liabilities. None of this though means that efective

<sup>7</sup>Technical assistance report—public investment management assessment IMF country report no 17/333 Ireland.

asset management depends upon the development of accrual accounting. It does not and what is more important is the maintenance of accurate asset records coupled with a managerial determination to ensure that assets are used in the most efcient and efective manner or are disposed of. (Te experience of this author is that a weakness in many countries of the approach to accrual accounting is that the arrangements for the identifcation of the current values of assets are inadequate and a need for a current valuation is regarded as unnecessary because the written down original cost is regarded as appropriate. Tis ignores how changes in the distribution of asset values occur with changes in circumstances and not least changes in demand for certain types of assets in particular locations over time. Accrual accounting can also require complex valuation arrangements to be adopted, for example, for infrastructure assets and spare parts when valuing plant and equipment, and a reality is that valuation expertise is not always available.)

#### **8.3.7 A Summary of the Role of the Head of Finance with the Introduction of PFM/IC**

In summary, the head of fnance with PFM/IC will still have the responsibilities of bookkeeper and fnancial controller and those other responsibilities which may exist under the pre-PFM/IC arrangements. However, with PFM/ IC the head of fnance in addition must develop those additional fnancial services and provide the advice and information that will meet the needs of the policy maker and the operational managers at all levels in the organisation. Te state secretary (or equivalent in a local government) should ensure that all these elements of fnancial management exist. In addition, the head of fnance will have a key role in developing the information required for external reporting and the development of transparency. Te head of fnance will also be responsible for securing the fnancial integrity of the organisation, both in the short and long run.

Four consequences of this expansion in the role of the head of fnance and the development of PFM/IC are that he/she:


• Has the personality and knowledge to challenge managers and those in authority, to justify the decisions that they may be making. Close cooperation with the state secretary or equivalent is essential and very importantly, maintaining the confdence of the state secretary or equivalent is equally essential.

Appointments should be based upon competence, not political afliation, and the head of fnance should be able to provide impartial advice, not least to the political level of management (in other words there are no political constraints determining the nature of that advice).

# **8.4 The Head of Finance Role in Developing a Financially Aware Operational Management**

# **8.4.1 The Centrality of the Role of Head of Finance**

With PFM/IC fnance has a much more signifcant role than with the traditional arrangements for public fnancial administration. Te head of fnance responsibility is to support the head of operational management (e.g., a state secretary), develop a fnancially aware organisation and support the head of operational management in creating a managerially oriented organisation aiming to improve efciency and efectiveness in the delivery of public services and activities and in meeting the objectives of the organisation. Te head of fnance therefore will need to become a key adviser to management at all levels in the organisation on the fnancial implications of proposed policy and investment decisions, on the costs of current operational activities, on the efciency and efectiveness of those operations and similarly on income generating activities, as well as on the utilisation of the assets of the organisation.

Te responsibility of the head of fnance is to push out the boundaries of fnancial management knowledge. Te focus upon outputs with PFM/IC rather than simply upon control of inputs creates new areas of fnancial management development. As performance information is developed over time the opportunities for strengthening the relationships between inputs and outputs will grow and the head of fnance should be a key contributor to driving improvements in performance measurement.

Tese changes will afect the status and authority of the head of fnance. Te head of fnance responsibility changes from simply acting as a channel providing information to assessing information critically and at times to resist managerial proposals and/or to make clear why objections are being made. Tese are reasons why the head of fnance should be a member of the top management team of an organisation or, if such a team does not exist, should be a key adviser to the state secretary (or head of a local government service). An assumption is that the state secretary (or equivalent in local government) is, in turn, a key adviser to the politically appointed ofcials on the development and strategy for the application of policy and that advice will include fnancial advice.

In considering the role of the head of fnance a useful model is to compare it with that of the fnance director within a private company. Te fnance director would have a very senior role on the board of management and the same should be true in principle within public sector organisations, even though the organisational circumstances may be diferent. Without that status and authority, fnance is likely to be treated simply as a control function.

Te analysis in this chapter also serves to demonstrate that to improve efciency and efectiveness, the control of expenditure against the traditional budgetary analysis required for ministry of fnance purposes is not sufcient. It may achieve budgetary control but this form of control does not tell a manager anything about efciency and efectiveness or whether what has been spent has achieved was what was expected to be achieved when the budget was agreed. In other words, the traditional approach to budgetary control tells the manager (and the ministry of fnance) nothing about the outputs that are expected to be achieved for the inputs.

Overall, the head of fnance should provide fnancial leadership throughout the organisation including the promotion of fnancial literacy and awareness. With PFM/IC fnance assumes a much greater signifcance within an organisation and the head of fnance has a key role in making clear to managers at all levels the importance of fnance as a main driver in improving managerial discipline within the organisation, in the search for improvements in efciency and efectiveness and of the importance of fnance to the development of efective strategic and business planning. Te fnancial integrity of the organisation is central to its overall reputation and the maintenance of fnancial integrity depends very heavily upon the capability and authority of the head of fnance.

#### **8.5 The Training of Heads of Finance**

What is set out above represents a considerable list of additional responsibilities falling upon the head of fnance compared with those which exist with pre-PFM/IC arrangements. If these responsibilities are to be properly applied, they will require the development of a professional cadre of fnancially trained ofcials. If the organisation were operating in the private sector, this need would be taken for granted, but that usually does not occur in public sector organisations. Te message from this though is that the PFM/IC reform is unlikely to be successful unless a commitment exists to secure the training that many current heads of fnance are likely to require. (A need for specialist training for internal auditors is accepted in most countries, yet the same perception does not appear to exist for the technically much more specialist, more demanding and higher status role of a head of fnance.) Terefore, a consequential responsibility of a ministry of fnance should be to prepare a development plan for the strengthening of fnance departments so that they have the complementary skills to support the managers. Tis plan should include ensuring that heads of fnance and their senior staf members have knowledge of the legal framework and regulations afecting fnance, an understanding of the principles of PFM/IC (as, e.g., identifed in this guide), the theory and practice of accounting, fnancial planning and the development of fnancial strategies including long-term fnancial strategy (see section on business and strategic planning and strategic fnancial planning below), all aspects of costing and how and when it can be used (see section on cost accounting below), all aspects of budgeting, investment appraisal, the management of income (including taxation in those organisations which have their own taxation resources, such as local governments), fnancial reporting and audit, the identifcation and management of risk and especially fscal risk, the exercise of fnancial leadership and the provision of advice to managers and policy makers.

A discussion of these diferent areas of knowledge is included in a publication by the Chartered Institute of Public Finance and Accountancy (CIPFA).8 Exactly what technical skills will be required will depend upon the business of a particular organisation. However, an important operational risk for a head of fnance is that he/she becomes absorbed in the various techniques and loses sight of the main responsibility fowing from the development of PFM/IC which is the provision of fnancial advice and support to management at all levels in an organisation. Terefore, an important feature in the training of heads of fnance should be in management and in the 'softer management skills' such as communications, negotiation, presentation and networking.

<sup>8</sup> International Public Financial Management: Essentials of Public Sector Accounting CIPFA/ Routledge 2019.

## **8.6 Accrual Accounting and Its Impact upon Financial Management and Financial Reporting**

A factor which could afect the fnancial management and reporting arrangements is the introduction of accrual accounting. Considerable pressure exists on countries to harmonise fnancial reporting by adopting the international public sector accounting standards, IPSASs (although for European countries a set of European standards are being developed9 ). Tese standards are not designed for management accounting purposes. However, should countries decide to adopt these standards, heads of fnance would need to become familiar with them and decisions would have to be made about how they would impact upon the management accounting arrangements. Consequential decisions would also have to be made about whether the budgeting arrangements should be converted to an accruals basis or not, and if not, arrangements would have to be made to reconcile systematically the results of two diferent bases for the provision of fnancial information. Very few developed economy countries have adopted accrual budgeting.

Again, the head of fnance will need to recognise the impact that a change to accrual accounting will have upon the information available to managers particularly about the utilisation of assets and the management of debtors and creditors. Ideally accrual accounting reform should be accompanied by a managerial reform like that required for the PFM/IC reform in order to create the managerial environment which would require managers to utilise the accrual accounting information to improve the quality of public fnancial management.

What can be said though is that an unwise decision would be to adopt these accrual accounting standards at the same time as adopting PFM/IC because the impact upon management accounting arrangements and hence upon both managers and heads of fnance would be signifcant.

## **8.7 The Organisation of the Finance Function**

Given the additional responsibilities falling upon managers and the head of fnance with the introduction of PFM/IC, an important factor that should be considered is how the fnance function should be organised. Traditionally in most countries the fnance function has been centralised for each

<sup>9</sup>European public sector accounting standards, EPSASs, are based upon the international standards.

organisation. Tis may continue to be appropriate for small organisations but with larger public organisations such as ministries of defence, internal afairs, social services, health and education (as well as in large cities) there is the possibility of decentralising the fnance function. Individual top managers of large-scale services or activities may require the support of their own 'in-house' fnancial experts if they are to perform their responsibilities efectively. For example, the manager of a major police department will require a fnance ofce capable of working with him/her to identify cost centres and of analysing costs over those costs centres and their activities as well as comparing cost centre performance. Tis is even though there will be a fnance ofcer employed within a ministry of the interior. Or again, the manager of a hospital or a university will want to identify the costs of diferent departments of a hospital or university as well as the activities within those departments, such as the utilisation of operating theatres or the costs of particular types of educational courses or of treating certain types of patients. Tis is even though there will be a fnance ofcer in the senior management team of the health and education ministries. Each of these major organisations will require their own cost analyses and the management accounting information should be capable of providing such information.

Te question that fows from this is if fnance stafs are to be decentralised should they be members of the fnance department of the organisation as a whole or should they be members of the staf of the relevant manager? Te answer will depend upon local circumstances. Tere is no right or wrong answer but if the answer is that the decentralised fnance staf should be members of the staf of the relevant manager, they would be the principal point of liaison about fnancial matters between the central fnance organisation and the individual manager's area of responsibility. Consequently, they would need to retain the confdence of the head of fnance of the organisation as a whole and meet the same professional standards expected of the centralised fnance organisation.

Tis is a complex question to consider and it may be appropriate to seek external advice perhaps through an aid agency or a specialist organisation but that advisory organisation should have experience of public sector management and not merely bring forward proposals based upon how private organisations manage their business. Te political dimension applying in the public sector should not be overlooked.

One other factor that should also be considered is the extent to which the ministry of fnance should be involved with the appointment (and dismissal) of the head of fnance. Tis chapter illustrates the signifcance of this role and the extent of responsibility for supporting all levels of management. Tese responsibilities may occasionally lead to confict between the management, both political and operational, and the head of fnance where a manager wishes to undertake an activity or incur expenditures which the head of fnance may regard as inappropriate. In such circumstances the ministry of fnance may feel that should such a confict occur, it should be consulted and therefore the ministry of fnance may wish to issue a decree or some other form of regulation requiring this to happen. (Where the operational managers are politically appointed the head of fnance could become especially vulnerable.) Tis potential for confict, regrettable though it might be, could also cause the ministry of fnance to take the view that it should be consulted over the appointment or proposed dismissal of the head of fnance. (See also Chap. 5.)

Overall, though, there is the question as to whether, given the signifcance of the role of head of fnance, the ministry of fnance should prepare a 'scheme of service' for fnance ofcials. Also, as part of that, should it develop a forum where heads of fnance could meet together to discuss common problems as well as emerging policies that could have a particular impact upon the role of the head of fnance.

#### **8.8 Costing**

Costing is a development of management accounting. Its purpose is to identify the cost of providing a service, or activity, or individual product. Costing is an essential tool in the development of the budget as well as in the day-today fnancial management of an organisation. Costing is a subject that a head of fnance should be particularly familiar with although the evidence available to this author from at least European and European neighbourhood countries is that there is little or no familiarity with this subject.

Te objective of costing is to help managers decide on the most cost efcient method of delivering services or activities by identifying the determinants of cost and how costs vary in diferent circumstances. As part of this managers will also need to know the comparative costs and performance of diferent units of activity providing the same type of service or activity such as regional ofces or schools or diferent regional or district police centres so that they are able to question why performance and costs difer where essentially the same service is provided by diferent cost centres. Cost accounting can provide the manager with the information to determine which are the efcient parts of a business and which are not. It can be used by managers to establish how to deliver services at lower costs and at the same time maintain volumes and quality; it allows a manager to assess the value of a proposed investment (and disinvestment). Using costing, the manager also can be provided with the type of analysis which would enable the manager to decide upon what would be an appropriate charge for a service (where such charges are levied). Tis would then enable policy makers and managers to determine who would be the benefciaries of any consequential subsidies and therefore whether they regarded this as appropriate or not.

Cost accounting therefore provides the information a manager requires to:


All of this will also help to improve the quality of budgets as well as how well resources are being used.

One of the most important questions to ask is what is meant by cost? 'Cost' is much more than the fnancial allocation for budgetary purposes. Te defnition of cost depends upon the decision the manager is trying to make. Te manager should be clear about the cost object and this can be a unit of service or activity, a process, a service itself, an organisational unit or a user of a service or activity. Te manager manages the inputs that drive the costs but the actual cost driver is the policy which generates the costs in the frst place. Examples have been given in previous chapters such as the cost of educating a pupil (which in turn depends upon the pupil/teacher ratio), but could be extended to cover the cost of a school (which depends upon the school building and maintenance policy as well as decisions about class sizes), the cost of a particular teaching activity, such as language teaching (which depends upon the educational policy), the cost of educating diferent age groups of children (which also depends upon educational policy), the cost of educating children from diferent social backgrounds, children with disabilities and so on (which all depend upon educational policy). Or to take another service, the costs of holding prisoners, the costs analysed over diferent types of prisoners, such as male, female, child, mentally disturbed, high risk, low risk and any other categories the prison managers require (all of which depend upon penal and judicial policy).

Costs can include 'direct costs' and 'indirect costs'. Direct costs are those costs that can be attributed to a single cost object (e.g., a child or a school or a prison). Indirect costs cannot be traced in full to one cost object and therefore must be shared between two or more cost objectives (as would, e.g., the costs of a specialist classroom teacher if the cost object was a pupil). Indirect costs also can be called overheads and the defnition of an overhead can change depending upon the 'cost object' the manager is concerned about.

Costs can also have diferent characteristics. Tey can be classifed as:


Costs can also be avoidable by providing a service or activity in a diferent manner from that adopted in the past.

Tere are a range of costing techniques or systems that can be employed and which is the most appropriate depends upon the circumstances. Te main costing techniques include:


Where costing techniques are to be used, the head of fnance should be required to prepare an analysis of the results and provide advice in the form of a commentary to the manager rather than just present the manager with a set of information. A working partnership between the manager and the head of fnance is essential. What is also required is a management accounting information system which enables cost and relevant performance information to be collected which, as has been pointed out above, will require not only a much more elaborate analysis of expenditure and income but also other analyses, including the preparation of timesheets to show how individual members of staf have allocated their time.

However, developing management accounting including costing is only worth investing in if there is a genuine desire and willingness for managers to focus on improving efciency and efectiveness. Te main point of the information that is produced is to enable the manager to more efectively control the service or activity for which the manager is responsible (i.e., exercise managerial discipline), to challenge present practice and to make reforms which will improve efciency and efectiveness and to make service delivery more responsive to changing circumstances.

Te exercise of operational managerial discipline and challenging present practice can be a cause of friction and dispute (including political opposition). For the operational manager to do this efectively will require considerable managerial skill and as has been pointed out previously, the independence of operational management from political interference. Tis manager should also be supported by the head of fnance and the provision of such support to management, assuming that the head of fnance agrees with what the manager wishes to do, should be an essential feature of the head of fnance/manager relationship.

Heads of fnance should be familiar with these diferent types of costing with the extent of familiarity required depending upon the business of the organisation. Which costing techniques should be applied will depend upon the circumstances.

# **8.9 The Head of Finance and Strategic and Business Planning and Strategic Financial Planning**

A distinction should be made (which has been pointed to previously) between longer term fnancial planning and medium-term budgeting. Te introduction of PFM/IC with its emphasis upon strategic planning, strategic fnancial planning and business planning will require the head of fnance to become much more involved in these activities and the fnancial analysis of policy developments and new investment proposals. As part of strategic planning, very importantly, the head of fnance will need to identify and assess the future costs of demographic, legal, technical, economic and environmental changes. An assessment should also be made of the impact of existing policies, recent investment decisions which may not yet have come on stream, proposed policies and investments, the costs of renewing existing investments, such as buildings and equipment or other infrastructure investments, and the maintenance of existing investments and any other factors which are likely to afect the long-run future fnancing of the organisation. Te head of fnance should also be aware of the policies of other public organisations that could have fnancial implications for his/her own organisation. Against this forecast of costs would be set the likely income that will be available from budgetary and other sources, including foreign aid (considering the risks that have been referred to previously, see Chap. 6, about the continued availability of foreign aid). Tis may afect medium-term budgets but the objective of longer term fnancial planning is to prepare an assessment of the future fnancial health of the organisation taking into account all its known or likely commitments. Such an assessment will, at a minimum, provide key evidence during budget negotiations with the ministry of fnance and will also inform the political head of the organisation about the feasibility of the policies that are being proposed, especially given the likelihood of the availability of budgetary resources.

Tis type of analysis provides to the political head of the organisation (the minister or mayor) a fnancial perspective that would not otherwise be available and therefore allows them to make judgements about what may or may not be afordable, no matter how politically desirable a particular policy may be. It also demonstrates that economies may well be needed to be made in the relatively near future and therefore a requirement from a ministry of fnance to cut costs does not come as a surprise resulting in hasty and inefcient decisions. Of course, such long-run forecasts will be tentative but if properly prepared such forecasts provide a broad perspective that is very important for the efective management of public organisations. Tis will be particularly true for social and environmental programmes, such as social services or in deciding how to respond to the impact of climate change. Demographic analysis will also help determine the future cost of pensions policies.

As part of the long-run fnancial planning the head of fnance should aim to identify any factor, such as the state of the economy or levels of unemployment, afecting the fnances of the organisation over the current, medium and longer term. An organisation that does not plan to match expenditure and revenues over these periods will very quickly get into fnancial difculty making it necessary to undertake those short-term and undesirable and inefcient decisions.

A state secretary should therefore be concerned to ensure that the head of fnance identifes any factors, commitments and policies which could cause signifcant variations to occur or might damage income earning activities, not just in the current year but also in the future and whether those commitments and policies are unlikely to be fnanceable from future budgetary resources.

With PFM/IC service managers should be expected to prepare strategic plans for the services for which they are responsible. Tese should always be accompanied by a fnancial assessment with the head of fnance being a key contributor advising on the long-run fnancial implications of such plans.

Strategic fnancial planning would also enable managers to take longer term decisions about how to develop strategies to deal with the possibility of future budgetary restrictions. Related to this is an increasing requirement that for proposed new laws and regulations a fscal impact assessment should be undertaken showing the fnancial consequences they will have on public and private expenditures and revenues. Such an impact assessment, if it is to be efective, will require close cooperation between a head of fnance and the service managers responsible for the drafting of such laws and regulations.

Quite separately, the head of fnance should ensure that managers within the organisation prepare a business plan when proposing new activities (and indeed also update regularly existing business plans). A business plan is in efect a mission statement that sets out the vision, structure and methods that are to be employed to achieve a particular business objective. Business plans have the following benefts:


Tis analysis of the role of the head of fnance with the introduction of PFM/IC emphasises that the head of fnance should be a signifcant contributor to the development of the business of the organisation and all aspects of its fnancial management. To regard the role as one limited to bookkeeping and fnancial control, as occurs with traditional systems of public administration, is a serious mistake.

# **8.10 Summary**

Introducing PFM/IC signifcantly changes the role of fnance within an organisation. Finance becomes central to decision making, whether of policy and strategy or of operational activity. Te head of fnance should be a leader ensuring that all operational managers within the organisation become fnancially aware. Traditional fnancial control remains important, although the form of it may change. Tere is much more to fnancial management than simply maintaining fnancial and budgetary control. PFM/IC impacts upon the type of fnancial information that an operational manager requires. Traditional fnancial accounting designed to meet the fnancial reporting and international statistical reporting responsibilities of the ministry of fnance does not provide the information that a manager requires. Te head of fnance should develop management accounting systems, including costing. Costing is valuable not only for managers to assess value for money but also in the development of the budget by identifying and assessing the fnancial implications of cost drivers. Te development of operational management will also impact upon how the budget is analysed because if each manager is to be responsible for ensuring that control over their budget is maintained, as they should be, they must know what the available budget is. Te budgetary analysis that meets the needs of the ministry of fnance is unlikely to meet the needs of the manager.

Te additional fnancial information that is required for efective management is also the type of information that will be required for policy making. Terefore, the head of fnance can have an important role in supporting the state secretary (or equivalent) in advising the political level of management in the development of policy and the strategy for the implementation of that policy.

PFM/IC also afects the 'discipline' applying within an organisation. It afects not only how operational managers behave because it introduces much tighter constraints, but as fnance becomes central to policy making and to business and strategic planning it afects the political level of management. Efective fnancial management also requires that regard is had to the longrun fnancial resilience of the organisation. An important responsibility of the head of fnance is to identify and analyse how diferent factors, both internal and external, are likely to afect the fnances of the organisation over the longer term. Tis may result in the head of fnance objecting to proposals even though there may be a managerial desire to implement them.

Another factor is that where a public organisation is responsible for secondlevel organisations, the operational management of the frst-level organisation, including the head of fnance, should ensure that the objectives of such second-level organisations are consistent with those of the frst-level organisation, that the fnances of those second-level organisation are well managed (no matter how they are fnanced) and that the objectives of these organisations are delivered efciently and efectively.

Te head of fnance should also ensure that neither the frst- nor secondlevel organisations should enter arrangements which would expose them to fscal risks without a full consideration of those risks including the impact they would have if they matured.

PFM/IC has an emphasis upon accountability and transparency. Traditional methods of fnancial reporting are unlikely to be adequate to meet the requirements of the international standards (i.e., those specifed by COSO). Each public organisation ought to publish an annual report showing how it has used its fnancial resources, its performance against its objectives and how efective its internal control arrangements have been (see also Chap. 13).

Te head of fnance has a key role in the development of strategic fnancial planning and in other planning exercises such as strategic planning and business planning.

Introducing PFM/IC consequently means that the role and responsibilities of the head of fnance will be signifcantly enhanced. Te role becomes a professional fnancial management role and, in most countries, this will require the development of specifc training arrangements. Tese enhanced responsibilities of the head of fnance can only be efectively undertaken if the head is able to withstand political pressure so that he/she can ofer independent impartial advice. Te head of fnance should work closely with the most senior ofcial (e.g., the state secretary or equivalent) and this is especially important where the advice of the head of fnance is contentious. Te head of fnance should operate within the context of a civil or local government service which is not politicised.

Because of the signifcance of fnance in management an issue that will need to be addressed is how should the fnance function be organised? Should it be centralised or decentralised because certainly in larger organisations managers will require specialist technical support and advice. Tis should be matter for local decision.

Another factor that should be considered is whether the appointment and dismissal of the head of fnance should be solely a responsibility of a particular organisation or whether the ministry of fnance should be consulted.

# **Annex 1: The Responsibilities of a Head of Finance in Supporting the Development of a Financially Aware Management**

With PFM/IC a main responsibility of a head of fnance is to support the head of operational management (a state secretary or equivalent) in developing and establishing a fnancially aware management. Set out below are the key activities the head of fnance should be engaged in.


diferent cost centres10 and provide a commentary to assist managers make decisions about the efciency and efectiveness of those diferent cost centres.


<sup>10</sup>Examples have been given earlier in this guide but to summarise could include regional ofces, police units, types of crime, individual departments of universities and schools, academic courses, military units, military training, individual sports facilities, types of sport, types of disease or medical care required, types of medical facility and units such as operating theatres and so on.

income is promptly collected: the costs and losses arising from the income collection arrangements should be kept to a minimum; this responsibility would include assisting managers make decisions about the level of charges for services and whether the proposed charges refect the full or marginal costs of providing such services or activities, depending upon the approved policy, or if charges are intended to recover only a proportion of the cost that clarity exists over the level of subsidies that are being provided and to whom.


• Ensuring that the organisation's conduct demonstrates probity and a sound fnancial administration, including compliance with regulatory standards as well as the actual control activities.

Te head of fnance whilst having a responsibility to interpret and secure the application of the fnancial regulations and other approved controls and procedures including those relating to procurement issued by the ministry of fnance should ensure that they are compatible with the management arrangements that exist within the organisation.

# **Annex 2: Financial Resilience**

Te following is based upon a fnancial resilience tool developed by the Chartered Institute of Public Finance and Accountancy for use by local governments in the United Kingdom. It facilitates comparisons between diferent local governments. However, the principles underpinning this tool are equally applicable to all public sector organisations including government ministries. Details of the fnancial resilience tool are set out at https://www.bing.com/sea rch?q=cipfa+fnancial+resilience+model&form. 11

Developing fnancial resilience is neither easy nor quick. It requires organisations to ask themselves difcult questions, challenge pre-existing decisions and consider new solutions. Tis means developing an approach to fnancial management that helps with scenario planning and decision making. Tis can lead to questions about the:


When assessing an organisation's fnancial resilience, the key factors that should be considered are:

<sup>11</sup>CIPFA ofers an advisory service to public organisations wishing to assess fnancial resilience.


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# **9**

# **The Role of the Department Responsible for Advising on and Securing the Application of PFM/IC**

Tis chapter describes the role of the ministry of fnance department responsible for supporting the state secretary in driving forward the application of PFM/IC,1 the driver department. Overall responsibility and hence accountability for the operational application of the reform, within the context of policies specifed by the minister of fnance and by the government, should lie with the state secretary in the ministry of fnance (see Chap. 5). Given the volume and often detailed nature of the work involved in the day-to-day application of the reform, the state secretary ought to be supported by a specialist department with the necessary expertise and resources. One of the main responsibilities of this department is an educational responsibility to secure a real appreciation of what the reform means and what it involves for those most directly afected by the reform. As has been explained in previous chapters, this is that the reform is not simply a fnancial control reform, of only interest to fnance stafs, but has a signifcant impact upon how organisations are managed which in turn afects the budgetary and accounting arrangements. It impacts too upon the arrangements for transparency and accountability and requires that attention is paid to the quality of governance. Te head of this department should recognise that the reform afects both politicians and ofcials and therefore that both groups need to be informed and their concerns addressed. Also, the reform should ultimately impact upon all public organisations, whether

<sup>1</sup> In European infuenced countries this department is often called a central harmonisation unit or department—a CHU. Te European Commission policy on fnancial management and internal control envisages that the most appropriate method of actually securing the application of that policy (as well as internal audit) is through the appointment of a specialist department or unit within the ministry of fnance. Countries not subject to European Union infuence may wish to make other arrangements.

frst- or second-level bodies, and therefore the application plan should take this into account. Te head should use the information and arguments contained throughout this guide as a help in that educational process.

An important preliminary step prior to the formal decision to adopt PFM/ IC should be a strategic analysis of the impact of the reform considering current cultural and managerial arrangements including how the reform would impact upon those arrangements. Te risks with implementing the reform can be considerable and these should be explored. Merely deciding to adopt the reform without this type of strategic analysis exposes the minister of fnance and the ministry state secretary to added risk in the efective implementation of the reform.

# **9.1 Introduction**

As the PFM/IC reform is about management and the quality of fnancial management, this should be the central issue for the department of the ministry of fnance responsible for its detailed implementation if PFM/IC is to be efectively introduced. Tis appreciation of the reform should be acknowledged from the outset. It is not simply a fnancial control reform. Te quality of management determines how successful a public organisation will be in delivering its objectives and doing so efciently and efectively.

Te head of the department responsible for advising on and securing the application of PFM/IC must work closely with the state secretary (or equivalent) in the ministry of fnance who has overall responsibility for the introduction of the reform on behalf of the minister of fnance. Te head would have the implementation responsibility to demonstrate to public organisations the benefts of introducing PFM/IC and how they can be achieved. Because the reform is likely to require quite radical changes to the management arrangements for the delivery of public services, some public ofcials (political and appointed) may fnd these changes difcult to accept and consequently the support of the state secretary will be essential to achieve the necessary changes.

Tis specialist department of the ministry of fnance is in efect the PFM/ IC 'driver' department supporting the state secretary. Establishing such a department would be an important statement of a substantive policy intention to introduce this reform. Tis department would be responsible for advising on the development of PFM/IC by individual ministries and other public organisations; on training and for systematically reviewing (annually, at least) the operational quality of public fnancial management and internal control throughout the public sector.

Tis chapter explains the main issues with which this specialist department should be involved with the introduction of PFM/IC. Because of the extensiveness of the reform PFM/IC can only be introduced efectively over time. Tere is no 'quick fx' solution but the basic managerial element of the reform should be established from the outset. Not only would this department, acting on behalf of the state secretary, be responsible for driving the reform, but to secure the quality of the reform and the maintenance of that quality over time, the department would in efect also become an oversight body.

# **9.2 Before a Decision Is Made to Introduce the Reform!**

What is essential before the 'driver department' is established is that key preparatory work is undertaken. Te critical feature of this reform, as has been explained earlier in this guide, is to deliver the policy objectives of the government along with the aimed for performance standards and objectives and to do so to time, within budget and efciently and efectively having regard to the quality of corporate governance, accountability and the arrangements for transparency. Tis also means establishing an appreciation that the reform is not simply a fnancial control reform (which in this author's experience is how it is often perceived). If simply strengthening control is what is required this can be achieved without the need for the extensive managerial reforms that PFM/IC requires. In previous chapters the point has also been made that the achievement of objectives and performance standards to time, within budget, efciently and efectively requires positive managerial actions, and it is to these 'positive managerial actions' that the PFM/IC reform should be directed. With the PFM/IC reform 'positive managerial action' must come from within the civil service, and in some countries, this will require civil service reform before the PFM/IC reform can be efectively introduced. But this can only come from within the civil service if there exists a government willingness to see this happen.

Terefore the policy initiative to introduce this reform should ideally come from government itself. However, as has been pointed out previously, it frequently comes from outside, from third parties such as aid agencies or other international organisations and sometimes from commercial consultancies seeing it as a potential source of work. Tis immediately raises four questions which need to be addressed before those responsible for driving the reform forward can efectively operate. One question is that of 'ownership'. For the reform to be successful, as has been pointed out, local ownership and local leadership are extremely important and are made more important because of the radical nature of this reform. Te second question concerns the recognition by those advocating the reform that PFM/IC is as much a managerial reform as a technical reform. Te third question to be addressed is about timing: is this an appropriate reform for the country at this time? Tere are many reasons why it may not be. Te fourth question particularly arises where an aid agency is promoting the reform because implementing PFM/IC is a longterm reform and the question is, would long-term fnancial support be available? As this would be unlikely to be forthcoming this adds to the risk that the reform will not be successful unless the government itself recognises that it will be required to provide the funding at some future point.

Tese are questions that should be addressed by the minister of fnance, supported by the ministry state secretary. And the answer may be that this is an inappropriate reform at the present time. In Chap. 4, nine tests were described which ought to be considered by the minister of fnance and the state secretary before a decision is made to implement the reform. To do otherwise, as has been explained earlier in this guide, would be likely to increase costs without any corresponding benefts and could only make a weak fnancial and budgetary control system worse. Where there is external pressure to introduce this reform, this would require resistance to that pressure on the grounds that the reform is premature. (Section 9.2.1 below suggests how an initial report should be framed before a decision to proceed is made.)

What is also necessary is that a recognition should exist amongst senior ofcials (political and civil service) that reform is necessary and that the adoption of PFM/IC will make possible improvements to the utilisation of public resources, will lead to a better quality of governance and enhance democracy through greater transparency and accountability. A question then is, how is the nature of this reform to be communicated to parliament and to senior political ofcials beyond the minister of fnance (and indeed also senior civil service ofcials) recognising that some at least will regard it as essentially simply a technical fnancial reform of beneft largely to the ministry of fnance? Te problem is made more complex if there is a high turnover of these ofcials. Te introduction of PFM/IC, as has been explained in earlier chapters, has signifcant implications for:


Tese implications need to be explained and if they are not acceptable, the reform should not proceed. An important initial step therefore should be to achieve widespread key ofcial, including parliamentary, appreciation of and support for the reform in principle at the highest political and ofcial levels. Tis means that the decision to introduce PFM/IC should not be made before the main features which would afect the implementation of the reform have been considered. All this should occur prior to the establishment of the specialist 'driver' department in the ministry of fnance. However, this preliminary exercise would provide essential training for those who would provide the nucleus of that department should a decision be made to proceed.

#### **9.2.1 The Strategic Analytical and Planning Report**

To prepare for the policy decision to introduce PFM/IC an initial step should be the development of a strategic analytical and planning report. Tis would consist of a preliminary analysis of the current public administration arrangements based upon those nine tests referred to in Chap. 4. Tis report should be prepared by or on behalf of the chief ofcial within the ministry of fnance and would be designed to ensure that before any decision is made to implement the reform, that PFM/IC is an appropriate reform for the country at the time and that it can be properly implemented or implemented in such a manner that the objectives can be achieved considering the cultural and political environment. Tis may afect how the objectives of the reform can be achieved and the timescale for achievement. Te starting point in the preparation of the strategic analytical and planning report would be the undertaking or commissioning by, ideally, a person familiar with the operational environment within government and the public sector as a whole. Tis report should not simply be concerned with the present administrative arrangements but also with the power distribution between diferent groups and individuals and the processes that create and sustain those relationships over time. Tis is what the PFM/IC reform should address because it is likely to challenge existing traditions and the current decision making processes. Te issues that such an analysis might consider and how they would change include:


#### **9 The Role of the Department Responsible for Advising…**


Te author of this report should recognise that decision making around any politically driven process takes place in both formal and informal spaces and that an appreciation of both is necessary. Without that the recipient of the report will not have the right information to be able to create the reform pathway.

<sup>2</sup> Ibid.: Tese questions are based upon questions incorporated into the UK Department for International Development 'How to' note, Box 3: Sample Questions for Conducting Sector Level Political Economy Analysis, page 12 and adapted by the author to refect the requirements of the PFM/IC reform.

Te strategic analytical and planning report should include an assessment of the quality of the civil and local government service and the entry qualifcation arrangements and therefore specifc questions should be asked about the civil service arrangements. Are those entrance qualifcations appropriate and the university educational arrangements appropriate? On entry are the training arrangements appropriate given the managerial responsibilities that will fall upon civil servants with the implementation of PFM/IC? What will be the extent of higher level management training that will be required? Another issue that should be addressed is an assessment of the quality of the public fnancial administration arrangements. Are they robust and can that robustness be maintained when authority for decision making is transferred from central ministry controls to local controls exercised by individual public organisations? A further factor that should be covered should be to ensure that the ministry of fnance itself is comfortable with how the reform will impact upon its role.

Tose responsible for the implementation of the reform should also ensure that there is an appreciation of the implications of the reform for the relationships between politicians and civil servants (and equivalent in local government). Tis will also raise the practical question about the changes to the responsibilities of the elected and the appointed ofcial within individual organisations. If these power changes cannot be resolved, then it is more than likely that the reform will fail. Again, are the managerial structures suitable for the application of the processes that will facilitate the achievement of the reform objectives efciently and efectively? Do organisational structures require reform? Tese elements of the reform afecting the managerial arrangements need to be fully coordinated with other civil service/public administration reforms. Is this feasible or are such reforms taking diferent reform paths? Will the personnel management arrangements require reform, especially given that with PFM/IC civil servants will be responsible for making operational management decisions? And very importantly, will the reform in reality have top level (political and appointed ofcial) support?

Te person responsible for the preparation of the strategic analytical and planning report, if a civil servant, would be ideally placed to become the state secretary's chief adviser on PFM/IC and the head of the department responsible for advising on and securing the application of PFM/IC (i.e., driving forward the reform). Tat civil servant should be well informed about PFM/ IC and ideally be an experienced manager.

A problem that this author has encountered is that many advisers and aid organisations responsible for supporting the application of this reform do not appreciate the political, managerial and cultural impact signifcance. Tey tend to have a 'standard template' approach and focus simply on the technicalities of the reform. Tey have not appreciated the impact upon the relations between elected and appointed ofcials, often on the grounds that this is either too diffcult or premature or not relevant to the culture of the country. Tey have also not appreciated that success with improving the quality of public services, both policy and delivery, is not about techniques but about people and the skills they bring to the formulation of policy and the implementation of that policy. Neither have they appreciated the wider implications of the reform such as the efect that this reform will have upon budgeting and accounting arrangements both for the ministry of fnance and within public organisations. Tey have also not considered whether this is an appropriate reform at this time given the current political, organisational and cultural background. Te reform can be seen as 'best international practice' and therefore, by defnition, a 'good thing' to adopt. Te idea of initially developing a policy design approach, given the managerial implications of the reform, is not recognised and therefore a strategic analysis and planning approach (as with many other technical reforms) is not perceived as a necessary step in the reform process.

## **9.2.2 The Risks with Implementing This Reform**

Implementing this reform is far from being risk free. Te possibilities that risks may arise should be considered in the planning and implementation process. Te potential risks fall into several categories and these are set out in the table below.


Possible areas of risk

<sup>(</sup>i). Opposition to the reform from political offcials and senior civil servants.

<sup>(</sup>ii). Those arising from the likely length of time the reform is likely to take.

As the reform will be a long-term reform, clear milestones should be identifed and a risk that should be recognised is that of 'reform fatigue'. Tose milestones should be identifed as achievements with which politicians and the civil service can identify.

Te main risks will be to those elements of the reform that result in changes to the distribution of power between political and appointed ofcials and between central and line ministries. Te underlying pressure will be to return to the *status quo ante* at least over time. Tis emphasises why it will be important to have wide support for the reform from parliament, the prime minister or president, the cabinet of ministers and very importantly from the most senior civil servants. Tat means that their concerns should be explored from the outset. Other risks are mainly of a technical nature and over time should be capable of solution.

# **9.3 Implementing the Reform**

## **9.3.1 Learning from Others**

Tis guide demonstrates what a considerable change will be required. What matters most is the people not the procedures, although this author's experience is that with PFM/IC reform the focus is always upon the procedures. And the reform must start at the very top of the organisation, considering both the political and civil service roles. At the civil service level, a mistake (which again in this author's experience occurs too frequently) is to start lower down the organisation with the head of fnance.

A practical problem with implementing the reform is that of fnding a role model to learn from. Tis is very difcult. Tere are many models existing of developing and transition economy countries that have regarded the reform as just a fnancial and budgetary control reform treating the COSO standards as simply procedural technical standards. Te result has added to bureaucracy, and cost, but with no beneft gain. Countries rarely discuss failures although it is from failures that the most important experiences can be gained. "Tere is not enough attention in the PFM community to failure. Failure is a better teacher than success! If I could see one change in the PFM community, I'd like to see a more open and forthright conversation regarding success and failure in PFM innovation."3

<sup>3</sup> IMF Public Financial Management Blog: Interview with Allen Schick Sept. 2011.

Te best models come from developed economy countries but this illustrates a major difculty with implementing PFM/IC reform. Tat problem is building a modern sophisticated reform onto a traditional system of public administration without also recognising that that system too also requires reform if the PFM/IC reform to be successfully implemented. To move from an administrative culture to a managerial culture is not at all easy. Apart from the reform requiring changes in the distribution of power between different groups, the willingness of civil service (and local government) managers to take risks and to develop new analytical skills can be problematic. Te reform is likely to generate resistance, sometimes overt and sometimes covert especially as it may mean making personnel changes and that may require redundancies, promotion of some staf and the transfer of some existing staf to alternative employments.

Success depends on persuading individuals to change the way they work and that requires altering the mind-sets of civil servants and politicians. Tis is no easy task and the requirements generated by PFM/IC cannot be separated from a more general reform to civil service culture. A publication by the consultants McKinsey on the psychology of change management included these remarks which although directed at private sector organisations are relevant to the civil service: "But what if the only way a business can reach its higher performance goals is to change the way its people behave across the board? Suppose that it can become more competitive only by changing its culture fundamentally—from being reactive to proactive, hierarchical to collegial, or introspective to externally focused, for instance. Since the collective culture of an organization, strictly speaking, is an aggregate of what is common to all its group and individual mind-sets, such a transformation entails changing the minds of hundreds or thousands of people."4

McKinsey went on to identify four conditions that were regarded as important:


<sup>4</sup>https://www.mckinsey.com/business-functions/organization/our-insights/

What this emphasises is that the strategic analytical and planning report ought to make clear that the PFM/IC reform must be integrated with civil service reform more generally. To treat it as simply a reform of limited interest to the ministry of fnance, albeit with a managerial context is not sufcient. An important component of the reform therefore, is how it fts with civil service reform more widely. It also means that those responsible for the development and application of the reform should have regard to the psychology of reform. To do that should mean consultation with experts in organisational change and in particular the psychology of organisational change. Once the strategic analytical and planning report is agreed, then this creates the policy framework to move to the next stage. Te head of the specialist 'driver' department should recognise the importance of this point about the psychology of reform.

## **9.3.2 The Preparation of an Operational Implementation Policy Paper**

Once the policy decision has been made to proceed with the reform, a detailed operational implementation policy paper should be prepared. Tis would be prepared in the name of the ministry of fnance state secretary but the head of the specialist PFM/IC 'driver' department normally should prepare this policy paper on behalf of the state secretary. Tis paper should form the basis for the operational implementation of the reform and it would be based upon the strategic planning and analytical report. It should address the practicalities of the reform, that is:


cannot drive the civil service/public administration reform but a failure of the civil service/PFM reform to match the requirements of the PFM/IC reform can prevent that reform being efective.)


<sup>5</sup>Very often fnancial information systems will have been installed by external consultants and will be 'standard' packages. Tis may make changes to those systems more difcult to achieve. Alternatively, where a country has developed its own fnancial information systems, it will need the technical capacity to make the changes that will be required.


*(continued)*

#### (continued)


• Clarify the timescales for the reform implementation and given the length of time that will be needed when the key assessment stages (milestones) are expected to occur where progress can be judged.


In preparing this policy paper the head of the 'driver' department should:


rent extent of delegation of operational management to the civil service (if any) and the arrangements where delegation exists for accountability to the political level of management.


Tis operational implementation policy paper should be agreed ideally by the state secretary in the ministry of fnance with the most senior civil servant in each ministry before submission to the minister of fnance and the government. Tis is because of the impact that the policy will have upon the organisation and operational management of each ministry. As with the strategic planning and analytical report an aim with the operational implementation policy paper should be to obtain the widest political support (as well as wide civil service support), including the support of politicians who are not presently part of the government. Te operational implementation policy paper, or a version of it, should be submitted to parliament. As has been explained above, wide political support is highly desirable because application of the reform is likely to take much longer than the period of ofce of any one government, and consistency in the policy of application is essential.

Because management and fnancial training will be a key component of the reform, the policy paper could also explore with academic institutions how this might be developed, and if there is to be an in-service training institution (or one may already exist) how this could contribute to the training needed.

An important feature of the policy paper should be an explanation of how transparency and external accountability will be afected and not least how parliament should be informed about the details of the reform and be able to make comments.

As a result of the discussions that should occur during the preparation of this policy paper, variations from the proposals and information contained in the strategic planning and analytical report may occur. Such variations should be discussed with the key political and senior civil servants before publication.

## **9.3.3 Actions of the Head of the PFM/IC Department Following the Approval of the Operational Implementation Policy Paper**

Once this policy paper has been approved practical implementation will commence. Te head of the PFM/IC department should focus initially on the managerial consequences of the reform. Whilst budgetary and fnancial control remains important, the key to success lies in strengthening or introducing those managerial arrangements, including managerial controls, that facilitate the delivery of the objectives of the government and the aimed for performance standards and objectives, to time, within budget and efciently and efectively.

Control will no longer simply be about 'inputs', important though that will remain but will also be about the delivery of 'outputs'. Failing to emphasise how important the managerial context along with the consequences for the political and top and senior civil service and local government ofcials and other levels of management of public organisations, would lessen he emphasis upon achieving objectives and performance standards and objectives efciently and efectively.

Te introduction of a managerially oriented approach to public service delivery with its focus upon outputs and the delivery of those outputs efciently and efectively will require that a set of managerial disciplines is employed to facilitate the development of a quality management approach. Tese managerial disciplines which are discussed in detail in Chap. 11 are usually described as international standards of internal control or the COSO standards.6 However, for the purposes of this reform those responsible for implementing the reform would be better to regard them as 'managerial disciplines' because they inform managers of the features that should exist if an organisation is to be well managed. Tese managerial disciplines cover fve

<sup>6</sup>https://www.coso.org

main areas, that is, the control environment, information and communications, control activities, risk management and monitoring. However, these managerial disciplines will be of little value if a number of preconditions applying to those fve areas do not exist. Tese are referred to in Chap. 11 but include clarity about objectives and performance standards, a managerial structure designed to deliver those objectives and performance standards, the consistency of budgetary allocations with the objectives and performance standards and the linkage of budgetary and accounting information with managerial needs as well as those of the ministry of fnance.

An important activity of the head of the department driving the PFM/IC reform, once the decision has been made to implement this reform is to ensure that these standards (managerial disciplines!) are applied. Tis is not a simple training exercise, not least because these standards impact upon each other and cannot be introduced completely in a single reform process. Te quality of application will evolve over time. Whether or not they have been properly applied can only largely be demonstrated by the quality of the outputs of the public organisation. Tat is, has the organisation achieved delivery of its objectives and performance standards and objectives efciently and efectively, to time and within budget. Success cannot be judged by whether the bureaucracy associated with those managerial disciplines exists although this is often how application is in practice judged. An important statement which should be required of management annually from which success can be judged is the statement of internal control (see Chap. 13).

# **9.4 The Ministry of Finance State Secretary Relations with Individual Ministries**

Whilst the state secretary of the ministry of fnance should have overall responsibility for the application of the reform, each ministry state secretary should also be intimately involved as the reform. Tis applies equally to spending ministries and income raising ministries such as those responsible for the diferent forms of taxation. Tere ought to be regular meetings of these ofcials chaired by the ministry of fnance state secretary. Tis process will require managing and this will usually occur through secretariat arrangements. Te head of the PFM/IC driver department should act as that secretary. Te agenda for such meetings should include:


As part of the practical application arrangements, it would be desirable for the head of the PFM/IC department to also establish two subordinate coordinating groups. One would be with those ofcials involved with public administration and/or civil service reform and a second with those involved with the practicalities of this PFM/IC reform within individual ministries, particularly those concerned directly with the fnancial management arrangements. Both groups should have a particular responsibility to identify problems and develop solutions. Tese groups should in turn 'feed into' the state secretary group chaired by the ministry of fnance state secretary.

A main source of information about emerging problems should be through the work of the 'driver' department supporting the state secretary because it should be in regular contact with each ministry implementing the reform. Potential emerging problems could include difculties in developing objectives and performance standards and in developing the necessary fnancial and performance information systems required by managers to enable them to be confdent about delivering objectives efciently and efectively. Another problem area could be in securing the appropriate training for managers. A further problem could arise over the development of personnel policies that are consistent with a managerial approach to public administration (see Chap. 14). One of the most sensitive changes that should result from the introduction of PFM/IC will be the delegation of operational management for the implementation of policy and strategy from the responsibility for the development of policy and strategy. In some countries this will have a major impact upon the role of political appointees, including ministers and mayors and on the role of top and senior civil servants. Tis separation is fundamental to the reform but is not intended to weaken political control but rather to strengthen it by causing control to be focussed on key issues with those key issues being defned by the political management. Tis is to change from a political management trying to make all decisions, no matter how trivial, on both policy and operational matters.

A further problem with implementing the reform is that the delegation element can be misunderstood leading to resistance and this may be an especial problem where the civil service is not well trained or is politicised (which anyway should raise questions about the appropriateness of this reform). Te result can be 'tokenism' in the development of delegation. Similarly, the requirement for each ministry (and other public organisations) to prepare annually a statement of internal control may be a cause of difculty because this statement involves disclosure of internal control problems that have emerged during the year and the actions taken to correct them.

An important function in the development of relations between the ministry of fnance state secretary and other state secretaries is to identify and address these areas of potential problem.

# **9.5 The Experience, Skills and Attributes Required to Build a Successful PFM/IC Application Team Supporting the State Secretary**

Te PFM/IC 'driver' department should be stafed with, or have available to it, the following range of skills:

(i). Staf experienced in organisational management, including the setting of objectives, performance standards and performance measures and indicators or that advice on these topics is available (which may include academic advice); and

(ii). Persons who are experienced in all aspects of fnancial management, including budgeting, that is, economists, fnancial accountants, experts in cost and management accounting and experts in interpreting the trends revealed by fnancial and performance information.

Such staf may be seconded from other ministry departments or from outside the civil service such as staf linked to university management schools and similar institutions which have an interest in promoting improvements in public sector management practices. (Some of these experts would not be fulltime appointments but should be available as required and could be experts specially hired for the purpose, such as experts in the management of taxation.)

Because support may be required in the development of budgeting, fnancial and cost and management accounting, and these are often in short supply in the public sector, this may involve recruiting or 'borrowing' staf from the private sector. Te support that should be looked for should have the capability to assist public organisations in the development of objectives, performance standards, performance measures and indicators, in developing strategic fnancial planning, in suggesting cost centre analysis and in routine performance analysis. Tey may also need to assist managers in ministries in developing business and strategic plans. In addition, such staf should be familiar with pricing where public organisations earn income from charges so that organisations can be helped to identify whether charges properly refect the costs of providing services and activities and where costs are not to be fully recovered, the extent of any subsidies and who benefts from those subsidies. Te budget available to the 'driver' department should refect the wide diversity of skills that are required to apply the reform.

In those countries where PFM/IC has been interpreted as primarily an enhanced form of fnancial control, the initial focus in the introduction of this reform has been upon the development of internal audit. Tis is very unfortunate and ignores the key managerial perspective of the reform. It is in efect 'putting the cart before the horse'. First, it confrms preconceptions that PFM/IC is simply a fnance orientated and basically fnancial control activity. Secondly, it tends to encourage politicians (who may be wholly unfamiliar with the requirements of management) that this is simply a fnancial reform and that it does not have the wider impacts upon managerial structures, budgetary and accounting and performance information arrangements, if the benefts are to be achieved. Tirdly, this in turn afects attitudes towards what is the necessary stafng structure and organisation of the department within a ministry of fnance responsible for supporting the state secretary. Of course, improvements to internal audit should always be looked for but they are not a precursor to the development of PFM/IC. Internal audit will be afected by the development of PFM/IC, but then so will many other aspects of public fnancial management, as this guide shows.

In summary, the successful application of PFM/IC requires a broad managerial approach to the reform; it requires reforms to budgeting and accounting arrangements and the availability of a wide range of skills within public organisations. Te 'driver' department will require a corresponding range of skills. Not all will be required immediately and not all will be a full-time requirement so the stafng arrangements for this department should be fexible. A responsibility of the head of the 'driver' department should be to ensure that the relevant skills are available when needed and of the right experience and calibre. Tat is likely to require a fexible approach to stafng and quite diferent from traditional arrangements. Te head basically requires the same fexibility in the delivery of the objectives of the department as the department will be trying to encourage to exist in other managements.

## **9.6 Achieving Local Ownership of the Reform**

Ensuring local 'ownership' at each ministry level is an important factor in the successful application of the reform. Although this reform will be promoted by the minister of fnance, the potential benefts to individual ministers in helping them to achieve their objectives are substantial. Te reform also provides opportunities for the civil service to develop its skills, responsibilities and initiative in achieving the relevant minister's objectives.

At the political level achieving local ownership will be primarily a responsibility of the minister of fnance. At the operational civil service level this will be a responsibility of the ministry of fnance state secretary working in partnership with other state secretaries (or their equivalents). Tese ofcials will generally provide the continuity of 'ownership' that political ofcials cannot provide. Te head of the 'driver' department has a duty to make clear, either directly or through the ministry of fnance state secretary, that responsibility for applying the reform within each public organisation and for ensuring that the quality is maintained should lie with the most senior appointed ofcial in the organisation, that is, the state secretary (or equivalent in local government). Terefore, a considerable efort will be required in presentations to and discussions with these ofcials. In this author's experience a frequent mistake is that too much focus is given to informing and training more junior ofcials such as heads of fnance in line ministries and then only in the bureaucracy of the reform processes rather than in informing and generating an understanding of the purpose of the reform at the highest levels of the administration. Tis does not achieve local ownership.

Te role of the minister of fnance is very important in the actual application of PFM/IC because that minister will need to act to ensure that political colleagues accept and in turn also fully appreciate what the reform means for them. Te ministry of fnance state secretary with the support of head of the 'driver' department consequently has an important role in providing a full brief to the minister of fnance on the implications of introducing this reform, for supporting the minister in the promotion of the reform, and for informing the minister on progress with implementation. Te head of the 'driver' department may do this directly or through the ministry of fnance state secretary.

# **9.7 The Practical Issues the Head of the PFM/IC 'Driver' Department Should Address**

Set out below are the practical issues the head of the PFM/IC 'driver' department should consider in supporting the ministry of fnance state secretary in the application of PFM/IC. Essentially the aim is to create a modern management style of organisation. Terefore, coordination with civil service reform is so essential and the civil service personnel policies should be compatible with those needed for the application of PFM/IC. Tese issues are all covered elsewhere in this guide, but are brought together here as a form of 'checklist' for the convenience of the head of this 'driver' department to ensure that his/her advice to the state secretary covers all the issues. Te order of the items is also important. For example, there is no point in seeking to introduce the bureaucracy of the procedures associated with the reform until other elements of the reform process, and not least the managerial elements, have been introduced. Te procedures should be designed to facilitate the development of quality management. Tey are not ends in themselves. Terefore, for example, the introduction of the COSO standards (managerial disciplines) should come later in the process rather than as almost the frst steps to be taken following the approval of the policy paper. To regard them as 'frst steps' indicates that the COSO standards are not seen as managerial disciplines but as the equivalent of other technical standards such as internal audit standards. Yet these managerial disciplines, as the name implies depend upon the existence of an efective management and that management is also responsible for maintaining their quality of application. Tis is a primary responsibility of the head of operational management in each public organisation.

As this is a long-term reform some of the activities will only mature over a long period of time such as raising fnancial awareness or improving the efciency and efectiveness in the delivery of public services. However, what is important is that the structures are put in place to facilitate this. An example would be making it possible for managers to have available the type of budgetary and management accounting information that they may require. Also, some of the issues that need to be addressed are complex, and whilst the principles can be stated the actual practice can require careful consideration. Tis applies to one of the central features of PFM/IC which is delegation and managerial accountability. In Chap. 14 the issues about the appropriateness of the arrangements for delegation and the development of managerial accountability are discussed in some detail. Tere is not necessarily a simple solution.

Te references in the schedule of activities set out below are to ministries and civil servants, but as local governments and other public organisations should also, at least over time, apply the reform these requirements should be adapted to cover local governments and other public organisations and to their ofcials.

Te practical issues that the head of the PFM/IC 'driver' department should be responsible for include:

	- Codes of practice governing the actions and behaviour of politicians and senior civil servants;
	- Managerial accountability arrangements including rules about the delegation of authority for decision making and reporting arrangements;
	- Contracting and procurement (which should be regarded as integral to the development of efective PFM/IC);
	- Te rules about approvals for investment decision making;

require a radical change to the current arrangements for budgeting and fnancial accounting. (See Chaps. 5 and 8.)

	- Te consequences of the development of external accountability and transparency (see Chap. 8 and the role of the head of fnance) including the information parliament and civil society is likely to require once the reform is introduced (which probably will be more extensive than that traditionally made available);
	- Te arrangements for reporting to parliament on the proposed reform and then on the progress of the reform;

the delivery of public services coupled with the need to improve efciency and efectiveness. Te head of the PFM/IC 'driver' department should initiate the development of training programmes to improve the quality of management. Tese training programmes should also cover cost and management accounting and longer term fnancial planning. Te capabilities of the head of fnance and those of the fnance staf should be particularly addressed. Tis is because with PFM/IC the responsibilities of the head of fnance and the staf of a fnance department go well beyond budgetary and fnancial control. Training should also be provided to managers in the utilisation of cost and management accounting. (Training requirements for the head of fnance and fnance stafs were discussed in Chap. 8.)

	- Managerial fnancial and performance analytical needs which will include, for example, analysis of costs over objectives, cost centres, cost drivers and any other form of analysis that a manager deems helpful. Budgetary and accounting coding structures should be sufciently fexible and elaborate to permit this and this may mean, as has been shown in earlier chapters, that each ministry should be able to agree with the ministry of fnance the development of the national chart of accounts coding structures (a top-down responsibility of the ministry of fnance) so that managers have available to them the information they require (a bottom-up responsibility of individual ministries). Tis would enable the need of both the ministry of fnance and that of individual ministry for management accounting information to be met.
	- Managers should be able to determine the values that should be included in the budget relative to the objectives and performance standards they are expected to deliver, if they are to accept it. In some countries the extent of the discretion available to managers in the formulation of the budget is extremely limited by the ministry of fnance and this will need to change. Te position should be that if the manager considers that the available budget is inadequate to meet the objectives and performance standards and performance objectives these latter should be adjusted as part of the budget negotiations so that budget, objectives and performance standards and objectives are compatible.
	- Again, change may also be required to the arrangements for contracts for the procurement of goods, services and assets where they are incompatible with the development of managerial accountability. Tis can occur, for example, where the administrative or other rules may require that only lowest price tenders are acceptable, irrespective of the

#### **9 The Role of the Department Responsible for Advising…**

quality of the proposal or indeed the reputation of the contractor. Also, a manager may have no ability to change from an original procurement plan where a change of specifcation occurs or even a change of price. All these restrictions inhibit the ability of a manager to exercise discretion, achieve efciency and efectiveness and hence impact on the manager's accountability.


ensure that the controlling ministry exercises efective supervision of such organisations. Efective supervision means that the controlling organisation:


Te head of the department responsible for the application of PFM/ IC should also ensure that the controlling ministry has a policy and technical capacity to fully monitor the activities of second-level organisations.

21. Corporate governance along with transparency and hence external accountability (not least to parliament and civil society) are features of PFM/IC. Advice and support are likely to be required by ministries to establish each of these features, particularly over the publication of fnancial and operational information. Te COSO framework specifcally refers to reliability, timeliness and transparency in external reporting but the framework recognises that other factors may be relevant as well depending upon local requirements. Not the least of these will be parliamentary requirements. Te likelihood is that each public organisation should be expected to produce an annual report explaining the utilisation of fnancial resources and what it has achieved or not achieved compared with its objectives. A further example of transparency will be the need to prepare statements of internal control (see point 22 above) including, or as a separate statement, information about how the organisation addresses risk along with its risk appetite. Tis transparency requirement could well be a cause of difculty because the identifcation of defciencies which may have occurred and been included in the statement of internal control, or of the extent to which an organisation is prepared to accept risk, may cause public controversy. However, transparency is a key element in the accountability process and attempts to suppress transparency should be resisted by the head of the 'driver'. (Te external auditor is also likely to have a specifc interest in the external reporting arrangements and in the extent to which transparency has been achieved.)

	- Te quality of budgeting when related to envisaged objectives and standards of performance and performance objectives;
	- Te relevance of the fnancial and performance information available to managers to assess and improve the level of efciency and efectiveness;
	- Te quality of the widened scope of the internal control arrangements;
	- Te accuracy and appropriateness of the annual statement of internal control;
	- Te relevance, accuracy and timeliness of the fnancial information being made available to managers and on the arrangements for transparency and corporate governance.
	- Te key internal audit reporting line, as was pointed out in Chap. 7 should be to the head of the civil service in the organisation and an audit committee where one exists, with the right to report to the appropriate political ofcial where the auditor deems that appropriate. A training programme should therefore be developed for internal auditors.

# **9.8 Summary**

Te head of the PFM/IC 'driver' department has a very important role in ensuring that there is a full appreciation of what this reform means for the management of public services including those organisations responsible for the collection of taxation and other forms of public income. Te key challenge is the creation of a modern managerial style of organisation. Te ministry of fnance state secretary, under the authority of the minister of fnance, should have overall responsibility for the application of the reform throughout the public sector. Te head should support the ministry of fnance state secretary in promoting the reform to other senior civil and local government appointed ofcials responsible for the operational management of public organisations. Promotion of the reform to public organisations should start with these senior ofcials and not with lower level ofcials. Te aim should be to secure local ownership of the reform and to make the ofcials aware of the benefts that can be achieved. Tis is particularly important where foreign aid agencies are involved who may have a limited appreciation of the country cultural and managerial context. Where support with the reform is being provided by foreign aid organisations, the head of the 'driver' department should ensure that their recommendations are relevant to the needs of the country and are not just a 'standard package' of reform proposals. An important responsibility of the head of the 'driver' department is to maintain control over the direction of the reform and to do that the head must have a thorough appreciation of what the PFM/IC reform is really about.

Not the least is the recognition that coordination of this reform with civil service or public administration reform is essential.

Te introduction of PFM/IC will cause radical changes to the way in which public organisations are managed and this could well generate opposition. Tere is every possibility that senior ofcials (political and appointed) may object to the reform and this reaction should be anticipated and policy options prepared. Failure to address this potential problem is likely to result in, at least, the gradual re-establishment of the former administrative arrangements.

An essential feature of the reform process should be a strategic analysis of the strengths and weaknesses of the present arrangements, including the budgetary processes and the problems and risks that implementation will generate. Tis analysis may result in the conclusion that this reform is inappropriate at the present time and that a diferent reform would be more appropriate. Te fundamental point is that this reform requires a complete change in the style of the management of public services, including how its fnances are managed. Te emphasis adds to the traditional fnancial input controls the control of outputs, although such a shift can only be justifed if input controls are strong and remain strong. A consequence of the reform is that the responsibilities of the most senior civil service or local government administrator in a public organisation change considerably and become much more extensive compared with those of a traditionally organised public administration, not least because of the focus upon improving efciency and efectiveness. Tis means that an important emphasis should be on developing policies to respond to the potential opposition from senior ofcials who have an entrenched view about traditional approaches to the administration of public services and this may require that they be replaced. Another important emphasis should be placed on management training, rather than simply on the bureaucracy associated with the reform, which is what very often happens. Because fnance becomes a central feature of decision making with PFM/IC, the development of the role and skills of the head of fnance is very necessary. Te responsibility of the head of the 'driver' department is to design and facilitate both these areas of training, not to undertake them.

Te responsibilities falling upon the head of the PFM/IC 'driver' department as well as upon the ministry of fnance state secretary are considerable. Together they should ensure that the 'driver' department is properly stafed with a range of expertise to support the reform. To support the application of the reform the state secretary with the support of the head of the 'driver' department should aim to achieve coordination of the reform through regular meetings with other state secretaries and ofcials to discuss application issues and solutions to problems that may be emerging.

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# **10**

# **Achieving the Benefts That Introducing PFM/IC Can Generate and Accounting for the Costs**

Adopting PFM/IC creates the opportunity to achieve important benefts. Tese are explained in this chapter. However, these benefts will only materialise if the political and senior ofcial management of public organisations recognise these beneft opportunities and are determined that they should be achieved. To achieve these benefts the political and senior ofcial levels of management need to recognise that PFM/IC should be treated as fundamentally a management reform. Te benefts arise principally from the better quality of management that PFM/IC facilitates.

Te application of the reform is not 'cost free' and the full range of costs should be identifed. Tey cover a wide range of issues and are about the professionalisation of civil and local government service management. Te process of identifying and assessing the costs will help, particularly ministries of fnance, to establish the range of issues that need to be considered to apply the reform and perhaps may also help them decide how they wish to proceed or even whether to continue with the reform. Exactly what a particular country's costs will be depends upon the starting point, that is, what information is currently available and the extent to which the associated managerial arrangements require reform. However, whatever the circumstances a major cost will be an investment in training, not just training in technical matters but in developing the skills of management. Success with achieving the benefts of the reform ultimately depends upon the quality of management. Other factors in assessing the costs include the proposed coverage of the reform (i.e., afecting all public organisations or only some), proposals for the phasing of the reform and the likely time the reform will take to achieve comprehensive application.

# **10.1 Management and Policy—The Core Factor in Achieving the Benefts of PFM/IC**

Te PFM/IC reform is not easy to apply. Te benefts do not 'automatically' emerge and they will mainly only emerge over time. Achieving the benefts is made possible through the development of good quality policy and the actions of managers responsible for the operational delivery of public services which the introduction of PFM/IC facilitates. Policy making is improved because PFM/IC potentially makes available better quality information to policy makers and to the operational managers advising them. Operational managers are enabled to make better quality decisions based upon the fnancial and performance information that should become available to them. But they need to know how to use that information, including how to motivate their staf to secure efcient and efective delivery of objectives and performance standards and objectives. In other words what becomes available is a combination of performance and fnancial analytical information to support the political and operational management objectives.

A feature of PFM/IC is efectiveness along with increased transparency and accountability. Efectiveness in expenditure requires that regard is had to the interests of the user of the service being provided, that is, is it relevant to their needs and provided in a manner which is convenient to the user? Efectiveness in income generation, particularly taxable income, depends upon clarity of the income generating policy (especially true for tax policy) and its consistency with government expenditure policies (e.g., fuel duties could be consistent with a government policy to reduce harmful emissions). Tax policy ought not to distort the development of the economy. Efective tax policy often also evolves from wide consultation, something that governments are not necessarily particularly good at. Introducing PFM/IC means that Top management will need efective communication skills to respond to increased parliamentary and civil society scrutiny of operational and tax performance.

None of the available literature on the development of PFM/IC1 specifcally refers to the benefts that can accrue from the reform. Te impression given is that the benefts that do arise come from strengthened internal control processes and then largely limited to fnancial and budgetary controls. Te linkage with an enhanced role for management and the controls it needs to deliver objectives and performance standards and objectives is usually not

<sup>1</sup>For example, the 'Orange Book' published by the European Commission: Welcome to the World of PIFC: 2006.

considered. Te discussion usually does not extend to the quality of management or the impact of enhanced transparency and accountability.

In describing the opportunities for generating benefts, Sect. 10.2.2. below shows how the focus on management, coupled with the additional fnancial and performance information required by the development of PFM/IC, creates the possibility to improve the efciency and efectiveness with which public services are delivered and public resources used. Tis is central to the achievement of the benefts because it facilitates better quality policy making as well as better quality operational management. Te section builds upon comments made in previous chapters of this guide. But to allow those benefts to emerge, budgetary stability is of central importance. Without the implementation of PFM/IC these benefts would not be available.

## **10.2 The Benefts of the Reform**

#### **10.2.1 Budgetary Stability**

To achieve the benefts of the reform, one of the most important factors besides the opportunity to improve the quality of policy making and operational management is budgetary stability and its accompanying partner cash fow stability. Budgetary stability means reliability in funding from the ministry of fnance to individual ministries and other public organisations. Te reality of management in many developing and transition economy countries is that budget funding is unstable (often caused by unreliable forecasts of taxable income) and managers are consequently very often mainly concerned with how to manage with shortfalls in funding and budgetary uncertainty. Such uncertainty efectively prevents management from achieving efciency and efectiveness and diverts the management focus from achieving objectives. An example of this is from a report into the efectiveness of the Health Sector Services Fund (HSSF) in Kenya. Here researchers from the KEMRI-Wellcome Trust Research Programme and the London School of Hygiene & Tropical Medicine evaluated the HSSF. One key challenge (and there were several) to efective implementation that they identifed was delays in receiving funds and arduous fnancial reporting requirements, both of which afected the ability of facilities to deliver services efectively.2 Similarly, a report prepared by US Aid on challenges to ensuring adequate and timely funding

<sup>2</sup>https://resyst.lshtm.ac.uk and Policy Brief, April 2015 KEMRI/Wellcome Trust: Health sector planning and budgeting in Kenya: recommendations to improve alignment.

for maternal, new born and child health commodities covering Bangladesh, Kenya, Nepal and Uganda identifed major bottlenecks that adversely afect fnancing and therefore access to the required commodities. Tese bottlenecks included, funds for health commodities were not allocated based on evidence, which leads to inadequate funding or budget allocations, disbursed funds do not always match the allocated funds or budget, delays in disbursement slow commodity procurement and distribution and complex processes for budgeting and fnancial reporting delay auditing.3

A good annual budget is underpinned by at least a realistic annual plan. Where inadequate budgeting arrangements are the reality, it does raise a question about whether PFM/IC is an appropriate reform in such circumstances. Regular instability and shortfalls in funding indicate that the budget process is defcient and, in such circumstances, aiming to build a sophisticated system like PFM/IC is almost certainly inappropriate without basic budgetary reform. Introducing PFM/IC will not solve underlying budgetary problems (just as it will not solve underlying fnancial control problems caused by indiscipline or by fraudulent or corrupt activity. Tese problems must be addressed frst.)

## **10.2.2 The Sources of Beneft Derived from Better Quality Management**

Te benefts that are potentially available from introducing PFM/IC arise from the following.

(i) *Linking fnancial inputs with outputs and the professionalisation of 'management'.*

PFM/IC adds signifcantly to the responsibilities of management because it requires that management should have objectives and performance standards and objectives and be expected to deliver them efciently and efectively. Given the size, complexity and the nature of the objectives of most public organisations, responsibility for operational management activity ought to lie with a professional managerial civil or local government service. Professional management requires specialist skills and experience and advantage cannot be taken of the benefts of applying PFM/IC without the existence of such a management. As is pointed out elsewhere in this guide, civil service reform is an essential concomitant to PFM/IC reform. It would be most unlikely

<sup>3</sup>https://www.usaid.gov: Challenges to Ensuring Adequate and Timely Funding for MNCH Commodities.

that a single individual (a minister or mayor) or a small group (deputy ministers and deputy mayors), appointed for political reasons without the practical experience of public service operational management would have the skills needed to deliver complex public services, no matter how skilled they may be, and be able to generate the benefts that PFM/IC potentially makes available. In practice, without managerial reform, many elements of PFM/IC, such as all those necessary to achieve efciency and efectiveness, will go by default. Terefore, introducing this reform will, or ought to, lead to the development of a more professional operational management. Successful operational management depends upon the employment of persons with managerial skills and with considerable experience, or whose managerial skills can be developed.

Te quality of operational management determines the quality of policy application, the efciency and efectiveness of the utilisation of public resources and the ability to engage with parliament and civil society in the scrutiny of public organisation activity. Without good quality operational management, the political level of management is exposed to added risk and criticism. It also cannot take advantage of the benefts that PFM/IC makes possible.

(ii) *Te focus of the management interest has a greater emphasis upon outputs (what is being achieved) and performance, and not just with what is being spent (the inputs).*

Te immediate impact of this change of emphasis is to improve the possibility that a government (central or local) will achieve its objectives. But it will only do so if those objectives are well defned and the focus on management attention is upon delivering those objectives, to time, within budget, efciently and efectively. All of this requires a much higher quality of and well informed operational management. Management activity will take up more time than the relatively simple task of delivering services and only being concerned with controlling 'inputs'. PFM/IC is designed to provide the tools to assist managers in this complex task. PFM/IC provides politicians with greater confdence, although not absolute confdence, because no government controls all circumstances (witness the 2020 corona virus pandemic) that its objectives will be delivered and that they will be delivered efciently and efectively.

Terefore, applying PFM/IC in substance is essential if a government is serious about achieving its objectives and doing so efciently and efectively.

(iii) *A feature of PFM/IC is the need for better quality planning such as business planning, forward strategic planning and strategic fnancial planning*

Business planning (described in Chap. 9) should be undertaken by operational management and should involve the head of fnance as well as the relevant managers. Te beneft that business planning has is that operational managers are required to defne how they will deliver a policy, examine the alternatives in a disciplined manner and then selecting the most appropriate arrangements, subject to any political approvals that may be required. Te political level of management consequently has the beneft of a well-informed assessment of a policy. Tat in turn may result in a reassessment of political policy decisions. Te beneft is the reduced possibilities of wasted resources and more efective delivery once the policy is determined.

Another factor afecting the delivery of objectives is the focus on strategic planning. Tis means that much more emphasis is placed on assessing all the factors afecting the delivery of objectives including the current and longer run fnancial and operational implications. Tis reduces the possibility of 'unforeseen' events including fnancial pressures impacting upon the ability of an organisation to achieve its objectives. Top operational management should engage in strategic planning as part of the process of informing political management. Strategic planning requires a longer term assessment of what is needed to achieve an objective and of the constraints including fnancial, environmental, personnel, technical and other constraints that will impact upon the possibilities of achievement. Tis makes the likelihood of achieving the objectives more likely and reduces the risk of unforeseen events impacting adversely upon the level of achievement. Terefore, again there is less likelihood that resources will be wasted.

Strategic fnancial planning requires a forward look at all the factors which could afect the fnances of the organisation into the future. For a public organisation to run out of funds, sometimes almost 'overnight' is both a reputational and an operational disaster as well as causing an actual or potential signifcant waste of resources. A feature of efective fnancial management is that decisions are not made which impose unsustainable fnancial commitments on the organisation in the future. Efective management of commitments is essential to avoid overspending. A manager must consider the impact that policy and investment decisions will have upon future current budgets and whether the costs of current policies can be aforded or whether those policies need to be changed.

Long-run fnancial resilience of an organisation should be a managerial aim and strategic fnancial planning enables decisions to be made which are less likely to over commit the organisation fnancially into the future. Tis, therefore, reduces the risk of political and top operational management having to make short-term, often inefcient cuts to service provision in order to meet a budgetary or other fnancial constraint.

(iv) *Managers are required to address the risks that may afect the delivery of the objectives.*

Delivering objectives carries elements of risk. Tis requires operational management to identify and consider the impact of those factors (i.e., risks) which may make it difcult or impossible to deliver the objectives that have been set and to consider how to best manage those risks. Risk management also reduces the costs that may be incurred because of the occurrence of unforeseen events. Tis again reduces the possibility of waste of public resources and makes more likely the achievement of political objectives.

(v) *Managers can actually achieve greater levels of efciency (see also item xi).*

An efective operational management should always be concerned to achieve improvements in efciency. Te operational manager should therefore know what drives costs, the costs of each operational activity, each cost centre and how costs would be afected by diferent pressures, such as more or less demand for a particular service or activity, that is, how performance afects costs. Tis emphasises the importance of linking performance information with costs. Cost analysis is also essential if appropriate decisions are to be made where the provision of services or activities involves charges levied upon the users of those services. Where charges are not based upon full cost recovery, this means that some users will be subsidised and the manager should know which users and the extent to which they are being subsidised. Cost analysis should not only consider the current year costs but also the forecast costs for forward years (the exact number of forward years depending upon the circumstances). Managers should also know the value and costs of the assets being employed to deliver those services and activities and whether they are being used in the best way or could be disposed of and used for other purposes. Determining efciency is not a 'one-of' process and managers should have a constant regard for efciency and that to secure and maintain it is a systematic process. Trough the managerial accountability process top and senior political management has not only the opportunity to obtain the information to enable it to set the efciency targets that it wants operational management to achieve, but also the knowledge of what is being achieved. To support the manager this means that the skills and role of the head of fnance and the fnance department will need to be enhanced including the development of management and cost accounting. All of this requires a much greater appreciation of fnancial awareness than that of simply ensuring that expenditure does not exceed budgetary limitations.

PFM/IC requires that fnance plays a much more central role in management than in traditional systems of public administration.

(vi) *Managers are expected to develop an assessment of efectiveness*

Efectiveness is derived from an understanding of what the user of a public service wants rather than assuming that the user wants what the supplying organisation continues to provide (the user could be another ministry or department or a third party such as a benefciary recipient, a student, parents of schoolchildren, a patient, a central or local government taxpayer, a supplier of services to the public sector or any other user of a public service). If a service is being provided that either is not required or is not being delivered in a way that is of value to the user or at a time the user requires, then resources are being wasted no matter how efciently that service or activity is being provided. Because very often public services and activities are provided in a manner which is convenient to the provider, rather than the user, assessing efectiveness may well cause this to change. Te user should be consulted. As national economies improve and society becomes better educated and wealthier, the demand to be consulted will grow. Consumers of public services are also likely to make comparisons with how private sector services are provided and expect the public sector to follow the same standards. Terefore, efectiveness should become a much more important feature of public service delivery. Te only way to fnd out what the user requires is to ask them. Asking them can take many diferent forms but establishing efectiveness should become an important feature of public service management. Tis is a key reason why parliamentary and civil society consultation is so important because it provides *inter alia* information about efectiveness.

PFM/IC encourages the development of a focus on efectiveness and it also does this through requiring enhanced transparency and accountability,

(vii) *Requires of managers greater discipline and quality in the operational management process both for top and senior management and for lower level managers*.

PFM/IC clarifes and extends the responsibilities of operational management by introducing more structure and discipline into the management process, including accountability. Managers should be held to account for achieving objectives, performance standards and performance objectives, not just for fnancial and budgetary control. Te responsibility of the political and the top operational management is to set those objectives and standards and to determine the policy framework within which they are to be achieved, along with the strategy for achievement. Teir responsibility is then to ensure that operational management delivers those objectives and performance standards to time, within budget and efciently and efectively.

A consequence of the PFM/IC reform will be that HR policies will need to be modernised with recognition being accorded to the role of civil and local government ofcials as managers and therefore being required to take risks. Managers will have to make judgements in taking decisions.

(viii) *Facilitates better quality policy making and strategy development*

If efectively implemented, PFM/IC facilitates better quality policy making and the strategy for the implementation of policy. It does this through potentially making available to the policy maker a better quality of fnancial and performance information and by introducing delegation. Delegation allows for more time to be available to political management to develop policy along with the implementation strategy by removing most operational management responsibilities through delegation. Delegation has the further advantage that it facilitates the development of the experience and quality of the civil or local government service and through that creates the potential for a better quality of policy implementation advice to the political management. Delegation has the beneft that it allows for a full political management focus on the issues that really matter politically, and for the civil (or local government) service to gain practical operational management experience. Critical to successful policy development and the strategy for its implementation is the need for efective coordination between policy makers and those experienced in delivery. Te more experienced those responsible for delivery are, the more efectively they can support policy makers.

(ix) *Facilitates improved operational management decision making.*

Improved operational management decision making is made possible because with PFM/IC managers can be provided with both performance and fnancial information. Tis is not available with traditional administrative systems. Te focus on fnancial awareness (see item xi below) makes possible an improved utilisation of public resources and through that more efective and consistent service provision. By delegating operational management decisions, apart from those with a signifcant political relevance or where there is considerable uncertainty, decisions will be made nearer to the problem, that is, decisions can be made by persons more expert and experienced in the delivery of the service concerned. Delegation means that, on the whole, extraneous and irrelevant factors (including political advantage) as far as possible do not enter into the routine operational decision making process. Consequently, the concerns of political management can be focussed only on those operational matters that may be of a particular interest for them.

(x) *Potentially reduces the risk of the development of a 'silo' mentality within a public organisation and hence enhances the opportunities for managers to make more efective use of available resources.*

Features of PFM/IC are a strong operational managerial leadership and improved communications within the organisation. Tis facilitates coordination of activity and more efective utilisation of resources. Tis applies whether services or activities are delivered by the frst-level organisation itself or by second-level organisations controlled by the frst-level organisation. A 'silo' mentality means that resources may not be efectively used and activities duplicated or diferent standards and objectives applied by diferent parts of the organisation. Trough the development of information and communications senior management can rationalise service delivery and activities.

(xi) *Operational managers are made more fnancially aware and this in turn encourages better quality budget making, more efective use of resources and performance delivery.*

Tis is because through the operational manager's involvement in the budget making process which ought to occur with the introduction of PFM/IC and the provision of cost and performance information:


#### **10 Achieving the Benefts That Introducing PFM/IC Can Generate…**


#### (xii) *Better quality of control can be exercised by political management and by top and senior operational management.*

Making every decision, no matter how trivial, does not put political management in efective control of an organisation, although some believe that it does. Establishing an efective management structure with operational managers appointed with delegated powers and accountable for how they have used those powers in the delivery of objectives and performance standards will give to political management a much clearer understanding of what is happening in the organisation. Political management also retains the power to 'call-in' decisions if they feel that appropriate or can set specifc conditions afecting the exercise of delegated powers. Trough these types of arrangements introducing PFM/IC provides a greater opportunity for political management to be in control of an organisation without feeling the need to try to make every decision.

Managers exist at all levels in an organisation and ought to work within a policy framework defned by the political and top operational management or by their immediate superior manager. Te organisational structures that should be introduced with PFM/IC mean that higher levels of management will also decide on what the lower levels of operational management are to achieve. Tey will also determine the powers and resources individual managers will have available to them. Tese conditions mean that managers at all levels can be held accountable.

By adopting the PFM/IC reform the political management are more able to secure control through the managerial accountability processes that will be established.

(xiii) *Creates the opportunity to identify much more systematically fscal risk.*

Fiscal risks ought to be identifed and assessed, and if they are not, a consequence could well be of an entirely unforeseen impact upon the fnances of an organisation. Fiscal risks can arise from a variety of circumstances. Tey may be treated as part of operational risks but very often they are not. Tey can arise from arrangements designed to defer immediate costs into the future, from long-term contracts, such as for specifc commodities (e.g., oil, or minerals), from certain types of contracts, such as public/private partnerships, from the issue of guarantees, from assumptions made in entering into agreements with third parties or from changes in economic conditions. Tey can also arise from arrangements made with aid agencies and other third party organisations, not least because the policy considerations of those third parties can change without any regard for the impact upon particular local circumstances. Specifc and potential fscal risks ought to be disclosed along with estimates of their magnitude and, where practicable, their likelihood. A particular responsibility of the head of fnance within a ministry or local government should be to ensure that top and senior political management is aware of such risks and that before such risks are accepted that appropriate consultation occurs with the ministry of fnance. Performance agreements with second-level organisations should include a specifc requirement that a second-level organisation should not enter into arrangements that may lead to fscal risks arising without the specifc approval of the frst-level organisation. Political management is particularly vulnerable where fscal risks emerge which ought to have been foreseen and PFM/IC should help to protect them from such a possibility.

(xiv) *Improves the quality of budgetary and fnancial control by operational management.*

Budgetary and fnancial control is improved because the operational manager responsible for a budget has to take direct responsibility for managing the budget on a day-to-day basis and for the way in which resources are used. At the same time the operational manager should deliver the objectives and the prescribed performance. Te primary responsibility for fnancial and budgetary control is not that of the fnance ofcer but the operational manager. However, the head of fnance should be advising the operational manager about spending and income (where appropriate) on a regular basis and should ensure that appropriate managerial action is taken should variations from the budget appear likely. Nor can the responsibility for budgetary and fnancial control be 'delegated upwards' to a political level or left to an external controller such as the ministry of fnance. PFM/IC involves a stronger fnancial discipline by ensuring that no commitments are entered into that will lead to a potential overspend at year end or generate unpaid liabilities that are not refected in the budgetary allocation. It should also require systematic re-forecasting of income and expenditure during the year measured against operational performance in achieving objectives. Te beneft of these arrangements is that there is a greater likelihood that resources will be well used compared with the traditional arrangements partly because an operational manager has a specifc responsibility and therefore can be challenged about those decisions and partly because the whole process results in the manager becoming more fnancially aware.

(xv) *Improves the quality of governance within public organisations*.

Because of the consequential separation of responsibilities for policy and strategy setting from operational management, if properly applied no single person should have full responsibility for all aspects of all decisions. Tis reduces the risk of mistake, because it makes challenge possible, and allows for diferent views to be considered. Te risk of corruption is also reduced. Te opportunity for 'challenge', as has been pointed out elsewhere, can be a valuable tool to test the quality of decision making. In some countries the idea of 'challenge' is not acceptable and this can be a legacy of the historical development of a country, including its colonial history. No one individual has perfect knowledge, particularly where complex issues arise. For their own sake top and senior management should not be 'sheltered' from what may be

uncomfortable realities. For fnancial management and internal control to be efectively applied, scope for 'challenge' should be accepted. (xvi) *Improves accountability externally*

With the development of PFM/IC and the availability of additional information about performance, the opportunity for parliamentary scrutiny of managerial performance is enhanced. Scrutiny of managerial performance by the state external auditor is also enhanced. Te state auditor usually has a responsibility to undertake performance audits and to report to parliament. Te additional managerial and performance information developed as part of the PFM/IC process will facilitate this. (Added parliamentary scrutiny is not always welcomed by a government but is a very important beneft from the point of view of transparency and accountability in a democratic environment. To be efective though, parliament may need additional technical assistance to enable parliamentary members to analyse information and to focus enquiry. Members of the parliament may also need to have available to them training support.) Not only is this an important element in the development of 'challenge' but it also provides an opportunity to inform civic society. External 'challenge' is a necessary element in the development of democratic processes and will serve to stimulate an improved quality of management.

Accountability should also indicate to interested parties, who may be external to the organisation, how all aspects of internal control have been applied including, where objectives and performance standards have not been met, what has gone wrong and the changes management has made in response. Political management needs to know this in order to avoid or lessen potential public criticism. External accountability is also improved with the publication of information about the quality and efectiveness of the internal fnancial control arrangements (see Chap. 13).

Externally, the civil or local government service is usually completely anonymous to the service user and yet with the delegation of operational management that anonymity should not necessarily remain, although much depends upon individual country traditions. In the normal course of business, the service user should know with whom they are dealing and should be able to directly communicate with them and not just via the political head of the organisation. Public accountability should be a feature of delegation.

Te accountability arrangements should also put the political head of the organisation in a better position to exercise pressure to improve the quality of operational management. Tese internal accountability arrangements also provide the political level of management with an 'early warning' system if something is going wrong or external events are occurring which are likely to afect performance. In summary, improved accountability, which PFM/IC requires, encourages the systematic improvement of the operational quality of public organisations, provided the signals generated by the internal and external accountability arrangements lead to appropriate managerial action being taken at whatever is the relevant level.

(xvii) *Efective mechanisms can be introduced where second-level agency and similar public organisations are established to ensure that the interests of the frst-level or controlling public organisation are properly protected.*

Second-level organisations should be properly supervised by the controlling organisation and should not be allowed to pursue their own objectives. Tey should also be set specifc terms of reference and objectives by the controlling ministry or local government and these should be set out in a formal agreement such as a service level or performance agreement (see Chap. 12). Tese may change from budget year to budget year depending upon the objectives and budget of the controlling ministry or local government. PFM/IC requires that better supervision of second-level organisations occurs and that mechanisms are put in place to ensure that this happens. Tis 'better supervision' will mean that the objectives and activities of secondlevel organisations will be more efectively coordinated with those of the controlling frst-level organisation. It will also require the secondlevel organisation to apply standards, including internal control standards set by the frst-level organisation and at the same time establish efective accountability arrangements between the second- and frstlevel organisations. To achieve this though, the controlling ministry or local government must develop a policy capacity to oversee and test the objectives and performance of second-level bodies. With PFM/IC controls should exist to prevent second level bodies being used as a mechanism to avoid budgetary and other controls.

(xviii) *Efective mechanisms exist to supervise those state-owned enterprises for which a ministry (or the equivalent in local government) has an ownership or supervisory responsibility.*

> State-owned enterprises have a degree of independence not available to other public organisations. However, very often the performance of such enterprises is poor. Tey can be used to avoid fscal controls and are a potential source of corrupt activity. Governance arrangements can be particularly weak. Tey also may accept fscal risks which if they mature could have signifcant adverse efects on

the owning or supervising ministry or local government. Where they operate in a contestable market place unless they are charged for the cost of capital and an allowance is made for risk in the fnancial returns they are expected to make, they can undermine the development of private market participants. Te introduction of PFM/IC creates the opportunity for the ministry of fnance and owning or supervising ministries (and local governments) to establish greater discipline over such enterprises and therefore limit losses and costs arising from inadequate performance. Te performance and governance arrangements of state-owned enterprises (and local government equivalents) should be systematically reviewed by the owning ministry or local government (see Chap. 12).

# **10.3 Summary on Benefts**

Tese benefts will only accrue with the recognition that PFM/IC is a comprehensive managerial reform. If governments are not prepared to undertake the managerial reforms that are required as part of the PFM/IC application programme, these benefts will not be achieved.

None of the available literature, so far as this author has been able to establish, refers to this catalogue of potential benefts or to the signifcance of the linkage with managerial reform. Tis lack of any reference to the benefts which fow from adopting the PFM/IC reform has the consequence that it serves to emphasise the impression that the reform is a fnancial reform of interest only to a ministry of fnance and to fnance stafs in ministries, rather than being primarily a management reform afecting the interests of government as a whole and promoting the opportunities to enhance transparency and accountability, not least to parliament and civil society.

A ministry of fnance responsible for applying this reform should aim to ensure that these areas of potential beneft are identifed in any policy paper and that an objective of the reform should be to ensure that the potential benefts are achieved. Tey will not be achieved immediately but over time and they require managerial reform. In the periodic reports by public organisations on the application of PFM/IC, the ministry of fnance should assess the extent so far, to which the benefts have been achieved and highlight the difculties where achievement is proving problematic. Equally the state external auditor in reviewing the performance of public organisations should include an assessment of efectiveness of the PFM/IC arrangements.

Tis schedule of benefts applies both to the management of public expenditure and to the management of public income and particularly taxable income. Most of the benefts described above apply equally to the development and management of tax policy and the arrangements for the collection of taxable income. In particular, the linkage of tax and expenditure policies is very important to avoid conficting signals developing in the economy.

## **10.4 The Main Areas of Cost**

Applying PFM/IC is not cost free and the analysis contained in this guide demonstrates the extent to which reform may be required, depending upon country circumstances. Tis afects costs. Te costs fall into 12 main categories and these are set out below. Te calculation of these costs should refect the period over which they would be expected to be incurred. In addition to these costs will be the costs of familiarising parliamentarians with the new processes and the utilisation of the information that will become available.

(i) *Te costs arising from the establishment of a specifc 'driver' department to assist in the application of PFM/IC.*

Tere will be considerable additional responsibilities falling upon the state secretary in the ministry of fnance to develop the policies and to secure their application. Because of this, the state secretary will require extensive support from a specialist department and an important area of cost would be that of this department. As explained in Chap. 9, the stafing of this department should refect the comprehensiveness of the PFM/ IC reform. (Tis would be in addition to the stafng required for the development of internal audit which would probably also be a responsibility of the same department.) Associated with the department stafng costs will be a range of other costs arising from the equipping and running of any ministry of fnance department, that is, ofce costs, transport costs and staf training costs. Such costs could also include the costs of visiting other countries which have either developed a PFM/IC policy and then applied it, including considering how they have responded to the managerial consequences of the reform.

(ii) *Te costs arising from the impact upon civil service and public administration reform coordination arrangements.*

Additional costs will be incurred falling upon the organisation responsible for civil service or public administration reform because of the very strong interdependence between the PFM/IC reform and civil service/ public administration reform. Tese costs though should not be signifcant but may require that an additional ofcial is appointed to act in a continuing liaison capacity. Te extent of this cost will depend upon the stage in the development of civil service/public administration reform that has been reached.

(iii) *Te costs of creating appropriate managerial structures.*

To reorganise the administrative arrangements within public organisations to create appropriate managerial structures will also add to costs and will take time (i.e., measured in years). Tis may mean introducing new levels of ofcial civil service/local government management, especially where the delegation of operational management responsibility is a new development. In some countries it may even require the development of a professional civil and local government service (see training below) and not least the appointment of an ofcial head (a state secretary or equivalent) in each public organisation, where such ofcials do not presently exist. Tis is a critical appointment given this ofcial's key role in the application of PFM/IC. It may also mean introducing new levels of management where the existing 'span of control'4 would be too great for efective management. Tis could be a substantial cost with the scale of those costs depending upon the present organisational arrangements. Because PFM/IC imposes additional responsibilities upon the manager, this is likely to require the appointment of additional staf to support state secretaries and other managers. Examples would include those responsible for the supervision of second-level organisations, for developing and undertaking risk management analyses, for those who will need to collect and interpret performance information.

(iv) *Te cost of providing management training for senior operational management.*

Training costs are likely to be signifcant and cover both this item and item (v). Specifc management training for the top and senior operational managers in public organisations (i.e., such as a state secretary or chief local government ofcial and their immediate deputies) will be required. A related area to managerial training will be to ensure that these managers have an appreciation of the implications and requirements of PFM/IC and are familiar with their additional responsibilities as the top operational managers and know how to take advantage of the additional information that should become available from its application.

Training in the development of managerial skills will be a critical activity. Where previously civil servants have not had managerial responsibilities, such training probably will require the support of a specialist

<sup>4</sup>Te area of activity and number of functions or people for which an individual manager is responsible.

organisation such as a university or perhaps the development of a governmental training institution. Tis training should include leadership skills and the raising of political awareness. Another important element of this training would be to develop the fnancial awareness of the top operational management including a focus upon the management of the fnances of the organisation, short and long term. Some technical training may also be required including in the specifc features of PFM/IC such as risk management, although what is central to this reform is management training.

Tese training costs may need to include fnancial support to a local academic organisation to provide appropriate courses where an 'in-house' training programme cannot be provided. Te cost of 'in-house' training is not cost free but its cost will depend upon the extent to which in-house training resources already exist.

Te costs incurred in this area of training and the types of training to be provided may need to be agreed with the ministry/department responsible for civil service/public administration reform.

Given the scale of the reform, training is likely to be an ongoing process over several years.

(v) *Te cost of training for lower level operational managers.*

Training for operational management at lower levels in public organisations will be required. Tis training should cover a wide range of managerial topics such as developing leadership skills (see previous point), decision making, delegation, management of staf and time management. For certain ofcials it would include technical training in the key elements of PFM/IC and not least in an appreciation of the fnancial aspects of PFM/IC, including what to seek for and how to interpret fnancial information. Tis training should also include raising fnancial awareness and creating an understanding of the manager's responsibility for managing the fnancial resources that are available, not least to improve efciency and efectiveness in the delivery of services and activities.

As with the previous item these costs may include fnancial support to a local academic organisation to provide appropriate courses. Te types of training to be provided may need to be agreed with the ministry/ department responsible for civil service/public administration reform.

(vi) *Te cost of developing a future civil service with a capability to manage in a changing environment*

Training is not a 'one-of' activity for a particular group of ofcials at a particular point in time. Public organisations should be concerned about the systematic development of staf at all levels in the organisation over time because the operational environment is constantly changing, not least because of technological and economic change. Te objective should be the establishment of a civil and local government service which has the capacity to respond to such changes. Te OECD in its publication on Skills for a High Performing Civil Service5 referred to the three main drivers of change:


Te publication indicated that this requires the development of a civil service:


Again, to develop such a civil service and local government workforce may involve coordination with an appropriate academic organisation and allowance ought to be made for the cost of the long-run provision of such courses that will facilitate the development of such a service. Tese are the characteristics that will be required as PFM/IC becomes embedded in the management processes.Te costs incurred in this area of training and the types of training to be provided may need to be agreed with the ministry/department responsible for civil service/public administration reform.

(vii) *Te cost of familiarising all other staf with the changed operational environment*

Training should not focus simply upon the staf most directly afected by the reform but should also include the familiarisation of staf with the new managerial operational environment for the public sector.

<sup>5</sup> Skills for a High Performing Civil Service (oecd-ilibrary.org) 2017: pp. 114–116.

<sup>6</sup>Tis is the authors summary of the OECD text.

Achieving staf commitment throughout the organisation is essential to creating an efective operational organisation. Tis will be necessary to support the managerial changes that PFM/IC will engender. It will also be necessary to engage staf in the whole reform exercise and to avoid the development of 'staf cynicism' about the reform. An example is that in many public organisations what appears to be paramount are the interests of the organisation rather than those it is supposed to be serving. Tere is in efect no 'customer orientation' of staf. Yet both efciency and efectiveness require that orientation and that is emphasised in the OECD report referred to above.

(viii) *Te cost of introducing performance information systems and developing a data analytical capacity*

To enable managers to focus upon outputs they require performance information systems. Building such systems and collecting the data to feed into those systems will be expensive both in terms of the systems themselves and the personnel required to collect and manage the information. Tis will also require developing a data analytical capability that will allow budgets and fnancial information to be analysed in a format that facilitates efcient and efective management. Tis will add to costs. Tis capability should be designed to allow budgets and fnancial information to be linked to individual managerial objectives and performance standards. At the same time the arrangements must facilitate the fnancial and budgetary controls. Tose controls should also provide the information that the ministry of fnance requires for its own budgetary control, fnancial reporting and statistical purposes. Tis may involve the commissioning of specifc consultancy support to advise on appropriate data analysis systems and the purchase of additional IT hardware and software, including the ongoing costs of providing technical support. A factor that should be considered in designing performance information systems is that it will also be essential to ensure that individual managers are not able to manipulate that performance information and those systems. Tis means considering security issues. Developing such systems and ensuring that they are robust and not capable of manipulation is likely to be an expensive exercise involving new information recording systems, stafng and supervision arrangements.

Accounting arrangements should allow for the allocation of costs (and any income) over *inter alia* individual cost centres, with the range of cost centres being determined, as explained in previous chapters by individual managers not by the ministry of fnance, and over those factors that a manager deems appropriate for his/her purposes which may include cost drivers. (Te forecast of costs should also include those for the retraining of internal audit staf to ensure that they are familiar with the managerial context in which they will be expected to operate.)

(ix) *Te cost of the research and analysis necessary to identify objectives and performance measures/indicators.*

To facilitate efective management, it will be necessary to identify and develop clear, defnable and measurable objectives and the associated performance measure/indicators and performance information systems, including the linking of those, as far as possible, to budgetary systems. Tis may require the employment of consultants and academic researchers.

(x) *Te cost of developing the fnance function.*

Tis will include both training costs and systems costs. Costs will also include raising the status of the head of the fnance department. Training will be required to enable the fnance department to undertake those fnancial analytical responsibilities that managers will require. Te role of the head of fnance as an adviser to operational management will also need to be developed. A state secretary will also require skilled fnancial managers who can advise on the development of policy and the strategy for its application as well as supporting the development of strategic fnancial planning including the provision of advice on the long-run fnancial resilience of the organisation. An important technical component of the training for a fnance function within an organisation will be the development of management and cost accounting. If these skills do not presently exist, then they will need to be acquired and that can be either through recruiting additional staf or training.

(xi) *Te costs or training the budgetary and fnance staf of the ministry of fnance.*

Ensuring that the capabilities of the ministry of fnance, especially of the staf concerned with budgetary management and fnancial accounting, are fully appraised of the revised arrangements and have the capacity to work with the management structures in public organisations. Te work of such staf is likely to be considerably developed by the increased emphasis upon performance with the application of performance measures and objectives including the linkages to budgets. Failure to do this is likely to create confict between the perceived needs of the ministry of fnance and those of ministry operational managers.

#### **10 Achieving the Benefts That Introducing PFM/IC Can Generate…**

(xii) *Te costs of employing consultants for specifc activities.*

Employing the consultancy advice that may be necessary to properly apply all the changes that will be required can be expensive. Developing the management of some public organisations in order to improve efciency and efectiveness may require the employment of specifc specialist consultancy advisors, especially where complex reforms are required. Envisaging what such advice may be required is difcult, but in assessing the overall costs of the reform this is a potential cost which should not be ignored. For example, assessing efectiveness is not necessarily a simple exercise and may require specialist research and advice. Terefore, those responsible for the application of this reform policy should consult with public organisations about what their consultancy requirements could be and when they might arise. A problem with employing external consultancy advice is that such advice needs to be directly relevant, familiar with the public sector operational environment and consistent. Such conditions may add to costs.

Te total of these costs depends entirely upon the base position, that is, the present administrative structures, budgetary and accounting arrangements. For example, if all decision making responsibility presently lies with politically appointed managers and there are no efective civil service or local government managerial structures within government organisations, then the extent of the reform required will be substantial and so will be the costs. Again, if the budget and accounting systems are designed to meet only the interests of the ministry of fnance, as, for example, most IFMIS systems are, or those of the fnance department of a ministry or local government, the costs also will be quite high. If though, for example, an elaborate coding structure already exists so that budgets and accounting information can be analysed over alternative headings to those required for budgetary control and statistical reporting purposes and that costing is a current feature of the fnancial management arrangements, then costs will be much less. Similarly, where management structures already exist based upon civil service or local government managerial arrangements and those managers have signifcant service or activity delivery responsibilities, the costs of the reform will be less. Another example would be that in some countries programme budgeting has been developed. In theory this should lead to lower costs of application, but only if the programme budgeting arrangements are themselves accompanied by managerial reform (which in practice does not always occur). Managerial reform would mean that a manager has specifc operational responsibility for the delivery of a programme and that each programme is accompanied by clear and measurable objectives and performance information. Te budgeting and accounting arrangements should fully refect the costs of implementing that programme.

Unfortunately, the reality is that the only costs that are usually identifed with the application of PFM/IC are those directly associated with the additional costs falling upon the ministry of fnance for staf employed in the PFM/IC 'driver department'. Te other costs which may also be identifed are training costs, but only of fnance stafs and of administrative/managerial stafs in undertaking the additional bureaucratic activities, such as risk management arrangements associated with the introduction of the managerial disciplines identifed by COSO. None of this covers the need for managerial training or recognises the diferent needs for diferent levels of management or the changes that are likely to be required to the approach of staf generally. Such costs are usually ignored including the additional costs falling on the organisation responsible for civil service reform as well as all costs associated with developing more elaborate managerial structures, coding, budgeting, accounting and costing systems.

A further factor associated with the costs of applying PFM/IC is the timeframe over which costs are likely to be incurred. Tat timeframe should be realistic and it should refect an assessment of what requires to be changed including how far and how quickly a government is willing to accept change, especially through the delegation of responsibility to civil service (or to local government service) managers. Another factor afecting costs is the decision about whether the application of the reform is to be through a single reform programme for the whole public sector or is it to be applied through pilot arrangements and in stages. Or alternatively, are the diferent types of public sector organisation to be reformed in sequence (e.g., central government, then local government, then second-level organisations such as public agencies or some other sequence)? Exactly what that sequencing should be will depend entirely upon local circumstances and hence local decisions. However, it should be borne in mind that some elements of the PFM/IC reform may be very difcult to implement in stages, such as personnel reforms.

Tis lack of cost identifcation with little or no regard to the timeframe over which the costs are likely to be incurred usually happens because of a lack of a substantive appreciation of what PFM/IC involves. Identifying the costs and the timeframe represents an important form of analysis that ought to be undertaken because it has the beneft, not just that it identifes the costs, but that it also recognises the scale of the reform required and therefore makes clearer the extent of the political decisions that will be needed.

Tis broader identifcation of costs will encourage governments to consider other factors such as:


What should be recognised though is that many of these costs arise from the need to professionalise the civil and local government service. Introducing PFM/IC is the stimulus for that but such costs should be accepted as necessary in any event if a country is to manage its resources efciently and efectively and to meet the needs of its citizens and the users of public services.

## **10.5 Summary on Costs**

Te costs of applying this reform can be substantial. A key responsibility of political leaders (and a minister of fnance in particular) is to ensure that the full costs are fully identifed, even if precise numbers cannot always be demonstrated. Te timeframe over which they are expected to be incurred should also be shown. Decisions can then be made about how those costs are to be fnanced.

Te costs that are to be incurred mainly arise from establishing the managerial structures that are required to deliver services efciently and efectively, the professionalisation of civil and local government service management and the consequent costs of managerial training and development. In addition, costs will also arise from generating the fnancial and performance

<sup>7</sup> If reforms occur out of sequence, for example, risk management being introduced before clear and defnable objectives have been set, the exercise will not be successful and resources will have been wasted. Similarly, if a requirement is imposed on managers that they must operate efciently, then this too will fail unless the budgeting, accounting and performance reporting systems have been established and staf trained in how to use them and to undertake fnancial analysis.

information that managers require if they are to manage efciently and efectively the resources that are made available to them through the budgetary process. Tese could be signifcant areas of cost.

Overall, the costs are wide ranging refecting the impact that this reform will have upon the arrangements for the management of the delivery of public services including a refocusing of the civil and local government service to have regard to public service user needs and interests rather than simply those of the organisation itself. Tey are not simply administrative type costs and they involve the acquisition of information and the utilisation of that information by managers to deliver more efcient and efective public services.

Although these costs can be wholly attributed to the implementation of the PFM/IC reform, in practice many of these costs are essential to the creation of an efectively functioning civil (or local government) service.

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# **11**

# **International Standards of Internal Control Relevant to the Application of PFM/IC**

Countries aiming to introduce PFM/IC, as well as other public fnancial management reforms, are usually encouraged to adopt internationally recognised standards as best practice. However little or no thought is often given to the context in which such standards are to be applied. Tese international standards, and especially those relating to PFM/IC, refect several assumptions about the organisations which are to adopt them. For PFM/IC those assumptions are about the application of the standards to a managerial-based organisation. Where the current context is that of traditional administrativebased government organisations, these standards cannot be applied without managerial reform. And this reform ought to come frst. (Te experience of this author is that those assumptions are not generally recognised by those seeking to apply them in developing and transition economies nor recognised by those advising them.)

Terefore, as has been pointed out earlier in this guide, trying to apply such standards may not be appropriate for a particular country at the time the PFM/IC reform is proposed to be implemented. In adopting a managerial approach various factors need to be considered. Tese include local cultural traditions, the relationships between political and appointed ofcials, the organisation and quality of the civil service, the existing management arrangements (or lack of them), the authority that individual managers have with the current arrangements over operational activity, the experience and training of managers to enable them to apply the standards in a managerial context, the quality of the existing budgetary arrangements and the strength of the existing fnancial control arrangements. In Chap. 3 a distinction was drawn between PFA/IC and PFM/IC and this distinction illustrates when adopting international standards may not be appropriate.

Tis chapter accepts that it would be appropriate to adopt PFM/IC international standards, that is, the standards published by the Committee of Sponsoring Organizations of the Treadway Commission' ('COSO').1 Tere are fve standards and these cover the control environment, risk management, control activities, information and communication and monitoring, although updating has resulted in some modifcations to them.

Tese fve standards of internal control exist to secure the achievement of the objectives of the organisation and to do so within the legal constraints and regulatory requirements, efciently and efectively and with proper regard for accountability. Tey therefore have a clear purpose and are not simply bureaucratic requirements associated with the development of internal control. Tey are integral to management. Tey are not 'stand-alone'. Tis is an appreciation that those responsible for the application of PFM/IC should achieve. Te fve standards are about managers having the authority and the information they require to make those judgements necessary to enable them to achieve their objectives. Tis would include meeting any regulatory requirements, including legal, fnancial and budgetary limitations, in the most efcient and efective manner. Tey provide an important improved procedural approach to the management of public organisations. However, most countries implementing PFM/IC have treated these standards simply as bureaucratic 'standalone' requirements, rather than being integral to the managerial process. Tey have therefore focussed their implementation upon the bureaucracy of the procedures to be adopted, rather than upon the efectiveness of management, that is, the manager as decision maker. (In most developing and transition economy countries a 'nominal' responsibility has been placed upon the political head of the organisation, the minister or mayor, to ensure that these standards are implemented. Tis cannot be a 'substantive' responsibility without other changes being made. Te necessary changes have been described earlier in this guide. Given the wide range of responsibilities that fall in practice upon a minister or mayor, an expectation that they will exercise anything other than a 'nominal' responsibility is misplaced. In other words, countries have not taken account the managerial context in which COSO is meant to apply and therefore the assumptions that lie behind the COSO initiative.)

Each of the fve standards of COSO as they were originally specifed is discussed in this chapter. Tey may be more appropriately described as 'managerial disciplines'. (Other examples of these standards exist such as the ISO 31000 standard which applies to risk management but again the responsibility is focussed upon the management.)

<sup>1</sup>https://www.coso.org.

Te COSO standards are normally treated as applying only to public organisations concerned with public expenditure, but they should apply equally (albeit with some adaptation) to those organisations concerned with the generation of income.

Tey are about 'good quality' management!

# **11.1 The Implicit Assumptions Contained Within the International Standards of Best Practice (COSO)**

COSO is about how large international private companies should be managed and describes fve standards of internal control that should be applied.

Internal control has been defned by COSO "as a process, efected by an entity's board of directors, management, and other personnel, designed to provide 'reasonable assurance' regarding the achievement of objectives in the following categories:


Tese standards, of which there are fve, that is, the control environment, risk management, control activities, information and communication and monitoring, refect the requirements of the private sector. Te standards are periodically updated with the latest comprehensive update being in 2017.2 In addition, COSO also published guidance on specifc features of enterprise risk management such as on cloud computing and artifcial intelligence.

Te public sector provides services which are not subject to a market test and it also has the responsibility to levy and collect compulsory taxes. Citizens of a country cannot escape from this compulsory levy except by legislative permission: there is no option available, as there would be in the private sector by not utilising a public service. Efective management of public expenditure and taxation policies is essential. Tese standards, which have been described previously as 'managerial disciplines' should be adapted to apply to organisations responsible for the development and management of both expenditure and tax policies.

In the public sector a critical feature of public fnancial management is the existence of the budget and that budget will have legislative approval. Governments and local governments are also required to ensure that public

<sup>2</sup>https://www.coso.org/Pages/erm.aspx.

services are delivered consistently and evenly to those members of society that they are expected to serve. Reliability and sustainability ought also to be characteristics in the management of the delivery of public services, and governments generally (subject to political policy change) should be assumed to have a continuing existence. Tey are not subject to the vagaries of the marketplace.

In applying these standards to public organisations, a ministry of fnance, the state secretary for that ministry and the head of the department responsible for the application of PFM/IC (the 'driver' department) should recognise that they contain implicit assumptions about the organisations to which they are being applied. Terefore, a simple 'read across' from the private to the public sector can be misleading. Unless public organisations recognise the signifcance of these assumptions, applying these standards will not achieve the objective of introducing efective internal control.

"Learning another language is not only about learning diferent words for the same things but learning another way to think about things" (Anon). Tis applies to these standards. Te assumptions contained in the COSO model are about the management and objectives of organisations. Te standards will only help top and senior management if those assumptions are replicated in the management and objectives of a public sector organisation. To regard these fve standards as 'stand-alone' features which, if adopted, will deliver efective PFM/IC is mistaken. Te key assumptions lying behind these fve standards are that:


performance, including externally set regulatory requirements against the available fnancial resources.


Tese assumptions which are implicit in the COSO standards (as has been indicated) might be better described as managerial disciplines demonstrate very emphatically that introducing PFM/IC is as much a management reform as a fnancial reform. As a management reform the requirements of PFM/IC need to sit within a managerially focussed organisation. Consequently, the COSO standards will not produce the potential benefts unless the public sector organisation has moved from a traditional administrative style (usually a frmly 'top-down' style) to a managerial style of organisational arrangements. Tis does mean that if these standards are to be efectively applied a competent, managerially oriented civil service (or local government) organisation needs to exist. Managers then need information about objectives, performance and fnance to enable them to meet their responsibilities. Countries should not assume therefore that a simple bureaucratic implementation of these standards can be achieved without ensuring that a public organisation exists which has a managerial capability. Civil servants (and local government ofcials) need to be trained managers and therefore be prepared to take decisions.

Treating these standards as managerial disciplines designed to help managers achieve their objectives efciently and efectively and to improve accountability demonstrates that civil and local government service and other reforms, such as budgetary and accounting reforms, may be necessary prior to the introduction of these standards. Te standards are not 'ends in themselves'. Te COSO executive summary points out the fve standards are integrated3

<sup>3</sup>Executive summary—page 4: https://www.coso.org/Documents/990025P-Executive-Summary-fnalmay20.pdf.

and therefore their impact should be considered as a whole. Te COSO standards are about improving the quality or, to put it another way, the professionalisation of management.

In developing and transition economies aiming to apply the COSO standards, none of the assumptions summarised above is recognised. Te usual practice, in the experience of this author, is to treat the COSO standards as only about fnancial and budgetary control, not management. Tis seems to be because the personnel involved in the reform process are usually only concerned with such issues and often start from an internal audit perspective. As this is a wrong approach, the minister of fnance, that ministry state secretary and the head of the 'driver' department should ensure that in applying these standards there is a recognition of the assumptions implicit in these standards and that the managerial context is refected in the reform processes. Tis means, as has been explained previously in this guide, that;


Tese are the characteristic features of a managed organisation: they are not those of a traditionally administered organisation.

Te fact that COSO was primarily aimed at commercial companies makes no diference in principle to its use for non-market organisations, merely that it requires an appreciation of the diferences between the private and public sector contexts and consequently an appropriate adaptation. (Management in the public sector, as has been pointed out earlier, for many services is much more complex with more confusing signals than in the private sector.)

Te efectiveness of the application of these standards depends upon the quality of management, both political and operational. What is important is clarity about the policy, objectives and performance standards and objectives set by the political level of management including the strategy for delivering them. Clarity is also required about how a ministry or local government or other public organisation is managed, both operationally and fnancially, to secure the efcient and efective delivery of those objectives and performance standards. Te introduction of these international internal control standards ought to be a signal that a managerial/performance culture is being established. Terefore, as has been explained earlier in this guide, accompanying the application of these standards a parallel managerial reform process should occur, and if this does not occur, then these standards will not be properly applied.

Previously in this guide, the person responsible for the application of PFM/ IC within an organisation was identifed as the chief civil service (or local government) ofcial such as a state secretary within an organisation. Tat ofcial should ensure that introducing these standards results in an organisation capable of delivering its objectives and performance standards and objectives, efciently and efectively and within any legal, fnancial or other constraints and that due regard is had to the interests of the users of the service or activity. Merely introducing the bureaucracy associated with the application of the international standards will not, of itself, demonstrate that PFM/ IC has been applied and that the ministry or local government is well managed. Tis is not correct at all.

In many countries a responsibility is placed upon the political head of the organisation, the minister or mayor, to ensure that these standards are implemented. Tis cannot mean that this ofcial must make all implementation decisions. Te substantive implementation responsibility should fall upon the head of operational management, that is, the most senior civil service or local government ofcial with that ofcial being accountable to the political head for the efective application of the standards.

# **11.2 Appreciating the Impact of COSO**

#### **11.2.1 The Standards of COSO**

Countries which have implemented PFM/IC following the COSO standards have tended to address four of these standards, 'the control environment', 'control activities', 'information and communication' and 'monitoring activities', in general terms only. Tey have merely required the responsible ofcial to pay attention to them, with the evidence of their application being the additional bureaucratic procedures that have been introduced. However, as has been pointed out, evidence of the existence of the bureaucratic procedures is not the same as the substantive application of those procedures. In most countries little specifc indication is provided of what managerial and operational changes have resulted from their application.

Te exception to this is the standard relating to risk management. A great deal of attention has been paid to risk management, but much of the emphasis has been upon risks to fnancial control systems such as risks of losses through error, fraud or other misuse of resources rather than to the risks of not achieving objectives and performance standards or of not providing a consistently reliable service or of meeting externally set regulatory requirements. With risk management the bureaucratic procedures are easy to specify and their existence can be easily checked. However, this does not mean that risk management is being efectively deployed by managers. Risk management has been regarded as perhaps the most important element and much energy has been devoted to providing advice and training programmes. Unfortunately, much of this is misguided. Te ofcials being trained have largely been fnance ofcials and internal auditors and this may be appropriate if risk were confned to fnancial control matters (i.e., not to broader fnancial management matters). But it is not so confned! COSO is fundamentally about those risks which will prevent managers (at all levels) achieving their objectives and performance standards and objectives, including any externally set standards and doing so efciently and efectively. Tis goes well beyond audit and accounting. Terefore, a priority before risk management is introduced is the existence of objectives and performance standards and objectives, a management structure with managers having an active concern to utilise risk management as a way of ensuring that their objectives and performance standards and objectives can be achieved. For efective management an information and communications process should also exist that provides the information that managers need and which facilitates the establishment of a 'corporate' approach to the management of the organisation so that in making decisions managers have regard not only to their individual objectives but to the broader objectives of the whole organisation. (A 'corporate approach' is 'an approach to managing people that supports an organisation's long-term goals with an overall planned and coherent framework. Tis helps ensure that the various aspects of people management work together to develop the behaviours and performance needed to create and distribute value. It focuses on longer term people issues, matching resources to future needs and largescale concerns about structure, quality, culture, values and commitment'.4 )

Te ofcials who should be trained in risk management should be the operational managers because risk management should be their responsibility. Tey will not be interested simply in fnancial systems risks unless they have a material impact upon their part of the organisation, upon its reputation and its ability to achieve its objectives. Tey will need to consider all risks, of whatever type, afecting their ability to deliver their objectives and performance standards. Some risks will also be of interest to the political level of management, such as a failure to meet political objectives or reputational risk (and reputational risk often can be adversely afected by a failure to meet externally set regulatory requirements) and the responsibility of a state secretary or equivalent is to ensure that information about such risks is available to that level of management.

Te development of risk management has been regarded as a priority activity in introducing COSO but this is not how it should be. Other standards of the COSO framework, apart from monitoring, should come frst. Again, this illustrates how risk management has been regarded as a 'stand-alone' activity rather than being integral to the managerial processes.

As with other international standards, the COSO standards are regularly updated and the head of the department responsible for the application of PFM/IC should familiarise him/herself with those and be aware of updates. In doing so the head should recognise that the updates tend to be written in the language of business enterprise and therefore need adapting to the operational environment of the public sector.

<sup>4</sup> Strategic Human Resource Management/Factsheets: CIPD www.cipd.co.uk.

#### **11.2.2 COSO and Management**

As COSO is about management, the emphasis in introducing PFM/IC should be on a management structure with managers appointed and their responsibilities defned. Tose managers, at all levels, need objectives and standards to work to, including performance objectives and standards. Tose objectives and standards should be derived from the objectives for the organisation as a whole, which should be set by the political level and then cascaded down the organisation by the senior operational management. Te performance standards should be, in general, related to user needs and any externally set regulatory requirements.

Tis is what is required before any of the standards of the COSO internal control framework can be made efective. Unfortunately, in most countries, none of this occurs. Te experience of this author in the application of PFM/ IC in most countries shows that the focus of application has been upon whether the bureaucratic procedures associated with the fve COSO standards have been applied. Assessments of reform performance have been based around assessments of the extent to which the bureaucracy associated with these fve standards has been introduced. Tey have not been regarded as managerial disciplines. Tis is a mistake and a mistake encouraged very often by aid organisations because the existence of the bureaucracy provides evidence of apparent action by the recipient country. Unless these fve standards are linked to managerial reform, with the development of a managerial structure, the appointment of managers, the setting of objectives, the development of information and fnancial systems with the accompanying accountability arrangements, these standards will have little or no practical efect upon the achievement of the objectives of the organisation efciently and efectively.

Another issue that should be addressed is how is that management to be made efective, with efectiveness being defned for this purpose, as delivering the objectives and performance standards set for them to time, to standard, within budget, efciently and efectively. Considerable emphasis is placed upon the issue of laws, decrees, rules and regulations and checking that the content of these has been obeyed. Whilst this can be important, management cannot easily be defned in such documents. Management at the top level in organisations is about setting the strategy, leadership, coordinating staf activity, making judgements between competing objectives, taking initiatives and applying the available budgetary and other resources to and ensuring that objectives are delivered efciently and efectively. Tis also requires a willingness to take risks because management involves making decisions and all decisions involve some element of risk. However, in most countries whether or not the requirements of these laws, decrees, rules and regulations introducing the fve COSO standards have been obeyed has tended to be the measured by how they have been incorporated into the internal rules of the organisation, not by the efect they have had upon the decision making processes. Tis is the 'check list' approach. What is much more important is an assessment of managerial efectiveness. In other words what matters is the impact that these fve COSO standards have had upon the performance of the management and hence of the organisation. Terefore, this is what the department responsible for implementing PFM/IC should concentrate on in assessing the quality of their application.

A particular example of the difculties of just looking at the literal application of laws, decrees, rules and regulations is the application of the frst standard, the control environment. Injunctions incorporated into laws and regulations about setting the 'right' control environment (very difcult to defne in any event) will not work unless accompanied by a commitment from the highest levels such as the prime minister and the cabinet of ministers to the need for all public organisations to ensure that appropriate ethical values and integrity ('tone at the top') are expressly stated and implemented. Tis requirement should cover both politically appointed ofcials and civil servants (including local government ofcials). Tis should also be accompanied by a further requirement that each organisation is committed to 'good governance' (see Chap. 1). However, none of this can be fulflled in practice unless an appropriate managerial structure exists with the assignment of authority and responsibility, including accountability arrangements for the diferent levels of management.

An approach to an assessment based simply upon the application of the laws, decrees, rules and regulations would in practice tell the department responsible for the application of PFM/IC very little about the real success in implementing the fve standards of COSO.

## **11.3 The Five Standards of COSO**

In this section of this chapter each of the fve standards is explained. Tey are discussed in the order in which they should be applied not in the order incorporated into the COSO or INTOSAI publications. Tis changed order refects the reality of the operational/managerial arrangements that apply before the introduction of PFM/IC. For example, and as indicated previously, risk management relating to objectives cannot be applied until objectives exist and a management structure has been established with managers appointed to deliver those objectives.

## **11.3.1 An Overview**

Te extent to which each of the standards can be applied depends upon the extent to which a managerial approach has been established. For example, the application of the control environment standard, as has been said above, depends upon the extent to which a managerial structure has been developed, including the separation of policy and strategy development from operational management, managers appointed and objectives and performance standards and objectives established with accountability arrangements defned. Tose accountability arrangements should not just be the internal accountability arrangements but also external accountability, not least to parliament and civil society. Although the political top manager may nominally be responsible for setting the control environment in practice, the application of that environment depends heavily upon the approach adopted by the top operational manager, in a ministry that would be the state secretary (or equivalent). However, the behaviour and attitude of the political ofcial(s) responsible for the ministry or other public organisation can afect how operational management is implemented and its success. Te political head may also change relatively frequently compared to an appointed ofcial and it would be totally inappropriate to expect the control environment to change with each new political head. Tat way would lie instability. In practice none of these fve standards could be introduced completely, certainly during the early stages in the development of PFM/IC: they will evolve over time. Also, as each of the fve standards overlaps with others, it is difcult, if not impossible, to disentangle the extent to which a particular standard has been applied compared with another. For example, if objectives are not being achieved is it because of inadequacies in the risk management processes or is it because of weaknesses in the provision of information or communications with another part of the organisation or with third parties, or again a weakness in the controls designed to secure the delivery of the objectives, or just poor management?

Chapter 13 of this guide refers to the need for management to prepare a statement of internal control. Tis statement should explain how management has performed during the year in terms of meeting its objectives and performance standards. Te statement should give the reader a clear understanding of the challenges facing the organisation and how those challenges have been responded to including remarks about what has gone wrong and the actions taken to make corrections. In other words, the statement should be an indicator of the quality of management. Tis statement would provide an important indicator of the quality of the internal control arrangements and would provide the best source of evidence.

#### **11.3.2 The Individual Standards**

#### **11.3.2.1 Te Control Environment Standard**

Internal control (IC) encompasses more than fnancial and budgetary control and more than compliance checks. It is a set of management arrangements that enhances the efcient and efective delivery of the organisation's objectives on time, in line with the performance standard and within the established budget. IC is based upon the COSO model. Both PIFC and IC should apply across the entire public sector and are applicable for the management and implementation of both national and EU funds.5

Te control environment determines the management attitude to the achievement of objectives, to the quality of the performance standards including externally set regulatory requirements, the operational processes, how operational managers and staf relate to each other, to the political management, to parliament and to the stakeholders in the organisation, particularly the users of its services (i.e., its clients/customers) and suppliers. It also determines attitudes to the utilisation of public resources and to developing efciency and efectiveness. Overall, it provides the basis for internal control across an organisation. Te control environment depends very much upon the personalities of the top and senior management (political and ofcial) and the personnel policies that are applied. (See also Chap. 14 which includes a discussion on delegation and personnel policies.) In the public sector, the control environment also should have regard to the principles of 'good governance' (see Chap. 1) although experience shows that this is rarely considered and neither are the principles of public administration considered (see Chap. 14), including the circumstances where delegation is appropriate or not. Again, the appropriateness of the personnel policies and their relevance to the

<sup>5</sup> SIGMA paper 59 June 2019 'Guidelines for assessing the quality of internal control systems' (https:// www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=GOV/ SIGMA(2019)1&docLanguage=En), page 21.

control environment are not considered. A characteristic of a control environment should be that it encourages a focus on the achievement of the objectives and performance standards and objectives of the organisation, so therefore these need to be in place frst. Te control environment should defne the standards of conduct that are expected to be applied throughout the organisation. Tat includes the integrity and ethical values of the organisation, how they can be embedded in the organisation and how the organisation's relations with third parties are to be conducted. It also requires the development of a 'can do' approach. Te control environment is also afected by the distinction made between the responsibility for policy and strategy development and operational management. As has been explained previously, this is because successful operational management depends upon the professional capabilities of the manager. To a large extent the control environment illustrates the 'intangibles' of management, that is, features that cannot be precisely described in a 'job description'.

In practice this standard is very difcult to implement and to demonstrate with evidence that it exists. Civil servants and other public ofcials appointed to managerial posts ought to be appointed basically for competence reasons, although this does not always happen and staf may be appointed for political reasons. Te expectation for the most senior civil service and local government ofcials (e.g., the state secretary and departmental heads) should include a capacity to set the control environment, even though it may not be defned in precise terms, and through their leadership ensure that the requirements of the control environment are implemented throughout the organisation.

A feature of the control environment should be a well-developed and managed personnel policy with a good and consistent leadership. As has been indicated, introducing PFM/IC represents a considerable change to the way in which public organisations are managed. Change can be very damaging to organisations unless it is well handled by the leadership of the organisation, that is, by the top and senior operational management. Staf must be motivated to work hard and use their talents and abilities, including initiative to make the best contribution they can to the work of the organisation. Change can cause morale to decline and be a cause of insecurity. Motivation is not just simply a function of fnancial reward, and in practice, diferent people are motivated by diferent things, in diferent ways and at diferent stages of their careers. A very important factor in staf motivation in the public sector is the quality of the work that is being undertaken.6 Other factors afecting quality

<sup>6</sup> See footnote 10 of Chap. 14 for an example.

can include how far staf are allowed to 'self manage' aspects of their jobs, the extent of staf development through training and the existence of development opportunities and feedback.7 Monetary rewards can work very well for tasks that are routine and measurable, but are less successful when creativity and imagination are required. Staf development policies designed to help staf develop their careers should be an important feature in motivation. Organisational culture also has a key role to play in the motivation of employees. If they are to be genuinely motivated to do a good job, rather than simply to comply with organisational rules and regulations, a sense of common purpose needs to be developed and employees need to understand how their individual contributions 'ft' within wider organisational objectives. Leadership and clarity are essential components of good personnel management. Yet this author has not come across any linkages between the introduction of PFM/IC and the development of personnel policies.

Associated with the control environment should be the development of professionalism within the civil and local government service. Professionalism is not just about competence and technical skill but is also about ethical behaviour. To reinforce behaviour codes of conduct or integrity for both politically appointed ofcials and civil servants should exist. Te content of the civil service or public ofcial code should be determined by the organisation responsible for the public service within a country and that for the politically appointed ofcials should be determined ideally, by the prime minister's or president's ofce. Tese should not just be 'token' codes but should be rigorously enforced.

Te reality is that an assessment of the quality of the control environment where there is no or very limited delegation with operational decisions being made by politically appointed ofcials would be very difcult to make (or even perhaps impossible). In such circumstances, assuming that the assessment would be undertaken by the 'driver' department in the ministry of fnance on behalf of the state secretary in that ministry, any remedial action probably could only be taken by the minister of fnance and his/her hands may be tied by political considerations especially if it involved criticism of another minister. If that other minister is not interested in the control environment or does not conform to the expected principles underpinning that control environment (e.g., the principles of good governance) unless there is a response to minister of fnance criticisms, the responsibility for action moves up to the prime minister which in turn makes any decision even more

<sup>7</sup>Debate: Motivating civil servants—insights from self-determination theory: Berend van der Kolk: Public Money and Management: published online 22 Jan 2020.

political. If in these circumstances the ofending minister is not really interested in or committed to applying the standards of internal control, then it is impossible to ensure that the rest of the organisation has that commitment. Tis is an important reason why the separation of operational management from policy and strategy development, with the application of PFM/IC, is so desirable.

A key factor in the establishment of the control environment is fnancial resilience. Without that the control environment will be subject to stresses that afect an organisation's ability to achieve its objectives. Te COSO commentary on the control environment does not specifcally refer to the establishment of a stable or predictable fnancial environment. However, implicit in the whole of COSO is that efective fnancial management and internal control exists and that means that the organisation management needs to be able to demonstrate that it is currently fnancially stable and has the fnancial resources to enable it to meet its objectives and that it will remain stable in the medium to longer term. Financial resilience means that expenditure and income will be matched at least over time and consequently that decisions made by the management or which are the consequences of external factors will not result in the fnancial destabilisation of the organisation. It also means that even within a fnancial year, budgetary fows are predictable and stable. However, experience shows that for countries introducing PFM/IC fnancial resilience is not considered as a factor in the management and delivery of public services and activities, and whilst an important feature of public fnancial management is the maintenance of fnancial resilience, in many developing and transition economy countries fnancial resilience depends upon the quality of the budgetary process, including its links with government objectives, and the quality of the assessment of the economic position of the country.

Te arrangements for assessing the quality of the internal control environment were described in the SIGMA paper referred to above (see note 6) issued by the OECD: Support for Improvement in Governance and Management Guidelines for assessing the quality of internal control systems.8 Tis paper described a set of principles that should be followed by managers. Five principles were described covering the quality of the internal control environment, that is, the public organisation:

Principle 1: Demonstrates a commitment to integrity and ethical values. Principle 2: Exercises oversight responsibility.

<sup>8</sup> SIGMA paper 59 June 2019 (https://www.oecd.org/ofcialdocuments/publicdisplaydocumentpdf/?cot e=GOV/SIGMA(2019)1&docLanguage=En), pages 22 to 32.

Principle 3: Establishes structures, reporting lines, authorities and responsibilities.

Principle 4: Demonstrates commitment to competence.

Principle 5: Enforces accountability.

IC quality assessment is a primary responsibility for the public organisation's management. Tis should not only consist of the evaluation of overall conformity with the established regulatory framework, but rather focus on how the functioning of IC enhances the operational efciency and efectiveness of the public organisation and the achievement of its objectives.9

Te characteristics that should be looked for in assessing the quality of the control environment were summarised in a European Commission paper based upon COSO as:10


Te oversight body referred to here is taken from the COSO principles and refers to the controlling board of a company. In the circumstances of developing and transition economy countries, the oversight body cannot be assumed to be the politically appointed top and senior management where that management has operational responsibilities and therefore has no role which is independent of the day-to-day operational management. It is doubtful if the politically appointed top and senior management could act as the oversight body even where that management is not responsible for operational activities unless it included a signifcant and genuinely independent membership which

<sup>9</sup>Guidelines for assessing the quality of internal control systems SIGMA Paper No. 59.

<sup>10</sup>Principles of Public Internal Control: Position Paper no 1: Public Internal Control an EU approach Ref 2015–1.

in a politically based organisation would be most unlikely. Te question then is who could form this 'oversight body'? Tere are four possibilities. One is that the ministry of fnance exercises this responsibility through the 'driver' department, acting on its behalf. A second is that this is made a specifc responsibility of the external auditor. A third is that each public organisation is required to appoint a body, such as an audit committee, which is independent of management and which has a capacity to report directly to the most senior level of management in an organisation (and that could be the political level of management) and that its reports are also copied to the department of the ministry of fnance responsible for the implementation of PFM/IC. A fourth is that the government or parliament establishes a new body with a specifc responsibility for overseeing the development of internal control activity within public organisations. Which solution should be adopted will depend upon local circumstances and that any organisation responsible for assessment has a high degree of independent membership. Tis points towards the third or fourth solutions. In addition, the external auditor should always review the quality of the internal control arrangements and report on them to parliament. What will be critical in assisting that organisation make a quality assessment of the internal control arrangements will be the statement of internal control referred to in Chap. 13.

## **11.3.2.2 Te Information and Communication Standard**

Tere is in practice potential overlap between this standard and the '*control environment*' standard. For internal control to be efective the managers and staf within the organisation need to know both what the organisation's objectives are and those that are set for themselves. Ideally, they ought also to know what the objectives are and the services and activities provided by other parts of their organisation. In other words, managers and staf need to know what is expected of them and how their responsibilities relate to those of others in the organisation. Tey also need to know the operational context for the whole organisation, as well as for their particular part of the organisation. Tat operational context includes knowing the resources available to them, that is, their budgets (i.e., *total* budgets including all elements of expenditure, not just some, such as only the sums available for procurement), how actual expenditure or income is occurring during the year, performance information that relates directly to their areas of responsibility and how performance is developing during the year, whether the demands upon a particular service are rising or falling, the short- and longer term strategic objectives, the pressure to improve efciency and efectiveness, the reaction of users of the service (whether internal or external to public organisations), actual and potential legislative, environmental and other changes afecting the operational environment.

Te exact information that will be required will depend upon the role and responsibilities of the manager and individual staf members. But, for example, if a manager has responsibility for the delivery of an objective, information about performance towards achieving that objective should be available to that manager as well as information about the fnancial resources that have been consumed. Tis should be available on a systematic and regular basis. If that manager is also responsible for efciency and efectiveness, as he/she should be, then that manager must know not only what the *total* available budget is but also in a format that is relevant to the manager. Te manager should receive fnancial accounting information showing progress against the budget in a similar format. In addition, the manager should have available information showing the allocation of budgets and accounting information over, for example, diferent cost centres, what drives costs or whatever else the manager requires. Te manager should also have available costing information so that judgements can be made about the most efcient methods of undertaking activities. In addition, efectiveness can only be judged by the impact that the activity is having and therefore the manager should be provided with user or customer information, whether the user or customer is internal to the government or external. Te 'driver' department should ensure that managers and staf have available to them the information they need. Unless they have that information, managers cannot efectively be responsible for risk management which is central to the successful delivery of objectives and performance standards.

Again, where a frst-level organisation uses second-level organisations to undertake activities on its behalf, the managers of the frst-level organisation must have the information necessary to enable them to exercise efective control and supervision of second-level organisation activity. Te manager must also ensure that second-level organisation activity is coordinated with that of the frst-level organisation and of other second-level organisations. Tis applies whether the second-level organisation is non-market based or market based (a state- or local government-owned enterprise). Te question that should be asked is, are the communication arrangements between the controlling or supervising organisation adequate to enable it to properly exercise its responsibilities?

Te responsibility of the political leadership of an organisation is to ensure that the top and senior operational management is kept informed of political developments that would afect the operational management. Te responsibility of the top or senior operational management is to ensure that the information individual operational managers require is available to them. If all this information is not available, managers can hardly be blamed for a failure to deliver objectives efciently and efectively. On the other hand, managers themselves may need to specify the information they require, and if top and senior management refuse to make the information fow possible, then at least some part of any responsibility for the failure to achieve objectives is transferred to those top and senior managers.

No organisation operates within a static environment and the changes afecting the operational environment need to be communicated throughout the organisation. Changes may become apparent at any level in an organisation, not just at the top and senior management level. Managers at all levels need to be aware of their responsibility to communicate signifcant change upwards to more senior managers through the accountability process.

Information and communication are not simply about internal activity. It is also about the provision of information to external organisations and individuals, its clients and customers. Communications with each of these groups should be clear, purposeful, relevant and timely. Without that the efectiveness of the organisation will be difcult to judge and its reputation could be adversely afected. Such external communications can include fnancial reports (but designed in a manner that is relevant to the reader of the report), communications about the organisation's policies and proposals and why the services that it delivers to its publics are designed in the way that they are and why any charges that it levies are also what they are and why they have changed (if that has occurred) from one period to the next. Clarity should also exist about arrangements for appeals against the actions of the organisation and how, where appropriate, compensation can be sought.

Tere are many factors that should be considered in assessing whether the information and communications strategy is being properly implemented. Te analysis shown below illustrates the difculty that exists for both management and the ministry of fnance 'driver' department in trying to identify separate features of management within each of the control standards. Overall, the real issue is the quality of management (Table 11.1).

Where there is little or no delegation of operational management responsibility from the political level, there can be difculties with communicating the policies and strategies within an organisation. Tis is because politically appointed ofcials do not normally regard staf communications as falling within their remit, except for those with whom they directly work. Again, the appointment of diferent political ofcials responsible for diferent policies


**Table 11.1** (continued)




aHR—Human Relations or sometimes Personnel Department (e.g., several deputy ministers or mayors) without any recognition of the need for coordination to harness the resources of the whole organisation itself encourages the development of a 'silo' mentality. (Te existence of 'silo mentalities' is a classical feature of public administration organisations.) A 'team meeting' of top politically appointed ofcials does not automatically mean that coordination will exist at lower levels in the organisation. Where operational implementation of policy is a responsibility of a civil or local government service management, then the development of a staf communications policy and associated activities should be easier to achieve provided that the top and senior civil or local government service management perceive the necessity and are willing to implement such a policy. Te organisational arrangements should accommodate this. But whatever the top management structure, emphasis should be put on developing an information and communications strategy for the organisation and an operational environment that encourages open and trusting relationships.

A feature of an efective information and communications policy is that if it is to encourage open and trusting relationships there must be adequate protection for 'whistle blowers'.11 Tis means that public organisations must fnd a reliable method of identifying and correcting any unlawful or unethical conduct that occurs within their organisation. Consequently, public organisations should:


Whatever the information and communication arrangements within an organisation, there can be a lack of understanding or interpretation between those making any statements (in whatever form) and those hearing or reading them. Merely issuing advice or an instruction does not mean that it will necessarily be interpreted in the way in which the author intended. How the recipient interprets that advice or instruction depends very much upon the position and perceptions of the recipient. Senior managers communicating with their stafs must be aware of the potential risk of the recipient of the communication hearing what they want to hear, rather than what the senior manager

<sup>11</sup>A whistle blower is an employee, who reveals information about activity within a private or public organisation that is deemed illegal, immoral, illicit, unsafe or fraudulent.

wanted them to hear. Tis author has been told by ofcials from several diferent countries that all that is necessary is to issue an instruction or regulation and it will be followed. Tat is a mistake! Te same problems exist with external communications. Care should be taken to avoid the use of 'jargon'.

Efective communication in the workplace helps staf and managers form highly efcient teams. It builds trust, reduces competition and encourages cooperation within and between units and departments and helps staf work together harmoniously leading to higher productivity, integrity and responsibility. Staf must know their roles and should know that they are valued.

A manager who openly communicates with staf can foster a positive relationship that benefts the whole organisation. Good communications can also improve employee morale. Employees do appreciate good communication from more senior management.

Te department responsible for the application of PFM/IC therefore should not just rely on legislative requirements set out in a public internal control or public fnancial management law or other formats to ensure that good communications are a feature of the internal control arrangements. Tis is though the apparently usual process in some countries adopting this reform. A deep understanding of efective communications is necessary and in reviewing the application of this standard, evidence that this exists should be looked for. In other words, the 'driver' department responsible for applying PFM/IC should look for the features of an information and communications strategy outlined here and for the efectiveness of the strategy. Tat responsibility also extends to external communications.

A European Commission paper based upon COSO defned a set of principles afecting information and communication. Tese were that the public organisation:

Principle 13: Obtains, generates and uses relevant, quality information.

Principle 14: Ensures proper internal communication.

Principle 15: Ensures proper external communication.12

#### **11.3.2.3 Te Control Activities Standard**

Te political management should have a responsibility to ensure that the objectives of the organisation are delivered, that they are delivered efciently

<sup>12</sup> SIGMA paper 59 June 2019 'Guidelines for assessing the quality of internal control systems' (https:// www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=GOV/ SIGMA(2019)1&docLanguage=En), pages 47 to 52.

and efectively, that performance standards and objectives are observed and especially those set by external regulators, that the resources of the organisation are properly safeguarded and used only for the purposes of the organisation and not, for example, for political or personal purposes. Tey also have an obligation to ensure that the objectives imposed upon the organisation by others and most notably by the ministry of fnance to maintain adequate budgetary and fnancial control are properly met. Top and senior operational and political management also have a responsibility to ensure that the fnancial reports to the ministry of fnance, including the year-end fnancial statements and other statement, are reliable. Controls should also be concerned with the longer term fnancial viability of the organisation. Te actual application of these responsibilities, as has been shown in earlier chapters, should be undertaken in practice normally by the operational management and this should be made clear through the delegation and accountability arrangements. Te accountability arrangements should be designed to ensure that the political management can be confdent that the operational management is acting competently and responsibly. Te aim of the control activities should be to ensure that all this is achieved. Te control activities should be designed to reduce the risk of failure by the operational management to achieve objectives and performance standards efciently and efectively and that public resources are being properly utilised. Te operational management should also ensure that commitments are not entered into which would afect adversely the fnancial sustainability of the organisation and should advise the political management where such a risk appears to be occurring or would occur if particular decisions were made.

A key feature of control activity is 'accountability'. Lower levels of management are accountable to more senior levels for the delivery of their objectives within the relevant constraints. Top and senior operational management responsibility is to test out in its actions whether the control activities are efective and this should be demonstrated in the accountability arrangements. Tat is, are the reporting systems efective; do they address the key issues; are reports used as the basis for decisions; do follow up processes exist and are acted upon? Similarly, the accountability arrangements between the top operational management and the political level of management should be assessed by both sets of management to ensure that they provide the confdence that the political level of management requires.

Te department responsible for the application of PFM/IC should assess as one of its monitoring activities both how well the control activities within an organisation are operating and the range of those control activities, most notably that they are not limited to traditional fnancial and budgetary controls. An indicator of this is by establishing how successful the organisation has been in achieving its objectives, within budget, to time, to standard, efciently and efectively and meeting all regulatory requirements. Some of the detailed analyses to assess the quality of the individual internal control processes include:


Te control activities should focus on outputs as well as inputs and a responsibility of top and senior operational management is to ensure that the appropriate controls exist.

One area of internal control activity that is frequently overlooked is that concerned with the risks to the longer run fnancial resilience of the organisation. Tis is discussed in Chap. 8. Most internal controls are focussed upon current operations, yet the ability to continue current operations into the future is heavily infuenced by longer run fnancial considerations. By undertaking strategic fnancial planning an organisation should be able to forecast its future demands for current funding from the national budget or for new capital investment. Only then will an organisation be able to either argue for additional resources or to assess the scale of the cuts to existing activities (if that is the situation) or consider adjustments to its strategic plans that it may need to make. Strategic plans should also exist and those strategic plans should include a fnancial dimension to demonstrate what the costs will be of achieving strategic objectives.

To assist top and senior operational management determine the appropriateness of the internal control arrangements (and it is their responsibility to ensure that these controls are appropriate) they ought to ask themselves a series of questions covering output and input controls and the controls concerned with longer term fnancial sustainability. (Tese questions which link with other internal control standards should also enable the 'driver' department responsible for the application of PFM/IC to form a judgement about the efectiveness of the controls.) Examples of some of the questions which refer to ministries, but which can be adapted to meet the needs of other types of public organisation such as local governments, are as follows:

## *Overall Questions***:**

	- Is each manager within the organisation clear about the objectives and standards that the manager is expected to meet?
	- Are the relevant managers fully aware of externally set regulations and do systems exist to demonstrate how they are being met?
	- Has each manager the information available so that not only can that manager monitor what is happening but also be fully and properly accountable?
	- What controls exist to ensure that objectives and standards are achieved efciently and efectively?
	- Where the health and safety of clients and staf is a major concern (as in hospitals or high-rise housing or child care facilities), is there absolute clarity about standards expected and do management systems exist to secure observance of health and safety standards?

where a policy decision has been made to subsidise those costs or to provide a surplus, that the fnancial information has been properly and fully calculated and therefore that the real level of subsidy is apparent and to whom?

## *Questions About Input Controls***:**


reduce the accountability of the manager? Te consequential question for top and senior management then is how does this, in turn, afect their responsibilities and should any external controls be challenged, for example, over stafng arrangements?

	- (ix) Are the controls that exist within the IT systems sufcient to protect against fraudulent misuse through inadequate security arrangements and against hacking and other forms of attack: what is the evidence that those controls have been fully tested? Are the controls only nominal or are they properly applied in practice and what is the evidence for that?
	- (x) Have all operating system updates issued by software manufacturers been applied?
	- (xi) Is there confdence that the reporting to the ministry of fnance (and where appropriate to other third parties) is accurate and timely and that the fnancial statements properly present the fnancial position of the organisation? (Internal and external audit have an important role but the primary responsibility is that of the management.)

breaches of security, mismanagement or IT breakdowns? Do 'back-up' systems exist? Archiving applies to all operational as well as fnancial records. Can these questions be answered positively for electronically held records as well as for physical records?

*Questions About the Controls Concerned with Longer Term Financial Sustainability***:**


Tese examples of control activities also demonstrate the interlocking of this standard with those for the control environment and information and communications. Tey also emphasise that control activities are not simply about fnancial and budgetary controls but that technical controls also are very important and a failure to observe technical controls is likely to result in major future costs as well as costs to reputation.

A European Commission paper based upon COSO summarised the requirements of control activities as the public organisation:

Principle 10: Selects and develops control activities Principle 11: Selects and develops general control activities over technology Principle 12: Deploys control activities through policies and procedures13

Te responsibility of the top and senior operational management should be to ensure that the control activities that are employed are efective and that the political management is satisfed with their quality. Tey also need to satisfy the external auditor and consequently parliament, and those to whom the organisation is accountable (e.g., to the cabinet of ministers, to parliament and to civil society). Te top operational manager should ensure therefore that appropriate control activities actually exist, operate efectively and be confdent that all staf are familiar with the controls that afect them and how they should operate. Tis would mean that staf job descriptions fully cover the responsibilities for the relevant controls and that staf appraisal arrangements also cover references to awareness of those internal control arrangements. Periodic assessments of the efciency and efectiveness of these controls should occur with internal audit and any relevant external organisation being assessors.

Te exact form of the control activities will depend upon the services and operational activities that the organisation is engaged in.

#### **11.3.2.4 Te Risk Management Standard**

#### *An Overview*

An important element of control activity is that the risk management processes operate efectively. Te aim of risk management is not to eliminate risk because only by taking risks will change and improvements in the delivery of services and activities occur. Te purpose is to identify and then manage the

<sup>13</sup> SIGMA paper 59 June 2019 'Guidelines for assessing the quality of internal control systems' (https:// www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=GOV/ SIGMA(2019)1&docLanguage=En), pages 41 to 47.

risks so that objectives and standards can be achieved and that adverse consequences can be avoided or minimised by careful assessment, planning and management. Te 'driver' department of the ministry of fnance should issue detailed guidance on how the reporting associated with risk management should be developed and applied taking into account the arrangements for delegation and managerial accountability that exist at the time.

Te key to the efective management of risks is the 'tone at the top' of the organisation (the 'control environment standard'). Tis afects the priority that the diferent levels of operational management and staf give to risk management and the comprehensiveness of the risk management arrangements. Te behaviour and actions of the top and the senior management and how they communicate with and challenge the diferent levels of management about risk illustrates the degree of signifcance attached to risk management. If the leadership attitude is one of indiference and there is no real top-level ownership, especially by top operational management, or the messages from the political leadership and top-level operational management are inconsistent, this will be damaging to the risk management process.

Te primary concern of the political level of management should be with the relevance and quality of the organisation's risk management policy.

Whatever the managerial circumstances and the level of risk, there are various ways in which risks can be addressed. One way is through building in additional controls, another is by changing the management arrangements, or by some form of insurance, by sharing the risk with a third party, by changing designs or even not going ahead with a policy, project or activity because the perceived risks are too great.

Te UK Treasury issued a publication on the Management of Risk— Principles and Concepts. Tis emphasised signifcance of the role of management as: "For the risk management framework to be considered efective, the following principles shall be applied: A. Risk management shall be an essential part of governance and leadership, and fundamental to how the organisation is directed, managed, and controlled at all levels. B. Risk management shall be an integral part of all organisational activities to support decisionmaking in achieving objectives. C. Risk management shall be collaborative and informed by the best available information and expertise. D. Risk management processes shall be structured to include: a. risk identifcation and assessment to determine and prioritise how the risks should be managed; b. the selection, design and implementation of risk treatment options that support achievement of intended outcomes and manage risks to an acceptable level; c. the design and operation of integrated, insightful and informative risk monitoring; and d. timely, accurate and useful risk reporting to enhance the quality of decision-making and to support management and oversight bodies in meeting their responsibilities. E. Risk management shall be continually improved through learning and experience."14 (Although this publication has been issued by a country with a well-developed public sector management structure, it does contain very clear guidance which could be usefully applied in countries introducing PFM/IC.)

For risk management to be efective:


If the top political and operational management are not interested in the development of risk management throughout the organisation (i.e., genuinely interested as opposed to 'going through the motions'), then there is something wrong not only with the risk management process but also with the management arrangements themselves. Te risk management process must be of genuine interest to these top ofcials. Tey cannot though be expected to personally manage all risks. Teir personal concerns should be that there is efective risk management throughout the organisation and that they are focussed on the signifcant risks to the organisation, perhaps no more than 15 to 20. However, this number does depend upon the nature of the service or activity. If the number rises above this level, then there is almost certainly

<sup>14</sup>Te Orange Book—Management of Risk-Principles and Concepts: P6: Published by UK Government, updated 2020. Orange Book—GOV.UK (www.gov.uk).

<sup>15</sup>Te ofcial within an organisation responsible for the managing and efectiveness of the risk management process should be the ofcial responsible for the application and quality of the PFM/IC reform within an organisation, that is, the state secretary or equivalent. If there is no delegation, in practice how a political ofcial could actually take on the responsibility for risk management is difcult to see because of the detailed operational management knowledge that is required and the detailed bureaucracy that is likely to be involved. However, the top political manager must recognise and accept the importance of risk management in ensuring that the political objectives of the organisation can be achieved. Terefore, interaction between the political head and the top operational manager is essential.

something not right about the risk management assessment arrangements and the top management is being drawn into too much detail. Tis is likely to devalue the risk management as a process. Once a risk has been accepted, then what matters most, given systematic review, is change in the level of risk. Why is that change occurring?

Te Orange Book referred to above also defnes 13 diferent categories of risk, that is, Strategy risks—Governance risks—Operations risks—Legal risks—Property risks—Financial risks—Commercial risks—People risks— Technology risks—Information risks—Security risks—Project/Programme risks—Reputational risks.16 For countries adopting PFM/IC to analyse risks over these 13 diferent categories at the initial stages of development may be too complex. Te following may be an oversimplifcation but initially an important distinction should be made between managerial or strategic risk management and systems risk management.

Managerial or strategic risk management should be concerned with the key or strategic risks facing an organisation, which could fall into any of the categories identifed above. A responsibility of the top operational management is to work with the political management to identify those risks with which the political management is concerned and how it wishes that they should be managed including being kept informed about them. Most risks will be managed by the operational management but others may have aspects which are of particular interest to the political management as well as to operational management. Te top operational management should identify and focus upon those managerial or strategic risks that have a direct impact upon their efective management of the organisation.

Examples of high-level risks that political management may be concerned about include signifcant potential damage to the reputation of the organisation, signifcant legal action against the organisation, signifcant fnancial losses, risk of death or serious injury to users of the service or to employees, an attack on the IT security systems that results in the theft of private personal data or the corruption of a major IT system that prevents a service or activity being delivered, such as social security payments or the taking of decisions that could signifcantly afect the long-run fnancial resilience of the organisation.

Another example of high-level risk that organisations should take into account is risk to the continued operation of the organisation as a whole or signifcant parts of it. An important responsibility therefore of top and senior

<sup>16</sup>Orange Book—p. 38.

management (political and ofcial) is business continuity planning in the event of some major external threat to the organisation. A recent example of this is the impact of a disease upon management and the clients/customers of the organisation and on the organisations that are major suppliers.

Systems risks may or may not be important to top and senior operational management, and sometimes political management may need to become involved. However, it all depends upon the circumstances. If the system is vital to the efective functioning of the organisation (such as a social security system or disease prevention in a hospital), then the top political management would inevitably become involved. Otherwise, most system risks could be managed by operational management.

As has been pointed out previously, all decisions involve some element of risk and in some countries the risks associated with usual day-to-day management activity have been incorporated into the formal risk management processes. Tis is a mistake. Tese normal operational responsibilities should not be included in the formal risk management processes and to include them, as some organisations do, is to devalue the impact of risk management.

Whatever decisions are made about risk management, whether by political or top operational management, risks should be subject to regular review because circumstances change. How frequently such reviews should occur should depend upon the particular risk being considered!

#### *Managers and Risk*

Te introduction of risk management into the management process adds considerably to the responsibilities of managers. In some organisations, defning and managing risk will be a complex process requiring considerable skill, expert knowledge and the exercise of judgement. Hence there may be a need to appoint staf to support the managers who are expert in identifying and making judgements about risk in a particular area of activity, for example, in the provision of health services, in the development of infrastructure, in policing and prison services, in services with a high risk of fraud such as those providing benefts to individuals or in fraud and corrupt practice in purchasing and supply arrangements. Tose risks that involve the health and safety of employees should always be discussed with the potentially afected employees, or their representatives, including the proposed mitigation measures.

Te management approach to risk at lower managerial levels should be based upon the risk to the achievement of that manager's objectives and the relevant performance standards (emphasising again that each manager should have objectives and standards). Te process for addressing lower level risks should be, in principle, the same as that described above for high-level risks. Each lower level manager should report those that he/she regards as the more serious risks to the next higher level of management to determine whether in turn they should be referred further up the management structure until they reach top and senior management. Tey should also report to the next higher level of management on changes in the level of risk, especially where those changes indicate a worsening of the level of risk. Once risks have been identifed, the individual manager's responsibility is to analyse those risks to determine how those risks should be managed and which risks may need to be reported to and agreed with more senior management.

An example of a service that will require specialist risk management skills is that of the management of hospitals. Hospital management will be concerned with the management of clinical and non-clinical risks and these will be managed in diferent ways.

Trough risk management there are signifcant opportunities for achieving improved quality of care, major costs savings, improved public perception and a reduction in clinical negligence claims by having the correct risk management strategy. Te goals of the risk management strategy could include:


Another example is the management of schools. A major immediate concern to the managers of a school will be the health and safety of pupils. Risk assessment involves considering the severity of consequences if a person or pupil is exposed to a potential risk, combined with the likelihood of it happening. Te level of risk will increase as the likelihood of injury or illness or its severity increases. A risk assessment can help determine:


<sup>17</sup>Extract from 'An exemplar operational risk management strategy' UK NHS January 1997: fle:///C:/ Users/User/Dropbox/Reference%20sources/Risk%20Management/An\_exemplar\_operational\_risk\_ management\_strategy.pdf.


#### *Te Practicalities of Introducing Risk Management*

A degree of bureaucracy is necessary to identify risk, indicate who is responsible for its management, demonstrate the actions that have been taken and identify the trends in the development of the risk. A formal risk register therefore should be established: a single register covering all risks can be unwieldy and a more practical approach can be to establish risk registers that address managerial or strategic risks and separately for lower order risks.19 Again, different risk registers can be developed for diferent parts of the organisation. Which is the most appropriate approach depending upon the management arrangements within the organisation? Top and senior operational management, subject to any political management concerns, should determine the monitoring and reporting arrangements. Te overall responsibility for the risk register process should lie with the head of operational management. However, the actual 'process' responsibility could be delegated to another ofcial. Tat a specifc ofcial should have this bureaucratic responsibility in no way removes from the top operational manager, the state secretary or equivalent, their ultimate responsibility for managing risk and for ensuring that an appropriate risk management process applies throughout the organisation.

Decisions should also be made about the frequency for the reporting of risks. Tis could vary depending upon the type of risk and the personalities involved. Tis will mean that the risk register(s) will need to be updated (and coordinated) so that each higher level of management is aware of the development of risks and the efectiveness of the mitigation measures. How often updating or review of risks should occur will depend upon the nature of the

19A typical risk register contains:


<sup>18</sup>Taken from https://www.education.govt.nz/school/health-safety-and-wellbeing/managing-risks-andhazards-at-school/risk-identifcation-assessment-and-management.

<sup>•</sup> A risk category to group similar risks

risk and the bureaucracy should have the capacity to be fexible about the updating arrangements. Particular regard should be had to trends in the movement of individual risks—is the risk declining or increasing?

## *Te Responsibilities of the Top and Senior Operational Management*

Te top and senior operational management have a substantial range of risk management responsibilities even though in practice some would be delegated to other ofcials. Te main responsibilities of the head of operational management should include to:


<sup>20</sup>Tis should be regarded as a dynamic activity because determining risk appetite is not a single fxed concept and it will vary both for individual types of risk and over time, all depending upon circumstances.

ment, natural events, unforeseen international price movements, failures in a supply chain such as bankruptcy (but this risk in some circumstances should have been foreseen and therefore the real cause is mismanagement), misjudgement of demand for a service or activity (again a potential cause is mismanagement) or in construction, unstable ground conditions or unavailability of key workers such as engineers.


How does top and senior operational management undertake these responsibilities towards risk management in practice? Te United Kingdom National Audit Ofce addressed this in a publication by setting out a series of questions for top and senior operational management to consider.21 Tese are:


<sup>21</sup>Managing Risks in Government: National Audit Ofce 2011.


#### *Risk Appetite Impact and Likelihood*

'Risk appetite' has been defned as "the amount and type of risk that an organisation is willing to take in order to meet their strategic objectives". Even though the top operational management may defne the policy on risk appetite, the political leadership should agree that policy because of its signifcance. "Organisations will have diferent risk appetites depending on their sector, culture, and objectives. A range of appetites exist for diferent risks and these may change over time."22 No risks should be acceptable which exceed the defned risk appetite. However, 'risk appetite' is not always quantifable and may require managerial judgement. PFM/IC requires a managerial approach to the delivery of the objectives of an organisation, and as all managerial decisions involve a greater or lesser degree of risk, the existence of a risk appetite statement provides guidance to managers about the risks that can be taken to achieve an objective.23

In making decisions about risk two features are important. Tese features are what is the likelihood of the risk occurring and if the risk does occur what will be the impact? Te management should assess these in terms of how the risk will afect the achievement of the objectives and performance standards and objectives. Te estimates of the costs can then be compared with the costs of taking mitigating actions and the extent to which those mitigating actions will reduce the risk. Tis type of analysis can be undertaken with varying degrees of detail and complexity, depending on the purpose of the analysis, the availability and reliability of information and the resources available. Also risk analysis can be infuenced by opinions, biases, perceptions of risk and judgements and the quality of the information used. Often a scoring method

<sup>22</sup> Institute of Risk Management UK 2017 (https://www.theirm.org/knowledge-and-resources/thoughtleadership/risk-appetite-and-tolerance/).

<sup>23</sup>A risk appetite statement sets out the amount and type of risk that an organisation is willing to take in order to meet its strategic objectives. Te appropriate level of risk will depend on the nature of the work undertaken and the objectives being pursued.

may be applied to provide a basis for assessing the signifcance of the risk. Both impact and likelihood should be scored (although some risks may be difcult to quantify and managers will need to make judgements).24

Te Institute of Risk Management has listed stages in the development of risk appetite statements.25 Tese are:


## *Publication*

Risk management/appetite statements ideally should be published on the grounds of transparency and accountability and as one of the improvements emerging from the development of the quality of corporate governance. In countries which are in the process of adopting PFM/IC, there are basically two other signifcant reasons for the ministry of fnance 'driver' department to require the development of annual risk management/appetite statements and for the completion of such a statement to be a specifc responsibility of top and senior management. Tese are:

• To cause top and senior management to be aware of their risk management responsibilities and that risk management is not a lower level requirement which can easily be met by leaving it to lower level staf or internal audit and to be completed through the traditional bureaucratic procedures; and

<sup>24</sup> Scoring may be on a three- or fve-point scale. With a three-point scale the scoring would be 'high' (3), 'medium' (2) or 'low' (1). Te fve-point scale elaborates on these three points. Te overall risk assessment calculation is made by multiplying the two scores.

<sup>25</sup>https://www.theirm.org/media/3296897/0926-IRM-Risk-Appetite-12-10-17-v2.pdf.

• To require top and senior management to engage in the systematic and ongoing review of risks and to then make decisions about the range of risks that the organisation faces, the extent to which risk is acceptable in order to achieve objectives and the appropriate mitigating measures.

Examples of risk management statements are included in the annex to this chapter. Tey refect diferent approaches to risk management. Te common features are that the details are published and the approaches to risk management as well as who is responsible are also made clear. In other words, they meet the most desirable features of transparency and accountability. Unfortunately, countries currently adopting PFM/IC do not appear so far, to publish such types of statements. Yet a requirement for top and senior management to publish such statements would encourage risk management to become embedded into managerial arrangements. In the examples, risk management is shown to be a fundamental feature of management processes and therefore the operational context will refect this as will the existence of objectives and performance information coupled with accountability pressures to achieve those objectives and levels of performance. Without a specifc requirement falling upon top and senior management to specify the risk management arrangements they have established and the extent to which risk is considered and is acceptable, there is every possibility that considerations about risk will be superfcial. Tis in turn, means that there will be less likelihood of objectives and standards being achieved. What is published for external stakeholders such as other ministries and the ministry of fnance as well as parliament, pressure groups and service users (i.e., civil society) may be diferent from that published for the beneft of internal stakeholders (i.e., primarily the managers within the organisation). Without such an internal statement, lower level managers within the organisation will be providing services and activities with no or insufcient guidance on the levels of risk that they are permitted to take. Tey may also be deterred from developing new ideas and proposals to improve services and activities for fear of taking on additional risks because they do not know what level of risk is acceptable to top and senior management. In an administrative culture that has been traditionally risk averse, which is the situation in most of the countries adopting PFM/IC, clarity about top and senior management towards risk is very important.

Where publication of comprehensive information is deemed to be too diffcult in a particular country, then all such reports should be available internally within a government. Similarly equivalent reports for individual local governments and state-owned enterprises should also be published.

Where agencies and state-owned enterprises are subject to the control or supervision by a ministry or local government, that ministry or local government should ensure, as part of its performance or service level agreement with the second-level organisation, whether market or non-market based (see Chap. 12), that risk management is introduced in those organisations. Te risk management arrangements that have been put in place should be covered in the reporting arrangements between the second-level organisations and the controlling or supervising ministry or local government. (NB. A particular feature of the risk management control arrangements between frst- and second-level organisations of whatever type should be that no fscal risks should be entered into without the specifc agreement of the frst-level organisation.) 26

#### *A European Commission Overview About Risk Management and COSO*

A European Commission paper based upon COSO summarised the requirements of risk assessment as the public organisation:


#### **11.3.2.5 Te Monitoring Activities Standard**

Te purpose of monitoring is to evaluate whether the arrangements for PFM/ IC are making it possible for an organisation to achieve its objectives, doing so efciently and efectively, to time, to standard and within budget and also

<sup>26</sup> Sources of fscal risks include inadequacy of budgetary contingencies, guarantees given to third parties, public/private partnership arrangements, long-term contracts, environmental events, risks arising from the disposal or acquisition of assets and liabilities, compensation or other payments arising from legal challenges.

<sup>27</sup> SIGMA paper 59 June 2019 'Guidelines for assessing the quality of internal control systems' (https:// www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=GOV/ SIGMA(2019)1&docLanguage=En), pages 70 to 79.

within the laws and regulations to which the organisation is subject. Monitoring is also concerned to ensure that the organisation has adopted and is applying a commitment to integrity and ethical values. If these features are not occurring, the next question is why is this? Te focus of monitoring in many countries that are introducing PFM/IC has been simply on whether the bureaucratic processes relating to the four other standards are in place with observations about the defciencies that exist (if any). However, the SIGMA Guidelines for assessing the quality of internal control (IC) systems states that "Monitoring of the IC system is essential to ensure that IC remains aligned with changing objectives, environment, laws, resources, and risks. IC monitoring assesses the quality of performance over time and promptly resolves the fndings of audits and other reviews. Corrective actions are a necessary complement to control activities in order to achieve objectives."28

Te monitoring processes that have been adopted in this author's experience do not in general appear to address the main purpose of the reform. In most countries they also do not recognise that each standard is not a 'standalone' process which can be separately assessed. Te procedural processes associated with each standard, as has been shown, are not easy to separately identify except at the most superfcial level. Because the standards are interlocking, the monitoring process needs to refect this. Tis will be best achieved by looking at the overall performance of the organisation in achieving its objectives and performance standards and objectives efciently and efectively. Reliance is also often placed on 'self-certifcation'. What this means in practice is difcult to understand. Te monitoring process needs to establish how far the assumptions, referred to at the beginning of this chapter, that lie behind the COSO process have been recognised. Monitoring is not therefore a simple 'tick-box' end of year type of process checking that the required bureaucratic procedures have been implemented. To emphasise, introducing the COSO standards is not simply a bureaucratic exercise but it has a specifc purpose. Tis purpose is to achieve the objectives of the organisation efciently and efectively, to time within budget, to standard with proper regard for integrity and ethical values, transparency and accountability and as part of this ensure that the law and regulatory requirements to which the organisation is subject are fully met. Monitoring should be aimed at this purpose, that is, is it being achieved and if not why not? Anything else at best can be regarded as an interim process. Each of the individual standards is ultimately aimed at

<sup>28</sup> SIGMA PAPER No. 59. Para 2.5 p. 51: OECD iLibrary | Guidelines for assessing the quality of internal control systems (oecd-ilibrary.org).

this purpose. Te most efective test for the application of PFM/IC is how successful the organisation management has been in meeting this purpose. Tat is the point from which monitoring should start.

Without such an evaluation, whether the COSO standards have been properly applied cannot be established. Terefore, whether the policy of PFM/IC is meeting expectations also cannot be established. So, the question cannot be asked. Monitoring should start from whether the objectives and performance standards and objectives of the organisation have been achieved efciently and efectively, within the law and budgetary constraints. Te monitoring aim should then be to identify if they have not, what are the weaknesses that have allowed this to occur.

Monitoring responsibility within an organisation should be that of the top and senior operational management where the overall responsibility lies for the achievement of the objectives and performance standards. Monitoring should form part of the accountability arrangements fowing up the organisation, ultimately to the top and senior management, ofcial and political. Monitoring should identify weaknesses in the quality of the management of the organisation itself (i.e., technical, operational and fnancial). A failure to properly carry out certain procedures is a management failure, not just a procedural failure which can simply be corrected by bureaucratic action.

Apart from the top and senior management, monitoring will be of concern to others. One will be to external regulators concerned with the observance of technical standards, another will be to the 'driver' department of the ministry of fnance responsible for the application of PFM/IC and a third will be to parliament. Te role of the ministry of fnance in monitoring should be to judge the quality of operational management. Lack of achievement of objectives and performance standards, a failure to meet external regulatory standards as well as the quality of fnancial control should afect future budgetary allocations. Parliamentary monitoring (i.e., scrutiny) should have a central concern for the quality of management, the delivery of objectives efciently and efectively and the meeting of technical regulations. Parliament may have its own scrutiny requirements and it may rely for advice on the external auditor who should have a concern about the quality of public expenditure through its assessments of value for money. Tis may lead on to a further form of external scrutiny, that of civil society.

What should also stimulate monitoring is that it should result in each public organisation publishing an annual report covering all its activities and, unless consolidated into a whole of government statement, its fnancial statements, along with a 'statement of internal control' (see Chap. 13). Te 'statement of internal control' should describe the efectiveness of internal controls applying within an organisation.

Monitoring should be an ongoing process and the PFM/IC driver department should provide advice on how that is to be undertaken, including the extent of the monitoring required. As PFM/IC is developed it may also wish to regularly review the outputs of those monitoring arrangements.

Internal audit has an important role in the monitoring process. But it can only undertake this role efectively if internal audit recognises that it is operating within the managerial context set by PFM/IC. Tis means that internal audit should have a thorough understanding of the PFM/IC reform and how it afects decision making by managers. Terefore, the training of internal audit should be aimed to ensure that internal audit capability extends beyond traditional internal control monitoring based simply upon systems controls with a focus upon fnancial and budgetary controls.

Te aim of an internal audit evaluation is to provide a 'lens' to show to the top and senior operational management how efective the application of the COSO standards by management is.

A European Commission paper based upon COSO summarised the requirements of monitoring as the public organisation:

16. Selects, develops and performs ongoing and/or separate evaluations.

17. Evaluates and communicates defciencies.29

# **11.4 Summary**

In this chapter the international standards of internal control have been described. Tese standards are essentially managerial disciplines. Te context into which they are to be applied is an operational management context. Tese international standards cannot be isolated from this managerial context and treated as individual 'stand-alone' features of PFM/IC. Te impact of each standard also cannot be clearly separated one from the other. Yet that is how they are treated in many developing and transition economy countries applying the standards. In considering the application of these standards regard should also be had to the assumptions that underpin these standards and these assumptions refect the managerial context in which the standards are to be applied. Again, this is not usually something which is either recognised or considered.

<sup>29</sup> SIGMA paper 59 June 2019 'Guidelines for assessing the quality of internal control systems' (https:// www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=GOV/SIGMA(2019)1& docLanguage=En), Pages 92 to 96.

Te detailed analysis of the application of each of these standards demonstrates how they impact upon the managerial arrangements. Tose managerial arrangements should be designed to deliver the objectives and performance standards and objectives of the organisation efciently and efectively within the budgetary and legal framework. Tese standards apply principally to operational management. Terefore, an important precursor to their implementation is the separation of operational management from the political level. Tese standards though also provide an opportunity for the political level of management to have an informed insight into how well the operational level of management is working. From this point of view therefore the political level of management should support the full application of these standards, but again what is essential is managerial reform.

An indicator of how well the standards have been applied would be described in the statement of internal control which each organisation ought to prepare as part of the annual reporting arrangements (see Chap. 13). Tis statement should be available to the ministry of fnance, to parliament and to the wider public (civil society) as part of the transparency and accountability arrangements. Either accompanying the statement of internal control or separately, a public organisation should publish a statement about its approach to risk, that is, its risk appetite.

## **Annex 1**

#### **Examples of Risk Management Statements**

Examples of risk management statements are set out below in a summarised form. Practical examples can be found by searching the web. Not all organisations are willing to publish such statements but with the introduction of PFM/IC and the emphasis upon transparency and accountability and an increased quality of governance, the managerial assumption should be in favour of publication unless there are very good reasons not to do so. Tese examples are for a hospital, a university and a state-owned industry and are based upon UK organisations. (Tese statements have been slightly edited by the author for publication within the context of this guide.)

**Example 1.** *A hospital* (Hospitals provided as part of the UK National Health Service (NHS) are established as trusts and are governed by trust boards. An operational management with a chief executive has the delegated responsibility for the day-to-day management of the hospital and is accountable to the board.)

#### **Risk Management Example Statement**

*Overview*

Te aim is to provide high-quality, efective and safe services which improve the health, wellbeing and independence of the population it serves. Te Board [i.e., the governing board of the hospital] recognises risk is inherent in the provision of healthcare and its services, and therefore a defned approach is necessary to identify risk context, ensuring that the Organisation understands and is aware of the risks it's prepared to accept in the pursuit of the delivery of the Organisation's aims and objectives. Tis Statement sets out the Board's strategic approach to risk-taking by defning its boundaries and risk tolerance thresholds and supports delivery of the Risk Management Strategy and Policy.

## **Risk Appetite Statement**

## *Clinical Efectiveness*



## *Patient Safety*

• We will hold patient safety in the highest regard and are strongly averse to any risk that may jeopardise it. Tis key value is a driver that directly supports our core objective to improve the safety of our services to patients.

• It can be in the best interests of patients to accept some risk in order to achieve the best outcomes from individual patient care, treatment and therapeutic goals. We accept this and support our staf to work in collaboration with people who use our services to develop appropriate and safe care plans based on assessment of need and clinical risk.


#### *Finance*

• We will strive to deliver our services within the budgets modelled in our fnancial plans. However, budgetary constraints will be exceeded if required to mitigate risks to patient safety or quality of care. All such fnancial responses will ensure optimal value for money.


#### *Patient and Service User Experience*



## *Workforce*



#### *Infrastructure*



#### **Risk Tolerance**

Risk 'tolerance' is the minimum and maximum risk the organisation is willing to accept as refected in the risk appetite themes above.

Detailed thresholds are articulated in the Risk Management Strategy & Policy statement and are dependent on the type of risk, against which all identifed risks are assessed for their likelihood and impact using a risk scoring matrix.

Te Executive Risk & Assurance Group will oversee all risks that score outside the risk appetite monthly and has established a rolling programme where each division (including Corporate Services) will present their full risk registers.

Te Trust Board have agreed that all risks with total risk score of '12' will require executive oversight by the Executive Risk & Assurance Group.

In addition, risks with an impact score of 5 (catastrophic) and likelihood of 2 (unlikely) will also be regularly reviewed at executive level.

Finally, themes and trends in reported risks will be identifed and escalated as appropriate to ensure that multiple similar risks of a low impact and likelihood are not ignored.

Te Board has a range of committees and groups all charged with the responsibility of reviewing risks related to their terms of reference and subject matter ensuing those risks are controlled and, where necessary, escalated.

Note by author: Tis statement is complemented by an appendix showing a risk management governance map, guidance on risk management scoring and guidance on risk likelihood scoring.

**Example 2.** *A university* (Te governance arrangements for a university in the UK are determined by the university's constitution which in turn depends upon how the university was originally established. Tere is therefore no standard model.)

Te university in this example has published a Risk Policy and Risk Appetite Statement. Tis is set out below as an example of a diferent approach to the publication of information about risk management.

Te university is governed by a 'court' which is the equivalent of a 'board' in other types of organisations. Te chief ofcial of the university who is the chairman of the university executive is the principal (other terms are used in other jurisdictions such as 'vice-chancellor'), and the principal is responsible for the overall operation of the university including that risk is identifed and efectively managed.

## **Te Risk Management Objectives**

Te university's risk management objectives are as follows:


## **Framework**

Te management of risks in the university is undertaken within a framework comprising:


#### **Roles and Responsibilities**

An efective risk management programme should permeate existing management processes and provide assurance over the management of key risks. It requires interdependence between strategic and operational objectives, management processes, governance arrangements and other policies.

Te court recognises that in order to pursue its objectives and to take advantage of opportunities, the university cannot avoid taking risks and that no risk management programme can aim to eliminate risk fully. Accordingly, the university's approach to risk management is intended to increase institutional risk awareness and understanding and thus support taking risks where appropriate, in a conscious, structured and controlled manner. Risk management must be embedded throughout the university. It is not the sole responsibility of senior managers but should be exercised by all staf, particularly those with management or operational responsibilities.

#### *Role of the Court*

Court has a requirement under the legislation to ensure the establishment and monitoring of systems of control and accountability, including risk management. Accordingly, its role is to:


## *Role of the University Executive (UE)*

Te UE is responsible for:


# *Roles of Heads of Colleges, Schools and Professional Services*

Responsibility for identifying and managing the risks in the university, as in any other organisation, lies with the management of the university. Heads of colleges, schools and professional services are responsible for:


## *Role of the Risk Management Committee*

Te role of the risk management committee is to support and advise the management, and through it the court, on the implementation and monitoring of the risk management policy. Its remit is to:

a. Ensure that the identifcation and evaluation of key risks that threaten achievement of the university's objectives is carried out and that a register of these risks is maintained.


## *Te University Risk Manager*

Te risk manager is a part of corporate services group. Te risk manager is responsible to the risk management committee for:


## *Role of Internal Audit*

Internal audit is responsible for independently and regularly reviewing the operation of the overall risk management process in the university. In doing this, it has regard to best practice as recommended by professional institutes and other relevant organisations. Internal audit will:


## *Role of the Audit & Risk Committee*

Te audit & risk committee is responsible for monitoring the university's general arrangements for risk management, and specifcally for:


## *Role of All Faculty and Staf*

All faculty and staf have a critical role to play in risk management. As a minimum, all members of the university have a responsibility to:


## **Risk Appetite**

Te risk policy and appetite establish the court's commitment to the risk management framework and process, set the goals and objectives of the university's risk management process, lay out risk management roles and responsibilities throughout the university and specify the amount of risk the university is willing to seek or accept in the pursuit of its long-term objectives. It indicates the parameters within which the university would want to conduct its activities.

In terms of priorities, the need to avoid reputational, compliance and overall fnancial risk will take priority over other factors, for example, it will be acceptable to undertake risks in research activities providing they do not expose the university to undue reputational, compliance or fnancial risk. Similarly, the university is open to innovation in education and student experience, if this supports and enhances its reputation and does not expose it to undue fnance or compliance risks. A balanced assessment has to be taken of risks—in many cases there are risks attached to both doing something and doing nothing.

Given the devolved nature of the University, the Statement is intended to act as a set of limitations within which academic and professional managers and committees should conduct their afairs, indicating:


Where appropriate, the implementation of the statement will be incorporated into processes and procedures of the university.

Responsibility for managing the activities of the university within the statement of risk policy and risk appetite lies with the management of the university, in particular heads of colleges, schools, professional services and subsidiary companies, as well as key university and college committees.

#### **Statement of Risk Policy and Risk Appetite**

The university's approach is to minimise its exposure to reputational, compliance and financial risk, whilst accepting and encouraging an increased degree of risk in pursuit of its mission and objectives. It recognises that its appetite for risk varies according to the activity undertaken and that its acceptance of risk is subject always to ensuring that potential benefits and risks are fully understood before developments are authorised and that sensible measures to mitigate risk are established.


The university's appetite for risk across its activities is provided in the following statements and is illustrated diagrammatically.



Note: Any particular activity may incorporate many categories of risk. A research project, for example, may in and of itself be at high risk of failure, and the court may be willing to tolerate this. They would be unwilling, however, to accept any risk associated that the same project's failure to comply with statute, regulation, professional standards, research or medical ethics, bribery or fraud and would similarly want reasonable assurance that the project did not pose an undue fnancial liability risk

**Reputation**—It is regarded as critical that the university preserves its high reputation. The university therefore has low appetite for risk in the conduct of any of its activities that puts its reputation in jeopardy, could lead to undue adverse publicity or could lead to loss of confidence by the Scottish and UK political establishment and funders of its activities.

**Compliance**—The university places great importance on compliance and has no appetite for any breaches in statute, regulation, professional standards, research or medical ethics, bribery or fraud. It wishes to maintain accreditations related to courses or standards of operation and has low appetite for risk relating to actions that may put accreditations in jeopardy.

**Financial**—The university aims to maintain its long-term financial viability and its overall financial strength. Whilst targets for financial achievement will be higher, the university will aim to manage its financial risk by not breaching the following minimum criteria30:

*Operational, Quantitative, Quarterly test*

• *We will ensure the basket of fnancial sustainability metrics is always at a weighted acceptable level.*

*Liquidity and gearing, Quantitative, Monthly test*


*Qualitative*


<sup>30</sup>Tese have been developed in conjunction with the Director of Finance.


*The above statements take priority over the statements of areas of risk appetite below.*

**Research**—The university wishes to be at the leading edge in the creation of knowledge and making a difference to society. It wishes to grow its research activities and improve its performance in each REF [research excellence framework] assessment compared to the previous assessment. It recognises that that this will involve an increased degree of risk in developing research activities and is comfortable in accepting this risk subject to (a) limitations imposed by ethical considerations and (b) ensuring that potential benefits and risks are fully understood before developments are authorised and that sensible measures to mitigate risk are established.

**Education and Student Experience**—The university wishes to stimulate students to develop a lifelong thirst for knowledge and learning and encourage a pioneering innovative and independent attitude and an aspiration to achieve success. It expects as a minimum to be in the top quartile of surveys related to student experience. It recognises that this should involve an increased degree of risk in developing education and the student experience and is comfortable in accepting this risk subject always to ensuring that potential benefits and risks are fully understood before developments are authorised and that sensible measures to mitigate risk are established.

**Knowledge Exchange**—The university wishes to be amongst the leaders in transforming knowledge, ideas, skills and expertise into advice, innovation, intellectual property and enterprise, thereby enriching society. It recognises that developing this may involve an increased degree of risk and is comfortable in accepting this risk subject always to ensuring that potential benefits and risks are fully understood before developments are authorised and that sensible measures to mitigate risk are established.

**International Development**—The university aims to achieve global impact in its activities and to promote research and other collaborations and staff/student exchanges with leading institutions across the world. It has a strong appetite for developing such networks to the extent that they support the mission and reputation of the university, a medium appetite for investing in research facilities overseas and a low appetite for investing in the development of student campuses outside of the UK.

**Major Change Activities** *(e.g., projects, collaborations, mergers)*—Major change activities are required periodically to develop the university and to adapt to changes in the regulatory and technological environment and in the nature and conduct of the university's activities. The university expects such changes to be managed according to best practice in project and change management and has low appetite for deviating from such standards.

**Environment and Social Responsibility**—The university aims to make a significant, sustainable and socially responsible contribution to Scotland, the UK and the world through its research, education, knowledge exchange and operational activities. It recognises that this should involve an increased degree of risk and is comfortable in accepting this risk subject always to ensuring that potential benefits and risks are fully understood before developments are authorised and that sensible measures to mitigate risk are established.

**People and Culture**—The university aims to value, support, develop and utilise the full potential of our staff to make the university a stimulating and safe place to work. It places importance on a culture of academic freedom, equality and diversity, dignity and respect, collegiality, annual reviews, the development of staff, and the health and safety of staff, students and visitors. It has low appetite for any deviation from its standards in these areas.

**Example 3. A State-Owned Enterprise:** (Tis is an extract from NETWORK RAIL LIMITED ANNUAL REPORT AND ACCOUNTS 201631)

Network Rail owns and operates most of Britain's railway infrastructure, including 20,000 miles of track, 30,000 bridge and viaducts and thousands of signals, tunnels, level crossings and points. We also manage rail timetabling and operate 20 of the largest stations. Our role is to provide a safe, reliable and efcient railway while growing and upgrading the network to better serve passengers and freight.

Network Rail is a public sector company, answerable to the Department for Transport (DfT) and Transport Scotland. It is governed by a board.

OUR APPROACH TO RISK MANAGEMENT

Our assets across the country work 24 hours a day, seven days a week, to provide a safe, reliable rail network. We are committed to providing a railway infrastructure that meets the performance and safety expectations of the travelling public, operating companies, and the tax payer.

With many assets working with often extreme environmental pressures, occasionally things break down. We are committed to resolving issues quickly in order to maintain service. We are also committed to improving our assets through comprehensive enhancement and maintenance programmes. In scheduling this work we recognise the disruptive impact on both the public and our commercial customers and strive to minimise disruption to complete works as efciently as possible.

Te purpose of our Enterprise Risk Management (ERM) process is to identify and mitigate risks to the delivery of a safe, reliable, and efcient service to

<sup>31</sup>https://www.networkrail.co.uk/wp-content/uploads/2016/11.

our customers. Our ERM framework supports all areas of the business to recognise both risk and opportunity early. Early recognition of risk allows us to work collaboratively and proactively with customers, stakeholders, and suppliers to manage our extensive portfolio of works better. Being better every day requires us to look at areas where we can improve our service. By careful consideration of risk, we can focus on those opportunities that have the highest potential to increase efciency and provide a better experience for our customers.

Introduction:


Embedded Risk Management Processes:


Approach to Risk Assessment:


Categories of Risks (i.e., Safety, Performance, Value) and Who Manages Tem:

All principal risks are mapped to performance reporting and strategic objectives. Te assessment of risk is informed by the performance targets and the company's risk appetite statements. Each principal risk is appointed an executive committee owner.

Network Rail's Defned Risk Appetite Is as Follows:


Risk Area:

## Safety

Tree strategic risks are identifed. Te responsible risk owners are: Te Group Director of Safety, Technical and Engineering and the Managing director, England and Wales.

Value:

One strategic risk is identifed. Te responsible risk owner is the Chief Financial Ofcer.

Performance:


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# **12**

# **Managing and Controlling Second-Level Organisations: The Responsibilities of the First-Level Organisation**

A feature of many public sector organisations is the existence of 'second level' organisations. In considering the introduction of PFM/IC regard should be had to how these organisations are managed by the controlling or frst level body. Tere are diferent types of second-level organisations and the focus in this chapter is on those that have delegated powers from the central or local government. Second-level organisations are widely used by central and local governments with many diferent types of organisational arrangement. Tere is no single model which can be regarded as appropriate for all countries and all types of second-level organisation operating with a delegated power structure. Included in this chapter is a reference to private fnance initiative (PFI) arrangements, which although do not strictly fall into the category of a second-level organisation, but can have similar characteristics from a control perspective.

Tere are diferent reasons for establishing second-level organisations, not all of which may be appropriate. Specifc regulations should be issued indicating when such organisations can be established. Tese regulations should specify a formal process of approval which for central government should involving not only the ministry concerned but also the ministry of fnance. Second-level organisations with delegated powers can be used for commercial and non-commercial purposes and sometimes they provide both types of services or activities at the same time. Te evidence from several developing and transition economy countries is that such organisations may not be well managed by their owning or controlling frst-level organisation and they may set their own agendas rather than have them set for them, as they should, by the controlling or owning frst-level organisation. Regular reviews of such organisations, including whether their continued existence can be justifed, do not happen but again such reviews ought to occur.

Tis chapter describes the actions that frst-level controlling or owning organisations should take to properly exercise their responsibilities towards their second-level organisations operating under delegated powers and towards PFI arrangements.

Examples are also included of how two developed economy countries manage the establishment and control of second-level organisations. Tey both require tight oversight by the controlling or owning frst-level organisation to be exercised over the second-level organisations.

# **12.1 An Overview of the Control of Second-Level Organisations with the Development of PFM/IC**

## **12.1.1 The Context for Establishing Second-Level Organisations**

Second-level organisations also come in various forms. Tese have been classifed by Cohen and Peterson1 into three types of decentralisation, that is, devolution, de-concentration, and delegation:


<sup>1</sup>Administrative Decentralization: Kumarian Press 1999 pp. 24–29

3. Delegation: Tis refers to circumstances where a central government, or a local government, delegates responsibility for defned areas of policy to organisations which are under its direct or indirect control or in some circumstances may be autonomous such as non-governmental organisations. Delegation may sometimes include power to develop particular areas of policy, as well as being responsible for the implementation of certain areas of policy. Tis usually occurs where a central government (or ministry or local government) feels that a service can be provided more efciently, efectively, and accountably. It may also occur where a particular service or activity is revenue raising. Delegation can sometimes lead on the privatisation.

In this chapter the defnition of second-level organisations is limited to the third category of organisations, that is, those which have delegated powers. Te problems that arise for governments to address is why have such delegation arrangements been made, how to ensure the highest level of efectiveness and efciency are delivered and how to decide whether those arrangements should continue?

Other questions may arise, for example, about the desirability of pushing accountability downwards, about privatisation and limiting the size and role of the central state or indeed of local government. Consequently, a discussion about second-level organisations may not be simply limited to organisational issues but can develop into a discussion about how public services are to be delivered. Should they be retained fully under the control of the public sector or should they be delegated to the private sector through arrangements such as those associated with private fnance initiatives (PFI). Tat is a question which can follow on from the examples taken from two developed countries described later in this chapter.

Second-level organisations can be responsible for almost any aspect of government, from delivering public services, to collecting taxes, to providing advice and to undertaking regulatory activities.

A primary question to be considered is the funding of second-level organisations**.** Te ultimate guarantor of the fnancial resilience of a second-level organisation is likely to be either the central or the local government, that is, the provider of public money. Public money is not just that provided from the budget but it can include foreign aid as well as income earned by second-level organisations themselves, particularly trading second-level organisations. In some countries where foreign aid is important it can also include nonmonetised support provided in various forms.

PFI arrangements have been defned as a system in which private companies build and sometimes manage large projects such as hospitals or roads, and then the government pays to use them.2 Te assets that are provided in this way very often are ultimately returned to the public sector at the end of the contract period.

## **12.1.2 The Criteria for Establishing Second-Level Organisations3**

Second-level organisations with delegated authority can be grouped into three types depending upon their fnancial objectives. One type is those which are wholly funded from the budget of the frst-level organisation. A second is those that provide services and activities for which they charge a fee although they may not actually be trading organisations with the budgetary contribution essentially being a residual payment to cover those costs which cannot be recovered through fees. Te third type is those which operate essentially as state owned enterprises and which may or may not be 'proftable'. Ideally, criteria should be set which would defne whether establishing a second-level organisation would be appropriate. Te criteria should apply, in principle, to all second-level organisations. Tese criteria could include:


<sup>2</sup>*Cambridge English Dictionary.*

<sup>3</sup>Controlling organisations referred to in this chapter include central government ministries, local governments, and other public organisations.

a market based activity, that it will be a proftable activity according to conditions specifed by the ministry of fnance.


Proposals to establish second-level organisations should be measured against this set of criteria, along with any others that may be added to meet local circumstances.

Important features of the relationships between controlling and secondlevel organisations are:


Where assets are provided through PFI-type contracts the reasons are usually fnancial, that is, of-balance sheet fnancing arrangements and not to do with efciency and efectiveness. Te public sector pays a charge (often monthly) for the asset and that charge covers the costs of building the asset, fnancing it, and operating it for the whole length of the contract.

Because operating circumstances do not remain the same for second-level bodies there should be a systematic review process, perhaps every 3 or 5 years (depending upon the service or activity being provided), so that whether the second-level organisation should continue is tested. Tat review process should involve the controlling organisation and at least the ministry of fnance. For local government there should be a similar review process. With contractual arrangements such as those for PFI-type schemes the opportunity for review during the contract period depends entirely upon the terms of the contract but those opportunities are likely to be much less than with conventional second-level organisation arrangements.

#### **12.1.3 Purpose of Establishing Second-Level Organisations and the Problems That Exist**

Tere are some organisations such as an ombudsman or the state auditor or organisations with a judicial-type function which should be excluded from this discussion even though they depend upon public money for their efective functioning. Tey may also receive their funding through the ministry of fnance rather than directly through parliamentary decision.

For second-level organisations with delegated powers, in general the main stated purpose of establishing them in developing and transition economy countries is usually to enhance efciency and efectiveness through the development of a specialist management and by giving them more autonomy. Tere can be other reasons as well, often unspecifed, including, for example, providing an opportunity to avoid budgetary controls or to create mechanisms to provide additional rewards to certain ofcials.

Very often though, the identifcation and measurements of efciency gains and the efectiveness of second-level organisations does not occur, even with this being the *raison d'être* for the establishment in the frst place. Experience shows that unless second-level organisations have clear objectives and there is clarity about the anticipated improvements in efciency and efectiveness, that managements have the fnancial and performance information necessary to enable them to judge efciency and efectiveness, and that they are properly supervised by the controlling frst-level organisation, the likelihood is that they will pursue their own interests in their own way. Te result will be that the controlling organisation will have difculty in ensuring that the interests of the second-level organisation and those of the controlling organisation coincide and that what the second-level organisation is expected to achieve will in fact be achieved. One of the reasons for this will be an asymmetry of information. Te second-level organisation will know more about all its activities and policies than the controlling organisation. However, the principle should be that the objectives and interests of the controlling and second-level organisations should be compatible.

Governments should have a developed policy, rather than ad hoc arrangements, towards the creation of second-level organisations. Tis developed policy should cover such issues as:


• Accountability arrangements: what will be the accountability arrangements to the controlling frst-level organisation?

Establishing a second-level organisation is not 'cost free'. Tere are the costs of establishing and managing the organisation itself as well as the additional costs incurred by the controlling organisation in supervising the performance of the second-level organisation. Where there are several (or sometimes many) such organisations these costs are multiplied. Proposals to establish secondlevel organisations should be carefully reviewed, not just by the controlling organisation but also by others involved in the development and management of public services, not least the ministry of fnance. (In local government there should be also a third party involvement in the assessment. Who it should be would depend upon how a local government was organised.) However, any such second-level organisation should be required to be subject to audit by the local government auditor.

Unless countries are clear about why they agree to the establishment of a second-level organisation and that they keep second-level organisation performance under review, a signifcant risk is that a second-level organisation will not only develop a 'life of its own' but the quality of performance may also deteriorate. A second-level organisation will generally want to justify its own existence and the continuation of its own programme of activity. If the controlling organisation is not either able or willing to exercise its control responsibilities the budget that the second-level organisation presents to the controlling organisation will be driven by the interests of the second-level organisation rather than by the interests of the controlling organisation. Te controlling organisation, in efect, risks becoming subservient to the interests of the second-level organisation and therefore inefective as a supervising organisation. Tis is inappropriate and the controlling organisation should be determining the policy and the strategy for the implementation of that policy by the second-level organisation. It should also be agreeing the performance standards and efciency and efectiveness targets and hence the budget of the second-level organisation. Tis is a serious risk and the impact should not be underestimated.

## **12.1.4 The Responsibilities of Controlling Organisation**

Controlling organisations as they represent the principal in the principal/ agency relationship which exists between a controlling organisation and a second-level organisation, have several responsibilities. As the principal, the controlling organisation with PFM/IC should specifcally determine the objectives and performance standards and objectives which second-level organisations are to achieve and should identify and agree the performance measures that are to be adopted to demonstrate whether they have been achieved in practice or not. Tese arrangements should be specifed in some form of 'contract' or oversight agreement such as a performance or servicelevel agreement (see below). In legal terms an organisation cannot contract with itself and that agreement would need to be a memorandum of understanding or equivalent unless the second-level organisation was a separate legal entity. Tese documents have been used in developed economy countries.

Success in delivering objectives and performance standards will depend upon the accompanying fnancial settlement. (A risk with these types of arrangements is that the controlling organisation may seek to 'ofoad' its responsibilities onto a second-level organisation and not provide sufcient fnance.) Te controlling organisation should also specify in the 'contract' the standards of governance and of internal control that are to apply in the secondlevel organisation. An important activity of the controlling organisation is to monitor their second-level organisations to ensure that they comply with those standards of governance and of internal control and meet any regulatory and legislative requirements. Te 'contract' may specify the monitoring arrangements. Performance monitoring should be a positive activity of the controlling organisation. Exactly how it is undertaken will depend upon local circumstances but it should include regular written formal reports as well as personal meetings between representatives of the controlling organisation (which for normal business relationships should be representatives of the operational management of the controlling organisation) and the chief executive and operational management of the second-level organisation. Te head of operational management of the controlling organisation (e.g. the state secretary) should then report to the political level of management including his/ her own observations on the performance of the second-level organisation. In normal operational circumstances the political level of management should not become involved in the management of second-level organisations. Where the political level of management should become involved is in the setting of the policies, objectives, and performance standards of the second-level organisation, in acting upon reports of the controlling organisation operational management, or where some unusual or inappropriate event or actions have occurred, such as a failure of governance or the making of inappropriate payments to senior executives. Such 'unusual' events anyway should have been reported upon by the controlling organisation operational management. Tis arrangement makes possible the development of political accountability without a minister (or mayor) becoming involved in the detailed operation of the second-level organisation.

Consequently, controlling organisations should have these capabilities, to:


Unless these types of arrangement are made the controlling organisation loses efective control over the second-level organisation. If controlling organisations do not follow this procedure this is an unsatisfactory situation and not compatible with the principles of PFM/IC. Tis is because some portion of the budgetary expenditure (or income) for which ultimately the controlling organisation should be responsible, will fall outside its fnancial management and internal control requirements.

To enable a controlling organisation to properly undertake these responsibilities the controlling organisation will need to include within its own organisation a specifc department or unit responsible for the management of second-level organisations. (Where the second-level organisation is small the controlling organisation responsibilities may be exercised by a specifc individual such as the head of fnance.) Tat department or unit should be able to defne the objectives, performance standards, fnancial returns (where appropriate), the operating budget and expected efciency gains of the second-level organisations for which the department has a responsibility and to then monitor what is happening. Tese are efective preconditions for the establishment of a second-level organisation and if they cannot be met then such an organisation should not be established.

Te reality, in this author's experience, is that in practice the objectives of second-level organisations can be vague and are often described, but only in general terms, in the legislation establishing the organisation in the frst place. Very often too that legislation has not been changed since its initial approval. Objectives are not usually linked to budgets, but they should be. (Where the objectives have been defned in the legislation establishing the second-level organisation, by defnition, they cannot be linked to current budgets and to argue that this is an adequate arrangement, as has occurred in this author's experience, is inappropriate.) Tose objectives can also be inconsistent with the objectives of the controlling organisation. Again, in some countries, the agreement of the annual budget and the consequential budgetary control arrangements are regarded as a sufcient form of control. However, these are nowhere near enough as a form of control for the following reasons:


Second-level organisations can be a potential source of mismanagement, fraud, and corrupt behaviour. Tere are many causes of this, not least inefective management by the controlling organisation. But another cause is poor internal control and poor corporate governance. Good corporate governance is potentially an efective anti-corruption tool. Corporate governance promotes transparency and accountability, so that clarity exists about how decisions are made and why. Consequently, a requirement should be that second-level organisations meet the standards of internal control and corporate governance (see Chap. 1) that apply to frst-level controlling organisations. To ensure that this does occur, efective supervision of second-level organisations by the controlling organisation is essential. Other steps may be taken to limit the possibilities of corruption including, for example, that second-level organisations may be restricted to procuring only low value items with high value items only being procured by the controlling frst-level organisation or with the specifc authority of the controlling organisation. Te frstlevel organisation should always maintain an efective capacity to properly supervise the policies and activities of the second-level organisation. In practice this does not always occur.

A requirement should be that the internal control arrangements that apply to controlling organisations should apply equally to second-level organisations although they may need to be adapted to the second-level organisation's operational circumstances and management. Even so they should still follow the basic procedures of internal control that apply to the controlling frst-level organisation. Tis means that the internal control arrangements, essentially managerial disciplines (see Chap. 11), should be designed, inter alia, to ensure that the second-level organisation delivers its objectives to time and standard, observes the approved performance standards and operates efciently and efectively within approved budgets and the law and regulations and meets the specifed standards of transparency and accountability. Te delegation and accountability arrangements should also ensure that a second-level organisation does not enter into commitments or take on fscal risks which could prejudice its future fnancial resilience and potentially that of the controlling organisation.

Te point is that second-level organisations should not be 'free-standing' and should be subject to active engagement with the frst-level controlling or supervising ministry. In general, under no circumstances should a secondlevel organisation negotiate its budget separately with the ministry of fnance from that of the controlling organisation but in some countries this does occur. (Te only examples where this could be appropriate would be, for example, the budgets of an ombudsman, the supreme audit organisation, and judicial bodies. Te supreme audit organisation should not be regarded as a second-level organisation in any event.)

In many countries and especially in developing and transition economy countries the reality is that the essential control and review features of secondlevel organisations do not exist. Often the controlling frst-level organisation does not have the capacity (or see the need) to exercise policy control (believing that the originating law is all that is required). Te only advice that the controlling organisation very often receives about the operations of a secondlevel organisation is from the second-level organisation itself, so it is hardly impartial. Tere are no arrangements for independent assessment. Yet a controlling organisation should always have a policy capacity, even if this requires the employment of a specialist independent organisation, to enable it to challenge the management of a second-level organisation.

Second-level organisations can also become permanent features of management in transition and developing countries. Tey may even report directly on their performance to the parliament rather than through the frst-level organisation. Tis efectively bypasses the controlling frst-level management. Tis is an inappropriate arrangement. Also, no arrangements for periodic review of the continued existence of a second-level organisation exists.

Te establishment of clear lines of accountability is crucial for controlling organisations. If the controlling organisation believes, through the exercise of its supervisory role that the second-level organisation is not performing as it should, then the responsibility of the controlling organisation is to take corrective action. Failure to do so leaves the controlling organisation exposed to adverse criticism. Tat corrective action may be taken directly by the head of operational management or by the political head on the advice of the head of the controlling organisation operational manager, depending upon the circumstances.

In some countries the only form of control exercised by a controlling organisation is budgetary control. Tis makes control one-dimensional and is not sufcient to ensure that objectives and performance standards are being achieved. Tis limited form of control also does nothing to ensure that there is any year on year improvement in performance or that the second-level organisation has responded to changing circumstances.

An important aspect of control is that the controlling organisation does *not* become part of the management of the second-level organisation. Tis does not mean that stafs cannot be interchangeable or that the rules that apply to the appointment of staf to frst-level organisations should not apply to the appointment of staf to second-level organisations. Ideally, they should be the same. However, controlling organisations in some countries do feel that to exercise control their ofcials have to be appointed to the board of the secondlevel organisation (or other executive body) and approve the day to day managerial decisions of the second-level organisation. In this way the controlling organisation becomes part of the second-level organisation management. Very importantly it also places those staf in a position where conficts of interest can occur. Tis is entirely wrong and can result in a failure of control by the frst-level controlling organisation. Tis is contrary to the principles of corporate governance and would prevent the controlling organisation exercising an independent assessment role of the performance of the second-level organisation. (Tis author has come across examples of where controlling ministry civil servants have been appointed as members of the board of second-level commercial organisations, as have ministers. Tis arrangement creates opportunities for such appointees to receive additional remuneration and other benefts, which of course may also be a motivation for appointment and such ofcials and such appointments may occur even though the appointee may have no specifc expertise. But in such circumstances the controlling ministry's ability to supervise and to independently assess the managerial performance of the second-level organisation can be heavily circumscribed.)

Overall, the responsibilities of the controlling organisation are to ensure that the second-level organisation:


cumstances arise not envisaged in the 'contractual' arrangements between the controlling and second-level organisation.

11. Tat reporting arrangements exist which enable the controlling organisation to efectively monitor the performance of the second-level organisation during the year.

Second-level organisations should also be required to prepare an annual report, including a statement of internal control, audited fnancial statements, that is audited by the state auditor, about their performance and activities. Te controlling organisation should approve the publication of that annual report including the audited fnancial statements along with the statement of internal control. A consequence of this is that the activities of second-level organisations should, in the normal course of events, be subject to parliamentary scrutiny.

Te focus of the controlling organisation should be on results not processes, on obtaining good and timely strategic management information, gaining strategic clarity about objectives and trends in performance, and ensuring that the second-level organisation has the management structure and staf capability to deliver its objectives and envisaged performance.

Te controlling organisation should recognise that a second-level organisation will always fnd activities or reasons to justify its existence but this does not necessarily mean that those activities or reasons are compatible with the interests or objectives of the controlling organisation or are indeed necessary. Terefore, the process of periodic review, referred to above, should exist which will require the second-level organisation to justify its continued existence.

Tese requirements mean that the controlling organisation must have available to it sufcient knowledge and operational information about the second-level organisation to enable it to assess the performance of that organisation and whether it should continue in existence. Unless these requirements exist, there is a risk that because of an asymmetry of information developing between the second-level organisation and the controlling organisation this exposes the controlling organisation, and hence the minister (or mayor), to the charge that it is not actually in control of the second-level organisation.

## **12.1.5 The Information That a Controlling Organisation Should Have**

A controlling organisation must have available to it sufcient knowledge and expertise to set objectives for the second-level organisation, to defne appropriate performance standards as well as the fnancial parameters for budgetary purposes, and to monitor performance during the year. A signifcant risk, pointed out above, for the controlling organisation, is that because the secondlevel organisation has detailed operational knowledge of the area of operations, the controlling frst-level organisation will not be able to properly exercise its control responsibilities. However, the existence of a 'contract' assuming that it is properly drawn up by the controlling organisation should ensure that the controlling organisation has the key information it requires to exercise efective control. With such 'contracts' the goals, targets, and fnancial resources should be agreed between the controlling frst-level organisation and the second-level organisation. Te second-level organisations should be held accountable for their achievement. Te controlling frst-level organisation, as has been indicated above, should systematically monitor the performance of the second-level organisation with the extent of the monitoring being determined by the conditions included in the 'contract'. Adopting a performance basis for control adds to the focus on compliance, a focus on results and their achievement efciently and efectively. However, to achieve these benefts requires capacity building both in the controlling organisation and in the second-level organisation.

## **12.1.6 Oversight Arrangements by Controlling Organisations: Service-Level Agreements— Examples of Arrangements in Ireland and the Netherlands**

Set out below are example arrangements which countries ought to consider in the establishment and management of second-level organisations. Tese arrangements are based upon a model published by the Irish Republic and regulations published by the Government of Te Netherlands. Te underlying principle is that the control arrangements and performance of secondlevel organisations should be carefully monitored by the controlling organisation.

A particular feature of the Netherlands arrangements is that the regulations governing the establishment of second-level bodies (called agencies in the regulations) specify diferent fnancial arrangements for agencies which are income earning from those which rely upon budgetary fnance. Tere is no specifc reference in the regulations to state owned enterprises.

In the Netherlands an agency is treated as a service part of a ministry that operates with its own management model and fnancial administration. It may be an income earning agency or an expenditure based agency. Te aim is to establish a management model which facilitates a more efcient operational management but one not adversely afecting the overall control of public expenditure. Te agency model is described as 'a form of internal independence in which the ministerial responsibility for the agencies is fully maintained'.4 Tere are diferent fnancial regulations afecting the two types of agencies. Te income earning agency, which is not a state owned enterprise, is required to prepare its fnancial accounts on an accruals basis of accounting and the expenditure based agency on a cash basis of accounting. Tis means that an income earning agency in determining the charges for its services, costs such as depreciation would be incorporated into the cost structure which they would not be were a cash basis of accounting employed. It also means that charges for the services provided by an income earning agency would be largely stable irrespective of the levels of capital expenditure incurred. An income earning agency is expected to earn sufcient income to meet its outgoings.

One important feature specifed in the Irish government arrangements is that all second-level organisations whatever their type should implement good corporate governance standards. Tose standards would be specifed by the Ministry of Finance. A second important feature is summarised in the following extract from the Irish code: 'Te oversight agreement should refect the State bodies legal framework; the environment in which it operates (e.g., commercial, non-commercial, regulatory body); the purpose and responsibilities of the State body; the State body's level of compliance with this Code; details of the Performance Delivery Agreement (e.g., outputs to be delivered); and arrangements for oversight, monitoring and reporting on conformity with Government policy including those actions and areas of expenditure where prior sanction from the parent Department and/or the Department of

<sup>4</sup>www.rijksoverheid.nl/onderwerpen/rijksoverheid/inhoud/agentschappen; Published in the Ofcial Gazette 4 December 2017: Arrangement of the Minister of Finance of 21 November 2017, laying down rules on the establishment and management of the agencies (Agency Scheme).

Public Expenditure and Reform is required.'5 Te starting point for clarity of accountabilities is a service-level or performance agreement (referred to in the Irish guide as an 'oversight agreement') between the relevant controlling organisation and the second-level organisation. Tis Code demonstrates that clear objectives, delegation, and accountability arrangements should exist which underpin efective managerial relations between controlling organisations and the second-level organisations for which they are responsible. Efective accountability depends upon the roles and responsibilities being clearly defned and understood by the controlling organisation and the second-level organisation.

Te 'oversight' agreement 'demonstrates that clear objectives, delegation, and accountability arrangements exist which underpin efective managerial relations between controlling organisations and the second-level organisations for which they are responsible. Efective accountability depends upon the roles and responsibilities being clearly defned and understood by the controlling organisation and the second-level organisation.'

Te contents of such agreements typically should contain the following sections (and these are based largely, but not wholly, upon the Irish and Netherlands requirements):


<sup>5</sup>Te Irish government publication applies to both non-commercial and commercial second-level organisations. 'Code of Practice for the Governance of State Bodies: Business and Financial Reporting Requirements 2016': http://govacc.per.gov.ie/wp-content/uploads/Business-and-Financial-Reporting-Requirements.pdf


Te measurement indicators of outputs (what actions the second-level organisation carries out) and impacts or results (what the second-level organisation achieves) should be credible and reliable.

As second-level organisations may carry out many functions/services, the focus should be on those functions/services which are central to delivering the strategic objectives of the controlling organisation, that is, the focus of control should be on the core activities. (Tis is to avoid overwhelming the agreement with bureaucratic requirements). Terefore, in selecting appropriate indicators, the aim should be on the quality of the information/indicators as opposed to quantity. Baselines should also be identifed from which targets for improvements could be measured.

<sup>6</sup>Te Irish government advice on preparing these agreements points out that the difculties in defning these levels should not be underestimated and will depend on the functions/services of the second-level organisation, ranging from straightforward, for example, 'number of customer queries handled', to the complex, for example, 'the volume of policy advice provided'.


organisation is an income earning organisation or receives its fnance from the budget or is a commercial organisation. Tese reporting requirements should include:

	- i. A review of the operational environment including changes that have afected the performance of the organisation.
	- ii. An afrmation that controlling organisation policy is being complied with and if not the reasons for non-compliance.
	- iii. Te actual operational performance of the organisation against the objectives incorporated into the service-level agreement with an explanation for any diferences.
	- iv. An explanation of any policy changes or major initiatives during the year.
	- v. Te prospects for the next and future 3 years.
	- vi. Any particular information that may have a political or public resonance in the country.
	- vii. Te statement of internal control (see Chap. 13).
	- i. Provide the information necessary for an assessment of the organisation's fnancial position and its fnancial performance analysed over main activities compared with the budget forecast (i.e. over main activity/objective headings and not the subjective headings usually required for budgetary control purposes).
	- ii. Te income of the second-level organisation from all main sources and analysed over those diferent sources along with the costs of generating that income.
	- iii. Any loans or other forms of fnancial support provided by the controlling organisation, or any other government ministry or agency or any commercial loans (which should be approved by the ministry of fnance) and how such fnance has been used.
	- iv. Te extent of liabilities including liabilities outstanding at the year-end.
	- v. Te extent of revenues due but not yet collected.
	- ix. A statement about 'sensitive' information (with the term 'sensitive' being defned as including any particular items that the controlling organisation and/or the ministry of fnance specify as necessary to be disclosed) but could include such items as remuneration, bonuses, and other payments to senior executives, termination/severance payments to employees, travel and subsistence payments analysed between national and international travel, hospitality expenditure, legal costs, and compensation paid.
	- i. Te overall proftability, taking into account the cost of capital, depreciation, and an appropriate share of overheads.
	- ii. Information about losses on any business activities after appropriate allowances for depreciation, the cost of capital and overheads.
	- iii. Te rate of return on assets employed and other appropriate commercial measures of performance.
	- iv. Market share, changes over time and prospects for future periods.

(Other examples of information that may be required by the controlling organisation of a state owned enterprise are included in Annexes 1 and 2 to this chapter.)

14. Duration and signatories to the agreement: this section should highlight the duration of the agreement and the commencement date. Te period covered by the agreement will depend on the nature and services to be provided by the second-level organisation.7

Tis is a lengthy list of requirements which it would be inappropriate to expect to be completed where small second-level bodies are involved. However, this then raises the question as to whether such small second-level bodies should exist and whether it would be more appropriate for the functions of such bodies to be absorbed into the functions of the controlling frst-level body. As has been pointed out above establishing second-level bodies is not 'cost free'.

In Annex 1 an example from Ireland of the requirements to be included in the chairman of a commercial state body statement is shown. Although this statement is designed primarily to refect the circumstances of commercial state bodies much of the content would be equally relevant to a noncommercial state body. Annex 2 shows the Irish fnancial information requirements for shareholders in commercial second-level state bodies. Again, the approach adopted here would have direct relevance to commercial secondlevel bodies in developing and transitional economy countries.

Te annual report and fnancial statements of all second-level organisations should be available as part of the accountability process to parliament, to users of the second-level organisation services and to civil society. Publication should be the normal practice and only withheld in exceptional circumstances.

Te approach of the Government of the Netherlands has these particular features:


<sup>7</sup> In Ireland the expectation is that these agreements would be typically for a 3 -ear period.

	- Will have an expected turnover or expected revenue of more than €50 million on an annual basis8 ;
	- Will have a result-oriented management model9 ;
	- Will work more efciently than as a regular service unit of the controlling organisation concerned and indicate how the service unit will further develop efciency as an agency during the next 5 years;
	- Can establish a link between expenditure, costs, and performance in such a way that funding based on performance is possible;
	- Can guarantee a sufcient level of quality of the fnancial function and fnancial management;

<sup>8</sup>Whilst the Netherlands Government recognises that the independence of an agency brings advantages there are also additional costs associated with the establishment of agencies. Tese costs include transition costs, the management costs of the agency and for the controlling organisation the costs of supervision and control of the agency services. For these reasons to ensure efective policy implementation, a minimum size has therefore been set for agencies. Tis minimum size is set at an expected turnover or expected revenue of €50 million per year.

<sup>9</sup>Te idea of the result-oriented management model is that agreements are made in advance between the relevant controlling organisation and the agency about performance, quality, costs, and risk management. Monitoring is based on these agreements. Te controlling organisation supervises the agency and emphasises the importance of understanding the costs and efciency of the implementation. Te result-oriented management model is designed in such a way that incentives exist for all parties that encourage efective action.

agency has a responsibility to ensure that the quality of fnancial management is maintained.


#### **12.1.7 Arrangements for the Systematic Review of Existence of a Second-Level Organisation: A Netherlands Example**

As has been explained above whether a second-level organisation should continue in existence should be subject to systematic review. Te Netherlands Ministry of Finance reviews the necessity for the maintenance of the status of second-level organisations. Tis provides an example for other countries.

In the Netherlands, at least once every 5 years, the controlling minister and the minister of fnance have a responsibility to jointly assess the efciency and efectiveness of an agency. Te relevant minister is required to publish the resulting report.

Te review is undertaken by the state audit service (which is a diferent audit service from the State Auditor, the Supreme Audit Institution) and the purpose of the audit is to form an opinion on the functioning of the agency in the areas of (a) governance, (b) funding, (c) efciency, (d) fnancial management, and (e) the future of the organisation.

Should a decision be made to close an agency, or to merge it with another agency, parliament should be informed and the Supreme Audit Institution.

On closure a fnancial audit is undertaken and the assets and liabilities of the agency are transferred to the organisation taking over the functions of the agency. (Tere are also special provisions relating to fnance but these are specifcally related to the Netherlands fnancing arrangements for agencies.) Tis provides a model arrangement which other countries could well follow. Without arrangements for regular review the possibility is that a second-level organisation could continue in existence when the underlying need for it has disappeared or it is not achieving its objectives or the standards set for it, assuming that they have been.

<sup>10</sup>A particular additional point that countries may wish to consider is that before a second-level organisation makes any decision to subcontract its responsibilities to a private sector organisation, or any other major policy changes, it should be required to seek the approval of the controlling organisation who should, if necessary, undertake a cost/beneft analysis of the proposal.

## **12.1.8 Questions to Be Asked About Second-Level Organisations When PFM/IC Is Introduced**

Introducing PFM/IC creates the opportunity to re-examine the relationships between controlling ministries or local governments and their second-level organisations. Tis re-examination should be regarded as an integral part of the application process of PFM/IC and the following questions about secondlevel organisations and the control arrangements should be asked by the ministry of fnance or the head of the 'driver' organisation responsible for the application of PFM/IC:

	- (a) ensure that the management of second-level organisations acts in accordance with the objectives set by the controlling organisation;
	- (b) that the resources of the second-level organisations are used only for the approved purposes;
	- (c) that the standards of internal control specifed by the ministry of fnance are fully applied throughout the second level organisations demonstrate the efectiveness of the internal audit function whether provided directly by the second level organisation or by the frst level organisation (see also below);
	- (d) that the management structure of the second level organisations evolves as the operational environment and objectives of the organisation evolve; and
	- (e) that the accountability arrangements between the second-level organisations and the controlling organisation properly present the operational and fnancial performance, including the end of year fnancial statements and annual reports, of the second-level organisations?

#### **12.1.9 Questions to Be Asked Where Private Sector Organisations Are Asked to Deliver Public Services**

Where public services are to be delivered through private sector organisations using private fnance initiative-type (PFI) arrangements other questions need to be asked of the organisation responsible for this type of arrangement, including:


Te United Kingdom National Audit Ofce looked at the quality of the management of PFI contracts in the UK National Health Service. Its overall conclusions included:

Most [Health] Trusts are managing their contracts well day-to-day and understand the risks to value for money. However, risks remain and, while many Trusts have recently increased the resources they dedicate to managing PFI contracts, some Trusts are not devoting enough resources. About 12% (9 of the 76) operational PFI contracts have no-one from the public sector assigned to contract management.

It is likely that Trusts will be expected to make efciency savings over the next few years, but their ability to make savings from their PFI contracts is very limited. Because Trusts pay an index-linked fxed sum, it is difcult for them to make savings without cutting back on services. Contractors who secure economies of scale through managing multiple PFI contracts are rarely required to share these efciency gains with Trusts.11

<sup>11</sup>Te performance and management of hospital PFI contracts—UK National Audit Ofce (NAO) Report

Te National Audit Ofce also looked at the problems which can emerge with all types of PFI contracts at the end of the life of a contract12 and there are lessons to be learnt from this. Tese included the following:


Tis illustrates the complexity of PFI contracts and why great care is required before they are entered into.

## **12.1.10 An Example of the Risks That Can Exist with Second-Level Organisations**

## **12.1.10.1 Introduction**

An example from a developed economy country, South Australia, of the problems that can emerge with the delegation of responsibilities from a controlling organisation is described below. Tis example also illustrates the signifcance of many of the issues that are relevant to the efective introduction of PFM/ IC and the control of second-level organisations. In Australia private sector has been used to support the provision of technical and further education (TAFE) for young people. Tis example also demonstrates that a market solution requires regulation to secure the benefts as the quality review report13

<sup>12</sup>Managing PFI assets and services as contracts end (nao.org.uk)

<sup>13</sup>Nous Group: Department of State Development: Quality Review of TAFE SA: 4 April 2018.

referred to below shows: 'Te early response by registered training organisations (RTOs) to the new market opportunities, and by students to the improved access to subsidised training, far outstripped expectations, with the consequence that government expenditure on VET [vocational education and training] ballooned and students were exposed to low-quality proft-seeking training providers.'14 Te response of the Australian government was to give a sharper focus to regulation; to introduce higher barriers to entry for the subsidised market; to provide incentives for students to enrol in courses with a higher public value; to provide improved information for prospective students so they could make better judgements about which course to choose.

## **12.1.10.2 Te example:**

Te public authority in South Australia responsible for the organisation of the delivery of tertiary technical and further education in that State had come under criticism for being slow-moving, inefcient, and overly protected in a market place where there were both public and private sector providers. Te quality of the educational outputs was, at that time, not contested. However, a quality review by the Australian Skills Quality Authority (ASQA) resulted in ASQA giving notice of its intention to suspend the registration of ten qualifcations from the Technical and Further Education (TAFE). Te shock of this fnding was such that the then Government of South Australia (SA) sought the resignation of the Board chair and accepted the Chief Executive Ofcer's ofer to step down. Te purpose of this quality review was to 'make recommendations to ensure the quality, sustainability, and reputation of the state's public vocational and education training provider'. Te criticisms included


<sup>14</sup> Ibid., Section 1, page 7


vide more professional development, particularly with respect to assessment processes.

• Culture—this presents both an opportunity and a risk for TAFE SA. Tere is large contingent of highly motivated and loyal staf who want to help restore confdence in the institution of which they are very proud, but who have felt alienated from and unclear about the overarching strategy and role of TAFE SA in the wider system. Tey have also been inculcated into a culture of fxed rules and entitlements that arguably diminishes a sense of trust, responsibility, and ability to 'lead from below'.

#### **12.1.11 Controlling Ministries and Boards for Second-Level Organisations**

Tere are diferent views on the appropriateness of boards to be responsible for overseeing the management of a second-level organisation. Te lack of a board structure makes the controlling organisation management dependent entirely upon the most senior ofcial (chief executive) of the second-level organisation. Te advantage of a governing board is that it should be prepared to act independently of the most senior ofcial. But it can only do this if the board includes independent experts, including the chairman. Te advantage of independent experts is that they should be impartial and can bring an expertise to the oversight of the management of the second-level organisation. (Independent does mean 'independent' and that means no political or family or other types of relationship to other key government ofcials should exist.) Tis arrangement lessens the risk caused by the asymmetry of information existing between the second-level and the controlling organisation. Te involvement of persons independent of the chief executive in the top-level decision making of the second-level organisation is a potentially very signifcant governance beneft! A board also provides in the second-level organisation governance structure a facility or feature able to challenge the chief executive of the organisation and therefore test out the plans, objectives, and assurances of that chief executive. Tis provides a degree of independent assurance to the controlling organisation.

However, appointing a board for every second-level organisation may not be appropriate where they are small or have a limited role (although this itself should raise questions about whether it is appropriate for such small secondlevel organisations to exist rather than their functions be undertaken directly by the controlling organisation), but for some and certainly for larger second-level organisations and especially for those that are commercially oriented the existence of a board would be entirely appropriate.

Where a board is created, particular attention should be given to its role, composition, and functioning. Governing boards should not interfere with the daily management of the second-level organisation. Teir role is the strategic control and supervision of the organisation, that is, the oversight of the management. Many countries have taken initiatives to introduce corporate governance models to optimise the relationships between board and heads of second-level organisations. But corporate governance calls for a clear delineation of responsibilities between those responsible for daily management (the chief executive and operational staf) and the board. Te board should be responsible for strategic decision making in terms of planning, overall budgetary envelopes, strategic tasks, reporting, and control of management. Board members should include persons with a range of expert knowledge, including in the subject matter of the second-level organisation activity, as well as in fnance, and where appropriate commercial and legal expertise. Te board should hold the executive head of the second-level organisation responsible not just for the quality and operational performance of the organisation but also for the way in which ethical and other control standards are introduced and applied. Te existence of a board provides in practice a counterweight to the authority of the executive head of the second-level organisation and this reduces the chances of inappropriate action on the part of that executive head.

However, if a board structure is to be efective the board members should be appointed for their specifc skills and this is especially important for the role of chairman. A risk that a ministry of fnance and the PFM/IC driver department should be concerned about is that the appointments made to a board are simply made for political reasons, that is, to reward political friends and or to provide opportunities for rent seeking. Where such is the situation, the likelihood is that the board appointments will be entirely cosmetic and may well serve to disguise the reality of the power structures that exist.

An example of the responsibilities of board members is described in the Irish government publication on second-level bodies as follows15:

Principle:

Each State organisation should be headed by an efective Board which is collectively responsible for the long-term sustainability of the organisation.

<sup>15</sup> Some countries have published detailed advice on the governance arrangements for state bodies (i.e. second-level organisations), including the role of a board: a particularly good example is that published by the Irish government: available at http://govacc.per.gov.ie/governance-of-state-bodies

Non-executive Board members should bring an independent judgement to bear on issues of strategy, performance, resources, key appointments, and standards of conduct.

Fiduciary Duty: All Board members have a fduciary duty to the State organisation in the frst instance (i.e. the duty to act in good faith and in the best interests of the State organisation).

Te principle fduciary duties are (NB the references to 'company' below, should be interpreted as to the 'second-level organisation'):


Te arrangements described above in Sect. 1.7 designed to monitor the ongoing performance of the second-level organisation would remain even with the existence of a board.

## **12.1.12 Audit and Second-Level Organisations**

All second-level organisations should be subject to internal and external audit. External audit may be by the state auditor or could be both by the state auditor and by a commercial audit frm if the organisation is operating in the marketplace. Internal audit may be undertaken by either the second-level organisation's own internal auditor or the internal audit of the controlling organisation. However, even where the second-level organisation has its own internal audit the controlling organisation still has an obligation to satisfy itself about the efectiveness of the control activities and therefore any agreement between the frst and second-level organisations should provide for the controlling organisation internal audit to undertake its responsibilities on behalf of the management of the controlling organisation. External audit should also encourage, for larger and commercial second-level organisations the establishment by the organisation of its own independent oversight organisation through, for example, the establishment of an audit committee. In some countries there already is a requirement that audit committees or audit and risk committees should be established by both controlling and secondlevel organisations with authority to:


To whom the external auditor should report will depend upon local circumstances but where a board has been appointed to oversee the activities of the second-level organisation, the external auditor should normally report to that board, rather than to the chief executive and the report should be available to the controlling frst-level organisation. If the second-level organisation is managed only by a 'head' or 'chief executive' the external auditor should always report to the controlling organisation with a copy to the head or chief executive of the second-level organisation. Usually, the external auditor will also provide a 'management report'. A question that each controlling organisation should consider is whether the external auditor should also be required to submit that management report to the controlling organisation.

Where responsibility for a service or activity is delegated to the private sector via a PFI-type arrangement that arrangement ought to include a recognition that the state external auditor should have access to assess performance under the PFI contract arrangements as well as ensuring that the PFI contract itself contains the appropriate range of controls and that those controls are being properly exercised.

#### **12.1.13 Using 'Performance' as a Basis for Control**

'Performance' ought to be used as one of the factors in the controls by the frst-level organisation. Te extent of the 'performance' information required will depend upon the service or activity in which the second-level organisation is engaged. Te information required for managerial control purposes will also be diferent from that required for public accountability purposes and it will be more extensive.

Using 'performance' as a basis for control, places the focus heavily upon the drafting of the service-level or performance agreement and the results or outputs of a second-level organisation. However, 'performance' can be very diffcult to defne in precise terms for some organisations, and consequently some countries have combined input and output controls.

Service-level agreements should describe the basis for defning the fnancial and statistical information systems to be used. An example, would be whether a cash or accrual accounting basis should be adopted (and this will depend mainly upon whether the second-level organisation is engaged in commercial activities). For statistical reporting purposes, sometimes it may be appropriate to require the use of defnitions developed by such recognised organisations as the World Health Organisation (WHO). Te agreement should also specify which control bodies (e.g. external audit or some other regulatory agency depending upon the service being delivered) should be involved in measuring or checking performance where that is appropriate, as, for example, with some medical or educational performance.

Whether 'performance' can be defned also depends upon whether the objectives for the second-level organisation have been clearly defned and linked to budgets. Where objectives are difcult to defne proxy indicators may need to be devised. For example, the performance of a second-level organisation responsible for improving health care cannot necessarily be precisely defned because almost every activity infuencing healthcare, such a diet, housing, and lifestyle, would not be under the control of the management of a second-level organisation (or frst-level for that matter). But it can take a range of actions designed to address specifc areas of healthcare such as programmes of vaccination, encouraging residents to adopt less sedentary lifestyles, or healthier eating, encouraging the stopping of smoking, and such actions can be measured. Tis would mean that the controlling organisation, sets out more specifc requirements than an overarching objective. Tese resulting performance measures though should be agreed between the controlling organisation and the second-level organisation and their impacts should be measured against objectives set by the controlling organisation. (Te problems with using performance are discussed in more detail in Chap. 5.)

Because of these difculties and sometimes the costs of obtaining detailed performance information for accountability purposes, the performance or service-level agreement should focus on the key performance information rather than try to incorporate every aspect of performance. However, for purely internal management purposes much more detailed performance information may be needed and especially given a requirement that an objective of management is to secure improvements in efciency and efectiveness.

All these factors point to a need for a close management dialogue between the frst and second-level organisation with the frst-level organisation having the knowledge and capacity to set the performance standards and objectives it expects to be achieved, whatever the form of performance (i.e. fnancial and/ or physical performance) and then having the capacity to monitor whether those performance objectives have been achieved.

# **12.2 Summary of Issues Concerning Second-Level Organisations and PFI-Type Schemes**

Te mere act of creating a second-level organisation, or of delegating responsibility for the delivery of a service or activity to the private sector via a PFI arrangement does not of itself guarantee improved performance (of whatever kind). Management action must be taken by the controlling organisation. PFI arrangements are usually entered into in order to bring forward investment activity, such as the advanced provision of a hospital rather than for any other reason. Autonomy alone for a second-level organisation is an insufcient condition to improve the quality of second-level management and performance. Improvements require constant vigilance by a controlling organisation to avoid the onset of management complacency and the pursuit by the second-level organisation of its own agenda. Tis is particularly true where there are no external incentives, such a competition, to drive improvements in performance, that is, in quality and in efciency and efectiveness and no threat of operational fnancial risk.

An important feature of controlling organisation management of secondlevel organisations is that there should be consistency between the objectives and policies of the controlling frst-level organisation and those of all secondlevel organisations. Controlling organisations should be organised in such a manner as to ensure this occurs. Tey should retain a capacity to set policy objectives for second-level organisations and a capacity to systematically review performance. Te operational heads of controlling organisations (state secretaries or equivalent) should ensure that second-level bodies are well managed, have objectives and performance standards which are consistent with those of the controlling organisation, adopt internal control policies which are also consistent with those of the controlling organisation and that systematic monitoring arrangements are established.

In countries which have well established arrangements for PFM/IC the evidence is that there is active management of second-level organisations and this extends to regular reviews not only of performance but also to whether the need for a second-level organisations remain. Active management also asks questions about whether new second-level organisations should be established at all. Establishing them is not 'cost free'.

An important element in establishing a managerial relationship between frst- and second-level organisations is the existence of agreements between the two levels of organisation setting out what each is expected to contribute and to achieve as well as how monitoring will be undertaken. Te agreements (performance or service level or an equivalent term) do not need to just exist but they should be actively monitored by the frst-level organisation.

A usual stated reason for establishing second-level organisations is to improve efciency and efectiveness. However, there is little evidence that such a beneft is achieved in many countries and with some arrangements challenge to the managements of second-level organisations is difcult to mount unless the conditions to do so are established from the outset.

Second-level organisations should be subject to both internal and external audit. Te specifc arrangements may depend upon whether the second-level organisation has commercial or non-commercial objectives. Te fact that audit arrangements exist does not mean that the controlling organisation should not directly engage in its own monitoring activities or in some way modify them. However, it should be clear about the role of its own internal audit organisation and ensure that it has access to the external auditor's report.

All second-level organisations should be expected to publish an annual report, a statement of internal control and fnancial statements.

# **Annex**

# **Irish Government Agency Report Requirements16**

## **Chairperson's Comprehensive Report to the Minister17**


<sup>16</sup>Te Chairperson's comprehensive report has been edited by the author to simplify the presentation by excluding references to specifc Irish legislation.

<sup>17</sup>Chairperson's comprehensive report to the minister: https://www.gov.ie/pdf/?fle=https://assets

<sup>18</sup>Te reference to 'body' is an equivalent term to 'organisation'.


## **Statement on System of Internal Controls in a State Body**

A statement on the system of internal controls in a state body should include the following items:

	- (a) A statement in relation to when the annual review of the efectiveness of control was conducted or where such a review was not conducted, a statement that it was not conducted.
	- (b) Disclosure of details regarding instances where breaches in control occurred—such breaches might include non-compliance with procurement rules or instances where other elements of the control system (e.g. internal audit, Audit and Risk Committee or other committees) were not operational.
	- (c) Disclosure of details of any material losses or frauds.
	- (d) Statement on System of Internal Controls is to be reviewed by the Audit and Risk Committee and the Board to ensure it accurately refects the control system in operation during the reporting period.
	- (e) Statement on System of Internal Controls is to be reviewed by the external auditors to confrm that it refects the audited body's compliance with the requirements of paragraph 1.9 (iv) and is consistent with the information of which they are aware from their audit work on the fnancial statements and where this is not the case, the external auditor should report on this in the audit report on the relevant fnancial statement.

## **Irish Government: Model Shareholder Expectation Letter19**

Strictly Private and Confdential

#### **SAMPLE LETTER TO COMMERCIAL SEMISTATE BODY FOR CORPORATE GOVERNANCE COMPLIANCE AND SHAREHOLDER EXPECTATIONS.**

<sup>19</sup> See footnote 16: section on Government Accounting: Model Shareholder Expectation Letter.

[On Letterhead of Relevant Line Minister]

Author's Note: Tis is an illustrative example of a shareholder expectation letter setting out what typically should be included. Please note that the shareholder expectation letter should be tailored to meet the particular circumstance of the commercial State body.

[Date] Intended Recipient:

Dear [] Introduction

Te Minister for Public Expenditure and Reform and I have given consideration to the way in which Government objectives for [insert name of entity] are formulated and shared with the Board of Directors (the 'Board'). Arising from that consideration, we are now proposing a more structured approach to confrming Government's objectives for [insert name of entity] over the short and medium term with a view to assisting the Board in its operations and in complying with its obligations under the prevailing governance framework.

Tis letter is intended to provide guidance to the Board with respect to Government's current objectives for [insert name of entity] and the primary considerations which will be taken into account in respect of matters for which consent may be required under legislation, [the entities Constitution] and/or the Code of Practice for the Governance of State bodies (the 'Code'). We believe that this letter will be helpful to the Board, particularly in its corporate and strategic planning processes, and it is our intention that we would in future issue a similar letter on an annual basis.

Te specifc objectives outlined in this letter should be considered in the context of the Government's overall policy objectives for [insert name of entity], namely that:


## **Dividends**

It is our view that a new Dividend Policy, tailored to the specifc circumstances of each commercial semi-state body, should apply in the commercial state sector, with a view to facilitating management in prioritising objectives and providing greater clarity on dividend payments over the medium term. We therefore request that the Board of [insert name of entity] would now develop a new formal dividend policy for [insert name of entity], which would take into consideration the following principles:


In this regard, it is proposed that a list of appropriate peer companies be agreed between our respective Departments and the Board. A suggested list of peer companies is set out in Appendix II.

As indicated above, the objective of formulating a new dividend policy is to assist the Board by bringing clarity to the Government's objectives as regards future dividend payments over the medium term, thereby avoiding the uncertainty created by special dividends potentially being requested from time to time. It may still be necessary or appropriate for special dividends to be paid from time to time (e.g. in event of sales of assets, windfall gains, etc.). However, to the extent that any special dividend is paid, it is our expectation that the likely impact of such payment on the policy would be reviewed at the time. We also believe that greater certainty on dividend policy will assist in enabling informed decisions to be made on fnancial management and investment, while providing an appropriate, regular, and predictable return to the Shareholder.

We ask that you engage with the Departments with a view to developing an appropriate new dividend policy, with a target of having this fnalised no later than [deadline].

#### **Return on Capital**

A key focus for the Shareholder(s) in the commercial state companies is the return generated on capital invested. We propose to augment our monitoring and measurement of [insert name of entity] investment returns and in this regard Appendix [see below] includes fnancial performance measures in respect of proftability and investment return which we propose to use to assess company performance. While acknowledging that returns will vary from year to year, sometimes due to temporary or non-controllable factors, it is, however, a key Government objective that [insert name of entity] delivers investment returns over the relevant period that are in line with peer companies, while also having regard to the cost of capital.

Tis proposed approach to developing a perspective on shareholder return will be reviewed on an on-going basis and may be adapted as necessary.

## **Sectoral Policy Objectives**

In addition to the overall policy objectives of [insert name of entity] listed above, we wish to ensure that [insert name of entity] continues to work actively to support general Government policy in the XXX sector [including … Tis will require an appropriate level of on-going investment by [insert name of entity], with care being taken to ensure that core areas of activity are prioritised within the resources available to the company for reinvestment.

## **Governance Arrangements**

## *Corporate Plan*

Te Code of Practice for the Governance of State bodies (the 'Code') sets out the governance framework for the internal management, and the internal and external reporting relationships of commercial and non-commercial State bodies. As you know, the Code requires State bodies to prepare a rolling 5-year corporate plan, which should be submitted to the relevant parent Department within six months of the year end. We would propose to engage with you early on in the process of preparing/updating this corporate plan, in order that we can provide feedback to you on the plan in a timely fashion.

## *Reporting*

Te Business and Financial Reporting Requirements document, appended to the Code, sets out the reporting requirements to which State bodies should adhere, including the provision of interim and fnal fnancial statements. We would propose to enhance the existing reporting arrangements by introducing regular three-monthly review meetings between [insert name of entity] and the Departments, to review progress in relation to the fnancial performance measures referred to above (as set out in Appendix) and other key performance indicators.

## *Board Evaluation*

Consistent with the requirement in the Code, we expect that the Board constantly reviews its own operation and performance and that of its committees and individual members and that the Board undertakes an evaluation of its performance on an annual basis.

## *Engagement*

Our expectation is that you will engage with the Department in the near term to discuss the matters set out in this letter in more detail. Please make arrangements with your usual contacts in the Department.

Yours sincerely. Minister for…

## **Financial Performance Measures**


#### Proftability/Efciency


Wages & Salaries


#### Leverage/Solvency/Credit Metrics


#### Defnition of Key Terms Used in Calculations


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# **13**

# **Monitoring the Change from Administration to Management: Demonstrating This Through the Utilisation of a Statement of Internal Control**

Te PFM/IC reform is not simply about a reform to existing procedures. Te reform is more fundamental than that. It is about moving from a traditional administrative approach to the utilisation of public resources to an entirely new environment, which is the management of public resources. Te monitoring of this change should be an important dimension to the reform. A requirement for public organisations to prepare annually a statement demonstrating the recognition of this change and how it has impacted upon the ability of an organisation to achieve its objectives and performance standards and objectives and at the same time ensuring that its resources have been efciently and efectively utilised and income collected should be an essential component of the reform. Tis statement, which is called here a statement of internal control (this statement may have diferent titles in diferent countries where an equivalent type statement exists), should explain how management has performed during the year. Te statement should give the reader a clear understanding of the challenges facing the organisation and how those challenges have been responded to including remarks about what has gone wrong and the actions taken to make corrections. In other words, the statement should be an indicator of the quality of management. Te statement should also address risk management. Where it does not do so a separate statement about how risk is being identifed and managed also should be published. Te publication of such a statement is an important feature in developing accountability and transparency and should be a requirement in the development of PFM/IC. Te external auditor (the auditor general or equivalent) should be expected to review this statement and it should be available to the parliament. However, in many countries neither a statement of internal control nor a statement about risk management are features of public organisation reporting. At the very least the ministry of fnance should require that such statements are prepared and the information contained in these statements is available to it. Where individual organisational statements are not published a summary should be published as part of the annual report on the government's fnancial statements.

# **13.1 Reporting on the Quality of Internal Control**

## **13.1.1 Management and the Statement of Internal Control**

In the current climate of fscal restraint and declining availability of resources, it is important that central government bodies can demonstrate the resources that they are responsible for are appropriately managed and controlled. High quality and proportionate internal control systems will help organisations achieve their aims. A useful method of demonstrating how well an organisation is performing would be a requirement on the operational management to prepare a 'Statement of Internal Control'. Te Statement on Internal Control (SIC) should be a public accountability document that describes the efectiveness of internal controls in an organisation.1

As has been explained throughout this guide, the PFM/IC reform represents a signifcant reform from a traditional administrative approach with an emphasis upon establishing a managerial approach concerned not only with securing fnancial and budgetary control but also with the achievement of objectives and performance standards and doing so efciently and efectively. Te evidence of this change. Te efectiveness of the reform should be demonstrated annually. Tis would be by the preparation and publication by the top operational management of public organisations (the state secretary or equivalent) of a statement of internal control. Tis would be an entirely new feature for most countries changing from traditional systems of public administration and for some countries that have already adopted PFM/IC.

Te statement of internal control should normally be published along with the annual fnancial statements or if separate fnancial statements are not published for each public organisation (e.g., for each ministry), then the statement

<sup>1</sup>UK National Audit Ofce: https://www.nao.org.uk/wp-content/uploads/2010/01/statement\_internal\_ control.pdf.

should be published either separately or it may be published in a consolidated form covering particular types of organisations, such as all ministries. However, as an objective is to achieve greater transparency and accountability, the greater the degree of consolidation the less the level of these characteristics, unless the consolidated statement addresses separately each public organisation. Transparency and accountability are important in generating pressure for improvements and to develop efective parliamentary scrutiny. Ideally statements of internal control should be published in such a manner that makes them also available to the taxpayer, the user of public services, suppliers and others who have dealings with public organisations. Some governments may resist this seeing publication as only necessary to a more limited group of users, namely, the minister of fnance, the cabinet of ministers and in some form to the parliament. But this does not create transparency and accountability in the 'open government' sense and this limited form of publication should either be discouraged or at best seen as a step towards wider publication as experience and confdence in the PFM/IC reform become established. At the least an aim should be to ensure that parliament has access to the information and if necessary to any statement of the actions to be taken by the ministry of fnance and/or the cabinet of ministers to correct weaknesses or to develop new policies to address emerging issues.

Statements of internal control are most efective where a distinction exists between political and civil service (or local government service) management (i.e., between the development of policy and the strategy for implementing that policy and day-to-day operational management). If that distinction does not exist, there is a possibility that what should be an annual assessment of the efectiveness of operational management internal control arrangements of an organisation could become a political criticism, both of policy and of operational management. Where this occurs, the risk then is that the confation of the two quite separate issues will lead to a focus on policy rather than the quality of the operational management internal control arrangements. Tis will then cause those with political responsibilities to be cautious about publishing any material that could potentially lead on to political as opposed to operational management criticism. Tis then is another reason why with the implementation of PFM/IC delegation of operational management should occur.

Te statement will be an important source of information about the development of internal control to the 'driver' department responsible for the implementation of PFM/IC.

#### **13.1.2 The Responsibilities of the Offcial Preparing This Statement**

Te most senior operational manager, that is, state secretary or equivalent, who should also be responsible for the implementation of PFM/IC, should be required to prepare this statement each year. Tis ofcial should take personal responsibility for the quality of the fnancial management and internal control systems.2 In those countries where there is no such single ofcial with individual heads of departments reporting directly to ministers, such a statement could not be efectively prepared. Tis is another reason why that arrangement would be inappropriate with the implementation of PFM/ IC. Te other key ofcial who should be involved in the preparation of this statement should be the head of fnance (see Chap. 8). Te reason for the involvement of this ofcial is the role that he/she has in ensuring that the organisation is fnancially well managed, that it has a focus on delivering efciency and efectiveness and using its resources efciently and efectively as well as economically. Tis head should also ensure that the organisation is managed in such a manner as will maintain its fnancial resilience over time.

In addition to provide confdence in the statement of internal control, the head of internal audit should also be asked to review the content of the statement.

Although the ofcial responsible for the implementation of PFM/IC should have a personal responsibility for preparing this statement and signing it, the content of the statement also should be agreed with and approved by the political head of the organisation, such as a minister or mayor where that political head has an overall responsibility for the quality of the management of the organisation. Where an audit committee exists, it should also be approved by that committee. Approval requires the political head to acknowledge how well the organisation is being managed (or not!) and to understand how emerging problems and weaknesses in the internal control arrangements have been addressed as well as the corrective actions that have been taken. Where signifcant problems and weakness have been reported in this statement, the day-today managerial accountability arrangements should have ensured that the political head of the organisation was well aware of them before the statement of internal control was prepared. Te political head should be fully informed about any signifcant weaknesses and be able to ensure that corrective actions have been taken. Ideally this should occur before external criticism emerges, whether from the ministry of fnance or the external auditor.

<sup>2</sup> If delegation has not occurred (which would be most unsatisfactory so far as the application of PFM/IC is concerned) the responsible person would be the politically appointed ofcial with the responsibility for overseeing the implementation of PFM/IC, which could be in some circumstances a minister or mayor.

#### **13.1.3 The Benefts of This Statement**

Tis statement, along with the results of any separate reports required by the 'driver' department of the ministry of fnance, will help establish how successful the reform is being implemented. It will enable the 'driver' department prepare an assessment of what still needs to be achieved which could include training and the development of new systems. New systems could include management accounting and performance information systems.

Ideally, the statement should be a by-product of day-to-day internal control processes. Tis statement may also include a statement about the risk management arrangements. If it does not include the risk management arrangements, then a separate risk management/appetite statement should be prepared and be available as part of the transparency and accountability arrangements. (See Chap. 11 for a detailed discussion on risk management.)

Te efectiveness of internal controls (and bear in mind that they are as much about the achievement of objectives and performance standards efciently and efectively, as well as about ensuring that rules and regulations governing 'inputs' are complied with and that assets and other resources are not misused) should be under constant review. Te information about the quality of those controls and the achievement of objectives and performance should fow up and down the management structure of the organisation to allow appropriate management action to be taken.

In preparing the statement of internal control the ofcial responsible will need to rely on information provided by others such as heads of second-level organisations and heads of ministry or local government departments. Te information required should largely be derived from the day-to-day implementation of the internal controls, especially identifying what has been shown to be weak or has revealed errors or risks or the reasons for a failure to achieve objectives or deliver specifed performance standards or a failure to achieve improved efciency and efectiveness.

#### **13.1.4 The Issues That Should Be Covered in the Statement**

Te head of operational management in preparing the statement of internal control should set out his/her responsibilities for the internal control arrangements. Te head should explain the purpose and provide a description of the system of internal control, that is, that it is designed to ensure that fnancial and budgetary controls are efective and that the objectives and performance standards can be delivered efciently and efectively and to time and that they are being delivered within the relevant legal and regulatory framework. Te statement should explain the arrangements for the management of public resources, including a description of how the top and senior operational management provide leadership to ensure that the internal control and risk management policies are embedded in the management processes of the organisation. It should also explain the training provided to staf to embed an appreciation of the internal control arrangements. Tis should also include how the internal control arrangements have been adapted to meet changing circumstances.

Te statement should also include the following:


circumstances and personal as well as events occurring beyond the control of management.)

	- might prejudice or prevent the achievement of the objective(s) and performance standards;
	- could have an impact upon budgetary and fnancial controls and fnancial reports to the ministry of fnance;
	- would be regarded by internal or external audit as signifcant;
	- might attract adverse public comment and/or could result in a breach of the law and regulations;
	- indicate departures from established practices including over the arrangements for procurement: the reasons for such departures should be clearly identifed;
	- would indicate weaknesses in the arrangements for the collection of revenues, including increasing levels of losses on revenue collection;
	- show any signifcant lapses in data security such as data losses or breaches of IT security;
	- have identifed fraudulent or corrupt activity occurring which afects the organisation, analysed between fraudulent or corrupt activity occurring within the management and staf of the organisation and that efected by third parties upon the organisation.

Te disclosure of signifcant internal control issues should be explicit and should include how the issue arose and the remedial actions taken and planned. Subsequent statements of internal control may also need to include progress in subsequent years in addressing identifed problems.

	- A statement about improvements in value for money in the delivery of the services for which the organisation is responsible and in the management of the organisation:

Te exact content will vary over time with the developing maturity of the internal control arrangements.

Te statement could cover the management of the relationships with all controlled second-level organisations, and whether in exercising this supervisory role, any difculties have emerged during the period. Te statement should disclose how they have been dealt with by the controlling organisation.

Tis represents a potential schedule of the issues that should be covered, but each country will decide what it wishes to see included within the statement and therefore may wish to amend this list.

## **13.1.5 The Role of Audit and This Statement and the Publicity Which Should Be Given**

Te head of internal audit should give an opinion on the overall adequacy and efectiveness of the organisation's internal control environment, providing any details of weaknesses. Te head should bring to the attention of the ofcial responsible for the implementation of PFM/IC (i.e., the state secretary or equivalent) any issues particularly relevant to the preparation of the

<sup>3</sup>Tis is relevant to the IMF Fiscal Transparency Code. "Fiscal transparency—the comprehensiveness, clarity, reliability, timeliness, and relevance of public reporting on the past, present, and future state of public fnances—is critical for efective fscal management and accountability. It helps ensure that governments have an accurate picture of their fnances when making economic decisions, including of the costs and benefts of policy changes and potential risks to public fnances." Tis code does not specifcally cover the statement of internal control but the information contained in such a statement would be of assistance to the ministry of fnance in compiling the information required by Te Fiscal Transparency Code.

statement. In some countries the head of internal audit may also be asked to sign the statement of internal control as well as the head of operational management.

Te state external auditor should also review the statement of internal control and provide observations on the quality of the internal control arrangements including whether the external auditor agrees with the remarks in the statement of internal control. Te external auditor (as well as the internal auditor) should have a concern for improvements in public value through value for money audits and the auditor's ability to undertake such audits will be afected by the quality of the fnancial and performance information available to management and hence to the auditor.

#### **13.1.6 Consequential Changes to Facilitate the Development of a Statement of Internal Control**

In Chap. 4, reference was made to the need to modify the sanction arrangements which could be applied against civil and local government ofcials with the introduction of PFM/IC to refect the change to a managerial culture. Unless such modifcations occur, their existence may also cause civil and local government ofcials to be cautious about identifying weaknesses which may result in criticisms of them and which may, in turn, cause the application of penalties (because of a penalty culture which may exist). Te implementation of PFM/IC which has a focus on the delivery of objectives efciently and efectively should also cause, as indicated in Chap. 4 (Test 8), a review of that penalty culture. Tis is because the risk of penalty may prevent the disclosure of information about failings in the internal control system. Yet disclosure of failings is central to improving the quality of public fnancial management and internal control. A process which discourages disclosure ultimately is not in the interests of top and senior management or in the interests of the ministry of fnance.

Quite separately the budget law in some countries may contain penalty arrangements which would fall upon any ofcial who breaches the conditions set out in the budget law.4 Such conditions may also require modifcation on the change from an administrative to a management culture.

<sup>4</sup> See, for example, the Croatia Budget Law 1994—article 49: worldbank.org/publicsector/pe/ BudgetLaws/Croatia.

## **13.1.7 Signs of Weaknesses in the Internal Control Arrangements**

Indicators of evidence of weaknesses in internal controls are:

	- Managers not efectively supervising the work and outputs of the staf they are responsible for?
	- No training in leadership, organisation management and particularly in staf management has been provided.
	- Delegation may exist but the delegation arrangements are unclear about what is expected of the staf and the limits of any discretion.
	- In practice staf are left to efectively 'manage themselves'. Te accountability arrangements are weak with superior managers not efectively supervising staf, not being concerned with outputs and not ensuring staf act in conformity with the delegation arrangements including any limitations on the exercise of discretion.

Is there evidence that the organisation's HR policies and practices are consistent with the organisation's ethical values and facilitate the achievement of its objectives including the management's ability to manage their staf efectively? Do those HR policies recognise that to achieve objectives managers will need to take decisions and this involves risk? Do those policies facilitate risk taking (and this may link up with the existence and application of the penalty policies referred to above)? Do staf have the necessary training to give them the knowledge, skills and tools to support the achievement of the organisation's objectives? Is there an efective incentive and reward policy including promotional policy? Does top operational management aim to establish an atmosphere of trust and mutual support within the organisation to encourage the fow of information between members of the staf and in this manner prevent to development of 'silo' mentalities and facilitate efective performance towards achieving the organisation's objectives. Does a culture of honesty and ethical behaviour exist? In some countries HR policies are not the responsibility of the employing organisation and may not refect the individual needs of particular organisations or are of low priority to top management. Tis can lead to managers seeking ways to circumvent externally imposed controls or a failure of the coordination of policies and activities within the organisation.

4. Te types of control that exist are inappropriate or do not cover the business of the organisation:

Looking at 'control' from the limited perspective of fnancial and budgetary control there are two types of control, preventative and detective. Preventive controls are designed to deter or prevent undesirable events from occurring. Detective controls are designed to detect undesirable acts. Te latter provide evidence that a loss has occurred but do not prevent a loss from occurring. A good internal control system not only has detective controls, but also has preventative controls. If both types of control do not exist, this is a signal of internal control weakness. However, with PFM/IC other controls should exist designed to ensure that intended performance is achieved. Do such controls exist and if not, why not?

5. Te objectives and/or performance targets set for managers are unrealistic or not compatible with budgetary and other resource availability:

A temptation can exist for top managers to set unrealistic targets for managers to achieve, targets which are not compatible with available resources. Tis situation can arise where top managers themselves feel under pressure, perhaps because of political pressure or reasons external to the organisation (such as civil society pressure). Te consequential risk then is that individual managers will seek to avoid the rules or take shortcuts in order to meet those targets, for example, to avoid competitive tendering because it takes time or to ignore health and safety requirements or to reduce the quality of services. Opportunities should exist for managers to express their concerns where they regard targets as unrealistic.

6. Risk management is not taken seriously by both top operational and political management:

Is risk management a serious or token responsibility of top operational management? What are the arrangements to involve the political level of management in the risk management process? Have measurable objectives been defned and linked with budgetary availability? Have the signifcant or strategic internal and external risks to the achievement of the organisation's objectives been identifed and assessed? Is there a focus of top management on those signifcant or strategic risks? Tere can be a real possibility that the importance of risk management is not well appreciated by top and senior management, and where this is the situation, this in turn afects confdence in the ability of the management to achieve its objectives efciently and efectively.

7. Reports and supporting documentation and other signifcant documents are missing:

Reports and original documents provide 'hard' evidence of business transactions and especially of sensitive decisions. Tey also provide the evidence that both the internal fnancial reports are reliable and the external fnancial reports. Missing reports and original documentation should raise uncertainty about the quality of the internal controls. Tis is a weakness that managers and staf would be able to take advantage of, particularly those that are under pressure to perform.

8. Te arrangements for the separation of duties are inadequate:

Not only is this relevant for the purposes of fnancial control but where performance and budgetary information is linked and managers are expected to achieve performance targets within specifc budgetary limitations the manager should have no opportunity to determine or control that performance information. In other words, it should be independently derived. Unless this is the situation confdence in that performance information can only be limited and therefore managerial claims of meeting performance objectives within budgets can also only be of limited value.

9. Te fnance department capability to support managers in the search for efciency is inadequate:

Has the head of fnance a programme to improve the fnancial awareness of managers and staf? Has the head of fnance ensured that each manager has the budgetary and fnancial and cost accounting information that individual managers require? Has the head of fnance the authority and status to assess and challenge managerial claims for improvements in efciency? Does this in fact occur?

10. Written procedures to explain how the diferent processes and activities of the organisation are to be undertaken and their current relevance:

Do such procedures exist and are such procedures regularly reviewed by managers to refect changing circumstances? Without current written procedures, employees may not be aware of the proper processes and this may lead to errors in decision making and recording.

11. Customer complaints procedures and the recording of such complaints: Does a 'customer complaints' procedure exist? Is there a process for reviewing customer complaints? Levels of complaint should provide evidence of compliance with standards of performance as well as evidence of the quality and relevance of the service and activities being provided. If a high number of complaints is made or in some circumstances an increase in complaints occurs, this would be an indicator of weak internal controls.

#### **13 Monitoring the Change from Administration to Management…**

#### 12. Arrangements for the systematic review of controls:

Is there a process which allows for a regular and systematic review of internal controls? Operational changes, procurement requirements, personnel changes, environmental changes, changes in fnancial constraints, changes in systems, changes in security requirements, especially for IT systems, all impact on internal controls or how those internal controls should be applied. Have such reviews occurred?

13. Managerial 'override' of controls:

Is there any evidence of managerial 'override' of controls? Management is responsible for the design, implementation and maintenance of the internal controls and therefore could override these controls should it so wish. Tis is an especial risk in those organisations where lower level staf have difculty in challenging a superior manager (e.g., as instanced above over unrealistic targets). Tis may lead on to fraudulent activity in one form or another. Examples would include the misappropriation of assets as well as fnancial resources or the favouring of certain suppliers or the entry into types of contracts which potentially could increase the fscal risks to the organisation, such as public/private partnerships. An important factor in discouraging this type of action is the quality of the 'tone at the top'. Terefore, in any review to determine whether weaknesses exist in the internal control system regard should be had to the approach of the top management, both political and operational, of the organisation.

14. 'Whistle blowing arrangements':

Does a 'whistle blowing' process exists which allows staf to expose inappropriate behaviours or actions? Tere are both advantages and disadvantages to the existence of such a policy which can be implemented in diferent ways. Sometime the 'whistle blower' can remain anonymous and sometimes not. Where such a policy exists, it can be a useful method of exposing weaknesses in the internal control systems sometimes resulting in fraud or the misuse of a public organisation's resources.

15. Efectiveness of internal audit:

Internal audit should be "an independent, objective assurance and consulting activity designed to add value and improve an organisation's operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the efectiveness of risk management, control and governance processes." (IIA)

Is this the actual situation?

In assessing the efectiveness of internal audit, a series of questions for consideration has been suggested by a commentator who was a chief risk ofcer at major global corporations.5 Such questions should be asked annually and they include:


# **13.1.8 Examples of Statements of Internal Control**

Examples of statements of internal control are included at Annex 1. Tey are from the UK and Croatia. Tey illustrate diferent approaches to the development of statements of internal control (which in Croatia is entitled 'Financial Responsibility Statement' and is accompanied by a detailed questionnaire to be completed by all public organisations). In Croatia, frst-level budget users (ministries, counties, cities, municipalities) must submit a 'Fiscal Responsibility Statement' to the department in the ministry of fnance responsible for the oversight of the implementation of PFM/IC. Second-level bodies must prepare and submit a 'Fiscal Responsibility Statement' to their supervising or controlling ministry or if subordinate to a local government, to the supervising or controlling city or municipality.

Tese examples refect the diferent political, managerial and fnancial management arrangements which exist in these two countries. However, the Croatia model refects the careful thought that the ministry of fnance in that country has put into the development of PFM/IC making it a leader amongst its peer countries.

<sup>5</sup>Te IIA website: https://iaonline.theiia.org/how-to-assess-the-efectiveness-of-internal-audit.

In the UK each public organisation publishes its own fnancial statements and the statement of internal control forms part of that publication package. A managerial culture exists and there is a clear separation of operational management by civil servants and local government ofcials from the political level of management responsible for policy and strategy.

Countries with a less developed managerial approach may feel that the Croatia model, where there is not the same managerial history as in the UK, may be a more appropriate model for them to follow. However, that model is not entirely consistent with the approach to PFM/IC set out in this guide. Te Croatia approach focuses heavily upon the implementation of the procedures (i.e., bureaucracy) involved in adhering to the fve COSO standards (see Chap. 11). Te approach adopted in this guide is to focus much more heavily on the impact upon management of the introduction of PFM/IC. (Te efectiveness of procedures anyway depends almost entirely upon the quality of the management responsible for the implementation of those procedures.)

Te UK approach emphasises two aspects of control. First, that a manager needs to be able to assure the ministry of fnance that budgetary control is being observed in terms which meet the requirements of the ministry of fnance. Secondly, the manager is also required to deliver efciency and efectiveness and to explain how this is being done.

Terefore, if the Croatia model is to be adopted, countries doing so should consider expanding the content of the 'Financial Responsibility Statement' to cover the matters indicated above. For example, a particular reference should be made to whether objectives, performance standards and performance objectives, (i.e. the outputs), have been achieved and therefore whether the internal controls that should be designed to secure their achievement are efective. If the outputs have not been achieved, the reasons should be explained by developing the statement, including reference to any weaknesses in the control arrangements and/or managerial capabilities. Reference should also be made to the organisation's ability to achieve improvements in efciency and efectiveness in its operational activities (not just in the control arrangements). Terefore the 'Financial Responsibility Statement' should seek information about the steps being taken to improve efciency and efectiveness. Secondly, the content of the statement also needs to focus upon the quality of the management arrangements and the achievement of the outputs of the organisation as well as on how improvements in efciency and efectiveness are being achieved. Tis would mean identifying:

• Te extent to which reform of the traditional administrative approach to the delivery of public services has occurred and therefore how a managerial approach to delivery is being or has been developed.


However, what is also important to note about Croatia, which is an important message to countries following the Croatia model, is that the department responsible for the oversight of the implementation of PFM/IC should be regularly reviewing and developing its approach. Tis demonstrates as a model how important it is to regard PFM/IC as an evolutionary process. Politicians as well as managers and auditors should encourage this.

#### **13.2 Summary**

For most developing and transition economy countries a requirement to prepare a statement of internal control (or an equivalent statement) would be a totally new requirement. Tat such a statement should be published as part of the development of the transparency and accountability arrangements would be a further requirement. However, as the introduction of PFM/IC requires a signifcant managerial reform, the statement of internal control should focus upon the development of the managerial arrangements including the arrangement for delegation and accountability. Accountability, as has been pointed out previously, is not simply internal accountability but also external. External accountability is to several diferent parties. Tere is accountability to the ministry of fnance about how public money has been used and whether the objectives for which it was allocated have been achieved. Tere is accountability to parliament and also to the user of public services, to the taxpayer and to other interested parties.

Te statement of internal control represents a formal mechanism for establishing transparency and external accountability about the use of public money, the delivery of objectives and performance standards and the actions that have been taken where weaknesses have occurred. It should include information about controlled second-level organisations.

Te person responsible for preparing this statement should be the ofcial responsible for the implementation of PFM/IC within an organisation. In a ministry that would be the state secretary or equivalent. Te statement should show how the implementation of PFM/IC has improved the utilisation of public resources. Te statement should not simply be directed at the efectiveness of fnancial and budgetary controls but should explain, if this is the situation, why objectives and performance standards have not been achieved. It should also include information to demonstrate actual improvements in efciency and efectiveness. An important feature of the statement should be a discussion on the arrangements for risk management and how risks are managed. If it does not do that a separate statement on risk management should be published.

For this statement to be a successful element in the development of PFM/ IC it must contain full and frank disclosures. Such an approach should not be discouraged or even prevented by a sanctions system upon ofcials which imposes penalties and other forms of discipline if objectives or other elements of public administration are not achieved. Te overall aim is to improve the quality of management and as management involves making judgements and taking risks inevitably diferent views may exist and some decisions will produce the anticipated results and others not.

Other ofcials who should be involved in the preparation of this statement should include the head of fnance and the head of internal audit. Te statement should be subject to review by the external auditor, the auditor general.

Te statement should be prepared annually and published along with the fnancial statements of the organisation. Where only consolidated fnancial statements are published either the statement of internal control should be published separately or in a consolidated form but identifying the key issues that the statements have revealed.

# **Annex: Example Statements of Internal Control**

## **Example 1: United Kingdom**

## **A Central Government Ministry**

Te frst UK example is taken from the Education Ministry. In the UK a ministry is called a 'department' and is headed by a 'permanent secretary' who is also titled the 'accounting ofcer'. Tis ofcial is a civil servant and is responsible for the quality of operational management implementing policies set by the politically appointed ministers. Accounting is on an accrual basis but the basis of the accounting is irrelevant for the purposes of drawing up the statement of internal control. Although the permanent secretary is responsible, a board is appointed which provides advice to that ofcial. Te board provides leadership for the department's business, helping it to operate in a business-like manner. Te board should operate collectively, concentrating on advising on strategic and operational issues afecting the department's performance as well as scrutinising and challenging departmental policies and performance, with a view to the long-term health and success of the department.

Advice on the content of the statement of internal control is provided by the Ministry of Finance. Te title of the Ministry of Finance in the UK is His Majesty's Treasury or HM Treasury.

For the fnancial year 2011–2012 and onwards, the annual Statement on Internal Control has been replaced by a requirement for departments, their executive agencies and arm's-length bodies to produce a Governance Statement in their annual report and accounts. By uniting disclosures formerly required to be made in the Statement on Internal Control with other existing requirements to publish a comprehensive explanation of organisational governance, the Governance Statement brings together in one place all disclosures about matters relating to an organisation's governance, risk and control.

However, for the purpose of these examples the more focussed statement of internal control has been used. Tis explains why examples are drawn from earlier years.

#### **Department for Education and Skills Resource Accounts 2006–2007 Statement of Accounting Ofcer's Responsibilities**

Under Section 5 of the Government Resources and Accounts Act 2000, the HM Treasury has directed the Department for Education and Skills to prepare, for each fnancial year, Resource Accounts detailing the resources acquired, held or disposed of during the year and the use of resources by the Department during the year. Te accounts are prepared on an accruals basis and must give a true and fair view of the state of afairs of the Department, and of its net resource outturn, resources applied to the objectives, recognised gains and losses and cash fows for the fnancial year.

In preparing the accounts the Accounting Ofcer is required to comply with the requirements of the *Government Financial Reporting Manual* and in particular to:


HM Treasury has appointed the Permanent Head of the Department as Accounting Ofcer of the Department. Te responsibilities of an Accounting Ofcer include responsibility for the propriety and regularity of the public fnances for which an Accounting Ofcer is answerable, for keeping proper records and safeguarding the Department's assets, are set out in the Accounting Ofcers' Memorandum issued by HM Treasury and published in *Government Accounting*.

#### **Statement on Internal Control Scope of Responsibility**

As Accounting Ofcer, I have personal responsibility for maintaining a sound system of internal control that supports the achievement of Departmental policies, aims and objectives, set by the Department's Ministers, whilst safeguarding the public funds and Departmental assets, in accordance with the responsibilities assigned to me in Government Accounting. Within the Department I require each Director General, and the heads of certain other units which report directly to me, to sign an annual statement covering risk management and the operation of related controls in their areas of responsibility, to supplement the regular reporting to the Board on their stewardship of risks. Similarly, the Chief Executives of the Non-Departmental Public Bodies (NDPBs), which are part of the Departmental Group, are responsible for the maintenance and operation of the system of internal control in their individual NDPBs6 and have signed a statement relating to those systems which are reproduced in the accounts of each body.

Te statements from directorates and NDPBs have been scrutinised and further information sought when necessary. Internal audit has examined the internal control systems and reported upon their efectiveness and the Audit and Risk Committee (ARAC) has made an independent assessment of the contents of the Statement and are satisfed that it is consistent with their knowledge of the Department.

Te Departmental Board includes two non-executive members and regularly meets to discuss all strategic policy management issues. Tis includes providing direction on major policy, delivery and operational issues, reviewing performance and ensuring that the Department is working economically, efciently and efectively.

#### **Te Purpose of the System of Internal Control**

Te system of internal control is designed to manage risk to a reasonable level, rather than to eliminate all risk of failure to achieve policies, aims and objectives. It can therefore only provide a reasonable, rather than an absolute, assurance of efectiveness.

Te system of internal control is based on an ongoing process designed to identify and prioritise the risks to the achievement of Departmental policies, aims and objectives; to evaluate the likelihood of those risks being realised and the impact should they be realised; and to manage them efciently, efectively and economically. Te system of internal control has been in place in the

<sup>6</sup>Non-departmental public bodies [NDPBs] are a form of second-level body or agency. When such a body is to be established, a ministry must consider many factors amongst which are:

<sup>•</sup> defne the functions, aims and objectives;

<sup>•</sup> defne the relationship with the sponsor ministry and accountability to the minister;

<sup>•</sup> consider its fnancial management requirements (accountability, planning, funding and control);

<sup>•</sup> ensure that the NDPB has adequate accounting and reporting systems to enable it to produce auditable accounts from the day of establishment;

<sup>•</sup> determine how performance against objectives will be measured and decide on arrangements for monitoring;

<sup>•</sup> consider the extent of its delegated responsibilities;

<sup>•</sup> consider when the NDPB should be subject to a review or, for bodies with a fnite remit, when and how they might be wound up.

Department for the year ended 31 March 2007 and up to the date of approval of the annual report and accounts and accords with HM Treasury guidance.

#### **Capacity and Capability to Manage Risk**

Te Board recognises the importance of leadership to create an environment where risk management is efective and a Departmental Risk Improvement Manager is in place. Two department-wide reviews of our risk management practice have been conducted to assess the progress made over the year regarding the improvement of the Department's risk management capacity and capability. Tese reviews found that we continue to make sound progress regarding the way in which we manage our risk. Tey also identifed several areas of risk management in the Department and its NDPBs which require further improvement.

Tese issues are now being addressed as part of the actions set out in the Department's Risk Improvement Plan.

Risk management continues to be embedded into the Department's fnance and programme and project management training which is widely available and achieves high take-up. Guidance on the identifcation, assessment and active management of risk in the Department is available to all staf. Te Department's Risk Improvement Manager has continued to work with corporate policy colleagues to ensure that risk management is further embedded into the Department's corporate governance, fnance management, business planning and assurance and performance management arrangements and improvement activities.

Te Department met the Corporate Governance Code of Good Practice criteria requiring a professional Finance Director to be on the Board by December 2006.

#### **Te Risk and Control Framework**

Te Department's approach is to assign risks to those best placed to manage them. Terefore, individual managers are responsible to the risk owners (Directors General) for managing risk as they have knowledge of the issues involved and can best manage risk and mitigate the potential impact. All managers are expected to systematically identify, assess and manage risk and document the underlying assumptions. Risk management guiding principles have been developed for NDPB sponsor teams for use with their sponsor bodies.

Te risk management process is built into the Department's business planning and reporting processes. With most of the Department's expenditure being on specifc programmes, the main risk management arrangements focus on the delivery of this work and the risks associated with changing the way public services are delivered. Tese are managed through a strong programme and project management framework. Tere is clear accountability and ownership of risk to ensure that risk is managed at the appropriate level and there are frameworks in place to escalate risks to ensure that signifcant risks are reported to senior management and, if required, the Board.

Improvements have been made over the year as to the way the Department manages its key risks via the Department's Risk Committee, which is separate from the Board and is chaired by the Director General of Corporate Services. In May 2006 the ARAC conducted a review of the Risk Committee. Sixteen recommendations for improvement were made and all of these have been implemented.

Te key risks facing the Department have been identifed and agreed by the Risk Committee. Te Board regularly reviews these risks and also considers new and emerging threats, ensuring that all are efectively managed. Every quarter I discuss and review key Departmental risks with the Secretary of State [Te Secretary of State is the equivalent of a minister].

Te Department judged that although it had all the necessary guidance and instructions required for efective control, they were dispersed and there was no efective check that they had been read and understood. A review of corporate governance led to the Board identifying ten key areas of compliance— 'the Basics'—that required particular emphasis. Tis led in turn to all members of the senior civil service receiving a corporate governance handbook, including a checklist covering these ten key areas. As part of the internal control framework, all members of the senior civil service will reafrm their personal responsibility for their and their staf's compliance with the Basics.

To support improvement in the risk and control framework management a proactive approach to fraud awareness, prevention, detection and investigation is taken by the Department. Tis has been demonstrated by development of a Fraud Risk Assessment Tool (FRAT) which provides guidance to managers on assessing fraud risks and is part of enhanced risk assessment arrangements that have been put in place in year. Its use will be evaluated in 2007–2008 and reviewed by the Fraud Sub-Committee.

During the year the National Audit Ofce (NAO)7 produced a number of reports which reviewed the value for money of operations involving the Department and its delivery agents. No serious issues were identifed.

Te recommendations in reports by the NAO and the Public Accounts Committee have been carefully considered during the year.

#### **Review of Efectiveness**

As Accounting Ofcer, I also have responsibility for reviewing the efectiveness of the system of internal control. My review is informed by the Directors General within the Department who have responsibility for the development and maintenance of the internal control framework, Internal Audit and

<sup>7</sup>Te NAO, the National Audit Ofce, is the state auditor.

comments made by the external auditors in their management letter and other reports. I have been advised by the Board, ARAC, the Risk Committee and the Departmental Risk Improvement Manager.

Te Department's internal auditors undertake a work programme approved by me to review risk management, internal control and governance. Te Head of Internal Audit produces periodic reports on Internal Audit's fndings, their assessment of risk management, corporate governance and control standards in the key corporate risks and delivery areas, and areas where action is required to address shortcomings. I meet with the Head of Internal Audit quarterly to discuss her report and consider progress in addressing major concerns. She also prepares an annual report which includes her professional opinion on the efectiveness of the overall systems of internal control and risk management within the Department. In addition, this year, Internal Audit have ofered advice to Directorates within the Department to ensure issues identifed through the audit work programme have been appropriately refected in the preparation of the Directorates' annual statements.

For 2006–2007 ARAC supported the Accounting Ofcer by ofering objective advice on issues concerning the control and governance of the Department. ARAC was chaired by a non-executive Board member and its role and composition was in line with the Treasury's best practice guidance. During the course of the year, ARAC also reviewed its own efectiveness. Again, a number of recommendations for improvement were made and all of these have been implemented.

Te Department takes seriously the potential impact that fraud can have on fnancial control and achievement of objectives, and the Fraud Sub-Committee meets on a regular basis. Teir role is to give assurance to ARAC that the risks to the Department's business from fraud and fnancial irregularity are being managed and monitored efectively and is another aspect of good governance.

#### **Internal Control**

#### *General*

From April 2006 the Department became responsible for payment of the Dedicated Schools Grant (DSG).

Tis involved the processing of additional £26 billion payments compared to previous years. Internal Audit have reviewed the DSG procedures and concluded that good control systems are in place over the payment process. Tis being the frst year of the grant, assurance has been derived from certifcation of Section 52 Budget Returns by local authority Chief Finance Ofcers when they set their budget in spring 2006. Tis provides assurance that the authority has budgeted to deploy the grant in support of the Schools Budget. Assurance on regularity of expenditure will be from the Chief Finance Ofcer certifcation of the Section 52 Outturn Statements around November 2007. Tis is in line with DSG operational guidance and with the assurance framework outlined in the Accounting Ofcer's letters of February 2006 to the Comptroller and Auditor General and March 2006 to Local Authority Chief Finance Ofcers.

2006–2007 has seen the second phase of Local Area Agreements. Te pooling of budgets across Government departments brings with it questions of how to ensure regularity, and this year's control regime rests heavily on the Department for Communities and Local Government's Accounting Ofcer with whom I have agreed a Memorandum of Understanding. I am satisfed that the arrangements provide a reasonable level of assurance.

Te efciency programme has now delivered £2.46 billion, some 56% of our overall target and despite signifcant movement in a number of profles we have maintained a contingency position of over £800 million through over attainment in the Technology Programme. We have also signifcantly reduced the risk associated with what were our two highest risk initiatives through substantial downwards re-profling.

#### *Issues*

Our internal control regime has highlighted several policy areas where we have traditionally made direct grant awards to an organisation but where we now need to introduce an element of competition into the funding process. Transitional arrangements to review new grant proposals for 2007–2008 have been agreed and reviewed by Internal Audit. Te review confrms that action has been taken in accordance with the transitional arrangements agreed by the Accounting Ofcer. Further work is to be undertaken in 2007–2008 which will both enhance value for money and further mitigate potential risks of the payments being regarded as state aid.

Tere have been some signifcant under-spends in 2006–2007. Some major capital programmes, notably Building Schools for the Future, have experienced slippage. Te budget reporting regime did not always identify underspends sufciently early for them to be deployed elsewhere to the Department's maximum beneft. Te Department is strengthening its management accounting function to improve the scope and ability for redeploying resources.

Internal Audit and National Audit Ofce work identifed some problems remained in the procurement and management of consultants by some users within the Department. We have continued to tighten the control regime and management information as part of our ongoing activity to improve further in this area.

Tere has been ongoing work by the Student Loans Company and the Department's Special Investigation Unit investigating Student Loan frauds. A Fraud project was set up in 2006–2007 to ascertain the fraud risks and to recommend and implement suitable treatments for these risks. A fraud risk exercise was commissioned and the initial estimate is that the fraud rate is around 0.6% of applications. Improvements have been made to fraud detection and prevention procedures throughout the student fnance process to mitigate this risk.

Two other NDPBs have also notifed us of frauds that could represent a reputational risk to their sectors. Both Accounting Ofcers have assured us that these do not represent a material threat to the operational efectiveness of the NDPBs and we are satisfed that appropriate remedial action is in train in both cases.

Tere have been some examples of NDPBs operating outside their delegated authority. None have been major in their own right, but they highlight the critical relationship between the Department and its key delivery partners, particularly its NDPBs. Te actions within the Capability Review Implementation Plan will further strengthen these relationships. Te monthly meetings between the Departmental Board and senior ofcials from our NDPBs and the various resulting working groups of functional leads from the DfES Group (including Finance Directors) will further strengthen the ongoing dialogue and foster a better shared understanding of areas of common concern.

Whilst recognising the above issues, good progress has been made in resolving them and there are plans in place to further enhance fnancial control systems and improve practice. As Accounting Ofcer, I am satisfed the above issues do not represent a material threat to operational efectiveness and that the Department and its NDPBs comply with the Treasury requirements on risk management, internal control and governance.

Signed by:

Accounting Ofcer/Permanent Secretary

#### **A Local Government**

Te second example is drawn from local government which is subject to a diferent set of detailed rules, although the principles are the same, as for central government. A local authority in the UK is managed by an elected council with the controlling political majority appointing a 'leader' who is in efect the top political ofcial of the local authority. Te mayor or, for some types of local authority, the chairperson generally has largely ceremonial responsibilities but also acts as the chairperson at formal meetings of the local authority. Operational management is undertaken by appointed ofcials (chief ofcers) working under the overall leadership of a chief executive but reporting formally to the relevant committees and ultimately to the council. A recent reform though has introduced the idea of 'executive mayors' who take over the role of leader with the chief ofcers reporting directly to that person or designated politically appointed deputies.

#### **London Borough of Bromley Statement on the System of Internal Control**

#### **Statement on Internal Control 2006/2007**

Tis statement is provided for the use of Bromley Council in support of its Statement on Internal Control (required under Regulation 4(2) of the Accounts and Audit Regulations 2003, as amended during 2006).

#### **Scope of Responsibility**

Bromley is responsible for ensuring its business is conducted in accordance with the law and proper standards and that public money is safeguarded and properly accounted for and used economically, efciently and efectively. Bromley also has a duty under the Local Government Act 1999 to make arrangements to secure continuous improvement in the way in which functions are exercised, having regard to a combination of economy, efciency and efectiveness.

In discharging this overall responsibility, Bromley is also responsible for ensuring that there is a sound system of internal control which facilitates the efective exercise of Bromley's functions and which includes arrangements for the management of risk.

#### **Te Purpose of the System of Internal Control**

Te system of internal control is designed to manage rather than to eliminate risk of failure to achieve policies, aims and objectives; it can therefore only provide reasonable and not absolute assurance of efectiveness. Te system of internal control is based on an ongoing process which is designed to identify and prioritise the risks to the achievement of Bromley's policies, aims and objectives. It also evaluates the likelihood of those risks being realised and the impact should they be realised as well as managing them efciently, efectively and economically.

Te system of internal control has been in place at Bromley for the year ended 31 March 2007 and up to the date of approval of the annual report and accounts.

#### **Te Internal Control Environment**

Te internal control environment encompasses all the organisation's policies, procedures and operations in place. At Bromley the system of control is based on a framework of regular management information, fnancial regulations, administrative procedures (including segregation of duties), management supervision and a system of delegation and accountability.

#### Corporate Framework

Bromley's plans outline how we will deliver our services and include specifc targets that allow us to measure our level of success. Some plans are produced in partnership with other agencies, which help us to focus our resources. Te planning framework is arranged under portfolio headings. We operate with a Leader and an Executive. Te Council maintains the policy and budgetary framework and appoints the Executive. In 2006/2007 this contained the Leader and eight Executive members.

Seven majority members of the Executive were responsible for their portfolios. Each portfolio holder annually outlines their aims over the coming three years, what they will be doing towards achieving their goals and their performance targets.

#### Formulation of Policies and Decision Making

Policy and decision making are managed and controlled within a strong well-established framework. Te Council's written constitution sets out in detail how the council operates, how decisions are made and the procedures to be followed to ensure efciency, transparency and accountability. Political and management control is exercised through the Executive who work to defned and established processes.

#### Compliance with Policies, Laws and Regulations

Compliance with policies, laws and regulations is dealt with through a range of written rules and procedures which are regularly reviewed and updated. Tese include the Constitution, Financial Regulations, Codes of Conduct and the Anti-Fraud and Corruption Strategy.

#### Performance Management

Performance management at Bromley is considered through a range of review arrangements including external inspection bodies, external/internal audit reviews and the detailed reporting of national and local performance indicators.

#### Financial Management

Te fnancial management of the Authority is organised through a wide range of well-established processes and procedures which delivers strong fnancial control arrangements. Bromley has in place a strategic budget planning process which includes detailed written procedures and which is supported by comprehensive Financial Regulations and procedures. Members and Chief Ofcers receive and consider detailed fnancial information on a regular basis and this facilitates the political decision making process.

#### **Review of Efectiveness**

Bromley has responsibility for conducting, at least annually, a review of the efectiveness of the system of internal control. Te review of the efectiveness of the system of internal control is informed by:


## Te Audit Sub-Committee

Te Audit Sub-Committee has the responsibility for developing and keeping under review all aspects of the Council's arrangements for audit and probity specifcally including


Internal audit reports all signifcant weaknesses to management and Members in the form of prioritised recommendations. All such recommendations are followed up for implementation or appropriate management action.

Internal Audit

Internal audit is an independent appraisal function that acts as a control that measures, evaluates and reports upon the efectiveness of internal controls, fnancial and others, as a contribution to the efcient use of resources within the Authority.

Internal audit's service aims are to:


Strategic and Annual Audit Plans are used to map out the cyclical coverage of fundamental fnancial systems and other audits. Tese plans are based on the identifcation of the Council's systems and activities to be audited, each assessed for risk. Work relating to prevention and detection of fraud and corruption is integrated into this audit planning process. Internal Audit operates to defned standards as set out in the Chartered Institute of Public Finance (CIPFA) Code of Practice for Internal Audit in Local Government. Te efectiveness of the system of Internal Audit is measured by compliance with this code.

Internal Audit provides an independent opinion on the adequacy and efectiveness of the system of internal fnancial control. Each audit is reported to the appropriate level of management together with agreed action plans where appropriate. Te supporting summaries of audit reports help inform the overall assessment of internal fnancial controls. Te Chief Internal Auditor is empowered to report any matter of concern directly and independently, to the Chief Executive, the Chairman of Audit Sub-Committee or the Leader of the Council, if necessary.

External Audit

Last year the external auditors in their assessment of Bromley's use of resources scored the Council 3 out of 4 for each of the fve aspects that go to make up the overall judgement detailed below:

*Element of the audit Latest score Financial reporting 3 out of 4 Financial Management 3 out of 4 Financial Standing 3 out of 4 Internal Control 3 out of 4 Value for Money 3 out of 4* 3 = consistently above minimum requirements—performing well

#### **External Inspections**

Tere have been no Audit Commission inspections published during 2006/2007 although their overall judgement, under the 2006 Comprehensive Performance Assessment, is that the Council has robust internal control and governance arrangements.

During the last year the Council has received the following assessments from other inspectorates:

**Commission for Social Care Inspection—Adult Social Care Services**

Rated as two stars out of three and 'serving most adults well with promising capacity to improve'.

**Te Beneft Fraud Inspectorate—Comprehensive Performance Assessment of the Benefts Service**

Rated as Good (level 3), with the Council meeting 5 of the 12 performance measures where the Department had set a Standard and 52 of the 65 enablers.

Action plans to address the issues identifed within these services are in place or under development.

#### **Ethical Governance Audit**

Tis audit was carried out by external audit and the results have been reported to the Standards Committee.

#### **Signifcant Internal Control Issues**

In 2006/2007 a number of control issues have been identifed as a result of the Internal Audit work undertaken in the year. Improvement points and action plans have been agreed for all these areas and scrutiny will be maintained to ensure that all priority control weaknesses are fully addressed by management.

In addition, as part of the assessment of controls each Chief Ofcer has signed a statement giving assurance on the level of controls with areas of improvement. Tis process was based on an assessment of key controls within Departments.

Although no new signifcant control weakness has been identifed for 2006/2007, the issues in previous years remain as those which will require ongoing monitoring, namely:


Although continuing progress has been made on all of the above, further work remains before these control issues can be reported as fully implemented. Arrangements for managing signifcant business risks need further work. Specifcally, a detailed review of partnership/contractual risks needs to be completed and management training made available to all elected members targeted to relevant members initially. Te procurement strategy is being implemented. Project and Programme management are still areas for further development; however, the approved standards are being implemented across the Council. Tere is an approved continuity plan in place as required by civil contingencies legislation, and work continues on developing service continuity plans.

Signed by:

Chief Executive (the top appointed ofcial, and by the Leader of the Council (the top political ofcial) [equivalent to an executive mayor in some countries]

#### **Example 2: Croatia**

#### **A Central Government Ministry—Fiscal Responsibility Statement**

In Croatia the requirement is that all public organisations are to prepare annually a Fiscal Responsibility Statement (FRS) which is designed to certify that:


Te FRS is supported by a fscal responsibility questionnaire and by an internal audit opinion on the system of fnancial management and internal control based on the internal audits performed in the previous year. Tese documents are to be sent to the department of the State Treasury [the Ministry of Finance] responsible for the implementation of PFM/IC.

In the period from 2011 to 2015, the arrangements for reporting on the implementation of fnancial management and internal control occurred in the following manner:


tion of the fve COSO components—control environment, risk management, control activities, information and communication and monitoring.

Under the control environment component, heads of organisations reported on ethics and integrity; the way in which management operates (how regular top management meetings are being held, involvement of the secondlevel budget user heads in the top management meetings about their budgets and other factors); the level of development of a planned approach to the operations (defnition of strategic objectives, programme objectives, the objectives contained in the organisational units' annual plans, including linkages between these objectives); delegation of authorities and responsibilities for the objectives/programmes/activities and budget resources; alignment between the reporting lines (on programme/project implementation and the associated budget resources); cooperation between budget holders within the organisation.

Under the risk management component, heads of organisations reported on the appointment of persons responsible for risk management coordination; the identifcation of risks versus the objectives; assessment of risk likelihood and impact; documenting risk data (risk registers):


Under the control activities component, heads of organisations reported on:


Under the information and communication component, heads of organisations reported on:


Under the monitoring and assessment component, heads of organisations reported on:


Where weaknesses and irregularities are identifed, a weaknesses and irregularities removal plan is required to be completed which covers the following:


#### Comment:

In 2015, Croatia adopted a new Public Internal Control (PIC) Law. Tis introduced a single form of reporting on fnancial management and internal control which was through a developed Fiscal Responsibility Statement (FRS). To facilitate this the questionnaire was expanded and the likelihood is that this questionnaire will be further developed in the future.

Budget user managers are expected to utilise the FRS as a 'self assessment' management tool. Te department responsible for PFM/IC in analysing the FRSs takes into account the State Auditor reports and internal audit reports. Tis department prepares an annual report on public internal control.

All of this activity involves extensive work but it enables the PFM/IC department of the State Treasury to establish what has to be improved in the PFM/IC methodology, where training should be directed, whether there is a need for additional guidelines and what are the priority areas for further development.

Te Financial Responsibility Statement takes the following forms:

Where no weaknesses have been identifed:

#### **FISCAL RESPONSIBILITY STATEMENT**\*

I, (*name, surname, title and function*), the Head of (*name of a local and regional self-government unit/state budget user/state extra-budgetary user/local and regional self-government unit's budget user/local and regional self-government unit's extra-budgetary user*), on the basis of a completed Fiscal Responsibility Questionnaire covering the areas of planning, execution, public procurement, accounting and reporting, the available information, the internal and external audit work results and my own judgment, hereby verify that:


(*date and place of issuance*) *Head's signature*

(*name, surname, title and function*)

Where weaknesses have been identifed:

## **FISCAL RESPONSIBILITY STATEMENT**\*

I, (*name, surname, title and function*), the Head of (*name of a local and regional self-government unit/state budget user/state extra-budgetary user/local and regional self-government unit's budget user/local and regional self-government unit's extra-budgetary user*), on the basis of a completed Fiscal Responsibility Questionnaire covering the areas of planning, execution, public procurement, accounting and reporting, the available information, the internal and external audit work results and my own judgment, hereby state that I have detected weaknesses and irregularities in the areas of:

(*Please indicate the areas and questions from the Fiscal Responsibility Questionnaire with partially afrmative and negative replies provided*), which will be removed in compliance with the Weaknesses and Irregularities Removal Plan.

I hereby state that the said weaknesses and irregularities bear no infuence on the legal, earmarked and purposeful use of the funds and the efcient and efective functioning of the fnancial management and control system within the framework of the resources defned by the budget, i.e., the fnancial plan.

On the basis of the aforesaid, I hereby verify that:


(*Date and place of issuance*) *Head's signature* (*Name, surname, title and function*) Comment:

Croatia regards fnancial management and internal control as an evolving activity and therefore the form of these documents will change over time. A recent development, for example, has been to increase the emphasis upon risk management.

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# **14**

# **Public Sector Reform, Delegation, and PFM/IC**

An organisation combines both human and material resources to achieve its objectives. Te major players in establishing an efective public organisation are those with responsibility for giving direction to the organisation, the politicians, and the top executive management within the civil or local government service. In this chapter the linkages between public sector reform, incorporating civil service reform, personnel management, and public fnancial management and internal control reform are discussed, together with an analysis of what 'delegation' means and where it is appropriate to introduce it. Delegation is treated by many PFM/IC reformers as though it were a single activity, but, whether it is appropriate or not is a more complex issue which does require careful consideration and which also requires to be accompanied by other reforms. An important consideration depends upon the quality of the civil service (or local government service) and the extent to which it has been reformed moving from an administrative style to a managerial style. Tis guide shows what an extensive management reform introducing PFM/IC is. Te reform does not just afect the top and senior management but how the personnel of an organisation perform. Efective personnel management (and personnel are the most important asset of an organisation) is of central importance to a successful organisation. To gain the benefts of the PFM/IC reform that reform should underpin civil service/public service reform by providing the information and analysis that managers require for the efcient and efective delivery of public services.

# **14.1 Public Sector, Including Civil Service Reform, and PFM/IC**

## **14.1.1 Introduction**

A central feature of PFM/IC is that it is about making better use of public resources. Te systems associated with PFM/IC make this possible but an essential requirement is the managerial reform that ought to accompany it. Without managerial reform PFM/IC will be just another bureaucratic system. Tat managerial reform should introduce signifcant change to a traditional style of public administration where top managers are political appointees and management structures are based upon a hierarchy of rules with a centralised hierarchy of decision making and controls with a civil service organisation and appointment system that in some countries was (is!) heavily dependent upon political patronage.

An important element of public sector reform is the recognition of the signifcance of the complementarities of the roles of the politicians and the top-level civil servants (or for local governments, top local government ofcials). For this to work civil servants must be well trained and apolitical. Unfortunately, many countries that have started to introduce the PFM/IC reform have not, in general, appreciated the extent of these complementarities because the reform has simply been regarded as a technical fnancial reform and training has tended to be in the bureaucracy of the reform rather than in the managerial opportunities that the reform creates. Earlier in this guide the impact of the PFM/IC reform upon diferent levels of management has been described and, particularly the impact upon the political and senior civil and local government ofcials. Te impact upon the head of fnance is also signifcant. What has also been pointed out is that the PFM/IC reform has a major impact upon budgetary, accounting, and fnancial reporting arrangements.

Because the PFM/IC reform has such a signifcant impact upon all these managerial arrangements, and not least upon the relationships between the political and the ofcial levels of management, the PFM/IC reform ought to be coordinated with the arrangements for public sector and civil service reform.

Reference is usually made in policy papers prepared to advise on the implementation of PFM/IC to the need to delegate responsibility and to establish managerial accountability. Earlier in this guide the argument has been that broadly, policy and strategy should be the responsibility of the political level of management, whether ministers or deputy ministers, mayors, or deputy mayors and that operational management should be delegated to the appointed ofcial level of management. However, the politician may not have the skills, experience, or technical knowledge to formulate policy or to defne how it is to be implemented. Te top civil service (or the equivalent in local government) should be the key advisers to the politician on the development of policy as well as having the responsibility for policy implementation. In efect their role is to turn political ideas into practical public services and activities. Tis requires though a stable, well-trained civil service (or local government service) with knowledge of the history of the experience of delivering the service or activity.

Although, in general terms, the civil (or local government) service should have the delegated responsibility for policy implementation, this is too simple a distinction. It does not recognise the complexities of many public service delivery arrangements and nor does it recognise the diferent circumstances often involved in decision making, and not least 'personalities'. Tese can complicate a delegation decision. In some circumstances politicians should become involved in operational management decision making. What should be avoided though, is politicians becoming involved in the day-to-day management of the organisation for this should be very frmly the responsibility of the civil or local government service top ofcial.

Te delegation of decision making is also a matter for operational management because delegation should be a feature of operational management. Te question then is, what types of decision should be delegated by senior managers to more junior managers?

In this chapter an analysis of the diferent types of decision or factors afecting a delegation decision are discussed. Tis will allow ministers of fnance and in particular the state secretary of the ministry of fnance along with the 'driver' department responsible for the implementation of the PFM/IC reform to focus their eforts on specifc areas where delegation can or should occur and where not or where delegation may be problematic. What to delegate and what not, does require careful consideration.

Along with delegation goes 'accountability'. In considering delegation and accountability the prior question is: 'what is management'? Tere is no universal defnition but an authoritative defnition is: 'management control is the process by which managers assure that resources are obtained and used efectively and efciently in the accomplishment of the organisation's objectives'.1

Tis idea of management underpins the whole concept of PFM/IC.

<sup>1</sup>Anthony, R. N., Planning and Control Systems: A Framework for Analysis (Boston, Mass.: Division of Research, Graduate School of Business, Harvard University, 1965, p. 17).

Success with implementing the PFM/IC reform depends upon the extent of managerial reform, which should be at the core of civil service reform. Tose responsible for civil service reform should recognise the implications for management of the PFM/IC reform. In most countries the impact upon management has not been the starting point and as a result there is no 'ownership' of the reform by organisation top and senior management. Consequently PFM/IC is often seen as an imposed ministry of fnance reform of beneft to that ministry rather than one of beneft to the management of the organisation itself. Where the reform is a function of foreign aid arrangements then the dominant party is the foreign aid organisation which adds to the difculties of achieving 'ownership'. Success in achieving 'ownership' makes possible the transfer of control from an external organisation, such as the ministry of fnance and also, because of the centralisation of decision making about personnel matters, from the organisation responsible for personnel management, to the internal management of an organisation.2

Governments want to achieve their policy objectives. Assuming that the resources are available, this is not achieved by simply 'top-down' instruction. An efective managerial organisation coupled with efective personnel management are essential components. Te following quotation illustrates this:

If people are the greatest creators of value in organisations, then good performance management is critical for an organisation's success. Employees need to understand what's expected of them, and to achieve those goals they must be managed so that they're motivated, have the necessary skills, resources and support, and are accountable. Performance management is the activities and processes that focus on these areas to maintain and improve employee performance in line with an organisation's objectives. Ideally, performance should be managed holistically, throughout the range of HR [Human Resource] activities and processes.3

## **14.1.2 The Main Features of Public Management-Oriented Organisations**

A pre-requisite therefore to the introduction of the PFM/IC reform is that there is a commitment to the reform of the structures involved in the management of government. Te process of reform should be that the managerial approach to PFM/IC builds upon an existing robust public administration

<sup>2</sup> See Chap. 1 and the observations of Professor Allen Schick on internal and external control.

<sup>3</sup>Te Chartered Institute of Personnel and Development: Performance management: and introduction 2019: https://www.cipd.co.uk/knowledge/fundamentals/people/performance/factsheet.

(i.e. essentially one based upon Weberian principles) but then evolves from that public administration style into a public management style. A 'Weberian' type public administration is a bureaucracy that has these six characteristics:


If a Weberian-style bureaucracy does not exist then the frst step in the reform process should be its creation. To then move from a Weberian-type bureaucracy to a management style of organisation requires that the following features are established:


managers require, such as cost centre and cost driver information (see Chaps. 5 and 8)


To summarise, for PFM/IC to be an efective reform, as opposed to a cosmetic reform or token reform, there should exist advanced management arrangements within government organisations. Tose advanced management arrangements require the involvement of both the political ofcials and the civil (and local government) service appointed ofcials. Tis, in practice, means that political decisions about policy, including the strategy for the implementation of that policy, should have regard to the practical experience and advice of the civil (or local government) ofcials about implementation. Tese two groups of ofcials should not be operating independently of each other and neither should the political ofcials feel that they should have responsibility for making all decisions (i.e. both policy and operational). Political ofcials should recognise that the experiences and advice in the formulation of policy and on proposals for the implementation of policy gained by appointed ofcials can make an essential contribution to the development and implementation of efective policy. Te benefts of PFM/IC will not be achieved without this cooperation between these two groups of ofcials.

However, to make this change is neither simple nor a speedy process. Some of the problems are discussed below in Sect. 14.2.1. An identifying aspect of a managerially oriented organisation is that managers have clear objectives and performance standards and objectives that they are expected to work to and that they have the performance and fnancial information to enable them to make the best use of public resources in the delivery of their objectives and performance standards and performance objectives.

Another identifying aspect is that the managerial structures in public organisations should be designed to refect the objectives that the organisation is expected to achieve.

All this impacts upon the arrangements for civil service recruitment and training and can represent a signifcant change in their role. Civil and local government servants experienced in operating within a traditional public administration but expected to operate in future in a managerially oriented organisation do not become managers 'overnight'. Managerial training should be an essential component of the reform.

If these management features summarised above do not exist or are not envisaged within the civil service/public sector reform programme, yet are requirements of the PFM/IC reform, clearly the two are incompatible. Te experience of this author is that the question of compatibility is rarely considered by those responsible for implementing the reform. Civil service/public sector reform programmes and PFM/IC reform programmes are considered independently. Tis compatibility is also what foreign aid donors should be looking for before agreeing to support the introduction of PFM/IC, although they do not seem to do so. If that commitment to achieve compatibility does not exist then achieving success with the introduction of the PFM/IC reform is most unlikely.

#### **14.1.3 Managing Complex Public Sector Organisations: Whether Delegation Is Appropriate or Not**

A central theme of PFM/IC is the development of delegation and managerial accountability.

In practice, little is said in any of the literature or in advice from the European Commission or professional bodies such as IFAC4 about the nature of delegation and managerial accountability and how it afects decision making. Te central theme of this guide is that improving the utilisation of public resources depends upon developing a managerial approach to the management of those resources. It is not simply about introducing techniques: what matters is how those techniques are utilised and that in turn depends upon the quality of management. Te IMF, for example, in its discussions about the introduction of performance based budgeting argues that 'the introduction of performance based budgeting will ideally require greater fexibility for ministries and program managers, who are expected to become more

<sup>4</sup>Te International Federation of Accountants: https://www.ifac.org.

accountable for results'.5 Performance-based budgeting is a technique but its success depends upon the quality of the management, not simply the existence of the technique. An appreciation of the context in which delegation is to occur and then how managerial control is exercised through managerial accountability arrangements is necessary if PFM/IC is to be efectively implemented. Delegation is not a simple matter and depends upon particular circumstances. A more sophisticated approach to delegation and managerial accountability is needed than a simple blanket policy. Such a 'blanket' policy is simply unhelpful because it does not provide any clarity about what could or should be delegated and what not. Te aim of this section of this guide is to explore what may be appropriate to delegate and what not. However, central to the idea of delegation and managerial accountability is the existence of a managerially oriented organisation.

Public sector organisations such as ministries and local governments will be headed by a single politically appointed ofcial, a minister or mayor. Nominally this ofcial is the single 'all-powerful' decision maker for the organisation and in many countries the law reinforces this position. But this person can maintain this 'all-powerful' position 'only to the extent that he is not dependent upon others within his organisation'.6 Te reality is that in practice in complex organisations, as are most public organisations, the objectives of the organisation are derived from compromises between diferent powerful groups (power bases!) within, and sometimes external, to the organisation. Tis single politically appointed ofcial therefore cannot make all decisions about the operation of an organisation. He/she must have regard to those groups that exercise infuence which can be internal or external to the organisation. One of those groups is, or ought to be, the bureaucracy bringing to any discussion information about the experience of policy development and application as well as a detailed knowledge of the 'market' for that policy. PFM/IC is about supporting the development of a more informed bureaucracy. A former foreign minister of Australia made the point that a minister (referring to the Westminster system) has 'two broad ambitions:


<sup>5</sup>A Basic Model of Performance-Based Budgeting; by Marc Robinson and Duncan Last, IMF Fiscal Afairs Department; IMF Technical Notes and Manuals—TNM/09/01; September 1, 2009.

<sup>6</sup>Organisations in action: James D Tompson: 1967, Chapter 10, p. 132: McGraw Hill.

<sup>7</sup>Public Money and Management Nov 2020: Vol. 40: Alexander Downey, p. 551.

He also went on to say: 'In reality, for a minister the implementation of policy efciently and efectively is by far the most important function of the civil service.'8

In a political organisation, key infuencers will be the prime minister and the minister of fnance. Other infuencers will be external regulators and pressure groups. Tis idea of the 'omnipotent individual' is also negated by other conditions, which include:


When such circumstances exist, as they will with most ministries and local governments, the number of power bases within the organisation expands and the result is that in highly complex organisations, such as ministries and local governments, power is, in reality, dispersed. Consequently, any decisions, apart from those that have only a very narrow impact, have to take into account the views and information available from those diferent power bases, Tat is, to use the observation of the former Australian minister, if the minister (or mayor) is to survive and prosper. A task of the bureaucracy is to bring together those diferent views and to ensure that the information available from those diferent sources is properly refected in the advice to policy makers. Te consequence of this is the emergence of what one academic commentator, Tompson, called a 'dominant coalition' which represents the diferent interests within an organisation. However, to get business done Tompson argued that what actually emerges in complex organisations is an 'inner circle'. Tis may be a formal or an informal group but which efectively conducts the business of the organisation that is, exercises leadership. Membership of that 'inner circle' should be dynamic to refect changing circumstances and particular interests. Te question then becomes who should be the members of this 'inner circle' in a public organisation? Tis is very important in considering the implications of the application of PFM/IC because it raises the question as to whether the membership of the 'inner circle' should be restricted only to the political appointees,

<sup>8</sup> Ibid., p. 552.

<sup>9</sup>Organisations in action: James D Tompson: 1967 Chapter 10, p. 133: McGraw Hill.

in efect shutting out the bureaucracy. It therefore afects delegation. An 'inner circle' that excluded the most senior ofcial and possibly certain professionals, depending upon the nature of the organisation would not facilitate the development of an efcient and efective organisation and would be incompatible with the idea of delegation. Tis is because to achieve the objectives of a complex organisation diferent interests and experiences need to be considered, not least those of the bureaucracy. For example, in some public organisations where there is a high technical professional input into decision making processes, such as in health, military, or educational organisations the 'inner circle' ought to include representatives of that technical professional element of the organisation. However, in the operational delivery of public services there is always (apart from very small public organisations) a 'high professional input', but not necessarily just a technical professional input. Tat high professional input will include 'professional' ofcials (i.e. the civil or local government service) whose responsibility will be to ensure that operational delivery refects not just 'technical professional' opinions, but also other opinions such as that the decision can be fnanced, that it is compatible with government policy, that it is legal, that it is practical, that it represents an efcient and efective utilisation of public resources. Te implementation of PFM/IC improves the capability of the bureaucracy to make that 'professional' contribution.

Te main representative of the civil service would be the most senior civil servant such as the state secretary in a line ministry (or the equivalent in a local government) and depending upon the circumstances other ofcials may be involved. In making their contribution to the decision making processes those senior civil servants should exercise judgement and political astuteness. Tey, in turn, will be advised by the diferent 'professionals' within the bureaucracy. One of those would be the head of fnance. 'Developing capabilities, including judgement, in those civil servants whose roles bring them into a close working relationship with politicians starts with clear and evidencebased analysis of the requirements which make civil servants efective in working with politicians.'10 Tis requires great skill and experience.

In all public organisations a critical factor is fnance, that is the availability of appropriate fnancial resources, stability of the fnances of the organisation and how well the available fnance is utilised not only in its allocation against priority objectives but also in its operational utilisation. Tis means that that 'inner circle' in practice ought to include not only representatives of those responsible for operational delivery, but also including those responsible for

<sup>10</sup>Hartley and Manzie: It's every breath we take here: political astuteness and ethics in civil service leadership development: Public Money and Management: Nov 2020 Vol 40: p. 569.

the management of the fnances of the organisation.11 As public organisations operate in a dynamic environment and frequently in an environment where there are many complex issues and judgements that need to be made the responsibility of the political element of management in making decisions should have regard to the views of all those whose knowledge and experience would have an impact upon the quality of the decision.

Tis demonstrates the need to involve the civil or local government service in advising on the policy making processes as well as on operational management decision making processes. Tis involvement would be particularly appropriate where the decisions that need to be made are for those areas of business where the 'professional ofcial' (technical and/or civil service) has the most appropriate knowledge. Tese are the circumstances which apply with both policy formulation and operational management. Tey would be the characteristics of a Weberian type civil service reformed to refect a managerial operating environment.

Tompson pointed out that decisions involve two major dimensions: preferences regarding possible outcomes, the political values and beliefs or the facts about cause/efect relations.12 Complicating any decisions are either 'certainty' or 'uncertainty'. Tis impacts upon who should make the decision, that is, on the appropriateness of delegation. Tese relationships were shown in a table by Tompson (which in turn was initially developed with a colleague13) and has been further developed by this author to refect the operational environment of the public sector (see Table 14.2).

In the public sector the primary concern of the politician, the minister or mayor, should be about policy and securing the implementation of that policy. Political policy is an expression of 'values'. Central to policy decision making is judgement about values and the politician will make those judgements. Te most important responsibility for a political leader is to reach an agreement on 'values'. Political values will be formed by many factors, including how special interest groups react, the views of independent policy 'think tanks', political party historical policy, and by the information available from the ofcial bureaucracy. In a democratic country political policy is also likely to be challenged.

In developing policy, a wide range of factors, some of which are external to the country do need to be considered. Tis task of assembling, assessing, and advising on the impact is essentially the responsibility of the bureaucracy. For

<sup>11</sup> See also, Who *Really Governs* and How: Considering the Impact of the Dominant Coalition: Andersson and Renz: Non Proft Quarterly October 2019.

<sup>12</sup>Organisations in action: James D Tompson: 1967 Chapter 10, p. 134: McGraw Hill.

<sup>13</sup> James D. Tompson and Arthur Tuden, eds., *Comparative Studies in Administration* (Pittsburgh: University of Pittsburgh Press, 1959), pp. 195–216.

example, internal and external factors can include a wide variety of matters such as those afecting fnancial regulation, food safety standards, environmental management systems, taxation, intellectual property, telecommunications, and infectious disease control, all depending upon the coverage of the policy. Te bureaucracy should be familiar with all such factors. External factors are likely to increase as the infuence and activities of international organisations increases, for example, over addressing climate change, economic management, and world health.

An example of a 'value' question which only politicians may need to address is, should technical and further education be delivered by public sector organisations or by private sector organisations? Whatever the arrangement, a further element of 'value' is a decision about who should meet the cost? Should it be the state from taxation or the student or a combination of the two or in some circumstances an employer? Another example of a 'value' decision would be who should be responsible for the delivery of health care and if the public sector, should that cover all aspects of healthcare or only some and for those that are to be delivered by the public sector should the public sector have a monopoly in health care provision or not? Associated with these questions is a further question about how should the services be fnanced, such as through taxation or by charging or by some combination of the two? Another question that would arise would be about the practicality of any decision. If, say, a decision was made to require technical and further educational provision to be provided by the private sector then ofcials should assess the capacity of the private sector, the likely cost, the practicality of such a policy decision, the arrangements for the monitoring of quality (see example of the TAFE arrangement in Australia, Chap. 12) and for the audit of consequential public expenditure. All such 'value' questions are likely to be controversial with the parties to any debate being more or less certain about the outcomes.

In summary, the political decision about values should be informed by facts or factors and the responsibility for providing information about the facts or factors should lie with the civil (or local government) service. Where advice has been accepted by politicians about the development of a government policy from external sources or where much of the analytical work may have been undertaken by third parties, such as academics, the civil service should have the capacity to assess or to make an independent assessment of the quality of such analytical work, including about levels of certainty. Tis assessment should cover costs, impacts, and forecast outputs and practicality. For many public service activities, the facts or factors may be uncertain. Costs can often be defned with reasonable accuracy, although not with complex projects, when assessments of impacts and outputs can be very subjective.

Te civil service should also advise ministers on an evaluation of possible alternatives and of the potential opposition to the proposed policy. Tis form of briefng serves to inform not only the political ofcials but also the civil service ofcials themselves about the strengths and weaknesses of policy proposals.

A summary of the facts or factors, including any international issues that the civil service should be concerned with in advising a minister on the development of a particular policy is set out in Table 14.1.

As for both the values and the factors afecting any decision there can be either certainty or uncertainty. An objective of both ministers and ofcials should be to achieve as much certainty as possible. Achieving certainty in values can be made more complicated where more than a single organisation is involved in making the judgement about values. For example, where diferent ministries or diferent levels of government are involved, each may have its own view of values. Te same can be true for all the factors afecting any decision.

Once a political decision has been made because there is agreement or majority agreement on values, policy can then be defned. Tis will require, as shown above, the determination of the cost, the establishment of feasibility and the acceptability of the proposed policy. Tis would be the responsibility of the civil (or local government) service taking into account all possible sources of advice. Teir further responsibility is to then implement that decision.


**Table 14.1** Dimensions for analysing public policya

Durability is the capacity to be sustained over time—an important feature of public fnancial management summarised in the term 'fnancial resilience—see Chap. 8. (This framework was developed for application by those persons working on public policies and who would interact with policy makers)

aA Framework for Analyzing Public Policies: Practical Guide September 2012: National Collaboration Centre for Healthy Public Policy: A Framework for Analyzing Public Policies: Practical Guide (ncchpp.ca): www.ncchpp.ca/docs/Guide\_framework\_ analyzing\_policies\_En.pdf

Without agreement on values there cannot be a clear implementation of policy.

Tere will be occasions where changing circumstances mean a rethink of values and similarly with facts (as the Covid pandemic has shown) in which event, implementation policy may need to change. Tis though is not about uncertainty but is about changes of circumstances. How complex decision making can be is illustrated by the following matrix shown below at Table 14.2. 14

Te civil or local government ofcial cannot be the decision maker so far as the values element of the matrix is concerned or indeed about the principles of implementation: that is entirely a political responsibility. But the civil or local government ofcial should be able to advise on such decisions and should be particularly well informed given his/her responsibility for the development of information about the facts or factors afecting implementation and the historical knowledge of previous policy initiatives.

Where there is certainty about a particular policy and about both the values and the facts coupled with agreement that resources are available, no further political decision is required and implementation can proceed (i.e. implementation would fall into quadrant 1 with implementation being the



aOrganisations in action: James D Thompson: 1967 Chapter 10, p. 134: McGraw Hill and James D. Thompson and Arthur Tuden, eds., *Comparative Studies in Administration* (Pittsburgh: University of Pittsburgh Press, 1959), pp. 195–216

<sup>14</sup> I am particularly grateful to Stephen Peterson, who served as the Faculty Chair of Harvard's Executive Programme in PFM (1986–2010) for his suggestion to use the Tompson-Tuden matrix.

responsibility of the bureaucracy, that is delegated to the ofcial level of the organisation). As operational implementation is developed practical questions may emerge which may require political intervention but these normally should be at the margin.

However, where the political policy is agreed but there is uncertainty about how the facts or factors will afect the implementation of the policy then a political judgement should be made about whether to proceed with operational implementation, and if so on what terms? In this situation there will be an element of guesswork about the efects of implementation and therefore a learning process will be required in which the civil service (or local government) ofcials responsible for implementation will need to consult with the political level. Te terms of the political approval to implementation will determine the scope that the bureaucracy has to make operational decisions and the point at which political approval will be required. Te overall message should be that in such circumstances implementation should be applied with caution and is likely to involve more detailed consultation between appointed ofcials and the political level but that does not mean that the political level should be responsible for all implementation decisions. What it may mean is that implementation should be more tentative. Application of policy under these conditions would fall into quadrant 2.

An approach to implementation in such circumstances is that advocated by Karl Weick of looking for small wins: 'A small win is a concrete, complete, implemented outcome of moderate importance. By itself, one small win may seem unimportant. A series of wins at small but signifcant tasks, however, reveals a pattern that may attract allies, deter opponents, and lower resistance to subsequent proposals.'15

Small wins can also hugely infuence motivation, by ofering people a sense of progress and achievement.16

Where there is uncertainty about values but there is certainty about the facts or factors afecting implementation, application of the policy would fall into quadrant 3. Appointed ofcial-level responsibility for implementation will be afected by the tentative nature of political confdence about the outcome of the policy to be pursued and the pressures upon the political decision maker will be intense as agreement is sought on values, or to fnd the best possible compromise. Tis may result in frequent modifcations to policy. But this should not mean that the politician should seek to take over responsibility for implementation. Why should that occur? Te problems of

<sup>15</sup> Small Wins Redefning the Scale of Social Problems: Karl E. Weick Cornell University: American Psychologist: January 1984.

<sup>16</sup>Te Power of Small Wins: Teresa M. Amabile and Steven J. Kramer Harvard Business Review, May 2011.

implementation will become more complex and that requires a more professional and experienced ofcial responsible for implementation capable of advising the political level about alternative policies to meet uncertainty about values. What it should mean is closer cooperation between the ofcial and political levels of management.

Where policy development and application fall into quadrant 4, that is, uncertainty about both values and facts or factors, an impossible situation exists which neither politician nor ofcial can fully address. In this circumstance, the most efective option is for the minister or mayor to work to achieve the maximum consensus on values when only then can a decision be made about operational implementation recognising the uncertainty about the factors afecting implementation. In such circumstances the ofcial responsible for operational implementation should exercise great caution working with the political level but any attempt by the political level to take over responsibility for operational implementation should be resisted. However, the reality is that a decision must be made: there cannot be paralysis, and the politician should take that decision but knowing the level of uncertainties which exist and the responsibility of the ofcial is to then implement that decision to the best of his/her ability. Tis also will require very close cooperation between politician and ofcial.

Politics is the art of the possible. Te aim of both the politician and the ofcial should be to move all activity as far as possible into quadrant 1.

Tis type of Tompson-Tuden analysis can only be undertaken where there has already been established a Weberian style of public administration with its development into a managerial style. For many developing and transition economy countries this emphasises the need for civil service/public sector reform as a condition for the implementation of PFM/IC. Without that there is only limited clarity about the roles and responsibilities of politicians and ofcials. Te experience of this author is that politicians tend to absorb the decision making responsibilities of the ofcial, even for some of the most routine and minor administrative decisions. Tey would particularly see their role as decision maker where there are the levels of uncertainty as expressed in quadrants 2–4 and of course ofcials, who could be anxious to avoid criticism, may be willing to let politicians take decisions in such circumstances. Te extent to which politicians take over decisions about implementation in efect limits the delegation of authority and prevents the development of the quality of the civil or local government service as an adviser to the political level. It also prevents the civil service being infuential in the decision making process, that is, in the 'dominant coalition' or 'inner circle' envisaged by Tompson. Tat is detrimental to efective decision making because it removes an important dimension from the decision making process. Where such circumstances exist and there is limited clarity about the roles and responsibilities of politicians and ofcials, the application of the PFM/IC policy is inappropriate unless there is a commitment to civil service/public sector reform. However, sometimes politicians express a lack of confdence in the quality of the civil or local government service and resist delegation for this reason. In such circumstances the most appropriate course of action is to reform the civil or local government service, not seek to substitute for the existing service, elected ofcials or 'friends' of elected ofcials who are unlikely to be able to bring that detached view which is so essential to efective policy implementation and not least to provide 'challenge'. Where this lack of confdence exists the introduction of PFM/IC is inappropriate.

Taking the example above to illustrate the circumstances where there is an inappropriate distinction between the roles of politicians and ofcials would be decisions about the routine administration of a ministry or local government. Routine administration should be treated as a civil or local government service responsibility. Yet in many developing and transition economy countries this does not always happen or only happens in part. Te politician becomes involved in the administrative decision making process. Delegation even at this most basic of levels is often limited and administrative decisions risk becoming politicised. Where the politician takes on the role of the administrator this also alters the structure of those comprising the 'inner circle' membership. Te same information would still be required for efective decision making but the personalities making the decision would change from the ofcial to the politician. In such circumstances the role of the politician in efect changes from politician to administrator and this will afect the membership of the 'inner circle'. Tat does not necessarily improve the quality of decision making, perhaps the opposite, and is likely to introduce other factors into administrative decision making, not least political values. Another factor that also should be borne in mind is that where the politician becomes the operational decision maker it creates opportunities for rent seeking because the politician has access to suppliers and the appointment of other ofcials. It also assumes that a managerial capability exists amongst elected ofcials not available to the civil or local government service. However, where such a situation occurs the message that really needs to be appreciated is that either there is a breakdown in the relationships between the political and appointed ofcial levels (and the reasons for this need to be established) or the bureaucracy is not, or is not perceived to be, of the appropriate quality. Tis almost certainly means that the bureaucracy does not meet the requirements of a Weberian style bureaucracy with the capacity to develop into a managerial style bureaucracy which is a necessary reform with the implementation of PFM/IC.

An alternative analysis of decision making to the Tompson-Tuden matrix which has a similar focus, although using diferent language, has been developed by Hofstede.17 Te Hofstede classifcation asks these questions:


Tose responsible for considering the issues surrounding delegation should consider both the ideas contained in the Tompsom-Tuden matrix and those of Hofstede. Whether the objectives (or using the Tompson-Tuden analysis, values) are unambiguous or ambiguous (item a) above) is regarded by Hofstede as the most crucial criteria afecting how the activity is to be managed. If there is clarity about the objectives (or values) and this is a political responsibility to be derived from political values then there can be a clear target to be achieved and this makes delegation in principle to the civil or local government service

<sup>17</sup>Hofstede G., Management control of public and not-for-proft activities: Accounting, Organizations and Society. Vol. 6, No. 3, pp. 193–211,198l.

relatively easy (i.e. provided a managerial capability exists within the ofcial level of management and is recognised by politicians to exist). However, the reality is that often objectives can be unclear for several reasons such as conficts of interest and/or, of values. Te example of a prison given in Chap. 1, illustrates the point: the director of the prison may be most concerned about security, psychiatric staf may be concerned about rehabilitation, and higher levels of management may be concerned about overall cost. Tus, what is the objective of management? Tis lack of clarity may require a political decision but once that decision has been made there is no reason why delegation could not occur. Other reasons for lack of clarity include rapid changes in the operational environment, such as new legislation, developments in IT, new drugs and so on where political agreement may be required to the appropriate response. However, responsibility for implementation, once agreement has been reached should remain at the ofcial level and appropriate accountability arrangements then developed. Clarity of management responsibility then becomes clear. Where unambiguous objectives exist and there are no conficts of interests and/ or values then delegation to the ofcial level would be appropriate.

Te second Hofstede classifcation (b above) is, are the outputs measurable (quantifable) or non-measurable. If measurable, management control presupposes that the output of an activity can be identifed and compared to the targets that have been set (or could be set). Consequently, if variations occur during implementation, decisions can be made about how to ensure as far as possible that the original targets can be met or alternatively whether the original targets remain valid. Again, where such circumstances exist delegation to the bureaucracy is possible. However, many public organisation activities cannot be easily quantifable and Hofstede gives as examples, an army in peacetime or a public relations department or the outputs of an education ministry. In these circumstances Hofstede argues that what can only be measured are inputs rather than outputs and those measures of input activities which can provide an indicator of the quality of performance in diferent circumstances should be used. Another example of the problem of measurement would be the assessment of the educational performance of individual schools. Tis may be measured by examination results although disputes may occur about the appropriateness of the examinations and whether, for example, they assess simply memory or a capacity for critical analytical thought. Another measure could be the proportion of children of diferent sexes and age ranges attending school and attending consistently or the proportion of children in a school from lower income families. Te political responsibility is to provide clarity about the values and from that, about the objectives to be achieved by management. In all such circumstances delegation is appropriate once clarity exists although consultation with politicians may be needed, but a requirement for consultation does not mean that the politician should take on the responsibility for operational management.

Te third classifcation (c above) is, are the efects of management interventions known or unknown? Where the civil servant or local government ofcial knows how and when to intervene in order to obtain the desired result and has the authority to manage resources to enable the desired results to be achieved delegation could occur. Hofstede points out that the relationships between a manager's intervention and the reaction of the organisation must be clear. In practice these relationships are not always clear particularly with the delivery of 'social welfare' and 'educational' activities. Usually what is important in such circumstances is the historical knowledge and experience of the civil servant or local government ofcial as manager. Where there is no delegation and politicians become the operational managers, such managers can change frequently and the opportunity for the political ofcial acting as the manager to gain such a degree of historical knowledge and experience to achieve the objectives is likely to be very limited. Tis argues again in favour of delegation of operational management to a more stable group, which should be the civil or local government service ofcials.

Te fourth classifcation (d above) is, is the activity repetitive or nonrepetitive? Repetitive activities (those that occur daily, weekly, a few times a year, once a year) allow a learning efect to occur. Repetitive activities facilitate learning. But this again can only occur if the operational management is stable and therefore has the opportunity to learn from repetitive activity which again points to delegation to civil or local government service ofcials from the political level. (Securing operational management stability is an important responsibility of the top operational manager.)

What this analysis points to is that opportunities for delegation do exist. Whether delegation can be achieved depends upon several factors. Delegation to be efective must be accompanied by a range of other reforms referred to in this guide such as those impacting upon the organisation of the civil service, budgetary processes, and the development of fnancial analytical and performance information. A critical factor though in the development of delegation is the level of confdence that the political level has in the civil or local government service because with delegation the civil or local government service has to make decisions, including about the utilisation of resources. Political stability is also very important because where instability exists the boundary between political and appointed ofcial decision making is also likely to be unstable and this will make delegation potentially much more difcult. Attempting to require delegation without looking at the wider consequences of delegation would be a mistake.

Having determined which decisions should be delegated and to whom, the form of the accompanying managerial control or how accountability arrangements should work, needs to be established. Hofstede defned six types of control. Tese are:


level of uncertainty, the likelihood is that even though this type of control would be exercised at the appointed ofcial level, probably this would be in close coordination with the political level. (Examples would be the use of new social welfare or child care procedures.) Tis would afect the form of the accountability arrangements.


laboration between the political and appointed ofcial levels is essential even though decisions may remain at the political level.

Because the provision of public services can be complex, cooperation between ministries and other public bodies (not least local government) can often be essential. Cooperation complicates decision making processes and when several organisations are involved, conficts of objectives can occur. In such circumstances policy decisions will almost inevitably tend to remain at the political level but such political decisions can also determine how operational management decisions will be made.

# **14.2 The Effect of Introducing the Concept of Effciency and Effectiveness into Public Service Administration**

#### **14.2.1 The Impact of Introducing Effciency and Effectiveness into the Managerial Arrangements**

A practical problem that public sector administrators have working within traditional public administrative arrangements is that they generally have little fnancial information on which to make decisions. Tere is no market test or pricing mechanism which limits or otherwise afects the demand for public services. Similarly, there is little or no information about the actual costs of providing a service or information about what drives costs or even detailed performance information. Terefore, a critical factor in the success of a move from public administration to public service management, as has been pointed out earlier in this guide, is the existence of public service fnancial management. Te aim of public fnancial management is to provide the range of fnancial analytical information, linked to performance, that the manager needs as well as that needed to meet budgetary constraints.

Ministers responsible for the delivery of public services and other public service ofcials are prone to believe that the resources allocated through the annual budget are inadequate to meet the needs of the users of these services or activities. (Tere is never enough funding!) Tis can be a cause of tension between ministers responsible for service delivery and ministers of fnance. However, unless a public fnancial management reform has been introduced incorporating fnancial information additional to that only usually available with traditional arrangements for public fnancial administration, neither ministers nor ofcials have a clear idea about what services actually cost. Generally, ministers and other public service ofcials want to provide the best possible quality of service and there can be a presumption that reducing the cost of service delivery conficts with this objective. Yet reduction in cost may emerge through improvements in efciency. An objective of ministries of fnance in seeking to impose economies can be to drive service ministries into looking for improvements in efciency.

Improving efciency and efectiveness is not simply a function of a 'topdown' style of management. It requires the engagement of all who are involved in the management process, not least in the 'inner circle' identifed by Tompson. Tat demands delegation. Te benefts of delegation and managerial accountability in this context include:


Te idea of efciency and efectiveness introduced into the delivery of public services changes the characteristics of public service administration into one of management, that is if the term 'efciency and efectiveness' is to have substantive meaning. No longer is it simply a matter of delivering the same type of service or activity and keeping within budgetary limits. Yes, budgetary limitations do have to be observed, but if managers are to deliver efciency and efectiveness, they will need more opportunity to use their initiative and to make decisions about how to best deliver services and activities. To improve efciency and efectiveness requires a recognition that 'challenge' is a necessary component of management. Traditional hierarchical structures generally do not facilitate 'challenge'. A managerial approach would include not just considering ways in which the costs of present delivery arrangements could be reduced but also considering alternative methods of delivery. Managers within an organisation will themselves need to decide what they require in terms of resources to deliver their objectives but of course within any overall fnancial constraints imposed by the ministry of fnance. Te IMF paper on performance based budgeting referred to above makes the point about '[i]ncreased input fexibility: line managers should be given greater fexibility to choose the input mix that can most efciently deliver services. Tis requires a reduction of the large number of distinct limits imposed upon expenditure by economic classifcation ("line item") in traditional budgeting.'18

Te question then is, is it possible to manage public services and activities and deliver efciency and efectiveness without moving to a managerially oriented organisation? As has been pointed out elsewhere in this guide many countries in seeking to introduce PFM/IC use the term 'efciency and efectiveness' but without any recognition of what it actually involves. In this guide the point has been repeatedly made that managerial change is necessary. Managers will be required to spend more time on assessing costs and benefts and where changes in the arrangements for the delivery of services and activities are to be made this adds to the time demands upon those responsible managers. Expert judgements will be increasingly required to assess alternatives (and there will always be alternatives, although following analysis, one of which will be to maintain the *status quo* but this too must be justifed). Te ability to make expert judgements depends upon knowledge and experience as well as upon training. It is not feasible for traditional administrative structures with operational management a political responsibility, to be maintained and at the same time undertake all these additional activities. Delegation therefore becomes essential, not only from politicians to ofcials but also from senior to more junior ofcials. However, as has been pointed out, delegation itself is not a simple matter. Te terms of delegation need to be clear. Tis means that those to whom responsibility is delegated must know what they are expected to do, that the delegated responsibility is within their competence and they have available and under their control the resources to enable them to deliver the delegated objectives. Only then they can be held fully accountable. If these conditions do not exist then accountability is diluted.

To establish a managerially oriented organisation with a focus on efciency and efectiveness, radical change is very often required and delegation must become an essential feature of the organisation. Without delegation (and the accompanying managerial accountability) the top hierarchy cannot undertake all the analysis and actions necessary to deliver objectives with efciency and efectiveness. If an attempt is made to retain decision making authority within a small group at the head of the organisation, that is, the politically appointed group, this small group is unlikely to have available within it the skills and specifc knowledge that an operational manager requires and only through managerial activity can substantive meaning be given to the terms 'efciency and efectiveness'. (Economy is easier to interpret because economy is often

<sup>18</sup> Ibid., p. 7.

equated with cheapness, or least cost, irrespective of the relationship with benefts and economy can be the enemy of efciency.) Concentration of power as in traditionally organised public administrations, which is usually accompanied by penalties and other forms of sanction, means that the administrative structures which exist in many developing and transitional economy country public service organisations do not in reality facilitate efective management and consequently delegation. Delegation may exist in a nominal form but in practice decision making remains concentrated at the top of the organisation.

Te development of managerial structures with appropriate arrangements for delegation facilitates the achievement of organisational objectives efciently and efectively. Without a managerial structure delegation giving managers discretion and then accountability for how that discretion has been used, is not possible. A managerial structure enables higher levels of management to, in turn, become accountable and control the way in which the actions of individual managers at diferent levels in an organisation can be coordinated to achieve the delivery of the objectives of an organisation.

## **14.2.2 Achieving Delegation and Managerial Accountability in Practice: The Importance of 'Trust' and Other Factors**

An important factor afecting membership of the 'dominant coalition' referred to by Tompson is 'trust'. Where, as with traditional systems of public administration, there has been historically no separation of policy and strategy development from operational management a failure to achieve separation is often caused by a potential lack of trust between politicians and appointed ofcials. As a result, politicians can be reluctant to delegate operational and administrative decision-making powers to civil service (or local government) ofcials or for those ofcials to accept such responsibilities. Sometimes, because of a lack of trust, key administrative positions may become politicised. Tis situation has several negative efects. Tese were described in a SIGMA/OECD paper as:

1. A tendency to politicise administrative decisions, that is, decisions tend to be based more on political convenience than in what is established in legislation so that it encroaches negatively on the principle of legality and legal certainty that must preside over administrative decisions.


All of this destroys professionalism within the civil (and local government) service. Te essential principles for any administrative organisation to work efciently and efectively, as the SIGMA/OECD paper points out are lacking in traditionally organised governments. To achieve an improvement in practice according to this paper:

there has to be an adequate distribution of work and responsibilities (competency), while ensuring internal and external coordination and cooperation, all this in pursuit of a common purpose (or mission) mainly through a more or less tight hierarchical control.

Te paper also points out:

However, one major problem is that the still prevailing culture is based on command and controls (verticalism) and makes it not easy to translate these constitutional principles into real administrative practice. A co-related problem is that certain administrative legal techniques that could contribute to efciency and efectiveness of public administration are either conceptually underdeveloped or not sufciently regulated in legislation or, what is even more worrisome, not applied in real practice of organisational behaviour in public administration.20

What is missing in this analysis is the point about inadequacy of information, fnancial and non-fnancial, leading to uncertainty. Tat information

<sup>19</sup>Te delegation of administrative decision-making powers: a tool for better public performance, p. 2. Francisco Cardona SIGMA/OECD: www.nispa.org.

<sup>20</sup> Ibid., p. 2.

may not be simply performance information but also would include information about the adequacy of controls. Whilst there is no argument in theory about the efects of a failure to delegate, politicians are only likely to be persuaded to delegate where they can be confdent that the change of culture (i.e. from a hierarchical command and control culture) will not cause them to lose control of operational activities even though ultimately, they remain responsible. Important factors in achieving such a change of cultural approach are the adequacy of the accountability arrangements, including the information available to the politician and the quality of the managerial controls. Tis presents a major problem for ministries of fnance and their department responsible for the implementation of PFM/IC. Not only do they need to ensure that administrative law facilitates delegation (which in some countries it may not. Terefore, change will be required to efectively implement PFM/ IC). However, where the operational culture discourages delegation, particularly through a lack of trust, information, and the quality accountability arrangements, that operational culture is much harder to change. Policy papers designed to facilitate the introduction of PFM/IC tend to overlook these problems and how they might be addressed unless careful preparation prior to the implementation of the PFM/IC policy occurs (see Chap. 9).

A failure to recognise these changes that the PFM/IC reform should bring about means that the implementation of PFM/IC will be more nominal than substantive. Te SIGMA/OECD paper suggests that the best solution 'is to promote informed debates and training aimed at producing changes in the prevailing politico-administrative culture'.21 Reviewing the law is relatively easy, what is much more difcult is culture change. Te reality is that cultural reform cannot be achieved simply through pressure to implement PFM/ IC. As has been said previously coordination with those responsible for civil service/public service reform is essential. Careful pre-reform preparation is also necessary as described in Chap. 9. Included in this is how to achieve recognition of the defciencies with the traditional arrangements, not least the difculties of delivering public services and activities within a constrained budgetary envelope against rising demands, particularly when there is a serious lack of information. Policy papers introducing PFM/IC do not in general address these difculties because of the focus on the procedural features of the reform. Te defciencies also include (as the SIGMA/OECD paper points out) '[a]ccountability mechanisms for damage or losses caused by inefcient performance in traditional systems are in general weak or non-existent and

<sup>21</sup> Ibid., p. 3.

responsibility is difcult to demand from politicians and civil (or local government) servants'.22

Whilst laws introducing PFM/IC almost always refer to the delivery of public services and activities efciently and efectively they do not indicate how this will be achieved and merely introducing these terms in legislation, as has been pointed out earlier in this guide, without recognising what is required to achieve them, is pointless. Given the need to change cultural approaches merely including such statements in the law is unlikely to have any practical efect, not least because not only is it necessary to introduce a managerial structure to facilitate delegation but those who have managerial responsibilities also need training and the support and information to enable them to determine whether a service or activity is being delivered efciently, efectively as well as economically and is achieving its objectives. As has been indicated previously, this means that changes are also required to the budgeting and accounting arrangements with the complementary development of fnancial techniques, such as cost analysis, as well as operational performance information. None of this is usually referred to in policy papers leading to the introduction of PFM/IC.

Another pressure which exists on public organisations, which is complementary to the need to focus on efciency and efectiveness, is a requirement for more openness through increased transparency and accountability for performance. Tis in turn should help politicians and senior civil service management to demand improvements in efciency and efectiveness as well as generating wider debate about quality and value for money in the delivery of public services by parliament and civil society. PFM/IC is part of the process for remedying the defciencies of the traditional arrangements.

Te SIGMA/OECD paper also remarks:

No administration can work efectively if all the decision-making power is wielded only by the top of the organisation. For an organisation to work smoothly it needs to delegate power down the hierarchical ladder. Tis delegation is also a condition of developing necessary policy-making capabilities, and administrative management skills and responsibility that will not emerge otherwise.23

Delegation requires a fnancially aware civil or local government service which understands the costs of providing services and activities and which has

<sup>22</sup> Ibid., p. 3.

<sup>23</sup> Ibid., p. 8.

the capability to decide on those reforms that will improve efciency and efectiveness, some of which may require political-level approval and some may not. Tese are characteristics of an efcient and efective public management. Tey also facilitate a higher quality of corporate governance because the distribution of responsibilities allows for a wider range of factors and opinions to be considered in any decision. It also separates political considerations from managerial decisions where that is desirable (i.e. the majority of cases). Delegation creates the opportunity to develop sound management at diferent levels in an organisation and has a better chance of making the optimum use of resources (efciency!). Tis is because it allows the development of expertise and it also creates more time for top and senior management to focus of developing a higher quality of policy and strategy which is the basis for an efcient and efective public management. In addition, delegation through the development of managerial accountability, provides the opportunity for the top and senior political management to assess how efcient and efective the civil (and local government) service actually is.

As the SIGMA/OECD paper points out:

[Q]uality considerations include: cost to the budget and the economy; whether implementation can be assured and controlled/enforced; interaction with other policies; legal quality criteria in the case that the policy leads to a legal instrument that the text responds to. All this needs the expertise that a professional civil service is meant to input into the policy-making process.24

Te paper further points out that 'good legal arrangements for delegation may promote improved administrative practices that in turn may have positive operational consequences in organisational design and in developing an efciency-oriented managerial culture and that may ultimately contribute to:


<sup>24</sup> Ibid., p. 9.

• An administration where an accountable and committed professional management takes root.'25

Civil (and local government) servants should have the training, experience, and technical expertise to enable them to make operational decisions. Tose operational decisions may involve a rethinking of how public services are delivered. An example is the increased utilisation of information technology and another would be the development of partnerships with other organisations such as charities, local governments, and private sector organisations. None of this detracts from the overall responsibility of the public sector manager to ensure that where public money is involved, such funds must be appropriately and efciently utilised. Civil and local government servants because they would normally be in post for longer periods than politicians also provide continuity and knowledge of implementation that would not be available to politicians acting as operational managers. Teir position is not, or should not be determined by the political cycle. Continuity and knowledge are essential to efcient and efective public management. Delegation coupled with accountability makes it possible for these benefcial features to be taken advantage of.

#### **14.2.3 Delegation and Questions About the Activities of the Organisation**

In Sect. 14.1.3 of this chapter the issues that should be considered in determining when and what to delegate were discussed. Delegation is not an absolute. In other words, there is no such thing as complete delegation. Tere will be some responsibilities of ministers and deputy ministers (or the equivalent in local governments) that are inappropriate to delegate at any point in time or, in particular circumstances. Also, those circumstances may change over time. Pressure to delegate (by the ministry of fnance and the 'driver' department responsible for the introduction and oversight of the PFM/IC process) should be therefore an informed pressure considering the issues and circumstances that should be considered in any delegation proposal. A very important point is that delegation means nothing, as has been said earlier, unless accompanied by the authority to make managerial decisions and the availability of resources. Tose promoting delegation should be looking for evidence of this. Tat authority to make decisions should include improving

<sup>25</sup> In a public management environment this would be better stated as a 'civil service' where an accountable and committed professional management takes root. Ibid., p. 9.

efciency and efectiveness, and this requires, as pointed out previously, delegated control over material and human resources. Withholding that diminishes the extent to which managers can be held to account. (Yet in countries introducing PFM/IC delegation is usually considered but without any substantive regard to the extent to which delegation requires knowledge of and control over budgets or human resources.)

Accompanying delegation should be arrangements for accountability.

However, delegation occurs within a context which is the overall objectives of the organisation. In determining the appropriateness of the activities of the organisation for which he/she is responsible, the political leader in conjunction with the top operational manager (the state secretary or equivalent), should consider these questions:


What this means is that decisions about delegation policy should be considered as part of an overall review of what the organisation is aiming to achieve.

<sup>26</sup>Tese questions are an adaptation of fve questions suggested by Peter Drucker: Te Five Most Important Questions You Will Ever Ask About Your Organization: ISBN: 978-0-470-22756-5 April 2008 Jossey-Bass 144 Pages

#### **14.2.4 Professional Experts and Delegation**

A complicating factor in making decisions about the delegation of responsibility in the provision of public services is the role of professionally skilled staf such as doctors, police, teachers, social workers, and engineers. (A further complicating factor in some countries will be the infuence of foreign technical advisers.) Te politician should not seek to impose his/her judgement over that of the professional in the professional's area of expertise. But where the professional is advising on the development of policy the situation is diferent. Such experts may have professional objectives that are incompatible with the objectives of politicians. Where the professional has a dominant role, the professional ethos will be to adopt the highest professional standards and approaches to the delivery of a service or activity. Tis may contrast with the approach of the politician who may have a limited budget and whose policy aim could be to deliver the maximum possible beneft for the least cost and who also may be subject to a range of political pressures which do not impact on the professional. Tat may require some form of compromise on professional standards or professional approaches to the delivery of a service or activity. (Professional standards can often be matters of opinion, rather than objective fact.) Tis raises questions about the ability of the politician to adjudicate on the views of the professional and in making the judgement the politician ought to be able to rely on the advice of the civil servant (or local government ofcial). Tat would require that such ofcials are well informed about all aspects of a decision. A policy of delegation should result in a more informed civil or local government service better able to advise the politician. If there is no delegation then the risk is that a minister or other politician is exposed only to a single source of advice. A difculty for the politician in such circumstances is how to decide which professional expert to rely upon and how far to rely on their advice and opinion.

An important consideration in the development of delegation arrangements and managerial accountability therefore is the capacity of the civil or local government service to efectively support the political management in policy development and to provide an objective assessment of the quality of any advice being provided by professional experts considering the overall limitations on the resources available to the organisation. Tis capacity should enable the politician to take a wider view of the policy and fnancial consequences of proposals advanced by professionals for the delivery and development of services and activities. Tat policy advisory capacity should be provided directly by or under the supervision of the most senior civil servant such as a state secretary (or equivalent). In other words, delegation provides a substantive opportunity to develop alternative arguments or approaches to those of the professional. Without the existence of delegation to an informed civil or local government service, the possibility is that the politician will become 'trapped' by the views of the professional. Tis may result in the ineffcient allocation of resources given the totality of the demands upon the available budget and to increased risk for the political decision maker.

# **14.3 The SIGMA 'Principles of Public Administration'**

## **14.3.1 The SIGMA Principles and Management**

PFM/IC is about management not just about procedures and techniques. With PFM/IC control is about both control of inputs and of outputs and, at the same time, ensuring that those outputs are delivered efciently and efectively. Managerial control is therefore 'multi-layered' compared with the administrative control that exists with traditional public administration arrangements. In efect, introducing PFM/IC is a commitment to moving from an administrative state where regulations, procedures, and techniques have priority to a managerial state where delivery of objectives, to quality, to time, to standard, efciently and efectively but within the laws and regulations become the primary concern of the manager. Tat managerial concern must extend to the interests of the user of the public service. In November 2022, in a meeting of the Public Governance Committee (PGC) at ministerial level, OECD ministers committed to 'reinforce, promote and strengthen the foundations of democracies acknowledging that they should rise to the challenges of growing and changing citizens' expectations in terms of representation, responsiveness, open government, and integrity of institutions, as well as green policies including through innovative approaches in the public sector' and to 'continue eforts to build professional, efective and efcient public institutions, and high-performing leadership and civil servants in support of stronger democracies'.27

Tat afects the whole approach to the delivery of public services and which must be refected in the application of PFM/IC.

<sup>27</sup>*Declaration on Building Trust and Reinforcing Democracy,* (2022), https://legalinstruments.oecd.org/en/ instruments/OECD-LEGAL-0484.

SIGMA publishes a set of 'Principles of Public Administration'. Te latest edition (issued in 2017) is currently undergoing review. Tat review will refect recent thinking about the organisational arrangements for public administration, which were summarised in the quotation above of the PGC. Te emphasis upon the creation of 'professional efective and efcient public institutions and high-performing leadership and civil servants' supports many of the arguments set out in this guide. Te ministry responsible for the policy of the PFM/IC reform and the head of the department responsible for the practical implementation of PFM/IC should therefore have particular regard to these Principles when they are published as relevant to this reform. Te 2023 edition of the Principles will demonstrate some change and refect more fully the managerial requirements of PFM/IC. In the Annex to this chapter an early draft of the revised Principles is shown but readers should recognise that this is not the fnal version. Tis will be incorporated into this guide when it becomes available.

Although the 'Principles of Public Administration' are primarily designed for countries wishing to join the European Union these Principles are equally applicable to a much wider range of countries. Tis is because they provide one of the most comprehensive statements of the issues that need to be addressed in public administration reform.

# **14.4 Personnel Management (Human Relations—HR)**

#### **14.4.1 The Signifcance of Personnel Management in the PFM/IC Reform**

Success with the introduction of PFM/IC depends upon the existence of high quality operational management. Tis requires that a well-managed, incentivised, and well-trained civil and local government service exists. A key requirement is that '[p]rofessionalism of public service is ensured by good managerial standards and human resource management practices'.28

Te SIGMA Principles make clear that recruitment of public servants based on merit is of utmost importance for developing and implementing policies as efectively as possible, regardless of the government of the day. Te 'Principles' also make clear that the public service should be apolitical and that public servants are distinguished from political appointees (i.e. political

<sup>28</sup>Principles of Public Administration: Sigma 2017: p. 40.

positions are not included in the scope of public service). Tey also recognise that an efective public service also depends upon other factors such as level of remuneration, performance appraisal, professional training and development, integrity measures and disciplinary procedures. 'Tese are needed not only to attract quality employees to the public service, but also to retain them and motivate them to achieve the strategic goals of the state. Te 'Principles' also make clear that 'regular professional training is recognised as a right and duty of all public servants. With PFM/IC that training not only has to cover technical training but, as has been pointed out earlier in this guide, it also should cover management training for all civil servants who have managerial responsibilities or who aspire to those responsibilities:

Modernising public administrations remains a key concern throughout the enlargement countries. Politicisation continues to erode capacities and public administrations' attractiveness as an employer. While there is awareness of key reform needs for creating more professional and merit based administrations overall, more leadership and efort will be needed for improving policy planning, public fnance, people management and accountability.29

In no policy papers relating to the introduction of PFM/IC has this author seen any reference to developing the quality of the civil service, apart from technical training in the bureaucratic arrangements for the implementation of PFM/IC. Tis is even though PFM/IC imposes quite signifcant additional and often completely new responsibilities, upon the civil or local government ofcials. Almost certainly this is because PFM/IC has been treated as simply a technical fnancial reform rather than as a reform impacting heavily upon management. Te OECD has published several papers on civil service training which heads of the 'driver' department responsible for the application of PFM/IC may fnd helpful such as 'Skills for a High-Performing Civil Service'.30

Francis Cardona in a SIGMA paper 'On the Attractiveness of the Public Service' said:

Te correlation found between public service attractiveness and the idea of the public interest emphasizes the dimension of the quality of the public governance arrangements and management systems as a magnet attracting people to work in the public service. Such correlation is also vital in fostering the commit-

<sup>29</sup> 2022 Communication on EU Enlargement Policy-v3.pdf (europa.eu), https://neighbourhoodenlargement.ec.europa.eu/system/files/2022 10/2022%20Communication%20on%20EU%20 Enlargement%20Policy-v3.pdf.

<sup>30</sup>https://doi.org/10.1787/9789264280724-en.

ment of individuals to public service values. Tis commitment may compensate for relatively lower fnancial rewards if compared with the private sector.31

#### Tis SIGMA paper also stated:

If a good governance system is not in place it will be very difcult to attract a signifcant share of the most talented people in the country and to utilise them efectively, which is a condition to retaining them in the service of the state: Governance environments that do not efectively practice the rule of law and do not protect and defend due procedures, justice, integrity and transparency usually do not have good public institutions that are able to attract and retain bright professional people.32

PFM/IC, if to be efective, will require the employment of 'talented people' and some, such as heads of fnance who in many countries do not presently have the required range of skills, will need to develop those skills or if that is not possible, they will need to be replaced. Te diference between PFA/IC and PFM/IC from an administrative/managerial perspective and which summarises why talented people are required to establish PFM/IC is that PFA/IC is input driven and rule driven with an emphasis upon procedures that control resources, while PFM/IC is output driven with an emphasis on managerial initiative in using resources better to achieve objectives (see also Chap. 3).33

In Chap. 1 the aim of PFM/IC was described as: 'to provide the information management requires to deliver the objectives and performance standards of the organisation, as expressed through the budget, efciently and efectively, to time and within budget'. Delivery occurs through the actions of the civil and local government service within the context of the policy and objectives determined by the political level of government. PFM/IC is about achieving delivery performance and that means that the personnel policies should be designed to support that. Consequently, an important feature of PFM/IC should be to support the development of a personnel or HR policy which has the following characteristics:

• establish objectives through which individuals and teams can see their part in the organisation's mission and strategy;

<sup>31</sup>Attractiveness of the Public Service: A Matter of Good Public Governance: June 2009: http://www. sigmaweb.org/publications/44110902.pdf.

<sup>32</sup> Ibid., p. 1.

<sup>33</sup>Tis distinction between PFA/IC and PFM/IC has been taken from a framework developed by Prof. Stephen Peterson in his book: Public Finance and Economic Growth in Developing Countries: Lessons from Ethiopia's Reforms: pp. 278–279; 285–286


To these characteristics could also be added 'provide challenging work'.

Tis does mean that personnel policies, as the Chartered Institute of Personnel and Development points out, should be established which aim to link an individual's performance and development priorities with the objectives of the unit or department of the ministry or other public organisation in which an individual works, which in turn should be linked to the organisation's objectives. Tis then allows individuals and managers to draw up appropriate plans and facilitates performance monitoring and allows for regular feedback between the manager and the individual employee. Tese feedback arrangements could be supported by periodic formal performance reviews. Te plans can also highlight organisation-wide processes that are required to support performance; for example, leadership, internal communications, and others. Tis links personnel policies to the COSO control environment and the information and communications standards described in Chap. 11.

# **14.5 Summary**

Tis chapter discusses the linkage between the PFM/IC policy and that for civil service/public service reform. It emphasises that that linkage should be extremely close and that if the two reform policies are not integrated either the PFM/IC reform will be difcult to implement or it will try to drive the civil service/public service reform, which would be inappropriate! Unless the objective of PFM/IC reform is clear, that is to introduce into government a managerial capability the likelihood is that the focus of public service reform will be simply limited to public administration reform, that is, a reform with no managerial focus. An important element in developing PFM/IC is an appreciation of the complexities of the decision making process and the uncertainties associated with that process, not just in terms of establishing agreement about the values leading to the policies that are to be pursued but also establishing as far as possible certainty about the facts or factors afecting the implementation of those policies. Te greater the degree of certainty and

<sup>34</sup>Performance Management: an introduction: Te Chartered Institute of Personnel and Development Nov.2019: https://www.cipd.co.uk/knowledge/fundamentals/people/performance/factsheet#6276.

the operational management has an important contribution to make to both elements, the better the quality of the decision. Te decision about values is and will remain a political decision.

An important element of PFM/IC reform is the development of delegation and managerial accountability. Te greater the degree of certainty, the greater the opportunity exists for delegation! Delegation and managerial accountability together are about making better use of resources. However, delegation is a complex issue and not all operational managerial activities are suitable for delegation. Diferent factors need to be considered in making decisions about the extent of delegation, including the nature of the activity to be delegated, and the control arrangements which exist or can be established.

In implementing the PFM/IC reform the relevant SIGMA Principles of Public Administration Reform should be considered recognising the greater emphasis upon the development of management that the latest version of the Principles envisage. Tis is a necessary pre-condition for the development of PFM/IC. However, there is little or no evidence that those responsible for PFM/IC reform in individual countries or donors supporting them consider the need for complementary managerial reform, or indeed that those responsible for civil service/public administration reform consider the implications for PFM/IC reform.

A further important factor in developing PFM/IC is personnel policy. Personnel policy is critically important in recruiting and retaining high quality staf which is essential for efective public service management. Efective staf management is linked to the COSO standards relating to the control environment and information and communications. Unless in applying these standards, personnel policies are also considered those standards cannot be efectively applied.

# **Annex: SIGMA Principles of Public Administration of Relevance to the Introduction of PFM/IC (An Early Draft of the 2023 Version Which May Be Subject to Change)**

Te Principles as drafted are grouped into the following thematic areas:35

<sup>35</sup> See para 21 of the Introduction.


Te Principles apply to all public bodies, including local and regional governments.36

To secure the efective application of the Principles, there are a number of prerequisites which are not written into every Principle. (All of which are fundamental to the introduction of PFM/IC and have been refected in this guide.) Tey are:


<sup>36</sup> See paras 18–20 of the Introduction.


**Principle 1**: A comprehensive, credible, and sustainable public administration reform agenda is established and successfully implemented, fostering innovation and continuous improvement.

Comment: Ofcials responsible for the implementation of PFM/IC should ensure that the public administration reform arrangements fully refect the requirements of PFM/IC.

**Principle 2**: Public policies are coherent and efectively coordinated by the centre of government; decisions are prepared and communicated in a clear and transparent manner.

Comment: Tis also means from a PFM/IC perspective, that policies are afordable and do not have adverse efects upon fnancial resilience. It consequently means too that there is efective coordination between strategic plans, operational plans, and fnancial plans.

**Principle 3**: Te government plans and monitors public policies in an efective and inclusive manner, in line with the government fscal space.

Comment: Tis requires that policy and fnancial plans are aligned, that objectives and performance standards are defned and appropriate.

**Principle 4**: Public policies are developed based on evidence and analysis, following clear and consistent rules for law making; laws and regulations are easily accessible.

Comment: Tis means that the cost implications are calculated and are consistent with available budgetary resources. Tis also emphasises the importance of the role of fnancial analysis in the policy making process.

**Principle 5**: All key external and internal stakeholders and the general public are actively consulted during policy development.

Comment: Implementing this Principle means that fnancial assessments may be subject to challenge, not just internal challenge but also to external challenge. Heads of fnance should be prepared for that.

**Principle 6**: Public policies are efectively implemented and evaluated, enhancing policy outcomes and reducing regulatory costs and burdens.

Comment: Te head of fnance should be involved in the evaluation process, not least because this will enable that person to assess the quality and robustness of initial fnancial calculations, and therefore the impact upon budgets and fnancial resilience.

**Principle 7**: Te parliament efectively scrutinises the government policy making and ensures overall policy and legislative coherence.

Comment: Implementation of this Principle will mean that heads of fnance are likely to be required to provide evidence which may be challenged as part of the parliamentary process.

**Principle 8**: Te employment framework balances stability and fexibility, ensures accountability of public servants and protects them against undue infuence and wrongful dismissal.

Comment: Tis Principle includes a requirement that public servants have the obligation to act professionally and neutrally and that they have the right to reject unlawful instructions, and that they also have protection against undue political and other interference in their professional judgement. Although not specifcally identifed in these Principles heads of fnance can be subject to inappropriate interference, especially in circumstances where in their professional judgement policy proposals and other actions generate risks to fnancial resilience or ofend fnancial principles such as those requiring that published accounts present a true and fair view of a fnancial position.

**Principle 9**: Public administration attracts and recruits competent people based on merit and equal opportunities.

Comment: Application of this Principle should help to ensure that competent staf are appointed to fnance departments and that they have appropriate experience.

**Principle 10**: Efective leadership is fostered through competence, stability, professional autonomy and responsiveness of accountable top managers.

Comment: Tis is a very important Principle, not least because it defnes 'top management' as: 'Te term "top managers" shall apply to the highest levels of professional management in public administration bodies, where managers enter into direct interactions with the political leaders. It shall apply to top-of-pyramid public servants in ministries (general secretaries or professional state secretaries), general directors of ministerial departments or equivalent positions in ministries, and heads of agencies. It shall not apply to political leadership in the executive (prime minister, minister, deputy minister, political state secretary and similar).'

Troughout this guide emphasis is placed on the role of the 'top manager' and the leadership that that manager provides. Tis Principle reiterates that as follows:


Each of these points is consistent with the efective introduction of PFM/IC. **Principle 11**: Public servants are motivated, fairly, and competitively paid and have good working conditions.

Comment: Tis Principle is relevant to the appointment and maintenance of a high quality fnance staf especially those requiring a skilled expertise. Public sectors generally have difculty in attracting and retaining skilled fnancial experts (qualifed accountants) and recruitment policies need to recognise this. As this guide has pointed out fnancial experts require a wide range of skills and such skill requirements will be increasingly needed by governments with the adoption of these Principles which emphasis the signifcance of managerial capabilities.

**Principle 12**: Professional development, talent, and performance management enhance the skills, efciency, and efectiveness of public servants and promote civil service values.

Comment: Tis Principle refers to the need for employees to have clear objectives (which in turn means that organisations themselves require clear objectives otherwise the employee objectives have limited credibility), that continuous learning processes exist and that appropriate training programmes are in place. All of this is central to the efective development of PFM/IC.

**Principle 13**: Te organisation and management of public administration foster accountability, efectiveness, and efciency.

Comment: Tis Principle addresses the need for coordination between public sector bodies, to avoid the development of 'silo' mentalities and also the need for the frst-level body to efectively manage the second-level bodies for which it has responsibility. It also includes the point that '[m]anagers at all levels have clearly assigned responsibilities, delegated authority for making decisions and the autonomy and resources necessary to achieve the results they are accountable for'. Tese requirements are all essential for the efective implementation of PFM/IC.

**Principle 14**: Tis is about the allocation of responsibilities between the diferent levels of government.

**Principle 15**: Public administration is transparent and open.

Comment: A feature of good corporate governance is that the public and interested parties have access to information. Tis includes access to all fnancial information, including budgets and fnancial statement. Heads of fnance should bear in mind that the presentation of information in a format for management and statutory purposes can be inappropriate for public information purposes and therefore may require representation. Openness may also result in challenge about the quality and coverage of fnancial analysis on which policy decisions have been made which emphasises the need for quality.

**Principle 16**: Te parliament, ombudsperson, supreme audit institution and civil society efectively scrutinise public administration.

Comment: Tis emphasis upon scrutiny may result in challenge to the quality in the arrangements for PFM/IC.

**Principle 17**: Te right to good administration is upheld through administrative procedure, judicial review, and public liability.

Comment: Tis Principle is primarily concerned with the quality of the public administration.

However, it can ask questions about the quality of public fnancial management and may lead to challenge about the organisation of government institutions, both frst- and second-level bodies. As has been pointed out in this guide, for example, the role and responsibilities of second-level bodies should be periodically review.

**Principle 18**: A coherent and comprehensive public sector integrity system minimises the risks of corruption.

Comment: Tis Principle is aimed at minimising the risks of corrupt activity occurring. Tose responsible for fnancial management (i.e. the operational implementation of PFM/IC) could well come across potential instances of corrupt or fraudulent activity. Examples would include where decisions are made which are difcult to justify, or where conficts of interest become apparent or transactions occur which are not properly authorised, or potential income is either not levied or collected, or assets are inappropriately used or disposed of.

**Principle 19**: Users are at the centre in design and delivery of administrative services.

Comment: Tis guide has pointed out that generally public services are designed with the interests of the supplier paramount. Tis is inappropriate and it diminishes the possibilities of achieving 'efectiveness'. Tis Principle emphasises that regard should be had to the interests of the user in designing public services and the bureaucracy that goes with them.

**Principle 20**: Te public administration delivers streamlined and highquality services.

Comment: Tis Principle emphasises again the need to take into account the interests of the user by ensuring that service delivery is streamlined for the maximum convenience of the service users.

**Principle 21**: Administrative services are easily accessible online37 and ofine, taking into account diferent needs, choices and constraints.

Comment: Tis Principle again emphasises the interests of the user and encourages the use of both ofine and online methods of communication, including the use of concise and understandable language. Tis is particularly important from a PFM/IC perspective in terms of fnancial communications with the public and where relevant information about the collection of income such as taxation income.

**Principle 22**: Tis is about the digitalisation of public services and the maintenance of cyber security.

Comment: Tis applies equally to those fnancial services for which a head of fnance is responsible.

Principles 23–32 are about public fnancial management. Te summary of this section of the Principles is: 'Te public administration plans and manages public fnances to ensure that they are sustainable and transparent and allow the delivery of policy objectives. Control, procurement and oversight arrangements are in place to ensure the economic, efcient and efective use of public resources shared across all levels of government.' Tis theme is entirely consistent with that of PFM/IC. However, the Principles extend beyond the areas

<sup>37</sup>Directive EU 2016/2102 of the European Parliament and of the Council of 26 October 2016 on the accessibility of the websites and mobile applications of public sector bodies, http://data.europa.eu/eli/ dir/2016/2102/oj.

covered by this guide to include economic management, purchasing, external audit, and the fnancing of local and regional governments.

Comment: Tose involved in the development of PFM/IC and in PFM/IC activity in the course of public business must recognise the signifcance of all these Principles and that Principles 23–32 are essentially concerned with the technical aspects of PFM/IC and not with the managerial aspects which are addressed in the other Principles and which are essential to the efective application of PFM/IC.

**Principle 23**: Te annual budget is comprehensive and formulated within a credible and rolling medium-term framework, balancing policy needs with fscal constraints.

Comment: An efective budget underpins PFM/IC and efective fnancial management depends upon the linkage of service objectives and plans with those both explicit and implicit in the budget. Equally medium-term operational and fnancial plans should be consistent with the medium-term fscal framework set out in the budget documents. Tis in turn is essential to securing fnancial resilience.

**Principle 24**: Te government supports budget implementation and service delivery by ensuring liquidity in the short and medium term.

Comment: Tis Principle links with the point made in this guide that cash fow forecasts should be reliable and that liabilities should not be entered into which are inconsistent with the current budgetary allocations.

**Principle 25**: Te government implements the budget in line with estimates and reports on it in a comprehensive and transparent manner, allowing for timely scrutiny.

Comment: Tis Principle embodies the requirements of fnancial control, including control of fscal risk. Whilst aimed at central government, for this Principle to be efectively implemented all public organisations should follow the same requirements. Tis guide also emphasises two other key features that ought to apply, namely that the monitoring of the budget should be at least monthly and that accompanying the published fnancial statements should be a 'statement of internal control'.

**Principle 26**: Public administration bodies manage resources in an efective and compliant manner to achieve their objectives.

Comment: Tis Principle covers all the internal control requirements described in this guide also it does not specifcally refer to COSO using instead the term 'international standards'. It identifes the need for objectives, for delegation, for managers to have the necessary information, including on performance, and that internal control arrangements should have regard to the risks that might afect the achievement of the objectives. It also refers to the need for appropriate controls to be exercised by frst-level organisations over second-level bodies, including enterprises. Te Principle makes clear that public managers are responsible for the implementation of management and control systems that ensure the legal, efective, efcient, and economic management of operations, assets, and resources. Tis guide makes clear that the ultimate responsibility for the quality of management lies with the head of operational management who in turn is responsible to the appropriate minister

**Principle 27**: Internal audit improves the management of public administration bodies.

Comment: Tis Principle requires the implementation of internal audit. Tis Principle advises that the internal auditor should report to the 'head' of the organisation which would be to the head of operational management. Principle 10, footnote 14, makes clear who should be the top operational manager. Where an audit committee exists the reporting arrangements would take into account the existence of that committee.

Principles 28–30 are concerned with procurement arrangements, including public-private partnerships and concessions.

**Principle 31**: All public funds are efectively audited by an independent auditor that provides assurance on the use of public resources and helps improve the functioning of the public sector.

Comment: Although this guide does not specifcally address external audit, nevertheless efective arrangements for PFM/IC will be of concern to the external auditor particularly with the auditor's concern for how organisations are aiming to achieve the efcient and efective utilisation of public resources.

**Principle 32**: Regional and local governments have resources and adequate fscal autonomy for exercising their competences, with fnancial oversight to foster responsible fnancial management.

Comment: Tis Principle addresses the need for subsidiary governments to have available to them a level of resources commensurate with their needs. Tis is a very important consideration in discouraging such organisations from taking

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# **Index1**

#### **A**

Accountability external, 29, 38, 56, 126, 225, 226, 274, 319, 329, 334, 352–353, 370, 376, 499, 524 internal, 29, 56, 225, 274, 352, 353, 376, 499 Accounting, 284, 360 cost/cost accounting, 24, 139, 159, 191, 198, 258, 266, 268–270, 282, 284–286, 295, 316, 319, 324, 331, 340–364, 370, 494 fnancial/fnancial accounting, 31, 34, 36, 77, 78, 82, 122, 132, 146, 159, 162, 167, 174, 183, 191, 257, 269, 270, 272, 291, 295, 307, 315, 316, 319, 324, 328, 329, 360, 452, 494, 498, 523 management, 17–18, 24, 34, 122, 131, 159, 167, 168, 170, 183, 191, 195, 198, 257, 258, 261, 263, 266–271, 283–285, 288, 291, 294, 295, 319, 324, 327,

331, 332, 346, 347, 360, 370, 393, 487, 506, 523 Anglophone systems, 9, 234n1

#### **B**

Benefts of the reform better quality control, 349–350 better quality management, 75, 124, 169, 173, 339, 342–354 better quality policy making and strategy development, 347 budgetary stability, 341–342 efective mechanisms to manage second level bodies, 353 enhanced fnancial awareness, 106, 346, 348 enhanced transparency and accountability, 346, 354 improved budgetary and fnancial control, 351 improved external accountability, 352–353

<sup>1</sup>Note: Page numbers followed by 'n' refer to notes.

Benefts of the reform (*cont.*) improved identifcation of fscal risk, 350 improved operational management, 341, 348, 351, 352 improved quality of governance, 29, 306, 351–352, 413 *See also* Public fnancial management and internal control (PFM/IC) Budget, vii, 1, 42–44, 48, 85, 98–100, 119, 159, 185–187, 204, 236, 257, 303, 340–342, 365, 436, 484, 520 circular, 101, 185 control, vii, 3, 7, 16, 18, 19, 23, 31, 36, 43, 55–58, 66, 67, 73, 76, 82, 83, 86, 88–91, 95, 96, 98–103, 119, 124, 125, 127, 131–133, 139, 146, 157, 160, 161, 165–168, 170, 174, 177, 183, 185–188, 195, 198, 201, 204, 206, 217, 224, 236, 248, 255, 260–264, 266, 267, 269, 270, 272, 273, 281, 291, 294, 295, 305, 306, 318, 320, 328, 329, 331–333, 335, 340, 347, 351, 359, 361, 370, 377, 391, 395, 396, 412, 438, 443, 445, 446, 453, 484, 487, 489, 497–499 development of, 100–103, 262, 277, 324 impact of PFM/IC on, 192 link to objectives, performance standards, operational performance, 77, 498 parliamentary scrutiny, 103, 104, 167, 226 performance budgeting, 6, 87, 88, 173, 336 performance information, 44, 78, 88, 226, 348, 382, 393, 494, 498

period, 296, 436 public participation, 24 silo mentality or silo, 24, 25, 171, 249, 348, 389, 492, 562 structures, 90 Budgetary, *see* Budget Business planning, 37, 105, 106, 224, 281, 288–292, 331, 344–345, 460, 503


budgetary, vii, 3, 7, 16, 18, 19, 23, 31, 36, 43, 55–58, 66, 67, 73, 76, 82, 83, 86, 88–91, 95, 96, 98–103, 119, 125, 127,

131–133, 139, 146, 157, 160, 161, 165–168, 170, 174, 177, 183, 185–188, 195, 198, 201, 204, 206, 217, 224, 236, 248, 255, 260, 262–264, 266, 267, 270, 272, 273, 281, 291, 294, 295, 305, 306, 318, 320, 328, 329, 331–333, 335, 340, 347, 351, 359, 361, 370, 377, 391, 395, 396, 412, 438, 443, 445, 446, 453, 484, 487, 489, 497–499 cash fow, 43, 90, 91, 133, 167, 187, 188, 199, 264, 272, 395 environment, 86–91, 147, 321, 330, 366, 367, 372, 375–382, 396, 399, 475, 490, 508, 510, 514, 556, 557 fnancial, vii, 1–45, 55–58, 60n7, 66, 67, 72, 73, 76, 82, 83, 86, 88–91, 95, 96, 119, 122, 124, 125, 127, 129, 132, 133, 139, 157, 160–162, 165, 166, 170, 183, 186, 187, 195, 200, 201, 204, 217, 221, 224, 228, 236, 240, 248, 255, 260–264, 265n2, 266, 291, 303, 304, 306, 318, 320, 324, 328, 331, 333, 335, 340, 342, 347, 351, 352, 359, 365, 370, 372, 377, 391, 396, 411, 412, 418, 446, 484, 487, 489, 494, 499, 505, 507, 509, 511, 523, 564 input, 2, 66, 88, 89, 91, 95–97, 102, 106, 130, 133, 162, 164, 188, 225, 228, 237, 267, 280, 320, 337, 343, 392, 394–396, 469, 552, 559 internal and external control, 19–22 objectives of, 95–98 output, 20, 66, 87, 97, 162, 164, 180, 188, 228, 320, 337, 392, 469, 552, 559

political, 124, 150, 151, 323, 358, 540 Corporate governance acting in the public interest, 30 managerial, 29, 250 Corruption, v, 21, 33, 50, 69n14, 92, 172, 193, 203, 207, 223, 225, 232, 264, 309, 351, 400, 443, 511, 562 transparency and accountability, 232, 443 COSO, *see* Committee of Sponsoring Organisations; International internal control standards Costs of the reform creating managerial structures, 356 developing civil service creativity, 357–358 developing fnance function, 360 driver department, 355, 362 employing consultants, 361 funding, 207, 456 integration with civil service and public service reform, 355–356 performance information systems, 359–360 research and analysis, 360 training ministry of fnance staf, 360 training operational management, 356–357 Culture, 11–14, 23, 36, 39, 61, 74, 82, 87, 132, 133, 135, 137–139, 137n6, 145, 147, 148, 150, 162, 163, 166, 169, 176, 195, 205, 207, 214, 215, 225, 227, 232, 239n3, 266, 300, 311, 313, 316, 371, 373, 379, 406, 408, 418, 419, 427, 465, 491, 492, 497, 545, 546, 548, 559

**D**

De Geyndt, 21, 67, 94–95, 132, 150, 205 Delegation accountability, 1, 7, 12, 23, 29, 31, 52, 59, 60, 62, 73, 82, 135, 146, 149, 191, 192, 194, 199, 210, 239, 314, 319, 322, 327, 330, 331, 336, 352, 391, 398, 444, 450, 464, 499, 508, 521, 525, 526, 539, 540, 542–551, 557 importance of trust, 544–549 PFM/IC and delegation, 79–80, 519–565 resistance to, 62, 323 whether appropriate or not, 519–565 Development agencies, 4 Driver department driving force for change, 156–157 monitoring of the reform, 336 operational application of PFM/IC, 303 operational implementation policy paper, 314–321, 327 practical issues, 326–336 range of skills, 323, 325, 555 state secretary meetings, 321 *See also* Ministry of fnance state secretary Drucker, P., 37, 53, 550n26

#### **E**

Efciency/efectiveness complexity in public sector compared with private sector, 152 securing efciency and efectiveness, 53–54, 72, 159, 177, 237, 238, 470

European Commission, 9, 15n10, 27, 32, 59, 60, 60n7, 81, 140, 147, 156, 178, 184n9, 219, 220n15, 258, 303n1, 377, 381, 390, 397, 409, 412, 525, 553 PIFC, 9, 60n7 European Union, *see* European Commission

#### **F**

Fake reform, 2, 216, 217 Finance function accounting, 31, 34, 36, 77, 78, 82, 132, 146, 159, 162, 167, 174, 183, 257, 269, 270, 272, 291, 295, 307, 315, 316, 319, 328, 329, 360, 449, 452, 454, 498 line ministries, 169–173 Financial management advice to managers, 282, 294 control, vii, 1–45, 66, 68, 280, 291, 332, 513, 515–517 cost centres, 47, 73, 122, 139, 168, 269, 332, 524 cost drivers, 40, 47, 57–58, 73, 122, 139, 168, 269, 332, 524 fnancial information, 17, 28, 33, 44, 53, 55, 61, 68, 76, 77, 100, 106, 170, 171, 174, 175, 180, 182–184, 191, 258, 264, 266–270, 283, 291, 292, 316, 316n5, 319, 332, 335, 348, 357, 359, 368, 370, 394, 454, 455, 498, 509, 524, 541, 562 fnancial planning, 41, 42, 70, 71, 106, 116, 139, 146, 170, 171, 173, 188, 266, 273, 274, 282, 288–292, 299, 324, 331, 344–345, 360, 392, 396 fnancial resilience, 22, 26, 42, 65, 70, 72, 79, 83, 105, 120, 169,

171, 173, 189, 199, 223, 258, 263, 271–274, 276, 292, 295, 296, 298–300, 308, 331, 345, 360, 380, 392, 396, 400, 435, 444, 454, 460, 486, 490, 531

#### **H**

Head of fnance accrual accounting, 278, 283 additional responsibilities with PFM/IC, 199, 281, 283, 330 cash management, 264, 271 check on aspirations of managers, 277–279 competencies, 172 costing, 170, 257, 261, 279, 282, 285–288, 291 development of policy, 258, 262, 270, 289 fnancial management, 57, 70, 258–262, 268, 273, 274, 279, 280, 283, 285, 291–293, 298, 563 fnancial regulations, 172, 264, 298 fnancial stability, 51–53 fnancial statements, 265, 269, 275, 297 management accounting, 170, 257, 258, 261, 263, 267–269, 271, 283–285, 288, 291, 294, 295, 331 ministry of fnance and quality of head of fnance, 264 organisation of fnance function, 261, 267, 268, 283–285, 293 pressures on, 172, 173, 293 responsibilities prior to the application of PFM/IC, 172, 211, 258–298 responsibilities with the introduction of PFM/IC, 170, 257, 263–280, 283, 288, 291

responsibility for promoting fnancial literacy and fnancial awareness amongst managers, 281 role of in decision making, 260–262 specifc responsibility, 53, 261 strategic and business planning, 281, 288–292 training, 268, 281–282, 293, 331 Hofstede, G., 536–539 How is the reform to be undertaken, 140–150 Human relations (HR), *see* Personnel management

**I** Information and communications, 147, 321, 330, 348, 366, 367, 372, 373, 382–390, 396, 514, 556, 557 Institute of Internal Auditors (IIA), 18n14, 495 Institute of Risk Management, 407 Internal audit efects of PFM/IC upon, 7, 15n10, 18, 104, 105, 157, 197, 210, 211, 228, 238, 254, 254n6, 255, 324, 325, 412, 490, 515 inspection, 254, 255, 475, 509 managers and risk, 401–403 monitoring, 254n6, 412, 452, 515 reporting, 105, 210, 254, 254n6, 255, 328, 472, 509 risks and unintended consequences, 208–212 role, 104, 208–212, 255, 335, 412, 421, 471 second-level organisations, 437, 452, 467–468, 471 statement of internal control, 333, 471, 486, 491 training, 156, 282, 335

Internal control defnition, 64, 156, 184n9, 254 in a fnancial management context, vi, vii, 47–50, 56 International internal control standards assumptions, viii, 2, 39, 127, 149, 169, 185, 187, 234, 263, 281, 291, 296, 350, 365–371, 410, 412, 413, 503 control activities standard, 330, 390–397 control environment standard, 330, 376–382, 398 examples of risk management statements, 408, 413 information and communications standard, 330, 556 management structures, 8, 10, 40, 52, 62, 63, 75, 78, 120, 134, 135, 181, 212, 249, 331, 349, 360, 361, 370, 372, 374, 376, 389, 399, 402, 447, 458, 460, 487, 520, 523 monitoring activities standard, 409–412 overview, 38, 93–95, 316, 376–377, 397–401, 409, 414, 434–470 risk management standard, 330, 397–409 International Monetary Fund (IMF), 61, 94, 94n5, 98, 104, 174, 278, 278n7, 490n3, 525, 542

#### **L**

Laing, Andrew, 2n1 Lassou, P., 207 Leadership managerial, 348 political, 14, 27, 50, 146, 152, 154, 239, 250, 253, 271, 291, 383, 398, 406, 560

Local government chief ofcial, 235 mayor, 24, 29, 141, 177, 235, 239, 250, 306, 507, 526 Local government equivalent, 354 Local ownership, 140–143, 145, 163, 176, 200, 207, 219, 222, 226, 252, 255, 305, 325–326, 337

#### **M**

Management accountability, 7, 8, 12, 29, 82, 275, 319, 341, 347, 352, 375, 391, 490n3, 508, 554 control, 16, 18, 64–66, 68, 228, 409, 466, 488, 489, 509, 521, 536n17, 537 delegation, 9, 12, 13, 33, 59, 61–63, 75, 92, 129, 137, 138, 146, 150–154, 157, 235, 250, 255, 319, 323, 352, 356, 357, 384, 485, 521, 538, 540 efectiveness, 16, 58, 63, 76, 97, 105, 121, 124, 131, 139, 153, 212, 237, 253, 268, 280, 331, 341, 343, 346, 349, 366, 371, 399n15, 422, 438, 470, 485, 488, 495, 498, 505, 542, 547, 561, 562 efciency, 19, 37, 58, 97, 98, 121, 124, 131, 139, 153, 159, 237, 253, 268, 280, 331, 341, 343, 346, 349, 361, 438, 470, 498, 542, 547, 561, 562 enhanced transparency and accountability, 341 features of a management oriented organisation, 519–565 importance of trust, 268, 544 integrating managerial reform with PFM/IC reform, 75–76 linking inputs with outputs, 342

operational, 2, 2n2, 3, 8–10, 12–16, 20–22, 24, 25, 27, 29, 31, 33, 35–37, 39–44, 51–54, 51n2, 58–60, 62, 70, 75, 92, 105, 120, 121, 123–125, 128, 129, 134, 135, 137, 138, 143, 146, 150–155, 157, 159, 162, 165, 170, 171, 173, 176, 177, 184, 197, 198, 210–212, 218, 226, 233–255, 262, 268, 271, 272, 274, 280–281, 288, 291–293, 300, 306, 307, 310, 314, 319, 323, 327, 331, 337, 340–352, 356–357, 360, 368, 370, 371, 374, 376, 378, 380, 381, 383–388, 391–393, 395–401, 399n15, 403–406, 411–413, 441, 445, 449, 484, 485, 487–489, 491–493, 495, 497, 498, 500, 507, 521, 529, 538, 540, 541, 543, 544, 553, 557, 565 performance, 69, 92n4, 124, 509 policy, 53, 57, 251, 398, 420, 422, 485, 488, 492, 502 political, 2n2, 8, 10, 22, 26, 33, 35–36, 40, 57, 59, 62, 120, 121, 123, 124, 128, 134, 158, 176, 210, 218, 226, 236, 250, 254, 255, 258, 262, 274, 280, 285, 288, 292, 300, 319, 323, 325, 340, 343–345, 347–350, 352, 353, 370, 371, 373, 377, 382, 390, 391, 396–401, 403–405, 413, 441, 488, 493, 495–498, 520, 524, 533, 539, 540, 548, 551, 555 quality planning, 344–345 risk management, v, 41, 65, 89, 105, 147, 153, 210, 212, 218, 220, 238, 251, 321, 328, 330, 345, 356, 357, 362, 363n7, 366, 367, 372, 373, 376, 383,

397–409, 413, 456n9, 483, 484, 487, 488, 493, 499, 502, 503, 505, 507, 512, 514, 517 (*see also* Managers) risk taking, 52, 418 structures, 8, 10, 14, 40, 52, 62, 63, 75, 78, 120, 134, 135, 181, 212, 249, 331, 349, 360, 361, 370, 372, 374, 376, 389, 399, 402, 447, 458, 460, 487, 520, 523 training, 8, 10, 14, 41, 62, 136, 155, 192, 195, 310, 315, 330, 338, 356–357, 503, 512, 554 Managerial accountability, 7, 8, 12, 19, 21, 29, 31, 52, 59, 60, 65, 73, 76, 121, 135, 146, 149, 151, 153, 176, 184, 191, 192, 194, 195, 199, 209, 210, 230, 239, 314, 322, 327, 330–332, 345, 350, 395, 398, 486, 520, 525, 526, 539, 542–549, 551, 557 arrangements, 1, 3, 45, 66, 124, 196, 208, 213, 304, 310, 314, 320, 331, 339, 361, 375, 408, 413, 450, 499, 520, 541–544 efect of introducing efciency and efectiveness, 541–552 delegation, 7, 12, 21, 29, 31, 33, 52, 59, 60, 73, 135, 146, 151, 153, 191, 192, 194, 199, 239, 314, 322, 327, 330, 331, 398, 499, 525, 526, 539, 542–549, 551, 557 disciplines, 82, 281, 288, 320–322, 326, 330, 362, 366, 369, 374, 412, 444 discretion, 3, 8, 33, 97, 121, 186 structures, 31, 40, 59, 92, 101, 146, 191, 206, 230, 310, 315, 318, 321, 324, 328, 330, 356, 361–363, 368, 374–376, 446, 498, 525, 544, 547

Managers accountability, 8, 333, 384, 395, 544 achieving the benefts of PFM/IC, 340 defnition, 374 delegation, 55, 564 detailed budgetary information availability, 316, 393 disciplines, 15, 347 fnancial awareness and fnancial literacy, 76–77 information requirements, 73, 182 inputs, 188, 281, 286 objectives, need for, 564 operational managers, 3, 8, 10, 12, 17, 36, 37, 44, 54–55, 57–59, 70, 71, 121, 123, 129, 130, 138, 146, 152–155, 168, 171, 176–177, 237, 260, 266, 267, 269–271, 276, 279, 285, 288, 291, 292, 294, 296, 306, 330, 332, 340, 344, 345, 348–349, 351, 356, 357, 360, 368, 370, 373, 376, 377, 384, 395, 397, 399n15, 403, 445, 486, 498, 538, 543, 549, 550, 565 outputs, 95, 181, 184, 188, 349, 359, 492 professionalisation of, 153 responsibility for achieving efciency and efectiveness, 7 responsibility for internal control, 315 risk management, 372, 373, 404, 421 (*see also* Management) who are the managers, 8, 51–53, 260, 401 McKinsey, 313 Mellett, Howard, 35 Merton, Robert K, 204 Minister, v, 8, 9, 11, 12, 24, 27, 29, 40, 48, 52, 62, 126, 135, 140, 141, 144, 151, 153, 154, 156, 157, 160, 161, 164–168,

175–177, 194, 196, 199, 203, 225, 226, 231, 233–240, 248–251, 254, 254n6, 255, 264, 265, 289, 306, 308, 312, 314, 318, 322, 323, 325, 326, 328, 330, 336, 343, 366, 371, 375, 379, 380, 389, 397, 442, 445, 447, 455–457, 472–474, 479, 485, 486, 486n2, 500, 502n6, 504, 520, 526, 527, 529, 531, 534, 541, 542, 548, 549, 551, 552, 560, 565 responsibilities, 325, 330, 549 Minister of fnance how to regard PFM/IC, 173–174, 498 parliament, 143, 154, 157, 162, 177–178, 485 PFM/IC responsibilities, 96 relations with other ministers, 154, 175–177 Ministry of fnance cash fow, 16, 90, 167, 187, 264, 272, 395 controls, 68, 88, 90, 139, 167, 187, 264, 272, 319, 395 department responsible for the operational application of PFM/IC, 178 (*see also* Driver department) fnancial regulations, 90, 194 responsibility for implementation of PFM/IC, 382, 496, 546 review of impact of PFM/IC reform, 196–197 state secretary, viii, 11, 141, 144, 145, 149, 159–201, 208, 212, 225, 235, 240, 249, 250, 252–253, 255, 314, 321–323, 325, 326, 328, 329, 337, 338 state secretary and department responsible for the operational application of PFM/IC, 144, 178

strategic analytical and planning policy paper, 164–166 sustaining the reform, 150, 160, 195–197 technical departments and PFM/ IC, 174–175 Ministry of fnance state secretary, viii, 144, 145, 163–165, 174–176, 212, 225, 249–250, 255, 314, 321–323, 325, 326, 328, 329, 337, 338

#### **N**

National Audit Ofce (NAO), 229, 405, 461, 462, 504, 504n7, 506

#### **O**

Objectives clarity of, 7, 55, 63, 66, 89, 321, 371, 399, 409, 438, 447, 476, 477, 536, 537, 559 operational and performance, 7, 12, 31, 40, 55, 57–58, 63–65, 93, 131, 146, 152, 180, 187, 198, 199, 237, 250, 253, 294, 296, 315, 319, 328, 330, 347, 348, 374, 419, 470, 494, 497 Organisation for Economic Cooperation and Development (OECD), 69, 87, 98, 104, 125, 174, 174n6, 220n15, 358, 358n6, 359, 544–548, 552, 554 Ouda, 36n28, 216n11 Ownership of the PFM/IC reform, 27–28

#### **P**

Parliament budget scrutiny, 16, 48, 103, 159 budget to incorporate objectives, 56, 67, 97

revised budget law, 16, 86, 87, 97, 186, 270 role, 48, 49, 82, 125–126, 143–144, 162, 163, 226, 307, 329 state auditor reports, 8, 32, 48, 191, 336, 352 PEFA, *see* Public Expenditure and Financial Accountability Penalty and inspection arrangements, 192–194 need for review with PFM/IC, 193 Performance information (PI), 7, 17, 24, 31, 33, 34, 39, 44, 60, 61, 66, 76, 78, 87, 88, 98, 121, 139, 142, 146, 169, 177, 179–182, 216–218, 222, 223, 226, 238, 253, 268, 269, 276, 280, 288, 315, 319, 322, 324, 328, 335, 340, 341, 345, 347–349, 352, 356, 359–360, 362, 363, 368, 370, 382, 393, 408, 438, 459, 469, 470, 487, 494, 498, 538, 541, 546, 547, 550 Performance standards, 3, 7, 8, 10, 12, 15, 19, 29, 31, 34, 37, 40, 43, 45, 48, 54, 57, 58, 63–65, 69, 77, 78, 82, 92, 93, 96, 101, 105, 106, 122–124, 128, 130–133, 138, 146, 152, 159–161, 167, 169, 170, 175–177, 180–182, 191, 197–199, 203, 209, 214, 223, 226, 228, 234, 236, 237, 250, 253, 255, 258, 271, 274, 276, 290, 294, 295, 305, 309, 315, 319–324, 328, 330, 332–334, 336, 340, 342, 347–349, 352, 359, 368, 370–374, 376–378, 383, 391, 399, 401, 406, 410, 411, 413, 439–442, 444–446, 448, 451, 458, 470, 471, 483, 484, 487–489, 492, 497–499, 523, 524, 555, 559

Personnel controls, 43, 89, 106, 125, 133, 134 Personnel management, 14, 53, 55, 62, 96, 133, 141, 227, 310, 322, 329, 368, 379, 437, 519, 522, 553–556 Peterson, S., ix, 21, 22, 149, 434, 532n14 Polzer, Tobias, 206 Public Expenditure and Financial Accountability (PEFA), 92, 92n4, 94, 94n6, 206, 206n4, 217 Public fnancial administration and internal control (PFA/IC) achieving local ownership, 325 applying the reform, 32, 325 basic elements, 31 behaviour change, 229 benefts, 3, 4, 36, 37, 94, 95, 148, 222 budgetary control, 56, 86, 90, 99, 103 comparison with PFM/IC, 93, 106, 167 control over inputs, 91 control over inputs and outputs, 88, 89 control over second level bodies, 91 control prior to the adoption of PFM/IC, 85–86 cooperation between ministries, 121 cooperation between political and operational management, 22 costs, 4, 13, 17, 106, 149, 150 cultural change, 87 delegation, 7, 9, 12, 13, 21, 23, 29, 33, 73, 75, 97, 129, 135, 137, 150, 151, 153, 157, 165, 194, 199, 230, 234, 235, 239, 255, 314, 323, 327, 336, 357, 485, 499, 521, 526, 536, 546, 549, 557

diference with PFM/IC, 106, 555 (*see also* Public fnancial administration and internal control (PFA/IC), comparison with PFM/IC) implementing the reform, 525 (*see also* How is the reform to be undertaken) integrated fnancial management information systems (IFMIS), 86 integrated with civil service/public service reform, 314, 556 lessons from the experience of other countries, 79 limitations of PFA/IC, 92–93 managerial accountability, 12, 21, 199, 209, 526 managerial impact, 4, 79, 92 misunderstandings, 7, 314 monitoring and evaluation of the reform, 230–231 more than a fnancial technique, 6, 9, 38, 547 an ongoing reform, 31 PFM/IC and decentralisation, 81 PFM/IC and delegation, 7, 9, 12, 13, 21, 23, 29, 33, 52, 60, 62, 73, 75, 79–80, 137, 149–151, 153, 157, 165, 191, 193, 194, 199, 234, 314, 319, 323, 327–329, 336, 347, 357, 362, 399n15, 485, 486n2, 499, 519–565 practical consequences, 32–35 purposes, 3, 18, 19, 36, 50, 67, 85, 120, 131, 132, 171, 188, 213, 228, 267, 409, 411 quality of public expenditure, 41, 45, 48, 49, 92, 96, 188–189, 206, 217, 260, 411 reactions to the reform, 337 regulation reform, 49, 143, 209

regulatory framework, 47, 143, 209, 211, 212, 222, 225, 381 responsibility for the reform, 14, 82, 127, 128, 134, 137, 140–142, 144, 151, 159–201, 209, 210, 212, 227, 230, 233–236, 254, 255, 265n2 risks, v, 2, 14, 16, 23, 24, 29, 30, 32, 37, 41, 50, 52, 65, 79, 83, 94–99, 102, 105, 128, 137, 138, 142, 147–151, 153, 154, 159, 160, 165, 169, 172, 173, 192, 195–197, 199, 201, 203–205, 207–212, 215–218, 220, 225, 227–229, 238, 260, 282, 304, 306, 309, 313, 329, 330, 334, 335, 343, 347, 350, 351, 353, 354, 356, 357, 362, 376, 399, 400, 406–408, 466, 483–485, 491, 499, 562 stages of the reform, 336 sustaining the reform, 150, 160, 195–197 tests to assess feasibility, 127–139 timetable, 12, 81, 122, 125–126, 141, 143, 144, 162, 163, 185, 195, 227, 327, 523 timing of reform, 30–32, 97, 179, 227, 228, 306, 329, 336 (*see also* Public fnancial administration and internal control (PFA/IC), timetable) undertaking the reform, v, 81, 134, 138, 140–150 unintended consequences, 159, 203, 205, 208, 209, 211–214, 216, 218, 221, 225, 228, 229, 231, 232 using bureaucracy as an indicator of performance, 216–218 Public fnancial management and internal control (PFM/IC), 1, 27–28, 40–42, 47–83,

85–116, 119–201, 203, 233–255, 257–300, 303–430, 434–471, 484, 519–565 strategic analytical and planning report, 307–311, 314 Public Money and Management, 379n7, 526n7, 528n10

**R**

Risk, 36n28, 159, 203–232 aid agencies, 217–221, 228 examples of unintended consequences, 213–216 factors causing risks and unintended consequences, 221–226 protecting against, 208–212 reducing the potential for, 207–208 unintended consequences, 97, 159, 203–232 causes, 204–206 warning signs, 226–230

**S**

Second level audit, 467–468, 471 boards, 42, 437, 445, 453, 465–467 controlling organisation information requirements, 448 controlling organisation oversight arrangements, 448–457 controlling organisation responsibilities, 440–447 criteria for establishing, 436–438 delegation, 191, 433–437, 444 Irish government agency requirements, 472–475 organisations, bodies, 15, 42, 91, 270, 297, 459, 471, 565 performance control, 469–470 policy for establishing, 316

Second level (*cont.*) questions when PFM/IC is introduced, 458–460 questions when private sector is involved, 460–462 risks, 356, 405, 409, 440, 446, 454, 462–465 service level agreements, 448–457 systematic review of existence, 457 SIGMA, ix, 125, 220, 220n15, 231, 231n20, 377n5, 380, 554, 555 Principles of Public Administration, 552–553, 557–565 SIGMA (and SIGMA/ OECD), 544–548 Silo mentality, 24, 25, 249, 348, 389, 492, 562 State auditor audit, 48, 352, 447, 452, 467, 516 driver department, 318 efects of PFM/IC upon, 48 parliament, 48, 49, 104, 144, 154, 184, 191, 352 review of PFM/IC arrangements, 48, 239 review of quality of internal control, 235 review of statement of internal control, 184, 197, 490 role, 330 second level bodies, 191 service level agreements, 452 Statement of internal control accountability, 413, 485, 486, 490n3, 499 audit, 177, 231, 333, 486, 491 benefts, 490n3 examples of statements, 496–498 indicators of internal control weakness, 104, 493, 512 issues to be covered, 487–490

publication, 333 state secretary, 251, 333, 484 State owned enterprises, 32, 42, 68, 71, 91, 189–191, 197, 199, 241n5, 266, 297, 316, 353–354, 408, 409, 427, 436, 449, 454 State secretary corporate governance responsibilities, 167, 190, 210, 225, 250 if no state secretary can PFM/IC be sustained, 10, 11, 52, 137, 140, 145, 159–201, 207, 208, 210, 233–241, 239n3, 252–255, 254n6, 260, 271, 293, 303, 304, 310, 314, 315, 318, 321–323, 325, 326, 329–331, 335, 336, 338, 355, 356, 368, 371, 376, 380, 399n15, 484, 486, 490, 498, 499, 521 internal audit and inspection, 254 (*see also* Ministry of fnance state secretary) PFM/IC leadership in a public organisation, 11, 53, 260 relationship with ministry of fnance state secretary, 144, 145, 163–165, 174–176, 212, 225, 249, 250, 252–253, 255, 314, 321–323, 325, 326, 328, 329, 337, 338 responsibilities before PFM/IC, 106, 234 responsibilities in a managerial environment, 125, 203, 238–240, 267 responsible for implementation of PFM/IF, viii, 3, 4, 9, 11–13, 22, 23, 29, 31, 49, 65, 78, 144, 145, 150, 160, 161, 164,

184, 236, 237, 241–248, 252, 254, 255, 271, 310, 337, 341, 382, 485, 486, 486n2, 490, 491, 496, 498, 499, 513, 520, 528, 534, 535, 546, 553, 554, 559, 562 specifc fnancial responsibilities, 241–248 top operational management ofcial, 233–255 *See also* Ministry of fnance state secretary Strategic planning, 282, 288, 289, 292, 314, 319, 320, 331, 344–345, 476, 514 Swedish International Development Agency (SIDA), 142n7, 220

**T**

Tompson J.D., 527, 529, 534, 542, 544 Tompson/Tuden matrix, 532, 534, 536, 540 Top management, 22, 23, 29, 250, 281, 389, 394, 400, 405, 450, 493, 495, 514, 560, 561 *See also* Minister; State secretary

Transitional and developing economy countries, 60 Treadway Commission, *see* Committee of Sponsoring Organizations Trust, 13 between central and line ministries, 23, 155 between politicians and ofcials, 20, 31, 62, 79, 497, 544 *See also* Delegation; Management

**U** Unintended consequences, *see* Risk

**V**

Virement, 16, 48, 89, 133, 185–187, 198, 333

**W**

Weber, M, 122, 122n1 World Bank, 35, 205, 206, 216, 217 principles in PFM reform, 205, 206