Operational Financial Accountability Reviewdocuments.worldbank.org/curated/en/314341468293148314/pdf/334… · EXECUTIVE SUMMARY General Kosovo 's unique historical and political

May 18, 2005

Document of the World BankR

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Report No. 33485-XK

KosovoOperational Financial Accountability Review

Operations Policy and Services UnitEurope and Central Asia Region

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TABLE OF CONTENTS

PREFACE ....................................................................................................................................... i

EXECUTIVE SUMMARY ........................................................................................................... 1

CHAPTER 1: ECONOMIC AND ADMINISTRATIVE BACKGROUND ........................... 10

CHAPTER 2: OVERALL FRAMEWORK FOR FINANCIAL ACCOUNTABILITY AND PUBLIC FINANCIAL MANAGEMENT .................................................................................. 16

1 . BACKGROUND AND ASSESSMENT FRAMEWORK .................................................................... 16

111 . SUMMARY OF FINDINGS ....................................................................................................... 19 I1 . FINDINGS ............................................................................................................................... 17

IV . RECOMMENDATIONS ...................................................................................... .. 19

CHAPTER 3: BUDGETING ...................................................................................................... 21

1 . BACKGROUND. ASSESSMENT FRAMEWORK AND THE KSP .................................................. 21 I1 . FINDINGS ............................................................................................................................... 23 111 . SUMMARY OF FINDINGS ........................................................................ ........................... 30 IV . RECOMMENDATIONS ........................ ........................................................... 30

CHAPTER 4: TREASURY AND CASH MANAGEMENT SYSTEM .................................. 32

I1 . FINDINGS ............................................................................................................................... 33 111 . SUMMARY OF FINDINGS ....................................... IV . RECOMMENDATIONS ............................................ ...........................

1 . BACKGROUND AND ASSESSMENT FRAMEWORK .................................................................... 32

CHAPTER 5: ACCOUNTING AND FINANCIAL REPORTING ......................................... 36

I1 . FINDINGS ............................................................................................................................... 35 111 . SUMMARY OF FINDINGS ..................................... IV . RECOMMENDATIONS .........................................

1 . BACKGROUND. ASSESSMENT FRAMEWORK AND THE KSP ACTION ..................................... 36

CHAPTER 6: INTERNAL CONTROL AND INTERNAL AUDIT ....................................... 42

1 . BACKGROUND. ASSESSMENT FRAMEWORK AND KSIP ACTIONS .......................................... 42 I1 . FINDINGS ............................................................................................................................... 43 111 . SUMMARY OF FINDINGS .............. IV . RECOMMENDATIONS ..... ...................................

CHAPTER 7 : EXTERNAL AUDIT ........................................................................................... 48

1 . BACKGROUND. ASSESSMENT FRAMEWORK AND KSIP ACTIONS .......................................... 45 I1 . FINDINGS ............................................................................................................................... 50 111 . SUMMARY OF FINDINGS ........................................................ IV . RECOMMENDATIONS ...................................

CHAPTER 8: FINANCIAL ACCOUNTABILITY ARRANGEMENTS FOR LOCAL GOVERNMENT .......................................................................................................................... 54

1 . BACKGROUND AND ASSESSMENT FRAMEWORK ..................................................................... 54 I1 . FINDINGS .................................................................................................. 111 . SUMMARY OF FIKDINGS IV . RECOMMENDATIONS ........................................................................................................... 57

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ANNEX I: ECONOMIC. SOCIAL AND NATIONAL ACCOUNTS DATA ......................... 58 ANNEX 11: KOSOVO GENERAL GOVERNMENT BUDGET (2000-2005) ....................... 59 ANNEX 111: PROGRESS ON KSIP ACTIONS RELATED TO PFM AND FINANCIAL ACCOUNTABILITY .................................................................................................................. 61 ANNEX IV: SUMMARY OF RECOMMENDATIONS .......................................................... 63

ANNEX V: KEY PERSONS INTERVIEWED (IN ALPHABETICAL ORDER) ................ 69

TABLES AND BOXES

TABLE 1: SCOPE OF THE OF ......................................................................................................... 11 TABLE 2 . KSP ACTIONS RELEVANT FOR OF AR ............................................................................ 12 TABLE 3 . PROVISIONAL INSTITUTIONS OF SELF-GOVERNMENT AND m K INSTITUTIONS ...... 18 TABLE 4 . STRUCTURE OF THE KOSOVO CONSOLIDATED BUDGET 2004 ........................................ 18 TABLE 5 . KSP ACTIONS RELATED TO BUDGETING ....................................................................... 23 TABLE 6 . BUDGET AND OUTTURNS 2003 (UN-AUDITED) ............................................................... 25 TABLE 7 . CALENDAR FOR PREPARATION OF KCB ......................................................................... 27

TABLE 8 . KSP ACTIONS RELATED TO ACCOUNTING AND FINANCIAL REPORTING ........................ 37 BOX 2: THE INTERNATIONAL STANDARDS FOR THE PROFESSIONAL PRACTICE OF INTERNAL

TABLE 9 . KSP ACTIONS RELATED TO INTERNAL CONTROL AND/OR INTERNAL AUDIT ................. 43 BOX 3 . OVERVIEW OF THE NTOSAI AUDITING STANDARDS ....................................................... 49 TABLE 10 . KSP ACTIONS RELATED TO EXTERNAL AUDIT ............................................................ 49 TABLE 1 1 . KSP ACTIONS RELATED TO FINANCIAL ACCOUNTABILITY FOR LOCAL GOVERNMENT54 TABLE 12 . RESPONSIBILITIES AND POWERS OF MUNICIPALITIES .................................................. 55

BOX 1 . THE TREASURY LEDGER SYSTEM ..................................................................................... 33

AUDITING (IsPPLA) ............................................................................................................... 43

Kosovo: Operafional Financial Accountabilitv Review i

PREFACE

The main objective of the Operational Financial Accountability Review (0FAR)’has been to identify an agenda for addressing key challenges in the Public Financial Man- agement (PFM) operational framework and point to areas where additional donor support may be needed. The audience o f the OFAR i s both the Kosovar authorities and the donor community. The OFAR is not an audit; it is not intended to, and does not, provide assurance on the specific uses to which World Bank funds have been or may be applied.

Context

Kosovo is characterized by unique historical and political conditions and challenges. Kosovo i s not a sovereign state and i t s future status remains uncertain while the political process for i t s resolution i s underway. The adoption o f the Constitutional Framework in M a y 2001 has been a key step in the transition to self-government. A very young administration largely filled with new staff, the Provisional Institutions o f Self-Government (PISG) enjoy increasing responsibility for governing Kosovo. Until KOSOVO’S final status i s determined, UNMIK maintains final legal authority to determine whether decisions by the PISG are within the framework o f UN Security Council Regulation (UNSCR) 1244. UNMIK also retains direct responsibility for reserve powers2, many o f which are central to development issues, including security, law and order, foreign relations, protection o f minority rights, banking supervision, customs, and management o f publicly-owned enterprises in the key sectors o f energy and mining. Municipal governments have also been established, fol lowing elections in October 2000 and November 2002.

Detailed Standards for Kosovo were elaborated by the Special Representative o f the UN Secretary General (SRSG) in December 2003 and issued in March 2004 after endorse- ment by the UN Security Council. These Standards are intended to outline the minimum conditions for what the SRSG has described as a “normal society.” These standards also apply to the P F M area. A comprehensive review o f progress toward meeting the Stan- dards i s expected in mid-2005, and decisions on how and when to begin discussions o f final status are anticipated to follow this review.

’ The OFAR assesses and presents capacity constraints and related donor support needs, rather than fiduciary r isks relating to funds provided by the Wor ld Bank and other donors and to the PISG’s own resources. Whereas weak capacity may often be the other side o f the fiduciary risk coin, the focus i s underpinned by the following rationale: (i) the fiduciary risk framework i s weakened by the complex and fragmented budget management arrangements; (ii) a young and largely inexperienced administration implementing new processes and procedures needs support and guidance as a matter o f priority, particularly in a context where donors are heavily involved in shaping the future resource management framework; and (iii) the fiduciary risks to Bank-supported knds are largely limited to ring-fenced arrangements. I t appears unlikely that the Bank w i l l provide budgetary support to the Kosovar authorities in the near future.

In areas where UNMIK retains reserve powers, the establishment o f “counseling and consultative bodies” that include representatives f r o m the Kosovo institutions i s anticipated.

The World Bank has been engaged in Kosovo through IDA grants. As no budget support i s anticipated, i t i s foreseen World Bank funds wil l continue to be managed by ring- fenced arrangements until 2005.

Scope o f the OFAR

The OFAR focuses on PFM arralzgements in the PISG rather than in the UNMIK administration. The UNMIK administration’s PFM wil l be discussed only when relevant to PISG (for instance, under budget preparation), as the OFAR i s intended to be used as a tool for strengthening local administration, particularly in a context where the PISG are anticipated to gain increased authority over their own resources and UN (and, indeed, do- nor) support might progressively dwindle.

The scope of the proposed OFAR is less than that of a full-scope CFAA. The reduced scope o f the OFAR has been determined on the basis of: (i) a preliminary assessment o f areas o f most significant need in terms o f capacity and institutional building; (ii) a review o f existing analyses and support by the World Bank (including project financial management) and other development organizations, with the aim o f eliminating or limiting over- laps; and (iii) discussions with the Ministry o f Finance and Economy (MFE) and with members o f the World Bank’s Kosovo team with a view to identify priori ty areas for analysis. Details on the scope can be found in Table 1 below.

Table 1: Scope of the OFAR Area of financial accountability

Framework for f inancial management

Budgeting (Note: budget preparation i s treated in detail by the IMF report3 to be supplemented by the forthcoming Public Expenditure Review)

Cash management (Treasury)

Accounting and financial reporting, including financial accounting and management information systems

Internal control arrangements, including ex- ante financial control functions, and internal audit functions

External auditing and scrutiny o f the P F M framework

Accountabil ity arrangements for municipalities

Relevant Standards

EC Financial Regulation (Counci l Regulation No. 160512002)

E C Financial Regulation

Treasury Reference M o d e l (Wor ld Bank and IMF)

EC Financial Regulation consistent with the terminology o f the International Accounting Standards (IAS) and International Financial Reporting Stan- dards (IFRS)

C O S 0 (internal control framework)

International Standards for the Professional Prac- tice o f Internal Auditing (ISPPIA)

I N T O S A I Audi t ing Standards (AS)

Same as for central administration

Kosovo: Preliminary Findings on Budget Processes IMF, 2004

Kosovo: Operational Financial Accountability Review iii

Methodology and Approach

The OFAR methodology is based on internationally-recognized regulations, standards and codes, including the EU framework where relevant (see Table 1 above).

The OFAR also assesses. and addresses challenges in achieving the Kosovo Standards Implementation Plan (KSIP) related to Public Financial Management (PFM). The relevant areas o f the KSIP are covered in this document, and there i s also an assessment o f the needed measures to progress on the KSIP.

Data Collection

The OFAR was prepared following a World Bank mission to Kosovo in February 2004 by a Task Team comprising Olav Rex Christensen (Senior Financial Management Spe- cialist, Deputy Country Manager for Albania, ECSPS) and Johannes StenbEk Madsen (Task Team Leader, Financial Management Specialist, ECSPS). The Initiating Concept Memorandum (ICM) for the review was prepared by Ranjan Ganguli (Consultant, Finan- cial Management, ECSPS).

The report i s based on the results o f interviews and discussions with public officials and an analysis o f data and documentation gathered during World Bank missions to Kosovo. The Provisional Institutions o f Self-Government (PISG), including the Kosovar Ministry o f Economy and Finance (MFE) and the institutions o f the United Nations Interim Ad- ministration Mission in Kosovo (UNMIK) lent their full and active support to the OFAR missions and engaged with the World Bank’s team in a comprehensive dialogue. A l i s t o f key persons interviewed i s provided in Annex V.

Acknowledgements

The OFAR team wishes to acknowledge the extensive and gracious cooperation and assistance received from the staff o f the various institutions that contributed to the OFAR, including officials and staff o f the PISG and UNMIK (see Annex V). The team would also l i ke to thank John Hegarty (Manager, Financial Management, ECSPS), Tracy Lane (Country Economist, ECSPE), Robert Jauncey (Consultant, ECCU4), Bill Dillinger (ECSPE), Roland Clarke (ECPSE), Mozammal Hoque (Sr. FMS, OPCFM), Pascale Ker- vyn de Lettenhove (Sr. FMS, ECSPS) and Br ian Olden (IMF). Thanks also go to Sioban Farey (Consultant, ECSPS), Roula Balkash (Assistant, ECSPS) and Ana Cristina Barros (Consultant, ECSPS) who assisted with the editing and formatting o f the report.

Kosovo OFAR: Execufive Summaw 7

EXECUTIVE SUMMARY

General

Kosovo 's unique historical and political conditions raise significant and unique challenges for Public Financial Management (PFM). Whereas significant progress has been made in building the capacity o f the Provisional Institutions o f Self-Government (PISG), they are largely characterized by young, inexperienced and fragmented organizations for pol icy formulation and implementation. Public resources are managed by two distinct, often polarized, structures (PISG and UNMIK) each with i t s own rules, procedures and systems. With significant hiring and turnover in the new administration, capacity issues are the dominant weakness in PFM, as systems, institutions and management culture are underdeveloped. These circumstances place significant limitations o n the scope and meaning o f financial accountability, and thus require a different approach to financial accountability assessment than usually found in Country Financial Accountability Assess- ments (CFAAs).

With these unique circumstances in mind, the report concludes that, despite significant progress since 2001, PFM in Kosovo suffers from fundamental weaknesses, and basic structures for financial accountability are still in their in fancy. There are considerable gaps between the practices o f the PISG Budget Organizations and the internationally- accepted standards and codes that constitute the assessment framework for the OFAR. This can be explained by the dearth o f qualified and experienced professional staff responsible for essential PFM functions in the Ministry o f Finance and Economy (MFE) and other PISG Budget Organizations. This issue should be addressed as a matter o f priority. The report also concludes that the PISG have already taken important steps towards meeting the requirements o f the Kosovo Standards Implementation Plan (KSP)4. How- ever, momentum needs to build up to progress on the next steps.

The overall legal framework for budgeting and budget management is largely compati- ble with internationally recognized standards but for some aspects it appears to be too advanced for the current administration's capacity. The budget i s not used as a pol icy management tool, as serious inefficiencies, particularly at the budget preparation stage, undermine budget management. Capacity, organization and coordination weaknesses considerably hamper a meaningful resource allocation process. Probably the biggest stumbling block in the Kosovo context i s the practice o f carrying over appropriations to the next fiscal year in a context o f very limited budget planning and financial programming ~ a p a c i t y . ~ These weaknesses are exacerbated by several factors, including the pro- tracted budget revision process; unreliable financial information o n budget execution, in turn owing to patchy and mult iple accounting practices by untrained staff; and the underdeveloped use of the Treasury System software. Inefficiencies in cash management are also reported. Checks and balances structures for central government, local governments

Adopted by the UN Security Counci l and made public on March 3 1, 2004. See Table 1 for details. Carry-overs amounted to a third o f the budget in 2004. The Kosovo Consolidated Budget has shifted f rom

a commitment basis to a cash basis as o f January 2005.

Kosovo OFAR: Executive Summarv 2

and State-Owned Enterprises (S0E’s)-mainly internal control and audit, and external audit-are in their infancy, thus limiting authorities’ ability to enforce effective spending. These issues are detailed below. A summary table o f recommendations, technical assistance needs, timing and priorities i s shown in Annex IV.

Specific

The legal framework for financial accountability and public financial management6 as set out in the Law on Public Financial Management and Accountability (LPFMA), reflects good international practices but appears to be too demanding for the PISG and does not prevent the perception of double standards in its implementation. In Kosovo, the unique legal framework complicates the application o f financial accountability, in that: (i) different provisions o f the LPFMA may in some cases apply to certain institutions o f the PISG and not to others o f the UNMIK; (ii) the Special Representative o f the UN Secretary General (SRSG) i s the authority responsible for the budget process for the Reserved Power Budget Organizations (RPBOs) and the MFE for the PISG Budget Organizations (BOs); but (iii) under the LPFMA, and in practice, the SRSG signs o f f on the KCB.

Within these constraints, the provisions related to P F M in the LPFMA generally correspond with good practices, for instance, as reflected in E C Financial Regulation No. 1605/2002 (hereafter referred to as “the EC Financial Regulation”).

However, the fol lowing issues need to be highlighted. First, this report fully agrees with the IMF7 in that the legislation may be too complex for the capacity o f the current PISG administration, particularly in relation to financial reporting and the development o f performance-based budgeting. Meeting the KSIP criteria related to implementation o f the LPFMA could take a long time. Second, the perception o f “double standards” for application o f the legislation with respect to budget preparation undermines the level playing field, and thus the credibility o f the legal framework under which the PISG operate. In that context:

0 Consideration could be given to revising the L P F M A and related legislation (for instance, the budget circular), in order to align them with current capacity levels. Alternatively, a more realistic time-bound approach for the LPFMA implementa- t ion could be envisa ed, including in relation to the relevant KSIP criterion (Stan- dard 5, Act ion 3.1.). B

The legal framework i s determined by: (i) Constitutional Framework for Provisional Self-Government in Kosovo (Regulation No. 2001/9); (ii) Public Financial Management and Accountability Law, or LPFMA (Regulation No. 2003/17); (5) The new Public Procurement Law (Law No. 2003/17 and Regulation 2004/3); (iv) Annual Regulation on the Approval o f the Kosovo Consolidated Budget (the 2004 budget version - Regulation 2003/41)

Op. cit. 3.1 “The adoption o f the K C B 2005 and annual budgets thereafter in full compliance with fiscal and

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budget regulations and the LPFMA, satisfying al l conditions for SRSG promulgation including sufficient attention to reserved areas, taking recommendations on IMF and other development partners into due account”. For a more elaborate presentation o f the KSIP, see Chapter 1, below.


0 T o avoid the perception o f “double standards” in the application o f the LPFMA and related legislation for budget preparation, RPBOs and other BOs should a l l apply the existing r u l e s conscientiously. Also, a closer cooperation and coordina- t ion between the MFE and a l l BOs in the budget preparation process i s encouraged.

Carry-over practices9 and weaknesses in capacity, organization and coordination hamper budget preparation and undermine the credibility of the budget as a policy management instrument.*0 BOs and RPBOs fo l low the budget preparation process set out by the MFE under i t s budget circular. A major stumbling block i s the practice o f carrying forward appropriations f rom one year to the next, wh ich contradicts the principle of annuality. Coupled with better than anticipated revenue performance,” the practice has led to frequent and significant budget revisions at mid-year, further distorting efficiency of allocations, as w e l l as creating inefficiencies in resource use. As BOs cannot rely o n predictable resources allocated through a transparent competit ion process, l i t t le incentive, or indeed capacity, exists to prepare realistic budgets based o n measurable indicators for activities and performance. This limits the application and enforcement o f the principle o f sound financial management that ensures that funds are spent in an economical and efficient manner. In addition, communication between budget users and the MFE i s inadequate, in part because o f inherent capacity weaknesses in the MFE and the BOs. The present operational decision-making and arbitration mechanisms should be developed further and enforced.

The relevant KSIP actions thus present great challenges for the PISG. To ensure progress in relevant areas (Standard 5, actions 3.2, 3.3, 3.6, and 3.7),12 there i s a need to increase transparency in the allocation process; predictabil ity o f resources should increase, supported by realism in budget estimates and a more realistic budget preparation calendar. Thus:

0 Consideration should be given to scrutiny o f the budget framework by an external party before f i na1 i~a t i on . I~ This may assist in increasing projection realism. I t also

The carry-over practice seems to have originated in the previous procurement l aw requiring that multi- year contracts be appropriated in the f i rs t year’s budget (to a l low the procurement process to be initiated). The Procurement L a w has been revised and i t i s expected that carry-overs wi l l progressively disappear, as new contracts wil l become effective under the new procurement l aw (2003). lo This issue i s discussed in details in the IMF Report: Kosovo, Preliminary Findings on Budget Processes (2004) ‘I Domestic revenue performance (actual) in 2001, 2002 and 2003 was, respectively, around 9 percent, 37 percent and 27 percent higher than budget estimates (MFE estimates). l2 3.2. Development o f a MTEF, including integration o f the public investment plan, wh ich i s non- discriminatory and takes in to account the priorit ies o f the Government and reserved areas; 3.3 Improvement of sector spending plans and dialogue between MFE and other budget agencies, with due consideration given to priorities o f women; 3.6 Compliance with the L P F M A and the Budget 2004 and 2005 regulations, i s monitored, with reporting fol lowing the timelines set out in this regulation; 3.7 Strengthening o f public expenditure management in maintaining fiscal discipline and efficient allocation o f resources l3 Under the current calendar, this process should take place in September-October


appears l ikely that the MFE may need further support to prepare a realistic fiscal framework underpinning the budget circular. Abolish the practice o f carrying forward multi-year appropriations. Unspent amounts at the end o f the year should be canceled and, if needed, should be re- appropriated in the following year (this i s possible for new contracts under the revised procurement law)I4. At the same time, greater transparency in the budget revision process i s encouraged. Extensive support i s needed to assist both the MFE and BOs with capacity for developing budget planning and financial programming. N o t only should the BOs be able to prepare a realistic cash-based budget for the whole year (per the LPFMA), but they should also be capable o f preparing quarterly or monthly cash requirement estimates. In relation to improved financial planning for procured goods and services, implementation o f the procurementhendor module o f the Treasury’s computerized payment systemI5 should be carried out as soon as possible, to al- l ow monitoring o f contracts. BOs’ financial plans should be submitted to and discussed with the MFE after completion o f the budget preparation process16 to determine quarterly cash envelopes. This process should be duly legislated. Institutional arrangements should be made, and legislated for, ensuring arbitration o f disagreements on allocation (this would pertain specifically to the role o f the Budget Commi~s ion ) . ’~ The budget circular may need to be revised to allow more time for BOs and RPBOs to prepare their submissions, and for the MFE to scrutinize and discuss submissions with BOs and RPBOs. Technical assistance may be needed in the MFE to strengthen analytical capacity.

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While treasury and cash management are well-regulated areas of PFM, they suffer from inefficiencies. The system through which Commitment and Payment Orders (CPOs) flow to ensure authorization o f payments i s well regulated. The Treasury authorizes commitments and payments based on requests and supporting documentation by BOs and municipalities. The Treasury pays from a single account in the central Banking and Payment Authority o f Kosovo (BPK).

However, weaknesses in practices and systems weaken the efficiency and effectiveness of resource use. First, until now, large cash surpluses have accrued at the end o f the year. As discussed above, these are largely attributed to: (i) the practice o f carry-over o f unspent amounts, (ii) better-than-anticipated revenue performance and significant budget revisions at mid-year (resulting in major shifts or increases in allocations to be spent in the last three months of the year); and (iii) absorption capacity. Probably as result o f this situation, there has not been any pressing need for Treasury to develop cash management ski l ls.

l4 This recommendation has been implemented as o f January 2005. The software used i s Freebalance, a Canadian computerized financial transaction and accounting system.

l6 Under the current calendar: between November 1 -December 3 1. ” For further discussions o n institutional and organizational issues, see IMF report: “Staff Visit to Kosovo march 10-19, 2004, Aide Memoire.


In addition, uneven development and/or use o f the Treasury System creates inefficiencies and weakens information availability and reliability. First, certain control modules o f the Treasury System software have not been implemented. Second, until recently the BPK had to manually re-enter al l the CPOs that have already been entered into the Treasury’s system. This i s however no longer the case. The B P K can now process payments from information provided in electronic format. Sti l l , payment requests from the Treasury Sys- tem are not submitted on-line but via disks. While the Treasury System has been rolled out to al l municipalities except one, i t has not been rolled out to central government BOs. In both cases, authorization for commitments and payments by Treasury however s t i l l requires manual transactions. The Treasury records transactions in the Treasury System and maintains the documentation trail. This dual system, while inefficient, i s likely to remain in place so long as financial management capacity, control and internal audit have not been developed in BOs and municipalities. Finally, whereas the Treasury System ensures the execution o f payments from a single account in the BPK, a great number o f individual bank accounts continue to exist. As there i s no central account clearing mechanism, these accounts are l ikely to have idle balances.

W h i l e no KSIP action directly addresses these issues, efficiency in resource use should be enhanced by the fol lowing actions:

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The MFE should take action to close al l existing bank accounts and process al l transactions v ia the Treasury’s account in the BPK. W h i l e the MFE has taken steps to strengthen i t s cash management function, additional support i s needed to hire and train staff. The MFE should r o l l out the Treasury System to al l BOs, while ensuring that the system’s implementation i s in l ine with the development o f financial management skil ls, internal control and audit in the BOs. The MFE should take the necessary steps to implement the bank reconciliation module o f the Treasury System.

As with most PFM functions, accounting is constrained by limited capaciq, and financial reporting needs more realistic requirements and statutory deadlines, improved procedures, and trained personnel. While important progress has been made over the past few years with the development o f the Treasury System, accounting i s s t i l l at an early stage, and the administration i s currently severely understaffed and lacking competent Kosovar accountants. The accounts, which are presumed to be kept on a cash basis, do not respect cash-based accounting principles. Use o f a chart o f accounts (COA) i s not a formal requirement, and no user’s guide o f accounting principles has been issued. Even simplified accounting and bookkeeping is often fraught with mistakes, while some BOs complain that the C O A does not provide them with the level o f detail needed for management purposes. A s a result, different parallel systems and spreadsheets coexist, a l l o f which contribute to undermine data reliability and quality. A serious effort to develop and train an adequate accounting function in the administration should have a high priority.

The LPFMA stipulates reporting requirements which seem to be too demanding for the current capacity (for instance, reporting on al l assets and liabilities). In addition, i t s cal-

Kosovo OFAR: Executive Summary 6

endar seems unrealistic considering current capacity constraints and when compared to international practice. Weaknesses are evident in the significant delays in the submission o f annual financial statements o f the KCB. In addition, it should be noted that both the budget and MFE’s annual financial statements have been largely prepared by foreign experts. Finally, when processing approved reallocation requests v ia the Treasury System the Treasury staff overwrites the visible appropriation data, which means that changes are difficult to keep track of. Indeed there are no standard reports in the Treasury System which documents reallocations.

Under these conditions, fulfilling Standard 1 , Act ion 11.4 o f the KSIP” seems ambitious, and developments so far have been insufficient to move the PISG closer to this objective.

The OFAR recommends that:

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The MFE assess the capacity o f the accounting function, and prepare a comprehensive plan to hire, train and retain accountants. While considering the need for flexibility in the creation o f analytical sub- accounts, the Treasury should review the COA, and consider issuing a set comprehensive accounting policies and procedures in close cooperation with all Budget Organizations. Recording o f financial assets and liabilities should also be envisaged. The use o f the COA should be made mandatory and it should be formally issued by the MFE. The Treasury should develop a standard report in the Treasury System to track current reallocations and clearly identify originally appropriated amounts.

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Internal control and internal audit at all levels of government are in their infancy. Considerable time and effort will be required to make them fully operational. Significant developments are underway in the f ield o f internal audit with the assistance o f the European Agency for Reconstruction (EAR). However, managerial accountability and intemal control are generally underdeveloped. K e y components that would constitute a sound internal control framework are absent. Public sector managers generally do not take on a strong ethical leadership role. There i s a lack o f written procedures for the majority o f Budget Organizations, namely those that are not linked to the Treasury System (all ministries except the MFE). Certain basic control activities are typically not performed, including bank reconciliations.

There i s currently one operational intemal audit unit (IAU) located in the MFE, which consists o f 25 staff. Another 75 staff have been recruited and are located in the BOs and municipalities, so far to l i t t le effect. Overall, internal audit positions are largely staffed with untrained personnel and, consequently, the management culture in the administration i s not conducive to a modern understanding o f an internal audit function.

l8 Ministries, Municipalit ies and Public Utility Entities publ ish annual reports including their financial statements. The reports are provided to the Kosovo Assembly, Munic ipa l Assemblies and UNMIK structures within three months o f the year-end.

Development o f a government-wide internal audit function i s supported by the EAR, via a EUR 1.9 mil l ion project implemented over a two-year period. However, given Kos- ovo’s capacity constraints, i t i s l ikely that, as in other former socialist countries, the IA function wil l take a long time to develop across central and local administrations, with possible implications for the development o f the P F M function. First, it should be expected, and i s indeed desirable, that audits wil l in the f i rst stage focus on compliance. Second, as mentioned above, i t i s l ikely that granting increased authority to BOs and municipalities wil l await an operational control and audit framework.

In that context, it i s hard to see that the benchmarks under the KSIP requiring operating internal audit and internal control^'^ could be reached soon and at an effective level o f quality. The OFAR recommends that the EAR project design be discussed with long-term partners in Kosovo in order to identify possible areas where additional actions and financing may be warranted. For example, consideration could be given to facilitating and funding the access to internationally-recognized examinations and certifications, (for instance, Certified Internal Auditor) for a number o f public sector internal auditors.

Public sector external audit is undeveloped and, as with internal audit, it will need sustained external support for its development. Recognizing the need to establish a Supreme Audit Institution (SAI) in Kosovo, a UNMIK regulation establishing the Office o f the Auditor General (OAG) was issued in 2002. An Auditor General was appointed in late 2003 and a three-year development program for the OAG was developed with financing from the EAR. Init ial steps have been taken under this program, but the O A G i s has yet to start i t s f i rst audit o f the execution o f the KCB, which so far has been contracted out to the Dutch SAI, the Algemene Rekenkamer. Reports o n the audit o f the UNMIK accounts o f 1999/2000 and 2001 have been completed. I t i s a major cause for concern that both reports were made public very belatedly. The audits for 2002 and 2003 were s t i l l being prepared when the data for the OFAR were collected.

There are minor shortcomings in the legal framework for the OAG, which the OAG should seek to address in the medium term. These include: (i) the absence o f explicit references to the INTOSA12’ Auditing Standards’ definitions o f different types o f audit; (ii) ambivalence as to whether audit reports should be made public, and (iii) a lack o f specificity concerning the procedures for appointment o f the Auditor General (AG).

Although the OFAR i s unable to veri fy the completion o f the KSIP actions for external audit,*’ most seem within reach by the end o f the three-year program, provided that the

IgStandard 1, Actions 1 1.2 Rules o f Government, Rules o f Procedure and Codes o f Conduct adhered to by PISG in practice and action taken by government for violations; 12.3 Internal audit units established for main expenditure units o f KCB, and internal audits conducted; 12.4 Results o n implementation o f audit recommendations noti f ied by each PISG unit. Standard 2 Actions 23.5 P ISG bodies comply fully with audits f rom Auditor General’s office; P ISG bodies introduce adequate internal f inancial controls and system o f internal audit; 24.1 Rules o f ethical conduct enshrined in Civil Service terms and conditions, explained to a l l c i v i l servants and effectively enforced. 2o International Organization o f Supreme Audit Institutions: http://www.intosai.org

General’s reports submitted to SRSG and the Assembly. Standard 2: 23.4 Auditors within OAG trained and Standard 1: 12.1 Audit plans drawn up by the OAG every year in advance and notif ied; 12.2 Auditor 21

Kosovo OFAR: Executive Summaw 8

O A G can rely on contracting out to other Supreme Audit Institutions (SAIs) or private auditors in the meantime. In addition, i t is critical that donor funding for the development o f the O A G be secured for at least three years. Based o n the above, the OFAR recommends that:

As a matter o f high priority that the appropriate authorities take action to ensure that the K C B Audit Reports are made public as soon as possible after their completion and formal submission to the SRSG. As with intemal audit, the plan for extemal audit development should be discussed with partners, to identify possible gaps. In order to address such gaps, complementary financing should be sought for relevant training and examination opportunities for O A G auditors. The O A G regulation, at the OAG’s initiative, should be amended to make explicit reference to definitions in the INTOSAI Auditing Standards when referring to different types o f audit, for instance regularity audits. To facilitate the successful completion o f the Kosovo Standards Implementation Plan’s action 12.1 the OAG should consider ways to externally communicate the completion o f the audit plan for the audit o f the K C B execution o f 2005. The O A G should prepare an information campaign aimed at raising awareness o f the OAG and its basic role and function in a Parliamentary democracy. This campaign should also be aimed at informing and educating members o f the Assembly.

Financial accountability arrangements for municipalities highlight central control over budget execution, matching severe capacity limitations in the municipalities. The major part o f municipal budgets i s financed from grants from the central government, which makes municipal budgets fairly predictable. All payments on the municipal budgets are paid directly from the Consolidated Fund in the BPK. Even municipalities’ own earmarked revenues are transferred from commercial bank accounts to the consolidated fund. Therefore, although the municipalities have power to formulate their own budgets, there i s tight central control over the implementation o f these budgets once they have been approved.

The municipalities are linked to the Treasury System, where they can enter commitment information to initiate payment requests directly. However, as mentioned above, the actual authorizations are st i l l paper-based and the supporting documentation must s t i l l be physically presented to the regional Treasury offices. Visits to two municipalities showed that the Treasury System is somewhat unstable, partially due to the weaknesses in the I T infrastructure. There are indications, for instance in reports f rom regional Treasury offices, that financial reporting i s not uniform, and that the C O A i s not applied universally. Currently, there are no operational intemal audit systems as discussed above, nor have extemal auditors been appointed at the municipal level. To enhance municipal budget management:

performing regular audits o f financial activity o f government bodies; 23.5 (2) PISG bodies comply f i l l y with audits from OAG.

Kosovo OFAR: Executive Summaw 9

0 Accounting and bookkeeping practices in al l municipalities should be reviewed in order to identify the most common problems faced by municipal Budget and Fi- nance Units (BFUs). This should be done in preparation for the development o f a new chart o f accounts and new accounting policies. Independent auditors to audit the financial statements o f each o f the 30 municipalities should be appointed and trained, possibly under the EAR-supported project.

0

Kosovo OFAR: Countrv, Economic and Adminisfrafive Backsround 10

CHAPTER 1 : ECONOMIC AND ADMINISTRATIVE BACKGROUND

1. Following the end o f armed conflict in June 1999, Kosovo was placed under United Nations administration by the authority o f Uni ted Nations (UN) Security Council Resolution 1244. This Resolution established the United Nations Interim Administration Mission in Kosovo (UNMIK) and called upon it to:

Perform basic civi l ian administrative functions; Promote the establishment o f substantial autonomy and self-government in Kos- ovo; Facilitate a political process to determine Kosovo’s future status; Coordinate humanitarian and disaster r e l i e f o f a l l international agencies; Support the reconstruction o f key infrastructure; Maintain c iv i l law and order; Promote human rights; and Assure the safe and unimpeded return o f al l refugees and displaced persons to their homes in Kosovo.

To implement its mandate, UNMIK has established four “pillars” under i t s leader-

Pillar I: Police and Justice, under the direct leadership o f the UN Pillar 11: C iv i l Administration, under the direct leadership o f the UN Pillar 111: Democratization and Institution Building, led by the Organization for Security and Co-operation in Europe (OSCE) Pillar IV: Reconstruction and Economic Development, led by the European Union (EU) v ia the European Agency for Reconstruction (EAR)

Until 2003, under Pillar IV the Central Fiscal Authority (CFA) was responsible for Public Financial Management. Today Pillar IV consists o f various components, among them also the Fiscal Affairs Office, which advises and supports the DSRSG on fiscal pol icy and budget issues, in particular on the formulation o f the parameters o f the Kosovo Consolidated Budget, and serves as the Secretariat o f the Economic and Fiscal Council (EFC).

4. In order to help prepare for the first phase o f self-government, the Kosovo Transi- tional Council was established to include representatives from ethnic Albanian, Serb and other groups. Local participation was broadened in early 2000 with the establishment o f the Joint Interim Administrative Structure in which 20 departments (equivalent to ministries) were co-managed by international and local experts. In M a y 2001, a further significant key step towards self-government was taken with the adoption o f the Constitutional Framework, which set out the Provisional Institutions o f Self-Government (PISG), including the President o f Kosovo, the Assembly and the Government. While the responsi- b i l i t ies o f the PISG are growing, SRSG retains authority over key areas such as security;

Kosovo OFA R: Countrv, Economic and Administrative Backaround 11

setting “broad parameters” for fiscal policy, including setting the budget and new laws into effect, after they have been passed by the Kosovo Assembly. There i s now a marked attempt to reduce the number o f international recruits within UNMIK and increase the role o f local Kosovar officials in carrying out the functions o f government, including financial management, as UNMIK progressively hands over functions to the PISG departments.

5. At the time o f its formation, the Kosovo Government outlined four broad economic priorities, one o f which was to ensure an efficient and transparent public administration. One o f the main economic challenges facing Kosovo therefore i s building inst i - tutional capacity. In conjunction with the transfer o f responsibilities to the PISG, there has been significant progress in building local institutions. This i s illustrated, for instance, by the creation o f a treasury function, the Banking and Payment Authority, and tax and customs administrations. As can be expected from very young institutions, however, capacity in many areas remains limited. One particular area where strengthened capacity i s needed i s improving strategic priori ty setting mechanisms and overall public expenditure planning and management. The Prime Minister ’s Office and the Ministry o f Finance have recently established a jo int coordinating body to improve processes in this regard, which is likely to be particularly important. Even with the further transfer o f responsibilities in December 2003, additional mechanisms are required to resolve differences between UNMIK and the PISG regarding budget priorities for transfewed and reserve powers. U1- timately, Kosovar authorities may need to consider moving gradually toward the development o f an inclusive priority-setting process such as a Poverty Reduction Strategy Pa- per.

Kosovo Standards Implementation Plan

6. In 2002, the SRSG presented to the UN Security Council a series o f benchmarks or standards for institutions to reach before the political process to determine KOSOVO’S future status could definitively begin. The standards presented were: (1) functioning democratic institutions; (2) the ru le o f law; (3) freedom o f movement; (4) returns and rein- tegration; (5) the economy; (6) property rights; (7) dialogue with Belgrade; and (8) guar- anteeing the civilian mandate o f the Kosovo Protection Corps (KPC). According to a recognized international observer, the International Crisis Group (ICG), the Standards were unfortunately developed without consulting the key institutions o f the PISG, which therefore cannot have been expected to have a strong sense o f ownership and commitment to them.

7. In December 2003, a document entitled “Standards for Kosovo” was published, which outlined eight standards that were subsequently endorsed by UN Security Council. Leading up to this, the UNMIK launched a public campaign to promote the standards, while explicitly tying the standards to EU efforts to ensure that Kosovo continue to ad- here to the process la id down by the EU Stabilization and Association Agreement (SAA). This has included television advertisements and posters illustrating the application o f the Standards as the road to EU membership.

Kosovo OFAR: Country, Economic and Administrative Backsround 12

8. In a document published on March 31, 2004, the Kosovo Standards Implementa- t ion Plan (KSIP) was made public. I t sets out in greater detail the concrete actions and policies that are to be undertaken in order to reach the Standards for Kosovo, which wil l determine the gradual transfer o f authority from the UNIMK pillars to the various PISG institutions. The actions are set out under the headlines o f the eight standards, with a timeline l inked to them. They consist o f actions o f direct relevance for the development o f key elements o f Public Financial Management (PFM) and financial accountability o f the government o f Kosovo. The specific actions in the KSIP subject to analysis in the OFAR al l fa l l under three Standards: Functioning o f Democratic Institutions; Rule o f Law; and Economy, as listed in Table 2 below:

Table 2. KSIP actions relevant for OFAR22 Number and

title o f Standard for Kosovo

1. Functioning Democratic Institu- tions

2. Rule o f L a w

K S I l Action

1 1.2 Rules o f Government, Rules o f Procedure and Codes o f Conduct adhered to by P ISG in practice and action taken by government for violations 1 1.4 Ministries, Municipalit ies and Public utility Entities publish annual reports including their financial statements. The reports are provided to the Kos- ovo Assembly, Munic ipa l As- semblies and UNMIK structures within three months o f the closing o f the year. 12.1 Audit plans drawn up by Auditor General’s Off ice every year in advance and noti f ied 12.2 Auditor General’s reports submitted to SRSG and the As- sembly 12.3 Internal audit units established for ma in expenditure units o f K C B , and internal audits conducted

12.4 Results o n implementation o f audit recommendations notified by each P ISG unit 23.4 Auditors within Audi tor General’s off ice trained and performing regular audits o f financial activity o f government bodies

Who

All P ISG

All P ISG with Pil lar I1

Auditor Gen- eral with Pil lar I V Auditor Gen- eral with Pil lar I V MFE with PISG and Auditor Gen- eral with Pil lar I1 All PISG and Pil lar I1

Auditor Gen- eral’s Off ice

Timeline

March 2004 on- wards


M a r c h 2004

December 2004

June 2004

Annual

Ongoing

OFAR topics

Internal control

Accounting and financial reporting, Financial accohtabi l i ty for local government

External audit

External audit

Internal control and internal audit

Internal control and internal

22 Actions contained in “Kosovo Standards Implementation Plan,” March 3 1, 2004. See l i s t o f abbrevia- tions on the back o f front cover.

j. Economy

ource: The Kosovo ,

23.5 PISG bodies comply fully with audits from Auditor Gen- :ral’s office; PISG bodies intro- h c e adequate internal financial :ontrols and system o f internal mdit 24.1 Rules o f ethical conduct znshrined in Civ i l Service terms and conditions, explained to al l i v i l servants and effectively Enforced 3.1 The adoption o f the K C B 2005 and annual budgets thereafter in full compliance with fiscal and budget regulations and the LPFMA, satisfying al l conditions for SRSG promulgation including sufficient attention to reserved areas, taking recommendations on IMF and other development partners into due account. 3.2 Development o f a MTEF, including integration o f the pub- l i c investment plan, which i s non-discriminatory and takes into account the priorities o f the Government and reserved areas 3.3 Improvement o f Sector spending plans and dialogue between MFE and other budget agencies, wi th due consideration given to priorities o f women 3.4 Improvement o f the implementation o f the budget timetable to ensure timely presentation o f the Mid-Year Review 3.6 Compliance with the LPFMA and the Budget 2004 and 2005 regulations, i s monitored, wi th reporting following the timelines set out in this regulation. 3.7 Strengthening o f public expenditure management in maintaining fiscal discipline and

ill PISG

UPS and 3CA

MFE with Pillar IV- FAO, EFC, Budget Zommission, Srants Commission, Assembly

MFE, MTI with Pillar

EFC IV-FAO,

MFE, OPM, Pillar IV- FA0

MFE with Pillar IV- FAO, EFC

MFE with Pillar IV- FA0

MFE with Pillar IV- FA0

eff ic ient allocation o f resources

3ngoing

Mid 2004 and thereafter ongoing

December 2004

November 2004

Ongoing

July 2004, 2005

Ongoing

Ongoing

Internal control tnd internal iudit and Exter- la1 audit

[nternal control

Budgeting

Budgeting

Budgeting

Budgeting

Budgeting

Budgeting

Economic b ackground23

9. Poverty in Kosovo i s widespread, and following an immediate improvement in economic growth after the end o f the 1999 conflict, growth i s again starting to slow. In 2000 and 2001 Kosovo experienced double-digit growth rates, which resulted in average GDP per capita doubling fi-om less than US$400 in 2000 to about U S 6 4 0 in 2002 and almost US$790 in 2003. However, estimates prepared in 2003 by the MFE with the assistance o f the IMF indicate that growth has slowed to approximately 4-5 percent per an- num. In terms o f the medium- and long-term perspectives for economic growth, i t i s a point o f concem that growth seems narrowly based and dependent o n donor flows. I t seems evident that the potential for longer-term growth i s linked to significant reforms o f the economy. Key economic and social data are included in Annex I.

Relationship to the TSS, program and policy dialogue with Kosovar authorities

10. The World Bank’s f i rs t Transitional Support Strategy (TSS) for Kosovo, dating f rom September 1999, defined the Bank’s strategy as helping to ensure the overall sustainability o f the reconstruction and recovery effort by using the Bank’s comparative advantage in aid coordination and pol icy advice and through selective financial support. A Trust Fund for Kosovo o f US$60 mi l l ion was made available by the Bank and was com- mitted by August 2001 to twelve projects, in addition to two post-conflict grants o f US$2 million. Co-financing o f projects to the amount o f US$62 mi l l ion has complemented the Bank’s resources. In addition to this, US$15 mi l l ion in IDA grants were provided between mid-2002 and end-2003. Through these projects, the Bank has played an important role in:

0

0

0

Institution building, economic reforms and providing critical budget support; Employment creation through support to the private sector; Restarting agriculture production and supporting the income generation capacity o f vulnerable rural families; Financing small infrastructure investments based on community initiative in conflict-affected areas; and Improving social services such as health, education and social protection.

1 1. The IDA grants and the World Bank’s current TSS, dated July 2002, responded to the Kosovar authorities’ priorities in the areas o f economic growth, poverty reduction, fiscal sustainability and good governance.

12. A revised TSS for the period to June 2005 was issued on April 13, 2004. Provid- ing a US$ l5 mi l l ion grant v ia the TSS, the World Bank focuses on the strengthening o f governance and public expenditure management. The support wil l include a US$5.5 m i l - l ion economic and public expenditure capacity development project. The TSS also makes the link to the OFAR as a contribution to guide initiatives and interventions.

23 Based on information contained in Memorandum o f the President o f the International Development As- sociation to the Executive Director on a Transitional Support Strategy o f the W o r l d B a n k group for Kos- ovo, Washington DC, April 13, 2004.

Kosovo OFAR: Countrv, Economic and Administrative Backqround 15

Administrative Background

13. With the passing o f UNMIK Regulation No. 2001/19 on a Constitutional Frame- work for Provisional Self-Government, decision-making powers were transferred from the UNMIK Pillars to Provisional Institutions o f Self-Government, including the Ministry o f Finance and Economy (MFE) and a number o f other key ministries. While essential and senior intemational staff in most cases has remained in the organizations involved, the process o f developing local sk i l ls and competencies is now ongoing. Currently, local administrative capacity in key financial management functions i s generally insufficient when i t comes to both training and experience. Important and significant developments appear, however, to be ongoing and could change this situation in the medium term.

14. The establishment o f the UN Interim Administration Mission in Kosovo 1999, was also marked by an almost complete tumover in local administration. Kosovo nation- als with l i t t le or no prior background or qualification in public sector management filled the vacancies left by the previous Serbian administration. Whereas significant changes have occurred since then with the help o f foreign experts, local staff i s generally st i l l at an early phase o f development.

15. A project to develop a new pay and grading system for the Kosovo c iv i l service has recently been concluded. This i s meant to serve as a basis for the MFE to develop a new framework for c iv i l service and provide appropriate training and other human resource management development activities. A c iv i l service law i s in place, UNMIK Regulation No. 2001/36, which has a Code o f C iv i l Service Conduct attached to it. The Code’s enforcement i s among the sections l isted in the KSP.

Kosovo OFAR: Overall Framework for Financial Accountabilitv and Public Financial Manaaement 16

CHAPTER 2: OVERALL FRAMEWORK FOR FINANCIAL ACCOUNTABILITY AND PUBLIC FINANCIAL MANAGEMENT

I. Background and Assessment Framework

Background

16. With the passing o f UN Security Council regulation No. 1244/1999, the UN Mis- sion in Kosovo (UNMIK) was established. This continues to be the basis for the authority o f the Special Representative o f the UN Secretary General (SRSG), who i s appointed by the UN Security Council.

17. The constitutional set-up for Kosovo is unique, as i t i s not a sovereign state but i s being administered by the UN via the SRSG.24 The SRSG i s in the process o f gradually transferring authority to the Provisional Institutions o f Self-Government (PISG), which consists o f a locally elected Assembly and an executive branch headed by a Prime Minis- ter and a President. Although the constitutional set-up does provide for these democratic institutions, including a government consisting o f a broad coalition o f political parties, they do not enjoy the full powers o f similar institutions o f the world’s nation states.

18. countability and public financial management.

This chapter covers the overall legal and institutional framework for financial ac-

Assessment Framework

19. Because o f the unique circumstances o f Kosovo, an uncritical comparison between the overall legal framework for financial accountability o f the administration o f a well-established nation state and that o f Kosovo cannot be justified. While the assessment framework in this chapter i s most relevant for government administrations o f established nation states, i t can also be used in a context o f a geographical entity that would eventually remain a regional rather than a national entity.

20. Considering the Kosovo population’s aspirations for independence and accession to the EU, the public financial accountability and management framework provided by the EC financial regulation appear to be an appropriate benchmark.25

21. The EC financial regulation represents a legal framework providing for:

0 A unitary budget including al l revenues and expenditures in the budgetary process;

24 Formally, sovereignty over the territory o f Kosovo is s t i l l with Serbia and Montenegro. 25 Counci l Regulation No. 160512002 on the Financial Regulation applicable to the general budget o f the European Communities.

Kosovo OFAR: Overall Framework for Financial Accountabilitv and Public Financial Manasemenf 17

0 Managerial accountability, ensuring that the top management assumes the responsibility as the overall authorizing officer, while granting it the right o f delega- t ion o f powers; and Definitions and designation of relevant financial actors, including legislature, govemment, authorizing officers and accounting officers, as we l l as internal and external auditors.

0

11. Findings

22. The Constitutional Framework for Provisional Self-Government took effect on M a y 15, 2001, with the issuing o f UNMIK Regulation No. 2001/9. The framework sets out the responsibilities o f the Provisional Institutions o f Self-Government (PISG) as wel l as those powers reserved for the Special Representative o f the UN Secretary General (SRSG), administrated by UNMIK authorities. The latter includes the UNMIK Customs service; the Directorate o f Administrative Affairs; Police; Justice; Correctional Services; Infrastructure; Radio and Television; the Kosovo Trust Agency (KTA - administering State Owned Enterprises); Banking and Payment Authority o f Kosovo (BPK - the Cen- tral Bank). The distribution o f responsibilities between PISGs and the reserved powers o f the UNMIK i s shown in Table 3 below:

Kosovo OFAR: Overall Framework for Financial Accountability and Public Financial Manasemenf 18

Table 3. Provisional Institutions of Self-Government and UNMIK Institutions

Authorities

Provisional Institutions o f Self- Government Budget Organizations Munic ipa l Budget Organizations Reserved Power Budget Organizations (UNMIK) Total

Provisional Institutions of Self-Government

Assembly, Off ice o f the President, Prime Minister

Ministers and Ministerial Offices

Ministry o f Finance and Economy

Ministry o f Public Services

Ministry o f Agriculture, Forestry and Rura l Dev.

Ministry o f Trade and Industry

Ministry o f Transport and Communications

Ministry o f Health

Ministry o f Environment and Spatial Planning

Ministry o f Culture, You th and Sports

Ministry o f Education

Ministry o f Labor and Social Welfare

30 Municipalit ies

Employees Approp r ia t i ons in P r o p o r t i o n of (Person years) m i l l i o n EUR appropriat ion, %

17,286 430.8 55.7 42,150 175.8 22.7 17,968 167.5 21.6

77,404 774.2 100

Reserved Power Institutions (UNMIK) Customs

Economic and Fiscal Counci l Secretariat

Directorate o f Administrative Affairs

Directorate o f Civil Protection (KPC)

Kosovo Police Service

Justice

Kosovo Correctional Services

Directorate o f Rural Affairs

Kosovo Trust Agency

Directorate o f Infrastructure Af fa i rs

Radio and Television o f Kosovo

Independent Media Commission

Banking and Payments o f Kosovo

Kosovo Pensions Savings Trust

jource: Kosovo Consolidated Budget 2004, Ministry o f Finance and Economy

23. In financial terms, the reserved powers constitute 21.6 percent o f the total K C B and 28 percent o f the total budget to central government. The budget distribution between the different groups o f institutions in the 2004 budget i s shown in Table 4:

Table 4. Structure of the Kosovo Consolidated Budget 2004

24. To emphasize the continued importance o f the UNMIK, i t i s worth mentioning that i t i s stated in the preamble to the Constitutional Framework that: “Affirming that the exercise o f the responsibilities o f the PISG shall not in any way affect or diminish the ultimate authority o f the SRSG for the implementation o f the UN Security Council Regula- t ion No. 1244/1999.”

25. The responsibilities o f the PISG, as defined in the Constitutional Framework, include economic and financial pol icy as wel l as fiscal and budgetary issues for the areas falling under the PISG’s authority. The Law on Public Financial Management and Ac-

countability (LPFMA) provides the framework for the budget process including for the definition and assignment o f roles and responsibilities o f the different actors and the basic checks and balances to ensure that resources are expended according to agreed allocations. The L P F M A differs from most other organic budget laws in that i t defines in very specific terms the internal organization o f the Ministry o f Finance and Economy (MFE). Management accountability i s established with the definitions o f the roles and responsi- bi l i t ies o f the “Head o f a Budget Organization” (HBO). I t provides for definitions and assignments of roles and responsibilities of key financial actors, including authorizing and accounting officers.26 The role o f accounting officer i s defined in the LPFMA to be with the “Chief Financial Officer” (CFO) o f each Budget Organization (BO), and the equivalent o f the E C financial regulation’s authorizing officers is defined in the L P F M A as the “Certifying Officer” (CO).

26. In the unique setup o f the Kosovo public budgeting system, the “Reserved Power Budget Organizations” (RPBO) should be highlighted. The budget approval process for these institutions, which in the 2004 budget s t i l l accounted for 21.6 percent o f the total Kosovo Consolidated Budget (KCB), differs from that o f the other Budget Organizations. Whereas an aggregate ceiling for the K C B i s decided by SRSG on the proposal o f the MFE and recommendations o f the Economic and Fiscal Council (EFC), the aggregate budget ceilings for the Reserved Power Budget Organizations and the sector-specific ceilings for the RPBO are set by the SRSG. KOSOVO’S unique constitutional framework gives ultimate authority to the SRSG, who therefore also has authority to make changes to the K C B after the Assembly has endorsed it. As this occurred in the preparation o f the 2003 KCB, i t promoted the perception’ o f “double standards” in determining the budget allocations for RPBOs and other BOs. To ensure that the K C B functions effectively as a unitary budget and to prevent double standards in the enforcement o f the rules o f the LFPMA, a close cooperation and coordination between the MFE and al l BOs in the budget process i s required.

111. Summary o f findings

27. The provisions o f the LPFMA generally correspond to provisions o f the E C F i - nancial Regulation. This being said, the basic checks and balances vary from those o f a typical national government administration in that: (i) different provisions o f the L P F M A may in some cases apply to certain institutions and not to others; (ii) the SRSG i s the responsible authority for the budget process for the RPBO, and the MFE for the PISG Budget Organizations; (iii) the SRSG has a veto right over the K C B as a whole and can change the final version o f the K C B .

IV. Recommendations

28. The OFAR recommends that:

0 A revision o f the L P F M A and related legislation (for instance, budget circular) could be considered, in order to adjust the legislation to match the current capac-

As defined in Counci l regulation (EC, Euratom) No. 160512002 on the Financial Regulation applicable to 26

the General Budget o f the European Communities (hereafter the EC Financial Regulation).

Kosovo OFAR: Overall Framework for Financial Accountability and Public Financial Manasement 20

ity level. Alternatively, a more realistic time-bound approach for the L P F M A implementation could be envisaged, including in relation to the relevant KSIP crite- r i a (Standard 5, Action 3.1.).27 To avoid the perception o f “double standards” in the application o f the L P F M A and related legislation for budget preparation, RPBOs and other BOs should al l apply the existing rules conscientiously. Also, a closer cooperation and coordina- t ion between the MFE and al l BOs in the budget preparation process i s encouraged.

3.1 “The adoption o f the KCB 2005 and annual budgets thereafter in full compliance with fiscal and budget regulations and the LPFMA, satisfying a l l conditions for SRSG promulgation including sufficient attention t o reserved areas, taking recommendations on IMF and other development partners into due account”

27

CHAPTER 3: BUDGETING

I. Background, Assessment Framework and the KSIP

Background

29. The Central Fiscal Authority (CFA) regulated budgetary expenditures in Kosovo from 1999 and was generally recognized as having enforced a sound fiscal system. Fol- lowing the establishment o f the central PISG institutions in 2002, the responsibility for preparing the budget for the PISG was transferred from the C F A to a new Ministry o f Fi- nance and Economy (MFE).

30. The Kosovo Consolidated Budget 2004 for central government was EUR 598.4 million, o f which 95 percent was financed by domestic revenues and the remaining 5 percent, by international donors. The PISG i s responsible for the administration o f 72 percent (EUR 430.9 million), while the remaining 28 percent i s used to finance U N M I K ’ s reserved power areas, such as the Kosovo Police Service, the Kosovo Protection Corps (KPC), the Kosovo Trust Agency (KTA), the Pristina Airport and the Housing and Prop- erty Directorate.


3 1. Considering KOSOVO’S aspirations for independence and subsequent accession to the European Union, one o f the benchmarks for the Kosovo framework for financial accountability and public financial management i s the E C Financial Regulation.

32. financial regulation:

The structure o f the assessment follows from the budgeting principles o f the EC

0 Principles of Unity and Accuracy (comprehensiveness). Because the budget forecasts and authorizes revenues and expenditures, a l l o f these must be included.

0 Principle of Universality. This principle i s based o n two rules: “non- assignment,” which states that budget revenues may not be allocated to particular items o f expenditure, and the gross aspect, which states that al l revenues and expenditures must be entered in full, without adjustments against each other. The principles aim to ensure aggregate fiscal discipline and efficient allocation o f resources, which require that al l expenditure programs be reviewed together. Principle of Annuality. Appropriations must be authorized for the fiscal year; ru les for carrying over funds from one year to the next are specified. For multi- year operations, E C regulations distinguish between payments authorized for the fiscal year and legal commitments authorized to cover multi-year operations. Principle of Equilibrium @seal discipline). Budget revenues and payment appropriations must be balanced. The budget o f EU member states i s bound by f is - cal rules defined in the Maastricht/Amsterdam treaties, which involve equilibrium and annual presentations to ensure fiscal discipline.

0

0

Principle of Specification. Each appropriation must have a purpose and be assigned to a specific objective to prevent any confusion between appropriations at the authorization and the execution stage; this ensures the budget i s unambiguous and executed according to the decisions o f the budgetary authority. Rules for making exceptions, such as transfers between appropriation accounts, must be specified. Principle of Sound Financial Management. This involves economy, efficiency and effectiveness in conducting activities and delivering public services. Specific, measurable, achievable, relevant, and t imely objectives must be stated for al l sectors covered by the budget and for monitoring and evaluation (M&E) o f performance indicators. Principle of Transparency. This ensures the objectives wil l be correctly formu- lated and pursued.

0

33. A Medium-Term Expenditure Framework i s a basic requirement for fiscal transparency. In addition, the IMF Fiscal Transparency manual identifies as a best practice the preparation o f medium-term budget (or expenditure) frameworks (MTEFs). I f the processes are disciplined, an MTEF provides a clear statement o f the effects o f current pol i- cies and a mechanism for planning, controlling and monitoring the introduction o f new and changed policies.

34. Most OECD countries have introduced instruments to create multi-year budget perspectives. However, such budgets vary from country to country. They can be either “extended MTEFs,” where each activity i s l isted separately and aimed at promoting and monitoring operational performance or those that cover broad expenditure programs and focus on inter-sectoral resource allocations. The former has the advantage o f addressing al l objectives o f public expenditure management, but i t s implementation requires robust reporting and accountability systems and highly disciplined processes.

35. teristics involve:

However sophisticated the expenditure programming process, key MTEF charac-

0 Well-defined fiscal pol icy objectives; 0

0

0

Integrated medium-term macroeconomic and fiscal forecasts; Estimates o f expenditures and receipts o f ministries in relation to sector pol icy priorities; The MTEF i s rolled over each year; the f i rs t out-year expenditure estimates become the basis for budget negotiations for the following year; The MTEF and budget are prepared under hard budget constraints.

Actions required under the Kosovo Standards Implementation Plan (KSIP)

36. As parts o f the KSIP are among the key issues addressed by the OFAR, the progress o f specific actions o f the KSIP i s assessed. The specific actions addressed in this chapter are set out with their respective deadlines in Table 5 below:

Table 5. KSIP actions related to Budgeting 5. ECONOMY 3.1 The adoption o f the KCB 2005 and annual budgets thereafter in full compliance with fiscal and budget regulations and the L P F M A , satisfying a l l conditions for SRSG promulgation including sufficient attention to reserved areas, taking recommendations o n IMF and other development partners in to due account.

3.2 Development o f an MTEF, including integration o f the public investment plan, which i s non-discriminatory and takes in to account the priorit ies o f the Govern- ment and reserved areas 3.3 Improvement o f sector spending plans and dialogue between MFE and other budget agencies, with due consideration g iven t o priorit ies o f women 3.4 Improvement o f the implementation o f the budget timetable to ensure t imely presentation o f the Mid-Year Review 3.6 Compliance with the L P F M A and the Budget 2004 and 2005 regulations, i s monitored, with reporting fol lowing the timelines set out in this regulation. 3.7 Strengthening o f publ ic expenditure management in maintaining fiscal disci- pl ine and efficient allocation o f resources

Timeline December 2004

November 2004

Ongoing

July 2004,2005

Ongoing

Ongoing

Source: The Kosovo Standards Implementation Plan. March 31, 2004

11. Findings

Legal Framework

37. Sections 17-24 o f the LPFMA lay down the procedures for budget preparation and budget review and the respective roles and responsibilities o f the key actors, including the CFOs o f the Budget Organizations, the MFE, the Government, the Assembly, the EFC, and the SRSG.

The Institutional Framework and Capacity

38. The key institutions in the PFM and financial accountability framework are the SRSG, the Assembly, the Ministry o f Finance and Economy (MFE), the Economic and Fiscal Council (EFC) and the secretariat o f the EFC.

39. The MFE central offices in Pristina include the Budget Department; the Munici- pal Budget Department; the Economic Policy Department; the Treasury and a Depart- ment for Tax Administration. The total number o f staff o f the Ministry i s some 996 (2003). The members o f the EFC are appointed by the SRSG, who also chairs it. The EFC secretariat consists o f a relatively small number o f some 5-10 staff, but exact numbers are not available.

40. Although the institutions in general suffer from a combination o f considerable staff tumover and expanding responsibilities, staff numbers in the MFE seem adequate. There is, however, a great need for specialist training o f staff at the MFE, as wel l as in the l ine ministries, in all disciplines related to budgeting and budget pol icy making.

Some, but far from all, needs are covered by on-going or forthcoming technical assistance.

The Budgetary Principles of the EC Financial Regulation

41. The LPFMA does not fully comply with the budgetary principles set out in the EC Financial Regulation. In terms o f budget accuracy or realism, the outtum o f the expenditure side o f the KCB 2003 showed that only 66.2 percent o f the appropriations had been spent,28 as can be seen from Table 6 below:

’* The outtum for the revenue side was in comparison very accurate with an implementation o f 100.9 percent. The information comes f r o m the “Interim Budget Report - Fourth Quarter 2003,” Fiscal Reporting Unit, MFE. The Kosovo Consolidated Budget (KCB) i s attached in Annex 11.

Table 6. Budget and Outturns 2003 (un-audited)

Total Expenditure

Central Government Operations

General services Defense Public order and safety Economic affairs Environmental protection Housing and community amenities Health Recreation, culture and rel igion Education Social protection Adjustment

Local Government Operations

General services Public order and safety Health Education

Designated Donor Grants

General services Defense Public order and safety Economic Affairs Housing and community amenities Health Education Social protection

2003 Total Appropriations and Desig- nated Donor Grants (EUR millions)

Plan

862.4

624.9

91.8 20.1 76.4

217.8 1.6

21.9 59.0 10.3 32.9 93.2

185.6

93.0 2.3

21.5 68.7 51.9

Actual

570.8

407.3

46.0 13.7 60.3

116.6 1 .o

15.3 37.2

9.4 18.1 87.1

L. I

138.4

52.2 2.0

17.9 66.3 25.2

4.1 0.1 2.0 9.7 4.1 2.2 0.9 2.1

Progress Against Plan

(”/.I ~

66.2

65.2

50.1 67.9 79.0 53.6 59.4 69.8 62.9 91.5 55.1 93.4

74.6

56.1 87.2 83.3 96.4 48.5

-

iource: Fiscal Actuals and Trend Analysis Report, Ministry of Finance and Economy, December 2003 (amounts rounded by World Bank staffi

42. This lack o f budget accuracy or realism can, for a large part, be explained by a practice o f carrying forward appropriations and by the way in which multi-year appropriations are accounted for. As can be seen from the figures presented in columns 4 and 5 o f Annex 11, out o f a total budget for FY 2003 o f EUR 536 mi l l ion some EUR 185 m i l - lion, or 34 percent, consisted o f unspent and uncommitted funds carried over from FY 2001 and 2002. In the budget circular for FY 2004, Section 6.5 read: “Unexpected balances o f designated donor grants, whose grants were actually received and recorded in the Treasury Accounting Record in 1999, 2000, 2001, 2002 and 2003 are appropriated and authorized for Fiscal Year 2004.”29 This practice contradicts the principle of annual-

29 UNMIK Regulation No. 2003141 o n the approval o f the Kosovo consolidated budget and authorizing expenditures for the period 1 January to 3 1 December 3 1.

ity, which implies that appropriations that have not been used after a predetermined dead- l ine shall be automatically canceled.

43. In term o f applying the principle of equilibrium, the budgets since 1999 have been balanced and implemented with a surplus outtum. N o t only have expenditures been lower than budgeted, collection rates have in some years, for instance 2003, been above projection^.^'

44. The principle of specificity implies that appropriations shall be used for specific purposes and that limits should be set for reallocations that can be made in the course o f the fiscal year. Such limits are also defined in the LPFMA. For example, the head o f a Budget Organization can obtain authorization from the MFE for the transfer o f up to 20 percent o f an appropriation to another appropriation, as long as justification i s provided to the MFE. In practice, authorizations for transfers o f appropriations are allowed fre- quently. These authorizations are signed by both the Director o f the Treasury and the D i - rector o f Budget Department o f the MFE. Upon the receipt o f the signed original paper- based authorization, a system operator at the Central Treasury changes the appropriation information in the Treasury System. In doing this, the system operator overwrites the existing appropriations, leaving no electronic record o f these change~ .~* In addition to these ad hoc changes in the budget, there i s a formal midyear budget review.

45. The principle o f soundfinancial management means that in order to promote and ensure an economic, efficient and effective execution o f the budget, specific, measurable, achievable, relevant and timed objectives shall be monitored by performance indicators for each activity. Information shall be provided by the BO authorizing offcers/certifying officers to the H B O and ultimately to the Similarly, the L P F M A sets out that the mission statement and the program performance plan o f each B O shall consist o f “a l i s t o f the measurable goals that are to be used to evaluate the success o f a budget organization in achieving i t s mission” (LPFMA, Art. 19.10). Compared to the E C Financial Regulation, the L P F M A i s not as specific when it comes to when and how the measurable goals are to be evaluated and utilized in subsequent budget cycles. Until 2004, the consolidated budget has not included measurable physical indicators for activities or performance.

46. Concerning the observation o f the principle of transparency, the LPFMA requires the involvement o f relevant and interested parties in the budget preparation process. Whereas the Assembly formally endorses the KCB, the SRSG must subsequently promulgate the K C B and can even at this late stage, make changes without being required to publicly justify them. Such changes were made by the SRSG in the preparation o f the 2003 K C B . Disregarding the unique context o f the Kosovo administration, such practice does not correspond with the principle o f transparency.

~~

30 In 2003, tax revenues were projected at EUR 512.2 m i l l i on but had an outtum o f EUR 520.8 m i l l i o n (Fiscal Actuals and Trend Analysis Report, December 2003, Ministry o f Finance and Economy). 3’ The system operator interviewed estimated that the MFE makes some 200-300 such reallocations and overwrites in the Treasury System per year. A paper record is kept in a binder o f which there i s on ly one copy. The binder i s not kept in a f i le cabinet but in an open shelf. 32 As set out in the E C Financial Regulation.

47. l ow ing timelines:

Table 7. Calendar for preparation of KCB

The LPFMA establishes a calendar for the preparation o f the KCB with the fol-

Date March 15

April 1

April 30

M a y 15

Deadline not set in L P F M A , but communicated in budget circular At least 21 days pr ior t o EFC meeting o n KCB At least 14 days prior to EFC meeting o n KCB At least 7 days pr ior t o EFC meeting o n K C B Deadline not set out in L P F M A o r budget circular Deadline not set out in L P F M A or budget circular N o later than Octo- ber 30 N o later than De- cember 3 l Within 30 days o f Assembly approval and SRSG promulgation o f K C B

iource: UNMIK regu

Action Develop estimates and projections for economy for each o f next three years. Develop and submit proposed aggregate expenditure ceil ing for K C B .

Develop and submit aggregate expenditure ceilings for RPBOs and BOs respectively. Issue budget circular o n methodology and forms to be used by BOs in preparing appropriation request for fol lowing FY. CFOs prepare budget and appropriation requests o f BOs and submit to MFE.

Submit t o the SRSG and the EFC and i n f o r m the BOs about the proposed KCB.

Any objections f rom BOs to MFE with respect to the proposed KCB.

Responses f rom MFE to any objections f rom BOs submitted to SRSG and EFC.

Provides MFE with copy o f i t s advice concerning K C B to SRSG.

Decide o n any modifications to the KCB deemed necessary and forward to and i n f o r m MFE.

Formal transmission to the Assembly o f the KCB.

Formal approval by Assembly and promulgation by SRSG o f KCB. Publish the K C B as w e l l as explanatory documents thereon in a comprehensive and publicly understand- able form.

Institution(s) MFE in consultation with IMF and the W o r l d Bank MFE in cooperation with EFC, IMF and W o r l d Bank SRSG after consultation with EFC MFE

CFOs o f BOs

MFE

BOs

MFE

EFC

SRSG

Executive o f PISG/Government Assembly and SRSG

MFE

tion No. 2003/17, Law on Public Financial Management and Accountability

48. Although the timetable provided defines a process that ensures a t ime ly prepara- t ion o f the KCB, the process described in Table 7 also illustrates the need for a high degree o f transparency in the budget process. This has particular relevance for the ro le o f the SRSG, who the right to change the KCB. Al though the EFC i s required under LPFMA to in fo rm the MFE, and thereby the Government, about i t s advice to the SRSG, the SRSG i s not required to justify i ts modifications o f the KCB. Based o n the interviews conducted under the OFAR, this to some extent limits the credibi l i ty o f the budget process and the authority o f the Assembly.

49. The Kosovo Consolidated budgets for 2003 and 2004 both contained a Medium- term Expenditure Framework with estimates for the budget year and the two fol lowing fiscal years. As stated in the 2003 KCB, the MFE expected to facilitate a proactive budget development process, which would also include a “more thorough” 2003 mid-year review process to provide a solid foundation for developing the 2004-2006 budgets. The budget also referred to the establishment o f a Grants Commission and Budget Commis- sion to take important decisions on the Government’s behalf, including approving the 2004-2006 budget. The team did not, however, observe any significant changes in the process for preparing the K C B 2004-2006 when compared to the preparations made for the K C B 2003-2005.

50. The budget estimates for the three-year MTEF are prepared on the basis o f an analysis o f macroeconomic data and trends. In addition, the budget contains a short summary o f the Government’s future policy priorities. Whereas the framework provides for three-year budget estimates, the estimates clearly do not work as hard budget constraints, which to some extent undermine the value o f the exercise.

Actions of the KSIP

5 1. KSIP Standard 5, Action 3.1: Adoption of the KCB 2005. The budgeting process for 2005-2007 has been delayed, as the MFE has not yet issued the budget circular, which was supposed to be circulated by M a y 15. Apart f rom this, the OFAR found that the provisions o f the LPFMA were substantially complied with by the BOs covered by the review.33 The same can be said for the two municipalities reviewed.34 Although the OFAR did not review whether the budget policies or priorities being given sufficient attention to reserved power areas 35, i t does consider i t most likely that the K C B can be adopted in full compliance with the fiscal and budget regulations and the LPFMA by December 2004. Based on previous experiences, i t seems unl ikely that the MFE and other BOs would not take the recommendations offered by the IMF and other development partners, such as the Wor ld Bank, into due account. In conclusion, the OFAR finds that there has been some progress in fulfilling this action o f the KSIP.

52. KSIP Standard 5, action 3.2: Medium-Term Expenditure Framework. As the K C B 2003, the K C B 2004 also included medium-term projections for the two years following the budget year. Whereas this represents a move towards a Medium Term Expen- diture Framework (MTEF), practice has shown that the estimates have not been treated as hard budget constraints. One o f the observations made in preparation o f this report was the existence o f large carry-forward balances from one budget year to the next. As concluded in the analysis o f the budgetary principles o f the LPFMA, the inclusion and appli-

~~ ~~~~

Ministry o f Finance and Economy; Ministry o f Education, Science and Technology; M in i s t r y o f Health; 33

Ministry o f Transport. 34 Municipalit ies o f Prizren and Rahovec. 35 Include the fo l lowing administrative enti t ies: Customs; Economic and Fiscal Counci l (EFC) secretariat; Directorate o f Administrative Affairs; Directorate o f Civil Protection (KPC); Kosovo Police Service; Jus- tice; Kosovo Correctional Services; Directorate o f Rura l Affairs; Kosovo Trust Agency; Directorate o f In- frastructure Affairs; Radio and Television o f Kosovo; Independent Med ia Commission; Banking and Pay- ments authority o f Kosovo; Kosovo Pensions Savings Trust.

KOSOVO OFAR: BudQefina 29

cation o f the principle o f annuality would explicitly address this problem. The adoption o f the new public procurement law should facilitate the application o f this principle. Unl ike the old law, the new law enables BOs to enter into multi-year contracts without being required to make legal commitments in the budget. To support and promote the change to an annual appropriation system, the OFAR recommends that the Principle o f Annuality be included as a basic principle in the LPFMA. In order not to undermine a medium-term perspective, this should however be done in parallel with the continued development o f a MTEF, which would provide for multi-annual financing frameworks to be formally adopted by the Assembly, combined with appropriations being provided o n an annual basis. Based on a recommendation recently made by the IMF, priorities should be given to the development o f a proper annual budget process. Based o n the above the OFAR concludes that there has been some progress in completing this i tem o f the KSIP.

53. KSIP Standard 5, Action 3.3: Improved Budget Dialogue. Although the dialogue between the BOs and the MFE is currently not very comprehensive, i t does appear to provide for a distribution o f financial resources that meets the needs expressed by the BOs. For RPBOs, the dialogue with the MFE appears to be underdeveloped. This could relate to the lack o f clarity in the LPFMA where the distinction between RPBOs and BOs and their relations to the SRSG and the MFE i s made. The OFAR finds that there has been some progress in completing the action.

54. KSIP Standard 5, Action 3.4: Improved Budget Timetable Execution for Mid- Year review. With the adoption+ o f the LPFMA, a clear budget timetable has been provided for a mid-year review. However, the mid-year review has not been initiated and there has been a delay in the issuing o f the budget circular. I t should also be noted that the IMF mission o f March 10-19, 2004, recommended that no mid-year review be undertaken during 2004, and that al l effort be devoted to determining this year’s (2004) levels o f cash expenditure and to improving the quality o f the budget formulation process for 2005. This effectively changes the timeline for the action from mid-2004 to mid-2005. There has been limited progress towards completing the KSIP action in question.

55. KSIP Standard 5, Action 3.6: Monitoring of L P F M A Compliance. I t appears that staff responsible for budget and finance issues in Budget Organizations i s generally well aware o f the requirements and the procedures defined by the LPFMA. N o specialized agency or department o f the MFE i s specifically charged with monitoring or evalua- t ion o f the implementation o f the LPFMA. However, one o f the core services o f the internal audit unit o f the MFE i s currently to check whether BOs comply with the LPFMA and other relevant laws and regulations. The OFAR did not obtain any information about the coverage o f the MFE’s internal audit unit (IAU). Based on this the OFAR finds that there has been some progress towards completing this action.

56. KSIP Standard 5, Action 3.7: Fiscal Discipline and Efficiency. Measured in terms o f absence o f budget overflows, fiscal discipline seems strong. I t is, however, worth noticing that whereas the Annual Budget Reconciliation Report and the quarterly interim reports have been provided by the MFE, monthly reports have not. Although the OFAR i s not explicitly addressing the issue o f efficiency in budget allocation, the existence o f large outstanding commitments and appropriations from earlier budget years

clearly point to inefficiencies in the allocations. The OFAR finds that there has been some progress in completing this action.

111. Summary of Findings

57. Whereas staff numbers generally appear to be adequate, there i s a great need for specialist training, both in the MFE and in the l ine ministries. Currently, the budget process i s characterized by a low degree o f realism. In addition, the practice o f carrying forward appropriations from one year to the next contradicts the principle o f annuality, leaving large deposits o f appropriated funds unspent years after they were appropriated. The frequent use o f budget revisions further undermines the principle o f specificity and dis- torts the intended usage o f the originally approved budget. Budgets are not translated into measurable indicators for activities and perfonnance, thus complicating the application o f the principle o f sound financial management that ensures that f inds are spent in an economical, efficient and effective manner. The budget calendar adopted with the L P F M A represents a significant improvement both in terms o f a more reliable and timely budget process, and improved transparency. Generally, some progress has been made in completing the actions related to budgeting under the KSIP. The KSIP actions related to monitoring o f the LPFMA’s application (Standard 5, Action 3.6) and budget efficiency (Standard 5, Action 3.7) represent the greatest challenge.

IV. Recommendations

58. There i s a need to eliminate distortions in competition and transparency in the allocation process; predictability o f resources should increase supported by realism in budget estimates and a more realistic budget preparation calendar, whi le budget execu- t ion should be smoother. Thus:

Consideration should be given to outside scrutiny o f the budget framework before f i n a l i ~ a t i o n . ~ ~ This may assist in increasing projection realism. I t also appears likely that further support could be needed by the MFE to prepare a realistic fiscal framework underpinning the budget circular. Due consideration should be given to now abolish the practice o f carrying forward multi-year appropriations. Unspent amounts at the end o f the year should be canceled, and, if needed, could be re-appropriated in the fol lowing year (this i s possible for new contracts under the revised procurement law)37. Greater transparency in the budget revision process should be encouraged. In either case, extensive support would be needed to assist both MFE and BOs with capacity for developing budget planning and financial programming. No t only should the BOs be able to prepare a realistic cash-based budget for the whole year (per the LPFMA), but they should also be capable o f preparing quarterly or monthly cash requirement estimates. In relation to improved financial planning for procured goods and services, implementation o f the procurementhendor mod-

0

0

36 Under the current calendar, this process should take place in September-October This recommendation has been implemented as o f January 2005. 3 1

Kosovo OFAR: Budqetinq 31

ule o f the Treasury System should be carried out as soon as possible, to allow monitoring o f contracts. BOs’ financial plans should be submitted to and discussed with the MFE after completion o f the budget preparation process,38 with the view o f determining quarterly cash envelopes. This process should be duly legislated. Institutional arrangements should be made and legislated for, ensuring arbitration o f disagreements on allocation (this would pertain specifically to the role o f the Budget C o m m i ~ s i o n ) . ~ ~ The budget circular may need to be revised to al low more time for BOs and WBOs to prepare their submissions, and for MFE to scrutinize and discuss submissions with BOs and RPBOs. Technical assistance m a y be needed in the MFE to strengthen analytical capacity.

’* Under the current calendar: between November 1-December 3 1. Fo r further discussions o n institutional and organizational issues, see IMF report (2004) 39

Kosovo OFAR: Treasurv and Cash Manaaement Svstem 32

CHAPTER 4: TREASURY AND CASH MANAGEMENT SYSTEM

I. Background and Assessment Framework

Background

59. The Treasury, part o f the MFE, has implemented a Canadian financial management information system, “FreeBalance,” (hereafter the Treasury System) to control, monitor and report on revenues and expenditures. Relevant parts o f the system have already been rolled out to the 30 municipalities that have been reviewed for certification by a private audit firm.

60. The Treasury i s planning to ro l l out the I T infrastructure o f the Treasury System in the near future but this had until recently not been communicated to the l ine ministries and the other central Budget organizations. The team has now obtained a document setting out a concrete time bound plan to ro l l out the system from a USAID framework contractor providing technical assistance to the MFE.


61. Treasury information systems are commonly established to control spending, eff i- ciently implement the budget and minimize the cost o f Government borrowing. Such systems should be able to provide for secure execution o f payments, which includes recording the required preliminary checks and commitments, validations and authorizations. The Treasury Reference Model (TRM) developed by the World Bank and the IMF provides an outline for what a Treasury System should deliver (see Box 1 below):

Box 1. The Treasury Ledger System.

A Treasury Ledger System includes a set o f summary control accounts (the ledger) that maintain ~

~ budget authority and actual spending, and handles al l posting and reports generated f rom this data- ~ ’ base. Such a system can create transactions and authority (appropriations, apportionments and allocations), record a l l transaction details, and consolidate and disseminate information. Some exam- ples include: I

1 Create authority and transactions

’ - Distribute appropriation and commitment authorizations to spending ministries; ~

- -

Distribute allocations to spending ministries; Print checks against payments instructions andor arrange for the electronic transfer o f payment inforination to an external paying entity (for example a bank), if required.

I

Record transactions

- -

Record in i t ia l budgets, as approved by the legislature; Record expenditures against commitments and allocations (for example due to purchase orders or other payments); Record revenues and other receipts against appropriate accounts; Capture and maintain records throughout the year on: (a) init ial and revised budgets; (b) budget transfers for a typical PBO; (c) commitments incurred by PBOs against approved limits and appropriations; and (d) funding allocations against appropriations and subsequent changes.

- -

Consolidate and disseminate transaction in formation and reports

- - - -

Print consolidated payment instructions for action by the banlung system; Consolidate data f rom al l ministr ies and regional offices as necessary; Facilitate/support easy retrieval o f data in system databases in various formats; Produce good reports, such as commonly required accounting and management reports.

i

I - -- Source: Treasury Reference Model, Worki Bank 2001, p. 16

11. Findings

Legal Framework

62. The Treasury i s established under the provisions o f Section 3 o f the LPFMA. Ac- cording to the Law, a Treasury shall be established within the Ministry o f Finance and Economy and shall be responsible for managing the Kosovo Consolidated Fund and for discharging all other functions assigned to i t v ia the LPFMA. The LPFMA provides for clear assignments o f responsibilities when i t comes to authorization and execution o f payments and planning and handling o f cash. This includes the definitions o f the functions as CEO, CFO and Certifying Officer, comparable to the te rms “director,” “accounting officer” and “authorizing officer” in the E C Financial Regulation.

Kosovo OFAR: Treasurv and Cash Manasemenf Svstem 34

Institutional Framework and Capacity

63. In accordance with the LPFMA, the Treasury is headed by a Director appointed by the SRSG o n the advice o f the Minster o f Economy and Finance. The Director i s supported by a Deputy Director, who i s appointed by the Minister o f Finance with the con- sent o f the Government. Organizationally, the Treasury consists o f a central office located in the MFE in Pristina, and five regional offices in Gjilan, Mitrovica, Peja, Prizren and Pristina. The central office employs some 50 staff and each o f the regional offices between three and four staff, bringing the total number o f staff to some 65-70 persons.

Practice

64. Creating authority and transactions. The Treasury System provides for the Treasury to authorize transactions o f al l central and local BOs. Commitment and payment requests are made o n Commitment and Payment Order forms (CPOs). For the 30 municipalities that have Treasury System terminals, commitment information i s entered elec- tronically into the system while signed printouts o f the CPO and supporting documenta- t ion are physically delivered to one o f the five regional treasury offices. Ministries and other central agencies use paper copies o f CPOs and deliver the completed forms, with supporting documentation, to the regional Treasury office in Pristina, where a Treasury employee enters the data into the Treasury System. The processing o f a payment takes two vis i ts in person to a Treasury office: once to submit the commitment request, and a second time to submit the payment request. As this involves the physical presence o f a B O staff at the Treasury office, the process i s obviously very time consuming and inef f i - cient. Even for the municipalities with Treasury System terminals, i s appears that the Treasury does not want to rely on the electronic data only, but insists on paper-based authorizations. Furthermore, the highly unreliable local IT infrastructure makes the Treas- ury System volatile, unpredictable and slow. The actual execution o f payment i s done by the BPK, which until recently upon the receipt o f the original paper CPO, typed the same information into i ts own I-Flex system to initiate the processing o f the individual payment. This situation has however improved as the BPK can now process payments on the basis o f data in electronic format. Payment request are s t i l l not processed on-line but via a disk submitted by the Treasury to the BPK.

65. The Treasury System has not been rolled out to any PISG Budget Organizations at the central level or to Reserved Power Budget Organizations at the central level but to the 30 municipalities. Furthermore, the interviews conducted by the OFAR team le f t a clear impression that a rollout o f the system to ministries and other central agencies were not foreseen in the immediate future and had not been communicated to BOs. Recently the USAID framework contractor in the field o f P F M has obtained the MFE’s approval o f a plan to start the roll-out o f the Treasury System to l ine ministries in 2005.

66. Recording Transactions. The central Treasury enters the appropriations for al l Budget Organizations into the Treasury System. The central Treasury enters the appropriations for al l Budget Organizations into the Treasury system. Every three months allocations are distributed to the Budget Organizations. Until FY 2004, the allocations were based on non-dynamic spending plans submitted by Budget Organizations, which meant

Kosovo OFAR: Treasury and Cash Management Svstem 35

that each o f the three monthly allocations consisted o f one-fourth o f the annual appropriation. The Budget Organizations forward l i s ts o f persons to act as Certifying Officers (COS), who have the authority to approve commitments and payments. Payments are executed from the MFE’s account in BPK. However, numerous bank accounts exist and, as indicated in the External Audit Report for the K C B 1999/2000, the total number o f bank accounts held by various BOs i s in fact unknown, despite the fact that the only justification for their existence i s formally the occasional need for petty cash.

67. Consolidating and disseminating transaction information and reports. Several o f the Treasury System’s features, including for bank-reconciliation and vendors, were not being utilized at the time o f the OFAR mission in late February 2004. A working group has been mandated to develop a solution that would enable the interfacing between the BPK’s I-Flex transaction and accounting system and the Treasury System, which would enable the use o f a bank-reconciliation module that i s currently not being utilized.

68. The format o f the reports that can be generated from the Treasury System i s for many municipalities not appropriate. Local ly elected officials often request a degree o f detail that the Treasury System cannot provide. One o f the municipal BFUs complained that they had not been consulted or advised properly about the format o f the reports that can be generated from the Treasury System.

111. Summary of findings

69. The processes through which the CPOs flows and provides authority to make payments i s well regulated, but there are serious inefficiencies in the system, which partially derives f rom the continued insistence on manual authorization processes. There are key control modules o f the Treasury System that have not been implemented, including the bank-reconciliation module. Although the system executes payments f rom a single account in the BPK, numerous accounts continue to exist. As there i s no central clearing mechanism, these accounts are likely to have idle balances.

IV. Recommendations

70. The OFAR recommends that the MFE:

0

0

0

0

Should take action to close al l existing bank accounts and process al l transactions v ia the Treasury’s account in the BPK. W h i l e taking steps to strengthen i t s cash management function, seek additional support to hire and train staff. Should ro l l out the Treasury System to al l BOs, while ensuring the development o f appropriate financial’management skills, internal control and audit in the BOs. Together with the B P K should take the necessary action to implement the bank- reconciliation module o f the Treasury System.

Kosovo OFAR: Accountincl and Financial Reportinu 36

CHAPTER 5: ACCOUNTING AND FINANCIAL REPORTING

I. Background, Assessment Framework and the KSIP Action

Background

71. As stated in the Audit Report o f the External Audit o f the 1999/2000 Kosovo Consolidated Budget (KCB), the fragile nature o f accounting systems in the years covered by the first external audit o f the implementation o f the K C B made i t impossible to actually produce financial statements in a way that would normally be expected from public sector institutions. The auditors (the Dutch Supreme Audit Institution, Algemene Rekenkamer) also stressed that the UNMIK had made significant progress in the course o f 1999 under very difficult circumstances.

72. More recently, the partial roll-out o f the Treasury system appears to have improved the reliability o f financial reporting somewhat, though certain problems appear to prevail.


73. The underlying principles for sound financial reporting in the public sector are reflected in the EU's 2002 adopted E C Financial Regulation. Providing a benchmark for public sector financial reporting and a legal requirement for managing the EU's own funds, this regulation wil l serve as the basic assessment framework in this chapter. The accounting provisions o f the EC Financial Reg~lat ion,~' which broadly reflect the terminology and accounting principles o f the Intemational Accounting Standards (IAS)/Intemational Financial Reporting Standards (IFRS), include:41

0 The annual accounts o f an [EC] administrative body shall consist o f financial statements and a report on budget implementation, where the f i rs t reflects the financial position and financial performance o f the reporting entity and the latter, the cash revenues and expenditure processed during the period. Financial statements should draw on generally-accepted accounting principles, including: (a) a going concem; (b) prudence; (c) consistent accounting methods; (d) comparability o f information; (e) materiality; (0 n~-nett ing;~~ (g) presenting reality over appearance; and (h) accruals.43 Financial statements should consist o f

40 Summarizes the key issues addressed in articles 76-90 o f Commission Regulation No. (EC, Euratom) No. 234312002. Terms are used as in the regulation. 4 ' Although the EC financial regulation clearly refers to a publ ic sector context the Intemational Public Sector Accounting Standards (IPSAS) terminology i s not used. 42 That receivables and debt may not offset one another.

Commission Regulation (EC, Euratom) No. 234212002, Articles 187-195. These principles reflect the principles for presentation o f financial statements l a id down in IPSAS 1. The introduction o f accrual-based accounting principles to the public sector i s no t a legal requirement for EU Membership. Nevertheless, when it comes to the management o f funds f r o m the European Union's budget, the application o f accrual- based accounting principles i s a legal requirement indeed. This requirement appears separately in the relevant E C regulations for specific funds (for instance, Cohesion o r Structural Funds). I t i s also a general

0

43

a “balance sheet,” “economic out-turn account,” “cash-flow table,” “statement on changes in capital” and an annex that discusses and supplements the information (notes). Budget implementation reports should consist o f budget out-turn accounts on revenues and expenditures and an annex with comments and supplementary information. An institution’s accounting officer should submit the provisional accounts to the [EC’s] accounting officer no later than March 1. Then the EC’s accounting officer consolidates the Commission’s accounts. A computerized accounting system must be in place to organize an institution’s budget and financial information. Once i t is, figures may be entered, filed and reg- istered. Moreover, the computer facilitates an audit trai l that can track accounting data backwards and forwards in the system. The central accounting authority (in the E C context, the Commission’s Account- ing Officer) must adopt a harmonized chart of accounts that institutions can ap-

The director (the most senior manager) must submit thefinal accounts to the Commission’s Accounting Officer (the central accounting authority, for example, MOF) and to the Court o f Auditors (the supreme audit institution) by July 1. The Court o f Auditors should, in turn, publish them by October 3 1 o f the year fol lowing the financial year.

Ply*

The structure o f the chapter follows from the above overview o f the accounting and financial reporting provisions o f the E C Financial Regulation.

Actions o f KSIP

74. In this chapter, the OFAR wil l also assess the implementation o f the action o f the KSIP that relates directly to accounting and financial reporting. The action i s presented in Table 8 below:

Table 8. KSIP actions related to accounting and financial reporting 1. FUNCTIONING DEMOCRATIC INSTITUTIONS 1 1.4 Ministr ies, Municipalities and Public Utility Entities publish annual reports

1 Timeline I March 2004 on-

including their financial statements. The reports are provided to the Kosovo Assem- bly, Municipal Assemblies and UNMIK structures within three months o f the clos-

wards I I ing of the year. Source: The Kosovo Standards Implementation Plan (KSIP). March 31,2004

principle o f the EC Financial Regulations and its implementing regulations. The GFS2001, ESA95, IPSAS and IFRS share an important commonality; they promote and provide guidance on the use o f accrual-based accounting principles.

11. Findings

Legal Framework

75. Financial reporting from BOs i s regulated via the provisions in LPFMA Section 39, according to which the CFO o f a B O shall record transactions and maintain accounting records in accordance with the rules developed by the Treasury and promulgated by the MFE, in accordance with the LPFMA. This includes the provisions in the annual budget circular. In accordance with the LPFMA, the MFE shall prepare quarterly reports for the Government’s review to be submitted to the Assembly within thirty days from the end o f each quarter (LPFMA section 40.1). The reports shall contain information about executed revenues and expenditures, assets and liabilities. In accordance with the LPFMA, accounts are to be kept on a cash basis.

76. Budget Organizations are also required under the LPFMA to annually submit to the Minister o f Finance within 90 days o f the end o f the fiscal year an annual report o n its financial activities, including financial statements showing the appropriations for the fiscal year, actual capital and operating expenditures and the number o f employees (LPFMA section 39.4).

77. The provisions o f the LPFMA sections 39.2-39.4 require that CFOs and CEOs o f BOs provide the Director o f the MFE Treasury with a copy of: (i) the financial accounts and (ii) a confirmation in writing that the financial accounts o f the Budget Organizations for the fiscal year concerned are a true and accurate presentation o f the finances and f i - nancial transactions o f the Budget Organization. I t also requires that the Director o f the Treasury, within 90 days o f the end o f each fiscal year, reconcile the financial accounts received from Budget Organizations with fiscal accounts and cash balances, and provide the financial accounts for al l budget organizations to the Auditor General for auditing.


78. All Budget Organizations have a Chief Financial Officer (CFO) and a Budget and Finance Unit that i s responsible for the preparations o f the budgets, payment orders and financial reports and statements. The Chief Executive Officer (CEO) i s in fact legally required to appoint a CFO and a certifying Officer (CO), which have to be two different individuals. The capacity in accounting and for preparing financial statements is insufficient, which i s part o f the reason why the preparation o f the annual financial statements for the K C B s t i l l has to be done with the assistance o f foreign external consultants.

Practice

79. In the f i r s t years fol lowing the establishment o f UNMIK, financial reporting was much delayed. As indicated in the external auditor’s report, i t i s commonly recognized that the postwar period had a significant negative impact o n the financial management o f public funds. The external auditors’ report on the 1999 and 2000 Kosovo Consolidated Budget (KCB) was only finalized in September 2003. The external audit o f the execution

Kosovo OFAR: Accountins and Financial Reportins 39

and financial statements o f the K C B 2001 i s likely to have been completed, but i t was possible to obtain a copy o f the draft report from the MFE. Audits o f the K C B execution for 2002 are s t i l l to be done.

80. The annualflnancial statements for the K C B for 2002 and 2003 are being completed .with the assistance o f extemal consultants in accordance with the Cash Basis IPSAS. Financial statements for the K C B are only made public in connection with the extemal auditors’ finalization o f the annual audit o f the KCB. Generally speaking, the reports do not seem to be used as a strategic input to inform management decisions.

8 1. Budget Organizations submit quarterly reports on realized revenues and expenditures to the MFE on a quarterly basis. This i s done via diskette or on paper or both. Debts and guarantees are reported on at the same time but there i s no reporting on non- financial assets and liabilities. Budget implementation reports with aggregate data are available on a current basis fi-om the Treasury System.

82. As noted by the extemal auditor in the audit o f the K C B 1999/2000, cash accounting principles was not applied correctly in the fiscal years 1999-2000, as transactions pertaining to the fiscal year were accounted for in the subsequent year. In the response to the audit report the SRSG stated that starting in 2003, facilities in the Treasury System would be implemented which would partly address the problem. I t was however not made clear which aspects o f the problem would not be address. In conclusion, the problem does not appear to be resolved.

83. Ministries and other Budget Organizations o f the PISG do not have modem accounting systems but rely on spreadsheets or outdated computer software for accounting and financial reporting.

84. Budget Organizations reconcile the data in their own books with aggregate data from the Treasury System’s reports received f rom MFE. There are no formal requirements for regular reconciliation o f banking and accounting information, which are therefore most often not performed.

85. A practice o f overwriting appropriation data visible for the users o f the Treasury System means that a complete electronic audit trail that enables the tracking o f a l l changes in the accounting i s not readily available.

86. able. For accounting and bookkeeping as such, detailed written procedures do not exist.

With respect to the functions o f Treasury System, detailed guidelines are avail-

87. There i s a standard Chart o f Accounts (COA) that Budget Organizations are expected to use. The COA, however, does not have legal document status and has never been formally endorsed. In addition, the C O A i s very simple and does not seem to provide the kind o f detail that one would need for even the most common management deci-

~ i o n s . ~ ~ I t was clear from interviews with staff working at the Treasury that bookkeeping mistakes were frequent and that the C O A was not applied universally.

88. Most Budget Organizations do not have accounting systems but depend on the use o f spreadsheets. At the same time, the limitations to the data available f rom the Treasury System mean that Budget Organizations are quite dependent on keeping such records in parallel with the system’s records. For example, as the Treasury System does not have a vendor register and procurement module, the implementation o f al l contracts, no matter how big, have to be monitored outside the system.

89. The implementation o f contracts is monitored at the level o f the individual BO, typically v ia the use o f spreadsheets. Although appropriations in the Treasury System are made for the full amount o f contracts, including multi-year contracts, there i s no current monitoring o f contract implementation at the level o f the MFE.

Actions o f KSIP

90. KSIP Standard 1, Action 11.4: Timely Annual Reports and Financial State- ments. The financial statements and the subsequent audits o f the K C B for FY 1999-2002 were submitted with significant delays. I t is, however, expected that as o f FY 2004, annual financial reporting will be in accordance with the provisions o f the LPFMA. The law states that a final budget reconciliation report for the previous FY should be submitted to the Assembly and the SRSG no later than March 31, and that no later than June 30 a set o f financial statements in compliance with “the relevant international accounting standards that have been audited” should be submitted to these institutions. Considering the continued dependence on external consultancies for preparing the annual financial statements for the KCB, progress made in completing this action o f the KSIP has been limited.

111. Summary of findinps

91. Annual financial statements o f the K C B are submitted with several years’ delay. The accounts that are presumed to be kept on a cash basis do not respect cash-based accounting principles. There i s currently no formal requirement to use the COA, which i s therefore not used universally. The C O A used in the Treasury System does not provide for sufficient detail for spending units to be able to rely on Treasury System reports exclusively, and Budget Organizations need to operate parallel accounting systems to meet their information needs. Bookkeeping and accounting are typically done in spreadsheets or by hand rather than in standard computerized accounting systems. W h e n reallocations are made in the Treasury System, the visible data showing the original appropriations i s overwritten. This means that an audit trail tracking the reallocations i s not readily available from the system. Fulfilling Standard 1, Action 1 1.4 o f the KSIP seems ambitious and progress until today has been insufficient.

There are only some 1 15 individual entry options in the COA. As an example, the Ministry of Heal th only have one account available to record multitude of medical supplies (under account 01 3630-Medical supplies).

44

Kosovo OFAR: Accounting and Financial Remrfina 41

IV. Recommendations

92.

e

0

The OFAR recommends that:

The MFE assess the capacity o f the accounting functions, and prepare a comprehensive plan to hire, train and retain accountants. Whi le allowing for flexibility in the creation o f sub-accounts, the MFE review the COA, and consider issuing a set o f matching comprehensive accounting policies and procedures in close cooperation with al l Budget Organizations. Recording o f financial assets and liabilities should also be envisaged. The use o f the COA should be statutorily mandated by the MFE. The Treasury should develop a standard report in the Treasury System to track current reallocations and clearly identify originally appropriated amounts.

Kosovo OFAR: lnternal Control and Infernal Audit 42

CHAPTER 6: INTERNAL CONTROL AND INTERNAL AUDIT

I. Background, Assessment framework and KSIP Actions

Background

93. So far, internal control as a concept has only been addressed indirectly v ia the development o f an intemal audit function. In 2000, the Central Fiscal Authority (CFA) established an internal audit unit. Towards the end o f 2000, the unit had 11 auditors who were auditing ministerial departments and municipalities. With the establishment o f the MFE, the intemal audit unit was transferred to this Ministry.

94. EUR 1.9 mi l l ion project financed by the EAR. The project runs to January 2006.

The work to develop internal control and intemal audit i s currently supported by a


95. The intemal control framework, as defined by COS045 consists of:

0

0

0

0

0

Control environment: a management philosophy and code o f conduct; Risk assessment: creating objectives and identifying/analyzing risks; Control activities: policies, procedures and practices established and encouraged by management to ensure effective operations; Information and communication: a system that provides appropriate and timely management information; and Monitoring: evaluating the effectiveness o f the control system (a task that can be handled by an intemal audit entity).

96. Internal audit, which i s an integral, yet distinct part o f the internal control framework, i s intemationally regulated v ia the International Standards for the Professional Practice o f Internal Auditing (ISPPIA), issued by the Institute o f Internal Auditors (IIA). The ISSPPIA are summarized in Box 2 below:

Committee of Sponsoring Organizations o f the Treadway Commission : http://www.coso.org . 45

Kosovo OFAR: Internal Control and Internal Audit 43

1. F U N C T I O N I N G DEMOCRATIC INSTITUTIONS

12.3 Internal audit units established for ma in expenditure units o f KCB, and internal audits conducted 12.4 Results o n implementation o f audit recommendations noti f ied by each P ISG unit

Box 2: The International Standards for the Professional Practice of Internal Auditing (ISPPIA)

Timeline

June 2004

Annual

T h e Attribute Standards

1000 Purpose, authority and responsibility 1 100 Independence and objectivity 1200 Proficiency and due professional care 1300 Quality assurance and improvement T h e Performance Standards 2000 Managing the IA activity 2100 Nature o f work 2200 Engagement planning 2300 Performing the engagement 2400 Communicating results 2500 Monitoring progress 2600 Management’s acceptance o f risks

Implementing standards apply the attributeiperformance standards to specific types o f engagements (for example, a compliance audit, fraud investigation, control self-assessment, and so forth).

23.5 (2) PISG bodies introduce adequate internal financial controls and system o f internal audit

iource: The Institute of Internal Auditors:

Ongoing

KSIP Actions

97. the KSIP listed in table 9 below:

In this chapter, the OFAR wil l also evaluate the implementation o f the Actions o f

11. Findings

Legal framework

98. Although the assignment o f responsibility between HBOs, CEOs, CFOs and Cer- tifying Officer i s clear f rom the LPFMA, which also prescribes proper segregations o f duties between these functions, the Law does not define or use the concept o f intemal control. I t defines a number o f formal payment and accounting controls and sanctions that can be imposed in case o f violations o f rules and procedures.

99. Currently, there are no legal requirements to establish internal audit government- wide in the PRSG administration. The existing intemal audit unit (IAU) o f the MFE i s established in accordance with the provisions o f Section 8 o f the LPFMA.


100. Besides the IAU o f the MFE, there are staff designated to specialized internal control or financial control functions for the institutions covered by the provisions o f the LPFMA.

101. The MFE’s IAU consists o f 22 auditors, the majori ty o f which are newly recruited. This group constitutes the only currently operating IAU. However, some 50 staff within exiting ministries and municipalities has been recruited with the objective o f being trained and eventually functions as intemal auditors. The I A U ’ s auditors are generally not trained or experienced as modem internal auditors. Training needs, which are significant, wil l partly be addressed by a EUR 1.9 mi l l ion project financed by the EAR.

Practice

102. The control environment consists o f hard as well as soft controls46 applied by senior management to ensure that an organization and its staff act in accordance with the organization’s business objectives and policies and in a way that i s legal, economical, efficient and effective. This would include values communicated explicitly through formal policies and communiquks, and implici t ly through the behavior models set by senior management. I t also involves organizational structures and a system for delegating authority, as well as adherence to sound financial reporting and accounting practices. The organizational setup, as well as the existence o f a formally adopted C iv i l Service Code o f Conduct, provides a foundation for a sound control environment in the Kosovar public sector. Sti l l , management generally does not take on a proactive role in providing ethical guidance and leadership. Recent reports on corruption in Kosovo suggest that although corruption does exist, i t shows a more optimistic picture than in other countries in the region. 47

103. framework, are not a common part o f public sector management.

Risk assessments, which should be an integral part o f a sound intemal control

104. Comprehensive user guides exist for payment and authorization processes related to the Treasury System. In addition, the regulatory framework, including primary and secondary legislation, i s in place. However, detailed written procedures with job descriptions are not common. In addition, Budget Organizations that are not connected with the Treasury System (all ministries except the MFE) do not have the detailed process guide- l ines provided to those who operate the Treasury System. In terms o f control activities, a shortcoming exists in that reconciliations between banking and accounting information _____

46 I t i s common in the framework o f the “COSO” model to distinguish between “hard” and “soft” controls; soft refers to informal controls and hard refers to the more traditional, formal controls.

“Corruption in Kosovo: Observations and Implications for USAID,” Management Systems International, Washington DC, July 10, 2003.

47

are generally not performed. This also goes for those institutions that are linked to the Treasury System, as the module in the system that can provide for this i s not activated. This was also reported by the Extemal Auditor’s report on the 1999/2000 Kosovo consolidated accounts.48

105. In terms o f communication and infurmation, the Treasury System does provide for some systematic financial transaction data at an aggregate level. However, for many decision-makers the reports from the system are not sufficiently detailed to inform their decisions. They therefore depend on their own, parallel system for accounting information. Systems to measure operations, controls o n their efficiency and effectiveness are neither wel l developed, nor are the instruments for monitoring of regularity, efficiency and effectiveness o f operations.

106. Internal Audit. I t i s the MFE’s declared intention to develop a govemment-wide decentralized internal audit system, with the support o f the EAR-financed PIFC and internal audit project. Currently, the system consists o f the IAU o f the MFE, where efforts seem to be focused on strengthening the unit, rather than facilitating and supporting the development o f IAUs in other ministries. I t i s not clear from the IAU’s legal base or the audit charter what role the IAU o f the MFE sees for i t s e l f in a future decentralized system o f IAUs.

107. Reports produced by the IAU in recent years appear to focus on compliance with budgeting and procurement rules and the quality o f bookkeeping. Although the issues being raised reflect the types o f problems faced by the PISG administration, they also reflect an approach to internal audit where l i t t le emphasis i s placed on the effectiveness o f the management systems but rather on compliance with ru les and procedures.

108. The IAU o f the MFE functions as a central inspectorate that primari ly reports to the MFE to provide an assurance on the legality and regularity o f the financial transactions, rather than to the management o f the audited organization to improve i t s operations and the effectiveness o f risk management, control and governance processes. In this respect, i t does not correspond wi th the IIA’s definition o f internal audit.49

109. There i s an internal audit charter for Kosovo issued in August 2003, which reflects the key issues o f the ISPPIA, including audit planning considerations and reporting requirements. The charter i s applicable to ministerial intemal audit departments. I t em- phasizes a system approach to internal audit similar to the approach promoted via the ISPPIA.

110. With respect to the operation o f the MFE’s IAU, i t appears to operate with a high degree o f independence and to have in place a formalized audit planning process. Judging from i t s reports, the competencies o f the auditors are primarily in the field o f administra-

48 The report i s available f r o m the Algemene Rekenkamer’s web-site: http://www.rekenkamer.nl/ Internal auditing i s an independent, objective assurance and consulting activity designed to add value 49 ( 6

and improve an organization’s operations. I t helps an organization accomplish i t s objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness o f risk management, control, and governance processes (IIA).” See Annex I1 for other relevant references.

Kosovo OFAR: lnfernal Control and lnternal Audit 46

tive procedure and bookkeeping. Training to develop a broader range o f competencies i s foreseen as part o f the EAR-financed internal audit and intemal financial control project.

11 1. Since 2001, the IAU o f the MFE completed 25-30 audits annually. Judging from the small sample o f audit reports reviewed, the areas selected for the audits have general ly been material. Whereas the audits clearly act as a deterrent they do not appear to have any focus nor impact o n the effectiveness o f management control systems or operations, as they are typically focused on specific procedural mistakes.

KSIP Actions

112. KSIP Standard 1, Action 12.3, and Standard 2, Action 23.5: Internal Financial Control and Internal audit. The progress in the establishment o f a government-wide system for internal financial control and internal audit has so far been limited. Concerning internal audit, the only operating intemal audit unit is the UU o f the MFE.

1 13. KSIP Standard 1, Action 12.4: Implementation of audit recommendations. Since the Kosovar administration i s unfamiliar with the functioning o f external and internal audit, the expectation that recommendations from auditors wi l l be implemented rigor- ously i s very ambitious at this stage, though feasible in the medium- to long-term. For the internal audits undertaken by the MFE’s IAU, there has been some progress in the implementation o f audit recommendations.


114. The key components that would constitute a sound internal control framework are absent. Public sector management generally does not take on a strong ethical leadership role. There i s a lack o f written procedures for the majority o f Budget Organizations, namely those that are not linked to the Treasury System (all ministries except MFE). Cer- tain basic control activities are typically not performed. This includes bank- reconcilia- tions. W h i l e the IAU o f the MFE provides an important ex-post assurance function for the MFE, there i s no government-wide internal audit system to support the management o f individual Budget Organizations.

11 5. The IAU o f the MFE consists o f 25 staff. Overall, the staff is untrained, and the management culture in the administration i s not conducive to a modem understanding o f an intemal audit function. Development o f internal audit i s supported by the European Agency for Reconstruction (EAR) v ia a EUR 1.9 mi l l ion project over a two-year period. However, given KOSOVO’S capacity constraints, i t i s l ikely that, as in other former social- i s t countries, the IA function wil l take a long time to develop across central and local administrations, with possible implications on the development o f the PFM function. First, i t should be expected, and indeed desirable, that audits wil l in a first stage focus on compliance. Second, as mentioned above, i t i s likely that increased authority to BOs and municipalities wil l await an operational control and audit framework.

Kosovo OFAR: internal Control and internal Audit 47

IV. Recommendations

116. The OFAR recommends that:

The EAR project design be discussed with long-term partners in Kosovo to identify possible areas where additional actions and financing may be warranted; for example, facilitating and financing intemationally-recognized exams (for instance, Certified Internal Auditor), for a number o f public sector internal auditors.

Kosovo OFAR: External Audit 48

CHAPTER 7: EXTERNAL AUDIT

I. Background, Assessment Framework and KSIP Actions

Background

117. Recognizing the need to establish a Supreme Audit Institution (SAI) in Kosovo, a UNMIK regulation establishing the Office o f the Auditor General (OAG) was issued and put into effect in 2002. The OAG has not yet undertaken its f i rs t audit o f the execution o f the KCB, which so far has been contracted out to the Dutch SAI, the Algemene Rekenk- amer. Reports on the audit o f the UNMIK accounts o f 1999/2000 and 2001 have just been made public, although the audits for 2002 and 2003 were s t i l l being prepared at the time that data for the OFAR was collected (up until September 2004).

118. In 2003 the EAR launched a EUR 2.2 mi l l ion project, “Support to the Creation and Establishment o f a Supreme Audit Institution in Kosovo,” to be implemented over a period o f 44 months. In November 2003, a former Auditor General o f Sweden took up the position as Auditor General and established the Office o f the Auditor General (OAG).


119. The commonly accepted standards for SAIs, to which the OFAR refers, are the INTOSAI Auditing Standards (AS). The content o f the I N T O S A I AS i s summarized in Box 3 below:

Box 3. Overview of the INTOSAI Auditing Standards

notified 12.2 Auditor General’s reports submitted to SRSG and the Assembly 2. RULE OF LAW 23.4 Auditors within Auditor General’s office trained and performing regular audits of financial activity o f government bodies 23.5 (2) PEG bodies comply fully with audits from Auditor General’s office

Basic Principles in Government Auditing Promotion of public accountability Legal basis for access Conflicts o f interest

General Standards in Government Auditing Independence Competence Applying standards Recruitment Training and development Audit guidance Staff composition and adequacy Monitoring efficiency and effectiveness

Field Standards in Government Auditing Planning Supervision and review

Audit Evidence Analysis o f Financial Statements

Study and evaluation o f Internal Control Compliance With Applicable Laws and Regulations

Reporting Standards in Government Auditing Fairness, accuracy and timeliness Statements o f assurance

,ource: INTOSAI: http://vvwiv. intosai.org

December 2004

Ongoing

Ongoing

KSIP Actions

120. 10. Progress o n the implementat ion o f these actions i s assessed in paragraphs 130. 134.

The specific actions in the K S I P that relate to the OAG are l is ted b e l o w in Table to

Table 10. KSIP actions related to external audit

1. FUNCTIONING DEMOCRATIC INSTITUTIONS 12.1 Audit plans drawn up by Auditor General’s Office every year in advance and 1 March 2004

I Timeline


11. Findings

Legal framework

121. Obviously, there are special circumstances for Kosovo, which just i f ies or explains some o f the specific characteristics o f the UNMIK Regulation No. 2002/18 o n the Office o f the Auditor General o f Kosovo (OAG Regulation). However, as a guideline for the future development o f a Supreme Audit Institution (SAI) in Kosovo, in l ine with international standards and practice, the OFAR believes that it could s t i l l be useful to identify those parts o f the regulation that wil l clearly have to be reconsidered if the present SA1 o f Kosovo i s to become a fully equal member o f the I N T O S A I family.

122. The detailed descriptions and definitions in Section 1 o f the OAG Act, on the different types o f audit that the O A G should be able to undertake, are not completely aligned with the terms used in the INTOSAI AS. These descriptions should preferably be replaced with references to the INTOSAI AS, for example to define regularity, financial and attestation audits.

123. The O A G Regulation would be clearer if Section 1 would simply refer to “internal control” rather than to an “internal control function,” as internal control i s not a specific function but rather the “sum” o f al l controls put in place by management. The defi- nit ion used appears to exclusively consider physical inspection and control activities.

124. The procedures for the appointment o f the AG set out in Section 2.4 o f the O A G Regulation do not provide any indication o f the recruitment and selection procedure, for example, whether the selection wil l be done via open competition or appointment. This also relates to Sections 2.6 and 2.9 o f the O A G Regulation. In addition, the tenure, stipu- lated to be between three and five years, seems to be short. Certainly, five years would be more appropriate than three years.

125. In Section 13.4.1 o f the OAG regulation, the reference to “EU auditing standards” i s unclear, since there are no commonly accepted auditing standards that carry this idedconcept. At the same time, a number o f standards may qualify to carry this reference, including the EU Implementing Guidelines for the I N T O S A I AS.

126. Although Sections 3.3 and 4.10.3 are somewhat ambivalent on this issue, SA1 reports should be made public as a matter o f principle. I t could o f course be decided in specific cases that the reports should be confidential, but this should be an exception rather than the rule.

Institutional framework

127. The Auditor General (AG) i s an intemational c iv i l servant with significant experience from a position as AG o f the Swedish SAI, Riksrevisionverket. Currently, the O A G consists o f a small secretariat supporting the AG, and a group o f some 20 auditors who are to be trained to perform audits. Resources for the development o f the OAG training and methodology are provided from an EAR-funded project. For the actual audit o f the

accounts for 2003 to 2005, the AG expects to contract out the audit for execution by the KCB, for example, to the Dutch SAI, the Algemene Rekenkamer.

128. Judging from the Audit Report for the External Audit o f the 1999 and 2000 Kos- ovo Consolidated Budgets, which were produced by small, six-auditor teams, the Alge- mene Rekenkamer would also be competent to undertake the audits o f the K C B for the 2003,2004 and 2005 KCBs in accordance with the I N T O S A I AS. The OFAR has, however, neither been mandated nor prepared to assess the suitability o f the Algemene Rekenkamer as auditor for the KCB.

Practice

129. Application of the INTOSAI AS. A s the O A G is not yet operational, i t has not been possible to assess i t s application o f the INTOSAI AS in practice. For certain aspects, for example concerning the development o f methodology and training o f auditors, an EAR-financed project are assisting the OAG. The project wil l provide EUR 2.2 m i l - l ion o f funding over 3 years and should be sufficient to prepare auditors for the audit o f the K C B execution 2006 undertaken solely by the OAG auditor with extemal assistance in planning and reporting.

130. I t i s expected that that the O A G contracts out the execution o f the K C B 2003 and 2004 to the Algemene Rekenkamer, as was the case for K C B execution for 1999-2002. Audit reports are authoritative and are commented o n by the relevant authorities, including the SRSG. The audit reports are however made public with considerable delay5'. This lack o f transparency does not support an effective implementation o f the reports' recommendations. Although there are minor shortcomings in the O A G regulation, i t does provide for a broad mandate for the extemal audit and i t s functional independence. The O A G itself i t i s not yet capable o f fulfilling its mandate, but wil l have to rely o n either external support or contracting out for the extemal auditing o f the two next fiscal years.

KSIP Actions

131. KSIP Standard 1, Action 12.1: External audit plans. At the time o f the OFAR appraisal mission (February 2004), the AG was considering the support needed to carry out the audits o f the K C B execution for 2003 and 2004. I t was later decided that audits on the K C B implementation for 2003 and 2004 would be contracted out to the Algemene Rekenkamer. According to the information obtained, the O A G has not prepared audit plans for 2005.

132. KSIP Standard 1, Action 12.2: External audit reports. The extemal audit wi l l be camed out by the Algemene Rekenkamer. The 2002/2003 KCB audit report was submitted to the SRSG in January 2005.

jo Bo th the audit report for the fiscal years 199912000 and the one for fiscal year 2001 were made public several months after there completion and formal submission to the SRSG.


133. KSIP Standard 2, Action 23.4: Auditor General’s Office Training. At the time o f the OFAR appraisal mission, the training o f auditors was about to start. The OFAR concludes that there has been some progress in completing this action.

134. KSIP Standard 2, Action 23.5: Full Compliance with external audit recommendations. Judging from the response o f the SRSG and EFC to the audit report o f the accounts 1999/2000, it i s reported that out o f 56 recommendations made in the audit o f 200 1,45 are recommendations that fol low up on the 1999/2000 audit. N i n e were reported to have been agreed and implemented; 28 are agreed and are in the process o f being implemented; 5 are agreed and are s t i l l to be implemented, while 13 recommendations were agreed but n o further action has been taken. From this, it must be concluded that there has been l imited progress in completing this action. The reports with detailed recommendations from the external auditor on the financial statements o f the K C B for 1999/2000 and 2001 have been made public with considerable delay. I t should be emphasized that the audits for the fiscal years 1999-2001 did not concern any PISG, but UNMIK organizations exclusively.


135. There are minor shortcomings in the legal framework that the OAG should seek to address in the medium term. These include the absence o f references to the I N T O S A I A S definitions o f different types o f audit; ambivalence concerning whether audit reports should be made public; and lack o f specificity concerning the procedures for appointment o f the AG. The O A G i s s t i l l not fully staffed or operational, but plans to rely o n external support and contracting out to perform i t s function for the next two annual statutory audits. Although the OFAR i s unable to verify the completion o f the KSIP actions for external audit, most seem within reach under the set deadlines. When i t comes to compliance with the recommendations o f the audit o f the K C B (KSIP Standard 2, Act ion 23.5), progress has been limited. These recommendations, however, were addressed to the UNMIK and not to the PISG, although some organizations that were under UNMIK authority in 1999 and 2000 are now part o f the PISG. This includes, for instance, the MIFE (before the CFA). If the O A G rel ies on contracting out to other SAIs, the external audit capacity could be considered adequate. Should the OAG decide to undertake the upcom- ing audits o f the K C B execution relying on i t s own capacity, i t would not be adequate to perform the task. The delays in making the K C B audit reports public i s a matter o f matter o f great concern.

IV. Recommendations

136. Based on the above, the OFAR recommends that:

0

0

As matter o f high priority the K C B annual audit reports most be made public as soon as possible after there completion and formal submission to the SRSG. As with internal audit, the plan for external audit development should be discussed with partners, so as to identify possible gaps. In that case, complementary financing should be sought. A contribution from the World Bank, which would be


a useful supplement to the on-going development program, would be the facilita- tion and financing o f internationally-recognized auditor certifications. The OAG regulation on the OAG’s initiative should be amended to reflect that explicit reference should be made to definitions in the I N T O S A I Auditing Stan- dards when referring to different types o f audit, for instance regularity audits. In order to support the implementation o f the KSIP, action 12.1, the OAG should consider ways to externally communicate the completion o f the audit plan for the audit o f the K C B execution o f 2005. The OAG should prepare an information campaign aimed at raising awareness o f the OAG and i t s basic role and function in a Parliamentary democracy. This campaign should also be aimed at informing and educating members o f the Assembly.

0

0

0

Kosovo OFAR: Financial AccountaMitv Arransements for Local Government 54

1 1.4 Ministries, Municipalities and Public utility Entities publish annual reports including their financial statements. The reports are provided to the Kosovo Assembly, Municipal Assemblies and UNMIK structures within three months o f the closing o f the year.

CHAPTER 8: FINANCIAL ACCOUNTABILITY ARRANGEMENTS FOR LOCAL GOVERNMENT


I. Background and assessment framework

Background

137. In 2002, the municipalities o f Kosovo transitioned to greater local autonomy. The 2002 Kosovo budget provided an intergovernmental transfer system to finance the transferred responsibilities as well as general municipal services. Municipalities now account for approximately 20 percent o f total K C B expenditures. As part o f the process o f transferring fiscal responsibility, each municipality is required to have i t s financial management systems certified by an independent auditor. In view o f the proportion o f the K C B for which municipalities are now responsible, as wel l as the scarcity o f local qualified accountants, this area o f the Kosovar PFM framework i s considered a priority area for continued capacity development.


138. In terms o f assessment framework, the OFAR will apply the same framework as for the central administration for the different parts o f PFM, namely PFM and financial accountability framework, cash and treasury management, accounting and financial reporting, intemal control, intemal audit and extemal audit. For details see the above chap- ters.

KSIP Actions

139. in Table 11 below:

In this chapter the OFAR wil l also assess the implementation o f the action listed

11. Findings

Legal Framework

140. Under the Constitutional Framework provided via UNMIK Regulation No. 2001/9, municipalities are defined as the basic territorial units o f local self-government. When i t comes to the responsibilities of the municipalities, these are stated in UNMIK Regulation No. 2000/45 on Self-Government o f Municipalities in Kosovo. W h i l e explicitly referring to Article 3 o f the European Charter o f Local Self-Government, the Regula-

Kosovo OFAR: Financial Accounfabilifv Arrangements for Local Government 55

t ion establishes “the right and the ability o f local authorities, within the limits o f the law, to regulate and manage a substantial share o f public affairs under their own responsibility and in the interests o f the local population.” Regulation No. 2000/45 requires municipali- t ies to publish an audited annual financial statement and the Central Fiscal Authority to appoint an independent auditor to audit the financial statements o f each municipality. Af- ter the discontinuation o f the CFA and the transfer o f i t s competencies to the MFE and the EFC Secretariat, i t i s not clear who would be responsible for appointing the auditors.

141. Financial management and accountability for municipalities i s regulated v ia Sec- t ion 55 o f the LPFMA. This implies that municipal budgets are prepared and implemented in accordance with the provisions applicable for the central Budget Organiza- tions, while any references to officials, employees or budget organizations “shall be read, for the purpose o f the application o f the LPFMA, to cover the corresponding municipal officials, employees and public authorities.”

142. The legal framework provides for basic structures to ensure accountability, while ensuring both local autonomy and the right o f central govemment to exercise supervision.


143. The regulation on Self-Government o f Municipalities in Kosovo defines the responsibilities or potential responsibilities o f municipalities. The areas are listed in Table 12 below:

Table 12. Responsibilities and powers of Municipalities

(a) Providing basic local conditions for sustainable economic development; (b) Urban and rural planning and land use; (c) Licensing o f building and other development; (d) Local environment protection; (e) The implementation o f bui lding regulations and bui lding control standards; (f) Service provision in relation to local publ ic uti l i t ies and infrastructure including water supply, sewers and drains, sewage treatment, waste management, local roads, local transport, and local heating schemes ; (g) Public services including f i re and emergency services; (h) Management o f municipal property; (i) Pre-primary, primary and secondary education; (j) Primary health care; (k) Social services and housing; (1) Consumer protection and public health; (m) Licensing o f services and facilities, including entertainment, food, markets, street vendors, local publ ic transport and taxis, hunting and fishing and restaurants and hotels;

burce: Regulation on Self-Government of Municipai

(n) Fairs and markets; (0 ) Naming and renaming o f roads, streets and other public places; (p) The provision and maintenance o f publ ic parks and open spaces and cemeteries; (4) Such other activities as are necessary for the proper administration o f the municipality and wh ich are not assigned elsewhere by law.

In addition to the activities specified in the Section above, municipalit ies may take action within their territories in relation to other matters o f concern to the municipality. These may include the fo l lowing activities:

(a) Tourism; (b) Cultural activities; (c) Sports and leisure; (d) You th activities; (e) Economic promotion; (f) Civ ic promotion.

ies in Kosovo, UNMIK regulation No. 2000/45

Kosovo OFAR: Financial Accountability Arranaements for Local Government 56

144. There are 30 municipalities. As required by the RSMK and the LPFMA, the municipal administrations visited5' had an administrative set-up that included an appointed CEO and a CFO, a Treasury and a Budget Department. Whereas staff numbers seem adequate, there i s an evident need for specialist training in operating and better ut i l iz ing the Treasury System, which despite i t s online instability has a greater potential when it comes to producing various financial reports.

145. Municipalities were expected to spend some 22.7 percent o f the K C B in 2004.

Practice - Financial Management and Accountability

146. Budgeting procedures are carried out as prescribed by the LPFMA. This implies that budget proposals are prepared by the local CFO after having received the budget circular from the MFE. This proposal i s discussed by the local government and agreed with the local assembly before i t i s forwarded to the MFE. As the municipalities are l inked to the Treasury System, their commitments and payments are al l carried out v ia the System. The System has been certified by a private audit firm.

147. The format o f reports from the Treasury System does not meet the needs o f municipal administrations for financial reporting. In one o f the municipalities that the OFAR visited, the Budget and Finance Director complained that the type o f reports he was asked to present before the local assembly could not be generated f rom the system. I t should be noted, however, that in a smaller municipality visited, the CEO seemed to rely on the reports h e received from the Treasury System. Still, in both cases the administra- t ion maintained parallel accounting and bookkeeping systems, either in an Excel spread- sheet or in a DOS-based database. In addition to this, one o f the municipalities kept a handwritten record o f al l entries made in the Treasury System.

148. o f internal control i s not a recognized concept in the public sector in general.

There are typically no internal audit functions in municipalities and the concept

149. The requirement o f Regulation 2000/45 to appoint an independent (external) auditor for each municipality had not been enforced by the time the KCB 1999/2000 was audited (September 2003). Subsequently, external audits o f municipalities have been undertaken by the Algemene Rekenkamer in i t s capacity as the auditor o f the K C B .

150. As two demonstrations o f the system showed, users are often unable to establish or maintain online connections to the Treasury System. This volatility o f the IT infrastructure prevents optimal use o f the system. During one o f the demonstrations o f a Treasury System terminal, which was made for the OFAR, the user o f the system was repeatedly denied access to the system, apparently due to a volatile online connection. The MFE should conduct a survey among the 30 municipalities and the 5 regional Treas- ury offices in order to get a complete picture o f the IT problems faced by these offices.

5 ' Prizren and Rahovec.

Kosovo OFAR: Financial Accountability Arranuements for Local Government 57

KSIP Actions

15 1. KISP Standard 1, Action 11.4: Timely Annual Reports and Financial State- ments. According to regional treasuries, there are many reporting mistakes on the part o f municipalities when they submit commitment and payment requests. Often the wrong account in the C O A i s used. Annual reports were significantly delayed for the fiscal years 1999 through 2002. The annual financial statements for 2002 and 2003 are being completed with the assistance o f a contracted party. Progress in completing the action has been limited.

111. Summarv of findings

152. As opposed to the l ine ministries, the municipalities have a great advantage in being linked to the Treasury System, where they can enter commitment information to process payments directly. The actual authorizations are, however, s t i l l paper-based and the supporting documentation i s s t i l l physically presented to the regional Treasury offices. The visits in two municipalities showed that the Treasury System i s somewhat unstable, partially due to the weaknesses in the IT infrastructures. There are strong indications that financial reporting i s not uniform, and that the C O A i s not universally applied. Currently, there are no internal audit systems in place at the municipal level.

IV. Recommendations

1 5 3. The OFAR recommends that:

e Accounting and bookkeeping practices in al l municipalities should be reviewed in order to identify the most common problems faced by municipal Budget and Fi- nance Units (BFUs). This should be done in preparation for the development o f a new chart o f accounts and new accounting policies.

58

ANNEX 1: ECONOMIC, SOCIAL AND NATIONAL ACCOUNTS DATA

Selected Economic and Social Data

Area Population L i f e exDectancv at birth Total ferti l i ty rate Poverty: 0 Population living in extreme poverty, under

food poverty l ine (2100 calories or US$O.88 per day) Population living under full poverty rate (US$ 1.65 per day)

0

1 1,000 square kilometers 1.892 mi l l ion (estimate) 7 1.5 vears (males): 76.5 vears (females) 2.6 births

14.9%

36.3%

National Accounts and Balance of Payments D a t a

Sources: IMF, CFNMOFE, Staff estimates * 2003 figures are projections

52 IMF estimate, prepared this year and based o n a populat ion number o f 1.9 mil l ion, excluding displaced persons o r refugees living outside Kosovo. The calculations are based on current prices and USD/Euro exchange rates.

54 Ne t Transfers f rom Abroad & General Budget Revenue calculation i s based o n current prices. GDP growth rates based on annual growth in local currency (Euro) to exclude exchange rate movements. 53

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ANNEX v: KEY PERSONS INTERVIEWED (IN ALPHABETICAL ORDER)

Name Function/ title Institution

AHLENIUS

ALI

ARIFI

BUBLAKU

BUNJAKU

BUZHALA

DAVIES

DENTON

DICK

DUBOVA

GERGURI

HAFIZ

HUSSEIN

ISLAM1

ISMAJLI

Inga-Britt

h e r

Habib

Rrahim

Ardiana

Xhavit

Greg

N e i l

Jasper

Jeton

Gani

Esad

Shehada

Musa

Lulzim

Auditor General Auditor General’s Office, UNMIK

Manager

Head o f Regional Treasury Off ice

Head o f The Divis ion for Budget, Finance & Plan- ning

Executive Director

Head o f PIU

Head o f Off ice

Director

Head o f Financial Report- ing

Chief o f Treasury

Manager

Director o f Economy and Finance

Resident Advisor

Deputy Head o f Treasury

Act ing Head o f Treasury

Deloitte & Touche, Pristina

Treasury Off ice o f Gj i lan

Ministry o f Education, Science and Technology

Society o f Certif ied Account- ants and Auditors o f Kosovo, S C A A K

Ministry o f Heal th

DFID Kosovo

Deloitte & Touche, Pristina

Pristina Airport

Post and Telecommunication in Kosovo, P T K

Research and Statistics De- partment, Banking and Pay- ment Author i ty o f Kosovo (BPK)

Municipal i ty o f Prizren

IMF, BPK

Ministry o f Finance and Econ- omy


Kosovo OFAR: Annex V: Key persons Intenliewed 70

IVES

JASHARI

KAOLLI

KAUFFMANN

KELMENDI

KRASNIQI

KRYEZIU

LASPASHTICA

LEEDS

MEHMETI

MEYER

MILO

MORINA

MULLER

NOVOBERDA

OSMANAJ

PERLASKA

M i k e

Avni J.

H a b i b

&-is

V i sa r R.

Agim

Ibrahim

H i d a j ete

Stephen L.

F e h m i

Alexandra

Petraq

B a l i

Thilo

Senavere

Rexhe

M arj an

Former Head o f Central Fiscal Authority and EU Pillar Fiscal Affairs Office

Deputy Head o f Finance

Head o f Regional Treasury Office

Co-Head o f Treasury De- par tment

Financial Director

Budget Director

Chief Executive Officer

Data Entry Assistant

Budget Policy and Devel- opment Advisor

Director

Adviser Financial Man- agement

Director o f Policy Advice

Head o f Regional Treasury Office

Task Manager, Good Gov- ernance & C iv i l Society Sector

Head o f Regional Treasury Off ice

Head o f the Budget and Finance Department

Executive Chief

UNMIK

Kosovo Trust Agency

Treasury Off ice o f Prizren

USAID, Economic Recon- struction Project, Ministry o f Finance and Economy

KEK


Municipal i ty o f Rahovec

Central Treasury, Ministry o f Finance and Economy


Internal Audit Unit, Ministry o f Finance and Economy

EU Pillar Fiscal Affairs Office, UNMIK

EU Pillar Fiscal Affairs Office, UNMIK

Treasury Office o f Mitrovica

European Agency for Recon- struction, Kosovo

Treasury Off ice o f Peja

Ministry o f Transport

Public Procurement Agency, UNMIK

Kosovo OFAR: Annex V: Kev Refsons Interviewed 71

RECI Adilane Director o f Administration and Finance

RRUSTEMI Naim Director

SANEJA Shkumbin Functional Consultant

SEFAJ Sefedin Permanent Secretary

SERT Mustafa Internal Audit Advisor

WAELKENS Benoit Deputy Governor

WILSON Heather Project Officer

Ministry o f Education, Science and Technology

Institute o f Public Administra- t ion o f Kosovo

Treasury Ledger Project, Min- i s t r y o f Economy and Finance


Internal Audit Unit, Ministry o f Finance and Economy

Banlung and Payment Author- ity o f Kosovo (BPK)

Auditor General’s Office, UNMIK

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