Setting up effective control systems in ULBs

BACKGROUND

The study undertaken by the World Bank under the caption “Public Financial Management and Accountability (PFMA) in ULBs in India”, infers that the main constraints to strong PFMA in ULBs are the weak legal framework, less demand for accountability, lack of incentives for compliance with existing rules and limited use of guidelines. The World Bank report recommends strengthening the audit function in urban local bodies through technical guidance, supervision and imposition of penalties for non-compliance. It is also desirable that besides internal controls and external audit, possibilities of public oversight be ensured. For this purpose financial performance report, management’s analysis etc. for the year is issued within three months of the year end to the authorities of the ULBs. An improved Financial Management and Accountability (FMA) environment has become crucial to better urban governance and performance in the ULBs. A strong FMA system is the key to achieving development objectives and an efficient service delivery mechanism in ULBs. The FMA framework brings out the linkages between legislative, budgeting, implementation, reporting and oversight process in the ULBs. Improved functioning in these areas would lead to increased accountability and enhanced levels of service delivery. There is a need and requirement to put FMA at the center-stage of improved governance and service delivery. 1. What is Municipal Financial Management? Municipal financial management involves very important activities of planning, sourcing, utilizing & disbursing, controlling and reporting.

• Planning: deals with selecting the activities to be financed; • Sourcing: is about identifying and making necessary arrangements for financing the

planned activities. • Utilizing & Disbursing: deals with the application of the finance in an economic, efficient

and effective manner. • Controlling: verifying the proper use of resources in an efficient, economic and effective

manner as per the guidelines and procedures; and action plan put forward so as to prevent or minimize fraudulent activities, wastage, etc.

• Reporting: is about compiling all the necessary data and producing an informative and timely report to the management, financiers and other stakeholders.

Core Features of Good Financial Management Good financial management is expressed through good budgeting, accounting and auditing.

• Good Budgeting: when budgets are prepared with inputs from implementers, supported by strong, effective and feasible action plans.

• Good Accounting deals with detailed identification and categorization of financial transactions; proper recording of the transactions and timely production and analysis of reliable financial statements by following generally accepted accounting principles.

• Good Auditing means strict and regular follow-up on the sourcing, allocation, and application of financial and other resources in line with the target and budget. The ultimate aim of auditing is to prevent public properties from embezzlement, abuse, misappropriation, etc. Moreover, good auditing practice calls for independent, impartial, timely and ethical evaluation of activities and financial transactions.

Municipal Financial Management Cycle The overall municipal financial management system can be viewed as a collection of several integrated and closely coupled components comprising accounting, budgeting, treasury management, internal controls and audit. Accounting is an essential element of the overall

system. Without proper accounting system, an ULB would not have any clear idea of how well it is performing financially, whether it is becoming more solvent or more indebted, whether it will likely have sufficient funds, whether financial activities are being executed according to the plans. Furthermore, without proper accounting, it becomes impossible to state whether funds entrusted to an ULB have been used for the intended purposes. Budgeting involves planning how resources are to be collected and distributed within/across activities. Budgeting should be realistic and relevant and it must periodically receive feedback from the accounting function. The entire budget exercise starts with setting up budgets and targets and ends with the taking of an action. Budgets are usually set up in the light of past experience after taking into account the changes that are expected to occur in the future. It must be the constant endeavor of the management to see that actual performance does correspond with the budget concerned. Since budgets assume the optimum efficiency attainable, the system of budgetary control helps to increase efficiency and enable the ULB to achieve targets, which are considered attainable.

• Treasury Management deals with the custody and management of assets and liabilities, such as checking accounts, petty cash, accounts payable and loans payable. The treasury component also provides important information to the accounting component that supports its recording, reconciliation and reporting tasks.

• Internal Controls consist of all resources, systems and tools that help in ensuring that the ULBs and its financial management functions operate as intended. They also help prevent errors, mis-statements, misappropriations, and other forms of losses to the ULB. Sound internal controls imply that the ULBs are operating efficiently.

• Internal Auditing is a monitoring component. It consists of internal audit conducted by auditors reporting to the Commissioners/ Councils of ULB, and external audit, which is more independent but typically involves a more narrow scope of work focused on attestation/certification of financial statements. All of the financial management components above are subject to review by the audit functions.

Need for effective control systems

In most ULB’s bill collectors, after collecting the tax, do not immediately deposit the money. To put a check on such possible misappropriation, the Double Entry Accrual Based Accounting System (DEABAS) should be followed by all civic bodies. The money received by a municipality should be reconciled with the dates of bank remittances and details of expenditure. Municipal commissioners have to reconcile on a daily basis the collection of property tax and water charges through Mee-Seva centres and E-Suvidha. The monthly receipts and expenditure should also be placed before the council for information. Further, there should be disciplinary action including criminal case proceedings in any cases of misappropriation of municipal funds and in committing any irregularities in making offline entries of property tax collection.

There is a need to dispense with manual collection of property and water taxes by municipal bill collectors who issue hand-written receipts, and to encourage tax-payers to pay their taxes at Mee-Seva centres or online counters at respective municipal offices. Further there is a need for ULBs to discourage use of bill books and to procure hand-held Point of Sale (PoS) gadgets which can be used by bill collectors to issue receipts. The payment thus made can be electronically recorded in the municipal office. In most of the ULBs, there is a mismatch between the tax collected and the money deposited by the bill collectors in the municipal offices or bank accounts. Most ULBs are increasingly finding it difficult to track the actual money received by bill collectors and the money deposited in the offices.

In most cases, offline entries made by data entry operators, bill collectors and revenue inspectors don’t tally with the collections made by bill collectors. It should be ensured by Municipal commissioners to ensure that offline entries of property tax collection on e-Suvidha should be tallied with bill collectors’ manual collections, failing which it would be construed as misappropriation and tampering with records and instructions have to be issued to data entry operators, bill collectors and revenue inspectors.

We need to ensure that the following information is properly maintained in an ULB. Books of Accounts:

• Vouchers • Cash Book • Ledger Book • Journal Book • Day Book • Trial Balance

Regular Registers: • Abstract Register of Receipts and Payments • Register of Adjustment • Register of Investments • Advance Ledger

• Deposit Ledger • Loan Register • Fixed Assets Register • Appropriation Register • Register of unpaid bills • Register of dishonoured cheques • Budget

MIS Reports:

• Borough/ Zone/ Ward wise Accounts • Ageing Reports for both debtor and creditor, (Ageing report should be • user defined) • Variance Analysis of Budget Vs Actual • Party wise Statement • Ratio analysis reports • Revenue trend analysis statement • Bank Reconciliation Statement

The specific period-end procedures in relation to various categories of transactions and to be followed on a daily, monthly, quarterly and annual basis are covered under the following heads:

1 The budgets shall be prepared as per the Chart of Accounts in the Accounting System 2 Display warning messages in case the budgetary limits are exceeded 3 Provision for variance analysis between budget and actual with percentage 4 Provision to capture ward-wise budgets 5 Provision to monitor the budget on a timely basis 6 Allow for multiple budget periods and provide for monthly/quarterly/half- yearly breakup of the actual/ budget forecasts

Daily Procedures

• Closing of Cash Book • Physical verification of cash balance • Deposit of collections (both cash and cheque) in the bank • Checking ledger accounts with the books of original entries, i.e., Cash Book and Journal

Book • Verification of number of receipts issued as reported by the collection office with the

Collection Register • Updation of Subsidiary Ledgers

Daily Income - Head wise

Daily Expense - Headwise

Budget – Income vs Projected

Periodic Income vs Expenditure

Periodic Income vs Expenses, liabilities and assets

House tax billing – ward wise by date

ii. Monthly Procedures

• Payment of pension fund & leave salary contribution for employees on deputation. • Remittance of Statutory recoveries. • Transfer to SC/ST Development Fund. • Transfer from ‘Specific Grant’ to ‘Income’ or ‘Deferred Income’. • Transfer from ‘Ear marked Fund’ to ‘Ear marked Fund utilised’. • Balancing of Ledger a/c. • Preparation of monthly R and P, Trail Balance, consolidated statements. • Bank Reconciliation Statement. • Reconciliation of Interfund transfer accounts. • Reconciliation of sub ledgers with control accounts.

iii. Quarterly Procedures • Reconciliation of deposits, advances, receivables and incomes • Provision for period-end expenses • Transfer of revenue grant received in advance for specific purpose to grant income • Recognition of grant income for revenue expenditure incurred in respect of grant

receivable as reimbursement • Accrual of interest on borrowings • Recording of provision for bills remaining unpaid in respect of Special Fund expenditure • Accrual of interest on investments • Accrual of interest on loans to employees • Reconciliation of Capital Work in Progress

• Reconciliation of Inter Unit Balances • Passing of adjustment entries • Closing of ledger accounts

iv. Annual Procedures • Reconciliation of Receivable account. • Physical verification of stores. • Reconciliation of closing stock with balances in GL. • Physical verification of Fixed Asset. • Reconciliation of Fixed Asset a/c. • Reconciliation of Deposits & Advance, Loans etc. • Confirmation of Permanent Advance & Miscellaneous advance. • Confirmation from Govt/ Govt Agency • Accrual of interest accrued, but not due on borrowings. • Accrual of interest on investments. • Provision for year end expenses. • Provision for unrealised receivables. • Accounting of depreciation. • Preparation of Annual Financial Statements. • Closing of Ledger accounts. • Carrying forward balances in Assets and Liability accounts

2. FINANCIAL MANAGEMENT AND ACCOUNTABILITY COMPONENTS

BENCHMARKS, POLICY AND PROGRESS Legislative Framework: a strong and comprehensive legislative framework leads to improved Financial Management and Accountability. ULBs are governed by respective state municipal acts. While laws in ULBs are comprehensive in areas such as financial control, budgeting and audit, there are gaps in procurement, monitoring and enforcement. Since these laws were primarily directed to make ULBs accountable to the state government, they are weak on participative planning, public accountability and modern accounting, audit and management practices. Although the legislative reform environment is positive (including a Model Municipal Law issued by the Government of India in 2003), ULBs lack in implementation capacity.

Planning and Budgeting: Budgets are generally seen as a statutory requirement and hence limited to providing sanction for expenses and revenues. Current budgeting practices are not directly linked to a larger management or strategic planning process. The rigor of planning is

replaced by incremental budgeting and the need for debates and participation is limited to the elected representatives.

Budget Execution: the budget is used as a tool for planning, procurement, and expenditure control

Financial Management and Accountability in Indian ULBs There is weak monitoring and follow up of budgets with hardly any review mechanism for variations. This, along with unpredictability of state funding causes uncertainty in the budget execution process. Re-scheduling of budget heads during the year is a common practice. Further, any shortfall in revenues generally leads to cut in capital expenditure and O&M.

Accounting and MIS: ULBs in India have traditionally been following the single entry cash basis of accounting. This limits their ability to prepare meaningful performance reports and statements of financial position. Predominantly manual, the multiplicity of registers and limited capacity of staff generally results in accounts remaining in arrears for several years.

Cash and Fund Flow Management: There are weak cash and treasury systems in most ULBs, primarily due to the weak accounting system currently in practice. Bank reconciliations are generally in arrears and cash management is limited to prioritization of checks issue. Along with their capacity, ULBs also need to improve their inter-departmental co-ordination for treasury management function to be successful.

Procurement: Almost 30 to 50 percent of the ULB budget requires external procurement, usually made by the consuming department itself. Legislation governing procurement, though rudimentary, defines procedures and limits for procurement. However, there is lack of focus on quality, performance and linkages with planning. Procurement practices lack modern concepts such as ‘just in time’ inventory, scientific determination of procurement quantities etc. although there is a need for moving to e-procurement and works based grievance redressal systems.

Internal Control and Audit: Most ULB Acts do not specify requirements for internal audit. Internal controls are generally incorporated in financial rules and focus on delegation of financial limits. Some ULBs have Standing Committee for audit and accounts with the objective of scrutinizing ULB accounts at each level and ensuring compliance with audit noting.

Assets and Liabilities Management: ULBs generally hold a significant amount of fixed assets in land, buildings and infrastructure. Few local bodies have exploited the commercial potential of these properties to generate non-tax revenues. For infrastructure assets, maintenance is poor and O&M expenditure is either not allocated in the budget or is not available due to deficits. Most ULBs do not have a proper inventory of assets nor do they update them regularly.

Similarly, ULBs again do not have complete listings of creditors. As a result they are neither able to utilize their assets effectively nor deal with liabilities in a planned manner. Modern accrual accounting practices are expected to address this shortcoming.

Reporting: The reporting requirements for ULBs remain weak.

Financial Management and Accountability in Indian ULBs Accountability to the state and hence reporting is limited to compliance certificates, budgets and periodic administrative statements. There are no guidelines on disseminating financial results to the public. These improved efforts are intended to improve the accountability of ULBs to the citizens.

External Audit: Audit is generally carried out by the Local Fund Auditor limited to transaction reviews and focusing on prudence and compliance. Audit objections or ‘paras’ are made where again the follow-up process is weak. There is a large backlog of audits due to limited capacity of Local Fund Auditor and increasing transactions of ULBs. The Comptroller & Auditor General of India has recently also been involved in ULB audits. With the adoption of double entry accounting system, audit capacity needs to be enhanced and professional independent audit commenting on the ‘truth and fairness’ of financial statements required in addition to the routine compliance audits.

External Oversight: Public involvement in ULB’s governance is prima-facie missing in the current legislative environment. Limited availability of reports in the public domain, weak community structures and lack of involvement of citizens lead to poor external oversight.

3. EFFECTIVE SYSTEMS NEED TO BE IN PLACE Effective institutions and systems of FMA have a critical role to play in supporting implementation of policies for national development and poverty reduction. Essentially, a strong FMA system is the key in ensuring achievements of development objectives, supporting aggregate fiscal discipline, strategic allocation of resources and efficient service delivery. Based on the understanding of the ULB system in India, critical dimensions of performance for an efficient FMA system are identified. Framework Component

1. Legislative Framework

• Enabling legislative framework • A strong and comprehensive legislative framework exists which encourages sound FMA practices

2. Planning and Budgeting

• Budget planning • Policy direction, budget planning and preparation is realistic, comprehensive, orderly and participatory within overall government policy

3. Implementation

• Budget execution • The budget is used as a tool for planning, procurement and control, ensuring transparency

• Accounting and MIS • Accounting system and management information system are complete, accurate, timely and meaningful

• Cash and fund flow management • Cash receipts, payments and fund flows are managed efficiently

• Procurement • Efficient system and management of procurement in place to ensure increased competition, value-for-money and transparency

• Internal control and audit • Clearly defined and effective policies, systems and procedures for internal control and audit are in use

• Asset and liabilities management • Policies, procedures and database of all assets and liabilities is available and used for effective decision making in capital investment and management

4. Reporting

• Reporting - Timely, meaningful and user-friendly reporting structures in place allowing effective engagement with various stakeholders

5. External Audit and Oversight

• External audit • clearly defined systems for timely, independent and effective external audit are in use

• Oversight • Functional independent systems for oversight are in place leading to improved decision making

4. KEY ISSUES AND WAY AHEAD

Review and Strengthening of ULB Audit. The area of ULB audit remains weak. MoUD may consider constituting a task force and review the existing capacity and suggest strengthening measures for audit in ULBs. It could also advise on moving towards performance and management audits, clear old audit backlogs and training of LFA auditors with reference to the changed financial reporting scenario, double entry accrual accounting and modern audit techniques.

Strengthening ULB Budgeting. Although current schemes promote bottom-up budgeting, there exists a gap in ‘operationalizing’ them. There is a need to consider a Budgeting Manual (perhaps on the lines of NMAM) for evolving budgeting into an efficient planning, review and management tool through Output budgeting; multi-year rolling plans, scientific forecasting and zero-based budgeting.

Staffing and Capacity Building. There are no benchmarks and capacity building plan in most ULBs. Most states and ULBs are using external consultants and donor support to implement FMA reforms, although this may not be sustainable in long run. MoUD may consider a review and advisory guidance for creation of skilled positions and restructuring / abolishing obsolete and outdated positions. This could include: staffing structure of critical areas (especially FMA related); review of current availability of staff, training requirements etc.

Ensuring Compliance. Ensuring compliance with laws is another weak link in the FMA cycle. Various mechanisms could be explored such as linking devolution of funds to compliance with rules and regulations; tabling the status of budget and financial statements of ULBs in state assembly and fixing timelines for action taken report on audit queries. In addition, some other areas that could be taken up include: • Promoting adoption of key FMA requirements from Model Municipal Law; • Handholding and assistance to states for developing accounting policies and implementation of NMAM; • Development of Procurement guidelines for independent, effective and cost efficient procurement.

Planning and Budgeting: The mission, through its reform agenda, tries to make the planning and budgeting exercise more comprehensive, realistic and participatory. It incorporates a multiyear perspective in budget preparation with timelines for implementation. Structural and administrative reforms will further streamline the planning process and help in preparing effective and achievable budgets.

External Audit and Oversight: State level nodal agency will maintain audited accounts of funds released to ULB’s, conduct techno economic appraisal of projects and monitor implementation of reforms. Public oversight will be an integral with the passing of Community Participation and Public Disclosure laws.

Setting up an Accounts Management System

Accounts Management System will be on accrual basis, will contain of receipts and payments (both through cash and bank transactions), adjustment entries through journals, fixed asset, budgeting, ledgers and trial balance and reports in the prescribed formats. The requirement has been broadly categorized under the following two heads: Functional requirements: The functional requirements are basically the financial accounting requirements of the systems. They have been grouped under the following heads:

• Accounting System • Payments • Receipts (including cash collection) • Fixed Assets • Budget

Reporting requirements: All necessary reports that needs to be generated on a periodic basis.

Required features 1. Cash Collections: The cash collection module should be able to collect cash, cheque and drafts on a daily basis and prepare a Daily Collection Register at the end of the day. Cash collection should be able to do multipoint collection and prepare point-wise Collection Register, which shall feed into the Cash Book. The Daily Collection Register once verified by the Accountant should then get consolidated as the Cash Book and post itself in the General Ledger. The cash collection module should also be able to track the deposit and dishonor of cheque. The module should also be able to connect with the revenue modules and collect the amount against bills issued. Cash collection should also be able for other municipal functions e.g. sale of forms, tender feed, etc. and on-account from debtors. 2. Journal Entry: The Accounting System should support journalizing functionality, which is the standard requirement of an accounting application. The journals need to be validated on-line during journal entry; thus, enabling accountants to quickly correct data without running a separate batch process. This benefit increases productivity and staff efficiency because it prevents repeated data correction cycles common to systems that validate data during batch processing. Accounting entries for recording payables and receivables shall be accounted for by using the Journal Entry. 3. Consolidation and Finalization: The system should have the facility to consolidate and finalize the accounts on a periodical basis e.g. monthly, and take out various reports like Receipts and Payments Account, Income and Expenditure Account, Trial Balance and Balance Sheet. The system should also have the facility to give reports such as Income and Expenditure Account and Balance Sheet for Field, Fund and Function codes. The system should automatically carry forward the opening balances in the next period. 4. Bank Reconciliation statement: The system should have an inbuilt bank reconciliation module. 5. Vouchers:

The system should have separate vouchers for receipts, payments, contra (cash to bank and viceversa), debit note, credit note and journal entry. The system should support narration in vouchers through user defined editable LOV (List of Values). 6. Control features: The system should be equipped with all security features like no backdating (except in case of finalization of accounts), approval process, access control and password protected. In case of backdating of vouchers, this should be allowed only to specific people who should use the same only during finalization of accounts on a periodical basis. 7. Approval features: The System should have Maker and Checker relationship, that is the entry made by a person, should not affect the general ledger, until and unless, approving authority has approved it. 8. Payments The system should be able to capture all the major payment processes which could be broadly classified under the following heads:

• Salary and Conservancy • Contractors and Suppliers • Administrative expenses e.g. Telephone and Electricity • Statutory Payments like Provident fund, Profession tax out of salary and deposit of

statutory obligations such as Tax Deducted at Source and Sales tax

9. Receipts Major receipt processes for the Corporation could be broadly classified under the following categories, which system should capture on the basis of similarity in nature of collection:

• Property Tax, Water Tax and Rent • Grants • Security Money and Earnest Money • Other collections

10. Fixed Assets The Accounting System should be able to maintain the Fixed Asset register. Details like asset number, location and person responsible pertaining to the asset should be captured in the register. It should be ensured that all Fixed Assets are correctly entered in the Fixed Assets Register. During purchase of any fixed asset, the account code selected will hit the General Ledger. Other details entered in the voucher will only be reflected in the Fixed Asset Register of Accounting System. During sale of any fixed asset, the account code selected for the specific asset along with profit/ loss on sale of the asset shall be posted in the General Ledger. Other details entered in the voucher will only be reflected in the Fixed Asset Register of Accounting System. Accounting System should be able to calculate the Depreciation of Assets, based on useful life calculation and straight line method. Accounting System should have the provision of revaluation, scrap, write-off and sale of assets. 11. Budgeting The Accounting System should have a provision for budgeting. The budgets shall be prepared as per

the Rules & Laws in the Accounting System. The Accounting System should be able to display warning messages in case the budgetary limits are exceeded. The Accounting System should have the provision for variance analysis between budget and actual with percentage. It should have the provision to capture ward-wise budgets. Also, the Accounting System should also have provision to monitor the budget on a timely basis. & should allow for multiple budget periods and provide for monthly / quarterly / half-yearly break up of the actual / budget forecasts. 12. Reports The Accounting System should have the capability to generate various reports (statutory as well as MIS) as and when required. The system should also provide facility to the users to take out various flexible and user-friendly reports, MIS reports as and when required. The system should have the flexibility to undertake the following: _ Incorporating all formats for reporting and books of accounts as prescribed in the National Municipal Accounts Manual _ Incorporation of existing formats of registers in specific ULBs. Some of the reports are as follows: Financial Statements:

• Balance Sheet • Income and Expenditure Account • Receipts and Payment Account – Showing the receipts and payments of cash major

head wise along with schedules • Cash Flow – Showing the receipts and payments of cash bifurcated into operating,

investing • and financing activities • Books of Accounts: • Vouchers • Cash Book • Ledger Book • Journal Book • Day Book • Trial Balance • Regular Registers: • Abstract Register of Receipts and Payments • Register of Adjustment • Register of Investments • Advance Ledger • Deposit Ledger • Loan Register • Fixed Assets Register • Appropriation Register • Register of unpaid bills • Register of dishonored cheque • Budget

MIS Reports:

• Zone / Ward wise Accounts • Ageing Reports for both debtor and creditor • Variance Analysis of Budget Vs Actuals • Party wise Statement • Ratio analysis reports

13. Interfaces with internal as well as external systems One of the most important features of the Accounts Management System should be its ability to interface with both internal as well as external systems. The various interfaces required for the Accounts Management Systems is given below: Integrated Payment Gateway features Payment Gateway interface will be provide an online interface for citizen login to facilitate online payments. Broad features of the gateway are

• This module should be used for online payment by the citizen • Audit trail for all the transaction should be maintained. • Single interface to the external Payment Gateway • Should be able to send back response to the external gate way • Display success/failure message to the Citizen. • It should keep a record of all transactions that go through it. • MIS Reports - date wise and status wise should be provided