1. Framework For Effective Local Government Finance
World Bank – Public Sector Management Thematic Group
Michael Schaeffer
March 2005

2. The ‘Quick Start’ Framework
Components of Effective Local Government Finance
A Shift in the Nature of Local Government Budgeting
The Capital Budget
The Role of Financial Reporting and Accounting
The Treasury System
Sequencing of Management Reforms

3. Essential Components:
Control Structure Derived From Legislative Framework
A Standardized Chart of Accounts / Accounting System
An Effective Treasury and Cash Management System
Internal / External Reporting
Effective [Timely] Budget and Reporting System

4. An Effective Financial Management System
Components of an
Effective Financial Management System
Community Driven
Performance Measurements
Community Ownership
Budget Policies
Formulation and Execution
Community (Participation) Driven
Effective Treasury and Cash
Management Systems
Standardized Transparent/ Accountable
Chart of Accounts (External / Internal Audits)
Accounting Systems

5. Shift in the Nature of Local Government Budgeting
“New Public Expenditure
Management:”
Budget Policies/Institutions
Incentives
Outputs/Outcomes
Performance Orientation
Decentralized Responsibilities
Transparency and Accountability
“Conventional Budgeting:”
Budget Process
Rules
Inputs
Compliance
Hierarchal/Centralized Control

6. Framing Local Government Policy
Budgets are Fundamental for Meeting Three Important Policy Objectives:
Aggregate Fiscal Discipline;
Allocation of Resources [Consistent with Strategic Policy and Priorities]; And,
Efficiency and Effectiveness

7. Local Government Budgets:
In Theory and Practice
Good Budget Practices
Poor Budget Practices
Comprehensive
Disciplined
Legitimate
Flexible
Predictable
Contestable: Subject to review and evaluation
Honest
Information must be accurate and timely.
Transparent: Information about budget practices must be accessible and communicated to a wider audience.
Accountable: Decision makers must be held responsible for the exercise of authority provided to them.
Source: Public Expenditure Management Handbook (1998) World Bank
Unrealistic Planning and budgeting
Short-term budgeting with no medium or long-term implications
Numerous budget revisions throughout the year
Government spends as cash becomes available not according to preset priorities
Deferred budgeting: Arrears build-up as expenditures are pushed into subsequent years.
Distorted priorities.
Informal management: Extralegal behavior dictates how government operates with respect to hiring and procurement etc.,
Corruption: Lack of enforcement of formal rules breeds illegal behavior (corruption).
Source: A. Shick (1998) A Contemporary Approach to Public Expenditure Management. World Bank Institute.

8. Effective Financial Management and Budgeting
Set of Activities Where Intentions of Local Government Managers and Politicians Becomes Operational
One Mechanism to Determine Local Government Performance is Audit
Performance Based Local Government Unit [LGU] Financial Management Necessitates a Change in Local Government Financial Management and Organization
Must Produce Information in an Integrated Manner – Budgeting, Accounting, Cash (Treasury) and Debt Management Must be Linked

9. Working Within Proper Legal Environment
Detailed Rules with Respect to Local Government Budgeting, Accounting, Cash And Debt Management
Internal / External Audit Responsibilities Should be Designated
Role of Any Oversight Agency Should be Defined
Jurisdictions, Level of Autonomy, and the Components of Local Government Financial Management Systems Should be Spelled Out

10. Perspective on Budgeting
Establish Clear Operating Procedures Between Management Sections of Each Implementing Department
Limit Programmatic Classifications to Only What is Necessary for Effective Decision-making
Simplify and Limit Account Classifications
Match Budget Authority with Operating Level
Codify Budget Procedures in a Manual
Develop Performance Measurements that Can Be Used to Measure Efficiency / Effectiveness

11. Budget Formulation and Adoption
Local Government Budget Should include the Following:
Program Elements Should Be Limited / Meaningful
Present Multi-Year Data to Include Prior, Current and Forecast
Include all Units that Require Government Resources in the Budget Formulation Process

12. Revenue Mobilization and Forecasting:
Two Principles:
Own-source Revenues Should Be Sufficient to Enable LGUs to Finance all Locally Provided Services From Own Resources
To Extent Possible, LGU Revenues Should Be Collected at the Local Government Level
Most Basic Forecast – Use Revenues From Current Year Increased By a Growth Factor
Better to Use Information on Forecasted Tax Bases and Planned Rates to Explicitly Calculate What is Legally Collectible
Should Use Information on Tax Compliance Levels to Determine Likely LGU Revenues

13. Expenditure Forecast and Control
LGU Budgets Should Be Examined For Conservative Characteristics
Appropriations Should Be Fixed at Levels Determined By Best Estimates of Available Work, Services, and Price Levels For the Year
Local Population [and, Legislature] Have Right to Know LGU Policy Objectives and Targets
Informing General Public Increases Transparency, Accountability, and Allows For a General Consensus to Be Reached

14. Budget Execution and Expenditure Control
Key Elements For Consideration in The Financial Management of Budget Implementation:
Provide Guidelines For Re-programming Budget Line Items
Re-programming Requiring Higher Level Approval Should Only Be For Shifts Between Major Line Items
Establish Clear Procedures for Committing Funds
Establish Clear Procedures for Distributing Allotted Budget Authority on a Quarterly [Monthly] Basis
Quarterly Budget Allocations Must Be Made in Conjunction With Aggressive Cash Management

15. Factors Influencing Escalating Expenditures
Soft Budget Constraints
Fragmented Approaches to Budgeting
Creating Future Expenditure Commitments By Under provisioning
Lack of Transparency
Systematic Errors in Budget Forecasting

16. The Capital Budget Concerned With Creation of Long-Term Assets
Organized Along Multi-Year (5-Year) Capital Investment Plan
Financing of Investments Often Requires a Different [More Complex] Set of Capacities
Officials Also Need Skills to Procure Construction Services in a Cost-Effective, Open Manner

17. Structure of Capital Budget
Inventory of Capital Assets
Multi-Year Capital Investment Plan (CIP)
Financing Plan

18. Structure of a Capital Budget
Revenue (Receipts)
Expenditures
I. Taxes and Property Earmarked for Capital Projects
I. Acquisition of Existing Assets
Plant, Property, Equipment
Financial
II. Surpluses from the Current Account
II. Acquisition of New Assets
Financial (Other than capital transfers)
III. Proceeds from Borrowing
Domestic
Accounts Maintained by the Government
External
Repayment of Loans
III. Capital Transfers
Transfers to Other Levels of Government
Transfers to Public Sector Enterprises
IV. Depreciation Allowances
IV. Repayment of Loans
V. Sale of Property
VI. Capital Grants
Source: A. Premchand (2000) “Capital Budgets: Theory and Practice.”

19. Determining Capital Expenditure Resource Allocation
Used in the Production [Supply] of Goods and Services [Productivity Criteria]
Life Extends Beyond a Fiscal Year
Not Intended For Resale in the Ordinary Course of Operations

20. Number of Capital Projects that LGU Can Finance, Depends On:
Level of Recurring Future Operating Expenditures
Cost Recovery Elements
Availability of Cost Sharing By Different Tiers of Government [or PPP]
Debt Structures and Instruments

21. Capital Budget Issues Functional Area Issues
I. Project and Investment Appraisal
Need to apply uniform and consistent guidelines
Analysis techniques in many countries are qualitatively deficient.
Analysis studies may lend themselves to manipulation and often become studies designed to support decisions already undertaken.
II. Funding Arrangements
Centralized Borrowing
Centralized borrowing may lead to resource fungibility and the loss of project identity. In the case of India (State and Local Governments) it may be difficult to measure loan performance effectiveness
III. Budget Formulation
Medium Term Rolling Plans
Contingent Liability and Associated Risk Management Should be Part of the Budget Decision Making Process
Risk Assessment
Possibility of Contributing to Budgetary Rigidity
Most Local (State) Budget Systems Have no Mechanism For this Purpose. Some Countries Have Initiated Efforts to Pass Legislation and Associated Regulations.
Changes in Interest, Inflation (and, Exchange Rates) Pose Serious Implications for the Financing of Self-Financing and Self-Liquidating Projects. In Many Cases, These Costs Are Borne by the General Budget. In Order to Understand the Risks, These Transactions need to be More Transparent.
IV. Budget Implementation
Release of Funds
Underfunding
Payment
Capital Projects Have Their Own Seasonality of Expenditure Flows. Each Project May Have Its Own Distinctive Requirements. Funding, Budgetary Authority, and Cash Management Must be Synchronized in Conformity with Project Requirements and Implementation Schedule.
Projects are in Many Cases Underfunded. Even the Amounts Estimated in the Budget May not be Released in a Timely Manner.
Project Payments are Generally Decentralized. There may be delays in payments. Arrears in Payments are Common and Reveal A Failure of Cash (Expenditure) Management System.
Source: A. Premchand (2000) Capital Budgets: Theory and Practice, and Schaeffer et al Croatia: Investment Packaging Manual (2004)

22. Role of Accounting and Financial Reporting
Accounting is Systematic Gathering of Financial Transactions
Compiling and Reporting of Transactions in a Meaningful and Systematic Manner

23. Unified Chart of Accounts
Represents Basic Structure of Municipal Financial Accounting
Must Include all Categories of Assets, Liabilities, Revenue and Expenditures, And Equity Accounts
Provides a Logical Structure For Classifying Transactions

24. Accounting Treatments:
Cash:
Simplest of All Accounting Procedures
Records How Much is Received
Records How Much is Paid Out
Records How Much is in the Bank
Simplest to Implement
However, May not Provide for Adequate Controls on LGU Transactions

25. Cash Accounting: Not Recommended By GAAP
Cash Received as Loan Illustrated as Revenue on Operating Statement not as Liability on Balance Sheet
To Correct: Most Cash Accounting Systems Recognize not only Cash, But Other Assets and Liabilities Arising Through Prior Cash Transactions.
Does Not Alter Fact that Outstanding Obligations In the Form of Contract or Purchase Orders are Not Immediately Reflected In Accounting Records records.
Available Balance May Be Overstated
Can Lead to Unwise LGU Expenditures and Potential Overspending
LGUs Operating on A Cash Basis May Ignore Obligations to Vendors For Services Received [But Not Yet Paid]
This Type of Action Creates A Floating Debt Outside the Normal Financial Management System
Cash Basis Accounting Does Not Adequately Record Liabilities Either to Provide Future Services or In Recognition of Services or Goods Received For Which the Bill Has Not Been Paid.

26. Accrual Accounting
Relates Revenues and Expenditures Not to the Time in Which the Cash is Received or Disbursement Made, But To the Period For Whose Benefit The Transaction Occurs
Involves Shifting Existing Financial Features of Current LGU Financial Operations
Shifting the Recording Basis From Cash To Commitment
Separation of Financial Activities into Current and Capital
Include Full Depreciation Allowances that Permit Allocation of Costs over the Life of The Asset Rather Than Recording Expenses When they are Incurred
Preparation of Financial Statements in Conformity with International Accounting Standards (IAS) or Generally Accepted Accounting Principles (GAAP)

27. Modified Accrual
Most Transactions are Accrued in the Period in Which Benefit Received
Other Transactions – Especially Revenue are Accrued on a Cash Basis
General Rule:
Expenses are Accrued
Income From Taxes, Fees, and Other Sources are Recorded only When Collected (Cash Basis)
Net Effect:
Bring Income in Line With Actual Cash Available to Pay Bills
Ensuring the Recording of Expenses cannot be Manipulated by Delaying Until the Bill is Paid

28. Deciding On An Accounting System
Moving From Cash to Modified, Accrual Systems Requires Changes in the Organization Flow of Local Government Institutions and Increase in LGU Capacity
Primary Importance of LGU Accounting System is that Financial Information Should be Timely, Transparent and Complete

29. Universal Features of Accounting Systems
Common Denominator:
All Systems Should Track Appropriations
Supplementary Estimates
Use of Appropriations
Release of Funds
Commitments
Expenditures at Verification Stage
Payments
May be More Effective to Assist LGUs in Improving Cash Basis Accounting First – Rather than Shifting to Other Accounting Systems

30. Financial Reporting
Process of Compiling and Organizing Financial Information Into Meaningful Reports
Financial Reports Should [In General] Include:
Balance Sheet [Not with Cash] – {However Can Use Simple Balance Sheet Recording Assets / Liabilities}
Income Statement
Cash Flow Statement

31. Auditing Audit Report Should:
Analyze the Financial Position of the Local Government
Include Trends
Quality of Receipts [Revenues]
Expenditure Analysis
Evaluate Performance of Government on Various Financial Management and Accounting Issues
Include Audit Observations

32. Auditing and Local Government
Audit Function of Local Government Found at Three Levels
The Local Government Itself (Internal)
Central [Supreme] Audit Office
External Private Auditing Companies

33. Shortcomings In LGU Audits
Audit Oriented Toward Reviewing Transactions Rather than Performance
Do Not Focus on Systematic Review of the Effectiveness of Internal Control Systems
In Some Cases, Appropriate Certification of Financial Reports [Annual Accounts] Not Provided

34. Treasury System Treasury Function Covers the Following:
Cash Management
Management of Bank Accounts
Financial Planning and Cash Flow Forecasting
Public Debt Management
Administration of Grants and Transfers
Financial Asset Management

35. What is Cash Management?
Controls Aggregate Local Government Spending
Implements the Budget Efficiently
Minimizes the Cost of Borrowing
Maximizes Opportunities for Using Government Resources

36. Controlling Cash Flows
Minimizing the Interval Time When Cash is Received and the Time Available For Financing Expenditure Programs
Excess Cash Resources Should Not Be Idle
LGU Treasurer Should
Establish Written Procedures for Certifying Payments and Transferring Payment Requests to Cash Management
Continuously Update Cash Flow Projections
Develop Payment Schedules that Allow Individual Departments to Track Payment Requests
Establish Standards and Procedures to Assure that Expenditures are Paid Within a Stipulated Time Frame

37. Framework For LGU Financial Management
Core Financial Functions
Funds Management
General Ledger Management
Cost Management
Payment Management
Receivable Management
Reporting
Service Delivery
Chart of Account /
Accounting
Data Mining and Mapping
Feeders: Local Government Information Systems
HR & Payroll
Benefits
Travel
Acquisition
Property Management
Inventory
Revenue
Grants
Loans
Insurance
Others
Management Information and Decision Support
Financial Information:
Financial Statements
Financial Reports
Budgeting
Budget and Performance Integration
Human Capital Management
Program Management
Performance Measurement
Resource Cost Accounting
Life Cycle Management
Planning and Decisions Support
Strategic Planning
Annual Performance Report
Fee Setting
Competitive Sourcing
Framework For LGU Financial Management

38. Sequencing Chart of Accounts Accounting
Local Government Fiscal Discipline
Treasury and Budget Systems