Estonian Experience: Performance Budgeting & Auditing

1. Urmet Lee Audit Manager, Audit Department I National Audit Office of Estonia (NAOE) 04.09.2008 Druskininkai, Lithuania The 9th Annual Meeting of the Representatives of the Baltic, Nordic and Polish Supreme Audit Institutions Estonian Experience Moving Towards Performance Budgeting and Related Auditing Issues

2. Content • General overview of developments in budgeting, government accounting and auditing in Estonia over the past 8 years; emphasis on the rise of performance orientation; • Estonian Ministry of Finance financial management reform plans and early warnings: does accrual-based performance budgeting have a prospect to live up to expectations (opinion of the Estonian NAO)?; • Underneath develops auditing: does performance focus change the mandates of (financial and internal auditors) auditors in the public sector?

3. General overview • Since 1999 nine major revisions have been made to theState Budget Act. Altogether these changes paved the way for performance budgeting in the Estonian public administration. • What has changed? • All budget revenues and expenditures are stated in the budget; • Legal framework for strategic and operational planning; • The government accounting system was modernized, accrual based accounting was introduced, number of accounting units was reduced and whole of governments accounts was prepared, audited and submitted to the Parliament.

4. General overview (cont.) • NAOE opinion about the budget proposal in 2000, strongly supported the selected course towards more extensive use of performance budgeting. • Ever since in everyYearly Report to Parliament NAOE has expressed it’s concern with the state-of-the-art of the performance budgeting, especially in regard to reporting of the performance. • Lately, a special report about the Ministry of Finance’s actions in developing the principles of performance budgeting and more generally the field of public financial management, has been prepared by NAOE to be presented this autumn to the Parliament.

5. Problems of performance budgeting that emergedover the last 8 years • Different budgetary documents (mid-term framework, budget proposal and annualperformance reports) use different and incompatible structures. • Different accounting principles (accrual for accounting and balance sheet; cash base for budgeting and reporting about the use of budget) force ministries and agencies to keep parallel bookkeeping. • Budget classification and Chart of Accounts do not match. • A moderate strategic planning skills (and sometimes unwillingness to present clear performance information) result in confusing, ambiguous or misleading goal setting. • The performance management and performance budgeting are not universally applicable to every organization or process.

6. Preparation of budgeting reform • The move towards the performance budgeting has produced various results (bad in regard to performance management, good in regard to accounting reform). • Ministry of Finance wanted to make a qualitative leap in the development of performance budgeting.In 2007 a Concept Paper On Public Financial Management Reform was prepared by the Ministry of Finance (it contained an idea of full scale performance and accrual based budgeting).

7. Reform vs. assisted evolution • NAOE has in the special report addressed the proposed reform agenda.We are suspicious about the judgments the Ministry of Finance has made about the preconditions for implementation of proposed solutions. • Why? • The apparent weakness of the mid-term budgetary framework means that a fundamental prerequisite for performance budgeting is missing; • A significant instability of objectives and the program structure of accompanying documents of the state budget means a lack of a stable base for evaluating performance; • A moderate or even poor level of performance management in the ministers and agencies creates a questionable foundation for full scale performance budgeting; • A misinterpretation of the cause and effect relation. Introduction of the state budget classified by programs is not a catalyst for improving the quality of performance management but is instead an expression of well developed performance management (e.g. New-Zealand) system. • Accrual based budgeting contains significant manipulation risks, need extensive improvement of accounting skills among the MPs and is implemented in only a few countries in the world – the reform must improve the decision making of policy makers not merely satisfy accountants.

8. Assisted evolution Alternative development of government financial management should start with: i) improvement of necessary preconditions for full scale performance budgeting, ii) involve substantial testing through pilot projectand iii) critical evaluation of applicability of performance management and performance budgeting techniques in Estonian public administration. Step one is to involve the MP-s in the process of changing the principles and outlook of budget.

9. In the realm of performance budgeting, what is going to change with the mandate of the auditors? • According to the Netherlands Court of Audit there are 6 big questions that need to be answered in the context of auditing the performance aspect of the budget: • In regard to planning: for what is government going to spend, what are the goal(s) and how much will be spent; • In regard to reporting: for what did government spent money on, what did it achieve and how much did it spend? • Who’s tasks it is to answer these questions? • How and by whom should this sort of information be audited?

10. The legal foundations for auditors mandates in Estonia • The mandate of NAOE auditors is defined in the Estonian Constitution and the NAOE Act. It authorizes the NAOE by auditing to inform the Parliament about how money has been spent for achieving any given results - i.e. on whether the result of an activity and the funds spent on it are in correspondence (performance audit); on whether the information relayed by the Government about the financial situation of the state is correct (financial audit). • The role and functions of internal auditors are defined in Government Act and decree by the Minister of Finance setting general framework for internal auditors. The main task for internal auditors is to evaluate and develop the internal control systems based on the risk assessments.

11. Who and how can do it? • At the grass root level the internal auditors should secure that organization sets the right performance goals and indicators, designs and uses appropriate measurement systems of results, produces accurate reports about performance results. This means that no major change is needed in the mandate of internal auditors, instead their capacity must be enhanced(currently in public sector organizations the internal auditors must also conduct the audit of annual accounts of particular organization). • From the external point of view the NAO must confirmwhetherthe fiscal information provided to the Parliament and to the public is correct. Expectations in regard to external audit of the performance information are not so clear. The standards of fiscal audit are widely recognized and they are backed with standardized accounting rules. Standardization of performance is probably impossible and unnecessary task. This means that at least currently the changes in the performance budgeting will leave the role and tasks of financial auditors mostly unchanged. In this ambiguous world of performance budgeting the performance auditors havebetter chance to get some grip of it and provide meaningful opinions about the performance results of the government.

12. Thank You for Your attention!