Report No. 39701-NP Nepal Public Sector Accounting and Auditing A Comparison to International Standards Country Report May 2007 Financial Management Unit South Asia Region Document of the World Bank Acknowledgments This assessment of accounting and auditing standards and practices in a public sector review was carried out in 2006 in active collaboration with the Government o f Nepal and various stakeholders, particularly the Office o f the Auditor General and the Financial Comptroller General Office. The review was conducted through a participatory process that involved these stakeholders whose responses to issues raised in the diagnostic questionnaires were especially useful, as were the reports and information available from the advising consultants, and recent World Bank assessments of public financial management. A draft report was circulated to the Government o f Nepal in September 2006. A stakeholder workshop was held in Kathmandu on February27, 2007 to discuss onthe draft report andto review the results ofthe assessment andto discuss and agree on actions to be taken. The list of such actions has been included in this final report at Part IV. The team o f advisors and development partners also contributed greatly to the early stages o f the concept note and framework development, as well as drafting of earlier reports for this study, which, with companion studies, ultimately covers the countries of the South Asia Region: Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. Discussions were held with senior officials o f the Ministry of Finance, the President of the Institute of Chartered Accountants of Nepal, the Presidents of the Nepal Accounting Standards Board, and the Nepal Auditing Standards Board. In particular, the following officials provided their time and expertise to this assessment: Mr.GehendraNathAdhikari, Auditor General(now retired) Mr.BachchuRamDahal,DeputyAuditor General (now Acting Auditor General) Mr.RameshRaj Satyal, DeputyAuditorGeneral Mr.DevB.Bohra, Assistant Auditor General Mr.MaheshKGuragain, Director,Ofice ofthe Auditor General Mr.Sushi1K.Sharma, FinancialComptrollerGeneral Mr.DevRajPathak, JointFinancialComptrollerGeneral Mr.DiwakarRimal, DeputyFinancialComptrollerGeneral Mr.RameshorePrasadKhanal, Acting Secretary(Revenue), Ministry ofFinance Mr.TirthaRajUpadhaya,PastPresident,NepalAccountingStandardsBoard Mr.K.K.Singh,PastPresident,NepalAuditing StandardsBoard Mr.NarayanBajaj, PastPresident,Institute ofCharteredAccountantsofNepal Mr.BinodBahadurRajbhandary, President,InstituteofCharteredAccountants ofNepal Mr.MadanKrishnaSharma, Chairman,AccountingStandardsBoard Mr.PrabhuRamBhandary,Chairman,Auditing StandardsBoard The responses to the diagnostic questionnaires by the chief executive officers and other concerned staff were helpful. The following state-owned enterprises participated inthis process: Dairy DevelopmentCorporation Employees ProvidentFund NepalElectricity Authority NepalOil Corporation NepalTelecom CompanyLtd. NepalWater Supply Corporation RastriyaBanijya Bank RastriyaBeema Sansthan Three experienced national consultants were heavily involved in the assessment. Pradeep K. Shrestha (Lead National Consultant) is a Chartered Accountant and former President of the Institute of Chartered Accountants of Nepal with an extensive background of auditing and accounting in Nepal. Satish Chandra Lal, a Chartered Accountant and Council Member of the Institute of CharteredAccountants of Nepal, has a strong backgroundo f accounting and auditing; and Tanka Paneru, a Chartered Accountant and Council Member of the Institute of Chartered Accountants o fNepal, has experienceinpublic sector audit. The report also benefited from the comments of its peer reviewers within the World Bank: Manoj Jain (Senior Financial Management Specialist) and Stephane Guimbert (Senior Economist) in the South Asia Region. As the external peer reviewer, the Institute of Chartered Accountants ofNepal alsoprovidedvaluable comments. The World Bank Task Team has beenresponsiblefor finalizingthis report. Task Team P. K.Subramanian, Lead Financial ManagementSpecialist Bigyan Pradhan, SeniorFinancial Management/OperationsSpecialist Ronald Points, Lead Consultant, Accounting MichaelJacobs, Lead Consultant, Auditing Advisors Simon Bradbury, Manager, LoansDepartment, World Bank David Goldsworthy, Operations Manager, International Technical CooperationProgram, UK,NationalAudit Office NoelHepworth, CharteredInstituteofPublic Financeand Accountancy, London Abdul Mudabbir Khan, Fiscal Affairs Department,International Monetary Fund IanMackintosh, Chairman, UK Accounting Standards Board N.R.Rayulu, Additional Comptroller & Auditor General(International Relations), Office of the CAG of India; Nominee of Asian Organization o f Supreme Audit Institutions (ASOSAI) Paul Sutcliffe, Technical Director, International Public Sector Accounting Standards Board, International FederationofAccountants Development Partner Collaborators ' David Biggs, Financial Management Advisor, UK Department for International Development Kathleen Moktan, Asian DevelopmentBank Contents Executive Summary ........................................................................................................................ i I Introduction 1 I1 PublicSectorAccounting .. ............................................................................................................................... ........................................................................................................ 4 A.InstitutionalFrameworkfor Public SectorAccounting ......................................................... 4 Accounting laws and regulations............................................................................................ 2. Educationand training ...................................................................................................... 4 6 3. Codeof conduct .................................................................................................................. 4. Public sector accountantarrangements.............................................................................. 7 5. EmpoweringNepal Accounting StandardsBoard to set accounting standards 8 B. AccountingStandards as Practiced....................................................................................... for thepublic sector ................................................................................................................ 8 8 10 I11 Public SectorAuditing .C .AssessmentofAccountingandAuditing inState-ownedEnterprises................................. .......................................................................................................... 12 A. Statutory Framework for Public Sector Auditing 1. Statutoryframework.......................................................................................................... ............................................................... 12 2. Settingauditing standards................................................................................................ 12 3. Code of ethics.................................................................................................................... 13 14 5. Ensuring independence.................................................................................................... 4.Accountability in the SupremeAudit Institution ............................................................... 14 6. Qualijcations and skillsfor the auditors.......................................................................... 14 8. Auditor competence........................................................................................................... 16 7. Training............................................................................................................................. . . 15 16 B.91AuditingStandards as Practiced.......................................................................................... . Quality assurance............................................................................................................. 16 . Audit planning................................................................................................................... 17 17 2.Audit supervision.,............................................................................................................. 3. Reviewing internal control................................................................................................ 17 4. Compliancewith laws....................................................................................................... 18 5.Audit evidence................................................................................................................... 18 6.Analyzingfinancial statements.......................................................................................... 18 19 8.Reporting onfraud..............,............................................................................................. 7. Reporting onfinancial statements..................................................................................... 19 19 9. Reporting on compliance.................................................................................................. 20 IV Action Plans . ........................................................................................................................... 21 Annex A Methodology of the Assessment . ................................................................................ 25 Annex B .Accounting and Auditing Standards ........................................................................ 27 IFAC-issuedInternationalPublic SectorAccountingStandards(IPSAS) 28 InternationalEducationStandards(IES) .................................................................................. ............................... 28 InternationalFinancialReportingStandards (IFRS) and InternationalAccountingStandards (IAS) ......................................................................................................................................... 29 INTOSAICodeof EthicsandAuditing Standards ................................................................... 30 IFAC-issuedInternationalStandardson Auditing(ISA) ......................................................... 33 Annex C NepalAuditingand AccountingLegislation ............................................................ 34 Annex D Benefitsof AccrualAccounting 42 Annex E Selectionand Trainingfor Accountants and Auditors ... ............................................................................... .......................................... 45 SupplementaryTable of Standards andGaps .......................................................................... 47 IPublicSectorAccounting . ......................................................................................................... 48 A. Assessment ofthe NationalPublic Sector AccountingEnvironment 48 B Assessment ofNationalPublic Sector AccountingStandards 56 C Assessment ofAccountingand Auditing in State-ownedEnterprises .. ............................................ ................................. ................................ 57 11PublicSectorAuditing . ........................................................................................................... 58 A Assessment of the Public Sector AuditingEnvironment B. Assessment ofPublicSector Auditing Standards and Practices......................................... . .................................................... 58 67 EXECUTIVE SUMMARY 1. This assessment ofpublic sector accounting and auditinginNepalis intendedto assist with the implementation of more effective public financial management (PFM) through better quality accounting and public audit processes. It is intended to provide greater stimulus for more cost- effective outcomes of government spending. The specific objectives are (a) to provide the country's accountingand audit authoritiesand other interested stakeholders with a common well- basedknowledgeas to where localpracticesstand inaccordancewith the internationallydeveloped standards of financial reporting and audit; (b) to assess the prevailingvariances; (c) to chart paths to reducethe variances; and (d) to providea continuingbasisfor measuringimprovements. 2. Adoption of international standards for accounting and auditing provides the basis for competent financial reporting and transparency. The International Public Sector Accounting Standards Board(IPSASB) of the InternationalFederationof Accountants (IFAC) has developed a core set of accrual-based International Public Sector Accounting Standards (IPSAS) and also a comprehensive IPSAS on the cash basis of accounting. These IPSAS establish an authoritativeset of independent international financial reporting standards for governments and others in public sector organizations. The study has taken the international standards as axiomatic with any acceptable optionsincorporatedinthe standards. The study has not assessedwhether Nepalshould adopt a limited version of the standards as the processes of developingthe standards have already consideredany acceptableoptions. 3. Application of IPSAS will support developments in public sector financial reporting directed at improving decision-making, financial management and accountability; it will be an integralelement of reforms directedat promotingsocialand economic development. The IPSASB has also developed guidance on the transition from cash- to accrual-based reporting.' The traditional emphasis on the cash basis of accounting has been found inadequate through failure to recognize true costs, and all assets and liabilities. Cash accounting can too easily neglect asset management, accumulatingarrears, future liabilities(e.g., pensions), and contingent liabilities(e.g., guarantees). 4. Annex A explains the methodology used for the study. The first part of the diagnostic questionnaires compares the nationalstandards to internationalstandards and the latter parts deal with the implementationpractices measured against the international standards, rather than the Nepal standards that are in use. The study is meant to assist with the adoption of international standardsby Nepal.It is not intendedto assess how muchofthe weakness inthe Nepaliaccounting and auditing is due to a problem of the standards that are in use, and how much is due to the manner of implementation.Proper implementationof the internationalstandards will correct any implementationproblems in the current Nepal standards and will be supported by international practicesand guidance. 5. Annex B provides a summary of accounting and auditing standards referred to in this study. Annex C provides national accounting and auditing legislation. Annex D includes a description of the benefits of accrual accounting, and Annex E describes the accounting and auditingstaffingarrangements inNepal. ' Transition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities, IFAC Public Sector Committee,December2003. 6. The desired actions indicated by this assessment are summarized in the following paragraphsanddescribedinmore detailinthe mainsections ofthe report. A more comprehensive plan is required for Nepal to adopt Cash Basis IPSAS as part of a longer-term program to adopt accrual-based reportingof expendituresfor each government entity. The Government of Nepal accounts have been maintainedon a cash basis of accounting since 1962 but not in line with Cash Basis IPSAS. The accounts of the local autonomous bodies, Village Development Committees and District Development Committees, are maintained on the cashbasisof accounting while the municipalitiescan maintainaccounts either onthe cash basis or accrual basis of accounting. The IPSASBencourages governmentsto progressto the accrual basis o f accounting and to harmonize national requirements with the IPSAS. All government departments should eventually use Cash Basis IPSAS in preparingfinancial statements, and then gradually move toward accrual-based IPSAS. The revenue is to be accounted on the cash basis of accounting. Programs for implementationshould ensure effective action on the ground and should not just look good on paper, as indicated by the Country Financial Accountability Assessment (CFAA). 7. Nepal accounting laws and regulations should specify adoption of International Public Sector Accounting Standards, Nepal Accounting Standards, and applicable International Accounting Standards and International Financial Reporting Standards. Prevailinglaws do not prescribe the adoption of IPSAS for the maintenanceand compilationof the Government accounts. As part of progressive planto enhance the public sector accountingsystem in compliance with IPSAS, the finance legislation should be amended to make mandatory requirements for the general budget sector to maintain accounts and prepare a consolidated financial statement as guided by IPSAS. With regard to state-owned enterprises (SOE), the Auditor General has already issued directivesto these entities to adopt the guidelines stated in the Company Act for presentation of financial statements. The Company Act specifies the Nepal AccountingStandards (NAS), but other applicable InternationalAccounting Standards (IAS) and InternationalFinancial Reporting Standards (IFRS) are not specified.2 Relevant laws governing state-owned enterprises should be reviewed and amended for adoption of these accounting standards. 8. More effective training requires curricula more attuned to international standards. Current practices for selection of government accountants do not provide accounting staff with appropriateskills. Accounting staffrecruitmentshouldrequire specialarrangementsrather thanthe standard general entry into the Nepal Civil Service. Current practices of government accountant and auditor training do not provide required skills commensurate to international standards. Orientation training provided for five weeks after recruitment and in-service training during continuedservice is not sufficient to understandthe accounting and auditing system properly and enhance skills to required levels. In this respect, the Government of Nepal should prepare and implement a long-term visiodstrategy in human resources development in developing the accountingandauditingsector. Assurance should be providedfor adequate resources to implement the strategy. 9. A code of conduct for accountants is needed. There is no specific code of conduct for public sector accountantswho are not members of the Instituteof CharteredAccountants of Nepal (ICAN). A specific code should be created based on the codes of ethics of ICAN and IFAC. It is importantto specifythe code ofconduct inthe relevant laws. * The InternationalAccounting Standards Board issuedIAS fiom 1973 to 2000. Since 2000, the IASB has issuedIFRS. ii 10. A chief financial officer should be designated and made accountable for specific functionsand duties.The Chief of FinanceAdministrationUnit of each governmentoffice should be designated as chief financial officer, who should be responsible for maintenance of accounts preparation, submission of financial statements, and resolution of final audit irregularities; and madeaccountable bothto the FinancialComptrollerGeneral and the Officer In-charge. 11. The Government should empower the Accounting Standards Board to set IPSAS- based public sector accounting standards. The Government of Nepal should empower the Accounting Standards Board through legal amendment or through appropriate decision, as required, to take a lead to introduce public sector accounting standards based on IPSAS. To facilitate the smooth functioning ofthe Board, to provide necessaryresources and communicate the accountingrequirementofthe Government, .aSteeringCommittee shouldbe formed, chairedby the Finance Secretary and representedby the FinancialComptroller General Office (FCGO), Office of the Auditor General (OAG), ICAN and two standard setting Boards (Accounting and Auditing). The Auditor General should issue directives to state-owned enterprises specifying to adopt applicableIAS and IFRS, and relevant laws governing state-owned enterprises should be amended for adoptionofthese accountingstandards. The NepalAccounting Standards Boardshouldprepare NationalPublic Sector AccountingStandardson the basis of IPSAS. 12. Corporate governance inthe statutoryauthoritysector needsto be improvedthrough more effective audit review committees. The SOE financial statements are not reported on time. Disclosures of the accounting policies are not adequate and transparent in accordance with InternationalAccounting Standards. The Ministry of Finance should set up a Financial Review Committeeto review the financial statementsof the state-owned enterprises and ensurecompliance with relevant laws and reporting standards (NAS, IAS and IFRS). Further, at the SOE level, it is recommended that an independent Audit Committee is set up for follow-up and monitoring of compliance with relevant laws and reporting standards. This has to be backed up by appropriate legislatoryamendment. 13. A Supplementary Table of Standards and Gaps at the end of this report providesa matrix detailing the current standards, the present position, and options for improvements,separately, for accountingand auditing. A summary of the accountingissues is shown in Table ES1, while Table ES2covers those relatedto auditing. TableES1. Summary ofAccountingStandards Issues Standard Currentstatus Activity required to adopt internationalstandards 1. Doesthe Public Sector No. A statement ofcashreceiptandpayment as perthe AccountingLaw adopt CashBasisIPSAScanbepreparedusingexisting IPSAS? information. Sometechnical assistancewill be needed. 2. Doesthe educationand Not fully. Accounting staffrecruitmentshouldrequirespecial trainingofaccountants arrangementsratherthanthe standardgeneralentry. accordwith IES? Forthe existingcadre ofaccounts staff(up to the highestlevel), appropriatetraining shouldbe designed andprovided. 3. Doesthe Code of No. A code ofconduct for accountants basedon IFACor Ethicsmatch ICANcodes is neededandshouldbe incorporatedin international relevant laws. standards? 4. Is there a body to No. The Accounting StandardsBoardshouldbe prescribepublic sector empoweredthroughappropriatelegalinstrumentto accountingstandards? developpublic sector accountingstandards. The iii Standard I Currentstatus I Auditor Generalshouldissuedirectivesto I Activity required to adopt international standards SOEs to adoptNASandother standardsas necessary. 5. Are thefinancial No. GovernmentofNepalshoulddevelop a planfor the statementsin medium-termto movetowardimprovingthe existing accordancewith cash-basedsystemto CashBasisIPSASwith international additionalvoluntarydisclosure(e.g., undrawn standards? borrowings, liabilities, outstandingadvances and realizationof assets andproperties). 6. I s the statement of No. Forimmediateimplementation,the Government CashReceiptsand couldlearnfromthe experienceof Sri Lanka in PaymentsinIPSAS adoptingCashBasisIPSAS. Forthis, the form? Governmentcouldform a coreteamfor a study visit 7. Are accounting No. to Sri Lankaandthenapply possiblechanges inthe policies and existingaccountingsystem. explanatorynotes reauired? 8. Are other disclosures No. inaccordwith IPSAS? 9. Doesthe government No. This shouldbereviewedonly after the general issueaconsolidated budgetsector hasbeenreportedaccordingto Cash financialstatement BasisIPSAS. whichconsolidatesall controlledentities? 14. There is a needfor the Office of the Auditor Generalto adopt the NepalStandardson auditingfor governmentaudit,inadditionto the INTOSAIAuditingStandards. The accounts of the Government offices, Constitutionalbodies, NepalArmy, Nepal Police, Supreme Court and other lower courts, corporate bodies fully owned by the Government, and other specific public organizations are audited and reported on by the Auditor General inthe manner as determinedby Law, with due considerationgiven to the regularity, economy, efficiency, effectiveness, and the propriety thereof. The Office of the Auditor General developed its Government Auditing Standards in 1996 based on the INTOSAI Auditing Standards. These standards were updated in 2005 to accord with the revised INTOSAI Auditing Standards. These Government Auditing Standards are too general and do not describe in sufficient detail the audit procedures. The ICAN- developed Nepal Standards for Auditing are based on the IFAC-issuedInternational Standards on Auditing (ISA). The Office of the Auditor General should also adopt the Nepal Standards for Auditing for government audits as recommended by the INTOSAI. The Office of the Auditor General should ensure that recently developed guidelinesprepared as per the INTOSAI standards are implemented. Adequate resources need to be ensured to implement guidelines recently developed. I S . The Audit Act should be revised to make provision for conducting any type of audit and to provide more effective independence. Effective scrutiny by the legislature to ensure effective implementation of fiscal and expenditure policies needs comprehensive, competent, external audits. The Audit Act 1991 specifies matters to be audited but does not cover other specialized audit. The Act should be amended to authorize the Office of the Auditor Generalto conduct other specialized audits, such as environment and forensic audits. Revisions of the Law should be considered in reference to international~tandards.~While conductingother specialized A ModelNationalAudit OficeAct, AssociationofCharteredCertifiedAccountants, UK,2004. iv audits, OAG may maintain a close coordination with other investigating agencies such as, the NationalVigilance Center (NVC) and the Commissionfor the Investigationof Abuse of Authority (CIAA) to beinformedabout ongoingdevelopments inthe subjectareas. 16. Strengthened Public Accounts Committee and other departmental administrative processes are needed for following up on issues raised in audit reports. Lack o f a Parliament for some years has left a gap in the review process through Public Accounts Committees. In the context ofrecent restorationofthe Parliament, the PublicAccounts Committee(PAC) has recently been reconstituted, and is expected to play a significant role in the scrutiny of public accounts as raised in audit reports: There is a need to strengthen the Public Accounts Committee through exposureto bestpracticeexamples, and by modernizingthe functioning of the PAC. 17. Audit appointments should include requirements for a degree with accounting or auditing content. With a need to make a substantial investment in developing its human resources, the Office of Auditor General has prepared a medium-term Human Resources Development Plan and requires adequate resources to implement it. To minimize new requirements for training, future appointees should already be adequately qualified in basic accounting and audit. The Office of the Auditor General should work with other Supreme Audit Institutions or professional institutions to make arrangements to assist the continuing education program for audit staff. This Plan is needed to strengthen the technical and professional competenceofthe OAG staffto produce quality audit reportsthat meet internationalstandardsand serve the need of the stakeholders. The existing staff capacity to implement the new audit guidelines needscontinuous enhancement. 18. Auditing methods need to be updated. The audit guidelines developedunder the Public Audit Reformand CapacityBuilding Projectareyet to be hlly implemented.For this the Officeof the Auditor General requires support with additionalresources to continue to provide and update staff skills to review internal control systems and assess audit risk appropriately. A more comprehensively structuredaudit planningand working paper system needs to be implementedto improve efficiencyand reliability ofthe audits. . 19. The timeliness and precision of financial statement reporting needs to be improved. Coordination between the SOE auditees and the auditors is inadequate to ensure timely audit. Improvements in the consultative arrangements are needed, supported by appropriate penalties throughlegislation. 20. An audit opinion needs to be provided on the consolidated government financial statement. The consolidated financial statements of the Government of Nepal need to be improved by providinga separate audit opinion. While implementingthe Cash Basis IPSAS, it is recommended that a separate audit opinion is also provided to the consolidated government financialstatements. 21. There is a need for forensic audit training and improved reporting. The OAG Annual Audit Report concentrates on noncompliance with the prevailing Laws and also assesses performance of projects/sectors and relates to fraudulent transactions but not in a sufficiently systematic way to enable effective corrective actions. To address this issue, there is a need for forensic audit training. The Public Audit Reformand Capacity BuildingProjectsuggested that the OAG Audit Reports could be improved in terms of communicatingclear objectives, addressing more relevant problems, making more effective recommendations, and involving more extensive The WorldBankhas beendevelopingguidancefor PublicAccounts Committees inthe SouthAsia Region whichmaybehelpfulto the Parliamentfor Nepal. audit work. There is potential to improve the effectiveness o f the Audit Report by more efficient action on enforcement of corporate governance requirements through the Public Accounts Committee, Audit Committees, and the audit report review cells inministries. 22. A summary o fthe auditingissues is shown in Table ES2. TableES2. Summary of Auditing StandardsIssues Standard Current status Activity required to adopt international standards Broadly yes, but some Deficiencies needto be addressedeither deficiencies needto be through issuanceofdirectives bythe corrected. Auditor General,or by amendmentofthe Audit Act, whichever is appropriate. TheNepalAuditing Standards Board publicsector auditing this. shouldbeempoweredto set publicsector standards? auditingstandards as per ISA and in keepingwiththe requirementsofOAG. 3. HaveINTOSAIand IFAC INTOSAIAuditing Theplanneedsto be developedto audit standards been adopted? Standards havebeen gradually adoptthe NSA and ISA. adopted. 4. Hasa codeofethics Yes. Since the existingcode of conduct is too equivalent to the INTOSAI rigidandunrealistic inimplementation, standards beenadopted? this may deserve review. 5. I s the accountability process Yes. inthe SA1inaccordwith MTOSAIAuditing Standards? 6. Doesthe SA1legalframework I Broadly. The AudrAct needsto be amendedto meet the INTOCAI standards providefor, inter alia, more involvement for independenceandpowers? ofthe legislature. 7. Doesthe educationand Broadly, but there is room Recruitment andcontinuingprofessional for imprivement. educationprocessesshouldberevised. Computer-assistedaudit technology and are needed. other technologicalaudit techniquesneed to be appliedwithin OAG for conducting the auditofentities havingcomputer- basedaccountingsystems. 9. Doesthe SA1havethe quality Yes, but implementation Action is to be takenas per its recent peer assurance programsto meet needsimprovement. review of its work. internationalstandards? 10. Does the processto planthe I Partially. The new methodologiesrecently audits meet international developedneedto be implemented standards? through a trainingprogram. 11. Doesthe processtosupervise Partially. the auditsmeet international standards? 12. Doesthe processto evaluate Partially. the reliability of internal controlmeet international standards? vi Standard Currentstatus Activity required to adopt international standards Broadly. auditsto assess compliance with laws meet international standards? 14. Does the auditprocess usedto Broadly. obtainevidenceto support conclusions meet international standards? 15. Doesthe auditanalyze the Partially. Yes, inthe case of Audit opinions needto be more specific financialstatementsto SOEsandproject financial inaccordancewith MTOSAI standards. establishwhether acceptable statements beingSubmitted accountingstandardsfor to the MoF. financialreportingand disclosure are compliedwith? 16. Does the auditorprepare an No, incase ofAG's Annual The OAG should issueaudit reports audit opinion onthe financial Report. Partially, incase of giving reference to the financial reporting statements ina form that specific audit report frameworkusedto preparethe financial accords with international providedto SOEs and Statements, andexpressingan opinionon standards? project financial statements the complete set o f financial statements of beingsubmittedto the MoF. the Governmentbudget sector andthe fully owned SOEs. 17. Does the consideration of Broadly. More systems-basedauditingwould be an fraud and error inan audit of improvement. financial statementsaccord with internationalstandards? 18. Are the Auditor General's Yes, but with delays. Process andtime allowedfor publication reportsmade public? should be laid down inthe Law. 19. Isthe process for takingaction No, inthe absence ofPAC Line ministries should form a separate onaudit recommendations for last four years. cell or unit to take actions on and monitor sufficiently effectiveto meet actions takento implement audit internationalstandards? recommendations. 23. Progressive implementation of the international standards will improve public financial management by providing a more ambitious and comprehensive reform program. The consequenceso f the above variances from international standards for accounting and auditing are reflected in the quality o f financial reporting. Public financial management relies on a comprehensive and timely accounting and financial reporting system. With assurance from a competent professional audit function, the system should work properly and provide reliable information. Current enforcement o f adequate compliance with financial regulations in the general budget sector and corporate governance in the public enterprise sector falls short of satisfactory standards. Use o f the PFM performance measurement framework developed by the Public Expenditure and Financial Accountability (PEFA) program is a good basis to develop and measure progress in the full cycle of PFM reform from budget formulation to legislative scrutiny and remedial a ~ t i o n .The performance indicators examined inthe PEFA Program provide guidance for ~ sequencingreforms that make logical sense to improve PFM inthe Nepal context. ~ The PEFA Program is a partnership among the European Commission, the UK Department for International Development, the Swiss State Secretariat for Economic Affairs, the French Ministry o f Foreign Affairs, the Royal Norwegian Ministryof ForeignAffairs, the Strategic Partnershipwith Africa, IMF, and the World Bank,. A Steering Committee, comprisingmembers of these agencies, manages the Program, A Secretariat is located in the World Bank inWashington, DC. vii 1. INTRODUCTION This assessment of public sector accounting and auditing in Nepal is generally meant to help implement more effective public financial management(PFM) through better quality accounting and public audit processes, and to provide greater stimulus for more cost-effective outcomes of government spending. More specific objectives are to (a) provide the country's accounting and audit authorities and other interested stakeholders with a common well-based knowledge as to where local practices stand in accordance with international standards o f financial reporting and auditing; (b) assess the prevailing variances; (c) chart paths for improving compliance in accordance with international standards; and (d) provide a continuing basis for measuring improvements. The findings o f this study will be a major input to the PFM work being undertaken by the Bank and country authorities. 1. As part of the general support program in South Asia for the assessment and improvement o f public sector accounting and auditing, the World Bank, with the cooperation of member governments, is conducting a Review of Public Sector Accounting and Auditing Practices in member countries. In conducting this assessment, a diagnostic questionnaire, developed in the light of the PFM Performance Measurement Framework6 by the Public Expenditure and Financial Accountability (PEFA) Program,' was used to gather substantial insight into country performance with regard to the external auditing and financial statement reporting PFM indicators. .Annex A discusses the methodology used for conducting the assessmentinthis report and provides the context and limitations o fthis study. 2. The diagnostic questionnaire was used to gather information on national standards and practices for accounting, financial reporting, and auditing in the government budget sector and in the state-owned enterprise (SOE) sector. Conducted in cooperation with country authorities, the diagnostic questionnaires incorporate the principles contained inthe public sector accounting and auditing standards promulgated by the International Organization of Supreme Audit Institutions (INTOSAI) and International Federation of Accountants (IFAC). Annex B summarizes the accounting and auditing standards referred to inthis study. The responsesto these questionnaires stimulated further discussions among the World Bank team and country authorities. These discussions examined accounts and audit reports and working papers as a means to explore the quality o f processesand products. 3. The system of maintenance of public accounts in Nepal began in 1768. Reforms to the accounting system were initiated in 1814 and 1880. Budget formulation was begun in 1952. The Government o fNepal enacted the Procedure Rule Relatingto Governmental Expenditurein 1960, bringinguniformity infinancial administration. Implementationofnew accountingsystems based on the double-entry system was developed with the help o f the U.S.Agency for International Development and phased in over six years, starting in 1962 for expenditures. This accounting The PFM Performance MeasurementFramework has been developed as a contributionto the collective efforts of many stakeholders to assess and develop essential PFM systems, by providing a common pool of information for measurement and monitoring of PFM performanceprogress, and a common platform for dialogue. The PEFA Program is a partnership among the World Bank, the European Commission, the UK Department for InternationalDevelopment,the Swiss State Secretariat for Economic Affairs, the French Ministry of Foreign Affairs, the Royal Norwegian Ministry of Foreign Affairs, the International MonetaryFund, and the Strategic Partnershipwith Africa. A Steering Committee, comprising members ofthese agencies, managesthe Program. A Secretariat is locatedat the World BankinWashington, DC. systemwas implementedto account for revenuesfrom 1974.The Accounts Codewas revisedand updatedinMay 1997.The Office ofthe CorporationCoordinationCouncilhadrecommendedthe financial accounting system for the state-ownedenterprises inJuly 1977, and this continues more or less to be followed by the state-owned enterprises, except companies and banks. Audit was started in 1862. The Office of the Auditor General (OAG) was established in July 1959 in compliancewith the ConstitutionofNepaland the Audit Act that mandate a constitutionalbody to conductaudit. 4. The accounting and auditing capabilities were strengthened with the help of a project executedby the Asian DevelopmentBank in 1988 and 1989. The main objectiveso f the project were to improve the government's central and district treasury office accounting systems to provide better control over the allocation and use of financial resources, better financial information for strengthening government accountability, and enhance the efficiency and effectiveness of existing financial audit procedures; identify the potential scope for performance auditing; develop performanceaudit methodology; train a smallteam o f audit instructors; review the demand upto the year 2000 for accountants and auditors; review the capacity of existing institutions for accounting education; and make recommendations to correct imbalances. The World Bank provided the InstitutionalDevelopment Fund (IDF) Grant in 1995 to assist in the strengthening of the internal audit system and to establish a system inthe FinancialComptroller General Ofice (FCGO) to monitor the status of release of funds and donor reimbursements project-wise, and thereby to take timely corrective action to accelerate requests for reimbursement in various projects. The United Kingdom's Department for International Development funded projects which commenced around 1998, that helped the Government of Nepalto initiate computerizationof government accounts in the Financial Comptroller General Office, which enabled this Officeto prepare timely financial statements through direct access to information systems in 56 out of 75 District Treasury Comptroller Offices. The Financial Comptroller General Office obtains expenditure data from the remaining 19 District Treasury Comptroller Offices manually(including copying data onto floppy disks, faxing information, or deliveringhard-copy statements). 5. The World Bank provided IDF grants from 1993 to 2005 for capacity-building and institutionaldevelopment of the Office of the Auditor General. The projectsimplementedduring 1993 to 1999 helped to improve the planning, organization, and operation of audits; develop government auditing standards; develop various audit guides in line with international best practices; develop a Performance Audit Guide; assist in implementation of revised auditing procedures; upgradecapacity in performance auditing;develop a specialized trainingprogramfor staft design a system of planning, monitoring and reporting; prepare a three-year development plan, and transfer technology, methodology and approaches. The latest Public Audit Reform and Capacity-building Project funded by the IDF grant was completed in March 2006. The main objectives were to enhance the institutional capacity of the Office of the Auditor General to deliverquality publicaudit inthe followingways: revisingand consolidatingthe existingaudit guidelines in conformity with Auditing Standards of the International Organization of Supreme Audit Institutions (INTOSAI), International Standards on Auditing'(ISA) issued by the International Federation of Accountants, and the changes in the statutes, Acts, rules, and requirement in public audit areas (revenue audit, procurement and public works audit, projectaccountsaudit, and an auditingproceduresgeneralguide); 2 improving the Auditor General's reporting methodology commensurate with best internationalpractices; and 0 developingthe HumanResources Development Plan, including strengtheningof the training division to create a strong and fully equipped unit capable of providing quality trainingto OAG staff. 3 II. PUBLIC SECTORACCOUNTING A. InstitutionalFramework for Public Sector Accounting 6. The institutional framework should include adherence to Nepal Accounting Standards (NAS), applicable International Accounting Standards (IAS), and International Financial Reporting Standards (IFRS);* the use of qualified accounting staff to provide timely, relevant, and reliable financial information that is needed to support all fiscal and budget-management, decision-making and reporting processes. The diagnostic questionnaires that were used in this assessment have collected information on the current arrangements and the apparent gaps in Nepal for accounting laws and regulations; education and training of public sector accountants; applicationofa cade of conduct; andnumbers and characteristicsof public sector accountants. Accounting laws and regulations 7. Nepal accounting laws and regulations should specify adoption of International Public Sector Accounting Standards. Prevailing laws do not prescribe the adoption of International Public Sector Accounting Standards (IPSAS) for the maintenanceand compilation of Government accounts. As part of a progressiveplan to enhance the IPSAS-compliantpublic sector accounting system, there is a need to amend the finance legislation to make mandatory requirements for the general budget sector to maintain accounts and prepare a consolidated financial statement as guided by Cash Basis IPSAS. The Government of Nepal should then prepare a time-bound roadmap to gradually transit to full accrual basis of accounting in accordance with IPSAS, with due consideration of the government capacity to adopt accrual system. An extraction of the Financial ProcedureAct is in Annex Cyalong with extracts from otherNepalauditing and accountinglegislation. 8. The Auditor General should issue directives to state-owned enterprises to adopt Nepal Accounting Standards and applicable International Accounting Standards and International Financial Reporting Standards; and relevant laws governing state-owned enterprises should be amended for adoption of these accounting standards. Laws governing state-owned enterprises have made provision for maintenance of accounts on the basis of a double-entry book-keeping system, following generally accepted accounting principles in cases of state-owned enterprises, except companies and banks. The double-entry system does follow Nepal Accounting Standards in cases of companies, but there is no provision for mandatory compliance of International Accounting Standards, except for banks. However, state-owned enterprises have been following the required I A S and NAS standards voluntarily. The Relevant Act of state-owned enterprises should be amended to prescribe for mandatoryapplication of Nepal Accounting Standards, and applicable InternationalAccounting Standards and International Financial Reporting Standards wherever Nepal Accounting Standards, have not been promulgated. The Auditor General has already issued directives to state-owned enterprises to adopt the guidelines stated in the Company Act for presentationof 8The InternationalAccounting Standards BoardissuedIAS from 1973 to 2000. Since 2000, the IASBhas issuedIFRS. 4 financial statements. The Company Act specifies the Nepal Accounting Standards, but other applicable InternationalAccounting Standards and InternationalFinancial ReportingStandards are not specified. RelevantLaws governingstate-owned enterprises are thereforerequiredto be reviewedand amended for adoption of these accounting standards. Until the amendment of Relevant Acts of state-owned enterprises takes place, it is recommended that the Auditor General issue directives to state-owned enterprises, exercising the authority entrusted to his office by the Audit Act to comply with Nepal Accounting Standards and important applicable InternationalAccountingStandards inadditionto InternationalFinancialReportingStandards. 9. Nepal should adopt the Cash Basis IPSAS. Nepal has been maintainingaccounts on a cash basis but not in accordance with Cash Basis IPSAS. There is a need for improvements in the existing cash system to comply with IPSAS. For example, advance payments are treated as expenditures in the existing cash basis of accounting. The audited consolidated fund statement and annual revenue and expenditure statement do not include accounting policies and explanatory notes as required by IPSAS; whereas the consolidated financial statements issued by the Financial Comptroller General Office for government use include basic accounting principles and assumptions. According to the 2003 standard for financial reporting under the cash basis of accounting, the International Public Sector Accounting Standards Board (IPSASB) of the IFAC recognizes the right of governments and national standard-setters to establish guidelines and accounting standards for financial reporting. The IPSASBconsiders that the Cash Basis IPSAS is an important step forward in improvingthe consistency and comparabilityof financialreportingand encourages its adoption. For immediate implementation, the Government of Nepal could learn from the experience of Sri Lanka in adopting CashBasis PSAS. The Government ofNepalcouldform a core teamto make a study visit to Sri Lanka and then apply possible changes in the existing accounting system. The Financial Comptroller General Office should take a lead in recommending and obtaining the approval of the Auditor General to base the format of consolidated financial statements on the Cash Basis IPSAS. Financial statements could be prepared on that basis for immediate implementationuntil the amendment of the Audit Act and the FinancialProcedure Act. For the medium-term, the Government o f Nepal should develop a plan to move toward improvingthe existing cash-based system of accountingto Cash Basis IPSAS with additional voluntary disclosure of, for example, un-drawn borrowings, liabilities, and outstanding advances. 11. All government departments should eventually use the Cash Basis IPSAS in preparing financial statements, then gradually move toward the accrual IPSAS. The Governmentbudget sector accounts should be prepared first by improvingthe existingcash basis accounting system in accordance with the Cash Basis IPSAS. A program to gradually move towardthe accrual-basedIPSAS for accountingand reportingof expenditures should consider the government's accounting capacity to reach that stage. The cash basis of accounting would be continued for accounting revenue. This would provide sufficient time to the accountants to understand the Cash Basis and accrual IPSAS and eventually make the respective Government offices and FinancialComptrollerGeneral Office more accountable for maintenanceof accounts and preparationof financial statements. The transitionfrom Cash Basis IPSAS to accrual-based IPSASwoulddependonthe capabilityof accountantsand availability of informationrequiredfor accrual-basedIPSAS. Annex Ddescribesthe benefitsofthe accrual accounting. 12. Establish timetables for the publication of audited annual accounts. The Financial Procedure Act 1997 prescribes the timetable for submission of financial statements by the respective Governmentoffices to the FinancialComptrollerGeneral Office and the Office of the Auditor General. The Act also prescribesthe timetable for submission of financial statementsof 5 consolidated accounts for each financial year, and accounts ofthe appropriation, revenue, deposit, foreign aid, and loan, and investment, apart from consolidated funds, to the Office o f the Auditor General by the Financial Comptroller General Office. But the laws do not prescribe the period within which the audited annual accounts have to be published. The Audit Act should mention the timetable for publication of audited annual accounts, and it should be publishedaccordingly.' 13. The Government o f Nepal can be assisted inmoving from the Cash Basis IPSASto the accrual-based IPSAS by utilizing an IFAC study on the transitional path to accrual IPSAS." The study has four main parts: 0 Introduction. Chapters 1-3 address generalplanningand project management issues. General Financial Reporting Issues. Chapters 4 and 5 deal with the selection, development and approval o f accounting policies, and issues associated with the definition and identification o f reporting entities. 0 Financial Elements. Chapters 6-8 outline the broad steps required for the identification, recognition, measurement and disclosure o f assets, liabilities, revenues, and expenses. The broad approaches discussed could be adapted and applied to particular items. 0 Specific Topics. Chapters 9-15 highlight implementation issues associated with four specific accrual-based IPSAS, and provide guidance in relation t9 a selection of topics not addressed, or only partially addressed, by existing IPSAS. 2. Educationand training 14. Current practices for selection of government accountants do not provide appropriate accounting skills. Currently, accounts cadre staff are being recruited from candidates with educational qualifications in commerce, law, economics, statistics, mathematics and other academic disciplines, other than accounting. As a result, they are not adequately skilled to carry out accounting functions as per international standards. Recruitment should focus on accounting staff with academic qualifications only in commerce, specializing in accounting or audit. Recruitment of accounting staff should require special arrangements rather than the standard general entry into the Nepal Civil Service. Details of the selection processes are discussed in Annex E. 15. Current practices of training do not provide required skills to the government accountants and auditors. Orientation training that is provided for five weeks after recruitment and continuing in-service training is not sufficient to understand the accounting and auditing system properly and enhance skill levels. Additional and continuing training is necessary to enhance the skills of the accountants and auditors, to aid in the implementation o f all required accounting and auditing standards, easily and efficiently. The period of orientation training should be appropriately increased from five weeks to at least ten weeks, and the duration of training needsto be determined as per needs and work responsibilities. A continuing professional education strategy for new recruitment as well as the existingcadre o f accounts staff, for short- term and long-term training, should be developed based on the academic qualifications and experience o f various levels o f the accountants. The continuing professional education training Quality and timeliness of annual financial statements is performance indicator No. 25 in the PFM performancemeasurement framework supportedby the World Bankand other developmentagencies. loTransition to the Accrual Basis of Accounting: Guidance for Governments and Government Entities, InternationalFederationofAccountants Public Sector CommitteeStudy 14, December2003. 6 should be provided compulsorily to all the accountants and auditors according to their level, within five years of the start of the program. In this respect, the Government of Nepal should prepare and implement a long-termvisiodstrategy in humanresource development in upgrading the accounting and auditing sector. Assurance should be provided for adequate resources to implementthe strategy. 16. More effective in-house training requires curricula more attuned to international standards. The syllabi of the Nepal Administration Staff College (NASC), Revenue Administration Training Center (RATC), and the OAG Training Directorate do not cover all areas recommendedby INTOSAIand IFAC. The training is meant to upgrade the skill levels to more productive working levels, as quickly as possible. Training curricula should be revised to include topics of IFAC-issued International Education Standards for Professional Accountants (IES) and, with the cooperation of the Institute of Chartered Accountants of Nepal (ICAN), to meet the professionalaccountancy needs of the public sector accountants and auditors based on the academic qualifications of professional accountants. The learning materials should be developed by accountingand auditing experts based on International Education Standards, and take into account internationalaudit and accounting standards as required for adoption by public sector organizations.Detailsoftrainingprocessesare discussedinAnnex E. 17. Introduction of International Education Standards and a professional education program is needed. The localuniversities should includeIAS, IFRS, NAS, IPSAS, and detailed IES-prescribed elements in the accounting degree curriculum. This basic knowledge would enable the trained staff to work independently. A professionaleducation program should be offered to already working accountants and auditors who should be encouraged to join the program. The ICAN and its sister organization, the Nepal AccountingTechnicianInstitute, can contribute significantly in providing training, by acting as resource providers and developing relevant materials. Further, a steering committee should be formed under the chairmanship of the Finance Secretary with representation from FCGO, ICAN, Accounting Standards Board, Auditing Standards Board, and Ministryo fEducation& Sports, to discuss on various options for a professionaleducationprogramincludingdevelopinga universityeducationprogram. 3. Code of conduct 18. A code of conduct for accountantsis needed. There is no specific code of conduct for public sector accountants who are not members of the ICAN. Public sector accountants are guided by the Civil Service Act (Code) amended in 1992, Anti-corruption Act 2002, Financial ProcedureAct 1999, and FinancialAdministrationRules 1999 (amendedin 2003). Also inthese above-mentioned laws for public servants, there are disciplinary rules and a general code of conduct underwhich disciplinaryactionsare taken for non-compliance. Therefore, it is necessary to develop and enforce a Code of Conduct for public sector accountantswho are not members of the ICAN. The new code, which should be incorporatedinto the relevant laws, should be based on the IFAC-issued Code of Ethics or ICAN-issued Code of Conduct for professional accountants. The arrangementsshould be made within the FinancialComptroller General Office to monitorand ensure that accountantsare working in accordance withthe code. 7 4. Publicsector accountantarrangements 19. The Chief FinancialOfficer (CFO) is to be designated and made accountable to the FinancialComptrollerGeneral and the ChiefAccounts Officer (CAO) through Officer-In- Charge (OIC) by assigning specific functions and duties. For timeliness, relevance, and reliability, there should be a professionallyqualifiedCFO functionto be responsibleto the Chief Accounts Officerfor maintainingsystems of internalfinancialcontrolsthat managerisks, andfor preparing regular financial accounts for each government entity. The Chief Financial Officer should be responsible for the maintenance and management of the chart of accounts, ensure the most appropriate technologicalsupport for financial management practices, manage training and education needs for financial management, report on key performance indicators, and assist program managers to develop an effective financial approach to the delivery of expected outcomes. The chief of the Finance AdministrationUnit of each government office should be designatedas the ChiefFinancialOfficer ofthe office, and shouldberesponsiblefor maintenance of accounts, preparation and submission of financial statements, and resolution of final audit irregularities.He should be made accountable both to the FinancialComptrollerGeneral and the ChiefAccounts Officer (CAO) through Officer In-Charge(OIC). The duties and functionso fthe chief financial officer should be defined in the Financial Procedure Act and Financial AdministrationRules. The CFO functionshouldalso includeeffectivemaintenance ofprescribed internalfinancialcontrolsystemsto minimizerisksandresolutionof final audit irregularities. 5. Empowering Nepal Accounting Standards Board to set accounting standardsfor thepublic sector 20. Empower the Nepal Accounting Standards Board to set public sector accounting standards based on IPSAS. The Government of Nepal should empower the Accounting Standards Boardthrough legal amendment or through appropriate decision, as required, to take a lead to set public sector accounting standards based on IPSAS. To facilitate the smooth functioning of the Board, to provide necessary resources and communicate the accounting requirementsofthe Government, a SteeringCommitteeshouldbe formedchairedby the Finance Secretary and represented by the Financial Comptroller General Office (FCGO), Office of the Auditor General(OAG), ICANandtwo standard settingBoards (Accounting and Auditing). The National Public Sector Accounting Standards should be promulgated based on international public sector accounting standards for consistency with the IPSAS. The Office of the Auditor General shouldreviewandreport on the complianceofthe public sector accountingstandards. B. AccountingStandards as Practiced 21. The diagnostic questionnaires collected information on current arrangements and apparent gaps with IPSAS in the maintenance of accounts and presentationof financial reports. This exercise helped to recommend activities that will help bring local standards in line with internationalstandards 8 22. More formalized arrangements are needed before setting accounting standards for the public sector. The Accounts Code sets out the detailed rules for the cash-based system o f accounts. It is issued and amended by the Financial Comptroller General Office, with the approval of the Auditor General who hasthe responsibility under the Constitution to prescribe the format of accounts and the authority to issue accounting directives to the public sector under the Audit Act. It would be appropriate to adopt IPSASas the standards for the public sector. 23. Table 1 identifies the current position and the steps required ifthe Cash Basis IPSAS are to be adopted in practice as well as on-paper inthe regulations. Table 1. RequiredSteps for Adopting Cash Basis IPSAS Requirements Current deficiencies Activity required to adopt Cash Basis IPSAS Financial The reporting structure focuses on A statement o f cash receipt andpayment statements consolidatedh n d andpublic as per the Cash Basis IPSAS canbe presentedinthe accountsand the CashBasis IPSAS preparedusingexisting information from IPSAS for financial statements i s not the accounting records. Also, for each followed. entity (i.e., ministry anddepartment), an additional statement inaccord with the Cash Basis IPSAS can be prepared. Information to The financial statementsdo not This work requires restructuring ofthe IPSAS in statement presentall the information inthe FCGO computerized reporting formats. of cash receiptsand format requiredbythe Cash Basis Technical advice is requiredto extract the payments IPSAS. All this information is information inthe requiredform and available onthe government presentthe consolidated financial reporting system, but is in formats statements inthe format prescribedby the that are inconsistent with IPSAS. IPSAS. Accounting The auditedconsolidatedfund There is aneedto state the accounting policies and statement and annualrevenue and policies and explanatory notes, and the explanatorynotes expenditurestatement do not include basis on which the accounts are prepared. accountingpolicies and explanatory notes, whereas the FCGO-issued consolidatedfinancial statements for government use include basic accountingprinciples and assumptions. General Audited financial statements are not Itwould be necessary to reducethe considerations available within 6 monthsofthe reporting lag and to disclose further Reportingperiod reporting period. Cashbalancesthat information required by CashBasis Adequacy of are availablefor use and cash IPSAS, for example, to disclose un-drawn information about balancesthat are subjectto external borrowing facilities, liabilities ofthe the entity restrictionsandun-drawn borrowing Government, and outstanding advances. BPresentationof facilities are not disclosed.The comparative presentationdoes not meet certain information transparency requirementsof IPSAS. 9 I Current deficiencies Activity required to adopt CashBasis Requirements . - IPSAS Correctionof The natureoferrors, the amount of Furthertrainingandbettersupervisionof errors disclosed the correction, andthe fact that accounts officer would be neededto Nature of error comparative informationhas been correctly classifyexpenditures and e Amount of restated,or that it is impracticableto disclosureof errors, andrestatementof correction do so, is not done. comparative information where Comparative practicable. information restated Consolidatedfinancial statementsof A statement ofcashreceipt and payment financial consolidatedfunds, the as perthe CashBasis IPSAScan be statements appropriation, revenue, deposit, prepared.Further steps will be neededto foreign aid and loan, and investment include controlledentitiesas perIPSAS. are prepared. Treatment of The cashreceipts, payments, and Needto comply with the treatment of foreign currency . cash balance are accounted as per foreigncurrency anddisclosure aspectsas cashreceipts, IPSAS, but financial statementsare per IPSAS. payments, and preparedusingevenclosingrates. balancestreated in The exchange difference of loan compliancewith liabilityduringprojectperiod is not IPSAS accountedto expenses. The government has not formulateda Needfor the OAG and FCGOto formally Part Iand migrationpathandtimeline for adopt IPSAS and for the FCGOto transitional achieving CashBasis IPSAS, PartI, preparean implementationplanand provision compliance. timeline settingout specific steps to be compliance. taken, includingdisclosure, ifnecessary, of applicationofthe transitionalprovision (i.e., full complianceachievedwithin 5 years) for reportingperiodsbeginningon a date within 5 years of first adoption of IPSAS. C. AssessmentofAccountingand Auditingin State-owned Enterprises 24. Audit reports from a sample o f state-owned enterprises were examined for purposes of this assessment. Those state-owned enterprises whose accounts were examined are listed in Table 2. The examination revealed that two enterprises (Nepal Oil Corporation and Rastriya Banijya Bank) had qualified audit opinions. 25. Corporate governance in the statutory authority sector needs to be improved through a more effective audit committee. The financial statements of state-owned enterprises are not reported on time. Disclosures of the accounting policies are not adequate and transparent in accordance with International Accounting Standards. The provision of an audit committee should be made in the Relevant Acts o f the state-owned enterprises. Audit committees are to be made active and effective so as to ensure corporate governance in reporting and resolve audit irregularitiesreported by the Auditor General. 10 Table 2. State-owned EnterprisesExamined 26. The FinancialReview Committee should be set up to check the financial statements for compliance with the adopted standards. The financial statements of the state-owned enterprises are audited and reportedupon by OAG-appointedindependent professionalauditors. These auditors are then reviewed by the Office of the Auditor General. The appointed auditors issue audit reportsto the Auditor Generalexpressingtheir opinionson the financial statementsof the state-ownedenterprises.The Auditor Generalreviewsthe reportand submitshisreportsto the management of state-owned enterprises in the prescribed format, Except for the financial statements of state-ownedenterprisesrequiredby donor agencies, the Auditor General, ordinarily, does not express his opinion on the consolidated financial statements presented in his Annual Report, as required by Section 4 (C) of the Audit Act. The Auditor General's Annual Audit Report, however, mentions the qualification as a comment. Action is needed to require state- owned enterprises to amendtheir accounts in accordance with audit findings so that true and fair accounts may be issuedfor general public scrutiny within a stipulatedperiod consistent with that of listed enterprises. The FinancialReview Committee in the Ministry of Financeshould be set up to review the financialstatements of the state-ownedenterprises and ensure compliance with relevant laws, Nepal Accounting Standards, InternationalAccounting Standards and International FinancialReportingStandards. 11 111. PUBLIC SECTOR AUDITING A. StatutoryFrameworkfor Public Sector Auditing 27. Effective scrutiny by the legislature to ensure effective implementation of fiscal and expenditure policies needs comprehensive, competent, external audits that are underpinned by International Standards on Auditing." The environment for an effective Supreme Audit Institution(SAI) requires a comprehensive approach to public financial management. Supreme Audit Institutions are not stand-alone institutions. They are part o f a PFM architecture that includes budgeting, accounting, internal control, audit and legislativeoversight, and government response. Improving the way the supreme audit institution functions is integral to providing informationfor improvingthe overall PFM system. But the action must be within the executive branch, yet under the watchful eyes of the legislatureand the public.A strong demand for good publicsector externalauditingis necessary for the SupremeAudit Institutionto have any impact. This requires the willingness of the executive branch to accept and respond to external scrutiny over its management of funds and to ensure that reform action is taken. It also requires public presentation of the audit reports to ensure public support for effective action. All of these requirements are covered by the INTOSAI and PAC Auditing Standards. These should be adoptedbythe Auditor General. 28. The diagnostic questionnaires collectedinformationdescribing current arrangements and the apparent gaps inthe countryfor the followingareas: Institutionalframeworkfor the SupremeAudit Institution, Processfor settingauditingstandards, Use ofcode of ethics or conduct, Arrangementsto ensure accountabilityinthe Supreme Audit Institution, Arrangementsto ensure independence, Arrangementsto ensure adequate skills andqualificationsfor the auditors, Arrangements for providingtraining, Arrangements to ensure auditorcompetence, and Arrangements for quality assurance. Thoseareas with significantscope for improvementare discussedbelow. 1.Statutoryframework 29. The Audit Act should make provision for conducting other specialized audits. The Constitutionestablishes the Auditor General. Annex C gives the relevant extracts from Part XI1 of the InterimConstitutionand from the Audit Act 2048 (1991) relatingto the Auditor General. The Interim Constitution authorizes the Auditor General to audit and certify accounts of the Legislative-Parliament, Constituency Assembly, Commission for Investigation of Abuse of Authority, Office of the Auditor General, Public Service Commission, Election Commission, National Human Rights Commission, Government offices, Constitutional bodies, Nepal Army, 11Scope, quality, and follow-up of externalaudit is performanceindicatorNo. 26 inthe PFMperformance measurementframework supportedbythe Bankandother developmentagencies. 12 Nepal Police, NepalArmed Police, SupremeCourt and other lower courts, corporate bodies fully owned by the Government ofNepal, andother public organizationsrequiredby law to be audited by the Auditor General. The Audit Act 1991 specifiesthat theAuditor General to the regularity, economy, efficiency, effectiveness and propriety -shall -with dueregard audit a specified set of matters but does not generalize the authority, so that it covers all types of audits (see Annex C). The Audit Act should beamendedto authorize the Officeofthe Auditor Generalto conductother specialized audits, suchas environmentauditand forensic audit. 30. The Financial Procedure Act should contain an adequate Offences clause. Full cooperation by auditeesand ethicalbehaviorby auditors are essentialfor effectiveaudit. Current legislationis inadequatein respondingto significant lack ofcooperation by the auditee.A culture of impunity must be strictly guarded against, and the auditee should be punished for non- cooperationby amendingthe FinancialProcedureAct. 2. Setting auditingstandards 3 1. The Audit Act should adopt Nepal Standards on Auditing (NSA) and International Standards on Auditing. The Office of the Auditor General developed Government Auditing Standards in 1996 based on the INTOSAI Auditing Standards. These Government Auditing Standards were updatedin 2005 to accordwith the revised INTOSAIAuditing Standards. These Government Auditing Standards are too general and do not describe in sufficient detail the audit procedures. The ICAN-developedNepal Standards for Auditing are based on the IFAC-issued InternationalStandards on Auditing (ISA). The Office of the Auditor General should also adopt the Nepal Standards for Auditing for government audits. The Office of the Auditor General should ensure that recently developed guidelines prepared as per the INTOSAI standards are implemented. Adequate resources need to be ensured to implement guidelines recently developed. The InternationalAudit and Assurance Standards Board is progressively rolling out InternationalStandards on Auditing. The INTOSAI is movingfrom maintainingits own auditing standards toward supporting the IAASB in order that the IAASB Auditing Standards appropriatelyreflect the interestsofthe internationalpublic sector audit community. 32. International Standards on Auditing and Nepal Standards on Auditing represent best international practices for the auditing ,profession, particularly in the areas of fhndamental auditingpracticesuchas: auditevidence, documentation, audit materiality, fraud, auditerrors, auditopinions, auditplanning, controlenvironment assessments, and supervisingthe work of audit staff. 33. The Auditor General has already adopted the INTOSAI Auditing Standards as the core of its own auditing standards. INTOSAI Auditing Standards are internationally recognized, credible, and readily available. However, it is generally recognized that INTOSAI Auditing Standardsneedthe underpinningsupport ofthe moredetailedInternationalStandardson 13 Auditing. With the decision by MTOSAIto adopt InternationalStandards on Auditing and to preparepublic sector practicenotes, where necessary,to support each ofthese Standards,the way is open for Nepalto usethe more comprehensive InternationalStandards on Auditing and Nepal Standards on Auditing. This is quite appropriate as Nepal is a member of INTOSAI and its regional group, the Asian Organizationof SupremeAudit Institutions(ASOSAI). 34. The audit opinion needs to be provided on the consolidated government financial statement. Currently, the consolidated financial statements of the Government of Nepal do not contain an audit opinion. While implementingthe CashBasis IPSAS, it is recommendedthat the audit opinion is also providedto the consolidated government financialstatements. 3. Code of ethics 35. An effective monitoring system should be put in place. The Office of the Auditor General adopted the INTOSAI Code of Ethics in 1996 and also developed its own INTOSAI- basedCode of Ethicsfor its staff in 1999,incorporatingprovisionsof various acts. The Office of the Auditor General needs to revisit its Code of Ethics to ensure that it is practicaland realistic, andthen set upa morerigorousmonitoringsystemto ensurecompliance. 4. Accountability in the SupremeAudit Institution 36. The Office of the Auditor General needs to prepare a five-year corporate plan and adopt the system of peer review. The Office of the Auditor General is basically functioning without a long-termplan. It should prepare and implementa five-year corporate plan.The Office of the Auditor General recently requested the MalaysianNational Audit Departmentto review OAG work; such a practice should continue on a regular basis by inviting peer reviewers from other supreme audit institutionsto review the quality of the audit and offer guidance to enhance the capabilityofthe OAGstaff. 5. Ensuring independence 37. The Audit Act needs to be amended to provide effective independence. Core principlesof SA1independencewere set out bythe MTOSAI. Some ofthese principleswere only partially,ifat all, metbythe current legislativeandadministrativeframework: 0 financial and managerial autonomy and the availability of appropriate human, material, andmonetary resources; 0 independence of the SA1Heads, includingsecurity of tenure and legal immunity in the normaldischarge oftheir duties; 0 sufficientlybroadmandate and full discretionin the discharge of SA1functions; and the freedom to decide on the content and timing of their reports and to publish and disseminatethem; and 0 existence of effectivefollow-up mechanismson SA1recommendations. 38. More statutorily independent arrangements for establishing the budget should be put in place by legislation. The Auditor General should be vested with more financial powers. 14 The annual OAG budget needs to be placed and approved by the Ministry of Finance, unlike other ministries, and passedby the Parliament without voting. The best internationalpractice is for the Public Accounts Committee to discuss the OAG budget and then submit it to the Parliament without specific need for the approval of the Ministry of Finance, but usually with some comment bythe Ministry ofFinance. 39. Legislationshould mention the period within which the Annual Audit Report is to besubmitted and requirethe Reportto be made public.The Law shouldfix the periodwithin which the Auditor General should submit the Annual Audit Reportto the Parliament through the PrimeMinister.The Law shouldprovidethat immediatelyafter submissionto the Prime Minister, the Report is presentedto the Parliamentfor discussion and concurrent publication. Submission and publication within six months of the end of the financial year is generally considered best practice. 40. Improved Public Accounts Committee and departmental administrative processes are needed for following up audit reports.I2 There is an enormous backlog by the Public Accounts Committee inhearingaudit observations. Due to political instability and dissolutionof the Parliament in 2002, there were no arrangements for public scrutiny of the Auditor General's Audit Reports. The Public Accounts Committee was not in existence for almost four years. Recently, Parliament has been reinstated as a result of major political movements. A Public Accounts Committee has been constituted. Since its constitution, PAC has begun to play an active role instigatingpublic debate on outstanding irregularitiesas reportedby the Annual Audit Reports, and .reiterating the need for financial discipline for effective public financial management. Due to this four-year gap, there would obviously be a need for major institutional strengthening of the Public Accounts Committee. No doubt, under a democratic system, the Public Accounts Committee should be made more effective to complete hearing of the Audit Reports within the period specified by Parliament. The respective Secretariat of the Ministry should form a separate cell to resolve audit irregularities in coordination with the respective auditee, FinancialComptrollerGeneralOffice, andthe Officeofthe Auditor General. 6. Qualifications and skillsfor the auditors 41. Basic qualificationsshould include an accounting or auditing specialization for all appointees. The current OAG recruitment criteria for financial auditors require a candidate to have graduated in commerce/managementfor officer leveland 10+2 for non-officer. The criteria do not require specializationin accounting or auditing. As a result, the staff do not possess the necessary skills to conduct quality audits. In order to bring the existing staff up to mainstream levels of competency, extensivetraining for longer durations will be needed. New recruitmentat all levels should require an academic degree specializing either in accounting or auditing. Emphasis should move toward providing more professionaltraining and encouraging staff to acquire professionaldiplomas or degrees.The Officeofthe Auditor General would berequiredto make a substantial investmentindeveloping its humanresources. Throughits last IDF grant, the Officeofthe Auditor Generalprepareda medium-termHumanResourceDevelopmentPlan. The success of the Plan will be seen only when it is judiciously implemented; for this to happen, additionalresourcesfor implementationare needed. l2Legislative scrutiny of external audit reports is performance indicator No. 28 in the PFM performance measurementframework supportedbythe Bank andotherdevelopmentagencies. 15 7. Training 42. The Office of the Auditor General should provide extensive orientationtraining on recruitment and operate a continuing professional development program for its staff. Newly recruited staff should be provided with at least 10 weeks of extensive training on IES- recommendedtopics and Government Auditing Standards as well as audit guidelines.In-service training should be provided on regular basis under a continuing education program, as per the Human Resources Development Plan, to enhance and update the audit skills for conducting specialized audits in accordance with the internationallyaccepted best practices. The Office of the Auditor General could work with other supreme audit institutions or professional organizations to arrange for OAG staff to participate in other established, continuingeducation programs. 8.Auditor'competence 43. It is necessaryto strengthen the technical and professionalcompetenceof the OAG staff to produce quality audit reports that meet internationalstandards and serve the need ofthe stakeholders. The Office ofthe Auditor General has developed various auditguidelines; a separate directorate is working within the Office on policy-making,maintenance and updatingof guidelines. The existing capacity of OAG personnel to implement these guidelines has not reachedthe desired level, thus requiringmore training and practicalexperience. The adoptionof the Nepal and internationalauditing standardswill help staff to understand audit methodologies. The Office of the Auditor General concentrates on regularity and performance audits, but now needsto improve implementationthroughtraining so as to build its in-house capacities to focus more on performance audits to assess the results. These will need to measure development outputs andoutcomes, and in a progressiveprioritizedmanner, introduceforensic, environmental, and informationtechnology audits. The Office of the Auditor General needsto create a few core groups of specialized professionalaccountants to conduct these specialized audits. Technology software support is needed for the audits of entities with information technology-based accounting. All these would require Government's commitment for significant reform of the Office of the Auditor General, by providing scaled-up resources, both financial and human resources,to comply with focus on new requirements. 9. Quality assurance 44. Improved structures and indexingof more comprehensive audit working papers is required to help audit supervisors to ensure specified quality standards. The Government Auditing Standards, consistingof policy standards and operationalguidelines, provide guidance on supervision, auditplanning, compliance with laws, internal control, audit evidence, review and interpretationof audit findings, materiality, report and presentation, peer review, and debriefing for quality control. The quality of the audit is assuredthrough direction inthe form of audit plan and program, close supervision, discussion on accounting and auditing issues with appropriate authority, and a review process. Moreover, the supervisorand higher-levelpersonnel review the work of assistants and finalize the audit findings, conclusions, and recommendations, taking into consideration the materiality and significance of the audit findings. But due to lack of trained personnel, the audit standards cannot be suitably implementedand audit working papers are not maintained properly as specified, in some cases. A robust quality assurance regime needs to be put in place and operate effectively. Working papers should be properly organized and 16 maintained; they should be indexed for easy cross-reference, quality control review, and recording quality supervision. There is a practice of internal post-audit quality review (peer review)to some extent.Sucha review systemcan be further enhancedthroughthe useof external reviewers. B. AuditingStandards as Practiced 45. The diagnosticsquestionnaireshavecollectedinformationaboutthe current arrangements for the audit methodology andthe apparent gaps inthe country inthe following areas: audit planning, audit supervision, reviewinginternalcontrols, reviewingcompliance with laws, ensuringthat adequateaudit evidence is collected, analyzingwhether the financial statementsaccord with accountingstandards, preparingaudit opinions, reportingon fraud, and reportingon compliance. Out of this exercise came recommendedactivitiesthat will help bring local standards in linewith international standards. 1.Auditplanning 46. More comprehensive auditing requirements based on specific objectives of the audits should be planned. The Office ofthe Auditor Generalis under-resourcedwith respectto personnel having knowledge to conduct all types of audit that meet the quality of its statutory obligations and experience to report within six months from the financial statement reporting date. Resource problems will be exacerbated as the Office of the Auditor General endeavors to audit all of the entities under its mandate, and to appropriately respond to the challenges of improved financial reportingover comingyears. More efficient auditingprocesses can alleviate the problem. The Auditor General's AnnualReports shouldproviderecommendations and advice to Parliament for improvement of the PFM system. The current introduction of comprehensive audit planning process under the Public Audit Reformand Capacity Building Project has not yet beenimplementedinall audits. Risk assessment, determinationof materiality level, reviewof the internalaudit work program and its preliminary assessment to identify both their strengths and weaknesses, and audit approach based on assessment of internal audit have to be specified in all audit plans. The existing system gives attentionto planningtimetable and human resources for the audits, but not sufficientlywith risk and materiality issues. The OAG staff needto be trained ina moreforward-lookingandmodernauditplanningprocess. 2.Audit supervision 47. A morecomprehensively structuredworking papersystem is neededfor all audits to attainthe normalaudit objectives regardingthe validity of transactions. Workingpapersare 17 not filed in a systematic way. Workingpapers should be more structured and cross-referenced to substantiate the audit conclusion and opinion. The OAG staff need more guidance on various techniques of audittestingand processof supervision. 3. Reviewing internal control 48. Implement internal control review process to identify audit risk recommended in the Operating Guidelines. Under the Public Audit Reformand Capacity Building Project, the Office of the Auditor General has already developed Audit Guidelines for Government audit. However, the Guidelines have not been fully implemented due to lack of sufficient technical knowledgeto review internalcontrolsystems and assess auditrisk appropriately.The controlrisk is not properlyassessed and substantiatedwith appropriate working papers, to the desired extent. Training on Audit Guidelines and various ISA-recommended audit methodologies should be provided to the OAG staff for learning how to implement guidelines and the International Standards on Auditing, andto review internalcontrols for assessment of audit risk, in additionto upgradingoverallaudit skills.An auditmethodologyshould clearly outlinethe following points: audit confidence level; requirementsfor auditplanning, auditwork papers, andaudit reporting; how audit materiality is determined and what is an acceptable level of audit risk and confidence; how to develop an appropriate mix ofaudit work to addressauditrisks. The audit should be completed by a processthat encompasses how audit errors are summarized andevaluatedagainst audit materiality. 4. Compliancewith laws 49. Obtain management representation letter from all government offices. The written managementrepresentationsshould be obtained as requiredby the auditingstandards from all the auditees with respectto compliance with all prevailinglaws. 5. Audit evidence 50. The supporting documents obtained for audit evidence should be more systematically maintained. The supportingdocumentsobtainedfor audit evidence are critical in substantiating the audit findings and comments made in the audit report. Audit evidence should be properlydocumented, filed, andcross-referencedinthe workingpaper file. 51. Inventory and investment should be valued. At year-end, the Office of the Auditor General should attendphysicalverificationof inventoryto obtain evidence of any impairment at some Government projectshavingconsiderableamounts of inventory.Similarly, the Government investment should be valued on the basis of share market price of shares of the entities listed in the share market and suitable valuation methods of shares of the entities not listed in the share market.Any impairmentof inventoryand loss on investmentare to be consideredfor reportingin the Annual Audit Report. 18 6. Analyzingfinancial statements 52. Audit testing needs to be more directed toward forming an audit opinion. Testing should be expanded to undertake full financial attest audits covering all financial assertions. A financial audit should be conducted to provide an audit opinion on the complete set of financial statements instead of commenting on the deficiencies found in the scrutinizedtransactions. The Audit Report is heavily compliance-based, identifyingregulatory breaches inthe transaction, and focuseson discrepancies found. The financialstatements ofthe government budgetsector andthe state-owned enterprises published in the Audit Report should present the disclosures about variouselementsofthe financial statements. 7. Reporting onfinancial statements 53. State-owned enterprisesneedto submit financial statements on time and haveaudits completed within a specified period. At present, the state-owned enterprises do not prepare financial statements on time for submission to the auditors. The audit takes longer than the expected time because of delays in responding to the audit queries and lack of adequate cooperation from some auditees. The state-owned enterprises also do not respond to the preliminary audit within prescribed periods. This has caused substantial delays in completion of the audits and subsequent reporting on the financial statements. The state-owned enterprises should be strictly instructedto submit the financial statements on time and helpto complete audit within prescribed period. Failing to meet the deadline, the responsible officers should be held liablefor any penaltyas warranted throughlegislation. 54. The requirements of ISA 700. The Auditor's Reports on Financial Statements, to form the audit opinionshould be adopted in full. The Audit Reportcontainsthe scope of audit, purpose of audit, audit standards, and methodologiesused, but does not contain reference to the financial reportingframeworkusedto preparethe financial statements andthe degree of detailset by ISA 700 (in paragraphs 12to 15). This leaves some uncertainties as to the standards usedfor the work. It is uncertain whether the audit providesa reasonable basis for the opinion, and ifthe audit was planned and performed to obtain reasonable assurance about whether the financial statements are fiee of material misstatement. The Office of the Auditor General should issue Audit Reportsgivingreferenceto the financialreportingframework and expressingan opinionon the complete set of financial statements of the government budget sector and the fully state- ownedenterprises. 8. Reporting onfraud 55. There is a need for forensic audit training. The Audit Report concentrates on non- compliance with the prevailing laws and covers fraudulent transactions. The Office of the Auditor General focuses on fraudulent transactions but not in a sufficiently systematic way. International Standards on Auditing (ISA) 240, TheAuditor's Responsibilityto Consider Fraud and Error in an Audit of Financial Statements, requires the auditor to perform procedures to obtain informationthat is used to identify the risks of materialmisstatement due to fraud. In addition, it requires the auditor to evaluate the design of the entity's relatedcontrols, including relevant control activities; and to determine whether they have been implemented. The ISA 240 19 also requires the auditor to informthe auditee's managementand its boardofany fraudand of the failure in its internalcontrol that ledto the fraud. The Audit Report should mentionthe reasons that ledto the fraud andactionstakenby the auditee to avoidrecurrence ofthe fraud. 9. Reporting on compliance 56. Improve the effectiveness of the Audit Report by more efficient action on enforcement of corporate governance requirements through the Public Accounts Committee,Audit Committees, and Audit ReportReview Cell. Underthe present process, a preliminary audit report is prepared on completion of the audit and provided to the entity for comment, which is then considered inpreparingthe reportthat is sent to the ResponsibleAccount Officerhlinister for final comment. Final observations on audit irregularitiesare includedin the Annual Audit Report that is submittedto the Prime Minister.A follow-up on actions to resolve the irregularities is carried out during the next years' audit, The Public Accounts Committeeof the Parliament calls the auditee/ministry for response to unresolved audit findings. The Public Audit Reform and Capacity Building Project found that OAG Annual Audit Reports could be improved in communicatingclear objectives, addressing more relevant problems, making more effective recommendations, and involvingmore extensive audit work. To reduce the number of unresolvedaudit objections to be includedin the AnnualAudit Report, minor irregularitiesare to be reportedin management letters addressedto the Secretary of the respective Ministry and the Finance Ministry. The Annual Audit Report should be concise and include only major irregularities that have system wide implications. In coordination with the respective auditee, Financial Comptroller General Office, and the Office of the Auditor General, a separate Audit Report Review Cell is to be formed in each Secretariat of the Ministry to resolve audit irregularities. This will also assist in reducingthe number of irregularitiesto be reportedto the Parliament for examination bythe PublicAccounts Committee. 20 I I a -3s 3s ANNEXA. METHODOLOGYTHE ASSESSMENT OF As part of the general support program.in South Asia for assessment and improvementof public sector accounting and auditing against international standards, the World Bank with the cooperation o f member governments is conducting the Review o f Public Sector Accounting and Auditing Practices in member countries. The development of the PFM Performance Measurement Framework13by the Public Expenditure and Financial Accountability (PEFA) ProgramI4has opened the way for a diagnostic tool to be developed, that is referenced to the accounting and auditing standards o f International Federation of Accountants (IFAC), the International Organization of Supreme Audit Institutions (INTOSAI), and other relevant international benchmarks. This exercise provides substantial insight into country performance with regardto the externalauditing and financial statementreporting F M indicators. A set of6 questionnairesare usedto collect relevant information on country practices: 1. The public sector accounting environment -collecting basic information about financial laws and standards-setting arrangements, educational requirements for accountants compared with IFAC International Education Standards, ethical requirementscomparedwith the IFAC CodeofEthics for ProfessionalAccountants. 2. Publicsector accounting practicesfor the generalbudget sector ifusingthe cash basis of accounting - compared with the requirements o f the Cash Basis International Public Sector Accounting Standards (IPSAS). 3. Public sector accounting practices for the general budget sector if using the accrual basis of accounting -compared with the IPSAS requirements that govern accrualreporting for the public sector. 4. Public sector auditing environment -- compared with the provisions of the INTOSAICode o fEthics and the INTOSAI generalstandards. 5. Publicsector auditingpractices comparedwith the requirementsof the INTOSAI - field standards and reporting standards, and the IFAC International Standards on Auditing (ISA). 6. Accounting and auditing practices for state-owned enterprises compared with - the requirements of the International Financial Reporting Standards (IFRS) and International Standardson Auditing that governcommercial reporting. The responses to the diagnostic questionnaires, prepared by the relevant country authoritieswith the help o f in-country experts retainedby the World Bank, are supplementedby a due diligence review conductedby membersof a World Banktask team. Various documents are examinedas part o f the review, including relevant laws, codes of conduct, national accounting and auditing standards, accountant selection and promotion l3The PFMPerformance MeasurementFramework has been developed as a contributionto the collective efforts of many stakeholdersto assess and develop essential PFMsystems, by providinga commonpool of informationfor measurementand monitoringof PFM performanceprogress, and a commonplatform for dialogue. l4 The PEFA Program is a partnership among the World Bank, the European Commission, the UK's Departmentfor InternationalDevelopment, the Swiss State Secretariat for Economic Affairs, the French Ministry of Foreign Affairs, the Royal Norwegian Ministry of Foreign Affairs, the International Monetary Fund and the Strategic Partnership with Africa. A SteeringCommittee, comprisingmembers ofthese agencies, managesthe Program. A Secretariat is locatedinthe WorldBank in Washington, DC. processes, training needs assessments, accountancy training course outlines, curricula and accreditation methods, sample accounts, sampleaudit reports and working paper sets. A country report on the assessment is prepared for each country and reviewed by an expert panel of advisors before examination by the World Bank country team. The draft is then sharedwith the Government for response before finalization. Discussionswill also be held with the relevant stakeholders to devise an implementationplan to address the way forward, with a view to minimizevariances from internationalstandards. 26 ANNEXB. ACCOUNTING AND AUDITINGSTANDARDS This Annex contains a summary of the frameworks that have been used for the public sector accounting andauditingassessment. The International Accounting Standards Board (IASB), the International Federation of Accountants (IFAC), andthe InternationalOrganization of Supreme Audit Institutions(INTOSAI)are cooperating insetting internationalstandards for accountingandauditing. The IASB is an independent, privately funded accounting standard-setter based in London, England. The IASB memberscome from ninecountries and have a variety of functionalbackgrounds. In the public interest, IASB is committed to developing a set of high-quality, understandable, and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the IASB co-operates with national accounting standard-settersto achieve convergence in accounting standards around the world. The IASB issued InternationalAccounting Standards (IAS) from 1973 to 2000. Since 2000, it has issued International FinancialReportingStandards (IFRS). The IFAC has its headquarters in New York, USA, and comprises 163 member bodies, mainly the nationalprofessional accountancy bodies of most countries around the world. The IFAC Board established the InternationalPublic Sector Accounting Standards Board(IPSASB) to develop high-qualityaccountingstandards for use by public sector entitiesaround the world inthe preparation of general purpose financial statements. These are the International Public Sector Accounting Standards (IPSAS). The full text of Standards and Exposure Drafts currently on issue is available at httD://w.ifac,org/Dublicsector. The first 20 IPSAS are based on I A S to the extent appropriate for the public sector. The IFAC also has establishedthe InternationalAuditing and Assurance Standards Board (IAASB) to prepare and promulgate International Standards on Auditing (ISA) and is now working incooperationwith INTOSAIon preparingpublic sector guidanceonthe useof ISA. INTOSAI includes the Auditors General from almost all national government audit departments around the world and has its Secretariat in the Vienna offices of the Auditor General of Austria. Its Auditing Standards Committee, chaired by the Auditor General of Sweden, produces the INTOSAI Code of Ethics and Auditing Standards, a set of standards of a higher and more generic level than the IFAC-issuedISA. The Auditing Standards Committee is workin with the IAASB to preparepracticenotes explainingthe applicationofeach ISA inthe publicsector. B The various standards are listedon the followingpages. IsWorking Group on Financial Audit Guidelines,INTOSAI Auditing Standards Committee, SwedishNational Audit Office, 2004. ANNEX B IFAC-issued International Public Sector Accounting Standards (IPSAS) IPSAS 1,Presentationof Financial Statements (May 2000) IPSAS 2, CashFlow Statements (May 2000) IPSAS 3, Net Surplus or Deficit for the Period, Fundamental Errors and Changes in AccountingPolicies (May 2000) IPSAS 4, TheEfects of Changes in Foreign ExchangeRates (May 2000) IPSAS 5, Borrowing Costs (May2000) IPSAS 6, Consolidated Financial Statements and Accounting for Controlled Entities (May 2000) IPSAS7, Accountingfor Investments in Associates (May 2000) IPSAS 8, Financial Reporting of Interestsin Joint Ventures (May 2000) IPSAS 9, Revenue@om Exchange Transactions(June 2001) IPSAS 10, Financial Reporting in Hyperinflationary Economies (June 2001) IPSAS 11,ConstructionContracts(June 2001) IPSAS 12, Inventories (June 2001) IPSAS 13, Leases (December 2001) IPSAS 14, Events after the Reporting Date (December 2001) IPSAS 15, Financial Instruments:Disclosureand Presentation (December 2001 ) IPSAS 16, InvestmentProperty (December 2001) IPSAS 17, Property, Plant andEquipment(December 2001) IPSAS 18, SegmentReporting (June 2002) IPSAS 19, Provisions,ContingentLiabilities andAssets IPSAS20, RelatedParty Disclosures IPSAS 21,Impairmentof Non-cash GeneratingAssets CashBasis IPSAS,Financial Reporting under the CashBasis of Accounting InternationalEducation Standards (IES) IES 1, Entry requirementsto aprogram ofprofessional accountingeducation IES2, Contentofprofessional accountingeducationprograms IES 3, Professional skills IES4,Professional valuesethicsand attitudes IES 5, Practical experiencerequirements IES 6, Assessment ofprofessional capabilities and competence IES 7, Continuingprofessional development IES 8, Competencerequirementsfor auditprofessionals 28 ANNEXB International Financial Reporting Standards (IFRS) and InternationalAccounting Standards (IAS) IFRS 1, First-time Adoption of International Financial Reporting Standards IFRS 2, Share-basedPayment IFRS 3, Business Combinations IFRS 4, Insurance Contracts IFRS 5, Non-currentAssets Heldfor Sale andDiscontinuedOperations IFRS 6, Explorationfor, and Evaluation OJ Mineral Resources IAS 1, Presentationof Financial Statements IAS 2, Inventories IAS 7, CashFlow Statements IAS 8,Accounting Policies, Changesin Accounting Estimatesand Errors IAS 10,Events after the Balance Sheet Date IAS 11, ConstructionContracts IAS 12, Income Taxes IAS 14, Segment Reporting IAS 16, Property, Plant and Equipment IAS 17,Leases IAS 18, Revenue IAS 19, EmployeeBenefts IAS 20, Accountingfor Government Grantsand Disclosure of GovernmentAssistance IAS 21, TheEffects of Changesin Foreign ExchangeRates IAS 23, Borrowing Costs IAS 24, RelatedParty Disclosures IAS 26, Accountingand Reporting by RetirementBenejt Plans IAS 27, Consolidatedand SeparateFinancial Statements IAS 28, Investments in Associates IAS 29, Financial Reporting in Hyperinflationary Economies IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions IAS 3 1, Interests in Joint Ventures IAS 32, Financial Instruments: Disclosure and Presentation see also; See also Financial Instruments - otherissues IAS 33, Earningsper Share IAS 34, Interim Financial Reporting IAS 36, Impairment of Assets IAS 37, Provisions, ContingentLiabilities and ContingentAssets IAS 38, Intangible Assets IAS 39, Financial Instruments: Recognition and Measurement see also; See also Financial Instruments - otherissues IAS 40, InvestmentProperty IAS 41, Agriculture 29 ANNEXB INTOSAI Code of Ethics and Auditing Standards Codeof ethics Integrity. Auditors have a duty to adhereto highstandards ofbehavior (e.g. honesty and candidness) inthe courseoftheir work and intheir relationshipswith the staffof auditedentities. Independence, objectivity and impartiality. The independence of auditorsshouldnotbe impaired by personalor external interests.There is a needfor objectivityand impartialityinthe work and the reports, which shouldbe accurate andobjective.Conclusionsinopinionsandreports should bebasedexclusivelyon evidenceobtainedand assembledinaccordancewith the SAI's auditing standards. Professional secrecy. Auditors shouldnotdiscloseinformationobtained inthe auditingprocessto thirdpartiesexceptfor the purposesof meetingthe SAI's statutoryresponsibilities. Competence. Auditors must not undertakework whichthey are notcompetentto perform. Basicpostulatesfor the auditingstandards (a) The SA1should consider compliance with the INTOSAIauditingstandards inall matters that are deemedmaterial.Certainstandardsmaynot be applicableto some o f the work done by SAIs, includingthose organized as Courts ofAccount, norto the non-auditwork conducted bythe SAL The SA1should determine the applicablestandards for such work to ensurethat it is ofconsistently highquality. (b) The SA1shouldapply its ownjudgmentto the diversesituations that arise inthe course of governmentauditing. (c) With increasedpublic consciousness, the demandfor publicaccountabilityofpersons or entities managingpublicresourceshas become increasinglyevidentsothat there is a needfor the accountabilityprocessto be inplaceandoperatingeffectively. (d) Developmentofadequate information,control, evaluationandreportingsystems within the governmentwill facilitatethe accountabilityprocess.Managementis responsiblefor correctnessandsufficiencyofthe form and content ofthe financialreportsand other information. (e) Appropriateauthorities shouldensure the promulgationofacceptable accounting standards for financialreportingand disclosure relevant to the needsofthe government, and audited entities should develop specific andmeasurableobjectivesandperformancetargets. ( f ) Consistent applicationof acceptable accounting standards should result in the fair presentationofthe financialpositionandthe results ofoperations. (g) The existence ofanadequate systemof internal controlminimizesthe risk oferrorsand irregularities.It is the responsibilityofthe auditedentityto developadequateinternalcontrol systemsto protect itsresources.It is alsothe obligationofthe audited entityto ensurethat controls are inplaceandfunctioningto help ensure that applicable statutesandregulations are compliedwith, andthat probityandproprietyare observedindecision making.The auditor should submit proposalsandrecommendationswhere controlsare foundto be inadequateor missing. (h) Legislativeenactmentswould facilitatethe co-operationofauditedentitiesinmaintainingand providingaccess to all relevantdatanecessaryfor acomprehensive assessmentofthe activitiesunderaudit. (i)AllauditactivitiesshouldbewithintheSAI'sauditmandate.* G) SAIs shouldwork towards improvingtechniques for auditingthe validity ofperformance measures. (k) SAIs should avoidconflictof interestbetweenthe auditor andthe auditedentity. 30 ANNEXB * The full scopeof governmentauditingincludesreguluriry andpevformunce audit. Regularity audit embraces: ... Attestation offinancialaccountabilityof accountableentities, involvingexaminationand evaluation offinancialrecords and expressionofopinionson financialstatements; Attestation of financialaccountabilityofthe governmentadministrationas a whole; .. Audit offinancialsystemsandtransactionsincludingan evaluation o fcompliance with applicable statutesandregulations; Audit of internalcontroland internalaudit functions; Audit ofthe probityand proprietyof administrativedecisionstakenwithin the audited entity; and Reportingofany other matters arisingfrom or relatingto the auditthat the SA1considers shouldbedisclosed. Performance audit is concerned with the audit of economy, efficiency and effectiveness, and embraces: .. Audit ofthe economyof administrativeactivities in accordancewith sound administrative principlesandpractices, andmanagementpolicies; Audit ofthe efficiencyofutilizationof human, financialand other resources, including . examination of informationsystems, performancemeasuresandmonitoring arrangements,andproceduresfollowed by audited entitiesfor remedying identified deficiencies; and Audit ofthe effectiveness of performanceinrelationto the achievement ofthe objectives ofthe audited entity, and audit ofthe actualimpactofactivitiescomparedwith the intendedimpact. Generalauditingstandards (a) The auditor andthe SA1mustbe independent. (b) The auditor andthe SA1must possessthe requiredcompetence. (c) The auditor andthe SA1mustexercise due care andconcernincomplyingwith the INTOSAI auditingstandards. This embracesdue care inplanning, specifying, gatheringand evaluating evidence, andinreportingfindings, conclusionsandrecommendations. (d) The SA1shouldadopt policiesandprocedures to recruitpersonnelwith suitable qualifications. (e) The SA1shouldadopt policiesandprocedures to develop andtrain SA1employeesto enable themto performtheirtasks effectively, andto define the basisfor the advancementof auditorsandother staff. ( f ) The SA1shouldadopt policiesandproceduresto preparemanualsandother written guidance and instructionsconcerningthe conduct of audits. (g) The SA1shouldadopt policiesandprocedures to supportthe skillsandexperience available within the SA1and identifythe skills which are absent; providea gooddistributionof skillsto auditingtasks and assign a sufficientnumberof personsfor the audit; and have proper planningand supervisionto achieve its goalsat the requiredlevelofdue care andconcern. (h) The SA1shouldadopt policiesandprocedures to reviewthe efficiencyandeffectiveness of the SAI's internalstandardsandprocedures. Field standards (a) The auditor shouldplanthe audit ina manner that ensuresthat an audit ofhighquality is carriedout inan economic, efficientand effectiveway, and ina timely manner. (b) The work ofthe audit staffat eachleveland auditphase shouldbeproperlysupervised during the audit; anddocumentedwork should be reviewedby a senior memberofthe audit staff. 31 ANNEXB (c) The auditor, in determining the extent and scope ofthe audit, should study and evaluatethe reliability of internal control. (d) Inconducting regularity (financial) audits, atest should be made of compliancewith applicablelaws and regulations.The auditor should designaudit steps andproceduresto provide reasonable assurance of detectingerrors, irregularities, and illegal acts that could have a direct andmaterial effect on the financial statement amountsor the results of regularity audits. The auditor also should beaware o fthe possibility o f illegal acts that could have an indirect and materialeffect on the financial statements or results ofregularity audits. Reportingstandards (a) At the end ofeach audit the auditor shouldpreparea written opinion or report, as appropriate, setting out the findings in a relevant form; its contentshould be easy to understandand free from vagueness or ambiguity, include only informationwhich is supportedby competent and relevant audit evidence, andbe independent, objective, fair and constructive. (b) It is for the Auditor Generalto decide finally onthe actionto betaken inrelationto fraudulent practicesor serious irregularities discoveredby the auditors. 32 ANNEXB IFAC-issued International Standards on Auditing (ISA) Introductorymatters Audit evidence 100Assurance Engagements 500 Audit Evidence 110 Glossary of Terms 501Audit Evidence Additional Considerationsfor - 120Framework of ISAs SpecificItems 505 External Con$rmations Responsibilities 5 10Initial Engagements OpeningBalances - 200 Objective and GeneralPrinciples Governing 520Analytical Procedures an Audit of Financial Statements 530Audit Sampling 210 Terms of Audit Engagements 540Audit of AccountingEstimates 220 Quality Controlfor Audit Work 550 RelatedParties 230 Documentation 560SubsequentEvents 240 TheAuditor's Responsibility to Consider Fraud and Error in an Audit of Financial 570 Going Concern Statements 580 Management Representations 240 A Fraud and Error 250 Consideration of Laws and Regulations in an Using the work of others Audit of Financial Statements 600 Using the Work of Another Auditor 260 Communications of Audit Matters with Those 610 Considering the Work of Internal Auditing Charged with Governance 620 Using the Work of an Expert Planning Audit conclusionsand reporting 300Planning 700 TheAuditor's Reports on Financial Statements 310 Knowledge of the Business 710 Comparatives 320Audit Materiality 720 Other Information in Documents Containing Audited Financial Statements Internalcontrol 400 Risk Assessments andInternal Control Specializedareas 800 TheAuditor's Report on Special PurposeAudit 401Auditing in a Computer Information Systems Engagements Environment 810 TheExamination of ProspectiveFinancial 402 Audit Considerations Relating to Entities Information UsingService Organizations Relatedservices 910Engagementsto Review Financial Statements 920 Engagementsto Perform Agreed-upon ProceduresRegarding Financial Information 930Engagementsto Compile Financial Information 33 ANNEXc. NEPALAUDITINGAND ACCOUNTING LEGISLATION (A) AuditingLegislation Extractsfrom Part 12ofthe Interim ConstitutionofNepal2007, relating to the Auditor General Article 122. Establishmentand Term of Officeof Auditor-General There shallbe oneAuditor-GeneralinNepal. The Prime Minister shall appoint the Auditor General on the recommendation of the ConstitutionalCouncil. The term of the Auditor General shall be six years within the restrictive Clause (7) from the dateofappointment. Providedthat: (a) ifbeforethe expiryofhisterm, theAuditorGeneralattainstheage ofsixtyfive, he shall retire. (b) hemaybe removedfrom his officeonthe same grounds and inthe same manneras hasbeenset forthfor the removal ofaJudge ofthe Supreme Court. The position of the Auditor General shall be deemed vacant in the following circumstances: (a) ifhisresignationissubmittedtothePrimeMinisterinwriting; (b) ifpursuanttoclause(3) histermexpiresor he isremovedfrom hisoffice, or (c) ifhedies. No person shall be eligible to be appointed as the Auditor General without having the followingqualificationand he: (a) holds a graduate degree inmanagement, commerce or account from a university recognized by Government of Nepal, or has worked in special class of the Nepal Governmentpassingcharteredaccountancyexamination, or has experience at least for twenty years; (b) is not a memberof any politicalpartyduringappointment; (c) attainedthe age offorty five, and (d) hasmaintainedhighmoralcharacter. The remuneration and other conditions of service of the Auditor General shall be as determined by law. The remuneration and other conditions of service of the Auditor Generalshall not, so longas he holdsoffice, be alteredto hisdisadvantage. A person once appointed to the office of the Auditor General shall not be eligible for appointment inother Government Service. ANNEXC Provided that nothing in this Clause shall be a bar to appointment to any position of a political nature, or to any positionwhich has the responsibility of makinginvestigations, inquiries or findings on any subject, or to any positionwhich has the responsibility of submitting advice, opinionsor recommendationsafter carryingout studies or researchon any subject. Article 123. Functions,Dutiesand Powers of the Auditor General The accounts of the Supreme Court, the legislative-Parliament, the Constituency Assembly, the Commission for the Investigation of Abuse of Authority, the Auditor General, the Public Service Commission, the Election Commission, the NationalHuman Right Commission, the Office of the Attorney General, other offices of the Constitutional Bodies, the Nepal Army, the Nepal Armed Police and Nepal Police, and all other government offices and courts shall be audited by the Auditor General in the manner as determined by law, with due consideration given to the regularity, economy, efficiency, effectiveness andthe proprietythereof. The Auditor General shall be consulted in the matter of appointment of auditors for carrying out the audit o f any corporate body of which Government of Nepal owns more than fifty percent o fthe shares or the assets. The Auditor Generalmay also issuenecessary directivessetting forth the principlesfor carryingoutthe auditof such corporatebodies. The Auditor General and his assistants shall, at all times, have access to documents concerning the accounts for the purpose of carrying out the functions stipulated in clause (1) above. It shall be the duty o f the concerned office to provide all such documents or information,which may be demandedbythe AuditorGeneralor his assistants. Inadditionto the accountsofthe officesreferredto inclause (1) above, the lawmayalso require that the accounts of any other office or institution be audited by the Auditor General. Article 124. Reportsof Auditor-Generalto be laidbeforeParliament (1) The Auditor General shall submit an annual report to the Prime Minister on the works he hasperformed.The PrimeMinistershallcause suchreportto be laidbeforeParliament. (2) Inaddition to the submission of the report as mentioned in the clause (1) above, the Auditor General shall providedetails of the statements of the entities audited, status of the irregularities, efforts made to resolve irregularities and progress achieved in clearingthe irregularitiesand suggestions for improvements. Extractsfrom Audit Act 2048 (1991) (Audit Act 2018 was repealed) Section 3 (1). MethodsofAudit The Auditor General may conduct final audit ofthe financialactivitiesand other activities relating thereto, of the offices, bodies or organizations under its jurisdiction, either in detail or sporadically or in samples, prescribe scope, methodology and timing of audit and presentthe facts obtainedtherefrom, makecriticalcommentsthereonand submit its reports. 35 ANNEXC Section 4. Matters to be audited The Auditor General, with due regard to the regularity, economy, efficiency, effectiveness andpropriety, shall audit following matters to ascertain whether: The amount appropriated in the concerned heads and sub-heads by the Appropriation Act for respective services andtasks have been expended for the specified purposes of designated services or tasks within the approved limit; The financial transactions comply with the existing laws, and the evidence relating to items of income and expenditure are sufficient; The accounts have been maintained in the prescribed forms, and such accounts fairly represent the position o f the transactions; The inventory of government assets is accurate and up-to-date, and the arrangement for protection and management of governmental property is adequate; The arrangements for internal audit and internal control o f cash, kind and other governmental property against any loss, damage and abuse are adequateand ifso, are they pursued; The accounts of revenue, all other incomes and deposits are correct and the rules relating to evaluation, realization and methods o f book-keeping are adequateand ifso, are they followed; The accounts relating to public debts, security, deposit, Debt Relief Fund and the amounts set aside for debt services and repayment of debts are accurate; The accounts of income and expenditure of industrial and business services, and their balance of cash and kind, and the arrangements and rules relating to their financial transactions are adequate and ifso, are they observed; The organization, managementandjob allocation ofthe office are sufficient andproper andare they operating accordingly; Any function is being unnecessarily performed induplication by any employee or agency or any essential function is beingomitted; The available resources, means and assets are properly utilized and the maintenance and preservation thereof against any loss or damage has been properly arranged; The progresshas beenachieved withinscheduled time andthe quality and quantity ofthe work i s satisfactory; 36 ANNEXC (m) The objective and policy o f the Office is explicit and the program is delineatedconformingto the specified objective and policy; (n) The program is being implemented within the limits of approved cost estimateandthe proceeds received incomparison to the cost i s reasonable; (0) The arrangements for maintaining data relating to target, progress and cost are adequate and reliable; Section6. Audit of CorporateBodies Wholly Owned by Governmentof Nepal Notwithstanding anything contained inthe existing laws, the audit o f the corporate bodies wholly owned by Government of Nepal shall be audited by the Auditor General, pursuantto this Act. Ifthe Auditor General is constrained by time and resourcesto audit the corporate bodies wholly owned by Government o f Nepal pursuant to Sub-section (l), he may appoint professional auditors according to the existing laws, as his assistants.While appointing auditor as such, he shall give priority to Nepali citizens. The auditors appointed pursuant to Sub-section (2) shall act under the direction, supervision and control ofthe Auditor General. The powers, functions, duties and responsibilities of the auditors appointed pursuantto Sub-section (2), andthe proceduresto be followed by them incourse of audit and provisions relating to their report shall be as prescribed by the Auditor General. The remuneration to be paid by the concerned organization to the auditors appointed pursuant to Sub-section (2) shall be prescribed by the Auditor General, keeping inview the volume of financial transactions, status of accounts, number of branches and sub-branches, work load and work progress of the concerned organization. Section7. Audit of CorporateBodies SubstantiallyOwned by GovernmentofNepal (1) The audit of the corporate bodies substantially owned by Government of Nepal shall be done inaccordance with the existing laws relatingto such body. (2) Notwithstanding anything contained in Sub-section (l), Auditor General shall the be consulted while appointing an auditor for auditing of the corporate bodies substantially owned by Government o fNepal. (3) The proceduresto be followed while consulting the Auditor General for appointing auditors pursuant to Sub-section (2) and on matters o f principles of audit to be followed by the auditors during their audit, shall be as prescribed by the Auditor General. 37 ANNEXC (4) The concerned organization shall deliver at the Office o f the Auditor General a copy of the report submitted by the auditor appointed in consultation with the Auditor General, pursuant to Sub-section(2). (5) The Auditor General may issue directives to the concerned organization inrespect of the irregularities observed inthe report received pursuant to Sub-section (4) and itshallbethe duty ofconcernedorganizationto abide bysuch directives. Section 8. Annual Report of the Auditor General The Auditor General shall submit its annual audit report, including his critical comments and recommendations thereon, to The Prime Minister on the final audit of Government Offices and other offices and organization prescribed by existing laws, which are subject to audit by the Auditor General. Provided that the Auditor General may submit at any time, a report to The Prime Minister if he deems necessary to take immediate action against any loss or damage already happenedor impending uponthe fixed andcurrent national assets. Section 9. Recruitment of Officers and Employees and Condition of Services (1) There shall be officers and employees as approved from time to time by Government o f Nepal in order to assist the Auditor General in the performance of his duties. The number of such employees shall not be reduced without the approval o fthe Auditor General. (2) A separate cadre o f officers and employees in the Office of the Auditor General shall be constituted. The recruitment and other conditions o f services of the officers and employees within the cadre shall be as prescribed in the Rules to be framed under this Act. Section 11. Powers to Frame Rules The Government o f Nepal may, in consultation with the Auditor General, frame Rules for the implementationo fthis Act. Section 12. Action to be taken Against Irregularities Necessary legal action shall be taken in respect o f the faults and irregularities ' observed during the audit o f income and expenditure and other financial matters of Government o fNepal, according to the existing laws. 30 ANNEXC (B)AccountingLegislation Extractsfrom Part 13 of the InterimConstitutionof Nepal2007 relatingto the Auditor General Article 123 (4). Form andmannerof keepingpublicaccounts The accounts to be audited pursuant to clause (1) above shall, subject to the relevantlaw, bemaintained insuch form as prescribed bythe Auditor General. ExtractsfromAudit Act 2048(1991) Section10. Powersto issueDirectivesby the Auditor General The Auditor General may, subject to the Constitution of Nepal and the existing laws, issue directives to the concerned Government Offices, and Corporate Bodies wholly or substantially owned by Government of Nepal, from time to time to make proper arrangements on matters of accounts andto maintainregularity therein. It shall be the duty of the concerned offices or organizations to abide by such directives. Extractsfrom FinancialProcedureAct 2055 (1997) Section4. Responsibilityto keepaccounts of consolidatedfund Maintenance o f up to date accounts o f consolidated fund and preparation of its annual statement shall be the duty and responsibility o f the Financial Comptroller General Office and for that and other function including submission of accounts, Financial Comptroller General Office may fix responsibility to Government office, Nepal Rastra Bank andother banks. It will be the duty of all respective offices and bank to take and execute the responsibilityas prescribed inthe Sub-section (1). Other procedures relating to operation o f consolidated fund, maintenance of central accounts and preparation of financial statement shall be as prescribed. Section 10. Keepingof accounts of transactions (1) Accounting system of transaction shall be as prescribed by the Government o f Nepal. Unless prescribed, accounts o f the transactions shall be maintained as per current prevailing accounting system till such system is not prescribed (2) Accounts o f the transaction shall be maintained in the format approved by the Office of the Auditor General. (3) Itwill bethe duty ofthe Financial Comptroller Generaloffice to get approvalofthe format as per sub-section (4) and for its implementation, Auditor General, if 39 ANNEXC deemed necessary to improve in the prevailing accounts format, may issue directives mentioning the improved format to the Financial Comptroller General office after obtaining suggestionof the Financial Comptroller General. Financial Comptroller General Office shall be responsible for maintaining accounts of other two kinds of transactions except foreign aid, loan grant, investment, appropriation, revenue apart from consolidated fund and to submit consolidated financial statement to the Auditor General. Respective office shall maintain accounts o f expenditures from any kind of grant or sources not included in the budget and submit its statementto the Financial Comptroller General Office within fifteen days from the end of fiscal year. Responsible Accounts Officer shall get the consolidated accounts prepared after obtaining all the financial statements of appropriation, revenue and deposit from subordinateoffices. Responsible Accounts Officer shall arrange for keeping statement o f other types of assistance received as per Sub-section (3) of Section (5) in the Subordinate office and be responsible for keeping its consolidated statement. Section 11. Responsible person shall be accountable (1) Responsible person shall clearly keep or arrange to keep accounts of each transaction following the procedures prescribed by the prevailing Laws. Section 12. Maintenance of accounts of revenue, submission of i s statements and its audit (1) Chief of office shall be responsible for submission o f records, statement and accountso frevenue, maintenanceof its accountsandaudit conducted. Section 13. Deposit and accounting of cash and stock (1) The responsible person shall deposit the cash in the same day or the next day & goods inthe appropriate place within 7 days of the receipt andmaintain the records ofthe same. Section 14. Submission of accounts (1) Financial Comptroller General Office shall submit financial statement of consolidated accounts o f each financial year and accounts o f the appropriation, revenue, deposit, foreign aid and loan and investment apart from consolidated fund within the period specified by the Auditor General to the Office of the Auditor General. (2) The Responsible Accounts Officer shall prepare and submit the consolidated financial statement o f all revenue and expenditures o f each fiscal year along with 40 ANNEXC subordinate office to the Financial Comptroller General Office and Office of the Auditor General. (3) The responsible person shall submit the accounts of transactions and related documentsto the concernedoffice or Auditor as prescribed. Section 16. Audit (1) Financial Comptroller General Office shall conduct or get conducted the internal audit as prescribed. (2) Each office shall get audit conducted from the Office of the Auditor General submitting prescribed accounts and financial statements o f all kinds o f income and expenditure. Section 18. Responsibilityfor settlementof findings (1) The responsible person shall be accountable for settlement of irregularities reported by the auditor by providing evidence/ documents or regularizing the legibility of the transaction or recovering. (2) The Responsible Accounts Officer shall be accountable to settle or get settled the audit irregularities as per prevailing laws supervising whether irregularities were settled or not as per Sub-section(I). Section 19. Audit and settlementof irregularities The respective office shall get audit conducted of the settlement of the irregularities within 35 days fiom the date of receipt of irregularities reported by the Office of the Auditor General. An application may be submittedto the Office o f the Auditor General mentioning reasons if available for not able to settle the irregularities within the time limit as prescribed in Sub-section (1). Office of the Auditor General shall extend the reasonabletime on receipt of suchrequest. The Office of the Auditor General shall intimate the responsible account officer if irregularities are not settled and audit of the same is not get conducted within the time limit as prescribed in sub-section (2) and Responsible Accounts Officer shall be accountable to initiate actions according to information received. The Auditor General shall intimate to the minister or state minister if the Responsible Accounts Officer does not take action. Section36. Makingof rules The Government ofNepalmay enactnecessaryrules to implementthe objectives of this Act. 41 ANNEXD. BENEFITSOF ACCRUALACCOUNTING Extractfrom Study No. 14, "Transitionto the AccrualBasisof Accounting: Guidancefor Governmentsand GovernmentEntities," IFAC Public Sector Committee,December2003 1.18 The PSC has commented extensively on the benefits of accrual accounting for governments and individual public sector entities in previous Studies (Studies 5, 6, 8, 9 10 and 11) and Occasional Papers (Papers 1, 3, 5, 6 and 7). In order to provide some context for readers who are not familiar with the PSC's other publications, this section contains a summary o f the benefits ofreporting onthe accrual basis. 1-19 The information contained in reports prepared on an accrual basis is useful both for accountability and decision-making. Financial reports prepared on an accrual basis allow usersto: assess the accountability for all resources the entity controls and the deployment o fthose resources; assessthe performance, financial position and cash flows o fthe entity; and make decisions about providing resources to, or doing business with, the entity. 1.20 At amoredetailedlevel, reportingon anaccrual basis: shows how a government financed its activities andmet its cashrequirements; allows users to evaluate a government's ongoing ability to finance its activities and to meet its liabilities andcommitments; shows the financial position of a government and changes in financial position; provides a government with the opportunity to demonstrate successful managementofits resources; and i s useful in evaluating a government's performance in terms o f its service costs, efficiency and accomplishments. Financial Position 1.21 Accrual accounting provides information on an entity's overall financial position andcurrent stock ofassets andliabilities. Governments needthis informationto: make decisions about the feasibility of financing the services they wish to provide; demonstrate accountability to the public for their management o f assets and liabilities recognized inthe financial statements; planfor future fhding requirements ofasset maintenanceandreplacement; planfor the repayment of, or satisfaction of, existing liabilities; and managetheir cashposition and financing requirements. 1.22 Accrual accounting requires organizations to maintain complete records o f assets and liabilities. It facilitates better management of assets, including better maintenance, ANNEXD more appropriate replacement policies, identification and disposal o f surplus assets, and better management of risks such as loss due to theft or damage. The identification of assets and the recognition of depreciation help managers to understand the impact of using fixed assets in the delivery of services, and encourage managers to consider alternative ways ofmanaging costs and delivering services. 1.23 Accrual accounting provides a consistent framework for the identification of existing liabilities, and potential or contingent liabilities. The recognition of obligations meeting the definition of a liability and the criteria for recognition: compels governments to acknowledge and plan for the payment of all recognized liabilities, notjust borrowings; provides informationon the impact of existing liabilities on future resources; means that it i s possible to allocate responsibility for the management o f all liabilities; and provides necessary input for governments to assess whether they can continue to provide current services and the extent to which they can afford new programs and services. 1.24 Accrual accounting highlights the impact of financing decisions on net assetdequity and may lead governments to take a longer term view when making financing decisions than is generally possible when relying on cash or modified cash reports. Information on net assetdequity also means t hat governments may be held accountable for the financial impact of their decisions on both current and future net assets/equity. Changes in an entity's net assetdequity between two reporting dates reflect the increaseor decrease inits wealth during the period, underthe particular measurement principles adopted and disclosed in the financial statements. Under the accrual basis of accounting, the financial statements will include a Statement o f Financial Position which discloses information about assets and liabilities. Where assets and liabilities are not equal, a residual figure for net assetdequity will be reported. Where this figure i s positive it canbe interpretedas the net resourcesthat may be applied for the provisionof goods or services in the future, and therefore the community's investment in the reporting entity. Where the figure is negative, it may be viewed as the amount o f future taxation or other revenues which are already committed to paying off debt and other liabilities. Net assetdequity can comprise some or all o fthe following components: contributed capital; accumulated surpluses and deficits; and reserves (for example revaluation reserve; foreign currency translation reserve). Financial Performance 1.25 Accrual accounting provides informationon revenuesand expenses, includingthe impact of transactions where cash has not yet been received or paid. Accurate information on revenues is essential for assessing the impact o f taxation and other revenues on the government's fiscal position, and in assessing the need for borrowing in the long term. Information on revenues helps both users and governments themselves to 43 ANNEXD assess whether current revenues are sufficient to cover the costs o f current programs and services. 1.26 Governments need information about expenses in order to assess their revenue requirements, the sustainability o f existing programs, and the likely cost of proposed activities and services. Accrual accounting provides governments with information onthe full costs o ftheir activities so that they can: consider the cost consequences of particular policy objectives and the cost of alternative mechanisms for meeting these objectives; decide whether to fund the production o f services within government sub- entities, or whether to purchase goods and services directly from non- government organizations; decide whether user fees should cover the costs associatedwith a service; and allocate responsibility for managingparticular costs. 1.27 Accrual accounting can provide financial information on whether sub-entities are delivering specified services, and delivering them within agreed budgets. The same information, at a more detailed level, can also be used within sub-entities for the management o f activity andprogram costs. 1.28 Accrual accounting allows an individual entity to: record the total costs, including depreciation o f physical assets and amortization o f intangible assets, o f carrying out specific activities: recognize all employee-related costs and to compare the cost of various types of employment or remuneration options; assess the most efficient way of producing their goods and services and of managing the resources over which they have beendelegated authority; determine the appropriatenessofcost-recovery policies; and monitor actual costs against budgetedcosts. Cash Flows 1-29 Accrual accounting provides comprehensive information on current cash flows and certain projected cash flows, including the cash flows associated with debtors and creditors. It can therefore lead to better cash management and may assist in the preparationo fmore accurate cashbudgets. 44 ANNEXE. SELECTION AND TRAINING ACCOUNTANTS AUDITORS FOR AND 1. There are two separate cadres o f accounts and audit staff inthe Government: (a) a cadre o f audit staff inthe Office o f the Auditor General, and (b) a cadre o f accounts staff inthe Financial ComptrollerGeneral Office. AccountsCadreStaff 2. Accounts cadre staff are requiredto have educational qualifications in commerce, law, economics, statistics, and mathematics for gazetted officers and any academic subject for non-gazetted second class appointments (non-officers); and are recruited by the Public Service Commission for assignment inthe Nepal Civil Service to work under the Financial Comptroller General Office. These staff are under the administrative control of the Financial Comptroller General Office, which controls their assignment, transfer, promotion, and disciplinary action. They work as accountants inthe government offices or as internal auditors to conduct internal audit of the government offices on behalfofthe Financial Comptroller General Office. 3. Accounts cadre staff of officer level are trained in the Nepal Administration Staff College and Revenue Administration Training Center for five weeks in a foundation course after appointment. The accounts cadre staff remains probationary for one year. They are then posted to the Financial Comptroller General Office. Advanced training is provided to the officer-level staff, once during their service at each officer level, for five weeks. Training to the non-officer staff is not compulsory during their service period; however, training is provided to some non-officer staff on a needs basis. Officer-level staff may also receive advancedtraining abroad. 4. The accounts cadre staff of officer level inthe NASC and RATC go through the following courses: Accountancy, elementary; Government accounting; Loandisbursementand accounting; Project accounting; Financial Procedure Act, Financial Administration Rules, Audit Act and other relevant Laws o f the government; Budgetingand reporting; Regularity and performance auditing; Internal audit; Financial management; Procurement procedure. General understandingofNAS and IAS Audit CadreStaff 5. Audit cadre staff are required to have a minimum educational qualification of graduatation in commerce or management for officer level and school grade 10+2 for non-officers. They are recruited by the Public Service Commission in consultation with the OAG, accordingto the OAG Employees ServiceRules. The Auditor Generalcan also hire the services of any expert requiredfor audit work, under contract with reasonable remuneration. 6. The OAG's training directorate providestraining to the newly recruited staff on accounting, auditing and relevant laws. It also provides training under a continuing education program on a needs basis. Training materials and curricula, and the skills of trainers need to be improved. The OAG's syllabus does not cover the whole syllabus recommended by the IES. Training in more specialized areas and in IT is outsourcedto professionaltraining institutions. Some staff are also provided with scholarships to study Chartered Accountancy courses. At present there are five Chartered Accountants in the OAG. The HumanResources Development plan developed in 2005 requires a minimum of 18 hours attendance in the continuing education program (CEP) annually and a minimum of 54 hours of CEP over a rolling 3 years period. The plan is inthe process of beingimplemented. 7. The audit cadre officers are providedtraining onthe following courses: OAG's organizationandmanagement structure; Governmentaccounting, project accounting; Auditing; Governmentauditing standards; Nepal Accounting Standards and its legalrelevance; Internal audit; Audit provisionmade inthe Company Act, Audit Act andvarious Acts; Audit plan, program, supervision, follow up andmaintenanceof audit file; Audit of state-ownedenterprises and autonomousbodies; Regularity, performance,revenue, procurement, and foreign-aided project audit; Audit of constructionprojects; Audit reportwriting; Functions, duties and authoritiesofthe Public Accounts Committee; Functions, duties andauthorities of the OAG; Financial ProcedureAct, FinancialAdministration Rules, and other relevantLaws governingaudit; and Civil Service Act andRegulationandOAG EmployeesRegulation. 46 SupplementaryTableof StandardsandGaps IPublicSectorAccounting . ......................................................................................................... 48 A.Assessment ofthe NationalPublicSectorAccountingEnvironment.................................. The Accounting Law............................................................................................. 48 48 Education and Training o fPublic Sector Accountants Code of Ethics for Public Sector Accountants .............................................................. ......................................................51 ......................................... 53 B. Assessment ofNationalPublicSectorAccountingStandards Public Sector Accountant Arrangements ............................................ 53 56 C.Assessment of AccountingandAuditing in State-OwnedEnterprises................................ Preparation andPresentationof Financial Statements onthe CashBasis............56 Framework for the Preparationand Presentationo f Financial Statements...........56 57 Financial Statements should comply with IAS and IFRS ..................................... 57 I1 PublicSector Auditing . ............................................................................................................ 58 A. Assessment ofthe Public Sector AuditingEnvironment.................................................... 58 Statutory Framework ............................................................................................. 58 Setting Auditing Standards ................................................................................... 60 Code of Ethics ....................................................................................................... 60 Accountability inthe SA1 ...................................................................................... 60 Independenceprovided by the Legislation -62 Qualifications and Skills of the Auditor ............................................................... .......................................................... ................................................................................................................. 64 Audit Competence................................................................................................. Training 65 .............................................................................................. 65 B. Assessment ofPublic SectorAuditing StandardsandPractices......................................... Quality of the Audit 66 67 Planning 67 Supervision . ................................................................................................................. ............................................................................................................ 68 Internal Controls.. .................................................................................................. 69 Compliance with Laws ................................................................................................................ .......................................................................................... 70 Analysis of Financial Statements.......................................................................... Evidence 71 72 Reporting on Financial Statements ............................................................................................... ....................................................................... 50 Reporting on Fraud 50 Reporting on Compliance ..................................................................................... 74 47 a) VI- i m vr v, m a 8 e w i% .-3 E u 5 I n B S 8 f 4 .-8 .-%m Y 2E a U .-m CI .s E LL 'CI c.' 8 Y 0 m P C 3E cusn 0 ri N U L d B .g a x o s Ji N 71 .5 .- el C n - 4 x 0 vi m k0 5 e, od M 0 d 0 b 3 U Q E E s rw 0 .-E0 Y rw 2a> 0 Q V .I Y .b -3 m