Financial Audits and Mechanisms for Good Governance of Public Funds: Levers in the Accountability Ecosystem for Greater Impact

Author: Khalid Hamid, International Director at CIPFA

Like many people, when I travel, I often take a taxi from the airport into the city center where I’m visiting or working. In my experience, taxi rides are a fantastic opportunity to learn about the local culture, find out which sights are worth a visit, or get recommendations about where to eat. What’s more, these drives are a prime opportunity to find out some more nuanced (and personal) information: how people perceive their government. In many instances, issues of corruption, inefficiency, and waste are openly shared by the driver, alongside personal perceptions of particular politicians. It’s a great, albeit anecdotal, way to get a feel for what local people are thinking or feeling. 

How… you may be wondering… is this related to the issue of financial audit and good governance? Good question. The indirect relationship between public services and technical audits is often opaque. In my experience, I have found that many stakeholders assume there is a positive correlation between good audits and strong public financial management. This isn’t always the case. I’m going to attempt to break down the aspects of financial auditing, and why additional support of compliance and performance considerations are needed to complete the circle for ensuring good governance – and ultimately how this might impact the views of local people, like the taxi driver. 

Back to basics

Financial auditing requires a few elements to be performed. The first is an accounting framework against which the audit is performed.  An accounting framework is a highly technical issue that often gets conflated with audit standards. In the INTOSAI world, there are a range of accounting frameworks. At the basic framework level, there are simple cash accounts that show the budget execution results, as well as salaries and procurement payments made over the year. In this case, this simply shows the tax receipts and how they’ve been used to fund government services. 

At the other end of the spectrum are sophisticated accounting frameworks that are designed with multinational companies’ operations in mind. This is known as the International Reporting Financial Standards (IFRS) and is controlled by a private sector foundation of the same name. A specific framework, similar to IFRS, for the public sector is known as the International Public Sector Accounting Standards (IPSAS). IPSAS is widely supported by the international community as the gold standard for public sector accounting. 

Public vs. private sector audit

Linking the audit discipline is the next thing to consider. Public sector financial audit relies on private sector standards issued by the International Accounting and Assurance Standards Board (IAASB). This is unlike the accounting discipline, where the IPSAS framework has been developed. Put simply, auditing is seen as no different for the public sector. What this means is that INTOSAI Standards of Supreme Audit Institutions (ISSAI) for financial auditing are simply the private sector standards with a commentary on the public sector perspective. The implications for treating public and private sector audit the same are profound.

Professionalization

Currently, financial audit can only add credibility to the accounting function. It doesn’t stand alone as a practice and/or function – it provides an opinion on the financial statements prepared by the accountants and audited entity. This means relying on the professionalism and capacity of the preparers of accounts and the finance staff involved in recording and approving transactions, events, and activities. 

In accounting and auditing frameworks, it is implicit that these functions are carried out by representatives of organizations aligned to the International Federation of Accountants (IFAC) – these are your typical Chartered Accountants or Certified Public Accountants. To qualify for membership, individuals are required to pass onerous exams that cover the IFRS and IAASB standards. Worth noting, these exams do not typically cover IPSAS standards. Therefore, the public sector is generally less qualified to undertake the auditing and accounting functions in-line with complex international standards (ie. IPSAS). 

New Zealand is often highlighted as the poster child for IPSAS implementation, and by association, represents a professional auditing establishment. However, in my experience, there are a majority of SAIs somewhere the journey towards full IPSAS implementation. This journey can be (and often is) ongoing for decades, and has seen significant support from the likes of international financial institutions. A simple reason for the frequently seen delays in IPSAS implementation the mismatch of skills and expectations; IFAC member accountants’ skills and experience are often not commensurate with the salaries and career paths offered by governments, including in some cases the Supreme Audit Institutions. Capacity remains an issue in most jurisdictions. 

Good governance and public trust

The question at this stage is: how has the professionalization of financial accounting and auditing in the public sector contributed to the wider good governance mechanism(s)? To illustrate this, I’m going to focus on public trust. 

Recent trends and challenges linked to declining levels of trust in government is a recurring topic that frequently comes up in professional conversations. The OECD recently published its survey of its member countries showing declining trust in governments. You put these results alongside the latest Transparency International Corruption Perception Index (CPI) and it leads to a depressing picture. Along with self-interested actors and a lack of political will, I think another factor is contributing to this alarming trend: financial audit’s negligible impact on policy and political priorities and decisions. 

A fundamental limitation 

In my view, all the accounting and auditing initiatives of the past thirty years have not improved the situation on a macro basis. The financial illiteracy of key stakeholders, like politicians and civil society leaders, can and does limit the understanding of the information provided in financial audit reports. 

It’s telling that the only result in the public domain of financial audits in the private sector is the audit report – a highly technical document that provides credibility that the financial statements incorporated into the annual report created by the audited entity are reliable. This report allows investors to make decisions about their future engagement with the audited entity through the buying and selling of shares. 

Conversely, the typical audit reports from public sector entities are often linked with compliance matters, and in many jurisdictions are published by the SAI itself. For example, the South African audit outcomes report includes a high impact report that summarizes the audit outcomes from financial and compliance audits conducted across a particular sector, such as local government. This is a perfect example that illustrates the unique value and landscape for public sector audit, and how different it is from the private sector.

Let’s consider in more detail how the private sector use of accounting and auditing departs from the public sector’s use. In the public sphere, we are not intending to move resources from health to education if education is performing better (as capital markets would react to two peer companies’ performance, for example). Therefore, the accountability of using public resources is the crucial output from the process. This financial audit will only take you so far.

Another example is that public money could be spent on the item recorded in the financial statements, but it may have been entirely wasted. This would technically still be a ‘correct’ recording, but we need other lenses – performance considerations – to scrutinize the waste. During the COVID-19 pandemic, we saw real concerns arise around public procurement in emergency situations, and SAIs stepped up by using real time auditing that didn’t rely on historical financial information for financial auditing. 

The limitation of financial audit is also exacerbated in an environment of corruption. The compilation of financial statements can certainly illustrate that expenditure and income are recorded correctly. But this fails to quell public perception concerns in many jurisdictions that the fundamental bases of most transactions are linked to cronyism, bribery, or nepotism. Again, this practical reality reduces the respect for the audit function. 

No silver bullet

These real-world challenges of course require more analysis. However, the point I’m trying to make is that financial audit is a valuable, but incomplete and dependent, service for the public sector. It’s not a silver bullet. Financial audit uniquely overlaps with a wide range of public sector functions and organizations. 

If we only rely on financial auditing, we can’t meaningfully respond to a taxi driver’s valid concerns in a comprehensive and accurate way. We could tell them how money is being spent and used, but not why they’re feeling like their government (or its services) are not working in their favor. Financial audit is one important lever in the wider public financial management and accountability ecosystem, but to maximise its impact, you have to conduct financial audits with performance and compliance audits in mind.