A Guide to Understanding National and County Audit Report

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2 A Guide to Understanding National and County Audit Report Published by: Parliamentary Initiatives Network With funding from International Budget Partnership IBP INTERNATIONAL BUDGET PARTNERSHIP Open Budget. Transform Lives. Parliamentary Initiatives Network, 2016

3 TABLE OF CONTENTS Acronyms and Abbreviations...iii Acknowledgements...iv 1.0 Background Objectives of the Guide : The Public Audit Process Importance of Audit Process : Mandate of the Auditor General in Kenya Types of public-sector audit Key Queries Raised by the Auditor Unsupported expenditure Excess Expenditure Pending bills Management of Imprests Types of Audit Opinion Unqualified Opinion: Emphasis of matter Modified Opinion Qualified Opinion Adverse opinion Disclaimer of opinion How to Read and Use Financial Audit Reports...13 ii A Guide to Understanding National and County Audit Reports

4 ACRONYMS AND ABBREVIATIONS AG COK DPP EACC ISA ISSAI IT MDA MOH OAG PAA PAC PFM Auditor General Constitution of Kenya Director of Public Prosecutions Ethics and Anti-corruption Commission International Standards on Auditing International Standards for Supreme Audit Institutions Information Technology Ministries Departments and Agencies Ministry of Health Office of the Auditor General Public Audit Act Parliamentary Accounts Committee Public Finance Management A Guide to Understanding National and County Audit Reports iii

5 ACKNOWLEDGEMENTS The Parliamentary Initiatives Network (PIN) would like to express its gratitude to the joint authors of this guide book for their spirited dedication towards its development. Special thanks to Ms. Jackline Kagume the PIN Coordinator, Mr. Noah Wamalwa of the Institute of Economic Affairs (IEA), Mr. Elias Wakhisi and Mr. Hillary Onami of the Institute for Certified Public Accountants of Kenya (ICPAK) and Mr. John Kinuthia of International Budget Partnership (IBP-K), who formed the technical team behind the development of this guide. We thankfully acknowledge the immense support by CPA Fred Riaga, CPA Nixon Omindi and CPA Patrick Obura of ICPAK who made invaluable contribution to this guide, Dr. Jason Lakin of IBP-K for his insightful input throughout the process and the entire ICPAK fraternity for their support and contribution to the development of the guide. PIN also expresses its gratitude to Dr. Wilfred Marube, Mr. David Munyaka, Mr. Meshack Onyango, Mr. David Gichana and Mr. Peter Opiyo of the Office of the Auditor General of Kenya, for their insights and contribution at the peer review of this document. Lastly, PIN would like to extend its sincere gratitude to International Budget Partnership for their generous financial support that made it possible to produce and publish this guide. iv A Guide to Understanding National and County Audit Reports

6 1.0 Background The Parliamentary Initiatives Network (PIN) identified the complex nature of audit reports as one of the key impediments to effective public advocacy around financial and other audits prepared by the Office of the Auditor General (OAG) of Kenya. The OAG has a constitutional mandate to audit the accounts of both levels of government and other public-funded entities and to submit reports of his findings to Parliament and the respective County Assemblies. PIN noted that the level of public engagement around audits is low compared to other stages of the budget process (formulation, approval and implementation). To remedy this, we embarked on a project to develop an easy to read Guide to Understanding Audit Reports to help organizations and individuals read and understand key issues in the various reports. Broadly, the Guide looks at the various types of public sector audit, the public audit process, types of issues raised by the auditor, audit opinions issued, and avenues for public engagement. It then details a set of important questions that ought to direct readers in identifying and finding the most critical information within the reports. Development of this guide has included discussions with the OAG in Kenya, who have on various occasions expressed their willingness to engage stakeholders in developing strategies on how to make audit reports simpler, clearer and easier for the public to understand. Although examples from the guide are from the national government audit reports, the same standards of audit apply to the county government level. PIN anticipates that better understanding of the reports will increase public demand for proper use of audit findings by both Parliament and the County Assemblies. 1.1 Objectives of the Guide Every year, the OAG produces a variety of audit reports as part of the accountability process in Kenya. The objectives of this guide are to: Demonstrate the importance of audit reports to the public Help organizations and individuals read and understand the issues captured in audit reports that are released by the OAG Enable the public and legislative assemblies to understand and follow up on audit findings and recommendations Build a more effective accountability environment in the management of public resources A Guide to Understanding National and County Audit Reports 1

7 2.0: The Public Audit Process An audit is the independent examination of the financial statements, as well as non-financial information, of an organization to ascertain fairness and accuracy of representation of the transactions carried out by the organization. After the budget implementation period comes to an end on 30 th June, all public funded entities are required to submit financial reports of that concluded financial year to the OAG by 1 st September. Upon receiving the reports, the audit process begins and the OAG is required to have concluded the exercise by 31 st December. The following chart illustrates the public audit process: Chart 1: The Public Audit process Follow-up of implementation of recommendations Letter of understanding sent to the auditedentily Reporting by Parliamentary and County Assembly Committee Planning Entrance meeting with management of the auditee Deliberation of reports by Parliamentary and County Assemblies Committee Feedback Executiion Audit queries are raised and feedback sought Reporting to Parliament Exit meeting is held final audit report is issued Reporting A draft audit report is issued to auditee and response sought A management letter is issued to accounting officer and response sought Source: Office of the Auditor General of Kenya The Auditor General submits all audit reports to the National and relevant County Assemblies. Within 7 days of receiving the report, Parliament is required to publicize it on its official website and other public spaces 1. On the other hand, the OAG is required 2 to make these audit reports public within 14 days after submitting the report to Parliament. 1 Section 32(2) of the Public Audit Act Section 32(3) of the Public Audit Act A Guide to Understanding National and County Audit Reports

8 To ensure there is wide access by the public, the OAG is required to have the reports on its website and other public spaces. These reports are then scrutinized by the National or County Assembly s Public Accounts Committee (PACs) inviting accounting officers to give explanations or information to clarify audit queries raised. The PACs are required to complete the debate on the reports within three months and take action. The PACs are not meant to re-audit but rather determine which issues are still outstanding and ensure that appropriate action is taken to rectify them. Within 3 months after PAC s recommendations, relevant agencies/individuals are obligated take steps to implement the recommendations or give an explanation to Parliament on why the report has not been acted upon. If there are criminal matters arising from the PAC process, the Police, the Director of Public Prosecution (DPP), the Ethics and Anti-Corruption Commission (EACC) and any other relevant bodies are then required to take up the matter. Figure 1: Responsible Institutions and Timelines 2.1 Importance of Audit Process Source: PIN technical team The public expenditure cycle is a framework that provides for planning and expenditure of public resources. Within the cycle, budget oversight serves as a control measure meant to minimize or manage finance-related risks by assessing whether public sector entities are doing what they are supposed to do. The audit process does not involve assessment of every single transaction by the entity. It is based on risk evaluation as determined by the auditor s objective judgment. Audit promotes due diligence and accountability since past performance of agencies should inform budgeting in the future. The 6 months provided by the Public Finance Management A Guide to Understanding National and County Audit Reports 3

9 (PFM) Act; from release of the OAG report to review by the PAC, to implementation of recommendations by implementing agencies, is a deliberate action to ensure this process informs the budgeting of the next financial year which commences on July 1st. If the AG s report is delayed and is not released by the 31 st of December deadline, this in turn delays the PAC review and in turn the delay of the corrective measures that should be implemented by the time the next budget cycle begins. Failure to meet these deadlines can lead to persistent auditing queries being raised year after year. 3.0: Mandate of the Auditor General in Kenya The Office of the Auditor-General Kenya The Office of the Auditor- General is established as an Independent Office under Article 248(3) of the Constitution of Kenya (COK). The Auditor-General is appointed in accordance with Article 229 of the Constitution to audit and report, in respect of each financial year, on- the accounts of the national and county governments, all funds and authorities of the national and county governments, all courts, every commission and independent office established by the COK, the National Assembly, the Senate and County Assemblies, accounts of political parties funded from public funds, the public debt, the accounts of any other entity that legislation requires the Auditor-General to audit The functions of the Auditor General are further provided for in Section 7 of the Public Audit Act as follows: a) give assurance on the effectiveness of internal controls, risk management and overall governance at national and county government; b) undertake audit activities in state organs and public entities to confirm whether or not public money has been applied lawfully and in an effective way; c) satisfy himself or herself that all public money has been used and applied to the purposes intended d) confirm that all reasonable precautions have been taken to safeguard the collection of revenue and the acquisition, receipt, issuance and proper use of assets and liabilities; and e) issue an audit report in accordance with Article 229 of the Constitution; f) provide any other reports as may be required under Article 254 of the Constitution; and 4 A Guide to Understanding National and County Audit Reports

10 3.1 Types of public-sector audit There are various types of public sector audits. In Kenya, the Public Audit Act (PAA) outlines the types that the OAG may conduct. The Table below briefly outlines the types of Audits: Table 1: Types of public-sector audit Type of Audit 1 Financial audit Description Focuses on determining whether an entity s financial information is presented in accordance with the applicable financial reporting and regulatory framework. Timelines and Mode (Optional or Compulsory) Within 6 months after the end of each financial year Report annually to Parliament and the respective county assembly. 2 Performance audit -Focuses on whether interventions and programs are using money well. The audit looks at Economy (buying what we can afford with our income), Efficiency (using money well) and Effectiveness (achieving our targets) and whether there is room for improvement. They are also referred to as Value for Money Audits. Optional (Section 36 of the PAA- The Auditor-General may undertake a comprehensive performance audit within six months after the completion of any National or County project to evaluate, whether the citizen has gotten value for money in the project) 3 Periodic Audits The Auditor-General may, upon request or at his or her own initiative conduct periodic audits which shall be proactive, preventive, and deterrent to fraud and corrupt practices, systemic and shall be determined with a view to evaluating the effectiveness of risk management, control and governance processes in State Organs and public entities. Optional Provided for under section 34 of the PAA 4 Procurement audits The Auditor-General may examine the public procurement and asset disposal process of a state organ or a public entity with a view to confirm as to whether procurements were done lawfully and in an effective way.nfo May, upon request or at his or her own initiative A Guide to Understanding National and County Audit Reports 5

11 Type of Audit Description Timelines and Mode (Optional or Compulsory) 5 Forensic Audit The Auditor-General may, upon request by Parliament, conduct forensic audits to establish fraud, corruption or other financial improprieties. May, upon request or at his or her own initiative 6 Environmental Audit Audit whose attention is devoted to the disclosure of environmental assets and liabilities and compliance with environmental legislation and conventions both national and international. It seeks to establish the impact of management actions on the environment May, upon request or at his or her own initiative 7 Information Technology(IT) Audit Examination and evaluation of an organization s IT infrastructure, policies and operations. It determines whether IT controls protect public assets and ensure data integrity and are aligned the overall goal of the entity. May, upon request or at his or her own initiative Source: PIN technical team and the Public Audit Act 4.0 Key Queries Raised by the Auditor 4.1 Unsupported expenditure In the absence of proper records and documentation, the auditor cannot be sure whether the expenditure is valid and follows procedure. These public funds may not have been utilized lawfully and in an effective manner as illustrated in the table below. Table 2: Illustration of a query on unsupported expenditure Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 6 A Guide to Understanding National and County Audit Reports

12 4.2 Excess Expenditure This refers to spending beyond what was approved ( appropriated ) by the National or County Assembly as illustrated in the table below. Table 3: Illustration of a query on excess expenditure Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 4.3 Pending bills This refers to Bills not settled or paid by the entity during the reporting period or the financial year under audit. This is a problem because agencies are only authorized to spend for one year at a time. Bills carried forward to a new year mean agencies are determining their own budgets for the coming year, which is not their role, but the role of Parliament. Furthermore, it is often the case that pending bills, if they had been paid during the year, would have resulted in excess expenditure beyond budget. The table below provides an example of queries raised on pending Bills Table 4: Illustration of a query on Pending Bills 4.3 Pending Bills Source: 2014/2015 Report of the Auditor General on Accounts of the National Government A Guide to Understanding National and County Audit Reports 7

13 4.4 Management of Imprests Imprests are a form of cash advance or a float which may be issued to officers who are required to make payments which cannot be conveniently be made through the cash office of a government entity or bank account. Imprests are sometimes intended to provide officers with funds with which they can meet travelling, accommodation and incidental expenses. The AG has in past pointed out to situations where imprests which ought to have been recovered or accounted for on or before the end of the financial year is still outstanding or unaccounted for as illustrated in the table below. Table 5: Illustration of a query on management of imprests 4.4 Management of Imprests S/n Ministry/Department/Commission/Fund Amount Kshs. Source: 2014/2015 Report of the Auditor General on Accounts of the National Government The issues raised above lead the auditor to form an opinion of the overall financial management of an entity. These opinions are discussed in the next section. 5.0 Types of Audit Opinion These opinions only apply to financial audits. While different countries might have variances in how some aspects of the opinions are defined, in this guide we use International Standards on Auditing (ISA) 3 to define the types of Audit opinions 5.1 Unqualified Opinion: This is a clean opinion, expressed when the auditor concludes that the financial statements give a true and fair view (or are presented fairly, in all material respects) in accordance with the identified financial reporting framework. 3 ISA A Guide to Understanding National and County Audit Reports

14 Table 6: Illustration of a paragraph on unqualified opinion Source: 2014/2015 Report of the Auditor General on Accounts of the National Government NOTE: The above example highlights an unqualified opinion with emphasis of matter Emphasis of matter Emphasis of matter refers to a paragraph included by the Auditor in his reports, to highlight an issue of importance that is fundamental to user s understanding of the financial statements. It can accompany both an unqualified or modified opinion. 5.2 Modified Opinion Modified opinion can either be in the form of a qualified opinion, an adverse opinion or a disclaimer of opinion. The decision regarding which type of modified opinion is appropriate depends upon: (a) the nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated (the transactions reflected are significantly affected by error or lack of sufficient audit evidence) (b) the auditor s professional judgement about the pervasiveness of the effects of the matter on the financial statements Note: Pervasiveness refers to the spread of the error and how frequently it occurs in the financial statements A Guide to Understanding National and County Audit Reports 9

15 Wording a modified opinion The effects on the wording of the opinion can be summarised as follows: Table 7: Summary of wording of a modified opinion Qualified Opinion Source: ISSAI 1705 Summary This type or modification is arrived at when the specific element(s) in the financial statements is material but not pervasive or the auditor is unable to obtain sufficient appropriate audit evidence but concludes that such undetected misstatement; if any, could be material but not pervasive. The auditor is basically stating that whilst there are, or maybe, material misstatements, they are confined to a specific element of the financial statements but the rest may be relied upon (i.e., not pervasive). Qualified opinion usually states that except for the matters described in the basis for modification paragraph, the financial statements present fairly (or give a true and fair view of)... The example below from the State Department for Devolution shows a qualified opinion and the auditors reasons for that opinion. Pending bills and outstanding imprests are two examples shown here. Table 8: Illustration of a paragraph on qualified opinion Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 10 A Guide to Understanding National and County Audit Reports

16 5.2.2 Adverse opinion Adverse opinion is expressed when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements as shown in the table below. Table 9: Example of a paragraph on adverse opinion Source: 2014/2015 Report of the Auditor General on Accounts of the National Government In effect, the auditor is stating that the financial statements should not be relied upon in any part, despite the fact that the entity has provided all the necessary audit evidence. Adverse opinion usually states that the financial statements do not present fairly (or give a true and fair view of) Disclaimer of opinion A disclaimer is expressed when the auditor is unable to obtain sufficient audit evidence on which to base the opinion, and the auditor concludes that the possible effects of undetected misstatements on the financial statements, if any, could be both material and pervasive. In effect, the auditor is claiming that the financial statements should not be relied upon in any part, because the entity failed to provide the necessary audit evidence to facilitate the audit process, thus enabling him to form an opinion. This is the worst form of opinion and may be attributed to inadequate or unreliable accounting records or the fact that the entity could not substantiate the transactions as reported in their financial statements, among other significant issues. Disclaimer of opinion usually states that I/we do not express an opinion on the financial statements. The example from the State Department for Planning shows a disclaimer of opinion and examples of issues that made the AG arrive at the opinion. A Guide to Understanding National and County Audit Reports 11

17 Table 10: Example of a paragraph on disclaimer of opinion Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 6.0 How to Read and Use Financial Audit Reports. 1. Does the audit report have a summary? Yes, the OAG usually releases two reports; a summary report, highlighting the main issues and the main report which provides details of the issues covered in the summary. These are the areas of most concern to the main users of the report, who are parliament and the public. In general, the summary highlights areas of improvement and areas of deterioration in financial management. It should also focus on those issues where there is the most money at risk, or where the issues are systemic. These issues should come with explanations on any significant changes over time. The table below shows a summary of audit opinions from the 2014/15 audit report. It contains information on the proportion of statements with different opinions, which is then compared to the previous year which is 2013/14 and helps to shows areas where Ministries, Departments and Agencies (MDAs) are improving or otherwise. 12 A Guide to Understanding National and County Audit Reports

18 Table 11: Illustration of summary Tables on Audit Opinions 3.2 Overall Audit Results Source: 2014/2015 Report of the Auditor General on Accounts of the National Government The second example shows a summary table of MDAs that contribute to queries on unsupported expenditure and the amount in question for each of them. Table 12: Example of summary table on unsupported expenditure 4.1 Unsupported Expenditure Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 2. Does the report provide a historical context (data from previous years) of audit issues at the total level as well as the MDAC level? The audit report should also have summary tables showing the changes in findings over time, both in the report summary and also for each ministry. The summary should also have information showing the changes over time in major areas (such as unsupported expenditure, imprest management, etc.) A Guide to Understanding National and County Audit Reports 13

19 The audit summaries and also MDA sections should have information on changes over time as shown in the example below. To give a full picture of changes in the total budget, the report gives figures over a period of five years showing the gross and actual expenditure. Table 13: Summary of revenue statements and exchequer Accounts Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 3. What is the audit opinion for each MDA and are clear reasons given for the opinion? This section should explain the opinions given in the summary and for each MDA and reasons given for that opinion. It should provide an opportunity to also show previous performance which can demonstrate if a ministry has a systemic issues or one-off problems in a particular year. This section should also help make the connection between the summary and each MDA. Each MDA section can start with a summary of the main issues under that MDA. Snippet 3 below shows the audit opinion given for the Ministry of Health (MoH) and that is followed by a section showing why this opinion was given. One reason related to balances from the former ministries before they were combined into the current ministry. Table 14: Illustration of the auditor s opinion of the MOH Financial Statements Source: 2013/2014 Report of the Auditor General on Accounts of the National Government 14 A Guide to Understanding National and County Audit Reports

20 4. Does the report make a connection between the structure of the approved budget and the audit report? Audits are supposed to help inform future budgets by identifying areas where there is a need for reform and areas where things are functioning well. For most users of public audits, it is important that the structure of the audit report connect to the structure of the budget. For example, if the Kenyan budget is produced in a program format, it should be possible to identify the programs and sub-programs where financial management challenges are concentrated so that these can be reviewed during the budget formulation stage in subsequent years. The public should be able to tell if the programs are meeting their targets and within budget. If there is no way to connect the audit of financial statements back to the original budget, it becomes difficult to know how to address challenges before the budget is approved. 5. Are the audit issues in the report clear? All the issues raised in the summary and the detailed report should be clear, using consistent terminology and with a full description of each issue and its classification. For example, all instances that relate to unsupported expenditure under a single ministry should be identified as such and grouped together. This will facilitate a link between the summary findings and the detailed findings. The example here tries to identify how clear audit issues are and compares what is in the summary and the detailed section of the report. The summary of unsupported expenditure has a line for Ksh 22.5 billion query transferred to a PSC. This detail in the MoH section of the report shows some issues with figures for compensation of employees. However, we are not able to see an explanation of PSC and also the actual amount of 22.5 billion. Clarity is not just about information in one section of the report but also about connection of different parts that explain or summarize same issues. Table 15: An example of an issue that was unclear in the 2013/2014 report 108 Ministry of Health 22,500,344,808 Amount reflected as a transfer to PSC but no documents were made available A Guide to Understanding National and County Audit Reports 15

21 Source: 2014/2015 Report of the Auditor General on Accounts of the National Government 6. Does the audit report show past audit queries that have not been resolved or implementation and are they separated from current audit queries? Issues that are captured in the report because they were not resolved in previous PAC processes should be highlighted but separated from current year issues to provide clarity about the extent of problems in each year and trends over time in performance. For example, it may be that a ministry has unresolved issues from previous years but has performed well in the current year. This scenario should be distinguished both from the scenario where there are problems in the past and in the present, and the scenario where there were no problems in the past but there are new problems emerging. The summary has a list of qualified issues that add up to Ksh 450 billion. The general assumption would be that this figure is the summary total of Qualified issues in 2013/14. However, as shown in the example below some of the issues are historical in nature. This builds a case for separating current and historical issues. Table 16: Example of classification of historical issues losses of cash and stores which occured between 1989 and 2000 and not recovered up to the close of the year of audit (2013/2014) Source: 2013/2014 Report of the Auditor General on Accounts of the National Government 7. Who audits the auditor? The OAG is audited by an independent auditor appointed annually by Parliament. 16 A Guide to Understanding National and County Audit Reports

22 Parliamentary initiatives Network C/o Institute of Economic Affairs 5 th Floor, ACK Garden House 1 st Ngong Avenue P.O Box Nairobi, Kenya Tel: , , Fax: info@pin.or.ke, Website: Supported by International Budget Partnership IBP INTERNATIONAL BUDGET PARTNERSHIP Open Budget. Transform Lives. A Guide to Understanding National and County Audit Reports 17