The Use of Performance Audit in the Public Sector

The Use of Performance Audit in the Public Sector MICHAELA KRECHOVSKÁ, PAVLÍNA HEJDUKOVÁ Department of Finance and Accounting Faculty of Economics University of West Bohemia Husova 11, Plzeň CZECH REPUBLIC mhorova@kfu.zcu.cz, pahejdu@kfu.zcu.cz http://www.fek.zcu.cz Abstract: The paper is focused on the public sector as an important part of the national economy from the perspective of its evaluation and maintaining efficiency. The emphasis on effectiveness, efficiency and economy of the public sector is a part of every public sector transformation strategy in recent years and should be maintained in the future if we want to ensure sustainable public sector. The results obtained from the studies clearly indicate that it is necessary to focus on monitoring and evaluation of public sector efficiency and spending of public sector funds. As well as the quality of the public sector and public services in the Czech Republic should be improved. It is needed to ensure the performance of public sector and provided services. It requires an analysis of public sector performance by means of auditing, especially performance auditing. The paper discusses performance auditing as a way how to assure transparency and accountability of public sector. It helps to identify potential improvements and reform public administration. Key-Words: Public sector, efficiency, effectiveness, economy, audit 1 Introduction The public sector is a very important part of the national economy in developed countries. The public sector provides public goods and it is associated with market failures as public goods, existence of monopoly, externalities, disregarded respect for environment and human capital or asymmetric information. The public sector plays more or less important role, it depends on many factors. The most important of them are political and social factors. Economics of the public sector is one of the fastest growing fields of theoretical and applied microeconomics [8]. Many authors deal with this issue such as Smith [18], Marshall [11], Buchanan [2], Musgrave [13] or Arrow [1]. Nowadays, the public sector has an important position in the economy and is the subject of many interesting studies [8], [17]. On the other hand, the public sector is not devoted as much attention as the private sector. The public sector is an instrument of public policy. The public sector does not have uniform definition. The public sector has according to the Peková et all [14] following functions: economic (provision of public goods, reducing negative effects in the market, new job opportunities and positive effects on the employment), social (providing services for low-income citizen, increasing social status of citizen and social relations) and political function (use of public sector in the process of public choice as part of the economic policy). Basic activities of the public sector can be defined as follows: providing of necessary public goods; private sector support; influence on economic growth factors as employment, improve the quality of human capital; ensure of greater equity in the distribution of income and wealth in society. The public sector is a part of the national economy which is mainly financed by public funds, decision-making in the public sector is based on public choice and so it is the subject of public control for example by means of mandatory audits [14]. The size and structure of the public sector and public services is different in individual countries. The theory defines several approaches of interpretation of the law to public services the liberal conception, the egalitarian conception and utilitarian conception. In the liberal conception, the private sector plays main role that means that each person has an individual responsibility for his behavior, solidarity is organized by the state, the majority of services for ISBN: 978-960-474-323-0 129

citizens is regarded as the goods and has the market price, and this conception is based on the principle of "each according to his possibilities" [9]. In the egalitarian conception, the public sector plays main role that means each person has the right to use public goods, state supports solidarity and absolute equality, services for citizens are called as social services, distribution of public goods is based on the principle "to each according to his needs" [20]. In the utilitarian conception, the financing of services for citizens are involved both: private and public sector, each person receives a public services (it is possible receive less than is the optimal amount of these goods), state supports a solidarity, as well as individual interest, services for citizens are public and individual value, conception is based on the principle of "to each according to his efforts" [10]. We can find some other approaches in the social policy, but their definition is not the main objective of this paper. All existing approaches require state intervention. In liberal economies where are services for citizen based on self-regulating ability of the market, the state intervenes also in case of socially vulnerable groups of population. In the social-market economies where the mail role plays state there are used especially administrative tools. Fundamental differences of opinions show two conception of the theory of the state: the liberal and welfare state (social market concept) [19]. 2 Problem Formulation The emphasis on effectiveness and efficiency of the public sector is a part of every public sector transformation strategy in recent years. According to the World Bank, one of the widely used indicators is the government's effectiveness. This indicator measures the quality and services of the public sector as the providing of public services, the quality of bureaucracy, the competence of officials, and independence of the authorities and the credibility of the government in the implementation of public policy [3]. As regards quality of the public sector, the quality of the public sector and public services in the Czech Republic was under the European Union average and the EU15 in 2005, as Figure 1 shows. Fig. 1: Government's Effectiveness in 2005 2,5 2,0 1,5 1,0 0,5 0,0 DÁN FIN NIZ Source: [3] LUX ŠVE VB BEL IRS RAK EU-15 NĚM FRA ŠPA EU-25 The same situation is by evaluation according to the misspending of public funds. The Czech Republic took the last place in the monitored EU countries in 2006, see Figure 2. Fig. 2: Misspending of Public Funds in 2006 6 5 4 3 2 1 NIZ DÁN FIN LUX Source: [3] VB RAK NĚM EU-15 KYP ŠPA EST LOT ŠVE EU-25 As show the results of realized research, it is necessary to focus on monitoring and evaluation of public sector efficiency. The situation should be monitored and evaluated thanks to public sector audit. The paper discusses usage of performance audit and its role in improvement of efficiency and effectiveness of the public sector. 3 Problem Solution According to Hakalová and Urbancová [5] the reform of public sector management is a necessary and irreversible process, unfortunately the objectives of the reform are accompanied by problems in theory and practice. Only the subsequent results of audit will show whether an entity selected correct way to solve a problem, so that the financial statements give a true and fair view of the accounts and financial position. BEL KYP FRA EST POR POR MAL SLV IRS MAL SLV SLK ŘEC ČR EU-8 EU-8 SLK LIT LIT MAD POL LOT MAD ŘEC ITA ITA ČR POL ISBN: 978-960-474-323-0 130

Public sector auditing includes accuracy auditing and performance auditing. The accuracy is evaluated based on the financial auditing and compliance auditing. Financial audit is analogous as audit of financial statements in the private sector. The performance auditing requires completely different approaches and is provided by Supreme Audit Institutions SAI in individual countries (for example National Audit Office in Great Britain, Office of the Auditor General in Canada, Government Accountability Office in the US, etc.). These institutions are the members of the International Organization of Supreme Audit Institution INTOSAI as an autonomous independent and non-political organization operating in the public sector audit. There are prepared the essential documents for the area of public sector auditing. More information about the documents as Declaration of Lima as the fundamental document, Ethical codex or audit standards are available on the website www.intosai.org. 3.1 Performance Auditing An audit is generally perceived as a systematic process of objectively obtaining and evaluating of evidence concerning information about the economic activities and events in order to determine the consistency between them and the established criteria and to communicate the results to stakeholders [16]. Raffegeau [15] states that audit is "a critical analysis which allows to verify the information supplied by an entity and to evaluate operational activities and systems used in their transmission. The term of audit has become synonymous for objectivity, effectiveness and management improving tool. While financial audit validates the data in the financial statements, the performance auditing analyses and evaluates the performance of governments and public services. Its results serve also citizens, because it should determine whether the citizens obtain an appropriate value for money paid into the state budget or not. Performance audit is an independent and objective examination of government undertakings, programs or organizations regarding the aspects of efficiency, effectiveness and economy with the aim of leading to improvements [7]. This type of auditing is focused on activities rather than the accounts as financial auditing. Figure 3 shows the three evaluated basic principles by performance auditing. Fig. 3: The Principles of Performance Auditing Efficiency Economy Effectiveness Source: own processing according to [7] The principle of efficiency formulates the relationship between outputs of an audited entity and expended inputs in terms of quantity, quality and timing of outputs. Effectiveness is understood as an achievement of the intended goals or objectives set. It examines the relationship between the intended objectives and the actual impacts of activities. The principle of economy is related with the minimization of inputs costs. The inputs used by an audited entity for its activities should be available in appropriate quantity, time and quality at the best price. The performance audit assesses if the right activities (or things) are been done and if these activities (or things) are been done in the right way. With regard to the above stated definition of performance auditing, the right activities (things) are those that achieve the intended objectives and have desirable impacts. The activities are then been done in the right way if they are carried out efficient and economical. As stated [6] it is usually better to do the right thing with mistakes than do bad things without errors. Some of differences between financial auditing and performance auditing are stated in Table 1. ISBN: 978-960-474-323-0 131

Table 1: Selected Differences between Financial and Performance Auditing Aspects Financial auditing Performance auditing Purpose Focus Assess if financial operations have been carried out in accordance with legislation and regulations and if financial statements and accounts are true and fair view, i.e. are reliable. Financial statements, financial transactions, accounting, control procedures. Assess if government interventions or public services have been conducted in accordance with the principles of economy, efficiency and effectiveness. Policy, programmes, organizations, activities or management system. Relevant experience Accountancy and law. Professional audit skills. Economics, political science, social science. Methods Standardised format of audit. Vary from audit to audit. Audit criteria Source: [4] 3.2 The Performance Audit Process The process of performance auditing is divided into these main parts: planning an audit, performance audit conducting, reporting and follow-up. Process of planning an audit includes strategic planning regarding the selection of problem area on that the audit will focused. The audit planning documents should contain [7]: information needed to understand the entity to be audited, to allow an assessment of the problem and risk, possible sources of evidence; the audit objective, questions or hypotheses, criteria, scope and period to be covered by the audit, and methodology (including techniques to be used for gathering evidence and conducting the audit analysis); an overall activity plan which includes staffing requirements, i.e. sufficient competencies, human resources, and possible external expertise required for the audit; estimated audit cost, the key audit timeframes and milestones, and the main control points of the audit. In the phase of performance audit conducting, the auditor should obtain sufficient and appropriate audit evidence to satisfy the audit objective and questions, to be able to draw conclusions and, if appropriate, to issue recommendations. The Standardised criteria set by legislation and regulation. Less open to the auditor s judgment. More open to the auditor s judgment. It is possible to use unique criteria for individual audit. evidence may be physical, documentary, testimonial or analytical [7]. The auditor should verify the system and methods that head of public administration and management of the use to achieve the objectives of a public authority in accordance with economy, efficiency and effectiveness of public funds. To these used methods belong [12]: Management by task when the objectives are given defectively and employees perform only the assigned tasks. Management by objectives that is based on the principle that top management sets objectives and executives together with staff adopt these objectives, the objectives on the lower level are coherent and follow the objectives of top management. Brainstorming if it is a team work and all group members spontaneously express their ideas. Delphi method if expert opinions are used to solve problems. SWOT analyses when strengths, weaknesses, opportunities and threats are identified. Cost-minimize analysis if only inputs are measured. It can be used by the distribution of resources or the selection of alternatives in the reorganization of the institution of government. ISBN: 978-960-474-323-0 132

Cost-effectiveness analysis that defining a goal (program action) and try to achieve this goal in the cheapest way. Cost-benefit analysis if the total inputs and total outputs are calculated and the benefits of proposed alternatives are compared and it is recommend the most suitable alternative. Content analysis that is used to control in the public administration (for example, the subsequent management control, monitoring). Required information is searched in the external and internal documents. Structurally functional analysis that analyses the problem as a system of mutually functionally interconnected relationships between elements of the system. Cost-utility analysis that is based on comparing the increase of resources with results expressed in the form of benefit from the program, project, event, etc. Then, the auditor reports on the economy and efficiency with which resources are acquired and used and the effectiveness with which objectives are met. The audit reports usually include information about the audit objective, audit questions, audit scope; audit criteria, methodology, sources of data, any limitations to the data used, and audit findings. Finally, follow-up should be a part of the audit process as it is an important tool used to strengthen the impact of the audit and improve future audit work [7]. 4 Conclusion The public sector plays very important role in every developed economy. The public sector substitutes some services for citizens which cannot be provided by the market. Providing these services should be monitored and controlled as well as in private sector, if not more, because main means of financing are public money. Performance auditing contributes to transparency and accountability of public sector. It can help to identify potential improvements and reform public administration. Successful implementation of performance audit requires political support, involvement of management, qualified staff and creating of performance auditing framework. It is not enough to focus only on issues of control and management of public resources, it is needed to implement and constantly innovate the systems of performance measurement and management in the public sector and subsequently monitor the overall efficiency and effectiveness of the use of public funds. In recent years, the application of management approaches and processes at the level of the public sector is becoming a common practice. Governments should recognize it and can respond by the implementation of the methods and models used for performance measurement and management in the business sector, such as the BSC method or model CAF. This paper was created within the project SGS- 2013-040 Paradigm of Development in the 21st Century and its Impact on the Behavior of Economic Entities. References: [1] Arrow, Kenneth, J., A Difficulty in the Concept of Social Welfare, Journal of Political Economy, Vol. 58, No. 4, 1950, pp. 328-346. [2] Buchanan, James, M., The Pure Theory of Government Finance: a Suggested Approach, Journal of Political Economy, Vol. 57, No. 6, 1949, pp. 496-505. [3] Epractice.eu, Efektivní veřejná správa a přátelské veřejné služby. Strategie realizace Smart Administration v období 2007-2015, Download from: <http://www.epractice.eu/en/d ocument/288197 >. [4] European Commission, ANNEX TO ISSAI 3100. Establishing a Sustainable Performance Audit Function: High Level Guidelines, Download from: <http://ec.europa.eu/dgs/internal_audit/pdf/conf erence_2010/annex_to_issai_3100_en.pdf>. [5] Hakalová, Jana, Urbancová, Alžběta, Účetní reforma veřejných financí v České republice a její vliv na účetnictví, účetní závěrku, přezkoumání hospodaření a audit účetní závěrky některých vybraných účetních jednotek, Acta academica karviniensia, Vol. XII, No. 2, 2012, pp. 29-42. [6] Hotra, Stanislav, Nováčková, Věra, Ochrana, František, Teoretické a praktické aspekty zkoumání auditu výkonnosti, In: Theoretical and Practical Aspect of Public Finance. Praha: Oeconomica, 2006, pp. 1-10. [7] International Organization of Supreme Audit Institutions, ISSAI 3100 - Performance Audit Guidelines: Key Principles. Download from: <http://www.intosai.org/en/issai-executive- summaries/view/article/issai-3100- performance-audit-guidelines-keyprinciples.html>. ISBN: 978-960-474-323-0 133

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