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Municipal Clean Audit Efficiency Series Financial Management: Edition 1 1

Municipal Clean Audit Efficiency SeriesFinancial Management

The reasons for this poor state of affairs are complex, but one key causal factor is that the basic principles of good financial management are not adhered to. Several of the major challenges identified by the Auditor-General (AG) are listed below and can be directly linked to poor financial management.

Nature and causes of qualifications as identified by the AG • “Material adjustments made to the Annual

Financial Statements (AFS) during the annual audit.” This indicates that the municipalities rely on the audit process to identify errors and omissions – a very risky strategy.

• “Incompleteness of the Fixed Asset Register (FAR).” This implies that the assets were not recognised as prescribed or that the FARs are not updated with additions, disposals or write-offs within the reporting period. The problem is further exacerbated by a lack of supporting documentation to support movements on the FAR.

• “Non-compliance with the applicable accounting standards.” This is a reflection of municipalities’ inability to attract and retain scarce financial skills.

• “Reconciliations between ledgers and supporting schedules and/or ledgers are not performed.” Basic financial management procedures and internal control processes are therefore neglected.

• “VAT principles are incorrectly applied.” This often leads to an under recovery of VAT, negatively impacting cashflow.

• “Liabilities, provisions, contingent liabilities and assets are not valued and recognised.”

• “Revenue is not adequately measured, recorded and collected.” Again, this can impact negatively on the municipality’s financial viability and service delivery capacity.

• “Suspense accounts are not being reconciled or cleared.” This failure can easily lead to abuse and the hiding of fraudulent activities.

• “Differences between sub-systems like salary systems and the general ledger are not followed up”. Again, this failure can lead to abuse and the hiding of fraudulent activities.

• “Accounting officers are not taking reasonable steps to prevent unauthorised, irregular, and/or fruitless and wasteful expenditure.” This failure is indicative of poor financial management, disregard for the supply chain framework and a lack of accountability and good stewardship of taxpayers’ money.

• “Expenditure management: Inability to pay creditors within the prescribed 30 days after receipt of statements or invoices. The primary reason for this relates to cash flow constraints.” This is also often due to poor planning and financial management as well as insufficient credit control and debt collection. This failure can also have devastating consequences for SMME suppliers.

• “Budgets: Inability to contain expenditure within the approved budget.” This can be indicative of both poor budgeting and poor financial discipline.

• “Ineffective contract and procurement management.” These failures often result in massive losses and leave the door open to fraud and corruption.

During the 2010/2011 financial year only 13 of the 283 municipalities in South Africa (including district municipalities and metros) achieved clean audits.


Linked to the above, the AG also identified the following basic internal controls required to support sound financial management and corporate governance:• Proper record keeping• Processing and reconciling controls• Regular and accurate reporting• Compliance with the legislative framework• Proper IT system controls• Effective audit committees• Effective internal audit function• Sound risk management framework• Effective leadership culture• Oversight responsibility• Sound HR management• Effective and updated policies and procedures• Clear action plans to address any deficiencies• Sound IT governance

What are the root causes of the issues raised and how can they be addressed?Effective financial management is critical to any organisation. In the context of local government, a lack of sound financial management will have a direct adverse impact on service delivery as there is a strong correlation between sound financial management and effective service delivery.

Below are some of the major areas municipalities should focus on to facilitate effective financial management. This article only focuses on selected aspects of financial management and its role in achieving a clean audit. In the coming weeks a series of articles will be presented by Deloitte’s multi-disciplinary Clean Audit Task Team, which will focus on related topics impacting the achievement of a clean audit.

Record keepingSound record management is fundamental for good governance and effective and efficient administration. It forms the basis for policy implementation, managing resources and service delivery. Records management also provides a basis for accountability and protecting the rights of individuals. To support continuing service delivery and provide the necessary accountability, municipalities should create and maintain authentic, reliable and usable records. Municipalities should also ensure that the integrity of the records are protected for as long as they are required as evidence of business operations.

Good practice in this area will ensure that sufficient audit evidence is available to help facilitate a clean audit. Too often this basic element of good financial management is neglected. It is therefore of utmost importance to implement proper record keeping in a timely manner to ensure that complete, relevant and accurate information is accessible and available to support financial and performance reporting.

Municipalities must also implement controls over daily and monthly processing and reconciling of transactions. Reconciliations and clearing of control votes and reconciliations between sub-systems like billing, payroll, fixed asset register and the general ledger should be done regularly. Variance and exception reports must be reviewed and followed up by the administrative leadership of the municipality.

Policies and procedures must be developed, updated and implemented to ensure an effective control environment. The implementation of effective policies and procedures will ensure:• Achieving control objectives;• Appropriate and consistent performance of day to

day operations by staff;• Clarity of expectations and accountability for

performance; and• Standardisation of processes and consistent

outcomes.

A sound record management system should include:• The setting up of a dedicated registry for the

safekeeping of records.• Register of files opened, containing a description and

opening dates of all files that were actually opened according to the subject provisions in the filing system.

• Access control and control over the movement of source documents.

• Register of disposal authorities, containing copies of all disposal authorities.

• Destruction register, containing information on the year in which non-archival records are due for destruction.

An integrated electronic document and records management system will assist to ensure that complete, relevant and accurate information is accessible and available to support financial and performance reporting. The use of such a system will lead to more discipline, greater efficiency and improved accessibility to records. This in turn assists with data cleanup and data optimisation as a means to enhance management information.

From the findings of the AG it is clear that the basics are not in place, thus preventing effective financial management.


ReportingSound corporate governance requires greater corporate responsibility and the conduct of business within acceptable ethical standards. Transparency and accountability in reporting and disclosure of information, both operational and financial, are internationally accepted to be vital to the practice of good corporate governance.

The principles of reporting (transparency, accountability and stewardship) should underlie the preparation and presentation of financial statements that are required to give a true and fair view of the financial position and performance of a municipality. Financial reporting should support good corporate governance through external and internal reporting. The Municipal Finance Management Act (MFMA) and reporting guidelines add to the onus of quality and relevance of financial reporting. They emphasise the importance of preparing regular, accurate and complete financial and performance reports that are supported and evidenced by reliable information. It is critically important that these reports are reviewed and monitored for compliance in line with the applicable laws and regulations.

Municipalities must also endeavour to produce reliable monthly/quarterly financial statements. These statements must be reviewed and monitored by the leadership in the municipality. Reliable financial statements and reports will support better decision making, ultimately impacting service delivery. Further, the preparation of monthly/quarterly financial statements will ensure that shortcomings are identified and addressed timeously, thus facilitating better audit outcomes at year-end.

In our experience there is a critical skills and capacity shortage for the preparation of GRAP compliant financial statements. Municipalities are too reliant on consultants in this regard. It is suggested that each municipality should develop a clear strategy to build the required in-house capacity to deal with all aspects of financial management and reporting. Appropriate recruitment and skills development strategies must be developed.

It is also critical that leadership monitor compliance with laws and regulations. For this purpose, reviewing and monitoring mechanisms such as checklists or dashboards need to be developed to ensure compliance. The MFMA also requires a range of reports to be prepared for different purposes by the municipal manager and/or the executive mayor or committee at regular intervals.

An increasing focus of the AG is on the auditing of performance information, an area which poses significant challenges for many municipalities, from the setting of appropriate predetermined objectives through to presenting evidence of achieving these. The performance information process must begin when policies are developed and must continue through each of theplanning, budgeting, implementation and reportingstages. If monitoring and reporting processes and systems are not set up initially, municipalities will struggle to provide accurate and complete audit evidence for actual achievements. Integration with the municipality’s performance management system is therefore critical.

Formal controls over IT systems must be developed and implemented to ensure that relevant and accurate management information is available, and that valuable data is protected. Municipalities must further ensure that information is accurate and complete in relation to its source documentation. This will ensure that appropriate audit evidence is available to support reported performance information. A proper disaster recovery framework must also be in place as part of sound governance.


Governance and oversight functions to monitor and report on progress made to resolve challengesGiven its importance, the topic of Governance will be dealt with comprehensively in a subsequent article in the coming weeks. For current purposes it should however be mentioned that there is a need for better and increased monitoring and oversight to actively address and resolve audit findings. The AG frequently mentions in his audit reports that it is possible to obtain a clean audit administration if the negative audit findings are addressed through the development and implementation of appropriate action plans.

The audit action plans must assign clear responsibilities, realistic time frames, appropriate resources and measurable milestones in order to clear all audit findings. This requires commitment by the leadership to constantly monitor progress as well as the involvement of an effective Internal Audit function. Stakeholders like the AG also need to be engaged during this critical process of resolving audit findings.

Lack of alignment between service delivery and performance management According to the AG “Leadership should assess the essential skills required and ensure that competent personnel are employed to perform the required activities. A system of performance assessment that includes consequences due to non-performance should be developed. Policies and procedures should be implemented which reflect expectations and hold individuals accountable. This should include incentives and rewards for good performance”.

This statement the AG addresses two root causes of the poor state of financial management: poor appointments and, secondly, a lack of job descriptions, performance management and accountability. To address this there should be an absolute focus on performance management, including systems, compliance monitoring and a culture of accountability.

Due to its importance and central role to achieving a clean audit, the topic of performance management will also be dealt with in a separate article in the weeks to come.

ConclusionThe audit outcomes for the 2010/11 financial year did not show any meaningful improvement. Many municipalities that received financially unqualified reports, only did so after being allowed to rectify mistakes during the audit process rather than based on sound financial management throughout the year.

Sound financial management will form the foundation of a clean audit and will further ensure and promote effective service delivery by facilitating the successful budgeting, planning and implementation of capital and operational projects. Getting back to basics will have a dramatic impact on the lives of ordinary citizens.

Municipal Clean Audit Effi ciency Series Financial Management: Edition 1 5

Key Contacts in the Deloitte Clean Audit Task Team:

Justin DiedericksAssociate Director in Risk Advisory, Audit and Public Sector Specialist,Co-ordinator of the Deloitte Clean Audit-risk Team

Tel: +27 (0)21 427 5700Email: [email protected]: +2782 337 8811

Nazeer EssopPartner in Audit and Deloitte Industry Leader for the Public Sector


Lungelo NomvaloDirector in Consulting and Deloitte Industry Leader for Metropolitan Municipalities


Authors:

Jan van CollerMunicipal Finance Specialist in the Deloitte Local Government Unit


Corne OberholzerDirector in Consulting and Deloitte Industry Leader for Local Government


Pramesh BhanaDirector in Risk Advisory and specialist in Governance, Risk Management, Internal Audit and Performance Evaluations


Patrick NdlovuPartner in Audit and specialist in Government Finance and Clean Audit interventions

Tel: +27 (0)11 806 6061 Email: [email protected]: +2782 804 1624

Gitesh MistryDirector in Consulting and specialist in Government Finance and Supply Chain Management


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