Annex_7_-_Improving_the_Usage_and_Design_of_the_GoK_Chart_of_Accounts_Report.pdf

PARTNERSHIPS FOR

DEVELOPMENT

IMPROVING DESIGN AND USAGE OF THE CHART OF

ACCOUNTS OF THE GOVERNMENT OF KOSOVO

July 31, 2017 This report was produced for review by the United States Agency for International Development. It was prepared by USAID Partnerships for Development implemented by Chemonics International, Prime Contractor, and Crimson Capital Corp. and Policy and Management Consulting Group, S b

PARTNERSHIPS FOR DEVELOPMENT

Improving design and usage of the chart of accounts of the Government of Kosovo

July 2017

Consortium Members: Crimson Capital Corp.

Policy and Management Consulting Group

Award No.: AID-OAA-I-12-00035

Order No.: AID-167-TO-14-00002

Contracting Officer’s Representative: Dardane Peja

Chief of Party: Hajdar Korbi

Disclaimer

The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government

CONTENTS

BACKGROUND

PURPOSE:

PROCESS

1.0 INTRODUCTION

2.0 CURRENT STATUS OF THE COA: FINDINGS OF REVIEW

2.1 CLASSIFICATION ERRORS

2.1.1 CERTAIN OPERATING EXPENDITURE HAS BEEN CLASSIFIED AS CAPITAL

2.1.2 PAYMENTS TO EMPLOYEES CLASSIFIED AS GOODS AND SERVICES

2.2 SYSTEMIC ISSUES WITH CURRENT CLASSIFICATION SCHEMA:

3.0 FACTORS CONTRIBUTING TO CLASSIFICATION ISSUES

4.0 TRANSITION FROM CASH TO ACCRUAL ACCOUNTING

4.1 PHASE 1: ELEMENTARY ACCRUAL ACCOUNTING

4.1.1 CHANGES TO COA STRUCTURE

4.1.2 IMPLEMENTATION OF PHASE 1

4.2 PHASE 1.5: ELEMENTARY ACCRUALS WITH ADVANCED COVERAGE

4.3 PHASE 2: ADVANCED ACCRUAL ACCOUNTING

4.4 PHASE 3: FULL ACCRUAL ACCOUNTING

5.0 ACCOUNTING POLICY

6.0 IMPLEMENTATION SUPPORT

ACRONYMS

BDMS Budget Development Management System

BO Budget organizations

CHU Central Harmonization Unit

COA Chart of Accounts

GFS Government Finance Statistics

IPSAS International accounting standards in public sector

IMF International Monetary Fund

KCB Kosovo Consolidated Budget

KFMIS Kosovo Financial Management Information System

MDA Ministries, Departments and Agencies

MoF Ministry of Finance (previously Ministry of Finance and Economy)

OAG Office of the Auditor General

PIP Public Investment Program

POE Publicly Owned Enterprises

TSA Treasury Single Account

LPFMA Law on Public Financial Management and Accountability

Background

The Chart of Accounts (“CoA”) is the coding scheme applied to classify transactions as they are budgeted for, recorded in accounts, and reported within the various public financial management systems of the Government of Kosovo (GoK). The chart of accounts, by defining the scope with which government transactions can be described, has a critical bearing on the content, scope and level of detail in which the GoK’s public finances can be planned and presented. As an example, the CoA currently reflects the cash-basis of budgeting, accounting and reporting and thus does not benefit from the additional elements that would be included within accrual accounting.

USAID Kosovo Partnerships for Development (PFD) is a 4-year 7-month project to support Government of Kosovo institutions at the central and local level to create a business-friendly, regionally competitive business environment that will attract foreign investment in Kosovo while at the same time maintaining macroeconomic stability.

The program has three main objectives:

1. Business environment improvement;

2. Improved implementation of construction reforms;

3. Enhanced macroeconomic stability and public financial management at the central and local level.

USAID Partnerships for Development is supporting the Ministry of Finance (MoF) to improve budget efficiency and transparency, through the adoption of international best practices in public financial management.

Purpose

In accordance with the agreed work plan for the Partnerships for Development project, the purpose of this review is improved design and usage of the Chart of Accounts (CoA) to enable data reliability, transparency improvements, and enhanced evidence-based fiscal policy formulation.

The principles guiding this work are as follows:

• Good classification supports a transparent & credible budget;

• Classifications used in budget preparation and budget execution must be fully integrated;

• Annual Financial Statements should be reliable – as reflected in the audit opinion provided by the Auditor-General;

• Kosovo should be in position to report timely reliable Government Finance Statistics (GFS) to IMF and Eurostat;

• Compliance with cash basis IPSAS is required by Law and is both a minimum standard for appropriate reporting and foundation for future reform;

• A transition towards accrual accounting/IPSASs is desirable, and

• The CoA framework, systems and support must enable decentralized processing of transactions.

Process

In undertaking this review, the followings processes and tasks have been undertaken:

• Review the application of cash basis IPSAS in the CoA and identify opportunities for improved adherence to IPSAS;

• Review the application of the IMF GFS Manual 2014 as a reference for the CoA economic classification;

• Identify opportunities for CoA improvement;

• Provide an initial assessment of the possibility for Kosovo to gradually move towards introducing modified cash accounting principles, and

• Provide recommendations and guidance on the formulation of future support activities.

In conducting the review, meetings were held and discussions conducted with key GoK counterparts, including with:

Director of the Treasury, Ministry of Finance, Mr. Fatmir Plakiqi

Director of the Budget Department, Ministry of Finance, Mr. Salvador Elmazi

Auditor General of Kosovo, Mr. Besnik Osmani, and his staff, Director of the Central Harmonization Unit Ministry of Finance, Mr. Kosum Aliu, Director of the Financial and Balance of Payments Statistics Department, Central Bank of Kosovo, Mr. Bedri Zymberi.

During the assignment, a brief meeting and discussion on some of the key findings of this report was held with the Deputy Minister of Finance, Mr. Agim Krasniqi.

Special gratitude is given to the Mr. Nysret Koca, the Deputy Director of the Treasury for Financial Reporting, who arranged and participated in meetings, presentations, and seminars that were conducted with the Reporting Unit of the Treasury, and resulted in a very constructive exchange of information and ideas.

1.0 Introduction

Kosovo has an account classification system that has largely served its purpose over the last decade.

The chart of accounts has supported effective public financial management in Kosovo.

The chart of accounts is consistently applied in each of the key steps of the budget cycle; specifically budget planning, budget execution and reporting. The chart of accounts is embedded within the budget formulation systems - public investment planning (PIP) and Budget Development Management Systems. The chart of accounts is also embedded within the general ledger within the Kosovo Financial Management Information System (KFMIS) which is used for accounting and budget execution purposes. The chart of accounts is reflected in the budget appropriation schedules that are approved by the Parliament and is central to the budget execution controls.

The chart of accounts and KFMIS has enabled the implementation of a Treasury Single Account concept and also supported systems of automated collection of government revenues through the banking system and automated decentralized processing of expenditures. As a result of these developments and by adopting bank transfers through the banking payment system, the GoK has achieved a largely cashless approach to processing all of its transactions.

Importantly, the chart of accounts and classification system is common to the whole of the general government sector, being used by both the central government as well as municipalities – which enables real-time consolidation and comprehensive reporting of government financial operations.

Reporting on budget execution can be performed on a monthly and annual basis, with draft annual reports able to be produced within several weeks of the end of the year.

With the authority of the Law on Public Financial Management and Accountability (LPFMA), the chart of accounts has supported the production of annual financial statements that are broadly consistent with cash-based International Public Sector Accounting Standard (IPSAS). Since 2015, the GoK has commenced reporting IMF Government Finance Statistics – again predominantly on a cash basis, with the general ledger being a primary source of data.

The chart of accounts was originally developed under a system of “commitment” based budgeting, which reflected the largely donor funded budget that existed in the post-war years 1999 to 2004.

However, this approach resulted in the accumulation of very large unspent commitments and also resulted in the budget becoming unrealistic in terms of actual cash spent. From 2005 and onwards, a cash-based budget system is used.

The chart of accounts in Kosovo has multiple segments and multiple layers, which are set out in the graphic below. Each of the six segments of the chart of accounts serves a specific purpose and is mutually exclusive from the other segments. The complexity of the chart of accounts reflects that it is used by multiple layers of government, to manage the different types of funds available to government (including donor funds) and is used to track specific projects as well as the costs within budget organizations. The object classification identifies the economic purpose of a transaction and, together with the organization/program, is the main mechanism for defining the budget.

Around 2005, a shift was made from commitment to cash based appropriations and at that time cash-based IPSAS (applied to the budgetary general government) was adopted as the accounting standard for the GoK. The cash-based IPSAS supports supplementary disclosures. GoK has required all budget organizations, in preparing their annual financial statements – to provide supplementary disclosures in relation to their accounts payable, payment arrears, accounts receivable, contingent liabilities and assets holdings1. These supplementary disclosures represent a recognition of the limitations of a purely cash based approach to accounting and reporting. At the same time, they reflect a desire to progressively transition from a purely cash based reporting regime towards the gradual adoption of accrual accounting.

From 2007 to 2013 Annual financial statements produced by the Treasury were assessed by the auditors as providing a true and fair representation of the finances of the GoK and thus received an unqualified audit.

1 See Ministry of Finance Regulation 2017/01 on Annual Financial Reporting by Budgetary Organizations.

2.0 Current Status of the CoA: Findings of Review

While acknowledging that the current chart of accounts has provided a very strong foundation for financial management in Kosovo, several concerns have emerged recently with regard to classifications within the chart of accounts, specifically related to the economic classification. These issues include misclassification of transactions according to the current economic classification schema, examples of misalignment of this schema with GFS 2014 and a recognition that the current schema has major limitations in terms of the gradual transition from cash to accrual accounting.

These issues are addressed in the following sections of this report:

2.1 Classification Errors

“While at the general level there are positive issues to report including increased revenues, the consolidated account has been qualified because of material misclassifications and inconsistencies within the Annual Financial Report of the Kosovo Budget” A-G Annual Report 2015

Recent audit reports, and the process of initiating formal GFS reporting to the IMF, have highlighted a number of significant examples of the misclassification of transactions. Indeed, these issues were a major factor in the GoK receiving a qualified audit opinion on the Government’s financial statements for 2014 and 2015. Significant examples of these errors include:

2.1.1 Certain operating expenditure is classified as capital2

The Auditor-General estimates that misclassification of operating expenditures as capital amounted to Euro 25 million in 2015. Examples include:

1. A number of operating expenditure items are classified as capital. As evidence of this, the Auditor-General cites Euro 4 million in transactions associated with the clearing of snow from roads as having been classified under “capital”. Repairs and maintenance of assets should be classified as an expense, specifically with “goods and services” under the current coding schema. Only those works that add to the value of an asset above its book value should be classified as capital expenditure3.

2. Books purchased to individual school students have been classified as capital. The only way those books could be classified as “capital” would be if they remained under the control of the government over a longer period of time as part of a broader library collection and then lent to students. The recurring nature and value of these payments indicates that books are not currently being held as part of a collection – but rather held by students - which makes the transaction more akin to a grant of books to students (which under the current CoA schema would fall under the classification of the “subsidies and transfers” category), rather than a capital expenditure.

2 Page 11, Annual Audit Report 2015, National Audit Office 3 Paragraphs 8.25 and 8.26 provide an explanation of the differences between capital expenditure and maintenance expense.

2.1.2 Payments to Employees classified as Goods and Services4

Salary payments for a significant number of government employees are being misclassified as contractual services. The Law on Civil Service provides for a number of mechanisms for engagement of government employees and identifies a specific group of employees as “fixed-term appointments” to be governed by Special Service Agreements. It is a misunderstanding of the current classification scheme to classify these as contractual services staff simply because their contract is titled a “service agreement”. While the engagement of these employees is governed by a contract, in almost all cases these staff still meet the definition of an employee and thus they should be paid from “wages and salaries”. The Treasury Accounting Manual and Treasury Financial Rules included an “employment test” which provides a clear direction as to what constitutes an employee. This test reflects the definition of employment that is also applicable to tax administration. Application of this test would show that, in almost all cases, fixed term appointees should be considered employees and thus be paid from Wages and Salaries.

4 Page 19, Annual Audit Report 2015, National Audit Office

2.2 Systemic Issues with Current Classification in the Chart of Accounts:

The basic elements of CoA were developed at least a decade ago having regard mainly to the principles of cash based budgeting and financial reporting. As a result, there are several issues/problems with the capacity of the CoA to support IPSAS and IMF GFS 2014 reporting, with the following as key among them:

1. Capital grants (mainly for Public Enterprises) are recorded under capital expenditure, which is consistent with the GFS 1986 definition of capital expenditure but not consistent with GFS 2001/2014 or with IPSAS. Under the accrual methodology capital expenditure is associated with the creation or acquisition of non-financial assets that are owned by the reporting entity. A capital grant however results in non-financial assets that would not be owned or controlled by the reporting entity, in this case the Government, and thus should be classified as a grant expense, and not as capital expenditure.

Recommendation: Reclassify capital grants under “grants”, a recurrent expense under GFS and IPSAS.

2. Operational costs incurred in acquiring or constructing non-financial assets is not capitalized under the current economic classification. Under both GFS 2014 and IPSAS, the cost of an item of property, plant and equipment includes any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. These costs can include:

(a) Costs of employee benefits (as defined in the relevant international or national accounting standard dealing with employee benefits) arising directly from the construction or acquisition of the asset;

(b) Costs of site preparation;

(c) Initial delivery and handling costs;

(d) Installation and assembly costs;

(e) Costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and

(f) Professional fees.

Recommendation: Develop a definition of capital expenditure that is appropriate for the Kosovo context but consistent with GFS 2001/2014 and IPSAS in allowing capitalization of certain operational expenses necessarily incurred in acquiring an asset.

3. While the coverage of the GoK accounting entities is broad, as reflected in the CoA, it does not, however, reflect the requirements of either GFS or IPSAS. The current CoA does not support full recording or reporting of financial data for the following central government institutions:

a. Radio and Television Kosovo (RTK),

b. Cultural institutions such as the Theatre or Museum

c. Privatization proceeds managed by the Privatization Agency of Kosovo.

Appendix A includes a graphic that assists in determining whether control exists for the purposes of identifying the appropriate reporting entity under IPSAS. Application of this methodology would likely determine that these entities are controlled and thus their financials should be consolidated. In GFS terminology, these entities would be classified as central government extra-budgetary funds. They are entities that are controlled by the Government but, due to some notion of required operational independence, the budgets for these entities is not determined by Parliament, although each does at times receive grants from government that are appropriated by Parliament.

4. For compliance with accrual IPSAS, coverage will need to be extended to include all controlled entities, including the publicly owned enterprises (POEs) which are fully owned by the general government. The POEs currently report their finances independently and are not consolidated into a broader whole of government reporting entity. As these entities are effectively under the control of the government, IPSAS would require that their financial are consolidated. There is currently an exposure draft for a new version of the IPSAS cash basis that would not require consolidation of the POE but, even if this should come into effect, achieving compliance with the accrual IPSAS requires full consolidation of POEs in the financial statements. The Auditor-General has recently undertaken audits of the financials of 4 POEs and advised that there are serious accounting capacity and compliance issues that would be required to be addressed in order to have confidence in the quality of data provided by the POEs.

Recommendation: Expand coverage of the GoK accounting entity to all controlled entities (refer to recommendations regarding phasing of such reform)

5. The current economic classification reflects a few cases of inappropriate use of the broader

CoA structure. An example of this is the inclusion of project specific codes in the economic segment. The CoA structure includes a “source of funds” segment which enables funds to be identified that derive from a specific source with a restricted use. A grant from a donor that is provided for a specific project should be classified accordingly within the source of funds segment, and not through the use of the economic classification segment. There is also a CoA “project” segment that allows individual projects to be separately identifiable.

Together, the source of funds and project segments enable each donor-funded project to be separately accounted for, including projects that have multiple funding sources. It is not necessary to include a project specific code in the economic segment (as currently exists) as it is not necessary and it results in an inability to apply a complete economic classification to all expenditures.

Recommendation: Clear the object segment of all items that do not represent an economic classification of transactions.

6. The classification schema reflects some inefficient accounting treatments. As an example, within the economic classification coding exists for advances of various types, including petty cash. This requires that expenses made for travel or petty cash need to be recorded twice

– once when the funds are released to the budget organization and then the original expense needs to be reversed (corrected) and a further expense recorded once the funds are actually spent (and replenished in the case of petty cash). The current process makes it difficult to undertake budget control and reporting effectively as advances are not budgeted for. A more conventional (and simpler) approach is to record the advances as a balance sheet transaction. This would initially record a movement of funds from the main bank account to a sub-bank account of the budget organization (or from the main account to “cash advanced” in the case of a cash advance). This reflects the fact that no expenditure has taken place at the time the advance is issued, simply that there has been a movement of cash from the main account to the control of the budget organization (debit cash advanced, credit KCF main account). Then once the expenses take place, the transaction is recorded according to the actual use of the funds (e.g domestic travel) posted against the BOs bank account or cash-on-hand (debit expense, credit cash advanced).

Recommendation: Undertake changes to accounting for advances and petty cash such that the accounts record the passing of cash from the main account into the hands of the budget organization and then requires recording of operating statement transactions only once advances are closed and/or replenished.

3.0 Factors Contributing to Classification Issues

There are a number of factors, that impact the application of the existing classifications with the chart of accounts of the GoK. These factors impact on how the classification system is applied and thus on the emergence of the issues/problems discussed above. They include the following key issues:

1. Lack of clear definition and standards for how codes are to be applied. While there is a listing of codes in the economic classification and a name is given for each, there is very limited supporting material that informs users how codes are to be applied. The Treasury Manual contains limited advice regarding the application of the classification system and is now out of date. Under the LPFMA, the Minister of Finance shall promulgate Financial Management and Control Rules (“FMC Rules”) which govern aspects of public financial management that are not specifically dealt with in the Law. At this time, these FMC rules are yet to be promulgated.

Recommendation: A financial management control FMC Rule should be drafted and promulgated that provides a clear definition of each of the economic classifications used in the chart of accounts and provides advice on the application of such definitions. This Rule should be referenced in budget circulars and budget related FMC rules to ensure harmonization of classifications during budget preparation and execution.

2. Internal controls over economic classification. The reports of the Auditor-General identify systemic problems regarding classification. Internal audit and other internal controls appear to be insufficient to avoid misclassification. While it was originally intended that Treasury would maintain oversight over classification, including in the period after expenditure control was decentralized, such central oversight could be stronger. In its 2015 annual report, the A-G noted that “The Ministry of Finance, i.e. Treasury, needs to be more proactively engaged in ensuring the quality of financial statements which require high standards of reporting and a transparent accountability regime.” In addition, the Central Harmonization Unit (CHU) should ensure that internal auditors are contributing to effective oversight of those controls and systems that enable correct classification. Some system and business process enhancements, including the uploading of invoices to payment transactions, would enhance the ability of the Treasury and CHU to maintain such oversight.

Recommendation: Treasury and the CHU for Internal Control proactively review compliance with CoA classification related rules during each year and take action to correct instances of non-compliance as they arise.

Recommendation: Treasury should upgrade KFMIS, including hardware, software and business processes, to enable copies of invoices to be uploaded with all non-payroll expenditures.

3. Lack of a management system over classification changes. Currently there is no formal managerial process for making changes to the classification system.

Recommendation: A managerial system regime should be established for changes in classifications applied in the chart of accounts. A committee should be established for this purpose, which could comprise the Director of the Treasury, Director of Budget Department, Director of the CHU for internal control, the Head of the Statistical Agency Economic Statistics Department and the Deputy Director of the Treasury responsible for reporting. The Director of the Treasury could chair the committee and the office of the Auditor-General could be invited to attend meetings. At a minimum, the committee should meet each year, prior to the commencement of the budget process to harmonize and agree on any changes to classifications prior to the commencement of the new budget process.

4. Some of the issues around classification have become very apparent with the introduction of budget control at 5-digit level. Whereas previously the budget was prepared at 5 digit level, funds were appropriated at 2-digit level and budget execution was controlled at 2-digit level. For example, provided that the total spending on goods and services (first 2 digits are 1 and 3, or “13”) was within budget such spending was allowed to proceed – irrespective of whether such spending perfectly matched the proposed allocation of the budget at 5-digit level. For example, more could be spent on domestic travel provided there was under-spending on other categories, such as international travel. As the classification scheme is quite detailed at 5-digit level, the application of budget controls down to this level has revealed problems, such as not having any proper budget planning for “travel advances”. It is simply not realistic to expect that a full 12 month budget can be prepared at 5-digit level with a perfect degree of certainty some months prior to the year commencing. A degree of flexibility in budget execution is required for good management.

Recommendation: While it is desirable to plan the budget at a detailed level, and report budget execution at a similar level to promote transparency and accountability, it is not practical to define appropriations and control budget execution at a detailed (5 digit) level. At a minimum, budget organizations – or their Chief Administrative Officers - should be delegated some authority to transfer budgets internally at 5-digit level, with notification to the MoF Treasury and Budget.

5. The budget process is largely incremental and inflexible and thus provides only limited opportunity to address classification problems. The budget process in Kosovo results in a largely incremental approach to the budget. Particularly on the recurrent side, irrespective of the timing or quality of budget submissions received, the recurrent budget of the prior year is the typical baseline for any future year. Policy driven changes only occur at the margin and on an incremental basis. Any savings typically are across-the-board cuts rather than a policy-based adjustment. Fiscal rules that have been applied over the years, both explicit and implicit, have sought to limit growth in the payroll but also limit goods and services expenditure.

The constraints on capital expenditure have been less restrictive – as is logical. But, in this context, it has been convenient to accommodate misunderstandings regarding correct classification of certain expenditures, particularly those that have enabled employee costs to be recorded as goods and services and goods and services to be recorded as capital (see classification issues outlined above). The end result of this practice is a budget that is less credible than it would be if expenditures were appropriately classified.

Recommendation: At the earliest practical opportunity – ideally now – the budget should be rebased to address the known systemic misclassifications. To the extent that fiscal rules are applied based on these classifications, these should also be rebased to reflect that this change is not policy-driven but rather a correction of both the budget and the baseline.

4.0 Transition from Cash to Accrual Accounting

Accrual accounting and reporting offers the prospect of enhanced fiscal management and greater transparency of public finances in Kosovo. The GoK is understood to be interested in transitioning to accrual accounting in the public sector, reflecting that this is the model of good practice adopted by European countries. Accrual accounting is also reflected in the IPSAS accounting standards and the IMF GFS manual, both of which are identified as appropriate models of good practice for Kosovo.

Due to the weaknesses in pure cash accounting and reporting, the existing practice in the GoK is to supplement cash-basis financial statements with additional accrual data, including a requirement to report payables, receivables, debt and non-financial assets in the notes to the accounts. This supplementary data is required by the LPFMA, which contains a listing of supplementary disclosures required to be published with the annual financial statements.

The IMFs Fiscal Affairs Department (FAD) has produced an excellent technical note (TNM2016-06) which sets out a practical pathway for transition from cash to accrual accounting. The FAD technical note is intended to be relevant for a range of developing countries and is highly appropriate for the GoK. This report is drafted in the expectation that readers will also read the TNM. Figure 1 below sets out this pathway in a graphical representation contained in the TNM.

In transition from cash to accrual accounting additional non-cash items are progressively added to the balance sheet. Of course, as these items are added to the balance sheet, maintaining the integrity of the double entry accounting system requires that all movements in the value of these assets and liabilities must be recorded and tracked. The difference between the value of assets and liabilities is the net worth of GoK and any transaction or economic event that impacts on net worth must be recorded on the operating statement. If these events are transactions, they will be recorded as revenues (increase net worth) or expenses (decrease net worth). There may also be economic events, which are not transactions, such as exogenous changes in the volume or value of assets and liabilities, which also impact on net worth and these are recorded as “other flows”.

Under pure cash accounting (Phase 0 in TNM 2016/06) only cash balances in bank accounts are recorded on the balance sheet. Only those transaction which impact on the cash balance are recorded as revenue and expenditure on the operating (cash flow) statement. The balance sheet at phase one includes both assets (bank accounts) and liabilities (debt).

Kosovo currently has a well developed debt management system for recording public debt (CS- DRMS) and coding is available in the chart of accounts for recording key debt aggregates in the KFMIS. Under Phase 0, debt can be recorded at initial value, without a requirement to fully track any changes in the market value of debt instruments and record associate “other flows”.

No change to the chart of accounts of the GoK is required solely for meeting the requirements of reporting under Phase 0. Existing systems and business processes support Phase 0 reporting and data consistent with Phase 0 is currently included within the annual financial statements. Institutional coverage of the accounts, and some of the supplementary reporting, is already in advance of Phase 0 for the GoK.

Figure 1: Phased transition from cash to accrual (Table 1 in IMF TNM 2016/06)

4.1 Phase 1: Elementary Accrual Accounting

Kosovo is well placed to make the transition from Phase 0 to Phase 1: “elementary accrual accounting”. Phase one involves introducing trade receivables and payables onto the balance sheet and expanding coverage of accounts to include the central government. The new elements introduced to the balance sheet are set out in Figure 4 of IMF TNM 2016/06 - replicated below:

Additional elements included in Balance Sheet in Phase 1: IMF TNM 2016/06

Some existing business processes will need to be changed to record receivables and trade payables.

As the KFMIS is currently used for managing and recording both revenue and expenditure transactions, the system can be configured to account for receivables and payables without a major change in approach. In relation to payables for example, business process changes need to change to require that purchase vouchers are recorded in the KFMIS when goods and invoice is received and have a separate mechanism for determining the timing of when payment is released.

Coverage of the accounts of the GoK currently extends beyond the Central Government sector, to include the General Government sector as a whole but with some specific exceptions. The full set out accounts needs to be collected for PAK, RTK and cultural bodies (museum, theatre etc) and consolidated within the KFMIS to enable reporting on the Central Government sector. Greater effort needs to be applied to identifying transactions within the central government between agencies (for example the subsidies paid to cultural institutions) so that these internal transactions can be eliminated during consolidation.

With the introduction of accruals in Phase 1, an operating statement can be produced as well as financial balance sheet in addition to the cash flow statement. The content and possible format of the operating statement is set out in Figure 5 in IMF TNM 2016/06 and is copied below.

Possible Structure of Operating Statement at Phase 1: Fig 5 IMF TNM2016/06

4.1.1 Changes to CoA Structure

With the introduction of accruals in Phase 1 it is proposed that the structure of the chart of accounts be significantly upgraded to support the complete transition from cash to accrual accounting and reporting and also assist in GFS and Eurostat statistical reporting. Essentially, it is proposed to adopt a similar structure and coding schema to GFS 2014 as summaries in the following table:

GFS Proposed CoA 1 Revenue 1 Revenue 2 Expense 2 Expense

Transactions in assets and liabilities 3 Capital expenditure

4 Capital revenue 4 Holding gains 5 Holding gains 5 Volume changes 6 Volume changes 6 Stock of assets and liabilities 7 Stock of assets and liabilities

However, some significant departures from the GFS structure are required, including:

1. At the early stages of the transition to accruals, prior to bringing non-financial assets onto the balance sheet, it is necessary to record capital accumulation as an expense and to record non-financial asset sales as a revenue. Nonetheless, it is clean to keep GFS 1 series and 2 series pure according to the accrual GFS structure (which cannot accommodate capital purchases and sales within the GFS coding schema). It is thus desirable to initially use 3 and 4 series for the purposes of recording capital and then let these fall away once full accrual accounting is adopted5. Coding for depreciation of non-financial assets would be introduced in the 2-series but only made available to users once depreciation is accounted for in the

KFMIS.

2. GFS first digit 3 is used in GFS statistical reports to track all transactions in assets and liabilities. This is appropriate for statistical reporting but not appropriate for a classification within a general ledger structure, where certain balance sheet transactions (such as “debit non-financial asset, credit cash” for an asset purchase) do not involve debiting or crediting a flow account. For GFS purposes the 3-series uses dot-point decimals (3.1,3.2,3.3) to distinguish types of flows, which is again not suitable for coding in a computerized general ledger context.

3. Adding the Kosovo-specific coding into the structure of the economic classification within the GFS-style classification scheme.

A complete coding structure has been drafted according to this proposed schema and has been discussed with the staff of the MoF. The current economic classification codes have been accommodated within the proposed structure and mapped according to GFS. A number of anomalies and suggested reclassifications have been identified in this process, many of which were agreed to by the MoF during the discussion seminars.

The structure proposed includes a complete set of coding to enable full accrual accounting. In the first transition phase, some of the coding that is exclusively used for accruals will be made unavailable but then made available as required during the transition. An important example relates to capital expenditure, which would be accounted for initially like an expense on a cash basis but then, when non-financial assets are recorded on the balance sheet, depreciation will be recorded as an expense and capital expenditure tracked (for reporting purposes) as changes to the stock of non-financial assets on the balance sheet.

4.1.2 Implementation of Phase 1

Implementation of the transition to Phase 1 should be possible by the end of 2019, to be reflected in the 2019 annual financial statements., if the recommendations of this report are implemented from 2017. The key changes that will be required are as follows:

• Introducing processes within the Treasury to enable and ensure that debt data is fully reflected in KFMIS on an ongoing basis, consistent with accounting standards. To commence in 2017 and completed during 2018.

• Introducing new business processes for budgeting, recording and managing trade receivable and trade payables in the KFMIS. This will be done on a decentralized basis (within budget organizations). These business processes and associated functional design as well as accounting transaction configuration in FreeBalance should be designed and tested during 2017. During 2018, uses should be trained and new business processes and reporting trialed, prior to full implementation from 2019. Any changes to budget preparation, including the budget presentation and annual budget law, need to be in place for commencement of the 2019 budget.

5 Series 3 and 4 may be retained for the purposes of budgetary control over capital transactions and for reporting “expenditure” in fiscal plans and reports.

4.2 Phase 1.5: Elementary Accruals with Advanced Coverage

Kosovo’s public finance system currently has broad institutional coverage that, with some exceptions, includes the entire General Government sector. Both the central government institutions as well as the municipalities participate in same consolidated budget process and use the same treasury systems (and treasury single account) for budget execution. Both the central government and the municipalities use the same budget systems and use a single instance of the general ledger in KFMIS (FreeBalance) on a common chart of accounts.

As outlined above, the independent operations of the privatization mechanisms with PAK and the public broadcaster (RTK) are not included in the budget or in GoK financial statements. This situation emerged due to a perception that it provides for greater autonomy. For more practical reasons, the financial management of cultural institutions, who rely on their own revenue as well as government grants, evolved somewhat outside of the Treasury (although some of their staff are on the payroll) and they report separately for those non-payroll operations.

Nonetheless, GoK could, even during phase 1 move to extend coverage of the accounts and the reporting entity to the full General Government Sector. For the purposes of the reform effort in Kosovo, this could be described as “Phase 1.5”. The action required to implement this change are:

• During 2017 consultations should commence with PAK, RTK and Cultural Institutions as well as the ministries that oversee these entities to scope the requirements for expanding coverage to including these institutions. Changes may need to be made to subordinate legislation, instructions prepared, systems amended and changes to the chart of accounts implemented.

• During 2018 these enabling changes should be introduced and reporting commenced on a trial basis.

• The 2019 budget should be prepared with RTK and the Cultural institutions being included on-budget, with the PAK privatization remaining extra-budgetary for 2019 (but with privatization financial projections provided as a supplementary report to Parliament with the budget).

• Reporting of year-to-date actuals from these entities should commence from 2019 and the 2019 annual financial statements should extend coverage to include these entities.

4.3 Phase 2.0 : Advanced Accrual Accounting

Moving from Phase 1.5 to Phase 2.0 involves introducing long term financial liabilities (such as pensions) and equity investments as well as non-tax receivables onto the balance sheet. At the end of this stage, the GoK would have a full financial balance sheet that encompasses all financial assets and liabilities and fully accounts for all changes in the value of those assets and liabilities, including those that occur due to value and volume changes as well as through transactions. During Phase 2 all value and volume changes in financial assets, including debt liabilities, need to be identified, tracked and recorded in the general ledger. This requires a more sophisticated approach to debt management where value changes in debt instruments are accounted for in accordance with the standards (IPSAS 28 & 29).

Implementation of changes required to move to Phase two should occur soon after the implementation of Phase 1.5. Work can commence immediately in identifying the changes to business processes and systems required to accommodate the enhanced accounting of payables, receivables and debt. In relation to pension obligations, Kosovo has a government-mandated defined contribution scheme (through the Kosovo Pensions Savings Trust “KPST”) where there are no unfunded liabilities. The accounting for this scheme is currently off-budget, except for the employee and employer contributions which are budgeted in full and both flow through the Treasury to the KPST and are accounted for when paid. Given that the complexities of a highly complex pension scheme do not exist, GoK could target implementation of Phase two for 2020. The changes to business processes, budgeting and accounting to transition from phase 1.5 to Phase 2 should commence during 2017 and aim to be completed in time for the preparation and execution of the 2020 budget.

4.4 Phase 3: Full Accrual Accounting

Phase three completes the transition to full accrual accounting. At this stage, a complete balance sheet is maintained, which also includes all non-financial assets and liabilities and tracks all changes of both financial and non-financial assets and liabilities. With a complete balance sheet, total net worth of the GoK can be tracked, with all economic events and transactions that impact on net worth benign captured on the operating statement, including other economic flows. Institutional scope expands to include all controlled entities in the public sector.

The introduction of non-financial assets to the balance sheet of the GoK will introduce some specific challenges in terms of systems and capacity. Asset management, including accounting for financial and non-financial assets, is undertaken at a decentralized level. Over recent years, the reports of the Auditor-General have consistently identified weaknesses in the asset registers maintained by budget organizations and the inconsistency between asset management systems and financial reporting of asset values. The capacity of budget organizations to track and record changes in the value of assets having regard to market dynamics is very weak. A substantial capacity building effort would be required, including systems and human capacity, to undertake full accrual accounting for all assets and liabilities according to IPSASs.

With the introduction of full accrual accounting, a decision will need to be made regarding how the budget treats capital expenditure (recognizing that it would not be expensed under full accrual accounting). Some countries approach this issue by continuing to appropriate funds for capital purchases on a cash basis. Thus, in terms of the chart of accounts, the ledger must be capable of separately identifying capital “expenditures”, whilst still accounting for such transactions on an accrual basis. Indeed, for budget presentations and fiscal reporting, it would be ideal to report “net lending” as the key fiscal measure, which includes transactions in non-financial assets. Under this standard GFS presentation of the operating statement (“statement of operations”), presented below, net investment in non-financial assets adds to expenses to produce total “expenditure”.

GFS Format Statement of Operations (GFS Manual 2014)

Transactions Affecting Net Worth:

1 Revenue

11 Taxes 12 Social contributions [GFS] 13 Grants 14 Other revenue

2 Expense

21 Compensation of employees [GFS] 22 Use of goods and services 23 Consumption of fixed capital [GFS] 24 Interest [GFS] 25 Subsidies 26 Grants 27 Social Benefits [GFS] 28 Other expense

NOB/GOB Net/gross operating balance (1-2) Transactions in Nonfinancial Assets

31 Net/gross investment in nonfinancial assets 311 Fixed assets 312 Inventories 313 Valuables 314 Nonproduced assets

2M Expenditure (2+31) NLB Net lending (+)/ Net borrowing (-) [GFS] (1-2-31=1-2M= 32-33)

Phase three, according to TNM 2016/06 also involves expanding institutional coverage to consolidate financial data for all controlled entities and thus would involve consolidation of the financial accounts of the publicly owned enterprises. The Auditor-General has identified significant issues in the accounting and reporting of a sample group of POE’s audited and the POEs have previously been reluctant to agree to undertake regular reporting to the MoF. To achieve consolidated reporting, standards must be set and accepted by the Ministry of Economy and the POE’s that require the POEs to report in a format consistent with the accrual CoA on a timely basis.

It is not considered appropriate to set a timeline for the transition to full accrual accounting. The Ministry of Finance, in consultation with stakeholders, should commence a program of commencing reporting by POEs at the earliest opportunity. Similarly, the quality of current supplementary disclosure of non-financial assets should be progressively improved, including capacity building for staff and systems enhancements. In the first instance, simplified approaches can be taken to asset valuation and revaluation as well as depreciation – which may not be completely consistent with IPSAS but avoids the need for subjective or complex revaluations and adjustments to the useful life of assets. Meanwhile, a training program for financial staff in budget organizations should be prepared to enhance the capacity of these individuals to undertake accounting for non-financial assets on a decentralized basis consistent with IPSASs.

4.5 Reform Pathway

The phased transition from cash to advanced accrual accounting is possible to be achieved over the period 2017 to 2020 but this requires careful planning. Figure 2 below sets out graphically the reform pathway, which involves progressively expanding the scope of institutional coverage of the accounts whilst simultaneously adding additional elements to the balance sheet and tracking movements in these assets and liabilities in the operating statement.

A platform approach to these reforms should be taken where each phase is completed and embedded prior to the next phase going live. This is not say that future phases should not be planned in advance (commencing now), as initial phases need to be planned having regard to the design and approach being taken in relation to the later phases.

It is essential that the chart of accounts and associated reforms recognize and synchronize the interlinked aspects of budgeting, budget execution control, fiscal reporting, financial reports and statistical reporting. All of these elements both inform and rely on the chart of accounts and will be impacted by progressive changes in the chart of accounts. Changes in business processes which support the gathering, recording and use of data need to be synchronized and sequenced to match the changes to the chart of accounts – ensuring that the data can be captured to populate the budget tables and accounts as contemplated and that the data is able to be used in the manner required for these various purposes.

As with all change management processes, communications and capabilities of users is just as important as the technical design and substantial effort must be applied in…