Financial audit in National Audit Office (NAO) of Estonia Ines Metsalu Head of Financial Audit Department ISSAI Seminar on June 2011 in Tallinn

Agenda 1.Public sector accounting in Estonia: regulation, systems and modernization; 2.Financial audit in NAO: changes in audit mandate and audit work; 3.The implementation process of international auditing standards in financial audit; 4.Implementation of compliance audit standards within financial audit and separately from financial audit; 5.Challenges in public sector financial audit.

Public sector accounting in Estonia From year 2004 the Minister of Finance enforced General Guidance of the Public Sector Accounting: –general accounting principles for public sector entities are based on full accrual principle; –the uniform chart of accounts, obligatory for reporting purposes to public sector institutions; –compilation of consolidated financial statements. Accounting principles in public sector are based on Estonian GAAP and on International Public Sector Accounting Standards; Consolidated financial statements also include budgetary execution report: –cash based reporting in budgetary reporting vs accrual based financial statements.

Public sector accounting in Estonia (2) All members of the Government Sector present their accounts monthly, others (public sector business enterprises and financial corporations) quarterly; –Reporting of public sector entities is inserted via internet in the public sector financial statements database of Ministry of Finance. All budgetary payments are reported via internet in State Treasury database; The State Accounting department at MoF is responsible for: –preparing and improving the General Guidance of the Public Sector Accounting; –collecting and checking the financial statements of the public entities; –preparing and presenting the consolidated financial statements of the State, the Government Sector and the Public Sector.

Financial reporting to the Parliament and public Financial statements of each ministry: –consolidated accounts include accounts of each ministry and its agencies; –public owned companies and state foundations governed by each ministry are recognised in the accounts by equity method; –annual accounts include management report, balance sheet, income statement, cash flow statement, statement of net assets, appendixes and report on the execution of the budget; –financial statements are prepared by 30 April and audited by 30 June in the following year; –statements are approved by the government and made publicly available on websites.

Financial reporting to the Parliament and public (2) Consolidated Annual Accounts of State –prepared by Ministry of Finance on the basis of the annual reports of state accounting entities; –draft presented to NAO on 30 June and audited by 31 August; –approved by the Government after receiving the audit report issued by NAO; –presented to the Parliament and made publicly available after approval; –discussed in Parliament both in Finance Committee and in State Budget Control Committee.

Annual accounts of the state Consolidated accounts of the public sector Bank of Estonia, etc Consolidated accounts of the governmental sector Local governments Bodies governed by public law Consolidated accounts of central government State owned companies, state foundations State accounting entities

Modernising accounting and budgeting in public sector 1.Shared Support Services project: –centralising all financial bookkeeping and accounting systems across the state administration in order to standardise the collection and reporting of financial information; –consolidating other “back-office” operations such as public procurement, human resources management etc. 2.Pilot projects in implementing accrual based budgeting alongside cash based budget: –to make better use of the accrual accounting information already available. 3.Piloting performance measurement and performance budgeting; strengthening linkages between strategic and budget frameworks.

Agenda Public sector accounting in Estonia: regulation, systems and modernization; Financial audit in NAO: changes in audit mandate and audit work; The implementation process of international auditing standards in financial audit; Implementation of compliance audit standards within the financial audit and separately from financial audit; Challenges in public sector financial audit.

Mandate of National Audit Office In the course of an audit, the National Audit Office may assess the following: –internal control, financial management, financial accounting and financial statements of the audited entity; –the legality of the economic activities, including economic transactions of the audited entity; –the performance of the audited entity with regard to its management, organisation and activities; –the reliability of the information technology systems of the audited entity. NEW: NAO is the group auditor of consolidated state accounts. NAO is also responsible for the direction and supervision of the audits performed by auditors of the components.

Development in financial audit Financial audit in NAO started in year 2000: –audit managers and head of audit department came from private sector auditing firms, learning from private audit firms; –audit of single institutions, focus on accounting issues and budgetary report, not on financial statements; –adapting private sector financial audit methodology to public sector and implementing compliance audit. From 2004 audits of consolidated financial statements of the state and legality of transactions: –audit work was divided between internal auditors and NAO Internal auditors were responsible for auditing the financial statements of ministries NAO was responsible for auditing the financial statements of the state

Development in financial audit (2) The reason for dividing the audit work between internal auditors and NAO was lack of resources; The main criticism regarding dividing of financial audit work: the system where internal auditors had a function of external audit was in conflict with international auditing practise and raised questions about the independence of auditors’ opinions issued within financial statements of ministries; the inefficiency of the system, meaning that NAO and internal auditors were duplicating their work. Lesson learned: co-operation with internal audit is recommendable, but the tasks of certified financial auditors cannot be delegated to internal auditing functions.

New tasks in financial audit Important changes took place in 2010: –task of auditing financial statements of ministries was taken from internal auditing function and assigned to NAO; –clear mandate for NAO to act as a group auditor, auditor of group financial statements; –as far as applicable NAO is obliged to follow professional standards, which are based on ISA-s; –public sector sworn auditor – certification, which allows to conduct audits in public sector entities; –financial auditors in NAO have to pass the abovementioned certification; –financial audits conducted in NAO are subject to the quality control carried out by the Association of Auditors.

Challenges within new regulative framework NAO has to fulfil the role of group auditor and we have set an ambitious goal to comply with ISSAI 1600; Our goal is to raise the awareness of private sector auditors auditing public sector entities that more emphasis should be paid on public sector context (incl expectations of parliament and taxpayers) and regularity issues while auditing financial statements; Working as a group auditor on state level adds additional tasks: –state owned companies, state foundations and bodies governed by public law are audited by private audit firms; –audit of compliance is obligatory in state owned companies and state foundations; –NAO has to issue guidelines for private sector auditors on compliance audit.

Challenges within new regulative framework (2) The role of group auditor based on ISSAI 1600 includes: –understanding the Group and all of its components (ministries, agencies, public sector companies, state foundations etc) –regular communication with components auditors and understanding of components auditors work; –NAO audit methodology differs from practices of components auditors in context of auditing compliance – need to prescribe audit procedures; –in some cases involvement in the component auditor’s risk assessment to identify significant risks of material misstatement of the group financial statements. The financial audit department must be ready for fulfilling the task by September 2012.

Scope of financial audits The current scope of financial audits includes: –an opinion, whether the audited financial statements of the ministry give true and fair view of the financial position and financial outcome of the ministry; –an opinion, whether the transactions of audited period are in compliance with State Budget Act and Annual Budget Act; –in addition NAO reports audit findings concerning the effectiveness of internal control systems and cases of non-compliance of other regulations, such as Public Procurement Act, State Assets Act. In implementing ISSAI 4100 we are in process to extend our audit opinion on regularity.

Planning of financial audits Planning of financial audits starts with overall audit strategy for the audit of consolidated state accounts: –overall audit strategy fixes materiality, siginificant components and risk assessment on state group level; –consolidation process is audited on state level, but transactions are audited on ministry level; –principles for cooperation are agreed on with external auditors. Audit strategy and plan on ministry level have to comply with the requirements fixed in overall audit strategy of the state –Materiality, siginificant components and risk assessment on ministry group level; –Relying on internal auditors’ work where applicable; –Single agencies are not audited.

Reporting of financial audits Procedures on transcations and accounts Audit reports by NAO relying on external and internal auditors Audit report by NAO Consolidated accounts of the state Consolidated accounts of ministry A Agency CAgency D Consolidated accounts of ministry B Agency F

Agenda Public sector accounting in Estonia: regulation, systems and modernization; Financial audit in NAO: changes in audit mandate and audit work; The implementation process of international auditing standards in financial audit; Implementation of compliance audit standards within the financial audit and separately from financial audit; Challenges in public sector financial audit.

Principles for financial audits in NAO The NAO’s Act and Auditing Standards give the main principles for conducting audits. These main auditing principles are specified in NAO’s Auditing Guidelines; NAO’s Auditing Standards and Guidelines are based on International Auditing Standards (ISA) and Public Sector Auditing Standards (ISSAI). The public sector accounting based on IPSAS does not leave much choice in audit approach. Using ISSAI-s was embedded into that system; –Our goal has been to implement ISA-s and ISSAI-s as much as applicable according to our mandate.

Implementing auditing standards in financial audits Necessary steps for implementing the standards: –Cooperation with and methodology advice from other SAI-s. Close cooperation with auditors from NAO of UK and Audit Scotland –Translation of INTOSAI Standards and implementing guidelines into Estonian (ISA-s have been translated by Board of Auditors); –Continuos training of staff; –Writing NAO’s specific guidelines in order to implement ISSAI-s in daily audit work; –Implementing the system of quality assurance.

Implementing auditing standards in financial audits (2) Audit methodology has been developed in financial audit department by financial auditors, no separate unit for audit methodology. Changes in methodology have been made step by step: 1.planning stage: templates for understanding entities business, audit risk assessment and defining audit procedures; 2.audit documentation alongside with audit software TeamMate; 3.group audit methodology on state level using work of internal auditors; 4.more focus on risk assessment at assertion levels (ISA 315), audit sampling and implementing software IDEA; 5.next stage will be group audit methodology based on ISSAI 1600.

Implementing international auditing standards in financial audits (3) Quality reviews of audits are conducted once a year by private audit companies; gives us valuable feedback, how to comply with international standards on auditing. Continuous trainings play a key role in implementing any audit methodology: –on regular basis financial audit seminars in audit department; –in the beginning of new auditing season lessons from previous season are discussed; –auditors take actively part in in-house trainings, but also in trainings organised by Board of Auditors, by Ministry of Finance. NAO has started cooperation with Tallinn University of Technology in opening a master study programme for financial auditors.

Agenda 1.Public sector accounting in Estonia: regulation, systems and modernization; 2.Financial audit in NAO: changes in audit mandate and audit work; 3.The implementation process of international auditing standards in financial audit; 4.Implementation of compliance audit standards within the financial audit and separately from financial audit; 5.Challenges in public sector financial audit.

Implementing compliance audit standards Implementation of compliance audit standards is going on in two directions: –ISSAI 4100 in audits of local governments (infrequently in performance audits), –ISSAI 4200 in financial statements audits; NAO audit standard specifies compliance auditing as equally important part of financial statement audits; so far NAO has expressed opinion based on reasonable assurance only on the subject matter concerning budget law; The main objective is to move from reporting in the form of reasonable assurance opinions to entity's compliance with authorities; limitation of scope is necessary – only the most important laws and provisions and relevant subject matter are audited on the basis of reasonable assurance.

Implementing compliance audit standards (2) The subject matter and scope of the compliance audit is based on the professional judgement of the NAO. Three particular laws and relevant subject matter are being focussed on: –The Budget Law, –The State Assets Act, –The State Procurement Act. The main challenges are determining of materiality and risk assessment at assertion level in compliance audit: –The fundamental principles of each law are handled as management assertions (criteria); External confirmations are taken from management confirming they have followed abovementioned fundamental principles; Irregularities are evaluated in the context of these fundamental principles/assertions.

Implementing compliance audit standards in auditing local governments NAO mandate includes conduct of financial audits and compliance audits in local governemnts: –mandate excludes performance audit; –no clear distinction between performance and compliance issues – audits touch upon both issues, complications for identifying audit criteria. Financial statements are audited by private auditors, NAO is sending guidelines to auditors; Single institutions audits and audits on horizontal issues usually 15 local municipalities are covered: –Public procurement, PPP-s, rendering public services in small LG-s –opinions issued on each local governments separately, an overall conclusion on subject matter and suggestions to regional levels, ministries.

Implementing compliance audit standards in auditing local governments (2) In 2011 the department started with pilot audits for introducing ISSAI 4100 in local governments audits: –identifiying suitable criteria; –defining materiality, assessing risks and functioning of internal controls; –distinct link between risks identified and audit procedures; –opinion on subject matter on the level of each local government and general conclusion based on findings of audited LG-s. The local governments’ audit department finds that using ISSAI 4100 enables more systematic approach to compliance audit and facilitates drawing conclusions on subject matter.

Main challenges for Supreme Audit Institutions in implementing ISSAI-s Reforms in public sector accounting and reforms in public sector auditing are interdependent: implementation of accural accounting and financial reporting based on IPSAS may require SAIs to adapt their financial audit work; Cooperation with other SAI-s is very fruitful; Training of staff is essential and enough resources must be planned; How to avoid “overauditing”? More attention on differencies between public sector and private sector auditing in standard setting and implementation; Application of ISSAI-s in compliance audit and performance audit is still debatable, also in NAO.

Thank you for your attention!