report no. 27425report no. 27425 moldova country...

Report No. 27425Report No. 27425Report No. 27425Report No. 27425

Moldova Country Financial Accountability Assessment September 12, 2003September 12, 2003September 12, 2003September 12, 2003 Operations Policy and Services Unit Europe and Central Asia Region

Document of the World BankDocument of the World BankDocument of the World BankDocument of the World Bank

CURRENCY EQUIVALENTS

(Exchange Rate Effective October 8, 2002) Currency Unit = Moldova Lei US$ 1 = 13.5020 Moldova Lei

FISCAL YEAR

January 1 to December 31

ABBREVIATIONS AND ACRONYMS

AAFM The Association of Audit Firms in Moldova ACAP The Association of Professional Accountants and Auditors of Moldova ACCA The Association of Chartered Certified Accountants ATU Administrative Territorial Units (Local Government authorities) CAS Country Assistance Strategy CD Customs Department CFAA Country Financial Accountability Assessment CoA Court of Accounts CPAR Country Procurement Assessment Report EBF Extra Budgetary Funds EBRD European Bank of Reconstruction and Development ECA Europe and Central Asia EU European Union FCR Department of Financial Control and Revision FY Fiscal Year EUROSAI European Organization of Supreme Audit Institutions IAS International Accounting Standards (encompassing IFRS) IASB International Accounting Standards Board IFAC International Federation of Accountants IFRS International Financial Reporting Standards INTOSAI International Organization of Supreme Audit Institutions IPSAS International Public Sector Accounting Standards ISA International Standards on Auditing LGI Local Government Institutions MoF Ministry of Finance MoLSP Ministry of Labor and Social Protection MTEF Medium Term Expenditure Framework NAS National Accounting Standards NBM National Bank of Moldova NGO Non-Governmental Organization NPA National Procurement Agency NSA National Standards of Auditing NSIH National Social Insurance House PEMR Public Economic Management Review PRSP Poverty Reduction Strategy SAI Supreme Audit Institution SAC-III Third Structural Adjustment Credit SOE State Owned Enterprise SSIB State Social Insurance Budget STS State Tax Service USAID US Agency for International Development

Regional Vice-President: Shigeo Katsu, ECAVP Country Director: Luca Barbone, ECCU2

Sector Director: Alain Colliou, ECSPS Sector Manager: John Hegarty, ECSPS

Task Team Leader: Ranjan Ganguli, ECSPS

Moldova: Country Financial Accountability Assessment i

TABLE OF CONTENTS

TABLE OF CONTENTS ...........................................................................................................................I

PREFACE ................................................................................................................................................. II

EXECUTIVE SUMMARY ..................................................................................................................... IV

DEVELOPMENT ACTION PLAN ....................................................................................................VIII

1. COUNTRY BACKGROUND ......................................................................................................... 1

2. PUBLIC SECTOR FINANCIAL MANAGEMENT .................................................................... 3

Budget formulation ................................................................................................................................. 3 Budget Execution .................................................................................................................................... 7 Revenue systems ................................................................................................................................... 10 Accounting and Financial Reporting..................................................................................................... 12 Internal Control and Auditing ............................................................................................................... 14

3. EXTERNAL OVERSIGHT OF PUBLIC FINANCIAL MANAGEMENT............................. 16

External Auditing .................................................................................................................................. 16 Parliament.............................................................................................................................................. 19

4. LOCAL GOVERNMENT INSTITUTIONS ............................................................................... 21

Local Government Budgets................................................................................................................... 22 Accounting and Treasury Systems ........................................................................................................ 24 Reporting............................................................................................................................................... 25 Internal Control and Internal Audit ....................................................................................................... 25 External Oversight................................................................................................................................. 26 Capacity of Local Government Institutions .......................................................................................... 26

5. PRIVATE SECTOR ACCOUNTING AND AUDITING ........................................................... 27

Enterprise Sector ................................................................................................................................... 27 Banking Sector ...................................................................................................................................... 32

6. FIDUCIARY CONSIDERATIONS IN RESPECT OF BANK-FINANCED PROJECTS ...... 35

Reliance on Public Sector Financial Management Framework............................................................. 35 Project Financial Management.............................................................................................................. 35 National Bank of Moldova .................................................................................................................... 37

ANNEX 1: CFAA NATIONAL STEERING COMMITTEE............................................................. 39

ANNEX 2: ARCHITECTURE OF PUBLIC FINANCIAL ACCOUNTABILITY.......................... 40

ANNEX 3: MAP OF MOLDOVA......................................................................................................... 41

Moldova: Country Financial Accountability Assessment ii

PREFACE

This report was prepared after missions to Moldova in 2002 and 2003 by a Task Team comprising Ranjan Ganguli (Task Team Leader, ECSPS), M. Mozammal Hoque (Senior Financial Management Specialist, OPCFM), Elena Nikulina (Economist, ECSPE), Andrew Mackie (Financial Management Consultant, ECSPS) and Andrei Busuioc (Research Analyst, ECCMD). A counterpart team in the form of a National Steering Committee (NSC), comprising members of Government, the Court of Accounts, the National Bank of Moldova and the Parliamentary Committee for Economy, Industry, Budget and Finance, was specifically formed for the purpose of the CFAA (the full composition of the NSC is shown in Annex 1). This CFAA was discussed fully with the NSC prior to finalization and the Development Action Plan (DAP) included within the report, listing and prioritizing the report’s main recommendations, was endorsed by the NSC.

The report is based on the results of interviews and discussions with various public and private institutions as well as an analysis of various data gathered during the missions including copies of various legislation, instructions and reports. Government and private sector counterparts lent their full and proactive support to the CFAA missions and engaged with the Bank’s team in a comprehensive dialogue. The Bank is grateful for this cooperation.

Objective of Country Financial Accountability Assessment There is considerable empirical evidence of a strong causal relationship from better governance to better development outcomes1. A country’s financial accountability framework is a significant element of that aspect of governance relating to the capacity of government to manage resources and implement sound policy.

A CFAA is a diagnostic instruments designed to facilitate a common understanding by the borrower, Bank and their development partners of the borrower’s public and private sector financial accountability framework. In turn this enables the development of plans to address any issues identified as well as of appropriate capacity-building programs.

CFAAs also support the Bank in the exercise of its fiduciary responsibilities by identifying the strengths and weaknesses of a country’s financial accountability arrangements and the risks that these may pose to the use of Bank funds. CFAAs are not audits; they are not intended to and do not provide assurance on the specific uses to which Bank funds have been or may be applied.

Relationship of the CFAA to the CAS, lending program and policy dialogue with the Government The Board endorsed the CAS Progress Report in June 2002, which provided emphasis in public sector reforms and improving governance. The Government confirmed its commitment for strengthening governance by adopting a comprehensive public sector reform strategy. The strategy comprises three elements: (i) public administration reform; (ii) public expenditure management; and (iii) public/private interface. The CAS Progress Report recognized that Government has made significant progress in streamlining and improving public expenditure management, especially in the areas of budget execution, cash management, and debt management. 1 Kaufmann, Kraay and Zoido-Lobatón (1999). “Governance Matters”. World Bank Institute Policy Research Working Paper 2196

Moldova: Country Financial Accountability Assessment iii

In addition, the Government is currently in the process of preparing a Poverty Reduction Strategy Paper (PRSP). The Government and all major stakeholders consider poverty reduction to be the major development challenge for Moldova. Meeting this challenge requires analysis and better coordination among agencies to design and monitor appropriate anti-poverty policies and programs. The Government has welcomed the PRSP process as the primary mechanism for orienting and coordinating government and partner activities. The Government’s PRSP preparation status report and action plan have been favorably assessed by Fund-Bank staff as reflecting Government commitment to poverty reduction and to the PRSP process. It is the intention that this CFAA will provide input to PRSP by contributing to the design of the program of reform for the country’s financial accountability framework.

Finally, the reform program supported by the Bank-financed Third Structural Adjustment Credit (SAC-III) includes measures to improve fiduciary management. The agreement by Government to implement the agreed stages of this CFAA’s Development Action Plan is a condition for disbursement of the third tranche.

Scope and terms of reference of CFAA The scope and terms of reference of the CFAA were articulated and agreed both internally within the Bank and externally with the Moldovan National Steering Committee in the CFAA Initiating Concept Memorandum of July 19, 2002.

Acknowledgements The CFAA team wishes to acknowledge the extensive and grateful cooperation and assistance received from the staff of the various institutions who contributed to the CFAA, including officials and staff of the Government, state agencies and enterprises, private sector institutions, and bi-lateral and multilateral organizations. Grateful thanks go also to the Bank’s Public Expenditure Management Review and SAC-III task team as well as the staff of the USAID-funded Fiscal Reform Project and Financial Management Training and Advisory Activity Project for their considerable research on which a significant proportion of this CFAA is based. In addition: Carlos Elbirt (Moldova Country Manager) provided invaluable in-country assistance and information; John Hegarty (Manager, Financial Management, ECA) and peer reviewers, Kapil Kapoor (SASPR) and Marius Koen (AFTQK), offered much appreciated comments and inputs; and Ana Cristina Hirata and Roula Balkash assisted with the editing and formatting of the report.

Moldova CFAA: Executive Summary iv

EXECUTIVE SUMMARY

1. The overall conclusion of this report is that despite some progress in improving public financial management, the financial accountability framework in Moldova is weak and requires substantial strengthening. This has important implications for both the Government and the Bank: the Government will need to make a significant effort over a long period of time to attend to the issues identified within this report; and the Bank cannot rely on the Moldovan financial accountability framework to ensure that funds are spent for intended purposes, but rather the Bank will need to review and assess each operation’s financial management risks and arrangements on its own merit. Public Sector 2. Budget formulation: The budget formulation process is fragmented and consequently the Government presents the budget to Parliament in a fragmented, rather than in a consolidated and comprehensive manner. The Law on Budget System and Budget Process (1996), requires Parliamentary approval of the state budget only, rather than the overall national budget framework. The State Social Insurance Budget is formulated by the National Social Insurance House and approved by the Parliament separately. Donor financed investments and extra-budgetary resources of institutions financed by state budget are not integrated into the state budget but approved as separate annexes to the annual state budget law. Domestically financed capital investments are incorporated in the state budget as a single line, without a breakdown by functional classification. No explicit allocation is made in the annual budget for repayment of arrears accumulated during the previous years. Based on the foregoing, the budget does not provide a comprehensive or complete view of public revenues and expenditures, which diminishes its effectiveness as a tool of public policy. The ongoing efforts to introduce medium-term expenditure framework (MTEF) are aimed at eliminating many of the above shortcomings. Due to capacity constraints budget formulation tends to follow an incremental and input oriented approach. Program budgeting pilots are being introduced gradually to take account of these structural weaknesses. The CFAA additionally recommends that each ministry’s Collegium Board formally and regularly consider its ministry’s budget and budget execution reports. 3. Budget execution and cash management: The CFAA identifies several weaknesses in the cash management process which, if addressed, would ensure greater predictability of cash release and reduce penalty payments on overdue liabilities. The establishment of a Cash Management Unit in the Ministry of Finance in 2001 is a positive development but much still needs to be done in order to improve its methodological skills. In addition, greater coordination is needed between related departments e.g. Budget Synthesis Department and Debt Department of Ministry of Finance and the Tax and Revenue authorities. More needs to be done in order to communicate cash forecasts and budget execution reports to the line ministries. 4. Public sector accounting: The Government enacted detailed instructions for accounting of public institutions in 1995, based on a double entry modified cash basis. No consolidated financial statements are prepared that reflect the financial position of the entire public sector. The present accounting and treasury laws and regulations should be more concise and simplified.

Moldova CFAA: Executive Summary v

5. Internal control and auditing: The role of public sector internal audit is relatively under-developed in Moldova. Existing internal audit organizations need to move from ex-post control and inspection activities to an audit model which is supportive of improving the overall control environment. The Ministry of Finance, after appropriate consultation with line ministries and the rest of the public sector, needs to establish a framework for internal audit within the public sector. 6. External audit: The Court of Accounts (CoA) is responsible for the independent audit of the financial statements of the public sector. The Law of CoA should be revisited; the Court’s excessive powers should be reduced; and its activities should focus exclusively on the audits of public sector organizations. The CoA needs additionally to gear its audit activities towards advising on systems improvements and risk mitigation measures rather than fault-finding. Although extensive legal powers and responsibilities are extended to the CoA, the office faces significant capacity constraints to carry out its mandate and requires substantial strengthening. Several proposals are suggested, including: (i) the twinning of the CoA with a more developed Supreme Audit Institution; (ii) the development and provision of learning events for the staff of the CoA, and (iii) the development of a revised audit methodology in accordance with international norms. 7. Parliamentary oversight: Parliament is active in improving financial accountability in the country. However, further development of Parliamentary oversight of public expenditures is still possible. As the executive arm of Government develops a more strategic approach to budgeting, Parliament, and particularly the Parliamentary Committee on Economy, Industry, Budget and Finance, should regularly review the financial performance and position of individual ministries. The CFAA also recommends that Parliament pay greater attention to the reports of both the Court of Accounts and the Ombudsman. 8. Local governments2: Moldova’s local governments share many of the same financial management capacity constraints as central government. They are additionally weakened by frequent changes in administrative-territorial organization of the country and the lack of clarity on the future direction of fiscal decentralization reforms. Local budgets are an integral part of the national consolidated budget and about 30 percent of public funds are used for local budgets. The CFAA proposes a range of reforms to improve local government financial management, including: (i) simplifying public sector accounting laws and regulations to make them more comprehensible; (ii) preparing annual performance reports and making them publicly available; and (iii) developing an institutionalized financial management training program for local government staff. Private Sector 9. Accounting and auditing: The reform effort for private sector accounting and auditing from 1995 onwards was led by the Ministry of Finance, with the support of technical assistance from the World Bank, USAID and the Soros Foundation. The CFAA recognizes the work that has been done in this area but argues that further resources are required in order to maintain and deepen the reforms achieved thus far.

2 The English-language version of this CFAA uses the term “Local Government” whereas, for linguistic purposes, the Romanian-language version uses a term that may be more directly translated as “Local Public Authorities”.

Moldova CFAA: Executive Summary vi

10. Financial reporting: the Law of Accounting was adopted in 1995. It needs to be completely revised to be consistent with EU Directives and other international norms. The Government has also introduced 23 National Accounting Standards (NAS), and another ten are under development. The Government needs to establish an institutional framework to maintain and update the NASs (see discussion below regarding the role of professional accounting institutions). The CFAA also recommends that: (i) financial institutions, listed companies and entities of public interest should be required to prepare consolidated financial statements in accordance with International Accounting Standards and applicable EU legislation; and (ii) the financial reporting for SMEs be simplified and brought into line with EU Directives and Regulations. 11. Auditing: a number of significant challenges have an adverse effect on the quality of enterprise auditing in Moldova. The present Law on Auditing is out of date and needs to be aligned with EU Directives and Regulations and best international practice. The rules that stipulate which companies require an audit, under the Law of Joint Stock Companies, should also be revised and simplified in accordance with EU Directives. The quality of the auditing education is poor and the process by which auditors are certified is not transparent. In addition, the mechanisms to monitor and license auditors need to be revised in line with international norms. The present laws confuse the role of statutory auditors with that of state-controlled activities. The statutory audit requirement should be extended to apply to non-banking financial institutions, listed companies and entities of public interest, including state owned enterprises and NGOs. 12. Accounting and auditing institutions: There is an urgent need for sustainable and adequately resourced accounting and auditing standard-setting institutions in Moldova. The Audit Law makes provision for an Association of Audit Firms in Moldova (AAFM) to coordinate the operations of audit firms, develop auditing standards and develop examination programs, however, this organization has not been established. Other institutions, such as the Association of Professional Accountants and Auditors (ACAP), an organization founded in 1996 with the support of USAID, are also fairly weak. 13. Accounting Education: There have been a number of initiatives aimed at improving the education of accountants and undergraduates. More needs to be done, in particular to improve the training, education and certification process for auditors. ACAP and other institutions have developed programs with could be developed as a pre-requisite for candidates seeking certification as auditors in Moldova. 14. Banking: In accordance with the Law of Financial Institutions (1995) and the Law on National Bank of Moldova, banks are licensed, regulated and supervised by the National Bank of Moldova (NBM). Some elements of IAS affecting banks have not been incorporated into NAS and as a result, there are some differences between NAS and IAS. Thus, and for reasons of compliance with local legislation and international comparability, banks with foreign stakeholders have to maintain accounting records and prepares financial statements under both NAS and IAS. As already noted, the CFAA recommends that the Law should require IAS for financial reporting in the banking sector. Auditors of banks are required to be acceptable to the NBM. The CFAA recommends that the NBM and MoF should work together to develop a common institutional framework for the education, training and certification of auditors, regardless of the sector in which they operate.

Moldova CFAA: Executive Summary vii

Fiduciary aspects in respect of Bank financed projects 15. The CFAA concludes that there is a need for substantial strengthening of the overall public financial management framework. It would therefore be inappropriate for the Bank to place a blanket reliance on that framework for the purposes of satisfying the Bank’s fiduciary financial management requirements. Reliance on any particular aspect of the country’s financial management framework would need to be established on a case-by-case basis with reference to the specific financial management arrangements of the institutions involved. Development Action Plan 16. It would be unrealistic and impractical for the authorities to try to simultaneously address the many recommendations in this report. Immediately following this executive summary is a Development Action Plan (DAP) that lists and prioritizes the main recommendations of this CFAA. The overall responsibility for the implementation of the DAP rests with the Ministry of Finance however the Ministry of Economy, the Ministry of Labor, the Court of Accounts and the National Bank of Moldova also play significant roles. The DAP was endorsed by the National Steering Committee that was formed specifically for the purpose of this CFAA.

Moldova CFAA: Development Action Plan viii

DEVELOPMENT ACTION PLAN

Timing Area Action Responsibility Short-term (less than 1

year)

Medium-term (1 to 3

years)

Long-term (over 3 years)

1. Budget formulation 1. Consolidation of the budget formulation process to take into account all public sector financial resources including the state budget, budgets of administrative-territorial units (local budgets), the state social insurance budget, extra-budgetary funds, and grants and loans for investment projects as well as other financial resources provided by donors.

Government X

2. The Collegium Boards of ministries should formally and regularly consider their ministries’ budgets and budget execution reports.

Line ministries X

2. Budget execution (including cash management)

1. Develop and make public a regulation on state budget cash allocations in order to increase transparency of public cash management.

MoF X

2. Local treasury systems should be upgraded as a matter of priority to capture commitments and enable a better assessment of government-wide cash flow requirements and settlement of arrears.

MoF/Treasury X

3. Cash balances held in local treasuries for state budget expenditures should be monitored closely, to allow for the redistribution of excess balances.

MoF / Treasury X

3. Accounting and Financial Reporting 1. The prescriptive laws, rules and regulations relating to accounting and treasury operations should be simplified in favor of a principles-based regime.

MoF X

2. The Ministry of Finance should prepare consolidated financial statements reflecting the financial position of the entire public sector.

MoF / Treasury X

4. Public Sector Internal Auditing 1. The MoF should prepare a strategy for a public sector internal audit function.

MoF X

5. Public Sector External Auditing 1. The CoA should initiate a twinning arrangement with a more developed Supreme Audit Institution (SAI) and should subject itself to a peer review by this SAI.

CoA X

2. The Law on the Court of Accounts should be revised to eliminate the CoA’s control and enforcement activities.

CoA X

Moldova CFAA: Development Action Plan ix

DEVELOPMENT ACTION PLAN

Timing Area Action Responsibility Short-term (less than 1

year)

Medium-term (1 to 3

years)

Long-term (over 3 years)

3. The CoA should review its staffing arrangements, compile an inventory of its skills and competencies, devise recruitment policies and procedures, and develop formal training programs.

CoA X

4. The CoA should revise its auditing methodology to include risk-based and systems-based audit models

CoA X

6. Local Government Institutions 1. Institutional arrangements for the training of financial management staff in local government should be developed.

MoF / Academy of Public

Administration

X

7. Private sector accounting 1. Revise and enact Law of Accounting in accordance with applicable EU legislation and IAS.

MoF / Parliament

X

2. Financial institutions, listed companies and entities of public interest should be required to produce consolidated financial statements in accordance with IAS and applicable EU legislation.

MoF / NBM X

8. Private sector auditing 1. The Law of Auditing and Law of Joint Stock Companies should be revised and enacted.

MoF / MoE / Parliament

X

2. Statutory audit requirement to be extended to apply to non-banking financial institutions, listed companies and entities of public interest.

MoF X

3. Harmonize the institutional framework for the education, training and certification of auditors.

MoF / NBM X

9. Fiduciary considerations in respect of Bank financed projects

1. Establish a forum to oversee development and management of project financial management systems including a consideration of standard qualifications, TORs, contracts and remuneration rates for project financial management staff.

MoF / NBM / CoA / WB

X

2. Bank to review quality of project auditors. WB X 3. CoA to receive explanation of and training in the specific areas of

disbursements, financial management and procurement in Bank-financed projects as well as the Bank’s project cycle more generally.

WB X

Moldova CFAA: Country Background 1

1. COUNTRY BACKGROUND

1. Moldova is a small republic lying between Ukraine and Romania. It is one of the poorest countries of Europe with a per capita GNP of approximately US$400. The total population of Moldova is 4.3 million (including Transnistria) and an estimated 55 percent of the population lives in poverty. Moldova is predominantly an agricultural country, with few natural resources. Poor economic performance over the past decade has been attributed to political instability and unresolved separatist conflict. Moldova is one of the Region’s most heavily indebted countries and it has been facing a liquidity crisis in servicing its debts. Moldova’s external debt service managed by the Ministry of Finance accounted for about 30 percent of state budget revenues in 2002 and is expected to exceed 35 percent in 2003.

Institutional constraints 2. The country has undergone a number of fundamental reforms to its institutions and legislation since gaining independence in 1991 from the former Soviet Union. The dissolution of the Soviet Union required the newly independent states to build from scratch the set of institutions which are part and parcel of modern statehood and democracy. Like other CIS countries, Moldova started the transition period with a low level of institutional capacity in its public sector. The situation in Moldova has, however, been exacerbated over the last decade by chronic political instability and volatility, with ten governments over this period. Moreover, increasing politicization has led to high levels of turnover in the civil service at each change of government.(up to 20 percent turnover at each change of government, with turnover down to deputy head of department). This has resulted in chronic policy discontinuity, weakening of institutional capacity, erosion of institutional memory, and extremely low staff morale.

3. Institutional capacity has, in some limited areas, improved since independence. For example, Moldova has one of the strongest central banks in the FSU. The Ministry of Finance’s technical capacity has also been considerably developed. Both these agencies were the beneficiaries of substantial externally funded technical assistance. However, even in these cases, the sustainability of the improvements will depend on implementing deep public sector reforms to depoliticize the public administration and provide appropriate incentives to be able to retain good quality professionals.

Quality of Governance 4. Overall, Moldova’s quality of governance has remained poor, and is among the weakest in the region. Moldova had the worst performance among twenty transition countries when compared on a governance index by the EBRD (1999). Moldova also rated the lowest among seven transition countries with respect to perceptions of quality and efficiency of central government services in the World Bank/EBRD Business Environment and Enterprise Performance Survey (BEEPS-1999).

5. Persistently extremely low compensation levels in the civil service combined with exposure to opportunities for rent-seeking as elements of a market economy developed (the new private sector, emergence of some SMEs, restructuring of existing enterprises, privatization) has led to Moldova experiencing high levels of both state capture and administrative corruption. At the same time there have been few external pressures on the system for appropriate behavior on the part of public officials. Politicians have been unable to

Moldova CFAA: Country Background 2

secure discipline within the system. The private sector has not been able to form business associations capable of lobbying effectively for business-oriented policies. Civil society is weak. Citizens have extremely low expectations of the public sector and extremely limited opportunities to participate meaningfully in decision-making processes.

Structure of Government 6. The transition period has been characterized by a large degree of political instability, with ten governments since independence. The absence of political consensus behind economic reforms over this period, frequent changes of government, and weak institutional capacity all combined to produce a stop-and-go pattern in the implementation of economic reforms.

7. The new Constitution was approved in 1994 and established a parliamentary form of government with the Prime Minister as the chief executive and the President as the head of state. A single chamber Parliament of 101 members is elected by the people for a term of four years3. The authority of Parliament was expanded in 2000 through amendments to the Constitution, following which the President is now elected for a four year term by Parliament rather than by direct popular vote. The Government consists of a Prime Minister, First Vice-Prime Ministers, Vice-Prime Ministers and ministers as determined by the organic law.

8. Moldova is a unitary republic comprising the central government and two tiers of local government. The structure of local government has been undergoing continuous changes during the last years. The most recent reform introduced through approval of the new Law on Administrative-Territorial Division took place in spring 2003 and basically reversed the earlier reform of 1999. The present administrative territorial division comprises 32 regions (rayons), autonomous territorial unit of Gagauzia with special legal status, Municipalities of Chisinau and Balti, 52 towns (municipalities) and 847 communes (villages). For the purpose of this CFAA the administrative territorial division introduced in 1999 was taken as a basis, as the assessment was done before the March 2003 Law was enacted. Also, so far, the most recent reform did not have significant implications for financial management framework at the local government level. In the former administrative territorial division, one tier of local public administrations was represented by ten Judets (counties), Chisinau municipality and the autonomous territorial unit of Gagauzia. Another tier of local government was represented by communes, villages and municipalities. As part of the 1999 reforms, the central government introduced the office of Prefect to represent central government in Judets, Chisinau municipality and the autonomous territorial unit of Gagauzia, and report to the State Chancellery. These offices were closed down though the March 2003 legislation and replaced with the 8 zonal offices of the State Chancellery. Each administrative territorial unit continues to elects its local council through popular vote. The heads of local public administrations (primars/mayors) are also directly elected by the people. Many of the units within local public administrations have dual subordination reporting to the respective central ministries as well as to the local public administration.

9. A schematic diagram depicting the interrelationships of the various organs of Parliament, central government and local government as relates to the country’s public sector financial accountability framework may be found in Annex 2. These organizations are considered further in the public sector sections of this CFAA.

3 The electoral system is based on the party list and not on direct vote for the people’s representatives.

Moldova CFAA: Public Sector Financial Management 3

2. PUBLIC SECTOR FINANCIAL MANAGEMENT

10. Effective public financial management is important in the promotion of economic growth. A well designed financial management system helps to allocate public resources efficiently, controls both the availability and use of funds, signals the future impact of current management actions and provides information for sound decision making. Basic financial and budgetary control is of extra significance in view of Moldova’s present financial hardship and cash flow constraints.

11. This section of the CFAA highlights issues relating to Moldova’s public sector budget formulation, budget execution, revenue systems, accounting and financial reporting, and internal audit. This includes a discussion of cash and debt management as well as of Treasury.

Budget formulation4

12. The national public budget of Moldova includes the State Budget, the Budget of the Administrative Territorial Units (ATUs or Local Budgets), Extra-Budgetary Funds (EBFs) and the Budget of the State Social Insurance Budget (SSIB). Each is described briefly below.

• The State Budget covers the operations of central government ministries and departments including their decentralized structures in the territories and transfers to SSIB and ATU (local) budgets.

• Budgets of Administrative Territorial Units are prepared by the respective local public administration authorities but adjusted based on the resources provided by the central government within 15 days of approving the State Budget Law. Budgets of ATUs account, on average, for 30 percent of the total national budget.

• EBFs include those funds earmarked by specific fees and charges corresponding to their end uses including, for example, the fund for social aid, the ecology fund, and the text book fund. EBFs are included into the State Budget Law in separate annexes. Budget institutions may also have extra-budgetary resources from charges and fees obtained through rendering services, authorized by legislation. In the 2003 State Budget, these extra-budgetary resources were also included in the annual State Budget Law as an annex. Extra-budgetary funds and resources account for about 6 percent of the national budget expenditures.

• The SSIB budget includes expenditures for pensions, non-pension social insurance programs (unemployment, sickness and maternity benefits), and most social assistance benefits, with pensions accounting for the largest share of expenditures. SSIB budgeted revenue comprises revenues from social insurance contributions of organizations and individuals and also includes transfers from the state budget to cover non-insurance program spending. The SSIB budget is approved by an annual social insurance budget

4 The Bank’s Public Economic Management Review gives a very detailed analysis of the process of budget formulation. This CFAA gives an overview of the process and highlights the salient financial management issues.

The Basics of Financial and Budgetary Control “Control is the first requisite of budgeting. Control must take the precedence because a government’s budget can not be reliably applied to up-grading the efficiency or effectiveness of public service if it does not accurately account for the expenditures of funds” ( Allen Schick).


law and is administered by a semi-autonomous agency, the National Social Insurance House (NSIH), which falls under the auspices of the Ministry of Labor (MoL).

13. The state budget cycle for any given fiscal year starts, in accordance with the Law on Budget System and Budget Process, in April of the preceding fiscal year. However, for the FY2003 and FY2004 budget cycles, the process began at the start of the preceding fiscal year with the approval by Government of an “Action plan for the formulation of a Medium Term Expenditure Framework and draft of the budget for respective year”. Based on this plan, the Ministry of Finance prepares a methodological note providing detailed guidelines and timetables to line ministries and departments about the budget formulation process. In early June, line ministries and departments submit their budget requests to the MoF, who reviews them and, after a process of bilateral negotiations, prepares a state budget incorporating the individual budgets of the line ministries and departments. State budget transfers to the SSIB are separately negotiated by the MoF and MoLSP, based on the legislative commitment to state-funded benefit payments.

14. Collection of state budget revenues is the responsibility of the Customs Department (CD) and State Tax Service (STS). The CD is responsible for the collection of taxes on imported goods, including VAT on imports, as well as customs duties; the CD contributes more than two thirds of state budget revenues (or about 40 percent of the national public budget revenues). The STS collects taxes on domestically-produced goods and all other domestic taxes including social insurance contributions. The Ministry of Finance is responsible for forecasting state budget revenues.

15. After the draft budget is reviewed and approved by the Government, the Minister of Finance, on behalf of the Government, presents it to Parliament in October for approval. Parliament reviews the budget both at the general session, and in sessions of the Parliamentary Commission for Economy, Industry, Budget and Finance and other parliamentary committees. Parliament approves the budget after three readings; the Ministry of Finance may make adjustments to the budget after the first and second readings based on the deliberations of Parliament. The state budget should be approved by Parliament before the date of December 5, however the FY2003 budget was approved by Parliament in mid-November 2002.

16. Local governments5 are responsible for formulating their own budgets, and line ministries are responsible for submitting budget proposals for their sectors as well as for formulating the budgets of their extra-budgetary resources. The analytical capacity of local government and line ministries is weak and reduces their ability to produce and defend their budget proposals. In most cases, budget formulation is incremental in nature and input-oriented rather than output- or outcome- oriented. Ministries, departments and local government institutions regard the budget formulation process simply as a means of extracting more resources from the public purse. As such, budget estimates are sometimes very high, often 50-200% in excess of the implicit ceilings provided to them by the MoF as part of the MTEF process (see discussion of MTEF further below). In addition, they bear little relationship with strategic priorities and often represent an opening gambit in budget negotiations with the MoF. This causes the MoF to play the role of “gate keeper” in preparing the national budget. Budget negotiations are often dominated by the MoF and the focus of the budget negotiations becomes one simply of controlling the budget numbers

5 The English-language version of this CFAA uses the term “Local Government” whereas, for linguistic purposes, the Romanian-language version uses a term that may be more directly translated as “Local Public Authorities”.


rather allocating resources efficiently and strategically. The process of prioritizing expenditures is weak and budgeted expenditures are seldom required to satisfy any particular rates of return other poverty reducing criteria.

17. The state budget is presented by the Government to Parliament in a fragmented rather than in a consolidated and comprehensive manner. The Law on Budget System and Budget Process (1996) only requires that Parliament approves the state budget. The NSIH together with the MoLSP are responsible for the preparation of the budget of the State Social Insurance Budget which, once approved by Government, is approved by Parliament separately from the state budget. Financing of capital investments is reflected in the state budget as a single item, without a breakdown by functional classification. Donor financed investments, as well as extra-budgetary resources of state budget financed institutions are not integrated into the state budget, but are approved as separate annexes to the annual State Budget Law. No explicit allocations are made in the annual state budget for repayment of arrears accumulated during previous years. These matters compromise the comprehensiveness and transparency of the budgets as a whole. Recognizing the shortcomings of this approach, the Ministry of Finance has initiated consolidated analysis of the national budget framework as part of the efforts to introduce medium-term budget planning. The first attempt to analyze the overall national budget framework, including the state budget, local budgets, state social insurance budget, extra-budgetary funds and resources, and donor financing of investments was undertaken in spring of 2003.

Budget Calendar for Preparation of Budget

Month State Budget Local Government (ATU) Budgets January Approval by Government of an “Action plan

for the formulation of a Medium Term Expenditure Framework and draft of the budget for respective year”

Mid April MoE begins updating macroeconomic indicators. Ministry of Finance issues Methodological Notes to line Ministries.

Methodological Notes issued by Ministry of Finance to judets. Judets forward the notes to villages, communes and cities.

Early June MoE finalizes macroeconomic forecasts. Line Ministries submit their budget requests. Villages, communes, and cities prepare draft

budgets submitted to judets. Judets develop draft budgets submitted to Ministry of Finance for review.

Mid-June to end July

Ministry of Finance finalizes macro-fiscal framework. Budget negotiations between Ministry of Finance and line Ministries.

Early-mid August PM/State Chancellery resolves budget disputes.

Local governments discuss divergences from the draft budget with Ministry of Finance.

Mid-end August Ministry of Finance finalizes draft budget. October 1 Government submits the Draft Annual

Budget Law to Parliament.

November 1 Villages, communes, and cities revise and submit draft budgets to local councils for approval.

November 15 Judets’ budgets submitted to judet councils for approval.

December 5 Parliament approves the state budget. December 10 Village, commune and city councils approve their

budgets December 20 Judet councils approve judet budgets


18. As implied above, strategic planning is weak across the Government both in line ministries and at the center. In recognition of this, the Government is moving towards a strategic approach of budget formulation through the development of a Medium-Term Expenditure Framework (MTEF) and the Ministry of Economy has prepared a medium-term macroeconomic forecast for the 2001, 2002 and 2003 budgets. In addition, a strategic budget planning phase was added to the budget calendar which was approved for the first time in a new format in February 2002. The Government also approved a paper, Main Directions of Budgetary-fiscal Policy, to underpin a medium-term budgeting strategy for the period 2003-2005. In December 2002, the Government approved the schedule for the preparation of 2004-2006 MTEF as part of the 2004 budget formulation process. The strategic planning being introduced by these initiatives should considerably improve the comprehensiveness and allocative efficiency of budget formulation.

19. The Government is still adapting to the MTEF process and needs further experience in order to benefit from this approach. However, the MTEF is a step in the right direction towards strategic planning and increasing the transparency of the budget process. The Government initially piloted a strategic planning of expenditures under MTEF in the ministries of Health and Education and the Ministry of Social Protection was included in the pilot for the 2004-2006 MTEF. In developing expenditure plans, sector expenditure strategies are being considered and, when fully developed, will be used to determine:

• resource allocation between sectors, identifying sectors that require a greater share of public expenditure resources;

• budget priorities within sectors, identifying programs that require a greater share of a sector’s resources; and

• key measures required to improve operational performance, identifying priority items within sector and program budgets.

20. In 2001, and with the support of the USAID-financed Fiscal Reform Project, the Government tested program budgeting on a pilot basis for the FY2002 budget in the ministries of Health, Education and Finance. However, success was limited by capacity constraints – the depth of capacity had been overestimated and thus insufficient assistance was provided to augment this capacity. The initial plan envisaged moving to full implementation of program budgeting for the preparation of the 2003 budget, with the aim of having it operational throughout Government in 2003. The plan has now been scaled downwards in view of the poor results of the pilots. In order to move forward with further implementation of program budgeting, it will be necessary to build capacity in the MoF, and also in the line ministries.

21. A key element of budgetary reform is to increase the transparency of budget formulation through a consultative process drawing in all stakeholders. Some limited consultation takes place regarding budget formulation, and indeed ministries do have so-called Collegium Boards comprising a fairly wide range of stakeholders which could provide a forum for such a consultative process. However, budget formulation remains quite a closed technical exercise. Recently, as part of the development of the MTEF, both trade unions and employer unions were included in the MTEF taskforce, the composition of which was approved by a government decision. This CFAA recommends that each ministry’s Collegium Board formally and regularly consider its ministry’s budget and budget execution reports. This will facilitate more creative ideas for budget preparation and also will increase the transparency of the budget process.


Recommendations – Budget formulation

• Consolidation of the budget formulation process to take into account all public sector financial resources including the state budget, budgets of administrative territorial units (local budgets), the state social insurance budget, extra-budgetary funds, and grants and loans for investment projects as well as other financial resources provided by donors.

• The Collegium Boards of ministries should formally and regularly consider their ministries’ budgets and budget execution reports.

Budget Execution

22. After the budget is approved, the MoF establishes monthly allocation limits to the line ministries based on forecast revenues and sources of financing. Line ministries use these limits to develop a financial plan showing the monthly distribution of budgetary expenditures for the fiscal year, by institution and also by expenditure category. These financial plans are then registered on the treasury ledger system to provide inputs on monthly expenditure and cash requirements for spending agencies. All adjustments to the financial plan are cleared through the MoF.

Flow of funds 23. The State Treasury is subordinate to the MoF and was created in 1993 through a Presidential decree to manage state funds, carry out budget operations and enforce budget discipline. Its responsibilities include: financial analysis, budget execution, cash management, accounting, the provision of financial information, and the maintenance of appropriate treasury systems. The primary objective of the Treasury is to ensure that sufficient cash is available from the various revenue agencies and other organizations to fulfill the day-to-day execution of the budget. The implementation of a central treasury system in 1997 contributed to improved control over cash and over unauthorized expenditures. The Treasury now validates all expenditures requested by line ministries against budget appropriations and the availability of funding prior to payment authorization. It also facilitates monitoring of budget execution and timely reporting of the state budget, thus contributing to improved fiscal transparency and accountability. The central treasury system is now able to provide information on the execution of the state budget at the end of each day. The state budget operations have been serviced by the Treasury since 1997, and budget of ATU (local budget) operations have been serviced since 2001.

24. Treasury operates four types of bank accounts, which are normally referred to as “treasury accounts”. These comprise: state budget accounts, accounts of administrative territorial budgets (i.e. local budget accounts), accounts of the extra-budgetary resources of institutions financed by the state budget, and foreign currency accounts. Central Treasury operates eleven accounts, all of which are held with the National Bank of Moldova, including: the single account for state budget revenues and expenditures, the special state budget account for the preparation of the winter season, the special state budget account for revenues from sales of land, and eight foreign currency accounts for various donor funding and assistance.

25. Territorial treasuries operate all four types of treasury accounts although not all maintain foreign currency accounts if local circumstances do not warrant them. Each territorial treasury operates a single account for all revenues and expenditures of all administrative territorial units served by the territorial treasury. The state budget accounts of


territorial treasuries are used to accumulate funds from the central Treasury’s state budget account at the NBM and subsequently to finance expenditures of state budget institutions located in the territory served by the territorial treasury. The state budget accounts throughout the treasury system are not operated as a “single treasury account” in that there is no requirement for territorial treasuries to transfer unutilized funds to the bank account of the central treasury at the end of each day or any other period, save for the end of the fiscal year, December 31, when unutilized balances must be returned to central Treasury. As a result, central Treasury cash management and particularly debt financing is made more difficult. No revenues pass through the state budget accounts of territorial treasuries. The territorial treasury bank accounts themselves are held at three commercial banks, Banca Sociala , Banca de Economii and Moldinconbank, which were selected after a tender process in FY2000.

26. The funds of EBFs such as the ecology fund, flow through the state budget accounts of the treasury system, either through the NBM account or through the state budget accounts of territorial treasuries. By contrast, extra-budgetary resources of state budget institutions are accumulated in separate bank accounts opened by territorial treasuries. Extra-budgetary resources of state budget institutions are deemed to have been ”earned” by the state budget institution and are not included in the state budget. These include, for example, revenues from fees charged by universities and health institutions. However, these earnings are monitored by the MoF through the treasury system.

27. The revenue bank account of the National Social Insurance House is held at the NBM with the central Treasury as its holder. The expenditure bank accounts of the SSIB are maintained at the commercial bank, Banca de Economii, and are administered by the NSIH. The expenditures of the SSIB fall outside the authority of the Treasury.

Cash Management 28. Cash management has three primary objectives: (a) to ensure that expenditures are smoothly financed during the year, so as to minimize borrowing costs; (b) to enable the initial budget policy targets, especially the surplus or deficit, to be met and (c) to contribute to the smooth implementation of both fiscal and monetary policy6. Effective cash management should:

• recognize the time value and opportunity cost of cash;

• enable line ministries to plan expenditure effectively;

• be forward-looking, anticipating macroeconomic developments while accommodating significant economic changes and minimizing the adverse effects on budget execution;

• be responsive to the cash needs of line ministries;

• be comprehensive, covering all inflows of cash resources; and

• plan for the liquidation of both short and long term cash liabilities.

29. In Moldova, peaks and troughs in cash availability create considerable uncertainty amongst budget executors. As a result, spending organizations are unable to implement their budgets and are forced to accumulate arrears even when operating within agreed budget parameters. The PEMR indicates that the deviations between planned and actual expenditures in the years 1999, 2000 and 2001 have been 6.1%, 2% and 10.7% respectively.

6 Guidelines for Public Expenditure Management, B.H. Potter and Jack Diamond, IMF, 1999.


Inadequate analysis of cash flow requirements makes it difficult to prepare and implement a cohesive borrowing plan to meet the demand for cash.

30. With unreliable cash forecasting and poor linkages to debt management, Treasury officials regularly plan and allocate cash for budget execution on a daily rather than on any longer period, based on the actual funds available on the day. Thus budget executors are not informed in advance about cash shortages and continue to enter into contracts and other obligations for which, although budgeted, no funds may be available. Formal adjustments to financial plans may take place only if amendments to the budget law are passed in Parliament, but this is a time-consuming process which can result in considerable delays in the execution of the budget. All of this undermines the Government’s role in setting expenditure priorities through the Budget Law. To improve the cash management process, the Government established a Cash Management Unit in 2001 in the Ministry of Finance; however, this unit still not effective in its intended role of managing cash in the public sector. The MoF should develop and make public a regulation on state budget cash allocations in order to increase transparency of public cash management..

31. A number of other issues have been identified that are symptomatic of broader weaknesses in cash flow management and internal control procedures: • payments to contractors are frequently made in advance of the goods or services being

delivered, which is inappropriate;

• the Government incurs significant penalty charges because of delays in paying suppliers as a result of the cash shortages;

• Until recently, the SSIB bank balance was held in a non-interest bearing commercial bank account. On December 31, 2002, the Government approved legislative acts allowing the NSIH to place and invest these funds in commercial bank deposit accounts and government securities. However, the procedures and regulations for the selection of the commercial banks and the investment in government securities have yet to be finalized. The latest Memorandum of Understanding concluded with the IMF requires the adoption of investment guidelines, including maturity and risk profiles, based on the best-interests of the Social Fund’s stakeholders.

32. Despite the above-described rather gloomy picture of cash management, some progress has been made in settling accumulated arrears although the situation in this respect remains unstable. As mentioned in the PEMR, in 2001, for example, the Government was unable to prevent accumulation of new arrears. While the most recent developments indicate a gradual reduction in the stock of accumulated areas for the past years, commitment control systems are not yet robust enough to ensure the sustainability of the trend.

33. The introduction of the treasury system led to improvements in controls over expenditure commitments in central government but control is still weak in local government. A computerized system has recently been developed to manage commitments but it is not fully operational in all territorial treasuries. Treasury currently records all purchases of goods and services over 5,000 Lei and therefore significant expenditures are tracked. However, the commitments system at the local government level needs to be fully implemented as a mater of priority, as it will play a significant role in improving cash management and allocation.


Debt Management 34. Moldova received its first credits in 1992 with an initial borrowing of US$ 13 million. By 1997, the total external debt administered by the Ministry of Finance had risen to US$ 797 million and by the end of 2001, total external public debt (including debt administrated by NBM) and publicly guaranteed debt stood at US$ 960 million7 representing about 65 percent of GDP8. The challenges facing the Government in debt management are greatest in the areas of energy arrears, repayments to multilateral and commercial creditors, and contractual contingent liabilities such as guarantees. Following the establishment of the legal arrangements for the issuance of guarantees, the Government has abstained from providing guarantees on loans contracted by state enterprises. However, it still honors debt service obligations resulting from old loan guarantees. Although contractual contingent liabilities have benefited from the existence of a clear rule-based approach, the materialization of various implicit liabilities in an ad hoc manner, particularly energy arrears of budget institutions and enterprises, has resulted in a rapid accumulation of public debt.

35. Strengthening debt management has been high on the agenda of institutional reforms promoted by the Ministry of Finance for several years, in order to obtain least-cost financing of the fiscal deficit in the short-term and fiscal sustainability of debt service over the medium- and long-term. The Government has given priority to the formulation of a debt strategy that incorporates all forms of government liabilities including external and domestic debt as well as direct and contingent liabilities.

36. Recently, the Government approved a decree establishing a new Department of Public Debt, distinct and separate from the Treasury Department, to be responsible for all public debt issues. The department’s responsibilities include the management of public debt, assets and liabilities, debt sustainability analysis, formulation of a comprehensive debt strategy, and the negotiation and contracting of loans.

Recommendations – Budget Execution

• Develop and make public a regulation on state budget cash allocations in order to increase transparency of public cash management.

• Local treasury systems should be upgraded as a matter of priority to capture commitments and enable a better assessment of Government-wide cash flow requirements and settlement of arrears.

• Cash balances held in territorial treasuries for state budget expenditures should be monitored closely to allow for the redistribution of excess balances.

Revenue systems

37. The main types of budget tax revenues are value added tax, excises, corporate income tax, personal income tax and customs duties. Corporate income tax, VAT and road tax are shared between state budget and budgets of ATU. Corporate income tax and VAT, usually is transferred wholly to ATU budgets with the exception of the Chisinau municipality, which retains only fifty percent of corporate income taxes and ten percent of VAT. Fifty percent of road tax is shared with budgets of ATU. Revenues collected by the State Tax Service (STS) and Customs Department (CD) are transferred to the Central Treasury on the date of receipt.

7 This figure excludes external energy arrears. 8 In 2001, total debt service for public and publicly guaranteed debt amounted to 42% of central government revenues (Source PEMR, table 1.7).


The Central Treasury in turn transfers shared revenues to the appropriate regional treasuries’ local bank accounts.

38. In 2001, collected state budget revenues were about 14 percent less than forecast and in 2002, revenues were at a level equal to 96% of those originally forecasted. General government revenues fell from almost 40 percent of GDP in 1997 to about 31 percent in 2001. Additionally, there are significant tax arrears. These matters raise concerns about the quality of revenue projections, revenue collections and revenue leakages. The Ministry of Finance is responsible for forecasting state budget revenue, the National Social Insurance House is responsible for revenue forecasts of SSIB, and local government is responsible for revenue forecasts of ATU budgets. The quality of revenue projections across the Government seems to be undermined by weaknesses in the analytical foundation and by the use of simplistic forecasting techniques. No computerized models are used and forecasts appear to be determined with limited inputs from the tax enforcement and collection agencies (the STS and CD). In addition, there is much that can be done to improve governance and enforcement capacity in order to improve the present situation. Finally, it was noted that the current subordination of the CD and STS to, respectively, the Prime Minister and Minister of Finance, makes it difficult to coordinate an effective strategy to collect all tax revenues due and tackle evasion.

39. The CD collects over two-thirds of total state budget revenues (or about 40 percent of the national public budget revenues), essentially through VAT on imports and excise, and revenue collection has increased in the past year by 34 percent. The Government sets monthly revenue targets to the Customs administration, which are essentially based on the previous year’s performance. The system of revenue targets is inspired by the old centralized planning, but does not have the expected impact. All Customs control mechanisms are designed to increase collections on existing transactions, with the strong suspicion that all importers are likely to defraud. Forgone revenues on fraudulent, or non-declared, transactions, is ignored. There is only a very limited concept of risk management, and no attention to facilitation. The marginal cost of compliance therefore becomes high, and it is borne both by the business community and the administration. A major problem facing CD is valuation fraud. As in many other transition countries, the CD had no culture of checking declared values in an environment of state-run foreign trade. The rapid emergence of small importers, combined with cross-border “suitcase trade” generated an enormous workload for Customs and created immediate opportunities for fraud and rent-seeking. The administration was incapable of controlling the large-scale revenue erosion and this situation led to the introduction of a Pre-Shipment Inspection system (PSI) in 2001, supported by the IMF9. Despite declared measures to improve control and reduce leakages of revenues, including the creation of specialized subdivisions for the prevention of customs fraud and the deployment of internal auditors to conduct regular inspections of economic entities, significant informal trade persists, especially through the Transnistria region. While the issue of Transnistria goes much beyond the role of the CD, it is essential that a real preventative and enforcement strategy be put in place. Recently the CD has embarked on a modernization strategy aimed at achieving EU best-practice standards, including integrated border management and consistency with numerous international conventions, such as the WTO, and, as far as border management is concerned, the Geneva Convention on simplification of border controls. The overall objective is to combat smuggling and reduce corruption. The main elements of the strategy include: reviewing procedures and operations, coordinating legislation, developing a new approach to organization and staffing, strengthening enforcement activities and computerizing operations. The CD is being assisted in the implementation of this strategy 9 At the time of the CFAA fieldwork, PSI was not operating pending legislation to be approved by Parliament.


through the Bank-financed project, Trade and Transport Facilitation in South Eastern Europe (TTFSE). The project will be implemented between 2003-2006 and is co-financed by the US Government.

40. STS has developed and has started to implement a rudimentary risk-based approach for the verification and control of taxes payable by economic entities in accordance with which the STS targets entities in sectors thought to have a high probability of tax evasion. The STS includes a security department which is an internal control function after a fashion in that it aims to control and monitor the activities and behaviors of the workforce of the STS. STS has expended considerable effort in improving national tax administration and these efforts were supported during the last few years by a large-scale technical assistance project, the USAID Fiscal Reform project. In addition, the new Tax Code enacted in 2001 with the assistance of the project included a specific chapter on tax administration. The efforts aimed at upgrading the capacity of the State Tax Service include a wide range of activities: the development of new procedures compatible with provision of the tax administration chapter of the tax code; the upgrade of the STS information systems; the establishment of the Large Taxpayers Unit; strengthening of internal audit; and training.

Accounting and Financial Reporting

41. The former Soviet Union had a highly regulated and prescriptive accounting framework. Moldova abandoned this framework, and Parliament enacted a new Accounting Law in 1995 which provides the basic rules for accounting. This Law is discussed in more detail in this CFAA in the section on private sector enterprise accounting. Based on the Law, the MoF issued detailed instructions for accounting in public institutions financed by the state budget, as well as for extra-budgetary resources. Ministries, departments and LGIs may additionally establish accounting procedures for subordinated public institutions.

42. The laws, rules and regulations relating to accounting and treasury operations are quite cumbersome. They are weakly drafted and structured, with no table of contents or grouping of clauses in a logical order. The regulations are overly detailed and prescriptive. Clear and concise drafting will support a greater understanding and reduce the cost of compliance. A recent trend in contemporary legislation has been to move away from prescriptive and detailed legislation to laws based on broad principles. This reflects the view that prescriptive legislation is unable to deal with a rapidly changing contemporary environment whereas principle-based legislation will generally continue to be appropriate despite environmental and other changes in the future.

43. The accounts of ministries and departments are maintained on modified cash basis10. However, line ministries and departments maintain lists of commitments and liabilities in their subsidiary systems. Spending units record liabilities as incurred, but revenues are recorded only when received. The spending units maintain their own accounting records in prescribed formats using a double entry system of accounting. Only the National Social

10 Under the modified cash basis of accounting , records are commonly held open for around a month after the end of the accounting period. Receipts and payments which occur during the specified period but originate in the previous accounting period are recognized as receipts and payments of the previous reporting period (IFAC – Governmental Financial Reporting – Accounting Issues and Practices – 2000).


Insurance House now maintains its accounts on an accrual basis and will produce financial statements in accordance with International Accounting Standards11 (IAS) as of 2002.

44. Treasury maintains records of all revenues and payments purely from a budget accounting perspective and follows a cash basis of accounting and budget appropriations whilst tracking expenditure commitments in central government. Since 1997, the Government has used both economic and functional classifications that are generally in line with the IMF-advocated Government Finance Statistics (GFS). In addition, the Government is currently developing program classifications that are being tested in the pilot sectors of health, education and social protection. The Treasury system is currently being set up in 37 local treasuries to serve 634 separate local governments where it will also track expenditure commitments in local government. With the expansion of the Treasury system, there is an associated increase in risk for public sector financial management. Treasury needs to assess these risks particularly in terms of procedures and controls, systems continuity, cash management and forecasting. For example, the disaster recovery plan for the Treasury’s computer systems appears inadequate.

45. The accounting functions in ministries are performed by dedicated units headed by Managers/Chief Accountants responsible for accounting for, reporting on and controlling budgeted expenditures, according to the Accounting Law and relevant instructions and guidelines. The integrity of primary documents, accounting registers, financial reports, their formulation and their archiving are the responsibility of the Manager/Chief Accountant.

46. It is not clear that appropriate use is made of financial information for the purposes of management. Treasury and line ministries prepare a variety of financial reports but many of these reports do not appear to be used. In addition, whilst each line ministry prepares its own financial statements, including balance sheets showing the individual ministry’s assets and liabilities, no consolidated financial statements are prepared that reflect the financial position of the entire public sector. Were such consolidated financial statements to be prepared, they would provide valuable information on the financial position of the public sector, provide key inputs to cash management systems, and also serve to increase transparency.

47. The Ministry of Finance prepares a report on the implementation of the state budget and its relationship with ATU budgets in respect of the period to December 31 of each year and presents this report to the Government and Parliament by May 1 of the following year. The approved state budget data is then made available to the public; the annual state budget and the local governments’ budgets are published in the Official Gazette12 and are also posted on the Government’s website. The Statistics Department disseminates budget execution data for all levels of government operations through its official publications, on a monthly and quarterly basis. The state budget’s monthly, quarterly, and annual data are generated by the Treasury and the MoF disseminates these data directly through the media, providing monthly fiscal data on tax collection, budget execution, and financing of the state and ATU budgets.

11 For the purposes of this report, the term “IAS” encompasses the standards endorsed by the International Accounting Standards Board (IASB), including those designated “International Financial Reporting Standards” (IFRS). 12 In addition, the four-volume Annual Report on budget execution for these levels of government is only for internal Government use.


Recommendations – Accounting and Financial Reporting

• The prescriptive laws, rules and regulations relating to accounting and treasury operations should be simplified in favor of a principle-based regime.

• The Ministry of Finance should prepare consolidated financial statements reflecting the financial position of the entire public sector.

Internal Control and Auditing

48. Public sector internal auditing is relatively under-developed, fragmented and suffers from a weak capacity. It is limited to ex-post verifications and inspections over the execution of the budget and aims to detect cases of inappropriate use of funds. There are no ex-ante assessments of the control framework of ministries and other government agencies, which are essential objectives of modern internal audit functions.

49. The Financial Control and Revision Unit (FCR) is a unit accountable to the Minister of Finance. The FCR performs financial audit activities and inspections of state budget, ATU budgets and EBFs. The audit of central government ministries and agencies is however outside the FCR’s mandate. The FCR also conducts audit activities regarding the use of budget allocations to state-owned enterprises.

50. The present organization of the FCR was approved by Resolution of the Government dated May 27, 2002 upon the creation of the Center of Struggle against Economic Crime and Corruption13. The traditions of the function date back much further to the Control and Revision Departments which operated under the former Soviet Union. In terms of its institutional arrangements, the FCR is physically and functionally separate from the accounting and reporting functions of the MoF. In operational terms, ad-hoc inspections based on requests from various enforcement and control bodies, such as the Court of Accounts, the President’s Office and Parliament, still absorb a lot of FCR’s resources and undermine the full development of a proper internal audit function.

51. Currently the FCR employs 155 staff headed by a director general who is appointed and can be dismissed by the Minister of Finance. The FCR has seven central units: General, Education, Healthcare, Public Institutions (two divisions), Audit Methodology/Legal and Economic/Financial. In addition it has ten territorial structures.

52. The value of the reports produced by FCR are limited because they focus on lapses and irregularities in individual transactions, but neither regularly nor in a systematic manner assesses issues of economy and efficiency, weaknesses in financial management, management performance, or procedures and internal controls. As the reports are in the main limited to compliance issues, the utility of the FCR as a means to improving public financial management is limited.

53. The MoF established a small internal audit department in the state Treasury in 1997. The department currently has five staff and in May 2002 became subordinated directly to the Minister of Finance. The role of the Treasury Internal Audit function is to audit the central and territorial treasuries. The department also conducts ad-hoc assignments at the request of

13 The Center was created with staff from the Financial Guard, Economic Police and a part of the former DFCR.


the MoF. In 1998, the department prepared an Internal Audit Manual with the technical assistance of an IMF adviser to the MoF.

54. The State Tax Service, Customs Department and National Social Insurance House have also recently established their own internal audit departments, all of which are in the early stages of development.

55. This CFAA recommends that a strategy should be prepared for an effective public sector internal audit function. There are various models of internal audit. The following bullet-points outline one possible approach:

• An Internal Audit Department would be created, headed by a Chief Government Internal Auditor (CGIA), reporting to the Prime Minister or Minister of Finance, and which would have the following responsibilities: (a) standard-setting - to develop public sector internal audit standards and enforce their implementation; (b) recruitment - to develop recruitment policy including entry and promotion criteria and recruit internal audit staff for all internal audit positions across the Government; (c) training - to develop and deliver structured training programs, including continuous education programs; (d) quality assurance - to develop quality assurance mechanisms to ensure high quality internal audit work; and (e) internal audit work - to carry out internal audit work upon the request of a line ministry, for example in circumstances where the line ministry lacks appropriate capacity.

• Each line ministry would be responsible and held accountable for maintaining an appropriate internal control framework. Each line ministry would establish an internal audit department responsible for conducting internal audit activities within the line ministry and which would submit internal audit reports to the line minister and the ministry’s Collegium Board. (Procedures would need to be established to ensure that staff are not transferred from accounts preparation departments to these internal audit departments to mitigate the risk that staff audit financial statements that they have prepared).

• Each line minister would prepare an annual assurance letter addressed to the Prime Minister or Minister of Finance confirming that an effective internal control framework has been maintained within the ministry and describing key issues as well as any remedial action plans to address material weaknesses. This would reinforce the accountability of the line minister to maintain an effective internal control framework in the ministry and strengthen the decentralized internal audit structure. The Prime Minister or Minister of Finance would annually prepare a summary table of all line ministers’ assurance letters and present it to the Council of Ministers for discussion. This would enhance the Government’s awareness of the state of its financial management framework.

56. Finally, the Government also recently established the Center for the Struggle against Economic Crime and Corruption. The Center is headed up by a director who is administratively responsible to the Prime Minister. It is understood that the Center has in the region of 1,000 staff, most of whom have been recruited from the Economic Police, the Financial Guard as well as from the Ministry of Finance’s Department of Financial Control and Revision.

Recommendations – Public Sector Internal Auditing

• The Ministry of Finance should prepare a strategy for a public sector internal audit function.

Moldova CFAA: External Oversight of Public Financial Management 16

3. EXTERNAL OVERSIGHT OF PUBLIC FINANCIAL MANAGEMENT

57. It is generally recognized that one of the important ways of increasing government accountability is to oversee in a regular and effective manner the way the Government and other public institutions raise and spend public funds. This section reviews the workings and effectiveness of the three main oversight institutions of the Court of Accounts (CoA), Parliament and its committees, and the Ombudsman.

External Auditing

58. The Constitution invests Parliament with the power to establish the Court of Accounts (CoA), the Supreme Audit Institution (SAI) of the Republic of Moldova. The CoA was established in 1994 upon the enactment of the Law on the Court of Accounts14 and its powers and functions have subsequently been modified on occasion15. The legislative framework has significant benefits in both defining and regulating its activities: the CoA enjoys the freedom to choose what to audit, how to audit and when to audit and report. The CoA also has the independence to develop its own audit methodology, including auditing standards, audit manuals and other necessary guidance. The independence of the office is thus theoretically guaranteed; there is no restriction on access to information or records needed to carry out their responsibilities. However, the CoA is dependent on the Ministry of Finance (MoF) for its budget allocation and consequently the scope of its activities is indirectly determined by the MoF

59. Broadly speaking, and in accordance with its legislative framework, the CoA audits and controls the formation, administration and use of all public funds and public property. The CoA is also empowered to audit the budget and expenditures of Parliament, the President, the State Chancellery, the Supreme Justice Court, the Economic Court, the General Prosecutor’s Office, specialized public administration authorities, the National Bank of Moldova and those commercial banks in which the state has an equity interest. Finally, and upon the written request of at least 20 members of Parliament, the CoA may be required to perform additional audits without further ratification by Parliament. The number of such ad hoc audit and controls, which cannot be accurately predicted nor planned in advance, accounts for approximately 20-25 percent of the workload of the CoA.

60. In addition to its auditing functions, the CoA has been invested with the power to undertake the following control and enforcement activities:

• demand that disciplinary action be initiated against those responsible for the misuse of public resources to recover damage caused to the state;

• suspend the bank accounts of audited organizations and individuals;

• submit materials to investigative agencies in respect of financial offenses;

• demand the suspension from office of those deemed to have grossly violated or failed to enforce the law; and

14 Law of Republic of Moldova on Court of Accounts - No. 312-XIII of December 8, 1994 published in the Official Monitor of the Republic of Moldova No. 7/77 of February 2, 199515 Law on Court of Accounts as amended by the Parliament on May 17, 2002 (Law 1063 XV)


• countersign all documents relating to public debt. The countersignature by the Chairperson of the CoA is required to ensure the legality of the debt and its registration in the public debt register.

61. The above described control and enforcement activities appear excessive and beyond the scope of what is generally considered the responsibility of a Supreme Audit Institution. There is too great an emphasis on control, prosecution and enforcement rather than audit. This CFAA therefore proposes the following revisions to the Law on the Court of Accounts:

• Article 4.1 gives the CoA free and unlimited access to any physical person’s or legal entity’s acts, documents, and information. In addition, article 26(g) gives the CoA the right to demand that disciplinary action be initiated against those responsible for violations in the use of public financial resources and recover damage whilst article 26(i) gives the CoA the right to demand the suspension from office of individuals who have committed gross violation of law or failed to enforce it. These investigative and prosecutorial powers of the CoA extend beyond the normal remit of a supreme audit institution and should be removed. Voluntary cooperation by individuals and entities should of course be encouraged, however, where the CoA suspects or discovers irregularities, it should refer the matter to the appropriate law enforcement or regulatory agencies (as is envisaged in article 8 of the law) and make reference to the matter in their audit reports.

• Article 20(g) permits the CoA to “exercise control over the … activity of other control bodies” which thus compromises their independence (e.g. there are instances, where the CoA instructed the Department of Financial Control and Revision of the Ministry of Finance to carry out some of the control functions on its behalf).

• Article 23 requires the CoA to countersign “all documents related to public debts, from which liabilities of the country appear”. This compromises the oversight function of the CoA by actively involving the CoA in the operations of Government.

• Article 31(e) gives the CoA the right to request copies of documents relating to any financial transaction from the National Bank of Moldova and commercial banks with state shareholdings. This appears to extend the audit scope of the CoA beyond the state sector and thus is unnecessarily intrusive given that the CoA is in any case invested with the right to audit and control the formation, administration and use of all public funds and public property.

62. The CoA operates under the leadership of a Chairperson with the support of a Deputy Chairperson and five Members. The Chairperson is appointed by Parliament for a term of five years. The Deputy Chairperson and five Members are also appointed by Parliament but are nominated by the Chairperson. The Parliament may dismiss the Chairperson, Deputy Chairperson and Members by majority vote in the event of unsatisfactory performance, violation of law or abusive of power. The Chairperson and the Deputy Chairperson are authorized to participate in Parliament and Government sessions.

63. The CoA staff numbers 187 of which 104 are at the central offices, and the remainder are at the territorial courts. Recent amendments to the Law on the Court of Accounts have eliminated the territorial courts, however the CoA intends to ask Parliament to sanction their reestablishment as well as increase CoA staff to 212. The CoA is organized in six main divisions: control and analysis; organizational, information and analytical; public funds formation and utilization control; public authorities control; state property management and banking activities; and legal.


64. The CoA appears to lack suitably qualified and trained audit personnel in most areas including basic financial auditing and computer auditing. In addition, the CoA does not maintain an inventory of the skills and competencies of its present staff with a view to determining its future staffing needs. There seem to be no entry requirements for staff joining the CoA in terms of experience and qualifications, although the positions of Chairperson, Deputy Chairperson, Members, and heads of departments, divisions and sections are required to have a higher education and at least fifteen years of work experience in finance, economics or law. Consequently the CoA mostly staffed by generalists. Recruitment of qualified personnel is difficult, given the small number of practicing accounting and auditing professionals, particularly those willing to join the relatively poorly paid public sector, yet the professional development opportunities offered to its staff are still rather limited. Some staff have had the benefit of participating in study tours of and fellowships in other more established SAIs, and also of attending EUROSAI and INTOSAI seminars and professional conferences, however, professional development of CoA staff primarily takes the form of on-the-job training.

65. The relatively weak capacity of the staff of the CoA is also reflected in its relatively poor audit methodology. Audits tend to be performed in a rather haphazard manner without reference to risk assessments or evaluation of the auditees’ procedures and control environments. In recognition of this, the CoA is committed to and is in the process of upgrading its audit methodology leveraging on its connections with neighboring SAIs, particularly that of Ukraine. Although much remains to be done, the prospects that the CoA’s audit methodology can be significantly improved in the next few years are good.

66. The reports of the CoA do not contain audit opinions on financial statements but rather detail lapses and irregularities in individual transactions. They do not provide assessments of issues such as economy, efficiency, performance, and accounting and internal control systems. The reports appear unstructured, rather long and detailed which make them difficult to understand, not only in terms of facts but also, and more importantly, in terms of implications for the state of the public sector financial accountability framework. Thus, the utility of the CoA audit as a means to strengthening the public financial accountability framework is limited.

67. CoA reports are finalized after consultation with the auditee in a public session in the offices of the CoA, at which all the Members of the CoA and the auditee are present. Although the full texts of the reports of the CoA are not made public, decrees based on their reports are published in the Official Monitor within ten days16.

68. There is currently no provision or arrangement for an external review of the activities of the CoA either by a private firm of professional accountants or by another country’s SAI. A twinning arrangement such as those arranged with the support of the EU between the CoA and a more experienced SAI would be very useful in this regard, not only to help develop the professional capacity of the organization but also to provide a degree of external review and assurance about the quality of the CoA.

16 In FY2002, the CoA issued about 200 decrees in the Official Monitor


Recommendations – Public Sector External Auditing

• The CoA should initiate a twinning arrangement with a more developed Supreme Audit Institution (SAI) and should subject itself to a peer review by this SAI.

• The Law on the Court of Accounts should be revised to eliminate the CoA’s control and enforcement activities.

• The CoA should review its staffing arrangements, compile an inventory of its skills and competencies, devise recruitment policies and procedures, and develop formal training programs.

• The CoA should revise its auditing methodology to include risk-based and systems-based audit models.

Parliament

69. It is understood that Parliament is fairly active in improving the country’s financial accountability framework. It has enacted various laws and decrees to improve both the internal and external oversight functions in Moldova. It has also instituted various parliamentary committees, of which the Committee on Economy, Industry, Budget and Finance is primarily responsible for attending to matters of financial management. Unfortunately, the CFAA team was not able to gain access to the proceedings or minutes of Parliament or its committees. Therefore this CFAA’s analysis of Parliament is necessarily restricted.

70. The state budget is approved by Parliament after three readings. Parliament also reviews the financial statements presented by Government with appropriate reference to the reports of the Court of Accounts and may direct the executive arm of the Government to attend to the matters raised in the CoA’s report. As discussed earlier, Parliament or a parliamentary faction comprising at least 20 members of Parliament, may require the CoA to perform additional audits and controls. Every May, the Ministry of Finance presents Parliament with financial statements showing the results of the previous fiscal year.

71. It is believed that both Parliament and the Parliamentary Committee on Economy, Industry, Budget and Finance do not regularly review the performance of individual line ministries and government agencies, particularly in terms of revenues generated, expenditures incurred, outputs and outcomes, value-for-money, and the quality of accounting and internal control procedures. Thus Parliament loses a valuable opportunity to shape the activities and strategies of the individual ministries and also strengthen the overall quality of public financial management. This CFAA recommends that Parliament should regularly review the financial performance and position of individual ministries.

72. In 1997, the institution of Ombudsman was established as a democratic and independent organ. It comprises three Parliamentary Advocates whose status, duties and terms of office are established by the Law on Parliamentary Advocates. The activities of the Parliamentary Advocates are aimed at ensuring the observance of constitutional human rights and freedoms by central and local public authorities, institutions, organizations and enterprises. The Ombudsman investigates formal complaints made by citizens or entities on a wide variety of matters including financial and direct remedial actions. By March 15 of every year, the Ombudsman is required to submit an annual report to Parliament, a summary of which is to be published in the Official Monitor. Unfortunately, it is understood that the


CY2001 annual report has still not been discussed by Parliament. The CY2000 annual report that was discussed by Parliament and summarized in the Official Monitor does not make a very favorable impression of the Ombudsman. The effectiveness of the Ombudsman is to a great extent dependent on the actions of Parliament, based upon the Ombudsman’s reports as well as the appointment of appropriate Parliamentary Advocates. Parliament should be encouraged to be more proactive in terms of reviewing the reports of the Ombudsman and acting upon the Ombudsman’s recommendations. Additionally, the full text of the Ombudsman’s reports should be made public.

Moldova CFAA: Local Government Institutions 21

4. LOCAL GOVERNMENT17 INSTITUTIONS

73. The Constitution of Moldova (Article 109-113) establishes the concept of local autonomy and addresses the organization and function of local governments. The administrative territorial division of the country has been undergoing continuous changes during the last years. The most recent change took place in spring 2003, after a new version of the Law on administrative territorial division was approved by Parliament on March 18, which basically reversed the earlier reform of 1999. In Moldova there are two tiers of local government. After the enactment of the March 2003 Law, one tier of local public administrations is again represented by rayons (these units already existed during the Soviet times), Chisinau municipality and Gagausi autonomous region. Another tier is represented by communes (villages) and municipalities. The administrative territorial division introduced in 1999 created ten larger intermediary level self-governing judets and Garauzia Autonomy and Chisinau municipality as Administrative Territorial Units. The 1999 reforms kept the former level of local governments of around twelve municipalities, 43 Town Primarias and 593 Communes Primarias. (These figures do not include the Transnistria Region, which is not under the control of the Government of Moldova and is not covered under the CFAA). The Judets Council coordinated the activity of the village and town councils to achieve public service at judets level. The judets council was elected and worked in accordance with the law. At village and town level, the public administration authorities through which local autonomy is executed are represented by the elected local councils and mayors. The new law on local public administration approved in March has not significantly changed the local public financial management framework. Current administrative territorial division comprises 32 rayons, autonomous territorial unit of Gagausia with special legal status, Municipalities of Chisinauand Balti, 52 towns (cities) and 847 communes. General finance divisions of administrative territorial units have been re subordinated to the new superior tier local public administration units. The role of Prefect has been replaced with 8 State Chancellery territorial offices. Judet councils have been replaced with rayon councils. For the purpose of this CFAA the administrative territorial division introduced in 1999 was taken as a basis, as the assessment was done before the March 2003 Law was enacted.

74. The local councils and the mayors operate under the law as autonomous administrative authorities and are assigned the task of solving public affairs in villages and towns. The above schematic diagram explains the organization of local government in Moldova and their reporting relationship to central government.

75. To monitor the activities of local government , the central government introduced the system of prefect’s offices in 1999. These offices represent the central government in judets and report to the State Chancellery. There is activating a General Financial Division of ATU, which is subordinated to the Prefect and to the Ministry of Finance. The General Financial Division of ATU plays a key role in the financial management of the ATU budgets 18. Each of the administrative territorial units elects its local council through a popular vote. The heads of local public administrations (primars/mayors) are directly elected by the people. Many of the units within local public administrations have dual subordination, reporting to the respective central ministries as well as the local public administration heads.

17 The English-language version of this CFAA uses the term “Local Government” whereas, for linguistic purposes, the Romanian-language version uses a term that may be more directly translated as “Local Public Authorities”. 18 In Chisinau, the General Financial Division is part of mayor’s office and reports both to the Minister of Finance and the mayor (the primary responsibility is to the Minister of Finance).


Structure of Local Government and Linkages with the Central Government19

76. In 2001, the newly elected Parliament initiated amendments to the legal framework that partially reversed the 1999 reforms. The implementation of these amendments remains unclear as the Constitutional Court subsequently invalidated part of them. In consequence, there is currently much confusion regarding the status of the 1999 reforms including the central issue of how much has actually been decentralized. This has in turn resulted in an unclear local budget formulation process with the General Financial Division (see below).

Local Government Budgets

77. The law on Budgetary System and Budgetary Process20 formally acknowledges and integrates budgets of local governments as autonomous entities into the country’s budgetary system. For preparing the ATU budgets, the central government establishes ratios between state budget and ATU budgets (normative of defalcations from general state revenues and quantum of transfers), which are stipulated in the State Budget Law. For this purpose the Ministry of Finance issues unique expenditure norms (taking into consideration some particularities of ATU) 21. Expenditure norms play a central role in the establishment of transfers amount from the state budget to ATU budgets. As these expenditure norms cannot

19 The chart is based on the territorial-administrative division that was introduced in 1999 and prior to the enactment of the revised March 2003 law on territorial administrative division. Budget organizations under upper big box are part of central government and budget organizations under the lower big box are local governments. The local governments have operational independence. But for budget, they depend on the Ministry of Finance for central government transfers and the General Financial Division of the Ministry of Finance also reviews their revenue generations. 20 Organic law #847/96, Article 2. 21 Expenditure “norms” are used as a planning tool and determine transfers from the state budget.

Parliament

Special ATU Gagauzia

Special ATU*Transinistria

Judets/Chisinau Municipality

Primaria of villages, cities

and Municipalities

Primaria of villages, cities

and Municipalities

Primaria villages, cities

and Municipalities

Prefect’s Office

State ChancelleryMinistry of Finance

Gen. Fin. Division

Other concerned Ministries


take into account totally the local peculiarities and specificities, they tend to cause misallocation of public resources.

78. Revenues of the ATU budgets include local taxes and fees, proportion of state taxes and fees, transfers from the state budget, sales of assets of local bodies and other collections as provided in the legislation. ATU budgets are prepared based on the projected tax revenue and transfers from the state budgets . ATU budgets in Moldova are generally revenue driven, meaning that amount of spending approved in the budget must be less than or equal to the amount of expected revenue. The General Financial Division subordinated to the Ministry of Finance tries to minimize the destabilizing effects of shortfall by estimating revenues as accurately as possible, however, and as discussed elsewhere in the CFAA, this is not always successful.

79. Local public bodies prepare their budgets showing the estimated taxes and expenditures and submit them to the Ministry of Finance through the ATU General Financial Division. After the approval of the state budget, the local public bodies amend their budgets to make it consistent with the annual state budget law and communicate as much to the Ministry of Finance. After approval of the budget, the local public bodies submit their budget to the Ministry of Finance with monthly distribution of revenues and expenditures.

80. The local council formally approves the budget but this approval does not of itself authorize local government to enter into binding agreements in respect of transfers from the state budget. Like many democracies, such authority comes from the annual state budget law approved by Parliament which species the amount of the transfer from the state budget to the ATU budgets . Parliament neither approves nor vetoes ATU budgets and the State Budget Law itself does not distribute funds, rather it grants authorization to enter into binding agreements.

81. There is little incentive for the local government to improve its revenue forecasting. The current transfer system creates an incentive for Primarias to underestimate their budgets, as this maximizes transfers from the state budget. As such, local government has a tendency to lower revenue projections in order to obtain larger transfers from central government. However, the General Finance Division of ATU, which plays an oversight role on behalf of the Ministry of Finance, can help to correct the situation by ensuring that the macroeconomic indicators and methodological notes prepared respectively by the Ministry of Economy and Ministry of Finance at the start of the budget formulation cycle are appropriately incorporated into ATU budget revenue forecasts.

82. Territorial treasury or any designated bank, which acts as the agent of the Ministry of Finance, carries out cash execution of ATU budget. All revenues are collected and all expenditures are made in accordance with the respective fiscal legislation and Law on Local Public Finances.

83. In order to ensure local autonomy, public administration bodies of administrative territorial units develop and approve income and expenditure budgets and are entitled to establish certain local taxes and duties. This, in theory, provides complete autonomy to local government institutions in the execution of ATU budgets. However, in practice, the General Financial Division of ATU subordinated to the Ministry of Finance, in the exercise of its oversight function, occasionally plays a significant role in budget execution and accordingly undermines the autonomy of local government institutions.


84. The budgets of villages (communes), cities (municipalities) and subsequent major adjustments to these budgets require the approval of the Local Councils. The village or city Council can approve minor changes between institutions while the Primaria can approve movements within an institution. All of these changes have to be agreed and registered with the ATU General Finance Division, which tends to give them a significant role in the determination of the changes. Normally, the ATU General Financial Division does not reject changes in the budget, particularly when they relate to the allocation of increased revenue flows. In many cases, expenditures are also tightly controlled through other mechanisms such as wage norms and rates, and limits placed on the number of employees in specific areas.

85. Changes to the overall budget position, such as an increase in total revenues, requires Local Council approval. A movement of funds between institutions requires Local Council approval while the movement of funds within institutions requires Primar approval. In the latter two cases, the changes have to be agreed and registered with the ATU General Financial Division thus undermining the authority of the Local Council and Primar.

86. The role and consequent influence of the ATU General Financial Division undermines the autonomy of the Primarias and creates delays in the processing of low-level budget changes. A more effective role for the ATU General Financial Division would be to monitor Primarias on key priority areas such as arrearsand the payment of salaries, and thus add greater value to the budgetary process.

Accounting and Treasury Systems

87. There are detailed laws and rules and regulations for accounting of local government institutions. These laws are very long, very cumbersome and difficult to understand. These rules may be simplified, and manuals and guidelines may replace some provisions of these very detailed rules and laws.

88. Currently, all treasury accounts are created and controlled by the Central Treasury. The Treasury controls how Primarias can capture and store financial information. For the purpose of consolidating government accounts and consistent accounting treatment this control is important. The Government introduced execution of ATU budgets through territorial treasuries in 2002, which improved controls over budget execution. However, the current 15-digit code for expenditures in the treasuries’ chart of accounts limits the budget executors ability to devise their own codes and thus get useful analyses from the treasury system.

89. Transfers from the State Budget to Judets or Primarias, and from Judets to Primarias are classified as revenues of Judet’s budgets and villages or cities budgets as appropriate. The Territorial Treasury ensures transparency of ATU budgets revenues and expenditures, controls spending of all government entities including state budget units located within the jurisdiction of each territorial treasury, and improves the availability, reliability, and timeliness of information on the ATU budgets . The territorial treasury consists of thirteen regional treasury offices and 26 local territorial branches in towns . All fiscal operations of LGIs are now conducted through local treasury branches. It is expected that this will improve transparency and accountability for the use of public funds by local governments.

90. The State Budget Law codifies the agreed sharing arrangements regarding the three revenues sources that are transferred in full to judets, being Value Added Tax, Income Tax and Road Tax. Current practice is for these revenues first to be brought into the bank


accounts of the state budget before distribution to the Administrative and Territorial Units (ATUs) budgets, which can result in long delays in the receipt of these revenues. Other revenues are retained in full by Primarias. A key issue for the Primaria is the sharing arrangements to the budgets of judets.

Reporting

91. Reports on local budget execution are prepared on monthly, quarterly, half-yearly, and yearly bases. These reports are disseminated to the public through local newspapers and notice boards both inside and outside local government institutions, which increases the transparency of the execution of the ATU budgets. However, there is no system of publishing annual performance reports reflecting the cost of services provided by the local governments.

92. Currently the treasury provides a limited range of reports for Primarias. Primarias and the ATU General Financial Division have identified additional information that they would like to receive, as well as different formats for this information. Providing different reporting formats is a relatively easy programming function. A small team of Primarias and ATU General Financial Division staff should be consulted on the production of reports to ensure that they are designed according to needs. Different Primarias may wish to receive different reports. It may be possible to create a unique reporting file for each Primaria, which stores the report profile. These reports would be produced as per current practice.

Internal Control and Internal Audit

93. There is still ambiguity about the roles and responsibilities of the Ministry of Finance, Prefect Office, ATU General Financial Division and the local governments. Providing clarity about the roles and responsibilities of each distinct organizational structure and some guidance on how each organization can best execute its role in the overall government control environment will facilitate a more coordinated approach to financial management. To assist all parties where conflicting demands or requests have been forthcoming, it would also be useful to prepare a diagram of the key decision flows and accountabilities in local government financial management.

94. Local government institutions issue all payment orders. However, these orders are sometimes issued without adequate verifications. After the introduction of the territorial treasury system, the local governments becomes more dependent on the territorial treasury to play the role of the “gate keeper”. This approach is increasing the burden of the Territorial treasury and weakening the internal control environment of the local government institutions. The Government should review this situation and try to increase the institutional capacity of the local governments, by establishing adequate internal control mechanism.

95. In local governments, many transactions are settled using cash, which carries a greater risk of theft and its use should be minimized. Again, collusion and fraud are not prevented by exclusive use of transfers, and opportunities for fraud exist with both methods of payment. As such, there is a need of more control both of cash payment and transfers including proper reconciliation for all transfers on a regular basis.

96. The Chisinau municipality has an internal audit unit and carries out internal audits on a regular basis. Audit is also carried out by the Department for Financial Control and


Revision of the Ministry of Finance once in a year for all municipalities and judets. For communes (villages), this audit is carried out once every other year.

External Oversight

97. The ATU General Financial Division subordinated to the Ministry of Finance and Prefects office carries out external oversight functions. In addition, the CoA also oversees judets’ budgets every year. There is little direct community involvement in budget preparation and review of financial statements of the local governments. In order to increase public participation and transparency, local government may consider forming Budget and Audit Committees that include representatives of civil society and ensuring that its financial statements are publicly available.

Capacity of Local Government Institutions

98. The capacities of local government institutions are very weak. Over-dependence on budget execution controls in territorial treasuries could paradoxically weaken the capabilities and accountabilities of local governments further. The active central government oversight of the many financial management activities of local government ranging from budget preparation through to control over budget execution impairs significantly the autonomy of local government. The longer this continues, the weaker will become the financial management capacity of local government institutions. It is a challenge to distinguish clearly the decentralized functions of central government from the decentralization or devolvement of power to local government.

99. The benefits of decentralization can only be realized when local authorities and managers are given sufficient autonomy and are made more accountable for their decisions. The Government may consider restoring the exercise of financial accountability both horizontally and vertically in local governments. The Government should also take major steps to develop the capacity of local government institutions i.e. both the elected council members as well as the executives working in local government institutions. .

Recommendations - Local Government Institutions

• Institutional arrangements for the training of the financial management staff of the local governments should be developed.

Moldova CFAA: Private Sector Accounting and Auditing 27

5. PRIVATE SECTOR ACCOUNTING AND AUDITING

100. The role of an accounting system during the time of Soviet central planning was to provide economic and statistical data and information relevant to the needs of the fiscal and other state authorities. These systems did not however satisfy the needs of a market economy. In recognition of this, the Government has made a considerable effort to develop and implement a private sector financial accounting and auditing framework in line with best international practice.

101. The reform effort was led by the Ministry of Finance with the support of technical assistance from the World Bank, USAID and the Soros Foundation. The key outputs of these reforms include the development of National Accounting Standards (NAS) and National Standards of Auditing (NSA) based respectively on International Accounting Standards22

(IAS) and International Standards on Auditing (ISA). The Association of Professional Accountants and Auditors of the Republic of Moldova (ACAP) was founded in 1996 with technical and financial assistance from USAID and became the first associate member of the International Federation of Accountants (IFAC).

102. The CFAA recognizes the work that has been undertaken in the area of accounting and audit reform but highlights a number of key areas in which reforms are still required. The CFAA recognizes the valuable recommendations of the 2002 Comparative Study on Accounting and Auditing, a report that was prepared with the support of an EU TACIS Project23, and endorses many of those recommendations.

Enterprise Sector

Accounting 103. The plan for the implementation of the accounting system reforms included a comprehensive set of NAS and revised chart of accounts within a revised legislative and regulatory framework. The reform put particular emphasis into the development of training materials and many of the NASs were issued with detailed comments on their application. The standards were approved by the Ministry of Finance having been prepared by the Working Group financed by the World Bank, the Government of Moldova and the USAID-financed Moldova Accounting Reform Project (MARP) .

104. The basic concepts and approach to accounting are laid out in the Law on Accounting (1995). In addition to the Law the following normative documents serve as the legislative basis for accounting in Moldova:

• Concept of Accounting Reform in the Republic of Moldova;

• National Accounting Standards;

• Chart of Accounts; and

• Comments on National Accounting Standards. 22 For the purposes of this report, the term “IAS” encompasses the standards endorsed by the International Accounting Standards Board (IASB), including those designated “International Financial Reporting Standards” (IFRS). 23 Assistance for Implementation of the Partnership and Cooperation Agreement between the Republic of Moldova and the European Union


105. The Law of Accounting was adopted by Parliament on April 4, 1995, before the development of the concept note and the other elements of the new framework. It therefore needs to be revised to conform with European Union (EU) Directives and Regulations, as well as IAS. The following five areas in particular have been identified as requiring revision:

• The Law (Art. 3) assumes that fiscal reporting is the objective of accounting, which is out of step with subsequent normative acts as well as international best practice. As discussed earlier, the needs of other stakeholders should also be considered.

• There are contradictions between the Law and NAS. For example, the Law requires only a balance sheet and income statement, while NAS 5, which is itself based on IAS, additionally requires a cash flow statement, a statement of changes in owners’ equity and explanatory notes to describe, amongst other things, the entity’s accounting policies.

• The Law has no provision for consolidated financial reporting as required by the EU 7th Directive and IAS. NAS 25 and 27 on the other hand, allow for consolidation and outline the basis of accounting for investments in associate companies.

• The present bookkeeping and accounting regulations in the Law and in NAS 4 could be simplified in line with EU Directives.

• The Law is overly prescriptive in terms of the rules and requirements regarding bookkeeping, the organization of an accounting department and internal control issues. All of these matters would be better addressed in guidance notes or other literature.

106. National Accounting Standards (NAS) were developed by a Working Group composed of experts from the Ministry of Finance, the tax authorities, practicing accountants and auditors, and academics. At the time of the CFAA fieldwork, there were 29 NAS in force with another 16 under development. Generally, the numbering and much of the narrative of the NAS corresponds to IAS; however the standards have been adapted with the apparent intention to accommodate the country’s specific requirements and legislation. As a result, whilst NAS can be said to be based on IAS, a number of important issues remain, including:

• NAS lag behind IAS and are therefore incomplete. Individual NAS are still being developed which correspond with existing IAS, e.g. IAS 8 (Net profit for the period) and IAS 10 (Events After the Balance Sheet Date). Additionally, there are some IAS for which no equivalent NAS exists and must still be drafted, e.g. IAS 36 (Impairment of Assets) and IAS 37 (Provisions, Contingent Liabilities and Contingent Assets).

• The period since the adoption of the initial NAS has been one of considerable activity by the International Accounting Standards Board (IASB), the IAS standard-setter. As a result many of the IAS on which the NAS have been based were amended. These amendments need to be reflected in the relevant NAS. The main example is relates to IAS 1 (Presentation of Financial Statements), which was amended to address issues formerly addressed by IAS 5 and IAS 13, both of which were subsequently withdrawn. However, NAS 1 has not been amended to reflect changes made in IAS 1.

• There is no formal note of or other guidance on the differences between NAS and IAS, which would be helpful to stakeholders, practitioners, standard-setters as well as actual and would-be foreign investors.

107. The effort to develop and implement NAS under the leadership of the Ministry of Finance is commendable. Despite the loss of momentum in the reform process since cessation of donor-financed technical assistance, the Government nevertheless needs to keep


abreast of developments in international accounting standards, particularly in view of significant harmonization efforts. For example, as of 2005, the EU will require listed companies, banks and insurance companies in its member countries to prepare consolidated financial statements in accordance with IAS24. This approach should also be adopted in Moldova. Further, and consistent with EU regulations, entities that fall outside the above definition, being mainly small and medium sized enterprises, should be given the option of applying IAS or NAS, rather than being required to comply with the very prescriptive NAS 4 (Accounting for Smaller Companies). The CFAA therefore also recommends that the Law of Accounting for SMEs be amended in conformity with the relevant EU Directives and IAS25.

Auditing 108. The basic concepts and approach to auditing are laid out in the Law on Auditing26. However, the Law on Auditing does not conform to international best-practice and the provisions of EU Directives. More specifically, the Law is deficient in the following areas:

• The current objective of the audit (Art. 3)27 as described in the Law blurs the distinction between a financial audit and the activities of state financial control. Consistent with the EU’s 4th and 7th Directives and also ISA 200, the objective of an audit of financial statements should be redefined unambiguously as enabling a qualified auditor to express an opinion whether the financial statements have been prepared, in all material respects, in accordance with an identified financial reporting framework.

• The Law (Art 5.) differentiates between four types of audits: enterprises, banks, other financial institutions and listed companies. Such differentiation is unnecessary as the conceptual framework for the conduct of audits is the same for each economic sector.

• The Law does not identify standards for the education, training and qualification of auditors as is set out in the EU’s 8th Directive. Although the Ministry of Finance has established minimum qualification requirements as well as a certification program for auditors, these need to be enhanced. The Law (Art. 8) provides for a qualifications committee within the Ministry of Finance to certify auditors. The qualifications and examination structure should be enhanced in line with international best practice.

• The Law (Art. 3) provides illustrations of the type of additional work that may be undertaken by statutory auditors. This is too general to be enforced and the issue is any event covered in detail in the recently issued Code of Professional Conduct for Auditors and Accountants (see below).

109. In 2000, with the assistance of the international donor community, the Ministry of Finance drafted a revised Law on Auditing. However, the process of enacting the law was halted after various negative comments including those which expressed concern regarding pervasive ambiguity in the formulation of the draft that would have allowed for a wide range

24 EU member states also have the option of extending the requirement to produce financial statements in accordance with IAS to unlisted companies, companies where there is a significant public interest (e.g. state owned enterprises) and to legal entities. 25 The International Accounting Standards Board (IASB) is currently working on a project to develop standards for Small and Medium Sized Entities. 26 Law on Auditing – Republic of Moldova No 729-XIII of February 15, 1996. 27 In accordance with Article 3 of the Law on Auditing, “the purpose of audit is reviewing and analysis of the financial reports, fiscal declarations, payments and settlements documents and other financial liabilities of business entities, in order to access their reliability, completeness and compliance of such documents with the current legislation and requirements for accounting and auditing”.


of interpretations and thus inconsistent implementation and audit quality. Thus the present Law on Auditing remains in urgent need of revision.

110. The Government should also review the certification and continuing education requirements of statutory auditors benchmarked against the EU 8th Directive and the IFAC International Education Guidelines 2 and 928. It is appropriate that certain aspects of the certification and licensing of auditors could be delegated to the auditing profession (e.g. education and training) in order to ease the burden on the Ministry of Finance.

111. The requirements for an audit of corporate bodies is dealt with in the Law on Joint Stock Companies which was adopted in 1997, and revised in 2002. According to the 1997 Law, joint stock companies with more than 50 shareholders are obliged to have an annual audit by an independent audit company. In the 2002 revision an audit is not obligatory unless requested by 10 percent of the shareholders29, the State Security Commission or court decision. Separate laws make various statutory provisions for the audits of banks, insurance companies and listed companies.

112. The statutory audit requirement should apply only to publicly traded companies, financial institutions and public interest companies. The CFAA recommends that the Government of Moldova apply the auditing exemptions in the EU 4th Directive for SMEs30 when there is no public interest requirement for the audit of financial statements. From a cost-benefit perspective this not only reduces the strain on professional accounting resources but also reduces the burden on smaller companies where auditing services do not proportionately serve the public interest.

113. At the time of the CFAA fieldwork, the Government had issued 37 National Standards of Auditing, which were developed by the Ministry of Finance Work Group that was established in 2000 with the support of USAID. The application of these standards became compulsory beginning with the audits of the year ending December 31, 2001. They closely follow the IFAC International Standards on Auditing and provide comprehensive rules regarding the conduct of the financial audit. The Government has also issued the Code of Professional Conduct for Auditors and Accountants, based on the Code of Ethics for Professional Accountants approved by IFAC.

114. The ISA and the Code of Professional Conduct represent international best-practice and provide a reliable benchmark on which to frame the institutional arrangements of the country’s audit profession.

Accounting and Auditing Institutions 115. There is an urgent need for sustainable and adequately resourced accounting and auditing standard-setting institutions in Moldova. The Audit Law makes provision for an Association of Audit Firms in Moldova (AAFM) to coordinate the operations of audit firms, develop auditing standards and develop examination programs, however, this organization has not been established.

28 The basic education, training and qualification requirements are set out in Art. 4-8 of the EU 8th Directive. 29 The Law requires the audit fees to be paid by the shareholders if the general assembly of the company does not concur with this requirement. 30 The EU 4th Directive provides exemptions for small companies based on the amount of turnover, new assets and number of employees.


116. The Association of Professional Accountants and Auditors (Asociatia Contabililor si Auditorilor Profesionisti - ACAP) was founded in 1996 with the support of USAID technical assistance. It is a voluntary public organization of individuals, formed based on their common interests in the development of accounting and auditing. ACAP currently has 1,900 members divided into a number of sub-categories ranging from full to student member. ACAP has no specific membership requirements and subscriptions are 45 MDL (US$3) per annum.

117. Members of ACAP participated in the Working Groups for the development of NAS and NSA and disseminated supporting training materials in accounting and audit. In addition ACAP is developing a certification program for accountants (see below for a discussion under accounting education). The CFAA recognizes the early work of ACAP to develop its constitution and certification program, however, ACAP has unfortunately suffered from constitutional difficulties over the last twelve months.

118. The Government should review the institutional arrangements of the private sector accounting and auditing profession. In the medium term, and once sufficient capacity has been established, appropriate institutional arrangements should be put in place for the development, maintenance and updating of standards, and also the training, education, regulation and oversight of professional accountants and auditors.

Accounting Education 119. ACAP developed a certification program for accountants that requires candidates to pass three tests within a two year period. Those qualified to take the exams and who have successfully passed all the stages are conferred the title of Certified Professional Accountant. The qualification does not meet all the requirements of the IFAC Education Standard No.9 but the syllabus is a highly relevant technician level qualification for Moldova at this time.

120. The first examinations took place in 1997. The examination procedures appear robust and there are international experts on the Examination Committee. The pass rate for the exam is low. In relation to the need for trained accountants, the number of applicants taking the examinations has also been low31. The program does not confer any special membership rights in ACAP and is not currently recognized by Government, for example as a pre-requisite for entry into the auditing profession.

121. The Chartered Association of Certified Accountants (ACCA) are also active in Moldova and it is estimated that approximately 35 applicants are currently undertaking these examinations in Chisinau. The majority of applicants are from the international audit firms and joint ventures, as classes and examinations are conducted in English. In order to prepare for the exam, applicants either enroll in correspondence courses or take classes in Romania. As with the ACAP certification the Government should consider this qualification as a pre-requisite for entry into the audit profession.

122. USAID, through its Financial Management Training and Advisory Activity (FMTAA) Project and the Soros Foundation have been conducting a range of other training and education activities:

• Education of accountants at its computer training center in Chisinau;

31 From 1999-2001 126 have participated in the certification examination and 22 have passed.


• Development of accounting curriculum at the Accounting faculty at the Academy of Economic Studies;

• Training of instructors in accounting, audit and financial management;

• Exchange program for accounting students and academic staff with the University of Nebraska; and

• Publication of textbooks and manuals in Romanian.

123. Overall, the CFAA notes the progress that has been made in the area of financial management training in the last five years. Moldova is making progress in the development of training courses that meet the needs of a market economy. This is important, since the demand for accounting professionals, particularly at an undergraduate level, is high. The CFAA recommends that further work be done to increase the supply of high quality professional level qualifications in Moldova.

State Owned Enterprises (SOEs) 124. SOEs are regulated by the 1994 Law on State Owned Enterprises, as well as other applicable laws relating to the activity of enterprises e.g. the Law on Joint Stock Companies. The legislation provides various regulations relating to the governance of SOEs but there are no specific requirements relating to accounting, financial reporting or auditing. The CFAA argues that there is a “significant public interest” in SOE activities and that they should be required to prepare their consolidated financial reports under IAS and be subject to an independent audit. This requirement should be included in a revision to the Law on State Owned Enterprises.

Non Governmental Organizations (NGOs) 125. NGOs are governed by the Law on Public Associations (1997) and the Law on Philanthropy and Sponsorship (1995). There are no specific regulations on accounting or financial reporting for NGOs and thus they adhere to the requirements relating to commercial enterprises. This creates a number of problems including: (i)·the reports submitted to the Government Statistical Department do not disclose sufficient information about the NGO’s activities because there are no specific financial reporting standards applicable to NGOs; and (ii) there are inconsistencies between the accounting rules and NGOs statutes with regard to the treatment of net income obtained from various types of statutory and non-statutory activities. A draft accounting standard for NGO accounting and financial reporting has been prepared and could be further developed to address financial accountability and transparency issues. Because of the public interest in transparent and accountable activities of NGOs it is appropriate that NGOs be obliged to have a statutory audit, although very small NGOs may alternatively be permitted to have independent examination by a citizen of good standing.

Banking Sector

Accounting 126. In accordance with the Law of Financial Institutions (1995) and the Law on National Bank of Moldova (1995), banks are licensed, regulated and supervised by the National Bank of Moldova (NBM).


127. The National Bank of Moldova participated in the Working Group for the preparation of NAS and developed NAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, a standard that closely resembles the similarly named IAS 30 but also contains specific cash flow disclosure requirements based on IAS 7, Cash Flow Statements, as well as some provisions of IAS 39, Financial Instruments: Recognition and Measurement32. In addition, some other elements of IAS affecting banks have not been incorporated into NAS. As a result, there are some differences between NAS and IAS. Thus, and for reasons of compliance with local legislation and international comparability, banks with foreign stakeholders often have to maintain accounting records and prepare financial statements under both NAS and IAS.

128. The CFAA recommends that banks be obliged to prepare consolidated financial statements in accordance with IAS.

Auditing 129. The Law on Financial Institutions was adopted in 1995. Article 34 of the Law requires every bank to appoint an independent external auditor acceptable to the NBM. Article 34 also provides that the auditor can assist in the maintenance of proper accounts and records in the manner established by the NBM. Whilst an auditor is clearly in a position to and indeed should advise a client’s management of accounting policies and procedures that do not conform with local legislation or international best-practice, the notion of an auditor assisting in the maintenance of a bank’s financial records runs contrary to international best-practice including IFAC’s Code of Ethics for Professional Accountants and ISAs, which deem such non-assurance services provided by the auditor to be a threat to the auditor’s independence. Accordingly, this CFAA recommends that clarification is issued in respect of this particular provision of Article 34 to distinguish clearly the circumstances where an auditor is involved in the maintenance of a bank’s accounting records from those in which an auditor is merely making management aware of material weaknesses in the design or operation of the bank’s accounting and internal control systems which came to the auditor’s attention during the course of the audit.

130. All banks are required to have an annual audit by external auditors deemed acceptable to the NBM as determined by a special committee of the NBM. As with auditors of enterprises, the acceptability of and continuing education requirements for auditors of banks would benefit from benchmarking against the EU 8th Directive and the IFAC International Education Guidelines 2 and 9. Also, the processes of MoF-certification and NBM-evaluation of auditors would be less onerous and more efficient and transparent if the criteria for these processes for non-bank and bank auditors were unified to the maximum extent possible and any remaining differences explicitly explained and reconciled.

Recommendations – Private Sector Accounting and Auditing

Accounting

• Revise and enact the Law of Accounting in line with applicable EU legislation and IAS;

• Financial institutions, listed companies and entities of public interest should be required to produce consolidated financial statements in accordance with IAS and applicable EU legislation;

Auditing

32 IAS 39 is effective for financial statements covering financial years beginning on or after January 1 2001.


• The Law of Auditing and Law of Joint Stock Companies should be revised and enacted;

• Statutory audit requirement to be extended to apply to non-banking financial institutions, listed companies and entities of public interest;

• Harmonize the institutional framework for the education, training and certification of auditors.

Moldova CFAA: Fiduciary Considerations in respect of Bank-Financed Projects 35

6. FIDUCIARY CONSIDERATIONS IN RESPECT OF BANK-FINANCED PROJECTS

Reliance on Public Sector Financial Management Framework

131. In view of the foregoing analysis it is clear that there is a need for substantial strengthening in the areas of budgeting, treasury management, financial reporting, internal auditing and external auditing in Moldova. It would be inappropriate to place a blanket reliance on the existing public sector financial management framework for the purposes of satisfying the Bank’s fiduciary financial management requirements if there are significant concerns about its operation and integrity. Reliance on any particular aspect of the country’s financial management framework for the purposes of satisfying the Bank’s financial management requirements would need to be established on a case-by-case basis with reference to the specific financial management arrangements of the institutions involved.

Project Financial Management

132. This section of the CFAA does not constitute a detailed assessment of the financial management arrangements affecting the projects financed by the Bank. The CFAA did not seek to and does not confirm the appropriateness of the projects’ financial management arrangements and is not a substitute for normal supervision of the portfolio’s financial management arrangements. Rather, this section of the CFAA identifies and addresses certain generic project financial management issues across the portfolio of Bank-financed projects in Moldova.

Issues raised by the Country Portfolio Performance Review 133. A Country Portfolio Performance Review (CPPR) held in Chisinau in October 2002 with representatives of the Bank, government and project implementing agencies raised the following issues which have a bearing on the financial management arrangements of Bank-financed projects:

• Standalone project implementing agencies. The CPPR concluded that, in general, beneficiary entities and government institutions lacked appropriate capacity to implement even relatively simple Bank-financed projects. Thus a specialized project implementation agency such as a Project Implementation Unit (PIU) would almost always be required to implement such projects. Over the course of time, a few specialized project implementation agencies have evolved to implement projects in an entire sector (e.g. agriculture, energy, banking and private sector, education and health) and their continued use is to be encouraged until sufficient capacity has been created within the appropriate ministry or beneficiary entity.

• Government counterpart funding. Due to the cash flow problems referred to elsewhere in this CFAA, the Government is not always able to collect sufficient funds on a timely basis for its contributions towards Bank-financed projects. In 1999, the Government of the Republic of Moldova received a grant from the Government of the Netherlands and thus was able to cover its counterpart commitments during 1999-2002. The draft CY2003 State Budget provides some preliminary allocations to cover the Government’s contribution to projects financed by the Bank and other development organizations, however these appear insufficient to meet the Government’s needs. It is understood that


the Ministry of Finance has drafted a regulation, currently under discussion, governing the disbursement of grant funds to address this issue.

• Taxes. Bank funds have been inappropriately used to finance ineligible taxes, primarily the income taxes of consultants employed by the various project implementing agencies. In one particular project, the Bank had financed a total of US$ 136k of ineligible income taxes, which the Government became obliged to refund to the Bank.

• Salary scales. There continues to be significant differences between salary scales of the financial management consultants employed by project implementing agencies and their peers in the civil service.

Project financial management staff 134. Project financial management staff comprises individual local staff and consultants employed on inconsistent TORs, duration of contract, and remuneration. It is moderately difficult to recruit qualified financial management staffs although it is by no means clear that all financial management consultants recruited are of the highest available caliber. The financial management personnel are remunerated primarily from Bank funds as well as grants administered by the Bank, which are co-financed by the Government. Project implementing agencies employ, on average, one or two financial management personnel.

135. The CFAA recommends the development of standard qualifications, TORs, contracts and remuneration for all projects’ financial management personnel in order to reduce the wide variations amongst them and increase the overall quality of such personnel. The CFAA also recommends that the “skills gap” between financial management civil servants and the project implementing agencies’ financial management personnel be evaluated with a view to assessing the feasibility of civil servants fulfilling the financial management needs of Bank-financed projects and replacing the more costly financial management consultants.

Project financial management systems 136. Project implementing agencies are free to develop their own financial management arrangements with no central guidance or oversight nor with any incentive or encouragement to share lessons learned and best-practice. Consequently, financial management systems range from those based on simple spreadsheets and standard accounting packages, to fully customized project accounting software. The most widely used project accounting software package is 1C Bookkeeping System, a simple Russian accounting software package. Other projects use various accounting software packages: some designed specifically to meet the requirements of Bank-financed projects; some which also satisfy local Moldovan accounting and reporting requirements. The prices for a fully implemented accounting software, tailored to particular project’s circumstances, able to produce appropriate financial monitoring reports, and including delivery of a full training course, relevant manuals and support, range from about US$ 2,000 to around US$ 30,000. This diversity of approaches have resulted in a significant amount of total financial management-related project expenditures, most notably software costs and consultancy fees. It was also noted that there is little, if any, integration with responsible line ministries and their financial management systems.

137. This CFAA recommends that in order to minimize the risks and costs associated with the development and management of multiple financial management systems at the many project implementing units implementing Bank-supported project, a forum to oversee such matters should be established, perhaps led and coordinated by the MoF’s Foreign Debt Department. This group could hold regular workshops to share lessons learned and examples


of best practice in the design and implementation of project financial management arrangements, including example procedures and accounting manuals. This group should also be charged with the responsibility to form a strategy better to integrate project financial management arrangements with those of responsible line ministries.

Audit arrangements 138. At the time of the CFAA, the borrower was substantially in compliance with all audit covenants of Bank-financed projects.

139. This CFAA recommends that audit firms currently performing the audits of Bank-financed projects as well as any others expressing an interest in performing such audits, should be reviewed by a team of Bank financial management specialists. This review would be conducted on the basis of both information provided by the auditors and on-site visits with the objective of confirming their acceptability to the Bank.

140. Additionally, the Court of Accounts (CoA) performs various ad hoc audits of Bank-financed projects. Unfortunately, there have been a few misunderstandings between the CoA and the various project implementing agencies about both the objectives of these audits and also the manner in which Bank-financed projects are implemented. This CFAA suggests that the CoA could benefit from some explanation and training in the specific areas of disbursements, financial management and procurement in Bank-financed projects as well as the Bank’s project cycle more generally.

Recommendations – Fiduciary considerations in respect of Bank-financed projects

• Establish a forum to oversee development and management of project financial management systems including a consideration of standard qualifications, TORs, contracts and remuneration rates for project financial management staff.

• Bank to review quality of project auditors.

• CoA to receive explanation of and training in the specific areas of disbursements, financial management and procurement in Bank-financed projects as well as the Bank’s project cycle more generally.

National Bank of Moldova

141. Given the key role of the National Bank of Moldova (NBM) in Bank-financed projects, particularly with respect to adjustment operations, this section of the CFAA evaluates the fiduciary risks to the Bank associated with the use of the NBM.

142. The basic legislation governing the NBM comprises the Law on the National Bank of Moldova (1995) and the Statute of the National Bank of Moldova. The NBM is managed by the Council of Administration comprising five members: the Governor of the NBM who acts as the Chairman of the Council, a First Vice-Governor and three Vice-Governors, all of whom are appointed by Parliament.

143. The NBM is required to maintain at all times accounts and records adequate to reflect its operations and financial condition in accordance with sound internationally acceptable accounting principles. The NBM is required to prepare annual financial statements, and although the NBM’s rules are less than unequivocal in its audit requirements, the NBM has since 1998 prepared financial statements in accordance with International Accounting


Standards (IAS) and has had them audited in accordance with International Standards on Auditing (ISA). The audits for the years ended December 31, 2000 and 2001 were performed by the Paris office of PricewaterhouseCoopers; the audit opinions were unqualified, however the audit reports did contain an emphasis of matter in respect of the “present uncertainty in the Republic of Moldova surrounding the likely future direction of domestic economic policy, regulatory policy and political developments”.

144. A high-level assessment of the NBM in mid-2002 concluded that although the NBM’s general quality of financial reporting appeared satisfactory, the NBM’s procedures and controls to manage resources could be strengthened. Key recommendations and concerns expressed by the assessment have either already been or are currently actively being implemented and addressed.

Moldova CFAA: Annex 1: CFAA National Steering Committee 39

ANNEX 1: CFAA NATIONAL STEERING COMMITTEE

The National Steering Committee for the CFAA comprised the following: Chair Mrs. Grecianii Zinaida Minister of Finance Members Mrs. Durlestanu Mariana First Deputy Minister of Finance Mr. Ivanov Alexei Deputy Head, Committee for Economy, Industry, Budget and

Finance in Parliament Mr. Lupu Marian Deputy Minister of Economy Mr. Pentelei Vasile Chairperson, Court of Accounts Mr. Prodan Ion Deputy Governor, National Bank of Moldova Mr. Revenco Valerian Minister of Labor and Social Protection

Moldova CFAA: Annex 2: Architecture of Public Financial Accountability 40

ANNEX 2: ARCHITECTURE OF PUBLIC FINANCIAL ACCOUNTABILITY

Ministry of Economy

Court of Accounts

Other Budget Institutions

Fin. Analysis and Regulation

Fiscal Pol & Accon. Methodology

Budget

Public Debt

President

Anti-Corruption Prime Minister

Treasury

LineMinistries

Ministry of Finance

Ministry of Labor

NSIH

LocalTreasury

Central Treasury

InternalAudit

Department for Financial Control

Parliament

People

Custom Department

State Tax Service

Moldova CFAA: Annex 3: Map of Moldova 41

ANNEX 3: MAP OF MOLDOVA

report no. 27425report no. 27425 moldova country...

Documents