The major goal of the Survey of the Existing System of Local Government Audit in Croatia is to give an overview of the most important issues regarding the audit function in the Croatian local government system. In this survey, existing audit practices at the local level are investigated in the context of presenting the current situation, identifying needs, and making recommendations for changes in legislation and human resources development.
To carry out the preparation of the Survey of the Existing System of Local Government Audit in Croatia, we used a methodology consisting of three parts: (i) comprehensive desk research (legislation and human resources development analyses; SWOT analysis);
(ii) case-study interviews (of representatives of several municipalities, towns, cities, and counties were interviewed to obtain a broader image on positive and negative aspects of the audit function at the local level), and (iii) recommendations for needed changes in legislation and human resources development.
In order to achieve our main goal, the current legal and institutional framework regarding the existing system of local government audit are also presented in the second part of this survey.
This survey will attempt to make a comprehensive clarification of the current human resources development in the area of existing audit practice at the local level. Human resource-development is presented in the third part of this survey.
The fourth part of the survey consists of a short SWOT analysis. The table includes a brief presentation of the major strengths, weaknesses, opportunities, and threats of the current legislative framework and human resources development concerning the audit system at the local level in Croatia. This SWOT analysis is the outcome of interviewing and presenting the experiences of several local government units (municipalities, towns, cities, and counties) on the subject of existing audit systems (legislation and human resources development). All of these case studies will be used to consider the basic constraints related to these preconditions, such as the preexisting knowledge gaps within local government units, to improve fiscal transparency and accountability.
The survey will also present conclusions regarding the improvement of audit func-tion at the local government level with the main view towards the improvement of fiscal transparency and accountability.
2. LEGISLATION
What follows is an explainion of the legal framework for the internal and external audit systems of local government units; the role of the State Audit Office; and the role of local government units in the audit function; as well as the roles of other institutions incorporated in the audit system in the public sector of Croatia.
2.1 Legal Framework
The legislative framework that provides the current legislative basis for local govern-ments’ financial management consists of the following laws and other important documents:1
• the Law on State Audit (Official Gazette, 70/93, 48/95, 105/99, 36/01, 44/01, and 49/03),
• the Law on the System of Internal Financial Control in the Public Sector (Official Gazette, 141/06),
• the Rulebook on the Internal Control of Budgetary Users (Official Gazette, 150/05),
• the Code of Professional Ethics of Internal Auditors in the Republic of Croatia,
• the draft Charter of Internal Auditors,
• the Handbook for Internal Auditors,
• the Handbook of Financial-Management System and Control,
• the Law on the State Budget (Official Gazette, 96/03),
• the Law on State Budget Execution for the Fiscal Year 2007 (Official Gazette, 137/06),
• the Law on the Organization and Domain of Central Government Administration Bodies (Official Gazette, 199/03, 30/04, 136/04, and 44/06),
• the Law on Financing Local and Regional Self-Government Units (Official Gazette, 117/93, 69/97, 33/00, 73/00, 127/00, 59/01, 107/01, 117/01, 150/02, 147/03, and 132/06),
• the Strategy for the Development of Public Internal Financial Controls (PIFC) in the Republic of Croatia.
2.1.1 Law on State Audit
The Law on State Audit regulates public-expenditures audit, financial report, and finan-cial-transactions audit of the public sector, local and regional self-government units, public bodies that receive funds from the State Budget, public companies, municipal companies, and other public bodies.
The term “public expenditures” covers all current and capital expenditures that are financed with revenues from the State Budget, extrabudgetary funds, and local budgets.
An audit, by definition, is an examination of documents, reports, systems of internal control and internal audit, accountant and financial procedures, as well as many other reports to determine whether the presented financial reports show the accurate financial results of all financial activities in correlation with approved accounting standards and principles. An audit contains an evaluation of public activities’ effectiveness as well as an evaluation of program performance.
A financial-report audit is an annual obligatory activity for each fiscal year. The State Audit Office has the Annual Audit Program accepted by the Croatian Parliament.
After performing an audit, a certified public auditor prepares and signs an auditor report. This auditor report is then delivered to a legal representative of the public insti-tution where the audit was performed.
2.1.2 Law on the System of Internal Financial Control in the Public Sector The Law on the System of Internal Financial Control in the Public Sector regulates the system of internal financial control, which consists of financial management, control, and internal audit in the public sector. This law fortifies the methodology, standards, relations, and responsibilities of the Ministry of Finance and other bodies in carrying out the system of internal financial control in the public sector.
The Ministry of Finance is responsible for the coordination of all activities and development of the system of internal financial control in the public sector. The Department for Harmonization of Internal Audit and Financial Control is in charge of the coordination and harmonization of all activities.
The purpose of introducing internal financial control in the public sector is to improve financial management and decision-making to achieve the general goals and targets of budgetary users.
The system of internal financial control in the public sector consists of two major parts: (i) financial management and control, and (ii) internal audit.
The head of the local budgetary user (head of local government units, the head of a municipal company) is responisble for the establishment, development, and imple-mentation of the system of internal financial control.
The Law on the System of Internal Financial Control in the Public Sector regulates concrete institutions in the public sector that have the duty to establish the system of internal financial control. Aside from central government ministries and institutions, local government units, municipal companies, and all other local budgetary users (insti-tutions) in which employees’ expenses and material expenses are financed from the local budget, have an obligation to establish the system of internal financial control.
There are three persons in charge of the establishment and development of financial management and control: the head of budgetary users, the head of financial management and control, and the coordinator of financial management and control.
The law proposes which staff of local government units could function as appropriate persons in the task of financial management and control. A Finance Department Chief at the county level, for instance, could function as the head of financial management and control. A City Finance Department Chief at the local level could also function as the head of financial management and control. Local government units or local budgetary users with but a small number of employees do not have an obligation to establish a
‘head’ of financial management and control. The coordinator of financial management and control could be nominated by the local government units, in response to the professional requests of the head of the local government unit. The head of the local government unit is in the position to ask for the establishment of an independent unit for financial management and control (if needed).
An internal audit is an important part of the system of internal financial control in the public sector. All budgetary users have an obligation to establish internal audit in one of the following ways: (i) independent unit for internal audit, (ii) joint unit for internal audit for multiple budgetary users (as agreed on by the Ministry of Finance), or (iii) in agreement with the Ministry, public institution, or local self-government unit (as agreed on by the Ministry of Finance).
The independent unit for internal audit is a very important unit of organization and belongs to the highest organizational level of budgetary users.
Another two possibilities regarding the establishment of an internal audit have been used in local government units which are not required to establish an independent internal audit unit. Because the Law on the System of Internal Financial Control in the Public Sector is new, it provides an opportunity to local government units to establish internal audit units during 2007, and at the latest by January 4, 2008. At the moment, it is impossible to give the total number of local government units that are going to decide on concrete way of establishing internal audit units. In practice, agreements with other authorities (contracting out), will also be used, and the form of the agreement will constitute an internal audit within the county for several small local government units.
It is expected that the majority of small local government units will take the second possibility—contracting with the county. Several local government units will take the
The head of an internal audit unit has the responsibility to prepare the annual report on the performed audit in accordance with the advice of the Central Harmoni-zation Unit.
There is a person in charge of inspecting irregularities, and is appointed by the head of the budgetary user. The following persons are not eligible to be appointed as the person in charge of irregularities: the internal auditor, or any persons in charge of financial management and control. The law proposes appropriate choices in local government units for who can in charge of inspecting irregularities: a Chief of the Administrative Department for Legal Affairs or Secretary at the county level, or a Chief of the City Administrative Department for Legal Affairs at the local level.
The Law on the System of Internal Financial Control in the Public Sector, provided for the establishment of the Internal Audit Council, with the aim of strengthening the development and monitoring of internal financial control and internal audit. The Internal Audit Council is an advisory body to the Central Harmonization Unit.
The law sets the responsibilities of the Central Harmonization Unit. One of the most important tasks of the unit is to prepare a consolidated annual report on the system of internal financial control in the public sector. This consolidated annual report is discussed by the Internal Audit Council, approved by the Minister of Finance as well as the Government of the Republic of Croatia.
2.1.3 Rulebook on Internal Control of Budgetary Users
The Minister of Finance adopted the Rulebook on Internal Control of Budgetary Users,2 which stipulates the conditions that an internal auditor must fulfill, the stand-ards and methodology for internal audit, common criteria upon which budgetary users organize the internal audit function, and the coordination of work of budgetary users’
internal audit.
The rulebook sets two criteria for the obligatory establishment of an internal audit unit for budgetary users. All budgetary users with more than 100 employees in central government bodies and 50 employees in local government units, or all budgetary users with annual total expenses exceeding HRK 30 million have an obligation to establish an internal audit unit.
The City of Zagreb, cities with more than 35,000 inhabitants, counties, county centers, and cities that finance decentralized functions in primary education, have an obligation to establish an internal audit unit.
According to current criteria, 9.4 percent of local government units, or 54 local government units (out of 576)3 are required to establish an internal audit unit. This means that the following local government units have an obligation for the establish-ment of such a unit:
• the city of Zagreb,
• 15 cities with more than 35,000 inhabitants,
• eight county centers (that are not included in the list of “big cities”),
• and 10 cities that finance decentralized functions in primary education (that are not included in the list of “big cities” or “county centers”).
The rulebook regulates cooperation with the State Audit Office and other bodies, as well as the authorities and tasks of the Ministry of Finance’s Central Harmonization Unit.
2.1.4 Code of Professional Ethics of Internal Auditors in the Republic of Croatia
The Code of Professional Ethics of Internal Auditors in the Republic of Croatia was adopted by the Minister of Finance on August 3, 2005, and is based on the principles and rules of the Code of Ethics of the Institute of Internal Auditors.
The code contains the principles and rules to which certified internal auditors must comply. Officials involved in the training for the certification of internal auditors, and other persons involved in internal-audit activities must also comply with the code. The adoption and implementation of the code promotes confidence in internal auditors and their work. Internal auditors must comply with the principles and rules of the code in order to ensure the independence, objectiveness, and integrity of their work while, at the same time, constantly improve their knowledge, with the aim of upgrading the quality of work.
The basic principles of professional ethics to which internal auditors must comply are as follows: integrity, independence, objectiveness, confidentiality, and the avoidance of conflicts of interest.
2.1.5 Draft Charter of Internal Auditors
The draft Charter of Internal Auditors was developed by the Central Harmonization Unit.
The Charter of Internal Auditors highlights a stronger functional independence of the realtively new profession of internal auditors in Croatia, and describes the relationship between internal auditors and the audited subject. The document contains the auditor’s competences, authorities, rights, and obligations which are confided to each audit office
the heads of budgetary users, sign the Charter of Internal Auditors as a kind of agree-ment on mutual rights and obligations of internal auditors and audited units.
The document is one that can be adjusted to the needs of each individual budgetary user, while the Code of Ethics is unique for all internal auditors.
The Central Harmonization Unit keeps the register of the Charters of Internal Auditors.ORT ON THE WORK OF THE DEPARTMENT FOR HARMONISATION OF
2.1.6 Handbook for Internal Auditors
During 2005, the Handbook for Internal Auditors was prepared by both the employees of the Central Harmonization Unit and experts of the CARDS 2002 project,4 and it is been in use ever since. The Handbook for Internal Auditors prescribes the methodology for conducting an internal audit and was supplimented in the second half of 2005 by material on two additional areas related to risk assessment and audit of pre-accession funds (funds of the European Union).
2.1.7 Handbook of Financial Management System and Control
A Handbook of Financial Management System and Control was developed by the Central Harmonization Units. It describes in detail the individual actions and proce-dures which must be implemented in order to establish the appropriate system within each budgetary user. The Handbook of Financial Management System and Control is updated annually, aiming to address the potential problems that might arise during the establishment of the system.
2.1.8 Law on the State Budget
The Law on the State Budget stipulates the definition of an internal audit, and its task. It is prescribed that budgetary users at the central and local level must organize an internal audit unit, and that this falls within the responsibility of the head of the budgetary user. The law regulates the competences of the internal auditor, but it also stipulates that the Minister of Finance should prescribe by the Rulebook on International Control of Budgetary Users the conditions which an internal auditor must fulfill, the work methodology, and the common criteria based on which budgetary users should establish the internal audit.
Among other things, the Law on the State Budget regulates the competence of the head of the budgetary user which is responsible for the lawful, efficient, economical, and purposeful disposal of budgetary resources.
Also, the role of the financial controller and the person accountable is prescribed in this documant. This is important for the establishment of internal controls.
2.1.9 Law on the State Budget Execution for the Fiscal Year 2007
The Law on the State Budget Execution for the Fiscal Year 2007 regulates revenues and expenses of the State Budget for the fiscal year 2007, budget execution, level of indebt-edness, state guarantee, public-debt management, financial and non-financial assets management, and the duties and responsibilities of budgetary users, etc.
2.1.10 Law on the Organization and Domain of Central Government Administration Bodies
The Law on the Organization and Domain of Central Governmental Administration Bodies regulates the organization, authority, and tasks of central governmental admin-istration bodies. The Law on the Organization and Domain of Central Government Administration Bodies was changed and supplemented in March 2004, when the Ministry of Finance became responsible for the development of public internal financial controls in line with international standards and the best of European practice. Thus, this task fell within the competence of the Central Harmonization Unit of the Ministry of Finance, and has subsequently became the primary task of this unit.
2.1.11 Law on Financing Local and Regional Self-government
The Law on Financing Local and Regional Self-government regulates revenue sources and the financing of responsibilities of local self-government units (municipalities, cities, and counties). This law strictly recommends fixed-purpose funds. The executive body in local self-government units is in charge of budget execution. The law regulates the audit function for usage of local revenues in two ways: (i) local self-government units (the representative body of local self-government unit) and (ii) the State Audit Office.
2.1.12 Strategy for the Development of Public Internal Financial Controls in the Republic of Croatia
The Government of the Republic of Croatia adopted the Strategy for the Development of Public Internal Financial Controls (PIFC) in the Republic of Croatia on June 15,
to highlight the key elements of the current situation, as well as the development of a strategy for the establishment of a comprehensive and efficient public internal financial control in Croatia.
The development strategy for the system of internal financial control, which is identical for both national resources and EU funds’ resources, is of major importance for the accession of Croatia in the EU.5
The principles of internal financial control systems described in the strategy were implemented in the Law on the System of Internal Financial Control in the Public Sector.
The strategy describes the current situation in the field of the PIFC along with the overall control environment and legislative framework regulating this subject.
Furthermore, it describes the system to be achieved, designating the goals to realize, and suggests a time framework for individual activities in PIFC development related to the accomplishment of the objectives within individual development stages, and also provides conclusions.
2.2 The Role of the State Audit Office in External Audit
It is obvious that the legislative framework allows and requires the State Audit Office to audit the financial affairs of local governments. The State Audit Office audits all public bodies and budgetary users where the majority of finances come from budget revenues.
This is an external audit system.
The State Audit Office is responsible for the auditing of all financial affairs of local government and local budget institutions (local budgetary users). Auditing includes the use of state revenues, intergovernmental transfers, grants and aids, as well as the “own”
revenues of local government units.
The state auditors audit local government units in correlation with the Annual Audit Plan of the State Audit Office. This means that, in practice, it is impossible that every local government unit be audited every fiscal year. Under the Annual Audit Plan the State Audit Office, every fiscal year concludes the audit of all counties (20), cities (126), and one-third of all municipalities. This means that the State Audit Office, every third year, audits all municipalities. As such, the State Audit Office audits the financial data in previous two years. An exception is made in the case of negative audit report.
Under this circumstance, the State Audit Office performs and audit in the following year as well.
After completing the audit, the state auditors are in a position to prepare the State Audit Report. In the State Audit Report, particular consideration is given to issues of viability, efficiency, and legality of using public revenues by different local budget users.
The State Audit Office audits and assesses the effectiveness of internal audit.